microsoft word document2 sajems ns 15 (2012) no 4 381 appendix to accompany gender differences in student perceptions of sexual appeals in print adverting advertisement 1: the french rugby team advertisement 2: durex xxl advertisement 3: peugeot advertisement 4: tom ford advertisement 5: gucci read online: scan this qr code with your smart phone or mobile device to read online. south african journal of economic and management sciences issn: (online) 2222-3436, (print) 1015-8812 page 1 of 1 corrigendum http://www.sajems.org open access authors: antje hargarter1,2 gary van vuuren1 affiliations: 1department of risk management, school of economics, north-west university, south africa 2school of investment and banking, milpark education, south africa corresponding author: antje hargarter, antje.hargarter@milpark.ac.za dates: published: 30 nov. 2017 how to cite this article: hargarter, a. & van vuuren, g., 2017, ‘corrigendum: assembly of a conduct risk regulatory model for developing market banks’, south african journal of economic and management sciences 20(1), a2210. https://doi.org/10.4102/ sajems.v20i1.2210 copyright: © 2017. the authors. licensee: aosis. this work is licensed under the creative commons attribution license. in the version of this article initially published, antje hargarter’s first affiliation was omitted. her first affiliation is the department of risk management, school of economics, north-west university, south africa. the error has been corrected in the pdf version of the article. the author apologises for any inconvenience that this omission may have caused. corrigendum: assembly of a conduct risk regulatory model for developing market banks read online: scan this qr code with your smart phone or mobile device to read online. note: doi of original article: https://doi.org/10.4102/sajems.v20i1.1462 http://www.sajems.org mailto:antje.hargarter@milpark.ac.za https://doi.org/10.4102/sajems.v20i1.2210 https://doi.org/10.4102/sajems.v20i1.2210 http://crossmark.crossref.org/dialog/?doi=10.4102/sajems.v20i1.2210=pdf&date_stamp=2017-11-30 https://doi.org/10.4102/sajems.v20i1.1462 abstract introduction and context empirical strategy and results conclusion acknowledgements references appendix 1 about the author(s) giampaolo garzarelli department of social and economic sciences (disse), sapienza university of rome, rome, italy institutions and political economy group, school of economic and business sciences, university of the witwatersrand, johannesburg, south africa yasmina rim limam faculty of economics and management sciences of nabeul, university of carthage, tunis, tunisia department of economics and social sciences, john cabot university, rome, italy citation garzarelli, g. & limam, y.r., 2019, ‘physical capital, total factor productivity, and economic growth in sub-saharan africa’, south african journal of economic and management sciences 22(1), a2309. https://doi.org/10.4102/sajems.v22i1.2309 original research physical capital, total factor productivity, and economic growth in sub-saharan africa giampaolo garzarelli, yasmina rim limam received: 27 jan. 2018; accepted: 15 oct. 2018; published: 26 mar. 2019 copyright: © 2019. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: a major question that received the attention of numerous theoretical and empirical studies during the past few decades relates to the issue of output growth decomposition and the sources of economic growth. the literature focuses on two sources of growth: factor accumulation (mainly physical capital) and total factor productivity (tfp) growth, presenting inconclusive results as to the relative importance of each. aim: this article investigates the relative importance of physical capital accumulation and tfp in explaining output growth in 36 sub-saharan african (ssa) countries over 1996–2014. the possibility of tfp-induced input effects is tested in order to better assess the role of tfp in total output growth. setting: 36 ssa countries over the period 1996–2014. method: the article uses a stochastic frontier analysis, an empirical methodology that decomposes total output growth into input growth, technological change and technical efficiency change. results: the contribution of physical capital to total growth exceeds that of tfp in 22 out of the 36 countries. the result withstands issues of tfp-induced effects on inputs. conclusion: a large share of growth in ssa is explained by factor inputs and not by tfp. there is therefore room for tfp to further increase growth in ssa. in order to create more opportunities for growth, ssa countries ought to invest in productivity-enhancing factors. introduction and context the channels for improving economic growth have been the focus of economists and other social scientists for several decades as countries experience marked differences in the development of their productive capacities and in the improvement of their standards of living. while some countries achieve rapid income growth and high standards of living, others cannot assure the subsistence needs of the population. the large cross-country disparity in output growth has been the focus of numerous economic studies interested in explaining economic growth, animating the literature on output growth for more than five decades, and leading to different theoretical and empirical results (caselli 2005; hall & jones 1999). this article takes as its object of analysis the decomposition of output growth in sub-saharan african countries. established growth literature attributes output growth to two factors: production inputs and total factor productivity (tfp). while inputs usually refer to physical capital (machinery and equipment) and workers (labour), tfp refers to everything else that affects growth other than physical capital and labour (institutions, policies, technologies, etc.). tfp is at the centre of studies on economic growth and production efficiency. the focus on tfp in many ways goes back to the days of adam smith, the founding father of economics, and his theory of specialisation. tfp measures how well inputs are used in production and is a key measure of a country’s comparative advantage. technological innovation, sound economic policies, and quality institutions are all factors that improve the level of output produced per unit of input, and therefore positively impact productivity. in turn, the level of productivity determines the rate of return on investment, setting the base from which profits and wages originate, leading to growth. there is general consensus that productivity is a crucial determinant of, among other things, a country’s growth rate, international competitiveness, and the population’s well-being (easterly & levine 2001; klenow & rodriguez-clare 1997). even though tfp has been the focus of government and international organisations around the world, the claim that tfp is the main source of growth does not have unanimous empirical support. quite the contrary is the case. a close look at country level data reveals that physical capital accumulation explains a large part of growth in most regions of the world. see table 1. table 1: contributions of sources of growth to aggregate gdp growth, major regions, 1999–2014. empirically, the first answers to the question of growth components arrive in the late 1950s when the first growth model (solow 1956) was tested using growth accounting, a method allowing the assessment of the relative contribution of each component (physical capital, labour, and tfp). early growth accounting results show that physical capital accumulation explains only a small part of total output growth and that the bulk of growth is attributable to tfp. this result was later found to be robust to alternative functional forms for production and different ways of measuring inputs and output (caselli 2005). recent growth accounting studies reject the importance of tfp in growth, and conclude that physical and human capital accumulation explains most output growth (turner, tamura & mulholland 2013). the limitations of growth accounting and the increased availability of panel data sets for developed and developing countries opened the door to models that focus on analysing issues related to efficiency, absorptive capacity, and tfp growth. the debate initiated with the so-called endogenous growth models (lucas 1988; romer 1986). these models, which claim that physical and human capital accumulation are important elements of growth, extended to a whole stream of literature comprising various more or less sophisticated techniques and assumptions that assess the relative effect of tfp and technological change in total output growth. cross-country regression analysis emerged as an extensively used method in the 1990s soon after the emergence of endogenous growth theory (benhabib & spiegel 1997; coe, helpman & hoffmaister 1997; miller & upadhyay 2000). the method consists of regressing a measure of output growth against a set of variables believed to explain growth and a residual associated with tfp. it presents several advantages as it permits a large variety of production function specifications as well as different assumptions regarding returns to scale, spillover effects, and technological change. the method proves particularly interesting with panel data, which incorporate country-specific effects. as regards the factors driving output growth, cross-country regression analysis seems to favour capital accumulation over tfp. for example, mankiw, romer and weil (1992) conclude that differences in physical and human capital accumulation explain almost 80% of income differences. the major drawback of cross-country regression analysis, however, is the potential endogeneity in the regressors, viz. that one or more explanatory variables can be correlated with the error term, leading to an inconsistent estimation (león-gonzalez & montolio 2015). the inconclusive results about the drivers of growth led to the adoption of more sophisticated methodologies that decompose output growth, such as stochastic frontier. frontier methodology allows the decomposition of output growth into input change, efficiency change, and technological change, and helps to pinpoint which component is relatively more important in determining a country’s growth. early frontier applications to growth confirm that it is capital accumulation rather than tfp that explains the largest share of growth (koop, osiewalski & steel 1999, 2000). further stochastic frontier studies find similar results (henderson & russell 2005; kumar & russell 2002; limam, miller & garzarelli 2017; nissan & niroomand 2006; pires & garcia 2012). the relative importance of physical capital accumulation and tfp in explaining growth is at the heart of the present article. more precisely, the article applies stochastic frontier to a sample of 36 sub-saharan african (ssa) countries over the period 1996–2014 in order to decompose output growth. this is in the footsteps of studies that using different methodologies examine the relative contributions of inputs and tfp to output growth in ssa. in a cross-country study composed of nine geographic regions, baier, dwyer and tamura (2006) find that tfp is an unimportant part of average output growth across all countries. in addition, the study reports negative tfp growth in central and southern africa, the region having the lowest contribution of tfp to output growth per worker. tahari et al. (2004) applies growth accounting to a set of 43 ssa countries individually and in sub-groups. in all cases, growth is found to be primarily driven by factor accumulation with little (or negative) contribution from tfp. despite these contributions, cross-country studies on the sources of growth in ssa remain limited and, except for a few, they mainly use the growth accounting method. a major limitation of growth accounting resides in the fact that the method associates the residual with tfp with no distinction between efficiency and technological change. by using stochastic frontier, this article introduces another way of decomposing output growth in ssa while accounting for efficiency as well as technological factors. the question of growth decomposition is particularly relevant for ssa as the region has registered impressive gross domestic product (gdp) growth rates in the past two decades. however, the gdp growth has not been accompanied by a gain in productivity (cazzavillan, donadelli & persha 2013). since the mid 1990s, the economic activity in ssa has more than doubled, resulting in an average yearly gdp growth rate of 4.5%, which places ssa on a comparable level to other developing regions. this performance represents an impressive surge in conditions after the catastrophic economic outcome of what is commonly referred to as africa’s ‘lost decade of the 1980s’, which left millions living in extreme poverty. this u-turn in economic performance was equally shared by both resource-rich and non-resourcerich african countries. despite this gain in growth, the region is still lagging behind when it comes to tfp, which shrank by an average of 0.8% over the period 1999–2014 compared to a world average tfp growth of 0.4% (the conference board total economy database 2015). the slow growth in productivity is attributable to a number of macroeconomic, institutional and human development factors. early studies on ssa mention a number of factors related to ssa’s low productivity, ranging from poor social and economic institutions, to ethnic fractionalisation, lack of education and political instability (easterly & levine 1997). according to the global competitiveness report 2013–2014 (schwab 2013), a global database that assesses the competitiveness of more than 130 countries worldwide and provides detailed insights into the drivers of their productivity, the region scores very low in the overall competitiveness indicator (out of 30 ssa countries in the report, 25 are among the lowest 25%). by taking a closer look at the 12 main pillars that compose the index, one cannot but notice that ssa underperforms in key factors that determine a country’s efficiency and productivity: health, higher education and training, technological readiness, market size, and business sophistication (see table 2). according to the same database, only four economies – mauritius, namibia, seychelles, and south africa – appear in the top half of the overall competitiveness ranking. table 2: number of sub-saharan countries among the lowest 25%. a detailed look at output growth decomposition in ssa and the rest of developing countries excluding ssa (distinguishing between fast-growing and slow-growing ssa countries) shows that except in fast-growing resource-rich countries, africa’s growth appears to be driven by factor accumulation rather than productivity growth. see figure 1. identifying the source of growth in ssa is of particular importance for researchers, governments, and national and international development agencies as differences in per capita output have important implications for a host of development indicators, such as income distribution, population happiness, efficient use of available resources, and unemployment. figure 1: contribution of the capital stock and total factor productivity to output per worker growth, 1995–2011 (median growth rate throughout the period). our results suggest that physical capital accumulation overtakes tfp in explaining growth in 22 out of the 36 countries covered by the analysis. we find that tfp-induced input effects are negligible. thus, our growth decomposition does not seem to be affected by endogenous impacts of tfp on inputs. empirical strategy and results frontier production functions were first introduced by farell (1957). two major approaches have been developed since: deterministic, which mainly consists of data envelopment analysis (charnes, cooper & rhodes 1978), and stochastic, which is largely based on econometric analysis (aigner, lovell & schmidt 1977; meeusen & van den broeck 1977). stochastic frontier uses data of the production units of interest (banks, firms, fisheries, regions, etc.) to estimate a best practice production function based on the best performers of the sample. each production unit can be producing on or below the production function – namely, on or below the frontier, which is also assumed to be stochastic because it is subject to random external shocks (e.g. coups, earthquakes, wars, weather). the distance between the actual output points and the frontier measures technical inefficiency, entailing that technical efficiency represents how well a production unit converts inputs into output. the intuition is that the closer the unit is to the best practice frontier, the relatively more efficient it is. hence, efficiency and inefficiency measurements are specular, and we can refer alternatively to one or the other according to context. in essence, a stochastic frontier is an empirically determined economic yardstick for assessing output performance in relation to inputs. or, to view it differently, frontier benchmarking is about feasibility: efficiency divergences in production units are determined in relation to a yardstick defined by the data and not in ideal terms. in our case, the production units of interest are countries. specification we assume that, within each country, aggregate units of physical capital and labour combine to produce aggregate final output. the frontier production function can be expressed as (battese & coelli 1992): and where yit equals total output of country i at time t, xit equals the vector inputs, f(xit ; b) equals a suitable production function of a vector, xit, of factor inputs associated with the production of country i at time t, b equals a vector of unknown parameters, ui equals the one-sided error term measuring technical inefficiency of country i, and vit equals a stochastic two-sided error term accounting for statistical error in measurement. the parameter η equals an unknown scalar representing the rate of change of technical inefficiency over time. vit represents independently and identically distributed random errors, , and ui represents non-negative random variables that account for the technical inefficiencies of the sample countries. the ui errors are distributed independently of vit, and follow a normal distribution, that is . different assumptions have been used regarding the distribution of the one-sided error term u. while the half normal case assumes that the mean of the one-sided error term follows a normal distribution with zero mean, the truncated normal assumes that the mean is truncated and positive. below, we test both assumptions. to assure that most observations fall below the frontier, we assume that ui > 0. the model allows for technical inefficiency, ui, to increase, remain constant, or decrease over time, when, η > 0, η = 0, or η < 0. the approach uses maximum likelihood estimation (ml) to estimate equations 1 and 2. technical efficiency is measured as: we assume that a single country produces total output using units of physical capital, labour and human capital according to a simplified translog production function: where the subscript it refers to country i at time t; y, k, l, h and t represent total output, private capital, labour, human capital and a time trend that accounts for the state of technology; u is a non-negative term that accounts for technical inefficiency, and v represents random errors. the interaction terms tlnkit, tlnlit and tlnhit allow possible non-neutral technological change and t2 reflects non-monotonic technological change. the elasticities of output with respect to capital, labour and human capital are easily determined from equation 4: given the use of a simplified translog technology, these elasticities are time specific. we estimate equation 4 using data from the penn world table 9.0 (feenstra, inklaar & timmer 2015). more precisely, y, k, l and h are respectively proxied by the variables rgdpna, kna, emp, and h from the penn world table. hypotheses testing stochastic frontier analysis requires a series of statistical tests. the first concerns the existence of the inefficiency component, uit, and consists of testing whether an ols rather than a stochastic frontier estimation better represents the data. this hypothesis is tested using the generalised likelihood ratio test: where l(h0) and l(h1) are the values of the likelihood function under the null (h0) and alternative (h1) hypotheses. under the null hypothesis, the test has a χ2 distribution with degrees of freedom equal to the number of restrictions. we test the null hypothesis that the frontier coefficients are jointly insignificant against the alternative hypothesis that at least one of the coefficients is significant. this test means testing γ= μ= 0. results show that h0 is strongly rejected, which entails that frontier is a better estimation technique than ols. the second test checks whether a translog production function fits the data better than a cobb-douglas one. we test whether we can reject h0: α4 = α5 = α6 = α7 = α8 = 0. results allow the rejection of the null hypothesis, which indicates that the translog specification is a better fit than the cobb-douglas. finally, we test for the statistical distribution and the time variance of the one-sided error term. results show that the one-sided error term follows a half normal distribution and that it is time varying. table 3 summarises the results of the hypothesis tests. table 3: summary of hypotheses testing. empirical results the groundwork to run the stochastic frontier in the panel of 36 sub-saharan african countries over 1996–2014 is now laid. appendix 1 lists the countries. table 4 summarises the results on technical efficiency ranking. results show that the average technical efficiency for all 36 countries is of the order of 0.45, indicating that, on average, countries in the sample register almost half the efficiency of the most efficient country. technical efficiency scores vary between a minimum of 16.8% and a maximum of 98%. south africa and sudan have the highest rank whereas liberia and central african republic are the lowest. table 4: technical efficiency ranking. it is not surprising that south africa numbers among the most efficient in ssa. south africa is endowed with the best infrastructure and technology among ssa countries. in addition, south africa’s relatively more competitive markets, sound financial system, and abundance of mineral resources make it a very attractive destination for foreign direct investment. during the past decade or so, sudan has seen wide-ranging structural reforms and sound macroeconomic management, reaching 6% economic growth in 2016. this growth has been largely supported by an increase in foreign direct investment by about 40% over the past decade and stronger political stability. liberia proving to be the least efficient country comes as no surprise as the country ranks as one of the poorest in the world and its economy is extremely underdeveloped. the country faces numerous economic challenges, including massive international debt, low degree of diversification, poor or nonexistent infrastructure and a low level of human capital. central african republic is also one of the poorest countries in the world. a largely rural and destitute population characterises it, with high levels of unemployment and limited infrastructure. table 5 reports the coefficients of the estimated frontier. the first nine rows exhibit the coefficients of the estimated frontiers whereas the last three rows report the two inefficiency statistics and the log-likelihood function. table 5: frontier results. notice how the coefficients of the stochastic frontier are consistent with expectations. the coefficients of lnk, lnl and lnh are all positive and significant implying that physical capital, labour and human capital all contribute positively to output growth. the coefficients on t and t2 are not significant however. only when interacted with lnk does technological change become highly significant, indicating that technology interacts with physical capital to generate output growth – that is, technological change is capital augmenting. technological change does not significantly interact with labour or human capital. one explanation could be that in this sample of countries the available labour force and the level of human capital do not allow the absorption and adoption of imported technology for the generation of additional output. for example, the level of human capital might not be up to the standard required for technology to affect growth. output growth decomposition perhaps the most controversial question in mainstream growth theory is whether it is factor accumulation or tfp that contributes to the larger fraction of growth. solow (1956) argues that it is tfp (determined as a residual component to growth after accounting for factors of production) and not factor accumulation that accounts for the bulk of output growth in the us. easterly and levine (2001) also find that the residual accounts for most of the income and growth differences across countries. to evaluate the role of tfp in growth, we calculate the share of tfp growth in total output growth. jorgensen and griliches (1967) calculate the rate of growth of tfp as the difference between the rate of change of real product and the rate of growth of inputs. applying this definition to our model, the contribution of tfp to growth is obtained as the residual after removing physical and human capital and labour contributions from total growth. change in tfp is calculated as follows: , where a dot over a variable indicates the rate of change of the variable over time. table 6 decomposes output growth per country. results show that, on average, physical capital accumulation exceeds tfp growth (out of the 36 countries, only 14 countries register a higher share of tfp in growth). a closer look at single country decomposition indicates that performance is not independent from a country’s achievements in terms of tfp and physical and human capital accumulation. table 6 shows that gabon is the country that registered the lowest output growth over the period and it is also the country with the lowest growth of tfp (the contribution of tfp to total growth is negative). at the same time, sudan is the country that registered the highest growth and it is also the country with the highest accumulation of physical and human capital. we also note that mauritius, namibia, and south africa list among the 10 most efficient countries, a result that accords with the global competitiveness report 2013–2014 (schwab 2013). table 6: output growth decomposition in rates. klenow and rodriguez-clare (1997) argue that one has to be careful when decomposing output growth because decisions to invest in physical and human capital are themselves likely to depend on tfp growth, and that a simple growth decomposition may ignore the portion of growth in inputs induced by productivity growth. one should therefore make sure that there is no endogeneity in the inputs used for production. in case the inputs are endogenous, the tfp-induced increase in inputs should be attributed to tfp growth and not to input growth. klenow and rodriguez-clare (1997) reduce the contribution of capital to output growth by limiting capital’s contribution to variation in the capital-output ratio (which automatically increases the role of tfp). applying a variance decomposition approach, they find that the share of tfp in total growth in south korea increases from 18% to 80% after accounting for the endogenous effects. variance decomposition however requires a growth accounting framework and is not genuinely compatible with our stochastic frontier approach. in order to give a more accurate picture of the role of tfp in our growth decomposition exercise and to detect tfp-induced input effects, we investigate whether there is a possible long-run relationship between the growth of tfp (tfpg) and the growth of both inputs (kg and hg). to the best of our knowledge, the question of a possible tfp-induced input effect (endogeneity) has not been investigated outside of a growth accounting framework. our article therefore represents a first attempt to investigate such effect in stochastic frontier. in the presence of a tfp-induced effect to either kgor hg (or both) the share of tfp growth displayed in table 6 will be underestimated and will have to be adjusted by the unaccounted effect of tfp on inputs. one procedure is to estimate two separate ordinary least squares (ols) regressions where tfpg is the dependent variable and kg and hg alternate as explanatory variables. however, this procedure requires that the variables of interest be stationary in level. if the variables are not stationary in level, then the ols estimation is spurious and the t-statistics not reliable, in which case dynamic ols (dols) or fully modified ols are more appropriate. we therefore examine the time series properties of tfpg, kg and hg. the levin-lin-chu (llc), hadri, fisher, harris-tzavalis (ht), and im-pesaran-shin (ips) unit root tests are performed in level and in first difference for the three variables in order to determine their order of integration. table 7 summarises the results. llc is the only test that shows stationarity in level for all three variables while tfpg is the only variable that shows stationarity in level in four out of the five tests. all variables are stationary in first difference. we can consequently generalise these results and conclude that the variables are not stationary in level, but stationary in first difference – or integrated of order one i(1) – which invalidates the ols procedure. table 7: unit root results. the fact that the variables are i (1) means that they can still be related by a stationary linear combination in which case they are said to be cointegrated. we expect kg and hg to be strongly cointegrated with tfpg if there is an induced (endogenous) effect from tfp to k and h. the pedroni cointegration test is performed and results are displayed in table 8. results indicate that kg and hg are not cointegrated with tfpg this result is further confirmed with a dols estimation where the coefficient of long-run relationship is found to be non-significant (see table 9). based on the cointegration tests and the dols coefficients, we can conclude that the effect of tfp growth on growth of inputs is very minor and that our stochastic frontier results do not seem to be affected by endogeneity. table 8: pedroni cointegration test results. table 9: dynamic ordinary least squares results, independent variable tfpg. conclusion this article presents a decomposition of output growth in 36 sub-saharan countries over the period 1996–2014. the results show that, on average, real gdp growth in the region over the period is driven primarily by physical capital accumulation (in the total 36 countries, only 14 list tfp as the main driver of growth). tfp growth is the second main component, while labour growth and human capital accumulation are the least important factors of growth. this result leads to the following recommendation: for growth in ssa to be sustainable, countries ought to invest in productivity 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quarterly journal of economics 70(1), 65–94. https://doi.org/10.2307/1884513 tahari, a., ghura, d., akitoby, b. & aka, e.b., 2004, sources of growth in sub-saharan africa, working paper wp/04/176 (september), imf, washington, dc. the conference board total economy database™, 2015, total economy database™ – key findings, viewed 06 january 2018 from https://www.conference-board.org/data/economydatabase/ the world bank, 2014, africa pulse: an analysis of issues shaping africa’s economic future, vol. 9, a document produced by the office of the chief economist for the africa region, world bank, washington, dc. turner, c., tamura, r. & mulholland, s., 2013, ‘how important are human capital, physical capital and total factor productivity for determining state economic growth in the united states, 1840–2000?’ journal of economic growth 18(4), 319–371. https://doi.org/10.1007/s10887-013-9090-4 appendix 1 sample of 36 countries: angola benin botswana burkina faso burundi cameroon central african republic (car) congo cote d’ivoire democratic republic of congo ethiopia gabon gambia ghana kenya lesotho liberia madagascar malawi mali mauritania mauritius mozambique namibia niger nigeria rwanda senegal south africa sudan swaziland tanzania togo uganda zambia zimbabwe sajems ns vol 7 (2004) no 1 170 the fdi-growth hypothesis: a var model for nigeria ________________________________________________________________ philip akanni olomola department of economics, obafemi awolowo university, nigeria ________________________________________________________________ abstract the objective of this study was to examine the causal relationship between foreign direct investment and economic growth in nigeria using annual data covering the period 1970 to 2002. the study employed the granger causality procedure to test the direction of causality between foreign direct investment and economic growth for the nigerian economy. the endogenous production function was derived to accommodate foreign investment and other domestic policies that could influence growth and foreign investment. the study found a one-way causality between from foreign direct investment to economic growth. the implication arising from this study is that nigeria should adopt policy whereby fdi is attracted to promote economic growth. jel f21, f23, 052 1 introduction there has been an increase in debate about the economic impact of foreign investment in the nigerian economy as in other host developing economies. this debate assumes special importance in view of recent changes in the composition and direction of foreign direct investment (fdi), and liberalization of government policies towards fdi in developing economies, including nigeria. according to lall (1998), after a decline of about 4 per cent each year during 1980-1985, the volume and share of fdi to developing economies has risen significantly. during the later part of the 1980s, fdi in developing economies increased by 17 per cent each year. in 1993, total fdi to developing countries was $70 billion, and the value of inflows of fdi increased by 125 per cent in the first three years of the decade. in nigeria, between 1970 and 2002, foreign direct investment inflow into the country averaged 17 per cent each year. this was an improvement over an average of 12 per cent between 1970 and 1980. sajems ns vol 7 (2004) no 1 171 the inflows of fdi to developing countries often raise the question of how these inflows affect these economies. thus, the objective of this study is to examine the direction of causality between foreign direct investment and economic growth within the framework of endogenous growth model for nigeria using data from 1970 to 2002. this analysis is crucial for a developing economy like nigeria for some reasons. first, the consensus view on fdi seems to be that there is a positive association between fdi inflows and developing country growth. however, the results of existing empirical studies on the causality based on different econometric techniques or data sets in general give mixed results. second, many empirical investigations have been carried out in nigeria on the determinants as well as the impact of foreign private investment on economic growth (see, for example, (ekpo & egwaikhide (1998); chete (1998); olomola & akinbobola (2000)). however, studies that examine the causality between them are sparse. this study therefore intends to fill this gap. the rest of the paper is organized as follows. section 2 presents some theoretical and empirical issues. section 3 presents the model specification and estimation technique. section 4 presents the empirical results, while section 5 concludes. 2 fdi and growth: some theoretical and empirical issues the theoretical foundation for empirical studies on fdi and growth derives from either the neo-classical models of growth or the endogenous growth models. in neoclassical models of growth, fdi increases the volume of investment and/or its efficiency, and leads to long-term level effects and medium-term, transitional increases in growth. the new endogenous growth models consider long run growth as a function of technological progress, and provide a framework in which fdi can permanently increase the rate of growth in the host economy through technology transfer, diffusion, and spillover effects. the endogenous growth literature argued that the role of rapid growth of foreign trade in stimulating a higher learning coefficient is twofold. first the importexport sector serves as a vehicle for technology transfer through the importation of technologically advanced capital goods (bardhan & lewis, 1970; chen, 1979; khang, 1987; keesing, 1987). second, rising exports help to relieve the foreign exchange constraints. a country's ability to import technologically sajems ns vol 7 (2004) no 1 172 superior capital goods is augmented directly by rising export receipts and indirectly by the higher flow of foreign credits and direct investment. evidence in the existing empirical literature on the causal relationship between fdi and economic growth is rather inconclusive. most of these studies conduct traditional causality tests, using single time series or panel data. in the latter case, the relationship between fdi and growth is assumed to be homogeneous across countries. in this section, we briefly review select papers that have investigated the causal relationship between fdi and growth and note several drawbacks of these traditional approaches. the empirical evidence on the relationship between foreign direct investment and growth can be categorized into two groups. on the one hand, there are those that focused on the role of multinational firms and on the determinants of fdi. on the other hand, there are those that apply causality tests based on time series data to examine the nature of causal relationship between fdi and output growth. most studies have applied the granger causality procedure (karikari, 1992; saltz, 1992; de mello, 1996; pfaffermayr, 1994 and united nations, 1993). there are some problems with most of these studies. many of these studies adopted arbitrary choice of lag lengths (kasibhatla & sawhney, 1996; and jordan et al., 1997). also, some of them applied cross sectional data. the problem with this approach is that it implicitly a common economic structure and similar production function across different countries. this, however, may not hold true, and further, economic growth of a country is influenced not only by fdi and other factors inputs, but also by a host of domestic policies such as monetary, fiscal and external policies (jordan et al., 1997). in attempt to take care of these methodological problems, ericsson and irandoust (2001) adopted the vector autoregression (var) approach to examine the causal effects between fdi growth and output growth for four oecd countries. the countries included namely denmark, finland, norway and sweden. using a multivariate var model including fdi, output and tfp growth and using the estimation techniques developed by toda and yamamoto (1995) and yamada and toda (1998), the authors failed to detect any causal relationship between fdi and output growth for denmark and finland. they however found a long-run uni-directional causal relationship running from fdi growth to gdp growth for norway. in another development, chakraborty and basu (2002) examined the link between fdi and output growth in india using a cointegration model with a vector error correction mechanism. their studies concluded that real gdp in india was not granger caused by fdi and the causality runs more from real gdp to fdi. earlier, nyatepe-coo (1998) assessed the contributions of fdi to sajems ns vol 7 (2004) no 1 173 economic growth in selected countries in southeast asia, latin america and sub-saharan africa covering the period 1963-1992. based on the model of endogenous growth and following the work of borensztein, de gregorio and lee (1995), nyatepe-coo constructed a model with growth as the dependent variable and fdi, human capital and a matrix of relative determinants (i.e. government consumption, trade policies, inflation and degree financial development) as independent variables. he found that fdi promotes economic growth in the majority of the 12 countries examined. he likewise found some evidence suggesting a direct relationship between foreign capital and economic growth. also, liu, burridge and sinclair (2002) wherein they tested the existence of a long-run relationship among economic growth, foreign direct investment and trade in china. using a cointegration framework with quarterly data for exports, imports, fdi and growth from 1981 to 1997, the research found the existence of a bi-directional causal relationship among fdi, growth and trade. although useful and illuminating, previous studies on causality between fdi and economic growth are biased due to the omission of variable phenomenon. in other words, they are bivariate in that they only focus on the relationship between fdi and economic growth. economic theory indicates, however, that other variables, such as the degree of openness and domestic capital (including investment in human capital) are equally important in the determination of fdi and real output growth. thus, bivariate models are potentially misspecified and may be flawed due to the omission-of-variable phenomenon. as a result, one would expect that both causality and cointegration tests would yield biased estimates or at best mixed results in these models (see miller, 1991 and darrat, 1994). therefore, in this paper, the intention is to re-examine the relationship between fdi and economic growth in the nigerian context using a multivariate model in which other relevant factors (degree of openness, human capital and domestic physical capital) are allowed to exert their influence on the two time series (fdi and economic growth). consequently, the present model explores the relationship among four variables, namely, real gdp growth (gy), fdi growth (gf), degree of openness (σ), domestic capital stock (gd), and human capital stock (gh). 3 model the theoretical model follows that of ericsson and irandoust, 2001; de mello, 1997, 1999) where the production function is defined as: sajems ns vol 7 (2004) no 1 174 y a k l= ψ ( , ) (1) where y=output, a=efficiency, k=physical capital and l=labor. a, captures the variable influencing the level of productivity in the economy. it contains control and policy variables as well as technology. k is decomposed into domestic capital, kd, and foreign capital, kf , that is: k k kd f= + (2) it is equally assumed that the recipient economy’s stock of knowledge, h, depends on the level of domestic and foreign capital, such that: [ ]h k kd f= α ξ (3) where kd=kd/l, and kf=kf/l, α and ξ are the marginal and inter-temporal elasticities of substitution between foreign and domestic capital stock respectively. since foreign capital, kf, enters the human capital definition, h, then it can be said that fdi affects the production function directly through its effects on capital, kf, and indirectly through its effect on human capital, h. thus, expressing equation (1) in per capita cobb-douglas production function, we have: y ak kd f= +β θ αθ (4) where β is the share of domestic capital, which is assumed to be less than one, implying diminishing returns to domestic capital, θ=ξ(1-β), with ξ>0. by taking the logarithm and time derivatives of equation (4), we have a general growth accounting equation of the form: [ ] [ ]g g g gy a d f= + + +β θ αθ (5) where gy = per capita income growth; ga = total factor productivity growth; gd = growth of domestic capital stock; gf = growth of foreign capital stock. in endogenous growth models, however, technology, a, the ultimate cause of growth evolves endogenously. it is not the consequence of a deliberate action by any economic agent. the models of aghion and howitt (1992), grossman and helpman (1990), and romer (1990) all associated evolution of technology sajems ns vol 7 (2004) no 1 175 with a measurable input such as research and development expenditure, the number of scientists and engineers, etc. the level of technology, which is fundamental to the endogenous growth model, is assumed to be of the form; g aa = +ln ( )π σ (6) where φ is a set of other economic and non-economic policy variables that affects growth. given equation (6), our estimating model becomes: [ ] [ ]g a g gy d f= + + + +ln ( )π σ β θ αθ (7) where ina is assumed to be the constant and φ the degree of openness. unlike ericsson and irandoust (2001), however, we do not assume that gd, is constant. as opposed to the limited contribution that the neoclassical growth theory accredits to fdi, the endogenous growth literature points out that, fdi can not only contribute to economic growth through capital formation and through trade (bloomstrom et al., 1996; borensztien et al., 1995) but also do so through the augmentation of the level of knowledge through labor training and skill acquisition (de mello, 1997, 1999) and organizational arrangements. method of estimation the first step is to examine the time series properties of the variables under consideration using the augmented dickey fuller (adf) tests. if the variables are non-stationary and integrated of order one, then they are cointegrated and they would have long-term co-movements evidenced by the number of cointegrating vectors. to determine the long run among the variables the johansen co integration procedure is utilized (see johansen 1991, and johansen and juselius 1990). the procedure involves the estimation of vector error correction (vecm) in order to obtain the likelihood-ratios (lr) for the shortrun relationship. the approach is set up as a vector auto regression (var) of non-stationary series: ∆ π γ ∆σy y i y vt i k i t t= + = + +− = − −1 1 1 1 µ (8) where y = [σ, gy, gd, gf] and; σ = degree of openness gy = per capita output growth gd = domestic investment growth gf = foreign direct investment growth sajems ns vol 7 (2004) no 1 176 ∆ is the difference operator that induces stationary; µ are the intercepts, and vt is a vector of normally and independently distributed error terms, v=[v1t, v2t) ’. the model is assumed to be vector white noise, that is, vt has mean zero, e[vt]=0, and nonsingular covariance matrix σv =e[vtv ’ t] for all. the coefficient matrix π, is also referred to as the long-run impact matrix, contains information about the stationarity of the variables and the long-run relationship between them. the existence of co integrating vectors (v) implies π is rank-deficient (kul and khan, 1999). if π is of full rank, that is, r=p, then all variables in y are themselves stationary with no common stochastic trend or long-run relationship exists between them. on the other hand, if π is a full matrix, that is, r=0, then co integration is not also present but variables in y are non-stationary. in this case, the usual var model is specified. the number of significant nonzero eigen values determines the number of co integrating vectors in the system. however, if π is of rank r(0<r< 2), then there are r linear combinations of variables in x that are stationary. this is an indication that the variables are cointegrated in the long run with r co integrating vectors. in this case, π can be decomposed as π=ϕz’, while ϕ(5xr) and z(5xr);. if the variables are cointegrated, then there exists at least granger causality in at least one direction. however, according to granger (1988) the conventional var analysis cannot be employed given cointegration, therefore, the following specification is used to establish the feedback effect: g g a a a g g z z z y f y a f i k i yt t ft t t t gy ga gf σ β σ ε ε ε ⎡ ⎣ ⎢ ⎢ ⎢ ⎤ ⎦ ⎥ ⎥ ⎥ = ⎛ ⎝ ⎜ ⎜ ⎜ ⎞ ⎠ ⎟ ⎟ ⎟ + ⎛ ⎝ ⎜ ⎜ ⎜ ⎞ ⎠ ⎟ ⎟ ⎟ ⎛ ⎝ ⎜ ⎜ ⎜ ⎞ ⎠ ⎟ ⎟ ⎟ + ⎡ ⎣ ⎢ ⎢ ⎢ ⎤ ⎦ ⎥ ⎥ ⎥ + ⎡ ⎣ ⎢ ⎢ ⎢ ⎤ ⎦ ⎥ ⎥ ⎥ = − − − − − − σ ψ ψ ψ 1 1 1 1 1 1 1 1 2 1 1 3 1 , , , (9) the rows of z are interpreted as the distinct cointegrating vectors. the ω(l) are finite polynomials in the lag operator. the ψ’s are the error-correction coefficients (loading factors) which indicate the speed of adjustment towards long-run equilibrium. this approach is particularly attractive over the standard var because it permits temporary causality to emerge from (1) the sum of the lagged coefficients of the explanatory differenced variable and (2) the coefficient of the error-correction term. in addition, the vecm allows causality to emerge even if the coefficients of the lagged differences of the explanatory variable are not jointly significant (see miller and russek, 1990; miller, 1991; engle and granger, 1987; granger, 1983; and, anoruo and ahmad, 2001). it must be pointed out that the standard granger-causality test omits the additional channel of influence (zt-1). sajems ns vol 7 (2004) no 1 177 in the model, the null hypothesis of non-causality from fdi to economic growth is rejected if either the group coefficient on the fdi is significant or the coefficient of lagged error-correction term is negative and statistically significant. the statistical significance of dk21 (l) and φ is exposed through joint f and t-tests. the f-test of the explanatory variables (in first differences) indicates the “short-run” causal effects, whereas the long-run causal relationship is implied through the significance or otherwise of the t-test of the lagged errorcorrection term that contains the long-run information. 4 data and estimation results data and data sources annual values for real gdp growth per capita, export growth, foreign investment growth were used. the sample point for the variables is 1970-2002. the degree of openness was measured by the export growth. alternative measure of degree of openness such as (export+import)/gdp proved insignificant in the analysis. the data for the variables were extracted from the statistical bulletin published by the central bank of nigeria. empirical results the results of the adf test for the variables in level and first difference form are presented in tables 4.1 and 4.2. table 4.1 gives results without trend while table 4. 2 present the results with trend. as evidenced from table 4.1, all the variables are non-stationary at levels both with and without trend. however, without trend, only foreign capital variable was not stationary. output growth per capita and degree of openness measured by export growth were stationary after first differencing them. on the other hand, when the trend variable was introduced into the adf equation, only export growth was stationary after first differencing. output growth and foreign capital demonstrated non-stationarity table 4.1 adf test (without trend) variable level first difference gy 0.22 -2.98 σ 0.07 -3.44 gf 0.17 -2.68 critical levels at 5%=-2.970 sajems ns vol 7 (2004) no 1 178 table 4.2 adf test (with trend) variable level first difference gy -1.64 -2.92 σ -1.72 -3.87 gf -1.90 -2.72 critical levels at 5%=-3.58 however, the results of the augmented dickey fuller (adf) test cannot be said to be conclusive evidence of the time series properties of the data. this is because the adf test has been described as being too restrictive given the assumption of independently and identically distributed guassian processes. therefore, the philip-perron z-test was employed to further examine the time series properties of the variables. the results are stated in tables 4.3 and 4.4 below, without and with trend variable respectively. table 4.3 pp test (without trend) variable level first difference gy 0.60 -3.60 σ 0.36 -4.27 gf 0.11 -4.39 critical levels at 5%=-2.970 table 4.4 pp test (with trend) variable level first difference gy -1.63 -3.61 σ -1.45 -4.25 gf -1.72 -4.43 critical levels at 5%=-3.58 as evidenced from tables 4.3 and 4.4, all the variables are stationary after first differences with trend and without trend. thus, the next step is to test for cointegration. the johansen (1988) and johansen and juselius (1990) multivariate cointegration test was adopted. it should be noted that given that the cointegration test is sensitive to the choice of lag length, and following judge et al. (1988), akaike’s aic criterion was used to determine the lag length. the model with the smallest aic was the one with two lag lengths. the results of the maximal eigen values and those of trace tests are in table 4.5. sajems ns vol 7 (2004) no 1 179 table 4.5 johansen cointegration test results (trace statistics under ho:rank=r) model trace statistics maximal eigenvalue statistics r=0 r≤1 r=0 r≤1 var= (gy, σ, gf) 51.6** 30.1 32.1** 12.5 ** denotes rejection of the hypothesis at 1 per cent level of significance the respective 5 per cent critical values for the trace tests are 39.68 and 32.6 respectively for r=0 and r=1. the 5 per cent critical values for the maximal eigenvalues are 21.1 and 17.88 for r=0 and r=1 respectively. ** indicate rejection of the null at 5 per cent level. as reported in table 4.5 above, both the trace test and maximal eigenvalues statistics shows that the var for nigeria has only one cointegrating vector. this implies that a long run relationship exists among the variables. here, the first cointegrating vector is normalized as the per capita output growth. thus, the result of the cointegrating vector is given as: gy = -3.21 + 0.33σ+ 0.08gf (0.149) (0.012) the standard errors are in parenthesis. the cointegrating vector shows that longrun per capita output growth in positively and significantly related to foreign capital growth and export growth. the coefficients suggest that an increase in fdi by 1 million naira would raise economic growth by 0.08 per cent. this finding supports de mello (1999) that foreign direct investment has a positive impact on output growth. the results of the granger causality tests are reported in table 4.6. the significance of f-statistic for the lag values of the independent variable indicates the presence of unidirectional short-run causal effect running from the independent variable to the dependent variable. the estimated results show positive short-run causal effect running from fdi to economic growth. in the fdi equation, there is no causal relationship from economic growth to fdi as the f-statistic was insignificant. in the long run, there is unidirectional causality running from fdi to gdp as evidenced in the output equation in table 4.5 above. thus it can be concluded that for the nigerian data over the period of 1970 to 2002, there is uni-directional causality between fdi and economic growth and the causal direction is from fdi to economic growth. sajems ns vol 7 (2004) no 1 180 table 4.6 causality results based on vector error-correction model (vecm) dependent variable f-statistics t-statistics model gdp (gy) fdi(gf) zt-1 gdp 4.14 -3.93 fdi 0.65 0.26 this result confirms other studies for developing countries. unctad (1999) for example found that past inflows of fdi causes growth in less developed countries. similar findings were obtained by borensztein et al. (1998) for 69 ldcs and bloomstron lipsey and zejan (1994) for developing countries. it is also confirmed similar findings for advanced countries such as belgium, denmark, germany, france and the u.k where foreign direct investment granger causes economic growth (mondatsu, 2001). the observations for nigeria’s recent economic development fit into the fdiled growth hypothesis. an important implication of this finding is that since fdi granger causes growth, this weakens the arguments for restricting fdi in nigeria. the role of multinational corporations in nigeria’s economic development over the years cannot be overemphasized. the inflow of foreign investment induces and creates the production from other industries, which can be measured by the backward linkage index. magbagbeola (1998) in a study argued that the advantage nigeria have derived over the years from foreign investment has been the increase in income, increase in the productivity of labor and other external economies as foreign exchange, managerial ability, personnel and technological knowledge, administrative efficiency and innovations in products. 5 concluding remarks this paper used the granger causality procedure to test the direction of causality between foreign direct investment and economic growth for the nigerian economy. the test was based upon annual time series data in a five variable var model. the results indicate that there is a one-way causality between fdi and economic growth with the direction of causation running from fdi to economic growth. the nigerian economy has benefited from the inflow of foreign investment into the country over the years which has enable nigeria to achieve economic growth. sajems ns vol 7 (2004) no 1 181 the implication arising from this study is that nigeria should adopt policy whereby fdi is attracted to promote economic growth. such policies could include granting concessional terms to foreign investors. moreover, good governance, with fiscal and monetary accountability and transparency, and eschewing corruption, would instill confidence in foreign investors and thus feel willing to direct investment to the country. moreover, political stability and less of religious and ethnic riots could stimulate foreign investment as it is a crucial variable in nigeria’s growth prospects. references 1 aghion, p. & howitt, p. 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(1999) “infrastructures and economic development”, african development bank economic research papers, 50: 1-20. 51 wickens, r.w. (1996) “interpreting co integrating vectors and common stochastic trends”, journal of econometrics, 74: 255-71. microsoft word 3 botha et al sajems 19(3) 2016.docx 358 sajems ns 19 (2016) no 3:358-368 how to cite doi: http://dx.doi.org/10.17159/2222-3436/2016/v19n3a4 issn: 2222-3436 art investment in south africa: portfolio diversification and art market efficiency ferdi botha, jen snowball and brett scott department of economics & economic history rhodes university accepted: february 2016 art has been suggested as a good way to diversify investment portfolios during times of financial uncertainty. the argument is that art exhibits different risk and return characteristics to conventional investments in other asset classes. the new citadel art price index offered the opportunity to test this theory in the south african context. moreover, this paper tests whether art prices are efficient. the citadel index uses the hedonic regression method with observations drawn from the top 100, 50 and 20 artists by sales volume, giving approximately 29 503 total auction observations. the index consists of quarterly data from the period 2000q1 to 2013q3. a vector autoregression of the art price index, johannesburg stock exchange all-share index, house price index, and south african government bond index were used. results show that, when there are increased returns on the stock market in a preceding period and wealth increases, there is a change in the citadel art price index in the same direction. no significant difference was found between the house price index and the art price index, or between the art and government bond price indices. the art market is also found to be inefficient, thereby exacerbating the risk of investing in art. overall, the south african art market does not offer the opportunity to diversify portfolios dominated by either property, bonds, or shares. key words: diversification, financial instability, art investment, wealth, citadel art price index jel: z11, g10 1 introduction portfolio diversification is widely accepted as an effective strategy to reduce the risk of investment for both businesses and households (teresiene & paskevicius, 2009; hagin, 2003) – a strategy also emphasised in south african media reports (greeley, 2013; kerrigan, 2013). one such proposed investment option is fine art, which was found to be an effective portfolio diversification strategy in australia during the financial crisis (higgs, 2012). the art market is unlike any other market, from its price discovery and risk and returns to the effect of a consumption component on investment demand, and may thus offer an opportunity for such diversification. when deciding where to invest, comparing conventional assets such as bonds and equities can be done easily, as information on their prices and returns is readily available. art, on the other hand has very little intrinsic value and its value can change depending on individuals’ preferences (goetzmann, renneboog, & spaenjers, 2009:2). in addition to being an investment, art may also have a consumption value component in the form of a “utility dividend” – the pleasure, and perhaps prestige, that is derived from art ownership (mandel, 2009). frey and eichenberger (1995) argue that media reports have given the impression that art investment offers high returns. the rapid increase of art prices in the 1980s and 2000s along with recent art price records being broken all fuel this idea (renneboog & spaenjers, 2013). however, due to the inelastic supply and luxury good status of fine art, prices can vary greatly depending on taste and current fashions. demand for art, and the willingness to spend by the wealthy, are thus the main determinants of art market activity (goetzmann et al., 2009; ait-sahalia, parker &yogo, 2004). in south africa, the investment company, citadel, released an art price index in 2011 to provide more information to investors and give them the ability to compare art investment to other kinds of investment. the index covers the period from 2000 to 2013. south africa’s local art market is abstract sajems ns 19 (2016) no 3:358-368 359 small compared to the world market but has seen some substantial growth in the past few years, especially with the establishments of new art fairs and galleries. it has a modest number of famous artists that have realised international fame and substantial commercial success, but this does not mean that there are not lucrative opportunities for investment. this paper seeks to discover whether art is a good way to diversify an investment portfolio by analysing the citadel art price index in relation to movement of the ftse/jse all share index, the absa house price index, and the south african government bond index. in addition, given the structure of art markets and the higher risk implications of insider information often present on reserve prices (david, oosterlinck & szafarz, 2013), the paper also explores whether south african art prices are efficient. 2 art and investment: theory of the art market art indices are released around the world so that the anomalies that exist in art markets along with investment behaviour can be better understood. when observing the art market one is struck by two major difficulties: firstly the diversity of products offered, and secondly the lack of trading, which means that trends become difficult to predict (renneboog & spaenjers, 2013:2). however there are methods that scholars have adopted to overcome these problems. with a hedonic regression, artworks are “valued for their utility-bearing characteristics” and therefore have the ability to control for quality changes between different works through “attributing implicit prices to specific value-adding characteristics” (renneboog & spaenjers, 2013:6). from there the implicit prices of the identifying characteristics are estimated and translated into dummy variables that will help explain the eventual price (fase, 1996:651). the implicit prices of these characteristics are used to estimate regression coefficients and are “deducted from the effective price of a painting” with the difference averaged annually to create the price of an “ordinary” painting (fase, 1996:652). the prices of these ordinary paintings are then captured along with the addition of a time dummy which produces the hedonic price index (fase, 1996:652). the most challenging part of creating a hedonic price index is identifying which characteristics will have the greatest impression on the price (renneboog & spaenjers, 2013:6). the most commonly used characteristics are easy to measure and easy to observe, for example, the artist, medium, size and the auction house the work was sold from while the living status and signature of the artist have been known to be used where appropriate (renneboog & spaenjers, 2013:6). the accuracy of each individual characteristic is important. a study by higgs and worthington (2005:122) shows that price was increased if the artist was deceased, if it was a larger work, whether works were in acrylic or oils, and if the work was sold at christies or sotheby’s. lower prices were associated with small etchings or charcoal works created by living artists sold at smaller auction houses (higgs & worthington, 2005:122). the advantages of the hedonic method are that differences in prices between paintings and price movements are easily distinguished and all auction data available is used (fase, 1996:652). the disadvantages are the assumption that a few characteristics, which do not include talent or artistic quality, are able to capture such large variability in a fixed component such as price and that these characteristics “do not vary systematically over time” (ashenfelter & graddy, 2003:767). such indices allow for art to be compared to other conventional investments. when comparing art to conventional assets there are two main indicators that investors will consider the risk of investing and the return that the investment promises. risk is the uncertainty about the return an investor will receive on an asset, while return measures how well a person has done by holding that asset. risk can thus be defined as the probability that the expected return is different from the actual return (howells & bain, 2008; mishkin, 2010). in this case, risk can be estimated by measuring the volatility of returns over the period (where a riskier asset is defined as one where there is a wide dispersion of returns around the mean). an analysis of the variance or standard deviation of the different asset classes thus gives an indication of risk, while mean values show what the investor can expect to earn over time. 360 sajems ns 19 (2016) no 3:358-368 however, there are problems when comparing the risk and return on art to conventional assets. firstly, art has both an investment and consumption component to it. secondly, as frey and eichenberger (1995:209) identified, transaction costs, taxation, financial comparisons and data problems are major drawbacks in studies on risk and return in the art market. these problems mean that the accuracy of comparisons between art and other investment vehicles can bequestioned. frey and eichenberger (1995:209) showed that the majority of studies use data from auctions, as these data are easily accessible and reliable while disregarding other sales from galleries and collectors that may also have important impacts on price movements (frey & eichenberger, 1995:209). these missed sales can have a substantial effect on returns. most studies also disregard high auction fees and transaction costs due to their variability and the difficulty in calculating them, but because of their size, they play a significant role in returns (frey & eichenberger, 1995:209). previous studies have also not taken taxes into account when calculating returns while taxes vary greatly between periods and countries (frey & eichenberger, 1995:209). however, art and art prices, particularly price data from auctions, offer a number of challenges. in an efficient market, prices reflect all available information, making future returns unpredictable. however, as david et al. (2013) point out, art returns calculated from an index of art auction prices certainly do not reflect all available information. this is because the seller fixes a reserve price, which only the seller and the auctioneer know. if the art work does not reach the reserve price, the work is reported as unsold and this information is not incorporated into the index. using a large database with more than a million observations, david et al. (2013) use four tests to assess the weak form of efficiency in the art market. results show that the art market is not even weakly efficient, since net returns are highly auto-correlated. thus, “it is structurally impossible for auction prices to be efficient” (david et al., 2013:24). potential investors in the art market thus need to be aware of this bias, which benefits those with insider information on reserve prices. risk and return on art investment is also atypical in that art has both an investment and consumption component to it. art is a hybrid of consumption and investment (mandel, 2009:1657), which makes it difficult to compare the return on standard financial assets to the return on art, since the difference in return may be capturing the value that the owner receives from owning an asset that is also a consumption good (throsby, 1994:6). people that purchase art fall into three categories or motives in terms of their purchasing decisions: intrinsic motives (the derivation of aesthetic value from the artwork); as a signal of wealth; for investment purposes; or some combination of these (mandel, 2009:1653). with reference to intrinsic value, it is difficult to predict varying taste and therefore consumption decisions. the income and wealth of the person who desires the artwork would be the only constraint to the consumption decision (goetzmann, 1993:1375). art as a signal of wealth suggests that demand could be seen as a form of conspicuous consumption, or to create a sense of cultural accomplishment through the purchase of artworks, which means that the purchase of the artwork has nothing to do with the intrinsic value of that good (mandel, 2009:1656; shipman, 2004:279; braun & wicklund, 1989:162). art purchasing may thus not always conform to consumption theory, which assumes a fully informed and rational economic agent. the last motive, purchase for investment, also does not follow conventional investment motivation. the fact that art has the potential for resale and that price can fluctuate over time means that art has some of the same features as financial assets, in that it can be used to protect against inflation, as a source of capital gain and a store of wealth (throsby, 1994:4). however, the way that artworks derive their value is different to other financial investments as art is a durable consumption good as well. mandel (2009:1654) states that the demand for an artwork as a financial asset will fulfil the need for savings while also proposing that art carries a "utility dividend" which increases the value of art as an asset. stocks represent a claim on the asset that provides a monetary return to the owner over a period, while an artwork provides a monetary return at the end of the ownership period as well as providing aesthetic value and social prestige to its owner (goetzmann, 1993:1375). an important impact of this characteristic is that “pure sajems ns 19 (2016) no 3:358-368 361 collectors” are insensitive to risk, whereas “pure speculators” are likely to be much more sensitive to risk and may leave the market during periods of price volatility (boyer, 2011). another aspect of an artwork’s price within financial markets that distinguishes it from other financial assets is that the supply is fixed (fase, 1996:650), which means that the price is fully determined by demand (fase, 1996:650). therefore at the given price of an artwork the buyer will face a trade-off: “the utility of giving up consumption to buy a piece of art exactly equals its expected conspicuous consumption benefit plus capital return next period” (mandel, 2009:1657). thus an art asset's payoff will be increased by the utility dividend and art investors will not need to be compensated by as much in financial terms as conventional financial assets (mandel, 2009:1662). goetzmann et al. (2009:8) conducted a study that sought to discover whether there was a relationship between equity markets and art markets and whether this relationship affected prices and activity in the art market. for their analysis they created an art price index from 1765-2007 of which 1,468 were observed repeat sales. they built an index of british stock price returns for the period that covered dividend return, total return and capital appreciation, which was then compared to the art market returns. results showed that there is a strong relationship between art and equity markets and that art prices are driven by capital gains and losses (goetzmann et al., 2009:16). this finding is supported by chanel’s (1995:527) work: “it would appear, then, that financial markets react quickly to economic shocks, and that the profits generated on these markets may be invested in art.” these results thus demonstrate that when wealth increases, especially that of the wealthy, the price of art can be expected to increase, creating the possibility of increased art market activity and an art boom (goetzmann et al., 2009:16). a similar study on the us art market (boyer, 2011) supported the finding. in the concurrent time period, boyer (2011) found that there was a negative relationship between stock market performance and the art price index. she suggests that this may support the “diversity hypothesis”, that when stocks perform well, people invest less in art. however, when the stock market index is lagged by two months, its relationship with the art price index is positive. mei and moses (2002) used a repeat sales regression to calculate an index of 4896 sales pairs from 1950 to 2000 for the american art market. their results showed that the art investment offered better returns than corporate or government bonds, and was less volatile. however, renneboog and spaenjers (2013) used a hedonic regression compiled by using more than 10 000 artists, including 1.1 million transactions. they compared the index to other markets for the period 1951 to 2007. their results showed that art did not perform as well as stocks (s&p 500 and the gdf global equity index) and that the reward to risk ratio was higher for stocks than for art. the art index did however have a better reward to risk ratio than government bond indices. as is the finding of a number of other studies, david (2014) argues that, except under very specific circumstances, art does not provide a “safe haven” for investment during times of crisis. she constructed an art price index for the french art market during, and just after the ww1 period (1911–1925). she finds that, in terms of risk weighted return, gold, real-estate, bonds and stocks, outperformed art. frey and eichenberger (1995) argue that, rather than comparing art investment to bonds and equities, they should be compared to assets like land and property, which are closer substitutes due to similar liquidity issues, holding periods and, in many countries, benefit from special tax treatment. 3 data and method the four variables used in this paper arethe ftse/jse all share index, the citadel art price index, the absa house price index, and the south african government bond index. data for the all share index and the bond index were obtained from the south african reserve bank website. the absa house price index was obtained directly from absa bank. similarly, the citadel art price index was obtained directly from citadel. one of the main reasons for the release of the citadel art price index was an identification of the need to help improve investors’ search for assets that provided 362 sajems ns 19 (2016) no 3:358-368 the ability “to improve risk-adjusted returns and to diversify their financial portfolios” (citadel, 2011:4). citadel thus adopted a hedonic regression as they believed it gave their index the ability to overcome two key diafficulties when evaluating the art market: the diversity of artworks and the infrequency of trading (citadel, 2011). citadel’s observations start from 2000 and the sample was drawn from the top 100, 50 and 20 artists by sales volume, argued to be an appropriate outline of the general market (citadel, 2011:10). the top 100 included 17 997 auction sales representing 61 per cent of total trades and 87 per cent of total sales revenue (citadel, 2011:10), giving approximately 29 503 total auction observations. all data are quoted quarterly from the period 2000q1 to 2013q3. this period was chosen due to the availability of the art price index for this period. the logged return values of the series are presented in figures 1 to 3. the graphs indicate that the art price index is a lot more volatile relative to the other asset classes. furthermore, art prices fell sharply during the global financial crisis, and changes in the all-share index tend to lead changes in the art price index slightly. table 1 reports some basic descriptive statistics of the four indices. while the mean return is highest for the all-share index, the art price index is the most volatile of the various asset classes. thus, investing in art appears to be the riskiest option. table 2 contains correlation coefficients between the variables of interest. the share prices and art prices are significantly positively correlated, thereby suggesting little value for investing in art as opposed to shares. this paper estimates a simple recursive vector autoregression (var) of the art price index, the absa house price index, the south african government bond index, and jse all share index. in addition, a dummy is included to control for the global financial crisis of 2008. this dummy is set to one for the period 2008q3 to 2012q4, and zero otherwise. this period was selected to coincide with a sharp fall in long-term government bond yields in the us and european union (2008q3) and the later reversal of such yields (2012q4). flowing from the var results, additional analyses include variance decomposition, impulse responses, and granger causality tests. variance and standard deviations are also used to comment on volatility, as an indicator of risk. in order to comment on the efficiency of art returns, this paper follows the approach of david et al. (2013) by using the net return on art for this purpose, defined as the art return minus the risk-free rate that is proxied by the 3-month tb rate. table 1 summary statistics all-share index art price index bond price index house price index mean 0.0311 0.0168 0.0274 0.0282 median 0.0463 0.0092 0.0286 0.0339 maximum 0.1581 0.3534 0.0822 0.0821 minimum -0.2184 -0.2709 -0.0605 -0.0266 standard deviation 0.0784 0.1337 0.0301 0.0241 skewness -1.1169 0.3836 -0.4826 -0.2130 kurtosis 4.1332 3.7652 3.0851 3.0738 jarque-bera (p-value) 14.1172 (0.0009) 2.6413 (0.2669) 1.4792 (0.0479) 0.4207 (0.8103) three approaches are adopted to test for weak efficiency, namely the ljung-box q-statistic to test for first-order autocorrelation, the lo and mackinlay (1988) variance-ratio test examining the null hypothesis of a random walk, and the bds test with bootstrapped probabilities for return independence (brock et al., 1996). the ljung-box q-statistic, rejection of the null hypothesis of no first-order autocorrelation (i.e. h0: q = 0) would imply significant first-order autocorrelation of returns and hence market inefficiency. the bds test explores whether art returns are independently and identically distributed. rejection of the null hypothesis would imply that returns are not independent (brock et al., 1996). the variance ratio test is concerned with whether “the variance of the price difference of order q equals q times the variance of the first difference” (david et al., 2013:24). consistent with david et al. (2013), the test is computed for 2 < q < 9. sajems ns 19 (2016) no 3:358-368 363 table 2 correlation coefficients all share index art price index bond price index house price index all share index 1.0000 art price index 0.3580*** 1.0000 bond price index -0.2933** -0.1111 1.0000 house price index 0.0593 -0.0840 -0.0415 1.0000 note: *** and ** denote significance at the 1% and 5% levels, respectively. figure 1 changes in the citadel art price index and the south african government bond index -.4 -.3 -.2 -.1 .0 .1 .2 .3 .4 .5 -.08 -.06 -.04 -.02 .00 .02 .04 .06 .08 .10 00 01 02 03 04 05 06 07 08 09 10 11 12 13 art price bond price figure 2 changes in the citadel art price index and the absa house price index -.3 -.2 -.1 .0 .1 .2 .3 .4 -.04 -.02 .00 .02 .04 .06 .08 .10 00 01 02 03 04 05 06 07 08 09 10 11 12 13 art price house prices 364 sajems ns 19 (2016) no 3:358-368 figure 3 changes in the citadel art price index and the jse all share index -.3 -.2 -.1 .0 .1 .2 .3 .4 -.4 -.3 -.2 -.1 .0 .1 .2 .3 00 01 02 03 04 05 06 07 08 09 10 11 12 13 art price all share index 4 results the akaike (aic) and schwarz (sic) lag length information criteria suggested the use of one lag as appropriate for the var, the results of which are reported in table 2. results show that the lagged all share index within the art price index equation is positive and statistically significant, indicating that the art price index rises by about 0.67 per cent for each percentage increase in the all share index. the lagged house price index is positively but not significantly related to the art price index. this also confirms expectations by frey and eichenberger (1995) that art investment may be more like illiquid land and property investments. the lagged government bond index, moreover, is negatively related to the art price index. though investment in art could thus potentially offer an effective portfolio diversification strategy for portfolios dominated by south african government bonds, the relationship is not statistically significant. table 2 var estimates art price index all share index bond price index house price index all share indext-1 0.6708*** (0.2267) 0.3739*** (0.1507) -0.0406 (0.0610) 0.0252 (0.0291) art price indext-1 -0.5031*** (0.1326) -0.1341 (0.0881) -0.0301 (0.0357) 0.0201 (0.0170) bond price indext-1 -0.5028 (0.5604) -0.0846 (0.3725) 0.1438 (0.1507) 0.0195 (0.0718) house price indext-1 0.0340 (1.1065) 0.1823 (0.7354) -0.1838 (0.2976) 0.1547 (0.1418) constant 0.0487 (0.0291) 0.0351 (0.0194) 0.0239*** (0.0078) -0.0035 (0.0037) crisis dummy -0.0635 (0.0343) -0.0280 (0.0228) 0.0023 (0.0092) 0.0041 (0.0044) adjusted r2 0.2574 0.0878 0.0149 0.0079 f-statistic 4.5358 1.9818 0.8498 0.9202 lm(1) 0.2928 white 0.3158 jb normality 0.3055 note: *** denotes significance at the 1% level. value for the lm-test reflects the p-value associated with the null hypothesis of no serial correlation at the first lag, whereas the white test’s value is the p-value related to the null hypothesis of no heteroscedasticity. the p-value of the jb statistic relates to the null hypothesis of normality sajems ns 19 (2016) no 3:358-368 365 impulse responses (figure 4) show that art prices react positively to a shock in the all-share index, which dies out after roughly five quarters. of note is that the contemporaneous impact of the allshare index on the art index is statistically significant for about two quarters. a granger causality test further reveals that changes in the all-share index granger cause changes in the art price index (p < 0.01), but bondand house prices do not granger cause changes in the art price index (table 3). in addition, variance decomposition analysis showed that, after seven quarters, the art price index explains roughly 82 per cent of its own variance, while the all-share index explains about 16 per cent of the variation in art prices (table 4). as a whole, therefore, when there are increased returns on the stock markets in the preceding period and wealth increases, there is a change in the citadel art price index in the same direction. this finding is consistent with goetzmann et al. (2009:8), who reported that there is a strong relationship between art and equity markets and that art price changes are driven by capital gains and losses. since art is a luxury good it would be expected that, when people become wealthier they invest in art as a means of savings, or as a status good (braun & wickland, 1989:163). figure 4 impulse responses of art prices regarding the weak efficiency of net returns on art, the q-statistic of 48.3 (p < 0.001) indicates significant first-order autocorrelation. for all values of q between 2 and 9, the variance ratios are significantly different from one, with p-values ranging from 0.0050 to 0.0473, thereby rejecting the random walk hypothesis. finally, the bds test suggests that the net art returns are not independent, as the null of return independence is strongly rejected (p < 0.001). these findings therefore indicate that, similar to the findings of david et al. (2013), the art market is not efficient. -.10 -.05 .00 .05 .10 .15 1 2 3 4 5 6 7 8 9 10 response of art to art -.10 -.05 .00 .05 .10 .15 1 2 3 4 5 6 7 8 9 10 response of art to all-share -.10 -.05 .00 .05 .10 .15 1 2 3 4 5 6 7 8 9 10 response of art to bonds -.10 -.05 .00 .05 .10 .15 1 2 3 4 5 6 7 8 9 10 response of art to house prices response to cholesky one s.d. innovations ± 2 s.e. 366 sajems ns 19 (2016) no 3:358-368 table 3 granger causality results for art dependent variable: art price index χ2 probability all-share index 8.7529 0.0031 bond price index 0.8049 0.3696 house price index 0.0009 0.9755 table 4 variance decomposition of the art price index period art price index all-share index bond price index house price index 1 100.0000 0.0000 0.0000 0.0000 2 82.6548 16.1723 1.1716 0.0013 3 82.7364 15.9929 1.2230 0.0477 4 82.5165 16.2033 1.2329 0.0474 5 82.5142 16.2029 1.2348 0.0481 6 82.5099 16.2069 1.2350 0.0481 7 82.5097 16.2071 1.2351 0.0481 note: variance decompositions are only shown up to period 7, as the magnitudes remain the same from period 7 onward 5 conclusion this paper set out to test whether art is a good way to diversify an investment portfolio, by analysing the changes in the citadel art price index in relation to the movement of the fste/jse all share index, the absa house price index, and the south african government bond index. results show that, when there are increased returns on the stock markets in the preceding period and wealth increases, there is a change in the citadel art price index in the same direction. as found in other studies (goetzmann et al., 2009; braun & wickland, 1989) this seems to indicate that growing wealth as a result of higher returns on the ftse/jse results in more investment in art. art does thus not seem to offer a good way to reduce risk in an investment portfolio dominated by shares. although the art price index is negatively related to the south african government bond price index, thereby suggesting that art offers a way of diversifying a bond portfolio, the relationship is not significant. of the four asset classes, investing in art seems to be the most risky, followed by shares. the riskiness of art as investment choice is also reinforced by the fact that the art market is found to be inefficient. some limitations are worth noting. first, the citadel art price index only includes auction data and thus can create a biased view of the art market. by not including gallery sales within the index, the index leaves out a large portion of the art market (frey & eichenberger, 1995). secondly, as dividends are not included in the calculation of the ftse/jse all share index; a large portion of return on investment is thus excluded. avenues for future research could include acquiring sales data from galleries to provide a more comprehensive overview of the south african art market. being able to compare the south african gallery system to the auction system may enable an analysis on the efficiency of the local auction system. acknowledgements the paper benefited from the comments of an anonymous referee. an earlier version of this paper was published as economic research southern africa (ersa) working paper no. 537 under the title “art investment as a portfolio diversification strategy in south africa.” the financial support of ersa is acknowledged. sajems ns 19 (2016) no 3:358-368 367 references ait-sahalia, y., parker, j.a. & yogo, m. 2004. luxury goods and the equity premium. journal of finance, 59(6):2959-3004. ashenfelter, o. & graddy, k. 2003. auctions and the price of art. journal of economic literature, 41(3):763-776. boyer, c. 2011. the market for fine art and the economy. journal of wealth management, 13(4):77-83. braun, o.l. & wicklund, r.a. 1989. psychological antecedents of conspicuous consumption. journal of economic psychology, 10(2):161-163. brock, w., dechert, d., sheinkman, j. & lebaron, b. 1996. a test for independence based on the correlation dimension. 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shipman, a. 2004. lauding the leisure class: symbolic content and conspicuous consumption. review of social economy, 62(3):277-289. teresiene, d. & paskevicius, t. 2009. portfolio construction and management during the period of financial crisis. economics and management, 14:195-201. throsby, d. 1994. the production and consumption of the arts: a view of cultural economics. journal of economic literature, 32(1):1-29. abstract introduction research questions literature survey research design results discussion of the results conclusion acknowledgements references about the author(s) hoffie cruywagen department of construction economics, university of pretoria, south africa josephine llale department of construction economics, university of pretoria, south africa citation cruywagen, h. & llale, j., 2017, ‘the role of quantity surveyors in public–private partnerships in south africa’, south african journal of economic and management sciences 20(1), a1522. https://doi.org/10.4102/sajems.v20i1.1522 original research the role of quantity surveyors in public–private partnerships in south africa hoffie cruywagen, josephine llale received: 14 dec. 2015; accepted: 10 oct. 2016; published: 26 may 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: quantity surveyors play an important role in providing cost and contractual advice in the built environment. this article seeks to investigate the current extent of their involvement in public–private partnerships (ppps) in south africa. aim: the study intends to establish factors that influence quantity surveyors’ participation in ppps. methodology: a mixed-methods research approach was followed by firstly conducting a survey amongst south african quantity surveyors in order to determine their level of participation in ppps. for triangulation purposes, a case study was also conducted. results: the results of the research show that, although quantity surveyors have the corresponding skills and competencies required in a ppp project, their current involvement in ppps in south africa is limited and that there is a greater role they can play in future. conclusion: quantity surveyors are uniquely positioned to play a bigger role in the implementation of ppps in south africa. introduction the quantity surveying profession is often regarded as an obscure profession. many people often confuse it with land surveying (ajalekoko 2004). in spite of its obscurity, the profession has been in existence for many centuries. its value to society is immeasurable. the following is stated in the bible, in the gospel of luke 14:28, ‘suppose one of you wants to build a tower. will he not first sit down and estimate the cost to see if he has money to complete it?’ (bible 2009). the term ‘quantity surveying’ was first used in the united kingdom (uk) in 1859 and is still widely used in many other commonwealth countries (association of south african quantity surveyors [asaqs] 2014). other countries use different titles such as ‘construction economists’, ‘value engineers’ or ‘cost engineers’ (drake 1995). as the quantity surveying profession in south africa has its roots in the uk, it is important to compare factors that have influenced its survival and evolution over the years in both countries to establish how the profession can position itself to continue to add value to the society in future. research questions in order to determine quantity surveyors’ current and future possible role in public–private partnerships (ppps), a survey and a case study were conducted. the aim of the research instruments was multi-pronged and sought to determine: by quantity, how many quantity surveyors are currently involved in ppps? how familiar are quantity surveyors with ppps? what are the factors that influence quantity surveyors to participate in ppps? what perceptions have quantity surveyors regarding their education and training and how their education or perception thereof determines their participation in ppps? what is the value of further education in the non-traditional role of quantity surveyors? what are the current role players’, such as property developers and government officials, views regarding the services provided by quantity surveyors in ppps? literature survey ppp is one of the catalysts to the evolution of the quantity surveying profession in the uk (cartlidge 2006). quantity surveyors in the uk have been able to transfer their skills and competencies to ppp projects. in south africa, the profession of quantity surveying, as that of their british counterparts, has come a long way since the arrival of the first quantity surveyors in south africa in 1896 (asaqs 2009). currently, south african quantity surveyors play an important role in the local built environment industry and most of the private quantity surveying firms in south africa focus on the traditional functions of quantity surveying such as estimating and cost advice, advice on tendering and contractual arrangements, financial control over contracts, project close-out and dispute resolution (asaqs 2014). the above-mentioned functions can be executed in either the commercial or in civil, mining and infrastructure projects. ppps in south africa are still in their infancy (as discussed later in the article) and currently the department of public works (dpw) (1997) is the custodian of public infrastructure in south africa. quantity surveyors are regarded as cost-and-contract specialists in the built environment and their role in the provision of infrastructural projects cannot be overlooked. it is, therefore, important to investigate their role in ppps, and hence the research questions that were stated in the section ‘research questions’. the theories that underpin ppps fall broadly into three main categories (mouraviev & kakabadse 2012): a partnership as a policy tool a ppp as an organisational and financial arrangement ppp performance, risk allocation and critical success factors. there is no universal definition of a ppp (mouraviev & kakabadse 2012). grimsley and lewis (in mouraviev & kakabadse 2012) define a ppp as: …an agreement where the public sector enters into a long-term contractual agreement with private sector entities for the construction or management of public sector infrastructure facilities by the private sector entity, or the provision of services (using infrastructure facilities) by the private sector entity to the community – on behalf of a public sector entity. ppps are often confused with privatisation. in a ppp contract, the government would continue to provide core services, while the private sector would provide the infrastructure and other non-core services. the core services include services such as health, education, welfare and suchlike. non-core services include maintenance, cleaning, security and other services associated with the infrastructure. there is also a difference between ppps and the traditional procurement method. according to infrastructure australia (2008), in the traditional method of procurement, the private sector knowledge and expertise are limited to the construction period, whereas in a ppp the private party’s knowledge and expertise can extend to 20 years or more. furthermore, the private party’s risks are limited to defects during a liability period in a traditional procurement method, whereas in a ppp the private party’s risks are wide-ranging and long-term. the factors that may influence governments to enter into a ppp project include increased efficiency in public service delivery and national economic development plans (kelman 2007). in a developing country such as south africa, which has a severe backlog in physical infrastructure, ppps can be an alternative in meeting the demand for infrastructure (kelman 2007). abedian (2012) estimates the monetary value of the infrastructure backlog to be at r3.5 trillion. the national development plan (ndp) was adopted in 2010 by the south african government as its 20-year economic growth plan aimed at eradicating poverty and reducing inequality (kpmg south africa 2014). the south african government identified the provision of infrastructure as one of the major economic drivers and, in line with the vision and objectives of the ndp, adopted the infrastructure plan in 2012 (presidential infrastructure coordinating commission [picc] 2012). according to kpmg south africa (2013), r11.8 trillion is required to reach ndp’s target by 2030. the south african government recognises the need to partner with the private sector in order to meet the infrastructural needs of the country. trevor manual, the former south african finance minister, argues that: …the diverse interests of different sectors can, in fact, be harnessed for the collective good. this is what ppps are about. the public gets better, more cost-effective services; while the private sector gets new business opportunities. both are in the interests of the nation. (south african national treasury public private partnerships unit 2004) in 2000, the south african national treasury established the ppp unit in its ministry in order to regulate ppps in south africa (south african national treasury public private partnerships unit 2004). ppps in south africa are governed by treasury regulation 16 of the public finance management act, 1999, which defines a ppp as: …a contract between a public sector and a private party, in which the private party assumes substantial financial, technical and operational risk in design, financing, building and operation of a project. as of june, 2014, there were 69 ppp projects in preparation and registered, according to regulation 16 of the national treasury in south africa (national treasury ppp unit 2004). this number is a drop in the ocean as compared to the number of ppps completed in the uk. according to the house of commons (2011), over 700 public finance initiatives (pfis) worth over £60 billion (at 2010 prices) had been contracted (2011). pfis are ‘a type of ppp used to fund major capital investments’ (house of commons 2008). the south african ppp market is still in its infancy or stage 1. according to the united nations (united nations economic commission for europe 2008), stage 1 is where there are a few ppp projects in the market. given the south african government’s commitment to infrastructure development in the country, the market for ppp is set to grow. south african quantity surveyors, therefore, need to take their rightful place in the ppp market in south africa. research design the research philosophy adopted for this study was based on the following research question: what is the current and future possible role of quantity surveyors in ppps in south africa? the research strategies engaged were a questionnaire survey and a case study. surveys are classified under the positivist philosophy, while case studies may fall under positivism or interpretivism (saunders, lewis & thornhill 2009). the major deciding factors in the use of both survey and case study strategies were guided by the research question. according to saunders et al. (2009), surveys are ideal in answering ‘what’, ‘how much’ and ‘how many’ questions. in order to answer the aforementioned research question, a survey using a self-administered questionnaire was used to determine the number of quantity surveyors involved in ppps and the extent of their involvement in the ppps. the case study, on the other hand, was mainly chosen for triangulation purposes. together with the literature review, the case study provided important insights into what ppps are in the real-life context in south africa. the data collection techniques chosen for the study were guided by the research objectives. as ppps are still in their infancy in south africa, there is no database that captures the number of quantity surveyors in south africa who have participated in ppps. given the lack of such database, the best way to determine the number of quantity surveyors involved in ppps was to collect this information via a questionnaire, and therefore quantitative data collection. for the case study, personal and telephonic interviews were conducted, mainly to gain insight into what ppps are in south africa and how they are implemented. this is a qualitative data collection method. from the above, it is therefore clear that, for this study, a mixed-method research approach was used. online survey the survey population for the online survey was made up of quantity surveyors in south africa. as of 31 december 2014, there were 3813 quantity surveyors listed on the database of the south african council for the quantity surveying profession (sacqsp 2015). after obtaining approval from the research ethics committee of the faculty of engineering, built environment and information technology, university of pretoria, the survey was posted on the website of the asaqs. there were 10 900 subscribers to the asaqs newsletter, with a link to their website, as of 23 october 2014. in addition to the online survey posted on asaqs website, the researcher sent 887 emails containing a link to the survey to potential participants (all quantity surveyors) to increase the number of potential respondents. this can be considered a purposive sample based on information from the asasq’s centenary publication, the researcher’s personal database as well as the internet. the survey was created by the author through a survey software program called ‘survey monkey’, which is user-friendly and allows participants to respond anonymously. ‘survey monkey’ was also used to capture and analyse the data. data coding is performed automatically by the software, but the data were also double-checked by using microsoft excel. after the data had been verified by a statistician, the results were presented in bar charts to give theoretical meaning to the results. from a total of 80 survey respondents, 71 were used for data analysis. some responses were incomplete, while the information provided on others was incorrect. the 71 respondents, therefore, constituted the sample that was used to determine the level of participation of quantity surveyors in ppps in south africa. a general rule of thumb for selecting a sample size is that the bigger the sample size, the more accurate the prediction (kumar 2014). however, flick (2011) is of the view that a smaller sample is acceptable only if it avoids gross generalisation. a sample of 70 was therefore considered sufficient for the purposes of the research. the online survey questionnaire was divided into five sections. section 1 solicited background information from the respondents, that is, size of the firm, the geographic location, the economic sector of the firm and the career experience of the respondents, in order to determine whether all quantity surveying firms participate in a ppp or whether it is only the big, private firms in the more economically developed provinces. section 2 of the questionnaire focused on the respondents’ level of knowledge regarding ppps and participation in ppps. the respondents who had participated in ppps were required to provide further information regarding the party they were providing services for, quantity surveying services they provided, phases of ppp they worked in and the distinctive quantity surveying skills they applied in the project. the main objective of section 2 was to determine the quantity surveyors’ current role and future possible role. section 3 of the questionnaire was intended to determine the extent of quantity surveyors’ involvement in non-traditional roles to establish whether most quantity surveyors prefer their traditional roles over their other non-traditional roles. section 4 solicited perceptions regarding the education and competency of a quantity surveyor by using the likert scale. according to nkado (2000), there is a link between knowledge and competency. the main objective of section 4 was to determine whether quantity surveyors’ education and training has provided them with the skills and competencies that can be transferred to non-traditional roles. section 5 of the questionnaire solicited information regarding respondents’ additional education to their initial training. the aim of section 5 was to determine whether further education determined if quantity surveyors who had further training in non-traditional role were likely to undertake work in their non-traditional roles functions. case study design as stated previously, a case study design was also used to determine the extent of the quantity surveyors’ participation in ppps in south africa. the greatest advantage of a case study is that it verifies its findings from multiple sources of evidence (blumberg, cooper & schindler 2008). the participants in the case study interviews were representatives from both the public party and the private party. the quantity surveyor for the transaction advisor (the person responsible for the feasibility study) participated in the research through a questionnaire similar to the online survey. the questions posed were both semi-structured and unstructured questions, as both types of questions are recommended by blumberg et al. (2008) for a case study. data were obtained through personal and telephonic interviews. consideration was given to time, cost, preference and convenience when selecting the type of method to be used in data collection. qualitative data analysis was used to analyse the case study results. by using narrative conceptualisation, the data collected from the interviews were arranged into themes and then presented in tabular format. results the survey results the results background information: the majority of quantity surveyors (49%) are from firms that do not employ more than five people and are employed in private quantity surveying firms (75%). of the respondents who have worked in ppps, an overwhelming majority (86%) were from firms that employed 1–20 people and 71% of them were employed in private firms. most quantity surveying firms are located in gauteng (31%). the majority (38%) of quantity surveyors who have participated in ppps were based in gauteng, followed by kwazulu-natal (kzn) at 24%. of the respondents, 46% have 25 years of experience or more. of the quantity surveyors who have participated in ppps, 29% had over 25 years of experience. the overall combined majority of 58% had a career experience of 1–15 years. level of knowledge and participation in ppps: although 70% of the respondents stated that they are familiar with ppps, the majority (49%) of respondents acknowledged that their familiarity with ppps is only average. the majority (70%) of respondents have also never participated in a ppp project. forty-four per cent of the respondents, who have participated in ppps, rate their familiarity to ppps as average. sixty-two per cent of those who have participated in ppp were consulting for the public entity. estimating is the most offered service (76%) in ppps. other quantity surveying services, such as feasibility studies and financial control, also received high scores, averaging a percentage of 61%. respondents who participated in a ppp were more involved in the procurement (85%) phase of the project. the overall results, however, show that no ppp phase is more suitable for quantity surveyors than another. other phases, such as inception and feasibility, scored an average of 60%. forecasting and budgeting (81%) are the most distinctive quantity surveying skills offered by most respondents who have participated in a ppp. traditional and non-traditional role of quantity surveyors: project management as a non-traditional quantity surveying role is the most likely (76%) non-traditional role to be offered by quantity surveyors. most respondents (59%), however, seldom undertook work in non-traditional quantity surveying roles, with only 41% of the respondents indicating that they regularly undertook work in non-traditional quantity surveying roles. there were no respondents who never undertook work in non-traditional quantity surveying roles. lack of enough market (71%) was cited as the main reason why respondents seldom undertook work in non-traditional roles. quantity surveyors’ perceptions regarding their education and competency: initial education and training is regarded by the majority (75%) of the respondents as the reason for their competency in the traditional role of quantity surveyor. of the respondents who have worked in ppps, 60% believe that their education has adequately prepared them for their traditional role. of the respondents, 59% either absolutely agreed (15%) or somewhat agreed (44%) that their training has also adequately prepared them for the non-traditional role. for respondents who have worked in ppps, 24% absolutely agree and 38% somewhat agree that their education has adequately prepared them for their non-traditional role. only 43% of the respondents absolutely or somewhat agree that tertiary education has adequately incorporated courses on non-traditional roles in their training. of the respondents, 28% are unsure, 31% disagree somewhat and 4% absolutely disagree. of the respondents who have worked in ppps, 62% either absolutely agree (14%) or somewhat agree (48%) that tertiary education has adequately incorporated courses on non-traditional roles. the majority of respondents (52%) somewhat agree (43%) or absolutely agree (9%) that their competency in the non-traditional role can be attributed to their initial education from a tertiary institution. of the respondents who have worked in a ppp project, 43% somewhat agree and 14% absolutely agree that their competency in the non-traditional role can be attributed to their initial education from a tertiary institution. of the respondents, 35% somewhat agree or absolutely agree (32%) that they feel just as comfortable in their non-traditional role as they do in their traditional role. for respondents who have worked in a ppp, 70% somewhat agree (35%) or absolutely agree (35%) that they feel just as comfortable in their non-traditional role as they do in their traditional role. of the respondents, 86% somewhat agree (54%) or absolutely agree (32%) that their education and training, knowledge and skills could easily be transferred to their non-traditional role. of the respondents who have worked in a ppp, 81% somewhat agreed (48%) or absolutely agreed (33%) that their education and training, knowledge and skills were transferable to non-traditional roles; however, the majority of respondents somewhat agree (46%) and absolutely agree (26%) that they need additional training to participate in non-traditional roles. of the respondents who have worked in ppps, 50% somewhat agree and 25% absolutely agree that they need additional training to participate in non-traditional roles. of the respondents, 43% absolutely agree and 31% somewhat agree that non-traditional roles should be offered as certificate courses by tertiary or other institutions. for respondents who have worked in ppps, 50% absolutely agree and 25% somewhat agree that non-traditional roles should be offered as certificate courses by tertiary or other institutions. quantity surveyors’ further education: sixty-six per cent of the respondents do not have formal training in non-traditional role as compared to 75% of the respondents who have participated in ppps. the majority of the respondents have formal training in project management (75%), while 80% of the respondents who have worked in ppps have formal training in project management. according to most respondents (53%), the most useful training for their organisation would be in project management. for respondents who have worked in ppps, valuation (61%) was rated by the majority as the most useful training their organisation could use. project management, quantity surveying in engineering, facilities management and property development were all tied at second. case study results the results interview with the public sector: prior to the ppp project, there were no quantity surveyors employed within the department of education. quantity surveyors in the ppp were expected to determine the capital cost and the project risk. the services provided by the quantity surveyor were satisfactory and are highly recommended in future projects. apart from partaking in the ppp, the quantity surveyor provided additional services on an ad hoc basis. the public party regards quantity surveyors as the indispensable part of the team; however, the project officer had limited knowledge about the services provided by the quantity surveyor prior to the project and had never engaged the services of a quantity surveyor before. as a result of the services provided by the quantity surveyor in the project, the department (public sector) is now engaging the services of quantity surveyors in their various infrastructure projects. interview with the transaction advisor: quantity surveyors formed part of the transaction advisor’s team. the phases in which the quantity surveyors were involved in included feasibility studies and procurement. during the development, delivery and closure phases, the quantity surveyors were expected to check variation cost on an ad hoc basis. according to the transaction advisor, the quantity surveyor’s service on the project was excellent. prior to the ppp project, the transaction advisor had worked with a quantity surveyor before. the transaction advisor who was interviewed is an engineer by profession and has a good understanding of the role of quantity surveyors in the built environment. as quantity surveyors’ services are secured, there were no additional services provided by the quantity surveyor. the transaction advisor regarded quantity surveyors as vital members of the team and thus recommends them for future projects. questionnaire with the private party: the quantity surveyor (the respondent) in this ppp project has over 25 years of quantity surveying experience. the respondent works for a private quantity surveying firm that employs over 100 people. the firm is based in gauteng. the list of his clientele includes the public party, the private party (special purpose vehicle), transaction advisor, the consortium contractor, the lender (financial institutions) and the operators ‘sub-contractor’. the respondent has worked in numerous ppp projects in his career and therefore has a high familiarity with ppp projects. feasibility and viability studies, estimating and cost advice, financial control and whole-life cycle are the main quantity surveying services that are provided by the respondent in ppp projects. quantity surveying skills were used by the respondent in all the six phases of a ppp project. the main distinctive quantity surveying skills that were applied include measurement, contractual advice and arrangement, forecasting and budgeting, analysis, cost planning, cost controlling and whole-life cycle costing. the private quantity surveyor provides the following non-traditional role functions: dispute resolution, property development, facilities management and project management. the respondent somewhat agrees that his education and training has adequately prepared him for the traditional quantity surveying role. the quantity surveyor absolutely disagrees that his education and training has adequately prepared him for the non-traditional quantity surveying role. the respondent was unsure of the statement that tertiary education adequately incorporated courses on non-traditional roles in their training, and he absolutely disagrees that his competency in the non-traditional role is largely because of his initial education from a tertiary institution. the respondent’s response to the statement that he feels just as comfortable in the non-traditional role as in the traditional role was that he absolutely agrees. the respondent also absolutely agrees that quantity surveying education and training, knowledge and skills can easily be transferred to the non-traditional role. the respondent somewhat agrees with the statement that quantity surveyors need additional training to competently provide services in the non-traditional role, and the respondent also somewhat agrees with the statement that non-traditional roles should be offered as certificate courses by tertiary institutions or other institutions. the respondent indicated that there should be some formal training in non-traditional quantity surveying role. this training is in leadership and management, facilities management and ppp courses. discussion of the results discussion of the results of the survey discussion of the results: background information from the background information provided by the respondents, an inference can be drawn that the size of the firm and career longevity do not determine participation in ppps. the result, however, indicates that quantity surveyors who are most likely to participate in ppps are from private firms in more economically active provinces. gauteng and kzn are the two top contributors to south africa’s gross domestic product (gdp). in 2012, gauteng contributed 34.7% and kzn contributed 15.8% (statistics south africa 2013). discussion of the results: quantity surveyors’ level of knowledge and participation in ppps the results indicate that most quantity surveyors are familiar with ppps even though the degree of their familiarity is average. the majority of quantity surveyors who have participated in ppps also rated their familiarity to ppps as average. familiarity to ppps is therefore not a determinant of participation in a ppp. section 2 of the survey questionnaire yielded other interesting points. firstly, even though estimating was more likely to be offered in a ppp project, generally, there is no particular quantity surveying service that is more suitable for a ppp than any other. the same conclusion can be drawn regarding the most distinctive quantity surveying skill suitable for a ppp, although forecasting and budgeting are more likely to be offered. secondly, most quantity surveyors are more likely to be engaged in the procurement phase of the project but their skills are not limited to the procurement phase only. lastly, the public party is most likely to engage the services of a quantity surveyor in a ppp. in south africa, ppps are usually initiated by the public party and it is, therefore, expected that the public party will require the services of a quantity surveyor especially at the initial phases of the project to determine the capital cost of the project. the capital cost of the project is important in determining whether a project should pursue the traditional route or go through a ppp procurement process. discussion of the results: traditional and non-traditional role of quantity surveyors most quantity surveyors seldom undertook work in the non-traditional roles of the quantity surveyor as a result of the perceived lack of market. it is, therefore, the market that determines participation in the non-traditional roles and not preference to the traditional role. this conclusion was supported by the fact that the results indicated that many quantity surveyors have been involved in other non-traditional roles in their careers – with the majority of them being involved in project management. discussion of the results: quantity surveyors’ perception regarding their education and competency the majority of quantity surveyors’ perception of their education is that it has adequately prepared them for their traditional roles and non-traditional roles. they also believe that their skills can easily be transferred to their non-traditional roles. the results, however, highlight that education influences competency and that training in their non-traditional roles would be of great benefit in their performance in their non-traditional roles. discussion of the results: further education the majority of quantity surveyors, including those who have worked in ppps, do not have additional training in their non-traditional roles. the majority of those quantity surveyors who have additional training in non-traditional roles have their training in project management. therefore, a conclusion can be drawn that quantity surveyors are likely to participate in project management as a result of market influences or their education, or both. discussion of the results of the case study the public party, the transaction advisor and the private party regard quantity surveyors as important role players in a ppp project. quantity surveyors’ services and skills were highly recommended for future ppp projects by all the interviewees. from these results, two inferences can be drawn. firstly, quantity surveying skills can be transferred to their non-traditional roles. it is also plausible, even though not all conclusive, that the reason for the quantity surveyors’ limited participation is perceived lack of market as the major stakeholders are of the view that quantity surveyors’ skills are indispensable in a ppp project. from the results of the questionnaire of the quantity surveyors who have participated in a ppp project, a few conclusions can be drawn. additional education in a non-traditional role is beneficial but not necessary for participation in a ppp or any other non-traditional quantity surveying role. conclusion the results from both the survey and the case study highlight that quantity surveyors currently play a limited role in ppps, although they possess the necessary skills required in a ppp project. the major reason for their limited participation is not the lack of adequate education or preference to the traditional role but the perceived lack of the market and the economy. if the south african government’s ndps come to fruition, it is likely that ppps will be engaged in the delivery of many infrastructure projects. it can thus be concluded that quantity surveyors’ market share in the ppps will likely increase in the future. acknowledgements competing interests the authors declare that they have no financial or personal relationships which may have inappropriately influenced them in writing this article. authors’ contributions both the authors have contributed equally to the writing of this article. references abedian, i., 2012, south african infrastructure drive: beware of inappropriate financial structuring, political economy note, pan african investment and research services, johannesburg. ajalekoko, j.o., 2004, ‘branding the quantity surveying profession to meet the challenges of built environment’, paper presented at the fourth world congress for the international cost engineering council, cape town, 17–21st april. association of south african quantity surveyors (asaqs), 2009, a century of quantity surveying in south africa, chris van rensburg publications (pty) ltd., johannesburg. association of south african quantity surveyors (asaqs), 2014, the history of quantity surveying, viewed 19 april 2014, from http://www.asaqs.co.za/?page=history bible, 2009, true identity. the bible for women: new international version, zondervan bibles, mi. blumberg, b., cooper, d.r. & schindler, p.s., 2008, business research methods, mcgraw-hill higher education, london. cartlidge, d., 2006, new aspects of quantity surveying practice, elsevier butterworth-heinemann, oxford. department of public works, 1997, white paper on creating an enabling environment for reconstruction, growth and development in the construction industry, government printer, pretoria. drake, b., 1995, construction economics in the single european market for the committee of european construction economists, spon, london. flick, u., 2011, a beginner’s guide to doing a research project, sage, london. house of commons, 2008, private finance initiative – its rationale and accounting treatment, viewed 6 may 2015, from http://www.parliament.uk/documents/upload/0807pfi.pdf house of commons, 2011, private finance initiative 17th report of session 2010–2012, the stationary office limited, london. infrastructure australia, 2008, national public private partnership guidelines: overview, australian government, infrastructure australia. kelman, s., 2007, discussion paper on procurement issues in south africa that effect growth and development, harvard university, cambridge. kpmg south africa, 2013, planned infrastructure expenditure and the ndp: mind the gap, kpmg services (proprietary) limited, johannesburg. kpmg south africa, 2014, ‘unpacking the infrastructure development plan’, infrastructure, 6 march, viewed 5 december 2014, from http://www.sablog.kpmg.co.za/2014/03/unpacking-national-infrastructure-development-plan/ kumar, r., 2014, research methodology: a step-by-step-guide for beginners, sage, los angeles, ca. mouraviev, n. & kakabadse, n.k., 2012, ‘conceptualising public-private partnerships: a critical appraisal of approaches to meanings and forms’, society and business review 7(3), 260–278. https://doi.org/10.1108/17465681211271332 national treasury public private partnerships (ppp) unit, 2004, standardised public-private partnerships provisions, viewed 1 april 2014, from http://www.ppp.gov.za/legal%20aspects/standardised%20ppp%20provinsions/national%20treasury%20ppp%20practice%20note%20no%201%20of%202004;%20standardised%20ppp%20provisions;%20first%20issue;%2011%20march%202004_1.pdf nkado, r.n., 2000, competencies of professional quantity surveyors in a developing economy, university of port elizabeth, port elizabeth. presidential infrastructure coordinating commission (picc), 2012, a summary of the infrastructure plan, viewed 07 december 2014, from http://www.economic.gov.za/communications/media/press-releases-2012/196-summary-of-south-african-infrastructure-plan/download saunders, m., lewis, p. & thornhill, a., 2009, research methods for business students, pearson, essex. south africa, 2001, ‘public finance management act no.1 of 1999’, government gazette no 22141: 1–50, viewed 7 march 2014, from http://www.treasury.gov.za/legislation/pfma/act.pdf south african council for the quantity surveying profession (sacqsp), 2015, email communication with the author on 19 january 2015, johannesburg, viewed n.d., from http://sacqsp.org.za south african national treasury public private partnerships unit, 2004, public private partnership manual: national treasury ppp practice notes issued in terms of the public finance management act, national treasury public private partnerships unit [cd], pretoria. statistics south africa, 2013, statistical release p0441: gross domestic product – november 2013, statistics south africa, pretoria. united nations economic commission for europe, 2008, guidebook on promoting good governance in public private partnerships, geneva, united nations. sajems ns vol 7 (2004) no 1 58 customer service in the residential property market of south africa ________________________________________________________________ sharon rudansky-kloppers and johan strydom school of business management, unisa ________________________________________________________________ abstract an increasing number of estate agencies are entering the real estate market in south africa and many are struggling to survive as competition grows stronger. customer service has become of overriding importance to establish a differential advantage that will ensure long-term survival. this study investigates customer service by estate agencies in the residential property market of south africa. the results indicate that estate agencies seem to be aware of the importance of providing good customer service and of being service-oriented, but they do not always seem to realise the need to conduct marketing research and test the actual satisfaction of customers with the services provided, leaving a potential gap between what the customer wants and what the estate agency provides. jel l85 introduction buying a home is one of the major events in the life of most individuals. it is usually the single largest financial decision that a household makes and often it is a once in a lifetime event. for most people the experience is physically tiring and mentally draining. in the majority of cases, estate agents are the people who not only play the leading role when it comes to buying a home, but – as a group of people – probably exert the single largest influence of any group during this process. their guidance, knowledge, assistance and the way they conduct and execute their duties can have a profound effect on the buyer and the seller, and ultimately on whether or not a house is sold. the position of the estate agent could thus be regarded as a vital factor in the buying and selling of property. the estate agency industry has an exceptionally high personnel turnover, that is, influx and departure, of sales staff (verbal communication with the estate agency affairs board). according to experts in the industry, it is generally sajems ns vol 7 (2004) no 1 59 accepted that approximately 40 per cent of the industry is leaving while another 40 per cent is joining at any given time (verbal communication with the estate agency affairs board). estate agents seem to have such high expectations of making millions within a short period, that when their expectations are not met, they tend to leave the industry. this generally results in poor customer service. building good relationships with customers is a crucial aspect of any selling situation. the estate agent can thus determine the potential customer’s needs, demands and preferences and therefore only show him1 homes that fall into the category he prefers. ultimately, by taking cognisance of the customer's needs and rendering good customer service, the estate agent will receive his commission. even if the customer does not require a new home himself, a satisfactory encounter with an agent may result in good word-of-mouth communication about the agent. however, there is some concern about the customer service which estate agents and agencies currently offer to customers. according to futrell (2000: 379), customer service refers to the activities and programmes provided by the seller to make the relationship satisfying for the customer. lewison (1997: 492) defines it as all the “features, acts and information that augment the customer’s ability to realize the potential value of a core product or service”. very little research has been done in the past on estate agencies and particularly on their provision of customer service. this article provides more insight into this problem and presents the opinions of residential estate agencies on customer service. background entry of estate agents into the industry was made easier in april 1994 when it was announced that it was no longer compulsory for estate agents to write the estate agency affairs board examination. this examination was first introduced in 1984 and covers all aspects of the estate agency industry (verbal communication with the estate agency affairs board (eaab). prospective estate agents may now register with the board and serve what is known as a one-year candidate period, after which they are registered as estate agents. the comparative ease with which estate agents can now enter the market is, however, a matter of great concern to estate agents who have been in the industry for many years. they contend that the compulsory examination was appropriate because the estate agent deals with large monetary investments and this requires extreme professional service on the part of the estate agent. the impetus for the study came from the realisation that increasingly more estate agencies are entering the real estate market in south africa, and many are sajems ns vol 7 (2004) no 1 60 struggling to survive as competition grows stronger (verbal communication with the eaab). customer service becomes of overriding importance in an environment in which these businesses try to survive and compete with one another. hence, if they wish to establish a differential advantage that will ensure long-term survival, estate agencies will have to learn more about the effective marketing of their services, with the emphasis on rendering excellent customer service. according to kurtz and clow (1998: 308) a differential advantage is some feature or attraction which competitive offerings lack, that will provide satisfaction or understandable benefits to buyers. since estate agents are the principal asset and financial investment of an estate agency firm, no estate agency can grow in size and prosper without qualified, professional, motivated and devoted estate agents (verbal communication with the eaab). the estate agency, therefore, has to be able to attract successful or potentially successful estate agents. human resource management in the estate agency business is thus of the utmost importance. if such management is not conducted properly, unsuitable estate agents could be recruited who may not be able to conduct the selling process effectively, provide customer service and develop enduring relationships with customers, which ultimately means lost business and a bad reputation for the firm. hence, customer service is a critical feature of the estate agency industry. good service pays off because it creates true clients, namely clients who are glad they selected a particular estate agency, customers who will use the estate agency again and sing the agency's praises to family and friends, who in turn may become loyal clients. in south africa, 68 per cent of customers who leave a company do so because they are dissatisfied with the service they are receiving (cheales, 2000: 6). as early as 1987, le boeuf (1987: 13-14) realised the importance of good customer service with the following finding: "a typical business hears from only four per cent of its dissatisfied customers. the other ninety six per cent just quietly go away and ninety one per cent will never come back". according to truter (1993: 20), the provision of good customer service is a key success factor of estate agencies in south africa. in order to render quality service, estate agents should be knowledgeable and informed. an agent should not be tardy in offering customers the benefit of his expertise, even on an informal basis, because this will add value to the service provided, thus improving the chances of creating a differential advantage. estate agents are sometimes regarded as fly-by-nights by the general public, who perceive them to be intruders who make easy money. it is, therefore, up to sajems ns vol 7 (2004) no 1 61 the members of the profession to change this perception by building a sound reputation through the quality of the service they render. truter (1993: 20) indicates that the maintenance of high ethical standards and inherently good customer service throughout the whole selling process, can help convince the public that estate agents are not parasites and work hard to earn their money. simple practicalities and sound logistics are an integral part of customer service. no estate agent who forgets appointments, arrives late, has insufficient information available, or appears to be disorganised, is rendering a good service. quality service makes a solid contribution towards a good professional reputation and helps to retain customers instead of simply "getting" them. there are numerous definitions of service quality, but quality is generally viewed in the light of the functions which a product or service must deliver (consumer need satisfaction). futrell (2000: 379) indicates that the quality of service must be based on customer expectations. customers expect a certain level of service from the seller. their expectations are frequently based on information provided by the salesperson, past experiences, word-of-mouth and personal needs. when buyers perceive the service they receive as the kind of service they expected, they are satisfied. according to kotler (2000: 438), when expectations are exceeded, service is perceived to be of exceptional quality and also to be a pleasant surprise. conversely, when expectations are not met, service quality is deemed to be unacceptable. when expectations are confirmed by perceived service, quality is satisfactory. pride and ferrell (2000: 331) also contend that service quality is an indication of how well the service level delivered matches customer expectations and that the provision of quality service means consistently conforming to customer expectations. these authors indicate that service quality is the difference between consumers’ expectations of a service and the service they actually receive. with the above as background, it was decided to conduct research into the views of south african residential estate agencies on customer service and their perceptions of their delivery of customer service. the research objectives were to determine: the profile of the estate agencies investigated; whether estate agencies have mission statements which refer to factors such as customer need satisfaction and customer service; whether estate agencies regard the principles of the marketing concept as important; sajems ns vol 7 (2004) no 1 62 whether estate agencies consider the service orientation of estate agents during the selection, appointment and training of agents; the differentiation methods used by estate agencies to establish a competitive advantage; the after-sales services offered by estate agents; specific activities engaged in by estate agencies in order to ensure customer service; the corporate climate and internal marketing activities of estate agencies; the policies of estate agencies on customer complaints. methodology the data were collected by means of a mail questionnaire (addressed to the owner/manager) that was posted to 8 121 estate agencies (the population) in south africa who were all officially registered with the eaab. the research design was, therefore, a census instead of a sampling procedure (jankowicz, 2001: 198). the questionnaire contained screening questions which eliminated all returned questionnaires that did not involve residential estate agencies. the total number of returned questionnaires for residential estate agencies was 486, all of which were completed by either the owner or manager of the estate agency. these questionnaires were thus used to analyse the results. the data were subsequently captured and analysed by means of the statistical software program sas (statistical analysis system). various statistical analyses were conducted on the data in order to facilitate a discussion of the research results. cross-tabulations were also used to determine the effect of certain dependent variables on certain independent variables. for these purposes, a one-way frequency distribution was constructed that showed the frequency incidence of selected main variables in terms of absolute and relative values. analysis and results the analysis and results will be discussed in the same sequence as the objectives formulated earlier in the study. profile of the estate agencies the study revealed that the majority of estate agencies that were investigated are close corporations, while sole proprietorships constitute the second most popular form. most of the agencies (79,9 per cent) employ between one to 10 agents and between one to five support personnel. the majority of agencies have one to two directors. the findings reveal that the most popular target market for the agencies is middle-class families, followed by upper-class sajems ns vol 7 (2004) no 1 63 suburbs, while the third most popular target market is first-time buyers. mission statement a mission statement describes the nature of the organisation’s activities. the results indicate that most of the respondents do not know what a mission statement is. it should be possible to derive the following answers from a mission statement (strydom et al., 2000: 477): what is the nature of the business undertaken by the enterprise? who are the consumers? what are these consumers' needs? what is the nature of the internal resources and abilities at the disposal of the enterprise? how can the enterprise satisfy consumer needs? what environmental factors have to be taken into consideration? although a large percentage of respondents (51 per cent) indicated that they do have mission statements, it was found that only seven respondents seem to have mission statements which meet some of the theoretical requirements for a mission statement. the rest of the respondents seem to regard a mission statement as a slogan or objective. the findings indicate that most respondents (68,5 per cent) who have “mission statements” communicate them to their agents by means of training sessions and advertising and promotions. what is thus communicated to the agents, is not the nature of the enterprise’s activities and the organisation’s raison d’être in the light of long-range opportunity, but short-term sales objectives. in fact, in most instances the message conveyed could create more confusion for the agents, instead of helping them to understand the purpose of the enterprise. the marketing concept in terms of the marketing concept − a managerial code or philosophy guiding an organisation’s entire activities − an estate agency can only be effective and efficient if it accepts and applies the four principles of the marketing concept, namely consumer orientation, profit orientation, systems orientation and social responsibility orientation. the survey results reveal that the majority of respondents regard the four principles as vitally important. systems orientation was ranked first, consumer orientation second, and a long-term approach to profitability, third. the fact that consumer orientation was ranked second indicates that estate agencies do seem to regard the consumer and his needs as important. selection, appointment and training of new agents no estate agency can grow and prosper without qualified, professional, sajems ns vol 7 (2004) no 1 64 motivated and devoted estate agents. the study reveals that when hiring new agents, the majority of agencies (86,6 per cent + 6,2 per cent = 92,8 per cent) always or frequently consider the agent’s ability to work with clients when hiring employees. hardly any agencies do not consider this as an important variable. the criteria which estate agencies use when appointing new estate agents were also investigated. the unit of measurement used in the questionnaire design mainly allowed for the generation of ordinal data (rating questions). this allowed for a typical descriptive analysis option with the arithmetic mean as the ideal method. the mean was defined by the sum of all sets of values divided by the number of observations. the means in table 1 indicate that honesty/integrity (3,91) and interpersonal skills (3,76) are viewed as most important and second most important criteria when appointing new estate agents. personality (3,68) and service orientation (3,67) are ranked third and fourth by estate agencies as criteria for appointing new estate agents. since 84,3 per cent always or frequently consider service orientation when appointing new agents, customer service thus seems to be significant for estate agencies. the criteria seen as least important by respondents are completion of the board examinations (3,03), education and previous training (3,00), previous experience (2,74) and aggressiveness (2,70). it would thus appear that estate agencies are not overly concerned about qualifications or experience in the field of real estate when appointing new agents. table 1 criteria used to appoint new estate agents statements never % seldom % frequently % always % mean no response % honesty/integrity 0,8 0,6 4,3 87,2 3,91 7,1 interpersonal skills in dealing with clients 0,8 2,5 14,4 73,0 3,76 9,3 personality 0,8 2,1 22,4 66,0 3,68 8,7 service orientation 0,4 2,7 22,6 61,7 3,67 12,6 courtesy 0,6 3,5 21,6 63,8 3,66 10,5 practicalities (eg transport) 2,3 4,7 15,2 65,4 3,64 12,4 appearance 0,6 3,7 27,0 59,7 3,60 9,0 ambition 1,0 4,7 28,2 53,3 3,53 12,8 creativity in presenting the property to buyers 1,9 9,3 30,7 45,3 3,37 12,8 sajems ns vol 7 (2004) no 1 65 table 1 continued statements never % seldom % frequently % always % mean no response % judgement ability 1,9 9,7 38,1 37,0 3,27 13,3 physical stamina to perform well 4,1 16,9 29,4 31,0 3,07 18,6 completion of the board examinations 8,0 18,7 23,5 37,0 3,03 12,8 education and previous training 4,5 19,1 36,6 27,8 3,00 12,0 previous experience 9,1 24,5 34,6 19,5 2,74 12,3 aggressiveness 9,3 25,5 30,5 18,9 2,70 15,8 the results on the training process reveal that a large percentage (63,6 per cent) of estate agencies train estate agents themselves. of the respondents, 31,3 per cent are of the opinion that on-the-job training is adequate for agents, while only 25,1 per cent sponsor further study programmes for their estate agents. very few estate agencies (5,6 per cent) feel that no formal training is needed. table 2 indicates the focal areas in the training of estate agents. the high means obtained for all the training aspects indicate that most respondents always concentrate on all the areas mentioned in this question. professionalism rated a mean of 3,87, while the code of conduct of the eaab was rated second (mean = 3,84). qualifying the buyer/seller (mean = 3,69) and legislation (mean = 3,68) were rated third and fourth respectively. factors such as building long-term relationships with clients (mean = 3,62) and after-sales contact with the buyer/seller (mean=3,58) also rated high means, which is encouraging since these are key components of customer service. table 2 focal areas in the training of estate agents training areas never % seldom % frequently % always % mean no response % professionalism 0,6 0,2 8,0 73,0 3,87 18,2 code of conduct of the estate agency affairs board 0,4 2,3 7,8 71,8 3,84 17,7 qualifying the buyer/seller 0,6 2,3 18,5 59,1 3,69 19,5 legislation on estate agents 0,6 3,5 16,3 59,3 3,68 20,3 inspecting the property 1,0 3,7 16,5 60,3 3,67 18,5 knowledge of the market 0,8 1,2 23,0 56,0 3,65 19,0 sajems ns vol 7 (2004) no 1 66 table 2 continued training areas never % seldom % frequently % always % mean no response % building long-term relationships with clients 0,8 4,5 19,3 56,8 3,62 18,6 assisting the buyer in obtaining finance 0,8 4,1 21,0 55,3 3,61 18,8 after-sales contact with the buyer/seller 1,2 3,3 24,1 53,3 3,58 18,1 how to work with mandates 1,9 2,7 25,7 49,6 3,54 20,1 the personal selling process 1,2 3,3 27,6 47,9 3,53 20,0 showing selected properties 1,0 6,0 25,5 46,5 3,49 21,0 advertising the property 2,1 5,8 28,0 45,3 3,44 18,8 in order to provide good customer service, the estate agent should take certain consumer-behaviour influences into account when attempting to sell his services. it was thus essential to determine whether customer-behaviour factors are also covered in the training programmes of estate agencies. table 3 reveals that on the three-point scale, the two factors which are discussed in greater detail than the others at training sessions, are buyers’ income/financial status (mean = 2,33) and buyers’ reasons for buying property (mean = 2,30). all the other factors rated means of less than two and are not discussed in great detail at training sessions. these include socio-demographic factors, learning and perceptual ability, pressure from social groups, the buyer’s lifestyle and the influence of the family. it is worrying that these factors are not included in training programmes to a greater extent, because agents need to be aware of them in order to render satisfactory customer service. cross-tabulations indicate a link between those agencies concentrating on the buyer’s income or financial status, at the same time claiming that they are consumer-oriented. however, these respondents sometimes appear to concentrate more on the buyer’s financial position than on his actual needs and the consumer behaviour influences. in order to be consumer-oriented and to provide excellent customer service, estate agencies need to concentrate on all the consumer behaviour influences and not only on financial means which is but one group of consumer behaviour variables. differentiation methods the methods which estate agencies use to differentiate themselves from competitive agencies were also investigated. it was found that the differentiation methods used most are total commitment to clients (80,2 per cent), best service quality (77,4 per cent), superior market knowledge (57,4 per cent), and involvement in community affairs (39,7 per cent). sajems ns vol 7 (2004) no 1 67 table 3 customer behaviour factors covered in training programmes knowledge of customer behaviour not applicable to our agency % mentioned briefly % discussed in detail % mean no response % buyer’s income/financial status 1,9 10,9 69,8 2,33 17,4 buyer’s reasons for buying property 1,9 14,0 66,7 2,30 17,4 the influence of the family on buyer behaviour 7,0 31,9 41,8 1,96 19,3 the effect of the buyer’s lifestyle on buyer behaviour 9,5 33,7 36,6 1,87 20,2 the learning and perceptual ability of buyers/sellers 7,8 36,6 34,4 1,84 21,2 the role of social demographic factors (age, language, education, occupation) in customer behaviour 9,7 33,7 35,6 1,84 21,0 the effect of pressure from social groups on buyer behaviour 19,5 36,2 21,6 1,57 22,7 cross-tabulations indicate that more than 68 per cent of respondents who indicated that they do marketing research and have superior market knowledge and the best service quality, actually do conduct research into these areas. unfortunately, approximately 30 per cent of respondents who indicated that they do not do marketing research still maintain that they offer the best service quality and have superior market knowledge. these respondents do not understand the linkage between marketing research and providing the best service quality and superior market knowledge. after-sales services respondents were required to indicate the after-sales services their estate agents render. the high means rated for the four-point scale in table 4 clearly indicate that most respondents make use of the after-sales services listed in the table. for example, the forwarding of a copy of the sales contract to conveyancing attorneys and the purchaser rated a high mean of 3,97, while following up with conveyancing attorneys on progress or problems experienced rated a mean of 3,92. the length of time during which the agent keeps contact with clients was also covered in the survey. of the respondents, 40,1 per cent indicated that they keep contact with respondents for more than a year while eight per cent keep contact for a year, 28,2 per cent for six months, 13,8 per cent for a month and sajems ns vol 7 (2004) no 1 68 5,8 per cent for a week. table 4 after-sales services offered by estate agents after-sales services never % not sure % sometimes % always % mean no response % forwarding a signed copy of the contract of sale to the conveyancing attorneys and purchaser 0,2 0,2 1,6 96,7 3,97 1,3 following up with the conveyancing attorneys on the progress/problems experienced with the transfer in order to give feedback to the buyer and seller 0,2 0,4 6,2 92,2 3,92 1,0 informing the seller of progress made in bond applications/transfer of property 0,2 0,4 12,3 86,4 3,86 0,7 informing the buyer and seller when the transfer occurs 1,2 0,4 12,1 85,4 3,83 0,9 being available to act as an intermediary in any disputes which may arise between the buyer and seller 0,6 0,8 14,6 82,9 3,82 1,1 informing the conveyancing attorney when the loan application has been submitted 2,5 0,8 10,3 84,8 3,80 1,6 supplying the conveyancing attorneys with the name of the current bond holder and account number, as well as the name of the person or attorneys to contact in this regard 2,5 1,0 17,1 78,0 3,73 1,4 presenting the buyer with a small gift on the day of occupation 9,3 3,1 42,0 44,0 3,23 1,6 establishing the whereabouts of the title deed of the property in order to inform conveyancing attorneys 14,0 1,4 34,0 47,5 3,19 3,1 keeping contact with the buyer after occupation (birthdays) 10,3 6,6 47,3 33,5 3,07 2,3 presenting the seller with a small gift after completion of the transfer 27,4 7,8 40,5 19,3 2,55 5,0 customer service activities and attributes good customer service creates true clients, namely clients who are glad they selected a particular estate agency, customers who will use the estate agency again and positively promote the agency to family and friends who, in turn, may sajems ns vol 7 (2004) no 1 69 become loyal clients. the survey investigated whether estate agencies engage in activities to deliver customer service (see table 5). table 5 activities to deliver customer service and quality statements never % seldom % frequently % always % mean no response % we discuss customer complaints with estate agents. 2,7 4,5 20,6 67,7 3,61 4,5 estate agents often work together to deliver high-quality service to clients. 1,2 4,9 28,8 57,8 3,54 7,3 estate agents are involved in the setting of service quality standards. 2,1 4,1 32,1 54,5 3,50 7,2 estate agents are informed of marketing plans. 2,1 4,5 32,1 53,1 3,48 8,2 estate agents are free from restrictions when selling properties. 12,6 12,6 25,1 39,9 3,03 9,8 we look at other service industries to learn more about service quality. 6,8 18,9 40,9 26,7 2,94 6,7 management interact with customers to determine their experience with support personnel. 8,8 23,0 37,9 22,0 2,80 8,3 there is a formalised feedback system with management for estate agents to share their experiences with customers. 16,3 21,0 25,9 26,5 2,70 10,3 we administer a formal questionnaire immediately after a transaction about the customer’s satisfaction with estate agents. 42,4 27,2 11,5 9,1 1,86 9,8 the means in table 5 reveal that most estate agency firms discuss customer complaints with the estate agents (mean = 3,61). a large number of respondents also indicated that their estate agents work together to deliver quality service (mean = 3,54), that their agents are involved in the setting of service quality standards (mean = 3,50) and that their agents are informed of marketing plans (mean = 3,48). the two activities which were ranked lowest are a formalised feedback system for estate agents to share with management their experiences with customers sajems ns vol 7 (2004) no 1 70 (mean = 2,70) and the administration of a formal questionnaire immediately after a transaction about the customer’s satisfaction with the estate agent (mean = 1,86). when identifying the differentiation methods, the respondents previously ranked the rendering of service quality to buyers as very important, and it is thus surprising that they now ranked these two activities, which are effective in establishing customer needs and satisfaction, as the lowest. cross-tabulations reveal that a large percentage of respondents who indicated that they would like to portray an image of excellent customer service, do engage in activities to portray this image. they always discuss customer complaints with agents and their agents collaborate to provide quality service. they therefore seem to realise that these are crucial customer service activities. unfortunately, less than 60 per cent of the respondents indicated that they engage in other customer service activities whilst wishing to also present an image of excellent customer service. this is worrying since no estate agency can portray an image of customer service excellence if it does not engage in all the crucial customer service activities, instead of only some of them. corporate climate and internal marketing employees in the estate agency should be well trained in customer service and be aware of the fact that their own job satisfaction ultimately rests on the success of the agency in the market. before an estate agency can generate satisfied and loyal customers, it must first ensure employee satisfaction and loyalty through the intensive management of internal relationships. the results of the survey reveal that the majority of respondents apply internal marketing activities such as evaluating advertising campaigns by consulting employees, discussing marketing plans with their employees and training employees to deal with customers. the survey also reveals that the majority of respondents strive to create a positive corporate culture in their agencies. for instance, they agree that all agents are always free to communicate their views to management and that everyone in the agency realises that the needs of clients are their priority. customer complaints the policies of respondents on customer complaints were tested in the survey. table 6 shows that complaints are referred to management in 77,2 per cent of the agencies. in 62,8 per cent of the agencies, complaints are discussed at meetings and in 67,3 per cent of the cases recurring complaints are investigated thoroughly. only eight per cent of the respondents indicated that a complaint book or list is kept for future reference, while a meagre 5,1 per cent indicated that they have no policy on customer complaints. sajems ns vol 7 (2004) no 1 71 table 6 customer complaints policies percentage frequency % no response we have no such policy 5,1 94,9 complaints are dealt with by the agent involved 52,7 47,3 complaints are referred to management 77,2 22,8 a complaint book/list is kept for future reference 8,0 92,0 complaints are often discussed at meetings 62,8 37,2 recurring complaints are investigated thoroughly 67,3 32,7 (multiple answers were obtained from respondents.) conclusions and recommendations all the objectives of the study were accomplished and the main findings are summarised below. the results of the study indicate that although a large percentage of the agencies indicated that they have mission statements, only seven have mission statements which meet some of the requirements for mission statements. the agencies seem to regard a mission statement as a slogan or objective. it can thus be concluded that the majority of respondents do not know what a mission statement is, leaving much room for education in this regard. such training could result in eliminating any uncertainty in terms of the basic purpose for the existence of the agency and what it should work towards in the light of longrange opportunity and the overall survival of the agency. when selecting and appointing new agents, the majority of agencies consider service orientation as important. it was, however, disconcerting to find that estate agencies are not overly concerned about qualifications (eg. completion of the board examinations) and previous experience in the real estate field when appointing new agents, since these are factors which could influence the way agents interact with clients as well as the services they provide to customers. where training is concerned, the survey reveals that the majority of respondents train estate agents themselves, with the resultant threat of in-breeding. during training, the majority of agencies concentrate on topics such as qualifying the buyer or seller, after-sales contact with the buyer or seller and the building of long-term relationships with clients. these are encouraging findings since these topics are key components of customer service. the findings reveal that the two sajems ns vol 7 (2004) no 1 72 customer behaviour factors covered most in training are income or financial status and the buyer’s reasons for buying the property. unfortunately, none of the other customer behaviour influences are discussed in great detail during the training of estate agents. cross-tabulations also reveal that respondents focus more on the buyer’s financial position than on his needs and the consumer behaviour influences. estate agencies need to be made aware of the importance of appointing agents with experience and training, since they tend to be better informed of the correct steps to take when selling a home, as well as of the principles of customer service, resulting in hopefully higher levels of customer satisfaction. the differentiation methods used most by both groups of respondents are total commitment to clients, best service quality and superior market knowledge. cross-tabulations reveal that a large percentage of the agencies do not research these areas of differentiation. although these respondents are of the opinion that they offer the best service quality and have superior market knowledge, it is impossible to do so without in-depth knowledge obtained by thorough marketing research. estate agencies should therefore do more research into areas such as delivering quality service and the market as this will enable them to better analyse the needs of customers and thus to render good customer service and strengthen relationships with customers. the survey results indicate that the majority of agencies engage in activities to ensure customer service, for example, they discuss customer complaints with estate agents, their agents work together to render quality service and also help to formulate quality standards. it is surprising that the two activities ranked the lowest, are a formalised feedback system for agents to share experiences with management and administration of a formal questionnaire after a transaction to test customer satisfaction. if estate agencies make use of formal feedback systems and questionnaires to test clients’ satisfaction with their services, they can adapt their strategies to the needs of customers and thus provide a better quality service, hopefully resulting in long-term relationships with clients. the survey reveals positive findings in terms of corporate climate and internal marketing. the results reveal that the majority of agencies engage in internal marketing activities. most of the agencies, for instance, evaluate advertising campaigns by consulting employees, discuss marketing plans with employees and train them to deal with customers. the majority of agencies also strive to create a positive corporate culture. respondents indicated that all agents are free to communicate their views to management and that everyone in the agency realises that the needs of clients are their priority. sajems ns vol 7 (2004) no 1 73 in conclusion it can be stated that estate agencies seem to be aware of the importance of providing good customer service and of being service oriented, but they do not always seem to realise the need to conduct marketing research and test the actual satisfaction of customers with the services provided, leaving a potential gap between what the customer wants and what the estate agency provides. endnote 1 in this article, for stylistic purposes, any reference to one gender shall include the other gender. references 1 anon (2000) “finance and manage your home loan” july/august: 11. 2 bennett, j.a. & strydom, j.w. (2001) introduction to travel and tourism marketing, juta: lansdowne. 3 christopher, m., payne, ass. & ballantyne, d. (1991) relationship marketing, butterworth: oxford. 4 cheales, p. (2000) i was your customer, johannesburg: zebra press. 5 clegg, b. (2000) the invisible customer, kogan page: london. 6 finance week (2002) “do your sums before you upgrade”, 8 march: 13. 7 futrell, c.m. (2000) abcs of relationship selling, mcgraw-hill: singapore. 8 grönroos, c. (2000) service management and marketing, wiley: new york. 9 gummesson, e. (2000) total relationship marketing, butterworth: woburn. 10 jankowicz, a.d. (2001) business research projects, (3rd ed.) business press: london. 11 kotler, p. (2000) marketing management. the millennium edition, prentice hall: new jersey. 12 kurtz, d.l. & clow, k.e. (1998) services marketing, wiley: new york. 13 lewison, d.m. (1997) retailing, new york: macmillan. 14 pride, w.m. & ferrell, o.c. (2000) marketing concepts and strategies, houghton mifflin: boston. 15 readers digest (2000) ”estate agents still ripping us off?”, may: 107. sajems ns vol 7 (2004) no 1 74 16 strydom, j.w., jooste, c.j. & cant, m.c. (2000) marketing management, juta: kenwyn. 17 sunday times (2002) “residential sector shrugs off interest blow”, business times, 3 march: 21. 18 truter, c. (1993) the real estate industry, van schaik: pretoria. abstract introduction knowledge management maturity mapping for continuous improvement research methodology ethical consideration discussion of key findings conclusion acknowledgements references appendix 1 appendix 2 about the author(s) mlungisi mthembu department of information and knowledge management, university of johannesburg, south africa tanya du plessis department of information and knowledge management, university of johannesburg, south africa citation mthembu, m. & du plessis, t., 2018, ‘maturity mapping for continuous improvement: a case study of a revenue services institution’, south african journal of economic and management sciences 21(1), a2044. https://doi.org/10.4102/sajems.v21i1.2044 original research maturity mapping for continuous improvement: a case study of a revenue services institution mlungisi mthembu, tanya du plessis received: 04 aug. 2017; accepted: 19 aug. 2018; published: 25 oct. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: continuous improvement is a topic that organisations sometimes avoid since it identifies areas lacking business excellence. continuous improvement is possible in organisations that take a holistic approach to managing knowledge, which gives them the ability to continue to innovate and sustain their value creation to their stakeholders. aim: the levels of knowledge management maturity in the tax audit business unit of a revenue services institution had to be identified in order to provide guidance on how to improve and contribute to future information and communication technology (ict) strategy planning. setting: the ict strategy planning process at the revenue services institution identified a gap in how it managed information and knowledge. this indicated a discrepancy in knowledge management (km) maturity. method: a deductive approach was followed, motivated by analysis of tested and well-researched theories to create a theoretical framework. this was then tested against empirical research conducted in a specific business unit. descriptive statistics in the form of frequencies, proportions, and means were obtained from the data, to describe the patterns and trends in the data set. results: the key findings confirm that generally the value of km is well regarded. barriers exist and levels of consensus generally drop as the levels progress towards the highest km maturity level, mostly lacking in terms of continuous improvement. conclusion: the conceptual km framework developed from this study will give revenue services institutions insights on how to innovate and sustain their value creation to their stakeholders. the desired activities for adoption of the framework will help achieve continuous improvement of a revenue services institution. introduction the strategies of revenue services institutions (rsis) are integral to a country’s overall development. gcabo and robinson (2007:358) argue that ‘as the developing world becomes more deregulated and integrated’, it is important that ‘tax strategies and/or tax policies be appropriately designed and continuously monitored’. this article builds on the argument, accentuating the need for continuous improvement based on sound knowledge management (km) practices. an organisation gains a competitive edge through what it knows, how it uses what it knows, how fast it can know something new, and how well it uses this knowledge to continuously improve itself for the purpose of its value proposition to clients (carlucci 2016; davenport & prusak 1998). in order to achieve business excellence, organisations have to continue to innovate and improve their practices. continuous improvement requires formal structures, methods and processes to manage its most valued intangible asset, that is, knowledge. knowledge management is necessary for sustainable value creation (smith, mckeen & jenkin 2009:8). while km takes centre stage in highly innovative organisations, many organisations have not adopted a holistic km approach throughout all their business units (esterhuizen 2012; langen 2000). discrepancies within a single business unit may cause km maturity delays (ehms 2001; langen 2000). organisations such as rsis have many business units, each striving towards optimal customer service delivery. the motivation for this study was to gain a deeper understanding of km maturity within a rsi in africa in order to inform its future information and communications technology (ict) strategy planning. based on this motivation, the perceived km maturity levels of the tax audit business unit, specifically of the assessment of income tax for both individual and company entities, were identified as the research gap. the ethical guidelines of the university of johannesburg suggested that all case studies employ the practice of anonymising empirical findings; in this study the institution is referred to as ‘the rsi’. in order to address the research problem, this study aimed to develop a suitable framework that would assist with mapping of the perceived km maturity levels of the rsi’s individual and company taxpayer entities. in order to develop the framework, these four research objectives applied: gain insight on the level of consensus about the value of knowledge in the organisation. determine the perceived value of lessons learned and of sharing lessons in order to ensure continuous improvement. identify the role of existing information infrastructure for retention and retrieval of knowledge. test the level of consensus of the role of leadership in creating a knowledge sharing culture. this would give an indication of how the rsi’s tacit knowledge is utilised or transformed to explicit knowledge in order to enable the continuous improvement of service delivery. since this was the first study of this nature at the rsi, an assessment of the maturity of km could take many forms. this study focused its investigation on a single case, simplified by following a knowledge management maturity model (kmmm) adopted for this study. generally, the levels of kmmms give an indication of how well the km function is organised. only if km is well organised, can it truly contribute to continuous improvement, and enhance organisational performance and achieve business excellence (carlucci 2016; rašula 2012). this article begins by providing the theoretical evidence used to construct the conceptual km framework. the research method, with an explanation of the case study research design, precedes the analysis and discussion of the research findings of km maturity. the article concludes with recommendations on adopting the conceptual km framework. the value of the study is towards strategic and tactical levels with the intention to address km maturity shortcomings. knowledge management maturity mapping for continuous improvement defining the concept of knowledge management will create better understanding in the broader context of management and economics sciences. probst (2005:22) defines knowledge as ‘the entirety of proficiency and skills that individuals use for problem solving’. that means all theoretical skills, as well as rules on how to act. knowledge uses data and information, but is always connected to individuals (probst 2005). knowledge is developed from individuals and represents the expectations about cause-and-effect relations (probst 2005). in business management, drucker (1988) accentuates the fact that without knowledge, organisations cannot add desired value in their endeavour to satisfy customers. drucker (1988) argues: knowledge results when the intellect (capacity to think) does a purposeful work using data and information. it generates new products, powers new processes, and spawns new materials. it affects all levels and functions in organisations. every individual is now a knowledge worker. (p. 47) given these definitions of knowledge, business management is defective without knowledge management. km applies in business as much as in government and non-profit organisations. some of the known benefits of km in local government found by ezra and smith (2009), gaffoor and cloete (2010) include: km creates the opportunity for employees to develop their skills, performance, and experience through group work and knowledge sharing. km improves organisational performance by means of better quality, innovation, productivity, and efficiency. km facilitates better decision-making, more collaboration, restructuring of organisational processes, and a decline in the duplication of work, consequently cutting operational costs and improving service delivery. km increases the financial worth of an organisation. knowledge sharing creates value in an organisation and strategically enables a competitive advantage. km supports intelligent choices, using limited resources, in order to execute the strategy of learning how to continue to improve. although these benefits give km its leverage, km activities have to be measured in order to make them more visible and positioned at strategic level (langen 2000:12). the barriers of km are noticeable especially in the public sector. paulin and suneson (2012:81) define knowledge barriers in the context of knowledge sharing and transfer, distinguishing the thin line between knowledge transfer and sharing. a knowledge barrier is a failure in knowledge transfer, and consequentially the barrier becomes interchangeably the failure to transfer knowledge (paulin & suneson 2012:88). barriers of km are broadly categorised as personal and organisational barriers (bernuy 2012; probst 2005). examples of these barriers are lack of awareness, poor leadership, lack of top management support, lack of motivation, lack of time and effort, no incentives, poor planning, and poor perception of value (benmoussa 2009:902–903). implementing km in the public sector is generally more difficult than in the private sector, owing to existing barriers and the complexity of stakeholder requirements (mcadam & reid 2000; united nations eclac 2013). the public sector goals aim at improving quality of life of citizens, economic growth, and environmental development, more than on profits. this dilemma requires km experts to help public sector managers and leaders to have a paradigm shift in addressing knowledge gaps and leveraging km for better outcomes in an integrated manner across all spheres of public sector entities. a specific focus is required in removing barriers to ensure better knowledge flows across, for instance, the value chain of a rsi. the theory of mapping km to measure maturity of knowledge practices in an organisation applies. knowledge management maturity models in km, maturity levels define an organisation’s capability to manage knowledge assets to ensure the continuous improvement of business through its lessons learned (ihrig & macmillan 2015; kulkarni 2007; weerdmeester, pocaterra & hefke 2003). it also broadly measures an organisation’s capability to initiate action once tacit knowledge is transformed into explicit knowledge. this may be in the form of innovation or decisions taken that improve business performance or enhance customer or stakeholder value (kulkarni 2007). maturity models typically have levels that are characterised by specific requirements and one level follows on another in a sequential manner (weerdmeester et al. 2003). usually, incremental layers of perfection determine the order of each level, and some models have punctuated equilibrium (sabherwal, hirschheim & goles 2003:331). entities are typically measured as they move upwards or progress forward to the next level. as a rule, levels cannot be skipped. most maturity models have common characteristics such as people, process and technology. for the purpose of this study, kulkarni’s (2007) maturity model was adopted (figure 1). figure 1: knowledge management maturity model. kulkarni’s (2007) model was best suited because it incorporated the km enablers that emerged in this study’s theoretical framework. knowledge management enablers and the importance of trust there are certain key km enablers required for effective km practices to be in place and poor focus on any of the enablers can act as a barrier to km. four common enablers of km emerged from the literature, namely leadership, people, culture, and information technology (almudallal et al. 2016; esterhuizen 2012; renzl, matzler & mader 2016; zhang 2014). also, researchers stressed the importance of trust in knowledge sharing. in this study’s context, trust refers to the confidence people have in knowledge shared by other people. the impact of trust on knowledge sharing among employees in public service is significant (zhang & jiang 2015:277–290). trust, as defined in this study, is the degree to which a person is willing to acknowledge another person’s intention as good (renzl et al. 2016:7). for example, the ibm institute for knowledge-based organizations (2002:1–11), conducted a study on the relationship between knowledge sharing and trust. they make a distinction between two types of trust, namely benevolence-based trust and competence-based trust. the commonly known trust is benevolence-based, in which an individual will not intentionally harm another, given a chance to do so. however, in knowledge sharing, competence-based trust plays a pivotal role as it is the pillar of a relationship in which an individual believes that another person is a subject matter expert in a specific area (ibm 2002:8). trust, commitment, cost, and the need to innovate and improve existing practices are the enablers that influence knowledge sharing (adner & snow 2010:76; casimir, lee & loon 2012:740). the literature reviewed in this study included the case studies and formative research of galliers and leidner (2014) and galliers and stein (2018), which contributed to the list of aspects included in km maturity mapping for this study (see appendix 1): clear communication generally contributes to trust within a business unit. km goals have to be specifically communicated to all in the organisation. organisational values support knowledge sharing in a business unit. expert knowledge is valued and rewarded. training has to be regularly scheduled to bridge knowledge gaps within a business unit. in this study of maturity mapping for continuous improvement of the rsi, a priori was that its ict strategy planning comprise strategic information management (sim) principles. the application of sim in the internal and external business environment improves leadership, innovation and continuous business improvement (galliers & leidner 2003:9; galliers & stein 2018). the underlying premise of this study was that good km practice, which includes sim, leads to efficiency, effectiveness and continuous improvement. the principles that the rsi should consider in order to increase its km maturity were established from literature and tested in practice. km theory and the adoption of kulkarni’s (2007) maturity model in this study formed the kmmm used as the test instrument in the empirical study. research methodology an empirical study followed on the literature study of the role of km in organisational learning for continuous improvement. the researchers considered how to measure maturity in different domains and then identified km maturity indicators (kmis) based on their function as km enablers. the approach was deductive and used descriptive statistics. the research findings were utilised in a quantitative research approach (figure 2). figure 2: research approach. the research philosophy was positivism, focusing on cause and effect, which assisted the researcher to make deductions. characterised by cause-and-effect epistemology, the study singled out one business unit in the rsi value chain as opposed to the entire organisation. in terms of this study’s reliability and validity, it is important to note that the study did not consider all aspects of all existing kmmms. instead, the relevant levels and indicators were pertinently covered. the study did not include the elements of strategy and processes of the entire organisation, it only covered limited scope focusing on kmis that would be most relevant to the selected business unit function of the rsi (figure 3). figure 3: revenue services institutions value chain. figure 3 illustrates the rsi’s high-level value chain in order to position this study’s unit of observation in terms of its participation as a business unit with the role of assessment of tax, namely individual and company audits. sound judgment is required based on facts and interpretation of the country’s tax law, which makes this business unit ideal for maturity mapping. research design the case study method, with a questionnaire categorised in kmmm themes, tested the levels of capability according to specific themes. based on leedy and ormrod’s (2010:187) description of the case study research design, a case study was most suited to obtain information relating to participants’ perception categories and levels of km maturity within the rsi. the literature review produced kmis and kmmm themes, used to test capability levels on how the value of knowledge was perceived, the value of sharing lessons learned, leadership role in creating an enabling environment, knowledge sharing culture, and the availability of technology and processes for km within the rsi (mthembu 2016). more specifically, research focus was on the tax compliance business unit, which is a sub-unit of the tax and individual business unit mainly focusing on ensuring compliance with regard to taxpayer records and tax affairs. this unit has a national footprint located in all branch offices, which deals with assessment of all direct and indirect tax declarations that are complex and require human intervention and expertise. it has tacit knowledge acquired through experience and learning plays a pivotal role in service quality and improvement of turnaround times. this unit’s core business deals mainly with the interpretation of tax laws in order to perform accurate assessments and the high reputational risk puts pressure on management; therefore, it is best suited for this case study. research sample the first order of sampling criteria applied the purposive sampling technique, which required individuals who in their daily assessment of tax compliance were utilising mostly tacit knowledge to resolve complex cases within stipulated service levels. the compliance unit was selected for participation in this research. the second order of sampling criteria made use of simple random sampling to involve managers, auditors, quality assurers, and specialists within each stratum (mthembu 2016). every member had an equal chance of being selected (leedy & ormrod 2010:207), which is characteristic of the positivist research paradigm. the sample size was 126 which is 40% of the entire business unit. in order to be able to generalise the research findings, the sampling method had to be appropriate and the sample size had to be exact in order to ensure representative results (fox 2009:8). the targeted sample was 126 respondents and 102 responses were received, resulting in a response rate of 81%. data collection and analysis techniques mono-method data collection was performed using an electronic questionnaire created with freeware (survey monkey). participants had to give specific responses of yes or no to statements given, depicting different levels of maturity, specifically for themes on perceptions of the value of knowledge, lessons learned, leadership role, culture, and trust. research ethics guided the data collection process, which meant a formal request for consent was sent to the executive of the compliance unit after having discussing the research and the value it proposed to the rsi. only after obtaining consent, did the executive distribute the questionnaire to senior managers, requesting them to distribute to their team members. the voluntary nature of participation at individual level and the contract of confidentiality allowed candid participation. descriptive statistics in the form of frequencies, proportions, and means were obtained from the data to describe the patterns and trends in the data set. the chi-square test of homogeneity was used to determine whether there was uniform distribution of responses across categories, that is, whether the proportions were equal across categories (mthembu 2016). in addition, the chi-square test of homogeneity tests the claim that different populations share the same proportion of specified characteristics (brase & brase 2015). in this case, the chi-square test of homogeneity was used to determine whether the proportions of those who said ‘yes’ was different from those who said ‘no’. composite variables were created by looking at the km maturity aspects and the number 1 was given to the expected response whereas a 0 was given to a response that was not ideal in km. the composite variable was obtained by summing the 1s to give a composite variable for ‘value of knowledge’, ‘lessons learned’, ‘leadership role’, and ‘trust’. the total scores were: ‘value of knowledge’ 12, ‘lessons learned’ 11, ‘leadership role’ 11 and ‘trust’ 6. high scores characterised more value of knowledge, more lessons learned, more leadership role, and more trust. the mean was used to describe the composite variable. the questionnaire was conducted over a 7-day research period. the complete research study was undertaken over a 3-month period, as the outcome of km maturity mapping was required by the rsi to serve as input to a business case. the data were entered in microsoft excel and exported to statistical package for the social sciences (spss) version 24 for analysis. the reliability of the instrument was measured using cronbach’s alpha, that is, its internal consistency. according to salkind (2014), internal consistency is a measure of reliability, which examines the unidimensional nature of a test. the degree of reliability was measured using the guidelines provided by revelle and zinbarg (2009), where reliability of 0.9 or higher is excellent, between 0.8 and 0.9 is good, 0.7 to 0.8 is acceptable, 0.6 to 0.7 is questionable, between 0.5 and 0.6 is poor, and less than 0.5 unacceptable. according to hair et al. (2014), the general agreed limit is 0.7, although in explanatory research it might decrease to 0.6. the reliability of the data was calculated to assess the effectiveness of the measures to measure the value of knowledge, lessons learned, leadership role and trust. no item had low reliability and thus all items were retained. ethical consideration the study gives revenue services institutions insights in how to innovate and sustain their value creation to their stakeholders. based on empirical findings we state the desired activities for adoption of a knowledge management framework that will help achieve continuous improvement (at the south african revenue services institution, with their permission to publish the results). the ethics committee permit number is ujfom_ikm2016_11_809571098. discussion of key findings findings are consolidated to map km maturity by consensus comparison across the five levels of the kmmm, adopted from kulkarni (2007), summarised in this article in terms of the value of knowledge, lessons learned, leadership role and trust. the five levels are: possible – abbreviated in figures as l1 encouraged – abbreviated in figures as l2 enabled/practised – abbreviated in figures as l3 managed – abbreviated in figures as l4 continuously improved – abbreviated in figures as l5 findings in figure 4 illustrate that the value of knowledge is well understood and knowledge assets as infrastructure are well identified. at the lowest level of the capability maturity scale, consensus is high at 93%. however, a reverse pattern is observed as consensus drops sharply at levels 2, 3 and 4 by an average of 30%, and there is a further drop by 20.1% at level 5. it is noted that at the lowest level of capability maturity scale, 6.9% of respondents did not concur; this difference could be attributed to new employees or to lower levels of education. this picture depicts that the value of knowledge is well understood. less effort is required in communication; it may only be required to sustain it at enterprise level. figure 4: value of knowledge. from juxtaposing levels 2, 3 and 4, one can see a pattern: that there are higher levels of disagreement indicating that there is no consistency and that is an indication that different roles perceive these levels differently and, therefore, leadership must take responsibility in inculcating a culture of knowledge sharing for better return on investment in intellectual capital. leveraged intellectual capital is the result of shared lessons learned. however, if knowledge is not shared, then an organisation is poorly positioned for continuous improvement. figure 5 illustrates the perceived value of capturing lessons learned and sharing these lessons to ensure continuous improvement. juxtaposing the value of knowledge and lessons learned, one can deduce that while the value of knowledge is well perceived, the level of consensus drops as the actual flow of knowledge within the business unit is measured. also, the level of consensus on levels 2, 3 and 4 seems to flatten indicating that progress is made across levels, but that the contrasting view is significant enough to warrant interventions. figure 5 presents evidence that there is effort in km implementation, although one cannot generalise it to the entire organisation or the public sector as a whole. findings confirm the theory of barriers of km within the public sector (e.g. see appendix 2, the chi-square test of homogeneity). figure 5: value of capturing lessons learned. findings in figure 6 indicate the perceived role of leadership in creating an enabling environment for knowledge sharing is critical. the only levels with consensus are levels 1 and 2; the rest indicate the perception that leadership is a barrier to knowledge sharing. figure 6: leadership role in knowledge sharing. in maturity mapping, the level of consensus indicates the level of maturity. in summary, the respondents’ level of consensus about the value of knowledge and lessons learned, is above 70% only with respect to the first level of km maturity. this indicates that km exists despite the barriers that persist. the pattern observed is a drop in level of consensus as the maturity levels move from level 2 to level 5. figure 7 shows that while the value of knowledge is well perceived, the sharing of knowledge is not at a desired level and leadership needs to assume a primary stance, leading the process in order to enable knowledge sharing for continuous improvement. figure 7: summary of level of consensus of how the value of knowledge is perceived. the study developed a conceptual km framework for the rsi, based on the research findings (figure 8). figure 8: conceptual knowledge management framework for a revenue services institution. mapping km objectives both at strategic and tactical levels will ensure that all km projects contribute towards organisation strategic outcomes. the same outcome may be achieved at tactical level by cascading km objectives to specific operational objectives. finally, analysis and interpretation of the research findings helped with identifying some desired activities for the adoption of the proposed framework, mentioned in the conclusion of this article. conclusion given that only a few business units were evaluated in the case institution, the results in this study are limited in generalisability with rsis. the rsi is on the baseline of level 3, that is, the enabled/practised level of km maturity. while knowledge is valued at the rsi, km is partially practised and enabled. this study indicates specific action steps that are required in order to reach the desired levels of maturity that lead to continuous improvement. the areas for improvement emerged, namely training, leadership role, trust, reward, and recognition, as well as embedding km by implementing processes, policies and procedures. the recommendation is adoption of the conceptual km framework presented in figure 8, to be used as pilot, and, if successful, adopted at enterprise wide level. the recommendation builds on sim principles, which are public sector specific: pareto principle, namely low effort and high impact. ease and cost of implementation. use of existing infrastructure and processes. blueprint for enterprise wide implementation. continuous improvement focused. alignment to departmental objectives. bottom-up process to ensure employee engagement. measurable outcomes. direct impact on services level improvement. the desired action steps include, firstly, develop km measures and include them on performance scorecard; secondly, establish baseline turnaround times for specific individuals and map to service levels and turnaround times; thirdly, roll out a training plan for the business unit and map outcomes to service turnaround times; lastly, develop a km strategy and initiate a km implementation project. in this regard, the critical success factors that emerged from this study include: leadership must lead the process of implementation. time is allocated for sharing of lessons as part of daily work. engagement of all members of the business unit. lessons learned are recorded and centrally stored for easy retrieval. measuring success as part of organisational performance process. human capital engagement and buy-in. the lesson learned from this study is the importance of using a model that is appropriate, specifically for rsis. suggestions for future studies require cognisance that validating or disproving assumptions of a benefit such as cost saving may help in gaining km maturity levels at a specific point in time but it is not necessarily a true representation of facts representing behaviour of the institution over a long period of time. a change in one of the variables used during assessment could change the outcome over a shorter period; one such example is a change in leadership or leadership style. this could shift levels of consensus positively or negatively over a short period in time. in conclusion, km maturity is necessary for continuous improvement, which is a precondition of business excellence. future study this study was the first of its kind in the case institution and the first step was to develop a conceptual framework for measuring perceived km maturity levels of the case institution’s tax audit business unit. from an academic viewpoint, the foundation work was critical. future studies should include a more comprehensive verification experiment, for example an in-depth case study. acknowledgements m.m. (university of johannesburg) was the mcom student researcher; t.d.p. (university of johannesburg) was the research supervisor. competing interests one of the authors is a permanent employee of the revenue services institution and presented the research findings to the particular business unit in order to ensure a true interpretation of data and presentation of information. the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contribution m.m. was a mcom student in 2016 and drafted the article from his dissertation. t.d.p., supervisor of the mcom student, converted the draft into a manuscript ready for peer review. references adner, r. & snow, d.c., 2010, ‘bold retreat: a new strategy for old technologies’, harvard business review march, 76–81. almudallal, a.w., bakri, n., mukta, s.n. & el-farra, m.m., 2016, ‘implementing knowledge management in the palestinian public empirical study on the presidency of the palestinian government’, international review of management and marketing 6(4), 101–107. benmoussa, c., 2009, ‘barriers to knowledge management: theoretical framework and a review of industrial cases’, world academy of science, engineering and technology 30(30), 901–911. bernuy, a.e., 2012, ‘knowledge management and e-business’, revista campus 19(1), 30–36. brase, c.h. & brase, c., 2015, understanding basic statistics, 7th edn., cengage, boston, ma. carlucci, d., 2016, ‘intellectual capital and business excellence for the 21st century organisations’, measuring business excellence 14(4), 1–87. casimir, g., lee, k. & loon, m., 2012, ‘knowledge sharing: influences of trust, commitment and cost’, journal of knowledge management 16(5), 740–753. davenport, t. & prusak, l., 1998, working knowledge: how organisations manage what they know, harvard business school press, boston, ma. drucker, p.f., 1988, ‘the coming of the new organisation’, harvard business review 66, 45–53. ehms, k., 2002, ‘holistic development of knowledge management with kmmm®’, siemens ag 1, 1–8. esterhuizen, d.c., 2012, ‘knowledge creation processes as critical enablers for innovation’, international journal of information management 32(0268–4012), 354–364. ezra, o.o. & smith, j.g., 2009, ‘the role of knowledge management in enhancing government service-delivery in kenya’, south african journal of library and information science 79(1), 28–39. fox, n., 2009, ‘sampling and sample size calculation’, in the nihr rds for the east midlands/yorkshire & the humber, pp. 1–41, national institute for health research, leeds. gaffoor, s. & cloete, f., 2010, ‘knowledge management in local government: the case of stellenbosch municipality’, south african journal of information management 12(1), 1–7. https://doi.org/10.4102/sajim.v12i1.422 galliers, r.d. & leidner, d.e. 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repositorio.cepal.org/bitstream/handle/11362/5042/s2012920_en.pdf?sequence=1 weerdmeester, r., pocaterra, c. & hefke, m., 2003, vision next generation knowledge management: knowledge management maturity model, viewed 07 august 2016, from http://km.aifb.kit.edu/fzi/vision/vision/docs/d5.2-km-final.pdf zhang, m.j., 2014, ‘the impact of trust and feeling on knowledge sharing among chinese employees’, new england journal of entrepreneurship 17(1), 21–28. https://doi.org/10.1108/neje-17-01-2014-b003 zhang, x. & jiang, j., 2015, ‘with whom shall i share my knowledge? a recipient perspective of knowledge sharing’, journal of knowledge management 19(2), 277–295. https://doi.org/10.1108/jkm-05-2014-0184 appendix 1 knowledge management maturity indicators this appendix relays the original question numbers (tables 1-a1, 2-a1, 3-a1 and 4-a1). the complete data collection instrument is available on request. table 1-a1: question 6: value of knowledge. table 2-a1: question 7: lessons learned. table 3-a1: question 8: leadership role. table 4-a1: question 9: trust. appendix 2 example of data analysis the chi-square test of homogeneity was performed to determine whether the difference between the categories, yes and no, were significant, that is, to determine whether frequency counts are distributed identically across a variable at the 5% level of significance (table 1-a2). table 1-a2: chi-square test on value of knowledge when at level 5 – continuously improved the hypothesis tested was: h0: there is equal distribution of responses across categories on value of knowledge capability area level 5 – continuously improved. hi: there is no equal distribution of responses across categories on value of knowledge capability area level 5 – continuously improved. in this case all p-values were more than 0.05, indicating that there was no significant difference between the proportion of respondents who agreed and those who disagreed on issues of value of knowledge in continuous improvement. thus one can conclude that there are mixed feelings within the rsi. mixed feelings are an indication that tools, processes and procedures are not consistently used across the business unit. the fact was that enterprise ict strategy revealed lack of enterprise-wide analysis technology as well as collaboration tools. it can be concluded that the tools are used in silos and not enterprise-wide. at this capability level, it is expected that the processes are enabled through technology for continuous improvement purposes. microsoft word 7 gladysek & chipeta sajems 15(4) 2012.docx sajems ns 15 (2012) no 4 429 the impact of socially responsible investment index constituent announcements on firm price: evidence from the jse olga gladysek and chimwemwe chipeta school of economic and business sciences, university of the witwatersrand accepted: august 2012 this paper examines whether socially responsible investment (sri) index constituent announcements have any impact on the returns of firms listing on the jse sri index. the event study methodology is utilised to estimate abnormal returns for the firms included in the index. the results indicate insignificant average abnormal returns (aars) for the years 2004, 2006, 2007, 2008 and 2009, suggesting no significant shareholder gains over the entire event window. however, the year 2005 is associated with positive and significant abnormal returns. post announcement cumulative average abnormal returns (caars) are positive for the years 2005 and 2007. however, the year 2008 exhibited extreme swings in caars with a general declining trend in the latter part of the event window. these swings are attributed to the global financial crisis of 2008. furthermore, the cumulative returns for the total sample show no clear outperformance of the sri over the jse all share index. key words: abnormal returns, event study, jse, socially responsible index jel: g14 1 introduction the johannesburg stock exchange (jse) implemented the socially responsible investment (sri) index in may 2004. some of the key objectives of the sri index are to recognise the companies that deliver on the triple bottom line (economic, social and governance reporting), and to provide a benchmark for comparing socially responsible and non-socially responsible companies. in order to participate on the index, firms are required to meet certain criteria, which are continuously being updated and improved. the sri index can therefore be viewed as a credible corporate social responsibility (csr) signal for investors who wish to invest in a responsible manner. in pursuit of this argument, it is imperative to test whether sri constituent announcements have a significant effect on the value of the firms listing on the index. fama (1991) affirms that, if market efficiency is maintained, then the value of the firm should change when new information enters the market. assuming that investors perceive the listing of a firm as part of the sri index as new information, share prices are expected to react in response to the addition of companies on the index. the empirical relationship between csr and shareholder wealth has primarily focused on black economic empowerment (bee) deal announce ments and short and long-term shareholder wealth. for example, sartorius and wolmarans (2009) examined the short-term wealth effects of bee transaction announcements on the jse for the period 2002-2006. additionally, ward and muller (2010) studied both the short and long-term wealth effects of bee transactions on the jse. similarly, chipeta and vokwana (2011) used non-parametric tests to test the significance of these transactions during the period 1999-2009. a notable empirical study that is closely related to this analysis was conducted by viviers, bosch, smit and buijs (2008). they examined the risk adjusted returns of various responsible investment (ri) funds in south africa for the period 19922006, and found that, over time, ri fund performance improved relative to their benchmark indices. the constitution of the sri index allows for further analysis of the abstract 430 sajems ns 15 (2012) no 4 performance of the firms listing on to the index. this paper therefore adds to the existing empirical work by examining two issues: the first issue relates to whether jse sri index constituent announcements have a significant effect on the abnormal returns of the firms listing on the index for the years 2004-2009. the second issue relates to whether the overall sri index outperformed the jse all share index (alsi) for the years 2004-2009. the results indicate insignificant average abnormal returns (aars) for the years 2004, 2006, 2007, 2008 and 2009, suggesting that there are no significant shareholder gains over the entire event window. however, the year 2005 is associated with positive and significant abnormal returns. post announcement cumulative average abnormal returns (caars) are positive for the years 2005 and 2007. the year 2008 exhibited extreme swings in caars, with a general declining trend in the latter part of the event window. these swings are attributed to the global financial crisis of 2008. furthermore, the jse sri index outperformed the jse all share index (alsi) only for the year 2004. however, insignificant outperformance was documented for the rest of the years and for the total sample. the remainder of the paper is organised as follows: section two discusses the literature review. section three describes the data used and the research methodology. section four reports the main results, and section five concludes the paper. 2 literature review 2.1 sri index performance the first approach in determining sri performance is one that evaluates socially responsible indices. sri indices were established to allow investors to trade shares of companies which are deemed to be socially responsible. these indices include the ftse4good, jse sri, domini-400 index and the dow jones sustainability group index (djsgi). these indices provide reassurance for investors and fund managers that the constituent companies are screened, monitored and assessed according to the objective esg criteria. 2.1.1 global sri performance knoepfel (2001) compared the dow jones global index (djgi) world to the dow jones sustainability group index (djsgi) world and found that the djsgi world outperforms the djgi world in terms of average returns on equity, assets and investments. this finding illustrates that, in some cases, choosing a sustainability-driven index can yield superior results in comparison with a regular equity index. alternatively, cerin and dobers (2001) reviewed the structure, transparency and performance of the djsgi world compared with the djgi world. they found that, in terms of financial performance, the sustainability global index performed better than the ordinary global index. the market capitalisation of the djsgi world is two and a half times greater than that of the djgi world. on the other hand, the djsgi world focuses more on the technology sector. both these facts are cited as reasons for the discrepancy in the performance between these indices. these reasons are a cause for concern as the aforementioned authors deem these factors as the cause of the outperformance rather than esg standards being managed effectively. in another study, dilling (2008) examined whether abnormal returns in subsequent years were experienced when companies were added to the djsgi world index for the period 20012005. the study found that newly-added companies experienced abnormal returns of 2 per cent in the year 2002 but this abnormal return decreased in the subsequent years. this conclusion is a matter for concern, as the concept of corporate social responsibility is growing in popularity worldwide. these results could have occurred because the criteria for csr reporting are not standardised or regulated. this makes it difficult for the investor to determine the quality of csr reporting. schröder (2007) examined the performance of 29 sri indices and found that sri indices neither underperformed nor outperformed their respective benchmarks. this finding is somewhat surprising, as screening investments according to socially responsible principles decreases the investment universe from which stocks are picked. portfolio management theory dictates that a restricted selection of stocks should lead to lower risk-adjusted returns. the sharpe ratio sajems ns 15 (2012) no 4 431 was incorporated into the study and indicated that some sri indices exhibited a higher risk profile than standard equity indices. this finding confirms that a risk assessment should be undertaken when considering investing in a socially responsible index. 2.1.2 european sri performance since 2008, the european sri market has experienced a remarkable growth of about 87 per cent over a period of two years (eurosif, 2010). this booming industry has prompted various researchers to analyse sri performance in europe. for example, curran and moran (2007) examined the financial performance of companies that were added to or deleted from the ftse4good uk index for the period 1999 2002. the authors provide evidence that the market reacted negatively to a firm’s exclusion from the index, and positively when a firm was added. however, these findings were insignificant, implying that there was no abnormal financial gain for firms that had been listed on the index over their sample period. collison, cobb, power and stevenson (2008) extended the sample period used in curran and moran’s (2007) study, and tested whether the ftse4good indices outperformed their relative benchmarks. they show that the ftse4good indices outperformed their relative benchmarks over a sample period of 1996-2005. however, this outperformance is attributed to a risk differential between the two indices. both of these studies thus conclude that investors who invested in the ftse4good indices can perform better than investors who do not follow a socially responsible investment trading strategy. 2.1.3 american sri performance sauer (1997) analysed the performance of the dsi-400 against two unrestricted benchmark portfolios in the united states, and concluded that screening investments in a social context does not necessarily have a negative impact on performance. additionally, statman (2000) compared the performance of the standard & poor’s 500 index (s&p 500) to the domini social index (dsi-400) for the period between 1990 and 1998, and established that the dsi400 had slightly higher raw returns. however, when risk-adjusted returns were taken into account, the dsi 400 underperformed the s&p 500, although this underperformance was insignificant. to conclude, the results of the aforementioned studies suggest that, in some instances, investors may have the incentive to invest in sri indices, as the performance of the sustainability indices is generally higher than that of the general equity index. the financial goal of reaping the bottom line may therefore be achieved with the additional benefit of being able to target companies that are concerned for their stakeholders and the environment in which they operate. in addition, sri indices are accessible to investors and can be used as a social screening mechanism much like a fund or trust. however, the investor needs to examine the relative risk of the sri index, as risk is a primary investment concern. 2.2 sri share price performance previous studies have documented a link between csr and financial performance. this is the second approach whereby sri company performance is tested to determine how it fares against non-sri company performance. the discussion on sri stock performance is divided into positive, negative and environmental sri performance. 2.2.1 positive sri performance a positive relationship between csr and financial performance is documented by cochran and wood (1984) after controlling for the average age of corporate assets. in a further assessment of the relationship between corporate social performance and financial performance, waddock and graves (1997) found that a link exists between current corporate social performance and financial performance. the authors also conclude that firms that employ socially responsible measures in the short term will reap benefits in the form of improved financial performance in the future. furthermore, kempf and osthoff (2007) studied the effects of sri stock selection on portfolio performance, and demonstrated that the strategy of purchasing stock with a high sri rating and selling stock with a lower rating provides exceptional returns. the highest abnormal return achieved in this study was 8.7 per cent, which occurred when stocks were screened on a best-in-class screening method. the conclusion reached in this analysis is that 432 sajems ns 15 (2012) no 4 not only are sri stocks able to outperform the market by a significant margin, but they also outperform the market when reasonable transaction costs are taken into consideration. 2.2.2 negative sri performance in general, the negative sri performance has been documented with respect to studies that examined philanthropy and disinvestment. seifert, morris and bartkus (2003) conducted an investigation into corporate philanthropy and documented a negative relationship between corporate giving and financial performance. this result indicates that, in certain instances, companies that behave in a socially responsible manner may be penalised. the apartheid era in south africa led numerous companies to disinvest from the country as a form of csr (lansing & kuruvilla, 1988). an analysis of the announcement of publicly-traded firms disinvesting from south africa was performed by wright and ferris (1997), who found that the apartheid disinvest ment strategy yielded significant negative excess returns. 2.2.3 environmental sri performance several authors have used environmental perfor mance as a proxy for csr. the findings of studies that include an environmental variable are explored in this section. stanwick and stanwick (1998) conducted a study incorporating firm size, environmental performance and financial performance variables. the authors found a relationship between firm size, the level of profitability and the amount of polluting emissions that a firm releases. the use of pollutant emissions as a proxy for environmental impact may be viewed as a limitation. this is because low emission industries that do tangible harm to the environment may not be classified as having a high impact on the environment. likewise, klassen and mclaughlin (1996) document the link between environmental management and financial performance by testing firm-specific events pertaining to environ mental occurrences. firm financial performance was analysed on the basis of whether a company either won an environmental award (positive information, suggesting strong environ mental performance) or experienced an environ mental crisis (negative information, suggesting weak environmental performance). the findings of this study were consistent with the hypothesis proposed which stated that there is a correlation between strong environmental performance and positive abnormal returns. from the preceding lines of argument, it is evident that companies need to be aware of their impact on the environment, and they need to control for environmental risks accordingly because investors value such behaviour. 2.3 south african sri performance the empirical research that has been conducted on the sri in south africa focuses mostly on the challenges facing the industry, and mostly examining the broader aspect of csr. heese (2005) highlights the fact that the lack of a formal and universally understood definition of the meaning of sri is inhibiting the growth of the sri sector in south africa. an element of this definition which is especially problematic and pertinent to south africa is how bee is defined and how it relates to the concept of sri. herringer, firer and viviers (2009) conducted semi-structured interviews with investment professionals from both buy and sell-side backgrounds. this analysis was performed in order to gauge the challenges facing csr in south africa. the interviewees highlighted the fact that more sri products, funds and investments are required to spur growth in this developing industry. the key challenges that have been argued to hinder industry growth are the negative perception of achieving a below-average return, the amount of human capital required to screen investments, the limited sri universe, the lack of accessibility to sri infor-mation and the lack of pension fund interest. viviers, bosch, smit and buijs (2009) cite two challenges facing the south african sri landscape. the first relates to the relatively small size of the sri industry in south africa, and the second is the institutional investors’ lack of interest in committing substantial investments into the sri stocks. in terms of performance, viviers et al. (2008) tested the risk adjusted returns of ri funds in south africa and they found that these funds did not consistently outperform their relative benchmark indices over the period of analysis. specifically, local ri funds underperformed their relative benchmark indices in sajems ns 15 (2012) no 4 433 some sub periods, while outperformance was documented in another sub period. 3 data and methodology 3.1 data the sample period used is from may 2004 (when the sri index was first implemented on the jse) to november 2009. the data for this study were sourced from the i-net bridge database.1 the number of firms examined is 38, 37, 45, 47, 55 and 63 for the years 2004 to 2009 respectively. companies for which no observations could be found were omitted for that particular year. various industries are represented in the sri index, including: mining, retail, finance and construction. 3.2 the event study methodology the event study methodology has been used by researchers to assess the effects of events on share prices. mackinlay (1997) describes the event study methodology as a credible way to capture the extent to which investors value a firm when their assessment of a firm changes. this change in investor assessment is due to an inflow of new information into the market. moreover, ruf et al. (2001) argue that event studies have documented a consistent association between poor corporate social performance and negative abnormal returns. if an event, such as the announcement of the constituents of an sri index, has no effect on the market, then the abnormal return of the companies listed on the index should remain unchanged. if, however, the announcement does affect the share prices of the listed companies, the abnormal returns reflect the markets’ reaction to the arrival of this new information. in order to draw reasonable conclusions from the results, the following assumptions are made: markets are efficient, there are no confounding effects during the event window analysed and the announcement was unanticipated by market agents. daily abnormal share returns are used as a proxy for financial performance and the sri index is used as a proxy for csr. the event window consists of 20 trading days prior to the announcement and 20 trading days after the announcement, including the announcement date (day 0). the total number of days in the event window is 41. the 41-day event window (-20, +20) is used to ensure that the investors have time to react to the news of the relevant firm being included in the index.2 following curran and moran (2007), share returns are calculated as follows: 𝑅!" = 𝑙𝑛  ( 𝑃!" 𝑃!"!! ), (1) where r!" is the share return of firm j on day t. p!" is the share price of firm j on day t and p!"!! is the share price of firm j on day t-1. curran and moran (2007) utilised the market model when generating expected returns. in this study, the theoretical framework of the capital asset pricing model (capm) is utilised in generating returns. this approach is followed in order to incorporate a market benchmark. the inclusion of a market benchmark, in this case the jse all share index (alsi), allows inferences to be made to compare the performance of the sri index relative to the south african market. the expected returns are derived as follows: 𝐸 𝑅!" = 𝛼! + 𝛽!(𝑅!" − 𝑅!"), (2) where r!" is the return on the market index (alsi) for day t. the αj represents the intercept of the regression and βj represents the slope of the regression. in order to generate unbiased α and β estimates for each sri constituent firm, returns are computed from 100 trading days prior to the announcement date up to 20 trading days post announcement date, (-100, +20). the 90-day banker’s acceptance rate is used as a proxy for the risk-free rate (r!"). the abnormal returns (ar) are calculated as follows: 𝐴𝑅!" = 𝑅!" − 𝐸(𝑅!"), (3) where ar!" is the unexpected return for firm j on day t. r!"  is the normal return for firm j on day t and e(r!") is the expected return for firm j on day t. the difference between the actual and expected return yields the abnormal return. the resultant value, ar!", is therefore an indication of share price movements caused by an event. an example of such an event would be the addition or deletion of companies on the sri index. if the event had no impact on the share price, the abnormal return would subsequently equal zero. 434 sajems ns 15 (2012) no 4 the average ars are calculated according to the following specification: ar! = ar!" n  , (4) where n represents the number of firms in the sample, in each given year. share returns can be noisy and therefore the abnormal returns are averaged. 4 discussion of results 4.1 basic results the descriptive statistics of the study are reported in table 1.  it is evident that the 2008 year had the highest standard deviation value. the announcement of the constituents of the sri index took place on 26 november of that year. the increased risk in 2008 can therefore be attributed to the world financial crisis, which was at its peak in the last quarter of 2008 (naudé, 2009). the extreme minimum and maximum values (-1.424 per cent, 1.932 per cent) in the 2008 period signify increased volatility of returns during the business cycle trough. comparatively, the standard deviation measures in the rest of the sample are significantly lower, with 2009 showing the lowest measure at a value of 0.118 per cent. t a b l e 1 descriptive statistics year mean median std dev min max 2004 -0.008 -0.031 0.407 -1.064 0.118 2005 0.098 0.114 0.277 -0.593 0.637 2006 -0.030 -0.039 0.300 -0.854 0.786 2007 0.058 0.063 0.317 -0.658 0.871 2008 0.094 0.023 0.928 -1.424 1.932 2009 0.016 0.018 0.118 -0.247 0.271 figure 1 illustrates the aars for the sri index for the years 2004-2006. the aars for 2004 and 2005 exhibit a decrease before the announcement date and an increase after the announcement date. the most significant increase in aars was experienced in 2004, which could be attributed to a short-lived shareholder interest in the new index. figure 2 shows aars for the sri index for the years 2007-2009. the greatest post announcement increase in returns can be observed in 2008. the substantial variability in the 2008 observations, during the event window, is due to the economic uncertainty of the market during that time. the remaining years display abnormal returns, which are generally concentrated around the zero return mark for the sample period. according to mackinlay (1997), if the daily aars exceed 2.5 per cent, then the announcement is perceived as good news. if the aars are below -2.5 per cent, it is perceived as bad news. if the aars are within the -2.5 per cent to 2.5 per cent bracket, the announcement is perceived as no news. it is clear from the aars and caars that at no point during the sample period do the abnormal returns exceed 2.5 per cent or fall short of -2.5 per cent. this result indicates that, when the constituents of the sri index are announced, the market perceives this information as no news. this observation suggests that the phenomenon of making socially responsible investment choices has not affected the south african market as it has done abroad. this may be due to the relatively small size of the market in south africa. direct implications of the small market size are thinly-traded shares (van rensburg & robertson, 2003). the market reaction to an event may therefore not be detected because of the minimal trading volume on the index. another potential explanation for this finding is that investors are unaware that the index exists or are misguided in believing that they will earn an inferior return if they choose an sri index over a general equity index. sajems ns 15 (2012) no 4 435 f i g u r e 1 average abnormal returns of the sri index for 2004-2006 notes: average abnormal returns observed from 20 days prior to the announcement date to 20 days post announcement day (41-day event window). f i g u r e 2 average abnormal returns of the sri index for 2007 to 2009 notes: average abnormal returns observed from 20 days prior to the announcement date to 20 days post announcement day (41-day event window). figure 3 displays caars for the years 20042009. in 2004, the caars displayed a downward trend from a return of -0.117 per cent at day -20 to a return of -2.219 per cent at the announcement date. however, post announcement returns increase to the level of 0.222 per cent at day +20. at announcement date, the highest caar can be observed in 2008 with a return of 3.174 per cent, whereas the lowest return occurred in 2004, with a return of -2.219 per cent. the year 2008 exhibited positive caar values over the sample period, with the exception of negative returns on day 3 and day 4. -2 -1,5 -1 -0,5 0 0,5 1 1,5 2 20 18 16 14 12 10 8 6 4 2 0 -2 -4 -6 -8 -10 -12 -14 -16 -18 -20 a a r s (% ) days 2004 2005 2006 -2 -1,5 -1 -0,5 0 0,5 1 1,5 2 20 18 16 14 12 10 8 6 4 2 0 -2 -4 -6 -8 -10 -12 -14 -16 -18 -20 a a r s (% ) days 2007 2008 2009 436 sajems ns 15 (2012) no 4 f i g u r e 3 cumulative average abnormal returns (caars) of the sri index notes: cumulative average abnormal returns observed from 20 days prior the announcement date to 20 days post announcement day (41-day event window). 4.2 empirical results the aars for each year are stationary and modest autocorrelation is present. as the autocorrelation of the daily aars is not extreme, independence is assumed when conducting parametric tests. the sample of the number of constituent firms for each year is sufficiently large and the data displays moderate non-normalities. parametric one sample t-tests were run in order to determine the significance of the aars from the period 2004-2009. the null hypothesis applied to the one sample t-test is that aars are equal to zero. parametric tests were therefore conducted under the normality assumption.3 nonparametric tests relax the stringent assumptions of parametric tests and were conducted to compare whether the results of these tests would yield the same conclusion. t a b l e 2 parametric and non-parametric tests year parametric test non-parametric tests students t test sign test wilcoxon signed rank test statistic p-value statistic p-value statistic p-value 2004 -0.121 0.904 -1.5 0.755 -21.5 0.784 2005 2.265 0.029 8.5 0.012 177.5 0.020 2006 -0.647 0.521 -2.5 0.533 -59.5 0.448 2007 1.170 0.249 3.5 0.349 95.5 0.220 2008 0.649 0.520 0.5 1.000 29.5 0.707 2009 0.881 0.384 2.5 0.533 65.5 0.403 table 2 indicates that, in all the years, with the exception of 2005 (p=0,029), the aars have insignificant p-values. the null hypothesis therefore fails to be rejected for all years with the exception of 2005 at a 95 per cent confidence interval. it can therefore be concluded that the aars equal zero over the larger portion of the sample with the exception of 2005, when the aars exceeded zero. as the data displayed slight non-normalities and minimal autocorrelation, non-parametric tests (sign and wilcoxon signed rank test) were run to correct these assumption violations. the wilcoxon signed rank test is more advanced than the sign test, as not only does it compare whether aars are significantly -6 -4 -2 0 2 4 6 20 18 16 14 12 10 8 6 4 2 0 -2 -4 -6 -8 -10 -12 -14 -16 -18 -20 c a a r s (% ) days 2004 2005 2006 2007 2008 2009 sajems ns 15 (2012) no 4 437 different from zero but it also measures the extent to which the returns deviate from the median value. the sign test hypothesis states that the median value of the aars is equal to zero. in all the years, except for 2005, the null hypothesis fails to be rejected at a 95 per cent confidence interval. the null hypothesis is rejected in 2005, illustrating that aars are statistically distinguishable from zero. this non-parametric test yields identical conclusions when contrasted with the wilcoxon signed rank test. t a b l e 3 summary of results year direction of average ar significance (p<0, 05) parametric test non-parametric tests 2004 negative none none 2005 positive significant significant 2006 negative none none 2007 positive none none 2008 positive none none 2009 positive none none table 3 reports summary results from both sets of parametric and non-parametric tests. all the aars are insignificantly different from zero. from the results presented, it can be deduced that, although the sri index does not earn significant average aars, the index does not underperform the market. on balance, it appears that the perception of the announcement is mixed. relatively speaking, additions to the sri index can be considered good news, as the majority of the mean average aars yield positive values. however, as the statistics associated with these returns are insignificant (with the exception of 2005), it can be inferred that no financial gain greater than the market return was achieved if an investor invested in the sri index over the window period. t a b l e 4 jse alsi and jse sri car at day +20 variable car at day +20 p value 2004_alsi 2004_sri -0.0019 0.0115 0.0450** 2005_alsi 2005_sri 0.0054 0.0107 0.9068 2006_alsi 2006_sri 0.0335 0.0357 0.6629 2007_alsi 2007_sri -0.0001 0.0046 0.9957 2008_alsi 2008_sri -0.0115 -0.0001 0.8868 2009_alsi 2009_sri -0.0149 -0.0162 0.8649 total car_alsi total car_sri 0.0017 0.0077 0.5508 4.3 a comparison of the sri and jse index performances table 4 compares the cumulative average returns (cars) for the jse alsi and sri indices at day +20.4 the sri index outperforms the jse alsi for the years 20042007. however, the outperformance is significant only for the year 2004. the associated p-value 438 sajems ns 15 (2012) no 4 is statistically significant at the 5 per cent level. this significant outperformance could be associated with the enthusiasm associated with the launch of the sri index. the cumulative returns for the years 2008 and 2009 are negative for both indices, highlighting the negative effects associated with the global financial crisis of 2008. overall, it appears that there is no clear sri outperformance during the sample period, as evidenced by the p-value of 0.5508 for the total sample period. 5 limitations and suggestions for future research the analysis in this paper is limited to shortterm shareholder wealth returns around the announcement dates. future research could analyse the share price and operating performance of sri index listed firms over a longer time period to gauge whether the industry is becoming a more prominent feature in the south african market. additionally, researchers could investigate whether investors perceive deletions of companies from the index as negative information. 6 conclusion this paper examined the effects of sri constituents announcements on the shareholder wealth of firms listed on the index. an event study methodology was employed, and, with the exception of the year 2005, investors do not earn any significant abnormal returns when investing in the sri index around the time when constituents are announced. furthermore, the sri outperforms the jse alsi only in the year 2004. this outperformance attributed to the enthusiasm for the establishment could be of the index. however, in the following years, no significant outperformance is documented. overall, the announcement event is considered as no news entering the market. endnotes 1 licensed to the university of the witwatersrand. 2 two other event windows are included in a separate analysis. these are -5 to +5 days, -1 to +1 days, and the results are insignificant. 3 the output of the assumption tests is available upon request. 4 the 2004 returns for 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ayodotun s. ibidunni department of business management, covenant university, nigeria joachim a. abiodun department of business administration, federal university of agriculture, nigeria oyebisi m. ibidunni department of accounting, bells university of technology, nigeria maxwell a. olokundun department of business management, covenant university, nigeria citation ibidunni, a.s., abiodun, j.a., ibidunni, o.m. & olokundun, m.a., 2019, ‘using explicit knowledge of groups to enhance firm productivity: a data envelopment analysis application’, south african journal of economic and management sciences 22(1), a2159. https://doi.org/10.4102/sajems.v22i1.2159 original research using explicit knowledge of groups to enhance firm productivity: a data envelopment analysis application ayodotun s. ibidunni, joachim a. abiodun, oyebisi m. ibidunni, maxwell a. olokundun received: 23 oct. 2017; accepted: 06 sept. 2018; published: 29 jan. 2019 copyright: © 2019. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the telecommunication industry is globally recognised to be a knowledge-intensive industry where high levels of technological sophistication are a key determinant of success and performance. consequently, existing research has examined the role of labour hours and the firm’s capital on productivity. nonetheless, research is yet to relate, with empirical evidence, productivity gains that accrue to organisations as a direct function of knowledge work and knowledge workers, especially with respect to group-explicit knowledge usage in emerging economies such as nigeria. the adoption of data envelopment analysis further provides originality in the area of benchmarking group-explicit knowledge in telecommunication firms to enhance productivity. as such, this research takes on a scientific investigation to fill this gap. aim: the purpose of this research work was to determine the influence of group-explicit knowledge on the productivity of telecommunication organisations. setting: the setting of this research is composed of the four leading telecommunication firms in nigeria and their customer service centres. methods: based on a sample size of 42 customer service centres of the four most active global system for mobile communications organisations in lagos state and federal capital territory (fct), nigeria, the research adopted the output-oriented data envelopment analysis model to show the influence of group-explicit knowledge on productivity. results: the results showed that 15 decision-making units (dmus) (representing 36%) were found to be technically efficient using the constant return to scale approach, while only 12 dmus (representing about 28.6%), based on variable return to scale approach, were found to productively engage their present input resources in outputs that achieve optimal productivity for the firm. conclusion: group-explicit knowledge dimensions that were investigated in this study significantly influence productivity of firms in nigeria’s telecommunication industry. it was recommended that dmus that were identified to be productivity deficient should hold resources input constant while their employees made efforts to scale up operations to enhance productivity. introduction organisations’ objective to achieve and improve productivity has been a major managerial concern for almost a century. organisational and behavioural theorists such as fredrick taylor (scientific management theorists), abraham maslow (hierarchy of needs), victor vroom, elton mayo, fredrick herzberg (motivator-hygiene theory) and peter drucker (management by objective) are typical examples of researchers who have attempted to enhance organisational and, indeed, workplace productivity through theoretical innovations. productivity refers to the increase in value of an organisation over time (phipps, priento & ndinguri 2013). thus, measuring productivity involves identifying human and non-human factors that contribute to organisational success. also, productivity according to syverson (2011) can be described as the degree of efficiency with which a firm transfers input to output. one way of measuring productivity is by examining capital and labour inputs in relation to their gross output or value-adding capability (schreyer & pilat 2001). this approach measures productivity based on single factors. the limitation identified with such an approach is that it does not explain the collective strength of input measures. thus, decision-makers stand at risk of misinterpreting the weighted average effect of productive factors (syverson 2011). therefore, most empirical literature takes a multifactor analysis or approach to the measurement of productivity (e.g. antonelli, patrucco & quatraro 2011; del gatto, di liberto, & petraglia 2011). this implies, therefore, that the measurement of productivity in empirical literature follows a more objective approach. more so, research on productivity of firms continues to gain the interest of practitioners and scholars (kremp & mairesse 2004). this is because productivity is an important part of firms’ performance that measures the degree to which the firms can improve on the quantity of output given a specified level of input (phusavat 2013). in nigeria, examining productivity-based performance of the telecommunication industry is critical because the industry is recognised to be a multibillion-dollar industry, where huge financial, intellectual and structural capital is invested yearly (david 2013). despite this, organisations’ operations are still characterised by poor signals during calls, call jamming and dropping, delay in or non-delivery of text messages after charges have been deducted and echoing of speech when making calls (cpc 2010; oghojafor et al. 2014). the telecommunication industry is globally recognised to be a knowledge-intensive industry where high levels of technological sophistication is a key determinant of success and performance. consequently, existing research works, such as igbaekemen (2014) and madsen and mikkelsen (2012), have examined the role of labour hours and firm’s capital on productivity. nonetheless, research is yet to relate, with empirical evidence, productivity gains that accrue to organisations as a direct function of knowledge work and the knowledge workers, especially with respect to group-explicit knowledge. it is also important to state that unlike existing productivity-based research, such relationship must be examined by objective rather than subjective means, in order to avoid chances of human bias. this research is therefore focused on investigating the influence of group-explicit knowledge on productivity of telecommunication firms in nigeria. group-explicit knowledge usage in organisations group-explicit knowledge represent codified forms of knowledge which are contained in firms’ policies and procedures and most often passed through signs and symbols (lam 2000). it also reflects the knowledge that organisations have in their database, process manuals and produce through intellectual property (fei, chen & chen 2009). a common characteristic of the group-explicit knowledge is that behavioural outcomes of organisations, when dwelling on this knowledge, are highly predictable (lam 2000). training programmes can also facilitate group-explicit knowledge exchange (ibidunni, ogunnaike & abiodun 2017; olokundun et al. 2018). group-explicit knowledge has been described in organisations as a form of internal organisational memory. according to englis, englis, solomon, valentine, bieak and turner (2006), organisational memory is the store of information and knowledge which the firm can retrieve and replicate among its members. the importance of such communised knowledge among organisational members is to foster unified understanding and a common pursuit of an organisation’s strategic directions by every member of the firm. enhancing teamwork and effectiveness among employee groups can be achieved through group-explicit knowledge. most of the discussions in existing literature about group-explicit knowledge reflect the capability of organisational members to share and utilise knowledge that is stored in the organisation’s informational technological systems (madhoushi, sadati & delavari 2011). lópez-nicolás and merono-cerdán (2011) observed that explicit knowledge of groups in the organisation influences its financial, process and internal performance. alegre, sengupta and lapiedra (2011) posited that knowledge storage and dissemination among groups can enhance innovative performance in the organisation. enhancing group-explicit knowledge through collective intelligence collective intelligence (ci) is the engagement of communal efforts (e.g. members of an organisation) as opposed to individual effort, to execute tasks or initiate solutions to problems, with the aim of achieving more effective and efficient outcomes (leimeister 2010). by implication, collective intelligence explains how people and technology can be connected to act systematically. it shows a combination of human cognition and technological memory to enhance the performance of groups of organisational members towards achieving organisational objectives. wooley, chabris, pentland, hashmi and malone (2010) observed that, with the help of collective intelligence, groups can use their combined cognition to solve single and a wide variety of tasks, which ordinarily individual knowledge might not be so competent at solving. the need for timely and accurate decision-making about the fast-paced and hyper-competitive business environment makes it quite risky for firms to rely on practices that encourage individual decision-making (bonabeau 2009). supposedly, this is why firms harness the advantages associated with team structures in designing, evaluating and implementing decisions. the ci theory of organisational knowledge propagates relational thinking, which means a way of human intellectual interactions within a social context, as an essential for enhancing organisational and workforce productivity, as well as goal achievement. it showcases organisational network systems (or practices) in which people interact among themselves and sometimes with computers and other information technology facilities, to generate and share knowledge for the use of the organisation. thus, it is multi-systemic in nature, creating a network form of knowledge that shifts focus principally from individuals to groups (liang-chieh & wen-ching 2015; svobodová & koudelková 2011). during the collective work process, it is vital that job tasks are organised in a way that suggest proper structuring in which individuals are aware of the roles they must perform to achieve the collective objective of the organisation. consequently, malone, laubacher and dellarocas (2009) opined that ci in organisations should involve defining two major factors, namely: (1) what and how job tasks must be executed and (2) who is performing the tasks and why. identifying what job task is to be done and how, involves the pattern with which groups would combine knowledge efforts together to generate novel ideas that advance the organisational competitiveness (shu-chen & chienhsing 2016). in this same light, they must decide how the tasks will be organised to achieve the set objectives of the organisation. deciding who should perform each task in the organisation depends on deciding whether it would be an individual or a crowd. crowd in this context is defined as a collection or group of individuals collaborating based on expertise and knowledge sharing. in organisational knowledge research, the theory of ci is significant in that it emphasises group tacit and explicit knowledge as important organisational factors for achieving competitive performance (leimeister 2010). the theory suggests that the capacity of groups to reason through their tacit knowledge is one aspect of organisational collective thinking that can achieve organisational objectives (rajendran, narendran & ai 2017; topchyan 2016). in the same way, it suggests that group knowledge encoded in explicit form by the organisation, can also be a part of the organisational knowledge asset (preece & shneiderman 2009). some of the modern expressions of collective intelligence in organisations include: crowdsourcing, decision support, open innovation and social collaboration. crowdsourcing is the outsourcing of organisational activities to a crowd of independent operators (howe 2009). it is an essential means through which organisations execute projects, with the aim of leveraging the efficiency and effectiveness capacity of experts. a group of communications experts building a new network communication system can enhance speed and quality in accomplishing the task. open innovation is an organisational practice in which opinions and ideas from stakeholders of the organisation are incorporated into a new product or service building process. according to chesbrough (2003), by incorporating the environment into their innovation process, organisations can enhance their innovation capabilities to achieve superior competitive performance. this is more likely to result from the fact that the collective knowledge gathered from customers and the organisation’s customer relations unit, for example, would guide the organisation’s new product design, promotion and pricing to satisfy customers’ expectations. organisations can also leverage on the use of social collaborations to generate ci. an example of one of the fastest growing social collaborations on the web is wikipedia (leimeister 2010). many other social collaborations have since emerged such as investopedia, business dictionary, slide share and so on. organisational knowledge utilisation in nigeria’s telecommunication industry the service sector is increasingly occupying the front line of economic activities in most industrialised economies across the globe (dejardin 2011; liu 2012; tick & oaxaca 2010). the world bank report (1995) reveals that high-income countries operate economies that run on 66% services, while middle-income countries operate on 52% and low-income countries on only 35% services. this growth could be traceable to the increasing trends of technological advancements in these economies (oecd 2000; osabuohien & efobi 2012). however, nigeria’s service industry still lags behind as the least explored sector of the economy. radwan and pellegrini (2010) observed that, as in developed economies, nigeria’s service sector must be empowered to take the lead in the midst of the ongoing knowledge economy. of particular interest is the telecommunications industry in the service sector. the nigerian telecommunications industry broadly consists of three major sub-sectors, namely: global system for mobile communication (gsm), code division multiple access (cdma) and fixed or fixed wireless operations. among these, the gsm sub-sector is the largest, consisting of four active operators: mtn, etisalat, globacom and airtel. statistics from nigeria communication commission (2016) reveal that mtn has the largest subscriber base followed by globacom, airtel and etisalat. this industry is knowledge based and driven by high levels of technology and innovation. therefore, there is an increasing demand on telecommunications organisations to further invest in knowledge-based resources and capabilities as a means of improving performance (dzunic, boljanovic & subotic 2012; liao & luo 2012; murmann 2003; sedziuviene & vveinhardt 2010). there is some level of looseness (informality) in the competition that exists in the industry. an important question of research interest is: could there be something the market leader knows and knows how to do that other competitors are not conscious of? an investigation of organisational knowledge and behavioural patterns in competition is necessary in the telecommunications industry. there is a substantial body of research on possible areas of relationship between organisational knowledge and performance (e.g. garrido-moreno & padilla-meléndez 2011; inkinen, kianto & vanhala 2015; kianto, vanhala & heilmann 2016; moore 2012; routley et al. 2013; shamsie & mannor 2013; zheng, yang & mclean 2010). proponents of the resourceand knowledge-based views of the firm identify that intangible organisational resources, such as knowledge, offer unique competitive advantages when they are differentiated and are difficult to imitate (barney 1991). however, within the existing body of literature on organisational knowledge, there is a gap in identifying how organisational knowledge should necessarily be linked to the business strategy as a means of improving performance (davenport 1999). in channeling corporate strength, organisational leadership should provide answers to the questions like: what are important factors or features of the environment (customers, competitors, and so on) to gain superior performance? of interest is the source of strategic knowledge (internal or external sources?). these issues that aid the discretion of decisions-makers are of concern in this research. furthermore, evidence of growth in nigeria’s telecommunications industry by gdp (growing from 1.06% in 2003 to 7.76% in 2013, nigeria communications commission 2015) indicates that the industry is highly competitive. besides, the mobile market is expected to hit a growth rate of over 10 billion by 2020 with an increase in the number of users to about 182 million (marketing edge mag 2015). knowledge management researchers have, to a large extent, discussed the fundamental effects of knowledge processes to business performance. but there is a paucity of empirical evidence to show the link between knowledge and the growing success of the nigerian telecommunications industry. consequently, in practice this situation gives rise to information and knowledge resources in the organisation not being: (1) vital for the strategic pursuit of the firm and (2) properly processed by the firms’ interconnected knowledge assets to achieve the desired competitive advantages. thus, managers at the strategic level of the organisation are often misdirected about key knowledge areas to focus on in achieving their highest performance levels (abdollahi, rezaeian & mohseni 2008). just as strategy is not designed in isolation of the business environment, neither is knowledge generated and reproduced into innovative products and services without the environment (hipp & grupp 2005; koch & strotmann 2008). very little is known by means of empirical research about how the nature of a competitive and dynamic business environment influences the orientation and performance of the nigeria telecommunications industry. environmental competitiveness refers to the degree to which the external environment is characterised by intense competition while environmental dynamism explains the rate of change and instability of the environment (dess, lumpkin & taylor 2005; jansen, van den bosch & volberda 2006; martínez-martínez, cegarra-navarro & garcía-pérez 2015). this research finds these two environmental contexts relevant in the major telecommunication industry, which largely demonstrates both traits. however, do these traits significantly influence competitive strategies adopted by telecommunication firms? in addition, which patterns of competitive orientation best represent the industry’s interest to attain superior performance? another way of looking at the disparity in performance and competitive patterns among telecommunication firms is in the area of firm size and age. gopalakrishnan and bierly (2006) observed that firm size and firm age moderate the organisational knowledge and technological strength relationship. this research may not be automatically implied in nigeria. hence, there exists a gap in how differences in size and age of telecommunication firms explain their perspectives to competition and performance outcomes. the results arrived at in this study will likely reflect important implications for knowledge strategy literature and practitioners. they show how large and small firms, with varying years of existence, configure knowledge-based processes, assets and capabilities along four important strategic knowledge dimensions to enhance organisational worth. organisational knowledge and productivity chang and gurbaxani (2012) empirically tested the impact of an it provider’s organisational knowledge on the productivity of client firms. their study proposed that a vendor’s it-related knowledge could be a major determinant of productivity for client firms. the knowledge–productivity relationship has also been tested by das (2003), using a context of technical support work. productivity was tested through call resolution time and the extent of call escalation. knowledge of technical support was measured through problem-solving tasks and moves dimensions. their research indicated that along different activity lines of technical work, the relationship between knowledge of technical support and productivity was significant. musolesi and huiban (2010) examined the relationship between the sources of knowledge, innovation and productivity in knowledge-intensive business services and reported internal and external sources of knowledge like patents and r&d. in addition, they showed that knowledge and innovation have a strong and positive effect on productivity. they also compared their findings with existing literature based on investigations in the manufacturing industry and their reports showed consistency in findings with previous research studies. the relationship between productivity and transference of knowledge among organisations is also an important area of research in strategic management. darr, argote and epple (1995) investigated the acquisition, transfer and depreciation of knowledge on productivity of 36 pizza stores in the usa. they reported that increased experience in production resulted in unit cost decline. also, unless productivity continues, the knowledge of production is likely to depreciate significantly within a short period of less than a year. whereas knowledge transfer was found to be possible between stores of the same franchise, it was inversely related across stores controlled by different franchisees. the insight revealed in literature shows the significant effect of various forms, sources and applications of knowledge to organisational productivity. consequently, this study hypothesises that: h1a: based on a constant return to scale, group-explicit knowledge enhances the productivity of firm. h1b: based on variable returns to scale, group-explicit knowledge enhances the productivity of firms materials and methods the research study is descriptive in nature. the use of descriptive research design is validated by the fact that populations for the study are already established, theories are not newly explored or determined and the research study simply attempts to describe the relationships among the variables included in the research (jong & van der voordt 2002). the sample size for this research includes the 124 customer service centres of the four biggest gsm firms in lagos state and fct, nigeria. the gsm sub-sector is pivotal to the telecommunication industry in nigeria because it has the highest number of subscribers (98.07%), thus serving as the major driver of growth in the industry. questions about group-explicit knowledge were developed based on chilton and bloodgood (2007) and fei et al. (2009). measuring organisational productivity was based on input and output factors relating to the firms and their customer service centres. the data envelopment analysis model this study adopted three input and three output factors, against a total of 124 decision-making units to satisfy this condition. the input and output measures determined for this study were selected based on their ability to represent knowledge resources and knowledge outcomes. the following notations are defined to guide the analysis. to achieve movement to the efficient frontier in a two-stage data envelopment analysis (dea), there is the need to optimise the slack variables. this requires running the model below under the same assumption as in the basic dea model above. subject to: input constraints: – estimated number of employees (i.e. first input) available in csc j – estimated expenditure on employee training (i.e. second input) in csc j in a year – estimated expenditure on new technology (i.e. third input) in csc j in a year output constraints: – average number of customers attended to daily (i.e. first output) in csc j – average number of customers with resolved cases (i.e. second output) in csc j – average number of innovations produced (i.e. third output) in csc j in a year scales constraint (vrs): analysis and result table 1 shows that employees in the customer service centres range between 5 and a maximum of 124. moreover, in some centres only 10 customers are attended to, while others have as many as 50 customers to attend to daily. resolved cases of customer complaints range from 5 to 400. firms in the telecommunication industry are also seen to incur huge expenditure in employee training and new technology, with average costs of 6 837 353 naira and 9 150 138 naira respectively. table 1: input and output measures for productivity of telecommunication firms. results of output-oriented constant returns to scale model: pure technical efficiency this study hypothesised that based on a constant return to scale, group-explicit knowledge enhances the productivity of firms. appendix 1 show the result of output-oriented constant returns to scale (crs) of pure technical efficiency of the four telecommunication firms’ customer service centres in lagos state and fct. the result from the analysis suggests that out of the 42 dmus analysed and represented in appendix 1, 15 (representing 36%) were found to be technically efficient, thus achieving productivity with the firms’ group-explicit knowledge. in other words, their productive capacity is fully optimised. these customer service centres serve as models which centres that are not technically efficient can follow. however, 27 other dmus were measured to be inefficient. inefficiency in the dea occurs when the efficiency scores are either greater than or less than 1. from the table the 27, dmus representing 64%, will be required to keep inputs constant while they attempt to utilise their existing output level to achieve productivity. results of output-oriented variable return to scale model: pure technical efficiency this study also hypothesised that based on a variable return to scale, group-explicit knowledge enhances the productivity of firms. appendix 2 shows the output-oriented vrs technical efficiency of customer service centres of the telecommunication firms. the results reveal that 12, representing about 28.6% of dmus, were found to productively apply the group-explicit knowledge to achieve optimal productivity for the firm. this implies that those 12 dmus fully utilise all input resources invested into them by the firms’ headquarters. every other dmu has a figure above 1, indicating that it is inefficient in the use of the firm’s resources to achieve its productivity objective. the ideal solution is for inefficient customer services centres to maintain their present input level and enhance utilisation of output targets such as achieving increased numbers of customers with resolved cases and producing more innovations that can help achieve the firms’ productivity objective. ethical consideration respondents participated in the survey willingly and their identities were not disclosed in accordance with their request. discussion the output-oriented constant returns to scale and variable returns to scale, obtained from using data envelopment analysis, justified the acceptance of the alternate hypothesis. viewed from the constant returns to scale model, 15 customer service centres across the four gsm telecommunication firms were found to be productive. this implies that they were yielding outputs that corresponded with the resources invested in them. however, the result of variable returns to scale showed some slight downward slope, as only 12 of the 42 customer service centres were reported to be productive. the assumption of constant returns to scale is that decision-making units, in this case customer service centres, would produce outputs that are directly proportionate to the resources invested in them. while on the other hand, variable returns to scale assume that, given the effect of environmental conditions on the production or transformation process, resources invested might not always yield proportionate outputs. the implication is that outputs will vary depending on the extent to which the transformation process is impeded (emerald group publishing 2010). hence, in reality the assumption of variability holds. productivity is a measure of firms’ input to output. the results obtained imply that the telecommunication firms’ management, especially for customer service centres that are productivity deficient, should retain resource investment in the customer service centres, while the supervisors and other employees at those centres are charged to upgrade their levels of output (abiodun et al. 2018; tyagi et al. 2015). in this sense, they will need to pay more attention to attending to all customers that complain about the firms’ products and services (ibidunni et al. 2018). they will also need to ensure that a larger number of customer complaints are resolved. conclusion and recommendation this study adopted the dea application to determine the influence of group-explicit knowledge on the productivity of telecommunication organisations in nigeria. data were gathered from the customer service centres of the telecommunication firms in the gsm sub-market and this gave very insightful details to the research work with respect to the use of explicit knowledge such as training and formal education, as a means of enhancing firm-level productivity. based on the findings of this research work, it is concluded that group-explicit knowledge influences the productivity of telecommunication organisations. however, bearing in mind the context of the study, telecommunication managers in nigeria, and similar developing economies, should pay attention to increasing the level of output of their firms’ customer service centres. consequently, strategic measures that will increase service demand should be implemented. it is further recommended that the firms’ management, especially for customer service centres that are productivity deficient, should maintain present resource investment in the customer service centres, while supervisors and other employees at those centres make efforts to increase their levels of output. acknowledgements authors of this research work express sincere appreciation to the management of covenant university for giving full sponsorship to the publication of this research work. this study was personally funded by the researcher. however, the article processing charge was paid for by covenant university, nigeria. competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contribution a.s.i. coordinated the writing of the article and wrote sections of the article, carried 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pretoria south africa citation nel, g.f., smit, e. & brummer, l.m., 2018, ‘the link between internet investor relations and information asymmetry’, south african journal of economic and management sciences 21(1), a1966. https://doi.org/10.4102/sajems.v21i1.1966 note: this article is partially based on the first author, george f. nel’s dissertation presented for the degree of doctor of philosophy (phd) in business management and administration at stellenbosch university, with promotor prof. e.v.d.m. smit and co-promotor prof. l. brummer, received december 2016, available here: http://scholar.sun.ac.za/handle/10019.1/100275 original research the link between internet investor relations and information asymmetry george f. nel, eon smit, leon m. brummer received: 02 june 2017; accepted: 21 nov. 2017; published: 12 apr. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: information asymmetry manifests when one party has more or better information than the other. information asymmetry is said not only to increase transaction costs and decrease liquidity, but also to diminish the quality of the investment decisions taken by investors, thus weakening the overall functioning of markets. aim and setting: a well-developed internet investor relations (iir) strategy, coupled with increased disclosure levels, should theoretically decrease information asymmetry levels. the majority of related studies to date used either an indirect disclosure proxy or involved an examination of the annual report, and have used data from united states or european companies. empirical studies to date have produced mixed results. the aim of this study was to ascertain whether a relationship exists between the quality of iir (via corporate websites) and information asymmetry. method: this study used data from johannesburg stock exchange (jse)-listed companies. multiple regression analysis was applied with information asymmetry as dependent variable and iir as one of a set of selected explanatory variables. a self-constructed measurement instrument was used to measure iir for a sample of 85 companies. given the inherent difficulty with direct observation of information asymmetry, three different proxies were used to estimate information asymmetry. results: a significant negative association was found between iir and information asymmetry for all three information asymmetry proxies that were used: bid-ask spread, price impact, and analyst following. conclusion: empirical support is provided for the notion that companies may potentially benefit from a well-developed iir strategy through reduced information asymmetry. introduction in view of both the costs and the skills required to gather information, not all investors are necessarily equally informed, resulting in there being both informed and uninformed investors. brown and hillegeist (2007) and chang et al. (2008:376) described information asymmetry as the situation where some investors have access to private information (‘informed investors’) while others only possess publicly available information (‘uninformed investors’). the separation of ownership (investors) and control (management), coupled with conflicting incentives between investors and managers, may further result in management having superior information about the company, relative to the investors. information asymmetry may therefore exist, either between the management of a company and its investors, and/or between investors themselves. akerlof (1970) first pointed out the negative effects of information asymmetry on the effective functioning of markets. amongst others, information asymmetry hinders the ability of investors to distinguish between good and bad investment opportunities (healy & palepu 2001), creates additional costs through promoting adverse selection (leuz & verrechia 2000:92; welker 1995:802) and decreases liquidity levels (gajewski & li 2015:117; lev 1988). empirical studies to date that have examined the effect of disclosure on information asymmetry produced mixed results. possible reasons for such mixed results include: different proxies used for disclosure and information asymmetry; different research methodologies (e.g. sample selected); and the characteristics of the country where the data were obtained (e.g. developing or developed countries).1 the majority of related studies to date have either used an indirect disclosure proxy (i.e., a proxy that is not based on an examination of the original disclosure vehicle), for example, analyst ratings issued by the association for investment management and research (botosan & plumlee 2002; brown & hillegeist 2007), or based on an examination of the annual report (ajina et al. 2015; cheng, courtenay & krishnamurti 2006; de la bruslerie & gabteni 2011). studies that entail an examination of the original disclosure vehicle (e.g. content analysis using a measurement instrument) may be regarded as direct disclosure proxy studies (hassan & marston 2010). as no reliable analyst ratings suitable for use in this study exist in south africa, and owing to the inherent shortcomings and diversity of alternative measurement instruments (as discussed in the literature review), a self-constructed measurement instrument was deemed appropriate. the corporate website as a communication medium has specific advantages for both companies and investors. for companies, it is cost-effective and flexible in format, and for investors, it may potentially be an easy, quick, cheap, complete, reliable and up-to-date source of information. although there exists a substantial amount of research measuring the use of corporate websites as communication channel, both in south africa (barac 2004; esterhuyse & wingard 2016; loxton 2003; nel & baard 2006; venter 2002) and internationally (aerts, cormier & magnan 2007; chang et al. 2008; froidevaux 2004; gajewski & li 2015; orens et al. 2010; trabelsi, labelle & dumontier 2008), the measurement instruments used by such studies are often criticised (as discussed in the literature review) and few of these studies explicitly measured investor relations. the purpose of this study was to test for the association between the quality of internet investor relations (iir) and information asymmetry by examining the corporate websites of a sample of johannesburg stock exchange (jse)-listed companies. gray, radebaugh and roberts (1990) found that voluntary disclosure items (e.g. iir) that are perceived to be useful in one country are not always valuable in other countries. aerts et al. (2007) and orens et al. (2010), for example, documented variations in the associations between disclosure and information asymmetry given the institutional regime. literature review the purpose of the literature review is threefold: to clarify the theoretical basis for the research, to review the literature regarding the measurement of iir and information asymmetry, and to identify independent variables, besides iir, co-producing variations in information asymmetry. disclosure and information asymmetry brown and hillegeist (2007) proposed two theories to explain how disclosure quality relates to information asymmetry. according to theory 1, depicted by the upper branch in figure 1, disclosure quality will decrease either one or both of the available sets of private information and the expected net benefits of searching for private information, which results in a decrease in private information search activities. private information will thus lose its value once the information is published (e.g. on a corporate website), and disclosure quality will, therefore, decrease the available set of private information. figure 1: the relationship between disclosure, private information search activities, privately informed trading and information asymmetry. public information will also reduce the incentives for investors, either to gather information privately or to buy the information from information intermediaries. disclosure quality will therefore diminish the expected net benefits for investors to search for private information, which is already freely available publicly. theory 2, as depicted by the lower branch in figure 1, is based on the argument that as information asymmetry depends on the balance between the informed and the uninformed (gajewski & li 2015:117), disclosure quality will decrease information asymmetry through reducing the relative amount of privately-informed trading. based on the investor recognition hypothesis (merton 1987), uninformed investors are more likely to invest in companies with which they are familiar. the lower branch of figure 1, however, suggests that increased levels of uninformed trading may also increase the levels of informed trading. although brown and hillegeist (2007:472) found a positive association between disclosure and uninformed trading, they concluded that this association is offset by a positive association between disclosure quality and the level of informed trading. brown and hillegeist (2007) therefore conclude that the association between disclosure quality and information asymmetry is primarily driven by theory 1. in view of the fact that investors require information in order to evaluate investments, they will either: (1) privately gather the required information; (2) buy the required information from other information intermediaries who have already collected and analysed the information; (3) not invest in the company; or (4) make a wrong investment decision (healy & palepu 2001). in view of the cost and the knowledge required to gather information, not all investors will be equally informed. private information in the context of this study therefore refers to information that is most probably available in the public domain but, due to cost and/or time constraints, is not available to all investors – the so-called uninformed investors. ashbaugh, johnstone and warfield (1999:255), on the other hand, reason that iir may increase or decrease information asymmetry across investors. if all investors have equal access to and expertise in the use of corporate websites as information source, iir may decrease information asymmetry, but, if not, iir may actually increase information asymmetry. given the development of information technologies since 1999, specifically the increased levels of accessibility to the worldwide web (internet), it follows that investors have since consolidated achieving equal access and greater expertise in the use of corporate websites as information source. ashbaugh et al. (1999) further argued that iir would increase information asymmetry if iir activities were dominated by unreliable information communicated to uninformed investors, stressing the importance of reliable and useful iir. measurement of internet investor relations marston (1996:477) defined investor relations as the link between a company and the financial community by means of which information is provided (i.e., disclosed) to the financial community as basis for the evaluation of the company. the activities of investor relations embody a range of information or disclosure types, for example mandatory and voluntary, financial and non-financial, as well as shareholder services to facilitate relationship management and/or strategic marketing. measurement instruments devised in the literature to measure the use of corporate websites as communication channel, frequently fall short in key aspects (nel & brummer 2016) by: ignoring important attributes (e.g. by merely measuring the level of financial reporting on corporate websites without attempting to measure the wider concept of investor relations and presentation-related attributes); not attempting to distinguish between quantity and quality or to measure quality; using weights without a clear rationale; and failing to perform the required reliability and validity tests. the measurement instrument used in this study is further discussed in the methodology section. measurement of information asymmetry leuz and verrecchia (2000:98) argued that as it is not possible to observe information asymmetry directly, an appropriate proxy should be used. a number of studies have used different proxies for information asymmetry (e.g. ajina et al. 2015; fu, kraft & zhang 2012; gajewski & li 2015; orens et al. 2010). three are retained here – the quoted or relative bid-ask spread, price impact, and analyst following. for reasons discussed below, the following proxies were not used: analyst forecast accuracy, time-weighted average spread, effective spread, depth-adjusted effective spread, and the probability of informed trading. 2 analyst forecast accuracy is based on analyst forecast dispersion. at least two analyst forecasts are required to calculate this measure and, as only 30 of the companies in the study sample are followed by two or more analysts, it was decided not to use this proxy. to calculate the time-weighted, effective, and depth-adjusted effective spread, as well as the probability of informed trading, intraday data are needed. given, firstly, the difficulties of accessing intraday data and, secondly, the similarity of results derived from alternative proxies,3 intraday-based proxies were not utilised. bid-ask spread the bid-ask spread, also known as the width or tightness, is calculated as the difference between the bid and the ask price. of all the variations of the bid-ask spread used in the literature (e.g. quoted or relative, time-weighted relative, effective and depth-adjusted effective spreads), the quoted bid-ask spread is the most popular. chang et al. (2008:382) asserted that periods of high information asymmetry are characterised by uninformed traders that revise their bid and ask prices away from the market to decrease the probability of trading with an informed investor. the bid-ask spread therefore has a positive correlation with information asymmetry and if iir decreases this adverse selection, it should result in a narrowing of the bid-ask spread. price impact liquidity can be described using three dimensions: width (bid-ask spread), market depth, and slippage (kyle 1985). slippage (also referred to as market resilience) captures the ability of investors to trade in a share without affecting its price. the price impact ratio was developed by amihud (2002) to capture slippage and is positively correlated with information asymmetry. if iir increases liquidity and decreases information asymmetry, it should be negatively related to the price impact ratio as small changes in the share price will result in a lower price impact ratio. analyst following lang and lundholm (1996) argued that both the effectiveness of analysts monitoring, as well as market efficiency in a particular company’s shares, are improved if the number of analysts following the company increases. merton (1987) and agarwal et al. (2016:35) argued that an effective investor relations programme increases analyst following. healy and palepu (2001), on the other hand, argued that one can either reason that companies which disclose more information attract more analysts by supporting these analysts to create superior forecasts, or that additional disclosure reduces the opportunities for analysts, implying a lower demand for their services leading to a lower analyst following. based on the argument that reliable analyst monitoring and ratings may potentially both increase uninformed trading (theory 2 in figure 1) and decrease private information search activities (theory 1 in figure 1), as discussed earlier, for present purposes a negative association between analyst following and information asymmetry was hypothesised. determinants of information asymmetry independent variables, beyond iir, used in the literature to explain variations in information asymmetry, are discussed in this section. share price the microstructure of financial markets stipulates that the share price should explain liquidity (ajina et al. 2015:1228). significant negative associations have been documented between share price and the following information asymmetry proxies: quoted bid-ask spread (ajina et al. 2015; healy, hutton & palepu 1999; welker 1995), time-weighted spread (chang et al. 2008) and effective spread (ajina et al. 2015; heflin, shaw & wild 2005). our study expected a negative association between share price and each of the following: bid-ask spread and price impact, while a positive association was expected between share price and analyst following. leverage theoretical arguments are used in the literature to hypothesise both positive (aerts et al. 2007; boot & thakor 1993) and negative associations (brown & hillegeist 2007) between leverage and information asymmetry. boot and thakor (1993) argued that higher levels of leverage will stimulate private information production, which will increase information asymmetry. in support of arguments for a positive association, orens et al. (2010) found a significant positive association between leverage and the bid-ask spread. our study expected a positive association between leverage and each of the following: bid-ask spread and price impact. a negative association was expected between leverage and analyst following. share price volatility according to orens et al. (2010:1072), share price volatility results from disagreements between buyers and sellers, and can therefore be associated with the requirement of higher risk premiums, which, in turn, will increase the bid-ask spread. share price volatility indicates the degree of uncertainty or risk (gajewski & li 2015) used as a measure of the price risk that investors have to bear (welker 1995:808). bhushan (1989:271) found a positive association between share price volatility and analyst coverage, suggesting that the demand for analysts’ services is higher for companies with a higher risk, as measured by share price volatility. our study expected a positive association between share price volatility and each of the following: bid-ask spread, price impact, and analyst following. ownership structure information asymmetry is related to the extent to which privately-informed trading takes place and to private information search activities. large institutional investors not only have the resources to generate private information, but also benefit from economies of scale – which will further decrease their information acquisition cost relative to smaller retail investors. the present study has used two ownership structure proxies, directors’ shareholding and free float. our study expected a positive association between directors’ shareholding and each of the following: bid-ask spread and price impact; while a negative association was expected between directors’ shareholding and analyst following. for free float, on the other hand, negative associations were expected with the bid-ask spread and price impact, and a positive association with analyst following. share turnover trading volume consists of both informed and uninformed trading. as discussed, it can be hypothesised that informed trading increases information asymmetry and uninformed trading decreases information asymmetry. ajina et al. (2015) argued that increased levels of trading volume may cause disequilibrium in the market, resulting in extra costs that have to be recouped by the enlargement of the spread. although the relationship between share turnover and information asymmetry is therefore somewhat ambiguous, the majority of studies to date found a negative association between share turnover, as independent variable, and information asymmetry, as dependent variable. our study expected a negative association between share turnover, as independent variable, and each of the following: bid-ask spread and price impact. analysts would be attracted to more visible companies. a positive association between share turnover, as independent variable, and analyst following was therefore expected. dual listing multiple stock exchange listings are often associated with increased transparency and increased disclosure (ajina et al. 2015:1229; orens et al. 2010:1070). our study expected a negative association between having a dual listing and each of the following: bid-ask spread and price impact. a foreign listing may, however, stimulate analyst activity in the foreign country, as foreign investors will experience more information asymmetry compared to domestic investors, thereby creating a demand for analyst research in the foreign country (aerts et al. 2007:1311). our study expected a positive association between having a dual listing and analyst following. methodology measurement of internet investor relations the measurement instrument was developed by means of a four-step methodology: review of best practices as published by the united kingdom investor relations society (http://irsociety.org.uk/); an extensive literature review of existing instruments; a pilot study; and, finally, a reliability (cronbach’s alpha) and construct validity assessment based on the iir measurement results, resulting in a measurement instrument that consists of 346 attributes, organised into 11 categories.4 the maximum iir score that could be achieved was 346. more specifically, quality of iir is assessed by, first of all, measuring information content in as detailed a manner as possible; second, by measuring the presentation of information (i.e. accessibility, timeliness and navigation); and, finally, by allowing for the measurement of attributes as only partially available (scored as 0.5) based on breadth, timeliness and usability. a sample of 25% of jse-listed companies was selected using stratified (jse industry) random sampling with proportional allocation per jse sector. the population was defined as all companies5 currently listed on the jse that had not been suspended, had traded since the inception date, had published 2013 annual reports, and had a dedicated, working website. a total of 85 companies were included in the sample. all iir measurements were done from march to september 2015. information asymmetry table 1 provides a brief description of how each information asymmetry proxy was calculated, as well as the expected association with iir. table 1: information asymmetry proxies – description and expected iir association. in theory, the first two proxies listed in table 1, bid-ask spread and price impact, are positively related to information asymmetry and the last one, analyst following, negatively. additional independent variables the stepwise regression method was used to examine the relationship between iir and each of the three proxies used for information asymmetry. besides iir, additional independent variables were used in the regression analysis to explain further variation in information asymmetry. table 2 summarises the calculation of these variables. table 2: independent variables used to explain information asymmetry: description. data collection all dependent and independent variables were captured from the inet bfa database with the exception of dual listing and free float that were obtained directly from the jse, and iir which was measured using the measurement instrument discussed above. endogeneity various studies to date have cautioned that disclosure, and therefore iir, should be treated as an endogenous variable when studying the effects of voluntary disclosure on information asymmetry (chang et al. 2008; core 2001; leuz & verrechia 2000; orens et al. 2010; welker 1995). if not accounted for, the endogeneity problem will result in spurious results and incorrect conclusions. hence, the wu-hausman test was used to test for endogeneity. results as a result of extremely thin trading, the bid-ask spread was not available for one company, as this company’s shares only traded for 40 days over the measurement period. the sample was therefore reduced to 84 companies. all the results reported pertain to the reduced sample. the natural logarithm (ln) of the bid-ask spread, price impact, share price volatility and share price were used to reduce skewness. however, the descriptive statistics in table 3 are presented prior to the use of any natural logarithmic transformations in the multivariate regression analysis. table 3: descriptive statistics. table 4 shows the pearson correlation coefficients between the three information asymmetry proxies and the independent variables. table 4: correlation matrix: information asymmetry and independent variables. all the coefficients reported in table 4 are as expected, except in three instances. first, no significant association between dual listing and any of the three information asymmetry proxies was found. dual listing was, however, found to be significant, and negative as expected, in the regression model where the bid-ask spread was used as information asymmetry proxy. second, the association between leverage and information asymmetry was expected to be positive in the case of the first two proxies (bid-ask spread and price impact) and negative in the case of the last one, analyst following. table 4, however, depicts associations contrary to what were expected. lastly, a positive association was expected between share price volatility, as independent variable, and analyst following, as information asymmetry proxy. although table 4 depicts a negative association, a significant and positive association was found in the respective regression model, as discussed below (see table 7). table 5 displays the pearson correlation coefficients between the independent variables. table 5: correlation matrix: independent variables. the high correlations between share price and share price volatility, and free float and share turnover send cautionary signals that tolerance values should be carefully monitored for signs of multicollinearity. as discussed above, the wu-hausman test is used to test for a potential endogenous problem. an instrumental variable is needed to perform the wu-hausman test. for the purpose of this study, being audited by a big four audit company was used as the instrumental variable. being audited by a big four audit company is highly significant and positively related to the endogenous independent variable, iir, (nel, smit & brummer 2017:63), but is not correlated with information asymmetry. the wu-hausman test results are showed in table 6. table 6: wu-hausman results: internet investor relations as independent variable and information asymmetry as dependent variable. the wu-hausman test also tests for the strength of the instrumental variable used. for each of the three information asymmetry proxies tested in this study, the ho hypothesis that the instrumental variable is a weak instrument was tested. as the p-values in table 6 indicate, all three hypotheses were rejected, thus showing the strength of the instrumental variable used. next, the ho hypothesis that iir is an exogenous variable was tested. as the p-values in table 6 indicate, none of these hypotheses were rejected. all three ho hypotheses were therefore accepted, thus showing that iir is not an endogenous independent variable. similar results were found by cheng et al. (2006) and gajewski and li (2015). the ordinary least square regression model is therefore used in all further analyses discussed in the remainder of this article. table 7 presents the results of the stepwise regressions. table 7: regression results. a minimum tolerance value of 0.31 confirmed the absence of multicollinearity. residual plots of predicted versus residuals were examined. from these residual plots no evidence of heteroscedasticity was found for the bid-ask spread and price impact model. the residual plot for analyst following, however, depicts evidence of heteroscedasticity. the breusch-pagan test for heteroscedasticity confirmed the existence of heteroscedasticity. the regression results reported in table 7 are before adjustments were made for heteroscedasticity. regression results, adapted for heteroscedasticity, are discussed below. bid-ask spread as depicted in table 7, the coefficient for iir is negative and significant at the 1% level. the coefficients of all other independent variables are as expected and highly significant, except for dual listing that is only significant at the 10% level. for the sample of jse companies the following hold in accordance with theoretical expectation: the negative iir coefficient indicates that enhanced iir reduces the level of the bid-ask spread, and therefore information asymmetry. most studies to date that have found a similar negative association, have used either an indirect disclosure proxy (e.g. analyst ratings) or measured the annual report as disclosure vehicle. however, gajewski and li (2015) and orens et al. (2010) have found a negative association based on a measurement of corporate website disclosure. on the other hand, chang et al. (2008) found no significant association between spread and their measurement of the quality of a company’s iir activities. chang et al. (2008:386) suggested two possible reasons for this non-significant association: website investor relations information may be perceived to be less credible by investors compared to annual report-provided disclosures; and the possibility of a non-linear relationship between disclosure and spread, suggesting that that there may be an upper limit in the reduction of spread as disclosure quality improves. the magnitude of the reported adjusted r² of 91% compares favourably with studies such as gajewski and li (2015) reporting an adjusted r² of 60%, welker (1995) 63%, ajina et al. (2015) 74%, leuz and verrechia (2000) 81%, and cheng et al. (2006) 85%. although various studies have used share turnover as independent variable in their regression models to explain variations in bid-ask spread levels (e.g. ajina et al. 2015; gajewski & li 2015), a reverse causality relationship may exist between share turnover and the bid-ask spread. if share turnover as independent variable is removed from the regression model reported in table 7, dual listing does not remain as a significant independent variable in the final regression result. share price, iir and share price volatility are, however, still highly significant at 1%, and free float remains as significant independent variable (direction of all coefficients as expected) with only a slight decrease in the adjusted r² to 88% from the 91% reported in table 7. price impact as depicted in table 7, the coefficient for iir, for the jse sample, is negative and significant, but only at the 10% level. the coefficients of all other independent variables are as expected and highly significant. the negative iir coefficient indicates that enhanced iir improves the ability of investors to trade in a share without affecting its price, resulting in increased liquidity levels and decreased information asymmetry. compared to the bid-ask spread as information asymmetry proxy, few studies have used the price impact ratio as measure of information asymmetry giving rise to mixed empirical results. fu et al. (2012), for example, found the expected negative association, whereas ajina et al. (2015) found no significant association. neither of these two studies however measured corporate website disclosure levels or investor relations levels. fu et al. (2012) used an indirect disclosure proxy, namely financial reporting frequency, and ajina et al. (2015) measured annual report voluntary disclosure levels. fu et al. (2012) reported an adjusted r² of 36% and ajina et al. (2015) a higher 67%, but with a non-significant disclosure coefficient. analyst following table 7 shows the expected positive association between iir, significant at the 5% level, and analyst following for the jse sample. the coefficients of all other independent variables are as expected and significant. the breusch-pagan test confirmed the existence of heteroscedasticity. corrected for heteroscedasticity, by applying heteroscedasticity-consistent estimation of the covariance matrix of the coefficient estimates, the iir coefficient remained positive with the level of statistical significance unchanged at 5%. in the adapted regression model, the statistical significance of the share price volatility variable, however, increased to the 1% level. orens et al. (2010:1078) discussed a problem of endogeneity with the extent of disclosure. they argued that either financial analysts are more likely to follow companies with more disclosure or companies may disclose more in order to attract more analysts. as discussed, the wu-hausman test results confirmed the absence of endogeneity. similar results (i.e., significant association between analyst following and iir, as well as the absence of endogeneity) were reported by abdelsalam, bryant and street (2007:20). as a high analyst following could lead to a high share turnover, a reverse causality relationship may exist between share turnover and analyst following. if share turnover as independent variable is removed from the regression model reported in table 7, all independent variables (iir, share price and share price volatility) remain significant. although the adjusted r² decrease to 43% from the 54% reported in table 7, the statistical significance of both iir and share price volatility increases from 5% to 1% (direction of all coefficients as expected). conclusion of the three proxies used for information asymmetry in this study, the bid-ask spread is not only the most popular and theoretically appealing proxy, but it also provides the strongest empirical support for a negative association between iir and information asymmetry. the majority of studies about disclosure and information asymmetry have, however, been performed using developed country data and have either used analyst ratings as disclosure proxy or have measured the annual report as disclosure vehicle. this study therefore not only provides further empirical support for a negative relationship between disclosure and information asymmetry, but more specifically provides support for the investor recognition hypothesis that states that a well-developed investor relations programme improves visibility and decreases information asymmetry. specifically in respect of iir, this study provides further support for the findings of gajewski and li (2015) who used a french sample, but contradicts the findings by chang et al. (2008) who found no association using an australian sample. although used far less as information asymmetry proxy, price impact seems to capture an important measure of liquidity, which is the ability of an investor to trade without affecting the share price. empirical support for a negative association between disclosure and price impact is, however, weak and unstable. this study not only provides strong empirical support for a negative association between iir and price impact, but also provides further support for the continuous use of price impact as illiquidity and information asymmetry proxy. although analyst following is considered a less precise measure of information asymmetry, the positive association between iir and analyst following support the arguments by merton (1987) and agarwal et al. (2016) that an effective investor relations programme will increase analyst following. this study therefore provides further evidence in support of economic theory that postulates a relationship between disclosure and information asymmetry, by using developing country data and through the examination of corporate websites as communication medium. based on research that found that annual report disclosure levels are positively correlated with disclosure levels through corporate investor relations and other publications (lang & lundholm 1993) and the voluntary nature of iir, this study contributes to international accounting literature by providing further support for the advantages of voluntary disclosure in an accounting context. given the advantages of a reduced level of information asymmetry, knowledge about the circumstances under which and how these may be achieved would enable companies to optimise their iir strategies. whereas several investor relations communication channels are available to companies, for example, media releases, investor presentations, social media (e.g. twitter) and corporate websites, the current study examines only one of these channels, namely the corporate website. given the recent growth in social media channels such as twitter, facebook and youtube, further research is needed on how companies use social media to communicate with investors, and to examine the effect thereof on information asymmetry. blankespoor, miller and white (2014), for example, found that the communication of company-initiated news via twitter is associated with lower bid-ask spreads and higher liquidity. economic theory links information asymmetry to the share price and the cost of capital. this warrants the need for future research to examine the association between iir, and the share price and cost of capital. acknowledgements competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced 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of the quality of internet investor relations – a study of companies listed on the jse’, south african journal of business management 48(1), 55–65. orens, r., aerts, w. & cormier, d., 2010, ‘web-based non-financial disclosure and cost of finance’, journal of business finance and accounting 37(9), 1057–1093. https://doi.org/10.1111/j.1468-5957.2010.02212.x trabelsi, s., labelle, r. & dumontier, p., 2008, ‘incremental voluntary disclosure on corporate websites: determinants and consequences’, journal of contemporary accounting & economics 4(2), 120–155. https://doi.org/10.1016/s1815-5669(10)70032-1 venter, j.m.p., 2002, ‘a survey of current online reporting practices in south africa’, meditari 10(1), 209–225. https://doi.org/10.1108/10222529200200011 welker, m., 1995, ‘disclosure policy, information asymmetry, and liquidity in equity markets’, contemporary accounting research 11(2), 801–827. https://doi.org/10.1111/j.1911-3846.1995.tb00467.x footnotes 1. ajina, sougne and lakhal (2015), for example, found a significant negative relationship between disclosure and bid-ask spread as information asymmetry proxy, but no significant relationship between disclosure and price impact as information asymmetry proxy. regarding the characteristics of the country where the data were obtained, orens, aerts and cormier (2010) found a significant negative relationship between disclosure and bid-ask spread using data from continental european listed companies, but no significant relationship using data from northern american listed companies. 2. although share turnover (e.g. cheng et al. 2006; orens et al. 2010) and share price volatility (e.g. cheng et al. 2006; leuz & verrechia 2000) are sometimes used as information asymmetry proxies and were tested as such in this study, the results thereof are not reported due to inherent limitations in the research design (e.g. endogeneity). for completeness’ sake, iir was found to be a significant positive independent variable (at 5%) and, together with share price, share price volatility and free float (all significant and positive), explained 51% (r²) of the variation in share turnover. share turnover was measured as the average daily of the rand volume of shares traded scaled by the market capitalisation (over-all trading days from 01 december 2014 to 30 november 2015). with regard to share price volatility, no significant association was found between iir and share price volatility where the latter was measured as the natural logarithm of the annualised share price volatility as on 30 november 2015. 3. gajewski and li (2015) studied the relationship between internet-based disclosure and information asymmetry. they used five proxies for information asymmetry (i.e., quoted spread, effective spread, time-weighted spread, probability of informed trading [pin] and adjusted pin) and found negative associations with disclosure for all five proxies. ajina et al. (2015) found statistically-significant negative relationships between both the quoted and the effective bid-ask spread, and their disclosure proxy (voluntary disclosure in annual reports). 4. the 11 categories are: accessibility, navigation, timeliness, company information, financial information, relevant news, investment case, shareholder information, bondholder information, corporate governance and corporate responsibility. space precludes the publication of the full measurement instrument, but all issues in the development of the instrument (e.g. reliability and validity tests performed) are comprehensively dealt with in nel and brummer (2016). the full measurement instrument, as well as the measurement conventions followed in the measurement process, is further available from the author on request. 5. both companies listed on the main board and altx were included in the population. although it is acknowledged that altx companies might have different trading behaviour (e.g. liquidity) and ownership structures compared to companies listed on the main board, they were specifically included for the following reasons: smaller companies are more likely to use their disclosure policy to influence market perceptions (lang & lundholm 2000) and research that found significant associations between disclosure/investor relations and, respectively, the cost of equity (botosan 1997) and analyst following (agarwal et al. 2016) for smaller companies/companies with a low analyst following, but none for larger companies/companies with a high analyst following. sajems ns 7 (2004) no 2 258 modeling switching behaviour of direct selling customers ________________________________________________________________ p msweli-mbanga school of economics and management, university of kwazulu-natal ________________________________________________________________ abstract the direct selling industry suffers a high turnover rate of salespeople, resulting in high costs of training new salespeople. further costs are incurred when broken relationships with customers cause them to switch from one product supplier to another. this study identifies twelve factors that drive the switching behaviour of direct sales customers and examines the extent to which these factors influence switching. exploratory factor analysis was used to assess the validity of these factors. the factors were represented in a model that posits that an interpersonal relationship between a direct sales person and a customer moderates the relationship between switching behaviour and loyalty. structural equation modeling was used to test the proposed model. the author then discusses the empirical findings and their managerial implications, providing further avenues for research. jel m31 introduction despite being the oldest method of marketing, relatively little is known about the direct selling industry, direct selling companies, direct selling salespeople and consumers who buy from direct sellers. according to peterson and wotruba (1996) this lack of knowledge is due to a number of factors ranging from the ‘invisible’ nature of direct selling and the fact that the majority of direct selling firms are privately held and relatively small. governmental reporting requirements are few and the companies are generally reluctant to release information about themselves. nevertheless, the industry is quite sizeable with a global annual revenue of $85 billion dollars (world federation of the direct selling association, 2001). in south africa the industry generates a turnover of approximately r2 billion annually, forty percent of which is consumed by the sales force and their families (ryan, 2002). it is estimated that there are almost 36 million individuals involved in direct selling worldwide (world federation of direct selling associations, 2001). sajems ns 7 (2004) no 2 259 these people are usually referred to as distributors or independent contractors and they operate from their home base, and selling consumer goods or services to consumers outside retail outlets. every distributor is essentially an entrepreneur running a small business under the direction of the founding leader. direct selling is a nonstore approach to retailing. it is a marketing activity involving face-to-face contact between customer and salesperson in a location other than a retail store. direct selling is unique in that the salesperson is the exclusive interface between the firm and the customer (lambert, sharma & levy, 1997). the personal contact between a salesperson and a customer in the direct selling context highlights the importance of the salesperson and his/her role, not only in the distribution channel, but also in maintaining relationships with customers. there are two types of direct selling organisations: (1) single level organisations and (2) multilevel organisations. in the case of single level organisations, a distributor is recruited and trained to sell a range of products offered by the organisation at a discounted price. distributors then make retail profit when they sell to their customers. in multilevel organisations, distributors generate income, not only from their personal sales, but also from commissions and bonuses based on the sales of those whom they may recruit directly or indirectly into their networks. the sales support functions of training, motivation, administration and delivery of goods are the responsibilities of distributors in the case of multilevel direct selling organisations. a number of advantages are cited for selling products through the direct selling channel of distribution. these include an increased ability to secure distribution and sales quickly at a low level of fixed cost (clothier, 1994), and the ability to gain entrance to a market, while avoiding excessive promotional and advertising expenses. while there are positive aspects of direct selling, there are negative aspects as well. there is evidence in literature for instance, that the direct selling industry suffers very low rates of distributor retention (tyagi & wotruba, 1993; bloch, 1996; berry, 1997). the low retention rate in the industry results in high costs associated with engaging new salespeople, and significant costs arising from broken relationships with customers. the broken relationships with customers lead to not only the spread of negative word-of-mouth, but to frequent switching from one product supplier to another. this study seeks to examine the switching behaviour of direct sales customers. there are very few studies that have addressed switching behaviour in the retail sector. keaveney (1995) points out that the reasons for switching services would differ from the reasons for switching retail goods. this study thus seeks sajems ns 7 (2004) no 2 260 to examine why retail customers switch suppliers. specifically, this study identifies the factors that lead to switching behaviour in customers who purchase directly sold goods and the extent to which these factors influence switching. an understanding of the switching behaviour of direct sales customers will be useful to both practitioners and researchers. practitioners will be able to devise strategies that reduce the tendency to switch, thereby retaining loyal customers. researchers could separate those who are most likely to switch from those who are least likely to switch and study the loyalty patterns within the two groups. objectives of the study the purpose of this study is to identify the variables that drive the switching behaviour of direct sales customers. the study builds on keaveney’s (1995) research by presenting a set of variables which include and extend upon those identified by keaveney (1995) in a parsimonious model that describes the switching behaviour of direct selling customers. the study tests a model that posits that interpersonal relationship between a direct sales person and a buyer moderates the relationship between switching behaviour and loyalty. this study adds to the understanding of switching behaviour by: identifying variables that impact on the switching behaviour of direct sales customers; examining the switching behaviour-loyalty link in the direct selling context; testing whether the switching behaviour-loyalty link in the direct selling context is moderated by interpersonal relations; examining the simultaneous effect of fifteen variables in the proposed switching behaviour model. the theoretical base for the proposed model switching behaviour of customers has long been of interest to marketing researchers (kuehn, 1962; morrison, 1966; bass, 1974) because of the link between switching behaviour and profitability. most of the switching behaviour research between the 70s and the 80s tended to focus on the impact of marketing mix elements and how these contributed to the switching behaviour of customers (chance & french, 1972; carpenter & lehmann, 1985; guadagni & little, 1983; gupta, 1988). in the 90s the switching behaviour literature was dominated by authors who linked switching behaviour to service quality and sajems ns 7 (2004) no 2 261 customer satisfaction (keaveney, 1995; mittal & lassar, 1998; de ruyter, wetzels, and bloemer 1998). in recent years there has been an ongoing debate over whether customer switching behaviour-customer satisfaction link (ganesh, arnold & reynolds, 2000) and the link between switching behaviour and perceptions of quality (keaveney, 1995). in line with this thinking, ganesh, arnold & reynolds (2000) argue that the switching behaviour of customers may not necessarily be related to customer loyalty. this notion is further supported by mittal and lassar (1998) who assert that customers who report a high loyalty rating may still possess a predisposition to switch suppliers. conversely, there are studies that suggest that loyalty is negatively related to switching behaviour (srnivasan, 1996), and that switching occurs far less frequently in the presence of loyalty. the reality is that loyal customers do display a predisposition to switch suppliers, and this has caused confusion in establishing an unequivocable connection between the two aspects of behaviour. lee and cunningham (2001) suggest that the confusion may be because the notion of switching barriers has never been considered. a switching barrier, as lee and cunningham (2001) explain, is determined by the degree of ease with which customers are able to change service providers. lee and cunningham (2001) argue that the impact of such a barrier on customer loyalty depends on the market structure and industry within which companies operate. by taking this theory into account, this study seeks to focus on creating a greater understanding of the switching behaviourloyalty link in the direct selling industry. the representation of customer loyalty and its link to personal relations in the direct selling industry builds on two sets of empirical findings. first, frenzen and davis (1990) report that direct selling consumers obtain social and psychological benefits from their personal relationships with the seller. the authors propose that buyers are bound by their close interaction with the sellers, and may even go to the extent of purchasing unwanted goods, paying premium prices, or forgoing discounts in order to benefit a particular seller. jones, mothersbaugh and beatty (2000) affirm this contention, although their study was based on service personnel. jones et al. (2000) define interpersonal relationships as the strength of personal bonds that develop between customers and their service employees. in their work, jones et al. (2000) found that interpersonal relationships and perceived switching costs have an impact on repurchase intention in the service industry. sajems ns 7 (2004) no 2 262 figure 1 proposed switching behaviour model (+) (+) (-) (+) (+) (+) (+) (+) (+) (+) switching behaviour loyalty service encounter pricing pushy unreliability ethics poor service inconvenience rebate error competition quitting risk (+) (+) response to core service failure (-) (+) interpersonal relationship sajems ns 7 (2004) no 2 263 as figure 1 illustrates, keaveney’s (1995) model was used as a base to identify the factors and descriptors of the factors that impact on the switching behaviour of direct sales people. keaveney’s (1995) research identified eight factors, namely (1) price, (2) inconvenience, (3) core service failure, (4) service encounter failures, (5) response to service failure, (6) competition, (7) ethical problems and (8) involuntary switching, explained by 27 items. this study generated 30 additional items arising from in-depth interviews with direct sales customers as discussed in the research methodology section below. research methodology research design and sampling issues in the initial phase of the research, in-depth interviews with direct sales customers and direct selling industry experts were conducted to tap into their insights about the factors that lead to the switching of product suppliers. a review of relevant literature identified several additional factors that could impact on switching behaviour of customers. a total of 68 items were generated from literature and the in-depth interviews. a questionnaire was developed to capture these items. next, the questionnaire was pilot tested on a sample of 15 customers who had purchased products from a direct selling firm. on the basis of the pretest, the questionnaire was revised and subsequently administered to a sample of direct selling customers in the kwazulu-natal area. sample members had to conform to one requirement – that of having bought products from a direct selling firm in the past six months. using a mall intercept method (churchill, 1996), data was collected from 200 respondents. there were more respondents (39 per cent) in the age category between 31 and 40 years and more than 40 per cent of the respondents had high school education. the proportion of female respondents was slightly higher (51 per cent) compared to male (49 per cent) respondents, and 17 per cent of them were black, 32 per cent indian, 34 per cent white, and 17 per cent coloured. measures factors impacting on switching behaviour before the proposed switching behaviour model could be tested, the factorial validity of the 68 items identified from literature and in-depth interviews had to be tested using exploratory factor analysis. evaluation of the eigenvalues and screenplot indicated a twelve-factor solution which explained 74 per cent of variation in the items. the items to measure each one of the twelve factors are sajems ns 7 (2004) no 2 264 outlined in table 1. all items were measured on a five-point likert scale ranging from “1” = strongly disagree to “5” = strongly agree. switching behaviour switching behaviour was measured using a single item: “what are your intentions with regards to switching from your current direct selling supplier to other direct selling suppliers within the next three months?” responses were scored on a scale of 1-3, with 1 = “definitely not switch”, 2 = “might switch”, and 3 = “definitely switch”. interpersonal relationship interpersonal relationship was operationalised on the basis of five items developed by the authors: (a) i have a good relationship with my direct sales person (b) my direct sales person gives me special attention (c) my direct sales person goes out of his way to help me (d) i trust my direct sales person (e) i have a long-term relationship with my direct sales person each of the items was measured on a five-point likert scale ranging from ‘1’ = strongly disagree to ‘9’ = strongly agree. loyalty the measure of store loyalty was adapted from the loyalty measure developed by sirohi and mc laughlin (1998). the measure is determined by three items: (1) how likely would you be to recommend a direct seller and his/her product range to a friend or relative? (2) how likely are you to purchase from your current direct seller in the next six months? (3) how likely are you to continue purchasing your products from your direct seller? the responses were measured on five-point likert scales, ranging from “1” = not at all likely to “5” extremely likely. analytical procedure initially, exploratory factor analysis was used to assess the factorial validity of the items used to develop the scale used to measure the determinants of switching behaviour. twelve factors were identified and structural equation modelling (sem) was used to test whether the twelve determinants of switching behaviour (as outlined in table 1) lead to switching, as well as the extent to which these variables influenced switching. structural equation modeling was also used to test whether interpersonal relations moderate the switching behaviour-loyalty relationship. as such, the simultaneous effect of the 15 variables as depicted in figure 1 was tested to assess model fit. sem is a confirmatory analytical tool, and its usefulness lies in providing estimates of the sajems ns 7 (2004) no 2 265 strength of all the hypothesised relationships as specified in the model illustrated in figure 2. the scores on all items for each variable were aggregated to obtain single dimension scores. the structural model was thus written as a completely endogenous model. this approach to model estimation is appropriate, given the objectives of the study: (1) to identify the variables that impact on switching behaviour and the extent to which they influence switching; (2) to evaluate the effect of variables in the hypothesised relationships as illustrated in figure 1. testing an endogenous model in these circumstances is advantageous and efficient because only the beta coefficients are estimated and the method does not require exogenous constructs to be nominated (jöreskog & sorbom, 1996). furthermore, a number of studies have based research conclusions on completely endogenous models (sager & menon, 1994; bagozzi, 1980; msweli-mbanga, 2001). the software program amos was used to test the hypothesised model. as recommended by anderson and gerbing (1988) a two-step procedure, that separately estimates and respecifies the measurement model prior to simultaneous estimation of measurement and structural model, was followed. empirical findings factor analysis results and validity of the switching behaviour determinants based on the in-depth interviews in the first phase of the research as well as the literature review, 68 items that influence switching behaviour were generated. all 68 items were factor analysed using component factor analysis to examine the underlying relationships among the items and to summarise into a smaller set of factors. although the sample size of 200 provides a case-to-variable ratio less than the minimum requirement of 1 observation to 5 responses, there are other scale developers (parasuraman, zeithaml & berry, 1988; churchill, ford & walker, 1974) who have used lower case-to-variable ratios. the factors were orthogonally rotated using the varimax method of rotation (norušis, 1994). according to hair, anderson, tatham and black (1998) an orthogonal factor solution is the best if the objective of research is to reduce a larger number of variables to a smaller set of uncorrelated variables for subsequent use in prediction techniques. kaiser’s criterion was used for deciding which factors to eliminate (bryman & cramer, 1994). the factor solution resulted in twelve factors with eigenvalues greater than one. the sajems ns 7 (2004) no 2 266 twelve factor solution accounted for 74 per cent of the variance. in order to purify the list, items with loadings of 0.3 and less were eliminated. items that correlated high with more than one factor were also eliminated to ensure that true discriminant validity had been established among the constructs. having eliminated items from the factors, one factor (service encounter failure) still had a considerably high number of items acting as indicators for the construct. apart from the theoretical basis that should be used to select indicators of a construct, hair, anderson, tatham and black (1998) contend that there is no upper limit in terms of the number of indicators. however, unidimensionality of the construct was checked using cronbach alpha as suggested by hair et al. (1998). the findings were within the bench mark of 7 indicating that the construct was unidimensional. the factor structure illustrated in table 1 was used to construct the causal model depicted in figure 1. reliabilities and descriptive statistics of variables in the model a total of 15 variables are hypothesised to interact as depicted in figure 2. cronbach’s alpha has been used to assess the internal consistency of the measuring scales. the cronbach’s alpha measurement is based on the average inter-item correlation, and the values range from 0-1, with higher values indicating higher reliability among items. table 2 shows that the internal consistency of the variables, measured by cronbach’s alpha, are within the benchmark of .70 as suggested by nunnaly and bernstein (1994). the single item measure of switching behaviour has been fixed to unity, because it is not empirically possible to estimate its reliability (hair et al., 1998). while the single item measure seems to tap into the central switching behaviour construct as conceptualised by keaveney (1995), a multiple item scale would have been preferable. however, single item measures have been used in previous studies using structural equation modeling methodology (refer to capraro, broniarczyk, & srivastava, 2003; mackenzie, podsakoff & ahearne, 1998; hom & kinicki, 2001). assessing the internal consistency of the variables is a requirement in sem and in theory testing (hair et al., 1998), not only to assign meaning to the parameters that are to be estimated, but also to assess unidimensionality. anderson and gerbing (1988) and hair et al. (1998), posit that unidimensionality of variables is assessed using internal consistency, and the alpha values in table 2 illustrate that the variables are indeed, unidimensional. sajems ns 7 (2004) no 2 267 table 1 determinants of switching behaviour sef service encounter failure factor loadings factor 1 1. not helpful 2. unfriendly 3. refuse to accommodate my requests 4. neglect to answer my questions 5. impatient 6. condescending 7. ill-tempered .82 .78 .75 .80 .72 .75 .74 price factor 2 pricing 1. prices too high 2. unreasonable price increases 3. prices were deceptive 4. prices charged unfair .82 .86 .74 .65 pushy factor 3 pushiness of direct seller 1. made me feel uncomfortable 2. did not have respect for my feelings 3. was over-bearing 4. employed sales tactics that were not professional .56 .58 .50 .53 ethics factor 4 ethical behaviour of direct seller 1. engages in deceptive consumer practice 2. terms of sale are ambiguous and unclear 3. does not perform in accordance with the terms of warrantees and guarantees .70 .76 .72 psq factor 5 poor service quality 1. wait too long to receive products ordered 2. mistakes in processing of orders 3. service quality deteriorates 4. product packaging damaged .77 .74 .50 .51 unrel factor 6 unreliability of direct seller 1. difficult to contact 2. does not respond to queries 3. does not make follow-up calls 4. does not fulfil promise to deliver products on time 55 58 53 60 risk factor 7 risk 1. products might be a risk to my health 2. if at risk of losing money by purchasing products that might not work 3. if products pose risk to my social image .81 .85 .76 quit factor 8 direct seller quit selling 1. direct seller quit selling 2. lost interest in selling 3. impossible to contact .89 .92 .85 sajems ns 7 (2004) no 2 268 table 1 continued sef service encounter failure factor loadings inc factor 9 inconvenience 1. product outlet not located closer to me 2. hours of operation inconvenient to me 3. delivery times not convenient .44 .49 .52 reb factor 10 rebate error 1. receive incorrect rebate statements 2. failure to correct errors in rebate statements 3. take too long to correct rebate error .60 .59 .57 rtsf factor 11 response to service failure 1. reluctant in responding to service problems 2. fail to respond to service problems 3. defensive instead of dealing with service problem .75 .81 .69 comp factor 12 competition 1. competitor more reliable 2. competitor friendlier 3. competitor provides better quality service .55 .43 .56 specification of the structural and measurement models based on the hypothesised relationships in figure 2, three equations have been constructed linking the exogenous constructs to the endogenous constructs as provided in table 3. table 3 also indicates how the linear regression equations have been used in specifying the structural and measurement model. the structural model in this study consists of 3 endogenous and 12 exogenous variables. the parameters β1, β2, β3, β4… β14 are the regression coefficients to be estimated. error terms represent the error in measuring the conceptual variables (maruyama, 1998). the error terms were fixed at unity to allow for the estimation of regression weights. sajems ns 7 (2004) no 2 269 table 2 internal consistency and correlation matrix α 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 1. sef .89 1.00 2. price .84 .32 1.00 3. pushy .82 .67 .31 1.00 4. ethics .78 .42 .28 .56 1.00 5. psq .72 .51 .56 .47 .33 1.00 6. unrel .77 .55 .25 .59 .28 .51 1.00 7. risk .71 .32 .32 .44 .34 .41 .41 1.00 8. quit .74 -.07 .12 .12 .18 -.09 .14 .14 1.00 9. inc .70 .16 .18 .15 .09 .23 .16 .12 .31 1.00 10. reb .77 .41 .53 .41 .33 .57 .38 .28 .09 .22 1.00 11. rtsf .70 .42 .23 .41 .42 .42 .27 .27 .17 -.10 .30 1.00 12. comp .70 .26 .16 .26 .33 .14 .25 .10 .09 .33 .16 .34 1.00 13. switch .08 -.09 .23 .12 .11 .13 .11 .17 .10 .66 .15 .09 1.00 14. relat .89 .22 13 .29 .11 .14 .22 .31 .14 .08 .05 .12 .08 -.11 1.00 15. loyal .74 .21 .15 .21 .20 .12 .11 .11 .33 .66 .23 .16 .15 -.29 .32 1.00 sajems ns 7 (2004) no 2 270 table 3 specification of the structural and measurement model switch = β1sef + β2price + β3pushy + β4ethics + β5psq + β6unrel + β7risk + β8quit + β9inc + β10reb + β11rstf + β12comp + ξ1 (1) relat = β13switch + ξ2 (2) loyal = β14relat + β15switch + ξ3 (3) figure 2 a path diagram for the switching behaviour model β12 β6 ξ1 ξ2 ξ3 φ1 φ3 φ4 φ5 φ6 φ7 φ8 φ9 φ10 φ11 β4 β13 β11 β10 β9 β8 β7 β5 β14 β3 β1 β2 φ2 β15 ethics β = regression coefficient φ = construct intercorrelation ξ = error term switch relat loyal sef price pushy psq unrel risk quit inc reb rstf comp model estimation the maximum likelihood estimates generated by structural equation modeling software (amos) are outlined in table 4. maruyama (1998) suggests that model parsimony can be achieved by eliminating insignificant paths, that is paths with critical ratio less than 2. table 4 shows that regression coefficients for poor service quality–switching behaviour link were lower than standard error, sajems ns 7 (2004) no 2 271 resulting in a critical ratio less than 2. this led to a decision to eliminate the path. the inconvenience-switching behaviour link was also insignificant as illustrated in table 4. service encounter failure was found to be most predictive of switching behaviour (β1 = .190), followed by pushiness (β3 = .179) and the unreliability (β6 = .163) of sales people. pricing had the least predictive power of the switching behaviour, indicating that direct sales customers are more concerned with the ethical behaviour (β4 = .128) of direct sales people, and their responsiveness to service failure than they are with the price. one would have expected the risk associated with purchasing directly sold products to have a bigger impact on the switching behaviour as suggested by kustin and jones (1995), whereas this was not the case. table 4 parameter estimates for the revised structural model path estimates standard error critic l ratio service encounter failure/switch β1 = .190 .093 2.10 price/switch β2 = .079 .052 1.52 pushiness/switch β3 = .179 .085 2.12 ethics/switch β4 = .128 .087 1.47 poor service quality/switch β5 = .003 .098 .030 unreliability/switch β6 = .163 .091 1.79 risk/switch β7 = .082 .049 1.70 quitting behaviour/switch β8 = .094 .044 1.57 inconvenience/switch β9 = .006 .046 .134 rebate error/switch β10 = .120 .071 1.69 response to core service failure/switch β11 = .105 .056 1.87 competition/switch β12 = .089 .055 1.62 switch/interpersonal relations β13 = -.14 .065 2.15 interpersonal relations/loyalty β14 = .309 .085 3.63 switch/loyalty β15 = -.145 .088 -1.67 table 4 also reveals that interpersonal relations have the highest predictive power of the loyalty of direct sales customers (β14 = .309) compared to switching behaviour (β15 = -.145). the direction of the switching behaviour– interpersonal relations, and switching behaviour–loyalty relations was negative as hypothesised. this suggests that there is a negative correlation between switching behaviour and good interpersonal relationships which implies that the sajems ns 7 (2004) no 2 272 more the customers exhibit switching behaviour, the weaker the relationship between the seller and the buyer. furthermore, a negative correlation between switching behaviour and loyalty would seem to suggest that the more meaningful the interpersonal relationship, the greater the demonstration of loyalty is likely to be; and the less likely it is that the consumer will switch to another supplier. figure 3 revised switching behaviour model .13 -.14 .11 .12 .09 .08 .31 .18 .19 .08 .16 .16 switch relat loyal sef price pushy unrel risk quit reb rstf comp ethics when evaluating the indicator loadings for statistical significance, the t values associated with each variable have to exceed the critical value of 1.96 at 0.05 significance level. table 4 illustrates that service encounter failure, pushiness, switching behaviour and interpersonal relations were the only variables whose t values exceeded the critical values for the 0.05 significance level (1.96). however, bentler (1980) argues that model parameters whose estimates are small compared to their standard errors are insignificant and should be eliminated when revising the model. this procedure was used by mackenzie et al. (1998), in their research, and is adopted in revising the model in this study. the statistical theory for this method is known as the wald test (bentler & sajems ns 7 (2004) no 2 273 chou, 1987, bentler, 1990). based on bentler and chou’s (1987) argument that, when the wald test is used, there is no need for a number of alternative models to be tested, one general model which was later modified was estimated in this study. using bentler’s argument and based on the wald statistical theory, it was found necessary to retain the following relationships in the model even though the t values associated with predictor variables were less than the critical values for the 5 per cent significance level: 1 price/switch 2 ethics/switch 3 unreliability switch 4 risk/switch 5 quit/switch 6 rebate error switch 7 response to core service failure/switch 8 competition/switch 9 switch/loyalty this was done because the model had a better fit when the nine relationships were included in the model. figure 3 illustrates the revised model after the insignificant paths were removed. as anticipated, the variable interpersonal relations is an intervening variable in the switching behaviour-loyalty link. figure 3 also shows that service encounter failure is the most predictive factor driving the quitting behaviour of direct sales people, followed by pushiness and unreliability. table 5 assessment of goodness-of-fit measures goodness-of-fit measure (n= 200) proposed model revised model chi-square (χ2) 130.22 90.04 degree of freedom (df) 95 25 significance level .48 .48 goodness-of-fit index (gfi) .788 .965 adjusted-goodness-of-fit index (agfi) .676 .887 normed fit index (nfi) .820 .905 root mean square error of approximation (rmsea) .092 .083 sajems ns 7 (2004) no 2 274 fitting the revised model resulted in an adequate fit (χ2 = 90.04, df = 25, p = 0.48) in accordance with the goodness-of-fit index (gfi) of .965, and adjusted-goodness-of-fit index (agfi) of .887. the normed fit index (nfi) of the revised model was found to be .905, and the root mean square error of approximation (rmsea) .083, verifying an acceptable fit of data to the hypothesised model (bentler, 1990). in comparing the results of confirmatory factor analysis and exploratory factor analysis, it can be observed that ten instead of twelve factors drive the switching behaviour of direct sales people. discussion and implications for management this study provides a broader perspective with regard to the switching behaviour of direct sales customers. the results confirm an earlier notion by srnivasan (1996) that low switching behaviour depends upon the propensity of customers to display loyalty. the findings emphasize that, as the inclination to switch suppliers increases, the loyalty levels decrease, suggesting that in order to improve loyalty among customers, direct sales managers might have to concentrate on reducing those factors that cause customers to switch suppliers. the question is how this can be achieved. in response to this challenge this study has identified ten variables that are most likely to cause customers to switch suppliers: (1) service encounter failure, (2) pushiness of direct sales people, (3) unreliability of direct sales people, (4) the ethics of direct sales people, (5) rebate errors, (6) responsiveness to service failure, (7) the quitting behaviour of sales people, (8) competitors, (9) risk, and (10) pricing of direct sales products. according to wald’s test these ten variables impact significantly on the switching behaviour as illustrated in table 4. as illustrated on table 1 and figure 4, both exploratory factor analysis and structural equation modeling have provided compelling evidence that service encounter failure exercises a greater influence on switching behaviour than other variables. the nature of service encounters in the direct selling industry often begins with a direct seller and a customer, or when customers purchase products from direct selling service centres. as this study has shown, the attitude of the service personnel, their helpfulness and willingness to accommodate requests impacts on decisions to switch suppliers. personnel in the service centres as well as direct sellers require skills and the right type of personality to handle service encounters effectively. the relevant skills and an appropriate personality coupled with training and motivation are essential in keeping direct selling customers satisfied. as revealed in the findings in a number of studies (peterson, albaum & ridgway, 1989; kustin & jones, 1994; sargeant & msweli-mbanga, 1999), sajems ns 7 (2004) no 2 275 pushiness and the unreliability of direct sales people are major factors in predicting switching behaviour in customers. given the invisible nature of direct selling, it becomes important for direct sales people to maintain access to their customers. if not, they lose their customers and their credibility. to counteract the unreliability of sales people, direct selling firms are now providing customers with additional avenues for accessing products. there are trends towards the establishment of direct sales retail outlets and kiosks in shopping malls. for example, unilever networks, and avon, both have retail outlets at the workshop – a shopping mall in durban. house of health has retail stores in la lucia mall, windermere centre, and sanlam centre in pinetown. some firms give customers the option of ordering directly via an 0800 number, by fax, or electronically. this move has provided leverage for direct selling and opened the way for improved performance. the pricing of direct sales products was found to have the least predictive power of the switching behaviour of customers compared to other factors. the reason for this is unclear. it is possible that direct sales customers place more emphasis on personalised service and a relationship with the seller than on price. the strong link between interpersonal relations and loyalty in this study is consistent with the findings of frenzen and davis (1990). this finding confirms that in the direct selling context, interpersonal relations moderate the switching behaviour-loyalty link. the implications of these findings are that, direct sales people need to develop relationship building skills not only to ensure the loyalty of their customers, and thereby to retain existing customers, but also in order to .attract new customers. limitations and future research the findings of this study are limited in their generalizability, firstly, because respondents were drawn from a non-probability sample. secondly, the sample size of 200 provides a low case-to-variable ratio, given that exploratory factor analysis was undertaken with 68 items. replication is needed with a bigger sample size to increase the statistical power of the findings. a measurement limitation in the research also need to be mentioned. switching behaviour was measured by a single item, whereas multiple items would have been preferable. it would be valuable to reproduce this study with a psychometrically valid measure of the switching behaviour variable. future research needs to examine whether there is a higher incidence of switching from one direct selling firm to another or from a direct selling firm to a conventional retail supplier. it would also prove to be useful to examine the extent to which customers interact with service personnel in distribution outlets sajems ns 7 (2004) no 2 276 compared to the extent to which they interact with the direct seller. based on the premise that a direct seller is psychologically closer to the customer than direct sales service personnel, one would expect service encounter with a direct seller to exert more influence on switching than service encounter with service personnel in retail outlets. further research is needed to gain perspective on other dimensions of the equation. while structural equation modeling confirms a specified model, with path specifications based on theoretical rationale, the technique does not confirm that it is the only acceptable model. further research is required to evaluate the model estimated in this study using either competing model strategy or nested model strategy. although this study has found that switching behaviour and interpersonal relations are the antecedents of loyalty, it is important to remember that loyalty is a consequence of a number of variables. this presents research opportunities to identify additional antecedents of loyalty within the direct selling context. references 1 anderson, j.c. & gerbing, d.w. 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(1993) “an exploratory study of reverse causality relationships among salesforce turnover variables”, journal of the academy of marketing science, 21(2): 143-53. 46 world federation of the direct selling association (2001) industry statistics, www.dsasa.co.za. abstract introduction literature review research method results discussion and conclusions acknowledgements references about the author(s) elize kirsten department of financial management, faculty of economic and management sciences, university of pretoria, south africa elda du toit department of financial management, faculty of economic and management sciences, university of pretoria, south africa citation kirsten, e. & du toit, e., 2018, ‘the relationship between remuneration and financial performance for companies listed on the johannesburg stock exchange’, south african journal of economic and management sciences 21(1), a2004. https://doi.org/10.4102/sajems.v21i1.2004 original research the relationship between remuneration and financial performance for companies listed on the johannesburg stock exchange elize kirsten, elda du toit received: 30 june 2017; accepted: 12 feb. 2018; published: 24 apr. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the executive directors of a company are the agents of the shareholders and should manage the company in the best interest of the shareholders, not only for personal gain. it is therefore important for companies to ensure that they implement remuneration policies which will result in motivated employees who will execute decisions and actions which are in the best interest of the shareholders. however, it is widely acknowledged that the relationship between company performance and executive remuneration is weak. this implies that executives are still rewarded excessive remuneration regardless of the performance of their companies. aim: the purpose of this study was to determine whether a relationship exists between the performance-based remuneration of executive directors and the financial performance of south african companies. setting: the study was conducted in south africa, specifically on companies listed on the johannesburg stock exchange. methods: the study design was quantitative and made use of a pearson correlation and generalised least squares regression with bootstrapping at a 95% confidence interval to analyse the relationship between executive director remuneration and the financial performance of 42 companies in the consumer goods and services industry of the johannesburg stock exchange (jse) from 2006 to 2015. results: the study established that the remuneration policies in place for south african executive directors within the consumer goods and services industry seem to be affected by the share price of the company. conclusion: in the south african environment, executive director remuneration is thus not directly related to profitability or company size, as was the case in some earlier studies. the link between executive director remuneration and share performance may be an indication that remuneration policies are based on the share price and are thus directly connected to the principle of shareholder wealth maximisation. introduction companies that give their executives the right rewards should outperform their peers under the right circumstances (wilkinson 2009). however, it has been argued that short-termism in remuneration packages to executives, even if performance-related, were in part responsible for the global economic crisis, which was a result of the collapse in the market capitalisation of banks in the united states (bebchuk & spamann 2010; fahlenbrach & stulz 2011; rajan 2005). employees who are strongly motivated by money and personal gain may also be tempted to commit fraud (see for example gill, prowse and vlassopoulos (2012) and brick, palmon and wald (2006)). colvin (2008) emphasises that any form of compensation should relate to the performance of a company, because many chief executive officers (ceos) are receiving excessive amounts of remuneration, often in the form of share options, despite their companies’ financial problems. xiaoning (2009) reported that chinese investors were up in arms after they had received reports showing that senior executives of loss-making companies rewarded themselves with immense general compensation packages. de wet (2013) found that similar objections against excessive executive remuneration had been heard from across the globe. the situation in south africa is unfortunately no exception. one may argue that high overall compensation is appropriate for the management of larger firms. as these firms are generally more complex and demanding to operate, a specific skill set is needed, which requires comparable compensation (coughlan & schmidt 1985; sigler 2011). performance-based remuneration is a common incentive system used by companies to motivate employees and to improve productivity and performance. schulz (1997) and kuo, ting and chiu (2013) discovered that firms with profit sharing and employee share ownership plans experienced increased employee productivity and performance. jensen and murphy (2010), murphy (1985) and sun, zhao and yang (2010) found that remuneration of executives is to some extent related to the observed productivity of a company. studies with similar results have been conducted around the world by authors such as mcgee et al. (2006), lourenco (2010) and pascual-ezama, prelec and dunfield (2013). however, other studies such as those by gill et al. (2012), samnani and singh (2014) and aguinis, joo and gottfredson (2013) indicated that rewarding employees based on performance leads to decreased motivation and increased fraud, employee bullying and other types of unsavoury behaviour in the workplace. even though the economic theories of efficient compensation forecast a positive relationship between company performance and executive remuneration, the efforts of researchers to document this relationship have been mostly unsuccessful. o’neill and iob (1999) and ozkan (2007) found little evidence to suggest any consistent relationship between executive remuneration and measures of performance. this may imply that executives are still rewarded with remuneration packages out of proportion to their efforts and the performance of their companies. de wet (2013) conducted a study on executive director remuneration in south africa, using economic value added (eva) and market value added (mva) as proxies for performance. this is a unique approach, as most previous studies observed measures for size (in terms of turnover or net assets) and measures for profitability. more recent studies include those by bussin (2015), bussin and blair (2015), bussin and modau (2015) and bussin and nel (2015). it is necessary to compare the results of our study with those of the majority of studies available. the main purpose of this study is thus to investigate the relationship between total executive director remuneration packages and the financial performance of south african companies listed on the johannesburg stock exchange (jse). the results provide some interesting insights, such as that executive director remuneration is mainly related to the value of the company, rather than financial performance as shown in the financial statements. these findings are significant to shareholders, as they provide evidence that executive directors are compensated for increasing company value, which benefits shareholders directly. from a practical perspective, the findings of this study should aid managers and decision makers of south african companies in designing and implementing suitable reward systems to motivate employees and improve productivity. the findings would also provide investors with an additional proxy in the form of executive director remuneration to evaluate a company’s potential performance. the study is presented as follows. the literature review, in which previous research on the topic is investigated, is followed by a description of the research design and methods used in this study. a discussion of the results of the study follows. conclusions in terms of the research and recommendations for further research are presented in the final section. literature review the agency problem and performance-based remuneration the theoretical foundation of this paper lies in agency theory. multiple factors influence the relationship between performance-based remuneration and the overall performance of a company. the agency relationship is deemed the most important and influential of these factors. an agency relationship is defined as a contractual agreement under which one or more parties, known as the principals, engage another party or parties, known as the agents, to perform a specific service on their behalf (boshkoska 2015; de wet 2013; jensen & meckling 1976; kuo et al. 2013). managers, as the agents of a company, would not act on behalf of the company if their interests are not fully aligned with those of the company (dyl 1988). jensen and meckling (1976) claimed that managers are unlikely to maximise the wealth of a firm, even if the manager is the only shareholder. bryant and davis (2012), however, argue that the agency problem can be controlled by incentivising managers, as agents, to act in line with the interests of the company. there are various methods by which a company’s shareholders can control the operations of the managers. one of these methods is the use of performance-based remuneration (boshkoska 2015). companies thus incur agency costs in the form of, for example, incentive schemes to motivate managers to run the company in the best interest of the shareholders and to maximise shareholder wealth in a sustainable manner (coughlan & schmidt 1985; de wet 2013). remuneration policies should aim towards long-term value creation in a company (iodsa 2016). a variety of studies focus on executive compensation and how this can minimise the agency problem (bebchuk & fried 2003). reward systems are designed to bridge the agency problem between shareholders and managers, but to bridge this gap, reward systems must be related to the performance of managers and the strategy of the company, and take into account the growth and nature of the company. reward systems should not only motivate employees, but also enhance the overall corporate values of the company (kuo et al. 2013). gill et al. (2012) and shin (2013) suggest that companies with bonus-based pay structures should consider that worker dishonesty might be an unintended consequence. studies such as those by edmans and gabaix (2009), tosi and gomez-mejia (1994) and yanadori and milkovich (2002) narrowed the focus from executive compensation to that of the ceo of a company. the role of the ceo is pivotal in managing the resources of a company, especially in the context of a continuously changing external economic environment, to ensure value creation for shareholders. there is increased scrutiny levelled at the remuneration committees of companies, especially those that have increased ceo compensation, even when they face disappointing financial results (bussin 2015). gomez-mejia, tosi and hinkin (1987) used ceo remuneration as a proxy for executive compensation and concluded that the payment of ceos is more responsive to performance in companies that have dominant shareholders and are owner controlled. the allocation of company profits is generally based on the condition of achieving a certain level of return on equity employed or a specified dividend, or even both. the aim of a bonus fund is primarily to regulate the use of company funds, as well as safeguard the shareholders’ interests (merrett & white 1968). the main determinant for executive remuneration is often firm size, based on the revenue figure of the company (baumol 1959; conyon 1997; jensen & murphy 2010; murphy 1985). executives may thus pursue a goal of sales maximisation, rather than wealth maximisation. coughlan and schmidt (1985) opine that the practice to base the bonuses of ceos on sales growth is not always the most optimal compensation policy. in a case were an executive is near retirement and expects a bonus-based on sales or sales growth, this executive might approve excessive expenditures for advertising campaigns or other increases in the sales force to ensure increased sales revenues, even though this might exceed the profit-maximising levels. a study by anderson and bizjak (2003) found that ceos who are members of their own compensation committees receive less overall compensation and have a large ownership share. according to the study, these compensation committees were doing more to link executive pay to the performance of the company than those of the control sample. to support this, sigler (2011) found that independent executive directors, and the consultants hired to advise the board, have relatively little motivation to safeguard the interests of the company’s shareholders. another method to link executive compensation to the overall performance of the company is using long-term incentive plans (ltips). pass (2003) found that most ltips were undemanding and rewarded average instead of outstanding performance. buck et al. (2003) concluded that ltips are generally associated with reductions in the sensitivity of the relationship between executives’ total rewards and shareholder returns and thus questioned their effectiveness. walker (2010) also concluded that there is an inadequate relationship between executive compensation and long-term company performance. various arguments state that executive remuneration policies played a role in the onset of the global economic crisis. according to bebchuk and spamann (2010), fahlenbrach and stulz (2011) and bussin (2015), the global economic crisis was a result of dramatic disintegration in the market capitalisation of usa banks. rajan (2005) suggests that the significant risks experienced by the global financial sector was, in part, a result of the compensation practices used within this sector. he argued that, even though executives in the financial sector were engaging in business practices that were eroding performance and threatening sustainability of the companies and, by implication, the entire financial system, these executives were still receiving substantial incentive pay-outs. this argument was based on the outlook that a weak performance–pay relationship exists, which allows risky business practices. a perfect compensation plan – one which links performance to payment – seems impossible to construct. however, hovy (2005) concluded that the most feasible mechanism to align shareholder wealth creation with executive performance is global performance-based remuneration plans. to achieve this, companies can follow the guidelines provided by van zyl smit and nel (2010), who claim that remuneration policies should embrace three basic principles, namely appropriateness, fairness and effectiveness, and should be tightly aligned with the long-term value and soundness of the company. according to coughlan and schmidt (1985) an optimal remuneration package should not be based solely on share options or other direct relationships between share performance and pay. a more efficient remuneration package is one which combines share-related components with components which are not linked to shareholder wealth, such as a salary or a bonus. at the discretion of the executive directors, a portion of the bonus can even be linked to share price performance as a signal that the share price is regularly being monitored (coughlan & schmidt 1985). a mix of the various components of pay into a single compensation package for an executive director allows for the deficiencies of one component to be counterbalanced by another component’s strength. including a cash bonus in the package motivates executive directors to focus on the short-term goals of the company, which counters the limitations of restricted share, namely only rewarding achievement of long-term goals (sigler 2011). according to the economic theories of compensation, the performance of a company should only influence an executive director remuneration to the point where it serves as a substitute for unobservable managerial efforts and productivity. even though most of the theories suggest a correlation between executive compensation and company performance, most of them do not mention the measure of performance. since the shareholders of the company are the principles within the agency theory, it would seem appropriate to define and measure performance in terms of shareholder return instead of accounting profits (murphy 1985). measurement tools can be used to indicate whether the company achieved or surpassed their goals and objectives. performance measures can also be used to evaluate, control and improve the production processes of the company (ghalayini & noble 1996). performance measurement is thus a process which quantifies the efficiency and effectiveness of actions. the action leads to performance, while the measurement is the quantification process. the level of performance a business attains, is a function of how efficient and effective it undertook all of its actions (neely, gregory & platts 2005). the two approaches most commonly used to empirically evaluate the financial performance of companies are accounting-based measures and market-based measures (cochran & wood 1984; spicer 1978). market-based measures are those that use corporate share returns to indicate the performance of a company (kuo et al. 2013), while accounting-based measures use performance measures from the financial statements, such as profit. according to bourne et al. (2000), performance management has a dual purpose. the first is the success of the chosen strategy’s implementation as a result of the measures derived from the chosen strategy. the second is that the information and feedback received from the measures should be used to test the strategy’s validity and challenge the assumptions made. the main purpose of performance management can thus be seen as an examination of past performance to stimulate future actions (neely et al. 2005). it is important to note that, to gain the full potential of performance measures, consistency within the implementation of these measures is needed. as mintzberg (1978) emphasised, strategies can be realised only through the consistency of actions. relationship between company performance and executive director remuneration there are many empirical studies that focused on the relationship between company performance and executive director remuneration. however, many failed to produce conclusive results and consensus (bruce, buck & main 2005; bussin & blair 2015). some of these papers include those by cosh (1975), hirschey and pappas (1981), lewellen and huntsman (1970), masson (1971) and meeks and whittington (1975). all of these papers made use of accounting information to measure the profitability of companies. as a result, the authors encountered measurement errors which led to biased empirical results (coughlan & schmidt 1985). table 1 below provides a summary of some of the previous research that investigated the relationship between company performance and executive director remuneration. the summary is categorised per year and shows the countries in which the studies were conducted. table 1: summary of previous research. the performance of both the company and executive directors are important, and both of these may be impacted by the remuneration packages chosen by the company. although many studies have been performed over a period of 45 years, there is still no conclusive evidence as to the relationship between executive director remuneration and financial performance as many studies show conflicting results. this study attempted to confirm conclusions derived from previous studies conducted in south african and developing countries with more recent data. the following section addresses the research design and methods used in this empirical study. research method the aim of the study was to investigate whether a relationship exists between performance remuneration of executive directors and the overall performance of a company. a quantitative research strategy was implemented to analyse the relationship between performance-based payments and the overall performance of companies. setting, data collection and sampling strategy the focus area of the study was companies listed on the johannesburg stock exchange (jse), south africa. to investigate the relationship between performance-based payments and the overall performance of companies, the consumer goods and services industry was used. this industry was chosen because of the companies’ prominent sales figures, which can be used as a proxy for company size in relation to total executive director remuneration. in addition, using one industry eliminates the need to make provision for industry-specific differences between companies. company financial data was obtained from inet bfa, south africa’s leading provider of financial data feeds and analysis tools. out of the 59 companies listed on the jse from the consumer goods and services industry, 17 could not be used because of incomplete data. a sample of 42 listed south african companies from the consumer goods and services industry were used. the total population of south african consumer goods and services industry companies is relatively small, which makes it impossible to employ proper random sampling (see for example vize et al. 2009). the sample companies’ data for 2006 to 2015 were obtained and investigated. the result is 420 individual observations. data and analysis method the independent variables used in the analysis were return on equity (roe), return on assets (roa), earnings per share (eps), sales figure/turnover (to) and price per share (pps). roe and roa are presented as percentages, eps and pps as a rand value per share and to as a total rand value. the dependent variable was the total executive director remuneration (rem) as a rand value, defined as executive directors’ emoluments plus executive directors’ share-based payments, both used in this study as disclosed on the statement of profit and loss and other comprehensive income. this figure for total director remuneration thus includes the executive directors’ basic salary and bonus, as well as other forms of remuneration, such as share-based payments and options. the statistical model set out to establish which of these independent variables show the most significant relationship to and perhaps represent a driving force behind director remuneration. the independent variables were chosen for the ease with which investors or other interested parties can obtain or calculate them, should these measures show a direct relationship with total director remuneration. the first control variable included in the model was the debt/equity ratio (de) as a proxy for size. previous research has shown a direct positive relationship between leverage and firm size (booth et al. 2001; fama & french 2002; rajan & zingales 1995; titman & wessels 1988). even though the market capitalisation of companies is often included as a control variable for company size, market capitalisation correlates too closely with the price per share (pps), which is considered to be an important variable not previously considered in the study by de wet (2013). the second control variable was the jse all share index (jse), which is included to compensate for market-related changes over the period under consideration. the variables were tested for stationarity, using the augmented dickey-fuller (adf) test. the results of the stationarity test indicated that the variables were non-stationary. non-stationary data have a variance and a mean that changes over time, which will affect the results obtained from any statistical analyses that are performed on the data (nason 2006). non-stationary data can be converted by using a return that is calculated by the logarithm of a data point divided by the previous data point (dahlhaus 1997). a drawback to the method of making data stationary is that one data point or sample member is lost in the process. if the sample had 45 points for instance, the regression analysis will run with only 44 points. the following equation is used to do the conversion from non-stationary to stationary data. calculating the natural logarithm and return for each variable has the benefit that variables, measured differently, become comparable, for example turnover as a total rand value and roe as a percentage. descriptive statistics for the adjusted variables are presented in table 2. table 2: descriptive statistics. the skewness and excess kurtosis figures in table 2 indicate that the data are not normally distributed. this is confirmed by significant jarque–bera test statistics for all series, despite the data being transformed by calculating the return of the natural logarithm of each variable. departures from normality in financial time series are widely recognised in the literature and the results of the descriptive statistics are an indication of this (see xiao and aydemir 2007). furthermore, all series are negatively skewed, except for changes in executive director remuneration, which is positively skewed. a lack of normality calls for the use of a non-parametric test or bootstrapping. the use of non-parametric tests was deemed inappropriate for this study, therefore bootstrapping at a 95% confidence interval was applied. bootstrapping also reduces the effect of a small sample size by adding robustness to the statistical tests (field 2013). in addition, the data showed signs of heteroscedasticity, which also calls for the use of a regression model. the data show no significant sign of endogeneity, therefore the authors decided to ensure that the issue of heteroscedasticity is sufficiently addressed. table 3 presents the pearson correlation results for the dataset making use of bootstrapping at a 95% confidence interval. table 3: pearson correlation with bootstrapping at a 95% ci. the results of the pearson correlation (table 3) indicated a clear correlation between total executive director remuneration (rem) and share price (pps). correlations with other financial performance measures were mainly negative and insignificant. a regression model would provide more insight into the relationship between executive director remuneration and share price. an initial regression analysis on the data indicated by means of collinearity diagnostics, as well as the tolerance and variance inflation factor (vif), that there is significant multicollinearity between roa and roe. for that reason, roa was removed from the list of independent variables before commencing with the final regression model. conducting an analysis on time series data can include delayed effects because of the nature of financial data. the actions of executive directors do not necessarily have an immediate effect on the performance of the company and performance-based remuneration only occurs after said performance has been achieved. the durbin–watson test is used to observe the effect of autocorrelation in a dataset; for this study it was calculated at 0.946. this is a clear indication of serial correlation between the errors in the regression model. according to ghalayini and noble (1996), the use of time series data can necessitate the use of a lagging metrics effect. this means that linear regression cannot be applied on the data as is and that a lag needs to be introduced for the dependent variable. a lag of ar (1) was thus introduced to the dependent variable in the regression model to eliminate the effect of autocorrelation. the variables for this study are all of a financial nature and therefore tend to be endogenous. consequently, the use of only ordinary least squares regression could result in biased findings and erratic results as ordinary least squares regression ignores time-invariant unobserved individual effects and endogeneity (flannery & hankins 2013; maddala & lahiri 2009). generalised least squares regression estimates unknown parameters in a linear regression model that can be applied when the variances of the observations are unequal or when there is a certain level of correlation between variables (rana & al amin 2015). the introduction of a lagged effect in the dependent variable significantly reduced the endogeneity of the dataset. linear regression was applied to the adjusted dataset, with bootstrapping at a 95% confidence interval (ci) to correct for non-normality and to compensate for the small sample size by adding robustness to the analysis. the regression model can be expressed as follows: the results of the regression analysis are presented in the next section. results a summary of the results from the generalised least squares regression model, with bootstrapping at a 95% ci, is presented in table 4. table 4: regression results. the overall model is rather weak, but the results indicate that the variable with the biggest relationship to executive director remuneration is the share price of the company and the performance of the jse all share index, both at p < 0.05. in the south african environment, executive director remuneration is thus not directly related to profitability or company size, as was the case in most of the earlier studies. further investigation into the reasons for the significant difference in results between this study and the one by de wet (2013) showed that de wet (2013) did not compensate for autocorrelation, which can be observed in the low durbin–watson statistic reported in his paper. not taking autocorrelation into account can result in overestimated t-statistics. the lack of a relationship between executive director remuneration and company size, as well as between executive director remuneration and profitability, speaks to the results of studies by bruce et al. (2005), bussin and nel (2015), duffhues and kabir (2008), jensen and murphy (2010), meeks and whittington (1975) and walker (2010). however, the results are in line with the results of bussin and blair (2015), conyon (1997), conyon et al. (2000), coughlan and schmidt (1985), fatemi et al. (2003), gabaix and landier (2008), kato et al. (2007), masson (1971), murphy (1985) and scholtz and smit (2013). the link between executive director remuneration and share performance may be an indication that remuneration policies are based on the share price (or market capitalisation) and is thus directly connected to the principle of shareholder wealth maximisation. a reasonable explanation for this result can also be that executive directors in south africa hold a significant number of shares in their own company (perhaps as part of a share-based option scheme) and is thereby incentivised with an increased share price. discussion and conclusions the belief exists that management who are strongly motivated by money and personal gain are usually the ones tempted to act in a fraudulent manner. brick et al. (2006) presented evidence that linked the underperformance of companies with excessive levels of executive director remuneration. previous research indicated that search for a link between executive director remuneration and company performance lead to inconclusive and mixed results. to align the aims of executive directors with those of shareholders, performance will always remain a key requirement. this study aimed to investigate the existence and strength, if any, of the relationship between executive director compensation and company size and financial performance in south african companies from the consumer goods and services industry. based on the research it does not seem that there is a specific performance-based remuneration system preferred by companies. it appears that most companies implement a system which they deem works best for them. a generalisation may be made that most companies do not rely on only one form of remuneration, but they implement remuneration packages consisting of various types of remuneration methods. the more favourable forms of remuneration that packages are made up of seem to be normal salaries, cash bonuses and share options. the conclusion can thus be made that there is not one specific remuneration system and package that will work for all companies but that each company should implement a system which works best for them. bootstrapped pearson correlation and bootstrapped generalised least squares regression were used to test whether there is a relationship between performance-based remuneration and the performance and size of companies. as most of the companies use different remuneration packages, the total executive director remuneration for each company was used as the dependent variable. the performance indicators were eps, roa, roe, turnover, and share price. from the initial correlation analysis, it seems that the variable which is most likely to have a relationship with total executive director remuneration and which will thus also be the best indicator for total executive director remuneration is share price. from the results, we conclude that executive director remuneration does not have a meaningful or significant relationship with any of the traditional performance measure variables of company performance. the lack of a relationship between executive director remuneration and accounting performance measures does not indicate that the companies did not take any performance measures into account when rewarding their executive directors; it simply indicates that financial performance was not the main driver for remuneration. since executive director remuneration shows a significant relationship with share price, it can be that share performance – the true measure of shareholder wealth creation – is an indicator of executive director remuneration levels. based on the results of this study, the conclusion can thus be made that south african companies within the consumer goods and services industry do not seem to base executive director remuneration on the accounting performance of the company but rather on its market performance. the message these results send to potential investors is a comforting one. it means that executive directors are compensated for their ability to generate wealth for a company’s shareholders. there are several limitations under which this research study was executed, providing areas for future research. this study focused on the consumer goods and services industry as well as companies listed on the jse. to attain more conclusive results, future research can be conducted on a wider range of industries as well as companies not listed or listed on other platforms. the performance measures used to conduct the research were also limited to more traditional performance measures which can be calculated using traditional cost management systems and figures found on the financial statements. these traditional performance measures have various limitations which result in them being somewhat irrelevant in the current competitive markets (ghalayini & noble 1996). a wide assortment of performance measures is available which include non-financial performance measures. further research on the topic can be conducted using more modern performance measurement systems. taking the more modern performance measures into account will provide a better insight into the current performance-based remuneration systems of companies. as recommended by bussin and blair (2015), it may also be worthwhile to investigate longer lag periods and investigate the relationship between executive director remuneration and financial performance over longer time periods. a study can also be conducted on the exact content of each company’s executive director remuneration, to establish how many shares each executive director holds in the company. share-based remuneration options may create an incentive for executive directors to ensure that shareholder wealth is created. 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between insiders and outsiders, cahrs working paper series, 44, cornell university: ithaca, ny. zhu, j., 2007, ‘the empirical study on the effect factor of top management remuneration in china’, journal of american academy of business 11(2), 213–221. abstract introduction literature review hypotheses methods results discussion conclusion acknowledgements references about the author(s) doris asiwe optentia research focus area, north-west university, south africa sebastiaan rothmann optentia research focus area, north-west university, south africa lene jorgensen workwell research unit, school of human resource science, north-west university, south africa carin hill department of industrial psychology and people management, university of johannesburg, south africa citation asiwe, d., rothmann, s., jorgensen, l. & hill, c., 2017, ‘engagement of employees in a research organisation: a relational perspective’, south african journal of economic and management sciences 20(1), a1534. https://doi.org/10.4102/sajems.v20i1.1534 original research engagement of employees in a research organisation: a relational perspective doris asiwe, sebastiaan rothmann, lene jorgensen, carin hill received: 12 jan. 2016; accepted: 17 feb. 2017; published: 07 apr. 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: increasing work engagement in a sustainable way remains a challenge despite years of research on the topic. relationships at work are vital to foster engagement or disengagement. while the relational model by kahn and heaphy is conceptually appealing to explain work engagement, it lacks empirical support. aims: the aims of this study were to investigate the associations among relational factors, psychological conditions (psychological meaningfulness, availability and safety) and work engagement and to test a structural model of work engagement. setting: a total of 443 individuals in an agricultural research organisation participated in a cross-sectional study. methods: four scales that measured relational factors, the psychological conditions scale and the work engagement scale were administered. latent variable modelling was used to test the measurement and structural models. results: the results confirmed a structural model in which relational facets of job design contributed to psychological meaningfulness. emotional exhaustion (inverse) and co-worker relationships contributed to psychological availability. supervisor relationships contributed to psychological safety. psychological meaningfulness and psychological availability contributed to work engagement, while emotional exhaustion contributed to disengagement. conclusion: the relational context is an important target for intervention to affect the psychological conditions which precede work engagement. to promote work engagement, it is vital to focus on psychological meaningfulness, psychological availability and emotional exhaustion. introduction work engagement is an important research theme for both practitioners and researchers because it correlates with many work participation outcomes (bakker & leiter 2010). increasing work engagement in a sustainable way remains a challenge despite years of research on the topic (rothmann 2017). research on engagement has often been done from the perspective of the job demands-resources (jd-r) model (bakker & demerouti 2007, 2008; schaufeli & bakker 2004). in contrast, kahn and heaphy (2014) developed a relational model of work engagement. an advantage of the relational model (compared to the jd-r model) is that it includes psychological conditions as experienced by individuals as possible mediators between work engagement and its antecedents. isolating the psychological conditions that mediate the relations between work engagement and its antecedents makes it possible to understand and manage the effects of such conditions. engagement reflects the simultaneous investment of cognitive, emotional and physical energies in such a way that one is actively and completely involved in the full performance of a role (rich, lepine & crawford 2010). hence, engaged employees are physically involved in their tasks, cognitively alert and emotionally connected to others when performing their jobs. engagement can be regarded as a psychological state (rothbard & patil 2012), which implies that, depending on specific antecedents, it could vary over time. according to saks, engagement involves being ‘psychologically present when occupying and performing an organizational role’ (2006:601). similarly, kahn (1990) conceptualised engagement as an extension of the self, through the psychological conditions of meaningfulness, safety and availability to a work role. these psychological conditions affect personal engagement and disengagement at work (kahn 1990; kahn & heaphy 2014). psychological meaningfulness, safety and availability are embedded in the context of relationships at work. therefore, relationships at work are vital to foster engagement or disengagement (kahn & heaphy 2014). work relationships affect people’s experiences of the purposes of their work, heighten their sense of belonging and energise them. individuals who feel emotionally exhausted might find it difficult to engage in work. furthermore, individuals define the context in which they can feel safe or unsafe to express themselves and sustain or weaken limitations essential to sustain availability at work (kahn & heaphy 2014). although the relational model of work engagement is conceptually appealing, it lacks empirical support. utilising previous research of kahn (1990), rothmann and welsh (2013) tested a model that did not focus exclusively on relational factors. they found that work role fit, job enrichment and the availability of resources affected work engagement indirectly via experiences of psychological meaningfulness, while the availability of resources and co-worker relationships affected work engagement indirectly through psychological availability. janik and rothmann (2016) focused on the effects of selected relational factors (i.e. co-worker, relationships, supervisor relationships and emotional exhaustion) on the psychological conditions and work engagement. they found support for an indirect effect of supervisor relationships and on work engagement via psychological meaningfulness. co-worker relationships and emotional exhaustion (inverse) indirectly affected work engagement via psychological availability. despite the importance of the context in affecting work relationships, studies are yet to investigate the effects of aspects of job design (in addition to other relational variables) on the psychological conditions and work engagement (kahn & heaphy 2014; truss 2014). the aims of this study were to investigate the associations among relational factors (including job design, co-worker relationships, supervisor relationships and emotional exhaustion), psychological conditions and work engagement and to test a structural model of work engagement. literature review the relational model of work engagement (kahn & heaphy 2014) was initially conceptualised in a study by kahn (1990). according to the relational model, specific relational factors are linked to work engagement via three psychological conditions, namely psychological meaningfulness, psychological availability and psychological safety. psychological conditions and work engagement psychological meaningfulness refers to the level of importance something holds for an individual (pratt & ashforth 2003). it relates to a person’s personal appraisal of events in his or her life and the importance ascribed to these events compared to his or her personal goals, values, beliefs and identity (matuska & christiansen 2008). people experience meaningfulness when they feel worthwhile, useful and valuable, knowing that they are making valuable contributions. designing workplaces that allow people to find meaning in their work results in designing a human nature that values work (schwartz 2015). in other words, focussing on meaningful work encourages individuals to consider meaningful work as a valuable work outcome. individuals will engage in work contexts characterised by psychological meaningfulness (cartwright & cooper 2014; rothmann & buys 2011). meaningless work often results in a lack of interest and indifference to one’s work (thomas & velthouse 1990). employees who are engaged in meaningful work are not only more likely to be available in their work but also cognitively present (steger, dik & duffy 2012) and more likely to be engaged. recent studies (geldenhuys, laba & venter 2014; may, gilson & harter 2004; rich et al. 2010; rothmann & rothmann 2010) have supported the role of a meaningful work setting in experiences of psychological meaningfulness and work engagement. psychological availability refers to ‘the sense of having the physical, emotional or psychological resources to engage at a particular moment’ (kahn 1990:714). it assesses one’s readiness or confidence to engage in a work role, given that individuals are also engaged in many other social activities. rothmann and buys (2011), as well as rothmann and rothmann (2010), found psychological availability to be a significant predictor of work engagement. psychological safety is defined as ‘feeling able to show and employ one’s self without fear of adverse consequences to self-image, status, or career’ (kahn 1990:708). psychological safety refers to a mutual belief that it is safe to speak up about one’s failures in the workplace without suffering any interpersonal costs in the form of possible embarrassment or interpersonal threat that may impact on members’ status, image or career (edmondson 2004). psychological safety is a key social psychological factor that enables effective learning processes, especially from previous failures (edmondson 1999, 2004). carmeli and gittell (2009) draw on the concept of high-quality relationships to promote understanding of the relational underpinnings of psychological safety. psychological safety has also been positively linked to work engagement (may et al. 2004; olivier & rothmann 2007). although significant relations among psychological meaningfulness, availability and safety have been reported in previous studies (e.g. rothmann & rothmann 2010; rothmann & welsh 2013), it was not of theoretical interest to investigate the effects of these conditions on each other. therefore, such effects are also not of interest in this study, given that they are not part of the relational model of work engagement. effects of the relational context on psychological conditions and work engagement variables in the relational context can affect individuals’ psychological conditions (i.e. meaningfulness, availability and safety) and work engagement. in line with the relational model of kahn, this study focuses on four variables, namely job design, supervisor relationships, co-worker relationships and emotional exhaustion. job design shapes experiences of psychological meaningfulness and engagement through a deepened purpose (kahn & heaphy 2014). a deepened purpose results from employees’ meaningful contact with the beneficiaries of their work (kahn & heaphy 2014). psychological meaningfulness is likely to be experienced when individuals recognise that they are working towards a clear purpose within the organisation and when their effort is geared towards a greater social good. people want to do good, make a social contribution, serve and make a difference. jobs that allow people to do good contribute to the engagement of employees (grant 2007, 2008). as people attach to supervisors and the missions those supervisors embody, the purposes of their work are enlarged and made more meaningful (kahn & heaphy 2014). therefore, performing work that is regarded as important to benefit people is a vital source of psychological meaningfulness and work engagement. autonomy also contributes to employees’ experiences of a deepened purpose (kahn & heaphy 2014; may et al. 2004). autonomy in a job relates to the degree of freedom with which employees can choose when and how to complete their tasks. it concerns the need to feel that one is in control of one’s actions and that one is not being controlled (deci & ryan 2000). when individuals occupy roles and perform tasks that culminate in purposes they define as important, they are more likely to experience their work as meaningful (kahn & heaphy 2014). encroachments on autonomous agency communicate to employees that they are not capable of competent decision making and block their development and maintenance of a sense that they are worthy of autonomy (veltman 2016). in contrast, work that bears the distinctive stamp of an employee is a source of the meaningfulness found in it. the relational nature of job design elements is evident from concepts such as independence, freedom and participation. performing work that offers opportunities for independent thought and action, freedom in carrying out work activities and participation in decisions about task completion are indicators that autonomous agency is valued. relationships deepen and affirm the meaningfulness of work (kahn & heaphy 2014) partly through a process of social identification. social identification provides positive confirmation of individuals’ identities and provides a sense of belongingness. therefore, supportive relationships with colleagues and supervisors (pratt & ashforth 2003; steger & dik 2010) shape experiences of psychological meaningfulness and work engagement through heightened belongingness (kahn & heaphy 2014). supervisors who foster a supportive work environment display concern for employees’ needs and feelings provide positive feedback and encourage them to voice their concerns, develop new skills and solve work-related problems (deci & ryan 1987). co-workers can play a fundamental role in affecting the experiences of belongingness of employees (kahn 1990; rosso, dekas & wrzesniewski 2010; rothmann & rothmann 2010). energising interactions as well as emotional relief and depletion affect psychological availability and work engagement (kahn & heaphy 2014). key factors that may affect psychological availability are (1) co-worker and supervisor relationships (rothmann & welsh 2013) and (2) the availability of cognitive, emotional and physical resources (may et al. 2004; rothmann & welsh 2013). kahn (1990) identified depletion of emotional energy (which happens when an employee experiences emotional exhaustion) as one of the factors likely to directly affect psychological availability. emotional exhaustion results in a loss of genuine interest in people at the interpersonal level (schaufeli & buunk 2003). many of the work characteristics that have been linked to emotional exhaustion involve contact with other people – either clients or co-workers (leiter & maslach 1988). when individuals are overwhelmed, they protect themselves from the possibility of further emotional material, which diminishes their capacities to feel on behalf of themselves and others (kahn & heaphy 2014). psychological safety ensues when the employee perceives the interpersonal relationships as characterised by mutual support, openness, trust, genuineness and flexibility (de clercq & ruis 2007). thus, relationships between supervisor and co-workers characterised by support, trust and flexibility in behavioural norms may lead to feelings of safety (may et al. 2004). feelings of safety result in employees taking more risks that express their true selves and make them more likely to invest in their employment relationship. furthermore, supportive co-worker relation enhances people’s belief that their co-workers will be constructive in whatever criticism they may give if they fail in their efforts (kahn 1990). also, employees are positively affected when they perceive from their interactions that their co-workers see them as capable. consequently, they are less likely to feel judged when they share personal views (edmondson 2003). psychological safety is a significant factor in increasing work engagement (kahn 1990). on the other hand, employees will likely become stressed if they perceive their workplace as psychologically unsafe (edmondson 2004). previous studies (kahn 1990; may et al. 2004; olivier & rothmann 2007) have provided support for the positive relationship between co-worker relationships and psychological safety as well as supervisor relationships and psychological safety. psychological conditions mediate between their antecedents and outcomes (chikoko, buitendach & kanengoni 2014; may et al. 2004; rothmann & buys 2011). may et al. (2004) provided some empirical evidence that the psychological conditions of meaningfulness, safety and availability could mediate between engagement and its antecedents. studies conducted in south africa (olivier & rothmann 2007) and namibia (rothmann & welsh 2013) did not support the findings concerning psychological safety by may et al. (2004). these studies did, however, show that the psychological conditions of meaningfulness and availability mediated the effects of antecedents on work engagement. rothmann and welsh (2013) found that a meaningful job and the availability of resources indirectly impacted on work engagement via experiences of psychological meaningfulness. work engagement was indirectly affected via psychological availability, by the availability of resources and by co-worker relationships. these results provide evidence of the important role of psychological meaningfulness and psychological availability as mediators between antecedents and outcomes of engagement. hypotheses based on the review of the literature, the following hypotheses were formulated: h1: job design, co-worker relationships and supervisor relationships predict experiences of psychological meaningfulness. h2: emotional exhaustion and poor co-worker relations predict low psychological availability. h3: good relationships with co-workers and supervisors predict psychological safety. h4: psychological conditions (meaningfulness, availability and safety) predict work engagement. h5: antecedents of psychological conditions indirectly affect work engagement via psychological meaningfulness, availability and safety. methods participants the data were collected using convenience sampling (fink 2009). the research participants were made up of employees from all employment groups and educational levels within a south african agricultural organisation. the diversity of the sample (and small sample sizes) made it difficult to assess the relations among constructs in sub-samples. moreover, given the importance of work engagement and psychological conditions for all employees, the authors wanted to test relations in the diverse sample. the participants with the lowest educational level had an adequate literacy level to complete the questionnaire. the demographic composition of the participants is provided in table 1. table 1: biographical information of participants (n = 443). table 1 indicates that approximately half of the participants, namely 221 (49.9%), were male participants. a total of 37.2% were afrikaans speaking, 16.5% were between 31 and 35 years of age and 19.4% had a master’s degree. measuring instruments a questionnaire was developed to gather information on demographic characteristics of the participants. four scales that represent relational factors in individuals’ jobs, that is, job design, co-worker relationships, supervisor relationships and emotional exhaustion (may et al. 2004), were administered. job design was measured using four items (ρ = 0.80), for example, ‘do you think you are doing important work people can benefit from?’ co-worker relationships were measured using two items (ρ = 0.80), for example, ‘can you ask your colleagues for help if necessary?’ supervisor relationships were measured using three items (ρ = 0.84), for example, ‘do you get on well with your supervisor?’ emotional exhaustion was measured using three items (ρ = 0.80) taken from the burnout scale (asiwe, jorgensen & hill 2014), for example, ‘i lack the energy to build relationships with people’. an adapted version of the psychological conditions questionnaire of may et al. (2004) was used to measure the psychological conditions of meaningfulness, safety and availability. psychological meaningfulness was measured using four items (ρ = 0.90), for example, ‘the work i do on this job is meaningful to me’. psychological safety was measured using a scale developed by asiwe (2014). it consists of five items (ρ = 0.80), for example, ‘there is a threatening environment at my workplace’. psychological availability was measured using five items (ρ = 0.88), for example, ‘i am confident in my ability to handle competing demands at work’. engagement was measured using a seven-item work engagement scale (wes; asiwe 2014). the wes measured three components of engagement based on kahn’s conceptualisation and the extension of the theory by may et al. (2004): physical engagement (two items), emotional engagement (two items) and cognitive engagement (three items). examples of items are as follows: ‘i am full of energy while working’ (physical enagement), ‘i am emotionally connected to my job’ (emotional engagement) and ‘i am not distracted while doing my job’ (cognitive engagement). all the items used in this study were scored on a seven-point likert scale ranging from 1 (never) to 7 (always). the reliability of the scale was acceptable (ρ = 0.84). research procedure and ethical considerations the researcher obtained written permission to conduct the research from the director of human resources of the organisation. subsequently, a letter that explained the aim of the study was emailed to employees within the organisation, requesting their participation in the survey and emphasising the confidentiality of the research study. the participants who indicated their readiness to take part in the study were personally provided with a consent form and paper-and-pencil questionnaires that were completed within a 6-week period. items were selected to fit the aim of the study. however, the results of factor analyses in a broader study by asiwe (2014) were also considered. a total of 472 questionnaires (indicating a 92% response rate) were returned. however, only 443 questionnaires were considered suitably completed and were used for the statistical analysis. data were captured in an spss data file for use in mplus 7.31. statistical analysis the analysis of the data was carried out using mplus version 7.31 (muthén & muthén 1998–2014). items of the questionnaires were defined as continuous, and the maximum likelihood parameter estimates (mlr) with standard errors were used as estimators. the mlr estimator provides standard errors and χ2 test statistics that are robust to non-normality (wang & wang 2012). the akaike information criterion (aic) and bayes information criterion (bic) were used to compare structural models. the aic, a comparative measure of fit, is meaningful when one estimates different models. the bic provides an indication of model parsimony (kline 2016). the lowest aic and bic values indicate the best fitting model. point estimate reliabilities (ρ) of scales were computed using a formula based on the sum of squares of standardised loadings and the sum of standardised variance of error terms (wang & wang 2012). point estimate reliabilities higher than 0.70 are regarded as acceptable. the χ2 statistic is usually examined to test for overall model fit (hooper, coughlan & mullen 2008). however, it is necessary to consider other fit indices in addition to χ2 because of some limitations in its use. these include sensitivity to sample size (the statistic most often rejects a model when a large sample is used) and to multivariate normality (hooper et al. 2008). therefore, the following fit indexes, produced by mplus, were used in this study: the root mean square error of approximation (rmsea), the comparative fit index (cfi) and the tucker–lewis index (tli). for the cfi and tli, a value of 0.90 and above indicates an acceptable fit (bentler 1992; schumacker & lomax 1996). according to cudeck and browne (1993), there is a good model fit if the rmsea value is less than or equal to 0.05. values up to 0.08 indicate reasonable fit (cudeck & browne 1993) while values above 0.10 indicate a poor fit (maccallum, browne & sugawara 1996). the indirect model function of mplus was used with the bootstrapping resampling option enabled and set to 10 000 samples (shrout & bolger 2002). we used cohen’s (1988) guidelines to assess the practical significance correlations and the percentage of variance explained (r2) by regression equations. the following guidelines indicate the practical significance of correlations: r < 0.30 – small effect, r > 0.30 – medium effect and r > 0.50 – large effect. the following guidelines indicate the practical significance of r2: <0.09 – small effect, 0.09 – medium effect and 0.25 – large effect. results in the next subsection, the results are reported. first, the results of the test of the measurement model are reported, followed by the results of the tests of the alternative structural models. testing the measurement model first, confirmatory factor analysis was used to test a hypothesised measurement model, to investigate whether individual measurement items loaded significantly onto the scales with which they were associated. the measurement model consisted of eight latent variables, namely: (1) job design (measured by means of four observed variables); (2) co-worker relationships (measured by means of two observed variables; (3) supervisor–worker relationships (measured by means of three observed variables; (4) emotional exhaustion (measured by means of three observed variables); (5) work engagement (measured by means of seven observed variables); (6) psychological meaningfulness (measured by means of four observed variables); (7) psychological safety (measured by means of five observed variables); and (8) psychological availability (measured by means of five observed variables). a χ2 value of 677.95 (df = 467) was obtained for the hypothesised measurement model. acceptable fit statistics were found for the four fit indices: tli = 0.95, cfi 0.95 and rmsea = 0.03 [90% confidence interval (ci) = 0.03–0.04, probability rmsea < 0.05 = 1.00], srmr = 0.05. descriptive statistics, reliabilities and correlations table 2 depicts the descriptive statistics, reliabilities and correlations of the latent variables. table 2: descriptive statistics, reliability (ρ) and correlation matrix of the latent variables. table 2 reveals a negative correlation between work engagement and emotional exhaustion (practically significant, medium effect). work engagement correlated positively with job design, co-worker relationships, supervisor relationships and psychological availability (all medium effects), as well as psychological meaningfulness (large effect). psychological meaningfulness correlated positively with psychological availability (large effect), job design and supervisor relationships (both medium effects) and negatively with emotional exhaustion (medium effect). psychological availability correlated positively with job design (large effect) and supervisor relationships (medium effect) and negatively with emotional exhaustion (negative effect). psychological safety correlated positively with job design and supervisor relationships (both medium effects) and negatively with emotional exhaustion. regarding the relational variables, job design was positively associated with supervisor relationships (medium effect). co-worker relationships were positively related to supervisor relationships (large effect). testing the structural model the structural model was tested based on the measurement model. three competing models were tested because of the cross-sectional nature of the data. the hypothesised relationships were tested using latent variable modelling as implemented by mplus 7.31 (muthén & muthén 1998–2014). direct and indirect effects were tested in model 1; only indirect effects were tested in model 2, while only direct effects were tested in model 3. table 3 shows the fit indices and standardised path coefficients estimated by mplus for the three models. results indicated a fair fit of the hypothesised model (i.e. the direct and indirect effects model) to the data: χ2 (df = 472) = 775.22; p = 0.000; cfi = 0.93, tli = 0.93, rmsea = 0.04 (90% ci 0.03–0.04), srmr = 0.07, aic = 43051.25 and bic = 43550.66. table 3: fit indices and standardised path coefficients of the structural models. next, the obtained relationships of the final structural model are discussed regarding the hypotheses of this study (see model 1 in table 3 and figure 1). figure 1: the final structural model. for the portion of the model predicting psychological meaningfulness, the path coefficient of job design (β = 0.31, p < 0.001) was statistically significant and positive, while the path coefficients of supervisor relationships and co-worker relationships were not statistically significant. the mlr-estimated equation accounted for a moderate proportion of the variance in psychological meaningfulness (r2 = 0.18). these results provide partial support for hypothesis 1. concerning the portion of the model predicting psychological availability, the path coefficient of co-worker relationships was statistically significant and positive (β = 0.20, p < 0.01), while the path coefficient of emotional exhaustion was statistically significant and negative (β = –0.26, p < 0.01). a moderate proportion of the variance in psychological availability (r2 = 0.12) was accounted for by the regression equation. these results provide support for hypothesis 2. regarding the part of the model predicting psychological safety, the path coefficient of supervisor relationships was statistically significant and positive (β = 0.49, p < 0.01), while the path coefficient of co-worker relationships was not statistically significant. a moderate proportion of the variance in psychological safety (r2 = 0.19) was accounted for by good supervisor relationships. these results provide partial support for hypothesis 3. with regard to the part of the model predicting work engagement, the path coefficients of emotional exhaustion (β = −0.35, p < 0.001), psychological meaningfulness (β = 0.27, p < 0.01) and psychological availability (β = 0.15, p < 0.05) were statistically significant and had the expected signs. the path coefficients of co-worker relationships, supervisor relationships and job design, were not statistically significant. a large proportion of the variance in work engagement was accounted for by the structural model (r2 = 0.45). these results provide partial support for hypothesis 4. indirect effects the procedure explained by hayes (2009) was used to determine whether the relations between job design, co-worker and supervisor relationships, meaningful work, and emotional exhaustion and work engagement were affected by psychological conditions of availability, meaningfulness and safety. bootstrapping (10 000 samples) was used to construct two-sided bias-corrected 95% cis to assess indirect effects. job design had a significant indirect effect on work engagement: the 95% cis of job design via psychological meaningfulness did not include zero. job design had indirect effects on work engagement via psychological meaningfulness (β = 0.09, p < 0.01; 95% ci = 0.03–0.17). no other significant indirect effects were found. this result provides partial support for hypothesis 5. discussion the aims of this study were to investigate the associations among relational factors (job design, co-worker relationships, supervisor relationships and emotional exhaustion), psychological conditions and work engagement and to test a structural model of work engagement. the results showed that psychological meaningfulness and psychological availability had positive effects on work engagement, while emotional exhaustion had a negative effect on work engagement. relational aspects of job design had a positive indirect effect on work engagement (via psychological meaningfulness). emotional exhaustion had a negative effect on psychological availability, while co-worker relationships had a positive effect on psychological availability. supervisor relationships contributed to psychological safety. as predicted by the relational model (kahn & heaphy 2014), work engagement was statistically significantly and positively associated with psychological meaningfulness. recent studies (janik & rothmann 2016; may et al. 2004; olivier & rothmann 2007; rothmann & rothmann 2010; rothmann & welsh 2013) showed that psychological meaningfulness predicts work engagement. our results confirm the findings of janik and rothmann (2016) that psychological meaningfulness was the most important psychological condition that contributes to work engagement. psychological meaningfulness is characterised by the feeling that one is making a difference, resulting in the ability to give yourself to others and your work (kahn & heaphy 2014). psychological availability (i.e. individuals’ confidence in their abilities to handle demands, think clearly, and display appropriate emotions) contributed to work engagement. kahn and heaphy (2014) pointed out that psychological availability reflects one’s readiness or confidence to engage in a work role, given that individuals are also engaged in other activities. previous studies (e.g. rothmann & buys 2011; rothmann & rothmann 2010) also showed that psychological availability is significantly associated with work engagement. however, this study showed that the effect of psychological meaningfulness compared to psychological availability on work engagement was almost twice as strong. in addition to the positive effects of psychological meaningfulness and psychological availability, emotional exhaustion had a negative effect on work engagement in the structural model. based on the relational model (kahn & heaphy 2014), and the findings of a recent study (janik & rothmann 2016), we hypothesised that psychological availability would mediate the relation between emotional exhaustion (caused by energy depletion) and work engagement. although we found that emotional exhaustion had a direct negative effect on psychological availability, it affected work engagement directly and negatively rather than indirectly via psychological availability. the negative relation between emotional exhaustion and psychological availability was expected: individuals whose emotional resources are not depleted will make themselves available psychologically to engage in relationships and work. the results support the importance and usefulness of relational variables in understanding individuals’ experiences of psychological conditions and work engagement (kahn & heaphy 2014). in the structural model, job design predicted psychological meaningfulness and also work engagement via psychological meaningfulness. relational aspects of job design aspects include perceiving one’s job as something important which can benefit people, opportunities for independent thought and action, freedom in carrying out work activities and participating in decision making. in line with the relational model (kahn & heaphy 2014) and research findings of grant (2007, 2008), individuals contact with beneficiaries (regarded as part of job design in this study) allows them to deepen the meaning and purpose of their work. furthermore, by allowing freedom, independence and participation in decision making, employees are encouraged to put their unique stamps on their work, which support their autonomous agency and deepen their purpose at work (veltman 2016). based on the relational model of work engagement, we expected that relationships with supervisors and co-workers would predict psychological safety. while both sound supervisor and co-worker relationships were positively related to psychological safety, the structural model showed that (only) supervisor relationships had a strong and significant effect on people’s feelings of psychological safety. the results showed a strong relation between supervisor and co-worker relationships, which might suggest that co-worker relationships tend to be good when supervisor relationships were good. concerning emotional exhaustion, psychological safety is threatened when employees feel overwhelmed, and they protect themselves from the possibility of further sensitive material (kahn & heaphy 2014). limitations this study had various limitations. first, the use of a cross-sectional survey design does not allow claims of causality of relationships because the findings of the study were based on correlational data. second, we used non-probability sampling, which means that it is not possible to generalise findings. third, we did not assess the measurement invariance of the relational model for different groups (e.g. job levels and cultural groups) in the organisation. conclusion recommendations investing in human resource management policies aimed at ensuring proper job design, good relationships with co-workers and supervisors and reducing emotional exhaustion are recommended for agricultural research organisations as this could ensure greater psychological meaningfulness, availability and safety and engagement of employees. organisations should provide a work environment that enhances meaningfulness and availability and reduces emotional exhaustion of workers to improve their engagement. future research should investigate the relational model of work engagement in different demographic groups using larger samples and a longitudinal design. this could provide more insight into the effects of job design, co-worker relationships, supervisor relationships and emotional 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accepted: 16 jan. 2019; published: 16 apr. 2019 copyright: © 2019. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: industrial clusters remain at the initial stage in the sub-saharan africa (ssa) region. they produce low-quality and similar products that are poorly innovative and therefore unable to expand. ethnicity is a characteristic imprint of ssa clusters. however, little research has been done on ssa industrial clusters being able to explore ethnic effects on cluster development, in particular the cases where ethnic majority is over-presented. aim: this study aims to investigate the effect of ethnic network between ethnic majority and minority on knowledge exchange in clustered micro and small-scale enterprises in africa. setting: this study was undertaken in the furniture cluster located in arusha city, tanzania, which has striking features in its ethnic composition of a dominant ethnic majority and a variety of ethnic minorities. a census survey on the 234 clustered furniture enterprises was conducted to collect comprehensive information on production skill and ethnicity at individual level. methods: probit and ordered probit models are employed to analyse the difference in manufacturing skill between the ethnic majority and minority as well as the inter-ethnic and intra-ethnic enterprises. results: results show a positive and significant effect of the strength of the ethnic networks in having advanced skills in furniture production; particularly evident is the skill that is governed by enterprises’ own capability rather than production facilities. comparing technological skills between the inter-ethnic enterprises and intra-ethnic enterprises, the former are more likely to share similar manufacturing technology with each other than the latter. while individuals in the ethnic majority resemble uniform manufacturing techniques in higher-priced furniture work, the ethnic minority exhibits a similarity in producing common goods. conclusion: ethnic network is a predictor of technological skills of clustered producers in the ssa region. however, the ethnic network effect can only influence the skills that are apparently observed and barely affects capital-intensive technology. these findings indicate the significance of the ethnic networking effect in knowledge exchange in africa, but remain ineffective in overcoming capital constraints. keywords: ethnic network; ethnic majority; knowledge exchange; industrial cluster; sub-saharan africa. introduction the informal economy contributes to about 40% of gross domestic product (gdp) and created more than 70% of employment in the sub-saharan africa (ssa) region (international labour office [ilo] 2013; schneider & enste 2000; the world bank 2004). businesses in the informal economy are mostly micro and small-scale enterprises (mses), and geographically concentrated in certain fields in the ssa region. ssa mses congregate in industrial clusters, fairly similar to mses worldwide, to have better access to industrial information, suppliers and labourers (david & rosenbloom 1990; kelly & hageman 1999; krugman 1991; marshall & marshall 1920; porter 1990; swann, prevezer & stout 1998). the distinctive difference between ssa industrial clusters and those in other regions is the ethnic context. social capital and innovation system are the two important factors affecting regional development (braczyk, cooke & heidenreich 1998; fukuyama 1995). these two seemingly parallel factors are intertwined in cluster development. innovation evolves frequent knowledge exchange, which contributes to cluster development (kelly & hageman 1999; kesidou & romijn 2008; paci & usai 1999). however, knowledge exchange does not happen randomly, but occurs within a group or between two persons who have a relationship of trust. the maintenance of trust consequently builds up social capital and networks in a community or region, which is the key factor predicting the success of the region and companies (audretsch 1998; breschi & lissoni 2001; crespo, suire & vicente 2013; fukuyama 1995; henderson 1997; li et al. 2013; powell, koput & smith-doerr 1996). most industrial clusters remain at the initial stage in the ssa region. they produce low-quality and similar products that are poorly innovative, and therefore end up without expansion (mccormick 1999). ethnicity leaves a characteristic imprint on ssa’s development. however, diverse ethnicity has an adverse effect on its economy (easterly & levine 1997). there is a lower trust relationship between ethnic groups and even hostile attitudes to each other, particularly in the case of the presence of the ethnic majority, which has privileges and gains control of resources. nevertheless, little research has been done on ssa industrial clusters being able to explore ethnic effects on cluster development in which the ethnic majority is over-presented. this study explicitly focuses on the impact of an ethnic network on clustered mses’ manufacturing skills in ssa, particularly with regard to the presence of an ethnic majority. the study site, which is the furniture cluster located in the city of arusha, tanzania, has striking features in its ethnic composition of a dominant ethnic majority and a variety of ethnic minorities. this study collected comprehensive information on production technology and ethnicity at individual level from a census survey of 234 clustered furniture enterprises. empirical results show that ethnicity is the predictor of mses’ manufacturing skills in the cluster. the strength of ethnic networks contributes to the acquisition of advanced techniques. however, the ethnic networking effect cannot overcome capital constraints. it cannot impact on the skills that cannot be apparently observed but necessitate capital-intensive facilities. accordingly, key contributions of this study help account for knowledge diffusion and breakdown of inter-ethnic exchange channels in ssa clusters. the remainder of the article is organised as follows: the section ‘industrial clusters and social networks’ documents literature reviews on the industrial cluster and clustered ethnic networks. the section ‘the furniture cluster in arusha’ introduces the study site, which is the furniture industrial cluster located in arusha city, tanzania. the section ‘methodology and data’ introduces probit models and the data. empirical results are presented in the section of the same name. lastly, the section ‘conclusion and policy implication’ provides conclusions and policy suggestions. industrial clusters and social networks industrial clusters fascinate economists investigating the formation, development and economic effect of industrial clusters on national economy. in practice, they enlighten authorities to strike industrial cluster relevant strategies for shaping national competitiveness. industrial cluster refers to a geographic concentration of interconnected companies and institutions in a particular field (porter 1998). industrial entities agglomerating in a certain area allures a skilled labour force, reducing transaction cost and accelerating knowledge creation, innovation and spillover among the involved participants. the extent of the economics of scale derived from the agglomeration of economy generates positive externalities to the national economy and heightens the strength of the country to compete in global markets (david & rosenbloom 1990; kelly & hageman 1999; ketels 2013; krugman 1991; marshall 1920; marshall & marshall 1920; porter 1990; sonobe & otsuka 2006; swann et al. 1998). knowledge creation and exchange in clusters that receive the largest attention in cluster literature on knowledge exchange are the foundation of innovation and the key driving force of a cluster’s development. knowledge spillover has occupied the central position in industrial cluster research. research is devoted to exploring the knowledge creation and innovation process, catalysis and the channels of knowledge spillover (rivera, soderstrom & uzzi 2010). scholars’ consensus through face-to-face interactions among clustered firms is that clusters enhance mutual trust and endow clustered firms with privileges in acquiring industry-specific information compared with their cluster-outside counterparts. marshall (1920) explicitly depicted the prominent advantage of being clustered: ‘the mysteries of trade become no mysteries in cluster; but are as it were in the air’. similar firms with divergent knowledge gather together to solve the same problems, and the rivalrous relationship motivates them to continuously monitor and compete with each other, which results in knowledge creation and innovation (porter 1990, 1998). through knowledge exchange, clustered small companies reduce uncertainty and risk entailed in their business routine and production (chung & kalnins 2001; folta, cooper & baik 2006; sorenson & audia 2000; stuart & sorenson 2003) and keep up with industry trends without further endeavours (brown & duguid 1991). however, studies have divergent views in terms of the types of knowledge to be exchanged. a strand of studies asserts that the knowledge exchange between clustered companies is limited to the non-technological level, whereas specialised knowledge should transfer through formal contracts. patent transferring is a case in point, as clustered knowledge sharing in business activity is not a natural phenomenon. clustered companies intrinsically compete rather than collaborate with each other due to the fact that recipients’ knowledge learning and imitation, in turn, hurt transfer profits (hoang & antoncic 2003; mesquita 2007; shaver & flyer 2000). another strand of studies on industrial clusters enriches the research in exploring the relationship between knowledge transfers, recipients and the channels. companies can gain knowledge diffusion from their competitors, suppliers and customers by having joint technical meetings, interpersonal communication and patent disclosure (harabi 1997; von hippel 1988). nevertheless, krugman (1991) surrendered the possibility of comprehending knowledge exchange because: … knowledge flows are invisible; they leave no paper trail by which they may be measured and tracked, and there is nothing to prevent the theorist from assuming anything about them that she likes (p. 53). musteen, francis and datta (2010) gave a clue for research on discriminating companies’ knowledge receiving and transferring channels by looking at the firm’s size: large-scale companies tend to use contracts while small and medium enterprises (smes) rely more on social networks. moreover, it is undeniable that those channels are established under mutual trust between recipients. even formal business contracts are initiated by two people who have a relationship based on trust. another issue is how to establish trust in clustered businesses. basically, trust is associated with ethnicity and linguistics (leigh 2006). inborn relationships such as kinship ties and inherent ethnic relations outweigh acquired trust in business activities. ethnicity can act as a natural social bond forging reciprocal trust among group members. greif (1993) illustrated the mechanism by modeling the coalition among ethnically jewish maghribi traders in the western mediterranean. he stated that the agency relation between merchants and agents was governed by a reputation-based trust mechanism, in which inter-ethnic culture and trust substitute for a contract by specifying ex ante group rules of behaviour and practising ex post group punishment. this means that inter-ethnic trust disciplines ethnic members not to disclose unapproved information to outsiders, otherwise the member will be eternally ostracised and ejected by the ethnic group. this is considered to be an effective way to attain ethnic prosperity in countries with lower property rights protection. in such countries, ethnic group members are encouraged to have a bigger vision and therefore perform altruism that is necessary when group members imperceptibly sacrifice and minimise self-interest. thus, some information is secured and only circulated within the ethnic traders’ group. the significance of ethnic networking in clusters is limited but being proved in literature. liang (1999) showed that ethnic networks serve as a wirepuller for outsiders to enter clusters in a regulated market. in the early 1980s, when china remained a closed economy, taiwanese and hong kong companies were able to access the shenzhen special economic zone owing to their ethnicity. in addition, zaheer, lamin and subramani (2009) looked at clustered businesses’ location decisions across 11 clusters in india, and confirmed an ethnic network of ceos that surpassed cluster characteristics as the key factor predicting companies’ locational choice. zaheer et al. (2009) explained that the reason behind this is that social networks reduce outsiders’ liability of being outsiders who have a lower understanding of the local market. without ethnic networks, outsider businesses are less likely to reap clustered economic benefits. clustered enterprises in ssa are not the exceptions. muto, chung and shimikoshi (2011) confirmed that tanzanian mses tend to locate their business near their ethnic members. kristiansen (2004) also mentioned the impact of personal networks information on entrepreneurial success in the tanzanian context. the aforementioned literature confirmed the importance of inter-group trust in business information exchange. however, the intra-ethnic discrepancy in clusters remains unknown. intra-ethnic disparity can cause hostility toward other groups and living distances (dustmann & preston 2001). it is because inter-ethnic trust erects a barrier preventing ex-ethnic groups sharing resources in business finance and information and, in turn, ethnic discrepancy harms a nation’s economic development, particularly in the overwhelming presence of a dominant ethnic majority. easterly and levine (1997) found african ethnic fragmentation adversely affecting its economic growth by 30% compared with other countries. studies prove that the ethnic majority has better access to financing and information. few studies have been able to answer the case of the presence of a dominant ethnic group within clusters despite its worldwide prevalence. this results from the difficulties in identification of individuals’ knowledge exchange without codified documents. it is more evident in ssa. numerous studies have investigated the technological transfer from advanced economies to less developed countries, in particular foreign direct investment (fdi)-led knowledge spillover from exporting countries to their destination countries (hoang & antoncic 2003; swenson 2008; todo & miyamoto 2006). most studies view research and development expenditures and patent citations as the best indicators of technology diffusion (alazzawi 2011; jaffe, trajtenberg & henderson 1993; keller 2002; kelly & hageman 1999). however, these codified proxies for knowledge transfers or diffusions are not applicable to africa where production units are informal sectors and in which data are not coded. conley and udry (2010) addressed the difficulty and offered a clue for african study. they collected data from the ‘information’ neighbourhoods of ghana pineapple farmers and compared the similarity in fertiliser use between individual pineapple farmers and their ‘information’ neighbours. they found that farmers adjust their inputs to align with their ‘information’ neighbours who have been successful in previous periods. the furniture cluster in arusha the study site arusha city is the biggest city of the arusha region which is the largest among the 31 regions of tanzania. the area size of arusha city is 82.5 km2 and the population is about 133 000 (2012 census). geographically, it is located in northern tanzania, close to the border with kenya. the city is at the foot of mount meru, surrounded by mt kilimanjaro, and the serengeti and ngorongoro national parks. the agreeable weather with an average temperature of 25 degrees and relative humidity of 82%, as well as abundant forest resources, favour the wooden furniture industry. the wooden furniture industry consists of small-scale enterprises, geographically gathering in five areas of arusha city: the nairobi-moshi area, industrial area, sokoine area, dodoma road area, and city centre area. as of the 2007 census survey on the cluster, conducted by japan international cooperation agency (jica) using personal questionnaires, five sub-clusters account for 34%, 25%, 16%, 13%, and 12% of the total number of 234 enterprises. the cluster as a whole mainly produces necessities for the locals; the three most observed products are beds, couches and cupboards. under the scant formal learning sources and fdi in the area, it is not surprising that arusha mses are prone to learn through personal ties. tanzania has more than 120 ethnic groups, among which sukuma is the largest, accounting for an estimated 3.2 million members, representing 10% – 13% of the total population, followed by nyamwezi. in the arusha region, iraqw, arusha, maasai, meru and barbaig are the main ethnic groups (according to the report of arusha region socio-economic profile 1998). the furniture cluster in arusha city can be described as a microcosm of most african countries that are ethnically diverse. it comprises 35 ethnic groups with the overwhelming ethnic majority chagga and a variety of ethnic minorities. chagga accounts for 41% of the total furniture entrepreneurs, triple the size of the second largest pare ethnic group (12%) in the cluster (see figure 1). despite the expansion of the cluster, chagga remains the majority. according to interviewees’ statements, the expansion results from the rising demand of the economic boom of construction and the hotel industries. compared with 3% of total clustered enterprises for the arusha indigenous tribes, the maasai and arusha, the over-represented number of chagga in the cluster proves its strength in the industry, based on the fact that chagga is an ethnic minority in the arusha region. figure 1: furniture producers in the cluster by ethnic group. based on the site information revealed by the interviewed enterprises, the chagga ethnic group has been known for their deftness in customer-luring and business connections with developed countries through religious meetings. exploiting the connections, they more easily acquire specialised catalogues and books than others. the legacy of racial segregation for eight decades during the colonial period appears to slightly add to the ethnic separation, but ethnically distinctive cultures weigh intrinsically and heavily on ethnic-based communities and economies. the colonial period can be dated back to the 1880s when tanzania was a german colony until 1919, when it became a british colony from the end of world war i to 1961. during the colonial period, germany established a rigid colonial racial hierarchy of europeans, asians, arabs and africans in tanzania, and britain maintained the german policy of this racial hierarchy. the racial segregation policy led each ethnic group to have its own schools, hospitals and places of entertainment. mixed racial activities were rarely observed. however, the policy no longer exists; nowadays all ethnic groups officially speak english and swahili. furniture production before exploring the arusha mse learning path, it is important to know its furniture production process and entities involved. the supply chain of the clustered furniture industry encompasses timber yards, furniture workshops, machining, metal materials and cart shops. as the industry division of labour is half-fledged, furniture enterprises carry out the major processing and logistic activities of furniture production from timber seasoning, and design, to component assembly, marketing and transportation (see figure 2). figure 2: integrated production organisation. among all, timber desiccation treatment and assembly are the two important processes in furniture production. with the first process, timber desiccation is highly related to temperature and humidity. wood in natural form is sensitively responsive to moisture, and its dimensions change imperceptibly with moisture content causing expansion or shrinkage which results in damage to the final goods. a conditioned storage room is necessary for furniture companies. however, temperature controllers are not affordable for arushan enterprises. thus, the timber seasoning process is heavily inhibited by environmental circumstances and enterprises’ care. some producers are keen on the process and carefully store timbers, while some disperse timber outdoors. the widely used measure of moisture content of wooden furniture is the equilibrium moisture content (emc) indicator. the optimisation of emc varies with its location; the optimum emc for arusha is 2. on the other hand, the assembly process is fully governed by the producers’ skills. basically, local producers use four tools for component assembly: wood, screw, nail and glue. a mortise and tenon joint, exclusively using wood, is considered to be a sophisticated approach. it is followed by using metal, such as screw and nail joints. lastly, gluing is the easiest and cheapest approach. furniture assembled with mortise and tenon joints, compared to butt joints in which pieces of wood are joined using screws, nails, or glue, is considered a high value-added item. creating mortise and tenon joints is time-consuming and requires skill; thus producers are less likely to use it on low-priced products. the ranking rules of assembly skills are: (1) joints including mortise joints which are ranked higher than those using screws, (2) joints including nails which are ranked below screwed joints, (3) joints with glue which are inferior to those using nails. accordingly, a higher ranking indicates a superior manufacturing technique. the ranks of 15 wood-joining techniques are listed in appendix 1. to trace the evidence on mutual knowledge exchange of specialised skills between two smes, the data on individual smes’ technologies applied in final products are required. however, this is daunting work and the primary challenge for an empirical study on the topic in ssa, where knowledge exchange is rarely codified. this study, thus, conducted a labourand cost-intensive survey for collecting comprehensive data pertaining to two important production techniques in the furniture industry: timber seasoning and assembly skills at the individual level. the timber seasoning skill was evaluated by the moisture content in three main products using a moisture meter hm52o (moco-2) and timber assembly skill was tested by a thorough inspection of the joints of three main products. for each product, at least three spots were measured. for example, the moisture contents of four legs and the plank in a bed were measured. in addition, the location of enterprises was identified by global positioning system (gps) equipment and the distances between two enterprises were calculated by geographic information system (gis) software. the clustered ethnic composition, one dominant ethnic group and a variety of minorities, suits this study to examine two hypotheses. firstly, the ethnic homogenous effect: ethnic-fellow producers possess similar manufacturing skills. secondly, the network strength effect: a bigger ethnic group (majority) is more likely to have advanced skills than small ethnic groups (minority). methodology and data probit model this study used the probit model with dyadic data to examine if two ethnic enterprises exhibited the same manufacturing techniques and if the number of ethnic members was a predictor of advanced technological skills. the latent variable, knowledge exchange is calculated as follows in equation 1: eij is the ethnicity variable, taking a value of 1 if producers i and j are from the same ethnic group; otherwise it is 0. a set of control variables xij including geographical distance captures characteristics between enterprises i and j. eij is an error term independent of explanatory variables eij and xij. knowledge exchange is unobservable and untraceable. in practice, yij is measured by the similarity in technology between i and j in equation 2: if knowledge exchange between producers i and j reaches a certain frequency, their manufacturing skills yij are similar, and take a value of 1; otherwise it is 0. the distribution of similarity in skills between two producers yij given eij and xij are as follows in equation 3: φ(.) denotes the standard normal cumulative distribution function. similarly, as seen in equation 4, the probability of non-similarity in technology between two producers is: therefore, the density of yij given xij is (see equation 5): the dependent variable is assembly or desiccation skill. explanatory variables include discrete and continuous independent variables. discrete variables include the ethnicity, past occupation and training experience variables, and the pair relationship is defined as 1 if producers i and j have the same value; otherwise it is 0. for continuous independent variables such as schooling years, the absolute values of each of the differentiated and summed values of the variables are added. in terms of interpretation, a negative sign on the differentiated variables denotes assortative matching, indicating that a small difference in the characteristics enhances a likelihood of two producers exhibiting the same skills. on the other hand, a positive sign on the summed values is named level effect, indicating two producers with a higher combined level of the attribute, which are more likely to exhibit the same skill compared to those with a total of a lower level of the attributes. thus, a negative sign on the differentiated schooling years and, simultaneously, a positive sign on the variable can be interpreted as two producers with a combined high level of schooling years and a small difference between them are more likely to possess the same skill. the total number of entrepreneurs in the cluster is 234, so there are unique enterprise pairs in the data. standard errors are adjusted to be robust to heteroscedasticity. data table 1 summarises the variables used in the analyses. the upper section presents the variables as a whole, and the lower shows the comparison statistics between ethnic majority and minority. in the table, ethnic strength is calculated as the number of ethnic fellow producers in proximity to each enterpriser. this number is restricted to those within a 1 km radius. the number of 1 km is considered to be a reasonable walking distance for enterprises to have a face-to-face contact as public transportation is not available in arusha city. enterprisers who want to communicate with each other or transport their products walk or use a cart. the statistics show that ethnic strength ranges from 0 to 17 with a mean of about 2, indicating that a furniture producer averagely has 2 ethnic members located nearby albeit a large difference among enterprises. four control variables related to enterprises’ production skills are included in analyses. enterprise size is measured as the number of workers and has a mean of five. schooling years has a mean of 9.53, a level equivalent to ordinary schooling, in which furniture specialisation knowledge has not been taught. nearly half of the enterprises relied on informal learning, and 49% of enterprises had no work experience. spin-offs are said to be one of the important channels of knowledge transfer. unreported data from the study show that few producers were spin-offs of other private or state-owned furniture factories. a typical clustered furniture producer is portrayed as a male in his 30s who is ordinarily educated, without furniture-relevant work experience. he is able to learn production skills through personal networks while starting up a furniture workshop in the cluster, as he has two ethnic fellows in the vicinity who also act as industrial peers. table 1: data summary. two measurements are used in terms of assembly skills, mortise and tenon joints (labelled mortise) and ranking of assembly skills (labelled assembly). mortise is a binary dummy equal to 1 if a producer performed mortise in any of his products, otherwise 0; ranking is a categorical variable ranging from 1 to 15, representing an ascending order of skills in an assembly. statistics show that mortise averages 0.89, indicating that 89% of producers can perform this assembly technique, and ranking averages 10.9, indicating that furniture producers tend to use four joining techniques (mortise joints, screws, nails and glue) all together in furniture work. emc averages 1.79 with a standard difference of 0.14, indicating a small difference in emc among the enterprises. the statistics in the lower section of table 1 show a significant difference in learning sources between ethnic minority and majority. the minority receives training through formal apprenticeship programmes, while the majority learns through personal ties. compared with 41% of ethnic minorities, a significantly higher number – 60% – of the majority (chagga) producers had no work experience. this suggests a piece of evidence on a collaborative learning support system in the majority (chagga) ethnic group. within the system, an inexperienced ethnic majority can start up in the cluster acquiring occupational skills. the assembly and desiccations skills exhibit a mixed result: ethnic majority is slightly skilled in furniture assembly, whereas the minority is skilled in timber desiccation. however, both figures are insignificant. table 2 presents the statistics on dyadic data used in analysing technology disparity within and across ethnic groups. the ethnic variables include three binary dummies: ethnicity is defined as 1 if producers i and j share the same mother tongue; majority equals 1 only if paired producers i and j are in the ethnic majority (chagga), otherwise, it is 0. likewise, minority takes the value of 1 if paired producers are from the same ethnic minority, otherwise, it is 0. the summary table shows that ethnicity averages 0.19, majority is 0.17 and minority averages about 0.03. these can be interpreted as the probability of having co-ethnic fellows to exchange knowledge in manufacturing skills for chagga, which is 17% and the number declines to 3% if the producer is an ethnic minority. distance is the geographic distance between two workshops and the figure shows the farthest distance between two workshops located in the cluster as 9.12 km while the closest two workshops are adjacent. likewise, the other independent variables including training source and past occupation take a value of 1 only if producers i and j have the same attribution, otherwise it is 0. the dependent variables are ranking of assembly skill and timber desiccation skill (emc). the former is a binary dummy equal to 1 if paired producers are in the same ranking, the latter is a continuous variable and calculated as absolute value of differentiated emc between enterprises i and j. table 2: pair data statistics. empirical results two aforementioned hypotheses are examined with the results reported in tables 3 and 4 and tables 5 and 6. table 3: assembly skill and ethnicity. table 4: desiccation skill and ethnicity. table 5: assembly skill and ethnic strength. table 6: desiccation skill and ethnic strength. ethnicity and production skills table 3 presents the estimation of the probit model using dyadic ethnicity variables on assembly skills. the dependent variable equals 1 if two producers rank the same in the assembly skills. a positive marginal effect on binary explanatory variables indicates that having the same attributes increases the probability of two enterprises having the same level of assembly skill; otherwise it is negative. a positive marginal effect on the summed continuous variables is interpreted as a level effect, indicating a positive relationship between the attributes and the number of links. on the other hand, a negative sign on the absolute value of the differentiated continuous variables is interpreted as an assortative matching, meaning a small difference in the characteristics enhances the likelihood of performing the same skills. specification (1) of table 3 shows a significantly positive sign on ethnicity, implying that co-ethnic producers are more likely to apply the same assembly skills than ex-ethnic producers. to further understand the difference between the majority and minority, two variables are simultaneously included in specification (2). results show a significant and positive sign for majority but a negative sign for minority, indicating that the chagga-chagga producers employ similar assembly skills, whereas minority members exhibit different skills. as the skills adapt to change with the products, the sample is divided by product lines and displayed in descending order of the number of observations. the product sofa, which is regarded as a luxury good by the locals, has a positive and significant marginal effect on majority and a positive but insignificant result on minority. in contrast, the product bed, which is a common good, shows opposite results on ethnicity variables from the specification sofa. results of some products are omitted due to the small number of observations. overall, these results imply that ethnic chagga enterprises adopted similar skills in producing higher-priced furniture work, while the ethnic minority used similar techniques in producing lower-valued ones. table 3 implies that ethnicity and assortative matching of educational background predict the similarity in assembly skills of two clustered mses. table 4 shows the result of timber desiccation skills by using the ordinary least squares (ols) model. the dependent variable is the differentiated emc, the disparity in desiccation skills between two mses. differing from table 3, a positive coefficient of binary explanatory variables indicates the same attribute that increases the difference in desiccation skills. ethnicity is anticipated to reduce the difference; thus, a negative value on three ethnicity variables is desired. differentiated variables, including distance and diffvariables, with a positive sign are anticipated, interpreted as similar characteristics of two mses which decrease their skill disparity. on the other hand, a negative sign on sumvariables is interpreted as a level effect. in specification (1), the estimated marginal effect of ethnicity is positive but insignificant, which seemingly indicates that ethnicity does not explain mses’ desiccation skill. yet, the numbers on majority and minority in specification (2) overturns the insignificant association between ethnicity and skill. a positive marginal effect on minority indicates the ethnic minority mses perform differently in the technique. these results imply that the ethnic majority exchanges technological knowledge on higher-priced products while the ethnic minority does so on common goods. the possible reason is that moisture content of timber is more sensitive to the environment than to producers’ skill. given the dearth of temperature-controlled facilities in the area, moisture content is not as easily controlled as the assembly skills. this feature makes it difficult for producers to learn from others. tables 3 and 4 prove the ethnic homogenous hypothesis that producers from the same ethnic group are similar in their production skills. results are stronger and more consistent in timber assembly skills than desiccation skills, which may suggest a weaker effect of ethnicity on the skills requiring precision equipment. network strength table 5 presents the results for the network strength hypothesis on having the sophisticated wood-joining techniques, the mortise and the assembly techniques. the regressions in the mortise section were examined using a probit model, and those in the assembly section were examined with an ordered probit model, in which 15 levels of joint skills were ranked and used as the dependent variable. to facilitate interpretation, the average marginal effect instead of coefficient was reported. specification (1) of the mortise section is a simple version that exclusively includes the ethnicity variable. the marginal effect of ethnic networks on performing mortise skills is 0.012 and significant (p-value of 0.01), indicating that another ethnic enterprise in proximity is likely to have mortise techniques. specification (2) adds variables capturing the entrepreneurs’ learning background including learning source, work experience and schooling years. learning source is a dummy in which a non-trained group is the baseline; past occupation contains none (the baseline), indicating no work experience and schooling years is a continuous variable. specification (3) adds interaction terms for ethnic networks and training programmes, which aims to analyse the relationship between network strength and a furniture producer’s responsiveness to training in manufacturing techniques, that is, whether a producer with more ethnic members outperformed those without ethnic members after a training programme. in contrast to what was expected, training programmes did not enhance producers’ manufacturing skills. the endogeneity bias of self-selection in schooling years and the dependent variable is often raised, and producers who attempt to produce sophisticated work are more likely to seek higher education. this scenario is less likely to happen in the arusha context, because none of the producers return to school to learn skills for their furniture business, and few of them graduated from schools with a furniture-related major. moreover, this study replicated the mortise section of table 5 by employing a heteroskedastic probit model; the estimated average marginal effects of ethnic networks increase on average by 0.001 across specifications, and all retain significance at 1%. therefore, endogeneity bias is not a concern in the study. the assembly section obtains similar results as the mortise section. the estimated average marginal effect on ethnic networks is positive and significant (p-value of 0.05) across specifications (2)–(4), indicating that the ethnic networks is the principal factor increasing the possibility of acquiring advanced assembly skills. one unit increase in the number of ethnic fellow producers increases the possibility of furniture producers acquiring advanced skill by 1.3%. table 6 presents the results of network strength effect on timber desiccation skills. in contrast to that of assembly skills, the average marginal effects of ethnic strength are insignificant across specifications, indicating that the size of ethnic group has no impact on the skill. however, the skill is positively associated with the scale of workshop. this indicates that the number of workers quantitatively contributes to a higher quality of timber desiccation. this is evident in that the largest workshop with 54 workers in the sample had extremely good performance in terms of timber desiccation, recording emc values of 2 for all its furniture work. this study infers that the moisture content of timber is heavily contingent on manpower for under-capitalised mses in africa. tables 5 and 6 verify ethnic strength impact on advanced skills but the impact is subjected to the one that wholly relies on producers’ skills rather than the need for a machine. together with the findings in tables 3 and 4, this study asserts that knowledge sharing in professional skills is the way the ethnic majority chagga reasserts its dominance in the cluster. conclusion and policy implication this study examines the ethnic networking effect on technology adoption of clustered producers in ssa. results imply that ethnic network is a predictor of technological skills of clustered producers in the region. in addition, the ethnic majority shares a similarity in producing higher-priced furniture work, whereas in contrast, the ethnic minority produces common goods. however, the ethnic network effect can only influence the skills that can be apparently observed and barely affects capital-intensive technology. this suggests the limitation of ethnic networks in overcoming capital constraints in the ssa region. this result is similar to the finding of munshi (2004) that technical learning outcomes strongly depend on the characteristics of the subjects to be learned. specifically, knowledge learning breaks down if the nature of the technology involved is imperfectly observed due to the complexity. with the same study site, muto et al. (2011) found that ethnic groups in the cluster chose to locate their workshops close to their ethnic fellows. chung (2018) revealed that the chagga ethnic group was deft at grabbing industry-specific training information and circulated the information inside the group even if the training organiser designed it to randomly and equally select trainees from each ethnic group. combined with the previous and current studies, some understandings of the chagga ethnic group are acquired. being an outsider and ethnic minority in arusha city, maintaining the dominance in an industry that supplies local necessities is important for the chagga ethnic group to survive in the disadvantaged milieu. tightly cementing ethnic networks with business networks is one of chagga’s strategies to accomplish ethnic prosperity in the region. thus, the chagga ethnic group anchors a guard net to industry-specific information and knowledge for its ethnic members to secure its superiority over other groups. building and maintaining various and unimpeded channels of knowledge exchange explains industrial clusters’ success (goodman et al. 1989). thus, suggestions for policymakers are to promote new entrants with diverse backgrounds to the industries and conduct specialised training courses. to avoid ethnic concentration, developing an ethnic product for ethnic minority mses is important. in addition, because capital constrains the strength of ethnic networks, establishing public professional facilities to upgrade the industry is necessary. lastly, some limitations of this study shall be raised and reconsidered in future studies. this study only observed technological skills of the cluster-based furniture producers in arusha city; the possibility that arusha clustered producers acquire their skills outside the clusters cannot be ruled out. the focus of this study is to highlight the disparity between ethnic majority and minority in cluster development. in terms of this, this study provides a piece of 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journal 2.indd sajems ns 9 (2006) no 4 413 the views of hr practitioners on ethical issues within organisations: a south african perspective bj erasmus school of management sciences, university of south africa russell wordsworth department of business management, university of south africa abstract this article reports on the results of a survey conducted among human resource practitioners in south africa regarding their involvement in and experience of business ethics and unethical behaviour in their organisations. the results of the study concur with the theoretical perception that human resource managers have an important role to play in the institutionalisation of good ethical behaviour in the organisation, with the majority of respondents reporting that the human resource department is a primary resource for ethical initiatives and that human resource professionals are involved in the formulation of ethics policies. the article provides some insights in terms of the role of the human resource managers in the management of ethics. in so doing, an attempt is made to address the question of whether human resource managers should be the drivers of ethics initiatives in the organisation. jel l20, m12 1 introduction business ethics, and more pertinently the management thereof, has in recent years emerged as one of the leading challenges facing modern managers. whether this increased attention is a result of proactive attempts by managers and academics to come to grips with the complexities of managing in an ethical manner or as a result of the reactive “hype” surrounding corporate scandals such as those faced by enron, worldcom and parmalat, remains debatable. debate is generally followed by academic inquiry and, as such, business ethics as a field of research has also enjoyed increasing attention in management literature (martin & woldring, 2001: 243). wells and schminke (2001: 137) report that between 1990 and 1999, over 4 500 books and journal articles explored business ethics issues. one such debate currently noticeable in management literature deals with the role of the human resource (hr) function and human resource manager in managing business ethics. martin and woldring (2001: 244) highlight the ongoing debate on the role of hr management in terms of “carrying the mantle” of ethical stewardship. brewster, carey, dowling, grobler and warnich (2003: 28) also highlight the role that the hr function could play in terms of ethical stewardship, and suggest that hr has a role to fulfil in the formulation, communication, monitoring and enforcement of an organisation’s ethics programme. 2 business ethics a search for the meaning of the concept of business ethics understandably has its origins with the concept of ethics. according to shaw (1991: 8), the etymology of ethics suggests its basic concerns to be firstly individual character, including what it means to be “a good person”; and secondly, the social rules 414 sajems ns 9 (2006) no 4 that govern and limit one’s conduct, especially the rules concerning right and wrong, which are often referred to as morality. buckley, beu, frink, howard, berkson, mobbs and ferris (2001: 13) describe ethics as a traditional area of philosophical inquiry that delves into the normative rules of behaviour. in other words, ethics is about how people ought to behave and thus focuses on duty and the boundaries between right and wrong. in furtherance of this idea, pratley (1995: 9) ascribes a twofold objective to ethics, namely that it firstly evaluates human practices by calling upon moral standards, and secondly, it may also give prescriptive advice on how to act morally in a specific situation. moving from ethics to business ethics, shaw (1991: 8) defines business ethics as the study of what constitutes right and wrong, or good and bad, in human conduct in a business context. according to beu and buckley (2001: 58), one could also add to this a focus on shared value systems that serve to guide, channel, shape and direct the behaviour of individuals in organisations in a productive direction. while it should be clear that both ethics and business ethics deal with what is right and wrong, it must be borne in mind that both these fields of philosophical inquiry take place within the constraints of subjectivism and relativism. subjectivism implies that because moral judgements are feelings and not facts, each individual is entitled to his or own ethical standards. relativism posits that no single ethical theory or approach is universal either because of specific historical or cultural factors or because people’s reasons for differing ethical beliefs are equally valid. 3 the institutionalisation of good business ethics whether organisations should conduct their business in an ethical and responsible manner in which the interests of the organisation (primarily profitability) as well as the individual employee and society are taken into account, is no longer debatable. schumann (2001: 94) notes management guru, peter drucker’s argument that “what is most important for management to realise is that it must consider the impact of every business policy and action upon society. it has to consider whether the action is likely to promote the public good, to advance the basic beliefs of society and contribute to its stability, strength and harmony”. as far back as in 1975, porter argued that the wellbeing and effectiveness of the organisation as a whole depend on both the technical and moral excellence of its employees (seutloadi, 1998: 50). frederickson and walling (1999: 502) take this viewpoint one step further when they describe ethics and values as a leadership imperative and an ubiquitous consideration in modern management. with the moral environment of the modern organisation consisting of a complex web of interactions, it is becoming increasingly important for the top management of an organisation to disseminate a clear set of values and morals to their employees. buckley et al. (2001: 16) support this view and suggest that chief executives have a role to play in communicating and encouraging an ethical consciousness of these values in their organisations. they stress that it is imperative that ceos deliver, believe in and model the message that their organisation is guided by certain morals and values. this implies that the most fundamental objective of any attempt to institutionalise business ethics or an ethical consciousness should be the generation of preferred behaviours throughout the management and employees of the organisation. mcnamara (2001: 1) points out that the attainment of such an objective is dependent not only on the generation of lists of ethical values, or codes of ethics, but also the generation of the policies, procedures and training required to translate values and morals into behaviour. it is at this point that the hr function finds itself or should find itself fulfilling a pivotal role in the institutionalisation of good business ethics. traditionally, the role of the hr function in many organisations has been to serve as the systematising, policing arm of executive management. in this role, the hr function served executive agendas well, but was frequently viewed as a roadblock by much of the rest of the sajems ns 9 (2006) no 4 415 organisation. martin and woldring (2001: 245) argue that the hr function’s role has expanded to the extent that hr initiatives have a strategic impact on organisations. according to ulrich (2003: 2), as the role of the hr function evolves, it should address the needs of the changing organisation. successful organisations are becoming more adaptable, resilient, quick to change direction and customer-centred. within this environment, ulrich (2003: 2) describes the role of the hr function as necessary for line managers in being • a strategic partner; • an employee sponsor or advocate and • a change mentor. as the hr function assumes a more strategic place in the organisation, so too does its role in creating an ethical consciousness and moral business environment. brewster et al. (2003: 28) point out that this is not surprising, considering that ethical issues are generally people issues. in support of the hr’s role in creating an ethical climate, buckley et al. (2001: 16) point out that ethical climates are perpetuated with effective attraction, selection and retention strategies, and as such, should be considered partners in creating an ethical culture in the organisation. as organisations move towards an ethical approach to doing business, the hr function, as strategic partner, should do all it can to support top management in such an endeavour. according to creelman (2002: 2), the hr function can be instrumental in this move for a number of reasons. • hr is often the first place employees turn to when they notice policy violations. each action taken determines how employees perceive enforcement. this will affect even the most senior managers in the organisation. a sensible, solid response effectively communicates the message that programmes are taken seriously. it not only reinforces the action of the employee who reported the infraction, but also emphasises the meaning of the policy for others and demonstrates the company's intention to act in future situations. • further, by establishing consistency and logic in the enforcement of every policy, hr contributes to an environment of higher-level ethical thinking across the board. an examination of current management literature suggests a multiplicity of roles for the hr manager in institutionalising good business ethics. also evident in management literature (buckley et al, 2001; shrm/erc, 1997; van zyl, 2002; kitson & campbell, 1996; martin & woldring, 2001; miller, 2004) are three broad approaches to institutionalising good business ethics, which could be, and in some instances, are the responsibility of the hr function. these approaches are as follows: • a code of ethics. rossouw (2002) states that one way in which managers can institutionalise good ethical behaviour is through ethical codes or written standards of ethical conducts. he goes on to define an ethical code as a document or agreement that stipulates morally acceptable behaviour in an organisation, which defines moral standards that need to be respected by all members. • ethics training initiatives. miller (2004: 7) contends that simply writing and distributing a code of ethics is insufficient to reap the benefits that an organisation could gain by rolling out a code in a thoughtful and effective manner. ethics training initiatives should be based on the contents of the code of ethics and should allow employees to develop a working knowledge of the code. kavathatsopolous (2001: 20) takes this one step further and states that ethics training initiatives should create what he refers to as “ethical competence” and should prepare individuals to cope with ethical conflicts. • an ethics office or ombudsman. the provision of an ethics office or ethics o m b u d s m a n i s s e e n a s a n e s s e n t i a l mechanism for the confidential and objective facilitation of fair and equitable resolutions to ethical concerns which may arise in the organisation. while this function can form part of the hr function, and often does, it is preferable to have a neutral office to which employees can address concerns or ethical dilemmas. 416 sajems ns 9 (2006) no 4 the above approaches have been illustrated in management literature as being significant in the process of institutionalising the good business ethics. based on this, the presence and effectiveness of codes of ethics, ethics training initiatives and an ethics office/ombudsman were investigated in terms of sample organisations in this study. findings in this regard are reported in later sections of this article. while it is not prescribed in current literature that the hr function be wholly responsible for the development and dissemination of a code of ethics, the delivery of ethics training and the provision of a neutral ethics office, it would appear that in many instances the hr function does fulfil this role. van zyl (2002: 21) points out that the hr function is usually responsible for the distribution of the code of ethics and also for the accompanying training initiatives. in the 1997 shrm/erc study conducted in the usa, nearly 70 per cent of respondents reported that the hr department was the primary resource for ethics policies in their organisations. similar findings were obtained in the current study and are reported on in later sections of this article. a final role that the hr function can play in terms of institutionalising good business ethics is identified by buckley et al. (2001: 16) as accountability mechanisms. these authors posit that good ethics become operationalised in the formal and normative accountabilities that occur in organisations. implicit in this thinking is the notion that people generally expect to be held accountable for their actions and therefore try to identify sources of accountability and tailor their behaviour to accommodate the said accountabilities. this in turn forms the foundation of ethical behaviours. to this end organisations have enacted accountability mechanisms designed to result in adherence to ethical expectations. it is in this regard that the hr function has a key role to play because the said mechanisms include such things as disciplinary systems, performance evaluations, merit compensation, reward systems and employee handbooks, all of which fall within the responsibilities of the hr function. the above discussion does not, however, imply that overall accountability for the ethical conduct of the organisation should rest with the hr function. this accountability should rest with the ceo and top management, the very place from which ethics and morals should originate, as highlighted at the start of this discussion. the above discussion suggests that the hr function’s role as a strategic partner is exactly that. it should assist top management, where possible, to institutionalise an ethical culture based on the ethics and values portrayed and disseminated by top management. 4 background to the research problem from the above discussion and also from an examination of current management literature (o’higgins & kelleher, 2005; harris, 2002: 55; vickers, 2005: 29; buss, 2004: 127; driscoll & hoffman, 1998: 121; lachnit, 2002: 10), it would appear that there is little consensus regarding the exact role that hr can play in the institutionalisation of good business ethics. it would also seem that, more importantly, the role the hr function is currently playing in south african organisations in this regard is not well researched, with limited literature available in the south african context. thus the researcher is guided by the following questions: • what types of general and hr-related unethical behaviours are observed in south african organisations? • do codes of ethics exist in south african organisations? • what role can the hr function play in institutionalising good business ethics? • what role is the hr function currently playing in terms of the institutionalisation of good business ethics? sajems ns 9 (2006) no 4 417 5 objectives of the study based on the above background to the research problem, the objective of this paper is to report on the views of hr practitioners on the • type of unethical behaviour observed by respondents; and the • role the hr function can and is playing in institutionalising good business ethics in south african organisations. 6 research methodology 6.1 target population the target population consisted of 2 800 registered members of the south african board for personnel practice (sabpp). the aim of the sabpp is to establish, direct and sustain a high level of professionalism and ethical conduct in personnel practice by enabling human resource practitioners to make significant contributions to their profession. questionnaires were mailed to all registered members of the sabpp, of which 306 were returned and were included in the study. this provided a response rate of 10.93 per cent. 6.2 research instrument a questionnaire was designed as a survey instrument. the design of the questionnaire was based on a questionnaire used for a similar study conducted by the society for human resource management (shrm) in the usa. permission was obtained from the shrm to modify and then administer the questionnaire in the south african context. the following points were covered in the questionnaire: • a general profile of the home language, qualifications and position of respondents, as well as an indication of the type and size of the organisations for which they work. • the ethical environment of the organisation, dealing with ethical standards, ethics training and management’s approach and commitment to ethics in the organisation. • unethical behaviours observed in the organisation. although some areas of the research instrument needed to be adapted to reflect the south african context more accurately, the content of the research instrument remained largely the same as the original questionnaire. 6.3 statistical procedures descriptive statistics such as the mean, standard deviations and frequency distribution were calculated using the statistical analysis system v8.2 (sas) computer program. further analysis consisted mainly of t-tests for significance with the level of significance used being 95 per cent as well as chi-squared tests which were conducted on certain items to establish whether significant relationships existed between variables. 7 results and discussion 7.1 biographical data respondents were from a wide variety of industry sectors with a large proportion from the manufacturing (18.09 per cent); electricity, gas and water (16.12 per cent) and finance and business services (14.47 per cent) industry sectors. a large number (27.96 per cent) of respondents also indicated their type of organisation as “other”. many of the respondents who were grouped under the category “other” were from higher education institutions and consulting firms. in addition, the majority of respondents (30.46 per cent) were from organisations employing between 1 001 to 5 000 employees, while a further 25.83 per cent were employed in organisations with more than 5 000 people. respondents were requested to indicate their position in their organisation. this information is contained in table 1 below. 418 sajems ns 9 (2006) no 4 table 1 position of respondents in organisations position (n) (%) human resource (hr) director 35 11.67 assistant hr director 9 3.00 hr manager 91 30.33 assistant hr manager 9 3.00 hr specialist 43 14.33 hr generalist 40 13.33 hr supervisor 6 2.00 other 67 22.33 total 300 100% * 6 missing frequencies (did not indicate job title) the majority of respondents (30.33 per cent) were human resource managers, followed by a group who were hr specialists (14.33 per cent) and hr generalists (13.33 per cent). the “other” group comprised an array of titles such as payroll specialists, industrial relations specialists, training consultants, administrative managers and employee assistance specialists. in addition to their organisational position, respondents were requested to indicate their academic qualifications. in this regard it can be reported that the majority of respondents (28.81 per cent) were in possession of an honours degree and those with a master’s or doctor’s degree represented 26.49 per cent. only a limited number of respondents (18 per cent) were in possession of a national diploma or lower qualification. 7.2 unethical behaviour observed the results of the study showed a high incidence of observed unethical behaviour, with just over 70 per cent (70.26 per cent) of the respondents reporting that they had personally observed some form of unethical behaviour in the year preceding the study. the questionnaire used in the study identified 23 possible unethical behaviours. respondents were requested to indicate which of the 23 unethical behaviours they had observed in the 12 months preceding the study. used as an indicator of the general level of observed unethical behaviour in organisations, a mean of 6.32 observed unethical behaviours (out of a possible 23) was recorded across all respondents. this implies that on average respondents indicated having observed any six of the 23 identified unethical behaviours. the mean also provides a broad indication of the level of unethical behaviour in organisations, and is used at a later stage in this discussion to measure the effectiveness of mechanisms such as ethical codes and ethical training initiatives. table 2 indicates the five most frequently observed unethical behaviours in terms of the percentage of respondents who reported observing the said unethical behaviour. table 2 most prominent types of observed unethical behaviour rank unethical behaviour percentage of respondents 1 stealing/theft 62 2 lying to supervisors 60 3 misusing the organisation’s assets 53 4 conflicts of interest 50 5 abusing drugs or alcohol 46 sajems ns 9 (2006) no 4 419 other unethical behaviours observed that warrant mention include employees engaging in fraudulent actions, violations of the basic conditions of employment act and the occupational health and safety act, as well as lying in reports (erasmus & wordsworth, 2004). it is significant that of the respondents who stated that they had observed unethical behaviour, only 67 per cent actually reported the incident to a superior. the reasons advanced by respondents for not reporting unethical behaviour included the belief that corrective action would not be taken; the respondent did not trust the organisation to keep the report confidential; a fear of retribution; as well a fear of being branded as someone who is not a team player. 3.3 presence and effectiveness of ethical codes, ethics training initiatives and an ethics office/ombudsman respondents were requested to indicate whether or not their organisations had in place any of the three mechanisms identified in the literature, to institutionalise good business ethics. table 3 below contains the findings in this regard. table 3 presence of a code of ethics, ethics training and an ethics office response code of ethics ethics training ethics office/ ombudsman yes 78% 54% 45% no 22% 46% 55% as indicated in table 3, a high percentage, more than three quarters, of organisations had a code of ethics in place. however, this declines to just over half in terms of ethics training and decreases even further to under half in terms of an ethics office/ombudsman. it would appear from these statistics that initiatives around the formulation of a set of standards, values and morals have been quite successful, but they have not been followed by substantial efforts to roll out the codes. buckley et al. (2001: 25) provide a possible explanation for this in what they term “substantive versus symbolic ethics”, whereby one must ask whether ethical initiatives are truly substantive or merely symbolic window dressing. in this instance, the creation of a code of ethics, but with little focus on implementation in terms of training and an ethics office, might be seen as somewhat symbolic. kreitner & kinicki (2002) elaborate further on this by referring to ethical laziness, whereby a ceo or manager has good ethical and moral intentions, but fails to create a culture around these intentions. the existence of a code of ethics could also reflect an hrm ethical framework of “human and employment rights”, but that not much is done thereafter to support the hrm framework of “ethics of efficiency”. the study also sought to determine the efficacy of the above three mechanisms in addressing unethical behaviour. this was done using the mean score for unethical behaviours observed (see sec 7.2) and testing for significant relationships between the mean score and the presence of codes of ethics, ethics training initiatives and an ethics office/ombudsman. this was achieved using the t-test for significance. all three mechanisms were illustrated to positively influence the level of observed unethical behaviour in sample organisations (note that positive influence implies that in organisations where, for example, a code of ethics existed, the mean score of unethical behaviours was less than in organisations that did not have a code of ethics). a highly significant difference was found to exist in terms of the level of unethical behaviour observed in organisations with a code of ethics and those without a code of ethics. this relationship is presented in tables 4 and 5. 420 sajems ns 9 (2006) no 4 table 4 relationship between written ethical standards and unethical behaviour using the mean score presence of written ethical standards (n) x s t yes 167 6.773 4.065 – 3.04** no 42 8.929 4.256 total 209 ** p < 0.01 table 5 t-test procedure on the relationship between written ethical standards and unethical behaviour variable method variances t-value alpha mi pooled equal –3.04 0.0026* * 95% level of significance while the findings illustrated that the presence of ethics training and an ethics office/ombudsman were shown to positively influence the level of unethical behaviour, the t-test procedure did not reveal significant relationships at the 95 per cent level of significance. hence these tables are not reported in the paper. the above findings illustrate what is reported in theory, namely that the presence of a code of ethics, ethics training and an ethics ombudsman all assist in the process of institutionalising good business ethics. further statistical analysis was performed on the data to determine whether biographical factors such as the size of the organisation and type of industry sector had a significant influence on the level of observed unethical behaviour. in terms of the industry size, no significant differences were shown to exist in terms of the level of observed unethical behaviour and the size of the organisation. through a multiple pairwise comparison, however, differences in the level of unethical behaviour were shown to exist among different industry sectors. a significant difference was found to exist in terms of the f-test (see table 6). multiple pairwise ttests were performed to determine which type of organisations contributed to this significant difference (f = 1.95, df = 11.195, p < 0.05). table 6 f-test for type of organisation and level of unethical behaviour source df sum of squares mean square f-value model 11 359.61 32.69 1.95* error 195 3261.79 16.73 corrected total 206 3621.40 *: p < 0.05 the analysis showed that significant differences existed between community, social and personal services organisations (x = 12.286) and electricity, gas and water (x = 6.610); finance and business services (x = 6.565); construction (x = 6); manufacturing (x = 5.892) and catering, accommodation and other trade organisations (x = 5). it is somewhat perplexing to note that the community, social and personal services sector had the highest average number of unethical behaviours observed. although these institutions are put in place to serve the sajems ns 9 (2006) no 4 421 public and are often non-profit organisations, they have a significantly higher level of observed unethical behaviour. the reasons for this difference could not be determined in this study but could be considered as a further research possibility. 3.4 hr’s role in institutionalising good business ethics the findings of the study suggest that the hr function plays a vital role in creating an ethical environment in the organisation. in the majority of cases respondents in the study reported that they are involved in ethics initiatives in the organisation. respondents were requested to indicate whether they agreed or disagreed with a number of statements that dealt with the role of the hr department in ethics initiatives. this was done using a five-point likert scale and the findings in this regard are reported in table 7 below. (note that 1 on the scale denoted “strongly agree” and 5, “strongly disagree”.) table 7 role of the hr function in ethics initiatives role of hr n mean standard deviation the hr department is a primary resource for my organisation’s ethics initiative 299 2.1806 1.3314 hr professionals are involved in formulating ethics policies for my organisation 299 2.2709 1.3248 hr professionals are not part of the ethics infrastructure, but are often tasked with cleaning up the messes caused by ethics violations 297 2.8721 1.4854 the individuals responsible for administering the ethics programme are qualified for the task 290 2.5552 1.2445 employees at my organisation know where to address their ethical concerns 293 2.6621 1.4185 the above findings show that in the majority of organisations, the hr function plays a key role in ethics initiatives and is often directly involved in the development of ethics policies. based on the above findings and those in the previous section, it would seem that one could conclude that the hr function in many instances would be responsible for, or at least be involved in, the formulation of a code of ethics, ethics training initiatives, and in some instances, act as an ethics office where employees can raise ethical issues. shrm/erc (1997: 5) report that two key indicators of the usefulness of ethical initiatives are whether employees know where to address ethics concerns and whether the individuals responsible for administering the ethics initiatives are qualified for the task. in this regard, only 53.44 per cent of the respondents stated that they believe employees know where to address their ethical concerns, while 59.04 per cent of the respondents felt that the person responsible for ethics initiatives was qualified to do so. the above results also suggest that while in many instances the hr function, whether by choice or not, finds itself responsible for ethics initiatives, this role might not be formalised as such in the organisation, with employees not knowing where to address these concerns and the hr function/manager not fully prepared for the role of managing ethics initiatives. to determine whether perceptions differed at different levels in the hr function regarding hr’s role in managing ethics, chi-squared tests were conducted between these two items. no significant differences were found on the 95 per 422 sajems ns 9 (2006) no 4 cent significance level. significant differences were also not evident when the results were compared across different organisational sizes, which is surprising considering how the role and importance of the hr function might differ in small to large organisations. the role that hr managers play in ethics initiatives and how they go about fulfilling this role is influenced by factors both inside and outside the organisation. to this end, the study sought the opinions of respondents with regard to factors that influence the ethical behaviour of hr personnel in the organisation. a fivepoint likert scale was once again used for this purpose. (note that 1 on the scale denoted “no influence”, while 5 denoted “great influence”.) the results in terms of influence on ethical behaviour are presented in table 8 below and are ranked from most influence to least influence. table 8 factors influencing ethical behaviour of hr personnel factor of influence n mean standard deviation personal values 208 4.0865 1.0320 attitudes/behaviour of senior management 209 3.9904 1.1308 attitudes/behaviour of supervisor 206 3.6553 1.1186 internal drive to succeed 208 3.6154 1.0615 performance pressures 209 3.5981 1.0657 no threat of punishment 204 3.2059 1.2891 political pressures 209 3.1675 1.3748 lack of standards within profession 208 3.1490 1.3084 declining resources 207 3.0386 1.1940 friends/co-workers 204 3.0245 1.1161 internal competition 205 2.9220 1.1938 lack of legislation 205 2.6927 1.3241 personal values are highlighted in the above table as having the most influence on the ethical behaviour of hr practitioners, which is understandable when viewed from the perspective of buckley et al. (2001), who describe business ethics as a shared value system that serves to guide, channel, shape and direct the behaviour of individuals in organisations in a productive direction. personal values are followed very closely by the attitudes and behaviours displayed by senior management and to a lesser degree supervisors and line managers. this again accentuates the views highlighted earlier that the ceo and top management should be the cornerstone of any attempt to create a climate of ethical consciousness. this view is further emphasised by o’higgins and kelleher (2005: 276). a comparison of the above findings with the hypotheses made by beu and buckley (2001: 61) reveals some interesting similarities and disparities. these authors hypothesise that individuals specifically held accountable for results and behaviour will engage in the least unethical behaviour. in this study, respondents report that no threat of punishment has a high influence on one’s ethical behaviour which is consistent with the hypothesis made. this hypothesis could also provide some explanation for the high level of observed unethical behaviour, in that many respondents did not report the behaviour because they felt sajems ns 9 (2006) no 4 423 nothing would be done about it (people would not be held specifically accountable). beu and buckley (2001: 63) further posit that individuals with a high internal drive to succeed (type a personalities) are more likely to engage in unethical behaviour. the results of this study also show one’s internal drive to succeed as having a high influence on ethical behaviour. one disparity with the current results and the hypotheses made by beu and buckley (2001: 63) is in the area of internal competition. although these authors suggest that individuals who are highly competitive are more likely to engage in unethical behaviour, the results of this study suggest that the respondents perceive an internally competitive environment to have only a minor influence on one’s ethical behaviour. further statistical analysis was conducted in the form of chi-squared tests using the pearson correlation coefficient to determine whether the factors influencing ethical behaviour differed across organisation size and whether they differed in terms of the position held by respondents. these results are presented in table 9 below. table 9 further analysis (chi-squared tests) of the factors influencing the ethical behaviour of hr personnel factor of influence n company size position held personal values 208 0.534 0.055** attitudes/behaviour of senior management 209 0.354 0.729 attitudes/behaviour of supervisor 206 0.130 0.206 internal drive to succeed 208 0.084** 0.712 performance pressures 209 0.266 0.790 no threat of punishment 204 0.064 0.638 political pressures 209 0.841 0.945 lack of standards in profession 208 0.123 0.332 declining resources 207 0.032** 0.759 friends/co-workers 204 0.048 0.195 internal competition 205 0.000** 0.672 lack of legislation 205 0.413 0.566 statistical tests conducted at the 95 per cent confidence interval ** denotes the existence of significant differences the table above illustrates some consistency of responses across groups, both in terms of company size and position of the respondents, with few significant differences evident. although a lack of standards in the hr profession was reported by respondents as not having a substantial influence on the ethical behaviour of hr personnel, at the same time 90.37 per cent of the respondents stated that the sabpp should prescribe ethical standards for the profession. a final question posed to respondents on hr’s role in institutionalising business ethics dealt with the frameworks that hr practitioners should use to ensure that ethical standards are maintained in the organisation. the results of this are presented in table 10. 424 sajems ns 9 (2006) no 4 table 10 frameworks to institutionalise ethical behaviour hrm framework n mean emphasise openness and consultation on matters affecting hrm (human and employment rights) 259 84% legal approach (social and organisational justice) 45 14.7% emphasise the roles and responsibility of the organisation and place less emphasis on the individual (community of purpose) 57 18.6% capitalism as a model for ethical behaviour, that is, relying on the bottom-line ethics of the marketplace (ethics of efficiency) 18 5.9% by treating people fairly, truthfully and avoiding injury to others in all possible ways (biblical ethical injunction) 223 73% emphasising the keeping of promises to employees and applicants 138 45.1% note: since the respondents could indicate more than one response percentages will not add up to 100 the hrm ethical framework selected by the majority of respondents (84 per cent) is the “human and employment rights” approach, followed closely by the “biblical ethical injunction” approach. openness and consultancy are emphasised in the case of the “human and employment rights” approach, while truthfulness and fairness are the essence of the “biblical ethical injunction” approach. keeping promises to employees is the third approach (45 per cent) chosen by respondents. the approaches selected by the respondents also correspond with aspects of the bill of rights in the south african constitution, further supported by the fact that the majority of south africans categorise themselves as christians. although ethical frameworks are developed to better understand and analyse hrm ethics, a compartmental approach to this issue should be avoided. 7.5 areas of hrm that lend themselves to unethical behaviour the preceding discussion has shown that the hr manager/function has a role to play in creating an ethical environment and also that the ethical behaviour of the hr practitioner is influenced by an array of factors. likewise, the hr manager operates in and has an influence on a number of areas within the scope of hrm. once again, a five-point likert scale was used to question respondents about which areas of hrm are most likely to lend themselves to unethical behaviour, the findings of which are presented in table 11 below. (note that 1 on the scale denoted “not at all” and 5, “greatly”). table 11 areas of hrm that lend themselves to unethical actions aspect of hrm n mean standard deviation nepotism 290 2.7345 1.3902 affirmative action 287 2.6934 1.4277 performance appraisals 287 2.6376 1.3693 diversity over merit 283 2.5901 1.2778 rewards 282 2.5887 1.3581 remuneration 287 2.5749 1.3433 sajems ns 9 (2006) no 4 425 succession planning 281 2.3950 1.2693 the use of part-time labour 285 2.3825 1.3496 recruitment advertising 284 2.3134 1.3827 disclosure of info 283 2.3110 1.1678 empowerment programmes 281 2.2206 1.2310 flexible working patterns 282 2.0284 1.1987 employment contract 280 1.6893 1.0973 psychometric testing 278 1.6259 0.9708 the priority areas (see table 11) that lend themselves most to unethical actions in organisations are nepotism, affirmative action interventions, the execution of performance appraisals, diversity issues over merit and rewards systems. the areas lowest on the list are empowerment programmes, flexible working patterns, the employment contract and psychometric testing. further statistical analysis was performed on the data to determine whether biographical factors such as the size of the organisation and the position of respondents in the organisation had a significant difference on the areas that lend themselves to unethical actions. in terms of the position of respondents (see table 1) no significant differences (chi-squared test procedure on the 95 per cent level of significance) were found to exist, but significant differences were found using the size of the organisation (see table 12 below). table 12 further analysis (chi-squared test) of the aspects of hrm that lend themselves to unethical behaviour aspect of hrm n company size recruitment advertising 280 0.569 nepotism 286 0.020 affirmative action 283 0.003** diversity over merit 279 0.046 psychometric testing 274 0.194 employment contract 276 0.080 performance appraisals 283 0.002** disclosure of info 279 0.037 succession planning 277 0.290 empowerment programmes 277 0.176 remuneration 283 0.276 rewards 278 0.010 the use of part-time labour 281 0.455 flexible working patterns 278 0.246 statistical tests conducted at the 95 per cent confidence interval. ** denotes the existence of significant differences. 426 sajems ns 9 (2006) no 4 the results depicted in the above table indicate significant differences in terms of company size on the items of affirmative action and performance appraisals. an analysis of the chisquared tables reveals that both these areas are viewed as lending themselves less to unethical behaviour in smaller organisations (500 or fewer employees). this is possibly explained by the fact that smaller organisations, because of their nature, may have less formalised performance appraisal systems and performance is probably evaluated more frequently on an informal basis because of a lack of human resource sections. also, in smaller organisations the performance appraisal system is not the main source for promotion and other important human resource-related decisions. succession planning is probably not even considered as an important dimension to the success of smaller organisations. larger organisations (more than 1 000 but fewer than 5 000 employees) may have performance appraisals systems that are not properly managed, which may lead to unethical decisions and impact negatively on succession planning decisions. the importance of a well-designed performance appraisal system in organisations and the smooth execution of the various steps in the process are once again emphasised. many decisions affecting employees like succession planning and pay, are based on the outcome of performance appraisals of employees and the management of organisations need to be aware of the potential impact this could have on the effectiveness of the organisation. in terms of the significant differences observed on the item of affirmative action, this is most likely explained by the fact that smaller organisations (fewer than 50 employees) are applying the employment equity act regulations more loosely and are also not under constant scrutiny from the department of labour. 8 conclusion the results of the study showed that a high level of unethical behaviour was observed by respondents in their organisations. these results would suggest a degree of justification in the observed increase in business ethics as a topical subject in management literature. the preceding literature study showed that the hr function is well poised to play an instrumental role in addressing such high levels of unethical behaviour. the literature study also suggested three key mechanisms to institutionalise good business ethics, namely a code of ethics, ethics training initiatives and an ethics office/ombudsman. the empirical study showed that in all three instances the presence of these mechanisms did reduce the level of observed unethical behaviour. what is of concern, however, is the fact that only a written code of ethics seemed to be implemented extensively in organisations, while ethics training initiatives and an ethics office/ombudsman featured in roughly half of the organisations, implying that effective roll-out, driving and support of ethics initiatives is not taking place at the desired levels. the reason for this could lie in the perceived ambiguity regarding who is responsible for ethics initiatives in the organisation. in this regard there exists, as the shrm/erc (1997: 2) reports, some ambiguity around the role of the hr function relative to ethics initiatives, where a large proportion of the respondents report that they are involved in ethics issues and the development of ethics codes, yet are often not part of the formal ethics infrastructure. this is also evident in the south african results with respondents stating that often unethical behaviour was not reported because they did not have confidence that the mechanisms in place would adequately address their concerns. hence the final question that needs to be addressed, is: what is the role of the hr function in institutionalising good business? buckley et al. (2001: 17) answer this question with the following quotation: “what is important is that ethical values are inculcated in employees and ethical behaviour results”. it was proposed in the above literature study that the said ethical values should come from the ceo and top management and flow through the organisation, creating an ethical culture and consciousness. in so doing the ceo and top management should remain the champions of good business ethics in the organisation. however, as the hr function sajems ns 9 (2006) no 4 427 assumes its role as strategic partner in the organisation, it must facilitate as far as possible the creation of an ethical culture --and herein lies its role. since ethical issues are people issues, the hr function should be involved in the development of a code of ethics. more importantly, the hr function should act as an implementation agent, ensuring that the code of ethics is not merely a symbolic document but a substantive tool through which ethics issues can be resolved. to achieve this, however, the role of the hr function needs to be clarified in the organisation to ensure that it is prepared for this facilitation role. as martin and woldring (2001: 244) point out, where organisations undertake ethics initiatives, hr is likely to be involved. it is, however, suggested that ethics in an organisation should be the responsibility of each employee and that the overall coordination of this task should lie with an “ethics manager/ombudsman” in the organisation. 9 references 1 beu, d.s. & buckley, m.r. 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(1996) “business ethics and human resource management”, personnel review, 25(6): 5. abstract introduction literature review research design findings discussion practical implications limitations and recommendations conclusion acknowledgements references about the author(s) karen swanepoel department of management, southern business school, johannesburg, south africa musawenkosi d. saurombe department of industrial psychology and people management, college of business and economics, university of johannesburg, johannesburg, south africa citation swanepoel, k. & saurombe, m.d., 2022, ‘the significance of an employee value proposition in the retention of teachers at selected south african private schools’, south african journal of economic and management sciences 25(1), a4358. https://doi.org/10.4102/sajems.v25i1.4358 original research the significance of an employee value proposition in the retention of teachers at selected south african private schools karen swanepoel, musawenkosi d. saurombe received: 27 sept. 2021; accepted: 23 nov. 2021; published: 23 feb. 2022 copyright: © 2022. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: private schools in south africa are currently faced with the challenge of retaining a talented pool of teachers. an employee value proposition (evp) could assist private schools in reducing teaching staff turnover. aim: the aim of this study was to investigate the significance of an evp in the retention of teachers at three selected south african private schools. the study thus sought to answer the following question: what is the significance of an evp in the retention of teachers at three selected south african private schools? setting: time and money are spent on the recruitment and development of teachers. high turnover of teachers reduces all staff recruitment and staff development efforts to useless financial expenses. methods: a qualitative research approach was followed. semi-structured interviews were used to gather data from teachers at three different private schools in johannesburg. results: the findings showed that most private schools lack a clear and differentiated evp. despite their importance, evps were often not clearly communicated to staff members and the value of evps in the retention of teachers was mostly underestimated. conclusion: the research highlighted the deficiencies in the evps of most schools. it also emphasised the backlog in the retention of teachers caused by a lack of a proper evp. keywords: teachers; employee value proposition; talent; retention; private school. introduction orientation the turnover of teachers has become a major concern in educational research and policy analysis during the past decade, mainly because of the demand it creates for replacement (faremi 2017). in both private and government schools the loss of leadership experience, knowledge, expertise and wisdom has the potential to weaken the institution and affects the performance of the school children. a study done in nigeria by faremi (2017) revealed a significant relationship between strategies aimed at the retention of teachers and job security in private secondary schools. the study highlighted a significant relationship between teacher turnover and job security. it also highlighted a higher rate of turnover in female teachers in the selected private secondary schools. based on the findings, it was therefore recommended that teacher retention strategies should rely on basic employee value proposition (evp) principles such as equal workers’ welfare packages, good working conditions, teacher mentoring programmes, reward programmes and teacher preparation to ensure job security. for any school management team, the challenge is to find and retain quality teachers – teachers with the skills, knowledge, experience, competencies and values that provide a match for the roles within the organisation. teachers look around, think about their circumstances, compare options, and then choose to take up or stay in positions based on the best value offered to them, as characterised by the evp. an attractive evp will also ensure the commitment and engagement of employees, the result of which would be better retention (alloush 2017; sabpp 2019). research purpose and objectives the main objective of this research was to investigate the significance of an evp in the retention of teachers at three selected south african private schools. more specifically, this research sought to determine how significant the role of an evp is and what the influence of a lack thereof is on the commitment, engagement and retention of teachers at three selected south african private schools. research question this research sought to answer the following question: what is the significance of an evp in the retention of teachers at three selected south african private schools? literature review the function of the employee value proposition an evp is the holistic package offered by an employer in exchange for the productivity of an employee. according to kissoonduth (2017), the evp functions as a dual transaction. on one side you have the employer providing remuneration, employee benefits, performance and recognition incentives, talent development opportunities, work-life initiatives and a healthy organisational culture (south africa 2019); on the other side you have the employee whose engagement with the evp determines their level of effort in bringing the vision of the institution to life. the purpose of the evp is to attract, engage and subsequently retain employees to achieve institutional success (salau et al. 2018). it is of critical importance that employers should focus on a competitive evp and a package offering to maintain a competitive edge. salau et al. (2018) describe the evp as the value or benefit an employee derives from their membership of an organisation. it has been suggested that the evp is a determinant of employee engagement and retention, with a direct effect on critical business outcomes. employee engagement is the intellectual and emotional attachment that an employee has to their work. it involves rational and emotional factors – what employees think (the mind) and feel (the heart) regarding the organisation. rational factors refer to aspects like having the necessary tools, resources and support that employees need to perform their jobs. rationally engaged employees understand how their work contributes to the success of the organisation, and how their roles link to company objectives. emotional factors refer to the sense of inspiration and accomplishment that employees get from their work. engaged employees are intellectually stimulated, emotionally inspired, and have a desire to stay with the organisation (manogharan, thivaharan & rahman 2018). the talent management strategy as competition for talented employees is on the rise, an increasing number of employers are shifting their focus from recruiting talent in the labour market (outside) to exploring the management of the talent of employees at the institution (inside). this implies an optimising of internal processes so that the right talent is available at the right time in the right place in the right capacity to achieve the strategic and operational goals of the institution (al aina & atan 2020). talent management is seen as a continuous cycle involving the identification, recruitment, development, engagement, deployment and finally the retention of employees who add value to the institution. the talent management process has an important focus regarding how high-performing and high-potential employees in the institution are managed towards their retention for as long as possible. sharif and islam (2017) encourage employers to be strategic in their policies and procedures and to use and create opportunities to convince their employees that they are employed by a competitive institution. ghosh (2021) suggests that a regular measurement of whether employees are engaged with their work as well as an analysis of exit interviews would assist the employer to identify gaps in the talent management strategy. ideally, employers should be flexible in their policies and practices to adapt to the changing needs of talented employees, even if it implies customising the retention mechanisms to suit the unique profile of these employees. generational effect as different generations of employees are employed at the same time at an institution, it becomes important for employers to understand the unique life experiences and expectations of the baby boomers, generation x and generation y employees. understanding the different generations could present opportunities to gain a competitive advantage in the market, especially if the employer succeeds in adapting the retention strategy to suit the needs of the different generations (rainie & anderson 2017). hirsch (2017) highlights that baby boomers are most likely to remain loyal to their organisations. they are highly respectful of authority, and favour consensus and a stable working environment. they are seen as the generation that is least focused on their career and social awareness. generation x employees seek out work-life balance and tend to chase higher salaries and benefits. they are generally independent but require more frequent feedback. they are focused on career advancement but exhibit a greater external locus of control than generation y. pinzaru et al. (2017) highlight that generation y is an optimistic generation, who are driven and demanding of their work environment. they tend not to deliberately seek out job security; they value skills development and are always looking for challenges. they are highly confident and value team interactions as well as the opportunity to take responsibility and make decisions. although salary is important to support generation y employees’ lifestyle, they will accept lower salaries if they believe in the long-term future of the company and if they are directly involved in designing that future. among them is increased emphasis on corporate philanthropy and social awareness. psychological contract employees’ expectations of their new workplace is often aligned to the psychological contract with the employer. employees create their own psychological contract through their recruitment experience, career development opportunities and reward received for the work that is performed (kissoonduth 2017). in this contract, employees try to align their expectations of the employer with what the employer offers in the negotiated employment contract. as the nature of this psychological contract is unspoken and subjective, the employer might be challenged in managing the employee’s expectations. to limit the misalignment between the two contracts, the employer needs to communicate a consistent message to the employee to build a relationship of trust. factors influencing employee engagement and retention in private schools and other educational institutions remuneration according to ashley (2018), remuneration is one of the most important factors that influence employee satisfaction. the study also found remuneration for academics to be comparatively low in comparison to equally qualified employees in other industries and countries. this explains why teachers may tend to leave the industry for better remuneration. when a depressed economy leads to a lack of salary increases, employees’ attitudes, such as satisfaction, commitment and intention to leave, are also affected. compensation is a key reason why academics are leaving teaching; therefore, compensation structures should be customised to retain academics. uncompetitive remuneration packages result in academics being poached by the private sector (bwowe 2020). discrimination discrimination in the workplace is not always limited to race. in the arena of higher education, examples of gender discrimination are still evident. for example, female employees at south african universities are often overlooked and replaced by their male counterparts. they seldom progress past the level of senior lecturer (naidu 2018). data shows that women make up 72.5% of the teaching staff at south african government schools, but only 37.3% of the principals on the state payroll are female. the possibility exists that female academics might look for other employment opportunities because they feel that they can’t be further promoted. unrealistic workloads ashley (2018) presents a discussion of how teachers must work in a demanding environment, while doing complex work. increased workloads and accountability lead to increased stress levels and dissatisfaction. in 2017, the national education union in england conducted a survey regarding the workloads of teaching staff at private schools. the survey found that a fifth of staff are spending the equivalent of four extra working days a week on marking and administration. nearly two-thirds of the participants remarked that their school has no policies in place to help manage workloads. it was also revealed that 22% of staff spend the equivalent of two extra working days (over 15 hours a week) on activities related to their job during evenings and weekends. a further 18% said they spend between 11 and 15 hours a week working outside of core hours. close to 50% of the teachers surveyed said they are expected to work extra hours. according to 58% of the participants, their school has no policy, system, or process in place to help manage workloads (allen-kinross 2017). staff development various studies prove that training plays a key role in workforce retention. as staff development has become a core issue, so has the need for management training. bwowe (2020) is of the opinion that insufficient career opportunities and inadequate academic staff development have an impact on academics’ career motivation, success and employability. education leadership should focus on a holistic understanding of how to attract, develop and sustain academic talent. while managers are focused on profits and development of the business, employees are interested in things like personal development, fulfilment and monetary rewards (bwowe 2020). recognition, feedback and communication manogharan et al. (2018) developed a talent retention diagnostic tool to determine the turnover and retention factors with regard to academic staff. taking the reliability analysis into account, it can be concluded that the compensation and recognition scale is a valid and reliable measure. of the employees used in the study, 43% reported inadequate emotional recognition. inadequate employee recognition has been linked to lower employee engagement and higher turnover intentions in previous studies. the previous authors refer to employees’ need for a symbolic reward: they wish to be appreciated, to have a sense of acknowledgement for their loyalty, hard work and commitment. osborne and hammoud (2017) also found that feedback practices within a higher education institution are inadequate and recommended that supervisors provide feedback throughout the year to improve employee engagement. recent studies have proved that pay and benefits have a weaker relationship regarding encouraging work engagement than recognition, incentives and intangible rewards, and concluded that quality of work, leadership, career development, organisational culture and work-life balance all have a greater impact on work engagement than monetary rewards (osborne & hammoud 2017). research design research approach this study adopted a qualitative approach, which was motivated by the fact that eight individuals at three different private schools would be interviewed. the focus of this study was on the experiences of members of each school’s management team – the deputy head of academics and either one or two subject heads were interviewed at each school. in this study, semi-structured, one-on-one interviews were used. the interviewer had a series of 12 open-ended questions on an interview schedule developed by the researchers. the interviews were conducted in english and lasted 1.5 h on average. the sequence of questions asked during each interview varied according to the scope of the answers and issues or themes emanating from the answers. the questions in a semi-structured interview tend to be more broadly framed than those in a structured interview. the interviewer further used probing questions, where necessary, to garner meaningful replies. qualitative methods are generally more flexible than quantitative methods as they allow greater spontaneity and adaptation of the interaction between the interviewer and the study participant (mohajan 2018). qualitative research seeks to understand a given research topic from the perspective of the people that it involves (mohajan 2018). it provides complex textual descriptions of how people experience a given research issue. this research falls within the phenomenological design – researching the world through the eyes of those with direct lived experience to discover how they interpret their experiences and make sense of their world (bryman et al. 2017). research strategy during the semi-structured interviews, the interviewer used an interview guide with a list of questions covering how the evp affects the retention of teachers, taking commitment and engagement factors into consideration. open-ended questions were used with the advantage of participants having the opportunity to respond in their own words and evoking responses that the researcher does not anticipate. questions that were not included in the guide were also asked, where necessary, to uncover deeper insights. research method entrée and establishing researcher roles permission was requested from the principals of various selected private schools in johannesburg to enter the schools and conduct the interviews. the researchers arranged a meeting with every principal to explain the nature of the research and to gain permission for staff members of the various schools to participate in the interviews. one of the two researchers conducted the interviews and is referred to as ‘the interviewer’ in the sections that follow. research participants and sampling methods there are a number of considerations to keep in mind when deciding on the sample size. a compromise usually has to be made between the constraints of time and cost, the need for precision and other considerations. according to braun and clarke (2021), larger sample sizes do not necessarily produce greater applicability, as depth may be sacrificed for breadth or there may be too much data for adequate analysis. this study made use of purposive convenience sampling. in purposive sampling, once the categories and the number of people to be interviewed within each category have been decided on, it is the interviewer’s job to select people who fit these categories (bryman et al. 2017). in this study, eight members of the management teams of three different private schools participated in the interviews. the criteria for participation were as follows: the deputy head of academics and either one or two subject heads at each school. the participants of this study were selected based on their willingness and availability to take part in the data collection process, considering that they fit the criteria. data collection methods the qualitative data collection was conducted using semi-structured interviews, following an interview guide that was developed by the researchers. the interviewer had a list of 12 open-ended questions on evp and retention, taking commitment and engagement into consideration. the following questions were included in the interview schedule for this study: research question 1: what are the perceptions of teachers of the current application of evp at south african private schools? what are the factors that motivated you to become part of this organisation? do these factors still contribute to your engagement and loyalty towards your employer? do you think the evp is successfully communicated to teachers and its elements relevant to the personal experiences of employees? research question 2: what are the perceptions of teachers of the significance of evp practices at south african private schools? in your perspective, do teachers understand the value of the evp? what are the factors that would make you consider joining another organisation? what elements of the evp would make your job more attractive to you? research question 3: are there any significant differences in the application of evp practices for teachers at south african private schools based on gender differences? do you think gender plays a role in promotion and career planning opportunities at your organisation? do you believe the evp at your school should be gender specific and why? data recording an audio recorder was used to record all interviews. the recordings were transcribed verbatim before data analysis could begin. recording and transcribing interviews has several advantages, as our memory has natural limitations (loubere 2017). reviewing recordings and transcripts allows for a more thorough examination of what people said and permits the reviewing of responses. transcripts of interviews are vital for data analysis and coding. the data should always be organised to make the analysis process easier (busetto, wick & gumbinger 2020). the researcher must know where the data came from and how it was collected; therefore, all data should be labelled, as fragments of the transcription are needed in support of the themes that are derived from all the data collected (busetto et al. 2020). the researchers followed these methods in this study. strategies employed to ensure data quality and integrity as qualitative research produces a considerable amount of data, it became necessary to ensure the easy retrieval of data for detailed analysis later. audio recordings and transcriptions were made in support of this method of data collection. notes were also taken during the interviews to provide information regarding the participants’ non-verbal communication. transcriptions of all usable and relevant data were made. participants were requested to offer remarks concerning the interview transcripts to determine if the themes that were constructed significantly represented the concepts that were examined. according to braun and clarke (2021), theme analysis also ensures reliability and validity in qualitative research. data analysis qualitative analyses begin in the field as researchers identify problems during observations and interviewing (bryman et al. 2017). during the interview, the interviewer interacted with the data by making preliminary notes of possible themes that would emerge upon analysis. in this study, the researchers used six steps of thematic analysis, as articulated by braun and clarke (2021). these six steps are subsequently delineated. first, familiarisation of the collected data occurred during transcription, to gain insights into participant perspectives. second, initial codes were manually identified using highlighter colour coding of the various possible codes in the transcript, which were ultimately collated according to colour. third, various main themes were sought for amid the list of codes, according to the research objectives, and sub-themes were collated. fourth, themes were reviewed and collapsed to achieve a more focused presentation of the findings. fifth, themes and sub-themes were named and defined to create a logical narrative for the reader to follow. sixth and finally, a concise and coherent report was generated to give the reader an account of the data obtained, using vivid examples as evidence of each theme and sub-theme. reporting style the findings of the research were written in narrative form, displaying the themes and various sub-themes that emerged from the study. the themes and sub-themes were substantiated by verbatim quotes obtained from the participants’ answers during interviews (braun & clarke 2021). findings sixteen themes were identified from the combined responses of the participants. ‘poor salaries’ and ‘lack of recognition for performance’ are the themes that occurred most often. the themes were further clustered into the six main categories of evp based on the frequencies (f) of the sub-themes (i.e. how many times each theme and sub-theme was mentioned throughout the interviews). the main themes and sub-themes are presented in table 1. table 1: categories of main and sub-themes. theme 1: remuneration remuneration was the theme that occurred most. below are some excerpts for the themes and sub-themes. sub-theme: poor salaries participants had many concerns over the salaries of teachers at the selected private schools. they highlighted that the salaries as compared to those of the private sector make teachers leave the profession. some of the responses included the following: ‘salary would definitely be a factor. i would like a better salary and better benefits. medical aid would be a nice thing to have.’ (participant 2, female, head of department, master’s degree, 14 years of work experience in the teaching profession) ‘compared to the marketplace, we are on the low range of earnings. there are no two ways about it. i realised that again when i saw the packages that my daughters have. and i realise that even though i have 30 years of teaching behind me, i am not even able to compete with them.’ (participant 5, female, head of department, bachelor’s degree, 30 years of work experience in the teaching profession) an interesting comment regarding a comparison with government schools’ salaries came from one of the participants: ‘but there are schools out there that are prepared to offer cell phone allowances, travel allowances and they also offer other benefits like extra incentives for sport coaching. and that’s not even private schools, that is state schools. and then, when you add all that together, they are definitely ahead of us. and the myth that we are salary wise above other schools is not true anymore.’ (participant 4, male, head of department, honours degree, 28 years of work experience in the teaching profession) sub-theme: salaries do not match cost of living most participants mentioned that teacher salaries are often not sufficient to cover their costs of living: ‘to me the salary and pension contribution are the most important factors. my salary has, however, undergone negative growth over the past few years. i have been at this school for 14 years.’ (participant 6, female, head of department, bachelor’s degree, 34 years of work experience in the teaching profession) ‘i am the main breadwinner. housing in this area is extremely expensive. my heart aches for beginner teachers. … i truly don’t know how they survive through the month. we barely do.’(participant 8, male, head of department, bachelor’s degree, 23 years of work experience in the teaching profession) theme 2: work-life balance work-life balance was the theme that was mentioned the second most in this study based on the sub-themes derived from the participants’ responses. sub-theme: gender-specific flexibility from the interviews it became clear that some private schools are currently meeting female staff members’ needs for more work flexibility. participant 1 stated the following: ‘when setting the timetable, we keep in mind who have babies at home. we always try to let their classes start later.’ (participant 1, female, head of department, honours degree, 35 years of work experience in the teaching profession) another participant added: ‘some of our younger, married ladies who have small children do tend to be the ones who benefit the most from the evp. they are, to a certain degree, allowed to select the hours that they work. on their timetables they are being given free certain periods. certain periods are kept open for them, so that they are able to drop and fetch their children from day-care facilities.’ (participant 3, female, deputy head, honours degree, 33 years of work experience in the teaching profession) sub-theme: management and collegial support support from management and colleagues was highlighted as an important contributing factor to the work-life balance of teachers. participant 2 mentioned: ‘what is really nice at this school, is there is a forum for teachers where we can continually bring up any suggestions, any grievance, and challenges that we face and they will try to assist and help us. it is called e-forum. one of the teachers at our school is a representative and we can take any kind of issue to them. for instance, a few years ago there was an issue about maternity leave. a lot of new moms were struggling with uif [unemployment insurance fund]. then we went to the e-forum. the result is that new mummies and daddies are paid full salaries from the board and they don’t have to worry about uif, which i think is an amazing benefit.’ (participant 2, female, head of department, master’s degree, 14 years of work experience in the teaching profession) participant 8 stated the following: ‘if there is a staff member who had an operation and is incapacitated for a while, either the parents or the staff themselves cook meals and provide meals to that person’s family.’ (participant 8, male, head of department, bachelor’s degree, 23 years of work experience in the teaching profession) participant 6 further shared her personal experience: ‘the community spirit within the school is incredible. i’ve gone through breast cancer twice and management has supported me incredibly through both journeys. the staff as well. i guess that is part of the reason why i am so loyal to this school.’ (participant 6, female, head of department, bachelor’s degree, 34 years of work experience in the teaching profession) sub-theme: flexible work from the interviews it became clear that having flexibility in their work schedules helps teachers to successfully balance work and personal responsibilities. participant 3 stated the following: ‘we get study leave as well. i did a post grad a few years ago and i had to do research collection and they were quite flexible with my timetable, which was very nice.’ (participant 2, female, head of department, master’s degree, 14 years of work experience in the teaching profession) participant 5 highlighted staff members’ frustration due to a lack of flexibility in some circumstances: ‘the hardest thing for me in teaching is the limitations of our leave days. there are things like funerals and the need to be with family, or children in hospital, or those kind of things. i understand that there is always the danger of being taken advantage of, but i also think there should be a little more flexibility with that. … for me the main aspect of joining another organisation would be the inflexibility of my leave. if i could get a little more flexibility there, that would be something that i might consider. sometimes you have really necessary things to attend to and when you ask for leave, you still feel as if you’re asking to go gambling.’ (participant 5, female, head of department, bachelor’s degree, 30 years of work experience in the teaching profession) sub-theme: generational effect from the interviews it became clear that older staff members need a different evp than those teachers only beginning their careers. participant 3 stated the following: ‘it seems to be your middle-aged lady, the category that i fall into, who tends to be doing all the work later on in the afternoons and who tends to be carrying the bulk of the extramural load, because they no longer have children at home and, supposedly, they now have more free time on their hands.’ (participant 3, female, deputy head, honours degree, 33 years of work experience in the teaching profession) participant 1 stated the following: ‘years of service and degrees do not improve your salary. a young beginner teacher coming in now could earn the same as i am earning after 20 years. that doesn’t make sense at all. experience and qualifications should count more.’ (participant 1, female, head of department, honours degree, 35 years of work experience in the teaching profession) theme 3: career development opportunities sub-theme: gender inequality the sub-theme relating to gender inequality was mentioned by five participants. participant 8 stated the following: ‘you should not get a higher salary because you are a male. salaries should not be gender specific – it should be related to your job description and your part in the management team.’ (participant 8, male, head of department, bachelor’s degree, 23 years of work experience in the teaching profession) participants highlighted unfair career advancement practices that are gender related. participant 4 stated the following: ‘i do believe that our organisation is definitely a male-dominated organisation and that females are discriminated against and not seen as management material. and as a male i do think that often female staff members who are better options for certain tasks or roles, are simply overlooked.’ (participant 4, male, head of department, honours degree, 28 years of work experience in the teaching profession) participant 7 supported the above statement: ‘to my opinion males are promoted much faster than females at this school. females are often not recognised for their qualities.’ (participant 7, female, head of department, bachelor’s degree, 35 years of work experience in the teaching profession) not all participants were in agreement that gender plays a role in career advancement practices. participant 6 stated the following: ‘we are always keen to get more male staff in our school, but if we had two people applying for a leadership position, we would not necessarily take the male. it will be the person with the best qualifications and who’s going to be the best fit for the school.’ (participant 6, female, head of department, bachelor’s degree, 34 years of work experience in the teaching profession) sub-theme: personal development the opportunity for personal development was mentioned by four participants as playing an important role with regard to their loyalty to their current employers. participant 2 stated the following: ‘i came to this school because i was looking for a new challenge, also a position of growth for myself and more responsibility. i was offered this position. it was time for change and growth. … i do believe i am still challenged. i am still learning new things every day, learning about people, which is really important to me. it is a skill i am not as good at yet; i am better with the task at hand. i am learning a lot about relationships, people management, team management and things like that.’ (participant 2, female, head of department, master’s degree, 14 years of work experience in the teaching profession) participant 5 added: ‘i feel that my current school has been good to me generally; therefore i will not go away. they promoted me, they have given me encouragement to enrich myself academically and to grow. i have been encouraged to do any courses i wanted to.’ (participant 5, female, head of department, bachelor’s degree, 30 years of work experience in the teaching profession) sub-theme: career advancement opportunities the majority of the participants who are close to retiring age did not mention career development opportunities. the younger participants emphasised advancement opportunities as an important attraction to other schools or jobs in the private sector. participant 2 stated the following: ‘i am looking for promotional opportunities. currently i am head of department, but i am highly motivated and would like even more responsibilities. i am seeking new opportunities like becoming a deputy head or something similar.’ (participant 2, female, head of department, master’s degree, 14 years of work experience in the teaching profession) participant 4 stated the following: ‘if a teacher wants to study further, and it is educational studies which the school will benefit from, then the school pays for those studies. one should however not expect to be promoted. opportunities for advancement are very rare at private schools.’ (participant 4, male, head of department, honours degree, 28 years of work experience in the teaching profession) theme 4: employee benefits sub-theme: availability of leave opportunities (i.e. family responsibilities, study, sick, maternity) participant 8 stated the following: ‘teachers who are pregnant obviously get their normal maternity leave. we also give maternity leave to male members of staff. to younger employees this is a very important benefit.’ (participant 8, male, head of department, bachelor’s degree, 23 years of work experience in the teaching profession) limited leave days were available at some of the schools, which had a negative impact on staff members’ perception that they are supported by management in maintaining a work-life balance. ‘the hardest thing for me in teaching is the limitations of our leave days. there are things like funerals and the need to be with family, or children in hospital, or those kind of things. … sometimes you have really necessary things to attend to and when you ask for leave, you still feel as if you’re asking to go gambling.’ (participant 5, female, head of department, bachelor’s degree, 30 years of work experience in the teaching profession) sub-theme: contribution to children’s educational cost it also emerged that teachers got a discount on their own children’s school fees. participant 4 stated the following: ‘as a parent, i think you get a value-added proposition because you get a huge reduction on your child’s school fees. at my school you only pay 10% of the school fees.’ (participant 4, male, head of department, honours degree, 28 years of work experience in the teaching profession) sub-theme: contribution to pension fund generally, the participants appeared to be very satisfied with the pension benefits offered by most private schools. participant 4 stated the following: ‘the school where i am currently employed contributes really good value in terms of my pension fund. the pension fund contribution of the school is fairly high in comparison to other schools. it does help to have 16.5% or 15.5% paid towards your pension fund from the school. and this is definitely value added to my package.’ (participant 4, male, head of department, honours degree, 28 years of work experience in the teaching profession) participant 7 added: ‘i was contacted by the head and she offered me a position. i was motivated to join the school by the higher salary and excellent pension plan. at my previous school i had no pension benefits.’ (participant 7, female, head of department, bachelor’s degree, 35 years of work experience in the teaching profession) theme 5: organisational culture sub-theme: workplace culture the findings revealed that a positive work culture contributes to staff members’ sense of belonging and happiness at the organisation. as mentioned by one of the participants: ‘i’ve been here for 8 years. i work in a lovely working environment. i am happy to come here every day. it has to do with the overall school culture. there is a positive support culture.’ (participant 2, female, head of department, master’s degree, 14 years of work experience in the teaching profession) participant 6 added the following: ‘i am not planning on leaving the school soon. the ethos of the school is something which i really value. the community spirit within the school is incredible.’ (participant 6, female, head of department, bachelor’s degree, 34 years of work experience in the teaching profession) sub-theme: job satisfaction and fulfilment the findings revealed that most participants want to feel that their work has purpose and meaning. as participant 1 mentioned: ‘the main thing was the kind of work i was going to do. i wanted to work with children. it was varied work where i felt i could use much of my skills. that was the main reason why i came. … i love my job and the work i am doing. that’s the most important thing. the school provides good service to its clients.’ (participant 1, female, head of department, honours degree, 35 years of work experience in the teaching profession) participant 6 stated the following: ‘i would only do a move if i were moving cities. i am incredibly happy here and i couldn’t imagine teaching anywhere else. i love my job! i feel that i am appreciated for what i am doing. i am contributing to the lives of many children and that keeps me motivated.’ (participant 6, female, head of department, bachelor’s degree, 34 years of work experience in the teaching profession) sub-theme: reputation of workplace three participants mentioned that they heard wonderful things about the school, which made them apply for positions at the school. it was evident from the interviews that they were still proud to be staff members at the school. participant 1 stated the following: ‘i heard that it’s great working here. it had a good reputation as a good place to work. the salary was not amazing. but it really is an excellent school to work at.’ (participant 1, female, head of department, honours degree, 35 years of work experience in the teaching profession) theme 6: performance management and recognition sub-theme: lack of recognition for performance the lack of recognition for performance was mentioned by the majority of the participants during the interviews. the participants discussed how teachers are often not recognised or rewarded for good performance, which in turn lowered their morale. participant 4 said the following: ‘i don’t feel that if i am valued. you have to show that in a salary or in a package that gets amended. staff that do not contribute and that do not fulfil their job descriptions should be given a lower increase. and the remaining money should be added to the salaries of people that are valued and who work hard and significantly contributes to the success of the organisation.’ (participant 4, male, head of department, honours degree, 28 years of work experience in the teaching profession) participant 3 stated the following: ‘it would be very nice to be rewarded if you have met certain criteria, evident in your staff appraisal. one can be rewarded with some time off or even little gifts, such as a sorbet voucher.’ (participant 3, female, deputy head, honours degree, 33 years of work experience in the teaching profession) sub-theme: poor performance management the schools showed to have no functional performance management system in place, apart from the annual appraisal system. participant 1 raised her reservation about her organisation’s appraisal system: ‘we have an appraisal system. our annual increases are based on our appraisal and i think it causes a lot of unpleasantness and the board needs to relook it. it is not motivating staff as it is supposed to be. it definitely isn’t motivating. it causes a lot of stress, while it is supposed to be a constructive motivational tool. it causes more stress than it is being motivational.’ (participant 1, female, head of department, honours degree, 35 years of work experience in the teaching profession) participant 4 added the following: ‘it is a secret oath not to discuss anything relating to salaries. it is also unknown of to discuss one’s performance management with management.’ (participant 4, male, head of department, honours degree, 28 years of work experience in the teaching profession) discussion outline of the results the main objective of this research was to investigate the significance of an evp in the retention of teachers at three selected south african private schools. the focus in this research fell on the success rate of an evp in retaining teachers by keeping them engaged, loyal and enthusiastic towards their employers. the following themes have been identified as factors that either contribute to and motivate job satisfaction or compel teachers to leave the current employer or the education industry as a whole: remuneration, work-life balance, career development opportunities, employee benefits, organisational culture, and performance management and recognition. the findings showed that even in private schools the compensation of teachers remains problematic. most of the participants were in agreement that teacher salaries are poor when compared to those in the marketplace and often do not keep pace with inflation rates. remuneration is one of the most important factors that influence employee satisfaction (ashley 2018). the participants in this study seemed to be fairly satisfied with their work-life balance. the findings showed that management and collegial support enabled teachers to deal with work and personal demands more effectively. support from management and colleagues often contributed to the maintenance of work-life balance. the findings of this research re-emphasised that generational and gender segments need to be considered in the construction of an evp. a differentiated evp might satisfy different segments in the workplace, ensuring work-life balance for all generations. in line with al aina and atan (2020), private school management should be flexible in their policies and practices to adapt to the changing needs of their employees. this implies customising the evp to suit the unique profile of every staff member. the findings of this research showed that career development opportunities are of high importance to most teachers, especially to the younger members of school management teams. previous studies have proved that insufficient career opportunities and inadequate teaching staff development have an impact on academics’ career motivation and retention (faremi 2017; manogharan et al. 2018). participants stated that they are often not able to benefit from the positive outcomes of career development, as there are generally very few opportunities for promotion at private schools. the findings also revealed that gender discrimination is still evident at some private schools. female employees are often overlooked when promotion opportunities arise (naidu 2018). the retention of female teachers becomes problematic at some private schools as female staff members feel that they cannot be further promoted. the participants in this study mostly appreciated and valued the benefits associated with teaching at a private school. leave benefits (i.e. maternity, study, family responsibility and health) were highlighted as important factors in maintaining a work-life balance, and in keeping them in the teaching profession. participants did, however, also highlight the negative effect of limited leave benefits at some private schools and the impact it had on their intention to stay at these schools. contributions to employees’ pension funds and a reduction of the school fees of employees’ children were often emphasised as benefits that would retain teachers at private schools. employee benefits alone will, however, not result in an engaged and retained workforce (kissoonduth 2017). the findings of this research showed that workplace culture plays a defining role in the retention of teachers at private schools. the participants were in agreement that a positive school culture contributes to teachers experiencing feelings of belonging, security and overall happiness at the school. once employees’ expectations of their workplace have been met and they feel fulfilled, the psychological contract between the employer and the employee will have been aligned (kissoonduth 2017). moreover, the findings also clearly pointed out that participants considered the reputation of the school as an indication of what it would be like to teach there. if the reputation was met, chances were higher that teachers would be retained. inadequate employee recognition can be linked to lower employee engagement and higher turnover intentions (manogharan et al. 2018). the participants in this research highlighted the lack of performance management systems at many private schools and specifically the lack of recognition for performance. they expressed the need to be appreciated and acknowledged for their loyalty, hard work and commitment. the findings of this research made it clear that recognition is a potential employee retention factor. practical implications the findings of this research study have important practical implications for the private school industry. school management teams should take notice of the deficiencies in the evps at most schools. the findings of this research highlighted the necessity for teacher retention strategies to rely on basic evp principles such as equal workers’ welfare packages, employee benefits, performance and recognition incentives, career development opportunities, work-life initiatives and a healthy organisational culture. limitations and recommendations the findings of this study cannot be generalised to all private schools in south africa due to the small sample size of participants. the findings of this research can also not be expanded to the rest of the province or country since it is only applicable to the specific area where the research was conducted. the data were collected at one point in time. this factor further limits the research in terms of creating a cause-and-effect relationship over a long period of time. future research should be expanded to private schools in other provinces to enable the comparison of findings. information gained in this research study should contribute to the currently limited empirical knowledge of the application of evp in south african private schools. the data can be used in the formulation of strategies to engage and retain teachers in private schools. conclusion this study sought to establish the significance of the evp in retaining teachers at three selected private schools. the findings showed that most private schools lack a clear and differentiated evp. despite their importance, as uncovered in this study (and substantiated by the literature), evps were often not clearly communicated to staff members and the value of evps in the retention of teachers was mostly underestimated. private school management teams should implement, adapt and communicate better the organisation’s evp to all teachers. the evp should be used as a powerful tool to attract, engage and retain teachers. acknowledgements competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions this article was adapted from the master’s research of k.s. who executed and wrote the article, while m.d.s. was the study leader and provided conceptualisation guidelines and editorial inputs. ethical considerations the authors obtained permission to conduct the research from the head of the private school and, further, ethical clearance from the southern business school’s research ethics committee to conduct the study was obtained, prior to data collection and the ethical 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employee value proposition (evp) and performance of selected fast moving consumer goods (fmcgs) firms in nigeria’, data in brief 19, 1907–1911. https://doi.org/10.1016/j.dib.2018.06.027 sharif, a. & islam, m.t., 2017, ‘branding for successful employment: a practical approach’, global journal of management and business research 17(3), 19–28. south africa, 2019, ‘sa board for people practices’, employer value proposition 2019(1), 1–12. abstract introduction literature review conceptual model research methodology results and discussion conclusions and recommendations acknowledgements references appendix a appendix b about the author(s) warren m. gertzen department of engineering and technology management, faculty ebit, university of pretoria, pretoria, south africa elma van der lingen department of engineering and technology management, faculty ebit, university of pretoria, pretoria, south africa herman steyn department of engineering and technology management, faculty ebit, university of pretoria, pretoria, south africa citation gertzen, w.m, van der lingen, e. & steyn, h., 2022, ‘goals and benefits of digital transformation projects: insights into project selection criteria’, south african journal of economic and management sciences 25(1), a4158. https://doi.org/10.4102/sajems.v25i1.4158 original research goals and benefits of digital transformation projects: insights into project selection criteria warren m. gertzen, elma van der lingen, herman steyn received: 03 may 2021; accepted: 01 dec. 2021; published: 28 feb. 2022 copyright: © 2022. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: digital transformation (dt) is an increasingly relevant concept for businesses to remain competitive. as dt projects are disruptive to an organisation and are significantly different from traditional information technology projects, it is important to understand the value that specific dt projects will bring to an organisation before they are implemented, so that dt project portfolios can be optimally managed. aim: this study aims to determine the key goals and benefits of dt projects, as well as the selection criteria for dt projects in south african businesses. the study also explores the most influential technologies for driving the implementation of dt projects. setting: south africa is an emerging economy. the study was performed in the initial phases of nationwide lockdown owing to covid-19. methods: semi-structured interviews were conducted with 11 leaders from south african businesses of varying sizes, but all in significant local markets. content analysis using caqdas was used to analyse the primary data, using both inductive and deductive coding methods. results: south african businesses use a combination of financial and non-financial project selection criteria across four main goals and benefit categories: customer experience, operational efficiency, business culture, and traditional project evaluation. the fifth proposed goal (new business models) was not used to evaluate dt projects. the most influential technologies that drive the selection of dt projects were data-related, such as data storage, data processing, machine learning, and data-driven decision-making. conclusion: companies in south africa can use traditional project evaluation criteria together with several new criteria to determine the value of dt projects more holistically. this study also suggests several key practical takeaways for businesses that are aspiring to implement their own dt projects. keywords: digital transformation; project selection criteria; project evaluation criteria; fourth industrial revolution; project portfolio management. introduction digital transformation (dt) is a radical change in the way that business is performed (wessel et al. 2021:44) through the use and integration of advanced digital technologies (matt, benlian & hess 2015:339) to enable new business models, improve operational efficiency, and enhance customer experiences (berman 2012:19; henriette, feki & boughzala 2015:440; morakanyane, grace & o’reilly 2017:433). digital transformation projects use new technologies to radically change the ways of working in an organisation to improve efficiency, reduce waste, manage data and information better, support better decision-making, and implement the dt of a business. henriette et al. (2015:432) discuss how simple technological innovation on its own (such as the use of smartphones, advanced analytics, and additive manufacturing) is best described as simple digitisation rather than as dt. digital transformation projects differ significantly from traditional information technology (it) projects. ebert and duarte (2018:1) note that ‘dt is about adopting disruptive technologies’. parviainen et al. (2017:65) describe how digitalisation is causing disruptive changes to the operating environment of businesses. lee et al. (2018:6) state that the introduction of these technologies is a form of disruptive innovation (and even go on to claim that dt should be classified as ‘super-disruptive’), as they are intended to address the needs of new markets with completely different needs from those of established markets. wessel et al. (2021:3) promote this idea that a project to implement dt is different from a typical project or an it organisational transformation. digital transformation projects redefine a company’s value proposition, aim to change an organisation’s identity, and drive a new business strategy. this differs from a traditional it project that aims to support and enable the existing strategy and identity. this shows that dt is significantly disruptive. projects to implement dt are therefore significantly different from traditional projects. there are some key differences between traditional and dt projects, as noted by several different authors (table 1). table 1: differences between traditional projects and digital transformation. kutnjak, pihiri and furjan (2019:1295) show some examples of dt projects: the manufacturing industry performs dt projects to improve their business processes, reduce their expenses, and integrate their technologies to remain competitive on the global scale. their dts focus on the adoption of fourth industrial revolution technologies to become integrated smart factories (such as digital printing, 3d production, and the internet of things). the retail industry has focused their dts on the adoption of e-commerce platforms and improvement of sales, which they have achieved through improved digital communication and the adoption of new ways of working (lean, agile, flexible work arrangements). healthcare has also leveraged dt projects, such as video consultations with patients, digitalisation of medical records and the introduction of e-health platforms. this has helped them to reduce their costs and improve the quality of care and has allowed for the adoption of telemedicine. keskin (2019:66) highlights that dt projects have high levels of uncertainty and high interdependence relationships, which make the ‘project portfolio selection decision considerably complicated’. rodrigues et al. (2019:291) suggest that research should be performed to understand the specific aspects of dt projects that could be included in decision-making models for project portfolios. henriette et al. (2015:440) state that information about the realisation of value from executing dt projects is lacking in the literature. even in standard projects, managing a portfolio of projects is a complex exercise, and the measurement of a project’s value is a key management tool to aid the project selection process. thus, this study adds to the literature by asking the question ‘how to measure the value of a dt project?’ in order to enable effective project portfolio selection. this study specifically investigates dt projects in south africa, as it is a unique and interesting context for dt. ndemo and weiss (2017:329) show that there is considerable adoption of digital technologies on the african continent. however, van dyk and van belle (2019:519) and mubako (2017) suggest that there is a lack of information on the perceptions and use cases of dt in south africa, as it is a fairly new phenomenon and there is limited literature in this context. de wet (2001) discusses south africa as a ‘technology colony’, where a reliance on overseas technologies and low local technology transfer drives a different strategic agenda to that experienced in ‘first world’ countries. it is thus necessary to evaluate whether ‘overseas’ literature applies equally well in the south african context. research objectives this research attempts to support management in considering multiple measures of value so that resources and capital spend can be appropriately allocated between traditional and dt projects. as dt projects are disruptive to an organisation (lee et al. 2018:6) and are significantly different from traditional it projects (wessel et al. 2021:8), it is important to understand the value that dt projects will bring to an organisation before they are implemented and make substantial changes to the business. the study was exploratory, and aimed to determine whether traditional criteria were sufficient to describe the full value of dt projects by asking three key research questions: rq1: what are the core goals and objectives of digital transformation strategies in south african businesses? rq2: what selection criteria and measures of value do south african businesses use for digital transformation project portfolio management? rq3: which technologies are the strongest drivers of digital transformation in south africa? interviews with managers and leaders within south african businesses were used to gather data and to draw conclusions, in order to capture nuances that could easily be missed in quantitative methods. the outcome of this research should help to guide managers in south africa to execute sustainable dt strategies – particularly to improve their project portfolio selection methodologies. literature review dimensions of digital transformation berman (2012:19) states that dt can be achieved across three dimensions: improving the customer experience, enhancing existing operations, and developing new business models (through a combination of the first two dimensions). berghaus and back (2016:4) discuss business culture as an additional dimension of dt. henriette et al. (2015:440) build on this model by discussing the digital capabilities that are pursued by organisations within these dimensions. companies have found it increasingly important to maintain and improve their customer relationships (kohli & johnson 2011:155). the rise of globalisation, the internet, and e-commerce adds a considerable amount of viable competition into the market. however, as technology improves, it also introduces new opportunities to capture markets that were previously out of reach. as such, the customer experience has become a key differentiator (sebastian et al. 2017:199) and is one of the main targets for dt. digitalisation can radically transform the customer’s experience through: creating omnichannel communications (newman 2019) improving the offerings to ensure that experiences and products are adapted to the requirements of the customers (lawson 2019) improving customer relationships through improved communication (which leads to increased trust) (westerman, bonnet & mcafee 2014:2). digital transformation also allows for more efficient operations, systems, and processes to be put in place. here, new technologies help to create more efficient environments and workplaces, which in turn support the key goals of companies. this creates improved margins for the company in many ways, including: reduced costs through the reduction of waste and the automation of tasks (sackschewsky et al. 2019) increased revenue through increased operating capacity (miers 2017) radical improvements to the productivity of individuals, business processes, and internal communications (sackschewsky et al. 2019). digital transformation can also lead to the adoption of new business models. a business model is the structure of elements that a company uses to deliver value to its customers. osterwalder et al. (2011) describe nine dimensions of business models in the well-known ‘business model canvas’. henriette et al. (2015:438) argue that the core goals of business model transformation centre on extending the existing market, improving the customer value propositions, or changing the business model in reaction to changes in the industry. kotarba (2018:126) reviews the major changes in business models over several ‘waves’ of innovation, such as the transition from analogue to digital resources, or the introduction of user-generated resources such as the public data posted on social media. other examples are revenue models, which have seen a shift from traditional sales and subscriptions to new models such as software-as-a-service and ‘freemium’ (where advertisements are placed within the product for revenue). berghaus and back (2016:4) discuss culture and expertise as explicit dimensions of their digital maturity model, highlighting the need for a company culture that embraces digital technologies and is less risk-averse to dt projects. several other authors briefly mention the importance of employees as enablers of dt; for example: henriette et al. (2015:437) discuss how these changes affect the way that people work, comment on the new skills required to enable dt, and mention the impact that human resources have on an organisation, and how it needs to evolve with transformation. morakanyane et al. (2017:436) discuss the requirement to improve employee productivity and to allow for shifts in company culture. matt et al. (2015:342) highlight the need for improved cooperation between people as a key enabler of dt. westerman et al. (2014:3) show that dt provides opportunities to unlock value by allowing employees to refocus their efforts on more strategic tasks. digital technologies can improve the environment for employees in terms of improved decision-making through access to data and insight (bose 2009:155), improved safety through advanced cyber-physical systems (romero et al. 2016:5), and vastly improved use of human capital through skills development and reduced work inequality (atiku 2019). however, dt projects do not live in isolation. an organisation needs to divide its resources between traditional projects and dt projects, and this is achieved through the execution of project portfolio management. project portfolio management according to the project management institute (2021:244), a portfolio is ‘projects, programs, subsidiary portfolios, and operations managed as a group to achieve strategic objectives’, and ‘portfolio management is defined as the centralised management of one or more portfolios to achieve strategic objectives’. project portfolio management (ppm) is thus a complex set of activities, and one of the key activities in ppm is selecting and prioritising projects. cooper (1990:1) set the standard for portfolio management with the introduction of the ‘stage-gate’ model. his model describes a project process consisting of several key and value-adding steps, with gates at the end of each stage that check that the project has achieved its sub-goals before moving on to further stages. this not only ensures proper governance and that project reviews are performed, but also acts to filter out projects that no longer seem promising. ideas are initially filtered out according to their proposed value from the business cases, and then subsequently measured to ensure that their value remains achievable. this can be seen in the updated model of cooper (2014:21) (figure 1). figure 1: idea-to-launch stage-gate model. there is a small but growing body of literature that describes the management of dt project portfolios. keskin (2019:66) notes that ‘the high level of uncertainty of industry 4.0 projects makes it difficult for decision-makers to evaluate projects precisely’. their solution is to consider decision-making under ‘fuzzy’ conditions. fuzzy logic is an approach that is popular with decision-makers and academics (berghaus & back 2017:5; chatterjee, hossain & kar 2018:482; rodrigues et al. 2019:286). project selection criteria one of the most important processes in ppm is the analysis and selection of the most valuable projects from a pool of project proposals. there are many methods for selecting projects in a portfolio (see kornfeld and kara, 2011, for a review of various techniques). however, those techniques still rely on a set of clearly defined selection criteria, along with ways of measuring those criteria. this study focuses on the development of those selection criteria in the context of dt projects. levine (2005:254) notes that, for most projects, the key indicators of project value are determined through financial criteria, such as return on investment (roi) or net present value (npv). however, cooper, edgett and kleinschmidt (1999:347) and killen, hunt and kleinschmidt (2008:52) state that financial methods and criteria are insufficient to prioritise projects fully. chatterjee et al. (2018:480) performed an analytical hierarchy process to prioritise a project portfolio according to various project selection criteria (table 2). table 2: examples of project evaluation criteria. however, barthel, stark and hess (2020:4) show that it is still unclear how ppm is implemented for dt projects. their research investigated companies that created new departments specifically to handle the complex multi-project environments for dt. very little literature currently exists on selection criteria that are specific to dt. rodrigues et al. (2019:290) conducted a useful review of the prioritisation techniques but did not provide insight into the specific criteria used in their models. isikli et al. (2018:97) developed a model for the optimisation of dt project portfolios. their linear programming solution made use of the generic criteria of investment cost, energy-saving parameters, labour-saving parameters, material-saving parameters, and inter-dependencies of projects. however, this presents only a single set of criteria, and does not provide insight into how these specific criteria were chosen. in summary, the literature reveals that there are some gaps in the knowledge of how to manage dt project portfolios. morakanyane et al. (2017:439) state that more research is required to understand how digital technologies and capabilities are used to create value in organisations. berghaus and back (2016:13) show that latecomer industries are prone to experimentation with dt, but do not embrace a scientific or systematic approach to dt until much later. this highlights a lack of overall maturity for dt in the industry, which can be attributed to a knowledge gap in how to manage dt projects. thus, there is a gap in the literature for the identification of project selection criteria that are specific to the management of dt project portfolios. this study aims to fill that gap. conceptual model the conceptual model (figure 2) is a representation of selection criteria for dt projects. the selection criteria are assessed during the business case development (stage 2 in cooper, 2014, p. 21) and are broken down into two layers: goals or benefit categories, and project selection criteria. figure 2: conceptual model. the goals and benefit categories are derived from various strategic dimensions proposed by different authors: berman (2012:19) and henriette et al. (2015:440): improved operating efficiency, improved customer experience, and new business models berghaus and back (2016:4): business culture jiang and klein (1999:65): traditional project evaluation criteria rq1 aims to investigate the extent to which the proposed goals or benefit categories are used by south african businesses for dt projects. within each of the five goals and benefit categories, various authors suggest selection criteria to consider when selecting a project. there is extensive literature on the numerous possible selection criteria to consider, and so the conceptual model cannot be comprehensive; instead, it exists as a framework that represents just one possible set of these criteria. rq2 aims to determine the specific sets of project selection criteria used by south african businesses for dt projects. metrics and calculation methods are then used to measure the specific values of each of the selection criteria (e.g. cost-focused criteria are broken down into specific metrics such as roi, npv, and internal rate of return). this level of detail is beyond the scope of this study. research methodology this applied research is an exploratory study to test certain notions presented in literature. a qualitative approach was chosen for this study. this is justified by the exploratory nature of the research, in which the outcomes are an understanding of the status quo in the local context, and the results populate specifics into the conceptual framework. here, interviews (as opposed to quantitative methods) were selected to ensure that a deeper understanding of the phenomena was captured. henriette et al. (2015:436) show that the majority of literature on dt utilised case studies as the methodology, ‘due to the contemporaneity of the subject’. semi-structured interviews were chosen as the research instrument. this is supported by rowley (2012:260), who argues that interviews are best suited to gaining insight into processes, experiences, behaviours, and attitudes. this is especially useful when it is possible to identify certain people in critical positions who have a large amount of information on the topic being researched. for the interviews, participants were purposively selected to be in senior or executive management positions of large companies with significant operations in south africa. all the interviewed businesses are performing, or have performed, dt to some degree. this lends some credibility to the results. the companies were not explicitly screened for their involvement in dt, but some potential respondents might have declined owing to their lack of active dt. potential interviewees were invited through several platforms, including direct email, linkedin messaging, and direct invitations through a professional network. the 11 interviewees were diverse in respect to industry, experience, company size, and digital maturity (table 3). all the interviewees worked for local companies (or multinational companies with significant local divisions), and each interviewee’s portfolio was mainly focused on southern african or south african markets. the sample consisted of all qualifying candidates who responded positively within the time constraints of the research. table 3: attributes of interviewees. the interviews were conducted virtually for 1 hour each, with 15 possible questions prepared. the interview recordings were transcribed by artificial intelligence (ai) systems (otter.ai) and edited by hand to create intelligent transcriptions. these were analysed within a caqdas system using descriptive coding and alternating between inductive and deductive approaches through three cycles. the resultant codes were then grouped into thematic clusters by the researcher. ethical considerations ethical clearance was obtained from the ethics committee of the faculty of engineering, built and information technology, university of pretoria (ebit/74/2020). more information can be obtained at https://www.up.ac.za/faculty-of-engineering-built-environment-it/article/15815/faculty-committee-for-research-ethics-integrity results and discussion rq1 what are the core goals and objectives of digital transformation strategies in south african businesses? and rq2: what selection criteria and measures of value do south african businesses use for digital transformation project portfolio management? the interviewees were asked to discuss their dt strategies and the specific goals that they set. the goals that were discussed fitted into the five goals and benefit categories of the conceptual model. the sections below discuss some of the key findings and a comprehensive tally of selection criteria can be found in appendix a. operational efficiency the most broadly discussed criteria for operational efficiency were financial, such as cost reductions and increased revenue. financial criteria were discussed by all 11 interviewees. this is not surprising, as dt projects still need to appeal to a business strategy, and any business strategy focuses on the bottom line. it also shows that south african companies place significant emphasis on finances when making their project portfolio decisions. however, several authors, including voss and kock (2013:848) and cooper and edgett (2003:48), have found that financial criteria alone are insufficient to ensure project portfolio success. the interviewees tended to agree, as can be seen by the diversity of the other criteria. the next most important criterion for dt projects was the development of business and digital capabilities, which are the unique combination of resources to further the goals of an organisation (sandberg, mathiassen & napier 2014:423). these capabilities included improved digital processes, upskilling out of legacy technologies, and improved digital integration. six interviewees (a; c; e; h; j; k) said that they considered improving on their existing capabilities through dt projects, while five (a; c; e; h; j) aimed to add new capabilities to the organisation through dt projects. these capabilities were often a response to assumed and proven external pressures, such as competitors adopting certain technologies or professional consultants offering suggestions. however, in some cases, the driver for capabilities was to reach aspirational goals: ‘how can we use technology to push the boundaries as far as we can?’ (b). interviewees also discussed production criteria, such as production rates (a; b; e; f; g; h; j; k), turnaround time (e; f; h; i; j; k), production efficiency (a; c; e; f; g; h; j; k), scalability (b; f; g; h; j), and capacity (b; j; k). these criteria were discussed through the lens of how digital solutions could improve the current operations: ‘embrace machine learning, ai, … robotic process automation, to improve your own operations in terms of efficiencies’ (j). this again highlighted the need for dt projects to enable improvements that ultimately support the business strategy. customer experience the two most important groups of selection criteria are the improvement of the customer relationship (b; c; d; e; h; j; k) and the measurement of customer activity (a; c; d; j). there were seven distinct measures for customer relationships, including understanding customer needs and customer behaviour. the relationship with the customer is a focus area for dt projects because new technologies create new opportunities to interact with the customer. the improved collection of data allows companies to build more realistic customer profiles and thus understand customer needs more closely: [there are] new ways of thinking about how to deal with customers, new ways of understanding the value that you can extract from applying digital processes and procedures, … new ways of understanding customer behaviours, (d). in turn, this enables companies to create products with features more relevant to the customer (sometimes with hyper-personalisation of the products). customer activity is a group of selection criteria that measure the details of the interactions between the customer and the company. these include more traditional criteria (additional sales, new customers), and digital-specific criteria (digital migration and platform adoption, profitability per customer). by understanding how the customer engages with the business, the company is better able to optimise those interactions, which leads to a stronger customer relationship. many of these interactions are being pushed onto digital platforms (e.g. mobile apps, e-commerce sites), and so dt projects play a critical role in changing the mode of engagement for businesses: ‘a big [customer] experience disruptor has been the advent of digital [because] by being relevant and close to the point of decision-making, you are more likely to get the customer’s business’ (k). the interviewees were also invested in customer experience and satisfaction. improved customer feedback (in respect of the quantity and quality of feedback) (f; h; j) and improved net promoter score (g; j) were mentioned as lagging criteria for the dt projects, as they could only be measured once the dt project had been implemented. interviewees also mentioned leading measures of customer experience, such as reduction of non-value-adding processes (b; c; d; e; j), ease of doing business (h; j; k), and reduced waiting times (c; e). adoption of new business models the discussions on new business models by the interviewees were brief. ‘the business model starts changing the fundamentals of the industry … and is accelerated through the introduction of certain digitisation and digitalisation trends that we see’ (a). in terms of the business model canvas by osterwalder et al. (2011), interviewees only commented on a handful of elements. some of the activities would change to match the shift in key resources as digital technologies were adopted. three interviewees (c; j; k) mentioned that they aimed to shift the value proposition to be more inclusive of personalised products and pricing, also mentioned by (lawson 2019), but the interviewees did not go into any detail. customer relationships were also discussed in detail, as mentioned in the previous paragraph, as were the adoption of online and omnichannel experiences mentioned by newman (2019). interviewees mentioned that two goals were to retain existing customers (a; c; f; h; k) and to capture new customers (e), but the only proposed changes were the shift from physical storefronts to more streamlined digital services (e.g. through apps), and incremental cost savings through the adoption of more efficient technologies. similarly, regarding the revenue structure, two interviewees (d; k) discussed new revenue streams (including cross-sell and upselling opportunities) but did not seem to value those ideas highly. it is worth noting that this section made up less than 5% of the interview data in each interview, and so it is unwise to draw generalised conclusions. business culture around half of the interviewees (b; c; e; g; h) did not mention the business culture aspects as part of their initial conceptualisation of dt. the other half (a; d; f; i; j; k) found it to be a critical component when considering dt projects, in line with the arguments made by hartl and hess (2017) and rowles and brown (2017). the first group of criteria focused on digital skills, with six interviewees (a; f; h; i; j; k) discussing it. some interviewees (a; b; g; i; j; k) discussed how the automation of work offered new opportunities for employees to be relieved of tedious, mundane work so that they could focus on insight generation and decision-making (tasks that the interviewees were reluctant to automate completely). these interviewees also described how technologies are not yet capable of fully replacing humans (even in automation solutions), and so it is important to make sure that the employees can handle the changes that come with dt. ‘look at your learning space to make sure that you’re upskilling individuals to be able to manage the space going forward’ (g). this aligns with chaka (2020:373), who outlined the digital nature of many critical skills that are required for the fourth industrial revolution. the second group of criteria focused on the impact of dt on a company’s structure, stating that, without a drive for reskilling, many employees could lose their jobs. ‘you either reskill people to return to somewhere in the organisation or you start cutting jobs’ (i). the depth of discussion on this dimension is noteworthy and may be attributed to the high levels of local unemployment and the drive to protect the workforce. however, this contradicts the conclusions reached by parschau and hauge (2020:129), who suggested that the adoption of digital technologies in south africa has either a negligible or a positive impact on employment. project execution criteria the interviewees briefly mentioned the project execution principles that are broadly discussed in the literature (chatterjee et al. 2018:485; iamratanakul, shankar & dimmitt 2009:287; jiang and klein 1999:65). these included project risks (a; g), roi (a; b; c; k), project costs (a; b; c; d; f; h; k), and strategic alignment elements (a; c; g; h; j; k). however, the interviewees did not consider these as unique to dt and referred to their traditional project processes to determine these values. thus, there is little evidence to include project execution in the final model. further research will be required to determine if these concepts need to be considered at a strategic level. changes to decision-making was the most discussed criterion in this group. this is owing to the link between decision-making and data technologies, such as machine learning and ai (which is discussed in more detail in the next section). the criteria included the timing and accessibility of data, as well as the quality of the insights drawn. summary of answers to rq1 & rq2 the results from the interviews showed that the core goals and objectives of dt projects in south african businesses are the improvement of operational efficiency, of customer experience, and of business culture. the implementation of new business models is a secondary objective. traditional project evaluation criteria are also considered but tend to be less focused on for dt projects. the selection criteria used by south african companies are a combination of traditional ones (revenue, new customers, strategic alignment), along with some dt-specific criteria used (digital migration of customers, upskilling, digital capability development). while the companies are making adaptations and changes to the processes that are used, these changes typically do not affect the structure of the portfolio management process. rq3 – which technologies are the strongest drivers of digital transformation in south africa? with this more exploratory research question, the study tried to discover which technologies had the greatest impact on local dt. this was measured by the frequency and relative importance that each interviewee placed on different technologies. while this method does not generalise to all companies in the local context, it provides an interesting snapshot of the technologies that provide most value in the current business environment. the full results are captured in appendix b. the most important technological shift for the interviewees has been the use of data. ‘a key thing for me is data, … because what digital does is it allows you to have access to a plethora of data’ (k). this includes all stages in the data lifecycle, from new data sources (digital sensors, social media), to storage (cloud migration, data lakes), to processing (data science, predictions, and the internet of things), to advanced machine learning (chatbots, machine learning, ai), and finally to data-driven decision-making. the interviewees spent a considerable amount of time highlighting the role that data has played in their transformation. ‘the ability to access any company data at any time on a live platform is transformative for business strategy’ (f). this rise in data and computing power is foundational for other radical technologies, such as predictive maintenance and process automation. however, the interviewees made special mention of the value of the integration of data and the integration of systems. data has existed for many years, but the new uses and integrations of data provide the step-change that enables dt. the interviewees also mentioned some other technologies. digital platforms (cloud storage, videoconferencing, and mobile applications) were discussed by many interviewees as enablers of new ways of working and as improved channels for communicating with and understanding of customers. ‘most companies now recognise that they are actually a digital or a technology platform company’ (h). some other technologies (specific to each business) were also briefly mentioned but were not the core focuses of the digital strategy. one interviewee stated that ‘in south africa, digital is so much more difficult than in first-world countries [sic] and countries a little more comfortable with technology’, showing that the adoption of all digital technologies in south africa is a challenging task. thus, there is substantial evidence that certain technologies have a greater impact on dt in south africa, and that the most influential technologies are: data – data science, machine learning, and ai digital platforms – cloud, videoconferencing, mobile applications this outcome has not been explored in any depth in the literature. conclusions and recommendations this study aimed to explore the selection criteria and measures of value used by south african businesses for portfolio management of dt projects. a qualitative approach was conducted through interviews with senior leaders of prominent businesses, in order to gain deeper understanding of the selection criteria. the diversity of the interviewees (in terms of industry, business size, and professional experience) enabled robust conclusions to be drawn. the results of this study align with the existing literature (berghaus & back 2016; berman 2012; henriette et al. 2015) about the alignment of the dimensions of dt with the goals and benefits of dt, which are improving operating efficiency, customer experience, business models, and business culture. these results extend the literature through the development of a goals and benefits framework for dt projects, with new detail of the selection criteria and measures of value that are used for each dimension, in the south african context. the interviewees noted that technologies that supported better use of data (data science, machine learning, and ai) were the primary drivers of their dts, but that technologies that supported digital platforms also made a substantial contribution to the change. in summary, south african companies use both traditional selection criteria (revenue, new customers, strategic alignment), along with some dt-specific selection criteria (digital migration of customers, upskilling, digital capability development) to measure the value of dt. when dt is still new to the organisation, the processes and selection criteria for measuring value are unclear, and thus extraordinary measures must be taken to pursue the project (justification through strategy alone, additional time to execute projects, measurement of value through benchmarks, etc.). however, as the company continues its dt journey, the unique aspects of the process become increasingly integrated into the standard processes. practically, there are several key takeaways for businesses: a company does not need a new or different ppm system to begin engaging with dt. organisations can use the existing processes but allow the selection of dt projects some flexibility in dealing with the unique and complex aspects. digital transformation goals typically fall into one of three key areas: improving operational efficiency, enhancing partner or customer relationships, and developing new business models. however, to execute these goals successfully, the strategy should also account for the empowerment of its employees (through cultural change, upskilling, and creating buy-in). in south african businesses, the use of data is the leading technological driver of dt, followed by the adoption of digital platforms. future work an unexpected outcome of the study has been the appearance of various stages of maturity in the ppm processes for dt. while this study does not cover the phenomena in significant depth, it does open a new avenue of study to determine the prevalence of ppm maturity in a dt context. this research was performed during the covid-19 crisis in 2020, when participants and companies were subject to a national lockdown. this significantly disrupted business through the restricted movement of people, disruptions to supply chains and business operations, and threats to employee health and safety. the magnitude of this disruption’s effect on the research is unclear. there would be value in studying the relationship between this crisis and dt in respect of changes to attitudes, drivers of dt, and the resilience of companies that did (or did not) engage in dt before the crisis. acknowledgements competing interests the authors have declared that no competing interest exists. authors’ contributions all the authors contributed to the development and writing of the article. w.m.g. conducted the research as part of his master’s dissertation under the supervision of e.v.d.l. and h.s. funding information this research received no 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finance and investment management, college of business and economics, university of johannesburg, johannesburg, south africa chioma okoro department of finance and investment management, college of business and economics, university of johannesburg, johannesburg, south africa abel olaleye department of finance and investment management, college of business and economics, university of johannesburg, johannesburg, south africa department of estate management, faculty of environmental sciences, obafemi awolowo university, ile-ife, nigeria citation dowelani, m., okoro, c. & olaleye, a., 2022, ‘factors influencing blockchain adoption in the south african clearing and settlement industry’, south african journal of economic and management sciences 25(1), a4460. https://doi.org/10.4102/sajems.v25i1.4460 original research factors influencing blockchain adoption in the south african clearing and settlement industry musimuni dowelani, chioma okoro, abel olaleye received: 27 nov. 2021; accepted: 19 may 2022; published: 10 aug. 2022 copyright: © 2022. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the adoption of and improvements in new technology in the south african capital market historically led to increased trade capacity and liquidity, which may be linked to the growth in market size. aim: in this study the aim is to investigate factors that will influence the adoption of blockchain technology in the south african clearing and settlement industry. methods: in this study semi-structured interviews to collect data among stakeholders in the clearing and settlement cycle/process of securities in the south african capital market are employed. participants were identified through a combination of purposive, snowball sampling and targeted sampling using social media. data were analysed using thematic data analysis with the aid of atlas.ti software. setting: the south african capital market, with specific focus on the clearing and settlement of equity. results: this study identifies people, organisation, technology, industry and country (potic) as factors important in influencing blockchain technology adoption in south africa. the study expands and contributes to traditional frameworks for adopting blockchain technology in the south african clearing and settlement industry by adding five factors: trust, load shedding, unemployment/layoffs, current infrastructure, useful life and educational campaigns. conclusion: the potic framework will be beneficial to the johannesburg stock exchange (jse) and shares transactions totally electronic (strate) when considering the adoption of blockchain technology for the integration of trade, execution and post-trade services to reduce the settlement cycle. in addition, when regulators need to formulate new regulations they will benefit from considering the potic framework. keywords: blockchain; clearing and settlement; south africa; strate; csd; equities; capital markets; jse. introduction the johannesburg stock exchange (jse) is the officially licenced exchange in south africa, and shares transactions totally electronic (strate), in which the jse has 44.5% shareholding, is responsible for the settlement of jse securities transitions; it is south africa’s only central securities depositories (csd) (jse 2021). the jse was formed in 1887 and its purpose is to connect buyers and sellers interested in exposure to south africanlisted companies quickly and efficiently (jse 2019). the jse introduced the johannesburg equities trading (jet) in 1996, which improved the settlement cycle from two weeks to seven days, meaning that the settlement cycle changed from t+14 to t+7. the jet system was an order-driven, centralised, automated trading system that allowed dual trading and negotiated brokerage commissions that replaced the open outcry trading floor. the implementation of the jet system brought to light the shortcomings of the jse’s paper-based settlement system; namely, there were instances when up to 40% of all trades failed to settle (mkhize & msweli-mbanga 2006). the electronic settlement of trades addressed the limitations of paper-based settlement by allowing for higher trade volumes while eliminating the risks of loss, theft or forgery of share certificates. this was evident in the increasing number of trades on jse after automation; the number of trades on the jse increased from about 2930 on an average day in 1995, to 6055 in 1997, and 29 050 per day in june 1998 (iol 1999). new technologies create opportunities to enhance and revolutionise current processes (greco 2019). in 1997, strate was introduced; this system allowed for the replacement of paper share certificates with electronic records of ownership, also referred to as demateralisation (mkhize & msweli-mbanga 2006). the implementation of strate solved most issues and problems linked to non-settlement in south africa (mkhize & msweli-mbanga 2006). before implementing strate, south africa was categorised as one of the worst emerging markets in terms of operational and settlement risk. trading volumes on the jse were averaging 4000 trades daily, very thinly compared to the 350 000 on average during a month in 2016 (strate 2016). in 2002, the jet system gave way to the jse securities exchange trading system (sets), which was implemented in partnership with the london stock exchange (lse). the new system increased the transparency, liquidity of trading, and investors’ confidence in the jse; it also helped reduce trading thinly. dicle and levendis (2013) analysed the effect of the implementation of the sets, the authors found that trading activity doubled, and trading became cheaper after the implementation of the system. moreover, they argued that lower trading costs and increased activity led to significantly improved market efficiency at the jse equity market. there is evidence that the implementation of a more advanced trading platform enhances the overall liquidity of the market. yilmaz et al. (2015) examines the effects of technological changes on the liquidity of stock markets using daily data of 361 stocks from 10 emerging market exchanges, namely colombia, indonesia, johannesburg, korea, malaysia, mexico, russia, shanghai, shenzhen and thailand. their study found that technological upgrade decreases the bid-ask spread and increases trading activity. with specific reference to south africa using, three years of data from 2005, it is found in the study that although trading turnover increased, volume and liquidity did not. the implementation of sets was later followed by an improvement in the settlement cycle from t+5 to t+3 to align with international standards (jse 2019). the t+3 settlement cycle came into effect on july 11, 2016 (jse 2019). evolving technology has reduced communication cost, transaction cost, and growth in trading in the global equity markets (hasan, malkamäki & schmiedel 2003). this is evident in the adoption of automated trading platforms, which significantly benefited institutional and private investors by allowing private investors low-cost, independent access to the market (poser 1992). friday and osundu (2014) reiterated the benefits of technology, arguing that technology fundamentally changed the global equity markets by lowering transaction costs and reducing asymmetric information; therefore, levelling the playing field for investors and issuers. and although technology has made it possible to link various stock exchanges together and provide access to a larger number of market participants at a lower cost (solomon & corso 1990), a substantial portion of the risks remains directly related to the length of time it takes for trades to settle (priem 2020). table 1 summarises the impact of technology on the jse equity market. table 1: summary of the impact of technology on the johannesburg stock exchange equity market. the study of the adoption of blockchain is in its infancy stage and has only recently begun to gain momentum. studies focused strongly on the factors influencing the adoption of blockchain by discussing the technical characteristics of blockchain technology, such as open access, decentralised consensus, immutability and distributed verification. furthermore, studies attempted to show how the adoption of blockchain may lead to more transparency, efficiency and disintermediation when applied to various industries (lustenberger, malešević & spychiger 2021). researchers have applied traditional technology frameworks and theories to the adoption of blockchain technology. these include the technology acceptance model (tam), the diffusion of innovation mode (doi) and technologyorganisationenvironment framework (toe). however, there are limited studies on clearing and settling, and more specifically in the context of south africa. the study, therefore, aimed to investigate factors that could influence the adoption of blockchain technology in the south african clearing and settlement industry. blockchain technology in this study the definition of blockchain is adopted from the organisation for economic co-operation and development (oecd) (2018:6), as follows: blockchain technology uses cryptography, smart contracts, and distributed ledger design in order to create digital records of transactions, shared to a network of users. the digital records of transactions between users are stored in chronological order. in addition, blockchain technology allows access to all the members of the network to identical copies of the ledger. networks may be open to all (permissionless to the public), open to authorised participants (permissioned to the public), open to a select group, who may have restricted access (consortium-based), or be restricted to network operators only (private-permissioned ‘enterprise’ network). blockchain is a decentralised digital ledger and a consensus mechanism used to confirm transactions to facilitate transparency of information to multiple parties in a way that preserves a high level of security and operational resilience (lewis, mcpartlan & ranjan 2017; manning 2016). blockchain solves the issues experienced in the traditional distributed database by combining peer-to-peer networking and distributed consensus algorithms. fekih and lahami (2020) emphasise that it is used to securely record transactions across many computers in a peer-to-peer network without the need for a third party. blockchain achieves this by providing a (joshi, han & wang 2018): a decentralised database network. using consensus models. transparency. open source. autonomy. anonymity. in the context of securities trading, the creation of a blockchain consists of four key elements (oecd 2018), including the trade; a record of the trade (via the shared ledger); a process of verification (via algorithmic and cryptographic consensus); and a method for storing the transaction (via encryption). shared data structure is described as blocks, a chunk of data that includes a list of ordered transaction records (yoshihama & saito 2018). if blockchain is adopted in the clearing and settlement industry, there will be four major benefits to the industry and its stakeholders. the trade and settlement could become one process because the dematerialised share certificates will be transacted without friction and at near-instant t speed. secondly, replacing the myriad of ledgers maintained in the current system, with one single source of truth, could lead to a significant increase in efficiency. thirdly, the reduction in settlement time has the potential to significantly reduce the cost of transacting. lastly, smart contracts make it possible to embed automatic rules that will govern dividend and interest payouts, rights issues, proxy votes and other services (de meijer 2016) theories of technology adoption the doi and the toe frameworks are suitable for examining technology adoption on the organisational level, while tam is on the individual level. technology acceptance model the technology acceptance model is utilised to predict the usage and acceptance of technology; tam proposes that the perceived usefulness and ease of use of new technology are the two main determinants in explaining individual users’ adoption intentions; when the perceived usefulness of a new technology is the extent to which potential users believe that using a particular system will enhance their job performance. whilst the perceived ease of use is the extent to which potential users believe that adopting the new technology will require minimal additional effort (lou & li 2017). diffusion of innovation theory the diffusion of innovation mode theory explains how an idea, product, or service is adopted through a system over time. this adoption of innovation occurs at different rates with different people or organisations, ranging from early innovators to late laggards. the adoption rate is described in five major categories of adopters: innovators, early adopters, early majority, late majority, and laggards. the theory assumes that the adoption categories follow a normal distribution as follows: first 2.5% as innovators to adopt the technology. the second 13.5% are the early adopters. the third 34% are the early majority. the fourth 34% are the late majority. and finally, the fifth 16% are the laggards. the five categories are mutually exclusive (woodside, augustine & giberson 2017). technologyorganisationenvironment framework the technologyorganisationenvironment framework states that an organisation’s technological, organisational, and environmental aspects may affect technology adoption (tornatzky, fleischer & chakrabarti 1990). the framework focuses firstly on the perceived benefits, the complexity and compatibility of the new technology. the perceived benefits of new technology is based on the extent to which adopters of the new technology consider that the use of a system would enhance their performance. complexity and compatibility indicate the extent to which the adopter of a new technology considers the technology difficult to use and whether it is in alignment with the values, past experience, and needs of an organisation (alharthi, cerotti & far 2020). secondly, on the organisational readiness, top management support, and new technology knowledge (alharthi et al. 2020): ‘organisational readiness can be defined as the availability of resources to adopt new technology. ‘top management support refers to the degree to which top management support provides adequate resources for the adoption of a new technology. ‘new technology knowledge is the degree of knowledge managers have of technology’. (p. 16) lastly, the … [e]nvironmental aspects of an organisation are part of its business activities. it focuses on the regulatory environment and government support. the regulatory environment can be defined as the degree to which the organisation/government policies affect the innovations. government support is the degree to which a government regulates its policies to assist institutions showing growth and development. (alharthi et al. 2020:17) empirical studies on factors influencing blockchain adoption the factors influencing the adoption of blockchain technology in the context of the securities trade with a specific focus on south africa are found in de castro, tanner and johnston (2020). the study employs a doi and toe framework. de castro et al. (2020) find that there are three main challenges faced by developing countries: high costs of adoption, lack of regulatory framework, and lack of support from leadership, which may be categorised as external environmental factors. in the study it is also acknowledged that specific business factors influence blockchain adoption, a view supported by dick and praktiknjo (2019), who determined that the adoption of blockchain is influenced by the complexity of the technology, its compatibility and the relative advantage the technology will provide, compared to current technology in the industry. relative advantage is the additional benefit of adopting blockchain in relation to the prerequisite costs of switching to blockchain technology (de castro et al. 2020). the framework of de castro et al. (2020) is illustrated in figure 1 below: figure 1: factors affecting the adoption of blockchain in the asset and wealth management industry. akaba et al. (2020) employed semistructured interviews with 12 stakeholders and experts in public procurement, private-sector procurement, blockchain technology and advocacy for transparency and the adoption of technology in the nigerian public-sector procurement. participants in the study identified barriers to the adoption of blockchain technology as poor infrastructure set up, lack of political will of the government to implement the necessary technology policies needed, lack of funding for a full implementation, resistance to change by public officials, and poor knowledge of blockchain technology by stakeholders involved in the process. clohessy, acton and rogers (2019) conduct a comprehensive review of the blockchain literature using the toe framework and concluded that organisational readiness, top management support, and organisational size are the top three factors influencing blockchain adoption. kulkarni and patil (2020) find, through the application of toe, that blockchain technology infrastructure, knowledge about blockchain technology, relative advantage, transaction cost, perceived security, organisational scope, consumer readiness, competitive pressure, government policies and bank partner readiness are the factors that affect the blockchain technology adoption in the banking industry in india. wamba and queiroz (2020) analyse the blockchain diffusion stages in the indian and united states of america (usa) supply-chain management industry. the study finds that the determinants of the intention to adopt blockchain were perceived benefits, top management support, absorptive capacity, blockchain trust for india, as well as perceived benefits and blockchain trust for the usa. the finding is supported by liu and ye (2021) who examine the interactive relationship between blockchain technology and the intentions of users to adopt blockchain technology. they find that trust and the tam constructs are significantly related, which indicates that the more the users trust blockchain technology, the more they perceive the value of this technology and the more they intend to use it. wong et al. (2020) employed toe to investigate the significance of relative advantage, complexity, upper management support, cost, market dynamics, competitive pressure and regulatory support regarding blockchain adoption for operations and supply chain management among small-medium enterprises (smes) in malaysia. they find that regulatory support and upper management support were insignificant. lustenberger et al. (2021) extended the toe framework to include ecosystem readiness as the most important factor for adopting blockchain. ecosystem readiness is characterised by three attributes: a large scope, stakeholders that are not yet collaborating in a trustworthy and regulated environment, and an organisation with market power leading the ecosystem (lustenberger et al. 2021). the organisation with market power leading the ecosystem must further intentionally promote innovation by making the benefits of this new technology observable, putting pressure on the other ecosystem participants to adopt the new technology, and eventually by striving for regulatory certainty in the application and use of blockchain. methodology a qualitative approach was adopted for the study. qualitative research is suitable for exploring a problem or issue and gaining a complex and detailed understanding through individuals’ shared stories, voices, contexts, or settings (creswell 2007). it allowed the researchers to describe the characteristics of people and events without using measurement or amounts to compare events (thomas 2003). semistructured interviews were used to collect data and discuss issues in unanticipated directions, with sessions recorded for ease of analysis and member checks (fontana & frey 1994). in addition, the semistructured nature of the interview also left room for the participants to add individual opinions and experiences in a non-constraining way (lampard & pole 2015). sampling method and size in the study a combination of purposive and snowball sampling is employed to target sampling, using social media. the sampling techniques aimed to get a heterogeneous sample, by contacting individuals involved in different areas of the south african clearing and settlement industry, and/or have a job role in the securities trading value chain. this approach enabled the researchers to describe and explain key themes that will emerge in the collection of data (saunders, lewis & thornhill 2016). the researcher contacted participants through the following channels: email, participants with whom the researcher had previous working relationships. linkedin. referrals from other participants. linkedin is a platform that connects professionals in various fields; it provided the researcher with the ability to target appropriate participants. this method of finding participants is also referred to as targeted sampling using social media. this approach is appropriate in research fields where participants would, in ordinary circumstances, be hard to reach (dusek, yurova & ruppel 2015). the researchers viewed this approach as appropriate for the study as individuals in the securities value chain are generally hard to reach. purposive sampling is used when the research involves a difficult-to-reach population. once a portion of the population is reached, the researchers may use initial participants as a spring board to reach more members of the population. this referral process is known as snowballing (creswell & plano clark 2011). a list of the participants for this study, as well as the organisation in which they work, is to be found in table 2. table 2: participants’ descriptors. the sample met the inclusion requirement as follows: pre-trade stage – individuals working in asset management both public and private assessment management in the form of analyst, as well as individual investors, were included. order-routing stage – individuals working in the banks (which are cds participants, were included) the assessors refers to them as the ‘eight entities’ supervised by strate. trading stage – senior individual from jse was included in the study. post-trade stage – senior individual from strate was included. some asset managers also have brokerage divisions, and although no individual from a specific brokerage firm was included, individuals from asset management ranged from analysts, traders, portfolio managers and in-house brokers. the roles of the participants are not disclosed, because the study aimed to protect their privacy and maintain anonymity, especially that of strate and jse employees. individuals from related or supported organisations, such as regulators, were not considered because they are not in the securities value chain. the interviews were by appointment and conducted online due to covid-19 lockdown restrictions and precautions. the average duration of the sessions was 45 min. the semi-structured e-interviews were hosted and recorded via zoom and microsoft teams. the interviews were conducted from november 2020 to march 2021. data analysis this study employs content and thematic analysis; this approach involves a detailed examination of human conversation (neuendorf 2002:1). the data analysis was carried out by using thematic content analysis based on the guidelines of braun and clarke (2006), as well as erlingsson and brysiewicz (2017). the qualitative analysis utilised by the researcher entailed the six-phase, thematic analytical process defined by braun and clarke (2006). the steps were as follows: familiarisation with the text. code the text. generate themes. review themes. define and name themes. writing up. tools of analysis interviews were recorded, transcribed and analysed with the aid of the atlas-ti software. the findings are presented in the next section under different emerging themes. findings blockchain needs to prove itself blockchain technology would first need to prove itself before it could be accepted into the mainstream industry, as stated by one participant: ‘blockchain has to prove itself against existing technology.’ (participant 2, cfa, ca[sa] [cio, asset management]) participants had this view because they had ‘doubts about blockchain’s efficiency’ and whether the technology could be trusted compared to existing systems. participant 5, in line with the literature was of the view that people prefer to use a system they trust: ‘general trust of the system is important because people prefer the trusted and old ways of doing things … people may question the trust until it has been proven that it’s working.’ (participant 5, msc [manager, stock exchange]) it is evident that the lack of trust will delay the adoption of blockchain, as described by another participant: ‘we are still operating in the traditional way of doing business. people need to trust the new system … that’s one thing which can delay the adoption.’ (participant 8, phd, cfa [professor, academic & bank]) due to the lack of a proven record, there is concern about blockchain’s actual efficiency; furthermore, blockchain technology experienced a decrease in speed as volume increases within the cryptocurrency space. moreover, there are concerns about blockchain’s ability to support transactions and trade volumes that are not cryptocurrency-based: ‘my concern is, would the platform be able to support non-crypto currency transactions?’ (participant 6, bcom [manager, bank]) a good track record and empirical evidence to show the benefits of adopting blockchain, compared to current systems, will strengthen trust in the technology. trust a commonly known factor influencing any technological adoption is a user’s ability to trust the technology. trust is a factor that will influence south africa’s adoption of blockchain, mainly because there is no incentive to abandon the current system: ‘the current csd environment has been in play for decades. we already have a system of trust, there is no incentive to abandon that trust system for a trustless system. we have already invested so much money and effort into building those trust mechanisms.’ (participant 2, cfa, ca [sa] [cio, asset management]) the study identifies trust as a factor that will influence adoption in south africa, mainly because there is no incentive to abandon the current system, which has been in play for decades. shares transactions totally electronic has a proven record of reliability; users trust it, and there is no incentive to abandon that trust system for a trustless system. the trust in the existing structures negatively influences the adoption of blockchain technology. this limiting factor may be resolved by educational campaigns as recommended by participant 8: ‘mistrust can be resolved through education around on [sic] the technology.’ (participant 8, phd, cfa [professor, academic & bank]) fear of and resistance to change a major influencing factor identified in the study is people’s fear of change. people prefer to stick to the status quo and not to make disruptive changes: ‘it’s an intangible factor, but fear, fear of the unknown.’ (participant 6, bcom [manager, bank]) fear of change results in resistance to change: ‘major factor will be resistance to change.’ (participant 9, togaf® 9 certified [manager, bank]) participant 9 expands on this by giving reasons why there may be resistance to change in the industry. current market players (intermediaries) will lose revenue, and employees their jobs. ‘many institutions will stand to miss out on some revenue. there’s a chance that some employees may lose jobs as well.’ (participant 9, togaf® 9 certified [manager, bank]) participant 8 attributes the resistance to change to education levels and the ability to trust: ‘the divergent nature of how educated our people are, especially in south africa, we would have a group of people who can easily adopt it and work efficiently. but we have got another group of people who are not well educated, that may not be able to use the blockchain technology, yet they have a lot of resources and a lot of money.’ (participant 8, phd, cfa [professor, academic & bank]) fear, lack of trust and resistance to change are linked to the lack of knowledge and skills. this can be combated by education campaigns and skills transfers aimed at stakeholders responsible for micro-infrastructure, such as individuals working within the jse and strate, the regulators, other intermediaries (banks and brokers), and end-users (buyers and sellers). switching cost it will be costly to switch over from current systems to blockchain, the switching cost is a factor that influences the adoption of the technology: ‘switching costs between old technology and new technology … we know how expensive it is, it’s a huge cost.’ (participant 1, llb [manager, csd]) the benefits derived from adoption must outweigh the switching cost. relative advantage of blockchain adoption and the cost to move a current platform to blockchain will influence adoption. this is because blockchain adoption is accompanied by capital investment. affected institutions will have to make these investments whilst providing services on existing platforms. current information technology infrastructure’s useful life many companies have invested a great deal of money into their current infrastructure and systems and these would need to run their course before blockchain adoption: ‘the current obstacle is that everybody is invested so heavily in their current it infrastructure that nobody will throw all of that out for blockchain right now.’ (participant 2, cfa, ca [sa] [cio, asset management]) it is more likely that blockchain technology will only be considered when it is time for an update as blockchain technology is not better or faster than the systems that are currently in place: ‘institutions are not going to switch – if they have just invested a whole lot in an old technology recently. it is an obstacle for them to adopt it, because they are first going to want to depreciate the old investment that they made, get their money’s worth before changing over.’ (participant 1, llb [manager, csd]) therefore, replacing new infrastructure would mean that the total return and use was not extracted from that infrastructure. in addition, if blockchain is phased in, new investment in blockchain would be running parallel to the undepreciated assets of the existing infrastructure. this would have a negative impact on profits and, therefore, discourage adoption. regulation financial market regulation is purposed to protect consumers in the economy and to help markets achieve high degrees of efficiency. the vital role played by the financial system dictates that financial institutions need to be regulated: ‘securities market is highly regulated. people put their lifesavings into securities, invested – the pension funds are all invested in the equities market. so government is very stringent about who can play in that market. everybody who participates is highly regulated.’ (participant 2, cfa, ca[sa] [cio, asset management]) in its current form, the regulatory environment does not adequately cater for, or focus on blockchain technology and the scope in which it can be used: ‘the current regulation is configured for the current system.’ (participant 3, cfa [analyst, asset management]) if the adoption of blockchain technology was to occur in a way that leads to creating a new eco-system outside the current securities trading value chain, current regulation would prohibit this to provide investor protection. the study found that new regulations and laws will have to be created if blockchain technology is adopted in order to maintain consumer protection: ‘regulation must provide investor protection. however, regulation is known to lag behind innovation and change.’ (participant 4, phd [manager, bank]) this is supported by participant 11: ‘regulation is generally a step behind technological advancements. so what you might see is technology leading the regulatory framework and the regulatory framework just trying to catch up.’ (participant 11, phd [senior lecturer, academic]) therefore, new regulations and laws will have to be created if blockchain technology is adopted. new regulations must maintain the core purpose of regulation, which is to protect market participants. the current scope of regulations is limited to the current systems and technologies and does not consider blockchain’s specific qualities, such as transparency and decentralisation. blockchain knowledge and educational campaigns knowledge and expertise about blockchain technology will influence the adoption of the technology. those who understand blockchain will be better positioned to adopt, than those who have little to no expertise. the lack of knowledge and education regarding blockchain technology leads to hesitancy to adopt it. ‘there might be a little bit of confusion and lack of understanding about blockchain, which could lead to hesitancy to adopt something along those new technological lines.’ (participant 12, cfa, mcom [senior trader, asset management]) in addition: ‘blockchain being an emerging technology we may just have a few individuals who understand it, who can execute it or put it into practice. the skills element might also be a problem in adoption.’ (participant 5, msc [manager, stock exchange]) participant 3 focuses on the issue that south africans do not like change, and makes the suggestion that this is due to a lack of knowledge: ‘south africans tend to stick to what we know, because of lack of knowledge.’ (participant 3, cfa [analyst, asset management]) for adoption to take place, all stakeholders will need to have some understanding of the technology. stakeholders are not limited to organisation, but also include the general public, who have very little knowledge of and expertise in blockchain: ‘the public generally knows very little about the technology.’ (participant 9, togaf® 9 certified, [manager, bank]) stakeholders’ lack of blockchain knowledge will influence adoption, a broad understanding of the technology’s benefits and functionality would motivate user-driven adoption. the gap in knowledge could be bridged through educational campaigns. this will help to improve stakeholders’ knowledge and broad understanding about blockchain technology: ‘education about it and how it could benefit, and education to every stakeholder in the industry, the banks, the regulators, the clearinghouses, all of that type of various different players, as well as the sell side, the buy side and why it’s important, like the benefits of it.’ (participant 12) teaching stakeholders about the technology will reduce misconceptions and resistance to change and lead to a higher desire to adopt the technology. the nature of the south african economy is that it is divided into two groups, those that are financially literate and those that are not: ‘most of our population is less developed and you would like to drive the adoption from the numbers on that side, instead of from the institutional base.’ (participant 5, msc [manager, stock exchange]) for adoption to be driven by end-users, the portion of financially educated users would have to increase. confidentiality issue the confidentiality issue pertains to the fact that some people would like to keep their identities hidden while trading, requiring encryption and decryption, complicating regulatory matters: ‘confidentiality can be a positive on one side, but a negative in the sense … because all of a sudden information is encrypted. it always needs somebody to decrypt it to know exactly what’s happening. without that knowledge, you will be fighting with the regulators to do with the issues of knowing your client and the money laundering issues.’ (participant 8, phd, cfa [professor, academic & bank]) this factor is linked to current regulation and the requirement to protect individual information. some users may not be comfortable with the implied transparency that comes with adopting blockchain and, therefore, will resist its adoption: ‘current set up, some people want to remain anonymous, and they don’t want people to know their trades.’ (participant 11, phd [senior lecturer, academic]) illicit activities and fraud fears of blockchain technology being used for money laundering and other illicit activities could influence the adoption of the technology: ‘blockchain technology can easily be used to perpetrate illicit trades if someone chooses then to be anonymous.’ (participant 5, msc [manager, stock exchange]) participant 9 identified the risk of money laundering that comes with the unregulated nature of blockchain technology, specifically how it currently operates in facilitating crypto-currency transactions. the system does not legally require buyers and sellers to disclose personal information whilst in the current securities trading value chain, banks require individual to disclose personal information and monitor activities in order to deter money laundering: ‘money laundering risk … in the current system you have kyc (know your customer) requirements, which is not a requirement on cryptocurrency platforms.’ (participant 9, togaf® 9 certified [manager, bank]) participant 8 adds that there is continual vetting of buyers and sellers in the current system, which helps regulators feel in control, reducing fears of money laundering. if blockchain is adopted, money laundering laws would have to be revised: ‘currently we do continuous vetting, where when we try to make a transaction, there’s a vetting happening and with this i feel like the regulators might just think that they are losing a grip on such things. because there’s fear of things like money laundering, people can just now – they won’t know who is doing the transaction.’ (participant 8, phd, cfa [professor, academic & bank]) participant 7, however, was of the view that the transparency and auditability functions of blockchain would reduce illicit or fraudulent activities: ‘blockchain technology would minimise fraud, minimise errors of transactions – yes, i look at it as more of an enhancement.’ (participant 7, ca [sa] [manager, bank]) from the above, the study concludes that the regulators desire to monitor and control money laundering and other financial crimes may inhibit adoption if users can hide their identities. monopoly nature of current industry competition drives innovation and progress, and without competition, there is no need to keep up or innovate. the strate having a monopoly would serve as a limiting factor to blockchain adoption: ‘[…b]ecause there’s no competition, there’s no rush for things to be done.’ (participant 6, bcom [manager, bank]) therefore, according to participant 12: ‘an increase in competition will encourage technology adoption … increased competition is also beneficial for innovation.’ (participant 12, cfa, mcom [senior trader, asset management]) the study, therefore, contends that because strate has a monopoly, the organisation has no incentive to drive blockchain adoption as one of the stakeholders in the industry. although they have the capacity to innovate on account of their profitability, they have little incentive to do so as the entire, highly profitable market is at hand. power supply the amount of electricity needed to run a network or system on blockchain technology will negatively influence blockchain adoption in a country with constraints to electricity production: ‘the power which is equivalent to running nigeria, for example, running a settlement system on blockchain would equivalent to running nigeria for those 10 minutes, that’s a lot of power and that is costly.’ (participant 8, phd, cfa [professor, academic & bank]) for the last decade and a half (since 2007), south africa has been battling for the sustained provision of power. the power utility, eskom, has been rationing electricity supply in an initiative referred to as load shedding. power interruptions influence the adoption of the technology as the lack of power supply would disrupt trading: ‘transactions may be impacted.’ (participant 5, msc [manager, stock exchange]) participant 8 reiterates this by stating the impact of load shedding on the verification process: ‘taking into consideration load shedding and scalability, the verification process will be impeded.’ (participant 8, phd, cfa [professor, academic & bank]) it can be concluded that inconsistent power supply in south africa will have a negative influence on adoption. layoffs government is concerned about the unemployment rate. if blockchain is adopted and intermediaries are eliminated from the industry, people who work in those companies, will lose their jobs: ‘employees employed within the settlement value chain can lose their jobs.’ (participant 3, cfa [analyst, asset management]) in addition, adoption of blockchain will have a negative impact on employment according to participant 9: ‘blockchain adoption may lead to the collapse of institutions and loss of jobs.’ (participant 9, togaf® 9 certified, [manager, bank]) participant 10, although in agreement about job losses, distinguishes between the impact on the industry and specific job roles: ‘blockchain is a threat to specific job roles, but not to the industry. the benefit for the industry is improved speed and efficiency in transactions. although certain roles will be eliminated, new functions will be created.’ (participant 10, msc [fund manager, asset management]) the study finds that potential job losses/ layoff in an environment in which unemployment is already high, will negatively influence the adoption of blockchain technology as government and other social stakeholders would not want to increase unemployment. discussion existing models are limited in that they do not address the scope of this study which is the adoption of blockchain technology in the clearing and settlement industry in south africa. the technology acceptance model is limited because it focuses on explaining adoption at the individual (end-user) level, while the toe framework is targeted at the organisation level. although doi theory encompasses both toe and the tam factors, it is limited, because it does not emphasise external factors (oliveira & martins 2011). blockchain adoption model addresses, to some extent, the external factors, which are categorised as ecosystem factors, but fails to consider industry and country-specific issues lustenberger et al. (2021). this study identifies people, organisation, technology, industry and country (potic) as factors important in influencing blockchain technology adoption in south africa. the study expands and contributes to traditional frameworks for adopting blockchain technology in the south african clearing and settlement industry by adding five factors: trust, load shedding, unemployment/layoffs, the useful life of current infrastructure and educational campaigns. the south african clearing and settlement industry is trusted and has a good track record. shares transactions totally electronic has a proven record of reliability; users trust it, and there is no incentive to abandon that system of trust for a trustless system. the ‘trust’ in the existing structures will have a negative influence on the adoption of blockchain technology. in empirical studies wong et al. (2020), as well as wamba and queiroz (2020) argue that trust in the context of the supply chain does not affect the behavioural intention to adopt blockchain. contrary to them, liu and ye (2021) assert that the more the users trust blockchain technology, the more they may perceive the value of it and the more they intend to use it. load shedding and the inconsistent supply of electricity have a negative influence on adoption. unemployment is a significant consideration in the south african economy; government, labour unions and other stakeholders would oppose innovations that would increase unemployment. this will lead to delayed adoption of blockchain technology. the useful life of current infrastructure was an element not identified in literature but added by participants. participants highlighted that the industry recently invested in infrastructure that is not yet outdated. thus, replacing this infrastructure would mean that the full return and use were not extracted from that infrastructure. educational campaigns could address issues of fear, lack of trust, resistance to change, lack of knowledge and skill. the study proposes that these campaigns should be aimed at stakeholders responsible for micro-infrastructure, such as individuals working within the jse and strate, namely, the regulators, other intermediaries (which include banks and brokers) and end users (buyers and sellers). the potic framework defines people, as current and potential stakeholders and users in the system, the public. the organisation is defined as a business in the securities value chain and clearing and settlement industry. technology is defined as blockchain technology. the industry is defined as the clearing and settlement industry, the environment in which the clearing and settlement happens. the country is defined as the geographical location in which the industry is homed; in this case, south africa. the sub-factors of each category are summarised in table 3: people, organisation, technology, industry and country propose that the adoption of blockchain technology in south africa is influenced by the factors in the first column; once the technology is adopted, it will lead to overall improved efficiency which is measurable, this is illustrated in figure 2. figure 2: people, organisation, technology, industry and country framework: factors affecting the adoption of blockchain in the clearing and setllement industy. table 3: theoretical factors. conclusion the potic framework will be beneficial to the jse and its subsidiary strate when considering adoption of the blockchain technology for the integration of trade, execution and post trade services to reduce the settlement cycle. in addition, when regulators need to formulate new regulations, they will benefit from considering the potic framework. the researchers recommend the inclusion of regulators’ perspectives and views, such as participants from the south african reserve bank and financial sector conduct authority who are outside the securities value chain. this recommendation is based on the findings in the study that the regulatory environment and the current regulation are factors that will influence the potential adoption of blockchain. acknowledgements competing interests the author(s) declare that they have no financial or personal relationship(s) that may have inappropriately influenced them in writing this article. authors’ contributions authors contributed as indicated in the discussion section. ethical considerations participants were asked to share information with the full knowledge that it is to be included and published in this study. participants signed a consent letter or form to indicate their willingness to participate in the study. any information collected from participants will not be made public without permission their. no information will be published about the identities of any specific individuals, the organisations they work for or are affiliated 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augustine, f.k. & giberson, w., 2017, ‘blockchain technology adoption status and strategies’, journal of international technology and information management 26(2), 65–93. yilmaz, m.k., erdem, o., eraslan, v. & arık, e., 2015, ‘technology upgrades in emerging equity markets: effects on liquidity and trading activity’, finance research letters 14, 87–92. https://doi.org/10.1016/j.frl.2015.05.012 yoshihama, s. & saito, s., 2018, ‘study on integrity and privacy requirements of distributed ledger technologies’, in 2018 ieee international conference on internet of things (ithings) and ieee green computing and communications (greencom) and ieee cyber, physical and social computing (cpscom) and ieee smart data (smartdata), pp. 1657–1664, ieee, canada. abstract introduction purpose and research objectives of the study first research objective: defining the constructs second research objective: reporting and explaining the relationship between the three variables method findings conclusion acknowledgement references about the author(s) anton grobler graduate school of business leadership, university of south africa, south africa maggie m.e. holtzhausen department of human resource management, college of economic and management sciences, university of south africa, south africa citation grobler, a. & holtzhausen, m.m.e., 2018, ‘supervisory trust to be earned: the role of ethical leadership mediated by person-organisational fit’, south african journal of economic and management sciences 21(1), a1920. https://doi.org/10.4102/sajems.v21i1.1920 original research supervisory trust to be earned: the role of ethical leadership mediated by person-organisational fit anton grobler, maggie m.e. holtzhausen received: 26 apr. 2017; accepted: 04 sept. 2017; published: 28 mar. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the trust relationship between employees and their supervisors (called supervisory trust) has a definite impact on employee behaviour and attitudes. furthermore, various studies found that ethical leadership impacts on supervisory trust, but in different contexts, and often with homogeneous or limited samples. the interactionist construct of person-organisational fit (p-o fit), consisting of a combination of supplementary fit (indirect fit or value congruence) and complementary fit (direct or person-job fit, as well as needs-supply fit), may however impact on the relationship between ethical leadership and supervisory trust. the unique permutations of these relationships are important not only for conceptualisation purposes, but also for intervention design to enhance the employees’ trust in their supervisors; this would contribute to positive employee behaviour and attitudes. aim: the purpose of this study was to determine whether a relationship exists between ethical leadership and supervisory trust, with possible mediation by p-o fit. setting: the research was conducted among ±60 employees from each of 17 private sector and 4 public sector organisations in south africa. method: this study utilised a positivist methodology based on an empirical approach, while using a cross-sectional design and quantitative analysis. the sample is relatively representative (in terms of race, gender and the south african work force), as it consisted of 60 employees from each of the 21 south african organisations that participated in the study, with 1260 respondents in total. results: significant, positive relationships were found between ethical leadership, p-o fit and supervisory trust. additionally, it was found that p-o fit partially mediates the relationship between ethical leadership and supervisory trust, confirming the proposed model. conclusion: a strong, positive relationship exists between ethical leadership (consisting of morality and fairness, role clarification leadership and power-sharing leadership) and supervisory trust, which is partially mediated by p-o fit (consisting of supplementary fit and complementary fit). introduction blau (1964:98) argues that trust lies at the centre of all relationships and, therefore, influences the way parties behave towards each other. the same may be said for supervisory trust that has been found to influence constructive employee outcomes, holding much benefit for organisations. for example, supervisory trust was found to relate positively to both individual and organisationally directed organisational citizenship behaviour (ocb) and to task performance (aryee, budhwar & chen 2002:276). in addition, davis et al. (2000:564; 568–571) maintain that employees who perceive their supervisors as trustworthy feel safer, act more productively and indicate loyal behaviour towards their organisation. fair and caring supervisory treatment and leadership create higher levels of trustworthiness, which potentially fosters social exchange relationships, resulting in employees who are more likely to perform beyond their normal call of duty (brown & treviño 2006:597; ruiz-palomino & martınez-canas 2014:103). when there is supervisory trust, a relationship develops which is characterised by a positive reciprocal concern, just behaviour and dedication (chen, aryee & lee 2005:465–466). the importance of supervisory trust for organisational success is evident from the above and the reason why further research on the topic is necessary. ethical leadership contributes to higher levels of supervisory trust as employees believe ethical leaders will remain true to their promises and will fulfil their obligations (kalshoven, den hartog & de hoogh 2011:65). perceived ethical leadership and behaviour heightens employee engagement through intensified feelings of vigour, dedication and absorption at work (den hartog & belschak 2012:42–43). ethical leadership directly and indirectly affects employees’ level of commitment and turnover intention (shin et al. 2015:54). this article therefore focuses on the relationship between supervisory trust and ethical leadership. the emphasis of the article lies in the relationship between supervisory trust and ethical leadership, but with the addition of person-organisational fit (p-o fit), a relationship that has not been widely researched. this is an important contribution as the significance of p-o fit as an interactionistic concept has been widely accepted, but not in combination with supervisory trust and ethical leadership. for instance, drawing on blau’s social exchange theory of 1964, farzaneh, farashah and kazemi (2014:683–684) found that the perceived fit employees experience between their needs and capabilities, versus the benefits provided by their job or organisation, prompts employees to commit to their organisations with increased levels of ocb and to perform tasks given to them. purpose and research objectives of the study the purpose of this study was to determine whether a relationship exists between ethical leadership and supervisory trust, with possible mediation by p-o fit. aligned to this purpose, four research objectives were formulated. the first two research objectives are based on the existing literature available, and the last two are based on the empirical investigation. the research objectives are: (1) to define the constructs ethical leadership, p-o fit and supervisory trust; (2) to identify and report on previous studies where the relationship between ethical leadership, p-o fit and supervisory trust and related concepts were found; (3) to determine the relationship between ethical leadership, p-o fit and supervisory trust; and lastly, (4) to test the mediating effect of p-o fit on the relationship between ethical leadership and supervisory trust. first research objective: defining the constructs the first research objective entails defining the constructs of supervisory trust, ethical leadership and p-o fit from literature. defining supervisory trust rousseau et al. (1998:395) define the general construct of trust as ‘a psychological state comprising the intention to accept vulnerability based upon positive expectations of the intentions or behaviour of another’ – thus emphasising two aspects central to most descriptions of trust: the positive expectations and beliefs of the person placing his trust in another that the other person is competent, honest and caring; and secondly, a willingness to accept vulnerability, reflecting the intent to be dependable on another. mayer, davis and schoorman (1995) define trust as: the willingness of one party to be vulnerable to the actions of another party based on the expectation that the other party will perform a particular action important to the trustor, irrespective of the ability to monitor or control that other party. (p. 712) similarly, mcallister (1995:25) describes interpersonal trust as the extent of confidence a person has to willingly act on the basis of the words, actions and decisions taken by another. more specifically to supervisory trust, sanders and schyns (2006:514–515) support the aspect of mutual dependency, stating that according to the leader-member-exchange (lmx) theory, subordinates will trust their leaders when they experience supervisors as trusting them. mulki, jaramillo and locaander (2006:20) conclude that most explanations of supervisory trust do, in fact, have this one common element of an individual’s behaviour that reflects his or her vulnerability to another person in an exchange relationship. defining ethical leadership ethical leadership is defined by the pivotal work of brown, treviño and harrison (2005:120) as ‘the demonstration of normatively appropriate conduct through personal actions and interpersonal relationships, and the promotion of such conduct to followers through two-way communication, reinforcement, and decision-making’. brown et al. (2005:119–121) thus recognise the two dimensions of ethical leadership as reported by the seminal work of treviño, hartman and brown (2000:28), namely the moral person and the moral manager. the reference to a moral person (treviño et al. 2000:28) touches on the characteristics and traits of the leader, e.g. being caring, honest, a principled decision maker, and behaving ethically – both professionally and personally. further characteristics of ethical leadership include fairness, integrity and consistent behaviour that, in turn, encourages ethical behaviour (brown et al. 2005:130; de hoogh & den hartog 2008:298; kalshoven et al. 2011:51; treviño, brown & hartman 2003:5;14–18). ethical leaders foster good relationships and behave courteously, politely and in a friendly manner towards employees and other stakeholders (frisch & huppenbauer 2014:32–38), thereby showing moral and legal conduct (de hoogh & den hartog 2008:298). they have an internal sense of duty and operate in ways conducive to the greater good (treviño et al. 2003:19). these characteristics result in ethical leaders being viewed by their employees as more credible and trustworthy (ruiz-palomino & martınez-canas 2014:97). in fact, according to research (brown & treviño 2006:597; frisch & huppenbauer 2014:34–35; treviño et al. 2003:14) ethical leaders regard it as imperative that their behaviour results in their employees considering them as ethical role models and are often influenced by ethical role models themselves. den hartog (2015:418–428) argues that, should leaders act as ethical role models, ethical conduct will increase in the total organisation and not only among the immediate followers. indeed, mayer et al. (2009:7–9) put forward a trickle-down model suggesting that ethical leadership flows down from top-level management through supervisors, to employees. demirtas and akdogan (2015:64) confirm that leaders modelling ethical behaviour achieve moral authority which positively affects organisational members; similarly, the ethical and moral behaviour of top management influences ethical supervisory behaviour (choi 2014:4776). the moral manager (treviño et al. 2000:28) refers to ethical leaders who actively endeavour to inspire change in their followers by demonstrating ethical conduct; they also encourage employee voice. while holding followers accountable for ethical behaviour and actions, they remain accountable for their own actions (treviño et al. 2003:18). ethical leaders communicate ethical standards to their followers by sending clear messages about ethical values, while also being clearly noticeable as ethical and honourable leaders (brown et al. 2005:120, 130; brown & treviño 2006:597; de hoogh & den hartog 2008:298; kalshoven et al. 2011:51; treviño et al. 2003:5,14–18). ethical managers and leaders consider fairness in all they do (e.g. in considering just compensation systems and providing job-related training or other suitable development opportunities), while also demonstrating trust in their employees through, for instance, increased decision-making powers (frisch & huppenbauer 2014:32–38; kim & kim 2013:157). ethical supervisors act in the best interests of all their followers (brown et al. 2005:130) – for example, employees, customers, society and the natural environment – thereby enhancing the well-being of several stakeholders (frisch & huppenbauer 2014:39). ethical leadership diminishes employees’ anxiety about job uncertainty or workplace behaviours (treviño et al. 2003:18). they are transparent and open in their communication with employees regarding their expectations and responsibilities (de hoogh & den hartog 2008:298), and they encourage a transparent organisational culture (huhtala et al. 2013:264). notwithstanding the many writings on ethical leadership, scholars such as den hartog (2015:426–428) and yukl et al. (2013:38) point out that the exact conceptual meaning of ethical leadership still causes confusion. contributing meaningfully to the research and findings on ethical leadership, den hartog (2015) and yukl et al. (2013) summarise the most important aspects as set out below. den hartog (2015:421–422) recaps ethical leadership as being comprised of leader behaviour that shows integrity and cognisance of moral values. in addition, ethical leadership is characterised as honest, fair, respectful, caring and trustworthy, with no indication of favouritism evident. ethical leaders use power in a socially responsible manner and will also share power. they engage in social responsibility initiatives and make principled choices, showing a concern for sustainability issues. furthermore, ethical leaders act in a transparent manner, engaging in open communication with followers, and encouraging employee voice. finally, ethical leaders give ethical guidance to employees and clarify roles and responsibilities so that employees comprehend what is expected of them (den hartog 2015). similarly, and based on both theory and research, yukl et al. (2013:40–41) summarise the most relevant aspects of this concept as including integrity (including consistent actions to advocate adopted values) and honesty; actions taken to communicate or administer ethical principles; fair decision-making and reward distribution (including no preferential treatment or use of rewards to motivate unsuitable actions); and conduct indicative of kindness, compassion and concern for others (altruism). yukl et al. (2013:47) furthermore conclude that ethical leadership significantly relates to lmx and leader effectiveness – concluding also that ‘ethical leadership is not only commendable but also effective’. defining p-o fit p-o fit is a complex and multidimensional construct (farzaneh et al. 2014:674), aptly summarised by ruiz-palomino and martınez-canas (2014:97) as the level of similarity between an employee’s and an organisation’s beliefs, norms, values (chatman 1989:339) and goals (kristof-brown, zimmerman & johnson 2005:318). kristof (1996), one of the original researchers on p-o fit, defined it as: the compatibility between people (employees) and organisations that occurs when (a) at least one entity provides what the other needs, or (b) they share similar fundamental characteristics, or (c) both. (pp. 4–5) similarly, liu, liu and hu (2010:616–617) emphasise three components to p-o fit, namely the congruence between an organisation’s characteristics and the employee’s personality; the compatibility between the goals of the employee and the organisation; and lastly, the extent to which an employee’s values and the organisational culture coincide. mitchel et al. (2001:1104–1105) concisely describe overall p-o fit as the way employees are perceived to be compatible and at ease with an organisation. various dimensions have developed regarding this broad concept, and scholars distinguish between supplementary and complementary fit (kristof 1996:3), needs-supplies versus demands-abilities (kristof 1996:3) and, lastly, the perceived (subjective) dimension contrasted with an actual (objective) dimension (kristof-brown & jansen 2007:132–135). kristof (1996:3) explained the complementary fit as occurring when an employee’s characteristics complete an environment by adding that which was missing, and supplementary fit as occurring when an employee supplements or holds characteristics comparable to other employees. to enhance the possibility of a fit between the organisation and the employee, the employee’s personal values, goals and plans should fit the organisational culture, values, norms and goals, and the demands of the employee’s job (kristof 1996:4). a second theory by kristof (1996:3) refers to the demands-abilities (occurring when an employee meets organisational demands) versus needs-supplies (occurring when the organisation fulfils the employee’s needs, requirements and preferences) theory. p-o fit will be higher when employees meet the demands of the organisation because the employees demonstrate the necessary abilities to do so, and the employee’s needs are also met by the organisation (kristof 1996:4). as stated above, kristof-brown and jansen (2007:132–135) described two further dimensions of overall p-o fit – the subjective (perceived) fit and the objective (actual) fit between the organisation and the employee. it is especially the subjective fit which often determines behaviour (kristof-brown & jansen 2007:132–135). other authors have offered similar dimensions, for instance cable and edwards (2004:822; 829–831) identified a supplementary fit, closely associated with the subjective fit of kristof-brown and jansen (2007:132–135). the subjective p-o fit occurs when similarity of personal and organisational values, beliefs, norms and goals is found, resulting in a feeling of being involved in the broader mission of the organisation (cable & derue 2002:876). the objective fit is associated with the complimentary fit (cable & edwards 2004:822; 829–831) and refers to aspects such as the match between the skills of the employee as measured by the performance management of the organisation (grobler 2014:5); or, differently put, the fit between the employee’s skills and abilities and the job or organisational demands (grobler 2016:1421). second research objective: reporting and explaining the relationship between the three variables the second research objective relating to the literature review focused on the relationship between the antecedent of ethical leadership and the outcome of supervisory trust, and how this relationship is mediated by p-o fit. research indicates that ethical leadership significantly impacts on both supervisory trust and p-o fit; however, the possible mediating effect of p-o fit on the relationship between supervisory trust and ethical leadership does not seem to be well researched. some of the important work that are based on the proposed theoretical model (see figure 1) will be discussed next. figure 1: a proposed model depicting the role of ethical leadership mediated by p-o fit in earning supervisory trust. this model assumes a three-variable system such that there are two causal paths feeding into the outcome variable: the direct impact of the independent variable (path c) and the impact of the mediator (path b). there is also a path from the independent variable to the mediator (path a). the relationship between ethical leadership and supervisory trust trust is central to both institutional and interpersonal relationships (mcallister 1995:25, 53–55). brown and treviño (2006:597) confirm that ethical leaders are regarded as trustworthy, and ethical leadership contributes significantly to enhanced supervisory trust (choi 2014:4771, 4776; kalshoven et al. 2011:65), aiding supervisors and their underlings to develop trust-based relationships (brown et al. 2005:122; 130). sallee and flaherty (2003:306) found in their research that, when a supervisor reflects a value system which portrays characteristics such as concern for their employees (noted as an ethical leadership quality), it benefits the formation of supervisory trust. ethical leadership enhances both affective and cognitive trust (newman et al. 2014:119). mcallister (1995:25–26) described affective trust as strong emotional ties that are formed between leaders and their followers when a process of reciprocated social exchange is evident. cognitive trust is described as trust-based on performance-related perceptions such as proficiencies, responsibility and dependability (schaubroeck, lam & peng 2011:864). brown and treviño (2006:597) confirm that ethical leadership is positively related to affective trust, while being negatively related to abusive supervision. chughtai, byrne and flood (2015:655) argue that blau’s social exchange theory (1964) supports the idea that ethical leadership enhances supervisory trust, as constructive and valuable actions by supervisors lead to high-quality exchange relationships with subordinates, who, in turn, will reciprocate in equally positive ways. according to the seminal work of blau (1964:94), employees will reciprocate through positive contributions towards the organisation, as social exchange relationships tend to engender feelings of personal obligations, gratitude and trust. aryee et al. (2002:267, 276) used a social exchange model to suggest positive relationships between interactional justice perceptions and supervisory trust. supervisory trust thus holds the perspective of a mutual exchange resulting from integrating both honesty and emotionally oriented activities (sallee & flaherty 2003:307). another significant finding relates to the impact of ethical leadership and supervisory trust on organisational culture. top management, supervisors and peers need to continuously display moral virtuous behaviour combined with formal ethics mechanisms to build a strong ethical culture (ruiz-palomino, martınez-canas & fontrodona 2013:184). a perceived ethical climate (where supervisors and managers are seen to honour ethical behaviour, remain true to their promises and act as ethical role models) enhances supervisory trust (treviño & brown 2004:72–73, 78–80). in fact, mulki et al. (2006:23–24) determined that an ethical climate is regarded as an important precursor to supervisory trust. moreover, ruiz-palomino et al. (2013:181) argue that validating ethical behaviour within the organisation’s culture holds potential for ensuring satisfied and committed employees who want to remain with the organisation, and that this is a likely outcome of solid trust-based human relationships. research has found that, even in situations where employees foresee a short-term relationship with the organisation and purely economic in nature, higher levels of emotional attachment to the organisation will exist, resulting in a bigger sense of obligation to it (philipp & lopez 2013:307; 310–311). ethical leadership encourages ocb on both individual and group levels (brown et al. 2005:130; kalshoven et al. 2011:65; mayer et al. 2009:8–11), with trustworthiness in supervisory ethical leadership being especially important in relation to ocb (brown & treviño 2006:612; ruiz-palomino, ruiz-amaya & knörr 2011:252–253). furthermore, ethical leadership significantly contributes towards an ethical climate, enhancing an environment of procedural justice which mediates the effects of top management ethical leadership on ocb (ruiz-palomino et al. 2013:175; 184; shin et al. 2015:52–54). additionally, ethical leaders contribute to higher levels of employee engagement, commitment and trust among followers, heightening desired behaviour among followers (brown et al. 2005:129–130; choi 2014:4771, 4776; den hartog and de hoogh 2009:220–223; engelbrecht, heine & mahembe 2014:6–8; hansen, brown & dunford 2013:444). chughtai et al. (2015:659–660) found that supervisory trust is fully mediated by the effects of ethical leadership on, respectively, work engagement and emotional exhaustion, and thus employee well-being. additionally, ethical leadership enhances trust among employees during organisational change, aiding the change process as employees trust their supervisors to take appropriate decisions and are therefore more likely to engage in ocbs (sharif & scandura 2014:186; 192). the mediating and moderating effects of p-o fit on ethical leadership and supervisory trust the mediating effect of p-o fit on the relationship between supervisory trust and ethical leadership was not extensively explored in the past. boon and biron (2016:2190–2102) found that the relationship between supervisors and their employees impacts on the perception of fit and subsequent behaviour, arguing that high-quality lmx relationships between supervisors and their employees affect the employee’s attitude and behaviour, and that the quality of these relationships is, among other things, based on the experience of high levels of trust between these two parties. kristof-brown et al. (2005:311) regard person-supervisor fit as a specific type of p-o fit and found a moderate relationship between p-o fit and supervisory trust. however, their study also suggested that employees do not regard their supervisors as ‘isomorphic representations of the organization’ (kristof-brown et al. 2015:316). kim and kim (2013:158–161) found that, as person-supervisor fit increases, moral competence becomes stronger among leaders and employees; however, they caution that the construct of moral competence is distinctive from ethical leadership. nonetheless, the finding is interesting and worthy of mentioning as moral competence is viewed as a multidimensional construct relating to integrity, responsibility, compassion and forgiveness (kim & kim 2013:156), and thus related to ethical leadership. ruiz-palomino and martınez-canas (2014:104–105) found overall p-o fit has a moderating effect on the relationship of ethical culture of which ethical leadership is a component (ruiz-palomino et al. 2013:173) and ethical intent. nonetheless, they also found that even when p-o fit is relatively poor, ethical culture is still strongly associated with ethical intent. in addition, ruiz-palomino and martınez-canas (2014:104–105) found that p-o fit mediated ethical culture and ocb. clearly, not much research exists on the mediating effect of p-o fit between ethical leadership and supervisory trust. subsequently, this study aimed to support two empirical research objectives, namely ‘what is the nature of the statistical inter-relationships between ethical leadership and supervisory trust?’ and ‘does p-o fit significantly mediate the relationship between ethical leadership and supervisory trust?’ method research design this study utilised a typical positivist methodology based on an empirical approach, while using a cross-sectional design and quantitative analysis. this approach enables the researcher to collect the required data across all participating demographic groups at the same time. sample the participants consisted of employees of a convenience sample of 21 organisations in south africa, with 17 organisations being from the private sector, including the medical, engineering, retail, construction, financial, telecommunication, pharmaceutical and information technology industries. the public sector is less represented, with four organisations, consisting of national and provincial departments, as well local government. in each organisation, 60 employees were selected to participate in the study. the pooled data could therefore be considered to be a convenience sample (because of the convenience sampling of the participating organisations). the fieldwork was conducted by 21 co-researchers working on a larger project; ethical clearance was granted by the institution. although race, gender and age were used as grouping variables to distinguish between groups, it is still important to reflect on the composition of the sample in terms of these demographic variables. the majority of the participants were africans (50%), followed by white people (31%), indians (11%) and mixed race (8%). the representation of the gender groups was higher for males at 58% compared to 42% for females. the racial and gender distribution of the sample seems to be relatively representative of the south african workforce in general, taking into consideration that the distribution of the workforce as indicated by statistics south africa (2016:appendix a) was 79.77% africans, 8.36% white people (over-represented in the sample), 2.49% indians and 9.17% mixed race. according to the same source, the proportion of males in employment is 49.36%, while the proportion for females stands at 50.64%. the mean age of the respondents was 37.26 years (s.d. = 9.29), and the mean tenure in the specific organisation 7.24 years (s.d. = 8.27). the assumption can thus be made that the sample is well representative of the general work force, and that the participants, in terms of age and tenure, would be able to provide an accurate assessment of their perceptions of the constructs being measured. measuring instruments the ethical leadership questionnaire (elq) developed by de hoogh and den hartog (2008:297–311), consisting of three sub-factors, was used. this instrument was designed to elicit respondents’ reports of behaviour of leaders with whom they are familiar and uses a 7-point likert scale. the first factor is morality and fairness (six items), and the first item reads ‘the leaders in my organisation make sure that their actions are always ethical’. the second factor is role clarification leadership, and a typical item reads ‘the leaders in my organisation explain who is responsible for what’. the last factor is power-sharing leadership (six items), and one of the items reads ‘the leaders in my organisation allow subordinates to have influence on critical decisions’. de hoogh and den hartog (2008:303) reported cronbach’s alpha coefficients of 0.81, 0.88 and 0.78 for the respective factors. p-o fit was measured using an instrument developed by cable and judge (1996:294–311). the initial instrument was multidimensional and consisted of three factors, with three items on each of the factors. however, grobler (2016:1419–1434) developed a reconfigured factor structure (still with all of the original nine items), but with two factors. the first factor, supplementary fit (organisation fit as values congruence), consists of three items with one of the items reading ‘the things that i value in life are very similar to the things that my organisation values’. the second factor, called complementary fit (that includes needs–supplies fit, as well as demands–abilities fit), consists of six items. two of the items read, for instance, ‘there is a good fit between what my job offers me and what i am looking for in a job’ (needs–supplies fit) and ‘the match is very good between the demands of my job and my personal skills’ (demands–abilities fit). the instrument uses a five-point likert scale. cronbach’s alpha coefficients of 0.92 and 0.89 were reported for the two factors respectively by grobler (2016:1428). supervisory trust was measured using robinson’s (1996:574–599) seven-item scale. this scale integrates both cognitive and affective views of trust between individuals, and a typical item reads ‘i believe my employer’s motives and intentions are good’. mulki et al. (2006:22) reported an acceptable cronbach’s alpha coefficient (α > 0.70) for this unidimensional instrument. statistical analysis the statistical analysis was performed by using the statistical package for the social sciences (spss version 24), supported by analysis of a moment structures (amos) version 24. descriptive statistics were calculated to provide information on the distribution, with the mean score as either the average, or as the precise centre of the amalgamated values, with the standard deviation as the measure of variability. skewness and kurtosis were also calculated to investigate the distribution of the data. the critical values for these two statistics are two and seven respectively (west, finch & curran 1995:74). the cronbach’s alpha coefficient (α) was calculated to test the proportional variance error and the internal consistency of the instrument. a score α = 0.70 or higher is considered by clark and watson (1995:309) as acceptable. multicollinearity (tolerance and variance inflation factor [vif]) of the items was also determined (with the main construct as dependant variable) to test a possible inflation of the reliability coefficient. correlations between the constructs were calculated by means of pearson’s product moment correlations. stepwise multiple regression analysis was used to determine the amount of variance explained by ethical leadership construct in supervisory trust, when p-o fit is forced into the analysis. the rationale for this forced inclusion of p-o fit is to determine whether it improves the model or not. the multiple regression was also utilised to determine the relative strength of the two independent variables in the prediction of the dependent variable (in terms of the beta values). the tolerance, as well as vif values, was also calculated to test for possible multicollinearity (pallant 2010:136–138). tolerance is an indicator of the amount of variance not explained by the other independent variables (in this case item) in the model, and should preferably be larger than 0.10. vif on the other hand is the inverse of tolerance, and values should be below 10. in addition to the multiple regressions, structural equations analysis by means of structural equation modelling (sem) was used because it presents some advantages over traditional multivariate techniques (haenlein & kaplan 2004:285). in order to perform sem, the missing values were deleted case-wise. the missing values were accounted for less than 2% of the total sample and thus did not impact on the analysis. amos, which is statistical software, was used to perform the sem to analyse the model from a theoretical perspective. to clarify the meaning of mediation, a path diagram was introduced as a model for depicting a causal chain. the basic causal chain involved in mediation is shown in figure 1. to assess the model fit, several fit indexes were used, including the comparative fit index (cfi), the root mean square error of approximation (rmsea), chi-square (χ2) and the ratio of the differences in chi-square to the differences in degrees of freedom (χ2/df). given that there is no one acceptable cut-off value of what constitutes adequate fit, it was elected to evaluate each model and to recommend the model closest to the cfi value of 0.90, an rmsea value of 0.05 and χ2/df, a ratio of less than 5.00 (byrne 2010). the baron and kenny procedure was also performed to confirm the relationship between the variables. the aim of this procedure is to determine whether the independent variable affects the dependent variable through a mediating variable (zhao, lynch & chen 2010:205). in addition to baron and kenny’s procedure, the sobel test, which is considered to be suitable for large samples (preacher, rucker & hayes 2007:200), was applied. preacher and hayes (2004:718) regard the sobel test as sufficient in terms of its power and intuitive appeal. they also indicate that the rough critical value for the sobel test is ±1.96 (p < 0.05) for a significant mediation effect. ethical consideration ethical clearance was obtained for the research from the relevant institution (school of business leadership, university of south africa). findings the descriptive and collinearity statistics of each of the items across the three constructs were calculated, and the majority of the values on the skewness and kurtosis scales reported were negative. this is an indication that the distribution tails off to the left. subsequently, the negative skewness contributes to the relatively high mean scores on ethical leadership (ranging from 4.05 to 5.10 on a seven-point likert scale), p-o fit (ranging from 3.27 to 3.96 on a five-point likert scale) and supervisor trust (ranging from 4.45 to 5.46 on a seven-point likert scale). the skewness and kurtosis values for the items do, however, not exceed the critical values of 2.00 and 7.00 respectively, which is an indication of a normal distribution of the data. the tolerance as well as the vif values on each of the items further suggests that there is no violation of the multicollinearity assumption within the respective constructs. the descriptive statistics and the psychometric properties of the instruments are reported in table 1. table 1: descriptive statistics and cronbach’s alpha coefficients of the factors of the ethical leadership, p-o fit and supervisory trust instruments. the descriptive statistics in table 1 show that the skewness and kurtosis values of the factors do not exceed the critical values of 2.00 and 7.00 respectively, which is an indication that the data are normally distributed. the majority of the values of the ethical leadership, p-o fit and supervisory trust constructs and sub-factors on the skewness scale were negative, which is an indication that the distribution has relatively few small values and tails off to the left. the cronbach’s alpha coefficients of the factors are acceptable if the guideline of α > 0.70 is applied. it would thus appear that the factors possess acceptable levels of internal consistency, providing some evidence that the items measure the same general construct, which assures the overall reliability of the instruments. third research objective: to determine the relationship between ethical leadership, p-o fit and supervisory trust in order to investigate the third research objective of this study, namely to determine the relationship between ethical leadership, p-o fit and supervisory trust, a correlational analysis and a stepwise multiple regression analysis were performed. the strength and the direction of the linear relationship between the factors (and total score) of ethical leadership, p-o fit and supervisory trust are reported in table 2. table 2: correlation matrix of the factors of ethical leadership, p-o fit and supervisory trust. the correlations coefficients reported in table 2 indicate a strong positive and statistical significant (p ≤ 0.001) relationship between the sub-factors of ethical leadership, p-o fit and supervisory trust. the purpose of this study is, however, to determine the relationship between the overall (or total scores) of the constructs. supervisory trust and ethical leadership are correlated (r = 0.71), while supervisory trust is also correlated with p-o fit (r = 0.58) (both p ≤ 0.001). there is thus a strong, positive relationship or association between supervisory trust and both ethical leadership and p-o fit. the practical implication thus is that a change in p-o fit as well as ethical leadership will impact (in the same direction) on supervisory trust. an improvement in p-o fit and ethical leadership will thus also lead to an improvement in supervisory trust. in order to analyse these relationships further (in support of the third research objective), a stepwise multiple regression analysis was performed. the results are reported in tables 3 and 4. table 3: results of stepwise multiple regression analysis – model summary with supervisory trust as dependent variable and the ethical leadership and p-o fit constructs as independent variables. table 4: results of stepwise multiple regression analysis – assessment of the relative predictive strength of the independent variables (ethical leadership and p-o fit), as well as multicollinearity between them. the stepwise multiple regression analysis, with supervisory trust as dependent variable and the two independent variables as unidimensional constructs (using the total scores of ethical leadership and p-o fit), yielded significant results with ethical leadership explaining 51% of the variance in supervisory trust (f(1, 1221) = 1261.60, p < 0.001). with the addition of p-o fit, the model improves by 4% (total variance explained is 55%), with f(2, 1220) = 748.50 (p < 0.001). the results of the stepwise multiple regression support the third research objective, as it shows that both ethical leadership and p-o fit explain the variance in supervisory trust. subsequently, in order to determine the relative strength of the independent variables (ethical leadership and p-o fit) in the prediction of supervisory trust, the beta coefficients (β) were determined. the results are reported in table 4. the tolerance value is 0.67 and the vif value is 1.49, indicating non-multicollinearity between the two independent variables, in this instance ethical leadership and p-o fit. thus, although ethical leadership and p-o fit are highly correlated (see table 2), it can still be used independently from each other with a substantial degree of accuracy. in support of research objective three, as well as previous results reported, it was found that the strongest predictor of supervisory trust is ethical leadership (β = 0.57, ≤0.001), followed by p-o fit (β = 0.25, ≤0.001). thus, in order to improve supervisory trust, the main intervention should be focused on the perceptions of ethical leadership. supervisory trust can further be enhanced with the addition of interventions to improve p-o fit. together, ethical leadership and p-o fit can contribute up to 55% in the improvement of supervisory trust. fourth research objective: to test the mediating effect of p-o fit on the relationship between ethical leadership and supervisory trust the fourth research objective of this study was to determine the possible mediating effect of p-o fit on the relationship between ethical leadership and supervisory trust. sem and specifically the baron and kenny’s procedure was performed to test the possible mediating effect, and the results are reported in table 5. table 5: results of baron and kenny’s procedure (supported by sobel z score) – the relationship between ethical leadership and supervisory trust through the mediation of p-o fit. after inspection of the results reported in table 5, it is clear that a mediated effect and direct effect exist and point in the same direction. the estimated beta value of the relationship between ethical leadership (independent variable) and supervisory trust as dependent variable is 1.18, but decreased to 0.86 after p-o fit was introduced as mediating variable. this is also referred to as complementary partial mediations or as ‘consistent’ or ‘positive confounding’ models (zhao et al. 2010:200). this finding is supported by sobel z score of 2.48 (p =0.01). finally, in order to confirm the model (as shown in figure 1), a sem was conducted. the results indicated a good fit (chi-square = 246.14, df = 44, p < 0.001, ifi = 0.97, tli = 0.96, cfi = 0.97, rmsea=0.06). this result supports the fourth research objective, as it was found that p-o fit causes mediation in the supervisory trust and ethical leadership. it thus explains the relationship between the supervisory trust and ethical leadership; it can be regarded as an intervening variable. practically, it means that p-o fit could be used as an intervening (or intervention) variable to improve the relationship between ethical leadership (the perceptions thereof) and supervisory trust. conclusion from the literature it is clear that ethical leadership significantly impacts on the level of trust evident in organisations, also between employees and supervisors. ethical leadership is evident through a trickle-down effect (mayer et al. 2009:7–9), impacting from the ethical leader at top management level, to the supervisor, to the employee. ethical leadership also enhances supervisory trust (choi 2014:4771–4776; kalshoven et al. 2011:65), resulting in high-quality social exchange relationships (e.g. chughtai et al. 2015:655). the advantages of both ethical leadership and enhanced supervisory trust are multifold, including for instance strong ocb and increased employee engagement. the literature further points out that a high-quality lmx relationship based on trust between supervisors and employees impacts positively on employees’ outlooks and behaviour (boon & biron 2016:2190–2102), enhancing p-o fit (ruiz-palomino et al. 2013:183). this empirical study also confirmed a strong, positive relationship between ethical leadership (consisting of morality and fairness, role clarification leadership and power-sharing leadership), p-o fit (consisting of supplementary fit and complementary fit) and the unidimensional supervisory trust. it was found that ethical leadership and p-o fit in combination explain 55% of the variance in supervisory trust, with ethical leadership explaining 51%. p-o fit was found to be a mediating or confounding variable, mediating the relationship between ethical leadership and supervisory trust. this implies that, if the targeted variable is supervisory trust in terms of intervention, the organisation should enhance the perception of ethical leadership through direct, honest and transparent communication, as well as the actual ethical conduct of leaders. this could be supported by interventions to improve overall p-o fit that consists of two components. overall p-o fit can therefore be enhanced through constant value-based interaction (to ensure value congruence between the employees and the organisation – component one), as well as direct job, performance and reward-related discussions (to ensure need-supply and demands-abilities fit – component two). however, this research has certain limitations – mainly in terms of the methodology. all three instruments are based on self-reporting – a method which may lead to method bias. this may be a reality, even with the assurance provided to participants during the briefing regarding anonymity and confidentiality. social desirability and subsequent response bias will always remain a concern and a limitation in studies such as this one, while self-reporting may be seen as a one-sided report from the respondents’ side. an additional possible limitation is that the wording of the initial scales was used ‘as is’, without adapting it to the south african (multilingual) context. a further limitation of this study is the drawback of a cross-sectional design 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reflect south africa’s endowment of relatively low levels of physical and human capital. the analysis shows that export products that are further from the country’s comparative advantage, make smaller contributions to growth in the intensive margin. it clearly shows the challenge of sustainably diversifying the export basket. key words: exports, intensive margin, diversification, structural transformation, south africa jel: f1, 14 1 introduction a vast empirical literature exists that shows the contribution of export diversification to economic growth. it is important to note that export diversification is especially beneficial for developing countries, as it involves a country having a varied export production structure that includes not only new, but also higher value products (amin gutiérrez de piñeres & ferrantino, 1997; imf, 2014). this enables countries to offset uncertainty, be less susceptible to commodity shocks and price fluctuations, and to experience positive spillovers that come from trade in higher skilled, high technology goods (naudé, bosker & matthee, 2010; reis & farole, 2012). for example, ancharez and pfister (2013) suggest that it was the diversified nature of the mauritian and tanzanian economies that enabled them to recover quickly from the global financial crisis. it is, therefore, not surprising that export diversification is frequently suggested in developing countries’ government policies as a driver for economic growth. before continuing, it is important to clarify the different types of export diversification. the imf (2014:10) defines extensive export diversification as an increase in the number of products exported or the number of trading partners. intensive export diversification, on the other hand, involves the shares of export volumes across existing export products or partners. here, intensive diversification occurs when a more balanced export portfolio is exported. in other words, having an export mix that includes more dynamic and higher productivity activities (this implies more manufacturing, higher valued services and fewer natural resource-type activities) is desirable. export diversification is closely linked to structural transformation of the economy. again, the imf (2014:11) provides a succinct definition – “structural transformation is the reallocation of resources across different sectors and products over time. development typically involves a shift to higher productivity”. this involves changing factor endowments to achieve diversification in terms of a more balanced production structure that includes exports from different sectors. sustaining a more balanced export mix is a challenge that many developing countries face. a trade guide by the wto and unctad (2012) explains that the median export spell length for a developing country is approximately two years and that a great deal of “churning” occurs. this means that new exporters struggle to survive. therefore export growth within these countries comes from existing exporters exporting products that are already exported (to existing trade partners) at higher volumes or higher prices (which is called the intensive margin) (türkcan, 2014). this emphasises the importance of sustainability by having the right type of expansion within the intensive margin, i.e. exporting more high-skill-intensive or high-value-added products. abstract 250 sajems ns 19 (2016) no 2:249-263 south africa provides a good example of a developing country that has identified the export sector as a means to achieve higher and more inclusive growth (purfield, farole & fernando, 2014). although the country has undergone significant changes (democratising and liberalising trade in 1994), its export performance is still poor compared to its peers (hausmann & klinger, 2006). furthermore, the majority of export growth (around 77 per cent) is generated through the intensive margin (matthee et al., 2015).2 figure 1 illustrates that south africa’s export growth has lagged behind compared to most country groupings as well as global exports in the period from 1994 to 2012. for a significant period, the country’s growth in exports was also lower than that of developed countries, which traditionally show lower growth rates than south africa. furthermore, compared to the growth in exports of its lowand middle-income and sub-saharan peers, south africa’s performance was dismal. in comparison to the other brics countries (not shown in the graph), the growth in the country’s exports since 1994 has also been much lower. figure 1 benchmark of south africa’s trend in exports (index: 1994 = 100) source: authors’ calculations based on data from un comtrade (2014) hausmann and klinger (2006) ascribed south africa’s poor export performance to the country’s lagging structural transformation that has resulted in an overreliance on commodities to achieve export growth. they show that south africa’s export portfolio has been relatively unsophisticated since 1975 when considering the country’s level of income. this has put a limitation on the growth of gdp and exports in general. in fact, the fuel, metals and minerals sectors contributed half of the export value between 2007 and 2012 and this made up 90 per cent of export growth over this time period (purifield et al., 2014). figure 2 provides a picture of the change in the broad structure of south africa’s exports since 1994. extractive industries’ share of exports has increased and was 48 per cent in 2012 (compared to 33 per cent in 1994), with manufacturing at only 19 per cent. however, not all is bad news; the recent report by the world bank (see purifield et al., 2014) on south africa’s export competitiveness, highlights the fact that south africa has a strong manufacturing base and that it does involve technological knowledge. there has been a shift towards medium and high technology sectors with the best performing sectors being industrial machinery and transport equipment. this brings forth a corresponding demand for high skills and capital investment. however, compared to its emerging market peers, south africa’s non-mineral export growth over the period 1994 to 2012 is below par. 345 0 100 200 300 400 500 600 700 800 900 1000 1100 1200 1300 1400 1500 1600 1700 1800 1900 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 e xp or t i nd ex ( 19 94 = 1 00 ) world high-income countries least developed countries low and middle income countries sub-saharan africa south africa sajems ns 19 (2016) no 2:249-263 251 figure 2 broad structure of south africa’s exports (1994 – 2012) source: authors’ calculations based on data from un comtrade (2014) in an analysis of the factor endowment content of south africa’s export basket, the world bank report reveals that exports are concentrated in products with human capital and physical capital beyond the country’s endowment capabilities, indicating a clear mismatch (purifield et al., 2014). added to this, fedderke (2014), in an empirical analysis of south africa’s unbalanced growth structure, shows that south africa’s manufacturing sector is declining in terms of value added and employment. this prompts the question: how sustainable are these types of higher valued (nonmineral) exported products? it is here where our paper contributes to the limited literature on the dynamics of south african exports. we further explore the issue of export sustainability by decomposing the intensive margin export growth from 1994 to 2012. to do this, we consider changes (increases, decreases and extinctions) in export relationships between 1994 and 2012 and begin by applying basu’s (forthcoming) skills and technology classification to determine the composition of south africa’s exported products. next, we shed some light on the sustainability of south africa’s exports using the revealed factor intensity indices compiled by shirotori, tumurchudur and cadot. (2010). our results show how south africa’s composition of exports and trade patterns has changed over the period 1994 to 2012. the largest increase was in non-fuel primary commodities (38 per cent), with the second largest increase being medium-skilland technology-intensive manufactures (22 per cent). the largest decrease was in the resource-intensive manufactures (50 per cent). low and high-skill and technology manufactures display persistence as the percentages of increases and decreases do not vary significantly. the factor intensity results show that south africa’s endowment levels in terms of human and physical capital are relatively low and that movements in the intensive margin are to some extent determined by the levels in human and physical capital endowments. any increases require pushing the boundaries of human and physical capital endowment. moreover, our correlation results emphasise that the further away an exported product is from the country’s endowment point, the smaller its contribution to increases in the intensive margin will be. similarly, larger distances from the endowment point result in larger decreases 9% 4% 10% 8% 33% 48% 11% 6% 20% 13% 10% 19% 2% 1%5% 1% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 sh ar e in to ta l e xp or ts agriculture, meat, dairy and seafood chemicals, plastics and rubber extractive industries food, beverages, tobacco, wood and paper iron, steel and other metals machinery, electronics and transport equipment other industries textiles, apparel, leather and footwear 252 sajems ns 19 (2016) no 2:249-263 (and extinctions) within the intensive margin. the article is structured as follows: section 2 provides a brief literature overview on a historical perspective of south africa’s export structure; section 3 provides the method and data; and section 4 contains the empirical analysis and results. finally, section 5 concludes the article with a summary and recommendations. 2 south africa’s export structure: a historical perspective in order to understand the dynamics of south africa’s export structure, it is important to consider the evolution of south africa’s trade since the beginning of the 20th century, as demonstrated by bell, farrell and cassim (1999). the authors identified a number of phases in which south africa’s export mix changed. the first half of the 1900s was characterised by a very strong dominance of gold and diamonds in exports. subsequently, industrialisation took place and the manufacture of value-added goods increased. the ratio of imports to domestic supply fell significantly. over the period 1956/57, exports became more diversified. the share of primary products in total exports fell and manufactures increased from eight per cent to 26 per cent (bell et al., 1999). furthermore, over the period 1926/27 to 1956/57, the exports of the downstream metal products group of industries grew more rapidly than those of the natural resource-based sectors. the period 1956 through to 1972 saw first a resurgence and then a decline in gold exports. as gold exports slowed from 1965, there was faster growth in manufactured exports, but the growth rate of total exports declined (bell et al., 1999). during this time, exports of natural resource-based manufactures grew strongly and by 1980 accounted for nearly 47 per cent of manufactured exports. bell et al. (1999:12) concluded that the rate of growth of exports from the metal products group of sectors decreased from eight per cent per annum over the period 1960 to 1970 to only 2.4 per cent per annum in 1972-80. their share of total manufactured exports fell from approximately 18 per cent in 1972 to 12 per cent in 1980. they ascribed this to a variation in the real exchange rate that caused the competitiveness of non-commodity manufactured exports to worsen when the competitiveness of natural resource-based manufactured exports improved. the early 1980s were characterised by an economic crisis, debt shock, a shift to exportorientated industrialisation and the eventual opening up of the economy. the period 1985 to 1990 saw much faster growth in downstream metal product exports compared to natural resource-based manufactured exports. the slow growth in the world economy between 1990 and 1993 saw no growth in total exports, but the downstream metal products group of industries showed some growth and increased their share of total manufactured exports. bell et al. (1999:18) concluded that the period 1985 through to 1993 was marked by significant diversification of south africa’s manufactured exports towards more downstream sectors. they argued that there was a substantial and persistent improvement in the competitiveness of downstream manufactured exports that were “apparently beginning to include the exports of high technology products” (bell et al., 1999:21). edwards and alves (2006) continued the story of south africa’s export structure through their study of the level and composition of manufacturing exports following the opening up of the economy in 1994. they applied a technology-based product classification to examine the performance of supply-dynamic products. exports were classified as primary products, resourcebased manufactures, low-technology manufactures, medium-technology manufactures and hightechnology manufactures. they argued that the more skills and technology are involved in the production process, the more growth will be driven by productivity gains. they then compared annual average growth rates of these exports from south africa to the exports of countries in the asia-pacific region and a “resource group” of 25 countries with similar shares of natural resource-dependent products in total exports to south africa in the late 1980s. the results show broad structural shifts in the pattern of exports for the world and for south africa. much of the overall growth in exports was in middle-income economies and that within high-technology and medium-technology products. the share of high-technology products in world trade rose significantly. a similar shift occurred in south africa: manufacturing exports as a sajems ns 19 (2016) no 2:249-263 253 share of total exports increased and within manufacturing exports the share of resource-based products declined. there was a significant increase in medium-technology exports attributed to the motor industry development programme. however, primary exports plus agroand mineralsbased manufactures still accounted for more than 60 per cent of total exports in 2002 (edwards & alves, 2006). in addition, the results showed the troubling result that south africa’s world market share of exports declined during the 1990s. manufacturing export growth was slower than the average of middle-income countries and of the countries in the resources group. overall, it made for a poor performance. edwards and alves (2006:482) concluded that the ability to diversify exports is constrained by the comparative advantage in resource-based products; but even in this area, south africa’s performance was weak. finally, edwards and lawrence (2008) extended the analysis above with a detailed analysis of south african trade performance and trade policy. they distinguished between non-gold commodities and non-commodities exports. the non-gold commodities include primary commodities and manufactured goods that have a relatively high share of primary commodity inputs in final sales. the non-commodities are exports of other manufactured products as well as services (edwards & lawrence, 2008:588). they highlighted the historically poor export performance described above, the decline of non-gold commodities and growth of non-commodity exports. for the more recent period, 2000 to 2005, they found that export volume growth was slow. automotive exports drove the growth in non-commodity exports. edwards and lawrence (2008) also examined changes in market shares and two periods emerged from their findings. over the period 1970 to 1983, south africa lost market shares and this was attributed to slower growth in world trade in commodities, a poor geographic distribution of export markets and declining competitiveness. over the period 1985 to 2000, south africa again lost market shares, but the cause was mainly the dependence on primary commodities. annual growth in manufactured exports was strong, in part reflecting the growth in automotive exports. they concluded that, recently, growth has been constrained by the pattern of specialisation. in summary, south africa’s large resource endowments and subsequent comparative advantage make it difficult to change its export composition, especially during periods with high commodity prices (or commodity booms). resource exports usually increase whenever commodity prices increase, and while diversification has always occurred, it tends to be neglected during these periods. conversely, during periods of commodity busts, diversification moved to the fore. 3 method and data 3.1 intensive margin calculation firms (and countries) either establish new export relationships or maintain existing ones. an export relationship is a trade flow and can be defined as the export of product j from country (firm) k to country (firm) i (see besedes & prusa, 2011). export growth therefore occurs through these export relationships, and can be either along the intensive or extensive margin. decomposing export relationships in the intensive margin reveals whether the relationship has increased, intensified or deepened (according to besedes & prusa, 2011); decreased or weakened; or become extinct. the extensive margin involves the formation of new export relationships (export discoveries) (brenton & newfarmer, 2009). in order to determine the changes along the intensive margin (using the un comtrade database), we calculate values for three categories; namely increases, decreases and extinctions. this is done by calculating how the values of existing exports changed between 1994 and 2014. for example, if a product had a value of usd 900 in 1994 and the same product had a value of usd 1100 in 2012, then it is calculated as an increase to the value of usd 200. we also assign dummy values in order to count the number of increases etc. table 1 summarises the specification for the three categories. 254 sajems ns 19 (2016) no 2:249-263 table 1 intensive margin calculation increase value12 > value94 then 1 is assigned and total is summed to indicate an increase in existing flows to existing countries decrease value12 < value94 then 1 is assigned and total is summed to indicate a decrease in existing flows to existing countries extinction value94 > 0 and value12 = 0 then 1 is assigned and summed to indicate a death which means that the relationship has become extinct 3.2 skills and technology intensity the composition of a country’s exports in terms of embedded technological and skills capabilities tell a great deal about its economic development path. this is supported by basu and das (2011) who found that higher quality exports could help to increase the per capita gdp in developing countries. the basis of their empirical analysis consisted of a classification of products into different levels of skills and technological intensity. basu (forthcoming) has developed this categorisation at hs6 level, which comprises six groupings, namely: i non-fuel primary commodities (e.g. maize, lead ores); ii resource-intensive manufactures (e.g. leather handbags, wallpaper, ceramic tiles); iii low-skilland technology-intensive manufactures (e.g. window frames, motorboats); iv medium-skilland technology-intensive manufacture (e.g. hydraulic turbines, hairdryers); v high-skilland technology-intensive manufactures (e.g. mobile phones, aircraft); and vi unclassified products (e.g. petroleum, monetary gold). south africa’s intensive margins are decomposed according to this classification in order to analyse the structural transformation in its export patterns for the period 1994 to 2012. this decomposition reflects the value share of each product grouping in total increases, decreases and extinctions. 3.3 revealed factor intensities the patterns of trade and process of export diversification have received renewed attention lately. hausmann and klinger (2006) argue that a product’s proximity to existing comparative advantages is one of the most important determinants of whether that country will develop a core competency in the production of that product. this relates to the factor endowment as an explanation of trade patterns as postulated by the hecksher-ohlin theory. shirotori et al. (2010) used this concept to develop a measure of revealed factor intensities of export products. this measure is based on the principle that if a specific product is predominantly exported by countries endowed with a certain combination of human and physical capital, this product has a revealed intensity of these factors. please refer to shirotori et al. (2010) for a complete overview of the methodology. shirotori et al. developed three indices of factor intensity at product-level: namely, “revealed human capital intensity” (rhci); “revealed physical capital intensity” (rci); and “revealed natural resource intensity” (rnri). the former two will be used in this study to analyse the factor content within south africa’s intensive margin. furthermore, the distance between the products within the intensive margin and the country’s endowments with regard to human and physical capital is investigated. this is done to reveal whether south africa’s level of comparative advantage in these factors determines the patterns within the intensive margin. this relationship is also empirically tested by estimating the spearman’s rho correlation coefficient (see table 4). 4 composition of south africa’s intensive margin firstly, a broad overview of the dynamics within the intensive margin over the period is provided in table 2. the results here exclude all transactions below us$10 000. the world bank’s (2012) exporter dynamics database suggests that the median export value for south african exporters is us$29 000. therefore, based on this and on the calculations in table 1, a cut-off value of us$10 000 will not exclude the median exporter, but will exclude the really small export flows (or any measurement errors that occurred). sajems ns 19 (2016) no 2:249-263 255 table 2 intensive margin over the period (1994 to 2012) number of export transactions value of changes (us$) increases 8 601 33 834 353 890 decreases 3 148 -4 520 962 968 extinctions 10 225 -14 452 922 600 source: authors’ own calculations the following sections discuss the results according to the skills and technology classifications and factor intensities. 4.1 skillsand technology-intensity the shares of the product groupings in the different intensive margins (i.e. increase, decrease and extinction) are analysed for all product classifications as well as for a set of selected countries and regions. table 3 presents the intensive margin dynamics per skills and technology intensity (sti) classification, as discussed in section 3.2, over the period 1994 to 2012. table 3 percentage changes within the intensive margin over the period 1994 to 2012 sti classification increase (1) decrease (2) extinction (3) unclassified products 16% 6% 66% non-fuel primary commodities 38% 19% 12% resource-intensive manufactures 3% 50% 6% low-skilland technology-intensive manufactures 11% 10% 7% medium-skilland technology-intensive manufactures 22% 6% 2% high-skilland technology-intensive manufactures 10% 8% 7% source: authors’ own calculations table 3 summarises the dynamics in south africa’s intensive margin over the period 1994 to 2012. products exported over this period are classified according to categories of exports that reflect different factor contents to show whether or not the country has attained a more balanced export mix since its integration in the global economy, and also in the process of structural transformation. the results show the percentage of product categories where the export relationship value increased from 1994 to 2012 (see column 1 of table 3). the largest percentage increase (38 per cent) stems from the non-fuel primary commodity category. this mainly consisted of the exports of iron, chromium and manganese ores. also notable is the increase in medium-skill and technology-intensive manufactures (22 per cent). this product group consists of a large variety of products, but is dominated by the exports of automobiles, filtering/purifying machinery and acyclic hydrocarbons. in terms of the export relationships whose value decreased over this specific period (see column 2 of table 3), a decrease in resource-or labour-intensive manufactures is by far the largest contributor. delving more deeply into this decrease, we see that it is mainly attributed to a decrease in the exports of raw diamonds. however, the remainder of the decrease is due to weaker exports in textile and textile articles, paper/pulp-related products and leather-related products. finally, the classification of the products that were exported in 1994 but not in 2012 (see column 3 of table 3) shows a large percentage (66 per cent) of unclassified products. this high level of extinction within this specific group is mainly attributed to one single product; namely hs9999aa un special code (65 per cent). most probably due to confidentiality issues, the exact nature of this product is not published in trade statistics. the level of extinction within the unclassified product was the highest for the eu-7. another product grouping that experienced relatively high levels of extinctions was non-fuel primary commodities. this was mainly attributed to export relations involving maize, copper mattes and coniferous woods that failed to be sustainable. 256 sajems ns 19 (2016) no 2:249-263 considering that this type of classification reveals information about the quality of the export basket, it is important also to consider the lowand high-skill and technology-intensive manufactures. the percentages of these two categories remain fairly level, which indicates persistence in the exports of these types of products. the implication of these results is that there appears to be a polarisation in terms of south africa’s export basket or mix. the export mix has become more balanced with a large increase in medium-skill and technology-intensive manufactures. however, this increase is accompanied by an even larger increase in non-fuel primary commodities, which brings the balanced mix into question. manufactures that utilise low and unskilled labour found in resource-intensive manufactures, appear to have decreased dramatically, which resulted in the polarised mix we find in 2012. in a study on south africa’s export competitiveness and structure during the 1990s, edwards and schöer (2001) found a low percentage of unskilled labour-intensive products (20 per cent of total exports) in comparison with the levels of technology and human capital intensive exports (50 per cent of total exports). agricultural and mineral-intensive industries contributed 30 per cent of total exports. over the period, edwards and schöer indicated that their results conflicted with other studies, i.e. that the contributions of unskilled labour-intensive and technology-intensive products have both risen, whereas those of resource-intensive, mineralintensive and human capital-intensive exports have declined. our article extends the period through a similar analysis, and shows a return to dependence on resource-intensive industries. in a similar vein to edwards and schöer (2001), we also consider south africa’s export composition from a geographical perspective, but with more detail. figure 3 shows the skillsand technology-decomposition for increases in the intensive margin per country/region. china dominated imports of non-fuel primary commodities from south africa, with the eu also importing the largest percentage of products in this category (41 per cent). the share in growth of mediumand high-skilland technology-intensive manufactures was especially high for exports destined for the usa (52 per cent) and sub-saharan africa (ssa) (35 per cent). figure 3 skills and technology composition of increases in south africa’s intensive margin (1994-2012) source: authors’ own calculations based on data from un comtrade (2014) and basu (forthcoming) eu-7: uk, belgium, germany, france, italy, luxembourg and the netherlands 18% 2% 7% 4% 79% 18% 41% 16% 4% 6% 17% 18% 1% 25% 35% 2% 13% 6% 21% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% china usa eu7 ssa in cr ea se in th e im co m po si tio n export partner high skilland technology intensive manufactures medium skilland technology intensive manufactures low skilland technology-intensive manufactures resource-intensive manufactures non-fuel primary commodities unclassified products sajems ns 19 (2016) no 2:249-263 257 figure 4 shows the composition of the decreases within south africa’s intensive margin per country/region over the period 1994 to 2012. china imported 74 per cent less low-skill and technology-intensive products. the exports of these products to the usa also declined by 30 per cent. the export of resource-intensive manufactures to the eu dropped the most (42 per cent) and to ssa (20 per cent). the decrease to the eu and ssa was predominantly caused by a drop in exports of precious stones and paper-related products, respectively. high-skilland technology exports to the usa decreased the most, with a percentage of 37. this decrease is largely in titanium oxides. figure 4 skills and technology composition of decreases in south africa’s intensive margin (1994-2012) source: authors’ own calculations based on data from un comtrade (2014) and basu (forthcoming) the decomposition of south africa’s extinctions in the intensive margin for the period 1994 to 2012 is depicted in figure 5. approximately 36 per cent of resource-intensive manufactures were exported to china in 1994, but not in 2012. the largest extinctions were in these paper-related products, wool-related products and leather-related products. another large extinction (35 per cent) was the exports of low-skilland technology products to the usa. the largest extinction to the usa comprised iron and steel products. finally, a large percentage (44 per cent) of highskilled and technology-intensive manufactures to the eu became extinct (these include chemical products). from the geographical results, it is evident that south africa’s export relationship with china over the period under investigation was characterised by a significant growth in the share of primary commodities in export growth. furthermore, exports of especially low-skilland technology-products to china mostly decreased or became extinct. growth within the export relationship with the usa was dominated by medium-skilland technology products, predominantly automobiles. on the other hand, exports of both lowand high-skilland technology-intensive products lost a great deal of ground in the usa. the intensive margin of exports to the eu-7 was characterised by both increases and decreases of primary commodities. this implies significant shifts in export relations in terms of products and destinations within this specific product group. the decline in resource-intensive manufactures to the eu-7 is also remarkable, as is the extinction of a significant proportion of high-skilland technology-intensive exports. 8% 2% 9% 12% 24% 36%13% 42% 20% 74% 30% 8% 12% 8% 11% 18% 17% 37% 7% 12% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% china usa eu7 ssa d ec re as e in th e im co m po si tio n export partner high skilland technology intensive manufactures medium skilland technology intensive manufactures low skilland technology-intensive manufactures resource-intensive manufactures non-fuel primary commodities unclassified products 258 sajems ns 19 (2016) no 2:249-263 figure 5 skills and technology composition of extinctions in south africa’s intensive margin (1994-2012) source: authors’ own calculations based on data from un comtrade (2014) and basu (forthcoming) exports to the region (ssa) were dominated by growth in mediumand high-skilland technology-intensive products. these types of products are not manufactured in most of these countries. decreases and extinctions in export relations with ssa were dominated by both primary commodities and resource-intensive manufactures. this may allude to the nature of the growth experienced by many african countries. 4.2 factor intensities section 3 discussed the product-level revealed factor intensity (rfi) indices as developed by shirotori et al. (2010). this section analyses the relative “distance” between the rfi of exports within south africa’s intensive margin and the country’s factor endowment for both human and physical capital. as south africa moves into the production of mediumand high-skilltechnology manufactures, its demand for higher human and physical capital is increasing. given the country’s endowments in both these factors will it be able to sustain this desired shift? with regard to its human capital endowment, reflected by the average years of schooling, the country ranks 69th globally (7.9 years). this is 4.8 years lower than norway, which is ranked second and just above the global average. in terms of physical capital endowment, south africa is ranked only 74th globally, placing it in the same range as namibia and kazakhstan. therefore, these endowment levels are relatively low for the 33rd largest economy (world bank, 2015) and an upper-middleincome country. the relative “distance” between south africa’s endowment point of human and physical capital and the revealed human capital index (rhci) as well as the revealed physical capital index (rci) of its exports may explain the sustainability of export relationships. export products that are distant from this endowment point require a different mix of human and physical capital than is currently supported by the economy (reis & farole, 2012). figure 6 shows the “distance” between the factor content of increases within the intensive margin (a total of 2 154 export products) and the country’s endowment point. the percentages reflect the value share of products located in each quadrant. it is evident from the figure that the factor content of most of the increases with the intensive margin (65 per cent) exceeds the country’s endowment level. 1% 3% 5% 17% 15% 26% 28% 36% 24% 18% 14% 26% 35% 10% 25% 7% 2% 1% 10% 13% 23% 44% 18% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% china usa eu7 ssa ex tin ct io n in th e im co m po si tio n export partner high skilland technology intensive manufactures medium skilland technology intensive manufactures low skilland technology-intensive manufactures resource-intensive manufactures non-fuel primary commodities unclassified products sajems ns 19 (2016) no 2:249-263 259 figure 6 increases in south africa’s intensive margin relative to factor endowments source: authors’ own calculations based on data from un comtrade (2014) and shirotori and tumurchudur (2010) using the mean distance as a benchmark, 58 per cent of the export value is located within a relatively small range of the human capital endowment and 83 per cent is located within a relatively short distance to the physical capital endowment. although the sustainability of a large share of the increase within the intensive margin is under pressure, the deviation is relatively small. as only 11 per cent of the working age population has tertiary education (statssa, 2015), the increase in exports of products that embed higher levels of human capital can only be realised by pushing the limits of educational attainment. comparative advantages in terms of factor endowments underpin success in exporting; however, a range of other factors are also important, e.g. productive capabilities, knowledge, exchange rate volatility, and demand conditions (reis & farole, 2012). figure 7 shows the distance between the factor contents of the decreases in the intensive margin (involving 1 492 products) and the country’s human and physical capital endowments. the figure shows that most of the decreases are located in the upper-left quadrant (53 per cent). this implies that south africa was not able to maintain these exports, even though their factor content lies below the country’s human capital endowment. furthermore, 83 per cent of the exports were in relatively short distance to its physical capital endowment. therefore, other factors hamper the sustainability of these specific export relationships. the distance between the factor content of south africa’s extinctions within the intensive margin and its endowment point is shown in figure 8. as mentioned, the extinctions are dominated by one single and unclassified product, which is depicted in the upper-left quadrant. the figure shows that most of the extinctions are located in the upper-right quadrant (21 per cent). this means that most of the export relations that became extinct are located beyond the country’s endowment in both human and physical capital. therefore, these exports could not be sustained based on the current levels of comparative advantage. 0 50 000 100 000 150 000 200 000 250 000 0 2 4 6 8 10 12 14 16 r ev el ae d ph ys ic al c ap itl a in te ns ity revealed human capital intensity im increase factor intensities 26% 65% 0.1% 10% 260 sajems ns 19 (2016) no 2:249-263 figure 7 decreases in south africa’s intensive margin relative to factor endowments source: authors’ own calculations based on data from un comtrade (2014) and shirotori and tumurchudur (2010) figure 8 extinctions in south africa’s intensive margin relative to factor endowments source: authors’ own calculations based on data from un comtrade (2014) and shirotori and tumurchudur (2010) in order to explore the empirical relationship between the intensive margin (im) and the distance to the country’s endowment point for physical(d_rci) and human capital (d_rhci), a 0 50 000 100 000 150 000 200 000 250 000 0 2 4 6 8 10 12 14 r ev el ae d ph ys ic al c ap itl a in te ns ity revealed human capital intensity im decrease factor intensities 53% 38% 9% 0.2% 0 50 000 100 000 150 000 200 000 250 000 300 000 0 2 4 6 8 10 12 14 16 r ev el ae d ph ys ic al c ap itl a in te ns ity revealed human capital intensity im extinction factor intensities 9% 21% 5% 0.4% unclassified 63% sajems ns 19 (2016) no 2:249-263 261 correlation analysis was conducted in spss 22 (with non-parametric data). the results are presented in table 4 and these reveal that there are some significant statistical relationships. increases within the intensive margin are negatively correlated with the distance between endowment point and factor intensity of physical and human capital. although the coefficients are relatively small, they are statistically significant. this implies that the further the product is removed from the country’s endowment point, the smaller its contribution to increases within the intensive margin will be. the decreases in the intensive margin are positively correlated with the distance to the country’s human and physical capital levels. since the decreases (as well as extinctions) are measured by negative values, these results are in line with expectations. therefore, the further removed from the endowment point, the larger the decreases within the intensive margin will be. products further removed from what can be supported by the economy in terms of human and physical capital are more difficult to sustain. the last column in table 4 shows that this is also the case for the extinctions within the intensive margin. table 4 correlation analysis of factor intensities within the intensive margin spearman’s correlation coefficients im_incr im_decr im_ext d_rci -0.066* 0.107* 0.155* d_rhci -0.035 0.055** 0.066* note:*significant at the 0.01 level, **significant at the 0.05 level source: authors’ own calculations using spss 22 the general pattern that arises from this section is that the shifts within the intensive margin are to some degree determined by the relative “distance” to the country’s endowment levels in human and physical capital. it was mentioned that other factors do play a role in sustaining and growing exports; however, increasing the levels of human and physical capital endowment will enhance the sustainability of export growth in specifically mediumto high-skilland technology-intensive manufactures. 5 discussion and conclusion most export growth occurs along the intensive margin: great volumes of the same products to the same markets. for developing countries the challenge is structural transformation and export diversification. this means exporting fewer primary commodities and more manufactured and higher productivity goods for growth and development. since south africa’s integration into the global economy in 1994, government strategies have emphasised export diversification as a means to drive growth. this paper decomposed south africa’s exports along the intensive margin. the results show that the largest increase in exports was in non-fuel primary commodities (38 per cent). the second largest increase was in medium-skill-, technology-intensive manufactures (22 per cent). the largest decrease was 50 per cent in resource-intensive manufactures. it was not the aim of this article to explain these changes, but the decomposition by export markets allows one to draw some conclusions. the growth in the exports of non-fuel primary commodities was driven by chinese demand. the decreases in the intensive margin can also be ascribed to decreases in chinese and u.s. demand for low-skilland technology intensive products from south africa. the product categories that saw the decreases and extinctions included precious stones, iron and steel products as well as, paper-, wooland leather-related products. more than a third of the growth in the exports of medium-skilland high-skilltechnology intensive products came from sub-saharan africa. the implications are clear: in the years to come, slower and less resource-intensive growth in the chinese economy will be to the detriment of south african exports. there may be opportunities in africa, but they require further diversification into mediumand high-skill products. 262 sajems ns 19 (2016) no 2:249-263 the results from the analysis of the factor intensity of exports show that diversification away from south africa’s comparative advantage will prove difficult. the further away an exported product is from the country’s endowment point, the smaller its contribution to increases in the intensive margin will be. products that are further away from the endowment point are also associated with larger decreases and extinctions. thus, the conclusions are obvious: exporter firms will find it easier to build on their strengths. policymakers who want to help to diversify markets, should support exporters of products close to the factor endowment. the analysis shows that this includes products such as meat, bovine leather, vegetable products, soya beans, copper ores and concentrates, industrial fatty alcohols and disodium carbonate. further diversification cannot be about assistance or incentives. it invokes the challenge of the structural transformation of the economy. to export more medium-skilland high-skill technology-intensive products will require the investments in infrastructure and human capital that everyone is calling for. endnotes 1 this author also acknowledges support from the national research foundation of south africa (grant number 90709). any opinion, finding and conclusion or recommendation expressed in this material is that of the authors and the nrf does not accept any liability in this regard. furthermore, the financial assistance of the world trade organization (wto) towards this research is hereby acknowledged. opinions expressed and conclusions arrived at are those of the authors and should not necessarily be attributed to the wto. 2 similar results on the contribution of the intensive margin to export growth can be found in studies on turkey (türkcan, 2014), china (amiti & freund, 2008), colombia (eaton et al., 2007), on a group of countries classified as both developed and developing (amurgo-pacheco & pierola, 2008) and on the manufacturing sector of 46 countries (besedes & prusa, 2011). references amin gutiérrez de piñeres, s. & ferrantino, m. 1997. export diversification and structural dynamics in the growth process: the case of chile. journal of development economics, 52(2):375-391. amiti, m. & freund, c. 2008. the anatomy of china’s export growth. policy research working paper no. 4628. world bank group: washington, dc. amurgo-pachero, a. & pierola, m.d. 2008. patterns of export diversification in developing countries: intensive and extensive margins. policy research working paper no. 4473. world bank group: washington, dc. ancharez, v. & pfister, a. 2013. trade as a compass for ldcs structural transformation. bridges africa, 2(2). available at: http://www.ictsd.org/bridges-news/bridges-africa/news/trade-as-a-compass-forldcs-structural-transformation [accessed january 2015]. basu, s.r. 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(2014). united nations' commodity trade statistics database [internet]. available at: http://wits.worldbank.org/wits/ [accessed december 2014]. new york, ny: united nations statistics division. world bank. 2012. exporter dynamics database. available from http://data.worldbank.org/datacatalog/exporter-dynamics-database [accessed december 2014]. world bank. 2015. development indicators of south africa. available at: http://databank.worldbank.org/ data/views/reports/tableview.aspx [accessed january 2015]. wto-unctad. 2012. a practical guide to trade policy analysis. available at: http://wits.worldbank.org/ wits/docs/wto_unctad12_e.pdf [accessed january 2015]. microsoft word 5 jacobs et al sajems 15(3) 2012.docx 294 sajems ns 15 (2012) no 3 the regulatory treatment of liquidity risk in south africa1 johann jacobs and paul styger school of economics, north-west university gary van vuuren fitch ratings, london and school of economics, north-west university accepted: january 2012 the basel accord describes the regulatory capital requirements for credit, market and operational risk. the accord aims to provide guidelines to level the playing field for all internationally active banks and to protect consumers against these risks. despite the growing significance to bank solvency of liquidity risk, it is omitted from the new accord2. banks are not required to measure and manage this risk yet they are often considerably exposed to the threat of severely diminished liquidity. this omission from the accord could have dire consequences for banks and the economy in which they operate: liquidity crises can occur without warning and spread quickly to other parts of the financial system. this article critically explores current practices in south africa and proposes guidelines for effective liquidity risk regulation. key words: liquidity risk, basel ii, regulatory capital, south africa jel: g28 1 introduction central to bank liquidity is the fact that most banks are in the business of liquidity transformation, i.e. they take deposits that are often payable to customers on demand or on notice over a short period and use it to fund credit facilities to borrowers over longer periods (financial supervision commission, 2005:2). it is often argued that credit risk is the single largest risk facing banks, but more banks have failed because of liquidity risk than credit risk (hoggarth, reidhill & sinclair, 2003:109). banks are particularly vulnerable to sudden unexpected demands for funds. liquidity problems experienced by a particular bank can quickly and easily spread to other banks and cause systemic risk (reserve bank of australia, 1998:1), thereby causing contagion effects across an entire banking system. west (2004:8-13) identified some major financial risk management crises that occurred during the past decade and found liquidity risk to be central. high-profile financial disasters such as those by orange county municipality, barings bank, long term capital management (ltcm), enron and amaranth advisors llc have reiterated the integral part that risk management has to play in the day-to-day management of banks and other institutions. it is, therefore, important that liquidity risk management be part of banks’ overall risk management strategies. tighter regulation (in the form of higher capital requirements) and an obligation to obtain long-term subordinated debt or specific liquid asset reserve requirements are two possible solutions (wolf, 2007). the core principles for effective banking supervision, developed by the bank for international settlements (bis) in co-operation with fellow regulators, have effectively become the standard for sound prudential regulation and supervision of banks (bis, 2006a:1). the basel core principles were first introduced in 1997 and revised in 2006. these determine the fundamental factors for banking supervision and represent the measures used for assessing abstract sajems ns 15 (2012) no 3 295 the performance of the bank supervision department (bsd) of the south african reserve bank (sarb) against international standards and they are used as a yardstick for supervising the performance of banks. the bis has issued guidelines on the sound management of liquidity risk for banking institutions. these practices, which comprise 14 principles designed to ensure sound liquidity management, are set forth in two papers called sound practices for managing liquidity in banking organisations (bis, 2000) and the joint forum: the management of liquidity risk in financial groups (bis, 2006c). these quantitative and qualitative standards and guidelines, together with the basel core principles, serve as the only guidelines on the regulatory treatment of liquidity risk. these guidelines and practices do not quantify liquidity risk and therefore do not draw sufficient attention to the severity posed by inadequate liquidity risk management. berger and bouwman (2006:1) support this view and note that no comprehensive measure for bank liquidity risk currently exists. for this reason they attempted to develop a comprehensive measure and explored the relationship between bank liquidity creation and capital. other insights are provided by belousov and bobyshev (2005:3) who explain how liquidity risk should be incorporated into overall market risk measurement while kronseder (2003b) explores the possibility of applying a ‘liquidity-at-risk’ measure to complement current measures. both kronseder (2003a:4) and the bis (2006c:6) have explicitly identified and discussed the sources of liquidity risk. the hong kong monetary authority (2004:52), among others, has identified early warning signals for liquidity problems. despite the importance of measuring and managing liquidity risk correctly, the regulatory treatment of liquidity risk under basel ii, however, remains vague and inadequate. the term ‘liquidity risk’ appears only three times in the basel ii accord of almost 350 pages and no capital charge (pillar 1) for liquidity risk is proposed (bis, 2000:1). the failure of many banks as a result of liquidity crises, the exposure of banks to liquidity risk on a daily basis and the uncertain treatment of liquidity risk under basel ii has prompted the following questions: • ‘should regulators require a capital charge for liquidity risk?’ and • ‘how should liquidity risk be treated from a regulatory perspective under basel ii, given current practices in the management and measurement of liquidity risk?’ inadequate liquidity risk management could be calamitous for banks since liquidity crises usually occur – like most risks – without warning. this article aims to explore current practices of the management and measurement of liquidity risk and to propose guidelines for effective liquidity risk regulation in south africa. in addition, recommendations regarding the regulatory treatment of liquidity risk in south africa under basel ii by the south african regulator, the bank supervision department (bsd) of the sarb, are also provided. the article is structured as follows: section 2 provides the context for the management of liquidity risk by briefly describing basel ii and reviewing some of the recent literature regarding the regulation of liquidity risk. section 3 describes the methodology used to analyse liquidity risk in south africa in order to provide conclusions and recommendations on the regulation thereof. the main analytical findings are presented in section 4 and section 5 discusses the major findings along with policy implications. section 6 concludes the article. 2 conceptual framework the basel committee for banking supervision (bcbs) was established by the central bank governors of the group of ten countries at the end of 1974 as a result of serious turbulence in international currency and banking markets (lachapelle & lenormand, 2007:5). this turbu lence was partly caused by the collapse of the bretton woods system of fixed exchange rates. during the early 1980s the bcbs became concerned that the capital reserves of the main international banks were deteriorating just when international risks, particularly those in comparison with heavily indebted countries, were growing (styger & vosloo, 2005:1). the bis (1999:4) adds that, for this reason, most of the bcbs time was devoted to capital adequacy and stronger convergence of the 296 sajems ns 15 (2012) no 3 measurement of global capital adequacy. with a capital buffer against unforeseen losses, the bcbs argued that the risk of crises in the banking system would be reduced and the stability of the system would increase (finansinspektionen, 2005:3). the result was the materialisation of a broad consensus on a weighted approach for the measurement of risks for both onand offbalance-sheet activities and the identification of the need for a multinational accord for the implementation thereof (styger & vosloo, 2005:1). this led to an accord titled international convergence of capital measurement and capital standards (bis, 1988). this document was intended to level the playing field in international banking by addressing geographic inequality in regulation and to establish consistent minimum regulatory capital requirements for banks (filenet, 2007:2) and has become known as the basel capital accord, or the 1988 accord. a minimum regulatory capital standard for member countries of 8 per cent of their risk-weighted assets was introduced in the accord by the end of 1992 (oesterreichische nationalbank, 2007:2). this framework has been progressively introduced in member countries since 1988, as well as in practically all other countries with active international banks (mendoza & stephanou, 2005:3). the 1988 accord was not intended to be static, but to evolve over time and, for this reason, the bis issued a proposal in june 1999 for a new capital adequacy framework to replace the 1988 accord (shadow financial regulatory committees (sfrc), 1999:1). cognos (2003:1) noted that the rationale for the new framework came from the significant changes to approaches in financial markets, banking, risk management and general management practices since 1998. the refinement of this proposal (bis, 2007b:3) has been taking place ever since which has concluded in the release of the comprehensive version of the new capital framework in june 2006, called international convergence of capital measurement and capital standards, known as basel ii (bis, 2006b). the purpose of basel ii is to promote world-wide financial stability by co-ordinating supervisory definitions of capital, risk assessments and standards for capital adequacy across countries (bis, 1999:9). in addition, a bank’s capital requirements were to be linked systematically to the risk level of its activities, including various off-balance sheet forms of exposure (cognos, 2003:1). basel ii was designed to improve the way in which regulatory capital requirements reflect fundamental risks and to provide better coverage of the financial innovation that has occurred in recent years (bis, 2007b:3). the changes from the 1988 accord were aimed at rewarding the advancements made in the field of risk measurement and providing incentives for improvements to continue (sfrc, 1999:2). in other words, basel ii intends to bring a greater emphasis to risk measurement and management practices in banks and to better align capital reserves with actual risk exposures (filenet, 2007:2). van roy (2005:7) argues that the basel ii accord is more risk-sensitive than the previous accord. basel ii consists of three pillars, namely (bis, 1999:6): 1) pillar 1: minimum regulatory capital requirements – the minimum level of regulatory capital requirements. pillar 1 seeks to develop and expand on the standardised rules as contained in the 1988 accord and sets out minimum capital requirements only for credit, market and operational risk. 2) pillar 2: the supervisory review process – the supervisory review of a bank’s capital adequacy and internal assessment processes, including its icaap. 3) pillar 3: market discipline – the effective use of market discipline to strengthen disclosure of information by banks and to encourage safe and sound banking practices. the bis believes that these three elements collectively are the essential pillars of an effective capital framework (van roy, 2005:7). banks and other interested parties have welcomed the three-pillar approach. despite the lack of detail regarding the regulatory treatment of liquidity risk in basel ii, the bis (1992:3) stated that the management and measurement of liquidity are considered to be among the most important activities undertaken by banks. a bank must assure itself that it can meet its obligations when they become sajems ns 15 (2012) no 3 297 due in order to reduce the probability of liquidity problems. in addition, a bank’s liquidity position determines the time that it has available to address problems even when such problems originate in other areas of the bank. since 1992, when the bis published a paper called a framework for measuring and managing liquidity, the bis focussed on enhancing the way in which international banks manage their liquidity on a worldwide basis. this paper is based on the presumption that the supervision of liquidity risk is most effective if it is based on regular interaction between banks and their regulators (bis, 1992:1). however, since publication, technological and financial innovations have provided banks with new and different ways of funding their activities and managing their liquidity. banks’ declining ability to rely on core deposits, along with increased dependence on wholesale funds and the global financial market turmoil in the mid to late 1990s, profoundly changed views on liquidity. a combination of all these changes left banks facing new challenges regarding the management and measurement of liquidity risk. for this reason the bis published a paper in 2000 which served as an update of the 1992 paper and was called sound practices for managing liquidity in banking organisations (bis, 2000). this paper sets out 14 key principles as recommendations to banks in their management and measurement of liquidity risk. principles 1 to 4 deal with the establishment of a structure for the management of liquidity risk; principles 5 to 7 deal with the management and measurement of a bank’s net funding requirements; principle 8 with the management of market access and principle 9 with contingency planning; principles 10 and 11 describe the management of foreign currency liquidity; principle 12 deals with the internal controls for effective liquidity risk management; principle 13 with the role and importance of public disclosure and reporting of liquidity risk; and principle 14 deals with the role of regulators. in 2006 the bis published a further paper called the management of liquidity risk in financial groups (bis, 2006c) which focused on best practices of managing liquidity risk in multinationals which were engaged in banking, insurance and securities activities. in march 2007 the institute of international finance (iif) published a paper named principles of liquidity risk management (iif, 2007). this paper was based on work done by a special committee that was established by the iif late in 2005 and represented about 40 of the largest banks in the world. the objective of the special committee was to develop a perspective and provide recommendations on liquidity risk measurement, monitoring, management and governance at financial institutions (weinberg, 2007:2). the special committee made 44 recommendations for the sound management of liquidity risk. the first 13 recommendations address the governance and organisational structure for managing liquidity risk, while recommendations 14 to 30 address the analytical framework for measuring, monitoring and controlling of liquidity risk. recommendations 31 to 44 address liquidity stress testing and contingency planning. it is important that the basel core principles be considered when developing an approach for the regulation of liquidity risk, since the bsd is assessed by the international monetary fund (imf) in terms of its compliance with these principles. although these articles may provide valuable insights for regulators regarding the regulation of liquidity risk, liquidity risk regulation is not explicitly discussed. for this reason, sharma (2004:5) argues that liquidity risk has been too long overlooked as a focus of attention for regulatory reform. this view is supported by the bcbs who issued a press release in october 2007 emphasising the need for ‘strengthening supervision and risk management practices in areas like liquidity risk’ after the liquidity crunch experienced by the large uk building society, northern rock, in september 2007 (bis, 2007a:1). since south africa forms part of the global economy, it is inevitably affected by global developments. while keeping in mind the turbulent financial markets that have been prevalent across the world over the past couple of years, including liquidity problems experienced, and the fact that south africa adopted the basel accord, a study around the regulation on liquidity risk is not only pertinent, but necessary. 298 sajems ns 15 (2012) no 3 3 methodology to explore current practices in south africa critically and propose guidelines for effective liquidity risk regulation, a quantitative analysis on liquidity risk in the south african banking system was conducted. a liquidity risk question naire was presented to various bankers and ex-bankers in order to assess whether it is prudent for regulators, in their view, to require banks to hold capital for liquidity risk. the questionnaire was tested on a number of bankers before it was sent to eight experienced professionals from the major south african banks including liquidity risk managers, treasurers, ex-treasurers, market risk managers and analysts. although it is acknowledged that eight professionals does not constitute a large enough sample to make meaningful conclusions, the purpose of the questionnaire was not to draw definitive conclusions, but rather to gauge different views among respondents. the analysis of the liquidity risk questionnaire was not done for a specific period analysed, but rather as a general point-in-time questionnaire that covered historical events and current and future views on liquidity risk in south africa. to determine the state of funding liquidity (and therefore the degree of funding liquidity risk in a country’s banking sector) the analysis of an aggregated balance sheet (of all the banks in a particular country) could prove useful. data were gathered from the sarb website where all di3 returns submitted by the banks to the sarb are available in an aggregated format. data from the di 100 (regulatory balance sheet) and di 300 (liquidity risk return) for 60 months (from may 2002 to april 2007) for the aggregate banking sector was applied. the liabilities and assets of the di 100 were analysed separately in terms of term structure and composition before a conclusion was reached regarding a possible funding mismatch of the south african banking sector (sabs) (aggregated). the analysis conducted on the aggregated di 300 used only lines 1-7 of the return, or the contractual mismatch (sarb, 2007a). the reason is that different banks apply different alco models and apply different assumptions to derive their respective theoretical mismatch figures, whereas contractual mismatches are not subject to any assumptions. the analysis on the di 300 was conducted to determine whether results would support those from the analysis done on the di 100. an analysis on the aggregated figures of the sabs, however, is not indicative of exactly where liquidity risk resides. the di 900 return (completed and submitted to the sarb on a monthly basis), indicates the institutional and maturity breakdown of liabilities and assets. data were collected from the di 900 for five quarterly periods from april 2006 to april 2007 and not for the same period of time as was the case for the analyses on the di 100 and di 300 returns. the reason was to avoid the onerous exercise of calculating eleven ratios for eleven institutions for sixty months. it should be noted that each return represents a datum only for the month in which it was submitted. the analysis conducted on the di 900 was similar to the analysis done by saayman (2003), where the ratios used fell perfectly into the paradigm of this article. the liquidity positions of 10 different banks as well as that of the total banking sector in south africa were calculated. the calculation included three large banks from peer group 1,4 one bank from peer group 2,5 three banks from peer group 36 two banks from peer group 47 and ons from peer group 58. five months of information was used, namely april 2006, july 2006, october 2006, january 2007 and april 2007. the most widely used ratios to measure the banks’ liquidity positions include the loan-todeposit ratio, the loan-to-liability ratio, the liquid-asset-to-liability ratio and the volatile liability dependency ratio (saayman, 2003:5). the liquidity ratios were calculated as follows: i the loan-to-deposit ratio. the following loan categories were included in the analysis, namely: loans and advances within the same group (line 101 column 3), instalment debtors (line 113 column 3), mortgage advances (line 118 column 3), credit card debtors (line 126 column 3), other overdrafts and loans to the public sector (line 154 column 3) and other private sector loans and advances (line 163 column 3). deposits include deposits over all terms sajems ns 15 (2012) no 3 299 and to all counterparties (line 1 column 8) (south africa (sa), 2000:228-238). a higher loan-to-deposit ratio indicates lower liquidity (olson research (or), 2000:12). from the definition, a loan-to-deposit ratio of one or more would indicate extremely low, or even negative liquidity. ii the loan-to-liability ratio. the same loan categories used to calculate the loan-todeposit ratio were used. total liabilities were calculated as the sum of total funding-related liabilities to the public (line 63 column 4), outstanding liabilities on behalf of clients (line 64 column 4) and other liabilities (line 65 column 4) (sarb, 2007a). a higher ratio indicates lower liquidity because this ratio indicates the contribution of loans to total liabilities (saayman, 2003:5). iii the liquid-asset-to-liability ratio. all items that can easily be turned into cash were viewed as liquid assets (saayman, 2003:5). these liquid assets include central bank money and gold (line 86 column 3), sa bank group funding, including negotiable certificates of deposit (ncds) (line 96 column 3), south african interbank group funding, including ncds (line 102 column 3), loans granted under resale agreements (line 109 column 3), liquid bills, notes and acceptances (line 131 column 3), deposits with and advances to the sarb (line 142 column 3), deposits with and advances to south african banks (line 143 column 3), marketable south african government stock (unexpired maturity of up to three years), other public sector interest-bearing securities (line 187 column 3) and debentures and other interest-bearing security investments (line 194 column 3) (sa, 2000: 228:238). although a lower ratio indicates lower levels of liquidity, it can be expected in south africa to be around 0.20 due to the liquid asset reserve requirements that are 5 per cent of banks’ reduced liabilities (saayman, 2003:5). iv the volatile liability dependency ratio. the volatile dependency ratio is the difference between volatile liabilities and liquid assets, relative to earning assets (saayman, 2003: 5). it measures the relationship between long-term earnings assets and net shortterm funds (or, 2000:13). liquid assets were calculated as described above, while the volatile liabilities were calculated as the sum of cash managed, cheques and transmission deposits (line 1 column 1), other demand deposits (line 1 column 2), short-term savings (line 1 column 3) and other short-term deposits (line 1 column 4). earning assets are calculated as the sum of deposits, loans and advances (line 95 column 3) and the investments (line 176 column 3) of a specific bank. a negative value indicates more liquid assets than volatile liabilities (or, 2000:13). in addition to these general measures of liquidity, liability liquidity measures were also calculated. liability liquidity refers to the bank’s ability to raise liquid funds through borrowings in the money market (saayman, 2003:4). four liability liquidity ratios for the 10 selected south african banks were calculated, being the total-deposit-to-totalliability ratio (as a measure of the bank’s asset composition), the equity-to-total-assets ratio (as a measure of the capital base) and the percentage composition of deposits (saayman, 2003:6). 1 the total-deposit-to-total-liability ratio. the total deposit value from the di 900 returns (line 1 column 8) was used and the total liabilities were calculated as above. higher ratios indicate more reliance on deposits (saayman, 2003:6). 2 the equity-to-total-asset ratio. the equityto-total-asset ratio was calculated by dividing the capital and reserve funds of the bank (line 71 column 1) by the total assets of the bank (line 224 column 3) (sarb, 2007a). a lower equity-to-total-asset ratio indicates that capital is applied more effectively (saayman, 2003:6). 3 the percentage composition of deposits. in calculating the percentage composition of deposits, the different types of deposits were determined relative to the total deposit value (line 1 column 8) of each bank – much the same as the percentage composition of liabilities calculated for the aggregated banks balance sheet. cash managed, cheque and transmission deposits (line 1 column 1) and other demand deposits 300 sajems ns 15 (2012) no 3 (line 1 column 2) were added to calculate the value of total demand deposits. shortterm deposits are the sum of short-term savings (line 1 column 3) and other shortterm deposits (line 1 column 4). mediumterm deposits are calculated as the sum of medium-term savings (line 1 column 5) and other medium-term deposits (line 1 column 6) and long-term deposits are indicated separately in the di 900 (line 1 column 7). 4 net liquid assets. net liquid assets are calculated as the difference between liquid assets and volatile liabilities. liquid assets and volatile liabilities were calculated in the same way as discussed above. a positive liquid asset value highlights the importance of assets as a source of liquidity for these banks. these calculations, however, do not explicitly describe liquidity risk or the perceptions thereof in south africa whilst clearly this need exists. because of the difficulty in measuring and observing liquidity risk, a short questionnaire comprising 11 questions was compiled in order to gauge different views on liquidity risk and its possible regulation9. the questionnaire was tested on a number of bankers before it was sent to eight experienced professionals including liquidity risk managers, treasurers, ex-treasurers, market risk managers and analysts. respondents answered the questionnaire in writing after which answers to questions were discussed with them. the questionnaire also served as the basis for structured telephone interviews conducted with some respondents. the responses of all the respondents were combined to represent the results. 4 results analysis of the aggregated banks balance sheet liabilities funding-related liabilities had the largest contribution to total liabilities, averaging 78.9 per cent over the 60 months analysed. second largest was other liabilities and trade creditors (oltc) that made up an average of 12.8 per cent. acknowledgement of debt (da) was the smallest component of total liabilities and averaged only 0.08 per cent (capital made up the remaining 8.26 per cent. therefore, any movements in funding-related liabilities to the public automatically have the greatest impact on total liabilities. the composition of the term structure of liabilities showed that the aggregate sabs balance sheet is, as expected, dominated by short-term liabilities that made up an average of 59.4 per cent of total liabilities and capital over the period analysed. medium-term liabilities averaged 17.2 per cent and long-term liabilities averaged 15.1 per cent over the period. capital was the smallest component of total capital and liabilities and averaged 8.3 per cent. this composition is illustrated by figure 2. figure 1 shows that general growth figures for all of the categories of liabilities did not show clear trends. short-term liabilities increased at an average annual rate of 14.5 per cent, medium-term liabilities at an average annual rate of 19.5 per cent and long-term liabilities at an average annual rate of 20.1 per cent over the period analysed. even though medium and long-term liabilities have been growing at a significantly higher rate than short-term liabilities, this trend should remain for many years to reduce the domination of short-term liabilities on the balance sheet. growth in capital did not match growth in total liabilities and grew at an average annual rate of 11.7 per cent, whereas total liabilities increased at an average annual rate of 16.0 per cent over the five years analysed. assets loans and advances make up the biggest portion of total assets at 77.6 per cent over the period analysed while trading and investment positions (the second largest component) averaged 17.0 per cent. other components cumulatively contributed to 5.4 per cent of total assets and are therefore considered negligible. the composition of assets is illustrated by figure 2 while growth in assets is illustrated by figure 1. total assets (as with total liabilities) increased over the period. loans and advances increased at an average annual rate of 15.6 per cent while investment and trading positions sajems ns 15 (2012) no 3 301 increased at an average annual rate of 29.0 per cent. although slightly higher, the growth in these two items is in line with the growth rate in total assets, at 15.6 per cent. the growth rate of investment and trading positions is distorted by a large increase which occurred in 2002/03. f i g u r e 1 selected liabilities and assets average growth: 2002-03–2006/07. the term structure of assets is not divided into buckets as is the case for liabilities, but it can be assumed that a large majority of loans and advances are long-term assets according to the definition used for liabilities, i.e. longer than 6 months. when considering that mortgage loans as well as asset and vehicle financing are included in this figure, short-term loans can reasonably be expected to contribute a relatively small portion of loans and advances. when making such assumptions, it becomes apparent that the south african banks’ aggregate balance sheet may be extremely short-funded. this implies that long-term assets are funded by short-term liabilities, creating a liquidity mismatch, hence reinforcing the prevalence of liquidity risk. although it may be argued that the same liquidity risk prevails (due to the type of business that banks do), the analysis of an aggregated banks’ balance sheet in south africa proved the existence of elements of significant liquidity risk. f i g u r e 2 composition of assets and liabilities 0% 5% 10% 15% 20% 25% 30% s ho rt -t er m m ed iu m -t er m lo ng -t er m c ap ita l to ta l l ia bi lit ie s lo an s an d ad va nc es in ve st m en t p os iti on s to ta l a ss et s liabilities growth asset growth g ro w th r at e funding related liabilities, 78,9% other liabilities and trade creditors, 12,8% debt acknowledgement, 8,0% liabilities loans and advances, 77,6% other components, 5,4% investment positions, 17,0% assets 302 sajems ns 15 (2012) no 3 analyses of the aggregated banks’ liquidity risk returns from the analysis conducted on the di 300 liquidity risk returns for the sabs, the existence of significant liquidity risk from balance sheet analyses was confirmed. a conclusion that may be drawn from this analysis is that short-term liabilities are increasingly used to fund long-term assets, which represents significant growing liquidity risk in the sabs. table 1 illustrates that, although assets and liabilities seem wellmatched in percentage terms, the small per centage differences translate to large nominal mismatches, demonstrating this liquidity risk. this can be seen where a small percentage difference in the 0–31 days bucket of 0.24 per cent translates to a r373 million difference in nominal terms. an analysis on aggregated figures does not, however, indicate exactly where the liquidity risk originates. for this reason, an analysis was conducted on liquidity risk in various banks in south africa. t a b l e 1 liquidity mismatch in percentage and nominal terms days 0 – 31 32 – 60 61 – 91 92 – 181 total matching of assets & liabilities (%) average assets 77.2% 7.5% 6.6% 8.6% 100% average liabilities 77.4% 8.8% 5.9% 7.8% 100% mismatch -0.2% -1.3% 0.7% 0.8% 0% matching of assets & liabilities (nominal rmn) average assets 533.2 51.4 44.9 59.4 688.9 average liabilities 907.1 102.5 68.7 91.4 1 169.7 mismatch -373.8 -51.1 -23.8 -32.0 -480.7 analyses of banks’ di 900 returns the results for the general measures of liquidity and liability liquidity provide the following insight: in terms of the loan to-deposit ratio, a higher ratio indicates lower levels of liquidity. the total banking sector had a loan-to-deposit ratio of between 0.85 and 0.90 meaning that liquidity was a relatively large risk in the south african banking system. only one bank was a prominent outlier, indicating an extremely large level of liquidity risk. the results for the loan-to-liability ratio differed between banks. again, a larger ratio presents lower levels of liquidity. in general, the loan-to-liability ratios were at relatively low levels, meaning that liquidity levels were relatively high. again, only one bank had a relatively low level of liquidity. for the liquid assets-to-liability ratio, most of the banks that were analysed displayed low levels of liquidity as most of them had quite low ratios. for the liquid assets-to-liability ratio, four banks had exceptionally good ratios. for the total banking sector, this ratio is quite low, but still around the expected 0.20. a negative value for the volatile liability dependency ratio indicates more liquid assets than volatile liabilities. the total banking sector was found to have more liquid assets than volatile liabilities and nine of the ten banks that were analysed had negative values. only one bank had more volatile liabilities than liquid assets. a higher total-deposit-to-total-liability ratio indicates a higher dependency on deposits. this ratio was found to be very high in the sabs. only two banks had low dependencies on deposits. all the other banks that were analysed had a large dependence on deposits. the total banking sector applies its capital effectively because it has a low equity-to-totalasset ratio. the banks analysed were divided with six banks applying capital effectively and four not as effectively. the composition of deposits for the total banking sector revealed similar results to the analysis conducted on the total banks’ balance sheet. a significant portion of deposits are made up of demand deposits and short-term deposits for the total banking sector. five banks displayed similar characteristics to the whole sajems ns 15 (2012) no 3 303 banking sector, whereas the composition of deposits for the remaining banks differed from bank to bank. but, as mentioned previously, it would be extremely difficult to receive 30-year deposits that would fund 30-year loans. the main finding from conducting liquidity ratio analyses on different banks is that liquidity risk varies from one bank to the next, meaning that a universal pillar 1 capital charge for all banks would not make sense, but that liquidity risk should rather be assessed by regulators on a case-by-case basis under pillar 2 of basel ii. it was also found that the sabs relies heavily on demand and short-term deposits. this confirmed the results obtained from the analyses conducted on banks’ aggregated figures, i.e. that the sabs is extremely short-funded. liquidity risk questionnaire in general, liquidity risk is not perceived as a threat in south africa, but banks and regulators are well aware of the potential danger that it holds for individual banks and the banking system as a whole. for this reason, liquidity risk is actively monitored and managed. liquidity crises at the individual bank level as well as on a systemic level could be triggered by a wide variety of internal and external events as well as internal practices of banks. banks have contingency funding plans in place. the details of such plans, however, differ greatly between banks. in response to the question posed on whether a liquidity crisis will spread from smaller banks to larger banks (the way that the saambou and boe10 crises spread), respondents felt that a liquidity crisis in south africa will not necessarily spread from smaller banks to bigger ones, but it may spread to smaller banks if big banks experience liquidity problems. a systemic liquidity crisis may be caused by a build-up over an extended period of time, and not necessarily by a single event. it is considered that a wide variety of events can cause a systemic liquidity crisis in south africa. liquidity risk in south africa seems to be well mitigated by banks as they make use of a wide variety of instruments and strategies to mitigate liquidity risk. emphasis was placed on the fact that active and effective management and monitoring of liquidity risk are considered to be the most important liquidity risk mitigants. the south african banking system is large and stable, well regulated and also adequately capitalised. these three factors are considered to be the main liquidity risk mitigants in the south african banking system. although major structural changes have taken place in the south african banking system since the crises in 2001/02, a liquidity crisis cannot really be prevented because it typically occurs without warning. the crux of these structural changes was that legislation in banking specifically has tightened significantly since 2002, meaning that banks operate in a better-regulated and more stable environment. in addition, there are fewer small banks in the south african banking sector than before, when liquidity risk typically originated from these smaller banks. the general view amongst respondents was that it would not make sense to hold capital for liquidity risk because capital is seen as being expensive and restrictive and not an effective mitigant for liquidity risk. by requiring banks to hold capital for liquidity risk, the south african banking system also runs the risk of being over-regulated. further difficulty regarding such a capital charge includes the way in which it should be calculated. respondents felt that it would be extremely difficult to calculate such a capital charge in a sensible manner. for these reasons, a pillar 2(b) capital charge under basel ii would be more sensible to regulate liquidity risk. the objective of such a capital charge would not be to cover liquidity risk per se, but rather to impose a ‘fine’ on banks that do not manage and measure liquidity risk prudently in the regulator’s opinion until such time as it is deemed to be managing and measuring liquidity risk prudently. 5 discussion this section discusses and summarises the main findings of this study. process for reviewing liquidity risk although pillar 2 reviews a variety of other risks and not only liquidity risk, it is proposed that the liquidity risk part of such reviews should be conducted on the basis of a questionnaire used to determine possible gaps 304 sajems ns 15 (2012) no 3 between banks’ practices and prescribed criteria regarding the management and measurement of liquidity risk. accordingly, banks would have to provide responses to a standard exhaustive questionnaire on liquidity risk after which the bsd evaluates banks’ responses to the questionnaire in order to determine possible gaps between banks’ practices and prescribed criteria. these gaps would then be addressed by means of an on-site visit to the bank by a bsd team. it is important to note that such an approach has a constraint in terms of the substantial amount of work that would have to be done on the regulation of liquidity risk by both regulators and banks. therefore resource constraints and the cost versus the benefit of such an approach would have to be considered carefully. regulatory capital for liquidity risk findings from the liquidity risk questionnaire indicate that capital is not considered an effective instrument for regulating liquidity risk, because when a bank experiences liquidity problems, the best way to cope is to have a stock of liquid assets or cash. the allencompassing conclusion of this article is that capital would not be an effective mitigant for liquidity risk for a number of reasons. liquidity risk differs from bank to bank and a general capital charge for all banks may not be sensible, therefore liquidity risk should be analysed on a bank-by-bank basis. in other words, capital could be charged for liquidity risk under pillar 2(b) of basel ii. such a capital charge would not serve the purpose of covering losses resulting from liquidity risk, but would instead impose a penalty on banks that are deemed to manage and measure liquidity risk imprudently. such a penalty would typically be quite small but would serve as an incentive for banks to improve their management and measurement techniques to the desired level as set out by prescribed criteria. the criteria that should be used for determining whether banks measure and manage liquidity risk prudently should be of such a nature that the bsd complies with revised basel core principle 14: liquidity risk in regulating liquidity risk. in addition, it should align the criteria used to the 14 principles for the sound management of liquidity as prescribed in the article called sound practices for managing liquidity in banking organisations (bis, 2000). the criteria for sound liquidity risk management could be incorporated into the questionnaire that may be used to assess liquidity risk under pillar 2(b) of basel ii as part of the supervisory review and evaluation process (srep)11 process conducted by the bsd. a simple scoring approach for each question (3 = satisfactory, 2 = average and 1 = unsatisfactory) could be helpful in assessing the quality of liquidity risk management and measurement as well as identifying possible gaps between banks’ practices and prescribed guidelines that should be addressed by a bank. the basis for determining a capital charge may be based on average scores obtained from banks answering the srep section of the questionnaire. for example, a certain increment of capital could be charged for each 0.05 under the perfect score, which would be three. this may not be a scientific way in determining a pillar 2(b) capital charge, but would make sense if applied consistently. an internal models approach for liquidity risk the bsd should not prescribe to banks which methods to use to report their liquidity risk, because banks differ in terms of size and sophistication. for this reason, banks should be allowed to follow an internal models approach for liquidity risk whereby banks are, subject to regulatory approval, allowed to use their own internal liquidity risk measures to report liquidity risk to the bsd. this approach is similar to the approach followed by the bundesbank in germany. a liquidity risk questionnaire a liquidity risk questionnaire could be drafted according to which banks’ liquidity risk management and measurement is assessed in terms of the sound principles for managing liquidity risk and the basel core principles. one questionnaire could be used for both assessing the quality of banks’ liquidity risk management and measurement in terms of an srep and approval application of an internal sajems ns 15 (2012) no 3 305 models approach for liquidity risk. alternatively, the questionnaire could be divided into two clear sections whereby all banks are required to answer the srep or pillar 2(b) section, and only banks applying for the use of an internal models approach for liquidity risk are required to complete the second section. regulatory liquidity risk policy framework a further conclusion of this article is that the south african banking regulator should publish a framework in which its approach to regulating liquidity risk is described in detail. some aspects that should be included in such a document include a widely-accepted definition for liquidity risk and guidelines/minimum standards for measurement and management techniques for liquidity risk and the process that will be followed under pillar 2 of basel ii. liquidity risk mitigants if the bsd is concerned about the level of potential liquidity risk in the south african banking system, it could consider having the additional instruments that are eligible as collateral as described by sarb (2007b) included as instruments eligible for liquid assets reserve requirements. the exact impact of doing this is uncertain, but will probably lead to banks holding a larger amount of liquid assets over and above the 5 per cent requirement. this would mean that the sabs will be better protected against and better equipped to deal with liquidity problems. the process for including these instruments as liquid assets will be a tedious one, because it will mean that the south african banks act12 will have to be amended to include these instruments, as the act defines only specific instruments that may be held for this. an additional mitigant for liquidity risk may be that the bsd requires banks to report their liquidity risk on a more frequent basis than the current monthly reporting. market risk is currently reported on a daily basis simply because of the ever-changing environment. liquidity risk can also be considered to be an ever-changing risk, which will warrant more frequent reporting. 6 conclusions the results of this study indicate that capital would not be an effective mitigant for liquidity risk for several reasons. liquidity risk differs from bank to bank and a general capital charge for all banks may not be feasible. instead, liquidity risk should be analysed on a bank-by-bank basis. capital could thus be charged for liquidity risk under pillar 2(b) of basel ii. by requiring banks to complete a standard, exhaustive liquidity risk questionnaire and then awarding banks scores for each question based on the level of satisfaction of such answers, a possible capital charge could be derived. capital could then be charged in a standardised manner according to banks’ average scores obtained. such a capital charge would not serve the purpose of covering losses resulting from liquidity risk, but would instead impose a penalty on banks that are deemed to manage and measure liquidity risk imprudently. such a penalty would typically be quite small, but would serve as an incentive for banks to improve their management and measurement techniques to the desired level as set out by prescribed criteria. the criteria that should be used for determining whether banks measure and manage liquidity risk prudently should be of such a nature that the bsd of the sarb complies with basel core principle 14: liquidity risk in regulating liquidity risk. it should also align the criteria used to the 14 principles for the sound management of liquidity as prescribed by the bis and the iif. although the findings of this article deal largely with the qualitative nature of liquidity risk management, the bis has introduced more quantitative measures to reinforce the qualitative approach in december 2010 as part of the new basel iii accord. the quantitative measures include prescribed amounts that should be achieved for banks’ liquidity coverage and stable net funding ratios. future research could include further studies on the quantitative side of liquidity risk management and supervision and the link between quantitative and qualitative measures in pursuit of a strong and resilient approach to liquidity risk regulation. 306 sajems ns 15 (2012) no 3 endnotes 1 article from master’s dissertation of the same title (december 2007). the opinions and views expressed herein are those of the authors and do not necessarily represent those of either the south african reserve bank (sarb) or north-west university. at the time of publication of this article the sarb would have decided on an approach for the regulation of liquidity risk which may not be similar to that contained in herein. 2 the bis has, since the completion of the paper upon which this article is based, finalised its approach to the regulation of liquidity risk in a paper titled basel iii: international framework for liquidity measurement, standards and monitoring in december 2010. 3 di returns were regulatory returns in which banks reported to the bsd, but these do not exist anymore as they were replaced by ba returns with the inception of basel ii. the basis of this change was simply to bring it in line with south african banking legislation, or the banks act, hence the ba-suffix. the di-suffix was for deposit-taking institution. 4 peer group 1 consists of banks that are considered to be systemically important to the south african financial system. 5 peer group 2 consists of foreign branches of banks with trading operations. 6 peer group 3 consists of banks that are involved in micro-financing and/or islamic banking. 7 banks that are included in peer group 4 are considered to be ‘niche banks’ or banks that operate in certain niche markets, such as high-value low-volume markets for more affluent clients. 8 peer group 5 consists of foreign branches of banks without trading operations. 9 the questionnaire is available from the author on request. 10 saambou bank was placed under curatorship following a run on the bank amid fears of insider trading, and bad debts in its micro lending business had put the bank under pressure. boe bank was eventually taken over by nedcor following a run on the bank by depositors amid concerns around its liquidity. in both cases, the share prices of smaller banks were significantly affected as a result. 11 the srep involves regulators identifying, reviewing and evaluating all risk factors and the relevant control factors associated with each of these risk factors. when conducting a supervisory review and evaluation process, regulators are prescribed by the bis to do a number of things. these are summarised as follows: review of adequacy of risk assessment, an assessment of capital adequacy, assessment of the control environment, a supervisory review of compliance with minimum standards and a supervisory response. 12 the south african banks act is the south african banking law with its objective being to provide for the regulation and supervision of the business of public companies taking deposits from the public; and to provide for matters therewith. references bank for international settlements, basel committee on banking supervision (bcbs). 1988. international convergence of capital measurement and capital standards. july. basel, switzerland. bank for international settlements, basel committee on banking supervision (bcbs). 1992. a framework for measuring and managing liquidity. september. basel, switzerland. 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(regulation gazette no. 21726). south african reserve bank. 2007a. electronic di returns and other information available to the public: di 100, di 300, di 310, di 400, di 900. june. available at: http://www.resbank.co.za/sarbdata/ifdata/ default.asp [accessed 2007-06-10]. south african reserve bank. 2007b. list of eligible collateral. 23 may. financial markets department. pretoria, south africa. available at: http://www.reservebank.co.za/internet/publication.nsf/ ladv/631936992c6c037f422572db00494266/$file/eligible+collateral+23+may+2007.pdf [accessed 2007-09-11]. styger, p. & vosloo, p.g. 2005. the banker’s guide to the basel ii framework. december. johannesburg, south africa. available at: http://www.banking.org.za/documents/2005/december/ infodoc_29781.pdf [accessed 2007-03-19]. van roy, p. 2005. credit-ratings and the standardised approach to credit risk in basel ii. european central bank working paper series no. 517. august. european central bank. frankfurt, germany. available at: http://www.ecb.int/pub/pdf/scpwps/ecbwp517.pdf [accessed 2007-07-27]. weinberg, m. 2007. iif report – principles of liquidity risk management: considerations for regulators. presentation given at apra liquidity risk management conference. 3-4 may. available at: http://www.apra.gov.au/policy/upload/2c-mark-weinberg-iif-report-principles-of-liquidity-riskmanagement-considerations-for-regulators.pdf [accessed 2007-06-7]. west, g. 2004. risk measurement for financial institutions. financial modelling agency, cam department, university of the witwatersrand. 25 november. johannesburg, south africa. available at: http://www.cam.wits.ac.za/mfinance/mpt2004/rm.pdf [accessed 2007-02-20]. wolf, m. 2007. from a bank run to nationalising deposits, article in financial times. 18 september. available at: http://www.ft.com/cms/s/02658970-65ec-11dc-9fbb-0000779fd2ac,s01=1.html [accessed 2007-09-19]. abstract introduction literature review research method and design results discussion: the utilisation of sustained export potential in ssa conclusions and recommendations limitations of the study and future research acknowledgements references footnotes about the author(s) gabriel mhonyera school of economics, north-west university, south africa ermie steenkamp school of economics, north-west university, south africa marianne matthee school of economics, north-west university, south africa citation mhonyera, g., steenkamp, e. & matthee, m., 2018, ‘evaluating south africa’s utilisation of sustained export potential in sub-saharan africa’, south african journal of economic and management sciences 21(1), a1927. https://doi.org/10.4102/sajems.v21i1.1927 original research evaluating south africa’s utilisation of sustained export potential in sub-saharan africa gabriel mhonyera, ermie steenkamp, marianne matthee received: 02 may 2017; accepted: 23 apr. 2018; published: 31 july 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: regional trade could be a powerful engine of economic growth and sustainable job creation. however, south africa’s exports to sub-saharan africa (ssa) are typically smaller and more short-lived than its exports to its traditional markets. this is despite south african policymakers considering trade with ssa to be a priority. aim: the aim of the article is to evaluate south africa’s utilisation of sustained export potential in ssa with a view to providing practical insights that will inform future policymaking and planning. setting: despite the priority attention given to ssa in the country’s trade policy, south africa is yet to make meaningful inroads into ssa’s largest and fastest-growing economies. method: the research method applied comprised three steps. the first step involved the identification, over a five-year period from 2010 to 2014, of consistently large and/or growing import demand in ssa for all products at the harmonised system (hs) six-digit level, as well as the identification of products south africa consistently exported competitively (sustainable exports). the second step entailed matching ssa markets with consistently large and/or growing import demand to south africa’s sustainable exports. the third step involved evaluating south africa’s utilisation of sustained export potential in ssa. results: the results reveal that south africa is utilising just over half (54%) of its sustained export potential in ssa. conclusion: south africa is, therefore, underutilising or not utilising close to 50% of its sustained export potential in ssa. most of the export potential that south africa is utilising is in eastern africa while most of the export potential that the country is underutilising and not utilising at all is in central and western africa. introduction as is the case with several other developing countries, south africa is facing considerable economic challenges, including stunted economic growth, stubbornly high unemployment, widespread poverty, and a waning interest in the country’s prospects from trade and investment partners (viviers et al. 2014). the latest economic blueprint for south africa, the national development plan (ndp), singles out the export sector as having the potential to become an engine of rapid and more job-intensive and inclusive economic growth (national planning commission [npc] 2013; world bank [wb] 2014). the ndp states that an export growth rate of 6% per annum (in volume terms) is needed to generate a 5.4% increase in real gross domestic product (gdp), which would be the catalyst for the creation of 11 million new jobs by 2030 (npc 2013:64). in 2015 and 2016, south africa registered economic growth rates of 1.3% and 0.3%, respectively (statistics south africa 2015), which point to a very worrying declining trend. although south africa’s economic growth rate has been projected to improve to 1.9% by 2020 (national treasury [nt] 2017:2), escalating political uncertainties in the country could produce a very different outcome. in the midst of this uncertainty, the need to boost export activity as a stimulant to economic activity and job creation remains a priority. even with a substantive and protracted depreciation of the domestic currency in recent years, south africa’s export performance has remained weak (international monetary fund [imf] 2015). for example, in the period january 2011 – july 2014, south africa’s exports contracted by an average of 5.7%, while the country’s share of global exports fell by almost 15% (imf 2015:49). porter, ketels and delgado (2007) acknowledge that exports based on a cheap currency or low wages are not able to sustain an attractive standard of living. although weak external demand along with low commodity prices have characterised the global economy in recent years, this does not completely explain south africa’s poor export performance. improving regional trade has been a policy objective of the south african government since the start of the post-apartheid era. in this regard, the south african government remains committed to the idea of forging mutually-beneficial trade relationships across the african continent (dti 2010). given its sizeable import market, which expanded from us$77.5 billion in 2001 to us$300 billion in 2016, sub-saharan africa (ssa) has much to offer to south african exporters (international trade centre [itc] 2017; steenkamp, sonja & viviers 2015). yet despite the priority attention given to ssa in south africa’s trade policy, the country is yet to make meaningful inroads into ssa’s largest and fastest-growing economies (industrial development co-operation [idc] 2014). for south african exports to ssa to gain traction and provide the foundation for enhanced economic growth, export opportunities have to be sustainable. for many developing countries, including south africa, new trade relationships often fail as a consequence of overlooking the significance of export sustainability (besedeš & prusa 2011; reis & farole 2012). it is thus essential for the south african government and exporting firms to target export markets that present clear and enduring export potential (shankarmahesh, olsen & honeycutt 2005). moreover, south africa should specialise in exporting products that it can produce and export consistently in a competitive manner (i.e. sustainable exports). in 2014, the wb published a report on south africa’s export competitiveness, pointing out that south africa’s exports to ssa have been more short-lived and of lower value than its exports to traditional markets (wb 2014); with the latter, in turn, having been declining for a number of years. the apparent mismatch between the opportunities presented to south african exporters by ssa and the actual export business generated prompts the central question in this article: is south africa utilising its sustained export potential in ssa? limited attention has been given in the literature as to how south africa has addressed potential export opportunities. to date, no study has been undertaken to evaluate south africa’s approach to tapping its sustained export potential in ssa. however, related studies exposed barriers to south africa’s export efforts in the ssa region (steenkamp et al. 2015) and identified specific export opportunities for south africa in the african continent (steenkamp & viviers 2012). these studies, though, are cross sections at one point in time and focused mainly on demand-side factors. this article goes further by identifying product-country combinations that reveal consistently large and/or growing import demand for the products that south africa can export consistently in a competitive way (i.e. sustainable exports)1, analysed over a five-year period. the article also evaluates south africa’s actual exports, over the five-year period, of these product-country combinations, and, therefore, determines the country’s utilisation of the sustained export potential in ssa. the rest of this article is structured as follows: section 2 contains a brief review of relevant international trade literature; the ‘research method and design’ section provides a comprehensive description of the research method and data used to determine south africa’s sustained export opportunities in ssa and to evaluate south africa’s utilisation of those sustained export opportunities; the ‘results’ section presents and analyses the results; and the ‘discussion’ section brings the article to a close with conclusions and recommendations. literature review a brief review of international trade literature establishes the theoretical basis of this article and consists of three parts: the first part focuses on export growth, the second on export sustainability and the third on export structure and factor endowments. export growth export growth has a stimulating influence across the whole economy in the form of technological spill-overs to other productive sectors and additional positive externalities (devi 2014). growth in exports is a facilitator of economies of scale and increased utilisation of capacity, inducing technological modification, easing the foreign exchange constraint and improving the productivity of capital and labour (awokuse 2003). however, export growth that is capable of stimulating sustainable economic growth takes place via the intensive and extensive margins of trade (matthee, idsardi & krugell 2016; van niekerk & viviers 2014). exports can grow in two ways. countries can export more of the goods they had previously been exporting, which is export growth in the intensive margin, or countries can begin exporting goods they had previously been exporting and/or goods they had not previously been exporting, to new destinations, which is export growth in the extensive margin (kehoe & ruhl 2003; reis & farole 2012). interestingly, for many countries (middle and high-income economies in particular) a higher proportion of export growth transpires in the intensive margin, that is, by exporting more of the same products to the same markets (brenton & newfarmer 2009). this is also true for south africa, as van niekerk and viviers (2014) and matthee et al. (2016) confirm. similarly, amiti and freund (2010:35) analyse china’s outstanding export growth along different dimensions and find that china’s real export growth, of over 500% since 1992, is primarily explained by high export growth in the intensive margin rather than the extensive margin. for developing countries, growth in the extensive margin, encompassing both new product innovations and existing products destined for new markets, is critical for driving exports and employment. lower susceptibility to external shocks, which flows from export diversification, is critical for long-term export and economic growth (reis & farole 2012). in fact, growth in the extensive margin or export diversification diminishes the risks of a balance of payments (bop) crisis and large instabilities in domestic output, such as price variations in global markets or output swings in trading partners, which can adversely affect external sector performance (agosin 2007). export growth through the intensive or extensive margins has to be sustainable if viable economic growth rates are to be achieved. in some instances, countries focus on increasing export growth without taking into consideration the survival of exports. in fact, export survival is a precondition for sustainability of export growth. export sustainability sustainability of exports is a precondition for sustainable export growth (aylward 2004). new trade relationships are important for both developed and developing countries. yet for many developing countries, new trade relationships rarely last more than two years (besedeš & prusa 2011; reis & farole 2012). cadot et al. (2011) assert that african exporters experiment a great deal in export markets that are customarily challenging. such experimentation by african exporters is usually on a small scale, with low survival rates and failure typically evident in the first year. cadot et al. (2011) also reveal that exporting firms that are diversified in terms of products, but even more diversified in terms of markets, are expected to survive beyond the first year, unlike those firms that have not achieved such diversification. furthermore, after a firm has survived the first year in a particular market, its exports grow significantly over time (cadot et al. 2011). nevertheless, current research on export survival proposes that exporting has an element of ‘learning by doing’ to it, and that the chances of export survival are greatly enhanced if a business exports identical products to other markets or exports additional products to the same markets (viviers et al. 2014). this is favourable in the context of international marketing as it reduces the impact of costly non-trade barriers, such as costs of accessing channels of distribution and product adaptation costs (anderson & coughlan 1987; calantone et al. 2004). in fact, exporters of identical products to similar export destinations exert a positive externality on new entrants. more specifically, the greater the export of identical products to similar export destinations, the higher the probability of new entrants surviving in the diversified export destinations, even though the impact is relatively small (cadot et al. 2011). besedeš and prusa (2011) clarify why so few products account for the majority of exports of developing countries and why new entrants fail in most cases. according to besedeš and prusa (2011), the literature often fails to make a distinction between export survival and trade deepening. they accuse existing studies of concentrating only on variations in export value and the number of export relationships over time, and prematurely viewing the latter as trade deepening without taking the important issue of export survival into consideration. to enhance the sustainability of export relationships, south african exporters should consider markets with consistently large and/or growing import demand. however, even in the presence of such import demand, if a country cannot consistently export competitively (i.e. maintain sustainable exports), its exports will not grow in a sustainable manner in the long run. in other words, what a country export has long-term implications for the sustainability and growth of its exports. to this end, the heckscher-ohlin trade theory emphasises the significance of a country’s factor endowments on its exports (gallagher, moreno-brid & porzecanski 2008). export structure and factor endowments current export and production structure matters for future export and economic growth since they favour innovation and permit economies to respond more flexibly to external shocks (hausmann, hwang & rodrik 2007). extensive theoretical literature centred on endogenous growth theory has proposed models to confirm that export and production structure is an essential determinant of economic performance (jarreau & poncet 2012). in addition to specialising in those sectors in which there is a comparative advantage, there are supplementary gains to be made by specialising in products that have superior positive externalities (jarreau & poncet 2012). strategies supporting this innovative process, such as promoting technology imports and technological learning, may initiate higher economic growth rates (jarreau & poncet 2012). this hypothesis received empirical support from hausmann et al. (2007), who employ cross-country panel regressions to validate that countries attaining the competence to export more sophisticated products grow more rapidly, controlling for preliminary income levels and factor endowments. therefore, what a country exports matters (hausmann et al. 2007). using regional variations within a single country (china), jarreau and poncet (2012) tested the hausmann et al. (2007) expectation that regions which develop more sophisticated products subsequently grow more rapidly. they found that even at the provincial and district level (and controlling for the level of development), significant disparity in export sophistication exists which, in turn, matters for economic growth. however, jarreau and poncet (2012) further found that growth gains from enhanced technology take place only when the technology is developed by locally-owned firms and is entrenched in ordinary trade. another channel through which export-encouraged specialisation stimulates economic growth originates in the ricardian view that certain economic activities might stimulate economic growth more than others, owing to either demand-side elements (e.g. price elasticities) or supply-side elements (e.g. technological necessities) (lee 2011). accordingly, what a country specialises in has repercussions for its economic growth performance. lee (2011) empirically investigated the extent to which technological qualities in exports affect the patterns of export-led economic growth across countries. he found that nations that have progressively specialised in exporting products with high technological content, such as electronics, pharmaceuticals and aircraft, have characteristically experienced more rapid economic growth. in contrast, countries that have trailed behind tend to progressively specialise in exporting ‘traditional’ or low-technology products, such as food and textile products. the structure of exports2 affects a country’s export and economic growth prospects. a technology-intensive export structure is desirable for a country with a considerable industrial base (lall 1999). trade liberalisation, when completely implemented, helps a country to realise existing competitive advantages, but it is highly unlikely to independently stimulate export growth (lall 1999). therefore, it is essential for countries to advance internal skills and technology and to lure foreign direct investments (fdis) to augment their export structures (lall 1999). additionally, to support the expanding role of exports and their transformation, countries’ domestic industrial policies call for emphasis to be placed on the promotion of investment in human capital, competent domestic institutions, and harmonious financial and trade supporting economic policies to increase the level of gdp per capita (hausmann & klinger 2006; rodrik 2007). research method and design study design the research method used to evaluate south africa’s utilisation of sustained export potential in ssa is shown in figure 1. the research method consists of three steps. the first step focuses on the identification of consistently large and/or growing import demand in ssa and the identification of products that south africa consistently exports competitively (i.e. sustainable exports). this is done for all products, at the harmonised system (hs) six-digit level, over a five-year period from 2010 to 2014. the second step focuses on matching ssa markets (product-country combinations) with consistently large and/or growing import demand to products that south africa consistently exports competitively (i.e. south africa’s sustainable exports). the third step focuses on an evaluation of south africa’s utilisation of sustained export potential in ssa. south africa’s actual exports (i.e. actual exports of existing products to existing and new markets) of the matched product-country combinations identified in ssa, over the five-year period from 2010 to 2014, are evaluated to determine whether they are being utilised (growing exports3), underutilised (declining exports4) or not utilised (no trade5 and/or extinct6 exports). figure 1: diagrammatic representation of the methodological steps followed in this article. a discussion of each of the methodological steps is provided in ‘data analysis’ section. data analysis step 1.1 in this step, consistently large and/or growing import demand in ssa is identified for all products at the hs six-digit level. the methodology applied in cuyvers et al. (1995:179) and cuyvers (1997:6; 2004:259–260) to identify markets with large and/or growing import demand for the different products is followed. three variables – short-term import growth, long-term import growth and import market size – are calculated for each possible product-country combination in ssa annually for five years from 2010 to 2014. short-term import growth is calculated as a simple annual growth rate in imports7, while long-term import growth is calculated as the five-year compounded annual growth rate in imports8. the relative import market size is calculated as the ratio of imports of country i for product j and the total world imports of product j (cuyvers 2004:259–260; cuyvers et al. 1995:178). import data at the hs six-digit level from 2005 to 2014 was accessed9 from the united nations commodity trade statistics database (un comtrade)10. to identify those product-country combinations in ssa attracting consistently large and/or growing import demand from 2010 to 2014, cut-off values are calculated for each of the three variables in each of the five years. following cuyvers (2004:260), cut-off values for the variables in this step are defined as follows: a scaling factor (sj) is defined first when determining the threshold of the shortand long-term import growth (willemé & van steerteghem [1993], as quoted in cuyvers [1997:5, 2004:260]). the scaling factor enables country i’s degree of specialisation in the exports of product j to be taken into consideration when defining cut-off values (cuyvers, 2004:260). it is argued that if the exporting country is already specialised in export product j as measured by the revealed comparative advantage (rca) index, the cut-off values for the demand in the importing country can be less stringent (cuyvers et al. 1995:179). the scaling factor (sj) can be mathematically formulated as (willemé & van steerteghem [1993], as quoted in cuyvers [1997:5, 2004:260]): where: rcaj: is the exporting country’s rca index for product j (balassa 1965; reis & farole 2012). rcaj is mathematically formulated as: where: xi,j: is the exports of country i (which is the country for which utilisation of sustained export potential is being evaluated) of product j xw,j: is the world exports of product j xi,tot: is the total exports of country i xw,tot: is the total exports of the world. the cut-off values are then defined as follows (willemé & van steerteghem [1993], as quoted in cuyvers [1997:5, 2004:260]): where: gi,j: is the shortor long-term import growth rate of product j in importing country i gj: is equal to, gw, j sj, if gw, j ≥ 0; or gj: is equal to, if gw, j <0 with gw,j being the rate of growth of total world imports of product j. this procedure is carried out five times for both short-term and long-term import growth rates for each year from 2010 to 2014 (cuyvers 1997:6, 2004:260). each product–country combination is assigned ‘1’ if the criterion mentioned in equation 3 is met or ‘0’ if otherwise. if the exporting country is not specialised in exporting product j (0 ≤ rcaj < 1), the shortor long-term import growth rate of product j in importing country i (gi,j) must be between one and two times the world’s average import growth rate of product j. if the exporting country is specialised in exporting product j (rcaj ≥ 1), the shortor long-term import growth rate of product j in importing country i (gi,j) is permitted to be a bit lower than11 or equal to the world’s average import growth rate of product j (cuyvers, steenkamp & viviers 2012a:62–63). in addition, the relative import market size of country i for product j is considered adequately large if (cuyvers 1997:6, 2004:260): where: mi,j : is the relative import market size of product j in country i cj : is the cut-off value for relative import market size taking into account the exporting country’s degree of specialisation in product j such that: cj = 0.02mw,j, if rcaj ≥ 1; or cj = [(3rcaj) / 100]mw,j, if rcaj < 1 with mw,j being the total world imports of product j. if the exporting country is not specialised in exporting product j (0 ≤ rcaj < 1), imports of product j in importing country i (mi,j) must be between 2% and 3% of total world imports of product j. however, if the exporting country is specialised in exporting product j (rcaj ≥ 1), imports of product j in importing country i (mi,j) must be greater than or equal to 2% of total world imports of product j (cuyvers et al. 2012a:62–63). again, this procedure is carried out five times for relative import market size from 2010 to 2014. each product-country combination is assigned ‘1’ if the criterion mentioned in equation 4 is fulfilled or ‘0’ if otherwise. the selection of markets in this step is made following the categorisation of product-country combinations, as illustrated in table 1 (cuyvers 2004:261). table 1: categorisation of product-country combinations in step 1.1. the product-country combinations are categorised annually for five years from 2010 to 2014. product-country combinations falling in any of the categories 3 to 7 (see table 1) in each of the five years from 2010 to 2014 are selected as markets offering consistently large and/or growing import demand in ssa. product-country combinations falling in categories 0, 1 and 2 (see table 1) in any of the five years are eliminated. therefore, for a product-country combination to be selected, it should consistently (that is, for five years from 2010–2014) have an import demand with at least one or a combination of the following characteristics (see table 1): relatively large import market size (category 3); relatively high shortand long-term growth (category 4); relatively high short-term growth and a relatively large import market size (category 5); relatively high long-term growth and a relatively large import market size (category 6); relatively high shortand long-term growth and a relatively large import market size (category 7). this article follows cuyvers et al. (1995:179) and cuyvers (1997:6, 2004:260) in determining markets with large and/or growing import demand. however, the article is unique in that, for the first time, it repeats this analysis annually for five years to identify those markets (in ssa) with consistently large and/or growing import demand. step 1.2 this step determines those products that south africa consistently exports competitively (i.e. sustainable exports). although the rca index is frequently used as an indicator of a country’s relative export competitiveness of a particular product, it only takes exports into account, overlooking the possibility that a country might be a net importer of the product (jessen & vignoles 2004). for that reason, the revealed trade advantage (rta) index which accounts for both exports and imports, is used in this step as a proxy for international product level export competitiveness (steenkamp et al. 2015; vollrath 1991). the rta is calculated by subtracting a country’s revealed import advantage (rma) for a particular product from its rca. in this article, it is assumed that if a product is exported consistently with a comparative advantage (rta > 0 and rca > 0.7) over a five-year period, it can be classified as a sustainable export. south africa’s export data at the hs six-digit level from 2010 to 2014 was accessed from un comtrade. therefore: where: mi,j: is the imports of country i of product j mw,j: is the world imports of product j mi,tot: is the total imports of country i mw,tot: is the total imports of the world. an rta index greater than zero discloses a positive comparative trade advantage or positive trade competitiveness (steenkamp et al. 2015; vollrath 1991). therefore, it can be assumed that an rta index greater than zero means that the majority of the products exported are produced domestically, as it corrects for re-exports (steenkamp et al. 2015; vollrath 1991). in addition to the rca and rta used in this article to identify products that south africa consistently exported competitively over a five-year period from 2010–2014 (which is assumed to indicate product level export production sustainability), factor endowments are normally used to measure product level export production sustainability (reis & farole 2012). the revealed factor intensity indices (rfii), namely, revealed human capital index (rhci) and revealed physical capital index (rpci) of products exported, reflect the human and physical capital content of exports (reis & farole 2012). according to reis and farole (2012), rfii arguably have a robust theoretical connection to comparative advantages derived from factor endowments. that is, products that are primarily exported by countries richly endowed with human capital are revealed to be human capital intensive, while those exported by countries richly endowed with physical capital are revealed to be physical capital intensive (see the ‘export structure and factor endowments’ section). economic theory envisages that countries will specialise in producing products that are intensive in their relatively abundant factor (wb 2013). data for rfii compiled by shirotori, tumurchudur and cadot (2010) were accessed from the united nations conference on trade and development (unctad)12. however, in this article, rfii are not used as selection criteria, but rather as classification criteria to indicate which of the products south africa consistently exports competitively (i.e. sustainable exports), fall within or outside south africa’s factor endowment point. this emanates from the following shortcomings of rfii: firstly, not all products exported by south africa are covered in unctad’s 2007 data for rfii compiled by shirotori et al. (2010); secondly, there are no recent data for rfii; thirdly, some products such as fresh grapes, which are generally considered to be sustainably produced by south africa, tend to have high physical and human capital requirements because they are also produced by developed countries (which are richly endowed with physical and human capital); and lastly, the latest available figure for south africa’s physical capital per worker is for 2007. south africa’s average years of schooling (9.9 years) (un 2013) and physical capital per worker of us$28 409 (shirotori et al. 2010) were used to define south africa’s factor endowment point. these are compared to the rhci and rpci required per product at the hs six-digit level to reveal whether the product falls within or outside south africa’s factor endowment point. if a product’s rhci ≤ 9.9 years and its rpci ≤ us$28 409, then the product is within south africa’s factor endowment point; if otherwise, then the product is outside south africa’s factor endowment point (see figures 2 and 5). figure 2: factor intensities for products exported by south africa which were selected in step 1.2. step 2 in this step, ssa’s consistently large and/or growing import demand is matched to south africa’s sustainable exports. in other words, ssa product-country combinations with consistently large and/or growing import demand (see step 1.1) over a five-year period from 2010 to 2014 are matched to products that consistently satisfied the selection criteria (rta > 0 and rca > 0.7, see step 1.2) over the same period, and qualified for final selection as products that south africa consistently exports competitively (i.e. sustainable exports). only product-country combinations qualified in step 1.1, and matching products qualified in step 1.2, are selected in this step. those product–country combinations with consistently large and/or growing import demand in ssa, but which south africa cannot consistently export competitively, are eliminated. this also applies to those product-country combinations that do not possess consistently large and/or growing import demand in ssa, even though south africa consistently exports the products competitively. the matched product–country combinations selected in this step qualify to enter step 3, the evaluation step. step 3 south africa’s utilisation of sustained export potential in ssa is evaluated in this step. the evaluation procedure is performed on those product-country combinations with consistently large and/or growing import demand in ssa (see step 1.1) and matched (see step 2) to the products that south africa consistently exports competitively (i.e. sustainable exports) (see step 1.2). south africa’s actual exports at the hs six-digit level over the five-year period (that is, 2010 to 2014) to these sustained export opportunities are evaluated to determine whether: they are growing, they are declining, there is no trade, or they have become extinct. these classifications are used to make recommendations to south african policymakers, export promotion organisations and industry associations. in this regard, recommendations are made as to which products and markets to investigate why south africa’s actual exports are declining, there is no trade between south africa and the importing country, or south africa’s actual exports became extinct. this is despite the presence of consistently large and/or growing import demand in such markets. similarly, policymakers, export promotion organisations and industry associations are also informed of those products and markets where south africa is utilising its sustained export potential in ssa, so that such utilisation is maintained. as discussed in the data analysis, the distance from south africa’s factor endowment point for products selected in step 2 and qualified to enter step 3 is calculated using the rfii to reflect whether the products fall within or outside south africa’s factor endowment point. these classifications are used to make recommendations to policymakers on which products need an improved endowment of human and/or physical capital, since insufficient human and/or physical capital endowments threaten export sustainability. results a broad overview of results obtained in steps 1.1 to 2 is provided in table 2. consistently large and/or growing import demand in ssa was identified in step 1.1 for all products at the hs six-digit level. no direct or mirror import data exist for the ssa countries of reunion and sudan over this period. as a result of this data constraint, consistently large and/or growing import demand was identified in the remaining 46 out of 48 ssa countries, excluding south africa. as shown in table 2, a total of 5 222 products imported by ssa countries, excluding south africa, yielded 163 452 unique product-country combinations which were analysed as a starting point in this step to identify consistently large and/or growing import demand in ssa. using the methodology as explained in the ‘data analysis’ section, a total of 223 product-country combinations with consistently large and/or growing import demand from 2010 to 2014 were selected in step 1.1, while 163 229 product-country combinations were eliminated. table 2: summary of results of product-country combinations obtained in step 1.1 to step 2. in step 1.2 (see table 2), the rta index, which includes the rca and rma indices, was used to identify products that south africa consistently exports competitively (i.e. sustainable exports). as mentioned in the ‘data analysis’ section, the rfii (that is, rhci and rpci) are normally used to measure product level export production sustainability. however, due to the shortcomings of rfii discussed in the ‘data analysis’ section, the rfii were not used as selection criteria in this article but rather as classification criteria to indicate which of the products south africa consistently exports competitively (i.e. sustainable exports) fall within or outside south africa’s factor endowment point. a total of 5 224 products exported by south africa were analysed in step 1.2 to identify which ones south africa consistently exported competitively (i.e. sustainable exports) over a five-year period from 2010 to 2014. a total of 604 products exported by south africa fulfilled the selection criteria discussed in the ‘data analysis’ section (i.e. rca > 0.7 and rta > 0 in all of the five years from 2010 to 2014), while 4620 products exported by south africa were eliminated. the rfii were used to reflect which of the 604 south africa’s sustainable export products selected in step 1.2 fall within or outside south africa’s factor endowment point. a total of 500 of the 604 products identified in step 1.2 fall within south africa’s human capital endowment (see quadrants c and d, figure 2) while a total of 42 products fall within south africa’s physical and human capital endowments (see quadrant c, figure 2). therefore, of the 604 products selected in step 1.2, a total of 42 products fall within south africa’s factor endowment point (products in quadrant c, figure 2), while 484 fall outside south africa’s factor endowment point (products in quadrants a, b, and d, figure 2). this should be interpreted in the light of the shortcomings of rfii discussed in the ‘data analysis’ section. however, 78 products also selected in step 1.2 are not covered in unctad’s data for rfii. although the rfii have limitations (see ‘data analysis’ section), this is an indication that south africa’s overall export production sustainability may be under threat due to the country’s low level of physical capital per worker (us$28 409). for export production of a particular product to be sustainable, the product must fall within the country’s endowments of human and physical capital (see quadrant c, figure 2). in step 2 (see table 2), a total of 223 product-country combinations with consistently large and/or growing import demand in ssa from 2010 to 2014 (selected in step 1.1) were matched to the 604 products consistently exported competitively by south africa (with rta > 0 and rca > 0.7), which were selected in step 1.2. a total of 94 matched product-country combinations were identified in ssa. this implies that 129 of the 223 product-country combinations selected in step 1.1 and 510 of the 604 products selected in step 1.2 were eliminated in step 2. a comparison of results obtained in steps 1.1, 1.2 and 2 at the hs two-digit level is shown in figure 3. with the exception of chemicals and allied industries, as well as minerals, the products in the product groups with the highest number of matched product-country combinations are mainly consumer agricultural products and agro-based manufactures. figure 3: comparison of results obtained in steps 1.1, 1.2 and 2 at harmonised system (hs) two-digit level. consistently large and/or growing import demand in ssa is low for products in the transportation and machinery and electrical product groups (see figure 3). these two product groups have a total of 60 products that south africa consistently export competitively (i.e. sustainable exports), but only five product-country combinations were identified as having consistently large and/or growing import demand in ssa and three of the five were matched in step 2. consistently large and/or growing import demand in ssa is also low for products in the metals product group. this group has a total of 98 products that south africa consistently export competitively (i.e. sustainable exports), but only eight product-country combinations were identified as having consistently large and/or growing import demand in ssa and three of the eight were matched in step 2. furthermore, the textile and clothing sector with 36 sustainable export products found no match in ssa’s consistently large and/or growing import demand (see figure 3). a total of 94 matched product-country combinations in ssa, identified in step 2, qualified to enter the final step (that is, step 3) in which south africa’s utilisation of sustained export potential in ssa was evaluated. the results of step 3 are discussed in the next section. discussion: the utilisation of sustained export potential in ssa in step 3, south africa’s actual exports at the hs six-digit level of the 94 matched product-country combinations identified in step 2 were evaluated to determine whether: they are growing; they are declining; there is no trade; or they have become extinct. markets in which south africa’s actual exports grew, provide evidence of utilisation of sustained export potential in ssa. on the other hand, markets in which south africa’s actual exports declined, provide evidence of underutilisation of sustained export potential in ssa, while those markets where there is no trade between south africa and the ssa importing countries, or south africa’s actual exports to ssa importing countries have become extinct, point to non-utilisation of sustained export potential in ssa. it is clear from figure 4 that south africa’s actual exports at the hs six-digit level in the five-year period from 2010 to 2014 grew in 58% of the 94 matched product-country combinations selected in step 2. however, south africa’s actual exports at the hs six-digit level in the five-year period from 2010 to 2014 declined in 21% of the 94 matched product-country combinations selected in step 2. furthermore, between 2010 and 2014, there was no trade between south africa and the ssa importing countries in 16% of the 94 matched product-country combinations selected in step 2, while south africa’s actual exports at the hs six-digit level became extinct in 5% of the 94 matched product-country combinations, over the same period. figure 4: south africa’s actual exports (from 2010 to 2014) to ssa countries at the harmonised system six-digit level for the matched product-country combinations selected in step 2. the regional status of south africa’s actual exports from 2010 to 2014 for the 94 matched product-country combinations identified in ssa is shown in table 3. most of the matched product-country combinations for which south africa’s actual exports grew from 2010 to 2014 are in eastern africa (54%). on the other hand, the majority of the matched product-country combinations for which south africa’s actual exports declined are in central africa (45%). western africa has a higher percentage (73%) of the matched product-country combinations where there is no trade between south africa and the ssa importing countries (see table 3). eastern and western africa each possess 40% of those matched product-country combinations where south africa’s actual exports became extinct. table 3: summary of the regional status of south africa’s actual exports from 2010 to 2014 for the matched product-country combinations identified in ssa. the results in table 3 reveal that south africa is increasing trade with its non-southern african customs union (sacu) southern african development community (sadc) counterparts. a total of 27 of the 29 matched product-country combinations for which south africa’s actual exports grew in ssa countries in eastern africa, over the five years from 2010 to 2014, are in non-sacu sadc members in this region. again, the rfii were used to reflect which of the 94 matched product-country combinations being evaluated fall within or outside south africa’s factor endowment point (see figure 5). figure 5: summary of results of factor intensities for the matched product-country combinations identified in ssa. of the 69 products14 under consideration, only eight fall within south africa’s factor endowment point, while 54 products fall outside south africa’s factor endowment point and seven products are not covered in unctad’s data for rfii compiled by shirotori et al. (2010). with the exception of sweetened milk and cream powder, as well as article kraftliner in quadrant b (see figure 5), products falling outside south africa’s factor endowment point are in quadrant d. this shows that south africa has the human capital but not the physical capital required to produce those products. as mentioned earlier, this is an indication that south africa’s overall export production sustainability may be under threat due to low levels of physical capital per worker. the top 10 matched product-country combinations with utilised sustained export potential in ssa are shown in table 4. there are 20 countries that possess sustained export potential that south africa is utilising. these countries include zambia, angola, zimbabwe, mozambique, and republic of the congo, which all separately possess more than five matched product-country combinations. table 4: top 10 matched product-country combinations with utilised sustained export potential in ssa. there are a total of 54 matched product-country combinations with utilised sustained export potential in ssa. examples of these matched product-country combinations include (see table 4): fresh or dried lemons to angola, the democratic republic of the congo and zambia; potatoes prepared or preserved to republic of the congo, madagascar and zambia; groats and meal of maize ‘corn’ to angola and lesotho; unfermented apple juice to cameroon and republic of the congo; and cereals (excluding maize) to angola and namibia. table 5 shows the matched product-country combinations with underutilised export potential in ssa. there are 11 countries that possess sustained export potential that south africa is underutilising. these countries include angola, gabon, ghana, mozambique, mauritania, mauritius, nigeria, tanzania, democratic republic of the congo, zambia, and zimbabwe. table 5: matched product-country combinations with underutilised sustained export potential in ssa. sustained export potential is being underutilised in 20 matched product-country combinations identified in ssa. a full list of these matched product-country combinations is provided in table 5. the matched product-country combinations with non-utilised sustained export potential in ssa are shown in table 6. there are 13 countries that possess sustained export potential that south africa is not utilising. these countries include côte d’ivoire, senegal, guinea-bissau, sao tome, malawi, niger, benin, burkina faso, cameroon, guinea, mauritania, somalia, and zambia. table 6: matched product-country combinations with non-utilised sustained export potential in ssa. there are a total of 20 matched product-country combinations with non-utilised sustained export potential in ssa. a full list of these matched product-country combinations is provided in table 6. the results presented in this section can be a starting point for policymakers and export promotion organisations as well as industry associations to obtain information and formulate strategies to enhance utilisation of sustained export opportunities for south africa identified in ssa. conclusions and recommendations in evaluating south africa’s utilisation of sustained export potential in ssa (a hitherto neglected area), this article makes an important contribution to international trade literature. the results reveal that south africa is utilising only 58% of its sustained export potential identified in ssa (i.e. growing exports in figure 4). however, it is underutilising 21% of its sustained export potential identified in ssa (i.e. declining exports in figure 4). in addition, the country is not utilising 21% of its sustained export potential identified in ssa (i.e. no trade or extinct exports in figure 4). most of the export potential that south africa is utilising is in eastern africa, whereas most of the export potential that it is underutilising as well as not utilising is in central and western africa. based on the main findings of this article, it is recommended that policymakers, export promotion organisations and industry associations investigate the reasons behind south africa’s underutilisation and non-utilisation of sustained export potential identified in ssa. having established the fundamental causes, these entities should formulate strategies aimed at enhancing the utilisation of sustained export potential in ssa which south africa is either underutilising or not utilising. policymakers, for example, can contribute by improving the country’s export environment (by investing in improved regional infrastructure to reduce trade costs), engaging in tariff policy negotiations with the relevant importing countries, and taking part in regional trade facilitation initiatives. following the recommendations of cuyvers et al. (2012b), south african export promotion organisations and industry associations can take the following actions to improve the utilisation of south africa’s sustained export potential in ssa: improving export incentives and trade financing instruments; providing market information to alert exporters to the potential of different markets; taking potential exporters on trade missions supported by media campaigns in the target countries; giving incentives to potential exporters for participating in specialised trade fairs and exhibitions which attract importers from the target countries; giving financial support for the development of publicity material and improving product design and quality; and matching south african exporters of complementary products with potential in the same target markets to form ‘piggy-back’ export systems. focus should not be completely redirected from sustained export opportunities that south africa is utilising in ssa. instead, the growth of south africa’s actual exports for such matched product-country combinations needs to be maintained. in this regard, policymakers, export promotion organisations, and industry associations should continue making strides towards improving south africa’s export competitiveness and the accessibility of such ssa markets where south africa is utilising its sustained export potential. limitations of the study and future research the following limitations related to this study are worth noting. firstly, the hs 2002 revision direct import data at the hs six-digit level is not available for most of the ssa countries (excluding south africa). in such circumstances, mirror import data had to be relied on despite direct import data being more desirable. secondly, only eight of the 9 254 product-country combinations identified in ssa countries in southern africa (excluding south africa) projected consistently large and/or growing import demand from 2010 to 2014. ssa countries in southern africa are all members of sacu. owing to the aggregation of trade data for sacu members in the un comtrade database until 2009, it is possible that the import data for individual sacu members were not properly captured. thirdly, with regard to the rfii, the results show that most of the products that south africa consistently exports competitively (i.e. sustainable exports) fall outside the country’s factor endowment point as a result of high requirements of physical capital per worker (see quadrants a, b, and d, in figure 2). such products include fresh grapes, fresh fruits, yoghurt, edible nuts, fresh apples and grape wines. the reason for these products falling outside south africa’s factor endowment point is simply that they are also produced by countries richly endowed with physical capital. hence, based on the calculation method of the rfii, they tend to have a high requirement of this factor endowment. this triggers questions about the accuracy of the 2007 unctad data for rfii compiled by shirotori et al. (2010) – notwithstanding the fact that the data have not been updated since 2010. however, this is the only available measurement of factor endowments required for exports. considering the above data limitations, future research could, firstly, investigate the accuracy of sacu data by gathering the customs data of the specific member countries. secondly, the unctad data for the rfii compiled by shirotori et al. (2010) must be updated. furthermore, to broaden the understanding of the results found in this article, future firm-level and country-specific research should be undertaken to establish the reasons behind south africa’s underutilisation and non-utilisation of sustained export potential identified in ssa. acknowledgements gabriel mhonyera acknowledges the financial assistance of the world trade organization (wto) towards this research. opinions expressed and conclusions arrived at are those of the authors and should not necessarily be attributed to the wto. in addition, marianne matthee acknowledges support from the national research foundation (nrf) of south africa (grant number 90709). any opinion, finding and conclusion or recommendation expressed in this material is that of the authors and the nrf does not accept any liability in this regard. competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions this article is based on the master’s-degree dissertation of g.m., who constructed the article. e.s. and m.m. were the supervisors, and assisted with conceptual construction of the study. references agosin, m. 2007. trade and growth: why asia grows faster than latin america, palgrave macmillan, london. amiti, m. & freund, c. 2010. the anatomy of china’s export growth. 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exports in 2014 are greater than its actual exports in 2010. 4. south africa’s actual exports in 2014 are less than its actual exports in 2010. 5. south africa’s actual exports = 0 for all the years from 2010 to 2014. 6. south africa’s actual exports > 0 from 2010 to 2013, but = 0 in 2014. 7. short-term import growth rate = ([imported value in year 2 – imported value in year 1] / imported value in year 1). 8. long-term compounded import growth rate = ([imported value in year 5 / imported value in year 1] ^ [1/n] – 1), where the number of years n = 5. 9. although the analysis runs over the period 2011 to 2014, import data for 2005 to 2010 is necessary to calculate long-term (5-year) import growth rates. 10. http://comtrade.un.org/data/ 11. between 0.8 and 1 multiplied by the world’s average import growth rate of product j. 12. http://unctad.org/sections/ditc_tab/docs/rfii_2010_excel.zip 13. sudan and reunion were excluded due to data constraints. 14. some of the matched product-country combinations consist of a single product consistently exported by south africa competitively matching to or more ssa markets with consistently large and/or growing import demand. hence, 94 matched product-country combinations identified in ssa comprises of a total of 69 products. abstract introduction theoretical foundation methodology findings conclusion acknowledgements references about the author(s) paul roos department of business management, faculty of economic and management sciences, university of pretoria, pretoria, south africa melodi botha department of business management, faculty of economic and management sciences, university of pretoria, pretoria, south africa citation roos, p. & botha, m., 2022, ‘the entrepreneurial intention-action gap and contextual factors: towards a conceptual model’, south african journal of economic and management sciences 25(1), a4232. https://doi.org/10.4102/sajems.v25i1.4232 original research the entrepreneurial intention-action gap and contextual factors: towards a conceptual model paul roos, melodi botha received: 02 july 2021; accepted: 10 feb. 2022; published: 26 apr. 2022 copyright: © 2022. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: previous work on entrepreneurial intention suggests that intention does not necessarily lead to entrepreneurial action; this is referred to in the literature as the entrepreneurial intention-action gap. current entrepreneurship literature has focused on this gap and how it occurs, but limited work focuses on the contextual factors, such as self-identity, family, and formal institutions, and their influence on the entrepreneurial intention-action gap. aim: to determine the influence contextual factors may have on an entrepreneur’s ability to overcome the entrepreneurial intention-action gap; therefore, an inductive conceptual model is developed that encompasses these influences. setting: this qualitative study was conducted with ten agri-entrepreneurs from different agricultural organisations in south africa. methods: semi-structured interviews, with a reverse-flow approach, were conducted telephonically with participants. the study employed a generic qualitative research design and atlas.ti was used to conduct thematic analysis to identify and analyse patterns (themes) that emerged from interviews with respondents. results: the study inductively develops a conceptual model that could be empirically tested in future research to determine whether this model can be used to bridge the entrepreneurial intention-action gap. this model may be applicable not only to the agriculture sector but also to other industries. conclusion: new knowledge regarding self-identity factors emerged from the findings. the article also supports existing literature by suggesting that family members have an influence on an individual’s success in becoming an entrepreneur. finally, the unique dynamics of formal institutions in south africa are presented and a contribution is made by shedding light on how entrepreneurs and formal institutions should collaborate to bridge the entrepreneurial intention-action gap. keywords: entrepreneurial intention-action gap; entrepreneurial intention; entrepreneurial action; contextual factors; self-identity; family business; formal institutions; agri-entrepreneurs; qualitative research. introduction many individuals have the intention to start a new venture and to become an entrepreneur, but only a small percentage of these proceed from intention to taking the new venture into action (oliveira & rua 2018:507–534). this creates the entrepreneurial intention-action gap and many scholars have investigated this gap by exploring the relationship between entrepreneurial intention and action (meek, pacheco & york 2010), the barriers to taking entrepreneurial action (bogatyreva & shirokova 2017; oliveira & rua 2018), and the probability of overcoming the intention-action gap (botha, carruthers & venter 2019). entrepreneurial intention refers to an individual’s belief that they will start a new business venture in the future (bird 1988:443; thompson 2009:681), whereas entrepreneurial action is action through new products or processes, entry into new markets, or the creation of new ventures (mcmullen & shepherd 2006:132). bogatyreva and shirokova (2017:34) emphasise that contextual factors may significantly affect the likelihood of an individual’s taking entrepreneurial action, suggesting that more emphasis must be placed on the context in which a prospective entrepreneur functions. current entrepreneurship studies have a descriptive focus on the skills and characteristics of an entrepreneur, but there is a need for a deeper understanding of the contextual factors that make up an entrepreneur (fitz-koch et al. 2018:129–166). fitz-koch et al. (2018:149–157) name three distinctive contextual factors within entrepreneurship that provide insight into the foundations of an entrepreneur: (1) self-identity in the entrepreneurship domain is concerned with the values and attitudes that influence motivations, goals, and intentions towards being an entrepreneur (fitz-koch et al. 2018:149–157), and plays a concrete role in the motivation process behind entrepreneurial actions (obschonka et al. 2015:773–794). (2) family influences: individuals who have entrepreneurial family members are more likely to become entrepreneurs (carr & sequeira 2007:1095; jodl et al. 2001:1249). scholars even suggest that growing up in an entrepreneurial family may be the strongest predictor for becoming an entrepreneur (lindquist, sol & van praag 2015:1). (3) formal institutions form the rules and norms of the environment within which an entrepreneur functions (bruton, ahlstrom & li 2010:422). to create an enabling environment for entrepreneurs to proceed from entrepreneurial intention to action, a strong institutional environment that motivates individuals to become entrepreneurs is crucial (autio & fu 2015:8; estrin, mickiewicz & stephan 2013:24). the purpose of this article is therefore to firstly conceptualise a deeper understanding of the gap between entrepreneurial intention and action. the understanding of this gap is crucial, as many potential entrepreneurs have high intention levels but never pursue a business start-up; that is, they never take entrepreneurial action. furthermore, this study aims to understand how the three contextual factors influence the entrepreneurial intention-action gap. the outcome of this article is to build a conceptual model that indicates how the three contextual factors influence an individual’s ability to proceed from entrepreneurial intention to action. this study is conducted in the agricultural sector and focuses on the influence that the three contextual factors have on the entrepreneurial intention-action gap of agri-entrepreneurs (i.e. entrepreneurs who are active in or closely linked to the agriculture sector). the following research questions guide the article: which self-identity traits influence the entrepreneur’s ability to progress from entrepreneurial intention to action? what influence did exposure to entrepreneurship through family members have on the entrepreneur’s ability to progress from entrepreneurial intention to action? what influence did formal institutions have on the entrepreneur’s ability to progress from entrepreneurial intention to action? this article makes two specific theoretical contributions. firstly, by developing an inductive conceptual model, value is added to an under-researched field and sector: entrepreneurship in the agriculture sector. the conceptual model is a valuable outcome for the academic community, as there is a need to form a deeper understanding of the foundation that makes up an entrepreneur who takes the leap from intention to action (bogatyreva & shirokova 2017; fitz-koch et al. 2018). inductively, the themes that emerged from the data are used to develop the conceptual model further. furthermore, understanding the contextual factors that could influence this intention-action gap could shed light on which factors are important to develop when bridging this gap. secondly, emphasising the importance of self-identity and its influence on the intention-action gap offers a greater understanding of what is required from individuals with entrepreneurial intentions to take the leap to entrepreneurial action. there is a lack of studies that focus on the role self-identity plays in taking entrepreneurial action (mcelwee 2008). the study also makes specific contributions to practice. firstly, the presented conceptual model can be used by entrepreneurial support organisations to identify potential entrepreneurs who are most likely to make the leap from entrepreneurial intention to action. the conceptual model has the potential to aid the screening processes of government entrepreneurship programmes and business incubators. secondly, future researchers can conduct empirical quantitative studies to confirm the model’s applicability. this is valuable for business incubators, as the conceptual model enables them to focus on candidates that are most likely to bridge the entrepreneurial intention-action gap, resulting in more efficient use of resources. thirdly, agri-entrepreneurs can use the conceptual model to understand how the contextual factors, specifically self-identity, can enhance their own ability to pursue new entrepreneurial opportunities or ventures within this sector. theoretical foundation defining entrepreneurs and agri-entrepreneurs longenecker et al. (2017:8) define an entrepreneur as an individual who pursues an opportunity in a new or existing business to create value, while assuming both the risks and rewards for their efforts. the definition indicates that an entrepreneur is an individual who not only recognises an opportunity but takes action in a bid to capitalise on an opportunity (kautonen, van gelderen & fink 2015:2). to make this study more specific, the term ‘agri-entrepreneur’ is used to describe an entrepreneur who operates a business in the agriculture sector. agri-entrepreneurs are farmers who have entrepreneurial attributes, such as being more equipped towards newness, innovativeness, diversification, being market orientated, and having more of an awareness of the entrepreneurial ecosystems they function in (fitz-koch et al. 2018:146; mcelwee 2008:471). although an entrepreneur is an individual who acts on recognised opportunities, being an entrepreneur is not a once-off action at a given time – entrepreneurship is a state of constant striving and improvement (boyd & vozikis 1994:63). for the purpose of this article, the term ‘entrepreneur’ refers to an individual who is exercising entrepreneurial action (e.g. starting a new business). conceptualising entrepreneurial intention and supported theories having entrepreneurial intention does not necessarily mean action and that a business will follow, because entrepreneurial intention only refers to the possibility of starting a new venture. ajzen’s theory of planned behaviour (tpb) implies there are three independent determinants of intention, namely (1) the individual’s attitude towards the intended behaviour, (2) the subjective social norms towards this intended behaviour, and (3) the individual’s perceived control over the intended behaviour (ajzen 1991:188). however, entrepreneurship research cannot depend solely on models that were developed in other domains, such as psychology, as many intention-behaviour studies concern single acts (such as taking medicine or exercising) and the entrepreneurial process is significantly more complex and enduring than performing a single act. shapero’s theory of the entrepreneurial event is more specific to the entrepreneurship domain by accounting for time lags in acting on and using potential by adding ‘propensity to act’ to the theory. the entrepreneurial event model (eem) implies that intentions are formed through perceived desirability and perceived feasibility, which are enforced by the individual’s propensity to act on decisions (krueger, reilly & carsrud 2000:418). the two main theories used in this study to shed light on entrepreneurial intention are (1) ajzen’s tpb, and (2) shapero’s theory on the entrepreneurial event (conceptualised in shapero’s eem model). these models are more similar than different; for example, common denominators in each model are the individual’s self-belief in their ability to complete a task (self-efficacy), how the individual feels about a task, and how personal and contextual factors may influence the formation of intentions. this shows that, although the theories differ, there are common themes that make up the micro-foundations that form the essence of an entrepreneur. figure 1 combines ajzen’s tpb and shapero’s eem to shed light on how these two theories together form entrepreneurial intentions. figure 1: ajzen’s theory of planned behaviour and shapero’s entrepreneurial event model on entrepreneurial intention. conceptualising entrepreneurial action and supported theories action is an imperative criterion for being an entrepreneur. the rubicon model of action (frese & zapf 1994:271–340) consists of four distinct phases that follow each other in a specific order, namely: predecisional phase, postdecisional-preactional phase, actional phase, and postactional phase. the predecisional phase is characterised by ‘wishing for and deliberating about ventures that an individual may want to pursue’. this is followed by deciding and the preactional phase, where the individual chooses which actions to pursue after having compared all possibilities and having weighed the desirability and feasibility of each. thereafter, the individual forms an intention to see the action through. the third phase is action initiation and the actional phase. here one must be mindful that not all intentions proceed into actions. the likelihood of proceeding from goal intentions to actions is determined by the volitional strength of the goal intention, meaning that an individual is more likely to pursue a goal if the individual believes they can obtain the goal and that the benefits of achieving the goal will be worthwhile. the final phase of the rubicon model of action is goal achievement and the postactional phase. this phase is concerned with evaluating whether the entrepreneur achieved the intended goal (frese & zapf 1994:271–340). the model based on the action regulation theory (gollwitzer 1990:53–92) is partially like the rubicon model of action. the steps within this action model are: (1) goal development, (2) orientation, (3) plan generation and decision, (4) execution monitoring, and (5) feedback. according to frese and zapf (1994), goal development is a complex process that stems from the wishes of an individual, which translate into wants and, after comparison with other wants, translate into intentions, whereafter a goal can be developed. the second phase is goal orientation, where the individual prepares to strive towards the goal. this is followed by plan generation and decision-making, where the individual synthesises the desired result and what is required to achieve this goal within the given environment. the next phase is plan execution and monitoring, where the individual navigates the environment and constantly adapts to changes to achieve their goals. the last phase in this model is the feedback phase, where they assess how far they have progressed towards the goal (frese & zapf 1994:271–340). the theory takes the individual through the process of first forming possible desirable outcomes and comparing these to find which outcomes to strive towards. after the individual decides on the best goal, planning and actions towards this goal follow. there is also a reflective phase that enables the individual to do introspection into goal attainment. figure 2 combines the rubicon model of action and action regulation theory in relation to entrepreneurial action. figure 2: the rubicon model of action and action regulation theory on entrepreneurial action. the entrepreneurial intention-action gap forming intentions and planning to start a new business are not enough to make an entrepreneur (mcmullen & shepherd 2006:134). entrepreneurial intentions are only a ‘screening process’ that separates individuals who intend to be an entrepreneur and individuals who are not interested in pursuing an entrepreneurial path. it appears that a significant portion of individuals who intend to become entrepreneurs are unable to close the gap between intentions and actions (bogatyreva & shirokova 2017; meek et al. 2010:493–509; oliveira & rua 2018:507–534). therefore, scholars investigate a growing research construct, namely the entrepreneurial intention-action gap (bogatyreva & shirokova 2017; botha et al. 2019:1–15; meek et al. 2010:493–509). oliveira and rua (2018:526) found that 69% of respondents were unable to proceed to entrepreneurial action and certain barriers had a significant impact on an individual’s ability to take entrepreneurial action. financial resources and personal barriers were the most significant in hindering an individual’s ability to continue to entrepreneurial action. with regard to the institutional environment, bogatyreva and shirokova (2017) found a positive relationship between a supportive entrepreneurial university environment and the likelihood of entrepreneurial action for university students. the same positive relationship occurs where there are well-developed entrepreneurial institutions. even among existing entrepreneurs, intentions do not always lead to action. botha et al. (2019) suggest that entrepreneurial competencies might be the missing link that is required to proceed from entrepreneurial intention to action. from these competencies, higher levels of self-efficacy led to higher levels of entrepreneurial intention and thus resulted in a higher likelihood of continuing to entrepreneurial action (lembana, chang & ke liang 2020:9). while it is clear that there is a gap between entrepreneurial intentions and the ability to proceed toward entrepreneurial action, the elements that enable an individual to proceed from entrepreneurial intention to action are not yet perfectly known. previous studies, as summarised in table 1, that focused on the entrepreneurial intention-action gap were mainly quantitative in nature (bogatyreva & shirokova 2017; botha et al. 2019; oliveira & rua 2018). in this article a qualitative perspective is taken, as it can add value by exploring a deeper understanding of how individual entrepreneurs have taken the leap from entrepreneurial intention to action. table 1: previous studies on the entrepreneurial intention-action gap. the influence of contextual factors on the entrepreneurial intention-action gap the next section explains the sectoral focus of the study to understand the context of this study and the uniqueness of entrepreneurship in the agricultural sector. thereafter, the three contextual factors and their individual influences on the entrepreneurial intention-action gap are discussed. sectoral focus agri-entrepreneurs work in a variety of circumstances and in different entrepreneurial ecosystems from typical entrepreneurs (mcelwee 2008:466). the agricultural sector has been neglected in recent entrepreneurship literature (fitz-koch et al. 2018; mcelwee 2006; vesala, peura & mcelwee 2007). entrepreneurs in the agricultural sector face unique challenges when navigating their business, such as the adverse and immediate impact the natural environment might have on the business’s feasibility (fitz-koch et al. 2018), making it an insightful sector to conduct research on. being a farmer does not equate being an agri-entrepreneur. mcelwee (2006:471) and fitz-koch et al. (2018) identify and categorise different types of farmers and indicate which types of farmers are considered to be agri-entrepreneurs. self-identity self-identity in entrepreneurship refers to the values and attitudes that influence a person’s motivations, goals, and intentions towards entrepreneurship (fitz-koch et al. 2018:149) and reflects the extent to which a person considers themselves to be fulfilling the criteria of a societal role (obschonka et al. 2015:773–794). vesala et al. (2007) investigated the entrepreneurial identity of farmers in finland and distinguished between portfolio farmers (agri-entrepreneurs) and conventional farmers. the separation lies in the fact that portfolio farmers have entrepreneurial characteristics, while conventional farmers only focus on primary production. the model was structured as follows: firstly, the individual in question had to categorise themselves as an entrepreneur. secondly, a number of aspects were investigated to get an understanding of the individual’s level of entrepreneurial identity, namely self-efficacy, optimism, personal control, risk-taking, growth orientation, and innovativeness, where higher levels of each led to a stronger entrepreneurial identity. portfolio farmers have a stronger entrepreneurial identity than conventional farmers (vesala et al. 2007:60). the values used by vesala et al. (2007) were able to distinguish between entrepreneurs and non-entrepreneurs. thus, one can use these values to further investigate an entrepreneur’s self-identity (fauchart & gruber 2011:935–957). studies have found that entrepreneurial self-identity is important to one’s ability to be an entrepreneur and to predict entrepreneurial action in nascent entrepreneurs. obschonka et al. (2015:773–794) and rise, sheeran and hukkelberg (2010:1085–1105) suggest that self-identity ought to be added to ajzen’s tpb to improve the theory’s ability to predict entrepreneurial action. the reinforcement, support, and confirmation of a person’s sense of self are key components in a person’s motivation to formulate intentions that may lead to action. furthermore, self-identity has different motivational origins from subjective norms and attitudes (rise et al. 2010:1099). this may shed light on the personal foundations that could affect an individual’s ability to progress from entrepreneurial intention to action. obschonka et al. (2015:773–794) added self-identity as a predictor variable in tpb and found that self-identity was more effective in predicting entrepreneurial intentions than the original predictor variables. current entrepreneurship literature does not emphasise entrepreneurial self-identity enough, and the key role it plays in the motivation process behind entrepreneurial actions. self-identity should not only play a vital role in predicting entrepreneurial action, but also be considered for the influence it has on other motivational factors (obschonka et al. 2015:773–794). family influence business succession within a family is a widespread practice in the agricultural sector, where there is a strong sense of family legacy in the business (fitz-koch et al. 2018:150). having entrepreneurial parents increases the likelihood that an individual will become an entrepreneur by up to three times more than individuals who do not have entrepreneurial parents (carr & sequeira 2007:1095; jodl et al. 2001:1249; lindquist et al. 2015:1). some scholars suggest that the strongest predictor for entrepreneurship is having parents that were entrepreneurs (lindquist et al. 2015:1). it is not due to inherited genetics that individuals are more likely to become entrepreneurs, but rather due to the parents’ nurturing effect through teaching their children about entrepreneurship (lindquist et al. 2015:33). this provides evidence that being an entrepreneur is still an individual choice, but exposure to entrepreneurship through family members may influence one’s motivations and decisions. contrary to the literature, zellweger, sieger and halter (2011:521–536) found that exposure to entrepreneurship through family members had a negative effect on a person’s likelihood to become an entrepreneur. even though the individuals saw entrepreneurship as a feasible career choice and had relatively high levels of self-efficacy, it did not mean that they saw entrepreneurship as a desirable career (zellweger et al. 2011:2). this was due to their experience of the sacrifices and constraints family members had to overcome to be entrepreneurs (zellweger et al. 2011:11). formal institutions to create a clear context of the environment in which an entrepreneur in an emerging economy functions, one must consider the impact of external role players, such as formal institutions. formal institutions are human-developed constraints that give structure to political, economic, and social interactions (estrin et al. 2013:24) and form the boundaries in terms of rules and norms of the environment and guide the expected behaviour of businesses in a country’s economy (bruton et al. 2010:422). entrepreneurship thrives in institutional contexts with a strong rule of law that consists of predictable policy, an equal playing field with a non-arbitrary government, and sound independent law (estrin et al. 2013:24). autio and fu (2015:8) emphasise that, to stimulate economic participation and encourage entrepreneurship, well-designed political systems that protect property rights and political freedoms are important. when one considers the institutional factors that may influence entrepreneurship in society, one should keep in mind the cultural context in which entrepreneurs function, since institutional rules and norms are perceived differently by different societies (dheer 2017:815). for example, individualistic societies see corruption as a hindrance in the entrepreneurial environment, but collectivistic societies may see corruption as a necessary part of the entrepreneurial ecosystem (dheer 2017:822). based on the literature review, a conceptual model is developed in figure 3, which presents the interlinked theory on the entrepreneurial intention-action gap. the conceptual model introduces the newly added contextual factors (fitz-koch et al. 2018:149–157) that influence an entrepreneur’s ability to proceed from entrepreneurial intention to entrepreneurial action within the agriculture sector. figure 3: a conceptual model for overcoming the entrepreneurial intention-action gap. developing a conceptual model a conceptual model as presented in figure 3 has been developed by following three distinctive steps: entrepreneurial intention literature and theories that support the literature are conceptualised by combining ajzen’s tpp and shapero’s eem. the theories are presented in the model by merging all factors as a determinant of entrepreneurial intention. entrepreneurial action literature and theories are conceptualised using the rubicon model of action as a general phase indicator and action regulation theory as exact steps in the process of proceeding from entrepreneurial intention to entrepreneurial action. the conceptualised entrepreneurial intention and entrepreneurial action models were then merged to paint a picture of how intention has led to action based on existing literature. the merged intention-action model was then further expanded by adding the three contextual factors of this article as possible factors that might influence an entrepreneur’s ability to proceed from intention to action. an additional step was added as the conceptual model in figure 3 was adapted using the themes and findings that emerged from the data. thus, the final model was further inductively developed and is presented as the inductive conceptual model (illustrated in figure 7). methodology research design this study employed a generic qualitative research design as this design originates from pre-knowledge of a specific topic and aims to more fully describe the topic from the participant’s perspective (plano clark & cresswell 2015:289). participants in this study were asked to elaborate on their perspective of the influence that the contextual factors had on their ability to progress from entrepreneurial intention to action. as the research phenomenon is fairly unknown, an interpretivist research philosophy was adopted in this article. this philosophy contends that individuals interpret the objective reality in many different ways, and supports the statement that individuals are not mere ‘puppets of society’, but rather act upon how they perceive reality from their own standpoint (plano clark & cresswell 2015). the participants’ perceptions regarding the influence of the three contextual factors on their progression from entrepreneurial intention to action varied and were recorded as the respondents experienced them. sampling the proposed study is conducted within the agricultural sector in south africa, with a specific focus on agri-entrepreneurs. the inclusion criterion for sampling at the organisational level is that the organisation must currently be active in the agriculture sector in south africa. the researcher sampled agricultural organisations from different geographic regions within south africa, ensuring that the study’s findings were representative across the country. although the transferability of the findings may be questioned, as the study is sector-specific, the sampling method provide detailed information from a specific sub-group of organisations (i.e. organisations in the agriculture sector in south africa). the sampling technique used to sample individual participants is maximum variation sampling, meaning that the researcher deliberately sampled individuals from diverse backgrounds and perspectives (polit & beck 2012:517–518). the motivation for using maximum variation sampling is that common patterns appear despite the diversity of the sample. this is of significant value to the capturing of core experiences (polit & beck 2012:517–518) and enriching the value of the findings of the proposed study. entrepreneurs with different demographic backgrounds may experience certain influences and situations differently; using maximum variation sampling takes these variables into consideration. inclusion criteria for individuals are that the individual must be a founder or a family successor of the organisation in the agricultural sector. data collection this study used semi-structured telephonic interviews for data collection. this data collection technique allows the researcher to explore the phenomenon in the study thoroughly and allows the researcher to actively adapt interviews within the structure of the discussion guide (creswell 2012:218). a section of the discussion guide was adapted from a similar study that explored self-identity of farmers in a quantitative study (vesala et al. 2007), and the rest of the discussion guide was formulated after careful consideration of existing literature. the researcher conducted a pilot interview with an agri-entrepreneur, resulting in a positive outcome. the discussion guide was thus used without any major alterations. a preliminary potential recruitment list was self-compiled prior to recruitment efforts commencing, consisting of 33 possible participants. fourteen of the potential participants were contacted via email, inviting them to participate in the study, of which three responses were received: one agreeing to participate, one unwilling to participate, and one intending to participate, but was unavailable at the time when the interview was scheduled. thereafter, certain prospective participants were contacted via phone call. this method yielded better results as more participants were willing to participate. data saturation refers to the point at which no added information comes to light when analysing data (polit & beck 2012:512). guest, bunce and johnson (2006:78) found that six participants in qualitative studies provide 80% of the information generated and that data saturation tends to occur between 6 and 12 participants. ten participants were used in this study as data saturation occurred after seven interviews, whereafter three additional interviews were scheduled. no further interviews were scheduled as data saturation had occurred and this study sampled the same number of participants as other studies in the business management paradigm (mostert, nieman & kotzé 2017:6). all interviews were audio recorded with permission from the participants, transcribed and stored on a cloud storage facility as well as an external usb drive. data analysis thematic analysis was used to analyse the data and involves searching across the whole data set for emerging patterns (themes) to answer the study’s research questions (braun & clarke 2006:86). a master list of codes was developed that consisted of pre-emptive codes (potential codes the researcher identified before data analysis) based on the literature review. as the researcher matched the pre-emptive codes with excerpts of text in the transcriptions, more codes were added to allow for added information that emerged. after the first round of coding, codes were combined by merging linked codes and removing redundant codes. the researcher analysed this final list of codes and matched it to overarching themes. trustworthiness and ethical considerations to ensure credibility, an established and proven research method was used (shenton 2004:64), namely semi-structured interviews, and the researcher used space triangulation by interviewing participants from different regions in south africa (polit & beck 2012:590). dependability refers to the stability of data over time and in various conditions (polit & beck 2012:585). to ensure that other researchers may replicate the study effectively, the study provides a clear explanation of the context and method. this study’s dependability is further ensured by using maximum variation when sampling individuals, thereby ensuring a wide spectrum of respondents from a wide background. confirmability refers to the ability to objectively gather and analyse data without the researcher’s preconceived ideas or any bias having an effect on the results (polit & beck 2012:587; shenton 2004:72). for confirmability, all recordings and notes of interviews were transcribed and documented without making amendments to the information. member checking was also used during interviews to ensure confirmability; this was done by repeating what respondents had said so as to ensure that the interviewer had correctly understood their response. for adequate levels of transferability, the study’s findings must apply to other contexts (shenton 2004:70). the study ensured adequate levels of transferability by providing detailed descriptive data about the study, such as demographic information of respondents, contextual information, the research process that was followed, and the data collection methods. although the transferability of the study may be questioned due to the study being sector-specific, sufficient information is provided to enable scholars to replicate the study in other contexts and sectors. the researcher also lists the identified limitations and future research opportunities that may arise from the study. the participants signed an informed consent form before the interview was conducted. the interviewer briefed the participants before each interview, emphasising that the interview was voluntary and that they and their businesses’ identities remained anonymous. findings description of the sample participants the study consisted of 10 participants from five different provinces in south africa. nine of the participants were male agri-entrepreneurs; one female entrepreneur participated. the majority of participants specialised in fruit or vegetable production, with one participant specialising in cattle and dairy. three participants specialised in certified organic production practices. half of the participants are successors in their family business and the other half of participants were founders of their businesses. table 2 provides a summary of the profiles of the individuals who participated in the study. table 2: summary of profiles of participants in the study. self-identity specific self-identity factors that are critical to overcome the entrepreneurial intention-action gap were found for agri-entrepreneurs in this study and are discussed below. figure 4 presents an overview of the data structure for the self-identity theme. figure 4: overview of the data structure for self-identity. self-efficacy self-efficacy refers to a person’s belief that they are capable of achieving outcomes and goals (boyd & vozikis 1994). this is linked to self-identity in the sense that it refers to how a person believes in their own capabilities. to be considered successful in closing the entrepreneurial intention-action gap, the participants had to identify themselves as entrepreneurs and showcase self-belief in their own capabilities to be an entrepreneur. all participants did identify themselves as entrepreneurs, and all participants did display self-efficacy. however, different levels of self-efficacy were noted, suggesting a continuum of different levels of self-efficacy and entrepreneurial levels: ‘it was always in my spirit to do business. to grow was always a part of me, it was a thing inside me … but i’ve always had an urge to be an entrepreneur.’ (p5, male, successor [translated from afrikaans]) this supports and expands on the finding of vesala et al. (2007) in confirming that self-efficacy is a crucial element of an agri-entrepreneur’s self-identity, and expands existing knowledge by suggesting that different levels of self-efficacy exist. it is also clear that it plays a key role in closing the entrepreneurial intention-action gap, as all participants showcased this self-identity factor. optimism optimism reflects the extent to which an individual holds a generally favourable future expectancy (carver, scheier & segerstrom 2010:879). optimism is linked to an individual’s self-identity because it refers to one’s general attitude towards a situation. all participants in the study revealed a sense of optimism. this was assessed by exploring if setbacks had caused individuals not to act on a particular business venture, and how they managed setbacks. no participant had surrendered a business venture opportunity due to a setback. passion towards one’s business was proven to be a key originator for the agri-entrepreneur’s optimistic attitudes: ‘if [the setback] was, let’s say, financial in nature, then you should because of that adapt and rather postpone to – instead of this year, rather do it next year. … we move it to a later stage, but it never stopped us.’ (p1, male, founder [translated from afrikaans]) this finding suggests that optimism is an important self-identity factor for taking entrepreneurial action; this harmonises with vesala et al. (2007) in proving to be an important factor in the self-identity of agri-entrepreneurs. the finding furthermore proposes entrepreneurial passion to be an antecedent to optimism. internal locus of control locus of control refers to an individual’s perceived control over various situations. individuals with an internal locus of control believe that they can decide their own future (van liew 2013). locus of control links to one’s self-identity by referring to one’s perceived control of and impact on decision outcomes. most participants demonstrated an internal locus of control and a belief of significant influence on their business’s success. a common denominator in participants who indicated an internal locus of control was their being disciplined in their decision-making. this suggests that discipline could be an antecedent for having an internal locus of control, as the reason for being disciplined could be because one makes the decision with the intent to evoke a specific outcome: ‘as your business grows, it becomes an organism and it’s very complicated and interdependent. … i think, you know the dna is created by the founder. that dna is to be picked up by other people in the group and, and the organism is interdependent.’ (p9, male, founder) this finding supports the literature (down & warren 2008; vesala et al. 2007) by showing that entrepreneurs have higher levels of perceived control over their future. calculated risk-taking risk-taking refers to one’s willingness to bear a state of uncertainty and the possibility of failure for the chance to make a profit or gain certain advantages (vesala et al. 2007:52). all participants showed a willingness to take calculated risks, by balancing potential downsides with upsides in a venture opportunity and then making a decision on whether the risk was worth taking. participants then implemented mitigation strategies in a bid to minimise the disruption the risk might have on their business. furthermore, all participants in the study concluded that it is impossible to be an entrepreneur without taking risks: ‘you should split your risks into smaller parts, and then you can take a proper risk on a smaller scale, because if the venture is not successful then your whole business is not in danger.’ (p4, male, successor [translated from afrikaans]) this supports existing literature (vesala et al. 2007) by suggesting that calculated risk-taking is part of the self-identity of an entrepreneur who has overcome the entrepreneurial intention-action gap, and elaborates on the literature by proposing that entrepreneurs make use of risk mitigation strategies to minimise the negative impact of potential risks. growth orientation being growth orientated means to aim for maximising profit through growing one’s business and expanding business activities (vesala et al. 2007:52). self-identity has to do with one’s core attitudes and values. therefore, the specific type of orientation a person is inherently inclined to forms part of one’s self-identity. all participants were shown to be actively growing their business or planning to do so in the near future. two core antecedents were identified as the reason for one’s desire to grow the business: (1) being ambitious about the future of one’s business, and (2) having organisational focus, by attending to detail, for example by knowing exactly what their business’s core profit drivers were. a third antecedent emerged as a source of growth orientation, namely diversification. interestingly, diversification was also an antecedent for innovation in participants, which will be discussed below: ‘i now look at my age and i say i still want to grow; the business can afford to invest in another farm or invest in other things.’ (p2, male, founder) this supports existing literature (down & warren 2008; vesala et al. 2007) through all participants showcasing an urge to grow their businesses and not stagnate in one place. this reaffirms existing literature by indicating that being growth oriented forms part of an entrepreneur’s self-identity. furthermore, the existing literature is expanded by proposing ambition, organisational focus, and diversification (jointly) to be antecedents to a growth orientation. innovation innovation refers to being curious and willing to experiment with and develop new products, markets, and practices (vesala et al. 2007:52). innovativeness springs from being curious and willing to try novel approaches, thus indicating a certain attitude in general, and forms part of the foundation that forms an individual. again, all participants except one showed a form of curiosity and willingness to try new things. curiosity was also identified as an antecedent of innovation, jointly with diversification: ‘i mean you shouldn’t try fixing something that isn’t broken, right, but i think how you change is how you progress. if you don’t adapt you will only stay behind.’ (p3, male, successor [translated from afrikaans]) this supports the literature in that innovativeness forms part of an entrepreneur’s self-identity and has helped them to take entrepreneurial action (vesala et al. 2007:52), and adds to the existing knowledge base by identifying antecedents of innovation and shedding light on their interrelatedness. resilience resilience refers to a specific mindset when confronted with adversity. it means having a positive disposition that translates into progression (bernard & dubard barbosa 2016). resilience is a function of one’s attitude towards a given situation and is therefore part of one’s self-identity. most participants indicated that they had to endure periods of adversity before they were able to achieve a certain entrepreneurship goal: ‘specifically, i would say [the key is] resilience, a good drive, like a business drive, have a good acumen, and, yes, be willing to adapt.’ (p7, female, founder) this finding expands the existing entrepreneurship literature by finding a new construct that proves to be an important variable in an entrepreneur’s self-identity, helping to close the entrepreneurial intention-action gap. social skills all participants cited the importance of an ability to communicate and socialise with other people, be it other entrepreneurs, employees, institutions, or people in general. therefore, in this study, social skills refer to one’s ability to effectively socialise with other people to evoke a positive outflow of information or actions. as social skills form part of one’s nature, it is also a fundamental self-identity factor. this was also not an expected construct of the study and was not found in the literature. that all participants cited this as a key factor for taking entrepreneurial action suggests that it is a crucial dimension to add to agri-entrepreneurs’ ability to close the entrepreneurial intention-action gap: ‘people will be people. … they also want to feel that they are valuable to the business. … i make a big point of it to make my people feel positive; without them i cannot progress.’ (p1, male, founder [translated from afrikaans]) this finding further expands entrepreneurship literature as it addresses a previously unidentified self-identity factor that proves to be crucial for closing the entrepreneurial intention-action gap. family influence having entrepreneurial parents increases the likelihood that an individual will become an entrepreneur (carr & sequeira 2007:1095). findings regarding the influence of relatives on agri-entrepreneurs’ ability to close the entrepreneurial intention-action gap are discussed below. figure 5 presents an overview of the data structure for the family influence theme. figure 5: overview of the data structure for the family influence theme. family legacy business succession within a family is a widespread practice in the agricultural sector, with a strong sense of family legacy in the business (fitz-koch et al. 2018:150). family legacy therefore refers to a sense of pride in taking over the business from earlier generations in the controlling family. it was found that 5 of the 10 participants (50%) did experience a sense of family legacy. it is noteworthy that the participants who did experience this sense of family legacy felt strongly about it: ‘the family bond runs and there is sentiment, that’s why i continued with [the business] … took over from his father and persevered and protected the property … it’s a lot more than just a business.’ (p6, male, successor [translated from afrikaans]) this was an intriguing finding from the study, as it contradicted fitz-koch et al. (2018:150), where a minority of participants had had this experience. this proposes that it might be a factor that is ‘extreme’ in nature, as it either has no influence or is a significant influence in an entrepreneur’s career. entrepreneurial exposure entrepreneurial exposure refers to seeing relatives who are entrepreneurs and understanding what it is like to be an entrepreneur. witnessing relatives who are entrepreneurs could be a major influence in pursuing an entrepreneurial career. all participants, except one, had had exposure to entrepreneurship through relatives: ‘my father had his own business. he had, what they call an egg packing business. … i used to work there every saturday and i used to work there every holiday.’ (p8, male, founder) this supports lindquist et al. (2015) by suggesting that being exposed to entrepreneurial relatives is a major influence for a person to become an entrepreneur. entrepreneurial role models entrepreneurial role models are a further extension of entrepreneurial exposure by not only witnessing entrepreneurship through relatives but having one or more individuals one looks up to. although the majority of participants (60%) had exposure to entrepreneurship, fewer had role models to whom they looked up. in essence, having entrepreneurial role models as relatives is a deeper form of exposure to entrepreneurship: ‘so, i learnt that skill from him, i give a lot of credit to [my] people and the fact that i had the honour to grow up in those circumstances.’ (p6, male, successor [translated from afrikaans]) this supports the literature (lindquist et al. 2015:33) by highlighting that relatives could have a nurturing effect on an individual. to add to existing knowledge, entrepreneurial exposure and entrepreneurial role models are interrelated; it was noted that high levels of positive entrepreneurial exposure transformed the young person into idolising an entrepreneurial relative, making them an entrepreneurial role model. formal institutions formal institutions are human-developed constraints that give structure to political, economic, and social interactions (estrin et al. 2013:24) and form the boundaries in terms of rules and norms of the environment an entrepreneur operates in. they guide the expected behaviour of businesses in a country’s economy (bruton et al. 2010:422). figure 6 presents an overview of the data structure for the formal institutions theme. figure 6: overview of the data structure for the formal institutions theme. government aid government aid refers to any sort of aid provided by a country’s government and is not necessarily financial aid. participants were asked if they had ever received any sort of aid from the government that helped them take entrepreneurial action. although half of the participants cited having received such aid, only one cited the assistance being one of the most important factors for taking entrepreneurial action: ‘it was literally free money. so that is what they did to help me. i can tell you that if they did not do it, it would have been factually impossible for someone to join in the fruit game.’ (p1, male, founder [translated from afrikaans]) this finding expands on existing literature by suggesting that governmental institutions not only create a positive environment to do business in (bruton et al. 2010:422), but also directly provide aid to individuals who are most likely to succeed. this may stimulate entrepreneurship and lower the high-capital entry barriers for entrepreneurs to enter the agri-sector. legislative barriers legislative barriers are synonymous with ‘red tape’ and refer to governmental barriers and hindrances that make it harder for entrepreneurs to take entrepreneurial action. most participants in this study said they were slowed down by red tape. participants had a good understanding that there are reasons for the barriers, but still regard it necessary for people to challenge these regulations: ‘look, in some cases you just have to adjust your businesses accordingly, and some areas you just need to challenge certain policies get the best out of it, but with our maturity we’ve also learnt that most of those regulations there’s a reason why they are there, although it might make it look like they making our lives difficult.’ (p2, male, founder) the finding supports existing literature (bruton et al. 2010:426), that a fine balance must be struck between too rigid and too little legislation, so as to keep entrepreneurs motivated to pursue new ventures in an ethical and lawful manner. it furthermore supports existing literature by providing evidence that institutional fairness is important to create an environment for entrepreneurs to function in, by providing a platform to appeal and challenge legislation in a legal system (autio & fu 2015:8). low confidence in government institutions confidence refers to the perceived competence and capability to effectively manage certain situations (shrauger & schohn 1995). if entrepreneurs are to receive aid from an institution, it is important to have confidence in the institution’s usefulness. all participants showed not having confidence in the aid government institutions may provide: ‘i think one of the problems in our country is that a lot of our farmers have a great confidence in the state and its ability to solve your problems. and in retrospect, if you think about it, they actually created more problems than they solve.’ (p9, male, founder) this finding expands the literature (autio & fu 2015:8) by suggesting that although a country may have a functioning political, economic, and legal system, there may still be unutilised potential for governmental assistance to aid entrepreneurs. participation in industry organisations this finding is a natural outflow from the finding above, as agri-entrepreneurs seek other ways to spearhead institutional support through the private sector. industry organisations are independent entities in the agri-sector and provide members with assistance through, for example, negotiating with regulators on behalf of the industry. all participants form part of an industry organisation in their domain. there are numerous benefits that were cited by participants, such as funding, networking opportunities, and bargaining power by negotiating as a group of agri-entrepreneurs: ‘the commercial partner got involved, the department of agriculture provided funds, and when we came to the farm again – it was a big success.’ (p1, male, founder [translated from afrikaans]) this finding further expands the literature (autio & fu 2015) by suggesting that, in an emerging economy context, with low perceived levels of confidence in governmental institutions, it is valuable to have an industry organisation platform where entrepreneurs can bargain collectively with regulators and have a platform for collaboration. summary of thematic analysis findings three main themes, each with several sub-themes, emerged from the findings. in table 3 each research question is outlined and linked to a main theme in the second column. the third column identifies each sub-theme, also linked to a main theme and research question. column 4 onwards indicates which sub-themes were identified per participant; each participant is listed per column. table 3: identified themes provided from the research per participant. conclusion summary of findings this study intended to conceptualise a deeper understanding of the entrepreneurial intention-action gap in agri-entrepreneurs and to introduce a conceptual model that represents factors that may have a significant influence on closing the intention-action gap. using a similar approach to vesala et al. (2007), all participants saw themselves as entrepreneurs. this, in conjunction with the implemented sampling method, confirms that participants were fit for the study. the interview data in this article confirmed that the predetermined self-identity factors that normally have a significant influence on closing the entrepreneurial intention-action gap are applicable in the south african agri-sector. antecedents of the predetermined factors were also identified and discussed in the previous section. furthermore, this article identified two additional self-identity factors that have a significant influence on closing the entrepreneurial intention-action gap. all participants highlighted that social skills (be it with other entrepreneurs, employees, or suppliers) are crucial for entrepreneurial action. the vast majority of participants also cited that resilience was key to building a successful agri-business, and that an agri-entrepreneur will go through trying times in their business cycle. it was found that family members had a significant influence on individuals’ ability to close the entrepreneurial intention-action gap, although not directly, but rather on a psychological level. it was found that family legacy for continuing business operations was not a significant influence for becoming an agri-entrepreneur; however, if the individual did have a sense of family legacy for the business, it had a signifiable influence on them to become an agri-entrepreneur. exposure to entrepreneurship through relatives proved to be a common factor that caused individuals to become entrepreneurs. however, only 6 out of 10 participants believed their relatives to be entrepreneurial role models. this novel insight suggests that the two constructs are interrelated and that entrepreneurial exposure may result in seeing an individual as an entrepreneurial role model. in the south african agri-sector, governmental aid to entrepreneurs is perceived to be low. the overall confidence in governmental bodies was low among participants as well. this suggests that legislative and regulatory support is not perceived by the participants to be sufficient to stimulate entrepreneurship. as entrepreneurs form part of industry organisations that allow for collective bargaining, the industry organisations function as a middleman between entrepreneurs and regulators. in this article support was found for industry organisations being crucial support structures for agri-entrepreneurs. figure 7 provides an expansion of the conceptual model as presented in figure 3 by following an inductive approach and incorporating the findings of this study. furthermore, this graphical illustration indicates how the findings influence and provide novel insight to current research. each of the main themes in this study has been listed as the factors that influence overcoming the entrepreneurial intention-action gap. each sub-theme is then linked to a main theme, accompanied by an explanation to provide further insight into the findings of the study. some sub-themes have additional sub-themes that provide further novel insight into the findings of the study. figure 7: inductive conceptual model: the influence of contextual factors on the entrepreneurial intention-action gap. theoretical implications this article sheds light on an under-researched area in the entrepreneurship literature, namely the entrepreneurial intention-action gap of agri-entrepreneurship. this study reaffirms that the pre-identified self-identity traits that are present in entrepreneurs are also present in agri-entrepreneurs, and further expands the knowledge on these self-identity traits by adding resilience and social skills as crucial self-identity traits. it is clear that self-identity factors play a significant part in enabling entrepreneurs to pursue new ventures. the study expands the knowledge on family legacy in the family business domain by suggesting that family legacy either has no effect or has a significant effect on entrepreneurs. findings also support existing literature that exposure to entrepreneurship though family members has a significant influence on individuals becoming entrepreneurs; however, this does not mean they see their entrepreneurial relatives as entrepreneurial role models. the study found that functional legislative systems are paramount in creating an environment for entrepreneurs to function. furthermore, the study expands the existing knowledge base by proposing that industry organisations are crucial for agri-entrepreneurs to flourish and increase their bargaining power with regulators. this study makes a significant theoretical contribution by introducing a conceptual model that highlights the influence that self-identity, family influence, and formal institutions have on the entrepreneurial intention-action gap. the conceptual model was further developed by inductively using the themes that emerged from the data. therefore, an inductive conceptual model is presented in figure 7 which graphically illustrates the findings of this article. managerial recommendations entrepreneurs and managers in businesses should use the identified self-identity traits in their screening processes when hiring new employees, as it will enable them to hire an employee who has entrepreneurial tendencies that will lead to higher performance, and will instil an entrepreneurial culture within the business, which may ultimately spearhead above-average performance. both agri-entrepreneurs, as well as government officials, should place more emphasis on the use of industry organisations as (1) they allow agri-entrepreneurs to bargain collectively, increasing their bargaining power, and (2) they provide more effective and accurate insights and communication between regulators and entrepreneurs. industry organisations give a collective voice to the agri-sector. the proposed updated model may, after confirmation through quantitative studies, provide useful insights to business incubators, as the use of the model will aid their screening processes and result in business incubators assisting candidates who are most likely to succeed as entrepreneurs. this will also lead to a more effective use of resources. limitations and directions for future research there is a limitation in the transferability of the findings in this study, as it focused only on the agricultural sector. future research may address this limitation by replicating the study and evaluating its applicability in other sectors of the economy. furthermore, the study followed a qualitative approach and may not be representative of entrepreneurs in general. the conceptual model was furthermore not tested quantitively and there is thus no certainty of the model’s efficacy. future research may address this limitation by testing the model in quantitative studies to find evidence of its efficacy. the factors that were investigated as influences on the entrepreneurial intention-action gap were based on future recommendations from fitz-koch et al. (2018); it may be the case that other influences on the entrepreneurial intention-action gap have been overlooked. a wider net in future studies can address this limitation by qualitatively exploring what other influences entrepreneurs experienced when closing the entrepreneurial intention-action gap. future studies may also explore each sub-theme in the identified themes in this study in more detail to show each specific influence on closing the entrepreneurial intention-action gap. for example, one could explore the sub-theme ‘self-efficacy’ (sub-theme to the ‘self-identity’ theme) in more detail to show its specific influence. acknowledgements competing interests the authors have declared that no competing interest exists. authors’ contributions p.r. collected and analysed the data as well as preparing the draft of the article. m.b. edited and reviewed the draft and assisted with the conceptualisation and writing of the final draft. ethical considerations in the case of qualitative studies, you may use the data collected during the pre-test of your discussion guide as the first interview for your main study provided that (1) the pre-test participant met all the inclusion criteria that apply to your main study, (2) you only made minor changes to your discussion guide based on the results of the pre-test and (3) the data collected during the pre-test still apply to your study. if you are unsure, consult your study leader. any further changes to your study’s purpose, research questions or objectives, methodology, and research instrument must be done in consultation with your study leader. mr theuns kotze (on behalf of the department of business management, university of pretoria): u16034482/2020, 21/08/2020. data availability the authors confirm that the data supporting the findings of this study are available within the article [and/or] its supplementary materials. disclaimer the views and opinions expressed in this article are those of the authors and do not 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https://doi.org/10.1016/j.jbusvent.2010.04.001 journal 3.indd 26 sajems ns 13 (2010) no 1 the south african business cycle: what has changed? philippe burger department of economics, university of the free state accepted september 2009 abstract this paper identifies the basic empirical characteristics and changes of the south african business cycle since 1960. as such, the paper examines changes in volatility as well as the co-movement between several national account variables and real gdp. to examine the co-movements the paper follows kydland and prescott, gavin and kydland as well as bergman, bordo and jonung and uses correlation coefficients and granger causality tests. following ramos, the paper extends the results of the granger causality tests using variance decomposition analysis in the context of a var (vector auto regression) to establish the contribution that selected national account variables make to the h-period-ahead forecast error variance of themselves and the other variables included in the vars. the paper indicates that since 1994 volatility in the south african economy decreased significantly, while durable consumption appears to lead the business cycle. keywords: volatility, business cycle jel e32, 53 1 introduction interest in business cycle behaviour has been rekindled during the last two decades. kydland and prescott (1990:3–4) note that business cycle research in the 1950s–70s focused either on creating business cycle theory, or empirical work that was based on structural systems of behavioural equations, themselves based on the theory. little empirical research took the form of reporting the data without imposing a probability model on it. kydland and prescott argue that there is not just room, but, indeed, a need for such research dedicated to establishing the empirical characteristics of business cycles. they continue that the need arises from wrong assumptions often made in the past about the co-movement between variables (kydland & prescott, 1990:4). they furthermore state that to first identify the empirical characteristics of the business cycle lays the groundwork to creating theory that will explain these empirical characteristics. given that such an approach was followed fruitfully in neoclassical growth theory, with solow building his theory on empirical characteristics identified by others, kydland and prescott (1990:3) argue that it might be just as fruitful in business cycle research. moreover, this approach by kydland and prescott represents a return to the original approach followed by burns and mitchell (1946) in their seminal work on business cycles. this paper seeks to contribute to the literature on the south african business cycle by identifying the basic empirical characteristics and the changes in the characteristics of the business cycle in a manner similar to kydland and prescott (1990) as well as gavin and kydland (2000). as such, the paper examines the correlation and co-movement between several national account variables and real gdp. 2 the empirical approach gavin and kydland (2000) continue with the kydland and prescott empirical approach to sajems ns 13 (2010) no 1 27 business cycle research when they consider how us business cycles differed prior to and after 1979, the year that the federal reserve in the us initiated its strong anti-inflationary stance. other authors also continue with this approach, most notably in the last decade, to identify what has happened to business cycle volatility. most of the research focuses on the us and finds that the volatility of gdp growth and the output gap has decreased significantly since the mid-1980s (cf. romer, 1999; mcconnell & perez-quiros, 2000; warnock & warnock, 2000; taylor, 2000; kahn, mcconnell & perez-quiros, 2002; 2001, blanchard & simon, 2001; stock & watson, 2003a and 2003b, gordon, 2005). some authors compared g7 countries to establish whether or not volatility also decreased in these countries (bergman, bordo & jonung, 1998, doyle & faust, 2002, barrell & gottschalk, 2004). the empirical approach states as few priors and imposes as few limitations on models as possible in an attempt to identify patterns in observed data. thus, the approach is inductive by nature. this explains why kydland and prescott (1990), bergman, bordo and jonung (1998), as well as gavin and kydland (2000) focus on correlations, cross-correlations and standard deviations of time-series to identify co-movements between variables as well as the volatility characteristics of individual series. this is also the approach followed in this paper, before it moves on to a var analysis and the accompanying impulse–response functions and variance decompositions. contrary to the recent upsurge in business cycle research in the us and g7, business cycle research in south africa is a rather underdeveloped field, with only a handful of authors working on the south african business cycle. these include work by the south african reserve bank (sarb), most notably by venter (2005), discussing the measurement of the business cycle. recent contributions from outside the sarb include du plessis and smit (2007) and du plessis (2006), whose work, in addition to focusing on the cyclicality of south african monetary and fiscal policy, also suggests and applies an alternative approach to the determination of business cycle turning points. this paper considers the period 1960:1 to 2006:4. though a host of other variables can be considered when characterising the business cycle, due to limitations of space this paper has a national accounts focus and therefore focuses specifically on gdp and the components of aggregate expenditure (e.g. consumption, investment, as well as their subcomponents).1 all variables are in real terms and the source for all data is the south african reserve bank (sarb) online download facility. figure 1 the real gdp gap and the sarb cycles 28 sajems ns 13 (2010) no 1 figure 2 the sarb and hp cycle periods to detrend the data and isolate the cyclical components of the series, the paper uses a hodrick-prescott filter (in this it follows, among others, kydland & prescott).2 fig 1 compares the real gdp output gap as estimated using a hp filter with the upswing and downswing periods as identified by the sarb. fig 2 shows the upswing and downswing periods identified by the sarb and the upswing and downswing periods identified by the hp filter.3 (the sarb identifies official turning points after a statistical analysis of approximately 230 time series as well as consideration of economic events in the vicinity of a possible turning point.) the upswings and downswings identified by the sarb and the hp filter largely overlap. as mentioned above, the objective of the paper is to establish which characteristics of the business cycle changed. as such, the paper needs to compare the characteristics of different sub-periods of the overall sample, which requires the division of the total sample into sub-periods. however, the literature contains different approaches to do this division. for the us blanchard and simon (2001), stock and watson (2003a) and gordon (2005) use the mid-1980s as a break because the 20-quarter moving standard deviation of us output clearly decreases in the mid-1980s. in contrast romer (1999), bergman et al. (1998) and taylor (1998) merely compare pre-wwi (e.g. 1880–1914) and post-wwii periods (i.e. post-1945) (with some consideration for the interwar period). given that south african national accounts data start only in 1946 for annual data and 1960 for quarterly data it is not possible to compare pre-wwi and post-wwii periods. thus, the paper opts for the simple approach, similar to blanchard and simon (2001), stock and watson (2003a) and gordon (2005), of looking at a graph to identify periods of low and high volatility. when inspecting the movements in the output gap from 1960 to 2006, the period 1960 to the mid-1970s and the period since the mid1990s has much less output volatility than the period between the mid-1970s and the mid1990s. after the transformation of the output gap values into z-values, figure 3 shows that throughout the total period 1960:3 to 2006:2, economic upswings reached standard deviations of between one-and-a-half and two, while in the periods up to the mid-1970s and since the mid-1990s economic downswings almost never exceeded one standard deviation. this contrasts sharply with the period between the mid-1970s and the mid-1990s when economic downswings often came close to or exceeded two standard deviations. the period of higher volatility commences with the soweto uprising that occurred in june 1976, after which followed a period of sajems ns 13 (2010) no 1 29 political turmoil in south africa. this turmoil and together with it the volatility ended with the first democratic election in april 1994. therefore, based on the historical markers of the soweto uprising and the first election, the paper sub-divides the sample into the subperiods 1960:3–1976:2, 1976:3–1994:1 and 1994:2–2006:2. figure 3 the real gdp gap (z-values) 3 cross-correlations and granger causality tests to consider the co-movement between time series for each of the three periods, the paper calculates the cross-correlation coefficients between the real gdp gap and the contemporaneous gap as well as five leads and lags of the gaps of the other variables, each time for the three periods.4 this is the same approach as kydland and prescott (1990) and gavin and kydland (2000), with bergman et al. (1998) following a similar approach but with fewer lags. besides the cross-correlations, the paper also explores whether or not the volatility of the other variables displays changes between the three periods that are similar to that of the real gdp gap. although the leads and lags of the crosscorrelations may provide an indication of the sequence of changes in the gap variables relative to changes in the real gdp gap, the paper follows in the spirit of bergman et al. (1998) and also runs granger causality tests in this section between the real gdp gap and the gap variables used to calculate the cross-correlations. the granger tests may give a better indication of not necessarily causality between variables, but the sequencing of changes in variables relative to gdp. the tables containing the granger causality test results are reported in appendix a. in the following section the paper extends the granger causality analysis by also estimating a set of vars. on these vars the paper then performs variance decompositions to establish the contribution that a variable makes to the h-period-ahead forecast error variance of itself and the other variables included in the var. according to ramos (2003), whether or not a variable explains the majority of its own forecast error variance, will determine whether or not that variable will be considered exogenous in the granger sense. 3.1 gdp and the components of expenditure on gdp though gdp is the key variable considered when exploring the business cycle (because it represents national income), it is by no 30 sajems ns 13 (2010) no 1 means the only one, particularly because the business cycle is defined as the co-movement of several economic variables (usually seen as a co-movement of variables with real gdp growth or its gap). hence, the question is which variables display such a co-movement and how similar is their behaviour to that of real gdp? more specifically, to what extent do the cyclical movements of real gdp lead, lag or coincide with the cyclical movements of other variables? table 1 presents the correlation coefficients between the real gdp gap in time t and the leads (time t–5 to t–1), lags (time t+1 to t+5) and contemporaneous (time t) values of variables such as consumption and investment. correlation coefficients that are statistically significant at the 5 per cent level are shaded in grey. table 1 correlation coefficients of gdp and its components correlation coefficient of cross correlation with gdp in time t per 1 t-5 t-4 t-3 t-2 t-1 t t+1 t+2 t+3 t+4 t+5 c 0.17 0.23 0.30 0.44 0.49 0.48 0.37 0.21 0.21 0.00 –0.07 g –0.06 –0.21 –0.08 –0.02 –0.07 0.08 0.13 0.12 0.19 0.23 0.17 i –0.20 –0.13 0.06 0.25 0.28 0.40 0.43 0.44 0.46 0.41 0.23 x 0.12 –0.16 –0.30 –0.12 –0.34 –0.20 –0.22 –0.33 –0.09 –0.10 –0.09 m –0.17 0.06 0.29 0.40 0.57 0.67 0.56 0.48 0.31 0.05 –0.08 per 2 t-5 t-4 t-3 t-2 t-1 t t+1 t+2 t+3 t+4 t+5 c 0.01 0.21 0.42 0.59 0.73 0.81 0.72 0.59 0.45 0.34 0.24 g –0.13 –0.13 –0.04 0.08 0.14 0.13 0.13 0.13 0.06 –0.06 –0.04 i –0.01 0.17 0.34 0.51 0.65 0.76 0.77 0.76 0.66 0.53 0.39 x 0.16 0.15 0.12 0.11 0.05 0.07 –0.04 –0.07 –0.14 –0.22 –0.21 m 0.11 0.29 0.49 0.68 0.77 0.79 0.70 0.50 0.26 0.02 –0.12 per 3 t-5 t-4 t-3 t-2 t-1 t t+1 t+2 t+3 t+4 t+5 c 0.17 0.34 0.48 0.58 0.70 0.78 0.75 0.63 0.47 0.31 0.15 g –0.50 –0.39 –0.16 0.11 0.28 0.34 0.35 0.30 0.24 0.18 0.13 i 0.06 0.06 0.08 0.15 0.31 0.49 0.59 0.65 0.64 0.57 0.51 x –0.05 –0.07 0.01 0.10 0.24 0.44 0.42 0.26 0.24 0.21 0.04 m 0.23 0.23 0.27 0.32 0.45 0.55 0.54 0.47 0.42 0.41 0.35 c: consumption by households, g: government consumption, i: investment, x: exports, m: imports correlations: probabilities lower than 5 per cent indicated by shaded area whereas leads and lags of the cross-correlations provide an indication of whether changes in a variable lead or lag changes in the real gdp gap, the granger causality tests provide a more rigorous examination of the leads and lags. if a variable displays high cross-correlations with the real gdp gap, while the granger tests yield statistically significant results, it serves as evidence that the changes in the variables lead or lag changes in the real gdp gap. however, if variables display high cross-correlations with the real gdp gap, while none of the granger causality tests yields statistically significant results, it is taken as evidence that changes in sajems ns 13 (2010) no 1 31 the variables are contemporaneous with changes in the real gdp gap. table a1 in appendix a reports the probabilities of the granger causality tests conducted between the real gdp gap and the real gap variables of the aggregate expenditure components. the granger tests were run four times, including two, four, six and eight lags. the results for four, six and eight lags are very similar, so only the two and four lags are reported in appendix a. the correlation coefficients between the real gdp gap and the gap variables of the main components of aggregate expenditure indicate that a strong contemporaneous correlation exists in all periods between the real gdp gap and the gaps for consumption, imports and investment (see table 1). the lags and leads of these variables also display strong correlations with the real gdp gap. a relationship between the real gdp gap and the export gap seems to be absent during the first and second periods, while the correlations between the real gdp gap and the contemporaneous value and the first lag of the gap for exports (t and t+1) in the third period exceeds 0.4. this finding goes against conventional wisdom, as it is often assumed that the foreign business cycle leads the south african business cycle via an increase in south african exports (cf. barr & kantor, 2002:59–60). however, the finding is similar to du plessis (2006:769–70) who finds a low concordance of export and output cycles. though kabundi (2009:1) finds that exports do play a role in the synchronisation of us and sa business cycles, he also finds that “...there is a decrease in integration over time translated by a drop in synchronisation of cycles”. government consumption expenditure displays a weak, if not absent correlation in the first and second periods, and a positive correlation in the third period. du plessis, smit and sturzenegger (2007) also find pro-cyclicality in the behaviour of fiscal policy, especially in more recent periods, though thornton (2007) finds the opposite. exploring the question regarding leads and lags further, the granger causality tests reported in table a1 in appendix a indicate that in the first and third period changes in the consumption gap led changes in the real gdp gap. not only do the granger causality tests indicate that changes in the consumption gap precede changes in the real gdp gap in the third period, but they report bidirectional causality. in the second and third period and counter to what would be expected on a priori grounds, changes in the investment gap lagged changes in the real gdp gap. the same is true for exports in the third period. as with investment, changes in the import gap lag changes in the real gdp gap during the second and third period. however, unlike investment, this accords with a priori expectation. although the differences in the correlation coefficients between the periods on first appearance are not that stark, moving from the second to the third period there was a significant reduction in the standard deviations of some of the gaps of the components of aggregate expenditure. this reduction coincided with the decrease in the standard deviation of the real gdp gap itself (see table b1 in appendix b). more specifically, in the third period the standard deviations of the real gdp gap as well as of the consumption, investment and import gaps – which are also the three variables that display the highest correlation coefficients with the real gdp gap – are approximately 50 per cent or less of what they were in the second period. (the differences are statistically significant at the 5 per cent level as indicated by the f-tests that test for whether or not the variances between two periods are statistically significantly different – see table b1 in appendix b for more detail). compared to the first period, the standard deviations of these three variables are also lower than during the second period (with the difference also being statistically significant at the 5 per cent level as indicated by the f-tests). the second period seems to be the most turbulent, with its standard deviations not only much higher than those in the third period, but also slightly higher than what they were in the first period. when comparing the second and third periods, the government consumption and export gaps, which are also the variables that displayed the lowest correlations with the real gdp gap, do not display the same large decrease in their standard deviations. lastly, the standard deviation of investment is significantly higher than that of consumption. this accords 32 sajems ns 13 (2010) no 1 with both a priori expectation and investment and consumption behaviour in, for instance, the us (cf. kydland & prescott, 1990:11 and gavin & kydland, 2000:fig 2). the standard deviations of the gaps of the aggregate expenditure components are also much larger than the standard deviation of the real gdp gap (see table b1 in appendix b). the lower standard deviation of the real gdp gap relative to the expenditure component variables indicates the effect of the co-variances between variables to reduce the overall volatility of the gdp gap. the difference between the standard deviations of several of the aggregate expenditure components and of the real gdp gap is similar to the behaviour of these same variables in other countries (cf. kydland & prescott, 1990:11; bergman et al., 1998:79, gavin & prescott, 2000:fig 2). for instance, for the 1960 to 2006 period the ratio of the investment gap standard deviation to the real gdp gap standard deviation is 3.7 for south africa, compared to the 4.9 found by kydland and prescott for the us for the period 1954 to 1989 (kydland & prescott, 1990:7). the components whose gaps display the highest standard deviations are the investment and import gaps. the relatively higher volatility of investment is similar to investment behaviour in other countries where the volatility of investment also exceeds that of, for instance, consumption (cf. kydland & prescott, 1990:11; gavin & prescott, 2000:fig 2). therefore, to conclude, those components that display the highest correlations with the real gdp gap are also those components that register a reduction in their volatility that coincide with the reduction in the volatility of the real gdp gap. these components are consumption, investment and imports. in the case of exports, it also appears as if an increase in correlation with the real gdp gap coincides with a reduction in the standard deviation of exports. as doyle and faust (2002:431) note, this is not necessarily surprising because the correlation coefficient equals the co-variance of two variables divided by the product of their standard deviations. thus, if the standard deviation of one or both decreases, while their co-variance remains unchanged, the correlation coefficient will improve. to consider the strengths of correlation coefficients and the reduction in volatility further, the paper analyses the different components of consumption and investment. this may trace the origins of the reduced volatility better and indicate which components of investment and consumption display the strongest cyclical behaviour. 3.2 consumption this section seeks to trace the behaviour of household consumption discussed above to the behaviour of the components of consumption. these components are durable, semi-durable and non-durable consumption goods, as well as services. table 2 correlation coefficients of the components of consumption correlation coefficient of cross correlation with gdp in time t period 1 t-5 t-4 t-3 t-2 t-1 t t+1 t+2 t+3 t+4 t+5 durable 0.27 0.40 0.42 0.54 0.53 0.47 0.28 0.13 0.09 –0.07 –0.12 semidurable –0.10 0.09 0.18 0.36 0.37 0.46 0.49 0.40 0.31 0.26 0.08 nondurable 0.04 0.06 0.11 0.30 0.27 0.35 0.27 0.23 0.21 0.00 –0.02 services 0.11 0.03 0.11 0.04 0.27 0.19 0.23 0.05 0.12 –0.01 –0.07 sajems ns 13 (2010) no 1 33 period 2 t-5 t-4 t-3 t-2 t-1 t t+1 t+2 t+3 t+4 t+5 durable 0.25 0.41 0.55 0.60 0.63 0.65 0.48 0.33 0.22 0.15 0.12 semidurable 0.05 0.26 0.47 0.61 0.70 0.75 0.70 0.63 0.54 0.46 0.34 nondurable -0.18 -0.08 0.11 0.32 0.50 0.64 0.63 0.58 0.47 0.38 0.24 services -0.09 0.09 0.23 0.41 0.56 0.63 0.63 0.49 0.37 0.26 0.19 period 3 t-5 t-4 t-3 t-2 t-1 t t+1 t+2 t+3 t+4 t+5 durable 0.18 0.39 0.55 0.67 0.75 0.79 0.73 0.58 0.33 0.06 -0.17 semidurable 0.10 0.14 0.18 0.24 0.34 0.38 0.30 0.21 0.13 0.08 0.10 nondurable 0.03 0.11 0.20 0.30 0.44 0.57 0.62 0.62 0.60 0.56 0.51 services 0.19 0.30 0.35 0.32 0.28 0.23 0.19 0.06 -0.08 -0.16 -0.28 type of consumption good listed in first column. correlations: probabilities lower than 5 per cent indicated by shaded area table b2 in appendix b indicates that during the second period the standard deviation of the gaps of all the components of consumption increased relative to the first period, and then fell during the third period. the decrease from the second to the third period was larger than the increase from the first to the second period. in the case of all the components, with the exception of non-durable consumption, the standard deviation decreased by 50 per cent or more. durable consumption goods displayed the highest volatility, followed by semi-durable consumption goods. this is as expected because the more durable consumption goods are, the more they are expected to behave like investment goods. the standard deviation of the durable consumption goods gap is also similar, if not slightly higher, than that of the investment gap. how do the correlation coefficients between the gaps of the consumption components and the real gdp gap compare? table 2 indicates that in all periods the leads of the durable consumption gap seem to be stronger than the lags. this is confirmed further by the granger causality tests for the first and the third period, with the granger test with two lags indicating bidirectional causality during the third period (see table a2 in appendix a). during the second period the semi-durable goods gap displays high cross-correlations with the real gdp gap, with the highest for the contemporaneous gap values of semi-durable goods and real gdp. the granger test with four lags points to causality running from the semi-durable consumption gap to the real gdp gap. though correlated with the real gdp gap, the granger tests indicate that the non-durables gap did not lead or lag changes in the gdp gap. 3.3 investment by sector just as the previous section seeks to trace the behaviour of household consumption to the behaviour of the components of consumption, this section seeks to trace the behaviour of investment to the components of investment. however, there are various ways in which investment can be sub-divided. the data of the sarb divides it in three ways: by sector, by institution and by asset type. the paper uses the sub-division of investment in terms of sector and by asset type to consider the behaviour of investment relative to the business cycle (real gdp gap). it does not use the sub-division of investment by institution (dividing investment into the investment by 34 sajems ns 13 (2010) no 1 general government, the private sector and public corporations) because the private sector largely encompasses the financial sector, the manufacturing sector and several of the other sectors delineated in the sectoral sub-division. the sectors covered are community, social and personal services; electricity, gas and water; financial intermediation, insurance, real estate and business services; manufacturing; mining and quarrying as well as transport, storage and communication. just as the volatility of the gaps of the components of expenditure on real gdp usually exceeds the volatility of the real gdp gap, so the volatility of the gaps of the sectoral components of investment exceeds that of the investment gap (see table b3 in appendix b). the standard deviations of all sectors changed in the second period compared to the first, though, except for the increase in the volatility in manufacturing, all these changes are statistically insignificant. with the exception of the electricity sector (with a statistically insignificant increase) and transport (with a statistically insignificant decrease), the standard deviations of all the components registered decreases in the third period that were statistically significant. proportionally the largest decrease occurred in manufacturing, which experienced a decrease in volatility of more than 75 per cent. financial services experienced decrease of almost 50 per cent, while the decrease in mining and community services was less spectacular. the large decrease in manufacturing volatility corresponds with the experience of the us (cf. warnock & warnock, 2000). in all three periods the financial sector registers strong correlations, while mining in the second and manufacturing in the third and to a more limited extent in the second period register strong cross-correlations (see table 3). the granger causality tests indicate that in the first and second period changes in the financial sector led changes in the real gdp gap (table a3 in appendix a). the more important role of manufacturing is also apparent in the granger test (with four lags) that indicate that in the third period changes in the manufacturing investment gap led changes in the real gdp gap. furthermore, as tables 3 and a3 in appendix 3 show, in the third period changes in the electricity sectors, typically a sector dominated by government, tend not to lag or lead changes in the real gdp gap (though they are positively correlated to the real gdp gap),5 while changes in the transport sector, another governmentdominated sector, seem to lag changes in real gdp. table 3 correlation coefficients of the sectoral components of investment correlation coefficient of cross correlation with gdp in time t period 1 t-5 t-4 t-3 t-2 t-1 t t+1 t+2 t+3 t+4 t+5 community –0.20 –0.36 –0.31 –0.18 –0.26 –0.13 0.00 0.19 0.35 0.43 0.43 electricity –0.16 –0.27 –0.17 –0.27 –0.44 –0.24 –0.13 –0.04 0.07 0.13 0.15 financial services –0.08 0.12 0.30 0.40 0.54 0.58 0.56 0.37 0.20 –0.02 –0.09 manufacturing 0.08 0.14 0.30 0.38 0.41 0.36 0.30 0.23 0.16 0.08 –0.09 mining –0.30 –0.17 –0.10 0.17 0.14 0.44 0.35 0.45 0.34 0.45 0.23 transport –0.10 –0.04 –0.08 0.01 0.07 0.08 0.17 0.24 0.37 0.35 0.24 sajems ns 13 (2010) no 1 35 period 2 t-5 t-4 t-3 t-2 t-1 t t+1 t+2 t+3 t+4 t+5 community –0.04 0.08 0.17 0.31 0.44 0.55 0.59 0.57 0.46 0.25 0.13 electricity –0.15 –0.16 –0.15 –0.10 –0.05 –0.01 0.06 0.15 0.12 0.08 0.08 financial services 0.12 0.30 0.49 0.63 0.72 0.72 0.63 0.49 0.34 0.22 0.12 manufactu-ring 0.16 0.28 0.38 0.46 0.51 0.57 0.57 0.55 0.47 0.39 0.31 mining 0.08 0.21 0.32 0.45 0.52 0.65 0.63 0.58 0.46 0.35 0.17 transport –0.34 –0.29 –0.23 –0.12 –0.01 0.14 0.25 0.36 0.46 0.41 0.33 period 3 t-5 t-4 t-3 t-2 t-1 t t+1 t+2 t+3 t+4 t+5 community –0.16 –0.12 –0.10 –0.03 0.16 0.36 0.47 0.42 0.19 –0.04 –0.05 electricity 0.22 0.27 0.31 0.35 0.38 0.40 0.42 0.40 0.34 0.25 0.19 financial services –0.03 0.05 0.19 0.37 0.56 0.70 0.74 0.72 0.62 0.49 0.33 manufactu-ring 0.40 0.47 0.49 0.51 0.60 0.65 0.53 0.40 0.29 0.17 0.06 mining –0.25 –0.34 –0.36 –0.38 –0.29 –0.16 –0.06 0.11 0.31 0.41 0.40 transport –0.17 –0.33 –0.46 –0.53 –0.52 –0.40 –0.16 0.13 0.37 0.53 0.62 sector listed in first column. correlations: probabilities lower than 5 per cent indicated by shaded area 3.4 investment by asset type dividing investment by asset, yields five types of assets; construction works, machinery, nonresidential buildings, residential buildings and transport equipment. with the exception of residential buildings, the standard deviations of the gaps of all asset types increased from the first to the second period, though only those of construction and non-residential investment are statistically significant (see table b4 in appendix b). in contrast, the standard deviation of the gaps of all asset types decreased from the second to the third period (see table b4 in appendix b). from the second to the third period the standard deviation of machinery and nonresidential buildings decreased by approximately 50 per cent, while that of transport equipment decreased by between 40 per cent and 45 per cent. the standard deviation of the gaps of construction equipment and residential buildings also decreased, but by not as much. table 4 shows that machinery and residential construction displayed the highest correlations with the real gdp gap in the first period. in the second period most types of investment displayed high correlations with the real gdp gap, while in the third period residential and non-residential construction, as well as machinery displayed the highest correlations. table a4 in appendix a, reporting the granger causality tests, indicate that in the first period the changes in machinery, residential and non-residential investment led the real gdp gap, while in the third period it is only non-residential investment. for both the second and third period the granger causality test indicates that changes in the transport equipment gap lag changes in the real gdp gap. in addition, the granger causality tests indicate that changes in the gap variables for investment in machinery, as well as residential and non-residential investment lag changes in the real gdp gap in the second period. thus, the evidence highlights the lagging nature of all these components (with a few exceptions such as non-residential investment in the third period) and, as such, indicates that investment in general does not lead the business cycle in south africa. 36 sajems ns 13 (2010) no 1 table 4 correlation coefficients of the asset components of investment correlation coefficient of cross correlation with gdp in time t period 1 t-5 t-4 t-3 t-2 t-1 t t+1 t+2 t+3 t+4 t+5 construction -0.29 -0.20 -0.21 0.05 -0.07 0.05 0.13 0.23 0.38 0.51 0.40 machinery -0.10 0.00 0.23 0.42 0.48 0.56 0.49 0.42 0.36 0.32 0.08 nonresidential -0.18 -0.27 -0.09 0.03 -0.02 0.14 0.11 0.20 0.25 0.18 0.14 residential -0.17 -0.08 0.10 0.19 0.38 0.47 0.57 0.54 0.41 0.20 0.10 transport -0.06 -0.08 -0.07 -0.08 -0.04 0.04 0.15 0.23 0.30 0.30 0.15 period 2 t-5 t-4 t-3 t-2 t-1 t t+1 t+2 t+3 t+4 t+5 construction 0.02 0.20 0.29 0.39 0.49 0.57 0.57 0.57 0.49 0.38 0.29 machinery 0.07 0.18 0.33 0.48 0.59 0.69 0.68 0.67 0.54 0.40 0.26 nonresidential -0.28 -0.23 -0.12 0.04 0.22 0.38 0.51 0.58 0.63 0.63 0.58 residential 0.12 0.24 0.34 0.43 0.46 0.44 0.38 0.24 0.10 -0.01 -0.09 transport -0.12 0.06 0.22 0.37 0.46 0.54 0.54 0.54 0.51 0.42 0.30 period 3 t-5 t-4 t-3 t-2 t-1 t t+1 t+2 t+3 t+4 t+5 construction -0.32 -0.28 -0.18 -0.08 0.06 0.21 0.30 0.32 0.30 0.25 0.27 machinery 0.16 0.12 0.11 0.12 0.25 0.39 0.38 0.43 0.51 0.49 0.50 nonresidential 0.35 0.46 0.43 0.46 0.47 0.47 0.50 0.45 0.30 0.20 0.07 residential -0.05 0.00 0.14 0.33 0.55 0.69 0.75 0.65 0.47 0.27 0.04 transport 0.02 -0.06 -0.14 -0.16 -0.12 0.02 0.25 0.44 0.48 0.50 0.45 type of asset/investment listed in first column. construction and transport are construction equipment and transport equipment. correlations: probabilities lower than 5 per cent indicated by shaded area 4 the variance decomposition ramos (2003:105) argues that a variance decomposition constitutes an alternative method to investigate granger causality.6 a variance decomposition estimates the relative contribution that variables in var equations make to the forecast error variance of the dependent variables of the equations. if the variance decomposition shows that a significant part of the variance of a variable is explained by its own innovation, that variable is exogenous in the granger causality sense. following this suggestion, the section takes the granger causality analysis, conducted above, one step further. it estimates a series of vars that contain the real gdp gap as well as the variables that according to analysis above, granger cause and are granger caused by the real gdp gap. on the basis of these vars the section conducts variance decompositions of the vars to explore the exogeneity/endogeneity of the variables and thereby seeks to confirm the findings of the granger causality tests. the decision as to whether or not a variable is exogenous depends sajems ns 13 (2010) no 1 37 on what proportion of its own forecast error variance a variable explains. ramos (2003:107) argues that in a one-year-ahead forecast in a six variable var, 50 per cent is high. the analysis in this paper also uses 50 per cent as cut-off point. however, instead of a one-year-ahead forecast, this paper uses a 12-quarters-ahead forecast since 12 quarters is the length of time that it takes for the contributions of most of the variables to the forecast error variances to stabilise. the section estimates three sets of vars for each of the three periods. the first combines the real gdp gap and the gaps for consumption, investment, imports and, for the third period, exports. the other two sets of vars also include the real gdp gap and the import gap in the first and second periods and the real gdp gap, import and export gaps in the third period. however, they replace the gaps for consumption and investment with the gaps of the components of consumption (e.g. durable consumption) and investment (e.g. manufacturing sector investment) that granger cause and are granger caused by the real gdp gap. both sets of vars include the gaps for durable consumption in the first and third periods and semi-durable consumption and services in the second period. what distinguishes the two sets is the components of investment that they include. the first includes the sectoral components of investment, while the second includes the asset type components. given that the focus is on the variance decompositions and because of the rather bulky nature of the tables containing the vars, the section does not present the var tables, but only the variance decompositions.7 4.1 vars using the gdp gap and the gaps of the gdp components the discussion above indicates that in all three periods the gaps of consumption, investment and imports either granger cause the real gdp gap or are granger caused by the real gdp gap. therefore, this section estimates a var for each of the three periods, containing these variables. in addition, based on the results of the granger causality, the var for the third period also includes the export gap. the lag length of each of the three vars was selected on the basis of information criteria such as the akaike and the schwartz information criteria. on the basis of these criteria the section estimated vars with three, four and five lags for the first, second and third periods respectively. in addition, given the argument made by some that the south african business cycle was typically export led (cf. barr & kantor, 2002:59–60), the section also presents the variance decomposition of vars for the first and second period that contain the export gap in addition to the gaps of real gdp, consumption, investment and imports. these vars were estimated with three and two lags for periods one and two, with the number of lags selected on the basis of information criteria. table 5 presents the results after 12 quarters. the first column of each period in table 5 shows the variable of which the variance is explained, while the subsequent columns list the contribution of each of the variables to the variance being explained. note that rows add up to 100 per cent. using 50 per cent as a cut-off point for exogeneity, the above analysis indicates that relative to the variables used in the var, the gdp gap was exogenous in the first and second periods (table 5 with or without the inclusion of exports), but endogenous in the third period (table 5). in the third period the gap for consumption explains 40.98 per cent of the forecast error variance of the real gdp gap, which is approximately the same proportion as the gdp gap explains of its own forecast error variance. the consumption gap itself is endogenous in both the second and third periods (see table 5 with or without the inclusion of exports). in the second period approximately 50–55 per cent of the variance of the consumption gap is explained by the shock to the real gdp gap (table 5 with or without the inclusion of exports). including the gap for exports in the vars of the first and second periods shows that the export gap was strongly exogenous, explaining 70.4 per cent and 88 per cent of its own forecast error variance (see table 5). in contrast to the first and second periods, exports become endogenous in the third period (table 5), with the real gdp gap explaining 32.9 per cent of the forecast error variance of exports. 38 sajems ns 13 (2010) no 1 table 5 variance decomposition of the vars using the gdp gap and gdp components variance decomposition of the vars using the gdp gap and the gaps of consumption, investment and imports period 1 period 2 gdp c i m gdp c i m gdp 69.77 20.42 2.03 7.78 gdp 71.25 6.85 17.41 4.49 c 17.85 75.75 4.39 2.01 c 49.37 30.73 17.73 2.18 i 17.72 48.50 26.94 6.85 i 48.06 15.07 36.47 0.39 m 30.32 35.68 2.03 31.98 m 42.69 10.48 14.21 32.63 variance decomposition of the vars using the gdp gap and the gaps of consumption, investment and imports period 1 period 2 period 3 gdp c i m x gdp c i m x gdp c i m x gdp 66.44 18.90 1.98 8.98 3.71 gdp 75.61 2.76 3.67 12.33 5.64 gdp 39.60 40.98 4.19 10.17 5.06 c 15.15 73.01 5.75 1.77 4.33 c 54.07 33.06 8.91 2.51 1.45 c 40.62 33.52 6.54 10.99 8.32 i 16.87 40.56 30.09 8.13 4.35 i 51.54 7.68 32.70 5.73 2.35 i 43.15 11.44 18.25 14.95 12.22 m 26.83 33.36 2.78 32.88 4.14 m 47.94 3.87 4.44 39.19 4.55 m 45.30 7.97 15.26 18.27 13.20 x 8.41 5.33 2.33 13.52 70.41 x 3.18 4.40 1.39 3.08 87.95 x 32.88 13.62 16.44 16.73 20.34 variance decomposition for var without exports after 12 periods with cholesky ordering: gdp, consumption, investment, imports and exports variance decomposition for var with exports after 12 periods with cholesky ordering: gdp, consumption, investment, imports and exports tables 5 also show that the inclusion of exports in the vars of the first and second period does not add much, with exports never explaining more than 6 per cent of the forecast error variance of any of the other variables. its inclusion in the third period, though allowing one to indicate that exports itself has become endogenous, adds only modestly to the explanation of the other variables. the export gap never explains more than 14 per cent of the forecast error variance of the other variables (see table 5). the real gdp gap explains more than 40 per cent of the forecast error variance of investment and imports in both the second and third periods. to consider how long it takes for a shock to die out once it affects the system the paper also estimates impulse response functions. these functions indicate that, for example, in the second period the effect on the consumption gap of a one standard deviation shock to the real gdp gap dies out after 20 quarters (see appendix c). in the third period it takes about 16-20 quarters for the effect of a one standard deviation shock to the real gdp gap on the gaps of consumption, imports and investment to die out, as well as the effect of a one standard deviation shock to the consumption gap on the real gdp gap (see appendix d). 4.2 vars using the gaps of the components of consumption and the sectoral components of investments the discussion about the presence of granger causality between the real gdp gap and the gaps of the components of consumption indicated that in the first and third periods the gaps for sajems ns 13 (2010) no 1 39 durable consumption and in the second period semi-durable consumption and services either granger caused or were granger caused by the real gdp gap. as such, these components of consumption were included in the vars estimated in this subsection and the next subsection. these vars also include the gaps for the real gdp and imports, while the third period var also includes the export gap. in addition, this subsection includes sectoral components of investment that also either granger caused or were granger caused by the real gdp gap. in the first period, these are investment in the electricity, financial services and mining sectors. in the second period they include investment in community services, financial services, mining and transport, while in the third they include investment in community services, financial services, transport and manufacturing. the information criteria were used to select the number of lags to include in the vars. this lead to the selection of two, four and two lags for the first, second and third periods. table 6 presents the variance decomposition of the vars after 12 quarters. using 50 per cent as cut-off point, the outstanding features of period one is that the gaps for real gdp, durable consumption and electricity are all exogenous in the granger sense (with mining virtually equal to 50 per cent), while the durable consumption gap explains 60.1 per cent of the forecast error variance of the gap of investment in the financial services sector (see table 6). table 6 variance decomposition: periods 1 – 3 period 1 gdp dur cons elec fin serv mining imports gdp 55.04 30.19 8.21 2.44 1.87 2.25 dur cons 2.78 91.26 3.54 0.85 0.29 1.27 elec 4.17 16.66 69.00 5.86 3.36 0.95 fin serv 4.60 60.07 4.98 25.88 2.11 2.36 mining 8.28 38.29 1.50 0.69 49.20 2.04 imports 14.28 43.34 5.59 1.43 2.65 32.71 period 1: variance decomposition after 12 periods with cholesky ordering: gdp, durable consumption, electricity, financial services, mining and imports period 2 gdp com fin serv min trans s-dur cons serv imp gdp 46.85 4.95 11.96 2.30 3.82 19.09 6.94 4.08 com 16.69 46.93 11.25 4.62 7.18 5.38 4.54 3.41 fin serv 17.65 10.59 27.87 4.78 12.51 20.48 3.53 2.60 mining 35.53 5.98 9.14 28.91 4.92 5.25 6.66 3.61 trans 13.15 7.02 2.27 3.81 46.59 10.35 6.93 9.88 semi-dur cons 33.95 6.01 3.86 0.96 15.39 32.85 5.74 1.23 serv 25.72 5.93 8.31 1.63 10.80 11.38 30.49 5.73 imp 21.63 7.40 8.34 4.36 6.57 21.24 5.38 25.08 period 2: variance decomposition after 12 periods with cholesky ordering: gdp, semi-durable consumption, consumption of services, community services, financial services, mining , transport and imports 40 sajems ns 13 (2010) no 1 period 3 gdp com fin serv trans man dur cons imp exp gdp 38.74 1.45 4.48 16.00 6.82 30.01 0.26 2.25 com 19.22 55.70 4.29 5.41 1.60 7.98 5.11 0.69 fin serv 13.16 0.74 46.08 21.66 1.07 15.16 0.23 1.90 trans 20.48 1.87 13.63 46.01 4.35 12.97 0.54 0.15 man 2.18 4.23 15.08 14.19 35.99 23.56 0.92 3.84 dur cons 12.53 1.98 4.86 29.33 10.52 39.33 0.32 1.11 imp 7.24 2.93 38.22 21.91 1.84 9.35 12.06 6.44 exp 8.84 5.01 2.59 14.41 17.36 4.18 7.31 40.30 period 3: variance decomposition after 12 periods with cholesky ordering: gdp, durable consumption, community services, financial services, transport, manufacturing imports as well as exports in the second period the gaps for semi-durable consumption and services together explain approximately 25 per cent of the variance of the real gdp gap in the second period. financial services explain a further 12 per cent. in the third period the gap for durable consumption explains 30 per cent of the forecast error variance of the real gdp gap and 23.6 per cent of the forecast error variance of the manufacturing gap (see table 6). note that in the third period exports do not explain much of the forecast error variance of any of the variables except its own. 4.3 vars using the asset type components of investments the investment gap variables in this subsection are defined in terms of asset types. in the first period var they are construction equipment, machinery, as well as residential and nonresidential buildings. in the second period var the investment gap variables include machinery, residential and non-residential buildings and transport equipment. in the third period only residential and non-residential buildings are included. again the lag lengths of the vars were selected on the basis of the information criteria. as such, the lag lengths selected for the vars for the first, second and third periods, were one, four and two. using the 50 per cent cut-off point, the gaps for real gdp, durable consumption and construction investment were exogenous in the granger sense in the first period (see table 7). during the first period the durable consumption gap explained 21.9 per cent of the forecast error variance of the real gdp gap, 44.8 per cent of the machinery investment gap, 43 per cent of the investment in residential buildings gap and 38.7 per cent of the import gap. in the second period, using the 50 per cent cutoff point, the gaps for real gdp and investment in residential buildings are exogenous, while the real gdp gap explains 29.1 per cent of the forecast error variance of imports (table 7). in the third period the durable consumption gap explain 35.3 per cent of the forecast error variance of the real gdp gap, 34.3 per cent of the residential buildings gap and 23.3 per cent of the non-residential buildings gap. it also explains 48.6 per cent of its own forecast error variance, rendering it borderline exogenous. the real gdp gap explain a further 14.4 per cent of the durable consumption goods gap, while the gap of investment in non-residential buildings explains 31.8 per cent of the forecast error variance of the durable consumption gap, and 19.8 per cent and 19.9 per cent of the forecast error variances of the real gdp gap and investment in residential buildings. note again that the exports gap in the third period does not explain much of the forecast error variance of any of the other variables, except its own. sajems ns 13 (2010) no 1 41 table 7 variance decomposition: periods 1–3 period 1 gdp dur cons const mach res non-res imports gdp 59.31 21.93 2.07 0.58 2.47 9.19 4.45 dur cons 0.44 81.83 0.75 1.38 2.31 6.35 6.94 const 3.61 10.99 71.83 0.39 6.36 1.29 5.53 mach 2.10 41.83 0.82 36.12 2.87 11.51 4.75 res 4.37 43.03 2.13 1.47 38.63 7.31 3.07 non-res 1.87 22.20 4.29 6.50 24.71 36.25 4.19 imports 10.59 38.68 3.90 0.32 3.52 6.86 36.13 period 1: variance decomposition after 12 periods with cholesky ordering: gdp, durable consumption, construction, machinery, residential and non-residential investment, as well as imports period 2 gdp mach res non-res transp eq s-dur cons serv imp gdp 53.99 5.47 0.83 2.65 1.73 17.41 5.82 12.10 mach 26.17 34.87 11.80 3.60 4.07 2.34 3.83 13.33 res 8.97 8.83 59.00 1.69 3.80 4.00 1.40 12.32 non-res 22.28 17.35 11.56 35.19 2.62 1.25 2.47 7.29 transp eq 15.71 8.59 9.93 4.80 31.82 10.94 5.43 12.77 s-dur cons 31.07 2.75 10.10 1.90 1.80 28.77 7.68 15.94 serv 20.80 6.09 8.65 3.25 7.15 9.36 29.04 15.67 imp 29.09 5.62 5.57 4.81 4.96 18.52 6.52 24.92 period 2: variance decomposition after 12 periods with cholesky ordering: gdp, semi-durable consumption, consumption of services, machinery, residential and non-residential investment and transport equipment period 3 gdp res non-res transp eq dur cons imp exp gdp 36.24 2.49 19.81 1.83 35.30 1.92 2.40 res 17.48 19.49 19.93 7.20 34.26 1.12 0.53 non-res 12.71 3.81 55.43 1.03 23.29 3.06 0.67 transp eq 23.51 6.30 6.00 42.47 13.26 8.01 0.44 dur cons 14.41 0.94 31.77 1.71 48.56 2.18 0.43 imp 7.54 8.13 12.24 32.26 18.41 16.88 4.53 exp 4.34 16.81 4.46 29.33 2.95 3.80 38.32 period 3: variance decomposition after 12 periods with cholesky ordering: gdp, durable consumption, residential and non-residential investment and transport equipment, imports as well as exports 42 sajems ns 13 (2010) no 1 6 conclusion the above analysis highlights a few key aspects of the south african business cycle and how it changed when comparing the periods 1960:3 to 1976:2, 1976:3 to 1994:1 and 1994:2 to 2006:2. the analysis indicates that some of those components of gdp that experienced a large decrease in their standard deviations are also components of which the gaps display statistically significant and relatively sizable correlation coefficients with the real gdp gap. in the second and third periods these would include durable consumption, manufacturing investment, as well as investment in machinery and non-residential buildings. the real gdp gap also displayed a high correlation coefficient in the second and third periods with the gaps of imports, non-durable consumption, investment in the financial services sector, as well as investment in residential buildings. the granger causality tests indicate that in the third period only the gaps for consumption, and more specifically durable consumption, and investment in the manufacturing sector, as well as investment in non-residential buildings granger cause the real gdp gap. this means that these are the only variables of which changes precede the changes in the real gdp gap. the variance decomposition support the granger causality findings and, as such, provide further evidence of the key role played by semidurable consumption in the second period and durable consumption in the third period. these findings also point to the possible roles of these consumption components in driving the south african business cycle (even though durable consumption constitutes only about 12 per cent of total consumption). the variance decompositions also highlight the small role that exports played as driver in south africa and as explanation for the business cycle. the key role of consumption and the small roles of exports and investment are rather surprising as conventional wisdom and a priori theory often assumes or postulates that changes in the investment gap and exports should lead changes in the real gdp gap. volatility decreased significantly from the second to the third period. as mentioned, it seems that the reduction in the volatility of gdp in south africa can be traced to the reduction in the volatility of household consumption (durables and services), together with the decreases in the standard deviations of investment in machinery, non-residential buildings and transport equipment, most notably manufacturing investment. sectors dominated by government, such as electricity and transport, did not contribute to the decrease in volatility. endnotes 1 a companion paper focuses on the relationship between the real gdp gap and variables other than national account variables. 2 cyclical gdp can also be obtained using for instance a production function approach. however, this can only be applied to the gdp series and not the other series used. for the purposes of this paper, the same detrending technique had to be applied to all time-series used in the paper to ensure consistency. the baxter-king bp filter could also be used, though the majority of the literature using statistical filters, selected the hodrick-prescott filter. as a result, this paper also uses the hodrick-prescott filter. this filter is a time-series smoothing technique where the smoothed time-series is obtained from selecting s so as to minimise y – s s – s – s – st t t t t t t t t t 2 1 1 1 2 2 1 m+ = + = _ ^ ^_i h hi! ! , where y is the time-series to smooth, s is smoothed series and  is the smoothing parameter. for quarterly data the convention is to set  = 1600. this convention is followed in this paper. note that due to the endpoint problem of the hp filter, some observations at both ends have been dropped. 3 for the latter approach this paper ignored peaks and troughs smaller than 0.01 in absolute terms. 4 an alternative approach is to calculate the correlation coefficients between the growth rates of variables. however, as barrel and gottschalk (2004:101) note, the use of growth rates is problematic given that the long-term component of the data might pollute the cyclical pattern of the growth rates. the second alternative would be to remove the cyclical component of the growth rates before calculating the correlation coefficients between the growth cycles. in preparing this paper both the gap variables and the growth cycles were calculated and used for the sajems ns 13 (2010) no 1 43 correlations and the volatility measures. because both sets of calculations yield very similar results this paper uses only the gap variables. 5 however, note that although there is no discernable correlation between the investment gap of the electricity sector and the gdp gap, odhiambo (2009) found a strong bi-directional causal relationship between economic growth and electricity consumption. 6 my thanks to meshach aziakpono for bringing this paper to my attention. 7 however, the tables containing the var results are available from the author on request. note that the var residual serial correlation lm tests indicated no serial correlation problems at a 5 per cent level for any of the vars. in addition, the joint test for heteroskedasticity indicates no hetero skedasticity at a 5 per cent level in any of the vars. references barr, g. & kantor, b. 2002. the south african economy and its asset markets. south african journal of economics, 70(1): 53-77. barrell, r. & gottschalk, s. 2004. the volatility of the output gap in the g7. national institute economic review, 188: 100-7. bergman, u.m, bordo, m.d. & jonung, l. 1998. historical evidence on business cycles: the international experience. in jeffrey, c. and schuh, s. (eds.) beyond shocks: what causes business cycles? federal reserve bank of boston, conference series, (4): 65–113. blanchard, o. & simon, j. 2001. the long and large decline in us output volatility. brookings papers on economic activity, 2001(1): 135-164. burns, a.f. & mitchell, w.c. 1946. measuring business cycles. national bureau of economic research: new york. doyle, b.m. & faust, j. 2002. an investigation of co-movements among the growth rate of the g7 countries. federal reserve bulletin, (oct): 427-37. du plessis, s.a. 2006. reconsidering the business cycle and stabilisation policies in south africa. economic modelling, 23, 761-74. du plessis, s.a. & smit, b.w. 2007. countercyclical monetary policy in south africa. studies in economics and econometrics, 31(1): 79-98. du plessis, s., smit, b, & sturzenegger, f. 2007. the cyclicality of monetary and fiscal policy in south africa since 1994. south african journal of economics, 75(3): 391-411. gavin, w.t. & kydland, f.e. 2000. nominal facts and the october 1979 policy change. the federal reserve bank of st. louis. working paper, no 2000-013a. gordon, r.j. 2005. what caused the decline in us business cycle volatility? nber working paper, no 11777 (nov). kabundi, a. 2009. synchronisation between south africa and the us: a structural dynamic factor analysis. south african journal of economics, 77(1): 1-27. kahn, j.a, mcconnell, m.m. & perezquiros, g. 2002. on the causes of the increased stability of the us economy. the federal reserve bank of new york policy review, (may): 183-202. kahn, j.a, mcconnell, m.m. & perezquiros, g. 2001. inventories and the information revolution: implications for output volatility. s.l. kydland, f.e. & prescott, e.c. 1990. business cycles: real facts and a monetary myth federal reserve bank of minneapolis, quarterly review, 14: 3-18. mcconnell, m.m. & perez-quiros, g. 2000. output fluctuations in the united states: what has changed since the early 1980s? the american economic review, 90(5): 1464-1476. odhiambo, n.m. 2009. electricity consumption and economic growth in south africa: a trivariate causality test. energy economics, 31: 635-40. ramos, f.f.r. 2003. forecasts of market shares from var and bvar models: a comparison of their accuracy. international journal of forecasting, 19: 95-110. romer, c.d. 1999. changes in business cycles: evidence and explanations. the journal of economic perspectives, 13(2): 23-44. south african reserve bank. 2007. online data download facility. online: www.reservebank.co.za. stock, j.h. & watson, m.w. 2003a. has the business cycle changed? in monetary policy and uncertainty: adapting to a changing economy. federal reserve bank of kansas city, 9-56. stock, j.h. & watson, m.w. 2003b. understanding changes in international business cycle dynamics. nber working paper, no 9859 (jul). taylor, j.b. 1998. an historical analysis of monetary policy rules. nber working paper, no 6768 (oct). taylor, j.b. 2000. recent development in the use of monetary policy rules. a written version of a dinner speech given at the conference, inflation targeting and monetary policies in emerging economies, at the central bank of the republic of indonesia, jakarta, indonesia, july 13-14, 2000. thornton, j. 2007. on the cyclicality of south african fiscal policy. south african journal of economics, 75(2): 258-64. venter, j.c. 2005. reference turning points in the south african business cycle: recent developments. quarterly bulletin (sept) south african reserve bank. warnock, m.v.c. & warnock, f.e. 2000. the declining volatility of us employment: was arthur burns right? board of governors of the federal reserve system, international finance discussion papers, no 677 (aug). 44 sajems ns 13 (2010) no 1 appendix a granger causality tests the columns headed by ‘x y’ reports the probability of making a mistake by rejecting the null hypothesis that a variable such as the real consumption gap, denoted by x, does not granger cause the real gdp gap, denoted by y. the columns, headed by ‘y x’ report the reverse causality result. using a 5 per cent significance level, probability values of less than 0.05 indicate that there is evidence that, for instance, changes in the real consumption gap precede changes in the real gdp gap. these statistically significant results are shaded in grey. table a1 granger causality between the gdp gap and the gdp component gaps period 1 period 2 period 3 granger (2) granger (4) granger (2) granger (4) granger (2) granger (4) x y y x x y y x x y y x x y y x x y y x x y y x c 0.03 0.43 0.06 0.17 0.64 0.07 0.44 0.01 0.00 0.01 0.02 0.03 g 0.60 0.66 0.41 0.65 0.29 0.41 0.18 0.25 0.08 0.59 0.19 0.79 i 0.78 0.17 0.03 0.29 0.40 0.00 0.21 0.23 0.86 0.02 0.86 0.06 x 0.08 0.06 0.06 0.30 0.25 0.81 0.43 0.36 0.47 0.00 0.37 0.00 m 0.01 0.11 0.02 0.10 0.04 0.00 0.22 0.00 0.42 0.01 0.39 0.00 granger causality tests: probabilities lower than 5 per cent indicated by shaded area table a2 granger causality between the real gdp gap and the components of consumption period 1 period 2 period 3 granger (2) granger (4) granger (2) granger (4) granger (2) granger (4) x y y x x y y x x y y x x y y x x y y x x y y x durable 0.00 0.93 0.01 0.40 0.14 0.38 0.12 0.13 0.00 0.05 0.00 0.08 semidurable 0.36 0.29 0.13 0.62 0.15 0.48 0.00 0.12 0.63 0.72 0.58 0.88 nondurable 0.37 0.16 0.57 0.30 0.28 0.03 0.60 0.11 0..26 0.10 0.62 0.27 services 0.26 0.09 0.32 0.42 0.11 0.00 0.43 0.01 0..29 0.34 0.52 0.38 granger causality tests: probabilities lower than 5 per cent indicated by shaded area sajems ns 13 (2010) no 1 45 table a3 granger causality tests between the real gdp gap and the sectoral components of investment period 1 period 2 period 3 granger (2) granger (4) granger (2) granger (4) granger (2) granger (4) x y y x x y y x x y y x x y y x x y y x x y y x community 0.11 0.17 0.06 0.07 0.41 0.00 0.87 0.00 0.62 0.05 0.86 0.01 electricity 0.01 0.87 0.01 0.76 0.83 0.58 0.85 0.72 0.22 0.63 0.40 0.46 financial services 0.02 0.04 0.04 0.13 0.02 0.05 0.03 0.22 0.10 0.03 0.19 0.29 manufacturing 0.10 0.80 0.07 0.997 0.66 0.10 0.66 0.12 0.61 0.26 0.03 0.58 mining 0.47 0.05 0.23 0.07 0.12 0.01 0.16 0.03 0.11 0.25 0.11 0.15 transport 0.98 0.31 0.63 0.09 0.22 0.05 0.76 0.03 0.53 0.01 0.89 0.08 granger causality tests: probabilities lower than 5 per cent indicated by shaded area table a4 granger causality tests between the real gdp gap and the asset components of investment period 1 period 2 period 3 granger (2) granger (4) granger (2) granger (4) granger (2) granger (4) x y y x x y y x x y y x x y y x x y y x x y y x construction 0.25 0.26 0.08 0.00 0.86 0.07 0.84 0.22 0.53 0.34 0.30 0.23 machinery 0.14 0.50 0.03 0.32 0.84 0.02 0.61 0.04 0.90 0.19 0.29 0.18 nonresidential 0.38 0.33 0.01 0.45 0.08 0.00 0.67 0.01 0.05 0.14 0.02 0.07 residential 0.15 0.01 0.04 0.01 0.19 0.01 0.61 0.07 0.10 0.00 0.27 0.01 transport 0.77 0.24 0.99 0.31 0.67 0.02 0.40 0.12 0.97 0.01 0.89 0.02 granger causality tests: probabilities lower than 5 per cent indicated by shaded area 46 sajems ns 13 (2010) no 1 appendix b standard deviations table b1 standard deviations of gdp and the components of aggregate expenditure c g i x m real gdp st dev 1 0.019 0.036 0.058 0.038 0.099 0.013 st dev 2 0.028 0.026 0.071 0.053 0.102 0.021 st dev 3 0.011 0.018 0.034 0.046 0.046 0.009 f test 1 & 2 0.00 0.01 0.09 0.01 0.80 0.00 f test 2 & 3 0.00 0.01 0.00 0.31 0.00 0.00 f test 1 & 3 0.00 0.00 0.00 0.16 0.00 0.01 st dev 1, 2 and 3: standard deviation in periods 1, 2 and 3; f test: null hypothesis of f-test is that the variances of two periods (say periods 1 and 2) are statistically not significantly different. thus, rejection of the null hypothesis indicates that the variances are not the same. probabilities lower than 5 per cent indicated by shaded area. table b2 standard deviations of the components of consumption durable non-durable semi-durable services st dev 1 0.079 0.026 0.016 0.021 st dev 2 0.104 0.044 0.020 0.030 st dev 3 0.048 0.024 0.014 0.008 f test 1 & 2 0.03 0.05 0.00 0.01 f test 2 & 3 0.00 0.00 0.00 0.00 f test 1 & 3 0.00 0.27 0.57 0.00 for explanation of abbreviations, see notes to table b1. table b3 standard deviations of the sectoral components of investment community electricity financial manufacturing mining transport st dev 1 0.077 0.111 0.093 0.124 0.157 0.127 st dev 2 0.066 0.127 0.091 0.167 0.125 0.145 st dev 3 0.044 0.135 0.050 0.043 0.083 0.124 f test 1 & 2 0.23 0.28 0.84 0.02 0.06 0.29 f test 2 & 3 0.00 0.61 0.00 0.00 0.00 0.25 f test 1 & 3 0.00 0.13 0.00 0.00 0.00 0.87 for explanation of abbreviations, see notes to table b1. sajems ns 13 (2010) no 1 47 table b4 standard deviations of the asset components of investment construction machinery nonresidential residential transport st dev 1 0.070 0.072 0.076 0.085 0.108 st dev 2 0.101 0.090 0.111 0.074 0.136 st dev 3 0.073 0.038 0.057 0.050 0.079 f test 1 & 2 0.00 0.07 0.00 0.24 0.06 f test 2 & 3 0.02 0.00 0.00 0.00 0.00 f test 1 & 3 0.75 0.00 0.04 0.00 0.02 for explanation of abbreviations, see notes to table b1. 48 sajems ns 13 (2010) no 1 appendix c impulse-responses for period 2 to interpret heading, ‘consumption to gdp’ means the response of the consumption gap to a one standard deviation shock to the gdp gap. sajems ns 13 (2010) no 1 49 appendix d impulse-responses for period 3 to interpret heading, ‘consumption to gdp’ means the response of the consumption gap to a one standard deviation shock to the gdp gap. microsoft word 6 saville & white sajems 19(1) 2016.docx 82 sajems ns 19 (2016) no 1:82-102 how to cite doi: http://dx.doi.org/10.17159/2222-3436/2016/v19n1a6 issn: 2222-3436 bringing pankaj ghemawat to africa: measuring african economic integration adrian saville1 citadel asset management and gordon institute of business science, university of pretoria lyal white gordon institute of business science, university of pretoria accepted: september 2015 a wealth of literature dealing with trade liberalisation, capital market liberalisation, labour mobility and related issues concerning globalisation asserts that economies that are more integrated with the global economy and, more specifically with their neighbours, tend to enjoy higher sustained levels of growth. empirical evidence with solid quantitative findings recently conducted by pankaj ghemawat has confirmed that more ‘open and connected’ economies display higher rates of economic growth, higher per capita income levels and greater levels of human welfare. against this backdrop, it is notable that the available evidence – whilst incomplete – suggests that african economies are amongst the least integrated in the world. given that integration and connectedness matter, and that there are material gaps in the evaluation of integration for african economies, it is important to develop better measures of african economies’ connectedness with their neighbours and with the world, how this connectedness is evolving and establish more comprehensive and robust means of economic integration compared to those historically available. using ghemawat’s framework, which measures flows of trade, capital, information and people (tcip) to determine connectedness, we develop the visa africa integration index to provide a more comprehensive and detailed gauge of economic integration for 11 african countries in three clusters: east africa, west africa and southern africa. the index results suggest that african economies are emerging off a modest base, with some economies demonstrating progressive structural improvements toward higher levels of integration with their respective regions and the world. east africa, in particular, shows signs of rising connectedness over the survey period. the index also illustrates that some countries are more integrated globally than regionally and vice versa, which is important information for policy makers toward improving deeper and broader integration in their respective regions. the index builds on previous research in the broad area of integration and helps us better understand the challenges and opportunities presented by africa’s economic changes and some of the implications for economic growth. key words: africa, integration, structural change, trade liberalisation, sustained development jel: f6, 63 1 introduction recent evidence suggests that countries with a higher degree of economic integration enjoy faster economic growth and display higher levels of human welfare and economic development (ghemawat & altman, 2014). however, whilst africa has grown faster than any other region since 2000 (power & stephan, 2012), the continent remains the poorest performer on most global development indices. to boot, the region is far less connected to the global economy and the world economy’s value chains than asia, latin america, north america or europe (saville & white, 2015). of the world’s different regions, africa is also the least connected internally. the flow of goods, services, capital, people and information among african economies is exceptionally low compared with intra-regional flows in other parts of the world. given the evidence regarding the positive role that integration plays in economic development, this low level of connectedness is a binding constraint to africa’s economic advance and limits the region’s economic potential.2 abstract sajems ns 19 (2016) no 1:82-102 83 in proceeding, it is critical to note that the concept of connectedness, or integration, is multifaceted and has varied usage, including economic, social and political aspects. this means that the terms “connectedness” and “integration” have many possible connotations. thus, for the purpose of this paper it is important to establish the intended meaning of the terms. on this score, the focus of this paper is firmly on economic integration and connectedness – from global and regional perspectives – with specific attention to the flow of goods and services, capital, information and people. other elements of connectedness and integration, including political and social aspects, are without question important to the globalisation debate, yet are beyond the scope of this paper. connecting to each other – and with the rest of the world – is an essential prerequisite for african economies to realise their full potential. specifically, the prospects of africa’s economies hinge critically on their ability to integrate with the world economy, given that the greatest gains from integration relate to local relationships. it is therefore essential that african economies connect with each other – via intra-africa trade, capital flows, movement of people and the exchange of information and ideas locally and regionally. such connectivity will serve to bolster and sustain africa’s rising prospects and help countries realise gains in socio-economic welfare. against this backdrop, this paper puts forward measures of economic integration across the continent that allows us to study the evolution of economic integration and better understand how integration contributes to africa’s socio-economic prosperity, namely the visa africa integration index. the visa africa integration index, outlined below, owes a great debt to the seminal work of pankaj ghemawat (2011a; 2011b) with regard to understanding global connectedness, its measurement and its impacts. elements of ghemawat’s trade, capital, information and people (tcip) framework and his dhl global connectedness index, that represent his principal contribution to the debate on global connectedness, form key building blocks for the instrument that we develop to specifically measure and analyse economic integration in africa. the debate on economic integration, referred to above, concerns the tangible flow of goods and services, capital, information and people, which is the focus of this paper, versus the often symbolic integration of markets negotiated by countries at regional and global levels. while ghemawat’s framework (2011a; 2011b) for measuring economic integration is robust and comprehensive – and for these reasons the framework serves as a key underpin to our work in this area – the visa africa integration index is distinct from ghemawat’s work in a number of ways. specifically, our study establishes new information by filling gaps in measurement for a number of countries in sub-saharan africa that were previously unrecorded. for example, ghemawat’s study – as well as other studies on this topic – fails to capture many important economies in the region. moreover, the data for many sub-saharan africa countries covered by his study, in many places are partial, incomplete or missing. our research goes some way to filling these gaps. in addition, our index affords insights into changes in the nature and patterns of integration in the african context that are not available from ghemawat’s work. as such, our index is not merely a replication of ghemawat’s (2011a; 2011b) initial work for the african context or, for that matter a simple extension of his work to a different economic region. that said, where the visa africa integration results overlap with ghemawat, they confirm his findings that africa ranks as the world economy’s most disconnected region. however, our findings also show that economic integration on the continent is rising, as is shown in this paper with a granularity that previously was not available. sections 3 and 4 of this paper elaborate on the uniqueness of our index and the contribution that this work makes to the literature. 2 outline the visa africa integration index is constructed for a set of 11 countries that are found in three clusters, namely: i an east african cluster, which includes kenya, rwanda, tanzania and uganda; ii a west african cluster, which includes ghana and nigeria; and 84 sajems ns 19 (2016) no 1:82-102 iii a southern african cluster, which includes angola, mozambique, south africa, zambia and zimbabwe. aside from allowing for the construction of a reliable and robust index, the 11 constituent countries are also highly representative of the region, with a combined population of 437 million people, or 55 per cent of the total population of approximately 800 million people at the end of 2014. in addition, the combined gross domestic product (gdp) of the 11 countries that make up the index represents approximately three-quarters of the region’s total output over the measurement period. based on the 11 constituent countries, section 3 of the paper explains the construction of the visa africa integration index in five parts. the first part describes the selection of a set of specific factors on the back of the so-called tcip framework, as developed by ghemawat (2011a). the second part defines and describes the quantitative metrics that are used for measuring each of the aspects of economic integration. in the third part the sample period is commented on, gaps in data availability are identified and ways in which gaps are dealt with are discussed. the fourth part discusses treatment of the “normalisation” of the resulting raw data to allow for diverse metrics to be combined into an index. the fifth part explains the way in which the various components are aggregated and weighted to produce the visa africa integration index. section 4 of the paper briefly highlights the features of the visa africa integration index that distinguish it from earlier research in this area. this is followed by a detailed elaboration of the results, wherein five key findings are discussed. in this section the 11 countries and the three clusters that make up the visa africa integration index are reported on in detail. the last section of the paper concludes with some reflections on the index’s contribution to our understanding of the nature and extent of economic relationships amongst some of africa’s largest economies with each other and with the world. 3 constructing the index 3.1 tcip aspects drawing on ghemawat (2011a:32), we define economic integration as “the depth and breadth of a country’s connections with the rest of the world, as manifest by its participation in [cross-border] flows of products and services, capital, information, and people”. measuring economic integration on the basis of this definition has at least three valuable attributes. first, we measure integration on the basis of depth and breadth. in terms of “depth”, a country is considered to be “deeply integrated” if the economy is particularly open and highly connected to the rest of the world. however, integration only becomes “deep and broad” if a highly connected economy is engaged with a wide variety of counter parties across the different strands of its global relationships. measuring economic integration by way of depth and breadth provides for a more comprehensive description and better understanding of the nature and granularity of integration beyond conventional economic measures. second, as defined above, economic integration is measured principally on the basis of flows that take place between and among countries. in other words, integration is assessed on the basis of objective observations as opposed to perceptions or other subjective inputs. that said, the visa africa integration index that we introduce in this paper allows for the inclusion of some enablers based on the argument that actual integration, by definition, always lags potential integration (ghemawat, 2011a:32). beyond this, focusing on actual flows means that the index is based on hard data which, as noted, removes the risk of conjecture and “makes it ideal for dispelling myths about globalisation” (ghemawat, 2011a:32). third, the definition of economic integration adopted here identifies four specific dimensions along which to measure global economic integration, namely the movement of goods and services, or trade (t); financial integration, represented by the movement of capital (c); the movement of information and knowledge (i), such as access to information, ideas and technology; and the sajems ns 19 (2016) no 1:82-102 85 movement of people (p). the make-up, influence and impact of each of these elements, including the relevant literature and empirical evidence, are discussed extensively in ghemawat (2011b) and saville and white (2013). interrogating the so-called tcip framework reveals a growing body of evidence that shows that cross-border interactions, economic openness and integration drive economic growth and socioeconomic advancement. within the four pillars of this tcip framework, individual types of flows become the building blocks of the visa africa integration index. these components, which are described in greater detail below, are selected on the back of ghemawat’s (2011b; 2011a:32-33) seminal research which sets out the different ways in which a country’s connectedness contributes to economic advance and human development. drawing on this work, the components that were included in the construction of the visa africa integration index are shown in table 1. table 1 pillars and components of visa africa integration index pillar component trade (t) merchandise trade services trade spending on freight, forwarding and courier services in-country transactions on foreign bank cards road, rail and air infrastructure capital (c) foreign direct investment (fdi) stocks foreign direct investment (fdi) flows information (i) internet users mobile cellular subscribers trade in printed publications social network users spending on data services and information education spending people (p) immigrants (foreign born) tourists (arrivals and departures) international students air transport passengers foreign bank cards versus domestic bank cards transactions on foreign bank cards source: adapted from ghemawat (2011a:33) and expanded by the author considering the factors identified, a number of points merit elaboration. first, based on the method of ghemawat (2011a), although the index construction includes mainly flow data, there are three notable departures from the use of flow data. the first of these come in the form of installed road, rail and air infrastructure and related logistics capacity. the second departure involves a consideration of the stock of fdi in addition to fdi flow data. the third departure entails measuring the stock of connectivity via information communications technologies that include internet access, mobile cellular telephony and social network footprints. the explanations for these extensions are given below. in the case of infrastructural capacity, the use of a stock measure is based on the recognition that the extent of economic integration, by definition, must lag the capacity to connect. in part, this presents the risk of the index measuring latent slack in the system rather than actual integration. concurrently installed infrastructure offers a leading indicator of integration that will be drowned out by other index elements if integration does not follow. over and above this, measuring the capacity of infrastructure and logistics to facilitate tcip flows acknowledges “the tremendous importance of logistics performance for economic growth, diversification and poverty reduction [that] has long been widely recognized” (arvis, mustra, ojala, shepherd & saslavsky, 2012:iii). 86 sajems ns 19 (2016) no 1:82-102 to this end, arvis et al.’s (2012) logistics performance index illustrates the importance of the ability of a country to facilitate tcip flows to that country’s income. drawing on a sample of 155 countries, arvis et al. (2012) show that a one per cent improvement in logistics performance corresponds with a 1.5 per cent increase in per capita income. in the case of fdi, as noted by ghemawat (2011a:33) foreign investment stocks, which are the result of investment flows accumulated over time, are an important broader indicator of enduring connections between countries. foreign-owned investments tend to have ongoing positive effects on host economies via corporate governance, for instance, and, in the case of fdi, through spillover effects via managerial control. in addition, fdi stocks also help balance out the high year-toyear volatility of investment flows. similar to fdi stocks, the stock of mobile telephony users, internet users and social network subscribers is arguably a better and more stable measure of connectivity than highly volatile (annual) flow figures. a further point that merits elaboration is the inclusion in the index of a broad set of country flow data made available by visa sub-saharan africa. as noted by young (2012:1), for many of the poorest regions of the world the underlying figures supporting existing estimates of economic activity and social welfare are minimal or, in some instances, non-existent. this is particularly the case in africa. for example, while the most recent penn world tables purchasing power parity data set provides real income estimates for 45 sub-saharan countries, in 24 of those countries it did not have any benchmark study of prices (young, 2012:2). in addition to helping us overcome problems of missing data, the proprietary, reliable and regularly-updated visa sub-saharan africa data help us overcome a second weakness in data sets dealing with african economic activity, namely data accuracy. as jerven (2013) demonstrates, even where numbers are available, figures are often misstated because of capacity constraints, changing economic structures and large “informal” economies that perform differently from the more readily measured “formal” economy. this means that one of the most urgent challenges in any survey of african economic development is to bolster statistical capacity. as jerven (2013) illustrates, reliable statistics are basic to the operation of governments in developing countries, vital to non-governmental organisations and invaluable to business. the data embodied in the visa africa integration index represent a step in this direction. 3.2 defining metrics building on the definition of global integration set out above, the metrics used to determine integration must be able to capture each flow’s depth as well as its breadth. depth refers to the size of a country’s international flows compared to a relevant measure of the size of its domestic economy, and as such reflects how important or pervasive interactions with the rest of the world are in the context of business or life in a particular country (ghemawat, 2011a:34-35). for the merchandise trade component, depth is evaluated by comparing each country’s merchandise exports and imports to its gdp, yielding the metrics merchandise exports and imports as per cent of gdp. thus, in 2010, south africa’s merchandise exports equalled 22.5 per cent of gdp and -imports 26.1 per cent of gdp. using this metric, table 2 compares trade depth of the 11 countries, and illustrates the importance of scaling depth metrics. to illustrate this point, in 2010 south africa exported $81.8 billion of goods, a figure that is more than ten times the size of ghana’s goods exports of $7.9 billion in that year. but in 2010, south africa’s economy measured more than 11 times the size of ghana’s economy. thus, even though south africa is a much bigger exporter than ghana in absolute terms, once we scale for the size of the economy it is apparent that ghana’s economy exports relatively more than the south african economy. a consideration of south africa and ghana’s merchandise imports reveal similar attributes, which underscores the importance of scaling. sajems ns 19 (2016) no 1:82-102 87 table 2 merchandise trade in absolute and relative terms for 2010 merchandise exports ($ billion) merchandise imports ($ billion) gdp ($ billion) merchandise exports % of gdp merchandise imports % gdp total merchandise trade % gdp angola 53.5 21.5 84.9 63.0 25.3 88.3 ghana 7.9 10.7 32.3 24.4 33.1 57.6 kenya 5.2 12.1 32.2 16.0 37.5 53.5 mozambique 3.2 4.5 9.6 33.4 46.9 80.3 nigeria 82.0 44.2 202.5 40.5 21.8 62.3 rwanda 3.0 1.4 5.6 53.0 25.4 78.4 south africa 81.8 94.9 363.9 22.5 26.1 48.6 tanzania 3.7 7.8 22.9 16.1 34.2 50.3 uganda 1.6 4.6 17.0 9.5 26.7 36.2 zambia 7.2 5.3 16.2 44.5 32.9 77.3 zimbabwe 2.5 3.8 7.5 33.4 50.8 84.3 source: imf (2011) the same principles apply to the other components that make up the index: to implement depth metrics, a relevant measure of a country’s domestic economy must be selected as the basis of comparison for each flow. such measures are identified in table 3, which also provides additional details about the metrics used for assessing depth. for example, foreign direct investment (fdi) flows are compared with gross fixed capital formation. ghemawat (2011a:34) notes this measure is a more precise domestic match for fdi flows than gdp, allowing the metric to characterise the percentage of a country’s fixed capital investment that takes place within country borders versus that across international borders. further, all of the scaling components are matched to the period in which observations are made. an exception is fdi flows, which are measured using a threeyear moving average, because these flows tend to be especially volatile. table 3 visa africa integration index depth metrics by component pillar component scaling component trade (t) merchandise trade domestic gdp services trade domestic gdp spending on freight, forwarding and courier services domestic gdp in-country transactions on foreign bank cards total card spend road, rail and air infrastructure capital (c) foreign direct investment (fdi) stocks domestic gdp foreign direct investment (fdi) flows gross fixed capital formation information (i) internet users population mobile cellular subscribers population trade in printed publications population social network users population spending on data services and information domestic gdp education spending domestic gdp people (p) immigrants (foreign born) population tourists (arrivals and departures) population international students tertiary education enrolments air transport passengers population foreign bank cards versus domestic bank cards transactions on foreign bank cards total bank card transactions source: adapted and expanded from ghemawat (2011a:33) 88 sajems ns 19 (2016) no 1:82-102 breadth is conventionally assessed by measuring how closely a country’s distribution of international flows across its partner countries matches the global distribution of the same flows in the opposite direction. however, given the nature of the data employed in this study, we instead measure breadth by considering the concentration of each of the flows. to measure concentration, we use a herfindahl-hirschman index (hhi), which is a widely accepted measure of economic concentration (herfindahl, 1955; hirschman, 1964). the hhi is conventionally used to measure industry concentration, where it is calculated by squaring the market share of each firm and then summing the resulting numbers. formally, the hhi is calculated by the equation: 𝐻𝐻𝐼 = 𝑠& ' ( &)* where si is the market share of firm i in the market and n is the number of firms. thus, in a market with two firms that each have 50 per cent market share: hhi = 0.502 + 0.502 = 0.25 + 0.25 = 0.50 from the formula, it follows that the hhi value can range from 1/n to one. by extending the input in the calculation from firm share to the share countries have in a given country’s export market, the hhi is readily converted from measuring market concentration – to assessing the narrowness or breadth of a country’s integration across the four pillars of the tcip framework. as breadth is desirable – representing a diversified portfolio of tcip flows – we calculate breadth as 1 – hhi and then scale the result by dividing by 0.01, or: 𝐵𝑟𝑒𝑎𝑑𝑡ℎ = (1 − 𝐻𝐻𝐼 = 1 − 𝑠& ' ( &)* )/0.01 measured this way, a score approaching 100 indicates great breadth and a highly diversified portfolio of tcip flows whilst a score approaching zero represents highly concentrated, or narrow, tcip flows. this measure of breadth is easily illustrated by taking the case of merchandise exports which we measure by considering country destination as well as product type. to illustrate this, consider the examples of angola and uganda, whose export destinations and export products are shown in table 4.3 squaring each country’s share of angola’s export market, summing the numbers and then subtracting the total from one, we arrive at a figure of 0.751. this converts to 75.1 when divided by 0.01. from comparative studies, this suggests angola’s merchandise exports are reasonably concentrated in destination, which we then describe as “narrow”. uganda, by comparison, achieves an hhi of 95.2 for export destination, indicative of greater diversification in export destinations and, therefore, greater breadth. considering product breadth, angola scores 7.8, which points to a high concentration reflecting the fact that 96.0 per cent of the country’s exports are in the single product category “crude petroleum oils”. by comparison, uganda’s hhi for exported products is 93.8, which reflects far greater diversification in product exports than angola. table 4 merchandise exports by destination and product (2010) angola export destinations % angola exported products % china 40.0 petroleum oils (crude) 96.0 united states 26.3 diamonds 1.4 india 9.4 petroleum oils (refined) 1.0 france 9.1 petroleum gases 0.7 canada 3.3 data processing machines 0.2 spain 2.1 printers and copying machines 0.1 netherlands 1.8 paper 0.1 sweden 1.6 structures and parts thereof 0.1 continued/ sajems ns 19 (2016) no 1:82-102 89 angola export destinations % angola exported products % united kingdom 1.2 aluminium tubes and pipes 0.1 germany 0.9 granite 0.1 export destinations (#) 67 exported products (#) 285 top ten destinations (%) 95.6 top ten products (%) 99.7 hhi score 0.25 hhi score 0.92 breadth score (1-hhi 75.13 breadth score (1-hhi 7.80 uganda export destinations % uganda exported products % sudan 9.4 coffee 20.6 drc 8.7 fish fillet or meat 6.8 kenya 8.1 petroleum oils, refined 5.6 rwanda 8.0 raw tobacco 5.3 netherlands 6.7 cement 4.6 germany 5.5 transmission apparatus 3.4 uae 4.8 live plants 2.7 italy 4.7 tea 2.6 burundi 4.3 cocoa beans 2.5 united kingdom 2.9 raw sugar cane 2.4 export destinations (#) 128 exported products (#) 745 top ten destinations (%) 63.3 top ten products (%) 56.4 hhi score 0.05 hhi score 0.06 breadth score (1-hhi 95.15 breadth score (1-hhi 93.81 source: centre for international data (2012); and united nations commodity trade statistics database (2012) in the same way that we can measure breadth by way of export destination, we can measure the breadth of other aspects of the tcip flows that make up the visa africa integration index. note, that because the breadth measure has absolute limits of 1/n and one, there is no need for a scaling factor. however, it is still necessary to identify a unit of measurement as a scaling component; we show this in table 5. table 5 visa africa integration index breadth metrics by component pillar component scaling component trade (t) merchandise trade export destination services trade product or service type spending on logistics and travel not relevant in-country transactions on foreign bank cards foreign issuer road, rail and air infrastructure not relevant capital (c) foreign direct investment (fdi) stocks home country foreign direct investment (fdi) flows home country information (i) internet users share of population mobile cellular subscribers share of population trade in printed publications not relevant social network users share of population spending on data services and information not relevant education spending not relevant people (p) immigrants (foreign born) host country tourists (arrivals and departures) home country and host country international students home country air transport passengers destination foreign bank cards versus domestic bank cards share of market transactions on foreign bank cards share of market source: adapted and expanded from ghemawat (2011a:33) 90 sajems ns 19 (2016) no 1:82-102 the importance of measuring breadth as well as depth are illustrated in figures 1 and 2. figure 1 shows the breadth calculations for our sample of 11 countries at the product and country level. from this, it is evident that whilst most countries’ product breadth and country breadth metrics marry up, there are exceptions. nigeria, ghana, angola and zambia stand out. in each case product breadth is narrower than country breadth, which highlights the capacity – and arguably the need – for the countries to develop product breadth. that aside, by taking a simple average of country breadth and product breadth scores for each country, we produce what we term “composite export breadth”. other factors that make up our index are scored in the same fashion. figure 1 merchandise export breadth at country and product level source: centre for international data (2012); and united nations commodity trade statistics database (2012) based on the above results, we can now compare country depth (derived from table 2), as measured by merchandise exports relative to gdp, to country breadth, as measured by the average of merchandise export breadth (figure 1). the result is shown in figure 2, from which it is evident that whilst some countries are reasonably deeply integrated with the rest of the world, this integration is not always broad. by way of example angola scores the highest on trade depth (63.0 per cent of gdp is represented by merchandise exports), but breadth is the narrowest in the sample (41.5 out of a possible 100 is scored, calculated by taking the simple average of country breadth and product breadth in merchandise exports). by contrast, uganda scores 94.5 out of 100 in terms of trade breadth, but has very “shallow” trade relations, with merchandise exports representing just 9.5 per cent of gdp. 41,5 89,1 95,7 74,0 92,9 94,5 89,2 90,2 94,5 83,2 59,9 0 10 20 30 40 50 60 70 80 90 100 a ng ol a m oz am bi qu e s ou th a fr ic a za m bi a zi m ba bw e k en ya r w an da ta nz an ia u ga nd a g ha na n ig er ia export breadth (country) export breadth (product) composite export breadth sajems ns 19 (2016) no 1:82-102 91 figure 2 merchandise export breadth and depth (2010) source: centre for international data (2012); and united nations commodity trade statistics database (2012) drawn together, the above illustrations point the way to measuring global integration by employing objective data in a fashion that captures the complexities and subtleties of this important – and often times emotive – subject. 3.3 survey period and addressing data gaps the visa africa integration index is constructed initially for the period 2011 and 2012, with the measurement period determined by data availability. over this period, the index is updated at six monthly intervals across the pillars that make up the depth and breadth measures of the index for all 11 countries. this translates into a substantial data requirement: nearly five million data points have been used to produce the index. given the substantial data requirement, it is unsurprising that there are cases where the targeted data are unavailable. to ensure universal coverage and continuity in the construction of the index, and following ghemawat (2011a:37-39), three methods were employed to deal with missing data, namely exclusion of some components from the breadth analysis; the adjustment of weights to account for missing countries for specific components; and the filling of gaps via interpolation and repetition. these aspects are outlined below. first, while we are able to measure all of the component flows’ depth, this is not the case for breadth because for many countries data are only available on the total magnitude of the flows in question, not how they are distributed by origin and destination. therefore, some components that are included in depth are excluded from breadth, as shown in table 6. second, there are situations where the data required for depth and breadth metrics are available for some but not all of the target countries. in such cases the weights for calculating a country’s pillar and index scores are adjusted so that the weight that would normally be applied to a missing component is redistributed proportionally across the remaining available components.4 third, for depth and breadth, there are cases where the required data for one or more countries are available in some but not all of the years for which the index is to be calculated. when there are gaps in the available data in the middle of a data series – for example data are available for the first half of 2011 and 2012 but not the second half of 2011 – linear interpolation is used to fill the gaps. when data gaps lie before or after all of the available data, repeating the values for the closest available observation fills them. for example, if the latest data available are from 2011 but 63,0 33,4 22,5 44,5 33,4 16,0 53,0 16,1 9,5 24,4 40,5 41,5 89,1 95,7 74,0 92,9 94,5 89,2 90,2 94,5 83,2 59,9 0 10 20 30 40 50 60 70 80 90 100 a ng ol a m oz am bi qu e s ou th a fr ic a za m bi a zi m ba bw e k en ya r w an da ta nz an ia u ga nd a g ha na n ig er ia merchandise export depth (% gdp) simple export breadth 92 sajems ns 19 (2016) no 1:82-102 no data are available for 2012, the 2011 value will be repeated in 2012. borrowing from ghemawat (2011a:38), this method was selected instead of linear extrapolation because the trend directions on many international flows are prone to disruption, as evidenced during the global financial crisis or, at a more local level during mexico’s “tequila crisis” of 1994, the asian crisis of 1997 or the russian crisis of 1998. this vulnerability of trends to substantial and sudden direction changes renders linear extrapolation especially prone to large errors and, thus, unsuitable as a method for fixing data gaps. notably, given the rigour of our data collection, gaps are modest, affecting less than two per cent of observations, thereby giving us a robust and reliable data set from which the visa africa integration index is calculated. table 6 visa africa integration index components pillar component included in depth measure included in breadth measure trade (t) merchandise trade yes yes services trade yes yes spending on logistics and travel yes no in-country transactions on foreign bank cards yes yes road, rail and air infrastructure yes no capital (c) foreign direct investment (fdi) stocks yes yes foreign direct investment (fdi) flows yes yes information (i) internet users yes yes mobile cellular subscribers yes yes trade in printed publications yes no social network users yes no spending on data services and information yes yes education spending yes yes people (p) immigrants (foreign born) yes yes tourists (arrivals and departures) yes no international students yes yes air transport passengers yes no foreign bank cards versus domestic bank cards yes yes transactions on foreign bank cards yes yes 3.4 making metrics comparable after computing the metrics and filling in the data gaps as described above, the results are made comparable by converting all figures to percentages and then stating the final figure as a percentage of the global average. in this way, a country which has an economy that is “as integrated” as the global economy, has a score of 100. countries with scores above 100 are leading integrators, whilst countries with scores below 100 are relatively unintegrated. changes in scores show the direction in which integration is moving relative to a (moving) global average. final figures are expressed at percentages of the global average because we believe it is important to contextualize africa in the global economy. moreover, by measuring integration against the rest of the world, we get a firm sense of the existing opportunity gap. in addition, where relevant, data are normalised by adjusting for purchasing power. this is an important iteration because spending $1 on data in nigeria in 2010, for instance, buys about one megabyte of data, whereas the same $1 spent in south africa buys four times as much data (opera software, 2012). 3.5 aggregation and weights the overall visa africa integration index is built up from its constituent components via four steps, which develops the approach employed by ghemawat (2011a:40-41). the method is shown in figure 3. sajems ns 19 (2016) no 1:82-102 93 figure 3 aggregation structure of the visa africa integration index source: adapted and expanded from ghemawat (2011a:40) first, the individual components are aggregated into the four tcip pillars, as shown in table 7. the individual components are assigned weights inside of each of the pillars along the dimensions of depth and breadth. this allows for the estimation of overall depth and breadth scores for the four pillars of trade, capital, information and people. table 7 shows the different weights that are assigned to individual components to measure the global tcip score. the assignment of weights is explained below. adapting ghemawat’s (2011a) approach, in the case of measuring depth in the trade pillar, the weight assigned to merchandise trade is two times the weight assigned to services trade. this is because over the past decade, merchandise trade has on average been four times larger than services trade. in the 11 countries that we survey, 2012 merchandise trade was three times larger than services trade. however, because the long-term growth rate of services trade is higher than merchandise trade, we make a subjective assessment to assign two times higher weight to merchandise trade versus services trade. spending on freight, forwarding and courier services, as the term implies, is assigned a services weight. in this fashion, we assign a services weight to incountry transactions on payments for goods and services made using foreign cards. road, rail and air infrastructure is assigned a balancing weight, given its association with physical trade and services trade. in the capital pillar, fdi is the only element considered in terms of economic integration. this is because fdi tends to last significantly longer than other forms of international capital flows. further, by its real economic engagements, fdi has visibly greater economic and social effects than, for instance, foreign portfolio investment (fpi) (lin, 2012). thus, as with trade, a subjective decision is made to assign all weight to fdi at the expense of other forms of international capital flows. within fdi, however, a significantly higher weight is assigned to stocks over flows given the cumulative nature of stocks. that said, stocks and flows each measure distinct and important 94 sajems ns 19 (2016) no 1:82-102 aspects of integration. flows indicate a country’s current participation in cross-border investment activity and stocks indicate the influence of an external shareholder on the country’s economy via technology diffusion, capital accumulation, skills transfer and so on. table 7 weighted depth and breadth metrics by component pillar pillar weight (%) component depth weight (%) breadth weight (%) trade (t) 17.5 merchandise trade 20.0 45.0 services trade 10.0 22.5 spending on logistics and travel 15.0 0.0 in-country transactions on foreign bank cards 15.0 32.5 road, rail and air infrastructure 7.0 0.0 total score for (t) 100.0 100.0 capital (c) 17.5 foreign direct investment (fdi) stocks 75.0 75.0 foreign direct investment (fdi) flows 25.0 25.0 total score for (c) 100.0 100.0 information (i) 32.5 internet users 20.0 25.0 mobile cellular subscribers 20.0 25.0 trade in printed publications 10.0 0.0 social network users 10.0 0.0 spending on data services and information 20.0 25.0 education spending 20.0 25.0 total score for (i) 100.0 100.0 people (p) 32.5 immigrants (foreign born) 30.0 35.0 tourists (arrivals and departures) 15.0 0.0 international students 30.0 35.0 air transport passengers 12.5 0.0 foreign bank cards versus domestic bank cards 6.25 15.0 transactions on foreign bank cards 6.25 15.0 total score for (p) 100.0 100.0 100.0 total tcip score 400.0 400.0 among the information components, internet usage, mobile connectedness, spending on data and spending on education are assigned double the weights given to trade in books and other printed publications and social network users. following ghemawat (2011a), this reflects the imperfection of some of the indicators: publications are often printed in multiple locations rather than traded across borders in physical form; and these weights also reflect the trend toward more information flows taking place in digital form rather than via physical trade in printed publications. social network use is given a relatively lower weight as, whilst this is an integrator, it remains in its infancy. within the people pillar, equal weights are assigned to migration and student mobility. each of these components reflects a distinct aspect of integration and spawn effects that span the other tcip components. for example, students serve as conduits of information and migrants tend to promote trade. following ghemawat (2011a), without a logical basis for assigning different weights, they are treated as having equal importance. air transport passengers and international flights are given material – but lower – weights. the number of foreign bank cards and transactions on foreign bank cards – which capture the number of people moving across borders and the extent of their economic activities – are given the balancing weight. this balancing weight is split equally across the two components. in each pillar, weights add to 100 index points, giving a maximum possible score of 400 index points for breadth and depth across the four tcip pillars. the next step in the compilation of the sajems ns 19 (2016) no 1:82-102 95 index is the four pillars are assigned weights to allow for the computation of an aggregate depth and breadth score for each country. ghemawat (2011a:41) assigns the trade and capital pillars weights of 35 per cent each versus the information and people pillars which are assigned weights of 15 per cent each. our research, however, suggests that of the four components, the integration of people and information have a materially higher influence on economic connectedness than trade and capital flows. this is at odds with conventional wisdom, and may be due to the overarching “invisible yet powerful” influence of people, information and knowledge. this observation is supported by the findings of saville (2013) which shows that the flows of information (i) and people (p) granger-cause trade (t) and capital (c) flows. against this backdrop, a weight of 32.5 per cent is assigned to the people and information pillars, whilst a weight of 17.5 per cent is assigned to the trade and capital pillars. these scores are then aggregated to yield a tcip global integration score. to this, we add a tcip regional integration score that is built along the same lines, including depth and breadth elements across each of the four pillars but scored using only regional flows, by which we mean flows between sub-saharan african economies. the construction of a separate regional element elevates the role that regional integration plays in facilitating economic advance. this separate element also allows for unique observation of africa’s connectedness, an aspect of economic development that historically suffers from feeble data and poor measurement. thus, the final step in the computation of the index involves combining the depth and breadth measures for the global and regional scores in equal weights, and then combining the global and regional scores in equal weights to produce the visa africa integration index. the final score is measured out of 100, with 100 points reflecting the global average. in addition to calculating levels of global integration of the 11 countries surveyed in this report, by aggregating the factors that make up the index by geography into a southern african, west african and east african cluster, we are in a position to measure the extent to which integration occurs in each of the major economic clusters. thus, over and above helping improve our understanding of africa’s economic relationships and the role that global integration plays in the region’s socio-economic advance, by emphasising regional integration the visa africa integration index provides a novel contribution to our understanding of african economies’ relationships with the world and with neighbours. 4 unique features of the visa africa integration index the visa africa integration index is not the first effort to assess the economic integration of countries. as noted by ghemawat (2011a:42), of the earliest handlings of this topic to receive widespread attention was the a.t. kearney/ foreign policy magazine globalization index (2007). this index is encompassing and includes multiple aspects of globalization (niklas, 2015). however, the index has not been updated since its 2007 edition. zurich eth university’s kof index of globalization receives significant attention and is regularly updated; the most recent update being the 2015 edition of the index. whilst the index provides valuable insights into the economic, social and political dimensions of globalization (dreher, gastron & martens, 2008), assessment is based only on depth and excludes the important dimension of breadth. further, the statistical methods that are used, especially principal component analysis, is prone to produce measures that are compromised in terms of their relevance to users. the ernst & young (2012) globalization index, generated in cooperation with the economist intelligence unit (eiu) has recently been updated. further, the dhl global connectedness index, highlighted throughout this report, represents a major contribution to the literature and our understanding of the subject of global integration. however, whilst offering rich insights into connectedness, economic integration and globalisation, each of these reports excludes many of the countries included in the visa africa integration index. the extent of coverage is summarised in table 8. 96 sajems ns 19 (2016) no 1:82-102 table 8 globalisation indices and country coverage a.t. kearney globalization index kof index of globalization ernst and young globalization index dhl global connectedness index angola ü ghana ü ü kenya ü ü mozambique ü ü nigeria ü ü ü ü rwanda ü south africa ü ü ü ü tanzania ü uganda ü ü ü zambia ü ü zimbabwe ü notwithstanding the valuable contributions made by these reports to the measurement of global integration and our understanding of the role that economic integration and economic assimilation play in socio-economic development, the visa africa integration index benefits from new or unique features that distinguish the index from prior research in this area. first, by employing reported flow data the index provides an unbiased measure of integration that yields a clearer picture of economic integration than comparable indices. second, by virtue of access to unique and accurate data, the index represents a reliable and regularly updated measure of economic integration. third, the use of proprietary data means that the gap between actual flows, the reporting of data and updating of the index is much smaller than is normally the case. this translates into an index that does not display the substantial construction latency suffered by other indices. fourth, the capacity to disaggregate the index into the sub-components of tcip global integration score and regional integration score affords unique insights into the nature and evolution of economic integration amongst 11 of africa’s biggest economies. finally, the index extends coverage to include economies of whom information on economic connectedness and integration has been limited. no other index offers these features. the results of the construction of the visa africa integration index and some key economic implications are set out in the next section. 5 results the final output of the visa africa integration index, reported for the four survey periods, namely biannually for 2011 and 2012, is captured in figure 4. whilst substantial information is carried in each data point, in the final analysis five key attributes stand out. first, whilst improving off a modest base, the countries that make up the index have undergone positive structural transformation over the past decade (saville & white, 2015). the index offers recent and robust evidence of this: all 11 countries show improvements in economic integration over the period measured. in some cases the improvements are modest. zimbabwe and angola record gains in integration that amount to less than one per cent over the period. in other cases the gains are swift and substantial. rwanda’s index score rises by almost 20 per cent over the two years. ghana, nigeria and zambia all record a robust single digit improvement in economic integration. second, given the rapidly improving economic environment and composition, the socioeconomic gains that accompany rising integration will translate into rising investment opportunities and prospects for new business relationships in the 11 countries covered. notwithstanding these improvements, the results of the visa africa integration index show no african country in the index scores above the global median of 100 at either the global or regional sajems ns 19 (2016) no 1:82-102 97 level. at the end of 2012, south africa scores highest amongst the 11 countries for global integration, as shown in figure 5. ghana scores highest for regional integration, as shown in figure 6. nonetheless, south africa and ghana are a long way off the global median recorded for global and regional integration, respectively. note that the scores in this analysis are rebased to 100 to allow for ease of comparison; in the index each form of integration is weighted at 25 per cent. figure 4 visa africa integration index the same observation holds for the underlying depth and breadth pillars that make up the index. whilst south africa scores highest for global depth (figure 5) and global breadth (figure 5) at the end of 2012; mozambique scores highest for regional depth (figure 6); and rwanda has the highest score for regional breadth (figure 6). notably, none of these scores achieves the global median. the net result is that whilst africa’s economic integration appears to be rising, the general case is that this improvement is off a low base and still has some way to go to achieve the global median recorded for economic integration. again, note that the scores in this analysis are rebased to 100 to allow for ease of comparison; in the index each form of integration is weighted at 25 per cent. third, whilst the survey period is admittedly short, the drivers of integration have some common elements. for example, over the survey period regional integration is a consistently more important contributor toward economic progress and social development than global integration. however, the pillars – in the form of contributions made by the tcip elements – vary. in the west african cluster the most important driver is people. while in east africa it is information and in southern africa it is trade and information that make the greatest contributions to rising integration. these variances in the tcip pillars make for interesting analysis. more notable, though, is that it is regional-– rather than global integration – that carries the greater weight in the integration index for most countries, as shown in figure 7. 53,9 47,3 45,3 48,3 52,1 40,6 28,8 42,4 63,3 35,8 31,1 0 10 20 30 40 50 60 70 80 90 100 k en ya r w an da ta nz an ia u ga nd a g ha na n ig er ia a ng ol a m oz am bi qu e s ou th a fr ic a za m bi a zi m ba bw e 2011 h1 2011h2 2012 h1 2012 h2 98 sajems ns 19 (2016) no 1:82-102 figure 5 visa africa integration index global depth and breadth (2012) figure 6 visa africa integration index regional depth and breadth (2012) 34,3 28,6 26,7 25,9 29,0 26,1 23,9 29,2 45,5 24,8 15,2 18,6 12,1 16,7 18,2 20,1 19,3 14,7 15,3 32,8 16,4 16,8 0 10 20 30 40 50 60 70 80 90 100 k en ya r w an da ta nz an ia u ga nd a g ha na n ig er ia a ng ol a m oz am bi qu e s ou th a fr ic a za m bi a zi m ba bw e breadth depth 14,3 12,9 11,6 18,4 15,9 9,5 7,5 27,3 11,4 13,3 16,0 40,6 41,0 35,5 34,9 39,2 26,1 11,7 12,9 37,0 17,1 14,2 0 10 20 30 40 50 60 70 80 90 100 k en ya r w an da ta nz an ia u ga nd a g ha na n ig er ia a ng ol a m oz am bi qu e s ou th a fr ic a za m bi a zi m ba bw e breadth depth sajems ns 19 (2016) no 1:82-102 99 fourth, there are relevant disconnects in some countries that do not follow the anticipated trend results. as a rule, the countries tend to have similar degrees of regional and global integration. however, some notable anomalies arise, in particular the cases of angola and south africa, where wide divides exist between global and regional integration, as shown in figure 7. note that the scores in this table are rebased to 100 to allow for ease of comparison; in the index each form of integration is weighted at 50 per cent. that aside, this evidence speaks of the nature, health and consistency of economic integration. figure 7 global and regional elements of visa africa integration index (2012) the fifth aspect that stands out is that africa – and more specifically according to these results sub-saharan africa – is not “one country” or “a place”. the region is not one amorphous aggregate, distinguished from the rest of the world as “being different”. rather, the findings reinforce the point that each of the 11 countries that makes up the index, and its three regions, have unique and discernible attributes that influence and inform the way in which they integrate with the world economy and with whom they connect. to be sure, each of the 11 countries – and each of the three regions – is made up of unique elements with their own economic, geographic, institutional and structural forces are at work. these are informed by their histories, a diversity of resources and contrasting possibilities. these variances and unique attributes are captured in figure 8, which shows integration by depth and breadth at the regional and global levels. thus, whilst economic integration is a driver of socio-economic advance, the influence and impact it has differs from region to region and country to country, which evolves with regional and global integration. this speaks to the value of the visa africa integration index, emphasising the fact that it is simply not possible to approach africa with a “one size fits all” mind set. the work done in compiling the index reveals that each region and every country that makes up the index presents its own opportunities and challenges, with idiosyncrasies and rewards, and each needs to be assessed in its own right. 52,9 40,7 43,4 43,4 49,1 45,4 38,6 44,6 78,2 41,2 31,9 54,9 53,9 47,1 53,3 55,1 35,7 19,1 40,2 48,4 30,4 30,2 0 10 20 30 40 50 60 70 80 90 100 k en ya r w an da ta nz an ia u ga nd a g ha na n ig er ia a ng ol a m oz am bi qu e s ou th a fr ic a za m bi a zi m ba bw e tcip global integration score regional integration score 100 sajems ns 19 (2016) no 1:82-102 figure 8 component contributions to the visa africa integration index (2012) whilst in the past fifteen years the surge in demand for natural resources may have kick-started the process of rapid economic growth that has come about for the countries that comprise the visa africa integration index, the available evidence and arguments identify structural change as an increasingly powerful driver of sustained socio-economic advance in africa. indeed, with the collapse in commodity prices observed over the course of 2013 and 2014, it is evident that structural forces and not commodity prices will have to serve as the basis for economic growth and development. the arguments underpinning the index and the analysis that follows from its construction show that the countries in the visa africa integration index are embracing modernity and necessary structural change, even if much still needs to be done. the strengthening of institutions, through the role of the state, improved legislation, macroeconomic policies, fiscal management and the entrenchment of individual rights are just some of the factors that have helped move these 11 economies into a positive direction, while achieving greater integration with each other and with the world. this has become a driver of socio-economic advance. 6 conclusion the tcip framework developed by pankaj ghemawat, which describes the nature and influence of key economic connections – international trade (t), cross-border capital movements (c), information and knowledge flows (i) and the movement of people (p) – identifies economic integration as a key driver of material improvements in a country’s economic and social welfare. yet, in the case of african economies this element of economic integration has largely been ignored. by virtue of having access to proprietary data, that represents more than five million observations across each of the elements identified above, the visa africa integration index is able to address this lacuna, and serve as a reliable and robust measure of economic integration for 11 of 9,3 6,0 8,4 9,1 10,1 9,7 7,3 7,7 16,4 8,2 8,4 7,1 6,5 5,8 9,2 7,9 4,8 3,7 13,6 5,7 6,7 8,0 17,1 14,3 13,3 12,9 14,5 13,1 11,9 14,6 22,7 12,4 7,6 20,3 20,5 17,8 17,4 19,6 13,1 5,8 6,4 18,5 8,5 7,1 0 10 20 30 40 50 60 70 80 90 100 k en ya r w an da ta nz an ia u ga nd a g ha na n ig er ia a ng ol a m oz am bi qu e s ou th a fr ic a za m bi a zi m ba bw e tcip global breadth score regional depth score tcip global depth score regional breadth score sajems ns 19 (2016) no 1:82-102 101 africa’s largest and fastest growing economies. drawing on the key building blocks laid by ghemawat, the visa africa integration index makes a new – and hopefully useful and important – contribution to our understanding of the nature and extent of economic relationships amongst some of africa’s largest economies. amongst other things, by developing the index we achieve a sophisticated measure of economic integration that incorporates the four pillars of economic connectedness, namely trade, capital, information and people (tcip) flows. in addition to measuring these pillars at the country level, the granularity of the data to which we have access allows us the ability to measure economic integration at global and regional levels, and also to measure the depth and breadth of these relationships. whilst the results provide for a number of new and detailed insights into the nature of economic integration amongst africa’s biggest economies, there are five key findings that stand out. first, whilst improving off a modest base, the countries that make up the index display rising integration over the survey period. whilst this is admittedly a short period, the evidence is encouraging. second, given the rapidly improving economic environment and composition, the socio-economic gains that come with rising integration will translate into rising investment opportunities and prospects for new business relationships in the 11 countries covered. third, for the set of 11 countries, regional integration demonstrates itself to be the greater component of integration. this is an important outcome given that regional integration is a consistently more important contributor toward economic progress and social development than global integration alone. fourth, there are some notable disconnects in the case of some countries that do not follow the anticipated trend results. this allows for useful insights into country dynamics, economic challenges and prospects. fifth, africa and more specifically, according to the results of this study, sub-saharan africa is not “a country” or “a place”. the region is not one amorphous aggregate. rather, the findings reinforce the point that each of the 11 countries that make up the index, and their three regions that we measure, represent a rich tapestry of economies that have unique and discernible attributes that influence and inform the way in which they integrate with the world economy and with whom they connect. regardless of how we approach the results produced by the visa africa integration index, our findings are unambiguous in at least two regards. first, whilst coming off a modest base, the economies that we measure are rising in terms of the degree and sophistication of economic integration. second, although the economies have some way to go in terms of catch up, by the evidence produced by the visa africa integration index they are evidently getting into the business of catching up. endnotes 1 adrian saville is chief strategist at citadel asset management and professor in economics and finance at the gordon institute of business science, university of pretoria. lyal white is associate professor and director of the centre for dynamic markets at the gordon institute of business science, university of pretoria. the authors would like to thank two anonymous reviewers and the editor for their helpful and constructive comments that greatly contributed to improving this paper. 2 the terms “connectedness” and “integration” are used interchangeably throughout the paper. there is no intended difference in meaning or connotation, rather the terms are used interchangeably for the sake of the reader given the frequency with which these terms are used in the paper. 3 for expedience we truncate the list at ten observations as the tails are long. in the case of angola, the country exported 285 products (using hs4 classification) to 68 other countries in 2010, but the top ten countries made up more than 90 per cent of export destinations and the top 10 products accounted for more than 99 per cent of exports. in the case of uganda, the country exported 745 products to 128 destinations in 2010, the top ten countries made up 60 per cent of export destinations and the top ten products explained more than half of all exports. thus, whilst we use the full population to calculate export destinations, for the sake of convenience we illustrate trade patterns by way of truncated lists. 4 for example, see minney (2012, 23) where for instance it is noted, “there is no official data that captures all sub-saharan africa’s capital flow”. as the index is an ongoing construction, once missing data become available the inferred data used for missing entries are replaced by actual data. 102 sajems ns 19 (2016) no 1:82-102 references arvis, j-f., mustra, m.a., ojala, l., shepherd, b. & saslavsky, d. 2012. connecting to compete 2012: trade logistics in the global economy. world bank: washington. a.t. kearney & foreign policy magazine. 2007. the globalization index 2007. foreign policy magazine. available at: http://foreignpolicy.com/2009/10/12/theglobalization-index-2007/ [accessed july 2014]. dreher, a., gaston, n. & martens, p. 2008. measuring globalisation: gauging its consequences. new york: springer. ernst & young. 2012. looking beyond the obvious: globalization and new opportunities for growth. ernst & young. available at: 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urban-rural income gap in china hao wei, hongbing li & ye guo school of economics and business administration, beijing normal university, china accepted: january 2013 this paper analyses the effect of foreign trade in china on the urban-rural income gap from certain angles including trade scale, trade structure and trade mode at the national and provincial levels. the empirical results indicate that, from the perspective of trade scale, the export and import in the eastern and national regions have an expansion effect on the urban-rural income gap, and, in the central regions, they have a reduction effect. furthermore, export in the western regions has a reduction effect while import in these regions did not have a significant effect. from the perspective of trade structure, the trade of high-tech products and labour-intensive products in the national and eastern regions has an expansion effect, and the trade of the above-mentioned products in the central regions has a reduction effect. the trade of labour-intensive products in the western regions has a reduction effect, and that of high-tech products an expansion effect. from the perspective of trade mode, processing trade and general trade in the national and eastern regions have an expansion effect, while in the central regions they have a reduction effect. general trade in the western regions would expand the urban-rural income gap, and processing trade does not have a significant effect. consequently, when the south african government is working out trade multiplicative and corresponding policy, they should consider the development of foreign trade and should pay attention to the labour market structure. key words: trade scale, trade structure, trade mode, urban-rural income gap, labour market structure jel: f16, j21 1 introduction since the 1970s, international trade has rapidly been developed, and problems like income disparity, of which the core problem is income gap expansion, are increasing, attracting widespread attention from international as well as labour economists (harrison, mclaren & margaret, 2010). scholars have researched this problem at two levels. on the one hand, research on the gap of trade benefits at national level has been done; and, at the same time research was done on the income gap of various groups and regions. from the perspective of the income gap, most literature recognises that there is an internal relation between foreign trade and the income gap. haskel and slaughter (2001) conducted empirical research on these aspects in england; while bernard and jensen (1997), and ebenstein, harrison, margaret & shannon (2009) conducted empirical research related to america. there are also some scholars who conducted this research on developing countries, like mexico (harrison & hanson, 1999); chile (beyer, rojas & vergara, 1999); columbia (goldberg & pavcnik, 2007) and the phillipines (hasan & jandoc, 2010). research on foreign trade for both developing and developed countries indicates that foreign trade has had an effect on the income gap, from the perspective of industry, region and the individual. in china, foreign trade and the urban-rural income gap are developing an era of reform and greater foreign exposure. the policies of reform, especially, relate to internal reform and greater exposure to the outside world. domestically, migrant rural labourers are the result of internal reform, while internationally china has implemented an export-oriented economy, which includes attracting foreign capital and vigorously developing processing trade. foreign trade promotes economic abstract sajems ns 16 (2013) no 2 97 development and reform due to greater foreign exposure. the conflict of these two approaches causes tension. along with the development of reform and foreign exposure, the scale of migrant rural labourers expanded exponentially. the 2 million migrant rural labourers in 1983, increased to 30 million in 1989. these grew to 62 million labourers in 1993, and 75.5 million in 2000. by 2001 the number had further grown to 83.99 million, and by 2002 this number had reached more than 100 million. migrant rural labourers in china have kept increasing ever since and by 2006, there were 132 million migrant rural labourers (cai &wang, 2009). the huge transfer of labour not only reduces surplus rural labour, but also increases the income of rural residents. further more, labour transfer also provides cheap labour resources for economic development and foreign trade development, especially the development of introductory industrial and processing trades. both statistical data and the current situation indicate that foreign trade development and migrant rural labourers are interactive. through the size of employment quantity, the biased effect of employment quality and the pulling-up effect of labour productivity, the foreign trade effect of rural labour, and its income, is increased. foreign trade impacts the urban-rural income gap by affecting the employment of diverse groups in a similar way. consequently, we must consider the factors of foreign trade when conducting research on the urban-rural income gap. from the perspective of trade scale, trade mode and trade structure, this paper employs panel data from 29 provinces spanning 1986-2010 to analyse the effect of foreign trade on the urban-rural income gap, which has attracted increasing international attention. this paper provides informative evidence of china, and it makes a significant attempt, from the perspective of foreign trade, to analyse the causes of the expanding urban-rural income gap and its solutions. this article consists of five parts. section 1 is the introduction to the study; section 2 is a literature review of foreign trade and the urban-rural income gap; section 3 provides the econometric model, design index and discusses the data; section 4 provides the empirical and results analysis; and section 5 concludes and provides policy suggestions. 2 literature review the heckscher-ohlin factor endowment theorem (h-o theorem) and stolper-samuelson theorem (s-s theorem) are often quoted in research on the relationship between foreign trade and the income gap. according to earlier research, because of the effect of income from production factors, foreign trade has improved the income level of unskilled labourers in developing countries, which had advantages pertaining to labour endowment, thereby narrowing the income gap (deardorff, 1982; bhagwati & srinivasan, 2002; bhagwati, 2004). regrettably, this theory was not supported by evidence from developing countries, particularly india (kumar & mishra, 2008), the philippines (hasan & jandoc, 2010), and 17 countries in latin america (perry & olarreaga, 2006). in those countries, the income gap was expanding instead of narrowing, during the greater foreign exposure era. the discrepancy between theory and practice attracted the attention of many scholars.many scholars have conducted empirical research on different countries and regions. amiti and davis (2008), and amiti and cameron (2012) used data from indonesian manufacturing enterprises from 1991 to 2000 to analyse the effect of tariff cuts on wages, and found that tariff cuts reduce wages in import-competing sectors and elevate wages in export sectors. from the perspective of technology progress and export destination, bustos (2007) used panel data from argentine enterprises from 1992 to 1996 and brambilla, lederman & porto (2010) used data from 1991 to 2000 to analyse whether the heterogeneity of technical levels and wage gaps in export destinations affect wage income, and consequently, expand the income gap between high-skilled and low-skilled workers. hummels, jorgensen, munch & xiang (2010) used firm-level data from the labour force and trade to determine whether the exogenous block of trade and offshore outsourcing on enterprise and wage level are different. import shocks increase the wages of skilled workers and decrease those of unskilled workers and, consequently, expand the income 98 sajems ns 16 (2013) no 2 gap. export shocks increase the wages of both types of workers, but the wage increase of low-skilled workers and middleskilled workers is more pronounced. wei and liu (2011) used data from 125 countries to analyse the effects of international trade on various countries as well as the wage income in different types of countries. they found that trade factors are important factors that affect the income inequality in asian developing countries. import is in favour of narrowing the income gap, and export results in an expanding income gap. compared with the results from other developing countries, the effects of import and export trade in asian developing countries are greater and more significant. a great deal of research on china has been conducted. wei and wu (2001) used data from 1988 to 1993 to conduct research on china, and they arrived at the conclusion that foreign trade contributes to the narrowing of the urban-rural income gap. however, scholars’ post-studies claim that foreign trade has expanded the urban-rural income gap in china. according to research by kanbur and zhang (2005), from 1979 to 2000 foreign trade expanded the urban-rural income gap. shen and zhang (2011) found that the inverted u-shaped relationship between foreign trade and the urban-rural income gap is uncertain. an increase in foreign trade expanded the urban-rural income gap. yuan, wei & yang (2011) found the increase in foreign exposure and in finished products’ trade proportion narrowed the urban-rural income gap. wei and zhao (2012) found international trade showed diverse outcomes on the employment and income of skilled and unskilled workers. the effect of international trade on employment in china is a biased effect of employment quality and employment expansion. furthermore, wan lu and chen (2007) demonstrated that from 1987 to 2001 the effect of foreign trade on the regional income gap in china is significantly positive, and has strengthened over time. wei (2009) found that the export gap has a durable and significantly positive effect on the regional income gap, and makes the greatest con tribution to the income gap. han, liu & zhang (2012) found that the regional wage gap expanded significantly after joining the wto. on the whole, a great deal of research has been conducted on the effect of international trade on the domestic income gap and changes in wages, but little research has been conducted on the effect of international trade on the urban-rural income gap, and the results of this research are conflicting. furthermore, previous research conducted from the perspective of trade scale, shows a lack of analysis from the perspective of trade by trade structure and trade mode. based on the latter, this paper makes use of panel data from 29 provinces from 1986 to 2000 to empirically analyse the effect of international trade and the urban-rural income gap. there are several key contributions in this paper. firstly, this paper considers the ratio of urban to rural income and the theil index as indicators measuring the urban-rural income gap, and conducts a comparative study. secondly, goods are divided into high-tech and labour-intensive products, and this paper analyses the effects of the trade of various products on the urban-rural income gap. this paper also analyses the effects of general trade and processing trade on the urban-rural income gap. thirdly, this paper analyses the effects of certain trade structures and trade modes on the regional urban-rural income gap, and proposes policies for the transformation of the development model of foreign trade. 3 model, variables and data 3.1 setup of econometric model and variable declaration based on research by wei et al. (2001), wan et al. (2007) and han et al. (2012), combining the reality of foreign trade and the urban-rural income gap in china, this paper implements the urban-rural income gap as explained variable and trade factor as explanatory variable. this paper also makes use of seven non-trade factors that may affect the urban-rural income gap as control variables, and consequently, the econometric model is set out as follows: sajems ns 16 (2013) no 2 99 ineq ijt =c+α 1 trade ijt +α 2 market it +α 3 fdi it +α 4 employ it +α 5 unemploy it +α 6 lnagdp it +α 7 capital it +α 8 education it +ε it (1) in this model, ineqijt represents the urban-rural income gap, and i、j and t represent province, various measures of indicator, and year, respectively. α1~α8 represents the coefficient of explanatory variables, measuring the marginal effect of explanatory variables on the urban rural income gap. c and ε represent the intercept term and random disturbance term, respectively. according to equation (1), the specification and measure of indicators are as follows. 3.1.1 explained variable the explained variable of this paper is the urban-rural income gap (ineq) and is measured by means of two methods; 1) the ratio of urban to rural income (income), suggests measuring the urban rural income gap by means of the ratio of urban residents’ per capita disposable income to rural residents’ per capita disposable income (lu & chen, 2004; yuan et al., 2011; wei & zhao, 2012). 2) theil index (theil). the theil index is widely used in research on the urban-rural income gap. this paper uses the theil index to measure china’s urban-rural income gap, and the ratio of urban to rural income is considered a comparative study. wang et al. (2007) made a meaningful attempt to calculate the theil index, and measured the urban-rural income gap in various regions and certain periods by calculating the theil index of i cross-sections and t periods. drawing from this calculation, and combining it with research by shorrocks (1980), this paper calculates the theili,t formula as follows: ⎟⎟ ⎠ ⎞ ⎜⎜ ⎝ ⎛ +⎟⎟ ⎠ ⎞ ⎜⎜ ⎝ ⎛ = ti c ti ti c ti ti c ti ti u ti ti u ti ti u ti ti z z p p p p z z p p p p theil ， ， ， ， ， ， ， ， ， ， ， ， ， lnln (2) where u and c represent urban areas and rural areas, respectively; pu i and pc i represent the overall income level (represented by product of population and per capita income) of urban and rural areas in region i, respectively. pi represents the overall income in region i. zu i and zc i represent urban and rural population size in region i, respectively. zi represents total population in region i. 3.1.2 explanatory variable a) trade factor (trade) this paper measures the trade factor on three levels, namely trade openness, trade structure and trade mode. trade openness includes openness of trade (trade), openness of export (export) and openness of import (import). the three indicators are measured by the ratio of total volume of trade, export volume, and import volume to regional gdp in the same year, and volume of trade, export volume and import volume are converted by the central parity of dollar to rmb in the same year. trade structure includes the trade of high-tech products (tectrade) and the trade of labour intensive products (labtrade). the total volume of trade minus the trade volume of high-tech products is regarded as the trade volume of labour-intensive products. the trade volumes of high-tech products and labour-intensive products are taken as the logarithm after being converted by the central parity of dollar to rmb in the same year. trade mode include general trade and processing trade, and they are measured by means of the volume of general trade and the volume of processing trade, which are taken as the logarithm after being converted by the central parity of dollar to rmb in the same year. b) other non-trade factors degree of denationalisation (private). this indicator represents the degree of the govern ment’s regulation and is measured by means of the ratio of workers in non-state owned enterprises to total workers in each province. openness to foreign direct investment (fdi). fdi affects the income gap of the host country by wage premiums and potential technology spillover. it is measured by means 100 sajems ns 16 (2013) no 2 of the ratio of utilised foreign capital to gdp in each province. employment structure (employ). the inflow of surplus rural labour changes the employment structure and influences the income level of labourers in both urban and rural areas. it is measured by means of the ratio of employment in the primary industry to total employment. urban unemployment rate (unemploy). with the adjustment of the economic structure and the dualism of urban and rural employment, employment opportunity becomes an important factor impacting the income gap between various groups. it is measured by using the unemployment rate registered by provinces over the year. economic development (lnagdp). it is gener ally acknowledged that developed areas aggregate more resources, provide more employment opportunities and higher wages, and conse quently increase the income levels of the local residents. it is measured by means of the logarithm of the per capita gdp of the provinces. ratio of urban to rural in fixed-asset investment (capital). for a long time, urban biased economic policy caused an inequality of fixed-asset investment between urban and rural areas, and the proportion of expenditure on agriculture to total financial expenditure is also declining, which may be an important factor that expands the urban-rural income gap (lu & chen, 2004). it is measured by means of the ratio of urban to rural fixed-asset investment. average level of education (education). the urban-rural education gap is caused mainly by the urban-biased education policy, and the education gap is a significant factor affecting the urban-rural income gap (chen et al., 2010). we measure the average level of education by means of the average years of schooling of persons who are six years and above. 3.2 data sources considering that the data of tibet is insufficient, and it has not been long since chongqing became a municipality, these two provinces are left out. this paper selects panel data spanning 1986 to 2000, from 29 provinces and cities, and they are divided into three areas, including the eastern, central and western areas. empirical research is conducted on the relationship between foreign trade and the urban-rural income gap. the urban-rural proportion and theil index used in this paper are calculated according to the raw data from the china economy information net and the china statistical yearbook. data pertaining to the total export import volume of provinces and foreign trade spanning 1986 to 1991 come from the china statistics compilation over 60 years. data pertaining to foreign trade spanning 1992 to 2010 come from the china statistical yearbook, and are collected according to the location of the operating agency. considering the availability of data and research priorities, this paper selects trade data from 2000 to 2010 pertaining to high-tech products and labour intensive products in provinces. the data are drawn from the websites of the ministry of commerce of the people’s republic of china (mofcom) and the state general admini stration of customs. data pertaining to general trade and processing trade from 2000 to 2010 are selected for a future study, and data spanning 2001 to 2008 were acquired from csmar, and missing data as well as data of other years come from the statistical yearbook of provinces. processing trade includes processing and assembling trade, feeding processing trade and outward processing. the data pertaining to foreign direct investment used by provinces come from the china statistical yearbook and the statistical yearbook of provinces. the central parity rate of rmb and the dollar comes from the china statistical yearbook, 2010. the employment structure, degree of denationalisation, urban unemployment rate, economic development, and the ratio of urban fixed-asset investment to rural fixed-asset investment are calculated according to the china statistics compilation over 60 years and the china statistical yearbook. the average years of schooling of persons six years and older are calculated according to the china statistical yearbook and the china population statistics and yearbook. sajems ns 16 (2013) no 2 101 4 empirical research and result analysis 4.1 analyses from the perspective of trade openness: regression at national level considering the individualities and charac teristics of the data, this paper uses a fixed effect method to estimate the model, and the hausman test also rejects the null hypothesis of random effect. table 1 shows the regression results, which take income and theil as explanatory variables, and its goodness of fit is high. an adjusted goodness of fit is more than 0.86. it is demonstrated that there is a high correlation between the urban-rural income gap and trade openness (trade), openness to export (export) and openness to import (import), and it is also demonstrated that foreign trade is an important factor affecting the urban-rural income gap in china. t a b l e 1 regression results of ratio of urban income to rural income and theil index: 1986 to 2000 ratio of urban income to rural income theil index openness to export openness to import trade openness openness to export openness to import c 7.9093*** 7.2581*** 7.6275*** 0.6501*** 0.6229*** 0.6327*** (12.36) (11.08) (11.86) (11.27) (10.83) (10.98) trade 0.6413*** 0.0314*** (11.72) (6.37) export 1.0948*** 0.0573*** (9.12) (5.44) import 0.9182*** 0.0431*** (10.92) (5.72) private -1.0235*** -0.8376*** -0.9773*** -0.1586*** -0.1505*** -0.1554*** (-4.92) (-3.92) (-4.65) (-8.45) (-8.02) (-8.25) fdi -3.6145*** -3.3540*** -2.9913*** -0.1675*** -0.1608*** -0.1340*** (-6.93) (-6.16) (-5.83) (-3.56) (-3.36) (-2.91) employ 1.3888*** 1.4369*** 1.2580*** 0.1024*** 0.1056*** 0.0958*** (6.29) (6.26) (5.65) (5.14) (5.24) (4.80) unemploy -0.0082 -0.0146 -0.0041 -0.0008 -0.0011 -0.0006 (-0.96) (-1.64) (-0.47) (-1.01) (-1.42) (-0.76) lnagdp -0.4216*** -0.4111*** -0.3510*** -0.0313*** -0.0314*** -0.0276*** (-6.43) (-5.99) (-5.39) (-5.30) (-5.22) (-4.73) capital 0.0166*** 0.0211*** 0.0126*** 0.0007** 0.0009*** 0.0005 (4.86) (5.88) (3.64) (2.16) (2.87) (1.54) education -0.2231*** -0.1692*** -0.2580*** -0.0279*** -0.0252*** -0.0295*** (-8.90) (-6.50) (-9.98) (-12.34) (-11.01) (-12.72) r2 0.79¥ 0.77 0.78 0.77 0.77 0.77 adj-r2 0.78 0.76 0.77 0.76 0.76 0.76 instructions: number in brackets is t-vale, and ***, **, * represent passing test at the 0.01, 0.05, 0.1 significance level, respectively. furthermore, from the perspective of openness to export and openness to import, their correlation coefficients are positive and pass the test at the 0.01 significance level. it is demonstrated that trade at national level is an important factor expanding the urban-rural income gap. furthermore, the regression results, which consider the ratio of urban to rural income and the theil index as explanatory variables, show that the effect of export on the expanding urban-rural income gap in china, of which the coefficient is 1.0948 and 0.0573, is more obvious than that of import, of which the coefficient is 0.9182 and 0.0431. 102 sajems ns 16 (2013) no 2 consequently, it is demonstrated that export has a greater effect on the urban-rural income gap than import does. among the other explanatory variables, all of them show a significant correlation, except for the urban unemployment rate (unemploy). the degree of denationalisation (private) is significantly negative, which demonstrates that the higher the ratio of workers in non state-owned enterprises to total workers, the higher the degree of market development. consequently, the convergence of wages is in favour of raising the income level of workers in non-state-owned enterprises. it is also in favour of narrowing the income gap between workers in different ownership enterprises, which is in accordance with the conclusions by yang, sylvie and li (2011) and theoretical expectation. economic development (lnagdp) and average level of education (education) have significantly negative correlations with income gap, and this demonstrates that the more developed an economy is, the more employment opportunities there will be. a higher average level of education is in favour of human capital accumulation, and consequently narrows the urban-rural income gap. openness to trade (fdi) has a significantly negative correlation, which means that, along with the development of greater foreign exposure, the inflow of foreign trade significantly suspends the expanding trend of the income gap. employment structure (employ) and the ratio of urban to rural fixed-asset investment (capital) have significantly positive correlations with the urban-rural income gap, which demonstrates that, if the proportion of workers in the primary industry is higher and the gap in urban-rural fixed-asset investment is wider, the income of rural residents will become less and the urban-rural income gap will expand. 4.2 analyses from the perspective of trade openness: regression at regional level tables 2 and 3 show the regression results making use of the ratio of urban income to rural income and the theil index as explained variables. the results demonstrate that trade is an important factor affecting the urban-rural income gap in the eastern areas, central areas and western areas; however, it has varying effects in different areas, and results with various explained variables are also different. a) the correlation coefficients of trade open ness, openness to export and openness to import in the eastern regions are signi ficantly positive. when using the ratio of urban to rural income as explained variable, the regression results basically agree with the theil index as explained variable, which verifies the robustness of the regression results (lines 1-3 in tables 2 and 3). at the same time, trade significantly expands the urban-rural income gap in the eastern regions, and the effect of export is greater than that of import, which is in accordance with results at national level. b) the correlation coefficients of trade open ness, openness to export and import in the central regions are significantly negative, suggesting that foreign trade is in favour of narrowing the urban-rural income gap. evidently, the regression results of the central regions vary from those of the western and eastern regions, and they differ from each other in two ways. on the one hand, the directions of influence are different. there are negative correlations between the three trade indicators and the urban-rural income gap measured by means of the ratio of urban to rural income, but they are not significant (lines 4-6 in table 2). there are significantly positive correlations between the three trade indicators and the urban-rural income gap measured by means of the theil index (lines 4-6 in table 3). the reasons for this occurance are that the two measurements have different focuses. on the other hand, the degree of the influence also varies, and the effect of import on the narrowing of the urban-rural income gap is greater than the effect of export. c) in the western regions, openness to trade has a significantly negative correlation with the urban-rural income gap, but there is no significant correlation between open ness to trade and the urban-rural income gap. export can significantly narrow the urban-rural income gap, but the effect of sajems ns 16 (2013) no 2 103 import is not apparent. comparing table 2 with table 3, it is demonstrated that the regression results of trade openness and openness to export are robust, while the regression result of openness to import is not robust. t a b l e 2 regression results (1) of trade openness and the urban-rural income gap at regional level: 1986 to 2000 explained variable: ratio of urban income to rural income eastern regions central regions western regions (1) (2) (3) (4) (5) (6) (7) (8) (9) c 3.7418*** 2.5163*** 3.8999*** -1.2261 -1.1674 -1.4056 1.0739 1.4920 2.0520* (4.70) (3.29) (4.52) (-1.13) (-1.06) (-1.30) (0.94) (1.35) (1.74) trade 0.3158*** -0.6771 -2.0889*** (7.87) (-1.07) (-3.09) export 0.6403*** -0.6589 -2.6930*** (8.29) (-0.67) (-3.47) import 0.3855*** -1.2309 -0.2325 (5.64) (-1.11) (-0.17) private 0.0662 0.2423 0.1933 3.9175*** 3.9414*** 3.9305*** -0.1732 -0.1485 0.1977 (0.31) (1.19) (0.86) (6.70) (6.74) (6.74) (-0.44) (-0.38) (0.5050) fdi -0.2870 -0.3932 0.2820 -8.9421*** -9.3778*** -8.6319*** -5.0726** -5.4481** -5.7534** (-0.64) (-0.88) (0.62) (-4.84) (-5.22) (-4.48) (-2.11) (-2.28) (-2.34) employ 0.9293*** 1.3042*** 0.6640** -1.2925*** -1.3228*** -1.2366*** 3.6446*** 3.4627*** 3.1548*** (3.59) (4.98) (2.43) (-3.06) (-3.11) (-2.91) (8.67) (8.7615) (7.35) unemploy -0.0195 -0.0426*** -0.0151 0.1116*** 0.1108*** 0.1110*** -0.0088 -0.0080 -0.0123 (-1.39) (-3.14) (-0.99) (3.54) (3.50) (3.52) (-0.88) (-0.80) (-1.21) lnagdp -0.1760** -0.1349 -0.1729* 0.0942 0.0845 0.1050 0.1256 0.0947 0.0095 (-2.09) (-1.63) (-1.95) (0.75) (0.67) (0.83) (0.99) (0.78) (0.07) capital 0.0149*** 0.0174*** 0.0138*** 0.0160 0.0140 0.0165 -0.0095 -0.0093 -0.0012 (4.19) (4.94) (3.65) (1.41) (1.26) (1.45) (-1.57) (-1.58) (-0.21) education -0.0616* 0.0196 -0.0818** 0.0217 0.0238 0.0251 -0.0922** -0.1086*** -0.1296*** (-1.94) (0.65) (-2.27) (0.35) (0.38) (0.40) (-2.23) (-2.74) (-3.05) r2 0.83 0.84 0.82 0.74 0.73 0.74 0.77 0.77 0.76 adj-r2 0.82 0.83 0.80 0.71 0.71 0.71 0.75 0.75 0.74 the regression results demonstrate that trade has diverse effects on the urban-rural income gap in various regions. one possible reason is that variances in the effects of trade on the urban-rural income gap are caused by differences in regional openness. for the eastern regions, because of the implementation of an unbalanced foreign trade strategy, which is characterised by the priority of greater foreign exposure. the trade development level in the eastern regions is higher than that in the central and western regions. the eastern regions gradually eradicated trade development based on the growth of the trade scale, and started to transform the growth pattern of foreign trade. this means that the growth model of foreign trade in the western regions changed from a scale-oriented to a quality-oriented trade and, consequently, intensified competition in the domestic product and labour markets. the substitution of the production factors of import for labour is strengthened, and enterprises’ preference for skilled labourers was changed. consequently, the promotion of trade development on the employment of unskilled workers is weakened, and the urban-rural income gap is expanded. on the whole, in the eastern regions, the biased effect of employment quality is obvious (wei & zhao, 2012). 104 sajems ns 16 (2013) no 2 t a b l e 3 regression results (2) of trade openness and the urban-rural income gap at regional level, spanning from 1986 to 2000 explained variable: theil index eastern regions central regions western regions (1) (2) (3) (4) (5) (6) (7) (8) (9) c 0.3841*** 0.3322*** 0.3691*** -0.1420 -0.1285 -0.1867* 0.1367 0.1598 0.2291** (4.96) (4.50) (4.53) (-1.38) (-1.22) (-1.81) (1.24) (1.50) (2.03) trade 0.0143*** -0.1664*** -0.1479** (3.65) (-2.77) (-2.26) export 0.0363*** -0.1573* -0.2187*** (4.86) (-1.67) (-2.93) import 0.0123* -0.3084*** 0.0702 (1.91) (-2.94) (0.53) private -0.0846*** -0.0816*** -0.0725*** 0.3316*** 0.3377*** 0.3346*** -0.1030*** -0.1050*** -0.0724* (-4.08) (-4.17) (-3.41) (5.96) (6.00) (6.04) (-2.69) (-2.80) (-1.94) fdi 0.0463 0.0251 0.0820* -0.9955*** -1.1029*** -0.9155*** -0.5825** -0.6053*** -0.6496*** (1.06) (0.58) (1.90) (-5.66) (-6.37) (-5.00) (-2.51) (-2.64) (-2.76) employ 0.0608** 0.0832*** 0.0510** -0.1873*** -0.1946*** -0.1733*** 0.2642*** 0.2548*** 0.2188*** (2.42) (3.29) (1.98) (-4.66) (-4.76) (-4.30) (6.52) (6.70) (5.34) unemploy -0.0011 -0.0022 -0.0013 0.0095*** 0.0092*** 0.0093*** -0.0005 -0.0004 -0.0007 (-0.83) (-1.64) (-0.91) (3.15) (3.04) (3.11) (-0.48) (-0.37) (-0.74) lnagdp -0.0138* -0.0123 -0.0128 0.0077 0.0053 0.0104 0.0101 0.00885 -0.0003 (-1.69) (-1.54) (-1.52) (0.64) (0.44) (0.87) (0.83) (0.76) (-0.02) capital 0.0007** 0.0008** 0.0007* 0.0010 0.0005 0.0012 -0.0012** -0.0013** -0.0005 (2.05) (2.48) (1.93) (0.95) (0.49) (1.07) (-2.05) (-2.25) (-0.97) education -0.0203*** -0.0166*** -0.0199*** -0.0010 -0.0004 -0.0002 -0.0169*** -0.0178*** -0.0205*** (-6.58) (-5.73) (-5.88) (-0.16) (-0.07) (-0.03) (-4.25) (-4.68) (-5.04) r2 0.77 0.78 0.76 0.73 0.72 0.73 0.72 0.73 0.72 adj-r2 0.76 0.77 0.75 0.70 0.70 0.71 0.70 0.71 0.70 for the central and western regions, the effect of trade scale is not fully functioning, and creating employment by means of foreign trade is still an important way to solve the problems of surplus rural labour and urban unemployment and to narrow the urban-rural income gap. according to china’s migrant workers survey report released by the national bureau of statistics, the employment of migrant worker in the central regions increased by 4.2 per cent in 2011, and in the western regions increased by 6.7 per cent, suggesting increases that are 1.1 per cent and 3.6 per cent higher than the increase in the eastern regions.1 this demonstrates that the marginal effect of employment created by trade in the central and western regions is greater than in the eastern regions. con sequently, it is practically significant for the central and western regions to expand trade scale, strengthen foreign exposure, and tap the potential of creating employment through trade. the increase of employment can significantly promote the income of rural labourers, improving the utilisation rate of labours, and narrow the urban-rural income gap. on the whole, the effect of employment expansion caused by an increase in trade scale is obvious (wei & zhao, 2012). unlike the regression results at national level, trade factors affect the urban-rural income gap in three regions, but they are different from each other in significance, directions of influence and the degree of the influence. further studies should be conducted on the effect of trade structure and trade patterns on the three regions. furthermore, from the perspective of other sajems ns 16 (2013) no 2 105 explanatory variables, the non-trade factors that have significant effects on both explained variables (income and theil) in the three regions are different. in the eastern regions, it is trade structure and the ratio of urban fixed-asset investment to rural fixed-asset investment that affect the urban-rural income gap. in the central regions, it is the degree of denationalisation, openness to foreign direct investment, employment structure, and urban unemployment rate that affect the urban-rural income gap. in the western regions, it is openness to foreign direct investment, employment structure, and average level of education that affect the urban-rural income gap. it is demonstrated that the non-trade factors that affect the urban-rural income gap in the three regions are different, and this situation is caused by differences between factor endowment and economic development. 4.3 analysis from the perspective of product structure of trade in order to study the effects of various products on the urban-rural income gap, this paper classifies products into labour-intensive (labtrade) and high-tech products (tectrade), according to technological content. this paper conducts research at both national and regional levels, focusing on the variation tendency since 2000. the regression results are shown in tables 4 and 5. a) at national level, regressions based on the ratio of urban to rural income and the theil index both demonstrate that the correlation coefficient of high-tech products is significantly positive while the effect of labour-intensive products is not significant. it is demonstrated that the development of high-tech product trade has significantly expanded the urban-rural income gap in china since 2000. this situation is caused by the biased effect of employment quality and an imbalance in the employment structure in the labour market caused by a trade structure upgrade. since the start of the 21st century, with the high-tech industry based on the information industry transferring to developing countries, product compositions in china have changed from labour-intensive to capital-intensive products and highor middle-tech-intensive products. the labour market is in favour of skilled workers and reduces the demand for unskilled workers. it is difficult to reverse this situation, as china has an abundance of unskilled workers and shortage of skilled workers. by the path of trade structure upgrade→biased effect of employ ment quality→expansion of wage gap, foreign trade expands the income gap between urban residents (based on skilled workers) and rural residents (based on unskilled workers). b) the regression results at regional level demonstrate that the variances in effect of trade structure on the three regions are significant. in the eastern regions, both the trade of labour-intensive and high-tech products have significantly positive corre lations with the dependent variables, and the effect of labour-intensive products on the expansion of the urban-rural income gap is more significant. in the central regions, the regression coefficients of the trade of labour-intensive and high-tech products are negative, but their significance is not stable. in the western regions, the regression coefficient of the trade of labour-intensive products is negative, and that of the trade of high-tech products is positive; however, neither of them is significant. in conclusion, the trade of products of any kind significantly expands the urban-rural income gap in the eastern regions, and the trade of products of any kind significantly narrows the urban-rural income gap in the central regions. in the western regions, the trade of labour intensive products narrows the urban-rural income gap, and the trade of tech intensive products expands the urban-rural income gap. these effects in the eastern regions are great, most significant and stable, and the effects in the western and central regions are small and not significant. the trading of products of different kinds has diverse effects on the urban-rural income gap, and this is closely related to trade structure and the structure of the labour market. on the whole, the reason why trade development expands the urban-rural income gap is because of the mismatch between the trade and labour 106 sajems ns 16 (2013) no 2 market structures in the eastern regions. similarly, because the trade and labour market structures are well matched in the central regions, the development of foreign trade has narrowed the urban-rural income gap. trade and labour market structures are not well matched in the western regions and there is a lack of skilled workers, and therefore the trade of tech-intensive products expands the urban-rural income gap. furthermore, from the perspective of other explanatory variables, the significances and correlation coefficients are nearly in accordance with the above as well as expectations. t a b l e 4 regression results (1) of trade structure and the urban-rural income gap at both national and regional level: 2000 to 2010 4.4 analysis from the perspective of trade mode tables 6 and 7 provide the regression results based on general trade and processing trade. specifically, at the national level, the regression coefficient of the processing trade is significantly positive, and the regression coefficient of general trade is positive, but without a stable significance. the regression coefficient of general trade in table 6 is not significant, and table 7 demonstrates a weak yet positive correlation. this means that processing and general trades expand the urban-rural income gaps at national level, and the effect of the processing trade is more significant than that of general trade. at a regional level, various trade mode have different effects on certain regions. general and processing trades in the eastern regions have positive and significant correlations with the urban-rural income gap, and general and processing trades in the central regions have negative yet insignificant correlations with the urban-rural income gap. in the western regions, explained variable: ratio of urban income to rural income trade of labour-intensive products trade of high-tech products nationwide eastern regions central regions western regions nationwide eastern regions central regions western regions c 7.7835*** 4.0445** 0.5612 3.7487 8.1045*** 3.9082*** -1.0575 5.8360** (5.92) (2.24) (0.25) (1.41) (6.47) (2.11) (-0.48) (2.23) labtrade 0.0364 0.1532*** -0.1483* -0.1016** (1.32) (5.76) (-1.67) (-2.14) tectrade 0.0381** 0.0892*** -0.0383 0.0021 (2.36) (5.23) (-1.09) (0.08) private -0.6835 -1.4807** 3.9970*** 1.4620* -0.8355 -0.7993 4.3275*** 0.7793 (-1.28) (-2.61) (4.41) (1.84) (-1.58) (-1.42) (4.54) (0.87) fdi -6.4300*** -1.3708 -13.2286*** -7.0998 -7.3387*** -3.4013*** -12.0032*** -4.6200 (-5.48) (-1.48) (-6.60) (-1.39) (-5.99) (-3.31) (-6.17) (-0.85) employ 0.0805 1.1113** -1.4990*** 2.8423*** 0.1653 1.0520** -1.8194*** 2.1653*** (0.23) (2.22) (-3.05) (3.75) (0.49) (2.05) (-3.75) (3.07) unemploy -0.0689 -0.0523*** 0.0699 -0.3363*** -0.0719** -0.0564*** 0.0734 -0.3319*** (-2.33) (-2.77) (1.63) (-4.04) (-2.48) (-2.93) (1.55) (-3.88) lnagdp -0.2186 -0.2016 0.1627 0.0166 -0.2259** -0.1189 0.0771 -0.1977 (-1.64) (-1.05) (0.71) (0.06) (-2.02) (-0.62) (0.35) (-0.78) capital 0.0197*** 0.0239*** 0.0101 -0.0024 0.0201*** 0.0176** 0.0095 0.0024 (3.76) (3.43) (0.70) (-0.26) (4.14) (2.59) (0.64) (0.26) education -0.3014*** -0.1281*** 0.0201 -0.03012 -0.3089*** -0.1137*** 0.0750 -0.1300* (-6.86) (-3.05) (0.25) (-0.36) (-7.07) (-2.63) (1.08) (-1.70) r2 0.76 0.71 0.69 0.67 0.77 0.70 0.69 0.65 adj-r2 0.73 0.66 0.63 0.60 0.74 0.65 0.62 0.58 sajems ns 16 (2013) no 2 107 general trade has positive yet insignificant correlations with the urban-rural income gap, and the effect of processing trade is uncertain. in other words, the development of general and processing trades in the eastern regions will significantly expand the urban-rural income gap, and in the central regions it will narrow the urban-rural income gap, but the effect is not significant. general trade in the western regions will expand the urban-rural income gap, while the effect is insignificant, and the effect of processing trade is uncertain. in particular, the effect of general and processing trades in the eastern regions on the urban-rural income gap is significant, which is in accordance with the regression results at national level; however, the effect of general trade on the urban-rural income gap in the eastern regions is greater than that of processing trade, which is in disagreement with the regression results at national level. t a b l e 5 regression results (2) of trade structure and the urban-rural income gap at both national and regional level: 2000 to 2010 explained variable: theil index trade of labour-intensive products trade of high-tech products nationwide eastern regions central regions western regions nationwide eastern regions central regions western regions c 0.7438*** 0.5461*** -0.0374 0.6108** 0.7749*** 0.5072*** -0.1710 0.7872*** (6.63) (3.64) (-0.15) (2.30) (7.27) (3.22) (-0.72) (3.12) labtrade 0.0037 0.0116*** -0.0116 -0.0042 (1.57) (5.27) (-1.22) (-0.89) tectrade 0.0038*** 0.0059*** -0.0036 0.0040 (2.78) (4.10) (-0.96) (1.64) private -0.1445*** -0.2015*** 0.3978*** -0.0403 -0.1595*** -0.1487*** 0.4282*** -0.1440* (-3.18) (-4.28) (4.09) (-0.51) (-3.54) (-3.11) (4.22) (-1.67) fdi -0.4441*** -0.0809 -1.1150*** -0.8491* -0.5354*** -0.2151** -1.0153*** -0.4686 (-4.44) (-1.06) (-5.19) (-1.67) (-5.13) (-2.47) (-4.90) (-0.90) employ 0.0356 0.0871** -0.1524*** 0.1813** 0.0443 0.0870** -0.1790*** 0.1612** (1.17) (2.10) (-2.89) (2.40) (1.54) (1.99) (-3.47) (2.37) unemploy -0.0051** -0.0026 0.0024 -0.0236*** -0.0054** -0.0031* 0.0031 -0.0245*** (-2.01) (-1.65) (0.52) (-2.84) (-2.18) (-1.91) (0.61) (-2.97) lnagdp -0.0269** -0.0282* 0.0013 -0.0199 -0.0274*** -0.0176 -0.0042 -0.0334 (-2.3597) (-1.77) (0.05) (-0.76) (-2.89) (-1.08) (-0.18) (-1.37) capital 0.0011** 0.0015** 0.0005 0.0001 0.0011*** 0.0009 0.0005 0.0003 (2.3629) (2.57) (0.34) (0.14) (2.64) (1.59) (0.33) (0.34) education -0.0344*** -0.0262*** 0.0077 -0.0185** -0.0352*** -0.0254*** 0.0118 -0.0268*** (-9.1928) (-7.53) (0.91) (-2.23) (-9.46) (-6.93) (1.59) (-3.64) r2 0.82 0.86 0.67 0.65 0.82 0.85 0.66 0.66 adj-r2 0.80 0.84 0.60 0.59 0.800 0.82 0.59 0.60 the proportion of processing trade to total trade is approximately 50 per cent. according to the data from customs, the proportion of processing trade to total trade is approximately 55 per cent, spanning 1997 to 2005, and even during economic encounters with the sub-prime mortgage crisis and the european debt crisis in 2008, the export of processing trade was 835.42 billion dollars, consisting of 44 per cent of total exports. at the same time, processing trade is grouped in the eastern regions. in 2011, the export and import of processing trade in the central and western regions were 84.54 billion dollars, consisting of 6.5 per cent of the total processing trade2. consequently, the effect of processing trade on the eastern regions is great and significant. at the same time, processing and general trades 108 sajems ns 16 (2013) no 2 have great and significant effects on the local urban-rural income gap. processing and general trades have an effect on the narrowing of the income gap, but the effect is slight and not significant. this demonstrates that the eastern regions achieve results in transforming their trade development pattern both in the fields of processing trade and general trade. t a b l e 6 regression results (1) of trade mode and the urban-rural income gap at both national and regional level: 2000 to 2010 explained variable: ratio of urban income to rural income general trade processing trade nationwide eastern regions central regions western regions nationwide eastern regions central regions western regions c 8.0922*** 5.2836*** -0.1203 7.6531*** 9.2680*** 7.0351*** -0.8077 7.3774*** (6.13) (2.79) (-0.05) (2.93) (7.04) (3.81) (-0.33) (3.08) gentrade 0.0419 0.1051*** -0.0764 0.0114 (1.31) (3.12) (-0.89) (0.19) protrade 0.0538*** 0.0730*** -0.0212 -0.0148 (3.28) (4.92) (-0.59) (-0.57) private -0.9945* -1.2823** 3.8802*** 0.2333 -1.3279** -1.1966** 3.8917*** 0.5228 (-1.71) (-2.08) (4.10) (0.24) (-2.41) (-2.11) (3.99) (0.67) fdi -4.8770*** -0.2291 -12.0366*** -4.9019 -5.8261*** -1.9079** -11.2947*** -5.5505 (-4.13) (-0.25) (-4.97) (-0.93) (-4.88) (-2.16) (-5.06) (-1.12) employ 0.2071 0.6161 -1.5646*** 2.0847*** 0.1876 0.3956 -1.5373*** 2.1574*** (0.59) (1.12) (-3.25) (2.98) (0.55) (0.76) (-3.19) (3.20) unemploy -0.0753** -0.0644*** 0.0529 -0.2650*** -0.0792*** -0.0922*** 0.0393 -0.2660*** (-2.50) (-2.77) (1.22) (-3.40) (-2.74) (-4.68) (0.95) (-3.41) lnagdp -0.2536** -0.2487 0.1525 -0.4240 -0.3338*** -0.3256* 0.1159 -0.4114* (-2.00) (-1.24) (0.58) (-1.65) (-2.96) (-1.78) (0.44) (-1.74) capital 0.0198*** 0.0148* 0.0064 0.0087 0.0219*** 0.0198*** 0.0072 0.0086 (3.81) (1.90) (0.44) (0.97) (4.47) (2.66) (0.50) (0.98) education -0.2916*** -0.1172** -0.0007 -0.0956 -0.2902*** -0.1134** 0.0086 -0.0657 (-6.19) (-2.42) (-0.01) (-1.13) (-6.42) (-2.50) (0.10) (-0.83) r2 0.75 0.67 0.72 0.64 0.76 0.71 0.72 0.64 adj-r2 0.72 0.61 0.66 0.57 0.73 0.65 0.66 0.57 furthermore, the reduction effect of general and processing trades on the local income gap is mainly generated by means of employment expansion, which is caused by the increasing of foreign trade scale. the expansion effect of general and processing trades on the local income gap is mainly generated by the biased effect of employment quality, which is caused by the upgrading of the industrial structure. 4.5 endogenous problem and robustness test in previous studies on foreign trade and the urban-rural income gap, the endogenous problem is seldom mentioned. reverse causality between foreign trade and the urban-rural income gap as well as measurement errors are likely to cause an endogenous problem, and this will lead to biased and inconsistent estimations. consequently, considering the endogenous problems of the explained and the explanatory variables as well as the time-lag effect of the explanatory variables on the urban-rural income gap, we use two new models to test the regression results above. the first lagged explanatory variables are used in the first new model, and the first lagged explained variable is used in the second new model. this approach reduces the endogenous problem and tests the robustness of the regression results above. sajems ns 16 (2013) no 2 109 t a b l e 7 regression results (2) of trade mode and the urban-rural income gap at both national and regional level: 2000 to 2010 explained variable: theil index general trade processing trade nationwide eastern regions nationwide eastern regions nationwide eastern regions nationwide eastern regions c 0.7775*** 0.6528*** 0.0305 0.9514*** 0.8761*** 0.8308*** -0.0663 0.8179*** (7.05) (3.98) (0.12) (3.88) (7.98) (5.34) (-0.25) (3.60) gentrade 0.0047* 0.0070** -0.0116 0.0078 (1.76) (2.40) (-1.26) (1.41) protrade 0.0051*** 0.0064*** -0.0026 0.0012 (3.72) (5.15) (-0.68) (0.47) private -0.1670*** -0.1807*** 0.3789*** -0.1662* -0.1924*** -0.1836*** 0.3759*** -0.0940 (-3.44) (-3.39) (3.74) (-1.83) (-4.19) (-3.84) (3.58) (-1.27) fdi -0.2959*** -0.0023 -1.0506*** -0.6998 -0.3864*** -0.1397* -0.9341*** -0.9111* (-3.00) (-0.03) (-4.04) (-1.42) (-3.89) (-1.88) (-3.89) (-1.93) employ 0.0371 0.0366 -0.1480*** 0.0979 0.0364 0.0163 -0.1432*** 0.1204* (1.26) (0.77) (-2.87) (1.49) (1.27) (0.37) (-2.76) (1.88) unemploy -0.0056** -0.0038* 0.0004 -0.0208*** -0.0061** -0.0056*** -0.0016 -0.0210*** (-2.23) (-1.90) (0.10) (-2.85) (-2.54) (-3.37) (-0.35) (-2.84) lnagdp -0.0312*** -0.0314* 0.0017 -0.0552** -0.0369*** -0.0444*** -0.0053 -0.0414* (-2.94) (-1.82) (0.06) (-2.28) (-3.91) (-2.88) (-0.19) (-1.84) capital 0.0011*** 0.0008 0.0007 0.0011 0.0013*** 0.0014** 0.0008 0.0008 (2.61) (1.18) (0.48) (1.30) (3.13) (2.16) (0.54) (0.94) education -0.0342*** -0.0254*** 0.0005 -0.0271*** -0.0339*** -0.0244*** 0.0024 -0.0225*** (-8.69) (-6.05) (0.06) (-3.43) (-8.98) (-6.40) (0.27) (-3.01) r2 0.81 0.81 0.70 0.68 0.82 0.84 0.70 0.67 adj-r2 0.79 0.78 0.64 0.62 0.80 0.82 0.64 0.62 the regression results of the first new model in table 8 demonstrate that correlations between trade factors and the urban-rural income gap are significantly positive, while correlations between trade factors, namely the trade of labour-intensive products and general trade, and the urban-rural income gap are not significant. the explanatory variables, from the perspective of trade openness, are significant, and the direction of influence of the urban unemployment rate, economic development, the ratio of urban fixed-asset investment to rural fixed-asset investment, and the average level of education, are in accordance with the regression results above. from the perspective of trade structure, the significance of openness to foreign direct investment, the ratio of urban fixed-asset investment to rural fixed-asset investment, and the average level of education is consistent. from the perspective of trade mode, the effects of openness to foreign direct investment and the average level of education on general and processing trades are significant, which is in accordance with the regression results above. 110 sajems ns 16 (2013) no 2 t a b l e 8 regression results of first lagged explanatory variables explained variable: ratio of urban income to rural income trade openness openness to export openness to import trade of labour-intensive products trade of high tech products general trade processing trade c 9.2773*** 8.6470*** 9.0330*** 7.7078*** 9.5693*** 7.2934*** 7.9805*** (10.67) (9.90) (10.40) (5.61) (6.48) (5.43) (5.15) trade_1 0.5785*** 0.9808*** 0.8255*** 0.0335 0.1435*** 0.0186 0.0908*** (7.84) (6.16) (7.35) (1.17) (7.54) (0.58) (4.75) private_1 0.6442** 0.8105*** 0.6895** -0.8742 1.2813** -0.8447 1.5117** (2.29) (2.85) (2.44) (-1.56) (2.06) (-1.42) (2.25) fdi_1 -0.2371 -0.0003 0.3223 -6.3130*** -5.4552*** -6.3187*** -3.6074** (-0.34) (0.001) (0.47) (-5.18) (-3.83) (-5.17) (-2.45) employ_1 -0.5409* -0.4933 -0.6652** 0.1314 -1.3283*** 0.2265 -1.2821*** (-1.79) -1.59 (-2.19) (0.35) (-3.33) (0.63) (-3.03) unemploy_1 -0.0115 -0.0170 -0.0079 -0.0699** 0.0130 -0.0716** 0.0155 (-1.01) (-1.47) (-0.69) (-2.27) (0.38) (-2.30) (0.43) lnagdp_1 -0.5903*** -0.5768*** -0.5275*** -0.1881 -0.6880*** -0.1256 -0.5049*** (-6.64) (-6.31) (-6.01) (-1.36) (-5.24) (-0.97) (-3.69) capital_1 0.0039 0.0077 0.0004 0.0173*** 0.0134** 0.0157*** 0.0096 (0.85) (1.64) (0.08) (3.20) (2.37) (2.97) (1.59) education_1 -0.2663*** -0.2164*** -0.2981*** -0.3022*** -0.3054*** -0.3010*** -0.2734*** (-7.80) (-6.22) (-8.51) (-6.530 (-5.91) (-6.39) (-0.52) r2 0.62 0.61 0.62 0.77 0.71 0.77 0.68 a-r2 0.60 0.59 0.60 0.74 0.67 0.74 0.63 the regression results of the second new model in table 9 demonstrate that the coefficient of the explanatory variables and their significances are without notable changes, irrespective of perspective (trade openness, or trade structure, or trade mode). furthermore, the regression results are optimised. the goodness of fit is improved, and the regression results of the variables are more in accordance with the regression results above. the goodness of fit of the degree of denationalisation, openness to foreign direct investment and employment structure is improved significantly. on the whole, the coefficients and significance of variables in the two new models are in accordance with the regression results above, demonstrating the robustness of the estimation results in this paper. t a b l e 9 regression results of first lagged ratio of urban income to rural income explained variables: ratio of urban income to rural income trade openness openness to export openness to import trade of labour intensive products trade of high tech products general trade processing trade c 4.4906*** 4.1462*** 4.0742*** 4.4560*** 4.0870*** 3.6952*** 4.7265*** (7.25) (7.00) (6.51) (3.73) (3.49) (3.09) (4.16) income_1 0.3657*** 0.3928*** 0.3769*** 0.3821*** 0.3689*** 0.3714*** 0.3742*** (14.49) (16.71) (14.39) (10.04) (9.73) (9.71) (10.09) trade 0.3120*** 0.6617*** 0.3466*** 0.0689*** 0.0347** 0.0381 0.0572*** (5.85) (6.26) (4.15) (2.83) (2.42) (1.38) (4.20) private -0.1632 -0.0598 -0.0770 0.4567 0.4547 0.4687 0.1676 (-0.84) (-0.32) (-0.39) (0.93) (0.91) (0.87) (0.34) sajems ns 16 (2013) no 2 111 fdi -3.1680*** -3.2943*** -2.7580*** -7.0649*** -7.8689*** -7.0101*** -8.0406*** (-6.88) (-7.12) (-6.06) (-7.00) (-7.36) (-6.86) (-7.89) employ 0.9512*** 0.9840*** 0.8728*** 0.0332 0.2533 0.2431 0.1802 (4.83) (5.00) (4.39) (0.11) (0.85) (0.80) (0.62) unemploy -0.0003 -0.0031 0.0011 -0.0025 -0.0161 -0.0095 -0.0072 (-0.04) (-0.42) (0.15) (-0.09) (-0.60) (-0.34) (-0.28) lnagdp -0.2509*** -0.2618*** -0.1988*** -0.2529** -0.1408 -0.1220 -0.2223** (-4.22) (-4.40) (-3.38) (-2.15) (-1.43) (-1.10) (-2.3) capital 0.0068** 0.0090*** 0.0050 0.0136*** 0.0112*** 0.0104*** 0.0136*** (2.17) (2.84) (1.57) (3.03) (2.63) (2.34) (3.26) education -0.1396*** -0.1042*** -0.1480*** -0.1961*** -0.2016*** -0.1975*** -0.1977*** (-6.08) (-4.62) (-6.12) (-4.92) (-4.99) (-4.79) (-5.06) r2 0.84 0.84 0.84 0.84 0.84 0.84 0.85 a-r2 0.83 0.83 0.83 0.82 0.82 0.81 0.83 5 conclusions and recommendations 5.1 conclusions from the perspective of trade scale, trade structure and trade mode, this paper made use of panel data from 29 provinces spanning 1986 to 2010 to study the effect of foreign trade on the urban-rural income gap at national and regional levels. a) from the perspective of trade openness, both export and import significantly expand the urban-rural income gap at national level, and the effect of export on the urban-rural income gap is greater than that of import. at regional level, foreign trade has various effects on the urban-rural income gap in certain regions, and there are differences in significance, the direction of influence and the degree of influence. in the eastern regions, both export and import significantly expand the urban rural income gap, and the effect of export on the urban-rural income gap is greater than that of import, which is in accordance with the regression results at national level. in the central regions, foreign trade significantly narrows the urban-rural income gap and import has a greater effect on the narrowing of the urban-rural income gap than export does. in the western regions, export significantly narrows the urban rural income gap, but the effect of import is not significant. b) from the perspective of trade structure, the effect of the trade of high-tech products on the urban-rural income gap at national level is expansive and significant, and the effect of trade of labour-intensive products is also expansive but not significant. at the regional level, the effects of products of different kinds on the urban-rural income gap in the various regions are dissimilar. in the eastern regions, the trade of products of both kinds contributes significantly to the expansion of the urban-rural income gap, and the trade of labour-intensive product has a greater effect on the expansion of the urban-rural income gap. in the central regions, the trade of products of both kinds contributes to the narrowing of the urban-rural gap. in the western regions, the trade of labour-intensive products narrows the urban-rural income gap, and the trade of high-tech products expands the urban-rural income gap. c) from the perspective of trade mode, at national level general and processing trades have an effect on the expansion of the urban-rural income gap, and the effect of processing trade is greater and more significant than that of general trade. at the regional level, the effects of various trade mode on different regions are not the same. in the eastern regions, the develop ment of general and processing trades contributes to significantly expanding the urban-rural income gap. in the central regions, the development of general and processing trades contributes to significantly 112 sajems ns 16 (2013) no 2 narrowing the urban-rural income gap. in the western regions, the development of general trade contributes to expanding the urban-rural income gap, but the effect of processing trade on the urban-rural income gap is uncertain. 5.2 recommendations based on the research on the effect of trade scale on the urban-rural income gap, this paper conducted studies on the differences in the effects of various products and trade mode on the urban-rural income gap, and the results have practical significance. the results of this paper demonstrate that the development of trade in certain regions is different, and therefore has various effects on the urban-rural income gap. in the same regions, different products and trade mode have different effects on the urban-rural income gap. the effects of similar product and trade mode vary according to region. consequently, government should formulate corresponding policies according to the development of trade in certain regions, and these policies can then achieve the expected effects in practice. policies without consideration of regional differences are not adapted to national conditions. this is very important for both china and other developing countries, especially african countries. the effect of foreign trade on the urban rural income gap may be an expansion or a reduction effect. the effect is determined by means of the development of foreign trade and the structure of the labour market, and consequently, if the development tendency is well matched with the structure of the labour market, foreign trade will contribute to the narrowing of the urban-rural income gap, and vice versa. when the government makes an effort to promote economic growth by developing foreign trade in order to allow foreign trade to narrow the urban-rural income gap, government should select appropriate trade mode and product types according to the structure of the labour market, or it should adjust the structure of the labour market in order to develop foreign trade. in other words, for developing countries, the structure of the local labour market should be taken into consideration when a regional government is developing a strategy for the development of foreign trade. other developing countries, especially south africa, should also pay more attention to this aspect during the development of trade. in the end, besides trade factors such as trade openness, the structure of trade and trade mode, this paper also demonstrated that government should consider non-trade factors that affect the urban-rural income gap, such as the human capital disparity caused by different educational statuses, urban-biased investment in fixed assets, and differences in government’s regulation of markets. taking non-trade factors into account, government should ease the expansion of the urban-rural income gap and allow more workers of different types to benefit from the development of foreign trade. endnotes: 1 data source: state statistics bureau, http://www.stats.gov.cn/tjfx/fxbg/t20120427_402801903.htm. 2 data source: website of customs statistics, http://www.hgtj.cn/. acknowledgements this paper is supported by “the social science research fund of education ministry” (no. 10yjc790272), “national social science research fund” (no.10zd&017, no.11ajl005) and “the fundamental research funds for the central university” (no. 105563gk). we would like to express our great appreciation to the anonymous reviewers for their valuable comments on this manuscript as it developed. references amiti, m. & cameron, l. 2012. trade liberalization and the wage skill premium: evidence from indonesia. journal of international economics, 87(2):277-287. amiti, m. & davis, d. 2008. trade, firms, and wages: theory and evidence. nber working paper, no. 141062008. sajems ns 16 (2013) no 2 113 bernard, a.b. & jensen, j.b. 1997. exporters, skill upgrading, and the wage gap. journal of international economics, 42:3-31. beyer, h. rojas p. 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openness, improvement of trade commodity composition and urban-rural income inequality: an empirical study based on provincial panel data in china. china soft science, (06). read online: scan this qr code with your smart phone or mobile device to read online. page 1 of 1 reviewer acknowledgement http://www.sajems.org open access acknowledgement to reviewers in an effort to facilitate the selection of appropriate peer reviewers for the south african journal of economic and management sciences, we request you to take a moment to update your electronic portfolio on https://sajems.org for our files, allowing us better access to your areas of interest and expertise, in order to match reviewers with submitted manuscripts. if you would like to become a reviewer, please visit the journal website and register as a reviewer. to access your details on the website, you will need to follow these steps: 1. log into the online journal at https://sajems.org 2. in your ‘user home’ 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selection of reviewers who have expertise and interest in the topics appropriate to each manuscript are essential elements in ensuring a timely, productive peer review process. we would like to take this opportunity to thank all reviewers who participated in shaping this volume of the south african journal of economic and management sciences. we appreciate the time taken to perform your review(s) successfully. abriham e. engidaw alex bignotti andrea saayman aurelio j.f. vincenti ayanda meyiwa carike claassen cecile duvenhage chengedzai mafini daniel p. schutte dannielle cerbone elda du toit ferdi botha freddy m. mgiba gary van vuuren gavin price gideon du rand gift mugano heinz e. klingelhoefer iris m. velez osorio jennifer roeleveld jesse de beer johannes h. kemp johannes (janus) i.f. henning jan w. swanepoel kayleigh greenslade kishor c. meher kore m. guei kurt naicker lindiwe n. kunene lukas i. ehlers mabutho sibanda mark h.r. bussin martin wittenberg michelle groenewald najmul hoda nhlanhla c. mbatha nigel t.f. chiweshe paschal b. nade randhir roopchund rob smorfitt theuns p. pelser veronique blum yudhvir seetharam http://www.sajems.org� https://sajems.org https://sajems.org https://sajems.org/index.php/sajems/user https://sajems.org/index.php/sajems/user mailto:publishing@aosis.co.za abstract introduction an executive coaching model to develop emotional and social intelligence competencies research design discussion contribution of the study conclusion acknowledgements references appendix 1 about the author(s) marlene dippenaar faculty of economic and management sciences, university of pretoria, south africa pieter schaap faculty of economic and management sciences, university of pretoria, south africa citation dippenaar, m. & schaap, p., 2017, ‘the impact of coaching on the emotional and social intelligence competencies of leaders’, south african journal of economic and management sciences 20(1), a1460. https://doi.org/10.4102/sajems.v20i1.1460 original research the impact of coaching on the emotional and social intelligence competencies of leaders marlene dippenaar, pieter schaap received: 25 aug. 2015; accepted: 25 jan. 2017; published: 28 mar. 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the development of the emotional intelligence of leaders has become an exceptionally popular enterprise. however, the empirical research conducted by practitioners to date does not provide convincing evidence of the effectiveness of emotional intelligence development interventions. robust and informative research on the effectiveness of coaching to develop the emotional intelligence of leaders is lacking. aim: the purpose of this study was to determine, describe and evaluate the impact of a theoretically substantiated coaching intervention on the emotional and social intelligence competencies of leaders in a financial services company. setting: the setting of the study is a financial services company in south africa. methods: a mixed method approach using a quantitative and qualitative research design was considered appropriate. the quantitative research method consisted of a quasi-experimental design using a non-equivalent preand post test control group to measure the impact of the coaching intervention on a sample of 30 leaders. the bar-on eq-i scale was selected as a reliable and valid measure of emotional and social intelligence competencies. wilcoxon’s statistic was calculated to determine the statistical significance of score differences between the experimental (n = 30) and control (n = 30) groups. the qualitative research method was comprised of semi-structured interviews with six of the leaders and their supervisors. results: the statistical results indicated that coaching significantly impacted the emotional and social intelligence competencies of leaders in terms of their overall emotional quotient (eq), intrapersonal competency, interpersonal skills, stress management, self-regard and empathy. the semi-structured interviews provided rich descriptive themes and evaluations that corroborated the quantitative findings. conclusion: this research provided convincing empirical evidence of the positive impact of a long-term, spaced and goal-focused coaching intervention on the emotional and social intelligence competencies of leaders in a financial services institution. the finding suggests that a theoretically well substantiated coaching intervention and a robust empirical study can be effective in demonstrating the impact of coaching on the emotional and social intelligence competencies of leaders. however, the implications of the limitations pointed out in this study could have influenced the findings, and future research aimed at improving relevant research models should take these into account. introduction most organisations constantly search for ways to improve the capabilities of their leaders so as to keep pace with the ever-changing business environment. leaders often lack effective leadership behaviour; therefore, they need effective interventions to develop their emotional and social intelligence competencies. the relevance of emotional intelligence (ei), also often referred to as ‘emotional and social intelligence’, to effective leadership behaviour in organisations is supported by numerous studies (kotzé & venter 2011; prins, van niekerk & weyers 2011; van oosten 2013). whereas the concept of emotionally intelligent behaviour is continually being developed and clarified as far as it is applicable at a personal level, there is a distinctive need to extend existing research to examine the development of emotionally intelligent behaviour in a work setting (goleman 1998). groves, mcenrue and shen (2008) note that, although the discipline of ei training has become an exceptionally popular industry, the experimental evidence provided thus far creates reservations about how effective the purposeful development of leaders’ ei really is. according to groves et al. (2008), there seem to be limited publications on ei training studies that are well-designed and psychometrically rigorous. in their comprehensive review across multiple academic and professional fields, mcenrue, groves and shen (2010) confirm that there are a number of training suppliers in the field of emotional training but that empirical evidence substantiating the quality and effectiveness of their training is lacking. according to boyatzis et al. (2013), typical leadership training has only a minor effect on permanently transforming leaders’ emotional and social intelligence behaviour, for instance, their emotional self-awareness, emotional self-control, optimism and adaptability. the problem with typical leadership training seems to revolve around the lack of transfer of training, which characterises traditional training approaches that emphasise teacher–learner, short-term, massed and one-size-fits-all classroom-based training (grant 2007; mcenrue et al. 2010). on the other hand, theoretically justified coaching programmes emphasising a holistic, multilevel, staged and intentional change process appear to have more lasting effects. more specifically, integrated and holistic coaching models implemented over the longer term and comprising frequent and goal-specific interventions appropriately spaced within a given time frame have proved to be more effective in transforming leaders’ behaviour permanently (grant 2007, 2010; grant, curtayne & burton 2009; passmore 2010). this study aimed to rigorously and empirically investigate the effectiveness of a coaching intervention in developing the emotional and social intelligence competencies of leaders. it was posited that emotional and social intelligence competencies as presented in the bar-on model could be developed by using an appropriately designed and theoretically substantiated coaching approach (bar-on 1997). more specifically, the researchers set out to determine, describe and evaluate the impact of a holistic, longer-term, spaced and goal-focused coaching intervention on the emotional and social intelligence competencies of leaders in a financial services company in south africa. it was hoped that the research would be of value to academic research, the profession of executive coaching, the practice of leadership development, and organisations in general. the study aimed to address the conceptual and assessment shortcomings of current studies on the process of ei development and to expand and enhance research and theory concerning the development of leaders’ emotional and social intelligence competencies that are required for effective leadership. the remainder of this article is structured as follows: the ‘literature review’ section provides a literature review seeking conceptual clarification of ei, emotional and social intelligence competencies, effective leadership and executive coaching. the efficacy of executive coaching and ei development programmes is reviewed, and a holistic executive coaching model is proposed and described. the ‘research design’ section provides the research approach, the coaching intervention, the quantitative and qualitative research design. the ‘discussion’ section provides the quantitative and qualitative findings, synthesis, an explanation of the contribution and limitations of the study, recommendations for future research and conclusive remarks. literature review the emergence of emotional intelligence ei theories can be traced back to edward thorndike (1920) who first recognised the concept of social intelligence, which, in today’s terms, is better known as ei (hayward 2005). the term ‘emotional intelligence’ was coined by peter salovey and john mayer in 1990 (mayer, roberts & barsade 2008). mayer et al. (2008) argue that the four components in their model of ei, namely, the abilities to perceive emotions, use emotions to facilitate thought, understand emotions and manage emotions, combine to form a legitimate intelligence that is founded on the theory and definition of intelligence. goleman (1995), who popularised the concept of ei, describes five skills that are related to ei: self-motivation, self-regulation, self-awareness, social skills (relationship management) and social awareness (empathy) (hayward 2005). the bar-on (1997) model of ei has been referred to as the most widely used model in the world (prins et al. 2011). bar-on (2006) describes this ei model as: a cross-section of interrelated emotional and social competencies, skills and facilitators that determine how effectively we understand and express ourselves, understand others and relate with them, and cope with daily demands. (p. 2) over the past two decades, there has been much controversy and confusion about the concept of ei and about the theoretical soundness and acceptability of its definitions, models and measures. distinguishing between emotional intelligence models numerous models and measures of ei exist. daus and ashkanasy (2005) suggest that ei models and measures should be classified according to the research themes of ability, trait and mixed models. the model of mayer, salovey and caruso (2000) differentiates ei as a distinct human ability, whereas mixed models focus on human effectiveness in broader terms. the models of goleman (1995) and bar-on (1997) can be described as mixed models because of the explicit inclusion of non-ability attributes or traits such as self-motivation, mood, self-regard and personal independence (cherniss 2010). according to cherniss, the lack of overlap between the different models has been a contentious issue among critics and supporters of ei. however, this author concludes that arguing whether certain models are more legitimate than others appears to be fruitless as all the major models are not only legitimate but also potentially useful depending on the outcome considered important (cherniss 2010:123). therefore, for the purpose of this research, the focus is on the theoretical model and measure most suitable for the context of use and relevant outcomes under investigation. in this study, the emphasis falls on the coaching of emotional and social intelligence competencies relevant to effective leadership, which calls for a concept of ei that is broader than the narrowly defined one in the ability model of salovey and mayer (1990). according to mccleskey (2014) and cherniss (2010), mixed models of ei can be considered emotional and social intelligence competency (esc) models as these models involve competencies that go beyond emotional abilities to include traits and personal qualities. a competency can be considered an underlying characteristic of a person that may lead to superior performance (boyatzis 2009). as such, emotional and social intelligence competencies (escs) can be conceptualised as behavioural manifestations of ei that may lead to outstanding work performance (boyatzis 2009). empirical support for a strong relationship between escs and performance at work is supplied in a systematic meta-analytic study by joseph and newman (2010). for the purposes of this study, the terms ei and esc were used interchangeably depending on the term used by the specific author(s) being cited. the bar-on model of emotional intelligence the bar-on mixed model of ei was the model of choice for the purposes of this study as it is based on an esc model (daus & ashkanasy 2005). the relevance of the bar-on model to the development of effective leadership behaviour in organisations is supported by a significant number of studies (kotzé & venter 2011; prins et al. 2011; stein et al. 2009). the five main components and 15 sub-components of this model are described in more detail in table 1. the model represents a 1-5-15 hierarchical model with components that converge into a single component known as the emotional quotient (eq). the first important main component, namely, intrapersonal competency, refers to the competency to be aware of oneself, to understand one’s strengths and weaknesses and to be able to express thought and feelings in a constructive manner. factors that facilitate or drive intrapersonal skills include self-reliance (independence) and self-actualisation in terms of achieving one’s goals and potential. the second main component, namely, interpersonal skills, refers to the competency to be aware of other people’s emotions, feelings and needs and to the ability to develop and maintain a cooperative, constructive and mutually satisfying relationship with others. the third main component, namely, stress management, refers to the ability to effectively and constructively manage the emotions a situation demands. adaptability is the fourth main component and entails being in touch with external realities, adapting and adjusting to new situations and effectively solving problems of an interpersonal and intrapersonal nature. the fifth main component, namely, general mood, refers to an ability that serves to facilitate emotional and social intelligence behaviour and consists of self-motivating tendencies such as having an optimistic outlook on life and feeling content and happy with oneself. table 1: bar-on’s emotional intelligence model. the link between emotional and social intelligence competencies and effective leadership according to boyatzis (2009), esc are predictors of effectiveness in professional, management and leadership roles and can be developed in adults. van oosten (2013) refers to a large number of empirical studies that support the relationship between escs and leadership behaviour or styles that are associated with effective leadership. effective leadership may encompass performance with respect to both task outcomes and relationship outcomes. task-related outcomes have to do with goal attainment and performance whereas relationship-related outcomes emphasise social-economic outcomes such as engagement, motivation, commitment and satisfaction. several studies using different measuring instruments and statistical methods point to a positive link between ei and transformational and authentic leadership (harms & credé 2010; pillay, viviers & mayer 2013; syndell 2008). in a meta-analysis studying the link between ei and leadership, harms and credé (2010) found that the bar-on mixed model of ei as measured by the emotional quotient inventory (eq-i) was a strong predictor of transformational leadership. more specifically, previous research has indicated connections between high eq-i scores and effective leadership (butler & chinowsky 2006). the importance of developing leaders’ escs to ensure effective leadership and organisational success is clear from the existing research presented earlier in this article. however, numerous reviews have shown that leadership development programmes that follow a traditional teacher–learner or classroom-based training approach rarely show sustainable change in escs, and coaching has been suggested as an alternative approach (boyatzis et al. 2013; grant 2007; mcenrue et al. 2010). coaching can help leaders understand their own emotional behaviour and make them mindful of the impact of their leadership style on their followers. the efficacy of executive coaching in leadership development the purpose of coaching in organisations is largely to develop leaders, and this is referred to as executive coaching. the practice of executive coaching has become progressively more popular in the business domain over the past decades and is seen as a fundamental developmental intervention by means of which organisations build executives’ skills (bono et al. 2009). determining the efficacy or benefit of coaching in respect of leadership development requires an understanding of what executive coaching entails. grant (2014) defines executive coaching as: a helping relationship formed between a client (the coachee) who has leadership, managerial, or supervisory authority and responsibility in an organisation, and a coach who uses a range of cognitive and behavioural techniques in order to help the client achieve a mutually defined set of goals with the aim of improving his or her leadership skills, professional performance, and well-being and the effectiveness of the organisation. (p. 2) although coaching may be defined specifically to suit an intended purpose and context, passmore and fillery-travis (2011) came up with the following broad definition after studying research and publications spanning more than a decade: coaching is: a socratic based future focused dialogue between a facilitator (coach) and a participant (coachee/client), where the facilitator uses open questions, active listening, summarises [sic] and reflections which are aimed at stimulating the self-awareness and personal responsibility of the participant. (p. 6) according to these authors, the socratic dialogue refers to guided discovery, where the coach believes that the answer to a question is located within the coachee. thus, the coach’s role is not that of an educator or trainer in the directive sense but that of a facilitator to self-discovery through shaping questions and focusing the attention on the next step of the process. unlike mentoring, training or consulting, coaching does not require in-depth domain-specific knowledge. however, effective coaches must have knowledge and experience of the psychology of stimulating self-awareness and personal responsibility that foster ongoing self-directed learning and personal growth. bresser and wilson (2010:9) state, ‘at the heart of coaching lies the idea of empowering people by facilitating self-directed learning, personal growth and improved performance’. executive coaching suggests an ongoing confidential partnership between coach and coachee (lasting a few months to a year and more), which is normally sponsored by a third party (the organisation) (bozer & sarros 2012). according to bartlett, boylan and hale (2014), the essence of coaching may be summarised by four keywords that are used in executive coaching definitions of 533 publications, namely, relationship, goals, learning and performance. much current literature on coaching explores executive coaching as a relatively new and promising practice linked to growth and development, but empirical research assessing the effects of coaching lags far behind the practice of coaching (bono et al. 2009; grant 2013). de meuse, dai and lee (2009) emphasise that the effectiveness of executive coaching needs to be clearly and scientifically demonstrated. according to page and de haan (2014), studies on the effectiveness of executive coaching lack experimental designs that include objective quantitative measures and comparable control groups. recent meta-analytical studies by theeboom, beersma and van vianen (2014) and jones, woods and guillaume (2016) show promising findings suggesting that coaching has significantly positive effects on various outcomes on different levels, for example, on organisational, affective, skills-based and individual (achievement, performance) levels. these meta-analysis studies indicate that coaching can be an effective intervention in organisations. however, each study pointed out the lack of robust research showing the fundamental mechanisms that make coaching interventions effective. jones et al. (2016) and theeboom et al. (2014) report that available research in the field of coaching provides insufficient details about specific coaching models, coaching schedules, coach and coachee characteristics, and tools and techniques used to allow for adequate theory building relating to the effectiveness of the different coaching processes and models. however, jones et al. (2016) are of the opinion that research in educational psychology and theories on adult learning may provide relevant guidelines for effective coaching as coaching is, in effect, a high-fidelity form of training and development. hence, the need for theoretically substantiated coaching interventions and sound empirical research to demonstrate the effectiveness of coaching is clear. the efficacy of emotional intelligence development programmes despite the increasing popularity of coaching, evidence outlining the necessity of coaching to enhance leaders’ ei and the impact of coaching is inadequate (carey, philippon & cummings 2011; groves et al. 2008; mcenrue et al. 2010). a review by mcenrue et al. (2010:3–19) shows that existing research fails to adequately confirm whether it is viable to develop individuals’ ei or in fact how to develop it. it seems that very few well-designed ei development studies that include valid measures of ei have been published (groves et al. 2008). more recently, schutte, malouff and thorsteinsson (2013) did a meta-analysis on ei training and highlighted only three experimental and control group design studies that had been done in an organisational context. these studies did show that ei training could have a significantly positive effect on ei. however, experimental and control group studies focusing specifically on the effect of coaching on ei in organisational contexts could not be found. groves et al. (2008:226–231) highlight the following common problems with studies on ei training that inhibit the quality of research findings, problems which may equally apply to studies involving specific coaching (i.e. non-directive, high-fidelity training): ei conceptual and assessment concerns: unknown or conceptually suspect ei models with questionable psychometric measurement qualities that make preand post-training results hard to interpret; no controlling mechanism to identify the presence of social desirability or other forms of personal biases that may have had an influence on reported development improvements. a lack of information concerning the training intervention: lack of details about the duration, content, process and techniques applied to develop ei. short duration of the training intervention: irregular interventions of short duration that may not be as effective for developing ei as regular interventions extending over longer periods. absence of essential statistical controls and/or a control group: failure to control for demographic factors such as gender, age and work experience may account for the results obtained. a comparative control group isolates the impact of group characteristics on the intervention. the use of randomised controlled studies is frequently regarded as best practice in determining the impact of interventions (grant et al. 2010). grant (2013) reports that only 10% of studies on the efficacy of coaching used control groups in the research design, of which half was randomised. mary et al. (2010) suggest that well-designed empirical research on ei, supplemented by research of a qualitative nature, may be useful in providing richer descriptions and a better understanding of the processes and outcomes of development interventions. this idea is echoed by grant (2013, 2014) and mcenrue et al. (2010) who also highlight the benefits of grouping participants’ experiences of the processes and outcomes of the interventions into broader meaningful themes. the remaining part of this article focuses on applying the principles, as advocated by groves et al. (2008), that an empirically sound research study on the impact of coaching on the escs of leaders should adhere to. in the next section, a theoretically substantiated coaching model is presented that is based on the principles of adult learning theory applicable to this study. an executive coaching model to develop emotional and social intelligence competencies research evidence discussed thus far suggests that coaching is an effective leadership development technique. executive coaching in particular is concerned with leader development within an organisational environment. research done by grant (2007:263) supports the notion that executives’ ei can be changed through regular training sessions that focus on specific behaviours that are associated with ei. grant’s (2007) empirical study involving spaced versus massed ei learning events indicate that frequent interventions over a longer term may be necessary to enhance ei. literature on spaced learning supports this conclusion (janiszewski, noel & sawyer 2003). research on spaced learning (distribution practice) versus massed learning that has been carried out over a period of more than a century demonstrates that learning benefits increase with increased time lags between learning events. it has been found that short and regular development sessions in combination with feedback are more effective than longer but less frequent sessions (cepeda et al. 2009). thus, coaches can facilitate deeper, more effective emotional learning through short learning episodes combined with a number of follow-up sessions than through long sessions of, say, 2 days without any follow-up sessions (grant 2007). according to cherniss et al. (1998), emotional and social learning benefits from the setting of specific, clear and optimally challenging goals because the setting of such goals makes the most of motivation, mastery and self-efficacy. there is adequate theoretical support for the importance of goal setting in adult and self-regulated learning (sitzmann & ely 2011). fundamentally, self-regulation is about the capability to set and work towards goals. the coach assists clients to identify and create potential solutions to problems, outlines a range of goals and options and then facilitates the development and endorsement of action plans to accomplish these goals (grant 2010:94). the multidimensional nature of adult learning calls for a more holistic and contextualised approach to learning (merriam 2008) and, therefore, for an integrative coaching model. however, existing coaching models are characterised by a lack of fertilisation across different coaching theories, thereby depriving the executive coach of a holistic model as a directive within an organisation (passmore 2007:68). passmore (2010) suggests the use of integrated models rooted in different schools of psychological thought, such as human behaviour and behavioural change theories (solution-focused coaching), behaviourism (the grow model), constructive developmental psychology (developmental coaching) and cognitive psychology (cognitive behavioural coaching). such integrated models offer the coach diverse ways in which to work by combining tools and techniques from different approaches and working at multiple levels in the organisation with the aim of building leaders’ escs and consequently equipping them to achieve organisational goals. according to passmore (2007), the development of a holistic executive coaching model that incorporates multiple models should be the focus of future developments and less emphasis should be placed on a single coaching model. the arguments presented in the preceding paragraphs formed the foundation of the holistic coaching model (see figure 1) that was developed by the primary author of this article to enhance the escs of leaders in the workplace. the aim of this model was to combine distinctly different coaching approaches and blend these to meet the coaching needs of leaders. the effective blending of the elements, tools and techniques of the different coaching approaches required an understanding and appreciation of the application value of each of the relevant coaching models. figure 1: a holistic coaching model for use by the executive coach. in designing the holistic coaching model, the following models, frameworks, techniques and principles were considered: bar-on’s model of ei, the framework for emotional learning developed by cherniss et al. (1998), practices applied in the science of emotion and interpersonal communication (carey et al. 2011; leskiw & singh 2007), passmore’s (2007) integrative coaching model, and the principles and best practices that lie at the core of various leadership development programmes (brown 2010; neenan 2010; popper 2005; turner & goodrich 2010). the following criteria were considered when selecting the theoretical coaching models to be reviewed for the development of the holistic coaching model: theoretical inclusivity (grant 2006:18): a range of psychological schools of thought were integrated (passmore 2010:157). wide acknowledgement in literature (passmore 2010): the coaching models had been cited a significant number of times. client-compatible, theoretically grounded techniques (grant 2006:18): the coaching models offered theoretically grounded techniques to assist coaches in understanding and implementing the models so as to best help their clients in reaching their goals (alexander 2010:87; grant 2010:100; neenan 2010:115; passmore 2010:166). potential to enhance performance in a business context (grant et al. 2009:396): the coaching models were acknowledged as organisational interventions to develop leadership (alexander 2010; passmore 2010; visser & butler 2008). the holistic coaching model is depicted in figure 1, which is followed by a brief discussion. the model depicted in figure 1 consists of four phases: phase 1: preparing for coaching: motivation for change. the coaching focuses on motivating the leaders before the beginning of the learning process. the preparation consists of a thorough needs analysis at both the individual and organisational levels. firstly, well-defined objectives of the esc programme for leadership are developed at an organisational level. next, the elements of successful emotionally intelligent leadership behaviour and the gaps in the leaders’ behaviour in comparison with the ideal are identified at individual level. the evaluation methodology for initiating emotional learning is built on the bar-on eq-i assessment of the leaders. phase 2: development intervention. the second phase (the coaching intervention) specifically involves the change process. it consists of practices that support the leaders in changing their thinking, beliefs and behaviour to cope with emotional and social difficulties. phase 3: transfer. the third phase (transfer and maintenance) focuses on what occurs after the official coaching practice. the coach encourages the leaders to apply newly acquired escs in the work environment and to continue doing so. phase 4: evaluation. the last phase involves ongoing evaluation and feedback. the evaluation techniques include a follow-up bar-on eq-i assessment and feedback interviews with supervisors. kirkpatrick’s four-level model of training evaluation (reaction, knowledge, behaviour and results) was applied as an approach to determine and reflect on the effectiveness of the coaching intervention (kirkpatrick & kirkpatrick 2005). the main objective of this study was to empirically determine, describe and evaluate the impact of a theoretically substantiated holistic, longer term, spaced and goal-focused coaching intervention on the escs (as defined in the bar-on model) of leaders in a financial services company in south africa. in aspiring to achieve this objective, the researchers endeavoured to overcome design problems that inhibited research findings (problems found to be common to studies on ei development) and to provide a template to facilitate more informative studies on the impact of coaching on esc. research design research approach a mixed method approach using qualitative and quantitative methods was used. firstly, a quasi-experimental research design approach was followed using a non-equivalent preand post-control-group design to measure the impact of the coaching intervention. thereafter, the impact of coaching was further investigated using qualitative methods and involving the experimental group and the relevant supervisors. the coaching intervention the coaching intervention was conducted by the primary author of this article. this researcher is a professional coach, registered industrial psychologist and human behaviour specialist with more than 10 years of coaching experience. the coaching model presented in figure 1 was interpreted and converted into 16 design principles that were followed to guide and inform the coaching process (see appendix 1). the design of the coaching intervention process is displayed in figure 2, which is followed by a brief discussion of the process. figure 2: the design of the coaching intervention process. the coaching preparation phase consisted of a thorough needs analysis to establish a connection with business strategy (leskiw & singh 2007), individual strengths and development areas based on the bar-on eq-i results. the coaching needs were linked to goal-orientated action plans (brown 2010). the coaching intervention process consisted of a regulated series of nine short coaching development sessions spaced over a period of approximately 9–12 months. the spacing of the coaching sessions granted leaders the opportunity to process and integrate their learning, thereby enhancing their escs. the coaching was conducted through one-on-one interactions, driven by the results of the bar-on eq-i report of the leaders and based on mutual trust and respect. according to mary et al. (2010), trainers should consider the support they offer to learners in the form of coaching and feedback as an important element of the design and application of an ei training study. in line with the coaching model, certain strategies were included such as ongoing feedback to leaders to give an indication whether they were heading in the right direction (cherniss et al. 1998) and shadowing of leaders in selected meetings and discussions (turner & goodrich 2010). this offered a platform for coaches to share observations on how effectively the leaders applied escs in the selected meetings and discussions. in the transfer phase, leaders were required to use new behaviours regularly over a couple of months while receiving the built-in support of their supervisors. the programme was evaluated using a post-intervention bar-on eq-i assessment and conducting interviews with the supervisors. next, the quantitative and qualitative phases used in this study to determine the impact of coaching are discussed. phase 1: the quantitative research design population, sample, questionnaire, data collection and analysis techniques leaders in a financial services company in the south african business context made up the target population of the study. these leaders were typically team leaders, middle managers or senior managers. the experimental group consisted of 30 participants in a randomly chosen voluntary coaching programme for leaders. the 30 members of the control group were sourced from the company’s internal recruitment assessment database consisting of leaders who had completed the bar-on eq-i for selection purposes. the latter group of leaders was randomly selected using stratified sampling according to age, race and gender. each member of the experimental and control groups had completed the bar-on eq-i self-report questionnaire as a preand post-intervention measure of escs. the bar-on eq-i self-report questionnaire consists of 133 items and a five-point anchored likert scale. the eq-i composite score represents a total eq measurement and consists of main components and sub-components. (descriptions of the eq-i components were presented in the ‘the bar-on model of emotional intelligence’ section). the raw scores of the self-report questionnaire were converted into standardised scores of which the average score was 100 and the standard deviation was 15. average to above average scores suggest that a respondent’s emotional and social functioning can be considered effective whereas below average scores suggest an inability to be effective and the possible existence of emotional, social and/or behavioural problems. the eq-i measure is computer scored and contains a correction factor that automatically corrects scale scores based on responses to positive and negative impression items (bar-on 2006). this procedure reduces the potentially negative effect of response bias and increases the accuracy of the scale scores. evidence of the reliability and validity of the bar-on eq-i’s scale in a south african context can be considered acceptable and comparable, with values ranging between 0.67 and 0.92 obtained elsewhere (bar-on 1997; gallant 2005:11). on average, a total eq reliability of 0.95 is very good (ekermans et al. 2011; gignac & ekermans 2010). the structural validity of the eq-i had been confirmed for various south african sample groups (ekermans et al. 2011; gignac & ekermans 2010), and according to kotzé and venter (2011:408), adequate evidence exists of the criteria-related validity across several countries. the statistical analysis was done using the statistical package for social sciences (spss) for windows (version 17.0). the difference in difference (dd) or double difference score analysis was considered to be the appropriate statistical method to use. dd is defined as the difference in mean outcome in respect of the experimental group before and after intervention minus the difference in mean outcome in respect of the control group before and after intervention. the dd equation would be: where e is the treatment group and c is the control group (0 = pretest; 1 = posttest). the dd score analysis method removes the difference in the outcome between the experimental and the control groups at the baseline, allowing for an unbiased estimate of the intervention effect (may 2012). the wilcoxon’s statistic and the associated z-approximation were used to determine the significance of the differences on the difference score analysis (after bonferroni adjustments had been made) over the 18-month period. the meaningfulness of the differences was evaluated using cohen’s effect size indicators for r (cohen 1988). practically meaningful levels of r are 0.1 = small effect, 0.3 = medium effect and 0.5 = large effect. the equation used for calculating r was (field 2005): where z = z score approximation for the wilcoxon statistic; n = total sample size (experimental and control group). a comparative analysis of the biographical variables of the experimental and control groups was done using pearson’s chi-square test to provide evidence of the level of equivalence of the two groups. furthermore, to explore group response biases (positive or negative impression forming), a comparative analysis of the pretest results in respect of the experimental and control groups was done. phase 2: the qualitative research design population, sample, data collection and analysis techniques participants considered for the qualitative phase consisted of two groups: leaders who had been exposed to coaching (experimental group) and the supervisors of those leaders. the primary author of this article conducted in-depth semi-structured interviews with the six leaders of the experimental group and their supervisors (all in all 12 interviews). table 2 presents the broad interview guide that outlines the proposed main and probing questions. the flow and contents of a discussion determined the structure and sequence of the questions posed. supplementary questions were formulated when needed to ensure the collection of rich data. table 2: interview guide for the leaders and their supervisors. the interviews were audio recorded and transcribed (saunders, lewis & thornhill 2009:485), after which the transcripts were read closely to verify the data obtained and to get an initial sense of the issues raised. phrases that occurred regularly and responses that were unexpected or counterintuitive were noted (miles & huberman 1984:22). the interview transcripts were sanitised (leaving out all names and references) before importing the data into the atlas.ti qualitative data analysis software program for coding and further processing. open coding (breaking down, examining, comparing, conceptualising and categorising data) and axial coding (categorising codes and identifying patterns and relationships) were used (strauss & corbin 2007:61). subthemes that emerged were escalated to main themes. according to boyatzis (1998:4), a theme is an identified pattern in the data that explains the probable interpretations or particular components of a research problem. in the following section, the findings of the quantitative and qualitative analyses will be presented. ethical consideration the ethics committee of the faculty of economic and management sciences, university of pretoria approved the study. discussion quantitative findings the bar-on eq-i overall score, composite scales and factors were used to determine the impact of the coaching intervention on leaders’ escs. the pearson’s chi-square test results were non-significant (p > 0.05), showing that the experimental and control groups appeared to be uniform in respect of gender, race, age and pretest scores, which eliminated the effect of these variables (see display in table 3) on the internal validity of the research results. table 3: biographical variable frequencies for the control and experimental groups (n = 30). the pretest and posttest scores for all components of the eq-i in respect of the experimental and control groups are presented in table 4. the wilcoxon’s statistic and the associated z-approximation showed that there were no statistically significant differences (all p-values > 0.05) between any of the pretest scores of the experimental and control groups (z-approximation values for pretest score differences were not presented in table 4 because of space restrictions). the mean total eq-i score and component scores for all the pretests in respect of both groups were close to the standardised mean (x = 100), representing the eq-i standardisation sample scores well. the small deviations observed could most likely be attributed to sampling error. as far as the pretests were concerned, these results confirmed the absence of notable response bias at group level. table 4: differences between the preand post-coaching evaluations of the experimental and control groups pertaining to the components measured (n = 30). the effect of the coaching intervention on the experimental group was evidenced by the dd score analyses which reflect in the significance of the z scores (see table 4). in respect of the two groups, the following bar-on eq-i main component scales differed significantly after allowing for bonferroni adjustments (p ≤ 0.01) (cohen’s (r) effect size indicators are given in brackets: see equation 2 in the ‘the coaching intervention’ section for the calculation of r): total eq (r = 0.56: large effect) intrapersonal (r = 0.51: large effect) interpersonal (r = 0.37: medium effect) stress management (r = 0.34: medium effect) the following bar-on eq-i sub-component scores differed significantly in respect of the two groups after allowing for bonferroni adjustments (p ≤ 0.003): self-regard (r = 0.42: medium to large effect) empathy (r = 0.38: medium effect) the findings indicated that coaching had a statistically significant and practically meaningful positive impact on the total eq, intrapersonal, interpersonal, stress management, self-regard and empathy dimensions of the eq-i scale. the largest notable changes based on cohen’s effect size indicators occurred on the total eq-i scores and on the intrapersonal component. this quantitative phase of the study provided evidence that coaching was an effective approach to develop some of the most important escs of leaders as measured by the bar-on eq-i scale (syndell 2008). boyatzis et al. (2013) indicate that in accordance with esc models, the ei is susceptible to development in adults. this notion is supported by dulewicz, higgs and slaski (2003) and jaeger (2003) who report that bar-on eq-i assessments have provided evidence that training could bring about substantial changes in escs. similarly, the current study demonstrated meaningful improvements in escs in respect of the experimental group. however, groves et al. (2008) caution that while some published and unpublished empirical research studies propose that ei can be developed, seemingly significant limitations in research design have caused reported results to be doubted. however, supplementing quantitative research with qualitative research may enhance the authenticity of research findings and provide richer descriptions of the processes and outcomes of the coaching intervention. qualitative findings in studying the interview data, the researchers identified themes that described the impact of coaching from the perspectives of the leaders and their supervisors. guided by a deductive approach they distinguished 5 main themes and 13 subthemes, which they arranged according to the conceptual correspondence between these themes and the bar-on eq-i composite and subscales. the themes reflected an overall improvement in intrapersonal skills, interpersonal skills, stress management, adaptability and general mood. the improvements were noted when compiling summative subtheme descriptions reflecting the actual responses of the participants interviewed. in these descriptions (see below), bar-on’s definition of each esc (as cited in prins 2007:82) was given first, followed by each respondent’s description of the impact of the coaching intervention on each esc. unfortunately, this article cannot report extensively on the interview responses because of limited space but the coded interviews are available from the corresponding author. the said summative descriptions that supported the finding that the participants’ responses relating to the main themes and subthemes reflected improvements in esc are presented below. the main themes and subthemes are indicated in brackets and a few examples of actual interview responses are included for illustrative purposes. intrapersonal skills (self-regard, emotional self-awareness, assertiveness, independence and self-actualisation) can be defined as ‘an enhanced understanding, expression and development of the inner self’. the respondents reported improved self-confidence and self-respect, better understanding and expression of emotions and the impact thereof on others, more assertiveness in communicating emotions, more self-directed and self-regulated thinking and actions, and improved understanding of and drive to achieve self-actualisation. examples of the participants’ responses relating to emotional self-awareness are: ‘well from before the coaching and after the coaching, definitely an improvement in my intrapersonal skills, particularly the self-awareness that was very big for me. you know, just the ability to be aware of what is going on before one can respond to the environment.’ [leader 2]. ‘and i think i have sensed that in the last six months or so, [leader 2] has become a bit more reflective. she thinks about things first, she thinks about different ways of doing things. so, you just get the sense she now thinks before she speaks, whereas in the past she didn’t always do that.’ [supervisor of leader 2]. interpersonal skills (empathy and interpersonal relationships) can be defined as ‘an enhanced capacity for empathy and interpersonal functioning’. the respondents reported an improved ability to try to understand the feelings of others, enhanced listening skills, improved leader-team connection and engagement, openness to the opinions of others and feedback. examples of the participants’ responses relating to interpersonal relationships are: ‘i think interpersonal relationships have improved. previously, before the coaching i would say that my relationships were very much at arm’s length. and maybe not, we were not interested in getting to know other people better, the person on the other side, but the coaching has given me some techniques … we have gone from the point of view that, you know this is an opportunity to have a private talk between two people and just open up any areas. and i think the end result of that was that i felt much more in tune with my staff.’ [leader 6]. ‘if i think about some of my interactions with staff, some of the feedback that i receive from them was that [leader 6] now sets up a session with them, if he sees that there are concerns. he addresses it one-on-one.’ [supervisor of leader 6]. stress management (stress tolerance and impulse control) reflects ‘the increased ability to withstand stressors without losing control or falling apart’. the respondents reported an improved understanding of and capacity to deal with stress, better management of volatile emotions and a deeper awareness of the triggers of impulses. examples of the participants’ responses relating to impulse control are: ‘so if i am angry, somebody is demonstrating a behaviour that to me is irresponsible. this is a key indicator for me. i need to acknowledge that is what is happening and not try to not be angry that the person is irresponsible and choose when to respond. so when i identify my anger, i am now able to choose not to respond in the middle of that.’ [leader 3]. ‘and then the other area that i sensed improvement as well is definitely around self-control. i think in the past i have experienced her to be quite impulsive and she would quickly go off and say something and sort of tie a flare to the mast without really giving it a lot of thought first.’ [supervisor of leader 3]. adaptability (flexibility and problem solving) can be described as ‘the ability to cope with environmental demands by being able to size up situations realistically and to deal with problematic situations’. the respondents reported an improved ability to adjust their emotions, thoughts and behaviours to changing situations and conditions, coupled with a better ability to define and solve problems. general mood (optimism and happiness) reflects the individual’s ‘ability to enjoy life and a general level of contentment’. the respondents reported improved levels of being motivated, positive, happy and appreciative of experiencing the moment and an improved ability to engage with others. next, the themes were interpreted guided by an inductive coding approach. the main themes that emerged were ‘the facilitators and obstacles to effective coaching’, ‘experiences of the coaching journey’ and ‘coaching outcomes’. although the themes contained many insightful details about the coaching intervention, this discussion will be limited to a summary of the most important observations. adjusting an existing leadership style and being inclined to fall back on old styles emerged as possible difficulties hampering the success of a coaching intervention. individual readiness factors, which include self-efficacy and receptivity to engage in ei development, behaviour change and coaching in general, may also play a role in determining the success of an intervention (groves et al. 2008; passmore & fillery-travis 2011). furthermore, if organisational and supervisor support is not sustained and ei skills are not practised sufficiently, leaders may transgress to their ‘starting points’ (nelis et al. 2009). the leaders experienced the coaching journey as valuable, enjoyable, relevant and impactful. they described their relationships with their coaches as positive and supportive and their coaches as knowledgeable and open-minded. a good coaching partnership is fundamental in facilitating change and growth within leaders (carey et al. 2011). overall, the outcome of the coaching process was considered to be positive. the general theme that emerged was that leadership was effective, interpersonal skills had improved, the relationship between team members was one of trust and support and enhanced escs would contribute to organisational success. these results corroborate the findings of studies (as cited in van oosten 2013:16) in which the notion is supported that effective leadership is associated with the relationship between escs and leadership behaviour. however, the complete translation of emotional and social intelligence knowledge into behaviour may still be problematic for specific individuals. trustworthiness of the qualitative research findings was achieved through triangulation, credibility and member checking. triangulation was attained through exploring the views of the leaders and their supervisors and determining which views they shared or did not share. credibility was ensured by making voice recordings of the responses of participants representing diverse leaders who had different thoughts about ei skills and coaching. member checking was applied to obtain interviewees’ confirmation of the recorded data and the interpretation thereof. ambiguities or misunderstandings were cleared up, and a printed copy of the findings was presented to each interviewee for confirmation (guion, diehl & mcdonald 2011). synthesis of the research findings both the quantitative and qualitative data gathered in this study showed that the coaching intervention had had a positive impact on the escs of the participating leaders in a financial services company. the qualitative nature of the theme descriptions provided rich data that assisted with the conceptualisation of the changes brought about by the intervention, and the qualitative data enriched the statistical findings in the quantitative phase of this study. the most notable finding in the quantitative phase, which was supported by the qualitative findings, was the significant positive impact ei coaching had on the intrapersonal, interpersonal, stress management, self-regard and empathy components of bar-on’s model of escs. these components have important implications as far as leadership effectiveness is concerned. syndell (2008) reports that the eq-i intrapersonal component, which includes self-regard and empathy, is the most significant predictor of a transformational leadership style. the second most important predictor is general mood, and the interpersonal component is also important but to a lesser degree. however, kotzé and venter (2011) have identified the interpersonal and stress management components as important differentiators of effective leadership. maintaining healthy and satisfying interpersonal relationships, showing empathy by being sensitive to the what, how and why of people’s feelings and contributing to the group’s well-being are critical for leadership success. stein et al. (2009) report that leaders possessing higher levels of self-regard (to accurately perceive, understand and accept oneself) and empathy are more likely to yield high-profit earnings for companies. the qualitative results suggested that, besides social responsibility and reality testing that never emerged as relevant themes, all the components and sub-components that contributed to the eq-i scale showed improvements. researchers have generally recognised the importance of all the eq-i components as factors contributing to leadership success (kotzé & venter 2011; stein et al. 2009). the inductive coding results discussed earlier revealed that, despite the challenges identified, the coaching process was generally considered positive and the likely impact thereof on effective leadership was recognised by the participants in the study. contribution of the study the results of this study have significance for academic research, the profession of executive coaching, the practice of leadership development, and organisations in general. the research results support the effectiveness of a holistic, longer term, spaced and goal-focused coaching intervention as a means to develop the escs of leaders in a financial services company in south africa. as mentioned earlier in the article, the study aimed to address the following restrictive issues that groves et al. (2008) have identified in existing experimental ei development studies: ei conceptual and assessment concerns. the focus of this study was on escs in respect of which adequate support exists for the reliability and validity of the eq-i that measures emotional and social functioning. a factor in this study that most likely mitigated the effect of positive social desirability was the built-in correction formula for biased scores based on positive and negative impression item responses. a lack of information concerning the training intervention. as this study clearly described the key elements and principles of the coaching model and the design of the holistic coaching programme, it would be particularly valuable for use by those engaged in training and research. a more detailed description, which was not possible in this article because of limited space, may be obtained from the corresponding author. short duration of the training intervention. in this study, a more in-depth and effective emotional learning intervention could be presented as it consisted of a regulated series of nine coaching sessions spaced over a period of 9–12 months. the leaders could consistently practise their newly acquired ei behaviours in their work and home environments during this period. absence of essential statistical controls and/or a control group. owing to the non-randomised control group design used in this study, the experimental and control groups could not be considered equal in all respects. however, the stratified sampling technique used ensured that the control group closely resembled the experimental group with respect to race, gender and age. the results of the statistical analyses confirmed the equivalence of the two groups with respect to these attributes. therefore, the potential effects of race, gender and age were isolated from the intervention. the value of supplementing quantitative research evidence with qualitative research evidence in the form of meaningful subthemes that support the quantitative findings was demonstrated in this study. according to lincoln and guba (1985:316), the transferability of qualitative research to other contexts depends on the thickness of description of the research approach and design. the description in this study was such that other researchers would be able to understand the approach and design and apply these with relative confidence to their own contexts. factors that most likely contributed to the success of the coaching intervention were the following: (1) it specifically focused on the development of escs that was relevant to the outcome, namely, effective leadership behaviour. (2) it involved longer term, regular and short coaching interventions to facilitate deeper, more effective ei improvement, which contributed to the effectiveness of the leaders (mcenrue et al. 2010). (3) it incorporated the main design elements and best practices applied in the fields of adult learning and leadership development, which resulted in more effective leadership development (mcenrue et al. 2010). (4) it brought together distinct coaching models and merged these into a holistic approach designed to focus on the coaching requirements of leaders (passmore 2007). research has shown that more effective leadership is needed to increase organisational performance. judging from academic contributions, effective leaders use more ei skills than do less effective leaders (coetzee & schaap 2005; goleman 1998; kotzé & venter 2011). the current research study provides the organisation with a coaching model that can be used to improve the escs of its leaders, in that way making these leaders more effective. limitations as is the case with all studies, this study had its limitations, and these are acknowledged by the authors. the use of self-reporting questionnaires increased the risk of leaders responding to the questionnaires in a socially desirable way, which might have affected the construct validity of the study. however, the built-in response bias correction formula discussed earlier might have had a mitigating effect. the eq-i questionnaire was initially completed by the control group in a high-stakes situation as the measure formed part of a pre-employment selection battery, whereas the second application (posttest) did not take place in a high-stakes situation. dunlop, telford and morrison (2012) indicate that the high-stakes testing is particularly susceptible to socially desirable responses. if social desirability was evident, it would have been reasonable to expect high pretest scores and lower posttest scores in respect of the control group. this was not the case as the control group’s overall pretest and posttest scores did not differ significantly. furthermore, the pretest mean scores of both the experimental and the control groups did not deviate markedly from the eq-i standardisation sample mean score (x = 100). irrespective of the arguments put forward, the possible effect of socially desirable responses on the results could not be negated completely considering that the leaders who received coaching participated willingly and might have been highly motivated to see the coaching succeed. furthermore, the context and purpose of the post-assessment in respect of the experimental and the control groups differed. considering the experimental group’s enhanced knowledge of the constructs measured, posttest scores might have been a reflection of construct knowledge rather than of true behavioural changes (dunlop et al. 2012). however, evidence obtained from the qualitative research component did suggest ei behavioural changes in the experimental group, which somewhat reduces the possibility that these changes could be ascribed to distorted assessment scores. it should be noted though that the subjective nature of the qualitative research process, the involvement of one of the researchers in the coaching intervention and this researcher’s evaluation of the interview data might have influenced the qualitative findings. however, to minimise subjectivity this researcher used well-recognised procedures, which included triangulation, credibility and member checking. the quasi-experimental design used for the purposes of this study might have resulted in variables other than race, gender and age to influence the outcome of the study. the qualitative research results did, however, indicate that meaningful changes ascribed to the intervention had taken place. research recommendations the following recommendations for future research could be made in the interest of advancing the practice and profession of coaching and broadening the knowledge base in coaching as an approach to develop the ei of leaders: to validate the impact of coaching on the ei of leaders over time, more longitudinal empirical research should be conducted using randomised experimental and control group studies. given the problems inherent in self-report assessments (which were applied in this study to measure the ei of the leaders), the bar-on eq-i 360-degree assessment should be used in future research. this type of assessment would allow superiors, peers, and/or followers to rate participative leaders on relevant characteristics. a significant variance between self-evaluation and the evaluation of others might give a better indication of whether or not participative leaders’ perceptions of their leadership style are accurate (syndell 2008). conclusion the professional practice of coaching as part of the discipline of leadership development is new and still evolving. it is posited that coaching as a leadership development strategy has nevertheless already been proven to be effective and to produce various positive outcomes. despite the evidence obtained from research that suggests that executive coaching may be an effective leadership development strategy, insufficient research has been done that demonstrates the impact of theoretically substantiated and appropriately designed coaching interventions on the escs of leaders. it has been broadly articulated that adequate theory building in respect of the effectiveness of specific development processes and outcomes is dependent on a sufficient number of well-designed and informative research studies (groves et al. 2008; jones et al. 2016; theeboom et al. 2014). this study aimed to develop a template of what can be considered an informative study on the impact of coaching on the emotional and social intelligence competencies of leaders. empirical evidence obtained in this study strongly suggests that the well-described and theoretically substantiated longer term, spaced and goal-focused coaching intervention that was implemented had a positive impact on the escs of leaders in a financial services institution. however, the implications of the limitations applicable to this study could have influenced the findings, and future research aimed at improving relevant research models should take these into account. coaching leaders in emotional effectiveness is an exciting field that offers vast opportunities for further research and practical application. the coaches, the organisations that engage in coaching, the leaders who are coached and the academics who research the coaching process are all breaking new ground in this growing field. acknowledgements competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. author’s contributions m.d. conceptualised the study, did an initial literature review, developed the coaching model, planned and executed the interventions, did the empirical data gathering and qualitative analyses and presented the findings as part of a doctoral degree study under supervision of the second author. she provided the first draft of the article and later made inputs on the reviewed versions of the article. p.s. wrote the article for publication with major revisions and updates of the literature component, refined the 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constant error in psychological ratings’, journal of applied psychology 4, 25–29. https://doi.org/10.1037/h0071663 turner, r.a. & goodrich, j., 2010, ‘the case for eclecticism in executive coaching: application to challenging assignments’, consulting psychology journal: practice and research 62(1), 39–55. https://doi.org/10.1037/a0018650 van oosten, e.b., 2013, ‘the impact of emotional intelligence and executive coaching on leader effectiveness’, unpublished doctoral thesis, case western reserve university, cleveland, oh. visser, c. & butler, r., 2008, ‘the effectiveness of solution-focused working in coaching and consultancy’, gedrag en organisatie 21(1), 35–55. appendix 1 the design of the coaching process the coaching model was interpreted and translated into 16 design principles which were followed to guide and inform the coaching process, as discussed below. design principles of the preparation phase: assessment of the organisational needs – the objectives of the emotional intelligence (ei) coaching intervention for leaders were determined by assessing the organisational needs (leskiw & singh 2007). this established a clear connection of the coaching intervention to the business strategy. self-assessments – the leaders completed the bar-on eq-i assessment at the beginning of the coaching process to identify areas of strengths and developmental needs and at the end of the coaching process to evaluate the impact of the coaching on the ei. provide insight in developmental positioning of leader – based on the results of the comprehensive ei assessments, the coach and leaders agreed on the leaders’ ei developmental positioning and their coaching needs in pursuit of their goal-orientated action plans (brown 2010). design principles of the development phase: series of short, spaced development sessions – a regular series of short, spaced coaching development sessions in combination with feedback was used to enhance ei (grant 2007). the coaching sessions were spaced over time to grant leaders the opportunity to process and integrate their learnings, thereby enhancing their ei skills (cherniss et al. 1998). strong coaching partnership – the coach established an open, trusting, non-judgemental and supportive coaching relationship with the leaders. the coaching partnership played a fundamental role in facilitating change and growth within the leaders (carey et al. 2011). goal-orientated action plan for development – the coach assisted the leaders to set clear emotional skill development goals after reviewing their behaviour based on the evidence from the bar-on eq-i assessment. the grow model provided a structure to compose a goal-orientated action plan for development (downey 2003). self-reflection on emotional skills – the coach guided the leaders through a process of self-reflection to create conscious awareness of the meaning, impact and benefits of emotional skills for leaders. the coach also guided the leaders in how and when to practise the emotional skills. ongoing feedback – feedback was essential during the coaching process to determine whether the leaders were heading in the right direction. the coach gave ongoing feedback to encourage leaders. such feedback can be highly reinforcing (cherniss et al. 1998). use of cognitive behavioural techniques – the coach deepened the leaders’ understanding of the connection between thoughts and behaviour. the coach assisted the leaders to explore the cognitive patterns underlying the leaders’ observable behaviours. the coach encouraged the leaders to classify, assess and alter their self-limiting thoughts, beliefs and toxic emotions to develop more useful behaviours and to grow more skilful at emotional management (neenan 2010). use of homework – the leaders participated in a number of homework assignments that allowed them to observe, practise and learn about numerous ei skills (leskiw & singh 2007). observation by the shadow coach – the coach shadowed the leaders in selected team meetings, discussions, meetings for conflict resolution or management discussions (turner & goodrich 2010). by observing the same incidents, a platform was offered to the coach and the leaders for more significant dialogue and reflection on how the leaders applied the ei skills. the coach shared observations on how effectively they applied and demonstrated ei skills in these selected sessions. examine and investigate patterns and their meaning – the coach sought to open up new insights for the leaders by bringing hidden aspects into conscious awareness and by using behavioural patterns to reveal thoughts and beliefs. the coach used patterns in the leaders’ behaviour at work and their childhood to reveal their unconscious beliefs and thoughts (passmore 2010). journaling – the leaders were encouraged to reflect in their journals on their feelings, thinking and realisations during the coaching session. they were also invited to capture their learnings and challenges during the period while practising their homework. in addition, participants reflected regularly in a journal on their own realisations and growth opportunities (turner & goodrich 2010). design principles of the transfer phase: encouraged the application of skills in the work environment – the coach required the leaders to use the new behaviours regularly and consistently over a period of a couple of months in their work environment and at home. built-in support – the supervisors of the leaders were involved in the coaching journey so that they could truly grasp and support the leaders in understanding how their actions are influenced by and affect the whole organisational system. the coach provided the supervisors with information about the progress of the leaders. design principles of the evaluation phase: conduct evaluation – with the aim of evaluating the impact of coaching on the ei of the leaders, a second round of bar-on eq-i assessments was conducted and interviews were held with the supervisors of the leaders. based on the feedback, the coach encouraged the leaders to reward successful implementation of skills and to focus on areas which still required development (cherniss et al. 1998; green 2002). abstract introduction research design analyses validity and reliability of the results of the analyses findings discussion conclusion acknowledgements references about the author(s) christiaan g. joubert air traffic and navigation services, south africa joseph a. feldman graduate school of business leadership, university of south africa, south africa citation joubert, c.g. & feldman, j.a., 2017, ‘the effect of leadership behaviours on followers’ experiences and expectations in a safety-critical industry’, south african journal of economic and management sciences 20(1), a1510. https://doi.org/10.4102/sajems.v20i1.1510 note: this article is partially based on the author’s doctor of business leadership thesis at the university of south africa, south africa, with promoter: dr j.a. feldman, received july 2014, available here: http://uir.unisa.ac.za/bitstream/handle/10500/18687/thesis_joubert_cg.pdf?isallowed=y&sequence=1 original research the effect of leadership behaviours on followers’ experiences and expectations in a safety-critical industry christiaan g. joubert, joseph a. feldman received: 01 dec. 2015; accepted: 15 mar. 2017; published: 26 apr. 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: motivation for this study was found in concern expressed by civil aviation organisations that specialists in the air navigation services provider sector require appropriate and beneficial organisational leadership to encourage, enable and manage transformation within this highly structured setting. also, academic research puts emphasis on a need for investigations of the roles, expectations and requirements of followers in the leadership–followership relationship. followers’ experiences and expectations of leadership behaviours in an air navigation service provider (ansp) organisation were investigated and served as orientation and setting applicable to this study. aim: the aim of the research was to identify and understand how follower experiences and expectations of leadership behaviours in a safety-critical commercial environment can affect leadership training and growth. the above-mentioned motivated this investigation of leadership traits and behaviours within an explicit context and from a follower’s viewpoint. setting: the setting for the study was twenty two air traffic and navigation services company sites where followers’ experiences and expectations of leadership behaviours in an air navigation service provider (ansp) organisation were investigated and served as orientation and setting applicable to this study. methods: an ethnographic case study research style was adopted and followed because it allowed for an all-inclusive, holistic narrative report and interpretation. the samples for the quantitative and qualitative components of this study were parallel and methods employed addressed different aspects of the phenomenon, which allowed for a mixed methods research design. a one-way causality in the research design was observed because traits of followers that might influence leaders’ behaviours were excluded. data were collected by means of a leader trait and behaviour questionnaire completed by participants, individual interviews and focus group consultations. results: research findings dispensed a deeper appreciation of followers’ epistemological and ontological views, within a specified context, which were supported by a common need to achieve organisational safety objectives. a practical managerial benefit was found in the insights presented by followers of leadership, which can possibly benefit leadership development and training needs, along with training and advancement of followers. conclusions: research findings potentially add to enhancing understanding of leadership development theory, synonymous with a safety-critical commercial setting. a critical insight into the ‘unexplored’ leadership behaviour qualities found within a safety-critical milieu is subsequently offered. introduction orientation outcomes of a global survey conducted by the civil air navigation services organisation (canso 2010) of air navigation service providers (ansps) acknowledged the existence of explicit safety and culture barriers. for example, information not shared with management, because of lack of trust, exhibited a limitation. instances of punitive actions serve as evidence of a cultural barrier. the above mentioned facts are attributed to leaders who exhibit egotistical, autocratic or domineering management styles. in contrast, it may be contended that within a highly regulated situation, it is anticipated that leadership behaviours should likely encourage follower actions, especially when compliance with strict rules is expected. consequently, leadership behaviours may well support and encourage such rule-based conduct. incongruity in this case possibly exists, whereby current leadership behaviours may not necessarily contribute to compliance expectations and activities. it is thus postulated that a thorough appreciation of prevailing leader qualities and performances can probably be found in encounters, observations and thoughts disclosed by followers. these reports may recognise and critically describe leadership behaviours that influence followership. accordingly, an expressive follower-emphasised study was warranted so as to find and uncover noticeable leadership behaviours. this study was conducted within a safety-conscious, highly regulated and technology-driven industry (aviation industry), a safety-critical sector (air navigation services) and a specific safety setting, namely, an air traffic and navigation services provider. literature review when considering studies conducted by avolio, walumbwa and weber (2009), whitener (2001), kellerman (2007) and yukl (2005), it can be argued that leader qualities and behaviours can be examined from, amongst others, an organisational, leadership or a follower perspective. leadership theories and paradigms tend to focus on leaders’ reports on leadership (kellerman 2007; shamir & howell 1999; vroom & jago 1988). studies have accentuated leaders as if they were completely separate from those they lead, while followers have tended to be acknowledged as an undifferentiated constituent (boezeman & ellemers 2008; collinson 2006; riggio, chaleff & lipman biumen 2008). this reported misconception may advance an argument for the important role that followers play in the leader–follower relationship and organisational performance (boccialetti 1995; chaleff 1995; kellerman 2008; kelley 1992). leadership encompasses social interactions between leaders and followers. emotional awareness and regulation influence the quality of these interactions and relationships (hill & lineback 2011; hur 2008; ibarra & barbulescu 2010; madera & smith 2009; wong & law 2002). howell and haii-merenda (1999) explain that in leadership research, an affiliation of some sort between leader and follower is anticipated. also, it is further proposed that the type and value of this relationship are critical when associating leader behaviour and follower response. cropanzano and mitchell (2005) found that within current management research, the social exchange theory has been afforded the most attention, especially in terms of workplace relationships. social exchange theory acknowledges that specific workplace antecedents lead to interpersonal connections – denoted as social exchange relationships (cropanzano et al. 2001). consequently, individuals regulate their interactions with other individuals based on a self-interest consideration of the efforts and benefits of such engagements (brown & mitchell 2010). people thus develop attitudes towards other people and things in the context of estimated personal benefits and costs to result from such encounters (brown & trevino 2006). in addition, whitener (2001) has found that research imbedded in social exchange theory has revealed that employees’ obligation to the organisation stems from their perceptions of the employers’ commitment to and support of them (eisenberger, fasolo & davis-lamastro 1990; hutchison & garstka 1996; settoon, bennett & liden 1996; wayne, shore & liden 1997). a study that postulates leadership and followership as interrelated events requires a methodological focus on interactions, connections, dependences and exchanges when investigating specific encounters, matters or situations (castro, perinan & bueno 2008; ilies, morgeson & nahrgang 2005; kupers 2007; mccann, langford & rawlings 2006; mushonga & torrance 2008; wood 2005). these inferred associations can also be explained as psychological contracts that refer to an individual’s system of beliefs grounded in commitments articulated or implied (rousseau 2010). leaders play a prominent role in the creation of the views followers have of leadership (gray & densten 2007). these views can be underlined with reference to the history of leadership theories as mapped by baicher (2005) being: 1920s: emergence of trait model (great man theories). 1940s: behavioural model. 1950s and 60s: situational/contingency model. 1970s: advent of neo-charismatic leadership model (transactional and transformational). 1990s–2000s: expansion of ethical/spiritual theories (ethical, shared, spiritual theories) and return of traits, universal and cultural-specific leadership. knowledge of the leadership–followership subject advocates that research in leadership studies leans towards centring the leader as the main point and principal element of the leader–follower relationship, mindful that such focus is really from the leader’s perspective (den hartog & belschak 2012; hollander 1992a, 1992b; kellerman 2004; kirchhubel 2010; lord & brown 2004; mayo & pastor 2007; shamir 2007; wang et al. 2014; yukl 2005). because followers are exposed to a leader’s style and actions, they are positioned to evaluate its effects on the leader–follower relationship (castro et al. 2008; hollander 1995; kirchhubel 2010; van vugt 2006).the previously mentioned thus draws attention to a follower perspective. identifying and exploring explicit follower views that are synonymous with both inspirational and unfavourable leadership behaviours depend on responses and testimonies from followers regarding these behaviours. hence, follower accounts, remarks, descriptions, incidents, clarifications, structured responses and perceptions served as data essential for this study. leadership traits and behaviours highlight social interactions and emotional filters contained by leader–follower relationships. moreover, leaders and followers (individually and collectively) delineate leadership and followership from diverse perspectives. however, leadership is understood as a complex set of behaviours found within a specific setting that directs conduct. a leader’s actions can inspire commitment or alienate followers (banutu-gomez 2004). organisational progress and performance may be restrained by paltry leadership (morris, ely & frei 2011). this study attempted to investigate reported experiences and expectations of followers with regard to leadership behaviour qualities within an ansp. both inspirational and discouraging leadership experiences and styles were probed. because of this exclusive and limited focus on followers, a one-way causality in the research design was followed. followership has been hailed as an understudied subject in the academic literature and viewed as an underappreciated topic amongst practitioners (bjugstad et al. 2006). avolio et al. (2009) found that one of the most interesting omissions in theory and research on leadership is the lack of discussions pertaining to followership and its impact on leadership. although it has always been important, the study of followership has now become even more important and noteworthy with the advent of the information age as well as vast changes in the workplace (bjugstad et al. 2006; shamir 2007; stetz, stetz & bliese 2006). bjugstad et al. (2006) describe followership as the capability to effectively follow instructions, while also supporting the efforts of a leader in pursuit of organisational success. followership schemas develop through socialisation and previous experiences with both leaders and other followers (hogg 2001). these are kept in memory and actuated when followers interact with leaders or other followers (hogg 2001). in terms of followership, the responses selected and employed by followers based on experiences and expectations of leadership behaviours and followership deserved investigation. it was accepted that follower responses can provide content-specific and context-specific information that can be used for organisational purposes, such as leadership development initiatives. furthermore, acquiring insight into influences that shape followers’ sentiments and beliefs can aid understanding of followers’ cognitive frameworks and contemplative practices. the mentioned cognitive frameworks are based on the assumption that individuals reason by trying to envisage the possibilities compatible with what they know or believe (johnson-laird 2013). research emphasis as a point of departure, it was accepted that one’s past experiences are likely to influence one’s current and future views. in lieu of this statement, it was recognised that follower experiences can be presented as personal, noteworthy or meaningful encounters, steered by reflective thoughts. as a result, leadership behaviours and qualities endured can influence followers’ mental models and subsequently encourage critical appraisals of leadership. mental model data can consist of ephemeral discernments or thoughts, as well as long-term knowledge and beliefs, and such data are accessible by means of introspection (johnson-laird 2013; knauff et al. 2013). as a result, follower expectations can be based on predictions and existing beliefs. consequently, the researchers depended on follower insights to comprehend and appreciate followers’ epistemological and ontological views of leadership (limited to a specific context). it was contemplated that these insights could be valuable to appraise leadership training and development theory. the research problem emerged as a result of the research gap in the academic literature on follower behaviour. it is articulated as follows: follower experiences and expectations of leadership behaviours have not been effusively amassed, scrutinised, understood, structured and utilised to further aid leadership development. it is imperative that it can now be done within a safety-critical commercial environment to support the realisation of this environment’s goals and objectives. the research problem was addressed through the answering of the following research questions: question1: how do followers within an ansp describe leadership behaviour qualities in terms of the impact of these behaviour qualities? question 2: how do current leadership behaviour qualities enthuse followership within an ansp? question 3: how do current leadership behaviour qualities demotivate followership within an ansp? question 4: how can follower experiences and expectations of leadership behaviours within an ansp benefit leadership training and development needs analyses? the remainder of this article highlights the research design, analysis, findings and discussion. the research design is presented inclusive of the research approach, paradigm and strategy and method. the research findings furnish the quantitative and qualitative insights as well as the triangulated results. links with the research questions are offered in the discussion of the findings, including recommendations and suggestions for future research. research design research approach mixed methods research is useful when a need arises to answer questions that cannot be addressed by qualitative or quantitative approaches alone (creswell 2003; greene, caracelli & graham 1989). johnson and onwuegbuzie (2004) add that a mixed method inquiry considers induction (or discovery of patterns), deduction (testing theories and hypotheses) and abduction (uncovering and presenting the best of a set of explanations for understanding one’s results). mixed methods research integrates aspects from both qualitative and quantitative paradigms to deliver converging findings in the context of intricate research questions. yin (2011) adds that mixed methods research offers an option that incorporates the similarities and dissimilarities in qualitative and quantitative methods. accordingly, the researchers introduced and followed a mixed methods research approach that facilitated and integrated both qualitative and quantitative investigations. research paradigm and strategy following deliberation, an ethnographic research case study strategy was preferred. because an ethnographic interview requires respectful listening (heyl 2001), the desired deeper descriptions were more viable. this necessitated listening for shifts in verbal variation, inconsistencies, topics avoided and hesitations. furthermore, the contextual orientation needed to be understood from an organisational viewpoint. this decision thus required a context-specific research focus and boundary, which lead to the use of a supportive case study. it was accepted that a case is an empirical inquiry that studies a current phenomenon within its real-life context and is typically used when the boundaries between phenomenon and context are not apparent (kohlbacher 2005; walshe et al. 2004; yin 2003). yin (2003) adds that the typical need for case studies arises out of the aspiration to understand complex social phenomena. in this research, the apparent goal of the case study was to reveal patterns, find meanings, construct inferences and build theory (kohlbacher 2005; noor 2008; patton & appelbaum 2003). the case study method allowed the researchers to follow an all-inclusive and meaningful trail of actual events as experienced and presented by followers. research method research setting leadership suggested in this context comprised ansp operations’ organisational management levels. so, a leader, for the purpose of this study, is an officially appointed person that is responsible for the performance of a group of employees/followers who report directly to him or her. he or she is also formally responsible for the realisation of organisational goals through the group’s performance. follower boundaries pertinent to this study excluded ansp management as well as non-operations personnel. population the target population amounted to 459 ansp employees and comprised 293 air traffic control officers (atco), 123 air traffic service officers (atso) and 43 aeronautical information management officers (aimo) in employment of an ansp. a total of 22 operational centres served as accessible research sites. sampling saunders, lewis and thornhill (2007) found that non-probability sampling is more commonly used when following a case study strategy. qualitative data collection had to be collected from a subgroup of the accessible population (comprising non-management operations employees employed by the ansp). a non-probability convenient sample was thus drawn. fifteen followers were individually interviewed, and nine followers participated in the focus group interviews. in turn, quantitative data had to be gathered from a subgroup of the accessible population (145 non-management employees employed by the ansp participated). this subgroup comprised 85 atco, 46 atso and 14 aimo from 21 ansp operational centres. the researchers’ sampling decision was based on the accessibility of participants and willingness of the participants to participate. this decision informed the type of sample drawn, being a non-probability convenient sample. data collection methods a leader trait and behaviour questionnaire, individual interviews and focus group interviews served as data collection methods. the leader trait and behaviour questionnaire was found to be suitable for this study because the term ‘leader traits’ denotes personality factors that are observable both within and outside the context of work (wilson 2004) and ‘leader behaviours’ focus on the activities engaged in by the leader, including his or her characteristic approach, which suggests his or her effectiveness (wilson 2004). this decision is aligned to the literature review where it was suggested that leadership behaviours may be conceptually framed as subdivisions that will allow followers to describe their realities. subdivisions of the questionnaire include the leader’s behaviours (as an individual), the leader’s interaction with the team (described as team behaviours) and the leader’s behaviour within a specific organisational setting. the leader trait and behaviour questionnaire consisted of wilson’s (2004) effective developmental leader trait instrument (edlti) and the effective developmental leader behaviour instrument (edlbi). wilson (2004) identified six leader traits (‘dedicated’, ‘practical’, ‘cooperative’, ‘assertive’, ‘personable’ and ‘analytical’) and seven leader behaviours (‘focused’, ‘supportive’, ‘developer’, ‘delegator’, ‘advisor’, ‘competitive’ and ‘charismatic’) considered to be synonymous with leader qualities that encourage followership. in summary, it should be noted that the aptness of this questionnaire was because of its focus (leader performance), its specific areas of interest (leader trait and behaviours), its leader development emphasis as well as favourable and supportive pilot testing results. qualitative data collection relied on the use of individual and focus group interview questions. these were formulated in terms of themes identified as key constructs derived from the literature review. therefore, it was necessary to understand how followers delineate leadership traits and behaviours in terms of significance of these behaviour qualities. it was envisaged that these views had to be understood and valued in terms of the juxtaposition of followers’ cognitions directed by their mental models and leadership behaviours reported within the ansp. further understanding also relied on juxtaposition that provided deeper understanding regarding the second and third key constructs. the second key construct was aimed at understanding leadership traits and behaviours that motivated followership. the third key construct highlighted leadership traits and behaviours that discouraged followership. the second and third key constructs demanded understanding of individual leadership behaviours, team leadership behaviours, organisational leadership behaviours and network behaviours. qualitative data collection continued until saturation (lincoln & guba 1985; ohman 2005) was reached. interviews were reinforced by field notes completed during each interview. this use of field notes corresponds to mouton’s (2001) and yin’s (2003) views that interviews can be enhanced when additional sources of evidence are used. mentioned is specifically pertinent in case study research within a specific context (mouton 2001; yin 2003). analyses interview data analysis was performed at a basic level of analysis and an interpretative level of analysis. inductive codes, identification of themes, patterns and relationships that were emerging across data were developed. the truthfulness of the qualitative data analysis was confirmed by an external codifier. emerging categories from individual interviews (table 1 is presented as an example) and focus group interviews identified followers’ experiences of leadership as synonymous with assertive leadership actions, and they reported that leadership foci were supportive of organisational goals. in support, statements serve as evidence such as, for example: ‘fill the tasks that are assigned to you, obeying by the rules or the rules of the leader, act to the instructions’ [participant 240, female, aeronautical information management officer] table 1: categories and associated subcategories (individual interviews). furthermore, an expectation to move towards a transformational leadership style that is inclusive of expressed follower development aspirations was highlighted. in support, it was, for example, stated: ‘like to follow, directs people, qualities being selfless, confidence, outspoken, intelligent and wise, monitor his people’s needs’. [participant 236, male, air traffic controller] similarly, transformational and pragmatic leadership experiences and expectations (from a follower perspective) were presented as emerging categories resulting from individual interviews. in this regard, statement examples are: ‘honest and outspoken, approachable but they can approach you too, are structured, well structured, willing to listen’. [focus group 224, females, air traffic controllers] however, specific mention was made by followers of encountered leadership concerns such as leader–follower communication problems and lack of leader support in terms of workplace task and relationship matters. comparable emerging categories were found as a result of focus group data analysed. noteworthy, in this case, was an additional emerging category that assisted to explain followership within the ansp. mentioned was a passive follower state, described in terms of behaviours suggesting inter alia compliance, obedience, uncertainty and deference. leadership trait and behaviour variances were derived from responses to the leader trait and behaviour questionnaire. descriptive statistics were used to explain continuous variables. the researchers adopted limits (termed ‘noteworthy’ and ‘negligible’) with reference to the 5-scale likert-style rating scale interpretation (a mean of 3.50 was considered). subsequently, data were standardised and interpreted with reference to developed and desired leader traits and behaviours (‘noteworthy’) and emerging/undeveloped but desired leader traits and behaviours (‘negligible’). common leader trait items were identified by the three vocational groups. these leader trait items were also part of the common trait items that were acknowledged by the three vocational groups collectively (as per tables 2–5). in summary, quantitative results stressed the presence of specific operational leader traits and behaviours within the ansp. a one-way analysis of variance (anova) was performed because it calculated significant difference between the population’s means. in addition, a kruskal–wallis test was employed as a nonparametric alternative to the one-way between-groups anova. scores were converted to ranks, and the mean ranks for each group were compared. no conclusive evidence of significant difference between the groups could be claimed because of the variability of data. no significant differences (p < 0.05), between the three vocational groups (atco, atso and aimo), were thus prominent. the quantitative results not only emphasised the positive leader actions and experiences but also showed areas where enhancements were required. table 2: noteworthy leader trait factors and items (noted as ‘b’). table 3: leader trait factors and items (noted as ‘b’). table 4: leader behaviour factors and items (noted as ‘c’). table 5: leader behaviour factors and items (noted as ‘c’). validity and reliability of the results of the analyses validity triangulation results signified consistency. data and method triangulation were effected. in support of data triangulation, evidence from multiple empirical sources was used to cross-check information. each portion of the evidence was assessed by associating it with other kinds of evidence on the same issue. in support of method triangulation, the evidence was assessed by collecting other evidence on those sources, using different research methods (e.g. by using questionnaires and interviews). the first phase of data and method triangulation relied upon external codifier feedback, member-checking comments, individual interview data and data from individual interview field notes. in this case, consistencies were found in an individual interview and individual interview field note–derived categories. the second phase of triangulation considered external codifier feedback, member-checking comments, focus group interview data and data from focus group interview field notes. again, consistencies were apparent. the third phase of triangulation depended on external codifier feedback, member-checking comments, all focus group interview data and all individual interview data. in this case, leader and leadership descriptive experiences as well as follower needs and concerns received different portrayals; however, consistencies were noted in terms of desired and undesired qualities. the final phase of triangulation considered the leader trait and behaviour questionnaire data, all focus group interview data and all individual interview data. of interest was that although the theme remained similar, differences were noted in terms of detailed focal points. differences were found in terms of leader traits, leader behaviours, leadership styles as well as follower characteristics. however, these also provided impetus for convergence. these differences were considered as diverse perspectives that were related to an integrated study of context-bound leadership. the researchers, therefore, considered these integrative outcomes as a valuable contribution to this study. the quality of data had to illustrate compliance with aspects of autonomy, beneficence and justice (orb, eisenhauer & wynaden 2000). evidence in support of autonomy can be traced to informed notice and consent received from the ansp and participants. beneficence was achieved by not revealing the participants’ identities. justice was evident from descriptions detailing the vulnerability of the participants and their contributions to the study. the rights of human subjects were also protected by, for example, not affecting emotional harm, and not encroaching on their rights to maintain self-respect and human dignity. moreover, data were collected, examined and stated by providing all information without misrepresentation, not consciously ascribing greater confidence than the measurements warranted and recording contradictory evidence. the internal validity of wilson’s (2004) edlti and the edlbi was established by an expert panel. an expert panel review aimed at strengthening the content validity of the leader trait and behaviour questionnaire suggested negligible changes, which were included in the final leader trait and behaviour questionnaire. construct validity of the leader trait and behaviour questionnaire was traced to the literature review with reference to a synopsis of leader trait and behaviour groups that resulted. maxwell’s (2009) seven-point checklist for validity in qualitative research was used. compliance subsequently becomes apparent in terms of the concentrated long-term involvement in the research setting, comprehensive data collection, confirming respondent validation, reporting discrepant evidence and negative cases, triangulation, use of different data sources, use of quasi-statistics and comparing results across different settings and groups within a specific context. reliability reliability in terms of qualitative research was facilitated by ensuring that all interview questions were derived from the literature review, distinct interview modus operandi were consistently applied, adhering to sampling criteria, guaranteeing confidentiality and ensuring ethical compliance. furthermore, inter-coder reliability (kohlbacher 2005; mayring 2003) was confirmed by an external codifier. a cronbach’s alpha was used to confirm internal consistency and to determine good inter-item correlation of the leader trait and behaviour questionnaire (table 6). the leader trait and behaviour questionnaire had good internal consistency, with cronbach’s alpha coefficients reported above 0.7. arrangements to confirm reliability were also consciously consolidated and strengthened during triangulation. table 6: reliability statistics for the leader trait questionnaire. table 7: reliability statistics for the leader behaviour questionnaire. designated trustworthiness schemes complied with gall, borg and gall (1996) and krefting’s (1991) recommendations to take account of triangulation, member-checking and to demonstrate a logical association between research questions, research procedures, raw data and outcomes. furthermore, a similar format, sequence and questions for each participant were used. also, thorough descriptions of participants, the sample drawn, data collection procedures and detailed transcripts of information collected were offered. findings the aim of this study was to examine, understand and appreciate experiences and expectations of followers (within an ansp context) of leadership behaviours. the intention was to analyse and report on the multiple realities associated with mentioned specific phenomenon. a total of 14 themes were revealed. a summary is presented: leadership as a construct followership as a construct contextualised leadership roles and responsibilities insight into the leader–follower relationship behaviours supporting effective leadership from a team viewpoint behaviours labelling less effective leadership from a team viewpoint behaviours supporting effective leadership from a follower mental model view behaviours that define less effective leadership from a follower’s perspective behaviours that reinforce effective leadership in a particular context less effective leadership behaviours in a specific context leader and leadership behaviour qualities (within an ansp) leader and leadership behaviour qualities that enthused followership (within an ansp) leader and leadership behaviour qualities that discouraged followership (within an ansp) leadership was apparent in the participants’ questioning attitudes, acceptance of dependence, professional commitment, openness to contribute, enthusiasm and excitement. discussion answers to the four research questions used to translate the research question for research design question 1 how do followers within an ansp describe leadership behaviour qualities in terms of the impact of these behaviour qualities? in summary, occurrences, descriptions, experiences, perceptions and explanations of leadership reported in the workplace were formed and guided by followers’ reflection, awareness and reasoning. followers understood, noted, rated, presented and described the workplace as a unit (inclusive of both work and social perspectives/influences) within which preferred and undesired leader qualities as well as leader and follower dissimilarities and similarities could be observed. an important and respected ‘own follower voice’ emerged. followers’ reflection, awareness and reasoning pertaining to leadership suggested that they perceive and identify themselves from a dutiful, passive and compliant perspective. question 2 how do current leadership behaviour qualities enthuse followership within an ansp? a brief review is offered. followers’ accounts, reports and explanations of leadership characteristics and competence showed that preferred leader qualities, behaviours, dealings and experiences were distinguishable and could be explained in terms of significance and benefit. leader behaviours that could suggest improved follower performance and leadership behaviour qualities that may conjure progressive followership were acknowledged. leadership experiences and expectations associated with positive leader support, follower advancement, as well as assertive and pragmatic leadership that supported transformational leadership, were preferred by followers. question 3 how do current leadership behaviour qualities demotivate followership within an ansp? noteworthy insights are presented. followers’ descriptions of undesired/discouraging leadership characteristics showed that such leader traits, behaviours, interactions and experiences were apparent, distinguishable and were explained in terms of apprehension and dissatisfaction. followers acknowledged that these undesired behaviours could potentially impede their performance. furthermore, behaviour qualities that did not induce positive followership were acknowledged. in response, it was found that leadership experiences and expectations supportive of leader backing and follower development, along with firm and pragmatic leadership that underlined transformational leadership, were preferred by followers. practical examples of leadership events that were not preferred by followers were provided by the participants. these were expressed as: ‘leaders … when it comes to implementation we are a bit lacking; you are just frustrated and you take it out on the guys that need you; in some cases too many people to report to and leadership in our department is seems as if they’re against their follower, they gave the other party the impression that i was wrong, leaders bending the rules a bit.’ [focus group 224, females, air traffic controllers] additionally, leader traits exemplifying slow responsiveness, workplace frustration, follower–leader relationship anxieties and concerns regarding risk-taking were specified. consequently, it was concluded that ineffective transactional leaders may be less likely to anticipate problems, difficulties and complications, whereas more effective transactional leaders take suitable action in a timely manner. this deliberation offers added support and approval for a transformational leadership style. according to avolio, waldman and einstein (1988), singer and singer (1990), yammarino and bass (1990) and roberts (1985), transformational leadership supports better group process, contentment and productivity and strengthens individual empowerment. question 4 how can follower experiences and expectations of leadership behaviours within an ansp benefit leadership training and development needs analyses? in summary, it was established that followers could sensibly evaluate, interpret and describe leader and leadership behaviours. subsequently, followers recognised a need for both successful leadership and teamwork guided by vocational competence. finally, a realisation that leaders had to appreciate, recognise and accept their organisational, team and employee roles and responsibilities were conveyed by followers. limitations and suggestions for future research as a limitation of this study, it should be noted that leadership was excluded. research findings and contextualising of results are only pertinent to this study. therefore, generalisation outside of this context is not inferred. it is accepted that different data collection strategies and different research methods could be used to promote understanding of this topic. finally, different researchers may or may not support all the findings when reanalysing the collected data. future inquiry aimed at determining the necessity to educate followers to be able to critically appreciate and evaluate leadership performance may be valuable. also, a greater understanding of how followers’ mental models internally represent complex, dynamic systems and how these representations change over time may also serve as a theme for future research. resulting research results may assist leadership training and development specialists to develop or improve leadership training and development. conclusion this study offered a systematic process that can be considered in pursuit of leadership development, enhancement and success. data collected, analysed and reported may aid the design, implementation and evaluation of fit-for-purpose leadership training and development solutions and interventions. possibly, this approach can also assist organisations to recognise, develop and implement an integrated leadership training and development approach, mindful that such an intervention should satisfy the identified needs that will enable leaders to learn, develop and experience the intended knowledge, skills and attitudes. it is proposed that mentioned leadership training and development could develop, strengthen and inculcate desired leadership behaviour qualities, which in turn may inspire sought-after followership. leadership is not static, and it was acknowledged that the roles and responsibilities of leaders are constantly shifting as a result of environmental and employee dynamics. accordingly, leadership training and development initiatives are acknowledged as continued undertakings. the value resulting from this study may be found by recognising the existence and impact of individual and shared mental models (followers’ ‘inner-voices’). furthermore, followers can indeed clearly describe desired and undesired leader–follower relationships. hence, it was also promising to note the level of insight and value of follower experiences and expectations of leadership behaviours. furthermore, the particular influence of the organisational context was accentuated by this study. research findings may contribute towards identifying and describing leadership qualities and behaviours that ought to be incorporated and excluded as part of learning and training interventions. subsequently, a leadership training and development needs analysis framework (albeit within a specific context) emerged. this needs analysis highlights the need to gain collective follower insights by exploring the theories-in-use and espoused theories held by followers (thus, constituting a prevailing mental model). in terms of research process, data collection methods for both inspirational and discouraging leader behaviours (directed by followers’ involvement and beliefs within a defined context) were revealed. data analysis phases used for both inspirational and discouraging leader behaviours were also described. furthermore, the importance and value of triangulation as a precursor for the clarification of findings were explained. finally, it may be conceded that the research findings can be used to present and outline a leadership training and development framework. acknowledgements competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions j.a.f.’s assisted c.g.j. with the choice of research paradigm and ways to achieve triangulation for increased validity and reliability. j.a.f. also assisted with the choice of the focus of an article that would be produced to relate the central and practical features of the research. j.a.f. wrote the article with c.g.j. and had it critically read by 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references about the author(s) robert w.d. zondo department of entrepreneurial studies and management, faculty of management sciences, durban university of technology, south africa citation zondo, r.w.d., 2018, ‘the influence of a 360-degree performance appraisal on labour productivity in an automotive manufacturing organisation’, south african journal of economic and management sciences 21(1), a2046. https://doi.org/10.4102/sajems.v21i1.2046 original research the influence of a 360-degree performance appraisal on labour productivity in an automotive manufacturing organisation robert w.d. zondo received: 08 aug. 2017; accepted: 17 apr. 2018; published: 30 july 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: south africa’s (sas) decline in labour productivity in the manufacturing sector is a cause for concern. the sector turns to employees for innovative productivity improvement initiatives. employees need to know what activities they are currently performing that need to improve. this is where a 360-degree performance appraisal system plays a growing role. the 360-degree performance appraisal is a valuable tool that provides an opportunity for employees to work together to identify strengths and areas that need improvement. aim: this study investigates the influence of a 360-degree performance appraisal system for the improvement of labour productivity in the automotive parts manufacturing sector in sa. settings: the study investigated the production and related experiences of an automotive parts manufacturing company that has adopted a 360-degree strategy. the company operates in the ethekwini district municipality in kwazulu-natal. it assessed if 360-degree performance appraisal is responsible for the company’s labour productivity improvements. methods: the investigation was achieved by collecting preand post-360-degree quarterly data for spoilage, absenteeism, capital investment and labour productivity. results: the 360-degree performance appraisal has no influence on labour productivity improvement. however, past capital investment plays a significant role in labour productivity increase. results also showed a relationship between spoilage rate and labour productivity improvement. conclusion: in order to maximise performance, a comprehensive performance policy must be developed, which aligns employee appraisal to performance. the study uncovered the strengths and weaknesses of a 360-degree performance appraisal system for labour productivity improvement in sa. introduction organisations are faced with the challenge of promoting innovative productivity improvement among employees. hence, productivity plays a crucial role in the organisation’s competitiveness. thus, innovation supports productivity through the new uses of technology in the business, improved industry methods, meeting changing customer demands and better systems and processes (business victoria 2016). for an organisation to evolve, people working within it have to be involved in processes that improve the organisation’s productivity. fourie (2008) is of the view that organisational effectiveness depends on an appropriate recognition and reward system. the recognition and rewards can be used to increase performance in organisations that have adopted the 360-degree performance appraisal. therefore, a comprehensive performance policy must be developed that aligns pay (or other incentives) to performance. the alignment of a 360-degree performance appraisal indicates that the process for achieving an effective performance management for productivity improvement should encompass a number of activities (parry & lacey 2000). this includes joint goal-setting, continuous progress review and frequent communication, feedback and coaching for improved performance, implementation of employee development programmes as well as the rewarding achievements. the 360-degree performance appraisal alignment is regarded as a systematic process by which the overall performance of an organisation can be improved. this can be achieved by developing the performance of individuals within a team framework, which ultimately increases productivity (kaur 2013). the performance appraisal process is a means of promoting a superior-performing workforce by emphasising job descriptions, identifying a performance-improvement plan and establishing a 360-degree feedback mechanism within a competence framework (fourie 2008). the 360-degree performance appraisal is the systematic collection and feedback of performance data on an individual or group, derived from a number of stakeholders on their performance, which in turn helps the organisation to identify performance gaps in order to build the required competencies among individuals and groups (mukhopadhyay 2016). a well-managed and integrated 360-degree feedback process provides good quality feedback from colleagues and supervisors, which can be a definite improvement over feedback from a single individual (fourie 2008). consequently, this study examines the suitability of a 360-degree performance appraisal system as an appropriate tool to increase labour productivity. oshodi (2011) emphasises that the systems of the 360-degree feedback provide one of the best methods for understanding personal and organisational developmental needs. many employees feel that 360-degree feedback is more accurate, more reflective of their performance and more validating than feedback from the supervisor alone (drakes 2008). when feedback comes from a number of individuals in various jobs, discrimination based on race, age, gender and other factors can be reduced (drew 2009). this multi-source feedback and its role in wider performance management practice has been the subject of considerable study, theoretical debate and divergent opinions. typically, a 360-degree feedback system is where an individual leader’s staff, peers, and supervisor are invited to provide scores on a range of questions relevant to their leadership role. the leader (who plays a role of a ratee) provides ‘self’ scores against which the perceptions of others are compared. peiperl (2001) defines this process as ‘peer appraisal’ which ‘begins with a simple premise that the people best suited to judge the performance of others are those who work most closely with them’. organisations in sa should revise their performance management philosophies and develop recognition strategies, policies and practices that help to achieve new business goals and support organisational and culture change (smith 2007). such revisions should enhance teamwork, employee development and customer service. hence, the performance management philosophies should provide a more objective measure of a person’s performance. it is against this background that the study focuses on a 360-degree performance appraisal system, given the low labour productivity levels in the south african manufacturing industries (unido 2013). problem statement: low labour productivity level in sa sa lacks both short-term and long-term growth in productivity (unido 2013). the conference board (2015) indicates that sa showed a weakening of productivity growth to –0.4% in 2014, while total factor productivity growth declined at an even higher rate of –3.3%. its labour productivity, in the manufacturing sector, is low when compared to korea, the united states of america (usa), taiwan, japan, france and the united kingdom (uk) (klein 2012). the south african manufacturing industry only achieved 36% of the usa productivity level in 2014 (the conference board 2015). hence, this study investigates whether a 360-degree performance appraisal system has the ability to improve labour productivity in the selected automotive parts manufacturing company. literature review this section discusses an overview of the 360-degree performance appraisal system. the appropriateness of the system as a performance-improvement tool as well as its process for superior performance concludes the section. overview of the 360-degree performance appraisal system the 360-degree feedback evaluation is a popular performance appraisal method that involves the evaluation of inputs from multiple levels within the firm and from external sources (mukhopadhyay 2016). the method is different from the traditional performance reviews, which provide employees with feedback only from supervisors (gallagher 2008). in this method, employees in the company provide ratings. this includes senior managers, the employees, supervisors, subordinates, peers, team members, and internal or external customers (drakes 2008). as many as 90% of fortune 500 companies use some form of 360-degree feedback for either employee evaluation or development (riboldi & maylette 2007). most companies use results from 360-degree performance appraisals not only for conventional applications but also for succession planning, training, and professional development. unlike traditional approaches, 360-degree feedback focuses on skills needed across organisational boundaries. by shifting the responsibility for evaluation to more than one person, many of the common appraisal errors can be reduced or eliminated (drakes 2008). the method may provide a more objective measure of a person’s performance. riboldi and maylette (2007) add that multiple sources of evaluation result in a broader view of the employee’s performance and may minimise biases that result from limited views of behaviour. having multiple raters also makes the practice procedurally and substantively fair. as a result, it is important for all parties to know the evaluation criteria, the methods for gathering and summarising the feedback and the use to which the feedback will be put (roman 2009). however, an appraisal system involving numerous evaluators will naturally take more time and, therefore, be more costly. nevertheless, the way companies are being organised and managed may require innovative alternatives to traditional top-down appraisals. on the other hand, some managers indicate that the 360-degree feedback method has problems (wright 2008). ilene gochman, the director of watson wyatt, indicated that the 360-degree performance appraisal negatively correlated with financial results (wright 2008). in addition, general electric’s (ges) former ceo, jack welch, maintains that the 360-degree system in his firm has been ‘gamed’ and that people were saying nice things about one another, resulting in all good ratings (kiger 2006). another critical view with an opposite twist is that input from peers, who may be competitors for pay raises and promotions, might intentionally distort the data and sabotage the colleague. yet, since so many companies use 360-degree feedback evaluation, it seems that they have found ways to avoid the pitfalls. google has a different approach to 360-degree feedback as it requires managers and employees to nominate ‘peer reviewers’ from anywhere across the organisation (drew 2009). however, the biggest risk with 360-degree feedback is confidentiality (wright 2008). consequently, many companies outsource the process to make participants feel comfortable that the information they share and receive is completely anonymous. the 360-degree as a performance-improvement tool organisations are continually looking for ways to improve performance and satisfy the demands of all stakeholders (peacock 2007). this involves change, which then becomes the pivotal dynamic for success. thus, 360-degree feedback plays a growing role in organisations through its ability to provide structured, in-depth information about current and future performance (kiger 2006). warr and bourne (2000) indicate that, when professionally managed, the 360-degree feedback increases individual self-awareness and, as part of a strategic organisational process, it can promote an increased understanding of the behaviours required to improve both individual and organisational effectiveness and contribute to more focused development activities built around the skills and competencies required for successful organisational performance. in addition, the 360-degree performance appraisal increases involvement of people at all levels of the organisation, increases individual ownership for self-development and learning, as well as providing the increased familiarity with the implications of cultural or strategic change (peacock 2007). it involves the evaluation of inputs from multiple levels within the organisation and from external sources (suri 2016). the 360-degree appraisal for superior performance typically, performance appraisal has been limited to a feedback process between employees and supervisors (mukhopadhyay 2016). however, with the increased focus on teamwork, employee development and customer service, the emphasis has shifted to employee feedback. hence, the questionnaire is the main approach used in the 360-degree performance appraisal (kiger 2006). the 360-degree performance appraisal committee validates the questionnaire by ensuring that the assessment instrument and procedures are effective in terms of its stated aim. it gathers structured feedback from a number of sources about the behaviour and style of an individual or team at work. for each individual, questionnaires on observable behaviours are completed by the individuals themselves, staff they manage, their peers, their customers and their managers. the results are compiled into a feedback report in which data from each source is presented separately. consequently, the report is provided to the individual who then plans how to build on competencies and improve personal performance. the reliability, fairness and acceptability of the feedback process are increased when the input is drawn from multiple sources. wright (2008) indicates that the competencies are requisite human capabilities for an organisation to maintain and develop competitive edge. these have a causal relationship with effective and superior performance in a job situation and therefore are predictive for an individual’s behaviour and performance (mukhopadhyay 2016). employees perform well when they are productive (fleenor & prince 2016). productivity implies concern for both effectiveness and efficiency. consequently, the 360-degree performance appraisal approach is a formal, structured system of measuring and evaluating an employee’s job, the related behaviour and outcomes to discover how and why the employee is presently performing on the job and how they can perform more effectively in the future (mukhopadhyay 2016). this shows a significant link to 360-degree performance appraisal as an important tool for productivity improvement. as a result, this study investigates whether the 360-degree performance appraisal system has the ability to improve labour productivity in the automotive sector. it explores the suitability of 360-degree performance appraisal as an appropriate tool for productivity improvement. hypotheses it is against this background that the following hypotheses have been developed: h1: the implementation of the 360-degree performance appraisal leads to labour productivity improvement in the automotive parts manufacturing company. h1o: the implementation of a gainsharing programme does not lead to labour productivity improvement in the automotive parts manufacturing companies. the following are sub-hypotheses: h2: an increase in the spoilage rate increases labour productivity in the automotive parts manufacturing companies. h2o: an increase in the spoilage rate decreases labour productivity in the automotive parts manufacturing companies. h3: an increase in the absenteeism rate increases labour productivity in the automotive parts manufacturing companies. h3o: an increase in the absenteeism rate decreases labour productivity in the automotive parts manufacturing companies. h4: an increase in the allocation of workers in production increases labour productivity in the automotive parts manufacturing companies. h4o: an increase in the allocation of workers in production decreases labour productivity in the automotive parts manufacturing companies. h5: the accumulation of past capital investments increases labour productivity in the automotive parts manufacturing companies. h5o: the accumulation of past capital investment decreases labour productivity in the automotive parts manufacturing companies. methodology the method for this research will be discussed under the following headings: research design and approach, company that participated in the study, data collection, as well as the time series data and analysis. research design and approach this study was quantitative in nature. it examines the relationship of labour productivity as a dependent variable to absenteeism and spoilage rates, the number of workers involved in production, as well as post 360-degree performance appraisal dummy. bryman and bell (2007) explain that the quantitative approach involves the use of statistical procedures to analyse the data collected. consequently, after the measurements of the relevant variables, the scores were transformed using statistical methods. the study was also conclusive in design. conclusive studies are meant to provide information that is useful in decision-making (yin 2008). company that participated in the study a convenience sample from one large automotive parts manufacturing company situated in the outer western region within the ethekwini district municipality in the province of kwazulu-natal in sa was used. this sampling technique relies on data collection from population members who are conveniently available to participate in the study (yin 2008). the company had adopted the 360-degree performance appraisal strategy and agreed to participate in the study. the 360-degree performance appraisal system was their first round of structured approach for measuring and evaluating employees’ jobs. this system was used on the company’s blue-collar employees whose job requires manual labour. the company had 1403 employees. it operates a three-shift system. data collection the collection of data from the company that participated in the study was carried out in two phases. this involved the collection of preand post-360-degree performance appraisal results from company records for spoilage, absenteeism, capital investment and labour productivity. the pre-360-degree performance appraisal results were quarterly data reflecting the company’s performance over the three-year period prior to 360-degree performance appraisal implementation. this includes data from the first quarter of 2004 to the final quarter of 2006. the post-360-degree performance appraisal data reflect the company’s performance for three years after 360-degree performance appraisal was implemented. this includes data from the first quarter of 2007 to the final quarter of 2009. in the period between 2010 and 2016, the company was involved in labour restructuring. this emanated from the strategic changes that took place in the motor assembly plant of the company it is supplying. hence, the data from the restructuring period were excluded from the study. time series data and analysis the company’s quarterly time series data on absenteeism, labour productivity and spoilage rates were used. the measurements were based on a total of 24 observations. a dummy variable, which assumed the value of 0 and 1 to represent the preand post-360-degree performance appraisal periods, respectively, was introduced into the ordinary least squares (ols) model. the aim was to isolate the preand post-productivity effects. consequently, if the 360-degree performance appraisal proved to be a useful strategy in raising productivity levels, this would result in a statistically significant coefficient on the dummy variable. hence, the favourable results regarding the co-integrating tests enabled the study to engage in quantitative analysis involving ols in order to quantify the magnitude of the influence that the implementation of the 360-degree performance appraisal has had on labour productivity. co-integration provides evidence of a long-run relationship between variables (juselius 2006). study results the ols model used was as follows: labour productivity = bo + b1 spoilage + b2 absenteeism + b3 number of workers involved in production + b4 investment + b5 pre/post dummy the above model identifies labour productivity as a function of spoilage rate, absenteeism rate, the number of workers involved in production, investment and the 360-degree performance appraisal strategy. the investment variable is the labour productivity lagged by one period (that is, one quarter). this variable aims to capture previous machinery input and skills obtained by workers both through skills development programmes as well as learning through work experience. for the study to achieve its objective, the stationarity tests (as shown in table 1) were conducted in order to determine the status of the variables. table 1: augmented dickey fuller stationarity test results. the results show that the variables exhibit mixed orders of integration. this suggests that the data have no long-run relationships. in principle, they can wander arbitrarily far away from each other (juselius 2006). however, this section presents the results on the influence of labour productivity on other production-related variables. labour productivity results table 2 presents the results for labour productivity as a dependent variable to absenteeism and spoilage rates, the number of workers involved in production, as well as the post-360-degree performance appraisal dummy. table 2: labour productivity results relating to spoilage and absenteeism rates, number of workers involved in production, and post 360-degree dummy. labour productivity as a dependent variable to spoilage rate the results show that spoilage rate has a relationship and is statistically significant to labour productivity as shown by its t-value of 3.61, which is above the critical t-value of 2.06 at the 5% level of significance (curwin & slater 2002). however, the results must be viewed with caution. the co-integration results suggest that there is no long-run co-integrating relationship between the variables. labour productivity as a dependent variable to absenteeism rate results as illustrated in table 2 show that absenteeism rate has no relationship to labour productivity. this is determined by its t-value of 1.25. the value is below the critical t-value of 2.06 at the 5% level of significance, thus accepting the null hypothesis of no relationships between these two variables. labour productivity as a dependent variable to the number of workers involved in production variable the results show that the number of workers involved in production has no relationship to labour productivity. this is determined by its t-value of 1.73 which is below the critical t-value of 2.06 at the 5% level of significance. this result is confirmed by the co-integration test that shows the non-existence of long-run relationships. labour productivity as a dependent variable to a 360-degree performance appraisal dummy variable results show that a 360-degree performance appraisal system has no relationship to labour productivity. this is determined by its t-value of −0.03, which is below the critical t-value of 2.06 at the 5% level of significance, thus accepting the null hypothesis of a relationship between these two variables. it has an adjusted r² of 0.3. furthermore, the serial correlation is also low at 1.32 when compared to the standard value of 1.89 at the 5% level of significance (curwin & slater 2002). the results are consistent with the co-integration tests carried out in table 2, which asserts that the long-run relationships between the variables do not exist. labour productivity results with past capital investment data lagged by one quarter table 3 illustrates labour productivity data as a dependent variable to past capital investment (lagged by one quarter), spoilage rate, absenteeism rate, number of workers involved in production and dummy variables. table 3: labour productivity results with past capital investment (lagged by one quarter) for spoilage and absenteeism rates, number of workers involved in production, and post 360-degree dummy. labour productivity as a dependent variable to capital investment results in table 3 show that capital investment has a positive and statistically significant relationship with labour productivity. the accumulation of past capital investment (lagged by one quarter) plays a significant role in explaining current labour productivity increases. results are determined by its t-value of 2.33. the results must be viewed with caution. the co-integration results suggest that there is no long-run co-integrating relationship between the variables. however, the results are above the critical t-values of 2.06 at the 5% level of significance, thus accepting the assumption of a relationship between the two variables. positive relationship indicates that past capital investments increased labour productivity. labour productivity as a dependent variable to spoilage rate the results show that spoilage rate (one quarter after the company has invested capital) has a relationship and is statistically significant to labour productivity. this is shown by its t-value of 3.81, which is above the critical t-value of 2.06 at the 5% level of significance. the results must be viewed with caution. the co-integration results suggest that there is no long-run co-integrating relationship between the variables. labour productivity as a dependent variable to absenteeism rate results in table 3 shows that absenteeism rate (one quarter after the company has invested capital) has no relationship to labour productivity. this is determined by its t-value of 1.67. the result is below its critical t-value of 2.06 at the 5% level of significance, thus accepting the null hypothesis of no relationship between these two variables. labour productivity as a dependent variable to the number of workers involved in production results in table 3 show that the number of workers involved in production variable (one quarter after the company has invested capital) has no relationship to labour productivity. this is determined by its t-value of –0.38. the result is below the critical t-value of 2.06 at the 5% level of significance, thus accepting the null hypothesis of no relationship between the two variables. labour productivity as a dependent variable to a 360-degree performance appraisal dummy variable results show that the 360-degree performance appraisal system (one quarter after the company has invested capital) has no relationship to labour productivity. this is determined by its t-value of 1.43 which is below the critical t-value of 2.06 at the 5% level of significance, thus accepting the null hypothesis of no relationship between these two variables. discussion this study investigates the influence of the 360-degree performance appraisal system for the improvement of labour productivity in the automotive parts manufacturing sector in sa. it examined the production and related experiences of an automotive parts manufacturing company that has adopted a 360-degree performance appraisal. quarterly time series data on absenteeism, labour productivity, spoilage, number of workers involved in production and capital investment were used to analyse data. results indicate that absenteeism at 1.25, the number of employees involved in production at 1.73 as well as 360-degree performance appraisal at −0.03 have no relation to labour productivity. their t-values are below the critical t-value of 2.06 at 5% level of significance. however, it showed the relationship between the labour productivity variable and spoilage rate variable at 3.61. its t-value is above the critical t-value of 2.06 at 5% level of significance. according to suri (2016), an increase in labour productivity reduces direct material cost. the study also indicates that the implementation of 360-degree performance appraisal has an influence on spoilage rate. hence, kiger (2006) emphasised that the 360-degree feedback approach increases individual self-awareness and, as part of a strategic organisational process, reduces the rate of spoilage in production. these results are also supported by fourie (2008), who adds that the organisational effectiveness depends on the appropriate appraisal systems. however, the results should be viewed with caution since the co-integration results suggest that there are no long-run co-integrating relationships between the variables. the researcher also measured the influence of the 360-degree performance appraisal to labour productivity (one quarter after the company has invested capital). it revealed that capital investment at 2.33 has a positive relationship with labour productivity. its t-value is above the critical t-value of 2.06 at 5% level of significance. on the other hand, it shows that absenteeism at 1.67, the number of employees involved in production at –0.38 as well as 360-degree performance appraisal at 1.43 have no relation to labour productivity. their t-values are below the critical t-value of 2.06 at 5% level of significance. such results show that the companies use 360-degree performance appraisal for succession planning, training, and professional development (riboldi & maylette 2007). implications of results for policy and practice organisations in sa should revise their performance management system and develop appraisal strategies, policies and practices that help to achieve new business goals and support organisational and cultural change (smith 2007). this must be based on an understanding of the economic factors affecting appraisal and pay systems, the significance of the psychological contract and the practical implications of motivation theory as it affects the provision of both financial and non-financial rewards. besides the achievement of study objectives, the following conclusions can be made on the 360-degree performance appraisal: it is a desirable alternative as it has an influence on the spoilage rate. the system has an ability to influence labour productivity one quarter after the company has invested capital. in order to maximise performance, a comprehensive performance policy must be developed, which aligns employee appraisal to productivity (smith 2007). conclusion the 360-degree performance appraisal creates a working environment that encourages worker participation. it is an appropriate system for succession planning, training and professional development (riboldi & maylette 2007). hence, there was no relation between the 360-degree performance appraisal and labour productivity. the system is not a solution to inherent labour productivity problems. it is an approach that takes advantage of a focused organisational strategy to combine employee appraisal and participation. the system can be used for developing employee capital in the organisations. thus, the employees will have the capabilities to solve organisational problems (brewster et al. 2003). consequently, the 360-degree approach was able to reduce the spoilage rate in the organisation. study limitations the study was limited to an automotive parts manufacturing company within the ethekwini district municipality. it was conducted in a single company that has adopted the 360-degree performance appraisal. hence, the results cannot be extrapolated to other companies within the sector. secondly, it did not examine the process followed during the 360-degree implementation including (among others) the individuals that participated in the implementation process. it only used quarterly time series data to determine the preand post-labour productivity effects resulting from the use of the 360-degree performance appraisal. lastly, the econometrics model (developed by the researcher) was of the ols variety, solely due to data constraints. future studies ought to use the more advanced johansen var methodology or panel data analysis, both of which rely on large data sets. future research required during the course of this study, issues relating to the long-term survival of a 360-degree performance appraisal after implementation were not intensively covered. this includes the applicability of the 360-degree performance appraisal to a wider sector of the economic activity, including the public sector. the nature of this research did not allow these areas to be covered in depth. it is recommended that future research should examine the following issues in greater depth: when to use and when not to use a 360-degree performance appraisal system. the applicability of a 360-degree performance appraisal approach to other industrial sectors. the process followed during the implementation of a 360-degree performance appraisal system. a more comprehensive investigation should be carried out using a randomised sample of the registered automotive component manufacturers that use the 360-degree performance appraisal to see if the results can be generalised. acknowledgements competing interests the author declares that he has no financial or personal relationships that may have inappropriately influenced him in writing this article. references brewster, c., carey, l., dowling, p., globler, p. & wärnich, s., 2003, contemporary issues in human resource management: gaining a competitive advantage, oxford university press, cape town. bryman, a. & bell, e., 2007, business research methods, oxford press, oxford. business victoria, 2016, 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warr, p. & bourne, a., 2000, ‘associations between rating content and self-other agreement in multi-source feedback’, european journal of work and organizational psychology 9(3), 321–334. https://doi.org/10.1080/135943200417948 wright, a.d., 2008, ‘at google, it takes a village to hire an employee’, hr magazine 53(1), 56–57. yin, r.k., 2008, handbook of applied research: california, sage, thousand oaks, ca. sajems ns vol 7 (2004) no 1 75 period of internet usage: an indicator of the buying behaviour of internet users? ________________________________________________________________ p j du plessis, p g mostert and e j north department of marketing and communication management, university of pretoria ________________________________________________________________ abstract this article focuses on the experience of the internet user with regard to purchasing goods and services. a self-administered survey, hosted on a dedicated website, was used as a data collection method and 1005 responses were received. it was found that the period of internet usage significantly influenced the decision to purchase via the internet. another finding was that the period of internet usage significantly influenced whether those shopping on the internet searched for, or considered searching for, product and service information online prior to purchasing from non-internet-based sellers. jel l86 introduction the expanding role of the high-tech global environment, in which consumers live, resulted in a substantial interest in the impact of the internet on consumer buying behaviour. the internet is widely acknowledged as a powerful and important distribution channel for marketers as well as a source of consumers. according to schiffmann and kanuk (2004: 5), through this medium prospective buyers not only have more access to information, but also more power than ever before by shopping for goods around the globe and around the clock from the convenience of their homes. it is predicted that the internet will impact the decision-making process of the consumer regarding buying and also improve the efficiency of the buying process (richardson, 2001: 137 and reibstein, 2002: 466). the time and cost of searching for product information, evaluating alternatives and negotiating terms are being cut down. through this communication technology the internet consumers have convenient access to the products with the lowest prices and highest quality. sajems ns vol 7 (2004) no 1 76 this view is supported by smith (2002: 446), prabhaker (2000: 158-171) and sinha (2000: 44-45), who add that the advantages for the consumer include the availability of free information, easily obtainable from the internet. the search for information is reduced to a few effortless keystrokes, whereas collecting the same information traditionally would require considerably more time and effort. the internet also offers direct information on product features, the quality of products and reliability of different suppliers, which shortens the time searching for information considerably compared to the non-internet environment. prices can be compared in real time at various online price comparison sites; purchasing experiences by previous buyers are frequently also available. it is important for marketers to have a thorough understanding of the internet user, who purchases online or searches for product and service information online prior to purchasing from non-internet-based sellers. knowledge about consumer decision-making and buying behaviour and the way consumers choose products will ensure more focused strategies to purchase a marketer’s product as opposed to that of a competitor. markets can be served more effectively and profitably if internet marketers understand the underlying reasons for differences in consumer choices (phau & poon, 2000: 102). since online buying is a relatively new consumer activity, it is expected that experience as an internet user can influence buying behaviour. this article focuses on the experience of the internet user and specifically whether the period of internet usage significantly influences the internet user’s buying behaviour. attention will also be given to the actual purchases on the internet and the search for information via the internet and subsequent purchases offline. literature review the internet can most probably be viewed as an additional sales channel and information search medium (and information source) that consumers can consider when purchasing products and services. bickerton, bickerton and pardesi et al. (2000: 149) note that not all products and services are equally suited to be sold via the internet. greenbury, in maruca (1999: 160) supports this view by stating that people will increasingly want to shop on the internet for at least a certain range of products because of convenience. therefore, marketers are interested in understanding the relationship between a consumer’s choice of channel and the information search via the internet. sajems ns vol 7 (2004) no 1 77 e-retailing will continue to establish itself as an alternative channel, alongside traditional shopping (rowley, 2000: 20–35); buying certain items (apparel) online represents a new form of consumer behaviour (hoffman and novak, 1996). consumers can benefit from a much wider selection of products to choose from since they are not bound to a certain selection of merchandise options, as is the case with traditional channels. mcquitty and peterson (2000: 233-48) argue that online shoppers can seek virtually any product at any time and from any location. consumers who desire extraordinary value can find the best deals by knowing which websites offer a given product and at what price. this is very similar to traditional shopping, but the internet provides consumers with an extraordinary search power, where a large number of websites can be visited with ease − which is virtually impossible in the traditional shopping environment. therefore, from a consumer purchasing point of view, consumers have a choice between different outlets from which to purchase a product or service. phau and poon (2000: 102-13) explain that a number of factors influence the choice between a retail store and in-home shopping methods, such as mail order, telephone order and the internet. these influences include socio-economic and demographic factors, product type and distribution methods, perceived purchase risk, personal characteristics and traits as well as shopping or delivery time. other possible factors influencing the channel selection include confrontation and contact control, manufacturer or brand reputation, type and source of the offer and price and refund or exchange policies. phau and poon (2000: 102-13) suggest that when in-house shopping is extended to internet shopping malls, the listed factors will become more apparent. as indicated above, the internet may highlight factors influencing and affecting consumer decision-making. research regarding internet users emphasises these influences and supports the view that such influences need to be considered to understand consumer differences before attempting to draft strategies to sell products and services to consumers through the internet. research findings regarding the age, gender and education of internet users show the possible influence of these demographic variables on the purchasing behaviour of internet users. although trocchia and janda (2000: 605-16) mention a valid limiting factor associated with age, namely that older individuals often suffer from physical disabilities, older individuals could possibly represent an opportunity to internet marketers due to their higher levels of free time and discretionary income when compared to younger individuals. sajems ns vol 7 (2004) no 1 78 another factor to bear in mind is that internet users are predominantly male and are more likely to engage in downloading from and purchasing on the internet than females (teo, 2001: 125-37). in addition to age and gender, hanson (2000: 117) provides a valuable perspective on education by stating that, after income, it forms the most important demographic variable determining internet usage, since education enables users to operate and appreciate computers and the internet. the internet provides consumers with an additional source of information and sales channel. since the internet has grown and shown advantages for both sellers and consumers, a number of traditional offline retailers have decided to offer their products and services to their customers via the internet as an additional sales and information channel. nunes, wilson and kambil (2000: 20) explain that it is easy to see why traditional sellers are moving to the internet to offer more ways to buy from them. they recognise that the same buyer may prefer different transaction mechanisms under different circumstances. for example, a consumer may not care about flight ticket prices when travelling for business, but may seriously consider lower prices when planning a family vacation. nunes et al. (2000: 20) explain that by offering multiple transaction approaches, sellers could possibly win a larger share of existing consumers’ business and also gain new types of purchasers. gulati and garino (2000: 113) state that an established traditional retailer benefits from offering the web as an additional sales channel, since it offers the seller instant credibility on the web (provided that the brand is recognised and respected). the seller’s current customers will, therefore, provide nearly immediate traffic and revenue and new customers will know that the site is legitimate and fewer buyers will fear credit card fraud. traditional sellers using the internet as an alternative sales channel will most probably be forced to offer the same prices as in the physical store so as not to confuse their current customers or leave them distrustful. the extent of offering online purchases by traditional sellers would, therefore, most probably depend on the strengths of existing distribution and information systems and their transferability to the internet (gulati & garino, 2000: 113). from the above discussion it can be concluded that more traditional sellers are offering online purchasing to its current and potential new customers. ghosh (1998: 129) explains that the decision to offer consumers an internet sales channel could possibly be based on a driving force exerted by competitors or sajems ns vol 7 (2004) no 1 79 through consumer demand. it is therefore also important for traditional sellers to understand the needs of their customers to ensure that they offer alternative sales channels, for example the internet, when customers demand an alternative channel. few studies in south africa have been done to determine whether the experience of the internet user (the period of internet usage) significantly influences the internet user’s buying behaviour. specific hypotheses to address this issue have been formulated and will be discussed below. hypotheses the first hypothesis is concerned with the experience of the internet user and whether the period of internet usage has an influence on the decision to purchase on the internet. h1: the period of internet usage significantly influences the decision to purchase on the internet. the second hypothesis deals with the issue of search on the internet for product and service information by internet shoppers and non-shoppers before buying from non-internet-based sellers. h2: the period of internet usage significantly influences the decision of internet shoppers and non-shoppers to search for product and service information on the net prior to purchasing from non-internet-based sellers. method to achieve the objective set for the study, a pluralistic approach was followed by first using a qualitative research technique (pre-test group), followed by a quantitative technique (surveys). the objectives set as outcomes from the pretest group included, among others, testing the questionnaire to be used during the quantitative phase of the study and ensuring that all the possible reasons that could influence internet users when deciding to purchase via the internet, were covered in the questionnaire. a selection of internet users was required to complete a self-administered questionnaire during the second, quantitative, stage. sajems ns vol 7 (2004) no 1 80 stage 1 pre-test group a pre-test or focus group normally involves collecting data and the analysis and interpretation thereof through observing what people do or say. in this study, 94 internet users participated in the pre-test group. the most important findings, together with actions taken based on the findings, were: respondents indicated that they considered more aspects when deciding to purchase via the internet. based on their comments, the number of issues considered by shoppers when buying via the internet, increased from 17 to 24; and the issues were phrased as questions; questions that could have been misunderstood or misinterpreted were rephrased to provide commonly understood questions in the final questionnaire. stage 2 survey for the purpose of this study, it was decided to use a self-administered survey, hosted on a dedicated website, as data collection method. the website was designed in such a manner that respondents would automatically be directed to the next question applicable to them, based on their input to the questionnaire. the responses were captured in a database only after respondents had completed the entire questionnaire. sampling for the purpose of the study, probability sampling was used. after careful consideration of the different probability sampling methods (simple random, systematic, stratified and cluster sampling cooper and schindler, 2001: 190), and paying attention to the advantages and disadvantages of each method (with specific consideration of the and hypotheses formulated for the study), it was decided to use the stratified method of sampling. the reason why the hypotheses set for the study played such an important role in deciding which sampling method to use can be justified the length of time of a consumer being an internet user is of critical importance to the success of the study since the hypotheses centre around identifying possible relationships with the period of being an internet user. simple random sampling was used to draw 5 000 subscribers for each of four different periods (strata) specified from which the sample elements had to be chosen. the sample units were randomly selected, following a ratio between the number of internet users in each time period and the total number required for each period. sajems ns vol 7 (2004) no 1 81 an e-mail message was distributed to the selected 20 000 south african internet users, inviting them to participate in the study. the letter briefly described the purpose of the study and contained a link that would, if clicked on, route interested internet users directly to the website where the questionnaire was hosted. survey participants a total of 1 005 respondents (aged between 18 to 65) completed the questionnaire. of the 1 005 respondents, 543 (54 percent) indicated that they have purchased via the internet before while 462 (46 percent) indicated that they have never purchased online. internet shoppers comprised 415 (76 percent) male and 128 (24 percent) female respondents, while non-shoppers consisted of 288 (62 percent) male and 174 (38 percent) female respondents. analysis cronbach’s alpha, representing a measure of internal consistency reliability (malhotra, 1996: 305) with values ranging between 0 and equal to 1, with higher numbers indicating greater reliability, was computed to determine the reliability of the questionnaire used in the study. for exploratory research a cronbach alpha greater than 0.60 is desired, although values greater than 0.70 are preferred (bagozzi, 1994: 18). cronbach’s alpha computed for instrument items of this study is 0.891, indicating a relatively high internal consistency reliability. table 1 indicates the period of internet usage for respondents who participated in the study. a relatively large percentage (35 per cent) of the respondents have been using the internet for more than four years and the “less than one year” time period represents the least number of respondents (11 per cent). table 1 period of internet usage period of internet usage frequency (n=1005) percentage less than 1 year 113 11.24% 1 year to less than 2 years 133 13.23% 2 years to less than 3 years 205 20.40% 3 years to less than 4 years 198 19.70% 4 years or more 356 35.42% sajems ns vol 7 (2004) no 1 82 a cross-tabulation between the period of internet usage and whether or not respondents have purchased via the internet is presented in table 2. table 2 relationship between internet shoppers, non-internet shoppers and period of internet usage purchased via the internet period of internet usage yes no total less than 1 year 23 90 113 1 year to less than 2 years 50 83 133 2 years to less than 3 years 100 105 205 3 years to less than 4 years 112 86 198 4 years or more 258 98 356 total (frequency) 543 462 1,005 (percentage) 54.03% 45.97% 100% although observable differences can be noted when comparing whether or not respondents have purchased via the internet before when considering the different time periods, it is important to determine whether or not differences can be supported statistically. a chi-square test was used for significance testing and yielded a value of 117.60 with an exceedence probability of <0.0001. when applying the decision-rule, which states that an exceedence probability value of <0.05 is an indication of significance, it can be deduced that the two variables portrayed in table 2 are related. the study also determined if the length of internet usage could be considered an influence, when internet users search for product and service information on the internet prior to purchasing from non-internet-based sellers. table 3 depicts the responses of survey participants, showing that 86 percent of internet shoppers and almost 70 percent of non-shoppers search for or consider searching for information on the internet prior to purchasing from non-internet-based sellers. based on these findings and taking into account the hypotheses formulated for the study, chi-square tests were performed to determine if the period of internet usage was related to whether internet shoppers and non-shoppers searched for or considered searching for online product and service information prior to purchasing offline. sajems ns vol 7 (2004) no 1 83 table 3 online information search prior to purchasing offline non-internet shoppers current internet shoppers description frequency per cent frequency per cent search for or consider searching for product and service information on the internet prior to purchasing from non-internet-based sellers 322 69.70% 469 86.37% don’t search for and don’t consider searching for product and service information on the internet prior to purchasing from non-internet-based sellers 140 30.30% 74 13.63% the first cross-tabulation analysis is illustrated in table 4 and considers the period of internet usage and whether non-shoppers search for product and service information on the net prior to purchasing from non-internet-based sellers. table 4 relationship between period of internet usage and product and service information searched for online prior to offline purchases (non-internet shoppers) search or consider searching for product and service information online period of internet usage yes no total less than 1 year 46 44 90 1 year to less than 2 years 55 28 83 2 years to less than 3 years 77 29 106 3 years to less than 4 years 63 23 86 4 years or more 81 16 97 total (frequency) 322 140 462 (percentage) 69.70% 30.30% 100% sajems ns vol 7 (2004) no 1 84 from table 4 it can be deduced that a larger number of non-shoppers, across all time periods, either search for or consider searching for product and service information on the net prior to purchasing from non-internet-based sellers than non-shoppers who don’t search for information online. a second observation is that 83 percent (81/97) of non-shoppers who have been using the internet for four years and more search for product and service information online prior to purchasing offline. a chi-square test was performed for the summarised cross-tabulation shown in table 4 to determine if a relationship exists between the period of non-shoppers using the internet and searching for online product and service information prior to purchasing from non-internet-based sellers. the chi-square test yielded a value of 23.85 and an exceedence probability of <0.0001. it can be concluded that the period of internet usage and whether or not non-shoppers search for product and service information on the internet prior to purchasing offline are related. the same cross-tabulation procedure was repeated for respondents who have shopped via the internet before. the results from a summarised cross-tabulation analysis are shown in table 5. table 5 relationship between period of internet usage and product and service information searched for online prior to offline purchases (internet shoppers) search or consider searching for product and service information online period of internet usage yes no total less than 1 year 16 7 23 1 year to less than 2 years 42 8 50 2 years to less than 3 years 83 17 100 3 years to less than 4 years 94 18 112 4 years or more 234 24 258 total (frequency) 469 74 543 (percentage) 86.37% 13.63% 100% they confirm that larger numbers of current internet shoppers, across all time periods, either search for or consider searching for product and service sajems ns vol 7 (2004) no 1 85 information on the net prior to purchasing from non-internet-based sellers than current shoppers who don’t search for online information. it can also be deduced that almost 91 percent (234/258) of respondents who have purchased via the internet and have been using the net for four years and more, search for product and service information online prior to purchasing offline. the chi-square test for significance performed for the summarised crosstabulation analysis depicted in table 5 produced a value of 11.39 and a resulting exceedence probability of <0.0225. it can therefore be concluded that the period of internet usage and whether or not internet shoppers search for or consider searching for product and service information online prior to purchasing offline are related. discussion and implications hypothesis 1 stated that the period of internet usage significantly influenced the decision to purchase via the internet. based on the results of the chi-square test for significance, this hypothesis can be accepted. it is suggested that marketers focus their attention on internet users who have been using the internet for at least a number of years. marketers also need to consider methods to stimulate internet service uptake, since greater success would probably only be achieved from a medium to long-term investment. hypothesis 2 concerns the influence of the period of internet usage on the decision of internet shoppers and non-shoppers to search for product and service information on the net prior to purchasing from non-internet-based sellers. two chi-square analyses were performed: from the first analysis, it could be concluded that the period of internet usage significantly influences whether or not non-shoppers search for product and service information on the internet prior to purchasing from non-internet-based sellers. the conclusion that can be drawn from the second chi-square analysis is that the period of internet usage significantly influences the decision of internet shoppers to search for or consider searching for product and service information online prior to purchasing from non-internet-based sellers. from these findings it can be concluded that the internet users utilise the internet as a powerful information source to search for product and service information prior to purchasing from non-internet-based sellers of products and services. hypothesis 2 can therefore be accepted. sajems ns vol 7 (2004) no 1 86 it is suggested that marketers should know and understand the importance of providing online product and service information (internet users may, after searching online, purchase at a “brick-and-mortar” seller). marketers have to seriously consider providing online information on the products or services they sell, even if they don’t sell via the internet. marketers should, however, first determine whether or not internet users search for (and more importantly consider searching for) information on the products or services they offer. future research future studies can be directed to the following areas: the possible differences in behaviour between male and female internet users with regard to the period of internet usage and buying behaviour the influence of ethnic orientation on internet usage and internet shopping the relationship of demographic variables of internet shoppers and the type of products and services purchased via the internet. conclusion it is predicted that the internet will have a great impact on the decision-making process of consumers regarding purchasing goods and services. for marketers to be successful on the internet, they have to understand the internet consumer and more specifically his/her decision-making process. knowledge obtained about the way consumers choose products will ensure more focused strategies to influence a consumer to purchase a specific marketer’s product as opposed to that of a competitor. from this study it can be concluded that marketers who consider competing in the internet environment need to pay special attention to the period of internet usage of their target market in formulating strategies to pursue the internet user. however, marketers are at risk of not being able to sustain their internet business when the success thereof can be related to the experience of the internet user. references 1 bagozzi, r.p. (1994) principles of marketing research, blackwell publishers: massachusetts. sajems ns vol 7 (2004) no 1 87 2 bickerton, p., bickerton, m. & pardesi, u. (2000) cyber marketing: how to use the internet to market your goods and services, butterworth heinemann: oxford. 3 cooper, d.r. & schindler, p.s. (2001) business research methods (7th ed.) mcgraw-hill irwin: boston. 4 ghosh, s. (1998) “making business sense of the internet”, harvard business review, march/april. 5 greenbury, r. in maruca, r.f. (1999) “retailing: confronting the challenges that face brick-and-mortar stores”, harvard business review, july–august. 6 gulati, r. & garino, j. (2000) “get the right mix of bricks & clicks”, harvard business review, may/june. 7 hanson, w. (2000) principles of internet marketing, south-western college publishing: cincinnati. 8 hoffman, d.l. & novak, t.p. (1996) “marketing in hypermedia computer-mediated environments: conceptual foundations”, journal of marketing, 60(3): 153-61. 9 malhotra, n.k. (1996) marketing research: an applied orientation (2nd ed.) prentice hall: new jersey. 10 mcquitty, s. & peterson, r.t. (2000) “selling home entertainment on the internet: an overview of a dynamic marketplace”, journal of consumer marketing, 17(3). 11 nunes, p., wilson, d. & kambil, a. (2000) “the all-in-one market”, harvard business review, may/june. 12 phau, i. & poon, s.m. (2000) “factors influencing the types of products and services purchased over the internet”, internet research: electronic networking applications and policy, 10(2). 13 prabhaker, p.r. (2000) “who owns the online consumer?”, journal of consumer marketing, 17(2). 14 reibstein, d.j. (2002) “what attracts customers to online stores, and what keeps them coming back?”, journal of the academy of marketing science, 30(4). 15 richardson, p. (2001) internet marketing: readings and online resources, mcgraw-hill/irwin: new york. 16 rowley, j. (2000) “product search in e-shopping: a review and research propositions”. journal of consumer marketing: 17(1). 17 schiffman, l.g. & kanuk, (2004) consumer behavior, pearson prentice hall: new jersey. 18 sinha, i. (2000) “cost transparency: the net’s real threat to prices and brands”, harvard business review, march/april. 19 smith, m.d. (2002) “the impact of shopbots on electronic markets”, journal of the academy of marketing science, 30(4). sajems ns vol 7 (2004) no 1 88 20 teo, t.s.h. (2001) “demographics and motivation variables associated with internet usage activities”, internet research: electronic networking applications and policy: 11(2). 21 trocchia, p.j. & janda, s. (2000) “a phenomenological investigation of internet usage among older individuals”, journal of consumer marketing, 17(7). abstract introduction problem statement, research objective and question significance of the study the concept of competencies research methodology results discussion conclusion ethical consideration acknowledgements references about the author(s) msizi v. mkhize college of law and management studies, school of accounting, economics and finance, university of kwazulu-natal, south africa citation mkhize, m.v., 2017, ‘accounting firms’ managers’ and trainees’ perceptions of managerial competencies required to manage diversity in kwazulu-natal, south africa’, south african journal of economic and management sciences 20(1), a1436. https://doi.org/10.4102/sajems.v20i1.1436 original research accounting firms’ managers’ and trainees’ perceptions of managerial competencies required to manage diversity in kwazulu-natal, south africa msizi v. mkhize received: 14 july 2015; accepted: 28 june 2017; published: 27 oct. 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: in south africa, there is a shortage of black chartered accountants, with some progress being made in transforming the industry. accounting firms’ managers must be prepared to effectively manage the increasing diversity of the profession. aim: the purpose of the study was to identify the managerial competencies required by accounting firms managers to effectively manage diversity in kwazulu-natal. setting: the setting for this study is accounting firms in kwazulu-natal. methods: a prospective, descriptive and analytical, cross-sectional design using systematic sampling was employed. the responses of 45 accounting firms’ managers and 114 trainees were analysed. results: both managers and trainees perceived the six managerial competencies important in managing diversity, but the ranking order of perceived importance indicated that there are variations in ratings. teamwork and self-management competencies were highly rated by managers, while communication and teamwork competencies were highly rated by trainees. conclusion: the managerial competencies are vital for the accounting firms’ managers. the study suggests that the accounting firms’ managers should consider the importance given by trainees and by themselves in prioritising the most important competencies they require in managing diversity. accounting firms are encouraged to incorporate the six managerial competencies into the job descriptions or job advertisements and in the firms’ management development programme or training and development programme as the managerial competencies will assist managers in managing the diverse workforce effectively. introduction in south africa, there is only one accounting body, that is, the south african institute of chartered accountants (saica) that manages the designation chartered accountant (south africa) – ca(sa). to become a ca(sa), one must complete university studies (bachelor’s degree in accounting and certificate in theory of accounting), a training contract, qualifying examinations (part i and part ii) and register with saica in order to use the designation ca(sa). chartered accountants work in the public sector, private sector and in government. the official saica statistics indicate that, in the apartheid era in south africa, white people dominated the accounting industry, almost exclusively constituting the profession (table 1). the under-representation of black cas in the profession is a direct result of race-based exclusion in the profession prior to democracy (khumalo 2009). in the post-apartheid era, the accountancy profession in south africa is becoming more diverse, with previously disadvantaged races now having access to the prestigious chartered accountancy (ca) career. while the elimination of discrimination and the provision of equal opportunities are essential steps forward in the social and economic progress of nations, strong opposition to discriminatory practices in south africa has only become evident in the recent past, the last two decades (hammond, clayton & arnold 2008; perumal 1994). table 1: new admissions to the south african institute of chartered accountants by decade. increasing the number of black accountants and auditors is a national imperative, which all stakeholders are working to address. the efforts to balance the scales of race and gender have started to bear fruit. the number of black candidates taking the ca qualifying examinations has increased dramatically in the recent past, and the pass rate of black candidates in the professional qualifying examinations increased from 41% in 2007 to 73% in 2008 (mulder 2009). therefore, accounting firms’ managers must be prepared to effectively manage the increasing diversity of the profession. saica membership statistics as at 30 june 2015, showed 39 128 registered chartered accountants (figure 1). figure 1: demographics of south african institute of chartered accountants membership as at 30 june 2015. problem statement, research objective and question in the diverse and competitive south african environment, previously excluded racial groups in the ca profession appear to be riding the wave of exclusion. south africa has a shortage of black chartered accountants. this situation has arisen because of a combination of political, socio-economic and related educational reasons during the four decades of apartheid rule. in recent years, numerous academic ventures have commenced in an attempt to increase the number of black chartered accountants (weil & wegner 1997). the accountancy profession developed a ca charter complying with the broad-based black economic empowerment act with the aim of increasing the number of black people in the ca profession to more closely reflect the country’s population demographics. these efforts are beginning to translate into a more diverse ca workforce, albeit very slowly and multiculturalism and multilingualism is noted among staff. the goals of accounting firms will not be achieved if these personnel are not effectively managed. the transformation of accountancy profession put strain on accounting firm managers. therefore, managers in accounting firms need to be skilled in managerial competencies rooted in general management to be effective in their job and managing diverse workforce because this will result in improved productivity, reduced absenteeism, decreased staff turnover and increased employee job satisfaction (swanepoel 2000). managers in the accounting firms are appointed to their positions without formal qualifications in management or training in diversity management. the purpose of the study was to identify the accounting firms’ managers’ and trainees’ perceptions of managerial competencies required to effectively manage diversity in the accountancy profession, against the background of the changing demographic profile of the profession. the main research question was: what are the accounting firms’ managers’ and trainees’ perceptions of managerial competencies required to effectively manage diversity in kwazulu-natal? significance of the study the findings will provide valuable insights for the accounting firms’ managers and the ca profession. the concept of competencies there are two approaches to competencies, the us competency approach and the uk competency approach: the united states competency approach (also called worker-oriented approach) the concept of competency has been developed by david mcclelland and the mcber & company – headed by richard boyatzis, in the early 1970s, initiated by the american management association (ama). ama envisaged that the research would lead to a programme for the development of superior managers and reveal what makes managers competent and design a programme where managers could learn these competencies (hafferman & flood 2000; wu & lee 2005). mcclelland’s research set out to identify those variables that – unlike intelligence testing or other measures – successfully predicted job performance or success in life. he found what he termed ‘competencies’ that can be shown to predict effective or superior performance in a job. he also found that by evaluating people for competencies it would be possible to predict their performance. boyatzis built on mcclelland’s research and investigated which characteristics of managers are related to effective performance (hafferman & flood 2000). wu and lee (2005) remark that competencies provide significant help with key problems, such as clarifying workforce standards and expectations as well as aligning individuals with the organisation’s business strategies. competency is broadly defined as an underlying characteristic of an employee. it could be a ‘motive, trait, skill, aspect of one’s self-image or social role, or a body of knowledge which he or she uses to complete the tasks or job successfully’ (hafferman & flood 2000; mbokazi, visser & fourie 2004). this view is supported by hellriegel, jackson and slocum (2005); hellriegel et al. (2007, 2014), who define competency as a combination of knowledge, skills, attitudes and behaviours and other characteristics that contribute to employee effectiveness. the united kingdom competency approach (also called work-oriented approach) the uk’s management charter initiative (mci) emerged in 1988 to improve the performance of uk organisations by enhancing the quality of their managers (siu 1998). the uk competency approach placed emphasis on the behavioural aspect of a competency by defining it as a set of behaviour patterns the employee needs to bring to a position in order to perform its tasks and functions with competence (mbokazi et al. 2004). the uk competency approach suggests not only skills and knowledge but also the range of qualities of personal effectiveness required to get a job done (hafferman & flood 2000). through extensive research work with the employers and managers of large and small organisations within the industrial, public and industrial sectors, mci identified standards of performance expected by employers of competent managers at different levels (senior, middle, first line and supervisory). the national vocational qualifications (nvqs) became the first nationally agreed statement of what effective management performance is and the levels of performance that employers expect. these nvqs have potential applications in a number of areas (siu 1998): identify competencies that a manager already acquired, identify training and development needs, design learning approaches, measure abilities against national standards, select and recruit managers, appraise managers’ performance and decide promotion requirements. meyer and semark (1996) provide a useful case both for and against the mci approach in which they highlight the need for a flexible, holistic and situation-specific approach to management competency. one of the basic criticisms of the work-oriented approach is that a list of work activities does not sufficiently indicate the attributes required to accomplish those activities efficiently (schoonover et al. 2000). for the purposes of this paper, the us competency approach applies because it focuses on the individual to determine whether they possess the skills and knowledge to perform a specific job or role (garavan & mcguire 2001). competency model the competency model is a set of competencies, namely, success factors that include the key behaviours required for excellent performance in a particular role. the competency model can be used to identify the competencies which employees need to improve performance in their current job or to prepare for the jobs (wu & lee 2005). developing and training of management on key competencies have become the focus of much attention during the past two decades (mbokazi et al. 2004). several surveys report that numerous modern enterprises are progressively adopting competency models as essential management technologies to enhance their competitiveness (wu & lee 2005). mbokazi et al. (2004) found that managers need competencies for managing themselves, competencies to manage other people and competencies to manage the task. lewis (2009) placed emphasis on the responsibility of the manager to, firstly, set objectives, plan, take decisions and organise work in the organisation and to, secondly, motivate, measure, control and develop other people. managerial competency model by hellriegel et al. (2005) applies to the study because it covers many managerial competency dimensions (see figure 2). managerial competences are sets of knowledge, skills, behaviour and attitudes that a person needs to be effective in a wide range of managerial jobs and various types of organisations (hellriegel et al. 2005, 2007, 2014). figure 2: managerial competencies model graphic display. managerial competencies the managerial competencies dimensions are discussed below. communication competency communication competency refers to the effective transmission of information from one person to another (ferreira 2006). managers are required to promote understanding between themselves and the diverse workforce through proper communication (steyn & steyn 2006; steyn, de klerk & steyn 2006). it is estimated that an average person spends four-fifths of his or her working life communicating (steyn 2006). communicating with a lot of managers does not mean that they are effective and efficient. a manager is an efficient communicator if he or she can transmit a message accurately in the least time. a manager is an effective communicator if a message is accurately understood by the other person (kinicki & williams 2006). according to a study conducted by greybe and uys (2001), communication abilities are essential in diversity adaptation. the success or failure of management’s strategies on diversity will largely depend on clear and unambiguous communication. the study conducted by tannen (1995) on the power of talk reveals that the managers who understand the dynamics of linguistic style can develop more adaptive and flexible approaches to running or participating in meetings, mentoring or advancing the careers of others and evaluating performance. hellriegel et al. (2007, 2014) state that communication competency is the ability to effectively transfer and exchange information that leads to understanding between managers and others in the firm. they further state that managing involves getting work done through other people (employees). communication competency is essential to effective managerial performance and includes the following: informal communication, formal communication and negotiation. planning and administration competency planning and administration competency involves deciding what tasks need to be done, determining how they can be done, allocating resources to enable them to be done and monitoring progress to ensure that they are done (hellriegel et al. 2007, 2014). steyn and steyn (2006) assert that managers are required to plan properly in order to effectively and efficiently achieve organisational goals and objectives. they further state that planning and administration competency comes to mind first when people think about managers and managing. according to hellriegel et al. (2007, 2014), planning and administration competency includes the following dimensions: information gathering, analysis and problem solving; planning and organising projects; time management; budgeting and financial management. teamwork competency teamwork competency refers to accomplishing tasks through small groups of people who are collectively responsible and whose work is interdependent. managers in companies that utilise teams can become more effective by: designing teams, creating a supportive environment, managing team dynamics (hellriegel et al. 2007, 2014; slocum, jackson & hellriegel 2008). robbins (2001) asserts that the evidence suggests that teams typically outperform individuals when the tasks being done require multiple skills, judgement and experience. as organisations have structured themselves to compete more effectively and efficiently, they have turned to teams as a way to better utilise employee talents. in south africa, with the cultural diversity, it is highly likely that workforce and work teams will be diverse. managers are encouraged to manage diversity in their organisations and provide diversity training and education programmes for team members (swanepoel 2000). strategic action competency strategic action competency refers to understanding the overall mission and values of the organisation and ensuring that one’s actions and those of people one manages are aligned with them. strategic action competency includes the following dimensions: understanding the industry, understanding the organisation and taking strategic actions. managers and other employees who understand the industry can accurately anticipate strategic trends and prepare for the future needs of the organisation, and they are less likely to find themselves looking for new jobs when the organisation changes direction (hellriegel et al. 2007, 2014). global awareness competency since 1994, sanctions and restrictive import and export regulations have been lifted, and south africa has become part of the global village. south african organisations are forming joint ventures with foreign partners (swanepoel 2000). global awareness competency refers to a manager’s ability to draw on the human, financial, information and material resources from multiple countries and serving markets that span multiple cultures. this competency has the following dimensions: cultural knowledge and understanding, cultural openness and sensitivity (hellriegel et al. 2007, 2014). since 1994, sanctions and restrictive import and export regulations have been lifted, and south africa has become part of the global village. south african organisations are forming joint ventures with foreign partners (swanepoel 2000). globalisation affects a manager’s people skills in at least two ways: (1) managers are increasingly likely to find themselves in a foreign assignment where they will manage a workforce that is different in needs, aspirations and attitudes; and (2) even in their own country, managers will find themselves with bosses, peers and other employees who were born and raised in different cultures. he asserts that to work effectively with these people, one has to understand their culture, how it has shaped them and how to adapt one’s management style to their differences (robbins 2001). northcliff melville times (29 october 1999), cited by swanepoel (2000), states that in few places in the world can one find such a diverse workforce as in south africa. our organisations are heterogeneous in terms of gender, age, race and ethnicity (11 official languages!). in addition, south africa has an influx of asian workers, as well as workers from neighbouring and other african countries. in johannesburg, the linden police station needs linguists fluent in chinese, portuguese, french and other languages to assist them. self-management competency self-management competency refers to taking responsibility for one’s life at work and beyond. self-management competency includes the following dimensions: integrity and ethical conduct, personal drive and resilience, balancing work and life issues, self-awareness and development (hellriegel et al., 2007, 2014). williams (2007) asserts that self-management (also known as self-control) is a control system in which managers and workers control their own behaviour by setting their own goals, monitoring their own progress and rewarding themselves for goal achievement. research conducted by penceliah (2003) affirms that self-management will make tomorrow’s leaders more adaptable and will give managers the flexibility to work across cultures and the flexibility to deal with uncertainty, ambiguity and change. this brief review of the literature indicates that the managerial competencies determine the effectiveness of managers in their job performance. therefore, it is essential for managers to have a thorough understanding of the six managerial competencies discussed above. it is essential for managers to continuously develop their managerial competencies because the challenges they are facing on the job are constantly changing. research methodology study design and sampling the research approach followed was quantitative in nature. a prospective, descriptive and analytical, cross-sectional design using systematic sampling was employed. systematic sampling involves selecting subjects from a population list in a systematic rather than a random fashion (steyn & steyn 2003). in this paper, the manager population can be explained as the total number of managers employed in accounting firms in kwazulu-natal. the trainee accountant population can be explained as the total number of trainee accountants employed in the accounting firms in kwazulu-natal. the saica provided the researcher with a list of managers and trainee accountants in accounting firms in kwazulu-natal and respondents were accordingly drawn using systematic sampling. this paper presents the results of the responses for 45 managers and 114 trainees. measuring instruments two parallel-worded versions of the questionnaires were used to collect data for accounting firm managers and trainees. questionnaires consisted of a demographic section and managerial competencies section. managerial competencies were measured using 3-point likert scale, ranging from 1 = disagree, 2 = neutral and 3 = agree. the questionnaire was pre-tested on a focus group of chartered accountants, saica eastern region council. a pilot study is conducted to detect weaknesses in the design of the research instrument and also to provide the researcher with sound basis for determining and refining the sample (strydom, du toit & gerber-nel 2002). the cronbach’s alpha was computed for both managers and trainees to determine reliability. reliability analysis tests were performed to establish the statistical validity of the overall results (table 2). table 2: cronbach’s alpha. statistical analysis all statistical analysis were two-sided and used spss version 15.0 (spss inc., chicago, illinois, usa). for all statistical comparisons, the 5% significance level was used. pearson’s two-sample chi-square tests were used to compare between managers and trainees for categorical nominal and ordinal variables. results the results obtained from the statistical analysis of the data are presented in various tables in the next section. demographic profile of respondents the information on the demographic profile of managers and trainees was collected to present their profiles and to provide a basis for analysis of the important aspects. table 3 depicts the demographic profile of managers and trainees. table 3: demographic profile of respondents. of the 45 managers surveyed, 38 (84.4%) were men, with 40 (90.9%) of managers between the ages of 30 and 60 years. white managers constituted 45.5% of all managers, indian managers constituted 45.5%, while african managers constituted 9.1%. of the 114 trainees surveyed, 54 (47.4%) were men, with majority trainees between the ages of 21 and 30 years. white and indian trainees comprised 44.7% of all trainees, african trainees comprised 51.8% and mixed-race trainees comprised 3.5% (table 3). several independent group t-tests were performed to test for significant differences between managers and trainees. respondents’ response on managerial competencies needed to manage diversity in the accounting firms the respondents were requested to indicate under each managerial competency the managerial tasks that they believe managers need to effectively manage diversity in the accounting firm (tables 4–9). table 4: results for communication. table 5: results for planning and administration. table 6: results for teamwork. table 7: results for strategic action. table 8: result for global awareness. table 9: results for self-management. communication as a managerial competency below are the perceptions of managers and trainees on management tasks under communication competency required by accounting firms’ managers in managing diverse workforce (table 4). significant differences between responses of managers and trainees were found in four managerial tasks under communication competency: manager informs people of relevant events and activities and keeps them up to date (p < 0.050); manager makes persuasive, high-impact public presentations and handles questions well (p < 0.050); writes clearly, concisely and effectively, using a variety of computer-based resources (p < 0.050); and manager negotiates effectively on behalf of a team over roles and resources (p < 0.050). no further significant differences were found among the two groups for the remaining managerial tasks under communication competency. planning and administration as a managerial competency below are the perceptions of managers and trainees on management tasks under planning and administration competency required by accounting firms’ managers in managing diverse workforce (table 5). significant differences between responses of managers and trainees were found in three managerial tasks under planning and administration competency: manager monitors and keeps to a schedule or changes schedule if needed (p < 0.050); manager understands budgets, cash flows, financial reports and annual reports and manager regularly uses such information to make decisions (p < 0.050) and manager creates budgetary guidelines for others and works within the guidelines given to others (p < 0.050). this finding means that the managers and trainees have different perceptions towards these management tasks. no further significant differences were found among the two groups for the remaining managerial tasks under the planning and administration competency. teamwork as a managerial competency below are the perceptions of managers and trainees on management tasks (under teamwork competency) required by accounting firms’ managers in managing diverse workforce (table 6). significant differences between responses of managers and trainees were found in one managerial task under teamwork competency: manager appropriately staffs the team, taking into account the value of diverse ideas and technical skills needed (p < 0.050). no further significant differences were found among the two groups for the remaining managerial tasks under teamwork competency. strategic action as a managerial competency below are the perceptions of managers and trainees on management tasks (under strategic action competency) required by accounting firms’ managers in managing a diverse workforce (table 7). a significant difference between responses of managers and trainees was found in one managerial task under strategic action competency: manager understands the concerns of stakeholders (p < 0.050). no further significant differences were found among the two groups for the remaining managerial tasks under strategic action competency. global awareness as a managerial competency below are the perceptions of managers and trainees on management tasks under global action competency required by accounting firms’ managers in managing diverse workforce (table 8). a significant difference between responses of managers and trainees was found in one managerial task under strategic action competency: manager understands, reads and speaks more than one language fluently (p < 0.050). no further significant differences were found among the two groups for the managerial tasks under global awareness competency (p > 0.050). self-management as a managerial competency below are the perceptions of managers and trainees on management tasks under self-management competency required by accounting firms’ managers in managing diverse workforce (table 9). no significant differences were found among the two groups for the managerial tasks under self-management competency (p > 0.050). comparison of the six managerial competencies by rank and gender comparison of the six managerial competencies between managers and trainees table 10 reflects comparisons between managers and trainees using mann–whitney test. table 10: comparison of the six managerial competencies between managers and trainees using the mann–whitney test. table 10 shows no significant differences between managers and trainees at the 95% level (p > 0.05). managers rated higher teamwork competency while trainees rated higher communication competency. global awareness competency was rated lower by both managers and trainees. comparison of the six managerial competencies between men and women table 11 reflects the comparisons of the managerial competencies between men and women using mann–whitney test. table 11: comparison of the six managerial competencies by gender using the mann–whitney test. table 11 shows no significant differences between men and women at the 95% level (p > 0.05). men rated higher teamwork competency while women rated higher communication competency. global awareness competency was rated lower by both men and women. discussion in all managerial tasks under the communication competency, the majority of managers and trainees indicated they agree that the tasks are required to manage diversity. however, significant differences were found between managers and trainees regarding managers informing people of relevant events and activities and keeping them up to date (p < 0.05) and making persuasive, high-impact public presentations and handling questions well. these findings disagree with the finding that managers build strong interpersonal relationships with other people. from the diversity results, both managers and trainees agreed that managers must encourage social gathering of diverse employees in their accounting firms. these gatherings will assist them in improving their soft skills. a significant difference was found regarding managers who write clearly, concisely and effectively, using a variety of computer-based resources (p < 0.05). this finding indicates that managers prefer interpersonal communication. however, managers need to improve in communicating through the use of audio-visual resources. managers need to also negotiate on behalf of their teams over roles and resources (p < 0.05). this finding is supported by greybe and uys (2001) and tannen (1995). in almost all managerial tasks under the planning and administration competency, the majority of managers and trainees agreed that the tasks are required to manage diversity. however, significant differences were found in three tasks: managers monitor and keep a schedule or changes schedule if needed (p < 0.05); understand budgets, cash flows, financial reports, annual reports and regularly uses such information to make decisions (p < 0.05); and create budgetary guidelines for others and works within the guidelines given by others (p < 0.05). managers need to accommodate diversity in their schedules and budget for diversity. no significant differences were found in almost all the managerial tasks under teamwork competency, except in one task. a significant difference was found between managers and trainees regarding managers appropriately staffing the team, taking into account the value of diverse ideas and technical skills needed (p < 0.050). no significant differences were found in almost all the managerial tasks under strategic action competency, except in one task, that is, managers must understand the concerns of stakeholders (p < 0.05). this finding contradicts with the finding that managers stay informed of the actions of competitors and strategic partners. managers must understand the concerns of all stakeholders, competitors and strategic partners. a significant difference was found in one of the managerial tasks under the global awareness competency. some trainees (13.2%) disagreed while 13.8% were neutral that their managers understand, read and speak more than one language fluently (p < 0.05). managers have to improve their linguistic skills so that they can communicate with people from different language backgrounds. a diversity committee or forum should organise workshops where the second language in the province will be taught. top management should financially support this initiative. no significant differences were found in managerial tasks under the self-management competencies. both managers and trainees unanimously agreed that the managerial tasks are important. this finding is supported by penceliah (2003). both managers and trainees perceived the six managerial competencies (communication, planning and administration, strategic action, teamwork, global awareness and self-management) important in managing diversity, but the ranking order of perceived importance indicated that there are variances in ratings. trainees rated communication and teamwork as the most competencies, while managers rated teamwork and self-management as the most important competencies. trainees rated planning and administration and self-management as the middle important competencies, while managers rated strategic action and communication as the middle important competencies. trainees rated strategic action and global awareness as the least important competencies, while managers rated planning and administration and global awareness as the least important. global awareness competency was rated lower by both groups. in terms of the gender comparison, it is interesting to note that the perceived importance given by men (women) is almost identical to the ratings of the six managerial competencies given by managers (trainees). this finding tallies with hellriegel et al. (2005, 2007), slocum et al. (2008) and steyn, de beer and steyn (2005) who found that senior managers are not just talented in teamwork, but they have strengths across the board. they encourage managers to know all the managerial competencies rooted in general management theory. the accounting firm managers should consider the importance given by trainees and by themselves on the six managerial competencies in prioritising the most important competencies they require in managing diversity. for managers to be effective in managing the diverse work environment, hellriegel et al. (2005, 2007), mbokazi et al. (2004), slocum et al. (2008) and steyn and steyn (2006) suggest that they must have knowledge of the six managerial competencies and must develop the competencies through study, training and experience. they further stress that if one develops oneself in managerial competencies, one prepares oneself for a variety of jobs in various industries and countries. conclusion the variations in ratings were found on how managers and trainees perceive the importance of managerial competencies required in managing a diverse workforce in the accounting firms, but all the variations were positive. both managers and trainees perceive all managerial competencies important. this finding calls for the accountancy profession to recognise the managerial competencies because these competencies will assist managers in managing diverse workforce and at the same time the managers will improve their job performance, which will result in improvement in the retention rate of managers, especially black managers. the accounting firms must also incorporate the six managerial competencies into the job descriptions or job advertisements and in their management development programmes. a democratic south africa demands a more diverse professional workforce and that serious efforts are made to improve the under-representation of previously excluded groups, with a coupled demand to effectively and sensitively manage the increasing diversity of the profession. recommendations it is recommended that managers increase their level of awareness on the six managerial competencies. the accounting firms are encouraged to include the six managerial competencies in the firm’s management development programme or training and development, as the managerial competencies will assist managers in managing the diverse workforce effectively. the older and white managers are also strongly encouraged to partake in the managerial competencies development programme so that they will respond appropriately to the increasing diversity of the workforce. ethical consideration ethical clearance was obtained from the human research ethics committee of the university of kwazulu-natal. participation was voluntary and anonymity of the respondents was protected in the gathering of the data and presentation of the findings. the university of kwazulu-natal ethical clearance approval number: hss/0046/09m. acknowledgements the study was funded by the south african institute of chartered accountants (saica). competing interests the author declares that he has no financial or personal relationship(s) that may have inappropriately influenced him in writing this article. references ferreira, g.m., 2006, ‘communication in the labour relationship’, politeia 25, 273–286. garavan, t. & mcguire, d., 2001, ‘competencies & workplace learning: some reflections on the rhetoric & the reality’, journal of workplace learning 13(4), 144–164. https://doi.org/10.1108/13665620110391097 greybe, l. & uys, f.m., 2001, ‘strategies for diversity management’, 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development methodology findings discussion of the findings conclusion acknowledgements references about the author(s) melodi botha department of business management, university of pretoria, pretoria, south africa amorie taljaard department of business management, university of pretoria, pretoria, south africa citation botha, m. & taljaard, a., 2019, ‘the bidirectional relationship between entrepreneurial intention and entrepreneurial competencies for nascent and existing entrepreneurs’, south african journal of economic and management sciences 22(1), a2230. https://doi.org/10.4102/sajems.v22i1.2230 original research the bidirectional relationship between entrepreneurial intention and entrepreneurial competencies for nascent and existing entrepreneurs melodi botha, amorie taljaard received: 29 nov. 2017; accepted: 06 mar. 2019; published: 29 may 2019 copyright: © 2019. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: although many scholars focus their research efforts on predicting entrepreneurial intention, these scholars have not determined the bidirectional relationship between entrepreneurial intention and competencies. aim: this article investigates whether entrepreneurial intention and various individual entrepreneurial competencies influence each other. the human agency and social cognitive theories suggest that these constructs have bidirectional relationships. furthermore, the direction and strength of these relationships are established. setting: results from a sample of 342 nascent and existing entrepreneurs from south africa are drawn. method: a quantitative research study is undertaken and structural equation modelling conducted. as far as could be determined, this study is the first to test the model fit between entrepreneurial intention and the individual entrepreneurial competencies in one model. results: the findings provide evidence of a bidirectional relationship between entrepreneurial intention and various entrepreneurial competencies, and the outcome thereof might lead to an increased business start-up. the strongest positive relationships were observed between entrepreneurial intention and self-efficacy, opportunity recognition, conveying a compelling vision, value creation through innovation (observing customer usage) and perseverance. previous scholars confirmed that self-efficacy is a strong predictor of entrepreneurial intention. the article found a moderate positive significant bidirectional relationship between entrepreneurial intention and self-efficacy. conclusion: the findings could assist policy-makers, educators, as well as potential, nascent and start-up entrepreneurs with the understanding that these specific entrepreneurial competencies are necessary for a successful business venture or for moving to the next stage of the venture life cycle. in addition to the previously mentioned practical implications, this study also shows educators, policy-makers and academics that they need to adapt their entrepreneurial training programmes to ensure that self-efficacy and entrepreneurial intention are taught simultaneously as these constructs influence each other. keywords: entrepreneurial intention; individual entrepreneurial competencies; bidirectional relationship; self-efficacy; nascent and existing entrepreneurs. introduction economic development highlights the importance of understanding entrepreneurship, and recognises that both factorand efficiency-driven economies express high levels of entrepreneurial intentions (kelley, singer & herrington 2017). thompson (2009:676) defines entrepreneurial intention as ‘… the self-recognition by an individual that they intend to set up a new business venture at some point in the future’. when studying actual new venture launches, krueger (2017) comments on the importance of understanding the preconditions that enable entrepreneurial activity. ‘we often seek to develop more entrepreneurial students and trainees in the classroom and communities, but in fact, we need to develop better entrepreneurs’ (krueger 2017:51). the complexity of the tasks required by entrepreneurs dictates that they need to prepare themselves with relevant competencies that could be used in developing a successful venture (ahmad, halim & zainal 2010:73). a number of comprehensive studies have been conducted to investigate the predictors of entrepreneurial intention (hmielski & corbett 2006:3, 19; krueger, reilly & carsrud 2000; lüthje & franke 2003; obschonka, silbereisen & schmitt-rodermund 2010; schwarz et al. 2009), specifically with entrepreneurial intention as the outcome variable (autio et al. 2001; krueger 1993; reitan 1996). at the same time, thompson (2009:670) states that ‘entrepreneurial intention is a useful construct in its own right that can be used not only as a dependent variable (dv), but also as an independent variable (iv) where intentions can lead to outcomes’. these outcomes include behaviours such as opportunity recognition, entrepreneurial action, increased entrepreneurial performance and the actual start-up of businesses. yet, there is limited empirical evidence in which entrepreneurial intention is treated as a predictor of these outcomes, with the exception of studies by ibrahim and abdullahi (2014) and ibrahim and lucky (2014). however, these studies were limited to student samples in nigeria, and they recommended that future studies should include a more comprehensive and representative sample. researchers such as morris et al. (2013) focused their research efforts on entrepreneurial competencies (bird 1995; brophy & kiely 2002; kaur & bains 2013; morris et al. 2013). entrepreneurial competencies can be defined as the skills, knowledge, values, attitudes and behaviours or a combination thereof that individuals need to perform a specific activity, such as starting and running a successful business (brophy & kiely 2002:166; kaur & bains 2013; morris et al. 2013:353). in this article, the entrepreneurial competencies are investigated from a behavioural lens (kiggundu 2002), where each competency is an activity or action. this article is supported by the social cognitive theory (bandura 1989) and human agency theory (bandura 2001) to link entrepreneurial competencies and intentions from a psychological perspective on a behavioural level (biraglia & kadile 2017; bird 1988; krueger 1993; zhao & seibert 2006). just like strategy, entrepreneurship has begun to wrestle with the psychological micro-foundations of its phenomenon, such as the ‘entrepreneurial mindset’ (krueger & welpe 2014:1). according to bandura (1989:1179), action is motivated and directed by cognitive goals. personal goal setting is influenced by perceived capabilities and competencies, identified by a self-efficacy process (bandura 1989:1175). the social cognitive theory, therefore, posits a multifaceted causal structure that addresses both the development of competencies and the regulation of action (bandura 1986). the agent (agentic perspective of social cognitive theory) is the individual that intentionally makes something happen that is represented by a present cognitive goal (bandura 2001:1, 3). human cognition is known as the ‘semantic layer’, referring to what we say and do. below this layer is the ‘symbolic level’, which holds all beliefs, attitudes and assumptions. however, below the semantic layer is the neurological layer, which represents the biological substrate of cognition (krueger 2017:62). previous studies have modelled entrepreneurial competencies (mitchelmore & rowley 2010) and entrepreneurial intention (as suggested by thompson 2009) as outcomes in separate models. however, the theory of planned behaviour by ajzen (1991) and the social cognitive theory by bandura (1989) lead us to question whether high levels of individual entrepreneurial intention are the cause of early entrepreneurial competence in the venture life cycle, which may lead to greater business start-up success and entrepreneurial action. previous scholars have established that, although the entrepreneurial intention of potential entrepreneurs may be high (singh, verma & rao 2016), the start-up rate of these individuals moving into entrepreneurial action is significantly low (nabi, holden & walmsley 2010). as stated by al mamun, nawi and shamsudin (2016:110), entrepreneurial action starts with entrepreneurial intention, which is formed through personality traits and competencies. thus, if entrepreneurial intentions predict behaviour and behaviour predicts action (fayolle, kyrö & liñán 2015), competencies should be further investigated from an input (antecedents to competencies) and process point of view (task of behaviour leading to competencies) (man, lau & chan 2002:131). according to weinert (2001), a range of dimensions influence an individual’s degree of competency, which includes experience, knowledge, ability, understanding, skill, action and motivation. although educational programmes can produce entrepreneurial intentions, there is a need to better understand whether entrepreneurship education in its current form increases perceived behavioural control (fayolle, gailly & lassas-clerc 2006), and leads to greater business start-up success and action within nascent entrepreneurs. studies have shown that approximately two-thirds of nascent entrepreneurs disengage from initial venturing efforts before they eventually start a business (reynolds 2007). therefore, a shift is required, from studying intentions and business formation to studying successful business development and growth (morris et al. 2013:363), and a bidirectional relationship between the constructs, in this article, might enforce such a shift. therefore, the purpose of this article is twofold. the first part is to investigate whether entrepreneurial intention has a bidirectional relationship with certain individual entrepreneurial competencies. competencies are seen as behavioural outcomes in this article because competency refers to the quality of action (bird 1995), and therefore if a bidirectional relationship is evident between entrepreneurial intention and the entrepreneurial competencies, it might enhance the outcomes such as business start-up or entrepreneurial action. the second part is to determine the direction and strength of the relationships between entrepreneurial intention and individual entrepreneurial competencies. mitchelmore and rowley (2010:97) state that entrepreneurial competencies should be measured at different stages of the entrepreneurial venture, as different competencies are required at each stage. hence, we include a sub-sample of nascent entrepreneurs and a sub-sample of existing entrepreneurs. the entrepreneurial intention of existing entrepreneurs is measured to establish whether the respondents are interested in starting another business in the near future. scholars such as thompson (2009) and zhao, seibert and lumpkin (2010) have also focused on measuring repeat entrepreneurial intention on existing entrepreneurs. we contribute to the entrepreneurial intention construct and intention models because thompson (2009:670) suggested that entrepreneurial intention can be treated as a predictor of outcomes such as behaviours, action and business start-up. yet, limited studies embarked on investigating thompson’s notion. therefore, this article determines the inverse relationship between entrepreneurial intention and entrepreneurial competencies, and tests bidirectional relationships which could enhance these outcomes. by challenging the existing body of knowledge where entrepreneurial intention was previously only tested as a dv, it might encourage other scholars to explore new avenues of testing entrepreneurial intention in different settings, contexts and countries. furthermore, educators and policy-makers, interested in promoting entrepreneurship, can pay attention to the specific entrepreneurial competencies that have a bidirectional relationship with entrepreneurial intention. the competencies with the strongest relationships can be included in start-up training programmes for potential and nascent entrepreneurs to enhance business start-up success. as previous work confirmed that self-efficacy is a strong predictor of entrepreneurial intention (bronowitz & rader 2008; kolvereid 1996; pfeifer, šarlija & zekić sušac 2016; wakkee, elfring & monaghan 2010), and self-efficacy is identified as an entrepreneurial competency that has a direct effect on behaviour (morris et al. 2013:363), it is important to determine whether entrepreneurial intention and self-efficacy influence each other. this is an important occurrence necessary for business success (boyd & vozikis 1994) and could bridge the gap between intention and action, but should be tested further in future research. this article is structured as follows. the theoretical foundation and hypotheses development are explained first, and then the research method and sample are addressed. the measurement and data analysis are then presented, followed by the findings, discussion of the findings and conclusions. some recommendations for future research are made, and the limitations of the study are addressed. theoretical foundation and hypotheses development according to bandura (2001:6), human agency (as part of the social cognitive theory) refers directly to what is done intentionally. the human agency theory is used to explain the link between intentional entrepreneurial actions and the competencies of the agent. there are four core features of the human agency theory that must be explored, namely, intentionality, forethought, self-reactiveness and self-reflectiveness. intentionality represents a future action to be performed in the form of a provocative commitment (bandura 2001:6). intentional agency functions in such a way that intentions are at least partially fulfilled in one way or the other. an individual, who intends to pursue a business opportunity within the next 3 years, is defined as an intentional entrepreneur (herrington & kew 2016:14; nieman & nieuwenhuizen 2014:25). in this article, the nascent or existing entrepreneur is an agent that has the intention of starting a new venture in the near future. forethought is a temporal dimension of planning agency, as it is future-directed. an individual creates a possible course of action with the desired outcomes (bandura 2001:7). when a potential entrepreneur becomes an intentional one (also referred to as a nascent or prospective entrepreneur), future-directed pre-launch preparation tasks are performed (giordano martínez, herrero crespo & fernández-laviada 2017:230; nieman & nieuwenhuizen 2014:25, 33). self-reactiveness refers to the motivation and self-regulation of planned actions, and involves the ability to make plans and choices. the ability to realise future plans affects motivation (bandura 2001:8). an individual can be motivated by necessity or opportunity to become an entrepreneur (kelley et al. 2017:8; nieman & nieuwenhuizen 2014:37). according to bandura (2001:8, 9), ability and competencies can affect aspirational pursuits and future goals. entrepreneurial competencies can, thus, influence the motivation of entrepreneurs (nascent or prospective), who aspire and plan to work for themselves. self-reflectiveness refers to a self-examining action. the capability to reflect upon and evaluate one’s actions, goals and plans is a core part of agency theory (bandura 2001:10). the ability to ‘see the bigger picture’ is an entrepreneurial example of a self-reflectiveness competency (nieman & nieuwenhuizen 2014:36). figure 1 illustrates a practical application of agency theory (intentionality, forethought, self-reactiveness and self-reflectiveness) to entrepreneurial intentions and capabilities. human agency theory refers directly to (1) what is done intentionally and (2) the ability to realise that the future affects motivation (also referred to as competencies). the agency theory suggests that self-reactiveness, where entrepreneurial competencies are included, is influenced by intentions. at the same time, bandura’s social cognitive theory (bandura 1986) suggests that an individual’s surroundings cause behaviour, but behaviour also causes the surroundings. bandura calls this concept a reciprocal determinism, where the world and the behaviour of persons are mutually caused. he believes that human conduct must be explained in terms of the reciprocal interaction between cognitive, behavioural and environmental determinants. figure 1: agency theory to link entrepreneurial intentions and competencies. the relationship between entrepreneurial intention and entrepreneurial competencies to test thompson’s (2009) notion that entrepreneurial intention can be treated as a predictor of outcome behaviours (such as opportunity recognition, entrepreneurial action, increased entrepreneurial performance and the actual start-up of businesses), we conducted a literature review on entrepreneurial intention (treated as the dv and a predictor). the literature search was conducted on entrepreneurial intention studies published in highly-rated entrepreneurial journals (impact factor of 1.0 or higher), such as the international entrepreneurship and management journal, international journal of entrepreneurship and small business and entrepreneurship as well as entrepreneurship theory and practice. the keywords used were ‘entrepreneurial intention’, ‘entrepreneurial intent’, ‘intention to start’ ‘dependent variable’, ‘independent variable’, ‘predictor’ and ‘bidirectional relationship,’ and only studies that were published between 2000 and 2016 were included in the analysis. we identified 31 articles which confirmed that most studies treated entrepreneurial intention as a dv, except for ibrahim and abdullahi (2014) and ibrahim and lucky (2014), in which entrepreneurial intention was treated as a predictor of entrepreneurial skills, entrepreneurial orientation and environmental factors, as well as attitudes towards business formation as dvs. ibrahim and abdullahi (2014) found that a positive relationship exists between entrepreneurial intention as the iv and the attitude towards business formation as the dv. a positive relationship was also found between entrepreneurial intention as the iv and entrepreneurial skills, orientation and environmental factors as the dvs in the study by ibrahim and lucky (2014). at the same time, a positive relationship was found between entrepreneurial intention (dv) and entrepreneurial skills (ivs), which was also previously found by fini et al. (2009) and sookhtanlo et al. (2009), who affirmed that entrepreneurial skills are significantly related to entrepreneurial intention. however, in the studies by ibrahim and abdullahi (2014) and ibrahim and lucky (2014), these entrepreneurial skills were not tested individually but condensed as one skill by conducting regression analyses. in a more recent study by rezazadeh and nobari (2018), a closer investigation was conducted into the antecedents (entrepreneurial attitude, complementarity and compatibility) and consequences (firm’s agility, customer relationship management, learning, innovative and sensing capabilities) of cooperative entrepreneurship. the results provide evidence of the significant positive impact on partners’ entrepreneurial attitude, complementarity and compatibility (as antecedents) of cooperative entrepreneurship, as well as the positive effects of cooperative entrepreneurship on firms’ agility, customer relationship management, as well as learning, innovation and sensing capabilities (as consequences) (rezazadeh & nobari 2018:479). an entrepreneur’s education, training and experience are also seen as antecedents of entrepreneurial competencies (man et al. 2002:135). findings by morris et al. (2013) indicate that education plays an important role in the development process of an entrepreneur. these authors continue and emphasise that it is imperative to provide key building blocks or scripts (i.e. norms, values and rules guiding desirable behaviour) and constructing experiences through which students can use these scripts, gain feedback, confirm or disconfirm their assumptions and understandings. in turn these experiences and understandings should mould their attitudes and behaviours into competencies. in this article, we discuss and test the bidirectional relationships between entrepreneurial intention and the individual entrepreneurial competencies, as the theory of planned behaviour (ajzen 1991) underpins the fact that entrepreneurial intention can predict behaviour and that behaviour is embedded in entrepreneurial competencies (kiggundu 2002). individual entrepreneurial competencies several scholars, such as man et al. (2002), baum (1994) and hazlina ahmad et al. (2010), identified entrepreneurial competencies that nascent entrepreneurs’ need, namely, opportunity recognition, building relationship, innovativeness, operational, human, strategic, commitment to business, learning and personal strength competencies. the strongest competencies that baum (1994) identified that existing entrepreneurs should have when growing the venture are the following: self-efficacy, technical skills, personal marketing skills, innovation and a passion for work. the weaker competencies in this regard were highlighted as related to the venture’s vision, organisational skills, growth objectives, skills of identification of opportunities and experiences in running the business. morris et al. (2013) built on the work of previous scholars and used the delphi-technique to identify 13 necessary competencies that is believed to lead to entrepreneurial action, namely, opportunity recognition, opportunity assessment, risk management, conveying a compelling vision, tenacity or perseverance, creative problem-solving, resource leveraging, guerrilla skills, value creation through innovation, maintain focus yet adapt, resilience, self-efficacy, and building and using networks. for this article, only eight of the individual entrepreneurial competencies, as identified by morris et al. (2013), were tested as explained in the factor analysis section. the next part of the literature review is divided into two sections: (1) support in the literature for a bidirectional relationship between entrepreneurial intention and entrepreneurial competencies and (2) the lack of support in the literature for a bidirectional relationship between entrepreneurial intention and entrepreneurial competencies. support in the literature for a bidirectional relationship between entrepreneurial competencies and entrepreneurial intentions opportunity recognition morris et al. (2013:358) define opportunity recognition as the capacity to perceive changed or overlooked possibilities in the environment, which may represent potential sources of profit or return to a venture. in earlier studies, opportunity recognition or identification has been referred to as entrepreneurial intention. for example, shaver and scott (1991) state that entrepreneurs have a type of motivation (i.e. entrepreneurial intent) that makes the entrepreneurial process result in opportunity realisation. likewise, krueger et al. (2000) also found that the opportunity identification process is an intentional process, which offers a means to better explain and predict entrepreneurship. the role of the entrepreneur in opportunity search and identification activities is controversial because intention models posit that entrepreneurs intend to be entrepreneurs before they locate opportunities (krueger 1993). in later studies, it was proposed that individuals with higher entrepreneurial intention have the ability and competency to identify opportunities (volery et al. 2013). krueger (1993) associated self-efficacy with opportunity recognition, and short et al. (2010) later established that self-efficacy is directly related to entrepreneurial intention, thus deducing that opportunity recognition and entrepreneurial intention have a bidirectional relationship. opportunity assessment although opportunity recognition is believed to be the first step in an entrepreneurial process, opportunity exploitation is thought to be the second step, which may start in the nature of the opportunity and individual differences (shane & venkataraman 2000), or simply in the decision of someone to act (alvarez & barney 2007). entrepreneurial intention is seen as the mental force that realises the value of a new business opportunity (cha & bae 2010:37). morrison, breen and ali (2003:423) note that intention, ability and opportunity are linked intrinsically, and business growth is unlikely to be achieved should one be missing or be unduly weak. without intention driven by entrepreneurial vision and energy, an opportunity cannot be assessed and opportunities will not be translated into business growth (morrison et al. 2003). thus, the preceding literature suggests that a bidirectional relationship is possible. conveying a compelling vision morrison et al. (2003:358) describe conveying a compelling vision as ‘the ability to provide an image of a future organisational state and to portray that image in a manner that empowers followers to enact it’. according to parente and feola (2013), entrepreneurial intention plays a role for a potential venture to be taken forward, predicting a vision that the entrepreneur has created in his or her mind. through conveying the entrepreneurs’ vision, the entrepreneurial intention initiatives new venture’s innovation processes and helps to build a new venture (cha & bae 2010). creative problem-solving creativity is a common manifestation of entrepreneurship and is well documented in the existing literature (becherer, mendenhall & eickhoff 2008:5). according to schein and schein (1978:149), typologies of entrepreneurially-oriented people portray them as obsessive with the need to create and solve problems. knowing that entrepreneurs have a higher level of entrepreneurial intentions than non-entrepreneurs, it can be deduced that higher levels of entrepreneurial intentions are present during problem-solving (mcmullen & shepherd 2006). zampetakis and moustakis (2006) presented a preliminary model which links creativity with entrepreneurial intention. value creation through innovation morris et al. (2013:358) describe value creation as the ‘capabilities of developing new products, services, and/or business models that generate revenues exceeding their costs and produce sufficient user benefits to bring about a fair return’. although innovativeness is found to be one of the factors affecting students’ entrepreneurial intention, it also adds economic value in terms of new product development, identifying new processes and exploiting new markets (al mamun et al. 2016:126). groves et al. (2008) found that successful entrepreneurs that exhibited high levels of entrepreneurial intention showed significant levels of non-linear thinking. it is not surprising then that innovation has been indicated to be a trigger of entrepreneurial intention–action. similarly, many other scholars, such as gorman, hanlon and king (1997), feldman and bolino (2000) and sternberg (2004), propose that individuals with a strong innovation anchor and the capacity to think outside the box are motivated to become self-employed. the innovativeness of a planned venture is, thus, important because an intention to be innovative is a leading indicator of higher performance in small and medium enterprises (smes) (kundu & katz 2003:31). cha and bae (2010) suggest that entrepreneurial intention may be considered as the internal driving force behind value creation because of its position at the centre of the underlying layers of the emergent process of opportunity realisation. based on the theory by ajzen (1991), which focuses on the intention to engage in a behaviour (e.g. the intention to adopt innovations), the predictive power of innovativeness is based on entrepreneurs’ intention to adopt innovation (marcati, guido & peluso 2008:1583). perseverance in the identification of entrepreneurial competencies, morris et al. (2013:358), who use tenacity and perseverance interchangeably, describe perseverance as ‘the ability to sustain goal-directed action and energy when confronting difficulties and obstacles that impede goal achievement’. there is an underlying assumption in the literature that perseverance is one of the motivating factors necessary for entrepreneurial intention because it acts as an inner drive towards a given goal (gibson et al. 2009). however, in a study by urban and richard (2015:264), the relationship between perseverance and entrepreneurial intention showed that, even though people may have low levels of perseverance, they may still have high levels of entrepreneurial intention. pendame (2014:39) and mangundjaya (2009) also found no significant relationship between perseverance and entrepreneurial intention. although mixed results are observed, there is still evidence of a positive relationship between entrepreneurial intention and perseverance. the literature shows support or at least partial support regarding the preceding individual competencies. however, these competencies have not been tested in a bidirectional relationship with entrepreneurial intention. therefore, it justifies the following hypothesis statements: h1: there is a positive bidirectional relationship between entrepreneurial intention and the following entrepreneurial competencies: h1a: opportunity recognition h1b: opportunity assessment h1c: conveying a compelling vision h1d: creative problem-solving h1e: value creation through innovation h1f: perseverance. lack of support in the literature for a bidirectional relationship between entrepreneurial competencies and entrepreneurial intentions self-efficacy it is well known that self-efficacy is a predictor of entrepreneurial intention (bronowitz & rader 2008; kolvereid 1996; pfeifer et al. 2016; wakkee et al. 2010), as well as a moderator in the relationship between entrepreneurial intention and action (boyd & vozikis 1994). as self-efficacy is defined as the perceived ability to perform a behaviour (or sequence of behaviours), it is expected that entrepreneurial intention will be a strong predictor of self-efficacy (boyd & vozikis 1994); however, this could not be confirmed in the literature and is therefore worthy of further investigation. building and using networks building and maintaining diverse social networks is a behavioural skill identified after interviewing innovative entrepreneurs who had engaged in this behavioural skill more frequently than typical executives (dyer, gregersen & christensen 2008:327). social networking plays an imperative role in developing entrepreneurial intentions among entrepreneurs and is the main reason for successful business (kefela 2011; zafar, yasin & ijaz 2012). taylor and thorpe (2004) seem to agree with this, adding that networks gained through previous work experience can positively impact the entrepreneurial intention of students. fayolle et al. (2015) contribute to the entrepreneurial intention and competencies relationship by adding that the greater an entrepreneur’s network orientation, the higher the level of competence development and the stronger the positive relationship between entrepreneurial intention and competencies will be (fayolle et al. 2015). however, no support could be found that entrepreneurial intention and the ability to build and use networks can influence each other. although support for the relationships between self-efficacy and the ability to build and use networks with entrepreneurial intention could not be confirmed in the literature, this article explores the possibility of a bidirectional relationship between entrepreneurial intention and these competencies, and model fit is determined later in the article. based on the preceding literature review, it is hypothesised that: h2: there is no bidirectional relationship between entrepreneurial intention and the following entrepreneurial competencies: h2a: self-efficacy h2b: building and using networks. methodology study area this quantitative research was carried out by means of a structured research questionnaire (survey) that was e-mailed (1450 respondents) or personally distributed (330 respondents) at various south african organisations such as the university of pretoria (tertiary institution), national youth development agency (government organisation) and the gauteng enterprise propeller (non-government organisation). the final realised sample was 342, which represents a response rate of 19%. potential heterogeneity bias, as a result of the industry in which an individual operates, was tested by conducting statistical difference testing. no statistically significant differences (all p > 0.05) between individuals from different industries were found for all the latent constructs tested. structured research questionnaire the questionnaire was divided into three sections. section a consisted of a combination of openand closed-ended questions that represent demographic and venture life cycle information. these include gender, race, age, highest level of education, business sectors and length of time the business has been in operation. section b captured 10 statements that measured the individual entrepreneurial intention scale, which was developed by thompson (2009). a four-point likert scale was used where 1 = very untrue, 2 = untrue, 3 = true and 4 = very true. this section included statements on the intent to set up a business in the future, as well as business opportunities and resources to start a business. in thompson’s study, the scale’s cronbach’s alpha coefficient of internal reliability was 0.89 for 450 randomly selected convenient respondents; 0.84 for 160 student respondents and 0.86 for an international sample of 947. hence, the scale seemed to have acceptable internal consistency (reliability). furthermore, the cronbach’s alpha coefficient of internal consistency (reliability) proved to be 0.668 on the original 10-item scale as used by thompson (2009); hence, the scale seemed to have acceptable internal reliability in this study in section c, the respondents were asked to answer self-perception questions on how the statements applied to them regarding their individual entrepreneurial competencies. this was done by including the entrepreneurial competency scale developed by morris et al. (2013:356). however, it was adapted to fit within the developing country context, which resulted in eight competencies that were tested in 51 statements using a five-point likert scale, in which 1 = strongly disagree, 2 = disagree, 3 = neutral, 4 = agree and 5 = strongly agree. in the morris et al.’s (2013) study, the cronbach’s alpha coefficient was tested individually for each of the competencies and varied between 0.62 as the lowest and 0.97 as the highest. sampling method and survey of the total sample, 219 respondents (64%) were categorised in the ‘nascent entrepreneur’ sub-sample, and as 123 respondents (36%) owned a business, they were labelled as part of the ‘existing entrepreneur’ sub-sample. we adopted the sampling frame used by davidsson and honig (2003) to divide the sample. an individual was considered a nascent entrepreneur if he or she had initiated at least one gestation activity for a current, independent start-up by the time of the measurement. these gestation activities included having prepared a business plan; developed an idea; recognised an opportunity; developed a new product or service; gathered other resources to start a business and so on. some existing business gestation activities included whether money had been invested; if the firm was already a legal entity and so on (carter, gartner & reynolds 1996; davidsson & honig 2003). data analysis confirmatory factor analysis was used first to determine an acceptable fit of the data to the model for entrepreneurial intention. in the case of entrepreneurial competencies, which were adapted from the original instrument, exploratory factor analysis (efa) was performed to determine the dimensionality of each. thereafter, structural equation modelling (sem) was conducted to determine whether entrepreneurial intention as the iv is a statistical significant predictor of the eight competencies used as dvs. structural equation modelling was used to test the paths between entrepreneurial intention as an iv and the eight competencies (dvs) simultaneously in one model. an acceptable model fit is indicated by a chi-square probability greater than or equal to 0.05. furthermore, an acceptable model fit is specified by a comparative fit index (cfi) with a value of 0.90 or greater, tucker–lewis index (tli) with a value of 0.90 or greater and an incremental fit index (ifi) value of 0.90 or greater (hu & bentler 1999:1). findings the validity and reliability of the scales the result of the confirmatory factor analysis indicated a non-acceptable fit for entrepreneurial intention (rmsea = 0.096; ifi = 0.750, cfi = 0.744 and cmin/df = 4.172). exploratory factor analysis was subsequently conducted, using principal axis factoring extraction and promax rotation, to determine the dimensionality of entrepreneurial intention and each of the entrepreneurial competencies. the required minimum acceptable level of consistency is 0.7 for all reported reliability coefficients (nunnally 1978) when using existing instruments. however, in exploratory research, 0.6 is considered acceptable (bagozzi & yi 1988:80; hair et al. 2010). this is confirmed by various entrepreneurship scholars such as farrington et al. (2012) and antonites and nonyane-mathebula (2012), who conducted their research on samples from developing countries such as south africa and accepted alpha values of 0.6. the harmon test for common method bias was carried out, and the results of the test indicated that no single factor solution emerged for the entrepreneurial intention construct and the first factor accounts for only 27% of the explained variance versus 24% for the remaining two factors (eigenvalues less than 1). therefore, no common method bias exists regarding entrepreneurial intention. the cronbach’s alpha values of two of the three factors were below the threshold of 0.6. six items loaded on the remaining factor, with a cronbach’s alpha values of 0.610 and 0.668 on the original 10-item scale, as used by thompson (2009). factor analysis: entrepreneurial competencies exploratory factor analyses were conducted to validate the scales. overall, these analyses indicated that of the 12 competencies, 10 indicated uni-dimensionality of the competency, and two of them, value creation and building and using networks, resulted in two sub-factors each. a total of two items were eliminated as they did not contribute to a simple factor structure and failed to meet the minimum criteria of having a primary loading of 0.4 or above, and/or cross-loading of 0.3 and above. table 1 presents the reliability analysis on the constructs that were retained for further analysis. no substantial increases in alpha for any of the scales could have been achieved by eliminating more items. overall, these analyses indicated that 10 competencies (distinct factors) were internally consistent. therefore, 10 factors were included for further testing. table 1: entrepreneurial competencies factor structure and measures. the efas confirmed uni-dimensionality in opportunity recognition, opportunity assessment, risk management, conveying a compelling vision, tenacity or perseverance, creative problem-solving, resource leveraging, value creation, maintaining focus, resilience, self-efficacy, and building and using networks. factor-based scores were subsequently calculated as the mean score of the variables included in each factor. factors with cronbach’s alphas lower than the threshold of 0.6, such as risk management (0.341); perseverance (sub-factor: consistency of interest -0.414); resource leveraging (0.442); maintain focus yet adapt (0.641) and resilience (0.413), were excluded from the analyses that follow. the demographic profile of respondents the nascent and existing samples have been explained and most of the existing entrepreneur respondents were in the business services, information technology and manufacturing sectors. thirty-five per cent of the respondents completed at least a secondary school-level education, with 24% having obtained a tertiary qualification (university degree). the total sample consisted of 43% female and 57% male respondents and most of the respondents were categorised in the 21–35 age group (mean value of 30.42). structural equation modelling results based on the literature review, the relationships between all eight entrepreneurial competencies and entrepreneurial intention were determined. figure 2 presents a graphical illustration of the hypothesised structural model whereby the relationship between entrepreneurial intention and the eight entrepreneurial competencies is tested. as indicated in the previous section, both value creation and building and using networks resulted in two sub-factors each. figure 2: hypothesised structural model. in table 2, it is evident that, for model 1, the chi-square mean/degree of freedom (cmin/df) value of 1.912 is less than the recommended value of 3.00. comparative fit index and ifi values for this model are equal or more than the recommended 0.90 and tli almost 0.90. an acceptable model fit is indicated by an rmsea value of 0.08 or less (hu & bentler 1999:1). in model 1, the 0.052 rmsea value is less than the required 0.08; therefore, this model is deemed an acceptable model fit. because of the overall model fit, this article confirms that a bidirectional relationship is evident between entrepreneurial intention and the set of entrepreneurial competencies tested in the model. the results of the standardised regression weights (path coefficients) indicated the statistical significance and strength of the individual relationships. table 2: goodness-of-fit indices (model 1). table 3 presents the direction and strength of the relationships (correlations) between the variables; the associated significance and the strength thresholds, as confirmed by pallant (2001), are used. these strength thresholds are 0–0.2 = weak; 0.2–0.4 = modest; 0.4–0.6 = moderate; 0.6–0.8 = moderately strong and 0.8–1.0 = strong. the findings in table 3 point out that a moderate positive bidirectional relationship is evident between entrepreneurial intention and self-efficacy (0.516) at a significance level of p ˂ 0.001. this relationship is the strongest and most significant and is also confirmed in the literature by bronowitz and rader (2008), kolvereid (1996), pfeifer et al. (2016) and wakkee et al. (2010), who state that self-efficacy is a predictor of entrepreneurial intention. however, the inverse relationship has not been established in previous research, and the finding in this article confirms our notion that a bidirectional relationship exists between these constructs and that they influence each other. table 3: standardised regression weights (path coefficients). entrepreneurial intention has a modest positive bidirectional relationship with the following entrepreneurial competencies: opportunity recognition (0.237); conveying a compelling vision (0.233) and value creation through innovation (sub-factor: observing customer usage 0.222) at a significance level of p ˂ 0.01. this is confirmed in the literature by parente and feola (2013:159), who state that entrepreneurial intention plays a role in the probability that a potential venture will be taken forward according to a predicted vision that the entrepreneur has created in his or her mind. cha and bae (2010:40) also found that through conveying the entrepreneurs’ vision, entrepreneurial intention initiates new innovation processes and helps build a new venture. the findings in table 3, furthermore, indicate that entrepreneurial intention has weak positive bidirectional relationships with perseverance (0.206) at a significant level of p ˂ 0.05. mixed findings were observed in the literature review regarding the relationship between perseverance and entrepreneurial intention. our findings confirm a bidirectional relationship although weak, and disagree with the findings of pendame (2014:39) and mangundjaya (2009), who found no significant relationship between perseverance and entrepreneurial intention. regarding the relationship between entrepreneurial intention and opportunity assessment (0.085) and creative problem-solving (0.078), these relationships are also weak and positive, but not significant. it is an unexpected finding as a significant bidirectional relationship was expected between these constructs, as the literature review also suggests that a bidirectional relationship is possible (cha & bae 2010; mcmullen & shepherd 2006). a weak, negative relationship is observed between entrepreneurial intention and building and using networks (sub-factor: maintain contacts -0.037 and sub-factor: participate in community events -0.095) and the relationships are not significant. these findings agree with most of the previous scholars (boyd & vozikis 1994; fayolle et al. 2015), which stated that networking and entrepreneurial intention have been linked; however, a bidirectional relationship cannot be confirmed. entrepreneurial intention also had a weak negative relationship with value creation through innovation (sub-factor: challenge status quo -0.021). although ajzen’s theory (1991), which focuses on the intention to engage in a behaviour (e.g. the intention to adopt innovations), suggests that the predictive power of innovativeness is based on entrepreneurs’ intention to adopt innovation (marcati et al. 2008:1583), a bidirectional relationship could not be confirmed in this article. discussion of the findings structural equation modelling was conducted to determine whether entrepreneurial intention and any of the individual entrepreneurial competencies have a bidirectional relationship whereby the constructs influence each other. an acceptable model fit is confirmed in this article as the fit indices (cfi and ifi) are greater than the recommended 0.90 and rmsea = 0.052. as far as could be determined, this is the first study that tests the bidirectional relationship between these constructs. furthermore, the strength and significance of the individual relationships were tested, and self-efficacy has the most significant relationship (moderate and positive) with entrepreneurial intention. entrepreneurial intention has also a modest positive significant bidirectional relationship with opportunity recognition, conveying a compelling vision, value creation (sub-factor: observing customer usage) and perseverance. at the same time, weak positive relationships were observed between entrepreneurial intention and opportunity assessment, as well as with creative problem-solving, yet these relationships were not significant. lastly, weak negative relationships were evident between entrepreneurial intention and building and using networks (both sub-samples) and value creation through innovation (challenge status quo). as previous research did not test the bidirectional relationships between entrepreneurial intention and these competencies, it can be confirmed that in this article the following hypotheses were either supported or not supported: h1: there is a positive bidirectional relationship between entrepreneurial intention and the following entrepreneurial competencies: h1a: opportunity recognition (supported) h1b: opportunity assessment (not supported) h1c: conveying a compelling vision (supported) h1d: creative problem-solving (not supported) h1e: value creation through innovation (sub-factor: observing customer usage – supported) (sub-factor: challenge status quo – not supported) h1f: perseverance (supported). h2: there is no bidirectional relationship between entrepreneurial intention and the following entrepreneurial competencies: h2a: self-efficacy (not supported) h2b: building and using networks (both sub-factors supported). therefore, when testing the individual entrepreneurial competencies by means of the standard regression weights (path coefficients), five of the individual entrepreneurial competencies had significant bidirectional relationships with entrepreneurial intention. they are opportunity recognition, conveying a compelling vision, value creation through innovation (observing customer usage), perseverance and self-efficacy. the findings in this article indicate that although previous research found that self-efficacy is a predictor of entrepreneurial intention (bronowitz & rader 2008; kolvereid 1996; pfeifer et al. 2016; wakkee et al. 2010), this article determined that these two constructs influence each other. mixed results are evident for value creation through innovation, as entrepreneurial intention did have a modest positive relationship with one sub-factor (observing customer usage) and a weak, non-significant, negative relationship with the other sub-factor (challenge status quo). the findings could not confirm a bidirectional relationship between entrepreneurial intention and the following entrepreneurial competencies: opportunity assessment, creative problem-solving, value creation through innovation (challenge status quo) and both sub-factors of building and using networks. although these entrepreneurial competencies did not have a bidirectional relationship with entrepreneurial intention, they might have a one-directional relationship and should be tested further in future research. conclusion although many scholars focused on the predictors of entrepreneurial intention (autio et al. 2001; krueger 1993; reitan 1996), in this article we test thompson’s (2009) notion that entrepreneurial intention can be used as a predictor of certain outcomes and therefore determined the bidirectional relationship with entrepreneurial competencies. the importance of establishing a bidirectional relationship between these constructs can be beneficial to educators and policy-makers who develop entrepreneurial training and education programmes, as a bidirectional relationship might increase the outcomes of business start-up and entrepreneurial action. the social cognitive theory and human agency theory established a link between entrepreneurial competencies and intentions on a psychological level (biraglia & kadile 2017; bird 1988; krueger 1993; zhao & seibert 2006). it is argued that this link should be tested by measuring entrepreneurs at different stages of the entrepreneurial venture life cycle. through sem we establish that a bidirectional relationship is evident between entrepreneurial intention and the set of entrepreneurial competencies tested in the model. the results of the standardised regression weights (path coefficients) indicated the statistical significance and strength of the individual relationships, and entrepreneurial intention has the strongest significant bidirectional relationship with self-efficacy. the contribution of this article is threefold: firstly, it answers the call by thompson (2009:670) to test entrepreneurial intention not only as a dv but also as the inverse relationships and therefore contributes to the entrepreneurial intention construct and intention models. the findings in this article present the possibility of testing other bidirectional relationships with entrepreneurial intention. by challenging the existing body of knowledge in which entrepreneurial intention was previously only tested as a dv, it might encourage other scholars to explore new avenues of testing entrepreneurial intention in different settings, contexts and countries. according to krueger (2017:59), one needs to take a second look at how intentions are modelled and the construct of intention itself. as we recall, all these models are grounded in the logic of a formative model, which is that there are antecedents that combine to form the target variable (krueger 2017:59). in an early study by liska (1984:68), it was suggested that the ‘antecedents’ may instead comprise a reflective model. bagozzi and warshaw (1990) also forced several changes in modelling intentions effectively, especially if one seeks to predict and not just explain. secondly, educators and policy-makers interested in promoting entrepreneurship may pay attention to the individual entrepreneurial competencies that have a bidirectional relationship with entrepreneurial intention. the competencies with the positive and significant relationships (self-efficacy, opportunity recognition, conveying a compelling vision, value creation through innovation – sub-factor observing customer usage and perseverance) can be included in start-up training programmes for potential and nascent entrepreneurs to enhance business start-up. therefore, to upskill ‘novice’ entrepreneurs into an ‘expert’, a more informed intent (krueger 2017:66) of entrepreneurs with the required competencies that leads to the growth phase of the venture life cycle is needed. for example, although entrepreneurs at the different stages of the entrepreneurial life cycle should be able to find this study beneficial, the ability to compare one’s competencies with those of existing entrepreneurs could provide potential, nascent and start-up entrepreneurs with the understanding that they should acquire individual entrepreneurial competencies, such as opportunity recognition, perseverance, self-efficacy, and value creation, if they wish to make the leap towards owning a successful business venture. lastly, previous work confirmed that self-efficacy is a strong predictor of entrepreneurial intention (bronowitz & rader 2008; kolvereid 1996; pfeifer et al. 2016; wakkee et al. 2010), as well as a moderator in the relationship between entrepreneurial intention and action (boyd & vozikis 1994:73). a positive significant bidirectional relationship is found in this article between entrepreneurial intention and self-efficacy. educators, policy-makers and academics can use this finding and adapt their entrepreneurial training programmes to ensure that self-efficacy and entrepreneurial intention are taught simultaneously as these constructs influence each other and can enhance the outcomes (business start-up or performance) of such a training programme. this could bridge the gap between intention and action, but should be tested in future research. limitations and future research avenues no study is without limitations. this article investigates nascent and existing entrepreneurs only. as suggested by mitchelmore and rowley (2010:104), entrepreneurial competencies should be explored at different stages of the entrepreneurial venture, as different competencies are needed at each stage. future research can include potential, start-up and even serial entrepreneurs, and draw comparisons between the competencies acquired at the different stages. as this study sets the stage for bidirectional relationships with entrepreneurial intention, future studies can investigate other outcomes of entrepreneurial intention, such as entrepreneurial action, performance and other behaviours. furthermore, future studies should test whether the bidirectional relationship between entrepreneurial intention and entrepreneurial competencies does, indeed, enhance or lead to the outcomes of business start-up and entrepreneurial action. the research in this article is carried out in a single period, and it is suggested that future research should conduct a longitudinal study over a 2-year period to measure whether high levels of entrepreneurial intention and entrepreneurial competencies may lead to entrepreneurial action (start-up) and business success. in the same sense, the model in this article can be tested, where entrepreneurial competencies are treated as mediators and/or moderators in the relationship between entrepreneurial intention and action, as well as between entrepreneurial intention and business success. scholars should take advantage of more rigorous experimental methodologies, such as neuroscience (neuro-entrepreneurship), to better understand the deeper structures of entrepreneurial competencies and intention. neuroscience could provide new ways to conceptualise and measure important facets of entrepreneurial decision-making (krueger & welpe 2014:6). we acknowledge that the set of entrepreneurial competencies used in this study is not exclusive of other competencies and that there might be competencies that are not included here. it is also advised that the antecedents of entrepreneurial intention and entrepreneurial competencies be investigated in more detail. as the sample in this article focused on south africa (developing country context), it is worthy to investigate the bidirectional relationship between entrepreneurial intention and self-efficacy in developed countries, as well as including a different sampling frame. it is acknowledged that mediators and moderators were not included in the present study, and future studies could include demographic variables, as well as other antecedents, to further test the bidirectional relationship between entrepreneurial intention and self-efficacy. acknowledgements competing interests the authors declare that they have no financial or personal relationship(s) that may have inappropriately influenced them in writing this article. the views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of any affiliated agency of the authors author’s contributions a.t. collected the data and 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analysis of south african output tax treatment results conclusion and recommendations acknowledgements references about the author(s) cecileen greeff department of economic and management sciences, school of accountancy, stellenbosch university, stellenbosch, south africa citation greeff, c., 2019, ‘an investigation into the output tax consequences of bitcoin transactions for a south african value-added tax vendor’, south african journal of economic and management sciences 22(1), a2162. https://doi.org/10.4102/sajems.v22i1.2162 original research an investigation into the output tax consequences of bitcoin transactions for a south african value-added tax vendor cecileen greeff received: 25 oct. 2017; accepted: 24 jan. 2019; published: 25 apr. 2019 copyright: © 2019. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the use of bitcoin in south africa is fairly new, but has increased as several online retailers now accept bitcoin as a means of payment. the south african revenue service has released a media statement regarding the normal tax treatment of cryptocurrencies (such as bitcoin), but policy regarding the value-added tax (vat) treatment of cryptocurrencies is still pending. aim: the objective of the study is to determine the output tax consequences for a south african vat vendor who receives bitcoins in exchange for the supply of goods or services that are subject to vat, and when the same south african vat vendor exchanges the bitcoins for south african rand at a local exchange platform. setting: this article examines existing literature in a south african vat environment. method: a non-empirical study based on existing literature is performed. results: it is found that when interpreting the (current) vat act no. 89 of 1991, the receiving of bitcoin in exchange for the supply of goods or services, as well as the exchange of bitcoin for south african rand, is subject to output tax at the standard rate of 14%, which will lead to ‘double taxation’. conclusion: it was shown through this study that the proposed treatment as explained in the previous section would impose ‘double taxation’. keywords: bitcoin; output tax; vat; vat act no. 89 of 1991; south africa. introduction and background bitcoin is a virtual cryptocurrency that exists in electronic form (berger 2016). it was launched in 2009 by satoshi nakamoto (franco 2015:108; chuen & deng 2018:177). bitcoin is defined as a ‘digital representation of value that is neither issued by a central bank or a public authority, not necessarily attached to a fiat currency, but is accepted by natural or legal persons as a means of payment and can be transferred, stored or traded electronically’ (european banking authority [eba] 2014:5). bitcoin can be held as an investment or can be exchanged for goods and services, such as buying physical goods and services using online stores (berger 2016:1). bitcoin as a means of payment for goods and services has grown substantially over the past few years, and merchants are more prone to accept bitcoin due to fees being lower than the typical credit card processors. more than 100 south african merchandisers are accepting bitcoin as a method of payment (visser 2016). the two most established bitcoin exchange platforms, where one can buy and sell bitcoin in south africa, are luno and ice3x, of which luno is the biggest in terms of user base and trading volumes (bitcoin zar n.d.). luno, founded in february 2014, is south africa’s first rand-to-bitcoin exchange platform with its headquarters in singapore and a development team in cape town (berger 2016:2). the number of bitcoins traded on ice3x is negligible (van rooyen 2018). the number of bitcoins traded in south africa on luno has increased from 1000 bitcoins per week in 2016 to between 4000 and 7000 bitcoins per week as of 09 november 2017 (businesstech n.d.). figure 1 (c. de kock [data request response] pers. comm., 21 may 2018; luno exchange 2018) shows the number of bitcoins that were exchanged for south african rand on the luno exchange platform for the period 01 march 2017 to 28 february 2018 (total of 217 017 bitcoins). what is of further interest is bitcoin’s value since its inception in 2009. from 2009 to early 2013, 1 bitcoin was worth between 10 and 20 dollars. since early 2013, however, its value has skyrocketed, to over $1000 per bitcoin around december 2013 (seforo 2014) and $9900 (approximately r130 000) in november 2017 (bitcoin zar n.d.). the value of bitcoin is based upon the demand for or the willingness of members of the virtual community to accept the currency in exchange for other items of distinct value (wicht 2016:20). figure 1: the number of bitcoins exchanged for south african rand on luno for the period 01 march 2017 to 28 february 2018. the user alert issued by national treasury on 18 september 2014 explains that virtual currencies such as bitcoin cannot be classified as legal tender as any merchant may refuse them as a payment instrument without being in breach of the law (national treasury 2014). the south african revenue service (sars) issued a media statement on 06 april 2018 regarding the normal tax treatment of cryptocurrencies such as bitcoin, but there is no published ruling, tax court decision or publication by government of interpretation notes on the vat considerations of bitcoin (sars 2018b; wicht 2016:10). however, during october 2018 national treasury (2018:51) proposed to include ‘the issue, acquisition, collection, buying or selling or transfer of ownership of any cryptocurrency’ as a financial service, which is an exempt supply for vat, in the taxation laws amendment bill of 2018. the vat consequences of bitcoin transactions therefore require investigation in an attempt to provide guidance on the consequences in terms of the (current) value-added tax act no. 89 of 1991 (hereinafter ‘the act’) in south africa. for a transaction to attract vat consequences, the requirements of ‘supply’ of ‘goods’ or ‘services’ in ‘the furtherance of any enterprise’ must be met. ‘supply’ contains a wide definition in terms of section 1 of the act, which could include any provision of goods or services in the course of the business of a taxpayer (de koker & kruger 2017). section 1 of the act defines ‘goods’ as any corporeal movable thing, fixed property or any right in any such thing. according to section 1 of the act the definition of ‘services’ would apply in instances where ‘goods’ are not supplied. the ‘furtherance of an enterprise’ requires that goods or services must be supplied for ‘consideration’ – thus payment in any form. should these requirements be met, vat will have to be levied at the standard, rate of 14%. given the proposed treatment in the taxation laws amendment bill of 2018 (national treasury 2018:51), the uncertainty of interest highlighted in this article is the possible exemption of the exchange of bitcoin by a south african vat vendor for south african rand in terms of section 12(1) of the act, which exempt any financial service from vat. uncertainty therefore exists as to whether the exchange of goods or services for bitcoin is subject to vat at the standard rate of 14%, and whether the exchange of bitcoin for south african rand could qualify as the exchange of currency which is specifically included as a financial service in section 2(1) of the (current) act. research objectives, scope and value of research in its first interim report on base erosion and profit shifting, the davis tax committee states that the use of bitcoin and other virtual currencies is increasing (davis tax committee 2014). the organisation for economic cooperation and development (oecd) published an action plan on base erosion and profit shifting in july 2013 in response to the growing use of virtual currencies such as bitcoin (oecd 2013). their working paper highlighted two issues: (1) the tax treatment of capital gain and losses in the cryptocurrency world, and (2) anonymity to avoid taxes with the use of virtual currencies (oecd 2013). south africa is one of the non-member economies with which the oecd has work relationships (wicht 2016:12). on 18 september 2014 the national treasury, the south african reserve bank (sarb), the financial services board, sars and the financial intelligence centre issued a joint statement to warn the south african public of the risks associated with the use of virtual currencies for investments and transactions (national treasury 2014). it is therefore evident that there is a need to address the vat consequences of bitcoin transactions in a south african context as virtual currencies are becoming increasingly popular among south africans to purchase goods and services (national treasury 2014). the objective of this research is to investigate the output tax consequences of bitcoin transactions in south africa from the perspective of a south african vat vendor based on a detailed understanding of what bitcoins are, how bitcoins work, a review of current vat (or goods and services tax [gst] as it is known in other countries) legislation of other countries, as well as an analysis of the (current) act. findings of this research could assist the south african regulator to evaluate the proposed treatment contained in the taxation laws amendment bill of 2018 (national treasury 2018:51) in terms of the output tax treatment of bitcoin transactions incurred by a south african vat vendor. consequently, the following two research questions provide context regarding the uncertainty of output tax compliance of bitcoin transactions (as set out in figure 2 with examples): figure 2: two research questions (with examples). research question 1: what are the output tax consequences for a south african vat vendor who receives bitcoin in exchange for services rendered or goods delivered (presumably to another south african vat vendor) which are subject to vat? research question 2: what are the output tax consequences for the same south african vat vendor, if the vendor exchanges the bitcoin on a local exchange (presumably to another south african vat vendor) for south african rand (ignoring any fees or commission payable)? a non-empirical study of existing literature was performed. a doctrinal research approach was followed, which includes the following steps (hutchinson & duncan 2012): gathering all the relevant facts. identifying the legal issue. analysing the legal issue from a legal perspective. collecting and studying research sources such as statutory laws, case law, interpretations and guides from sars, academic articles, dissertations, academic books and non-academic articles. analysing primary research sources such as legislation. combining all issues within the context. drawing up a conclusion. the article is structured as follows in order to address the two research questions: a discussion of the functioning of bitcoin. a review of the output tax implication of bitcoin transactions in five other countries. a discussion of the requirements for a transaction in south africa to be subject to output tax. results, conclusion and recommendations for further research. the study can potentially highlight areas for improvement or, at least, for consideration by the south african regulator to clarify the output tax treatment of bitcoin transactions for a south african vat vendor. the study can potentially also assist taxpayers to be aware of the potential output tax consequences of relevant new transactions and to correctly apply the act in their vat returns in relation to bitcoin transactions. this could prevent possible unfair vat consequences to either south african taxpayers or the fiscus. bitcoin bitcoin was invented by an anonymous user ‘sathoshi nakamoto’ in 2008 (nakamoto 2008) and released as open source software in 2009 (franco 2015:108). it is an ‘open source’ medium of exchange that is acquired, held and traded electronically without the involvement or control of an intermediary such as a bank, western union, moneygram, paypal, any company or the government (franco 2015:5; national treasury 2014; thomas & rudman 2016:24; wiseman 2016:420). it is therefore a virtual currency which cannot be redeemed for gold or other commodity (berger 2016), but is traded electronically and functions as a unit of account or a store of value (wiseman 2016:420). the european banking authority (eba) defines bitcoin as ‘a digital representation of value that is neither issued by a central bank or a public authority, not necessarily attached to a fiat currency, but is accepted by natural or legal persons as a means of payment and can be transferred, stored or traded electronically’ (eba 2014:5). there are several methods available to acquire bitcoins, which includes the following (wiseman 2016:421): receiving bitcoins as payment when selling goods or rendering services. buying bitcoins at a bitcoin exchange. mining for bitcoins. bitcoin is created digitally, by a community of people that anyone can join, through a computer process known as bitcoin mining. bitcoin mining uses computing power (software programs that follow a mathematical formula) and specialised hardware in a distributed network (franco 2015:46–48; wiseman 2016:421). the bitcoin system makes use of a shared and public database or ledger (known as a block chain) to keep record of the number of bitcoins a person owns at a certain point in time (seforo 2014). new bitcoins are created when a new block, comprising several transactions, is attached to the block chain once a complex algorithm is solved by a miner for a reward of 12.5 bitcoins (25 bitcoins until july 2016) (franco 2015:16; wiseman 2016:421). solving the algorithm confirms the validity of the block’s transactions by providing mathematically that the transaction occurred, and does not constitute double spending of bitcoins. therefore, once a transaction is committed to the block chain, it is irreversible (wiseman 2016:421). when paying for goods or services using bitcoin, the transaction is added to the block chain, and will result in a decrease in the payer’s quantity of bitcoins and a corresponding increase in the quantity of the payee’s bitcoins (seforo 2014). bitcoins are stored online in a digital wallet which is installed as an application on a computer, laptop or smartphone (franco 2015:17–18), but one could also exchange ordinary money (such as south african rand) for bitcoin at bitcoin exchanges all over the world (seforo 2014; wiseman 2016:521). since 2009 there have been 236 165 171 bitcoin transactions up until 30 june 2017 and 16 419 900 bitcoins in circulation on 30 june 2017 (blockchain n.d.). the bitcoin protocol stipulates that only 21 million units of bitcoin can ever be created by the miners (ah kun 2014; chuen & deng 2018:177), which is predicted to be reached in 2140 (wicht 2016:12). however, these bitcoins can be divided into smaller parts (the smallest divisible amount is one hundred millionth of a bitcoin and is called ‘satoshi’) (bitcoin zar n.d.). comparison of the value-added tax treatment of bitcoin transactions across countries due to the recent development of digital currencies (including bitcoin), there is no global consensus on the vat treatment of bitcoin transactions (ram 2018:217). different tax jurisdictions treat it in different ways, depending on the objectives of the local authorities and on the way that their tax system operates (australian government 2016:3). five countries (australia, united kingdom, italy, japan and singapore) have developed and issued views, interpretations and guidelines to taxpayers regarding the tax treatment of bitcoin transactions (australian government 2016; ey 2016; her majesty’s revenue and customs [hmrc] 2014; moskowitz 2014; young 2017b). the taxation systems of the five countries are very similar to the taxation system of south africa (berger 2016:10; wicht 2016:15) and four of the five countries are members of the oecd (oecd n.d.). the vat consequences relating to bitcoin transactions in the five countries are outlined below. australia recently the australian government exempted bitcoin trading from gst in the 2017/2018 budget report (young 2017b). this will ensure that consumers are no longer ‘double taxed’ when using bitcoin to buy goods and services already subject to gst (suberg 2017). the australian treasury changed its regulations and taxation policies on bitcoin after seeing a sharp decline in interest in bitcoin in the country (suberg 2017; young 2017b). from 01 july 2017 bitcoin is treated as money in australia, but gst still applies when exchanging those digital currencies for other goods and services that are themselves subject to gst (young 2017a). when purchasing and selling bitcoin through regulated exchanges and trading platforms, the transactions are not subject to gst (young 2017a). before 01 july 2017 australia did not recognise bitcoin as ‘money’ for gst purposes nor as a foreign currency (australian government: australian taxation office [ato] 2014; pwc 2016). the ato released several rulings on the gst of bitcoin in december 2014. for the gst treatment of bitcoin, the ato ruling outlined that bitcoin is considered a form of intangible property under the new tax system (goods and services) act 1999 (gst act) and the new tax system (goods and services tax) regulations 1999 (gst regulations) (australian government 2016). this resulted in the exchange of bitcoin for money to be subject to gst; where bitcoin is exchanged for other taxable goods or services the transaction is also subject to gst as it is the exchange of property for property (australian government 2016:2). united kingdom the revenue and customs brief 9 (hmrc 2014), published on 03 march 2014, sets out the position on the tax treatment of income received from and charges made in connection with activities involving bitcoin and other similar cryptocurrencies. in march 2014, hmrc outlined that when bitcoin is exchanged for foreign currencies, such as euro or dollar, no vat is due on the value of the bitcoins themselves, as they are recognised as ‘other negotiable instruments’ (australian government 2016; hmrc 2014; saunders 2015). when bitcoin is received in return for the provision of goods or services, the value of bitcoin in sterling at the point the transaction takes place is subject to vat in the normal way (hmrc 2014; saunders 2015). italy the italian tax authorities have issued guidance on the vat treatment of bitcoin in resolution no. 72 which is dated 02 september 2016 (ey 2016). bitcoins are classified as financial transactions and it also clarifies that bitcoin transactions undertaken by businesses should be considered to be vat exempt services (ey 2016). the tax authorities of italy consider that bitcoin transactions should be included in the definition of ‘transactions related to foreign currency with an official exchange rate and credits in foreign currency’, regulated by article 10, paragraph 3 of the italian vat law. this italian guidance on bitcoin transactions references the decision reached by the court of justice of the european union (cjeu) in case c-264/14 skatteverket v david hedqvist. on 22 october 2015 the cjeu ruled that in this case it was evident that the taxpayer, mr hedqvist, wished to deliver the service of an exchange of traditional currencies for bitcoin (and vice versa), which constituted a supply of services that should be exempt from vat (ey 2016). this was based on the grounds that the bitcoins had no other purpose other than to be a means of payment. as a result, the cjeu held that article 135(1)(e) of the european vat law also covered the supply of services which consisted of the exchange of traditional currencies for bitcoin (and vice versa) (ey 2016). japan on 01 april 2017 japan officially declared bitcoin’s exemption from consumption tax (similar to vat) and eliminated the possibility of double taxation on trading (young 2017b). singapore the inland revenue authority of singapore (iras) gave guidelines regarding the gst treatment in bitcoin exchanges in 2014 (moskowitz 2014). the iras regards the exchange of bitcoin in return for consideration in money or in kind to be a taxable supply of services which is subject to gst at 7%. therefore, if the seller of the bitcoins is a gst-registered person, they would have to account for output tax on the sale of the bitcoins in the furtherance of their business (moskowitz 2014). where bitcoins are accepted as payment for goods or services, the transactions are treated as barter transactions. gst should be accounted for on the individual supply made, thus the supply of the goods or services and the supply of the bitcoins, if the parties are registered for gst. this would mean potential double taxation of gst, as the seller of the goods or services will be liable for gst as well as the customer. but, if the bitcoins are used in exchange for virtual goods or services (such as virtual gaming), the supply of bitcoins will not be a taxable supply (moskowitz 2014). according to iras the supply of bitcoins is not a supply of money as bitcoins do not meet the requirements of the definition of ‘money’ or ‘currency’ under the gst act (moskowitz 2014). therefore, the supply of bitcoins is treated as a supply of services or goods as it involves the granting of the interest in or right over the bitcoins (pasick 2014). it will thus attract gst. table 1 summarises the different output tax consequences of bitcoin transactions in australia, the united kingdom, italy, japan and singapore in terms of the two research questions. table 1: summary of different output tax consequences by country methodology based on data retrieved from luno exchange (2018) the average price per bitcoin for the period 01 march 2017 to 28 february 2018 was r86 157. by multiplying the average price per bitcoin by the number of bitcoins that were exchanged for south african rand (as in figure 1) for the same period, the result is an amount of r18 697 533 669. it is difficult to link these exchanges to south african vat vendors, due to the anonymity of bitcoin trades (businesstech n.d.). for the purposes of this study, the assumption is made that 1% of the exchanges relates to exchanges made by south african vat vendors; the result is an amount of r186 975 337 which is possibly subject to output tax at a rate of 14%. to evaluate the above, the south african requirements for a transaction to be subject to output tax are analysed in the next section to assist formulation of the potential output tax treatment of bitcoin transactions (as set out in the two research questions) for south african vat vendors. this is done after understanding the functioning of bitcoins as well as reviewing the output tax implication of bitcoin transactions in five other countries that have already issued guidelines for the vat treatment of bitcoin transactions (discussed in the previous section). analysis of south african output tax treatment according to the act vat is levied at a rate of 14% (which was increased to 15% from 01 april 2018) in south africa (de koker & kruger 2017; sars 2018a). vat is an indirect tax which means that the tax is indirectly assessed by sars through the taxation of transactions (de koker & kruger 2017). it is basically a tax on the consumption of goods or services in south africa (de koker & kruger 2017). in south africa, output tax is the tax charged by the vendor on the selling price of goods or services according to section 7(1)(a) of the act. the selling price of the goods or services is normally vat inclusive. the vat levied on the selling of goods or services must be paid over to sars. taxable supplies can either be supplies at the standard rate of 14% or supplies charged at the zero rate (0%). if the vendor acquired taxable supplies of goods or services from another vendor (the supplier), the vat paid on such expenditure may be claimed as an input tax at a rate of 14% (sars 2017:39). section 7(1)(a) of the act reads verbatim as follows: subject to the exemptions, exceptions, deductions and adjustments provided for in this act, there shall be levied and paid for the benefit of the national revenue fund a tax, to be known as the value-added tax – on the supply by any vendor of goods or services supplied by him on or after the commencement date in the course or furtherance of any enterprise carried on by him; … calculated at the rate of 14 per cent on the value of the supply concerned or the importation, as the case may be. (republic of south africa 1962:608) therefore, for vat implications to arise in south africa, the transaction needs to meet the requirements of ‘supply’ of ‘goods’ or ‘services’ by a ‘vendor’ in ‘the furtherance of any enterprise’ (de koker & kruger 2017). each of the requirements will be considered in detail in this section and will be applied to the two research questions to ascertain as to whether output tax is chargeable or not (refer to figure 2). the first requirement for a transaction in south africa to attract vat is that the transaction should constitute a supply for vat purposes. the definition of ‘supply’, section 1 of the act reads verbatim as follows: ‘supply’ includes performance in terms of a sale, rental agreement, instalment credit agreement and all other forms of supply, whether voluntary, compulsory or by operation of law, irrespective of where the supply is effected, and any derivative of ‘supply’ shall be construed accordingly. (republic of south africa 1962:606) for a supply to occur it is necessary that there should be a supplier and a recipient (de koker & kruger 2017). section 1 of the act defines the recipient as ‘the person to whom the supply is made’ and the supplier as ‘the person supplying the goods or services’. it is evident that the term ‘supply’ has a wide meaning (sars 2017:39) and therefore it has to be explored further. the normal dictionary meaning of supply according to the english oxford living dictionary (n.d.) is to ‘provide’ or ‘to make something available’. a supply can also include a supply under a barter exchange transaction (de koker & kruger 2017). a barter transaction is when goods or services are supplied for a consideration that is not money (de koker & kruger 2017; sars 2017:36). according to the sars (2017:36) the consideration will be the open market value of the goods or services received. in the case of south atlantic jazz festival (pty) ltd c csars (2015, zawchc 8), the sponsors provided money, goods and services to the taxpayer for staging annual jazz festivals in cape town. in return the taxpayer provided goods and services to the sponsors in the form of branding and marketing. both the taxpayer and the sponsors were vat vendors. the courts held that output tax should be accounted for by the taxpayer as well as the sponsor in respect of taxable supplies. sections 8 and 18(3) of the act contain provisions to ascertain whether a transaction is a supply or not or if the transaction is a supply of services or a supply of goods. section 8 also deems certain transactions to be a supply, although they do not meet all the requirements, such as ceasing to be a vendor, indemnity payments, supplies to independent branches, fringe benefits, payments exceeding considerations, etc. none of these deemed supplies seems to be applicable to bitcoin transactions as set out in the two research questions. the second requirement for a transaction in south africa to attract vat is that the supply should be either a supply of goods or a supply of services. the definition of ‘goods’, section 1 of the act, reads verbatim as follows: ‘goods’ means corporeal movable things, fixed property, any real right in any such thing or fixed property, and electricity, but excluding – money; any right under a mortgage bond or pledge of any such thing or fixed property; and any stamp, form or card which has a value and has been sold or issued by the state for the payment of any tax or duty levied under any act of parliament, except when subsequent to its original sale or issue it is disposed of or imported as a collector’s piece or investment article. (republic of south africa 1962:602). the definition of ‘money’, section 1 of the act, reads verbatim as follows: ‘money’ means – coins (other than coins made wholly or mainly from a precious metal other than silver) which the south african reserve bank has issued in the republic in accordance with the provisions of section 14 of the south african reserve bank act, 1989 (act no. 90 of 1989), or which remain in circulation as contemplated in the proviso to subsection (1) of that section, and any paper currency which under the said act is a legal tender; any coin (other than coins made wholly or mainly from a precious metal) or paper currency of any country other than the republic which is used or circulated or is intended for use or circulation as currency; any bill or exchange, promissory note, bank draft, postal order or money order, except when disposed of or importer as a collector’s piece, investment article or item of numismatic interest. (republic of south africa 1962:603) from the above definitions it is evident that bitcoins cannot be classified as ‘goods’ or subsequently ‘money’ in terms of the act. the sarb (2014:2–5) issued a position paper in which it is explained that bitcoin does not have legal tender status (but is exchangeable for legal tender), and is also not electronic money as electronic money is redeemable for physical cash on demand, while bitcoins are tradable for cash. for normal taxation purposes both berger (2016) and wicht (2016) classified bitcoin as an asset in terms of the south african income tax act 58 of 1962. the definition of ‘services’, section 1 of the act, reads verbatim as follows: ‘services’ means anything done or to be done, including the granting, assignment, cession or surrender of any right or the making available of any facility or advantage, but excluding a supply of goods, money, or any stamp, form or card contemplated in paragraph (c) of the definition of ‘goods’. (republic of south africa 1962:605) the general rule is that when a supply is not a supply of goods and also not specifically excluded from the definition of ‘goods’, it will be categorised as a supply of a service (de koker & kruger 2017). the third requirement for a transaction in south africa to attract vat is that the transaction should constitute a supply of goods or services by a ‘vendor’ (de koker & kruger 2017). this means that if a person is a vendor, they have to levy output tax on the selling price of their taxable supplies. according to section 1 of the act a ‘vendor’ is any person ‘who is, or is required to be, registered under this act’ (republic of south africa 1962:606). for purposes of this study, it is assumed that all parties involved in the bitcoin transactions are registered vat vendors with sars. the fourth requirement for a transaction in south africa to attract vat is that the transaction should constitute a supply of goods or services by a vendor in the course or furtherance of an enterprise. an ‘enterprise’ is generally defined as any enterprise or activity, carried on continuously or regularly, in south africa or partly in south africa, by any person, in the course or furtherance of which, goods or services are supplied for a consideration, whether for profit or not (de koker & kruger 2017). the definition of ‘consideration’, section 1 of the act, reads verbatim as follows: ‘consideration’, in relation to the supply of goods or services to any person, includes any payment made or to be made (including any deposit on any returnable container and tax), whether in money or otherwise, or any act or forbearance, whether or not voluntary, in respect of, in response to, or for the inducement of, the supply of any goods or services, whether by that person or by any other person, but does not include any payment made by any person as a donation to any association not for gain. (republic of south africa 1962:598). if all four of the above requirements of a transaction are met, output tax needs to be levied on the selling price of the goods or services. no output tax is levied on exempt supplies (de koker & kruger 2017). section 12 of the act lists the exempt supplies and one exempt supply which could possibly be applicable to transactions involving bitcoins is the supply of financial services in terms of section 12(1) of the act. this could be the case when bitcoin is exchanged for south african rand (research question 2). therefore, it is necessary to determine if such transaction could be a potential exempt supply. table 2 was used to analyse the supply of financial services that are exempt to determine if it could possibly include transactions relating to the exchange of bitcoin for south african rand. from the analysis performed, it is clear that the exchange of bitcoin for south african rand (research question 2) will not constitute a supply of financial services in terms of section 2 of the (current) act. table 2: determine if research question 2 constitutes a financial service. results the vat requirements explained in the previous section will result in the following output tax treatment based on the two research questions (also refer to table 3 for a summary): research question 1: the receiving of bitcoin in exchange for the selling of goods or rendering of services by a south african vat vendor will be deemed to be a ‘supply’ of ‘goods’ or ‘services’ as it will constitute a barter transaction. it also meets the requirements of ‘vendor’ and ‘in the course or furtherance of an enterprise’ as the goods or services are supplied for a consideration, which is not money, but something else, namely bitcoin (an asset as classified by berger 2016, sars 2018b and wicht 2016 in terms of the south african income tax act, no. 58 of 1962). it is therefore evident that output tax of 14% should be levied on the market value of the bitcoins on the day that the bitcoins are received in exchange for the goods or services. in the example provided in figure 2 this will result in the south african vat vendor (entity a) having to account for output tax of r14 000. research question 2: the exchange of bitcoins by a south african vat vendor for south african rand would constitute a ‘supply’ of ‘services’. as bitcoins will not be treated as ‘goods’ in terms of the act, it will automatically qualify as a supply of ‘services’ in exchange for consideration which is money (south african rand). therefore, all the requirements are met and output tax of 14% should be levied on the value of the exchange (which is the south african rand received). it will not qualify as an exempt supply as it does not meet the requirements of a ‘financial service’ as set out in section 2 of the (current) act. in the example provided in figure 2 this will result in the same south african vat vendor (entity a) having to account for output tax of r31 370 (r255 438 × 14 / 114). as a result the south african vat vendor (entity a) is ‘double taxed’. based on the assumption made under the methodology section on the information provided in figure 1, this would result in output tax of r22 961 883 (r186 975 337 × 14 / 114) to be accounted for by south african vat vendors for the period 01 march 2017 to 28 february 2018. table 3: summary of conclusion based on interpretation of the act. conclusion and recommendations to conclude, it was shown through this study that the proposed treatment as explained in the previous section would impose ‘double taxation’: once on the selling of goods or rendering of services in exchange for bitcoins and once when the bitcoins are exchanged for south african rand. this output tax treatment could possibly result in a decrease in the use of bitcoin by south african taxpayers. aggressive taxation policies on bitcoin could result in a delayed and limited growth for the south african exchange market and the bitcoin industry. against the background of the above, the following recommendations are made to the south african authorities to issue appropriate guidelines to taxpayers in terms of the output tax treatment of bitcoin transactions in south africa: treat both the receiving of bitcoins in exchange for the selling of goods or rendering of services, as well as the exchange of bitcoins for south african rand, as transactions that are subject to output tax at the standard rate of 14%. alternatively, treat the receiving of bitcoins in exchange for the selling of goods or rendering of services as a transaction that is subject to output tax at the standard rate of 14%, but treat the exchange of bitcoins for south african rand as an exempt supply, in terms of the delivery of financial services. based on an interpretation of the (current) act and with reference to the bitcoin exchange figures in south africa, the first proposed treatment could result in decreasing the budget deficit should the exchange of bitcoins for south african rand be subject to output tax. this proposed treatment would therefore benefit the fiscus. the second proposed treatment in the article corresponds with the taxation laws amendment bill of 2018 (national treasury 2018:51) to include ‘the issue, acquisition, collection, buying or selling or transfer of ownership of any cryptocurrency’ by amending section 2(1) of the act. this means that the exchange of bitcoins for south african rand by a south african vat vendor will be treated as a financial service and will therefore be exempted from vat. should this proposed treatment be promulgated by national treasury, the south african vat vendor will obtain the benefit as no output tax will be levied on the exchange of bitcoins for south african rand. note: since the article was accepted for publication, section 2(1) of the act has been amended to include ‘the issue, acquisition, collection, buying or selling or transfer of ownership of any cryptocurrency’, effective from 01 april 2019. recommended research the second research question of this article focused on the output tax implications for the south african vat vendor who receives bitcoins in exchange for selling goods or rendering services, who then exchanges these bitcoins on a bitcoin exchange market for south african rand. in a follow up article both the input and output tax consequences are investigated for such vendor whose business is that of mining and trading with bitcoin. acknowledgements the author would like to thank the anonymous reviewers for their time and input which has been most helpful in refining and improving this article. i sincerely believe that the revised article is of a much higher standard after the recommended changes. competing interests the author declares that she has no financial or personal relationships that may have inappropriately influenced her in writing this article. references ah kun, a., 2014, ‘influence: bitcoin the currency of the future?’, accountancy 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bitcoin be eliminated? the case of south africa [online], viewed 19 june 2017, from https://cointelegraph.com/news/should-tax-on-bitcoin-be-eliminated-the-case-of-south-africa sajems ns 6 (2003) no 4 848 on productivity and technology diffusion in nigeria ________________________________________________________________ ndem ayara ndiyo department of economics, university of calabar, nigeria ________________________________________________________________ abstract this study analyses the long-term trend in knowledge diffusion and productivity growth in nigeria using a translog specification. the results indicate the need for technological upgrading and imply that policies designed to promote technological development should address the complementarities between different factors of production. the article, thus, provides some support for the argument that total factor productivity (tfp) is technological knowledge and can impact significantly on productivity in a developing economy. jel o14, o31, o32 1 introduction technology is the bedrock of human civilization. it determines how production can be realized and sets limits on the amount and types of wealth that can be derived from a given combination of resources. the ultimate impact of technology is the enhancement of the well-being and influence of man through the creation of wealth. technology achieves this impact by making man more productive in his environment (adiele, 2002: 3-4). in the process, man gains a better understanding of his environment and enjoys a higher standard-of-living and control. in the world today, the nations that have acquired advanced technologies are also the most affluent and most powerful nations. economic literature suggests that technological deficiency is a critical factor in the analysis of productivity and of course the economic backwardness of developing economies. the quest for technological development is justified in terms of the hypothesis that a fast rate of economic growth is invariably related to high growth rate of inputs, of which technological development is an important aspect. this is perhaps because economic growth, technical change and productivity are closely linked. change in technology is a critical factor, which enables man to utilize his resource environment more efficiently and to generate the increases in productivity, which are at the heart of the process of sajems ns 6 (2003) no 4 849 economic growth. therefore, output may be increased by technological innovations, which increase the productivity of the existing supply of resources. the characteristics of technology as an economic good may explain why this initially neglected and now widely investigated factor of production remains relatively concealed. technology (which is a method of doing things) is a public good with property rights that are rarely enforceable (navaretti & tarr, 2000: 2). it is hardly quantified or priced; it is sometimes codified, but more frequently tacit and difficult to observe. although well established in economic theory, the link between technology and productivity has been tested by relatively few rigorous empirical studies. the international reference often quoted in this area is coe and helpman (1995), which focuses on knowledge diffusion among organizations for economic co-operation and development (oecd) countries. such aggregative studies assume uniformity in factors of production across countries, which may not necessarily be the case. in nigeria specifically, previous attempts are usually based on the cobb-douglas specification of the production function, which assumes unitary elasticity of substitution between labour and capital, and hicks-neutrality of technical progress. however, an empirical estimation of the technology function using the translog production function has not been attempted so far. typically, if technology is upgraded production processes are enhanced. however, the link between technology and productivity is often assumed to be exogenously determined in the production process. this study is motivated by the need for a deeper understanding of the impact of technological diffusion on productivity performance in nigeria. an empirical analysis of the links between productivity and knowledge diffusion is useful for distilling out some of the key predictions of the theory of endogenous growth models. the focus of this article is, therefore, devoted to the empirical analysis of the diffusion of technological knowledge and economic performance in nigeria. the study attempts to measure the relative contribution to economic growth resulting from technological knowledge and raising productivity of resources. the above objective is achieved by, first of all discussing the relationship between technological knowledge and productivity after examining some conceptual issues in section 2. this is followed by the framework of analysis and some methodological arguments in section 3. the empirical results and research outcomes are presented in section 4 of the paper. implications and concluding remarks close the study in sections 5 and 6. sajems ns 6 (2003) no 4 850 2 conceptual issues productivity is a quantitative relationship between output and inputs (iyaniwura & osoba, 1983; antle & capalbo, 1988, oyeranti, 2000). as long as the basic concept refers to the relationship between the quantity/quality of goods and services produced, this definition of productivity remains the same regardless of the type of production system. in other words, productivity is a ratio of some measure of output to some index of inputs used or the ratio between the quantity of resources used in the course of production. this concept of productivity implies the efficiency with which resources are utilized in production. in effect, productivity becomes an index for measuring the attainment of the highest level of performance with the lowest possible expenditure of resources (eatwell & newman, 1991; samuelson & nordhaus, 1995; prokopenko, 1987). however, productivity is measured by how efficiently resources are transformed from inputs to output, which can also be measured in relation to each of the factors of production. a distinction is made between productivity of labour, productivity of capital, productivity of land and productivity of the entrepreneur. this makes productivity an encapsulating concept that is comprehensively distinctive. thus, the conditions that lead to the improvement of productivity of any factor would vary according to which resource is under consideration. the differential becomes even more pronounced when we consider intersectoral and interindustry characteristics, which are seldom uniform. basically, productivity provides the basis for analyzing the relative dynamism of different economic activities. the increasing focus on productivity is directed towards being able to know more about the process of technical change. it is common practice to classify inputs into land (gifts of nature), labour (human resources), capital (physical and financial assets), and material. olaoye (1985) argues that productivity as a concept has two dimensions: namely, partial factor productivity (pfp) and total factor productivity (tfp). pfp relates output to any factor input, implying that there will be as many measures of productivity as inputs involved in the production process. pfp relates to labour productivity, capital productivity, land productivity, etc. this average product concept measures only output per unit input, ignoring the contributions of other factors to the detriment of production process reality. on the other hand, tfp measures the relationship between output and a composite index of inputs (i.e., the sum of basic resources notably labour, capital goods and natural resources). at the moment, research interest on productivity has focused more on pfp measures, in which comprehensive aggregates of outputs and inputs are related. however, it is common in productivity literature to see emphasis being placed on labour productivity. one justification for the special emphasis on labour sajems ns 6 (2003) no 4 851 productivity is perhaps the fact that labour is a universal key resource (oyeranti, 2000). however, in recent times, advancement in information technology seems to suggest that labour productivity may actually be subordinate to the productivity of capital and other scarce resources such as energy or raw materials. therefore, productivity is better perceived as the end result of a complex social process involving science, research, training, technology, management, production plant, trade union, as well as labour among other interrelated factors. it is a comprehensive measure that is concerned with efficiency and effectiveness simultaneously. the quest for technological development, the world over, is to ensure continued improvement in the standard of living of the people. the ability of a country to sustain rapid economic growth in the long run is highly dependent on the effectiveness with which its institutions and policies support the technological transformation and innovativeness of its enterprises. this perhaps emanates from the close link between technology and education, knowledge and skills. technological progress entails improved ways and methods of doing things. skills, know-how and advancement in knowledge encapsulate technological growth. the improvements in knowledge and know-how are also propagated through education, training and research. it is now obvious that to be a part of the world, there must be science and technology elements in the development process. expanding access to science and technology information and capacity into developing regions will similarly accelerate the paths to development and prosperity in an environmentally sustainable manner. the three main stages of technological development are invention, innovation and diffusion (or adaptation) of invention. the invention stage involves the articulation of ideas, which will eventually help to improve existing methods of doing things. innovation as the second stage is concerned with the process by which inventions are systematically harnessed into new techniques or products, while the third stage, diffusion of invention, consist of commercial production and widespread use of new techniques or new products among potential alternatives (inang, 1982: 34). it should be stressed at this point that, although the diffusion of existing technology is emphasized in this review, continued and sustained growth requires the persistent search for and the introduction of improved methods that are embodied in the former two stages. technological development has over the years been pioneered largely by the advanced industrialized countries which are able to mobilize the huge financial and other resources usually needed for achieving technological progress. the pursuit of technological development in nigeria has been generally approximated with the desire for rapid industrial development. in the less developed countries (ldcs), technological progress has been very slow, and, sajems ns 6 (2003) no 4 852 sometime, almost non-existing, because of the dearth of capital coupled with weak existing national capacities, and sometimes outright unwillingness on the part of the industrialized countries to part with technological knows-how (inang, 1982: 314-515). however, the basic motives for wanting technological development are enormous. advances in agricultural biotechnology will be essential for raising developing world food productivity in order to feed burgeoning populations. new technology applications will be crucial to providing adequate and safe water supplies. clean and renewable energy technologies will be needed to ensure sufficient and sustainable energy supplies for the developing world. similarly, advances in biomedical science and technologies are critical if developing countries are to overcome the daunting public health challenges posed by infectious diseases. however, some advances, such as wireless communications and fuel cells for transportation or distribution of power, can leapfrog older technologies. the above is just a small sampling of areas in which science and technology advances can have enormous beneficial leverage. 2.1 technology and production technology is holistic to production because production says “what” is produced while technology demonstrates “how” it is produced. in fact, production and technology may mean the same thing and are often use interchangeably in reference to the process of wealth creation (adiele, 2002: 8). the essence of production is to create new utility, with the aid of technology. however, a given technology remains unchanged in a particular production process regardless of how long the production process continues. hence, technology is a catalyst in the production process. technology is fast changing the global economic landscape by increasing the importance of knowledge as a factor of production. it is also changing the nature of markets, competition, and source of comparative advantage. fueled by research and the rapid generation of new techniques, technological innovation has become the major factor behind increases in productivity. lucas (1988), young (1991) and stokey (1988; 1991) attribute productivity growth to learning processes, which facilitate the production of increasingly sophisticated products and the accompanying knowledge spillovers. in this way, the more rapidly learning takes place, through schooling or through learning by doing, the higher is the rate at which new high-tech products are introduced into the market, and the higher is the rate of productivity growth. however, in models of economic growth (whether neoclassical or evolutionary), technology usually gets reduced to a single number: total factor productivity (tfp). as a source of tfp, technology combines with capital, land, and labour sajems ns 6 (2003) no 4 853 to produce goods and services. one effect of technological change is to alter the nature of goods, markets, and competition of firms. the great speed of technological change and the rapid accumulation of new techniques demonstrate that firms failing to incorporate new technological knowledge in their production processes lag behind in productivity and competitiveness. technology is a practical description or a demonstration of the entire production process (adiele, 2002: 3). output depends on many factors (inputs) including the total hours of labour, education of the workforce, technology and the amount of capital. output growth, in turn, depends on changes in these factors. in particular, the contribution of technology to output growth is the amount by which output growth would have been reduced if the stock of knowledge capital had not changed while all the other factors that affect output changed. the size of this contribution depends on the importance of the level of technology relative to other factors. it is widely accepted that production theory remains the basis for analyzing the factors that explain changes in output levels resulting from three basic factors; namely, (i) the quality and quality of resources utilised in the production process; (ii) the state of technology or kind of production process that is in use; and (iii) the efficiency with which resources are utilized (oyeranti, 2000: 13-14). these factors measure the differences in productive efficiency, the scale of production, and the state of production technology employed. in this way technology is gradually gaining prominence in the production function. the section, which follows this one, formalizes this intuition and then uses the framework to analyze the contribution of technology to output growth in nigeria. 3 framework for analysis the framework used to assess the role of technology in productivity growth is the standard growth accounting framework. growth accounting allocates the growth rate of national output among the determinants of output that changed and caused growth. it has, however, been demonstrated that the production function methodology can underestimate or ignore the use of improved technologies at the firm level, thereby affecting estimates of multi-factor productivity (mfp) growth (nelson & pack, 1998; djankov & hoekman, 2000). moreover, differences in technological capacity across firms in an industry may be an important determinant of mfp. data confirming these differences is hard to come by, as information on variables relevant to the level of technology of individual firms and the composition of their workforces is hardly available. the trends in the practical productivity indices with respect to individual factors, include the effect of capital depending on the context of capital accumulation in sajems ns 6 (2003) no 4 854 a growing economy. thus, increases in labour productivity may be due to improved efficiency and technological progress as well as the employment of more capital per unit of labour. however, the latter two sets of influences do not operate independently of each other. more specifically, labour productivity may increase because of improved and larger numbers of machines. in fact, if capital investment generates positive externalities, then investment in capital generates social returns in excess of the private returns to firms that made the investment. romer (1990) argues that capital accumulation may result in knowledge spillovers, where increases in the level of capital stock not only increase the productive resources of the firm, but also increase the level of technology available to other firms. the production relationship can be formally derived by assuming that the aggregate production function takes the simple form: y = f(lα, kβ, eλt) (1) where y = output k = capital input l = labour input λt represents a measure of technological diffusion in production over time. the production function in equation (1) implies the following relation between marginal physical products (mpps) and output: y´ = αƒ´(l) + βƒ´k + λt (2) in equation (2) λt measures the technology change or total factor productivity (tfp) growth which may not be accounted for by the increase in inputs used. this implies that beyond partial factor productivity, the growth of output can be decomposed into the contribution of changes in inputs and in tfp. thus, the production function relates the contribution of additional inputs to changes in output and the residual, otherwise called ‘multi-factor productivity growth’ mfpg. the observed increase in λt will underscore the impact of pure productivity of capital and labour in production. it is reasonable, therefore, to argue that in a situation where capital intensity is increasing over time, the analysis of partial productivity changes would overstate the increase in labour productivity and understate the increase in capital productivity. two approaches are used in the measurement of tfp; namely (i) the growth accounting approach, and (ii) econometric approach (antle & capalbo, 1988; oyeranti, 2000). the growth accounting methodology involves compiling detailed accounts of inputs and outputs, summing them into input and output sajems ns 6 (2003) no 4 855 indices, and using the indices to calculate a tfp index. the origins of the growth accounting framework and multifactor productivity (mfp) growth theories can be traced to tinbergen (1942) and solow (1957). the literature on the subject has continued to grow subsequently, reflecting advances in the theory of production and the theory of index numbers and aggregation. the econometric approach on the other hand, involves the specification of a function representing technology as a production function and estimating the derivatives. thus, differentiating the production function with respect to time yields: y = sll + skk+ mfp (3) where l´, k´ and mfp represent the growth rates of the labour input, real capital stock, and multi-factor productivity, respectively, and sl and sk are the income shares of the labour input and the capital stock. under the assumption of competitive equilibrium suggesting that factors of production are paid the value of their respective marginal products and constant returns to scale, the rate of growth of output can be written as: gy = slgl + (1 sl )gk + λ (4) where gy = the growth rate of output gl = the growth rate of labour gk = the growth rate of capital sl = the share of labour in output 1-sl = the share of capital in output λ = residual under the specific assumptions that are made with respect to the production function and market conditions, λ measures that part of growth that cannot be explained by either growth of labour or capital. λ is technically the growth of the weighted sum of all inputs. by relying on mfp as the dependent variable, we assume that the adoption of new technologies will, with some lag, improve productivity. one problem with this assumption is that as the case-study literature has documented, such improvements depend on the absorptive capacity of domestic firms (djankov & hoekman, 2000). the solow concept of mfp growth is unambiguous for infinitesimally small shifts in technology in continuous time. empirical estimates of productivity change, however, are based on a discrete set of price and quantity data. a solution to this problem lies in using a “flexible” functional form of production function, which is a second-order approximation to any arbitrary production function, which is twice differentiable. one such sajems ns 6 (2003) no 4 856 flexible functional form is the logarithmic (translog) production function developed by christensen, et al. (1971, 1973) and popularized by ahluwalia (1991). it does not only naturally accommodate discrete time analysis, but also imposes fewer a priori restrictions on the underlying technology of production, and may not assume a hicks-neutral or a constant rate of technology change. the function is written as: log y = α0 + αl(log l) + αk(log k) + αtt + ½βll(log l) 2 + ½βkk(log k)2 + βlk (log l)(log k) + βlt(log l)t + βkt (log k)t + ½βttt 2 (5) where, the αs and βs are the parameters of the production function. differentiating log y with respect to l and k, respectively, results in ∂log y = αl +βll(log l) + βlk(log k) + βltt (6) ∂l ∂log y = αk +βkk(log k) + βlk(log l) + βktt (7) ∂k in this specification, the elasticity of output with respect to inputs is not constant but depends on input levels and time. this is in contrast with the cobb-douglas production function where these elasticities are constant. the coefficient of the translog production function also provides information on the possibility of factor substitution within the model. when a coefficient is positive, under competitive equilibrium, the factor share increases with the level of the input, assuming the levels of other inputs remain unchanged. the rate of technical progress or total factor productivity growth in a translog production function is given by: ∂log y = αt +βttt + βlt(log l) + βkt(log k) (8) ∂t where αt is the rate of autonomous tfp growth, βtt is the rate of change of tfp growth, and βlt is positive, meaning that the share of capital increases with time and there is a capital-using bias. following ahluwalia (1991), the translog estimate of tfpg can be written as: ∆logtfp(t) = ∆logy(t) -½[sl(t) + sl(t-1)]∆log l(t) – ½{[1 – sl(t)] + [1 – sl (t-1)]} ∆log k(t) (9) since the main focus of this article is to relate productivity growth and technology diffusion, equation (5) has been augmented by including capacity utilization (cu), the incremental capital-output ratio (icor) as well as the capital-labour (k/l) ratio as additional factors of production. control variables sajems ns 6 (2003) no 4 857 for the effects of other changes in the economic environment are also required. good proxies for these changes are not available nor can we account for each of them individually. for this reason an annual dummy variable (t) is included in the estimation equation. this variable picks up the net effect of changes in the aggregate economy. 3.1 methodological arguments data on the macro aspects of the nigerian economy are all gathered from the cbn statistical bulletin and statement of accounts. the latest revised national accounts for 1998 and 2001 form the main sources of data for this analysis. as is well known, there is no universally accepted method of measuring capital stock because of the wide differences existing in the actual methodology used to build the estimates of capital stock. for this reason, gross fixed capital formation (including depreciation) as published by the cbn is used for this study. since this resolution by its very nature is in the realm of second best, the results need to be viewed with appropriate caution. the data analysis started with the ordinary least squares (ols) method. but as usual, a common observation of the time series regressions reveals that the residuals are correlated with their own lagged values. this serial correlation violates the standard assumption of regression theory that disturbances are not correlated with other disturbances. thus, standard errors computed using the textbook ols technique are not correct and they are generally understated, biased and inconsistent. because of the probable correlation between the productivity index and the independent variables, ols may give biased and inconsistent estimates. this simultaneity problem is endemic to the empirical literature on measuring productivity. one widely used model of serial correlation is the first-order autoregressive or ar(1) model. this study employs the ar models, using both linear and loglinear regression techniques. this approach has the advantage of being easy to understand, generally applicable and easily extended to non-linear specifications and models that contain endogenous right-hand variables. it should be noted that the estimates are asymptotically efficient. the approach also enhances the efficiency gain from the serial correlation correction. the coefficients may be interpreted in the usual manner, but the results involving the residuals, however differ from those computed in ols settings. for the simple ar(1) model, the estimated parameter is the serial correlation coefficient of the unconditional residuals. normally, there is no strong reason to examine these residuals. for a stationary ar(1) model, the true marginal significance level lies between negative 1 (extreme negative serial correlation) and positive 1 (extreme positive sajems ns 6 (2003) no 4 858 serial correlation). the stationarity condition for general ar(1) processes is that the inverted roots of the lag polynomial lie inside the unit circle. 4 research outcomes in order to examine the actual impact of factors of production on productivity, we have estimated factor-specific productivity functions, for which data are available. estimates are carried out with semi-log and double-log formulations using the least squares technique. although a large number of variables were included in the preliminary analysis, only a few of them find a place in the final analysis. in order to eliminate the less important variables and avoid a severe problem of multicolinearity, the correlation matrix1 approach has been used. the variables for incorporation in the final specifications have been selected based on the correlation matrices. a number of permutations and combinations of the selected variables have been tried in order to select the good fit in terms of explanatory power and significance of the variables for the final analysis. after trying a number of variables, the final equations for interpretation as shown in tables 1 and 2 below have been selected. all through the presentation of the estimated results, the t-statistic for each coefficient appears in parenthesis below the coefficient. the term ‘statistical significance’ is used to indicate that the coefficient is significantly different from zero and is of the sign indicated at the conventional 5 per cent level of significance for a two-tailed test. in cases where the durbin-watson test rejects the hypothesis of zero autocorrelation, the equation is re-estimated correcting for the first-order autocorrelation using the ar(1). table 1 time series estimate of restricted translog specification of productivity functions in nigeria 1970-2000 dependent variable/ independent variables gdp lab log gdp lab gdp gfcf log gdp gfcf intercept 3240.822*** (3.46) 9.968752*** (15.53) 21694.20* (1.92) 9.952755*** (16.16) lab -42.51723** (-2.50) 1365.202*** (5.79) gfcf 2.847326 (0.86) -80.73023** (-2.06) sajems ns 6 (2003) no 4 859 table 1 continued dependent variable/ independent variables gdp lab log gdp lab gdp gfcf log gdp gfcf time 0.002057 (0.14) -3057.87*** (-12.33) loglab -0.85608*** (-4.27) 0.157945 (0.97) loggfcf 0.155465*** (3.03) -0.83802*** (-28.76) gfcf/lab -0.017478* (-1.47) -0.018376* (-1.75) cu 15.64316** (2.06) 0.007929** (2.32) -333.922*** (-3.53) 0.007550*** (4.41) ar(1) 0.758040*** (6.99) 0.273865* (1.21) 0.279773* (1.44) r2 0.85 0.92 0.93 0.99 adj. r2 0.82 0.89 0.92 0.99 dw 2.05 1.91 1.37 1.91 rss 199.86 0.0896 2.60e+08 0.0897 f-stat 26.56 41.06 67.48 3674.66 no of observations 31 30 31 30 note: (a) figures in parentheses are t-values; (b) *, **, and *** indicate increasing levels of significance at 10, 5, and 1 percent respectively. source: author's calculations the results on table 1 indicate that the double-log specifications are better in terms of their explanatory power and level of significance. as expected a positive relationship was found between labour productivity and capital, as well as between capital productivity and labour. but in contrast to the a priori expectation, labour input contributed negatively to labour productivity while capital input impacted negatively on capital productivity. as found in earlier studies of productivity in nigeria, these results also show that there are some depressing truths when estimating nigeria's production function. as argued in ndiyo (2002), the aggregate data used on the standard growth-accounting model suggest that education has not had the expected positive growth impact on economic growth in nigeria that is so widely acknowledged by many. the resolution of this puzzle begins with a proper understanding of the causes of such an unanticipated relationship. pritchett (2001) in a similar study observes that a single answer to this puzzle is grossly insufficient. it is theoretically quite possible that there could be a wasteful oversupply of education in today's sajems ns 6 (2003) no 4 860 developing economies. one of the best-known manifestations of this occurrence has come be called the external brain drain. this would certainly encourage brain drain since in an open economy like nigeria, this will cause well-educated nigerians to travel abroad for greener pastures. clearly the brain drain is not the result of a simple quantitative oversupply of trained people. it comes about because too many are supplied with the kind of skills for which there is an insufficiency of effective demand at home (gordon, 1973: 3-4). the case of emigrant medical doctors and nurses from nigeria illustrates this problem. why do nigerian doctors and nurses depart by the hundreds when any objective observer would agree that health care in nigeria needs substantial improvement? the answer perhaps is that there are not enough positions in nigeria with sufficiently high incomes to bid trained medical practitioners away from the incomes they can command abroad. however, the resources devoted to their training, convey little or no positive benefit to nigeria after their departure. also, excess qualified manpower tends to draw wasteful investment from the domestic economy in the form of costs that may bear little return. this in turn leads to arbitrary substitution of qualified people by people who are over qualified which indeed is one reason why additional education tends to be socially wasteful although personally profitable. these problems are certainly counter-productive. such imbalance can decrease the prevailing level of output. interestingly, the capital-output ratio is inversely related to both labour and capital productivity. the explanation for this is simply the high labour intensity of nigeria's production processes. the signs for capacity utilization coefficients in table 1 are of particular interest. a positive sign for the estimated coefficient shows that an increase in the value of the variable will result in an increase in the level of productivity. for the overall significance of the model, an analysis of variance needs to be applied (gujarati, 1995). an analysis of variance uses the f-test, which is similar to the t-test, by formulation of null and alternative hypotheses then comparing f-calculated against f-critical. from the results, it can be concluded that the overall model is highly statistically significant, because f-calculated is greater than f-critical. finally, the average r-squared is well above 90 per cent, implying that a very high percentage of variation in the dependent variable is explained by the independent variables. the translog production function specified in this study with its flexible assumptions with respect to technical progress, elasticity of substitution, and returns to scale, yields estimates that are statistically significant with regard to productivity growth. the central findings which emerge from this analysis are discussed below. sajems ns 6 (2003) no 4 861 table 2 gives results from the estimation of a restricted translog specification. the results from the translog model show that capital is positively related to national output while labour maintains its negative impacts across the three specifications. table 2 restricted translog specification of production function in nigeria, 1970-2000 independent variables gdp loggdp(t) loggdp lab -2874.195 (-0.16) -0.193628 (0.17) -0.142196 (-0.81) gfcf 47.56 (0.53) 0.003906 (0.62) 0.001055* (1.04) loglab -9421554** (-2.27) -665.5699** (-2.12) -115.124*** (-3.24) loggfcf -483376* (-1.58) -33.74636* (-1.50) -5.961559** (-2.23) tfp 58140.49** (2.34) 4.090812** (2.19) 0.743410*** (3.61) time 25125.97 (0.69) 6.653338** (2.47) (loglab)2 2410180** (2.088) 166.1378* (1.94) 28.6991** (2.33) (loggfcf)2 -29679.93 (-0.89) -3.756732* (-1.69) -0.436447 (-1.11) (loglab)(loggfcf) -185755.8 (-0.99) -6.998283 (-0.56) -2.291801 (-1.05) loglab(t) 31002954** (2.34) 2180.786** (2.19) 396.6552*** (3.61) loggfcf(t) 3214641** (2.34) 226.4282** (2.19) 41.09030*** (3.61) ar(1) 0.272090 (1.13) r2 0.93 0.92 0.93 adj. r2 0.90 0.89 0.92 dw 1.79 1.86 1.87 rss 6.00e+08 2.19 0.06 no. of observations 31 30 30 note: (a) figures in parentheses are t-values; (b) *, **, and *** indicate increasing levels of significance at 10, 5, and 1 percent respectively source: author's calculations sajems ns 6 (2003) no 4 862 the results for the translog model show that some of the input parameters are not significant even at 10 per cent level. a pertinent research issue at this juncture is – what do the results indicate for production efficiency and the determinants of inefficiency? the specifications indicate that tfp should be included in the production model because observations are all positive and significant either at 5 per cent or lesser level. however, the tfp parameter in table 2 may be interpreted loosely in the present context as a symbol of the amount of unexplained variation in technical efficiency. there has been negligible and insignificant growth in total factor productivity between 19702000. it is worth noting that the semi-log trend analysis using the growth accounting framework of tfp growth had shown better results. generally, the estimates of the translog production function suggest the absence of constant returns to scale, and negligible growth in total factor productivity. the results obtained here, like those of ahluwalia (1991), show that the estimate of tppg is negative and statistically significant, although increasing returns to scale compensate for the declining efficiency in factor use to a certain extent. attempts were also made to estimate the commonly used cobb-douglas production function, but this empirical exercise was severely hampered by the high noise element in the data, and a strong time trend in technological bias of the production function. 5 implications policy and regulatory frameworks should encourage technological upgrading and allow firms to respond to the changing global economy in an efficient way. in order for this to happen, government action is required to get institutions and networks started that can tap information about technology and market trends both locally and worldwide. adaptation of new technologies to local problems and condition is required for better diffusion, adoption, and use of new technologies. the process of diffusion and implementation is greatly strengthened if there is feedback from the users of technology to the generators of knowledge through a network of research laboratories linked to the private sector. there is a need, therefore, to pool scientific, technological, and educational resources among different sectors of the economy in order to generate a critical mass of resources beyond individual sector capacities. workers need an educational and training system, that enables them to increase their experience in dealing with emergent situations and provides them with opportunities for paramount learning. new knowledge must be grounded in what is already understood by knowledge technological concepts and linked to local culture and knowledge. sajems ns 6 (2003) no 4 863 6 concluding remarks most attempts made in the past to estimate production functions for nigeria have been based on the cobb-douglas specification of the production function, which assumes unitary elasticity of substitution between labour and capital and hicks-neutrality of technical progress. estimates of production functions for the whole economy using the translog production function have not been attempted thus far. in this study, the evidence supporting the effect of technology diffusion on productivity growth through capital goods is examined. an empirical model in which capital productivity is related to the number of technological factors (inputs) employed, is developed. three conclusions emerge from the analysis. first, there is evidence that technology influences the total variation in nigeria’s productivity growth rates. these results suggest that a large impact on productivity comes from labour than from capital. it is likely that the contribution of capital sources of technology is larger than that of labour in nigeria. to confirm this conjecture, high-quality industry-level measures of productivity and technological effort, which are often difficult to obtain, are required. given the spillover effect of technological advances for a typical developing country such as nigeria, one would expect a stronger effect on productivity growth resulting from capital inputs, than was estimated here. it also follows that the source of technology diffusion is of significant importance. achieving sustainability in development demands new knowledge, which science and technology must provide. research and innovation are essential for increasing nigeria's ability to deal with the sustainable development challenge. technology diffusion and its causes need to be better understood. its impact, magnitude, tie scale and probability need to be assessed. trends in technology diffusion and the effects of certain specific actions need to be ascertained. test solutions must be developed, outcomes predicted and potentially harmful actions mitigated so that informed policy decisions can be made. the pursuit of technical knowledge is an ongoing process and the knowledge base must be constantly renewed and replenished. experts in the biological, physical and engineering sciences must work closely with experts in the social and behavioural sciences to speed up the application of innovations and insights to the needs of society. there is every confidence that advances in science and technology would enable countries to increase the efficiency of resource use which would in turn raise living standards to levels necessary for global prosperity and long-term sustainability. sajems ns 6 (2003) no 4 864 however, technology is not a package that can be bought off the shelf and become immediately productive. rather it is a commutative process of learning. thus, for developed and developing countries alike, the ability to realize knowledge-based productivity depends on a country’s capacity to tap the global system of generation and transmission of knowledge, generate indigenous knowledge, diffuse and transfer information, and use that knowledge in production processes. endnotes 1 the correlation matrices have not been presented here in order to save space. in order to check for multicollinearity, the rule is that, if the simple correlation coefficient of two independent variables is greater than the value of multiple “r”, then one of the two correlation variables has to be dropped (klein, 1962: 64). sajems ns 6 (2003) no 4 865 appendix gross domestic product, inflation rate, labour force, consumer price index, real wage & unemployment rate in nigeria, 1970-2000 year gdp infr labf cpi cu rwag unpr gdp/lab infr/ unpr 1970 54148.9 13.8 32.1 10.8 74 2.5 10 1686.882 23.8 1971 65707 15.6 32.9 12.5 74 2.6 10.5 1997.173 26.1 1972 69310.6 3.2 33.8 12.9 70 2.7 10.5 2050.61 13.7 1973 73763.1 5.4 25.8 13.6 70 2.89 9 2859.035 14.4 1974 82424.8 13.4 26.6 15.4 76.6 4.03 8 3098.677 21.4 1975 79988.5 33.9 27.4 20.7 77.4 5.73 8 2919.289 41.9 1976 88854.3 21.2 28.3 25.6 78.7 6.83 8.5 3139.728 29.7 1977 96098.5 15.4 29.2 29.6 72.9 8.34 8.8 3291.045 24.2 1978 89020.9 16.6 30.1 34.5 71.5 10.06 8.9 2957.505 25.5 1979 91190.7 11.8 31.1 38.5 70.1 10.27 9 2932.177 20.8 1980 96186.6 9.9 32.1 42.3 73.3 11.88 9 2996.467 18.9 1981 70395.9 20.9 32.9 51.2 63.6 16.22 9 2139.693 29.9 1982 70157 7.7 33.8 55.1 49.7 16.5 10 2075.651 17.7 1983 66389.5 23.2 34.7 67.9 43 16.41 11 1913.242 34.2 1984 63006.4 39.6 35.6 94.8 38.3 14.66 12.5 1769.843 52.1 1985 68916.3 5.5 36.6 100 38.8 15.23 13 1882.959 18.5 1986 71075.9 5.4 37.6 105.4 40.4 14.68 13.5 1890.317 18.9 1987 70741.4 10.2 38.6 116.1 42.4 16.77 15 1832.679 25.2 1988 77752.5 38.3 39.7 181.2 43.8 19.89 15.6 1958.502 53.9 1989 83495.2 40.9 47.7 272.7 40.3 22.82 18 1750.424 58.9 1990 90342.1 7.5 41.9 293.2 42 26 25 2156.136 32.5 1991 94614.1 13 43.1 330.9 38.1 29 26 2195.223 39 1992 97431.1 44.5 44.3 478.4 37.2 25.58 27 2199.348 71.5 1993 100015 57.2 45.6 751.9 30.4 27.18 28 2193.316 85.2 1994 101330 57 46.1 1180.7 39.3 26.62 28.5 2198.048 85.5 1995 103503 72.8 46.8 2040.4 32.5 24.9 39.8 2211.600 112.6 1996 107020 29.3 47 2601.1 30.4 26.4 40.7 2277.021 70 1997 110400 8.5 47.4 2856 30.1 27 41.6 2329.114 50.1 1998 113000 10 52 3039 31.4 27.9 42.5 2173.077 52.5 1999 116400 6.6 57.9 2947.5 30 30.1 43.4 2010.363 50 2000 120090 6.9 61.3 2993.3 32.3 33.2 44.3 1959.054 51.2 source: cbn statistical bulletin and annual report and statement of accounts (various issues) sajems ns 6 (2003) no 4 866 references 1 adiele, c.j. 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(1990) “endogenous technological change”, journal of political economy, 98(5). 22 samuelson, p.a. & nordhaus, w.d. (1995) economics, (15th ed.) mcgraw-hill, new york. 23 solow, r.m. (1957) “technical change and the aggregate production function”, the review of economics and statistics, august (39): 312-20. 24 stokey, n. (1988) “learning-by-doing and the introduction of new goods”, journal of political economy, 96(4). 25 (1991) “human capital, product quality and growth”, quarterly journal of economics, 1: 6-9. 26 young, a. (1991) “learning-by-doing and the dynamic effects of international trade”, quarterly journal of economics, 106(2). abstract introduction implementation of spanish oda the efficiency issue assessing efficiency data envelopment analysis applying dea to evaluate efficiency of the non-profit sector method results discussion and conclusion acknowledgements references appendix 1 appendix 2 footnotes about the author(s) victor martin-perez department of business and marketing, business school, university of valladolid, spain natalia martin-cruz department of business and marketing, business school, university of valladolid, spain citation martin-perez, v. & martin-cruz, n., 2017, ‘efficiency of international cooperation schemata in african countries: a comparative analysis using a data envelopment analysis approach’, south african journal of economic and management sciences 20(1), a1401. https://doi.org/10.4102/sajems.v20i1.1401 original research efficiency of international cooperation schemata in african countries: a comparative analysis using a data envelopment analysis approach victor martin-perez, natalia martin-cruz received: 26 may 2015; accepted: 16 jan. 2017; published: 28 feb. 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: efficiency measurement by means of data envelopment analysis (dea) in the non-profit sector has focused on the so-called stage i of non-profit organisations, namely, fundraising efforts (which are the most influential determinants of raising funds in order to increase the amount of contributions). however, for the so-called stage ii of non-profit organisations, namely, spending the achieved resources to program services delivery, dea studies are very scarce. in attempting to address this research gap and to the best of our knowledge, this investigation is the first study that applies dea to the assessment of international cooperation schemata. consequently, we offer a significant contribution to the literature by overcoming the limitations of other techniques used to assess the efficiency and providing new insight into the efficiency of targeted different international cooperation schemata (ics) in international cooperation development projects. aim: the purpose of this study is to evaluate and compare the efficiency of the ics of developmental projects funded by the spanish agency for international cooperation for development. setting: our setting is composed of different international cooperation projects funded with different schemata by the spanish agency for international cooperation for development between 2002 and 2006 in two african countries that are top priority targets of spanish international aid: morocco, and mozambique. methods: using a sample of 48 international cooperation projects carried out in two african countries considered priorities in the spanish cooperation master plan, we analyse project efficiency using dea. results: the findings suggest that some schemata are more efficient than others when applied to international cooperation projects (ics). specifically, we find that permanent open-call subsidies are more efficient than non-governmental development organisation subsidies. conclusion: measures for evaluating international aid projects with respect to efficiency are problematic. the dea method provides an ex-post meausure of efficiency that allows for the measurement in a specific and objetive way of the results achieved by each project and to propose corrective actions for the future. the comparison among ics provides an opportunity to identify the conditions under which an ics may achieve greater efficiency. introduction international cooperation has grown significantly in recent years, in fact, in 2009 the organisation for economic co-operation and development’s development assistance committee (dac) provided 85  874 million euros in official development assistance (oda), of which 6% corresponded to spanish oda (maec 2009). the increase in the volume of aid and other resources towards achieving the united nations’ eight millennium development goals by 2015 has been accompanied by a growing demand for effectiveness in development assistance (ocde 2005:1). countries that participated in the second high level forum on aid development effectiveness in paris in 2005 recognised and committed to increasing aid effectiveness to achieve the millennium development goals. bilateral oda from dac countries, especially in the case of spain, represents more than 70% of total aid since 2000. african countries are specially considered in the destination of this specific aid. in fact, two areas are priorities for spanish international cooperation: north of africa (maghreb, middle and near east: algeria, morocco, mauritania, tunisia) and sub-saharan countries (sub-saharan africa: mozambique, angola, namibia, senegal and cape verde). in the period 2002–2006, countries belonging to north africa received approximately 15% of bilateral oda per year on average and those from sub-saharan africa received approximately 10% of bilateral oda per year on average. although different international cooperation schemata (ics) are used to run these bilateral aid projects, all ics are implemented either by non-governmental development organisations (ngdos) or by the spanish agency for international cooperation for development (aecid). in each case, the primary focus is on effectiveness as the essential principle. however, in a world of scarce resources–especially in the international cooperation sector–effectively achieving goals is not sufficient. what really matters is efficiency: that is, controlling the level of resources used to achieve a certain goal (banerjee 2008; duflo & kremer 2003). increasing efficiency implies that a project is able to carry out more activities using the same amount of resources, which allows the project to extend the effect of the assigned resources for development as well as to reduce the pressure on the founder organisations and entities. in addition, the trend of national governments towards outsourcing international development aid makes efficiency imperative for non-profit organisations, especially ngdos. accounting measures of efficiency in the non-profit sector, such as programme spending, price, technical efficiency and allocative efficiency, are based on ratios. these ratio measures only show the average percentage of the available resources devoted to the mission of the non-profit organisation or to the goals of the projects implemented by a non-profit organisation, but they do not provide information about the level of the achievement of the objectives or the level of resources applied, that is to say, they indicate how much of the donors’ contributions goes to the cause but do not take into account the impact of the non-profit’s spending. to address this limitation, dea methodology is proposed to analyse the relative efficiency in the non-profit sector. this technique estimates the relative efficiency objectively and numerically, taking into account several inputs and outputs without assuming weights and functional form of the production function, which makes it especially suited for non-profit organisations and, consequently, for the evaluation of international cooperation projects. this methodology has already been used in earlier efficiency studies in the non-profit sector, but these studies have focused on the so-called stage i of non-profit organisations, namely fundraising efforts (which are the most influential determinants of raising funds in order to increase the amount of contributions). however, for the so-called stage ii of non-profit organisations, namely spending the achieved resources to programme services delivery, dea studies are very scarce. in attempting to address this research gap, this article assesses how efficiently the aid funds are actually spent by different spanish aid instruments for the intended purposes and to compare different instruments in this regard. specifically, this study, applying dea, evaluates and compares the efficiency of a set of spanish international cooperation projects funded with different schemata by the aecid between 2002 and 2006 in two african countries that are top priority targets of spanish international aid: morocco and mozambique. to the best of our knowledge, this investigation is the first study that applies dea to the assessment of ics. consequently, we offer a significant contribution to the literature by overcoming the limitations of other techniques used to assess the efficiency and providing new insight into the efficiency of targeted ics in international cooperation development projects. the remainder of this article is organised as follows. ‘implementation of spanish oda’ section explains the various ics applied to implement the oda. ‘the efficiency issue’ section presents the different measures that have been used to assess aid efficiency and the measurements resulting from applying dea. the section also discusses the appropriateness of applying dea methodology to this study. the ‘method’ section describes the sample, information sources and variables used to measure efficiency. the ‘results’ section provides the main results, and the ‘discussion and conclusions’ section offers conclusions, discusses the main limitations of the study and provides some lines for further research. implementation of spanish oda international cooperation projects are funded using different ics from oda. the organisation for economic co-operation and development (oecd 2008) defines oda as resources transferred to recipient countries on the dac1 list as well as to multilateral institutions for development. this assistance is provided by international agencies to promote the development and welfare of recipient countries. in addition, to be characterised as oda, transfers must be concessional2 in character. bilateral or multilateral oda to recipient countries can be provided by different sorts of agencies (i.e. state or local governments or by their executive agencies). we focus on non-reimbursable and bilateral oda schemata funded by the aecid. permanent open-call subsidies (poc) and ngdo subsidies (ns) are the kinds of schemata most employed by the aecid. poc subsidies fund international cooperation projects of a particular initiative of any non-profit organisation. call resolutions of the current spanish cooperation master plan and the international cooperation annual plan state the priorities for granting these subsidies. in the selection of applicants, the aecid considers the project’s application to the sectorial and geographical priorities of spanish cooperation; its complementarities with other projects related to cooperation for development; the content, relevance and quality of the project; and the appropriateness and viability of the project. according to the spanish cooperation master plan 2005–2008, ngdo funding is held in accordance with the objectives and priorities of the spanish international cooperation policy. consequently, subsidies to ngdos are in line with the principles of cooperation, complementarities, quality and effectiveness of aid. aecid can fund ngdo projects by means of two schemata of cooperation: actions and programmes. firstly, cooperation for development actions has a single development goal, is carried out in one country and targets a predefined population; in addition, their effects should extend beyond the execution period. secondly, programmes have a multiyear basis and pursue an overall development goal shared by both the ngdo and the aecid. they can involve actions in more than one country and in more than one sector. they have a maximum duration of 4 years, which can be extended for two additional years. in addition, only ngdos identified as ‘qualified’ by the aecid (based on criteria such as years of experience, financial strength, transparency, accountability and human resources, among others) can access these cooperation instruments. spanish cooperation establishes geographical priorities for aid. these priorities are based on several factors: development indicators, the presence and articulation of spanish cooperation in the country, the possible partnership framework in the country, the potential of the country as a development partner and the relative position of spanish cooperation regarding other donors3. given these priorities, beneficiaries of assistance can be broken down into three subgroups: (1) countries with a wide association, (2) countries with a focused association and (3) countries associated for consolidating development achievements. countries with a wide association include the least developed countries, with lower-middle income. in these countries, large volumes of oda can be channelled through a long-term framework and the application of different kinds of ics. countries with a focused association also include least developed countries with lower-middle income but in which the cooperation programme does not allow a long-term or established framework association. the development impact in countries in this group increases when the aid is focused on a particular aspect identified along with the partner country. therefore, a more selective use of instruments is recommended. finally, some countries associate to consolidate development achievements, that is, the aim of aid in these countries is to strengthen inclusive public policies, promote south–south cooperation, encourage triangular cooperation and provide global public goods. the efficiency issue to assess the efficiency of ics, we must first define efficiency. the concept of efficiency widely refers to the relation between the level of objectives achieved and the amount of resources applied (martín, martín & hernangómez 2007). the first problem relative to this definition is as follows: given the relation between objectives and resources, how can we determine whether it is efficient? or, in other words, how do we establish an appropriate standard of efficiency? a second problem lies in the objective’s multiple dimensions (outputs) and the multiple resources used (inputs), which requires that we assess all dimensions simultaneously and that we assign weights to all organisational factors (hernangómez et al. 2009). to evaluate the efficiency of ics, we must determine the goal. in this sense, the understanding of the framework within which they operate is required. that is, ics are the means by which organisations act to improve the quality of life in developing countries. the schemata are tailored to address a specific need (or set of needs) in the receptor country. consequently, if the objective of the ics is related to the question of what they are trying to achieve, the answer is to improve the quality of life and welfare for people in developing countries, an objective that is shared by the ngdo subsector globally. therefore, the objective of the ics is to improve the welfare of as many people as possible by meeting the specific need for which they were created. extending this thinking to the institutions that manage ics, the notion of efficiency suggests that if ngdos were marketable, an investor would find more value in organisations with the ability to generate greater prosperity or bring benefit to a greater number of people using the least possible resources. that is, the buyer would choose the organisation that manages more efficiently the chosen instrument of cooperation. therefore, to evaluate the efficiency of ics, we extrapolate the arguments used to assess the efficiency with which ngdos operate. assessing efficiency assessing the efficiency of non-profits organisations such as ngdos and their instruments – in this case, cooperation for development projects – involves certain difficulties because the objective is often more difficult to identify and measure than the objective of a firm4. in addition, because projects have multiple dimensions (project quality, relevance to the needs they serve, sustainability, impact, etc.), the production function can be difficult to determine. proposed methods for evaluating the efficiency of ngdos are commonly based on accounting measures, mainly ratio analysis, and include price, programme ratio, technical efficiency and allocative efficiency. price is defined as the cost, for a donor, of purchasing a dollar of output for an organisation’s beneficiaries. without accounting for tax deduction, price is measured as the inverse of the percentage of expenditure on projects (callen 1994; posnett & sandler 1989; tinkelman 1998; weisbrod & dominguez 1986). some studies use programme ratio represented as the percentage of project expenditures to total expenditures to measure efficiency (baber, roberts & visvanathan 2001; roberts, smith & taranto 2004). baber et al. (2001) argue that this measure may indicate the fundraising strategy of the non-profit organisation. allocative efficiency, a very similar and also widely used measure (andrés-alonso, azofra-palenzuela & romero-merino 2010; andrés-alonso, martín-cruz & romero-merino 2006; callen & falk 1993; hernangómez et al. 2009), calculates the percentage of project expenditures to total revenue of the entity. technical efficiency or administrative expense ratio (andrés et al. 2006, 2010; callen & falk 1993; greenlee & brown 1999; hernangómez et al. 2009) is defined as the percentage of administrative expenses on total expenditures. however, these measures do not correspond to the concept of efficiency as previously defined – that is, the relation between the objectives achieved and the resources used – because they address neither the level of achievement of the objectives nor the level of resources applied. they only provide information on the extent to which a non-profit organisation devotes the available resources to its mission, which corresponds to the definition of efficiency established by parsons (2003); that is, these definitions commonly show the average percentage of each donation that reaches the beneficiaries of the organisation. despite their limitations, these indicators – especially technical and allocative efficiency – are widely used by both donors (hyndman 1991; khumawala & gordon 1997) in their donation decisions as well as by the organisations themselves to show an image of transparency and fulfilment of their mission in hopes of generating greater fundraising. the use of these indicators is based mainly on its simplicity, easiness of obtaining information and the possibility to make uniform comparisons among entities. in comparison with accounting methods, frontier analysis is becoming more and more important. frontier analyses use the construction of efficient frontiers as a means to measure the relative efficiency of a group of organisations. the notion of the existence of a maximum achievable level underlies this methodology. efficient frontiers can be calculated using either parametric or non-parametric techniques. parametric techniques require the specification of a functional form of the production function to estimate (i.e. regress) the optimum relation between outputs and inputs. these techniques are very sensitive to the specification of the production function. when the functional form is not correctly determined, results are significantly biased. thus, the efficient frontier method is only recommended if a specification of the production function close to the underlying production technology can be obtained. non-parametric methods use dea to determine the efficient frontier based on a global efficiency indicator that relates objectives (outputs) and resources used to obtain these objectives (inputs). therefore, dea allows us to measure the relative efficiency of homogeneous decision-making units (dmu) while including a large number of variables and relations (constraints). this method is particularly suitable for the non-profit sector for two reasons. firstly, dea is especially adaptable to the features of non-profit organisations, in which the pricing of products and services is difficult, production function is not easily defined and multiple inputs and outputs are at play. secondly, dea establishes an objective indicator of efficiency for groups of organisations that do not have aggregate indicators and considers the multiple simultaneous objectives that non-profits try to achieve (hernangómez et al. 2009). data envelopment analysis developed by charnes, cooper and rhodes (1978), data envelopment analysis (dea) consists of a linear programming technique that evaluates the relative efficiency of different dmu. the method identifies the efficient5 units and builds a frontier shaped by the linear combinations between these units. the efficiency of other units is measured by their distance from the estimated efficient frontier. the analysis is formulated as a mathematical optimisation problem in which the estimated variables are the efficiency indices – defined as the weighted sums of outputs and weighted sums of inputs ratio – and the corresponding weights. it is a non-parametric technique because it does not specify a functional form between the maximum achievable outputs and required inputs. thus, the application of this methodology makes it possible to obtain an efficiency indicator for each dmu that varies between zero and one (with one as the indicator of those dmu located in the frontier). in addition, the weights are endogenously determined, with their values corresponding to the maximum achievable efficiency. therefore, this methodology allows us to compare the efficiency level of different dmus, assists in identifying best practice and objectively determines the productive improvement and overcomes the problems associated with accounting and parametric frontier methods. several dea models exist according to different assumptions about production technology and the related restrictions incorporated. figure 1 provides the mathematical formulation of the basic model, assuming constant returns to scale for output and input orientation. where ϕ0 and φ0 represent the efficiency indicators for each orientation, yrj and xij represent the amount of output r and input i of dmu j, ur0 and vi0 represent the weights of output r and input i. finally, ε is a small enough-positive value which the weights cannot fall (basso & funari 2004). figure 1: ccr model. as previously mentioned, multiple outputs and inputs can be included in the analysis. however, as the number of included variables increase, the discriminating power of the dea6 decreases. in addition, no tests can determine the statistical significance of the included variables or evaluate the goodness of fit. because of these considerations, the general recommendation is that the number of inputs and outputs should not exceed one-third of the sample size (banker, charnes & cooper 1984; banker et al. 1989; mcmillan & datta 1998). moreover, as dea estimates relative efficiency, the dmu included in the analysis must be homogeneous because of the sensitiveness of this technique to extreme values. that means that they must apply the same production technology and operate under the similar institutional framework. a final consideration is related to the choice of analysis orientation (output vs. input). this option depends on the nature of the problem and is related to the ability of organisations to control variables. if the analysed units are restricted in the management of inputs, output orientation is chosen, and vice versa. in the output-oriented approach, a unit is defined as efficient when no other unit can produce a higher level of output using a lower level of input. likewise, for an input-oriented approach, a unit is defined as efficient when no other unit can reduce the input amount (keeping the proportion) and get the same amount of output. in sum, we apply dea to assess the efficiency of ics. this analysis allows us to measure efficiency – defined by the relation between the objectives achieved and the resources used – and to include multiple inputs and outputs without defining the functional form of the production function. furthermore, dea makes possible valid comparisons among projects, and the available data meet the methodology requirements. applying dea to evaluate efficiency of the non-profit sector we are motivated to apply dea to the non-profit sector to evaluate the efficiency of non-profits to produce the goods and services provided to beneficiaries with the donated resources simultaneously considering their multiple objectives. this methodology is particularly applicable because it allows us to identify the input reduction necessary to achieve efficiency (mcmillan & datta 1998) as well as the levels of inefficiency of different units (charnes et al. 1994; farrel 1957; farrell & fieldhouse 1962) and their causes. research on the study of efficiency in the non-profit sector, especially in the areas of health (al-shammari 1999; garcía et al. 1999; hofmarcher, paterson & riedel 2002; magnussen 1996; valdmanis 1992; watcharasriroj & tang 2004) and education (avkiran 2001; banker, janakiraman & natarajan 2004; johnes & johnes 1995; korkonen, tainio & wallenius 2001; mcmillan & datta 1998; ruggiero 1999), is extensive. yet, in the field of international cooperation for development, the literature is still scant. however, several prior studies have applied dea to measure the relative efficiency of the ngdos (hernangómez et al. 2006, 2009; martín, martín & hernangómez 2005, 2007), the efficiency of the two stages of the production process of ngdos (garcía & marcuello 2007; golden et al. 2012; marcuello 1999) and the efficiency of international cooperation for development projects (martín, martín & gámez 2012). although a functional form of the production function is not necessary, dea does require that the relevant outputs and inputs of the evaluated activity be established. the most common approach to making this determination is the development of a list of outputs and inputs, identified either from observation of evaluated units or from a literature review. from this list, the most suitable outputs and inputs are selected, considering the preservation of dea discriminating power (garcía & marcuello 2007; hernangómez et al. 2006, 2009; marcuello 1999; martín et al. 2005, 2007). output determination requires the definition of the objectives to be achieved. regarding the mission of the ngdos, two main objectives have been considered, such as the eradication of poverty in the non–developed countries and education for development in northern societies. in line with these objectives, prior empirical studies that have applied dea to the field of international cooperation have used project expenditures (golden et al. 2012; marcuello 1999), total funds raised (garcía & marcuello 2007; golden et al. 2012) and the number of projects (hernangómez et al. 2006, 2009; martín et al. 2005, 2007) as outputs. previous research has measured inputs as operating costs, donations and grants (golden et al. 2012; marcuello 1999), number of volunteers (garcía & marcuello 2007; marcuello 1999), administrative expenses (garcía & marcuello 2007), income, number of employees (garcía & marcuello 2007; hernangómez et al. 2006, 2009; martín et al. 2005, 2007) and the age of the organisation (hernangómez et al. 2006, 2009; martín et al. 2005, 2007). some measures have been used both as inputs and outputs, given the two stages identified in ngdos functioning: activities aimed at fundraising and the application of the obtained resources to perform projects. method sample and information sources the objective of this study is to analyse the efficiency of the ics for spanish oda instruments applied in two african countries with a wide association (i.e. a long-term framework and the application of different kinds of ics are possible), morocco and mozambique. these countries are considered with top priority for spanish cooperation aid. the study period extends from 2002 to 2006. this term of 5 years includes the latest available data at the collection moment (june–december 2009) and is long enough to draw conclusions from the analysis. because of the lack of a database, information was obtained at the headquarters of the aecid using information reports from ngdos, aecid technicians and the audits of performed projects as well as in-depth interviews with technicians of the analysed countries. table 1 shows figures of bilateral oda received by the two sample countries between 2002 and 2006. aid to these countries grew over the whole period, especially towards the end when new policies of aid for development that aimed at reaching a rate of 0.7% of the gross domestic product were enacted. the lowest percentage of aid to these countries is 3.3% in 2003, and the highest percentage of aid is 6.1% in 2004. our sample consists of 48 ics, of which 18 are poc subsidies and 30 are ngdo subsidies. furthermore, of a total of 48 ics, 30 correspond to morocco and 18 to mozambique. table 1: spanish bilateral official development assistance. the 48 ics analysed are projects related to the millennium development goals focused on community development (health, democratic governance, gender, education, rural development, economic growth and employment), infrastructure and agriculture. instruments focused on community development represent 90% of the total ics, whereas those focused on infrastructure and agriculture represent 6% and 4%, respectively. so our sample is composed of quite homogeneous instruments because the inputs employed to perform most of them are very similar (intensive in human factor and low capital-intensive). this way, we feel confident about the homogeneity of the sample and think that dea application should not be a serious concern. no database collects information about the ics management. therefore, we were required to build a new database with information provided by the aecid. in so doing, we needed to solve some problems. firstly, no protocol exists for monitoring these instruments. as a result, quantitative information is not always available for all projects, and it is not possible to obtain all the items identified for all sample projects. in addition, the period of execution is commonly extended and delays occur. consequently, the sample includes projects currently underway and projects for which information gaps exist. secondly, aecid has an established set of accounting items for budgeting ics (see appendix 1). in the database used to perform dea, we set a correspondence between those items and the items associated with the national public accountancy plan (npap). thus, identified inputs correspond to the npap items. variables in the section titled ‘applying dea to evaluate efficiency of the non-profit sector’, we presented the main variables used to measure the efficiency of ngdos as well as their chief objectives and the main resources used in achieving them. however, we are not trying to assess the efficiency of the actual ngdo missions but rather the efficiency of the specific instruments used to achieve these missions. therefore, we must conceptualise the objective of these instruments to define the outputs as well as the main resources to determine the inputs to be included in the analysis. martín et al. (2012) argue that the objective of international cooperation projects performed by ngdos is the maximisation of social welfare of the population or area where the project is being carried out. in this line, we define the objective of the ics as meeting the specific need for which they were created for many people as possible. then, we establish a list of dimensions that make this objective operative and for which data are available. our list consists of the number of activities, beneficiaries, areas, families, and organisations and duration in months7. when determining the dimensions to measure the output, we considered the availability of information and level of importance that aecid technicians gave to these dimensions. our goal is to select dimensions with information available for as many instruments as possible so that we can make significant dea comparisons. in addition, we asked 15 aecid technicians, who are responsible for ex-ante evaluation, monitoring, supervision and ex-post evaluation of the different instruments, to rate the importance of the chosen dimensions on a scale from least important to most important. table 2 shows the results. unfortunately, the two dimensions most valued by the aecid technicians have the lowest level of information; therefore, data availability is the primary criterion for the selection of outputs, which dictate that we focus on duration, activities and areas served. table 2: data availability and importance of the outputs. we select the following as the main inputs to measure the efficiency of ics: purchases of raw materials, staffing costs (salaries), communications and other services, services from independent professionals, purchases of other supplies, repairs and maintenance, leasing charges and fees, and subsistence allowance. in selecting the inputs for the efficiency analysis, we assume that those inputs used by most instruments are the ones that endow a higher discriminating power to dea because they allow for a more homogeneous comparison. table 3 shows that most often used inputs are purchases of raw materials, staffing costs, and communications and other services – all of which are used by over 90% of the instruments included in the sample and together represent 91% of total executed expenditures. table 3: use and importance of inputs. in sum, the production function (the base scenario) with which we assess the efficiency of ics includes purchases, wages and salaries, and communications and other services as inputs and activities performed, and areas served as outputs. we opt for an output orientation to perform dea because we assume that, given a certain resource level (i.e. available budget), each instrument will attempt to maximise results (i.e. to reach the largest number of individuals or areas, perform the most activities, etc.). results in this section, we present the results of the dea analysis performed by means of the previously discussed outputs and inputs. the sample consists of 48 instruments, of which 18 are poc subsidies and 30 are ngdo subsidies. firstly, we assess the efficiency of the two types of ics. then, we analyse the efficiency with which these instruments are implemented in each of the two priority african countries for spanish oda included in our sample (general model). these results are subjected to a sensitivity analysis, in the first place by removing the extreme cases (the most efficient and the least efficient instruments) and secondly by performing the dea analyses with different inputs specification, to assess the effects from inclusion or exclusion of certain cost categories. finally, we complement our analysis with two additional models (alternative models 1 and 2) to measure the consistency of results and to check the robustness of the analysis. table 4 shows the inputs and outputs for the three models. appendix 2 reports the results for the two alternative models. table 4: models employed to perform data envelopment analysis. table 5, panel a, provides a summary of results of the general model. the results show that 12 instruments are efficient, which represents 25% of the total observations included in the sample. in terms of efficiency by type of instrument, five poc subsidies (27.7%) and seven ngdo subsidies (23.3%) are efficient. the average efficiency for each type of instrument – 0.70 for poc subsidies and 0.65 for ngdo subsidies – is in line with values obtained by prior empirical studies that apply dea to the cooperation for development sector (hernangómez et al. 2006, 2009; martín et al. 2005, 2007). table 5: instrument efficiency: general model. although these results allow us to compare the efficiency of different instruments, we continue our analysis by applying our dea model to a narrower scope. specifically, we consider independently each of the two countries included in the sample in panel b of table 5. this examination allows us to make comparisons within a single environment and thus avoid complications and differences caused by differing contexts. in addition, we can identify any pattern of significant differences across countries for particular instruments. panel b shows the percentage of efficient instruments and the average efficiency in the performance of analysed instruments for each country. morocco achieves results both in the percentage of efficient instruments as well as the average efficiency in the performance of analysed instruments that are clearly superior to mozambique. that is, the results suggest that the different instruments of cooperation for development are implemented with greater efficiency in morocco. in panel c, we further narrow our focus as we now analyse the ics for morocco alone, because, with a sample of 30 ics, it is the only country that fulfils the requirements imposed by dea and thus allows us to perform the analysis. as shown in panel c of table 5, three poc subsidies (27.4%) and five ngdo subsidies (26.3%) are efficient – in both cases, higher percentages than those obtained for the total sample, especially for poc. the average values are also higher than those achieved for the whole sample and show again that poc subsidies is the instrument that achieves the highest levels of efficiency (0.77). when we estimate the frontier by removing the most efficient (12) and the least efficient (12) instruments, results (see table 6) are quite similar regarding those obtained with the whole sample; again poc subsidies are more efficient than ngdo subsidies. average efficiency and percentage of efficient instruments are a bit higher than initial results, but it must be considered that a small sample size reduces the discriminating power of dea so that the number of efficient units and the average efficiency tend to increase. these results show no significant influence of extreme values on the efficient frontier. table 6: instrument efficiency without extreme values: general model. we have also estimated the general model (outputs: activities performed and areas served) with different combinations of inputs, relative to the original model. purchases, staffing costs, and communications and other services are the cost categories considered because they represent a substantial amount of the instruments’ budget (at least 10% of the total expenditure) and are included in almost all instruments (over 90%). the results of the analyses performed with the abovementioned combinations of inputs (see tables 7–9) are in line with the results of the initial analysis. table 7: instrument efficiency: general model (inputs: salaries and purchases). table 8: instrument efficiency: general model (inputs: purchases and other services). table 9: instrument efficiency: general model (inputs: salaries and other services). table 7 shows the results of the analysis performed with salaries and purchases as inputs, the most important factors regarding their percentage over total expenses (45% and 34%, respectively). average efficiency is almost identical relative to the base scenario (0.67 vs. 0.66), and the percentage of efficient instruments is quite similar (27.1% vs. 25%). poc subsidies efficiency is higher than ngdo subsidies efficiency both in the whole sample and in the subsample including only morocco’s instruments. in addition, the average efficiency of the instruments performed in morocco is higher than the average efficiency of instruments executed in mozambique. in general, these results give support to those obtained in the base scenario of the general model. table 8 shows the results of the analysis performed with purchases and other services as inputs. we observe a similar tendency relative to the base scenario: poc subsidies are more efficient than ngdo subsidies both in the whole sample and in the subsample including only morocco’s instruments, and the average efficiency of the instruments performed in morocco is higher than the average efficiency of the instruments developed in mozambique. however, in this analysis, the average efficiency of the whole sample and the percentage of efficient instruments are lower than in the base scenario. these findings pose that salaries as input have a considerable influence on dea results, which is understandable given its importance over total expenses (34%). table 9 shows the results of the analysis performed with salaries and other services as inputs. again, we observe a similar tendency relative to the base scenario: poc subsidies are more efficient than ngdo subsidies both in the whole sample and in the subsample including only morocco’s instruments, and the average efficiency of the instruments developed in morocco is higher than the average efficiency of instruments performed in mozambique. average efficiency of the whole sample and percentage of the efficient instruments are a bit lower than in the base scenario. again, these findings show that purchases as input have a considerable influence on dea results, which is understandable given its importance over total expenses (45%). we have performed two additional analyses to check the consistency and robustness of our results, identified as alternative model 1 and alternative model 2 (see appendix 2). alternative model 1 includes activities performed, areas served and institutions involved as outputs and purchases, wages and salaries, and communications and other services as inputs, whereas alternative model 2 includes activities performed, areas served and number of beneficiaries as outputs and the three aforementioned inputs. the results of these analyses show that among the instruments examined, again poc subsidies are more efficient than the ngdo subsidies and morocco outperforms mozambique regarding the level of efficiency achieved in the execution of the ics. average efficiency is higher in dea alternative models than in the base scenario of dea general model (0.74 and 0.76 vs. 0.66). likewise, the percentage of efficient instruments is higher in dea alternative models than in the base scenario of dea general model (29.8 and 36.4 vs. 25.0), which is understandable taking into account dea properties: the discriminating power of the dea decreases both when the number of included variables increases and when sample size decreases, resulting in better average efficiency and a higher percentage of efficient units. therefore, these findings give support to the results obtained in the base case scenario of the general model. discussion and conclusion as we pose throughout this study, measures for evaluating international aid projects with respect to efficiency are problematic because there is no evident bottom line, and the measurement of performance, unlike firms, cannot be done in terms of profit or profitability alone. accounting measures, mainly ratio analysis, do not capture efficiency of output and are subject to measurement error through valid or invalid accounting manipulations (golden et al. 2012). in a multiple input and output environment as is the case of international aid projects, dea is an appropriate method because it provides a measurement that can simultaneously identify inefficient projects and also produces information regarding sources of inefficiencies, what inputs are being over-utilised and by how much to make the project efficiency and also identifies a set of efficient project against which to benchmark. thus, dea analysis allows for the comparison of international aid projects efficiency across different ics responding the donors’ concern of what types of instruments best allocate the donated resources to the dedicated cause. our results show that among the instruments examined within the sample countries, poc subsidies are more efficient than the ngdo subsidies. these findings are substantiated by the results from both alternative models, reported in appendix 2. furthermore, when we conduct the analysis exclusively for morocco – the country in which the greatest number of ics is put into effect among our sample countries – the result holds. therefore, we may infer that this result is considerably independent from the particular environment in which the ics are performed. with respect to the efficiency achieved in each country, assessed through the general model and all its different specifications, morocco achieves a higher level of average efficiency in the execution of the ics. this result is confirmed by both alternative model 1 and alternative model 2, which qualifies morocco as the most efficient country. considering the results of all models, morocco appears to be the most efficient country, but it is required to take into account that efficiency can vary depending on the model specification (inputs and outputs employed to assess the efficiency). findings should be interpreted cautiously given that the relative position of countries in terms of efficiency could be variable and it is not usual that a country would be absolutely more efficient than the rest. several implications for the aecid (which is the founder of the analysed instruments) can be derived from these findings. the use of this ex-post measure of efficiency allows for the measurement in a specific and objective way of the results achieved by each project and to propose corrective actions for the future. likewise, the comparison among ics provides an opportunity to identify the conditions under which an ics may achieve greater efficiency. however, dea is not without drawbacks, for example, its sensitiveness to model specification, so a critical decision is the determination of inputs and outputs because the results could be substantially different if the model is estimated with a different combination of inputs and outputs. considering the pros and cons of dea, the assessment of international aid projects needs to be complemented with other types of analyses to obtain consistent and reliable results. a solid in-depth qualitative assessment of projects analysing dimensions such as their relevance, effectiveness, sustainability and impact (variables recommended by the dac to assess project performance) is crucial to the success of the projects. although dea can contribute towards shedding some light on assessing the efficiency of international aid projects, more research is needed to address this important issue. this study has several limitations. firstly, the main limitation is the sample size. a greater number of observations and even variety of ics would be desirable; however, it is extremely difficult to obtain systematic information of inputs and outputs of the ics because of the lack of a common procedure and computerised collection of information by agencies (in this case, the aecid). secondly, dea requires that units included in the analysis must be homogeneous because of the sensitiveness of this technique to extreme values. although we consider our sample homogenous enough, we are aware that it is always advisable to gather a more homogeneous sample. thirdly, instruments’ data do not allow us to perform dea analysis with the most relevant dimensions of the output, as they were ranked by the aecid experts. fourthly, dea results are sensitive to model specification, so it is very important to include relevant inputs and outputs. future research may measure the impact of the ics to improve the quality of inputs and outputs used to characterise the production function. finally, the analysis period corresponds to a time horizon of 5 years. it would be interesting to extend this period and to perform an analysis by year to assess whether the composition of the selection committee may influence the choice of more or less efficient projects. acknowledgements the authors would like to thank the anonymous reviewers for their constructive comments, as they have proved very helpful towards improving the manuscript by providing further work or additional clarification when required. financial support has been received from the aecid (08-cap2-0770). competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. author’s contributions the authors contributed equally to the writing of this article. references ahsan, k. & gunawan, i., 2010, ‘analysis of cost and schedule performance of international development projects’, international journal of project management 28(1), 68–78. al-shammari, m., 1999, ‘a multi-criteria data envelopment analysis model for measuring the productive efficiency of hospitals’, international journal of operations and production management 19(9), 879–890. andrés-alonso, p., martín-cruz, n. & romero-merino, e., 2006, ‘the governance of nonprofit organizations: empirical evidence from nongovernmental development organizations in spain’, nonprofit and voluntary sector quarterly 35(4), 588–604. andrés-alonso, p., azofra-palenzuela, v. & romero-merino, e., 2010, ‘beyond the disciplinary 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accommodation and expenses a xii. financial expenses b i. administrative expenses of spanish non-governmental development organisations (ngdo) b ii. administrative expenses of local ngdo appendix 2 table 1-a2: summary of dea: alternative models results. footnotes 1. all lowand middle-income countries with the exception of g8 members, eu members and countries with an admission date for entry into the eu. 2. at least 25% of aid must be a contribution, and interest rates on loans must be below market levels. 3. plan director de la cooperación española 2010. same criteria are applied from 2010. 4. instead of efficiency, recent studies have focused on the outcomes or success of international cooperation projects (ahsan & gunawan 2010; diallo & thuillier 2004). 5. pareto efficiency criterion is used: a unit is efficient if no others obtain higher levels of one output without producing less of another output and without increasing the use of any inputs. or, if no unit produces the same amount of outputs using less of some input without increasing the use of others (charnes et al. 1978). 6. a greater number of variables relative to sample size increase the likelihood to be efficient in any of the variables for the analysed units. 7. the time spent in a manufacturing process is taken as an input and, in the comparison of processes, efficiency is rated by the amount of time spent at the same cost: a more efficient process requires less time but equal cost. however, we consider real time by which duration is considered an output. that is, because a longer contract period extends the project’s capacity to benefit the target population, more time at the same cost equals greater efficiency. therefore, a real-time analysis assumes that between two projects with equal cost, a donor will prefer to finance the one that requires more time to perform. abstract introduction literature review problem investigated research objectives research method ethical consideration results and findings managerial implications and recommendations limitations and recommendations for future research conclusion acknowledgements references appendix 1: about the author(s) dinko h. boikanyo department of business management, faculty of management, university of johannesburg, south africa marita m. heyns optentia research focus area, north-west university, south africa citation boikanyo, d.h. & heyns, m.m., 2019, ‘the effect of work engagement on total quality management practices in a petrochemical organisation’, south african journal of economic and management sciences 22(1), a2334. https://doi.org/10.4102/sajems.v22i1.2334 original research the effect of work engagement on total quality management practices in a petrochemical organisation dinko h. boikanyo, marita m. heyns received: 17 feb. 2018; accepted: 05 oct. 2018; published: 26 feb. 2019 copyright: © 2019. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: work engagement can be defined as a positive, fulfilling, work-related state of mind that is characterised by vigour, dedication and absorption. there is a general belief that there is a connection between work engagement and business results, as well as total quality. practitioners and academics have over the years agreed that the consequences of work engagement are positive. total quality management is an essential practice that can be used to improve the quality of products on a systematic basis to meet customer satisfaction. it is important for an organisation to have engaged employees as it is evident that such an organisation is likely to prosper and attain total quality management (tqm). aim: the main objective of the study was to determine the effect of work engagement on total quality management practices in a petrochemical organisation. setting: the study was carried out in the petrochemical industry, which is of economic significance to the country. the degree of work engagement is essential for sustainable performance in this industry. methods: two questionnaires were used for the study, namely the utrecht work engagement scale and tqm. a total of 166 of responses were received from employees working for a petrochemical organisation. results: overall, the results showed that work engagement had a positive relationship with the dimensions of tqm, which was used as a measure of quality, which is a non-financial measure of performance. conclusion: managers need to enable an organisation to attract, develop and retain highly engaged employees to ensure a sustainable competitive advantage. introduction to survive and compete successfully in today’s turbulent economic environment, organisations require employees to be proactive, show initiative and remain committed to performing at high standards (bakker & leiter 2010:181; purcell 2014:242). organisational agility requires employees who exhibit energy and self-confidence and demonstrate genuine enthusiasm and passion for their work (bakker & schaufeli 2014). summing up, modern organisations need an engaged work force. employees who are engaged want to contribute, have a sense of belonging, defend the organisation, work hard and are not interested in moving to other employers. employees who are not engaged cause a gap between employees’ effort and their organisational effectiveness. this significantly affects an organisation’s financial performance (saks 2017:78). the focus of this research was on the influence of work engagement on total quality management (tqm) practices in the manufacturing facility of a petrochemical organisation. this organisation operates production facilities in south africa and supplies a range of chemicals to local and international markets. its competitive advantage lies in its people and its unique technology and products. the manufacturing of good quality products is not only dependent on the technology and operating equipment used, it is also dependent on the operators and effective management of the whole value chain. managers working in the manufacturing facilities usually face issues on a daily basis that require direct attention and quick response. with production facilities being at the core of business operations, these issues can directly affect the company in substantial ways. there is a high cost due to inconsistencies in quality of the intermediate and final products and this affects the whole value chain, including the relationship with the customers. the pressure on manufacturers to produce high-quality products that are safe is therefore an increasing challenge. total quality management is an essential practice that can be used to improve the quality of products on a systematic basis to meet customer satisfaction (karia & asaari 2006:30). by pursuing tqm, an organisation will improve the quality of its products and reduce rejects and reworks, which will indirectly reduce production costs (prajogo 2007). pursuing tqm demands that the organisation controls the production processes to minimise defects in their outputs, and also reduce failure costs. therefore, the successful implementation of a quality management system yields a number of benefits, such as low production costs and higher productivity attributable to the reduction of rejects and reworks. another benefit is customer satisfaction leading to customer loyalty and repeat business. according to biswas and bhatnagar (2013:27), it is important for an organisation to have engaged employees as it is evident that such an organisation is likely to prosper and attain tqm. the degree to which these employees are engaged is therefore critically important for the implementation of tqm practices and the success of the business. this study’s contribution is to show the degree (extent) of employee engagement in the organisation, and the possible link between engagement and tqm practices. this type of study has never been conducted within this particular environment, and as such a valuable contribution could be made to more effective performance management within this context. another purpose of the study will be to produce managerial recommendations and also produce findings of practical relevance and value for the petrochemical organisations. literature review work engagement it became evident from literature that work engagement is defined differently by various organisations and authors. these definitions are in most cases adapted to what the organisations deem important for them. a prominent researcher (kahn 1990:694) defines work engagement as ‘the harnessing of the organisation’s members’ full selves to their work roles; in engagement, people employ and express themselves physically, cognitively, and emotionally during role performances’. thus, according to kahn (1990:693; kahn & heapy 2014:164), engagement means to be psychologically present when occupying and performing an organisational role. other researchers such as rothbard (2001:656) and rothbard and patil (2012:64) also define engagement as psychological presence, but go further to state that it involves two critical components: attention and absorption. attention refers to ‘cognitive availability and the amount of time one spends thinking about a role’, while absorption ‘means being engrossed in a role and refers to the intensity of one’s focus on a role’. burnout researchers define engagement as the opposite or positive antithesis of burnout (maslach, schaufelli & leiter 2001:398). according to maslach et al. (2001:399), engagement is characterised by energy, involvement and efficacy, the direct opposite of the three burnout dimensions of exhaustion, cynicism and inefficacy. research on burnout and engagement has found that the core dimensions of burnout (exhaustion and cynicism) and engagement (vigour and dedication) are opposites of each other (gonzalez-roma et al. 2006:166). according to schaufeli and bakker (2004a), work engagement is defined as follows: engagement is a positive, fulfilling, work-related state of mind that is characterized by vigor, dedication, and absorption. rather than a momentary and specific state, engagement refers to a more persistent and pervasive affective-cognitive state that is not focused on any particular object, event, individual, or behavior. vigor is characterized by high levels of energy and mental resilience while working, the willingness to invest effort in one’s work, and persistence even in the face of difficulties. dedication refers to being strongly involved in one’s work and experiencing a sense of significance, enthusiasm, inspiration, pride, and challenge. absorption, is characterized by being fully concentrated and happily engrossed in one’s work, whereby time passes quickly and one has difficulties with detaching oneself from work. (p. 5) in summary, work engagement has been defined as a distinct and unique construct that consists of cognitive, emotional, and behavioural components that are associated with individual role performance. measuring levels work engagement according to schaufeli et al. (2002), a self-report questionnaire called the utrecht work engagement scale (uwes) was developed and includes the three constituting aspects of work engagement: vigour, dedication and absorption. vigour is assessed by the following six items that refer to high levels of energy and resilience, the willingness to invest effort, not being easily fatigued, and persistence in the face of difficulties: (1) at my work, i feel bursting with energy; (2) at my job, i feel strong and vigorous; (3) when i get up in the morning, i feel like going to work; (4) i can continue working for very long periods at a time; (5) at my job, i am very resilient, mentally and (6) at my work i always persevere, even when things do not go well. those who score high on vigour usually have much energy, zest and stamina when working, whereas those who score low on vigour have less energy, zest and stamina as far as their work is concerned. dedication is assessed by the following five items that refer to deriving a sense of significance from one’s work, feeling enthusiastic and proud about one’s job, and feeling inspired and challenged by it: (1) i find the work that i do full of meaning and purpose; (2) i am enthusiastic about my job; (3) my job inspires me; (4) i am proud of the work that i do and (5) to me, my job is challenging. those who score high on dedication strongly identify with their work because it is experienced as meaningful, inspiring and challenging. additionally, they usually feel enthusiastic and proud about their work. those who score low do not identify with their work because they do not experience it to be meaningful, inspiring or challenging; moreover, they feel neither enthusiastic nor proud about their work. absorption is measured by six items that refer to being totally and happily immersed in one’s work and having difficulties detaching oneself from it so that time passes quickly and one forgets everything else that is around: (1) time flies when i’m working; (2) when i am working, i forget everything else around me; (3) i feel happy when i am working intensely; (4) i am immersed in my work; (5) i get carried away when i’m working and (6) it is difficult to detach myself from my job. those who score high on absorption feel that they usually are happily engrossed in their work, they feel immersed by their work and have difficulties detaching from it because it carries them away. as a consequence, everything else around is forgotten and time seems to fly. those who score low on absorption do not feel engrossed or immersed in their work, they neither have difficulties detaching from it, nor do they forget everything around them, including time. a study by bakker (2013) and recently by tauetsile (2016) found using t-tests and anova that there were some minor group differences in age, gender and ethnicity in relation to the levels of work engagement. however, the study found significant differences in groups for education level, job position and tenure. firstly, employees who had a certificate or diploma significantly differed from those with a degree in terms of their engagement level. those with a degree seemed to have a higher engagement level. secondly, top management seemed to be more engaged than the executive level. thirdly, in terms of tenure, it seemed that employees who had worked for less than 5 years were more engaged than those who had worked in the organisation for between 8 and 10 years. individuals who are fairly new to the organisation may find their job more interesting and challenging, and thus be more engaged than those who have been in the company longer (bakker 2013). below is a discussion of quality and total quality management. quality and total quality management quality there is much published work on quality as a performance measure in the manufacturing industry (kazemkhanlou & ahadi 2014). quality is most often defined as the ability of a product or service to consistently meet or exceed customer expectations (evans 2013). lillrank (2002:691) classifies quality definitions found in the literature to be divided into four categories: excellence, value for money, conformity to requirements and meeting or exceeding customer requirements. lillrank (2002) further emphasises that excellence-based definitions include the idea that products or services may include elements that are perceived as superior, which are often very subjective, hard to measure and which confuse quality with product segments or grades. the most widely used definitions from the american society for quality and more recently iso 9000 – 2000, are based on customer satisfaction, which may be achieved, not only through conformance to requirements, but through some inherent characteristics of the product or service, and the way it is presented and delivered to the customers (barnes 2009). the importance of quality as an objective is now widely recognised throughout the world. as a result of increasing customer demands and the removal of barriers of trade, inefficient suppliers or suppliers of low quality goods or services will find it difficult to survive (kazemkhanlou & ahadi 2014). total quality management total quality management (tqm) as defined by mohrman et al. (1995:26) is an approach to managing organisations, which emphasis the continuous improvement of quality and customer satisfaction. it entails the application of systematic tools and approaches for managing organisational processes with these ends in mind (continuous improvement of quality and customer satisfaction), and involves the establishment of structures such as quality improvement teams for maintaining focus and enacting organisational improvement processes (liao, chang & wu 2010). according to lau and tang (2009:410), tqm is defined as the management philosophy and company practices that aim to harness the human and material resources of an organisation in the most effective way to achieve the objectives of the organisation. tqm is further explained as a management-led process to obtain the involvement of all employees, in the continuous improvement of the performance of all activities, as part of the normal business to meet the needs and satisfaction of both the internal and external customers. tqm is further explained as a visionary, cultural movement, which represents recognition of a management philosophy that encourages employees to share responsibility for delivering quality services and products. below is what each abbreviated letter in tqm means as follows: the t-component of tqm: tqm implies a total, company-wide commitment to quality and calls for everyone, including suppliers, to be responsible for quality and involved in all the efforts to maintain or upgrade their work. the q-component of tqm: the major goal of quality management is to meet and exceed customer expectations. internal customers are as important as external customers. continuous improvement should be integrated into the management of all systems and processes. effective training should also teach and empower all employees to understand and solve quality related problems. the m-component of tqm: the broad nature of tqm efforts requires commitment of top management to the process. top management is responsible for creating clear and visible values and to integrate these values into strategic business plans. tqm requires that all employees are to be involved and, as a result, it is important to re-shape the organisational culture that supports it. research was conducted by zhang, waszink and wijngaard (2000) to develop an instrument to measure tqm implementation in the manufacturing industry in china. based on the comprehensive review of the tqm literature, the following constructs were considered to be the tqm practices (what an organisation does to demonstrate its commitment to tqm): leadership commitment, supplier quality management, vision and plan statement, evaluation, process control and improvement, product design, quality system improvement, employee involvement and empowerment, recognition and reward, education and training, and customer focus. according to karia and asaari (2006:30), tqm practices are a set of practical measures such as: continuous improvement, meeting customer requirements, reducing re-work, long-range thinking, increased employee involvement and teamwork, process re-design, competitive benchmarking, team-based problem-solving, continuous monitoring of results and closer relationship with suppliers. the above involves the combined efforts of all members of the organisation – from senior management to shop-floor employees. mohrman et al. (1995:26) emphasise that the key to tqm is the definition of quality as meeting customer requirements, and a belief that the organisational capability to deliver quality is enhanced by continuously improving the capacity of the work processes of the organisation to deliver value to customers. tqm has been widely implemented throughout the world. many firms have arrived at the conclusion that effective tqm implementation can improve their competitive abilities and provide strategic advantages in the marketplace (snee 2016). several studies have shown that the adoption of tqm practices enable firms to compete globally (allen & kilimann 2001:110). total quality has developed to what it is today along with other business management philosophies. it is a diversified way to see the growth of the whole business. tqm posits certain numerical and non-numerical goals for a company. reaching these goals is typically not easy. it requires support from management, long-term strategic decision-making and motivated personnel (garvin 1988:319). in general, product or service quality measures are essential to find out information that is important to customers about each product or service. this information can help to drive the new product design process, which fits the customers’ requirements (snee 2016). moreover, measuring product and service quality is identifying information on what customers want, as well as what dimensions of products or services need to be measured and controlled. antecedents and consequences of engagement and how engagement relates to total quality management studies continue to look at the antecedents and consequences of work engagement. it is understandable that organisations wish to increase work engagement, given that engaged employees are willing to make use of their full potential in their work roles in a positive way (kahn 1990:694), have better well-being (hallberg & schaufeli 2006:120), are more productive and remain in their jobs for longer (saks 2006:602; schaufeli & bakker 2004:293). many researchers have tried to identify factors leading to work engagement and develop models to draw implications for managers. their diagnosis aims to determine the drivers that will increase work engagement level. three antecedent conditions of psychological meaningfulness, availability and safety which provide opportunities for intervention to increase levels of engagement were proposed by kahn (1990:694). psychological meaningfulness is influenced by work characteristics, such as challenge and autonomy (bakker & demerouti 2007:310). psychological availability depends on individuals having sufficient psychological and physical resources, such as self-confidence, to invest in their role performances (hallberg & schaufeli 2006:121). psychological safety stems from the organisational social systems, with consistent and supportive co-worker interactions and organisational norms, allowing for greater engagement (bakker & xanthopoulou 2009:157). this third antecedent condition, psychological safety, offers the most potential for leadership to influence engagement. specifically, leadership that provides a supportive, trusting environment allows employees to fully invest their energies into their work roles. kahn (1990:694) established theoretical and initial empirical evidence for a link between supportive leadership and work engagement. in a study by blessing (2008), it was found that almost 60% of surveyed employees want more opportunities to grow forward to remain satisfied in their jobs. a strong manager-employee relationship is a crucial ingredient in the work engagement and retention formula. development dimensions international (ddi 2005) states that a manager must do five things to create a highly engaged workforce. they are: align efforts with strategy; empower; promote and encourage teamwork and collaboration; help people grow and develop; provide support and recognition where appropriate. top 10 workplace attributes that will result in work engagement were identified by perrin (2003:8). the top three among the 10 drivers listed by perrin are: senior management’s interest in employees’ well-being; challenging work; decision-making authority. after surveying 10 000 nhs employees in great britain, the institute of employment studies (robinson, perriman & hayday 2004) points out that the key driver of work engagement is a sense of feeling valued and involved, which has the components such as involvement in decision making, the extent to which employees feel able to voice their ideas, the opportunities employees have to develop their jobs and the extent to which the organisation is concerned for employees’ health and well-being. in his study, yen (2003:257) found that work engagement is a necessary predecessor for successful tqm. a study by biswas and bhatnagar (2013:27) found a positive relationship between aspects of work engagement and tqm practices in an organisation. it is therefore important for an organisation to have engaged employees, as it is evident that such an organisation is likely to prosper and attain tqm. in turn, this will result in an increase in returns and earnings (chung et al. 2015:72). therefore, the literature suggests that it is important for workers to be engaged in order to achieve tqm. greater outcomes of an organisation, such as organisational practices and quality products and services, as well as customer satisfaction that make up tqm can be derived from committed and engaged employees (biswas & bhatnagar 2013). the gallup organisation (2004) also found critical links between work engagement and customer loyalty, which is also one of the aspects of tqm. they compared the scores of these variables among a sample of stores scoring in the top 25% on work engagement and customer loyalty with those in the bottom 25%. stores in the bottom 25% significantly under-performed across three productivity measures: sales, customer complaints and turnover. gallup cites numerous similar examples. the international survey research (isr) team has similarly found encouraging evidence that organisations can only reach their full potential through emotionally engaging employees and customers (isr 2004). while this research does not show investors and business leaders exactly what organisations are doing on a day-to-day basis to develop engaged employees, the findings do demonstrate differences in overall performance between companies, and gallup’s meta-analyses present strong evidence that highly engaged work groups within companies out-perform groups with lower work engagement levels, and the recent findings reinforce these conclusions at the workgroup level. the meta-analysis study shows that top quartile business units have 12% higher customer advocacy, 18% higher productivity and 12% higher profitability than bottom-quartile business units. in contrast, bottom-quartile business units experience 31% – 51% more employee turnover than those in the top quartile of workplace engagement. this research into earnings per share provides a degree of proof that work engagement correlates to crucial business outcomes. problem investigated the maintaining of quality at expected levels in an organisation is usually challenging. the number of product recall cases is growing each day. poor quality products cause business disruption, financial loss, costly lawsuits and long-lasting damage to the brand and corporate image of organisation. a brand or even the organisation’s reputation can be damaged irreparably. engaging the employees of the petrochemical organisation is important as this sector forms a significant part of a country’s economic system, especially in the supply of fuels and chemicals. having employees that are engaged means they will work alongside the organisation to achieve its goals and objectives and they can provide the organisation with a competitive advantage. thus, by engaging their employees they can improve levels of productivity, job satisfaction, motivation and commitment, and reduce turnover rates. current research appears to fail in measuring the extent to which work engagement is related to tqm practices to reduce cost of poor quality. there is also a dearth of literature about the extent of work engagement according to the biographical profile of the participants in this type of industry and environment. there is still a void in academia and in practice about the effect of work engagement, which is an element of organisational behaviour on the quality performance of the organisation, which is an element of operations management. there is a need to establish how the human-related issues can be translated into measurable business results, and also on the impact of these human variables on the management of the organisations. it was also important to determine if there are differences in levels of engagement as found by other researchers. the following research hypothesis is formulated for the purposes of this study: h1: statistically and practically significant positive relationship exists between work engagement and tqm practices. research objectives the research objectives are divided into primary and secondary objectives. primary objective the primary objective of this study is to investigate the extent of work engagement and the possible impact it has on the total quality management practices used in the petrochemical organisation. secondary objectives to achieve the primary objective, the following secondary objectives include the need to: empirically assess the outcomes of work engagement using the uwes questionnaire; empirically assess the extent of the use of tqm practices in the organisation using tqm questionnaire; determine the relationship between the dimensions of engagement and tqm; determine the demographic differences in terms of age, gender, race, duration of employment and qualification of the participants; make recommendations. research method the empirical research used to achieve the objectives of this study is based on a descriptive research approach. this type of research is used when there is a clear statement of the research problem and detailed information needs (bhattacherjee 2012). saunders, lewis and thornhill (2012) indicate that such formalised studies are used to achieve research objectives that involve characteristics associated with a subject population, estimates of the proportions of a population that have these characteristics and the discovery of associations among different variables. the survey is a positivist research design in which a selected sample is studied to make inferences about the rest of the population (saunders et al. 2012). surveys typically use questionnaires and interviews in order to determine the opinions, attitudes, preferences and perceptions of persons of interest to the researcher. a survey design is used in this case. it was identified as relevant to study the influence of work engagement on the tqm practices in a petrochemical organisation. according to barbie and mouton (2015), the research methods used in this type of research design are structured and quantitative in nature. in view of the above considerations, the quantitative approach was opted for as the most suitable for the purposes of this research. participants a research population is a group that the researcher wants to generalise from and the sample is the group of people that are selected to be in the study (bhattacherjee 2012). the targeted population for this study was the employees of a south african petrochemical organisation. the company has about 583 employees. workers from all levels, ranging from professional to skilled, were included in the study population. random sampling was used to send the questionnaires to 200 employees. randomisation of the probability sample means selecting a sample from the whole population in such a way that the characteristics of each unit of the sample approximate the characteristics of the whole sample (saunders et al. 2012). the sampling technique used for this study was therefore probability sampling. a list of all employees was received from the human resource (hr) department of the company. a consecutive number was assigned to each of the employees from 1 to 583. a computer program (excel random generator) was then used to generate a list of random numbers from which a sample of 200 employees was randomly drawn out of a population of 583. an email was sent to the selected employees to participate in the research. hard copies of the questionnaires were also distributed to those who have no access to email. the objectives and nature of the research were explained, as well as the different constructs. the questionnaires were conducted anonymously, requiring the people to respond either directly by email or indirectly by means of the boxes placed in the control rooms for the hard copies. timelines were indicated on the questionnaires and agreed upon. voluntary participation was highlighted and participants were thanked for their involvement. a total of 166 questionnaires were received. measuring instruments two standardised questionnaires were used in the empirical study. a biographical questionnaire, regarding participants’ age, gender, race, education and years employed, was also included in the measuring battery. the first questionnaire was the uwes, which was used to measure the levels of work engagement of the participants (schaufeli et al. 2002). according to the authors, the uwes includes three dimensions, namely vigour, dedication and absorption. the questionnaire consists of 17 questions. storm (2002) obtained the following alpha coefficients for the uwes in a sample of 2396 members of the south african police service: vigour 0.78; dedication 0.89; absorption 0.78. the questions are discussed and shown in section 2.1.1. the second questionnaire was based on tqm. it was adopted from zhang et al. (2000), based on variables which include top management commitment, employee involvement, continuous improvement, employee empowerment, customer focus and satisfaction. the instrument was tested on, and validated by 212 chinese manufacturing companies. the overall values of cronbach’s alpha for independent variables were above 0.8, which means that the constructs were reliable. toga (2017) also obtained cronbach’s alphas above 0.75 using a sample of participants in the south african foundry industry. employee involvement and empowerment are analysed to determine if the concept of tqm is embraced. in order for the company to meet customers’ changing needs, it is important to have continuous improvement, which is a pivotal aspect of tqm. because there is no business without customers, customer focus and satisfaction are also measured. a five-point likert scale is used as a measuring system throughout, with the following scores: not satisfactory: (1), somewhat satisfactory (2), unsure (3), satisfactory (4) and very satisfactory (5). the use of the interval scaling method enables the use of traditional statistical analyses methods, which are discussed below. statistical analysis in this study the data were captured and analysed using the spss and statistica statistical programs. exploratory factor analysis (efa) was used to examine constructed equivalence and to enhance the reliability results of both the uwes and the tqm. the reason why efa was used as opposed to confirmatory factor analysis (cfa), was because of the small number of participants (n = 166). hoelter (1983:325) recommends that a minimum of 200 participants should be included before carrying out cfa; hence, efa was employed in this study. the number of factors in the total sample of the uwes and tqm was determined by the principal component analysis. subsequently components extraction was used to estimate the number of factors followed by principal axis factoring extraction using a rotation method of direct oblimin with kaiser normalisation or varimax on the uwes and tqm. cronbach’s alpha coefficients were used to determine the internal consistency of both instruments (the uwes and tqm). pearson product-moment correlation coefficients were used to specify the relationship between the variables. in terms of statistical significance, the correlation is practically significant at p ≤ 0.05. effect sizes (cohen 1988:15) were used to decide on the practical significance of the findings. a cut-off point of 0.30 (medium effect) and 0.50 (large effect) are set for practical significance of correlation coefficients. t-tests and analysis of variance (anova) were employed to determine differences between the groups in the sample. effect size (cohen 1988:15; steyn 1999:12) was used in addition to statistical significance to determine the importance of relationships. effect sizes served to indicate whether the results obtained were practically significant. ethical consideration ethical approval was given by north-west university (nwu) as part of a dissertation for master of business administration (mba). results and findings a total of 166 questionnaires were received representing a response rate of 83%. table 1 represents a numeric dispersion of the sample. the sample consists of 166 respondents with 126 men (75.9%) representing the majority of the sample and 40 (24.1%) women comprising the minority of the sample. table 1: biographical profile of the respondents. regarding age, the largest group was 85 (51.2% of the sample) who indicated that they are between 31 and 40 years of age. the second largest group was 42 (25.3%) respondents who indicated that they are between the ages of 41 and 59 years. the 37 (22.3%) respondents in the third largest group are between the ages of 21 and 30 years. there was only one person below 20 years and only one person above 60 years. regarding their race, the largest group was those 88 (53%) respondents who indicated that they are black respondents. the second largest group (38.6%) were white respondents while the indianand mixed race respondents were 4.2% and 3.6%. the majority of respondents were middle managers (50.0%), followed by junior employees (37.7%) and senior management (13.9%). there was only one respondent in top management. regarding qualification, the majority (50.6%) of the respondents have either a diploma or a degree, followed by those who only have matric. a total of 10.8% of the respondents have a postgraduate qualification, while the minority (3%) do not have matric. discussion of the findings the general aim of the study was to determine the effect of work engagement on the total quality management practices in the petrochemical organisation. to achieve the general objective, specific objectives were determined and analysed through statistical properties of the two measuring instruments (uwes and tqm), namely to determine their construct validity, reliability, as well as the correlation between the instruments, and to determine the demographic differences between groups in the experience of engagement and tqm principles. to answer the first objective of the study with regard to the conceptualisation of engagement and tqm, from the literature review, it came out that organisations wish to increase work engagement, given that engaged employees are willing to make use of their full potential in their work roles in a positive way (kahn 1990:694), have better well-being (hallberg & schaufeli 2006:120), are more productive and remain in their jobs for longer (saks 2006:602; schaufeli & bakker 2004:293). mohrman et al. (1995:26) emphasise that the key to tqm is the definition of quality as meeting customer requirements, and a belief that the organisational capability to deliver quality is enhanced by continuously improving the capacity of the work processes of the organisation to deliver value to customers. the gallup organisation (2004) found critical links between work engagement, customer loyalty, business growth and profitability. yen (2003:257) found that work engagement is a necessary predecessor for a successful tqm. the second objective of this study was to determine the factor structure and internal consistency of the uwes. the results of this study revealed that engagement is a two-factor model after the principle factor extraction was done. all the items are loaded in total on factor 1 (labelled vigour-dedication) and factor 2 (labelled absorption) as shown in table 2. this two-factor model explained 59% of the total variance. however, in a study by coetzer and rothmann (2007), they found an acceptable fit for purpose statistics for the three-dimensional structure of the uwes for employees in an insurance company. storm and rothmann (2003a) and naudé (2003) established that there are high correlations between work engagement dimensions (vigour-dedication and absorption) by which they suggested that work engagement as measured by the uwes is a two-factor construct. therefore, the results of this study also confirm that the uwes can be a two-factor construct. table 2: the results of factor loadings of work engagement. the cronbach’s alpha coefficients showed acceptable internal consistency for both dimensions (0.92 for vigour-dedication and 0.88 for absorption), which is above the guideline as prescribed by nunnally and bernstein (1994). it can therefore be concluded that the uwes as utilised in this research is a valid and reliable measuring instrument. the new sub-scale scores were calculated using the mean score on the items per factor. results are presented in table 3. table 3: descriptive statistics of the two dimensions of work engagement. to answer the third objective, efa was conducted on the tqm and the results revealed that the questionnaire has a seven-factor structure with all the items loading on those factors explaining 68% of the total variance as shown in table 1-a1 in the appendix. antony et al. (2002) also identified seven critical factors for tqm. the reliability coefficients for their results ranged from 0.62 to 0.95. the reliabilities of six of the factors identified in this study ranged from 0.75 to 0.88, as shown in table 4, indicating strong reliability. table 4: results of the factor reliability for the dimensions of total quality management. the factor with a value of 0.65 was also retained as it is also deemed acceptable in social sciences (field 2009:675). it can therefore be concluded that the tqm questionnaire as utilised in this research is a valid and reliable measuring instrument. factor loadings are shown in table 5. table 5: descriptive statistics of the dimensions of total quality management. the sub-scale scores were calculated, using the mean score on the items per factor. results are presented in table 5. the fourth objective was to determine the relationship between dimensions of engagement and tqm constructs. the results indicated a strong positive statistical and practical correlation between vigour-dedication and absorption as dimensions of the uwes scale. previous studies by storm (2002) indicated a similar outcome of high correlations between work engagement dimensions of vigour, dedication and absorption. this correlation suggests that energetic and dedicated employees are highly likely to be happy in their work to the extent that they are unlikely to detach themselves from their work. the results of the product-moment correlation coefficients between the constructs are shown in table 6. table 6: product-moment correlation coefficients between engagement and total quality management dimensions. overall, the results indicate that work engagement has a positive relationship with the dimensions of tqm. this finding is in agreement with the conclusions drawn by practitioners and academics that the consequences of work engagement are positive (saks 2006:603). kahn (1992:322) as well as kahn and heaphy (2014) also proposed that work engagement leads to both positive outcomes for individuals (e.g. quality of people’s work and their own experiences of doing that work), as well as positive organisational-level outcomes (e.g. the growth and productivity of organisations). the results are summarised as follows: reward and training dimension is positively correlated to vigour-dedication as well as absorption (practically significant, medium effect). supplier focus is positively correlated to vigour-dedication and absorption (practically significant, medium effect). empowerment is positively correlated to vigour-dedication as well as absorption (practically significant, large effect). top management support relates positively to vigour-dedication and absorption (practically significant, medium effect). process improvement shows a statistically significant, positive relationship with vigour-dedication (practically significant, medium effect), but it does not meet the cut-off point of 0.3 that was set for practical significance when related to absorption. customer focus had a weak correlation with the two dimensions of engagement with values below 0.3. teamwork is positively correlated to both vigour-dedication and absorption (practically significant, medium effect). based on these results, the hypothesis has been successfully met. the results are also in agreement with the findings by biswas and bhatnagar (2013) that there is a significant positive relationship between work engagement and tqm practice. with regard to the fifth objective, some significant differences were found between the various demographic groups and their scores on engagement. the results are summarised as follows: gender: women were more engaged in terms of absorption, but had similar level of engagement in terms of vigour-dedication. a t-test was conducted to test whether men and women responded differently to the sections. from the p-values obtained for gender, it was concluded that for absorption the p-value was smaller than 0.05, indicating that the participants answered the questions in a significantly different manner statistically. for the other dimensions, the p-values were greater than 0.05 indicating that the participants answered the questions in a significantly similar manner statistically. the effect size for absorption had a d-value of 0.426. this d-value is closer to the practically visible difference value and can be considered practically visible. age group: employees aged in the 41–59 category were slightly more engaged than the other groups. the p-values for absorption and teamwork were both below 0.05 indicating that there was a statistically significant difference in the way the different age groups responded to the questions. this was confirmed by the anova results for the two dimensions. the results for the effect sizes indicate that for absorption, the d-values were 0.54 and 0.50 for the age groups 21–30 and 31–40 when compared to the 41–49 age groups. this indicates a medium practically visible difference. in the case of teamwork a medium practically visible difference was seen between the 31–40 and 41–59 age groups. for all the other dimensions with p-values above 0.05, there were no significant differences in the responses by different age groups. race: the mixed race group came out as the most engaged, followed by the indian participants while the black employees were the least engaged. according to the p-values and the anova results, a significant difference was only noticeable on the dimension of absorption. level of employment: employees in the middle and senior management levels were the most engaged. junior employees were the least engaged. the p-values for vigour-dedication, absorption and top management support were all below 0.05 indicating a significant difference in the way different levels of employment responded. this was confirmed by the anova results. the effect sizes indicate that there were some medium practically visible differences in the way the various levels responded to the three dimensions. duration of employment: employees with 0–2 years’ experience were the most engaged, while the level of engagement was similar for the rest of the employees. according to the p-value of 0.03 and the anova results, a significant difference was only observed for the dimension of teamwork. qualification: employees who had no matric qualification were the most engaged. the p-values and anova results indicated that significant differences were only observed for the responses to reward and training, supplier focus and customer focus with respect to qualifications. this study has shown that the use of the uwes is still acceptable for measuring engagement of employees in a petrochemical industry because of its construct validity and high level of reliability. the use of the tqm questionnaire was also suitable because of its construct validity and high level of reliability. the results confirm that there is a practical, significant, positive relationship between work engagement and tqm practices. managerial implications and recommendations research has shown that there is a link between levels of engagement and tqm. human resource practices that have a strong focus on people have demonstrated a significant impact on improvements in productivity, satisfaction and financial performance. in addition, engagement needs to be viewed as a broad organisational strategy that involves all levels of the organisation: a string of actions and steps, which requires the contribution and involvement of organisational members, as well as consistent, continuous and clear communication. companies with engaged employees have higher employee retention because of reduced turnover and reduced intention to leave the company. they also have higher productivity, profitability, growth and customer satisfaction. for managers, the work on work engagement starts at day one through an effective recruitment and orientation programme; the work on work engagement begins from the top, as it is unthinkable to have engaged people in the organisations where there is no engaged leadership. managers should enhance two-way communication, ensure that employees have all the resources they need to do their job, give appropriate training to increase their knowledge and skill, establish reward mechanisms in which good job performance is rewarded through various financial and non-financial incentives, build a distinctive corporate culture that encourages hard work and keeps success stories alive, develop a strong performance management system which holds managers and employees accountable for the behaviour they bring to the workplace, place focus on top-performing employees to reduce their turnover and maintain or increase business performance. quality management originated from two ideas about how to run organisations better. the first idea revolved around customers. if the organisation can determine what its customers like, they can deliver it the same way every time. customers will come back to purchase such products and services, and will also tell others about these products and services. the second idea the organisation needs to explore is efficiency. if the organisation can figure out the most efficient way to produce a product or service and stop wasting time and materials, replacing poor quality goods or delivering unsatisfactory services, then it will be more successful. management-led processes should be enhanced within the organisation to obtain the involvement of all employees, in the continuous improvement of the performance of all activities, as part of the normal business to meet the needs and satisfaction of both the internal and external customers. to continue to be at the leading edge, the organisation must continually analyse and systematically improve their business processes measures. therefore, attention must be given to continuous process improvement to meet the customers’ requirements and increase market share. training and development of employees is required to ensure competent people in the long run. it is important to communicate with everyone in the organisation; empowerment and delegation are largely about giving each employee a sense of responsibility for manufacturing a product or for performing a service to satisfy customers. limitations and recommendations for future research this study has some limitations. the cross-sectional survey design allows for the identification of the existence of relationships between variables, but implies that more complicated forms of infrequent connections could not be examined. prospective longitudinal and quasi-experimental research designs are needed to further validate the interpreted relationships within this study. there was a low number of participants and the use of the participants within a single organisation, which limit the generalisations that could be made to the whole petrochemical industry. in spite of the noted limitations, the findings offer valuable suggestions for future research. the findings obtained in this study can be replicated with larger sample groups in order to draw conclusions about the factor structure of the uwes and tqm in the south african context. it is recommended that larger samples be utilised to enable generalisation of the findings to other similar groups in the petrochemical industry. longitudinal research is recommended to establish levels of engagement and total quality management over a period of time. participants in different demographic groups experienced different levels of engagement. possible reasons for this should be established by further research. evidence suggests that new employees score the highest on levels of engagement, which may in part be due to the optimism and enthusiasm they experience upon starting a new job. further research is needed to determine exactly which attitudes they possess at this stage and what elements they are so highly engaged with in their work. once these have been identified, managers can attempt to maintain that high level of engagement employees’ experience at the beginning of their employment throughout their entire period of employment by understanding clearly what predicts engagement for those individuals. conclusion one of the main objectives was to determine the relationship between the dimensions of engagement and tqm. overall, the results indicate that work engagement has a positive relationship with the dimensions of tqm, which is used as a measure of quality, a non-financial measure of performance. this finding is in agreement with the conclusions drawn by practitioners and academics that the consequences of work engagement are positive. significant differences were found between the various demographic groups and their scores on engagement. acknowledgements this was taken from a dissertation that was used as partial fulfilment of a master’s qualification at north-west university. i thank nwu 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y.z., 2003, ‘implementing sustainable tqm system: employee focus’, tqm mag 15, 257–265. https://doi.org/10.1108/09544780310486164 zhang, z., waszink, a. & wijngaard, j., 2000, ‘an instrument for measuring tqm implementation for chinese manufacturing companies’, international journal of quality & reliability management 17(7), 730–755. https://doi.org/10.1108/02656710010315247 appendix 1: results for the factor loadings of tqm table 1-a1: factor loadings of the dimensions of total quality management. abstract introduction tests for evolving efficiency data methodology results conclusion acknowledgements references footnotes about the author(s) andré heymans department of risk management, school of economics, north-west university, south africa leonard santana school of mathematical and statistical sciences, north-west university, south africa citation heymans, a. & santana, l., 2018, ‘how efficient is the johannesburg stock exchange really?’, south african journal of economic and management sciences 21(1), a1968. https://doi.org/10.4102/sajems.v21i1.1968 original research how efficient is the johannesburg stock exchange really? andré heymans, leonard santana received: 05 june 2017; accepted: 24 aug. 2018; published: 29 oct. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: there are various studies that confirm the efficiency of the johannesburg stock exchange (jse), implying that there are no opportunities for active portfolio managers to earn excess returns over the long run. aim: the aim of the research is to prove that the sub-indices on the jse go through cycles of efficiency and inefficiency even though the jse as a whole might be considered informationally efficient. setting: although the jse as a whole can be considered to be weak-form efficient, portfolio managers are not bound to investing in large liquid stocks alone. many aggressive funds allow managers to also allocate a portion of their portfolio to smaller stocks. this has implications when considering the efficiency of the stocks being selected. methods: given the impact efficiency has on portfolio selection, we test for the adaptive market hypothesis using a representative sample of stock indices by means of the automatic variance ratio test, the chow–denning joint variance ratio and the joint sign test on the jse. results: our results confirm that some of the smaller, and in some instances younger, indices are not always as efficient as the all share index, thus allowing portfolio managers with an active management approach some opportunities to profit from informational inefficiencies in the market. conclusion: the practice of active management by portfolio managers in the south african market seems to defy logic if one considers the fact that the jse as a whole is at the very least weak-form efficient. by proving that some of the sub-indices that make up the all share index are inefficient most of the time, this article shows that the phenomenon of active portfolio managers is less of a surprise. introduction testing for market efficiency is an age-old quest. the first major test to this effect was performed by bachelier (1900) when studying the mathematical theory of random processes. he speculated that the movement of stock prices followed a brownian motion and are, by implication, unpredictable. since this is difficult to test, it was not until 1953 that maurice kendall and austin hill documented that stock and commodity prices move randomly. market efficiency, as formalised by eugene fama’s seminal paper on efficient capital markets in 1970, is generally used to refer to informational efficiency. under this hypothesis, markets are generally believed to act as effective clearing places that quickly and correctly reflect current security prices. although intuitively appealing, the efficient market hypothesis (emh) has been under attack since the mid-1970s. a new body of research began to form as many researchers began to point out that certain anomalies cannot be explained by the emh. in fact, the literature between the 1970s and late 1990s is littered with proof of market anomalies. the most prominent of these behavioural finance anomalies are: the seasonality in stock returns, the existence of dividend yields and earnings yields in stock returns, the impact of macroeconomic factors on stock returns, the presence of autocorrelation in stock returns and size-related anomalies. each of these anomalies has been documented in detail and comprises several hundred papers on each anomaly. the attack on the emh also came from psychologists and experimental economists who documented a number of specific behavioural biases that are common in human decision-making under circumstances of uncertainty. to this end, prominent studies were performed on the impact of overconfidence on the outcome of investment decisions (e.g. barber & odean 2001), as well as the impact of overreaction (see de bondt & thaler 1985), loss aversion (see kahneman & tversky 1979), regret (see bell 1983), psychological accounting (see tversky & kahneman 1981) and herding (see huberman & regev 2001). this field of research is in direct contrast with the emh, proposing that investors are often irrational, and that all people, and thus all investors, exhibit predictable behaviour. the supporters of the emh were, however, also active in this period. in his seminal review, fama (1970) surveyed the empirical evidence for the weak form, semi-strong form and strong form emh. in 1991, fama conducted a second review of the market efficiency literature using variables such as the dividend price ratio, earnings price ratio, book-to-market ratio and several measures of interest rates. although his review shows mounting evidence of return predictability from past returns, dividend yields and a number of term-structure variables, he argues that these findings might be spurious and should be met with scepticism. the supporters of behavioural finance, however, remain convinced that markets are not as efficient as fama (1991) claims. the 1990s saw a great number or works still disputing market efficiency, prompting eugene fama to publish yet another review on market efficiency in 1998, this time on the sustainability of anomalies in the long run. here fama (1998) argues that overreaction occurs as often as under-reaction and that post-event continuation of pre-event abnormal returns is almost as frequent as post-event reversals. fama (1998) also asserts that most of the long-term anomalies in the literature disappear as different techniques are employed to test for them. it is only in the early 2000s that the concept of varying market efficiency seems to have brought about some respite in the almost 40-year feud between the staunch emh supporters and the behavioural finance contestants. emerson, hall and zalewska-mitura (1997), for example, track the evolution of market efficiency over time by employing a multifactor model with time-varying autocorrelation coefficients and generalised autoregressive conditional heteroskedasticity (garch) errors. they gauge the degree of return predictability, and therefore inefficiency, by observing whether the time-varying autocorrelation coefficient estimates stabilise over time or not. this study was a definitive break from the concept of testing whether markets are either efficient or inefficient. zalewska-mitura and hall (1999) took this idea further and attempted to quantise the movement towards efficiency by employing a multifactor model with time-varying autocorrelation coefficients and the garch-m method. their work is seen as the formalisation of the tests for evolving efficiency (tee). similar tests for evolving efficiency were also done on the developing markets of central and eastern europe (zalewska-mitura & hall 2000), africa (jefferis & smith 2004, 2005) and china (li 2003a, 2003b). this research was the first move in the direction of combining the beliefs of the likes of fama and those of the behavioural finance supporters. lo (2004, 2005) builds on the concept of changing efficiency over time by comparing the market to a living organism that adapts to a changing environment. in his seminal paper, lo (2004) goes on to explain that markets are forever changing and that market participants will always aim to adapt equally fast to these changes. there are, however, periods when market participants are incorrect about the underlying fair value of certain assets and that it is during these periods that markets move away from their efficient behaviour. the research that followed on from lo (2004) concentrated on retesting the efficiency of markets in a moving time-frame paradigm. as such, some recent advances under tees will be discussed in the next section. what is, however, not prevalent in the literature is the evolution of market efficiency over time for smaller sub-indices. understanding the flow of information in smaller indices is critical in understanding the behaviour of portfolio managers following an active management approach. because active portfolio managers often also invest in smaller or less familiar stocks, it is important to determine the link between market efficiency and these less familiar stocks. mainstream research often focuses on stock indices that represent the most liquid and largest stocks. it is, therefore, often the case that these markets are found to be efficient. portfolio managers are, however, in the position to invest in smaller stocks as well, and they often do. the effects these stocks have in bigger indices then disappear in efficiency tests. the reason these effects are more prominent in smaller stocks is because information is not as abundant as it is in larger stocks (lakonishok, shleifer & vishny 1992). as such, there are a number of factors that obstruct the flow of information. smaller stocks suffer from illiquidity that affects the market’s capacity to accommodate orders (chordia, roll & subrahmanyam 2005), and since a low degree of competition results in the presence of dominant players, it is easy for active market participants to deal in large enough quantities and so cause stock prices to deviate from their intrinsic value. the general lack of market transparency for smaller stocks – as reflected by corporate information scarcity and low auditing experience – also result in truncated fundamental information (lakonishok et al. 1992). these informational and other inefficiencies are to the knowledge of the authors not yet explored in a varying efficiency framework for smaller sub-indices on the johannesburg stock exchange (jse). this is important from a portfolio manager’s point of view, since excess returns might be generated if they concentrate their efforts on dealing in more predictable stocks only. this research will consequently aim to provide clarity on this issue and so add to the growing body of knowledge under the adaptive market hypothesis (amh). the remainder of this article will discuss the background of the tee next, followed by a description of the data and methods used in the third and fourth sections. the results are reported in the fifth section and the sixth section will conclude. tests for evolving efficiency in weak-form efficient markets, returns are not predictable since price changes are random and they fully reflect all of the available information in the market. this explanation of the market can be best described by the random-walk hypothesis (rwh). the literature on the existence of autoregressive conditional heteroscedasticity (arch) effects in stock returns data is, however, also prevalent, thus opening the door for the extensive testing of dependence in the higher moments of stock data. to date, the main approach for testing for these dependencies was based on absolute efficiency, where markets are defined as either efficient or not, by means of tests for the random walk or for the martingale hypothesis over a single period. more recently, a number of studies set out to analyse changes in efficiency over time by either applying absolute efficiency tests for separate time periods (e.g. borges 2011), using a fixed-length rolling window (e.g. kim & shamsuddin 2008) or testing for changing efficiency with garch-in-mean models with time-varying parameters (see jefferis & smith 2005). this new strand of research is based on the work of andrew lo. the amh was first formalised by lo (2004) as an explanation for the seemingly adaptive nature of markets. lo goes on to explain how the degree of market efficiency is similar to an ecological system, in that market participants are constantly faced with changing circumstances to which they must adapt. it is this adaptation that leads to, among other things, varying efficiency across time and markets (lo 2005). the amh does not, therefore, propose that the emh is wrong, but merely that it is incomplete (lo 2012). after lo’s (2004) proposition that markets are not either efficient or not, but rather go through cycles of inefficiency, a number of studies set out to find evidence of these changes in efficiency over time. to this end kim, shamsuddin and lim (2011) analysed the dow jones industrial average index (djia) between 1900 and 2009 and found cycles of inefficiency occur mostly over periods of economic shocks. this result was confirmed by lim, luo and kim (2013) who tested for return predictability on the djia, the s&p 500 composite price index and the nyse composite. by testing for efficiency on a rolling window basis on 11 middle eastern stock markets, niemczak and smith (2013) also found periods of efficiency followed by periods of inefficiency. some research also set out to provide more clarity on the degree to which some markets are more or less efficient than others. under this strand of research, lim (2007) ranks several markets according to efficiency and found the united states (us), korea and taiwan to be some of the most efficient markets and that malaysia, chile and argentina are relatively less efficient. lim and brooks (2010) found similar results and report that developed markets are relatively more efficient, most of the time, and that developing markets depart from efficiency on a more regular basis. smith (2012) tested for the martingale hypothesis on a rolling basis for 15 emerging european stock markets and compared it to the developed markets of greece, portugal and the united kingdom (uk), and found the most efficient markets to be in turkey, the uk, hungary and poland, while the least efficient are in the ukraine, on malta and in estonia. jefferis and smith (2005) and smith and dyakova (2013) also tested for relative efficiency, but on the lesser developed african markets. they too found that the relatively more developed egyptian and south african markets are more efficient when compared to the less developed markets of kenya and zambia. given the international evidence from the literature, it is clear that markets, and indeed sub-divisions within markets, are all subject to cycles of efficiency, followed by cycles of inefficiency. should these cycles exist within a particular market, it might add to our understanding of the discrepancy between practice and theory insofar as the existence and, indeed, the success of fund managers following an active management style are concerned. so, can we reconcile practice and theory by shedding more light on the microstructure of a frontier market such as the jse? data daily index values are used to test for varying efficiency on the jse. all the data are sourced from the inet bfa database and span a period between 03 july 1997 and 03 march 2015 (4415 daily observations). we have not included each and every index listed on the jse, since some indices are only available later – some as late as 2008. the indices covered are, however, all available from the same date. the data were transformed by means of miller, muthuswamy and whaley’s (1994) proposed method for removing thin trading effects, and converted to daily returns for testing with the automatic variance ratio (avr), chow–denning joint variance ratio (jm) and joint sign (js) tests. all the indices have positive average returns. this is not surprising given that the jse all share index grew by 695% over this period. of the 31 indices, 17 are negatively skewed and all the series are leptokurtic. when interpreting the jarque-berra (jb) test in table 1, it is also clear that none of the original data series is normally distributed. although not included here, all the white tests performed for conditional heteroskedasticity rejected the null hypothesis of homoskedasticity for all the indices listed here. table 1: descriptive statistics. methodology since the methodology for testing market efficiency can influence the findings, it is prudent to ensure that robust tests are used. the test andrew lo used for proving the amh in 2004, was a simple rolling first order autocorrelation test on monthly returns data. after lo (2004, 2005), a number of studies started to explain their results in terms of the amh, and introduced new methods to test for this hypothesis. cajueiro and tabak (2004) and lim and brooks (2010), for example, employ a rolling hurst exponent to prove evolving efficiency, while phengpis (2006) tee based on a rolling augmented dickey-fuller unit root test. lim (2007) makes use of a rolling bicorrelation test to measure serial dependence. he transforms the data by subtracting the sample mean from each data point and then dividing by the sample standard deviation. lim asserts that market efficiency is visible under these conditions if the bicorrelation of each sub-sample is zero. the most popular test for varying efficiency, however, remains the variance ratio (vr) test, as introduced by lo and mackinlay (1988). they asserted that if stock prices follow a random walk, the variance of the k-period return should be equal to k times the variance of the one-period return. this means that the vr should be equal to 1 for any holding period k, under the null hypothesis of serially uncorrelated stock returns. chow and denning (1993) expanded on lo and mackinlay’s (1988) vr test to provide a procedure for the multiple comparison of the set of variance ratio estimates. another improvement on lo and mackinlay’s (1988) vr test came from wright (2000) who tested the null that a series is a martingale difference sequence (mds) by using the ranks and signs of a time series to form vr tests. because these tests can be exact, they have better power properties than the test applied by lo and mackinlay (1988). wright’s (2000) sign-based vr test starts out with the assumptions that the sign (st) is an independent and identically distributed sequence with zero mean and unit variance that takes the value −1 and 1 with equal probability. he posits that for any series xt, u (xt, q) would be equal to 1 = (xt > q) – 0.5. in this instance u(xt, 0) is 0.5 if xt is positive and −0.5 otherwise. this means that st is equal to 1 with probability 0.5 and is −1 otherwise. under these conditions, st is generated by a mds, and the vr test for signs can be given as (wright 2000): although this is an improvement on lo and mackinlay’s (1988) vr test, this modified sign version test still suffers size distortions when they are sequentially applied at several k values. in order to solve this, kim and shamsuddin (2008) proposed multiple-sign vr tests, based on wright’s (2000) original rankand sign-based tests. they also applied p-value adjustments for multiplicity with the assumption that the test statistics computed at different intervals are uncorrelated. in order to test for the joint null hypothesis (as proposed by chow & denning 1993) that v(ki) = 1 for i= 1,…,l against the alternative hypothesis that v(ki) ≠ 1 for some holding period ki, kim and shamsuddin (2008) takes wright’s (2000) idea of a sign-based test to change the chow and denning (1993) test to equation 2: the js statistic has an exact sampling distribution, and its critical values can be obtained by simulation in a similar way to that of s1(k) given in equation 1. the null hypothesis is rejected when the observed js statistic is greater than the critical value. kim and shamsuddin (2008) also employ multiple vr tests, based on the wild bootstrap method, and make use of monte carlo simulations to prove that these non-parametric tests have superior small sample properties when compared to the conventional chow–denning test. kim (2006), on the other hand, improved on the lo and mackinlay (1988) test by employing a wild bootstrap to obtain p-values instead of using a regression process to solve for the multiplicity problem in small samples. the lo and mackinlay test used by kim is shown in equations 3 and 4: kim (2006) also improved on the chow and denning (1993) test by employing a wild bootstrap method. the test by chow and denning has the null hypothesis that v(ki) = 1 for i= 1,…,l the test statistic can be written as , which asymptotically follows the studentised maximum modulus distribution with l and t degrees of freedom under assumption h* of lo and mackinlay (1988). kim’s (2006) wild bootstrap version of the chow–denning test is performed in three stages. during stage 1, a bootstrap sample is formed of t observations where ηt is a random sequence with e(ηt) = 0 and . in stage 2, the mv(x, ki) statistic obtained from the bootstrap sample is used to calculate mv*as follows: mv* ≡ mv(x*, ki). during stage 3, the first two stages are repeated enough times to form a bootstrap distribution of the test statistic . the p-value of this test is the proportion by which exceeds the sample value of mv(x, ki). the wild bootstrap version of the lo and mackinlay (1988) test can be implemented in a similar manner to a two-tailed test, where mv* ≡ mv(x*, k) is obtained in stage 2 and in stage 3. conditionally on is a serially uncorrelated sequence with zero mean and variance , which is a special case of assumption h* of lo and mackinlay (1988). mv* and m* therefore have the same asymptotic distributions as mv(x, k) and m (x*, k). since is a serially uncorrelated sequence, wild bootstrapping approximates the sampling distributions under the null hypothesis. the test statistics being bootstrapped are pivotal asymptotically, under the condition that xt follows a mds, therefore satisfying assumption h* of lo and mackinlay. however, when using the chow and denning (1993) type joint vr tests, a set of holding periods must be chosen. it is therefore important to select an optimal value of x since the specific set of values selected can affect the power of the tests. choi’s (1999) avr test solves this by using a data-dependent method to select the optimal value of x. choi showed that under the null hypothesis of no serial correlation in the returns series, the test statistic is calculated through equation 5: as pointed out by kim (2009), however, choi’s (1999) avr test still exhibits size distortions under conditional heteroskedasticity, and since all the jse index returns data are heteroskedastic in nature, this must be accounted for by the model. to solve for these size distortions, kim suggested that choi’s avr test can also be improved by applying the wild bootstrap method. this improves choi’s test, providing more power against a wide range of both linear and non-linear models with no size distortion (charles, darné & kim 2011:153). the wild bootstrap version of choi’s (1999) avr test is performed in the same manner as the wild bootstrap versions of chow and denning’s (1993) vr test and wright’s (2000) sign-based test. as before, the estimated p-value is the proportion by which the absolute values of the bootstrap distribution exceed the absolute value of as calculated from the returns series xt. for the purpose of this study, the wild bootstrap vr test of kim (2006), the js test of kim and shamsuddin (2008) and the avr test of kim (2009) will be employed since they provide the best defence against the size distortion and allow for the testing of varying efficiency. in order to measure the varying nature of efficiency, we make use of the rolling window approach followed by lim (2007), lim and brooks (2010) and more recently smith and dyakova (2013), as well as verheyden, de moor and vanpée (2016). this approach uses the percentage of subsamples that rejects the martingale null hypothesis on a rolling basis with the three tests identified above. by doing this, it is possible to compile an indicator for relative predictability. a higher average percentage of rejections over the three tests indicates higher predictability in the data, while a lower average percentage indicates less predictability and, therefore, market efficiency. the length of the rolling windows for each index under investigation is 500 observations. this window length was also used by smith (2012) and lim et al. (2013), who provide evidence that a 500-observation window is sufficiently short to detect short-horizon predictability, while being long enough to still have good power and size properties. the wild bootstrap vr test of kim (2006), the js test of kim and shamsuddin (2008) and the avr test of kim (2009) also suffer no size or power issues with 500 observations (see the evidence of monte carlo tests performed by kim and shamsuddin 2008; kim 2009; charles et al. 2011). these tests are, however, all testing for some form of predictability in the data based on the autocorrelation in returns, something that will also be displayed naturally in thinly traded data.1 this incorrect assumption of auto correlated data can easily lead to the conclusion that the market is not efficient when, in fact, it might be. since the problem of thin trading is especially prevalent in developing country data, this study will address this before continuing to test for efficiency. this will be done by following miller et al.’s (1994) proposed method for removing thin trading effects. their method has been widely used for emerging stock markets (e.g. al-ajmi & kim 2012; bley 2011; loc, lanjouw & lensink 2010). in order to remove thin trading effects, miller et al. make use of a moving average model that reflects the number of non-trading days. however, since it is difficult to identify non-trading days, they showed that an equivalent adjustment can be obtained with the following ar (1) model: in equation 6, xt is one-period returns estimated by an ordinary least squares (ols) process. the residuals, εt and estimated coefficient, , are then used to obtain the returns corrected for thin trading as follows: in equation 7 is the returns corrected for thin trading. to adjust for the changes in thin trading over time, equation 6 will be run by a recursive least squares process, and the corrected recursive estimates are used in equation 7. autocorrelation in the corrected returns will now be an indication of return predictability, and therefore market inefficiency. results as mentioned above, we tested for the percentage of subsamples that rejects the martingale null hypothesis on a rolling basis with the avr, jm and js tests. the first window started on 03 july 1995 and ended on 02 july 1997, and holding periods of 2, 5, 10, 20 and 40 are used for all the tests. each of the three tests are therefore performed on 500 data points, after which the window is moved on by one observation. the final window thus started on 01 march 2013 and ended on 03 march 2015. each of the tests will, therefore, display when a specific index was efficient, by indicating when the martingale hypothesis holds and when not. when testing for market efficiency by means of the avr and jm tests, p-values below the 5% significance level (the horizontal dotted line in each of the graphs) leads to a rejection of the martingale hypothesis, implying inefficiency in the market or return predictability. for the js test, a test statistic above the 5% critical value will lead to a rejection of the martingale hypothesis, thus indicating inefficiency or return predictability. the market efficiency of each index will therefore be displayed as a dynamic state, indicating how efficiency evolves over time. each date on the graph displays the state of efficiency at that point, based on the previous 500 observations. figure 1 displays the results of selected indices (the all share index, the top 40 index, gold mining index, financials index and small cap index).2 figure 1: j203 – all share index: (a) avr p-values, (b) jm p-values, (c) js p-values. from figures 1 through 5, it is clear that the sub-indices on the jse move rapidly between states of efficiency and inefficiency. all of the indices tested display periods of market efficiency, followed by periods of market inefficiency, thus conforming to the amh as described by lo (2004). the three tests also corroborate each other. for most of the indices, p-values above the 0.05% critical value for the avr and jm tests indicate market efficiency for the time frames that the js statistic spends time below the critical value, indicating market efficiency. this is especially prominent for the all share index where market inefficiency seems to be present for the periods leading up to the years 2000, 2006 and 2014. this trend is also reflected in some of the other indices. the small cap index, for example, experiences inefficiency over the years 2000, 2006 and 2014, but also for a considerable time before and after. figure 2: j200 – top 40 index: (a) avr p-values, (b) jm p-values, (c) js p-values. figure 3: j150 – gold mining index: (a) avr p-values, (b) jm p-values, (c) js p-values. figure 4: j580 – financials index: (a) avr p-values, (b) jm p-values, (c) js p-values. figure 5: j202 – small cap index: (a) avr p-values, (b) jm p-values, (c) js p-values. although there might be many reasons for this fluctuation in efficiency, the value of these tests is in the comparison between indices. as expected, some indices are also clearly more efficient than others. it is not surprising then that the all share index is not the most efficient of the indices tested. the all share index represents all the stocks traded on the main board, and will therefore also reflect the relative efficiency of less efficient stocks. the overall percentage of the three tests over the full period (13.08% between 1997 and 2015) also compares well with the result of smith and dyakova (2013) who reported 15.73% between 1998 and 2011. the all share index therefore shows improved efficiency when observing it over the longer time frame and when considering newer data. this result, too, corroborates previous findings that developing markets become more efficient over time (see cajueiro & tabak 20043). to appreciate how drastically the levels of efficiency differ among the sub-indices, the results are ranked after combining the results of the avr, jm and js tests. by calculating the total number of rolling windows that reject the martingale null hypothesis, it is possible to compile an indicator for relative predictability. a lower average percentage of rejections over the three tests will then indicate less predictability in the data and thus more efficient data. a higher average percentage indicates more predictability and therefore market inefficiency. table 2 reports the rankings of indices based on their relative efficiency.4 table 2: efficiency rankings. the results in table 2 are ranked from most efficient to least efficient. once the different indices are compared with one another, it becomes apparent that not all the sub-indices on the jse are equally efficient. although there are a number of surprising results, most of the indices rank how one would suppose they should. it is expected, for example, that the older indices – like forestry and paper, gold mining and industrials – should be fairly efficient by now. some stocks in the gold mining and forestry and paper indices have been listed for more than 100 years, and market participants are therefore well aware of their potential growth, as well as the fundamental forces that drive their stock prices. analysts have also been reporting on these stocks for a long time, allowing market participants to form an informed opinion on what these stocks would be worth at any given time (gleason & lee 2003). it should then not be surprising that telecommunication, small caps and the media indices would rank on the less efficient, and therefore more predictable, side of the scale. telecommunication is a relatively young index5, consisting of a few major companies (telkom, mtn and vodacom). the telecommunication industry was long controlled by the south african government, and telkom only listed officially in 2003, while mtn listed in 1995 and vodacom in 2009. it is further no surprise that the small cap index displays market inefficiency. smaller companies are not as well researched by market analysts, leading to truncated fundamental information and, therefore, more predictable behaviour (hong, lim & stein 2000). although the media index displays a fair amount of liquidity6 it is still one of the most predictable indices on the jse. upon closer inspection, this predictability can be explained by the growth of naspers that makes up more than 99% of the index based on capitalisation. naspers grew by more than 2050% between 2005 and 2015, resulting in a very strong underlying trend in the data. since all three tests are designed to test for serially uncorrelated returns, it explains why the media index, and indeed any series that exhibits such strong underlying trends, will be deemed inefficient. age and the coverage of analysts are, however, not the only determinants of efficiency. in essence, these tests for efficiency would naturally rank data as more efficient if the time series is made up of data that follow a random walk. data that follow more well defined trends will then naturally be defined by the tests as less efficient. the most inefficient index – automobiles and parts – lost 89.99% of its value between 02 february 1996 and 28 march 2001. the index then gained 1568% in value from 28 march 2001 to 28 february 2014, thus making for very predictable data, which was consequently found in the results. this trend is also visible in the other inefficient indices. the general financial index gained 281% between 28 march 2001 and 28 february 2014, while the growth of the other indices over the same period was 261% for the financials index, 322% by banks, 843% by telecommunication, 871% by small caps and 6829% by media. not all the results are that easily explained though. the vr tests reject the martingale hypothesis 0.98% of the time less for top 40 index when compared to the all share index. although the difference is not great, this is fairly surprising, given that almost all of the stocks in the top 40 index are followed closely by market analysts. these stocks also form part of most fund managers’ portfolios, and are very liquid when compared to the rest of the stocks being traded on the jse (fang & peress 2009). one would, therefore, expect the top 40 index to be more efficient than the all share index. this result might be explained by the same means as before, in that the top 40 index consists of a small number of very large companies, and that these companies experienced very pronounced trends over the period under observation. another surprise result is the relative predictability of the bank index. south africa has one of the most sophisticated financial systems in the world, and although this contributes little to the informational efficiency of the stock prices, its inefficient nature is an unexpected result. some of the banks are also very old – standard bank for example has been operating in the country for more than 150 years. the fact that the banking sector is dominated by the big four banks also fails to explain this apparent lack of informational efficiency. upon closer inspection, however, it is clear that the four big banks – namely standard bank, barclays group africa, nedbank and first rand group – are highly correlated.7 with the exception of nedbank, all the banks have seen a steady increase in their stock prices from the start of the period under consideration. all four banks peaked in june 2007, reached a bottom in march 2009 and continued their upward momentum into 2015. this long-term upward momentum, coupled with the dominance of these four banks, might go some way to explaining the relative inefficiency of the bank index. it seems then that inefficiency in this instance can partly be explained when market participants in certain indices act in unison based on clear market signals – such as those in a crisis. market efficiency tends to break down over times of crisis (anagnostidis, varsakelis & emmanouilides 2016; horta, lagoa & martins 2014; lim, brooks & kim 2008). overall, the results are mostly in line with the current literature. the all share index is, at the very least, weak-form efficient 13.08% of the time, as reported by smith and dyakova (2013). this efficiency also changes over time, conforming to the amh as found by lo (2004, 2005) and for the jse by jefferis and smith (2005) and smith and dyakova (2013). the fact that the small cap index and some of the other less known indices are more predictable than the all share and top 40 indices is also in line with the research of jefferis and smith (2004) who gave a number of reasons for this result. although jefferis and smith give a range of reasons for this phenomenon, the most prominent are the availability of information, size of the market, size of the individual stocks and the diversity of activities the company is involved in.8 the implications of these findings are that portfolio managers with an active management approach would therefore find opportunities to profit from informational inefficiencies in the market. the fact that the all share index is informationally efficient most of the time leads many studies to conclude that this was and will not be possible. however, save for index tracking funds, portfolio managers do not invest in the all share index per se, but have some subset of stocks in their equity portfolios.9 it should, therefore, be logical that they will be invested in stocks that are informationally efficient at times, but also in stocks that are not. this is clear when considering our results. should portfolio managers hold a portfolio that consists of banks, telecommunications stocks, media stocks and other small capitalisation stocks for example, they would be invested in a portfolio that is informationally inefficient more often than not. although this is not something that portfolio managers can take advantage of directly, it should be possible to make use of momentum, value, or other trading strategies with more success than would otherwise have been possible in more efficient markets. finding portfolios that outperform the general market on a risk-weighted basis should, therefore, not be seen as an anomaly, but rather as a logical consequence of the varying efficiency paradigm. conclusion by testing for the martingale hypothesis by means of rolling window vr tests, we established that the jse all share index is weak-form efficient and that all the indices tested move from periods of efficiency to periods of relative predictability. this result is in line with the literature on the amh as proposed by lo (2004, 2005). as expected, the indices consisting of older and more established companies are efficient more often than indices consisting of younger companies. the top 40 index also ranks higher up the efficiency scale, while the small cap index ranks close to the bottom. it is therefore clear that the degree of predictability is related to size and liquidity, and that the indices consisting of stocks that are covered more regularly by market analysts tend to ranks higher on the efficiency scale ceteris paribus. the fact that there are various indices that are fairly predictable, suggests that it would be possible for portfolio managers to follow an active management approach with some success. this informational inefficiency and therefore relative predictability is also persistent in some indices, thus indicating that market participants have not yet managed to get to grips with the drivers of stock prices in these indices. these findings speak not only to the jse, but transcend any market with similar characteristics. fund managers following an active management style might thus make use of varying efficiency in any market given that there will always be new indices, smaller firms, and both firms and indices not covered extensively by market analysts, regardless of the age and sophistication of that market. given the varying efficiency displayed in the jse index data, the next question 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stock exchange’, economics of planning 33(1–2), 3–18. https://doi.org/10.1023/a:1003913725499 footnotes 1. the vr test of kim (2006) tests for the null hypothesis of a mds; the js test of kim and shamsuddin (2008) evaluates the distribution of the signs of the underlying returns series, produced by a mds, and the avr test of kim (2009) tests for a null hypothesis of no serial correlation in the returns series. 2. including all 31 indices is unnecessary since a complete ranking will be given in table 2. the graphs are included to illustrate the general idea of evolving efficiency and to show how the final results were derived. 3. cajueiro and tabak (2004) used the hurst exponent to test for long memory on a rolling window basis in 11 emerging markets between 1992 and 2002. 4. table 2 reports the ranking of the different indices from most informationally efficient to least efficient after the returns were corrected for thin trading. 5. following the research of zalewska-mitura and hall (2000), li (2003a), jefferis and smith (2005) and hull and mcgroarty (2014), there seems to be clear evidence from the literature that market efficiency is not only changing over time, but that there is a clear direction in this evolution. these studies all find clear evidence that markets move from inefficiency towards efficiency over time. building on this empirical evidence from the literature, the authors expects the telecommunication index to become more efficient over time. 6. this index consists of four companies: african media entertainment (0.06% of the index), caxton publishers and printers (0.59% of the index), e media holdings (0.06% of the index) and naspers (99.29% of the index). 7. the pearson correlation coefficient between the banks are: standard bank and barclays group africa (0.98); standard bank and nedbank (0.67); standard bank and first rand group (0.91); barclays group africa and nedbank (0.64); barclays group africa and first rand group (0.88); nedbank and first rand group (0.82). 8. jefferis and smith (2004) explain that as good quality information is expensive, leading market analysts tend to concentrate their efforts on larger firms. because of this, the size of the market creates an economy of scale effect in both relative and absolute terms. 9. almost all portfolio managers have naspers in their portfolios. naspers makes up 99.29% of the media index and, as such, the test for the relative efficiency of the media index is a test for the relative efficiency for naspers. it follows then that portfolio managers can easily include inefficient assets in their portfolios regardless of the overall level of efficiency of the market as a whole. 10. samuelson’s dictum states that individual stocks are more informationally efficient than the market as a whole, leading the efficient market hypothesis to work better for individual stocks than for the total market (see jung and shiller 2005). abstract introduction literature review research methodology results recommendations and conclusions acknowledgements references about the author(s) vanessa m. gregory school of accounting, economics and finance, college of law and management studies, university of kwazulu-natal, pietermaritzburg, south africa citation gregory, v.m., 2023, ‘integrated report content evolution: a case study of the johannesburg securities exchange food and drug retail sector’, south african journal of economic and management sciences 26(1), a4397. https://doi.org/10.4102/sajems.v26i1.4397 original research integrated report content evolution: a case study of the johannesburg securities exchange food and drug retail sector vanessa m. gregory received: 17 oct. 2021; accepted: 14 july 2022; published: 24 jan. 2023 copyright: © 2023. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: since the release of the king iii report in 2009, and the adoption of these principles in the johannesburg securities exchange (jse) listing requirements, there has been a surge in integrated reporting guidelines, including the release of the international integrated reporting council (iirc) framework and global reporting initiative (gri) sustainability reporting standards, with an updated code for corporate governance, king iv, subsequently being published. these introductions have simulated a growth in research on integrated reporting; however, the impact of these initiatives on the annual integrated report (air) composition or format has not been explored. aim: the objective of this article is to examine, compare and contrast identified trends in the composition of published airs following the release of the aforementioned guidelines. setting: jse-listed companies in the food and drug retail sector were analysed from 2009 to 2018. methods: the study applied both qualitative and quantitative content analysis techniques to analyse the composition of airs. results: the composition of airs of companies within the given sector and timespan has shifted, shown through a decrease in the number of pages containing annual financial statements and an increase in governance, strategy and sustainability information. annual integrated reports have moved to explaining financial results with reference to full financial statements published online, with the other identified shifts coinciding closely with the release of integrated reporting developments. these results suggest that there has been an uptake in application of new reporting initiatives. contribution: the article revealed that new reporting guidelines had been applied, generating a change in the composition of airs over the years, contributing to the body of knowledge on the reporting of economic, environmental and social perspectives. conclusion: a comprehensive foundational study has been created that has illustrated that airs have developed in relation to new reporting initiatives. keywords: integrated reporting; sustainability reporting; international integrated reporting council (iirc); global reporting initiative (gri); king code of corporate governance; food and drug retail sector; composition of annual integrated reports; annual integrated report structure. introduction annual integrated reports (airs) are an essential tool for investors and other stakeholders to obtain social, environmental and governance information, together with financial information for their decision-making. the king iii report was released in 2009. while this report was a code of governance, it encouraged the publication of airs, and subsequently the johannesburg securities exchange (jse) made it obligatory to follow the king iii principles for all those listed thereon for financial years commencing on, or after, 01 march 2010. as a result, while integrated reporting was not mandatory, it had to be employed on an ‘apply or explain’ basis (jse 2017); and numerous jse companies began producing these reports (saica 2010). when the jse made the above change, the only guidelines available on integrated reporting were king iii and global reporting initiative (gri) 3.1. subsequently, more attention has been devoted to integrated reporting guidelines. the international integrated reporting council (iirc) was established, and then issued an integrated reporting framework in december 2013 and, with effect from june 2021, has merged with the sustainability accounting standards board (bouvier 2021). the gri has developed gri 3.1 into a full set of sustainability reporting standards (published in october 2016), followed by king iii having been updated to king iv (released on 01 november 2016). as south africa was then the first and only country to enforce integrated reporting on the ‘apply or explain’ basis (appiagyei et al. 2018; eccles, krzus & solano 2019; hoang et. al. 2020), it was referred to as the pioneering country in that respect, (de villiers, rinaldi & unerman 2014; dumay et al. 2016) and has remained the current world leader in integrated reporting practices (du toit 2017). studies such as that of du toit (2017), dumay et al. (2016), haji and anifowose (2016), rinaldi, unerman and de villiers (2018), as well as scholtz, mans-kemp and smit (2018) have found that integrated reporting is a trending topic and research in this sphere has been growing, but the impact and value of all the new reporting initiatives have not been fully explored. the majority of the existing research utilises specific disclosure checklists, rather than evaluating the overall composition of the air, was performed within a relatively short time frame and focuses on companies from sectors other than the jse food and drug retail sector. the objectives of this article are two-fold, contributing to research on the impact of integrated reporting initiatives on the overall composition of airs: to examine and identify trends in the composition of airs of companies listed in the jse food and drug retail sector, following the release of king iii and other guidelines on integrated reporting; and to compare and contrast identified trends in the composition of airs between each of the companies listed in the jse food and drug retail sector, following the release of king iii and other guidelines on integrated reporting. the study does have one key limitation, being that the assessment has been limited to jse companies listed in the food and drug retail sector. as such, the findings are not representative of the entire jse and not generally applicable to other sectors. however, other sectors could be analysed in a similar manner and those findings contrasted to the findings of this study to expand the research base. the article is structured as follows: the next section contains a literature review on integrated reporting and the numerous integrated reporting initiatives introduced, following the publication of the king iii report. this is followed by an explanation of the research methodology, data collection and the results, findings and conclusions from the analyses. thereafter recommendations are provided. literature review annual integrated reports are useful tools through which companies communicate past and current performance, future prospects, legitimise management actions and influence perceptions (du toit 2017). such reports have been relied upon, not just for decision-making by investors, but to hold management accountable for their actions, for the monitoring of performance and the discouragement of inappropriate management behaviour and, consequently, posed a significant influence on stakeholders (dube 2017). despite their usefulness, researchers have criticised airs for their financial focus, clutter, complexity (dube 2017; lee & yeo 2016) and reflection on historical performance, rather than exhibiting a consolidated representation of the company with forward-looking information (beattie, mcinnes & fearnley 2004; beck, dumay & frost 2017; bernardi & stark 2018) and the disclosure of non-financial information in a self-interested manner (adams et al. 2016). for these reasons, the reporting regime has been developed and the volume of reporting of non-financial information has increased (dube 2017). the king series of reports, gri guidelines and the iirc framework are examples of initiatives that have been developed following investor demands. each of these changes and their impact on airs are explored in more detail below. king codes in 1994, king i was released (de villiers, hsiao & maroun 2017a; dumay et al. 2016). this first king code of corporate governance principles introduced the incorporation of all stakeholders and largely focused on governance, particularly the desired conduct of the board of directors (dube 2017). king ii followed in 2002 with the suggestion of incorporating sustainability (environmental, social and corporate governance performance) and risk management in reporting (de villiers et al. 2017a; dumay et al. 2016; scholtz et al. 2018), resulting in a number of entities including this in their air and others publishing separate sustainability reports with their air. several years later, in 2009, king iii was published to encourage an increase in accountability of companies to their various stakeholders (ackers & eccles 2015). it was accepted that existing guidelines were inadequate and disclosure modifications were necessary (de villiers et al. 2014). the code proposed the publishing of an air that would holistically represent performance on both financial and non-financial matters (de villiers et al. 2017a; dumay et al. 2016), but this would be done on an ‘apply or explain’ basis (companies decide to either apply the principle, or explain to the users why it had not been applied [giles 2017; institute of directors 2009]). the jse subsequently mandated king iii application for financial years commencing on, or after, 01 march 2010 and, consequently, south africa became the first and only country to embrace integrated reporting principles on the ‘apply or explain’ basis (appiagyei et al. 2018; bernardi & stark 2018; de villiers et al. 2017a; dube 2017; eccles et al. 2019; giles 2017; hoang et al. 2020; jse 2017). certain principles became mandatory through the introduction of the new companies act, for example, establishing a social and ethics committee to comply with section 72(4). king iv is the latest development in the king code series. published on 01 november 2016, it has changed from the ‘apply or explain’ basis to an ‘apply and explain’ basis with recommended practices on how to apply principles. the code refers to the iirc framework with part 5.2 including recommended reporting practices, one being that an integrated report should be issued at least annually (institute of directors 2016). the jse has mandated the application of king iv as part of their listing requirements effective for financial years commencing from 01 april 2017 (giles 2017). global reporting initiative the global reporting initiative was established in the 1990s to investigate sustainability issues and how progress and goals could be disclosed to stakeholders, consequently creating the first reporting framework in 2000, and periodically updating this, to arrive at the first global standards for sustainability reporting in october 2016 (gri 2016; scholtz et al. 2018). the gri guidelines have a stakeholder focus similar to king iii and iv (de villiers et al. 2014), encouraging full presentation of both positive and negative aspects (gri 2016). a number of countries, south africa included, have companies that include sustainability reporting in their airs so that all information is holistically presented (appiagyei, djajadikerta & xiang 2016; hunter 2014), but due to the level of detail the gri requirements specify, it was found that it can be problematic for readers to link the multitude of required information (de villiers et al. 2014). international integrated reporting council framework the increase in integrated reporting sentiments created a need for integrated reporting guidelines to be devised and, as such, the iirc was formed in 2010 (pwc 2013) and it published an integrated reporting framework in december 2013 (dumay et al. 2016). the principles-based framework (dissimilar to the rules-based gri guidelines [dube 2017; dumay et al. 2016; lee & yeo 2016]) has more of a shareholder focus (providers of financial capital) with emphasis on strategy and information on future company plans for value creation, integrated into a single report, rather than stand-alone reports (de villiers et al. 2014,2017a; dumay et al. 2016; pwc 2014). the framework defines an air as: … a concise communication about how an organisation’s strategy, governance, performance and prospects, in the context of its external environment, lead to the creation of value over the short, medium and long term. (iirc 2013:7) ultimately this illustrates that the aim of an air is to provide holistic information that shows a clear interrelation between financial and non-financial material (dube 2017), leading to a broader and more cohesive presentation of a company’s performance, than the traditional financial and sustainability reporting and communicating of a full range of material factors that contribute towards a company’s value creation (de villiers et al. 2014). through the introduction of the eight integrated reporting content elements within the iirc framework (iirc 2013; scholtz et al. 2018), airs have encompassed explanations on internal and external environments, forms of capital employed to create value, descriptions on how interactions with capitals and environments create value (rinaldi et al. 2018), as well as social investment activities and how these link to strategy and value creation (adams et al. 2016). impact of guidelines on annual integrated reports having entered the integrated revolution stage (dragu & tiron-tudor, 2013), the introduction of the aforementioned guidelines has had an impact on airs, with a surge of interest in research, following the king iii release. of the several studies within this sphere, content analysis was noted as the dominant research method. numerous researchers used checklists to comment on the quality of the report and the compliance, with specific integrated reporting guidelines, rather than looking at the overrall picture of the air and many cover only a short time period; however, the majority conclude that there has been a positive impact on integrated reporting. these studies are summarised in table 1. table 1: summary of studies on the impact of integrated reporting guidelines in south africa. despite the apparent positive impact, concerns have still been raised that an air cannot provide all the necessary information needed by non-financial stakeholders, are lengthy, circumlocutory, incomparable (de villiers et al. 2017a; de villiers, venter & hsiao 2017b), complex and hard to understand (du toit 2017). there was a noticeable bias towards writing positive information to disguise negative information and make it less noticeable to readers through the use of the passive voice and making the narrative shorter and more complex (du toit 2017). other findings have shown that companies are reducing clutter in their airs by summarising information and making full details available on other platforms such as their corporate websites (du toit et al. 2017; nel 2019; pwc 2014). the consulted literature has revealed that there have been many developments in the integrated reporting realm in south africa, and despite this constant update in information, there is still an arena for growth on the topic and room to improve. research methodology the study followed a longitudinal design aimed at analysing and comparing the composition of airs over time and applied both a qualitative and quantitative approach, using content analysis. qualitative content analysis entails the derivation of themes or categories to analyse data and has often been utilised in the analysis of airs to quantify disclosures (beattie 2005; de villiers, dumay & maroun 2019). in this study qualitative content analysis was used to arrive at the seven key areas presented in the airs (refer table 2) and to explore the key differences in disclosures over time. content analysis can also be quantitative in nature and, used in conjunction with qualitative content analysis, maximises the research methodology (merkl-davies, brennan & vourvachis 2011). this study utilised quantitative content analysis to quantify disclosure and descriptive statistics to analyse these quantifications. disclosures can be quantified using the number of words, sentences or pages in an air (galant & cadez 2017; unerman, 2000). fewer errors could arise in counting sentences, rather than words, due to the magnitude of information to be analysed (milne & adler 1999; unerman 2000); however, hackston and milne (1996) did demonstrate that these methods give similar results. a strong argument in favour of quantifying disclosures in relation to pages rather than words, or sentences, is that non-narrative disclosures (such as photographs, tables, charts and diagrams) are ignored (unerman 2000). non-narrative disclosures are considered to be a powerful and effective means of communication in airs (davison 2007; penrose 2008) and, therefore, it was decided to utilise the number of pages to conduct the content analysis, so that all forms of disclosures are included. other studies that have utilised the number of pages include clayton et al. (2015), cowen, ferreri and parker (1987), gray, kouhy and lavers (1995), o’dwyer (2003), as well as unerman (2000). table 2: seven key areas in annual integrated reports. the period chosen for analysis, 2009 – 2018, is significant as the king iii report was issued in 2009 encouraging the publication of airs, followed by the iirc framework and gri reporting standards. king iii was then updated to king iv within the period. although king iii was only mandated for jse-listed companies with financial years commencing on, or after, 01 march 2010, the incorporation of 2009 and 2010 financial year ends would enable the results to encompass any early adoption, as well as the beforeand after-effects of mandating king iii. similarly, any early adoption of king iv could be reflected in the 2017 (all companies in the sector) and 2018 (only pick n pay) financial year ends, as the report was released in november 2016, but only mandated by the jse listing requirements for financial years commencing on or after 01 april 2017. as there are a vast number of companies listed on the jse in south africa in which integrated reporting is uniquely applied on an ‘apply or explain’ basis, the study was limited to a particular sector on the jse, namely, the food and drug retail sector. the sector has been mostly unexplored in the literature and all the companies within it are essential services and would be well-known and familiar to the majority of the south african population. understanding the population may facilitate this comprehensive foundational study to be better understood as when individuals are presented with alternatives; they would usually prefer the option they are most familiar with (de vries, erasmus & gerber 2017; fox & levav 2000; fox & tversky 1995), thus providing a platform for replication to other sectors. there were eight companies listed within the sector in december 2018 (moneyweb 2018), but choppies, listed in 2015, and bidcorp, dis-chem and gold brand, listed in 2016, were consequently excluded from the research sample, due to not being listed for the entire research period (2009–2018); hence four companies formed part of the study, namely: pick n pay, shoprite, spar and clicks. annual integrated reports published between 2009 and 2018 were sourced from the websites of each company within the research population. an examination of how the total number of pages of the air had changed over the analysis period was performed (refer to figure 1), revealing that the number of pages of each company in the report tended to increase initially, peak at one point in time, and thereafter to decrease substantially. clicks was the first to show this trend, with their peak being in 2011, followed by shoprite in 2012, pick n pay in 2015 and spar in 2016. as per the literature, it was suspected that this shift could have resulted from summarising information (pwc 2014), shifting information online to corporate websites (nel 2019), less duplication of information and/or a decrease in the amount of integrated reporting (du toit et al. 2017). a limitation to shifting reported items online is that historical information might not be accessible or easily located (nel 2016). further analysis into the contents of each report was necessary to draw relevant conclusions. figure 1: number of pages in annual integrated reports from 2009 to 2018. the contents of all the reports were investigated further for each company and each year to examine the trends in the presented information. the investigation revealed seven key areas that had been presented throughout the airs over the analysis period. the seven key areas are: annual results (in full or as a summary) (afs), reports from key board members (rep), contents pages and pictures to facilitate the appearance and readability of the report (cont), explanation of financial information (fin), governance information (gov), shareholder information (sh) and information on strategy and sustainability considerations (strat/sus). detail of the types of material that was classified into each of the seven key areas can be found in table 2. this analysis assisted to arrive at inferences about how the structures of these airs changed over the period following the introduction of the numerous reporting initiatives outlined in the literature. ethical considerations the humanities and social sciences research ethics committee of the university of kwazulu-natal has given full approval for this study to be conducted as a sub-study of the main study titled ‘an evaluation of corporate sustainability and financial performance for jse listed companies in the food and drug retail sector’ (hss/1271/018d). results companies’ airs were sourced and analysed between 2009 and 2018. the analysis entailed scrutiny of each company’s airs, according to the number of pages presented in the report, relative to the seven key areas outlined in the research methodology. the results have been tabulated, graphed and explained subsequently. table 3 and figure 2 summarise the composition of 10 years of airs for each company into the seven key areas identified. table 3 indicates the number of pages per section (p) and the percentage of the total report for the year (%) and figure 2 shows a graphical breakdown of the percentage of the total air per area to easily identify trends. in table 4 the number of pages from table 3 is analysed using descriptive statistics. figure 2: graphical depiction of the composition of annual integrated reports (percentage of total pages): pick n pay, shoprite, spar and clicks (a-d). table 3: annual integrated report composition: pick n pay, shoprite, spar and clicks. table 4a: descriptive statistical analyses of page numbers: pick n pay, shoprite, spar and clicks. table 4b: descriptive statistical analyses of page numbers: pick n pay, shoprite, spar and clicks. table 3 and figure 2 show that there has been an evidential shift in the quantity of information supplied in each section for all four companies between 2009 and 2018. all companies showed a downward trend in the financial statement section and an upward trend in the governance and strategy and sustainability sections, but spar’s strategy and sustainability information did decrease in 2017 and 2018. shareholder information declined in pick n pay and clicks, and financial explanations increased marginally for three of the four companies, the exception being clicks. all other sections were consistent other than a large increase in contents and pictures for clicks in 2018. each section has been scrutinised further below. annual financial statements annual financial statements initially comprised the largest proportion of the airs (around half the air content in 2009, the lowest being clicks at 43%) for all four companies. this proportion declined substantially in each company with the annual financial statement section showing the greatest variability evidenced by the largest standard deviations and the largest page range over the analysis period (refer table 4). figure 2 highlights the substantial decrease in annual financial statement content in the air for pick n pay in 2012 and 2016 onwards; shoprite in 2013 onwards; spar in 2017 onwards; and clicks in 2012 and 2015 onwards. in these years, extracts from the annual financial statements were presented in the air rather than a full set of financial statements with selected notes to the financial statements being disclosed rather than the full notes. further investigation revealed that the full set of financial statements for each company in those years was located in a separate document in the investor relations section of the respective company’s website in line with findings from nel (2019). in 2018 pick n pay only presented two pages: one showing the statement of comprehensive income and the other the statement of financial position. in 2015, clicks took the unique approach of only presenting their annual financial statements in a stand-alone document and not in their air, but still referred to such statements in their financial explanation sections with their air. reports the number of pages occupied by reports ranged from 4 to 11 and, with the exception of clicks, was consistently below 10% of the air each year. the consistency within the reports section is further supported in table 4, reflecting the lowest standard deviation with a range of 4 (spar and clicks) and 7 pages (pick n pay and shoprite) respectively. each company presented a separate chairman’s report and chief executive officer’s report, except spar that combined their chairman and chief executive officer’s reports into one, with the exception of years 2014, 2015 and 2016. there was no evidence into the reasoning for this combination, but it could have been done in an attempt to further summarise and de-clutter the air, as information could be repeated if separate reports were produced, but the choice does not appear to have had a material effect on the composition of the air. shoprite showed an increase in page numbers in 2010 from 5 to 11 pages in which a 4-page chief operating officer’s report was also published. contents and pictures shoprite was the most consistent in their presentation of contents and pictures indicated by a standard deviation of only 0.789 in table 4. it was observed that the number of pages in this section ranged from 5 to 7, and was below 10% of the air. the other three companies experienced more fluctuations in the contents and pictures section, evidenced by higher ranges and standard deviations (see table 4a and table 4b). the increase in page numbers mostly occurred as a result of more full-page images being presented in those years. had different bases (such as the number of words or sentences) been used for the analyses, this observation would have gone undetected. a section explaining to users what the air contained, was introduced by each company. shoprite, spar and clicks introduced this section in 2011, with shoprite expanding the section to be more comprehensive in 2017 and 2018, while pick n pay introduced this in 2012. in 2010, pick n pay published a once-off tribute to raymond ackerman, the founder and ex-chairman of the board, as it was his retirement year. financial explanations financial explanations mostly comprised 10% and less for the four companies. shoprite was the most consistent in their financial explanations with the number of pages, ranging from 5 to 9 pages and a standard deviation of 1.135 (see table 4). additions to financial explanations coincided with the decision to change from presenting full annual financial statements to presenting extracts for both pick n pay and shoprite. pick n pay’s financial highlights increased from 1 to 4 pages in 2016 and shoprite introduced pro-forma financial information in 2017. spar showed an increase in the percentage of financial explanations due to the introduction of a narrated financial review in 2013 that was presented annually thereafter. clicks was the only company to display a decrease in the number of pages containing financial explanations. the decrease was evident as a result of no longer presenting a business unit trading analysis and value-added statement and presenting a shorter 5-year review after 2011. although not impacting on the page composition, it was observed that pick n pay initially presented a 10-year financial review in the years 2009 through to 2011 and in 2012, moved over to presenting a 5-year financial review; shoprite moved from a 5-year financial review to a 3-year financial review in 2017, while spar consistently presented a 5-year financial review and uniquely presented ratios and statistics to users annually. governance information the analysis in table 3 and figure 2 illustrates that governance information presentation has tended to increase in volume, both as a percentage of the total report, and in number of pages for all four companies, with clicks being the most consistent year on year evidenced by the lowest standard deviation (see table 4). an upward trend was expected from the 2011 financial year end, due to the introduction of king iii as a mandatory condition in the jse listing requirements for financial years commencing on, or after, 01 march 2010 and ending on, or after, 28 february 2011. however, all companies were voluntarily applying king ii in 2009 and once king iii had been released, they began adapting disclosures and referring to king iii in 2010 already. this being so, an upward trend was identified in pick n pay and spar, but the number of pages did not increase dramatically. shoprite’s increase only took place in 2012 and clicks remained consistent. pick n pay saw their highest page numbers in 2014 and 2015, mainly as a result of all six board committees publishing reports in those years. table 5 divides the governance information further and indicates the different reports that were produced between 2009 and 2018. this additional analysis shows that many of the reports were consistent in nature between 2009 and 2018, with pick n pay showing more committee reports in 2014 and 2015. both pick n pay and clicks published an audit committee report annually, but ceased this publication in the air, following the shift in presentation of financial statements as explained in the annual financial statements section. further investigation revealed that pick n pay disclosed their corporate governance, remuneration, audit and risk, as well as nominations committee reports in separate documents in the investor relations section of their company website in 2016, 2017 and 2018 in accordance with findings from nel (2019). spar initially reported a combined governance report containing all the committee reports until 2014 where the committee reports were shown individually thereafter. spar originally had a combined remuneration and nominations committee and audit and risk committee which then divided into separate committees: the audit and risk committee divided in 2010 and the remuneration and nominations committee divided in 2016. table 5: governance reports: pick n pay, shoprite, spar and clicks. holistically, the greatest increase in governance reporting in the latter of the analysis period stemmed from an increase in information in the remuneration committee report. pick n pay initially published a 3-page report which increased to 14 pages in 2017 and 19 pages in 2018; shoprite’s report grew from 1 page in 2011 to 10 pages in 2018; spar from 5 pages in 2017 to 12 pages in 2018; and clicks from 5 in 2013 to 10 pages in 2017 and 2018. shareholder information shareholder information provided in the airs has fluctuated from year to year for each of the four companies with no general trend. the maximum number of page numbers reflected in table 4, for the shareholder section, was reported in 2011 for spar, 2012 for pick n pay, 2014 for shoprite (with 2012 being the second largest year) and 2013 for clicks. further analyses revealed that the spikes in shoprite for 2012, spar and pick n pay were due to the once-off presentation of the new memorandum of incorporation, following the introduction of the new companies act in south africa comprising 18 pages for spar, 16 pages for pick n pay and 26 pages for shoprite. the 2014 spike for shoprite and that of clicks were due to a notice to shareholders regarding the annual general meeting and other special general meetings: 32 pages for shoprite and 16 for clicks. strategy and sustainability information strategy and sustainability information has shown a general upward trend between 2009 and 2018 (see figure 2). this upward trend could be explained by the introduction of the iirc framework that indicated that ‘an integrated report should provide insight into the organisation’s strategy and how it relates to the organisation’s ability to create value’ (iirc 2013:5) and gri guidelines that promote publication of sustainability information. certain anomalies were identified when analysing the trend more comprehensively. shoprite showed a decrease in presentation from 2011 to 2016 when they minimised their detailed 24‑page sustainability report down to a summarised 5-page non-financial report. the company did increase presentation of strategic information, such as their business model, operating context and emphasis on how value had been created from 2017 through to 2018. spar showed a general upward trend, mostly due to an expansion into ireland in 2014, and switzerland in 2016, resulting in more information on strategy, company profile, store formats and distribution centres, and more regions to report sustainability matters on. in 2017 and 2018 the strategy and sustainability information decreased from almost one third of the report to 15% due to spar releasing their printable report as an abridged version in an effort to ‘go green’ and referring stakeholders to their website for further information in accordance with findings from nel (2019). clicks showed a decrease from 2013 to 2015 due to not publishing a sustainability report and presenting a lower number of pages in the operational review. the page numbers reverted to the higher numbers in 2016 when clicks created a section titled ‘creating value through good citizenship’. it was observed that pick n pay showed two general jumps, one in 2015, due to a new section on strategic focus, and another in 2017 due to a section on material issues, risks and opportunities. overall analyses in table 3 and figure 2 the composition of all four companies’ airs between 2009 and 2018 have been summarised, with descriptive statistics in table 4. while the composition of the reports varied year on year, and from company to company, numerous similarities in reporting trends were noted throughout the analysis. as an overall analysis, the number of pages of the airs all peaked at a point and thereafter decreased. the comprehensive analysis of each reporting section revealed that the majority of this decrease was due to a common change in presenting annual financial statements in stand-alone documents on the relevant corporate website, rather than as part of the air. both pick n pay and clicks ceased presenting audit committee reports coinciding with their changes in financial statement display as the audit committee report formed part of the document containing the full set of annual financial statements. the second commonality identified amongst the four companies was the increase in governance information, mainly due to a longer remuneration report. the increase in information has likely stemmed from the early adoption of king iv principles. king iv only became effective for financial years, beginning 01 april 2017 and, therefore, for pick n pay this meant application for the 2019 financial year (financial year end february) and the 2018 financial year for clicks, shoprite and spar. king iv was released in november 2016 and all of the companies had begun applying the king iv principles in their 2017 and 2018 financial years. all companies constituted a social and ethics committee in either their 2012 or 2013 reporting year in compliance with section 72(4) of the new south african companies act. there was a common consistency in the reports from key board members (chairman and chief executive officer). the final commonality identified was an increase in strategy and sustainability information. in respect of three of the four companies (excluding clicks), strategic information increased in the same year that the reports indicated application of the iirc’s framework (2013 for pick n pay and spar and 2017 for shoprite). pick n pay and clicks showed similarities in their decreasing shareholder information and increase in contents and pictures. this was consistent with findings by du toit et al. (2017) who discovered a reduction in the volume of disclosure presented over their analysis period from 2012 to 2014. both companies no longer presented their notice of their annual general meetings and proxy forms, as these were made available on the company website and both had an increase in full-page images. pick n pay displayed similarities with spar in their financial explanations, with both increasing in 2013, due to the introduction of a narrated financial review. in the year that displayed increased shareholder information, pick n pay, shoprite and spar had disclosed their memorandum of incorporation in accordance with the new companies act. clicks displayed this information in 2012, but rather than the full memorandum, they produced a three-page summary and referred shareholders to their website for further information; therefore, not making an impact on the volume of shareholder information provided. recommendations and conclusions literature revealed that since the introduction of integrated reporting initiatives, in particular king iii, airs have been positively affected. the majority of the research used checklists to comment on quality and compliance within the integrated report and had a short-term of coverage, with no research commenting on the actual composition or format of the air. this article was aimed at contributing towards this shortcoming in research through a comprehensive analysis of airs from companies listed in the jse food and drug retail sector between 2009 and 2018. the comprehensive analysis revealed that the composition of airs of companies listed in the jse food and drug retail sector has shifted between 2009 and 2018. the airs now contain less annual financial statements and instead explain the results with reference to the full financial statements contained on the companies’ websites. other references to corporate websites were found for pick n pay that disclosed a number of governance reports thereon for 2016, 2017 and 2018, as well as spar that published abridged annual reports and referred the users to the website for more information. pick n pay and clicks both moved their notice of agm and proxy forms online. the findings are consistent with pwc (2014) and du toit et al. (2017) indicating that volumes have decreased resulting in airs becoming less cluttered. they also add to the findings of nel (2019), who showed that companies refer readers of airs to corporate websites for additional information, rather than incorporating everything into the air, but did not have the jse food and drug retail sector within his sample. further research can be conducted, both locally in south africa and internationally on alternative communication channels to the airs, as well as those that support or supplement the air and how these channels are utilised. other changes in the presentation of airs coincided with the release of certain integrated reporting developments which could have spurred this modification in presentation. the first such instance was the increase in governance information that was discovered to be due to an increase in remuneration reports. the increases coincide with the financial years in which the companies had begun implementing king iv, that contains more definitive and stringent disclosure requirements, with respect to the remuneration report. the second such instance was the rise of strategy and sustainability information. strategy information tended to rise in line with the release and application of the iirc framework that emphasised disclosure of strategic focus being linked to future business prospects through disclosures on business model, risks and opportunities and strategy and resource allocation. sustainability information increased in line with the updates of the gri guidelines. lastly additional shareholder information giving the new memorandum of incorporation was presented and the companies all formed a social and ethics committee, following the introduction of the new companies act in south africa. despite the noted adherence to the newest innovations on integrated reporting (especially the iirc framework that has not been mandated by the jse listing requirements such as king iii and king iv), it is questionable as to whether the compliance has stemmed from treating the compilation of airs as a box-ticking exercise as suggested by haji and anifowose (2016) and de villiers et al. (2017a). the alternative to this suggestion is that these innovations are functioning as intended and companies are applying their discretion to these principles when compiling their airs. it is recommended that future research in this arena be conducted through an interview or questionnaire aimed at those involved in drafting the airs. one key limitation of the study is that only one sector has been analysed and, therefore, results are neither fully representative of the entire jse nor are they generally applicable to other sectors. although this limitation is present, the methodology of the article has resulted in a comprehensive foundational study that may be applied to other sectors and contrasted with these findings to expand the research base further. a replication of this study, utilising other sectors within the jse listing, is recommended to contrast results across sectors. similar research can be conducted on international security exchanges to compare the results against those that do not mandate integrated reporting on an ‘apply or explain’ basis. acknowledgements competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. author’s contributions v.g. is the sole author of this article. funding information this research received no specific grant from any funding agency in the public, commercial or not-for-profit sectors. data availability data sharing is not applicable to this article as no new data were created or analysed in this study. disclaimer the views and opinions expressed in this article are those of the author and do not necessarily reflect the official policy or position of any affiliated agency of the author. references ackers, b. & eccles, n.s., 2015, ‘mandatory corporate social responsibility assurance practices: the case of king iii in south africa’, accounting, auditing and accountability journal 28(4), 515–550. 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literature review and hypotheses development research design and methodology empirical results discussion, conclusions and recommendations acknowledgements references appendix 1 about the author(s) elmarie venter department of business management, school of management sciences, nelson mandela university, south africa janine kruger department of business management, school of management sciences, nelson mandela university, south africa citation venter, e. & janine kruger, j., 2017, ‘exploring women’s perceptions regarding successful investment planning practices’, south african journal of economic and management sciences 20(1), a1486. https://doi.org/10.4102/sajems.v20i1.1486 original research exploring women’s perceptions regarding successful investment planning practices elmarie venter, janine kruger received: 13 oct. 2015; accepted: 04 may 2017; published: 22 aug. 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: compared to men, women are not as confident and knowledgeable about financial and investment matters. as a result, women often do not conduct investment planning until it is too late, and they are confronted with a financial crisis or a life predicament such as a divorce or death. in addition, limited scientific research exists on the investment planning practices of women in south africa. this study contributes to the body of knowledge on investment planning by better understanding the unique financial needs and challenges of women. recommendations made by this study will assist women and financial planners to make more informed investment decisions as they progress through life. aim: therefore, the primary objective of this research was to investigate the factors that influence women’s perceived successful investment planning in the nelson mandela bay area. after conducting a comprehensive literature study, six factors (independent variables), namely, values, attitudes, time horizon, personal life cycle, risks and returns, and investment knowledge, were identified as influencing the perceived successful investment planning (dependent variable) of women. setting: as this study focussed on the perceptions of women concerning the factors that influence successful investment planning, the target population was all women in the nelson mandela bay area older than 20 years with some investment experience. methods: a quantitative research methodology was followed, and data were collected from 207 women using a structured self-administered questionnaire. results: the results of the multiple regression analysis revealed that only one independent variable emerged as having a significant influence on perceived successful investment planning of women, namely, investment knowledge. conclusion: based on the empirical results of this study, several recommendations have been made in an attempt to assist women to make more informed investment decisions and manage their investment planning more effectively as they progress through life. introduction, problem definition and research objectives it is important for individuals to engage in financial planning and set financial goals because this will assist them to persevere in difficult financial times and flourish in good times (gitman, joehnk & billingsley 2014:16). in order to achieve these financial goals, several types of planning need to occur, and investment planning is one of them (gitman et al. 2014:27). a proper investment plan will help individuals, regardless of gender, to achieve their specific financial goals, such as contributing to an education fund or building a reasonable retirement fund. investment planning involves investing money in various investment vehicles, such as ordinary shares, government or corporate bonds, collective investment schemes and real estate. various risk levels are associated with each of these vehicles; therefore it is wise to engage in investment planning to ensure that a balance is maintained between individuals’ goals, risk tolerance levels and the chosen investment vehicle (botha et al. 2015:579). despite the importance of undertaking financial planning in general and investment planning in particular, mhlanga (2012) highlights that many women still do not engage in such planning. in addition, studies conducted by hung, yoong and brown (2012:5–6, 10), as well as aegon (2014:2, 10), point out that although most women manage the daily finances and take short-term financial decisions at home, they are not involved with long-term financial planning as they spent most of their time caring for their families (why money is different for women 2014). in addition, a study conducted by goldsmith and goldsmith (2006:64) found that women have less knowledge and skill than men in managing their personal finances and investments. therefore, many women may be reluctant to involve themselves in investment planning because they are afraid of losing their investments (fisher-french 2013; sa women keep secret savings – survey 2012). willows (2013:38–39) concludes that women are more risk-averse than men when it comes to handling financial matters, including investments. it has also been found that the general lack of confidence in investing and the avoidance of more risky investments are prevalent in the global environment (fisher-french 2013). mhlanga (2013) is of the opinion that women would rather focus on repaying debt and closing store accounts than on investing for retirement, which remains a major concern for many women. a study by visa found that fewer than 2% of south african women invest directly into equity, and that many of those doing so regard this action as a poor investment decision (lammas 2014). furthermore, eikmeier (2007:6) and blayney (in schulaka 2015:10–11) caution that women are exposed to unique financial challenges that may differ from those of men, as well as from each other. these challenges include, amongst others, women typically earn less than men, they work fewer years than men, they work in entrepreneurial and non-traditional enterprises, they need more late-in-life care and they live on average 5 years longer than men. even though falahati and paim (2011:1765) suggest that financial satisfaction and its effect on the quality of life have received considerable attention in recent decades, plagnol (2011:45) points out that limited research is available regarding financial satisfaction and how it changes over an individual’s life cycle. furthermore, no scientific research has been conducted on women’s perceptions of investment planning practices in south africa in general and in the nelson mandela bay in particular. previous research on women’s perceptions concerning financial and investment practices are based on in-house reports from financial institutions, such as banks and insurance companies, as well as articles published in non-academic media sources. therefore, the primary objective of the present research is to investigate the factors that influence women’s perceived successful investment planning in the nelson mandela bay area, situated in the eastern cape province of south africa. this study will contribute to the body of knowledge on investment planning by better understanding the unique financial needs and challenges of women. recommendations made by this study will assist women and financial planners to make more informed investment decisions as they progress through life. literature review and hypotheses development based on the existing literature on financial and investment planning, several factors influencing women’s perceived successful investment planning have been identified (harbour, n.d.; malcolm 2012:5; watters 2011). these factors are values, attitudes, time horizon, personal life cycle, risk and return as well as investment knowledge. the hypothesised relationships and proposed hypothesised model are depicted in figure 1. figure 1: hypothesised model of factors influencing women’s perceptions of successful investment planning. perceived successful investment planning (dependent variable) as illustrated in figure 1, the dependent variable of this study is perceived successful investment planning of women. for the purpose of this study, this variable refers to the degree of satisfaction women experience with the growth, income or profits of their investments that will enable them to stay in control of their finances as well as to plan and achieve their financial goals and objectives. williams (1997:77) suggests that people only perceive their investment planning as successful when they are able to control their finances and investments through engaging in investment planning. in addition, budgar (2011:22) states that individuals only experience and perceive their investment planning as successful when they receive some form of income, profits or growth of their investments. factors influencing investment planning (independent variables) figure 1 illustrates six factors that potentially influence women’s perceived success when investment planning is undertaken, as identified from the literature and previous empirical studies. a discussion of these factors, namely, values, attitudes, time horizon, personal life cycle, risk and return and investment knowledge, will follow. the theoretical support for each of these hypothesised relationships between these factors (independent variables) and the dependent variable (perceived successful investment planning) will be discussed. values according to hockenbury and hockenbury (2007:34), individuals’ goals are a reflection of their personal values. values are relatively permanent personal beliefs about what everybody regards as important, worthy, desirable or right in the way they live and work (giraldi & ikeda 2008:171–176). values tend to reflect an individual’s upbringing, and change very little without a conscious effort from her or him. for example, some families and individuals regard happiness as having a very high value; for others, power or status may be a greater value (bobowik et al. 2011:488). kreie and cronan (2000:66–67) are of the opinion that values should determine people’s priorities in general and investment planning in particular. when it comes to investment planning, women’s values are often guides on which to base their investment goals. while setting up personal investment goals, women become more specific about how they want to achieve their goals and how to judge whether their goals are realistic (kohli 2014; swenson 2013:13). for instance, if a woman values her independence in terms of finance, she will invest in an investment portfolio to gain adequate funding to buy her own car or house. in other cases, if a woman’s most important value is her children, she will invest funds in her children’s health or education (sa women keep secret savings – survey 2012). tengler (2014) suggests that women can achieve success in their investment planning when setting clear goals that are linked to their values. values-based goals assist investors to achieve their life plans, dreams and personal values, while achieving success in their investment planning (irving 2012:51; knight 2010; liersch 2013:9). for the purpose of this study, values refers to women’s personal, family, religious, ethical and cultural values that guide them when investing. the following hypotheses are thus formulated: h01: there is no relationship between values and perceived successful investment planning. ha1: there is a relationship between values and perceived successful investment planning. attitudes according to chaiklin (2011:31), there is no universally accepted definition of ‘attitude’. waits (2012:21) states that psychologists define attitudes as a learned tendency to evaluate objects in a certain way. this can include evaluations of people, issues, objects or events. such evaluations are often positive or negative, but they can also be uncertain at times. for instance, a little girl may have mixed feelings about a particular person or issue. however, in social sciences, an attitude often refers to a mental position with regard to a fact or a state, or a feeling or emotion towards a fact or a state (chaiklin 2011:32). in addition, attitudes reflect a position individuals have taken with regard to their values, and are much more flexible than values (boninger et al. 1995:159). according to maio and haddock (2015:4), attitudes are an overall evaluation of an object based on information that may be a thought, a feeling or past behaviour. therefore, attitudes may emerge because of direct personal experience, or they may result from observation (marcus 2011:34). social roles and social norms can have a strong influence on attitudes. social roles relate to how people are expected to behave in a particular situation or context. social norms involve society’s rules for which behaviours are considered appropriate (boninger et al. 1995:159). therefore, women’s attitudes towards investment planning are partially influenced by the cultural and social expectations of how they should manage their finances as women. before 1950, women were expected to engage in early marriage and look after their families as a universal norm. men were expected to be the main wage-earner in the family who catered financially for their wives and children (davey 2008:121). over the past few decades, however, more women have entered the workforce and helped to support their families financially together with their husbands (campey 2012:7; goudreau 2012:15; hira & loibl 2006:2; mellon 2015). research shows that in some cultures, men view women as better budgeters and possessing greater self-control. a culture’s expectation dictates gender roles and different attitudes towards managing finances and investments. therefore, women find themselves more focussed on short-term finances than engaging in investment planning (sa women keep secret savings – survey 2012). the survey result of visa (sa women keep secret savings – survey 2012) supports the findings of arti, sunita and julee (2011:5) that female investors tend to display less confidence in their investment decisions, owing to a lack of knowledge and being risk-averse, and therefore have lower satisfaction levels. female investors are also more cautious with regard to investment in shares, especially if the availability of their funds is low. the reason is that they feel uncomfortable investing in shares which are associated with higher risk levels than other investment vehicles. hira and loibl (2006:65) comment that many women find making investment decisions stressful, difficult and time-consuming. as a result, it is suggested that women’s attitudes towards investment planning have a direct effect on their involvement and success in this planning. for the purpose of this study, attitudes refers to women being comfortable and confident when making investment decisions. based on the discussion, the following hypotheses have been formulated: h02: there is no relationship between attitudes and perceived successful investment planning. ha2: there is a relationship between attitudes and perceived successful investment planning. time horizon time horizons are simply the length of time for which investors place funds in different investments in order to obtain their investment goals (e.g. capital growth or regular income from withdrawals of investments, or both) (droms & strauss 2003:73; jaeger, rausch & foley 2010:12–18). sometimes time horizon is also referred to as investment horizon. a time horizon can be as short as a few seconds or it can constitute a period that lasts for decades (constable 2014). setting a time horizon for any investment usually has to do with the goals of the investor. investment time horizons can be categorised as short-term, intermediate-term and long-term (jaeger et al. 2010:16). women can maximise their financial security in the short-term and the long-term without any conflict between the two if they correctly identify the time horizons of each investment goal (young 2013:2). for instance, if a female investor is seeking to invest in short-term vehicles as a way of financing the purchase of a home in 5 years, this goal will help to define the parameters of her investment activity. the investor will actively look for ways to invest funds in investment options that will generate a sufficient return at the end of this 5-year period to allow for the purchase of a home within a specified price range (parker 2011:6). at the same time, a longer time horizon may be more in line with the investor’s goal of creating a solid financial base for the retirement years. in this scenario, the investor will probably move towards investments that show a consistent growth pattern over the years, with little to no downturns anticipated. the time horizon for this approach may span 30 years or more (zugang & jia 2010:323). for the purpose of this study, time horizon refers to the knowledge and preference women have of the time horizon (length) of their investments, which are less than 4 years (short-term horizon), from 4 to 9 years (intermediate-term horizon) or longer than 10 years (long-term horizon) when investing. consequently, the following relationships are hypothesised: h03: there is no relationship between time horizon and perceived successful investment planning. ha3: there is a relationship between time horizon and perceived successful investment planning. personal life cycle it appears that people’s financial priorities change as they move through the different phases of their personal life cycle (overton 2010:385). in support, plagnol (2011:52–53) has found that individuals’ priorities and preferences will change as they move through the life cycle stages; not only do their financial priorities change, but also their perception of financial satisfaction. according to cooper and worsham (2009:23) and swart (2002:145), people go through five separate phases in a personal life cycle, based on different age categories: the young years, the family years, the career years, the pre-retirement years and the retirement years (cooper & worsham 2009:23). it is important they should know that throughout the five life stages, continuous and diverse investments should be made to match specific investment needs at each stage. caldwell (2012:20) notes that women’s life situations reduce the chances of their attaining certain investment goals because of unexpected events such as becoming a single mother, getting divorced, or becoming a widow (uglanova & staudinger 2013:265). after such a life situation, the investment needs of a woman will change, and the investment plan needs to be adapted accordingly (hira & loibl 2006:72). therefore, it is important for women to practise, monitor and alter investment planning throughout different stages of their life cycle to achieve and maximise their success in investment planning (uglanova & staudinger 2013:265–286). for the purpose of this study, personal life cycle refers to women being aware that their investment needs, priorities and goals change as they move through different life stages, as well as different age groups; therefore, women need to monitor and change their investment planning accordingly. based on this discussion, the following hypotheses have been formulated: h04: there is no relationship between personal life cycle and perceived successful investment planning. ha4: there is a relationship between personal life cycle and perceived successful investment planning. risk and return according to droms and strauss (2003:72), one of the key steps in investment planning is the assessment of women’s risk tolerance so that an investment portfolio (i.e. a combination of two or more investment instruments) can be structured that is consistent with their willingness to trade risk for reward. hsin-yuan, dwan-fang and shang-yu (2010:39) agree that it is necessary to consider investment risks and returns when doing investment planning. in doing so, women will be able to maximise the possibility of reaching their financial goals and protecting their portfolios (weatherholt 2009:12). lee (2013) defines risk as the possibility of suffering a loss, implying that there is a chance that the return on an investment may be lower than was anticipated. return refers to the income or profit on an asset or the possible loss involved in owning such an asset or investment (jordan, miller & dolvin 2012:2). in general, an investor will anticipate a higher return on an investment with a high risk, and a lower return on an investment with a low risk. risk and return are, therefore, positively correlated. in other words, the higher the risk, the higher the anticipated return, while the lower the risk, the lower the anticipated return. time plays a major role in risk and return, because the longer the investment period, the greater the anticipated risk and the greater the anticipated return on an investment or asset (swart 2002:132). a number of studies focussing on risk-taking in investments point out that there are differences between men’s and women’s risk tolerance levels. charness and gneezy (2012:50) note that women are more risk-averse than men. mittal and vyas (2011:45) suggest that women’s attitude towards risks is less aggressive than their male counterparts, because they generally have less confidence than men in making investments. as a result, women often take a more conservative approach to making investment decisions, which in turn leads to lower returns on their investments (hira & loibl 2006:73). similarly, rutterford and maltby (2007:313) find that women have a low tolerance towards investment risks. however, women who possess some level of education, financial knowledge and/or wealth are willing to accept more investment risks than others. for the purpose of this study, risk and return refers to women’s awareness of risks and returns as well as their positively correlated relationship (i.e. the higher the risk, the higher the return) when investing. therefore, the following hypotheses are formulated: h05: there is no relationship between risk and return and perceived successful investment planning. ha5: there is a relationship between risk and return and perceived successful investment planning. investment knowledge according to miller (2005:124), more women than men admit that they are not very knowledgeable about investment planning. therefore, women tend to feel less confident than men in their understanding of investment products as well as the current economic conditions that influence their ability to make investment decisions (malcolm 2012:5). the only way for women to achieve some form of success in investment planning is for them to gain basic investment knowledge, such as knowing the types of existing investment vehicles (fisher-french 2013:11; rogers 2011:4). it is important for women to familiarise themselves with the different types of investment vehicles available to them, the risks and returns, as well as the fees related to each investment vehicle. fees can include brokerage commissions and advisory fees, and every effort should be made to avoid unnecessary costs that can limit the gains on their investments (bellingsley, gitman & joehnk 2016:249; carney 2009:10). women should also understand and make use of diversification when engaging in investment planning. hira and loibl (2006:15) maintain that women are less likely than men to diversify their investments, because of the liquidity level and low risk. however, the lack of knowledge about diversification leads everyone in general and women in particular to accept lower returns and higher risks (hira & loibl 2006:15). for the purpose of this study, investment knowledge refers to women having knowledge about the different types of investment vehicles, knowing the investment length and cost implications of each investment, past investment experiences and s knowing how and where to obtain help and relevant investment information in making investment decisions. based on the discussion presented above, the following hypotheses have been formulated: h06: there is no relationship between investment knowledge and perceived successful investment planning. ha6: there is a relationship between investment knowledge and perceived successful investment planning. research design and methodology population, sampling procedure and response rate as this study focussed on the perceptions of women concerning the factors that influence successful investment planning, the target population was all women in the nelson mandela bay area older than 20 years with some investment experience. owing to the unavailability of a database containing the details of women investing in the eastern cape, non-probability convenience and snowball sampling techniques were adopted to draw the sample for this study. client databases of female investors are confidential, and therefore access to these databases was not possible with investment firms and financial institutions. sekaran and bougie (2010:276) note that convenience sampling is particularly useful during the exploratory stage of a research project. financial and investment institutions in the area, such as first national bank, standard bank, old mutual, sanlam, consolidated financial planning, spectrum group and south city, agreed to assist the researcher in approaching possible respondents. research contacts, family members and friends in the area were also requested to identify any suitable respondents who could participate in this study. the size of the sample was further increased by referrals made by the participating respondents through follow-up communications via email. potential respondents were provided an electronic link to complete and return the questionnaire. in total, 965 respondents were identified to participate, and 225 completed questionnaires were returned by the respondents, but only 207 were usable for further statistical analysis, indicating a response rate of 23.31% for the study. scale development the measuring instrument employed consisted of a cover letter and a questionnaire, comprising four sections. a detailed description of the purpose of the study and type of information requested was provided in the cover letter. the cover letter also addressed the issues of the respondents’ confidentiality, anonymity and opt-out options and emphasised that the completion of the questionnaire was voluntary. the required ethical clearance to conduct the research was also carried out. section 1 of the self-administered questionnaire consisted of 49 statements (items) that were adapted from previously used scales designed to measure the factors influencing respondents’ perceptions of successful investment planning. the items and the scales used are listed in table 1-a1. a seven-point likert-type interval scale was adopted, because it excels in objective accuracy, perceived accuracy and ease of use (finstad 2010:108). the respondents were requested to indicate the extent of agreement with each statement by placing a cross in the appropriate column. the scale ranged from 1 (strongly disagree) to 7 (strongly agree). section 2 of the questionnaire requested demographic information of the respondents, namely, their age, ethnic background, marital status, highest education level, occupation, investment experience, involvement in investment planning and type of investment instruments owned. section 3 requested information relating to the respondents’ actual engagement with investment planning. both sections 2 and 3 used nominal scales. section 4 provided an open-ended question to gather respondents’ suggestions and comments relating to investment planning. results from sections 3 and 4 were used to support and possibly justify the empirical results of section 1. as far as possible, valid and reliable items were sourced from previous studies, but were rephrased to fit the context of the present study. each variable was operationalised in terms of the scale, and are summarised in table 1. table 1: operationalisation and sources of variables. methods of data analysis the collected data were analysed by using microsoft excel and statistica version 12. according to quinlan (2011:336), the questionnaire and scale designed by the researcher must be a valid measure of the phenomenon being studied. according to collis and hussey (2014:53), there are a number of different ways in which the validity of research can be assessed. in this research, the face validity was ensured by approaching female academics with investment experience while the questionnaire was piloted amongst 20 female investors to ensure content validity (struwig & stead 2013:146–150). in addition, an exploratory factor analysis (efa) was conducted to assess the construct validity of the scales measuring the independent and dependent variables (hair et al. 2014:115). cronbach’s alpha coefficients were calculated to assess the reliability of the measuring instrument. in this study, a cronbach’s alpha coefficient value greater than or equal to 0.7 was deemed as reliable (hair et al. 2014:123). the data were analysed by using descriptive (mean and standard deviations) statistics (struwig & stead 2013:159). inferential statistics, namely, the pearson product–moment correlation coefficients, were calculated to determine links between the dependent and independent variables (lind, marchal & wathen 2012:463) and multiple regression analysis was performed to test the hypothesised relationships (hair et al. 2014:157). ethical considerations ethics clearance was obtained from the nelson mandela university, with ethical clearance number: h13-bes-bma-029. empirical results sample demographics the majority of the respondents were between the ages of 40 and 49 (32%), followed by those between the ages of 30 and 39 (23%) and between the ages of 50 and 59 (22%). only a few respondents were between the ages of 20 and 29 (14%) or older than 60 years (9%). with regard to ethnic background, most of the respondents were white (71%), whereas a small group was asian (3%) or indian (3%). the remaining ethnic groups, namely, black (11%) and mixed race (11%) participated equally. three respondents (1%) were not willing to indicate their ethnic affiliation. most of the respondents were married (64%). a few respondents indicated that they were single (18%), divorced (10%), in partnerships (5%) or widowed (3%). regarding the respondents’ highest qualifications, most indicated that they held a post-graduate degree (45%), followed by respondents who had a diploma (24%). some of the respondents had a bachelor degree (15%), grade 12 certificate (14%) or a grade 10 and tertiary certificate (2%). the great majority of respondents were employed full-time (84%), whereas a small group were employed on a part-time basis (8%). the remaining respondents indicated that they were retired (3%), homemakers (1%), students (1%), employed on contract or self-employed (3%). nearly half of the respondents had investment experience in excess of 10 years (45%), between 1 and 5 years (31%) and between 6 and 10 years (17%). only 7% of the respondents indicated having investment experience of less than 1 year. results of the validity and reliability assessments after face and content validity were assured, an efa was undertaken to assess the construct validity of the measuring instrument. items with loadings greater than 0.5 that loaded onto one factor only were considered significant in this study (hair et al. 2014:115). factors with loadings of two or less items were excluded from further analysis (suhr 2006:4). in order to verify the reliability of the measuring instrument, the cronbach’s alpha coefficients were calculated. cronbach’s alpha coefficient values of at least 0.7 (hair et al. 2014:123) were regarded as reliable for the purpose of this study. the factor structure of the dependent and independent variables, as well as the cronbach’s alpha values are provided in table 2. table 2: factor structure of the variables. despite only five of the seven items originally developed to measure investment knowledge loading onto this factor, its name remained unchanged, because the other items that loaded onto it also referred to women’s knowledge about making investment decisions. the items’ loadings onto investment knowledge ranged between 0.558 and 0.822, and the factor explained 17.22% of the variance in the data. the cronbach’s alpha of the investment knowledge was 0.924. as five of the six items originally used to measure personal life cycle loaded together, the name for this factor remained unchanged. the items’ loadings onto personal life cycle ranged between 0.669 and 0.839, and the factor explained 7.95% of the variance in the data and the factor was regarded as reliable (cronbach’s alpha = 0.839). six of the seven items originally developed to measure values loaded onto this factor. therefore, the name for this factor remained unchanged and the factor was regarded as reliable (cronbach’s alpha = 0.793). the items’ loadings onto values ranged from 0.584 to 0.742, and the factor explains 6.69% of the variance in the data. despite only five of eight items originally expected to measure perceived successful investment planning loading onto this factor, the name remained unchanged. the items’ loadings onto perceived successful investment planning ranged between 0.504 and 0.728, and the factor explained 7.13% of the variance in the data. the cronbach’s alpha for this factor was 0.793. according to suhr (2006:4), only factors with three or more item loadings that were reliable would be considered for further analysis. therefore, the factor time horizon was excluded from further analysis (only two items remained after rephrasing the one item with the negative factor loading). similar to the factor time horizon, the factor risk and return was excluded from further analysis as only two items loaded onto this factor. even though the loading of the factor attitudes provided a valid result and there were more than two items loaded onto this factor, the cronbach’s alpha coefficient for attitudes of 0.480 indicated that the factor was unreliable. therefore, the factor attitudes was excluded from further analysis. based on the efa, the operationalisations of the various constructs were reformulated, and the original hypothesised model (see figure 1) and hypotheses (table 3) were revised. table 3: summary of revised hypotheses. results of the descriptive statistics in order to describe the sample data, descriptive statistics consisting of the mean, standard deviation and frequency distribution for the sample as a whole were calculated. the response options relating to the statements measuring all the independent variables and the dependent variable (table 4) varied between ‘strongly disagree’ to ‘strongly agree’. these responses were re-categorised as ‘disagree’ (1.00 ≤ × < 3.00), ‘neutral’ (3.00 ≤ × ≤ 4.00) and ‘agree’ (4.00 < × ≤ 7.00). table 4: descriptive statistics results. from table 4 it can be seen that the factor personal life cycle produced the highest mean score of 6.064. therefore, the majority (97.59%) of respondents agreed that the personal life cycle factor has a strong influence on investment planning. a mean score of 5.156 was reported for the factor investment knowledge. the majority (76.81%) of respondents considered the factor investment knowledge as important to them when planning their investments. the factor values returned a mean score of 4.463. only half of the respondents (57.01%) agreed that values should be taken into account while doing investment planning. the remainder were neutral (22.71%) or considered the factor values as not important (20.29%) to them when planning their investments. the dependent variable perceived successful investment planning produced a mean score of 5.112. the majority (73.91%) of respondents agreed that they considered their investments successful, and were satisfied with their current investment planning. only 6.28% of the respondents perceived their investments as unsuccessful, with 19.81% being neutral regarding the statements measuring perceived successful investment planning. results of the pearson product-moment correlation coefficient the pearson product-moment correlation coefficients were calculated to measure the linear association between the dependent and independent variables. the pearson product-moment correlation coefficient indicated positive significant correlations between most variables in the study. the strongest positive significant correlation was reported between perceived successful investment planning and investment knowledge (r = 0.541; p < 0.05). the associations between personal life cycle and investment knowledge (r = 0.192; p < 0.05), values and investment knowledge (r = 0.185; p < 0.05), perceived successful investment planning and personal life cycle (r = 0.172; p < 0.05) were regarded as weak but statistically significant. the associations between values and personal life cycle (p > 0.05) and perceived successful investment planning and values (p > 0.05) were both not statistically significant. results of the multiple regression analysis multiple regression analysis was performed to determine the influence of the various independent variables (i.e. investment knowledge, personal life cycle and values) on perceived successful investment planning (dependent variable) (table 5). table 5: influence of the independent variables on perceived successful investment planning. according to table 5, the three independent variables explained 30% of the variance in the dependent variable perceived successful investment planning. only one independent variable emerged as having a significant positive influence on perceived successful investment planning of women, namely investment knowledge (b = 0.550; p < 0.001). in other words, if respondents increase their investment knowledge, it is likely that they will be more successful with their investment planning. table 6 summarises the acceptance decisions of the three formulated hypotheses. table 6: summary of acceptance of formulated hypotheses. only the investment knowledge of the respondents had a significant influence on whether the respondents were satisfied with the income and growth they received from their investments, as well as being able to achieve their financial goals through investing. however, whether the women considered the personal life cycle and values as important or not, had no influence on their perceptions of the success of their investments. discussion, conclusions and recommendations the findings of the study revealed the existence of a significant positive relationship between investment knowledge and perceived successful investment planning. in other words, women who are comfortable and confident with making investments, having knowledge of investment trends, the different types of investment vehicles, knowing the investment risks involved and length of each investment, as well as knowing how and where to obtain help and relevant investment information in making investment decisions, are likely to be satisfied with the income and growth they receive from their investments, as well as being able to achieve their financial goals through investing. the results of this study are consistent with that of other researchers who have also found a positive relationship between investment knowledge and success (goldsmith & goldsmith 1997:236; goldsmith & goldsmith 2006:57; olsen & cox 2001:30). in order to obtain and develop knowledge about investments, women should consider becoming more knowledgeable about topics related to investments, and reduce their fear and their lack of confidence when making investment choices, as well as not feeling obliged to invest with a particular advisor or a particular investment vehicle. by obtaining more knowledge about investments, women can make better and more informed investment decisions without the influence of their emotions. in particular, they should equip themselves with knowledge about the different investment vehicles available to them, their growth rates and possible risks, and possible fees related to each investment vehicle, as well as investments that cater specifically for women. in addition, they should be aware of the tax implications of investment vehicles to minimise unnecessary costs. women should consult with financial and investment advisors in order to get assistance and guidance on how to make correct investment decisions and monitor their investment more effectively. this applies especially to women who are not confident themselves about making investments or have limited time to take care of their investment planning. however, they should still be aware of the performance and management of their investments by requesting regular up-to-date reports on the performance of each investment. if women want to manage their investments themselves, it is advisable that they attend investment workshops, short courses, seminars or conferences presented by investment experts in order to gain practical investment knowledge, and tips and strategies on how to make good investment decisions. reading investment books and magazines which provide useful information about investments could assist women to get started in investment planning, and to increase their confidence in making investment decisions. based on an analysis of the open questions in the questionnaire, the majority of the respondents agreed that it is important to start investing from an early age. one respondent stated that to start investing early before marriage helps women learn how to become financially independent of their spouses. in addition, the earlier women start investing and take out life insurance, disability and dread-disease cover, the cheaper the cost of these investment vehicles will be. furthermore, it is important for women to educate their children about the benefits of saving and investing from a young age. the respondents in this study stressed that access to reliable investment options that suit individual needs should be more easily available to women. one respondent suggested that investment options should be made to be more easily withdrawn, with fewer penalties imposed, while other respondents recommended that investors should not be given a choice to terminate their investment plans. the results of the multiple regression analysis did not show a significant relationship between personal life cycle and perceived successful investment planning in this study. previous researchers hira and loibl (2006:10), malhotra and crum (2010:43) and uglanova and staudinger (2013:265) however suggest that the life cycle of a person influences investment planning. a common conclusion from all these researchers has been that it is important for women to practise, monitor and alter investment planning throughout different stages of their life cycle to achieve and maximise their success in investment planning. a possible explanation for the non-significant relationship could be the demographic profile of respondents in this study. as the majority of women in this study were between 30 and 59 years of age (77%), one can assume that they were in the phase of their life cycle where they were engaged in making investments as they take greater responsibility for their financial well-being. in this study, no significant relationship was found between values and perceived successful investment planning. however, value-based goals are important as they could assist women to gain happiness in life by being able to live according to their values, but also to achieve success in their investment planning. limitations of the study and recommendations for future research although the present study has attempted to make a significant contribution to financial and investment planning literature, some limitations were encountered. firstly, because non-probability convenience sampling was used, the results of the study cannot be generalised with absolute confidence to all women in south africa. in order to make the research more valuable, future research concerning women’s perceptions on investments should extend to other areas of the eastern cape or to the other regions of south africa. secondly, several of the factors identified as influencing perceived successful investment planning in the literature did not load together as expected when undertaking the efa, and had to be eliminated from further statistical analysis. in future studies, the scales developed to measure the various factors identified in the literature as influencing perceived successful investment planning should be reconsidered and redeveloped to ensure that the influence of those factors can be assessed. thirdly, this study focusses only on six variables that influence women’s perceived successful investment planning, namely, investment knowledge, personal life cycle, values, time horizon, attitudes, and risks and returns. however, the literature suggests that it is also necessary to consider women’s involvement in the seven steps of the investment planning process, which could influence the possible level of success in such planning. the majority of respondents that participated in this study were white (71%) and married (64%) with previous investment experience. these results showed that the demographic characteristics of the respondents in this study were homogeneous. future studies should make use of a stratified or a quota sampling method in order to avoid the problem of over-representation of one particular ethnic group, for example. future research could also be conducted amongst women with and without investment experience. despite the limitations mentioned, the research still provides a significant contribution to the existing literature of research on financial and investment planning. most previous research focussed on different components of financial planning such as retirement planning or risk management other than investment planning. only limited research has addressed women’s perceptions of investment planning. in addition, suggestions were made to assist women to make better investment decisions and manage their investment planning more effectively. acknowledgements the authors would like to acknowledge the contributions of ms. t.a.t. dao in the completion of this article. competing 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2013, ‘investing: how to choose which investment products are right for you’, personal finance, 16 february, p. 2. zugang, l. & jia, w., 2010, ‘time, risk, and investment styles’, financial services review 19(4), 323–336. appendix 1 table 1-a1: scales measuring the dependent and independent variables. sajems ns vol 7 (2004) no 1 89 perceived institutional obstacles in doing business: a comparative study of south africa and the philippines ________________________________________________________________ mary jesselyn co school of economics and management, university of kwazulu-natal ________________________________________________________________ abstract there is ample evidence indicating that institutional environments have a direct effect on the performance of small enterprises. furthermore, perceptions of how the institutional environment will hinder or foster their respective firms shape the actions entrepreneurs take. this research investigates whether there are differences between south african and filipino entrepreneurs in their perceptions of institutional obstacles in doing business specifically the government-business interface. a sample size of 615 small and medium sized firm owners from different industries from both countries were provided with a list of 15 areas where the firm is confronted with government action and were asked to evaluate the degree to which these different areas create obstacles for conducting business. a discussion of the overall findings, as well as applicable lessons and future research follows. jel e31, 37, 52 introduction there is strong evidence that supports the belief that productive entrepreneurship is an essential explanatory factor for the economic performance of a country, and hence that cross-country differences in the degree of productive entrepreneurial activity are partial explanatory factors of observed cross-country differences in economic performance (davidsson & henrekson, 2000). the promotion of smes has become an important strategy for economic development for most countries. it is interesting to note that despite differences in the institutional environments, entrepreneurs still flourish. in developing countries such as south africa and the philippines, rates of business start-ups have increased, which is despite the difficulties in finding financing, high tax regulations, inflation, crime and theft and corruption. sajems ns vol 7 (2004) no 1 90 attitudes towards smaller businesses and entrepreneurial start-ups appear to be shifting favourably among political and economic decision-makers as the evidence of their importance mounts (lundstrom & stevenson, 2001). the role of the government in the development and growth of smes cannot be underemphasised. the government’s role in encouraging entrepreneurship is not just limited to providing a stable political scene and an institutional environment conducive for business. to stimulate economic growth through entrepreneurship, the government must provide the right combination of policies and incentives to attract individuals to become entrepreneurs. in identifying key institutional determinants of firm emergence and growth, davidsson and henrekson (2000) analysed a number of institutions and policy measures that are likely to have contributed to an environment that discourages firm activity and growth. the aspects dealt with included: the lack of entrepreneurship in the care sectors and household related services, taxation of entrepreneurial income, incentives for wealth accumulation, wage-setting institutions and labour market regulations. the investigation provided evidence of a low prevalence of nascent entrepreneurs and a small employment contribution by high growth firms. among the high growth firms that existed in 1987 either as independent companies or as sme company groups, and which still existed as independent entities in 1996, the most spectacular growth case added 596 new jobs. only fourteen cases added more than 250 jobs each; collectively these fourteen cases added 5217 new jobs over the ten-year period. this represents close to a complete void of spectacular high growth firms. entrepreneurs may be discouraged from starting a business if they have to adhere to an excessive number of rules and procedures. the level of procedural requirements for registration and licensing, taxes, and financial reporting may either facilitate or hinder entrepreneurial activities. research shows that most small businesses consider paperwork very time consuming and cumbersome (dana, 1987, 1990; young & welsch, 1993; fogel, 1994). countries that keep procedural requirements to a minimum generally have a viable and dynamic entrepreneurial sector. research also shows that tax and other start-up incentives have a positive impact on small business establishments and growth (davidsson & henrekson, 2000). in a worldwide study of institutional environments, a world bank policy team (brunetti, kisunko & weder, 1997) surveyed more than 3,600 entrepreneurs from 69 countries and developed five quantitative indicators of institutional uncertainty: predictability of laws and policies, reliability of the judiciary, political stability, corruption in bureaucracies, and security of property rights. they found that uncertainty about policies, laws and regulations has hampered development of the private sector in many developing countries. sajems ns vol 7 (2004) no 1 91 the above-mentioned investigation has motivated this research. the main purpose of this study is to describe and compare the perceived institutional obstacles affecting entrepreneurs in south africa and the philippines. the index developed in the world bank report on the overall government-business interface as perceived by entrepreneurs themselves shall be the focus of this paper. problem statement this paper primarily focuses on the perceptions of the entrepreneurs on various obstacles in doing business. they consist of the following items: start-up regulations, price controls, foreign trade regulations, financing, labour regulations, foreign currency regulations, tax regulations, inadequate infrastructure supply, policy instability, safety/environmental regulations, inflation, general uncertainty on cost of regulations, crime and theft, corruption and terrorism. this research will compare the perceptions of entrepreneurs from south africa and the philippines as well as from less developed countries (ldc), sub-saharan africa (ssa) and the overall world bank findings. to date, very few studies have evaluated the institutional environment surrounding smes. even rarer are cross-country comparisons of institutional environments affecting small businesses. cross-country comparisons would give more insight into how differences in context would affect the conduciveness of a country towards entrepreneurship. this type of investigation will also present similarities and differences in the perceptions of entrepreneurs from different countries, regardless of the context. it is also important to note that in this study, the entrepreneurs themselves evaluated the institutional environment. in order to be effective in promoting and developing smes, it is important to evaluate the institutional environment from the point of view of the main actor the entrepreneur. theoretical background institutional theory is the theoretical framework used in this study. this theory developed by developed by douglass c. north, primarily analyses economic structures by explaining how institutions and institutional changes affect the performance of economies. veciana (1999) stated, “without doubt the theory that currently supplies the most consistent and appropriate conceptual framework to probe the influence of environmental factors on entrepreneurship is institutional theory.” sajems ns vol 7 (2004) no 1 92 institutions, according to north (1989: 238), which arise because of the uncertainty associated with human interaction, provide structure and order, the rules of the game to human exchange, whether political, social or economic. it provides the framework, the structure, to facilitate certain kinds of exchange as well as a framework within which people have some confidence as to how outcomes will be determined. they consist of both formal and informal constraints as well as their enforcement characteristics. informal constraints include norms, codes of behaviour, subjective perceptions and traits. they arise to coordinate repeated human interaction and these constraints are extensions, elaborations, and modifications of formal rules, social sanctions and internally enforced standards of conduct. formal constraints on the other hand include political (and judicial) rules, economic rules, and contracts (north, 1991: 47). the function of these rules is to facilitate political or economic exchange. enforcement on the other hand refers to whether the rules and informal constraints are enforced (and how rigidly it is enforced) or not enforced. using north’s institutional theory, the perceived overall government-business interface has an effect on the entrepreneurs’ perceptions of conduciveness of the environment for business. if entrepreneurs perceive the obstacles as being problematic, this hampers development of the private sector. therefore, individuals tend to feel discouraged in pursuing entrepreneurial endeavors. this study will only focus on the formal institutional factors specifically the government-business interface. other aspects such as informal and enforcement factors will be dealt with in a forthcoming paper. methodology sample the total sample consisted of 615 randomly selected entrepreneurs from the cities of durban and manila. firms that had an employment size of 10-199 (for the philippines) and 10-100 (for south africa) employees served as respondents. only the following four industry sectors were included in the survey of entrepreneurs: manufacturing; wholesale and retail; finance, real estate, insurance and business services; as well as community, social and personal services. almost 90 per cent of all smes in durban and manila are from these industry sectors. table 1 shows the breakdown of the sample by industry and size of the firm. sajems ns vol 7 (2004) no 1 93 table 1 breakdown of sample by industry and size of the firm south africa the philippines industry n % n % manufacturing 75 23.08 58 20.00 wholesale and retail 113 34.77 105 36.20 finance, real estate, insurance and business services 53 16.30 55 18.97 community, social and personal services 84 25.85 72 24.83 employment size small 299 92.00 247 85.17 medium 26 8.00 43 14.83 instrumentation the complete questionnaire contained 25 questions. they were from a world bank survey questionnaire conducted by brunetti, kisunko and weder (1997). the researcher obtained permission to use the questionnaire from the authors. this paper will deal with only one aspect of institutional obstacles specifically the government-business interface. this section provided the respondent with a list of 15 areas where the firm encounters government action and asks the owner to evaluate the degree to which these different areas create obstacles for doing business. the questionnaire used a likert scale of six choices. the answers for the questions ranged from one (not a problem) to six (very strong problem) with the option of answering zero if the question was not applicable to the respondent or where there was no response. data gathering procedure use was made of research assistants, who after instruction learned how to distribute and collect the questionnaire. each research assistant distributed the questionnaire to several assigned firms. they emphasized that only the entrepreneurs themselves should answer the questionnaires. they then collected the completed questionnaire the following day. before leaving the premises of the firm, the research assistant ensured the completion of all questions. this method of data collection ensured a higher response rate. data analysis the data analysis in this study includes descriptive statistics such as means, frequencies and cross-tabulations. the index of obstacles for doing business on the other hand, takes the mean scores of the sample’s responses on each of the sajems ns vol 7 (2004) no 1 94 15 items. in determining differences between south african and philippine entrepreneurs, t-tests measure differences between means of the obstacles while chi-squares (χ2) indicate differences in the percentages of perceived problematic obstacles. the analysis also compares the results of the south african and philippine sample with the results obtained by brunetti, kisunko and weder’s (1997) study on world, less developed countries (ldcs) and subsaharan africa countries (ssas) results table 2 presents the comparative index of obstacles for doing business. table 2 comparative index of obstacles for doing business obstacles sa phil world ldc ssa t-test value start-up regulations 2.48 3.69 3.22 3.19 3.24 -10.016* price controls 2.76 3.75 2.67 2.72 2.63 -8.214* foreign trade regulations 2.84 4.07 3.45 3.57 3.57 -10.038* financing 2.87 4.04 4.06 4.18 4.17 -9.838* labour regulations 3.23 4.12 3.50 3.39 3.47 -7.298* foreign currency regulations 2.71 4.16 3.16 3.32 3.47 -11.105* tax regulations/high taxes 3.59 4.67 4.65 4.72 4.65 -9.146* inadequate infrastructure supply 2.58 3.92 4.02 4.16 4.31 -11.472* policy instability 2.52 4.07 3.68 3.88 3.63 -13.584* safety/environment regulations 2.85 3.90 3.24 3.21 3.36 -8.990* inflation 3.65 4.51 3.82 4.06 4.30 -7.258* general uncertainty on cost of regulations 2.91 4.02 3.75 3.86 3.84 -9.480* crime and theft 3.95 4.49 3.88 4.17 4.27 -4.050* corruption 3.15 4.65 4.21 4.45 4.67 -10.727* terrorism 2.47 4.07 2.38 2.45 2.28 -11.515* *significant at ρ ≤0.05 the findings in table 2 indicate that there are significant differences (based on ttest results) in how south african and philippine entrepreneurs view the various obstacles for doing business. at 14 degrees of freedom and ρ≤0.05, the critical value from the χ2 table is 6.571. on all types of obstacles, the south african entrepreneurs perceived them as less problematic than their philippine counterparts. all of the mean responses sajems ns vol 7 (2004) no 1 95 of the south african entrepreneurs are between 2.5 to 4 (out of a scale of 1 to 6), which is between the not problematic to moderately problematic scale. the philippine respondents on the other hand have scores ranging from 3.69 to 4.75, which indicate a scale between moderately problematic to very problematic. south african entrepreneurs generally perceive their obstacles as less problematic even when compared to the world, ldcs and ssas in all instances except price control, terrorism and crime and theft (only when compared to world figures). philippine entrepreneurs on the other hand have higher indices when compared to the world, ldcs and ssa countries except in the inadequacy of infrastructure supply, financing, crime and theft, corruption (ssas), and taxation (ldcs). table 3 presents the percentage of the respondents that perceive the various obstacles as being problematic, that is, they indicated a response of 4 to 6 in the scale. results show that based on the chi-square tests, there are significant differences between the south african and philippine respondents. at 14 degrees of freedom and ρ≤0.05, the critical value from the t-test table is 2.145. table 3 perceived problematic obstacles (comparative percentages) obstacles sa phil world ldc ssa χ2 value start-up regulations 21.00 58.50 38 37 37 127.470* price controls 27.85 58.09 26 29 26 75.489* foreign trade regulations 30.35 66.54 44 47 46 99.715* financing 30.26 70.11 62 64 62 118.593* labour regulations 42.24 71.54 46 42 44 68.192/* foreign currency regulations 31.77 68.18 38 41 45 119.685* tax regulations/high taxes 51.89 82.12 76 79 78 75.647* inadequate infrastructure supply 23.74 66.28 60 65 69 118.046* policy instability 22.55 69.47 52 57 49 148.993* safety/environment regulations 30.36 69.50 38 36 43 115.438* inflation 57.54 79.92 55 61 67 58.428* general uncertainty on cost of regulations 34.91 70.27 51 53 51 128.740* crime and theft 58.68 80.37 57 62 67 66.612* corruption 41.12 79.10 65 73 78 103.436* terrorism 27.86 66.15 21 22 19 150.302* *significant at ρ≤ 0.05 sajems ns vol 7 (2004) no 1 96 there were less respondents from south africa that perceived the various obstacles as problematic when compared to the philippines, the world, ldcs and ssas except on terrorism, crime and theft (world), labour regulation (ldcs), and price control (world and ssas). in contrast, a higher percentage of filipino entrepreneurs perceived the various obstacles as being problematic when compared to south african entrepreneurs, the world, ldcs and ssas except in only one obstacle inadequacy of infrastructure supply (ssas). this result is consistent with the findings presented in table 2. table 4 presents the various obstacles, as well as how the respondents from the two countries and country groups ranked them. the table also highlights the top five obstacles for each group. table 4 comparative ranking of obstacles obstacles sa phil world ldc ssa start-up regulations 15 14 12 13 13 price controls 12 15 14 14 14 foreign trade regulations 9 11 10 9 9 financing 10 7 3 3 6 labour regulations 4 5 9 10 11 foreign currency regulations 7 10 13 11 10 tax regulations/high taxes 3 1 1 1 2 inadequate infrastructure supply 13 12 4 5 3 policy instability 14 9 8 7 8 safety and environment regulations 8 8 11 12 12 inflation 2 3 6 6 4 general uncertainty on cost of regulations 6 6 7 8 7 crime and theft 1 2 5 4 5 corruption 5 4 2 2 1 terrorism 11 13 15 15 15 it is interesting to observe that the top five obstacles perceived by both south african and filipino entrepreneurs are the same – crime and theft, inflation, tax and labour regulations and corruption, although the order of the ranking is slightly different. these obstacles are also among the top five indicated by respondents from the world, ldcs and ssas except for labour regulations. the world, ldc and ssa respondents indicated that inadequate infrastructure supply is a bigger problem. ssa respondents however also perceive financing as a bigger problem in their country. the rankings of the obstacles also varied considerably between south africa, philippines, world, ldcs and ssas. sajems ns vol 7 (2004) no 1 97 conclusions and recommendations the research results show that entrepreneurs in different countries have similar perceptions of their diverse environment. entrepreneurs can take comfort that they are not alone in their situation. entrepreneurs from south africa ranked the same top five obstacles as their philippine counterparts. this reinforces the fact that some obstacles encountered by entrepreneurs are universal and are unaffected by the context of each individual country. furthermore, it is also interesting to note that in both the countries studied most entrepreneurs perceived crime and theft, tax regulations and inflation are the main problematic obstacles entrepreneurs face. as expected there are several aspects where the south african and philippine entrepreneurs differed (e.g. foreign currency regulations, general uncertainty on cost of regulations, and terrorism). these differences highlight the fact that entrepreneurs in the philippines encounter more institutional obstacles than in south africa. in certain aspects, south africa can be classified as a relatively developed country its banking system first world, its currency more stable, regulations and policies affecting start-ups more clear cut, better infrastructure, and a more stable economy. the philippines, on the other hand is still experiencing problems regarding political and economic stability, in addition to inadequate infrastructure supply, plus terrorism down in the southern part of the country. these differences however, do not indicate that the two countries are not comparable. some contextual problems common to both countries include high unemployment rates, problems with poverty, crime as well as corruption. based on the results of the study it is important to point out that there should be an open channel of communication between the entrepreneurs and the government. if the government shows its willingness and sensitivity to hear the entrepreneurs’ problems, the more willing the entrepreneurs will be to giving suggestions. the government must adjust the environment and its policies to make it more conducive to the needs of the entrepreneurs as well as encourage other individuals to follow the entrepreneurial path. the entrepreneurs from both countries have indicated the specific areas they have found problematic and it is now the government’s responsibility to improve on these areas of difficulty. perceptions will improve once entrepreneurs see efforts exerted to alleviate their conditions – this can be in the form of new legislation, reduction of bureaucracy and corruption, information availability, tax incentives, crackdown on crime and theft, and overall improvement in the economic and political stability of the country. sajems ns vol 7 (2004) no 1 98 cross-country studies like these also help emphasize similarities and differences between countries. the results will indicate necessary policy changes that will help improve the start-up conditions of small firms in similar institutional contexts. for future research, it would be interesting to relate these perceptions of institutional obstacles to success and/or failure rates of businesses. in addition, it would be noteworthy to study these perceived institutional obstacles and relate them to informal institutional factors (e.g. culture, beliefs and attitudes towards entrepreneurship), and how they can affect enterprise formation. references 1 brunetti, a., kisunko, g., & weder, b. (1997) “institutional obstacles to doing business: region-by-region results from a worldwide survey of the private sector”, world bank development report. 2 dana, l.p. (1987) “entrepreneurship and venture creation: an international comparison of five commonwealth nations”, frontiers of entrepreneurship research, babson college: wellesley, ma. 3 dana, l.p. (1990) “saint martin/sint maarten: a case study of the effects of culture on economic development”, journal of small business management, 28(4): 91-98. 4 davidsson, p. (1991) “continued entrepreneurship: ability, need and opportunity as determinants of small firm growth”, journal of business venturing, 6(4): 405-29. 5 davidsson, p. & henrekson, m. (2000) “institutional determinants of the prevalence of start-ups and high-growth firms: evidence from sweden”, paper presented at the jönköping international workshop institutions, entrepreneurship and firm growth, jönköping, sweden, january. 6 fogel, g. (1994) “perceptions of small business owners: a study of entrepreneurship in hungary”, midwest review of international business research, academy of international business: 89-99. 7. lundstrom, a. & stevenson, l. (2001) “entrepreneurship policy for the future”, paper presented at the sme forum, stockholm, sweden, march. 8 north, d. (1991) institutions, institutional change and economic performance, cambridge university press: new york. 9 north, d. (1989) “institutional change and economic history”, journal of institutional and theoretical economics, 145(1): 11-23. sajems ns vol 7 (2004) no 1 99 10 veciana, j.m. (1999) “entrepreneurship as a scientific research programme”, revista europea de dirrecíon y economía de la empresa, 8(3): 2-10. 11 young, e.c. & welsch, h.p. (1993) “major elements in entrepreneurial development in mexico”, journal of small business management, 31(3): 80-85. abstract introduction literature review research design the strategic response of south african retail banks implications of the study summary acknowledgements references footnotes about the author(s) johan coetzee department of economics and finance, university of the free state, south africa citation coetzee, j., 2018, ‘strategic implications of fintech on south african retail banks’, south african journal of economic and management sciences 21(1), a2455. https://doi.org/10.4102/sajems.v21i1.2455 original research strategic implications of fintech on south african retail banks johan coetzee received: 09 may 2018; accepted: 02 aug. 2018; published: 26 sept. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: since the global financial crisis, banks have been exposed to new opportunities and threats unprecedented in history driven fundamentally by technology. so-called ‘fintech disruptors’ are aggressively tapping into their service delivery chain to offer clients a better (cheaper, more convenient or efficient) value proposition. as banks have subsequently been forced to think more strategically about how to conduct themselves due to the imminent use of, for example, virtual reality, artificial intelligence, biometrics and big data, regulators have simultaneously had to ensure that the pervasiveness of technological disruption does not threaten the soundness of banks and the stability of economies. aim: to identify the strategic implications of fintech on south african retail banks. setting: the study is conducted in the south african retail banking industry. methods: a post-positivist paradigm approach that is qualitative in nature. results: there are several main findings: firstly, technology-based skills are becoming mandatory for staff and regulators alike; secondly, interaction policy is migrating clients towards a remote-based distribution strategy; thirdly, the bank of the future will not rely as heavily on brick-and-mortar branches as it has in the past; fourthly, new competitors are entering the fray and offer competitive digital-only solutions; finally, given the innovation and growth shown by these disruptors, financial sector regulators will have to find ways to hold them accountable. conclusion: by adapting to the fintech revolution, south african retail banks are hoping to become strategically pre-emptive rather than merely proactive. this will allow them not only to identify opportunities first, but also to offer solutions before competitors are able to do either of these. introduction the way banks operate will change dramatically over the next decade as technology and changing consumer preferences redefine how they do their business, what solutions they offer and how interaction occurs. technological advances such as artificial intelligence (ai), biometrics and robotics are set to become the norm and challenge conventional thinking about how to interact and offer banking products and services. a completely new era in banking has therefore emerged and done so post the global financial crisis (gfc) of 2008 (arner, barberis & buckley 2015; chiu 2017). how banks capitalise on these new opportunities and manage the threats they potentially impose will be central to strategy going forward, especially if they want to survive the competitive environment of tomorrow (rossi 2017). although technology has been integrated into banking product and services offerings for the best part of the past three decades, it was initially limited to the automation of back-office operations (masocha, chiliya & zindiye 2011). it has, however, dramatically challenged this notion as the sales and specifically client-facing environment has seen a dramatic uptake in the use of technology. this is driven by the desire of clients to seek ‘experiences’ and use technology when dealing with their banks (cairns 2017). technology has therefore revolutionised the way the modern economy functions and is set to do this at an exponential rate going into the so-called fourth industrial revolution (schwab 2015). one only has to realise that the speed of current technologically related breakthroughs and disruption is unprecedented in history and does not discriminate against country nor industry – it is pervasive and evident in entire systems including production, management and governance (schwab 2015). not to be part of it is not to be part of society. for this reason, technological disruptors in the financial services industry (referred to as fintech) have revolutionised the playing fields for banks and resulted in their redefining what they offer, how they offer it, and to whom they offer it. the strategic direction banks adopt over the next decade will be important, therefore, to ensure that they stay relevant and competitive (weichert 2017). this article investigates the challenges facing south african retail banks driven by the fintech revolution and provides insights into how they are strategically adapting. background in 2005 hedley et al. (2005:6) stated that ‘non-traditional competitors (potentially) have the resources, superior value proposition, technological savvy and customer goodwill to wipe out traditional banks altogether in the near future’. referring to this as an ‘intriguing notion’, they put forward three reasons why this might in fact not turn out to be the case: firstly, regulatory scrutiny would discourage such competitors from entering the fray; secondly, banks have the necessary networks and specialist skills at their disposal which would essentially negate any competitive pressures from these new entrants; thirdly, security and privacy is something that traditional banks offer their clients that these competitors are unable to provide. in 2018 these non-traditional competitors have revolutionised the environment that banks function within. emerging technological breakthroughs such as ai, 3d printing, humanoid robotics, autonomous vehicles, nanotechnology, biotechnology, quantum computing, mobile internet, self-learning algorithms, drones, holograms, and predictive analytics (dapp 2015; schwab 2015) are busy revolutionising the financial services industry. as things currently stand, it can be argued that this so-called fintech environment is the beginning of a new period that will redefine how banks operate. for example, research suggests that technological breakthroughs will become integral to how society operates on a daily basis and banks will have to adapt or face possible extinction (chen et al. 2017; yeoh 2016). furthermore, due to offering reduced cost banking solutions and encouraging disintermediation, banks will need to increasingly adapt their strategy to partner with fintech companies to provide banking solutions (arner et al. 2015; bunea, kogan & stolin 2016; he et al. 2017). the ‘bank of the future’ is therefore one that needs to be compatible with the technological solutions that fintech offers, but to an extent that is unprecedented in history. although the use of technology in banking is not new, the importance and extent of it has grown significantly in the past decade. non-traditional competitors with strong technology-driven offerings have entered the traditional banking environment to ‘disrupt’ traditional modes of financial technology solutions (dapp 2014). these fintech competitors provide a plethora of complex offerings ranging from digital payments solutions and information services to simpler savings and deposit-taking products, online banking facilities, multi-channel advice, securities trading, and financial software (dapp 2014). their influence in the banking world has also grown substantially in recent years. schueffel (2016) provides evidence that the search popularity on google for the term ‘fintech’ has increased significantly since 2011 on the back of the gfc. a further study conducted in 2016 found that no us bank holding company surveyed mentioned fintech as a competitive risk in any of their respective annual securities and exchange commission reports prior to 2016 (bunea, kogan & stolin 2016). so, although banks have used technology in their day-to-day operations for several decades, the notion of fintech transcends the typical applications of technology in present-day banking. the purpose of this article is therefore not to argue that banks are increasing the use of technology per se, but rather to investigate how the new and advanced types of technologies that have never before been integrated into banking are changing the strategic landscape for banks. given the unique regulatory requirements that banks have to comply with and the ramifications of the gfc, the impact of investigating the impact of fintech cannot be overstated, especially regarding how they are strategically addressing the competitive challenges it poses. if regulators know how banks are responding to fintech, they are better positioned to regulate the environment that these disruptors are entering. for this reason, the article investigates what south african retail banks are doing to strategically address fintech. a non-positivist paradigm is adopted in which qualitative judgements will be made based on the retail strategies of the major south african retail banks, namely absa,1 first national bank (fnb), nedbank, standard bank and capitec bank. literature review a new operating context regulatory considerations with the events of the gfc of 2008, regulators, both domestically and internationally, have redefined the ‘boundaries’ emanating from predominantly technology-driven activities impacting directly on the day-to-day operations of banks. this has placed pressure on regulators because as carrel (2014) suggests: [one of the] regulators’ main challenges [is] to define regulatory boundaries for the financial institutions to operate and control their risks while allowing enough freedom for them to proposer and innovate. (p. 233) because of this, banks are innovating not only their mode of interaction, but also the mix of products and services in order to redefine their bank-client relationships in a fundamentally new way. they have also had to work actively on perceptions regarding trust and how fairly they are seen to maintain bank-client relationships (moin, devlin & mckechnie 2015; roy, devlin & sekhon 2015). as perceptions of risk escalate from the client’s point of view, trust in the bank-client relationship diminishes (järvinen 2014). moreover, regulators are placing more pressure on banks to realign their organisational culture to be in the interests of their clients. market conduct regulation packaged under the auspices of ‘treating customers fairly’ has become increasingly more important post gfc, especially to eradicate any tendencies towards moral hazard and conflicts of interest (hõbe 2015). also, due to the proliferation of information in the public domain, cybersecurity and the protection of client information is seen as a serious risk facing banks in the technology era. insurers in the us, for example, are providing insurance against cyberattacks in a market estimated to already be worth $2.5 billion in 2017 (mcwaters & galaski 2017). the insurer american international group (aig) estimated that in 2017 the cyberinsurance industry grew at a rate close to 30% per annum (camillo 2017). cybersecurity, and especially the protection of proprietary client information, is therefore a vitally important regulatory priority. this client information is central to the ability of so-called fintech companies to identify patterns and trends via big data analytics and offer technology-based solutions on a mass scale. if the information is not protected by regulatory reforms, trust in the financial system will be eroded and contribute to systemic risk concerns. these regulatory developments suggest that the environment facing banks has changed dramatically and, importantly, placed increased pressure on regulators to enforce compliance. in the context of this study, the challenge will be to what extent disruptors will be held accountable to the same regulations and compliance requirements as banks are, especially when they start behaving more like banks (lee 2017). even if, as treleaven (2015) suggests, technological disruption creates unprecedented opportunities to reform regulation in the financial services industry, regulators will still have to ensure that trust in a sound regulatory environment is maintained so as to avoid escalating systemic risk and potential economic crises. this risk is acknowledged by the south african reserve bank (sarb) who emphasise especially the interconnected and contagion implications of poor regulatory oversight as the adoption of fintech increases (sarb 2017). put simply, the increasingly integrated and complex use of technology in ways unprecedented in the past cannot be allowed if the soundness of the banks themselves is not simultaneously ensured. changing consumer behaviour due to the ubiquitous nature of information on the internet, clients are more informed about and resultantly more demanding of personalised banking solutions. this is especially prevalent among younger consumers who do not know a world without the internet and smart devices. the millennials (those born between 1980 and 2000) in particular exhibit dramatically different buying patterns and consumption expectations than older generations such as the baby boomers (kpmg 2017). they are also increasingly averse to interacting with a bank, especially via a branch, and rely heavily on their smart technology-driven devices (hõbe 2015). a study in the us found that 75% of millennials would prefer using financial services from paypal, amazon or google as opposed to a bank, one-third would be prepared to switch banks in the next 90 days, 53% think that all banks are the same, and, rather comically, 71% were more willing to get root canal surgery at their dentist than interact with a bank (kadlec 2014). consumer behaviour and the demands it places on banks has revolutionised product and services offerings. at the heart of this is the use of technology by a generation of clients who cannot imagine a world without it. another interesting phenomenon that has arisen in these technologically driven times is how consumers consume goods and services – they are less willing to ‘own’ them and would prefer to merely have access to using (or ‘renting’) them. music and movies, for example, are streamed via the internet instead of purchasing the physical cd or dvd (dapp 2015). apple also offers the option to ‘rent’ access to its full music library without actually owning the songs and this is done through cloud technology for a nominal monthly fee. ownership does not accrue as the consumer effectively only rents the use of the music. this alternative business model allows goods and services to be shared (think also of uber or airbnb) and forms part of the so-called ‘sharing economy’ (dapp 2015:5). a resultant paradigm shift has emerged: from the ownership of to the use of, which suggests that clients will become increasingly less loyal to service providers if they are not seen to facilitate tailor-made products and services in real time. research suggests that if banks do not ensure seamless transactions in real time, clients are more inclined to move to another bank (or non-bank) as competition for clients is rife (weichert 2017). in essence, therefore, if banks are to adapt, they need to become enablers of rather than providers of banking products and services due to non-traditional competitors offering similar or even better products and services. this thinking is central to strategically preparing for the disruption posited by the fintech revolution. what is fintech? although it may seem that the marriage of finance and technology (into ‘fintech’) only came to the fore in recent years, the earliest reference to it dates back to 1972 where it was defined as ‘an acronym which stands for financial technology, combining bank expertise with modern management science techniques and the computer’ (bettinger 1972:62). fintech companies provide digital financial ecosystems that are able to collect vast amounts of data and derive economies of scale and multi-stakeholder participation (mok & saha 2017). in doing so, banks have in recent years realised not only the importance of these ecosystems, but also the need to engage and partner with these companies (dapp 2014). the digital ecosystem business model is characterised by strong sales and earnings growth driven by an innovative and cost-effective environment and has brought into question the viability of traditional operating models adopted by banks (dapp 2015). a study conducted by pwc (2017) found that approximately 82% of financial services providers expected to increase their partnerships with fintech companies before 2022. the benefit for both bank and fintech company is therefore mutual: the bank partners with a company that provides innovative and noticeably cheaper and more efficient banking solutions (be it product-, serviceor process-related), and the fintech company benefits by earning a revenue for offering the service, while simultaneously gaining access to a large client base on whom to test their innovative theories and models (pwc 2017). these fintech companies have, therefore, revolutionised the playing fields in which not only banks, but financial institutions in general operate. with the advent of fintech companies the regulatory environment has been equally challenged and raises concerns whether or not regulators will be empowered to adequately regulate them (mcwaters & galaski 2017; weichert 2017). due to many of them being venture capital start-up companies, it seems that they will indeed escape the regulatory net applicable to banks (arner et al. 2015), at least in its current form. this is a major concern for regulators. what makes matters more complex is that the world of fintech is not static and there is already evidence of alternative applications of technology into so-called wealthtech, insuretech and regtech. the latter, for example, is ‘the use of technology to address regulatory and compliance requirements more effectively and efficiently’ and may include electronic-based know-your-customer facilities, improved fraud monitoring, and automatic clearing registries (arner, barberis & buckley 2016). these regtech proposals are intended to improve operational efficiencies and at the same time reduce compliance costs (arner, barberis & buckley 2016). technology is therefore being applied not only on the sales side of the banking transaction, but also on the regulatory and compliance side. this raises new opportunities for banks, but at the same time additional risks, especially in terms of fintech partners not falling into the regulatory net. fintech therefore offers opportunities to both banks and fintech companies, but hinges on a sound functioning banking industry. if an integrated fintech-driven environment is not suitably captured by regulators, systemic risk implications come to the fore that can threaten the stability of entire economies. this must be avoided at all costs. typical applications of fintech the use of technology in finance is applied in several ways. below follows a discussion on the major applications thereof. the use of big data and analytics according to sas (2017): big data is a term that describes the large volume of data – both structured and unstructured – that inundates a business on a day-to-day basis. [the] primary value from [it] comes not from the data in its raw form, but from the processing and analysis of it and the insights, products, and services that emerge from [this] analysis. in its raw form the data in itself is, therefore, meaningless and the value lies in what can be extrapolated from it. banks will thus need to adapt to expected future trends as opposed to merely addressing current trends, similar to the approach adopted by the global package delivery company ups who use data to be prescriptive (that is, forward-looking) as opposed to being merely descriptive or predictive (which would typically be associated with being static and historical-based). where, they argue, typical big data methodologies acquire information which results in knowledge, their data architecture goes beyond this to fostering ‘wisdom’ and ultimately ‘clairvoyance’. this, in their view, has revolutionised how they service clients as their predictive analytics hopes to one day predict future problems and solve them before they become operationally significant (dix 2014). the use of big data suggests that the potential benefit to the bank is that it identifies opportunities before competitors become aware of them: pre-empting opportunities will therefore be more effective than merely being proactive. moreover, technology facilitates innovation which enables banks to provide customised and differentiated banking solutions to clients (hõbe 2015). in fact, data analytics and mobile devices were seen globally by banks in 2017 to be the most important technical areas of investment in the coming 12 months (pwc 2017). algo-banking, for example, analyses the financial information of markets and customers to customise financial advice and product recommendations, supposedly more efficiently than any human (frost & sullivan 2016). due to being privy to client information, banks are also able to link clients to service providers such as retailers, airlines and hotels. this internet of things (iot) enables banks to become part of every part of a client’s life (oracle 2015). big data and its associated analytics are therefore seen to be crucial to understanding and pre-empting the behaviours of the client of tomorrow. automation and digitisation structural digital changes will predominantly apply to products and services that are easily standardised and can be automated due to their repetitive, routine and predictable nature (dapp 2014). bersin (2016) suggests that one of the most fundamental changes that technology, and in particular the automation and digitisation of products and services, brings to the fore is the design of organisations. this implies an organisational structure that is flatter, focusing less on function and more on teams that are more empowered, talent that is mobile, an organisational culture that is shared, and leadership that is more hands-on. ultimately, the benefits gained from the use of technology will be geared towards a more user-friendly environment for clients (dorfleitner et al. 2017). the use of technology does, however, have the potential to replace humans in the delivery of banking products and services. a study conducted at oxford university (frey & osborne 2013:38) predicts that approximately 47% of jobs in the us will be ‘automatable over some unspecified number of years, perhaps a decade or two’. the study contends that jobs related to office and administrative support, sales and services, and the construction industry are at a particularly high risk of being computerised due to their relatively low reliance on human social intelligence. this social intelligence refers to typical work-related tasks such as negotiation, persuasion, empathy, emotions, and the ability to respond intelligently in a manner that emulates ‘common sense’ (frey & osborne 2013:27). jobs that require a high degree of creativity (such as fashion designers), perception and manipulation (such as surgeons) also have a low probability of being automated. the notion that computers will replace humans in banks is becoming more prevalent by the day. the use of robo-advisers, for example, is raising concerns for employment prospects, especially in emerging markets given their ability to replace unskilled labour (world economic forum 2017). although their use seems to be the next logical step in using algorithm-based technology, banks must be careful to ensure that clients are indeed willing to be assisted by such virtual assistants (mok & saha 2017) as this will redefine the interactive nature of the bank-client relationship. this in turn has very real implications for both the size of the staff complement and the number of physical branches manned by humans. emerging technologies emerging technologies such as blockchain, cryptocurrencies, biometrics, and ai are seen to be vitally important areas of investment by both fintech companies and large financial institutions. as of 2017, 77% of fintech companies expected to adopt blockchain in their processes or production systems by 2020 (pwc 2017). due to blockchain (and similar distributed ledgers) being decentralised, there are reduced costs and a built-in disincentive to commit fraud due to changes being scrutinised by the entire network (arner et al. 2015). this raises alternative opportunities for regulators to gather information from banks both directly and instantly in order to ensure compliance in real time (he et al. 2017). by implication, regulatory reporting as it is currently done may become a thing of the past. furthermore, although cryptocurrencies (such as bitcoin) offer a low-cost payment method that is accessible, anonymous and unregulated (frost & sullivan 2016), they raise regulatory concerns (dorfleitner et al. 2017). case in point, the ceos of both nasdaq and bank of america recently raised their trepidations regarding the lack of regulation for cryptocurrencies, especially with regard to encouraging illicit criminal behaviour due to the anonymity involved (keller 2018). banks are also experimenting with the use of biometrics to activate credit cards through smart card technologies (kpmg 2017) and identify clients though fingerprint scanning (arner et al. 2015). voice, face, handwriting and touchscreen keystroke recognition are further examples of this technology and, coupled with location-based identification, will reportedly reduce client fraud going forward (centre of excellence in financial services 2017). recent research suggests that voice recognition is more than three times more accurate than typing (bersin 2016). moreover, dapp (2015) indicates that banks are even experimenting with biometric technologies such as hand vein scans and gait identification. there are also risks to using biometrics, however, for example, it could cause ‘data theft’ where fingerprints are replicated through high quality, high-resolution photographs (arner et al. 2015). cyberattacks also threaten the safekeeping of not only biometric data, but also that related to personal and financial information of clients (camillo 2017). as a result, cyberattacks reduce the trust in banks and also stifle innovation and have serious implications for the effectiveness of regulators to ensure stability in financial systems (he et al. 2017). as long as the use of biometrics does not violate human rights and banks are able to secure private information, it seems to be integral to how banks will identify clients in the future. furthermore, ai relies heavily on biometric technologies to identify clients and offer tailor-made advice through the use of big data and self-learning (world economic forum 2017). robotics and ai effectively ‘derive patterns used to predict behaviour … and in the end mimic human judgement in automated decisions’ (he et al. 2017:10). robo-advisers are expected to become the norm when interacting with clients, especially with regards to investment advice on passive investment and diversification strategies (dorfleitner et al. 2017). the complex algorithm-based technologies essentially allow machine learning by estimating the risk appetite of investors and identifying investment opportunities (centre of excellence in financial services 2017). virtual reality will also be used to promote social learning through simulations and gamification (bersin 2016). banks are also providing apps as a means to interact more socially with clients. although us banks were quick to adopt web 2.0 technologies and capitalise on the social network dynamic of interaction, south african banks were initially slow in the uptake (bagley, mothlala & razack 2013). however, a 2016 study indicated that banking-related apps are the third most downloaded by south africans behind social networking and instant messaging apps (columinate 2016). the ability of clients to access information quickly was also cited as the most important factor driving the use of apps. ideally, banks want to provide a seamless integration between socially driven technology-based behaviour and banking and to do this, they need to provide platforms that are totally integrated in the social media environment (dapp 2015). as an example, suppose a client transfers money via an app on the phone while chatting on social media – this is seamless, quick and real-time and epitomises what fintech companies claim as adding value to banks. research design this study adopts a non-positivist paradigm focusing on a qualitative research design. this approach seeks contextual understanding of the underlying phenomenon (belal, abdelsalam & nizamee 2015), which in this case is to investigate the strategic approaches of the major retail banks in south africa given their adoption of fintech. when adopting a qualitative design, it is important to ensure that the methods are unbiased and trustworthy (morse, olson & spiers 2002). as such, the sampling frame was the five major south african retail banks namely absa, fnb, nedbank and standard bank and more recently capitec bank, which has aggressively increased its market share in recent years (businesstech 2017a). these banks represent the retail banking environment in south africa. when investec bank is included, the banks account for more than 90% of retail deposits in south africa (nhundu 2016). however, due to investec focusing exclusively on the high net worth affluent market as opposed to the retail banking market, it was omitted from the study. for this reason, the five banks depicted in table 1 are by far the most representative of the south african retail banking market. sampling bias is, therefore, reduced. table 1: the number of branches, automated teller machines and clients for the big south african banks. the information on how banks deal with fintech was sourced primarily from the annual reports and websites of the respective banks. this ensured that the source documents were trustworthy and from the banks themselves where strategy is clearly provided (coetzee & crous 2016). by assessing the strategy reports of the banks in their respective annual reports, qualitative judgements were made based on the strategic approaches adopted that corresponded to the literature review on fintech. more specifically, statements and references made by banks were assessed where specific mention was made of the strategic impact that fintech has on their operating environment and which future plans are being put in place. by applying this research design, greater insight is gathered with regard to the strategic responses by south african retail banks to fintech. the strategic response of south african retail banks the extensive and integrated use of technology will become a norm all of the banks have embraced the technology revolution. so much so that it has become part of their strategic direction over the next few years. table 2 provides key strategic value propositions that they have put forward reflecting the role of technology over the coming years. table 2: selected strategic value propositions relating to fintech by the south african retail banks. table 2 indicates that the environment facing south african banks cannot be entered into without having information technology (it) at the centre of operational strategies. key strategic drivers such as economies of scale, efficiency, cost reduction, innovation, competitiveness and simplicity are inherent to the value propositions that it evidently brings to the fore. the firstrand group, for example, prides itself on being innovative and specifically disruptive through the use of technology. by the end of 2017, approximately 8% of total sales were digital-related and a key driver of growth (firstrand group ltd 2017). furthermore, nedbank (2017:30) states that ‘the digitisation of banks means that technological developments take centre stage in banking’ and absa, through its ‘separation strategy’ will explicitly focus on integrating technology in a new strategic path post barclays (barclays africa group ltd 2017a). banks will be competing aggressively against non-traditional fintech disruptors the banks also realise that disruption by both traditional and non-traditional competitors especially in the supply chain is threatening their survival. as standard bank puts it (2016a:19), ‘to prove our relevance in an increasingly digital world, we are actively embracing disruption and innovation, and working with innovation partners to deliver better value for our clients’. absa further regards the disruption of fintech companies as a key operational risk impacting competitiveness (barclays africa group ltd 2017a:16). this disruption and especially the innovation it brings with it should not, however, be at the expense of ensuring simplicity in product and service offerings. capitec bank reiterates this (2017:15): ‘new products will continue to have the same foundation of simplicity and affordability as our other products’. as of the first quarter of 2018, several fintech disruptors were imminent in the south african retail banking industry: tymedigital, a subsidiary of the commonwealth bank of australia, was planning to become the first full-service digital bank in south africa to provide affordable and accessible online banking services. explicitly focused on disrupting the south african banking industry by offering cheap and technology-based banking services, the bank has strategic partnerships with pick n pay and boxer stores to operate money transfer. the bank also emphasises the importance of educating its client base of the benefits of using online-only banking facilities.2 a former ceo of fnb is in the process of starting a new bank called bank zero which functions solely through an app on smart devices and offers no physical branches. the bank will not initially provide credit but will focus on transactional services with the purpose of launching an aggressive low-fees strategy aimed at attracting both retail and business clients. this in itself will be an opportunity for major disruption as business clients are traditionally charged very high fees by banks.33. discovery bank is an attempt by insurance house discovery to enter the retail banking industry in south africa. due to its having a substantial client base in its insurance business, it plans on launching a full-service banking platform to these clients and providing the services through digital channels (businesstech 2018). with many clients having their medical aid and insurance at discovery, it provides a golden opportunity for the new bank to poach banking clients from, especially, the ‘big four’. the business model of capitec bank can also be regarded as being disruptive as it purposefully differentiates its strategy from that of the big four. where the latter are all trying to reduce the number of physical branches, capitec is intentionally increasing theirs. it also does not try to differentiate between clients, striving rather to treat them all the same. for example, where the other banks have loyalty programmes, capitec does not have one, stating (thomas 2018:9): ‘we have no plans to introduce a loyalty programme and will never have one in which a very small proportion of customers gets most of the benefits’. postbank is a further example of a disruptor as it provides affordable banking services through the post office branch network. the client reach is therefore extensive and poses a real threat to client acquisition in terms of its physical branch network especially in the remote areas of south africa.4 the technology-based skill sets of staff will become essential the dynamic and exponential growth in the use of technology in banking services has placed pressure on banks to employ staff with the requisite skill sets. not only must staff be able to stay abreast of the latest developments in technology, they also need to identify new and innovative solutions that will enable a bank to remain competitive. as such, the ability of staff to analyse data is expected to become a ‘mandatory core competency’ of professionals across the board (tableau 2017:12). nedbank, for example, places a lot of emphasis on the changing nature of skills required from staff to deal with: … robotics process automation, user interface design (ui), user-experience design (ux), social media client services, digital innovation, cyberor digital security, data security, data mining, predictive risk analytics and client experience management. (nedbank group ltd 2017:34) standard bank regards the skill set required by staff to face digitisation and automation as a major concern going forward. they proactively strive to improve human capital by offering specialised skills development and learning programmes, partnering with universities to develop it curricula, and upskilling, redeploying and exposing staff to new business models and thinking in the technology space (standard bank group ltd 2016a). they place a high premium on empowering staff suitably to address the rigours of the technology age to: ‘provide access to advanced technology and tools that support the future world of work and fulfil the promises we make to our clients’ (standard bank group ltd 2016a:60). absa (barclays africa group ltd 2017a:4) highlights the threat posed by cyberattacks and the need for staff with the ‘expertise to defend against the threat landscape’. the bank also recognises the competition for scarce skills in it, data analytics and risk management as a key market driver both now and in the near future (barclays africa group ltd 2017a:14). for example, in recent years absa invested in critical skills in technology, digital, data and cyber security platforms by hiring 843 professionals. of these, 71 focused solely on cyber security and 91 on data analytics (barclays africa group ltd 2017b:39). similarly, the firstrand group increased its spend on skills development by almost 240% in 2017 from 2015 levels (firstrand group ltd 2017:9) and due to capitec focusing on simplifying banking and doing so cheaply for retail clients, the bank recruits staff who have ‘the ability to interact constructively and support clients’ to ‘empower clients to structure solutions according to their preference[s]’ (capitec bank ltd 2017:36). more efficient (and fewer physical) distribution channels as a key performance indicator for its strategic focus, nedbank is optimising branch floor space through digitisation to ensure smaller and more efficient branches (nedbank group ltd 2017). as they put it, they will ‘continue to innovate and roll out digital branches to enable clients to migrate to digital channels and empower our staff with digital tools to serve clients’ (nedbank group ltd 2017:47). by implication, this means that by using technology, banks are reducing their relative reliance on brick-and-mortar distribution channels as evidenced for the four-year period 2012 to 2015 where the number of branches by the big four banks fell by 5% from 3005 to 2862 (tarrant 2016). as indicated in table 1, the big four have all reduced their respective number of branches, with only nedbank marginally increasing the number of atms and the rest decreasing. this is a major strategic shift from previous years where branches and atms increased substantially in an attempt to increase opportunities to interact with clients (coetzee 2009). the opposite is happening now. nedbank, for example, has indicated that by the year 2020 they intend reducing the number of branches to 82% of 2017 levels (nedbank group ltd 2017:73). and, although they have reduced the number of staffed outlets, they have introduced 336 digitally focused ‘branch[es] of the future’ (nedbank group ltd 2015). in november 2017 nedbank launched a self-service digital branch called ‘nzone’ offering an interactive wall, a virtual reality area, a secure video kiosk to interact with bankers and free wi-fi. this branch not only exposes clients to new technology-based products, but also acts to inform and ‘prepare clients for the future of banking’ (khumalo 2017). although capitec (capitec bank ltd 2017:12) focuses on increasing ‘out of branch transacting’ (i.e. transactions through digital channels), it is the only bank that has an explicit strategy to increase the number of physical branches – by 50 a year (capitec bank ltd 2016). this is due to the focus to increase market share, and especially to make the bank the primary bank for as much as 25% of retail clients by 2020 as they conduct up to five times more transactions than those with multiple bank accounts (capitec bank ltd 2017). from all accounts, though, the banks are reducing the number of physical branches in favour of digital channels. client migration to cheaper and more technology-focused digital channels following the drive to reduce expensive brick-and-mortar distribution channels, banks are intentionally migrating clients to cheaper and more technology-driven digital platforms. this so-called ‘relationship banking paradox’ (coetzee 2016) suggests that the banks are moving towards a remote interaction strategy and have embraced technology in the bank-client relationship. for example, absa acknowledges that technology has ‘redefined transactional banking’ and places emphasis on an ‘intelligent relationship’ that integrates ‘data, insights-driven solutions and human interactions’ across all channels in the bank-client relationship (barclays africa group ltd 2017b:35). as with all the banks, electronic or digital channels attract a pricing model that encourages and rewards customers more favourably. standard bank indicates that the number of clients in south africa is ‘static’ and results in a hugely competitive market for clients with increasingly more digital-based habits (standard bank group ltd 2016b:38) and nedbank acknowledges the role that technology is playing in disrupting the traditional dynamics of the bank-client relationship. by migrating clients to digital channels, banks will use branches to offer advice and also self-service facilities to clients. the branch will not be the primary channel of interaction and will have an underlying purpose to migrate clients to cheaper digital channels. the pervasive use of technology is also expected to become more prominent. for example, nedbank (nedbank group ltd 2017:37) is incorporating facilities such as intelligent depositor devices, video banking, quick-chat banking, self-service kiosks, robo-advisers, virtual reality, a grab-and-learn wall and facial recognition into their digital branches. cloud computing, big data and analytics, blockchain, ai, biometrics and quantum computing are also expected to become inherent to bank strategy (capitec bank ltd 2017; standard bank group ltd 2016b). compared to 2016 levels, fnb indicates that digital transactions increased by 88% in 2017 driven primarily by banking app volumes increasing by 68% and mobile device volumes increasing by 20% (firstrand group ltd 2017:52). in order to operationally support these fintech applications banks are, for example, rationalising internal it systems (nedbank group ltd 2017:37), offering a multi-channel and device approach (barclays africa group ltd 2017b:39), reducing the total square metreage of branches without any material change in the number of branches (standard bank group ltd 2016a:67) and even selling and simultaneously financing mobile devices such as cellphones and tablets (firstrand group ltd 2017:56). these responses strongly suggest that the use of fintech applications will drastically alter both how banks interact with clients and also the operational platforms to enable the use of the applications. implications of the study the integration of technology into financial services has the potential to radically change the nature of distribution channels (masocha et al. 2011) as well as to redefine banks from being providers of banking services to enablers of banking services. the findings of this study indicate this. south african banks are realising not only that the status quo cannot be maintained, but also that failure to embrace the technological revolution will be to their detriment. moreover, due to technology reducing both the switching costs for clients and the barriers to entry for disruptors (bersin 2016), failure to adapt will severely impede survival. all the south african banks have realised this and have aggressively focused on upskilling their staff to have the requisite skill set to deal with the digital era. the banks indicate that technology is in the process of radically changing how they interact with clients. traditional brick-and-mortar branches are becoming less of a long-term option, at least in their current format where human interaction remains a dominant feature. offerings and client interaction will become increasingly more integrated with automation, digitisation, smart devices and virtual interaction. in a more extreme case, interaction will be through the use of robotics and virtual reality. branches are thus expected to become smaller and there will be fewer of them due to their high fixed costs. in fact, with fintech competitors such as tymedigital and bank zero relying solely on digital platforms to interact, retail banks will be forced to aggressively migrate clients to digital channels in order to compete. the bank-client relationship will therefore in all likelihood be defined along remote interaction dynamics, especially among the younger, more technology-savvy generation. having said this, human interaction will not disappear altogether as it remains pivotal to promote trust and relational commitment between the parties in a banking relationship (johns 2012). the banks themselves also acknowledge that personal interaction remains important and in branches, where this primarily occurs, the format and design will change rather than become totally obsolete. several banks in the us for example are experimenting with new ways to use branches to attract clients. umpqua bank offers smaller-sized branches that host social activities ranging from yoga classes to oktoberfest-style parties where beer and pretzels are served. similarly, capital one has opened several ‘café branches’ that offer all the typical amenities of a coffee shop while consulting a personal banker (wack 2017). opportunities such as these must be investigated suggesting that, as things currently stand, the exact structure and nature of a branch is realistically a work in progress. what is clear however is that it will be fundamentally technology driven and experimental in design. furthermore, the wealth of information banks have on clients will allow them to profile and segment clients beyond mere biographical and financial information to include medical and even health-related financial solutions. if one considers that absa, fnb, nedbank and standard bank are all part of larger holding companies that have some exposure in either health care or insurance, it holds true that big data and the fintech solutions attached to that will allow banks to provide banking solutions that are not merely reactive, but pre-emptive – that is, to open up and capitalise on opportunities before competitors become privy to them. this is because the banks wil be able to profile clients more accurately and use predictive analytics to better address financial needs, be they specifically banking-related or generally financial-services related. although the window of opportunity may be short-lived until competitors offer similar solutions, at the heart of this will be a seamless financial offering where the bank is effectively an enabler of banking solutions as opposed to being a provider of one. this has manifested itself in banks not only engaging strategically with fintech companies, but also entering into strategic partnerships with, for example, retailers and supermarkets. finally, a very real concern is how fintech companies will be regulated. the sarb must provide clear guidelines to both fintech companies and banks as to how they will need to comply with existing regulatory and legislative requirements. failure to do this can result in very real systemic implications that puts the stability of the banking industry at risk. this must be avoided at all costs, especially given that technology is fundamentally intended to improve the lives of clients. in order to assess current developments in fintech, an inter-governmental fintech working group that includes the sarb, the financial services board (renamed to the financial services conduct authority in 2018), national treasury and the financial intelligence centre was established in 2017 (south african reserve bank 2017). at the time of writing, the sarb fintech unit had also been established to monitor in particular the financial, operating and systemic risks posed by fintech. of note is the specific mention that the unit had been established ‘to develop the capacity to understand [the] risks (and benefits) of fintech’ (sarb 2017:38), suggesting that a comprehensive understanding of fintech and its implications are still a work in progress for the regulator. summary this study identified several strategic responses that will dominate the way south african retail banks conduct themselves in the future. due to the exponential growth in technology and the constant drive to innovate to stay competitive, the skill set of staff not only to stay abreast of the latest developments in the technology space, but also to innovate and offer new solutions is more important than ever. the skill set for the ‘typical’ banker of the future is therefore not the same as that of the banker of the past. furthermore, the migration of clients to digital platforms will dominate interaction policy. clients are more technology savvy and less loyal in the traditional sense as they are becoming increasingly more likely to use solutions that are seamless and convenient, through either a bank or a non-bank. discrimination between these two is becoming increasingly blurred in the view of today’s client. the traditional shape and design of distribution channels are also under threat in favour of cheaper and more efficient technology-based channels. the way that banks interact with clients in the future will therefore not be the same as the way they interacted with them in the past. furthermore, new competitors that are not traditional 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https://tymedigital.co.za 3. see http://www.bankzero.co.za 4. see https://www.postbank.co.za abstract introduction limitations and assumptions research method and design results and discussion of the south african tax consequences and considerations conclusion acknowledgements references about the author(s) silke de lange department of mercantile law, faculty of law, stellenbosch university, south africa danielle van wyk school of accountancy, faculty of economic and management sciences, stellenbosch university, south africa citation de lange, s. & van wyk, d., 2018, ‘exploring the south african tax consequences of a residential property lottery’, south african journal of economic and management sciences 21(1), a1951. https://doi.org/10.4102/sajems.v21i1.1951 original research exploring the south african tax consequences of a residential property lottery silke de lange, danielle van wyk received: 23 may 2017; accepted: 12 oct. 2017; published: 12 apr. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: disposing of a residential property by way of a lottery sounds peculiar, but a number of these transactions relating to residential properties in south africa have recently taken place. as this is not an ordinary way of disposing of and acquiring residential property, it is submitted that it is necessary to explore the tax consequences resulting from such a transaction. aim: the objective of this article is to explore some of the most pertinent south african tax consequences of such a residential property lottery transaction, from the viewpoint of the owner (‘seller’) who disposes of the residential property and the winner (‘purchaser’) who acquires the residential property in terms of the lottery. setting: this article examines existing literature in a south african income tax environment to explore the tax consequences resulting from a disposal and acquisition of residential property by way of a lottery. methods: a non-empirical study, which entails the study of the various south african tax provisions and an application thereof to the facts of the lottery transaction, was conducted. a doctrinal research approach was followed within the realm of exploratory research. results: disposing of and acquiring residential property by way of a lottery results in a number of actual tax consequences, as well as a number of uncertainties regarding taxes (referred to as uncertain considerations). conclusion: the conclusion is reached that the possible tax consequences of such a transaction can create tax risks or can result in unintended tax consequences relating to inter alia income tax (including capital gains tax), transfer duty and donations tax. the insights provided in this article do not always result in conclusive answers but they may, however, result in further research to be conducted, and a number of such areas for further research were identified. should residential property lottery transactions occur more frequently in south africa in future, it is recommended that the south african revenue services (sars) issues clear guidance on the tax treatment from the perspective of the owner and the winner of such a transaction to ensure that any uncertainties are dealt with correctly. introduction disposing of a residential property by way of a lottery sounds peculiar, but a number of these transactions relating to residential properties in south africa have recently taken place. according to tswanya (2015), one transfer of residential property situated in the val de vie estate in paarl and two transfers of residential properties situated in the diemersfontein estate between wellington and paarl took place in the form of a residential property lottery. as such residential property lottery transactions are unconventional, especially in south africa, no academic literature currently exists on the topic in south africa. in the united kingdom, for example, the law society issued a practice note titled ‘house competitions’ in 2011 due to the increase of such transactions (united kingdom law society 2011). it is stated in the practice note that this increase can be ascribed to factors such as an economic recession, which makes it more difficult for home-buyers to obtain financing and that home-owners are therefore trying to sell their properties by way of a competition in which the property can be won (united kingdom law society 2011). the united kingdom law society notes in the practice note that one of the risks associated with these transactions is the possibility of fraud by not paying the relevant taxes (united kingdom law society 2011). it is submitted that similar risks associated with property lottery transactions exist in south africa, but no similar guidance on such transactions and their consequences is currently available. the terms and conditions of the lottery of the house situated in val de vie (‘the property’) were evaluated for purposes of this article. as the property is situated in south africa, the objective of this article is to explore some of the most pertinent south african tax consequences of such a transaction from the viewpoint of the owner (the person in a position similar to a seller in a typical sale transaction) who disposes of the property in terms of the lottery, and from the viewpoint of the winner (the person in a position similar to a buyer in a typical sale transaction) who acquires the property in terms of the lottery. to illustrate how the lottery works, the facts of the specific transaction relating to the property, as noted by tswanya (2015), and the lottery’s terms and conditions are presented. the tax consequences discussed below are based on these facts: the lottery of the property was administered in austria by an austrian attorney and 9999 lottery tickets or lots were available to be sold at €119 each. payment for a lot had to be made into a trust account of the austrian attorney. once all the lots were sold, a draw took place and the winning lot won the property, as well as a number of additional prizes, being the contents of the property (such as furniture), two return flights to south africa and accommodation for a week, including meals, tours and transport. a further promotional prize (a safari tour) was also available upon the condition that the winner agreed to have his or her name published, together with a photo and a follow-up story. the owner of the property was only entitled to funds that equal the market value of the property. the proceeds realised from the sale of the lots, however, far exceeded the market value of the property. the proceeds realised from the sale of the lots, after deducting the market value that was paid over to the owner and after deducting costs, such as the costs of the transfer of the property and the costs of the lottery, had to be paid over to a charity. further specific terms and conditions relating to the lottery transaction will be referred to below, as those are relevant or applicable to a specific tax issue being explored. in essence, the owner realises the full market value on the disposal of the property but also obtains some additional benefits. it was stated by the owner that there are benefits from disposing of the property in this way such as not being liable for estate agent commission (which is usually paid over by the owner to the estate agent from the sale price) (tswanya 2015). further, it was stated that selling the property in this way has the benefits that the owner does not have to make the house available for viewings, that the owner does not have to consider any offers, and that the sale will not be subject to conditions such as the buyer’s mortgage bond approval (tswanya 2015). the winner pays a fixed amount for the lot and, upon acceptance, acquires the property with a substantially higher value in return together with some additional prizes and an optional promotional prize. limitations and assumptions focus is placed on exploring the tax consequences for both the owner and winner, and it is assumed that both are natural persons. it is, however, unknown whether the owner of the property and the winner of the property are ‘residents’ as defined for tax purposes. the tax consequences of a transaction often vary depending on the tax residency status (‘resident’ or ‘non-resident’) of the parties involved. the income tax act 58 of 1962 (‘the income tax act’) defines a resident as a natural person who is ordinarily resident in the republic, or a natural person who is not at any time during the relevant year of assessment ordinarily resident in the republic, if that person was physically present in the republic for a prescribed number of days during the relevant year of assessment and the 5 years of assessment preceding that year of assessment (section 1 of the income tax act). it seems from the terms and conditions that the lottery was mainly aimed at selling lots to foreigners. this is clear from the facts as the additional prize includes air tickets to south africa and because a participant in the lottery was required to be in possession of a valid passport and visa to travel to south africa. however, ‘participants from south africa’ also purchased lots (tswanya 2015). the winner could thus either have been a ‘resident’ or a ‘non-resident’, and the same would apply to the owner. the discussion below however assumes that both the owner and the winner are ‘residents’ as defined. it is further assumed that neither the owner nor the winner is a ‘vendor’ as defined in the value-added tax act 89 of 1991 and that the transaction therefore has no value-added tax consequences. the scope of the article is limited to residential property only. specific consequences, should such residential property constitute a person’s primary residence, are addressed below. the provisions of the income tax act relating to deductions for residential buildings, residential units and low-cost residential units (sections 13ter, 13sex and 13sept) fall beyond the scope of this article. the article further focuses only on the tax consequences relating to the property, and does not include a discussion on the tax consequences relating to the contents of the property, the additional prizes and the promotional prize. the legality or lawfulness of such a lottery in south africa, or whether it is allowed for south african citizens to take part as owners or buyers of lots in such a lottery, falls beyond the scope of this article. it was reported that ‘participants from south africa are accounting for a good portion of the people taking part’ (tswanya 2015). for purposes of this article it will be assumed that a valid transaction was successfully concluded. the terms and conditions of the lottery provide that the owner may decide to discontinue the lottery if participation is not sufficient, in which case the buyers of lots will be refunded. the discussion below is, however, based on the assumption that all the lots are sold and that the draw proceeds. it is further assumed that the proceeds from the sale of the lots will cover at least the market value of the property, the costs of the additional prizes and promotional prize and all the other costs that are covered from the lottery takings and that an amount to be donated to a charity remains thereafter. it is assumed that the charity to whom the donation is made is an approved public benefit organisation as contemplated in section 30(3) of the income tax act. it is not clear from the available terms and conditions who the donor of this donation to the charity is. it is, however, assumed that the donor is not the owner as the owner is only entitled to the market value of the property. it should lastly be noted that all the tax aspects that are explored below could not be addressed comprehensively and in depth in this article. this creates opportunities for further research as referred to in the conclusion. research method and design what are the most pertinent south african tax consequences of disposing of a residential property by way of a lottery for the owner and the winner? this is the research question this article aims to address, within the realm of exploratory research. the research objective of this article is to explore some of the most pertinent south african tax consequences of such a transaction as no such research currently exists and no specific guidance is available in this regard. a non-empirical study, which entails the study of the various south african tax provisions and an application thereof to the facts of the lottery transaction, was conducted. hutchinson and duncan (2012) suggest the following steps to solve a specific research problem, referred to as a doctrinal research approach: gathering the relevant facts identifying the relevant tax issue at hand analysing the issue from a tax perspective studying relevant background material such as textbooks and journal articles, inter alia analysing primary research sources such as case law and legislation combining all issues within the context reaching a preliminary conclusion. the doctrinal research approach is embedded within the ambit of exploratory research in this article. exploratory research entails focusing on research problems that have not been previously investigated (brown 2006:46) and does not intend to provide a conclusive answer to research problems, but it can provide significant insights on the matter (singh 2007:64). while it is acknowledged that the insights provided in this article do not always provide conclusive answers, it may, however, result in further research to be conducted. exploratory research is therefore considered to be appropriate to this study. the research objective was achieved by doing the following: evaluating the facts of such a transaction as included in the terms and conditions of the lottery identifying the capital gains tax, other income tax, donations tax and transfer duty issues at hand analysing the relevant tax issues from the perspective of the owner and the winner studying and analysing available resources such as textbooks, case law and legislation to explore the south african tax consequences reaching a preliminary conclusion within the ambit of exploratory research. even though such property lottery transactions might not take place regularly, it is important to consider the tax consequences thereof as the benefits seem to be attractive upfront, although it might not necessarily be the case once the tax consequences are taken into account. this article should not be construed as tax advice on such a transaction, but should rather be seen as exploring some of the most pertinent tax consequences in order to establish tax risk areas or uncertainties, some of which could have been unforeseen, for both the owner and the winner involved in the transaction. the research is conducted in order to create an awareness of the most pertinent south african tax consequences of such a transaction, thereby creating opportunities for further research. while some actual tax consequences are discussed, a number of possible but uncertain tax consequences are also highlighted in this article. these are referred to as tax considerations and are seen as areas of uncertainty with possible tax risks. results and discussion of the south african tax consequences and considerations the tax consequences and considerations are discussed below in the following order. firstly, the capital gains tax consequences for the owner are explored (considering the disposal of an asset by the owner on the transfer of the property by way of the lottery), followed by the capital gains tax consequences for the winner. the capital gains tax consequences for the winner include a discussion of capital gains tax on gambling, games or competitions and a discussion of the base cost of the property for purposes of a future disposal of the property by the winner. subsequently, other income tax considerations are explored for the owner and the winner respectively. for the owner, it is considered whether the fact that the owner decides to dispose of the property by way of a lottery, instead of by way of an ordinary sale, could result in the owner moving over from the realisation of a capital asset to a scheme of profit-making. it is also considered whether the savings or advantages relating to the disposal of the property by way of the lottery (compared to an ordinary sale) could result in any tax consequences in the hands of the owner. for the winner, it is considered whether any income tax consequences arise due to the difference between the amount paid for the lot and the value of the property received in return as a prize. transfer duty and donations tax are two other types of taxes which are explored thereafter. capital gains tax consequences capital gains tax consequences for the owner for a capital gain or loss to possibly exist for the owner on the transfer of the property by way of the lottery, paragraphs 2(a), 3 and 4 of the eighth schedule to the income tax act require an asset, disposal, base cost and proceeds to be present. immovable property is included as an ‘asset’ in paragraph 1 of the eighth schedule. in terms of paragraph 11(1)(a) of the eighth schedule, the sale, donation, exchange or any other alienation or transfer of ownership of an asset is considered to be a disposal for capital gains tax purposes. none of the disposal exclusions as listed in paragraph 11(2) of the eighth schedule are applicable to this specific transaction. accordingly, the transfer of the ownership of the property in terms of the lottery from the owner to the winner can be regarded as the disposal of an ‘asset’. it is submitted that it falls beyond the scope of this article to determine the exact type of disposal (e.g. as a sale, donation or exchange) as it is in any event a ‘transfer of ownership of an asset’. to determine the base cost of the property, it should be established whether the property was acquired by the owner before or after 01 october 2001 (‘valuation date’ as per paragraph 1 of the eighth schedule). the first properties on val de vie (where the property is situated) were only purchased in 2004 (val de vie 2016); therefore, the property could only have been bought by the owner after 01 october 2001 and thus no valuation calculations are required in terms of the eighth schedule on 01 october 2001 to determine the base cost. paragraph 20(1) of the eighth schedule provides that the base cost of an asset is the sum of, among others: the expenditure actually incurred in respect of the cost of acquisition or creation of that asset (this would include the cost price of the erf and the costs of the erection of the house by the owner) amounts actually incurred as expenditure directly related to the acquisition or disposal of that asset such as transfer costs, transfer duty and advertising costs (paragraphs 20(1)(a) and (c) of the eighth schedule). the promotional and other costs relating to the disposal will be recovered from the balance between the market value of the property and the total value of all lots sold (tswanya 2015). these costs relating to the disposal of the property by the owner could, in principle, be considered to form part of the base cost according to paragraph 20(1)(c) of the eighth schedule. however, seeing that such costs are recoverable from ‘any other person’ as referred to in paragraph 20(3)(b) of the eighth schedule, such costs are excluded from the base cost as these costs will be paid from the lottery takings exceeding the market value of the property, and therefore will be recoverable, albeit indirectly, from the lottery participants. proceeds from the disposal are the final requirement to be determined. according to paragraph 35(1) of the eighth schedule, the proceeds from a disposal are equal to the amount received by or accrued to that person in respect of that disposal. in geldenhuys v cir (3) all sa 379 (c):389 it was held that ‘received’ means ‘received by the taxpayer on his own behalf for his own benefit’. ‘accrued’ on the other hand means ‘to which the taxpayer has become entitled to’ (lategan wh v cir 2 satc 16:20). in this specific transaction, the owner may recover the current market value of the property, namely r5.7 million (tswanya 2015). the value of the total 9999 lots sold at r1658 a lot (tswanya 2015 based on €119 per lot, converted at an exchange rate of €1:r13.93), will however be approximately r16.5 million. the question is, therefore, which of these two amounts (the market value or the total value of the lots sold) will be seen as the proceeds for capital gains tax purposes. as the terms and conditions of the lottery provide that the owner is only entitled to the market value of the property, the smaller amount of r5.7 million as the market value of the property is submitted to be the proceeds for capital gains tax purposes, as the owner is only entitled to receive this amount for his or her own benefit. as mentioned above, it is assumed that the owner is only entitled to the market value of the property. paragraph 38(1)(a) of the eighth schedule provides that the proceeds of an asset are equal to the market value of the asset for the person who disposed of the asset (i.e. for the owner) in certain circumstances. the application of paragraph 38 of the eighth schedule to the lottery is further considered below. paragraph 38 of the eighth schedule would, however, not affect the determination of the proceeds for the owner in terms of paragraph 35 of the eighth schedule as it would in any event be the market value of the property. after determining the base cost and the proceeds of the property, a capital gain or loss must be calculated on the disposal in terms of paragraphs 3 or 4 of the eighth schedule. if a capital gain or loss exists in this specific transaction, the application of paragraph 45(1) of the eighth schedule should also be considered. the owner as natural person will be allowed to disregard r2 million of the aggregate capital gain or loss determined with regard to the disposal in the case of the property being a ‘primary residence’. ‘primary residence’ is defined in paragraph 44 of the eighth schedule as, essentially, a residence in which a natural person holds an interest and which that person or a spouse of that person ordinarily resides or resided in as his or her main residence and uses or used mainly for domestic purposes. therefore, if the property in this specific transaction is the only primary residence of the owner and the requirements of paragraph 45 of the eighth schedule are met, the owner will be entitled to the primary residence exclusion. the owner will, however, not be entitled to the ‘personal-use assets’ exclusion in terms of paragraph 53(1) of the eighth schedule, due to ‘immovable property’ being excluded from ‘personal-use assets’ in terms of paragraph 53(3)(b) of the eighth schedule. as the lottery lots were sold for €119, with participants from all over the world, including an austrian lawyer and european promotor (tswanya 2015), paragraph 43(1a) of the eighth schedule should also be considered. this paragraph relates to exchange rates where a person disposes of an asset for proceeds in a foreign currency or after having incurred expenditure in respect of that asset in a foreign currency. this will result in careful consideration and detailed attention when computing the owner’s capital gain or loss on the disposal. capital gains tax consequences for the winner capital gains tax on gambling, games or competitions: if it is assumed that the winner did not take part in this lottery as a business or as part of a profit-making scheme, then the receipts will be capital in nature and therefore excluded from the winner’s ‘gross income’ (ostler 2013, and see also below for a more detailed discussion on capital nature and ‘gross income’). the capital receipt in this regard (value of the property) is significantly higher than the lot’s price. paragraph 60(1) of the eighth schedule applies to the winner of a gamble, game or competition when winning and provides that a person must disregard a capital gain or capital loss determined in respect of a disposal relating to any form of gambling, game or competition. the capital gain or loss, which is generally disregarded, would be calculated as the difference between the value of the prize and the cost of taking part in the gamble, game or competition. paragraph 60(2)(b) of the eighth schedule, however, provides that a capital gain may not be disregarded by any natural person, unless that form of gambling, game or competition is authorised by, and conducted in terms of, the laws of the republic. in essence, legal gambling, games or competitions in south africa do not give rise to a capital gain or a capital loss for the winner upon winning, but winnings from illegal or foreign gambling, games or competitions are subject to capital gains tax if there is a capital gain. the first question that arises is whether this lottery of the property is considered to be ‘any form of gambling, game or competition’. the sars comprehensive guide to capital gains tax (‘cgt guide’) (2015:452) indicates that paragraph 60 of the eighth schedule ‘encompasses all manner of activities such as horse racing, the national lottery, casino winnings and the like’. if it is assumed that this lottery is a form of gambling, game or competition, the second question is whether it is a form of gambling, game or competition that is authorised by, and conducted in terms of, the laws of the republic. in this case, the lottery is legal in austria and is administered and legally takes place in austria (qukula 2015), but it is not clear whether the lottery is also authorised by, and conducted in terms of, the laws of the republic. as stated earlier, the legality or lawfulness of such a lottery in south africa or whether it is allowed for south african citizens to take part as owners or buyers of lots in such a lottery falls beyond the scope of this article. however, kok (2009) points out that a similar raffle scenario could be considered as an illegal lottery in south africa. without concluding on this matter, it is submitted that the capital gain cannot be disregarded and that the winning of the property will be subject to capital gains tax should paragraph 60(2)(b) of the eighth schedule be applicable. this will give rise to a substantial capital gain in the hands of the winner, determined as the difference between the value of the prize (r5.7 million as the value of the property) and the cost of taking part in the gamble, game or competition (r1658 as the amount paid for a lot). base cost of the property: irrespective of the application of paragraph 60 of the eighth schedule, the base cost of the property for the winner should also be considered for purposes of a future disposal of the property by the winner. the question in this regard is whether the market value of the property (approximately r5.7 million) or the lot price paid (approximately r1658) will be regarded as the base cost for the winner. according to the provisions of paragraph 20 of the eighth schedule, dealing with the base cost of an asset, primarily the expenditure actually incurred in respect of the cost of acquisition or creation of that asset is considered to be the base cost. in this case, it would therefore be the amount of r1658 paid for the lot by the winner. if the winner bought more than one lot, the base cost would arguably be the total amount of all the lots purchased. this may result in a significant capital gain in the future (even if the winner bought more than one lot) as the base cost would be insignificant. paragraph 38(1)(b) of the eighth schedule provides, however, that the base cost of an asset is equal to the market value of the asset for the person who acquired the asset (i.e. for the winner) if (1) a person disposed of an asset by means of a donation or (2) for a consideration not measurable in money or (3) to a person who is a connected person in relation to that person for a consideration that does not reflect an arm’s length price. the first and third scenario should be considered in respect of the lottery transaction. it is submitted that the second scenario is not applicable as there is consideration that is measurable in money (the amount paid for the lot). as it is required in terms of the first scenario of paragraph 38(1)(b) of the eighth schedule that the person (the owner) must dispose of the asset by means of a donation, it could be argued that there is no donation by the owner to the winner as the owner gives up the property and receives the market value of the property in return. nothing is therefore donated from the owner’s point of view in respect of the property, and as such, the first scenario of paragraph 38(1)(b) of the eighth schedule is not applicable. alternatively, in terms of the third scenario, only if the winner is a connected person to the owner, and if it is argued that the transaction did not take place at arm’s length (if one takes into account the price of the lots compared to the value of the property) then the base cost for the winner will be the market value of the property when acquired. it is submitted that it will rarely be the case that the owner and the winner are related and therefore it seems that the base cost for the winner will be the lot price paid, which will result in significant capital gains tax consequences in the future should that person decide to dispose of the property. at the time of disposal, other inclusions in the base cost may be relevant, such as expenditure actually incurred in respect of improvements to the property (paragraph 20(1)(e) of the eighth schedule), but a detailed discussion thereof falls beyond the scope of this article. other income tax considerations other income tax considerations for the owner scheme of profit-making: south african courts have often drawn a distinction between the realisation of a capital asset and ‘selling an asset in the course of carrying on a business or embarking on a scheme for profit’ (natal estates ltd v secretary for inland revenue 37 satc 193:216, ‘the natal estates case’). amounts realised in terms of the former (i.e. when capital assets are realised) will be of a capital nature, with possible tax consequences in terms of the eighth schedule, while amounts realised in terms of a scheme of profit-making will be of an income nature, with a possible inclusion in ‘gross income’. it has been assumed above that the property was disposed of by the owner in terms of the lottery as a capital asset (for example, as the owner’s primary residence), and not as trading stock or as part of a scheme of profit-making. accordingly, there should be no inclusion in the owner’s ‘gross income’, as defined in section 1 of the income tax act, as ‘gross income’ excludes, with some exceptions known as the special inclusions, receipts or accruals of a capital nature. it should, however, briefly be considered whether the fact that the owner decides to dispose of the property by way of a lottery, instead of by way of an ordinary sale, could result in the owner moving over from the realisation of a capital asset to a scheme of profit-making, which could result in an inclusion in the owner’s ‘gross income’. in accordance with the terms of the lottery, the owner is only entitled to the market value of the property, which is in line with an ordinary realisation of a capital asset at market value (assuming that transactions ordinarily take place in an open market at arm’s length between a willing buyer and a willing seller). the owner did, however, acquire certain benefits in addition thereto, such as not being liable for estate agent commission. the question regarding whether the owner moved over to a scheme of profit-making is arguably even more relevant had the owner been entitled to the full proceeds from the sale of the lots, assuming that this amount could be substantially in excess of the market value of the property. there is no definition in the income tax act of ‘capital nature’. the most important factor to be considered when determining whether an amount is of a ‘capital nature’ is the taxpayer’s intention when acquiring, holding and disposing of the asset (de koker & williams 2001:§ 3.2). it is trite law that the intention of the owner with which an asset is held could change from holding the asset as a capital asset to the intention of profit-making when the asset is later disposed of. even if it is assumed that the property was initially acquired as a capital asset (for example, as the owner’s private residence), the question is whether the owner’s intention changed when embarking on the method of disposal of the property by way of a lottery. the realisation of a capital asset may be to the taxpayer’s best advantage, ‘however business like’ (the natal estates case:214), and even if the realisation required the taxpayer to undertake certain ‘operations’ (which could arguably include lottery operations), the proceeds can be of a capital nature (the natal estates case:217). the mere fact that a taxpayer realises an asset to his or her best advantage (for example, by way of a lottery rather than an ordinary sale) does not necessarily mean that the taxpayer embarked on a scheme of profit-making (elandsheuwel farming (edms) bpk v sekretaris van binnelandse inkomste 39 satc 163:182, ‘the elandsheuwel case’). despite this, ‘there are, however, limits to what a taxpayer may do in order to realise to best advantage’ (the elandsheuwel case:182). the question is whether such limits are transgressed when embarking on the method of realisation of the property by way of a lottery. while the taxpayer’s intention is the most important factor, such an intention must be aligned with the facts (de koker & williams 2001:§ 3.12). this requires that a number of objective factors must also be considered when it is determined whether an amount is of a capital nature (de koker & williams 2001:§ 3.12). even though the lottery might, for example, be a once-off transaction for the owner, it is established law that: it is not an essential requirement that a taxpayer be carrying on a trade or business in a particular type of asset in order for the proceeds derived from the sale of such an asset to be regarded as income. (de koker & williams 2001:§ 3.15) therefore, the fact that the lottery only happens once does not automatically classify the proceeds as being of a capital nature. the question is rather whether there was an intention or a motive of profit-making (de koker & williams 2001:§ 3.15). in essence, a determination of whether an amount received or accrued is of an income or a capital nature will depend on the facts and circumstances of each case. more information regarding the owner and the owner’s intention would be necessary to make such a determination. there is, however, a possibility that the commissioner considers the proceeds from the lottery (or at least part thereof, i.e. the market value of the property accruing to the owner as the terms of the lottery provide or had it been the full proceeds from the sale of the lots) to be of income nature in the hands of the owner. this will result in an inclusion in ‘gross income’, if the lottery operations are regarded as something more than just the realisation of a capital asset. this is arguably the case as setting up the lottery, administering the lottery, the draw of the winning lot, etc. could be regarded as something more than just disposing of a residence by way of an ordinary sale. the taxpayer would then have the onus of proof to show that the amount is of a capital nature (section 102 of the tax administration act 28 of 2011, ‘tax administration act’; cgt guide 2015:12). should the result be that the proceeds from the lottery are included in the owner’s ‘gross income’, it would also have to be considered whether any deductions can be made relating to such an inclusion, but a detailed discussion thereof falls beyond the scope of this article. savings and advantages for the owner: the owner embarks on the sale of the property by way of a lottery as it results in a number of savings and advantages, namely that the owner is not liable for estate agent commission, that the owner does not have to make the property available for viewings, that the owner does not have to consider any offers and that the sale will not be subject to conditions such as the buyer’s mortgage bond approval (tswanya 2015). it should be briefly considered whether any of these savings or advantages could result in any tax consequences in the hands of the owner. the saving of estate agent commission has an actual monetary value, while the values of the other advantages are not clear in monetary terms. the mere fact that the owner is not liable for estate agent commission is similar to a situation where a seller sells a property privately, in other words, without the assistance of an estate agent. the fact that no estate agent commission is payable, assuming that the proceeds from the sale of a property are of a capital nature, already results in the realisation of a larger capital gain or a smaller capital loss. this is due to the fact that estate agent commission can be added to the base cost of the asset as an amount actually incurred as expenditure directly related to the disposal of an asset in terms of paragraph 20(1)(c)(i) of the eighth schedule. a lower base cost (if estate agent commission is not added) results in a larger capital gain or a smaller capital loss. the question is whether such a saving of estate agent commission (which can be valued if a market related commission percentage is applied to the market value of the property, but which cannot be converted into money) could be taxable in the hands of the owner, for example as an amount accrued to the owner (i.e. ‘gross income’). in this regard, commissioner for south african revenue service v brummeria renaissance (pty) ltd 69 satc 205 (‘the brummeria case’) should be briefly considered. in this case, the taxpayers granted life rights to occupiers in a retirement village in exchange for interest-free loans from the occupiers. albeit the fact that the right to retain and use the loans interest-free could not be converted into money, the supreme court of appeal held that ‘the right to retain and use the borrowed funds without paying interest had a money value, and accordingly that the value of such right must be included in the companies’ gross incomes for the years in which such rights accrued to the companies’ (the brummeria case:212). it is, however, submitted that the brummeria case is not applicable to the benefit of saving estate agent commission for a number of reasons. firstly, in the brummeria case, there was a right to retain and use the funds interest-free. in the case of the owner saving estate agent commission, there is no right being applicable; it is rather a consequence of the transaction being structured in a particular way. further, in the brummeria case, a quid pro quo was given by the taxpayers in exchange for the right to retain and use the funds interest-free (namely the life rights granted to the occupiers). such a quid pro quo does not exist in the facts of the lottery as the owner gives nothing in return for the saving of estate agent commission. also, it could be argued that the benefit of saving estate agent commission is regarded as a receipt or accrual of a capital nature, which means that there will not be an inclusion in ‘gross income’. the other benefits referred to, in addition to the saving of estate agent commission, could equally apply in an ordinary sale of property, where the buyer is unable or does not want to view the property, if the first offer is made in line with the price being advertised and if there are no conditions such as the buyer’s mortgage bond approval. these benefits are not rights, cannot be converted into money and would further not have a monetary value as the valuation of these intangible benefits would not be possible or at best be highly speculative. these advantages or benefits from the sale of the property by way of a lottery accordingly do not give rise to any additional tax consequences in the hands of the owner, other than the consequential implications such as a larger capital gain or smaller capital loss as explained above. other income tax considerations for the winner from the winner’s point of view, it is clear that an amount is paid for the lot and that the property, worth substantially more, is received in return as a prize. the question in this regard is whether anything could fall within the winner’s ‘gross income’ relating to the prize. there is authority for proceeds of gambling, betting and lotteries being included in the ‘gross income’ of a taxpayer where the taxpayer conducts such activities regularly or systematically (de koker & williams 2001:§ 3.26). it is, however, assumed that the winner of the property does not partake in house lotteries regularly or systematically, but rather as a hobby or for entertainment and, as such, the value of the prize is not required to be included in the ‘gross income’ of the winner as it will be considered as being of a capital nature. see above for a discussion on the capital gains tax consequences for the winner. transfer duty consequences the main concerns regarding transfer duty in this specific transaction are the value on which transfer duty will be calculated and who will be liable for the transfer duty. the transfer duty act 40 of 1949 (‘the transfer duty act’) provides in section 2 that transfer duty is levied on inter alia the value of any property acquired by any person by way of a transaction or in any other manner. it should be considered whether the winner acquires ‘property’ by way of a ‘transaction’ (each of these terms being defined in section 1 of the transfer duty act) by winning the property and, if so, what the value of the property is for purposes of transfer duty. in respect of the latter, the value could be, for example, the amount paid for the lot, the market value of the property or the full proceeds realised from the sale of the lots. it is clear from the definition of ‘property’ in section 1 of the transfer duty act that the winner acquires ‘property’ as the latter means land in the republic and any fixtures thereon. further, the property is being acquired by way of a ‘transaction’ as this means an agreement whereby one party (being the owner) thereto agrees to otherwise dispose of property to another person (being the winner) (section 1 of the transfer duty act). acquisition is not defined in the transfer duty act, but its meaning has been settled by our courts as the acquisition of ‘the right to acquire the ownership of property’ (commissioner for inland revenue v freddies consolidated mines ltd 21 satc 132:138). in accordance with the terms of the lottery, the winner becomes entitled to the property once he or she accepts the prize. transfer is then effected, after which the winner becomes the owner of the property. by being the holder of the winning lot and by accepting the prize, the winner ‘acquires’ property as the winner acquires the right to acquire ownership of the property. it is, accordingly, clear that the requirements of the charging section for transfer duty are met. section 5 of the transfer duty act regulates the value on which transfer duty is payable. in terms of section 5(6) of the transfer duty act, the transfer duty payable shall be calculated on the highest of the consideration payable by the person who acquires the property, the declared value of the property or the fair value of the property. ordinarily, the consideration payable is used, and where no consideration is payable, the declared value is used (section 5(1)(a) and (b) of the transfer duty act). however, section 5(6) of the transfer duty act then grants the commissioner the power, if the commissioner is of opinion that the consideration payable or the declared value is less than the fair value of the property, to use the fair value of the property. these various values can further be analysed in terms of the lottery transaction as follows: the consideration payable by the winner who acquires the property is the purchase price of the lot (r1658), being a minimal amount compared to the actual market value of the property acquired. the ‘declared value’ is used where no consideration is payable and is defined in section 1 of the transfer duty act as ‘the value of the property as declared in the declaration completed in terms of section 14 of the transfer duty act by the person who has acquired the property’. according to the sars transfer duty guide, ‘declared value’ means ‘the ‘fair market value of the property as at the date of acquisition’ (south african revenue service: transfer duty guide 2016:52). it is submitted that the declared value will, however, not be applicable as there is consideration payable by the person who acquires the property, being the price of the lot paid by the winner. lastly, the ‘fair value’ of the property means ‘the fair market value of that property as at the date of acquisition thereof’ (section 1 of the transfer duty act). ‘fair market value’, which is not defined in the transfer duty act, is defined in section 1 of the tax administration act as ‘the price which could be obtained upon a sale of an asset between a willing buyer and a willing seller dealing at arm’s length in an open market’. this would be the value of r5.7 million. it is clear from the above that the fair value of the property (r5.7 million) will be higher than the consideration payable by the winner (r1658). section 6 of the transfer duty act, which requires that certain payments must be added to the consideration that is payable for the acquisition of property, should however be briefly considered. if one assumes that the price paid for the lot is the consideration payable for the acquisition of the property, it has to be considered whether section 6(1)(c) of the transfer duty act would, for example, require that the surplus (the portion in excess of the market value of the property which must be paid over to a charity after the deduction of certain costs) must be added to the consideration payable for purposes of the transfer duty calculation. in this regard, section 6(1)(c) of the transfer duty act requires that there must be added to the consideration payable: any consideration which the person who has acquired property has paid or agreed to pay to any person whatsoever in respect of or in connection with the acquisition of the property, over and above the consideration payable to the person from whom the property was acquired. it is submitted that neither of the provisions of section 6(1)(a) – (c) of the transfer duty act are, however, applicable as each of these provisions requires that an amount must be paid ‘by the person who acquired the property’. as the winner is not required to pay any amounts to, for example, the charity, these provisions are not applicable. the fair value of the property (r5.7 million) is thus the value on which transfer duty must be determined. the amount of transfer duty will be calculated in accordance with the rates set out in section 2(1)(b) of the transfer duty act. the rates are progressive and increase as the value or amount to which the rates are applied increases. based on the rates applicable from 01 march 2017 and on the market value of the property of r5.7 million, transfer duty would amount to r460 000. section 2 of the transfer duty act clearly places the liability for transfer duty on the winner as he or she is the person acquiring the property. in this regard, it is noted from the terms of the lottery that ‘all transfer costs and costs related to the transfer of the property will be covered by the owner via the lottery takings’. it is assumed that transfer duty will be included under ‘all transfer costs and costs related to the transfer of the property’. accordingly, it seems that these costs are paid from the surplus, that is, the excess of the proceeds realised from the sale of the lots after the owner has received the market value, which is eventually, after the costs have been paid, paid over to a charity. if the winner’s debt towards sars in respect of transfer duty is paid from the surplus, this could amount to a ‘donation’ (as defined in section 55 of the income tax act) to the winner which could be subject to donations tax at 20% (section 54 read with section 64 of the income tax act). a ‘donation’ is defined in section 54 of the income tax act as ‘any gratuitous disposal of property’. without concluding on whether there would be a ‘donation’ in this regard, this possible tax consideration serves as proof that the selected method of the disposal of the property by way of the lottery may have unintended or unplanned tax consequences for the parties involved. it is submitted that the brummeria case would, however, not be applicable to this benefit obtained by the winner (i.e. the benefit of not having to pay transfer duty for which the winner is liable, which benefit can be valued but which cannot be converted into money) for the same reasons outlined above in the discussion of the owner’s savings or advantages by disposing of the property by way of a lottery. even though the winner has a right to the benefit of not having to pay transfer duty in accordance with the terms of the lottery, there is no quid pro quo given by the winner in exchange for the right. donations tax considerations and consequences a possible donations tax consequence has already been highlighted above in respect of the transfer duty being paid on behalf of the winner from the surplus. two further possible donations could exist. firstly, due to the fact that the price paid for the lot by the winner is much lower than the value of the property received in return by the winner, the question arises as to whether the transaction (disposing of the property through a lottery) amounts to a ‘donation’. secondly, the donation to a charity should be considered in respect of the surplus (i.e. the difference between the market value of the property to which the owner is entitled and the total value of the lots sold, which will be donated to a charity, after promotional and other costs are deducted). section 55 of the income tax act defines a ‘donation’ as ‘any gratuitous disposal of property including any gratuitous waiver or renunciation of a right’. therefore, the meaning of ‘gratuitous’ is important to define a ‘donation’. de koker and williams (2001:§ 23.3) state that if the disposed item is ‘given for nothing, without charge, free’, then the disposition is seen as gratuitous. it is noted above that there is no donation made by the owner as the owner disposes of the property but receives the market value of the property in return. nothing is thus donated from the owner’s point of view in respect of the property as there is no ‘gratuitous disposal’. therefore, although from the winner’s point of view it seems like a donation exists, as the property worth substantially more than the lot price is received in return, no donation is made by the owner and the lottery transaction as a whole is not a ‘donation’ by the owner to the winner. the surplus given to a charity is clearly a ‘donation’ in terms of section 55 of the income tax act. it is assumed that the charity to whom the donation is made is an approved public benefit organisation, which means that the donation will be exempt from donations tax in terms of section 56(1)(h) of the income tax act and no donations tax will be payable. as mentioned above, it is not clear from the available terms and conditions who the donor of this donation to the charity is. it is, however, assumed that the donor is not the owner as the owner is only entitled to the market value of the property. it may be noted that donations tax is only applicable in terms of section 54 of the income tax act if the donation is made by a ‘resident’ as defined in section 1. as such, considering the exemption from donations tax in terms of section 56(1)(h) may be irrelevant if the donor is not a ‘resident’. conclusion the research objective of this article is to explore some of the most pertinent south african tax consequences of the disposal and acquisition of a residential property by way of a lottery, as no such research currently exists, and no specific guidance is available in this regard to determine the south african tax consequences of such a transaction. it has been set out above that a transaction as such results in a number of actual tax consequences for the owner and the winner, while a number of uncertainties were also identified (referred to above as ‘considerations’). it was determined that the lottery transaction can create potential tax risks or can result in unintended tax consequences, relating to inter alia income tax (including capital gains tax), transfer duty and donations tax for the owner and the winner. should a person consider disposing of property by way of a lottery (i.e. from the owner’s point of view), it should be carefully considered whether the tax consequences that arise as a result of the disposal being structured as a lottery, in addition to the tax consequences had the disposal being structured as, for example, an ordinary sale, still make the transaction as attractive and beneficial as it appears to be. the benefits for the owner by disposing of the property by way of a lottery may be outweighed by the possible additional tax liability (should the transaction, for example, be regarded as a scheme of profit-making, resulting in an inclusion in the owner’s ‘gross income’) and other unintended tax consequences. should a person buy a lot and be the winner of the property (i.e. from the winner’s point of view), the transaction may result in immediate and significant tax consequences (for example, should paragraph 60 of the eighth schedule be applicable). if the winner is not able to settle a possible tax liability as such, he or she may be necessitated to sell the property which, as a disposal of an asset is also identified as a significant tax consequence. as mentioned above, the scope of this article is limited, and a number of assumptions were made. the tax consequences and considerations that are explored above could not be addressed comprehensively and in depth in this article. in this regard, areas for further research are identified, which include: determine if the lottery or participation therein is illegal or unlawful in south africa and the tax consequences, if any, should the lottery or participation therein be illegal or unlawful in south africa. determine the time of disposal for the owner in terms of paragraph 13 of the eighth schedule. consider the tax consequences if the amount in excess of the market value of the property also accrues to the owner. determine the implications, if any, of paragraph 20(1)(c)(vii), read together with paragraph 22, of the eighth schedule in terms of which a portion of donations tax payable is included in the base cost of an asset in the case of a disposal of an asset by a person (the owner) by way of a donation. this becomes relevant should the ‘disposal’ by the owner be classified as a donation in terms of paragraph 11 of the eighth schedule. should the result be that the proceeds from the lottery are included in the owner’s ‘gross income’, determine whether any deductions can be made relating to such an inclusion. consider the exchange control consequences of the transaction as it was administered in austria. should residential property lottery transactions occur more frequently in south africa in future, it is recommended that the sars issues clear guidance on the tax treatment from the perspective of the owner and the winner of such a transaction to ensure that any uncertainties are dealt with correctly. acknowledgements competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions both, s.d.l. and d.v.w. the authors have contributed equally to the writing of this article. references brown, r.b., 2006, doing your dissertation in business and management: the reality of research and writing, sage, london. commissioner for inland revenue v freddies consolidated mines ltd 1957 21 satc 132. commissioner for south african revenue service v brummeria renaissance (pty) ltd 2007 69 satc 205. de koker, a.p. & williams, r.c., 2001, silke on south african income tax, electronic edition updated april 2017, lexisnexis, viewed 03 october 2017, from http://www.mylexisnexis.co.za.ez.sun.ac.za/index.aspx elandsheuwel farming (edms) bpk v sekretaris van binnelandse inkomste 1978 39 satc 163. geldenhuys v commissioner for inland revenue 1947 14 satc 419. hutchinson, t. & duncan, n., 2012, ‘defining and describing what we do: doctrinal legal research’, deakin law review 17(1), 83–119. https://doi.org/10.21153/dlr2012vol17no1art70 kok, l., 2009, 2010 villa raffle: scam or 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of south africa, south african revenue service, 2015, comprehensive guide to capital gains tax (issue 5), sars, pretoria. republic of south africa, south african revenue service, 2016, transfer duty guide, sars, pretoria. singh, k., 2007, quantitative social research methods, sage, london. tswanya, y., 2015, upmarket home up for grabs in lottery, viewed 31 october 2016, from http://www.iol.co.za/news/south-africa/western-cape/upmarket-home-up-for-grabs-in-lottery-1892419 united kingdom law society, 2011, house competitions, viewed 28 june 2017, from https://www.lawsociety.org.uk/support-services/advice/practice-notes/house-competitions/ val de vie, viewed 12 december 2016, from http://www.valdevie.co.za/aboutus/our-history.html journal 2.p65 ������������ ��� ����� ��� ��������������� ����� ������� �� ������ ����������� � ������ ������ �� ��� ��������� ��� ����� ������� �������� � ���� ������� ����� ���������� ����������� � ����� � � �������� �������� ���� � �������������������������� 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f!����1 ��� +� $���"�� �� %���� ���1������8���)��0����(�� �:���� . 8�"1������� ��� ���7����������)�����h��) �������)0��'����2������&�*(�)= ����0�>> 2���:���� ��4 ������))�'��a�/(*5�� +� microsoft word 9 griffin-el sajems 17(3) 2014.docx sajems ns 17 (2014) no 3:349-362 349 network diversity structure, closeness and innovation of south african micro-entrepreneurs eliada griffin-el graduate school of business, university of cape town accepted: january 2014 this study qualitatively explores the embeddedness of the innovation process of south african microbusinesses by investigating how small local entrepreneurs in the greater johannesburg area utilise their social networks to source entrepreneurial value. a comparative grounded theory analysis enabled the original conceptualisation of network diversity structure and formulates the central proposition that the network dimensions of diversity and closeness enable the innovation process among manufacturing microbusinesses more so than in service microbusinesses. furthermore, the study proposes that both a structural and relational/experiential dimension of closeness, enables micro-entrepreneurs to create meaning and knowledge collaboratively with other entrepreneurs and actors. this socially facilitated process of exchanging ideas, information, and resources is central to the innovation process of firms traditionally limited by both their size and historical social institutions. key words: social networks; micro-entrepreneurship; social embeddedness; innovation jel: d85, j15, l26, m13 1 introduction micro-sized but formally registered businesses of the south african entrepreneurial landscape occupy a particular place on the country’s development agenda. as micro-enterprises, they face the well-known challenges of achieving scale and productivity levels; yet, as formally registered businesses, they serve as a bridge between the central and peripheral markets that both constitute the south african economy. with their failure rates presumed to be high, yet their success presumed to be important, understanding how they facilitate their entrepreneurial process while having limited capacity becomes a question of both intrigue and development implications for economic inclusivity. the purpose of this study is to explore the structural embeddedness of south african microbusinesses – and to better understand how they have engaged with the social relationships in which they are embedded in order to advance and support their entrepreneurial activity. this study is driven by the initial open-ended research question, “is there value in microbusinesses’ relationships that enable them to entrepreneurially function – and even excel beyond their resource and capacity constraints?’ inspired by assumptions of the economic sociological literature, the analysis attempts to visually depict the shape of their ego-centric networks, in order to convey the perceptual distance or closeness that they bear with various entities. additionally, the study provides a conceptualisation of the diversity relational types and entrepreneurial value they contribute. conducted as a comparative grounded theory analysis, data was collected via the indepth interviews of 30 formally registered microbusinesses of black south african entrepreneurs from the (clothing) manufacturing (set i) and service sectors (set ii). the study took place in greater johannesburg in partnership with the business place. all firms included/ involved? employed 10 or less employees. as suggested by findings of the qualitative analysis, the study presents the central proposition that the innovation process involved in a microbusiness’s value chain is facilitated by a high degree of closeness with a diverse set of relationships. microenterprises in the abstract 350 sajems ns 17 (2014) no 3:349-362 clothing manufacturing sector appear to have a higher degree of closeness with a diverse array of actors, which enables them to undergo an interaction-oriented innovation process as a key part of their entrepreneurial process. the data did not present similar evidence to suggest the service microenterprises’ networks support the same phenomenon. moreover, the data emphasises the relational nature of the innovation processes in design and production by engaging in a collaborative creation process with similar and different microbusinesses. hence relationships with these individuals tend to be highly valued and enacted frequently, facilitating a closeness. network diversity structure (nds), an original core concept of the emergent theoretical framework, refers to the degree of closeness, diversity, and number of relationship types that constitutes the structural shape of ties. as in the grounded theory tradition, the discussion explores how the findings are supported by and contribute to the literature on networks and innovation. 2 review of the literature social embeddedness and social capital literature suggest that relations, interactions, and norms inform economic behavior that shapes the market. in turn, entrepreneurs influence and are influenced by their engagement with the broader society within which they are embedded (granovetter, 1985; giddens, 1986; woolcock, 1998; grootaert, narayan, jones, & woolcock, 2003; dobbin, 2004; urban, 2011). at the core is the assumption that an economic actor makes his or her decisions resulting from a negotiation of their personal utility and the information and norms they draw from their engagement with others (granovetter, 1985). the social embeddedness perspective moves away from the individualor organisational-centered outlook of entrepreneurship and provides a view by which to examine entrepreneurs in respect to their relational context (portes & sensenbrenner, 1993; portes, 1998). network studies particularly examine “the structure of the relations between social actors and how patterns in those relations influence a variety of outcomes,” (stuart & sorenson, 2005:233). also referred to as a structural analysis, network studies assist in unveiling the restrictions and opportunities that an actor inherits as a result of the relationships they are embedded within (garcia, 2006). hoang and antoncic (2003) acknowledge the need for theory building that captures the nexus between outcomeand process-oriented studies. this speaks to the dynamism of networks and their ability to support a small firm’s evolving needs (hite & hesterly, 2001). it is in this gap of networks’ role in the entrepreneurial process that this study hopes to contribute. this study draws from social capital literature’s broad distinctions across relationship types. horizontal relationships – or bonds and bridges loosely describe relationships between entities from close, familial settings and similar characteristics and relationships between parties of different circles or communities, respectively (gittell & vidal, 1998; woolcock & narayan, 2000). vertical relationships, termed as linkages, refer to relationships between entities and institutions (woolcock, 1998, 2002). bonds, bridges, and linkages will provide the conceptual language and theoretical reference point of the idea of diversity in networks. apart from the entrepreneurial process, the empirical arm of the literature tends to focus on the characteristics influencing, resources gained from, or the composition of the network structure. attributes such as culture (greve & salaff, 2003; klyver, hindle, & meyer, 2008), economic sector (spence, schmidpeter, & habisch, 2003), and business phase (klyver et al., 2008) of entrepreneurs have been featured. size (barr, 1995; 2002); global exposure (mcdade & spring, 2005); gender (kuada, 2009; rutashobya, allan, & nilsson, 2009); one’s ‘identity landscape’ (pingle, 2001); and ethnicity (bruce, 2003) are also highlighted entrepreneurial attributes that lend to network structural variation. broader environmental factors – such as the degree of regional development (garcia, 2006) or economic liberalisation (meagher, 2006) – have also been recognised as a contributing variable. resourcebased network studies highlight network gains – such as knowledge acquisition and production capacities (yli-renko, autio, & sapienza, 2001); security (barr, 1995, 2002); and innovation aspects (barr, 1995, 1002; sajems ns 17 (2014) no 3:349-362 351 bakker, oerlemans, & pretorius, 2008). social arrangements such as familial ties (luo, 1997; fafchamps & minten, 2002); sub-contracting ties (luo, 1997); home-based networks (zhou, wu, & luo, 2007); and extra-, inter-, and intra-firm linkages (yeung, 1997) describe the network composition that even enable a small firm’s adjustment to global changes (chen, 2009; lu & beamish, 2001; yeung, 1997; zhou et al., 2007). although the literature appears to be growing, there is still much more to learn about how network structure facilitates the entrepreneurial processparticularly with small, emerging firms within african economies which are increasingly opening and connecting to a global economy (naude & havenga, 2005). studying the formally registered microbusiness community within the backdrop of a dynamic emerging economy such as south africa bears its own distinct significance (human, 2009). the relational structures of such firms embody both formal and informal ties that span the formal and peripheral economies. hence, an inductive, exploratory approach is applied in order to grasp the network characteristics that are embedded within diverse economic domains. 3 methodology 3.1 grounded theory analysis data was analysed using the grounded theory methodology. entrepreneurial research in general, as makela and turcan (2007) suggest, has room to be enriched by the capturing of nuanced factors. grounded theory analysis, like most qualitative analyses, guides the investigator towards identifying abstract themes from the raw data. grounded theory’s distinguishing objective is to derive an original ‘theory’ from the data which conceptually captures the intrinsic process of the phenomenon being studied (glaser & strauss, 1967). beyond the initial phase of thematic coding, analysis also entails a constant comparison and categorisation of codes to gradually reveal the main concepts of the emerging theory. upon reaching theoretical saturation, the central conceptual category is identified to which all other conceptual categories relate to build an explicatory narrative of the phenomenon. propositions can be formed to be tested in future studies. (glaser & strauss, 1967; strauss & corbin, 1990). 3.2 research participants data was collected in june to august of 2008 via in-depth, open-ended interviews with thirty micro-sized south african firms. the sample was constructed via random selection of willing, available firms from the business place opportunity exchange database, the johannesburg fashion week listings, and to a lesser extent, the snow-balling method via referrals. ‘micro’ in this study is defined as firms hiring ten or less full-time employees. all the businesses were formally registered in south africa and all the entrepreneurs were black south africans. approximately 47 per cent of the subjects interviewed hired at least one employee and 30 per cent spoke to having at least one business partner. the median age of the business organisations was three years, ranging from a minimum of 4 months to a maximum of 12 years. more than 50 per cent of the entrepreneurs themselves fell within the ages of 25 and 30, the youngest being 21 and the oldest more than 50. 47 per cent of entrepreneurs operated their businesses from the central business district of johannesburg. the remaining were based in the broader johannesburg metropolitan area consisting of the surrounding townships, suburbs, and towns – such as soweto, vosloorus, benoni, alberton, and vereeninging in the vaal. the broad spectrum of enterprises of various ages that are featured in the study hold the commonality of being microenterprises. in this study, their small scale is primarily measured in terms of employment, where all firms have ten or less employees. the broad spectrum allows for the analysis to identify patterns common across the relational structure of micro-enterprises, despite the duration of time that have been in operation. in this manner, the variable of size is kept constant. extended analysis, as well as literature, does suggest that the structure of networks for even small-scale enterprises varies by the age of the firm. nonetheless, considered beyond the 352 sajems ns 17 (2014) no 3:349-362 scope of this study, the analysis focuses upon cross-cutting network trends across microfirms of all ages for this phase of the analysis. of all the subjects interviewed, data from twenty-four firms was analysed. exactly half of the set are from the clothing/fashion manufacturing industry. the other 50 per cent was comprised of firms from the service industries five construction firms, four media and publicity firms, and three health and beauty enterprises. firms which were selflabeled ‘construction firms’ mostly provided services of customised renovation and design services to both private and public property. such work is categorised under ‘specialised consumer discretionary services,’ according to the standard and poor’s global industry classification standard, and hence, was noted as ‘services’ in this study (2008). most interviews were held either on the first floor of the business place headquarters in johannesburg cbd, while others were conducted at the location of the business or an alternative location chosen by the entrepreneur. 3.3 data collection the interview instrument used for this study was a revised version of abigail barr’s original entrepreneurial network diversity questionnaire used for her study of the ghanaian manufacturing industry in accra, ghana (1995). south african entrepreneurs were asked of their relationship with eight entities – 1) similar entrepreneurs; 2) different entrepreneurs; 3) entrepreneurs in other south african provinces; 4) entrepreneurs in other countries; 5) immigrant entrepreneurs; 6) larger businesses; 7) government; and 8) financial institutions. the following five questions were asked about the relationship with each of the aforementioned entities: a how many people do you know in this particular group? b is this (are these) relationship valuable to your business? if so, how? c how often do you communicate with contacts in this group? d when did you meet the first contact in this group? e how did you meet them? as a key initiating question, i asked the entrepreneurs to ‘tell their story.’ this ‘story telling’ provided a richness of data that largely illustrated the process of their development, the relationships along their journey, and an elaboration of the subject’s context through their own voice. 4 data analysis 4.1 diversity of relationships: bonds, bridges, and linkages in alignment with the literature, and for the sake of simplification, the diversity of relationships is loosely categorised as bonds, bridges, and linkages. although entrepreneurs were asked about their relationships with eight types of entities, qualitative data unveiled that entrepreneurs interacted with each type of entity in multiple ways. hence, 16 distinct bond, bridge, and linkage relationships were derived from the data, each bearing their own functionality and contributing their unique value to the entrepreneur’s experience. this differentiation was useful in dispelling the monolithic perception of broadly labeled groups, such as ‘different types of entrepreneurs’ or ‘government.’ since listing the specifics of all 16 relationships is beyond the scope of this paper, the structural depiction of their network will simply convey this diversity in terms of bonds, bridges, and linkages, providing details of the most prominent relationships. each relational type is differentiated by the node’s geometric shape. 4.2 network diversity structure the concept of network diversity structure (nds) refers to the structural arrangement of the diverse relationships within the small entrepreneurs’ networks. nds in this study was comprised of three defining properties, as derived from the data: 4.2.1 the diversity of relationships. the primary conceptual identities of – and the sub relationships within the categories of different bonds, bridges, and linkages derived from the data via the coding analysis. sajems ns 17 (2014) no 3:349-362 353 4.2.2 the relative number of relationships for every type. dimensions of this property (i.e. many, some, few, and none) were assigned a summative scale (i.e. 3,2,1,0 respectively) as well as geometric shapes of consecutive size order in order to visually depict a scale of group size. in other words, a large number of contacts were depicted by geometrically-shaped nodes of a corresponding size. 4.2.3 the relative closeness of the ties to the entrepreneur in the network. the conceptual property of ‘the closeness of ties,’ is measured here by how often they communicate and how valuable the relationship is to their business. closeness refers to the distance of a relationship to the entrepreneur based upon 1) how much he or she values the relationship, and 2) how much time is spent with the entity. to visually convey the close relationships in a network, the indicator combines (by averaging) both the relationship properties of value and frequency. a summative scale is assigned to the dimensions of each of the properties so as to calculate the average. the calculated average of the value and frequency dimensions corresponds with different spheres of the entrepreneur’s network (see figures 1 and 2), which are also assigned a summative scale. the study proposes, as suggested by the data, that the less the value and/or the lower the frequency of communication, the farther the relationship. visually, a less close relationship is conveyed by greater distance – or a longer line – between the central entrepreneur (the white circle in the middle) and the contact. the data does not sufficiently suggest that either the value or frequency variable influences entrepreneurial development more than the other, and hence, are weighed the same. nonetheless, this aspect is worthy of further examination in future studies. the nds diagrams for both clothing manufacturing (entrepreneur set i) and service entrepreneurs (entrepreneur set ii) is conveyed in figure 1 and 2, respectively. figure 1 network diversity structure of entrepreneurship set i property: number many – 3 some – 2 few – 1 or none 0 property: value very valuable – 1 valuable – 2 somewhat valuable – 3 not valuable 4 property: frequency very often – 1 often – 2 sometimes – 3 rarely 4 not at all 5 network diversity structure of entrepreneur set i legend bonds bridges linkages 354 sajems ns 17 (2014) no 3:349-362 figure 2 network diversity structure for entrepreneurship set ii the nds for each set of entrepreneurs reveals a visible contrast in closeness of their most prominent relationships. similarly, both network structures also reveal comparable farness of the same relationships. the following section will compare the structure of both networks in its most obvious differences. subsequent parts of the discussion will then highlight the identity of the innermost cluster of relationships depicted in both networks in order to further unveil the nature of diversity and the process to which they contribute value. 4.3 exploring the conceptual closeness of south african microbusiness’ networks the contrast between the structural depictions of the networks portrays an obvious difference in the general distance of relationships from the central entrepreneur. as made clear by the contrast in the images, the obvious difference between both network diagrams is that of the closeness of the relationships to the central actor, and inversely, the farness of the relationships visually residing in the outer rings of the depictions. it is to be noted, that this study conceptualises closeness derived from qualitative data and analysis. conceptually, based upon the data, a relationship that is close to the entrepreneur is that with which the entrepreneur engages and communicates frequently as well as values highly in regards to their business. in turn, relationships that are less close are those, which at the time, were not perceived as valuable to the business and with which communication was seldom. the network depictions are star-shaped, ego centric formulations. the qualitative coding of closeness is structurally conveyed in the location of the node on the diagram. the closeness coding of each entrepreneur-within each set was then aggregated to inform where the node should be placed on the diagram. ties drawn from the nodes to the central entrepreneur portrayed the visual distance of each relationship. this inner ring hosts the relationships considered very valuable and communicated with very frequently. the ‘inner-most’ circle reveal the most obvious contrast between property: number many – 3 some – 2 few – 1 or none 0 property: value very valuable – 1 valuable – 2 somewhat valuable – 3 not valuable 4 property: frequency very often – 1 often – 2 sometimes – 3 rarely 4 not at all 5 network diversity structure of entrepreneur set ii legend bonds bridges linkages sajems ns 17 (2014) no 3:349-362 355 depictions. the network of entrepreneur set i shows the innermost circle to be occupied with multiple types of relationships as well as a large number of each. in fact, the bulk of relationships within this network reside within the first and second concentric circle. in contrast no nodes relationally reside within the ‘inner-most’ circle of the of entrepreneur set ii. the closest relationships border on the second and third concentric circles from the center. with the first set of entrepreneurs, a variety of bond and bridge relationships constitute the close hub of their network within which the central entrepreneur is situated. the coding of data regarding relationships with similar entrepreneurs revealed two distinct relationships depicted by circular-shaped nodes. they were labeled as peer bonds and mentor bonds. the shortness of their distance from the central entrepreneur suggests that clothing entrepreneurs appeared to frequently communication with entrepreneurs of the same industry. peer bonds refer to those relationships with similarly small firms in the fashion industry. the relatively large visual conveyance of peer bonds suggests that clothing entrepreneurs have many relationships with other clothing entrepreneurs. frequent and casual interaction with peer bonds would offer the pleasant and inspiring exchange of ideas for fashion innovation. data confirmed this as the microbusinesses interviewed attested to constant engagement in both formal (i.e. fashion shows) and informal settings (i.e. shared studio or workspaces). charged by personal exchanges ranging from prevailing ideas of youth identity, politics, and global trends to the sharing of newly-founded sources for materials or exhibit shows, peer bonds provided a space where emerging entrepreneurs’ dreams and creativity could be shared. in these relationships clothing entrepreneurs would experience the artistic freedom to explore all boundaries of design with their peers– regarding which combination of colors and fabrics alongside the controversial formulation of collective symbolism and meaning creation that would shape garments that speak to south africa’s dynamic marketplace. peer bonds were most valuable when they were constructive and trustworthy, as some entrepreneurs also acknowledged a competitive spirit and information hoarding behavior that would occasionally manifest between entrepreneurs of the fashion industry. mentor bonds described ties with more advanced fashion designers. entrepreneurs would often attest to holding apprenticeships in the studios of established designers during the early stages of their career. in this relationship, they spoke to gaining invaluable knowledge in the technical and artistic skill of the garment creation process as they contributed directly to the value chain of innovation and production in their mentor’s shop. furthermore, they would gain insights in how to run the business side of the clothing manufacturing sector. the initial stages of the apprenticeship would entail small contributions of design and assembly from the young entrepreneurs. as they would mature in their development, their responsibilities within the shop would increase, from overseeing components of the design process to producing whole fashion lines or managing the general business activity of the organisation. square-shaped nodes in the network structure depict bridging relationships, or those that connect the central entrepreneur to groups that have dissimilar attributes. several relationship types with a bridging quality were coded from the data regarding entrepreneurs of dissimilar industries and immigrant entrepreneurs. the data revealed a relational type labeled communal bridges those relationships exhibiting such visible closeness to the central entre-preneur, often in the arrangement of a close-knit circle of high trust and familiarity. the high frequency of interaction that these relationships offered were often enabled by the close physical proximity between entrepreneurs. entrepreneurs would describe the buzzing and gregarious environment of work and friendship formed within buildings that have several studios and workspaces belonging to small enterprises from different fields or the opening of an entrepreneur’s shop to others within which a communal space of co-creating, exchange, and relating in life and passion was made. hence, through these enjoyable exchanges, relationships would grow and people valued each beyond the potential contribution they could offer to one’s business growth alone. such an atmosphere of trust and 356 sajems ns 17 (2014) no 3:349-362 respect served to forming business partnerships in launching new, unprecedented initiatives. in this regard the growing entrepreneur is becoming more privy to the opportunities of innovation and collaboration that exists with working alongside the likes of entrepreneurs from all angles of artistic expression as well as those in sectors such as transportation, catering, and event planning. the culture of treating each other as ‘family’ built the expectation of freely sharing information and sharing creative ideas with one another without fear of duplication. a supportive and more secure environment augmented through the familial atmosphere cultivated the assurance that one’s innovations and originality would be respected. the environment also encourages increased sense of world awareness. when asked to describe their relationship with immigrant entrepreneurs (interpreted as nationals from other african countries), clothing entrepreneurs consistently referred to a process of consulting immigrant entrepreneurs for production assistance or a specialised skill. they referred to this process as ‘outsourcing.’ such insight led to the conceptualisation of the outsource bridge. as apparent in the network diagram, the outsource bridge also holds close ties to entrepreneurs of the first set, and in sizeable number. often, clothing entrepreneurs from other countries have specialised skills such as embroidery, buttoning, or cloth painting which are common in their respective countries’ clothing and fashion industry. additionally, they often possess specialised machinery – such as an embroidery machine. furthermore clothing microbusinesses experience a surplus of demand which their production capacity cannot bear alone, risking poor workmanship, late delivery, and the loss of clientele. in both these circumstances, south african clothing entrepreneurs would seek the services of immigrant entrepreneurs. immigrant entrepreneurs gradually play an essential role in the communal bridging process as they contribute to a culture of a receptive, open, and diverse exchange. hence, the value of their ties is drawn from the mutual assistance and sense of security naturally fostered by these intimate business relationships. participating in the hub of information by which entrepreneurs access less expensive supplies and other artisans with specialised skill, they represent another relationally driven resource. such relationships are particularly operationally valuable as they would relieve the small entrepreneur’s burden of performing all the work ‘in house’ as well as enabling the high level production without bearing the legal implications and financial obligations of hiring workers for which they may not have the capacity. collaborative bridges, a relationship represented by another square-shaped node of high closeness to the central entrepreneur, refers to the ties between entrepreneurs who would take on business opportunities in the form of combined production assets and joint agreements. in contrast to communal bridges, as the data suggest, collaborative bridges are based more upon the project and appear to be much less intimate. they were not apt to be described in terms of friendships and family as communal bridges were. rather, they appeared to strictly serve an income-generating purpose – increasing capacity for joint agreement so as to increase productivity or to provide means of expansion or diversification for the small clothing enterprise. hence the primary value of collaborative bridges with entrepreneurs of a different line of business is related to increased productivity. by combining resources and production capacities, small businesses are able to provide for markets of greater demand and compete at levels at which, by themselves, they would be less able. small businesses continue to acquire knowledge of new trends and techniques as they begin to engage with these new market opportunities. furthermore, via this collaboration, small businesses acquire means by which to engage with potential partners and gain access to unfamiliar markets and new business activities. on the other hand, the general nds of service entrepreneurs depicts a relatively smaller network, in terms of the numbers and diversity of relationships, and a looser network, where relationships qualitatively conveyed a farther distance from the central entrepreneur. in sharp contrast to the network of clothing entrepreneurs, the bulk of relationships which constitute the inner-circle of closely positioned ties did not exist within the service entresajems ns 17 (2014) no 3:349-362 357 preneurial nds. service entrepreneurs made nearly no reference, for example, to the need and/or recognition of high trust, close knit entrepreneurial spaces within which small firms of different industries engage in a collaborative creation process, as depicted in the communal bridges within clothing entrepreneurs’ networks. rather, the data conveyed that service entrepreneurs appear to work largely independently, and source support from each other on a need-basis. the qualitative relational dimension of entrepreneurial engage ment that appeared to be of such high value to clothing entrepreneurs did not emerge in the data of service entrepreneurs. outsource bridges also a highly prominent tie of the clothing entrepreneurs’ nds – appeared not to be as evident among service entrepreneurs’ networks. data presented little evidence that a close relationship between service entrepreneurs and immigrant entrepreneurs in terms of shared production was a common occurrence. the occasional mentioning of immigrant entrepreneurs suggested relationships on a friendly basis, but very little on productionor capacity-building value. outsourcing as a general practice was not frequently mentioned among service microbusinesses to substantiate a conceptual relationship, although some entrepreneurs did mention the occasional hiring of freelance work to carry a project on to completion. 4.4 network diversity structure of service entrepreneurs (set ii) so then, what did the structure of network diversity among service entrepreneurs convey? from first glance, the obvious distinction is that the network diagram depicts nodes to be structurally farther from the central entrepreneur in set ii than in set i. nonetheless, relationships which were positioned the closest – and hence valued highly and communicated with frequently were those with larger entities and institutions, namely government and larger corporations. this observation is an intriguing contrast to clothing entrepreneurs, where the closest relationships were with similarly sized firms of the same or different industry. the data conveyed that these particular ties for service entrepreneurs mostly take place in the form of sub-contracting. the triangularshaped nodes represent a tie with an institution. a linkage with governmental institutions that is of particular closeness to service entrepreneurs was coded the public agency linkage. this tie represents a connection with a government agency, often times facilitated through the awarding of tenders. service entrepreneurs also spoke of how they sought to be placed on government databases so as to be consulted in time of needed services that they may provide. similarly, corporate client bridges represented relationships with larger businesses where the microbusiness was hired to provide a precise service towards the company’s overall value chain. both ties were deemed as highly valued ties because they provide a small firm with the opportunities to become part of larger production chain hosted by a bigger organisation, and hence, an entrance into the industry. additionally, public incubator linkages – government-related or funded business development services, also represent one of the closer positioned nodes as service firms affirmed their high valued provision of skills and training to increase the effectiveness of their firms. relationships such as the corporate client bridge or public agency linkage held a position of moderate closeness within the network structure of the clothing entrepreneurs. only those fashion entrepreneurs who had the capacity to manage voluminous orders considered doing business with larger firms as a positive contribution to their businesses’ growth. hence, the ability of small clothing firms to engage in contractual agreements as suppliers of mass-produced garment goods to corporate clients appeared to be a function of business capability and maturity. the same is the case with ties with government agencies. unlike service entrepreneurs, only a few clothing entrepreneurs perceived public agency linkages – relationships in which clothing entrepreneurs were suppliers to government agencies – as valuable, suggesting clothing entrepreneurs formed these relationships under certain conditions or at a particular time in the development of their capabilities. instead, the closer links that clothing entrepreneurs had with government were more in the form of personal ties, codes as public official linkages. 358 sajems ns 17 (2014) no 3:349-362 public official linkages refer to a relationship whereas individual government officials and their affiliates (i.e. spouse, friends) are direct purchasers – and hence, provide useful input towards the development of the designer’s creation. comparatively, financial linkages and global bridges appear to be relationships of least closeness for both entrepreneurial groups. although both groups of entrepreneurs expressed their desire to connect to parties overseas – to whom they could distribute their goods or extend their services – and to secure financing from banks, the reality held that to maintain either relationship was difficult. having few acquaintances in other countries – and not having consistent access to internet – served as two critical reasons for the low value and communication infrequency of global bridges. the unproven viability of most entrepreneurs interviewed appeared to be a deterrence to securing formal financial credit. 5 discussion and conclusion the analysis has revealed a nuanced conceptualisation of relationships beyond the simplification of bonds, bridges, and linkages in order to capture the contextual features within which the innovation process is embedded. clothing microbusinesses frequently communicate with a combination of ties across similar and dissimilar entrepreneurs. within this exchange is a reiterative process of sharing ideas and inspiration towards the creation of the product. further, data described an innovation process that goes beyond the conceptualisation of design. the synergistic combining of resources and capacities also lend to the innovation of mutually beneficial processes by which small firms can achieve the multiple goals of producing high quality, niche products that meet a burgeoning demand beyond their individual capacities. as a result, participating entrepreneurs in the innovation process would collaboratively secure a revenue stream from which both draw income. these ties of the ‘inner circle’ would vary in their relational closeness, and range in perception as ‘friends and family’ to the collegial but more product-driven partnerships. either way, these distinct attributes of the clothing entrepreneur constituted a dynamic innovation process supported by the closeness of these diverse relationships. on the other hand, data from entrepreneurs in the service sector does not speak of this on-going engagement of collaborative creation. their network structure qualitatively – and hence visually appears to be more dispersed. their ‘closest’ ties were those with institutions and larger organisations. even in these relationships, the coded data revealed only a moderate frequency of interaction and very little on co-creation or collaboration. arguably, the innovation process may be hampered by the established bureaucracy of such organisations that allow limited space for bargaining, negotiating, or creating meaning of multiple sources of knowledge and experience. consequentially, such ties provide the great value in presenting opportunities of entering the industry by which a small enterprise of emerging capacity, can become an integrated component of an established organisation’s value chain with a proven competitive advantage. hence, the primary gain is that innovation is a highly socially embedded process within a network structure of close, diverse ties. moreover, the central argument posed that qualitative, intangible, and experiential aspects of closeness – fostered by the structural composition of closeness – is critical in fostering the innovation process as well. the findings were generally supported by the literature on networks and firm innovation. overall, the literature supports a generally positive relationship between networks and innovation, which pittaway et al. (2004) confirm through their comprehensive systematic review of both conceptual and empirical works. tsai (2001) highlights that network position does have a positive impact on innovation, mediated by the actor’s capacity to absorb the knowledge gained externally. lipparini & sobrero (1994) bring particular attention to small and medium enterprises, as they argue that small enterprises can use their relational capabilities to find new combinations of knowledge and further competitive advantage beyond the limitations of their size. similarly, this study confirms such insight by exploring the interaction between network sajems ns 17 (2014) no 3:349-362 359 structure and sector, while keeping the firm size constant. future studies that examine how the link between the variation in firm size and sector informs networks of innovation value has useful implications for business development (rogers, 2004). the specific attention given to the structural closeness of an entrepreneur’s network as an innovation-enabling attribute resonates with findings of those such as schilling & phelps (2007), who emphasise the reach and cluster of a firm’s relationships as significant contributors to the innovation process. the reach referring to the capacity to access diverse actors and a wider array of knowledge, and cluster referring to the positioning of nodes that permit the high degree of exchange and information – bear semantic variation but conceptual resemblance to the noted ideas of diversity and closeness in this study. swan, newell, scarbrough, and hislop, (1999) echo the imminent value of having actors in spaces of close proximity so as to facilitate consistent engagement and exchange. nonetheless, the ‘relational’ or ‘experiential’ closeness that diverse actors of a network share is a very distinct dimension from that of the ‘structural’ closeness. this study would argue that it is the structural closeness that creates the environment conducive to the cultivation of the relational closeness. and as mentioned, this study argues that it is within this qualitative, intangible experience of closeness that the innovation between actors is spurred and facilitated. swan et al.’s (1999) study of community-based networking affirms this logic by highlighting the collaborative cocreation and negotiation of knowledge that enables institutionally-defying innovation of people working together. according to blomqvist & levy (2006), this engagement demands the prerequisite of a ‘collaborative capacity’ that describes the genuine activation of trust, commitment, and communication in participating actors– in order to optimise the interactions taking place in the network. ahuja’s (2000) empirical work, however, reminds us that different aspects of an entrepreneur’s network can provide contradictory aspects to an entrepreneur’s innovation process. although this was not a prevalent theme that emerged from the data, a few respondents occasionally mentioned a competitive, rather than collegial, attitude between entrepreneurs. this aspect was acknowledged as a social and attitudinal dimension of the entrepreneurial community that could influence innovation in adverse ways and is worthy of further exploration. the proposed argument presents alternative insights to two respected assertions presented in the economic sociology literature. first, granovetter’s strength of weak ties argument has long been revered and is foundational in the social embeddedness literature (1973). granovetter postulates that ties beyond one’s immediate identity group, allow an actor to access a variety of information that aids in their economic advancement. the findings from this study suggest that among microbusinesses in this emerging market setting, different types of ties provide different types of economic value, rather than asserting that one type of tie has more economic value than another (ahuja, 2000). hence, the qualitative findings from this study suggest that close ties – which would be considered ‘strong ties’ in granovetter’s study, and in turn, not as economically potent – actually have innovation oriented value towards the economic success of microenterprises. “strong ties” of highly perceived value and high frequency of communication provide a space of continual exchange, inspiration, and combined capacities as all parts of the co-creation process. a second assertion of abigail barr (2002) suggested that, in lieu of studying the network use of ghanaian manufacturing firms, there is a difference depending upon the firm size. she argues that large firms draw innovative value from their networks, whereas small firms ideally source security from their web of relationships. the south african case presented here argues that the dichotomy between ‘secure’ and ‘innovative’ networks is to be further interrogated. rather, this study suggests that the innovation process is embedded and driven by a sense of secure relationships – those fueled by a high 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citation naude, m.j. & naude, r.t., 2022, ‘a proposed risk framework as a tool for sustainability for the south african wine industry’, south african journal of economic and management sciences 25(1), a4235. https://doi.org/10.4102/sajems.v25i1.4235 original research a proposed risk framework as a tool for sustainability for the south african wine industry micheline j. naude, rodney t. naude received: 05 july 2021; accepted: 23 nov. 2021; published: 28 feb. 2022 copyright: © 2022. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract aim: there is an existing gap in the literature that addresses the importance of risk management as a tool for sustainability in the winemaker’s activities and operations. the purpose of this article is to propose a risk management framework for the south african wine industry that can be used as a tool for sustainability. setting: the study comprised 10 participants at five wine-producing estates located in the five different wine-growing areas within the stellenbosch region. method: the study is exploratory in nature, adopting a case study approach. interviews with wine producers in the stellenbosch region of the western cape province of south africa were conducted in order to identify the various risks they face. result: a thematic analysis was used to analyse the data. the four steps of risk management were used as a reference point and to underpin the proposed risk management framework. the study was done using the supply chain operations reference model, which is divided into six process categories, namely plan, source, make, deliver, return and enable. conclusion: the article makes a twofold contribution. firstly, wine producers might use the proposed framework to identify and mitigate their risks and thus as a tool for sustainability. secondly, the proposed framework is expected to contribute to the existing body of knowledge on risk management and sustainability. keywords: sustainability; risks; risk management; risk management framework; wine producers. introduction sustainability can be defined as the survival of a business, requiring the successful integration of economic, social and environmental aspects. sustainability is likely to be achieved by a business that manages and integrates economic principles (maximising welfare and improving efficiency), and social (equity principles) and environmental strategies (conservation of resources) (arnold 2017; rauter, perl-vorbach & baumgartner 2017; schaltegger, lüdeke-freund & hansen 2012). many businesses, including the wine industry, face significant challenges in tackling global warming, protecting ecological support structures, conserving energy and resources, and sustaining functioning societies (arnold 2018; santini, cavicchi & casini 2013). thus, unsustainable management decisions and the neglect of social and environmental issues will prevent businesses from improving in terms of sustainability (arnold 2017; schaltegger et al. 2012). the wine industry participates in and is committed to sustainability as is evidenced in an extensive and expanding body of academic literature (santini et al. 2013). in south africa, the industry leads the world in production integrity. since 1974, the wine of origin scheme has certified that the labels stating where the grapes originate from, the vintage year and the variety are correct and valid. in 1998, guiding principles on sustainability were established, and it is estimated that 95% of the wine growers follow these principles (wosa 2021a). furthermore, south african wine producers are mindful of conservation – around 45 000 ha of land is owned by grape farmers who are world wide fund for nature conservation champions, and 22 000 ha of this is held as part of the cape floral kingdom (wosa 2021a). the south african wine industry contributes significantly to the country’s economy. it employs 269 096 people across the entire wine industry and accounts for 4% of global wine production, making it the world’s eighth largest wine producer (wosa 2021b). in 2020, the various operations and value-added activities of the wine supply chains contributed over r55 billion, or 12% of south africa’s gdp (wosa 2021b). achieving sustainability in the wine industry is complex, as wine producers operate and compete in a highly traded local and international wine market. all activities that are carried out on a wine farm relate to sustainability – financial and environmental activities as well as all aspects of human resources (employees and the surrounding community) (santini et al. 2013). for a business to be sustainable in the short and medium term, it needs to understand its potential business risks, as these are recognised as one of the largest threats to sustainability. thus, risk management, as a tool, may lead to improved competitiveness and financial performance (giannakis & papadopoulos 2016). sustainability opens up a variety of research possibilities, including the development of a risk framework that can be used as a tool. it is relevant in south africa that principle 11 of the king iv report on governance observes that ‘the governing body should govern risk in a way that supports the organisation in setting and achieving its strategic objectives’ (institute for directors southern africa 2016). the report further recommends practices for conducting risk management and for measuring the performance and sustainability of a business from an economic, social and environmental perspective. while the king iv report lays down principles that all jse-listed companies are required to adhere to, its recommendations aim to cover all businesses, regardless of their size. the study contributes to the current body of knowledge by addressing the gap that exists in literature on the importance of risk management as a tool for sustainability in the wine producer’s operations. supply chain risk assessment and management is an important concept for handling risks within the supply chain and this approach is gaining momentum across supply chains (mvubu & naude 2020). although south african wine producers are aware of the risks they face, the severity of these risks and the measures they take to mitigate those risks, they do not conduct formal risk assessments (naude & badenhorst-weiss 2020). this lack is not unique to wine producers and the wine industry, and applies to small and medium enterprises (smes) in general. despite evidence that companies that implement risk management strategies are more likely to survive and expand, many smes in south africa do not consider risk management to be critical for organisational success (naude & chiweshe 2017). there is, moreover, a lack of research exploring the sustainability-related risks in an integrated manner and developing risk management strategies to treat these risks (giannakis & papadopoulos 2016). within this context, the purpose of this article is to present a risk management framework that may be used as a tool for sustainability for the south african wine industry. in this article, ‘sustainability’ refers to the survival by a business managing and the integration of its financial, social and environmental strategies, together with risks, responsibilities and opportunities. the operational framework suggested by naude and chiweshe (2017), focused on four risk management process phases, namely risk identification, risk evaluation, risk response, and risk monitoring and control, was used as a starting point and served as the foundation of the framework presented in this article. the data were collected through in-depth semi-structured interviews with participants at selected wine producers – who grow crops and use it to produce wine; the different categories of risks were defined and are incorporated in this proposed framework. theoretical background risk management risk management can be defined as a formal process that entails different approaches in order to identify risks, assess the probability of the risks arising, analyse the potential impact of the risks, develop strategies to mitigate them, and implement risk monitoring and control (jacobs & chase 2018; rogers et al. 2015). these observed steps from the definition provide managers with strategic knowledge to help them select risk mitigation strategies that improve their businesses’ overall performance (simba et al. 2017). however, it is important that risk management is carried out in an economical and cost-effective manner in order to manage risks efficiently (badenhorst-weiss, van biljon & ambe 2017). each step in the management of risks is described below. risk identification the identification of the risk is the first step in the risk management process. identifying the origins of any possible internal or external risks is part of this procedure, which begins with an examination of the supply chain to determine where risks could occur and what might cause them (hallikas & lintukangas 2015; zsidisin & ritchie 2008). simba et al. (2017) state that it is difficult to develop appropriate mitigation strategies without first identifying the risks. a vital part of this process is to ensure that, once the risks have been identified, these risks are registered and then monitored (scarborough, wilson & zimmerman 2009). risk analysis and assessment the second step in risk management is a systematic process to predict the probability of a potential risk occurring and its effects on the business. thus, this stage has two aspects: the probability that a risk will occur, and the extent of the effect on the business if the risk occurs (ho et al. 2015). in this process, each risk must be assessed individually in order to determine an appropriate mitigation strategy so that failure during mitigation can be avoided (sharma & bhat 2014). once this step is complete, appropriate strategies can be developed and adopted in the mitigation process (simba et al. 2017). risk response and mitigation strategy the third step in the chain risk management process entails generating and reflecting on alternative solutions, evaluating and judging the merits of these solutions, deciding on suitable solutions, and then putting these solutions into action (chang, ellinger & blackhurst 2015a). this procedure leads to the agreement on risk reduction techniques to minimise, reduce or mitigate the defined risks (hoffmann, schiele & krabbendam 2012). risk avoidance, risk assumption, risk elimination, risk reduction and risk transfer are all possible strategies. risk avoidance is the process of taking steps to prevent a risk. risk assumption happens when the party exposed to the risk simply acknowledges the risk and the potential losses; if the cost of taking action to mitigate a risk is high in comparison to the cost of the actual loss, this will be an appropriate strategy. risk elimination involves taking steps to eliminate a risk. risk reduction happens when steps are taken to minimise a risk – it attempts to lower the chances of a loss occurring or to lessen the impact of a loss that does occur. risk transfer is the act of moving a risk to another entity, such as through a lease arrangement with a third party; for example, leasing motor vehicles enables the user of the equipment to transfer the risk of obsolescence to the owner (badenhorst-weiss et al. 2018; paul, sarker & essam 2016, sudeep & srikanta 2014). risk monitoring and evaluation the fourth and final step in the risk management process entails tracking, overseeing and managing solutions, as well as evaluating their effect on a specific business area or the entire business (chang et al. 2015a). through risk monitoring and evaluation, it can be determined how the mitigation strategies are progressing, deviations and new preventative measures can be identified, and possible further risks predicted (simba et al. 2017). since risks and the severity of their effect can change over time, risk management is a dynamic and continuous process (chang, xu & song 2015b). supply chain operations reference model the supply chain operations reference (scor) model was developed in 1996 and endorsed by the supply chain council as the cross-industry standard diagnostic tool for supply chain management (apics dictionary 2019). the scor model is a management tool used to address, improve and communicate supply chain choices within a company as well as to customers and key suppliers. it comprises the six broad process categories of plan, source, make, deliver, return and enable (hugos 2018). any business in the overall supply chain that delivers a product or a service is involved in at least one of these categories (hugos 2018; jacobs & chase 2018). each of these categories is briefly explained. plan the plan process covers the processes necessary strategically to manage a supply chain and is essential to the success of the other supply chain operations of source, make, deliver and return (wisner, tan & leong 2016). the planning process includes demand and supply planning, balancing resources with requirements, establishing and communicating supply chain plans, planning of business rules, policies and procedures, data collection, information technology systems and databases, inventory, capital assets, transportation requirements and regulatory requirements (hugos 2018; stevenson 2021; wisner et al. 2016). in the south african wine sector, the plan process refers to all facets of planning of the business and its operating activities. this category covers: planning for the business and its operations of the farm and crop management, deciding on the procurement plan, establishing the bottling and packaging strategy, and projecting the sales and distribution of the wine (naude 2019; naude & badenhorst-weiss 2020). source the source process includes the activities related to the procurement of materials and services to meet planned and actual demand (apics 2017). this involves the selection of suppliers, the obtaining of quotes, the delivery tactics and payment processes, and the procedures for monitoring and strengthening the business’s relationship with its suppliers (badenhorst-weiss et al. 2018; johnson & flynn 2020). in the south african wine sector, the source process includes the activities related to sourcing of materials, manpower, machinery and the services for the business (naude 2019; naude & badenhorst-weiss 2020). make the make process includes activities related to producing the goods or providing a service to meet planned or actual demand (apics 2017). this process includes scheduling the processes for the workers, coordinating the materials and plant and equipment to support the producing of the product, scheduling the activities that are required to produce goods on time, and the preparation for delivery (stevenson 2021). in the south african wine sector, the make process includes all the activities of wine production, such as land management, vine management, crop management, harvesting, the wine production processes and the activities involved in the bottling and packaging of the wine (naude 2019; naude & badenhorst-weiss 2020). deliver the deliver process is also known as the logistics aspect of the supply chain. transporters are chosen to transport finished goods to storage warehouses and customers. these operations include activities such as planning and arranging the flow of information and goods through the supply network, designing and running a warehouse network, and managing the information systems that handle customer orders (johnson & flynn 2020). in the south african wine sector, the deliver process includes all aspects of sales customer invoicing, warehousing, sales, transportation of the wine to the distributor or customer, and after-sales service (naude 2019). return the return process provides support for customers who have problems with delivered products (apics 2017). this process deals with returning or receiving defective products and excess products from customers (hugos 2018; jacobs & chase 2018; wisner et al. 2016). in the south african wine sector, the return process includes product returns and excess stock not required by the customer (naude 2019; naude & badenhorst-weiss 2020). enable the enable process involves actions that support the design and management of the supply chain’s planning and execution processes. the enable process of management activities (organising and controlling), like the planning component, covers the whole supply chain and the other activities of source, make, deliver and return (apics 2017). examples include managing activities such as establishing and planning, maintaining, and monitoring information relationships, resources, assets, business rules and contracts required to operate supply chains (apics 2017; wisner et al. 2016). in the south african wine sector, the enable process includes the support, design, and management of the planning and execution processes of the supply chain (naude 2019; naude & badenhorst-weiss 2020). combining the six processes and their underlying activities is important to provide a quality product or service at a reasonable price. these six processes also provide a basis on how to manage and improve the components within the supply chain. risk exists in each of these six processes. the six process categories of source, make, deliver, return and enable were used as the framework to examine the risks within the wine industry supply chain. operational framework naude and chiweshe (2017) present an operational risk management framework that smes could use (figure 1). the four risk management process steps, namely risk identification, risk assessment, risk response and mitigation, and risk monitoring and control, form the foundation of this framework, presented across the tops of the table (figure 1); the rows down the left side of the framework indicate the four broad risk categories of operational, market, technical and financial risks. the four process steps of risk management are further broken down into subcategories. figure 1: operational risk management framework. risk identification identifying and understanding potential risk sources is the first step in the risk management process. there are three sections in the risk identification column: category, risk description and responsible person. the category column helps identify the general risk, the description column explains the specific risk, and the responsible person column identifies who will be in charge of managing and reducing the risk. as shown in the rows of the framework (figure 1), each potential risk area of the business, such as operational, market, technical and financial risks, can be populated. naude and chiweshe (2017:12) note that, depending on the size and nature of the business, risk categories would vary from one sme to the next. hence, for the purpose of presenting a proposed risk framework as a tool for sustainability for the south african wine industry, these potential risk areas have been replaced by plan, make, source, deliver, return and enable, in line with the scor model. risk assessment the next step in the process is risk assessment. three sub-categories have been added to the risk assessment column. the first column of the risk framework of risk assessment deals with the severity rating of the identified risk. severity rating is sub-categorised according to the potential impact of the risk on various parts of the business, such as finances, health and safety, the natural environment, and the sme’s reputation, or the potential legal implications. the risks are then ranked from 1 to 10 on a severity scale, with 10 being the most significant. the probability rating assigned to each risk is dealt with in the second column under risk assessment. on a scale of 1 to 10, businesses must assess the chance of this risk occurring. a score of 10 indicates that the risk is likely. the risk is scored in the last column under risk assessment. the likelihood rating is then compounded by the severity risk rating. the higher the score, the more likely the risk is to materialise and affect the business. each risk must be assigned a score, with the higher values indicating the more serious risks. risk response and mitigation strategy the risk response and mitigation strategy is the third step in the risk process framework. after each possible risk has been scored, they should be sorted and rated in order of importance. the risk management team can then work their way down the list dealing with the highest-scoring risks first. risk monitoring and control the fourth and final step will be to monitor the risks. this is a critical step since it can provide early warning of increasing risk levels, allowing the business to respond to changes and establish and change mitigation methods. research methods the purpose of this article is to present a proposed risk management framework that may be used as a tool for sustainability for the south african wine industry. in order to do this, the risks that threaten the sustainability of south african wine producers had to be identified. a case study approach was used because the study had to be focused on current events (sekaran & bougie 2019; yin 2014). the target group for the study was the wine producers in the stellenbosch wine region, south africa’s largest wine-producing region. there are 546 wineries in the country, of which 191 are situated in stellenbosch. wines of south africa (wosa 2018:31) notes that stellenbosch includes five significant wine growing areas, namely greater simonsberg, stellenbosch berg, helderberg, stellenbosch valley and the bottelary hills. a non-probability purposive sampling methodology was found to be suitable for selecting the wine producers. ten participants at five wine-producing estates located in the five different wine-growing areas within the stellenbosch region participated in the study. in order to identify the risks wine producers face, data were collected through in-depth semi-structured interviews, using an interview guide and field notes taken during the interviews. face-to-face semi-structured in-depth interviews were conducted, allowing the authors to probe and expand on the participants’ responses. several academics reviewed the interview guide for content validity as part of the ethical clearance procedure. the purpose was to fine-tune the questions so that participants would be able to answer them without difficulty, as well as to examine the validity of the questions so that the data collected would be reliable (saunders, lewis & thornhill 2019). the interviews were recorded, the recordings transcribed verbatim, and the data cleaned for accuracy to ensure its trustworthiness. the data were analysed using thematic analysis. ethical clearance through unisa desttl (2018_cems_esttl_005) was obtained. all participants had considerable experience in the wine industry (table 1). in the list of the participants, pseudonyms are used for each participant and each wine producer estate to ensure anonymity. table 1: list of participants. eight of the participants had viticulture expertise ranging from 19 to 35 years, while the owner at each wine producer estate had financial and business management skills. these participants were chosen for the study because of their in-depth knowledge of the operational tasks, challenges and risks at their wine-producing farms. ethical considerations the low-risk application was reviewed by the desttl ethics review committee in june 2018 in compliance with the unisa policy on research ethics and the standard operating procedure on research ethics risk assessment. the decision was approved on 04 june 2018 by the unisa desttl ethics review committee results the objective of the interviews was to identify the supply chain risks of the wine producers that threaten their sustainability or survival. this section presents the findings according to the thematic analysis. the key risk themes are plan, source, make, deliver, return and enable. the themes, sub-themes and codes are dealt with in the sections that follow. risk category 1 – plan this section encompasses the risks highlighted by participants in the business planning area, as well as all of its operations, from farming and crop management to wine sales and distribution. the findings revealed two main sub-themes, namely demand vs supply and long-term investment. the plan risks identified by each participant are indicated in table 2. table 2: plan risks identified by participants. demand vs supply relates to managing and balancing product supply so as to avoid excess inventory or stock-outs. excess inventory would result from fewer sales than planned and stock-outs from higher demand than planned: ‘a lot of the customers will order now, but that will be stock for 6 months or might be stock for a year or might be stock for 18 months, so it’s very difficult to get into a pattern and that’s a big challenge.’ (participant 6, owner and cellar master, male, 21 years experience) ‘you could overproduce or under produce. we have had a few cases of underproduction as well that’s quite tricky. what we do is, for every wine we will say what’s the current vintage and do your projections for the next four or five years. but it’s not that easy.’ (participant 9, ceo and financial executive, male, 5 years experience) ‘the south african and overseas customers are ‘spoilt for choice’ for wines and can move their purchases from producer to producer.’ (participant 3, owner and sales & marketing, female, 19 years experience) long-term investment is the risk that wine producers experience in investing in new vineyards. the risk is the uncertainty that consumers will buy the wine from the vineyard, as current and future tastes may change. since investment in a new vineyard is significant, the challenge is to decide what cultivar to plant: ‘you are planting over 3000 vines in a hectare. this little block here [pointing to a map] is a hectare. to plant a vineyard, it probably sets you back r250 000.’ (participant 7, owner and cellar master, male, 35 years experience) ‘we are planning another vineyard now. while this vineyard is going to last 25 years, what is the demand going to be like in 25 years what will the style be? how can i know that?’ (participant 6, owner and cellar master, male, 21 years experience) risk category 2 – source this section presents the risks identified by the participants in the source component of the business and its activities. the findings revealed two main sub-themes, namely bought out grapes and dry goods. the source risks identified by each participant are indicated in table 3. table 3: source risks identified by participants. it was found that many wine producers acquire grapes for wine production (bought out grapes). the risk highlighted was the recent drought, which had resulted not only in a shortage of grapes for purchase but also a substantial increase in the price of grapes: ‘the prices of grapes have gone up substantially. it is now 2018 and because of the drought, everybody said that the 2018 grape yield would be 25% down. everybody was saying – i need to buy grapes because i am not going to get the quantity. and the prices went up because suddenly they could sell them for more.’ (participant 3, owner and sales & marketing, female, 19 years experience) ‘we could buy a year or two ago, at r5 000 to r7 000 per tonne. now we pay r14 000 to r18 000 per tonne.’ (participant 5, viticulturist, male, 22 years experience) ‘i have seen the prices double already in the last 6 months.’ (participant 10, cellar master, male, 24 years experience) dry goods comprise all the items used in the wine-making process, as well as bottling and packaging of the wine. items used in the production of wine include yeast and oak wine barrels used for wine maturation. packing includes bottles, boxes, labels and corks. the risks highlighted in this area were the costs of the products, the lead time for these goods that resulted in the holding of excess stock by wine producers, and the poor quality of these items. among the examples provided were weak and faulty bottles, labels that do not attach to bottles, cartons that collapse, and contaminated cork: ‘on the sourcing side, bottles, boxes, capsules, barrels we tend to pay higher prices. the suppliers tend to work on high margins in general because it’s a small industry. to give you an example, on average we are paying 40% more for our glass than what they are paying in europe. and when you look at the costs of labour, the cost of raw materials, it doesn’t even make sense.’ (participant 6, owner and cellar master, male, 21 years experience) ‘well if you look at capsules, they’re basically all imported. that’s always a tricky thing because you’re dealing with the middleman.’ (participant 6, owner and cellar master, male, 21 years experience) ‘the problem is convenience because if we are bottling, we need 700 000 bottles per year. it’s a lot of pallets. where do you put them? if you want to order 50 000 bottles you can do it from consol and it can come in dribs and drabs. sometimes they have a furnace that isn’t working so you have to plan it quite well in advance.’ (participant 7, owner and cellar master, male, 35 years experience) ‘bottles are a major problem because the main supplier is consol and they are not really interested in the small guys. beer is what keeps them ticking along and they are dreadful to work with. the quality of the bottles is very poor and we’ve also had labels that don’t stick on the bottles.’ (participant 7, owner and cellar master, male, 35 years experience) participant 10 explained his move from cork to ‘fragmented cork’ due to quality issues with imported cork being contaminated: ‘before with ordinary cork i had lots of problems. it’s why i went to technical cork’. risk category 3 – make the risks identified by the participants in the make component of the business are presented in this section. all aspects of land, vine and crop management, as well as harvesting and all other wine-making processes, are included. the findings revealed five sub-themes, namely costs, nature, infrastructure, in-process and human resources. the make risks identified by each participant are indicated in table 4. table 4: make risks identified by participants. high and increasing costs of all the farming activities were identified by participants as a significant risk. land tending, planting, growing, vine tending, picking, labour, water, power and waste treatment are examples of farming activities. explaining the impact of costs increases, participant 6 commented: ‘it’s created pressure on the business. i mean obviously you can’t keep paying more than inflation. our labour costs, if you look at it over the past 20 years has way outpaced the inflation level.’ (participant 6, owner and cellar master, male, 21 years experience) the yield or volume declines also have an impact on unit costs: ‘if your vintage is down 15, 20, or even 40%, your fixed costs stay the same. i mean ultimately you need certain volumes to run a business, it’s as simple as that.’ (participant 9, ceo and financial executive, male, 5 years experience) the sub-theme nature covers the environmental concerns that winemakers must contend with in order to grow vines and grapes. a key risk was the negative impact of the drought on the yield of grapes. the picking of the berries when they are ripe and when the ambient temperature is the coolest was another key risk identified by the participants. the risk of disease (powdery and downy mildew) and pests (mealybug, stemborer and snout beetle) were also identified as risks. another risk factor impacting wine producers is fire. not only does fire burn the vines but also smoke damages the fruit (smoke taint): ‘in 2018 we were down about 20% and that was because of the drought.’ (participant 6, owner and cellar master, male, 21 years experience) the importance of ripeness was explained: ‘it affects the whole style of the wine potentially. over ripe, we have a window where we have to pick and if we get delayed by a week, then your sugar jumps and your alcohol will end up a lot higher than you intended it to be. that can happen. you can lose market. supermarkets won’t stock your wine, won’t shelve it if you have more than 14% alcohol level.’ (participant 8, winemaker, male, 22 years experience) ‘diseases, it’s basically oidium which is a powdery and downy mildew, so the two mildews are the two main diseases that we would be concerned about.’ (participant 2, ceo and cellar master, male, 19 years experience) ‘the wind is a problem now and again when the wind speeds get to a point where they break the shoots off at a very sensitive stage. when the shoots are 30 to 40 cm then the shoots are not well cemented to the main frame and they can be blown off quite easily.’ (participant 10, cellar master, male, 24 years experience) ‘you get a variety of pests; the most dangerous ones are called mealybug which is the carrier of the leaf-roll.’ (participant 10, cellar master, male, 24 years experience) the sub-theme infrastructure covers all the risks associated with the infrastructure required for vine and grape growing, such as irrigation, power and use of land. in-process is a broad risk that is associated with the process activities during the wine-making process. these include the checking, testing and managing of the must to ensure that the wine develops correctly. with regard to this risk category, participants indicated the necessity of controlling the processes as well as the consequences if they are not adequately managed or become out of control. the risk is that this could result in spoiled wine. finally, human resources includes the risks of industrial action or strikes, the retention of skills of winemaking, safety risks and the risks of damage and theft from employees. risk category 4 – deliver the risks identified by the participants in the deliver component of the business are presented in this section. the category includes all actions related to the selling and delivery of wine. this would involve finished wine warehousing, invoicing, sales, delivery of the wine to the customer, and after-sales service. the findings revealed three sub-themes, namely revenue, market and inventory; the risks identified by each participant are indicated in table 5. table 5: deliver risks identified by participants. a significant risk identified by the participants was that of sales revenue. it was noted that there was a negative correlation between input costs and selling price increases. in as much as selling prices increased annually, these were generally below the inflation level, as a consequence of the intense competition for wine in south africa. another challenge is the volatility of the rand and the difficulty of increasing wine prices once the product and price point have been established in the market. with regard to costs, participants highlighted the risk of high and increasing logistics and transportation costs: ‘the biggest thing is that there is a lot of competition out there and the other risk is obviously with consumers being under threat or pressure right now with economic conditions, they buy down so they are not willing to buy better quality at a higher price. they are looking for ok or good quality at a cheaper price.’ (participant 9, ceo and financial executive, male, 5 years experience) ‘we are always watching those logistic costs. one of the big things is selling on fob [free on board] basis. fob cost is a big part, a very big part for selling for wineries. it’s one factor that we are regularly looking at because there are a lot of minimums in pricing fob. we estimate that 2,5% of our revenue will be spent on fob costs, which is pretty high, but a lot of wineries are spending a lot more on that.’ (participant 10, cellar master, male, 24 years experience) under the sub-theme market, a significant risk identified by all participants who interface with the customer is bad debts. some producers sell to large wholesalers as well as restaurants and other small businesses. as a result, their risk profile increases. an example of bad debts was provided where restaurants started up and then closed: ‘we had some bad debts, it’s very much part of the industry, typical restaurants, opening up and closing down.’ (participant 9, ceo and financial executive, male, 5 years experience) two different types of risks were identified under inventory, namely inventory damage in the warehouse or during transportation, and delays in getting the wine to the consumer. delivery delays can be as a result of strikes, weather conditions, road closure, service delivery protests and demonstrations. risk category 5 – return the sub-theme return encompasses the activities associated with the returns of the product and of stock not required by the customer. the participants noted that product returns rarely occurred and that there were no risks around this area. risk category 6 – enable the risks identified by the participants in the enable process of the business are presented in this section. this category includes all activities related to the support, design, planning and execution processes of the supply chain. the findings revealed two sub-themes, namely profitability and cash flow. the enable risks identified by each participant are indicated in table 6. table 6: enable risks identified by participants. with regard to profitability, it was found that all the participating wine estates were profitable; however, there were concerns that profitability was declining. participants noted that the sustainability of many south african wine producers was threatened due to financial constraints. one of the reasons highlighted was the increasing annual input costs, in line with or above the level of inflation in south africa: ‘our biggest risk to our business is cost control because the inflationary pressures in south africa, the inflation of labour. that’s our biggest risk. and if you look at internationally, because it goes back to this idea that it is an export driven business, that we don’t have the inflation in the overseas markets that you do now, wine prices have been very, very sticky over the last 20 years, i.e. they have not had inflation increases. and that’s a very big challenge to maintain profitability.’ (participant 6, owner and cellar master, male, 21 years experience) ‘i think return on investment [in the wine industry] or return on equity is marginal in sa. it’s very low. most of the wine farms … you get your 15%; the other 85% survive basically. there is probably another 30% who just break even and are sometimes profitable, sometimes not, and so on.’ (participant 9, ceo and financial executive, male, 5 years experience). the second sub-theme was that of cash flow, which was identified as another significant risk. the wine supply chain is long, and a 1-year investment might pay off in 3–5 years. hence, the supply chain absorbs cash resources, with cash returns occurring only when the debtor pays for the wine – usually 30–90 days after delivery. it was found that wine producers require large capital resources, which can be obtained through investment or short-term borrowings such as overdrafts. however, banks are concerned about the wine business and extending of credit: ‘but the wine business is an inherently risky business. because it costs a lot to invest in a vineyard, especially if you are making red wine. but that feeds into the risk of things of handling the product that can off go off because you’ve got to keep it. you know you have three years of maintaining it. it’s a very long time in the storage, so if you have an issue it can really impact on your, on your cash flow.’ (participant 6, owner and cellar master, male, 21 years experience) proposed operational risk framework this section presents the proposed risk framework that can be used as a tool for sustainability for south african wine producers. it integrates the key risk categories of plan, source, make, deliver, return and enable with the risks identified from the interviews in the form of the themes, sub-themes and codes. these have been populated in the proposed risk framework (figure 2) in the objectives and description of risk columns. figure 2: proposed risk framework for the south african wine industry. conclusion to recap, the purpose of this article is to present a risk management framework that may be used as a tool for sustainability for south african wine producers. the operational framework presented by naude and chiweshe (2017:9) was utilised as a reference point and created the foundation for the framework presented in this article, which was based on the four risk management process steps of risk identification, risk assessment, risk response, and risk monitoring and control. this proposed framework incorporates the many categories of risks identified through in-depth semi-structured interviews with participants at wineries. it summarises the key risk categories of plan, source, make, deliver, return and enable with the risks detailed under the description of the risks. although the participants in this study were aware of the risks they face, risk management is dependent on previous occurrences and experiences. the downside is that winemakers do not formally consider the future or potential risks that may occur. for this reason, naude (2019:184) suggested that, because the wine industry is inherently risky, wine producers should implement a structured risk assessment and risk management procedure. this is key to the survival and sustainability of wine producers. it has already been noted here that sustainability can be achieved through managing and integrating financial principles, and social and environmental strategies. however, achieving sustainability in the agricultural sector is complex as it involves everything that is done on the farm, including the economics, the environmental impact, human resources and the surrounding community. within this context, the risk framework proposed here can be used as a tool for sustainability for south african wine producers. various risks identified encompass financial risks (demand vs supply, costs, sales revenue, etc.), environmental risks (weather conditions, pests and diseases) and social risks (human resources). the study is not without its limitations. only one wine producer from each of stellenbosch’s five wine regions was included. accordingly, the findings and the list of identified risks is not exhaustive and cannot be generalised across the whole wine-producing region of south africa. risks could differ from wine producer to wine producer and from country to country. the proposed risk framework is robust, allowing for identified risks to be included or excluded where necessary. another limitation is that, since the management team at any wine producer is small, wine producers may view the undertaking of a formal risk assessment as a time-consuming exercise. it would, however, be possible for the process to be handled on an annual basis in only one day during a risk review session. it is suggested for future research that this study could be extended to all south african wine producers in order to (1) identify additional supply chain risks, (2) measure the extent of these risks and (3) explore how these risks can be mitigated. this article makes a twofold contribution. firstly, wine producers can use the proposed framework to assess and mitigate their risks, making it a tool for sustainability. secondly, the proposed framework is expected to contribute to the existing body of knowledge on risk management and sustainability. risk management to achieve business success and sustainability is of great importance. as gary cohn (harper 2011) wrote, ‘if you don’t invest in risk management, it doesn’t matter what business you’re in, it’s a risky business’. acknowledgements we acknowledge that this is our own work and all sources we have used or quoted have been indicated and acknowledged by means of complete references. dr c. goodier language edited this article. competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions the research methodology and findings are derived from the master’s study of r.t.n; m.j.n. was the project leader, made conceptual contributions and finalised the article and r.t.n. collected and analysed the primary and secondary data and wrote up the literature review. funding information this research received no specific grant from any funding agency in the public, commercial or not-for-profit sectors. data availability the data that 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ritchie, b., 2008, supply chain risk: a handbook of assessment, management and performance, springer, bowling green, ky. sajems ns 7 (2004) no 2 316 financial liberalization, currency substitution and savings in nigeria: evidence from cointegration and error correction modeling ________________________________________________________________ meshach aziakpono department of economics and economic history, rhodes university sanmi babatope-obasa1 department of economics, national university of lesotho ________________________________________________________________ abstract the study set out to test the mckinnon-shaw proposition that financial liberalization will significantly increase savings mobilization. the results partly supported the financial liberalization proposition. variables that capture the effects of currency substitution such as the interest rate differential, a proxy for underground economy, the inflation differential (as a measure of macroeconomic instability) and a dummy for political instability were significant in their adverse impacts on the saving mobilization process in nigeria. we, therefore, advocate for an active monetary policy that will help manage the delicate balance between domestic and foreign interest rates. this should be combined with macroeconomic policies that create a stable economic environment along with appropriate financial and exchange rate policies, in order to discourage economic agents from preferring foreign denominated assets to those held in the domestic currency. jel g10, 20 1 introduction in the last two decades, we have witnessed large-scale financial sector reforms in many african countries. a major emphasis of these reforms was, inter alia, the need to adopt financial liberalization measures to establish more open credit markets, achieve flexible and eventually freely determined interest rates and enhance financial intermediation (cbn, 1993). the original theoretical analysis, which provided a rationale for financial liberalization, as a means to promoting financial development and hence economic growth, was given by mckinnon (1973) and shaw (1973). their models focus specifically on financial repression in the form of ceilings on sajems ns 7 (2004) no 2 317 deposit and/or loan interest rates. independently and in a rigorous way they highlighted the dangers of financial repression and argued the case for financial liberalization. their argument is based on the premise that real interest rates influence growth in the economy through their effects on savings and investment, under the implicit assumption that prior saving is required for investment. though the mckinnon and shaw frameworks are based on different transmission mechanisms by which real interest rates affects savings, investment and growth, they both agree on the general impact of financial repression and the need to liberalize financial markets. mckinnon’s position, often referred to as the complementarity hypothesis, states that since economic agents have to accumulate money balances (or save) before investment can take place, money and physical capital are essentially complementary. since the real deposit rate of interest positively influences the rate of accumulation of money balances (or saving), interest on deposits will encourage investment. his argument was based on two assumptions: that all investment is self-financed, and that investment expenditure is more indivisible than consumption (gibson & tsakalotos, 1994). on the other hand, shaw takes a debt intermediation view. according to shaw, financial liberalization will lead to an increased role for financial intermediaries. since financial intermediaries are able to reduce the costs associated with intermediation between savers and investors through economies of scale, risk diversification, liquidity management and so on (see levine, 1997 for a detailed discussion of these and other channels), they can offer savers more attractive deposit accounts – including higher interest rates and better liquidityand lenders will get lower borrowing rates. thus, investment and savings would be encouraged and as a result, economic growth promoted. the policy implication of the mckinnon-shaw proposition is that ceilings on interest rates, and, more generally, other government regulations, which prevent the loan market from operating competitively, should be removed. empirical evidence on the prediction is mixed. while some studies have found a positive and significant relationship between savings and real interest rates, others have obtained insignificant, and sometimes negative relationships (see gibson and tsakalotos, 1994 and aziakpono, 1999 for a survey of the literature). in discussing financial liberalization models, and also in their testing, it is frequently the case that no clear distinction is made between financial savings and total saving. often the two are treated as synonymous. as demonstrated in aziakpono (1999) this is wrong. also, often no account is taken of the leakage from the formal financial system. perhaps, more importantly, most tests of the financial liberalization hypothesis give no consideration to the phenomenon of currency substitution, which is prevalent in sajems ns 7 (2004) no 2 318 many developing countries that have adopted financial liberalization (nissanke & aryeetey, 1998: 38). aziakpono (1999) has argued in his analytical review of the theoretical and empirical relationship between financial liberalization, savings and currency substitution that in countries with currency substitution, the interest rate, per se, may not be the only crucial variable in the process of financial liberalization. other determinants, such as the differential between domestic and foreign interest rates, macroeconomic stability and exchange rate may prove very crucial for the success of financial liberalization. in this paper we provide further evidence on the issue. specifically, we advance the argument in aziakpono (1999) by empirically exploring the relationship between financial liberalization, savings and currency substitution using quarterly data between 1980 and 1998 from nigeria. the rest of the paper is organized into five sections. section two provides some facts about the nigerian economy. section three reviews the literature on the relationship between financial liberalization, currency substitution and saving. in section four we provide the framework for the empirical analysis. section five contains empirical results, and we conclude with section six. 2 some facts on the nigerian economy 2.1 financial sector reforms as part of the structural adjustment programme (sap), the nigerian government, in 1986, initiated a large scale restructuring of the financial system. in general, according to oresotu (1992), the financial sector reforms could be conveniently classified into three categories: reforms for the improvement of the financial structure, reforms designed to improve monetary management, and reforms to strengthen capital movements and the foreign exchange market. we briefly highlight the first two here. 2.1.1 reform of the financial structure a major policy thrust was directed at the expansion of the financial sector. there was a deliberate effort to encourage the emergence of new institutions and the expansion of existing ones. in the banking sub-sector, the procedure for licensing new banks was eased. as a result, the number of commercial banks rose rapidly from 28 in 1985 to 66 with over 2358 branches, at the end of 1993. the number of merchant banks rose even faster, from 12 in 1985 to 53, with 124 branches, at the end of 1993. as a measure to protect banks with an inadequate capital base, the nigerian government raised the minimum paid-up capital of commercial and merchant banks to n50 and n40 million, respectively sajems ns 7 (2004) no 2 319 (cbn, 1993). efforts were also made to recapitalize insolvent banks and solve the problem of non-performing assets, in order to restore confidence in the banking system. moreover, to ensure safe and sound banking, prudential guidelines and strengthened banking supervision were put in place to minimize the occurrence of non-performing assets. an important element of the prudential guidelines consisted of bringing capital adequacy ratios in line with international standards, and allowing provisions for non-performing assets. 2.1.2 monetary policy reform initial steps adopted included the rationalization of credit controls. the sectorspecific credit distribution targets were streamlined with a view to giving banks great discretion in the sectoral allocation of credit. a major monetary policy measure was the deregulation of interest rates, which was carried out in stages. the initial gradual upward shifts in bank lending rates were followed by changes in the minimum rediscount rate (mrr). for instance, the mrr, which was fixed at 15 per cent in august 1987, was reduced to 12.75 per cent in december of the same year. during the same period, the saving deposit rate of commercial banks, on the average, was 11.5 per cent and the interest rate paid by merchant banks on 90-day funds was 15 per cent. the prime lending rates of commercial and merchant banks were, on the average, 18.0 and 20.5 per cent respectively, while their corresponding maximum lending rates were 19.2 and 22.0 per cent. following the need to moderate monetary expansion in 1989, the mrr was raised to 13.25 per cent (oresotu, 1993). another policy element in the determination of interest rates was the fixing of the spread between the saving deposit rates and the prime lending rate as well as the margin between the prime and the maximum lending rates. subsequently, the spread between the saving deposit rates and lending rates was fixed at seven percentage basis point. also, the margin between the prime and the maximum lending rates for each bank was fixed at400 basis points, while the inter-bank rates were to be at least 100 basis points below the prime lending rates. in 1991, the cbn fixed a maximum spread of 400 basis points between the cost of funds of commercial and merchant banks and their lending rate. the banks were also directed to observe a maximum lending rate of 21 per cent and a minimum deposit rate of 13.5 per cent. however, the ceiling on interest rates was removed in february 1992. this policy was renewed in 1993. some measure of regulation was reintroduced into interest rate management in 1994 because of the wide variation and high rates observed following complete deregulation (oresotu, 1993). deposit rates were set at 12 to 15 per cent per annum, while a ceiling of 21 per cent was fixed for lending. however, the sajems ns 7 (2004) no 2 320 changes in interest rate management were significantly different from what prevailed during the era of regulation. first, the new policy allowed for a band within which deposit interest rates could be negotiated. secondly, lending rates, unlike in the past, were not specified for activity sectors. negotiation up to a limit of 21 per cent per annum was allowed for. 2.2 response of selected macroeconomic and financial indicators 2.2.1 financial savings financial savings grew in the years following the financial reform measures. between 1980 and 1986 before the reform measures were introduced, the stock of financial savings (sfs) stood, on average, at 1.4 per cent of the gdp annually. with the adoption of the reform measures (1987-1994) the sfs rose to an annual average of 2.8 per cent of the gdp, a 100 per cent growth rate in comparison to the previous period (1980-1986). the deregulation of interest rates appears to have encouraged the rapid growth in financial savings. as can be seen from table 1, the deposit rate (savings) averaged 15.53 per cent per year between 1987 and 1994 compared to the period between 1980 and 1986 (prior to reform), when the interest rate on savings averaged just 7.93 per cent. 2.2.2 gross national savings and the leakage gross national saving (gns) is gross domestic income net of consumption. when compared with the response in financial savings, gns recorded a higher growth rate during the period of reform. the difference was accounted for by the leakage from the formal financial sector, which also experienced a tremendous growth during the period of the reform, as can be seen from table 1. hence, while the economic reforms of the sap era may have brought about increased national savings, much of the savings was held outside the formal financial system. a closer look at the figures in the table show that the proportion of domestic savings held outside the formal financial system increased further during the reform era. for instance, before the reforms, the share of the leakage in total savings was about 70 per cent, while that of financial savings was about 18 per cent. however, with the reforms in place, the share of the leakage rose to 80.4 per cent, while that of financial savings rose to 19.6 per cent. one of the macroeconomic variables associated with changes in the policy regime was inflation. as can be seen from the table 1, inflation was sporadic during the period of reform, which provided a very unstable macroeconomic environment. also, the exchange rate of the naira in relation to other major currencies depreciated significantly during the period. while the official sajems ns 7 (2004) no 2 321 exchange rate may indicate a moderate depreciation, the prevailing rates were far lower than the declared official rates. these developments may lead to the phenomenon of currency substitution, a subject we turn to next. table 1 selected macroeconomic and financial indicators year sfs/ gdp % ffs/ gdp % gds/ gdp % le/ gdp % ex rater inf rate % sav. dep. rate % lending rate % prime max 1980 3.2 11 22 18.8 0.5464 9.9 6 7.5 9.5 1981 1.6 13 11 9.5 0.61 20.9 6 7.75 10 1982 1.8 15 8 6.2 0.673 7.7 7.5 10.25 11.75 1983 -3.4 17 6.3 2.9 0.724 23.2 5 10 11.5 1984 2.4 17 4.2 1.8 0.765 39.6 9.5 12.5 13 1985 2.1 17 5.5 3.3 0.894 5.5 9.5 9.25 11.75 1986 1.9 19 -2.1 -4.0 2.021 5.4 9.5 10.5 12 1987 4.4 17 3.3 -1.1 4.018 10.2 14 17.5 19.2 1988 3.2 16 9.6 6.5 4.537 38.3 14.5 16.5 17.6 1989 0.3 11 26.7 26.5 7.392 40.9 16.4 26.8 24.6 1990 2.2 11 28.9 26.6 8.038 7.5 18.8 25.5 27.7 1991 2.5 12 22.2 19.7 9.91 13 14.29 20.01 20.8 1992 3.1 10 13.4 10.3 17.299 44.5 16.1 29.8 31.2 1993 4.1 12 6.4 2.3 22.051 57.2 16.66 36.09 39.06 1994 2.8 12 3.6 0.9 21.886 57 13.5 21 21 1995 -0.04 5 -3.6 -3.6 67.66 72.8 12.61 20.18 20.79 1996 1.0 5 5.8 4.8 81.253 29.3 11.69 19.74 20.86 1997 1.5 6 9.8 8.7 81.649 15.1 4.8 13.54 23.32 1998 1.3 8 -5.7 -7.0 83.807 7.9 10.04 18.36 21.41 average 1980 -86 1.4 15 7.8 5.5 0.8904 16.02 7.93 9.68 11.36 1987 -94 2.8 12.6 14.3 11.5 11.891 33.76 15.53 24.15 22.55 1995 -98 0.94 6 1.6 0.73 78.592 31.2 9.79 17.96 21.6 note: the leakage (le) is the difference between gns and sfs (le = gnssfs). the sfs is the difference between the flow of financial savings of the current year and that of the previous year (sfst = ffst – ffst-1). er is the nominal exchange rate of the naira to us dollar. source: central bank of nigeria (1998) sajems ns 7 (2004) no 2 322 3 currency substitution: concept and implication on savings el-evian (1988) defined currency substitution as a phenomenon in which foreign-currency-denominated money has replaced, either wholly or in part, domestic money in serving as store of value, medium of exchange, and unit of account. this reflects the individual’s attempt to protect the value of his or her wealth in the context of deteriorating economic and financial conditions that adversely affect the return on holdings of domestic money relative to those on foreign-currency-denominated money balances, as well as changes in the political and institutional environments that influence expectations regarding the absolute and relative liquidity of domestic and foreign currency denominated assets. currency substitution covers a wide variety of possibilities, such as holding foreign currency deposits in the domestic financial system, foreign money held abroad by domestic residents and foreign currency notes circulating within domestic boarders (hussain, 1996). according to hussain (1996) currency substitution can be grouped into two types: the first is the formal component, which includes authorized foreign currency bank deposits in the domestic financial system. the second is the informal component, which comprises the unauthorized holding of foreign exchange inside and outside the country. in developing countries, which are often affected by currency substitution, it is often the case that the formal and the informal components co-exist and interrelate. foreign fiat money is observed to shift between these components, with the direction and magnitude of change depending on the macro-economic and political environment. if the macro-economic and political environment is perceived to be unstable, foreign exchange tends to shift from formal foreign currency deposits to the black market and household hoarding. capital flight, which is normally financed by drawing on foreign exchange bank deposits and/or foreign fiat money circulating in the black market, will also increase. this will tend to reduce savings held in the normal financial system (financial savings). if the environment is perceived to be stable, the shifts will be reversed, reducing the size of the black market and household foreign exchange hoarding and encouraging the return of capital, which will tend to increase financial savings (ramirez-rojas, 1985). thus, irrespective of movements in interest rates, financial savings are affected by factors promoting currency substitution. foreign currency deposits, the black market for foreign exchange, foreign exchange hoarding by households and capital flight all originate from the general lack of credibility of the overall macroeconomic policy, ultimately reflected in a lack of confidence in the domestic currency. these phenomena, as sajems ns 7 (2004) no 2 323 noted by hussain (1996) are often associated with successive devaluations of the official exchange rate, inadequate real interest rates, the existence of capital controls and rampant inflation caused by excessive money supply or excessive government expenditure. many developing countries have experienced that growth in the black market for foreign exchange and foreign currency hoarding outside banks actually force the authorities to grant residents the right to hold foreign currency deposits in the domestic financial system. but, as experience has also shown, foreign currency deposits in the domestic financial system are under greater control by the authorities than the foreign fiat money hoarded outside banks, or the foreign currency deposits held as accounts abroad. thus, as pointed out by hussain (1996), granting residents the right to open foreign currency deposits in the domestic financial system often fails to eradicate the black market for foreign exchange, or contain capital flight. as long as the fundamental factors that encouraged currency substitution (such as macroeconomic and exchange rate instability) remain uncorrected, foreign currency deposits are unlikely to contain the informal component of currency substitution or offset and prevent outflows of hard currency. the holders of foreign currency deposits in the domestic financial system usually have the right to withdraw the amount deposited in the same foreign currency as the initial deposit, which represents a potential leakage (outflow) to foreign countries or to the domestic black market. empirical investigations of the impact of currency substitution on savings have not been carried out for many developing countries. a few exceptions include egypt (hussain, 1996 and el-evian, 1988); yemen arab republic (el-evian, 1988)2 and argentina, mexico, and uruguay (ramirez-rojas, 1985). hussain’s (1996) results are particularly striking. these reveal that a strong negative relationship exists between the variable that is used as a proxy for currency substitution (interest rate differential and inflation rate differential) and saving (both financial and domestic savings). 4 analytical framework in this section, we are interested in examining how financial saving; total saving and the leakage react to a given set of determinants, with special reference to the role of the real interest rate. the three models are specified thusly: ( ) −+−+−+ = 2,1,1/,ln,,ln dumdummcrgdprirdrirnfrfs (1) sajems ns 7 (2004) no 2 324 ( ) +−++− = 2,1,1/,,ln dumdummcrirdrirnfrle (2) ( ) −++−+− = 2,1,ln,,ln / dumdumrgdpinfdrirnfgns (3) where in denotes the natural logarithm of the relevant variable. the definition and measurement of variables are provided in the data appendix. 4.1.1 financial saving function the financial saving function (equation 1) is expressed as a function of the real interest rate, the real interest rate differential, real income, a proxy for underground economy and two dummy variables. it is expected that financial savings (fs) will be positively related to real income ( ). this is based on keynes’ absolute income hypothesis, in which the average propensity to save rises with per capita income. it is also positively related to the real rate of interest ( ) in line with the financial liberalization argument. because of the important role played by currency substitution (especially the informal component) and capital flight in the nigerian economy, an attempt is made to estimate the effect of these factors on financial savings. this is done by including, as an independent variable, the differential between the real interest rate in nigeria ( ) and real interest rate in the united states of america ( ), that is, rgdp rirn rirn rirus rird . a similar variable was used in hussain (1996) for the case of egypt. since substitution between domestic currency and foreign currency deposits should leave total saving unchanged, a positive coefficient on the differential implies that increases in the differential attract additional resources from the components of the leakage, including the black market for foreign exchange and the return of flight capital. also, because of the importance of underground activities, particularly the black market for foreign exchange dealings, the proportion of narrow money (m1) held as currency outside banks (c) is included as an independent variable. this ratio is commonly accepted as a measure of the activity of the informal credit market (serieux, 1993, and shaw, 1973). it can also be used to reflect the activities of the black market for foreign exchange and the underground economy (see hussain, 1996, as example). in our study we followed the latter application of the ratio. financial saving is negatively related to the proxy measuring the activities of the underground economy, since such activities in the underground economy require large amounts of cash to be held outside the banking system. the first dummy ( ) attempts to measure the effects of the shift in financial policies. a significant positive coefficient of this dummy indicates a shift in the savings behaviour following reform. the second dummy ( ) is introduced to capture the effects of political instability in the country on financial savings. it is believed that political instability, especially since the 1dum 2dum sajems ns 7 (2004) no 2 325 annulment of the presidential election on june 12, 1993, would negatively affect financial savings. 4.1.2 the leakage function besides the real interest rate ( ), which measures the opportunity cost of holding money outside the financial system, the leakage function includes the real interest rate differential ( rirn rird ) and the proxy for measuring the activities of the underground economy ( ) as well as the exchange rate of naira ( ). the leakage ( 1/ mc er le ) is negatively related to the real interest rate, since an increase in the real interest rate would increase the opportunity cost of holding money outside the formal financial system. the differential real interest rate is positively related to the leakage. as economic agents try to maximize their gains, they will prefer to save their funds where returns are highest, all thing being equal. hence, lower domestic compared to foreign real interest rates would lead to increase in capital flight as economic agents seek to maximize their gains. similarly, the leakage is positively related to the proxy measuring the activities of the underground economy and the exchange rate3. also, the political instability will lead to increase in the leakage, while financial reform is expected to reduce the leakage. 4.1.3 total national savings function it is hypothesized that real national savings ( ) is positively related to real income ( ), based on keynes absolute income hypothesis. the other variables incorporate relevant non-keynesian theories of saving behaviour. for instance, the inflation differential between nigeria and the united states of america ( ), a proxy for macroeconomic instability, is introduced on the assumption that the higher the macroeconomic instability the lower the domestic savings will be. lastly, the real interest rate ( ) is introduced. however, whether total saving is positively or negatively related to the real interest rate, will depend on the relative strength of the income and substitution effects of changes in the rate of interest (warman & thirlwal, 1994). the dummies are expected to have effects similar to that on financial savings, except that the channel of effect for political instability on domestic savings is through its effect on domestic income. tgns rgdp infd rirn 4.2 econometric procedures in this study we employed cointegration and vector error correction using the johansen (1991) approach. this is preferred to the engle-granger (1987) approach because the latter is based on the assumption that there exists only one cointegrating vector that connects the cointegrated variables. under the sajems ns 7 (2004) no 2 326 assumption of one cointegrating vector, ols estimation applicable to the cointegrating equation will give consistent estimates (seddighi et al., 2000). however, as argued by seddighi et al. (2000: 297), in the case where there is more than one cointegrating vector the engle-granger methodology is no longer valid, because it produces inconsistent estimates. since our models are multivariate, there is a likelihood of having more than one cointegrating vector. in implementing the johansen methodology, we followed the “general to specific” modeling framework as suggested by hendry et al.4 as against the “specific to general” traditional approach. the “general to specific” framework has become increasingly popular since the 1990s. the framework starts with the specification of a very general model with over-parameterization and then, using different tests, reduces the model to the most parsimonious one. specifically, we followed the 8-step procedure outlined in seddighi et al. (2000: 303-5). the estimation begins with unit root tests to confirm that all the variables of the model are suitable to be included for cointegration. the next step is to formulate and estimate the appropriate var model. thereafter, suitable trace tests and maximum eigenvalue tests can be undertaken to identify the number of cointegrating vectors in the model. then, the long-run estimation (cointegrating regression) is obtained from the normalized coefficients of the model generated from the cointegrating vector. lastly, the short run vecm is estimated. for the sake of space, we do not fully discuss the steps here, however, some of the relevant issues involved in the steps are highlighted (interested readers are directed to seddighi et al., 2000). 4.2.1 testing for unit root in testing for unit root the most commonly used methods in the literature are the dickey-fuller (df); augmented dickey-fuller (adf) and the phillip-perron (pp). though these methods have been criticized for their low power and size distortions5 they have continued to be routinely used in most analyses due to their availability in most econometrics software packages. in this study, we also employ the df and adf for this obvious reason. several authors have presented sequential procedures within the “general to specific” framework for testing unit roots if the data generating process (dgp) is not known (see holden & perman, 1994 and enders, 1995)6. a modified mixture of these sequential procedures is also outlined in seddighi et al. (2000: 274-75). two issues are, however, of concern to us, here namely: (1) determining the appropriate lag length of the differenced term, and (2) determining the dgp or what is often referred to as conditional hypothesis testing in unit root tests. we briefly describe the methods used in this study below. sajems ns 7 (2004) no 2 327 given an adf model as follows: ∑ − −− +∆+++=∆ q j tjtjtt xxtx 2 1 εδδβα (4) where is the difference operator, ∆ α is the constant term or the drift, β is the linear deterministic trend (or time trend) and t is time, and ε is a white noise error term. equation (4) is the adf, but when the difference term in the right hand side (rhs) is not included, the adf reduces to a df model. in either case, the series is said to be stationary if the coefficient 0=δ using the τ statistic7. the first problem relates to whether the α and/or β in the model is individually significant. this is the test of conditional hypothesis for unit root. dickey and fuller (1981) provided three symmetric critical ijτ values 8 called pατ , αβτ and pατ , for testing the drift parameter α and the linear trend parameter β , conditionally upon 0=δ . these conditional hypotheses are the following: (a) using equation (4) without the difference term: ho: 0=α given that ,0=δ if | t | < | pατ | ha: 0≠α given that ,0=δ if | t | > | pατ | (b) using equation (4) without the difference term: ho: 0=β given that ,0=δ , if | | < | t αβτ | ha: 0≠β given that ,0=δ if | | > |t αβτ | (c) using equation (4) without the difference and the linear trend terms: ho: 0=α given that ,0=δ if | t | < | pατ | ha: 0≠α given that ,0=δ if | t | > | pατ | seddighi et al. (2000). the second problem relates to finding the proper number of the differenced terms to be included in equation (4). two criteria are used in this study. these are: schwarz (sic) and akaike (aic), and they are information criteria based on the minimization of an objective function. in model selection the principle is that the smaller the value of the information criteria, the better the model. comparing the two criteria, the schwarz is more restrictive than the akaike (deserres & guay, 1995). also, shibata (1976) has shown that, for a univariate finite order ar process, aic asymptotically overestimates the order with positive probability, whereas schwarz provides a consistent estimator asymptotically with probability 1. these results are also valid in a var case (deserres & guay, 1995). in our analysis, therefore, where there are conflicting results between the two methods, we based our decision on the schwarz criterion. sajems ns 7 (2004) no 2 328 4.2.2 the cointegrating system the johansen procedure applies maximum likelihood to the var model, assuming that the errors are white noise (maddala & kim, 1998). typically, the general infinite var representation is ttit it itt zxbxx ερ ++∆+π=∆ − ∞ = − ∑1 (5) where is a vector of variables, tx ( )1i tx∆ are all ( )0i and 0=π if there is no cointegration, and tz is a vector of deterministic variables. however, to estimate the system, we need to fit a finite autoregression of order : k tktit k it itt zxbxx ερ ++∆+π=∆ − = − ∑1 (6) since 1.... +−∆∆ ktt xx are all but is ( )0i tx ( )1i , in order that this equation is consistent, should not be of full rank. let its rank be r. then we have: iπ 'αβ=πi (7) where α is an rn × matrix and is an 'β nr × matrix. then are the 1 ' −txβ r cointegrated variables, is the matrix of coefficients of the cointegrating vectors and 'β α has the interpretation of the matrix of error correction terms9. in estimating equation (6) one needs to determine the appropriate order of the var. in our analysis we used three criteria to do this. the first two are the schwarz and akaike information criteria, as discussed above. next, we consider a sequential test for the significance of the coefficients on lags. the commonly used sequential tests are the wald statistic and the lr statistic (deserres & guay, 1995). we employed the likelihood ratio (lr) test, which depends on the usual likelihood ratio statistic given by: ( )k ( )( )[ ] (( ) )jpnxkctlr jp −ω−ω−= 22~lnln (8) where is a correction factor equal to the number of variables in each unrestricted equation in the var, ( )kc t is the number of observations, n is the number of estimated parameters in the var, pωln is the log of likelihood of the complete coefficients (unrestricted equation) and jωln is the log of likelihood of the smaller coefficients (restricted) equation. while ( )jpn −2 is the number of restrictions imposed (deserres & guay, 1995). assuming the coefficients of a var (k) model, the corresponding lagged variables are given by the matrix ( )kaaaa ..., 21= . the test works by testing in sajems ns 7 (2004) no 2 329 a sequence, the following hypotheses, starting from a large assumed lag length k. 0:0: ≠= kako avshah 0:.0: 110 ≠= −− kak ahvsah given that ak = 0 given that 0:0: 220 ≠= −− kak avshah 01 == −kk aa …. given that 0:.0: 110 ≠= ahvsah a 0... 21 ==== − aaa kk (9) the test stops when a null hypothesis is rejected using the lr statistic and the var order , for , is selected accordingly (holden & perman, 1994; and seddighi et al., 2000). q 1≥≥ qk using the appropriate lags, the var model is estimated, which we then used to test for the rank of cointegration. in order to obtain the cointegrating relations, we adopted the normalization performed by e-views, but first we arranged the variables such that the dependent variable comes first. we also explored the five deterministic trend assumptions. however, our final decision on deterministic variables to include was based on our findings from the unit root tests, in which case, if some of the series have an intercept and/or a trend, then we include the intercept and/or trend terms in the var model. this principle was also followed in our vecm. 5 empirical results 5.1 unit root results as noted earlier, the analysis begins with the testing of each variable for a unit root. the results are presented in table 2. for each variable we reported the results of the tests for the conditional hypotheses, whether the variable has a drift and/or a deterministic trend, the value at which the null hypothesis for unit root was rejected and the corresponding test level (whether the variable was in level or first difference form), and the appropriate lag length at which the aic and sic criteria were satisfied with their corresponding values. lastly, the table contains the relevant durbin-watson statistic and the order of integration i (d) of each variable. as can be seen from table 2, all the variables are first difference stationary, that is, they are i(1), except for the inflation variables which are i(0). the fact that inflation variables are stationary is not surprising since they are rate of changes in cpis, which means they have been differenced already. of all the variables, sajems ns 7 (2004) no 2 330 only the log of real gdp contains a significant positive drift. similarly, the real interest rate (deposit) in nigeria has a significant positive trend. thus, apart from these two cases, we could not reject the conditional hypotheses as specified earlier. the variables also reflect different lag lengths ranging from zero lag to three lags. the reported lags correspond to the values where the two information criteria were at a minimum. table 2 unit root result variable trend drift station ary level 1st diff d.w aic sc lag diff order of integ 1 2 3 4 5 6 7 8 9 10 11 lnrfs x +3 -4.945 3 1.981 -2.55 -2.48 1 1 lnrgn s x x -8.311 3 2.029 3.95 3.98 0 1 rirn + 3 x -11.2 3 2.088 6.51 6.57 1 1 lnrle x x -6.893 3 1.976 1.811 1.842 0 1 infd x x -3.979 3 1.99 6.54 6.57 0 0 infd x x -8.771 3 1.998 6.359 6.45 2 1 er x x -8.275 3 2.007 7.557 7.587 0 1 rird x x -2.679 3 2.022 6.49 6.62 3 0 rird x x -10.8 3 2.056 6.577 6.638 1 1 c/m1 x x -11.07 3 2.051 3.938 3.901 0 1 lnrgd p x +3 -4.683 3 2.007 1.065 1.187 2 1 note: the values reported as stationary are the values at which the hypothesis of unit root was rejected with the adf test at 1 per cent level of significance. 5.2 cointegration analysis and long-run relationships the var models estimated correspond with equations (1), (2) and (3) separately. for equation (1), the financial saving function, the var model consists of five variables, namely: log of real financial savings ( ), log of real income ( ), real interest rates in nigeria ( ), real interest rate differential ( rfsln rgdpln rirn rird ) and the ratio of currency held outside banks to m1 ( ). the dummy variables were not included at this stage, because we felt that they will most likely affect the short run relationship between these variables. in the leakage function, the var model also has five variables, viz: the log of real leakage ( 1/ mc rleln ), real interest rate in nigeria ( ), exchange rate ( ), the real interest rate differential ( rirn er rird ) and the ratio of currency held outside bank to m1 ( ). while in the third model, the gns function, four variables were 1/ mc sajems ns 7 (2004) no 2 331 included in the var. these are, real interest rate in nigeria (rirn), inflation differential between nigeria and the united state of america ( ), and the log of real income ( ). infd rgdpln the estimation of each model was carried out using the e-views in version 3.1. the lag length selection procedures used are the general to specific rule and the two information criteria, schwarz (sic) and the akaike (aic) as explained above. in estimating the models we experimented with the five deterministic trend assumptions as indicated in e-views10. table 3 below reports the number of cointegrating vectors corresponding to the different lag lengths and the fourth assumption for two of the models. in the financial savings function two lag lengths, one and five, were chosen on the basis of the diagnostic tests. on the basis of the sic criterion, one lag was chosen, while the other two led to the choice of five lags. as noted earlier, the choice of a particular assumption should depend to a large extent on the dgp of the series involved. thus, since in our unit root test results, two variables, and possessed a positive drift and deterministic trend, respectively, we run the cointegration test using assumption 4, that is, we assumed that both series x and the cointegrating equations have linear trends. this seems to be justified, since macroeconomic variables have a tendency to increase over time. corresponding to the lag length one, the test indicates one cointegrating relation, while five lags indicate at least two cointegrating relations. rgdpln rirn table 3 johansen cointegration test variable no. of lag length by selection criteria no. of cointegrating vectors by lag length lnrfs aic 5 sic 1 lr 5 2 1 2 lnrle aic 4 sic 1 lr 4 1 0 1 lngns aic 4 sic 1 lr 1 1 1 1 note: the numbers of cointegrating vectors were determined on the basis of the trace statistic, and the hypothesis of no cointegration rejected at a 5 per cent significance level sajems ns 7 (2004) no 2 332 in the case of the leakage function, the diagnostic tests led to the choice of four lags. the cointegration test based on assumption three11, indicates only one cointegrating relation (table 3). the diagnostic test in the third var model (the gross national saving function) resulted in the choice of two lag lengths, one and four lags. the test was based on assumption four, since two of the variables, and , have a drift and trend respectively. also, for this model one cointegrating vector was found. rgdpln rirn 5.2.1 the cointegration regression the results of the cointegrating regressions, that is, the long-run relationships are presented in table 4. these were obtained from the first normalized coefficients associated with the unique cointegrating vector. 5.2.2 financial savings one normalized equation of the financial savings function is reported in table 4. the model performed well in terms of the expected signs and significance of the variables12. the income elasticity in this model is positive and significant at 5 per cent. its magnitude is also high, showing that financial saving has a highincome elasticity. the rird has a significant negative coefficient. this coefficient shows that holding other things constant, financial savings changes by about 25 per cent for every one per cent change in the differential of real interest rates between nigeria and the united state of america. the negative coefficient implies that a higher real interest rate in the united states of america, will lead to an increase in the components of the leakage, including the black market for foreign exchange and capital flight. the coefficient of the rirn shows that, holding other factors constant, a one per cent increase in the interest rate will lead to a 20 per cent increase in financial savings. the coefficient was significant at 10 per cent, which lends support to the liberalization argument. the proxy measuring the activities of the underground economy has the expected negative sign although the coefficient is not significant. 5.2.3 the leakage as expected, the leakage is negatively related to the rirn, but positively related to the rird and the proxy measuring the activities of the underground economy. the coefficient of the rirn implies that a one per cent increase in the real interest rate will lead to an approximately 17 per cent leakage reduction. importantly, however, this result is not significant at the standard levels of significance. the coefficient on the proxy for underground economy was significant at 1 per cent. the coefficient of rird was also significant, but at 5 sajems ns 7 (2004) no 2 333 per cent. the results show that there is a long-run relationship between the leakage, the proxy for the underground economy and the rird. the coefficient of the exchange rate has a negative sign, but was not significant. as noted earlier this may be due to the fact that the official exchange rate does not often reflect the prevailing rates. 5.2.4 total domestic savings two of the normalized equations of the total domestic savings model are reported in table 4. the first was based on the var of order one, while the second was based on the var of order four. the first performed better in terms of the expected signs and significance of the parameters. real income proves to be the most important determinant of total domestic savings, dominating the equation with a large coefficient and very high t-ratio, significant at 5 per cent. the estimated income elasticity of total domestic savings is very large. this large income elasticity of saving suggests a rising ratio of total domestic saving to income over the long term. the coefficient of the infd, which measures overall macro-economic stability/instability, is negative and highly significant. a one per cent increase in the differential, keeping other things constant, causes total domestic savings to fall by about 49 per cent. the coefficient of the rirn is positive, in line with the financial liberalization argument, but the coefficient is small in magnitude and statistically insignificant. 5.3 the vecm results based on the numbers of the cointegrating vectors and their corresponding lags obtained in the earlier stage, the vecms for each of the models (financial savings, leakage and total domestic savings) were estimated. the deterministic trend assumptions used are the same as the ones employed in the cointegration regression, and they were based on the presumed dgp, as explained above. the summary of the results is presented in table 5. in this brief analysis we focus on the coefficients of the dummies. as shown in table 5, the dummies in most of the models have the expected signs, but often were not significant. the dummy for financial reforms (dum1) in the financial savings function was positive in the two specifications. however, it was only significant at 5 per cent when the model with two cointegrating vectors and five lags was employed. the coefficient of the second dummy (representing the effect of political instability on financial saving) shows, as expected, that political instability in the economy affected financial savings negatively. it was, however not significant at the standard levels. sajems ns 7 (2004) no 2 334 table 4 cointegration regressions: lnrstfs; lnrle; & lngns dep var lag c trend c/m1 rird lnrgdp rirn er infd ll lnrfs 1 9.615 0.0299 (2.295)** -1.29942 (-0.2055) -0.2509 (-2.543)** 3.1002 (2.711)** 0.2036 (1.9306)* -242.55 lnrle 4 28.81 6.2178 (5.013)** 0.21514 (2.455)** -0.1756 -0.014 (-1.7564) (-0.49) -327.29 lngns 1 28.65 -0.039 (-1.28) 6.6713 0.2772 (2.239)** (1.6941) -0.489 (-2.546)** -531.79 lngns 2 87.74 -0.0278 (-0.699) 17.916 -0.1145 (2.238)** (-0.553) -0.5861 -503.08 (-2.077)** note: ** significant at 5 per cent level and * significant at 10 per cent level. values in parenthesis are the t-value. sajems ns 7 (2004) no 2 335 table 5 vector error correction model, rfsln rleln and rgnsln variable rfsln rfsln rleln rgnsln rgnsln model 1 2 3 4 5 ecm1 -0.0879 (-3.965)a -0.3359 (-3.119)a -0.0057 (-1.711)c -0.1277 (-2.962)a -0.369 (-3.991)a ecm2 -0.0065 (-1.20) c -0.069 (-1.133) 0.1262 (1.361) -0.4859 (-2.023)b -0.3878 (-0.997) -0.362 (-0.981) dum1 0.00112 (0.014) 0.2683 (2.387)b -0.7588 (-0.961) 0.3628 (0.708) 0.0276 (0.059) dum2 -0.0872 (-0.035) -0.0551 (-0.469) 0.7243 (2.332)b 0.4567 (0.921) 0.575 (1.178) adj.r2 0.3912 0.5487 0.0435 0.1307 0.2601 f-statistic 6.7826 3.8508 1.1425 1.165 1.641 note a significant at 1 per cent; b significant at 5 per cent; and c significant at 10 per cent. model 1 used one lag; model 2 used five lags; model 3 used four lags; model 4 used one lag and model 5 used four lags. values in parenthesis are the t-value. the coefficients of the dummies had the appropriate signs in the leakage function indicating that financial reforms negatively affect the leakage while political instability encourages the leakage, although it was only the coefficient of the political instability dummy that was significant (at 5 per cent). thus, it is apparent that, while financial reforms have the potential to reduce the leakage from the formal financial system, a desired result can only be achieved if there is stable political and macroeconomic environment. finally, the coefficients on the dummies in the case of total domestic savings did not behave in line with expectations, and importantly, were not significant. 6 policy implications of the results and conclusions the results indicate that, with regards to currency substitution, both the real interest rate and the interest rate differential are important. increasing financial saving and reducing the leakage from the formal financial sector will require not only an increase in the real interest rate on domestic currency deposits, but also the maintenance of the real interest rate on domestic currency deposits which are higher than the real return on foreign currency deposits and the expected real return on foreign assets. high real interest rates, however, might attract sajems ns 7 (2004) no 2 336 excessive capital inflows, jeopardize monetary control and discourage investment (hussain, 1996). also, given the important role of macroeconomic and political stability in the process of savings mobilization, it is important that the achievement of these should be a matter of priority. over the short term, where macroeconomic and political stability are given high priority, improving the efficiency of investment and enhancing investment by increasing the maturity of loanable funds may check the negative effects of high interest rates. in the medium to long term and following the restoration of macroeconomic and political stability, the interest rates might be allowed to fall gradually. the appropriate interest rate would not discourage investment or encourage currency substitution and capital flight. in addition to a prudent interest rate policy, the dangers of expanding the leakage (and its components) can be averted through the development of a capital market and the propagation of alternative financial vessels such as stocks, corporate bonds and government securities. these financial vessels will provide good alternatives to holding foreign fiat money and allow savers to diversify their portfolios and minimize their risk of holding financial assets denominated in domestic currency. however, such measures must be combined with macroeconomic policies that tend to create a stable economic environment and adopt appropriate financial and exchange rate policies in order to reduce the incentives for economic agents to prefer foreign denominated assets to domestic currency assets. this is because, under such policies, inflation rates, exchange rate depreciation, and interest rate instability will be minimized while the growth of real income will be stable. endnotes 1 the authors would like to thank the two anonymous referees of this paper for their valuable comments. they are also grateful to mr david croome for his useful comments on the initial version of this paper. in addition, comments by participants at the 8th annual conference of the african econometrics society have been very useful in revising the paper. however, the usual disclaimer applies. 2 el-evian (1988) is a comparative study of egypt and yemen arab republic. 3 the black market premium (the difference between the black market and official exchange rate should be the most appropriate here, and it should be positively related to the leakage. the difficulty of obtaining reliable data on the black market rate compels us to use the official rate. 4 see hendry and mizon (1978), hendry and richard (1982, 1983). sajems ns 7 (2004) no 2 337 5 see maddala and kim (1998), chapter four, for a detailed discussion of these and other problems relating to these testing methods for unit roots. 6 the interested reader may consult the latter reference for details. 7 both dickey and fuller (1979) and mackinnon (1991) have tabulated critical values for the tδ statistic which they call the ‘τ (tau) statistic, for testing the hypothesis of unit root. 8 the table of these critical values is reproduced in seddighi et al. (2000: 272). 9 this is granger’s representation theorem. 10 the five deterministic trend assumptions are: (1) series x has no deterministic trend and the cointegrating equations do not have intercepts; (2) series x has no deterministic trend and the cointegrating equations have intercepts; (3) series x has linear trends but the cointegrating equations have only intercepts; (4) both series x and the cointegrating equations have linear trends; and (5) series x has quadratic trends and the cointegrationg equations have linear trends. 11 preliminary experiments show this assumption to be the most valid one. for instance, the coefficient of the trend variable was insignificant. this is also in harmony with unit root tests, which indicate that all the variables in the model, except rirn, are without a constant or a deterministic trend. 12 an alternative model with five lag lengths was also estimated, however, the model did not perform well in terms of the expected signs and the significance of the variables, hence it is not reported here. sajems ns 7 (2004) no 2 338 data appendix: data measurement and sources the data used for the regression equations are defined and measured as follows: financial savings ( ): this is the sum of savings and time deposits with commercial and merchant banks, the national provident fund, savings at the federal savings bank and the federal mortgage banks and premium bonds, savings certificates and savings stamps. since saving is a flow, financial savings is measured by the change in the flow of total financial saving, i.e. fs fs∆ , and then deflated using the consumer price index to obtain the real financial saving for each period. the data for financial savings was obtained from the central bank of nigeria (cbn) statistical bulletin. gross national savings (gns) is the residual from what is consumed of gross disposable income from the agricultural, industrial, mining and petroleum, retail trade and other sectors of the economy. this is measured in million naira at 1990 constant prices and was obtained from the cbn statistical bulletin. the leakage ( le ) is defined as the difference between total savings (gns) and the financial saving, as measured above, i.e. le = ∆(gns fs). real interest rate ( rir ) is measured as the difference between nominal interest rate and the inflation rate: and represent real in nigeria and usa respectively. it is expressed as percentage points. the deposit interest rate was used as reported in the imf international financial statistics (ifs). inflation ( ) is the rate of change in consumer price index (cpi) using 1990 as the base year; it was also obtained from the ifs. the nominal variables were deflated using this index. inflation differential ( ) is the difference between inflation rate in nigeria and the united states of america as a proxy for macroeconomic instability. is the ratio of currency held outside banks to m1, a proxy for the underground economy, where m1 is the narrow definition of money (currency plus demand deposits) and were obtained from the ifs. income is the real gdp at 1990 constant prices from the cbn statistical bulletin. exchange rate is the official nominal exchange rate (naria/1us$) as reported in ifs. is a dummy variable representing the effects of financial reform, it assumes the value of one for the period 1987 to 1998 and zero otherwise. is a dummy variable representing the influence of political instability and it assumes a value of one for the period 1993: 3 to 1998 and zero otherwise. rirn rirus inf infd 1/ mc 1dum 2dum sajems ns 7 (2004) no 2 339 references 1 aziakpono, m.j. 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(1976) "selection of order of an autoregressive model by akaike's information criterion”, biometrika, 63: 117-126. 29 warren, v. &. thirlwal, a.p. (1994) “interest rate, savings, investment and growth in mexico, 1960-1990: tests of financial liberalization hypothesis”, journal of economic development, november. 30 yusuf, s. & peters, r.k. (1994) “savings behaviour and its implications for domestic resource mobilization: the case of the republic of korea”, world bank staff working paper, no. 628, the world bank: washington d.c. abstract introduction theoretical foundations research design and methodology results discussion conclusion acknowledgements references appendix 1 appendix 2 about the author(s) antonia m. garcia-cabrera department of business administration, facultad de economía, empresa y turismo, universidad de las palmas de gran canaria, spain maria g. garcia-soto department of business administration, facultad de economía, empresa y turismo, universidad de las palmas de gran canaria, spain jeremias dias-furtado economic community of west african states (ecowas), cape verde citation garcia-cabrera, a.m., garcia-soto, m.g. & dias-furtado, j., 2018, ‘the individual’s perception of institutional environments and entrepreneurial motivation in developing economies: evidence from cape verde’, south african journal of economic and management sciences 21(1), a2377. https://doi.org/10.4102/sajems.v21i1.2377 original research the individual’s perception of institutional environments and entrepreneurial motivation in developing economies: evidence from cape verde antonia m. garcia-cabrera, maria g. garcia-soto, jeremias dias-furtado received: 17 mar. 2018; accepted: 13 june 2018; published: 10 sept. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: international organisations and national governments have made great efforts to stimulate entrepreneurial activity in the less-advanced economies, but the results of their programmes have often been disappointing. this may be because a distinction between the institutional factors that generate an individual’s desire to become an entrepreneur and those that generate a motivation that actually leads to entrepreneurial action has not been considered sufficiently. aim: this work is an attempt to respond to the following question on the basis of the individual’s perception of regulative, normative and cognitive institutions: in developing economies, what institutional factors generate an entrepreneurial motivation that makes individuals desire to become entrepreneurs and what factors cause an entrepreneurial motivation that actually leads them to entrepreneurial action? setting: we use empirical evidence from the african nation of cape verde for the analysis. the study was carried out on 6 of the 10 islands of the archipelago. method: the sample of study comprises 237 people: 93 entrepreneurs and 144 individuals with different levels of desire to become an entrepreneur. we used multiple linear regression analysis to test the hypotheses. results: our findings show that institutional factors which generate the entrepreneurial motivation that forges an individual’s desire to become an entrepreneur, and those which generate the motivation that leads him or her to actually set up his or her own business are not the same. we also find differences in the institutional factors that influence the opportunity, necessity and social components of entrepreneurial motivation. conclusion: theoretical implications for better understanding the factors that condition entrepreneurship in developing economies and practical implications useful for improving the planning of growth in these countries are offered. introduction international organisations and national governments have made great efforts to stimulate entrepreneurial activity in the less-advanced economies. to this end, they have paid much attention to the environmental factors that condition entrepreneurial behaviour (stenholm, acs & wuebker 2013), but the results of their programmes have often been disappointing (mahto & mcdowell 2018) – for example, regulation to foster entrepreneurial activity such as incentives to push individuals towards entrepreneurship, the offering of financial resources to support the new ventures, education and scientific training, etc. this may be because a distinction between the institutional factors which generate an individual’s desire to become an entrepreneur and those which generate a motivation that actually leads to entrepreneurial action has not been considered sufficiently, this being a distinction of particular relevance since human motivations are able to influence entrepreneurial decisions and actual business action (carsrud & brännback 2011; mahto & mcdowell 2018; shane, locke & collins 2003). in addition, the programmes implemented have not sufficiently distinguished between the different components of entrepreneurial motivation and their antecedents either. the academic literature has studied two of these components in some depth: opportunity and necessity. these two components can – either individually or in combination – give rise to entrepreneurship (williams 2009). distinguishing between them is important because previous research has found that it is entrepreneurship motivated mainly by opportunity that generates economic growth and employment (acs, desai & hessels 2008). on the other hand, the most recent literature has looked at the social component of entrepreneurial motivation and its role in the sustainable development of the less-advanced economies (e.g. azmat 2013; ghalwash, tolba & ismail 2017). although the previous literature suggests that the contextual factors of the environment condition the development of entrepreneurial motivation (hechavarria & reynolds 2009), researchers have not yet fully established the factors that generate each component of entrepreneurial motivation. for example, the research warns that because of the difficulties developing economies face, entrepreneurship motivated mainly by necessity is relatively common, while entrepreneurship motivated by opportunity is less common (valliere & peterson 2009). however, an entrepreneur can simultaneously develop two or more of these components (jayawarna, rouse & kitching 2013) and one component may turn into another if the context changes (williams 2009). thus, it would be interesting to identify the environmental factors that generate each component of entrepreneurial motivation, because this would help provide guidelines for policymakers seeking to encourage particular motivations. in the current work, we aim to identify which factors in the institutional environment influence the opportunity, necessity and social components of entrepreneurial motivation, distinguishing between those factors that forge an individual’s desire to become an entrepreneur and those that actually lead them into entrepreneurial action. we use the recent approaches to new institutional theory for this purpose. a growing body of literature supports the institutional approach, which argues that the institutions – for example, laws, cultural values, business practices and knowledge – govern human interactions and condition the behaviour of people and organisations (north 1990; puffer, mccarthy & boisot 2010). the first versions of new institutionalism stress the individual’s compliance with and adaptation to their institutional environment, but subsequent versions – labelled ‘neo-institutionalism’ by greenwood and hinings (1996), who coined the term – afford greater importance to the actor’s role and capacity of agency in the decision processes (battilana, leca & boxenbaum 2009). studies based on the first versions of new institutionalism take a macro-perspective and apply a determinist approach to explain how the institutions at the national level, measured via proxies taken from international databases, facilitate or constrain the economic activity of the individual firm. nevertheless, the latest interpretations note that the individual has the ability to act willingly in responding to the institutional framework (meyer et al. 2009), so they attempt to establish a bridge between the macro and micro-levels of analysis (dunning & lundan 2008) based on the individual’s capacity for agency. according to this approach, individuals adopt a leading role when they interpret their environment and make business decisions (north 1990). thus, dunning and lundan (2008:580) defend a ‘bottom up’ logic in their study of the relationship between businesses and institutions, arguing that the firm’s activity ‘rests on the information processing of the individual entrepreneur’. the literature on entrepreneurship has provided support for this idea, commonly showing interest in identifying, at the micro-level, the entrepreneur’s characteristics (e.g. busenitz, gomez & spencer 2000), cognitions (kautonen, gelderen & fink 2015) and motivation (e.g. jayawarna et al. 2013) as antecedents that give rise to entrepreneurial action. however, entrepreneurial motivation is conditioned by the institutional environment (hechavarria & reynolds 2009; stenholm et al. 2013). therefore, in focusing on how the individual perceives the institutional framework and, consequently, how their motivations evolve, a causal link may be uncovered which could shed light on the relationships observed by researchers at the macro-level (szyliowicz & galvin 2010). in this respect, it seems important to distinguish between individuals claiming they have a motivation to engage in entrepreneurial action but who have not founded any business (i.e. they are not yet actual entrepreneurs) and those who have actually put their ideas into practice and founded their own business (i.e. they are entrepreneurs). this is because such a distinction would differentiate between the institutions that lead the individual to develop motivations encouraging their desire to be an entrepreneur, from those leading them to actually engage in entrepreneurship. this distinction seems to be crucial if we are to design the right programmes aimed at encouraging entrepreneurship in developing economies, particularly if the research finds important evidence in this respect. however, except for the work conducted by urban (2013), which analyses the influence of the individual’s perception of institutional environment on students’ entrepreneurial intentions in an emerging economy, previous literature on entrepreneurship has never used this approach. indeed, we have found no previous studies exploring the aforementioned distinction and accepting that the entrepreneur can have diverse motivations (birley & westhead 1994). thus, in the current research, we study the opportunity, necessity and social components of entrepreneurial motivation to identify the factors of the institutional environment that can influence them, and hence encourage entrepreneurial action in a developing economy. the expected contribution of this work is of relevance because according to bjørnskov and foss’s (2016) literature review, there is a lack of detailed micro-level data that can help to understand the interaction between macro-level institutions and individual and firm-level responses, which prevent more detailed knowledge about the transmission mechanisms connecting institutions and entrepreneurial outcomes. our work answers this call, and for this purpose we carried out a study in the republic of cape verde, which is an ideal country for this research because its economy is poor in resources and natural wealth but it has become one of the five most successful countries in africa at encouraging entrepreneurship. specifically, we take evidence from a sample of 237 people, 93 of whom actually set up and manage their own business (entrepreneur subsample), and 144 who are individuals with different levels of desire to become an entrepreneur (hereafter, non-entrepreneur subsample). the results of this research may be useful for developing economies since, in identifying the institutional factors that generate each component of entrepreneurial motivation, we offer new implications for improving the planning of growth in developing economies. this is very important for these economies because the different components of entrepreneurial motivation do not generate an equal proportion of productive entrepreneurship (acs et al. 2008; valliere & peterson 2009). for this reason, results may also be relevant for researchers and politicians from developed economies, where providing a boost to productive entrepreneurs is often also a challenge. they might gain awareness through our study about the existence of the various effects of institutional factors on the different components of entrepreneurial motivation, as well as on the individual’s final decision to commit to entrepreneurial action; in other words, on the interaction between macro-level institutions and individual-level responses, which is currently not well enough understood (bjørnskov & foss 2016). the manuscript is organised into six sections. following this introductory section, we review the literature on institutional environment and entrepreneurial motivation in developing countries; we then develop the research hypotheses. this is followed by an explanation of the research methodology used to carry out the study. in the next section, we present the results with regard to hypothesis testing. the article ends with the discussion and conclusion sections. theoretical foundations institutional environment and the individual’s institutional perceptions institutions make the rules of the game in an organisational field and determine the viability of participating in an economic activity (north 1990). under the institutional approach, the type of organisation created will be determined by the opportunities that the institutional framework provides (meyer & nguyen 2005), for example in terms of new firms’ focus on innovation and international trade growth (simón-moya, revuelto-taboada & fernández-guerrero 2014). scott (1995) conceptualised three dimensions of institutions as things that happen within them and because of them: regulative, normative or cognitive. the regulative dimension includes the laws governments introduce to encourage certain behaviours and discourage others (scott 1995), and their subsequent effect on economic growth (stenholm et al. 2013). the normative dimension has to do with the cultural values relating to acceptable human behaviour (scott 1995), among them desirable career choices (lim, oh & de clercq 2016). the cognitive dimension reflects the business knowledge organisations share in an area and includes the past decisions that other organisations have taken and succeeded with (lu 2002). these latter elements contain validated experiences (scott 1995) that help the decision-maker to choose between acceptable options (lu 2002). under this institutional approach, entrepreneurship is considered to be a product of the institutional factors (williams, & gurtoo 2017) and, consequently, the three institutional dimensions are currently being widely considered in the study of entrepreneurship (e.g. lim et al. 2016; simón-moya et al. 2014; stenholm et al. 2013; valdez & richardson 2013). the most recent versions of new institutionalism posit that individuals take on an active role in the institutional process as they can either comply with the current institutions, adapt to them, ignore them or attempt to modify them if they are obstacles to them achieving their objectives (battilana et al. 2009). under this new approach, the regulative, normative and cognitive dimensions are social structures that limit and enable, but do not determine the actor’s final choice (hoffman & ventresca 2002), the latter retaining some room for discretion. reactions, which will cause response heterogeneity, are likely dependent on the individual’s level and kind of motivation (bjørnskov & foss 2016), and the relevance granted to the information perceived in the institutional environment (dunning & lundan 2008), among other things. at this point, we should remember that only individuals can possess motives and make decisions to achieve their goals within a particular institutional framework (north 1990). hence, institutions represent a reality that is objective and external to the individual (north 1990), who will hold their own, subjective point of view regarding that reality (garcía-cabrera, garcía-soto & durán-herrera 2016; urban 2013), and so different individuals will interpret and respond to the possibilities offered by the current institutions in different ways (bjørnskov & foss 2016; szyliowicz & galvin 2010; valdez & richardson 2013; zwan et al. 2016). thus, the approach offered by the most recent form of institutionalism is useful in the study of entrepreneurship because it provides theoretical bases that allow us to distinguish between the external, objective reality and the individual’s subjective perception of that reality, which is what will affect their motivations and actions. components of entrepreneurial motivation although research on the concept of entrepreneurial motivation is scarce (mahto & mcdowell 2018), the term can be understood as those factors or forces within individuals that encourage them to become entrepreneurs (carsrud & brännback 2011; shane et al. 2003). according to this, fossen and büttner (2013:67) observe that ‘entrepreneurs are a heterogeneous group, primarily because of large differences in their motivations to become entrepreneurs’. despite the warnings against an over-simplification of these motivations (williams 2009) – for example, economic gain, improved social status, contribution to community well-being (birley & westhead 1994; jayawarna et al. 2013; manolova, eunni & gyoshev 2008) – authors have frequently classified them: opportunity and necessity (e.g. block & wagner 2010; zwan et al. 2016). but there has also been recognition that both types of motivation can be components of a single individual’s entrepreneurial motivation at one point or another, or even simultaneously at a particular point in time, and even that the main component of a person’s entrepreneurial motivation can transform into a different component over time (williams 2009; williams & gurtoo 2017). the opportunity component exists in individuals who voluntarily decide to initiate a business project in order to exploit opportunities that allow them to achieve their personal goals, while the necessity component exists in individuals who fail to find employment or satisfactory employment and see entrepreneurship as a last resort (williams 2009). in addition, the recent literature has paid particular attention to the social component of entrepreneurial motivation (mair & martí 2006), especially in developing economies (azmat 2013; ghalwash et al. 2017). this component, like the previous two, aspires to create value, but unlike the other two the entrepreneur also has intrinsically social reasons. the social component of motivation leads the individual to explore opportunities that allow them to meet social needs or drive social change – for example, helping others, helping the community, etc. (ghalwash et al. 2017; renko 2013). thus, the social motivation we analyse corresponds to the entrepreneur’s ethical and moral responsibility motives, which combine with other, commercial motives to give rise to profitable and sustainable businesses (renko 2013). in the opportunity component, the entrepreneurship contributes to generating wealth and employment in an area and hence can be considered productive from a social perspective (acs et al. 2008), but the priority in this component is the pursuit of self-realisation, wealth or personal well-being (jayawarna et al. 2013). conditions encouraging each of the three components have barely been analysed in the literature. some studies identify individual-level antecedents – for example, business experience, education (jayawarna et al. 2013) – while others stress that such motivations are associated with environmental factors (cassar 2007), although the literature has yet to determine the possible influence of the institutions on their development. the relationship between the institutional environment and entrepreneurial motivation in developing economies a developing country is a nation with a less-developed industrial base and a lower human development index than other countries (sullivan & sheffring 2003). the contexts of developing countries significantly contrast with those of developed countries, as the former deal with challenges such as extensive poverty and poor transportation and financial infrastructure (ghalwash et al. 2017). in addition, such countries commonly lack institutional structures that stimulate entrepreneurial activity (meyer et al. 2009), their legislation tends to be unstable and at the mercy of unpredictable and inconsistent changes (puffer et al. 2010), and there is limited information about the competition in the market (acs et al. 2008) and insufficient knowledge about how to exploit business opportunities. other institutional limitations are bureaucracy (ghalwash et al. 2017), the ineffective functioning of the public administrations, the lack of independence of the legal system, and political instability (puffer et al. 2010). as a consequence, the high level of uncertainty limits the number of business opportunities because entrepreneurial activity becomes more complex and riskier (manolova et al. 2008). in addition, in developing country contexts, illiteracy and low levels of education are frequent (ghalwash et al. 2017), so the education system is hardly able to generate a knowledge base that can lead individuals to entrepreneurship (urban 2013). other institutional factors, such as cultural and social norms, do not usually make entrepreneurship a highly desirable career choice for the country’s population (herrington, kew & kew 2010). thus, the abovementioned regulative, normative and cognitive institutions in developing countries may lower entrepreneurial motivation in the area (hechavarria & reynolds 2009; urban 2013). that is relevant because, as stated by shane et al. (2003), human motivations influence decisions made by individuals after the discovery of business opportunities, so that the variance in entrepreneurial motivations across people will affect whoever exploits identified opportunities by starting up a firm, decides to stick to the process, or perhaps fails to find the suitable setting needed to turn desires into actions. in this respect, carsrud and brännback (2011) state that motivations may be the catalyst that transforms intentions into actual actions. according to this, we can distinguish between people with entrepreneurial motivation, but who have not yet started a business (hereafter, ‘non-entrepreneurs’), and people with entrepreneurial motivation who have started and run their own business (hereafter, ‘entrepreneurs’). previous literature has studied factors that condition the development of entrepreneurial motivation by focusing mainly on either entrepreneurs (e.g. ghalwash et al. 2017; zwan et al. 2016) or non-entrepreneurs (e.g. mahto & mcdowell 2018; urban 2013). we focus on both. hypotheses development: institutional dimensions and components of entrepreneurial motivation in developing economies as the three components of entrepreneurial motivation – opportunity, necessity and social – are conceptually different, the promotion of each will conceivably be associated with different institutional factors. in particular, we look first at how and why the individual’s perceptions of the regulative, normative and cognitive dimensions of institutions can condition each of them. the regulative institutions can favour different components of entrepreneurial motivation (block & sandner 2009) to the extent that they establish measures that exert a push effect – for example, support for entrepreneurship among the unemployed – or pull effect – for example, favourable environments for the development of high-growth entrepreneurship – on entrepreneurship. thus, individuals who perceive such institutions and analyse them using a rational or instrumental perspective will develop the opportunity component if they foresee profits from investing their resources (block & wagner 2010), or the social component if, having such a sensitivity, they identify social problems and calculate that their entrepreneurial effort can simultaneously help to solve such problems and generate profits. the literature identifies institutions that exert this pull effect in developing economies. for example, the existence of a legal structure that protects private property rights (north 1990; stenholm et al. 2013). similarly, legislation that produces stimuli to entrepreneurship – for example, tax incentives – will increase the search for business opportunities to exploit such incentives (stenholm et al. 2013; valdez & richardson 2013). in contrast, the perception of insufficient information, administrative complexities, rigid bureaucratised processes and excessive government controls can inhibit both the opportunity and social components of entrepreneurial motivation (hechavarria & reynolds 2009; urban 2013; zwan et al. 2016). nevertheless, it is other factors that will be the main determinants of the necessity component of the entrepreneurial motivation. this motivation is unlikely to come from applying an instrumental logic to analysing the environment in order to identify business opportunities. instead, if the individual uses such a logic, it will be based on the desire to find an urgent solution to their precarious situation. for example, if the individual perceives legislation guaranteeing the supply of continuous training in support of entrepreneurial activity, they could view entrepreneurship as the last resort in response to their precarious situation, increasing their motivation to start a business. consequently, their motivation will be mainly a reaction to the push effect generated by the regulation via training programmes, rather than a proactive response based on the pull effect of the opportunities generated by the current legislation. these training initiatives could also contribute towards increasing the opportunity and social components of motivation since they support entrepreneurs, but they are not so critical in the gestation of these components in the individual. as block and sandner (2009) point out, when entrepreneurs pursue a business opportunity, they commit time to acquiring an overall education in multiple ways – for example, professional career, experience in the sector – so that the development of the motivation may precede the planning of the specific training activities to undertake. based on the above, and because the current research aims to identify the factors within the institutional environment that influence the components of entrepreneurial motivation, distinguishing those factors that forge the individual’s desire to become an entrepreneur and those that actually lead them to entrepreneurial action, we posit two complementary hypotheses, one referring to non-entrepreneurs and the other to entrepreneurs (hereafter, we use he to refer to hypotheses postulated for entrepreneurs, and hne for hypotheses for non-entrepreneurs): h1ne: in a developing economy, the greater the individual’s perception of regulative institutions that establish push and pull measures favourable to entrepreneurial activity, the greater the opportunity (h1ne-a), social (h1ne-b) and necessity (h1ne-c) components of the entrepreneurial motivation that makes them desire to become an entrepreneur. h1e: in a developing economy, the greater the individual’s perception of regulative institutions that establish push and pull measures favourable to entrepreneurial activity, the greater the opportunity (h1e-a), social (h1e-b) and necessity (h1e-c) components of the entrepreneurial motivation that leads them to entrepreneurial action. the normative dimension includes the cultural values that individuals share in a community and that inform acceptable human and business behaviour (scott 1995). individuals who pay attention to what these institutions establish, apply a logic based on their desire to behave in accordance with the behavioural norms they have assimilated (szyliowicz & galvin 2010). in this respect and given that the regulative institutions are unstable and ineffective in developing economies (meyer & nguyen 2005; puffer et al. 2010), the resulting uncertainty often prevents the use of instrumental logic based on the exploitation of the opportunities that the legislation generates (huang & sternquist 2007). thus, the individual needs to legitimise their motivation in cultural norms that are more stable, with the aspiration that their motivations will be acceptable to the interest groups in their community (scott 1995). if the society to which the individual belongs views entrepreneurship as a desirable professional option and if the individual perceives this to be the case, this will favour the entrepreneurial motivation based on the pursuit of opportunities (stenholm et al. 2013; tominc & rebernik 2007; valdez & richardson 2013). these normative institutions will also be relevant for constructing the social component by establishing the socially acceptable business objectives and the right ways to achieve them (huang & sternquist 2007) – for example, the possibility of seeking profits and thereby satisfying a social demand. in fact, hechavarria and reynolds (2009) identify how values related to well-being – for example, concern for the environment – generate opportunity motivation by providing the individual with a feeling of personal achievement. but this content of the normative institutions does not seem likely to favour the necessity component because individuals who are unemployed seem unlikely to start a business for non-monetary reasons (block & sandner 2009). in contrast, other cultural values, for example associated with the subsistence economy, will be able to generate this motivation – for example, social acceptance of ‘homeless’ businesses such as street selling. we do not study these latter normative contents in the current work because this is not a motivation that can drive development in developing economies. based on the above, we posit two hypotheses, referring to non-entrepreneurs and entrepreneurs respectively: h2ne: in a developing economy, the greater the individual’s perception of normative institutions that lend dignity to successful, high-revenue generating entrepreneurship, the greater the opportunity (h2ne-a) and social (h2ne-b) components of the entrepreneurial motivation that makes them desire to become an entrepreneur, although these institutions will not affect the necessity component (h2ne-c). h2e: in a developing economy, the greater the individual’s perception of normative institutions that lend dignity to successful, high-revenue generating entrepreneurship, the greater the opportunity (h2e-a) and social (h2e-b) components of the entrepreneurial motivation that leads them to entrepreneurial action, although these institutions will not affect the necessity component (h2e-c). the cognitive dimension captures the knowledge shared in an area about the ideal business practices to compete successfully (lu 2002; scott 1995). this knowledge can come from higher-level technical training programmes that feed the area with qualified professionals, or from the business experience of people who have started their own firms previously. under the cognitive institutional approach, the quality of the knowledge available and of the practices of entrepreneurs is important because when individuals follow a logic based on the orthodoxy (szyliowicz & galvin 2010), they will imitate or develop entrepreneurial motivations compatible with their perception of what the accumulated knowledge recommends (what they see in their environment) – for example, exploit an opportunity based on the supply of high-class hotel services, seek to make ends meet via street selling, solve social problems, etc. in the case of the necessity component and given that the individual has not chosen entrepreneurship as a professional option voluntarily, this decision tends to be made without adequate planning (fossen & büttner 2013). the individual faces high uncertainty because they have not accumulated enough knowledge resources (block & wagner 2010). lacking such knowledge (lu 2002; scott 1995), the individual will only develop the necessity component when the orthodox logic based on the previous business experience of others so recommends. in contrast, if the individual perceives an accumulation of high-quality business experience – that is, associated with high-growth, knowledge-based firms – this will undermine the construction of an entrepreneurial motivation oriented towards low-quality businesses. similarly, the existence of economically viable firms founded to meet social needs can encourage – via the mimetic effect – the development of the social component in individuals who perceive these experiences. along a similar line, manolova et al. (2008) warn that the existence of business models of growth will generate an entrepreneurial motivation based mainly on the search for opportunities, but only if the individual perceives the existence of such opportunities (garcía-cabrera et al. 2016). these practices are not usual in developing economies (valliere & peterson 2009), so in such countries these cognitive institutions may have a limited capacity to generate the opportunity component. in the absence of these practices, it will be the accumulation of quality knowledge acquired by individuals in advanced training programmes that awakens opportunity motivation. in these cases, as found by lim et al. (2016), a positive, direct influence of cognitive institutions in the form of good and adequate preparation by individuals for the development of the opportunity component takes place. this knowledge not only provides the individual with resources to exploit valuable business opportunities, but also helps the individual to recognise such opportunities – for example, identify the value of the environmental information and apply it to commercial ends (block & sandner 2009). these arguments may also be applicable for the social component because specialised training may awaken or inspire a greater social awareness in individuals, as found by ghalwash et al. (2017) in their study carried out in an african developing country. based on the previous discussion, we hypothesise: h3ne: in a developing economy, the greater the individual’s perception of cognitive institutions that concern knowledge and good business practices for successfully running their own business, the greater the opportunity (h3ne-a) and social (h3ne-b) components of the entrepreneurial motivation that makes them desire to become an entrepreneur, but the lesser the necessity component (h3ne-c). h3e: in a developing economy, the greater the individual’s perception of cognitive institutions that concern knowledge and good business practices for successfully running their own business, the greater the opportunity (h3e-a) and social (h3e-b) components of the entrepreneurial motivation that leads them to entrepreneurial action, but the lesser the necessity component (h3e-c). finally, we can make further considerations referring to the relevance of the institutional dimension on the development of individuals’ entrepreneurial motivation, distinguishing between entrepreneurs and non-entrepreneurs. previous literature suggests that in the absence of developed regulative frameworks to facilitate business activities and the unstable character of regulation in developing economies (meyer & nguyen 2005), there is a greater development of commonly accepted customs and habits – the normative and cognitive institutions (puffer et al. 2010). so, we can expect that normative and cognitive institutions will be considered to a greater degree by individuals, and hence will be more able to affect their entrepreneurial motivation, because these aspects of institutions are more trustworthy (garcía-cabrera et al. 2016). indeed, some authors have found that while cognitive and normative institutions condition the level to which individuals engage in entrepreneurship in developing economies (i.e. individuals develop activities of not only opportunity recognition, but also evaluation, or even exploitation), regulative institutions do not have such a direct influence (e.g. lim et al. 2016). however, distinctions between the normative and cognitive dimensions of institutions can also be made. firstly, as the normative dimension reflects the degree to which a society believes that starting a new business is worthy and valuable to society, and so provides societal legitimation to business activities (stenholm et al. 2013; urban 2013), these aspects of institutions may condition the individual’s perception of entrepreneurship as a desirable career choice (lim et al. 2016). in this respect, krueger, reilly and carsrud (2000) state that the beliefs and expectations of a social reference group will affect individuals’ entrepreneurial desires and intentions. so, we can expect that normative institutions are especially relevant for generating entrepreneurial motivation among non-entrepreneurs. secondly, as the cognitive dimension captures the knowledge shared in an area about the ideal business practices to compete successfully, coming from either technical training programmes or aggregate business experience in the area (lu 2002; scott 1995), these aspects of institutions may equip individuals with the required resources to identify business opportunities (urban 2013), estimate a level of performance and have confidence in that level (stenholm et al. 2013), and so reduce perceptions of risk associated with the exploitation of such identified opportunities (lim et al. 2016). thus, cognitive institutions may influence entrepreneurial motivation because they nurture the individuals with the criteria to perceive and truly exploit opportunities in the marketplace, all of it necessary to engage in entrepreneurship by starting a firm. so, we can posit the following hypotheses: h4ne: in a developing economy, perceptions of normative institutions that lend dignity to successful, high-revenue generating entrepreneurship, rather than those of cognitive and regulative institutions, will condition the development of entrepreneurial motivation that makes the individual desire to become an entrepreneur. h4e: in a developing economy, perceptions of cognitive institutions that concern knowledge and good business practices to successfully run one’s own business, rather than those of normative and regulative institutions, will condition the development of entrepreneurial motivation that leads the individual to entrepreneurial action. research design and methodology the current research adopts a deductive approach in order to test the validity of the hypotheses posited above. the study bases itself on quantitative data and data collection was carried out making use of a survey. specifically, data collection was used to gather the information from two subsamples of resident entrepreneurs and non-entrepreneurs in a developing economy, which was required to evaluate the hypotheses and reach the research objective. further details about research design and methodology are provided below. the setting: cape verde background cape verde is an african country that, according to the country classification elaborated on the basis of the world economic situation and prospects (wesp), is classified as a developing economy (united nations 2014). the country is one of the few democratic and politically stable nations on the african continent, and also one of the fastest growing economies after the liberalisation of its economy in the 1990s with the establishment of independent regulation, the privatisation of public firms and the institutionalisation of a democratic regime. successive governments have implemented policies aimed at incentivising firm creation and hence strengthening the national business fabric and the private sector. as a result of these efforts, cape verde was considered one of the 10 best reformers in africa in 2010, with the country showing positive social, economic and political indicators, particularly in comparison to other countries in west africa. currently, the macro-economic indicators at the aggregate level for the country point to a favourable general environment, with a real gross domestic product (gdp) growth of 3.89% from 2016 to 2017. according to cape verde’s national statistics institute (ine 2017), the tertiary sector makes up 61.6% of the economy (i.e. real gdp), followed by secondary (17.3%) and primary (7.5%) sectors. within the tertiary sector, real estate services (9.92%), trade (9.63%) and transports (8.88%) are the most relevant subsectors, whereas tourism – accommodation and catering – reaches 4.1% of real gdp. despite the mentioned advances, cape verde still faces significant structural challenges such as poverty (for example one in four individuals is considered poor, surviving on less than us$2 per day). with respect to the human development index, cape verde reached a value of 0.648 in 2016 (it ranks 122 out of 188 countries, and it is number 10 when considered on the list of african countries by human development index). as in other developing economies, the business people and entrepreneurs in cape verde suffer from a weak institutional environment characterised by (ucre & unido 2011): (1) the ineffectiveness of the regulative institutions and the legal system and (2) problems with the public administration, such as the low level of qualifications of many public employees, and the slow processes and bureaucracy. but there are other problems too, concerning: (1) transport, (2) qualifications of the workforce, (3) the electricity supply, (4) access to credit and (5) informal competitors. population, sampling procedure and data collection the population we are studying consists of the entire active population of cape verde (people between 15 and 64 years old). according to ine (2011), the universe of study comprises 491 875 people in 2010 (infinite population), so that accepting a confidence level of 95.5% and sampling error rate of 4.5% the defined sample size is 247. after carrying out the fieldwork in june 2012, we obtained a final sample of 237 (valid questionnaires), hence sampling error slightly raised to 4.59%. the study was carried out on 6 of the 10 islands of the archipelago (sal, boavista, santiago, sao vicente, fogo and maio), and to collect the information we used a structured questionnaire written in portuguese, which we pretested previously. we used stratified sampling with proportional allocation for the variables concelho, gender, age and education. in addition, a quota was set up for entrepreneurs (40%) and non-entrepreneurs (60%) in order to guarantee the presence of enough individuals in the two subsamples to test the posited hypotheses. the procedure for carrying out data collection was the following: we first chose nine survey takers who were university students and spoke both the official languages of the country (portuguese, which is learned at school) and crioulo (a common dialect used in daily life, especially by the section of the population with a lower educational level). these survey takers were instructed about terms and items in the questionnaire. later on, for the data collection, personal and direct surveys were carried out on public highways and areas of population movement, among them markets, public squares and so on. different routes were established for each survey taker. reliability and validity of measurements the questionnaire included items referring to entrepreneurial motivation and perceptions on institutional factors, as well as demographic issues. we measured all except the demographic variables using a 5-point likert scale, where the maximum value indicates respondents’ total agreement with the statement. dependent variables we measured entrepreneurial motivation using 11 items based on williams (2009) for the opportunity and necessity components, renko (2013) for the social component, and birley and westhead (1994) for all three components (appendix 1). in order to assess the internal reliability of items in this scale, the cronbach’s alpha coefficient was calculated for the subsamples of both entrepreneurs and non-entrepreneurs, and we obtained values of 0.774 and 0.686, respectively. validity of the scale was measured through content validity and construct validity. to ensure content validity, we first carried out an exhaustive literature review on the topic. later on, we asked for an expert review from three qualified researchers in the field of entrepreneurship and research methodology, their feedback being considered in the formulation of the final research instrument. construct validity was verified through the convergent validity of the scale and by analysing the components’ loadings (appendix 1). specifically, a principal components factor analysis with varimax rotation confirms the homogeneity of the scale for both subsamples: entrepreneurs (kmo = 0.710; χ2 = 290.144; variance explained = 70.5%) and non-entrepreneurs (kmo = 0.702; χ2 = 214.897; variance explained = 61%). for the sample of non-entrepreneurs, we identify only two components, opportunity (alpha = 0.607; variance explained = 25.4%) and necessity (alpha = 0.782; variance explained = 35.6%). for the subsample of entrepreneurs, we identify the three expected components of entrepreneurial motivation, that is, opportunity (alpha = 0.751; variance explained = 23.2%), necessity (alpha = 0.706; variance explained = 21.4%) and social (alpha = 0.780; variance explained = 25.9%). all the components loadings show scores that range from 0.463 (in the non-entrepreneur subsample) to 0.912 (in the entrepreneur subsample). independent variables the information about the institutional dimensions was collected using a multiple-item scale that included 30 items (appendix 2). for the normative institutions, we used six items from tominc and rebernik’s (2007) scale. we built the regulative and cognitive scales in coherence with the most recent versions of new institutionalism, the aim being to make them measurable via individual perceptions. we followed authors who have previously measured these variables, in particular busenitz et al.’s (2000) proposal, which manolova et al. (2008) successfully replicate. internal reliability of 30 items in this scale was assessed by the cronbach’s alpha coefficient in the subsamples of entrepreneurs and non-entrepreneurs, obtaining values of 0.864 and 0.798, respectively. content validity was ensured by an exhaustive literature review on the topic and a subsequent expert review from the three qualified researchers mentioned above, whose feedback was considered in the design of the final research instrument. finally, construct validity was tested through the convergent validity of the scale and by analysing the components’ loadings (appendix 2). in detail, for the two subsamples of entrepreneurs and non-entrepreneurs, a principal components factor analysis with varimax rotation confirms the homogeneity of the scales (kmo = 0.706, χ2 = 907.975, variance explained = 71.5% and kmo = 0.746, χ2 = 1171.470, variance explained = 67%, respectively). for the subsample of entrepreneurs, we obtain: (1) two factors relating to the cognitive institutions: educated population available (alpha = 0.813; variance explained = 11.9%) and local business experience (alpha = 0.762; variance explained = 11.2%), (2) four factors for the regulative institutions: legal incentive for entrepreneurship (alpha = 0.668; variance explained = 9.5%), continuing training opportunities (alpha = 0.717; variance explained = 9.4%), flexible labour legislation (alpha = 0.853; variance explained = 8.9%), and government control of quality (alpha = 0.730; variance explained = 7.8%), (3) and one factor for the normative institutions: entrepreneur’s image and social status (alpha = 0.778; variance explained = 12.8%). for the subsample of non-entrepreneurs, we obtain: (1) three factors relating to the cognitive institutions: educated population available (alpha = 0.815; variance explained = 12.9%), local business experience (alpha = 0.839; variance explained = 7.8%), and mimetic pressure (alpha = 0.716; variance explained = 7.2%), (2) three factors for the regulative institutions: legal incentive for entrepreneurship (alpha = 0.791; variance explained = 10.9%), continuing training opportunities (alpha = 0.722; variance explained = 9.2%) and flexible labour legislation (alpha = 0.707; variance explained = 8.9%), and (3) one factor for the normative institutions: entrepreneur’s image and social status (alpha = 0.730; variance explained = 10.1%). all the components’ loadings show scores that range from 0.545 to 0.850, both displayed in the non-entrepreneur subsample. control variables on the basis of the previous literature (e.g. block & sandner 2009; block & wagner 2010; fossen & büttner 2013; jayawarna et al. 2013) we use the following control variables: individual’s age, number of relatives who depend economically on the individual, and education (1none, 2primary, 3secondary, and 4tertiary). data analysis after using principal components factor analysis with varimax rotation, we obtained synthetic indicators of institutional dimensions and components of entrepreneurial motivation. the standardised values (mean = 0, standard deviation = 1) of these indicators were used in the further analyses. specifically, we first carried out a correlation analysis between the independent variables (i.e. control variables and synthetic indicators) and later we used multiple linear regression analysis to test the hypotheses. for the entrepreneurs, we estimated three models, one for each component of entrepreneurial motivation, and for the non-entrepreneurs we estimated two models, one for each of the opportunity and necessity components. we evaluated the potential instability of the regression coefficients using a multicollinearity diagnosis. finally, the current research is cross-sectional and uses a single source of data, which could give rise to common method variance. to minimise this risk, we guaranteed the respondents’ anonymity, pretested the questionnaire and tested for the existence of common method variance, using harman’s one factor, which is one-technique based on factor analysis to check if the majority of the variance (more than 50%) can be explained by a single factor (podsakoff & organ 1986). harman’s test does not identify the existence of common method variance in both subsamples. for entrepreneurs, the test finds nine factors with eigenvalues greater than 1, whether we run the principal components factor analysis unrotated (variance explained = 71.6%), or with varimax rotation (variance explained = 71.6%), or a principal axis factor analysis with varimax rotation (variance explained = 61.1%). the first factor obtained in each of these estimations explains 22.8%, 10.4% and 9.8% of the total variance, respectively. for non-entrepreneurs, harman’s test identifies 10 factors with eigenvalues greater than 1, whether we run the principal components factor analysis unrotated (variance explained = 70.48%), or with varimax rotation (variance explained = 70.48%), or a principal axis factor analysis with varimax rotation (variance explained = 56.8%). the first factor obtained in each of these analyses explains 15.8%, 10.1% and 8.8% of the total variance, respectively. results sample description sample proportions and quotas were highly met for the variables concelho, gender, age and education (table 1), as well as quotas for entrepreneurs and non-entrepreneurs. specifically, the sample has roughly equal numbers of men and women (50.2% – 49.8%), and their average age is 34. with regard to education, 6.3% have no formal education, while 36.7% have a primary, 44.3% a secondary, and 12.2% a university education. in addition, 39.2% of the sample (93 individuals) currently own a firm, while 60.76% (144 individuals) are non-entrepreneurs, either employed or unemployed. table 1: sample distribution. the firms founded by the entrepreneurs are on average five years old and employ 10.06 people. the most common sectors are the catering industry (18.3%), trade (15.1%), transport (11.8%), leisure (8.6%), hotels (7.5%), and travel operators (4.3%), while less common sectors include professional services, industry, agriculture or construction. with regard to the founder’s profile, 52.7% of these are male and they have an average age of 39.07. table 2 and table 3 show the means, standard deviations and correlations between the independent and control variables in the subsamples of non-entrepreneurs and entrepreneurs, respectively. as we use synthetic indicators of institutional dimensions and components of entrepreneurial motivation obtained from principal components factor analysis, their means and standard deviations (sd) correspond to standardised values (mean = 0, sd = 1). table 2: correlations, means and standard deviations: non-entrepreneurs subsample. table 3: correlations, means and standard deviations: entrepreneurs subsample. findings: hypotheses test table 4 (model 1 and model 3) shows the regressions estimated for the non-entrepreneurs. as we only identified two components of entrepreneurial motivation for this subsample, that is, the opportunity and necessity components, hypotheses referring to the social component cannot be tested (h1ne-b, h2ne-b y h3ne-b). results show that the individual’s perception of the regulative institutions influences the opportunity (model 1) and necessity components (model 3) as proposed in h1ne-a and h1ne-c. the results show that when the individual perceives incentives for entrepreneurship, the necessity component increases, while the perception of legislation guaranteeing support for entrepreneurship via continuing training opportunities favours the opportunity component. thus, h1ne-a and h1ne-c can be accepted. in turn, when the individual perceives normative institutions that bestow a positive image and status on entrepreneurs, the opportunity and necessity components increase. these results offer support for h2ne-a, but not h2ne-c, an unexpected statistical significance being obtained for the latter. table 4: results of estimated models for components of entrepreneurial motivation: entrepreneurs and non-entrepreneurs subsamples. with respect to the cognitive institutions, when the individual perceives that there are individuals nearby with business experience, the necessity component increases, but the opportunity component remains unaffected. thus, h3ne-c can be rejected, because the sign is the opposite to what we expected. we should take note that this hypothesis refers to high-quality business experience, which is uncommon in developing economies. thus, knowing people who have started ventures merely to survive will encourage others to do the same and with the same motivation, but the opportunity component will not be affected. thus, h3ne-a can be rejected since the available, well-educated sections of the population do not have a positive effect on the opportunity component either, as we initially expected. table 4 (models 2, 4 and 5) shows the regressions estimated to analyse how the individual’s perceptions of the institutions affect each component of entrepreneurial motivation in the subsample of entrepreneurs. the entrepreneurs’ perception of the regulative institutions conditions the opportunity (model 2) and necessity components (model 4) as proposed in hypotheses h1e-a and h1e-c, respectively, but not the social component (model 5), meaning we can reject h1e-b. these results show that when the entrepreneurs perceive laws and regular controls by the administration to ensure the quality of firms’ products and services, the opportunity component of their entrepreneurial motivation falls, and the perception of incentives under that legislation does not incentivise this motivation. thus, h1e-a is rejected. the necessity component is favoured by the perceived existence of legislation, guaranteeing the support of entrepreneurship via the offer of continuing training opportunities, so h1e-c finds support in these data. on the other hand, when the entrepreneurs perceive normative institutions that bestow a positive image and status on those who start businesses, the opportunity and social components increase, but the necessity component remains unaffected. these results offer support for hypotheses h2e-a, h2e-b and h2e-c. finally, concerning the cognitive institutions, while the perception of individuals in the vicinity with business experience does have a positive effect on the necessity and social components, it is the belief that an educated workforce is available in the area that strengthens the entrepreneur’s opportunity motivation. these results provide support for h3e-a, h3e-b and h3e-c. all these results are summarised and depicted in figure 1. figure 1: influence of institutional perception on construction of entrepreneurial motivations. finally, and considering the obtained values for standardised beta coefficients, results show that whereas the normative dimension of institutions condition to a greater degree the opportunity component of the entrepreneurial motivation of non-entrepreneurs, there are aspects of the regulative institutions that influence the necessity component more strongly. thus, h4ne must be rejected as we only find support for one component of the entrepreneurial motivation of non-entrepreneurs. concerning entrepreneurs, we found that cognitive aspects of institutions are more relevant than the normative and regulative ones in their influence on entrepreneurial motivation, irrespective of the component of entrepreneurial motivation considered, that is, opportunity, social and necessity. so, h4e finds support. discussion the current research identifies the institutional factors that explain the entrepreneurial motivation driving the individual’s desire to become an entrepreneur or actually leading them to entrepreneurial action in a developing economy, distinguishing between three components of entrepreneurial motivation: opportunity, necessity and social. neo-institutionalism (greenwood & hinings 1996) provides the theoretical foundations for this study. our findings suggest that how the entrepreneur perceives the institutional dimensions will affect the components of their entrepreneurial motivation. in contrast to the early approach to new institutionalism, which analyses how the environment determines the individual’s behaviour, our results are coherent with valdez and richardson (2013) or garcía-cabrera et al. (2016) and support the thesis that room exists for individual discretion. this explains why, when faced with the same institutional framework, different individuals construct – to varying degrees – each component of entrepreneurial motivation – opportunity, necessity and social. in addition, this study allows us to elucidate whether or not the same institutional factors generate the entrepreneurial motivation that forges an individual’s desire to be an entrepreneur and the motivation that leads them to actually set up their own business. our findings show that they are not the same. components of entrepreneurial motivation in entrepreneurs and non-entrepreneurs entrepreneurs and non-entrepreneurs in a developing economy can be clearly distinguished by the components of their entrepreneurial motivation. the current work has identified three differentiated motivational components for entrepreneurs, but only two for the non-entrepreneurs, with the main difference between the two groups being the presence or absence of the social component of motivation. firstly, the arguments based on the interest in creating jobs in the community or the commitment to family members and friends – both associated with the social component – explain the existence of a motivational factor in the group of entrepreneurs. but this component cannot be identified for the non-entrepreneurs. this last group of individuals have two main motivational factors – opportunity and necessity – which are also present for the entrepreneurs. this difference can be explained on the basis of the conceptual distinction between the components. thus, unlike the personal focus inherent in the reasons to become an entrepreneur found among the opportunity and necessity components – for example, desire for wealth, finding a means of sustenance – the social component corresponds more to reasons of moral responsibility towards the community (ghalwash et al. 2017; mair & martí 2006). these results suggest that it is mainly personal reasons that generate the desire to be an entrepreneur in developing economies. in contrast, concern for others – that is, for the needs of the community – takes on a role in the path that the individual takes from the initial state of wanting to become an entrepreneur to actual entrepreneurial action in a developing economy. embarking on entrepreneurship is often seen as a way of helping or creating jobs for one’s people: family members, close friends and acquaintances. in this respect, we should underline that both the concept and the scope of the family are very broad in many developing economies such as cape verde. the family goes beyond blood ties to include other, more distant relatives, friends, and even members of the individual’s community of origin or residence. so, our work adds to others that have found an increased relevance of the social component of entrepreneurial motivation in the less-advanced economies (e.g. azmat 2013) and factors that influence such motivation among entrepreneurs (ghalwash et al. 2017), because we found that social reasons are unlikely to be present at the initial emergence of entrepreneurial motivation, but these reasons acquire an increased relevance in the path to entrepreneurial action. institutional perceptions and the entrepreneurial motivation in entrepreneurs and non-entrepreneurs the current work identifies how the individual’s perception of institutional factors favours the different components of their entrepreneurial motivation, both for individuals who have actually acted on their entrepreneurial motivation and started a firm and for individuals whose motivation has not yet led them to start a firm. the social component develops in the entrepreneur who perceives in their community consolidated business practices that guide their actions. similarly, the fact that the community has a high opinion of entrepreneurship as a professional option also incentivises their social motivation. thus, it is the forms of logic based on orthodoxy and morality (szyliowicz & galvin 2010), respectively, that condition this component, compared to the instrumental logic based on a rational actor who analyses the opportunities provided by the regulative institutions. in fact, neither the legal incentives for entrepreneurship, nor the training courses seem to affect the development of the social component among the entrepreneurs. in the development of the opportunity component of the entrepreneur’s motivation, the individual’s perception of all the institutional dimensions has an impact, so the results suggest that its gestation could be the most demanding. the individual constructs this component when they perceive in their area: (1) advanced, high-quality knowledge acquired in the classroom, (2) cultural values that lend dignity to the entrepreneur’s work, and (3) legislation that does not necessarily incentivise entrepreneurship, but that at least does not inhibit it through its inefficiencies. for the case of the non-entrepreneurs, the opportunity component seems to be conditioned by similar, though not identical, factors. firstly, and coinciding with the entrepreneurs, they seem to need to perceive cultural values that lend dignity to the entrepreneur’s work. secondly, rather than the existence of advanced knowledge acquired in the classroom and not conditioned by local business practices, what conditions the construction of the opportunity component is the availability of training that provides workers ready for hire, as well as training courses for starting a business. consequently, the results suggest the importance of the knowledge and skills of the workforce in the development of the opportunity component. but while it is important for the entrepreneurs to perceive that there is an educated population available (cognitive dimension), what is important for the non-entrepreneurs is the perception of the availability of training courses (regulative dimension). it seems to be facts rather than possibilities that entrepreneurs, through their executive vision, base their motivations on. finally, it is interesting to note that the perception of incentives for entrepreneurship provided by the regulative institutions does not generate the opportunity component, either among entrepreneurs or non-entrepreneurs, in contrast to what many governments would expect. in regard to the necessity component of motivation, important differences between the entrepreneurs and non-entrepreneurs can be identified. for the entrepreneurs, this motivation is positively conditioned by regulative institutions that offer continuous training in business and cognitive institutions relating to accumulated business experience, probably because they offer a guide to valid behaviour. thus, these two institutional dimensions seem to complement each other to offer the individual the basic knowledge to become an entrepreneur, which is relevant when such a decision is unintentional and unplanned. perceiving cultural values that lend dignity to entrepreneurship does not affect the necessity component for this group. focusing on the non-entrepreneurs, we note that the regulative institutions that generate this component are the ones that provide legal incentives for entrepreneurship. as happens with the entrepreneurs, perceiving in the area accumulated business experience that offers a model to imitate also has a positive effect on the necessity component for non-entrepreneurs. finally, for this group, the existence of cultural values that lend dignity to entrepreneurship does represent a positive determinant factor. thus, for non-entrepreneurs constructing the necessity component seems to require a greater perceived institutional support than constructing the opportunity component. these results for the non-entrepreneurs suggest that the opportunity component seems to derive more from the individual’s entrepreneurial dream than from an analysis of their immediate environment. the fact that the opportunity component of motivation develops without such broad institutional support may explain why the entrepreneurial intentions based on opportunity among the non-entrepreneurs do not end up materialising in action in developing countries. this interpretation of the results is coherent with our findings for the entrepreneurs. nevertheless, a necessity motivation based on normative institutions that legitimise entrepreneurship as a professional option, cognitive institutions concerning the existence of models to imitate that guide new entrepreneurs, and regulative institutions generating economic incentives for entrepreneurship will produce more solid entrepreneurial motivations that are more likely to lead to actual entrepreneurial behaviour in developing economies. this is because of the consistency between the institutional reality of the environment perceived by the individual and the necessity component of their entrepreneurial motivation that they construct. we now look at the relative importance of each of the institutional dimensions in their capacity to stimulate a particular component of entrepreneurial motivation. our results allow us to conclude that the regulative institutions are the least important among the entrepreneurs for all three motivational components, and also for the opportunity component among the non-entrepreneurs. the instability of the legislative body may undermine the capacity of the regulative institutions to encourage entrepreneurial motivation, as previous literature suggests (puffer et al. 2010) and empirical works have found (lim et al. 2016; valdez & richardson 2013). this is because these institutions’ influence is associated with the use of rational criteria in evaluating the environment, a question that our evidence shows only becomes critical for the necessity component among non-entrepreneurs. in the case of these individuals, their situation of extreme necessity may lead them to see a framework of regulative incentives as relevant for their entrepreneurial motivation, although this framework may only be operational in the short or medium term. thus, as an addition to previous works’ focus on entrepreneurial activity (e.g. lim et al. 2016; valdez & richardson 2013), our study identified the fact that the regulative aspect of institutions matters for increasing the necessity component of the motivation of non-entrepreneurs in developing economies. in addition, and again in line with our results, previous authors have stressed that because of the high uncertainty associated with these unstable regulative environments (meyer & nguyen 2005), the normative and cognitive institutions determine the emergence of entrepreneurial motivation to a greater extent than the regulative ones (lim et al. 2016; puffer et al. 2010). finally, we identify the cognitive institutions as having the greatest effect on the development of all three components of entrepreneurial motivation for the group of entrepreneurs, reflecting the importance of knowledge for progress in developing economies, which is in line with simón-moya et al.’s (2014) generic results. again, we find an important difference with respect to the non-entrepreneurs because the cognitive institutions are always the least important for developing their entrepreneurial motivation. in our opinion, it is because these individuals are still not close to taking entrepreneurial action which explains why they focus more intensely on factors unrelated, at least directly, to the resources they need to start a firm and run it successfully. conclusion this research offers interesting theoretical and methodological insights, as well as practical implications for improving the planning of growth in developing economies since we identify the institutional factors that generate each component of entrepreneurial motivation. theoretical contributions firstly, and this represents a novelty in the literature on entrepreneurship in developing countries, the current work identifies institutional factors that influence the gestation of the individual’s desire to be an entrepreneur and those that lead them to actually start their own firm and become an entrepreneur. this distinction is very important for these economies because the different components of entrepreneurial motivation do not generate an equal proportion of productive entrepreneurship (acs et al. 2008; valliere & peterson 2009). in this respect, whereas three components of entrepreneurial motivation are identified for entrepreneurs, that is, opportunity, necessity and social components, only the first two are identified for non-entrepreneurs. secondly, our work finds that the probability of being an entrepreneur with opportunity, social and necessity components of entrepreneurial motivation, will depend on individuals’ perception of the institutional environment. thirdly, education is an important factor favouring the opportunity component among individuals who eventually become entrepreneurs, the educated population being in the best position to achieve it; in addition, the cognitive institutions concerning the existence of business experience accessible to new entrepreneurs are most responsible for the emergence of the social and necessity components of entrepreneurial motivation. referring to normative institutions, they are the most relevant for stimulating the opportunity component of entrepreneurial motivation, mainly among non-entrepreneurs. in contrast, the incentives designed to encourage people to create firms do not achieve the expected results. this is because these incentives apparently have no influence on any of the three components studied here for the group of entrepreneurs, nor on the opportunity component among the non-entrepreneurs. this may be because there is little trust that this regulation will remain stable over time. methodological contributions unlike previous studies that analyse the effect of the institutional environment on entrepreneurship from a -macro-level of analysis, and so compare countries on the basis of data available in international data sets, the current work is based on neo-institutionalism and uses a micro-level perspective to analyse how the individual’s perception of the institutional environment in a given developing country affects their entrepreneurial motivation. as the institutional dimensions scale, built to measure the perception of regulative, normative and cognitive factors, allows us to identify differences in the perception of institutions in a developing economy, as well as their effects on the entrepreneurial motivation in both of the subsamples, ‘entrepreneurs’ and ‘non-entrepreneurs’, the research instrument can be considered as a methodological contribution. the instrument also shows reliability, as well as content validity and construct validity in both subsamples. so, further authors may find it useful for studying institutional factors from the most recent versions of new institutionalism. practical implications as there exist differences in the impact of the dimensions of institutions, as perceived by an individual, on the components of their entrepreneurial motivation, a first and practical implication of this work is that policies aimed at boosting a given component of entrepreneurial motivation (e.g. opportunity) should not be similar to those aiming at stimulating the other components (e.g. social, necessity). secondly, as institutional factors exert a different influence on the entrepreneurial motivation of non-entrepreneurs and entrepreneurs, such policies should likely be based on a segmentation of the target audience, for example distinguishing between young people whose motivation to become entrepreneurs in the future may be stimulated, and adults already in a position to actually start their own business. it seems necessary in order for the programmes that are designed, to reach the objectives for which they are conceived. thirdly, because components of entrepreneurial motivation will depend on the individual’s perception of the institutional environment, government policies could be targeted not only at enhancing those institutional factors that positively affect components of entrepreneurial motivation that are of interest, but also at modifying people’s perceptions of such regulative, normative and cognitive institutions, as zwan et al. (2016) also suggest. fourthly, and from an educative perspective, since aspects of cognitive institutions related to education are important factors favouring the opportunity component among individuals who eventually become entrepreneurs, authorities should make greater efforts to reconcile the regulative and cognitive institutions that favour productive entrepreneurship by designing laws that guarantee an officially recognised higher-level training, as well as the population’s access to and success in the educational system in all its different stages. in addition, and because normative institutions are of relevance to non-entrepreneurs, especially for increasing the opportunity component of motivation, training efforts could also be focused on socialising people, especially the younger generations, in existing values that legitimise entrepreneurial activities in the country. also, training of young people could focus on shaping those normative beliefs that expectedly will increase entrepreneurial motivation, for example by carrying out activities similar to the ones suggested by valdez and richardson (2013): earlier exposure to entrepreneurial experiences and concepts, gamification of entrepreneurship using software of simulation, creation of entrepreneurship contests and competitions, awards to better projects, inclusion of entrepreneurship in elementary to post-secondary curricula, etc. limitations and future research finally, although the use of a single country is suitable for allowing researchers to analyse the differences between individuals’ perceptions of institutions, the doubt remains whether the conclusions we reach are relevant beyond the particular geographic context analysed or not. dunkelberg et al. (2013) warns that the psychology of entrepreneurship is likely to vary in different societies, both in terms of the entrepreneurial motivations and of the effect of these motivations on the entrepreneurs’ behaviour. in addition, as we collected data from a survey focused on participant’s opinions, our results may be subject to self-report biases. for example, individuals may report high in components of entrepreneurial motivations that are socially desired (e.g. entrepreneurs could say they started a business because they wanted to make a social contribution instead of confessing that they had no other option or were motivated purely by the prospect of financial gain (zwan et al. 2016). furthermore, our work focuses on understanding how the individual’s perception of institutions affects the construction of the different components of their entrepreneurial motivation, so we ignore other relevant questions for understanding this phenomenon, such as the individual’s psychological traits and other personality characteristics, such as their entrepreneurial alertness, propensity to assume risks, and so on. therefore, the literature would benefit from future research aiming to address this limitation. in addition, because according to some authors institutional dimensions are interlinked (szyliowicz & galvin 2010), researchers could empirically study how they interact to generate each component of entrepreneurial motivation. acknowledgements financial support from spain’s economy, industry and competitiveness national department (project: eco2016-80518-r) is gratefully acknowledged. competing interests we declare that we have no significant competing financial, professional, or personal interests that might have influenced the performance or presentation of the work described in this manuscript. authors contributions a.m.g-c. conceived and designed the research questions or hypotheses, performed the literature research on components of entrepreneurial motivation and wrote 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1-a1: entrepreneurial motivation scale. configuration matrix from spss pc 17.0: non-entrepreneurs and entrepreneurs subsamples. appendix 2 table 1-a2: institutional dimensions scale. configuration matrix from spss pc 17.0: non-entrepreneurs and entrepreneurs subsamples. 490 sajems ns 10 (2007) no 4 black economic empowerment in the eastern cape automotive industry: challenges and policies gideon s horn department of logistics management, nelson mandela metropolitan university abstract original equipment manufacturers (oems) in south africa are under pressure to meet the black economic empowerment (bee) policies and charters of the south african government by giving bee suppliers additional opportunities to tender. however, many bee suppliers, due to being historically disadvantaged, experience various problems which make it difficult for them to win tenders, including lack of finances, opportunities to tender and management and business skills, and problems with quality and capacity. this paper outlines these practical problems experienced by bee suppliers, the effects of these problems on risk and complexity in the south african automotive industry and policies that address these problems and assist bee suppliers to become a-rated suppliers. data for the paper was obtained from interviews with: senior employees of the aidc involved with supplier development training; middle managers of supplier quality and development departments at the three oems in the eastern cape province; and bee and small suppliers identified to undergo aidc training. the findings of the study are that unless sufficient training is given to bee and potential bee suppliers, supply to oems will remain in the hands of existing established suppliers and very little transformation will occur within the automobile industry in south africa. jel j70, l62 1 introduction the performance of the south african automotive industry and its contribution to the country’s economic growth in recent years has been significant. the automotive industry’s economic achievements include the following (automotive industry development centre, 2005: 7, 11; national association of automobile manufacturers of south africa, 2007): • a contribution of 6.6 per cent towards south africa’s gross domestic product (gdp); • becoming the third largest sector in the economy after mining and financial services, accounting for 30.0 per cent of the country’s manufacturing output; • the employment of approximately 297 000 people directly, and of many more as an indirect result of the sector’s growth; • as the twentieth largest manufacturer of vehicles in the world, integration into the global framework of parent companies and multinationals; • an increase in the export of fully built-up vehicles from 139 912 in 2005 to 179 859 in 2006 (an increase of 28.6 per cent), generating a significant amount of foreign exchange, in spite of growing competition from imports and worsening international conditions. the success of the south african automotive industry has resulted in it becoming a benchmark for the other prioritised sectors in the country. however, the industry is now challenged to maintain and improve on its successes. in addition, the south african government’s general policies and charters with regard to black economic empowerment (bee), equity and redress make this challenge even more sajems ns 10 (2007) no 4 491 daunting. the reason for this is that in terms of these bee policies, pressure is put on large and financially strong enterprises, including original equipment manufacturers (oems), also referred to as motor vehicle assemblers, to procure to a greater extent from bee or previously disadvantaged suppliers (hugo, badenhorst-weiss & van biljon, 2004: 53). these suppliers, however, tend to experience various problems and do not always meet the stringent standards demanded by oems. these problems, which will be discussed in the findings of this article, need to be addressed, and the role played by bee suppliers closely monitored and encouraged if they are to make a greater contribution to the country’ economic development and the economic empowerment of previously disadvantaged groups. the objectives of this article are therefore to outline: • practical problems experienced by bee and small suppliers in the eastern cape automotive supply chain; • the possible effects of these problems on risk and complexity in the south african automotive supply chain; • policies and procedures currently in place to assist bee and small suppliers in the south african automotive industry to secure more contracts; and • challenges faced by higher education and other training institutions in their efforts to develop the required human resource capacity among bee suppliers. 2 background notes on the eastern cape automotive industry the south african automotive industry is concentrated in three regions in the country (automotive industry development centre, 2005: 13). the most important region is the gauteng province, which is home to four oems (bmw, nissan, fiat and ford), and represents approximately 50 per cent of the country’s automotive components industry. the second most important region is the eastern cape province, which is home to three oems as well as almost 30 per cent of the country’s automotive components industry. the three oems situated in this region are general motors in port elizabeth, volkswagen in uitenhage and daimlerchrysler in east london. port elizabeth also houses the ford engine plant which is a major manufacturer and exporter of motorcar engines. the third major region is durban/ pietermaritzburg, which has one oem (toyota), and represents approximately 15 per cent of the country’s components industry. although the eastern cape is the second most important automotive region in south africa, it is regarded as one of the country’s poorest provinces in terms of both the human development index (hdi) and the provincial poverty rate (ppr) (may, 2005). as economic development and bee challenges are acute in this province, a theoretical and empirical study was undertaken to determine the main practical problems experienced by bee suppliers in the eastern cape automotive industry. 3 research methodology this article is based on research that combined a literature review and an empirical study. the aim of the empirical study was to identify the main problems experienced by bee and small suppliers in the eastern cape automotive industry. this process formed part of a bigger study on the automotive industry, funded by the national research foundation (nrf), to determine the skill shortages of previously disadvantaged suppliers in the industry. information was gathered by means of a structured questionnaire used to elicit information. the sample comprised selected participants who took part in the cluster training offered by the automotive industry development centre (aidc), which is explained in the next paragraph. in both the eastern cape and gauteng provinces where it has offices, the aidc runs various training and other programmes for small firms in partnership with business, government departments and other organisations, especially higher education institutions, 492 sajems ns 10 (2007) no 4 f o c u s i n g o n f u n c t i o n a l , i n t e r a c t i v e a n d leadership competencies in career areas such as manufacturing, logistics, finance and human resources. in the eastern cape province specifically, the eastern cape aidc has been very successful in running total production improvement programmes, focusing particularly on logistics and production processes. the programmes were developed by the united nations industrial development organisation (unido) and the confederation of indian industries (cii). these training programmes are funded mainly by the department of trade and industry (dti), with small additional contributions from the businesses undergoing the training. in the programmes, businesses are clustered into groups of five. these small clusters are first assessed in terms of the whole production spectrum, which includes procurement, logistics, warehousing, marketing, cost reduction, material flow and production planning, and specific problem areas identified. the clusters are then given training focussed on the identified problem areas. once these supplier businesses reach the appropriate standards, their names are placed on bidders lists from which oems can source their supplies. a sample size of 30 respondents was decided on and consisted of the following people: • two senior employees of the aidc who are involved in supplier development training; • five middle managers of supplier quality and development departments at the three oems in the eastern cape province; and • 23 bee and small suppliers who were identified to undergo training. before the survey was conducted, the questionnaire was evaluated for non-ambiguity, relevance, transparency, general validity and interpretation. interpretation refers to the respondents’ feedback which indicates whether the questions were in line with what the researchers intended measuring. the results of this evaluation were used in determining the final format of the questionnaire, to make sure it was properly adapted for the specific objectives of the study. because of the nature of the questionnaire, the windows-based statistical package for the social sciences (spss) software package was used. this is a complete package that can be used to enter, analyse, graphically display and report information. this computer package also allows the user to capture open-ended questions as they appear on the questionnaire. to minimise the measurement errors associated with a single survey of this nature and to verify the authenticity of the gathered information, as many cross-tabulations were run as possible. the data obtained in this study can therefore be considered reliable, as every precaution was taken to ensure that questions were clearly understood before the responses were recorded. the responses obtained are tabulated, interpreted and discussed in this article. 4 theoretical perspectives on problems faced by small suppliers textbook theory states that any business whose main focus is satisfying customer needs should, if it aims to achieve maximum profit, obtain the highest possible return (output) with the lowest possible cost (input) of production resources (hugo et al., 2006: 7). this involves procuring requirements of the right quality in the right quantities at the right time and price, from the right source, and with delivery at the right place (vogt, pienaar & de wit, 2005: 23). to achieve all these elements simultaneously is very difficult, indeed not always possible, so successful purchasing is often a compromise between these various criteria. for example, if a particular component is needed right away, the urgency of the need overrides the best price as the most important factor in supplier selection. in all cases, however, selecting the wrong supplier is costly. it can weaken a business’s competitive position, causing stock to run out, interruptions in production, the payment of unnecessarily high prices for supplies, consequent higher production costs and lower profits or even losses (hugo et al., 2006: 82). such a business also runs the risk of being excluded from tendering for future business. the conditions of the modern business world, characterised by globalisation, tough competition, increasingly stringent quality requirements and sajems ns 10 (2007) no 4 493 the technological revolution which shortens the life cycle of products, make selecting the right supplier a daunting challenge for purchasing and supply management. to complicate the selection and purchasing process further, a modern global trend is to focus on closer relations, which implies fewer preferred suppliers, longerterm contracts and e-procurement (leenders, johnson, flynn & fearon, 2006: 495). burt, dobler and starling (2003: 84) define a good supplier as one with a stable background; who always supplies the specified quality at a fair and competitive price; and takes the initiative when it comes to technical renewal, technical support, technical expertise and the suggestion of better methods of production and service delivery. only established suppliers, however, tend to meet these criteria. disadvantaged and small suppliers throughout the world, both new entrants to or at the fringes of the main markets, experience a combination of the following problems in their efforts to break into the major markets and become partners of established businesses (hugo et al., 2006: 341): (i) poor communication ineffective interpersonal communication is one of the greatest obstacles to the success of small business purchasing programmes. this is particularly problematic if the business is owned by previously disadvantaged individuals, since this often creates problems with language and cultural divides (hugo et al., 2006: 341). together with poor communication go expectations that cannot be met, mistrust and prejudice. small suppliers often accuse buyers of making false promises relating to contracts, loans and technical assistance, while buyers often accuse small suppliers of insisting on being given a contract simply because they are small and belong to previously disadvantaged groups. (ii) high transaction costs for an established business, the cost of tracing, evaluating and developing small suppliers is high in terms of time spent visiting and making telephonic contact, and handling complaints caused by poor quality and/or late deliveries. on the other hand, the small business owner, who is often also the manager and the driving force behind the enterprise, has limited human resource capacity (grant, lambert, stock & ellram, 2006: 102). he or she, therefore, has to spend a great deal of time on completing complicated tender documents, negotiating with buyers, learning about the purchasing enterprise’s complicated procedures, and developing the technical ability to comply with specifications. (iii) satisfaction with current bigger suppliers as mentioned above, the global trend is for buyers to deal with fewer preferred suppliers (leenders et al., 2006: 495). buyers at established businesses prefer to deal with existing suppliers who have been giving them good service for years, even decades, and with whom they have maintained healthy long-term relations. furthermore, global sourcing enables established businesses to enjoy the benefits of advanced technological expertise, high-quality standards, lower costs and better service in the form of just-in-time (jit) delivery. given these complex issues with procurement from new and/or small suppliers, it is international practice for buyers to use what is known as a scoring and assessment process, also referred to as a supplier qualification rating or weighted points process, to assist them in their decision to appoint the best possible supplier (chopra & meindl, 2007: 429). in such a process, potential suppliers are rated according to specific evaluation criteria which include: • quoted price. • replenishment or lead time. • timely delivery. • flexibility and viability. • delivery frequency or minimum lot size, • supply or service quality; and • design collaboration capability. each of these listed factors impacts on cost structures in the total supply chain. the importance of each factor is therefore considered and a relative weight allocated to each (for example a score out of 10). the weight of each factor is then multiplied by the rating given for each supplier. a total value or rating for each supplier is obtained this way, which decides who the best supplier is to procure from. 494 sajems ns 10 (2007) no 4 5 results of the interviews the process of assessing, selecting and appointing a good or the best supplier is not always straightforward in south africa and is, in most cases, complicated by political pressures. the broad-based black economic empowerment act 53 of 2003, for example, was adopted by the government as a strategy to redress the imbalances in south african society by encouraging and facilitating meaningful participation by previously disadvantaged individuals in the economy (dekker, 2005). as part of the strategy, industry-specific bee charters and achievement scorecards are constantly developed and revised for all the key sectors of the economy. businesses are given empowerment targets to meet in terms of black ownership, management, supplier procurement and skills development, with the main aim eventually of creating a non-racial south africa (balshaw & goldberg, 2005: 21). purchasing from small, disadvantaged businesses is regarded as an appropriate tool by which large enterprises can assist in the development of small businesses (hugo et al., 2006: 335) and support the government’s bee strategy. pressure is, therefore, put on oems in south africa to procure to a greater extent from bee suppliers and in this way become actively involved in the socio-economic development of the country. a complicating factor to be considered, however, is the fact that, by early 2004, all oems operating in south africa were either fullyor majority-owned by parent companies which are situated in foreign countries (automotive industry development centre, 2005: 7), in which different political and socio-economic conditions prevail. furthermore, the parent oems are mainly interested in maximising their profits and, therefore, assess potential suppliers from any country that tender for contracts, including south africa, purely in terms of the following four main criteria: quality, supply reliability, technology and price (kpmg, 2004: 3). owing to various historical, political and other reasons, bee and small suppliers in south africa do not always meet these basic criteria and, therefore, mostly fail to win tenders to supply direct materials, in other words motor vehicle components, to oems. this situation is seen as a main reason why the minister of trade and industry announced on 26 october 2004 at the auto africa conference in johannesburg that the original bee charter for the automotive industry will not be enforced, but that the industry will be allowed to commit to its own initiatives (motor industry allowed to bee, 2004: 17). it is within this context that we present the findings from the interviews conducted during this project. these findings represent the perspectives of the majority of the respondents on the practical problems experienced by bee and small suppliers in the eastern cape automotive industry: (i) lack of finances notwithstanding the fact that more sources of funding are currently available from the government, the private sector and foreign sources than ever before, the majority of the bee respondents indicate that a lack of the necessary finances is a main factor that limits their chances to tender successfully for contracts and earn a sustainable income. the bulk of the motor vehicles, parts and accessories sector is capital-intensive and technologically advanced, requiring that suppliers have the necessary expensive capital equipment and the latest technology in place. unfortunately, most bee suppliers lack the necessary finances to acquire expensive capital equipment and the latest technology, and are thus not in a position to compete internationally. when applying for loans at banks, they also need to produce collateral, which they usually lack. (ii) problems with quality and capacity owing to their lack of finances, bee and small suppliers are often forced to operate on shoestring budgets for their labour, material and capital equipment requirements, which often leads to the production of sub-standard quality and insufficient volumes. because of the highly competitive environment in which they operate, however, oems do not tolerate poor delivery performance or quality risks caused sajems ns 10 (2007) no 4 495 by, for example, deviations from specifications or the use of inferior materials. these quality and capacity problems cause production stoppages and delays which require production rescheduling at customer plants. this eventually slows down the entire supply chain and leads to longer lead times, more backorders and lost sales. oems operating in south africa are part of the latin american, african and middle east (laam) umbrella standards body and adhere to the same international quality requirements, engineering specifications and purchasing policies for the procurement of their supplies as any oem anywhere in the world. these standards are continuously evaluated and strictly controlled by means of weekly international telephone conferencing, where members of each oem’s supplier quality and development (sq & d) department discuss local supplier pricing and quality, as well as the acceptability thereof. day-to-day quality is generally measured in what is called parts per million (ppm). the ppm criteria is calculated as the total number of defective parts delivered divided by the total number of parts delivered, multiplied by 1 million. the industry average is currently between 50 and 200 ppm. for a supplier to achieve a 50 ppm benchmark, the reality is that he or she can in effect deliver only 5 defective parts per every 100 000 deliveries. this is not easily achieved by new market entrants. a second daily evaluation measure is the number of problems that are reported to the supplier, and a third measure is whether the supplier causes the oem’s production line to stop. all potential suppliers to oems are audited before being awarded a contract. the audit covers aspects such as quality accreditation, production capacity, process capability, design capability, technical agreements, management capacity, staff turnover and joint ventures. local oems send representatives from their supplier quality assurance (sqa) departments and their procurement divisions, including materials management and production control, to the premises of all existing and potential suppliers to evaluate their ability in terms of the abovementioned laam quality criteria. all bee suppliers are similarly audited. furthermore, potential suppliers are required to have a system in place to accredit or certify their achievement of a minimum threshold of quality in order for them to tender successfully. the quality standards for the american and german oems, e.g. general motors, volkswagen and daimlerchrysler which operate in the eastern cape, are sanctioned by the automotive industry action group (aiag) and the verband der automobilindustrie (vda) respectively. the quality standards for production-part suppliers are set out in qs 9000 or iso/ts 16949, and the minimum requirements for warehousing and distribution are described in iso 9001. all these thresholds are minimum requirements for placement of business as stipulated by the oems. it is clear that bee suppliers experience difficulties in meeting these stringent standards, especially if they are not supported by a third party in developing capacity. fortunately, the oems have indicated that they do employ supplier development specialists, called supplier quality assurance representatives, who assist suppliers who do not meet the required standards. this assistance takes the form of interim corrective action programmes for the supplier which aims to salvage the situation within a set time schedule. the oems then undertake follow-up visits to assess the progress of these suppliers. in practice, new suppliers who are given a chance to supply parts to an oem are at first only given contracts to produce low risk production parts. once better established, and on condition that the oem is satisfied with their quality and capacity, the suppliers are given higher value contracts and even more critical production parts to produce. lowrisk or non-critical production parts include, for example, headrests. cars can go to the stockyard or cripple stockyard until the noncritical parts, in our example the headrests, arrive and the car can be fully completed. critical parts include engine-mounting brackets, handbrake-cable assemblies and gearboxes. these parts are also known as no-build parts, since no further production can take place if supply is insufficient or if there is a quality problem with these critical parts. 496 sajems ns 10 (2007) no 4 the daily changing of demand schedules by oems also places tremendous pressure on small supply firms who already experience capacity problems. the further back in the supply chain they find themselves, the more exposed they are to erratic call-offs. (iii) lack of multi-skills required to source internationally these skills include tooling and tool making. when the foreign-based parent company of a south african oem designs a new model car, that same parent company does the sourcing of each required component on a global basis. purely on the condition that the parent oem is satisfied with a component supplier in terms of quality, supply reliability, technology and price, that same supplier is given the contract. the components are designed by means of computer-aided design (cad) systems that use computer graphics (stephenson, 2007: 144). growing numbers of components are designed this way globally as it increases productivity and makes designs and design specifications available much more quickly and cheaply. however, in practice only established suppliers have the supporting infrastructure and computer systems that enable them to design and process the required components and put in tenders. many bee and small suppliers have staff who are computer-illiterate, while many of those who are computer literate do not have the finances to afford computers and cad software. an established supplier in a foreign country which is closer to a parent oem thus has a major advantage over a potential south african bee or even established supplier in terms of lead time and distance to the market. bee and other suppliers in south africa are also disadvantaged by the global strategies of assemblers which affect the relationship they have with suppliers in a number of significant ways (automotive industry development centre, 2005: 4). firstly, design activities have shifted from assemblers to suppliers, with suppliers moving towards greater customisation and tailoring of their products to the needs of specific assembling companies. the assembler provides the overall performance specifications and information about the interface with the rest of the car, and the supplier, using its own technology, then designs a solution. secondly, there is a shift towards the supply of complete functions (namely, systems and subassemblies) rather than individual components. a first-tier supplier thus becomes responsible not only for the assembly of parts into complete units, but also for the management of secondtier suppliers. thirdly, the assemblers have become more involved in specifying the production and quality systems of their suppliers. with the increasing importance of jit production systems and the imposition of quality-at-source controls, even simple tasks have become critical for the overall efficiency of operations. for this reason, assemblers have to invest to a greater extent in their relationship with their suppliers, thereby contributing towards the trend of assemblers having longer-term relationships with fewer suppliers. this preference by assemblers in many different locations to use the same (few) suppliers is known as follow sourcing. the supplier thus follows the assembler to new locations. this practice is a logical consequence of the supplier taking more responsibility for design and for the increasing commonality of models between markets. using a follow source ensures that the rest of the supply chain meets the assembler’s standards (automotive industry development centre, 2005: 5), thereby reducing possible risk. this global trend, however, has the potential for oems in the country to marginalise local suppliers in preference for trans-national suppliers based in foreign countries, underlining the difficulty for bee suppliers to win contracts. for example, instead of dealing with a large number of local south african suppliers (including bee suppliers) whose designs and prototypes have to be homologated (tested and approved for use), and whose production and quality systems have to be audited and improved, the assembler rather deals with a limited number of foreign-based follow source suppliers to provide the required parts or subassemblies at the required standards. (iv) lack of opportunities to tender it is important to note that oems are private companies that cannot easily be forced to give sajems ns 10 (2007) no 4 497 bee suppliers the opportunity to tender, especially if they are satisfied with their current suppliers. having established comfort zones, oems are unwilling to enter into new partnership agreements, especially with new and unknown suppliers. oems prefer to simply renew contracts with suppliers they know, with whom they have a satisfactory history, whose products meet their stringent quality standards, and who have a good track record. only a few lucky new suppliers thus get to know about new tenders and are given the opportunity to tender. if they do get an opportunity to tender, bee suppliers often have a problem presenting themselves as they lack the necessary experience and confidence. two other factors that limit the opportunities of bee suppliers in south africa to tender for contracts are global overcapacity and a small domestic market (automotive industry development centre, 2005: 14). given the south african automotive industry’s export orientation, it enjoys marginal status in relation to an international industry that is rapidly globalising and which has 25–30 per cent excess production capacity. bee suppliers in south africa are also limited by the fact that the country does not have the advantage of a major domestic market such as china, brazil or india, nor is it located adjacent to major markets as is mexico (in relation to the united states) or central european countries (in relation to the european union). (v) inability to penetrate into oems bee suppliers find it difficult to penetrate into oems because as relatively new entrants into the market these suppliers have difficulty obtaining what are known as technical tie-ups with specialised and experienced suppliers, especially those based overseas. foreign-based specialised gearbox manufacturers, for example, have advanced research and development (r&d) facilities that assist them in developing their products more extensively. they are also more interested in keeping and expanding their own market share and thereby maximising their own profits than in sharing their expertise and market share with newcomers. (vi) lack of management and business skills although many bee suppliers have the necessary technical skills to produce components, they sometimes lack various management and business skills. because they operate on a much smaller scale than their established counterparts, these small suppliers do not have the luxury of different departments with skilled personnel responsible for different business functions such as marketing, warehousing, materials handling and packaging. the design staff is often responsible for most of these functions themselves without possessing the necessary skills. specific skills that are lacking include the following: • good management skills: bee suppliers find it difficult, for example, to delegate tasks, prepare and keep within budgets, and also lack the necessary sales and marketing skills. skill in planning effectively is often lacking, especially in up-front planning. bee suppliers are often too hasty and excited to get their products out to the market, causing products to be reproduced or reworked. they also lack the necessary robust planning skills required to optimise their manufacturing methods. • logistics skills: bee suppliers often do not have effective control over materials and ignore the importance of lead times. furthermore, they experience material flow problems, warehouse problems and inherent wastage as space is not always maximised. this result in the multiple handling of parts and components, as well as high sourcing and storing costs. • communication skills: english is in most cases not the mother tongue of bee suppliers, so they are hampered in their efforts to understand highly technical specifications and contractual clauses. lack of familiarity with complex business terms may also result in poor communication. as bee suppliers often accept orders over the telephone, without insisting on hard-copy documentation, incorrect interpretations can lead to confusion, with too little or too much stock ordered and materials either running out or being wasted. 498 sajems ns 10 (2007) no 4 (vii) previous lack of opportunities in corporate business under the previous dispensation, most previously disadvantaged suppliers were deprived of exposure to and experience in the corporate world. for example, they did not form part of the formal business network that could have aided their development. this means that many of them, under the current dispensation of redress and empowerment, find themselves relatively new to business, and having to concentrate mainly on their internal production processes in order to become better established. (viii) unrealistic expectations the majority of the respondents in the interviews report that they find the going tougher than they expected. one put it this way, “this game is not for sissies”, while another said, “i lived a pipe dream”. the bee suppliers acknowledge that they did not foresee many of the problems outlined above, which now limit their activities severely. the one honestly said, “i definitely lack experience and certain skills” and another, “i have to teach myself many things.” others bluntly state that “it is very difficult to access finance” and “it is very difficult to access contracts from oems.” one result of these problems is that bee suppliers are often only successful in winning tenders for non-production or soft activities. these include mainly the provision of stationery, furniture, security and catering or cleaning services. another result, which has a more immediate and widespread impact on the south african economy, is a possible increase in the risks and complexities faced by the south african automotive supply chain, as will now be discussed. 6 possible risks and complexities as a result of bee supplier problems logistics and supply chain management deal with intangibles, compared to the tangible products which a producer manages in the physical production environment. to ensure the efficiency and effectiveness vital to competitiveness, and to shorten cycle times, decisions are constantly made in a supply chain. the intangible nature of logistics thus requires that each member of the south african automotive supply chain has full knowledge of how the entire chain functions and realises the importance of his/her contribution towards the chain’s overall success. however, because bee suppliers are relatively new to the corporate world, many do not set up logistical management systems but focus mainly on their internal production. they are therefore prone to the problems explained above. these suppliers often lack a holistic understanding of the automotive supply chain within which they operate. this can lead to the following risks and complexities: • slower reaction time of the total supply chain. this happens, for example, when the parts with which the bee suppliers are entrusted are delivered later than the date specified by the customer’s release order, because of the practical problems the suppliers experience or because they do not realise the ripple effect that their late delivery causes further down the total automotive supply chain. furthermore, multinational oems know that, even though bee suppliers often control only one part, the late or non-delivery of this part can bring the whole supply chain to a complete stop. such a risk factor could make the south african automotive supply chain less attractive to such multinationals. • inventory obsolescence and consequent higher cost caused by engineering changes. due to the economies of scale principle, which explains that production output is based on minimum quantities, bee suppliers can end up producing too many of a given part in an effort to minimise their production unit costs. however, when engineering changes specify a change in component levels (in other words new and/or improved parts are required), the already produced parts are no longer required and thus become obsolete. such waste has cost implications for the supplier. furthermore, if such a bee supplier insists that his/her parts be used, there is a risk that the production line of sajems ns 10 (2007) no 4 499 the customer firm, and therefore the entire supply chain, could come to a standstill, thus negatively affecting both response time and cost. • ultimate consumers paying higher prices and receiving inferior service. as a result of their limited supply chain view and the fact that they do not have a culture of challenging price increase requests initiated by their own supplier base, bee suppliers often lack ultimate customer affordability information. furthermore, because of the communication problems discussed above, they are not always customer-orientated, with the result that final consumers can be offered products that do not meet their requested specifications. this can lead to the total rescheduling of production, cancelled sales and eventually higher costs. these risks could cast doubt on the attractiveness and profitability of the south african automotive supply chain, and will only become more complex and intractable if they are not addressed. negative factors such as late deliveries, production stoppages, bad service and higher cost structures may cause existing customers and/or potential customers of bee suppliers to rather source from other suppliers in the same automotive supply chain or even from competitor supply chains. 7 policies and programmes in place to assist bee suppliers the south african automotive industry is guided by a common vision “to establish a viable, competitive industry domestically and internationally, capable of achieving both continuous growth and sustainable job creation” (automotive industry development centre, 2005: 7). the development and upliftment of bee suppliers, as well as the minimising of possible risks and complications in the south african automotive supply chain, form part of this vision. however, the results of our survey show that bee suppliers in south africa are in desperate need of assistance to enable them to become “a-rated” suppliers or at least suppliers to first-tier suppliers. a-rated suppliers are suppliers whose quality, supply reliability, technology and price standards qualify them to become first-tier suppliers to oems with the prospect of being awarded continuous business and long-term contracts. bee and small suppliers need to be assisted to become at least secondand third-tier suppliers who supply components of a safety and critical nature to first-tier suppliers in both south africa and foreign countries. policies and programmes already in place in the south african automotive industry to assist bee and small suppliers include the following: (i) the automotive industry development centre (aidc) bee and small suppliers in south africa currently receive major assistance from the automotive industry development centre (aidc). the aidc is a government-supported service provider company that plays a supportive and development role by addressing the needs and objectives of the industry, the government and the wider society as a whole. in 2005, based on its experience in the industry and in consultation with its stakeholders, the aidc set itself specific institutional objectives, including (aidc, 2005: 18): • increasing the contribution of small enterprises to the country’s economy; • increasing broad-based bee significantly; • increasing market access opportunities for and export of south african goods and services; • contributing towards building skills, technology and infrastructure platforms from which enterprises can benefit; • creating jobs through supplier development programmes, export readiness programmes and the promotion of foreign investment; and • contributing towards building a single economy that benefits all and bridging the divide between the first and second economies. the aidc then restructured its activities to focus its activities towards achieving these goals. 500 sajems ns 10 (2007) no 4 currently, therefore, the aidc’s three main focus areas are (aidc, 2005: 24): • supply chain development: here the aim is to move the automotive industry towards global competitiveness by means of macro logistics projects that are financed by the government. these include strategic infrastructure projects such as airports, ports and supplier parks. • supplier development: here the aim is to move the enterprise, with the aid of appropriate shop-floor training programmes, towards global competitiveness. • skills development and training: here the aim is to help people achieve global competitiveness by means of appropriate training. the various training and other programmes which the aidc offers to small firms and bee suppliers in partnership with business, government departments and other organisations, including higher education institutions, were outlined earlier in this article in the “research methodology” section. (ii) direct empowerment mechanisms are in place to directly empower bee and small suppliers. according to government legislation, all suppliers who tender for a contract are evaluated in terms of their executive management responsibility, that is, the percentage of previously disadvantaged individuals (pdis) in the business who are active decision-takers at middle management, senior management and board level. only those suppliers who have satisfactory scores can be awarded contracts. (iii) indirect empowerment methods of indirect empowerment include p r e f e r e n t i a l p r o c u r e m e n t a n d e n t e r p r i s e development. preferential procurement involves an oem assessing whether suppliers that tender are truly bee companies or merely fronting. the share certificates of these companies are inspected to verify and validate their status. all this is followed by on-site visits to inspect the supplier’s quality systems, technology, staff composition, social responsibility and spending on enterprise development. in enterprise development, the formation of joint ventures (jvs) with established white suppliers is strongly encouraged. the following example explains what is meant by a joint venture: assume that business a, which supplies stationery, is owned by “whites”, has state-of-the-art technology, is engaged in e-business, is big, well established and is sound financially. business b, on the other hand, is small, owned by pdis and operates without the latest technology. business b, however, is strategically much better situated to serve government contracts in rural areas or negotiate contracts at bhisho, the provincial capital of the eastern cape province. business a then buys shares in business b and ensures that there is a transparent transfer of skills. business a also ensures that business b acquires the latest technology in order to improve its technology capacity, such as e-business and on-line ordering, thereby assisting it to reduce its costs and become more competitive. with business b now certified as a bee company with modern technology and being in a jv with a strong business, it has a much better chance of winning state contracts than the white business a on its own. the main argument here is thus that both businesses benefit as the two parties share in the profits. according to current law in south africa, 25.1 per cent is the minimum percentage of shares to be bought in such a jv. this is seen as part of enterprise development where shares are bought in a small business enterprise. (iv) human resource (hr) development and employment equity programmes when an oem evaluates a supplier that tenders for a contract, factors such as employment equity and equity targets, as well as processes to improve equity targets, are considered. key questions asked include: • what sum of money is spent in the business toward human resource development as a percentage of the business’s total payroll? sajems ns 10 (2007) no 4 501 • what are the employment equity plans of the business? do these comply with government legislation? what plans are in place to develop pdis to enable them to participate at middle management, senior management and board level? (v) black business supplier development programme (bbsdp) the dti has instigated the black business supplier development programme (bbsdp), which offers financial support to black-owned enterprises in south africa by way of a 20 percent: 80 per cent cost sharing cash grant incentive scheme (national association of automobile manufacturers of south africa, 2005). the scheme is designed to assist these firms to improve their core competencies, upgrade their managerial capabilities and become more competitive by means of training. the bbsdp qualification is confined to enterprises: • that are majority black-owned (50.0 per cent plus one share) and have a significant representation of black managers; • with a maximum annual turnover of r12 million; • that have a trading history of at least one year; and • that comply with regulatory requirements (for example those of the south african revenue service). 8 challenges faced by higher education and other training institutions we have mentioned several times that manufacturing and supplier quality assurance follows strict internationally defined standards, and that this implies that local suppliers must be able to design, develop and manufacture complex components that meet oem specifications if they are to be competitive. modern trends and the rapid growth in vehicle technology have put severe pressure on all stakeholders to provide the required specific skills in the domestic automotive industry, especially at technical and customer management levels. only 50.3 per cent of total employment in the sector is currently semi-skilled or unskilled, while 31.4 per cent of the workforce performs jobs that require high-level skills (automotive industry development centre, 2005: 12). to find workers with the necessary skills has thus become a major challenge for the local automotive industry in its effort to be viable, internationally competitive and capable of achieving continuous growth and sustainable job creation. this skills challenge exists against a background of a general skill shortage in south africa (skills development planning unit, 2005: 31). the legacy of apartheid, particularly the denial of access to quality education to the vast majority of the population, has caused many employees in the automotive industry to lack the basic skills required to meet the challenges posed by the industry’s structural transformation. fortunately, this reality is fully appreciated by the current south african government, which has in recent years committed itself to the human resource development strategy (hrds) and the national skills development strategy (nsds) in order both to be more responsive to the education and training needs of its citizens and also to make south africa more globally competitive. furthermore, support organisations, such as the aidc (both eastern cape and gauteng), are increasingly busy establishing partnerships with the higher education sector to facilitate the implementation of learnerships and are actively involved in various skills development programmes. the skills shortage together with these various programmes implemented by the aidc and individual oems offer south africa’s higher education sector an opportunity and a challenge. higher education institutions must form partnerships with the automotive industry, the aidc and the government to equip the current labour force and new entrants with the specific skills they require. unfortunately, many lecturers at universities and further education and training (fet) colleges still suffer from what can be called the “classic textbook syndrome”. this means that in the classroom environment students are merely 502 sajems ns 10 (2007) no 4 told about and not shown what happens in industry. however, it has become necessary for higher education institutions to go to industry and find out how things work in practice. academics need to be made aware of the fact that they need to teach what industry requires. speakers from industry should be encouraged to visit the classroom. for these reasons the aidc introduced the tertiary education industrial (tei) programme whereby students are assisted to develop capacity and to align themselves with the current trends and requirements of industry. the tei programme was initiated in gauteng and then replicated at the nelson mandela metropolitan university and various colleges in port elizabeth and the eastern cape. the idea of the tei is to equip facilitators and lecturers to deal with the requirements and needs of industry. in the tei programme, students work on projects within industry to support their studies and to build their understanding of how industry works in practice. the generic knowledge students acquire at higher education institutions is then complemented by more specialised knowledge they gain from firms in the automotive industry. this attitude and method of giving students more practical exposure and training assists higher education institutions in addressing two of their main challenges, namely, to ensure that the programmes they offer: • are relevant, job specific and comply with industry requirements; and • enable students to become employable and ready for the job market. 9 conclusion and recommendations if previously disadvantaged and/or bee suppliers are to successfully tender for contracts, they need to be capable of meeting the stringent global requirements for the quality, supply reliability, technology and price of their products and services. if not, they will limit their competitive edge and ability to win contracts. the south african government prioritises redress, so any lack of competitiveness among previously disadvantaged suppliers can have serious negative consequences for national and international perceptions of the risks and complexities associated with the south african automotive supply chain. the policies and political objectives recommended by the south african government, therefore, need to be synchronised with the programmes and policies currently followed by the aidc and other private stakeholders involved in the south african automotive industry, if previously disadvantaged suppliers are to share in the successes of the country’s automotive industry. these policies and programmes need to create an environment in which bee suppliers are given sufficient support to enable them to develop, reach their potential and become a-rated suppliers who can supply to oems and/or first-tier suppliers both locally and internationally. higher education institutions also need to ensure that they offer job-specific learning content that enables their students to be appropriately skilled and become employable in the internationally competitive automotive industry. this project has several limitations. it investigates only a few of the problems experienced by previously disadvantaged suppliers in the eastern cape automotive industry. however, since the sample size for the survey was only 30 respondents, the intention is not to make generalisations about the country’s automotive industry as a whole, but to offer focused insights into the industry in the eastern cape. also, although training for disadvantaged suppliers and students is offered at various higher education institutions in the country, this article focuses more on the specific training offered by the aidc in the eastern cape province. however, the findings of the article can be used as a basis to conduct further research on various issues affecting the south african automotive sector. note: the nrf is acknowledged for its financial assistance in this research project. references 1 automotive industry development centre (2005) strategy and business plan for the sajems ns 10 (2007) no 4 503 automotive industry development centre: aidc gauteng and aidc eastern cape, automotive industry development centre: pretoria. 2 balshaw, t. & goldberg, j. (2005) cracking broad-based black economic empowerment, human & rosseau: pretoria. 3 burt, d.n.; dobler, d.w. & starling, s.l. (2003) world class supply management, mcgrawhill: new york. 4 chopra, s. & meindl, p. (2007) supply chain management, pearson education: upper saddle river, nj. 5 dekker, c. (2005) “business and investment in south africa”. http://www.cliffedekker.co.za/ literature/invest/bee.htm. (accessed 7 december 2005.) 6 grant, d.b.; lambert, d.m.; stock, j.r. & ellram, l.m. (2006) fundamentals of logistics management, mcgraw-hill: london. 7 hugo, w.m.j.; badenhorst-weiss, j.a. & van biljon, e.h.b. (2004) supply chain management, van schaik: pretoria. 8 hugo, w.m.j.; badenhorst-weiss, j.a. & van biljon, e.h.b. (2006) purchasing & supply management (5th ed.) van schaik: pretoria. 9 kpmg (2004) auto executive survey. [compact disk]. kpmg: pretoria. 10 leenders, m.r.; johnson, p.f.; flynn, a.e. & fearon, h.e. (2006) purchasing and supply management (13th ed.) mcgraw-hill: new york. 11 the herald (2004) “motor industry allowed to bee”, the herald, 28 october, p.17. 12 may, j. (2005) “poverty and inequality report”, school of development studies, university of kwazulu-natal: durban. 13 national association of automobile manufacturers of south africa. (2005) “black business supplier development programme (bbsdp): incentives available from the department of trade and industry”, http:// www.naamsa.co.za/bee/bbsdp/htm. (accessed 13 september 2005.) 14 national association of automobile manufacturers of south africa. (2007) “industry vehicle sales, exports and imported data”, http://www.co.za/naamsa/papers. htm. (accessed 24 june 2007.) 15 skills development planning unit. (2005) state of skills in south africa, 2005. department of labour: pretoria. 16 stephenson, w.j. (2007) operations management, mcgraw-hill: new york. 17 vogt, j.j.; pienaar, w.j. & de wit, p.w.c. (2005) business logistics management, oxford university press southern africa: cape town. abstract introduction a brief note on the state of south africa’s marine biodiversity biodiversity reporting method results conclusion acknowledgements references footnotes about the author(s) kieran usher school of accountancy, university of the witwatersrand, south africa warren maroun school of accountancy, university of the witwatersrand, south africa citation usher, k. & maroun, w., 2018, ‘a review of biodiversity reporting by the south african seafood industry’, south african journal of economic and management sciences 21(1), a1959. https://doi.org/10.4102/sajems.v21i1.1959 original research a review of biodiversity reporting by the south african seafood industry kieran usher, warren maroun received: 26 may 2017; accepted: 28 sept. 2017; published: 03 apr. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: biodiversity reporting is an area of sustainability accounting research that has received comparatively little attention from the academic community. this is despite the growing scientific concern about climate change, habitat destruction and extinction of species and mounting evidence on the implications of these environmental issues for our current way of life. this necessitates additional research on biodiversity reporting, especially in a south african context given that the country is home to some of the richest biodiversity regions on earth. aim: this research examines what information companies in the south african seafood industry are reporting on biodiversity. this includes the development and application of an easy-to-use disclosure scorecard to track the quality of biodiversity-related disclosures. setting: the study focuses on south african biodiversity reporting. the choice of region is informed by the country’s significant marine resources and mature corporate reporting environment, where non-financial disclosures are expected to be well developed. methods: content analysis was used to collect data from a sample of companies’ integrated and sustainability reports. the data were analysed interpretively to determine what biodiversity disclosures companies provide and the quality of those disclosures. conclusion: the study shows that while the quantum of biodiversity reporting is relatively low, some companies are starting to provide more detailed accounts of their biodiversity impact, pointing to higher levels of reporting quality. there is still room for improvement, but these findings suggest that reporting on non-financial sustainability issues is maturing and that companies are beginning to appreciate the importance of preserving biodiversity for ensuring long-term sustainability. introduction there are numerous national and international standards dealing with what is referred to generally as ‘sustainability reporting’ (dumay, guthrie & farneti 2010). the guidelines issued by the global reporting initiative (gri) are the most prominent. they are used by over 90% of the world’s largest companies when preparing their sustainability and, more recently, integrated reports (dumay et al. 2010; hughen, lulseged & upton 2014). of particular interest for the purpose of this research is the gri’s (2016) emphasis on the biodiversity reporting as part of the broader sustainability agenda: protecting biological diversity is important for ensuring the survival of plant and animal species, genetic diversity, and natural ecosystems. in addition, natural ecosystems provide clean water and air, and contribute to food security and human health. biodiversity also contributes directly to local livelihoods, making it essential for achieving poverty reduction, and thus sustainable development. (p. 185) given the importance of biodiversity for assessing sustainability, academics have begun to evaluate reporting on biodiversity-related issues by some of the world’s most prominent companies (adler, mansi & pandey 2018; atkins et al. 2016a; hossain 2017; jones & solomon 2013). this research is, however, limited mainly to biodiversity reporting in developed economies (jones & solomon 2013). in addition, the work concentrates on describing what information companies are reporting, the extent of compliance with reporting frameworks and the quantity of biodiversity disclosures (mansoor & maroun 2016; rimmel & jonäll 2013; romi & longing 2016). the quality of biodiversity reporting has not been considered in detail. this research addresses this gap. the aim of this article is to examine biodiversity reporting by south african food producers and harvesters, focusing specifically on seafood production and consumption. drawing on the prior corporate social responsibility (csr), (laine 2009b; michelon, pilonato & ricceri 2015) and integrated reporting research (atkins and maroun 2015; stent & dowler 2015), the study develops a normative scorecard that is used to evaluate the quality of biodiversity disclosures. this complements the biodiversity reporting research that has neglected one of africa’s largest economies and biodiversity regions (jones & solomon 2013; mansoor & maroun 2016). it also adds to the body of integrated reporting research that deals in detail with the proliferation of environmental, social and governance (esg) disclosures by leading south african corporations (e.g. see de villiers & van staden 2006; pwc 2015; raemaekers, maroun & padia 2016; solomon & maroun 2012) but stops short of focusing specifically on biodiversity reporting. finally, although this article examines the quality of a specific type of environmental reporting by a relatively small group of companies, it provides a basis for future researchers wishing to deal more generally with the quality of non-financial reporting by companies. the remainder of this article is structured as follows. the section ‘a brief note on the state of south africa’s marine biodiversity’ provides a brief context of south africa’s marine biodiversity. ‘biodiversity reporting’ and ‘method’ outline the prior research on biodiversity reporting and develop a biodiversity reporting framework that is used to evaluate the quality of biodiversity reporting in the chosen sub-sector of the south african food industry. the ‘results’ section presents the findings. the last section concludes and identifies areas for future research. a brief note on the state of south africa’s marine biodiversity south africa is among the world’s most biodiverse regions. it is made up of nine biomes, some of which are home to unique plant and animal species (mayes 2012; wynberg 2002). this biodiversity is, however, under threat because of climate change, expanding human populations and unsustainable use of natural resources (daly & friedmann 2016; endangered wildlife trust [ewt] 2016). south africa’s marine territories have been particularly hard hit by over-fishing which has placed populations of key species under pressure and threatened the sustainability of the local seafood industry (brookbanks 2012; petersen 2016; planet earth herald 2016). it is estimated that approximately 61% of the world’s fish stocks are fully exploited and that 29% of fish stocks are over-exploited. alarmingly, 63% of fish stocks need to be protected to allow populations to recover and to prevent the complete collapse of vulnerable species (world wildlife fund south africa [wwf-sa] 2014, 2016). for south africa in particular, abalone, rock lobster and several line fish species have been overfished, a problem compounded by the growing prevalence of illegal harvesting (department of agriculture forestry and fisheries [daff] 2014; wwf-sa 2014). these trends pose a significant risk for the south african economy. commercial fisheries create an estimated 27 000 jobs and generate over zar5 billion (usdf560 million) in revenue per annum (wwf-sa 2016). from a social perspective, the oceans are an important source of food, providing an estimated 17% of average protein intake (wwf-sa 2014). as a result, a number of environmental agencies (including government departments) and non-governmental organisations (ngos) have reacted to the threats posed to south africa’s marine biodiversity. the most prominent agencies include the ewt, daff, the marine stewardship council (msc), the south african national biodiversity institute (sanbi) and wwf-sa. the daff was formed in 2009 to oversee and support the agricultural, forestry and fishery sectors through sustainable policies and programmes. daff is involved in monitoring sustainable fishing practices including, in particular, the enforcement of the fishing rights allocation process (frap) that regulates the harvest of fish stocks. daff also provides advice on utilisation of fish resources and marine ecosystem conservation (daff 2017). its work is supported by sanbi which conducts biodiversity research and monitors biodiversity levels in south africa. sanbi is also concerned with ecosystem restoration and rehabilitation in order to curb the effects of unsustainable natural resource consumption (sanbi 2017). from an ngo perspective, the msc is involved in the certification and labelling of seafood that is designed to promote consumer awareness about species threatened by overfishing and to change consumption patterns. the msc also works closely with harvesters to encourage the use of sustainable fishing methods and manage their business needs to ensure long-term supply of fish stocks (msc 2015). this is similar to the wwf-sa which seeks to conserve biodiversity and ensure the sustainable development of local ecosystems. the wwf-sa works to improve communities dependent on natural resources, protect biodiversity by encouraging companies and individuals to be more environmentally responsible and, ultimately, ensure healthy oceans and sustainable populations of fish species (wwf-sa 2017). the most notable effort in this regard is the southern african sustainable seafood initiative (sassi). launched in 2004, sassi seeks to raise awareness about growing seafood sustainability concerns and the absence of a clear position by harvesters and retailers on ensuring that seafood was being sourced responsibly. sassi has resulted in a significant change to the industry. it has highlighted biodiversity concerns to consumers who, in turn, are demanding action by suppliers and retailers. these organisations have responded with clear commitments to ensure environmental responsibility and the incorporation of the applicable biodiversity risks into their corporate strategies (sassi 2016). biodiversity reporting the last 20 years has seen a steady increase in the range of environmental data being included in sustainability and integrated reports (pwc 2014, 2015) and, to a lesser extent, details on biodiversity conservation and management (atkins & maroun 2018; jones & solomon 2013; mansoor & maroun 2016). according to the gri (2007): biodiversity is the variability among living organisms from all sources, including, inter alia, terrestrial, marine and other aquatic ecosystems and the ecological complexes of which they are part, this includes diversity within species, between species and of ecosystems. (p. 11) elements of biodiversity reporting to provide a detailed account of how an organisation is managing its biodiversity impact, the gri recommends that a company report on different biodiversity indicators. these are summarised in table 1. table 1: global reporting initiative biodiversity indicators. the disclosures recommended by the gri are similar to those found in the prior biodiversity reporting research (see jones & solomon 2013; mansoor & maroun 2016) which suggests that companies provide a descriptive account of the species and habitats affected by their operations (van liempd & busch 2013), paying particular attention to animal populations and ecosystems under pressure because of human activity (atkins et al. 2015b). these can be complemented by ‘scene-setting disclosures’ that include a clear explanation of what a company understands about biodiversity, its biodiversity mission statement or policy and an explanation of any affiliations with applicable environmental groups, ngos or research communities (jonäll & rimmel 2016; mansoor & maroun 2016; van liempd & busch 2013). additional detail can be provided on specific engagements with these groups, including partnerships, conservation initiatives and any advice provided on how to make business models more sustainable (partnership engagements). companies in the food industry are also likely to interact with local communities, governments and consumers on their operating practices and the extent to which these conform to recommended environmental practices. details on these social engagements should also be reported (stakeholder engagement) (jonäll & rimmel 2016; rimmel & jonäll 2013). for a company’s account of biodiversity impact to be more than just policy-focused, providing feedback on how it has performed against biodiversity targets, rehabilitation costs incurred and the successes and challenges of its partnerships with ngos and environmental agencies are important (performance evaluation reporting) (atkins et al. 2015a; atkins & maroun 2018). this should be supported by a clear explanation of the risks posed by biodiversity loss (risk reporting) and specific actions or plans used to mitigate or manage these risks (internal management reporting) (hossain 2017; van liempd & busch 2013). a company can support its biodiversity risk management with details recommended by the gri and its involvement in specific environmental initiatives such as its participation on the sassi project (wwf-sa 2016). each of the disclosure elements or themes is explained in table 2. table 2: summary of disclosure themes. to ensure high-quality reporting, a company needs to comply with the relevant external reporting frameworks and ensure that it has policies in place to identify biodiversity-related risks and report on them effectively (jones & solomon 2013). under the gri’s principle of clarity, this requires providing sufficient information on how the company defines and measures biodiversity risk, the species affected by operations and how the company is managing its biodiversity impact (see gri 2007, 2016). this requires detailed reporting on, for example, which species of fish are at risk of being over-exploited; the assessed impact of over-exploitation on the business model and how the company plans to reduce the use of that species (atkins et al. 2016b. this can include the use of ngos and active engagement with key stakeholders to, for example, assess biodiversity risks more accurately, make recommendations on how to improve harvesting methods or review the sustainability of operations (atkins & maroun 2018; de villiers & maroun 2018). finally, high-quality biodiversity reporting needs to be supported by an effective internal management function which provides the policies, procedures, operating standards and controls for sustainable harvesting of seafood and ensures that the disclosures included in an integrated or sustainability report are not just rhetoric (see alrazi, de villiers & van staden 2015; mcnally, cerbone & maroun 2017). assessing the quality of biodiversity disclosures assessing the quality of biodiversity reporting based on the themes provided in table 2 is both complex and subjective. to provide an easy-to-use disclosure framework or scorecard to assess the quality of biodiversity reporting, this research draws on the prior csr literature that points to the following quality dimensions, each of which is adapted for assessing biodiversity disclosures: a quantity indicator (qi) – a measure of the total amount of information provided on biodiversity according to a defined reporting framework (see beretta & bozzolan 2004; wolniak & hąbek 2016) a density indictor – the total biodiversity reporting relative to the length of the integrated or sustainability report (see dagiliene, leitoniene & grencikova 2014; michelon et al. 2015). an emphasis indicator (ei) – an assessment of the perceived relevance of biodiversity reporting as indicated by the extent of disclosures included a corporation’s primary rather than complementary reports to stakeholders (de villiers & van staden 2011). an action indicator (ai) – the extent to which disclosures deal with actions, plans and projects designed to mitigate the risk of biodiversity loss rather than just descriptive, policy or compliance-related disclosures (cho et al. 2015; freundlieb, gräuler & teuteberg 2014; michelon et al. 2015). an assurance indicator (asi) – this takes into account whether or not companies make use of any independent assurance services for their sustainability reporting (jones & solomon 2010; michelon et al. 2015). this would include, by default, details on biodiversity. quantity indicators according to beretta and bozzolan (2004), the quality of disclosure ‘depends on both the quantity of information disclosed and on the richness offered by additional information’ (p. 266). providing detailed disclosures on key esg issues ensures that stakeholders are provided with sufficient information to understand the relevant risks and how these are being managed (gri 2016). high levels of esg reporting can also be used to signal that a company understands its environmental and social impact, has developed the relevant systems to monitor and report on this and is taking appropriate action to respond to underlying risks (see beretta & bozzolan 2004; de villiers & maroun 2018; dube & maroun 2017; wolniak & hąbek 2016). this is, however, provided that the disclosures deal specifically with the relevant esg issues and are presented clearly in corporate reports (atkins & maroun 2014; michelon et al. 2015). in this context, the simplest indicator of biodiversity reporting quality is provided by a measure of the extent to which each of the biodiversity themes according to table 2 are covered in annual, integrated and sustainability reports. the indicator focuses only on biodiversity-specific reporting and disclosures that deal directly with biodiversity risks related to the seafood industry (see michelon et al. 2015; romi & longing 2016). to calculate a qi, the total number of biodiversity disclosure themes is expressed as a percentage of the total number of themes that are expected to be included in the corporate’s reports. for a company preparing an integrated and sustainability report, this is expressed as follows: where qi is the measure of disclosure quantity, σir d is the number of disclosure themes per table 2 addressed in the integrated report, σsr d is the number of disclosure themes per table 2 addressed in the sustainability report and dir and dsr denote the total possible biodiversity disclosures (being eight themes in the integrated report and eight themes in the sustainability report). a qi equal to 1 means that the biodiversity metrics referred to by the gri and prior literature (per table 2) have been addressed. this implies1 a high level of quality. conversely, a score of 0 indicates low quality. density indicator the increase in the extent of environmental reporting does not necessarily mean that companies are providing more useful information to users of integrated or sustainability reports (michelon et al. 2015). for example, an analyses of south african-integrated reports have found that, while more detail on esg issues is being provided to users, this information is often repetitive or generic and, as a result, unhelpful for understanding the respective organisations’ environmental impact (see pwc 2015; solomon & maroun 2012). in addition, an increase in the extent of reporting can make it difficult for stakeholders to identify the most pertinent information or be used obfuscated negative facts and circumstances or divert attention (cho, roberts & patten 2010; michelon et al. 2015). to address this, we calculate a density index (di). this can be carried out at the level of individual words, sentence or phrases (michelon et al. 2015). as a practical expedient, the di is calculated with reference to the number of pages in the integrated or sustainability report dealing with biodiversity-related issues relative to the total number of pages found in these documents. where di is the measure of disclosure density, σir pb is the number of pages in the integrated report that contain information dealing with biodiversity metrics and σsr pb is the total number of pages in the sustainability report that contain information dedicated to biodiversity issues. the total numbers of pages in the integrated and sustainability report are denoted by pir and psr, respectively.2 a di close to 1 implies that there is little dilution and that biodiversity-related disclosures are not being repeated in multiple sections of the integrated and sustainability report, implying a higher level of quality. a score tending to zero suggests low quality. emphasis indicator when voluntary disclosure is necessary for reducing information asymmetry, lowering the cost of capital or responding to the most material information needs of important stakeholders, the disclosures are normally concentrated in the corporation’s primary report (de villiers & van staden 2011). in contrast, disclosures that are required only for addressing a general expectation for, at least, some reporting on the respective metric are likely to be included mainly in secondary reports or on webpages (de villiers & van staden 2011; michelon et al. 2015). the same principle applies for evaluating biodiversity reporting by south african companies. companies that see biodiversity metrics as material should include this information in their primary report to stakeholders, this being the integrated report (see mansoor & maroun 2016; rensburg & botha 2014). we therefore calculate a ratio of the total biodiversity disclosures included in companies’ integrated reports, relative to the total biodiversity disclosures found in the sustainability reports to measure an emphasis quality dimension: where ei is the emphasis indicator, σir is the total biodiversity disclosures included in a company’s integrated report and σsr is the total disclosure included in the same company’s sustainability report. an ei tending to 1 represents a higher level of reporting quality. a minimum score of zero implies low quality. action indicator biodiversity reporting can be focused on policy-related issues and form part of a broader environmental rhetoric without resulting in actual changes to business practices (cho et al. 2015; tregidga, milne & kearins 2014). to address this, we differentiate between biodiversity reporting that is descriptive, compliance-focused or related only to policy (organisational rhetoric) and disclosures on specific plans, actions or projects (organisational action) (see table 3). table 3: biodiversity theme classification. an ai is used to measure the emphasis on action-focused reporting relative to policy-related information or organisational rhetoric. this is calculated as follows: the sum of action-related biodiversity disclosure in the integrated σir a and sustainability report σsr a is expressed as a sum of the action and rhetoric-related disclosure in both documents. the total score is averaged. a score tending to 1 implies that most reporting focuses on details on different partnerships, stakeholder engagement and internal plans for managing biodiversity loss rather than, for example, on general details on biodiversity policy, affected species and compliance with external reporting frameworks. this is indicative of higher quality reporting. conversely, a score tending to zero implies that most disclosure is at the level of organisational rhetoric and that reporting quality is therefore low (see beretta & bozzolan 2004; cho et al. 2015). assurance indicator finally, a comprehensive measure of report quality takes into account whether or not a company relies on independent external assurance services. presently, companies do not provide external assurance on the validity and reliability of their integrated or sustainability reports as a whole or on whether or not their environmental plans and actions are adequate to prevent biodiversity loss (see farooq & de villiers 2018; maroun 2017). nevertheless, elements of their sustainability or integrated reports may be assured by an independent practitioner. examples include historical and factual data such as carbon emissions, populations of species and compliance with the gri (jones & solomon 2010; maroun & atkins 2015). these assurance services are typically associated with higher levels of reporting quality, even though they are not mandated (michelon et al. 2015). as a result, our quality index (qind) includes an asi that is ‘1’ if at least some sustainability assurance services are relied on and ‘0’ if this is not the case. final quality index the final qind is calculated as follows: a score tending to 5 indicates high biodiversity reporting quality and a score of zero implies low quality reporting. the index is an inferred measure of quality but is a useful way of evaluating non-financial disclosures without overemphasising the high levels of disclosures that may not necessarily provide useful information to users of an integrated or sustainability report (michelon et al. 2015). table 4 summarises the elements in the final quality index. table 4: summary of quality index elements. method to apply the qind outlined in the ‘biodiversity reporting’ section, the research focuses on companies listed on the johannesburg stock exchange (jse) and included in the farming and fishing sector. companies not involved with the harvesting or sale of seafood were excluded. this left a total of seven companies for review.3 the relatively small sample size may appear to be an inherent limitation of this research. it is a function of the size of the local industry and is also in keeping with an exploratory research design. the aim is not to extrapolate results, generalise findings and confirm or reject hypotheses. the study is interpretive. it demonstrates how a mix of quantitative and narrative information on biodiversity can be summarised by a normative qind that can be used to evaluate the development of biodiversity reporting and, by default, other types of non-financial disclosures included in integrated or sustainability reports. data collection the researchers analysed the companies’ integrated and sustainability reports from 2013 to 2015. the 2016 and 2017 reports were not available at the time of data collection. periods prior to the introduction of the international integrated reporting council’s (iirc) framework (in 2013) were excluded. this ensured that the basis being used to prepare the corporate reports included in the study was consistent. the researchers used content analysis, a method that is commonly used to study esg disclosures (merkl-davies, brennan & vourvachis 2011; michelon et al. 2015). data collection began with the lead researcher reading each report to gain a sense of its overall content and structure. following a similar approach to rimmel and jonäll (2013) and mansoor and maroun (2016), sections of the reports dealing with issues relating to biodiversity were then identified and analysed in more detail to identify specific words, sentences or paragraphs that dealt with the biodiversity. for this purpose, the disclosure themes per table 2 (‘elements of biodiversity reporting’ section) were used as codes: scene-setting species related disclosures partnership engagements stakeholder engagements performance evaluations risk or policy disclosures internal management external reports. specific disclosures found in the integrated or sustainability reports were flagged and grouped according to which of the disclosure themes or codes these related to. a score of zero or one was used to indicate the absence or presence of a specific disclosure per code or disclosure theme. results were aggregated in a frequency table. once this was done, the disclosure could be analysed according to the qind elements. for this purpose, the location of disclosures (in the integrated or sustainability report), whether or not the disclosure was actionor policy-orientated, the presence or absence of an external assurance report and the number of pages in the integrated and sustainability reports were also recorded. for example, the researcher identified a paragraph in one of the sustainability reports under review on fishing quotas. the disclosure was examined carefully. it contained three sentences that explained different species of fish affected by the quota and an arrangement with an ngo to prevent over-exploitation. the disclosure was coded as species-related and partnership engagement. the frequency table recorded a score of 2 (quantity element). the two disclosure themes were recorded as being located in the sustainability report (emphasis element). the first theme was rhetoric-focused because it dealt only with the species of fish affected by over-exploitation. details on the work performed with the ngo to ensure responsible harvesting (the second disclosure theme) were recorded as action-orientated (action element). the disclosure was located on a single page in the sustainability report. there were no other biodiversity disclosures on that page. a score of 1 was recorded for the purpose of calculating the density element. the assurance element was only assessed in total once all of the disclosures were coded and scored according to the other quality elements. it should be noted that data collection was carried out in the interpretive tradition, with the result that the coding is dependent on the lead researcher’s judgement and, as a result, is inherently subjective (adapted from laine 2009a). as a result, once all of the integrated and sustainability reports were coded, the researchers re-examined the reports to ensure that the data had been coded consistently. no changes to the original coding were made as a result of this review. in addition, to ensure that all relevant disclosures were identified, the lead researcher performed a third analysis of each report and also performed a key word search. examples included: biodiversity, conservation, fish, marine, sassi,4 wwf and total allowable catch (tac).5 this revealed no additional disclosures and did not result in any changes to the original coded results. data analysis as the study focuses only on reports issued from 2013 to 2015, when there were no material changes to local codes of governance and reporting frameworks, an analysis of changes in disclosures over time was excluded. an average disclosure score was computed for the 3 years for each disclosure theme. once this was complete, the lead researcher was able to calculate each of the indicators included in the qind discussed in the ‘biodiversity reporting’ section and compute a total quality score. the results are presented in the ‘results’ section. to provide additional information of the types of disclosures evaluated and scored, the researchers included specific examples of biodiversity disclosures found in the integrated and sustainability reports being reviewed. the examples were selected based on an interpretive analysis of the integrated or sustainability reports by the lead researcher and according to the disclosure theme or code to which they related (see above). they were chosen to provide clear illustrations of the disclosure elements being examined and add to the depth of analysis of the quality of biodiversity reporting (see merkl-davies et al. 2011; solomon & maroun 2012). finally, the researchers acknowledge that the analysis process is inherently subjective. this subjectivity is a characteristic of interpretive-inspired research and, far from being a threat to validity and reliability, was essential for evaluating qualitative or narrative disclosures typically included in the integrated and sustainability reports being reviewed (see laine 2009b; maroun & jonker 2014; tregidga et al. 2014). results the total biodiversity-related disclosures included in the integrated and sustainability reports for the 3 years under review are shown in figure 1. figure 1: biodiversity disclosures (2013–2015). in total, there are 50 biodiversity-related issues disclosed in 2015 compared with 48 and 42 disclosures in 2014 and 2013, respectively. social engagements account for 20% of the 140 disclosures over the 3-year period. this is followed by species-related disclosures and details on external reports that account for 16% of total disclosures each. risk (6%) and scene-setting disclosures (5%) had the lowest scores. on average, companies include only seven disclosures per annum in their integrated and sustainability reports combined. this low level of reporting is consistent with the findings of van liempd and busch (2013), mansoor and maroun (2016) and romi and longing (2016) and implies that biodiversity reporting is underdeveloped or marginalised (jones & solomon 2013; maroun 2016). the quantity of disclosures is not, however, a definitive indication of the quality of biodiversity reporting. as a result, the researchers calculated a qind score presented in figure 2. figure 2: quality index. when the low level of biodiversity reporting (qi) is assessed relative to the other quality indicators, the results are more positive. figure 2 shows that half of the companies have a qind of 2.7 or more. the most material contributors to the qind are the ei, ai and asi. each of these is discussed in more detail below. assurance indicator none of the companies under review provides direct assurance over their biodiversity reporting including, for example, assurance on the adequacy of their risk assessment, action plans and environmental impact (see cohen & simnett 2015; maroun 2017). five of the companies did, however, rely on an independent assurance provider to test some elements of their sustainability reporting. this typically involved compliance with the gri and provides, at least, indirect evidence of the quality of the biodiversity elements which the gri recommends should be included in a sustainability or integrated report (jones & solomon 2010; michelon et al. 2015). emphasis indictor the ei is inherently subjective. the fact that companies tend to include more of their biodiversity reporting in their integrated rather than their sustainability report does not prove that the disclosures are of a high quality (see de villiers & van staden 2011). nevertheless, an analysis of the specific types of disclosures found in integrated reports suggests, at least, some commitment to biodiversity conservation. for example, one company acknowledges clearly its responsibility for the environment in context of a business model dependent on harvesting marine resources: ‘beyond integrity and transparency in our dealings with our shareholders, customers, consumers, employees and other stakeholders, this also encompasses a commitment to ensuring that [the company] plays its role as a corporate citizen to minimise any adverse environmental impact…’ [company 1, integrated report 2015] similarly, a second company establishes sound biodiversity management as part of its overall strategy: ‘mission statement: to be the leading empowered fishing and commercial cold storage company in africa… responsibly harvesting a diverse range of marine resources.’ [company 4, integrated report 2014] as indicated in figures 1 and 2, the scene-setting and risk themes had two of the lowest disclosure scores. the companies under review do not provide a clear definition of ‘biodiversity’, lists of affected species and a breakdown of biodiversity impact by geographical or operating segment (van liempd & busch 2013; gri 2016). explicit statements on the risks posed by biodiversity loss are also limited (mansoor & maroun 2016; raemaekers et al. 2016). as such, the extent to which biodiversity is being incorporated into an integrated assessment of companies’ business models can be questioned. it may, however, be premature to conclude that current biodiversity reporting is not providing any relevant information for users of integrated reports. there are indications of companies beginning to frame the risk of fish species becoming extinct (an otherwise biological issue) as a material business risk. for example: ‘our material risks: our variation/depletion in availability of marine resources.’ [company 4, integrated report 2015] similarly, as part of the risk review sections of its corporate reports, company 5 states: ‘we drive change throughout our seafood supply chain to mitigate risks of over-fishing.’ [company 5, sustainability report 2015] these illustrations should be interpreted in the context of an overall low qi and di and the fact that some companies (such as companies 5 and 7) reported relatively low eis. this reflects the fact that risk disclosures were often generic, a clear biodiversity management plan was not apparent and there were indications that disclosures were compliance-focused, rather than the result of a complete commitment to change business practices (see mansoor & maroun 2016; raemaekers et al. 2016). in addition, while some companies dealt with biodiversity-related issues at the strategic level or as part of their risk management plans in their integrated reports, others placed more emphasis on general environmental disclosures in their sustainability reports (see cho et al. 2015; de villiers & van staden 2006). as a result, the researchers examined the focus on reporting on specific actions, plans and projects designed to mitigate biodiversity impact to gain a better sense of reporting quality. action indicator favouring disclosures in a sustainability report (leading to a low ei) often occurred in conjunction with more narrative or disruptive reporting, rather than details on the specific actions, projects or initiatives used to manage biodiversity risks (leading to a low ai). there are, however, some exceptions. consider the following example of how a company improves the detail provided on its internal management plans relating to overfishing: ‘while [the company] takes care to minimise its impact on the environment, certain risk factors are beyond our direct control and can affect performance. [the company] has a detailed plan on how to address the impact within its control and influence and manage the factors outside its control.’ [company 4, sustainability report 2013] the organisation acknowledges the biodiversity-related risk and makes reference to the need to mitigate it but the details are limited and the disclosure is an example of biodiversity rhetoric rather than of biodiversity action. by 2015, however, the disclosure is more extensive. a detailed analysis of performance is not provided but the company outlines the broad elements or component of its biodiversity management plan: obtaining independent research reports of the resources in order to monitor the status of the resources compliance with the regulatory framework complying with responsible fishing practices training crew on responsible fishing practices. [company 4, sustainability report 2015] there are also examples of quantified commitments to different conservation projects driven by some of the environmental groups discussed in ‘a brief note on the state of south africa’s marine biodiversity’ section: ‘since 2010 we have invested r13.5 million in the world wildlife fund’s sustainable fisheries programme. (by year-end 45% of our seafood products by species, and 87% of these products by sales, met our seafood sustainability targets).’ [company 5, integrated report 2015] similarly: ‘the [company] entered into a relationship with wwf’s southern african sustainable seafood initiative (sassi) in december 2010. the initiative is aligned to the [company’s] sustainable business strategy, in which the group commits to: driving innovation in our house brands to reduce the environmental impact of their full lifecycles raising awareness and improving education around sustainability issues within our own organisation, our retailers’ businesses and our own communities engaging and collaborating with our suppliers and retailers to ensure that their business practices are ethical and environmentally sustainable.’ [company 6, integrated report 2014] another company focuses on its use of internal sustainability champions to create an awareness of biodiversity-related initiatives and to provide staff with an opportunity to provide feedback: ‘one of the [sustainability champion’s] main responsibilities is to share monthly [sustainability] newsletters with their colleagues during a let’s talk meeting. these discussions aim to provide colleagues with the opportunity to grasp issues such as climate change, water scarcity, food security and biodiversity, and learn how [the company] is tackling some of these issues.’ [company 7, sustainability report 2013] these disclosures need to be improved. for example, it would be useful to know the level of financial commitments to partnerships; exactly how the companies’ brands and internal processes are being revised, the successes and challenges of any education initiatives and the specific outcomes from supplier, staff and community engagement. for these reasons, the ai scores of these companies do not equal the maximum. what is, however, encouraging is that, despite the relatively low quantum of disclosure (qi < 0.5), the companies provide some insight into their partnership with environmental groups and some detail on how they are reacting to the risks posed by overfishing and associated biodiversity loss. as a final illustration of action-related reporting, some companies are starting to include biodiversity-related performance-measures in their corporate reports. for example, dealing with environmental audits carried out by ngos, one company comments: ‘annual progress against agreed targets for key environmental initiatives, the company’s participation in external accreditation surveys and the results of health and safety and environmental audits of company sites and vessels were reviewed and found to be satisfactory.’ [company 4, integrated report 2014] a second company reports on its harvesting of a specific species over the 3 years under review and the need to ensure that this did not result in undue pressure on fish stocks. in the 2015 integrated report, the company concludes: ‘in may 2015 the marine stewardship council (‘msc’) recertified that the south african hake resources met the requisite environmental standards for sustainable fishing for a further five years. this certification gives assurance to buyers and consumers that the seafood comes from a well-managed and sustainable resource, which is increasingly relevant in [the company’s] export markets.’ [company 1, integrated report 2015] the above disclosure is a good example of how a company has partnered with an ngo to provide an independent review of its harvesting process and how this accreditation process is used to reassure customers (and other stakeholders) about the long-term sustainability of the seafood supply. as indicated, it can be argued that the disclosure could be bolstered by, for example, providing quantified measures of harvested seafood, number of certificates issued, specific feedback received from the ngo and any plans to change operating practices. at the same time, the illustration (coupled with the ai score) gives a good indication that companies are becoming more aware of biodiversity management and reporting. conclusion prior studies on the extent of biodiversity reporting in developed economies in europe (rimmel & jonäll 2013), the united kingdom (jones 1996) and usa (romi & longing 2016) find low levels of disclosures that often give only a high level account of biodiversity risk and impact (jones & solomon 2013). to some extent, these findings are applicable in a south african context where a review of integrated and sustainability reports by a sample of the country’s seafood producers and retailers finds low levels of reporting on biodiversity-related issues. this is despite the important contribution of south africa’s marine resources to the economy (wwf-sa 2016) and the country’s leading role in championing codes of corporate governance and reporting standards designed to emphasise the importance of the environment for generating responsible returns (maroun, coldwell & segal 2014; rossouw, van der watt & malan 2002; solomon 2010). an examination of the quality – rather than the quantity – of disclosures presents a different perspective. drawing on the prior csr and integrated reporting literature (see, e.g., cho et al. 2015; de villiers et al. 2018; freundlieb et al. 2014; michelon et al. 2015), this research makes an important contribution by proposing a scorecard for calculating a qind for biodiversity disclosures. based on the work of michelon et al. (2015), the index includes a measure of the total and relative quantify of disclosure (qi and di). this is complemented by a review of whether or not the disclosures are included in the primary report to stakeholders (ei), the focus on reporting on policies or general biodiversity detail or specific plans of action (ai) and the use of independent assurance services to address the quality of sustainability reporting in general (asi). the quality index reveals a number of important findings. the quantity of reporting is low (average qi = 0.42) and not always discussed in detail in the different sections of the integrated and sustainability reports (average di = 0.39) but this does not mean that south african harvesters and retailers are completely marginalising biodiversity risk. there has been a shift in reporting emphasis with companies including relatively more detail in their integrated reports rather than in complementary sustainability reports (average ei = 0.75). arguably, the disclosures included in integrated reports do not provide a complete account of biodiversity risk, how this links to an organisation’s strategy and steps being taken to reduce biodiversity impact. this is in line with prior research on environmental and social reporting by south african companies in general which finds that local organisations are taking time to understand their non-financial impact and explain this clearly and comprehensively in their integrated reports (atkins & maroun 2015; pwc 2014; solomon & maroun 2012). nevertheless, there are indications that non-financial reporting practices (de villiers, rinaldi & unerman 2014), including biodiversity reporting (atkins et al. 2016a), are improving. the companies under review are relying on sustainability assurance services, pointing to a higher level of reporting quality in general (michelon et al. 2015). companies are also complementing descriptive biodiversity information with commitments to reduce their biodiversity impact and details on partnerships formed with ngos to assist with management of their biodiversity footprint (see atkins et al. 2015b, 2016a; jonäll & rimmel 2016). perhaps, most important are disclosures dealing with different plans, actions and conservation initiatives being implemented in response to the risks associated with biodiversity loss. this suggests that companies’ biodiversity reporting is not only rhetoric (average ai = 0.44); there is room for improvement but companies are beginning to realise the importance of supporting policy statements with details on action to manage biodiversity risk. to avoid losing momentum, companies need to be provided with more detailed guidance on how to interpret and define biodiversity risks, assess their impact and incorporate biodiversity issues in long-term business strategies. this needs to be supported by the development of a framework for how management and corporate reporting systems can be enhanced to enable biodiversity protection. examples include how operations can be tailored to reduce biodiversity impact, the type of data that should be collected to monitor these changes and how best to explain internal developments to stakeholders. finally, it should be noted that the findings presented in this article are not without limitations. the results are based on a relatively small number of companies and focus on a very specific section of the broader food industry. more research is needed to understand the extent and quality of biodiversity reporting in other sectors with a high environmental impact before definitive conclusions can be reached. this can be complemented by an expanded analysis of biodiversity reporting in south africa and how it compares with other developed and developing economies. apart from providing additional empirical evidence on biodiversity reporting, more is required to be done at a practical and theoretical level. this article is limited to the development of a normative scorecard for evaluating the quality of biodiversity reporting. future research can concentrate on the drivers of biodiversity reporting and how, for example, organisational systems, the availability of resources and attitudes or cultures affect the commitment to high-quality biodiversity (and other types of non-financial reporting) (alrazi et al. 2015; de villiers, rouse & kerr 2016). perhaps, most important is the need for additional research on the role which accounting can play in preserving biodiversity. the current body of research on biodiversity reporting takes the position that biodiversity is under threat and that associated risks should be reported in the interest of transparency and accountability (jonäll & rimmel 2016; maroun 2016; romi & longing 2016). examining how the process of accounting for biodiversity may be used to create an awareness of biodiversity loss, change organisational dynamics and begin to have a positive effect on biodiversity conservation can contribute significantly to the understanding of how accounting functions. this avenue of research may also create an opportunity for accountants to participate in the conversation process rather than in after-the-fact reporting on continuing environmental degradation. acknowledgements the authors would like to thank the participants at the meditari accountancy research conference (2016) for their comments on earlier drafts of this article. in particular, the authors would like to acknowledge the support received from prof. jill atkins, prof. robert garnett, prof. nirupa padia and lelys maddock. special thanks also go to the national research foundation for partially funding this project. competing interests the authors declare that they have no financial or personal relationship(s) that may have inappropriately influenced them in writing this article. authors’ contributions this article was developed jointly by the authors and based on the postgraduate thesis of the first author. references 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‘quality assessment of csr reports–factor analysis’, procedia-social and behavioral sciences 220, 541–547. https://doi.org/10.1016/j.sbspro.2016.05.530 world wildlife fund south africa (wwf-sa), 2014, wwf-sassi retailer/supplier participation scheme report 2014, viewed from http://www.wwf.org.za/media_room/publications/?12201/wwf-sassi-retailer-supplier-participation-scheme-report-2014 world wildlife fund south africa (wwf-sa), 2016, ocean facts and futures: valuing south africa’s ocean economy, viewed from http://awsassets.wwf.org.za/downloads/wwf_oceans_facts_and_futures_report_oct16.pdf world wildlife fund south africa (wwf-sa), 2017, our goals, viewed 07 january 2017, from http://www.wwf.org.za/what_we_do/our_goals/ wynberg, r., 2002, ‘a decade of biodiversity conservation and use in south africa: tracking progress from the rio earth summit to the johannesburg world summit on sustainable development’, south african journal of science 98(5&6), 223–243. footnotes 1. we say ‘imply’ because the quantity indicator by itself only considers whether the disclosure themes are included in the integrated or sustainability report and not whether sufficient detail has been provided to explain the biodiversity impact. as a result, we use additional quality indicators to refine the measure of quality as per michelon et al. (2015). 2. no adjustment is made for the number of times the same or different biodiversity theme is dealt with per page in an integrated report. as a result, using the number of pages to calculate the density indicator is less accurate than using individual words, sentences or disclosure themes. this was, however, a practical limitation given the large volume of data that would need to be processed if the density indictor is calculated by coding each word, sentence or disclosure theme in the integrated and sustainability reports (see michelon et al. 2015). 3. one company’s integrated and sustainability reports included no biodiversity-related disclosures. as a result, it was treated as an outlier and excluded from the analysis. 4. the sassi provides information, through the sassi list, about certain fish species and their consumption (sassi 2016). 5. total allowable catch is a catch limit set for commercial fish stocks (european commission 2015). microsoft word 11 hammond & luiz sajems 19(4) 2016.docx 630 sajems ns 19 (2016) no 4:630-646 how to cite doi: http://dx.doi.org/10.17159/2222-3436/2016/v19n4a11 issn: 2222-3436 the co-operative model as a means of stakeholder management: an exploratory qualitative analysis darrell hammond and john luiz graduate school of business, university of cape town accepted: september 2016 the south african economy has for some time been characterised by high unemployment, income inequality and a skills mismatch, all of which have contributed to conflict between business, government and labour. the co-operative model of stakeholder management is examined as a possible mitigating organisational form in this high-conflict environment. international experience indicates some success with co-operative models but they are not easy to implement effectively and face severe obstacles. trust and knowledge sharing are critical for enabling a co-operative model of stakeholder management, which requires strong governance and adherence to strict rules. the model must balance the tension between optimisation of governance structures and responsiveness to members' needs. furthermore, support from social and political institutions is necessary. we find barriers to scalability which manifest in the lack of depth of business skills, negative perception of the co-operative model by external stakeholders, government ambivalence, and a lack of willingness on the part of workers to co-operate for mutual benefit. key words: co-operatives, stakeholder management, social contracts jel: j54, 50, l23 1 introduction the problem of poverty, unemployment and inequality in south africa has resulted in an environment of rising tensions where the lack of a social contract between business, government and labour has become increasingly apparent (see luiz, 2014, 2016). the conflict in the labour market came most starkly to the fore during the tragic marikana killings in 2012. as one widow from the community directly affected by the incident states, “i blame the mine, the police, and the government because they are the ones who control this country” (alexander, lekgowa, mmope, sinwell, & xezwi, 2013:7). the collective bargaining process that was once useful appears to have become fragmented and may have outlived its purpose. business is progressively being viewed as a major cause of social and economic problems and companies are perceived as prospering at the expense of the community (porter & kramer, 2011). the main contributor to the failure is an outdated approach to value creation that focuses on short-term financial performance and ignores wider stakeholders, thereby affecting long-term sustainability (martin, 2009). there is thus an apparent need for a new model of stakeholder management in a highly conflictual environment. a challenge in the south african labour market is how to empower a significant labour force which is largely unskilled and for which demand is waning. some initiatives which corporates have tried to introduce have been unsuccessful, due in part to low levels of education and to structural shifts in the economy. calls for higher wages do not address these problems and some would argue that higher wages would be economically unsustainable and would lead to higher unemployment. interventions to improve skills and then to reward workers for their increased contribution may provide an alternative, sustainable solution in certain cases. this context forms the backdrop to our study and explains why there is a renewed focus on alternative organisational forms such as co-operatives. while such co-operatives may not impact directly on this macroenvironment, they may be viable options under particular conditions. the co-operative model is unique in that it is typically applied where the workforce relies on lower skill sets and in areas which are considered economically marginal. this type of model has been used successfully in countries like spain and italy but has been less successful in south abstract sajems ns 19 (2016) 4:630-646 631 africa. it may be necessary to re-invent the co-operative model to turn it into one that recognises south african realities – a hybrid model which combines traditional capitalist models with new shared values and co-operative principles. the purpose of this research is to evaluate the stakeholder literature with emphasis on the co-operative model within an environment of social and political conflict to determine whether the co-operative model is viable on a larger scale in south africa. south african interest in co-operatives received a boost during 2015 as a result of a backlash against the previous decade of outsourcing non-core activities in both the public and the private spheres. for example, as a result of the #feesmustfall movement, universities were put under pressure to return to insourcing activities which they had been outsourcing and many universities undertook to investigate various options for doing so, including that of worker co-operatives (see http://mg.co.za/article/2015-10-15-wits-mulls-co-ops-to-end-staff-woes). this research is exploratory in nature and relies on a qualitative approach using four case studies. the paper is structured as follows: the next section presents a literature review on co-operative models and outlines factors that contribute to their success or failure. thereafter we discuss the research methodology, followed by the presentation and discussion of our results. finally, we conclude with a conceptual framework. 2 literature review freeman (1984) defines the stakeholders of an organisation as any group or individual without whose support the organisation would not exist. an individual or group qualifies as a stakeholder if it affects or is affected by the organisation’s objectives (freeman, 1984), and therefore has a legitimate interest in the activities of the organisation (donaldson & preston, 1995). stakeholder theory contends that each stakeholder, whether an individual or a group, should be able to influence decision-makers in the business (jones, 1995). effective management requires attention to be given to all relevant stakeholders and the failure to obtain buy-in from all key stakeholders may result in the failure of the organisation (donaldson & preston, 1995; sautter & leisen, 1999). the traditional view is that managers have an obligation to increase the value of equity for shareholders in the firm. in contrast, the stakeholder view argues that there are other role players – such as government, unions, and social, trade and political groupings, whose interests need to be considered. the operation of firms in society is becoming more complex and it is apparent that a new framework is required to manage stakeholders’ needs (turnbull, 1997). although there have been numerous conceptual, theoretical and empirical studies relating to stakeholder theory, very little has been done to integrate the theory into practical process models which could be effectively implemented by the firms (preble, 2005; roloff, 2008). in co-operatives there is a more natural disposition towards managing stakeholders (gijselinckx, 2009) as ownership rights and control are usually assigned to a single stakeholder category. the concept of the co-operative recognises the need for a change in the structure of the traditionally capitalist economic model and possible political mobilisation (lele, 1981). it attempts to find a balance between economic and socio-political power in order to benefit those who are often marginalised by traditional models. 2.1 overview of the co-operative model in 1844, the rochdale pioneers, consisting of 28 cotton weavers in england, got together and formed a co-operative society and formulated several principles on which to conduct business. this was to form the basis for the worldwide co-operative movement (birchall, 1997). the rochdale pioneers could not afford the high cost of food, and accordingly opened a store which sold goods such as sugar, flour and butter to their members at more affordable prices. the cooperative was seen as a means of combating the impact of industrial capitalism, or an embryo of socialism within a capitalist economy (philip, 2003). since then there has been a growth not only in the number of co-operatives but also in the models and structures on which they are based and the purposes they serve. they come in various forms, including non-monetary, retail, social, consumer, worker, and business and employment co-operatives. 632 sajems ns 19 (2016) 4:630-646 mazzarol, simmons & mamouni limnios (2011) developed a conceptual three-level framework, consisting of the system, co-operative and members, to help explain co-operative structures and the nature of the problems faced. this framework, which is shown in figure 1, demonstrates four key inputs and two outputs. on the input side: social co-operation is driven by the community that is being motivated; this community is able to mobilise, and has skills, money and resources. government policy can have a significant impact on co-operative development through its policies in relation to market regulation, corporate governance and tax legislation, as well as social and economic policies. industry structure relates to porter’s five-force model, which includes level of competitiveness within the industry, power of buyers and sellers, and threats from new entrants and substitutes. environmental impacts can be significantly affected by access to land and water, disease, climate change, and drought or floods. the outputs of the model are economic capital, measured by the creation of wealth, jobs and assets, and social capital, made up of trust, reciprocity and networks. figure 1 co-operative conceptual framework source: mazzarol et al. (2011) there is no general consensus on the factors that explain success and failure of the co-operative model. simmons and birchall (2008) indicate that the success factors vary significantly between types of co-operative, country and time period. however, the literature shows that success factors can be split between internal and external factors and these are evaluated in more detail below. sajems ns 19 (2016) 4:630-646 633 2.1.1 internal success factors trust: a core value of the co-operative model lies in the lowering of transaction costs through self-governance and trust which has been found to be fundamental to co-operative development and its sustainability (cook, 1995; birchall, 1997; sabatini, modena & tortia, 2014). in the absence of trust, self-governance and co-operation often fail. in a highly conflictual environment there are high levels of mistrust, and co-operatives may provide the means to reverse this mistrust, but attempts to introduce self-help initiatives without unity often fail (parnell, 2003). before a cooperative model can be introduced, the trust-building process needs to have commenced (parnell, 2001). however, once the process has started, co-operatives can accelerate the building of trust because of the mutual benefit to all members; this necessitates a sense of community and willingness for members to engage (mazzarol, 2012). knowledge sharing: in order to function successfully, a co-operative is a business which requires people who are skilled in business processes and knowledgeable about markets. selfregulation requires the support of a reliable and fast information network so as to ensure that all members have access to information in a transparent manner (turnbull, 1997; borgen, 2004). a well-defined stakeholder ownership and control structure improves performance significantly by providing more reliable information via multiple channels, and thereby reducing transaction costs and increasing operational efficiency (turnbull, 1997). birchall (2011) suggests that co-operative failure, due to disengagement on the part of members, is the result of a lack of education rather than a problem with motivation, and investing in the education of members is crucial to cooperative success. when co-operatives in more developed countries are compared with those in less developed countries, the case of mondragon1 in the former group suggests that although the community was poor owing to unemployment, they were educated and each member was therefore able to contribute towards the growth of the co-operative. in contrast, the communities in the latter group are often uneducated, and the challenge therefore lies in enabling these communities to improve their skills in order for the co-operative to be successful. as the co-operative grows larger, the flow of information becomes slower. a lack of information and institutional failure may lead to risk and uncertainty within the co-operative (borda-rodriguez & vicari, 2013). greater information flow can be achieved through decentralisation and the creation of smaller business units, which then leads to additional channels of communication. this feeds into the networking strength of co-operatives. governance: governance plays a pivotal role in motivating members to engage by managing conflict between members’ interests within a well-defined framework (philip, 2003; cook, 1995; mazzarol, 2012; dyer & singh, 1998). the choice of governance structure depends on the type of relationship and perceived risk for each member entering into the agreement. ultimately, the structure chosen needs to minimise transaction costs and maximise efficiency (dyer & singh, 1998; nilsson, 1999). parties can either rely on third parties to enforce agreements, or else selfenforce them. the co-operative achieves a self-regulating governance mechanism through a set of guiding principles which every member is required to adhere to. the management structure is based on participation, democracy and transparency. as in a traditional organisation which has stockholders and is managed by a management team and board, at the core of the co-operative there is a board or governing body. there is normally a chain of command and actions are carried out through delegation from top management to the shop floor (lutz, 1997). the principle underlying the governance role of the governing board of a co-operative is to service the interests of co-operative members. although many co-operatives start with a single board, sustainability is achieved through multiple or compound boards. with the introduction of a compound board, outside strategic stakeholders are able to get involved and provide impartial guidance in the interests of the co-operative. a compound board has the advantages of reducing corruption, increasing the number of individuals participating in control and minimising information distortion and the overloading of single board members. 634 sajems ns 19 (2016) 4:630-646 incentive to invest: motivation for members to engage is driven by the ability of the cooperative to satisfy the needs of the member as a consumer of the co-operative products, member of the community, owner and investor. it is therefore necessary to look at the factors which motivate and hinder cooperation and engagement on the part of members, such as the horizon problem, where a worker’s permissible claim to the co-operative assets is recognised for a shorter period than the life of the asset, and hence there is little incentive to invest capital in the cooperative (novkovic, 2008; porter & scully, 1987). this relates back to the governance structure already discussed and the importance of a well-defined framework. on retirement or exit from the co-operative, the worker is only entitled to withdraw the capital in instalments. this effectively solves the problem where capital in the co-operative is indivisible and provides motivation for workers to invest in the co-operative. the instalment only policy on retirement means that there is a large capital pool from which the co-operative can draw funds for growth. 2.1.2 external success factors networking: one of the strengths of a co-operative lies in co-operation with external stakeholders, suppliers and customers (birchall & simmons, 2004). co-operation is based on self-regulation, which can be achieved through sufficiently wide stakeholder participation, including with the broader community. from a network perspective, this provides a means of scaling up operations by building more extensive networks through small co-operative clusters (birchall & simmons, 2004; porter & kramer, 2011). the principle on which the development of local clusters is based is the premise that the firm’s success is affected by the communities and infrastructure around it (porter & kramer, 2011). the term “cluster” refers to the geographical proximity of businesses, suppliers and supporting infrastructure – which includes educational institutions, utilities, the regulatory framework, market transparency, and the community. porter and kramer (2011) point out that clusters are crucial in driving productivity, innovation and competitiveness. however, the potential for expanding participation in networks is affected by perceptions of other network partners (parnell, 2001) and their willingness to transact. inside a network the interaction moves away from pure economic drivers to factors driven by social dynamics (granovetter, 1992). the trend towards social dynamics suggests that building personal relationships through trust and good governance is critical in building strong networks. political and social institutions: government policy is a very important factor influencing the development of co-operatives. in developed countries, co-operatives have been free of government control and have been based on the rochdale principles of self-governance, namely one-memberone-vote with distribution of surpluses to members (simmons & birchall, 2008). in contrast, the co-operatives in less developed countries were developed predominantly by governments as a means of transforming traditional economies, but they were controlled by politicians to further their own interests rather than the interests of members. this top-down approach from government policy to co-operative development in developing countries has led to the failure of co-operatives in these countries (simmons& birchall, 2008). although it plays a vital role in providing the framework and environment for the co-operative to develop, the government’s involvement should not hamper the autonomy of the co-operative to function as its own entity and make its own decisions. the state’s role should be to provide political, legal and administrative frameworks. the state also plays a critical role in providing access to resources and to new markets (awuah & amal, 2011). the relationship with the government and outside stakeholders is therefore beneficial and critical as long as they do not interfere with the management of the co-operative. 3 research methodology an inductive, qualitative method of analysis was used as the method of inquiry as this was deemed most appropriate for a study that focused on understanding social phenomena within the context of the participants’ perspectives and experiences (merriam, 2002). furthermore, because the qualitative method is more responsive and flexible it lends itself better to contextual interpretation sajems ns 19 (2016) 4:630-646 635 than quantitative research does. the main data collection method was through interviews with respondents at government organisations and selected co-operatives. a semi-structured questionnaire was used in the interviews and the researchers used field observations and data to provide additional insights and put the results in context. the research instrument is provided in appendix a. the interviews were recorded, with permission, for later transcription and evaluation. in selecting which co-operatives to include in the research, an analysis of the south african cooperatives was carried out. the age data of these co-operatives as of september 2013, according to the department of trade and industry (dti), are shown in table 1. the data indicate a considerable increase in the number of new co-operatives registered in the preceding five years. however, the data also reflect relatively poor performance by co-operative organisations and a high failure rate, since only 260 co-operatives have survived for more than ten years. we have therefore included a tiered selection of co-operatives: one organisation which has been in existence for one year, another for five years, and two for over twenty years. the reason for this was to identify possible characteristics that could contribute towards scalability and sustainability of the co-operative model. a total of 27 interviews were conducted across the four co-operative organisations. case studies have three possible aims: to provide descriptions, test theory, or generate theory (eisenhardt & graebner, 2007). our aim was to conduct an explorative, descriptive study and thus an age-defined purposive sample was deemed appropriate. the 27 interviews included the managers of each co-operative (4), the director of the national development agency (within the department of social development, tasked with contributing towards poverty eradication by engaging civil society organisations and capacitating them to empower communities and also with exercising oversight over co-operatives), and 22 workers/members distributed across each of the co-operatives. table 1 co-operatives in south africa co-operative age (years) count <5 73 000 5-10 3 300 10-20 160 20+ 100 the researchers employed an auditing trail to ensure that complete records were kept throughout all phases of the research. these records included field notes, research processes, recordings, interview questionnaires and transcripts, and data analysis files and methods. a thematic analysis was performed to analyse the data and provide a comparison between the literature and field research and thereby gain insight into similarities and differences. initially the focus was on reviewing the data to become familiar with them and ensure accuracy. thereafter, initial coding, based on the key themes identified, was undertaken. an iterative process of coding was employed until the rich themes emerged which allowed us to tell the exploratory story below. a multimethod framework was used to gather data. the framework included interviews, observations by researchers at the actual sites, and the use of secondary documents among which were co-operative reports and official government documents. furthermore, we ensured that we heard multiple voices, including those of the managers and workers/members as well as representatives from government as part of our interviewed sample. this research was conducted in accordance with the ethical requirements of the university the authors are attached to and was cleared by the university ethics committee. this required that the research would not have any significant ethical consequences in terms of physical, psychological, social, legal, economic, or other risks to participants. no participants were below the age of eighteen years. the research was conducted with full consent from all parties involved and participation was voluntary. the purpose of the study was clearly communicated to respondents, who were under no obligation to provide information and could withdraw at any time. 636 sajems ns 19 (2016) 4:630-646 4 results and discussion 4.1 background of sampled co-operatives 4.1.1 diepsloot worker co-operative diepsloot worker co-operative (dwc) is located in diepsloot township, north of johannesburg and was started in september 2012. the co-operative employs 32 members from the diepsloot community, most of whom are women, and produces bags made from plastic shopping packets, pvc, and leather offcuts. their value proposition lies in producing high quality products. however, most of the items are very simple to manufacture. the co-operative operates differently from the conventional co-operative model, in that members do not own and control all the means of production. instead, the co-operative focuses on core skills of workers while functions such as legal, financial, marketing and general administration are outsourced. members earn a monthly wage based on output and a share of the profits which are paid out annually, in accordance with the co-operative legislation. the external support received by the co-operative included a start-up loan, as well as the outsourced support, although the co-operative pays market rates for these support services. 4.1.2 pretorium trust pretorium trust (pt) was formed in 1938 by a group of government employees, in order to reduce the price of household goods through collective purchasing. commission was charged on purchases made from the co-operative. the commission was re-invested in the co-operative and the surplus paid out annually as dividends to members. the co-operative is based in pretoria and has 23 employees servicing 23 000 members. the current general manager has been in this post since 1966 and the majority of the 23 employees have been with the organisation for over 20 years. employees have the choice of becoming members, but are not obliged to do so. the cooperative remains a buying association, with the primary income obtained through rebate agreements with selected retailers. the rebate typically ranges between two percent from larger retailers up to five percent from smaller retailers. additional revenue streams include short-term insurance, loans and vehicle finance. a fee of r10 is required for every new application, after which a compulsory monthly fee of r15 is charged, which is used to fund working capital. each member is also required to deposit an amount of twice his/her monthly credit limit, which helps protect against member defaults. 4.1.3 coastal farmers’ co-operative limited coastal farmers’ co-operative (coastals) was started in 1946 by a group of farmers in kwazulunatal. their goal was to reduce the price of fertiliser, diesel, fuel and other farming commodities for themselves and other members through economies of scale. the co-operative is currently the largest purchaser of farming commodities in the kwazulu-natal coastal belt and has increased its product range significantly since inception. the head office is located in mount edgecombe, north of durban, and employs approximately 150 people. the current general manager (gm) has been at the helm since 2005, before which the previous gm headed the co-operative for 39 years. its membership consists of approximately 1400 predominantly sugar, banana and citrus farmers. all employees of the co-operative are non-members, unless they are farmers, in which case they have the opportunity to become members. the board of directors are all farmers and members of the co-operative. according to the 2013 financial statements, the revenue was r240 million. 4.1.4 ujimabakwena shoemaking co-operative ujimabakwena shoemaking co-operative was a merger of two shoe-making co-operatives, one of which was formed by a group of retrenched workers from a shoe factory. the co-operative has 17 members and 23 non-members. non-members are employed on a non-permanent basis according to the requirements of seasonal demand. the co-operative supplies its shoes through the department of sajems ns 19 (2016) 4:630-646 637 social services (dss) in gauteng, which subsidises 40 000 learners from disadvantaged communities. the dss supports the initiative on the understanding that the levels of quality, price and service are not compromised. in addition, the co-operative supports other co-operatives with its skills, while also receiving support from these other co-operatives. additional business skills and financial support are provided by government and certain private sector companies. 4.2 the drivers of the co-operative model in a high-conflict environment the relationship between business, government and labour internationally has gone through periods in which models of stakeholder management have been questioned. in south africa this relationship has been problematic, given its history of inequality and political instability, which has led to extremely volatile labour relations. the co-operative model is said to be more effective because it is able to strengthen relationships between stakeholders (birchall & simmons, 2004). respondents were asked about what they thought the drivers of the co-operative model were and broadly speaking it was contended that these were building trust and knowledge sharing. table 2 identifies the key emergent themes which arose relating to trust. table 2 pertinent quotes and themes relating to trust theme quote source trust is essential if the co-operative is to succeed if trust is lacking, it would not work…we are dealing with people's money. manager: pretorium trust the co-op requires even more ethics than standard business. manager: pretorium trust trust goes with integrity. your members must trust you. if they don't, it will be like a fire spreading, and pretty soon you will be out of business. you need to maintain the highest possible quality of business standards and ethics for those members. if there is no integrity, you will not be trusted. manager: pretorium trust they do what they say they will do. they have earned their trust. member: coastals [building trust] open and honest and have high moral values in dealing with our customers and members. manager: coastals transparency and communication fundamental to building trust very important...trusting each other…but to be trusted by others, transparency should prevail…each and everything should be in black and white. manager: ujimabakwena communication and transparency are essential. manager: ujimabakwena our intention is fair. we have a transparent system here. manager: diepsloot as and when it [conflict] arises, we intervene immediately. manager: diepsloot [dealing with conflict]. not always aligned with the same objective. speak to that person to see if we can solve that problem. manager pretorium trust trust that the customer member is getting a fair deal. trust is the key principle that is embedded in the dna of the co-operative. manager: coastals one of the key things which make the co-operative work, we don’t just instruct people…we always negotiate. as workers, they have the right to say no…we always give them options. manager: ujimabakwena [relationship between workers and members] there are rules. we sit down and everyone has something to say. worker: ujimabakwena family environment and sense of community to build trust yes, we trust everyone. when we are doing something, we teach each other…we think we are going to gain more for what we are doing. worker: diepsloot because it is like a family. you are working like a family. manager: diepsloot living that values system through the entire organisation from the board to the lowest level staff members. basic principles – such as honesty, integrity and responsibility. manager: coastals conflict between management and staff is not there. manager: pretorium trust we need to treat each other like a family. manager: ujimabakwena one thing we are very strict about, we do not entertain individual conflicts. draw a line that it mustn't affect the work. manager: ujimabakwena need to foster collaboration…and sometimes even force it. need to dialogue more. it is a function of leadership and the trust environment. director: national development agency difficult to build trust. culturally and demographically it is difficult to work together…but it comes back to strong leadership. when we are here, we are a family, we are a team. manager: diepsloot 638 sajems ns 19 (2016) 4:630-646 all respondents agreed with cook (1995), birchall (1997) and sabatini et al. (2014) that trust was fundamental to the co-operative’s success. but how do the co-operatives build this trust in an environment where there are high levels of mistrust? two key themes emerged: open and honest communication, and a family environment. in order to create a family environment, the co-operatives were very cautious when selecting members and employees, which was indicative of the high levels of mistrust in the general community. this finding was more evident with the developing cooperatives because the more established co-operatives had already institutionalised the working environment. when conflict arose, it was dealt with decisively in all four co-operatives. this sentiment was confirmed by managers, workers, members and non-members alike, and this highlighted the importance of each co-operative seeking to maintain a stable, low-conflict environment. within the co-operatives, conflict was dealt with by applying strict rules requiring members and employees to set their differences aside. if members did not accept these principles, then they were asked to leave. pretorium trust allowed members to join by following a standard credit approval process, but coastals admitted only members who were farmers. however, if members defaulted or failed to meet their obligations, their membership was cancelled. knowledge sharing was found to be another important contributor to the success of the cooperative – a number of subthemes emerged within this theme and they are summarised in table 3. a strong theme confirmed by all four co-operatives was the need to operate as profitable businesses (mazzarol, 2012). however, depth of business skills was found to be lacking in the start-up co-operatives. for their co-operatives to function effectively, ujimabakwena and diepsloot worker co-operatives realised that there was a need to focus on their core strengths in order to build the organisations into sustainable entities. diepsloot worker co-operative adapted its business model by outsourcing functions such as marketing, bookkeeping and general administration where it lacked the required skills. ujimabakwena leveraged its links with government and outside agencies to provide training in the functions for which it had limited skills. all four co-operatives indicated a strong need for ongoing education and knowledge sharing between members and fellow workers. table 3 themes related to knowledge sharing theme quote source depth of business skills essential it is not the sector, it is the foundation of business development which is lacking. director: national development agency the co-operative really is business. our product has to be world class. manager: diepsloot depth of skill is lacking in business development...requires market access, funding, skills, inclination to run business on different level. director: national development agency co-op is still a business enterprise. on the one hand we are capitalistic, we make profits. on the other hand we are socialistic, everything goes back to the members. that is the true platform of co-ops manager: pretorium trust strong leadership it takes a key man on the ground to get things going…it needs the key management. manager: diepsloot i am passionate about the business. manager: coastals focus on core skills we must let co-ops do what they are good at. director: nda we allow members to focus on their core strength and outsource other business functions. manager: diepsloot ongoing learning fundamental to cooperative development if you have got nothing, no education, nothing is going to come from it. manager: diepsloot we pay half of the studies for anyone who wants to attend a tertiary institution. manager: pretorium trust whatever we have learnt from training, we take it to all the members. manager: ujimabakwena we discuss all the problems once a month. manager: pretorium trust i teach this lady and she teaches me as well. worker: ujimabakwena we take education very seriously hence most of our staff are receiving both internal and external training through reputable organisations like unisa and the local chamber of commerce. manager: coastals sajems ns 19 (2016) 4:630-646 639 4.3 the role of governance in the co-operative sustainable governance of a co-operative must be achieved through a self-regulating information and control system (dyer & singh, 1998; turnbull, 1997), but the governance structure needs to be balanced against the ability to meet members’ needs. respondents were asked how the cooperative met their needs as members and what incentivised them to become members. the key themes which emerged included the family working environment, learning and development, financial remuneration, and strong governance – see table 4. table 4 motives for joining a co-operative theme quote source strong family environment [why work here] excellent work/personal life balance. has a family culture where employees are not just a number. manager: coastals we are working as a family. management, they are like parents. worker: diepsloot here we are simunye, we are 'in one'. worker: diepsloot maybe less employees allows more time to respect each others’ work. manager: pretorium trust the people will make me stay. it doesn't matter if i don't get paid 'cos i like my job. manager: diepsloot from an employee point of view the atmosphere is family oriented and therefore the desire to stay over long periods of time is evident. manager: coastals they treat us very well. they communicate with us. worker: ujimabakwena balance between learning and financial reward we do some different things and we learn…and we work hard to get the money. worker: diepsloot providing a job and teaching us more things we didn't know. worker: diepsloot [willing to accept lower salary] definitely. manager: pretorium trust i get money when working so hard…i get more experience, i can learn here. worker: diepsloot [what motivates you to work here] the other members…and the bonus. 60 % environment, 40 % bonus. manager: pretorium trust knowledge sharing if have work, i know, i see. manager: diepsloot i teach myself and i teach others. i like here…i learn more...if i am on the other side [other company] i didn't learn more. now i'm just improve…my dreams start to open…i like my job…i am proud of my work. manager: diepsloot i choose this co-operative because it makes me great, it grows me, it's everything to me, so i am proud. i don't care about money. worker: diepsloot it is not about the money, it is about the satisfaction about what you have done. worker: ujimabakwena [what do you value most?]. to get more knowledge. worker: diepsloot need to alleviate poverty co-op born out of need to alleviate poverty. social enterprise trying to compete as a business. a hybrid model of social entrepreneurship. manager: pretorium trust surely i want to live a better life…being an owner makes me 100 percent responsible. manager: ujimabakwena i am able to put food on the table. worker: diepsloot strong governance essential we have 5 managers at the top…before taking decisions, we go back to members to discuss…we share the responsibilities as management. manager: ujimabakwena we have got one vision. manager: ujimabakwena as much as we are all equal, there is leadership in this co-operative…it is almost a process of holding hands. manager: diepsloot as we employ people we put in laws…creates discipline. manager: ujimabakwena we cannot all lead, but we must choose the leaders who can lead us to the right direction. manager: ujimabakwena we used shared governance. worker: ujimabakwena [balancing governance with workers' needs] it’s not easy...all the rules given to the employees make it easier…we don't just tell them, we give them the reason. worker: ujimabakwena good governance structures…are the simple rules and regulations that are set with monitoring systems that are restorative and fair. manager: coastals the role of governance was found to be instrumental in the co-operative’s development and ongoing success. the governance structures of all four co-operatives are shown in figure 2. all 640 sajems ns 19 (2016) 4:630-646 four structures were found to follow a normal chain of command where actions are carried out through delegation from top management to the shop floor. figure 2 organograms of co-operatives diepsloot workers’ co-operative: the general manager (gm) and two team leaders manage the co-operative. together, they are able to adequately and quickly address the needs of the member workforce through communication of a single vision and strong leadership. ujimabakwena shoemaking co-operative: the co-operative has 17 members and 23 nonmembers and governance is shared between five members. the operation is based within a single facility and members and non-members are all treated equally. the five-member board appoints two members as operations managers and they oversee daily operations. however, members and non-members are regularly updated and consulted on all matters, and the management also freely communicates with workers as and when the need arises. diepsloot worker co-operative ujima bakwena co-operative pretorium trust coastals farmers' co-operative general manager team leader team leader members member 2 member 3 member 1 member 4 member 5 2 managing members managing member managing member managing member managing member managing member general manager trading manager internal auditor finance manager regional manager regional manager board directors general manager 17 branch managers board directors sajems ns 19 (2016) 4:630-646 641 pretorium trust: the co-operative has a board of directors and a gm. the organisation is located in a single building and has 23 working members servicing 23 000 member customers. more effective communication is achieved via the use of a well-structured it system. however, the gm maintains a close relationship with all employees, to which the fact that most employees have been with the company for over 20 years bears testimony. the gm has also been in his post since 1966 and maintains an open-door policy. coastals farmers’ co-operative: the co-operative is headed by a board of directors, each with his/her own ward or region. the allocation of directors to wards improves communication with members: ‘directors are members of the co-operative and are farmers in their respective areas. this allows for easier communication with members (customers) and directors are aware of the importance of communication with members.’ this structure has shown its effectiveness in meeting the needs of the members and demonstrated sustainability through its existence over the past 67 years. the research indicates that as the co-operatives become larger, the governance structures need to adapt to include boards of governors in order to service the interests of the members better. although the larger co-operatives have a well-defined governance structure in place, there is a certain degree of informal management in order to engage with members. building relationships with suppliers, customers and other co-operatives is an essential component of the successful operation of a co-operative (birchall & simmons, 2004). respondents were asked what they thought was required to build and maintain these relationships, and what impeded their progress. the dominant themes which emerged related to governance, relationship management and trust – see table 5. table 5 themes in building external networks theme quote source mistrust of cooperatives by external stakeholders a large corporate said: “we do not deal with co-operatives. the co-operative members don't trust each other. inherent mistrust with external stakeholders.” manager: diepsloot worker amongst our old established customers they view our organisation as high value to their operation…younger entrants feel that they could achieve much better deals on their own. some perceive the co-operative as a “white man's business”. manager: coastals move towards social dynamics our members are our customers. our members are in a long-term business. managing relationships is crucial. manager: coastals generally, co-operatives have a good perception. they are not seen as “capitalist” and vehicles for exploiting customers or employees. manager: coastals communication. building trust between parties. aligning parties with similar/common goals. manager: coastals we share our challenges with other co-operatives. manager: ujimabakwena although your neighbour is a fellow farmer, he is not viewed as a competitor (unlike how it works in other businesses). this allows for sharing of information, best practice, co-operation with security, purchasing etc. manager: coastals governance crucial for building strong networks and relationships internal governance is extremely important to developing external relationships. the first order was sold on the quality and the promise of delivery. the second order was sold on the track record of delivery and the quality. manager: diepsloot [good governance] integrity, honesty and fairness as part of the culture of the coop which is visible to members/ customers, staff and third parties e.g. suppliers. manager: coastals integrity is not negotiable in our dealings with members, suppliers and other stakeholders. manager: coastals credibility and reputation come with good governance. member: coastals building networks requires trust and dedication building trust with customers…we get in front of them. manager: diepsloot i have gained trust from my suppliers…a promise is a promise. manager: ujimabakwena over the years families pass on their assets from one generation to another and the trust is measured by the value of our growth within our organisation; the fact that the newer generations remain closely aligned with our organisation means there is high value of trust. manager: coastals 642 sajems ns 19 (2016) 4:630-646 the results show that the co-operatives view governance as a critical component in developing strong relationships with suppliers, customers and other co-operatives, and that integrity, honesty and delivering on a promise are the enablers of strengthening these relationships. however, a significant barrier to developing external relationships is the inherent mistrust of co-operatives (parnell, 2001). this was powerfully illustrated in the following statements: ‘we do not deal with co-operatives. the co-operative members don't trust each other’, and the co-operative is a ‘white man’s business’. a further contributor to mistrust of the co-operative model relates to the high failure rate of co-operatives; businesses do not want to risk dealing with entities which have a high perceived likelihood of failing. 4.4 the role of social and political institutions in co-operative development in socially conflicted environments, the co-operative model has shown success in tapping into local experience and knowledge (parnell, 2001). we therefore examine the extent to which external support is required for the successful development of the co-operative and the results broadly indicate that support from both political and social institutions is important – see table 6. table 6 themes for support from social and political institutions in co-operative development theme quote source government, private enterprise and other co-operatives providing support to start-up cooperatives government invested r200 m over 5 years. nda [a large company] put up starting capital of r500 000. manager: diepsloot we didn't have a clue on how to run a business. we need to consult outside people who will tell us whether we are taking the right decisions. manager: ujimabakwena we got skills [to manage company] through business skills south africa, education from service providers through support from dti. manager: ujimabakwena we are using other co-operatives to provide training for us. manager: ujimabakwena support for non-core activities we have products, production management and sales and marketing to assist these other co-operatives. let's help the co-operative with things which are not their core strength. manager: diepsloot mentors crucial to success in particular, you can tell the difference between those co-ops which have had a mentor and those which have not. nda external support diminishes as size of co-operative increases no government support. no support from outside agencies. manager: pretorium trust we don’t receive support from external agencies. manager: pretorium trust [government involvement] minimal direct involvement manager: coastals there were two dominant themes which emerged from the research. the first was that in a less developed, socially conflicted environment the co-operative model requires support from political or social institutions in the early stages of development in order to succeed, but chances of obtaining the required support are inhibited by mistrust of the co-operative model and therefore support institutions are reluctant to invest. the second was that as the co-operative becomes larger and self-regulating the need for external support diminishes. in the case of diepsloot worker cooperative, support was provided by private corporate institutions. this support was both financial and service-related, the latter being based on the outsourcing of critical business functions which the co-operative was not able to perform due to lack of skills. ujimabakwena received both financial and educational support from government. this support was provided without any conditions from government, which is significant as it allowed the co-operative to remain autonomous without external interference in the governance of the co-operative. in the case of pretorium trust and coastals, the co-operatives do not require support from external agencies at present and are self-regulating and self-sustaining entities. this shows that the need for support is reduced as the co-operative becomes larger. sajems ns 19 (2016) 4:630-646 643 5 conclusion the objective of the research was to describe the co-operative model as a means of stakeholder management in a high-conflict environment such as south africa, where there has been increased tension between business, government, and labour. the challenge lies in finding a model which empowers workers with low skills and which could mitigate highly conflictual environments. international experience indicates some success with co-operative models but it is important to realise that they are not easy to implement effectively and face severe obstacles. pretending that they is some sort of general panacea to the macro environment is problematic but this does not mean that they do not have a place under particular circumstances where traditional models of stakeholder management have become less effective. on the basis of our research we argue the following as regards the conditions for successful cooperative models: 1 trust and knowledge-sharing are critical in enabling a co-operative model of stakeholder management and this requires adherence to strict rules and strong governance. 2 the co-operative model needs to balance the tension between optimisation of governance structures and responsiveness to members' needs. 3 the ability of the co-operative to develop strong networks with external stakeholders is dependent upon strong governance and relationship management to build trust. 4 support from social and political institutions is necessary to enable a co-operative model of stakeholder management in a less developed, high-conflict environment. our results are summarised in our conceptual framework, which is reflected in figure 3. the model is made up of internal and external factors. external factors include the political and social institutions such as government, ngos, external education and support organisations. during the early phases of co-operative development, external support structures are extremely critical for enabling success. the complexities of the kind of collective organisation that is required to run a co-operative often require initial external support, especially in environments where there is high conflict and a lack of education. such contexts may require external facilitation to organise into a co-operative, since this would mean overcoming the challenges associated with a lack of trust or understanding around the workings and rationale of co-operatives. independent, impartial, external institutions can facilitate the process of building a co-operative but this requires that they are trusted by all parties and are seen as being objective and without vested interests. furthermore, in the early stages co-operatives may be especially in need of external support to develop the management acumen and market networks necessary for long-term viability. these external factors contribute towards developing governance structures and motivating factors which influence members to co-operate; such co-operation in turn feeds into the governance structure at the core of the co-operative. a strong governance structure, enabled through knowledge-sharing and trust, promotes the creation of strong networks with suppliers and customers. as the sustainability of the co-operative increases, so the need for external support is reduced. there are, however, major barriers to the scalability of the co-operative model. firstly, the depth of business skills within the co-operative limits the ability of the co-operative to compete in the market. secondly, the way co-operatives are perceived by external stakeholders may significantly hinder investment and growth opportunities for the co-operative. thirdly, the lack of alignment of government communication and policy to the co-operative model is particularly important during the early stages when the co-operative requires external support. a high-conflict environment requires a more accommodative and inclusive model, which necessitates even greater levels of open communication, knowledge-sharing and governance in order to succeed. however, the last barrier, namely the willingness of the workers or members to co-operate for mutual benefit, is closely linked to the success of this inclusive model. where there are high levels of conflict, social unrest, unrealistic expectations regarding higher wages, or where there is a mindset of entitlement, the co-operative model may not be the appropriate solution. this becomes further 644 sajems ns 19 (2016) 4:630-646 complicated where there are high levels of ethno-linguistic fractionalisation, with this diversity making a family-like environment difficult (see luiz, 2015). the traditional co-operative model may therefore require further adaptation to accommodate diversity in high-conflict environments and this is an important area for future research. figure 3 conceptual model for co-operative success a limitation of the research is that the sample of co-operatives was small and may not be representative of worker co-operatives in high-conflict environments more generally. this limits our generalisability and our ability to understand the full diversity and heterogeneity of our population. our research is exploratory in nature and like many qualitative studies its purpose is not to generalise but rather to provide a rich, contextualised understanding of these particular cases. this immediately suggests possibilities for future research, which could develop more representative samples so as to extend the generalisability of the results. alternatively, a longitudinal study of a limited number of co-operative cases would allow us to examine the way co-operatives evolve and develop over time. furthermore, such studies would allow us to analyse how this model reacts to socio-political shocks at the macro level. endnote 1 mondragon corporation is the embodiment of the co-operative movement that began in 1956, the year that witnessed the creation of the first industrial cooperative in mondragón in the province of gipuzkoa, spain. the corporation’s mission combines the core goals of a business organisation competing in international markets with the use of democratic methods in its business organisation, the creation of jobs, the human and professional development of its workers and a pledge to development with its social environment. in terms of organisation, it is divided into four areas: finance, industry, distribution and knowledge, and is today the foremost basque business group and the tenth largest in spain. see http://www.mondragon-corporation.com/eng/about-us/ references alexander, p., lekgowa, t., mmope, b., sinwell, l. & xezwi, b. 2013. marikana: a view from the mountain and a case to answer. johannesburg: jacana media. awuah, g. & amal, m. 2011. impact of globalization: the ability of less developed countries' (ldcs') firms to cope with opportunities and challenges. european business review, 23(1):120-132. 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stakeholders: a tourism planning model. annals of tourism research, 26(2):312-328. turnbull, s. 1997. stakeholder co-operation. journal of co-operative studies, 29(3):18-52. appendix a: research instrument 1 what is working with current relationships between labour, government and business? 2 how can the relationships between labour, government and business be improved? 3 what methods or processes are being used currently to manage internal and external stakeholders? 4 what makes the co-operative model work effectively? 5 what is the value of trust within the co-operative? 6 how does the co-operative deal with education and transfer of knowledge? 7 what does not work well in the co-operative? 8 what do you value most working in the co-operative? 9 what could be done better? 10 what determines a good governance structure? 11 how does the co-operative deal with conflict between internal stakeholders? 12 what motivates co-operation? 13 how important is the network of relationships, both internally and with external co-operatives and stakeholders? 14 how do you strengthen networks? 15 what effect does the economic climate have on the co-operative? 16 what is your perception of co-operatives in the community? 17 how does the co-operative deal with a lack of trust between members and external stakeholders? 18 how does the co-operative deal with external conflict? 19 is there a history of political involvement or state control of co-ops? 20 what is the legal framework in existence for co-ops? 21 what role do external sources of knowledge and support play in development of the cooperative? 22 what effect does government policy have on the co-operative? 23 what is the value of the community to the co-operative? 24 what is the effect of culture on the co-operative? abstract introduction a strategic and developmental approach to infrastructure procurement in south africa the new universities project as an exemplary south african megaproject critical analysis of the public infrastructure regulatory regime conclusion acknowledgements references footnote about the author(s) jonathan klaaren department of law, faculty of commerce, law, and management, university of the witwatersrand, johannesburg, south africa ron watermeyer department of construction economics and management, faculty of engineering, university of the witwaterand, johannesburg, south africa citation klaaren, j. & watermeyer, r., 2022, ‘reforming procurement standards in order to effectively deliver public infrastructure: rethinking the regulatory environment in post-pandemic south africa’, south african journal of economic and management sciences 25(1), a4465. https://doi.org/10.4102/sajems.v25i1.4465 research note reforming procurement standards in order to effectively deliver public infrastructure: rethinking the regulatory environment in post-pandemic south africa jonathan klaaren, ron watermeyer received: 04 dec. 2021; accepted: 17 june 2022; published: 27 sept. 2022 copyright: © 2022. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract this research study identifies a specific layer of regulation within the governance regime which is a key factor impeding the procurement and delivery of public infrastructure in south africa. we first identify current weaknesses of conflict and confusion at the level of soft law in the procurement and delivery of public infrastructure projects. then we present a detailed case study of a successful south african megaproject (the procurement and delivery of the public infrastructure for two new universities, the new universities project) to demonstrate that these weaknesses can be avoided. the research note’s regulatory account focuses on the key element of quality in the south african public procurement regime, distinguishing that concept from the often conflated notion of value-for-money. we discuss how the problems identified could be addressed by means of changes to soft law prior to the finalisation of the current and ongoing public procurement legislative reform process. contribution: through a case study of the on-time and with-budget public procurement and delivery of two new universities for south africa, the article demonstrated that national policy on public infrastructure can be successfully implemented, with attention to the key soft law layer of regulation. keywords: supply chain management; standards; public procurement; public management; regulation; soft law; value-for-money; megaprojects; public infrastructure. introduction south africa’s response to the coronavirus disease 2019 (covid-19) pandemic envisioned an eventual focus on longer-term policy reform to ignite inclusive economic growth. this is reinforced in the national infrastructure plan 2050 (nip 2050) which seeks to create a foundation for achieving the national development plan’s (ndp) vision of inclusive growth and to promote dynamism in infrastructure delivery, address institutional blockages and weaknesses, and guide the building of stronger institutions. this research study identifies a specific layer of regulation within the governance regime which, if rectified, will promote the efficient, economic and effective delivery of public infrastructure in south africa. while money is tight, it is clear that one element of this longer-term response will be a significant investment in new infrastructure (planting n.d.). this research study supports incorporating a strategic and developmental approach into south africa’s public procurement policy regime and applying such an approach specifically in implementing investment in new infrastructure post-covid19. a strategic and developmental approach to public procurement would represent a major advance beyond the administrative paradigm currently dominating the procurement regime. this study’s focus upon the regulatory framework in terms of which a pipeline of megaprojects can be delivered is crucial. as is broadly admitted across various government levels, it is not the availability of money but the ‘regulatory and policy environment’ that is weak in regard to infrastructure delivery (planting 2020). this sentiment is confirmed in a recent national planning commission (npc) background paper which found significant underspending of infrastructure budgets in all spheres of government and state-owned entities, as well as many differences in the understanding and interpretation of infrastructure regulation, policy and practice which undermine the effective and efficient procurement of public infrastructure (watermeyer & phillips 2020). research has shown government policies are one of the significant factors exerting influence on supply chain flexibility. in turn, supply chain flexibility exerts a positive influence on the performance of the public supply chain (mhelembe & mafini 2019). we begin our study in part two by contextualising the strategic and developmental approach to public procurement with historic experience and economic reasoning. we situate our policy proposal in the recent history of the south african public procurement regime (brunette, klaaren & nqaba 2019) and show the basis of this approach in the evidence marshalled in the recent npc background paper on infrastructure delivery (watermeyer & phillips 2020). in part two the significant question of the degree to which infrastructure delivery is conceptually unlike the procurement of other public goods and services is raised and discussed. in part three a case study is presented of a megaproject for which there is detailed information publicly available: the delivery of two new universities in the northern cape and mpumalanga provinces. implementing this case study research method and highlighting the particular megaproject, should contribute to deepening and augmenting the south african literature in this area. in this part and in the research study as a whole, our research method is a case study analysis, a method with a long social science tradition. in one of the established research handbooks in this field the scope of a case study is defined as ‘an empirical method that investigates a contemporary phenomenon in depth and within its real-life context, especially when the boundaries between phenomenon and context may not be clearly evident’ (yin 2017). we collected primary public documents relating to the new universities project (nup). this was facilitated by the participation of one co-author in the management of this megaproject (specifically as a member of the nup management team [nupmt], see below part 3). employing then a socio-legal approach to the case study analysis, we researched further legal and governance instruments and referred to relevant local and international secondary literature to assist in understanding the case study and its context (argyrou 2017). broadly speaking, the case study method has been applied to other megaprojects in southern africa including the gautrain (fombad 2015). case studies in the performance of megaprojects with particular attention to their linkages to the governance arrangements in south africa are beginning to emerge (laryea 2019; laryea & watermeyer 2020; watermeyer 2022). this welcome trend has nonetheless in part been triggered by enquiries into infrastructure project failures and the poor performance of megaprojects in countries such as the uk (denicol, davies & krystallis 2020; watermeyer 2019). in a concluding section, part four, we argue for drawing the connections between a strategic and development approach to government procurement policies, the objective to deliver a quality-ensured megaproject within budget and on time, and the sort of value-for-money essential in order to conduce to a transformed, resilient, and sustainable post-pandemic south africa society. while we do not consider the broader public impacts of the infrastructure megaprojects themselves, this section interrogates the principle of value-for-money and identifies as beneficiaries both the fiscus and the suppliers and contractors interacting with the delivery of the public infrastructure project during its delivery. this part also ties together the preceding sections of our research study. a strategic and developmental approach to infrastructure procurement in south africa the historical context of the contract state history shows the importance of understanding the government policies around public procurement. since around 1980, south africa has followed the international trend of an expanding ‘contract state’. public procurement has become increasingly important to state operational and allocative concerns. this has made attempts to change the form and content of its public procurement regime significant. since 1994, south africa’s public procurement regime has become progressively configured into an essentially decentralised organisational form (brunette et al. 2019). however, due to domestic public procurement politics, the further development of this organisational form of the state has been truncated. this has resulted in the establishment of only limited central steering capacity and the elaboration of a regime pursuing procurement through financial management rules. the result – apparent soon after 2010, if not before – has been a public procurement regulatory regime which is fragmented, incoherent, and formalistic, as a whole contributing to problems of state incapacity and corruption (brunette et al. 2019). in 2013 south africa’s minister of finance announced a major push to reform south africa’s contract state. the effort aims to better establish, locate and extend the public procurement regulatory authority. it has begun to elaborate a centre-led, strategic and increasingly developmental procurement methodology. it is moving towards more flexibility, which is effectively an attempt to reduce rigidity in rules, while building more robust and distributed disciplinary mechanisms, ones which take account of deficits in regulatory capacity and political will (brunette et al. 2019). most recently, national treasury has published draft legislation (the draft public procurement bill of february 2020) promising to overhaul this regime. at the same time, the presidency embarked upon its drive to establish a pipeline of shovel-ready fundable infrastructure megaprojects. economic reasoning the economic reasoning behind the provision of public infrastructure in a post-pandemic south africa is fairly straightforward and compelling. ‘the ndp 2030: our future – make it work’ sets a target for public infrastructure expenditure of 10% of the general domestic product (gdp) and anticipated that government’s inability to spend its infrastructure budgets would be addressed over a period of time. however, instead of a steady increase in infrastructure investment during the last decade, as envisaged in the ndp, such investment has been in decline in real terms and has hovered around half this target. furthermore, underspending has increased rather than decreased. nevertheless, the ndp’s identification a need for an increase in gross fixed capital formation to realise inclusive growth remains valid. an increase in the quality and quantum of public infrastructure is required to enable the economy to grow faster and become more productive (watermeyer & phillips 2020:79). at least two caveats should be added to the current consensus that an increased focus on public infrastructure procurement can and should be effected in order to pull south african out of its preand post-pandemic blues. while this study explores institutional and public policy avenues through which the principle of value-for-money may be assured in public infrastructure procurement, there are factors that may interfere with that result. first, it has long been recognised in the field that cost underestimation in megaprojects cannot be explained simply as error and may best be explained as strategic misrepresentation (deception), optimism bias (delusion) and escalating commitment (denicol et al. 2020; fombad 2015:1209). second, the value-for-money principle is only one of a number of relevant governance principles, which could additionally include consensus participation, transparency, accountability, risk transfer, political will, sustainability and corporate governance (fombad 2015:1204). distinctiveness of infrastructure procurement throughout this research study, we demonstrate that the subject matter of public infrastructure is indeed distinctive as a policy domain of the public procurement system from the policy domain of goods and services for consumption with which it is often conflated. purchasing is commonly a back-office or administrative function, whereas procurement is a front-office or strategic function which needs to be linked to the department or directorate responsible for delivering projects and services. the handling of procurement by a specific purchasing resource or department under a finance department rather than being frequently a central competency within portfolio, programme and project management in complex projects leads to unforeseen issues developing which inevitably lead to time, cost and quality overruns (watermeyer 2022; watermeyer & phillips 2020). arguments have long been made for the worth of distinguishing carefully between the public procurement of goods and services on the one hand, and the procurement of construction works and infrastructure on the other (anthony 2018:chap. 2). the international organisation for standardisation (iso) 10845-1 (2020) identifies the distinguishing features between the procurement of infrastructure and that for general goods and services for consumption. the procurement of general goods and services for consumption involves the direct acquisition of goods or services which are standard, well-defined and readily scoped and specified. such procurement is routine in nature and driven by the development of a specification which then forms part of the requisition for the required goods or services. an immediate choice can be made in terms of the cost of what is offered. in contrast, the procurement of infrastructure is strategic in nature as there are many more risks to manage due to unforeseen events during the delivery of the project. in addition, infrastructure requirements are often established from a perspective of desired performance, rather than a well-defined specification. a range of different combinations of goods and services with distinctive characteristics such as initial cost, reliability, life-cycle costs, and operating costs may satisfy the performance requirements. furthermore, the final contract price is commonly the sum of the initial contract price, price adjustment for inflation and the cost of risk events for which the client is at risk. as a result, there can be a significant difference between the starting value of a contract and the final value (out-turn cost). budgetary provisions (contingencies) are required to fund this difference. infrastructure projects need to be planned, specified, procured and delivered. once decisions are made on what the project needs to deliver, who will deliver it and how it will be funded and governed, the remaining decisions centre on how it will be managed through to completion. such management takes place within a project-specific environment which continually involves the management of risk events, which may be foreseen or unforeseen, having the potential to negatively impact on project outcomes during the protracted delivery process. furthermore, the procurement of infrastructure involves the programming and coordination of a network of suppliers of goods and services bound together through contracts which are required to collectively deliver or alter infrastructure on a site. such a network can include different companies specialising in design, manufacture, supply, assembly or construction (iso 10845-1 2020; iso 22058 2022; watermeyer 2018, 2022; watermeyer & phillips 2020). other important project variables include what is delivered, the client’s value proposition for projects (the promise of measurable benefits), stakeholder influences, resources employed, constraints, processes and procurement practices that are pursued in infrastructure delivery. furthermore, a central issue that needs to be dealt with is the financial liability related to the uncertainty of information when decisions are made, as risk taking is necessary when delivering projects. accordingly, client procurement and delivery management practices (the client buying functions) are central to the performance of the infrastructure supply chain and have a direct impact on the realisation of the client’s value proposition for the project (watermeyer 2018, 2022). as a final aspect of their distinctive nature, infrastructure projects are furthermore characterised by multiple contracts which need to be procured and managed in such a way that the anticipated benefits are progressively realised. there are accordingly several interfaces and interdependencies between contracts as works (products) that are developed or maintained on a site. a supply chain needs to be contracted and mobilised. demand is managed through service life plans, based on an assessment of current performance against desired levels of service or functionality and strategic infrastructure plans. demand also needs to be proactively managed through the delivery process to prevent scope creep. value for money in this context is the optimal use of resources, or the effective, efficient, and economic use of resources to achieve intended project outcomes (watermeyer 2018:24, 25, 73, and 74). the new universities project as an exemplary south african megaproject in this section the r2b nup is outlined and classified as a megaproject, while the structural and project-specific institutions and factors that contributed to the success of the nup are further explored. while most megaprojects in south africa are either over estimated cost or subject to long delays or (most often) both over budget and late, the nup showed the opposite – successful delivery of public infrastructure on time and on budget. megaprojects are subject to definitional debates (parrock 2015), but may be understood as large public sector infrastructure projects usually taking at least five years to complete (watermeyer & phillips 2020:46). one list (watermeyer & phillips 2020) identified the following as south african megaprojects: the gauteng freeway improvement project, the gautrain rapid rail link system, the ingula pumped storage scheme, the king shaka international airport, the new multi-product pipeline, the kusile coal power plants, the medupi coal power plant, the nup, and the renewable energy independent power producers procurement programme (reipppp). the government’s annual budget reviews contain an annexure listing major infrastructure projects at various stages of consideration but not yet approved for funding. table d2 of the 2020 annual budget contains 31 such public infrastructure projects, with cost estimates ranging from r500 million to r112 billion (gautrain rapid rail potential extension) (national treasury 2020). these projects vary among the stages of prefeasibility, feasibility, feasibility completed, procurement, and implementation. on 24 july 2020, minister de lille gazetted a list with 18 new strategic integrated projects (sips) (presidential infrastructure coordinating commission 2020). these were numbered 19–36 and carried on from an earlier list of 18 sips. six of these july 2020 sips had subprojects identified (a total of 50 sub-projects). undoubtedly, the best-documented public infrastructure project in south africa is the nup, a subproject of sip 14 (nupmt 2018a). around 2010, the department of higher education and training (dhet) developed a project to establish two new universities in the mpumalanga and the northern cape provinces. the project was planned to be fully developed over a period of 15 years, consisting of different phases. significantly, the dhet decided in 2011 to use wits university as an implementing agent. a memorandum of agreement (moa) was signed between wits and dhet, establishing the nupmt. wits and dhet together formed the client team. the task of nupmt was to direct academic and institutional preparation, including the setting of a vision, and, for the first phase of the two universities, to plan (decide on what needs to be done, how it is to be resourced and achieved and in what time frames, and set a budget), specify (define the functional and other requirements for the project clearly and precisely), procure (obtain internal and external project resources to execute project activities) and oversee delivery (observe and define the execution of the project to realise the client’s value proposition associated with a business case). there were different supply teams contracted to provide the works for each university. the project governance was carried out through a project steering committee (psc) and a technical integration committee (tic); and each new university had a project management team, design teams, support services teams and supply teams procured and overseen by the numpt (laryea & watermeyer 2020; watermeyer 2022). the new universities took over the plan, specify, procure and oversee delivery functions of the nupmt around 2016 and 2017. the implementation of this project differed from the usual arrangement in public infrastructure in south africa. as described by laryea (2019) (following laryea & watermeyer 2017): [… i]nfrastructure projects in the south african public sector are typically delivered using an implementer such as a national or provincial department of public works or a state-owned enterprise. where such delegation or assignment is made, the ‘sponsor’ and the ‘implementer’, although being different organs of state, collectively function as the ‘client’. typically, the ‘implementer’ assumes responsibility for programme management, procurement, payment of contractors and professional service providers, overseeing the administration of contracts and the provision of technical advice and inputs. (p. 2067) in the nup’s implementation, an important distinction was made between the client/sponsor and the client’s implementer team (laryea 2019). the nupmt exercised an extraordinary degree of discretion. they could be described as having ‘single point accountability’. perhaps as importantly, the nupmt was insulated from direct political interference, both through the top management layer of wits university and through the client, the dhet. three further contextual factors also, arguably, contributed to the success of this project. firstly, the nupmt was able to draw on their experience of at least five years of management capital projects in the higher education sector. secondly, while governed by a tender committee and a governance scheme in wits, the nupmt was able to focus on this single project. thirdly, the management team had a continuity of personnel and adhered to united professional ethics during the project and further on, this ethics were aligned with the organisation in which it was operating. (nupmt 2018) value for money was an important concept in implementing the new universities project. the world bank suggests that value for money is the ‘effective, efficient, and economic use of resources’ (‘the world bank procurement regulations for ipf borrowers’ 2020). in line with practice of the national audit office in the uk (national audit office n.d.), the south african national treasury (national treasury 2015) defines value for money as ‘the optimal use of resources to achieve intended outcomes’. accordingly, value for money in an infrastructure context is regarded as the most desirable possible outcome from the use of resources (finances, people, equipment, plant, materials, etc.) that can be drawn upon, given implied or expressed restrictions or constraints, such as risks and costs (watermeyer 2018). value for money is considered to be achieved when the gap between what is planned and what is delivered is narrow. the understanding of the value-for-money concept in the implementation of this megaproject (and its difference from the concept of quality) may be seen through the example of the building cost norm. in 1996 dhet established a procedure for the setting of a cost norm for buildings in the higher education sector (department of education [south africa] 2009). this norm provides a basis for cost estimation, including feasibility planning, and can be used to establish an order of magnitude cost estimate for a building during the initial planning for a project, to set an early design cost estimate, for cost control during the design phase of a project and to establish if value for money has been achieved in the delivery of a building project. a building which is delivered within these cost norms is deemed to represent value for money. quality is thus an indirect rather than a direct factor; as the dhet’s document notes, the norm ‘provide[s] a broad framework within which institutions, with proper planning, have ample room to creatively erect suitable, quality buildings’. the cost norm is not based on the gross area of the building. it is based on the assignable square meters (asm), that is, floor area available for assignment to an occupant or for specific use, without deductions for columns and projections. this basis encourages the minimisation of the amount of space in a building that is essential to the operation of the building but not assigned directly to people or programmes; that is, the non-assignable area which includes circulation areas such as corridors, staircases, stairwells and lobby areas, building service areas (e.g. water heating rooms and hub/ict [information and technology] room) and mechanical areas (e.g. lift shafts). this encourages the minimising of non-assignable areas as such areas do not contribute to the building cost norm. the feasibility report submitted to national treasury in september 2012 to secure the necessary funding was based on the asms required to support the assumed university activities which were scheduled to commence during february 2014. the financial modelling was based on the number of full-time students that were to be enrolled, the asms required to support learning and the cost norm associated with the year in which facilities would be completed and allowances for land improvements, bulk services, furniture, fittings and equipment, et cetera. the medium-term expenditure framework (mtef) allocation confirmed by national treasury (including both capital and operational) amounted to r300m, r659m and r1 166 314 for the 2013/2014, and 2015/2016 financial years. estimating costs is one thing. delivering construction work and infrastructure within cost estimates and a narrow margin of error is quite another. buildings were refurbished, repurposed and ready to receive the first start-up intake of students at the start of the 2014 academic year – 127 students at the sol plaatje university (spu) in kimberley and 169 at the university of mpumalanga (ump) in nelspruit. the second intake in february 2015 increased the total number of student enrolments to 337 at spu and 828 at ump. the third intake of 2016 planned to significantly increase the student population to 700 students at spu and 1255 students at ump. this increase in student population required new teaching and residence facilities to accommodate the increased enrolments at a cost of approximately r925m. the construction plan envisaged that the delivery management oversight for the buildings associated with the third intake of student would be undertaken by staff at the new universities. it became evident during the latter half of 2014 that the universities lacked the management expertise and the human resources to do so. the nupmt were accordingly required to step in and oversee the delivery of the construction of these new facilities. the new facilities for the 2016 intake were built over a 14 month period, enabling academic activities to commence at the start of the academic year within the cost norms (spu and ump approximately 5% and 3.5% below the norm respectively) with very small differences between the estimated cost at the start of construction and the final cost – the spu and ump starting control budget of r726 024 282 and r331 821 515, respectively, whereas the final account was r695 763 114 and r320 468 987, respectively. this was despite 70% of the works not capable of being priced when construction commenced and the extremely short construction period of 14 months which straddled two december industry holiday periods (laryea & watermeyer 2020). in the physical construction of the universities, local content was promoted, particularly targeting those previously excluded from working on projects due to the apartheid system, while 545 construction staff and workers were given approximately 40 000 h of structured workplace learning. one of the buildings even received a commendation at the world architectural festival. from the point of view of public procurement of infrastructure in south africa, two aspects were of particular note about the implementation of the nup project. firstly, the time taken between the political decision to develop a new university and the receiving of the first intake of students was extremely short – just 28 months. secondly the necessary academic facilities and residences were delivered at the start of an academic year in a cost-efficient and effective manner, and they were delivered within the constraints of public sector procurement legislation whilst supporting the development of the surrounding community: [o]ver 143 procurements were undertaken, resulting in 219 appointments [14–10]. of the r1.62 billion total expenditure, r1.46 billion (90.4%) was procured through public tenders issued by the nupmt, and all tenders were adjudicated by the wits tender committee. tenders were generally awarded to the highest points for price, preference and quality. tenders for professional services were most often awarded at rates lower than those recommended by the relevant professional bodies. (laryea, watermeyer & govender 2020; nupmt 2018:276) significantly (and as discussed further in the following section), wits’s procurement policy was almost a carbon copy of the draft national treasury standard for a construction procurement system and was structured around the draft standard for an infrastructure delivery management system which was also released for public comment during november 2012. these two draft treasury standards were subsequently combined into one document, namely the standard for infrastructure procurement and delivery management (sipdm) and issued by national treasury in 2015. this national treasury document drew upon the experience gained by the nupmt in applying the draft standards (nupmt). extensive use was made by the nupmt of the construction industry development board (cidb’s) standard for uniformity in construction (2011) which informed and was aligned with the provisions of the iso 10845 series of international standards for construction procurement (watermeyer & phillips 2020). critical analysis of the public infrastructure regulatory regime in our preceding sections, we have contextualised the need for and the delivery of public infrastructure in south africa, as well as presented a case study of a recent successful megaproject. in this section, we argue that an effective implementation strategy for megaprojects in south africa can be promoted by changing the existing soft law environment. this argument aligns with the key finding of the 2019 study conducted by the human science research council (hsrc) that there are differences in the understanding and interpretation of infrastructure regulation, policy and practice which undermine the effective and efficient procurement of public infrastructure (hawkins & pienaar 2020). it is in this zone of interpretation and implementation that the south african soft law of public infrastructure delivery poses a significant regulatory obstacle. the national treasury sipdm and the cidb standard for uniformity in construction procurement supported a differentiation in the approach to the procurement and the management of the supply chain from that of general goods and services. following a change in senior leadership in national treasury, this policy position was however reversed to support one institutional supply chain management (scm) system as opposed to two scm systems. this eroded the recognition of the distinctive nature of public infrastructure procurement significantly. accordingly, sipdm was replaced with framework for infrastructure delivery and procurement management (fidpm). the cidb also introduced a standard for uniformity in engineering and construction contracts. as has been pointed out in published open-access research dating the historical analysis back a decade, these recently issued soft law standards – the fidpm and the local government fidpm (lgfidpm) (respectively the public finance management act [ pfma] presidential infrastructure coordinating commission [ picc] and municipal finance management act [mfma] versions) – have by no means reduced pre-existing confusion around government procurement policies but have instead added to such confusion (klaaren & watermeyer 2020). this research disentangles the separate concepts of functionality, quality, and value-for-money at hard law, soft law, and institutional levels over three distinct periods of the public procurement regime from 2011 to the present. in this prior research, as well as the current paper, we employ an analytic difference between hard law (constitutional, statutory and court-made law) and soft law (standards, guidance, and instruction notes). the fidpm is poorly drafted and misaligned with critical built-environment processes and practices. it is furthermore difficult to interpret and impractical to implement. the recent changes brought about in the cidb prescripts have undermined the integrity of the standard that evolved since 2004 and are difficult to interpret and implement. for example, the fidpm makes reference to ‘applicable cidb standards for uniformity’ and ‘cidb prescripts’. the construction industry regulations define construction procurement as ‘procurement in the construction industry, including the invitation, award and management of contracts’. the most recent version of the cidb standard for uniformity in construction procurement (2015 edition) deals with professional service, term service, supply and engineering and construction contracts. the cidb standard for uniformity in engineering and construction contract, issued in 2019, has a narrow scope and only deals with engineering and construction contracts. there is accordingly an overlap between these documents and consequent confusion as to what is applicable (klaaren & watermeyer 2020; watermeyer & phillips 2020). the recovery from covid is likely to be very slow under the current public procurement regime due to the current incoherent and conflicting regulatory instruments and confusing plethora of guidelines and circulars which have been issued to clarify various aspects of the scm regulations, instructions and guidelines and the preferential procurement regulations. there is an urgent need to address this unfortunate state of affairs before the finalisation and eventual implementation of the procurement bill. the procurement bill which was published in february 2020 for public comment envisages a single and uniform regime, a common framework and a soft law approach to the regulation of infrastructure procurement and delivery in the form of standards which permits flexibility and provides an opportunity for the use of familiar concepts, rules and terminology. there are, however, several shortcomings in the procurement bill which, if not addressed, will inevitably undermine the effective implementation of what is intended for infrastructure procurement and delivery management. firstly, the 2020 bill perpetuates aspects of the prevailing procurement and scm practices which are designed primarily for general goods and services for consumption and also distributes the requirements for infrastructure over numerous sections of the bill rather than consolidating them in one chapter. secondly, although the bill purports to be a framework, it contains detail which introduces requirements which are likely to work against requirements for flexibility and differentiation in more complex procurements. such provisions are better located in regulations, or in the soft law layer of the procurement government regime. thirdly, although the bill seeks to create a single regulatory framework for public procurement to eliminate fragmented procurement prescripts, it proposes no amendment to the cidb act. it is not clear if this is an omission or in recognition of the fact that the cidb has no mandate to regulate procurement except when this is granted to the cidb by national treasury. this issue needs to be clarified going forward. fourthly, the definition for infrastructure is inadequate. the definition is not sufficiently broad to cover engineering works including process plants. it also omits ict networks and the dismantling or demolition of construction works. it also needs to be expanded to cover furniture, fittings and equipment necessary to enable a new or refurbished facility to be delivered as a fully functional entity. the definition also does not expressly cover professional built-environment services. the end of this hard law process is unlikely on current trajectory before the end of 2023 on a best case scenario. the infrastructure development act of 2014 provides an opportunity to address these issues through hard and, significantly for the purposes of immediate corrective action, soft regulatory instruments. this act establishes a council for the presidential infrastructure co-ordinating commission comprising the president, the deputy president, ministers designated by the president, the premiers of the provinces and the executive mayors of metropolitan councils, as well as the chairperson of the south african local government association. this council is tasked with, amongst other things, the identification of any legislation and other regulatory measures that impede or may impede infrastructure development and may advise the executive authority of the relevant sphere of government. along the lines of this research study, a research group could be tasked by this council with analysing the text of the fidpm, cidb prescripts and standards for uniformity, treasury instructions and circulars etc. and with identifying and explaining why certain provisions impede the effective implementation of infrastructure procurement and delivery management practices.1 such an initiative could propose solutions preferably within the confines of existing legislation and have their proposals presented to the picc who can then deal with the issues in terms of their founding legislation. there are positive signs that a solution along the above or similar lines is increasingly aligned with current executive direction. the recently published nip 2050 (department of public works and infrastructure 2022) signals a shift in infrastructure procurement and delivery management policy. this plan is, amongst other things, premised on there being significant capacity development within infrastructure procurement and delivery management, an enabling regulatory and institutional framework, a strategic approach to infrastructure, systems of accountability and a robust asset management system. this plan in recognising the need to strengthen institutions for delivery has identified a number of conditions to be met to achieve the nip 2050 vision including the following: the regulatory framework must enable network infrastructure procurement and delivery. the regulation of scm for infrastructure must enable integrated projects with built-environment professionals playing a significant role. supply chain management for infrastructure must be handled as a strategic function, not simply a financial one. the procurement of infrastructure must be differentiated from that of other goods and services. a strategic approach must be taken to infrastructure procurement. the focus must be on value for money and prioritised over lowest cost. this must include robust cost-benefit analysis. infrastructure procurement and delivery management will be de-linked from centralised purchasing and led by a chief procurement officer and/or high-level office specifically mandated and capacitated with built-environment professionals to procure and deliver infrastructure. infrastructure delivery must be managed as an ‘enterprise’ and not an ad hoc collection of projects. systems of accountability will become aligned with effective infrastructure delivery. conclusion in a context characterised by the effects of the pandemic and a need for economic recovery, as well as pre-existing development challenges, south africa needs to urgently rethink its regulatory environment for procurement in order to enable management practices that can respond to changing circumstances. as we have explored in detail in the above discussion, south africa is currently faced with two major challenges in moving forward. firstly, the current plethora of laws dealing with public procurement which evolved since 1994 have led to uncertainty as to which law is applicable, and inconsistency in the interpretations resulting in an inflexible system which hampers development and service delivery and exposes the state to corruption. secondly, the fiscus has not been able to fund infrastructure at the levels proposed in the ndp (10% of gdp) and significantly less funds are available to fund infrastructure in the wake of covid-19 which has had a devastating impact on the economy. the demand for infrastructure remains. accordingly, infrastructure needs to be delivered more efficiently. our argument that a specific layer of our procurement governance regime – soft law – requires immediate attention is in line with developments elsewhere. other jurisdictions are also looking at their procurement regimes postpandemic. in particular, the uk currently has the opportunity to reimagine public procurement law after its withdrawal from the european union (eu). a prominent procurement law and policy academic, prof arrowsmith, has recently suggested that the uk’s new hard-law regime should shift from ensuring open markets as is the current eu requirement to eight key objectives, namely: value for money, integrity, accountability, equal treatment, fair treatment of suppliers, effective implementation of industrial, social and environmental objectives, opening markets, and an efficient procurement process. arrowsmith then argues that reform should be based on seven principles: an open contracting approach which involves making information publicly available and usable through an electronic system; a single and uniform regime for the westminster jurisdiction; significant legislative simplification involving a shift from hard to soft law; use of familiar concepts, rules and terminology where appropriate; a rebalancing of interests (away from open market objectives towards value for money, sustainability and reduced procedural costs) and a related shift in regulatory strategy to increase flexibility; a more effective and balanced approach to enforcement; and a common framework across uk jurisdictions (arrowsmith 2020). the south african constitution, of course, requires that our procurement system be fair, equitable, transparent, competitive and cost effective, and embraces a procurement policy providing for categories of preference in the allocation of contracts and the protection or advancement of persons, or categories of persons, disadvantaged by unfair discrimination. the procurement system also needs to promote the principles governing public administration embedded in the constitution relating to the efficient, effective and economic use of resources in an accountable and development orientated manner, as well as administrative action that is lawful, procedurally fair and reasonable. these constitutional imperatives resonate closely with key objectives identified in jurisdictions elsewhere. without discounting the role of legislative statutes including the current drafting process towards comprehensive public procurement legislation, this research study has focused on soft law, on such crucial implementation standards, rather than on the more usual materials of legal analysis such as acts of parliament. as detailed, we have demonstrated how a megaproject such as the nup may be both allowed and assisted to be delivered on time and on budget by appropriate soft-law governance instruments within the current less-than-ideal hard law environment. this demonstration is both interesting in its own right and significant for south africa’s current economic objectives. we have also demonstrated that there is a good argument to be made about genuine flaws in current public infrastructure legislation and guidelines. the implication of linking these two findings is that the successful implementation of south africa’s current roster of megaprojects is best served by changing the soft law of public infrastructure delivery. to focus on soft law is both a more straightforward and a speedier process than hard law reform. while there are limitations in our research method – one case study cannot be generalised automatically – we would nonetheless argue that with appropriate soft law reform south africa can quickly improve significantly its implementation of megaprojects, including vitally needed public infrastructure. our case study in the successful delivery of the nup is a contribution to the literature on megaprojects, as well as the broader interdisciplinary literature concerned with the politics of regulating public infrastructure delivery. in this respect, we re-emphasise that our argument in this research study has turned on two key distinctions. the first is the difference between procurement of goods and services and the procurement of infrastructure. the second key distinction is the difference between hard (constitutional, statutory and court-made) law and soft law (standards, guidance, and instruction notes). in this research on the delivery of public infrastructure in south africa, we have found there is a lack of understanding and appreciation of the first distinction in the existing procurement regime and that there is confusion and conflict within the existing governing soft law instruments. there are lessons to be learned for future processes as well. the need to standardise procurement processes, methods and procedures for the procurement and delivery management of infrastructure needs to be done in a generic and flexible manner which supports and does not frustrate infrastructure delivery. this will enable those engaged in a range of infrastructure delivery activities to perform their duties, within the confines of their organisation’s procurement policy, in a uniform and generic manner, enabling procurement documents to be readily compiled in a uniform and generic manner. it also enables curricula to be developed to capacitate those engaged in a range of infrastructure delivery activities and the public sector to readily develop an internal procurement skills base, which is not lost when members of staff move between different departments or levels of government or public entities. acknowledgements we acknowledge the able research assistance of nino rodda. competing interests r.w. was employed by the new universities project. authors’ contributions both authors contributed to the writing and research of this article. ethical considerations this article followed all ethical standards for research without direct contact with human or animal subjects. funding information this research note is adapted from a working paper researched and written as part of the rethinking economic policy post-covid19 project in the faculty of commerce, law and management at the university of the witwatersrand. the funding assistance of the national institute for the humanities and social sciences is gratefully acknowledged. data availability data sharing is not applicable to this article as no new data were created or analysed in this study. disclaimer the views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of any affiliated agency of the authors. references anthony, a.m., 2018, ‘the legal regulation of construction procurement as a relational construct in south africa’, doctoral thesis, stellenbosch university, stellenbosch, viewed 11 may 2018 from http://scholar.sun.ac.za/handle/10019.1/103815. argyrou, a., 2017, ‘making the case for case studies in empirical legal research’, utrecht law review 13(3), 95. 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and construction sector dynamism in the south african economy’, background paper, national planning commission, viewed 3 august 2020 from https://www.nationalplanningcommission.org.za/assets/documents/public%20infrastructure%20delivery%20and%20construction%20sector%20dynamism%20in%20the%20south%20african%20economy.pdf. yin, r.k., 2017, case study research and applications: design and methods, sage, los angeles, ca. footnote 1. the standard for infrastructure procurement and delivery management (sipdm) was crafted as soft legislation which did not conflict with the pfma and mfma and their associated supply chain management regulations. the conflicts have occurred in instructions, circulars and guidelines that were issued following the issuing of the sipdm. 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accepted: 06 sept. 2017; published: 04 dec. 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: with reports of widespread failures in south africa’s land reform programmes, the levels of policy uncertainty in the political rhetoric that influences land reform have been increasing. since 1994 policy targets to transfer land to black farmers have not been met. of the 2005 target to transfer about 25 million ha of commercial farmland to black farmers by 2014, less than 5 million ha. have been transferred for commercial use. some studies report failure rates in resettlement projects of up to 90%. to account for the failures, revisions of policies and amendments to legislations have been proposed within a political environment that is becoming increasingly intolerant to slow progress in land transfers and to resettlement failures. aim: against this environment, this paper presents a typology for understanding and evaluating important elements of the land reform project in order to influence progress in the process. setting: the study adopts a historical review of land reform processes in post-colonial kenya and zimbabwe in order to identify potential challenges and key lessons for south africa. methods: hence, using institutional and historical analytical lenses in exploring different narratives, the paper reviews reported failures and successes in land reform policy cases from the selected countries. from an institutional framework, prevalent social institutions and key lessons from kenya, zimbabwe and south africa, a typology for evaluating important elements of the land reform process in south africa is developed and discussed. additionally, a review of global data collected on average sizes of farms in different regions of the world is provided as evidence to support propositions of what would constitute efficient farmland size ranges for small to medium commercial farms in south africa. results and conclusion: a proposition is made on how to use the typology to guide policy and research interventions to reduce failures and promote successful cases in different areas of the land reform process in south africa, and possibly other similar contexts. introduction land reform programmes in post-colonial africa continue to be challenging as currently illustrated by south africa’s experiences. more failures than successes in reform projects have been reported since 1994. the process to transfer land to beneficiaries in the redistribution programme has remained slow. the plan to create many small family farms is also progressing slowly. in 2005 the revised land reform target was to transfer 30% of land (about 25 million hectares) to almost 800 000 new black farmers. lyne (2014) estimated that by 2014 a total of only 9 million hectares had been transferred since 1994, in both the restitution and redistribution programmes. this means the redistribution programme achieved only less than 20% of its revised 2005 target. fewer than expected claims had been lodged within the restitution programme by 2014. many of those lodged before 2014 remain unsettled. the restitution of land rights bill amendment no. 15 (2014) was enacted to reopen a window for strategic claims to be lodged until 2019. the lrc (2017) reports that of the claims before 2014 about 11 000 remain unresolved. after the 2014 bill, the land commission has already received 12 464 new claims for processing. these trends highlight the challenges faced with respect to land transfers in the land reform project as a whole. moreover, in projects where black farmers have been resettled, there is high number of failures in terms of dropping productivity levels. mbatha and antrobus (2012) reported that more than 50% of such projects had failed. some studies have put the figure at around 90% (cde 2008; the conversation 2016). it is clear that the land reform project requires a more logical and easily understood framework to achieve better results. the aim of this paper is to propose a useful framework for the programme, which is also aligned with the aspirations of the country’s national development plan (2011). based on reviews of land reform experiences in selected countries in sub-saharan africa, of global data on efficient average farm sizes, and of local experiences, a typology to understand different aspects of the land reform project is presented. the typology also provides guidelines for research and policy on areas including progress evaluation of resettlement cases. for instance, the typology illustrates why progress should be evaluated differently in restitution versus redistribution cases. this study is presented as follows: the ‘methodology’ section outlines the methodology adopted for the discussion and a summary of methods used in selected literatures. the ‘literature review’ section reviews historical cases from selected african countries and highlights lessons for south africa. the ‘discussion and proposed typology’ section uses key elements from the reviews and data trends to develop a typology for how research and policy should understand, evaluate and influence different aspects of the land reform programme in south africa. finally, the ‘summary and concluding remarks’ section presents a concluding summary of the study. methodology the primary method used was a review of historical literature on land reform projects in three purposefully selected countries in sub-saharan africa. the land reform histories selected for comparative analyses were from kenya, zimbabwe and south africa. relevant data for validation came from additional african cases, including ethiopia and tanzania. the primary cases of kenya and zimbabwe were selected because: these countries’ land reform projects were characterised by a high degree of similar political upheaval (e.g. mass revolts) in the 1950/1960s and the 1990s, respectively. the lessons were relevant for south africa, whose land crisis is simmering currently. the three countries’ histories are similar in terms of their colonial british rule, with similar laws and policy thinking that shaped both their colonial and post-colonial trajectories. kenya’s transition to a post-colonial state took place two decades before that of zimbabwe; hence, its review formed the basis upon which a historical comparison could be made between the two countries. a sequential list of events from kenya and then zimbabwe was synthesised to establish a lens through which the south african case can be analysed. therefore, this discussion is a comparative analysis of similar land reform projects in selected parts of sub-saharan africa that were british colonies. in south africa, the review had two approaches. a historical presentation of an evolving land reform policy landscape is presented alongside a review of ethnographic cases in two regions (limpopo and kwazulu-natal). the local resettlement data come from cases of sugarcane farmlands of kwazulu-natal (mbatha & antrobus 2012; mbatha et al. 2010), as well as community settlement cases presented by terblanche, stevens and sekgota (2014). throughout the discussion, a reflection on what threads run across the international and local cases is compared for general and specific themes. moreover, quantitative data on global average farm sizes were reviewed from secondary sources containing data from different regions. these data on average farm sizes were collated by lowder, skoet and raney (2016:16–29) from representative agricultural censuses of all farms globally. these include survey data from the programme for the world census of agriculture (wca) collected since 1950 on about 160 countries. for these surveys food and agriculture organization (fao) provides governments with a methodology to be followed. lowder et al. (2016) reported that from 1930 to 1980 the data were collected twice a year, but from 1990, with improved standardisation, it was collected only once annually. for this discussion, historical data that were grouped by geographical region and incomes were used to identify trends by the same variables (region and income) to argue for what would make for efficient average farm sizes in the context of developing countries. other historical reviews of average farm size data in asia from ahmad and quresh (1999) are presented to support selected parts of the discussion. in summary, the paper presents and analyses, for common trends and themes, mostly historical and qualitative data from purposefully selected countries. the paper also presents quantitative data from studies that analyse global data on average farm sizes to propose a range of what would constitute small but efficient farms locally. ultimately the data are used to develop a typology for understanding different historical elements of land reform projects in selected african countries and how those elements would need to be approached to avoid similar challenges from recurring in south africa. the typology is also useful for identifying policy areas that may be replicated for their successes. literature review the review starts off with a presentation of the land reform process in south africa. this is followed by a historical review of kenya’s land reform and lastly a review zimbabwe’s land reform history. key issues are summarised from the kenyan and zimbabwean experiences for lessons for south africa’s land reform project. an overview of challenges in south africa’s land reform process lyne and darroch (2003), centre for development and enterprise (cde 2008), lyne (2014) and mbatha and muchara (2015) provide some of the important economic accounts and analyses of the land reform programmes in south africa since 1994. more sociological accounts and analyses are discussed by neves (2006) and hall (2009). they all present cases of negative effects of racial segregation achieved by the state through apartheid policies founded on the natives land act of 1913. they show that segregation policies ensured that 87% of land was owned by white people with the only 13% in the hands of black people, in what were ‘homeland reserves’ before 1994. logically the effects of unequal racial ownership of resources would cement other inequalities along racial lines. in attempts to redress the effects the democratic government, post-1994, would use three approaches in the land reform project, namely, land restitution, land redistribution and land tenure upgrade. the aim of the land restitution programme (restitution of land rights act (22) 1994) was to return land to communities that were moved forcibly through the land act (1913). after 1994 communities were allowed to lodge land claims until 1998 (neves 2006:200). in 2014 elements of the land restitution process were extended for 5 years to allow for the return of land earmarked for strategic areas including heritage sites and historic landmarks. from this process more than 12 000 thousand claims have been received by the land commission (legal resources centre (lrc) 2017). the aim of the land redistribution programme was commercial in nature and was to facilitate the transfer of land to black farmers for business use through the government grants. this process has also faced challenges in terms of the rates of land transfers as well as poor or failed commercial uses after transfers (see mbatha et al. 2010). the aim of the land tenure reform was to extend security of tenure in former homelands as well as to extend tenure to farm workers and tenants on commercial farms. the approach has also met challenges given conflicting interests of stakeholders. conradie (2007) reported cases where the process to extend tenure to black workers led to them losing jobs. low transfer rates of land, partly blamed on unresolved claims and disputes on land prices for land acquisition in the restitution and redistribution programmes, as well as low productivity rates in land earmarked for commercial uses have characterised south africa’s land reform processes. with respect to land prices, the market systems (willing seller) used to acquire land by government in both programmes have also been challenged. the constitutional principle of compensating land owners at market related prices for land identified for the restitution or redistribution (department of land affairs (dla) 1997; mbatha et al. 2010) has been identified by some as one of the factors contributing towards low transfer rates. this was clear at south africa’s land summit in 2005 where the willing seller framework was under discussion for possible review (mbatha et al. 2010). post 2005, questions on the appropriateness of the framework have remained (if not intensified) in political debates. in the 2013 national address, the south african president stated that ‘we must shorten the time it takes to finalise a claim. in this regard, government will now pursue the just and equitable principle for compensation, as set out in the constitution’ (state president 2013). to eliminate some of these challenges, a number of amendments to legislation have been passed by parliament including the restitution of land rights amendment bill act no. 15 (2014) to accommodate strategic land claims, and the property valuation act no. 17 (2014) to establish just and fair prices through the office of the valuer-general. the developments indicate the complexity of concerns in land reform processes whose details are presented below. by the end of 1998, only 68 000 claims had been lodged with the land claims court. from those claims only 12 623 households had benefitted from about 268 306 hectares in 2000. this was only 1% of total land available for redistribution. the process got some momentum when then state president instructed officials to finalise all pending claims by 2005 (lyne & dorroch 2003). nevertheless many claims still remain unresolved in 2017, especially with the restitution of land rights bill amendment no. 15 (2014) having reopened a window for claims to be lodged until 2019. from the process prior to 2014 about 11 000 claims had not been resolved. after 2014 the land commission received an additional 12 464 claims for processing (lrc 2017). this means that challenges with respect to land transfer rates will remain for some time. of land that has already been transferred many farms are reported to be lying idle. different studies have reported between 50% and 90% of resettlement projects that have failed (cde 2008; mbatha & antrobus 2012; the conversation 2016). these cases are what tuner and ibsen (2000 in lyne & darroch 2003:3) labelled as the ‘new rural “dumping grounds” that were…linked to (no) development process that (offered) livelihoods to beneficiaries’. based on these reports, the primary purpose of this discussion is to propose a typology for intervention to promote success cases in the whole process. lessons from a review of selected farmer cases in a review of south african experiences in establishing emerging farmers the fao (fao 2009) found that implementing and overseeing agencies themselves lacked the required capacity to execute their work. for the redistribution programme, the review proposed that a more rigorous selection was required to identify beneficiaries. incentives to promote performance have to be designed; there has to be better coordination and cohesion among service providers in the land reform process. improved skills on use of technology, finance and farm management and market information are some of the basics required for the productive use of farmlands. successful cases, on the other hand, were characterised by: sound business plans that were developed and owned internally farmers who possessed most of the required skills to execute their own plans an alignment between the plans and physical as well as natural resources available to farmers an access to inputs and output markets farmers who had a voice to shape policy. terblanche et al. (2014) reviewed performances of two restitution cases in mashishimale (limpopo province) and nkumbuleni (kwazulu-natal province). both cases had hundreds of households forming part of each community. in the first case a community property association (cpa1) was established to act on behalf of the community’s interests, while a community trust (ct) was established in the second case. the cpa’s responsibilities were clearly defined with a strong business plan and it appointed skilled managers to run different businesses on the farm. the ct’s responsibilities and functions, in the second case, were not as detailed. the ct appointed a strategic partner to manage business processes on its farms. in the end more successes than challenges were reported for the cpa compared to the ct case. in addition mbatha and antrobus (2012) reported on more than 30 transaction cases under the land redistribution programme in kwazulu-natal’s two district municipalities of ilembe and uthungulu. they found that cooperative partnerships between outgoing and incoming farmers maintained or improved production levels on farmlands in post transfer periods. the partnerships ensured that critical skills and market networks were available to incoming farmers. these cases emphasise the importance of clear plans, boundaries, skills, networks and markets – noted in fao (2009) as attributes for success cases. a review of selected countries in sub-saharan africa the aim of this subsection is to highlight key issues from the kenyan and zimbabwean land reform experiences. lessons from these issues are then used to develop a typology to guide the land reform process in south africa. an overview of the reform process in kenya there are parallels in some colonial events and political trends between kenya and south africa. harbeson (1971) presents a political discussion of specific key events of the period before and after independence in 1963 from the 1950s to the 1970s to propose that the land process was used more to manipulate african politics in the country as opposed to promoting economic development. kanyinga (1996) presents an overview of different policies and their impacts over time, and rutten (1997) highlights some lessons for south africa from the kenya experience, especially on the usefulness of group versus individual tenure. in kenya, like in south africa, there was deliberate alienation of africans for the acquisition of land as preludes to the establishment of a colonial state. ‘through force, the colonial state subdued different communities opposed to land expropriation’ (kanyinga 2016). this resulted in a situation where ‘africans worked on european farms they were not permitted to buy, and europeans and asians operated businesses even if they did not own land in african areas’ (harbeson 1971:231). mamdani (1996) describes how the state’s legislation created reserves for ‘natives’ away from areas demarcated for white european settlers. in south africa, there was a creation of homelands, which acted as reserves for black labour surplus for the white economy on white farmlands and mines (mbatha et al. 2010). these events led to population congestions and land erosion in black reserves, leading to political revolts against the state in both countries. the historical differences in these events are also pronounced. for example, while in kenya there was an active effort by the colonial state to promote private property rights over ‘diffuse collective rights’ including in the reserves, in south africa land rights and control remained mainly under tribal authorities in homelands. this is an important difference to note for this discussion as we explore further points for comparison in selected country cases previously under the british colonial rule in africa. kanyinga (2016:3) and harbeson (1971) argue that the promotion of private property rights to land in kenya’s native reserves was to keep them preoccupied in their holdings while preventing them from participating in revolts against the state. harbeson (1971) further states that the land reform was deliberately used as a tool to counteract the development of african politics especially in rural communities. in south africa the establishment of semi-autonomous governments in homelands as custodians of local tribal authorities may have had a similar effect of keeping black people preoccupied with their internal tribal politics. ultimately, the resulting racial inequalities in terms of land ownership and access between white people and black people in both countries are comparable. in kenya’s 365 000 sq. km, only about 32% (113 920 sq. km) is arable. of this arable land (113 920 sq. km), about 21 360 sq. km (18.25%) was owned and controlled by only 3600 white families, while 6 million black people occupied the remaining 84 000 sq. km (74%) (kanyinga 2016). rutten’s (1997:73) gini-coefficient on unequal distribution of land holdings was 0.77 in 1980. at this time, ‘almost 32% of all rural households (were) estimated as having holdings of less than 1.0 ha of land’. these are huge ownership inequalities but still better than those reported for south africa in 1994, where white people owned 87% of land resources, with only 13% owned by black people (mbatha et al. 2010). harbeson (1971) argues that the land reform processes to reverse the ownership disparities in transition from colonial to post-colonial kenya were political and strategic in nature, crafted to work against the development of african politics. they were also marked by policy trial and errors. to a degree this seems to be the case in south africa too, where ‘the land question’ remains highly political. however in south africa there is yet to emerge a cohesive strategy to deal with the politics of land (lyne 2014). while some policy reforms in kenya worked effectively to reduce political instability, which was a key objective, they did not achieve economy-wide goals of increasing land use for both subsistence and commercial production. some key lessons from kenya are summarised alongside those of zimbabwe after the following subsection. an overview of the land reform process in zimbabwe the reviewed land reform case for zimbabwe is divided into two phases. the first phase was after independence from 1980 to 1990 and the second phase was after the elapse of the lancaster agreement in 1990. overall, political factors, as opposed to economic challenges at farm management level, have had a greater determination on the direction to which the land reform process has gone after 1990. the first period of the reform before 1990 was characterised by a design and implementation of technical policies, with some success stories recorded. the period after 1990 was on the other hand characterised by a politicisation of the land reform process with dire outcomes recorded for the reform process and for the whole economy.2 this appears similar to what harbeson (1971) reported for kenya between 1950s and 1970s. at a political level and under ‘power-sharing’ arrangements, cliffe (2011) presents a sophisticated comparative study of zimbabwe and kenya’s land reform projects. the study illustrates that like in kenya as well as in south africa, the land reform process in zimbabwe had a number of phases with different approaches and objectives stemming from slow progress made and political factors as described by moyo (1986); kinsey (1999); thomas (2010) and others. at independence zimbabwe, like kenya and south africa, inherited high inequalities with respect to land redistribution along racial lines. almost 70% of farmland was occupied by white people and only 23.5% by black people, who formed the majority of the population. white commercial farmers occupied 15.5 of 33.2 million hectares of land while black smallholders occupied only 1.6 million hectares, and the rest was occupied by 750 000 subsistence households. thomas (2010) reports that the average farm sizes of commercial black farmers were a maximum of 20 hectares while those of white farms were as large as 3000 hectares. these are the extents of land inequalities that most african governments have had to contend with after independence. while it is clear that zimbabwe and kenya were characterised by a greater hunger for land by their masses,3 in south africa this attribute has not been dominant so far. the hunger for land led to mass invasions of farms in both kenya and zimbabwe. this has not yet been the case in south africa. the land reform and resettlement programme (lrrp) in zimbabwe began with what seemed like reasonable frameworks and objectives for the 10-year lancaster agreement between the uk and the zimbabwean government. there were clear guidelines on how land would be acquired and used for resettlements as well as objectives for transfer targets. for example, 8.3 million hectares of land was targeted for redistribution to about 162 000 households. for 10 years the land rights of white farmers would be protected with funds set aside for compensations if such rights were abused. the british aid would fund land purchases from willing sellers at market prices. the uk would fund 50% of black farmer settlement costs. compulsory purchases would only be affected where land was underutilised by current owners (thomas 2010). at farm management level, like in kenya, individual rights and smaller holdings for new black farmers were preferred. ninety per cent of schemes had farm sizes of around 6–7 hectares leased to individual farmers, and only 10% were under the collective management of cooperatives. the resettlement programme also dictated what and how much was produced to ensure that high levels of productivity continued in post transfer periods. underutilisation of land would lead to revoking of leases from new farmers. although very few farms were transferred between 1980 and 1989 (i.e. 2.1 of 8.3 million hectares) there were reported cases of success in the programme. to a degree, the lessons of success in zimbabwe before 1990 mirrored those reported for kenya. moyo (1986, 2000) and thomas (2010) reported on some of the internal political factors that led to failures in the resettlement programmes after 1990. the factors included a lack of willingness to sell by white farmers stemming from burgeoning land prices as well as measures to contain an increasing budget deficit by fiscal policy. externally, the effects of trade liberalisation on agricultural output which formed part of structural adjustment reforms promoted by institutions including the imf appear to have had the most negative impact on zimbabwe’s land reform project. under trade liberalisation programmes, the removal of import trade barriers meant an increase in relative local farming costs especially for small black farmers who were forced to shut down. imf’s insistence on cutting government spending also had an effect on the level of support given to emerging farmers. after 1990, with low land transfer rates, the government changed its approach to the reform process to ensure that land acquisition targets were met through the land acquisition act. in this second phase, compulsory acquisitions with little compensation were instituted. in the lrrp, farms from absent land lords, underutilised farms and those owned by farmers with more than one property were identified for redistribution at low compensation. the international donor community and the uk government did not support the new approach and without external support for internal spending the zimbabwean economy collapsed (thomas 2010). while a number of factors outlined in the lead up to the macro-economic collapse after 1990 seem technical in nature, they cannot be separated from the country’s politics, as was the case in kenya (harbeson 1971). it must be noted that while there have been great losses reported for zimbabwe’s economy, there have also been emerging reports of social gains, especially around improved land access and social justice for a large section of the population (e.g. scoones et al. 2010). to evaluate the net effects of the country’s key reforms, future studies would have to estimate and weigh overall reported costs against benefits. this discussion is deliberate (with limitations) in focusing mostly on technical factors and their impacts at macro-economic and farm management levels. such factors, without telling a complete story, are singled out purposefully to draw out useful historical lessons for comparative analyses across the three countries. below a synthesis of key lessons from kenya and zimbabwe is presented for possible lessons for south africa. key lessons from kenya and zimbabwe the kenyan and zimbabwean land reform projects provide general and specific lessons which are useful for noting in south africa: in kenya it was shown that acquiring huge loans, from institutions like the world bank to purchase farms for the land reform project may not be a sound option without effective plans on how new farmers would contribute to the government’s servicing of such loans (harbeson 1971; kanyinga 2016; rutten 1997). in zimbabwe, the overreliance on international donors for the land project and the general public funds within the structural reform programmes proved catastrophic for the economy in the end. an appropriate mixture of individual or group ownership rights in kenya could be used where there were clearly defined desired effects and objectives for each choice (rutten 1997:71). in zimbabwe more emphasis was put on individual management and ownership of land (i.e. 90%) versus 10% of cooperative ownership. nevertheless both models could work with clear definitions and guidelines. linked to the previous point, land reform schemes should not cater only for economic activities but should satisfy other needs, such as social justice, around land ownership by the majority of the population. it is true that livelihood activities do not and should not only relate to agricultural production, but other economic activities that would improve social welfare.4 a similar point to this one is highlighted in section four for south africa in discussions of other possible sociological uses of land that should also be permissible, especially in the restitution programme. the demand and ownership of land by as many people as possible in kenya, over and above efficiency considerations, also contributed to smaller farms being owned by individuals -not in excess of what is globally considered big farms (i.e. 20 hectares) (lowder et al. 2016). the zimbabwean case supported a similar conclusion indicating that smaller farms (about 6 to 7 hectares) especially in the 1980s were more efficient in terms of utilising available land resources. it is also noted that while farms tend to be smaller in east africa where there is more demand for land by the population, in southern africa farms owned by black people are slightly bigger. nevertheless the average size range for efficient land use seems to be between 2 to 5 hectares, depending on factors including actual demand for land, climate, the type of production, technology (as we see later for asian cases), etc. in both kenya and zimbabwe evidence shows that big farms tended to be underutilised. the kenyan story shows that there has to be incentives for resettled farmers to keep their units productive, for example, through requirements to share settlement costs with government. in zimbabwe the threat to evict non-performing farmers was used to ensure continued productions in the 1980s. in kenya, collective owners could hire farm managers to supervise production with owners sharing profits. this seems to have also been successful in selected south african cases. in both kenya and zimbabwe where politicians, government officials or the elite acquired farmlands, the land was often underutilised and this is a lesson to be avoided in south africa. in kenya and in south africa, it is shown that legally defined rights to own land (as a group or individuals) lead to better economic land usage than diffuse ownership rights. collective farms are best suited for meeting subsistence farming and the general population hunger for land access. in south africa subsistence farming seems more applicable to restitution than redistribution cases. in kenya, smallholders would often need off-farm incomes to support their farming businesses. this should be recognised and planned for in south africa especially where land is used mostly for subsistence farming and other sociological reasons. the challenges presented by the willing seller framework in zimbabwe have already been identified as contributing towards slow land transfer rates in south africa. a distinction between the willing seller framework and compensation at market prices still needs to be made. the two concepts present separate challenges and they should not implicate each other. in zimbabwe failing to pay market related compensation presented additional political challenges to land reform projects. finally, the zimbabwean case, especially, showed that the success or failure of land reform programmes also depends on external economy-wide factors as well as international variables. hence the management of the economy as affected by international factors will also have a bearing on how the land reform process unfolds in south africa. growing levels of joblessness and decreasing economic opportunities in secondary and tertiary sectors could increase demand for farms. this will put further strain on land reform projects which are already struggling to succeed. discussion and proposed typology the issues identified in the preceding reviews inform the discussion aimed at developing a typology to understand holistically the land reform process in south africa. the typology is also useful for identifying areas for policy intervention to achieve better results at improving land transfer rates and agricultural productivity. as indicated already, the main challenges in south africa’s land reform project have two tiers: (1) the low transfer rates for both restitution and redistribution programmes, and (2) the underutilisation of land in post transfer periods. issues around the subdivision of farmlands, subsistence and commercial uses of land cut across the two tiers of challenges. a comment was made by lyne (2014) and in the mail and guardian (2015) that the land and agrarian reform project (larp) now: proposes that government would … be responsible for purchasing and sub-dividing the land into smaller plots,5 selecting the right tenants with demonstrable skills to farm productively, leasing the land to selected communities or individuals, monitoring their performances, evicting non-performers…those who succeed commercially would be given an opportunity to purchase the land at market value. (p. 12) this is a positive development in policy thinking and seems responsive to many research questions raised over the years. although challenges still remain with respect to the specifics, for example, around the lack of coordination in implementing such objectives, the lack of tradable ownership rights after subdivisions and allocations have occurred and the lack of models on business management under collective versus individual access or ownership. to these, lyne (2014:4) reported that about: twenty hectares of land, on average, were allocated to a household during the (larp) process. that land did not translate into family-owned farms or businesses; the majority translated into community trust owned or operated farms with obscurely defined property rights. those rights have been in the form of voting and benefit rights in such trusts or community property institutions. and therefore incentives for doing business through investing time, money and effort in farming under such institutional arrangements have been compromised. (p. 4) these mean that challenges would persist in preventing successful land transfers and productive land uses, especially in redistribution cases. given the status quo this section presents a typology that brings a higher level of clarity and cohesion in the process of acquiring and allocating land appropriately to different types of land reform beneficiaries in restitution and redistribution programmes. the framework is also useful for evaluating and analysing progress for the effective use of appropriate incentives. it also provides guidance on how land would be subdivided, owned, managed and used by groups or individuals for subsistence, commercial farming and other sociological uses. a typology for managing the land reform project for economic benefits in south africa although points are made about other possible sociological uses of acquired land by communities and individuals in post transfer periods, specific attention is given to the second tier of challenges that have been outlined in preceding sections. those relate to reported underutilisation of agricultural land in resettlement cases. the limitation of the typology presented is that it does not give guidance on how land can be used for other sociological or economic purposes outside agriculture – and specifically crop cultivation. nevertheless, from policy making at a national level to productive activities on land, the motivations are made in the typology for inclusion of logical thinking to promote effective: land ownership and management in terms of appropriate property rights subdivisions of land for a variety of land uses dis/incentives to promote desired and stated objectives on land use public policy coordination. beyond the land reform process, this framework also informs the character of a ‘capable and developmental state’ espoused in chapter 13 of the national developmental plan (2011). among others, such a state should demonstrate: institutional competence with low transaction costs; embedded, autonomous and competent bureaucracies, well defined property rights, compatible incentive schemes investments in people, skills, technology and innovation. building from our earlier research (mbatha & muchara 2015) the current discussion acknowledges the importance of understanding the different types of land uses that may be promoted under different types of ownership rights available to land recipients, and summarised in table 1. table 1: land rights ownership and use continuum. a continuum of land ownership rights it is illustrated that on the one extreme, undefined ownership rights would most likely lead to poor land management in line with the tragedy of the commons thesis (hardin 1968). somewhere in the middle, collective or communal rights would support a mixture of subsistence and commercial or competitive use of land. from the table the promotion of clearly defined rights to own or use land is foundational to successful land protection and thereafter commercial use. this was also observed as a limiting factor in the development of land markets by lyne (2014) referring to the larp. this discussion also acknowledges that while most restitution cases have involved community groups and would most likely lend themselves to collective ownership rights, redistribution cases with commercial objectives should lend themselves to individual ownership rights. this however is not a rule cast in stone. there could be individuals laying claims under restitution and vice versa. nonetheless a policy decision to support and develop clearly defined – even if varied – ownership rights to groups or individuals is advocated strongly for successful land reform projects. without clarity of what rights are permissible under traditional systems, collective management systems and individual ownership, many land reform projects cannot be successful. there are also different types of land ownership associated with different types of rights (table 1). without rights to access or use of resources, no group or individual can claim true ownership of resources. at one extreme, in african traditional systems households normally have access rights to land use while the traditional leader is the custodian of the community’s ownership rights. the understanding is that chiefs would sanction other legitimate sociological uses on land, for example, including clan gatherings for warship purposes (neves 2016). in land reform projects traditional leaders should be granted collective ownership title deeds to specified land areas by the state. the leader in consultation with his subjects would then make long term strategic decisions on how land resources are used. the restitution programme especially should be equipped in designing models for how traditional communities would own and use land collectively and fairly (ostrom 1992). some ownership models already exist, for example, community trusts that own businesses such as mines. the models could be adapted to land reform projects. ownership regimes could range from traditional to group (or collective) systems (e.g. community trusts) to individual private property rights. while both the restitution and redistribution programmes would deal with any of these types of land ownership regimes (or combinations thereof), it should be anticipated beforehand that traditional and collective ownership systems would mostly arise in restitution cases (e.g. cases in terblanche et al. 2014). individual land ownership rights on the other hand should be anticipated in redistribution cases. in redistribution cases it is up the state to subdivide land for efficient agricultural economic usage.6 this should be the case even if it is a traditional community that acquires redistributed land through public funds. as noted by lyne (2014) the subdivisions in redistribution cases should enable the development of land markets. such land should always be used commercially irrespective of whether it is owned or leased to a community or an individual. while the land is under lease occupants must be monitored for performance and appropriate incentives should apply them to promote full utilisation of land. operational principles for collective bodies where land resources are owned collectively (e.g. cpa), it is important to note ostrom’s (1990, 1992) principles in their establishment and operations. this would be done to avoid their misuse and mismanagement. she advocated among other things that (1) boundaries (physical, legal, etc.) are defined clearly, (2) governance rules match local needs and conditions, (3) those affected by rules should have power to change the rules and these powers should be respected externally, (4) members must have an acceptable system to monitor one another, (5) there should be graduated sanctions for rule violations, (6) resolution of disputes must be easy, cheap and accessible to members, (7) responsibility to govern resources must be nested in the whole system. these principles should apply to production decisions and business management (e.g. profit sharing in collective entities – including traditional systems for business sustainability). land ownership versus land/business management land can be owned and managed by the same person or group of recipients in both the restitution and redistribution programmes and under collective or individual rights. however, this should not be a rule cast in stone. ownership of land should not imply farmland management by the same entity. the kenyan experience presented cases of successful land owners hiring skilled on-farm managers leading to effective productions. south africa already has cases where groups of land recipients under the restitution programme, represented by cpas, have hired skilled managers of businesses while the cpa with community members make only long term strategic decisions(e.g. how the land should be used). in those cases the roles of owners are separate from those of managers, given the required set of skills for different business tasks (terblanche et al. 2014). different aspects of business management along the supply value chain can also be allocated to different managers based on the best skills available. the long term strategy of the cpas should then include developing critical business and other required skills among land recipients to insource task performances whenever possible.7 the role of extension services is critical in building such skills. land uses in restitution versus redistribution cases in restitution cases involving communities, the collective would normally make decisions on how they would use their land assets through the cpa. in traditional communities, an appropriate traditional system would apply. at a policy level, information and data on many use options, including commercial business options, should be made available to all recipients for them to make decisions that would improve their welfare. neves (2006) discusses many other valid land uses which may be non-commercial in nature, including using different portions of land as burial sites, places of warship and community gatherings, nature conservation, etc. these activities should be acknowledged and valued equally to commercial uses (agricultural and others) of land by researchers and policy makers in restitution cases. when communities decide to use their land only sociologically in restitution cases this should not imply case failures. communities may not necessarily have commercial aspirations for their land resources. this needs acknowledgement by policy, even if such sentiments may not seem aligned with the attributes of a developmental state,8 whose main objective could be economic empowerment. access to land for warship, for example, and social justice are also valid enough motivations for land reform as reported in some zimbabwean cases. nevertheless land uses in restitution cases could also be a mixture of sociological and commercial activities. it could also be a mixture of subsistence farming alongside commercial farming. but when public funds are used to acquire land it is the responsibility of a developmental state to dictate how the land is subdivided and used productively to improve socio-economic welfare. different types of incentives to promote productive use of land should also be designed when public funds are used in restitution or traditionally owned areas. other community assets should be identified for surety in cases where public funds are lost because of non-performance in commercial agricultural ventures. the guiding principles should be for public funds not to be invested: (1) without guarantees of performances and (2) without incentives in place to promote performance. land uses in redistribution cases should be clearer. the main objective of the programme is to promote commercial use of land. the larp has put in place a framework to select potential black farmers who are likely to succeed commercially. when farmers are not performing commercially they would be evicted and those who perform would be given a chance to purchase the land at market value. the level of production and commercial success form part of an evaluative framework, irrespective of whether the land is owned by a group or an individual. ultimately, the production level should be such that farmers are able to meet their monthly contributions in land purchases. a framework should be developed for when it can be accepted that farmers are not performing at the right level or have defaulted. less stringent conditions may be adopted compared to measures used by commercial banks. nevertheless, the selection and evaluative process that may lead to farmer evictions would work best when farmers hold individual rights to land. this is why it should be the norm for redistribution cases to adopt individual land leases or ownership, even when the land was originally acquired by a group. in cases where a community is purchasing the land, different types of incentives can be designed to promote performance and accountability. non-performance at a community or individual level should not be rewarded. farmland subdivisions for productive activities the following discussion acknowledges that (1) although the subdivision of agricultural land act (1970) was repealed in 1998, it remains effective as instructed by the constitutional court in 2008 until new guidelines are provided by the legislature, and (2) reviewed data indicate that there is a range somewhere between two and five hectares of acceptable farm sizes. on average, sizes below 1 hectare seem to be poverty traps (fao 2015). sizes of 2 hectares seem to be a global convergence for productive capacity. five hectares seems like the ceiling and reasonable norm for efficient small farms especially in countries where farming is not technologically intensive. for different types of production systems, there would be different points where diseconomies (appendix 1) start creeping in given factors including deteriorating quality of oversight and management of increasing input resources, including the management of increasing labour resource units. so, although there is theoretical and empirical support for smaller farms, this still does not mean however that any small size farm would be efficient, as illustrated for cases of farms smaller than a hectare and characterised by the high levels of poverty reported in some east african countries (fao 2015). in those countries it is mainly the hunger for scarce land resources and big populations that determine farm sizes, not efficiency considerations. this discussion does not advocate the types of small farms that are not efficient and that are associated with poor living conditions. in any case a guideline for what farm size would make for the most efficient farm on average, cet. par., is important. historically, and from theory and empirical evidence, the ilo and other development agencies have promoted the idea that smaller farms outperform bigger ones (harbeson 1971; kanyinga 2016; lowder et al. 2016; rutten 1997). this thinking also informed kenya’s policy to promote smaller subdivisions of farmlands for more efficient household productivity. in the review of zimbabwe and south africa’s land reform, arguments for smaller farms are also supported, for efficiency and the promotion of land markets (lyne 2014).lowder et al. (2016:16–29) present data of about 150 million farms globally showing that average farm sizes have converged towards just under two hectares in the last five decades. their data set contains sub-saharan african and high-income countries contributing 9% and 4%, respectively, to total number of farms. there are indications that farm sizes in high-income countries have always been smaller than two hectares while in former colonies average farm sizes have declined dramatically since the 1960s, most probably with land reform projects ensuring more equitable land distributions. these trends are illustrated in figure 1. farm sizes are smaller in developed countries most likely because of they use more technology. figure 1: average farm sizes, 1960–2000. of the high-income countries, australia presents opposite trends where average farm sizes increased from less than 2000 to over 3000 hectares between 1960 and 2000 (lowder et al. 2016:23). in south africa farm sizes have also remained larger than the global average, with medium scale commercial farms between 55 and 216 hectares (lyne 2014:5). with the subdivision of agricultural land act of 1970 still effective this is likely to remain the case for a while. in any case, 85% of farms globally are smaller than two hectares, and only 6% are bigger than 5 hectares. based on these trends it would be reasonable and risk adverse to advocate for the floor size of farms to be around 2 hectares and for five hectares to be the ceiling of small efficient cultivation farms.9 the decision on where in this range efficient farm size subdivisions could lie in south africa would also depend on factors including, the type of crop cultivation considered, climate conditions, water availability, technology use, etc. these factors should guide broadly the subdivisions of land in redistribution projects or other projects where communities display aspirations to farm commercially. given these broad guidelines, each business case would still require more in-depth research for more accuracy in determining the most appropriate unit sizes. what should be clear from evidence is that australian and south african farm sizes are out of synch with global trends in both lowand high-income countries. they cannot be used as guides for how farms should be subdivided for black economic empowerment in agriculture. this is an important point to stress for south africa given the country’s history of adopting a number of natural resource management policy models from australia in the last 20 years, for example the integrated water resources management framework (madigele, snowball & fraser 2015). incentive schemes for promoting production by a monitoring and evaluation body the proposed typology, with the required human infrastructure, cannot design, establish and execute itself. therefore an overarching and coordinating body would be required to implement and manage it. in this light, some of the principles from ostrom (1990, 1992) that were outlined for managing common resources sustainably would be useful. the coordinating body should encourage the productive use of land by groups or individuals in redistribution cases through appropriate incentive schemes. this should include providing farmers with support in terms of skills, networks, markets, etc. the body should ensure that agricultural extension services are the centre of skills development and provide not only practical farming skills to beneficiaries, but also skills to run successful businesses, networks, and skills for interpreting the land reform policy landscape. through appropriate disincentives the body should prevent poor performances and take action against defaulters. the body should work at national and local levels with coordination, monitoring and evaluation functions performed by qualified experts. it is noted that some of these responsibilities are already stated as aspirations in the land reform strategic plan (lrsp) (2015–2020) of the department of rural development. some of the functions have been assigned to the valuator general in the property valuation act no.17 (2014). it would therefore make sense to locate the body in the office of the valuator general. summary and concluding remarks the framework proposed in this discussion is primarily an analytical and guiding tool for understanding and supporting various types of land reform projects. it is a tool potentially useful for policy formulation and implementation as well as for research. its key elements are depicted in figure 2, showing potential responses to questions that normally arise at different stages of implementing and evaluating land reform projects. for example, before an evaluation of whether or not a land resettlement project has been a failure one would need to first know whether or not the project in question was a land restitution or redistribution case. if it was a redistribution project, then a different set of expectations and guidelines would apply with respect to (1) what kind of ownership rights should be promoted by state agencies in that project, (2) and for what purpose the land resources in that project should be used, (3) how the land should be managed, (4) how it should be subdivided and demarcated, etc. figure 2: typology of guidelines for land reform projects. if the land project in question falls under the restitution programme, then how the land is used after resettlement would depend more on the wishes and aspirations of new owners. for such projects it must be remembered that many other sociological uses are possible beyond economic and agricultural ones. figure 2 illustrates some examples of land for such projects. it is also possible that portions of land under restitution projects can later form part of empowerment programmes for economic benefits, whether those are agricultural or not. in those instances land portions for economic uses should be clearly demarcated and managed like a redistribution project between its owners and the state. the terms of how farming units are subdivided and envisaged businesses are managed, should be evaluated using criteria similar to those used for redistribution purposes. in this sense, the typology provides guidelines for responding to potential questions in the course of implementing land reform projects. it is a guide that should be used with careful consideration in different contexts. it should also evolve with more lessons over time. given that many other competing and growing economic uses of land resources are emerging; for example, environmental protection and tourism, it is important to note that for different uses different versions of this typology would have to be conceptualised to guide practitioners and researchers in implementation and evaluation. acknowledgements competing interests the author declares that he has no financial or personal relationships that may have inappropriately influenced him in writing this article. 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24(4), 691–712. https://doi.org/10.1080/0143659032000105821 appendix 1 figure 1-a1: economies and diseconomies of scale. footnotes 1. ‘the cpa is a legal body though which members of disadvantaged communities may collectively acquire, hold and manage property in terms of a written constitution’ (dla 1997:51). 2. while all zimbabwean experiences (positive and negative) are useful for south africa to learn from, it also appears that most of the positive experiences for potential policy emulation are those experienced before 1990 in zimbabwe. 3. especially in east african countries, such as ethiopia, growing populations and high demand for land have contributed to allocations of smaller and unsustainable farms (fao 2015). 4. this is an important point to stress that even though the focus of the present discussion is limited mostly to land reform objectives aimed at improving agricultural productivity, additional opportunities exist outside the agricultural sector, for example, in mining. those need to be explored in a similar and systematic fashion as done in the current discussion. 5. it must be noted that the subdivision of agricultural land act (1970), founded on the idea that smaller farms are not economic, prohibited moves to subdivide agricultural land into smaller units. although the act was repealed by the subdivision of agricultural land act repeal (act 64 of 1998) it remains effective until the legislature ‘chooses definitive course of action’, – instruction from the constitutional court in 2008 (frantz 2010). 6. in the current discussion economic use is limited mainly to agricultural land use, even though it is acknowledged that economic uses of the land could and should be open to a wide range of other uses for social benefits. promotions of other efficient economic uses, other than agriculture, would however most probably require different approaches and typologies to be developed. 7. these proposals are meant to assist current and future cases in the land reform process; however, their practical application should not exclude past cases wherever possible, especially where reforms have been a failure. it would be expected that each one of the past (and failed) cases would have their own dynamics which would or may require different steps and legal considerations to resolve and bring update. finding workable and context specific solutions to past cases that went wrong need to be done. 8. nevertheless, within a developmental state approach efforts to inspire and guide beneficiary communities to becoming productive and self-reliant should always be made through varied skills development programmes including through extension services. a more self-reliant citizenry would also imply a decreasing burden on the fiscus. 9. most definitely farm sizes below 2 hectares, although prevalent may be too risky and not economically and politically sustainable given the farming conditions described in fao (2015) for such farms in low-income countries including ethiopia and kenya. abstract introduction location of burns and stalker’s ideas in management and organisational fields burns and stalker’s works: theoretical foundations conceptualisation of organisational structure and structural variables theoretical framework presenting burns and stalker’s propositions external (macro) environment as an independent variable methods results discussion conclusion acknowledgements references about the author(s) ntandoyenkosi sibindi international business and trade, african leadership university, kigali, rwanda olorunjuwon m. samuel school of economic and business sciences, faculty of commerce, law and management, university of the witwatersrand, johannesburg, south africa citation sibindi, n. & samuel, o.m., 2019, ‘structure and an unstable business operating environment: revisiting burns and stalker’s organisation-environment theory in zimbabwe’s manufacturing sector’, south african journal of economic and management sciences 22(1), a2113. https://doi.org/10.4102/sajems.v22i1.2113 original research structure and an unstable business operating environment: revisiting burns and stalker’s organisation-environment theory in zimbabwe’s manufacturing sector ntandoyenkosi sibindi, olorunjuwon m. samuel received: 21 sept. 2017; accepted: 29 aug. 2019; published: 10 dec. 2019 copyright: © 2019. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: turbulent socioeconomic contexts coupled with volatile political environments pose a serious survival threat to business organisations. complex operational environment of this dimension most often resists application of conventional management theories and practices. organisational managers are therefore constantly challenged to adopt contingency strategies that will not only keep their organisations afloat, but also entrench competitive advantage that could effectively sustain operations. aim: to update burns and stalker’s theory on structure and business environments. setting: the dynamics of the zimbabwe’s economy has assumed an extraordinary proportion of complexity due to intractable political instability and hostile economic environment. methods: using a survey research design and employing quantitative research strategy, this article examines the underlining propositions that defined the seminal work of burns and stalker regarding strategy adoption by organisations in a dynamic operating environment. primary data was collected from 189 randomly selected managers in 350 manufacturing firms operating in zimbabwe using a structured questionnaire. data were analysed using structural equation modelling. results: the major finding of the present study suggests that firms adopt a hybrid structure when confronted with an unstable operating environment. conclusion: the finding is inconsistent with that of burns and stalker, who concluded that firms adopt organic structure in an unstable operating environment. while burns and stalker’s study was conducted in a relatively stable socioeconomic context, the present study was conducted in an operating environment that is characterised by turbulent socioeconomic and political instability. these environmental divergences could have influenced the outcome of both studies. keywords: burns and stalker; competitive advantage; contingency approach; organisational structure; mechanistic structure; organic structure; political instability; underdeveloped economies; unstable operating environment. introduction zimbabwe’s business operating environment has been characterised by extremely volatile circumstances. it has been described as the most unstable environment outside a war zone (moyo 2010). the inconsistency of policies has resulted in the unstable socioeconomic situation that makes it difficult for businesses to operate. the major challenge posed by the scenario described above has necessitated the need for businesses to structure themselves in order to survive the hostile operating environment. organisational and management literature is dominated by the seminal works of burns and stalker (1961) on how businesses can structure themselves in different operating environments (daft 2001, 2013; griffin & moorhead 2014; robbins et al. 2011). responding to environmental changes in the 1960s as a result of technological and market forces, burns and stalker (1961) developed two propositions on how organisations should structure themselves in order to mitigate the impact of the emerging changes. starting from the open systems approach to organisations, burns and stalker proposed that in stable operating environments, organisations should adopt a mechanistic structure and, conversely, in unstable environments, it is best for organisations to adopt an organic structure. the current study is interested in the second proposition by burns and stalker which has received empirical support by other studies (sine, mitsuhashi & kirsch 2006) conducted in turbulent and uncertain economic environments in the united states of america and the united kingdom. a research gap has therefore emerged for burns and stalker’s propositions to be empirically verified in a highly unstable and uncertain operating environment such as zimbabwe. mechanistic structure finds its origin in the works of weber (1947) and is defined by its characteristically low complexity, high centralisation, high formalisation and high stratification. on the other hand, an organic structure is highly complex and has low formalisation, centralisation and stratification (burns & stalker 1961; etzioni-halevy 2010; hage 1965). the post-world war ii (1946–1970) economy in europe in general and in britain and scotland in particular experienced government’s initial reduction and subsequently removal of defence contracting thus exposing most firms to competition (miner 2006). these environmental changes inevitably necessitated the need for firms to devise a competitive way of surviving. it was against this background that burns and stalker (1961) conducted their seminal study which sought to determine the best structure that organisations could adopt in a dynamic operating environment. burns and stalker’s work was further influenced by the open system approach of organisations and the emerging contingency theory (miner 2006). this influence was accentuated by the apparent inability of both the classical and scientific management and human relations theories to resolve the complexities occasioned by environmental changes (ashton, hopper & scapens 1995). the failure of these theories thus led burns and stalker to seek explanation for the influence of external environment on organisational design. this was an attempt by the authors to adopt a macro approach, rather than the predominant micro structural approach by sociologists (miner 2006). the study concluded that the ‘the utility of the notions of mechanistic and organic management systems resides largely in their being dependent variables to the rate of environmental change’ (burns & stalker 1961:103). environmental change in this context refers to the technological bases of production and market situation. this change has therefore defined the nature and pace of contemporary business environments as distinct from factors that drove operating environments in the early 1900s. fundamentally different from technological and market orientation factors are prevailing profound political, economic, social and legal environments that have variously combined to define the environmental change in which organisations operate in underdeveloped economies such as that of zimbabwe. in a volatile business environment such as zimbabwe, businesses need to innovate and survive, to adapt and develop. for more than four decades the works of burns and stalker have offered a framework for businesses to achieve this. the notion that organisational design depends on the environment has guided the contingency thinking based on the finding of burns and stalker. with the growing technology and other forces at play, the environment has become more complex than that of burns and stalker’s time. this calls for a development of a new framework of organisation and development for businesses. works building on burns and stalker’s framework are intended to pave the way for a more recent multiple continua model that explains the effects of the complex environment on organisational design. such a call was made as far back as 1982 by hull and hage (1982). to our knowledge such a call has not received scholarly attention. burns and stalker’s work was qualitative in nature and that limited the applicability of their findings in certain ways. one noticeable limitation that is generally associated with quantitative studies is the problem of generalisation of knowledge produced (bryman & bell 2011; yin 2004). burns and stalker’s study was conducted on 66 electronic firms in britain and scotland five decades ago and might not be generalisable in contemporary economies, and most particularly in an extremely unstable and volatile operating environment like that of zimbabwe. this methodological limitation coupled with environmental dynamics provided motivation for the present study. the study is aimed at extending the scholarship of burns and stalker by using a quantitative research strategy (bryman & bell 2011; creswell 2014; yin 2004) within the context of an underdeveloped economy. this is predicated on the strengths and ability of quantitative research findings to be generalised to other contexts beyond the primary research setting (bryman & bell 2011; cresswell 2014). furthermore, this study, unlike that of burns and stalker, cut across different firms in the manufacturing sector and, more importantly, investigated independent variables beyond market and technological factors to include socioeconomic, political and macroeconomic factors. the problems of contextualisation and limitations associated with burns and stalker’s study as articulated in the preceding section has led to the following operational research question: considering zimbabwe’s volatile socioeconomic and political operating environment, can the same conclusion by burns and stalker regarding the relationship between organic structure and unstable operating environment be arrived at? this is the autopsy that guides this article. using a quantitative research strategy, it is envisaged that this article would incrementally extend the scholarship of burns and stalker on the relationship between organisational structure and unstable operating environments. location of burns and stalker’s ideas in management and organisational fields the works of burns and stalker have far-reaching influence in both management and organisational fields. textbooks and journal articles are awash with different presentations and interpretations of burns and stalker’s ideas. mainstream textbooks that have presented burn and stalker’s ideas include organisational theory and design (daft 2001), organisational behaviour (robbins 2003) and management and organisational behaviour (mullins 2005). daft (2001) presented burns and stalker’s ideas as an option between two alternative structures: mechanistic and organic to fit either stable or volatile environments. robbins (2003) and mullins (2005) echoed the same sentiments as daft and concluded that burns and stalker’s ideas are a framework to guide organisations and management practice in the two alternative environments. it is interesting to note that the environments are either stable or volatile and no suggestion is made of a moderate environment. the mainstream textbook presentation of burns and stalker lacks insights into the relations among structure, human agency and environment. it is in this vein that this article considers structural variables that have elements of human agency: complexity, formalisation and centralisation (employee involvement, attitudes and participation, etc.). a handful of textbooks has, however, seen the works of burns and stalker beyond compatibility between structure and the environment. pugh and hickson (1976) considered the complications of switching from a mechanic structure to an organic one. the scholarship of burns and stalker as presented by leading journal articles over the last 50 years (human relations, administrative science quarterly and journal of management science) is not different from the mainstream textbooks. it gives a formulaic outline of burns and stalker’s ideas and concludes that the theory is conceptually straightforward (lawrence & lorsch 1967). contemporary scholars such as lewin and volberda (2003) have upheld these interpretations of burns and stalker’s ideas. burns and stalker’s works: theoretical foundations to contextualise and consolidate the conceptualisation of burns and stalker’s ideas, we discuss the theoretical foundations of their ideas. we consider the prevailing thoughts and approaches to management and organisational fields, the parameters that determined their rapidly changing and stable environments and the broader external environments that influenced their ideas. the works of burns and stalker emanated from sociological perspectives. sociologists concluded that members of a firm retain latent social identities that are different from the rational needs of the firm. the rational needs of a firm include relational networks (miner 2016). this approach acknowledges the complications of including and determining the influence of human agency in organisational structures. contemporary management and organisational theory attempts to match societal and organisational identities to achieve organisational goals (clark 2001). this is the approach we take in this article. the external environment of burns and stalker was influenced by the shift of postwar policies in britain and scotland. the change from government protection to a free market resulted in new management practices to make firms competitive. the rapid changes in the environment that underpinned burns and stalker’s ideas were therefore influenced by postwar policies. furthermore, the concept of rapid changes in the environment was at industrial level rather than macro level. the technological changes in the electronic firm accelerated the pace of change in burns and stalker’s formation (clark 2001). on the other hand, in the zimbabwean context, the environmental changes were hyper in nature and beyond industrial level. the theoretical foundations of burns and stalker’s ideas were therefore not driven by the hyper instability faced by firms in zimbabwe. beyond how to structure organisations in a rapidly changing environment as embodied in burns and stalker’s ideas, there is a lack of a theoretical framework on how firms can structure themselves in a hyper unstable situation. by considering burns and stalker’s ideas in an environment like zimbabwe, we hope to inspire a theoretical framework that informs practice on how to organise in a hyper unstable environment. conceptualisation of organisational structure and structural variables the body of knowledge underlining what organisational structure is has originated differently. theoretical studies of weber (1947; weber, roth & wittich 1978) and urwick (1956) conceptualised organisational structure from a bureaucratic perspective. such an approach was criticised for its lack of empirical support; it thus remains a conceptual model (meier & o’toole 2006). furthermore, weber’s and urwick’s theoretical concepts also failed to consider important informal organisational elements such as human relations, leadership, communication networks and motivation (hummel 2007). in order to remedy the pitfalls of the bureaucratic school of thoughts as represented by weber and urwick, the functionalist movement adopted the case study approach which provided empirical evidence to establish organisational structure within the context of contingency theory (clegg, kornberger & pitsi 2005). the functionalist perspective is identified with the works of blau (1970), woodward (1980) and the aston group (pugh & hickson 1976). the work of the functionalist group focused preliminarily on organisational process rather than the structural characteristics of organisations themselves. however, notwithstanding the empirical establishment of organisational structure by the functionalist movement, their efforts also suffered from lack of external validity, which is often associated with case study research (yin 2004). the theoretical importance of organisational structure is predicated on its ability to deal with uncertainties and rapid changes that pervade the operating environments. these dynamics are conceptualised within the precinct of contingency theory. it has been argued that ‘contingency is something that managers cannot avoid’ (clegg et al. 2005:125). the contingency theory premises its argument on the notion that organisations are unable to structure themselves. the optimal way of organisational structuring can be determined only by internal and external constraints (tolbert & hall 2015). extant literature has therefore identified dominant organisational contingences as size, technologies and environment (clegg et al. 2005). the central consideration by the contingency theorists revolve around the way in which organisational structure interacts with size, environments and technology and how each of these contingencies determine structural design (jones 2010). the major contribution of the contingency theorists to organisational theory is the establishment of causal relationships between organisational structure, size, environments and technologies. robbins et al. (2011) describe structure by its key functions and variables. complexity is one of the variables identified and described by robbins et al. (2011) as the amount of vertical, horizontal and spatial differentiation that is present in an organisational structure. this differentiation facilitates effective control and coordination of organisational operations. it is therefore assumed that the ability of an organisation to deal with rapid environmental changes is contingent upon the complex nature or composition of its structures. formalisation is another variable identified by robbins et al. (2011). this variable demonstrates the extent to which rules and procedures are applied in an organisation. the degree or rigidity of formalities in an organisation is capable of enhancing the level of structural complexity. similarly, centralisation is a functional variable that determines the locus of authority where decision-making power resides in an organisation. the last structural variable identified by robbins et al. (2011) is functional specialisation which is defined ‘as the concentration of the types of tasks assigned to any one founding team member’ (sine et al. 2006:124). this personnel function describes the extent to which individual employees concentrate their efforts on the performance of various sets of tasks that have been assigned to them by the organisation (dalton et al. 1980). in summary, these structural variables as described in the foregoing literature represent organisational structure properties that one would normally expect to find in any population of organisations (clegg et al. 2005). however, the structures are most often distributed differently from one organisation to the next. other authors are consistent with robbins’s (2005) categorisation and definition of organisational structural variables. the earlier works of dalton et al. (1980) categorised organisational structural variables into two as ‘structural’ and ‘structuring’. structural variables include physical attributes such as size and span of control. structuring variables are policies and activities occurring within an organisation that prescribe guidelines for the behaviour of members. these structuring variables include formalisation, complexity, specialisation and centralisation. fink, jenks and willits (1983) are also consistent with robbins’s idea of what structure is. all the authors expand the definition of structure by proposing two fundamental processes which they refer to as ‘differentiation’ and ‘integration’. differentiation, according to fink et al., refers to the process of breaking down the task into sub-tasks, while integration is concerned with how a business coordinates its operations along functional divisions. theoretical framework this article is conceptualised within the framework of three distinct organisational theories which will be discussed in the following section. the theories are classic organisation theory, neoclassical organisational theory and contingency theory. weber’s (1947) bureaucratic model provided the core grounding for the development of the classical theory. weber’s model is premised on a work system that is firmly organised on an established bureaucratic task structure using chains of command. managerial duties are organised on a functional line such as planning, organising, staffing and controlling. each functional department is headed by a manager to whom other line employees report. this, according to weber, is the best way for large organisations to achieve efficiency. organisational structure under the classical theory is mechanistic in line with burns and stalker’s classification (jones 2010). central to the neoclassic theory are the people who perform the tasks, hence the human relations approach. this approach, unlike the traditional bureaucratic structure, considers the input and importance of employees in achieving organisational efficiency. organisational structure viewed through the neoclassic lens is a social system which is organic in nature (harper 2015). from the contingency approach, organisational structure is a function of the situation and prevailing environment. this approach is dominated by the work of burns and stalker (1961), who proposed that mechanistic structures are well suited for stable environments and organic structures for unstable environments. the applicability of the organic structure as proposed by burns and stalker has been confirmed by numerous studies (e.g. aiken, bacharach & french 1980; hull & hage 1982), which reported that large and well established organisations operating in dynamic environments perform better with a more organic structure (sine et al. 2006). however, this proposition, according to sine et al. (2006), failed to hold for new venture firms. it is imperative to emphasise that studies that had provided empirical evidence in support of burns and stalker’s propositions (e.g., aiken et al. 1980; hull & hage 1982; sine et al. 2006) were conducted many years back. the factors that define external environment have since changed in pace, nature and scope, given the dynamic political, economic, social and technological drivers. to our knowledge, no contemporary research has updated the propositions of burns and stalker in the context of prevailing external business environments. presenting burns and stalker’s propositions burns and stalker (1961) identified three structural variables responsible for the functioning of both mechanistic and organic structures: complexity, centralisation and formalisation. these structural variables are presented and discussed together with the respective propositions that were derived by burns and stalker. complexity complexity refers to the number of activities or subsystems within the organisation. these activities are represented in the number of functions (e.g. occupations or specialties) that are performed in an organisation (daft 2013; griffin & moorhead 2014; wang & tai 2003). consequently, daft (1992) and anderson (1999) identify three measures of complexity that are operationalised within the organisational context as vertical differentiation, horizontal differentiation and spatial differentiation. the level of authority in organisations is depicted using vertical differentiation in a hierarchical form (stacy & mowles 2016). a higher order ranking indicates the level of authority an individual occupies in an organisation, and also shows the direction in which such authority flows. this hierarchical arrangement is sometimes referred to as organisational chart or organogram. a vertically differentiated organisational structure positions the chief executive officer (ceo) at the pinnacle of the chart (stacy & mowles 2016). this is followed by other offices or positions in order of seniority down to the lowest ranked manager (mostly line or operational heads). authority is equally expected to flow from top to bottom along the same order, with strategic decisions formulated at the top (management) and passed down the hierarchy to operational managers for implementation. however, hodge and anthony (1988) warned that an organisation with more hierarchical levels is likely to experience coordination and integration problems. hodge and anthony’s warning is important when designing a vertical organisational structure. on the other side of vertical organisational structure is horizontal differentiation. this form of differentiation is organised along job title, occupation or the nature of the task performed (daft 2013; griffin & moorhead 2014; jones 2010). it is therefore common to see functional departments such as marketing, engineering, production, administration and others in large organisations with individual managers as the head. we must mention here that, unlike in vertical differentiation, horizontal differentiation exhibits a parallel level of authority as no departmental manager is superior to another. the functional departments complement each other in order to achieve organisational efficiency. the degree of structural complexity depends on the multiplicity of different occupations within the organisation that require specialised knowledge and skills (harper 2015; mcquaid 2010). the last structural variable identified by burns and stalker is spatial differentiation. this has been described as the degree of geographical dispersion experienced by an organisation (mohrman 2007). it is a common operational strategy for large and multinational organisations to establish branches of their offices or operations in several locations both locally and internationally (daft 2013; griffin & moorhead 2014; wang & tai 2003). for example, while the organisation coca-cola has its headquarters located in atlanta, georgia (united states [us]), it has various offices located across the us and in several countries in the world. spatial differentiation is measured by the number of separate locations, the average distance of these sites from headquarters and the proportion of the organisation’s personnel located at these separate units (wang & tai 2003). burns and stalker (1961) concluded that organic structures have a high level of complexity and this enhances the ability of organisations to adapt effectively to change. this conclusion has found empirical support in fabac (2010) and robbins (1987), who affirmed the enhancing role of complexity in organisational adaptation. consistent with the foregoing literature, burns and stalker proposed that: proposition 1: in an unstable environment, organisations adopt high levels of complexity as compared to a stable environment. centralisation managers at different levels of authority assume responsibility for exercising decision-making powers in accordance with their positions within the organisational hierarchy. in some organisations, decisions are concentrated at the centre (e.g. headquarters), while in others power is devolved (decentralised) across all levels of authority (scattolini 2009). centralisation thus depicts the way decision-making power is distributed in relation to resource allocation within an organisation (daft 2013; griffin & moorhead 2014; tsai 2002). the practice in some organisations is to allocate power to only a few individuals occupying certain job categories, while others allow much wider participation (harper 2015). hage (1965) proposed the following measurement of centralisation, which has been adopted by contemporary researchers such as pertusa-ortega, zaragoza-saez and claver-cortes (2010) and willem and buelens (2009): centralization or authority or hierarchy is measured by the proportion of occupation or jobs whose occupants participate in decision making and the number of areas which they participate. the lower the proportion of occupations or jobs whose occupants participate and the fewer the decision areas in which they participate the more centralized is the organization. (pp. 294–295) in burns and stalker’s formation, an organic structure should be less centralised in order to allow an organisation to manage unstable operating environments. such a proposition has received much attention among organisational and management scholars. siggelkow and levinthal (2003) support this notion in relationship to adaptation and exploration. drawing from the above discussion, burns and stalker argued that: proposition 2: in an unstable environment, organisations adopt a less centralised organisational structure compared to a stable environment. formalisation contemporary organisations are managed through established operational procedures, rules, regulations and policies. these administrative procedures are fully documented and the extent of such documentation defines the intensity of formalisation in the organisation (daft 2013; griffin & moorhead 2014; liao, chuang & to 2011). formalisation is often measured by simply considering the volume of administrative procedures that are established to guide behaviours and operations within the organisation. one of the widely acknowledged attributes of modern organisational structure is the extent to which tasks and functions are defined and formalised (lindner & wald 2011; patel 2011). task performance in highly formalised organisations is therefore defined and characterised by bureaucratic practices (patel 2011). such characterisation involves explicit job descriptions, high volume of organisational rules and clearly defined procedures regarding work processes (jones 2010). to this extent, a job incumbent exercises a limited amount of discretion in terms of job descriptions and the modality for its accomplishment (daft 2013; griffin & moorhead 2014; patel 2011). in other words, what is to be done, when it is to be done and how it should be done are prescribed in the rules and procedure document and all that is required of a job incumbent is to act strictly according to the rules and procedure. such regimented behaviour does not enable employees to exercise any form of work autonomy or innovation. in a bureaucratic or highly formalised organisation, tasks are performed using the same input and method, thus achieving a consistent and uniform output (liao et al. 2011). on the other side is a less formalised organisation where employees’ behaviour and task processes are less programmed, with relatively low rigidity (pertusa-ortega et al. 2010). apart from enhancing task autonomy and innovation, such a flexible work process assists organisations in adopting a contingency management strategy in an unstable operating environment, thus providing the basis for an organic structure (burns & stalker 1961; wilden et al. 2013). burns and stalker (1961) argued that in a dynamic environment, high formalisation decreases organisational adaptability to environmental changes and increases the risk of organisational failure. on the other hand, the organic organisation emphasises role flexibility (burns & stalker 1961). several empirical studies (e.g. willem & buelens 2009) have provided support regarding the relationship between formalisation and firm performance in dynamic environments. on the basis of the above documented evidence, burns and stalker further proposed that: proposition 3: in an unstable environment, organisations adopt a less formalised organisational structure as compared to a stable environment. external (macro) environment as an independent variable the efficiency of firms is largely dependent on the business environment in which they exist (morgan 2007). research concludes that among the key determinants of a business’s performance is its external environment (luthans 2011). along that line, the contingency theorists have assigned external environment the role of an independent variable in research (burns & stalker 1961; luthans 2011; mintzberg 1979; morgan 2007). business environment is a very common independent variable in management and organisational studies (fabac 2010). the nature and characteristics of business environments are defined by several environmental dimensions that include technological changes, demographic issues, economics, complexity and political issues (gibson & birkinshaw 2004). these determinants of the environment render it either stable or unstable (fabac 2010). the stability of an environment is dictated by the pace of changes of the environmental dimensions. if the pace of change is moderate, the external environment is said to be stable. if the pace of change is volatile and rapid in nature, the external environment is envisaged to be unstable (burns & stalker 1961). in stable external environments, businesses are able to plan and execute their operations within clearly defined parameters. on the other hand, in unstable environments, it is difficult to plan and operations are distorted. it is in this vein that businesses should organise themselves to be able handle any prevailing business external environment. even as a common independent variable in management and organisational circles, the measurement of external business environment has encountered major methodological challenges that may have generated biased estimates or account of issues such as errors in variables and endogeneity of regression. this article focuses on country level analysis of the external environment. in determining the independent variables that constitute the business environment, this article adopted pest analysis – that is, political, economic, social and technological. the acronym was developed from aguilar’s (1967) taxonomy of the environment – ‘etps’, that is economic, technical, political and social. later in the 1980s, a number of scholars, for example fahey and narayanan (1989) and morrison and mecca (1989), extended aguilar’s taxonomy to include the variables environment and legislation in order to extend the acronym to pestle. for this research, only pest variables will be considered. methods research strategy this article employed a quantitative research strategy in order to enhance objectivity of data and the prospect of generalising research findings (blanche, durrheim & painter 2006; cresswell 2014). participants the study participants comprised 325 managers of manufacturing companies who were drawn from zimbabwe’s business directory’s database. to select the managers from the selected firms, the study used convenience sampling. the convenience was the availability of email addresses of managers in zimbabwe’s business directory’s database; hence, all managers whose email address was found in the directory and whose business fell in the manufacturing category were part of the study. questionnaires in google forms were emailed to the participants who had to complete and submit the form. organisational managers possess a good understanding of the firm-level attributes (gibson & birkinshaw 2004; young 2009) that constitute the variables of investigation in this study. measuring instrument organisational structure variables formalisation was measured using the six items, on a five-point likert scale adapted from robbins’s measures of organisational structure scale (robbins 1987) which was previously used by salgado (2005): (1) very low, (2) low, (3) average, (4) high and (5) very high. items measuring formalisation are shown in table 1. table 1: examples of questions on formalisation. centralisation was measured using seven items on the five-point likert scale measures of organisational structure developed by pennings (1973). the scale was further developed by sathe (1978) and used by walton (1981). items measuring centralisation are shown in table 2. table 2: examples of questions on centralisation. complexity was measured using a scale developed by pugh et al. (1963). the scale consists of seven items measured on a five-point likert scale: (1) being very low, (2) low, (3) average, (4) high and (5) very high. the scale was used by bresser and dunbar (1986). items measuring complexity are shown in table 3. table 3: examples of questions on complexity. business environment variables the business environment variables were measured using a pest questionnaire adopted from morrison and mecca (1989) with a total of 19 items. all the items used a five-point likert scale in which (5) was the most volatile and (1) the most stable. the political variable had five items. examples of items measuring the political variable are shown in table 4. table 4: examples of questions measuring the political variable. the economic variable had five items. examples of questions measuring the economic variable are shown in table 5. table 5: examples of questions measuring the economic variable. the social variable had five items. examples of the social variable are shown in table 6. table 6: examples of the social variable items. the technological variable had four items. examples of items measuring the technological variable are shown in table 7. table 7: examples of questions measuring the technological variable. data analysis to establish a relationship among the research variables, structural equation modelling (sem), employing the linear structure relations (lisrel) model was used to fit the model of data. an important justification for the use of sem is that it allows for easy analysis of the relationships between latent variables (marsh, hau & wen 2004). structural equation modelling also allows for accurate analysis of the dependencies of constructs without measurement errors. as a statistical tool, current sem software integrates many standard methods such as correlation and multiple regressions. ethical considerations consent forms signed by the participants were obtained and an ethical clearance certificate was issued by university of the witwatersrand research committee: h16/02/32. results of the 350 google forms sent to the participants, 189 were completed and submitted, which translates into a 54% response rate. babbie, mouton, vorster & prozesky (2001) concluded that a 50% response rate in the social sciences is good, 60% very good and 70% excellent. saunders, lewis & thornhill (2009) also consider a response rate of above 50% in the social sciences to be adequate for data analysis. given that a response rate of 54% was recorded in this research, it was considered adequate for analysis of the results. reliability all the variables recorded reliability scores above 0.70 on the cronbach’s alpha scale, as recommended by nunnally (1967). the seven items measuring centralisation recorded a reliability score of 0.83, the seven items measuring complexity recorded a combined reliability value of 0.78 and the six items measuring formalisation recorded a score of 0.82. the 19 items measuring the environment variable had a combined score of 0.74. it was therefore concluded that the instrument was reliable for the research and likely to produce reliable results. results of independent variables measured on a likert scale of 1–5 (1 being stable and 5 most volatile), the descriptive statistics showed a highly unstable political and economic environment with a mean of 4.5, a standard deviation of 0.45 and a variance of 0.39. social factors were fairly volatile with a mean of 3.1, standard deviation of 1.0 and a variance of 1.209. technological factors were the least volatile with a mean of 2.222, a standard deviation of 0.988 and a variance of 0.978. in summary, the results showed that business operating environment in zimbabwe was highly unstable. political and economic factors are the major contributors to the volatility business scenario in zimbabwe. the moderate social and technological factors are not enough to mitigate the volatile nature of the overall business operating environment in zimbabwe. results of dependent variables using measurement on a likert scale of 1–5, centralisation showed an above average mean of 4.2, a standard deviation of 2.41 and a variance of 3.17. formalisation reported a moderate mean of 3.12, a standard deviation of 1.63 and a variance of 2.43. complexity also demonstrated an above average mean of 3.90, a standard deviation of 1.91 and a variance of 3.40. given the results of the descriptive statistics, organisations operating in zimbabwe still adopt a significant level of centralisation and moderate and considerable levels of both formalisation and complexity. goodness of fit statistics table 8 represents the goodness of fit statistics. the degrees of freedom were recorded at 41. the minimum fit function chi-square is 63.53 (p = 0.014), the normal theory weighted least square chi-square is 58.05 (p = 0.0041). the estimated non-centrality parameter (ncp) was recorded at 17.05 with a 90% confidence interval of 0.80. the population discrepancy function value was recorded at 0.21 with a 90% confidence interval at 0.0096, 0.5. the entire statistic reported on the chi-square index was acceptable, in agreement with the guidelines of the ranges being as high as 5.0 (wheaton, muthen, alwin & summers 1977) to as low as 2.0 (tabachnick & fidell 2007). the root mean square error of approximation (rmsea) was recorded at 0.071. the adjusted goodness of fit index (gfi) is 0.82. it has been argued that an rmsea of between 0.08 and 0.10 provides a mediocre fit and that below 0.08 shows a good fit (maccallum, browne & sugawara 1996). therefore, the recorded rmsea of 0.078 is acceptable. the gfi was recorded at 0.89. previously a cut-off point of 0.90 was recommended for the gfi; however, simulation studies have shown that when factor loadings and sample sizes are low, a higher cut-off of 0.95 is more appropriate (miles & shevlin 2007). in light of this, the gfi was acceptable. the root mean square residual (rmr) and standardised root mean square residual (srmr) of 0.12 and 0.11 were recorded. values for the srmr range from 0 to 1.0, with well-fitting models obtaining values less than 0.5 (byrne 1998; diamantopoulos & siguaw 2000); however, values as high as 0.8 are deemed acceptable (hu & bentler 1999). thus the srmr value of 0.11 is acceptable. the non-normed-fit index (nnfi) was recorded at 0.83. values for this statistic range between 0 and 1, with bentler and bonnett (1980) recommending values greater than 0.80 as indicating a good fit. in the past two decades suggestions have been made that the cut-off criterion should be nnfi ≥ 0.95 (hu & bentler 1999). the comparative fit index (cfi) was recorded at 0.87. this is one of the most popularly used fit indices, as it is one of the measures least affected by sample size (fan et al. 1999). for this, a value of cfi ≥ 0.95 is presently recognised as indicative of good fit (hu & bentler 1999). table 8: goodness of fit statistics. most of the fitness statistics confirmed that the measurement model of the relationship between business environment and the three organisational structure variables of centralisation, complexity and formalisation was fit for the purpose. relationships between variables the propositions about the relationships between the variables presented above are discussed here. the assessments of the relationships are based on the t-values presented in table 9, the beta and gamma matrices. table 9: the gamma matrix. proposition 1: in an unstable environment, organisations adopt high levels of complexity compared to a stable environment. from the gamma matrix, the causal path between environment ξ (exogenous latent variable) and complexity η (endogenous latent variable) is linked by the t-value of 1.60 with a standard error of 0.06 (see table 9). the t-value is below the cut-off point of t ≥ 1.96 p (0.05) recommended by hu and bentler (1998) and diamantopoulos and siguaw (2000). this indicates that there is no significant relationship between unstable environment and high levels of complexity. the proposed relationship between the two variables could not be supported. proposition 2: in an unstable environment, organisations adopt a less centralised organisational structure compared to a stable environment. from the gamma matrix, the causal path between the environment ξ (exogenous latent variable) and centralisation η (endogenous latent variable) is linked by the t-value of 1.40 with a standard error of 0.06 (see table 9). the t-value is below the cut-off point of t ≥ 1.96 p (0.05) recommended by hu and bentler (1998) and diamantopoulos and siguaw (2000). this indicates that there is no significant relationship between environment and centralisation. the proposed relationship between the two variables could not be supported. proposition 3: in an unstable environment, organisations adopt a less formalised organisational structure compared to a stable environment. from the gamma matrix, the causal path between environment ξ (exogenous latent variable) and formalisation η (endogenous latent variable) is linked by the t-value of 1.42 with a standard error of 0.052 (see table 9). the t-value is below the cut-off point of t ≥ 1.96 p (0.05) recommended by hu and bentler (1998) and diamantopoulos and siguaw (2000). this indicates that there is no significant relationship between the environment and formalisation. the proposed relationship between the two variables could not be supported. discussion the purpose of this article was to reconsider the propositions made by burns and stalker (1961) on how organisations should structure themselves in unstable environments. burns and stalker proposed that in unstable environments, organisations tend to adopt organic structures. the main properties of an organic structure as identified by the authors are low centralisation, high specialisation and high formalisation. the three propositions formulated by burns and stalker were empirically tested in this article. this article considered the environment as the independent variable denoted by the four elements: political, economic, social and technological. the original works of burns and stalker considered the environment as a function of only two elements, that is, technological and marketing forces. it was necessary for us to expand the independent variables used by burns and stalker in our study as a result of: (1) fundamentally different environmental contexts and (2) the rapidly changing socioeconomic environment between 1961 when the seminal work was conducted and the present. moreover, it is our conviction in this article that the relationships between organisation structure and operating environment could be explained using more variables other than market and technology. our findings in this article were inconsistent with the original work of burns and stalker. the research setting of our study exudes a high propensity for instability which one could consider as conducive for the empirical testing of burns and stalker’s organic structure proposition. however, business organisations in zimbabwe do not seem to adopt an organic structure despite the unstable environment in which they operate. consistent with our findings, zimbabwean organisations adopt a hybrid structure that suggests a combination of both mechanistic and organic structures. we attempt to attribute this contrasting outcome partly to the methodological problem of case study of homogeneous electronic firms that was adopted by burns and stalker. this contrasts with our quantitative research strategy, using heterogeneous firms in the manufacturing sector which represents the largest business sector in zimbabwe’s economy. research methods literature has consistently argued in favour of the prospect of generalisable outcomes in quantitative research (bryman & bell 2011) in comparison to qualitative research, and case study research design in particular. similarly, while burns and stalker’s work was conducted in an economically unstable environment in the uk, the drivers of operating instability in zimbabwe fundamentally transcend what could be referred to as a ‘normal’ economic environment to include complex political, turbulent social and, most importantly, ‘abnormal’ economy. beyond methodological and environmental factors that we have described above, the expansion of independent variables employed by burns and stalker and our study further accounted for the variations in both studies. it is our submission in this article that the present study has succeeded in empirically establishing a novel dimension in the existing relationship between organisational structure versus operating environment. this dimension presents an important incremental theoretical and practical contribution to the prevailing body of knowledge in the broad field of strategic and change management. lastly, through this article, we have responded to a stream of scholars advocating for an empirical establishment of hybrid organisational structures in addressing the rapidly changing business operating environment (battilana & dorado 2010; doherty, haugh & lyon 2014). we therefore, based on our finding in this article, recommend a managerial practice that embraces a hybrid structure, rather than concentrating solely on the adoption of an organic structure in a dynamic environment. conclusion in a highly dynamic operating environment like the one currently seen in zimbabwe, it is theoretically expected that organisations adopt burns and stalker’s organistic structural postulation in order to achieve some degree of efficiency. however, it is our argument in this article that rather than the norm, organisations in zimbabwe react and adapt to the hostile and unpredictable dynamics in the economy by opting for a hybrid structural adaptation mechanism. furthermore, it is characteristic of organisations to hurriedly downsize their workforce when confronted with operational difficulties occasioned by rampant economic and sociopolitical uncertainties. the outcome of such unplanned downsizing is the high propensity of the organisation losing employees whose skills and expertise are critical in the formulation and implementation of a turnaround strategy. we consider such practice as a ‘panic’ reactionary instead of proactive and sustainable contingency approach in managing organisational change. short-term adaptation strategy of this description could be more damaging to optimal organisational efficiency and ultimate survival in the long run. acknowledgements the authors would like to acknowledge the african leadership university, rwanda, for their contribution to the publication fees. competing interests the authors have declared that no competing interests exist. author’s contributions n.s. conceptualised the paper and performed data collection, analysis and discussions. o.m.s. provided theoretical grounding and coordinated compilation. funding information this research received no 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material costs, improving operational efficiency has become a necessity for margin purposes and long-term business success. this research study attempts to develop a model for process operations variability reduction that integrates the fundamental drivers, the intermediate measures and the four traditional competitive capabilities: quality, cost, delivery reliability and speed of delivery. in addition, it highlights the precise mechanisms in plants that lead to multiple competitive capabilities development. the concept of a routine-based approach to capabilities development provides a nexus between the earlier actions by the organisation and competitive advantage. using longitudinal data from the manufacturing circle of south africa, a statistical analysis was conducted to support the model, and path analysis models were developed which confirmed that the performance frontier is really a surface that spans many different dimensions. it is observed that the model clearly outlines pathways to process operations variability reduction through better execution of the routines concerned with maintaining the performance by current processes, improving existing processes, and transforming or changing to new processes. key words: manufacturing, firms, competitive capability, process management, longitudinal data analysis jel: m11, c32 1 introduction today’s process manufacturers are faced with a volatile economy, intense competition and rising energy and material costs. improving operational efficiency has become a necessity for margin purposes and long-term business success (bates, kimberley, flynn & flynn, 2009; chang & park, 2012). several analysts’ reports and surveys in recent times have identified operational costs reduction, process operations variability reduction, and competition from low-cost sources as the top three key pressures for process manufacturers (fonzi & shah, 2008; chen & miller, 2012). with the critical need to reduce costs, process manufacturers could turn to operations to address the additional significant pressure, which is the need to reduce the variability of process operations. the business environment confronts operations managers with changing operating conditions and complex internal challenges that cause variations throughout the operational chain (bozarth, warsing, flynn & flynn, 2009). such process operations variability, regardless whether they result from the organisational strategy, predictable suppliers or customers’ behaviour, or from unforeseeable events that are beyond immediate control, negatively affect the performance capabilities of firms in aspects such as quality, cost efficiency, speed of delivery and delivery reliability (hopp & spearman, 2001). klassen and menor (2007) studied trade-offs between inventory, manufacturing firm capacity, and operations variability, and suggested that further study where integrative conceptual models, such as competitive capability models, could be better informed by using a different approach to process operations’ variability. however, researchers who developed capability models have conducted a relatively limited number of studies on the mechanisms of performance factors. much of the existing work in this field used cross-sectional data and focused on the interactions between abstract sajems ns 19 (2016) no 3:448-466 449 the competitive capabilities (mapes, szwejczevski & new, 2000; sarmiento, sarkis & byrne, 2008). other researchers have focused on performance drivers at the manufacturing firm level. the current research study attempts to correct this deficiency. mapes et al. (2000) in their study of “process variability and its effect on plant performance”, developed the mechanisms between performance drivers and performance capabilities, using crosssectional data. the purpose of this study is, therefore, to examine the fundamentals drivers and the performance capabilities, as well as the mechanisms within manufacturing firms that would lead to multiple competitive capabilities using longitudinal data. this was in order to develop a model for process operations variability reduction so that recommendations may be made to management to ensure improvement in operational efficiency. this was done by using the longitudinal data of 54 manufacturing firms in south africa. the validity of this model was tested statistically. 2 literature review 2.1 background the concept of capabilities in operations management refers to a business unit’s anticipated or realised competitive performance or operational strengths (boyer & lewis, 2002; flynn & flynn, (2004) and are therefore evaluated using operational performance, which often takes account of quality, cost, delivery reliability, speed of delivery, and flexibility, as discussed by tsang, dultrade-lima, csillag and oyodomani (2015). swink and hegarty (1998) point out that the concept of capabilities in operations management which has a performance-based approach is conceptually too aggregated to visibly provide clear direction for the proper use of manufacturing resources. one of the most fundamental areas for operations managers wishing to improve performance is an in-depth understanding of the interactions that exist between different measures of operational performance. there has been an ongoing debate on the relationship among competitive capabilities. this debate has been evolving amid three schools of thought: trade-off, cumulative capabilities and rigid flexibility models. the findings on the critical evaluation of competitive capability models are summarised in table 1. table 1 summary on critical evaluation of competitive capability models competitive capability models academics strengths weakness trade-offs models skinner (1969, 1974, 2007); mapes & new (2002); klassen & menor (2007); sprague (2007); sarmiento & shukla (2011); krause, youndahl & ramaswarmy (2014) trade-offs models focus on analysing manufacturing performance at the marketplace and industry level in order to prioritise strategic objectives and allocate accordingly resources to develop required competitive capability. static model embedded in classical economic theory. improving operational performance on one dimension could only be accomplished by trading this off against reduction performance on one or more other dimensions. the model does not focus on manufacturing firm internal improvements over time. trading off capabilities lead to increase variability. cumulative capabilities models ferdows & de meyer (1990) ; avella et al. (2009); wang & masini (2011); schroeder, shah & xiaosong peng (2011); ferdows & thurnheer (2011); bortolotti et al. (2015) sequential and cumulative internal improvements enable manufacturing firms to override production tradeoffs the model is manufacturing-driven and inward-looking instead of market-driven and outward-looking. the sequence of capability building is not marketdependent and is exclusively pre-set as suggested by the model. rigid flexibility models collins & schmenner (1993); collins, gordon & julien (1998); da silveira (2006); sarmiento et al. (2008); fazli (2012) this model focuses on embedding discipline and simplicity in processes and procedures which become a source of competitive advantage. the order and priorities of competitive capabilities building is market-driven which result in improve responsiveness the model does not specify or provide a roadmap that leads to the goal of rigidflexibility 450 sajems ns 19 (2016) no 3:448-466 the main schools of thought on the competitive capabilities models described above provide a range of contending views on how manufacturing firms can accomplish improved performance that results in the development of competitive advantage. however, the traditional competitive advantage approaches are oriented to competitive capability sequential and/or interactional development. the tidal wave analogy presented by corbett and van wassenhove (1991) suggests that there is a dynamic hierarchy in the traditional competitive priorities and necessities, beyond which human resources are the only source of competitive advantage. schroeder et al. (2011) tested the actual sequence of the sand-cone theory, and suggested a contingency theory, as they did not find universal support. flynn and flynn (2004), using cross sectional data, found that there is environmental contingency in the pattern of cumulative competitive capabilities, which is closely associated with country and industry differences. da silveira and slack (2001) assess the managers’ perceptions of the existence and importance of trade-offs. they point out that trade-off is an easily understood theory which describes the operating compromises usually made by operations managers. they conclude that the implication of specific trade-offs within any process operations is expected to be governed by two factors, which are the importance and the sensitivity of the trade-off. deriving useful principles of operations management that are managerially practicable remains a challenge, because operations managers are confronted with a complex set of operational issues and challenges that dictate trade-offs (klassen & menor, 2007); internal and external sources of process operations variability related to these operational matters further complicate the operations manager’s mandate. while da silveira and slack’s (2001) study reveals the perceptions and practice of operations managers regarding trade-off, it also highlights their attitudes to process operations variability reduction. trading-off competitive capabilities will result only in an increase in operations variability; in turn, this will decrease manufacturing firms’ performance efficiency. schmenner and swink (1998) propose a concept that takes account of both the trade-offs and the cumulative competitive capabilities laws: the performance frontier (stevenson & hojati, 2007; cai & yang, 2014). performance frontiers are created depending on the choices in manufacturing firm design and investment (asset frontier), and the choices in process operations (operating frontier). the manufacturing firm’s performance is bounded subsequently by the operating frontier and its asset frontier. similarly, it could be argued that the competitive capabilities, such as delivery reliability, the speed of delivery, cost, and quality, are immediately bounded by the operating frontier, and are subject to process operations variability. moreover, in line with operations variability, it could be argued that the dimensions of the business environment, such as munificence, which describes the level of resources scarcity, and dynamism, which refers to unpredictable changes in the business environment, affect the operating frontiers (bourgeois, 1980; ward et al., 1995; cai & yang, 2014). 2.2 performance drivers’ mechanisms many researchers report that a shorter throughput time is the most critical driver, being closely associated with with high-quality consistency, productivity, speed of delivery and delivery reliability. schmenner and swink (1988) maintain that, although a short throughput time does not improve productivity by itself, it creates a synergy of complementary actions and tactics within the manufacturing firm, which results in productivity improvement. cambitsis (2012) concurs by considering downtimes that occur as consequences of the downstream and upstream starvation and choking effects of each activity. according to plossl (1991), all the benefits are directly in proportion to the speed of flow of materials and information within the process operations. mapes et al. (2000) mention that low throughput times and high stock turns are intermediate measures. however, they are a major source of competitive capability; they are themselves the outcome of earlier actions by the organisation (hall, 1987; ohno, 1988). sajems ns 19 (2016) no 3:448-466 451 it could be argued that process operations variability should be reduced depending on the earlier actions by the organisation. these earlier actions will result in low inventory and shorter throughput times in the high-performing manufacturing firms. this will, in turn, result in a fast speed of delivery, high delivery reliability, greater quality consistency and high productivity. based on the above, it could be argued that the fundamental drivers that lead to concurrent improvements in cost, speed of delivery, delivery reliability and quality consistency are all aspects of the reduction of process operations variability and uncertainty within the operational system. the fundamental drivers of any improvement are core skills or competencies, which lead to an increased adherence to schedule, the increased reliability of supplier deliveries, reduced process output variability, and reduced process time variability (porter, 1980; hayes & wheelwright, 1984; collins & schmenner, 2005). 2.2.1 increased adherence to schedule the less uncertainty there is regarding future customer prospects, availability of materials and machineries processing times in the production line, the easier it is for manufacturing firms to follow the predetermined schedule. uncertainty about future demand prospects and a rolling horizon trigger volatility. glock et al. (2014) claim that volatility leads to nervousness in the process operations through the cancellation of existing setups, the introduction of new setups, and alteration of the production volumes. kazan, nagi and rump, (2000) and beck, grosse and tebmann (2015) argue that the main adverse effects of unplanned changes to the manufacturing schedule are an increase in the throughput times and the work-in-progress stocks. the outcome is higher costs, slower speed of delivery and poor delivery reliability. armistead and mapes (1993) find that the key factor in high operating efficiency and customer service is the integration of supply/customer by means of sharing production schedules in order to reduce uncertainty and increase the degree of adherence to the planned schedule. rivera-gómez, ghabi and kenné. (2013) and kazaz and sloan (2013) argue that the adherence to schedule can also be affected by the association of equipment reliability and quality challenges. since maintenance ineffectiveness results in the escalation of downtime and overtime costs, poor quality, excessive change over time, unreliability of production machinery, as argued by onawoga and akinyemi (2010); salonen and deleryd (2011) are convinced that maintenance management activities should be viewed in a similar light to quality management activities and that the cost of poor maintenance should be treated like the cost of poor quality. farrero et al. (2002) and prajapati, bechtel & ganasan (2012) claim that the proper integration of the maintenance approaches mitigates the risk of sub-optimality and premature equipment failure. 2.2.2 increased reliability of supplier deliveries ambulkar et al. (2015) and knemeyer et al. (2009) maintain that, in today’s turbulent and uncertain business environment, manufacturing firms are subject to disruptive events which trigger a disturbance in the flow of goods or services (craighead et al., 2007). wright (2013) states that robustness to supply chain disruptions is considered to be a key priority in this ever-changing business environment. having material on hand or inventory means carrying costs composed of the cost of capital, stores, personnel salaries, facilities, field delivery, obsolescence of inventory, information systems, utilities, insurance, security, and so on (wagner & bode, 2008; narasimhan & talluri, 2009). xinlin, tang and rai-arun (2014), vanpoucke, vereeckeb and wetzels (2014), and mapes et al. (2000) suggest that manufacturing firms should develop customer-suppliers relationships so that suppliers could provide on-time delivery. the result of on-time delivery would be not only the reduction of the throughput time and an increase in delivery reliability, but also a reduction in the amount of inventory that should be held. danesen (2013) points out that supplier integration and fast supply network structure practices have provided significantly positive effects on the manufacturing firms’ performance measures like efficiency, schedule compliance and flexibility. wonga, sakun and wong, (2011) emphasise that competitive capabilities, such as delivery and 452 sajems ns 19 (2016) no 3:448-466 flexibility, are extremely sensitive to uncertainty from the external environment and, as a result, could be improved by external integration. in the same way, competitive capabilities, such as quality and cost, are more internally dependent, and could therefore be improved through internal integration (ragatz, handfield & peterson, 2002; droge, jayaram & vickery, 2004; danesen, 2013; euehun, semi, hye & rho, 2013). 2.2.3 reduced process time variability hopp and spearman (2001) claim that process time variability derives from either controllable or random processing time variation. the end result of processing time variation, irrespective of its type, is that it increases the throughput time (johnson, 2003). mapes et al. (2000) argue that the greater the process time variability of each production step the more complex is the task of coordinating these steps. the common practice used by operations managers in dealing with process time variability is to introduce work-in-progress buffers between the steps, diversifying the overall system, or creating a rapidly reconfigurable or responsive system, as stated by fonzi and shah (2008). the shortfall of the buffering practice is that it increases the throughput time, as the process time variability remains unchanged. the consequential effect is an increase in cost, customer lead times and a reduction in delivery reliability. koufteros, vonderembse and doll (1997) argue that time-based manufacturing comprises organizational level practices that compel shop-floor worker participation in problem-solving in order to reduce throughput time. other researchers point out that employee involvement drives improvement efforts (krishnamoorthi, 2006; heizer & render, 2008; stephen, rungtsusanatham, zhao and lee (2015). improved workforce problem-solving skills facilitate the re-engineering of setups and the establishment of culture of quality conformance improvement (su et al., 2014) and the implementation of effective preventive maintenance strategy as discussed by sharma and yadava (2011), salonen and bengtsson (2011) and prajapati et al. (2012). hafner (1991) and wuakan and mcginnis (2012) conclude that the reduction of the standard deviation of the processing and inter-arrival times has a similar effect on throughput times, which results in an increase in manufacturing capacity. 2.2.4 reduced process output variability mapes et al. (2000) state that, the lower the variability in the output at each manufacturing step, the higher the percentage of adherence to quality conformance, and the lower the reject rate. the overall effect is an improvement in throughput rates, cost and delivery reliability. researchers have studied the relationship between several quality practices and quality performance. their results show that quality practices, such as leadership, support, workforce involvement, process management, and cross-functional product development, have a beneficial outcome on quality performance (flynn, schroeder & flynn, 1999; dow, samson & ford, 1999; ward & duray, 2000; su et al., 2014). zhang, linderman and schroeder (2012), and d’aveni, dagnino and smith (2010) argue that two general forms of learning processes are frequently debated in line with quality management: firstorder and second-order learning. first-order learning consists of augmenting existing know-how in order to be able to proactively detect and correct quality defects. it is described as refinement, effectiveness, improvement and exploitation. in contrast, second-order learning implies search, experimentation, innovation and exploration. total quality control relates to first-order learning, whereas total quality learning relates to second-order learning. employee involvement and improved workforce problem-solving skills enable the establishment of a culture of quality conformance improvement (deming, 1982). it can be argued that the quest for process operations variability is directly related to first-order and second-order learning, which trigger a reduction in process output variability. 2.2.5 linking routines to capabilities in operations management the common pointer to the achievement of the key performance drivers is the core skills or competencies, which are intangible resources. mascarenhas, baveja and jami (1998) and sajems ns 19 (2016) no 3:448-466 453 arrighettia, landinib and lasagnia (2014) maintain that core competencies include technical subject matter know-how, reliable process operations, supplier/customer integration, product development or culture, employee dedication, and best human resource management. hayes and wheelwright (1984) and clark (1996) argue that higher performance is eventually established depending on the people in an organisation (lin & wu, 2013; kumlu-ömer, 2014). the correct management principles, organisational systems and structures, and procedures are important (persaud, 2005). however, the capabilities that generate competitive advantage derive from people: their skills, discipline, motivation, ability to resolve problems and their capacity for learning. the impact of routines for developing process operations-based competitive advantage has been highlighted in the discipline of operations management. winter (2003) and rerup and feldman (2011) indicate that routines are generally described as regular and predictable patterns of behaviours, or, more specifically, the way work is done. xiaosong-peng, schroeder and rachna (2008) state that routines and performance capabilities are embedded in the synergy of multiple knowledge sources and are more firm-specific and less transferable, thus leading to competitive advantage. clark (1996) notes that ,in several cases, competitive advantage in process operations is developed through better execution of similar routines. grant (1991) observes that the repertoire of routines provides a means for manufacturing firms to implement their value-creation strategy, and, as a result, is critical to performance capability improvement. competitive capabilities are defined in operations management as bundles of interrelated, yet distinct routines (prahalad & hamel, 1990; stalk, evans & shulman, 1992; hult, snow & kandemir, 2003; xiaosong et al., 2008). this routine-based approach to capabilities allows the untangling of capabilities into specific and identifiable routines, and thus accurately generates probable pathways to capability development (foss, heimeriks, winter & zollo, 2012). a number of operations management researchers claim that, while competitive capabilities at the manufacturing firm level are defined as cost, quality, delivery reliability, and speed of delivery, operations-level capabilities should refer to routines (ghosh, 2001; schroeder et al., 2002). capabilities building is linked mainly to the influence on organisational routines at the individual, organisational and network levels, which include customer/supplier integration and competitors (capaldo, 2007; newey & zahra, 2009; lisboa, skarmeas & lages, 2011; capaldo & messeni, 2011). stephen et al. (2015) point out that process management consists of three dimensions, which are process control, incremental process improvement and radical process improvement. process control is an organisational capability established in bundles of routines and practices that aim to exploit existing processes by stabilising process performance to meet the required specifications, as discussed by howard-grenville and parmigiani (2011). incremental process improvement is an organisational capability established through a set of routines and practices aiming to exploit existing process by enhancing their performances continuously at a gentle pace and on a small scale. krishnamoorthi (2006) and heizer and render (2008) maintain that process control prevents the production of defective units by detecting and stopping undesirable variations, thereby creating stable and predictable processes. according to benner and tushman (2002), incremental process improvement focuses on improving existing processes by eliminating non-value-added activities and reducing common variations. radical process improvement is characterised by a fundamental rethinking and redesign of processes to obtain a drastic improvement in various dimensions of organisational performance. it consists of challenging the status quo and building new processes with a new resource base (peng et al., 2008; chang yuan-chich, chang, ru, huei & deng, 2012; young, kumar & kumar, 2013; lim-chaisung, han & ito, 2013). 2.2.6 foundation of the process operations variability reduction model while the analysis in section 2.2 of performance drivers is in no way complete, it does allow for the identification of some general patterns. figure 1 summarises the general patterns identified in the analysis of manufacturing performance drivers, which then provide the basis of the model this research study intended to develop. 454 sajems ns 19 (2016) no 3:448-466 figure 1 foundation of the process operations variability reduction model process operations variability reduction theory matters because it not only reflects the practice of the industry, but also helps to constitute the practice. one of the ways in which it does this is by favouring the practices of continuous improvement and betterment. in line with the above. the researcher takes the view that process operations variability reduction is influenced by social systems made up of people, their aspirations, know-how or expertise, work practices, frustrations, and egos. 3 the proposed model a model for process operations variability reduction, which is the ultimate goal of this research study, must address the core problems that have continually led to operations variability in most south african manufacturing firms. it has been said that the conceptual model for process operations variability reduction to be developed must be a generic process operations model that can be used by various process operations. the reason for this is that the model should be driven by the requirements of the manufacturing firms, which are determined first by the requirements of the south african business environment’. in other words, to what extent are the competitive capabilities of south african manufacturing firms able to meet the demands of the business environment? the research has identified three classes of performance drivers/factors that influence and contribute to the development of the process operations variability reduction model. the first two classes of factors together affect the competitive capabilities. in other words, by considering these three classes of performance drivers/factors in the design and implementation of process operations variability reduction, it can be expected to consistently reduce operations variability and continuously improve performance capabilities. the three classes of factors are: fundamentals drivers, intermediate measures and competitive capabilities. the two categories of beneficial movement within the performance space are improvement and betterment, as discussed by schmenner and swink (1998), and cai and yang (2014). improvement takes a firm to its operating frontier. by contrast, betterment alters manufacturing operating policies in ways that move the operating frontier forward to the asset frontier. the fundamental drivers of improvement or betterment are the core skills or competencies that lead to more adherence to schedule, increased reliability of supplier deliveries, reduced process output variability, and reduced process time variability (porter, 1980; hayes & wheelwright, 1984; collins & schmenner, 2005). core skills / competencies emphasis on improvement and betterment through routines focused on maintaining the performance of current processes, the incremental improvement of existing processes, and the radical transformation to new processes increased adherence to schedule; increased reliability of supplier deliveries; reduced process time variability; reduce process output variability greater adherence to schedule; lower process time variability; more frequent deliveries by suppliers; more reliable deliveries by suppliers; lower scrap rates; lower stock levels and lower throughput times quality dependability speed cost sajems ns 19 (2016) no 3:448-466 455 these earlier actions by the organisation, which derive from skills or competencies, are expected to relate to the establishment of operating systems that are considerably more stable and reliable. within the operations of manufacturing firms, all the benefits are in direct proportion to the speed of flow of materials and information which implies that short throughput times and high stock turns are intermediate measures (plossl, 1991). faster throughput times and lower stock levels lead to improvements in the external performance, but they derive from earlier actions by the organisation, which are embedded in the core skills or competencies (carmeli, 2004; smith, 2008; lin & wu, 2013; kumlu-ömer, 2014). a manufacturing system operations variability is buffered by the integration of inventory, capacity and time. the intermediate measures highlight any buffering tendency. process operations variability will therefore be reduced, depending on the earlier actions by the organisation, which will lead to low inventory and faster throughput times in the high-performing manufacturing firms (mapes et al., 2000). this subsequently leads to a faster speed of delivery, more reliable delivery, higher quality consistency and lower costs. in other words, the fundamental drivers that lead to concurrent improvements in cost, speed of delivery, delivery reliability and quality consistency are all aspects of reduced process operations variability and uncertainty in the operating system. the requirements of the conceptual model discussed above provide a framework for the conceptual model and reflect a particular set of performance factors that, in combination, will achieve the stated objectives of operations variability reduction in the manufacturing firms. the proposed process operations variability reduction model shown in figure 2 provides an appropriate description of a model for building multiple competitive capabilities through process operations variability reduction. this model not only provides increased visibility for performance factors, but also untangles the complex relationship between performance factors. as stated earlier, there are three classes of factors of importance in examining the model: • fundamentals drivers. • intermediate measures. • competitive capabilities. the key factors are to consider the input elements of each imperative that makes up the operations variability reduction. the input elements depicted in figure 2 should always be appropriate to the specific imperative requirements in question in terms of process operations variability reduction. the model for process operations variability reduction integrates fundamentals drivers’ imperatives, intermediate measures imperatives and competitive capabilities imperatives. the theoretical cooperation proposition leads to the development of the process operations variability reduction model shown in figure 2. figure 2 process operations variability reduction model core skills / competencies feedback core skills / competencies lower stock levels faster throughput times quality consistency higher productivity speed of delivery delivery reliability 456 sajems ns 19 (2016) no 3:448-466 the proposed model suggests that an improvement in core skills / competencies will result in an improvement in throughput, inventory, and quality. subsequently, faster throughput times and lower stock levels will result in an improvement in delivery reliability, productivity and the speed of delivery. the feedback loop provides an opportunity for the critical review of a manufacturing firm’s performance, particularly by exploring continual improvement as bundles of routines which enable an organisation to improve its capabilities. 4 research methodology the empirical statistical support will be conducted using the manufacturing circle survey, which is compiled by pan-african investment and research services in the best interests of the manufacturing circle. the quarterly survey aims to capture economic and business conditions in the south african manufacturing industry. the manufacturing circle database includes 54 different manufacturing firms drawn from different industrial categories. they vary from small to large south african manufacturing firms. the empirical data used to assess the relationship of each pair of performance measures were collected from the manufacturing circle quarterly survey for the past four years (2010 to 2014). the respondents represent different industries which cover all the manufacturing sectors. the research study will use the quarterly data for the past four years, as it is intentionally a longitudinal study. longitudinal studies observe individual over a period of time in order to study the relationship between variables to determine the cause and effect relationship and assess the observable antecedents and precedents. longitudinal data present information on what happened to fundamentals drivers, intermediate measures, and competitive capability during a series of time periods. in order to explore the relationship between core skills or competencies, throughput, stock levels, delivery reliability, speed of delivery, productivity and quality consistency, the 2010 to 2014 quarterly survey database of the manufacturing circle was used. the actual performance measures used were: status of skills availability in the industry, throughput or level/volume of general business output (non-monetary measures), inventory or level/volume of overall purchased stock of materials and goods used in the normal business or activities (non-monetary measures), supplier delivery or overall delivery performance versus that of the previous month of suppliers of materials, goods and services purchased, speed of delivery or the difference between new sales orders and the backlog of sales orders, and the level of labour productivity over the quarter. unfortunately the database has no measures relating to quality. quality will be discussed, according to previous research findings. the measurements of manufacturing firms’ performance took place multiple times. a total of seventeen observations are used in the empirical analyses. path analysis is used to provide support for the proposed model (akintunde, 2012). 5 analysis of the results the results of the statistical analysis are summarised in table 2. the cronbach’s alpha was computed and provided a result of 0.87, which indicates a good reliability or internal consistency of the test. the results show that nearly all of the pairs of performance measure have correlation coefficients or strength of a relationship between variables of 30 per cent or better; and which are significant at the 0.05 level or better. each pair of variables shows a statistically significant correlation. the extent to which these results support the proposed conceptual model is discussed below. 5.1 fundamentals drivers – intermediate measures substantial statistical support was provided for the relationship between the fundamental drivers and the intermediate measures. the statistical correlation coefficient is 78.8 per cent and is significant at the 0.0000001 level for the relationship between skills and throughput. the correlation coefficient between skills and inventory is 30.8 per cent and is significant at the 0.011733 level. core skills/competencies are required to achieve faster throughput times and lower stock levels. sajems ns 19 (2016) no 3:448-466 457 table 2 results of statistical analysis – correlations, means and standard deviations skills / compe tencies throughput inventory productivity speed of delivery delivery reliability quality mean standard deviation skills / competencies correlation (%) 1 78.8 30.8 -29.3 -1.0 -12.9 24.2 4.6 significance 0.0000001 0.011733 0.015838 0.4713 0.1771 throughput correlation (%) 1 48.7 66.4 68.9 -46.8 50.9 4.0 significance 0.00009392 0.0000001 0.0000001 0.000168 inventory correlation (%) 1 -35.2 50.5 -41.7 53.9 2.6 significance 0.0047375 0.00004899 0.0008454 productivity correlation (%) 1 27.4 1.31 52.6 3.6 significance 0.022319 0.46234 speed of delivery correlation (%) 1 -35.03 12.6 5.2 significance 0.004697 delivery reliability correlation (%) 1 52.4 2.0 significance quality correlation (%) 1 significance while the correlation between skills/competencies and inventory is statistically significant, the level of significance is lower than for the other pairs of variables. this is rather surprising and requires further investigation. however, it could be argued that a different set of skills is required to improve throughput times and lower stock levels. figure 3 shows the status of skills availability in the manufacturing industry. the scarcity of skills remains a stumbling block for the manufacturing industry to the extent that 76.8 per cent of the respondents believed that skills availability in the manufacturing industry was either poor or less than adequate. it is worth mentioning that some manufacturing firms introduced internal training programmes to address the matter of skills scarcity. the relatively low correlation coefficient between skills/competencies and inventory indicates that manufacturing firms operate with high levels of inventory to protect themselves from uncertainty from the external/internal environment. this corroborates to the findings that show that supplier reliability decreases as throughput increases. figure 3 skills profile in the manufacturing industry over the last four years (2010 – 2014) 17,4 59,4 22,1 1,1 0,0 10,0 20,0 30,0 40,0 50,0 60,0 70,0 poor less than adequate adequate good status of skills availability in your industry (%) 458 sajems ns 19 (2016) no 3:448-466 figure 4 shows the profile of adequate skills over the last four years (2010 – 2014). r-squared is 34.81 per cent, which indicates that the regression line explains a small but reliable percentage of the variability of the response data around its mean. the linear regression line depicts a relatively weak uphill trend, suggesting that there are some skills improvements. figure 4 profile of adequate skills over the last four years the proposed model showed that specific routine tasks should be integrated into the quest for improvement and betterment; which will lead to increased adherence to the schedule, increased reliability of supplier deliveries, reduced process output variability, and reduced process time variability. these routine tasks, which mean improvement and betterment, are an integral part of core skills or competencies, which are the cornerstone for the quest for process operations variability reduction. first, in order to maintain their current performance, organisational capability established in bundle of routines and practices is required to exploit existing processes by stabilising process performance to meet required specifications. this will lead to the prevention of the manufacture of defective units by detecting and stopping undesirable variations, creating stable and predictable processes. it will also minimise any uncertainty caused by the external environment by integrating externally to maintain strategic partnerships, information-sharing and joint collaboration between customer and supplier. secondly, in order to incrementally improve organisations’ current performance, organisational capability established through a set of routines and practices is required to exploit the existing process by continually enhancing their performance at a gentle pace and on a small scale. this would eliminate non-value added activities, reduce common variations through refining existing products, process technologies and operational practices on one hand; and enhance the aptitude of manufacturing firms to find best partners, initiate and develop relationships, and design governance policy for effective cooperation on the other hand. thirdly, in order to fundamentally rethink and redesign the processes, organisational capability established through a set of routines and practices is required to challenge the status quo and build new processes with a new resource base. this means obtaining drastic improvements in various dimensions of organisational performance. in order to achieve this, manufacturing firms will have to become involved in cooperative relationships with numerous external partners, including customers, suppliers, academic research and development institutions to integrate their value co-creation processes. 5.2 intermediate measures – competitive capabilities statistical analysis provided substantial support for the relationship between throughput and delivery reliability, throughput and the speed of delivery, and throughput and productivity. y = 0,0091x 349,83 r² = 0,34811 0 5 10 15 20 25 30 35 40 profile of adequate skills (%) sajems ns 19 (2016) no 3:448-466 459 the relationship between throughput and supplier delivery reliability had a correlation coefficient of 46.8 per cent, significant at the 0.000168 level. throughput and supplier delivery reliability had a negative correlation coefficient, which indicates that supplier delivery reliability decreases as throughput increases. this implies that an increase in throughput triggers a supply chain disruption event which results in a disturbance of the flow of goods or services. robustness to supply chain disruptions can be attained through customer/supplier integration and fast supply network structure practices. the outcome of customer/supplier integration is an in-depth understanding of market outlooks and opportunities, enabling on-time delivery to customer requests by matching supply with demand. the relationship between throughput and the speed of delivery had a correlation coefficient of 68.9 per cent, significant at the 0.0000001 level. the results show that as throughput increases so does the speed. the speed of delivery is the dimension of flexibility which can enhance the capability of coping with volume fluctuations. externally, the speed of delivery provides the advantage of being able to respond swiftly to customer orders. the internal effects of the speed of delivery are related more to the manufacturing cost reduction. the relationship between throughput and productivity had a correlation coefficient of 66.4 per cent, significant at the 0.0000001 level. the results show that productivity increases with an increase in throughput. the model confirmed the findings of many researchers who report that faster throughput time is the most critical driver, which is closely associated with the high speed of delivery, productivity and delivery reliability. the relationship between inventory and productivity had a correlation coefficient of –35.2 per cent, significant at the 0.0047375 level. the results show that, as inventory increases, productivity trends down. high inventory means carrying costs. researchers have indicated that some manufacturing firms have a carrying cost as high as 61 per cent, and the costs of defective material are generally up to 30 per cent. it could be argued that manufacturing firms are required to adopt customer/suppliers integration and fast network structure practices to enhance on-time delivery and minimise inventory. the uncertainty of future demand or supply prospects triggers volatility, which leads to the cancellation of existing setups, the introduction of new setups, the alteration of the production volumes, and an increase in inventory. this will result in an increase in the throughput times and work-in-progress stocks. the outcome is higher costs, a slower speed of delivery and poor delivery reliability. the less uncertainty there is regarding future customer demands, the availability of materials, and machineries processing reliability, the easier it is for manufacturing firms to follow a predetermined schedule. the manufacturing circle database does not include parameters that can be related to quality. however, other researchers have suggested that skills improvement translates into an improvement in quality. su et al. (2014) argue that, to sustain quality, manufacturing firms should focus first on meta-learning, which continually increases an organisation’s ability to learn. second, there should be a focus on sensing weak signals, which gives organisations the ability to detect subtle changes that could disrupt their quality performance. third, there should be a resilience related to quality disruptions, which would help organisations to adapt quickly and recover from disruptions when they occur. 5.3 path analysis the correlation between the competitive capabilities will remain unanalysed, because we have chosen not to identify one variable as the cause of the other variable. any correlation between these variables may actually be casual (one competitive capability causing another and/or inversely) and/or may be owing to (both competitive capabilities) sharing common causes. similarly, the feedback loop will remain unanalysed, as it provides an opportunity for critical review of a manufacturing firm’s performance by exploring continual improvement as bundle of routines to enable development of multiple competitive capabilities. 460 sajems ns 19 (2016) no 3:448-466 5.3.1 skills – throughput – delivery reliability the results of the regression analysis of skills – throughput – delivery reliability are presented in table 3. r-square with all three variables is equal to 0.642 and the adjusted r-square is 0.577. the path analysis model showed some interesting results in terms of model fit: chi-square is equal to 0.000, df is equal to 0, f is equal to 9.882567 and p-value is equal to 0.003494. as in the regression analysis, significant parameter estimates were observed: skills (p-value is equal to 0.007044) and throughput (p-value is equal to 0.001092). table 3 parameter estimates – path analysis (skills – throughput – delivery reliability) coefficients standard error t stat p-value lower 95% upper 95% intercept 0.108108 skills 1.441012 0.436308 3.302736 0.007044 0.480703 2.40132 throughput -1.63475 0.37289 -4.384 0.001092 -2.45548 -0.81403 5.3.2 skills – throughput – speed of delivery the results of the regression analysis of skills – throughput – speed of delivery are presented in table 4. r-square, with all three variables, is equal to 0.654 and the adjusted r-square is 0.591. the path analysis model showed some interesting results in terms of model fit: chi-square is equal to 0.000, df is equal to 0, f is equal to 10.42212 and p-value is equal to 0.002891. as in the regression analysis, significant parameter estimates were observed: skills (p-value is equal to 0.032983) and throughput (p-value is equal to 0.001677). table 4 parameter estimates – path analysis (skills – throughput – speed of delivery) coefficients standard error t stat p-value lower 95% upper 95% intercept -0.36452 skills -0.83372 0.342074 -2.43725 0.032983 -1.58662 -0.08082 throughput 1.206952 0.292353 4.128406 0.001677 0.563487 1.850417 5.3.3 skills – throughput – inventory – productivity the results of the regression analysis of skills – throughput – inventory – productivity are presented in table 5. r-square, with all four variables, is equal to 0.777 and the adjusted r-square is 0.710. the path analysis model showed some interesting results in terms of model fit: chi-square is equal to 0.000, df is equal to 0, f is equal to 11.63602 and p-value is equal to 0.001337. as in the regression analysis, significant parameter estimates were observed: skills (p-value is equal 0.00181), throughput (p-value is equal to 0.000822) and inventory (p-value is equal to 0.001272). table 5 parameter estimates – path analysis (skills – throughput – inventory – productivity) coefficients standard error t stat p-value lower 95% upper 95% intercept -1.3699 skills -3.73074 0.886911 -4.20644 0.00181 -5.7069 -1.75457 throughput 3.955029 0.838718 4.715561 0.00082 2.086247 5.82381 inventory -1.16219 0.26228 -4.4311 0.00127 -1.74658 -0.57779 path analysis models showed that improvement in core skills/competencies will result in an improvement in throughput and inventory. subsequently, faster throughput times and lower stock levels will result in an improvement in delivery reliability, productivity, and the speed of delivery. sajems ns 19 (2016) no 3:448-466 461 6 conclusion a model has been developed which attempts to provide mechanisms for process operations variability reduction which link the different operational performance measures at the manufacturing firm level. analysis of the manufacturing circle survey database provides a fair degree of support for this proposed conceptual model. statistical analysis shows that all the pairs of performance measure, according to the proposed model, have significant correlations with each other. path analysis models not only untangle the incomprehensible and complex relationships between the performance factors, but also show that process operations variability reduction is a function of earlier actions (derived from core skills/competencies) by the organisation that will have a positive impact on delivery reliability, the speed of delivery, cost, and quality. this model clearly outlines mathematical pathways to process operations variability reduction mechanisms through better execution of routines concerned with maintaining the performance of the current processes, improving the existing processes, and transforming or changing to new processes in order to develop sustainable competitive advantage. the path analysis models confirmed that the performance frontier is really a surface that spans many different dimensions, with each point representing different combinations of the various performance measures. altering the shape of the frontier in one dimension possibly also changes its shape in other dimensions. it should also be emphasised that the model presented here is essentially a dynamic one. it considers relationships between different performance measures according to longitudinal data; as performance improvement paths are time dependent. 7 suggestions for further research the manufacturing circle survey is compiled by pan-african investment and research services in order to capture economic and business conditions in the south african manufacturing industry. this research suggests that the survey should include the operating measure quality conformance. this would allow trending product quality and provide informed comment enabling future research to assess this competitive capability in the south african business environment. the theory of performance frontier suggests that manufacturing firms that are under the operating frontier will be subject to multiple competitive capabilities development, while the firms that are close to or on the operating frontier will be subject to trade-off. it would be interesting to differentiate firms that are below the operating frontier and those close to or on the operating frontier and then statistically empirically test the proposed 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research unit, south african reserve bank c harmse investment and trade policy centre, university of pretoria ________________________________________________________________ abstract this paper tests whether tariff liberalisation has lead to increased competitiveness in the south african economy. the 46 sectors of the south african economy are classified as exportable, importable, importable and exportable and non-tradable. the impact of trade liberalisation on domestic prices for importables and exportables is then assessed by making use of real exchange rate calculations. it is concluded that while increased globalisation of production processes in south africa may have improved the competitiveness of the tradable sector, tariff liberalisation played a minimal role in improving competitiveness in the manufacturing sector. jel f13, 31 1 introduction extensive trade (tariff) liberalisation was implemented in south africa during the 1990s. the primary motivation for this liberalisation policy was to improve competitiveness. a hypothesis that warrants further testing in the south african context is whether tariff liberalisation has led to increased competitiveness? this hypothesis informs the analysis in this paper. one way of assessing the effects of trade liberalisation is to consider its impact on the domestic prices for importables and exportables (dijkstra, 1997: 8). this paper uses real exchange rate (rer) calculations based on the relative prices of exportables and importables to non-tradables to analyse the impact of tariff liberalisation on competitiveness during the 1990s. section two gives an overview of some of the theoretical issues relating to the rer. section three provides a brief review of the tariff liberalisation policy of the 1990s. the penultimate section undertakes rer calculations and tests the sajems ns 6 (2003) no 4 644 above-mentioned hypothesis for south africa during the 1990s. finally, some conclusions are drawn in section five. 2 some theoretical considerations: the effect of trade liberalisation on the rer the real exchange rate (rer) provides an indication of the competitiveness and profitability of producing tradable goods. however, there are different definitions of the real exchange rate, which has led to some confusion in the use of rers in empirical analysis1. the purchasing power parity definition of the real exchange rate considers relative prices (domestic and international prices) multiplied by the exchange rate. this is given by: p p erer * 1 = (1) where e, p, p* refer to the exchange rate, domestic prices and foreign prices respectively. as holden (1988: 1-2) points out, when consumer price indices (cpis) are used as price measures, the rer captures the relative price of the baskets of consumption goods in the two countries. similarly, when producer price indices (ppis) or gross domestic product (gdp) deflators are used, the relative price of a basket of production goods is measured. in terms of equation (1) a country's competitiveness increases (decreases) if the relative price of its tradable goods decreases (increases). changes in the rer in south africa have attracted attention in economic literature (holden, 1988; kahn, 1998; walters & de beer, 1999; golub, 2000; edwards & schoer, 2000). the afore-mentioned studies have considered different measures of the rer and have mostly argued there was an improvement in south africa's competitiveness2. however, none of these studies have explicitly analysed the effects of trade liberalization on the rer competitiveness indicator. the rer, measured as the ratio of the internal relative price of tradables (pt) to the price of non-tradables ( np ), is probably the most popular analytical definition of competitiveness (edwards, 1992: 7). this definition emanated from the dependent economy model where the economy consisted of two sectors, namely the tradables and non-tradables sectors (corden, 1985; frenkel and mussa, 1984; frenkel and razin, 1987)3. in this case the rer is given by: n t p p rer =2 (2) where tp and np refer to the price of tradables and non-tradables respectively. sajems ns 6 (2003) no 4 645 an increase (decrease) in 2rer implies that the opportunity cost of producing tradables, measured in terms of foregone output of non-tradables has decreased (increased). this in effect means that the production of tradables is encouraged (discouraged). stated differently, an increase (decrease) in 2rer depicts a decline (improvement) in competitiveness. viewed in this way, rer changes reflect changes in the internal competitiveness of tradable goods vis-à-vis nontradable goods. aggregating exportables and importables into a single category implies that relative prices remain unchanged (holden, 1988). however, the impact of trade liberalisation is not uniform across import and export prices. liberalisation does not move the prices of exports and imports in the same direction, nor at the same pace. thus, the use of a composite tradable price index in the calculation of the rer may not accurately indicate movements in competitiveness during periods of trade liberalization. here, some of the important aspects in this regard are outlined, but readers are referred to milner and mckay (1996) for a more elaborate exposition4. the price of tradeables is a geometric average of the price of exportables ( xp ) and importables ( mp ), that is: )1( ββ −= xmt ppp (3) where β refers to the share of importables in tradables. substituting equation (3) into equation (2) and considering the proportionate change in the variables gives: nxm ppprer ˆˆ)1(ˆˆ 2 −−+= ββ (4) where mp̂ , xp̂ and np̂ refer to the proportionate change in the price of importables, exportables and non-tradables respectively. further, if it is assumed that the domestic price for exportables and importables is equal to the corresponding foreign prices multiplied by )1( te + and that foreign prices are constant )0ˆ( * =p then, equation 4 can be expressed as: nxm pdtdterer ˆ)1(ˆˆ 2 −−++= ββ (5) where e = exchange rate; t = trade measure; )ˆ1( ii tdt += ; i=x,m sajems ns 6 (2003) no 4 646 for simplicity a fixed exchange rate ( 0ˆ =e ) and exogenously determined nontradeables prices ( 0ˆ =np ) are assumed, then import liberalisation )0( <mdt would mean that in terms of equation 7 there is a real depreciation )0( 2 <rer . if the price of non-tradeables is endogenously determined say a positive relationship between np and the price of tradeables (i.e. 0ˆ >np when 0>mdt ) then with import liberalisation )0( <mdt 02 >rer when np̂ >∃dtm and 02 <rer when np̂ <∃dtm. thus, the impact of trade liberalisation on 2rer is ambiguous and depends on the change in the price of non-tradables (milner & mckay, 1996: 78). the relationship between non-tradable and tradable goods prices has an important bearing on the definition of the rer. it is important to recognise that the income and substitution effects emanating from tariff liberalisation could also influence the price of non-tradables. to restore equilibrium in the economy, the proportionate change in the price of non-tradables ( np̂ ) is given by: yupwpwp xxmmn ˆˆˆˆ ++= (6) where nnnn nini iw ηε εη − − = nnnn y n ηε η µ − = niη and niε are the elasticities of demand and supply for non-tradables with respect to the price of i ( xmi ,= ). ynη represents the income elasticity of demand for non-tradables. the first two terms on the right hand side reflect the substitution effects while the last term captures the income effects5. assuming homogeneity of degree zero in prices implies that 0>iw and the sum of iw is unity. equation (6) can thus be rewritten as follows: yupwpwp xmmmn ˆˆ)1(ˆˆ +−+= (7) substituting (7) into (5) and for simplicity assuming no income effects )0ˆ( =y gives: sajems ns 6 (2003) no 4 647 xmmmxm pwpwdtdterer ˆ)1(ˆ)1(ˆˆ 2 −+−−++= ββ (8) this translates into: xmmm dtwdtwerer )()(ˆˆ 2 ββ −+−+= (9) with mm dtp =ˆ ; xx dtp =ˆ further, if it is assumed that an exchange rate adjustment is equivalent to a uniform tariff on imports )( me and a subsidy on exports )( xe then the exchange rate effects could be represented as: xxmm edtedte +=ˆ (10) substituting (10) into equation (9) gives: )()())((ˆ 2 xxmmmm edtwedtwrer +−++−= ββ (11) in summary the effects would be as follows: • with no change in trade policy, the exchange rate effects are neutral. • trade liberalization )0;0( >< xm dtdt accompanied by an exchange rate depreciation )0;0( >> mx ee would cause the price of exportables to increase (since 0;0 >> xx edt ) but the movement in the price of importables is uncertain (since 0;0 >< mm edt ) i.e. import liberalization causes the prices of imports to decrease whilst the exchange rate depreciation causes importable prices to increase6. in addition, the substitution effects (wm) are important since they also influence the movement in the price of both exportables and importables. there are a number of factors influencing the price of tradables and nontradables. the theoretical analysis presented above has considered four factors, namely, trade policy changes, exchange rate changes, the substitution and income effects. the analysis has shown that under certain conditions trade liberalization could have ambiguous effects on the price of importables. it is for this reason, that if the intention is to analyse the likely effects of trade liberalization, then the rer measure should distinguish between the exportables and importables sectors (milner and mckay, 1996: 79). defining the rer in terms of the price of exportables ( xp ) and importables ( mp ) and replacing ( tp ) with ( xp ) and ( mp ) in equation (2) gives two definitions of the rer namely 7, sajems ns 6 (2003) no 4 648 n x a p p rer =2 (12) n m b p p rer =2 (13) since the primary concern here is the effects of tariff liberalisation during the 1990s, the effects of liberalisation on the two rer measures reflected in (12) and (13) need to be considered. with tariff liberalisation (and no change in the exchange rate), it can be expected that both arer 2ˆ and brer 2ˆ would depreciate (i.e. be <0); the depreciation in arer2 probably being less than that of brer2 8. however, tariff liberalisation accompanied by a depreciation in the currency, would cause arer2 to depreciate. the likely effects of this on brer2 would now be ambiguous depending on whether tariff liberalisation exceeds the depreciation in the exchange rate and the likely income and substitution effects emanating from the implementation of tariff liberalisation. in the latter case, it is thus possible that, with large depreciations in the currency, import prices would not decrease with tariff liberalization in relative terms. however, it is important to realize that separate relative price indices provide an indication of how macro-economic and other economic policies affect overall incentives in the economy (edwards, 1997), and as such one should be careful not to assign the primary importance to trade policy effects without due consideration to other factors that could have precipitated the change in the rer9. the empirical work to date has not always given due consideration to this aspect. further, with imperfect competition, domestic prices may not change in the expected direction with trade liberalisation. a possible reason for this may be due to lower import prices at the border not being passed on consumers (dijkstra, 1997: 8). this could result if there are a few importers dominating the market, or alternatively, if the retail network is dominated by a few sellers10. another reason could be the prevalence of "pricing to market" behaviour on the part of foreign suppliers. in this case, profit margins are reduced to absorb the tariff so as to maintain market share. in such cases, tariff liberalisation may not necessarily lead to reduced import prices11. sajems ns 6 (2003) no 4 649 3 a brief review of south africa's tariff liberalization policy during the 1990s12 by the beginning of the 1990s south africa's official policy stance was one of export-oriented industrialisation. the general export incentive scheme (geis) was introduced on 1 april 1990, with the objective of encouraging the production of value added exports. however, while export subsidies were used to reduce the anti export bias in the economy, the view that the path to export production should entail trade (and more specifically tariff) liberalisation began to gain ground. this is evident in the recommendations made by an official investigation into south africa’s tariff protection policy: “progress to greater export orientation, requires the responsible adjustment of the competitiveness of the existing industrial structure, which has been built up through import replacement, so as to enable it to deliver products at prices more in line with world prices. a generally accepted method of achieving this is to reduce tariffs and in addition, to follow a realistic exchange rate policy. the reduction of import tariffs is therefore an integral part of a process of progress towards export orientation” (idc, 1990: i–ii)13. this view was based on the evidence that south africa: “had the most tariff lines (more than 13000), most tariff rates (200 ad valorem rates), the widest range of tariffs and the second highest level of dispersion (as measured by the coefficient of variation) among developing countries” (imf, 2000: 54). for policy makers in south africa, “the lowering of tariffs will, however, serve first and foremost to strengthen the export orientation of south africa’s trade policy” (idc, 1990: v). there was thus a firm belief that the tariff protection policies (of the previous decades) created an anti export bias and hence did not promote competitiveness and economic growth. at the beginning of 1990, the protection system consisted mainly of quantitative restrictions, customs duties and import surcharges. in addition, the protection policy was subject to frequent changes, biased against exports and fairly complex (fallon and pereira de silva, 1994: 81)14. the overall statutory tariff while not too high (approximately 28 per cent) by international standards, nevertheless had a wide dispersion. within the manufacturing sector, consumer goods enjoyed the highest protection. with the election of a democratic government in 1994, the economic policy bias towards exports as a major stimulant of economic growth was further entrenched. this is clearly borne out in the growth, employment and redistribution (gear) strategy, which has since become a cornerstone of government policy. gear is aimed at “…strengthening the competitive sajems ns 6 (2003) no 4 650 capacity of the economy in the long term” (government of south africa, 1996: 7). further; competitiveness in the tradable goods sector is to be achieved through: “a reduction in tariffs to contain input prices” (ibid., 1996: 4)15. government policy is thus premised on the assumption that exports are vital for economic growth. further, reduced input costs improve cost competitiveness, which in turn facilitates increased export production. by the mid 1990s, it was clearly evident that the government was committed to abolishing geis, partly as a result of its incompatibility with gatt rules and partly because of a policy shift that entailed tariff liberalisation as a means of reducing the anti-export bias in the economy. the government's tariff liberalisation policy culminated in south africa’s offer to the gatt in 1994 and implemented in january 1995. in terms of the gatt offer, south africa agreed to bind 98 per cent of all tariff lines and to cut tariffs by a third (holden, 2001). the country also offered to convert all quantitative restrictions on agricultural imports to ad-valorem rates and to liberalise sensitive industries over an eightyear period (imf, 2000: 54). the offer to gatt clearly displayed a commitment to opening up the economy to foreign competition16. in terms of the offer, industrial protection was to be substantially reduced over a five-year period from an average tariff of around 12 per cent in 1994 to approximately 5 per cent in 2001. the average import weighted tariff rates were to be reduced to well within the wto bound rates; from 34 per cent to 17 per cent for consumption goods, from 8 per cent to 4 per cent for intermediate goods and from 11 per cent to 5 per cent for capital goods (tips, 2002: 11)17. south africa's commitment to liberalisation offer is borne out by an analysis of the applied rates over the latter half of the 1990s. the average import weighted tariffs since the gatt offer were significantly reduced from 28 per cent in 1990 to 10 per cent in 1998 (imf, 2000: 55). for agricultural products the rate was lowered from 9.23 per cent (1996) to 1.4 per cent (2000) while for industrial products it was reduced from 11.4 (1996) per cent to 8.6 per cent (2000). the average for the economy as a whole has seen applied rates come down from 11.3 per cent in 1996 to 7.3 per cent in 2000 (tips, 2002: 14). thus, the relevant question is whether the significant tariff liberalisation undertaken during the 1990s favourably impacted on competitiveness. this hypothesis will be tested for south africa in the next section. 4 trade liberalization and changes in the rer in south africa during the 1990s section 2 highlighted the influence of trade liberalization on the prices of tradable goods. the first step in calculating rer measures of competitiveness sajems ns 6 (2003) no 4 651 is to develop separate price series for importables, exportables and non-tradable goods. this is the focus of the next section. 4.1 developing price measures for the tradable and non-tradable sectors in order to establish the disaggregated price series it is necessary to distinguish between the tradable and non-tradable sectors. while the distinction between tradable and non-tradable sectors is central to many economic theories and models, much of the empirical work has relied on crude estimates to distinguish between the sectors. one such approach relies on a-priori assumptions about sectors. for example, goldstein and officer (1979) suggest that since exports and imports dominate in the agriculture, mining and manufacturing sectors; these sectors could be regarded as tradable sectors. this distinction was used in a study for australia (shann, 1982 cited in knight & johnson, 1997), mauritius (milner & mckay, 1996) and south africa (holden, 1988). however, a major disadvantage of this classification is that it is performed at a fairly aggregate level and as such may lead to inaccuracies in measurement. this may be due to some sub-sectors or industries (for example, in manufacturing) being wrongly classified as tradable when they may not be engaging in trade or vice versa. in addition, this classification does not allow for a shift between the tradable and non-tradable sectors. knight and johnson, (1997) suggest an industry based approach to distinguish between the tradable (exportables and importables) and non-tradable sectors. in this approach an industry is classified as exportable if it displays a significant degree of export orientation, importable if it is significantly involved in importsubstitution and otherwise non-tradable. for the classification of industries, the threshold values are important. dwyer (1992), balassa and associates (1982) and knight and johnson (1997) suggest a threshold value of 10 per cent to distinguish between sectors. the distinction between sectors is done on the following basis: • exportable (e) sectors have an export orientation (exports as a ratio of domestic production) exceeding 10 per cent. • importable (i) sectors are those in which imports as a ratio of domestic demand exceeds 10 per cent. • non-tradable (nt) sectors are all other sectors in the economy. • tradable sectors include the exportable and importable sectors. sajems ns 6 (2003) no 4 652 table 1 classification of sectors [1] lib. sect. [2] 1990 [3] 1991 [4] 1992 [5] 1993 [6] 1994 [7] 1995 [8] 1996 [9] 1997 [10] 1998 [11] 1999 [12] 2000 [14 2001 [15] agr, forestry & fishing e e e,i e e e e e e e e e coal mining e e e e e e e e e e e e,i gold and uranium mining e e e e e e e e e e e e other mining l e,i e,i e,i e,i e,i e,i e,i e,i e,i e,i e,i e,i food nt nt nt nt nt nt e i e,i e e,i e,i beverages nt nt nt nt nt nt e e nt e e e tobacco nt nt nt nt nt nt nt nt e e e e textiles e,i e,i e,i e,i e,i e,i e,i e,i e,i e,i e,i e,i wearing apparel l nt nt nt nt nt nt nt i i e,i e,i e,i leather i e,i e,i e,i e,i e,i e,i e,i e,i e,i e,i e,i footwear l nt nt i i i i i i i i i i wood & wood prod l nt nt nt e,i e,i e,i e,i e,i e,i e,i e,i e,i paper & paper prod l e,i e,i e,i e,i e,i e,i e,i e,i e,i e,i e,i e,i print, pub & recording i i i i i i i i i i i i coke and ref petrol l e e e e e e e,i e,i e,i e,i e,i e,i basic chemicals l e,i e,i e,i e,i e,i e,i e,i e,i e,i e,i e,i e,i other chem & man fibres l i i i i i i i i i i i i rubber i i i i i e,i e,i e,i e,i e,i e,i e,i plastic prod l nt nt nt nt nt nt i i i i i i glass & glass product l i i i e,i i i e,i e,i e,i e,i e,i e,i non metallic minerals nt nt nt nt i i i i i e,i i e,i basic iron & steel l e e e,i e e,i e,i e,i e,i e,i e,i e,i e,i basic non ferrous met. l e,i e,i e,i e,i e,i e,i e,i e,i e,i e,i e,i e,i metal prod excl mach. nt nt nt i i e,i e,i e,i e,i e,i e,i e,i machinery & equip l i i e,i e,i e,i e,i e,i e,i e,i e,i e,i e,i electrical machinery l i i i i i e,i e,i e,i e,i e,i e,i e,i tv radio and equip l i i i i i e,i e,i e,i e,i e,i e,i e,i professional & scientific l e,i e,i e,i e,i e,i e,i e,i e,i e,i e,i e,i e,i motor vehicles parts l i i i i i i i e,i e,i e,i e,i e,i other transport l i e,i e,i e,i e,i e,i e,i e,i e,i e,i e,i e,i furniture l nt nt nt nt e e e e e,i e,i e,i e,i other manufact. l e,i e,i e,i e,i e,i e,i e,i e,i e,i e,i e,i e,i electricity, gas & steam l nt nt nt nt nt nt nt nt nt nt nt nt water supply nt nt nt nt nt nt nt nt nt nt nt nt building construction nt nt nt nt nt nt nt nt nt nt nt nt civil eng. & other constr. nt nt nt nt nt nt nt nt nt nt nt nt wholesale and retail trade nt nt nt nt nt nt nt nt nt nt nt nt catering & accomm. serv. e,i e,i i i e,i e,i e,i e,i e,i e,i e,i e,i transport & storage e e nt nt e e e e e e e e communication nt nt nt nt nt nt nt nt nt nt nt nt finance & insurance nt nt nt nt nt nt nt nt nt nt nt nt business services nt nt nt nt nt nt nt nt nt nt nt nt medical, dental and vet. serv. nt nt nt nt nt nt nt nt nt nt nt nt excl medical, dental & vet. serv. nt nt nt nt nt nt nt nt nt nt nt nt other producers nt nt nt nt nt nt nt nt nt nt nt nt general govt. services nt nt nt nt nt nt nt nt nt nt nt nt source: data from tips, own calculations sajems ns 6 (2003) no 4 653 table 1 (see previous page) classifies the 46 sectors of the south african economy into either exportable (e), importable (i), importable and exportable (i,e) or non-tradable (nt). the dynamic nature of the classification procedure is clearly evident from the table as in the case of the food sector, which was classified as non-tradable up until 1995, exportable for 1996 and 1999 and importable for 1997 and both exportable and importable for 1998, 2000 and 2001. the number of non-tradable sectors has decreased from 22 (1990) to 12 (2001) during the period under analysis. of interest is that the number of sectors that are classified as importable and exportable (i,e) has increased from 8 in 1990 to 25 in 1991. this indicates that a larger number of sectors have been subject to increased competition in both the domestic and international markets. the question at this point is, what has been the role of tariff liberalisation on the competitiveness of these sectors? table 1 (column 2) also reflects those sectors that became more liberalised during the 1990s. this classification is based on the relative change in the average effective rate of protection (erp) measures between the period 1988-93 and 1994-98. a minimum 10 per cent reduction qualifies the sector for classification as liberalised. the erp measures used in the classification of the sectors are contained in table 2 (see later page). using this industry classification, the price series at the disaggregated sector level are established. trade liberalisation measures are meant to influence the prices received by domestic producers for their output. table 3 reflects the respective price series. the price of importables ( mp ) is the weighted sum of the gdp deflators for the importable sectors18. similarly the price of non-tradables is given by the weighted sum of gdp deflators for the non-tradable sectors. three different calculations are undertaken for the price of exportables. 1xp is an export weighted sum of gdp deflators for the exportable sectors19. 2xp is an exportweighted sum of the price of exports of the respective industries20. 3xp is the export price series calculated by the south african reserve bank (sarb)21. it is interesting to note that there is very little difference between 1xp and 2 xp which implies that there is very little difference between the prices charged for domestic goods and similar goods that are exported. however, the price series of the sarb ( 3xp ) shows a significant upward divergence after 1995. this may be primarily due to the sarb index being dominated by resource intensive commodities and as such the depreciation of the currency, coupled with the increases in commodity prices during the latter part of the 1990s, may have biased the price index upwards22. tp is a weighted sum of 2 xp and mp 23. sajems ns 6 (2003) no 4 654 table 2 effective rate of protection for sectors of the south african economy sector erp88 erp89 erp90 erp91 erp92 erp93 erp94 erp95 erp96 erp97 erp98 erp8893 epr9498 agr, forestry & fishing 0.04 0.04 0.05 0.06 0.06 0.06 0.06 0.05 0.07 0.06 0.08 0.052 0.064 coal mining -0.01 -0.01 -0.01 -0.01 -0.01 -0.01 -0.01 -0.01 -0.01 -0.01 -0.01 -0.010 -0.010 gold & uranium mining 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.04 0.02 0.000 0.012 other mining -0.08 -0.04 -0.04 -0.07 -0.07 -0.07 -0.08 -0.05 -0.06 -0.04 -0.04 -0.062 -0.054 food -0.01 -0.01 0.02 0.04 0.07 0.05 0.08 0.07 0.05 0.06 0.06 0.027 0.064 beverages 0.03 0.00 0.00 0.01 0.00 0.01 0.01 0.01 0.01 0.02 0.01 0.008 0.012 tobacco 0.02 0.02 0.06 0.02 0.03 0.06 0.07 0.22 0.07 0.22 0.04 0.035 0.124 textiles 0.15 0.14 0.11 0.10 0.07 -0.01 0.03 0.08 0.17 0.17 0.23 0.093 0.136 wearing apparel 0.15 0.19 0.15 0.09 0.08 0.03 0.06 0.07 0.07 0.11 0.11 0.115 0.084 leather 0.22 0.20 0.20 0.21 0.20 0.21 0.20 0.17 0.22 0.24 0.26 0.207 0.218 footwear 0.33 0.26 0.24 0.31 0.33 0.33 0.34 0.21 0.23 0.23 0.21 0.300 0.244 wood & wood prod 0.03 0.02 0.03 0.02 -0.01 0.02 0.02 0.00 0.01 0.02 0.02 0.018 0.014 paper & paper prod 1.24 1.14 1.00 1.15 1.14 1.20 0.87 0.49 0.62 0.54 0.56 1.145 0.616 print, pub &recording 0.14 0.10 0.11 0.15 0.14 0.14 0.14 0.10 0.14 0.14 0.15 0.130 0.134 coke & ref petrol -0.01 -0.02 -0.01 -0.02 -0.01 -0.01 0.00 -0.01 -0.03 -0.01 -0.01 -0.013 -0.012 basic chemicals 0.10 0.06 0.06 0.04 0.04 0.05 0.03 0.03 0.03 0.02 0.03 0.058 0.028 other chem & man fibres 0.05 0.04 0.04 0.05 0.03 0.03 0.03 0.02 0.08 0.03 0.01 0.040 0.034 rubber 0.17 0.18 0.18 0.17 0.16 0.16 0.16 0.13 0.16 0.19 0.18 0.170 0.164 plastic prod 0.17 0.15 0.15 0.34 0.15 0.16 0.16 0.10 0.12 0.10 0.11 0.187 0.118 glass & glass prod. 1.25 1.14 0.88 0.86 0.86 0.93 0.78 0.54 0.46 0.47 0.57 0.987 0.564 non metallic minerals 0.01 0.00 0.01 0.01 0.01 0.01 0.01 0.00 0.01 0.01 0.01 0.008 0.008 sajems ns 6 (2003) no 4 655 table 2 continued sector erp88 erp89 erp90 erp91 erp92 erp93 erp94 erp95 erp96 erp97 erp98 erp8893 epr9498 basic iron &steel 0.21 0.20 0.23 0.22 0.19 0.21 0.21 0.13 0.15 0.17 0.16 0.210 0.164 basic non ferrous met 0.06 0.07 0.08 0.07 0.05 0.05 0.07 0.05 0.06 0.02 0.02 0.063 0.044 metal prod excl mach. 0.01 0.02 0.02 0.00 0.00 0.01 0.01 0.01 0.01 0.01 0.01 0.010 0.010 machinery & equip 0.00 -0.01 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 -0.002 0.000 electrical machinery 0.05 0.04 0.04 0.04 0.04 0.04 0.03 0.02 0.04 0.03 0.03 0.042 0.030 tv radio & equip 0.11 0.11 0.12 0.11 0.12 0.12 0.09 0.06 0.03 0.03 0.02 0.115 0.046 profess. &scientific 0.11 0.10 0.10 0.10 0.09 0.09 0.11 0.06 0.07 0.08 0.10 0.098 0.084 motor vehicles parts 0.08 0.07 0.06 0.07 0.05 0.05 0.03 0.03 0.04 0.04 0.02 0.063 0.032 other transport 0.01 0.00 0.01 0.01 0.01 0.01 0.00 0.00 0.01 0.00 0.00 0.008 0.002 furniture 0.17 0.07 0.08 0.11 0.08 0.04 0.01 0.03 0.05 0.06 0.04 0.092 0.038 other industries 0.05 0.04 0.05 0.05 0.04 0.04 0.03 0.02 0.02 0.00 0.00 0.045 0.014 elect gas and steam 0.07 0.07 0.07 0.07 0.07 0.07 0.07 0.05 0.07 0.06 0.06 0.070 0.062 building const. -0.01 0.00 0.00 -0.01 -0.01 -0.01 -0.01 0.00 -0.01 -0.01 -0.01 -0.007 -0.008 wholesale & ret. trade 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.000 0.000 transport &storage 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.000 0.000 finance and ins. -0.19 -0.18 -0.20 -0.20 -0.20 -0.20 -0.20 -0.15 -0.22 -0.17 -0.18 -0.195 -0.184 med, dent, health & vet. 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.000 0.000 source: fedderke & vase, 2001, own calculations sajems ns 6 (2003) no 4 656 figure 1 price of exportables, importables and non-tradables 50 70 90 110 130 150 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 year p ri ce in de x pm pn px sajems ns 6 (2003) no 4 657 figure 2 growth rates of exportable, importable and non-tradable price 0 2 4 6 8 10 12 14 16 18 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 pm pn px sajems ns 6 (2003) no 4 658 figure 1 graphically depicts the price indexes for the importable, exportable and non-tradables sectors24. in general the trend is the same for all the price series. however, during the early 1990s, exportables and importables prices increased faster than those of non-tradables. between 1996 and 2000, non-tradable prices increased faster than those of exportable and importable prices with a relative moderation in the price of tradables being particularly evident between 1995 and 1999. the moderation in prices is analysed by considering the annual rate of increase in the price of exportables, importables and non-tradables sectors (figure 2). this is informative as it gives an indication of the trend in the rate of price increases. the three price series have the same trend. throughout the period under analysis there has been a continuous deceleration in the price of nontradables, to the extent that, by the end of the period under analysis, the annual rate of increase in prices was lower than that of the exportable and importable commodities. the price of importables shows a moderation in its rate of increase from 1995 to 1998 and the price of exportables from 1993 to 1997. however, the price increases of importables (since 1998) and exportables (since 1997) have accelerated quite rapidly. it is important to realise that the competitiveness of an industry does not depend on absolute but relative prices. this aspect is explored in more detail in the next section. 4.2 trade liberalisation and its effect on prices during the 1990s l mp (in table 3) reflects the price series for the importable sectors that were liberalised and nlmp the importable sectors that were not liberalised 25. the liberalised sectors are those reflected in column 2, table 1. one advantage of distinguishing between the liberalising and non-liberalising sectors is that it provides an indication of the likely impact of trade liberalisation on prices. in other words, if all other effects (e.g. exchange rate changes, substitution and income effects, cost influences, etc.) are assumed to be uniform across the importables sector, then any divergence between lmp and nl mp would be due to trade liberalisation measures26. lmp and nl mp show very little divergence from each other implying that the price of importables that were liberalised increased at the same pace as those that were not liberalised. this suggests that the liberalisation implemented during the 1990s may not have had the intended (expected) effect of reducing the prices of importables. tsikata (1999: 10) argues that tariffs had a reduced impact on prices during the 1990s. figure 2 provides some implicit support for this, in the sense that there is a moderation in increase in all tradable (exportables, importables and tradables) prices during the period of trade liberalisation (particularly between 1995 to sajems ns 6 (2003) no 4 659 1999). however, on closer examination, it should be noted that the moderation in prices began in the early 1990s some time before the implementation of tariff reform in 1995. thus the deceleration in prices suggests that there may be other factors (for example, the abolition of sanctions) that could have played a greater role in improving competitiveness than tariff liberalisation per se. in addition, tsikata's (ibid.) conclusions are drawn by comparing the local currency value of manufactures (muvlc) and the domestic import price of manufactures (ppim). muvlc is proxied by "the product of the us dollarbased international manufactures unit value and the nominal exchange rate visà-vis the us dollar" (ibid.: 10) and this is taken to represent the expected rate of increase in domestic prices. a comparison (of muvlc and ppim) is taken to reveal whether import prices (ppim) have in fact decreased faster than what would have been expected (muvlc). however, some reservations can be expressed about the proxies used in the analysis. firstly, the manner in which muvlc is calculated does not give due recognition to the major differences between the structure of the us manufacturing sector vis-à-vis that of south africa27. secondly, ppim represents the price of imports and not necessarily importables; and in analysing the effects of liberalisation we are concerned with the impact of trade liberalisation on the price of importables28. table 3 price series of exportables, importables, tradables and nontradables year mp lmp nl mp np 1 xp 2 xp 3 xp tp 1990 65 65 62 56 68 66 69 65 1991 68 70 70 64 70 69 72 69 1992 76 75 78 74 71 72 77 74 1993 83 83 83 84 82 82 83 82 1994 90 90 90 91 91 91 93 91 1995 100 100 100 100 100 100 100 100 1996 107 107 106 108 110 109 108 108 1997 115 115 116 119 115 115 116 115 1998 120 120 122 127 121 121 129 121 1999 127 128 128 135 128 129 138 128 2000 141 145 132 144 146 146 157 143 2001 155 155 155 154 160 160 183 158 source: authors' calculations with data from quantec as mentioned earlier in the theoretical section, a measure of the internal competitiveness of a sector is obtained by considering the price indexes for the importables, exportables and tradable sectors relative to the price index for nonsajems ns 6 (2003) no 4 660 tradables (dwyer, 1992: 451). an increase (decrease) in any of these relative prices represents a decline (improvement) in competitiveness. the price indices are reflected in table 4. table 4 relative prices of exportables, importables, tradables and non-tradables year n t p p n x p p n m p p n l m p p n nl m p p 1990 117 118 115 116 110 1991 107 108 105 109 108 1992 99 97 102 101 104 1993 99 98 99 99 100 1994 99 100 99 99 99 1995 100 100 100 100 100 1996 100 101 99 99 98 1997 97 97 97 97 98 1998 95 95 95 94 96 1999 95 95 94 94 95 2000 100 101 98 100 92 2001 102 104 101 101 100 source: table 3, authors' calculations the rer measures recorded in table 4 reveal some interesting characteristics of the tradable sectors. all indices depict a declining trend (improved competitiveness) for most of the period29. once again it is evident that the improvement in competitiveness during the major part of the 1990s, started before the implementation of tariff reform. in addition, the fact that the competitiveness of the non-liberalised sectors ( n nl m p p ) differs very little from the liberalised sectors ( n l m p p ) also calls into question the extent to which tariff liberalisation may have increased competitiveness during the 1990s. 5 conclusions in this paper we have analysed the competitiveness of tradable sectors vis-à-vis non-tradable sectors using a variant of the conventional rer measure. while increased globalisation of production could have contributed to the improved competitiveness of the tradable sector, the evidence presented in this paper suggests that tariff liberalisation (which essentially began in 1995) may have sajems ns 6 (2003) no 4 661 played a minimal role in improving the level of competitiveness of south africa's manufacturing sector. it could be the case that factors such as the abolition of sanctions, pricing to market behaviour on the part of foreign suppliers, domestic and international cost factors, etc. could have been more important determinants of competitiveness. these aspects warrant further empirical analysis. endnotes 1 see edwards (1989) for a discussion of the ambiguities related to the different definitions of the rer 2 the evidence suggests that indicators based on real effective exchange rate calculations have overstated the extent of the improvement in south africa's competitiveness. these studies have in the main emphasized the different theoretical and measurement issues pertaining to the calculation of the rer. 3 tradables are classified as those goods whose prices are determined on the world market; they include both exportables and importables. nontrabables on the other hand are classified as those goods whose prices are determined domestically. 4 milner and mackay (1996) provide an elegant theoretical justification for the use of disaggregated tradable (i.e. exportables and importables) price indices in the calculation of the rer. they use the rer calculations to date the liberalisation episode in mauritius. however, in this paper we use the rer calculations to analyse the impact of trade liberalisation on competitiveness. 5 see milner and mckay (1996) for a more elaborate exposition of these concepts. 6 this occurs even if import liberalization exceeds the depreciation in the currency (i.e. 0<+ mm edt ), rer2>0 when mw>β 7 following, edwards (1992), the rer for the economy as a whole can be expressed as: rer = arer2α + )1( α− brer2 where α and )1( α− represent the respective trade weights. 8 the depreciation in arer2 depending on the share of imported inputs used in production. for simplicity the income and substitution effects are ignored. 9 an attempt is made to address this issue by distinguishing between the price movements in the price of liberalised and non-liberalised importables. 10 this was the case for food prices in nicaragua (see dijkstra ,1996). sajems ns 6 (2003) no 4 662 11 therefore the analysis of the effects of pass-through effects of tariff changes to import prices is important to ascertain if the envisaged benefits (reduced import prices) are in fact realised. 12 see bell, 1997 and tips, 2002 for a more elaborate review of the protective measures during this period. 13 the minister of trade, industry and tourism commissioned the industrial development corporation, in collaboration with the board of trade and industry, to "investigate the efficacy of the existing tariff protection policy". 14 complexity was due to a variety of different tariff rates and exemptions granted on a firm-by-firm basis rather than a product-byproduct basis. 15 it is interesting to note that the objective of striving for international competitiveness is not meant to be isolated from social objectives. in fact one of the stated intentions of economic policy is “to support a competitive and more labour-intensive growth path” (gear, 1996: 7). 16 this section is mainly based on tips (2002). 17 the bound rates are 26 per cent, 4 per cent and 15 per cent for consumption, intermediate and capital goods respectively. 18 the laspeyres price index formula was used which is given by 0i it it p p wp ∑= where itw reflects the share of industry i contribution to the total value of output of the importables sector in time period t. pit is the price index of the commodities produced by industry i in period t and pi0 the price index of the commodities produced by industry i in the base period. the price indices were proxied by the gdp industry deflators which were obtained from the tips standard industrial classification database. 19 the weight used in the calculation of the index is the share that the respective industries contribute to the value of exports of the exportable sectors. 20 the index was constructed from the export price series of the respective industries, which were obtained from the tips standard industrial classification database. 21 the export price series calculated by the sarb, is an extrapolation done from unit values of some of south africa's major export commodities. the major difference between 2xp and 3 xp is that the former is derived from the gdp deflators of all the exportable industries while the latter considers the export unit values of some of south africa's major export commodities. 22 the nominal effective exchange rate depreciated by 35 per cent between 1990-95 and by 43 per cent between 1995-2001. 23 the weights are made up of exports and domestic demand for exportables and importables respectively. sajems ns 6 (2003) no 4 663 24 export prices used in the graph are given by 2xp and import prices by mp in table 3. 25 the weights used were the respective share of the industries to the value of output of the liberalised and non-liberalised importable sectors. 26 with the exception of 1992, 1997 and 1998, the price index for liberalised sectors was either the same (for most of the years) or even higher (as in 1996, 2000) than that for non-liberalised sectors. 27 the us manufacturing sector is composed of more technology intensive sectors. 28 as argued earlier on, it may the case that due to lack of competition between importers the benefits of lower import prices may not be passed on to consumers. 29 during 2000 and 2001 there was a relative decline in the competitiveness of the tradable sector. references 1 balassa & associates (1982) development strategies in semiindustrial economies, world bank: washington dc. 2 bell, t. 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(1984) "asset markets, exchange rates and the balance of payments: a reformulation of doctrine" in jones, f. and kenen, p (eds), handbook of international economics, north holland: amsterdam. 13 frenkel, j.a. & razin, a. (1987) fiscal policies and the world economy, mit press: cambridge, massachusetts. 14 government of south africa, (1996) growth, employment and redistribution: a macroeconomic strategy, ministry of finance: pretoria. 15 goldstein, m. & officer, l. (1979) "new measures of prices and productivity for tradable and non-tradable goods", the review of income and wealth, series 25(1): 413-27. 16 goldstein, m. & officer, l. (1980) "prices of tradable and nontradable goods in the demand for total imports", review of economics and statistics, lxiii(2): 190-99. 17 golub, s.s. (2000) "south africa's international cost competitiveness", tips working paper no 14, tips: johannesburg. 18 holden, m. (1988) "definitions and calculations of real exchange rates: an application to south africa", occasional paper no. 20, economic research unit, department of economics, university of natal: durban. 19 holden, m. (2001) trade policy in a liberalising economy, mimeo, university of natal: durban. 20 industrial development corporation (1990) modification of the application of protection policy, idc: sandton. 21 international monetary fund (2000) "south africa: selected issues", imf staff country report no. 00/42: 51-58, imf: washington. 22 kahn, b. (1998) "assessing south africa's competitiveness: is the reserve bank's real exchange rate measure misleading?", centre for research and finance in south africa quarterly review, centre for research and finance in south africa, lse: london. 23 knight, g. & johnson, l. (1997) "tradables: developing output and price measures for australia's tradable and non-tradable sectors", working paper no 97/1, australian bureau for statistics: canberra. sajems ns 6 (2003) no 4 665 24 milner, c. & mckay, a. (1996) "real exchange rate measures of trade liberalisation: some evidence for mauritius", journal of african economies, 5(1): 69-91. 25 shann, e.w. (1986) "australia's real exchange rate during the twentieth century: comment", in nguyen, d. and gregory, r. (eds), exchange rates and the economy, supplement to economic record: 79-91. 26 trade and industry policy strategy (2002) the state of trade policy in south africa, tips: johannesburg. 27 tsikata, y. (1999) "liberalisation and trade performance in south africa", informal discussion papers on aspects of the economy of south africa, southern africa department, world bank: washington. 28 walters, s & de beer, b. (1999) "an indicator of south africa's competitiveness", sarb quarterly bulletin, (september): 54-65. abstract introduction literature review research methodology findings managerial implications and recommendations conclusion acknowledgements references appendix 1 about the author(s) musenga f. mpwanya department of marketing, logistics and sport management, tshwane university of technology, south africa cornelius h. van heerden faculty of management sciences, office of the executive dean, tshwane university of technology, south africa citation mpwanya, m.f. & van heerden, c.h., 2017, ‘a supply chain cost reduction framework for the south african mobile phone industry’, south african journal of economic and management sciences 20(1), a1464. https://doi.org/10.4102/sajems.v20i1.1464 original research a supply chain cost reduction framework for the south african mobile phone industry musenga f. mpwanya, cornelius h. van heerden received: 28 aug. 2015; accepted: 26 aug. 2016; published: 31 mar. 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the costs incurred in the provision of products and services across the supply chain are on the rise in many industries, including the mobile phone industry. despite this, there is limited information in south africa on the perceptions of supply chain players regarding cost reduction in the mobile phone industry. furthermore, there is currently no framework for reducing supply chain costs in the south african mobile phone industry. aim: the purpose of this study is to explore supply chain costs in the south african mobile phone industry, and to develop a supply chain cost-reduction framework for the south african mobile phone industry. setting: this study explores supply chain costs in four mobile phone companies operating in the south african mobile phone industry, of which three mobile network operators and one mobile retailing group. it uses semi-structured interview data collected in 2011. method: this study adopted a qualitative case study design to understand supply chain costs and develop a supply chain cost-reduction framework for the south african mobile phone industry. eight semi-structured interviews with managers of mobile phone companies were conducted. the data were analysed with the help of atlas.ti, using an adapted three-phased analytical framework as suggested by miles and huberman (1994) and o’ dwyer (2004). results: the study found that consolidation of strategic relationships through collaboration and strategic alliances between mnos and other supply chain players is one of the ways to drive costs down across the supply chain. outsourcing of some of the support activities and retailers’ direct purchasing transactions from device manufacturers were also found to be other avenues for reducing supply chain costs in the industry. conclusion: the study suggests that mobile network operators (mnos) need to consolidate their strategic relationships by increasing the share of the network infrastructure, and emphasising the need to strive for operational efficiencies. this combined effort should result in significant cost reductions across the supply chain. the findings of this study provided some avenues that managers of mobile-phone companies could consider to drive costs down supply chain-wide and service end-users at lower rates. the findings of this study could also help regulating authorities to get insights into supply chain cost reduction and develop appropriate mobile phone policies in south africa. introduction accurate information on supply chain processes is a key factor in managing costs in supply chains, and in gaining and sustaining a competitive advantage. however, operating expenses, like supply chain costs, expended by many companies, including mobile phone companies in the provision of products and services, are colossal. these costs impact on the tariffs paid by the end-users. this has led many companies to embark on cost reduction programmes supply chain-wide. aqua management consulting group (2008) outlines that cost reduction should be a continuous improvement commitment for companies seeking to meet their customers’ demand for a better quality of products or services at a lower price. likewise, fawcett, ellram and ogden (2007) state that implementing cost reduction as an isolated improvement programme would be ineffective, because cost reduction affects other functions, like the supply chain, and the firm’s value proposition to its customers. wagner, erhun and gross-ruyken (2009) conducted a study on top supply chain challenges that motivate action in the united states and europe. they identified cost reduction as one of the major supply chain challenges faced by manufacturing companies and one of the most powerful ways to increase profitability. the study also highlights a range of value-adding and improvement mechanisms that could be used to reduce supply chain costs. these mechanisms include process efficiencies, shorter cycle times and increased supply chain visibility, lean techniques, resource utilisation, as well as the elimination of unnecessary resources and lower inventory levels. wisner, tan and leong (2009) agree with the above authors and state that cost reduction remains one of the top supply chain priorities. at its maturity stage, supply chains tend to focus on performance improvement in terms of identified cost reduction activities, using continuous improvement efforts, better supply chain communication and inventory visibility, and a further integration of business processes pertaining to waste, purchasing, distribution, inventory and non-value-adding activities among supply chain partners. in an effort to drive costs down and to focus on the core business, several telecommunications network operators in the united states have used the shared-service model in some key functions (katz & hamilton 2003). in a study by sachan, sahay and sharma (2005), on developing a supply chain cost model in the indian agricultural sector, the use of the system-dynamics grain supply chain model was suggested to reduce costs supply chain-wide. research by wu (2005) in the united states automatic test equipment industry found that architectural costs are hierarchically organised and interrelated. aqua management consulting group (2008) conducted its study in the indian automotive industry. this study suggests that supply chain cost reduction can be achieved by maintaining balanced inventory levels, increased inventory returns and better resource utilisation. however, little is known on supply chain cost reduction in the south african mobile phone industry or in the rest of the world. more importantly, no public study has provided a supply chain cost reduction framework for the south african mobile phone industry. the research question posed for this study is: how can the south african mobile phone companies effectively reduce their costs supply chain-wide? the purpose of this study is to develop a supply chain cost reduction framework for this industry. the rest of the article is organised as follows. ‘the literature review’ section includes background on cost in the telecommunication industry and on supply chain cost reduction models. ‘the research methodology’ section provides the methodologies followed to collect the data and answer the research question. ‘the findings’ section’ reports and discusses the findings and presents the proposed supply chain cost reduction framework for the south african mobile phone industry. and, the ‘conclusion’ section is followed by the last section ‘managerial implications and recommendations’. literature review cost in the telecommunication industry the telecommunications industry allocates enormous funds to operating expenditure (opex). the major components of the overall cost include information technology, finance and sales and marketing (katz & hamilton 2003). with regard to technology cost, harmantzis, trigeorgis and tanguturi (2006) indicate that the telecommunication market requires substantial technological investment. because of the speed in technology change, mobile phone companies are constrained to upgrade their network infrastructure and provide better service to their end-users. mishra et al. (2005) view opex as the cost expended by mobile network operators (mnos) for operating and maintaining the network infrastructure and for providing services to customers. it consists of labour costs, recurring power costs, licence fees and per call termination charges. al-debei and avison (2009) and peppard and rylander (2006) point out that mnos’ opex exceeds the capital expenditure (capex) in value. pattanavichai, jongsawat and premchaiswadi (2011) define capex as the expenses incurred to purchase the physical resources needed for the upgrade of the telecommunication infrastructure. this includes the site construction cost, base station cost, switch cost, antenna cost, radio cost and the integration cost, which are expended for building a single cell site. however, although capex is considered as ‘a good indicator of the level of investment performed by mnos’ (idate consulting 2015), high capex with low return on investment has become another challenge faced by the telecommunication industry globally (firli, primiana & kaltum 2015; pwc analysis 2012). an mno is a firm that owns a mobile network facility, and it provides mobile telecommunication services to customers (jing & xiong-jiang 2011). in addition to network connectivity that mnos offer to their customers, camponovo and pigneur (2003) note that mnos also offer a variety of network-related services, ranging from location information to user identification via billing services to customers. in the south african context, the business portfolio of mnos includes network connectivity, starter packs and air times. this has contributed to the strength and dominance of mnos over other players and to weak competition in the mobile phone industry. in order to address this situation, telecommunication policies need to be revisited. in a global effort to increase competition and provide better service propositions to customers, many countries have embarked on more deregulations of the mobile phone space, which have led to the emergence of mobile virtual network operators (mvnos). kalmus and wielhaus (2010) define an mvno as a business entity that purchases capacity or minutes at wholesale rates from an mno and then resells these under their brand label to customers. in this way, they avoid owning and operating their own mobile network facility. song (2010) believes that mvnos are vehicles that strengthen competition for various mobile services. he argues that the establishment of mvnos should, in principle, increase retail competition and therefore reduce the prices of mobile services (song 2010). however, in south africa, the introduction of mvno and the reduction of mobile termination rates through regulations have not yet fully translated into increased retail competition and lower mobile services to the end-users. camponovo and pigneur (2003) argue that given the central role of mnos in the mobile telecommunication landscape, they should partner with other industry players including content providers, application providers, service providers (sps), virtual operators and portals, in order to effectively fulfil their core business. differentiating content providers and content enablers from sps, sabat (2002) pointed out that while application providers, also known as content enablers, determine the possible services that users should utilise when they are connected to the internet network, or to other telecommunication networks, content providers offer tailor-made and predetermined contents to the end-users. these are referred to in some circles as personalised contents, whereas mobile-wireless sps ensure that users have access to mobile-wireless content via the networks. according to brito and pereira (2006), an sp is a firm that purchases air time from an mno and then resells them to the final consumers. echoing collaboration, communication and co-operation, al-debei and avison (2007) assert that the complexity of a value network is largely dependent on technological advances. these changes in technology require mnos to establish collaboration, communication and co-operation in order to be effective. these authors go on to say that such collaboration among value network companies is critically important in enabling the acquisition of assets and the provision of any complementary services needed to meet the needs along the value network (al-debei & avison 2007). stuhmeier (2012) argues that the rollout of long-term evolution (lte), also known as fourth generation (4g), has caused mnos to embrace collaboration on infrastructure building or use the infrastructure or network sharing approach. lange (2012) views 4g as the highly advanced mobile technology. in order to monitor supply chain cost effectively, it is important to understand what drives cost in organisations. mowen, hansen and heitger (2009) view a cost driver as a causal factor that measures the output of the activity that causes cost changes to occur. fawcett et al. (2007) point out that ‘cost drivers vary over time and among different products and services’. according to mowen et al. (2009), companies that identify and manage cost drivers are believed to be well positioned to ensure better cost forecasting and cost control. many scholars classify capex among the main cost drivers of the mobile phone industry (harmantzis et al. 2006; sabat 2002). according to machuca (2006), capex and opex make up network operators’ total cost of ownership. considering the ever-growing nature of opex for the mobile telecommunications industry (pattanavichai et al. 2011) and the increasing need for cost reduction in the mobile telecommunications industry globally, mnos should revisit their total cost of ownership and decrease their opex. a decrease in supply chain costs could be one of the keys in addressing the high costs of mobile services in the south african mobile phone industry. supply chain cost reduction models the increasing need for reducing telecommunications costs has led several network operators in the united states to use the shared-service model for some key functions (katz & hamilton 2003). ulbrich (2006) describes shared services as a business approach that combines or consolidates services within an organisation. bergeron (2003) argues that firms that implement the shared-service model have many benefits, including reduced costs (resulting from increased efficiencies, decreased personnel requirement and improved economies of scale), improved services, a greater focus on the firm’s core activities and the externalisation of the potential profit centre. the shared-service model can be used by a single firm or in a supply chain setting. in south africa, because of pressure to reduce costs from the independent communication authority of south africa (icasa), the mnos have embarked on the shared-service model, whereby they have returned network infrastructure and its maintenance cost to manufacturers (suppliers). however, in comparison with other countries, several studies point out that mobile service costs in south africa are still too high for the end-user (chetty 2011; research ict africa 2013). su and lei (2008) proposed a theoretical supply chain cost reduction model containing four pillars, namely supply chain costing, improving processes, compressing supply chain time and smoothing the interfaces. wisner et al. (2009) suggest that companies can reduce supply chain costs through waste reduction, purchasing and product-distribution costs, as well as excess inventories and non-value-adding activities among the supply chain participants. anklesaria (2008) suggests two approaches to reducing supply chain costs, namely cost negotiation and breakthrough ideas. cost negotiation is a multi-fold process. it begins with the creating of robust sourcing teams responsible for trading volume for price. this is followed by price monitoring that balances a buying firm’s benefits against an industry pricing trend. to outdo the market trend and to sustain the price monitoring effort, graphs and maps relating to industry price trends are used against current prices charged for a range of specific products and services. on the contrary, the authors emphasise that breakthrough ideas lie in building and maintaining buyer-supplier collaborative relationships. collaboration can provide many benefits to a buying firm if there is a strategic emphasis on managing supplier relationships. to achieve significant savings in capex and opex, many mobile phone companies have embarked on a set of business agreements, including collaboration and outsourcing. according to hasbani et al. (2009), telecom players need to combine outsourcing of operational functions (such as field operations and network services) with infrastructure sharing, in order to reduce their cost. frisanco et al. (2008) argue that, for network operators who aim to reduce their operating costs through collaborative schemes, outsourcing becomes the right option. these authors point out some of the benefits associated with outsourcing, which include higher interactions (synergies) from services alignment, the facilitation of the sharing process, the provision of a neutral governance model and the protection of each operator’s data (frisanco et al. 2008). companies that outsource operational functions should not only aim to reduce costs but also to enhance effectiveness, so that high-standard products and services can be provided to their customers. yu and yang (2011) argue that efficiency can be successfully achieved in the business-chain system when mnos outsource various content services from professional content providers. according to frisanco et al. (2008), there is a need for full turnkey equipment and operation outsourcing to support network sharing efforts and to thereby increase savings on capex and opex. gsma (2014) points out that there have been some moves to introduce network sharing in south africa, nigeria and ghana, but so far it has not been widely adopted by operators as a strategy to increase capacity and coverage. (p. 32) network sharing and reduction in capital and operating costs do position mobile phone companies not only for increased profitability but also for greater competitiveness and reduced mobile prices to end-users. liao and gonzalez (2009) maintain that for telecommunication companies to become more competitive and profitable, they should concentrate more on improving their productivity and efficiency. similarly, liao and lin (2011) point out that although productivity and efficiency play a crucial role in competitive markets, companies need to know themselves in terms of their strengths and weaknesses, in order to alter their managerial efforts strategically, and to increase their efficiency and profitability. this could help them build and secure the competitive edge. outsourcing has driven many companies globally to become more efficient and cost reduction inclined or oriented (marshall, mc ivor & lamming 2007). it is argued that outsourcing partners could consolidate their production processes to pave the way for better and lower-cost services to customers in countries that encourage outsourcing (berkers et al. 2010). when considering the supply chain cost models mentioned above, it should be noted that all of these models were designed for manufacturing industries. because of this, a conceptual framework of relationships forming the basis for data collection and data analysis of this study is presented in figure 1. this framework, which is service industry-oriented, is based on literature review and the use of a qualitative case study methodology. figure 1: a conceptual framework for supply chain cost reduction in the south african mobile phone industry. the development of the conceptual framework for this study the framework in figure 1 shows the relationships among three major components, namely cost drivers, areas for cost reduction and cost reduction implementation in the south african mobile phone supply chain. these components are instrumental in ensuring the effectiveness of mobile phone companies in south africa. cost drivers to achieve their organisational goals, mobile phone companies perform a set of activities and processes that generate costs. failure to better understand these costs could result in a waste of resources and in high-input costs within the company. consequently, it is important to first put in place a cost control mechanism that would identify and manage all the cost drivers of south africa’s mobile phone companies because these companies, like their counterparts elsewhere in the world, are known for their high operating costs. area for cost reduction the identification of cost drivers should be followed by the identification of opportunities or possible areas for cost elimination or reduction because cost reduction efforts are related to the control of cost drivers for each activity performed by south africa’s mobile phone companies. the cost structure of mobile phone companies, particularly their operating costs could help identify possible areas for cost reduction. the identification of areas for cost reduction through cost driver analysis should culminate in elimination or reduction of non-value-adding activities and thereby enhancing value-adding activities and efficient processes and relationships among supply chain partners (mobile phone companies). implementing cost reduction the climax of any process of re-engineering should be the implementation of cost reduction efforts, as all identified processes with high costs are either eliminated or reduced. cost reduction is neither a one-time activity nor a linear process, but an ongoing improvement effort. implementing cost reduction measures could enable south african mobile phone companies to become more efficient and better serve the end-users. research methodology nature of the study, selection of components and participants to gain insight into managers’ perceptions relative to cost reduction in the south african mobile industry, this study has used a qualitative research approach with a single case study design focussing on supply chain players (components) in the south african mobile phone industry. in this study, the term ‘case study’ is used as the research method and as the unit of analysis (nieuwenhuis 2007). the initial selection of supply chain components for this study, framed from the supply chain literature review in the mobile phone industry, included device manufacturers, equipment vendors, content providers, content enablers, mnos, the mvno, sps, mobile retailers and users. these are mobile phone players supply chain wise (camponovo & pigneur 2003; kalmus & wielhaus 2010; sabat 2002), and the discussion on each of these players is out of the scope of this single article. because of the non-disclosure agreements with mnos and the competition, some of the role players chose not to participate in this study. the final selection of participants for this study consisted of three mnos, one sp and one mobile retailing group. users were excluded from the final component selection as they could not provide significant insights regarding the study that deals with supply chain cost reduction by suppliers. the participants mainly consisted of procurement managers and logistics managers for mnos, a supply chain manager and a managing director for a retailing group and for the sp, respectively. they were all knowledgeable about the supply chain in the south african mobile phone industry and willing to participate in the study. the sampling was purposeful and aimed at gaining insightful information into supply chain cost reduction in the south african mobile phone industry. the interview protocol was developed from the literature review and included questions related to supply chain costs in the south african mobile phone industry. prior to the data collection, a pilot case study involving interviews with two willing managers of mnos was used to refine the interview protocol and to ensure that the interview questions and interview procedures were clear to the participants (yin 2009). convenience, access and geographic proximity were key criteria followed in selecting the participants in the pilot case study (yin 2009). data collection eight semi-structured interviews were held from august 2011 to december 2011, involving six managers from three mnos (two managers per mno from different branches), one manager from an sp and one manager from a retailing group, as illustrated in table 1. table 1: participants’ sample the interviews were all pre-arranged, conducted in english and audio-recorded. the average duration for interviews was 1 hour and 20 minutes. interview transcriptions took place after each interview session and took into consideration field notes made during the interview sessions. saturation was reached with the mnos’ component at interview number six as the same responses were being received from the participants. on the contrary, saturation was hard to reach with the sp component and the mobile retailing group component because of the small number of willing participants interviewed – one participant for each component. besides semi-structured interviews, observation and documents were also used to gather the data. the observations mainly focused on participants’ body language, discomfort and hidden meanings during the interview sessions. all these mind-revealing attitudes were noted and considered in the reporting and analysis of findings (marshall & rossman 2011). annual reports of mnos and other published documents related to telecommunication costs were gathered in this study. these guided the first author in the identification of any potential issues to be addressed in the research questions. the collection of multiple types of data is well recognised in qualitative studies, and particularly in qualitative case studies (baxter & jack 2008; creswell 2009; eisenhardt 1989). validity, reliability and triangulation all eight semi-structured interviews were audio-recorded, transcribed verbatim and sent to the participants for validation and then returned to the researchers. as suggested by mckinnon (1988), the study also used probing to address any concerns relative to the validity and reliability in qualitative research. to further ensure validity and reliability, triangulation was also used (hair et al. 2007; willis, jost & nilakanta 2007). data triangulation was employed to compare and contrast the opinions of participants representing various supply chain components of the mobile phone industry. method triangulation was also employed because multiple sources of evidence, including interviews, observations and documents, were used and compared. data analysis interview transcripts were analysed with the help of atlas.ti, using a three-phase process, as proposed by o’dwyer (2004). this process, which is an adaptation of miles’ and huberman’s (1994) analytical framework, includes data reduction, data-display and data interpretation and conclusion-drawing. in the data reduction phase, the interview data per participant were transferred from the recording device to a desktop computer and labelled for confidentiality reasons. each participant’s interview data were carefully listened to and reviewed. this led to the emergence of preliminary themes, which were noted and refined at a later stage. next, all the transcripts were transferred from the desktop to atlas.ti (version 6.2) where they were coded with the help of atlas.ti using a bottom-up, inductive approach. the coding process in the data reduction stage and data-display stage was complex and lengthy. this led to or resulted in the creation of two types of codes, namely open codes and core codes. 104 open codes, known as initial codes, were created and represented loose themes. these codes were revisited and refined at a later stage in line with the research question of this study. in the quest for patterns and themes, similarities and contrasts were identified by means of the comparison of transcripts. the data-display phase identified links resulting from the data reduction phase through mind mapping. this helped link this study to previous studies on supply chain cost reduction conducted in various industries globally. the themes resulting from the data reduction phase mirrored this study’s research questions. outlying statements were noted and matrices were constructed by using the 10 core codes created from the 104 open codes created in the data reduction stage. this helped in making comparisons between the different supply chain components of the south african mobile phone industry and to identify patterns in the data for refinement at the data interpretation and conclusion-drawing stage. in the data interpretation and conclusion-drawing phase, the opinions of the participants were investigated, across and within the matrix, in order to build a holistic and comprehensive view of supply chain cost reduction in the south african mobile phone industry. any stand-alone quotation that could contrast and challenge the comprehensively developed view was also noted. next, the participants’ thick descriptions and pertinent quotations were selected to indicate how the participants understand supply chain cost reduction in the south african mobile phone industry. according to lincoln and guba (1985), a thick description provides others with a database for the possible transfer of findings to other environments. as opposed to quantitative research that seeks statistical generalisation, this qualitative case study has attempted to develop an analytical generalisation as people are given the opportunity either to learn from the case for themselves or to apply to a population of cases (creswell 2007). findings the themes that emerged from the data analysis are discussed in relation to the available literature. for confidentiality purposes, pseudonyms are used for the participants and the names of the companies involved are also withheld. various acronyms are used to link the opinions of supply chain players to their respective component in the south african mobile phone industry to each pseudonym (where mno = mobile network operator, sp = service provider and r = retailer). to answer the research question ‘how can south african mobile phone companies effectively reduce their costs supply chain-wide?’, the following interview question was posed to participants: what approach could be used to reduce supply chain costs in the south african mobile phone industry? perceptions on which approach could be used to reduce supply chain costs in the south african mobile phone industry the major themes emerging from the reporting of findings include the consolidation of strategic relationships, outsourcing and direct purchasing transactions from device manufacturers. each of these factors is discussed below. consolidation of strategic relationships consolidation of strategic relationships emerged as one of the pathways to cost reduction in the south african mobile phone supply chain. this insight is captured in the following quotation from one of the participants: ‘earlier, i indicated that consolidation could be the answer if you could have one supply chain company, one warehouse that distributes all the handsets, so you could still order them. you still have the [names of network operators] that have their procurement; but all goes to one distribution centre; and all goes to one or more courier companies, speed delivery and start getting that synergy, you start sharing the towers and a lot more, then [you would] start seeing some real costs being taken out of the business.’ [timothy, mno, head of logistics department, 50-year-old male] mnos emphasise the consolidation of strategic relationships, in order to drive costs down supply chain-wide. to achieve this, both collaboration and strategic alliances are needed. the findings of several studies have shown how collaborative relationships of mobile players, particularly mnos, could play a vital role in cost reduction. for instance, frisanco et al. (2008) suggest that mnos should share sites, in order to achieve a major reduction in capex and opex. in addition, sabat (2008) asserts that for network operators to reduce their capex and opex, they might also consider entering into network sharing agreements, whereas each network operator still retains its licence to provide wireless voice and data services to its customers. in the south african context, collaboration on both the technical and logistical sides is needed. on the technical side, south african mnos should share more and more network facilities among them, particularly base stations, and they should shift the competition from network infrastructure to price. besides the shared-service arrangements between equipment manufacturers and mnos, a ‘pay-as-you-sell’ approach could also be negotiated, whereby device manufacturers are paid for only those devices that have been sold by mnos. this approach, when applied, would challenge device suppliers to offer sought-after devices, or marketable devices, and they could thereby unburden the devices’ purchasing costs for mnos. such a contractual approach could also be negotiated between mnos and retailers. on the consumer side, collaboration between mnos should focus on the logistical aspect, particularly warehousing and distribution. mnos could also share a single warehouse with effective delivery mechanism to respond to customers’ demands or needs, rather than each mno owning a warehouse, and the transportation costs of devices and network infrastructure-related equipment’s, because they all purchase from the same equipment manufacturers and device manufacturers. outsourcing outsourcing emerged as one of the pathways to cost reduction in the south african mobile phone supply chain. this insight is captured in the following quotation from one of the participants: ‘uh, i think that probably rethinking the model of how we work, moving away from peter drucker’s model, where in order to get a high margin, you have to have everything under your own roof… so, now in order to be more efficient, you have to outsource everything you don’t need, not everything completely, but you can…’ [philetus, mno, senior procurement group consultant, 45-year-old female] because of the high operating costs in the mobile phone industry, caused by the speed in technology change, as well as the constant upgrading of network facilities and service end-users at low mobile costs, mobile phone companies should revisit their business model by making their activities and processes more efficient. one of the ways to achieve this is through horizontal integration. such horizontal integration would consist of outsourcing some activities to third-party logistics companies. marshall et al. (2007) pointed out how many companies adopt the outsourcing approach, in order to become more efficient and to reduce costs globally. in south africa, as logistical activities and call-centre activities are performed in-house, mnos might well outsource them from specialised sps. besides these two activities, mnos should dedicate or invest more energy in their core activity, which is network connectivity. there is also a need for mnos to revisit their network equipment and device-acquisition forecasting approach. combining these activities could result in substantial costs reductions and a decrease in supply chain costs. direct purchasing transactions from device manufacturers direct purchasing transactions from device manufacturers emerged as one of the pathways to cost reduction in the south african mobile phone supply chain. this insight is captured in the following quotation from one of the participants: ‘…the model suggested is that i, as [a] retailer [need] to buy directly from original equipment manufacturers and sell handsets to customers, who [would] decide whether to connect with any network operator…. they [network operators] need to support the infrastructure that is directly linked to their core business, which is to provide network.’ [raphael, r, supply chain manager, 40-year-old male] currently, mobile retailing companies in south africa purchase handsets from mnos and sell them to end-users. this business model gives mnos greater leverage over mobile retailers and thus increases the volume or size of purchasing costs because of the involvement of mnos acting as intermediaries between device manufacturers and mobile retailers. to enhance efficiency from a retailer and end-user perspective, mobile retailers should be allowed to purchase handsets directly from the device manufacturers. this would drive costs down across the supply chain, and foster better deals for end-users. given the oligopolistic trend in the south african mobile phone industry, mobile phone companies need to embrace a broader operational outsourcing, in order to decrease their supply chain costs substantially. regulating authorities should revisit the mobile telecommunications policies in south africa by allowing retailing companies to deal directly with device manufacturers. network diagram on supply chain cost reduction in order to grasp the different links among core codes, a network diagram on supply chain cost reduction was designed. two phases took place, namely the first attempt of a network diagram on supply chain cost reduction and the final network diagram on supply chain cost reduction, as depicted in figures 2 and 3. this helped, enlightened and guided in the development of the supply chain cost reduction framework for the south african mobile phone industry. figure 2: first attempt to create a network diagram on supply chain cost reduction. figure 3: network diagram on the relationships between core codes. through interview data immersion and the literature review of the mobile telecommunication industry, 21 core codes of the first attempt to create a network diagram on supply chain cost reduction, as shown in figure 2, were reduced through merging to 10 major core codes to enlighten the various links among the core codes and to gain new insightful information into the supply chain cost reduction in the south african mobile phone space. the merging of core codes into major core codes were made based on relatedness and inseparability. for instance, core codes, such as it and software, were merged into core-code ‘technology’; network infrastructure, network maintenance, the voice and the data were merged into the core-code ‘network’, just to name few. from the findings of this study, as discussed in ‘perceptions on which approach could be used to reduce supply chain costs in the south african mobile phone industry’ and ‘network diagram on supply chain cost reduction’ sections, multidimensional relationships between the various core codes or loosely categorised themes have emerged, and these are depicted in figure 3. the relationships show the influence of core codes or loosely categorised themes on one another. the relationships also show the complexity of the core codes or loosely categorised themes relative to cost reduction in the south african mobile phone space from a supply chain perspective. however, it is important to note that a single article cannot suffice to discuss in detail each of these relationships or links, because of the volume of data regarding the relationships of different core codes of the final network diagram on supply chain cost reduction. the proposed framework from this study’s findings, two main themes emerged in relation to cost reduction in south africa’s mobile phone supply chain, namely outsourcing and the consolidation of strategic relationships. these themes are pivotal for the development of the proposed supply chain cost reduction framework in the south african mobile phone industry, as depicted in figure 4. figure 4: the proposed supply chain cost reduction framework for the south african mobile phone industry. the multiplicity of companies and activities in the mobile phone supply chain makes mobile phone companies a complex part of the proposed supply chain cost reduction framework for south africa’s mobile phone industry. the interplay between mnos and between mnos and other mobile phone companies in the attainment of their core business and objectives helps to uncover a variety of links, as depicted in figure 1-a1, (see appendix 1). the figure shows a multiplicity of activities and relationships or links that mobile phone companies undertake in order to provide a variety of services to customers in the supply chain setting. a detailed discussion on each of the links in figure 1-a1, (see appendix 1) falls outside the scope of this article. the interconnection between mnos and between mnos and fixed network operators plays a critical role in enabling end-users to communicate from the same network or on another network. this is facilitated by the help of the network infrastructure. the ability of an mno’s network infrastructure to provide continuous, reliable and quality mobile services and the decision relative to handset purchasing depends on the technology, because the mobile phone industry is technology-driven. to cope with the rapidly changing technology in the industry, foreign consulting services are used by mnos to identify the latest working technology to be adopted, and foreign technical experts are employed in the training of local technical staff on the imported technology and network equipment. besides the logistical needs associated with imported network equipment, mobile phone companies are also responsible for the warehousing and distribution of handsets to various retailing outlets. this activity requires safety and security measures. the prices of mobile services are set, based on, among other factors, the network infrastructure, interconnection and marketing, and sales. one of the ways that can be used to service end-users at lower mobile prices is for mobile phone companies to embrace the consolidation of strategic relationships and learn to be efficient in their operations. being the key players in south africa’s mobile phone supply chain, mnos control the network infrastructure, the devices and sim card businesses, and therefore, effective supply chain cost reduction requires the co-operatively synergised commitment and effort in the mobile phone supply chain, particularly with mobile phone companies. to achieve this, there is a need for consolidating relationships at the strategic level between mnos and other mobile phone supply chain players in south africa. these would include device manufacturers, equipment manufacturers, content providers, content enablers, the mvno, retailers and sps. the proper implementation of this business approach could trigger more synergy, effectiveness and significant cost reductions in the entire mobile phone supply chain. mnos should strive for better sourcing strategies to lower their purchasing costs. as they all purchase network equipment and devices from the same equipment manufacturers and device manufacturers abroad; they could, for instance, consider combining their network equipment and handset expenditures. it is tremendously important that mnos should go a step further in identifying a set of areas that a handset manufacturer can provide and make various procurement deals – rather than purchasing single items, such as mobile devices. this might not only consolidate strategic relationships, but also pave the way for mnos to become more effective and efficient in south africa’s mobile phone supply chain. mnos also need to seek operational efficiencies through the outsourcing of logistical activities from third-party logistical providers. these activities include warehousing, distribution, insurance and the security of purchased handsets. additionally, they could also outsource all their call-centre services from third-party logistics providers. the outsourcing of both logistics and call-centre activities from third-party logistics providers would help mnos save substantially on their opex and decrease their supply chain costs in south africa’s mobile phone industry. this input into cost reduction through total cost of ownership supply chain-wide might, therefore, contribute to a reduction in call tariffs, on the one hand, and on the other hand, enhance competition because of various mnos’ business offerings. warehousing and call-centre facilities owned and managed by mnos could be leased to other business organisations, and headcount costs (salaries and wages), electricity and other related operating costs would be saved. other mobile phone companies (supply chain players) could also achieve operational efficiencies and the consolidation of strategic relationships – by outsourcing other non-core activities (support services), while increasing the focus on their core competences. the consolidation of strategic relationships with operational efficiencies by mobile phone companies would lead to higher synergies and greater supply chain cost reduction for south africa’s mobile phone industry and subsequently to lower mobile prices for end-users. it should be indicated that the link between mobile phone companies and the consolidation of their strategic relationships, the link between mobile phone companies and outsourcing, the link between the consolidation of strategic relationships and supply chain cost reduction, the link between outsourcing and supply chain cost reduction, and the link between supply chain cost reduction and mobile phone companies were explored in the section dealing with the discussion on the findings. because of the speed of technology changes and the pressure for lower mobile service tariffs, mobile phone companies need to revisit their current business model and identify adequate technology to meet the various needs of end-users, while at the same time driving costs down supply chain-wide. to this end, there is a need for more and more network infrastructural sharing and greater internal operational efficiencies. managerial implications and recommendations managerial implications the study has highlighted some ways whereby managers of mobile phone companies could drive their supply chain costs down to service their end-users at lower prices. on the contrary, the findings of this study could help regulating authorities (i.e. the independent commission authority of south africa and the department of communications) to implement informed mobile phone policies that support and encourage the emergence and growth of local suppliers of telecommunication equipment and attract foreign investment in the industry. recommendations the findings of this study single out mnos as the most powerful players in the south african mobile phone supply chain because they have control of the three main streams of the mobile telecommunication business – the network, handsets and starter packs. additionally, compared with other players in the industry, mnos necessitate huge spending on opex, which is one of the contributors to high-cost mobile services, particularly call tariffs. to effectively drive their supply chain costs down, mnos need to focus more and more on their core business, which is the provision of network connectivity, and to outsource non-core activities, such as logistics and call-centre services from specialised sps. these steps would significantly lower the costs of warehousing management, security, insurance, headcount, transport and the maintenance of call-centre facilities. other mobile phone companies should also focus on their core competences and outsource all other support services to decrease supply chain costs. this would result in considerable cost reductions across the supply chain and in better service offerings at lower prices for all the end-users. the department of communications and icasa need to provide a robust regulatory framework that promotes intensive competition through the softening of entry barriers into the mobile phone industry. this would open doors for new entrants into the business and new approaches in terms of packages offered to customers and pricing. the department of communications and icasa also need tailor-made telecommunication policies to support local suppliers of telecommunication equipment in building their technological capability. this initiative would address the dependence on the import of telecommunication equipment from foreign suppliers, which is costly and weighs heavily on the capex of mnos. finally, the department of communications and icasa need to find ways that would attract original equipment manufacturers to build their equipment plants in south africa. this would reduce or eliminate equipment import costs. conclusion globally, mobile telecommunications is a capital-intensive and rapidly changing industry. given the high capex and opex, and the increasing need of end-users for mobile communication services at lower prices, mobile phone companies need to revisit their business model and find ways to lower their opex, while remaining profitable. one of the ways to achieve this is the decrease of costs supply chain-wide. the study suggests that mnos, the key players in the south african mobile phone supply chain, need to consolidate their strategic relationships with other supply chain players through increased sharing of the network infrastructure. mnos also need to strive for operational efficiencies by outsourcing their logistics and call-centre activities from specialised sps. these combined actions should result in considerable supply chain cost reduction, which might also result in lower call tariffs to the end-users. acknowledgements competing interests the authors declare that they have no financial or personal 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process and time analysis’, proceedings of the 2008 ieee international conference on industrial engineering and engineering management, singapore, december 8–11, viewed 13 june 2013, from http://ieeexplore.ieee.org/stamp/stamp.jsp?tp=&?arnumber=4738147 ulbrich, f., 2006, ‘improving shared service implementation: adopting lessons from the bpr movement’, business process management journal 12(2), 191–205. https://doi.org/10.1108/14637150610657530 wagner, s.m, erhun, f. & cross-ruyken, p.t., 2009, dressing for the weather: top supply chain challenges motivate action, viewed 17 august 2009, from http://www.entrepreneur.com/tradejournals/article/194529463.html willis, j.w., jost, m. & nilakanta, r., 2007, foundations of qualitative research. interpretive and critical approaches, sage, thousand oaks, ca. wisner, j.d., tan, k.c. & leong, g.k., 2009, principles of supply-chain management. a balanced approach, 2nd edn., international student edition, south-western, mason, oh. wu, c., 2005, ‘total supply-chain cost model’, m.b.a. and msc thesis, massachusetts institute of technology. yin, r.y., 2009, case-study research: design and methods, 4th edn., sage, thousand oaks, ca. yu, k. & yang, y., 2011, ‘study on the innovation capability of mobile communications industry in china’, in 2nd international conference on emergency management and management sciences, beijing, china, august 8–10, viewed 12 september 2012, from http://ieeexplore.ieee.org/stamp/stamp.jsp?tp=&arnumber=6015793 appendix 1 figure 1-a1: complexity of mobile phone companies and the associated links. microsoft word 2 viljoen et al sajems 19(2) 2016.docx sajems ns 19 (2016) no 2:175-191 175 how to cite doi: http://dx.doi.org/10.17159/2222-3436/2016/v19n2a2 issn: 2222-3436 “i would rather have a decent job”: potential barriers preventing street-waste pickers from improving their socio-economic conditions1 kotie viljoen department of economics and econometrics, university of johannesburg phillip blaauw school of economics, north-west university rinie schenck department of social work, university of the western cape accepted: november 2015 as a result of the high levels of unemployment in south africa, many unskilled people are forced to resort to a variety of income-generating activities in the informal economy. the activity of collecting and selling recyclables presents virtually no barriers to entry, making it a viable option. very little research focusing on street-waste pickers has been undertaken, and, when it has been conducted, it has mostly taken the form of case studies. this paper reports the results of the first countrywide research into the potential barriers that prevent street-waste pickers from improving their socio-economic circumstances. the study used a mixedmethod approach. structured interviews were conducted between april 2011 and june 2012 with 914 streetwaste pickers and 69 buy-back centres in 13 major cities across all nine provinces in south africa. low levels of schooling, limited language proficiency, uncertain and low levels of income, as well as limited access to basic social needs make it difficult for waste pickers to move upwards in the hierarchy of the informal economy. the unique set of socio-economic circumstances in which street-waste pickers operate in the various cities and towns in south africa make the design of any possible policy interventions a complex one. policymakers will have to take note of the interdependence of the barriers identified in this research. failing to do so may cause policies that are aimed at supporting street-waste pickers to achieve the exact opposite, and, ironically, deprive these pickers of their livelihood. key words: informal economy, street-waste pickers, recycling jel: j46, o17 1 introduction a colombian waste picker once said, “if we were any poorer, we’d be dead” (ballve, 2008:1). along with 1 per cent of the world’s urban population, collecting and selling recyclable waste has become alternative informal employment for at least 37,000 people in south africa (langenhoven & dyssel, 2007). most of these people form part of the semi-skilled or unskilled portion of the labour force that is unable to find employment in south africa’s formal economy in the face of persistently high rates of unemployment (fluctuating between 24 and 26 per cent in the period 2009 to 2015). their only alternative is to explore the possibilities of self-employment in the informal economy. the unemployed resort to different strategies to survive and informal economic activities, such as waste picking, are one of these strategies (theron, 2010:1). waste pickers are broadly defined in the literature as small-scale, self-employed people who are mostly active in the urban informal economy (hayami, dikshit & mishra, 2006:42; schenck & blaauw, 2011b). theron (2010:1) confirms this, stating: “most waste pickers have created their own jobs, and work for themselves: in other words they are self-employed.” waste is collected either for their own use or to sell (samson, 2010) to higher-level traders and/or buy-back centres abstract 176 sajems ns 19 (2016) no 2:175-191 (bbcs) in order to earn a living. waste is therefore a livelihood for the unemployed. the terminology used to refer to people who collect and sell recyclable waste reflects and forms attitudes and perceptions regarding these people (samson, 2010). they are referred to as “waste pickers”, “scavengers”, “waste recyclers”, “garbage pickers” or, on a more positive note, as “waste salvagers” and “reclaimers” (chvatal, 2010; samson, 2010). we prefer the most commonly used term “waste pickers”, as it describes the person’s actions exactly. most waste pickers in the informal economy earn a very low income for their work and effort, and their socio-economic conditions and working conditions remain appalling. many also face chronic poverty despite their attempts to generate a livelihood in the informal economy (masocha, 2006:839). attempts to earn a living in the informal economy are diverse. on the one hand, activities in the informal economy can be of a survivalist nature, such as day labouring or other casual, temporary or unpaid jobs, street trading, subsistence agriculture, or selling recyclable waste. the “informal sector” can also refer to the unofficial nature of business activities in order to avoid taxes or the effects of labour legislation. the informal economy can furthermore be divided into upper-tier and lower-tier activities. the segmentation of the informal economy into a primary sector, or “upper tier”, which is more organised and provides higher income-earning potential, and a secondary sector, or “lower tier”, that is less organised and has a lower income-earning potential making the informal economy a complex phenomenon (lehmann & pignatti, 2007:3; wills, 2009:2). maloney (2004:1159) refers to the upperand lower-tier activities as “voluntary entry” and “involuntary entry” into the informal economy, respectively.2 the upper-tier activities attract people who enter the informal economy voluntarily in the expectation that their earnings will be higher in the informal economy than in the formal economy (fields, 1990:66; günther & launov, 2012:89). entry into the lowertier activities is involuntary and such activities are only performed by those who cannot find work in the formal labour market and who do not meet the capital and skills requirements for the activities of the upper-tier, self-employment informal economy (günther & launov, 2012:89). the lower-tier activities are seen as the disadvantaged segment of the informal economy. activities at this level involve the poor and include single street traders, micro-enterprises and subsistence farmers (chen, 2012:8; djankov, lieberman, mukherjee & nenova, 2002:4; launov & günther, 2006:11; viljoen, 2014). no aspirant jobseeker would like to perform these activities, as they do not generate sufficient income in order to reduce poverty (escap, 2006:15; fields, 1990:68; gërxhani, 2004:268). barriers that push many of the unemployed into these lower-tier activities include relatively high start-up capital, labour relations issues, and the lack of basic financial-literacy skills. these barriers also prevent many from moving from the lowerto higher-tier activities in the informal economy (fields, 1990:66; günther & launov, 2012:89; wills, 2009:2). such entry barriers also play a role in keeping the informal economy in south africa relatively small in comparison with that of other developing countries (heintz & posel, 2008:27). previous research on waste pickers in south africa focused mainly on the socio-economic position of waste pickers on dump sites (chvatal, 2010; samson, 2010; theron, 2010). samson (2010) found 19 studies conducted in south africa on this subject, only five of which dealt with the street-waste pickers in different cities. research on street-waste pickers in south africa has, therefore, been confined to small-scale case studies (langenhoven & dyssel, 2007; mclean, 2000). furthermore, the focus of previous research on the various barriers experienced by street-waste pickers was limited. also, prior to the present study, no countrywide analysis of street-waste pickers had been conducted. we have attempted to fill this particular gap in the literature on both counts. the aim of this research is to explore the nature of the barriers that may prevent street-waste pickers in south africa from improving their socio-economic conditions. we identified human-capital constraints, labour market characteristics, limited earning potential, and social aspects as possible barriers. the education levels of street-waste pickers, their language proficiency, as well as their previous full-time job experience were examined so as to explore the possible human-capital and labour market barriers. these are all aspects that may sajems ns 19 (2016) no 2:175-191 177 influence the street-waste pickers’ likelihood of finding employment in the higher tier of the informal economy or in the formal labour market. the income earned by street-waste pickers was also analysed to determine whether it provides them with an opportunity to improve their socioeconomic conditions. the social background and conditions of street-waste pickers were investigated to observe the extent to which these serve as social barriers, preventing them from integrating and being part of the larger community in which they live. the analysis presented in this paper is based on data collected from a sample of 914 streetwaste pickers in south africa, using a mixed-method research approach. the results of the research follow the discussion of the literature and research methodology presented in the next sections. 2 literature review the concept of the informal economy gained recognition in the literature with the seminal paper of hart (1973). various theoretical approaches have been used to study the informal economy since then. the dualist theory postulates that the informal economy can absorb the growing number of people who cannot find economic opportunities in the more productive and remunerative formal economy (heintz & jardine, 1998:32). the informal economy features unregistered or unofficial small-scale or even subsistence enterprises, temporary employment and self-employed persons (becker, 2004:13; hart, 1973:68). table 1 gives an overview, derived from the literature, of the characteristics of these subsistence and unofficial enterprises. table 1 characteristics of subsistence and unofficial enterprises in the informal economy informal sector subsistence enterprises (completely informal) unofficial enterprises (informal) degree of informality do not declare income; have no protection and regulation; are the least dynamic do not declare all income; not all workers are registered; more dynamic; informal type of activity single street traders; micro-enterprises; subsistence farmers; waste pickers small manufacturers; service providers; distributors; contractors factor intensity labour-intensive mostly labour-intensive owner profile poor and low education and skills levels poor or well-off; well educated; high skills levels markets barriers to entry are low; highly competitive product homogeneity barriers to entry are low; highly competitive; some product differentiation finances required need working capital need working capital, investment capital and supplier credit other needs need personal insurance and social protection need personal insurance and, in some cases, business insurance source: becker (2004:25) the subsistence enterprises or activities in the informal economy are also referred to as “lowertier, informal-economy activities” (fields, 1990:69). activities in the lower tier are often characterised by low productivity, by income-earning opportunities that yield low wages, and by irregular working hours (becker, 2004:13). there is agreement in the literature that income in the informal economy tends to decline as one moves closer to the subsistence or lower-tier activities (wills, 2009:1). lower-tier activities are often the ones with few barriers, or even unrestricted entry (fields, 1990:69). waste picking also falls into this category. waste picking as a subsistence activity is labour-intensive, requires no capital or start-up costs, no education or skills are needed, and the waste picker has a guaranteed buyer for the waste picked. the only requirements for the waste picker are the physical ability to pick waste, access to waste, and access to a buyer of waste – whether a buyback centre (bbc)3, craftsmen, middlemen or informal waste collectors with their own transport, also referred to as “hawkers” (viljoen, schenck & blaauw, 2012:21; viljoen, 2014). 178 sajems ns 19 (2016) no 2:175-191 the low entry requirements make waste picking a feasible income-generating opportunity for the very poor and economically disadvantaged to earn cash income (masocha, 2006:843). streetwaste picking is one of the means of subsistence for the poor who have no other incomegenerating options available to them (carrasco, 2009:17; ullah, 2008:10). waste picking serves as a survivalist strategy, safety net and temporary substitute for social protection (losby, else, kingslow, edgcomb, malm & kao, 2002:9). as a source of raw materials, these activities are also at the bottom end of the recycling industry’s hierarchy (ullah, 2008:2). the hierarchy of the role players in the recycling industry is illustrated in table 2. table 2 hierarchy of role players in the recycling industry source: wilson, velis and cheeseman (2006:800) the level at which the informal recycling activities occur has an influence on the income earned, the working conditions, and the social status of the participants. people active at the lower end of the hierarchy are less organised, lack support networks, and add less value to the waste they collect. these influences increase their vulnerability to exploitation, which is reflected in the low incomes they earn (wilson et al., 2006:801). despite their contribution to the recycling of waste products, which benefits the community at large, the social and economic circumstances of streetwaste pickers keep them on the margins of poverty. according to the sustainable livelihood approach, any person needs the capabilities to reap the benefits from economic opportunities in order to reduce their poverty and to provide them with economic security and social well-being (krantz, 2001:10-11). these capabilities do not only entail the ability to earn an income, but also the capacity to consume and to earn assets. authors such as adato and meinzen-dick (2002:6), and krantz (2001:10-11), categorise the main types of assets or capital as human, financial, natural and social capital, as well as access to information. a lack of capabilities will constrain the poor from seizing any opportunities that may lift them out of poverty. low levels of education, deficient language proficiency, and little previous experience in the formal economy may limit street-waste pickers’ labour market mobility. as a result, it can be difficult for them to move away from the marginalised and lower-tier activities of the informal economy to higher-tier, informal or formal labour markets (viljoen, 2014). the existence of social barriers may prevent street-waste pickers from acquiring social capital that will enable them to become part of the community, to be integrated into society, and to form part of the larger group. these barriers can also deprive them of the ability to build the trust and relationships needed to function efficiently (adato & meinzen-dick, 2002:6; krantz, 2001:10-11). to improve their position, they need to move upwards in the hierarchy (wilson et al., 2006:800), within the recycling industry, to other higher-tier, informal-economy activities or to the formal economy. a synthesis of the available literature suggests that, in low-tier activities such as waste picking, the informal economy offers its participants little opportunity to invest in human capital in order to increase their skills level. the implication is that, once in the informal economy, their chances of moving up the ladder are constantly diminishing (suharto, 2002:116). the literature on street-waste pickers in south africa does not focus on the barriers that prevent them from improving their socio-economic conditions. this paper therefore reports on research conducted to fill this gap. survey research among the waste pickers themselves is the only feasible option for achieving the research objective. the following sections describe the research methodology and present the results and analysis. highest value lowest value manufacturing industries brokers, wholesalers, other processors buy-back centres, craftsmen, middlemen informal waste collectors with own transport (hawkers) individual, informal waste pickers sajems ns 19 (2016) no 2:175-191 179 3 research methodology: survey of street-waste pickers in south africa 3.1 research type and strategy in an ideal world, the research methodology would have required, at a minimum, data over two time periods, that is, panel data in order to determine if certain characteristics are correlated with the probability of transitioning into a hypothetical, improved socio-economic position. given the fluid nature of this activity and the ethical requirement of anonymity, panel data is not a viable option. as an alternative, one would need some kind of comparison group to allow one to ascertain if certain identified characteristics are correlated with the probability of being a streetwaste picker rather than doing anything else. the issue, however, is that the majority of streetwaste pickers have not chosen this as a preferred occupation, but see it as a second-best alternative to formal employment. street-waste pickers are regarded as an “unknown population” and as a “hard-to-reach” research population in terms of their numbers and the difficulty of finding them owing to the nature of their work (viljoen, 2014). these characteristics, coupled with the flexibility needed to accommodate the holistic nature of the research objectives, provided the rationale for using a mixed-method approach for this research. the mixed-method approach was used to mix quantitative and qualitative data in the collection and analysis stages in a single study (creswell & plano-clark, 2011:5). the results of the qualitative questions support the quantitative data and reflect the voice of the street-waste pickers. primary data were collected in two phases using a survey design in each phase. in the first phase, quantitative and qualitative data were collected concurrently from bbcs. the rationale for including the bbcs in the research was to obtain a more complete understanding of the streetwaste pickers, of their activities in the recycling industry, and of factors that affect their socioeconomic conditions. without the bbcs, the average waste picker cannot operate. the best places to find the street-waste pickers were at the bbcs where the street-waste pickers sell the waste that they have collected (schenck & blaauw, 2011a:419). thus, data on the best place and best time to find the street-waste pickers were also collected from the bbcs. the data and information obtained from this data set informed the procedures that were to be followed in collecting data from the street-waste pickers. in the second phase, quantitative and qualitative data were collected concurrently from the street-waste pickers. the quantitative and qualitative data sets obtained in both phases of the study were analysed separately and were integrated in the reporting and interpretation stage. the integration of these two data sets, coupled with the integration of the data and information obtained from the literature review and theoretical overview in the reporting and interpretation stage, enhanced the reliability of this study. 3.2 survey instrument a face-to-face survey approach was used to collect data and information on the socio-economic conditions of the street-waste pickers. face-to-face surveys can be used effectively when members of the research population have limited literacy levels, such as is the case with street-waste pickers (babbie & mouton, 2011:249). the survey instrument used by schenck and blaauw (2011a) formed the foundation for the design of the structured qualitative and quantitative questionnaire to be used for the collection of the data. advice and input from melanie samson, an expert on research among women in the informal economy and on waste pickers in south africa, as well as the input and advice of a statistician, were incorporated in the final version. the revised questionnaire was pilot-tested by the research team during their visits to the bbcs in the reconnaissance phase. owing to the lack of research on bbcs, a completely new questionnaire had to be designed to collect data from them. a thorough review of the existing literature on waste pickers and the limited information available on bbcs served as a starting point and informed the type of 180 sajems ns 19 (2016) no 2:175-191 questions to be included in the questionnaire. to help shape the final questionnaires and to ensure the validity and adequacy of the research instruments, a pilot version of the two questionnaires was administered among street-waste pickers as well as among two bbc owners. 3.3 sampling method street-waste picking is not officially recognised as an occupation and only estimates on the total number of street-waste pickers in south africa are available. some street-waste pickers also do not have a fixed address and sleep on the street or in the bushes. during the day, they move around the cities to collect waste, depending on the availability thereof. the recycling industry as a whole is largely under-researched and no central or reliable database on the location of bbcs could be found. the research team visited all the envisaged cities in a recognisance effort to locate and visit all the bbcs. the bbcs were also not able to provide reliable estimates on the number of street-waste pickers who sell their waste to them owing to the nature of the street-waste pickers’ visits to the bbcs. the street-waste pickers visit the bbcs at different times of the day and on different days of the week. in some cases, they visit the same bbc more than once on a particular day, or they visit more than one bbc on the same day. because no sampling frame is available for this research population, a non-probability sampling technique was used, as suggested by bhattacherjee (2012:70), to collect data from both the bbcs and the street-waste pickers. the non-probability sampling technique used was snowball sampling, which is a respondent-assisted sampling method. all ethical considerations were strictly adhered to and ethical clearance was obtained before the research commenced. 3.4 data collection the results of the study are based on data collected from 914 street-waste pickers and 69 bbcs (excluding scrap-metal dealers) in 13 cities across all provinces in south africa. the cities included all the provincial capitals as well as other important economic centres in each province. the data were collected between 19 april 2011 and 28 june 2012. the next section provides insights into the human-capital, labour market, economic and social barriers that make it difficult for street-waste pickers to improve their socio-economic conditions. 4 analysis and interpretation of results 4.1 human-capital and labour market barriers high levels of unemployment as well as structural changes in the form of lower demand for semiskilled and unskilled workers force many people in south africa into the informal economy (carrasco, 2009:17). institutional failure is, however, not the only reason why street-waste pickers are unable to move upwards in the hierarchy of informal-economy activities. certain inherent characteristics may also contribute to their inability to find employment in the formal or informal economy. these individualities relate to the street-waste pickers’ level of human-capital development, which includes their highest education levels, language proficiency, and previous full-time work experience. there are few job prospects for uneducated people (fryer & hepburn, 2010:6). an analysis of their educational levels reveals that only three street-waste pickers were on a level higher than grade 12. an overwhelming majority (92.9 per cent) of the street-waste pickers had not completed their formal schooling. only 44 per cent had some secondary schooling, with 48.5 per cent having more limited schooling or no schooling at all (see figure 1). sajems ns 19 (2016) no 2:175-191 181 figure 1 highest educational-attainment levels of street-waste pickers, 2012 (n=903) source: survey data the age groups 35-44 years and 45-54 years contained the largest proportions of street-waste pickers without any formal schooling, namely 19 per cent and 17 per cent, respectively (see table 3). table 3 highest educational-attainment levels according to age groups of street-waste pickers compared with the unemployed in south africa, 2012 age group total 14-34 years 35-44 years 45-54 years 55+ years percentage of unemployed in south africa n 903 n=338 n=100 n=401 n=64 4,470,000 no schooling 14.0 10.1 19 17.0 7.8 1.5 some primary schooling 27.7 23.1 18 30.9 46.9 6.6 completed primary schooling 24.4 19.5 25 27.9 26.6 4.4 some secondary schooling 19.4 23.1 25 16.2 10.9 46.9 completed secondary schooling 14.6 24.3 13 8.0 7.8 33.5 other 7.1 total 100 100 100 100 100 100 source: survey data youth street-waste pickers between 14 and 34 years of age (the broad definition) had the highest school-attainment levels. they also constituted the age group within which the highest percentage of street-waste pickers had completed their secondary schooling. the high percentage of young people involved in waste picking is a reflection of the employment crisis, which takes a heavy toll on the youth in south africa in general. having completed secondary schooling is indeed no “meal ticket”, but merely a “hunting licence”, with no guarantee of finding a job. low education levels make it even more difficult for the young street-waste pickers to compete for jobs. the reasons why so many of the street-waste pickers left school early provide a qualitative perspective on their inability to acquire higher levels of human capital. not completing school constitutes an important barrier in terms of future labour market involvement and limits the current and future accumulation of human capital that is important in order to compete in a labour market characterised by decreasing demand for unskilled labour. the respondents were therefore asked in an open-ended qualitative question about the reasons why they had not been able to complete their schooling. seven themes were identified. the majority (68 per cent) of the street-waste pickers left school early owing to financial difficulties, as indicated in table 4. of concern is the fact that 17.9 per cent of those who left school because of poverty or financial problems had lost one parent, or both parents, and had no one to care for them. poverty has a 6,5 30,9 11,1 44,4 7,1 0 10 20 30 40 50 no schooling some primary schooling completed primary schooling some secondary schooling completed secondary schooling per cent 182 sajems ns 19 (2016) no 2:175-191 detrimental effect on the capability of an individual to obtain benefits from schooling (fryer & hepburn, 2010:6). table 4 types of financial difficulties (n=527) types of financial difficulties n % financial hardship/poverty 294 37.9 both parents died (no money or no one to support them) 98 12.6 father died – no money 41 5.3 had to go and work owing to money problems 43 5.5 raised by welfare – no money for education 1 0.1 parents, grandparents/other relatives could not provide support 37 6.6 total 527 68 source: survey data reasons other than those of a financial nature that made young people leave school early included family-related issues, problems at school, behavioural issues, health, and age. family-related issues were the second-most common reason for leaving school early (see table 5). table 5 thematic analysis of the other reasons why street-waste pickers left school before completing grade 12, 2012 (n=248) themes thematic analysis of reasons for leaving school n % of total related to poverty and finances 527 68 school-related failed too many times; too far from school (farm/village); bad treatment; abuse and beating by teachers; school burnt down; problems at school; quit school; school was difficult; new syllabus was introduced 42 5.4 family-related problems at home; had to work on a farm; mother passed away; had a child; abandoned by parents; no support; did not have to go to school; was not sent to school; parents had too many children; grandparents passed away; got married; parents not serious; father moved away 121 15.6 behavioural issues expelled from school; did not like school; did not want to go to school; disciplinary problems; just left school; bad influence; just naughty; jail sentence; became a gangster; became a street kid; drinking problem; got arrested for selling dagga and had to go for rehabilitation; lack of motivation; lazy; peer pressure; ran away from home 42 5.4 health-related health problems; illness; disability 7 0.9 age-related too old 1 0.1 general reasons bad circumstances; problems; political reasons; was abused and ran away; no transport to school; ran away because of hunger; they made me mad at school; things did not work out for me 35 4.5 total 775 100 source: survey data when people are excluded from school, regardless of the reason, they are deprived of the literacy and numeracy skills that can be attained as a result of formal schooling (berntson, 2008:26). without the basic skills mentioned above, it becomes difficult to find employment, whether in the formal or informal labour market, and any inability to properly communicate exacerbates the situation. the self-perceived language proficiency of the respondents shows that the majority (53.7 per cent) of the street-waste pickers could not understand english well and 56 per cent could not speak english well. the same trend was observed with afrikaans, where 51.8 per cent of the street-waste pickers were not able to understand afrikaans, and 53.7 per cent could not speak afrikaans well (see figure 2). sajems ns 19 (2016) no 2:175-191 183 figure 2 language understood and spoken well, 2012 (n=914) source: survey data a comparison between language proficiency and age revealed that the majority of the street-waste pickers who could speak and understand english and afrikaans well were in the older age categories (between 35 and 54 years). table 6 shows that the largest percentage of street-waste pickers who could not speak and understand afrikaans, english, or both, was in the youngest age categories, namely 14-24 years and 25-34 years. table 6 language proficiency and age, 2012 (n=914) age group 14-24 25-34 35-44 45-54 55+ total number n=129 n=254 n=223 n=175 n=133 n=914 percentage % % % % % % english 31.8 35.4 19.7 9.1 10.5 22.4 afrikaans 10.9 10.6 29.1 33.7 45.1 24.6 english and afrikaans 13.2 18.5 25.1 22.9 18.0 20.1 none 44.2 35.4 26.0 34.3 26.3 32.8 total 100 100 100 100 100 100 source: survey data the results could be an overestimation of street-waste pickers who were proficient in english and afrikaans, because language proficiency was not evaluated and the self-assessment merely reflected the street-waste pickers’ own perception of their level of proficiency. notwithstanding this, it was clear that a lack of language proficiency can constitute a barrier for a third of the streetwaste pickers in their possible attempts to find alternative employment. this finding correlates well with the low levels of educational attainment, where only 24.5 per cent of the young street-waste pickers (14-34 years) had completed their secondary schooling. the implication is that younger street-waste pickers may find it even more difficult to compete for possible formal employment opportunities where language proficiency is critical, especially against the backdrop of an oversupply of unschooled labour in south africa. the level of human-capital development in terms of school-attainment levels, work experience, skills, and language proficiency are barriers that make it difficult for the street-waste pickers to find formal employment or more highly paid informal jobs. consequently, their ability to improve their socio-economic conditions diminishes. according to standard labour market theory, education and training are two important factors of human-capital development and can improve a person’s earnings (berntson, 2008:26). high levels of human capital also enable people to initiate and use other productive assets (adato & meinzen-dick, 2002:6; krantz, 2001:10-11). the lack of human-capital development and the effect thereof on the employability of the street-waste pickers are reflected in the analysis of their previous full-time work experience. just english (22%) afrikaans (25%) english and afrikaans (20%) none (33%) 184 sajems ns 19 (2016) no 2:175-191 more than half (52.4 per cent) of the street-waste pickers previously had a full-time job with benefits.4 these street-waste pickers also tend to be those with relatively better levels of education.5 almost half of the respondents therefore lacked full-time work experience, which could also make them more vulnerable in the competition to find and get a full-time job. the majority of the street-waste pickers who previously had full-time jobs also did not have them for long periods of time, as indicated in table 7. table 7 previous full-time job experience, 2012 (n=480) period employed n % less than a year 87 18.1 1-2 years 74 15.4 2-5 years 145 30.2 5-10 years 97 20.2 more than 10 years 77 16.1 total 480 100 source: survey data the street-waste pickers who had held their previous full-time work for longer periods were the older street-waste pickers who only picked waste to supplement their pension or old-age grants. the reasons they gave for leaving their last full-time work are presented in figure 3 and relates to disciplinary actions, quitting of jobs, lay-offs and other reasons. figure 3 reasons why street-waste pickers left their previous full-time job, 2012 (n=493) source: survey data the responses to a qualitative question on whether the street-waste pickers were looking for, and would like to have a full-time job revealed that 85.7 per cent of the street-waste pickers were indeed looking for another job. more than a third (345) of the street-waste pickers indicated that they would take any job they could get. to them, street-waste picking was just a survival activity. most street-waste pickers would have preferred to have full-time employment, as indicated by the excerpts that follow: “i would rather have a decent job.” “i want to find a job.” “not a good way of making a living.” contract ended (12.8%) quit/medical reasons ( 8.5%) quit/wage too low, (16%) disciplinary reasons (6.1%) laid off/business downsizing (9.3%) laid off/business moved/sold (7.5%) laid off/business closed (15.4%) other (24.4%) sajems ns 19 (2016) no 2:175-191 185 “i just want a good job.” the responses of the street-waste pickers also implied that street-waste picking does not yield high levels of income. low income can possibly constitute an economic barrier preventing street-waste pickers from improving their socio-economic conditions. 4.2 income-earning opportunities as an economic barrier the analysis of the income of street-waste pickers shows that their income was earned either on the day on which they had collected their waste or on a weekly basis. most of the street-waste pickers (751 or 82 per cent) earned their income for a day’s waste collected. half of these street-waste pickers earned an income of r50 or below on a usual day. another 25 per cent earned an income of between r51 and r85 on a usual day. the average income on a usual day was only r67.26, showing that the majority of street-waste pickers earned low incomes. the average income received for a usual week was r505.06, with half of the street-waste pickers getting only r300. the global poverty measure of usd2.50 per day for a high middle-income country such as south africa, discounted at the purchasing power parity exchange rate in 2012 of r5.69 (irs, 2013:1), amounted to r14.23 per person per day. the usd2.50 per day poverty line represents the income necessary for one person, and not a whole household, to survive (mclean, 2000:20). on average, a street-waste picker had to support three people (excluding themselves). therefore, the nominal income necessary for four persons amounted to r56.90, which is more than the median usual day income earned by the street-waste pickers. the income needed to support four people for a week in 2012 amounted to r398.30, which is also higher than the usual week median income of r300. the majority of the street-waste pickers therefore earned an income below the poverty line (see figure 4). figure 4 mean and median nominal income earned on a usual, good and bad day and in a usual, good and bad week, 2012 source: survey data the uncertainty about the street-waste pickers’ income is another aspect that makes it difficult for them to improve their socio-economic conditions (viljoen, 2014). the street-waste pickers’ income differs from day to day. on some days, they might earn high incomes, and, on other days, they might earn low incomes, as reflected by the mean and median incomes received on a good and bad day or week as shown in figure 4. it seems as if the street-waste pickers cannot be certain of the income they will be earning by collecting waste on any given day or in any particular week. there were significant differences in the incomes earned on a usual, good and bad day and in a usual, good and bad week. factors that influence the income are the type and value of the recyclable waste products available, the location (e.g. residential or business) where the waste is picked, the weather, the demand and supply of recyclable waste, the fluctuating prices received for 50 120 25 300 500 150 67,26 159,35 31,92 505,06 658,41 214,24 0 100 200 300 400 500 600 700 usual good bad usual good bad day week rand median mean 186 sajems ns 19 (2016) no 2:175-191 recyclable waste products, the level of competition for recyclable waste products, and the type of equipment used to carry the waste (viljoen, 2014). exogenous factors such as the behaviour of people in the other “sectors” of the waste-producing and waste-removal “system”, industrial action, and unforeseen holiday periods also play a role in this regard. the street-waste pickers’ low and uncertain income levels and their resultant inability to meet their basic needs were a real concern for them, as shown by their comments on this issue: “the uncertainty of my income worries me.” “sometimes you don’t make enough to buy food.” the expenditure patterns of street-waste pickers showed that food was the major consumable item purchased. this comes as no surprise. sen (1999) points out that, because their earnings are so low, the income of marginalised people such as waste pickers is mostly spent on food, that is, for survival purposes. the second-most products bought were cleaning materials and cigarettes, tobacco, snuff, or other items for smoking. fewer street-waste pickers bought clothes, shoes and blankets (some of these items were salvaged from the waste they collected), or paid for transport and sources of energy. only 26.2 per cent paid for the place where they slept and a mere 4.2 per cent incurred medical expenses. a large percentage (41.6 per cent) of the street-waste pickers also spent some of their money on alcoholic beverages such as beer, wine and spirits. these behavioural patterns are analogous with research findings that show that poor people spend a larger portion of their incomes on alcohol and tobacco than do richer people (gangopadhyay & wadhwa, 2004). very few (4.7 per cent) paid school/college fees and only 4.2 per cent made contributions to a stokvel or burial society. again, the literature confirms the inability of the poor to exercise consumption choices with potential future benefits (banerjee & duflo, 2007). the income earned by the street-waste pickers was not enough to enable them to participate fully in their community. this finding echoes furedy’s (1990:10) observation that street-waste pickers are also inhibited by social barriers from translating their earnings into improved standards of living. 4.3 social barriers indicators that contextualise the social conditions of street-waste pickers are access to resources that meet their basic human needs (like the type of structure or shelter where they usually sleep), access to food, and access to, or the availability of, other basic household services. a lack of means to fulfil these social needs inhibits the street-waste pickers’ capability to be productive. figure 5 illustrates the type of structure or shelter where the street-waste pickers usually sleep. figure 5 type of shelter in which the street-waste pickers usually sleep, 2012 (n=901) source: survey data construction site (0.1%)backyard room (5.7%) veld/bushes/ streets (32.2%) shack/backyard shacks (30%) hostel/shelter (5%) house (bricks/reeds) (22.6%) buy-back centre/depot (0.2%) other (3.8%) sajems ns 19 (2016) no 2:175-191 187 the lack of proper housing and of a place to store their collected waste are serious problems among street-waste pickers. the street-waste pickers who slept on the street or in the veld or bush also lacked access to other basic household services such as drinking water, toilet facilities, cooking facilities and washing facilities. as one of the street-waste pickers put it: “my concern is a place to live and a place to bath … .” table 8 illustrates the situation. table 8 street-waste pickers’ access to basic services, 2012 no access to basic facilities such as: % drinking water 10.8 toilet facilities 20 a place to wash themselves 30.5 additional food sources % from dustbins/waste 32.9 from other waste pickers 13.9 somebody else, e.g. church/individuals/restaurants 43.6 source: survey data the street-waste pickers expressed their gratitude for the food that they received. one of them said: “i am thankful to all the people who bring food to us after hours.” the above findings confirm that street-waste pickers are generally deprived of the social capital needed to become part of the community. the reasons given by respondents for becoming street-waste pickers also show that these people are indeed marginalised. the single-most important reason given by 36.4 per cent of the streetwaste pickers for becoming such pickers was that they had no other option. another 14 per cent also said that they were doing the job because they could not find work. for 19.4 per cent, the motive for becoming street-waste pickers was to earn some income, and some indicated that they picked waste just to be able to buy food. the human capital, labour market, and social barriers are interdependent and are collectively responsible for keeping street-waste pickers in the lower levels of the informal economy, with little hope of improving their socio-economic conditions. 5 conclusion high levels of unemployment and structural changes in the south african economy are forcing scores of low-skilled and unskilled people into the lower tiers of the informal economy. collecting and selling recyclable waste is one of the activities people resort to in an effort to earn an income in the informal economy. existing research on the activities and lives of waste pickers mostly focuses on the waste pickers working on municipal-dump sites and generally takes the form of small-scale case studies. research on the obstacles facing the street-waste pickers is limited. consequently, the aim of the research reported in this paper was to fill the gap by investigating the barriers standing in the way of the street-waste pickers improving their socio-economic situation. the barriers in question relate to the street-waste pickers’ lack of human capital, labour market immobility, income earned, and the acquisition of social capital. a mixed-method research approach was used. a countrywide survey of 914 street-waste pickers and 69 bbcs in all nine provinces of south africa formed the foundation of the analysis. deprived social and economic backgrounds played a significant role in preventing the majority of the street-waste pickers from completing their formal schooling. their low levels of education, limited language proficiency, and lack of formal work experience impacts negatively on their labour market mobility and on their ability to compete for jobs. the street-waste pickers face an economic barrier in the form of low and uncertain income earned. all the income variables analysed suggested that, given the number of their dependants, 188 sajems ns 19 (2016) no 2:175-191 most street-waste pickers found themselves below the global poverty line appropriate for a high middle-income country like south africa. any form of planning for the future or attempts to improve their socio-economic situation therefore become extremely difficult if not impossible. from a social perspective, the prospects of improving their socio-economic conditions are also limited. lack of proper housing, lack of access to basic services, and, in some instances, lack of food constitute a social barrier that seems almost insurmountable. most street-waste pickers are caught in a poverty trap from which it is difficult to escape. the human-capital, labour market, economic and social barriers are therefore dualistic in nature, as they do not only contribute to the street-waste pickers’ poor socio-economic conditions, but may also keep them trapped in the lower tier of the informal economy. interventions to address these barriers are needed in order to enable street-waste pickers to improve their position. any policy interventions will therefore have to address, almost simultaneously, the poverty, human-capital, economic, social and labour market barriers that make it inherently difficult for street-waste pickers to improve their socio-economic conditions. interventions aimed at supporting street-waste pickers should not deprive them of their livelihood, meagre as it is. a blanket-type strategy is bound to fail. the only feasible approach to achieve this awareness is to conduct in-depth studies at a microlevel into the social and economic lives of street-waste pickers. if this can be coupled with the use of a longitudinal approach and/or comparison group, it will contribute to an improved understanding of the topic at hand. the research process was subject to the same limitations as experienced in all cross-sectional studies. issues such as endogeneity make inferences in terms of causality difficult. however, the research reported on in this paper lays a suitable foundation for focused research initiatives in all towns and cities in south africa. waste pickers in south africa share the same tribulations as those in columbia. pushing their trolleys, collecting their waste, and selling constitute the only alternative for many of south africa’s citizens. indeed, they cannot afford to become any poorer. endnotes 1 the authors wish to thank the anonymous referees of economic research southern africa (ersa) and of the south african journal of economic and management sciences (sajems) for their helpful comments on earlier versions of the paper. the authors also wish to acknowledge ersa for financial assistance with this research. all errors and omissions remain our own. 2 ease of entry into the lower-tier activities also differs. for small manufacturing industries, small retail stores, and backyard industries, the capital and start-up capital varies. the larger operations that require higher levels of skills need more startup capital than the smaller operations, which require lower-skilled labour (house, gerrishon & mccormick, 1993:1213). the entry requirements for domestic workers, single street traders, day labourers and waste pickers also differ to some extent. see viljoen (2014) for a detailed exposition of this aspect. 3 viljoen et al. 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2012. the role and linkages of buy-back centres in the recycling industry: pretoria and bloemfontein. acta commercii, 12(1):1-12. wills, g. 2009. south africa’s informal economy: a statistical profile. women in informal employment, globalizing and organizing (wiego), urban policies research report number. 7. available at: http://www.inclusivecities.org/research/rr7_wills.pdf [accessed november 2012]. wilson, d.c., velis, c. & cheeseman, c. 2006. role of informal sector recycling in waste management in developing countries. habitat international, 30(4):797-808. sajems ns 19 (2016) no 2:175-191 191 appendix 1 full-time jobs previously held by street-waste pickers, 2012 (n=468) artisan boilermaker, fashion designer, hairdresser, carpenter, baker, butcher, chef, painter, seamstress, tailor, welder construction/building brick maker, bricklayer, builder, scaffold builder, construction worker, cable layer, ceiling installer, roof installer, daggaworker, construction electrician, plasterer, road worker, site manager, tiller industry auto electrician, diesel mechanic, mechanic, assistant mechanic, mechanical fitter, assembler, cutting-tool operator, cook (food factory), deboner, electrical assistant, engineering aid, fisherman, fluorescent wiring, foreman, forklift driver, front-end loader driver, machine operator, meat processor, panel beater, chainsaw operator, miner, operator, pipe-worker, power-tool technician, clothes presser, printer, sandblaster, shoe sewer, sheet-metal worker, shopfitter, solderer, spray painter, steelworker, storeman, technician, textile worker, tombstone-manufacture assistant, welding assistant, winch operator, wind controller, workshop assistant, factory worker, timber-worker, artisan’s assistant, cabinetmaker assistant, farm worker services accounts manager, clerical assistant, clerk, despatch clerk, salesperson, debtors clerk, personal assistant, air-conditioner installer, ammunition primer, bottle crusher, bus driver, car-park attendant, caretaker, cashier, chauffeur, cleaner, crane driver, crèche teacher, delivery worker, domestic worker, door installer, driver, driver’s assistant, handyman, irrigation installer, landscaper, maintenance worker, managing own internet cafe, merchandiser, messenger, griller, municipal worker, order picker, packer, parcel sorter, paver, petrol attendant, planter, receiver of flowers, plumber, primary-school teacher, fridge repairer, rifleman, security guard, vegetable seller, shop assistant, signage and design assistant, soldier, stock receiver, taxi driver, teacher, trolley porter, truck conductor, tyre fitter, box packer, gardener, bus washer, scrapyard worker, spoornet labourer, casual worker, general worker, assistant, piece-job worker source: survey data. appendix 2 levels of education of street-waste pickers with full-time job experience (n=468) source: survey data post-school (0.6%) no schooling (5.3%) some primary schooling (25.2%) completed primary schooling (12%) some secondary schooling (47.2%) completed secondary schooling (9.6%) sajems ns 6 (2003) no 4 868 changing approaches to financing and financial management in the south african local government sector ________________________________________________________________ d sing school of public administration & development management, university of natal ________________________________________________________________ abstract sections 152 and 153 of the constitution of the republic of south africa, 1996 (act 108 of 1996) have given local government a developmental mandate. local government has a constitutional obligation to participate in national and provincial development programmes. local government should become a powerful development catalyst in collaboration with other spheres of government, the non-governmental sector and the local citizenry. it has to address social, economic and infrastructural backlogs and inequalities in a stable and sustainable manner to ensure developmental outcomes are reached. different financing and financial management policies, strategies, structures, processes and procedures have to be instituted with a view to transformation and innovation. constant and consistent monitoring, analysis and evaluation of these policies, strategies structures, processes and procedures should ensure these constitutional imperatives. jel h71, h72, h77 1 introduction sections 152 and 153 of the constitution of the republic of south africa, 1996 (act 108 of 1996) (hereafter referred to as the constitution) mandate the development role and responsibility of the local government sphere and also oblige it to participate in national and provincial development programmes. existing and pending legislation views the local government sphere as a powerful development agency. according to parnell and pieterse (2002: 79) developmental local government as an official policy objective presents the first sign that a new wave of post-apartheid reconstruction is beginning. for local government to perform a development role in addressing social, economic and infrastructural backlogs and inequalities in a viable and sustainable manner, sajems ns 6 (2003) no 4 869 innovative and transformative financing and financial management policies, strategies, structures, processes and procedures have to be instituted. 2 national transfers in their discussion of intergovernmental financial relations, official national government documents distinguish between the different types of grants, agency payments and other forms of national transfers to support national priorities. a conditional grant is an allocation from one sphere of government to another, subject to the delivery of certain services or compliance with specified requirements (medium term budget policy statement (medium term bps), 1998: 78). conditional grant programmes, which apply to municipalities, are administered by a variety of national departments including provincial and local government, the national treasury, water affairs and forestry, transport and public works. such conditional grant programmes are the consolidated municipal infrastructure programme (cmip), the local economic development fund (ledf), the community water and sanitation services programme (cwssp), the community based public works programmes (cbpwp), the south african housing fund, the national electrification fund, and the urban transport fund. in addition, small infrastructure transfers, mainly in the form of asset transfers, such as those linked to the settlement and land acquisition grant managed by department of land affairs (intergovernmental fiscal review (ifr), 2000: 141-42). agency payments are payments made by one government department to another in the same or in a different sphere of government for services administered by the department receiving the payment (medium term bps, 1998: 77). conditional grants and agency payments are designed to provide for national priorities in the budgets of municipalities. those payments promote national norms and standards and support local government transition by funding capacity building and restructuring. such grants also aim to address backlogs and regional disparities in social transformation (ifr, 2000: 133). section 227 (1)(b) of the constitution makes provision for local government to receive conditional or unconditional grants from national government revenue. the equitable share vertical transfer to the local government sector is a constitutional entitlement in terms of section 227(1)(a) of the constitution and is regarded as an unconditional transfer to assist municipalities in providing basic services and performing their assigned functions. the equitable share is administered by the department of provincial and local government and is a sajems ns 6 (2003) no 4 870 sub-programme of the institutional reform and support programme. the formula-driven horizontal distribution methodology attempts to ensure a greater equity in the allocations to local authorities. these allocations are determined in terms of a policy framework (national expenditure survey, 2000: 15). the formula for distributing equitable share between municipalities has two components: the i grant supports municipalities with limited capacity and the s grant supports all municipalities in the delivery of a basic level of service. the formula has strong poverty bias and attempts to measure the number of povertystricken households. it favours poor rural households, and has reduced allocations to large metropolitan municipalities (ifr, 2000: 122). the predictability of these transfers will be addressed through three-year allocations. their targeting will be improved through refining the data used in identifying poor households (ifr, 2000: 110). formula-based direct, horizontal distribution of equitable share transfers to municipalities promotes uniformity and predictability. this distribution also prevents manipulation and perverse allocation incentives such as emergency support and the historical pattern of expenditure (the introduction of equitable share of nationally raised revenue for local government, 1998: 5). 3 financial municipal infrastructure the white paper on local government (1998: 111-12) emphasizes that the system of municipal finance has to include a number of basic policy principles to meet the objectives of the constitution. one of the policy principles stresses that an increase in investment in municipal infrastructure is required to meet the basic needs of service backlogs. a major role of the department of local and provincial government is its partnership with local government and the provision of structured support to municipalities for successful delivery. consolidated municipal infrastructure programme (cmip) is such a support system and is regarded as a critical part of redistribution funding to the local government sector (ifr, 2000: 104). the cmip is operated by the department of provincial and local government and is a sub-programme of its governance and development programme. the programme funds the creation, extension, upgrading or rehabilitation of internal bulk, connector and internal infrastructure and community services for lowincome households (ifr, 2000: 141). projects include water and sanitation services, roads, storm-water infrastructure, solid waste disposal and community services. projects typically involve local contractors and are labour intensive, targeting women, and youths for employment and training (estimates of national expenditure, 2002: 106). sajems ns 6 (2003) no 4 871 like all requests for conditional grant funding, the application procedures are stringent and thorough. funding is provided to municipalities through the submission of an application for project assistance to the provincial government. this includes a municipal council resolution approving each project. the provincial government prioritizes applications and informs municipalities with the highest priorities to prepare business plans. these business plans are again prioritized and submitted to the provincial executive council for approval. they are then submitted to the department of provincial and local government, which, if satisfied that all requirements have been fulfilled, recommends funding for the projects (ifr, 2000: 141). 4 financing local economic development the fundamentals for a development-orientated local government are set out in section 195 (1)(c) of the constitution. development-orientated local government is regarded as a principle and a value underlying public administration in south africa. the focus on economic development is set out in section 152(1)(c) of the constitution as one of the objectives of local government. as far as the national government is concerned, local economic development is no longer reserved for the national and provincial spheres of government. local authorities can help stimulate the economy and improve the lives of their citizens, thus engaging in local economic development (led), by utilizing the unique powers and objectives of local government, and working in partnership with community stakeholders (the local authority’s role in economic development, 1998: 1). led is multi-dimensional. it aims to create and retain employment opportunities for local residents, alleviate poverty and distribute resources and opportunities to benefit all local residents. led can stimulate large and small enterprises within a locality. a municipality can support led by providing direct economic services such as the provision of business facilities, the promotion of agri-industry, support to tourism initiatives and human resources development programmes (local economic development fund: year 20002001 announcement, 2000: 2). government support for led is enabled through the institution of the local economic development fund (ledf), which is a sub-programme within the department of provincial and local government’s governance and development programme (national expenditure survey, 2000: 20). sajems ns 6 (2003) no 4 872 the department of provincial and local government has developed an application form for municipalities to facilitate the approval of funds. municipalities have to provide information on the location of, and main access routes to the project. a business plan, a project description and information about the estimated duration of the project, project sectors, sustainability, as well as the direct and indirect beneficiaries of the project, are required. information about sustainability has direct financial and management implications for a project. the questions include : • who will be responsible for the operations and maintenance costs of the projects over the next three to five years? • what management structures will be in place to facilitate the project? • should the project require further finances over the next three to five years, who or what will be the source of such finances? • what role will the municipality play? 5 municipal infrastructure investment unit the municipal infrastructure investment unit (miiu) was established on 20 march 1998 as a non-profit company incorporated under section 21 of the companies act, 1973 (act 61 of 1973). it reports to the minister of provincial and local government and is a sub-programme of the governance and development programme of the department. the company was established as a five-year intervention to develop a market for technical assistance on project preparation in the sphere of municipal infrastructure and services (annual report miiu, 1999: corporate profile). the objectives of miiu are twofold. the first objective is to encourage and optimise private sector investment in core local authority services on a basis that is sustainable at local and national level. the second objective is to assist the development of an established market containing informed local authority clients, private sector advisers, private sector investors and service providers (estimates of national expenditure, 2002: 112). private sector investment can take any of a broad range of forms, including: • private sector financing of municipal debt. • contracting out of the management of ongoing services. • concessions to operate the local authority’s assets over a defined period. • contracts requiring the private sector to design, build, finance and operate assets to deliver services for the local authority. • privatisation of assets and services (annual report, miiu 1999: corporate profile). sajems ns 6 (2003) no 4 873 for the miiu to function as a company capable of responding to the demands of local government and the related legal and regulatory environment, various procedures and documents have been established and designed (annual report, miiu 1999: corporate profile). the documents and procedures include: • applications and approval procedures. • procurement and contracting procedures. • an application questionnaire. • a project preparation report. • a grant agreement. • cost-sharing guidelines. • terms of reference. • requests for proposals. • newspaper advertisements. • a consulting contract. the grant funding application questionnaire is a comprehensive document which requires qualitative and quantitative information on the infrastructure and existing system of delivery (annual report miiu 1999: corporate profile). the questionnaire consists of two sections. section a, deals with project information and focuses on project identification, project justification and project preparations. section b, the national ring-fencing exercise concentrates on cost information, debt information, revenue information, tariff information, service coverage information and information on future investment needs. the grant funding application questionnaire is also linked to other documents such as the grant agreement and cost-sharing guidelines. the grant agreement is an agreement between a municipality and the miiu. it provides a description of the project, the terms of reference for the work to be undertaken, as well as the roles and responsibilities regarding project supervision, information sharing and disbursement procedures. the cost-sharing guidelines focus on the sharing of project preparation costs between the miiu and a municipality (annual report miiu, 1999: corporate profile). the preamble to the questionnaire stipulates that the miiu portion of the cost share will be based on economic need, previous expenditures, project and financial or technical sustainability. in general, the miiu will reduce its share in the later stages of the project. 6 project viability programme project viability is the responsibility of the department of provincial and local government and was launched in 1995 (by the then department of sajems ns 6 (2003) no 4 874 constitutional development) (project viability, 1998: 2). it is sub-programme of the institutional reform and support programme of the department (estimates of national expenditure, 2002: 106). it is regarded as a national intervention programme which aims at building the financial, administrative and management capacity of financially compromised municipalities in order to make them financially viable. the programme focuses on: • monitoring the financial position of municipalities on a quarterly basis. • conducting management audits in municipalities that have financial difficulties based on the results of the quarterly survey. the objective is to identify the cause of the problem and determine the level of support required by those municipalities. • instituting management support programmes in municipalities that are experiencing financial difficulties. • implementing a training and mentoring programme (department of constitutional development, annual report, 1998: 61). project viability is then a multi-dimensional management tool which uses the questionnaire to collect data as illustrated in questionnaire 23. the questionnaire includes both financial and non-financial indicators. it is divided into sections and sub-sections and requires municipalities to provide information relating to: • corporate governance. • capacity to deliver services. • consumer management. • management information systems. • audited financial statements. • current financial situation. • current financial results. • analysis of cash flow. • analysis of bank investments. • analysis of account receivable. • analysis of accounts payable. • risk management. • performance improvement. • key statistics and indicators. • summary of latest audited financial statements. • rates, taxes, service suppliers and levels for domestic consumers. reports based on this questionnaire enable the department to institute a combination of strategic and operational measures to restore the financial health of municipalities. these measures include improving credit control, promoting sajems ns 6 (2003) no 4 875 alternative service delivery mechanisms, performance management systems and performance contracts, organizational redesign, improving accounting practices and promoting economic development (ifr, 2000: 101). at the initial stages of project viability, questionnaires were completed voluntarily. however, during 1997, the minister promulgated regulations which made it mandatory for the chief executive officers of municipalities to provide the minister or a designated institution, with the necessary information to determine the soundness of a municipality’s finances within 21 days. in certain circumstances the relevant member of the executive committee (mec) may grant exemption from this requirement (department of constitutional development, annual report, 1998: 2). 7 transforming and reforming municipal budgets the national government has prioritized transforming and reforming budget formats, budget preparation, implementation, monitoring and reporting within the local sphere of government in order to enable municipalities to meet their constitutionally-determined developmental role and responsibilities (ifr, 2000: 116). section 215 of the constitution mandates the national treasury to prescribe the form and format of municipal budgets as well as the budgetary processes. furthermore, it must prescribe the information that should be included therein (local government budget reforms, 1999: 1). as with other aspects of government, municipal budgets have to be governed by the basic values and principles that are contained in chapter 10 of the constitution. these include for example, promoting efficient, effective and economical use of resources, transparency, public accountability, public participation and a development orientation. in order for national treasury to meet its constitutional obligations relating to municipal budgets, a budget reform project was commissioned. the executive summary of the report and annexures adopted the following framework for its recommendations: • encouraging the development role and responsibilities of municipalities. • formalising the role of the department of finance (now national treasury) in the budgetary and monitoring processes. • encouraging community participation in the budgetary process. • facilitating financial management and informed decision making through budget preparation and monitoring processes. sajems ns 6 (2003) no 4 876 • specifying the minimum content that constitutes a municipal budget. • instituting appropriate monitoring processes to identify deviations from the budget and financial impact of such deviations on fiscal performance. • reflecting economic realities of each municipality. • complying with certain information requirements to meet certain international reporting protocols. • considering performance management as a part of the budgeting process (local government budget reforms, 1999: 1-2). to give effect to these recommendations several annexures were developed to obtain meaningful and usable information. some of the information that must be detailed includes operating and capital expenditure, municipal budget framework, a summary of the integrated development plan and budget process (local government budget reforms, 1999: 8-39). the information requirements set out in the various annexures serve as instruments of budge transformation and reform and enhance the role of the national treasury in meeting its constitutional obligations. they particularly aim to establish an enabling framework for ensuring that: • three-year municipal operating and capital budgets are prepared as in national and provincial spheres of government. • there is simplification and allocation certainty in the national and provincial grants, on a three-year basis. • municipalities have a three-year grant system. • all revenues and expenditure are accurately shown on the budgets. • there is a greater involvement by council, the executive and citizens in the budget preparation process. • the quality of budgets presented to councils is improved to ensure a better understanding by the general public of the trade-offs between different provinces. • budgets contain meaningful information to encourage reporting against set objectives and performance indicators. • an in-year reporting system for early diagnosis of financial problem exists, so that appropriate support programmes can be implemented. • comparisons between municipalities are encouraged and general benchmarks are generated through standardised uniform budget formats. • a standard accounting and reporting system is introduced. standard classifications for revenue and expenditure in a uniform chart of accounts will allow for benchmarking so that south african municipalities can be compared with one another and with similar municipalities globally (ifr, 2000: 113-17). sajems ns 6 (2003) no 4 877 8 shifting the paradigm in accounting policies, standards and practices in terms of section 216(1) of the constitution, the national treasury is required to develop and prescribe generally recognised accounting standards and practices for all spheres of government. generally accepted municipal accounting policies (gamap) have been developed for municipalities in accordance with this constitutional requirement (an introductory guide to gamap, 1999: 1). the white paper on local government (1998: 125) recommends applying accounting policies, standards and practices specifically tailored for municipalities to address shortcomings in existing municipal accounting practices. current practices based on the different provincial ordinances are complex. they encourage taxation in advance of need, and adversely affect the accurate costing of services and do not promote transparency. the financial statements of municipalities therefore do not portray their financial position accurately, limiting access to external loans and other finance for essential development in municipalities (letter to the holder of the handbook for municipal finance officers, institute of municipal finance officers, 28 october 1999). the aim of gamap is not to regulate transactions of a municipality through legislation. it merely aims to ensure that the transactions that a municipality has entered into are disclosed in the financial statements, regardless of whether such transactions are legal or illegal. gamap require that a municipality disclose transactions in the financial statements in a consistent manner using recognised practices, to enable users to accurately assess operating results, the financial position and the cash flows of municipalities. municipalities that use the same accounting policies, practices and standards facilitate comparisons between them. gamap ensures that south african municipalities use accounting policies, practices and standards that are generally recognised both nationally and internationally, and which apply to both public and private organizations (an introductory guide to gamap, 1999: 1-2). 9 municipal financial emergency section 44 of the constitution read in conjunction with sections 139 and 155 stipulate that national and provincial governments have legislative and executive authority to ensure that municipalities perform their functions effectively. these measures provide for provincial government intervention and, if this is not done effectively, national government can then intervene in the affairs of municipalities. failures in the functions of municipalities are often manifest in the development of a financial crises (policy framework for municipal sajems ns 6 (2003) no 4 878 borrowing and financial emergencies (policy framework for mbfe), 2000: 17). existing procedures are complicated and are not necessarily conducive to effective ratification. the reason is that existing constitutional and legal provisions are not entirely optimal, especially with respect to situations where interventions fail to bring about the desired results. in order for such problems to be avoided, a system with clear and effective procedures and authorities is needed. to this end, the national government has begun a process of establishing a set of procedures, to be authorized by the judiciary and to be overseen by a municipal financial authority. the purpose of the procedures is to deal with municipalities when, notwithstanding all other interventions, they run into a situation of financial distress (policy framework for mbfe, 2000: 120-23). the municipal financial emergency authority will be established as a separate institution outside the public service and will have a juristic personality. it will have the task of overseeing the administration of financial emergencies in a manner analogous to the master of the high court in respect of judicial managements. the authority will be required to supervise recovery plans for municipalities where a situation of financial emergency has been declared by a court order. in order to give effect to the court order the authority has to promptly appoint an administrator whose main task will be to develop a recovery plan (policy framework for mbfe, 2000: 122-24). the fundamental objectives of the recovery plan will be inter-alia to: • restore the municipality to a sound financial and fiscal condition as soon as possible and to restore it creditworthiness. • identify the underlying fiscal or financial problems of the municipality. • describe a general strategy for addressing these problems. • describe the anticipated time framework for recovery, and milestones to be achieved. • identify the principal objectives of the plan and methods for achieving those objectives (policy framework for mbfe, 2000: 137-38). the administrator shall intervene in the affairs of the municipality to the extent appropriate to the municipality’s condition, using the least intrusive practical measures and means to effectively address the situation. in a case where a municipality takes necessary actions to the satisfaction of the administrator, the administrator need not exercise its powers in-lieu of the municipality. the main objectives of the intervention by the administrator are to restore fiscal integrity and full democratic governance as soon as possible (policy framework for mbfe, 2000: 122). other implications are that national government is intent on distancing itself from day-to-day operations of municipalities and that sajems ns 6 (2003) no 4 879 national government will act as a guarantor in case municipalities fail (pauw et al., 2002: 267-68). 10 conclusion viability and sustainability are fundamental factors in municipal service delivery if local government is to address its development role effectively. the financing of economic and social development and municipal infrastructure, using appropriate national transfers needs constant and consistent analysis and evaluation. strategic interventions, such as project viability studies, budget reform and the generally accepted municipal accounting policies, promote a holistic approach to achieving developmental objectives of local government. policies and procedures for dealing with financial emergencies will ensure that municipalities do not fail in achieving their objectives. references 1 department of constitutional development (1998) project viability, pretoria. 2 department of constitutional development (1998) annual report, pretoria. 3 department of finance (1999) local government budget reforms, executive summary, pretoria. 4 department of provincial and local government (2000-2001) local economic development fund, announcement, pretoria. 5 institute of municipal officers (1999) an introductory guide to gamap. 6 institute of municipal officers (1999) letter dated 28 october to holder of the handbook for municipal finance officers. 7 ministry of provincial affairs and constitutional development (1998) white paper on local government, pretoria. 8 municipal infrastructure investment unit (1999) annual report, midrand, halfway house. 9 parnell, s. & pieterse, e. (2002) “developmental local government”, in parnnel, s. et al. (eds.) democratising local government: the south african experiment, university of cape town press, cape town. 10 pauw, j.c. et al. (eds.) (2002) managing public money: a system from the south, heinemann publishers (pty) ltd, sandown. sajems ns 6 (2003) no 4 880 11 republic of south africa (1996) the constitution of the republic of south africa act, act 108 of 1999. 12 republic of south africa (1998) medium term budget policy statement, department of finance, pretoria. 13 republic of south africa (1998) the introduction of an equitable share of nationally raised revenue for local government, department of finance, pretoria. 14 republic of south africa (2000) “policy framework for municipal borrowing and financial emergencies”, government gazette no. 21423, general notice 2739, 28 july, pretoria. 15 republic of south africa (2000) intergovernmental fiscal review, national treasury, pretoria. 16 republic of south africa (2000) national expenditure survey, national treasury, pretoria. 17 republic of south africa (2002) estimates of national expenditure, national treasury, pretoria. 18 the local authority’s role in economic development (1998) a handbook for councillors and officials, international republican on institute. microsoft word 6 boshoff & cloete sajems 15(1) 2012.docx 72 sajems ns 15 (2012) no 1 can listed property shares be a surrogate for direct property investment behaviour? douw boshoff and chris cloete department of construction economics, university of pretoria accepted: november 2011 the listed property sector in south africa has grown to a size which could be considered to be a good representation of the income producing property market in general. stock market listed property investment funds offer the opportunity to compare indirect property investment to direct property investment, which could bridge the gap between irrational investment behaviour and intrinsic asset values. this study investigates the relationship between listed property share prices and the property values in listed property funds. the share prices are correlated with various factors, such as the accounting ratios of the companies, the financial statements of the companies and general economic variables. the outcome of the study is an explanation of the behaviour of listed property shares, and its relationship to the direct property market and the general economy. this would assist in the explanation of market behaviour and provides the opportunity to more accurately predict portfolio asset values, which might be used in the valuation of individual real estate assets. key words: property demand, property values, macro-economic property variables, construction demand jel: g11 1 introduction behavioural finance theory has shown that share price movement follows the irrational behaviour of the market and that the market is not as efficient as traditional economic theory would want to believe. according to shiller (2003:102), ‘the fundamental value of stocks (shares) is hard to measure, and moreover, if speculative bubbles last a long time, then even this fundamental relation may not be observed except in very long sample periods.’ the above quotation is understandable for the different listed companies that are providing various services, manufacturing and mining. such a company should use its assets to derive an income, and the effectiveness of the management of the company will determine the amounts of profits that can be delivered. this means the more effectively the assets are utilised in mining or manufacturing processes, the more profitable the company, and theoretically the more popular it shares would be. but investors do not have the inside details of these companies and are therefore reacting differently on events that could cause the company’s share price to change. this ultimately causes the share prices to be volatile, with movements that cannot always be directly correlated with specific events. but what about listed property shares? a listed property company is not much different from a portfolio of properties owned by a number of shareholders, apart from the fact that a number of people are operating these properties on behalf of the shareholders, and the shareholders can exchange their shares on the stock exchange. ultimately it is still a number of investors that together own a portfolio of properties. this means that the share price of a listed property fund should be stable, and theoretically mimic property values. the outcome explains the share price of the listed property company in relation to the variables, from where it is possible to make predictions in the direct property investment market by considering activities in the indirect investment market. the research method is based on a correlation analysis of variables identified as abstract sajems ns 15 (2012) no 1 73 the value forming attributes in the companies under review. although there are limited abilities in the use of correlation analysis only, it provides a good base for further research in the relationship between company equity value or share price performance and the underlying real estate assets. this study is therefore limited to an initial identification of the extent that individual items could be indicative of share price behaviour, which could then be used for further research on the topic. 2 background to the study ‘unfortunately, property values cannot be determined by quick reference to the stock market, but have to be determined independently’ (hager & lord, 1985:23). the study is done with the listed property market as case study, as this is a dynamic market that can provide much information on both the direct real estate investment market and the indirect and financial markets. in order to achieve this, previous research on the listed property market, property valuation and macroproperty modelling have been considered. hager and lord (1985:23) noted that the shape of the return from a direct property investment is in some senses similar to that of an index-linked gilt. giliberto (1990:259) stated that in american equity real estate investment trusts (ereits), which are essentially reits but exclude mortgage reits, prices track the stock market, with its attendant volatility, but they have income characteristics of direct real estate investment. furthermore, ereit’s correlation with the stock market has declined over time, while the correlation with bond returns has increased. sagalyn (1990:209) found that the performance of real estate securities is driven by security market pricing. prices react quickly to changes in the economy, and, compared to direct investments in real estate, real estate security returns are volatile. institutional as well as individual investors often perceive investment in listed property vehicles, or real estate funds such as property loan stock (pls) or property unit trusts (put), to be equivalent to investment in direct real estate, while retaining a degree of liquidity that is unavailable from other forms of real estate investment. the studies mentioned above show that there are certain correlations between the behaviour of listed funds and direct real estate, but also indicate that real estate shares have similarities with the stock market in general. the presumption is that listed real estate funds are influenced by factors similar to those influencing direct real estate. yet the correlation between indices of listed funds and direct property investment is highly questionable (giliberto, 1990:259). giliberto (1990:262) showed that stock and bond market movements heavily influence ereit’s performance, but have a relatively minor effect on direct real estate investment. however, if financial market effects are removed, a strong positive correlation is evident. this suggests the presence of a common factor, or factors, in both sets of returns. chan, hendershott and sanders (1990:432) showed that three factors consistently drive both real estate and stock market returns: change in the risk structures, term structures and unexpected inflation. according to gyourko & keim (1993:39) real estate shares traded on the new york and american stock exchanges reflect changes in real estate market fundamentals in a more timely fashion than a widely used appraisalbased system. they mention that two findings are of particular relevance: • there is no significant contemporaneous correlation between ereit and appraisal series returns. • ereit returns are significantly positively correlated with broader stock market returns. these findings have led many to conclude that share prices are not reliable guides to real estate values. they do, however, show that the stock market provides reliable return measures for one of the most important, yet least studied and understood, asset categories. they show that decisions based on movements in appraisal-based indexes rely, in large part, on stale information. the stock market, however, provides a reliable measure of real estate conditions. 74 sajems ns 15 (2012) no 1 fisher, geltner and webb (1994:137-160), considered the history of commercial property values by comparing different methods of constructing commercial property value indices and return series. three types of indices were examined: i) indices that attempt to reconstruct property market values by ‘unsmoothing’ appraisal-based indices; ii) indices that trace average ex post transaction prices of commercial properties over time; and iii) an index based on unlevering reit share prices. under the three types, five indices of the historical value of commercial property have been quantified. some common messages emerged from the different indices, and as the indices have been developed using different methodologies and assumptions, and to some extent different data, the conclusion is considered fairly robust. the different indices showed a fair pattern in terms of property values over time, therefore confirming each other’s findings. some other interesting differences also emerge across the different indices, which reveal and illustrate aspects of the index construction methodology as well as the nature of commercial property markets. all the indices show greater volatility than the appraisal-based index, with the transaction price index and reit share price index showing visibly greater volatility than the other indices. this shows the influence of the transactions on volatility, but also contains more ‘noise’ than the other indices. another interesting phenomenon is that the appraisalbased index lagged behind the reit share price index by approximately two years, indicating that the reit share price index registers value changes much more quickly, which might also explain the higher volatility. geltner (1996) introduced a repeatedmeasures-regression-based index (rmr) which allows the construction of indices of capital value at a greater frequency than the interval time between the reappraisals of the properties within the index. the rmr has been widely used in the construction of transaction price-based housing indexes in the united states, but was not used for appraisal based indexes of commercial property. geltner investigated the application of the method for use in appraisal-based indices of commercial property. peterson and hsieh (1997:322) found that most of the evidence regarding reit performance indicates that reits tend to either outperform or perform about the same as common shares. lizieri and satchell (1997:12) showed that property shares also exhibit a strong contemporaneous correlation with overall equity performance. ling and naranjo (1999:483 & 505-506) indicated that the market for exchange-traded real estate companies, including reits, is integrated with the market for exchange traded (non-real estate) shares. however, when appraisal-based returns (adjusted for smoothing) are used to construct real estate portfolio returns, the results fail to support the integration hypothesis, although this may reflect the inability of these estimated private market returns to accurately proxy for commercial real estate returns. glascock, lu and so (2000:178-179) indicated that reits and unsecuritised real estate should be cointegrated. however, cointegration between reits and stock market may not be present because the key gains in securitised real estate may come from management and risk-sharing rather than the underlying asset of real estate per se. booth and marcato (2004:147) found that the two main causes of the difference between the performance of direct real estate and real estate share indices is firstly due to the smoothing of valuation-based indices and secondly the gearing ratio of property shares or reits indices. it was found that there is a close relationship between de-geared indirect market indices and unsmoothed direct market indices and that there is granger causality running from the indirect to the direct market. booth and marcato mentioned that direct real estate indices do not measure the performance of underlying transaction prices properly because they are based on valuations, and therefore maybe subject to valuation smoothing. indirect real estate indices do not properly measure the value investors put on the sajems ns 15 (2012) no 1 75 underlying assets of real estate companies, because real estate companies are geared. they furthermore note that the analysis of the relationship between annual returns from direct real estate and annual returns from real estate shares suggests that de-geared real estate share returns have useful information content that could help understand performance in the direct real estate market. it is shown that when direct real estate data are unsmoothed, measures of dependency between the direct and the de-geared indirect market strengthen considerably, and if it is assumed that unsmoothed direct real estate returns better reflect underlying transaction prices than direct real estate data, the results suggest that data from the market for real-estate shares could be useful for filling the gaps in direct market series. doppegieter and rode (2002:2) explain that puts’ dividend yields and capitalisation rates used for valuation are not based on the same variables, and differences should be expected. they state that put dividend yields provide a better indication of commercial property values in south africa than compared with cap rates. the mentioned studies consider mostly the relationship between direct real estate investment and investment through listed vehicles by way of the similarities in the return obtained. the factors driving the return are discussed and the effect on share prices is tested and used to construct indexes to predict return behaviour, rather than value. there is also evidence of the similarities between real estate share behaviour to the behaviour of other shares. again it is largely based on returns, rather than actual share prices or value. no evidence of studies conclusively comparing the value of shares directly to the value of the underlying real estate could be found. chan, leung and wang (1998:357) indicate that ownership structure (together with the resulting shareholder activism) has a direct impact on the ability of shareholders to monitor management’s activities. in addition, this monitoring ability provided by institutional investors could affect a firm’s value. they furthermore state that several studies show that the investment strategy of institutional investors has an impact on share returns and their autocorrelation. chan et al. (1998:357-358) continue that there are relatively fewer institutional investors investing in reit shares than in the general stock market. in addition, reit shares with a higher percentage of institutional ownership perform better than other reit shares with fewer (or no) institutional investors. it therefore appears that the participation of institutional investors increases the control and monitoring ability of shareholders, and hence increases the value of reit shares. furthermore, there are some large institutional investors who concentrate their investments in the reit stock market. consequently, the monitoring and control aspects of those reits must be improving, as institutional investors normally have the expertise and are more willing to spend resources to monitor the companies in which they invest (p. 372). downs and güner (1999:518) stated that problems associated with observing the value of the underlying asset in real estate securities are frequently cited by practitioners and academics. brennan (1990:727-728) refers to this as a latent-asset problem, in other words, the information acquisition problem of investors when the value of some assets is not observable. glascock, lu and so (2000:177-178) indicate that as the reit market continues to develop, institutional investors are more comfortable in this form of real estate investment, and institutional holdings of reit ipo’s have increased from less than 10 per cent before 1990 to 41.7 per cent after 1990. this increase in institutional investment in the reit market is partly facilitated by the tax reform act in 1993. the tax reform allows more institutional investment without jeopardising the trust’s tax-favoured status. these structural changes are important to portfolio management because they may allow reits to behave more like traditional (smallcap) shares than real estate. wilson and zurbruegg (2003:205-206) indicated that with the emergence of securitised real estate as a viable alternative for institutional investors in the late 1980s and early 1990s, it has become an integral part of 76 sajems ns 15 (2012) no 1 the research debate as to whether the direct and indirect property markets are driven by different forces. they state that a shortcoming in the literature appears to be a lack of effective identification of those factors that appear to have a lasting effect on moving property markets (permanent components) and those that do not (transitory components). identifying these factors is important because: • institutional investors have both longand short-term goals driven by their strategic and tactical asset allocation objectives. isolating the objectives would provide them with more effective info to adjust their portfolios • securitized property markets have their underlying assets in the direct property sector. it is therefore reasonable to suppose that the permanent driving forces should be the same in both, although the transitory components may differ. • isolating permanent vs. transitory components will help identify the sort of controls that monetary and fiscal authorities have over domestic real estate, which again have important ramifications for institutional investors. doppegieter and rode (2002:5) indicate the distinction between direct and indirect property investment as the level of involvement of investors in the actual operation of the specific building. it is apparent from the above that the behaviour of listed property share prices are influenced by the involvement of institutional investors, and also by the amount of information that is available to them in making investment decisions. when considering the influence of economic factors, wilson and zurbruegg (2003:207) state that surges in employment growth and real interest rates produce equally severe cycles in real office rents, while it was found that real gross domestic product (gdp) is an important underlying component of real estate cycles for offices in sweden. gdp was found to be an important driver of the canadian commercial property market (clayton, 1996:353), while growth in real per capita consumption, real short-term interest rates, the real term structure of interest rates and unexpected inflation was found to be fundamental drivers that systematically affected returns of both direct and indirect real estate markets in the us (ling & naranjo, 1997:283). in periods of expansion, the productivity level was seen as an important driver of both direct and indirect real estate markets in the us, while capital markets also played a role during periods of increased volatility (grissom & delisle, 1999:110-113). it was further found in various countries that domestic economic growth could partially explain real estate behaviour (quan & titman, 1999:183) as well as interest rates and general economic fundamentals (edelstein & paul, 2000:66-68; mera, 2000:84). wilson et al. (2003:207-208) further indicated that there is also a growing interest in the globalisation of real estate and the identification of global drivers. there is a link between real estate cycles and growth in deregulated finance, the internationalisation of financial and economic relationships, as well as a link to fundamental economic conditions in each country. the development of closer links between real estate and capital markets and the less restricted flow of capital has spread the value cycle of real estate to a global dimension (renaud, 1997:37). change in world gdp is also found to be an important driver of real estate markets (case, goetzmann & rouenhorst, 2000:2-3) this was extended and it was suggested that international markets were linked to the us real estate markets through the health of the us economy (wilson et al., 2003:208). lee and stevenson (2007:551) found strong linkages between reits and value shares, but they state that there remain sufficient differences in their return behaviour and driving forces for the two sectors to retain a level of distinctiveness, providing portfolio optimisation opportunities for which the one is not substitutable with the other. viezer (1998) (also viezer, 1999) developed a real estate econometric forecast model (reefm). the reefm pooled an unbalanced panel to estimate six behavioural equations for each of four property type markets (apartments, office, retail and warehouses). the six stochastic behavioural equations were occupancy, real rents, cap rate, market value sajems ns 15 (2012) no 1 77 per square foot, net change in stock, and real construction cost. reefm integrated real estate’s space and capital markets econometrically rather than diagrammatically as per previous studies (see also archourfischer, 1999, dipasquale & wheaton, 1992 and fisher, 1992) it significantly increased the number of metropolitan areas in the pooled equations, and estimated equations for four separate property types. reefm also employs a unique equation for determining the change in stock of space. this equation links the space and capital markets and the short and long run by combining both price and quantity signals. both the reefm and the fdw models, however, have the shortcoming that it can only do market interpretations on a macro level, in other words, to consider the long term effects of a specific type of property in a specific market. it doesn’t consider the micro level influences on the property that differentiates it from other properties around it. boshoff (2004) furthered the application of theory to the concept of spaceand capitalmarket interdependencies, by assessing the relevance of two models for real estate markets to the south african economy. the models concerned are the fdw (fisher-dipasqualewheaton) model, and the reefm (real estate econometric forecast model). while the reefm is an econometric model based on statistical principles that can forecast property market behaviour by interpretation of specific given variables, the fdw model provides a diagrammatic explanation of the behaviour of the property market, and while the fdw model, despite its explanatory and pedagogic merit, is of little value as an investment tool, the reefm can forecast implicit market returns. boshoff, by application of the reefm to de-centralised office space in the major cities in south africa, revealed a close correlation with actual trends, indicating that the reefm can be used as a model for the forecasting of the office market. viezer (1998:1-16) indicated that there is resistance to the application of portfolio theory in real estate, due to the following: • the nature of the real estate market, i.e. adoption of the do-the-deal principle. (p 4 8, figure 1.1) • questions regarding the quality of real estate return data (pp. 8-12) from the above studies it is identified that various similarities between listed property shares and other shares were found in the literature, as well as between property shares and direct property, while property shares were found to be more volatile than direct real estate investment but less volatile than other shares. studies of direct and indirect property almost throughout consider the relationships with regard to returns on investment, while no studies were found where the actual values where compared to each other. it is indicated in the studies that if the stock market attributes could be removed from property shares, information could be obtained that could be useful in the direct property market. the latter is indicated to be unpredictable due to a lack of transparency and information, and this could therefore be well explained by indirect markets. some studies focus on direct real estate, essentially on space and capital markets, to explain the equilibrium position and market cycles. rather than focussing on the space and capital market equilibrium, this study considers the possibilities to obtain information from the more liquid indirect real estate market in order to explain the direct market. 3 accounting methods of valuation the listed property market in south africa consists of pls companies and real estate investment trusts, previously put funds. reits in south africa are similar to reits elsewhere in the world, but as its assets consist largely of investment in other property vehicles (indirect real estate), the value comparison abilities between share prices and direct real estate values are diminished. as such this study is limited to plss which mainly invest in direct real estate. there are 21 pls companies, with a total market capitalisation of r93 582 324 000, which is a combination of different property types, locations, and classes. as indicated in the literature, the performance of these companies would largely depend on the 78 sajems ns 15 (2012) no 1 ownership structure. from the 21 companies, it was identified that eight companies had institutional shareholding of more than 40 per cent on average over the past four years. these companies were identified to show significant higher correlation in their share price movement to the movement in the jse all-share index. the companies also dominate the pls market in terms of size, confirming the literature on shareholder activism. one of the companies (hospitality) focuses on leisure properties, and as such performs differently from the others. the remaining thirteen companies showed significantly less accuracy in terms of the results given in this study. as such, the focus for purposes of this paper remains on seven companies, where it was found that information is of higher availability, and the performance seems to confirm the shareholder activism theory. it was found that these seven companies holds approximately 90 per cent of the pls sector in terms of market capitalisation and as such are considered to be a good representation of the sector. the pls sector makes up approximately 4.1 per cent of the financial sector of which it forms part, and 0.8 per cent of the jse. the daily share prices of the seven pls companies are shown in figure 1. the similar movement for the various funds is obvious and is an indication that it might be external factors that drive the volatility of the shares, in other words, general economic conditions, or stock market confidence, rather than specific company variables. the movement of the share prices, and ultimately the market capitalisation of the different companies, could be investigated by way of relative comparison, using the accounting method of valuation. it involves the comparison of the different accounting ratios as performance indicators to the same ratios of other companies, thereby providing a base for comparison of share performance. the financial ratios are divided into five categories: 1 common size statement. 2 internal liquidity (solvency) 3 operating performance: a) operating efficiency; b) operating profitability. 4 risk analysis: a) business risk; b) financial risk; c) liquidity risk. 5 growth analysis. f i g u r e 1 daily share prices of pls companies 0 1000 2000 3000 4000 5000 6000 dec-99 dec-00 dec-01 dec-02 dec-03 dec-04 dec-05 dec-06 dec-07 dec-08 dec-09 date c lo si ng p ric e acucap growthpoint hyprop pangbourne redefine resilient vukile source: mcgreggor bfa sajems ns 15 (2012) no 1 79 the significance of these ratios is tested by correlation of each ratio to the share price performance over a 10-year period from 2000 to 2009. a high positive correlation would indicate that the specific ratio is a good indicator of value driver with a positive relationship, in other words, when the ratio increases it will motivate investors to purchase the share at a higher price, while a high negative correlation indicates that an increase in the ratio would demotivate investors and subsequently the price of the share would fall. a low correlation would indicate that an investor is indifferent to the movement of the ratio when taking a decision to buy or sell shares. the correlation of the individual companies’ share prices with their respective ratios is determined, but is also combined to obtain the correlation of share prices with accounting ratios in general. table 1 provides the correlation coefficients for the different variables to the year-end closing price of each company. t a b l e 1 accounting ratios correlation to closing share prices of plss acucap growthpoint hyprop pangbourne redefine resilient vukile combined current ratio -.818* -.698* .097 .247 .246 -.459 .522 -.207 debt-assets ratio -.979** -.738* -.804** -.907** -.974** -.622 -.826 -.619** debt-equity ratio -.798* .322 -.620 -.925** -.659 -.616 -.916* -.130 net profit margin .079 -.464 .469 .501 .878 -.534 .875 .300* operating profit margin .036 -.628 .417 .346 .926* -.445 .867 .383** quick ratio -.817* -.560 .097 .008 .246 -.496 .257 -.221 return on assets -.291 -.816** -.034 -.050 .120 -.770 .026 .022 return on capital empl. -.881** -.482 .035 -.021 -.632 -.973** -.788 -.245 return on equity -.838* -.728* -.845** -.573 -.329 -.789 .a -.717** total assets turnover -.011 -.483 .233 .515 -.003 -.755 -.162 .060 ** correlation is significant at the .01 level * correlation is significant at the .05 level a cannot be computed because at least one of the variables is constant. source: author t a b l e 2 accounting ratios’ correlation to weighted average share prices of plss acucap growthpoint hyprop pangbourne redefine resilient vukile combined current ratio -.828* -.665* .066 .178 .292 -.467 .214 -.217 debt-assets ratio -.850* -.618 -.788* -.966** -.941** -.620 -.938* -.600** debt-equity ratio -.718 .044 -.609 -.930** -.615 -.617 -.881* -.163 net profit margin -.123 -.354 .412 .657* .215 -.534 -.257 .253 operating profit margin -.173 -.583 .354 .539 .370 -.445 -.273 .325* quick ratio -.828* -.416 .066 -.038 .292 -.505 -.033 -.220 return on assets -.480 -.748* -.092 -.058 -.043 -.761 -.521 -.052 return on capital empl. -.885** -.391 -.005 -.064 -.726* -.966** -.911* -.276* return on equity -.846* -.676* -.829** -.733* -.715 -.777 .a -.720** total assets turnover -.205 -.386 .183 .536 -.179 -.746 -.634 .009 ** correlation is significant at the .01 level * correlation is significant at the .05 level a cannot be computed because at least one of the variables is constant. source: authors 80 sajems ns 15 (2012) no 1 from table 1 it is evident that some of the ratios do provide a high level of correlation with the closing share price, but the correlation is not consistent for all companies. where this is the case, the relevance of such a correlation is questionable. variables that show a fair degree of consistency, as well as a high degree of correlation with combined data, are the debt-assets ratio and return on equity. table 2 consists of the same ratios, but the correlation is tested to the weighted average share price for the year, rather than the closing price. again the same ratios as with the closing price correlation test, being the debt-assets ratio and return on equity, stand out to show fairly consistent high degrees of correlation on the individual company data as well as the combined data. in both the correlation tests, the negative correlation between the share price and the return on equity might come as a surprise: normally the higher the return on equity, the more effective is the company on its assets, and the higher the share price would be. in order to explain this reversed situation, consideration should be given to general valuation principles for income-producing properties, namely the capitalisation of the first year’s income to calculate the value of the property. this is done by the formula: value = net income/capitalisation rate 1 if this is rewritten in the format to determine the capitalisation rate, it is: capitalisation rate = net income/value 2 if it is compared to the return on equity ratio, it can be seen that it is in the same format, with the total return to equity holders divided by the total value or price of the shares of the company. this indicates that the lower the ratio of income to the asset value, the lower the capitalisation rate; or, the lower the return attributable to equity holders as percentage of the price paid for the share, the lower the return on equity ratio. the capitalisation rate in the property sector is however a measure of risk, indicating that the lower the rate, the higher the confidence of the investor that the specific asset will provide the cash flow as foreseen. due to the fact that the pls sector consists of a portfolio of properties, and therefore the income is the sum of the rental streams of these properties, it is therefore expected that the share price will increase as the confidence of the investors increases that the assets will deliver the required cash flow. therefore investors are prepared to pay higher prices for the shares for a given amount of return, if they perceive the risk to decrease. it can therefore be concluded that with pls companies, the return on equity ratio is not an efficiency ratio as with manufacturing and other firms, but rather a confidence ratio, that will have a negative correlation with the share price of the company. the negative correlation of the share prices with the debt-assets ratio is an indication that investors are seeing the higher debt levels as a risk to their investment, and therefore are not prepared to pay more for shares as debt increases. this indicates that the debt levels are above the optimum debt level. the structure of the pls companies makes it difficult to analyse this variable accurately, as the total debt also includes the debentures which form part of the investment of the shareholders. therefore this ratio should be carefully considered taking into consideration the share capital, debenture and other debt structures of each company, in other words, growthpoint has the highest level of debt at 95.6 per cent and then vukile at 75.8 per cent, yet vukile has the third highest correlation between debt-equity ratio and share price (0.938 at the 95 per cent confidence level), while growthpoint has a correlation of -0.618 but below the 95 per cent confidence level. it is evident that the debt-equity ratio is not the primary driver of share prices, and reliance is put on other factors as well. investors seem insensitive to debt at higher levels, and therefore the debt structure of each company should be considered in more detail to get a conclusive result on this ratio. it should however be mentioned that growthpoint is the largest of the pls companies, while vukile is a much smaller and volatile company. this confirms that investors would consider more than a single variable to make decisions, and would consider companies in accordance with their risk profiles. from the above it is presumed that although sajems ns 15 (2012) no 1 81 some significant correlations are observed, the valuation of listed property funds does not entirely rely on accounting returns, and therefore confirms the criticism of various authors on the method (van heerden de wet, 2004), and that reliance for value in this sector might have to be put on other variables. 4 share price correlation with financial statements in order to test the reliance of the share price of the pls companies on variables other than the accounting ratios, the share price of each of the seven pls companies under consideration is correlated with its financial statements, in other words, the balance sheet and income statements. the results of this can be seen in tables 3 to 6. when considering the correlations in table 3, the share prices show significant correlations with the different balance sheet items, the most consistently high correlations as well as the highest correlations for combined data being assets, fixed assets, equity, ordinary shareholders interest and deferred tax. although the main operation of these companies is property investment and one could expect a close correlation of the share price with fixed assets, the correlation with total assets is higher, indicating that shareholders recognise assets other than fixed assets as also important, such as investments in other companies, as these assets provide additional income. total liabilities also provide correlations that are similar to the correlation with assets, yet the correlation of the combined data in both these cases shows a much weaker situation. this is explained by figure 2, with debt as example, where regression lines of the individual companies can be seen, compared to the combined situation. t a b l e 3 balance sheet correlation to closing share price of plss acucap growthpoint hyprop pangbourne redefine resilient vukile combined assets .843** .907** .992** .751* .949** .922** .981** .358** fixed assets .855** .911** .978** .703* .918** .901** .979** .331** current assets .408 .622 .693* .696* .837** .696* .880** .218 non current assets .515 .472 .851** .399 .445 .a .559 .317** intangible assets .330 .486 .a .780** .a .456 .964** .047 equity .829** .513 .995** .779** .927** .899** .921** .655** ordinary s.h. interest .829** .513 .979** .760* .927** .898** .914** .614** outside s.h. interest .a .a .639* .306 .445 .a .149 .564** liabilities .836** .904** .970** .749* .950** .921** .973** .243* current liabilities .579 .779** .983** .601 .908** .763* .945** .253* deferred tax .947** .485 .993** .604 .905** .973** .939** .748** long term liabilities .861** .905** .939** .817** .946** .902** .958** .174 **correlation is significant at the .01 level *correlation is significant at the .05 level a. cannot be computed because at least one of the variables is constant. source: author from the close correlation that can be seen in the individual company’s regression lines, it could be deduced that the share prices are explained to a large degree by the debt levels in the various companies, but from the large differences in slope of these regression lines it is concluded that debt cannot be seen as a primary driving factor for share prices in general; therefore, in order to explain share price movement, other factors should also be considered. equity has also shown a high level of correlation for all the companies, but with a higher level of correlation for the combined data than with the other variables. this is to be expected due to the fact that the equity is the 82 sajems ns 15 (2012) no 1 company’s representation of the value of the combined shares, and this is a confirmation that the share price, being the market’s interpretation of equity value, follows the financial statements’ or directors’ indication of equity value. f i g u r e 2 total debt correlation to closing share prices of plss source: author table 4 provides the closing share price as it correlates with the income statement items. a fair degree of consistent high correlation for various items is evident, but again there are a number of variables that correlate well for company specific data, but have a substantial lower correlation for combined data. this is especially visible for the turnover figures, and is represented in figure 3. t a b l e 4 income statement correlation to closing share prices of plss acucap growthpoint hyprop pangbourne redefine resilient vukile combined turnover .837** .892** .911** .832** .919** .927** .774** .254* operating profit .870** .877** .833** .659* .844** .897** .968** .573** interest received .616 .678* .710* .543 .695* .662* .931** .312** total income .893** .879** .843** .652* .856** .939** .970** .577** total cost shown .470 .504 .946** -.142 .152 .790** .965** .102 e.b.i.t. .893** .892** .842** .686* .855** .937** .969** .583** interest & finance .799** .879** .965** .780** .911** .915** .981** .283* profit before tax .458 -.411 .757* .340 .564 .785** .862** .549** taxation .501 -.077 .619 .323 .599 .632* .764* .512** profit after int. & tax .439 -.484 .792** .339 .483 .823** .880** .540** e.b.i.t.d.a. .891** .887** .843** .714* .836** .938** .969** .562** ** correlation is significant at the .01 level * correlation is significant at the .05 level a cannot be computed because at least one of the variables is constant. source: author ! sajems ns 15 (2012) no 1 83 f i g u r e 3 turnover correlation to closing share prices of plss source: author it is noticeable that the profit items are having higher correlations than the items that include expenses. operating profit, earnings before interest and tax (e.b.i.t.). and earnings before interest, tax, depreciation and amortisation (e.b.i.t.d.a.) are the highest correlating variables for the combined data, with equally high correlations for the individual companies. this would suggest a high consideration for the returns of the companies in share price determination. tables 5 and 6 consider the correlation to the various companies’ balance sheets and income statements respectively to the average share prices for the year opposed to the closing share price as seen in tables 3 and 4. t a b l e 5 balance sheet correlation to weighted average share price of plss acucap growthpoint hyprop pangbourne redefine resilient vukile combined assets .918** .973** .984** .871** .973** .928** .979** .409** fixed assets .930** .974** .968** .833** .941** .908** .978** .379** current assets .401 .660* .717* .841** .870** .695* .808** .272* non current assets .650* .685* .878** .267 .524 .a .693* .374** intangible assets .338 .678* .a .665* .a .469 .930** .100 equity .898** .700* .992** .890** .944** .911** .963** .689** ordinary s.h. interest .898** .700* .978** .870** .944** .909** .957** .651** outside s.h. interest .a .a .629 .532 .524 .a .135 .553** liabilities .913** .971** .959** .872** .980** .922** .958** .291* current liabilities .736* .803** .976** .766** .936** .771** .902** .319** deferred tax .948** .679* .993** .755* .927** .980** .952** .766** long term liabilities .913** .974** .924** .913** .976** .900** .942** .219 ** correlation is significant at the .01 level * correlation is significant at the .05 level a cannot be computed because at least one of the variables is constant. source: authors 84 sajems ns 15 (2012) no 1 t a b l e 6 income statement correlation to weighted average share prices of plss acucap growthpoint hyprop pangbourne redefine resilient vukile combined turnover .892** .952** .890** .818** .953** .924** .843** .298* operating profit .836** .946** .814** .815** .779** .886** .911** .594** interest received .644* .715* .743* .732* .761* .676* .929** .364** total income .864** .947** .825** .812** .793** .931** .913** .601** total cost shown .428 .686* .935** -.098 .199 .788** .986** .127 e.b.i.t. .864** .953** .824** .845** .792** .929** .911** .605** interest & finance .849** .947** .951** .824** .954** .915** .976** .330** profit before tax .368 -.599 .739* .513 .456 .774** .759* .533** taxation .398 -.156 .606 .450 .575 .615 .631 .496** profit after int. & tax .356 -.688* .772** .524 .360 .814** .789** .525** e.b.i.t.d.a. .863** .955** .825** .865** .773** .930** .911** .584** ** correlation is significant at the .01 level * correlation is significant at the .05 level a cannot be computed because at least one of the variables is constant. source: authors the financial statement items show more consistent correlations with the weighted average share prices than with the correlation with the closing price of the company shares. it is also notable that the correlations are higher also for the combined data for the average share price than with the closing price. the items showing best correlations are however similar to those identified for the closing share price, and the tendencies are also similar, for the same reasons as mentioned earlier. the correlations however seem to provide a slightly stronger explanation on share prices than did the accounting ratios. this could however not be stated conclusively. as the share price of a company is only the price paid for a single share, but the financial statements consider the company as a whole (i.e. all the issued shares), consideration should also be given to the market capitalisation of the companies, in other words, the latest share price multiplied by the number of shares in issue. although this is not strictly speaking the correlation of the share price with financial statements, it is the total value of the company as per the daily share price movement. due to the higher correlation of weighted average share prices with all different variables, it is expected that the weighted average market capitalisation (weighted average share price multiplied by weighted average number of shares) will also provide higher correlations with the different variables in question than the closing market capitalisation. this was tested and confirmed to be the situation, but is not shown here. subsequently, only the weighted average market capitalisation of each company is considered, to the extent that it correlates with the financial statements of the company. the results of this are shown on tables 7 and 8. the correlation of the weighted average market capitalisation with the balance sheet and income statement of the respective company shows levels of consistent correlation that are substantially higher than the correlation with the weighted average share prices. what is however of interest is that in these two tables, the variables that had t he largest discrepancies between individual company and combined data, are now showing the highest correlations for the combined data, which are also substantially higher than any correlations found in the test for correlation with singles share prices, or accounting ratios. sajems ns 15 (2012) no 1 85 t a b l e 7 balance sheet correlation to weighted average market capitalisation of plss acucap growthpoint hyprop pangbourne redefine resilient vukile combined assets .997** .993** .984** .969** .996** .989** .962** .983** fixed assets .996** .992** .968** .950** .995** .982** .960** .976** current assets .357 .801** .684* .936** .957** .782** .793** .598** non current assets .879** .749* .867** .104 .670* .a .741* .743** intangible assets .573 .839** .a .489 .a .696* .934** .776** equity .992** .855** .994** .977** .994** .992** .980** .437** ordinary s.h. interest .992** .855** .993** .973** .994** .992** .976** .445** outside s.h. interest .a .a .568 .541 .670* .a .047 .119 liabilities .986** .994** .948** .965** .980** .962** .932** .970** current liabilities .885** .822** .982** .893** .982** .911** .887** .794** deferred tax .913** .838** .989** .906** .984** .973** .971** .429** long term liabilities .967** .994** .921** .986** .961** .926** .909** .953** ** correlation is significant at the .01 level * correlation is significant at the .05 level a cannot be computed because at least one of the variables is constant. source: authors t a b l e 8 income statement correlation to weighted average market capitalisation of plss acucap growthpoint hyprop pangbourne redefine resilient vukile combined turnover .968** .991** .884** .927** .966** .937** .877** .965** operating profit .688* .987** .770** .792** .682* .737* .878** .764** interest received .831** .639* .742* .837** .879** .858** .935** .707** total income .744* .981** .782** .802** .700* .812** .880** .782** total cost shown .325 .850** .936** .073 .176 .758* .980** .475** e.b.i.t. .745* .979** .780** .812** .699* .810** .878** .772** interest & finance .950** .982** .961** .957** .992** .960** .961** .969** profit before tax .099 -.793** .684* .379 .311 .587 .712* .094 taxation .139 -.422 .536 .257 .507 .381 .596 .109 profit after int. & tax .083 -.827** .725* .411 .207 .646* .739* .085 e.b.i.t.d.a. .742* .983** .781** .825** .702* .810** .878** .764** ** correlation is significant at the .01 level * correlation is significant at the .05 level a cannot be computed because at least one of the variables is constant. source: authors the variable with the highest correlation is total assets. this is indicated by figure 4, where the similar slope in the regression lines for all the companies can be seen. this is an indication that shareholders take a combined look at the company as a whole when making individual share price decisions. shareholders are therefore reacting on the actions of all other investors, and are comparing the sum of all shares to the value of the company’s assets. this furthermore is an indication that the total sum of all shares as seen by market activity is in line with the market’s expectations of the total assets of the company. an interesting deduction is that the correlations on the combined data for the balance sheet are higher than the correlations in the income statement; therefore it seems as if investors are putting emphasis on the assets, and they are purchasing a share in a portfolio of properties for the actual return that they will receive. 86 sajems ns 15 (2012) no 1 f i g u r e 4 total assets correlation to weighted average market capitalisation of plss source: authors in summary, the correlation of normal financial statement items with the share prices of the pls companies seems to be slightly better than the correlation of the accounting ratios and share prices of these companies. there is also a slightly higher correlation between the weighted average share price for the year and the financial statement items, than between the closing share price and the financial statements, indicating that investors are considering the operations of the company in the long term, and the share price that fluctuates daily is doing so within the boundaries that are created by the essentials of the company, being the variables on the financial statements. this confirms the presumption that pls companies are unique in the sense that the balance sheet items, or assets in themselves are the investment, rather than the operations of the company, as found with other jse listed companies. the correlation of the weighted average market capitalisation with the financial statement items is, however, of more reliance than the individual share prices. the accounting ratios provide information on the company’s performance, but as ratios they provide information that is significant for individual shares, while the financial statements provide information on the company as a whole, and should therefore be considered in relation to the market capitalisation. the longterm market capitalisation of these companies is therefore a good indication of how investors are viewing these companies, and with the high correlation with total assets, is also a good indication of the values of the properties underlying the balance sheet, hence also the direct property market. 5 correlation of share price with the jse in the previous section it was indicated that a high level of correlation exist between the financial statements and the market capitalisation of the shares of such a company. it is also evident that the correlation exists in a similar way for all companies, and that the total market capitalisation could be accurately predicted by considering the balance sheet of the companies. this ultimately is influenced by investors in the price they are prepared to pay for the shares, taking into consideration the number of shares that are issued. equally, the sajems ns 15 (2012) no 1 87 value of the underlying assets could be predicted by considering the going share price, multiplied by the total number of shares issued. if, however, we again consider figure 1, there is much fluctuation in the share price, and subsequently in the market capitalisation of the shares between year-end dates, when information on company performance becomes available to shareholders and prospective investors. it is presumed that shareholders cannot have sufficient information on the individual companies that could drive them to make buy-and-sell decisions on a daily basis that could cause such high fluctuations in the market. in this section the fluctuations in the share prices will be considered in order to resolve this question. when the share prices of the different companies are viewed as per figure 1 it can be seen that the prices are moving in a similar way. it is therefore presumed that the cause of the fluctuations is affecting the companies alike, and should therefore be of an external nature, rather than originating from variables within the company itself. as part of the pls sector, which in turn forms part of the financial sector and the overall jse, the share prices are compared to various indexes in order to explain the fluctuations. the indexes under consideration are the following: • the j253 sa property index; • the j256 pls index; • the j203 all share index; and • the j580 finacials index. if this is correlated with the individual share prices, the results are as indicated in table 9. t a b l e 9 jse indices correlation to weighted average share prices of plss acucap growthpoint hyprop pangbourne redefine resilient vukile combined j253 sa property .989** .987** .991** .982** .991** .965** .980** .996** j256 pls .990** .995** .997** .988** .991** .990** .976** .998** j203 all share .931** .928** .944** .929** .941** .931** .909** .936** j580 financials .938** .926** .935** .941** .938** .858** .866** .927** ** correlation is significant at the .01 level * correlation is significant at the .05 level a cannot be computed because at least one of the variables is constant. source: authors the high correlation with the j253 and j256 is expected, as the companies that are considered form a major part of these indexes. as said earlier, the seven companies under consideration make up 90 per cent of the pls sector, and therefore the index is just a reflection of the sum of these companies. therefore the combined correlation between the companies and the index should be close. it could be argued that this is also the case with the financial and all share indexes, but if it is taken into consideration that the pls sector makes up only 4.1 per cent of the financial sector and 0.8 per cent of the jse, a change in a single company, or even in the pls sector as a whole, will not have any significant effect on the two respective indexes. it is therefore stated that the influence is the other way round, with fluctuations in the share price of individual pls companies being influenced by general jse sentiment, and not by anything caused by company operations. this confirms that irrational behaviour of investors is equally applicable to property shares as to other listed shares, and provides the opportunity to further investigate behavioural finance theory on property investment. if the principles of behavioural finance could be applied to property shares, a lot could be learnt from the listed property sector which, due to the correlations that were seen earlier in this paper between property shares and the underlying assets, could be applied to direct property investment as well. 88 sajems ns 15 (2012) no 1 6 correlation of share price with economy in the previous section it was shown that the fluctuations in the share prices of pls companies are caused largely due to the jse sentiment, in other words, factors affecting the jse as a whole rather than the operations of the companies itself, although the long-term growth in share prices could be determined by the growth in assets, divided by the number of shares issued. it should however be asked, what is driving the growth of the pls companies in the long term? why are pls companies growing and what causes the longterm increase in balance sheet and therefore share prices? if the driving forces in the longterm growth can be identified, it is also possible to determine the extent that these companies are likely to grow in the long term, and what fundamentals to address, or opportunities to explore in order to excel. it furthermore could provide a link to predict market capitalisation movement within a specific framework, from where the value of the underlying assets could be predicted. with these questions, the share prices, market capitalisation and balance sheets of the t a b l e 1 0 economic factors correlation to closing share prices of plss acucap growthpoint hyprop pangbourne redefine resilient vukile combined total employment in the private sector .869** .883** .885** .879** .860** .945** .827** .893** total employment in the public sector .859** .888** .898** .856** .873** .930** .748** .891** total employment in the nonagricultural sector .881** .897** .900** .890** .874** .947** .822** .906** disposable income of households .863** .893** .898** .869** .867** .912** .700** .897** ratio of saving by households to disposable income -.920** -.915** -.929** -.910** -.911** -.888** -.820** -.927** total national government debt as % of gdp -.840** -.878** -.882** -.851** -.849** -.901** -.719** -.880** national government revenue as % of gdp .732** .719** .725** .721** .721** .634** .522** .720** national government expenditure as % of gdp .326** .318** .332** .305** .298** .331** .200** .325** gross domestic product at market prices (gdp) .852** .884** .891** .858** .862** .909** .686** .888** gross value added at basic prices of construction (gdp) .824** .858** .861** .833** .828** .894** .681** .861** repo -.296** -.203** -.227** -.297** -.195** -.002 .440** -.258** ** correlation is significant at the .01 level * correlation is significant at the .05 level a cannot be computed because at least one of the variables is constant. source: authors case study are compared to various macroeconomic variables. the main drivers of the economy that are tested are the following: • total employment in the private sector • total employment in the public sector • total employment in the non-agricultural sector • disposable income of households • ratio of saving by households to disposable income of households • total national government debt as a percentage of gdp • national government revenue as a percentage of gdp • national government expenditure as a percentage of gdp • gross domestic product at market prices (gdp) • gross value added at basic prices of construction (contractors) (gdp) • repo rate sajems ns 15 (2012) no 1 89 the correlation of these variables with the individual companies’ share prices, number of shares and market capitalisation is indicated in tables 10 to 12. t a b l e 1 1 economic factors correlation to number of shares of plss acucap growthpoint hyprop pangbourne redefine resilient vukile combined total employment in the private sector .843** .847** .898** .753** .570** .863** .811** .817** total employment in the public sector .981** .948** .901** .905** .670** .940** .745** .910** total employment in the nonagricultural sector .869** .869** .911** .779** .588** .876** .807** .840** disposable income of households .974** .950** .935** .919** .674** .955** .723** .921** ratio of saving by house-holds to disposable income -.798** -.803** -.889** -.629** -.473** -.696** -.719** -.745** total national government debt as % of gdp -.969** -.947** -.900** -.908** -.682** -.933** -.690** -.915** national government revenue as % of gdp .507** .532** .633** .285** .265** .352** .525** .469** national government expenditure as % of gdp .335** .375** .337** .310** .302** .380** .179** .367** gross domestic product at market prices (gdp) .987** .960** .928** .933** .696** .967** .708** .933** gross value added at basic prices of construction (gdp) .962** .949** .904** .907** .681** .962** .698** .915** repo -.037 -.210** -.343** .015 -.250** -.022 .450** -.261** ** correlation is significant at the .01 level * correlation is significant at the .05 level a cannot be computed because at least one of the variables is constant. source: authors t a b l e 1 2 economic factors correlation to market capitalisation of plss acucap growthpoint hyprop pangbourne redefine resilient vukile combined total employment in the private sector .860** .879** .896** .843** .635** .909** .866** .864** total employment in the public sector .970** .970** .941** .962** .740** .965** .795** .957** total employment in the nonagricultural sector .883** .901** .913** .867** .655** .919** .862** .887** disposable income of households .955** .962** .940** .968** .732** .961** .750** .953** ratio of saving by house-holds to disposable income -.844** -.857** -.920** -.776** -.576** -.753** -.832** -.837** total national government debt as % of gdp -.954** -.962** -.923** -.956** -.736** -.961** -.765** -.947** national government revenue as % of gdp .588** .596** .695** .477** .371** .445** .530** .577** national government expenditure as % of gdp .337** .347** .341** .349** .313** .373** .209** .355** gross domestic product at market prices (gdp) .966** .971** .939** .977** .752** .974** .736** .962** gross value added at basic prices of construction (gdp) .938** .946** .908** .951** .732** .973** .731** .935** repo -.081** -.120** -.196** -.106** -.230** .041 .478** -.167** **correlation is significant at the .01 level 90 sajems ns 15 (2012) no 1 the correlations show various items that have high correlations with the share prices, number of shares and market capitalisation of the companies. it could be seen that the correlation of all the items with the number of shares issued and market capitalisation of redefine is substantially lower than the other pls companies. upon investigation it was revealed that redefine had a substantial increase in market capitalisation during 2009 due to a merger with two other pls companies, and it is therefore providing a distorted view of the real situation, as the financial information of the other funds prior to the merger is not taken into consideration. the combined correlations are indicated in table 13, from where it is possible to compare the correlations to each other. t a b l e 1 3 most relevant economic correlations closing price no of shares market cap total employment in the private sector .893** .817** .864** total employment in the public sector .891** .910** .957** total employment in the non-agricultural sector .906** .840** .887** disposable income of households .897** .921** .953** ratio of saving by households to disposable income -.927** -.745** -.837** total national government debt as % of gdp -.880** -.915** -.947** national government revenue as percentage of gdp .720** .469** .577** national government expenditure as % of gdp .325** .367** .355** gross domestic product at market prices (gdp) .888** .933** .962** gross value added at basic prices of construction (gdp) .861** .915** .935** repo -.258** -.261** -.167** ** correlation is significant at the .01 level * correlation is significant at the .05 level a cannot be computed because at least one of the variables is constant. source: authors as shown in table 13, it is evident that the highest correlations are with the market capitalisation of the pls companies. variables that are significant are those of the employment levels, which is not surprising, due to the fact that with higher employment come more requirements for place to work, and subsequently higher levels of property investment, being retail, commercial or industrial, and subsequently the increase in market share growth for property. the highest correlation is, however, that of gross domestic product (gdp) as it correlates with market capitalisation. gdp growth is generally seen as one of the most important indicators of economic growth, and it would subsequently also influence the demand for property. with an increase in economic activity, firms are in more need of real estate space to provide manufacturing, goods and services. it is notable that gdp also correlates closely with the number of shares issued, being an indication of the expansion of the pls companies, not taking into consideration the price level increases of the shares. although not shown in the tables above, the three company variables were also tested against real gdp, and the results were that market capitalisation is correlating slightly lower at 0.957**, and the number of shares issued is slightly higher at 0.967**. this confirms that the company growth is determined by gdp growth, but the market capitalisation and gdp both include general price level increases, while number of shares issued is an indication of real growth in the company. this last statement could however be distorted by share splits, or combinations. another important measure is that of gross value added at basic prices of construction. a positive correlation is expected due to the fact that an increase in property demand would sajems ns 15 (2012) no 1 91 initiate construction. the growth in property investment, as seen in the increase in market capitalisation of property shares, drives the construction levels, and therefore this variable is not considered to be a driver of property investment, being direct or indirect, other than stock adjustment and subsequent influence on demand and supply equilibrium (dipasquale et al., 1992), but is the dependent variable. the correlation of disposable income of households with the market capitalisation of shares is also significant. the disposable income of households is expected to increase with an increase in gdp as per general macroeconomic theory (case et al., 1999). the one explanation is therefore that both market capitalisation and disposable income are dependant variables on gdp. the second explanation would be that households are increasing investment with an increase in disposable income, causing an increase in investment levels also in the direct and indirect property markets. correlations that were found to be much less reliable are those of national government revenue as percentage of gdp, national government expenditure as percentage of gdp, and the repo rate. the highest negative correlation is of total national government debt as percentage of gdp with market capitalisation. this indicates that the effective use of government debt is an important driver of the economy, and ultimately the property market. if government is increasing its debt levels more quickly than the expansion of the gdp, it is destroying value and therefore the total market value levels of property are diminishing. this might be due to money that flows towards government debt rather than funding economic growth. another notable correlation is that of the ratio of savings by households with disposable income of households that shows significant negative correlations with the share prices of the pls companies. this specific economic variable correlates even higher with the allshare index at -0.942**. gdp consists of household consumption, investment spending by firms, government expenditure and net exports, therefore an increase in household consumption would increase gdp. over the past 20 years disposable income decreased from an average level of approximately 65 per cent to approximately 62 per cent of gdp. although it is a negative trend, it does not appear to be drastic. if it is considered that disposable income consists of consumption by households and savings, it is deduced that if disposable income is stable, an increase in consumption spending by households should be funded from savings. this has the effect of an increase in gdp, which is explained earlier to cause an increase in direct and indirect real estate investment prices, at the cost of reduced savings. therefore, although this negative correlation is evident from the case study, it is not an occurrence that would always exist, and is not to be seen as a reliable indicator of performance of shares, specifically in the property sector. the situation depicted here is actually of people that are saving less in order to risk their savings in higher risk / higher return investments, such as the stock market, or just consuming more at the cost of savings, which does increase gdp and subsequently property investment, but it is not investment by themselves. this situation is considered not to be sustainable and it is evident from the economic downturn that was experienced in south africa from 2008. if the trend continues, savings will be depleted and this will result in a reduction in consumer spending and subsequently gdp growth, due to a lack of disposable income. the result of this is a downturn economic activity, including direct and indirect real estate investment. 7 conclusion in the study it is identified that listed property share price behaviour, and more specifically pls shares, can provide accurate information on the movement in share prices. the accurate correlations shown suggest that the share price could be a surrogate for the asset values. the study is, however, performed within the limits of simple linear correlations, and excludes the combined effect of more than one of these items in a multiple regression. the results are shown to be within the limits of the involvement of shareholders to monitor the activities of the company, which is found to be 92 sajems ns 15 (2012) no 1 the case with companies having high levels of institutional shareholding. it is furthermore within the limits of long-term views of the share price, as the short-term share price is fluctuating in line with wider jse sentiment. as such the study indicates that the relevance of accounting ratios as a method of share valuation for listed property companies is inferior to other methods for determining the value of listed property shares. the correlation of share prices and subsequently the market capitalisation of the pls shares with the financial statements of the companies reveals that the assets of the companies, being property, are in themselves the investment. it is therefore stated that the pls companies are growing by finding opportunities in the market by which they are expanding. by finding these opportunities they create the boundaries of a new playing field, being the share trading market. the investors in the shares of the pls companies stay within these boundaries, as confirmed by the high correlation between market capitalisation and the balance sheet, and the high correlation of interest payments to investors with the market capitalisation, being the sum of all shares. the long-term opportunities for the pls companies are created by the wider economic variables. the gdp growth and various employment levels are seen in close correlation with property market activity, which influences the opportunities that exist for pls companies. from this it can be concluded that listed property shares can provide good information on how investors are viewing the balance sheet, or the portfolio of properties of the company itself, which can be used for interpretation of direct property market activity. this should, however, be used cautiously within the parameters of the irrational behaviour of investors, that causes short-term fluctuations in the share prices, and which could distort interpretations. but still it provides the opportunity to get information on property market activity more quickly. furthermore, the correlations with economic variables provide the opportunity to also predict property behaviour, based on estimates of future economic activities. this could therefore add to the interpretation of property economics. the study forms the basis for further research, where the items under review in this paper could be combined in a multiple regression to investigate the possibilities for share prices to explain underlying asset values, 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analysis of south african indirect tax policy reform and the welfare consequences of such reform has been limited by a lack of reliable consumer demand system estimations. one reason for potentially unreliable demand estimations is not using actual price data in estimation. in this paper, the results of a nutritional goods demand system estimation and a complete demand system estimation are reported. both systems were estimated with the use of the quadratic almost ideal demand system (quaids) model incorporating demographic variables and using actual price and expenditure data. subsequent to estimations, expenditure, own and cross-price elasticities of demand were calculated for both demand systems. the coefficients estimated provided largely statistical significant results and all elasticities calculated seem plausible in sign and magnitude. key words: quadratic almost ideal demand system, indirect tax, elasticities jel: d12, 63 1 introduction despite relatively strong economic growth in recent times, many african countries are faced with several challenges, including high unemployment, poverty and income inequality, food insecurity, and a lack of economic transformation (united nations, 2014). further, sustained development for african countries will require additional publicly financed investments, but, unfortunately, most government budgets do not allow for these investments (cnossen, 2015). owing to the decrease in aid from developed countries, decreases in taxes on imports and exports, uncertain future foreign investment and generally high levels of debt, african countries will have to look to increasing domestic tax revenues for sustained development (african economic outlook, 2010; cnossen, 2015). africa’s economic growth has also benefited south africa (lipton, 2013), which faces similar challenges. with a gini coefficient of 0.65, south africa has the highest level of income inequality in the world (world bank, 2015).1 the level of income inequality also appears to be on an upward trend, being measured at 0.56 in 1995, 0.57 in 2000, 0.63 in 2009 and 0.65 in 2012 (world bank, 2015). besides income inequality, south africa has the sixth-highest unemployment rate in the world, a population of which less than half the inhabitants are food-secure, and an education system ranked 146 out of 148 countries considered (world bank, 2015; south african national health and nutrition examination survey, 2012; efa global monitoring report, 2010). if south africa were to address these challenges (as mentioned in the objectives of the government’s national development plan 2030), additional domestic tax revenues would be required (davis tax committee, 2014). south africa may well consider reform of indirect taxes, especially the value-added tax, but such reform should be coupled with empirical analysis of welfare consequences (davis tax committee, 2014; ebrill, keen, bodin & summers, 2001). a key determinant of the accuracy of such an empirical analysis is accurate measures of individual (or household) consumer behavioural changes in relation to a change in indirect tax policy (banks, blundell & lewbel, 1997). these behavioural changes can be estimated with the use of a consumer demand model. abstract 616 sajems ns 19 (2016) no 4:615-629 models that have been proposed in estimating demand systems include the linear expenditure system (see stone, 1954), the rotterdam model (see theil, 1965), the translog model (see christensen, jorgenson & lau, 1975), the almost ideal demand system (see deaton & muellbauer, 1980a), the cbs demand system (see keller & van driel, 1985), and, more recently, the quadratic almost ideal demand system (see banks et.al, 1997). although the use of each of these models for demand system estimation has received attention in the literature, in recent years most demand systems have been estimated by either a linear approximated form of the almost ideal demand system (la/aids) (deaton & muellbauer, 1980a), the almost ideal demand system (aids) or the quadratic almost ideal demand system (quaids). within the south african context, demand system estimation has received some attention in the literature. contributions include those of alderman and del ninno (1999) as well as dune and edkins (2008), who applied the aids model in estimating the demand for different food groups. also estimating the demand for food, agbola (2003) applied the la/aids model, while bopape and myers (2007) applied the quaids model (only for demand in kwazulu-natal). selvanathan and selvanathan (2004) estimated a complete consumer demand system by way of a comparison between the cbs demand system and the aids model.2 however, the surveys on household expenditure used for previous estimations of demand in south africa did not record price data. although it was mentioned by bopape and myers (2007) that the kwazulu-natal income dynamics survey included price data, closer inspection of this data set revealed no recorded prices. the living standards and development survey used by alderman and del ninno (1999) required households to record either total expenditure or quantity purchased. in the case where a household reported both, an indication of market price can be obtained, although this could also be an indication of quality of the good purchased (deaton, 1987). other recent surveys include the national income dynamics study and the income and expenditure survey of households of south africa. both of these data sets only recorded expenditures. in this paper, the results of two demand estimations with the use of the quaids model are reported. the first estimation is a complete demand system estimation of all goods and services supplied in south africa (grouped into eight categories). the second estimation is a nutritional goods demand system estimation of all food and drink supplied in south africa (grouped into five food groups). expenditure, own and cross-price elasticities of demand are also calculated for both demand systems. the research reported contributes to the previous literature on demand estimation for south africa, as no previous estimation of demand in south africa has used actual price data. further, the quaids model has not been previously applied to all goods and services or all food groups in south africa. this is a contribution in its own right, since, as is shown in this paper and by bopape and myers (2007), south african household expenditure is non-linear and only the quaids model (of the previously mentioned models) provides for non-linearity. as noted by blundell and robin (1999:209): it is not reasonable to assume linearity of expenditures in terms of total budget and relative prices; even the log linear expenditure share models that form the underlying shape of the popular translog and almost ideal models of jorgenson, christensen and lau … and deaton and muellbauer … respectively have been shown to require further non-linear terms. these terms reflect the growing evidence from a series of recent empirical studies that suggest quadratic logarithmic income terms are required for certain expenditure share equations… . the research reported in this paper also distinguishes itself from most of the previously mentioned studies by incorporating demographic variables.3 lastly, when considering the previous use of the quaids model by bopape and myers (2007) for kwazulu-natal, the research conducted for the present study provides a larger number of statistically significant results. in the remainder of this paper the aids model and, as an extension thereof, the quaids model are described. next, the data used for estimation are discussed, followed by a discussion on sajems ns 19 (2016) no 4:615-629 617 determining the demand systems’ categories, groups, and category and group prices. thereafter, the empirical results of the research conducted are provided and discussed. the conclusion then follows. 2 the aids and quaids models the aids model proposed by deaton and muellbauer (1980a) builds on the rotterdam and translog models, with advantages over these two models. the aids model gives an arbitrary firstorder approximation to any demand system; it satisfies the axioms of choice exactly; it aggregates perfectly over consumers without invoking parallel linear engel curves; it has a functional form which is consistent with known household-budget data; it is simple to estimate, largely avoiding the need for non-linear estimation; and it can be used to test the restrictions of homogeneity and symmetry through linear restrictions on fixed parameters (deaton & muellbauer, 1980(a):312) the aids model has also been shown to perform well when estimating known elasticities (barnett & seck, 2008). as with most demand systems, the aids model is specified with household budget shares (𝑤") as the dependent variable, with the budget share for good 𝑖 defined as 𝑤" ≡ 𝑝"𝑞" 𝑚 (1) where 𝑝" is the price paid for commodity 𝑖, 𝑞" is the quantity of commodity 𝑖 purchased, and 𝑚 is the total expenditure on all commodities in the demand system. the aids model in budget shares form follows: 𝑤" = 𝛼" + 𝛾"ln𝑝+ 𝛽" ln 𝑚 𝑎 𝑝 2 -34 (2) where 𝑝is the price of commodity 𝑗 and 𝑎 𝑝 is a price index used to deflate total expenditure, defined as ln𝑎 𝑝 ≡ 𝛼6 + 𝛼" ln𝑝" + 1 2 𝛾"ln𝑝" ln𝑝2 -34 2 "34 2 "34 (3) for the model to adhere to consumer demand theory, adding up conditions requires that 𝛼" = 1 2 "34 𝛽" = 0 2 "34 𝛾"= 0 2 "34 ∀ 𝑗 (4) homogeneity conditions require that 𝛾"= 0 2 -34 ∀ 𝑗 (5) lastly, slutsky’s symmetry implies that 𝛾"= 𝛾-" (6) the consumer demand theory conditions in notation (4), (5) and (6) are imposed during estimation and ensure that notation (3) defines 𝑎 𝑝 as a linearly homogeneous function of the individual prices. further, where notation (4), (5) and (6) hold, notation (2) provides a system of demand functions which add up to total expenditure ( 𝑤" = 1), are homogeneous of degree zero in prices and total expenditure, and adhere to the slutsky symmetry theory (deaton & muellbauer, 1980b). the aids model can, therefore, be interpreted as follows: if relative prices 𝑝 and “real” expenditure ( = > ? ) do not change, the expenditure shares (𝑤") are constant (𝑎"). 618 sajems ns 19 (2016) no 4:615-629 as an extension to the aids model, the quaids model proposed by banks et al. (1997) adds a quadratic term in the logarithm of expenditure. this allows for household expenditure share engel curves that are non-linear and thereby permit commodities to be necessities at some expenditure level and luxuries at others (banks et al., 1997). the quaids model in budget shares form follows: 𝑤" = 𝛼" + 𝛾"ln𝑝+ 𝛽" ln 𝑚 𝑎 𝑝 + 𝜆" 𝑏 𝑝 ln 𝑚 𝑎 𝑝 b 2 -34 (7) where all terms are as in (2) and 𝑏(𝑝) is the simple cobb–douglas price aggregator, defined as 𝑏(𝑝) = 𝑝" cd 2 "34 (8) to adhere to consumer demand theory, an additional adding-up condition is required, given as 𝜆" 2 "34 = 0 (9) from the above it is evident that the quaids model will be equal to the aids model when all the 𝜆′𝑠 are zero across all equations. statistical-significance testing of the 𝜆′𝑠 would, therefore, indicate whether or not the quaids model is preferable to the aids model for the data considered (i.e. whether household expenditures are linear or non-linear). for purposes of the research reported in this paper, a set of demographic variables is added for each household using ray’s (1983) method based on an expenditure (cost) function of the form 𝑒 𝑝,𝑧,𝑢 = 𝑚6 𝑝,𝑧,𝑢 ×𝑒l (𝑝,𝑢) (10) where 𝑧 represents a vector of 𝑠 household characteristics, 𝑒l 𝑝,𝑢 is the expenditure function of a reference household, and 𝑚6 𝑝,𝑧,𝑢 scales the expenditure function to account for household characteristics and can be decomposed as 𝑚6 𝑝,𝑧,𝑢 = 𝑚6(𝑧) ×𝜙(𝑝,𝑧,𝑢) (11) where 𝑚6 measures the increase in a household’s expenditures as a function of z, and 𝜙 controls for changes in relative prices and the actual goods consumed. further, 𝑚6 𝑧 is parameterised as 𝑚6 𝑧 = 1 + 𝜌𝑧 (12) where 𝜌 is a vector of parameters to be estimated. 𝜙 𝑝,𝑧,𝑢 is parameterised as ln𝜙(𝑝,𝑧,𝑢) = 𝑝co2 -34 𝑝pdq2 -34 − 1 1 𝑢 − 𝜆ln𝑝2 -34 (13) where 𝜂represents the 𝑗th column of 𝑠×𝑘 parameter matrix 𝜂. to adhere to consumer demand theory, a further adding-up condition is required, given as 𝜂u2 -34 = 0 (14) for 𝑟 = 1,…,𝑠. the quaids model for purposes of estimation takes the form 𝑤" = 𝛼" + 𝛾"ln𝑝+ 𝛽" + 𝜂"𝑧 ln 𝑚 𝑎 𝑝 𝑚6 𝑧 + 𝜆" 𝑏 𝑝 𝑐(𝑝,𝑧) ln 𝑚 𝑎 𝑝 𝑚6 𝑧 b + 𝜀 2 -34 (15) where sajems ns 19 (2016) no 4:615-629 619 𝑐(𝑝,𝑧) = 𝑝pdq 2 -34 (16) similar to the aids model, where the consumer demand theory conditions in notation (4), (5), (6), (9) and (14) hold (which are imposed during estimation), notation (15) provides a system of demand functions which add up to total expenditure ( 𝑤" = 1), are homogeneous of degree zero in prices and total expenditure, and adhere to the slutsky symmetry theory. subsequent to estimation of the quaids model, the coefficients obtained can be used to calculate price and expenditure elasticities of the commodities. the uncompensated price elasticity of good 𝑖 with respect to changes in the price of good 𝑗 is calculated as 𝜖"[ = −𝛿"+ 1 𝑤" 𝛾"− 𝛽" + 𝜂"𝑧 + 2𝜆" 𝑏 𝑝 𝑐 𝑝,𝑧 ln 𝑚 𝑎 𝑝 𝑚6 𝑧 × 𝛼+ 𝛾-] ln𝑝] ] − 𝛽+ 𝜂-𝑧 𝜆" 𝑏 𝑝 𝑐 𝑝,𝑧 ln 𝑚 𝑎 𝑝 𝑚6 𝑧 b (17) where 𝛿"is the kronecker delta taking the value of 𝛿"= 1 if 𝑖 = 𝑗 and 𝛿"= 0 if 𝑖 ≠ 𝑗. the expenditure elasticity for good 𝑖 is calculated as 𝜇" = 1 + 1 𝑤" 𝛽" + 𝜂"𝑧 + 2𝜆" 𝑏 𝑝 𝑐 𝑝,𝑧 ln 𝑚 𝑎 𝑝 𝑚6 𝑧 (18) by invoking the slutksy equation, the compensated price elasticities are calculated as 𝜖"` = 𝜖"[ + 𝑤-𝜇" (19) notations (1) to (6) are borrowed directly from deaton and muellbauer (1980a), and notations (7) to (19) are borrowed from poi (2012) with reference to banks et al. (1997). 3 data used for estimation 3.1 data used for budget share and demographic variables data on budget share and demographic variables used for purposes of estimating the quaids model in notation (15) were obtained from the 2010/2011 income and expenditure survey of households (ies 2010/2011) of south africa. this survey was conducted by statistics south africa and used three data-collection instruments: a household questionnaire, a weekly diary and a summary questionnaire (statistics south africa, 2012). the household questionnaire consisted of four modules. the first module recorded a variety of demographic variables in respect of each household. the second to fourth modules collected information on different categories of expenditure covering education, health, dwellings and services, clothing, footwear, expenditure when away from home, domestic workers, furniture and equipment, transport, computers, telecommunications, finance and banking, as well as particulars of income (statistics south africa, 2012). the weekly diary (completed for two weeks by each household) consisted of a booklet wherein households recorded their daily expenditures, where they incurred these expenditures, and the purpose of the expenditure (e.g. own consumption or a gift). the summary questionnaire consisted of questions that were only used by the interviewer. the purpose of this questionnaire was to assign consumption according to purpose (coicop) codes to the weekly diary expenditures of household, and to ensure accuracy and completeness of the diary (statistics south africa, 2012). the survey was conducted over a period of one year, with each household being in the sample for a period of four weeks. the sampling frame was obtained from statistics south africa’s master sample, which provides a national coverage of all households in south africa, excluding certain institutions (e.g. prisons). although an initial sample of 33 420 households was identified, 620 sajems ns 19 (2016) no 4:615-629 only 82.8 per cent were in scope and, of these households, the overall response rate was 91.6 per cent (statistics south africa, 2012). the ies 2010/2011 was preferred for the purposes of this paper, as it is the largest recent survey of its kind for south africa. it is also the only large survey in south africa that attempts to capture all consumption expenditure by households. it appears that an appropriate methodology was followed in obtaining the data and that the data is representative of the population of south africa. 3.2 data used for prices as previously mentioned, the ies 2010/2011 (as well as any other large sample data set currently collected in south africa) does not include price or quantity purchase data, but only expenditure data. this is a limitation as far as consumer demand estimation in south africa is concerned, a limitation that also applies to the research reported on in this paper. it was therefore necessary to calculate the prices faced by households from another data set, of which the best data set available is the data set on prices collected by statistics south africa and predominantly used in calculating the south african consumer price index (herein after referred to as “the cpi data set”). the cpi data set is not publicly available, but application can be made to statistics south africa to obtain it. the cpi data set is obtained by way of field-based and head office collections (statistics south africa, 2013). field-based collection entails the use of fieldworkers who record actual prices at sample outlets (enumerator method of collection). this collection is carried out monthly and mostly includes prices of goods, although some prices for services are also included. head office collections makes use of staff based at the statistics south africa head office and mostly involve the collection of prices of services by means of telephone, internet, e-mail or other similar methods. these collections are done monthly for certain services and at other intervals for other services (statistics south africa, 2013). for purposes of the cpi data set, prices for a specific good or service (e.g. one litre of full-cream, long-life milk) collected in more than one municipal area are averaged for each of the nine provinces in south africa (i.e. the data set show price per month and per province in respect of a specific good or service). 4 determining demand systems’ categories, groups, and category and group price 4.1 demand system categories and groups in utility maximisation theory, a consumer or household allocates its budget to all goods taking into account the price of a specific good, the price of all other goods, and its own income (varian, 2010). owing to the complexity of empirically analysing the budget allocation of each consumer on all goods, these goods are mostly grouped into larger commodity groups. this approach also decreases issues with multicollinearity between prices. one of two approaches are generally applied in grouping commodities. the first is the generalised composite commodity theorem (hicks, 1936; lewbel, 1996) that treats goods in respect of which prices increase or decrease similarly as a single good. owing to relative prices fluctuating considerably in practice, the composite commodity theorem’s usefulness is limited for the purpose of empirical analysis (deaton & muellbauer, 1980b). the second approach is that of separability, according to which commodities are grouped in accordance with consumer preferences. commodities are grouped so that “preferences within a group can be described independently of the quantities in other groups” (deaton & muellbauer, 1980b:122). if preferences for specific goods are weakly separable, those commodities are grouped together. although weak separability can be tested empirically, these tests are largely limited to time series data and were not used for the purposes of this paper. further, multicollinearity in aggregate price data limits the usefulness of these tests (bopape & myers, 2007). weak separability is, therefore, commonly assumed and is also assumed for the purposes of this paper. this means that sajems ns 19 (2016) no 4:615-629 621 it is assumed that sub-utility functions can be defined for each group of commodities so that the sum of the value of each of these sub-utilities will give total utility. a general problem in estimating demand systems is observed zero expenditures on categories or groups of goods. such zero expenditure categories or groups result in inaccurate estimated coefficients and deleting households with zero expenditure categories will be subject to selection bias. certain methods have been proposed to address the observed zero expenditure problem when establishing the market demand (for a recent example, refer to shonkwiler & yen, 1999), but these methods are not employed. although the market demand is estimated and provided in the results of this paper, it is the objective of this paper to estimate the demand of individual households (since it is household behaviour towards changes in indirect tax policy that is of interest). to address the zero expenditure problem, households with zero total expenditure on all goods and services were removed from the data set. households with zero expenditure on food were also removed from the data set. this approach seems reasonable, since it could be expected that a household has some expenditures during the survey period. further, as shown to be acceptable by blundell and robin (2000), certain weakly separable groups of commodities (transport and communication; and edible oils and other nutritional goods) which contained observed zero expenditures were grouped together. these three strategies that have been mentioned greatly decreased the amount of observed zero expenditures, but it should be noted that this paper is limited by some zero expenditures that remained in the sample. to avoid selection bias, further strategies were not employed. following the assumption of weak separability in grouping commodities and also addressing the problem of observed zero expenditures, for purposes of the complete demand system the 899 coicop items in the ies 2010/2011 were grouped into eight expenditure categories. the expenditure categories are: nutritional goods; clothing; housing and utilities; household contents; health; transport and communication; recreation (including dining at restaurants); and other goods and services (these include mainly luxury items and other items not previously listed). similarly, for purposes of the nutritional goods demand system, the 288 food items in the ies 2010/2011 were grouped into five nutritional goods groups. the five nutritional goods groups are: grains, bread and cereals; meat and fish; dairy; fruit and vegetables; and other nutritional goods (these include sugars and sweets, edible oils and non-alcoholic beverages). the two demand systems allow for the estimation of a two-stage budgeting process followed by households concerning nutritional goods expenditures. closely related to the concept of a utility tree, as proposed by strotz (1957), two-stage budgeting is based on the premises that consumers first allocate their expenditure to broad groups of goods (or, in the present case, expenditure categories) and thereafter allocate the expenditure on that group of goods to the goods in that group (in the present case, the nutritional goods groups). consumer behaviour as a result of changes to indirect tax policy applicable to foodstuffs can, therefore, be particularly accurately measured. 4.2 category and group prices calculating representative prices for each of the eight expenditure categories and five nutritional goods groups is a methodologically tedious task (predominantly since code can likely not be written to simplify this task). the cpi data set includes prices for 830 different goods and services for each month and in each of the nine provinces of south africa. as previously indicated, prices are not provided for categories of goods (e.g. milk), but rather for specific goods (e.g. one litre of long-life, full-cream milk; one litre of fresh full-cream milk; 500 millilitres of long-life, full-cream milk – and the same for low-fat milk, etc.). the physical weight of edible goods is also provided. the manner in which the data are collected improves the accuracy of prices, since they are not dependent on changes in quality. however, it also increases the methodological burden of calculating group prices. the first methodological issue is that, for some provinces, data is not consistently collected for all goods and services. this limits the amount of goods and services that can be included for each 622 sajems ns 19 (2016) no 4:615-629 province, since the representative price should be consistently determined for each province. to overcome this issue, only prices and goods and services that were included for each province were used. in only a few instances where a price was not available for a single month in a single province, the provincial consumer price index and the price during the previous month were referred to in estimating a representative price for that month. another methodological issue is the physical measurement used when calculating prices. for instance, when calculating the representative price for hake, fresh hake may be given as price per kilogram, but frozen hake is sold per box and weighs 500 grams. to address this issue, the average price that a consumer can be expected to face in deciding whether to spend on an item, was calculated. this was done by calculating an average price based on the average weight at which goods are bought. this approach was followed, as it would make little sense to determine the price of, for instance, eye drops per litre (which would cost approximately r2 466) when this is not the price faced by consumers in deciding whether to purchase eye drops. a further methodological issue is that a consumer is unlikely to give equal consideration to each good and service in an expenditure category or food group. it stands to reason that goods and services on which more is spent by the average consumer should carry a greater weight towards the expenditure category or nutritional goods group price. not doing so would, for instance, give equal weight to beef mince (which is purchased often) and pork fillet (which is generally purchased less). some expensive goods, such as biltong (which is similar to beef jerky), will also drive the representative price of a category or group up, although few households can afford this good. to address this issue, expenditure weights were obtained from statistics south africa. the expenditure weights are used by statistics south africa for the purpose of determining the prices of the provincial consumer price indexes. the weights are calculated based on household expenditure in the ies 2010/2011 data set (the same data set as used to obtain household expenditures for the estimations in this paper). weights are calculated based on coicop codes and are provided for each sub-subcategory (e.g. fish), subcategory (e.g. meat and fish) and category (e.g. foods) of goods. these weights were then applied to the representative prices for each sub-subcategory, subcategory and category of expenditure items. for a few services (e.g. electricity, household rent), prices are not provided in the cpi data set. all of these services are services which are typically only paid for once during a month. to align with the method used in calculating a representative price for goods and services in the cpi data set, the representative price for these services was calculated as the average expenditure of households in a specific month in a specific province. this method is, therefore, also an approximation of the average price faced by households. the resulting 117 prices per expenditure category and food group were matched with the relevant households based on month surveyed and the province in which the household is located.4 5 empirical results 5.1 results pertaining to the complete demand system the parameters of the quaids model were estimated in stata 12 by way of iterated, feasible, generalised non-linear least-squares estimation, with the theoretical restrictions of adding up, homogeneity and symmetry imposed during estimation. this method aims to address heteroscedasticity in the residuals while adhering to economic theory. although there exists some multicollinearity between prices of commodity groups, this should only influence the standard errors of the estimates, resulting in less significant estimates. table 1 provides the coefficients estimated for the complete demand system, with 86 of the 104 coefficients estimated being statistically significant at the 1 per cent level of significance. in determining whether the quaids model is preferable to the aids model for the data set, the quadratic expenditure term is relevant. as is evident from table 1, the quadratic expenditure terms (𝜆′𝑠) are all significant at the 1 per cent level, except in the case of housing and utilities. sajems ns 19 (2016) no 4:615-629 623 consequently, a wald’s test was performed to determine whether the sum of the quadratic expenditure coefficients is significantly different from zero. this test statistic is 373.42 (p-value = 0.0000). as it cannot be accepted that the quadratic expenditure terms are equal to zero, the quaids model is preferred to the aids model for the data set. this means that south african total household expenditure is non-linear. table 1 complete demand system coefficients estimated with quaids nutritional goods clothing housing and utilities household contents health transport recreation other goods and services constant 0.1195* 0.1694* 0.0677* 0.1490* 0.0642* −0.1292* 0.0332 0.5262* (0.0398)* (0.0193)* (0.0166)* (0.0206)* (0.0097)* (0.0337)* (0.0178) (0.0223)* price: nutritional goods 0.1250* 0.0123 0.0658* 0.0496* −0.0028 −0.1225* −0.0590* −0.0684* (0.0115)* (0.0071) (0.0055)* (0.0062)* (0.0029) (0.0102)* (0.005)* (0.0069)* price: clothing 0.0123 0.0050 −0.0570* −0.0161* 0.0112* 0.0073 0.0285* 0.0089 (0.0071) (0.0055) (0.0034)* (0.004)* (0.002)* (0.0065) (0.0034)* (0.0037) price: housing and utilities 0.0658* −0.0570* 0.0707* −0.0114* −0.0142* 0.0030 −0.0397* −0.0173* (0.0055)* (0.0034)* (0.0044)* (0.0034)* (0.0019)* (0.0057) (0.003)* (0.0044)* price: household contents 0.0496* −0.0161* −0.0114* 0.0010 −0.0095* 0.0119 0.0103* −0.0357* (0.0062)* (0.004)* (0.0034)* (0.0059) (0.002)* (0.0067) (0.0035)* (0.0039)* price: health −0.0028 0.0112* −0.0142* −0.0095* −0.0056* −0.0189* 0.0234* 0.0164* (0.0029) (0.002)* (0.0019)* (0.002)* (0.0016)* (0.0031)* (0.0016)* (0.0017)* price: transport −0.1225* 0.0073 0.0030 0.0119 −0.0189* 0.0807* 0.0194* 0.0191* (0.0102)* (0.0065) (0.0057) (0.0067) (0.0031)* (0.015)* (0.0058)* (0.0073)* price: recreation −0.0590* 0.0285* −0.0397* 0.0103* 0.0234* 0.0194* 0.0318* −0.0148* (0.005)* (0.0034)* (0.003)* (0.0035)* (0.0016)* (0.0058)* (0.004)* (0.0033)* price: other goods and services −0.0684* 0.0089 −0.0173* −0.0357* 0.0164* 0.0191* −0.0148* 0.0917* (0.0069)* (0.0037) (0.0044)* (0.0039)* (0.0017)* (0.0073)* (0.0033)* (0.009)* expenditure −0.1316* −0.0250* −0.0158* −0.0188* 0.0012* 0.0205* −0.0095* 0.1790* (0.0044)* (0.002)* (0.0033)* (0.0021)* (0.0008)* (0.0039)* (0.0018)* (0.0057)* quadratic expenditure −0.0029* −0.0020* 0.0004 −0.0049* 0.0008* −0.0049* −0.0032* 0.0167* (0.001)* (0.0004)* (0.0008) (0.0005)* (0.0002)* (0.0009)* (0.0004)* (0.0011)* settlement type −0.0081* 0.0027* 0.0131* −0.0025* 0.0003* 0.0009 0.0008* −0.0073* (0.001)* (0.0003)* (0.0006)* (0.0003)* (0.0001)* (0.0006) (0.0003)* (0.0007)* household size 0.0012* −0.0013* 0.0021* −0.0005* 0.0000 −0.0010* 0.0004* −0.0011* (0.0002)* (0.0001)* (0.0001)* (0.0001)* (0) (0.0001)* (0.0001)* (0.0001)* notes: (1) * indicates statistical significance at the 1% level. (2) estimated standard errors are in parentheses. (3) all prices are in logarithm form. for empirical analysis of indirect tax reforms, expenditure and, in particular, own and cross-price elasticity of demand are of importance. it should be noted that the elasticities at the household level are required (and were calculated) for accurately estimating welfare consequences as a result of indirect tax reform. as it is not possible to provide the result for each household here, only the mean results (market demand) are reported here. table 2 provides the expenditure elasticity for the expenditure categories, and table 3 and table 4 provide the uncompensated and compensated own and cross-price elasticity, respectively. table 2 expenditure elasticity nutritional goods clothing housing and utilities household contents health transport recreation other goods and services expenditure elasticity 0.5618 0.5082 0.9304 0.3112 1.3095 0.9669 0.4443 2.1366 624 sajems ns 19 (2016) no 4:615-629 table 3 uncompensated elasticity nutritional goods clothing housing and utilities household contents health transport recreation other goods and services nutritional goods −0.6351 0.0370 0.2558 0.1760 −0.0036 −0.2837 −0.1775 0.0751 clothing 0.0945 −0.9407 −0.7266 −0.2062 0.1577 0.2383 0.4033 0.4888 housing and utilities 0.5338 −0.4637 −0.4181 −0.0901 −0.1149 0.0424 −0.3202 −0.1014 household contents 0.6827 −0.2918 −0.1317 −0.9741 −0.1493 0.4069 0.1961 0.0016 health −0.0976 0.7588 −0.9707 −0.6331 −1.3791 −1.3579 1.5468 0.7892 transport −0.7443 0.0356 0.0197 0.0656 −0.1090 −0.5148 0.1125 0.1855 recreation −1.6394 0.7051 −0.9628 0.2679 0.6044 0.6664 −0.1709 0.1363 other goods and services −0.1407 0.0633 −0.1806 −0.1925 0.0620 −0.2366 −0.1107 −1.4501 note: the entry in row 𝑖, column 𝑗 of the matrix, indicates the percentage change in the quantity of good 𝑖 consumed for a 1% change in the price of good 𝑗. table 4 compensated elasticity nutritional goods clothing housing and utilities household contents health transport recreation other goods and services nutritional goods −0.4644 0.0786 0.3248 0.2096 0.0048 −0.1868 −0.1554 0.1948 clothing 0.2489 −0.9031 −0.6642 −0.1759 0.1654 0.3259 0.4233 0.5970 housing and utilities 0.8164 −0.3948 −0.3038 −0.0346 −0.1009 0.2028 −0.2836 0.0967 household contents 0.7772 −0.2688 −0.0935 −0.9555 −0.1446 0.4606 0.2083 0.0679 health 0.3001 0.8557 −0.8099 −0.5549 −1.3594 −1.1321 1.5982 1.0681 transport −0.4506 0.1072 0.1384 0.1233 −0.0944 −0.3481 0.1505 0.3915 recreation −1.5045 0.7380 −0.9083 0.2944 0.6111 0.7430 −0.1535 0.2309 other goods and services 0.5083 0.2215 0.0817 −0.0649 0.0941 0.1318 −0.0268 −0.9951 note: the entry in row 𝑖, column 𝑗 of the matrix, indicates the percentage change in the quantity of good 𝑖 consumed for a 1% change in the price of good 𝑗. as is evident from table 2, none of the expenditure categories’ expenditure elasticities can be associated with inferior goods, as all expenditure elasticities are positive. all expenditure categories’ expenditure elasticities are associated with normal goods, and health and other goods and services’ expenditure elasticities are associated with luxury goods. it should be considered that the other goods and services expenditure category includes a large number of items which are generally deemed to be luxury goods. regarding the view that health is a luxury item, it should be taken into account that most medicine and hospital fees are subsidised by the state through public hospitals, and that only 17 per cent of south african households (ies 2010/2011) are members of a medical aid fund. however, expenditure on health items is arguably expenditure that is not subsidised by the state and not covered by a medical aid. most items that are generally considered to be luxury items are included in the other goods and services’ expenditure category. economic theory requires that all own price elasticities are negative and this requirement is upheld, as is evident from the diagonal of table 3. this means that, for expenditure categories in the complete consumer demand system, demand for a category will decrease if the price of that category increases. further, the own price elasticities seems plausible in magnitude, with nutritional goods, housing and utilities, transport and communication, and, interestingly, recreation being relatively inelastic. clothing, household contents, and other goods and services are relatively unit elastic and health is relatively elastic. it seems reasonable that nutritional goods, housing and utilities, and transport and communication would have inelastic demand, since these goods can be argued to be necessities. sajems ns 19 (2016) no 4:615-629 625 the finding that recreation expenditure is inelastic seems to suggest that, despite the increase in prices, consumers are slower to respond to the higher cost of recreation or are unwilling to decrease expenditures on recreational items. this result is similar to the results of selvanathan and selvanathan (2004), the only other study that could be found that also considers the demand for recreation (in totality) in south africa. the finding that health is relatively elastic appears to align with the finding that health is a luxury item, as previously discussed. the magnitude and patterns of cross-price elasticity evident from the off-diagonal of table 3 and table 4, indicating substitution and complementary expenditure categories, seem plausible. many of the cross-price elasticities are close to zero, which would indicate that the two applicable expenditure categories are independent. a positive cross-price elasticity, as in the case of household contents and nutritional goods, indicates substitutes. negative cross-price elasticities, as with recreation and nutritional goods, indicate complementarities (varian, 2010). 5.2 results pertaining to the nutritional goods demand system the same model (quaids) and method as used for the estimation of the expenditure categories previously described were used in estimating the parameters for the five nutritional goods groups. these results, of which 38 of 50 of the estimated coefficients are significant at the 1 per cent level of significance, are provided in table 5. table 5 nutritional goods demand system coefficients estimated with quaids grains, bread and cereals meat and fish dairy fruit and vegetables other nutritional goods constant 0.4617* −0.0534 0.0200 0.2002* 0.3715* (0.0218)* (0.0328) (0.0207) (0.0170)* (0.0301)* price: grains, bread and cereals 0.1416* −0.0832* 0.0281 −0.0589* −0.0276 (0.0206)* (0.0174)* (0.0124) (0.0121)* (0.0168) price: meat and fish −0.0832* 0.2138* 0.0655* −0.0384* −0.1577* (0.0174)* (0.0265)* (0.0173)* (0.0141)* (0.0251)* price: dairy 0.0281 0.0655* −0.0927* 0.0523* −0.0532 (0.0124) (0.0173)* (0.0250)* (0.0127)* (0.0274) price: fruit and vegetables −0.0589* −0.0384* 0.0523* 0.0005 0.0445* (0.0121)* (0.0141)* (0.0127)* (0.0137) (0.0159)* price: other nutritional goods −0.0276 −0.1577* −0.0532 0.0445* 0.1941* (0.0168) (0.0251)* (0.0274) (0.0159)* (0.0409)* expenditure −0.0524* 0.0720* 0.0013 −0.0270* 0.0062* (0.0029)* (0.0032)* (0.0018) (0.0020)* (0.0024)* quadratic expenditure 0.0017 −0.0037* −0.0072* 0.0051* 0.0041* (0.0011) (0.0012)* (0.0006)* (0.0007)* (0.0009)* settlement type 0.0479* −0.0320* −0.0091* −0.0068* −0.0001 (0.0019)* (0.0020)* (0.0012)* (0.0011)* (0.0014) household size 0.0062* −0.0027* −0.0024* −0.0024* 0.0012* (0.0004)* (0.0004)* (0.0002)* (0.0002)* (0.0002)* notes: (1) * indicates statistical significance at the 1% level. (2) estimated standard errors are in parentheses. (3) all prices are in logarithm form. subsequent to estimation, a wald’s test was performed to test whether the sum of the quadratic expenditure coefficients is significantly different from zero. this test statistic is 157.36 (p-value = 0.0000). the quaids model is therefore also preferred for this estimation and south african households’ nutritional goods expenditure is also non-linear. similar to the above, table 6, table 7 and table 8 provide expenditure, own and cross-price elasticity of demand for the food groups. 626 sajems ns 19 (2016) no 4:615-629 table 6 expenditure elasticity grains, bread and cereals meat and fish dairy fruit and vegetables other nutritional goods expenditure elasticity 0.9162 1.0464 0.3077 1.2300 1.2609 table 7 uncompensated elasticity grains, bread and cereals meat and fish dairy fruit and vegetables other nutritional goods grains, bread and cereals −0.46119 −0.28928 0.106064 −0.18982 −0.0838 meat and fish −0.33678 −0.20751 0.237596 −0.15876 −0.57686 dairy 0.40561 0.910578 −1.78413 0.543658 −0.36252 fruit and vegetables −0.45449 −0.40507 0.343244 −0.99848 0.273569 other nutritional goods −0.19803 −0.88804 −0.3018 0.201032 −0.08041 note: the entry in row 𝑖, column 𝑗 of the matrix, indicates the percentage change in the quantity of good 𝑖 consumed for a 1% change in the price of good 𝑗. table 8 compensated elasticity grains, bread and cereals meat and fish dairy fruit and vegetables other nutritional goods grains, bread and cereals −0.20246 −0.0364 0.202305 −0.06424 0.098995 meat and fish −0.0413 0.08129 0.347505 −0.01534 −0.36811 dairy 0.492495 0.995501 −1.75181 0.585832 −0.30114 fruit and vegetables −0.10717 −0.06559 0.472441 −0.82989 0.518955 other nutritional goods 0.158035 −0.54001 −0.16935 0.373866 0.171149 note: the entry in row 𝑖, column 𝑗 of the matrix, indicates the percentage change in the quantity of good 𝑖 consumed for a 1% change in the price of good 𝑗. it is evident from table 6 that all nutritional groups are normal goods. grains, bread and cereals, together with dairy, are necessities. meat and fish have an expenditure elasticity of 1 and can therefore be regarded as a necessity or a luxury good. fruits and vegetables and other food are luxury goods. these results seems plausible when considering that a large portion of poor (income decile 5 or lower) south african households spend the majority of their nutritional goods budget on grains, bread and milk (ies 2010/2011). meat and fish, fruit and vegetables, and other food are purchased more by wealthier households than poorer households (ies 2010/2011). it is further evident (see table 7) that all uncompensated own price elasticities are negative, as required by economic theory. this means that the demand for any nutritional-good groups will decrease if the price for that nutritional-good group increases. grains, bread and cereals, meat and fish, and other nutritional goods (which include sugars and sweets, cooking oils, and non-alcoholic beverages) are inelastic. fruit and vegetables are unit elastic and dairy is elastic. the finding that the demand for dairy is elastic, although being a necessity, appears contradictory. in interpreting this result, it should be considered that the dairy nutritional group contains items that can be regarded as luxury items (e.g. cheese). it is therefore suggested that further research may want to consider the individual demand for the items within the dairy nutritional-good group in order to obtain a better understanding of the demand dynamics within this group. the cross-price elasticities provided in table 7 and table 8 seem plausible in magnitude and sign. sajems ns 19 (2016) no 4:615-629 627 6 conclusion south africa is faced with a number of challenges which, in order to be addressed, may require additional tax revenues. in considering additional domestic tax revenues from indirect taxes, the south african government may do well to consider the welfare consequences as a result of a change in indirect tax policy. the results of the complete consumer demand system and a nutritional goods demand system reported in this paper form a necessary part of the base of an empirical analysis to determine such welfare consequences. it was shown in this paper that south african household expenditure is non-linear. this supports bopape and myers’ (2007) findings that the quaids model is preferred when applied to south african household data. the quaids model was therefore used to estimate the demand for eight expenditure categories and five food groups. this is the first study of multiple-good demand systems in south africa that incorporates actual price data. further, it is the only study of demand systems in south africa that allows for a two-stage budgeting process by households. the estimation of the complete consumer demand system provided largely significant statistical results, with 86 of the 104 coefficients estimated being significant at the 1 per cent level of significance. the calculated expenditure elasticities indicate that all goods in this demand system are normal goods. nutritional goods, clothing, housing and utilities, household contents, transport and recreation are necessities. health and other goods and services are luxury goods. the price elasticities calculated for this demand system indicate that the demand for nutritional goods, housing and utilities, and transport and communication are inelastic. the demand for clothing, household contents, and other goods and services is unit elastic and the demand for health is elastic. the estimation of the nutritional goods groups also provided results that are largely statistically significant, with 38 of the 50 estimates significant at the 1 per cent level of significance. the calculated expenditure elasticities indicate that all food groups are normal goods. grains, bread and cereals and dairy are necessities. meat and fish can be regarded as either a necessity or a luxury good, and fruit and vegetables and other nutritional goods are luxuries. the calculated price elasticities indicate that the demand for grains, bread and cereals, meat and fish, and other nutritional goods are inelastic. further, the demand for fruit and vegetables is unit elastic and the demand for dairy is elastic. these results form part of a larger study of quantitative measurements of policy options to inform vat reform in south africa. 5 apart from being used for purposes of this larger study, the estimated elasticities could be used by other researchers and government in the empirical analysis of policy changes. this may include policy on farmer subsidies, housing subsidies, food subsidies or increases in wealth (e.g. property taxes) and consumption taxes. endnotes 1 it should be noted that the data of the world bank (2015) do not contain inequality measures for all countries. 2 demand estimation of a single group of goods is not included here. examples of such estimations are taljaard, alemu and van schalkwyk (2004), in estimating the demand for meat, and van schalkwyk, van schalkwyk, alemu, taljaard and obi (2005), in estimating the demand for oilseeds. there are also a number of research papers on the demand for electricity in south africa. 3 agbola (2003) and bopape and myers (2007) also incorporate demographic variables into their models. 4 the prices used can be obtained by contacting the author at marius.vanoordt@up.ac.za. 5 this is a phd study that was funded by the national research foundation and is publicly available from the university of pretoria (up space). references african economic outlook. 2010. https://sustainabledevelopment.un.org/content/documents/ aeo2010_part1_p76.pdf [accessed june 2015]. agbola, f.w. 2003. estimation of food demand patterns in south africa based on a survey of households. journal of agricultural and applied economics, 35:663-670. 628 sajems ns 19 (2016) no 4:615-629 alderman, h. & del ninno, c. 1999. poverty issues for zero rating vat in 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wbapi_data_value+wbapi_data_value-firstandsort=asc [accessed may 2015]. journal 4.indd 50 sajems ns 13 (2010) no 1 the determinants of public expenditure and expenditure on education in particular in a selection of african countries1 olusegun a akanbi and niek j schoeman department of economics, university of pretoria accepted july 2009 abstract this study reports on research aimed at measuring the drivers behind public expenditure with specific reference to education expenditure in africa. the empirical estimations are carried out using a public choice model on a panel of 15 selected african countries over the period 1995– 2004. the results show that government expenditure on education is resilient to shocks and the education sector is not seriously affected by allocative changes that favour corruption. expenditure on education in the countries included in the study generally complies with the guidelines set by the imf in terms of their fiscal adjustment programmes. jel h52 1 introduction investment in human capital through education has received much attention in the millennium development goals (mdg) as a blueprint for building a better world in the 21st century. education is seen as one of the main development challenges for especially african countries to sufficiently invest in their people in a sustainable fashion. most empirical studies focus on the determinants of military spending. this is not surprising, since the latter absorbs more than 5 per cent of world resources annually. however, there seems to be consensus that in developing countries, military expenditures mostly constrain economic growth and absorb resources that should have been spent on capacity building such as education (hewitt, 1992). thus lately, fiscal adjustment programmes in developing countries have been featured by less expenditure on military and more on socio-economic development including education and health (davoodi et al., 2001; chu, ke-young et al., 1995; and imf, 1997). the relatively poor economic growth performance of most african economies over the past few decades raises the question whether this is not because of its lack of capacity and therefore educational inadequacies. this paper aims to provide some answers to the posed question by looking at allocational expenditure priorities in a selected number of african countries with a specific focus on education expenditure. the hypothesis is, therefore, to investigate the drivers behind spending allocations with a specific focus on expenditure on education. the rest of the paper is organised as follows; section 2 outlines trends in education spending in some selected african countries. in section 3 the theoretical framework and methodology used in the study is presented and section 4 contains a description of the data used in the study. section 5 contains an analysis of the results of the various estimations and diagnostic tests conducted and section 6 concludes. sajems ns 13 (2010) no 1 51 2 trends in education spending in most african countries a few basic trends have emerged over the past few years with regard to the patterns of education expenditure and total government expenditure as a share of gross domestic product (gdp). figure 1 shows the average growth rates of the ratios of education spending and total government expenditure as a share of gdp in some selected african countries. the figure shows that between 1998 and 2004, total government expenditure and education expenditure as a share of gdp have been moving in opposite directions. figure 1 overall average growth rates of education and total government expenditure as a share of gdp in the selected african countries source: world bank; african development indicators over the period 1996 to 2004, the average annual growth rate of the ratio of education expenditure as a share of gdp amounts to 10.3 per cent compared to the growth rate of the ratio of total government expenditure/gdp of only 0.45 per cent. the trend shows, however, that while the growth rate of the ratio of government expenditure to the gdp is rising, the growth rate of education expenditure as a percentage of total government expenditure has been declining2. one would a priori expect that increasing expenditure on education as a proportion of a developing country’s budget would be an indicator of improved skills and thus higher levels of economic growth. naturally, such spending should be properly administered to ensure good quality education. it is this aspect that is criticised most in the literature, especially given the relatively large amounts spent on education in developing countries in africa. the fact is that according to the research findings of, for example, lucas (1988) and barro (1990) a positive correlation between human capital investment and growth and development is indisputable. the question then is what drives expenditure priorities and are there some common characteristics to be found in such expenditure allocation decisions in the panel of african countries included in this study? naturally, it would be interesting to investigate the way in which spending patterns by governments actually reflect individual desires (public choice) but due to the lack of country data this is simply not possible. instead, this study is limited to expenditure patterns only as reflected in education and total expenditure. 52 sajems ns 13 (2010) no 1 3 theoretical framework the framework used in this study follows a public choice approach similar to that used by hewitt (1991, 1992, 1993) and davoodi et al. (2001). however, instead of analysing military expenditures within the context of total government expenditures as in the models referred to, this paper focuses on the relationship between education spending and overall government spending. using a similar model to analyse education expenditure within the context of total government expenditure could be questionable given the fact that the latter is normally seen as a mixed or even merit good (i.e provided both privately and by government) compared to military expenditure which is a purely a public good. the implication being that the drivers behind such expenditure could be different. however, given the nature of budget expenditure patterns of the 15 african countries under investigation, the authors are convinced that the spending fundamentals are not substantially different from those in a military/total spending context. education in these countries is close to being purely a public good with extremely few alternative service providers, non-rival in consumption and from an ethical point of view, non-excludable. the model allows for the optimisation of government expenditure separate from total expenditure with an exposition of the drivers behind both education and total expenditures thus, the determination of education spending is modelled as a government optimisation problem meaning that the decision of how much to spend on education as proportion of the size of a budget and other votes are being taken by the political leadership. the welfare function of the government is assumed to be: w = f (c, e, o, z) (1) where c = private consumption; e = education spending; o = non-education government spending; and z = state variables (i.e corruption index, imf programs, population index, etc.) the government’s choice of the level of education and overall government spending is affected by the state variables. overall government spending is represented by: g = e + o (2) abstracting from private investment and the external account, the budget constraint is determined by the available resources in the economy: g = y – c (3) where y represents the value of gross domestic product. to get a simple analytical solution, a cobbdouglas specification for equation (1) is assumed, while abstracting from the presence of state variables. thus, w = c e oa b c (4) choices of e and g that maximise equation (4) subject to equations (2) and (3) will result in3: e = g +b c b (5) and g = ( )e y + + +a c a a c c (6) equations (5) and (6) show the simultaneous relationship between education spending and overall government spending. higher education spending will lead to higher overall spending and vice versa. dividing both equations by y and allowing for the state variables to enter the equations, results in: ; y e f y g z1= c m (7) and ; y g f y e z2= c m (8) where f1 and f2 are functions. equations (7) and (8) form a structural model. furthermore, the impact of imf-supported adjustment programmes on education spending is assessed using a similar model by davoodi et al. (2001) and others such as (de masi & lorie, 1989; abed, george et al., 1998; schiff, gupta & clements, 1998; and gupta, sanjeev, mcdonald & ruggiero, 1998). however, the sajems ns 13 (2010) no 1 53 framework adopted in this study also allows for measuring the effects of corruption on education and overall government spending equations. similar work has also been done by mauro (1998) using cross sectional data and finding that corruption reduces government spending on education. 4 methodology and data a panel data econometric technique is used in estimating the required models with 15 cross-sectional data points of selected african countries over the period 1995–20044. the econometric models are specified in natural logarithms form based on equations (7) and (8) which are presented below: ( ) ( ) ( ) ( ) ( )ln ln ln ln lneduc ypc gov pop ur cor u14imfit it it it it it it it1 2 3 4 5 6= + + + + + +a a a a a a a (9) ( ) ( ) ( ) ( ) ( )imfln ln ln ln lngov ypc educ ur cor pop v65it it it it it it it it1 2 3 4 5 6= + + + + + +b b b b b b b (10) where educ = ratio of education spending to gdp, ypc = real per capita gdp, gov = ratio of overall government spending to gdp, pop14 = population 14 years and under, cor = corruption index, imf = existence of imf supported adjustment program (dummy variable), ur = urbanization ratio, pop65 = population above 65 years, and u it and v it are error terms. the subscript (it) refers to country and time period respectively. the state variables in the specified equations (9) and (10) include an imf dummy variable, real per capita gdp, population under 14 years, corruption index, urbanisation ratio, and population above 65 years. these variables are assumed to influence the parameters of education and government expenditures similar to the approach followed by davoodi et al. (2001), hewitt and van rijckeghem (1995), mauro (1998) and heller, peter and diamond (1990). the specification of the models reveals a possible simultaneity problem between education spending and overall government spending and this has rendered the use of ordinary least square (ols) to be inappropriate in the estimations. in order to derive robust estimates of the parameters in equation (9 & 10) a two stage least square (tsls) estimation method is adopted and the lag values of all the independent variables are used as instruments to remove the simultaneity problem that exists between education and government spending. as discussed earlier, the estimations were carried out using a full panel data set of 15 african countries for the period 1995–2004. due to the lack of available data over a long period of time, for some of the variables in specific countries, our analysis is restricted to a 10-year period for which a full data set could be obtained. initially, about 28 african countries were included in the estimations based on the data set available, but the number of crosssections was restricted to only fifteen. the reason for excluding some of these countries from the estimations is because they tend to produce unexpected and implausible signs for some core coefficients that are at odds with similar studies found in the literature. countries included in our analysis were selected on the basis of their homogenous features relating to expenditure patterns. countries that spend less than 5 per cent on education as a share of gdp were excluded from the data set with the remaining countries all showing higher levels of expenditure on health as a share of gdp, the idea being that those would be countries with their budget priorities 54 sajems ns 13 (2010) no 1 more focused on the quality of life of its citizens5. omitted variables include school enrolment ratios, adult literacy rates and educational attainment which may have captured the determinants of education spending in these countries, but the non-availability of such data restricted the analysis to the variables specified in equations (9 & 10). the relationship that exists between total gov e rnme nt e xpe ndit ure a nd e duca t ion expenditure is found to be ambiguous. one would expect that an increase in total government expenditure results in a corresponding rise in education expenditure but such a rise in overall government expenditure may also lead to a reprioritisation of votes on the budget. in contrast, an increase in education expenditure is expected to result in an increase in total government expenditure if not being compensated for by the reprioritisation of other votes on the budget. the gdp per capita which serves as a measure of welfare or development is expected to show evidence in favour of wagner’s law. this means that a higher level of welfare is accompanied by an increased share of government expenditure to gdp. however, in the literature, evidence in favor of this phenomenon is mixed (easterly & rebelo, 1993; rodrik & dana, 1996; and commander et al., 1997). considering the two population age groups that are being used in this paper, it is expected that the size of the age group below 14 years should correlate positively with education expenditure. the reason being that the highest share of government expenditure on education goes to primary and secondary education, with a large number of pupils falling in the age group younger than 14 years. also, the age group above 65 years is expected to correlate positively with overall government expenditure since an increase in the number of the aged also results in an increase in government spending on social welfare and pensions. however, it is also known that in many african countries little or no pension provision is available. evidence from hewitt (1992) shows that increases in the population and corresponding urbanisation will also lead to increased overall government spending that affects the level of education expenditure. corruption which can be regarded as a symptom of bad management of the resources of a country also affects expenditure priorities. a rise in the level of public expenditure and lower revenue as a result of corrupt systems may lead to adverse budgetary implications with poor infrastructure and public services. corruption is difficult to quantify though, but in this study the corruption control index is used with higher numerical numbers indicating less corrupt governance6. it is expected that a more corrupt government will spend less on education than on other components of expenditure where corrupt expenditures are less visible. this is because it may be easier to collect substantial bribes on large infrastructural projects such as defence expenditures than on textbooks or teachers’ salaries (mauro, 1997). also, overall government expenditure will rise as the government becomes more corrupt. the composition of government expenditure may be distorted as corrupt government officials choose to direct expenditures to sectors such as defence or transport that tend to favour bribery. the imf dummy reflects those countries that embrace the imf supported programmes and those that do not. it is expected that the former countries will spend more on education but reduce their total expenditures which is what most imf programmes prescribe (imf, 2002). the data used were obtained from the world bank data base except the imf dummy variable which was taken from the imf country reports. the real per capita gdp, size of the population under the age of 14, urbanisation ratio, population above 65 years, total population, real gdp, education expenditure, and total government expenditure series were obtained from the world bank: african development indicators. the corruption control index was sourced from the worldwide governance indicators. 5 estimation results as discussed earlier, the structural models of equations (9) and (10) are estimated using a twostage least squares (2sls) procedure. a fixed effect (both country and time specific effects) sajems ns 13 (2010) no 1 55 estimation technique is adopted based on the assumption that these countries are not poolable since they may not be similar in many other aspects. the advantage of estimating the structural model with the lagged values of the independent variables as instruments is that it provides point estimates of the response of education spending to exogenous changes in government spending and the response of government spending to exogenous changes in education spending. the results shown in table 1 are encouraging with r-square coefficients of 0.97 and 0.99 in equations (9) and (10), respectively. this result represents the 15 countries that are included in the estimations7. 5.1 total government expenditure the significance of the coefficient of the ratio of government spending to gdp corresponds to a priori expectations. it shows that an increase of 1 percent in total government spending as a share of gdp will lead to an increase of about 0.54 per cent in education expenditure as a share of gdp. this is an indication that these countries devote a substantial part of their additional budget resources to education rather than shifting them to other votes on the budget. 5.2 education expenditures the indirect influence of exogenous variables on education spending can be seen through the total government spending equation. since education expenditure is a component of total government expenditure it is expected that a higher level of spending on education will result in a higher level of total government spending. this is confirmed by the estimation. total government expenditure as a share of gdp rises by about 0.32 per cent if education spending as a share of gdp increases by one per cent. the statistical significance of this coefficient shows that education expenditure still comprises a small share of total government expenditure in these countries. table 1 results of education and government expenditure equations dependent variables independent variables ratio of education spending to gdp ratio of government spending to gdp real per capita gdp 0.84*** (3.87) –0.29** (2.23) ratio of government spending to gdp 0.54*** (2.03) ratio of education spending to gdp 0.32*** (6.92) urbanization ratio 2.41*** (2.69) 0.5 (0.88) population below 14 3.31*** (4.13) population above 65 imf dummy 0.08 (0.64) 0.1 (0.94) corruption control index 0.15** (2.17) –0.05* (–1.95) number of observation 135 135 r-square 0.97 0.99 note: *** significant at 1% level; ** significant at 5% level; * significant at 10% level source: authors calculation and analysis of data 56 sajems ns 13 (2010) no 1 5.3 real per capita gdp the significance of real per capita gdp in the education expenditure equation shows that the higher the welfare level of a country, the more that country spends on education. the coefficient shows that a one per cent increase in real per capita income will lead to a 0.84 per cent increase in education spending as a share of gdp. however, in the case of the total government expenditure equation, an increase in the per capita income by one per cent results in the overall government spending to gdp ratio to fall by about 0.3 per cent. 5.4 corruption control index the response of education spending to the corruption index shows that as the government becomes less corrupt its spending on education rises. an improvement in the corruption index by one unit, results in an increase in education expenditure as a share of gdp of about 0.2 percentage points. this is not surprising since the education sector is not an attractive sector for politicians attempting to seek their own personal gain. similar results were found in mauro (1997), who nevertheless cautions readers not to interpret expenditure on education as being free of corruption. however, the results seem to indicate that the incidence of corrupt practices in the education sector is much lower than in other sectors. the response of total government expenditure to less corrupt governance is also in line with expectations. the statistical significance of the corruption index shows that as the corruption index declines (more corrupt) by one unit, total government expenditures as a share of gdp tend to rise by about 0.1 percentage points. in other words, a more corrupt government will tend to increase its expenditure by either inflating its projects or choosing those that will be easier to levy bribes on. this is contrary to what is found in the case of education spending and could reflect the self-interest of politicians and bureaucrats. 5.5 imf dummy given the strict fiscal rules and conditions for the implementation of imf supported programmes one would expect that expenditure on education would increase while total expenditure is constrained. despite a statistically insignificant relationship between the imf dummy variable and education spending as a share of gdp, the results tend to suggest that the imf supported programmes can be associated with increased spending on education. however, in the case of total expenditure as a share of gdp the results indicate that imf supported programmes contribute to increased levels of expenditure. this result is, however, not compatible with the findings of davoodi et al. (2001) in which two measures of international tension and an interaction term are included. 5.6 population and urbanisation the age and the urbanisation ratios included in the estimations are in line with a priori expectations as far as expenditure on education is concerned but the general lack of socio-networks causes the results for the number of aged people and total expenditure to be distorted. the results reveal that a one per cent increase in the size of the population under 14 years will increase spending on education as a share of gdp by about 0.05 per cent. similar results have been found in mauro (1998) where he included the share of the population aged between 5 and 20 in order to raise the magnitude of the coefficient on corruption. as indicated the model failed to find any particular relationship between age and government expenditure, probably because of the lack of data on social programmes for the elderly in the african countries included in the model. the urbanisation ratios have a positive impact on education spending as a share of gdp as well as total government spending as a share of gdp. however, the results are not statistically significant in the total government expenditure equation. the results show that an increase in the urbanisation ratio by one per cent will lead to an increase of about 2.4 and 0.5 per cent in education expenditure as a share of gdp and total government expenditure as a share of gdp, respectively. the reason for the statistical significance of the urbanisation ratio in the education equation may be based on the sajems ns 13 (2010) no 1 57 fact that most of the educational institutions are located in urban areas. in contrast, the statistically insignificance of the urbanisation ratio in the total government equation may be related to the fact that much of government expenditure in africa is not really directed at urban infrastructural development. 6 conclusion this study investigates the impact of a number of selected variables on government expenditure on education and total public expenditure in 15 selected african countries. the estimations performed (after corrections to the various statistical problems encountered) portray a robust estimate of the parameters in the models. the impact of total government expenditure on education spending shows the expected results, namely, that the share of education spending to total government spending increases when fiscal policy is expansionary. this means that government expenditure on education is resilient to shocks in total government spending and total government expenditure on the other hand is found to be resilient to shocks in education spending. in other words, expansionary fiscal policy in these countries results in a dedicated part of the expansion automatically being directed to the education sector. the positive, significant and robust relationship found between corruption and education spending as a share of gdp also shows that the education sector is not affected by corruption as much as other components of government expenditure. similar results were reported by mauro (1998) who ascribed this relationship to the fact that most corrupt governments find it easier to collect bribes on non-educational expenditures such as infrastructure spending and the military. although not statistically significant, the results show that imf supported programmes have contributed to increased spending on education in the countries included in this study. it is interesting to note though, that increased use and implementation of imf programmes have actually led to increased levels of public spending in general. one would assume that the increased expenditure was made possible by funds invested by the imf but that does not seem to constrain total government expenditures. while the results indicate that expenditure on education receives its fair share with a rise in total expenditure, there seems to be a tendency for expenditures on other votes on the budget to grow while the growth in the share of education is gradually declining. this is a concern given the need for skills and human capacity building in general in developing countries. also, from a good governance point of view, the fact that expenditure on education is less affected by negative factors like corruption indicates that fiscal prudence can be promoted by increasing this sector’s share of total expenditure. future research should attempt to correct some of the shortcomings of this study such as the lack of available data which resulted in a number of countries being excluded and some relevant variables not being included in the estimations. endnotes 1 we are thankful to dr e nyamongo for his assistance in obtaining data for this study and also his constructive suggestions and comments. 2 note: figure 1 depicts the trend of the two variables and is calculated using a hodrick– prescott filter. 3 the solution for the optimal choice of e and g is shown in appendix 1. 4 list of the countries included in the estimations is shown in appendix 2. 5 list of countries excluded from the estimations is also shown in appendix 2. 6 most corrupt (–2.5) and least corrupt (+2.5) 7 appendix 3 present the results of the countries that are excluded from the sample. references abed, g. & others, 1998. fiscal reforms in lowincome countries: experience under imf-supported programs. washington: international monetary fund. anon. not dated. united nation development programme (undp): millennium development goals. [online] available from: http://www.undp.org/mdg/ basics.shtml [accessed: 2007-2-20]. barro, r.j. 1991. economic growth in a cross section of countries. quarterly journal of economics, 106(2): 407–43. 58 sajems ns 13 (2010) no 1 chu, ke-young & others, 1995. unproductive public expenditures: a pragmatic approach to policy analysis. imf pamphlet series, no. 48. washington: international monetary fund. commander, s., davoodi, h.r. & lee, u.j. 1997. the causes of government and the consequences for growth and well-being. policy discussion paper, no. 1785. washington: world bank. davoodi, h., clements, b., schiff j. & debaere, p. 2001. military spending, peace dividend, and fiscal adjustment. imf staff papers, 48(2): 290–316. de masi, p. & lorie, h. 1989. how resilient are military expenditures? imf staff papers, 36(3): 130–65. easterly, w. & rebelo, s. 1993. fiscal policy and economic growth: an empirical investigation. journal of monetary economics, 32(3): 417–58. gupta, s., mcdonald, c. & ruggiero, e. 1998. worldwide military expenditures appears to have leveled off. imf survey, may: 149–50. heeler, p.s. 2005. understanding fiscal space. imf policy discussion paper, 05/4. heller, p.s. & diamond, j. 1990. international comparisons of government expenditure revisited: the developing countries. 1975–86. washington: international monetary fund. hewitt, d.p. 1991. military expenditure: econometric testing of economic and political influences. imf working paper, wp/91/53 (washington: international monetary fund). _______ 1992. military expenditure worldwide: determinants and trends journal of public policy. 12(2): 105–52. _______ 1993. military expenditure 1972–1990: the reasons behind the post-1985 fall in world military spending. imf working paper, wp/93/18. washington: international monetary fund. hewitt, d.p. & van rijckeghem, c. 1995. wage expenditures of central governments. imf working paper. wp/95/11. washington: international monetary fund. international monetary fund. 2007. regional economic outlook: sub-saharan africa. washington d.c. international monetary fund. 2002. fiscal adjustment in imf-supported programs. draft issues paper, march 28. international monetary fund. 1997. reducing unproductive expenditures is important for fiscal adjustment. imf survey, february 24, pp.49-51. lucas, r.e. 1988. on the mechanics of economic development, journal of monetary economics, 22: 3-42. mauro, p. 1998. corruption and the composition of government expenditure. journal of public economics, 69: 263–79. mauro, p. 1997. why worry about corruption? international monetary fund. [online] available from: http://www.imf.org/external/pubs/ft/issues6/index.htm. rodrik & dani. 1996. why do more open economies have bigger government? nber working paper, no. 5537, cambridge, massachusetts: national bureau of economic research. schiff, j., gupta, s. & clements, b. 1998. worldwide military spending 1990–95. defense and peace economics, 9(3): 237–81. sajems ns 13 (2010) no 1 59 appendices appendix 1 forming a langragian from (4) subject to (2) and (3). l = ( )c e o y – c – e – o+ ma b c since; e + o = y – c f.o.c l c = aca-1eo –  = 0 (1) l e = cae-1o –  = 0 (2) l o = caeo-1 –  = 0 (3) l k = y – c – e – o = 0 (4) equating (2) and (3) o = e o = e b c (5) substituting (5) into (4) y – c – e – e b c = 0 but y – c = g g – e1 + b c e o = 0 e = g +b c b (6) also, equating (1) and (3) ao = c c = o c a (7) substituting (7) into (4) y – o c a – g = 0 for g = e + o y – g – e c a ^ h – g = 0 y + e c a = g1 + c a d n g = e y + + +a c a a c c 60 sajems ns 13 (2010) no 1 appendix 2 list of countries countries included countries excluded botswana angola ivory coast burundi djibouti cameroon ethiopia eritrea ghana gambia kenya guinea bissau lesotho mali mauritius malawi morocco madagascar namibia niger rwanda nigeria sierra leone senegal tunisia swaziland uganda south africa sajems ns 13 (2010) no 1 61 appendix 3 results for countries excluded from the estimations dependent variable: ratio of education spending to gdp total pool (balanced) observations: 117 instrument list: c ln_gov?(–1) imf?(–1) cor?(–1) ln_ypc?(–1) ln_pop14?(–1) ln_ur?(–1) variable coefficient std. error t-statistic prob. c 2.289275 3.301217 0.693464 0.4897 ratio of government spending to gdp 0.617170 2.520862 0.244825 0.8071 real gdp per capita 0.344243 1.019042 0.337811 0.7362 imf dummy 0.016969 0.268633 0.063169 0.9498 corruption control index 0.000876 0.128534 0.006812 0.9946 population below 14 –0.037749 0.259084 –0.145701 0.8845 urbanisation ratio 6.059133 1.468762 4.125334 0.0001 r-squared 0.928747 dependent variable: ratio of government spending to gdp total pool (balanced) observations: 117 instrument list: c ln_gov?(–1) imf?(–1) cor?(–1) ln_ypc?(–1) ln_pop14?(–1) ln_ur?(–1) variable coefficient std. error t-statistic prob. c –3.261680 32.15533 –0.101435 0.9194 ratio of government spending to gdp –0.058431 1.303423 –0.044829 0.9643 real gdp per capita 0.233750 1.779611 0.131349 0.8958 imf dummy –0.067811 0.374417 –0.181112 0.8567 corruption control index –0.054173 0.038008 –1.425304 0.1572 population below 14 0.783598 5.000243 0.156712 0.8758 urbanisation ratio 0.088003 16.20648 0.005430 0.9957 r-squared 0.996545 abstract introduction objective of the study development of hypotheses research methodology ethical consideration discussion of findings conclusion acknowledgements references about the author(s) amos engelbrecht department of industrial psychology, stellenbosch university, stellenbosch south africa olorunjuwon m. samuel school of economic and business sciences, university of the witwatersrand, johannesburg, south africa citation engelbrecht, a. & samuel, o.m., 2019, ‘the effect of transformational leadership on intention to quit through perceived organisational support, organisational justice and trust’, south african journal of economic and management sciences 22(1), a2338. https://doi.org/10.4102/sajems.v22i1.2338 original research the effect of transformational leadership on intention to quit through perceived organisational support, organisational justice and trust amos engelbrecht, olorunjuwon m. samuel received: 20 feb. 2018; accepted: 12 mar. 2019; published: 12 june 2019 copyright: © 2019. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the literature has extensively presented evidence to establish that employee turnover is costly and destructive to organisational processes and outcomes. organisations in south africa are experiencing a high rate of turnover and it is becoming increasingly difficult to retain employees whose skills are critical to organisational success. this provides a compelling necessity to direct research attention to turnover intention in order to avoid actual turnover. aim: the purpose of this article was to use partial least squares to test the relationships among selected antecedents of intention to quit. setting: the study was conducted using employees in organisations that were surveyed in both public and private sectors in the western cape, eastern cape and gauteng provinces of south africa. methods: the study employed a survey research design using a quantitative research strategy. data collected from 207 conveniently sampled respondents were used to validate a structural model developed through the review of existing literature. a standardised measurement instrument consisting of all the variables under investigation was used for data collection. results: the results indicate the following path sequences in predicting employee turnover intention: transformational leadership through perceived organisational support and transformational leadership through organisational justice impact intention to quit. however, the path sequence from transformational leadership through organisational trust impacting intention to quit was not confirmed. conclusion: a replication of this study using a longitudinal research design is recommended in order to overcome the methodological limitations of the current study. the conceptual model developed in this study provides relationships that could be used as guidelines to effectively manage the retention of key employees in organisations keywords: intention to quit; employee turnover; structural equation modelling; transformational leadership; perceived organisational support; organisational justice; organisational trust. introduction withdrawal of employees from an organisation could have a substantial negative impact on organisational processes and outcomes, particularly when such withdrawal is voluntarily motivated. the consequences of employee turnover for organisations are multidimensional and include loss of employees who possess valuable competencies and, most often, organisational memory that is difficult to replace. similarly, organisations incur the high cost of recruiting and training new employees, diminished morale among remaining employees; and the psychological and social disruption experienced by colleagues of departed employees (tirelli & goh 2015). a high rate of turnover thus potentially has a negative outcome for the level of organisational productivity, customer service delivery and, ultimately, the organisation’s profitability. the category of employees presenting a high rate of turnover most often includes those who have essential skills and whose services are critical to the achievement of organisational goals and success. ironically, less talented employees whose skills and experiences are in less demand by employers demonstrate less intention to quit (tanova & holtom 2008). employee turnover has been heightened by the rapidly shrinking global labour market and this portends implications for the mobility of talented employees across geographical work locations. previously, a plethora of research has been conducted to understand the complexity of turnover in organisations (e.g. abubakar, chauhan & kura 2014; deconinck 2010). however, the phenomenon continues to be a dominant discourse in contemporary management literature. a major directional shift in research is, however, swinging attention from actual turnover to turnover intention among employees. turnover intention or intention to quit (itq) generally refers to an employee’s intention to move from the present employment to another in the near future (nadiri & tanova 2010). it represents a deliberate thought process in which an individual employee evaluates the present job conditions in order to determine their continued membership of the organisation. transformational leadership potentially decreases a follower’s intention to leave an organisation since the leader enables followers to identify with their leaders, builds emotional commitment to work goals and shows individualised consideration towards followers (bass & riggio 2006; hughes, avey & nixon 2010). various studies found that transformational leadership has an indirect influence on itq through perceived organisational support (maertz et al. 2007; rhoades & eisenberger 2002), organisational justice (engelbrecht & chamberlain 2005; loi, hang-yue & foley 2006) and organisational trust (loi et al. 2006; marques de lima rua & araújo 2013). objective of the study the objective of this study was twofold. the first was to conceptualise and empirically test existing relationships between selected predictors of itq (i.e. transformational leadership, perceived organisational support, organisational justice, organisational trust). the second objective was to validate the predictor variables within the framework of a structural model. the research objectives were formulated on the basis of the need to focus attention on predicting turnover intentions rather than actual turnover, since it is possible for management to manage turnover intentions by devising corrective mechanisms rather than the actual turnover. ajzen and fischbein’s (1980) theory of reasoned action, which postulates that behavioural intentions are the best predictor of behaviour, provided the theoretical framework for this study. development of hypotheses the relationship between perceived organisational support and intention to quit perceived organisational support (pos) concerns the estimation by employees regarding the importance attached to their inputs and the extent to which the organisation cares for their well-being in the course of employment (riggle, edmondson & hansen 2009). the construct is postulated within the context of the social exchange theory and reciprocal behaviour (lee & peccei 2007). perceived organisational support as a key predictor of turnover intention is well documented in the literature (maertz et al. 2007). it is reasonable to assume that turnover intention would be low among employees who feel that they have received the necessary support from their employer since employees often respond positively to the support they receive from their organisations (sherony & green 2002). perceived organisational support therefore promotes a strong intention to stay among employees. this explanation accounts for a number of research reports that found a negative association between pos and employee intention to leave an organisation (rhoades & eisenberger 2002; van schalkwyk, els & rothmann 2011). the general context of organisational psychology research suggests that employees with a high level of pos tend to express stronger feelings of affiliation and loyalty to their organisation (loi et al. 2006). thus, the following hypothesis based on the above literature can be formulated: h1: pos has a significantly negative effect on itq. the relationship between organisational justice and intention to quit organisational justice represents the perception of fairness by organisational members in terms of the processes, procedures and reward mechanisms in an organisation (greenberg & baron 2003). cropanzano, bowen and gilliland (2007) identify the ability of organisational justice to inspire substantial trust and commitment of employees to both the organisation and its managers. the perception of such fairness or the lack thereof evokes the decision about whether an employee wants to continue or terminate the employment relationship (cohen-charash & spector 2001). perception of justice therefore remains a crucial determinant of itq (loi et al. 2006). it is on the strength of this literature that the following hypothesis was formulated: h2: organisational justice has a significantly negative effect on itq. the relationship between organisational trust and intention to quit due to its multidimensional nature, there is no common definition of the concept of organisational trust. however, this study relates more to the definition provided by gilbert and tang (1998) as the feeling of confidence and belief in both organisational leadership and goals on the part of employees. this belief also includes the expression of confidence in the extent that organisational actions will ultimately be to the benefit of employees (gilbert & tang 1998). based on this confidence, employees are willing to engage in positive work behaviour on the assumption that the employer is sincere and intends to act in a manner that most benefits employees (restubog et al. 2008). the link between trust and itq is well supported in the literature (ferres, connell & travaglione 2004). this link has resulted in a strong and negative relationship between organisational trust and the individual employee’s turnover intention (ooi, safa & aumugam 2006). the promotion of trust as a deliberate organisational culture thus presents a decisive factor for decreasing turnover intentions (ooi et al. 2006). this conclusion is based on the premise that employees are willing to maintain their membership of an organisation that shows concern for their well-being and also values their services (ng & feldman 2012; tekleab & chiaburu 2011). the ensuing hypothesis was therefore stated as: h3: organisational trust has a significantly negative effect on itq. the relationship between transformational leadership and pos the relationship between transformational leadership and pos appears not to have been adequately evaluated in the literature. however, a handful of studies have shown that employees who have been well supported by the organisation over a period of time, as assessed by pos, are likely to engage in a high-quality exchange relationship with their supervisor (asgari et al. 2008). because the supervisor acts on behalf of the organisation when evaluating an employee’s performance and allocating rewards, employees consider the discretion they are allowed by the supervisor as a signal of organisational support (eisenberger et al. 2002). since transformational leaders empower followers to identify with their leaders, clarify work goals and objectives and show individualised support towards followers (bass & riggio 2006; hughes et al. 2010), these leaders may have a positive impact on pos (rhoades & eisenberger 2002). it could therefore be argued that: h4: transformational leadership has a significantly positive effect on pos. the relationship between transformational leadership and organisational justice facilitating and encouraging employees to express their concerns is a notable role of transformational leadership (wells & peachey 2010). this role is linked to the justice theory. there is therefore a tendency for organisations to experience lower levels of itq when employees are able to express their concerns regarding the fairness of organisational processes (wells & peachey 2011). empirical evidence has shown that organisational commitment and trust in the leader are positively affected when people perceive that fair procedures are used to determine the outcomes they receive (e.g. yusof & shamsuri 2006). engelbrecht and chamberlain (2005) and krafft, engelbrecht and theron (2004) variously found a positive association between transformational leadership and organisational justice. the deduction from the literature thus is expressed as: h5: transformational leadership has a significantly positive effect on organisational justice. the relationship between transformational leadership and organisational trust earlier seminal studies on transformational leadership (e.g. bennis & nanus 1985) argue that effective transformational leaders earn the trust of their followers, thus creating a direct relationship between transformational leadership and trust. this relationship becomes more essential because of the need for a transformational leader to mobilise followership commitment to the leader’s vision (bass & avolio 1994). this argument has led to the existence of a direct positive linkage between transformational leadership and organisational trust, with transformational leadership enhancing organisational trust (marques de lima rua & araújo 2013). interestingly, however, krafft et al. (2004), as well as engelbrecht and chamberlain (2005), have failed to establish support for a significant direct association between transformational leadership and trust. rather, the scholars provided a new insight regarding the extent to which interactional justice probably plays a mediating role in the relationship between the two constructs. thus, it is argued that: h6: transformational leadership has a significantly positive effect on organisational trust. conceptual model based on the relationships proposed above, we developed a structural model of the antecedents of itq (see figure 1). figure 1: theoretical model of the effect of transformational leadership on intention to quit through perceived organisational support, organisational justice and organisational trust. research methodology sample participants comprised 232 conveniently sampled employees drawn from various organisations (public and private sectors) in three provinces of south africa. the gender composition was 101 (44%) males and 131 (56%) females. the majority (40.8%) of the respondents occupied middle-level management positions. measuring instruments self-administered and online questionnaires were used to collect data. the questionnaire contained statements concerning the opinions of the respondents regarding the selected variables of the study. all items were measured on a six-point likert scale. intention to quit intention to quit was measured using a six-item scale adapted from cohen (1993) (two items), deconinck and johnson (2009) (one item) and becker (1992) (three items). perceived organisational support we adapted 12 items from the original version of the survey of perceived organisational support (spos) (eisenberger et al. 1986) as modified and used by cho, johnson and guchait (2009). organisational trust organisational trust was measured by using an adapted 24-item workplace trust survey (wts) developed by ferres et al. (2004). for the purpose of this study, only two of the three subscales of the wts were used, namely trust in the supervisor or leader (10 items) and trust in the organisation (14 items). organisational justice an adapted 21-item organisational justice scale developed by niehoff and moorman (1993) was used to measure distributive justice (five items), procedural justice (six items) and interactional justice (nine items). one additional item was adapted from the interactional justice scale developed by colquitt et al. (2001). transformational leadership transformational leadership was measured using the 20-item multifactor leadership questionnaire (mlq) developed by bass and avolio (1995) and adapted by engelbrecht, van aswegen and theron (2005). transformational leadership was assessed through four subscales: (1) idealised influence (eight items), (2) inspirational motivation (four items), (3) intellectual stimulation (four items), and (4) individualised consideration (four items). research ethics the conduct of the empirical research conformed to all ethical standards and was approved by the ethics committee at the university of stellenbosch. statistical analysis item analysis and exploratory factor analysis (efa) were used to determine the reliability and unidimensionality of the measuring instruments (pallant 2010). structural equation modelling (sem) through partial least squares (pls) was conducted to evaluate the construct validity of the structural model (henseler, ringle & sinkovics 2009). partial least squares was also performed to determine the relationships among the latent variables. missing values the method of imputation was used to address the problem of missing values (lohr 1999). the prelis software (jöreskog & sörbom 1996) was used to impute missing values in the data set. after eliminating data that contained missing values using imputation, a total of 207 of the original 232 questionnaires were found to be useable for analysis. research results the pls sem methodology was used to test the relationships among selected antecedents of itq among employees of the surveyed organisations. one important motivation for using the pls path modelling, is its suitability for prediction-oriented research with emphasis on the explanation of endogenous constructs (henseler et al. 2009). the results are reported in the following section. item and dimensionality analysis results of the item analysis showed that all the cronbach’s alpha values exceeded the 0.70 criterion and indicated excellent reliability (> 0.90) (nunnally & bernstein 1994; pallant 2010) (see table 1). in addition, all items presented satisfactory item-total correlations (> 0.20) (nunnally & bernstein 1994). furthermore, all variables achieved acceptable composite reliabilities (> 0.60), as well as average variance extracted (ave > 0.50) (henseler et al. 2009), as depicted in table 1. each scale was therefore considered to be internally consistent and reliable. table 1: reliability of measuring instruments. exploratory factor analyses were conducted to confirm the unidimensionality of each scale and subscale. unrestricted principal axis factor analysis with oblique rotation was performed on the various scales and subscales. all the scales and subscales demonstrated unidimensionality. sampling adequacy was evaluated to determine the suitability of the correlation matrix of the items in the scales before performing the efa. a kaiser-meyer-olkin (kmo) test exceeded 0.60 and a significant (p < 0.05) bartlett’s test of sphericity confirmed that data were suitable for factor analysis (pallant 2010). the guideline provided by kinnear and gray (2004), that is, ‘eigenvalue greater than 1’ was used to determine the number of factors to be extracted. all the factor loadings for the subscales were acceptable (> 0.50) (kinnear & gray 2004), except for one pos item with a factor loading of 0.42. the items in the scales explained an acceptable percentage of the variance in the specific latent variables (71% – 90.4%) (tabachnick & fidell 2001). discriminant validity discriminant validity is a measure of the degree to which the measures of two constructs that theoretically should not be related, are in fact not related. discriminant validity was assessed by using the heterotrait-monotrait ratio of each construct, as well as the 95% confidence intervals. it was established that all the postulated related latent variables demonstrate discriminant validity (farrell 2010; henseler et al. 2009), as depicted in table 2. table 2: discriminant validity and relationships between latent variables. ethical consideration the substantive empirical study (phd) was approved by the ethics committee at stellenbosch university. discussion of findings the pls methodology was used to test the relationships among the selected antecedents of itq. one important motivation for using the pls path modelling, is its suitability for prediction-oriented research with emphasis on the explanation of endogenous constructs (henseler et al. 2009). the results are reported in this section. hypothesis 1: perceived organisational support has a significantly negative effect on intention to quit the pls results confirmed a low (tredoux & durrheim 2002), but significantly negative relationship between pos and itq (see h1) (path coefficient = –0.36, p < 0.05) (see table 2). this finding is supported by previous studies (e.g. loi et al. 2006; maertz et al. 2007; rhoades & eisenberger 2002; van schalkwyk et al. 2011). the finding from the present study supports the expectation that employees who perceive lack of sufficient care and support from their organisation will seek alternative employment, thus heightening their turnover intentions. research outcomes regarding perceived organisation support in relation to turnover intentions are often explained in the context of the social exchange or organisational support theories (ahmed et al. 2014; islam et al. 2013). these theories postulate that employees, when they perceive support from their organisation, reciprocate this support by means of positive job-related outcomes such as job satisfaction and commitment. this reciprocal behaviour decreases employees’ turnover intention. in line with these theories, the present study illustrates that turnover intention would be low among employees who feel that they receive the necessary support from their employer. hypothesis 2: organisational justice has a significant negative effect on intention to quit a low (tredoux & durrheim 2002), but significant negative relationship between organisational justice and itq (path coefficient = –0.37, p < 0.05) was found, as postulated in h2 (see table 2). this finding is consistent with a similar finding by nadiri and tanova (2010). the fairness of the manner in which rewards are distributed and procedures adopted in the decision-making process concerning well-being and career development and progression are of utmost importance to employees. adams’s (1965) equity theory provides support for the empirical finding in this study to the extent that employees conduct comparative input-reward ratio analysis in order to determine the degree of fairness that is demonstrated by management. the outcome of such analysis could potentially influence an individual employee decision to quit or to remain in an organisation. thus, the present study confirmed that a lack of perceived organisational justice could stimulate turnover intentions. hypothesis 3: organisational trust has a significant negative effect on intention to quit the pls results indicated a non-significant relationship between organisational trust and itq (h3) (see table 2). therefore, no support was found for hypothesis 3. the pls result contradicts the literature (ferres et al. 2004; ooi et al. 2006). one possible explanation could be the influence of the values of pos and organisational justice, which are related to itq. low pos can reduce the influence of trust on intention to leave if employees do not feel that the organisation provides sufficient support for their well-being in exchange for their input. employees’ trust in the organisation to fulfil its promises will also reduce if they have previously perceived unfair treatment and unjust practices. this explanation is supported by schoorman, mayer and davis (2007: 346) who argued that ‘the level of trust is an indication of the amount of risk that one is willing to take’. it is important that organisational managers make an effort to sustain mutual trust through perceived support, as well as fairness in decision-making and treatment of employees (paillé et al. 2010). organisational trust could therefore be a mediator between pos and itq, as well as between organisational justice and itq. however, according to the present study the promotion of trust in organisations does not decrease turnover intentions. hypothesis 4: transformational leadership has a significantly positive effect on perceived organisational support the pls analysis indicated a moderate (tredoux & durrheim 2002), but significant, positive relationship between transformational leadership and pos (path coefficient = 0.61, p < 0.05) (see table 2). building on the leader-member-exchange theory, hassan and ul-hassan (2015) affirmed that demonstration of pos resulted in employees’ decision to improve on their performance as a way of compensating the organisation for treating them in a favourable manner. the significantly positive relationship that was postulated in h4 between transformational leadership and pos therefore found both theoretical and empirical support. hypothesis 5: transformational leadership has a significantly positive effect on organisational justice a strong (tredoux & durrheim 2002) relationship between transformational leadership and organisational justice (path coefficient = 0.72, p < 0.05) was found, as postulated in h5 (see table 2). some of the attributes that define an effective transformational leader are trustworthiness and integrity (palanski & yammarino 2009). leadership ability to effectively inspire subordinates is largely determined by the degree of integrity that is demonstrated by the leader (bacha & walker 2013). a leader with the attribute of integrity is perceived to be acting fairly and, as such, creates a sense of enthusiasm and optimism in subordinates when communicating the organisation’s vision (bacha & walker 2013). the above assertion thus provides an essential basis for a positive relationship between transformational leadership and organisational justice, as found in the present study. hypothesis 6: transformational leadership has a significantly positive effect on organisational trust lastly, the high (tredoux & durrheim 2002) level of association (path coefficient = 0.75, p < 0.05) between transformational leadership and organisational trust confirmed h6 (see table 2). previous authors (e.g. lee 2008) provided consistent evidence to support the findings of the present study. this finding emerges against the backdrop of leaders assigning higher and more challenging but achievable responsibilities to subordinates who they have mentored and coached, and in whose competence they have established sufficient trust. employees develop trust in leaders who relate to them in an open and truthful manner (ilies, morgeson & nahrgang 2005). ethical and transformational leadership revolves around building trust by personally displaying a high moral standard with integrity and involving employees in the decision-making process. the results of the present study confirmed the positive influence of transformational leadership on organisational trust. in conclusion, the present study found a significant positive relationship between transformational leadership and pos, organisational justice, and organisational trust (see figure 2). furthermore, a significant negative relationship was found between itq and pos and organisational justice. however, no significant relationship was achieved between organisational trust and itq. figure 2: empirical results of the relationships among transformational leadership, perceived organisational support, organisational justice, organisational trust and intention to quit. managerial implications of the findings the conceptual model developed in this study provides practical implications for the formulation of human resources policy regarding employee retention. based on this model, management may consider it most important to capacitate management employees who exercise leadership functions, as most of the antecedents of turnover intentions are motivated by or associated with leadership behaviours. the study revealed that managers will have a positive indirect impact on organisational retention strategies if they are selected and consciously trained to embrace transformational leadership behaviours. such behaviours are expected to have a positive influence on the organisational justice climate, as well as on employees’ perceived organisational support. the turnover intention would be low among employees who feel that they have received the necessary care and support from their leaders and organisations. we find that a good starting point for effective implementation of a retention strategy would be to train transformational leaders to develop a culture of fairness and justice in the organisation. the fairness of the manner in which rewards are distributed and procedures adopted in the decision-making process concerning well-being and career development and progression may affect the turnover intentions of employees. an organisational justice climate inspires substantial commitment and loyalty of employees to both the organisation and their leaders. limitations and recommendations for future research a methodological limitation of this study is inherent in the use of both a non-probability sampling procedure and a cross-sectional research design. the sampling procedure raises concern about the representativeness of the respondents and, by implication, the ability to generalise the results of the study. the concern with generalisability or external validity is particularly strong in quantitative research using a cross-sectional research design (bryman & bell 2011). this study should be replicated over a relatively long period of time (longitudinal design) to determine causality. future research should also extend the structural model of itq by examining the mediating effects of other variables (e.g. organisational commitment, empowerment, psychological contract, work engagement) on the relationship between transformational leadership and itq. it would also be useful to focus on occupation-specific (e.g. accountants), job category specific (e.g. middle-level managers) and sector specific (e.g. public service) in order to overcome the inherent limitations of this study. conclusion managers may take into consideration the specific turnover antecedents that were investigated in the structural model of this study when formulating strategic retention policies. the results indicated that organisations should focus on the indirect influence of transformational leadership on intention to quit through an organisational justice climate and perceived organisational support. such policies should be specifically targeted at high-performing and premium employees, rather than the entire workforce. acknowledgements the authors assume responsibility for the views canvassed in this article as their own, and not necessarily the official position of stellenbosch university or university of the witwatersrand. competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. the views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of any affiliated agency of the authors. author’s contributions o.m.s. was responsible for conceptualisation of the study and literature development, data collection, interpretation of research results, adaptation and writing of the journal article. a.e. was responsible for the construction of the study model, statistical analysis and interpretation, and writing of the journal article. references abubakar, r.a., chauhan, a. & kura, k.m., 2014, ‘turnover intention among nigerian nurses’, international journal of business and 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‘the association between corporate social responsibility reporting and firm value for south african firms’, south african journal of economic and management sciences 21(1), a2236. https://doi.org/10.4102/sajems.v21i1.2236 original research the association between corporate social responsibility reporting and firm value for south african firms riana horn, marna de klerk, charl de villiers received: 16 dec. 2017; accepted: 17 may 2018; published: 28 aug. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: corporate social responsibility (csr) disclosure is widespread among the largest companies in south africa due to the listing requirements of the johannesburg stock exchange (jse). these companies have also increasingly pursued external assurance of their csr disclosures in recent years. the increased regulation of csr disclosure and the increased rate of obtaining assurance of these disclosures motivated us to perform our study. aim: to examine the association between csr reporting, including both csr disclosure and csr assurance, and firm value of large south african companies. setting: the jse listing requirements place south africa, the setting for our study, at the forefront of corporate governance and csr reporting. method: tobin’s q is used as a measure of firm value. three measures of csr disclosure and three of csr assurance are used in this study. the measures are based on data collected by klynveld peat marwick goerdeler (kpmg) international on the csr reporting practices of large south african companies. the sample period for this study coincides with the sample period covered in the kpmg surveys conducted during 2008, 2011 and 2013. results: no significant association is found between csr disclosure and firm value. however, a significant negative association is found between csr assurance and firm value. additional analysis found that the negative association between firm value and csr assurance is more significant for companies that are not listed on the socially responsible investment (sri) index. conclusion: the results found between csr disclosure and firm value may suggest that firm value is unaffected by csr disclosures. taken together, the findings on csr assurance and firm value and the additional analysis may suggest that in south africa managers with negative csr issues are more likely to obtain assurance on their csr disclosure. the findings may be of interest to regulators when considering current and future disclosure and assurance requirements for csr reporting in south africa, as well as other parts of the world, shareholders when considering investment options, and managers when considering the benefit of certain csr reporting practices. introduction the king code of governance principles, the king report on governance (king iii) and the johannesburg securities exchange (jse) requirements place south africa at the forefront of corporate governance and corporate social responsibility (csr) reporting. the jse was the first exchange to incorporate king into the listing requirements for financial years starting on or after 01 march 2010, thereby mandating that companies either apply integrated reporting or explain non-compliance (de villiers, hsiao & maroun 2017; jse 2013a). integrated reporting entails the disclosure of both the company’s financial and sustainability (also referred to as csr) performances (dumay & dai 2017; dumay et al. 2017; king committee 2009). disclosures should consider the economic, social and environmental result of the company’s operations (king committee 2009; macias & farfan-lievano 2017; mcnally, cerbone & maroun 2017). mandatory csr reporting requirements in south africa have resulted in a 98% csr reporting rate among the 100 largest companies surveyed by klynveld peat marwick goerdeler (kpmg) during 2013 (kpmg 2013). the rate of csr reporting in 2013 is consistent with the 2011 rate of 97% but represents a considerable increase from the 2008 rate of 45% (kpmg 2011). compliance with some form of csr reporting comprising mostly non-financial information about the impact of social and environmental change and strategies employed by companies is prescribed in south africa. to manage the related risks and opportunities (de klerk, de villiers & van staden 2015; kpmg 2013), the extent and detail of these disclosures is not prescribed since it is mandated to ‘apply or explain’ (du toit, van zyl & schutte 2017; jse 2013b). therefore, even in this environment of mandated csr reporting, the ‘what’ and the ‘how much’ are still left to the discretion of management. the kpmg international survey of corporate responsibility reporting for 2013 indicates that only france and south africa are forging a mandatory approach to obtaining external assurance of the csr report. companies were mainly found to be motivated to obtain voluntary assurance to demonstrate credibility, to meet the requirements of sustainability indices, and to create possible internal value through more reliable data and better insight into csr issues (kpmg 2013). both o’dwyer and owen (2005) and park and brorson (2005) found these assurance statements to represent a managerial tool rather than enhanced credibility. the report on the kpmg international survey (2008, 2011, and 2013) indicates an increase in the 100 largest companies in south africa seeking third-party assurance of their sustainability reports from 16% in 2008 to 30% in 2011 to 43% in 2013. firm value incorporates both the firm’s future cash flow and the assessed inherent risk reflected in the discount rate (i.e. cost of capital) (de villiers & marques 2016). any potential benefit manifested as a financial consequence associated with csr can be expected to be included by market participants when they assess the firm’s future prospects and associated risks. firm value represents a measure similar to market value and is widely used as a proxy for the latter (jiao 2011). firm value highlights the incremental portion of the market price that exceeds the book value. we examine the association between csr reporting (focusing on disclosure and assurance), and the long-term expected value of the firm by employing a tobin’s q model (cahan et al. 2016). we aim to contribute to the current debate by responding to the call made by de klerk and de villiers (2012) to refine the csr measures and extend the assessment period. de klerk and de villiers (2012) point to the possibility that the effect of csr disclosure, and possibly also csr assurance, is context specific. a further possibility is that the effect is period specific. the instinctive expectation may be that the association between csr and firm value will strengthen as regulation and public awareness increase over time. however, an alternative expectation may be that the association will weaken as csr becomes regulated and routine. we incorporate more refined measures for csr disclosure and also of csr assurance, over a more recent period. to measure csr, we use survey data prepared by kpmg international, an external organisation, for three periods, namely 2008, 2011 and 2013. the survey data text is converted to quantifiable measures to determine csr. the use of the kpmg external rating (the first report was published in 1993) is considered more reliable and stable than a self-constructed disclosure index and is widely accepted in literature and business (cahan et al. 2016; de klerk & de villiers 2012; de klerk et al. 2015). we contribute to the literature in several ways. firstly, to our knowledge this is the first comprehensive analysis of the association between csr disclosure and assurance and firm value in south africa. secondly, we use data from more recent periods over an extended period, namely mid-2007 to mid-2008, mid-2010 to mid-2011, and mid-2012 to mid-2013. thirdly, we use data collected by an independent accounting firm (kpmg) to construct six measures for csr reporting. three variables measure trends in csr disclosure, and three variables measure trends in assurance of csr reports. finally, to our knowledge this is the first study conducted in south africa that additionally tests for the robustness of its findings by attempting to both control for csr performance and separating the sample into two groups: sample companies listed on the socially responsible investment (sri)1 index, and sample companies not listed on the sri index. the sri index is used as a proxy for csr performance. our results for the main analysis, as well as the additional tests, do not support our expectation of a significant association between csr disclosure and firm value, which might indicate that both the regulation of disclosure and the high rate of disclosure among companies in south africa have a limiting effect on the significant association found in previous literature. cahan et al. (2016) refer to the possibility that the informative value of csr disclosure might be reduced because the market has less information to assess the potential and risk of a company relative to its industry peers. a significant negative association is found between two of the three measures of csr assurance and firm value. the results of the additional tests suggest that the negative association between firm value and csr assurance is more significant for companies that are not listed on the sri index. the results are supported by the findings of simnett, vanstraelen and chua (2009), who indicate that the choice by companies to obtain voluntary csr assurance could be ascribed to an attempt to enhance the csr credibility of a company. the findings of our study may be of interest to regulators and the jse when considering current and future regulations, shareholders when considering investment choices, and managers considering the cost versus benefit of providing csr disclosure and csr assurance. the findings may also be of interest to regulators in other parts of the world who are considering mandating csr reporting (i.e. csr disclosure and csr assurance). the remainder of the article is structured as follows: in the ‘prior literature and development of hypotheses’ section, the existing literature on the relationship between csr reporting and the economic and financial consequences is explored and the hypotheses are developed. in the ‘sample, data, and research method’ section, details are provided regarding the sample, data sources, the measures of csr reporting, and the research method. the results are then presented, as well as a conclusion, where suggestions are made regarding possible related research in the future. prior literature and development of hypotheses background rising interest regarding the natural environment and the responsibilities of companies as corporate citizens and their economic, social and environmental performance may cause shareholders to require more accountability for environmental and social issues from the companies (management) in which they invest (de villiers & van staden 2011b; king committee 2009). csr information, as disclosed by management, can affect firm value by either enabling better prediction of future cash flow, or reducing cost of capital (clarkson et al. 2013), as it confirms a company’s commitment to communicating its long-term performance and risk management strategies (dhaliwal et al. 2011) to shareholders. a survey conducted by kamala, wingard and cronje (2016) found that 83% of the sampled users had read an environmental report in the past calendar year. csr reporting (both disclosure and assurance) provides shareholders with information that is not readily available from other sources, which allows them to assess possible strategic opportunities (de klerk et al. 2015). the extant literature generally suggests a negative association between cost of equity capital and csr (dhaliwal et al. 2011, 2014; reverte 2012). we seek to contribute by examining the anticipated value of csr reporting through testing for an association between csr reporting (both disclosure and assurance) and firm value. we use the concept of information asymmetry from the agency theory as applied in the voluntary disclosure literature (de klerk & de villiers 2012; de klerk et al. 2015). with this we examine the usefulness of management’s csr reporting in providing incremental information about companies’ risks and future performance and their management strategies thereof to shareholders to better enable them to estimate firm value in making investment decisions. agency theory posits that information asymmetry exists where there is separation of ownership (shareholders) and control (managers). we argue that the information asymmetry considerations affect the ‘what’ and the ‘how much’ csr reporting discretion of management. ownership (shareholders) information needs arguably incorporate information about the company’s csr practices to enable them to assess long-term investment opportunities. a south african survey conducted by de villiers and van staden (2010) found individual shareholders to be interested in the disclosure of environmental risks, impacts, policy, targets, subsequent performance and costs. a study performed by turyakira, venter and smith (2014) indicates a positive association between csr activities associated with the workforce, society, the market and regulation and increased competitiveness. however, a negative association was found to exist between csr activities relating to the environment and increased competitiveness (turyakira et al. 2014). shareholders may either be less able to predict future cash flow and profitability or require a higher rate of return on investment if they do not have relevant information, which affects firm value (clarkson et al. 2013). prior research exploring expected financial consequences of corporate social responsibility disclosure and hypothesis development an association between csr disclosure and firm value is expected if csr disclosure conveys incremental information about companies’ current and future environmental risks and opportunities (clarkson et al. 2013). choi, kwak and choe (2010) investigated the association between csr performance, measured by a stakeholder-weighted korea economic justice institute index, and financial performance, measured by return on equity, return on assets and tobin’s q. they found a significant positive association between their measures of financial performance and their measure of csr performance, which suggests that companies align their csr activities with the activities most valued by their primary stakeholders (choi et al. 2010). a similar study conducted in 2010, using the kld as a stakeholder score, also found a positive association with tobin’s q, driven mainly by employee relations and environmental issues (jioa 2010). jiao (2011) then examined the association between both voluntary and mandatory corporate disclosures and firm value (and stock returns) and found that the results indicate a positive association between their disclosure rating and tobin’s q (and stock returns), suggesting a sincere effort by management to communicate positive information about future earnings to stakeholders. a positive association between unexpected csr disclosure and firm value, as measured by tobin’s q, is observed in cahan et al.’s cross-country investigation (2016) of the incremental information included in csr disclosures. no association is found between expected csr disclosure and firm value. shareholders require information about the environmental risks involved in a company’s operations (al-tuwaijri, christensen & hughes 2004; de villiers & van staden 2010) and management’s response to these risks (clarkson et al. 2008; de villiers & van staden 2010) to assure them of the company’s profitability and their investment value. following agency theory, managers have an incentive to provide higher levels of csr disclosure in order to decrease the information asymmetry and increase firm value. hypothesis 1 is stated in the alternate: h1: csr disclosure levels are positively associated with firm value. the limited number of existing studies that examine the association between csr disclosure and firm value as measured by tobin’s q serves as motivation for further investigation. prior research exploring expected financial consequences of corporate social responsibility assurance and hypothesis development the 2013 kpmg survey report indicates that in 2013, 59% of the 250 largest global companies reporting csr chose to obtain external assurance of their report. this is a substantial increase from the 46% and 40% respectively of companies reporting on csr that had their reports externally assured in 2011 and 2008. the 100 companies reporting the highest revenue in south africa have also increasingly sought third-party assurance of their sustainability reports. data from the kpmg international survey (2008, 2011, and 2013) indicate that, in 2008, 16% of these companies obtained third-party assurance, with subsequent increases to 30% in 2011 and 43% in 2013. o’dwyer and owen (2005) analysed assurance statements of environmental, social, and sustainability reports to gain an understanding of the extent to which these reports increase transparency and accountability. they found that assurance statements are not used as a stakeholder accountability control, but rather as a managerial tool to make an internal assurance exercise public. in fact, interview data from a swedish study indicate that companies view third-party assurance as useful for developing internal reporting systems, but not for increasing credibility (park & brorson 2005). an international research project focusing on the content of triple bottom line (tbl) report assurance statements in europe and the united kingdom (uk) further demonstrates that uncertainty and inconsistency in current assurance practices undermine the desired transparency and accountability, and the project ultimately expresses doubt about whether assurance adds value to the tbl report (deegan, cooper & shelly 2006). a south african survey found that users ranked the improvement of the reliability of environmental reports, with specific reference to independent verification, as highly important (kamala et al. 2016). simnett et al. (2009) examined the emergent voluntary assurance of sustainability reports market and found that companies with a greater need to enhance the credibility of their sustainability reports are more likely to seek assurance. companies (and thus their managers) have a choice of whether or not to obtain third-party assurance of their csr reports. as the level of disclosure is at the discretion of managers, obtaining third-party assurance may have a limited effect on enhancing the credibility of these disclosures, as the assurance market is still plagued by inconsistencies (deegan et al. 2006). a second possibility is that obtaining assurance of the csr report is positively associated with firm value, as the market views the choice to obtain assurance as enhancing value. de villiers and van staden’s (2010) survey results indicate that 75% of shareholders in the south african study want environmental information to be audited in order to improve the reliability thereof. a third possibility is that assurance is obtained only by companies (managers) with negative csr issues, which will result in a negative association between assurance and firm value. simnett et al. (2009) found that a company’s choice to obtain voluntary csr report assurance is likely made when a company has pre-existing credibility issues. as companies (managers) that choose to obtain third-party assurance of their csr report may do so either to signal credibility to the market, or to mask credibility issues from the market, we refrain from forming an expectation regarding the direction of the association between the csr assurance measures and firm value. hypothesis 2 is stated in the null: h2: obtaining third-party assurance of the csr report is not associated with firm value. the current trend observed in the market, which shows that companies increasingly choose to obtain third-party assurance of their csr reports, justifies an investigation of the association between this emerging assurance market and firm value. by examining whether there is a positive association between csr disclosure and firm value, and whether the choice to obtain third-party assurance of the csr report is not associated with firm value, we aim to contribute a comprehensive analysis on the association between csr disclosure and assurance and firm value in south africa to the literature. sample, data, and research method sample the sample consists of the 100 largest south african companies based on revenue, as identified by the kpmg survey of corporate responsibility reporting for 2008, 2011, and 2013. we exclude eight companies from the 2008 sample, one from the 2011 sample, and four from the 2013 sample on the grounds that those companies are unlisted entities. we further exclude eight companies from the 2008 sample and seven from each of the 2011 and 2013 samples for which we are unable to obtain financial data on the mcgregor bfa database. we also exclude 14 companies from the 2008 sample, 13 from the 2011 sample, and 12 from the 2013 sample to control for the unique financial ratio characteristics of these banking and insurance companies. finally, we exclude five companies from the 2008 sample, and four each from the 2011 and 2013 samples, for which trading data is not available on the bureau van dijk orbis database. our final sample consists of 65 companies for the mid-2007 to mid-2008 sample period, 75 companies for the mid-2010 to mid-2011 sample period, and 73 companies for the mid-2012 to mid-2013 sample period. the sample periods used in our study follow the periods used in the kpmg international survey of corporate responsibility reporting for 2008, 2011, and 2013, which examines csr reporting practices (kpmg 2008, 2011, 2013). data the kpmg international survey of corporate responsibility reporting for 2008, 2011, and 2013 is used to obtain data about the csr reporting practices of the 100 largest south african companies based on revenue (kpmg 2008, 2011, 2013). kpmg performed a comprehensive study of company reporting on csr performance using only publicly available information in annual financial reports, standalone csr reports, and company websites (kpmg 2013). six measures for csr reporting (based on the kpmg database for csr) are used. three of these measure csr disclosure trends, and the remaining three measure the assurance of csr report practices. the first measure of csr disclosure (intrep) measures the level of integration of csr reporting in the annual report. we convert the level of integration of csr reporting in the annual report by awarding a score of 3 for csr reporting information that is included in both the directors’ report and a separate section of the annual report, a score of 2 for csr reporting information included only in a separate section or chapter of the annual report, a score of 1 for csr reporting information included in only the directors’ report, and a score of 0 if csr reporting is not integrated into the annual report. the second measure of csr disclosure (global reporting initiative [gri]) is an indicator variable that is set to 1 for companies using the gri guidelines, and otherwise to 0 (de klerk & de villiers 2012; de klerk et al. 2015). the gri guidelines represent the leading reporting framework for csr reporting globally, as over 78% of the top 100 companies from the 41 countries included in the survey use the gri guidelines for csr reporting (kpmg 2013). in south africa the trend continues, with 85 of the top 100 companies using the gri guidelines for csr reporting in the 2013 survey, which signifies an increase from 67% and 46% in the 2011 and 2008 surveys respectively (kpmg 2008, 2011, 2013). the third measure of csr disclosure is a composite measure (compdisc) of the extent of coverage in terms of csr information provided, taking into account both the level of integration of csr reporting information in the annual report of the company, and whether csr reporting information is provided in a standalone csr report or on the company website. the first measure of csr assurance (assdum) is an indicator variable set to 1 for companies with a formal third-party assurance statement, and otherwise to 0. the second measure of csr assurance (assscope) measures the scope of the formal assurance statement provided by the assurance provider. we convert the scope of the formal assurance statement by awarding a score of 3 to a whole-report scope, a score of 2 to a chapter scope, a score of 1 to indicators and, otherwise, a score of 0. the third measure of csr assurance is a composite measure (compass) of csr assurance practices. financial data for the sample companies were obtained from the mcgregor bfa and bureau van dijk orbis databases. research method firm value we examine whether higher levels of csr reporting are associated with expected financial consequences as reflected in the firm value. tobin’s q measures firm value and reflects the market’s assessment of risk and expected future performance (dhaliwal et al. 2011). to address hypotheses 1 and 2 regarding the association between csr disclosure or obtaining third-party assurance and firm value, we use the following tobin’s q model: qi,t = β0 + β1csri,t + β2sizei,t + β3stock_turnoveri,t + β4roai,t + β5capital_expenditurei,t + β6debti,t + β7dividendsi,t + β8intangible_assetsi,t + β9r&di,t + β10return_volatilityi,t + yr + εi,t. tobin’s q is the ratio of the market value of a firm’s assets and can be regarded as both a performance measure and a measure of information asymmetry (de villiers & van staden 2011a). q is measured as the market value of assets deflated by the book value of total assets, where the market value of assets is calculated as the sum of the book value of assets and the market value of common stock, less the book value of common stock and book value of deferred taxes (cahan et al. 2016; roll, schwartz & subrahmanyam 2009). the control variables included in the equation are consistent with those used by cahan et al. (2016), as based on prior literature (coles, daniel & naveen 2008; jiao 2011; roll et al. 2009). csr is measured as one of the csr disclosure measures (intrep, gri, and compdisc) or the csr assurance measures (assdum, assscope and compass) that are separately included in the regression. size is measured as the natural logarithm of the company’s market capitalisation. stock_turnover is calculated as the annual share turnover in the underlying stock over the applicable sample periods. roa is measured as net income deflated by total assets. capital_expenditure is measured as capital expenditure deflated by total assets. debt is measured as total debt deflated by total assets. dividends is an indicator variable set to 1 if the company paid a dividend in the applicable year, and to 0 if that is not the case. intangible_assets are measured as the difference between 1 and the ratio of net property, plant and equipment to total assets. r&d is an indicator variable set to 1 if the company’s research and development intensity (r&d deflated by total assets) is greater than the 75th percentile value of the sample companies, and otherwise to 0. return_volatility is the annualised volatility close measure over the applicable sample periods. based on hypothesis 1, we expect β1 to be positively and significantly associated with firm value for the measures of csr disclosure and, based on hypothesis 2, to not be associated with firm value for the three measures of csr assurance. we control for year fixed effects by including the variable, yr. additional analysis future cash flow and future profitability: we examine whether higher levels of csr reporting, including disclosure or obtaining third-party assurance of the csr report, are associated with realised financial consequences as reflected in future cash flow and future profitability. the examination of future cash flow and future profitability is useful for obtaining a better understanding of the firm value component driving the expected value and the future realisation of market participants’ expectations. future firm cash flow and future firm profitability reflect the consequences of current csr initiatives on actual (versus expected) future cash flow and future profitability (cahan et al. 2016). in order to explore whether csr reporting is associated with future cash flow and profitability, we regress the average operating cash flow (avecfo) and the average return on assets averoa as the dependent variable on the control variables (clarkson et al. 2013) and each of the six measures of csr reporting separately. to explore the association between csr reporting (both csr disclosure and csr assurance), and future cash flow and future profitability, we follow clarkson et al. (2013) and estimate the following regressions: avecfoi,t+1,2,3,4,5 = β0 + β1csri,t + β2cfoi,t + β3sizei,t + yr + εi,t. avecfo is measured as the average cash flow from operations one to five years ahead for the 2008 csr measures, the average cash flow from operations one to three years ahead for the 2011 csr measures, and the average cash flow from operations one year ahead for the 2013 csr measures. csr is measured and included as discussed in the ‘firm value’ section. in the above regression, when the csr assurance measures are separately included as csr, we address the possibility that disclosure may have a significant effect on assurance by including gri and compdisc as control variables for disclosure. cfo is measured as operating cash flow scaled by total assets. size is measured as the log of the company’s market value at the end of the applicable financial year. we include indicator variables to control for the year-fixed effects (yr). averoai,t+1,2,3,4,5 = β0 + β1csri,t + β2roai,t + β3sizei,t + yr + εi,t. averoa is measured as the average return on assets one to five years ahead for the 2008 csr measures, the average return on assets one to three years ahead for the 2011 csr measures, and the average return on assets one year ahead for the 2013 csr measures. csr is measured and included as discussed in the ‘firm value’ section. roa is measured as the net operating income divided by total assets at the beginning of the year. size and the indicator variables are measured and included as discussed above. sensitive industries: following the example set by de klerk et al. (2015), we examine whether there is a difference between companies in environmentally sensitive industries and companies in other industries with regard to the association between csr reporting, including both csr disclosure and csr assurance, and firm value. an indicator variable for environmentally sensitive industries (es) and an interaction variable between csr reporting and environmentally sensitive industries (es*csr) are incorporated. the indicator variable (es) is set to 1 if a company operates in an environmentally sensitive industry, and otherwise to 0. es and es*csr are not deflated as they are regarded as independent of firm size. we expect the association on the interaction variable to differ significantly between companies in environmentally sensitive industries and companies in other industries. control for socially responsible investment index: we attempt to control for the possibility that shareholders know the financial and environmental performance of the company and that the association previously tested between csr reporting and firm value is actually due to the company’s csr performance (clarkson et al. 2013). the clarkson et al. (2013) study uses the toxics releases inventory (tri) as a proxy for environmental performance. since no such index exists in south africa, we use the sri index as a proxy for csr performance (jordaan, de klerk & de villiers 2018). we attempt to control companies’ csr performance by including the sri index rating as a control variable and performing the main analysis regressions on a segregated sample. the control variable (sri) is an indicator variable that is set to 1 for companies listed on the sri index, and otherwise to 0. the segregated sample analysis is performed by dividing the total sample into two separate samples based on the company’s inclusion in the sri index. results descriptive statistics table 1 depicts the overall descriptive statistics in terms of the number of companies that use the gri guidelines, that provide third-party assurance statements, and that are included in the sri index. the percentage of companies that use the gri guidelines has increased from 43% of the sample companies in 2008 to 65% in 2011 and 83% in 2013. the percentage of companies that provide a formal third-party assurance statement has also increased significantly from only 13% of the sample companies in 2008 to 27% in 2011 and 38% in 2013. the number of sample companies categorised as environmentally sensitive (es) has remained comparable in the different sample periods (de villiers, naiker & van staden 2011). table 2 depicts the descriptive statistics for the variables included in the equations. table 1: descriptive statistics for the sample. table 2: descriptive statistics for regression models. the dependent variable in table 2 is tobin’s q with the variables of interest in table 2 being the csr measures for csr disclosure and csr assurance. the control variables in table 2 are: (1) size, natural logarithm of the company’s market capitalisation; (2) stock_turnover, annual share turnover in the underlying stock over the applicable sample periods; (3) roa, net income deflated by total assets; (4) capital_expenditure, capital expenditure deflated by total assets; (5) debt, total debt deflated by total assets; (6) dividends, indicator if the company paid a dividend in the applicable year; (7) intangible_assets, difference between 1 and the ratio of net property, plant and equipment to total assets; (8) r&d, indicator if the company’s research and development intensity – r&d deflated by total assets – is greater than the 75th percentile value of the sample companies; and (8) return_volatility, annualised volatility close measure over the applicable sample periods. regression results for firm value we expect the measures of csr disclosure to be positively and significantly associated with firm value (h1), while no association is expected between csr assurance and firm value. the regression results for tobin’s q are presented in table 3 (csr disclosure) and table 4 (csr assurance). table 3: regression results for firm value – corporate social responsibility disclosure measures. table 4: regression results for firm value – corporate social responsibility assurance measures controlling for disclosure. the dependent variable in table 3 and 4 is q which is tobin’s q measured as the market value of assets (sum of the book value of assets and the market value of common stock, less the book value of common stock and book value of deferred taxes) deflated by the book value of total assets. csr measures csr disclosure as intrep, gri, or compdisc, separately included in the regression. size is measured as the natural logarithm of the company’s market capitalisation. stock_turnover is calculated as the annual share turnover in the underlying stock over the applicable sample periods. roa is measured as net income deflated by total assets. capital_expenditure is measured as capital expenditure deflated by total assets. debt is measured as total debt deflated by total assets. dividends is an indicator variable set to 1 if the company paid a dividend in the applicable year, and to 0 if that is not the case. intangible_assets are measured as the difference between 1 and the ratio of net property, plant and equipment to total assets. r&d is an indicator variable set to 1 if the company’s research and development intensity (r&d deflated by total assets) is greater than the 75th percentile value of the sample companies, and otherwise to 0. return_volatility is the annualised volatility close measure over the applicable sample periods. year fixed effects are controlled for by including the variable, yr. the significance of table 3 and 4 is two-tailed, except for the variables of interest, which are one-tailed. intrep, gri and compdisc are positively and not significantly associated with firm value. the insignificant result for the csr disclosure measures suggests that firm value is unaffected by csr disclosures, consistent with these csr disclosures having become regulated and routine and providing limited incremental information beyond other companies’ csr disclosures. the results are in line with the finding of cahan et al. (2016) on the expected portion of csr disclosures. we find the coefficient on size and return on assets are positively signed and significant at the 1% level. this indicates that firm value is significantly affected by the size and profitability of the company. the csr assurance measures are negatively associated with firm value. the association of two of the three csr assurance measures, namely assdum and compass, are significant at the 5% level. the significant negative result for these csr assurance measures suggests that managers may choose to obtain assurance of the sustainability report in an attempt to enhance the csr credibility of the company, consistent with the choice to provide csr assurance being positively associated with the need to enhance the credibility of the csr report. the results are in line with the finding of simnett et al. (2009) that companies with pre-existing issues with credibility are more likely to obtain csr assurance. similar to the regression results for the csr disclosure measures, we find that firm value is significantly affected by the size and profitability of the company. the variance inflation factors (vifs) of all the variables included in the main analysis range from 1.228 to 6.691, which are well below the standard benchmark of 10 (de villiers & marques 2016). in summary, the results suggest that there is no significant association between csr disclosure and firm value. the association between assdum and compass and firm value is negative and significant. results of additional analysis regression results for future cash flow and future profitability the untabulated results suggest that there is no significant association between csr reporting and future cash flow, as intrep, gri, and compdisc are not significantly associated with future cash flow and the coefficients for the csr assurance measures are not significantly associated with future cash flow. csr disclosure is not significantly associated with future profitability. the measures of csr assurance are negatively associated with future profitability in period t+1, t+4, and t+5. the negative association for assdum is significant at the 10% and 5% levels for periods t+2 and t+3 respectively, assscope is significant at the 10% level for both periods t+1 and t+3, and compass is significant at the 10% and 5% levels for periods t+2 and t+3 respectively. in summary, the results suggest that while there is no significant association between csr disclosure and future profitability, the three csr assurance measures do have a significantly negative association with future profitability after three years (and some of the prior years). sensitive industries csr disclosure is not found to differ significantly between companies in environmentally sensitive industries and companies in other industries. however, in terms of csr assurance, the coefficient for the interaction term (es*csr) is negative and significant at the 10% level (assdum is significant at 5%), indicating a significant difference between companies in environmentally sensitive industries and those in other industries. the results are untabulated. control for socially responsible investment index the untabulated results for the analysis of firm value when sri is included as a control for csr performance remain qualitatively similar for the csr disclosure and assurance measures. finally, the results for the analysis of firm value when the sample is segregated indicate that the association between firm value and the csr disclosure measures is not significant for both sri index-listed and non-listed companies, with the exception of a positive association between gri and firm value for companies listed on the sri index, which is significant at the 10% level. the csr assurance measures remain negatively associated with firm value for both sri index-listed and non-listed companies. the association between assdum and compass and firm value is significant at the 10% level for companies listed on the sri index. the association between assdum, and compass and firm value is significant at between 1% and 5% for companies not listed on the sri index. conclusion we conduct an analysis to evaluate whether higher levels of csr reporting are associated with firm value (using tobin’s q as measure of firm value) of large south african companies. we argue that managers have an incentive to provide higher levels of csr disclosure to enable better prediction of future cash flow and future profitability associated with the future competitive advantage obtained through their csr activities (clarkson et al. 2013). we further argue that increased csr disclosure will reduce information asymmetries between managers and shareholders, which will increase firm value. therefore, csr disclosure levels are expected to be positively associated with firm value (h1). companies (managers) may choose to obtain third-party assurance of their csr reports either to signal credibility to the market, or to mask credibility issues from the market. inconsistencies in the assurance market may; however, limit the effect assurance has on enhancing the credibility of the disclosure (deegan et al. 2006). therefore, no expectations are formed with regard to the direction of the association between the csr assurance measures and firm value (h2). we do not find evidence of a significant association between csr disclosure and firm value. the results, therefore, do not support h1, which may indicate a weakening of the association between csr disclosures and financial consequences as csr disclosure is becoming more regulated and routine and supports the findings of marcia, maroun and callaghan (2015) that corporate responsibility reporting may not add value in a south african setting. the results are robust when controlling for companies on the sri index. the regression results of h2 find the association between assdum and compass and firm value to be significantly negative. the negative association between firm value and csr assurance is more significant for companies not listed on the sri index. given the limitation of the relatively small group of companies that provide csr assurance during the sample period, the results suggest that south african companies (managers) with negative csr issues are more likely to obtain and provide assurance on their csr disclosure. the results can potentially be explained by the findings of simnett et al. (2009). simnett et al. (2009) conclude that the choice to provide csr assurance is positively associated with the need to enhance the credibility of the csr report, and likely to be obtained when companies have pre-existing issues with credibility. we contribute to the literature by being, to our knowledge, the first researchers to examine the association between firm value and csr disclosure and csr assurance in south africa. south africa provides an ideal setting in which to explore and gain an understanding of csr practices, as it is at the forefront of mandating both csr disclosure and the assurance thereof. our separate investigations of the trends in csr disclosure and csr assurance contribute to the literature by addressing the possible contrasting effects of these separate management choices. we further contribute by investigating whether the association with firm value differs between companies listed on the sri index and companies not listed on the sri index. our research findings may be of interest to regulators in other countries who are considering legislation around csr reporting. our results are indicative of a possible weakening of the association between csr disclosures and firm value, which contrasts with the mostly positive association documented in the relevant literature (cahan et al. 2016; jiao 2010, 2011). the significant negative association found between csr assurance and firm value may further interest regulators when considering mandating assurance of the csr report. it may not be possible to generalise our study to smaller companies and companies in countries where csr reporting is not mandated. regulatory requirements potentially affect both managers’ decision to disclose csr and obtain assurance of the csr report, and stakeholders’ assessment thereof. in light of the small sample size, the results for obtaining assurance of the csr report should be interpreted with caution. our csr reporting measures have a limited scope and do not represent comprehensive measures of csr reporting, as only certain aspects of disclosure and assurance are included. furthermore, our study does not test the association between csr reporting and the financial consequences separately for the sample years. future research could examine the period effect and the change, if any, in the association between firm value and csr reporting over time, in order to gain an understanding of the effect of increased public awareness of corporate responsibility and the effect of regulation on the communication and assurance of companies’ csr activities. a continuation of the investigation of the association between assurance of the csr report and the financial consequences thereof on a larger sample and across different settings could be another avenue for future research. the increasing trend for companies to provide csr assurance may result in more archival data becoming available and warrant an analysis of whether the level and the scope of csr assurance 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comparison’, the accounting review 84(3), 937–967. https://doi.org/10.2308/accr.2009.84.3.937 turyakira, p., venter, e. & smith, e., 2014, ‘the impact of corporate social responsibility factors on the competitiveness of small and medium-sized enterprises’, south african journal of economic and management sciences 17(1), 157–172. https://doi.org/10.4102/sajems.v17i2.443 footnote 1. the johannesburg stock exchange (jse) introduced the jse socially responsible investment (sri) index in 2004 to elevate corporate practices that are sustainable and transparent (jse 2014). companies included on the ftse/jse all share index are assessed annually against environmental, social and governance criteria for inclusion on the sri index (jse 2014). abstract introduction literature review for thematic content analysis strategy as practice and process research methodology for thematic content analysis thematic content analysis of strategy as practice and competitive intelligence conceptualised framework acknowledgements references about the author(s) rachel maritz department of business management, faculty of economic and management sciences, university of pretoria, south africa adeline du toit department of business management, faculty of economic and management sciences, university of pretoria, south africa citation maritz, r. & du toit, a., 2018, ‘the practice turn within strategy: competitive intelligence as integrating practice’, south african journal of economic and management sciences 21(1), a2059. https://doi.org/10.4102/sajems.v21i1.2059 original research the practice turn within strategy: competitive intelligence as integrating practice rachel maritz, adeline du toit received: 16 aug. 2017; accepted: 12 feb. 2018; published: 25 apr. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background and aim: this article investigated the positioning of competitive intelligence within the field of strategy. methods: publications on strategy and competitive intelligence were reviewed through thematic content analysis based on an extended literature review to determine their respective contents and how strategy as practice related to the crystallised competitive intelligence themes. results: the research demonstrated that strategy and competitive intelligence are inextricably interwoven. competitive intelligence was shown to be not merely an activity or sequence of activities within the broader strategic management process, but a significant strategic practice. conclusion: we argued, based on a comprehensive literature review, that competitive intelligence is an integral practice within strategy that should be explored further for its contribution to emergent and deliberate strategies and the linkage between intra-organisational and extra-organisational activities. we proposed a framework to position competitive intelligence within strategy as practice and in relation to the process view of strategy. the conceptualised framework contributes to the corpus of strategy research as it formalised competitive intelligence as a critical part in the thinking about and the practice of strategy. it moved competitive intelligence from a position on the periphery of strategic management literature, where it was regarded as a mere activity, to an integral practice of strategy to be recognised by strategy scholars and worthy of further research. introduction the field of competitive intelligence attracts the attention of scholars worldwide. competitive intelligence is regarded as a system of environmental scanning which integrates the knowledge of everyone in a company (calof & wright 2008:717). competitive intelligence has evolved from being traditionally associated with knowledge management and market research (adidam, banerjee & shukla 2012:243; pellissier & kruger 2011) to a more generalised discipline that focuses on gathering and analysing intelligence necessary for strategic planning (adidam et al. 2012:243; porter 1985). it has furthermore attracted interest for its commercial application as well as its importance as an academic field (adidam et al. 2012; calof & wright 2008). strategy, on the other hand, is regarded as a ‘master concept’ within contemporary organisations (carter, clegg & kornberger 2008:85), recognised in business schools where strategy is essential for the ‘rite of passage’ in becoming a strategist and understanding the essence of the organisation. carter et al. (2008:87) therefore urge scholars and researchers to engage with strategy in a manner that not only contributes to its corpus, but is also critical and questioning. strategic management is seen as a subfield within the overarching field of strategy, with a managerial orientation focusing on the sequential process from the inception of a vision and formulation of objectives to the implementation of detailed strategic plans (shrivastava 1986). strategy as practice claims a space in strategy research as an emerging approach, one that draws on alternative approaches but also stakes out new ground in joining academics and practitioners (whittington 1996:731). strategy as practice shares the strategy research arena with process research (langley 2007:272). langley regards it as important to situate process thinking with respect to the subfield of ‘strategy process research’ and also with respect to the growing ‘strategy as practice’ movement. since process cannot be separated from practice (carter et al. 2008:84), a ‘processual view’ of strategy as well as the ‘strategy as practice’ perspective will be adopted for this article. in this regard, strategy process could play out on a continuum of strategising approaches ranging from a rational, deliberate process where formulation and implementation are formalised, to an emergent approach where strategies evolve outside of a formalised process (maritz 2008; mintzberg 1994). whittington (2006:613) calls for a more integrated view on strategy as an intra-organisational as well as extra-organisational activity to advance research from the strategy as practice perspective. in this regard an appeal is made for strategy research to investigate both organisation-specific practices that shape how strategising takes place within organisations (such as routines and operating procedures) and practices that occur on an extra-organisational level (such as industry recipes that guide organisational behaviour from an external perspective) (whittington 2006:616). the authors make a specific contribution in this regard by studying competitive intelligence for its role in integrating intraand extra-organisational intelligence through systematic environmental scanning (calof & wright 2008:717). the contribution of this article lies in linking competitive intelligence and strategy in such a way that it adds to the corpus of strategy (carter et al. 2008). we set out to position competitive intelligence within strategy as practice and in relation to the process view of strategy. this integration of two seemingly separate areas of management is important in organisations as it draws attention to the process of strategic decision-making as both competitive intelligence and strategy focus on conceiving an actionable strategic plan that could lead the organisation to improved performance (adidam et al. 2012; porter 1985; rouach & santi 2001). strategy as practice as an emergent research approach within the field of strategy focuses not only on strategy as an academic construct but also on the practice of strategy and general application of strategy in business (whittington 1996). the same is true for competitive intelligence, which has wide commercial applicability with a strong practitioners’ focus (global intelligence alliance 2007). as such we explain the relationship between strategy as practice (with its emphasis on the process of strategy) and competitive intelligence, which should illuminate the marriage between practice and academic research as well as afford competitive intelligence its rightful place as critical practice inside strategy and not on the periphery. despite the seeming similarities between the field of competitive intelligence and the field of strategy (especially with regard to strategy formation/strategising), surprisingly few studies have explicitly examined this relationship – a gap that this article addresses. this article will also show that competitive intelligence is an integrating practice that unites the bifurcation between intraand extra-organisational activities. to achieve the purpose of this article, a comprehensive literature review making use of thematic content analysis and focusing on competitive intelligence and strategy is presented. following the literature review, our methodology is described. we conclude with discussions on our findings, our proposed framework, and conclusion and limitations, which include some recommendations on possible future research. literature review for thematic content analysis competitive intelligence similar to many new study fields where coalescence around the domain and scope has not occurred, there are numerous definitions of competitive intelligence. it would seem that there is no commonly accepted term for referring to internal and external intelligence required for business decision-making. market (or marketing) intelligence, competitive intelligence, business intelligence and other terms are all used at various times to describe more or less the same concept (venter & tustin 2009:89). according to campos, rubio and quintero (2014), strategic intelligence is used to manage risks in the external environment as an early warning to management. pellissier and nenzhelele (2013) define competitive intelligence as the gathering of actionable information about the competitive environment for decision-making. it can be regarded as a system for environmental scanning that integrates the knowledge of all organisational members and encompasses marketing, structural, strategic and other organisational elements (calof & wright 2008:717). within this system there are very specific activities at play, namely the gathering, analysing and distributing of intelligence for the development of an effective business strategy (du toit 2015). xu, liao and song (2011) take this definition further by focusing on the role of management as strategic decision-makers to whom the competitive intelligence practitioners should communicate competitive intelligence that was gathered from various sources, analysed and interpreted. the concept has been studied under various labels since 1960 (adidam et al. 2012:243). since then, several publications, including books and academic articles, have been published on marketing intelligence (adidam et al. 2012; solberg søilen 2010). the term ‘environmental scanning’, which focused on how executives ‘scan’ their organisation’s environment, has been used as part of the research on marketing intelligence and market research (adidam et al. 2012:243; calof & wright 2008). another such label was that of ‘competitor analysis’, associated with porter (1985). competitive intelligence was seen to focus on the gathering of competitive data to be used for decision-making (begg & du toit 2007; david 2011; fatti & du toit 2013; kalinowski & maag 2012; kühn 2012; pellissier & kruger 2011; saayman et al. 2008; strain 2013). it is clear from literature that competitive intelligence has grown in prominence since the early 1980s and a number of works on competitive intelligence have appeared, suggesting that competitive intelligence is a separate function in an organisation and a separate subject field (fleisher & bensoussan 2007; kühn 2012). competitive intelligence has developed as a distinct field, and the activities have come to serve all business functions (adidam et al. 2012:243). porter (1980) reported that while companies were carrying this activity out informally, in his opinion this was nowhere near sufficient. he advocated the need for a structured intelligence process in order to continuously and systematically identify business opportunities and threats. porter’s work on strategic management and competitiveness created the background for the development of competitive intelligence as a subject field (porter 1990; viviers, saayman & muller 2005b:578). this is especially important for the emergence of competitive intelligence as a generalised subject field that can contribute to the expansion of the field of strategy as a critical decision-making function within the organisation (adidam et al. 2012:243; carter et al. 2008; sewdass & du toit 2014). during the 1990s, competitive intelligence’s growth was fast paced, but areas such as competitive analysis and its dissemination received less attention than others (du toit & muller 2005:321). the works of campos et al. (2014), kühn (2012), and pellissier and kruger (2011) emphasised the role of competitive intelligence as a system of activities within strategic management focused on providing actionable intelligence for management decision-making. research highlighted that individual departments do not share information as part of the strategy formation process within the broader strategic management process (calof, marcoux & robinson 2010; david 2011; kalinowski & maag 2012). this view regards strategic management and competitive intelligence as two separate concepts that are competing for prominence in the organisation. in this article, the authors suggest that competitive intelligence should be seen as an integrative practice within strategy as practice. some research has the business organisation at centre stage and considers competitive intelligence from the perspective of strategic management (cuyvers et al. 2008; saayman et al. 2008). this vein of research focuses specifically on the tasks of a strategic manager to ensure that an organisation achieves a competitive advantage. cuyvers et al. (2008:85) and saayman et al. (2008:384) see competitive intelligence as synonymous with business intelligence. according to these authors, competitive intelligence emanates from competitors, customers, suppliers, technologies, environmental intelligence and potential business relationships. this line of research regards competitive intelligence as a critical activity in formulating a strategy that is based on actionable intelligence, but its role as an overarching practice that integrates micro-level activities is not investigated (cuyvers et al. 2008; saayman et al. 2008). competitive intelligence is mostly seen by these authors as a tool in knowledge management and business intelligence and as such is regarded as an activity of tactical nature instead of a strategic practice. some authors make a case for the integration between intra-organisational intelligence and extra-organisational intelligence emanating from the social structures of the industry in which the organisation is embedded. the focus in these articles is on the influence of external environmental changes on the competitiveness of the organisation and the need to integrate external environmental information with internal business information for planning purposes (begg & du toit 2007; calof et al. 2010). this vein of research provides insight into the integrating role of competitive intelligence between extra-organisational and intra-organisational activities but does not explicitly delineate this relationship (fahey 2007). it does suggest, however, a greater role for competitive intelligence to integrate the strategy process and enhance the practice of strategy. the research presented in this article serves to highlight the importance of competitive intelligence, not only as an activity within the business functions but as a practice that integrates a variety of activities and contributes to a well-informed, insightful, future-oriented strategy in a significant way. our research will show that competitive intelligence enhances the strategy process, not only as a set of separate activities but also as a practice within systematic strategy-making that integrates individual activities. this article will furthermore focus on competitive intelligence from a strategy as practice perspective and will not regard competitive intelligence as an isolated system of environmental scanning, but rather as a high-level strategic practice integrating the strategy process through activities relating to the gathering and interpreting of intelligence from both intraand extra-organisational sources. however, the article will provide a new perspective not previously discussed in competitive intelligence articles, namely the relationship between competitive intelligence and the practice of strategy. the marriage between process and practice in this research fills a research gap, contributes to the strategy as practice research domain (langley 2007:272) and contributes to the research agenda in terms of taking a more integrated view on competitive intelligence as an intraand extra-organisational practice (whittington 2006:613). strategic management, strategy and strategising the literature review on strategic management, strategy and strategising establishes the research framework within which to position and conceptualise competitive intelligence. whittington (1996:731) claims that the field of strategy research has never been as richly diverse as today, nor as crowded with competing theories. according to nag, hambrick and chen (2007:935), strategic management represents a case of an academic field whose consensual meaning might be expected to be fragile, even lacking, and asking strategic management scholars to define the field might elicit an array of responses. however, despite the seeming fragmentation, nag et al. (2007:936) believe that the field still has a collective identity and distinctiveness due to a strong implicit consensus about the essence of the field, even though there may be ambiguity about its formal definition. strategic management has always been successful both in practice and as the research field. nag et al. (2007:952) conclude (based on a distinctive strategy lexicon in 447 strategic management articles, appearing in major management journals) that there is general consensus on the essence of strategic management. nag et al. (2007) suggest the following definition as portraying the essence of strategic management: the field of strategic management deals with the major intended and emergent initiatives taken by general managers on behalf of owners, involving utilization of resources, to enhance performance of firms in their external environments. (p. 942) the above definition is especially important to this study for the reference to ‘intended and emergent’ initiatives in the process of strategising. the reference to the internal resources and initiatives/activities as a way to enhance organisational performance within external environments is also important as our research suggests that competitive intelligence plays an integrative role in this regard. research in strategy has traditionally been divided into the content and process tradition (furrer, thomas & goussevskaia 2007; hilse & nicolai 2004:372). content research concerns itself with the linkage between performance and market position, resource provision and a host of organisational attributes. process research, on the other hand, examines the sequential strategic management process, planning methods as well as the traditional strategic management cycle (lechner & mueller-stewens 2002). from the processual perspective, strategy research is essentially concerned with choice processes (strategic decision-making) and implementation processes (strategic change) (pettigrew, ferlie & mckee 1992). in academic literature, strategy process plays out in a dichotomy of processes of which one extreme is the deliberate planning or rational approach to strategising and the other is the emergent approach to strategising (brews & hunt 1999; mintzberg 1985, 1994; pretorius & maritz 2011:25). pettigrew et al. (1992:17) describe strategy in terms of process that does not unfold according to ‘neat logic’ of the more traditional economic strategy research associated with scholars such as ansoff (1965, 1994) with his seminal work on strategic management (clegg, kornberger & pitsis 2011:137). here it is important to highlight the distinction between emergent and deliberate processes. deliberate process is concerned with a rational process of strategy formulation, implementation and evaluation associated with strategy design, positioning and analysis (mintzberg 1994; porter 1980; pretorius & maritz 2011:25). the emergent approach to strategy is associated with integration between formulation and implementation, where the two phases are not necessarily separated and strategies evolve from day-to-day business activities (brews & hunt 1999; mintzberg 1994; pretorius & maritz 2011:25). according to farjoun (2007:198), organisations should base their strategies on emergent strategy (mintzberg 1994) and simple rules rather than on the more deliberate, structural approach comprising the positioning model and the resource-based view (porter 1980) in order to stay more dynamic and be flexible to adjust to required change in their markets. the deliberate approach has been institutionalised in academia and business and remains the dominant approach to strategic thinking – scan the environment, assess your strengths and weaknesses, formulate the strategy, and then go on to secure its implementation (kay, mckiernan & faulkner 2006). however, this approach has been challenged for its inflexibility and its inability (unlike the emergent approach) to incorporate learning into the strategy process and adjust to dynamic industries (liedtka 2001). szulanski, porac and doz (2005:xiii) attribute the ‘enduring scholarly interest in the process of strategy making’ to ‘the abiding assumption that some ways of strategizing are more efficacious than others, and thus lead to higher firm performance in the long run; higher than luck alone would bring’. it is therefore not surprising that ‘the quest to uncover stable principles of good strategy making has attracted much support of interest over the years’ (szulanski et al. 2005:xiii). finally, strategy as practice has grown as a research field with a new emphasis on organisational theory and strategic management (vaara & durand 2012). strategy as practice has more recent origins, emerging out of a reaction against prevailing assumptions of economic rationality (johnson et al. 2007; johnson, melin & whittington 2003; suddaby, seidl & lê 2013:330). these economic views of strategic planning depict an idealised ‘rational actor myth’ of strategic decision-making without fully attending to the complex and often convoluted day-to-day processes of decision-making or decision-makers (jarzabkowski, balogun & seidl 2007). the emergence of strategy as practice is in line with the more processual understanding of organisation and management (suddaby et al. 2013:331). strategy as practice and process in order to provide an analytical framework in which competitive intelligence can fit as part of strategy, the authors focus on the work of scholars who suggest understanding strategy as a practice and process. strategy as practice provides further analyses of microand everyday activities that constitute the ‘labour of strategy’ (clegg et al. 2011:137; jarzabkowski 2004), focusing on praxis, practitioners and practices (jarzabkowski et al. 2007; whittington 2006). strategy as practice literature tends to use the verb (strategising) rather than noun (strategy). langley (2007:275) is of the opinion that changing strategy, the noun, into strategising, the verb, reflects the emphasis on a process within strategy as practice research. movement is thus added to a relatively static concept that is linked to the action of sense-giving and sense-making of strategy (rouleau 2005). this heralds a shift in focus to participation on micro-organisational level and how participants take part in activities that contribute to strategising. praxis refers to the sheer labour of strategy, the flow of activities such as meeting, calculating, investigating and presenting through which strategy is made. practices involve the various routines, discourses, concepts and technologies through which this strategy labour is made possible – not only those that form part of strategy reviews, but also those embedded in consulting tools (porter’s analysis, hypothesis testing, etc.) and in more material artefacts (powerpoint, flip-charts, etc.). the key strategic practices are the formal operating procedures involved in the direction setting, resource allocation, and monitoring and control (jarzabkowski 2003:23). strategy practitioners are defined widely to include both those directly involved in making strategy (managers and consultants) and those with indirect influence (policy-makers, media, business schools who shape legitimate praxis and practitioners) (jarzabkowski & wittington 2008:101). whittington (2006:620) explains that practices play out on many levels. at one level, practices might be organisation-specific, embodied in the routines, operating procedures and cultures that shape how strategising takes place in the organisation. however, practices can occur on an extra-organisational level as well. these are practices that derive from the larger social fields or systems in which an organisation is embedded (such as appropriate strategic behaviour set by industry recipes). at a still higher level, there are practices of whole societies – societal practices that inform norms of appropriate strategic scale, structure, scope and inform legitimate ways of developing strategy. this is where competitive intelligence as a system of environmental scanning which integrates the knowledge of everyone in the organisation (calof & wright 2008:717) and involves activities of competitor analysis (ghoshal & westney 1991) could play an integrative role by bringing together extra-organisational and intra-organisational intelligence to inform actionable strategies. research in the field of strategic management has evolved from a sole focus on process (langley 2007) to the micro-organisational focus of strategy as practice (jarzabkowski 2003; johnson et al. 2007). it is clear from the literature that strategy as practice cannot be divorced from the process of strategy (farjoun 2007; johnson et al. 2007; langley 2007). langley (2007:273) refers to process as the elephant in the room, meaning that process cannot be ignored within the practice perspective. it is also important to situate strategy as practice within the subfield of strategy process research. the article expands on this research by situating competitive intelligence within the overlap of strategy practice and strategy process research. it does this in order to provide a theoretical frame for positioning competitive intelligence and seeking a logical and meaningful place for competitive intelligence within the strategy research field, emphasising its rightful role in the strategy domain. from the above account of research in the field of strategy, the following key linkages with competitive intelligence become clear (figure 1). figure 1: key linkages between strategy process, strategy as practice and competitive intelligence. the key linkages have been crystallised from the literature review and illustrate a twofold focus, namely considering strategy as practice as the overarching research paradigm, but also regarding strategy process as an inseparable guide to organise and link competitive intelligence activities/praxis (thompson et al. 2016:20; carter et al. 2008:90): the focus on strategy process provides a contextual structure within which competitive intelligence can be positioned. competitive intelligence activities are not depicted separately in this figure as it will be organised and specifically linked to themes and topics in the content analysis of the extended literature review. research has focused on a sequential and causal process of decision-making (dameron & torset 2014). competitive intelligence research has likewise emphasised the value of competitive activities for strategic decision-making, although not explicitly relating it to the strategic management process, suggesting a key linkage (begg & du toit 2007; david 2011; fatti & du toit 2013; kalinowski & maag 2012; kühn 2012; pellissier & kruger 2011; saayman et al. 2008; strain 2013). in figure 1, the deliberate strategy has been illustrated as a sequential step-by-step process organised according to strategy-making and execution. as part of strategy process, the continuum of emergent and deliberate approaches to strategising provides further structure to our eventual analysis. where the emergent strategy relies more on current contextual competitive intelligence to evolve, the deliberate strategy uses competitive intelligence in a neat, logical process of strategic exploration (brews & hunt 1999; mintzberg 1994; pretorius & maritz 2011). in figure 1, the emergent process is depicted below and the influence of evolving strategies on every step of the deliberate process is indicated by arrows. strategy as practice provides the framing context for competitive intelligence with its focus on micro-organisational practices and praxis. it is also significant that practices can play out on extraand intra-organisational levels (whittington 2006). in figure 1, the strategy as practice research lens is illustrated as the context within which the strategy processes are situated and which informs the activities contextually. the extra-organisational level is shown as surrounding the organisational strategy processes and the intra-organisational level is indicated by means of a patterned line. this level functions within the organisational environment. finally, the belief that strategy can lead to higher performance levels (szulanki et al. 2005) makes the significance of linking competitive intelligence to strategy all the more evident. research methodology for thematic content analysis the research question can be formulated as follows: what is the position of competitive intelligence within the field of strategy? to answer the research question, the authors employed a thematic content analysis based on an extended literature review. thematic content analysis is described as an independent qualitative descriptive approach and as a ‘method for identifying, analysing and reporting patterns (themes) within data’ (braun & clarke 2006:76). thematic analysis involves searching across data, in this case research publications, to find repeated patterns of meaning (braun & clarke 2006:80). in this instance, the authors conducted the analysis to position well-researched and well-known competitive intelligence activities within the strategy as practice research paradigm as well as within the well-established process of strategic management. the authors set out to discover overarching themes that correspond with the process of strategic management and can be categorised as either praxis or practices within the framework of strategy as practice. according to elo et al. (2014:1), thematic content analysis and processes involve the phases of preparation, organisation and reporting of the results. in line with these three phases, the authors have used the following process in conducting the analysis: preparation: the data collection method followed the authors examined peer-reviewed strategic management and competitive intelligence articles in the database abi/inform published between 2004 and 2016 and considered the following terms: business as strategy, business intelligence, competitive intelligence, competitor intelligence, marketing intelligence, strategic intelligence, strategic management, strategy as practice and technological intelligence. these terms were published in the title, abstract or subject fields of abi/inform. the authors focused on publications published between 2004 and 2016, to ensure research impact, noting cooper and schindler’s (2014) guideline that at least five years’ research should be used for representative analysis. an extensive literature review was conducted to identify publications on strategic management, strategy as practice and competitive intelligence. fifty strategic management and strategy as practice and 45 competitive intelligence publications were identified. the authors used the following inclusion criteria for publications: publications reporting on the content of strategic management, strategy as practice or competitive intelligence. publications reporting on the practices (activities) of strategic management, strategy as practice or competitive intelligence. publications reporting on what strategic managers or competitive intelligence professionals do. publications reporting on practitioners of strategy or competitive intelligence. publications reporting on the origin/evolution/future of the concepts strategic management, strategy as practice or competitive intelligence. organisation: abstraction of meaning through the emergence of themes during the organisation of data phase, the authors analysed the documents and focused on conceptualisation where theories, models and concepts were explored (leedy & ormrod 2013). main issues explored in the articles were grouped. these concepts were written down, connected with lines, grouped, regrouped and explained. specific competitive intelligence topics emerged. the topics were also evaluated for their contribution to either the deliberate strategising approach or the emergent strategising approach. the authors then critically discussed and interpreted the topics that emerged, explored the themes for representativeness and subsequently evaluated the positioning of the themes within strategy as practice and the process of strategy (elo et al. 2014:5). these topics were then grouped into overarching themes and organised according to the strategic process steps as depicted by kay et al. (2006) and strategy as practice, with higher-level practices and associated lower-level praxis. reporting: making connections between data by positioning the themes within a framework the final phase of our thematic content analysis was focused on deducing meaning from the themes that emerged by evaluating them within the context of strategy as practice and the strategic process. the focus was on developing a framework to position competitive intelligence within the strategy as practice and process theory. an integrated framework was also compiled, illustrating the integration of competitive intelligence with strategy as practice in the process of strategising. the framework and findings are discussed in more detail below. thematic content analysis of strategy as practice and competitive intelligence when reviewing the literature on competitive intelligence, it became apparent that some authors assume that competitive intelligence is a means of strategic management to improve competitiveness (de pelsmacker et al. 2005; du toit 2013:31; pellissier & kruger 2011). different competencies are required for various competitive intelligence roles and responsibilities (du toit 2013; pellissier & kruger 2011; strauss & du toit 2010a, 2010b). strauss and du toit (2010a) only looked at the competitive skills necessary to enhance south african competitiveness and pellissier and kruger (2011) focused only on competitive intelligence as a strategic function. dameron and torset (2014:297) identified sharing of strategic intelligence as one of the codes emerging from interviews that they conducted with 69 strategists in organisations, which suggest the critical link between competitive intelligence and strategising. we have noted, in line with whittington’s (2006:620) explanation of integrating practices, that strategic practices exist on multiple levels, including organisation-specific and extra-organisational levels. competitive intelligence occupies a special and significant place within the practice turn of strategy as it is embedded in extra-organisational as well as intra-organisational practices. in applying content analysis to these strategic management and competitive intelligence publications studied, certain themes relating to strategic management and competitive intelligence practices or praxis emerged. the competitive intelligence activities and routines are organised according to typical strategic management phases of formulation and implementation (carpenter & sanders 2014; kay et al. 2006). during the strategic planning cycle, practices associated with the formal operating procedures are key, such as direction setting, resource allocation and monitoring and control. these are not the only practices from which strategic action evolves but are ‘theoretically valid’ within the strategic management literature and innately practical and concerned with strategising (jarzabkowski 2003:23). the dominant competitive intelligence activities emanating from the literature were initially organised into 12 topics (praxis). the authors further combined these topics into seven overarching themes that correspond with the typical strategy process portrayed in literature and also with higher-level strategy practices (jarzabkowski 2003; kay et al. 2006). the initial topics were similar to the activities/praxis included in the competitive intelligence cycle. the competitive intelligence cycle is described by the competitive intelligence association (cia) as ‘… the process by which raw information is acquired, gathered, transmitted, evaluated, analysed and made available as finished intelligence for managers to use in decision-making and action’ (johnson 2012). this confirmed to the authors that the topics are relevant and in line with prevailing literature on competitive intelligence. the following table provides a depiction of the connectedness of the themes (practices) and topics (praxis) as well as the linkages with strategy process and strategy as practice. the topics (praxis) were linked together to form overarching themes (practices). the themes that emerged can be strongly linked to a step in the typical strategy process (kay et al. 2006) and confirms the sound relationship between strategy process and competitive intelligence. an explanation of the overarching themes and associated topics derived from the thematic content analysis follows below table 1. table 1: themes (practices) and associated topics (praxis). theme 1: environmental scanning of the intra-organisational environment and extra-organisational environment this is the enveloping practice of conducting internal and external analyses and environmental scanning. environmental scanning typically includes competitor analysis and industry analysis as practices. practitioners are typically competitive intelligence analysts, and employees knowledgeable on the external and organisational environment. environmental scanning is associated with systematic analysis as part of a deliberate strategy. it is clear from the extended literature review and subsequent content analysis that this theme is well developed within the competitive intelligence research field. a consequent classification of research along the vein of activities grouped in topics below is evident from the literature. topic 1: activities and steps in conducting environmental scanning the praxis includes activities of executing environmental scanning, gathering information and analysing information. topic 2: collecting information sources the praxis associated is the collection of information sources. this activity ties in with the broader practice of information gathering as part of environmental scanning. practitioners are competitive intelligence practitioners and employees knowledgeable on the external macro-, market and organisational environment. topic 3: formulating key intelligence topics this is a praxis that can be regarded as an activity within the practice of environmental scanning. the praxis involves the determination of intelligence needs as determined by internal clients. the practitioners are typically competitive intelligence practitioners. when this praxis is focused at aligning intelligence needs with strategic objectives, this is associated with the deliberate strategy where specific ends and means are formulated. this could be applicable to the formulation as well as implementation phase. in the latter, a process of scrutinising strategy documents and conversations to determine intelligence needs is typically adopted. the deliberate process would be built on the foundation of routinely and diligently perusing and extracting intelligence to determine strategic positioning in the market. ansoff (1965) linked strategy to planning and believed that strategy is the selection of a single course of action. brews and hunt (1999) discussed the nature and purpose of planning, while grant (2015) discussed how companies plan ahead. pellissier and kruger (2011) investigated strategic management in the south african insurance industry and recommended that companies use information systems to generate intelligence. according to these authors, business intelligence, competitive intelligence and knowledge management all form part of strategic intelligence, although business intelligence is usually seen as information significant to the business activities of an enterprise. topic 4: capturing information held by the organisation’s employees this activity is a typical praxis performed by the data capturers as practitioners. it is a lower-level strategy activity and could be associated with the strategy process or practices of sense-making. topic 5: using ethical methods to collect information this is one of the key topics in the competitive intelligence literature and is associated with the praxis of collecting information. this in turn forms part of the broader practice of environmental scanning. the practitioners are typically competitive intelligence practitioners and employees that are knowledgeable about the industry and organisational environment and that are involved in environmental analysis. theme 2: assessing strengths and weaknesses; opportunities and threats this is a practice that could be associated with the application of the strengths, weaknesses, opportunities, and threats (swot) analysis and systematic analysis of information in the internal and external environment. the practitioners will typically be competitive intelligence analysts as well as strategy and market specialists. analysis is associated with the deliberate strategy, especially the formulation phase, where a strategy is based on systematic application of analysis tools and techniques. however, this could also be associated with emergent strategising where analysis forms part of a more fluid process but still fosters a mutual understanding of strategic issues and eventually leads to strategic intent. topic 6: generating competitive intelligence foresight of the organisation’s revenue-generating activities this praxis is linked to the process of assessing the internal strengths and weaknesses. financial analyses are conducted based on the organisation’s income and expenses. typical analyses include ratio analysis and comprehensive analysis of financial statements. the practitioners are typically employees skilled in finance, marketing and strategy. forecasting based on financial information and analysis is strongly associated with the deliberate strategy. topic 7: foreseeing opportunities and threats to create a competitive advantage this praxis involves systematic gathering and interpretation of data. practitioners are typically strategy consultants or competitive intelligence practitioners. topic 8: strategic analysis – analysing information gathered this praxis includes the interpretation of information, which falls within the broader practice of strategic analysis, where information gathered in an ethical manner from a variety of external and internal sources is analysed using various tools and techniques. the practitioners are analysts, competitive intelligence practitioners or strategy specialists. analysis is associated with the deliberate strategy. themes 3 to 6 themes 3 to 6 seem to have been less well-structured in the literature, although sufficiently covered in research to warrant the combination into themes. that is the reason for topics not being well demarcated and a classification not being as clear as with the preceding themes. this offers a research opportunity in strategy to investigate why less emphasis is placed on competitive intelligence in the formulation of deliberate and emergent strategies, communication and implementation. the literature showed an overall interest in these themes but without the in-depth organisation evident in themes 1 and 2. theme 3: formulating a deliberate strategy through combined competitive intelligence praxis and practices of gathering, capturing and analysing information, competitive intelligence serves as an input into the strategy process and strategising. it is also an intricate practice of direction setting, enabling sense-making and strategising within the organisation. the practice of competitive intelligence is used to determine strategic outcomes and priorities. this is a formalised process with sequential steps, such as setting the vision, objectives and selecting strategies (grant 2015). practitioners include strategists, consultants or managers. this is typically linked to the deliberate strategy process. topic 9: activities associated with planning rationally and comprehensively all competitive intelligence activities and routines culminate in planning. competitive intelligence is inextricably linked to strategising and the process of strategic planning. practitioners are strategists, consultants, managers or competitive intelligence practitioners. theme 4: making provision for emergent strategies and adjustment to strategy this practice is a comprehensive process of forecasting or simulating probable or possible changes in the marketplace based on a series of observations or analyses and making strategic decisions on reacting to those changes. the practitioners are typically strategists, managers from a variety of organisational functions and top management. the practices stem from a societal focus and from the interplay between intraand extra-organisational stimuli. forecasting is associated with the deliberate strategy, while reacting to changes and adapting strategy to changes in the marketplace is associated with a more flexible emergent strategy. topic 10: anticipating changes in the marketplace the praxis is one of individual organisational members reacting to changes that emanate from the external environment and adjusting their routine activities to suit changed market conditions. theme 5: communicating strategy this practice is associated with the discourse around competitive intelligence gathered and communicated, for example workshops. the practice of communicating the strategy and making it explicit in the organisation is typically associated with deliberate strategy. this is also strongly associated with the final step in formulation of strategy and communicating the well-formulated strategy to operationalise the objectives. this practice is also critical in documenting the deliberate strategy process and final strategy. topic 11: disseminating information this praxis is that of communicating strategic issues relating to strategising through various media. another praxis is the interpretation of information to decide what the priorities are and what should be communicated. any organisational member could be a practitioner involved in communicating information in a host of possible forums. the dissemination of information is associated with both the emergent and deliberate strategising approaches. emergent strategising requires discourse on strategy-related issues to establish strategic intent and strategic thinking, which benefits the emergent approach to strategising. theme 6: implementation the final practice in the strategy process is the implementation of a deliberate strategy. this theme also includes references to monitoring and evaluation as the final step in the deliberate strategy process. literature on the emergent strategy refutes the idea of separate phases of implementation and formulation and argues that strategy may often be operationalised while it is still in the decision-making phase (mintzberg 1994). however, the practice of implementation is well documented in literature and includes various praxis, such as developing lower-level objectives and implementation frameworks (kay et al. 2006). topic 12: receiving feedback from management and employees this topic covers a variety of praxis, such as inviting feedback on the strategy, structuring feedback mechanisms and recording feedback from different levels of management and lower-level employees. this step typically completes the competitive intelligence loop. practitioners are employees from all levels of the organisation, including managers. feedback practice forms part of the implementation phase of a strategy, and more specifically the evaluation of the implemented strategy. feedback can also be less formalised and would then lead to an emergent strategy, which is adjusted as internal or external circumstances dictate. theme 7: supporting the decision-making process in the medium and long term this theme, which is focused on competitive intelligence in decision-making, spans all six other themes as all of the preceding themes and topics involve strategic decision-making. literature regards decision-making as an entwined process that has an impact on each of the other themes. this is an iterative practice associated with the competitive intelligence process of sourcing information, analysing information and applying information in making strategic decisions. decision-making is an inevitable part of strategising and sense-making in both the deliberate strategy and the emergent strategy approach. all organisational members involved in any of the associated praxis can be regarded as practitioners. the content analysis linked strategic management and particularly strategy as practice and process view with competitive intelligence activities. conceptualised framework competitive intelligence is a critical integrating practice within strategy. the framework (figure 2) shows the overlapping area between strategy as master concept and competitive intelligence. the area of competitive intelligence that does not overlap with strategy is the area where competitive intelligence is specifically linked with fields such as marketing or knowledge management. the overlapping area between the two fields of research clearly plays out in both the process of strategy and the practice of strategy. the topics that were identified as the first level of coding in the thematic content analysis could be clearly identified as praxis. these are routine activities associated with the labour of strategy (jarzabkowski 2003:23). when the topics were logically grouped, the themes that emerged showed clear characteristics of the typical deliberate strategy process, but also the emergent strategy process (kay et al. 2006). theme 4 is particularly associated with the emergent strategy since adjustment to the environment would favour a more flexible strategy that makes provision for strategic intent and strategic thinking (liedtka 2001). according to whittington (2006), intraand extra-organisational practices involve linking the internal organisational environment with that of the external environment in which the organisation is embedded. it is clear from the themes that emerged that themes 1, 2, 4 and 6 could play out in both the intraand extra-organisational environments. these themes are shaded to indicate the integrating nature of the practices. competitive intelligence embodies seven themes that are all associated with the strategy process. these themes form practices that encompass both choice and implementation (pettigrew et al. 1992). as these practices span both intraand extra-organisational activities, competitive intelligence can be seen as an integrating practice (whittington 2006). it is not only a selection of praxis that entails tactical activities but embodies logical overarching practices of a strategic nature. figure 2: integration of strategy and competitive intelligence: a conceptualised framework. our research has shown that competitive intelligence is an overarching strategic practice that integrates all the associated strategic practices and praxis. competitive intelligence is critical for both emergent and deliberate strategies and is associated with rational planning as part of the deliberate strategising process, but can be regarded as a critical practice to ensure emergence of strategy. integration of these two approaches is critical for strategic alignment (that is, the fit between an organisation’s strategic priorities and its environment) (walter et al. 2013:305). figure 2 shows that competitive intelligence is not merely an isolated activity or sequence of tasks, but binds together various praxis on the lower level, which in turn unite in higher-level practices within strategy. competitive intelligence seems to link, as an integrating higher-level strategic practice, various practices and praxis. it informs the strategy process at various phases of the process and is associated with critical micro-organisational practices that integrate strategic decision-making at the external and internal organisational level. conclusion and limitations this research set out to review articles and books published on strategy and competitive intelligence to determine their respective contents in order to answer our research question, namely: what is the position of competitive intelligence within the field of strategy? we conducted a thematic content analysis based on an extended literature review. this article demonstrates that strategy and competitive intelligence are inextricably interwoven and organised in the process and practice perspective. competitive intelligence is shown not merely to be an activity or sequence of activities within the broader strategic management process, but to be a significant strategic practice. the findings of the thematic content analysis crystallised into seven competitive intelligence themes. these themes were discussed in relation to the strategy as practice perspective as well as the deliberate and emergent process views. this was depicted in a framework that links competitive intelligence to strategy process and practice. it was illustrated that there are areas of competitive intelligence that are less well-defined than others, based on the well-defined topics within each of the themes. the dominant focus in existing competitive intelligence literature seems to be on competitive intelligence as an activity on the periphery of strategy. it became clear that most research focuses on competitive intelligence activities as part of environmental scanning, analysis and decision-making (themes 1, 2 and 7) and less on the eminent positioning of competitive intelligence within strategy development, communication, implementation, monitoring and evaluation (themes 3 to 6). this opens up opportunities for research in the field of strategy to investigate why less emphasis is placed on competitive intelligence in the formulation of deliberate and emergent strategies, communication and implementation. our research has highlighted the need for the elevation of competitive intelligence as an area of research interest and more specifically as an overarching strategic practice. this may play a role in practice, where competitive intelligence can be used to supplement and enhance strategising and not only be seen as a supporting and peripheral activity. we conclude on the basis of the content analysis that competitive intelligence is an overarching practice encompassing various key activities (praxis). strategy as practice provides a positioning framework for competitive intelligence that shows its significance as integrative practice, integrating extra-organisational and intra-organisational activities within both formulation and implementation phases and within emergent strategy as well as deliberate strategy. strategy as practice shares the strategy research arena with process research (langley 2007:272). langley regards it as important to situate process thinking with respect to the subfield of ‘strategy process research’ and also with respect to the growing ‘strategy as practice’ movement. this article contributes to the strategy as practice field by adding the processual view as a combined research perspective. vaara and durand (2012:251) challenge strategy scholars to be mindful of the variety of practices, not only to be able to more effectively analyse major societal issues but also to be able to better understand the challenges of their solution. according to vaara and durand (2012) researchers should focus on how strategising is enabled and constrained by prevailing strategic and organisational practices as this would reflect real-life practices that are institutionalised. this perspective is in line with strategy as practice research which emphasises the importance of current strategic practices informing theory (tsoukas 2010; vaara & whittington 2012). this would inevitably lead to a more nuanced understanding of the agency of strategy or strategising that enables the practitioners of strategy through a combination of practices. this demonstrates the importance of developing a framework for the practice of competitive intelligence within the master concept of strategy. whittington (2006) implores researchers to understand the origins of practices, which have been illustrated in this article. competitive intelligence can be regarded as a legitimate integrated practice that links intra-organisational and extra-organisational levels of strategy. as such, competitive intelligence offers a way for all managers to be included in strategy, which is not always the case (balogun & johnson 2004; davis, jansen van rensburg & venter 2014a, 2014b; whittington 2006). traditional strategy research focused on the role of top managers and in particular the ceo in making strategic decisions (ansoff 1965). however, the focus of strategy as practice is on the middle manager as the critical link between operational staff and managerial staff – the latter typically makes the strategic decisions and the former implements the strategies (davis et al. 2014b; whittington 2006). this embeddedness in the structure of organisations and the body of research and education as a societal practice emphasises the importance of competitive intelligence within strategy (whittington 2006), also from a practical point of view. seidl and whittington (2014:3) argue that the practice perspective conceptualises strategy as ‘field of knowledge and power’, which defines the real problems in organisations and the parameters of the real solutions to them. it therefore empowers other actors in the strategising arena (knight & morgan 1991). we have shown that competitive intelligence can be used from a practice perspective to enlighten organisational members in terms of strategising. this provides a further research opportunity for exploring actual competitive intelligence practices and solutions at micro-organisational level in more depth and to explore these from a practice perspective. if competitive intelligence is developed and incorporated into the formal strategising process, management can make better decisions. competitive intelligence has evolved as a critical strategic practice benefitting both the deliberate strategising process and the emergent strategising process. competitive intelligence has been institutionalised as a significant overarching and high-level strategic practice with associated lower-level practices and praxis in organisations. this is important as a societal practice that is shaped and legitimised through tertiary education courses. in this sense management will benefit from further research and the development of competitive intelligence as integrating practice. some limitations to the study should be noted. these include methodological limitations. according to braun and clarke (2006:97), thematic content analysis is a flexible method that allows for a wide range of analytic options, which means that the potential range of conclusions about the data can be broad. while this is an advantage, it can also be a disadvantage in that it makes developing specific guidelines for higher-phase analysis difficult and can be potentially paralysing to the researchers trying to decide which aspects of their data to focus on. our study has been aided in this regard by the use of strategy as process and practice as a research lens. a further disadvantage is that thematic analysis has limited interpretative power beyond mere description. however, in this study the theoretical framework assisted in interpretation, albeit to a limited extent. future research can investigate the practice of competitive intelligence in strategy empirically to explore the relationship in more detail. it should be pointed out that this study was only exploratory in nature, and, as such, the findings cannot be generalised. the systematic review of the literature demonstrated that competitive intelligence is a very relevant and current field within strategy as practice that should be explored further for its contribution to emergent or deliberate strategies. further research could be conducted on the application of competitive intelligence practices in the organisation and their influence on the strategy of the organisation. case study research could be conducted to explore the field and add more depth and breadth to the study and add to the corpus of strategy as practice research. acknowledgements competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions a first draft of the manuscript was developed by both authors, who each researched their respective areas of literature, namely the competitive intelligence by a.d.t. and the strategy by r.m. both authors conducted the thematic content analysis, crystallised findings and conclusions and developed the integrating model. subsequent refinement and changes to the first draft were made by r.m. due to a.d.t.’s retirement as a result of prolonged illness. references adidam, p.t., banerjee, m. & shukla, p., 2012, ‘competitive intelligence and firm’s performance in emerging markets: an 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practice and illustration conclusion and recommendations acknowledgements references appendix 1 about the author(s) mareli dippenaar school of accountancy, stellenbosch university, south africa citation dippenaar, m., 2018, ‘a critical analysis of the meaning of the term ‘value’ in section 30(6)(e) of the companies act’, south african journal of economic and management sciences 21(1), a1985. https://doi.org/10.4102/sajems.v21i1.1985 original research a critical analysis of the meaning of the term ‘value’ in section 30(6)(e) of the companies act mareli dippenaar received: 15 june 2017; accepted: 30 jan. 2018; published: 26 apr. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: sections 30(4) and 30(5) of the companies act 71 of 2008 (the act) require, inter alia, disclosure of the remuneration received by each director in a company’s annual financial statements. section 30(6) defines the term ‘remuneration’, which includes, inter alia, in section 30(6)(e) the ‘value’ of any option or right granted to a director, as contemplated in section 42, which deals with options for the allotment or subscription of securities or shares of a company. it is uncertain what the intended meaning of the term ‘value’ is in this context and it is interpreted differently by different companies in practice. aim: the objective of this study was to understand the meaning of the term ‘value’ in section 30(6)(e) of the act (including the date of measurement thereof), as intended by the legislature. setting: this article examined existing literature in a south african corporate and legislative environment. method: a non-empirical study of existing literature was conducted by performing a historical analysis within a south african context. a doctrinal research approach was followed. results: possible interpretations of the term ‘value’ include the grant date fair value of the rights, the fair value at reporting date, the fair value on vesting date, the expense calculated in terms of the international financial reporting standard on share-based payments, the gain on exercise of the rights and the intrinsic value on reporting date. it is submitted that the most likely meaning is the grant date fair value. conclusion: it was found that the meaning of the term ‘value’, for purposes of section 30(6)(e) of the act, is unclear and interpreted differently by different companies. it is, therefore, recommended that the wording of section 30(6)(e) is amended to reflect the meaning intended by the legislature. introduction sections 30(4) and 30(5) of the companies act 71 of 2008 (the act) require disclosure of certain information in a company’s annual financial statements, including the remuneration, as defined in subsection (6), and benefits received by each director or individual holding any prescribed office in the company. section 30(6) contains details of what the term ‘remuneration’ referred to in sections 30(4) and 30(5) includes and is a very broad concept. section 30(6)(e), read together with section 30(4), requires the disclosure (per director) of ‘the value of any option or right given directly or indirectly to a director, past director or future director, or person related to any of them, as contemplated in section 42’. section 42 deals with options for the allotment or subscription of securities or shares of a company. according to steyn and cairney (2016), very few companies actually disclose the value of long-term incentive compensation, which includes share-based payments (sbps), and generally these values need to be calculated by the users of financial statements, using the information published in the companies’ remuneration reports. according to voller (2016), companies are not disclosing directors’ remuneration properly in their annual financial statements, as required by the act. pwc (2015:13) has also found that ‘the overall level of long-term incentives … disclosure is not yet on par with global standards’. the term ‘value’, as used in section 30(6)(e), is not defined in the act and its meaning is unclear. scrutiny of some listed companies’ annual financial statements confirmed that companies interpret this disclosure requirement differently, with values varying between ‘gross’ values, such as fair value on grant date or annualised grant date fair values, to ‘net’ values, such as gains on exercise of share options only or of all share incentives exercised (or combinations thereof) (dippenaar & steenkamp 2017). the uncertainty regarding which ‘value’ is required to be disclosed by the act (including the measurement date and appropriate valuation method) and the inconsistent interpretations applied by companies reduce the comparability of companies’ annual financial statements for shareholders and other stakeholders. the objective of this study is to understand the meaning of the term ‘value’ as used in section 30(6)(e) of the act, including the date of measurement thereof, as intended by the legislature. there is currently no guidance available regarding the meaning of this disclosure requirement. the study can potentially highlight areas for improvement or, at the very least, for consideration by the minister of trade and industry to clarify the meaning of the term ‘value’ in section 30(6)(e) of the act. the study can potentially also assist companies to understand the intended meaning when preparing the disclosure in their annual financial statements. this could enhance comparability of companies’ annual financial statements. research methodology a non-empirical study of existing literature was conducted by performing a historical analysis within a south african context. a problem-based doctrinal research approach was followed, using interpretive and qualitative analysis. the following steps, as suggested by hutchinson and duncan (2012), were followed to solve the specific research problem: assemble the relevant facts. identify the legal issue at hand. analyse the issue from a legal perspective. study relevant background material such as dictionaries and journal articles. locate primary research sources such as case law and legislation. interpret, analyse, compare and combine all issues within the context. reach a tentative conclusion. this research objective was achieved by investigating the following: the meaning of the term ‘value’ as used in section 30(6)(e) of the act (including the date of measurement thereof), by exploring the ordinary definition thereof and attempting to use logical reasoning in order to determine the most likely meaning, as there is no specific guidance available in this regard. the impact of the different possible interpretations of the term ‘value’ in section 30(6)(e) of the act on companies’ annual financial statements. during the study, it was found that a possible interpretation of ‘value’ is ‘fair value’ (as discussed later). different techniques could be applied to appropriately determine a fair value. it is, however, not in the scope of this study to evaluate or prescribe a specific valuation technique. the study is structured as follows: a brief discussion of the relevant aspects and principles of interpretation of legislation is presented. this is followed by a summary of all the possible literal (ordinary) meanings of the term ‘value’. thereafter, the context of the wording in section 30(6)(e) is explored in an attempt to determine the intended meaning of ‘value’. the possible interpretations of the term are discussed based on the types of sbps in use and the regulatory frameworks that govern the disclosure of sbps and a logical reasoning is applied in an attempt to determine the most likely meaning. a practical illustration of the impact of each possible interpretation on a company’s financial statement disclosure is presented and a conclusion regarding the most likely interpretation intended by the legislature, based on the literature study performed, is finally presented. lastly, recommendations for the amendment of the existing wording in section 30(6)(e) are made and a future research opportunity is highlighted. interpretation of words used by the legislature principles of interpretation the golden rule of interpreting statutes, subject to certain exceptions, is to apply the literal or ordinary meaning of the words used to determine the intention of the legislature, when the words are clear and unambiguous (venter v r [1907] ts 910). in order to do so, the grammatical meaning of the words should be applied and dictionaries can be helpful in this regard. however, if a word is used in a technical sense, it has to be interpreted using its technical meaning, that is, its meaning within a specific trade, business or profession and not its ordinary meaning (de ville 2000). sometimes the intention of the legislature could be ascertained by referring to the context of the statute. this is usually when the ordinary meaning would be unreasonable or unconstitutional or lead to an ambiguity, absurdity or inconsistency (devenish 1992; de ville 2000; ngcobo and others v salimba cc; ngcobo v van rensburg 1999 [2] sa 1057 [sca]). ‘value’, as used in section 30(6)(e), is not so much ambiguous, but it is simply too vague to establish its true meaning in the context of the section. it is possibly even incomplete, as it does not specify what value should be used or on what date the value should be determined. in order to determine the context of a word, we refer to the scope and purpose of the specific section of the act, as well as to its background (de ville 2000; jaga v dönges no 1950 [4] sa 653 [a] 662). the literal meaning there is no definition of ‘value’ in the act; however, based on the dictionary meaning (oxford english dictionary 2017), ‘value’ is commonly understood as, inter alia: … the material or monetary worth of something; the amount at which something may be estimated in terms of a medium of exchange, as money or goods, or some other similar standard … [or] … the relative worth, usefulness, or importance of a thing or (occas.) a person; the estimation in which a thing is held according to its real or supposed desirability or utility. other definitions include ‘the worth of a thing in money or goods at a certain time; market price’ (webster’s new world college dictionary n.d.) or ‘the balance between what a customer sees as the benefit to them of a product and the price they have to pay for it’ (collins english dictionary 2017). a value can usually be expressed in a currency. the technical meaning seeing that section 30(6)(e) of the act deals with the disclosure of directors’ remuneration and, specifically, with share incentives, ‘value’ is possibly used in a technical (accounting) sense in this context. international financial reporting standards (ifrs), however, do not define ‘value’. ifrs (and the accompanying illustrative examples) usually do not even use the standalone term ‘value’, but specify the type of ‘value’ (table 1). all of these different ‘values’ have different meanings, so they are either defined or ifrs explain how that value should be determined. accounting standards were originally named international accounting standards (ias) but newer standards (issued by the current standard setting body) are named ‘ifrs’. collectively these standards (including ias and ifrs standards) are also referred to as ‘ifrs’. when reference is made to an individual standard, it is referred to as ‘ias x’ or ‘ifrs x’ (x being the number of the specific standard). table 1: terminology used in international financial reporting standards to specify a type of value (listed alphabetically). when ifrs use the term ‘value’, without specifying which value, it is understood in its ordinary sense, namely the monetary worth of something. an example is when ifrs 16 leases (ifrs 16) refers to ‘asset … of low value’ (ifrs 16.6) or when ias 20 accounting for government grants and disclosure of government assistance (ias 20) refers to ‘those … which cannot reasonably have a value placed upon them’ (ias 20.3). however, whenever ifrs require disclosure of a value, the standard would specify the type of value or how that value needs to be determined. even when it appears to only refer to ‘value’ (as a standalone term), it has usually been specified earlier in that standard or section what was meant by ‘value’, for example a ‘fair value’, which is a term that is defined (ifrs foundation 2016). table 2 provides examples of such uses in ifrs. ‘value’ is also usually understood to be a gross value and not a net value (such as, for example, the difference between two values – i.e. a gain), although exceptions exist. table 2: some examples where ‘value’ is used as a standalone term in international financial reporting standards. since the literal meaning of the term ‘value’ is too vague to understand what is meant in section 30(6)(e) and ifrs do not clarify it either (from a technical sense), it is necessary to establish the context of the word within the statute. the context of section 30(6)(e) the purpose of legislation provides context to determine the scope and intended effect of the law (thornton 1996). in order to determine purpose, reference is made to section 5 of the act, which states that: … this act must be interpreted and applied in a manner that gives effect to the purposes set out in section 7 … [and] to the extent appropriate, a court interpreting or applying this act may consider foreign company law. section 5 does not provide much assistance with interpreting section 30(6)(e) either. section 7 of the act is considered to establish the purpose of the act, but the purpose is too general in nature and not helpful in determining what could be meant by ‘value’ in section 30(6)(e). the explanatory summary of the companies bill 2007 was also consulted, but again there was nothing specific in the commentary relating to annual financial statement disclosure or directors’ remuneration. in order to consider the background of the section, the history of the section was considered by referring to previous versions of the section. section 30(6)(e) was first introduced in the 2008 act and there were no previous versions of this specific section. the companies act that applied before the 2008 act became effective, was companies act 61 of 1973 (the 1973 act). the 1973 act contained a section 297(2a)(g)(i) which appears to be the predecessor of the current section 30(6)(e) disclosure requirement. section 297(2a)(g)(i), added in 1999, required the disclosure of: … gains made on the exercise of share options, the gain being the difference between the price paid for the shares and the market price of the shares on the date of exercise, and that date being the date on which the director takes ownership of the shares and is entitled to dispose of them. the original 1973 act also required the disclosure of directors’ emoluments, but ‘emoluments’ were only later defined when section 2a was added by the companies amendment act 37 of 1999. the object of this was to improve disclosure and ensure more transparency, by enabling stakeholders to inspect the level of remuneration, without compromising an individual’s right to privacy (republic of south africa 1999b). the provisions relating to directors’ remuneration disclosure, and specifically to sbps, were clearly narrower and much more specific in the 1973 act: it only related to share options, whereas in the 2008 act it has been broadened to refer to ‘any option or right’ and it specifically required disclosure of the gain on exercise of the options. it was also more prescriptive, as it required the gains to be disclosed in table format. there was, however, no requirement to make the disclosure per director, as is the case in the 2008 act. the use of the word ‘value’ in the new act can be interpreted in various ways, from variations of gross values like a fair value on certain dates to net values like gains realised on exercise of share options. possible interpretations of ‘value’ based on the types of share-based payments in use examples of sbps to employees and directors that are commonly used are, share options (a right to purchase shares at a predetermined exercise price), share appreciation rights (a right to receive a cash payment equal to the increase in value of shares from the grant date to the exercise date), phantom shares (a right to receive cash equal to the value of shares) and contingent or restricted shares (where the shares are granted for free) (massie, collier & crotty 2014; mavrodinov 2012; steyn 2015). sbps are classified as either equity-settled or cash-settled in terms of ifrs 2 share-based payment (ifrs 2), based on the nature of the sbp. table 3 provides a summary of what these schemes are typically classified as in terms of ifrs 2. table 3: ifrs 2 classifications of typical share-based payments to directors. table 4 provides a summary of the possible interpretations of ‘value’, in the author’s opinion, and the types of sbps to directors for which the values could be relevant. for the purposes of table 4, two categories of sbps are identified, namely options or share appreciation rights (including share purchase plans accounted for as options) and shares or phantom shares (including deferred bonus plans which are similar to the granting of shares). this classification is based on the fact that options and share appreciation rights could have an exercise date that is different from the vesting date, while shares or phantom shares usually only have a vesting date, which is also the exercise date. table 4: possible interpretations of ‘value’. another possible interpretation of ‘value’ could include the fair value of the underlying shares (in the case of share options), although it is unlikely that this could be regarded as a ‘right’, as required by section 30(6)(e). similarly, it is unlikely that companies would interpret ‘value’ in the context of section 30(6)(e) as meaning the amount payable to exercise the right (i.e. the exercise price). these two ‘values’ are rather the two items needed to calculate the gain on exercise that was required to be disclosed by the 1973 act. the author is of the opinion that the term ‘value’ in the context of section 30(6)(e) does not imply a net value like a gain on exercise or an annualised value like the ifrs 2 expense, otherwise the legislature would surely have provided clarification on how to calculate such a value, as was the case in the 1973 act that provided details on how to calculate the gain. surely if the term ‘value’ in section 30(6)(e) was intended to still mean ‘gain on exercise’, the legislature would not have changed the wording in the act completely from what it was in the 1973 act. in the light of the ordinary meaning of ‘value’, it would make more sense for ‘value’ to be interpreted as a gross value, such as ‘fair value’. however, if the intention was for a ‘fair value’ to be disclosed, it is uncertain why the legislature did not use those specific words, as was the case in the other 14 places in the act where specific mention is made of ‘fair value’ (inter alia in section 38(3)(b) relating to share issues). not only is it unclear if a gross or net value is implied, but if a gross value should be disclosed, then it is uncertain on what date the value should be determined. possible interpretations of ‘value’ based on other regulatory frameworks in an attempt to determine the most likely meaning of the term ‘value’ in section 30(6)(e), other regulatory frameworks requiring disclosure of sbp to directors were consulted to establish which ‘values’ these sources require to be disclosed, regardless of whether it should be disclosed per director or in total. it is possible that the legislature intended for the same ‘value’ to be disclosed. these other sources include ifrs 2 and ias 24 related party disclosures (ias 24) (ifrs foundation 2016), the king report on governance for south africa 2009 (king iii) (iodsa 2009) and the johannesburg stock exchange (jse) listing requirements (jse limited 2017). all companies registered in south africa and that are required to be audited, need to comply with section 30(4) of the act, while only those listed or wishing to list on the jse need to adhere to the listing requirements. only those companies that are required to, by the act, or those that choose to apply ifrs, need to comply with the requirements of ifrs 2 and ias 24. the king code effective at the time of writing this article was king iii. king iv replaces king iii in its entirety and is effective for financial years beginning on or after 01 april 2017 (iodsa 2016). compliance with king iii is not legally binding. however, the jse listing requirements require that companies apply certain principles of king iii (jse limited 2017). below follows a discussion of the disclosure requirements of these other regulatory frameworks in an attempt to establish the possible meaning of the term ‘value’ that is used in section 30(6)(e). consequently, disclosure requirements of narrative or qualitative information, or of quantitative information that is not currency values, such as for example the number of options granted or exercised, are excluded here. ias 24 ias 24 requires disclosure of the sbp compensation to all key management personnel, including directors, in total (not per individual), that is, the current year ifrs 2 expense. this is a possible interpretation of the term ‘value’ in the context of section 30(6)(e), but there are other more likely interpretations, as discussed below. ifrs 2 the disclosure requirements of ifrs 2 are set out in table 5. a discussion of whether these requirements are possible interpretations of ‘value’ in the context of section 30(6)(e) is also included in table 5. table 5: ifrs 2 disclosure requirements and applicability to section 30(6)(e). jse listing requirements the jse listing requirements require disclosure of the exercise price of each option or right outstanding at the beginning of the year, awarded during the year, exercised during the year and outstanding at reporting date. in addition, the price at which shares were issued or allotted (but not yet fully paid for) in terms of a share purchase or option plan (i.e. the exercise price) must also be disclosed. it is unlikely that ‘value’ in the context of section 30(6)(e) should be interpreted as the exercise price, as the amount payable to exercise the right does not constitute the value of the right. the wording of the jse listing requirements also seems to imply that the disclosure requirements are different from those required by the act: ‘in addition to complying with ifrs, section 30 of the act and paragraph 3.84 of the listings requirements, issuers are required to disclose the following information’ (jse limited 2017:par.8.63). king iii the author is of the opinion that ‘value’ in section 30(6)(e) of the act should be interpreted to have the same meaning as that specified in king iii. the introduction of the act was the reason for a newer version of the king code (i.e. king iii) and it seems as if the purpose of king iii and the act is to require disclosure of the same directors’ remuneration values: companies should provide full disclosure of each individual executive and non-executive directors’ remuneration, giving details as required in the act of base pay, bonuses, share-based payments, granting of options or rights, restraint payments and all other benefits (including present values of existing future awards) (iodsa 2009:par.180, own emphasis added). king iii, read together with the remuneration practice note (iodsa 2013), requires disclosure of the fair value of share-incentive grants, options or rights and specifies that this value should be based on the expected net present value of the instruments. this constitutes the grant date fair value of the instruments that is expected to vest. the practice note continues to state that best practice would be to disclose the ‘value at grant per grant’ (i.e. the grant date fair value), ‘the value of all unvested/unexercised historical awards at current expected value’ (i.e. the reporting date fair value) and ‘the value realized from all options exercised or share-based awards settled in the period under review’ (i.e. the gain on exercise). it is, therefore, submitted that ‘value’ in section 30(6)(e) should be interpreted as grant date fair value and, possibly, also reporting date fair value and gain on exercise. although the ifrs 2 expense is not the most likely interpretation of the term ‘value’ in the context of section 30(6)(e), as discussed, it is not ruled out as a useful value to disclose. according to urson (2016), it should be mandatory for companies to make more comprehensive disclosure of their compensation schemes on a per director basis. he is of the opinion that companies should disclose both the gain on exercise of share options and the ifrs 2 expense on a per director basis, as this would grant shareholders the necessary flexibility to choose a metric for their own analysis, provide greater transparency and improve comparability, especially with international companies. current practice and illustration from a preliminary inspection of companies’ annual financial statements, it seems that companies are disclosing the following values per director (dippenaar & steenkamp 2017): grant date fair value (required by king iii, read together with the remuneration practice note). gain on exercise of share options only (previously required by the 1973 act, although not required per director). value of all share incentives exercised during the year (seemingly an extension of the 1973 act’s requirement from options only to all share incentives). sufficient information to calculate the value of all share incentives exercised. ifrs 2 expense (required by ias 24 and ifrs 2, but not per director). a combination of the above. since only the grant date fair value is required to be disclosed per director, it is assumed that these other values noted are disclosed either voluntarily or in an attempt to comply with the act. the uncertainty regarding which ‘value’ is required to be disclosed by section 30(6)(e) and the inconsistent interpretations applied by companies lead to incomparability between similar companies. the following example illustrates the differences in numbers that companies might disclose in their annual financial statements, depending on their interpretation of the term ‘value’ in section 30(6)(e). these differences could be significant in bull or bear market conditions. for purposes of the illustration, a share option plan is used, where the directors have the option to purchase shares in future (during the exercise period), but at an exercise price equal to the share price on the grant date of the options. share appreciation rights would be similar, except that the directors cannot purchase physical shares, but benefit by receiving cash for the increase in share price from grant date up to exercise date. in respect of plans where shares or phantom shares are granted, the vesting date and exercise date is the same; therefore, these types of plans were not selected to illustrate the full effect of the differences in interpretations of the term ‘value’. assume that company x grants 100 share options to each of its 10 directors on 01 july 20´1. company x has a 31 december reporting date. each grant is conditional upon the director remaining in the service of company x for another 3 years. in other words, the share options will vest on 30 june 20´4. the share options can be exercised at an exercise price of 15 rand (r) at any time during the 6 years post vesting date, i.e. by 30 june 20´10. the relevant fair values of the shares and share options, throughout the life of the share options, are presented in table 6. table 6: fair values of shares and options throughout the life of the options. on the basis of a weighted average probability, company x estimated on grant date that two of the directors would leave during the 3-year period and therefore forfeit their rights to the share options. this turned out to be true and eight directors’ share options vested on 30 june 20´4. five directors exercised their share options on 30 june 20x8, while the other three directors’ options expired on 30 june 20x10, since they were not exercised by that date. company x could disclose the following amounts, per director, per year (in table 7), in its annual financial statements, in respect of the ‘value’ of the sbps. the information is presented for each of the financial years from 20x1 until 20x9 (at 31 december each year) and for each of the possible interpretations of ‘value’ in section 30(6)(e). no value will be disclosed in 20x10, as the options have expired. values are rounded to the nearest rand and calculations for the values in table 7 are provided in appendix 1. table 7: disclosures of share-based payment ‘value’, per director, in the 20x1 to 20x9 financial statements of company x. conclusion and recommendations the meaning of the term ‘value’, for the purposes of section 30(6)(e) of the act, is unclear and can be interpreted in various ways, from variations of ‘gross’ values such as fair value on certain dates or even annualised values such as the ifrs 2 expense, to ‘net’ values such as the gain realised on exercise of sbps or the intrinsic value thereof before exercise. not only is it unclear if a gross or net value is implied, but if a gross value should be disclosed, then the date on which it should be determined is also uncertain. since the meaning is unclear and the legislature’s intention is unknown, the author attempted to use logical reasoning in order to determine the most likely meaning. the term ‘value’ is commonly understood as ‘the monetary worth’ of something. the author is of the opinion that it does not imply a net value like a gain on exercise of share options, as then surely the legislature would have used the existing wording in the 1973 act. the fact that the wording was completely altered, shows that a different meaning should be ascribed to the term ‘value’ than gains on exercise of share options. the author is of the opinion that a fair value should be disclosed, although it is uncertain why the legislature failed to use that exact term in section 30(6)(e), seeing that ‘fair value’ is used 14 times in other sections of the act. fair value on grant date, reporting date, vesting date and exercise date would all be useful to disclose, but the author is of the opinion that it should be interpreted as the grant date fair value, as required by king iii. it could even possibly be extended to also refer to the reporting date fair value and gain on exercise, which are stated as best practice in the king iii practice note on remuneration. the uncertainty regarding the meaning of ‘value’ in section 30(6)(e) has significant consequences in terms of comparability of company annual financial statement disclosures and it is recommended that the wording of section 30(6)(e) is amended to reflect the meaning intended by the legislature. it would be even more helpful if the act could provide more detailed requirements of how particular components of remuneration should be calculated, as is the case in the united kingdom in respect of quoted companies (united kingdom 2013). it is also recommended that the act is amended to be more prescriptive as to the format to be used for the disclosure, as was the case in the 1973 act (which required the gain on exercise of options to be provided in a table format) and the united kingdom, where part 3 and part 4 of the regulations to the companies act 2006 require disclosure of directors’ remuneration to be made graphically in bar graphs and tables (united kingdom 2013). this would enhance the comparability of companies’ disclosures. other studies (asafo-adjei 2015; madlela & cassim 2017) have also found that the act’s minimum standards of remuneration disclosure are too low and agree that the act should standardise the disclosure of directors’ remuneration, similar to that of the united kingdom. the level of disclosure of directors’ remuneration by companies is still a problem for shareholders and users of financial statements. in order to help address this problem and to assist companies with the preparation of their disclosures, especially those that need to be disclosed per director, as required by so many different sources, future research could include the development of an easy-to-use disclosure checklist. fair value could be determined using a variety of valuation techniques. the study is limited as it does not attempt to evaluate valuation techniques nor to prescribe the most appropriate valuation method to determine the fair value of share-based remuneration. a future research study could consider the appropriateness of different valuation methods available or applied by companies to value their share-based incentives. acknowledgements competing interests the author declares that she has no financial or personal relationships that may have inappropriately influenced her in writing this article. references asafo-adjei, m.a., 2015, ‘regulation of executive directors remuneration in south africa: the road to achieving good corporate governance’, master’s thesis, university of cape town, cape town. collins english dictionary, 2017, viewed 22 may 2017, from https://www.collinsdictionary.com/dictionary/english/value devenish, g.e., 1992, interpretation of statutes, juta & co., ltd., cape town. de ville, j.r., 2000, constitutional & statutory interpretation, interdoc consultants pty ltd, cape town. dippenaar, m. & steenkamp, g., 2017, ‘disclosure of directors’ remuneration’, accountancy sa, november 2017, 54–56. hutchinson, t. & duncan, n., 2012, ‘defining and describing what we do: doctrinal legal research’, deakin law review 17(1), 83–119. https://doi.org/10.21153/dlr2012vol17no1art70 ifrs foundation, 2016, a guide through international financial reporting standards, parts a1, a2, b1 and b2, ifrs foundation, london. institute of directors southern africa (iodsa), 2009, king report on governance for south africa 2009, iodsa, johannesburg. institute of directors southern africa (iodsa), 2013, practice notes – a guide to the application of king iii: remuneration, iodsa, johannesburg. institute of directors southern africa (iodsa), 2016, king iv report on corporate governance for south africa 2016, iodsa, johannesburg. jaga v dönges no 1950 (4) sa 653 (a) 662 jse limited (jse), 2017, jse limited listing requirements, viewed 26 may 2017, from https://www.jse.co.za/content/jserulespoliciesandregulationitems/jse%20listings%20requirements.pdf madlela, v. & cassim, r., 2017, ‘disclosure of directors’ remuneration under south african company law: is it adequate?’, south african law journal 134(2), 383–414. massie, k., collier, d. & crotty, a., 2014, executive salaries in south africa: who should have a say on pay?, jacana media, auckland park. mavrodinov, n., 2012, ‘the changing landscape of long-term share-based compensation in south africa’, master’s thesis, university of cape town, cape town. ngcobo and others v salimba cc; ngcobo v van rensburg 1999 (2) sa 1057 (sca) oxford english dictionary online version, 2017, viewed 22 may 2017, from http://www.oed.com/view/entry/221253?rskey=lcofkv&result=1#eid pricewaterhousecooper inc. (pwc), 2015, executive directors practices and remuneration trends report, 7th edn., south africa, viewed 02 june 2017, from https://www.pwc.co.za/en/assets/pdf/executive-directors-report07.2015.pdf republic of south africa, 1973, companies act 61 of 1973, government printer, pretoria. republic of south africa, 1999a, companies amendment act 37 of 1999, government printer, pretoria. republic of south africa, 1999b, companies amendment bill, government printer, pretoria. republic of south africa, 2007, companies bill, government printer, pretoria. republic of south africa, 2008, companies act 71 of 2008, government printer, pretoria. steyn, f. & cairney, c., 2016, ‘maf 08: long-term incentives: do shareholders get what they pay for?’, in southern african accounting association national teaching and learning and regional conference proceedings, cape town, south africa, 02 september, pp. 244–267. steyn, g.f., 2015, ‘the relationship between ceo compensation and future share returns in south africa’, master’s thesis, university of western cape, cape town. thornton, g.c., 1996, legislative drafting, 4th edn., tottel publishing, united kingdom. united kingdom, 2006, companies act 2006, viewed 09 june 2017, from http://www.legislation.gov.uk/ukpga/2006/46/section/421 united kingdom, 2013, large and medium-sized companies and groups (accounts and reports) (amendments) regulations 2013 no. 1981, viewed 09 june 2017, from http://www.legislation.gov.uk/uksi/2013/1981/pdfs/uksi_20131981_en.pdf urson, m., 2016, ‘ceo pay ratios and company performance: a study of jse-listed consumer goods and services companies’, master’s thesis, university of cape town, cape town. venter v r [1907] ts 910 voller, r., (acting commissioner of companies and intellectual property commission), 2016, notice no. 20 to customers: non-disclosure of remuneration and benefits of directors and prescribed officers in annual financial statements, 14 march 2016, viewed 09 june 2017, from http://www.cipc.co.za/files/8414/5796/3772/notice_20_of_2016.pdf webster’s new world college dictionary, 4th edn., n.d., viewed 22 may 2017, from http://www.yourdictionary.com/value#websters appendix 1 table 1-a1: calculations of values disclosed in table 7. abstract introduction proof of concept and the need for a unifying theoretical framework the mobilisation of the crowd post-mobilisation: operationalisation synthesis conclusion acknowledgements references about the author(s) chris w. callaghan department of management and human resources management, school of economic and business sciences, university of the witwatersrand, south africa citation callaghan, c.w., 2017, ‘the probabilistic innovation theoretical framework’, south african journal of economic and management sciences 20(1), a1416. https://doi.org/10.4102/sajems.v20i1.1416 original research the probabilistic innovation theoretical framework chris w. callaghan received: 12 june 2015; accepted: 24 apr. 2017; published: 31 july 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: despite technological advances that offer new opportunities for solving societal problems in real time, knowledge management theory development has largely not kept pace with these developments. this article seeks to offer useful insights into how more effective theory development in this area could be enabled. aim: this article suggests different streams of literature for inclusion into a theoretical framework for an emerging stream of research, termed ‘probabilistic innovation’, which seeks to develop a system of real-time research capability. the objective of this research is therefore to provide a synthesis of a range of diverse literatures, and to provide useful insights into how research enabled by crowdsourced research and development can potentially be used to address serious knowledge problems in real time. setting: this research suggests that knowledge management theory can provide an anchor for a new stream of research contributing to the development of real-time knowledge problem solving. methods: this conceptual article seeks to re-conceptualise the problem of real-time research and locate this knowledge problem in relation to a host of rapidly developing streams of literature. in doing so, a novel perspective of societal problem-solving is enabled. results: an analysis of theory and literature suggests that certain rapidly developing streams of literature might more effectively contribute to societally important real-time research problem solving if these steams are united under a theoretical framework with this goal as its explicit focus. conclusion: although the goal of real-time research is as yet not attainable, research that contributes to its attainment may ultimately make an important contribution to society. introduction in a global context experiencing exponential growth in stocks of knowledge and information, the ‘breakneck pace of genome-technology development’ has ‘revolutionised bioscience research’, and the scientific fields that underlie medical research and development (r&d) are advancing as never before (hayden 2014:294). notwithstanding these developments, kaitin (2010) stresses the lack of progress associated with contemporary pharmaceutical innovation: forged in the early 1960s, the paradigm for pharmaceutical innovation has remained virtually unchanged for nearly 50 years. during a period when most other research-based industries have made frequent and often sweeping modifications to their r&d processes, the pharmaceutical sector continues to utilize a drug development process that is slow, inefficient, risky and expensive. (p. 356) the number of ‘new drugs approved per billion us dollars spent on r&d has halved roughly every 9 years since 1950, falling around 80-fold in inflation-adjusted terms’ notwithstanding the ‘huge advances in many of the scientific, technological and managerial’ factors that are inputs into the r&d process (scannell et al. 2012:191). this deficiency is particularly acute in contexts of rapidly ageing populations who are experiencing rising levels of chronic illness amidst dramatically increased societal health budgets [world health organization (who) 2015], as well as in contexts of resource scarcity, where many cannot afford the medicines they need (nathan 2007). it is argued in this article that a deficiency in the knowledge management literature exists, as the current dysfunctional medical r&d paradigm, which currently lacks the capacity to deal effectively with potential global pandemics such as ebola, middle east respiratory syndrome (mers), or with rapidly developing antibiotic resistance (callaghan 2014), poses a serious potential threat to society. specifically, what is absent from the literature is knowledge of how the current dramatic advances in the fields that underlie medical science can be transmitted to pharmaceutical r&d outcomes. this article seeks to offer a theoretical framework to develop this knowledge, and a synthesis of theory is undertaken, based on the argument that the current paradigm of pharmaceutical innovation faces a threshold limit, and that there may be a methodology that can overcome these constraints. some authors, such as kaplan and haenlein (2011:253), have drawn a parallel between the rapid spread of lethal viral epidemics and the ‘viral’ spread of social media; such a comparison highlights the development of new technologies that can support a relatively new and rapid form of problem-solving that utilises the ‘crowd’, or large numbers of people, to improve the probability of success in r&d, part of a body of literature termed ‘probabilistic innovation’ (callaghan 2015). the rapid mobilisation of knowledge flows using large numbers of people, or the ‘crowd’, is the subject of this growing body of literature, which may have important implications for how crowds can be used to solve problems in real time, or quickly enough to stop certain disasters unfolding. viral communication (kaplan & haenlein 2011) is one example of how technology has enabled a radical acceleration in the speed at which crowds of people communicate. this article seeks to stress the importance of drawing insights from the way viral social media and internet communications operate, as well as the way flash mobs work, in order to add to a synthesis of theory to develop a theoretical model of how the crowd can be used to solve knowledge problems on the scale of global epidemics. the rationale that underlies this process is that the spreads of viruses or epidemics have certain characteristics that are common to the spread of viral communications, and that a transdisciplinary meta-theoretic synthesis is necessary to develop systems of real-time problem-solving, or problem-solving research that can be undertaken under intense time constraints. it is argued that the development of this theoretical synthesis can be taken to represent the genesis of a new paradigm within knowledge management, or a ‘second generation’ of innovation theory, termed ‘probabilistic innovation’ (pi) (callaghan 2015). the term pi is taken to reflect the way the probability of solving problems can be increased exponentially if the number of problem-solvers, or problem-solving inputs into problem-solving, can also be increased exponentially. similarly, the speed at which problems can be solved is also taken to be a function of the extent to which the same probabilistic mechanisms can be harnessed in support of real-time problem-solving. key to the development of this field, however, is the development of its theoretical foundations. to understand how to unearth the underpinning body of theory that explains how crowds work and how crowd-based distributed knowledge management systems can contribute to real-time research systems, it is necessary to draw together theory from a wide range of literatures. this article seeks to do this, and hence to make a contribution to the knowledge management literature in the following ways. firstly, with the relatively recent emergence of crowdsourcing (howe 2006) as an area of study in the academic literature, the field of crowdsourced r&d seems to be advancing rapidly, but seems to lack a coherent theoretical structure that relates its constituent elements. pi as a developing field seeks to offer this structure. the core theoretical structure of the crowd-based problem-solving literature devoted to pi currently has its roots in: (1) economic theory and the problems posed by decentralised (hayek 1945), or tacit (von hippel 1994), knowledge; (2) theory of how crowds in the form of markets solve pricing problems (fama 1970, 1995; smith 1962, 2003[1764]); (3) swarm intelligence theory (bonabeau & théraulaz 2000; dorigo, bonabeau & theraulaz 2000; garnier, gautrais & theraulaz 2007); (4) collective intelligence theory (malone & klein 2007; woolley et al. 2010), as well as (5) the use of the crowd as applied to disaster management (zook et al. 2012) as well as how crowdsourcing can be used to reorganise work to support accelerated problem-solving (niederer & van dijck 2010).whereas these constituent dimensions contribute useful knowledge to this emerging field, what is lacking is their integration into a single theoretical framework with a clear rationale which can inform the further development of the field as a unified area of study within the area of knowledge management. this article attempts to contribute to this vision, and offers a theoretical framework in support of this. secondly, given wide acknowledgement of the decreasing returns to investment of pharmaceutical r&d (gassmann & reepmeyer 2005; grasela & slusser 2014; horrobin 2000; martin & scott 2000; munos 2009; nathan 2007; scannell et al. 2012), and its failure to address problems such as ebola outbreaks, rapidly increasing antibiotic resistance or microbial drug resistance in general within a global context of dramatically rising healthcare costs (which are particularly problematic in certain regions with ageing populations or severe resource constraints), knowledge management theory is needed to address these knowledge problems in a way that is useful to r&d practitioners and theorists. in light of these challenges, this article argues that a new paradigm in r&d is necessary to solve the knowledge problems of a new era. in light of these challenges, this article builds on theory relating to the pi paradigm and second generation innovation, which is differentiated from first generation innovation on the basis of its use of probabilistic mechanisms (callaghan 2016), which in turn is derived from the open innovation literature (chesbrough 2011), in an attempt to provide useful insights into how real-time research problem-solving might be enabled. thirdly, the field of knowledge management, through its specialised focus on knowledge management systems, requires a theoretical ‘bridge’ from knowledge theory across to other fields to which it can contribute theoretical and practical problem-solving insights. this article seeks to build linkages between crowd-based knowledge management theory and its application in the scientific field in general and in medical or pharmaceutical r&d in particular. given the serious problems outlined above, theory from a wide range of disciplines needs to be integrated into a framework that is useful to scientists in general. this article therefore seeks to integrate (into the body of pi theory described above) further insights that relate to the phenomena of flash mobs, viral marketing and congestion theory to provide an overarching framework that can serve certain knowledge needs of scientists in many fields. this framework therefore builds on the use of crowdsourcing, which is increasingly being applied to solve research problems in the medical field (adams 2011; armstrong et al. 2012; foncubierta-rodriguez & müller 2012; sims et al. 2014; yu et al. 2013). having outlined the objectives and rationale behind the paper, it proceeds as follows. firstly, proof of concept as it relates to crowd-based problem-solving is considered to demonstrate the salience of the growing body of literature that forms the basis for the developing pi theoretical framework. certain challenges to the development of the field are then acknowledged, and the importance of a constant and ongoing synthesis of theory is stressed. next, insights from the way flash mobs are able to mobilise members of the crowd are identified as examples from which pi theory can be developed, as are the ways flash teams can offer insights into how teams can be formed almost instantaneously and be designed to grow or to break up in response to the requirements of the problems they solve, or in response to the ‘problem landscape’. the focus then shifts from the mobilisation of the crowd in support of problem-solving to operationalisation, and the role of artificial intelligence (ai) and theory relating to congestion is briefly considered as a prelude to the discussion of an overarching pi theoretical framework, as well as certain arguments in support of its theoretical synthesis. the paper then concludes with a summary of its arguments and recommendations for further research. proof of concept and the need for a unifying theoretical framework the field of crowd-based problem-solving is developing rapidly. different terminologies have emerged, that relate to essentially the same domain. at the heart of this domain is the notion that large numbers of people, or crowds, can be harnessed to solve problems. zhai et al. (2011:879) offer the notion of expert-citizen engineering, or citizen engineering, described as ‘a concept that engages a cohort of physically dispersed citizens connected by the internet to collaboratively solve real-world problems through massive cooperation’. zhai et al. (2011) explain this concept as follows. with advances in information technology, we can build transformative cyber-infrastructures to effectively leverage the ‘wisdom of crowds’… regarding the citizen engineers who function as the main contributors, there is a wide spectrum of human resources that that crowdsourcing system designers can harnessfrom amateurs/hobbyists, lacking practical experience, to experts/licensed engineers, with years of professional training. as such, we are encouraged to investigate proper approaches to design ces that can sufficiently engage and support expert citizens who have unique needs that may be different from those of amateur citizen engineers. (p. 879) the implementation of second generation innovation systems and the principles of pi has been made possible by recent advances in information technologies. zhai et al. (2011) also offer the following vision of these recent information technology advances. emerging information technologies empower us to build transformative cyber-infrastructures. characterised by broad-band networks, high performance processors, these novel technologies have facilitated expansive collaboration among users scattered across many physical and institutional locations. (p. 879) on the back of rapidly developing technological capabilities, a host of different platforms have developed that can enable crowd-based work and problem-solving. a range of different platforms in the form of online marketplaces have emerged which allow for crowdsourced work, such as amazon’s mechanical turk (amt); this type of platform, however, is limited to tasks that are mutually independent, of shorter duration, and less cognitively challenging (zhai et al. 2011). zhai et al. (2011:880) argue that while the development of wikipedia required only about 100 million brain hours to develop, much more than this is spent by crowds on leisure activities per year, and a cognitive surplus exists within the crowd which can be captured by citizen engineering, where ‘researchers are encouraged to develop well-designed mechanisms and methodologies to channel and motivate humans to solve challenging problems that computers cannot yet handle well’. examples of this include the development of mozilla firefox and the apache web server, and other examples of ‘proof of concept’ relating to crowdsourced projects in the literature include ebird, galaxy zoo, foldit, people-centric sensing, knowledge collection, stardust@home, human search engine, crowd photo tagging, participatory risk management (prm), and online team gaming (zhai et al. 2011). despite the widespread success of crowd-based platforms in solving complex problems, the field is still new and its potential relatively untapped; however, certain challenges exist that will need to be addressed for the field to move forward, particularly in terms of crowdsourced r&d, which will typically require some proportion of expert input from the crowd. according to zhai et al. (2011:880), there are three primary challenges faced in attempts to develop expert-citizen engineering projects: (1) task complexity (associated with the need for high human intelligence and the need for advanced levels of skills as well as the need to ‘conduct a whole range of experiments to provide objective, insightful and trustworthy consultancy’), (2) recruitment difficulty (because of the complexity inherent in tasks, ‘available human resources are limited and membership eligibility is rather selective, compared to traditional crowdsourcing tasks’) and (3) resource requirements (complicated tasks can require sophisticated analysis tools and computational resources; for example, current analysis and design methods, such as ‘nonlinear finite element analysis and design methods, such as nonlinear finite element analyses of complex structures, can overstress in-house computational capabilities of many firms and laboratories and far exceed the resources of most citizen engineers’). the system design functions of crowdsourced r&d systems can also be provided by the crowd itself. however, to do this system designers face a further challenge as crowd-based users have diverse backgrounds and malicious users can also create challenges; practicable workflows are necessary to achieve an effective aggregation of results and to maintain quality control (zhai et al. 2011). zhai et al. (2011:886) stress that to ‘leverage the expertise from skilled citizens, we need to develop new principles and theories that can guide system designs to satisfy the unique needs of high level users’. the pi field will need to borrow theory from wherever it can to supplement the theory it develops in order to develop system design processes that can manage very large numbers of problem-solving inputs in real time. at this point in time these challenges seem daunting. however, given the rapid speed of technological development it might be possible to accelerate progress towards this end as long as an overarching theoretic framework can exist to guide these developments. the mobilisation of the crowd an important dimension of theory development for the pi field relates to challenges associated with the need to mobilise the crowd. a flash mob is formed by groups of people that semi-spontaneously form in public space, typically for the purposes of performance or as part of a guerrilla marketing strategy, a process that is made possible by social media (grant, bal & parent 2012). the literature related to flash mobs and the development and management of ‘flash teams’ offers further insight into how the pi field might integrate useful insights from these phenomena. brejzek (2010) offers the following description of the effects of flash mobs. since 2003, stunned commuters, shoppers, sales staff and politicians have been confronted unexpectedly with flocks of seemingly unrelated people congregating in the central business districts (cbds) from leipzig to teheran, london to munich. performing nonsensical actions, the individuals tend to disperse shortly after their action has taken place without so much as a word to each other. (p. 112) as a cultural phenomenon, flash mobs have been described as a manifestation of the physicalisation of viral culture (brejzek 2010; wasik 2009). what sets this phenomenon apart from other social media applications is the way physical action is enabled and directed through a powerful effect that captures the imagination of the crowd. the ability to capture the imagination of crowd participants is an important dynamic, and the pi literature should not neglect this stream of its literature development. to invest effort in the crowdsourced r&d process and to produce almost instantaneous research results will require the mobilisation and motivation of large numbers of people. the flash mob conception can be related to the more technical aspects of managing problem-solving teams through the use of the concept of ‘flash teams’. retelny et al. (2014:75) offer a framework for assembling and managing paid experts from the crowd, termed ‘flash teams’, which ‘advance a vision of expert crowd work that accomplishes complex, interdependent goals such as engineering and design’ according to sequences of ‘linked modular tasks and handoffs that can be computationally managed’. flash teams can be defined as ‘computationally-guided teams of crowd experts supported by lightweight, reproducible and scalable team structures’ which seek to ‘embed the techniques of high performing offline teams within a model that can take advantage of computation’s ability to abstract, scale, and visualise progress’ (retelny et al. 2014:77). the use of reproducible and scalable team structures are an example of systems that can be used to manage processes associated with very large numbers of problem-solvers as they populate a problem space. the ultimate goal of this process is to have the crowd also provide direction and interactive systems to manage r&d work as it unfolds in real time. the work of retelny et al. (2014) is now given special attention in order to highlight these concepts, which are considered especially important to the emerging pi literature. interactive systems are used to plan and reconfigure the structures of these teams, so as to create larger organisational structures in response to user requests, immediately hiring in reaction to needs, and to ‘pipeline intermediate output to accelerate completion times’ (retelny et al. 2014:75). retelny et al. (2014:75) present an end-user authoring platform, namely ‘foundry’, which allows uses to initiate modular tasks and manage teams though the stages up to handoffs of intermediate work; in this way crowdsourced design prototyping, course development and film animation is enabled, ‘in half the work time of traditional self-managed teams’. this example is but one of many which can be used to highlight practical solutions to the problem of managing very large numbers of problem-solvers in real time, and to the problem of coordination. according to retelny et al. (2014:75), crowdsourcing systems ‘coordinate large groups of people to solve problems that a single individual could not achieve at the same scale’, and microtasking systems typically use ‘highly-controlled workflows to manage paid, non-expert workers towards expert-level results’. however, this becomes more difficult when it comes to more complex real-world tasks requiring deep domain knowledge that is less easy to decompose into independent microtasks which any member of the crowd can complete; with regard to their suggested system of structured collaborations between experts from the crowd as a solution to this problem, retelny et al. (2014) offer the following vision to: enable anybody with a napkin sketch of a design idea to ask the crowd to follow the user-centred design process and create a user-tested, high-fidelity prototype of that idea within twenty-four hours? (p. 75) the importance of this body of work is in its focus on design; to have the crowd design its own solutions to design, system and quality assurance problems would be an important dimension of the pi literature. retelny et al. (2014) suggest that the use of expert crowd work can be designed around the concept of flash teams, organised around sequences of linked tasks, which have the same coordinating strength as more lightweight team structures while at the same time being used to leverage and support collaboration, automatically create teams, manage the size of these teams and instantaneously combine teams into larger organisations. to do this, each task would need an input and an output, and end users would need to link modular tasks and each task’s output becomes the input for the next task, as web applications are used to monitor the workflow as computational systems leverage this structure and create crowd dynamics; in this way, work can be pipelined, and in-progress work that is helpful to downstream tasks is passed along to support these tasks (retelny et al. 2014). research into these processes is important, as flash teams have the potential to leverage the scale of paid crowdsourcing for expert work, going further than volunteer crowd systems, and the scaling process can be ramped up through computational management of an elastic work force, resulting in complex work at crowd scale as the structures of traditional organisations are automated (retelny et al. 2014). the vision here is to have an organisational structure, or structures, that morph in real time to the contours of the problem space. this process is illustrated in figure 1. figure 1: erosion of problem space driven by swarm intelligence configurations. the phenomenon of swarm intelligence (bonabeau & théraulaz 2000; dorigo, bonabeau & theraulaz 2000; garnier, gautrais & theraulaz 2007) can be taken to provide further insights into the process whereby very large numbers of problem-solvers can ‘populate’ the problem space of a particular problem landscape. the importance of swarm intelligence in this process relates to how large numbers of problem-solvers can work on a problem in the absence of central direction. for example, ants build complex architectural structures, complete with passages and antechambers, without central coordination, using a process termed stigmergy, where each individual ant reacts to its point of contact with the ‘problem space’ and ‘erodes’ this problem space at that point on the front-line of the problem landscape. this process is also illustrated in figure 1, which also seeks to illustrate the process whereby flexible organisational structures can form, grow or break up in real time as needed (retelny et al. 2014), according to the unique configuration of the problem landscape. an example of this process is the case of proteomics research, where an almost infinite number of permutations of protein strings represents the problem landscape and ‘first generation’ innovation or r&d processes (which do not use probabilistic mechanisms) are simply not able to populate this landscape with the many thousands of researchers required to make a difference in such a large problem space. pi may offer an opportunity for real-time research in large problem space contexts such as proteomics and genetics, or in the ‘new’ pharmaceutical space dominated by (large molecule) protein research. figure 1 therefore seeks to illustrate two dimensions of the challenges pi needs to solve to become a successful field, namely the problem of coordination of large numbers of the crowd engaged in large scale problem-solving in the absence of (or under constrained conditions of) central direction, and the way individuals can come together almost instantaneously and form micro-organisations in real time in response to specific problem-solving needs at a specific point on the problem landscape configuration. it is acknowledged that each point of contact with the problem landscape may have unique characteristics relevant to problem-solving. as stressed previously, the mobilisation of the crowd in support of problem-solving is the focus of a rapidly developing body of literature. crowdsourcing can successfully mobilise large numbers of problem-solvers, yet to date platforms have developed that are well suited to tasks requiring few skills, such as amt, and those using amateur input, such as foldit, and most crowdsourcing workflows and algorithms now aim to produce expert-level performance from non-expert contributions (retelny et al. 2014). examples of success in this process include mapreduce frameworks which channel crowdsourced inputs into encyclopaedia entries, document editing, translation and visual question answering, which can be optimised using ai (retelny et al. 2014). the transition of crowdsourced problem-solving, from successfully addressing problems that require a limited skill set to being able to solve problems that are extremely complex, may be the core theoretical and practical problem that the emerging pi literature needs to resolve. whereas certain insights can be gleaned from how flash mobs successfully capture the imagination of the crowd and are successful in mobilisation, further insights can be drawn from the use of different platforms that seek to operationalise the problem-solving potential of the crowd. post-mobilisation: operationalisation according to retelny et al. (2014), problem-solving crowdsourcing that recruits experts has to date typically been restricted to single-expertise areas and have been ‘one offs’, but what is needed are platforms such as foundry, which can support large numbers of tasks on demand at using higher-level work flows based on expert knowledge. the capacity of crowds to undertake expert work using non-experts and to leverage the skills of experts can be enabled using visual workflow and management tools. more complex problem-solving processes can be enabled using visual workflow tools and management tools like gantt charts which are based on a visual timeline language; these processes can be designed to facilitate worker interest, honesty, and motivation, and a process of visible collaborators with clear goals underpinned by class hierarchies which integrate with business processes in a team-based context (retelny et al. 2014). theory from the field of organisational behaviour already provides insights into how challenges to effective team coordination, such as geographic dispersion, technology-mediated communication and dynamic changing team membership can be managed in expert crowdsourcing (retelny et al. 2014). similarly, theory from the field of ai can offer complementary perspectives of how the crowdsourced r&d process can be managed. ai can therefore offer further important insights into how the crowd can contribute to real-time problem-solving. in practical terms, propositional methods of planning algorithms can be used to convert planning challenges into ‘propositional conjunctive normal form formulas for solution using systematic or stochastic’ methods; interleaved planning and execution is now part of the ai landscape (weld 1999:93). the speed at which classical planning problems can be solved has increased exponentially over time (weld 1999). theory related to the planning and management of flash teams is therefore especially salient in three areas: (1) in how encoding can be used to align responsibilities and coordination using structures that manage shared space and shared work around clearly defined work roles, (2) in how management modularity theory predicts how loosely coupled system components with standardised interfaces can be used in multiple configurations and (3) in how multiple integration mechanisms, including pipelining, structured handoffs, and directly responsible individuals (dris) can address weaknesses in key points of coordination (retelny et al. 2014). key to the success of expert crowdsourced teams is the need to quickly comprehend issues related to shared work, interdependencies and roles, which, when complemented by team structures, modularity, and coordinating mechanisms allow for the leverage of automation, computation, the economies of scale of the crowd and the flexibility of the crowd (retelny et al. 2014). however, if these economies of scale are achieved, the management of congestion and overcrowding at the surface of the problem space also needs to be considered. a consideration of how very large numbers of the crowd can solve problems in real time would therefore not be complete without a discussion of congestion, and theory related to this is potentially also an important dimension of the pi theoretical framework. with regard to congestion and transport systems, vickrey (1969) makes the following observations. investment in transport facilities necessarily begins by being largely investment in the provision of new routes or new services under conditions of substantial indivisibilities and increasing returns to scale. under these conditions the usual profitability tests for determining the desirability of specific investments lead generally to underrather than to overinvestment in transportation facilities. at this stage, cost-benefit analysis needs to include substantial elements of consumers’ surplus on the benefit side in order to arrive at correct evaluations. as investment proceeds, however, larger and larger proportions of transportation investment are made primarily, or at least in large measure, to relieve congestion on existing routes and to expand overall capacity. in such instances criteria based on apparent profitability may be seriously misleading in the opposite direction, and when notions of consumers’ surplus are narrowly applied without regards to the overall situation, the errors may be compounded. (p. 251) in his seminal work, vickrey (1969:251) offers six categories of congestion: (1) simple interaction, multiple interaction, bottleneck, triggerneck, network and control, and general density. a synthesis of theory that seeks to show how to exponentially increase the numbers of problem-solvers that populate a problem space will need to draw insights from the categorisation of different types of congestion to manage what will, if successful, become a congested ‘space’. at some point, a critical mass might be reached in pi processes that successfully mobilise very large numbers of problem-solvers, and the critical success factors of the process might shift towards managing congestion in the problem-solving system. this challenge might be particularly acute under a real-time temporal constraint. these categories are now briefly outlined, using vickrey’s (1969) transport analogies: (1) single interaction relates to the case where two units pass each other in a way that requires a delay so as to avoid collision; these are typical to light traffic, and congestion delay ‘tends to vary as the square of the volume of the traffic’ and a driver will experience a similar delay to what he or she causes; (2) multiple interaction refers to conditions at high levels of traffic density, but short of capacity (between 0.5 and 0.9 in capacity), under which one additional vehicle can contribute a multiple of the congestion it experiences; (3) the pure bottleneck situation relates to the presence of a relatively short route segment with a fixed capacity that is not sufficient to meet demand; (4) the triggerneck occurs when queues at a bottleneck interfere with other traffic not on route through the bottleneck; (5) network and control congestion occurs when peak traffic requires control measures in order to manage it, which in turn may slow traffic; and (6) general density of traffic can lead to long-run increasing costs, as more routes need to be planned and constructed. the rationale behind the inclusion of this congestion typology here is simply to suggest a central place for theory related to congestion in the developing theoretic framework of pi, given the challenges of coordination and management of very large numbers (high volume traffic) of problem-solvers. intuitively, the pi framework can seem to be a vision that is a ‘bridge too far’, or a vision that seems difficult to attain at this current time, but it is argued that with a comprehensive incorporation of theory this vision will be possible to attain, and the management of congestion in the crowd may have a central place in this framework. understanding the mechanisms whereby congestion can be managed by some form of internalising pricing mechanisms, or by imposing differentiated costs on congestible behaviours, is one dimension of this. according to vickrey (1969:258), congestion can be managed by allowing pricing to allocate transport flows, as pricing ‘makes it possible to exclude the low-value uses and base the magnitude of the improvement primarily on the uses that are valued sufficiently highly so that they warrant the marginal cost of the final increment to the magnitude of the improvement’. as with other flows of traffic, if airport landing fees reflect congestion costs then relief from congestion is possible; where ‘charges for the use of alternative routes fail to reflect congestion costs at the margin’, then congestion will be problematic (vickrey 1969). these charges also have an informational role, as they can provide information on capacity as well (vickrey 1969). understanding the relative value of different types of problem-solving inputs might provide a way to ensure that the costs of congestion are balanced with benefits; further research might do well to build on this work in anticipation of the success of the crowd mobilisation process. having considered certain aspects of how knowledge of flash mobs can contribute to knowledge of how to mobilise crowds, more specific knowledge was considered, of how crowds, once mobilised, could be managed in such a way as to change their configurations and their permutations of team structures, from individual to micro-organisational, according to the dictates of the problem space. under conditions of successful crowd mobilisation, however, the management of congestion arguably becomes an increasingly important challenge, and vickrey’s (1969) congestion theory was therefore briefly reviewed. at this point, it is necessary to provide an integrative logic to the discussion, and figure 2 is used for this purpose. figure 2: from theory synthesis to theory development: the field of probabilistic innovation and what it offers. synthesis figure 2 illustrates a theoretical framework that can be taken to underlie the development of the field of pi at this point in time. to capture pi advantages such as extremely large economies of scale in relation to accelerated problem-solving that approaches real-time capabilities, certain knowledge is first required as to how large scale crowd-based problem-solving systems work. the theory discussed thus far in this article is now included in a broader theoretical synthesis, which seeks to provide an overarching overview of how different streams of literature fit together to enable the pi vision. the seminal basis of this body of work remains the work of smith (2003 [1764]). the solving of the problem of resource distribution on a large scale by the market mechanism, or the ‘invisible hand’ (smith 2003 [1764]) is an example of how very large ‘crowds’ of people solve the knowledge aggregation problem, notwithstanding the existence in certain cases of market failure. at the heart of the challenges facing real-time crowdsourced r&d is the knowledge aggregation problem (hayek 1945; von hippel 1994), or the problem of how to distribute knowledge and how to bring together knowledge that is geographically dispersed and difficult to find. to some extent, the solution to the knowledge aggregation problem as it relates to crowdsourced r&d has two aspects: a global knowledge aggregation, or macro, dimension and a more localised, or micro, dimension. the former relates to how very large numbers of people can be mobilised and motivated to contribute inputs into the problem-solving process. the latter relates to how the knowledge inputs are integrated and processed at the individual level, so that they can be channelled into real-time r&d outputs (while managing the congestion associated with a deliberate ‘overpopulation’ of the problem space. the ‘macro’ process holds the key to capturing the probabilistic effects associated with large numbers. the central limit of probability theory (bernstein 1944) suggests that as numbers in a sample increase, certain distributional effects occur. galton (1907) drew attention to the way crowds, if large enough, can be effective in solving certain types of problems, offering the example of a crowd of 800 at a stock and poultry exhibition who provided individual estimates of how much an ox would weigh after it was processed (and who were able to, on median aggregate, predict this within 0.008 of its value: the median estimate was only nine pounds off the weight of 1198 pounds). while evidence abounds of the effectiveness of the crowd to solve scientific research problems, as in the case of innocentive (howe 2006), it is argued here that little is known of the upper limits, or ultimate potential, of the collective crowd in problem-solving; different literatures seem to offer up different pieces of this puzzle, certain of which are included in figure 2. however, it is argued that this body of theory might be just ‘the tip of the iceberg’ and part of a wave of literature that is building up, and which will ‘break’ at some point in the near future, and will yield benefits in human health, medicine and science itself. galton (1907) stresses the effectiveness of democracy as another example of what he terms ‘the wisdom of crowds’. an objective of pi as an emerging field would be to apply a decomposition analysis to this phenomenon (the wisdom of crowds), to understand the causal effects that make crowds effective at solving certain problems, over and above how the knowledge aggregation problem is solved through the use of the crowd. however, to understand the wisdom of crowds, one first has to take recourse to other bodies of theory that illustrate crowd problem-solving in its different forms. galton’s (1907) example of a betting market also echoes seminal work on how crowds solve pricing problems in larger betting markets such as stock markets (fama 1970, 1995; smith 1962). galton’s (1907) betting market analysis has been taken up in work such as hanson’s (1995, 2000, 2003), which argues that betting markets are very effective at solving knowledge problems and that the principles that underlie them can also be applied to the research process itself as well as many other applications. collective problem-solving can be found in other contexts, and biological examples exist, such as the use of collective intelligence on the part of insects. swarm intelligence (bonabeau and théraulaz 2000; dorigo, bonabeau & theraulaz 2000; garnier, gautrais & theraulaz 2007) offers insights into how social insects like ants can build advanced architectural structures as a swarm without central direction or central planning (and no blueprints). this has relevance for crowdsourced r&d because when very high numbers of contributors provide knowledge inputs into problem-solving, they need to ‘populate’ the problem space in a way that can be independent of the need to direct the problem-solving processto be effective even in instances where the processes of central direction are not, or cannot, cope with congestion or volumes of inputs. this is an important theoretical stream of literature as applied to pi, which is expected to grow in its importance over time, as exponentially larger numbers of problem-solvers become part of the kiehrasearch process (to be discussed shortly). theory that draws from swarm intelligence is part of the bedrock of theory that is taken to contribute to the development of the field of pi. in figure 2, certain theoretical frameworks are shown, which are drawn from different fields that contribute to the ‘bedrock’ of the larger pi meta-theoretic platform on which further theory development needs to take place. the bodies of theory which form part of this ‘bedrock’ include collective intelligence theory (malone & klein 2007; woolley et al. 2010) which seeks to leverage the problem-solving abilities of groups, and disaster management principles (zook et al. 2012) which can be used to guide the pi process in attaining real-time capabilities to solve serious problems under serious time constraints. theory relating to how crowdsourcing can reorganise work is also important, as a rapidly growing area of literature is devoted to new work systems and to the way work is being reorganised to be performed by crowds (niederer & van dijck 2010); this body of literature offers novel micro-level insights into how large scale problem-solving can be effective. this literature also offers insights into how to differentiate processes between expert work and non-expert work, and how far this ‘front-line’ can be extended; how far non-experts can be enabled to perform expert work or to support expert work. however, to recruit and manage exponentially increasing numbers of knowledge inputs, or capturing ‘viral effects’ also requires multiple platforms, or a proliferation of problem-solving platforms. an example of such a platform is therefore included in figure 2. in figure 2, the kiehrasearch platform is taken to represent an example of an operational platform, or website, dedicated to solving knowledge problems and developing real-time research processes to do this. the kiehrasearch platform is an example of a crowdsourced r&d platform that is under development but is similar to other platforms such as innocentive, the difference being that it is non-profit in nature; it is used here simply to illustrate the need for such platforms to proliferate to also populate the problem space on the macro level. in other words, platforms that seek to address these problems need to also be developed in large numbers in order to support the exponential increase in problem-solvers required for pi to develop. the non-profit nature of these platforms can become a problem-solving advantage in that knowledge inputs can be fed back into the crowd to develop a ‘three-dimensional’ problem-solving space (callaghan 2014), as this might enable and accelerate innovation and knowledge creation exponentially. as a research methodology, pi is perhaps a necessary complement to existing research systems, and should not be used to supplant current r&d systems and the profit-seeking model of innovation, as pi systems are ideally suited only to large scale foci and the extensive mobilisation of resources, which may only be appropriate for target problems which have certain characteristics. figure 2 shows a clustering of three types of problems that might be uniquely suited to pi interventions: (1) emergent epidemics require the development of a disaster management capability, and it is argued that pi is well suited to this; (2) the large scale threats posed by antibiotic resistance and the chronic disease burden on society is another area that may be well suited to the large scale resource mobilisation associated with pi; and (3) the problem of ageing populations in a context of rapidly rising health costs poses another societal problem that might be uniquely suited to problem-solving using probabilistic platforms. while it may never be possible to reverse ageing, it might be possible to solve many of the diseases that hasten the ageing process, and thereby to decrease the pressures on national health budgets through increasing levels of health in spite of the ageing process. conclusion the objective of this article was to outline a theoretical framework for the development of pi as a field of academic enquiry, and to identify different literatures as candidates for inclusion in this framework. firstly, dangers associated with the absence of a global real-time problem-solving system in the face of unsolved knowledge problems such as epidemics like ebola as well as other threats such as increasing antibiotic resistance were highlighted. the concept of expert-citizen engineering was introduced, to locate the crowdsourced r&d literature that followed in relation to notions of expert crowd problem-solving. literature was then considered that was related to the mobilisation of the crowd in support of real-time problem-solving, with a specific focus on the temporal aspect of flash mobs and the use of flash teams as a potentially important stream of future research. next, the role of ai, swarm intelligence and congestion theory within this overarching framework was discussed. the paper concluded with the development of an overview of the theoretical framework of pi as a field currently, and three practical targets of the pi process, namely the development of: (1) real-time research disaster management capability suited to managing global epidemics like ebloa, (2) the development of real-time research with the potential to tackle societal health threats, or solving the current ‘epidemic’ of chronic illnesses such as diabetes as well as problems such as rising levels of antibiotic resistance, and (3) real-time research capability to focus on ageing research, as rising health costs associated with ageing populations pose threats to societies. in all, this article sought to offer some sort of ‘road map’ for the development of the pi field, in a way that sought to include the theory-search process, or the process whereby theory-search and incorporation contributes to a synthesis of literatures, and a vision of potential outcomes for the field. although there is perhaps little in common between the spread of lethal viral epidemics and the viral spread of social media-enabled communication, what does seem to link them is the notion that these are both highly effective processes; and it is hoped that the fledgling field of pi can offer concrete benefits to science by continuing to develop theory based on insights from the study of other highly effective processes, or processes that explicitly harness the probabilistic forces of innovation. acknowledgements competing interests the author declares that he has no financial or personal relationships that may have inappropriately influenced him in writing this article. references adams, s.a., 2011, ‘sourcing the crowd for health services improvement: the reflexive patient and “share your experience” websites’, social science and medicine 72(7), 1069–1076. https://doi.org/10.1016/j.socscimed.2011.02.001 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health policy 29(2), 7–33. abstract introduction literature review legislative framework united states rescue mechanism united kingdom rescue mechanism south africa’s rescue mechanism success factors of the us rescue mechanism research methodology discussion of research findings ethical consideration discussion of quantitative results ranking recommendations arising from the study conclusion acknowledgements references about the author(s) rajendra rajaram school of accounting, economics and finance, university of kwazulu-natal, south africa anesh m. singh graduate school of business, university of kwazulu-natal, south africa navitha s. sewpersadh school of accounting, economics and finance, university of kwazulu-natal, south africa citation rajaram, r., singh, a.m. & sewpersadh n.s., 2018, ‘business rescue: adapt or die’, south african journal of economic and management sciences 21(1), a2164. https://doi.org/10.4102/sajems.v21i1.2164 original research business rescue: adapt or die rajendra rajaram, anesh m. singh, navitha s. sewpersadh received: 26 oct. 2017; accepted: 27 july 2018; published: 30 oct. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the low success rate of business rescue has prompted debate relating to the effectiveness and continued suitability of business rescue as a mechanism to rehabilitate financially distressed companies. although this legislation was implemented in may 2011, statistics indicate that the success rate for business rescues is only approximately 12%. a feature of the business rescue environment in south africa is the lack of knowledge, necessitating more research in the field. aim: this study focused on changes required to ensure the survival and increased success of the business rescue legislation. setting: this research was undertaken in south africa between 2015 and 2017. methods: a mixed-methods research approach was utilised for the study. the approach entailed interviews with 7 of the top 10 business rescue practitioners to diagnose reasons for business rescue failure and establish factors that would contribute to successful business rescues. a survey was conducted with the membership of the turnaround management association of southern africa. results: the survey was mailed to 130 members and the response rate was 54%. this study found that the causes of business rescue failures are mainly attributable to the skills deficit of the business rescue practitioner or the practitioner’s abuse of legislation. there is also a negative impact of appointing a liquidator as a business rescue practitioner. other factors contributing to the failure of business rescues are management’s delay in filing for business rescue, either due to the resistance of filing or their lack of awareness of their distressed status. this study also provided the ranking order for business rescue success factors with the accreditation of a business rescue practitioner being ranked as first. conclusion: the study chiefly focused on diagnosing and understanding the reasons for business rescue failure. the original contribution of this study to knowledge is the ranking of an accreditation framework for practitioners as the most important factor that would contribute to a successful business rescue. this study not only explains the low success rate of business rescue but ways to improve and succeed in rescuing ailing businesses. introduction substantial emphasis has been placed on the need for a corporate rescue culture because there is a greater probability of a successful reorganisation if a business rescue is attempted at a pre-insolvency stage (kastrinou & jacobs 2017). over 35 years ago, the pioneering study conducted by whetton (1980) highlighted the scarcity of studies in the management of organisational decline and the need for research to mitigate the impact of an emerging era of retrenchment. the study proposed a joint agenda for research, teaching and consulting to rectify the neglect (whetton 1980). therefore, there is a growing need for theoretical and empirical investigations into organisational decline. notably, the threat of organisational decline has increased since whetton’s (1980) efforts to increase research. as evidenced in the continued weakness of the global economy, the persistent threat of decline remains a highly relevant global concern (trahms, ndofor & sirmon 2013:1278). internationally, the rescue system developed by the usa was incorporated in chapter 11 of the bankruptcy code (1978) (herein referred to as ‘chapter 11’). in the uk, kastrinou and jacobs (2017) illustrated the corporate rescue culture, as publicised in the enterprise act (2002) together with the insolvency act (2000) (herein referred to as the ‘uk system’). adopting from these developed economies, south africa introduced the companies act no. 71 (2008) in april 2009; however, it only came into effect on 01 may 2011 (burke-le roux & pretorius 2017). the business rescue provisions incorporated into chapter 6 of the companies act (2008) (herein referred to as ‘chapter 6’) led to a new regime of reform in south africa, where business rescue was proposed as an alternative to liquidation for ailing businesses facing insolvency (burke-le roux & pretorius 2017). however, burke-le roux and pretorius (2017) also noted that despite the revolutionary intentions of the chapter 6, revisions to the act commenced in 2016 because there were problems discovered within the provisions of the act. thus, it is essential for more research to be conducted in the field of business rescue legislation, because research in this field would further the goal of better understanding organisational decline and improving an organisation’s response to financial distress (mckinley, latham & braun 2014:88). as business rescue legislation focuses on distressed companies, this field forms an important focal area for research. this is because the enhancement of knowledge about the practical process of planning and performing a business rescue, specifically in relation to the establishment of factors of success, would provide a distressed company with the knowledge-based resources to obtain a profit and, ultimately, survive. literature review researchers have attempted to construct different models of the theory of the firm in order to explain the rationale for the continued existence of a business. the firm is frequently described as an economic institution whose objectives, decisions and activities are the result of fundamental market forces (spulber 2009:11). the firm is also referred to as a point of coordination for transactions between its different stakeholders (fleming, heaney & mccosker 2005:31). jensen and meckling (1976:3) likened the firm to a ‘black box’, which is operated in order to adhere to relevant market conditions relating to inputs and outputs, thereby maximising profits or returns to shareholders (correia et al. 2011:13). in the mid-1980s, there was an extension of the traditional view, relating to the utilisation of factors of production to maximise profits, towards one whereby the firm is conceptualised as a broad set of resources that are strategically utilised to enhance the performance of a firm (priem & butler 2001:22). the resource-based view of the firm was introduced by wernerfelt in 1984 to highlight the influence of proper utilisation of company resources on its competitive strategy and profitability (priem & butler 2001:23). a logical extension to the resource-based view of a firm is the knowledge-based view of the firm. this view emphasises the importance of knowledge as a resource (curado 2006:5). nonaka (1991, as cited in curado 2006), highlighted the importance of knowledge when concluding that the only true and lasting competitive advantage in a firm is the knowledge developed by that firm. accordingly, knowledge-based resources should become the focus of research in order that a sustainable competitive advantage is developed in the modern globally competitive economy, where knowledge is considered critical (curado 2006:5). the development of knowledge relating to the initial failure and subsequent rescue of a firm would serve as an enabler for a distressed firm to return to profitability and sustainability. when companies are established, an inherent expectation is that they will survive in the long run. however, many businesses experience financial distress because of mismanagement and adverse economic forces. operating under decline implies operating under distress, at which point, if the business is not rehabilitated, its death and closure would result (baird 2014:17). a rebirth can be achieved by the development of knowledge resources and capabilities relating to the field of business rescue. baird (2014:3) concluded that the identification or acquisition of knowledge, best practices or secrets of success, contributes to the rebirth of dying or distressed organisations. the acquisition or enhancement of a firm’s knowledge resources in relation to the planning and performance of a business rescue process will contribute to improved profitability and thereby facilitate a resurrection and continued existence of the firm. business rescue was introduced to rehabilitate financially distressed companies and thereby prevent their liquidation (lotheringen 2013). the companies and intellectual property commission (cipc) estimated that the success rate of business rescues is approximately 12% to 14% (lotheringen 2013). more recent statistics released by the cipc indicate that the success rate has not improved since 2013 (voller 2015). existing literature identifies certain factors, which translate into a successful business rescue. these factors include the effective planning of a business rescue (institute of directors in southern africa 2009), the management of the business rescue process (levenstein 2011), access to funding during business rescue (du preez 2012) and effective communication with stakeholders (van der burgh 2013). legislative framework many international solvency systems have established a formal process to rehabilitate companies experiencing financial distress (pretorius & rosslyn-smith 2014:109). conradie and lamprecht (2015) found that the international business rescue regimes and chapter 6 share similar goals. thus, the usa and the uk rescue mechanisms were selected for review for the following reasons: the business rescue mechanism of these countries represents the latest developments internationally. there are similarities in law between south africa and the uk. the us regime is credited with initiating the modern changes associated with business rescue (du preez 2012:10). united states rescue mechanism chapter 11 governs reorganisation that serves to resurrect ailing businesses, which is an alternative to chapter 7, where there is an immediate liquidation of a business. this is achieved primarily by encouraging financial restructuring that is binding on all parties (bracewell & giuliani 2012:1). its commencement may be voluntary, where it is filed by the debtor or company, or involuntarily, where it is filed by the creditors. when a creditor involuntarily files a petition, it involves an amount of risk as the court may order the petitioners to pay compensatory and/or punitive damages if it finds that the petition was filed in bad faith (mindlin 2013:2). however, chapter 11 also allows a company experiencing financial difficulty substantial protection against its creditors. this protection is in the form of a moratorium on payments, which is effective until a plan of reorganisation is adopted by the company (bharath, panchaegesan & werner 2013:1). the ‘debtor in possession’ under chapter 11 refers to management of the distressed firm, who work together with the business rescue practitioner to produce a plan for the bankruptcy court to ratify (burke-le roux & pretorius 2017). a key focus of chapter 11 is the preservation of the going concern value over the liquidation value by means of a plan of reorganisation (jones day 2007:6). this mechanism allows management to maintain control over and continue to operate the business. therefore, chapter 11 provides managers of a distressed firm with an unparalleled ability to control the reshaping of the firm’s capital structure (baird 2014:1). united kingdom rescue mechanism the uk formal mechanism to rescue a financially distressed company is referred to as ‘administration’, which is legislated according to the enterprise act of 2002. according to pretorius and rosslyn-smith (2014:116), this act is considered the best contender to rank with chapter 11. the enterprise act aims to achieve a successful resurrection of a financially distressed company by the creation of breathing space, during which a company is given time to formulate a plan for reorganisation (jones day 2007:8). the primary goal of administration is to rescue a financially distressed company as a going concern (museta 2011:57). if this primary goal is not achievable, then administration seeks a better result for the creditors or the distribution to secured or preferential creditors in the event of a liquidation. loubser (2010:56) noted that administration is only possible when approved by the courts and that such approval relies heavily on the information supplied by the prospective administrator. the notification process does not require the general body of creditors to be informed and is limited to the company, the applicant and the prospective administrator, who must be appointed before the application. the strictly regulated system of appointment of the administrator is an important feature of the success of the process (loubser 2010:197; museta 2011:59). an administrator who is not a member of a professional body or authorised by the secretary of state is strictly prohibited (loubser 2010:198). acting as an administrator without the required qualification is an offence, which may be sanctioned by imprisonment or a fine (museta 2011:59). management of a company in administration is required to carry out their statutory duties during the administration period (museta 2011:61). within 8 weeks of the administrator’s appointment, a proposal for achieving a rescue of the business is presented and such a proposal requires a simple majority vote of those creditors present. an administration expires after 12 months unless the court approves an extension (jones day 2007:15). a key difference to the usa’s chapter 11 is that the uk system involves the appointment of an administrator to oversee the process and therefore utilises a ‘practitioner in possession’ principle, as opposed to the usa’s debtor in possession (pretorius & rosslyn-smith 2014:116). south africa’s rescue mechanism the former regime of rescuing financially distressed businesses was handled under judicial management as provided for under the section ‘compromises and arrangements’ in the companies act 61, 1973. however, this was overhauled by chapter 6, ‘business rescue and compromise with creditors’, as provided for under the companies act of 2008, which defines ‘business rescue’ as measures to facilitate the rehabilitation of a financially distressed company through the temporary supervision of the affairs, business and property of the company. the supervision of affairs is carried out by a business rescue practitioner, who is appointed either by the directors in voluntary filings or by court appointments as per section 131. therefore, financially distressed businesses can prevent liquidation or forced closure by enacting an informal turnaround or a legislated business rescue. one of the main objectives of section 7 of the companies act (2008) is to provide for the efficient rescue and recovery of financially distressed companies, in a manner that balances all relevant stakeholders’ rights and interests. thus, the companies act of 2008 provides for two pre-insolvency proceedings, namely section (s.) 129, ‘business rescue’, and s. 155, ‘compromise with creditors’. although both pre-insolvency proceedings provide an ailing debtor trying to evade liquidation with access to corporate reorganisation, its procedures are drawn from the international rescue mechanisms discussed in the sections above. the s. 129 business rescue provisions are considered more traditionally like the administration procedure under the uk system (bradstreet 2014), because under business rescue, the company’s management loses decision-making abilities and is displaced by the business rescue practitioner (bradstreet 2014). in contrast, the provisions in section 155 for compromise with creditors, although simpler, are similar to those of the usa’s chapter 11 debtor in possession, where the debtor maintains control of its affairs and a compromise is reached between the company and the majority of its creditors (bradstreet 2014). therefore, the ‘debtor-friendly’ system under the companies act (2008) that allows the debtor company’s participation in the rescue sharply diverges from the traditional creditor-oriented approach under the previous companies act 61 (1973) (bradstreet 2014). however, the study by pretorius (2016) found a debtor-friendly fallacy after an examination of the legislative tension and its practical outcome posited a de facto creditor-friendly regime. calitz and freebody (2016) posit that a sudden 180-degree change to a debtor-friendly system after having a creditor-friendly regime in south africa for so long may not yield positive effects in the short term. notably, irrespective of who initiates the business rescue, the process would only continue if more than 75% of the creditors accept the business rescue plan (kastrinou & jacobs 2017). therefore, dissenting minority creditors are bound by the majority of the creditors who approve the business rescue plan in rescue proceedings (kastrinou & jacobs 2017). another feature of the companies act (2008) is section 135, which allows post-commencement financing to ailing companies that have filed for business rescue. post-commencement financing is funding available to companies after filing for administration or reorganisation, and it is used to enable the companies to pay for rehabilitation fees, carry on trade and pay for fixed costs (mkhondo & pretorius 2017). according to mkhondo and pretorius (2017), many regimes use post-commencement financing in some form, which is typically legislated or otherwise regulated. this type of financing is akin to the usa’s debtor in possession financing (mkhondo & pretorius 2017). section 134 of the companies act (2008) deals with protection of property interests, apart from sale of assets as part of the business rescue plan; the business under rescue can dispose of assets in the ordinary course of business, at arm’s length and for a value approved by the business rescue practitioner. according to mkhondo and pretorius (2017), the companies act (2008) does not cater for prepackaged sales, which encompasses new or existing funders acquiring a (further) equity in the company or the formation of a new company to acquire the assets of the company. success factors of the us rescue mechanism business rescue process the study by warren and westbrook (2009:629) concluded that a key success factor of a chapter 11 rescue is the speed at which cases are resolved. their study highlighted that a typical chapter 11 turnaround was resolved in about 9 months and that the average time for the resolution of a case was about 11 months. in contrast, the study by conradie and lamprecht (2015) identified key indicators for evaluating success, namely the going concern status on exiting business rescue and the comparison of the creditors’ actual return as opposed to the liquidation return. furthermore, the findings showed a need to establish indicators that would measure the shortto long-term economic viability of the business after reorganisation. additionally, the study by conradie and lamprecht (2018) illustrated that experts in the sample reached a high level of consensus on several indicators of a successful business rescue – notably, the need to compare the actual number of jobs saved as opposed to the numbers estimated in the business rescue plan. this study also found that 64% of the experts agreed that a success indicator based on the public interest (pi) score should be used but recommend that a customised pi scorecard or verifier be researched and developed. business rescue practitioner the study by loubser (2010:246) noted similarities between the chapter 6 rescue legislation and the uk system of administration, such as the appointment of a practitioner or administrator. loubser (2010) recommended the use of changes in the south african legislation to address current shortfalls to the appointment of a business rescue practitioner, in particular the absence of a system of accreditation for business rescue practitioners. likewise, pretorius’ (2015) study also found a need to address issues such as the accreditation, regulation and competencies of the practitioner. furthermore, pretorius (2015) highlighted the dominant role of the business rescue practitioner, referred to as a ‘disproportionate influencer’, which refers to the power and influence exercised in a business rescue. burke-le roux and pretorius (2017) also examined the role of business rescue practitioners as disproportionate influencers. however, this study focused on entrepreneurial learning during a formal business rescue by examining three key content dimensions, namely, rescue process, business-related and personal learnings. interestingly, entrepreneurs within the sample that had positive experiences of business rescue were able to gain more knowledge in all the criteria tested in comparison with entrepreneurs with negative experiences. therefore, this study’s key finding was that the behaviour of the business rescue practitioner was a significant driving or restraining factor on entrepreneurial learning. courts mindlin (2013:18) stated that bankruptcy judges are experienced specialists who possess sound commercial judgement as they have handled thousands of cases and have practised as bankruptcy lawyers for many years. however, the study by joubert (2013) found that there was uncertainty experienced by the courts regarding the meaning of ‘reasonable prospect’ when permitting an order of business rescue to be examined through case law. joubert (2013) established that eloff a.j. in the southern palace case applied the criteria of restoring the company to ‘a successful one’, which set a precedent that subsequent judges used. this criterion of ‘a successful one’ set a high threshold akin to the burden of proof that was required in terms of judicial management (joubert 2013). although there has not been a development of a clear definition of the recovery requirement as yet, the high threshold has been lowered and a more constructive approach applied, as seen in the ensuing propspec case decision (joubert 2013). prepackaged funding bracewell and giuliani (2012:24) highlighted the use of prepackaged plans as a success indicator. this involves an arrangement whereby the debtor’s plan, on the first day of court proceedings, is accompanied by votes confirming the plan. this arrangement is achieved as the debtor coordinates with major creditor groups prior to filing for chapter 11 and a plan is agreed to in advance. this concurs with mindlin’s (2013:18) study, which highlighted the active role of creditors, especially large creditors, and noted that an official committee of creditors is appointed in most sizeable chapter 11 cases. pretorius (2015) found that over 50% of the respondents in the study supported a bigger role for the creditors in the appointment of a business rescue practitioner. mindlin (2013) also found that the availability of chapter 11 funding results in companies having a better chance of meeting their liquidity needs after filing. many investors are eager to acquire companies that have entered chapter 11. in addition, there is good access to information. bharath et al. (2013:10) also emphasised the increase in the availability of funding for a chapter 11 reorganisation as a success factor. pretorius (2015) found that in 29% of the cases, business rescue practitioners were able to obtain post-commencement funding, which is thus a limitation to business rescue success. likewise, the study by calitz and freebody (2016) established the significance of post-commencement finance as an important business rescue success indicator. the lack of post-commencement finance in south africa can be attributed to the underdevelopment of the legislation (calitz & freebody 2016). in contrast, mkhondo and pretorius (2017) established that prepackaged funding is used widely in many regimes and revealed that many of the funding institutions employ a variety of complementary funding mechanisms (prepackaging interchangeably with other post-filing mechanisms). funding institutions, particularly hedge funds, frequently apply prepackaged funding as an entry to the acquisition of such distressed assets (mkhondo & pretorius 2017). because the acquisition of the distressed assets is usually before the default event, these hedge funds have qualified investment professionals to perform actuarial calculations in order to ensure optimal values for the instruments (mkhondo & pretorius 2017). furthermore, mkhondo and pretorius (2017) found that sophisticated funding mechanisms and a vibrant distress funding market are correlated, which forms the foundation of prepacks. other factors bharath et al. (2013:10) also highlighted the emergence of key employee retention plans, which enable key, high-earning employees to receive court-approved bonuses to induce them to remain with the firm during the reorganisation. many creditors have concluded that providing these incentives to management was preferable to the time-consuming and disruptive process of recruiting new managers. other factors cited include management’s exclusive right to propose a reorganisation plan within 120 days. in summary, the us chapter 11 and the uk administration procedure highlighted certain factors of success in the evaluation of turnarounds. however, an emerging economy like south africa cannot rely blindly on the success indicators used by foreign researchers. the literature review has shown that there is an absence of research on the identification and ranking of a common set of factors relating to businesses either in business rescue or intending to file for business rescue. this study aims to contribute to the extant literature by using business rescue experts to identify and rank a collective set of indicators that can contribute towards a successful business rescue. research methodology research objectives and questions the objective of this study was to gauge the consensus on what highly knowledgeable and experienced business rescue practitioners would consider as indicators of a successful business rescue in south africa. therefore, the following research questions were formulated in order to achieve the research objective: what are the indicators of a successful business rescue according to turnaround managers? which indicators, ranked from lowest to highest, contribute to successful business rescues according to the cipc top 10 practitioners? research design saunders, lewis and thornhill (2003:96) recommended qualitative research to find out ‘what is happening, to seek new insights, to ask questions and to assess phenomena in a new light’. the three principal methods that they advocated to achieve this objective are to undertake a search of literature, talk to experts, and conduct interviews (saunders et al. 2003:97). therefore, a mixed-methods approach was utilised for this study. sampling the companies act (2008) states that a practitioner should be a member of the law, accounting or business management profession (government gazette 2009). in addition, the companies act (2008) also states that the practitioner should have experience in the practice of business turnaround (government gazette 2009). therefore, because the intention of this study was to obtain insight from expert practitioners, accordingly the practitioners selected for the interview were required to be experienced and possess substantial knowledge of the business rescue process. this requirement is aligned to the companies act (2008), which places emphasis on the experience of the business rescue practitioner. turnaround management association (tma) is an organisation that regulates and sets standards for the rehabilitation of financially distressed companies (baird 2014:42). in an effort to obtain expert opinion about the business rescue process, 130 registered members of tma’s local affiliate, turnaround management association – southern africa (tma-sa), were requested to respond to the questionnaire. tma-sa represents the southern african region (south africa, swaziland, lesotho, namibia, angola, zimbabwe and mozambique). furthermore, a list of the top 10 practitioners that was released by the cipc in march 2015 was used as a sample for the expert interviews conducted. the top seven practitioners are ranked according to the number of business rescue practitioner appointments (voller 2015). because of their substantial exposure to business rescues, these practitioners have significantly more practical experience of the business rescue process and can provide valuable insights. all interviewees who participated in the study had served as a business rescue practitioner for more than 3 years and had been appointed to more than five business rescues. the average number of business rescue practitioner appointments per interviewee was approximately 51. this is above the average of seven business rescue practitioner appointments per conditionally registered business rescue practitioner (voller 2015). data collection sekaran and bougie (2013:112) stated that the manner in which data is collected for solving a research problem has a fundamental impact on the effectiveness of solving the problem. the deductive method of solving a research problem emphasises the need to collect data so that any causal relationship that exists between variables can be identified and explained (saunders et al. 2003:88). to effectively address the aim of this research, it was vital for the data collection method to facilitate the establishment and ranking of factors that result in a successful business rescue. an efficient data collection method recommended by sekaran and bougie (2013:147) is to use a questionnaire so that respondents can record their answers. questionnaire design although the questionnaire is a formidable tool to gather data, it is critical that the questionnaire be answered by individuals who will provide the correct answers to solve the research problem (sekaran & bougie 2013:240). for that reason, the questionnaire, comprising closed-ended questions, was used to address the objective of this study and aligned to the research objective. the questions were aligned to the research aim. the interview questions facilitated an understanding of business rescue failure and the interventions required to ensure the survival of the organisation. discussion of research findings although the introduction of business rescue legislation resulted in a significant difference in the manner that financially distressed companies were managed, there were ‘no guidelines, structure or case law’. this led to difficulties being experienced during the implementation of the legislation as a result of its complex nature. however, since implementation, there have been more guidelines and assistance to understand the scope and nature of business rescue legislation, because it was misunderstood upon implementation. all seven business rescue practitioners supported the implementation of the business rescue legislation because of the potential to grow the economy. however, all interviewees indicated that there was a level of unpreparedness when the legislation was implemented in 2011. in figure 1, interviewees mentioned reasons for the unpreparedness; notably, four interviewees stated that the main reason was complexity of legislation. figure 1: reasons provided for the unpreparedness in the application of the legislation. the low success rate of business rescue was acknowledged and accepted by all interviewees. the reasons provided for the low success rate are presented in table 1. table 1: reason for low success rate in a business rescue. according to table 1, three interviewees felt that the low success rate was attributable to companies filing for business rescue late, mainly as a result of management ignoring initial distress signals and/or not being aware of the business rescue legislation and the remedy offered to rehabilitate a financially distressed company. these practitioners encountered numerous failed business rescues that would have been successful if the rescue had commenced earlier. by the time practitioners got involved, it was too late for the rescue to be a success. according to the interviewees, creditors were reluctant to support the business rescue at an advanced stage of distress, which resulted in a failed rescue. an interviewee linked the late commencement of business rescue with management not complying with section 129(7) of the companies act. according to this section, if the board of a company has reasonable grounds to believe that the company is financially distressed, but the board has not adopted a resolution to commence business rescue, the board must deliver a written notice to each affected person setting out the reasons for not filing for business rescue. the interviewee suggested that management of companies that are financially distressed has a simple choice – they must either file for business rescue or comply with s. 129(7) of the companies act. according to him, non-compliance with section 129(7) delays the commencement of the business rescue by about ‘eight to twelve months’. as a testament to the low compliance rate, the interviewee mentioned that he had not seen a section 129(7) notice in the sector since implementation of the business rescue legislation. an interviewee indicated that there is a negative correlation between the time that elapses and the asset value in a distressed company. an unfortunate consequence of the diminution in asset value is that it becomes very difficult or impossible to secure post-rescue finance. according to this interviewee, he did not find it difficult to get post-rescue finance in the normal course of events. however, when a business rescue commences late, it is difficult to obtain finance. furthermore, two interviewees highlighted the negative impact of extensive litigation on a business rescue. another interviewee mentioned that he had been involved in business rescues where the business rescue plan had been voted on and approved but then there was litigation that prevented the successful implementation of the plan. some of the litigation had been ongoing for more than 3 years, which prevented a successful implementation of the business rescue plan and the completion of the rescue. the impact of the extensive litigation is compounded because of the inability of courts to urgently resolve business rescue cases. an interviewee with many years of litigation experience in business rescue stated a belief that the lack of judicial infrastructure and skills have the impact of muting the benefits of business rescue legislation. one of the interviewees mentioned that, in his opinion, the single most important reason for the low success rate was management abuse of the provisions of chapter 6 legislation. the abuse manifests itself frequently when management, requiring more time before a liquidation, file for a business rescue. in these instances, there is no realistic chance of a successful business rescue. filing for business rescue under such circumstances is simply a mechanism to delay a liquidation and to plan around the needs of management. another factor that surfaced, in relation to failed business rescues, was the adverse impact of unaccredited business rescue practitioners. according to two interviewees, the lack of experience and the necessary skills among practitioners to deal with difficult circumstances generally had an adverse impact on the success rate of business rescues. all seven interviewees felt that business rescue practitioners contribute significantly towards a failed business rescue. the unanimous response from the interviewees prompted the researcher to probe why business rescue practitioners are often the cause of failed business rescues. the reasons provided are illustrated in figure 2. figure 2: business rescue practitioners’ role in failed business rescues. according to figure 2, business rescue practitioners cause rescues to fail because of insufficient skills and knowledge. a majority of the interviewees highlighted the lack of knowledge and understanding of business rescue legislation as justification for their belief that business rescue practitioners are often the cause of failed rescues. additionally, some of the interviewees reported that business rescue practitioners lacked managerial skills to manage finances and deadlines. although practitioners cannot be expected to be a legal, financial and managerial expert, they should possess managerial skills to delegate or outsource tasks that they are incapable of performing themselves. an interviewee shared his experience of two instances where procedural mistakes were made by the business rescue practitioner that had a negative outcome on the rescues. according to this interviewee, many business rescues were terminated because of practitioners failing to follow legislative procedures, especially in the first 7 days after filing for business rescue. this demonstrates that if practitioners do not understand, and consequently do not comply with, the procedural requirements of legislation, then the rescue becomes a nullity (which is classified as a failed business rescue). one of the interviewees also expressed concern about the communication skills of business rescue practitioners. he indicated that business rescues were failing because of the practitioners’ inability to communicate effectively and transparently with creditors, including financial institutions. for example, it was mentioned that practitioners often failed to provide the worst-case scenario to the creditors, which caused creditors to be over-optimistic. consequently, creditors refused to negotiate or compromise during a business rescue, resulting in a failed rescue. the active role of liquidators in the business rescue sector was highlighted by an interviewee because many liquidators are appointed as business rescue practitioners. he considered this to be a paradox, as liquidators are skilled at salvaging and selling business components rather than rehabilitating a distressed business. in his view, many liquidators attempt to rescue a business without the financial, business modelling and turnaround skills. many liquidators do not possess the basic understanding of financial statements and do not understand financial terminology. a liquidator’s training and focus is to maximise the salvage value of a distressed business. it becomes problematic when these skills are applied to rehabilitate a business. the practitioner’s observation was that the appointment of liquidators as business rescue practitioners was causing business rescues to fail, because the liquidators lacked the skills required to successfully rehabilitate a financially distressed company. the adverse role of practitioners in the abuse of the business rescue process was highlighted by an interviewee. he expressed concern that some practitioners acted on behalf of unscrupulous business owners to abuse business rescue legislation. in those cases, as mentioned above, owners filed for business rescue with the intent of using the process to some other ends (such as delaying a liquidation). the practitioner was thus complicit in the process of abuse as they were aware of the business owner’s intent. the failure of these business rescues is partially attributable to the practitioner as a result of their use of the legislation for purposes other than the rehabilitation of a distressed company. as stated by rajaram and singh (2018), a successful business rescue practitioner should have a multitude of skills and qualifications, as seen in figure 3. figure 3: competencies required to be an effective business rescue practitioner. furthermore, the improvement requires an increased effort and changed mindset from the different role players in the sector. the factors that may contribute to an increased success are illustrated in table 2. table 2: factors that may result in an increased business rescue success. according to table 2, five interviewees were of the opinion that the accreditation of business rescue practitioners would enhance their competency and professionalism, leading to more successful business rescues. one of the interviewees felt that if business rescue practitioners do not conform to an accreditation framework, business rescue will not survive because of the low success rate. the demise of business rescue can be prevented by ensuring that there are more experienced and competent practitioners, which would be facilitated by an accreditation framework. another success factor that was highlighted by the interviewees was the increased availability of post-rescue funding. whilst a fresh injection of long-term capital is vital for the success of a business rescue, one of the interviewees also emphasised the benefit of securing immediate, short-term funding. such funding facilitates the continuance of the business immediately at the commencement of business rescue. the interviewee recalled that short-term payment of taxes and expenditure were major issues in several of his business rescues. if the practitioner can obtain short-term and long-term funding for the business, the rescue will be successful. furthermore, the business rescue success rate can be improved by educating business people so that they are more aware of business rescue as a mechanism to rehabilitate underperforming businesses. the increased awareness can be achieved by informing the public and others in the business sector about the benefits of business rescue so that the stigma attached to a business rescue is removed. business rescue must not be seen as a death sentence. an awareness and culture of support for business rescue would definitely improve the success rate of these rescues. a practitioner stated that an increased awareness and support for business rescue would enable an early application and commencement of business rescue. in addition, this early commencement would be facilitated by ensuring that the requirements of s. 129(7) of the act become compulsory. it is vital for the business community to take section 129(7) seriously. the practitioner also suggested that creditors approach the court to obtain compensation from directors who do not comply with s. 129(7) of the act. if south african revenue services, creditors and other affected parties required strict compliance with section 129(7), there would be earlier applications for business rescue and a higher success rate. the success of business rescue also lies in more court cases being resolved at the constitutional court. according to an interviewee, several decisions by the supreme court of appeal have been very questionable. the judges are not qualified or competent in business rescue legislation. it is important that the questionable supreme court of appeal decisions be challenged at the constitutional court. in addition, consideration must be given to the establishment of specialised business rescue courts. there should be a greater scrutiny of management wanting to file for business rescue, and one of the interviewees suggested that management of companies filing for business rescue should be interviewed. he said that he undertook interviews with company management whenever he was approached to be the business rescue practitioner. this interview process enabled him to assess if the business rescue was worthwhile or if the company should be liquidated. another interviewee mentioned that there is currently an unnatural wish by role players to save jobs. the legislation is very strict regarding labour relations and this affects the viability of a business rescue. businesses are liquidated because of staff demands and the cost of labour. there is great pressure on the financial institutions and government organisations (such as south african revenue services) to vote to save jobs. however, saving jobs is costly and makes it unavoidable for the company to be liquidated. flexibility from organised labour to allow certain retrenchments would contribute to a higher success rate. ethical consideration the questionnaire for members of the turnaround management association of southern africa and the interview schedule for business rescue practitioners were approved by the humanities and social science research ethics committee of the university of kwazulu-natal. discussion of quantitative results reliability coakes and steed (2010:140) stated that there are a number of different reliability coefficients. one of the most commonly used is cronbach’s alpha, which is based on the average correlation of items within a test if the items are standardised. if the items are not standardised, it is based on the average covariance among the items. cronbach’s alpha can range from 0 to 1. the cronbach’s alpha for the questions was 0.84. the alpha value is indicative of high internal consistency. the results of the study therefore display a high degree of reliability and integrity. discussion of results respondents were requested to complete a likert scale question for each possible success factor. the scale comprised five categories, namely: ‘strongly disagree’, ‘disagree’, ‘neutral’, ‘agree’ and ‘strongly agree’. the responses for the ‘strongly disagree’ and ‘disagree’ categories and the responses for the ‘strongly agree’ and ‘agree’ categories were combined into two categories, respectively, as listed in table 3. table 3: business rescue success factors and ranking. according to table 3, 92% of respondents either agreed or strongly agreed that strict accreditation criteria for the appointment of a business rescue practitioner would contribute to a successful rescue. in order for business rescue legislation to survive, practitioners need to become more professional and better organised. in england, an important success feature of the formal rescue process rests with the strict accreditation of administrators (loubser 2010; museta 2011). in south africa, there are many professions, such as in law, auditing and accounting, that have strict accreditation criteria. the respondents to the questionnaire favour a similar route of accreditation as the main factor that would contribute to a successful business rescue. the results in table 3 also indicate that businesses need to use early warning signals to anticipate financial distress in order for an early commencement of business rescue, which contributes to its success. this view was supported by 79% of respondents as a success factor, which concurs with the study by muller (2014), where the benefits of an early commencement of business rescue was illustrated in the successful rescue of shelly point hotel. the early commencement of that rescue facilitated timeous raising of post-rescue finance (ranked as the main factor contributing to a failed business rescue). businesses should be educated about early warning signals as a sign of financial distress to facilitate the early planning and preparation for a business rescue. establishing an effective business plan is also an important factor for successful business rescue as is the business rescue time frame being increased from 6 months to a year. the issue of post-rescue funding being available for a successful business rescue is again emphasised. the issue of abuse by management and business rescue practitioners was highlighted as a crucial deterrent to business rescue success. the research also indicates that business rescue practitioners must ensure that employees of the company in business rescue are highly motivated for a successful business rescue. this is related to effective communication, a quality that a business rescue practitioner must possess. the company strategy is another important factor that businesses should consider for successful business rescue. the use of liquidators as business rescue practitioners highlights the potential for misguided attempts at business rescue because of their training to dissolve rather than rehabilitate a business. government and related agencies, as well as banks, creditors and other financial institutions also need to be involved in the business recue process. in addition, specialised courts are critical for a successful business rescue. ranking whilst the respondents’ feedback in table 3 provided an indication of success factors, these factors had to be ranked according to their mean scores to establish their importance – provided above in table 3. the ranking of the mean scores in table 3 was triangulated with the responses from the seven business rescue practitioners interviewed to establish the important factors for the improvement of the success rate of business rescues in south africa. the interviewees felt that the accreditation of business rescue practitioners would contribute to an improved success rate and this supports the findings from the quantitative methodology. this finding also confirms feedback from the members of tma-sa, namely that the implementation of strict accreditation criteria was the highest ranking factor that would contribute to a successful business rescue. these findings are supported by the view of researchers that a strong business rescue practitioner is vital to ensure that the rescue is a success (bezuidenhout 2012; levenstein 2011). international research into the finnish restructuring of enterprises act indicated that the management of the rescue is an important factor in determining whether the rescue will be successful or not (collett, pandit & saarikko 2014). the accreditation of business rescue practitioners will address many of the complaints relating to these practitioners. the complaints are about practitioners filing for termination of business rescue too late in order to earn more fees (du preez 2012), poor quality of work coupled with exorbitant fees (pretorius 2013) and their inability to control costs (visser 2013). these findings concur with the study by pretorius (2015) when the role of the business rescue practitioner as a disproportionate influencer was explored. du preez (2012), when analysing the status of post-commencement finance in south africa, stated that a primary reason for the lenders’ reluctance to fund a business rescue lies in the profile of a business rescue practitioner. an important component of a successful financial rehabilitation is competent leadership (bibeault 1999:97). balgobin and pandit (2001:304) concurred with this finding by stressing the importance of human resources to effect a successful turnaround. they identified that effective management of all stakeholders is a priority and would greatly improve the chances of a successful turnaround. in a legislated turnaround, effective leadership can be obtained through a system of accreditation (loubster 2010; museta 2011; pretorius & rosslyn-smith 2014). the responses from the interviewees indicated that earlier filing for business rescues would improve the success rate of rescues. this finding complements the findings of the quantitative methodology that businesses need to heed early warning signals to anticipate financial distress. the study ranked this factor as having the fourth highest impact on a successful rescue. in order to successfully rehabilitate a distressed company, it is important that the company’s economic vulnerabilities are diagnosed and responded to as early as possible (bussiere & fratzscher 2006:956). in the south african context, it is essential that the commencement of business rescue occur as early as possible to improve the chances of success (iodsa 2009:2). levenstein (2011:4) recommended that companies diagnose early warning signs and apply for business rescue as early as possible. the early detection of financial distress and a timeous response has been noted as a key success factor in the rehabilitation of a distressed business (borio 2012:5). an analysis of the business rescue process highlighted the need to be proactive by engaging with all stakeholders prior to the application for business rescue (van der burgh 2013). this will facilitate the early application of a business rescue. because of the stringent deadlines and time frames that are imposed by business rescue legislation, the cipc suggested that as much of the financial analysis of a distressed company as possible should take place prior to the application for business rescue (terblanche 2014). the benefits of early application for business rescue were highlighted in the successful rescue of shelly point hotel (muller 2014). because of the owner’s proactive stance in detecting financial difficulties relating to cash flow and working capital, an early application for business rescue was filed. this resulted in more time being available to arrange for post-rescue funding and to reduce costs. whilst there is a convergence in the findings between the mixed-methodology approach of this study and existing literature, the interviews established an effective method of facilitating the early application. it was recommended that the requirements of s. 129(7) of the business rescue legislation be viewed in a more serious manner. this section compels management of a distressed company to provide reasons to all affected parties as to why management did not apply for the commencement of business rescue. the enforcement of this responsibility will ensure that financially distressed businesses apply for business rescue earlier. another factor the interviewees recommended to improve the success rate of business rescues is an increase in post-rescue funding. the literature noted that a key success of the chapter 11 process is the availability of rescue funding (mindlin 2013). this view is supported by bharath et al. (2013:13), who correlated the increased success rate of chapter 11 with the increase in funding available. the results of the quantitative methodology ranked the availability of post-rescue funding as having the fifth highest impact on a successful business rescue. the interviews identified innovative ways to increase the availability of post-rescue funding. because of the concern of banks relating to the competency of the business rescue practitioner and management, an interviewee suggested the establishment of a closer relationship with funders. the close relationship will enable a funder to be involved in and monitor the business rescue. it would allow for additional oversight, management of the rescue and provide a level of comfort to the funder that their funds are properly invested. in this relationship, concerns that funders have about management can be effectively addressed by either replacing management or complementing their skills. the interviewees also highlighted the potential for the formation of private funding for business rescues in south africa. based on the international experience of an interviewee, there are many private funders in the us chapter 11 turnaround sector. he believes that there are similar opportunities in south africa to increase the post-rescue commencement funding. the interviewees indicated that the establishment of specialised business rescue courts would increase the chances of a successful business rescue. this response is similar to the ninth highest success factor established by the findings of the quantitative methodology. it addresses the concerns raised regarding the ability of the south african judiciary to handle business rescue cases. the concerns relate to the lack of specialist business rescue judges, contradictory judgements and judges that do not understand business rescue legislation (ensor 2014). pretorius (as cited in visser 2013) noted that there have been several contradictory business rescue judgements. this highlights the need for courts that have the necessary business rescue skills. according to mindlin (2013:18), an important feature that contributes to the success of chapter 11 rescues in the usa is the presence of experienced judges who have specialist knowledge. the interviewees stated that until this is achieved, there should be more appeals against the supreme court of appeal. although not established as a success factor by the results of the quantitative methodology, the interviewees felt that an increased awareness of business rescue legislation would improve the success rate. this could be undertaken by an educational campaign to improve the business community’s awareness and understanding of business rescue legislation. according to the business rescue practitioners interviewed, there is a stigma attached to companies that file for business rescue. business rescue should not be confused with liquidation, nor should it be perceived to be a death sentence. creating an awareness of business rescue legislation would improve the success rate as companies would be able to file earlier. the interviews also identified greater flexibility from labour on their demands that jobs be saved during business rescue. a primary objective of business rescue is the preservation of jobs (rushworth 2010). however, an effective turnaround strategy often involves aggressive retrenchment to prevent further decline in the financial fortunes of a distressed business (pearce & robbins 2008:129). in order to achieve a successful rescue, there must be a compromise between retrenchments and job preservation. the interviewees mentioned that there is an unnatural wish by role players, like government organisations, to protect jobs at all costs. these parties do not support a business rescue unless all jobs are saved. however, because of the expenditure required to save jobs, the company is ultimately liquidated. a greater degree of flexibility from organised labour and government would increase the success rate. recommendations arising from the study in order for business rescue legislation to survive and have a meaningful impact on the south african economy, the following recommendations are made. department of trade and industry and the companies and intellectual property commission an independent regulator should be established by the department of trade and industry and the cipc to manage the business rescue sector. the role of the department of trade and industry and the cipc should be limited to facilitating the creation of a regulator. the management and functioning of the regulator should be independent of the cipc. the following core responsibilities of the regulator are essential: create an awareness of business rescue legislation: educational campaigns should be established to improve the business community’s understanding of the potential benefits of business rescue legislation. business workshops and seminars should be utilised to better inform business owners and management of the technicalities relating to the legislation. the improved understanding would contribute to an increased and more effective utilisation of business rescue legislation to rehabilitate financially distressed businesses. it would also result in an earlier application for companies intending to file for business rescue. establish a framework for the accreditation of business rescue practitioners: the framework should include the skills and qualifications required for successful accreditation. create a continuous development programme of training for business rescue practitioners: this will ensure that practitioners remain updated on changes to legislation and industry trends. the justice ministry the justice ministry should establish specialised courts to handle and fast track business rescue cases. in the interim, courts should utilise assessors with expertise in business rescue legislation and commercial law. the financial sector the financial sector needs to adopt a more proactive stance on the provision of business rescue finance. the proactive stance relates to the financial sector’s involvement in commencing business rescue and the provision of post-rescue funding. based on financial records maintained by banks, businesses could have a low risk or high risk status indicator. risk indicators that are connected to cash flows, profitability and debt ratios can be used as an early warning system to indicate the need to file for business rescue. the study indicated that there is potential for the expansion and growth of the funding for business rescues, similar to the funding industry in the usa. the growth can be achieved by the establishment of specialist funding vehicles for companies that are in or about to file for business rescue. management of these funds would require an in-depth knowledge of business rescue legislation, such as tight deadlines. it is essential to consider the funder playing a more active role in the business rescue. the current post-rescue funding environment requires an improved working relationship between funders, management and business rescue practitioners. a closer working relationship will facilitate an effective mechanism for the business rescue practitioners to address concerns relating to the management of the business rescue. management in addition to efforts by the regulator to improve the awareness of business rescue legislation, management should ensure that they understand and comply with business rescue legislation. business rescue legislation should only be utilised for the intended purpose of rehabilitating a financially distressed firm. any abuse of the legislation should be avoided. strict penalties should be imposed on those found guilty of abusing the process. in order to ensure that financial distress is detected timeously, consideration should be given to the use of early warning distress signals. the early detection of financial distress will facilitate an earlier application for business rescue. in the event that management decides to apply for business rescue, an effort must be made to communicate details of the filing to all affected parties. because of tight deadlines, important decisions and planning must be undertaken prior to the application for the business rescue. examples of these decisions are the appointment of a business rescue practitioner and the negotiation of post-commencement finance. in the event that management of a financially distressed company does not apply for business rescue, the requirements of s. 129(7) must be complied with immediately. conclusion this study found that poorly skilled business rescue practitioners are very often the cause of failed rescues. the negative impact is mainly attributable to a lack of skills and knowledge of the business rescue practitioner. this study also highlighted the negative impact of appointing a liquidator as a business rescue practitioner because of the different skill set possessed by a liquidator, compared to a successful business rescue practitioner. furthermore, this study found that business rescue practitioners are responsible for failed business rescues because of their complicit role in abusing legislation. this abuse was also found in management’s decision either to file for business rescue in order to delay liquidation or to resist filing because of their failure to detect financial distress. this study also found that management’s poor awareness of rescue legislation and/or lateness in applying for relief contributed to the failure of business rescue. the low success rate of business rescue can be improved by adopting and implementing the recommendations of this study. an increased success rate could be achieved by the establishment of an independent regulator to manage the business rescue sector. the implementation of an accreditation framework by the regulator would enhance the impact of business rescue legislation. this would facilitate a more vibrant business rescue sector and an improved success rate, ultimately ensuring the survival of business rescue in south africa. using a triangulation approach, this study has confirmed existing literature and has contributed new knowledge to understanding business rescue in south africa. acknowledgements competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contribution all authors equally contributed to the writing of this article. references baird, s., 2014, ‘an empirical investigation of successful, high performing turnaround professionals: application of the dynamic capabilities theory’, unpublished ph.d.-dissertation, georgia state university, atlanta, ga. balgobin, r. & pandit, n., 2001, ‘stages in the turnaround process: the case of ibm uk’, european management journal 19(3), 301–316. https://doi.org/10.1016/s0263-2373(01)00027-5 bezuidenhout, p., 2012, 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171–180. https://doi.org/10.1002/smj.4250050207 whetton, d., 1980, ‘organisational decline: a neglected topic in organisational science’, academy of management review 5(4), 577–588. sajems 24-1_2021_contents.indd http://www.sajems.org open access table of contents original research supply chain management antecedents of performance in small to medium scale enterprises welby v. loury-okoumba, chengedzai mafini south african journal of economic and management sciences | vol 24, no 1 | a3661 | 22 february 2021 original research spousal effects on wages, labour supply and household production in ghana emmanuel orkoh, phillip f. blaauw, carike claassen south african journal of economic and management sciences | vol 24, no 1 | a3535 | 02 march 2021 original research not all experts are equal in the eyes of the international auditing and assurance standards board: on the application of isa510 and isa620 by south african registered auditors marianne kok, warren maroun south african journal of economic and management sciences | vol 24, no 1 | a3784 | 18 march 2021 original research human capital and economic growth in south africa: a cross-municipality panel data analysis nicholas ngepah, charles s. saba, ntombomzi g. mabindisa south african journal of economic and management sciences | vol 24, no 1 | a3577 | 19 march 2021 original research the influence of agri-entrepreneurship courses studied on youth farm entrepreneurial intention: evidence from folk development colleges in tanzania paschal b. nade, christian k. malamsha south african journal of economic and management sciences | vol 24, no 1 | a3788 | 07 april 2021 original research valuation practices under business rescue circumstances in south africa shaneen conradie, christiaan lamprecht south african journal of economic and management sciences | vol 24, no 1 | a3721 | 26 april 2021 original research south african universities in a time of increasing disruption johan coetzee, brownhilder neneh, karlien stemmet, jana lamprecht, constance motsitsi, winnie sereeco south african journal of economic and management sciences | vol 24, no 1 | a3739 | 26 april 2021 original research happiness lost: was the decision to implement lockdown the correct one? stephanié rossouw, talita greyling, tamanna adhikari south african journal of economic and management sciences | vol 24, no 1 | a3795 | 28 april 2021 84 97 115 128 139 148 161 173 page i of ii table of contents research note regulating south africa’s retirement funds: the case for clearer objectives rob rusconi south african journal of economic and management sciences | vol 24, no 1 | a3943 | 30 november 2021 original research voluntary social performance disclosure and firm profitability of south african listed firms: examining the complementary role of board independence and managerial ownership frank sampong, na song, gilbert k. amoako, kingsley o. boahene south african journal of economic and management sciences | vol 24, no 1 | a3346 | 11 january 2021 original research broad-based black economic empowerment and corporate financial health jan a. dreyer, suzette viviers, nadia mans-kemp south african journal of economic and management sciences | vol 24, no 1 | a3652 | 21 january 2021 original research reflecting on the changing landscape of shareholder activism in south africa nadia mans-kemp, marilee van zyl south african journal of economic and management sciences | vol 24, no 1 | a3711 | 25 january 2021 original research assessing the effectiveness of an occupational health and safety system in a selected automotive assembly organisation in south africa robert w.d. zondo south african journal of economic and management sciences | vol 24, no 1 | a3553 | 26 january 2021 original research the performance measurement conundrum: construct validity of the individual work performance questionnaire in south africa leoni van der vaart south african journal of economic and management sciences | vol 24, no 1 | a3581 | 27 january 2021 original research tourism destination competitiveness: a view from suppliers operating in a country with political challenges erisher woyo, elmarie slabbert south african journal of economic and management sciences | vol 24, no 1 | a3717 | 28 january 2021 original research finance-growth nexus in sub-saharan africa celsa m.d.c. machado, antónio f.m.g. saraiva, paulo d.d. vieira south african journal of economic and management sciences | vol 24, no 1 | a3435 | 19 february 2021 1 11 23 33 44 52 63 73 vol 24, no 1 (2021) issn: 1015-8812 (print) | issn: 2222-3436 (online)south african journal of economic and management sciences http://www.sajems.org open access table of contents original research black economic empowerment policy and the transfer of equity and mine assets to black people in the south africa’s mining industry sixta r. kilambo south african journal of economic and management sciences | vol 24, no 1 | a3479 | 13 may 2021 original research a new affordable housing development and the adjacent housingmarket response aliksa ludick, david dyason, alicia fourie south african journal of economic and management sciences | vol 24, no 1 | a3637 | 01 july 2021 original research determining the potential of informal savings groups as a model for formal commitment saving devices marna landman, morris mthombeni south african journal of economic and management sciences | vol 24, no 1 | a3940 | 20 july 2021 original research the role of personal relationships in supply chain risk information sharing: perspectives from buyers and suppliers of logistics services marco van der walt, wesley niemann, arno meyer south african journal of economic and management sciences | vol 24, no 1 | a3703 | 30 july 2021 original research estimation of the potential economic welfare to be gained by the south african customs union from trade facilitation shahrzad safaeimanesh, glenn p. jenkins south african journal of economic and management sciences | vol 24, no 1 | a3796 | 16 august 2021 original research balancing quantitative and qualitative value-creation reporting cornelie crous, marike c. van wyk south african journal of economic and management sciences | vol 24, no 1 | a3936 | 31 august 2021 original research household saving and wealth in south africa fanie joubert, theo van der merwe south african journal of economic and management sciences | vol 24, no 1 | a3764 | 26 october 2021 184 198 208 220 235 249 257 original research work engagement and perceived customer value, the mediating role of meaningfulness through work marita heyns, sean mccallaghan, werner beukes south african journal of economic and management sciences | vol 24, no 1 | a3749 | 27 october 2021 original research has mobile phone technology aided the growth of agricultural productivity in sub-saharan africa? omotomiwa (tommy) adenubi, omphile temoso, isiaka abdulaleem south african journal of economic and management sciences | vol 24, no 1 | a3744 | 25 november 2021 original research development and preliminary validation of the work-unit performance questionnaire jonathan seland, carl c. theron south african journal of economic and management sciences | vol 24, no 1 | a3926 | 08 december 2021 original research youth’s participation in agriculture: a fallacy or achievable possibility? evidence from rural south africa unity chipfupa, aluwani tagwi south african journal of economic and management sciences | vol 24, no 1 | a4004 | 17 december 2021 original research international patent applications and innovation in south africa ulrich schmoch, anastassios pouris south african journal of economic and management sciences | vol 24, no 1 | a4146 | 17 december 2021 reviewer acknowledgement south african journal of economic and management sciences | vol 24, no 1 | a4483 | 22 december 2021 267 274 283 296 308 315 page ii of ii abstract introduction literature review method results discussion managerial implications conclusion acknowledgements references about the author(s) mervywn k. williamson school of management, information technology and governance, college of law and management studies, university of kwazulu-natal, durban, south africa kressantha perumal school of management, information technology and governance, college of law and management studies, university of kwazulu-natal, durban, south africa citation williamson, m.k. & perumal, k., 2022, ‘the relationship between procedural justice and person–organisation fit: the mediating role of organisational trust’, south african journal of economic and management sciences 25(1), a4412. https://doi.org/10.4102/sajems.v25i1.4412 original research the relationship between procedural justice and person–organisation fit: the mediating role of organisational trust mervywn k. williamson, kressantha perumal received: 21 oct. 2021; accepted: 25 apr. 2022; published: 02 nov. 2022 copyright: © 2022. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the effects of person–organisation (p–o) fit on key work outcomes has been the subject of a plethora of research in the last few decades. however, scant attention has been given to exploring the antecedents of p–o fit in the workplace. this study addressed this gap in the literature. aim: the aims of the study were to determine if there was a relationship between procedural justice and p–o fit, and whether organisational trust could be considered a potential mediating variable in this relationship. setting: the research was conducted among permanent employees representing a range of businesses in kwazulu-natal. methods: in order to address the study objectives, a quantitative survey and cross-sectional design were used. data were collected from a convenience sample of 118 permanent employees who were registered for degrees in commerce and business administration and attended part-time classes at a university in the province of kwazulu-natal. results: the results of the statistical analysis revealed a significant and positive association between procedural justice and employees’ perceived p–o fit. organisational trust was found to partially mediate this relationship. conclusion: the results make a significant contribution to p–o fit theory and the management of p–o fit in the workplace. keywords: p–o fit; procedural justice; organisational trust; social exchange theory; relational models of procedural justice. introduction the concept of person–organisation (p–o) fit generated considerable research interest in the past few decades (de cooman et al. 2019:646–651; hamstra, van vianen & koen 2019:600; oh et al. 2014:101; treviño et al. 2020:287). broadly, p–o fit refers to the compatibility, match, similarity or congruence between employee and the organisation (cable & derue 2002:875; kristof 1996:4–5). this similarity may occur in a single dimension, or a range of dimensions, such as values, goals, culture and beliefs. past research demonstrated a link between p–o fit and a plethora of desirable or positive work outcomes (hoffman & woehr 2006:389–399; kristof-brown, zimmerman & johnson 2005:310; park, oh & lee 2020:2089; verquer, beehr & wagner 2003:473–489). for example, studies showed that when employees perceive high levels of fit with their organisations, they are generally satisfied with their jobs (andela & van der doef 2019:567); are more committed to their organisations (bahat 2021:1255); experience increased psychological well-being (koburtay & alzoubi 2021:103), higher work engagement (rayton, yalabik & rapti 2019:401–414), and lower burnout (andela & van der doef 2019:567); and are less inclined to leave and seek employment elsewhere (abdalla et al. 2018:863). previous studies also positively associated p–o fit with organisational citizenship behaviour (ashfaq & hamid 2021:19) and employee creativity (seong & choi 2019:129). scholars also recognised the significance of p–o fit in the recruitment and selection processes of organisations (vanderstukken, proost & van den broeck 2019:602). although the extant literature revealed a sizeable body of research into p–o fit and its link to a variety of employee attitudes and behaviour, several gaps remain, particularly, in the area of the factors that influence employees’ perceptions of p–o fit (vleugels et al. 2018:1067). to date, studies examining the antecedents of p–o fit focused on constructs such as high performance work practices (uppal 2021:356), transformational leadership (raja et al. 2018:913–930), workplace spirituality (afsar & badir 2017:95), workplace ostracism (chung 2017:328) and organisational socialisation (coldwell, williamson & talbot 2019:511–527; oh 2018:360). gabriel et al. (2014:390) noted that a large volume of work argued for ‘causal precedence of fit perceptions’. for example, job satisfaction and organisational commitment are assumed to be the consequence of an assessment of how well an employee fits in with the organisation. however, it has been suggested that the causal flow may be reversed to consider the impact of work-based affect and attitudes, such as job satisfaction on perceived fit (gabriel et al. 2014:390; yu 2009:1210–1226). this line of reasoning will usher in new avenues for research in our quest to uncover novel predictors of p–o fit and further deepen our understanding of the dynamic nature of the this important construct. vleugels et al. (2018:1078) highlighted that employees’ work experiences could play a significant role in the development of person–environment fit perceptions and urged scholars to pursue this area of research. one such variable that could potentially influence employees’ p–o fit perceptions is procedural justice. the concept of procedural justice generated considerable interest in the past few decades and is an important antecedent variable in organisational behaviour and management research (colquitt et al. 2013:199–236). in general, procedural justice refers to employees’ perceptions of fairness in the processes and procedures used to arrive at the outcomes of decisions taken by organisations and their leaders (colquitt 2001:386). it represents a significant dimension of organisational justice and was found to have an impact on employees’ attitudes directed towards the organisation (folger & konovsky 1989:115–130). for example, employees who demonstrated high perceptions of procedural justice are more likely to display high levels of commitment to their organisations, engage in organisationally directed citizenship behaviour and have lower intentions to leave their organisations (cohen-charash & spector 2001:278–321; viswesvaran & ones 2002:193–203). procedural justice was also shown to positively influence employee engagement in the workplace (biswas, varma & ramaswami 2013:1570; he, zhu & zheng 2014:681). a study linking procedural justice as an antecedent to p–o fit will broaden our knowledge of how p–o fit could be influenced in organisations. we propose that employees, who perceive that their organisations use fair procedures and processes when arriving at decision outcomes, will reciprocate by displaying trust and faith in their organisations. in turn, this could translate into positive attitudinal or behavioural outcomes, such as an increase in employees’ perceived p–o fit. a critical factor to our understanding of how procedural justice could influence p–o fit, is shedding light on the intervening mechanism through which this relationship may occur. organisational trust has been submitted as a potential mediating variable in this relationship. in broad terms, trust has been described as ‘confident, positive expectations about the words, actions, and decisions of another in situations entailing risk’ (colquitt et al. 2012:1). prior research suggested that trust could be a useful intervening variable in explaining how organisational justice influences work outcomes (aryee, budhwar & chen 2002:267–285; jiang, gollan & brooks 2017:973–1004). according to shockley-zalabak, ellis and winograd (2000:35), organisational trust refers to ‘positive expectations individuals have about the intent and behaviours of multiple organisational members based on organisational roles, relationships, experiences, and interdependencies’. we considered organisational trust to be an apposite explanatory mechanism in the procedural justice and p–o fit relationship. this article, therefore, focuses on the relationship between procedural justice and p–o fit, and the mediating role of organisational trust. aims and objectives of the study the aims of the study were to determine if there was a relationship between procedural justice and p–o fit and whether organisational trust could be considered a potential mediating variable in this relationship. linked to these aims, four research objectives were articulated. these included: (1) to examine the relationship between procedural justice and p–o fit; (2) to examine the relationship between procedural justice and organisational trust; (3) to examine the relationship between organisational trust and p–o fit; and (4) to test the mediating role of organisational trust in the relationship between procedural justice and p–o fit. literature review antecedents of person–organisation fit past research exploring the antecedents of p–o fit have done so in the context of p–o fit serving as a mediating variable in a number of predictor–outcome relationships. these studies suggested that p–o fit may be influenced by certain specific variables, and in turn, affect a number of work outcomes. one such variable is the quality of the relations that employees have with their organisational leaders. badawy et al. (2019:86–98) found that employee p–o fit mediated the relationship between trust in leader and job performance, suggesting that high-quality employee–leader relations, exemplified in the high trust in leadership, may serve as a useful predictor of p–o fit. zhang, lam and deng (2017:1017–1019) examined the influence of dyadic relationships such as leader–member exchange and supervisor–subordinate guanxi on employee fit perceptions, helping behaviour and turnover intentions. the findings suggest that leader–member exchange may have a stronger influence on employees’ p–o fit perceptions than supervisor–subordinate guanxi. the next important variable is the type of leadership and how this may influence p–o fit. grobler and holtzhausen (2018:8) found support for the mediating role of p–o fit perceptions in the relationship between ethical leadership and supervisory trust in a sample of south african employees across a wide range of organisations. the concepts of morality and fairness revealed by leaders were one of the key dimensions assessed in this research and thus suggesting that employees being valued honestly and fairly by their leaders, could result in an increase in their levels of p–o fit. in a recent study among public sector employees, lim, lee and bae (2019:144) investigated the mediating role of p–o fit in the relationship between two affect-based work variables (i.e. transformational leadership and role clarity) and job satisfaction. the findings provided substantial support for the mediating role of p–o fit in the transformational leadership and job satisfaction relationship. employee perceptions of human resource management (hrm) practices have also been demonstrated to influence p–o fit. for example, boon et al. (2011:149–152) found support for the mediating role of p–o fit in the relationship between a set of high performance hrm practices and work outcomes such as organisational commitment and organisational citizenship behaviour. in this large-scale study conducted in the netherlands, employees were asked to what extent their organisations offer them a number of critical or strategic hrm practices in areas such as selection, training, participation, teamwork and rewards. similarly, mostafa (2016:1229) found that p–o fit perceptions mediated the relationships between high-performance hrm practices and outcomes, such as work stress and intentions to quit, among public health employees. in a study conducted on employees at a dutch university, kooij and boon (2018:69) showed that high performance work practices increase the levels of perceived p–o fit over time. moreover, perceived p–o fit mediated the relationship between high performance work practices and affective commitment. the impact of hrm practices on p–o fit was also examined by takeuchi and takeuchi (2013:2100) who reported that p–o fit mediated the relationship between perceived hrm practices and organisational commitment among employees in the japanese healthcare industry. these hrm practices may reveal to employees a number of important factors about their organisations in terms of values, ethics and justice, which could have an influence on their perceptions of p–o fit. such findings and theoretical expositions suggest that procedural justice could be a significant predictor of employees’ perceived p–o fit. however, a rational explanatory mechanism in the form of a mediating variable will further cement this link. in a study, examining the mediating role of p–o fit in the relationship between psychological contract breach and employee engagement, lv and xu (2018:1271) reported that psychological contract breach had a negative influence on p–o fit in a sample of chinese workers. it was argued, using blau’s (1964) social exchange theory, that when employees experience a psychological contract breach, they would respond adversely by developing unfavourable views about their organisation. consequently, these employees may adjust their perceived p–o fit downwards (lv & xu 2018:1263). the extant literature alludes to the possibility of exploring the predictive capacity of other work-related variables on perceived p–o fit. we propose the examination of procedural justice as a potential antecedent variable. procedural justice is an important variable in the south african workplace and has been the subject of increased scholarly inquiry in recent years (mrwebi, smith & mazibuko 2018:495–524). the relationship between procedural justice and person–organisation fit to date, little is known about whether and how employee perceptions of procedural justice influences perceived p–o fit. blader and tyler (2015:351) aver that procedural justice ‘conveys a positive message to justice recipients about their relationship with the entity enacting the justice’. therefore, one would expect that employees who perceive high levels of procedural justice will tend to strengthen relationships with their organisations. according to the group-value model, employees could use procedural justice as an indicator of their social standing in organisations (tyler 1989:830). employees will feel valued and respected by their organisations when they perceive that they have been treated in a procedurally fair manner. this could result in employees developing increasing levels of trust in their organisations (de cremer 2005:5). the group-engagement model highlights the importance of fair procedures in shaping employees’ cooperation with their work groups, organisations and societies at large (tyler & blader 2003:349). procedural justice plays a significant role in influencing employees’ social identity within their work groups or organisations (blader & tyler 2009:454). the mediating role of organisational trust in the relationship between procedural justice and person–organisation fit blau’s (1964) social exchange theory is useful in understanding procedural justice and work outcome relationships. social exchanges have been described as ‘voluntary actions which may be initiated by an organisation’s treatment of its employees, with the expectation that such treatment will eventually be reciprocated’ (gould-williams & davies 2005:3). an organisation’s fair treatment of an employee in the form of procedural justice, may encourage this employee to respond accordingly in terms of positive attitudes and behaviours directed at the organisation. trust has been regarded as a significant factor in understanding social exchange relationships and will be enhanced when social exchange relationships are favourable between organisations and its employees (lehmann-willenbrock, grohmann & kauffeld 2013:457). consequently, trust could serve a critical role in various organisational justice and work outcome relationships by functioning as an intervening mechanism that could explain these organisational justice effects (stinglhamber, de cremer & mercken 2006:443). past research has recognised organisational trust as a promising mediating variable in procedural justice’s influence on a range of employee outcomes. for example, aryee et al. (2002:267) found that organisational trust partially mediated the effects of procedural justice on employees’ job satisfaction, organisational commitment and turnover intentions. in a large-scale study across three different countries, jiang et al. (2017:973) reported that organisational trust fully mediated the relationship between procedural justice and affective organisational commitment. lehmann-willenbrock et al. (2013:454) demonstrated that the procedural justice effects on organisational citizenship behaviour were mediated by organisational trust and organisational commitment. chen et al. (2015:11–12) showed that the procedural justice, perceived by nurses at a medical centre in southern taiwan, significantly and positively impacted their organisational trust and organisational identification. in turn, organisational trust demonstrated the strongest impact on affective commitment. if procedural justice is related to organisational trust, then organisational trust could help explain the effects of procedural justice on p–o fit. however, for this to be realistic, it requires showing that organisational trust is also related to p–o fit. to date, not much is known about the effects of organisational trust on employees’ p–o fit perceptions. according to schneider’s (1987:437–453) attraction-selection-attrition theory, individuals are attracted to organisations that reflect values similar to their own. organisations, in turn, recruit and select employees who display values that are congruent or fit in with their values and culture. over a period of time, employees who discover that their values diverge from or does not fit in with their organisations, leave. employees’ levels of organisational trust could influence their experiences of value similarity or p–o fit. for example, social exchange theory suggests that trust plays a significant role in enabling ‘social exchange reciprocation’ whereby employees will react in positive ways from developing high levels of organisational trust as a consequence of being treated procedurally fair (jiang et al. 2017:978). although not previously empirically examined, we propose that one such positive outcome in response to employees’ high levels of organisational trust would be an increase in perceptions that their values are closely aligned or show high p–o fit. evidently, there is a paucity of research that examined the link between procedural justice and employees’ perceptions of p–o fit. moreover, the mediating role of organisational justice in this relationship has yet to be satisfactorily explored. this research sought to address this gap in the literature. method research design and approach a positivist research philosophy was embraced. in line with this, a deductive approach using a quantitative survey and cross-sectional research design were employed. the approach was appropriate for a study of this nature wherein relationships between different variables were examined and inferences made to the wider population about the findings. selection and description of participants the target population consisted of permanent, full-time employees who were registered for degrees in commerce and business administration and attended part-time classes at a university in the province of kwazulu-natal. due to the red-tape and challenges of selecting a sample in this context, a non-probability, convenience sampling approach was used. a convenience sample is a simple, efficient, speedy and cost-effective way to select a sample of participants (cooper & schindler 2014:359). this technique proved apposite in this study as the researchers, with the permission of the lecturers, approached the potential participants via email with a request to participate. those who indicated a willingness to do so, formed part of the final sample which totalled 118 participants. it appears, in line with krejcie and morgan (1971:608), who indicated that for a population of 160, that the suggested sample size should be 113 participants. the sample was made up as follows: there were 63% female and 37% male participants. these participants occupied various jobs ranging from non-managerial to senior management. their organisational tenure ranged from under 2 years to over 21 years. a wide range of sectors were represented in the sample: public sector (29%), retail (21%), financial services (18%), health and welfare (16%), manufacturing (10%), and logistics (6%). data collection the researchers obtained the email addresses of participants from the course administrators. participants were then emailed the self-administered questionnaire to fill in and return. a number of reminders were conveyed to ensure prompt completion. self-administered questionnaires are useful quantitative data collection tools and offer a number of advantages such as a reduction in researcher bias and providing a convenient and non-threatening way in which participants may respond to questions (bryman & bell 2011:232–233). the questionnaire comprised two sections. firstly, the demographic section wherein participants were required to respond to questions concerning their gender, job level, organisational tenure and sector in which employed. secondly, the independent, dependent and mediating variables section, consisting of multi-item scales. measuring instruments multi-item scales were used to measure p–o fit, procedural justice and organisational trust. all items were presented in statement form and participants were required to respond accordingly by marking their ratings on a 7-point likert scale (1 = ‘strongly disagree’, and 7 = ‘strongly agree’). person–organisation fit employees’ perceived p–o fit was measured using cable and derue’s (2002:879) 3-item perceptions of p–o fit scale. these items included: ‘my organisation’s values and culture provide a good fit with the things that i value in life’; ‘the things that i value in life are very similar to the things that my organisation values’; and ‘my personal values match my organisation’s values and culture’. cable and derue (2002:879) achieved chronbach’s alpha coefficients of 0.91 and 0.92. procedural justice colquitt’s (2001:389) procedural justice scale was used to measure employees’ perceptions of procedural justice. this scale consists of seven items and addresses a number of principles that are considered necessary for fair processes such as voice, consistency, free of bias, accuracy, representation, ethicality and correctability. these items were: ‘my organisation has procedures designed to generate standards so that decisions could be made and applied with consistency’; ‘my organisation has procedures designed to ensure that information used by management for making decisions is accurate’; ‘my organisation has procedures designed to provide employees with opportunities to appeal or challenge decisions taken by management’; ‘my organisation has procedures designed to ensure that employees have an influence over decisions taken by management’; ‘my organisation has procedures designed to ensure that decisions made by management are made in an unbiased manner’; ‘my organisation has procedures designed to allow employees the opportunity to express their views, concerns and feelings about decisions made by management’; and ‘my organisation has procedures designed to ensure that the highest ethical and moral standards are upheld by management when making decisions’. colquitt and rodell (2011:1191) reported chronbach’s alpha coefficients of 0.86 and 0.90. organisational trust a 4-item scale adapted from robinson’s (1996:583) trust in employer scale was used to measure employees’ perceptions of organisational trust. these items were: ‘i believe my employer has high integrity’; ‘i have utmost trust in my employer’; ‘in general, i believe my employer’s motives and intentions are good’; and ‘my employer is open and upfront with me’. robinson (1996:583) achieved chronbach’s alpha coefficients of 0.82 and 0.87. data analysis all the statistical analysis was undertaken by using the statistical package for the social sciences (spss version 27). descriptive statistics, reflecting the percentage distribution of the demographic profiles of the participates, were computed, as well as the mean, standard deviation, skewness and kurtosis scores of the p–o fit, procedural justice and organisational trust variables. to investigate the research objectives, inferential statistical tests were performed to determine the relationships among the different variables. the first test involved the calculation of the pearson’s product moment correlation coefficient which revealed the significant strength and direction of the relationships among the three variables. multiple regression analysis was used to examine the relationships between procedural justice and p–o fit, procedural justice and organisational trust and, organisational trust and p–o fit. hierarchical regression was utilised to test the mediating influence of organisational trust in the procedural justice and p–o fit relationship. the researchers were guided by baron and kenny’s (1986:1177) steps to examine mediation effects. firstly, the independent variable (procedural justice) must show a significant association with the dependent variable (p–o fit). secondly, the independent variable (procedural justice) must be significantly related to the proposed mediating variable (organisational trust). thirdly, the proposed mediating variable (organisational trust) must have a significant influence on the dependent variable (p–o fit). if these conditions are satisfied, the direct influence of the independent variable (procedural justice) on the dependent variable (p–o fit) should show a significant reduction (partial mediation) or be eliminated (full mediation) when the proposed mediating variable (organisational trust) is included in the hierarchical regression test. psychometric properties of measuring instruments reliability reliability refers to the consistency of a measuring instrument (saunders, lewis & thornhill 2016:451). there were three measuring instruments used in this study and each consisted of multiple items. thus, establishing internal reliability was deemed appropriate and this was assessed, using cronbach’s alpha coefficient. in this regard, the average of the split-half reliability coefficients were computed for the three measuring instruments. a rule of thumb score of 0.80 is generally considered to be an adequate level of reliability (bryman & bell 2011:159). in the study, the p–o fit scale (cronbach’s alpha = 0.93), procedural justice scale (cronbach’s alpha = 0.92) and organisational trust scale (cronbach’s alpha = 0.98) all displayed high reliability scores. validity the validity of a measuring instrument relates to whether it actually measures the construct or concept it claims to measure (saunders et al. 2016:202). the researchers focused on establishing two forms of validity: content validity: the content validity of a measuring instrument relates to the extent to which its items give proper coverage of the research question it endeavours to address (cooper & schindler 2014:256). measuring instruments for p–o fit, procedural justice and organisational trust were adapted from well-established measuring instruments that were used by scholars in the field. the various items were reflected upon by the researchers to ensure relevance. construct validity: construct validity refers to the extent to which an operationally defined construct is reflected in the theory underpinning the concept to be investigated (cooper & schindler 2014:259). in evaluating construct validity, an exploratory factor analysis (efa) was conducted on the items representing the measuring instruments on the questionnaire. the results of the kaiser-meyer-olkin (kmo) measure of sampling adequacy was 0.88 (˃ 0.6 minimum value) and bartlett’s test of sphericity was significant at 0.00 p value. the principal component analysis was used to extract the factors. three factors had eigen values of greater than one and explained a cumulated variance of 81.09%. after rotating the factors, using varimax with kaiser normalisation, a total of three factors finally emerged, representing the variables in the study. the factor loadings were all above 0.50, which could be considered practically significant (hair et al. 1998:111). common method bias common method bias is frequent in attitudinal and behavioural research, particularly when there are self-reported measuring instruments used. guided by podsakoff et al. (2003:879–903), a number of steps were taken to reduce the level of common method bias in this study. firstly, the question order of the measuring scale items were mixed to reduce the inclination of each participant to respond in a preconceived manner. secondly, careful attention was paid to ensure that the wording of the measuring scale items were clearly written and understood. thirdly, by safeguarding their anonymity, participants were more disposed to responding in a candid way without fear of victimisation by their organisations. the application of harman’s (1967) single-factor test to all the study variables revealed that there was no one factor that accounted for most of the variance. moreover, as highlighted above, the results of the efa showed there were three factors, and not one factor, that accounted for 81.09% of the cumulative variance. more specifically, these factors generated an explained variance of 33.67%, 27.57% and 19.85% respectively, with the first factor not surpassing the explained variance of 50%. these tests show that common method bias may not have had a significant impact on the results of this study. ethical considerations ethical standards as prescribed by the researchers’ affiliated institution were adhered to throughout the research process. ethical clearance was obtained prior to commencement of data collection. the researchers endeavoured to act with integrity and transparency when dealing with participants. all participants were assured anonymity by not disclosing their names in the study findings. the confidentiality of their responses was also preserved. informed consent was obtained from all participants. ethical clearance was obtained from the university of kwazulu-natal, humanities and social sciences research ethics committee (hssrec/ 00002231/2020). results statistical tests the mean, standard deviation, skewness and kurtosis were computed for p–o fit, procedural justice and organisational trust. these are reflected in table 1. the mean scores on a 7-point likert scale were comparatively high for the p–o fit (5.07), procedural justice (4.65) and organisational trust (4.84). the skewness values were negative for all the variables (procedural justice = –0.40, organisational trust = –0.74, p–o fit = –1.02) and the kurtosis values were negative for procedural justice (–0.75), organisational trust (–0.74) and positive for p–o fit (0.36). these values represented no major deviation from range of normal distribution. table 1: descriptive statistics of the variables. a correlation analysis was performed to show the relationships among the three variables of p–o fit, procedural justice and organisational trust. the correlation matrix is shown in table 2. there is a positive and significant correlation between procedural justice and p–o fit (r = 0.44, p ≤ 0.01). in addition, procedural justice and organisational trust show a positive and significant correlation (r = 0.57, p ≤ 0.01). organisational trust and p–o fit also demonstrated a positive and significant correlation (r = 0.47, p ≤ 0.01). table 2: correlation matrix of the variables. research objective 1: to examine the relationship between procedural justice and person–organisation fit a multiple regression analysis was conducted with procedural justice as the independent variable and p–o fit, the dependent variable. the results reflected in table 3 show that procedural justice is significantly and positively associated with p–o fit (b = 0.44, p ≤ 0.01). table 3: regression analysis (dependent variable: person–organisation fit; predictor: procedural justice). research objective 2: to examine the relationship between procedural justice and organisational trust a multiple regression analysis was conducted with procedural justice as the independent variable and organisational trust, the dependent variable. the results reflected in table 4 show that procedural justice is significantly and positively associated with organisational trust (b = 0.57, p ≤ 0.01). table 4: regression analysis (dependent variable: organisational trust; predictor: procedural justice). research objective 3: to examine the relationship between organisational trust and person–organisation fit a multiple regression analysis was conducted with organisational trust as the independent variable and p–o fit, the dependent variable. the results reflected in table 5 show that procedural justice is significantly and positively associated with organisational trust (b = 0.47, p ≤ 0.01). table 5: regression analysis (dependent variable: person–organisation fit; predictor: organisational trust). research objective 4: to test the mediating role of organisational trust in the relationship between procedural justice and person–organisation fit the findings of the first three research objectives fulfilled the first three requirements of baron and kenny’s (1986:1177) test for mediation. to satisfy the final requirement, a hierarchical regression was undertaken with procedural justice inserted in step 1 and organisational trust in step 2. the findings are shown in table 6. table 6: hierarchical regression analysis (dependent variable: person–organisation fit; predictors: procedural justice, organisational trust). in step 1, procedural justice demonstrated a positive and significant relationship with p–o fit (b = 0.44, p ≤ 0.01). in step 2, with the inclusion of organisational trust in the regression model, there was a resulting decrease in the beta coefficient for procedural justice (from b = 0.44, p ≤ 0.01 to b = 0.26, p ≤ 0.01). thus, this finding shows that organisational trust partially mediates the relationship between procedural justice and p–o fit. discussion as highlighted in the beginning, there is voluminous research that investigates the effects of p–o fit on a range of work outcomes. however, scant attention has been given to the antecedents of p–o fit. to date, not much is known about whether and how procedural justice influences employees’ p–o fit perceptions. we sought to address this gap in the literature by articulating and accomplishing four key objectives. the first objective was to examine the relationship between procedural justice and p–o fit. the results revealed that procedural justice was significantly and positively related to employees’ perceived p–o fit. this finding places in the foreground the importance of procedurally fair treatment received by employees from their organisations and the significant role it plays in influencing their levels of p–o fit perceptions. the relational models of procedural justice, namely, the group-value model (tyler 1989:830–838), the relational model of authority (tyler & lind 1992:115–191) and the group-engagement model (tyler & blader 2003:349–361) all advocate the notion that ‘procedural justice matters’ to individuals (blader & tyler 2015:356). organisations that treat their employees in a procedurally fair manner convey an affirmative message to them that they are valued and belong to their organisations. consequently, this may strengthen relationships between the two parties (blader & tyler 2015:351–356). employees in this position may appraise their fit with their organisations and conclude that they have high levels value similarity or p–o fit. the second objective was to examine the relationship between procedural justice and organisational trust. the results demonstrated a significant and positive link between procedural justice and organisational trust indicating that employees who were procedurally fairly treated by their organisations responded favourably by increasing their levels of trust in their organisations. this finding is consistent with past empirical research reporting that procedural justice had a positive impact on organisational trust when organisational trust was examined as a mediating variable in a number of procedural justice and work outcome studies (aryee et al. 2002:267; chen et al. 2015:11–12; jiang et al. 2017:973; lehmann-willenbrock et al. 2013:454). procedural justice has been accredited with initiating favourable social exchange relationships between organisations and its employees (jiang et al. 2017:974). moreover, trust is intrinsically associated with social exchange theory, meaning that when social exchange relationships are favourable between organisations and its employees, organisational trust will be heightened (lehmann-willenbrock et al. 2013:457). the third objective was to examine the relationship between organisational trust and p–o fit. organisational trust was found to be significantly and positively associated with p–o fit. this result suggests that when employees show increasing trust towards their organisations, they will react by perceiving higher levels of p–o fit. previous research has given scarce attention to examining this link. however, social exchange theory may offer a plausible explanation as to why organisational trust was found to be positively related to p–o fit. according to this theory, employees who developed high levels of organisational trust from being treated procedurally fair, will return this benevolence by reacting in a variety of positive ways (jiang et al. 2017:978). one such could be in increasing their levels of perceived p–o fit. the fourth objective was to test the mediating role of organisational trust in the relationship between procedural justice and p–o fit. organisational trust was found to partially mediate the procedural justice and p–o fit relationship. this result is significant as it sheds light on the previously untested procedural justice and p–o fit relationship. accordingly, by including organisational trust as a mediating variable, we offer a plausible explanatory mechanism of how procedural justice could act as an antecedent variable to employees’ perceived p–o fit. in the past, organisational trust was shown be a useful mediator in procedural justice and work outcome relationships (aryee et al. 2002:267; lehmann-willenbrock et al. 2013:454). the results of this study reinforces the notion that the procedurally fair treatment received by employees from their organisations sends positive signals to these employees that they are valued members of their organisations. in turn, these employees increase their levels of trust in their organisations. this increased level of trust may propel these employees to perceive high value congruence or p–o fit. managerial implications the results have a few practical implications. this study shows that employees’ perceived p–o fit levels may be increased by ensuring that they are treated in a procedurally fair manner by their organisations. therefore, this finding raises the prominence of procedural justice as an antecedent of employees’ perceived p–o fit in the workplace. this finding could prompt managers to ensure that fair treatment in terms of procedural justice is consistently applied when making decisions that affect employees. by doing so, employee p–o fit levels will be enhanced resulting in a number of positive attitudinal and behavioural outcomes. this study has also highlighted the importance of organisational trust as a mediating variable in the procedural justice and p–o fit relationship. therefore, it is imperative that management take cognisance of this and seek ways to ensure that employees increase their levels of trust in the organisations they are employed in. conclusion limitations and suggestions for future research this study has some limitations that should be highlighted. firstly, the convenience sampling method and the relatively small sample size limit the generalisability of the results across a wider population of employees. secondly, the use of a cross-sectional design may have concealed the extent of the relationships among the different variables in the study. this study offers a few suggestions for future research. future research could replicate a study of this nature, using probability sampling techniques and across a more diverse and larger sample. this could improve the generalisability of the results. future research should also examine the relationship between procedural justice and p–o fit using other mediating variables such as social identity. this could shed more light on the nature and dynamics of the relationship. further research could also broaden the number of organisational justice dimensions as predictor variables, such as distributive and interactional justice. in addition, a more comprehensive operationalisation of the fit construct could be used as criterion variables that includes dimensions such as person–job fit and person– group fit. this could provide a more comprehensive picture of the link between organisational justice and person–environment fit. in order to establish a more accurate understanding of the nature and strength of the relationships among procedural justice, organisational trust and p–o fit, future studies should examine these relationships using a longitudinal design. this study addressed the dearth of research investigating the antecedents of p–o fit by empirically examining the relationship between procedural justice and employees’ p–o fit perceptions. the results confirmed a significant and positive association between these two variables and thus elevating the prominence of procedural justice in the workplace and the impact it has on employees’ perceptions of p–o fit. this study also shed light on organisational trust, the potential intervening mechanism through which these two variables may interact. besides reflecting links with procedural justice and p–o fit, the results showed organisational trust to partially mediate the procedural justice and employee perceived p–o fit relationship. acknowledgements competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions all authors 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zondo roger s. brown ronald h. mynhardt saima batool salome van coller-peter samuel jibao sandra perks sanjana b. parumasur sanlie middelberg sebastiaan rothmann seeku a.k. jaabi segnon aguey sergey i. krylov shagufta parveen sibindi ntandoyenkosi sonja grater stefanie kuhn stephanus j. joubert stephen m. duffield stephen zhanje surika van rooyen syden mishi taeyoung yoo talita greyling tanya du plessis tebello thabane tesfatsion t. gesho theuns steyn thokozani p. mbhele thomas hering tinah moyo vassili j. de latour vera zelenovic vinessa naidoo vivence kalitanyi vukmirovic goran waldo krugell wesley rosslyn-smith yudhvir seetharam zebulun kreiter we appreciate the time taken to perform your review successfully. http://www.sajems.org� abstract introduction methodology and data results conclusion acknowledgements references appendix 1 appendix 2 about the author(s) sudhir madaree financial services institute of australasia (finsia), australia citation madaree, s., 2018, ‘factor structure of south african financial stocks’, south african journal of economic and management sciences 21(1), a2001. https://doi.org/10.4102/sajems.v21i1.2001 original research factor structure of south african financial stocks sudhir madaree received: 28 jun. 2017; accepted: 20 july 2018; published: 11 sep. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the financial sector within the locally listed equity market is an important component of the economy. understanding the inherent risks of this sector is vital from a portfolio risk management perspective, as such insights can aid in protecting against capital loss in the event of exposure to risk factors in this sector. aim: the study aims to identify and explain the principal risk factors over time inherent to the financial stock sector of the locally listed equity market, accompanied by explaining the volatility of such principal risk factors. setting: the study looks at financial sector stocks within the south african listed equity space from june 2007 to march 2017. methods: the methods used to perform such an investigation were twofold, namely, factor analysis to statistically identify risk factors latent in a basket of financial sector firms and generalised autoregressive conditional heteroscedasticity (garch) analysis to examine the volatility of the principal risk factors. results: the findings suggest that the heterogeneity of risk factors within the financial sector has burgeoned in the past five years, explaining a large proportion of risk during this period. however, over the long-term, banks appeared to have been the main factor driving risk within the financial sector, explaining around 55% of risk. the volatility of banks was most noticeable during business cycle falls that were underpinned by known economic or political instability. conclusion: banks have been the riskiest factor within financial sector firms over the past decade, explaining more than 50% of risk in recent years and notably susceptible to economic and political uncertainty. introduction the financial sector represents an important part of the economy, as it facilitates the savings and investment process of economic agents. understanding the risks inherent in such a sector is vital, particularly from a portfolio risk management perspective. insight into the risks can aid in protecting against capital loss in the event of large exposure to such risk factors. the past several years have borne witness to economic and political events that have caused a steady decline in the credit ratings of local banks and sovereign bonds. the most recent downgrade by s&p of foreign-denominated south african debt to junk status is an outcome of the challenging effects of local economic and political conditions (south african reserve bank [sarb] 2017). these uncertainties have the ability, ceteris paribus, to impact the profitability of firms within the financial sector, particularly banks (appleton 2016). amid a sluggish growth environment, this trend reinforces lower profitability. a related aspect of deteriorating sentiment concerns the impact of capital flows on the stock prices of listed firms, such as those of banks, and the consequent volatility associated with these price movements. portfolios may utilise listed equity markets such as the johannesburg stock exchange (jse) all share index in portfolio construction, which the financial sector is inherently a component of. from a portfolio risk management perspective, it is important to identify risk factors latent within a sector and explain the volatility over time. this may allow one to protect against capital loss, particularly portfolios that are substantially exposed to financial sector stocks. several studies in the literature have discussed the behaviour of listed stocks from international and local perspectives. from a local perspective, moolman and du toit (2005) examined the relationships between the south african stock market and macroeconomic variables from q3 1987 to q4 2000 using an error correction technique. this was intended to capture the short-term dynamics between the variables in question. results revealed that in the short-term, volatilities or fluctuations in the local stock market were caused by macroeconomic variables, such as, inter alia, short term interest rates, the rand/us$ exchange rate and the gold price. szczygielski and chipeta (2015) utilised an asset-pricing model, namely, the arbitrage pricing theory (apt) to explain the risk factors of south african stocks from july 1995 to march 2011. results revealed that various factors explained the behaviour of the south african stock market, namely, local inflation, changes in money supply, oil prices, real economic activity and the rand/us$ exchange rate. van rensburg (1995) utilised a multifactor model to examine the relationship between the local stock market and several macroeconomic factors, namely, term structure of the interest rate, returns of the new york stock exchange, the gold price and inflation expectations. results revealed all four factors were significant drivers of local stock prices. from an international perspective, mouna and anis (2016) investigated the sensitivity of returns in three financial sectors to macroeconomic variables, namely, the interest rate, stock market and the exchange rate using an adapted generalised autoregressive conditional heteroscedasticity (garch) model during the financial crisis. eight countries were sampled and examined during this time period (2006–2009). results revealed that overall across the eight countries, stock market returns, exchange rate volatility and interest rates had significant effects on the returns of the three financial sectors (banks, financials and insurance) during the financial crisis. zeng et al. (2014) examined whether the united states of america (us) banks played an important role in explaining the volatility of us stocks. the authors utilised a multifactor model based on monthly returns of us stock portfolios, size and value factors from january 1980 to december 2007. results revealed that the banking risk factor significantly explained volatility in stock returns. schuermann and stiroh (2006) examined the common factors that drove us bank stock returns from 1997 to 2005 using several multifactor models. results revealed that the market factor noticeably drove the returns in bank stocks, with interest–related factors not being helpful in explaining such return behaviour of banks, particularly for the largest banks. berkowitz (2001) utilised the fama and french (1993) model for determining common risk factor drivers of canadian stock returns. the author used this type of multifactor model on monthly canadian stock returns from january 1982 to december 1999. it was revealed that three factors explained the major part of the volatility in canadian stocks over time. the above studies in conjunction with a scan of available literature suggested no apparent presence of studies, at least locally, that have examined inherent risk factors within particular sectors of listed equities through time, such as the financial sector. thus, a knowledge gap exists, which this study aims to fill by offering scientific value to the local literature. to investigate the problems of identifying and explaining the intertemporal principal financial sector risk factors and their related volatilities, two statistical models were employed. firstly, factor analysis was used to extract risk factors latent within local financial sector stocks over three-year, five-year and 10-year periods. the aim was to identify the main risk factors and any changes in those factors. secondly, because time-series variables tend to exhibit volatility clustering properties, a garch (1,1) model was used to explain the volatility of identified principal risk factors through time. this allowed us to clearly identify periods in which principal risk factors were volatile, and to attach economic rationale to those periods of volatility. the methodology and data section is followed by the results section. the final section provides the concluding remarks. methodology and data data data for all financial sector stocks listed on the jse main board between june 2007 and may 2017 were obtained from the data provider inet bfa, denominated in south african rands (zar). this was the method used to obtain the financial sector stocks. the financial sector comprises stocks from the industry membership groups of banks, insurance, real estate and financial services (ftse russell 2016). weekly pricing history was utilised for all variables and was converted into monthly returns (equation 1) and standardised (equation 2) for factor extraction. details on the variables appear in appendix 1. factor analysis was conducted to extract risk factors latent within local financial sector stocks over three-year (short-term), five-year (medium term) and 10-year (long-term) time horizons. the respective monthly data points were 156, 260 and 520. prior to standardisation, variables were checked for consistency regarding weekly returns. those that did not have such on a frequent basis were excluded from the analysis. thus, the sample size diminished as the time horizon increased, representing a limitation to this study. all variables used in the study were standardised or normalised through the calculation of z-scores, which has the effect of preserving the normality nature of the variables in question, particularly transforming variables into new scores with a mean of zero and a unit standard deviation (abdi & williams 2010). a z-score for each observation of a variable is calculated by subtracting the mean of the variable from each observation’s value, and then dividing the answer by the standard deviation of the variable in question (refer to eqn 2). mean centring and autoscaling are critical in factor analysis as they allow all variables to have equal importance in contributing to the analysis. factor analysis factor analysis extracts uncorrelated factors latent in a data set, with the approach aiming to explain most of the variance for the data, particularly the covariance between underlying variables. factors constitute linear combinations of underlying variables, typically from a transformed matrix based on standardised variables such as a correlation coefficient matrix (landau & everitt 2004). standardisation is critical as it centres the mean of each variable to allow for comparative analysis. factors are analogous to eigenvectors, with each eigenvector exhibiting an eigenvalue. an eigenvalue represents a measure of variance in all variables within a data set. various factor extraction methods can be used, such as principal components analysis (pca), principal factor analysis (pfa) and the maximum likelihood method (iacobucci 2001). the pfa method was employed for this study as an appropriate method to extract the factors, as it takes into account uniqueness or measurement error of the underlying variables (landau & everitt 2004). in other words, pfa extracts factors based on the degree of variation between variables, whereas pca extracts factors based on the level of variance within individual variables. the higher the level of common variance (known as communality) and the lower the level of uniqueness (non-common variation) of a variable, the more relevant the variable becomes in explaining the meaning of a factor. fundamentally, eigenvalues of a square matrix were computed using equation 3: where: a = i*i matrix v = column vector of eigenvectors λ = eigenvalue or determinant equation 3 above is analogous to an optimisation or maximisation problem solved by the lagrange-multiplier λ. the pfa method uses spectral decomposition as suggested by anderson–rubin in 1956 (statacorp 2013) to segment a correlation coefficient matrix into factors, assuming i variables and j factors: where: c = i*i correlation coefficient matrix λj = j*j diagonal eigenvalue matrix ej = i*j factor loading matrix orthogonal in nature = transpose of ej εi = i*i diagonal matrix of residuals/uniqueness after factor extraction is complete, rotation of the factors is required to clarify the interpretation of the factors (yong & pearce 2013). traditionally, orthogonal varimax rotation is used as it preserves the lack of correlation among factors (walker & maddan 2013). this rotation approach geometrically rotates the extracted factors to form ‘new’ (adjusted) axes in a clockwise manner, causing the factors to remain perpendicular or orthogonal to each other. mathematically, rotated loadings of underlying variables become correlated close to one in one eigenvector and close to 0 in other eigenvectors. ideally, each factor should have a few large positive loadings and a large number of small or negative loadings. after factor rotation, the last step is to describe the extracted factors, and to interpret their meaning in terms of economic theory. the factor analysis method is underpinned by variables that exhibit high loadings and low uniqueness levels clustering together (yong & pearce 2013); the researcher then attaches a description based on these clustered variables. common descriptions refer to the fundamental characteristics of stocks, such as valuation metrics and industry memberships. valuation metrics entail using valuation measures of stocks, such as price-to-book and earnings growth levels, to describe variables. industry membership entails using the nature of the business based on revenue generation to describe the variables. the latter method was used in this study. the generalised autoregressive conditional heteroscedasticity model generalised autoregressive conditional heteroscedasticity models are a type of conditional volatility model. the garch model explains and forecasts the volatility of time-series variables that exhibit autocorrelation and heteroscedasticity. a garch (1,1) model assumes that the best predictor of the current period’s error variance is a function of a weighted long-run variance average, information obtained in the previous period (squared residual) and the previous period’s variance (poon & granger 2005). equation 5 is as follows: in essence, garch transforms each original variance at time t to be conditional upon the above three terms, thus taking into account heteroscedasticity and autocorrelation. this method provides a robust way to explain volatility through time (engle, 2001). although other models exist that are able to explain through time volatility of financial variables, such models were not investigated as this was not the sole focus of the paper. thus, a robust, parsimonious and popular model was selected to show through time volatility of financial variables that exhibited heteroscedasticity and autocorrelation, namely, the garch (1,1) model. the statistical software stata was used to run factor analysis and garch analysis in this study. results factor extraction a prerequisite for factor extraction is that variables must show moderate to moderately high levels of correlation. this enables factors to be extracted and underlying variables to be assigned to the factors. the data conformed to this requirement, as confirmed by the high kaiser–meyer–olkin (kmo) values of 0.865 for the short-term, 0.908 for the medium-term and 0.9336 for the long-term models, respectively (details provided in appendix 2). the kmo statistic measures the proportion of variance among variables that might be shared. as a general rule, a kmo value of between 0.8 and 1 indicates sampling adequacy. table 1 shows the rotated factors that account for approximately 80% of the variance – hence volatility – in the financial sector. in this particular case, the variance can be labelled as risk in the financial sector. over the short, medium and long terms, a single factor (factor 1) stands out as explaining a large proportion of risk. the variance of this factor has diminished in recent years; it explained only 39% of variance (risk) over the most recent three-year period, compared with 55% over the longer 10-year period. however, factor 1 still accounts for a large proportion of financial sector risk. table 1: factor eigenvalues (varimax rotation). the sample size across the three time horizons was not consistent, owing to certain stocks not having a complete pricing history. this implies that the stock composition of the financial sector appears to have expanded during recent years. the sample was smallest for the 10-year time horizon and largest for the three-year time horizon (these details are provided in appendix 1). this difference might explain the dilution in volatility contributed by factor 1 for the shorter time horizons. the risk composition of the financial sector appears to have become more diverse, with a greater number of risk factors witnessed over the short-term that explain approximately 80% of the financial sector risk. with the proliferation of short term risk factors latent in the financial sector and the dilution of risk emanating from factor 1 over the short-term, the question arises: what does factor 1 comprise? answering this question would allow economic meaning to be attached to the factor. an inherent problem within factor analysis is the subjectivity in naming or describing factors. an approach to quantitatively naming the factors is to refer to the level of variance a variable contributes to the overall eigenvalue of the factor, in conjunction with the level of uniqueness of the variable in question. highly unique variables imply a lesser relevance in explaining the factor in question. table 2 shows the loadings for each model and the variance each variable contributed to factor 1. as factor 1 accounts for a large amount of volatility across the three time horizons, it is the focus of this paper. table 2: contribution to factor variance: three-year time horizon. table 3 shows a similar level of loadings over the medium term, with most of the same stocks appearing to have the greatest relevance in explaining the variance of factor 1. however, bank stocks appear to have greater relevance than insurance stocks, accounting for around 37.82% of the variance in factor 1, compared with the 16.78% accounted for by mmi, slm and rmi. (dsy accounted for less than 4.5% and was therefore dropped from explaining the factor.) none of the insurance stocks had loadings in excess of 0.8, unlike in the short term model. thus, for the five-year time horizon, factor 1 can best be described more clearly as ‘banks’. table 3: contribution to factor variance: five -year time horizon. table 4 shows loadings over the long-term, with bank stocks clearly appearing to account for most of the variance of factor 1 at around 52.38%. none of the insurance stocks had high enough loadings and low enough uniqueness levels to attach much importance to their role in describing factor 1. thus, for the 10-year horizon, banks contributed most to the risk in the financial sector and it is reasonable to describe factor 1 as ‘banks’. this finding provides impetus for examining the volatility of banks more in detail as it is the principal risk factor. the ‘garch analysis section’ of this paper provides an explanation of the use of a garch (1,1) model to investigate the ftse/jse south african banks total return index. the garch (1,1) was selected as it represents a simple version of the garch model and provides parsimony to the analysis. table 4: contribution to factor variance: 10-year time horizon. the generalised autoregressive conditional heteroscedasticity analysis figure 1 shows the weekly performance of south african banks over the past decade, proxied by the ftse/jse sa banks total return index. the data were obtained from inet bfa. graphically, there have been periods where volatility has clustered, highlighted by the red circles. this pattern renders the data appropriate for a garch model, which requires data to exhibit volatility clustering so that the model can appropriately explain volatility through time. a prerequisite for using garch is to determine whether an autoregressive conditional heteroscedasticity (arch) effect exists; the lagrange-multiplier (lm) test is used for this purpose (abonongo, oduro & ackora-prah 2016). the lm merely tests whether coefficients in a regression are jointly equal to zero, implying no arch effect. this null hypothesis must be rejected to statistically confirm that arch effects do exist. the output from the lm test on our data can be found in table 5. figure 1: weekly performance of south african banks. table 5: lagrange-multiplier test for autoregressive conditional heteroscedasticity effect. table 5 shows a p-value less than 0.0001, which is highly significant. this means the null hypothesis (‘there is no arch effect’) can safely be rejected and the need for a garch model to explain the volatility is required. we, therefore, ran the garch (1,1) model on the data for weekly returns in the sa bank index. the start point was week 22 of 2007 (03 june 2007) and the end point was week 20 of 2017 (14 may 2017). the output of the garch (1,1) model transformed the original residuals as a function of equation 5. a visual depiction of these transformed values is shown in figure 2, which highlights various periods in which volatility has clustered. figure 2: conditional variance. of particular interest are the clusters highlighted in red circles in figure 2. the first circle approximately represents the period october 2008 to march 2009, and the second circle approximately represents the period december 2015 to january 2016. the first period coincided with a fall in south africa’s business cycle, a period of volatility and uncertainty. this decline in the business cycle can be attributed to the global financial crisis (gfc). figure 3 shows an estimation of the business cycle using the hodrick–prescott (hp) filter method to decompose seasonally adjusted real gross domestic product (gdp) into its trend component and cyclical component. the latter represents the business cycle (hodrick & prescott 1997). seasonally adjusted real gdp data were obtained from the south african reserve bank (sarb). the hp filter minimises the following function to determine the trend within seasonally adjusted real gdp: figure 3: south african business cycle. the first term of equation 6 above represents the sum of the squared deviations of output at time t from the trend. the second term represents the sum of squared second differences in the trend penalised by the lagrange (λ) parameter (hodrick & prescott 1997). the λ parameter represents the extent to which the trend is required to be made smooth. such a parameter is required to be specified, with a rule of thumb for calculating the estimation – that is, λ = 100*(number of periods in a year)2. quarterly data, for example, are given the parameter of 1600. thus, the cyclical component is calculated by the difference between actual output and its trend. the second period also coincided with a decline in the business cycle, witnessed from the start of 2015, a period rife with political instability. a case in point was the dismissal of finance minister nene early in december 2015, which resulted in a sharp increase in the yield of the south african sovereign 10-year note by over 10%. this raised government borrowing costs and impacted bank stocks. although no causality can be inferred from this apparent association, the pattern clearly shows that bank stocks are extremely volatile during periods of economic and political uncertainty, ceteris paribus. conclusion the heterogeneity of risk factors inherent within the financial sector has burgeoned in recent times, explaining a large proportion of the risk within the sector. this trend appears to be because of the expansion of stocks within the financial sector. however, over the long-term (10-year horizon), a single risk factor evidently drove most of the risk (55%), and three risk factors collectively explained around 84% of the risk in the financial sector over the same period. using industry membership as a basis to describe principal risk factors, it was clear that banks represented the principal risk factor over the long-term. banks have been significantly volatile over two periods within this long-term time horizon, as shown by the garch analysis. the first period coincided with the fall in south africa’s business cycle, precipitated by the gfc. the second period was because of increased political risk (ceteris paribus) immediately after the dismissal of finance minister nene, suggesting that economic and political risks have an intense effect on banks. the increased heterogeneity of risk factors within financial stocks in the short-term (three-year horizon) holds implications for portfolio risk management. portfolios having wide exposure to the financial sector require one to be cognisant of the increased array of risk factors now present. such awareness may aid in protecting against capital loss in the event of increased economic and political uncertainty. given the current landscape in south africa, such a scenario seems fairly probable at present. acknowledgements the findings and interpretations of the paper are solely those of the author and should not be attributed to finsia. competing interests the author declares that he has no financial or personal relationships that may have inappropriately influenced him in writing this article. authors’ contributions the author declares that he has no financial or personal relationships that may have inappropriately influenced him in writing this article. references abdi, h. & williams, l., 2010, ‘normalizing data’, in n. salkind, d. dougherty & b. frey (eds.), encyclopedia of research design, pp. 935–938, sage, thousand oaks, ca. abonongo, j., oduro, f. & ackora-prah, j., 2016, ‘modelling volatility and the risk-return relationship of some stocks on the ghana stock exchange’, american journal of economics 6(6), 281–299. appleton, m., 2016, know your asset attributes, global perspectives, ashburton investments, bellville, south africa, p. 19. berkowitz, m., 2001, common risk factors in explaining canadian equity returns, working papers, university of toronto, department of economics toronto. engle, r., 2001, ‘garch 101: the use of arch/garch models in applied econometrics’, journal of economic perspectives 15(4), 157–168. https://doi.org/10.1257/jep.15.4.157 fama, e. & french, k., 1993, ‘common risk factors in the returns on stocks and bonds’, journal of financial economics 33, 3–56. https://doi.org/10.1016/0304-405x(93)90023-5 ftse russell, 2016, industry classification benchmark (equity), viewed 06 june 2017, from http://www.ftse.com/products/downloads/icb_rules.pdf hodrick, r. & prescott, e., 1997, ‘u.s. business cycles: an empirical investigation’, journal of money, credit and banking 29(1), 1–16. https://doi.org/10.2307/2953682 iacobucci, d., 2001, journal of consumer psychology’s special issue on methodological and statistical concerns of the experimental behavioral researcher, lawrence erlbaum associates, mahwah, new jersey. landau, s. & everitt, b., 2004, a handbook of statistical analyses using spss, chapman & hall/crc press, boca raton, fl. moolman, e. & du toit, c., 2005, ‘an econometric model of the south african stock market’, sajems 8(1), 77–91. mouna, a. & anis, j., 2016, ‘market, interest rate, and exchange rate risk effects of financial stock returns during the financial crisis: agarch-m approach’, cogent economics & finance 4(1), 1–16. https://doi.org/10.1080/23322039.2015.1125332 poon, s. & granger, c., 2005, ‘practical issues in forecasting volatility’, financial analyst journal 61(1), 45–56. https://doi.org/10.2469/faj.v61.n1.2683 south african reserve bank (sarb), 2017, financial stability review first edition 2017, financial stability department, pretoria. schuermann, t. & stiroh, k., 2006, visible and hidden risk factors for banks, frb of new york staff report no. 252, econstor, frb of new york, new york. statacorp lp., 2013, stata multivariate statistics reference manual, stata press, college station, tx. szczygielski, j. & chipeta, c., 2015, ‘risk factors in returns of the south african stock market’, journal for studies in economics and econometrics 39(1), 47–70. van rensburg, p., 1995, ‘economic forces and the johannesburg stock exchange: a multifactor approach’, de ratione 9(2), 45–63. https://doi.org/10.1080/10108270.1995.11435059 walker, j. & maddan, s., 2013, statistics in criminology and criminal justice, jones & barlett learning, burlington, nj. yong, a. & pearce, s., 2013. ‘a beginner’s guide to factor analysis: focusing on exploratory factor analysis’, tutorials in quantitative methods for psychology 9(2), 79–94. https://doi.org/10.20982/tqmp.09.2.p079 zeng, l., yong, h., treepongkaruna, h. & faff, r., 2014, ‘is there a banking risk premium in the us stock market’, journal of financial management, markets and institutions 2(1), 27–42. https://doi.org/10.12831/77235 appendix 1 names of variables table 1-a1: variables used in factor analysis models. appendix 2 measure of sampling adequacy table 1-a2: kaiser–meyer–olkin measure of sampling adequacy. sajems ns vol 7 (2004) no 1 100 the effect of a budget deficit on inflation: the case of tanzania m solomon and w a de wet department of economics, university of pretoria abstract the tanzanian economy has remained one of the limited numbers of countries that has experienced a relatively high inflation rate, accompanied by high fiscal deficits for a prolonged period in the absence of any hyperinflation. this paper examines the deficit-inflation relationship in the tanzanian economy and establishes the causal link that runs from the budget deficit to the inflation rate using cointegration analysis over the period 1967-2001. some dynamic simulations are done to gauge the effect of a change in the budget deficit and gross domestic product on inflation over time. due to monetisation of the budget deficit, significant inflationary effects are found for increases in the budget deficit. jel e62, h62 1 introduction the fear that the public sector deficit will eventually be monetised and thus lead to inflation is a deep rooted one among economic agents (buiter, 1985: 21). often, the recurring question is whether larger public deficits are always associated with higher inflation. sargent and wallace (1981) answered the question affirmatively, but their relationship is blurred, because governments finance deficits by borrowing domestic and abroad as well as printing money. various factors, including unstable demand for money, exchange rate depreciation, and widespread indexation shadow the relationship between money financing of deficits and inflation over shorter periods (easterly & schimdt-hebbel, 1993: 220). the tanzanian economy has remained one of the limited cases that have experienced a relatively high inflation rate, accompanied by high fiscal deficits (for a prolonged period) in the absence of any hyperinflation. this paper examines the deficit-inflation relationship in the tanzanian economy and establishes the causal link that runs from the budget deficit to the inflation rate using cointegration analysis over the period 1967-2001. some dynamic sajems ns vol 7 (2004) no 1 101 simulations are done to gauge the effect of a change in the budget deficit and gross domestic product on inflation over time. the budget deficit is found to be significantly inflationary due to the structure of the tanzanian economy. the paper is organised as follows. section 2 gives an overview of the tanzanian situation, while section 3 discusses the budget deficit and inflation from the monetarist perspective. section 4 estimates the relationship empirically, while section 5 provides some concluding comments. 2 the tanzanian economy, the budget and inflation 2.1 the budget deficit and its financing government deficit spending in tanzania has been the subject of much concern in tanzania's current economic problems. particularly, government spending is considered to have contributed significantly to the country's inflation and external imbalance. accordingly, surmounting these phenomena has been seen as being very much dependent on securing a closer look at the dynamics of the components of the budget balance. according to the central bank (bank of tanzania) the government has been continuously pursuing an expansionary fiscal policy with the exception of the years 1997,1998 and 2000. the main culprit for the expansionary fiscal stance was increasing pressure from the public seeking to achieve faster economic growth. the government responded by expanding its expenditure on development projects and infrastructure improvements. however when the impact of the increasing fiscal deficit was felt at the end of 1996, an immediate policy shift was observed. the ensuing macroeconomic instability (high inflation rate and high interest rates) was combated using tight fiscal discipline. the low inflation rate achieved at the end of 1990s and early twenty first century is explained by the introduction of improved fiscal discipline. the government, with the assistance of the donor community, embarked in 1985 on an ambitious stabilisation and reform agenda. in the fiscal area, efforts were focused on strengthening fiscal management via broad-based policy and administration reforms. at the same time, increased transparency and coordination with donors on macroeconomic policies and structural reforms helped mobilise financial support and kept the share of budget deficit to gdp below 5 per cent. looking at how the budget deficit is financed in tanzania gives a realistic picture of the inflationary effect of the fiscal deficit. in tanzania, budget deficits sajems ns vol 7 (2004) no 1 102 have been financed from domestic and foreign sources. the source of finance implies a different effect of a budget deficit on inflation. domestic financing is more inflationary than foreign financing in many developing country economies because of the fact that the economies of these developing countries is characterised by inefficient capital markets and high dependence on developed countries for foreign reserves. therefore, domestic financing is mostly done by borrowing from the banking system which is often monetised by the government. tanzania's economy is not different from many other developing countries. table 1 source of total government finance in tanzania years total financing (schilling) per cent of foreign finance per cent of domestic finance per cent of non-bank borrowing per cent of bank borrowing 1984 4,824.40 54.1 45.9 -55.6 155.6 1985 7,922.10 30.74 69.3 34.9 65.1 1986 7,910.20 49.2 50.8 53.4 46.6 1987 9,715.50 36.4 63.6 20.3 79.7 1988 18,749.50 75.9 24.1 63.3 36.7 1989 24,727.80 80.0 20.0 47.7 52.3 1990 29,728.60 106.0 -6.0 -150.9 250.9 1991 48,745.90 75.2 24.8 30.9 69.1 1992 42,461.00 121.9 -21.9 -62.2 162.2 1993 82,230.40 102.6 -2.6 -410.9 510.9 1994 73,579.60 40.0 60.0 13.7 86.3 1995 104,515.00 61.2 38.8 65.5 34.5 1998 64,559.00 4.6 95.4 9.4 90.6 1997 21,269.50 -164.1 264.1 111.7 -11.7 1998 -77,139.30 63.6 36.4 92.9 56.5 1999 68,137.20 94.6 5.4 -643.3 743.3 2000 -24,423.60 76.5 23.5 121.4 -21.4 2001 113,271.60 93.1 6.9 2.1 97.9 source: bank of tanzania the deficits were largely financed through borrowing from the banking system. government borrowing from the banking system as a percentage of gdp was as high as 86.3 per cent in 1994 and 90.8 per cent in 1998. in 1990, as stabilisation and liberalization policies and the related reform agendas began to be implemented, the availability of foreign financing increased. as a result the share of foreign financing of the total financing has increased. this has helped support the government in its resolve not to make use of relatively expensive or sajems ns vol 7 (2004) no 1 103 inflationary domestic financing, while allowing sufficient credit resources for the private sector and a necessary build up of foreign reserves. the rationalisation of expenditure programs and the progressive shift from domestic to foreign financing were at the core of tanzanian macroeconomic stabilization in the middle of the 1990s, contributing to a sharp reduction in inflation. 2.2 inflation performance in tanzania the historical trend of inflation in tanzania shows inflation has always been a two-digit figure starting in 1966. in the 1970s it has been limited to fluctuate between 10 per cent and 20 per cent. at the end of the 1970s and the beginning of 1980, a radical increase was recorded. inflation rose to the level of 30 per cent. it stabilised at this level, only dropping to 20 per cent at the end of 1980s. the government of tanzania's strategy for reducing inflation has, since 1986, focused on tight monetary policy and increased output production. this focus has been determined by the fact that tanzania's inflation has been both a monetary and a structural phenomenon (rutayisire, 1986). the task of slowing down inflation proved difficult. this difficulty was due to structural problems that hindered efficient production (for example, dependence on the weather) and inflationary financing of persistent fiscal deficits, caused by a combination of high government expenditure and poor domestic revenue collection. inflation remained high during these periods, although at a slightly lower level than the pre-reform level of 22.3 per cent in 1985. the significant decline in the inflation rate since 1994 reflects the impact of tight monetary and fiscal policies pursued by the central bank and government. one observes that the growth rate in the money supply declined from 32.5 per cent in 1994 to approximately 7.7 per cent in 1998. the budget deficit expressed as a percentage of gdp also declined from 6.4 per cent in 1994 to 2.9 per cent in 1998. the year to year underlying inflation rate, which is the rate of inflation excluding changes in food prices also decreased significantly from 13.8 per cent to 8.0 per cent in 1998. the decrease is partly attributed to the decline in prices of most non-food group items such as rents, fuel, electricity and water, and transportation. 3 theoretical links of the budget deficit and inflation in the monetarist perspective money supply drives inflation. if monetary policy is accommodative to a budget deficit, money supply continues to rise for a long time. aggregate demand increases as a result of this deficit financing, causing output to increase above the natural level of output. growing labour demand sajems ns vol 7 (2004) no 1 104 increase wages, which in turn leads to the shift in aggregate supply in a downward direction. after some time the economy returns to the natural level of output. however, this happens at the expense of permanent higher prices. according to the monetarist view, budget deficits can lead to inflation, but only to the extent that they are monetised (hamburger and zwick (1981)). in the monetarist (and neo-classical) models, changes in the inflation rate closely depend on changes in the money supply. generally, the budget deficit per se does not cause inflationary pressures, but rather affects the price level through the impact on money aggregates and public expectations, which in turn trigger movements in prices. the money supply link of causality rests on milton friedman’s famous theory of money, which dictates that inflation is always and everywhere a monetary phenomenon. the theory explains that continuing and persistent growth of prices is necessarily preceded or accompanied by a sustained increase in money supply. the expectations link of causality works through the inter-temporal budget constraint, which implies that a government with a deficit must run, in present value-terms, future budget surpluses (walsh, 1998: 138-57). one possible way to generate surpluses is to increase the revenues from seignorage, so the public might expect future money growth. the deficit-inflation relationship is also discussed by considering direct effects of inflation on outstanding debts, tax revenues and expenditures. the dynamic interaction between public deficits and inflation could go in one of two directions. either the effect of inflation to reduce the real value of debts dominates, or inflation worsens the fiscal position of the government due to collection lags, which reduces the government’s real revenue (dornbusch, 1990). this fall in the revenue, in itself, is accepted as a contributing factor in the inflationary process by increasing the money supply to finance these inflation-induced deficits (tanzi, 1991; aghevli & khan, 1978). empirical work on the relationship between deficits and inflation has yielded conflicting results. although the direction of the causation is generally accepted from deficits to inflation empirical evidence on this unidirectional causation is inconclusive (e.g. abizadeh & yousefi, 1998; ahking & miller, 1985; barnhart & darrat, 1988; dwyer, 1982; hamburger & zwick, 1981; hondroyiannis & papapetrou, 1997). while some studies provide results to support the idea that inflation is caused by deficits, in many studies there is no significant evidence. on the other hand, aghevli and khan (1978), ahking and miller (1985), barnhart and darrat (1988), hondroyiannis and papapetrou (1997) find a bidirectional causation between deficits and inflation. most of the empirical studies have adopted ad hoc approaches using econometric techniques. the relationship has been generally examined through the relationship between money growth and inflation. the monetarist assumption, which suggests that inflation is mainly a result of an increase in the money supply, is explicitly or sajems ns vol 7 (2004) no 1 105 implicitly held in many studies. even some studies questioning the relevance of the unidirectional relationship between deficits and inflation presume a direct relationship between money growth and inflation (e.g. de haan & zelhorst, 1990; hondroyiannis & papapetrou, 1997; hamburger & zwick, 1981; mcmillin & beard, 1982). the most common empirical method to examine the deficit-inflation relationship has been to employ a single equation model for money growth or inflation, treating deficits as an exogenous variable among others (e.g. abizadeh & yousefi, 1998; ahking & miller, 1985; hamburger & zwick, 1981; mcmillin & beard, 1982). conclusions have been based on these estimates, and a positive and statistically significant coefficient on the deficit variable has been taken as evidence to support the hypothesis that deficits ‘cause’ money growth and/or inflation. in such a single equation approach, a possibility for a reverse causation from inflation to deficits is generally ruled out. it appears that the “budget deficit-inflation” link in fact exhibits a two-way interaction, i.e. not only does the budget deficit through its impact on money and expectations produces inflationary pressure, but high inflation then also has a feedback effect pushing up the budget deficit. basically, this process works through significant lags in tax collection. the problem lies in the fact that the time of tax obligations’ accrual and the time of actual payment do not coincide with payment usually made at a later date. in view of this, high inflation during such a time lag reduces the real tax burden. we may therefore have the following self-strengthening phenomenon: persistence of the budget deficit props up inflation, which in turn lowers real tax revenues; a fall in the real tax revenues then necessitates further increases in the budget deficit and so on. in economic literature this is usually referred to as the olivera-tanzi effect. as sachs and larain (1993) show, the evidence from the developing world in the 1980’s supports the conclusion that this self-strengthening process may well destabilise an economy and lead to a very high inflation. some researchers also argue that budget deficit financing by means of accumulating domestic debt seems to only postpone the inflation tax. if government finances its deficit by printing money now, then in the future the burden of servicing existing stock of government debt will be easier. interest payments that otherwise add to the next periods’ government expenditures will not exert additional pressure on fiscal authority and the deficit will not increase over time. as sachs and larrain (1993) put it, “borrowing today might postpone inflation, but at the risk of even higher inflation in the future”. sargent and wallace (1981) observe that when the fiscal authority sets the budget independently, the monetary authority can only control the timing of sajems ns vol 7 (2004) no 1 106 inflation. recently a new direction of theory has emerged, which may also be seen as an extension of the deferred inflation hypothesis. according to the new fiscal theory of the price level (see komulainen & pirttila, 2000 and carzoneri, cumby & diba, 1998) there can be two regimes for price determination. under the so-called “monetary dominant” regime, monetary policy determines the price level, and fiscal policy remains reactive. the government balances its intertemporal constraint taking the inflation as given. in the “fiscal dominant” regime, in contrast, the price level is determined by the intertemporal budget constraint. if the future surpluses fall short of financing the deficit, the price level must adjust upwards, reducing the real value of the government debt. monetary policy is reactive in a “fiscal dominant” regime: money supply reacts to price level changes to bring the money demand equation in balance (carlston & fuerst, 1999). 4 empirical analysis of tanzania’s inflation the most common empirical method to examine the deficit-inflation relationship has been to employ a single equation model for money growth or inflation, treating deficits as an exogenous variable among others [e.g. abizadeh and yousefi (1998), ahking and miller (1985), hamburger and zwick (1981), mcmillin and beard (1982)]. in this study a four variable single equation model is employed. budget deficit, gdp and exchange rate are treated as an exogenous variables and inflation (cpi) as an endogenous variable. 4.1 the model for the estimation of the influence of a budget deficit on inflation, one can start from the long run government budget constraint: ∑ ⎟ ⎟ ⎠ ⎞ ⎜ ⎜ ⎝ ⎛ −+−= + −− +++ − jt jt jtjtjt jt t p m mg rp b ) ( 1 11 τ [1] where bt-1/pt = government debt rj = the discount rate jt+τ = total tax revenue gt+j = total government expenditure mt = broad money supply considering the particular case where the public debt cannot grow implies that the entire budget deficit is ultimately financed through seignorage. imposing this restriction on the public debt, one obtains the short run budget constraint: sajems ns vol 7 (2004) no 1 107 ⎟⎟ ⎠ ⎞ ⎜⎜ ⎝ ⎛ − +−= −− t tt tt t t p mm g p tb 11 )( τ [2] where b(t) is the debt with the maturity in period t that has to be paid and is not rolled-over. this can be rewritten as ⎟⎟ ⎠ ⎞ ⎜⎜ ⎝ ⎛ − =+− −− t tt tt t t p mm g p tb 11 )( τ . [3] the term on the left hand side is the budget deficit formed from the fiscal deficit and repayment of public debt with the maturity in period t and the term on the right hand side is seignorage. seignorage revenue (s) can be written as a function of the inflation rate and real money supply: t tt p mfs )(π= [4] where )( tf π is a reduced form money demand equation. considering that seignorage is increasing with the inflation rate and combining equation 3 and equation 4 one obtain the equation estimated by catao and terrones (2001) that explains the inflation rate by the budget deficit and money supply: t s ttt mpd /β=π [5] where β is the inverse linear multiplier dt is the budget deficit which is dt=gt-tt-bt-1 m/p is the money supply if one divides by nominal gdp (y) one obtains a relation between the size of budget deficit (d) in gdp and the level of inflation: tttt ymyd ///=π [6] the long run equation developed in this study includes the ratio of the budget deficit to gdp and the exchange rate as exogenous variables and the consumer price index, as the endogenous variable. sajems ns vol 7 (2004) no 1 108 the influence of the budget deficit on inflation is positive. the higher the budget deficit, the greater will be the rate of inflation. the budget deficit affects inflation only if it is monetised to increase the monetary base of the economy. from friedman's theory of money inflation is a monetary phenomenon. accordingly if the budget deficit is monetised it increases the money supply thereby increasing the price level. when the budget deficit is monetised, an extremely high correlation exists between the budget deficit and money supply. the problem of multicollinearity and reducibility precludes one from using both money supply and the budget deficit as explanatory variables in the regression analysis. therefore, in order to estimate the effect of the budget deficit on inflation, the budget deficit is used as explanatory variable instead of the money supply. the exchange rate has a deterministic effect on the level of prices in underdeveloped economies. it’s included as a control variable in this paper that can explain inflation. in countries like tanzania, an exchange rate depreciation (appreciation) could increase (decrease) the price of imported commodities. tanzania’s markets are heavily based on imported commodities, which imply the depreciation of the exchange rate could be immediately reflected on an increase on the price of the consumer’s basket of commodities. the third important explanatory variable is the level of gdp, which is negatively related with the level of inflation. the functional form of the model is: cpi = f(bdef, exch, gdp) where: cpi is the consumer price index (1995=100) bdef is the consolidated budget deficit (before grants) gdp is the level of gross domestic product at constant price exch is the exchange rate of tanzania’s shilling against u.s.dollar annual data obtained from the world bank and the bank of tanzania for the period between 1967-2001 was used. from the adf test result all the time series variables are non-stationary and exhibit stochastic trends that can be removed by differencing once or more than once (see appendix a, table 2 for the results of the adf tests). the adf unit root test results show all four variables under discussion [log(cpi), log(bdef), log(exch), log(gdp)] are integrated of the order one at a 5 per cent level of significance. a vector autoregressive (var) model with a lag length of 1 was used to test for the number of cointegrating relationships between the variables in the long run equation (table 3). in order to test for cointegration between the variables, the johansen test was employed. for a var (1) the johansen likelihood ratio test for the number of cointegrating relationships (denoted by r), based on the maximum eigenvalue and the trace of sajems ns vol 7 (2004) no 1 109 the stochastic matrix, suggests one cointegration relationship at a 5 per cent level of significance between the variables in the long run cointegration relationship. these results are presented in table 4. the long run relationship was estimated with no intercept or trend and the figures normalised on the dependent variable is reported in table 5. the residual derived from the long run equation, allows for the specification of the error correction model (ecm), representing the short run dynamic adjustment process. this result is reported in table 6. in the ecm the coefficient on the residual indicates the speed of adjustment towards the long run equilibrium and its value is between -1 and 0. large absolute values of the coefficient on the residual shows equilibrium agents remove a large percentage of disequilibrium in each period i.e. the speed of adjustment is very rapid. low absolute values are indicative of a slow speed of adjustment towards equilibrium. all variables used were in their first differenced form. dum87 is a dummy variable that represents the change from a highly controlled economic system to a more liberalised economic system in 1987 under the economic recovery program. diagnostic tests in table 5 suggest that the equation is statistically well specified, with no violations of the gaussian assumptions. the result of the ex post simulation of the consumption price function is presented graphically in figure 1. the aim of the simulation is to determine the policy implications on inflation in tanzania, with specific reference to the budget deficit. to observe the sensitivity of the consumer prices in the model to variations in the parameters of the exogenous variables, shocks are induced to two of the independent variables. the independent variables, i.e. the budget deficit and gross domestic product are shocked systematically and variations in the solutions are evaluated in terms of deviations from the base solution. sensitivity tests in the form of dynamic simulations will determine whether the resulting multiplier effects are consistent. more importantly, it will establish the duration or “pipeline” effects of a shock to a dependent variable on consumer prices. this will enable policy makers to determine how long it takes consumer prices to converge after an increase in the budget deficit or gdp. the variables are shocked one at a time. figure 2 reveals that a 10 per cent increase in the budget deficit from 1980 onwards, results in a sharp and almost immediate increase of 30 per cent in the level of inflation. it takes 5 years for consumer prices to converge again to a long run path. as a priori expected, this higher budget deficit is at the expense of permanent higher consumer prices. sajems ns vol 7 (2004) no 1 110 figure 1 the overall dynamic fit of log(cpi) 1 0 1 2 3 4 5 6 1 9 7 0 1 9 7 5 1 9 8 0 1 9 8 5 1 9 9 0 1 9 9 5 2 0 0 0 a c t u a l l o g ( c p i ) e x p o s t s i m u l a t e d l o g ( c p i ) this increase in the budget deficit induce higher inflation due to higher aggregate demand, resulting from an increase in expenditure as well as the increase in money supply, to monetise the increase in the budget deficit. figure 2 dynamic adjustment properties on cpi due to a 10 per cent increase in the budget deficit the gdp is increased by 10 per cent permanently from 1980 onwards. the outcome of the shock shown in figure 3 reveals that consumer prices fall by nearly 35 per cent from its long run equilibrium and converge in 1986 at a lower price level. the increase in output eases the demand pressure in the economy and lowers the level of inflation. the effect is so large because of the structure of the tanzanian economy. being an economy that relies heavily on agriculture 0 5 1 0 1 5 2 0 2 5 3 0 3 5 1 9 7 0 1 9 7 5 1 9 8 0 1 9 8 5 1 9 9 0 1 9 9 5 2 0 0 0 b u d g e t d e f i c i t s h o c k e d l o g ( c p i ) sajems ns vol 7 (2004) no 1 111 for basic food and income, it often happens that the supply in the economy is insufficient to satisfy demand – especially in dry seasons. figure 3 dynamic adjustment properties on cpi due to a 10 per cent increase in the gdp 4.2 policy implications in the past the government has often monetised its budget deficit. this resulted in a high inflation rate for tanzania. the simulated results showed that increasing the budget deficit profoundly affects the level of prices. after conducting sensitivity tests, tanzania’s economic growth and budget deficit seem to have a considerable effect on inflation. increasing the level of economic growth in the country by 10 per cent can permanently lower the level of prices by up to 35 per cent. the growth in gdp, especially if it emanates from the agriculture and food processing industry, could ease the demand pressure for food related products. the consumer price index assigns a weight of 65 per cent for food products in tanzania. higher agricultural output will decrease the inflation rate significantly. these simulations imply that the government could increase the budget deficit marginally. however, in order to keep inflation at low levels, the government should be spending in such a way that it also increases economic growth. this increase in gdp might offset partially or completely, the pressure on the inflation rate from a higher budget deficit. although more possibilities emerged in the past few years to finance the fiscal deficit in tanzania, the fiscal imbalance still has an inflationary impact. cutting the budget deficit is disinflationary, even more so when the monetised share of 3 5 3 0 2 5 2 0 1 5 1 0 5 0 5 1 9 7 0 1 9 7 5 1 9 8 0 1 9 8 5 1 9 9 0 1 9 9 5 2 0 0 0 g d p s h o c k e d l o g ( c p i ) sajems ns vol 7 (2004) no 1 112 the budget is falling. even if the government resorts to non-inflationary financing of the budget deficit, it has to build credibility in government debt management. economic agents should trust that the government would not be forced to revert to monetisation. development of an efficient capital market and maintaining the independence of the central bank is a policy alternative for the tanzania’s government. although not explicitly simulated in this paper, the elasticity coefficient indicates that the exchange rate has a high and sustained long run effect on inflation. the government should be very careful in its exchange rate management policies. 5 conclusion the relationship between public sector deficits and inflation is one of the important and controversial issues in the academic literature as well as in economic policy field. using annual data of tanzania, from 1967-2001, the existence of a stable long run relationship between the budget deficit, exchange rate, gdp and inflation is tested in this study and the result has been affirmative. using the cointegrating vector found in the study, a significant impact of the budget deficit on inflation in tanzania cannot be refuted under the assumption of long run monetary neutrality. simulations indicate that inflation is very responsive to shocks in the budget deficit as well as gdp. this implication is important for developing countries with inefficient and under developed financial systems. governments in these countries should take note of the sensitivity of price levels to fiscal policy. the simulations also highlight the supply problem faced by many developing countries. these countries tend to be highly depended on agriculture and producers are at the mercy of weather conditions. any shock to the agriculture sector has great influence on consumer prices via a decrease in the gdp. as long as developing economies are heavily dependent on the agricultural sector, these shocks are likely to persist. sajems ns vol 7 (2004) no 1 113 appendix a table 2 adf tests for non-stationarity variable lags model τ∞τµτ φ∞φ3 log(cpi) 1 trend&intercept -2.50 16.98 0 intercept -1.45 2.10 0 none -1.49 log(bdef) 1 trend&intercept -3.96 5.29 0 intercept -0.76 0.58 0 none -2.08 log(exch) 1 trend&intercept -2.22 13.45 0 intercept 1.19 4.24 0 none 1.49 log(gdp) 1 trend&intercept -2.25 5.99 0 intercept -1.61 2.58 1 none 2.73 ∆log (cpi) 0 trend&intercept -6.31*** 19.93*** 0 intercept -6.26*** 39.13*** 0 none -6.34*** ∆log (bdef) 2 trend&intercept -6.05*** 22.77*** 2 intercept -6.13*** 31.26*** 2 none -6.26*** ∆log (exch) 1 trend&intercept -5.49*** 14.9*** 1 intercept -5.50*** 22.50*** 1 none -5.60*** ∆log (gdp) 1 trend&intercept -3.14 5.12 1 intercept -3.15** 9.92** 1 none -1.46 (**) [***] represents rejection of the null hypothesis of the existence of unit roots at 10%, (5%), [1%] level of confidence table 3 selection of the order of the var: consumer prices order of the var ll aic 2 99.534 67.534 1 67.798 51.798 sajems ns vol 7 (2004) no 1 114 table 4 the johansen test for the number of cointegrating relationships: consumer prices cointegration lr test based on the maximal eigenvalue of the stochastic matrix null alternative statistic 95% critical 90% critical r=0 r=1 79.1997 23.92 21.58 r<=2 r=2 13.2543 17.68 15.57 cointegration lr test based on trace of the stochastic matrix null alternative statistic 95% critical 90% critical r=0 r>=1 99.7171 39.81 36.69 r<=2 r>=2 20.5174 24.05 21.46 table 5 estimate of cointegration equation dependent variable: log(cpi) variable coefficient log(bdef) 0.445817 log(exch) 1.234753 log(gdp) -0.487306 sample period: 1967 – 2000 r=1; table 6 the ecm equations dependent variable: ∆log(cpi) variable coeff std. error t-statistic residt-1 -0.054 0.031 -1.74 ∆log (gdp)t 0.554 0.081 6.80 ∆log (gdp)t-1 0.397 0.079 4.97 dum87 -0.223 0.039 -5.62 sample period adjusted r-squared s.e 1969 to 2000 0.62 0.055 purpose of test test probability* normality jarque-bera 0.332 heteroscedasticity white hetr. test 0.279 serial correlation breusch-godfrey lm 0.090 stability ramsey reset 0.205 *indicates the probability of falsely rejecting the null hypotheses of zero restrictions on the coefficient or diagnostic. sajems ns vol 7 (2004) no 1 115 references 1 abizadeh, s. & yousefi, m. (1998) “deficits and inflation: an open economy model of the united states”, applied economics, 30: 107-316. 2 aghevli, b. & khan, m. (1978) “government deficits and the inflationary process in developing countries”, imf staff papers, 25(3): 383-416. 3 ahking, f. & miller, s. (1985) “the relationship between government deficits, money growth and inflation”, journal of macroeconomics, 7(4): 447-67. 4 akcay, o. (1996) “budget deficit, money supply and inflation: evidence from low and high frequency data for turkey”, bogazici university, department of economics, december. 5 barnhart, s.w. & darrat, a.f (1988) “budget deficit, money growth and causality: further oecd evidence”, journal of international money and finance, 7(2): 231-42. 6 buiter, w.h. (1985) “a guide to public sector debt and deficits”. economic policy (1): 13-80. 7 carlstrom, c.t. & timothy s.f. (1999) "money growth and inflation: does fiscal policy matter?" federal reserve bank of cleveland, april 15. 8 carzoneri, m.; cumby, r. & diba, b. (1998) “is the price level determined by the need of fiscal solvency?” nber woking paper no.6471 9 catao, l. & terrones, m. (2001) “fiscal deficits and inflation: a new look at the emerging market evidence”, imf working paper no.74/01. 10 de haan, j. & zelhorst, d. (1990) “the impact of government deficits on money growth in developing countries”, journal of international money and finance, 9: 445-69. 11 dornbush, r. (1990) “extreme inflation: dynamics and stabilization” in brookings paper on economic activity, w.c. brainard and g.l.perry (eds.) brookings institution. 12 dwyer, g. (1982) “inflation and government deficits”, economic inquiry, 20: 315-29. 13 easterly, w. & schmidt–hebbel, k. (1993) “fiscal deficits and macro economic performance in developing countries”, the world bank research observer 8(2): 211-37. 14 hagger, a.j. (1977) inflation: theory and policy, macmillan press ltd. 15 hamburger, m.j. & zwick, b. (1981) “deficit, money and inflation”, journal of monetary economics, 7. sajems ns vol 7 (2004) no 1 116 16 hondroyiannis, g. & papapetrou, e. (1997) “are budget deficits inflationary?” applied economics letters, 4(8): 493-96. 17 komulainen, t. & jukka, p. (2000) “fiscal explanations for inflation: any evidence from transition economies” bofit discussion papers, no.11. 18 mcmillin, w. & v. beard, t. (1982) “deficits, money and inflation: comment”, journal of monetary economics, 10: 273-77. 19 piontkirsky, r. (2001) “the impact of the budget deficit on inflation in ukraine”, intas, may. 20 rutayisire, laurean w. (1986) "measurement of government budget deficit and fiscal stance in less developed economy: the case of tanzania, 1966-84," the university of dar el salaam, eastern africa economic review, 2(2). 21 sachs, j. & larrain, f. (1993) macroeconomics in the global economy, englewood cliffs, nj, prentice hall, inc. 22 sargent, t. & wallace, n. (1981) “some unpleasant monetaristic arithmetic”, monetarism in the united kingdom: 15-41. 23 tanzi, v. (1991) public finance in developing countries, edward elgar publishing limited: england. 24 thorbecke, w (2002), "budget deficits, inflation risk, and asset prices", journal of international money and finance, 21(4): 539-53. 25 turnovsky, s. & v mark, e. (1987) "alternative modes of deficit financing and endogenous monetary and fiscal policy 1923-1982." nber working paper 2123, january. 26 walsh e., carl (1998) monetary theory and policy mit press, cambridge, massachusetts, london, england. abstract introduction economic characteristics of the five regional economies input-output approach multiregional input-output model linkages in the kwazulu-natal spatial economy application of the new multiregional input-output model summary and conclusion acknowledgements references about the author(s) clive e. coetzee school of economics, north-west university, potchefstroom, south africa ewert p.j. kleynhans school of economics, north-west university, potchefstroom, south africa citation coetzee, c.e. & kleynhans, e.p.j., 2019, ‘estimating trade flows between regions of kwazulu-natal, south africa’, south african journal of economic and management sciences 22(1), a2390. https://doi.org/10.4102/sajems.v22i1.2390 original research estimating trade flows between regions of kwazulu-natal, south africa clive e. coetzee, ewert p.j. kleynhans received: 03 apr. 2018; accepted: 04 apr. 2019; published: 05 june 2019 copyright: © 2019. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the enhancement of trade creates employment and wealth and should be promoted. during planning and economic development of a region knowledge regarding the effect of initial actions on the final economic indicators such as total demand, purchases, sales, imports, exports, value addition and employment is indispensable. the specific value of trade flows and the multiplier effects involved, indicating the magnitude of linkages on a local and global level is essential. aim: the final and intermediate trade flows between regions of kwazulu-natal, south africa, are investigated in this article. setting: the five major regions of kwazulu-natal province. methods: to investigate these spatial linkages, a modified multiregional input-output model was constructed. a survey approach was used to construct the model and involved primary data collected through a specially designed survey. results: the results show that richards bay and durban had the highest output multipliers, leading to the largest effect on output and trade flows. it was found that the values of intra-trade of these regions are much higher than the trade between the various urban regions. durban has a fairly open economy, trading significantly with the other four regions, followed by pietermaritzburg and richards bay. port shepstone and newcastle are relatively closed economies, trading predominantly internally. conclusion: the results suggest that there is indeed some flows of goods and services between the five regions, both intermediate and final. however, the estimated inter-regional spillovers, as well as feedback effects, seem to be rather limited. keywords: trade flows; inter-regional; input-output; multipliers; economic interdependency. introduction this article investigates the intermediate and final trade flows between the five major regions of the province of kwazulu-natal (kzn), south africa. these five major regions are not autonomous entities operating as closed economies with no movement of goods and services, labour or capital between them and as such it can be argued that to some degree they are mutually dependent on one another. on the other hand, these regional economies are also spatially fairly dispersed, which could lead to spatial isolation or convergence (coetzee & kleynhans 2018:221). the extent of the economic correlation interdependence between these five regional economies is therefore very uncertain, with some economic forces supporting greater interdependence, while some are constraints to greater interdependence. economic growth and development are low in most parts of the country, especially in some regions of kzn. many people experience poverty and unemployment, with little hope for the future; for example, the number of discouraged work seekers has increased from 179 000 in march 2008 to 708 000 in december 2016 (stats sa labour force survey 4th quarter 2016). the enhancement of production and trade is therefore essential, as it creates employment and wealth. in order to achieve this, it is necessary that a clear view of the province’s points of strength and challenges are identified with regard to value-added production and trade flows. although each of the five regional economies is unique in their own right, they are characterised by a large number of complex and intimate interrelationships between their own markets and markets outside their boundaries. for this reason, a regional economic input-output approach, with its capacity for describing detailed transactions among economic units, is especially well suited to the analysis of the economic interdependence between the five main regional economies. essentially, input-output is a method of tracing and using information about transactions between buyers and sellers (hirsch 1973), but can also be modelled to show the flows of transactions between firms of specific and various other regions (schaffer 1999). to determine trade flows of the province, this study measures the extent of the economic interdependency between the five regional economies by constructing an inter-regional input-output (irio) table that links the five regional economies of kzn, using the chenery-moses model, with data from the annual regional economic business confidence surveys that have been conducted since 2005. the survey contains questions relating to the proportion of products and services by businesses in a particular regional economy sold to other regional economies. the study firstly explores important economic characteristics of the five regional economies. then, the design of the regional input-output table and how it illustrates trade flows is explained. furthermore, an input-output model is developed incorporating inter-regional spillover and feedback effects. next, the multiregional input-output model (mrio) is constructed and the regional economic multipliers are estimated. finally, the mrio model is applied using elementary examples, and deductions are made. economic characteristics of the five regional economies the five regional economies of kzn represent the major urban or municipal regions of the province. these regions are durban, which constitutes the provincial centre of economic activity, with south africa’s largest harbour. the durban harbour is also the largest harbour in sub-saharan africa (african business central 2015). second largest is pietermaritzburg, capital of kzn, followed by richards bay, the manufacturing centre, with the largest coal export terminal globally and large aluminium smelters. the whole of kzn is renowned for its tourist attractions and scenic beauty. there are 21 beaches in the urban region of port shepstone, covering a coastline of 90 km2. finally, the newcastle region has very large coal resources and agricultural land. these five regional economies dominate the economic landscape of the province, entailing approximately 55% of the provincial population, producing approximately 80% of the provincial gross domestic product (gdp), and income per capita exceeds twice that of the rest of the province. space filled by new business and financial institutions, retail and warehouses and industries of these five regions account for approximately 93%, 86% and 78% (2001–2008). these five regions cover only 8.5% of the total provincial land, but compared to the whole province, the poverty levels are almost half, and the population density in these regions exceeds the rest 12 times (global insight 2018; stats sa 2018). these five regions also differ significantly in terms of their population size, especially when compared to durban (see table 1). table 2 displays the annual average contribution rates for each economic sector as a percentage of their total gross geographical product for each of the five regions compared to the national and provincial economies (2002–2016). the structural differences are fairly evident; for example, richards bay and newcastle are ‘production’ economies (manufacturing accounts for around 39% and 31% of their economies), while pietermaritzburg and port shepstone are ‘consumer’ economies (tertiary sectors account for around 68% and 62% of their economies). durban has a much more diversified economy (fairly evenly balanced between the three primary economic sectors), quite similar to the national economy. table 1: population size, 2002–2016. table 2: annual average contribution rates (sector percentage of total gross domestic, provincial and geographical product), 2002–2016. the gross geographical product and economic growth rates of the five regions fluctuate much (measuring gross geographic product [ggp] at million rand 2010 constant prices, where ‘rand’ is the south africa currency). table 3 displays the annual ggp and average economic growth rate of each of the regions and the national and provincial economies. the differences in total economic output are very large and substantial, although the economic growth rate disparities are marginal. it is also noticeable that the regional economic growth rates have been much more volatile (as reflected by the standard deviation statistics) than the national and provincial growth rates, with the exception of pietermaritzburg and richards bay. table 3: annual gross domestic product (r million, 2010 constant prices), 2002–2016. with regard to spatial distribution, table 4 indicates the road distance (kilometre) between the five cities. durban and pietermaritzburg are closest to each other, while newcastle and port shepstone are farthest from each another. the two largest cities are nearest to each other, while the two smallest cities are farthest from one another other. table 4: road distance matrix (km). input-output approach hirsch (1973) states that input-output is, at one level, a theoretical approach with a set of assumptions, well-defined mathematical properties, and close relation to the general equilibrium models of walras and cassel. at another level, the technique can be considered as the empirical implementation of a special sort of general equilibrium analysis in which restrictions on the data available and simplifying assumptions convert the technique to a relatively highly disaggregate economic accounting and forecasting tool (isard et al. 2017). input-output models are matrixes with rows and columns representing all the industries and sectors of an economy and indicate how they are structurally related. each row summarises all the inputs from other sectors that a sector uses for its own production. each row can basically be regarded as a production function, indicating the inputs from all other sectors in a transaction table. with such a table, the production and trade flows in a region can be traced and predicted (united nations 1999). a change in production in one sector will have a ripple effect throughout the economy affecting the related demand, prices and outputs of all other sectors (bazzazan, alavinasa & banouei 2005). included in this matrix are the value added by each sector and both intermediate and final demand from industries, household, government and other regions, channelled through sales and trade flows, within and exogenous to the regions (volkwyn & kleynhans 2014:4). the input or technical coefficients can be determined from the input-output matrix, which indicates the extent to which each sector is related to the others. these technical coefficients show the relative input share necessary from each sector for the production of a single product or service (pissarenko 2003). the model represents the whole economy, but for the current study, it will be restricted to the processing sector industries. the input-output table can then be applied to a wide range of economic investigations and analyses. multiregional input-output model much and varied research has been conducted on a regional level using input-output matrixes. some studies study economic and trade flows within regions, while others investigate the activities between regions. most regional models are equivalent to the national input-output tables, but only differ in that regional input-output models cover a smaller geographical region. the first multiregional input-output models (mrio) were compiled by chenery (1953) and moses (1955). they made the simplified assumptions that trade flows between regions are only determined by the regions between which the flows occur and ignored the particular industries or customers. mrio analysis allows users to define a large region and capture leaked impacts while maintaining the specificity and individual identities of the direct impact location and each of the linked regions of interest. when a change in final demand exerts an exogenous impetus to specific production in a region, more factors of production will be required from both the local and other regions, implying spillovers (sargento 2009). in an effort to supply the required inputs from the various regions, an increase in the demand for intermediate inputs will occur, implying interaction and feedback. this implies an initial increase in final demand in one region, leading to both intraand inter-regional trade flows (miller 1998). as the mrio model accommodates these interactions, feedback effects and spillovers, this model is regarded as ideal for the current research. the direct changes in production and trade flows in reaction to final demand changes for a certain commodity or region are represented by the technical coefficients, which can be summarised in a macro-economic input-output matrix (a) for five regions as: the respective intra-regional trade flows within each of the various regions (1–5) are represented by the technical coefficients a11, a22, a33, a44 and a55.the other technical coefficients indicate the inter-regional flows between the various regions. if the regions were countries, this would indicate global trade between countries. in the current study, it will represent various regions in the province of kzn. in the same manner, the vectors of total output (x) and final demand (y) are represented as: if the matrix is subtracted from an identity matrix, it yields a leontief inverse matrix, which may be represented as: assume the final demand for a good or service in region x1 increases for whatever reason. since region x1 is reliant on itself (intermediate flows from its own firms) and on intermediate flows from firms in regions x2 to x5 (at various levels) to meet the increased demand (final demand), region x1 and regions x2 to x5 (domestic exports) increase their production to meet the increased demand in region x1. the increase in production in regions x1 to x5 will be dependent on the level of self-sufficiency of region x1 and the degree of inter-regional linkages (spill effect) between region x1 and regions x2 to x5. in order for regions x1 to x5 to increase their production, they have to buy intermediate goods and services (intraand inter-regional intermediate flows) from regions x1 to x5 (imports for regions x2 to x5). the increase in the purchasing of intermediate goods and services in regions x1 to x5 (feedback effects) will be dependent on the increase in production in each region, the level of self-sufficiency in each region and the degree of inter-regional linkages between the regions. to summarise: the mrio model adds inter-regional spillovers and inter-regional feedbacks to the original single-region input-output table, with this new scenario, which can be represented as: the way that any exogenous final demand influences regional trade flows can be represented by the mrio model in a consistent framework, which quantifies the relative input shares demanded, including inter-regional spillover and feedback effects. the standard input-output approach can be used to estimate how changes in one regional economy affect the regional economies linked to it, that is, to estimate or model inter-regional interdependence (isard et al. 2017). based on the assumption that the regions have open economies and the required data is available, these inter-regional relationships between different regional economies can then be estimated using regional input-output tables. there is consequently a constant flow of goods and services between the various regional economies so each regional economy buys and sells from each of the other regional economies. the output of any regional economy (for example, the pietermaritzburg economy) is needed as an input to many other regional economies, or even for that regional economy itself; therefore, the ‘correct’ (i.e. shortage-free, as well as surplus-free) level of regional economic output will depend on the input requirements of all the regional economies (n). in turn, the output of the many other regional economies will enter into the pietermaritzburg economy as inputs, and consequently the ‘correct’ output levels of the other regional economies will, in turn, depend partly upon the input requirements of the pietermaritzburg economy. this can be demonstrated with this set of equations: where: xn is the five regional economies. αijnnxn is the input demand of the five regional economies; these are known as coefficients. dn is the final demand for the output of the five regional economies. after moving all terms that involve the variables xn to the left of the equal signs, and leaving only the exogenously determined final demands dn on the right, the ‘correct’ output levels of the n regional economies of the system of n linear equations change to: a special regional input-output table was designed for the current study. the following section provides a practical application of this methodology to the economy of kzn. linkages in the kwazulu-natal spatial economy an annual regional economic business confidence survey has been conducted in kzn since 2005 and contains questions relating to the proportion of products and services sold by businesses in a particular regional economy (or district) to the other regional economies. the survey is conducted through the various local chambers of business and other local business organisations operating in the five economic regions. the survey is an online internet-based anonymous business survey designed specifically to generate data and information on a number of local economic characteristics and trends, and the general level of business confidence in the particular urban centre (kleynhans & coetzee 2017:15). it is important to note that the survey is conducted at the same time each year – march and april – in order to ensure consistency. in general, the response rate is between 1% and 2% of the total membership of the various chambers of business and business organisations (between 300 and 400 responses per year). unfortunately given the ‘inconsistent’ response rate in terms of the number of responses and sector responses per year there can rightly be questions about the credibility of the results and thus the level of inference. fortunately, given that the survey has been conducted over a 10-year period the use of the average responses in this study can account for many of the inconsistencies in the responses. the newcastle respondents, for example, will therefore indicate the proportion of their total sales (exports) to the other four regional economies. the annual proportions (2011–2016) have been averaged in order to minimise the risk of outliers and are displayed in matrix format in table 5; this constitutes the technical coefficients in a so-called leontief matrix. the totals do not equal 100 because they exclude the proportions of the total sales sold outside these five regional economies, for example to the rest of the province. given the low response rates and other data problems mentioned it must be acknowledged that the results are very much specific to this survey data set. the aim of the article is in the first place to suggest and illustrate a concept and research instrument. table 5: production and output matrix. the technical coefficients, as displayed in table 5, are obtained by extracting the information from the survey itself in terms of the question (question 18) relating to the percentage of sales of the business. each respondent is asked to indicate the percentage of the sales of the business that took place in each of the five regions, the rest of the province of kzn and south africa. the question within the survey looks as follows: as a percentage, how much of your total sales occur in the following locations? durban pietermaritzburg newcastle richards bay/empangeni rest of kzn south africa port shepstone and/or margate the individual responses of each region are then averaged to calculate the percentage total sales of each region within each of the other regions and expressed as a decimal number within the technical coefficient matrix as displayed in table 5. when the technical coefficients matrix is subtracted from an identity matrix, it yields an i-a matrix, which is an essential step in calculating the actual multipliers. its numbers, per se, do not mean anything. table 6 illustrates the i-a matrix. table 6: i-a matrix (sales). the regional economic multipliers are indicated in table 7. the multipliers are derived from inversing the i-a matrix. it shows, for example, that when demand for goods and services in the pietermaritzburg economy increases by r1, production of goods and services in the pietermaritzburg, durban, richards bay, newcastle and port shepstone economies will increase on average by r1.91, r0.29, r0.26, r0.21 and r0.12, indicating spillover effects. table 7: regional economic multipliers of sales. an illustration of the way this new input-output model could be applied in practice is provided in the following section. application of the new multiregional input-output model this newly developed modified mrio model can now be utilised in a practical example and applied to the existing regions. assume final demand in the pietermaritzburg economy increases by r100 for a particular reason with no change in final demand in the other four regional economies. we apply the ceteris paribus principle for illustrative reasons only, that is, to build and test the mrio model understanding that final demand is not static and will continuously change irrespective of the final demand in each of the five regions. applying the regional multipliers (interdependence coefficients) (table 7) provides the estimates of how final demands for products and services change in the pietermaritzburg economy, both directly and indirectly (in rand). the new level of output in each region is displayed in table 8. the cumulative production (intraand inter-regional flow of final goods and services) that has taken place in the five regions combines to meet an increase in final demand totalling r278.27. table 8: output change – multiplier effect (rand). using the technical coefficients of table 5, the intraand inter-regional flows of the value of the deliveries and sales are calculated and shown in table 9. the rows contain the output of a region, that is, the value of the deliveries and sales of a region to the different regions. this now shows, for example, that trade flows of r85 are generated within the pietermaritzburg region itself, while a total of r4.26 flows to durban in the form of goods and services, as well as r100 of final demand. the values are derived by multiplying the output change values in table 8 by the technical coefficient values in table 5. table 9: intraand inter-regional flows in deliveries and sales (rand). for each region to increase their production to the new total output levels as indicated above, each region has to buy intermediate goods and services (raw materials and semi-finished) from itself and from the other regions (columns). for example, for the production of r190.87, pietermaritzburg spends r84.65 in pietermaritzburg, r11.45 in durban and the primary costs (capital and labour) are r75.74. the total values of intermediate inputs purchased or spent for pietermaritzburg are r115.13 when the spending in each region is added together. the value of primary and intermediary inputs yields the total production, which sum equals r190.87 table 10 displays the comparative results of a r100 increase in final demand in each of the regions individually (ceteris paribus). the cumulative effect (total production) is the highest when final demand (for total inputs) increases in richards bay (r436.46) and the lowest when final demand increases in port shepstone (r205.47). this can possibly be explained by the fact that the manufacturing sector in richards bay is very large, accounting for around 40% of its economy while the manufacturing sector is relative small in port shepstone (12.24% of its economy) since the manufacturing sector is responsible for the production of goods. table 10: cumulative impact of a r100 increase in final demand per region (rand). table 11 displays further statistics when final demand increases by r100 in each region individually (ceteris paribus). from this, it can be inferred that the impact a higher final demand in durban has on the remaining four regions collectively is largest (r213.40), while the weakest impact of raising demand is that of the port shepstone region (31.76) (in monetary rand value terms). one possible explanation is that the durban economy is very big and much diversified (see table 2) and thus sells and buys a large variety of goods and services not necessarily available from within while the port shepstone economy is relatively small and concentrated and thus sells and buys a fairly small variety and number of goods and services from outside itself. table 11: domestic versus external impact (rand). the domestic and regional trade flows, value added and total domestic production with regard to the total impact, derived from a r100 increase in final demand in each of the regions individually (ceteris paribus), can now be estimated and is displayed in table 12. durban exports and imports (to the other regions) the most (r106.27), while port shepstone exports and imports (to the other regions) the least (r12.85). value added (wages, interest, profit and taxes) is highest in port shepstone (r90.52), and lowest in durban (r13.90). this suggests that a r100 increase in final demand in port shepstone (ceteris paribus) is mainly supplied by businesses in port shepstone while a r100 increase in final demand in durban (ceteris paribus) is mainly supplied by businesses within the other regions. table 12: domestic and regional trade flows (rand). table 13 displays the percentage of intraand inter-regional flows for each of the five regions. it shows that durban is the most ‘open’ regional economy and port shepstone the least. logically, the opposite follows in accordance. as durban is the most open, trade flows within the durban regions are lowest (50.26%) and the closest economy trades most (84.9%) internally among its own sectors. table 13: intra-regional versus inter-regional flows (%). table 14 displays each of the five regions’ major trading partners in terms of sales and purchases. table 14: major trading partners. table 14 indicates that final demand and trade flows are largest between the most open and strongest regional economies, and the weaker economies are more dependent on the stronger regions, durban, pietermaritzburg and richards bay. summary and conclusion this article investigated the trade flows in and between the various regions of kzn, south africa. a modified mrio model was constructed to investigate the final demand, production and trade flows of the major regional economies in the province and how they link economically with each other using the chenery-moses model. the results suggest that there is indeed some flow of final and intermediate goods and services between the five regions of kzn. however, the estimated inter-regional spillover and feedback effects seem to be marginal. the original leontief input-output model was developed during the 1930s, to estimate the interrelationships between sectors in an economy. it is an instrument that indicates the various shares of input factors of production that are needed to produce a unit of output by a specific sector. originally, input-output analyses were used to study structural flows and effects on the national level. the current study went further and developed a unique regional model to study spatial trade flows within and between smaller regions, such as urban areas or municipal districts within a particular province. the mrio model can be used for various estimates such as multiplier, linkage, and impact analyses, as well as the estimation of inter-regional spillover and feedback effects. a diacritical feature of this study is that, unlike most other studies that construct input-output models for a single country, the mrio model was developed to link the five major regional economies in kzn. a survey approach was used for the construction of the mrio model, which essentially involves using primary data collected from a specially conducted survey to develop the mrio model. the multiplier analysis found that the richard bay economy had the highest output multipliers, while port shepstone had the smallest. the analysis of the economic relationship between the five regions found that the value of intra-trade between these five regions was much higher, by varying degrees, than the value of the inter-regional trade between the various regions. durban seems to have a fairly open economy, trading significantly with the other four regions, followed by pietermaritzburg and richards bay. port shepstone and newcastle seem to be fairly closed economies, trading predominantly internally. this possibly explains the reason why the multiplier analysis found that the port shepstone and newcastle economies had the smallest output multipliers. the method and analysis followed in this article can also be applied fruitfully to other regions of the country, as well as the rest of africa and the world, studying final output, demand and trade flows. acknowledgements the authors acknowledge the support from the world trade organization (wto) and the national research foundation (nrf). opinions expressed, and conclusions arrived at in the article, are those of the authors and should not necessarily be attributed to these institutions. data availability statement data sources are available from the sources indicated in the reference list. more information is available from the authors. competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. opinions expressed and conclusions arrived at in the article are those of the authors and should not necessarily be attributed to these institutions. author’s contributions c.e.c. designed the original concept and analysis. e.p.j.k. assisted in the composition, analysis and wrote the final article. references african business central., 2015, online market intelligence. london: abc, viewed 29 april 2019, from https://www.facebook.com/pg/africanbusinesscentral/about/?ref=page_internal. bazzazan, f., alavinasa, m. & banouei, a.a., 2005, ‘construction of regional input-output table and its applications: the case of yazd province’, paper presented at the 15th international conference on input-output 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(eds.), methods of inter-regional and regional analysis, pp. 41–134, ashgate publishing, farnham. moses, l., 1955, ‘the stability of inter-regional trading patterns and input-output analysis’, american economic review 45(3), 803–832. pissarenko, d., 2003, ‘basics of input-output analysis’, tc 20(2), 180. sargento, a.l.m., 2009, regional input-output tables and models inter-regional trade estimation and input-output modelling based on total use rectangular tables, faculdade de economia, universidade de coimbra, coimbra. schaffer, w.a., 1999, regional impact models, georgia institute of technology, atlanta, ga, viewed 29 april 2019, from http://www.rri.wvu.edu/webbook/schaffer/toc.html. statistics south africa (stats sa), 2018, various publications, stats sa, pretoria, viewed 29 april 2019, from www.statssa.gov.za. united nations, 1999, handbook of input-output table compilation and analysis, series f, no. 74, un, new york. volkwyn, b.j. & kleynhans, e.p.j., 2014, ‘die verskaffing van elektrisiteit deur eskom: die impak van beurtkrag en hoër pryse op die suid-afrikaanse ekonomie’, suid-afrikaanse tydskrif vir natuurwetenskap en tegnologie 33(1), 1–11. https://doi.org/10.4102/satnt.v33i1.430 abstract introduction literature review research method ethical consideration results discussion managerial implications and recommendations conclusion acknowledgements references about the author(s) leon t.b. jackson workwell research unit for economics and management sciences, faculty of economics and management sciences, potchefstroom business school, north-west university, south africa edwina i. fransman north-west school of business and governance, faculty of economics and management sciences, north-west university, south africa citation jackson. l.t.b. & fransman, e.i., 2018, ‘flexi work, financial well-being, work–life balance and their effects on subjective experiences of productivity and job satisfaction of females in an institution of higher learning’, south african journal of economic and management sciences 21(1), a1487. https://doi.org/10.4102/sajems.v21i1.1487 note: this article is partially based on one of the author’s unpublished work: fransman, e.i., 2015, ‘determining the impact of flexible work hours on women employed in a higher education institution’, unpublished mba dissertation, north-west university, potchefstroom. original research flexi work, financial well-being, work–life balance and their effects on subjective experiences of productivity and job satisfaction of females in an institution of higher learning leon t.b. jackson, edwina i. fransman received: 13 oct. 2015; accepted: 04 oct. 2017; published: 29 mar. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: expressions such as ‘there are not enough hours in the day’ and ‘the 25 h workday’ or cliché statements such as ‘working 24/7’ have become common overtones in the way employees feel about time at work. because of this ‘lack of time’ feeling, alternative work arrangements such as flexitime, telecommuting and practices such as work–life balance have emerged as popular topics for researchers, employees, organisations and the like in the past few decades. setting: women are still the main caregivers of family members and households, and compared to men, they are less likely to be granted flexitime by their employers. it therefore seems realistic to imagine that women would suffer more from work–life conflict. women still earn, on average, less than men and are more likely to have part-time jobs. this has an impact on the financial well-being of women. these issues have yet to be investigated in an institution of higher learning in south africa. aim: this study was aimed at determining: (1) the relationship between flexi work, financial well-being and work–life balance, productivity and job satisfaction, (2) the role of flexible work, financial well-being and work–life balance in productivity and job satisfaction, and (3) the mediating effect of productivity (job satisfaction in the alternative model) in the relationship between flexible work, financial well-being and work–life balance and job satisfaction (productivity in the alternative model). methods: a cross-sectional survey was used with a convenience sample (n = 252) of female support employees, employed in a higher education institution in the north west province of south africa. results: findings of the study indicated a statistically significant relationship between the variables. results indicated that financial well-being, work–life balance and productivity were statistically significant predictors of job satisfaction, and in addition, subjective experiences of productivity serve as partial mediators in the relationship between financial well-being and work–life balance on the one hand, and job satisfaction on the other hand. conclusion: it seems like financial well-being and work–life balance play a more important role in job satisfaction and that financial well-being and work–life balance are more important for job satisfaction through subjective experiences of productivity. it would therefore make sense to increase experiences of financial well-being and work–life balance to address experiences of low levels of job satisfaction and subjective experiences of productivity. introduction work–life balance (wlb) and work–life satisfaction may have an impact on productivity in the workplace (mušura, korican & krajnovic 2013). chimote and srivastava (2013) concluded that reducing absenteeism and turnover, improving productivity and image, and ensuring loyalty and retention are the benefits of wlb according to the organisational perspective, whereas the employees’ perspective highlighted job satisfaction, job security, autonomy, stress reduction and improving health as the benefits of wlb. many organisations explore the various alternative work arrangements (awa) to capitalise on the benefits of wlb. grobler and de bruin (2011) noted that despite the benefits of awa, very few companies in south africa have more than 20% of their staff utilising flexi work practices at present. employees’ use of flexitime is, however, not solely dependent on preference, but is also influenced by leader or manager perceptions (bianchi & milke 2010; cooke 2005; downes & koekemoer 2011). a recent south african qualitative study (downes & koekemoer 2011) noted that work pressures and workload, client needs and expectations, leader or manager support or lack thereof, nature and scope of work, inherent job requirements, personal choice or working style, personal commitments and responsibilities, and supportive infrastructure, such as childcare that is flexible to adjust to changing work schedules, are the factors that restrict the use of flexitime. downes and koekemoer (2011) also revealed that frustration was evident in those participants whose access and use of flexitime were obstructed or reduced by such influencing factors. in addition, the families and work institute’s 2008 ‘national study of the changing workforce’ reported that women are less likely to be granted flexitime by their employers compared to men. the 2016 ‘women at work report’ of the international labour organization (ilo) reported that among wage and salaried workers, gender wage gaps can be substantial but appear to be showing signs of a moderate reduction over time (international labour organization [ilo] 2016). globally, the gender wage gap is estimated to be 23%; in other words, women earn 77% of what men earn (ilo 2011). indeed, among 37 countries and territories with data for two periods, the gender wage gap has generally shown a reduction; this can be seen from the simple average of the gap in these countries, which has declined from 21.7% to 19.8%. the ilo has noted that, without targeted action, at the current rate, pay equity between women and men will not be achieved before 2086 (ilo 2016). steyn and jackson (2015) also reported evidence of gender-based wage differences in a selection of south african companies. they found evidence for higher post gradings and salary for males compared with those of females. however, the differences that were observed were not statistically significant and this suggests a numerical but not a statistical or practical meaningful wage gap. productivity has become a driving force for flexibility in the workplace and because of that many employees and employers are interested in flexibility programmes (avery & zabel 2001; bond et al. 2005). organisations are constantly trying to improve employee productivity; therefore, implementing flexible working arrangements in the first place is a good incentive for doing so (bond et al. 2005). pinsonneault and boisvert (2001) confirm that improved productivity associated with telecommuting is the most cited organisational benefit in the literature. in their research, they cited 24 studies about telecommuting and the positive impact it had on individuals and organisations. flexitime scheduling allows for more job autonomy and, consequently, leads to higher job productivity and performance (dodd & ganster 1996; hackman & oldham 1976) and job satisfaction (cao 2005; neufeld 1997; thomas & ganster 1995). awa such as flexitime and job satisfaction are a heavily researched relationship and one of the most commonly reported associations in the literature (pinsonneault & boisvert 2001). several studies have found that employees who report high levels of work–family conflict had lower job satisfaction than their counterparts with low levels of conflict (bedeian, burke & moffett 1988; frone, russel & cooper 1997; netemeyer, boles & mcmurrian 1996; rice, frone & mcfarlin 1992). the productivity, job satisfaction, flexitime, work–life balance and financial well-being relationship in an institution of higher learning (ihl) in south africa are, however, not such a common reported association in the literature and are in fact lacking. given the above-mentioned factors, women are less likely to be granted the permission to use flexitime at work, experience more work–life conflict and pro-male gender wage inequalities and, therefore, being in a disadvantaged position regarding their financial well-being. in this study, we were interested in the role of flexi work, work–life balance and financial well-being in job satisfaction through subjective experiences of productivity of women in an ihl. as job satisfaction has been studied, there is a debate whether it is utilitarian as a concept or whether anything productive is necessarily a result of the satisfaction. a quantitative review of the literature suggested that the true correlation between job satisfaction and performance was quite small (0.17) (iaffaldano & muchinsky 1985). however, more recent evidence reveals that the relationship is larger than what was previously thought. a comprehensive review of 300 studies determined that when the correlations are corrected for the effects of sampling error and measurement error, the average true score correlation between overall job satisfaction and job performance is 0.30 (judge et al. 2001). therefore, it appears that a happy worker is more likely to be a productive one. of course, the relationship between satisfaction and performance may be reciprocal. not only may employees who are happy with their jobs be more productive, but performing a job well may lead to satisfaction with the job, especially if good performance is rewarded (judge & klinger 2009). given the possible reciprocal nature of the job satisfaction–productivity relationship, we were rather interested in the productivity–job satisfaction relationship. given the happy worker–productive worker hypothesis and in order to gain a comprehensive picture, we also tested the alternative job satisfaction–productivity relationship. more specifically, we investigated the mediating role of subjective experiences of productivity (job satisfaction in the alternative model) in the relationship between flexi work, work–life balance and financial well-being on the one hand, and job satisfaction (productivity in the alternative model) on the other hand. literature review this research project proposes a model that depicts flexible work, financial well-being and work–life balance as important antecedents for subjective productivity and job satisfaction. in addition, it is argued that flexible work, financial well-being and work–life balance increase the subjective experiences of productivity and job satisfaction. more specifically, it is maintained that productivity (job satisfaction in model 2) serves as a mediator in the relationship between flexible work, financial well-being and work–life balance and job satisfaction (productivity in model 2). mediators are variables that provide additional information on how or why two variables (dependent and independent) are strongly associated with each other. according to wu and zumbo (2008), for a mediation model, the independent variable (in this case, flexible work, financial well-being and work–life balance) is presumed to cause the mediator (e.g. productivity in model 1 and job satisfaction in model 2), and, in turn, the mediator causes the additional influence of the independent variable on the dependent variable (e.g. job satisfaction in model 1 and productivity in model 2). the hypothetical model illustrating the mediating effect of productivity (job satisfaction in the alternative model), as suggested, is depicted in figure 1. (fransman 2015) figure 1: the hypothetical model. independent variables (flexible work, financial well-being and work–life balance) flexible work business leaders continue to adopt non-traditional work–life benefit policies, including virtual work programmes, in response to the financial savings realised and the unique flexibility these programmes offer (purvanova 2014). workplace flexibility as defined by hill et al. (2008:152) is ‘the ability of workers to make choices influencing when, where, and for how long they engage in work-related tasks’. they explain further that it is a multi-faceted concept that includes discretion over where work is performed (e.g. telecommuting), the duration of individual and collective sessions of work-related tasks (e.g. part-time employment), as well as options for multiple points of entry and departure from paid work, for example, career flexibility (hill et al. 2008) (fransman 2015). flexibility is referred to by costa, sartori and akerstedt (2006) as the level of individual discretion and autonomy. literature classifies flexible work practices as office-based practices and flexi-place practices (grobler & de bruyn 2011); as well as flexitime and flexi-place (munsch, ridgeway & williams 2014). kelly, moen and tranby (2011) refer to flexibility as schedule control, because flexible work options can include contingent work, contract work and just-in-time staffing. the extent to what employees experience as flexible working hours requires supportive organisational culture (galea, houkes & de rijk 2014), and it is important that management within organisations acknowledges the fact that employees go through different phases during careers and specific requirements can change (fransman 2015). results indicated that job flexibility, such as flexi-place (telework) and flexitime, has a positive effect on wlb (hill et al. 2001). research by moen et al. (2011) argues that greater employee work-time control and flexibility by means of an organisational policy initiative can reduce employee turnover. increased competitive advantage, higher productivity, attraction and retention of top talent are also some of the benefits for employers, while they list improved employee morale and quality of life, as well as decreased unscheduled absences as benefits for employees (grobler & de bruyn 2011). most employers adopt flexible work practices as a means to achieve greater operational efficiency (appiah-mfodwa et al. 2000). flexible work has the potential to benefit employees and organisations alike by supporting positive job attitudes such as organisational commitment, motivation and job satisfaction and high levels of job performance (fransman 2015; leslie et al. 2012; nadeem & henry 2003). financial well-being originally, financial well-being was understated as simply happiness or general satisfaction with the financial situation. based on the results of census 2011, the official unemployment rate among men was 25.6%, while among women it was 34.6%, where the average female-headed household income was just more than half the annual income less than their male counterparts (statistics south africa 2012). economic pressures over the past 20 years have challenged the traditional role of men at work and women at home (crompton & lyonette 2007). with more than 40% of households headed by women, and many of the rest dependent on the financial contribution women make (van rooyen 2014), it is unfortunate that many women are not as financially healthy as they could or should be (fransman 2015). basic needs are closely linked to a physiological interpretation of those things that are vital to human survival (quellette et al. 2004), specified as food, clothing, shelter, water and sanitation that are necessary to prevent ill-health and under-nourishment. quellette et al. (2014) explain further that relative material needs are needs that may vary depending on circumstances or norms such as social wealth and context. as a society gets richer, the relative standard of needs changes to reflect societal wealth. within contextual terms, a basic need, such as food, may be set in relative terms far above the physiological minimum, but may correspond to a view as to what people ‘should’ have (fransman 2015). the reality is that women do face more financial risks than men do. women, who earn less, are expected to live 7 years longer in retirement and the majority of mothers are single breadwinners. women remain the main caregivers in the south african society, with a high rate of single mothers; therefore, children’s well-being depends on their mother’s financial stability (liberty advisory services 2014) (fransman 2015). pay and perceptions seem therefore important for financial well-being. although pay level is not an important issue for global job satisfaction, pay fairness can be very important. people are not concerned if those in other jobs make more money, but they are concerned if people in the same job earn more. pay satisfaction is affected by how an individual’s salary compares to the others in the same rather than people in general jobs, according to the equity theory of motivation (jawahar & stone 2011; judge et al. 2010; spector 1997; williams, mcdaniel & ford 2007; williams et al. 2008). rice et al. (1990) found a significant practically large correlation (0.50) between pay and job satisfaction in a sample of mental health professionals who all had the same jobs. mitchell, lewin and lawler (1990) estimate that the proper use of piece-rate plans leads to performance gains in 10% – 15%. work–life balance work–life balance is described by jyothi and jyothi (2012) as achieving a balance between the demands of employees’ family life and work lives. satisfaction with the work–life balance is defined by valcour (2007:1513) as ‘an overall level of contentment resulting from an assessment of one’s degree of success at meeting work and family role demands’ (fransman 2015). the traditional south african household (where the man was the sole earner and the woman took care of the children) is being replaced by working couple families (schreuder & theron 2001). globally, the traditional role of a woman as the main caretaker of the family has also changed dramatically. women nowadays strive to contribute as both paid worker and as productive family caretaker (sekaran & leong 1992). while the work responsibility is perceived to be a man’s primary area, women are still mainly responsible for the home and children (doucet 2000; windebank 2001). as such, employed women have to manage with the demands from work, together with family roles, to a greater extent than employed men (coetzer 2006). duxbury and higgins (2001) found that women are more likely than men to report high role overload, and men more likely to report high levels of work-to-family conflict. studies done by galea et al. (2014) explored flexible working hours as a win-win situation for both employers and employees, and found that flexible working hours appeared to be a tool to facilitate the flow of transition between work and personal life. making use of flexible working hours enables employees to manage priorities on hand, either family or personal needs or organisational needs. (fransman 2015) providing flexible working arrangements can be mutually beneficial to both workers and employers. when combined with regular childcare measures, flexible work arrangements can contribute to work–family harmonisation. with awa, workers, primarily mothers, do not have to take a career break or leave the workplace entirely to provide care (ilo 2016). for employers, even small and medium-sized enterprises, these schemes improved staff retention, motivation and engagement without detrimental costs or implementation challenges for businesses (chartered institute of personnel and development 2012). in addition, the work–life balance and job satisfaction link was confirmed by malik, saleem and ahmad (2010). chimote and srivastava (2013) concluded that wlb reduces absenteeism and turnover, and improves productivity. job satisfaction job satisfaction is described in the literature as an important attitude of employees and managers to their jobs (oplatka & mimon 2008) and one’s feelings about a job (bogler 2005). any person with a high degree of job satisfaction will in comparison display a positive attitude towards his or her career (pirbasti et al. 2014). mcshane and von glinow (2010) describe job satisfaction as a person’s evaluation of his or her job and work context – it is an appraisal of their perceived job characteristics, work environment and emotional experiences at work. job satisfaction represents the well-being of employees and is predictive of higher job tenancy and lower counterproductive behaviours and withdrawal (grandey, cordeiro & crouter 2005) (fransman 2015). high rates of employee job satisfaction are associated with high commitment levels and elevated productivity (rama devi & nagini 2013). according to the perceived organisational supportiveness (pos) theory of eisenberger et al. (1986), if workers perceive that their organisation shows concern and sensitivity to its personnel and their needs and values, including work–family needs, they will respond by showing positive job-related outcomes, such as job satisfaction and organisational commitment. employees engaged in more effective and flexible workplaces are more likely to have greater engagement in their jobs and higher levels of job satisfaction (bond et al. 2005). cross-sectional research done by booth and van ours (2008) indicated that women were less satisfied with their jobs if it was full time. if supervisors of firms tend to not concern themselves about the quality of subordinates’ work–family lives (kim, lee & sung 2013), employees may not appreciate the firms’ efforts towards work–family obligations, which can provide damaging effects on their job attitudes (fransman 2015). a variety of research findings have shown that poor work–home and home–work interaction is linked with serious consequences for the individual (including poor self-rated, negative emotions and depression, low energy and optimism, fatigue, sleep disorders – stress, stress-related illness, family strife, violence, divorce, reduced life satisfaction and substance abuse, increased stress and burnout) and the organisation (withdrawal behaviour, including turnover and non-genuine sick absence and escalated absenteeism, and healthcare costs, as well as reduced productivity, employee satisfaction, commitment and loyalty towards the organisation), all of which negatively impact the organisational performance and, consequently, organisational profits (allen et al. 2000; anderson, coffey & byerly 2002; hämmig & bauer 2009; hughes & bozionelos 2007; thomas & ganster 1995). green and heywood (2011) suggested that flexible work had a general positive influence of job satisfaction (fransman 2015). in addition, the awa–job satisfaction relationship seems to be leaning towards a positive, albeit small-to-medium effect size. reasons for positive attributes of the alternative work arrangement (flexi work and telecommuting) and job satisfaction relationship entail increased flexibility, job autonomy, control of work schedule and circadian rhythms (sukal 2009). pay, wage rate, income, salary or the perceptions of fairness thereof (kreitner & kinicki 2008; okpara 2004; rad & yarmohammadian 2006; viera 2005) are significantly related to job satisfaction. based on the above-mentioned factors, it can therefore be expected that perceptions of access to flexi work arrangements, financial well-being and work–life balance would be related to job satisfaction. subjective experiences of productivity productivity is the ability to carry out a duty or job that sustains the profitability of the organisation. it is a comparison of the amount of effectiveness (ratio of inputs and outputs) that results from a certain level of cost associated with that effectiveness (sukal 2009). productivity indicates the extent to which a firm’s human capital is efficiently creating output (guthrie 2001) (fransman 2015). it is important to note that we are looking at the role of subjective productivity at work and therefore in line with guthrie (2001) and sukal (2009), we are here dealing with employees’ subjective views of their ability to carry out a duty, job or task that sustains profitability through the organisation and efficiently creating output. the basis of productivity management should be the aim of management to provide appropriate conditions to achieve the highest performance (nazem & seifi 2014). the workforce will be remembered as one of the most important resources in achieving organisational productivity (pirbasti et al. 2014). companies can increase their productivity by increasing the well-being of personnel (pietilä, lahdensaari-nätt & tuure 2011). flexible working hours enhance staff productivity and lower overheads, while staff members have a significantly better work–life balance, higher satisfaction and motivation (fransman 2015; symanowitz 2012). many employers have discovered that increasing work schedule flexibility does not interfere with maintaining acceptable levels of productivity (reese, rowings & sharpley 2007). pay influences perceptions of financial well-being. at the individual level, there are three major types of pay-for-performance systems: traditional incentive systems, variable pay configurations and merit pay plans. traditional incentive plans include piece-rate plans and sales commissions. with piece-rate incentive plans, an employee is paid a specified rate for each unit produced or each service provided. mitchell et al. (1990) estimated that the proper use of piece-rate plans leads to performance gains in 10% – 15%. based on their review of the literature, locke et al. (1980) concluded that the median productivity improvement from piece-rate plans is 30%. contextualising the study the promotion of well-being should be connected to management and the structure of personnel administration, and should be taken into account in strategies and processes, as well as be included in daily activities (pietilä et al. 2011). the institution, from which the sample was taken, has an employee wellness policy in place where the aim is to improve employees’ work, psychological and physical wellness needs. the objective of the wellness programme is to improve the institution’s health and wellness strategy in order to contribute to the morale, productivity and the quality of life of employees. the programme provides services such as personal or financial counselling, managerial services, help with planning of a vacation, car emergencies, trauma counselling, buying of a house, relocation and even help with employees’ children’s homework. the idea is that employees make use of trained consultants to help manage the time-consuming pressures and stressors of daily life, instead of carrying the burden all by themselves. despite services rendered by the wellness department to employees, aiming to enhance well-being, very little is known about the role of flexi work, financial well-being and work–life balance in subjective experiences of productivity and job satisfaction by women employed by the ihl where this study was conducted. in addition, scientifically speaking, the link between flexi work, financial well-being, work–life balance, productivity and job satisfaction is still very vague in the south african context (and more specifically in ihl) (fransman 2015). mediators are variables that provide additional information about how or why two variables (dependent and independent) are strongly associated with each other. in the case of this project, a mediation model is proposed where the independent variable (flexible work, financial well-being and work–life balance) is presumed to cause the mediator (productivity and job satisfaction in the alternative model), and, in turn, the mediator causes the additional influence of the independent variable on the dependent variable (job satisfaction and productivity in the alternative model) (fransman 2015). given the above-mentioned role of flexi work, work–life balance and perceptions of financial well-being, it can be expected that the independent variables in this study would influence productivity and job satisfaction in this sample. not only may employees who are happy with their jobs be more productive (in the alternative model), but performing a job well may lead to satisfaction with the job (judge & klinger 2009). given the reciprocal nature of the job satisfaction–productivity relationship, we were rather interested in the productivity–job satisfaction relationship. however, to gain a comprehensive view, we also tested the alternative model production–job satisfaction model. more specifically, we investigated the mediating role of subjective experiences of productivity (job satisfaction in the alternative model) in the relationship between flexi work, work–life balance and financial well-being on the one hand, and job satisfaction (subjective experiences of productivity in the alternative model) on the other hand. this project was aimed at filling this void. therefore, the aim of the study was to test the following hypotheses: h1: the independent variables (flexi work, work–life balance and financial well-being) are significantly positively related to subjective experience of productivity. h2: the independent variables (flexi work, work–life balance and financial well-being) are significantly positively related to job satisfaction. h3a: subjective experiences of productivity mediate the relationship between the independent variables (flexi work, work–life balance and financial well-being) and job satisfaction (the hypothesised model). h3b: job satisfaction mediates the relationship between the independent variables (flexi work, work–life balance and financial well-being) and subjective experiences of productivity (the alternative model: model 2). research objectives the main goal of the study was to investigate the role of flexible work, financial well-being and work–life balance in the productivity and overall job satisfaction in a sample of women employed in an ihl. more specifically, this study was aimed at determining: (1) the relationship between flexi work, financial well-being and work–life balance, productivity and job satisfaction, (2) the role of flexible work, financial well-being and work–life balance in productivity and job satisfaction, and (3) the mediating effect of productivity (job satisfaction in the alternative model) in the relationship between flexible work, financial well-being and work–life balance and job satisfaction (fransman 2015) (productivity in the alternative model). research method research approach a quantitative research approach with a cross-sectional design was used. web-based questionnaires, accompanied by a covering e-mail, explaining the aim of the project, the anonymity and voluntary nature of the research and an invitation letter with contact information of the researchers were distributed to most female employees in support departments of the ihl (fransman 2015). participation in the study was entirely optional. sampling participants for the study were female support staff of a south african ihl, employed both full time (permanent and fixed-term appointments) and part-time (temporary). a small convenient sample was taken from female employees in all support divisions of an ihl in the north west province. the respondents each completed a web-based questionnaire divided into two parts, which included items concerning the respondent’s biographical details. table 1 represents the demographic characteristics of the participants (n = 252) (fransman 2015). table 1: participant characteristics. table 1 indicates that the sample represented only female employees. the respondents (n = 252) consisted mainly of employees between the ages of 26 and 35 years (32.54%), with white people being major participants (83.33%). married participants were the most (53.57%), followed by singles (32.94%). almost half of the participants were either in possession of a bachelor honours degree (28.17%) or a bachelor’s degree (18.65%), were employed in permanent positions (73.02%) and not in management (71.43%) (fransman 2015). measuring instruments the measuring instruments consisted of six sections: flexibility, financial well-being, work–life balance, job satisfaction, productivity and demographics. all scales (except for the demographics section) followed a five-point likert format ranging from strongly disagree (1) to strongly agree (5) and negatively phrased item scores were reversed before the analyses so that positive scores could reflect the targeted construct. the cronbach’s alpha coefficients (which is used to determine the internal consistency and reliability) that were obtained in this study for the instruments used are reported in table 2. instruments that were used include in the study were the following (fransman 2015): flexible work: a seven-item measure, developed for the project, was used to determine the support for flexibility in the workplace and the use of flexi work by the participants. of the four items, one item was adapted from thomas and ganster’s (1995) control scale (e.g. control over hours worked each day or week) (fransman 2015). financial well-being: this instrument, developed for the project, was a seven-item measure of the extent to which employees are satisfied with their current financial situation, that is, the household is able to secure necessities, being fairly compensated, being satisfied with their basic living standards and receiving a certain level of income to be able to live a safe and healthy life. a typical item was ‘my level of income enables me to live a safe and healthy life’ (fransman 2015). work–life balance: this instrument, developed for the project, consisted of seven negatively phrased items where participants had to measure the current work–life balance support of their organisation, energy levels at the end of the workday, doing work at home and workload. a sample item included ‘i am too involved with my work and hardly have time for family responsibilities’. scores of the negative phrased items in this scale were reversed before analysis (fransman 2015). job satisfaction: a seven-item scale was adapted from cammann et al. (1979) and measured the level of job satisfaction of respondents. this measure assesses aspects such as looking forward to going to work, feeling positive about your work on a monday morning, feeling valued and affirmed at work, having an opportunity to do what you do best at work and whether your manager cares about you. ‘i feel positive about my job’ is a sample item of this scale (fransman 2015). subjective experiences of productivity: this eight-item instrument was developed for the study and measures subjective experiences of productivity of respondents. it focuses on issues such as whether respondents are productive, give their best at work, complete planned weekly tasks, the quality of their work, whether managers acknowledge the work done by them and whether team members appreciate their efforts. one of the items in the scale was ‘my quality of work is high’. (fransman 2015). a biographical questionnaire was also included, dealing with biographical questions such as age, ethnicity, marital status and employment status (fransman 2015). table 2: descriptive statistics (n = 252) and correlation analysis. data analysis the statistical analysis was completed with the aid of the spss program (spss inc. 2010). descriptive statistics including means, standard deviations, skew and kurtosis were used to analyse the data. the cronbach’s alpha coefficients were used to determine the internal consistency. pearson’s product–moment correlation coefficients were used to stipulate the practical relationship between the variables in terms of statistical significance. a stepwise multiple regression analysis was conducted to determine the proportion of variance in the dependent variable of productivity that was predicted by the independent variables, namely, flexible work, financial well-being, work–life balance and job satisfaction (fransman 2015). a multiple regression analysis was also conducted to determine the proportion of variance in the dependent variable of job satisfaction that was predicted by the independent variables, namely, flexible work, financial well-being, work–life balance and productivity. the parameters 0.10 (small effect), 0.30 (medium effect) and 0.50 (large effect) were set for practical significance of r2 (steyn 1999). a cut-off point of 0.30 (medium effect) was set for the practical significance of correlation coefficients (cohen 1988). the effect size in the case of multiple regressions is given in the formula (steyn 1999), to indicate whether obtained results were practically important. the parameters 0.01 (small effect), 0.09 (medium effect) and 0.35 (large effect) were set for practical significance of f2 (steyn 1999). structural equation modelling (sem) was performed using amos 21 (arburkle 2014) program to investigate the mediating role of productivity in the relationship between flexible work, financial well-being, work–life balance and job satisfaction (fransman 2015). ethical consideration ethical clearance was first obtained from the research unit and thereafter faculty management provided approval to conduct the study. results the results of the study are presented in three parts: firstly, the exploratory factor (factorial validity) analysis; secondly, descriptive statistics and correlational analyses of all the measures in the study; thirdly, the regression analysis with subjective experience of productivity and job satisfaction as dependent variables; and lastly, testing for the mediating effect of productivity (job satisfaction in the alternative model) in the relationship between flexible work, financial well-being, work–life balance and job satisfaction (subjective experience of productivity in the alternative model) of female employees in an ihl (fransman 2015). factorial validity all items used in the study were subjected to an exploratory factor analysis to determine if items loaded on the intended scales. the results of the exploratory factor analyses and inspections of the screen plots and eigenvalues showed that eight factors that explained 66.60% of the variance could be extracted. however, difficulty in interpreting the multi-factorial solutions because of double loadings, loading of items on unintended factors and a sharp decline of the eigenvalues after the fifth factor, as well as closer inspection of the screen plot, led us to the decision to subject the individual items of separate scales to separate exploratory factor analysis. the results of the separate exploratory factor analyses and inspections of the screen plots and eigenvalues of the factors indicated that all scales used to assess the variables were unidimensional. the choice for one factor was based on difficulties in interpreting multi-factorial solutions as well as on the significant decrease of the eigenvalue after the first factor. the unifactorial solutions extracted explained 52.65% of the variance in flexible work (with item loadings ranging from 0.32 to 0.89); 54.74% of the variance in financial well-being (with item loading loadings ranging from 0.74 to 0.83); 52.29% in work–life balance (with item loading loadings ranging from 0.46 to 0.85); 60.51% in job satisfaction (with item loading loadings ranging from 0.73 to 0.84); and 40.68% of the variance in productivity (with item loading loadings ranging from 0.44 to 0.75) (fransman 2015). descriptive statistics and correlational analyses the descriptive statistics and correlation results for the variables in the study are presented in table 2. an assessment of table 2 indicates that all the alpha coefficients were higher than the guideline of an acceptable alpha coefficient larger than 0.70 (nunnally & bernstein 1994) (fransman 2015). table 2 reveals that flexible work and financial well-being were statistically positively related to one another (small effect sizes). financial well-being was practically significantly related (medium effect) to work–life balance and job satisfaction, and statistically significantly related to productivity (small effect). work–life balance was also positively related to both job satisfaction (medium effect) and productivity (small effect). job satisfaction was statistically significantly related to productivity (large effect) (fransman 2015). regression analysis to determine the impact of flexible work, financial well-being and work–life balance as predictors of productivity and job satisfaction the study also covered the impact of flexible work, financial well-being, work–life balance and productivity as predictors of job satisfaction for female employees. on the other hand, the impact of flexible work, financial well-being, work–life balance and job satisfaction as predictors of productivity also needed to be determined. regression analyses with flexible work, financial well-being and work–life balance as predictors of productivity and job satisfaction are presented in table 3 (fransman 2015). table 3: regression analysis with flexible work, financial well-being and work–life balance as predictors of productivity and job satisfaction. closer inspection of table 3 shows that flexible work, financial well-being and work–life balance account for 9% (medium practical significance) of the variance in productivity, with financial well-being (β = 0.17/t = 2.66) and work–life balance (β = 0.19/t = 2.91) proving to be statistically significant predictors of productivity. however, with the inclusion of job satisfaction in the second model, the variance explained in productivity increased from 47% (large practical significance) with job satisfaction (β = 0.70/t = 13.52), proving to be the only statistically significant predictor of subjective experience of productivity (fransman 2015). flexible work, financial well-being and work–life balance also explain 21% (medium practical significance) of the variance in job satisfaction, with financial well-being (β = 0.29/t = 4.79) and work–life balance (β = 0.25/t = 4.16), proving to be statistically significant predictors of job satisfaction. however, with the inclusion of productivity in the second model, the variance explained in job satisfaction increased from 21% to 54% (large practical significance) with financial well-being (β = 0.19/t = 3.97), work–life balance (β = 0.14/t = 2.94) and productivity (β = 0.61/t = 13.52) proving to be the statistically significant predictors of job satisfaction (fransman 2015). the mediating effects of productivity in the relationship between flexible work, financial well-being and work–life balance on the one hand, and job satisfaction on the other hand structural equation modelling was performed using amos 20 (arburkle 2013) to test for mediating effects of productivity (job satisfaction in the alternative model) in the relationship between flexible work, financial well-being and work–life balance on the one hand, and job satisfaction (productivity in the alternative model) on the other hand. the hypothesised model was a mediation model in which flexible work, financial well-being and work–life balance influenced perceived productivity (job satisfaction in the alternative model), which, in turn, had an impact on job satisfaction (productivity in the alternative model). a closer examination of the direct and indirect effects was made to evaluate their relative sizes. the result of the hypothesised model and the alternative (model 2) mediation model is presented in figures 2 and 3 and the results of the mediation analysis are presented in table 4. figure 2: the results of structural equation modelling analysis for the hypothesised model: model 1. figure 3: the results of the structural equation modelling analysis for the alternative model: model 2. table 4: direct, indirect and total standardised effects of flexible work, financial well-being, work–life balance and productivity (and job satisfaction in the alternative model). a very good fit was obtained for the proposed hypothetical model (see figure 2): χ2(3, n = 252) = 5.66, p = 0.13 (recommended p < 0.05); χ2/df = 1.89 (recommended ≤ 3.00), adjusted goodness of fit index (agfi) = 0.99 (recommended ≥ 0.90), the tucker–lewis index (tli) = 0.97 (recommended ≥ 0.90), the comparative fit index (cfi) = 0.99 (recommended ≥ 0.90), and the root mean square error of approximation (rmsea) was 0.06 (recommended ≤ 0.05). however, a relative poor fit was obtained for the proposed alternative model 2 (see figure 3): χ2(2, n = 252) = 5.41, p = 0.07 (recommended p < 0.05); χ2/df = 2.71 (recommended ≤ 3.00), agfi = 0.94 (recommended ≥ 0.90), tli = 0.93 (recommended ≥ 0.90), cfi = 0.99 (recommended ≥ 0.90), and the rmsea was 0.08 (recommended ≤ 0.05). in addition, all direct paths from the independent variables were insignificant, as well as the path from flexi work to the mediator (job satisfaction). an inspection of table 4 indicated that, in line with observations from figure 2, financial well-being and work–life balance had total, direct and indirect effects on job satisfaction. in addition, the significance of the total, direct and indirect effects suggested that the link with job satisfaction was partially mediated by financial well-being and work–life balance. financial well-being and work–life balance have, therefore, a salient influence on subjective experiences of productivity. direct and indirect effects were all positive and reinforced each other to increase job satisfaction. it can be concluded that subjective experiences of productivity partially mediate the path from financial well-being and work–life balance to job satisfaction. this means that financial well-being and work–life balance and subjective experiences of productivity are important for the enhancement of job satisfaction in this sample. however, when we tested the alternative model where job satisfaction is assumed to mediate the relationship between the independent variables and productivity, a different picture emerged. it turns out that financial well-being and work–life balance had only indirect and total effects on productivity. in addition, the significance of the total and indirect effects suggested that the link between productivity and financial well-being and work–life balance is fully mediated by job satisfaction. this means that job satisfaction is needed for financial well-being and work–life balance to impact subjective experiences of productivity in this sample. discussion the first aim of the study was to determine the relationship between flexible work, financial well-being, work–life balance, productivity and job satisfaction. financial well-being and work–life balance were positive related to job satisfaction and productivity. this was also confirmed by gupta (2011) who indicated that adequate remuneration had a positive relationship with employees’ satisfaction. work–life balance was positively related to job satisfaction. this was also confirmed by padmar and reddy (2014), who found that work–life balance was a strong predictor of job satisfaction. job satisfaction was positively related to productivity. in support of this finding are the studies by halkos and bousinakis (2010) and wood et al. (2012), who found positive relationships between job satisfaction and productivity. the second objective of the study was to determine the role of flexible work, financial well-being and work–life balance on productivity and job satisfaction. regression analysis indicated that financial well-being and work–life balance prove to be statistically significant predictors of productivity and job satisfaction. this means that financial well-being and work–life balance are essential for subjective experiences of productivity and job satisfaction. nazem and seifi (2014) also found that the work–life quality significantly affected the productivity of staff. the findings also seem to concur with the findings of richter et al. (2014), who indicated that employees with high subjective financial dependence were more satisfied with their jobs. carlson, grzywacz and kacmar (2010) noted that work-to-family enrichment was strongly correlated with job satisfaction, suggesting that when workers recognise the benefits families receive from their work, they attribute those synergies to the source, which, in turn, benefits job satisfaction. fung, ahmad and omar (2014) also confirmed a significantly strong relationship between work–family enrichment and job satisfaction. with the inclusion of productivity (job satisfaction in the alternative model) in the second step as predictor of job satisfaction (productivity in the alternative model), the variance explained in job satisfaction (productivity in the alternative model) significantly increased, suggesting that not only may employees who are happy with their jobs be more productive, but performing a job well may lead to satisfaction with the job (judge & klinger 2009). however, this study has demonstrated that flexible work does not necessarily enhance productivity and job satisfaction (fransman 2015). mcguire and liro (1986) concluded in their study that there were limited effects of flexitime on job productivity. hartman, stoner and arora (1991) reported that family disruption is negatively correlated with telecommuting productivity. their solution to this problem is to create a work schedule while working at home, one that is adequately communicated to family members to minimise disruptions. to ensure that productivity is maximised, there must be good productivity tools to coordinate and communicate with managers and co-workers. good project management and coordination to allow remote work (as in the case of telecommuting) are also necessary (hartman et al. 1991). cooper and kurland (2002) and mccloskey (2001) purport that social isolation and decreased social interaction as a result of being away from the office and from co-workers may have a negative effect on job satisfaction. belanger (1999) mentions that the three most common reasons for not wanting to telecommute were the need to share information with others, being more productive at the office site and the need to socialise with colleagues. another justification for specifically flexitime having a low effect on job satisfaction is that it limits on-the-job enrichment (narayanan & nath 1982). the third objective of the study was to determine the mediating effects of productivity (model 1) and job satisfaction (alternative: model 2) in the relationship between flexi work, financial well-being and work–life balance on the one hand, and job satisfaction (model 1) and subjective experience of productivity (alternative: model 2) on the other hand. the results of this study seem to suggest that subjective experiences of productivity partially mediate the path from financial well-being and work–life balance to job satisfaction, while it fully mediates the path from flexi work to job satisfaction. the job satisfaction levels will and can only increase if female support staff experience subjective productivity, thereby confirming that performing a job well while using flexi work may lead to satisfaction with the job (judge & klinger 2009). work–life balance and financial well-being on the other hand, have a direct and indirect link (through productivity) with job satisfaction. this means that financial well-being and work–life balance lead to subjective experiences of productivity (fransman 2015), which in turn enhances the job satisfaction. when comparing the hypothesised and the alternative model 2 with job satisfaction as the mediator, it seemed that the variance explained in the mediator (job satisfaction) was much higher and that the variance explained was much lower in the dependent variable (subjective experience of productivity) in the alternative: model 2. another difference between models seems to relate to the statistical significance of the direct paths. all specified direct paths in the alternative model were insignificant, while only the direct path of flexi work was insignificant in the hypothesised model. this means that mediation effects were predominant partially in the hypothesised model (except for flexi work where productivity fully mediated the relationship with job satisfaction), while the mediations were predominant fully in the alternative model. we can therefore conclude that financial well-being and work–life balance lead to subjective experiences of productivity, which in turn enhances job satisfaction. managerial implications and recommendations research done by perry-smith and blum (2000) suggested that organisations with more extensive work–family policies had higher perceived firm-level performance. if workers perceive that their organisation shows concern and sensitivity to its personnel and their needs and values, including work–family needs, they will respond by showing positive job-related outcomes, such as job satisfaction, organisational commitment (eisenberger et al. 1986) and subjective experiences of productivity. employees engaged in more effective and flexible workplaces are more likely to have greater engagement in their jobs and higher levels of job satisfaction (bond et al. 2005) (fransman 2015). this study has confirmed the significant impact of work–life balance and financial well-being on subjective experiences of productivity and job satisfaction. this means that management of this ihl should start to review and implement policies, procedures and practices that focus on assisting with work–life balance and address the issues of pay equality that influence perceptions of financial well-being to enhance the subjective experience of productivity and job satisfaction. it is therefore suggested that the organisation should experiment with strategies to promote greater work–life balance such as compressed workweeks, telecommuting, on-site childcare, part-time work and job sharing. limitations of the study the common method variance because of self-report bias is a limitation of the study. common method variance refers to the degree to which correlations are inflated, because of a methods effect (meade, watson & kroustalis 2007; podsakoff, mackenzie, lee & podsakoff 2003). in this study, common method bias may have occurred because of the use of the same source to gather data on independent and dependent variables. bias may lead to common method variance (i.e. variance attributable to a methods effect) (podsakoff et al. 2003). it is suggested that future research should include other sectors and academic staff, which use more flexi work to firmly establish the impact of flexi work on job satisfaction and subjective experience of productivity. it is also suggested that future studies make use of longitudinal designs to establish cause and effect. no causal conclusions can be drawn from any cross-sectional design (avey, patera & west 2006).the use of bigger samples and the inclusion of staff from other ihls could increase the generalisability of the findings of this study. conclusion in conclusion, the study also explored the role of flexi work, financial well-being and work–life balance in job satisfaction (model 1) and in subjective experience of productivity (alternative: model 2). the findings indicate that in summary, financial well-being and work–life-balance are more important for both job satisfaction and subjective experiences of productivity (fransman 2015). financial well-being and work–life balance together explained less of the variance in subjective experiences of productivity (r2 = 0.09) compared to in-job satisfaction (r2 = 0.20). in addition, financial well-being and work–life balance explain more of the variance in-job satisfaction (r2 = 0.54) through subjective experiences of productivity compared to their role in subjective experiences of work success (r2 = 0.48). it therefore seems that financial well-being and work–life balance play a more important role in job satisfaction (compared to their role in subjective experiences of productivity) and that financial well-being and work–life balance are more important for job satisfaction through subjective experiences of productivity (compared to their role in subjective experiences of productivity through job satisfaction). i would, therefore, make sense to increase experiences of financial well-being and work–life balance to address experiences of low levels of job satisfaction and subjective experiences of productivity. acknowledgements competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions l.t.b.j. was the study supervisor and was responsible for the data analysis and refining of the literature. e.i.f. was a master’s student and was responsible for the data collection and initial data analysis and 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document high and significant returns in days preceding a holiday in south africa. our results indicate that the month of the year effect is prevalent in african stock returns. however, we argue that, owing to illiquidity and round trip transactions costs, the anomalies uncovered do not necessarily violate the no-arbitrage condition. key words: calendar effects, african stock markets, month of the year and pre-holiday effects jel: c22, 52, g10 1 introduction the efficient market hypothesis (emh) postulates that asset prices fully reflect all available information (fama, 1970). this implies that past prices should have no predictive power over future prices; hence, successive price changes should be random. however, a number of studies have established not only that stock prices are predicable on the basis of previous information, but also that indicators such as dividend yields and gross domestic product contain information that is useful in predicting stock prices. moreover, earnings/ price and book-to-market ratios, among other seasonal patterns which have no basis in extant theoretical models seem to predict stock prices. this latter evidence, commonly called calendar anomalies (effects), is the subject of this paper. broadly speaking, calendar anomalies refer to the tendency of financial asset returns to display systematic patterns at certain times of the day, week, month or year. this paper focuses on the month of the year and the pre-holiday effect on african stock markets. the area of academic and practitioner research in financial economics that has generated the most excitement and attracted the most attention in financial economics concerns persistent cross sectional and time series patterns that have been documented world-wide. a number of variables, such as firm size, ratio of book-to-market, and price/earnings ratios, seem to have significant predictive ability. for example, basu (1977) and banz (1981) both found that the ratio of price to earnings and market capitalisation of common equity respectively provided considerably more explanatory power than beta of common stocks. also, stock returns are found to be systematically higher or lower depending on the time of the day, the day of the week, and the month of the year. the month of the year and the turn of the month effect hold that returns are estimated to be higher in the month of january, particularly in the first few trading days of the month (see rozeff & kinney, 1976; keim, 1983; gultekin & gultekin, 1983) than in other months of the year. over the years, evidence has shown that returns observed on days preceding a public holiday are, on average, higher than returns on other trading days (ariel ,1990; vergin & mcginnis, 1999). the latter writers produced seminal papers which served as springboards for much subsequent research that confirmed the ability of variables other than beta to explain crosssectional differences in returns. these regularities in stock returns, otherwise known as calendar anomalies (effects), have abstract sajems ns 16 (2013) no 1 65 occupied empirical research on asset pricing models for nearly half a century, and present a paradox in empirical finance. their existence casts doubt on the validity of asset pricing models and hence challenges the belief in stock market efficiency. for instance, investors could buy stocks on days (months) with abnormally low returns and sell on days (months) with abnormally high returns. further, if the pre-holiday effect holds, it is possible to devise strategies that would yield returns over and above buy and hold. these would be inconsistent with the efficient markets hypothesis (emh). however, since their discovery, seasonal patterns in stock returns have failed to yield consistent returns over and above buy and hold strategies. it could be argued that any ‘trading rules’ derived from the expectations of anomalies would be more than offset by the 'round trip' transaction costs and illiquidity (french, 1980; draper & pauydyal, 1997; brooks & persand, 2001; mills & coutts, 1995). thus, small calendar-specific anomalies need not violate no-arbitrage conditions. further, it has been argued that even if there are no calendarspecific effects, an extensive search (mining) over a large number of possible seasonalities is likely to yield something that appears to be an ‘anomaly’ by pure chance (see lo & mackinlay, 1990; sullivan, timmerman & white, 2001 burton, 2003). for evidence on african markets, see coutts and sheikh (2002), who investigated the all gold index of south africa and found no evidence of seasonality. claessens, dasgupta and glen (1995) find significant returns in march and june for nigeria, but no seasonality in zimbabwe, while alagidede (2008) investigates the day of the week effects in six african stock markets. african markets have a variety of institutional features that differentiate them from one another and from the markets in industrial and other emerging economies. the search for seasonality or other anomalies in the returns of african markets could provide important information on the role of institutional features in return behaviour. this information may help stock traders and regulatory authorities in improving the microstructure of security trading and stock market performance. the results indicate that the month of the year effect is more pronounced in mean than in conditional variance for nigeria and zimbabwe. in egypt, only january returns are significant. with the exception of south africa, where preholiday effects are estimated to be 0.3 per cent, there are no pre-holiday effects in the markets. the rest of the paper is organised as follows: section 2 briefly outlines the literature on anomalies. we specify the general ols approach of investigating anomalies and adjust for conditional heteroscedasticity in section 3. evidence of month of the year and pre-holiday effects are presented in section 4. we conclude and offer promising ideas for future research in section 5. 2 calendar effects: world-wide evidence much of the research on the cross-sectional predictability of stock returns has focused on the relationship between returns and the market value of common equity, commonly referred to as the size effect. banz (1981) published one of the earliest articles on the ‘small-firm effect’. banz (1981) estimated a model of the form, where si is a measure of the relative market capitalisation (size) for firm i for the new york stock exchange between 1926 and 1975. banz documented that excess returns accrued to holders of small stocks over the period 1936-1975. in the uk, dimson and marsh (1984) report evidence of a size effect on the portfolios constructed from a sample of stocks from the london share price data (lsdp). over the period 1977 to 1983, the portfolio of smallest stocks earned a compound annual return of 41 per cent, while the portfolio of largest stocks realised a compound annual return of 18 per cent. however, in a follow-up article, dimson and marsh (1999) indicate that there was a reversal in the size effect in the london stock exchange. more recently, mills and jordanov (2003) have shown that there is significant autocorrelation in small stocks using the ftse-actuaries all share index 19821995. the implication of these findings is that market structure may be an important influence on the measured size effect. if so, then analysis of the international evidence, where we observe ri =a0 +a1bi +a2si +ei 66 sajems ns 16 (2013) no 1 very different market organisations and structures, should reveal significant differences in the magnitude of the size premium across markets. hawawini and keim’s (1999) review of the size effect from equity markets in australia, new zealand, canada, mexico, japan, korea, singapore, taiwan and eight european countries, for varying periods of time, showed that the size premium was positive for all the countries in their sample except korea. in terms of monthly size premium, mexico recorded 4.18 per cent between 1982-87; australia and japan recorded 1.2 per cent and 1.2 per cent between 1958-81 and 1965-87 respectively, although there are differences across countries. there has been extensive research into the possible explanations of anomalous returns behaviour between small and large firms. one research avenue is the way returns are measured using asset pricing models. the argument is that the betas for small firms are too low, so estimates of expected return using the capm would be positive, even if it was zero when the expected return was correctly estimated. a substantial number of studies has found that part of the size effect occurs in the month of january. the january effect refers to the anomaly whereby firms experience abnormal returns in the first few days of trading in january. the persistence of these returns stands in opposition to the efficient market hypothesis and has been a target for investigation. rozeff and kinney (1976) examined the january effect using new york stock exchange stocks for the period 1904-1974, and concluded that average return for the month of january was 3.48 per cent compared to only 0.42 per cent for other months. keim (1983) employed the same data set for the period 1963-79 and established that nearly 50 per cent of the average magnitude of risk-adjusted premium of small firms relative to large firms was owing to the january abnormal returns. further, more than 50 per cent of the january premium was attributable to large abnormal returns during the first week of trading in the year. fama (1991) reports the results of the s&p 500 for the period 1941-1981, during which small stocks averaged a return of 8.06 per cent in january, with large stocks managing a return of only 1.342 per cent. for japan, see kato and shallheim (1985); for the uk see mills and coutts (1995); for international evidence see gultekin and gultekin (1983) and al-khazali, koumanakos and pyun (2008); for the bond market see keim and stambaugh (1984). however, there is little agreement on the causes of the monthly seasonality. competing reasons, including, but not limited to the tax loss selling hypothesis, microstructure issues, spurious causes such as outliers, concentration of listings and de-listing at year-end, and insider trading, have been adduced. these can be broadly classified under two headings: one that is consistent with stock market efficiency and equilibrium asset pricing models, and one that is at variance with the hypothesis (seyhun, 1993). the tax-loss selling hypothesis posits that investors sell their losing stocks before year end in order to obtain the tax savings from deducting those losses from capital gains realised during the year (rozeff, 1986). the selling pressure in late december is then followed by buying pressure in january as investors return to desired portfolio compositions. fortune (1991) finds this to be inconsistent with the efficient market hypothesis because, in efficient markets, investors with no capital gains taxes should identify any tendency towards abnormally low prices in december and should become buyers of stocks oversold in late december. in effect, the tax-loss selling should affect the ownership of shares but not their price. chan, chen and hsieh (1985) posit omitted risk factors as a reason for the monthly anomaly. this explanation holds that it is riskier to hold stocks in january than in any other month of the year because of certain risk factors omitted in that month. for this reason, investors get, on average, a higher return in january to compensate for these omitted risks. there has also been an explanation linking the january effect with the small firm effect. keim (1989) attributed this to microstructure biases. according to this explanation, the last trade in december for most stocks is at the bid price, which causes returns to appear high in the first few days of january. keim (1989) found that the tendency for stocks to be at the bid price for the last trade in december was very pronounced for small stocks. in addition, small stocks have higher bid-ask-spread and a sajems ns 16 (2013) no 1 67 lower price. the return would therefore be bigger for small stocks, which partly explains the differences between large and small stocks in the january effect. 3 calendar effects: a methodological note previous studies of stock market anomalies may, in general, be divided into four groups based on the methodology employed. the first group of studies calculate returns, means and variances for each day (month) of the week (year) and estimate a simple ols regression with dummies, using standard t and f tests or anova to check the significance and equality of mean returns, without paying attention to the time series properties of the sample data (see french, 1980; gibbons & hess, 1981, for evidence). whereas this may give an indication of the presence or otherwise of some specific anomalies, the data generation process and misspecification effects could cast doubt on the reliability of the results reported in such studies. the second group of studies also report mean daily (monthly) returns based on ols regressions. however, hypothesis tests are carried out using t-statistics and calculated using heteroscedasticity-consistent standard errors. this group does not, however, examine the distributional properties of the data used. in the third group, normality of returns is tested for by means of the kolmogorov-smirnov d statistic. if the returns are found to be normally distributed, then t and f-tests or anova are employed. otherwise nonparametric tests are used to tests the existence of anomalies. the last group of studies starts by reporting descriptive statistics of the distributional properties of the return series. if these statistics indicate that the series are highly leptokurtic relative to normal distribution, the outcome provides a justification for the use of a garch model to investigate the presence of anomalies. this paper extends the work of the fourth group by explicitly testing for iid in the empirical residuals. 3.1 january and the month of the year effect monthly continuously compounded log returns are calculated as ( )t t-­‐1 p t pr = log *100 (1) the standard methodology employed in investi gating seasonality in monthly returns entails estimating an ols regression with dummies to capture month of the year effects as 1 1 2 2 12 12,...,t t t t tr m m mα α α ε= + + (2) rt is the continuously compounded index return on month t as shown in (1) and tp denotes the asset price at time t. the mit are dummy variables so that m1t=1 if month t is january and zero otherwise; m2t=1 if the month t is february and zero otherwise and so forth. the ols coefficients 1α to 12α are the mean returns for january through december respectively and tε is the stochastic term. the presence of monthly seasonality implies α α α0 1 2 12h : = ,..., = 0 against 0α:h i1 ≠ for i=1,…, 12 (3) if the null hypothesis is rejected, then stock returns must exhibit some form of monthly seasonality. previous evidence examined the month of the year effect in various markets in the context of equation (2), using the standard t and f-test without paying attention to the time series properties of the data. for instance the error in the model may be autocorrelated, resulting in misleading inferences. also the error variances may not be constant over time, resulting in inefficient estimates if there is time-varying variance. the first drawback is resolved by including autoregressive terms in (2). however, since we are dealing with monthly data, the issue of non-synchronous trading is not so prominent in our data. the second drawback that is of interest to us is resolved by making the variance time varying. ht =ω+αεt-1 2 +βht-1+ φi i=2 12 ∑ mit (4) where itm represents monthly dummies, th is the conditional variance and α and β represent the lagged squared error term and conditional χ2 68 sajems ns 16 (2013) no 1 variance respectively. equation (2) represents our mean equation for the month of the year and equation (4) accounts for conditional heteroscedasticity in the month of the year effect. thus we jointly estimate (2) and (4). 3.2 pre-holiday effect the pre-holiday effect postulates that returns observed on days preceding a public holiday day are, on average, many times greater than returns on other trading days (see ariel, 1990). the pre-holiday effect is tested via the following regression: 1 1 2 2t t t tr h hξ ξ ε= + + (5) where 1ξ and ξ2 are the mean returns for days prior to holidays and all other days respectively. h1t is a dummy that takes the value of unity at all times other than days immediately preceding a public holiday, when it takes a value of zero. on the other hand, 2th takes the value of one before a public holiday and zero at all other times. the null hypothesis that means pre-holiday returns are equal to the mean for other days is 0 1 2:h ξ ξ= against 1 1 2:h ξ ξ≠ (6) 4 evidence of month of the year and january seasonality 4.1 data employed the data consists of monthly stock prices for the following countries: nse all share index for nigeria, nse20 index for kenya, tunnindex for tunisia, masi index for morocco and ftse/jse all share index, case30 share index and zse industrial index for south africa, egypt and zimbabwe respectively. these are the biggest markets in africa and together they account for over 90 per cent of stock market capitalisation and domestic company listing on the continent. the data was obtained from datastream for various sample sizes, as shown in table 1. the most consistent data we have for the original all share indices for the sample of countries under consideration ends in 2006. since then, the index compositions and calculations have changed and, to maintain consistency, we limit the sample to 2006. table 1 indicates that, over the sample period, monthly stock returns have averaged 0.006 to 0.082 for egypt and zimbabwe respectively. t a b l e 1 summary statistics of monthly returns (logarithmic returns) sample egypt kenya morocco nigeria s. africa tunisia zimbabwe 1997m07 to 2006m09 1990m01 to 2009m09 2002m1 to 2006m10 1990m01 to 2009m09 1997m07 to 2006m10 1997m12 to 2006m09 1995m06 to 2006m09 obs. 111 201 58 201 112 106 136 mean 0.006 0.0086 0.014 0.024 0.008 0.007 0.082 st. dev 0.088 0.091 0.050 0.055 0.068 0.037 0.220 skewness 1.139 1.923 0.827 0.492 -1.136 1.728 1.117 kurtosis 5.546 22.425 6.172 7.798 8.807 9.214 7.093 jarque-bera 53.5** 3267.5** 30.38** 260.9** 179.8** 221.1** 122.3** note: ** indicates significance at the 1% level. the distributional properties of monthly stock returns are far from being normal: for instance, we observe negative skewness in south africa while, in general, all countries show excess kurtosis. these basic features of the monthly returns provide the rationale for adjusting for conditional heteroscedasticity. evidence of (2) is shown in table 2. the january seasonality is evident in egypt, nigeria and zimbabwe. it can be seen from table 2 that, apart from january, there are no significant monthly returns for egypt. the above findings have to do with the microstructure of african markets. sajems ns 16 (2013) no 1 69 t a b l e 2 monthly seasonality african stock returns egypt kenya morocco nigeria south africa tunisia zimbabwe january 0.119** (4.26) 0.0223 (1.004) 0.018 (0.75) 0.035* (2.91) 0.032 (1.43) 0.017 (1.32) 0.282** (4.41) february -0.027 (-0.99) 0.077** (3.413) 0.073** (3.001) 0.025* (2.177) 0.046 (2.02)* 0.013 (1.03) 0.00628 (0.09) march -0.007 (-0.25) -0.004 (-0.171) 0.0201 (0.915) 0.013 (1.025) 0.0002 (0.011) 0.012 (0.980) -0.016 (-0.25) april 0.012 (0.44) -0.042 (-1.916) 0.005 (0.247) 0.023* (2.00) -0.007 (-0.33) 0.017 (1.39) 0.042 (0.67) may -0.039 (-1.41) 0.013 (0.576) 0.031 (1.39) 0.023 (1.96) 0.024 (1.029) 0.009 (0.731) 0.077 (1.21) june -0.025 (-0.904) 0.007 (0.329) -0.014 (-0.64) 0.051** (4.2641) 0.0006 (0.028) -0.014 (-1.112) 0.112 (1.76) july -0.004 (-0.141) 0.017 (0.764) -0.010 (-0.459) 0.012 (0.98) -0.004 (-0.18) 0.011 (0.863) 0.236** (3.70) august 0.009 (0.31) -0.0001 (-0.006) 0.014 (0.65) 0.026* (2.262) -0.015 (-0.65) 0.0101 (0.793) 0.097 (1.59) september 0.028 (1.04) -0.018 (-0.844) 0.046* (2.14) 0.012 (0.99) -0.005 (-0.23) 0.0094 (0.742) 0.077 (1.265) october -0.003 (-0.089) -0.0009 (-0.03) -0.009 (-0.402) 0.029* (2.44) -0.008 (-0.36) -0.0039 (-0.293) 0.094 (1.47) november -0.016 (-0.56) 0.026 (1.16) -0.016 (-0.66) 0.016 (1.39) 0.041 (1.79) -0.003 (-0.225) 0.019 (0.300) december 0.012 (0.443) 0.013 (0.58) 0.019 (0.781) 0.012* (2.15) -0.005 (-0.21) 0.0061 (0.450) -0.015 (-0.244) f-statistic 3.093** [0.009] 1.575 [0.101] 1.158 [0.341] 2.71** [0.002] 0.881 [0.561] 0.550 [0.863] 2.995** [0.001] aic -2.120 -1.918 -3.0189 -2.992 -2.435 -3.614 -0.257 sbc -1.799 -1.7029 -2.588 -2.814 -2.142 -3.31 0.023 arch(5) 0.298 [0.912] 1.078 [0.373] 0.531 [0.752] 1.322 [0.401] 0.996 [0.423] 0.165 [0.974] 0.429 [0.871] notes: estimates of equation (2).p-values are shown in [ ] while t-statistics are shown in ( ). *, ** indicates significance at the 1% and 5% levels respectively. we are inclined to rule out the tax loss selling hypothesis for the reasons indicated beneath table 3. what is plausible, however, is the issue of omitted risk factors in the month of january. a glance through the institutional reforms instigated in the three markets that reported significant january return indicates a strong link between the market microstructure and returns in january. most reforms, such as demutualization, and the introduction of new tax rules, are likely to occur at the end of the year in december and this may be responsible for depressed stock performance in other months and subsequent recovery in january as investors adjust to the new rules. investors thus get on average a higher return in january to compensate for the uncertainties surrounding new rules and reforms, which may impact on the risk-return relationship. a second explanation may be liquidity, which remains the most critical risk factor in price discovery, as it is required to drive the market. although african markets suffer low liquidity in general, we surmise that the tendency for liquidity to be lower is pronounced at the close of year and is back up only when investors return to the desired portfolio levels at the beginning of the year. this helps explain in part the high january return. this explanation is consistent with the notion of market efficiency. although monthly returns in july are significant for zimbabwe, overall they are no greater than the january return. thus for these two markets (egypt and zimbabwe), we can confirm the hypothesis that mean monthly returns in january exceed those in other months of the year. our results contrast with those of claessens et al. (1995), who find no evidence of a month of the year effect for zimbabwe. table 2 also indicates seasonality in other 70 sajems ns 16 (2013) no 1 months of the year. there is a february effect for morocco, kenya, nigeria and south africa. the hypothesis that returns for all months are equal can be rejected for egypt, nigeria and zimbabwe. for four markets (morocco, kenya, tunisia and south africa) there is insignificant variation between monthly returns, and none of them exhibit any january seasonality. overall, the estimates show that monthly seasonality is pronounced for nigeria; seven months record statistically significant returns, with the highest falling in the month of june. except for nigeria and zimbabwe, we do not find evidence of conditional heteroscedasticity in the other countries. we therefore implemented a garch model to further investigate the month of the year effect in these two countries (table 3). t a b l e 3 month of the year in mean and volatility nigeria zimbabwe mean equation(2) january 0.0209**(3.623) 0.254**(4.085) february 0.0015(0.266) -0.206*(-2.59) march 0.0043(0.606) -0.224**(-3.142) april 0.0043(0.59) -0.229**(-3.346) may -0.008(1.150) -0.204*(-2.67) june 0.017*(2.488) -0.169*(-2.073) july 0.0078(1.211) -0.154(-1.471) august 0.0119(1.622) -0.231*(-2.751) september -0.003(-0.506) -0.226**(-3.434) october 0.009(1.163) -0.219*(-2.28) november 0.007(0.870) -0.265**(-3.595) december -0.001(-0.143) -0.228*(-2.75) f-statistic [1.2220.2] 10.25**[0.002] variance equation(4) january 0.0004(1.721) 0.034(1.04) february -0.0005(-1.315) -0.053(-0.989) march -2.38e-05(-0.063) -0.033(-0.97) april -0.0006*(-2.203) -0.0411(-1.18) may -0.0002(-1.132) -0.021(-0.610) june 0.004(1.188) -0.030(-0.813) july -0.003(-1.561) 0.003(0.063) august 0.0003(0.621) -0.039(-0.87) september -0.0007*(-2.54) -0.0497(-1.326) october 0.0001(0.383) -0.009(-0.251) november -0.0004(-1.225) -0.046(-1.379) december -0.0006*(-2.03) -0.029(-0.84) aic -3.461 -0.433 sbc -3.091 0.147 ll 476.9 56.28 arch(5) 1.8448[0.10469] 2.223[0.1123] f-statistic 0.3493[0.5550] 2.0243[0.1577] notes: estimates of equation (4).p-values are shown in [ ] while t-statistics are shown in ( ). *, ** indicates significance at the 1% and 5% levels respectively. after accounting for conditional heteroscedasticity we find that the january seasonality is significant in both mean and variance. throughout the sample, nigeria records 0.02 returns in january, while zimbabwe records 0.25. we also find significant positive june sajems ns 16 (2013) no 1 71 returns for nigeria, while for zimbabwe there are more significant but negative returns in almost all months. the monthly seasonality is not very prominent in volatility. only december, september and april have significant negative returns in nigeria. from these results, it appears that the turnof-the-tax-year effects found for many industrial economies do not extend to african markets. one could attribute this to the peculiar characteristics of the trading systems and market microstructure of the countries. however, it could also be possible that the tax codes of these economies do not give rise to selling stocks at the end of the tax year to generate a loss for tax purposes, the hypothesis often cited as an explanation for the turn-of-the-taxyear effect in developed economies. in addition to tax codes that are designed differently in emerging economies (compared with those for industrial economies), lax legislation and poorly developed legal infrastructure, especially regarding the security markets in africa, could well explain the lack of evidence for the tax-lossselling hypothesis. overall, the estimates show that monthly seasonality is pronounced for nigeria; seven months of the year record statistically significant returns, with the highest in the month of june. this evidence confirms results for claessens et al. (1995), who find june and march returns to be significant for nigeria. although we find significant january effects for egypt, nigeria and zimbabwe, the evidence is not convincing as to whether the tax loss selling hypothesis could be working for those countries. for instance, we do not find evidence of any other monthly effect for egypt, whereas for zimbabwe and nigeria, the january average return is not necessarily greater than in other months. further evidence is thus required to confirm these results. the results also raise further questions warranting further investigation. is the january effect related to the size effect? this requires richer data on individual stocks than those available to us here, which opens the door for future research. finally, is it profitable to apply trading rules to exploit these anomalies? here, data on transactions costs/or mutual fund spread would be required to judge the profitability of applying a trading rule on the patterns identified. our own conclusion is that, given the current state of illiquidity in african markets, such rules may prove unprofitable. 4.2 the pre-holiday effect the definition of holidays varies among researchers (brockman & michayluk, 1998). one definition looks at days, other than saturday or sunday, on which the market is closed (lakonishok & smidt, 1988). however, this excludes exceptional events, such as the end of apartheid in south africa, the recent widespread political crises in kenya that caused the market to close to traders, and natural disasters like hurricanes, which can cause abrupt closure of markets. furthermore, some holidays (e.g. easter and most religious holidays that follow the lunar calendar) change over time. to this end, we define the holiday effect as the return from the pre-holiday close to the post-holiday close. in other words, the holiday returns are the daily returns for the trading weekday that follows a non-trading weekday. we summarise these for all the countries in table 4. t a b l e 4 summary of national holidays egypt january: coptic christmas, eid al adha, el hijra. april: prophet’s birthday#, coptic easter, sham el nessim, sinai liberation day. may 1: labour day#. july 23: national day #. september 11: coptic new year# .october: eid al fitr december: eid al adha kenya january: new year’s day (1)#; new year holiday (2)#. april: good friday, easter. may: labour day (1) #. june: maraka day (1)#. october 10: moi day; 20#: kenyatta day; eid al ftr# december : independence day (12); christmas day(25)#; boxing day(26)# morocco january :new year’s day(1st)#;eiud al adha; independence manifesto day(11th)#; islamic new year april: prophet’s birthday (10th)#. may: labour day (1)#. july: throne day (30)#. august: oued eddaha allegiance day; revolution day (20th)#; the king’s birthday (21st)#. october: eid al ftr. november: ;independence day(18th)# december: eid al adha 72 sajems ns 16 (2013) no 1 nigeria january: new year (1st)#; id el kabir. april: the prophet’s birthday (10th)#; good friday; easter. may: labour day (1) #; democracy day (29th)#. october: national day (1st)#; national holiday (2nd)#; id el ftr. december: christmas (25th)#; boxing day (26th) #; id el kabir. s_africa january: new year (1st); public holiday (2nd)#. march: human rights day. april: good friday; easter; freedom day(27th)# may: workers’ day (1)#. june: youth day. august: women’s day. september: heritage day; public holiday. december: world aids day(1st)#;day of reconciliation(16th)#; christmas day (25th)#;good will day(26th)# tunisia january: new year (1st)#; islamic new year (31st)#. march: independence day (20th); youth day. april: martyrs day. may: labour day (1)#. july: republic day (25)#. august: women’s day. october: korite. november: new era day (7th)#.december: tabsaki(31)# zimbabwe january: new year (1st)#; new year holiday (2nd)#. april: good friday; easter; independence day (18th)#. may: labour day (1)#; africa day (25th)#. august: heroes’ day (14)#; defence forces day (15th)#. december: unity day (22nd)#;christmas day(25th)# ; boxing day(26th)# notes: # holidays that occurred throughout the sample period in each country. the days in question are given in parenthesis. table 5, for the entire estimation period, shows that the average pre-holiday returns (apart from south africa) and those for all other days are insignificant. the results reported in table 5 represent significant departures from the empirical literature on other markets. for the six markets with no pre-holiday effect, we can surmise that negative information does not arise in the days immediately before a holiday. this, however, is an unlikely explanation, since the general consensus is that information (negative or positive) arises randomly. the results could also be specific to african markets microstructure, and further evidence is required to explain this. for south africa, the market is more developed and tends to have features similar to those of developed economies. several factors, including economic and behavioural, could contribute to the observed positive pre-holiday returns in south africa. one possible explanation is that the significant pre-holiday returns are a manifestation of the well-documented closing effect in which high returns for securities are observed at market closings. on the behavioural side, explanations range from short-sellers closing their risky positions prior to holidays, to psychological reasons such as investors’ good mood around holidays indicating greater optimism about future prospects. t a b l e 5 pre-holiday effect in african stock returns egypt kenya morocco nigeria south africa tunisia zimbabwe pre-holiday -0.003(-0.21) -0.002(-1.21) 0.0003(0.32) -0.002(-0.219) 0.003**(3.107) 0.0002(0.361) -0.0017(-1.082) other 0.001(0.91) 0.001(0.87) 0.0007(0.768) -0.0012(-1.592) 0.0003(0.351) -0.0007(-1.57) -0.002(-1.528) f-stat 0.268[0.604] 0.198[0.65] 0.862[0.353] 2.66[0.102] 6.735**[0.009] 1.239[0.289] 4.503**[0.034] notes: estimates of equation (5).p-values are shown in [ ] while t-statistics are shown in ( ). *, ** indicates significance at the 5% and 1% levels respectively. 5 concluding remarks calendar anomalies are now accepted stylized facts in stock markets world-wide. with a variety of trading arrangements and institutional features, the search for seasonal patterns in stock returns of african markets could provide important information on the role of institutional features in return behaviour, and exemplify the role of policy in microstructure design and reform. this paper investigated two anomalies in security returns: the month of the year and the pre-holiday effect, and accounted for conditional volatility in the month of the year effect. the existence and persistence of anomalies tend to negate the notion of market efficiency, since traders can earn abnormal returns just by examining patterns and setting trading strategies accordingly, resulting in returns that are not commensurate with risk. we showed that the pre-holiday effect is present in south africa. however, this finding is not applicable to the other stock markets in our sample. for south africa this might be attributed to the closing effect in which high returns for securities are observed at market closings, and investors’ good mood around holidays, indicating greater optimism about future prospects. we also found that january returns are sajems ns 16 (2013) no 1 73 positive and significant for egypt, nigeria and zimbabwe. february returns are higher for kenya, morocco and south africa. tunisia has no monthly seasonality. while ruling out the tax loss selling hypothesis as the reason for the significant january effect, we posit that liquidity constraints and omitted risk factors may help explain the january effect for egypt, nigeria and zimbabwe. the discovery of statistically significant anomalies could imply the ability of trading rules to yield superior outcomes if they are also economically significant. however, our evidence indicates that the anomalies uncovered are too marginal economically to justify the deployment of trading rules, and hence do not present any challenge to the no-arbitrage condition. moreover, investors must incur transactions costs to exploit them, and, given the illiquidity of african markets, the use of trading rules might not yield profits over and above a simple buy and hold strategy. at the same time, however, the evidence presented in this paper opens the door for further research on stock return predictability in general, and calendar anomalies in particular. first, is the january effect manifested by the size effect? second, do the seasonal patterns uncovered in our study yield returns over and above buy and hold? these are interesting questions to which future research may do well to provide answers. acknowledgement: sincere thanks to the editor and two anonymous referees for very helpful comments. the usual caveat applies. 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estimates of fiscal multipliers in south africa the changing fiscal dynamics methodology results conclusion acknowledgements references appendix 1 footnotes about the author(s) theo janse van rensburg south african reserve bank, pretoria, south africa shaun de jager south african reserve bank, pretoria, south africa konstantin hristov makrelov south african reserve bank, pretoria, south africa citation janse van rensburg, t., de jager, s. & makrelov, k.h., 2022, ‘fiscal multipliers in south africa after the global financial crisis’, south african journal of economic and management sciences 25(1), a4191. https://doi.org/10.4102/sajems.v25i1.4191 original research fiscal multipliers in south africa after the global financial crisis theo janse van rensburg, shaun de jager, konstantin hristov makrelov received: 31 may 2021; accepted: 11 nov. 2021; published: 31 mar. 2022 copyright: © 2022. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: south africa’s fiscal position has deteriorated considerably over the last 10 years, with debt levels reaching historical highs in the post-apartheid period. national treasury’s intentions for fiscal consolidation have again drawn attention to the fiscal multiplier literature. aim: the aim in the study is to calculate the size of fiscal expenditure multipliers over the period 2009 to 2019, taking into account the specific economic conditions and the funding choices of government. setting: in the study fiscal policy is considered at a time when the debt to gross domestic product (gdp) ratio was rising rapidly. methods: we use an econometric model to calculate the fiscal multipliers over the past decade. our estimates take account of the specific fiscal conditions for each year, in particular the changing relationship between debt and the sovereign risk premia as well as the impact of tax increases. results: the model suggests that the fiscal multiplier declined from 1.5 in 2010 to around zero in 2019 as the debt levels became progressively more unsustainable and large tax increases muted the aggregate demand effects from higher government expenditure. conclusion: the low fiscal multipliers suggest that fiscal consolidation will be less costly in terms of growth forgone than generally perceived. jel classification: c50, e62, h62, h63 keywords: fiscal policy, fiscal multipliers, econometric model, south africa. introduction despite higher tax rates, south africa’s fiscal position deteriorated considerably over the last 10 years. large structural deficits have been accompanied by rising risk premia and slowing economic growth (loewald, faulkner and makrelov 2020). national treasury’s intentions for fiscal consolidation to stabilise debt and avoid a debt crisis focused attention on the fiscal multiplier literature. the fiscal expenditure multiplier reflects what happens to the rest of the economy when government changes its spending. if a fiscal multiplier is 1, gross domestic product (gdp) changes by exactly r1 for every extra r1 of government spending. if it is more than 1, extra spending by government crowds in even more domestic output. if it is less than 1, activity does not rise as much as the spending increase, perhaps because of import leakage, capacity constraints or crowding-out effects. the fiscal multiplier literature identifies a range of channels through which government spending could affect the economy. the simplest is that an increase in spending raises aggregate demand. this impact is reduced, however, if the extra expenditure pulls in more imports. multipliers also vary, depending on the composition of spending, with investment having the largest positive multiplier over the longer term. the size of the multiplier is further affected by the business cycle: if an economy is already operating at full capacity, multipliers will be smaller than when there is a negative output gap (batini, eyraud, and weber 2014). ghassibe and zanetti (2019) show how the source of economic fluctuations determines the size of fiscal multipliers and the effectiveness of different fiscal instruments in supporting aggregate demand and supply. policies that boost aggregate demand will be ineffective if the downturn is driven by supply factors such as electricity shortages. advanced economy estimates also show much larger multipliers when monetary policy is constrained by the zero lower bound (christiano, eichenbaum, and rebelo 2011). financing channels matter too. if government spending is paid for with higher taxes, the economic impact of higher government expenditure will tend to be small or even negative. the economic literature finds that the tax multipliers are larger than the expenditure multipliers.1 funding through debt can support a higher multiplier when the increase in debt is perceived as sustainable. however, when sustainability is in doubt, higher debt burdens may reduce capital inflows, raise interest rates for the entire economy, reduce domestic demand and undermine confidence in the economic outlook, thereby lowering the multiplier (bonam and lukkezen 2019; huidrom et al. 2019). this effect is stronger when there is a large financial sector that holds government bonds as safe assets: rising fiscal risk weakens these balance sheets, in turn negatively affecting the supply and pricing of loans (dell’ariccia et al. 2018). even in the absence of large holdings of government debt, financial sector concerns regarding the fiscus and the economy may increase lending spreads (borio and zhu 2012). rising risk aversion and risk premia also increase the neutral interest rate (jaramillo and weber 2013; summers and rachel 2019). the size of the multiplier also depends on whether the fiscal change is anticipated, its persistence and the country’s economic characteristics such as the level of development and the exchange regime (ramey 2019). given these channels, we should expect multipliers to vary based on time and conditions. the relationship between government debt and the risk premium is particularly important for our analysis. the economic literature suggests a strong non-linear relationship. at low debt levels, the risk premium remains unchanged and it may even decrease if the fiscal policy intervention is temporary and targeted. at high and rising debt levels, the risk premium starts to increase more exponentially.2 this study makes use of a small quarterly macroeconometric model (qmm) that is specifically designed to capture the relationships between government and the real economy. our model estimation methodology is similar to akanbi (2013), but the structure of the model, the estimation period and the model simulations are different. we have chosen this approach due to its greater flexibility to incorporate different conditions/states compared to other large models. in our estimates, we take into account the specific fiscal conditions for each year, which are based on the changing relationship between debt and the sovereign risk premia over the last 10 years, the impact of tax increases on economic activity, as well as the presence of certain supply constraints, such as those in the electricity sector. our results show that the fiscal multiplier declined from 1.5 in 2010 to almost zero in 2019, as taxes increased and the government debt levels became progressively more unsustainable. in the next section, we provide previous estimates of fiscal multipliers in south africa and discuss how these should be interpreted. section 3 briefly presents the fiscal policy developments in south africa over the last 10 years. this is followed by a description of our methodology and model. the results are presented in section 5 and section 6 outlines the conclusion. estimates of fiscal multipliers in south africa the recent south african literature presents a wide range of fiscal multipliers depending on the methodology used and the different impact channels incorporated in the estimates.3 in one of the more comprehensive studies, jooste, liu and naraidoo (2013) calculate expenditure multipliers for south africa using a calibrated dynamic stochastic general equilibrium (dsge) model, a structural vector error correction model and a time-varying parameter vector autoregressive (var) model. they generate multipliers smaller and larger than 1 depending on the methodology and assumptions regarding the business cycle, the share of ricardian households and the import intensity of the economy. jooste and naraidoo (2017) extend the dsge approach further and show how labour dynamics affect the size of fiscal expenditure multipliers. they find that sticky wages, credit-constrained households and elastic labour supply increase the multiplier effects. kemp and hollander (2020) also employ a dsge model, but with debt dynamics. this presents an additional channel in the fiscal policy transmission mechanism and lowers expenditure multipliers. in the presence of supply and savings constraints, mabugu et al. (2013) find small expenditure multipliers in a computable general equilibrium (cge) framework. similarly, akanbi (2013) finds multipliers below 1 when the economy is supply constrained. in the absence of supply constraints and assuming that higher government expenditure does not increase imports, the multiplier can exceed 1.5 (schröder and storm 2020). kemp (2020) provides empirical estimates of expenditure multipliers using a var approach. the expenditure multiplier over the period 1970 to 2019 is small, but also highly dependent on the identification approach. in line with global literature, the tax multiplier is larger than 1. a similar long-term estimation approach is employed by nuru (2020), who finds small multipliers. none of these studies considers the role of the financial sector in amplifying fiscal shocks even though the global literature suggests that this is an important channel. for example, fernández-villaverde (2010) and carrillo and poilly (2010) find that the size of the fiscal multiplier increases significantly in the presence of financial frictions, which work through the balance sheet of a representative firm. the only south african study that incorporates financial sector dynamics is makrelov et al. (2020). they employ a stock and flow consistent model in the tradition of backus et al. (1980) with bounded rationality for households. the expenditure multiplier exceeds 2, but under very specific conditions of large capital inflows, a large and negative output gap, and sustainable government debt. under these conditions, the financial sector positively amplifies the initial government expenditure shocks. under different conditions, the financial sector’s amplification effect is weaker and may work in the opposite direction. understanding the limitations and assumptions of each approach supports the appropriate use of the different estimates. results, which assume that south africa is a closed economy, are clearly inappropriate for policy use as the country is a small open economy. using multiplier estimates, generated under conditions of sustainable government debt, is not useful when the government debt trajectory is perceived as unsustainable. one needs to distinguish between empirical estimates often generated using a var model, and estimates generated using large calibrated models such as cge and dsge models or econometric models. the empirical estimates should provide more accurate estimates of fiscal multipliers. however, the need for a certain number of observations, or their sensitivity to the number of variables included in the var model, or the identification strategy makes them a less reliable source of estimates. presenting a fiscal multiplier over the period 1970 to 2018 is useful for long-term fiscal reviews, but it is less useful for policy decisions over the next three years, or for reviews of fiscal policy over the last five years. generating state-dependent multipliers in some emerging markets is also challenging. for example, south africa has only one period after 1994 in which the debt-to-gdp ratio exceeded 80%. this does not provide a sufficient number of observations to generate robust results under different debt regimes. large calibrated or econometric models provide estimates based on the assumed structure of the model. these are useful as laboratories to show how different channels and assumptions affect the size of fiscal multipliers. the estimates need to be interpreted in the context of the assumed model structure. for example, does it make sense to assume that government and household consumption are substitutes, as in kemp and hollander (2020)? how would the result change if this feature of the model was modified? how would different asset demand function parameters in the model of makrelov et al. (2020) change the results? how would the multipliers change if the economy was not supply or savings constrained, as in the model developed by mabugu et al. (2013)? every model has limitations and no model will be able to incorporate all the channels; however, these models provide a useful platform to discuss and understand how different channels play out. in some cases we do not need complicated models to have a view of the fiscal multiplier. when the risk premia are rising exponentially, due to rapid accumulation of debt, the economy faces supply constraints, taxes keep increasing and the composition of government spending shifts away from investment and towards consumption, the economic experience tells us that the multiplier is likely to be small and even negative. it is exactly these conditions that have dominated the south african fiscal landscape for most of the past 10 years. the changing fiscal dynamics in 2008 and 2009, south africa’s debt-to-gdp ratio stood at 26%, hardly unsustainable. the fiscal policy decisions in the 10 years prior to the global financial crisis created the space for a strong fiscal response. while the initial post-crisis response was justified, the stimulus deviated from two key conditions. it was not temporary and it was not well targeted as a rising portion of expenditure was spent on wages rather than on investment. strong real growth in spending was achieved, with growth averaging almost 4% per year over the entire period, and increased by more than 7% in 2019 and 2020. attempts at fiscal consolidation were done through taxes rather than expenditure, which contributed to lower economic growth.4 figure 1 indicates that the ratio of expenditure to gdp increased from 27% in 2008 and 2009 to 33% in 2019 and 2020. initially, fiscal deficits were funded by debt issuance at very competitive rates as south africa benefitted from the quantitative easing policies in advanced economies. this suggests that the expenditure multipliers were large. however, government started using tax increases to fund expenditure, which raised the tax-to-gdp ratio by 2 percentage points, from 23.9% in 2010 and 2011 to 25.9% in 2016 and 2017, muting the positive aggregate demand effects from higher government expenditure. tax increases were also accompanied by large tax shortfalls, suggesting substantive negative impacts on gdp. figure 1: expenditure and revenue. the south african risk premium, as measured by the emerging markets bond index plus (embi+) measure, decreased in the period immediately after the global financial crisis (figure 2). a large part of the decline was driven by domestic factors, suggesting that at the time fiscal policy was perceived as sustainable and having a positive impact on economic activity. however, over the period 2013 to 2019, the risk premium increased by 200 basis points, contributing to higher borrowing costs throughout the economy and generating large crowding-out effects (loewald, faulkner, and makrelov 2020). figure 2: risk premium (embi+). the latter part of the period was also characterised by large supply shocks, such as disruptive labour strikes in the mining and manufacturing sectors, drought conditions, rising levels of policy uncertainty and an increasingly binding electricity supply constraint. these factors decreased potential growth and the effectiveness of expansionary fiscal policy. figure 3 presents a simple proxy indicator of the fiscal expenditure multiplier. it shows the incremental government expenditure to output ratio. this has more than doubled since 2015, indicating that the growth of government expenditure over the period saw a much smaller increase in output compared to previous periods. figure 3: government spending to growth. methodology we employ an macroeconometric model similar to the reserve bank’s core econometric model and the bureau for economic research (ber) econometric model.5 the structure of the economy is represented by a set of econometric equations and identities based on economic theory and the relationships in the system of national accounts. long-term dynamics are represented by a set of co-integrating relationships while the methodology also allows for deviations in the short-run from the long-run equilibrium. the economy is continuously bombarded by a range of shocks, which are transmitted via changes in prices (exchange and interest rates and consumer prices) affecting income and in turn decisions to invest and consume. the adjustment by economic agents to these shocks occurs over several periods, depending on the particular shock and the specific characteristics of the sector. the model has more than 20 estimated equations and roughly 100 identities. the framework incorporates five major tax rates, endogenous risk premia and a lending spread. these model characteristics are particularly important for our analysis. this type of model has been subject to the lucas critique (lucas 1976). yet it has remained the workhorse of many central banks and ministries of finance due to its ability to incorporate more channels relevant to a particular policy question than other macro-economic models, its better fit with the data and its flexibility to create different economic scenarios. it is for these reasons that we have chosen to develop and use an econometric model. our framework is based on adaptative expectations. forward looking behaviour based on bounded or rational expectation is important for fiscal analysis. the ricardian equivalence theorem stipulates that under rational expectations, expansionary fiscal policy increases private savings and reduces consumption, reducing the expenditure multipliers. the empirical evidence of the presence of ricardian equivalence dynamics in south africa remain inconclusive. in a cross-sectional study including south africa, nadenichek (2016) rejects the ricardian equivalence proposition. the study does not cover the most recent period of fiscal deterioration as it covers the period 1970 to 2013. next, we describe the model and its properties, followed by a discussion of our model simulations. non-technical model description the qmm models the behaviour of firms, households, policymakers (both monetary and fiscal) and the rest of the world. the qmm structure captures the key expenditure and income relationships reported in the national accounts. figure 4 provides a diagrammatic representation of the model. figure 4: simplified model structure. firms hire labour and invest in capital to produce goods and services in the economy. in the long run, the costs of additional workers are compensated by the extra revenue they generate, implying that the pace of growth in real wages cannot exceed the growth in labour productivity. there is a homogenous relationship between growth and employment, such that employment growth only exceeds output if it is accompanied by reduced real wages. however, over the short(-er) term, prices and wages are ‘sticky’ so labour can temporarily make relative gains (losses) against firms through higher (lower) real wages or employment. the growth in nominal wages is a function of real wage growth and inflation expectations. private investment follows the investment accelerator approach by modelling investment as a function of gdp (jorgenson 1963). in addition, we capture the effects of higher borrowing costs on investment. the household sector consumes imported and domestically produced goods and services. household consumption spending is driven by permanent real after-tax income, consistent with the permanent income hypothesis. monetary policy decisions affect household consumption, via commercial banks’ effective lending rate, which is a function of the repo rate. the long-run equilibrium for real export volumes is determined by a foreign demand (income) variable and a competitiveness (price) indicator. rand-denominated export commodity prices and domestic producer input prices determine export competitiveness in the model. import volumes react to the equilibrium level of domestic demand as the income variable and a competitiveness indicator in the form of import prices (i.e. the rand equivalent of foreign inflation and oil prices) relative to the gdp deflator. positive and negative output gaps also affect import volumes over the short term. when the output level is above potential, the import propensity to gdp increases. interest rate movements vis-à-vis the united states (interest parity condition) determine the exchange rate along with the balance of the current account. the exchange rate feeds into the export and import prices of south african goods and services. qmm distinguishes between government consumption (split into wages and non-wages), transfers (mostly to households), subsidies and the interest payments on government debt. these are all exogenously determined and subject to discretionary fiscal policy. government expenditure is financed by tax revenues and/or issuing of bonds. the model provides for five major taxes, namely personal and corporate income taxes, value-added tax (vat), fuel levies and custom receipts, which are modelled as exogenous effective rates on the relevant tax base. the role of monetary policy is to anchor prices at the mid-point of the target range. headline inflation is modelled as a function of demand pressures captured by the output gap and the producer price index (ppi). the latter captures both demand and supply factors affecting the cost structures of firms. these factors include unit labour costs and import prices. the qmm uses a calibrated taylor rule, with the policy interest (repo) rate reacting to changes in the foreign equilibrium real interest rate (referenced by the us fed rate), south africa’s risk premium, the output gap and the deviation of inflation from the target. the risk premium is measured by the jp morgan embi+ measure6 for emerging markets. the real repo rate in the model increases in response to a higher risk premium, a more positive output gap or inflation expectations exceeding the target level. inflation expectations are adaptive in the model. this specification is supported by kabundi and schaling (2013) and crowther-ehlers (2019), who find that expectations formation tends to be more adaptive in south africa.7 real long-term interest rates reflect the trend in the real short-term policy (repo) rates and the fiscal balance (as % of gdp). the risk premium enters the long-run interest rate equation via the repo rate. by affecting output and the cost of borrowing, fiscal and monetary policy decisions impact income and the real cost of capital, which in turn affects economic activity. in qmm the output gap is derived from the difference between actual and potential gdp – with the latter informed by a hodrick–prescott filter. this is in contrast to the sarb core model in which the output gap for all periods is calibrated to the estimates generated by botha, ruch, and steinbach (2018). for the most recent years, we use estimates produced for the monetary policy committee. the model framework tries to capture how the financial sector tends to amplify economic shocks through changes in the aggregate lending spread. we define the lending spread as the banks’ weighted effective lending rate minus the repo rate. the spread is driven by changes in the jse all-share index and south africa’s risk premium. a deterioration in the global and domestic environment affects equity prices and risk premia, increasing the risk aversion of the financial sector and leading to a higher lending spread. this mechanism captures some elements of the theoretical models of borio and zhu (2012) and woodford (2010). key model equations in this section we present some of the key equations in the model and their diagnostic statistics.8 table a in the annexure lists the remaining equations and the explanatory variables. real fixed investment in the private sector similar to the sarb’s core model, real private-sector fixed-investment spending is primarily based on the growth accelerator specification (jorgenson 1963). higher economic activity, as measured by gdp, leads to more investment and capital accumulation in the long run. our econometric estimation imposes a homogenous relationship between investment and output. other drivers include the cost of capital measured by the real yield on long-term bonds, as well as output gap dynamics, which tend to generate more investment as the output gap becomes more positive: r2 = 0.69 dw = 1.88 (breusch-godfrey (lm) tests do not reject h0 of no serial correlation in residuals up to 4th order) β1 = 0.346 (-3.67); β2 = -0.330 (-2.60); β3 = 0.524 (1.67); β4 = -0.683 (-3.60); β5 = 0.199 (2.36); β6 = 0.152 (3.97); β7 = -0.088 (-4.15); β8 = -0.065 (-3.69) sample = 2005q1 – 2020q1 where: privinv1 = private sector investment spending (seasonally adjusted constant 2010 prices) gdp1 = gross domestic product (seasonally adjusted : constant 2010 prices) realglr = real yield on government stock with a maturity of 10 years less expected consumer price index (cpi) inflation gdpgap = real gdp output gap (seasonally adjusted : constant 2010 prices) realrdol = real effective exchange rate (index 2010 = 100) real yield on long-term government bonds we model the term premium spread as the difference between the real long bond rate and the real repo rate. the main driver of the term premium in the long run is the government-deficit-to-gdp ratio, while in the short run it is the lagged risk premium. the risk premium specification captures short-term volatility caused by both domestic and international events. a change in south africa’s risk premium has a direct impact on long rates, that is, over and above the change working indirectly via the repo rate. r2 = 0.48 dw = 2.09 (breusch-godfrey (lm) tests do not reject h0 of no serial correlation in residuals up to 4th order) β1 = 0.2653 (-5.16); β2 = -0.2114 (-5.02); β3 = -0.2819 (-2.55); β4 = 0.4100 (4.48); β5 = 0.2342 (1.99); β6 = 1.4242 (2.45) sample = 2000q3 – 2020q1 where: realglr = real yield on government stock with a maturity of 10 years less expected cpi inflation realrepo = sarb repo rate in real terms (cpi adjusted) govdefr = government deficit as a ratio to nominal gdp sarisk = south africa’s risk premium risk premium south africa’s risk premium is measured as a weighted maturity structure of long-term government bonds to the corresponding weighted structure of us bonds (jp morgan embi+ measure for south africa). in the long run, the domestic risk premium is informed by the jp morgan emerging markets bond index (embi), while the change in the federal reserve’s balance sheet captures quantitative easing dynamics and serves as a proxy for risk on/off events in emerging markets. the risk premium is also affected by the domestic debt-to-gdp ratio. this specification ensures that long bond yields are directly affected by flow dynamics via the fiscal deficit and indirectly by stock dynamics captured by the debt-to-gdp ratio in the risk premium equation. r2 = 0.89 dw = 1.76 (breusch-godfrey (lm) tests do not reject h0 of no serial correlation in residuals up to 4th order) β1 = 0.0657 (-1.91); β2 = -0.1284 (-1.82); β3 = 0.8857 (1.81); β4 = 1.4769 (1.63); β5 = 0.6427 (9.67); β6 = 1.3211 (4.19); β7 = -1.3952 (-6.49) sample = 2003q1 – 2020q1 where: sarisk = south africa’s risk premium embi = emerging market risk premium as spread to weighted us long bond maturities usafedl = liabilities on us federal reserve bank balance sheet govtdebtr = government-debt-to-nominal-gdp ratio effective lending spread the nominal effective lending spread is calculated as the difference between the banks’ nominal weighted effective lending rates and the official sarb repo rate (eflendrate – repo). the spread is a function of the jse all-share index and the risk premium. deterioration in these variables increases the lending spread as valuations worsen and probabilities of default increase. this approach strives to capture the theoretical mechanisms identified by borio and zhu (2012) and woodford (2010), but the framework is not able to generate financial accelerator effects. when economic conditions deteriorate, banks become more reluctant to extend credit to applicants as the threat of non-performing loans increases. our approach is different to grobler and smit (2015). in their specification, the lending spread is affected by macro-prudential ratios. in our specification, this relationship is assumed implicitly as higher risk premium and negative shocks to equity prices should require banks to hold more capital: r2 = 0.59 dw = 1.87 (breusch-godfrey (lm) tests do not reject h0 of no serial correlation in residuals up to 4th order) β1 = 0.374 (-4.50); β2 = -0.506 (-2.21); β3 = 0.374 (5.33); β4 = 5.363 (2.32); β5 = 0.508 (5.87); β6 = -1.401 (-3.41); β6 = 0.998(-2.54); β8 = 0.631 (2.92) sample = 2005q1 – 2020q1 where: eflendrate = south africa’s weighted effective lending rate in the banking sector repo = sarb’s repo rate jsealsi = jse all-share index sarisk = south africa’s risk premium real rand/us dollar exchange rate the real rand/dollar exchange rate is modelled as a function of the real riskadjusted interest rate differential between the us and south africa. balassa samuelson effects are captured via the current account balance. in addition, the real rand/dollar exchange rate is affected by the real us$/euro exchange rate to reflect the importance of the euro area as a major trading partner of south africa: r2 = 0.57 dw = 1.80 (breusch-godfrey (lm) tests do not reject h0 of no serial correlation in residua ls up to 4th order) β1 = 0.1068 (-2.38); β2 = -0.1169 (-2.16); β3 = -0.5112 (-2.89); β4 = -0.9917 (-1.66); β5 = 0.2926 (2.46); β6 = -0.5626 (-4.03); β7 = 0.1568 (3.17); β8 = 0.1433 (2.59); β9 = -0.1560 (-3.20); β10 = 0.1011 (2.10) sample = 2000q1 – 2020q1 where: realrdol = rand/us$ exchange rate in real terms realdeuro = us$/euro exchange rate in real terms intdiff = interest rate differential between south africa’s repo rate and the us fed rate sarisk = south africa’s risk premium cabopr = current account of the balance of payments as a ratio to nominal gdp cabopeqr = equilibrium level of the cabopr model properties in this section we illustrate the model properties by showing the response of the model to two exogenous shocks. repo rate shock figure 5 shows the effects of a 1 percentage point increase in the sarb repurchase interest rate for four quarters to illustrate the monetary policy transmission mechanism in qmm. the model dynamics capture the main channels via market rates, the exchange rate, asset prices, expectations and risk taking via the bank lending spread.9 the model’s response is in line with those generated by the sarb’s quarterly projection model (de jager, johnston, and steinbach 2015). figure 5: model response (a–b) to four-quarter real repo rate shock. banks’ effective lending rates increase by slightly more than 1 percentage point as lending spreads also increase due to the slowdown in economic activity and the moderation in share prices. higher banking rates and lower share prices reduce household consumption. the repo rate also filters through to long-term interest rates, which, together with the reduced keynesian demand accelerator, cause investment to decline. consequently, gross domestic expenditure and capacity utilisation fall and wage pressures moderate. wages respond with a lag, indicating some degree of wage stickiness in the south african labour market. the exchange rate appreciates as the balance on the current account improves and the favourable interest differential widens. this supports the steady reduction in headline inflation. the slowdown in inflation expectations is slower than the moderation in headline inflation, in line with our assumption of adaptive expectations. the maximum inflation impact of around 0.3 percentage points is reached in six to eight quarters after the initial change in interest rates. real gdp declines by 0.25% some four to five quarters after the repo rate increase. south african risk shock figure 6 depicts the impact of a four-quarter shock to south africa’s risk premium. the transmission mechanism is somewhat similar to the repo rate shock described earlier – as the risk premium raises the repo rate. however, the real economic impact is larger because the long rate is affected not only indirectly by the higher repo rate, but also directly via the risk premium increase. consequently, the negative investment response is stronger than in the repo rate scenario, which in turn results in large and negative impacts on other demand components. the impact on the banks’ effective lending rate is stronger as the higher risk premium also affects the lending spread directly. it is this channel that causes household consumption to decline by more than in the repo rate shock scenario. the higher risk premium causes the exchange rate to depreciate in real terms, which in turn supports export volumes and reduces the demand for imports. figure 6: model response to four-quarter (a-d) real south african risk shock. model simulations the model provides a laboratory to calculate the multipliers under different conditions. we identify three main periods: the first period is immediately after the global financial crisis, which is characterised by falling risk premia, large negative output gaps and large capital inflows. in the second period, post-2010, these conditions start to reverse and government starts to use tax increases to reduce the fiscal deficits. the economy also experiences several supply-side shocks such as protracted and disruptive strikes in the mining and manufacturing sectors, droughts, as well as sporadic episodes of load-shedding. the last period, from 2014 onwards, is characterised by more rapid increases in the risk premia in response to rapidly deteriorating fiscal metrics and heightened policy uncertainty. each period is characterised by different assumptions regarding funding of expenditure, the relationship between risk premia and fiscal dynamics, and the size of the output gap. in period 1, for example, expenditure is debt funded, but it does not increase the risk premia as the fiscal risks are perceived as low and the country benefits from substantial capital inflows, which reduce the domestic savings constraint. the model simulations are summarised in table 1. table 1: shocks to the model. we have chosen this approach rather than generating time-variant coefficients as we do not have enough observations to generate robust results under our current estimation period. extending the estimation period into the 1980s can provide observations covering a large fiscal deterioration, but at that time the structure and behaviour of the economy were very different to the post-apartheid period. structural change is a major problem when analysing emerging and developing economies because it renders long estimation periods less useful for economic analysis. in periods 2 and 3, funding is a combination of tax and debt funding and the shares reflect the actual mix. the risk premium responds in these periods, pushing both the neutral interest rate and the lending spread up. we calibrate the elasticity of the risk premium to the debt-to-gdp ratio so that the model fits the actual data. the transition between the three periods is gradual. shocks to expenditure reflect the actual compositional changes to wage and non-wage expenditure over the period. consumption in each year is shocked by 1% and we present the fourth quarter multiplier. figure 7 outlines some of the structural changes that the model dynamics and shocks try to capture. these include recovery in investment and growth and a stronger growth accelerator effect in period 1 (figure 7a and 7b). both investment and growth declined in period 3, suggesting that the growth accelerator effect is smaller. the initial period is also characterised by smaller import leakage than in later periods. figure 7d shows the steady increase in the risk premium since 2013. figure 7: key drivers (a-d) of underlying conditions. results we calculate the fiscal multipliers for each calendar year. figure 8 shows the impact multipliers, calculated as the change in gdp, divided by the change in real government consumption expenditure. the fiscal expenditure multiplier is time-varying and ‘state dependent’. it also takes into account how expenditure is funded. initially, the expenditure multiplier increases to 1.5 after the global financial crisis, but then gradually declines towards zero as the fiscal situation deteriorates and south africa is faced with a series of supply shocks. figure 8: the fiscal multiplier over the last decade. we now briefly explain how these results are generated in our framework. the first period is characterised by low government-debt-to-gdp ratios, large output gaps and significant capital inflows. during this period, an increase in government spending does not translate into higher risk premia or higher policy rates. there are no crowding-out effects and the higher levels of economic activity support the stock market, leading to lower lending spreads. this amplifies the initial positive impact on output. the growth response generates a stronger growth accelerator effect during the first period via the investment equation (equation 1). at the same time, government consumption expenditure does not crowd out government investment, which provides further support to the growth accelerator mechanism in the model. the import leakage is also relatively small due to the large output gap supporting a higher multiplier. figure 9 shows the impact on household consumption and investment. during the first period the response is strong and positive. figure 9: average response of key variables (1st year of impact % deviation from baseline). in the second period, post-2010, the dynamics change. the economy is hit by a series of transitory and permanent supply-side shocks. these include falling commodity prices and binding electricity constraints, particularly for exportand electricity-intensive sectors such as mining and manufacturing. the output gap is no longer large and negative. the structural factors from the first period have started to reverse. the import leakage is higher now as the supply constraints and the previous recovery in the economy require a greater degree of importation. the fiscal shock now leads to a higher policy rate and risk premium (equation 3). the real long-term yield and the lending spread increase, following the dynamics outlined in equations 2 and 4. the response of private investment relative to the first period is muted, reflecting a much smaller positive growth accelerator effect and also higher borrowing rates in the economy. government spending is less efficient in its efforts to stimulate economic activity. in addition, the expenditure shock is accompanied by tax shocks that increase the effective pit rate, negatively affecting household consumption. the tax-to-gdp ratio increased from 23.9% in 2010 and 2011 to 25.9% in 2016 and 2017. the average impact on investment is still positive but very small and on consumption it is negative (figure 9).10 in the last period, post-2014, the negative dynamics are exacerbated. the response of the risk premium to rising debt is now stronger. the tax increases are higher, including a vat increase. the supply constraints become even more binding. long rates and lending spreads increase by more than in period 2. under these conditions, household consumption and investment decline relative to the baseline (figure 9). these dynamics generate small and, in some years, even negative multipliers. conclusion our results show that the space for generating strong positive growth effects from a fiscal expansion has long gone. the multiplier was close to zero by 2015. yet, government has been growing expenditure, increasing taxes and growing debt. the outcome of this policy has been declining growth and limited fiscal space to respond to the covid-19 crisis. our results suggest that the costs of fiscal consolidation will be less harmful to growth than generally perceived as the multiplier is currently very small. our results compare favourably to previous estimates.11 the multipliers are similar to those calculated by schröder and storm (2020) but also to mabugu et al. (2013) and jooste, liu, and naraidoo (2013). what we illustrate is that changing fiscal conditions, as well as structural shifts in the economy can materially change the size of fiscal multipliers. generating multipliers under one economic state and assuming that they apply under different economic states is an incorrect approach, which will generate large policy errors. there are several possible extensions of the paper. this includes, for example, accommodating non-adaptative expectations in the model framework and cumulative multipliers to get better sense of the longer-term effects of fiscal policy or providing the multipliers associated with different expenditure components. acknowledgements competing interests the authors have declared that no competing interests exist. authors’ contributions all authors were involved equally in all parts of the research. ethical considerations this article followed all ethical standards for research without direct contact with human or animal subjects. funding information this research received no specific grant from any funding agency in the public, commercial, or non-for-profit sectors. data availability the article used publicly available national accounts data. disclaimer the views expressed in this paper are those of the author(s) and do not necessarily represent those of the south african reserve bank or south african reserve bank policy. while every precaution is taken to ensure the accuracy of information, the south african reserve bank shall not be liable to any person for inaccurate information, omissions or opinions contained herein. references akanbi, o. a., 2013, ‘macroeconomic effects of fiscal policy changes: a case of south africa’, economic modelling 35, 771–785. alesina, a., favero, a. c. & giavazzi, f., 2018, ‘what do we know about the effects of austerity?’, aea papers and proceedings, 524–530. backus, d., brainard, w., smith, g. & tobin, j., 1980, ‘a model of u.s. financial and nonfinancial economic 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h. & hollander, h., 2020, ‘a medium-sized, open-economy, fiscal dsge model of south africa’, unu-wider working paper series no. 128, united nations university world institute for development economics research. loewald, c., faulkner, d. & makrelov, k., 2020, ‘time consistency and economic growth: a case study of south african macroeconomic policy’, south african reserve bank working paper no/20/12. lucas, r e., 1976, ‘econometric policy evaluation: a critique’, carnegie-rochester conference series on public policy, 19–46. mabugu, r., robichaud, v., maisonnave, h. & chitiga, m., 2013, ‘impact of fiscal policy in an intertemporal cge model for south africa’, economic modelling 31, 775–782. makrelov, k., arndt, c., davies, r. & harris, l., 2020, ‘balance sheet changes and the impact of financial sector risk-taking on fiscal multipliers’, economic modelling 87, 322–343. nadenichek, jon, 2016, ‘a cross-country test of ricardian equivalence and the twin deficits hypothesis’, international journal of applied economics, 13, 32–42. national treasury, 2020, budget review, government printing, pretoria. nuru, n. y., 2020, ‘monetary and fiscal policy effects in south african economy’, african journal of economic and management studies 11(4), 625–638. ramey, v. a., 2019, ‘ten years after the financial crisis: what have we learned from the renaissance in fiscal research?’, journal of economic perspectives 33, 89–114. sarb, 2021, monetary policy review, south african reserve bank, pretoria. schröder, e. & storm, s., 2020, ‘fiscal policy in south africa: closed input-output income and employment multipliers’, ifj research note series no 1, international federation of journalists. smal, d., pretorius, c. & ehlers, n., 2007, ‘the core forecasting model of the south african reserve bank’, south african reserve bank working paper no. 3195. summers, l. h. & rachel, l., 2019, ‘on falling neutral real rates, fiscal policy, and the risk of secular stagnation’, brookings papers on economic activity. woodford, m., 2010, ‘financial intermediation and macroeconomic analysis’, journal of economic perspectives 24, 21–44. appendix 1 table 1-a1: qmm key equations. footnotes 1. for a review of the global literature see alesina, favero and giavazzi (2018). kemp (2020) finds that the tax multipliers in south africa are much higher than the expenditure multipliers. 2. see, for example, bayoumi, goldstein and woglom (1995) and haugh, ollivaud and turner (2009). 3. in a review of the us and eu literature, ramey (2019) also finds a wide range for multipliers due to state dependency. 4. for a review of fiscal policy see loewald, faulkner, and makrelov (2020); burger and calitz (2020); and ber (2021). 5. for a description of the reserve bank’s core econometric model, see smal, pretorius, and ehlers (2007), and for the ber model, see grobler and smit (2015). 6. the measure is a weighted spread of south africa’s long bonds to the matched risk-free (us) rates. 7. the presence of empirical evidence supporting adaptive expectations suggests that some elements of the lucas critique are less applicable to our analysis. 8. as part of our equation robustness checks, we also calculated the t-stats adjusted for heteroscedasticity. the significance of the various coefficients remains unchanged, except the β1 coefficient in the risk premium equation, which is significant only at the 10% level. 9. see borio and zhu (2012) for a discussion of the monetary policy transmission mechanism. 10. we present the impact multipliers as we are interested in the very short-run impact (2 years). if we have used cumulative present value multipliers, these would have been even smaller based on the dynamics in the post 2010 period. 11. our framework does not have financial accelerator effects. these would have increased the positive multiplier at the beginning of the period but also the negative multipliers at the end. abstract introduction research objectives conceptual and theoretical framework literature review research methodology ethical consideration results conclusion acknowledgments references appendix 1 about the author(s) emeka a. ndaguba institute for development assistance management (idam), bhisho, south africa school of government and public administration, university of fort hare, south africa ogochukwu i. nzewi school of government and public administration, university of fort hare, south africa edwin c. ijeoma institute for development assistance management (idam), bhisho, south africa school of government and public administration, university of fort hare, south africa matemba sambumbu school of government and public administration, university of fort hare, south africa modeni m. sibanda school of government and public administration, university of fort hare, south africa citation ndaguba, e.a, nzewi, o.i., ijeoma, e.c., sambumbu, m. & sibanda, m.m., 2018, ‘using taylorism to make work easier: a work procedure perspective’, south african journal of economic and management sciences 21(1), a2120. https://doi.org/10.4102/sajems.v21i1.2120 original research using taylorism to make work easier: a work procedure perspective emeka a. ndaguba, ogochukwu i. nzewi, edwin c. ijeoma, matemba sambumbu, modeni m. sibanda received: 01 oct. 2017; accepted: 01 june 2018; published: 20 aug. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: complexities generally are conundrums that inhibit efficiency and effectiveness in research and practice; one of the symptoms of this is nebulous obstruction to task completion in the workplace. complexities in work procedures create complications in the application of procedures for completing tasks. recent trends in the auditor general’s report have demonstrated the metastasising culture of non-compliance to work procedures in municipalities in south africa. research, as well as the audit outcomes for the eastern cape in particular, is a testament to this assertion. therefore, there is no need to make work more complex. aim: to ascertain whether the application of taylorism in the workplace could improve performance and to access the utilisation of work procedure in municipalities in the eastern cape. setting: this study was carried out using quantitative data collected from a district municipality and its five local municipalities at the transkei area of the eastern cape, south africa. method: a survey completed by 593 municipality workers (junior workers) was collected and analysed using statistical methods and triangulation. results: findings from the article reveals that work procedures in the organisation might be old and archaic. it may be relevant to workers who have little or no interference from externalities with regard to their job commitments. it recommends that those officials that perform routinised functions in municipalities should use a work procedure manual when completing their task. based on the notion that work procedures engender compliance, increase outcome and output, increase productivity, save time, reduce stress and organisational friction or conflict in organisations. conclusion: it concludes that procedures that are comprehensible (simple), accessible (organically inputted and communicated) and accurate (effectively designed) will improve the daily functionality of lower echelon staff in the municipalities, especially those requiring little or no external influence on the completion of a task. introduction today’s newspapers, magazines and articles show particular concern with non-compliance in work procedures that improve the performance of government functionality in south africa as alluded to by the auditor general south africa (agsa) reports 2010–2015. this assertion is reinforced by scheepers (2012): ‘… negligence is a failure to comply with the standard of care that would be exercised in circumstances by a reasonable person’. the implication of scheepers’s assertion can be summarised as the effect of non-compliance on organisational success, in that non-compliance impacts negatively on staff performance, increases government wastage and results in suffering of the community and consequences that go far beyond the penalties and fines assigned to the individual or the department. taylor’s famous dictum is thus useful here: ‘… in the past, man has been first, in the future the system will be first’ (kanigel 1997; rastegar 2004:78); this stresses the need for systems to operate optimally over individuals. therefore, compliance is not mere rhetoric or mere formalities; rather, it is an avenue to rid a system of controversies and uncertainties and to improve a system rather than improving an individual. the study gives a conceptual account of basic concepts and draws on essential principles guiding public administrators in south africa. using the fundamentals of taylorism and the mechanistic approach, it summarises the finding of the study while stating some recommendations, which could improve organisational performance in line with the ideas and tenets of taylorism in municipalities. research objectives to ascertain whether the application of taylorism in the workplace could improve performance. to access the utilisation of work procedures in municipalities in the eastern cape. conceptual and theoretical framework taylorism taylorism is an ideological shift towards production efficiency methodology that breaks every action, work, task or job into small particles or segments in order to complete them easily and without stress (crown online 2015). taylorism, as developed by frederick taylor and other scholars of the scientific management school, introduced and popularised the concept to the field of management in the early 20th century. taylorism has six main objectives: to achieve maximum job fragmentation. to minimise skill requirements and job learning times. to separate the execution of work from work planning. to separate direct labour from indirect labour. to replace rule-of-thumb productivity estimates with precise measurements. to make possible the payment-by-result method of wage determination. it ultimately introduces time and motion study (gilbreth & gilbreth 1973) for optimum job performance, cost accounting and tool and workstation design, and create baselines that are useful when evaluating future procedures, changes and resources (business directory 2015; harper & mousa 2015). work procedure in every governmental agency and department difficult work is broken into smaller tasks to increase efficiency and productivity. division of such tasks enables the agency or department to function effectively (see the principles of division of labour by karl marx) by organising individuals and groups of employees to accomplish a task that only one person would have not been able to complete (the reason for public administration is to roll a stone that neither could roll alone) (mundel & danner 1994; ndaguba 2014:18). work procedure can thus also be seen as a planned activity, involving mental and physical effort established as an official way of achieving an action or line of actions in a systematic way (reid 2012). the main purpose for the utilisation of work procedure can be understood in these five cardinal points of view: it enables systematic completion of a task by: emphasising task specificity which leads to specialisation of a task ensuring that tasks are completed with less risk and stress; this is based on the wisdom that individual burnout leads to lowered productivity in organisations reducing repetition and idleness in the workplace reducing friction in task completion preventing organisational chaos and conflict (crown online 2015; volunteer canada 2001). work structure all work is structured, tailored to a certain goal. hence, the work structure of an organisation determines what the organisation intends to achieve and the means through which such is achieved. in other words, it determines the vision of the organisation and the mission through which such visions are achieved. therefore, there is a need to take cognisance of the structure of an organisation, because the structure determines to some or a large extent the procedures in the fulfilment of organisational tasks. therefore, according to allen (n.d.), work structure is a step-by-step method that identifies dysfunctional aspects of workflow, procedures and systems, and realigns them to fit current realities to realise the goals of the organisation. the focal point of work structure is to improve both the technical side and compassionate side of the organisation (prabhu 2010). however, connor (n.d.) argues that work structure must not be merely limited to mapping out an organisation’s total structure. like prabhu (2010), connor argues that other aspects, such as functions, processes and strategies, as well as how these strategies, functions and processes are coordinated and harmonised, are necessary to achieve the overall objective of the organisation (connor n.d.:1). literature review mechanistic and classical organisational theories work structure or design in the mechanistic realm is characterised by job functions which are ‘broken-down into specialist tasks that were “precisely defined”’ (burns 1963:103; connor n.d.:5). this model adopts the form of ‘rigidity’ because of the relatively stable business environment conditions in which it functions (shafritz et al. 2011). its major attributes include high rigidity, high levels of formalisation, low adaptive capabilities, high centralisation, high stratification, low complexity, high productivity and efficiency and low job satisfaction (lunenburg 2012:4). see figure 1 for more clarification of work procedure design. figure 1: bureaucratic organisational design. thus, the conditions for organisational success in the mechanistic approach include: the overall goal of the organisation consists of tasks that can be divided into subtasks. each task is simple enough that expertise for planning its execution is concentrated at higher levels. valid measures of individual performance can be obtained. employees respond to the monetary rewards for improved performance. authority of managers is accepted as legitimate (robey 1991). these conditions were first set out in the principles of scientific management by frederick taylor in 1911, but still remain relevant. taylorism in 1911 taylor published his book on the principles of scientific management, in which he spelt out the process of scientifically studying work to improve workers’ efficiency (shafritz et al. 2015:68). the fundamental principle underlying taylor’s theory shaped the notion of organisational performance, organisational compliance and efficiency theory in the 20th century and beyond. taylor’s notion of work dealt significantly with, ‘… task specialization, assembly line production practices, job analysis, work design, incentive schemes, person-job fit, and production quotas and control’ (giannantonio & hurley-hanson 2011:7; rahman 2012:33). taylor’s argument was that work procedures should be characterised by job functions, which are ‘broken-down into specialist tasks that were “precisely defined”’ (ndaguba 2014). there was a clear separation from employee to final completion of a product in that every employee was meant to focus on a little aspect of the production line (eyre 2015), thereby gaining expertise as a result of routinisation of functions and tasks. of note was that employees’ performance was measured based on the number of tasks successfully completed (this notion has some similarities with the balance scorecard in monitoring and evaluation). however, employees completed their tasks with little or no knowledge as to the overall output of the product (connor n.d.:5; ndaguba 2014). this was one of the pitfalls of taylorism, along with the notion that it sees employees as a cog in the wheel. however, one of the essential features of taylorism is the close supervision of junior employees in task completion and, more so, the idea that only those who understand certain functions are meant to occupy such positions (square peg in square hole) (burns 1963:103). taylorism has four underpinning principles, namely: to find the one ‘best way’ to perform each task, to carefully match each worker to each task, to closely supervise workers, and use reward and punishment as motivators, and finally to manage, plan and control (walonick 1993). these principles were seen in the early 20th century as being the only way through which employee performance could be measured accurately and the means through which productivity and efficiency could be improved. although the notion of taylorism was promulgated by an engineer, a core scientist, its ideas still remain relevant. considering the nature of transdisciplinary research in social sciences and public administration, it would be misleading for one to disassociate taylorism from understanding efficiency in the municipal system. research methodology the research instrument research design is the master plan or the logic of any inquiry. it gives an understanding of how research is conducted by demonstrating the structure and research strategy. this study employs a quantitative method in collecting its data for the work procedure design in municipal organisation. the questionnaire was sampled amongst junior workers at the district municipality and its surrounding five local municipalities. research method the most popular classification of research methods is qualitative and quantitative. at one level, qualitative and quantitative may refer to distinctions between the nature of knowledge and the researcher’s world view or the ultimate aim of the research. on another level, the terms refer to the way in which data are collected and analysed, and the type of generalisations and representations derived from such data (brysman & burgess 1999:45). this study adopts a quantitative technique for gathering data. it uses a survey questionnaire while using cross-tabulation and regression to determine the strength of the relationship between variables. this article used a descriptive research design. a quantitative empirical research approach was adopted, distributing self-administered questionnaires with the assistance of 12 students in all 5 local municipalities (king sabata dalindyebo, nyandeni, ngquza hill, port st john’s and mhlontlo local municipality) and the district municipalities in 2014. over 1200 questionnaires were distributed and 754 were returned. from this 754, 593 were correctly completed by junior employees. in selecting the respondents for this study, the purposive sampling method was utilised for the simple fact that we needed junior employees. measuring instrument in this article, the likert scale developed by rensis likert (1932) was favoured as the instrument for data collection. this instrument gives a wide range of answers to the respondent, in other to have a fair view as to how work is carried out in the municipality. the likert scale gives range of choices of level of agreement with each option: ‘every time’ (100%), ‘frequently’ (70% – 90%), ‘sometimes’ (50% – 60%), ‘rarely’(10% – 30%) and ‘never’. there are no right or wrong answers, since the idea is to procure the perceptions of the employees. the questionnaires for the study were self-administered; guidance was given by the researcher where necessary. interpretation was also facilitated by the researchers who are native speakers of isixhosa. the study used an identical and standardised questionnaire for every respondent. the likert scale questionnaire type was used to elicit a broad spectrum of perspectives of junior employees in these municipalities. data collection techniques there are two major sources of data collection techniques: primary and secondary data collection techniques. while primary data collection was done through surveys, secondary data were gathered using the desktop approach. rationality for the choice of data collection technique this article adopted the primary technique of data collection on the basis that the topic is new to the municipality and to avoid speculations or assumptions about the state of affairs in the municipalities with regard to work procedure and work procedure design, and the usability of these procedures in the municipalities. therefore, the best way forward to ascertain this was to use a survey questionnaire, and thereafter benchmark work procedure in the municipality by testing awareness, utilisation, attitude, type and design of work procedure in the municipalities. sampling methods sampling simply means selecting participants who best yield knowledge without bias. having that in mind, sampling refers to the statistical process of selecting and studying the characteristics of a relatively smaller number of items from a relatively larger population of such items in order to make statistical inference about the characteristics of the entire population. thus, empirical (quantitative) analyses tend to establish results that can be generalised to a larger set beyond the sample studied. the population of a study can either be homogeneous (if all members are identical, e.g. line management at port st. johns) or heterogeneous (if all members of the population are different from one another, e.g. assistant managers, managers, supervisors and other top officials). the essence of sampling is to get a sample (a subset of the population). there are two broad types of sampling design open to scholars in social sciences: non-probability sampling techniques and probability sampling techniques. for this study the non-probability technique is favoured, because senior managers have no chance of being selected in this study. non-probability sampling is a sampling technique which in the samples are gathered in a process that does not give all the individuals in the population equal chances of being selected (crossman n.d.). it is a sampling technique that is used to select participants premised on their knowledge of the study. to derive a sample, the judgmental or purposive sampling technique was utilised to avoid the inclusion of senior management in the research. judgmental sampling refers to techniques used by the researcher to choose participants for research with the aim of achieving the research objectives. analysis for this study was carried out using r and triangulation of existing literature and the data set generated. a referral kind of questioning was used, in which we asked similar questions in different ways. that protects the researcher, the research team, the research respondent and the environment from misconduct. thereafter, a letter from the research institution through the principal investigator was sent to the gatekeeper informing the municipality of the period for the study. the major information that was addressed in the letter included: the need and importance of the study reduction of chaos redundancy the opportunities that this study could create for engendering and promoting work procedure design in the municipality. a consent form stipulating the rights and privileges of the respondents was circulated to all participants; it was also explained in isixhosa for non-english speaking employees. ethical consideration ethical clearance application was made to the university of fort hare research ethics committee (rec) for an ethical clearance certificate. results description analysis study method, population and sample to ascertain whether or not the application of taylorism has any impact on performance, the data analysed below will show a distribution at a glance. therefore, cognisance at this point must be drawn to the understanding that respondents of this survey are officials of the municipalities under consideration, responsible for the day to day utilization of work procedure. there are five categories for rating the application and utilisation of work procedure for performance enhancement which includes: (1) never (2) rarely (10% – 30%); (3) sometimes (31% – 60%); (4) frequently (61% – 90%); (5) every time (91% – 100%); (6) na. figure 2 in this paper outlines the distribution by municipalities that participated in this survey. figure 2: the distribution of participants by municipality in percentage (%). two hundred questionnaires were distributed to all the local municipalities. however, 400 were circulated in the district area. this was principally the reason why the district municipalities had more employees than the local municipalities. the reason for the use of taylorism as a means for improving efficiency, productivity and performance in the municipalities is born of the idea that a higher percentage of junior workers in these municipalities have little educational qualification (see table 1). this makes it presumably valid to argue that complexities in work procedure would complicate the assignments that need to be carried out, thereby depleting productivity, performance, outcomes and efficiency in delivering services to communities in a sustainable manner. table 1: distribution by qualification. the next section of this article shows the results of the study. bar charts were used to present the data, and beneath the presentation lies the analysis from which the finding from this article was synthesised with the literature and aim of the study (see figure 3). figure 3: compliance with accepted standards for completing a task in the municipality. figure 3 demonstrates that about 22% of the respondents agreed that they comply to acceptable standards for completing task in the municipalities. in addition, 33% and 27% responded that they comply almost every time and occasionally. the study invariably shows that a total of 81% (which is a combination of ‘every time’, ‘almost every time’ and ‘occasionally’) of respondents uses acceptable procedure documents for completing municipal functions in order to ensure efficiency and productivity. productivity is seen by the encyclopedia of management (crown online 2015), as the overall measure of the ability to produce a service or goods in relation to an outcome. more specifically, productivity is the measure of how resources of organisations are managed to accomplish the objectives of a task in a timely manner (see figure 4 for compliance). figure 4: compliance with the administrative reporting provisions of tasks. figure 4 shows that about 24%, 36% and 22% (representing ‘every time’, ‘almost every time’ and ‘occasionally’) comply with administrative provisions for municipal reporting as contained in several municipal guidelines, such as municipal strategic self-assessment (mussa) reports and local government management improvement model (lgmim). this infrequent use of work procedures in the municipalities explains the lack of productivity: with a paltry 24% using procedures to reduce friction and risk, one cannot wonder at the decay of service delivery and the failure of compliance of the financial statements of the municipalities (see agsa reports 2011–2015, strike actions with regard to service delivery in the municipalities). however, while in figure 3 22% of participants meet the acceptable standard for completing a task, in figure 4 where the utilisation of work procedures is analysed, 24% suddenly comply. this shows some discrepancies as to whether the employees of the municipalities are really aware of what constitutes proper work procedure, despite the two-day workshop offered to orientate the municipalities to the need for the use of work procedure and the importance of work procedure design for workplace improvement in municipalities. the importance of adherence to work procedure cannot be over emphasised. as osterberg (2005:487–497) and goldberg et al. (2009:39) argued, the full benefit of a medication is achieved when a patient follows the prescribed regimen reasonably closely. as in the field of medicine, in most disciplines in the sciences there exists one best way of carrying out a procedure (hence taylor’s assertion); thus in this study we believed that in order for adherence to be achieved in the municipalities, there must exist one best way to complete a task, but not limited to the tenets of scientific management. hence, there is a need to develop work procedure through consultation with staff, community workers, community organisations and non-governmental organisations (ngos) in the communities in order to create the ideal municipality. the central piece of taylorism is not just the establishment of one best way that reduces friction and chaos in organisations, while eliminating waste, undesired motion (processes) and time, which could result in saved costs and increased efficiency and productivity in the public service in south africa (locke 1982:15), but also setting a baseline for future engagements and the ability of public servants to be responsible for their actions (see figure 5). figure 5: establishment of organisational responsibility in municipal employees’ roles in relation to completing a task. figure 5 shows that only 9.76% have never used established work procedures in completing their tasks. in contrast, 20.22% of the participants are certain that in completing every task (this is still in sync with the assertion of figure 3), they adhere strictly to procedures that describe the role they play in achieving the overall functionality of the municipalities. meanwhile, 61.23% (consisting of ‘almost every time’ and ‘occasionally’) state that they use work procedure in the establishment of roles and in discharging their functions. this implies that most of the employees (junior) have a specific role. this is unarguably one of the resounding advocacies of taylorism when he opined that each worker must be assigned a specific task (role) of a certain quality. this is reinforced by the work of adam smith on ‘an inquiry into the nature and causes of the wealth of nations’, where he opines that ‘division of labour leads to specialization’ (adam smith 1776). gilbreth and carey (1948), in the time and motion study cheaper by the dozens, argue that the responsibilities and remote task of employees lead to the general organisational success in any sector (gilbreth & carey 1948; smith 1776). but where the lines of communication is compromised, much is left unanswered (see figure 6). figure 6: establishing lines of communication in relation to the task. figure 6 establishes that issues pertaining to the lines or channels of communication are paramount. taking a scenario from a practical tv channel for instance: having one channel and sticking to that channel enables one to be familiar with every programme and the timing of each programme, which also gives the listener the opportunity to critique the channel where necessary, as compared to having several competing channels. take another scenario, electronic mail: having a single email account for all correspondence in most cases is much preferable to having several email addresses. hence, to reduce complexities in the workplace, it is also important that one established channel of communication is used, to avoid a situation or probability that employees do not receive the required communiqué at the appropriate time. thus figure 6 shows that 23.38% of the participants adhere strictly to established communication lines in the municipalities. meanwhile 36% of the participants argue that they use the established lines of communication ‘almost every time’. 23.09% and 6.94% of the participants use established communication lines ‘occasionally’ and ‘almost never’. a paltry 11.05% of the participant argue that they have never utilised the established lines of communication by the municipality in the performance of their duties in the public service. although 11.05% might seem miniature, it could be the reason why the agsa has always insisted that the municipalities have not met the mandatory standards for reporting (agsa 2014). also, and more importantly, if they have not been using the established means of communication, or not using them every time, what do they use? this is important and calls for further probing; hence, it will be wise to learn whether the means of communication used by other workers are more or less effective than the established lines of communication. the need for communication is as important in an organisation as the need for the existence of that organisation. where an organisation fails to communicate adequately and properly, it diminishes its relevance and existence. in this light we argue that every good report stems from good and effective communication. good and effective lines of communication (verbal or written) are key to proper or optimal functionality and efficiency in any organisation (johnson 2011). more so, communication on its own is a tool that cannot be ignored in everyday life, be it personal or public (lorette 2010). in the public service, good communication (a prerequisite to transparency and accountability) is important to the daily operation of the service. without good and effective (timely) communication, the internal and external structure of any organisation can face numerous challenges that can ultimately lead to its demise (voicegrid 2015). three more scenarios illustrate the need for effective and good communication in organisations: good communication is an essential tool in achieving productivity and maintaining strong working relationships at all levels in the public service. municipalities and government agencies who invest time and energy into establishing clear lines of communication will rapidly build up levels of trust amongst employees, leading to increases in productivity, output and employee morale in general. poor communication in the workplace will inevitably lead to unmotivated staff that may begin to question their confidence, abilities and that of the organisation (michael page 2015) in completing tasks. therefore, it is paramount to establish clear channel of communication in relation to task completion in the municipalities, and also ensure that established legislative parameters are adhered to (see figure 7). figure 7: compliance with established legislative parameters in completing a task. figure 7 shows that 23%, 36% and 20% of participants (representing ‘every time’, ‘almost every time’ and ‘occasionally’) adhere to established legislative procedures to a high degree. however, 10.28% participants have never complied with established legislative provisions in completing their tasks. legislative frameworks as exemplified in the municipal finance management act (republic of south africa 2007) speak to proper financial management and performance management, transparency, accountability, stewardship and good governance; the employment equity act explains how recruitment occurs. therefore, the limited number of those utilising this legislative framework could be one of the reasons why most of these municipalities have not been able to clinch a clean audit outcome from the agsa report since 2011 and the reason for several interventions and multiple strike actions in 2014. it is important to note that to have an operational government at all levels, work procedures following legislation on finance and human resources must be taken seriously as they guide the way the budgets are formulated and presented, and stipulate clearly what the municipalities must strive to achieve, primarily in line with the procedural requirement of each municipality (see figure 8). figure 8: compliance with procedural requirements of tasks. for every task that is broken down there must be a procedure geared to fulfilling or performing or completing the task with less effort and fewer resources (taylor 1911). taylorism is mainly about ‘task specificity’, ensuring that a task assigned to an employee is specific, and that the employee is trained to meet the requirements (see capability management) for fulfilling the task, is seen as one of its four principles (taylor 1911). figure 8 agrees totally that compliance with procedural requirements in fulfilling a task saves time and cost, with 23.47% of respondents saying that they comply every time with procedural requirements when doing their work. meanwhile 36.13% and 20.63% confirm that they comply with procedural requirements in the completion of their tasks, but only to a certain degree. it is therefore important to understand what compliance with work procedures does to organisational efficiency: when compliance increases in a sector, does performance also increase or vice versa? in order to demonstrate whether or not compliance is an issue for municipalities, the presence or absence of a relationship needs to be established. limitations of the current study one of the inadequacies of this study is that it did not take cognisance of all the negatives of taylorism. we have used its positives in this argument because we strongly believe that taylorism is an option for improving the efficiency of junior workers in municipalities in the area under review. the study is limited to junior workers in municipalities, so responses from management were not solicited. nonetheless, this article nourishes the idea that certain approaches in taylorism are vital in achieving organisational improvement, efficiency and productivity. this was the premise for using taylorism to ensure the adoption and use of work procedures in municipalities in the eastern cape. summary of findings the article demonstrated that: taylorism has the potential for making work easier. taylorism can improve performance and reduce friction and chaos. taylorism is rejuvenating the public service in south africa with over 80% of the participants agreeing that they use work procedures to complete tasks in the service in the municipalities. compliance with work procedures is a prequel to performance improvement and efficiency in the sector for junior workers. employees in the public service in south africa use work procedures to establish processes in line with the roles and responsibilities for completing a task. work procedures reduce organisational conflicts and chaos. clear and properly written procedures enable workers to comprehend the direction and vision of the organisation. a well-coordinated work procedure enhances productivity in municipalities. about 90% of the participants have utilised the established lines of communication in relation to completing a task in the service, by implication complying with work procedure. established parameters or provision for the completion of tasks is important because it reduces fraud and increases productivity. adherence to administrative and legislative procedures increases efficiency, influences higher performance and productivity in the public service in the municipalities. cross-referencing the four principles of taylorism against the findings of the article shows that there exists a way of or pattern for doing things in the public service in south africa, though it is not necessarily the one best way. recommendation the study suggests that management of these municipalities must develop the ‘one best way’, which should be revisited frequently to ensure that functions are tied to the objectives of the municipality. the study suggests that municipalities with large numbers of staff in the lower echelon, performing routine functions, requiring low complexity and technicality in completing a tasks or functions in the municipality, could find certain elements and tenets of taylorism useful in improving the performance of these workers. finally, for employees in the lower echelon in municipalities in the eastern cape to work in concert with the vision of the municipality, tasks need to be broken down and precisely defined. this will enable managers to exact accountability from junior employees of these municipalities. the notion of good governance is premised in relation to compliance to standard, openness, effective communication on decisions reached, information on service delivery, transparency in government business and accountability in the appropriation of government properties; these are at the centre of the ideal of taylorism. therefore, a skillful application of the tenets of taylorism would result in an improved performance that reduces organisational conflict, government wastage, improper cost and chaos, and engender task completion that invariably improves the outcomes and performance of municipalities in delivering services to locals on the one hand and achieving the agsa outcomes on the other hand. conclusion in conclusion, taylorism is a call to compliance, a call to break down complex work processes, a call for higher productivity and efficiency. it is more useful and user friendly for employees of lower capabilities or lower qualification performing routine jobs. it is best in and suited to a stable environment with little or no external influence. a workplace such as the municipalities under review, having low complexity, low adaptive capacity or ability and routinised work processes and procedures, would harness significant growth if it were to stick to the principle of taylorism (lunenburg 2014:4; shafritz et al 2015). the article found that the tenets of taylorism are rejuvenating amongst less qualified staff members in the south african public service, especially with regard to junior workers. as seen in the results, the majority of employees use this method for completing tasks in these municipalities on a daily basis. however, worrisome is the nature of work procedure used in these municipalities, which might be derailing performance, effectiveness and efficiency. hence, there is a need to revisit the work procedure as it is presently constituted and look for the right and best way for task completion in the 21st century, which is in tandem with the call for neo-taylorism in the 21st century. the objectives of the article were realised, in that the results demonstrated that work procedure application in the workplace leads to the improvement of performance. acknowledgments competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions e.a.n. was the primary writer of this paper, he was supervised by o.i.n., the leader of the study was e.o.c.i., m.s. and m.m.s. were very instrumental in data collection and analysis of the study. references auditor-general south africa, 2013, general report on the audit outcomes of local government mfma, agsa, pretoria. auditor-general south africa, 2014, general report on the audit outcomes of local government mfma, 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of organisational procedures this section deals with the use of organisational procedure with regard to compliance and efficiency. indicate appropriately (please select the applicable number in the table below): 1 = (0–20) never 2 = (21–40) almost never 3 = (41–60) sometimes 4 = (61–80) almost every time 5 = (81–100) every time table 1-a1: i use work procedures to…: microsoft word 3 sethibe & steyn sajems 18(3) 2015 .docx sajems ns 18 (2015) no 3:325-337 325 how to cite doi: http://dx.doi.org/10.17159/2222-3436/2015/v18n3a3 the relationship between leadership styles, innovation and organisational performance: a systematic review tebogo sethibe and renier steyn school for business leadership, university of south africa accepted: january 2015 this paper is an attempt to consolidate the published scientific knowledge about the impact of leadership styles on the relationship between innovation and organisational performance. concepts, statements and conceptual frameworks were used as structure to analyse the body of scientific knowledge. after consulting 31 major research databases using the systematic literature review methodology, only seven journals articles that examined the link between leadership, innovation and organisational performance were identified. the synthesis of the journal articles revealed (a) that consensus exists among researchers as far as the relevant concepts are concerned; (b) that most agree on the definition of leadership and innovation but that a uniform understanding of what constitutes organisational performance is lacking; and (c) that conceptual models are too simplistic and do not consider mediator variables or multiple financial criteria measures. the findings further reveal that innovation is significantly and positively related to superior organisational performance, and that, although transformational leadership style is significantly and positively related to innovation, transactional leadership style is more appropriate when the aim is to instil a culture of innovation. transformational leadership style, by contrast, is mostly associated with organisational performance. in addition, the findings further reveal that none of the studies investigate the mediating effect of the nature of innovation (incremental and radical) on the relationship between leadership and organisational performance, and that none of the studies use the objective measures of financial performance such as roa, roe, price/earnings (p/e) and tobin’s q calculated from annual financial reports. key words: transformational leadership, transactional leadership, organisational innovation, organisational performance, systematic review jel: o31 1 introduction innovation is broadly seen as an essential component for competitiveness and survival, embedded in organisational structures, processes, products, and services within the organisation (gunday, ulusoy, kilic & alpkan, 2011). as a result, innovation is considered by many scholars as one of the most important determinants of firm performance (adegoke, walumbwa & myers, 2012; durán-vázquez, lorenzo-valdés & moreno-quezada, 2012; grant, 2012). according to garcíamorales, matías-reche and hurtado-torres (2008), leadership style has been recognised as one of the most important factors influencing the relationship between innovation and organisational performance, because leaders have the authority to set specific goals and encourage innovative initiatives from subordinates. there is no shortage of documented studies in the literature that investigate the relationship between leadership and innovation. the general consensus among scholars is that transformational leadership style is significantly and positively related to organisational creativity and innovation (al-husseini & elbeltagi, 2012; hu, gu & chen, 2012; tipu, ryan & fantazy, 2012). on the other hand, several studies (adegoke et al., 2012; nybakk & jenssen, 2012; durán-vázquez et al., 2012) show that innovation is positively related to superior financial performance. although some studies show no relationship (selby, 2010; lööf & heshmati, 2006; kandybin & kihn, 2004), others show mixed results with non-innovative firms outperforming innovators in some instances (martin, 2012; forsman & temel, 2011; kannebley, sekkel & araújo, 2008). abstract 326 sajems ns 18 (2015) no 3:325-337 however, despite this overwhelming empirical evidence showing the link between leadership style and innovation on the one hand and innovation and financial performance on the other, very few studies have been designed to trace systematically the causal path of the effect of innovation on financial performance by examining the influence of leadership style. therefore, the purpose of this paper is to review systematically the state of research on the relationship of these strategic variables, namely, leadership style, innovation and organisational performance. 2 literature review a systematic review is a process for reviewing relevant literature using a comprehensive, preplanned strategy to locate existing literature, evaluate its contribution, analyse and synthesise findings and report on evidence to allow conclusions to be reached about what is known and what is not (denyer & tranfield, 2009). originating in the medical sciences, a systematic review differs from conversional reviews in that it aims at synthesising research in a systematic, transparent and reproducible manner (tranfield, denyer & smart, 2003). according to robson clarke, cullen, bielecky, severin, bigelow, irvin, culyer and mahood (2007), a systematic literature review uses explicit, thorough methods to identify, select, appraise and synthesise a set of research studies on a well-defined topic. in management research, a literature review process is a key tool used to manage the diversity of knowledge for a specific enquiry (robson et al., 2007). thus, the primary purpose of a literature review is: (1) to identify knowledge gaps and develop a research problem; (2) to identify the appropriate theoretical framework, issues and variables related to a particular research topic; and (3) to find conceptual and operational definitions and the appropriate methodologies for investigation (kaniki, 2009). on the other hand, theory building is an essential process in the development of new knowledge (morrison, 2003). conceptually, knowledge can be seen as the result of three courses of action; namely, the creation of new theories; the expansion of existing theory; and the disconfirmation of theories that do not survive empirical scrutiny (handfield & melnyk, 1998). therefore, knowledge is not simply a matter of content, but the capacity of content to bring about effective actions (morrison, 2003). perhaps it is in this context that reynolds (1971) posits that a scientific body of knowledge consists of concepts and statements that scientists consider to be useful for achieving the purposes of science. advancing the same argument and building on the seminal work of mouton (1996) and kerlinger and lee (2000), de vos, strydom, fouché and delport (2011) present the three building blocks of science, namely; concepts, statements and conceptual frameworks. • the oxford dictionary defines the term “concept” as “an idea or principle that is connected with the abstract” (hornby, 2000:234). a more generalised definition put forward by omar and leite (1998:3) is a “specific classification based in common attributes of objects, people, events, phenomena, instances or specific ideas”. concepts act as the carriers of meaning; in other words, they enable researchers to identify and refer to a social phenomenon and as such, one could argue that concepts are the symbolic constructions by means of which people make sense of the attributive meaning of their words (mouton, 1996). thus, possession, understanding and use of concepts by researchers are the most basic requirements of scientific enquiry (de vos et al., 2011). • statements, on the other hand, include definitions, hypotheses and propositions (de vos et al., 2011). according to mouton (1996) a definition is a statement that delimits or demarcates the meaning of a word in terms of its sense of reference. however, it is worth mentioning that there are two distinctive types of definitions; namely, theoretical (connotative) and operational (denotative) definitions. a theoretical definition refers to the specification of the meaning of the connotative meaning of a concept, whereas an operational definition describes certain operations, usually some type of measurement, under which the use of the concept is valid. sajems ns 18 (2015) no 3:325-337 327 along the same lines, a hypothesis is an expectation about the nature of things derived from theory and is a statement of something that should be observed in the real world if the theory is correct (de vos et al., 2011). as a result, an empirical hypothesis is an information item that becomes transformed into new observations via interpretation of the hypothesis into observables, instrumentation, scaling and sampling (handfield & melnyk, 1998). the observable units in this context refer to variables (entities which are capable of assuming two or more values) which can be operationalised empirically by measurements (bacharach, 1989). in contrast, a proposition is a statement which contains testable claims (mouton, 1996). at an abstract level, a proposition states the relationship between constructs (bacharach, 1989). the primary difference between propositions and hypotheses is that propositions involve concepts, whereas hypotheses require measures (whetten, 1989). in other words, although propositions and hypotheses are merely statements of relationships, propositions are the more abstract and encompassing of the two. propositions relate the more abstract constructs to one another, whereas hypotheses are more concrete operational statements built from specific variables (bacharach, 1989). • conceptual framework typically includes typologies, models, theories and paradigms (de vos et al., 2011). according to mouton (1996), typology can be defined as a conceptual framework in which phenomena are classified in terms of characteristics that they have in common with other phenomena. capecchi (1968) defines typology, in its simplest form, as a selection of a certain number of combinations of groups of variables. this selection may be based on the data afforded by empirical research. thus, a typology presents a static image or cross-section of a specific class of events (mouton, 1996). conversely, a model is defined as a representation of reality (de vos et al., 2011). in an attempt to simplify the term “model”, whetten (1989) presents an interesting analogy by suggesting that if we think of theory as a story about why, then a model can be properly viewed as a visual aid that helps storytellers highlight the main features of their explanations. however, it is worth mentioning that a model does not necessarily equate to theory. according to kerlinger and lee (2000), a theory is a set of interrelated constructs (concepts), definitions and propositions that present a systematic review of the phenomena by specifying relations about the variables, with the purpose of explaining and predicting a phenomenon. as bacharach (1989) points out, the primary purpose of theory (theoretical statements) is to organise “parsimoniously” and to communicate “clearly”. when the researcher embarks on a process of organising and communicating or explaining unknown phenomena, the research paradigm plays an important role. according to de vos et al. (2011), a paradigm is a general framework for looking at life, and as such, influencing how the researcher views and interprets material about reality and guiding the consequent action to be taken. therefore, this paper will follow the three building blocks of science (concepts, statements and conceptual framework) to review the state of research that investigates the relationship between leadership style, innovation and organisational performance. 3 methodology while systematic reviews are designed to reduce bias, a full operational protocol should be written to define and guide the search process (white & schmidt, 2005). hence, the systematic review methodology has been developed to minimise the effect of selection, publication and data extraction bias (nightingale, 2009). according to nightingale (2009) the methodology of the systematic literature review should clearly state the aims and objectives of the review, the inclusion and exclusion criteria for studies, the way studies are identified, and the plan of the analysis. in this way, the systematic review helps to develop a reliable knowledge base by accumulating knowledge from a range of studies (tranfield et al., 2003). given this purpose, clear guidelines should determine which research should be included and excluded in the final analysis 328 sajems ns 18 (2015) no 3:325-337 (green, johnson & adams, 2006). moreover, it is worth noting that the decision pertaining to inclusion and exclusion remains relatively subjective. thus, to increase reliability, it is recommended that this stage of the systematic review should be conducted by more than one reviewer (tranfield et al., 2003). to enhance the reliability of the present research, two researchers (the author and co-author) were involved in the literature search. the primary aim of this systematic review was to analyse prior studies that investigate the relationship between leadership, innovation and organisational performance, and to identify emergent themes based on the building blocks of science presented in the literature review. the keywords “leadership” (leaders*), “innovation” (innov*) and “performance” (perform*) were used in the search. as the keywords “creativity” (creative*) and innovation are occasionally used interchangeably in the literature, these were also included. similarly, the keywords “financial” (financ*), “output” (outp*), and “return on investment” (return*) were used because they are occasionally used interchangeably with “performance”. the options (criteria) selected for the search were full text, peer-reviewed and scholarly journals. target articles needed to include all three keywords in a title. with no time limit set, 21 databases (africa-wide information, business source complete, cab abstracts, communication & mass media complete, communication abstracts, ebook collection (ebscohost), econlit with full text, education source, eric, humanities & social sciences index retrospective: 1907–1984 (h.w. wilson), humanities source, library & information science source, library, information science & technology abstracts, masterfile premier, psycarticles, psycbooks, psyccritiques, psycextra, psycinfo, regional business news, social work abstracts, socindex) were searched on ebscohost and 13 articles were retrieved. again no time limit was set on a search of ten databases (applied social sciences index and abstracts (assia) (1987 current) information, cos scholar universe information, ebrary® ebooks information, eric (1966 current) information, library and information science abstracts (lisa) (1969 current) information, pais international (1914 current) information, proquest business collection (1951 current) information, proquest central (1971 current) information, social services abstracts (1979 current) information, sociological abstracts (1952 current) information) on proquest, which resulted in ten articles being retrieved. in total 23 articles were retrieved from both ebscohost and proquest. however, six duplicate articles were identified, resulting in 17 distinct articles retrieved from the search. the abstracts of the articles which met the first level of inclusion criteria were analysed in order to identify those articles that (1) use financial performance as a measure of organisational performance; (2) are published in english; and (3) treat leadership style, innovation and performance as variables. seven articles (presented in table 1) met these criteria. 4 findings from table 1 it is clear that only seven articles retrieved investigate the relationship between leadership styles, innovation and organisational performance. these findings illustrate that there is a lack of research that investigates the link between leadership, innovation and corporate performance. however there is no shortage of studies that investigate the relationship between these strategic variables. when the keywords “leadership” (leader*) and “innovation” (innov*) were used, 377 articles from ebscohost and 161 articles from proquest were retrieved. similarly, when the keywords “innovation” (innov*), and “performance” (perform*) were used in the search strategy, 843 articles were retrieved from ebscohost and 361 articles from proquest. from the obtained sample of seven articles, five articles focus specifically on transformational leadership style, whereas two articles investigate both transformational and transactional leadership styles. of the seven articles, one is more than ten years old, while the others were published in the last eight years. the seven articles that explicitly investigate the relationship between leadership style, innovation and organisational performance were analysed according to sajems ns 18 (2015) no 3:325-337 329 the three building blocks of science (concepts, statements and conceptual frameworks) identified by de vos et al. (2011). table 1 articles that investigate leadership styles, innovation and organisational performance article year author (s) title journal 1 1993 howell & avolio transformational leadership, transactional leadership, locus of control and support for innovation: key predictors of consolidated-business-unit performance journal of applied psychology 2 2008 garcía-morales, lloréns-montes & verdú-jover the effects of transformational leadership on organizational performance through knowledge and innovation british journal of management 3 2008 garcía-morales, matías-reche & hurtado-torres influence of transformational leadership on organizational innovation and performance depending on the level of organizational learning in the pharmaceutical sector journal of organizational change management 4 2008 matzler, kepler, deutinger & harms the relationship between transformational leadership, product innovation and performance in smes journal of small business and entrepreneurship 5 2013 overstreet, hanna, byrd, cegielski & hazen leadership style and organizational innovativeness drive motor carriers toward sustained performance the international journal of logistics management 6 2013 noruzy, dalfard, azhdari, nazarishirkouhi & rezazadeh relations between transformational leadership, organizational learning, knowledge management, organizational innovation, and organizational performance: an empirical investigation of manufacturing firms international journal of advanced technology 7 2013 golla & johnson the relationship between transformational and transactional leadership styles and innovation commitment and output at commercial software companies the business review, cambridge 4.1 concepts the words that appear in the keywords list are classified as concepts. however, only three of the seven articles list keywords. the most common keywords that appear in the three articles are “transformational leadership” and “organisational performance”. other keywords are “organisational learning”, “knowledge management”, “organisational innovation”, “manufacturing firms”, “pharmaceuticals industry”, “innovation”, “supply chain management”, “dynamic capabilities”, “organisational innovativeness”, “transportation”, “survey methods”, and “structural equation modeling”. 4.2 statements as stated in the literature review, statements include definitions, hypotheses and propositions. 4.2.1 definitions the most common words/terms and phrases defined are “transformational leadership”, “innovation”, “organisational innovation” and “organisational performance”. other definitions included in these articles are those of “knowledge slack”, “leadership”, “organisational innovativeness”, “innovativeness”, “innovation commitment”, “innovation output”, “innovation strategy alignment”, “percentage of expenses allocated to innovation”, “percentage of revenue allocated to innovation”, “transactional leadership” and “theoretical framework”. however, for the purpose of this paper, the focus is on the three variables under investigation; namely, leadership styles, innovation and organisational performance. • leadership styles: the articles mention transformational and transactional leadership styles. according to howell and avolio (1993) transformational leaders are leaders that focus their “efforts on long term goals, place value and emphasis on developing a vision and inspiring followers to pursue the vision, change or align systems to accommodate their vision rather than work within the existing systems, and coach followers to take a greater responsibility for 330 sajems ns 18 (2015) no 3:325-337 their own development, as well as the development of others”. along similar lines, garcíamorales et al. (2008) define transformational leaders as leaders who can influence the fundamental attitudes and assumptions of an organisation’s members by creating a common mentality to attain the firm’s goal. similarly, garcía-morales et al. (2008) define transformational leadership as the style of leadership that heightens consciousness by the organisation’s members of a collective interest and helps them to achieve it. more recently, noruzy et al. (2013) define transformational leadership generically as a managerial style that seeks to inspire employees by charismatic speeches, motivation, and intellectual stimulation. in the same vein, golla and johnson (2013) define transformational leadership based on four components; namely, influence/charisma, inspiration, intellectual stimulation and individualised consideration. only two articles investigate the influence of transactional leadership on the relationship between innovation and organisational performance. howell and avolio (1993) describe transactional leadership as a leadership style in which a leader-follower relationship is based on a series of exchanges or bargains between leaders and followers. similarly, golla and johnson (2013) define transactional leadership as a style of leadership that focuses on individual self-interest and motivates individuals though rewards. • innovation: only four of the seven articles define the terms “innovation” and “innovativeness”. garcía-morales et al. (2008) adopt the innovation definition formulated by the product development and management association (pdma), which describes innovation as a new idea, method or device, or an act of creating a new product, service or process. similarly, golla and johnson (2013) adopt the term “innovation” in relation to product and define product innovation as the market introduction of new goods or a significantly good service with respect to its capabilities, such as quality, user friendliness, software or subsystems. conversely, overstreet et al. (2013) opt for the term “innovativeness” rather than “innovation” and describe innovativeness as the propensity of an organisation to deviate from conventional industry practices by creating or adopting new products, processes or systems. • organisational performance: an interesting finding is that only one (overstreet et al., 2013) of the seven articles that investigate the relationship between leadership, innovation and organisation performance attempts to define organisational performance. according to overstreet et al. (2013) organisational performance can be measured using two distinct but related constructs; namely, operational and financial performance. according to them, operational performance refers to the firm’s ability to efficiently and effectively provide services to the customer; whereas financial performance includes, among others, profitability and monetary measures such as return on investment, return on sales and operating ratios. although other studies do not explicitly define organisational performance, attempts were made to show how organisational performance is measured. for instance, golla and johnson (2013) use the combination of innovation commitment and innovation output as a proxy for organisational performance. they calculate organisational performance as the difference between innovation output and innovation commitment. innovation commitment is calculated as a percentage of expenses allocated towards innovation and innovation strategy, whereas innovation output is calculated as a percentage of revenue related to innovation and the number of new or enhanced products. 4.2.2 hypotheses, propositions and truth statements in the seven articles identified, a total of 54 hypotheses are postulated and tested. however, of the 54 hypotheses tested, only 26 investigate the link between leadership style, innovation and organisational performance. 11 hypotheses test the relationship between leadership style and organisational performance; nine hypotheses test the relationship between leadership style and organisational innovation, and six hypotheses test the relationship between organisational innovation and organisational performance. other hypotheses test mediating effects such as locus of control, knowledge slack, absorptive capacity, organisational learning, tacitness, size and knowledge management on the relationship between leadership style, innovation and sajems ns 18 (2015) no 3:325-337 331 organisational performance. no phrases resembling propositions were found. however, the tested hypotheses provide many truth statements. the results reveal overwhelming evidence that transformational leadership style is positively associated with innovation, and in turn, innovation is positively associated with organisational performance (garcía-morales et al., 2008; garcía-morales et al., 2008; matzler et al., 2008; overstreet et al., 2013; noruzy et al., 2013). of the 11 hypotheses which suggest a relationship between leadership style and organisational performance, nine hypotheses postulate a positive relationship between transformational leadership and organisational performance, and all hypotheses are supported by empirical findings. of the 11 hypotheses that test the relationship between leadership style and organisational performance, two hypotheses postulate that there is a positive relationship between transactional leadership and organisational performance. both these hypotheses were rejected, indicating that there is no relationship between transactional leadership and organisational performance. eight hypotheses test whether a positive relationship exists between transformational leadership and organisational innovation or innovativeness, and the results reveal mixed results, with the overwhelming majority (seven) of the hypotheses supported, although one hypothesis test was rejected. interestingly enough, the studies that show no relationship between transformational leadership and organisational innovation also reveal a statistically significant positive relationship between transactional leadership and organisational innovation (golla & johnson, 2013). the six hypotheses that postulate a positive relationship between organisational innovation and organisational performance are supported by the data. 4.3 conceptual frameworks as described in the literature review, a conceptual framework consists of four building blocks; namely, theory, model, typology and paradigm. however, the seven articles analysed are quantitative in nature with no theoretical findings, and in turn no paradigms are discussed. however, several models were developed using various typologies/constructs; in particular, typologies related to organisational performance. 4.3.1 typologies as stated earlier, typologies can be defined as conceptual frameworks in which phenomena are classified. these are discussed with reference to the three key search terms. • leadership typologies: two types of leadership styles, transformational and transactional, are investigated by two studies (howell & avolio, 1993; golla & johnson, 2013). the five other studies (garcía-morales et al., 2008; garcía-morales et al., 2008; matzler et al., 2008; overstreet et al., 2013; noruzy et al., 2013) focus exclusively on the transformational style of leadership, • innovation typologies: none of the articles analysed investigate innovation in terms of typologies. • performance typologies: the two most popular typologies of organisational performance (operational and financial) are utilised in the seven articles analysed. two articles (howell & avolio, 1993; noruzy et al., 2013) use operational performance, four articles (garcía-morales et al., 2008; garcía-morales et al., 2008; matzler et al., 2008; golla & johnson, 2013) use subjective financial performance, while one uses both operational and subjective financial performance measures (overstreet et al., 2013). interestingly enough, none of the articles analysed use objective measures (based on publicly reported annual financial reports) of financial performance. 4.3.2 model and theories five of the seven articles analysed developed a model (garcía-morales et al., 2008; garcíamorales et al., 2008; noruzy et al., 2013; overstreet et al., 2013; matzler et al., 2008), whereas two studies (golla & johnson, 2013; howell & avolio, 1993) tested the hypotheses without integrating the results into a model. garcía-morales et al. (2008) developed a model using eight 332 sajems ns 18 (2015) no 3:325-337 constructs, namely, transformational leadership, knowledge slack, absorptive capacity, tacitness, organisational learning, performance, innovation and size. the model investigates the impact of transformational leadership on knowledge slack, absorptive capacity, tacitness, organisational learning and innovation. the model further investigates how tacitness, organisational learning and innovation influence organisational performance. of significance to this study, the model demonstrates a positive relationship between transformational leadership, innovation and organisational performance. subsequently, garcía-morales et al. (2008) developed another model using only three constructs; namely, transformational leadership style, organisational innovation and organisational performance. the model investigates how transformational leadership style can influence organisational innovation and organisational performance. furthermore, the model examines the influence of organisational innovation and organisational performance. the results of the model show that transformational leadership style significantly and positively influences both innovation and organisational performance. in similar vein, the results of the model reveal that organisational innovation also positively influences organisational performance. along the same lines, matzler et al. (2008) investigated the relationship between transformational leadership style, innovativeness, growth and profitability and also developed a model. although the results reveal that transformational leadership style impacts positively on growth and profitability, the results of the model illustrate that transformational leadership style contributes more significantly to innovativeness. the results also show that innovativeness influences both growth and profitability. more recently, noruzy et al. (2013) developed a model using transformational leadership style, organisational learning, knowledge management, organisational innovation and organisational performance. their study investigates the mediating effect of organisational learning and knowledge management on the relationship between transformational leadership style and organisational innovation. the authors further investigate how transformational leadership style, organisational innovation and organisational learning impact on organisational performance. in support of prior findings, the model shows that transformational leadership style positively influences organisational innovation and in turn, organisational innovation positively influences organisational performance. following a different strategy, overstreet et al. (2013) developed a covariance-based structural equation model and tested the effect of transformational leadership style on organisational innovativeness and organisational performance (operational and financial). the results support both the direct and indirect effects of organisational innovativeness on the relationship between transformational leadership and organisational performance. it is interesting to note that organisational innovativeness contributes more to operational performance relative to financial performance. it is also worth mentioning that the model illustrates the impact of operational performance on financial performance. in neither of the other two articles analysed were models developed, but the findings of these studies contribute to the body of knowledge. contrary to studies in which models were developed, these studies investigate the effects of both transactional and transformational leadership styles on innovation and organisational performance. furthermore, although howell and avolio (1993) did not develop a model, the results of their study validate the model developed by bass (1985) in several ways. in the first instance, findings show that transformational leadership style directly and positively predicts organisations’ unit level performance; and secondly, the results support the fact that innovation moderates the relationship between transformational leadership style and organisational performance. in contrast with previous findings, the results of the study by golla and johnson (2013) show a statistically significant relationship between transactional leadership and new product innovation, and a statistically significant relationship between transformational leadership style and revenue related to innovation. interestingly, the results reveal no relationship between transformational leadership style and new product innovation, and no relationship between transactional leadership style and revenue related to innovation. sajems ns 18 (2015) no 3:325-337 333 4.3.3 paradigm none of the articles explicitly mention the paradigm adopted for those studies. however, it can reasonably be argued that the only paradigm that fits these studies is the positivist paradigm. according to bryman (2004), positivism is an epistemological position that advocates the application of the methods of natural sciences to the study of social reality and beyond. the research methodologies for all articles analysed are deductive in nature and the hypothesis testing was conducted in the positivist manner. 4.4 summary the key findings are summarised in table 2 following the three building blocks of science developed by de vos et al. (2011). table 2 key findings regarding knowledge of leadership, innovation and performance building blocks of science findings concepts the most common keywords are transformational leadership and organisational performance. others include organizational learning, knowledge management, organizational innovation, innovation, dynamic capabilities and organizational innovativeness. statements the following is a synthesis of the definitions found in the articles: leadership: transformational leaders focus on long term vision and inspire and motivate followers to buy into that vision. transactional leaders focus on individuals’ self-interest. innovation: introduction of a new idea, product, service or process. organizational performance: the ability to efficiently and effectively provide a service to the customer while maintaining superior financial returns. several hypotheses recurred in the articles: transformational leadership style is positively and significantly associated with innovation. innovation is positively and significantly associated with superior organizational performance. however, when both transformational and transactional leadership were tested, the results reveal that transactional leadership style is better suited to fostering organizational innovation, whereas transformational leadership style is better suited to improving organizational performance. conceptual framework the following typologies were common in the articles: leadership: leadership style is classified into two most popular known styles of leadership, namely, the transformational and transactional leadership styles. the studies investigated do not mention other types of leadership styles. innovation: none of the studies investigated bother to explore how innovation typologies will impact the nature of the relationship between these three constructs. performance: the two typologies of organizational performance are operational performance and financial performance. the results reveal that transformational leadership is positively associated with operational performance and in turn leads to superior financial performance. however, only one study explored these typologies. none of the studies explored these typologies using both transformational and transactional leadership styles. there was little distinction between the models presented: the synthesis of all the models developed reveals that leadership style influences organizational innovation and in turn, innovative organisations exhibit superior organizational performance compared to that of competitors. although none of the studies explicitly mention the paradigm adopted, it can be deduced that researchers adopted a positivist approach of the epistemology paradigm. 5 conclusion this paper reviewed seven peer-reviewed articles from ebscohost and proquest. the primary aim was to analyse articles that investigate the relationship between leadership style, innovation and organisational performance using three building blocks of science; concepts, statements and conceptual frameworks, as identified by de vos et al. (2011). in assessing the concepts (keywords) used, it can be concluded that the majority of scholars focus exclusively on transformational leadership style when investigating the relationship between three constructs. interestingly enough, none of the articles use transactional leadership style as a concept. in the same vein, none of the articles use innovation typologies (incremental and radical), nor financial performance typologies such as return on investment (roi) or return on assets (roa). this suggests that very little attention, if any, is paid to the mediating effect of the nature of innovation, namely, incremental and radical, and to the objective measures of financial performance. however, a number of other mediating factors like organisational learning, knowledge management, and dynamic capabilities are considered. 334 sajems ns 18 (2015) no 3:325-337 with regard to definitions, the analysis reveals that transformational leadership is the leadership style that is most frequently discussed. the common themes for transformational leadership style that emerge are: (1) influential (2) inspirational; (3) charismatic; (4) motivational; and (5) intellectually stimulating. in contrast, the common themes for transactional leadership style are: (1) exchange or bargain; and (2) individual self-interest. in the same vein, the common themes that emerge for innovation are: (1) new idea; (2) new product; or service or process. the central theme of organisational performance, on the other hand, is based on operational effectiveness and efficiency and the financial performance of the organisation. where hypotheses and truth statements were studied, the evidence shows that transformational leadership style plays a significant role in cultivating the culture of innovation in the organisation and, in turn, organisations that practise innovative behaviour generally exhibit superior organisational performance, relative to organisations that display less innovative behaviour. in contrast, more comprehensive analyses (studies that investigate both transformational and transactional leadership styles) of leadership styles reveal that transactional leadership style is better suited if the aim is to instil a culture of innovation, whereas transformational leadership style is mostly associated with the enhancement/improvement of organisational performance. typology was the first conceptual framework to be reported on. the assessment reveals a number of gaps in the literature. firstly, despite the recent study conducted by golla and johnson (2013), which illustrates the importance of including transactional leadership style when investigating the relationship between leadership styles, innovation and performance, the majority of studies focus exclusively on transformational leadership style. secondly, none of the studies investigate the mediating effect of the nature of innovation in the relationship between leadership, innovation and organisational performance. thirdly, none of the studies use the objective measures of financial performance based on generally accepted accounting principles (gaap) and market-based measures such as price/earnings (p/e) and tobin’s q. theories and models are based on the truth statements and the models previously developed. from studying the reported models, it can be concluded that both transformational and transactional leadership styles have a role to play in cultivating innovative behaviour in the organisation and improving organisations’ performance. it is interesting to note that organisational learning plays a pivotal role in the relationship between leadership, innovation and organisational performance. this article does not only contribute to the understanding of a theoretical link between these variables, but also has practical implications for those in managerial positions. the latter should be aware of the importance of clearly understanding the precise meaning of concepts when discussing relationships between them, and linked to this, the importance of using standardised measures when trying to demonstrate the link between these variables. managers may also draw from this research that there is indeed a relationship between leadership styles, innovation and organisational performance, and that the appropriate leadership style is required to foster innovation and facilitate organisational performance. however, this is not a simple relationship. if the main aim is to improve organisational innovation, managers should consider adopting a transactional leadership style. if the main aim is to improve organisational performance, managers should consider adopting a transformational leadership style. if the main aim is to improve organisational performance using innovation as an enabler, managers should consider adopting both a transactional and a transformational leadership style. this is clearly a complex matter and managers are urged to proceed with caution, as available empirical research linking these variables is limited. 6 limitations and direction for future research the first limitation of this study is the sampling procedure. the study did not consider unpublished articles and dissertations. it has been a matter of speculation whether the results of this paper might have been different had dissertations been included as part of the search. secondly, only sajems ns 18 (2015) no 3:325-337 335 ebscohost and proquest databases were searched. although these databases are comprehensive, it is not known whether additional articles could have been found on other databases that met the specified search criteria. however, this inherent problem of reviews of the research literature is generally considered to be acceptable. furthermore, very few articles (only seven) met the set criteria when all three variables were used (i.e. leadership, innovation and performance), indicating a gap in the literature. the following future research on leadership, 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doi: http://dx.doi.org/10.17159/2222-3436/2016/v19n1a10 issn: 2222-3436 private shareholding: an analysis of an eclectic group of central banks jannie rossouw school of economics and business sciences, university of the witwatersrand accepted: october 2015 although the title seems to be a contradictio in terminis, this paper identifies a small, eclectic number of central banks with private shareholders about which little has been published. it is shown that only the central banks of belgium, greece, italy, japan, south africa, switzerland, turkey and the united states (us) federal reserve banks allow shareholding other than by the government of the respective countries, although not in all instances by the general public. this paper considers private shareholding in this eclectic group of central banks, despite the trend of nationalising central banks that commenced in 1935. private shareholding is defined as shareholding in a central bank by any party other than the respective government or governments (e.g. the european central bank) where the central bank is located. large differences in the classes of shareholders of these eclectic central banks and differences in their approaches to dividend payments are highlighted in the paper. the conclusions reached are, firstly, that investment only in the shares of the central banks of belgium and greece (albeit only for residents in the latter instance) can be regarded as growth investments. secondly, shareholding in the italian central bank has been used to recapitalise ailing commercial banks. thirdly, shareholders play no role in the formulation and implementation of monetary policy. lastly, the shareholding structure of these banks contributes to improved governance in the case of the central banks of belgium, greece, italy, south africa, switzerland and turkey, but no evidence can be found that central banks with shareholders in any way outperform central banks without shareholders. key words: central banks, shareholders jel: e42, 50, 58, 59 1 introduction the title of this paper seems to be somewhat of a contradictio in terminis, as it gives rise to the question whether there are indeed central banks with private shareholders. private shareholding is defined as shareholding in a central bank by any party other than the respective government or governments (e.g. the european central bank) where the central bank is located. this paper reviews this eclectic group of central banks about which surprisingly little has been published. the first challenge is the identification of these central banks, as there is no “generally accepted” or standardised list of such central banks, and very little has been published that identifies or compares these central banks. a review of the available literature shows considerable divergence between these institutions. central banks with private shareholders identified from the available literature were approached with a request to complete questionnaires on their shareholding structures. this paper reports, among others, the information obtained from these questionnaires. it further considers the degree to which private shareholding in the remaining central banks plays a role in their structures and operations. the policy conduct of central banks, comparisons of such conduct, and policy options of central banks receive considerable attention in the literature on central banking and monetary policy. however, little has been published on the institutional structures of central banks. this paper seeks to make a contribution to a specific aspect of this under-researched area of central banking. the remainder of the paper is organised as follows: section 2 reviews the literature on central banks with private shareholding. section 3 describes the salient features of a questionnaire on the abstract sajems ns 19 (2016) no 1:150-159 151 shareholding of central banks. section 4 compares central banks having private shareholding and reports the survey results received from the central banks, as well as other salient features of these institutions. the conclusions follow in section 5. 2 literature review1 the available literature shows that the ownership structure of central banks has been the subject of considerable change over time. recent literature on this topic is limited to two papers by rossouw and breytenbach (rossouw & breytenbach, 2011a; rossouw & breytenbach 2011b), while various editions of the book, central banking, by de kock (see, for instance, de kock, 1939; de kock, 1956; or de kock, 1974) also cover these institutions. de kock served as deputy governor (from 1932 to 1945) and as governor (from 1945 to 1962) of the south african reserve bank (meiring, 1994). central banking, first published in 1939, was regarded as one of the first comprehensive textbooks on this topic and was translated into spanish, portuguese, japanese, hindi and gujarati. at the time, de kock (1939:298) classified the ownership of the capital of central banks into seven different groups: 1) all shares held by the government. 2) all shares held by private shareholders (juristic persons and the general public). 3) all shares held by banks. 4) shares held by the government and private shareholders. 5) shares held by the government and banks. 6) shares held by the government, banks and private shareholders. 7) all shares held by banks and private shareholders. this paper focuses on central banks with shareholding in any combinations of 2 to 7 above. in the case where commercial banks are not specifically identified in 2 to 7 above (i.e. 2 and 4), this does not imply a prohibition on such shareholding, but merely indicates that banks are not under any obligation to hold shares in the central bank. de kock (1939:299) states in respect of 2 and 4 above that “banks may be found amongst the shareholders of some of these central banks, but not because they were originally required to subscribe to the capital of the central bank”. in the case of 3, 5, 6 and 7, banks have an obligation to hold shares in the central bank as a requirement of their licensing conditions. de kock (1939:298) identified the central banks in australia, bulgaria, china, costa rica, finland, latvia, russia, sweden and uruguay as institutions where all shares were held by the government by 1935 (i.e. as being in group 1 above). sole ownership by the government was therefore the exception at the time, rather than the rule, as is currently the case, as central banks2 were to be found in 40 countries by 1935. the remaining central banks had any combinations of shareholder structures described in 2 to 7 above (see rossouw & breytenbach, 2011a:s125 for details of these institutions). this group of central banks includes the 12 federal reserve banks in the united states (us) as one institution. some of the central banks in existence by 1935 ceased to exist or were replaced by other institutions, for example the reichsbank of germany was replaced by the bundesbank, while the central banking functions of the commonwealth bank of australia were taken over by the reserve bank of australia in 1950. the ownership structures of central banks started changing from 1935. the first nationalisation of a central bank can be a topic of debate. rossouw and breytenbach (2011a:s125 & 2011b:85) state that the reserve bank of new zealand was nationalised in 1935. this nationalisation is confirmed by the reserve bank of new zealand (2009). nationalisation was part of an approach of “big government” in the aftermath of the great depression in new zealand, when the state accepted responsibility for a wide range of functions in the economy (reserve bank of new zealand, 2009). 152 sajems ns 19 (2016) no 1:150-159 to the contrary, de kock (1956) identifies denmark as the first country where a central bank was nationalised, stating that this happened in 1936. the objective of nationalisation of this central bank was to give the danish parliament and government greater insight into the policies and activities of the central bank. naturally, nationalisation is not a precondition for greater insight; this objective can be achieved in a number of different ways. examples of ways in which this objective can be realised, irrespective of the ownership structure of the central bank, include a requirement that the governor of a central bank appears periodically before a standing or select committee of parliament and/or a requirement that the annual report of the central bank is tabled in parliament for debate. the first nationalisation of a central bank and the reasons for nationalisation therefore remain debating points. as shown below, de kock was somewhat of a visionary in 1939 when stating that “ … a definite trend in the direction of greater state intervention in the ownership and administration of central banks is to be observed in recent changes in central bank statutes …” (de kock, 1939:324). de kock (1939:324) adds that the league of nations stated on page 81 of its monetary review for the period 1937 to 1938 that “(i)n the statutes as drawn up or amended in recent years, the state has generally assumed a more important role both in respect of the ownership and management of central banks”. in de kock’s assessment, “(t)his trend towards increased state intervention … commenced in 1930 under the stress of the world-wide depression … and was accentuated by the suspension of the gold standard … ” (de kock, 1939:325). de kock adds that “(i)n many cases central banks were virtually obliged to provide the financial facilities demanded by the state … ” (1939:325). after the second world war, nationalisation of central banks gained momentum (de kock, 1956:319), and, with the exception of the central bank of pakistan3, all central banks established after the war had no shareholders other than the government since their inception (de kock, 1956:319). by 1974, 27 central banks had some form of private shareholding (de kock, 1974:305) in terms of the definitions in 2 to 7 above. at that time, the central banks of greece, italy, south africa, switzerland and the 12 federal reserve banks in the us had no shareholding by their respective governments. in chile, colombia, ecuador, portugal and turkey, the respective governments held a minority shareholding (de kock, 1974:305). in austria, belgium, japan, mexico, pakistan and venezuela, the respective governments held at least 50 per cent of the share capital (de kock, 1974:305). de kock (1974:306 and 307) draws attention to the imminent nationalisation of the central bank of colombia, but the central banks of chile, ecuador, portugal, mexico, pakistan and venezuela were also nationalised in 1974 and 1975. no information in english could be obtained further elucidating these nationalisations, but the nationalisation of the central bank of portugal might be linked to a change in government in that country that resulted, inter alia, in the independence of its territories abroad (e.g. angola and mozambique). reasons for this “wave” of central-bank nationalisation, particularly in south america, could be an area of further research on this topic. rossouw (2004) stated incorrectly that “the reserve bank … [in south africa] … the belgium national bank and the swiss national bank are the only central banks left with the public as shareholders” by 2004. lybek and morris (2004:7) also incorrectly identified the central banks of austria, belgium, greece, italy, japan, pakistan, south africa, switzerland and the federal reserve banks in the us as institutions with private shareholders, as the turkish central bank also has shareholders and the central bank of pakistan was nationalised in 1975. by 2004, central banks with private shareholders were therefore to be found in austria, belgium, greece, italy, japan, south africa, switzerland and turkey, while the 12 federal reserve banks in the us also had shareholders at that time. this changed in 2010, when the central bank in austria was nationalised. this nationalisation received very little attention at the time, perhaps because no shares were held by the general public. only the austrian government (with 70.27 per cent of the share capital) and austrian banks sajems ns 19 (2016) no 1:150-159 153 held shares in the austrian national bank before its nationalisation. the objectives of the nationalisation were to: (i) improve government supervision over the central bank; and (ii) avoid possible conflicts of interest, as banks supervised by the austrian national bank were also its shareholders and appointed its governing board (en publishing, [s.a.]). remaining central banks with private shareholders are therefore those in belgium, greece, italy, japan, south africa, switzerland and turkey, and the 12 federal reserve banks in the us. archer and moser-boehm (2013) concur with this list of central banks. 3 questionnaire on shareholding of central banks in the literature, little has been published on the organisational and governance structures of central banks, and even less has been written about central banks with shareholders. the following summary shows that there are considerable differences in shareholding among this eclectic group of central banks, ranging from: 1) government shareholding combined with institutional shareholding; 2) only commercial banks being shareholders, with shareholding banks obliged to hold such shares; 3) commercial banks obliged to hold central-bank shares, combined with shareholding by private individuals, to 4) private shareholding only (which can include institutions such as commercial banks and private individuals), but with no obligation on any party to hold such shares. likewise, the research shows that the rights of the shareholders in these institutions can differ considerably, while institutional dividend policies and practices also show considerable differences. particular differences are as follows: 5) conditions of private shareholding differ, e.g. there may be any number of possible combinations of government and/or private shareholding, where the latter may be limited to commercial banks (with or without a legal obligation to hold such shares), or may include any business enterprise and/or private individuals. 6) eligibility for shareholding differs, e.g. instances where only institutions and/or individuals domiciled in and/or citizens of the country where the central bank is located are eligible for shareholding. 7) powers of shareholders differ, e.g. in respect of voting (if applicable) attached to shares and/or preconditions for exercising voting rights. in an effort to overcome these difficulties and to foster a common understanding of private shareholding in central banks, a questionnaire was compiled and distributed to the company secretaries of the central banks of belgium, greece, italy, japan, south africa, switzerland and turkey. in the case of the us, copies of the questionnaire were distributed to the secretary of the board of governors of the federal reserve system in washington (the fed) and to the federal reserve bank of atlanta. responses were received from the central banks in italy, switzerland and turkey. in the case of the south african reserve bank, the questionnaire was completed by rossouw, author of his paper and one of the authors of rossouw and breytenbach (2011a; 2011b), who served as secretary of the bank on two occasions (from 1994 to 2000 and from 2010 to 2011). this was supplemented by research on all central banks with shareholders. the findings are analysed in the next section. 4 comparison of central banks with private shareholders this section analyses the salient features of the central banks identified above. however, the 12 federal reserve banks in the us deserve special mention, as is explained below. the central banks with shareholders can be classified as follows in terms of the classification by de kock (1939:298) highlighted above: 154 sajems ns 19 (2016) no 1:150-159 8) all shares held by private shareholders (juristic persons and the general public, which can include banks, but with no obligation on banks to hold such shares): greece and south africa. 9) all shares held by banks: italy and the 12 federal reserve banks. 10) shares held by the government and private shareholders (which can include banks, but with no obligation on banks to hold such shares): belgium and japan. 11) shares held by the government and banks: no examples. 12) shares held by the government, banks and private shareholders: turkey and switzerland (cantonal governments, rather than central government). 13) all shares held by banks (with an obligation to hold such shares) and private shareholders: no examples. one central theme that emerges from the analysis of the questionnaires and the information available on the central banks with private shareholders is that their shareholders play no role in the formulation and implementation of monetary policy (see, also, archer & moser-boehm, 2013:7 on this matter). 4.1 federal reserve bank in the united states the 12 federal reserve banks in the us form part of the federal reserve system (“the fed”). the 12 federal reserve banks have commercial banks in their federal reserve districts as shareholders. no questionnaires were received from the fed or from the federal reserve bank. the analysis in this section is therefore based on available literature. in the establishment of the fed in 1913, particular care was taken to avoid some of the perceived shortcomings that contributed to opposition to the renewal of the charters of the two earlier central banks in the us, the first bank of the united states (which existed from 1791 to 1811) and the second bank of the united states (which operated from 1816 to 1836). the federal reserve act provides for a board of governors as a federal-government agency which has, inter alia, broad oversight responsibility for the operations and activities of the 12 federal reserve banks. section 5.1 of the federal reserve act stipulates: “(t)he capital stock of each federal reserve bank shall be divided into shares of $100 each. the outstanding capital stock shall be increased from time to time as member banks increase their capital stock and surplus or as additional banks become members, and may be decreased as member banks reduce their capital stock or surplus or cease to be members. shares of the capital stock of federal reserve banks owned by member banks shall not be transferred or hypothecated (federal reserve act; see, also, the federal reserve system, 2005).” section 7.1(a) of the federal reserve act stipulates that stockholders (own emphasis) of the federal reserve banks are entitled to an annual dividend of 6 per cent on the paid-in capital stock (own emphasis) that they hold in federal reserve banks (see also, the federal reserve system, 2005). this leaves the impression that the interests of member banks in the federal reserve banks show many elements of bondholding, rather than shareholding. the 12 federal reserve banks are therefore not included in the further analysis in this paper. 4.2 salient features of other central banks the rest of the central banks with private shareholders identified above have shareholders in the conventional sense of the word, but the research shows that the rights of the shareholders in these institutions can differ considerably, and, also, that institutional dividend policies and practices differ considerably. 4.2.1 belgium the belgian central bank (official english name: “national bank of belgium”) has an issued share capital amounting to €10 million, represented by 400 000 shares (each with a nominal value of €25). the belgian state holds 50 per cent of these shares, while the remaining shares are listed on sajems ns 19 (2016) no 1:150-159 155 the nyse euronext and are held by companies and private individuals. the price was €3 099.45 per share at the end of august 2015. each share confers the right to one vote at the general meeting of shareholders and the statue of the bank does not limit shareholding or voting in any way. the bank annually pays shareholders a first dividend of 6 per cent of the share capital (amounting to €1.5 per share on the nominal value of €25 per share) and a second dividend calculated as 50 per cent of the net proceeds from the portfolio of assets which the bank holds as counterpart to its total reserves, after deduction of corporate tax. in 2015 total dividends (paid on 22 may 2015) amounted to €108.69 per share after withholding tax. the current dividend yield is 3.5 per cent. 4.2.2 greece the greek central bank (official english name: “bank of greece”) has an issued share capital amounting to €111 243 362.00, represented by 19 864 886 shares. the nominal value of each share is €5.60. by law, the greek government and public enterprises may not hold more than 35 per cent of the nominal issued share capital of the bank. shares are held by companies and private individuals. every shareholder who owns at least 75 shares and has been registered as a shareholder for not less than three months prior to the general meeting of shareholders can vote at the meeting, on condition that the shareholder has greek citizenship or is a company registered in greece, which is also a condition for shareholding. the bank pays an annual first dividend equal to 12 per cent of the nominal value of the shares, amounting to €0.67 per share per annum, should profits permit. a supplementary second dividend is determined annually by the general council (board) of the bank, which is dependent on the profitability of the bank. total dividends per share amounted to only €0.49728 per share before withholding tax of 10 per cent in 2014. this implies that the bank could not even afford to pay the first dividend of €0.67 that year. the shares trade on the athens exchange and the share price was about €8.96 at the end of august 2015. this is a substantial decline from its level of €30.67 at the beginning of 2011. the current dividend yield is 5.6 per cent before withholding tax. 4.2.3 italy the italian central bank (official english name: “bank of italy”) previously had an issued share capital amounting to €156 000, represented by 300 000 shares. the nominal value of each share was €0.52. this changed in 2014, when the capital of the bank was revalued to €7.5 billion, which is a more accurate reflection of the underlying value of the capital and reserves of the bank (investor active, 2014). this revaluation resulted in an improvement of the capital position of italian banks holding shares in the central bank. the main financial beneficiaries of the revaluation were the two banks with the largest shareholding in the central bank, namely intesa sanpaolo and unicredit crd.mi (investor active, 2014). from an overall perspective, however, the main beneficiaries were banca monte dei paschi siena4 and banca carige, two banks with a shareholding in the central bank experiencing financial difficulties at the time that could report an increase in their asset holdings owing to the revaluation5 (investor active, 2014). this improved their liquidity and solvency positions. the ownership of the shares is governed by law and the shares may be transferred only with the prior consent of the board of directors. all shares are held by italian banks and similar financial institutions, and the bank has no other companies or private individuals as shareholders. shareholders who have held 100 or more shares for at least three months before a meeting of shareholders have the right to attend shareholders’ meetings. shareholders entitled to attend have one vote for every 100 shares held up to 500 shares, and one vote for every 500 shares held over and above the first 500, but voting per shareholder, irrespective of the number of shares held, is limited to a maximum of 50 votes. 156 sajems ns 19 (2016) no 1:150-159 the bank pays an annual first dividend equal to 6 per cent of the nominal value of the shares, which amounts to €9 360 per annum, a second dividend of 4 per cent per annum of the nominal value of the shares, amounting to €6 240 per annum, and a third “supplementary” annual dividend not exceeding 4 per cent of the amount of the reserves. the shares do not trade freely. no current or latest price or dividend yield can therefore be determined. 4.2.4 japan the japanese central bank (official english name: “bank of japan”) has an issued share capital amounting to ¥100 million, represented by 1 million shares. the nominal value of each share is ¥100. the government owns 55 per cent of the shares. the shares trade on the jasdaq securities exchange. companies and private individuals may hold shares in the bank. the bank does not hold an annual general meeting of shareholders. the bank pays an annual dividend not exceeding 5 per cent of the nominal issue value of the shares, amounting to ¥5 per share per annum. this dividend is prescribed by legislation. at a price of ¥48 000 per share at the end of august 2015, the effective yield is 0.01 per cent per annum. this yield should be viewed against very low yields on fixed-interest financial instruments currently prevailing in japan, as well as periods of deflation in that country. 4.2.5 south africa the south african central bank (official english name: “south african reserve bank”) has an issued share capital amounting to r2 million, represented by 2 million shares. the nominal value of each share is r1.00. the south african government holds no shares in the bank, but can buy shares within the legal prescriptions (e.g. up to a maximum of 10 000 shares) should it wish to do so. the shares trade on an over-the-counter market and the price was r1.55 per share at the end of august 2015. companies (including banks) and private individuals may hold shares in the bank. every shareholder who owns at least 200 shares and has been registered as a shareholder for not less than six months prior to the ordinary general meeting of shareholders can vote at the meeting, on condition that the shareholder is ordinarily resident in south africa. no shareholder may hold more than 10 000 shares in the bank. shareholders have one vote for every 50 shares, with a maximum of 200 votes. the voting rights of company groups with board or ownership control, and of family groups, are limited to 200 votes, irrespective of the number of shares they hold over 10 000. the bank pays an annual dividend of not more than 10 per cent of the nominal value of the shares, amounting to r0.10 per share per annum. this dividend is prescribed by legislation and is subject to dividend withholding tax of 15 per cent (hence a net dividend of 8.5 cents per annum). at the prevailing share price, the dividend amounted to a return of 6.5 per cent per annum before dividend withholding tax. 4.2.6 switzerland the swiss central bank (official english name: “swiss national bank”) has an issued share capital amounting to chƒ25 million, represented by 100 000 shares with a nominal value of chƒ250 each. about 52 per cent of the shares are owned by cantons and cantonal banks. the remaining shares are mostly owned by other companies and private individuals. the confederate government does not hold any shares. registration with voting rights is limited to 100 shares per shareholder. this limitation does not apply to swiss public-law corporations and institutions or to cantonal banks pursuant to section 3a of the federal banking act of 8 november 1934. the annual dividend may not exceed 6 per cent of the nominal value of the share capital. the shares trade on the six swiss exchange and the price was chƒ1 117 per share at the end of august 2015. the effective yield was therefore 1.3 per cent per annum, which should be viewed against the backdrop of prevailing low yields on fixed-interest instruments in switzerland. the bank convenes an annual general meeting of shareholders, and any shareholder listed in the share register is eligible to attend the meeting. sajems ns 19 (2016) no 1:150-159 157 4.2.7 turkey the turkish central bank (official english name: “central bank of the republic of turkey”) has an issued share capital amounting to tl25 000, represented by 250 000 shares. the shares have a nominal value of tl0.012 each. the bank has four classes of shares. class a shares are held exclusively by the turkish treasury and represent 51 per cent of the capital. class b shares are held by national banks operating in turkey. a maximum of 15 000 shares can be held as class c shares by banks other than national banks holding shares as class b shareholders. class d shares are held by turkish commercial institutions and companies, and private individuals of turkish nationality. shareholding is therefore limited to turkish citizens and entities. at the bank’s annual general meeting of shareholders, shareholders have one vote for every 10 shares held. the bank pays an annual first dividend of 6 per cent of the nominal value of its share capital to shareholders, and a second dividend not exceeding 6 per cent per annum of the nominal value of the share capital can also be paid to shareholders, subject to annual approval by the general assembly (general meeting of shareholders) of the central bank. as a result, the maximum annual profit distribution to shareholders is limited to 12 per cent of the nominal value of share capital. this amounts to tl0.12 per share per annum. the shares in the turkish central bank cannot be transferred freely between shareholders. a dividend yield for the share can therefore not be calculated. table 1 below summarises the salient features of the central banks discussed in this section, with the exception of the 12 federal reserve banks, as the shareholding of commercial banks in these banks comprises a reserve holding, rather than a shareholding in the true sense of the word as is the case with other central banks discussed in the section. the analysis and the summary in table 1 clearly show that shareholding in central banks has different meanings in different jurisdictions. in particular, there are considerable differences in the dividend policies of these central banks. table 1 summary of the salient features of central banks with shareholders belgium greece italy japan south africa switzerland turkey official government shareholding yes no no yes no yes* yes official shareholding by banks no no yes no no yes yes general shareholding yes yes no yes yes yes yes general ownership limitations (e.g. citizens only)** no yes yes no no no yes annual meeting of shareholders yes yes yes no yes yes yes voting limitations yes yes yes n/a yes yes yes dividend payment (profits permitting) maximum 6% of nominal value of shares as the first dividend a second dividend, calculated as 50% of the net proceeds after tax from the portfolio of assets which the bank holds as counterpart to its total reserves maximum 12% of nominal value of shares as a first dividend a supplementary second dividend is annually determined by the general council (board) of the bank maximum 6% of nominal value of shares as a first dividend 4% of nominal value of shares as a second dividend a third “supplementary” dividend not exceeding 4% of the amount of the reserves maximum 5% of paid-up capital maximum 10% of issue value of shares maximum 6% of the share capital maximum 6% of nominal value of shares as the first dividend a second dividend of a maximum of 6% of the nominal value of shares approved annually by the general assembly (general meeting) of the bank * cantonal governments, rather than central government. ** some central banks (e.g. the south african reserve bank) limit the number of shares that shareholders may own. sources: rossouw & breytenbach, 2011a and used in rossouw & breytenbach, 2011b; own additional research. 158 sajems ns 19 (2016) no 1:150-159 5 conclusions this paper draws attention to an eclectic group of institutions about which very little has been published, namely central banks with private shareholders. a number of conclusions can be drawn from this paper. the organisational and governance structures of central banks have received very little attention in the literature on monetary policy and central banking. more attention should be focused on this area of research, as central banks can draw on one another’s experiences in this regard. only a small number of central banks have private shareholders, and an even smaller number (belgium, greece, japan, south africa, switzerland and turkey) allow shareholding by the general public. an even smaller group (belgium, japan, south africa and switzerland) allows its shares to be held by foreigners, but shareholder rights are often limited by the number of shares an individual can hold, and/or by limitations on voting rights. the large differences in the approach of central banks with shareholders to the payment of dividends are noteworthy. dividend policies range from a fixed dividend prescribed by law to a large degree of discretion in the payment of dividends. from an investment perspective, only the central banks of belgium and greece (albeit only for residents in the latter instance) can be considered. these are the only central banks where dividends are not capped or otherwise limited, but are linked to the profitability of the central bank. however, the central bank of greece could not sustain its dividend payments after the financial crisis of 2008. the austrian central bank is the most recent example of nationalisation of a central bank. this nationalisation, the first in some 35 years, received surprisingly little attention and is an area for further research. likewise, the “wave” of central bank nationalisation in 1974 and 1975 is an area for further research. there is no single answer to the matter considered in this paper, namely whether private shareholding still has a role to play in the structures of these central banks, but a number of conclusions can be drawn. firstly, from an investment-return perspective, only the central banks of belgium and greece (albeit only for residents in the latter instance) can be considered a growth investment by investors. secondly, in the case of italy, the shareholding in the central bank has been used as an instrument to recapitalise ailing commercial banks. this is the only such example of emergency liquidity or solvability assistance to ailing banks, but this approach can be replicated (if needed) by the 12 federal reserve banks in the us, as these institutions only have banks as shareholders, as is the case in italy. thirdly, the shareholding structure of these banks contributes to improved governance in the case of the central banks of belgium, greece, italy, south africa, switzerland and turkey. this is not the case with the bank of japan and the 12 federal reserve banks in the us, as these institutions do not have ordinary general meetings for shareholders where the shareholders can call the management of the central bank to account. lastly, a central theme that emerges from the analysis of these central banks is that their shareholders play no role in the formulation and implementation of monetary policy. moreover, no evidence can be found that central banks with shareholders in any way outperform central banks without shareholders. endnotes 1 this section draws on rossouw and breytenbach (2011a). 2 some of these institutions were initially known as banks of issue, that is, institutions entrusted by the government with the monopoly power to issue banknotes. 3 as is shown below, the central bank of pakistan was subsequently nationalised. 4 banca monte dei paschi siena was founded in 1472 and is the oldest bank in the world. 5 this is an interesting way of providing emergency liquidity assistance (also known as lender-of-last resort assistance) for troubled banks. sajems ns 19 (2016) no 1:150-159 159 acknowledgements the author wishes to acknowledge economic research south africa (ersa) for financial assistance with this paper. references annual reports of the central banks of austria, belgium, greece, italy, japan, south africa, switzerland and turkey (various copies of different years). archer, d. & moser-boehm, p. 2013. central bank finances. bis papers no 71. basel: bank for international settlements. de kock, m.h. 1939. central banking. london: p s king & son. de kock, m.h. 1956. central banking. (3rd ed.) london: staples press. de kock, m.h. 1974. central banking. (4th ed.) london: staples press. discussions with mr gerhard hohäuser of the austrian national bank. discussions with mr paul moser-boehm of the bank for international settlements. en publishing. [s.a.] available at: http://www.enpublishing.co.uk [accessed february 2014]. investor active. 2014. italy parliament approves revaluation of central bank’s capital. available at: http://www.iii.co.uk/news-opinion/reuters [accessed february 2014]. lybek, t. & morris, j. 2004. central bank governance: a survey of boards and management. imf working paper wp/04/226. washington: international monetary fund. meiring, j.g. 1994. biographical sketches of directors. pretoria: sa reserve bank. national bank of belgium. 2009. corporate report 2009. available at: http://www.nbb.be/pub/01_00_00_00_00/01_00_00_00_00.htm?l=en [accessed february 2014]. oesterreichische nationalbank. 2009. annual report. vienna: oesterreichische nationalbank. reserve bank of new zealand. 2009. the history of the reserve bank of new zealand. wellington: reserve bank of new zealand. rossouw, j. 2004. a brief note on nel and lekalake: monetary transparency in south africa. south african journal of economics, 72(5). rossouw, j. 2010. south african reserve bank: history, functions and institutional structure. (2nd ed.) pretoria: sa reserve bank. rossouw, j. & breytenbach, a. 2011a. identifying central banks with shareholders: a review of available literature. economic history of developing regions, 26 (suppl 1). rossouw, j. & breytenbach, a. 2011b. when private shares meet public interest. central banking, vol xxii:2, november. the federal reserve system. 2005. purposes & functions. washington: board of governors of the federal reserve system. available at: http://www.federalreserve.gov/pf/pf.htm [accessed february 2014]. statute of the bank of greece. statute of the bank of italy. statute of the bank of turkey. statute of the national bank of belgium. united states of america. 1913. federal reserve act. websites of the central banks of austria, belgium, greece, italy, japan, south africa, switzerland and turkey. journal 4.p65 ������������ ��� ���� ��� �������������� ���� ������ ����� �� ���� ������������ ������������ �� ���� � �� ������ � � �� ��� ��� ���������� � � ������ ����������� ���� 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'�;; b8� ��> �8%!) �b��&*� +*�*(�� 2 � � ������� �� � �����$ 5�! � � 6� 7e? #��� -�� #��� ���7��dd #� 6� @� � �������? ��7� �,//��� � � �� � � �������������� � � �� � ��� ���� ���� ��� �������� ��������������� ���������� ��� �ab8�1 ������ �!" #�� $ �*�� �8>�� � 4 6����� :��� ����=� �������������� �� �� � ���� ������� %+*� �&���&� �� �*�&) �8%�&�;$ #��!8��*� � � : ���� 7��� � ������ ?��� ������ "������ ���� � ��������� ��� *�����8;;�� $ -�> e8�'� , / :)�!� #*��� 8� -*!�8�*; �!�*!�(" b8� !)� 7���;8�+��! *�1 #�8+8!�8� 8b �+*;; �% ��� �� �8%!) �b��&*� ����3� #����������# $���� �8����+��! #���!�� $ �*�� �8>�� , � :��? �� #��� ����4� ��� ��� �������������� ������� � ��%� � ��� ���� ���� ������������ �� � ��� ���� � ������ #�!+*�$ �8�18�� abstract introduction the dynamics of the baltic dry index data and method findings discussion conclusion acknowledgements references footnotes about the author(s) kurt sartorius school of accounting, university of the witwatersrand, south africa benn sartorius school of public health, university of kwazulu-natal, south africa dino zuccollo westbrooke alternative asset management, south africa citation sartorius, k., sartorius, b. & zuccollo, d., 2018, ‘does the baltic dry index predict economic activity in south africa? a review from 1985 to 2016’, south african journal of economic and management sciences 21(1), a1457. https://doi.org/10.4102/sajems.v21i1.1457 original research does the baltic dry index predict economic activity in south africa? a review from 1985 to 2016 kurt sartorius, benn sartorius, dino zuccollo received: 12 aug. 2015; accepted: 05 oct. 2017; published: 05 apr. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the ability of the baltic dry index to predict economic activity has been evaluated in a number of developed and developing countries. aim: firstly, the article determines the primary factors driving the dynamics of the baltic dry index (bdi) and, secondly, whether the bdi can predict future share price reactions on the johannesburg stock exchange all share index (jse alsi), south africa. setting: this article investigates the dynamics and predictive properties of the bdi in south africa between 1985 and 2016. methods: the article uses a review of a wide range of published data and two time-series data sets to adopt a mixed methods approach. an inductive contents analysis is used to answer the first research question and a combination of a unit root test, correlation analysis and a granger causality model is employed to test the second research question. results: the results show that the bdi price is primarily driven by four underlying constructs that include the supply and demand for dry bulk shipping, as well as risk, cost and logistics management factors. secondly, the results indicate a break in the bdi data set in july 2008 that influences a fundamental change in its relationship with the jse alsi index. in the pre-break period (1985 to 2008), the bdi is positively correlated with the alsi (0.837, α = 0.05) before sharply diverging in the second period from august 2008 to 2016. in the first period, the bdi showed an optimal lag period of 6 months as a predictor of the alsi index, but this predictive ability ceases after july 2008. the article makes a two-part contribution. firstly, it demonstrates that the bdi is a useful predictor of future economic activity in an african developing country. secondly, the bdi can be incorporated in government and industry sector planning models as a variable to assess future gross domestic product trends. conclusion: the study confirms that the bdi is only a reliable indicator of future economic activity when the supply of shipping capacity is well matched with the demand. introduction six billion tonnes of sea freight were transported in 2010 by 93 000 vessels operating in 25 key shipping routes (bowden et al. 2010). approximately 40% of sea freight consists of dry bulk cargo.1 the demand versus supply of dry bulk shipping capacity is tracked by the baltic dry index (bdi)2 (geman & smith 2012), which is developed from data obtained from an international panel of ship brokers. the bdi index has changed considerably between 1985 and 2016 (see figure 1). from its inception in 1985, the bdi demonstrated a steady increase until 2008/2009 and then declined sharply until 2016. simultaneously, the johannesburg stock exchange all share index (jse alsi) index increased until 2009/2010; however, it did not track the bdi trend after 2009. the bdi index, based on the demand for dry bulk cargo, has widely been proposed as a proxy for future economic activity (bakshi, panayotov & skoulakis 2011; koskinen & hilmola 2005). figure 1: baltic dry index price chart, 1985–2016. given the changes in the trends of these two indexes, the question needs to be posed as to whether the bdi has lost its predictive properties with respect to the alsi index as a measure of economic activity in south africa. the bdi has been used as an economic indicator because it reflects the supply and demand for sea freight that translates into economic activity as reflected by stock market value or growth in gross domestic product (gdp) (apergis & payne 2013; baltyn 2016). the demand, for instance, for raw commodities like iron ore, is intuitively expected to translate into increasing the gdp (manufacturing output) of the importing country. changes therefore in the bdi have been assumed to reflect changes in future global economic activity (alizadeh & talley 2011; blanchflower 2010; lin & sim 2013). the bdi’s reliability as a predictor has been enhanced by the proposal that its calculation is devoid of speculative activity (apergis & payne 2013; koskinen & hilmola 2005). in recent times, the bdi has fallen to an all-time low, reflecting the shrinkage of global gdp because of the cooling of large manufacturing economies like china. simultaneously, excess dry bulk capacity was created as a result of the over-optimistic commissioning of new vessels during the 2005–2009 peak in dry bulk demand (hyung-geun 2011). in south africa, the importance of dry bulk shipping is significant. in 2010, for instance, 132.7 million tonnes of dry bulk cargo were exported, making up 87% of the country’s total seaward exports for the year (sars 2013). the objective of the article is to investigate the dynamics of the bdi, as well as test whether it is a useful predictor of economic activity in a south african context. two primary problems are investigated. firstly, what the fundamental dynamics of the bdi and their underlying constructs are and, secondly, whether the bdi predicts share price reactions on the alsi index of the jse. the article is essentially an exploratory study and much of the data used to test the first research question are located outside of peer review journals. the remainder of the article is organised as follows: ‘the dynamics of the baltic dry index’ section establishes the dynamics of the bdi in order to hypothesise the relationship tested in the second research question. ‘data and method’ section outlines the data and method to test the second research question. the ‘findings’ section presents the results and the ‘discussion’ section concludes the study, as well as makes recommendations for future research. the dynamics of the baltic dry index the overall bdi is disaggregated into four sub-indexes of cargo, namely the capesize, panamax, supramax and handysize indexes (geman & smith 2012). these sub-indexes reflect the cost of different shipping capacity based on the dead weight in tonnes of cargo. a synthesis of the available literature identifies a number of fundamental factors that drive the bdi price. global commodity demand versus shipping supply the most fundamental driver of the bdi is the demand for commodities, which is influenced by factors such as global gdp, agricultural production and global energy demand (see figure 2). the bulk shipping market is seasonal, cyclical and highly volatile (zeng & qu 2014). because of the non-stationary and non-linear nature of price series and the complexity of influencing factors, it is difficult to analyse the fluctuations in the bulk shipping market. the relationship between gdp and the bdi is explained by assuming raw commodities such as corn, cocoa, coffee, primary metals and coal form the primary ingredients in industries such as the food, manufacturing and energy sectors (feyrer 2009a, 2009b; lin & sim 2013; mcphail, du & muhammad 2012). regional indexes like the asian steel index have a major influence on the bdi (chou et al. 2015) and individual changes in the larger economies like china that now accounts for 50% of iron ore imports (lin & sim 2013). the bdi price, for instance, decreased 38% in 2 months following the decision by the chinese government to ban new investment in industries such as steel, automobiles and real estate (hyung-geun 2011). figure 2: growth rate of global exports plotted against global gross domestic product growth rates. the inelasticity of supply has a leverage effect on the bdi and supply inelasticity is a function of long lead times involved in new ship acquisitions that create a fixed tonne-mile capacity in the short term (bakshi et al. 2011; devanney 2010). the ability to change supply capacity is restricted to a 2–3-year period compared to the short-term fluctuations in the demand for cargo carriage (koskinen & hilmola 2005). other key baltic dry index price drivers other factors influencing the bdi index, include the lapse between the date the sea freight is contracted for and the date it is required (laycan period)3 and the speculation effects by ship brokers. in addition, older vessels are more expensive to operate and this can also influence their respective hire rates (alizadeh & talley 2011). bunker prices, closely linked to the price of crude oil, account for 25% – 33% of the total cost of operating a transport vessel. the volatility of crude oil prices, in turn, has an influence on the bdi price (geman & smith 2012; notteboom 2012:#967). the existence of bottlenecks (choke points) in global shipping routes has also been identified as a key factor driving the bdi price (feyrer 2009a, fu et al. 2010). nearly half of the world’s oil tankers pass through a few narrow sea corridors, which are often subject to piracy, conflict, severe winters and accidents because of high traffic volumes. in recent times, the incidence of piracy in areas like the somali coastline, the gulf of aden and the suez canal, has emphasised the risk (cost) associated with these choke points. the risk of piracy is illustrated in 2010 by 500 hostage incidents involving seafarers from more than 18 countries (bowden et al. 2010). although difficult to quantify, bowden estimates that piracy costs the global economy between $7 and $12 billion per year. for some cargo operators, the increased risk associated with travel in these regions has rendered travel through the gulf of aden and the suez canal unfeasible. as a result, many cargo operators have decided to re-route via the cape of good hope, which increases the distance by 3500 miles. the length and severity of winters along key shipping routes, coupled with seasonal pressures such as reduced global crop yields during winter months, have been identified as further bdi price drivers. these pressures are especially significant along the choke points between january and march each year because of variations in factors like the extent of winter ice in the baltic sea (koslowski & loewe 1994). other factors influencing the bdi show that freight rates possess a 2.25–4.5-year cyclical tendency; it is supported by the fact that both the recessions of the 1970s and of the 1990s lasted approximately 5 years (goulielmos & psifia 2006). the mean reverting nature of freight rates, discussed above, appears to add credence to this argument (tvedt 2003). if it is understood that freight rates tend to diverge from their mean value, and then revert to that value at some point in the future, it can be argued that this property is in itself a form of cyclicality, provided that the length of the reversion property is constant. in the case of freight rates, this is proved true through the findings of goulielmos and psifia (2006). the baltic dry index as a predictor of economic activity changes in international shipping freight rates can predict international stock market returns (alizadeh & muradoglu 2014). a number of studies demonstrate that the bdi has a lagged relationship with share prices and commodities (ouyang, wei & zhang 2009). empirical evidence suggests that this lag period appears to have varied between 1 and 3 months (bakshi et al. 2011; oomen 2012; ouyang et al. 2009). one of these studies, for example, that incorporated 23 developed and 25 undeveloped nations, showed a 1-month lag period between the bdi and global stock prices (oomen 2012). furthermore, it was found that the bdi was most effective as a predictor for global stock returns in the technology, telecommunications, consumer services and industrial sectors. in terms of the disaggregated bdi index, the panamax appeared to be the best predictor of economic activity (bakshi et al. 2011; oomen 2012). other research also demonstrated a significant relationship between the bdi and the msci metals and mining index (kärrlander & lanneström 2010) and that steel and corn prices show the strongest correlation to the bdi growth rate (mariana 2008). data and method the article adopts a mixed method approach to test the research questions. an inductive approach, incorporating contents analysis, is employed to test the first research question. the second research question tests whether a causal relationship exists between two sets of time-series data, namely whether the bdi index influences the jse alsi index. the data the data for the first research question largely consisted of narrative that was accessed from journal articles, maritime reports, financial and media commentary, as well as internet website articles, other reports and reviews. the data for the second question included two financial time-series data sets, namely the bdi and alsi data indexes. data from these two indexes were accessed from the reuters and jse websites, respectively, for the period may 1985–april 2016. research question 1 the first research question was to determine the fundamental dynamics of the bdi. contents analysis incorporating axial and selective coding, was used to analyse the data. firstly, axial analysis resulted in developing themes influencing the bdi. selective coding then interrelated some of these and was used to develop an aggregated construct. because of the multiplicity of factors influencing the dynamics of bdi, a qualitative approach, using an inductive lens, was thought to be the most suitable method (cresswell & plano clark 2011; ryan, scapens & theobald 2002). research question 2 the zivot–andrews unit root test was first employed to identify the break in the bdi data (zivot & andrews 2002). this endogenous structural break test incorporates the full sample and uses a range of different dummy variables for each potential break date. the actual break is selected where the t-statistic from the augmented dickey–fuller (adf) test of unit root is at its most negative value. furthermore, the order of integration was calculated using the adf unit root test (dickey & fuller 1979) with and without first differencing. the adf test tests the null hypothesis that a unit root is present in a given time-series. the alternative hypothesis is usually stationarity or trend stationarity. the adf test statistic is a negative number and the more negative it is, the stronger the rejection of the hypothesis that there is a unit root at a predefined level of confidence (i.e. usually 95%). the adf test can handle more complex models than the standard dickey–fuller test, and it is more powerful (harris 1992). correlation analysis for the two periods was then briefly inspected using spearman’s rank correlation (based on fisher’s transformation) between the two data sets. we employed the johansen–juselius test to ascertain whether the alsi and bdi indexes were co-integrated. the johansen–juselius test is a multivariate generalisation of the adf test and is an examination of linear combinations of variables for unit roots. the johansen–juselius test and estimation approach makes it possible to estimate all co-integrating vectors when there are more than two variables. if there are two variables (as in our case) each with unit roots, there can be at most one co-integrating vector (johansen & juselius 1990). a grainger causality model was constructed for both periods (engle & granger 1987) using different lag periods. we tested for the absence of granger causality by estimating the following var model: then, testing h0: b1 = b2 = ….. = bp = 0, against ha: ‘not h0’, is a test that x does not granger-cause y. similarly, testing h0: d1 = d2 = ….. = dp = 0, against ha: ‘not h0’, is a test that y does not granger-cause x. the properties of the model were tested at a range of lag periods (1–9 months). the optimum lag period was confirmed by the akaike information criterion (aic) (akaike 1977). finally, a range of diagnostics to ensure the validity of the grainger causality model included the wald test for granger non-causality, where rejection of the null hypothesis implies causality. furthermore, we employed the vector error-correction model (vecm) (johansen 1988) to estimate the adjusted parameters (including an alpha to obtain the short-run adjustment parameters) for both alsi and bdi to ascertain which one potentially responded more to shock or disequilibria. shortand long-run equilibria between alsi and bdi were assessed using the vecm (engle & granger 1987) (second stage) with following specification: where d(alsi) is the first difference of alsi, d(bdi) is the first difference of bdi, εt−1 is the one-period lag of residual obtained from the ols estimation**, b2 is the short-run equilibrium coefficient and b3 is the coefficient for the one-period lag-correction term or residual from the first stage model and relates to the restoration of the system back to equilibrium, that is, long-run equilibrium and v is the error term. **ordinary least squares (ols)-level model (first stage): where alsi is the all share index value, bdi is the baltic dry index value, t is the month, εt is the error term (residual difference between observed and fitted values), b0 is the intercept and b1 is the slope coefficient for unlagged bdi versus alsi. findings research question 1 axial coding of the contents documents demonstrates a number of key themes that were demonstrated in all the literature (see figure 3). these themes include the demand for shipping, the fixed nature of shipping supply, the laycan period, vessel size and age, bunker prices, the effect of piracy and global winters. other factors include the number of shipping routes (25), the number of vessels, port costs, administration and a cyclical component. selective coding was used to aggregate the axial codes into four major constructs. this included a demand and supply function that largely incorporated global demand for shipping versus shipping capacity. figure 3: factors influencing the baltic dry index and its resultant impact on economic activity. the other axial codes included a risk management and speculative component (laycan period, broker speculation, piracy, climatic conditions and a cyclical component), a logistics construct (number of vessels, number of routes, choke points and climatic conditions) and a cost management aspect (cost and maintenance of vessels, bunker oil prices and docking fees). the bdi, which is disaggregated into four major components (see figure 3), is thus influenced by a complex set of variables that make it difficult to model empirically. research question 2 the zivot–andrews unit root test was first employed to identify the break in the bdi data (zivot & andrews 2002) to effectively create two data sets. correlation analysis was used to illustrate the association in both periods, before confirming the first data sets were co-integrated using the johansen–juselius test for co-integration. an optimal granger causality model was then developed and tested. lastly, a vecm was developed to assess the magnitude of the coefficients and also ascertain which variable was leading and which was lagging. descriptive analysis and unit root analysis figure 4 depicts the relationship between monthly bdi price and jse alsi price movements for the period 1985–april 2016. an application of the zivot–andrews test indicates a structural break in the bdi series, occurred in july 2008 (minimum t-statistic was −5.641: critical values: 1%: −5.57, 5%: −5.08, 10%: −4.82). from 1985 to july 2008, the bdi had a steady upward trend that appeared consistent with the jse alsi trend. after july 2008, the bdi declines markedly, while the alsi index maintains its upward trend to 2016. figure 4: baltic dry index and all share index trends (including identified break). the mackinnon approximate p-values from the adf test for unit without differencing for both alsi and bdi with a trend component were 0.852 and 0.218, respectively (see table 1). as a trend in levels becomes a constant in first differences, no trend was included for the first differenced dickey–fuller tests but drift assumed. both null hypotheses are rejected for the differenced series (p < 0.01 for both). table 1: augmented dickey–fuller test results for level and first difference for both all share index and baltic dry index time-series, 1985–2016. as both raw series are not stationary but the first difference is stationary and invertible as suggested by the adf test results, this suggests that both times series are (1). correlation analysis and co-integration in the first period up to june 2008, the correlation = 0.836 on 138 observations (95% confidence interval (ci): 0.797–0.868), as illustrated in figure 5. it is clear in this period that both the bdi and the alsi have increased, showing that they were positively correlated (red line) with a linear trend between the two indexes (green line) to reflect both a higher bdi price as well as increased share prices. figure 5: scatterplot with fit lines and marginal boxplots showing correlation between all share index and baltic dry index pre-break, may 1985–june 2008. in the second period (july 2008–april 2016), we observed a negative correlation of −0.677 on (95% ci: 0.774 to −0.550) clearly illustrating the downward turn in the bdi index, while the alsi continued to increase. prior to the break in 2008, the first hypothesis for the johansen–juselius test, r = 0, which tests for the presence of co-integration, had a test statistic of 23.21 (which exceeded the 17.95 critical cut-off at 5% level and was close to the 1% critical value of 23.52), that is, p < 0.05, and thus suggested that we have evidence to reject the null hypothesis of no co-integration, that is, the two series (alsi and bdi) were co-integrated prior to the break. we observed a similar finding post the identified structural break in 2008, with a test statistic of 23.21 for r = 0 (which exceeded the 23.52 critical cut-off at 1% level), that is, p < 0.01, and thus suggested that we have strong evidence to reject the null hypothesis of no co-integration, that is, the two series (alsi and bdi) were also co-integrated post-break. granger causality the results of the granger causality test pre-break (january 1985–june 2008) indicated a p-value of 0.001), and thus we rejected the null hypothesis of no granger causality (table 2). this indicates that model 2 (alsi ~ lags(alsi, 1:6), i.e. without bdi as a causal covariate) is too restrictive as compared with model 1 (model 1: alsi ~ lags(alsi, 1:6) + lags(bdi, 1:6), i.e. with bdi included as a covariate). this relationship was no longer significant post-break (p = 0.246), that is, for the post-break period, we observed an inverse and non-linear relationship between bdi and alsi. table 2: grander causality test results for all share index versus baltic dry index for the full period and preand post-break, 1985–2016. vector error-correction model the adjusted parameter estimates for alsi and bdi from the vecm model suggest that alsi may respond more if there is change or shock in the system compared to bdi [alpha coefficient (α) = 0.0032 (p = 0.017) and α = 0.0016 (p = 0.025)], respectively. however, the overlap of the confidence intervals (cis) suggests that these alphas are not significantly different (α 95% cis of 0.0006–0.0057 and 0.0002–0.003, respectively). leading and lagging variable the coefficient on the error-correction term (e^t−1) is highly significant for alsi (p < 0.001), suggesting that changes in bdi do affect alsi (table 3). furthermore, the error-correction coefficient in the bdi equation is not statistically significant (p = 0.862), suggesting that changes in alsi do not influence bdi. table 3: vector error-correction model results for the pre-break period, may 1985–june 2008. the coefficients of d(bdi) and one-period lag error-correction term (ut−1) represent the equilibrium position in the short and long runs, respectively (table 4). the coefficient b3 is positive, indicating that there is positive relationship between d(alsi) and d(bdi) as expected based on the previous results. a one unit change in difference bdi series results in a 0.55 shift in the differenced value of the alsi (p < 0.0001). table 4: results of error-correction model using first difference for all share index and baltic dry index for estimation of shortand long-run disequilibrium correction. short-run equilibrium the estimated value of b3 (short-run coefficient which represents the short-run equilibrium) is 0.55 and is statistically highly significant (table 4). in brief, it indicates the rate at which the previous period disequilibrium of the system is being corrected. thus, the value of 0.55 suggests that the system corrects its previous period disequilibrium at a speed of 55.0% between variables alsi and bdi. long-run equilibrium the coefficient of b4 was significant and is significant at 5% level (table 4). this suggests that the system corrects its previous period disequilibrium at a speed of 1.6% monthly, that is, monthly correction for reaching long-run equilibrium steady state. discussion this section discusses the dynamics of the bdi and its underlying constructs before examining the predictive properties of this index in a south african context. the dynamics of the baltic dry index the findings, based on an inductive review of a wide range of data, suggest that four key constructs influenced the bdi price between 1985 and 2009. the validity of the themes (axial codes) in our results are underpinned by a wide range of literature that suggests that the bdi is influenced by the inelasticity of shipping supply volume (koskinen & hilmola 2005), global commodity demand (oomen 2012), country-level effects like the ‘chinese factor’ (hyung-geun 2011) and the contract details and speculation effect (laycan period) between ship owners and charterers (alizadeh & talley 2011). other factors included costs such as bunker prices, the maintenance of vessels and other freight costs (notteboom & vernimmen 2009), and choke points in global shipping routes because of issues like weather (the baltic winter) and the effects of piracy (fu et al. 2010). aggregating these themes, this article proposes that they are better understood in terms of four basic constructs, namely supply and demand of dry bulk shipping, and a combination of risk, cost and logistics management factors. the bdi is currently at an all-time low. recent speculation indicates that the dynamics of the bdi have changed because of an oversupply of shipping capacity. increased demand for dry bulk cargo is therefore unlikely to be reflected in an increase in the bdi in the short term because of this excess capacity, which was commissioned when the bdi was at a peak in 2009/2010. a question therefore exists as to whether the historic dynamics of the bdi will resume over the longer term as supply and capacity are eventually matched. the baltic dry index as a predictor of the all share index periods of significant convergence or divergence the results clearly demonstrate a fundamental difference between 1985–july 2008 compared to the ensuing divergence until 2016. in the first period, the hypothesised predictive power of the bdi appears to hold true and the relationship between the bdi and the alsi exhibits a period of significant convergence. this positive association is supported by other studies that show co-integration, high levels of correlation and significant causality between the bdi and share price indexes in both developed and developing countries (apergis & payne 2013; bakshi et al. 2011; baltyn 2016; lin & sim 2013; oomen 2012). the post-break relationship between the bdi and the alsi in the period 2008–2016 illustrates negative correlation (−0.677), namely that an increase in the alsi index was associated with a decrease in the bdi. although this negative correlation is significant (α = 0.05), it represents a medium-term anomaly that is caused by having more ships than cargoes and the recognition that the bdi index has both supply and demand components (worstall 2015). in this period, the supply of shipping capacity doubled, while global gdp and exports cooled. in the period 2009–2016, south africa’s dry bulk trade growth of iron ore, coal, agricultural commodities and steel actually increased. this would explain why the alsi index increased at the same time as the bdi decreased. it could be expected, however, that a normal positive relationship would re-assert itself in the future when shipping capacity for dry bulk is again more evenly matched with demand. optimal lag period the optimum pre-break bdi lag period, which maximises the significance of granger causality between the bdi and alsi, was 6 months. this lag is considerably longer than the findings of bakshi et al. (2011), as well as those of oomen (2012), who both conclude a lag period of between 1 and 3 months, maximise the correlation of these two data sets. these studies were based on a relationship between the bdi and share price indexes in both developed and developing countries. the longer lag period in our results needs to be examined further and a question remains as to how a commodities-based economy like south africa’s influences this lag period. in this regard, a developing country like south africa has primarily relied on the export of minerals. conversely, developed countries import the same commodities as ingredients in a range of industry sectors. according to our results, a possible explanation for the difference in the lag period is that different economic sectors translate a bdi-related transaction into shareholder wealth in different time frames. limitations the exploratory nature of the article is acknowledged and our findings should be subjected to further rigorous empirical investigation to generalise our conclusions. firstly, the causal relationship between the bdi and the alsi for the period 1985–2008 should be disaggregated to test the relationship of the bdi with specific industry sectors on the jse rather than the aggregated alsi index. the data exist therefore to more acutely test a range of relationships between components of the bdi and different industry sectors in south africa, as well as other developing countries, in order to understand the role of the bdi when (presumably) the oversupply of shipping capacity corrects itself over time. in the shorter term, the dynamics of the bdi need to be re-assessed in order to understand the implications of the relationship between global economic activity and the bdi. the data exist, for example, to determine freight volumes as a proxy, while the bdi remains understated because of spare capacity. conclusion this article examined two key questions that included evaluating the dynamics of the bdi and whether the bdi was a predictor of economic activity. firstly, the bdi price is an economic indicator that is influenced by four primary constructs that include supply and demand, as well as risk, cost and logistics management components. these constructs are underpinned by the global demand for raw commodities versus supply of shipping capacity, the laycan period, broker speculation, piracy, a cyclical component (risks) bunker prices, maintenance (costs) and choke points, shipping routes, the volume of shipping and climatic conditions (logistics). secondly, the results indicate that for the bdi to act as a proxy for future economic growth in south africa, the supply of shipping capacity must be matched with the demand for sea freight. in the first period, namely, 1985–2008, both shipping capacity and demand had a steady upward trend. the results show significant positive correlation between the two variables and the grainger causality model demonstrated that changes in the bdi influence changes in the alsi in the pre-break period. the bdi in this period showed a positive lagged (6 months) causal relationship with the alsi. in the period 2009–2016, however, global shipping capacity doubled while demand cooled, precipitating a sharp drop in the bdi. at the same time, however, the alsi index increased, thus reflecting negative correlation with the bdi. although the data sets are negatively correlated in the second period, it is assumed to be a short-term anomaly that will correct itself as demand catches up with supply. future research could further investigate the optimal lag period between the bdi and alsi sectors. our article acknowledges that the granger causality model was developed purely to show a causal relationship between two aggregated time-series data sets that should ideally be disaggregated into their components for sharper comparison. in this regard, our intention was to adopt a broad exploratory approach, and thus, we caution against 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february, p. 1. zeng, q. & qu, c., 2014, ‘an approach for baltic dry index analysis based on empirical mode decomposition’, maritime policy & management 41, 224–240. https://doi.org/10.1080/03088839.2013.839512 zivot, e. & andrews, d.w.k., 2002, ‘further evidence on the great crash, the oil-price shock, and the unit-root hypothesis’, journal of business & economic statistics 20, 25–44. https://doi.org/10.1198/073500102753410372 footnotes 1. dry bulk cargo is dominated by five main commodities: iron ore, coal, phosphate, grain and alumina (oomen 2012). 2. the baltic dry index is the successor to the baltic freight index and was brought into operation for the first time on 01 november 1999. 3. the laycan period is jargon-specific to the shipping industry (alizadeh & talley 2010) and denotes the period of time between the fixture date and the layday. the fixture date is defined as the date of the conclusion of negotiations between the ship owner and ship charterer. the product of these negotiations is a signed charter contract. the layday is defined as the contractually stipulated date on which the chartered ship must be delivered to the charterer. abstract introduction literature review research methodology quantitative research qualitative research discussion of findings triangulation of quantitative and qualitative research conclusion acknowledgements references about the author(s) rajendra rajaram school of accounting, economics and commerce, university of kwazulu-natal, south africa anesh m. singh school of accounting, economics and commerce, university of kwazulu-natal, south africa citation rajaram, r. & singh, a.m., 2018, ‘competencies for the effective management of legislated business rehabilitations’, south african journal of economic and management sciences 21(1), a1978. https://doi.org/10.4102/sajems.v21i1.1978 original research competencies for the effective management of legislated business rehabilitations rajendra rajaram, anesh m. singh received: 08 june 2017; accepted: 11 oct. 2017; published: 12 apr. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: in 2011 a new companies act (no. 71 of 2008) was implemented in south africa. a feature of this act was the introduction of business rescue legislation. although this legislation was implemented in may 2011, statistics indicate that the success rate for business rescues is approximately only 12%. this low success rate prompted debate relating to the effectiveness, and continued suitability of a legislated business rescue as a mechanism to rehabilitate financially distressed companies. a feature of the business rescue environment in south africa is the lack of knowledge, necessitating more research in the field. aim: due to the importance of the business rescue practitioner in the overall success of a rescue, the research focused on establishing competencies required to be a successful practitioner. setting: the research was undertaken in south africa between 2015 and 2017. methods: a mixed methods research approach was utilised to identify the important competencies of a successful practitioner. a survey was conducted with the membership of the turnaround management association of southern africa. the survey was mailed to 130 members and the response rate was 54%. the survey was complemented by undertaking interviews with 7 of the top 10 business rescue practitioners, according to their number of practitioner appointments. results: the original contribution to knowledge of this study is the identification of a set of competencies that can be utilised to accredit business rescue practitioners and the emphasis on an accounting qualification and effective cash management skills that a successful practitioner must possess. conclusion: the knowledge generated from this research will benefit business rescue practitioners, the financial sector and stakeholders of companies intending to go into a legislated business rehabilitation. introduction financial distress was originally defined by beaver in 1966 as bankruptcy, insolvency, liquidation, a default on loan obligations or the inability to meet dividend payments (1966 in muller, steyn-bruwer & hamman 2012:24). outecheva (2007) undertook an empirical analysis of distress risks and compiled several definitions of financial distress. some of these definitions refer to financial distress as a likelihood of bankruptcy, a default on a debt situation and an intermediate state between solvency and insolvency. based on the definitions by beaver and outecheva, financial distress is characterised by a lack of resources that results either in an involuntary business closure or an attempted restructure. financial distress occurs when a firm’s promises to creditors are broken or are honoured with difficulty. it may result in dismantling and selling the firm’s assets (senbet & wang 2012:7). whilst the liquidation of a business is one of the adverse outcomes of financial distress, many financially distressed firms can be financially rehabilitated. wang and shiu (2014:233) noted that some financially distressed firms will experience a rebirth. this rebirth or resurrection phase is commonly referred to as a turnaround (baird 2014:19). there are many countries that have adopted a legal framework to facilitate the turnaround and continued existence of financially distressed firms. the south african business rescue legislation defines financial distress as a situation in which a company is reasonably unlikely to be able to pay all of its debts as they become payable and due within the immediate ensuing 6 months, or it appears to be reasonably likely that the company will become insolvent within the immediate ensuing 6 months (rsa 2008:128). the main aim of the legislation is to facilitate the rehabilitation or turnaround of a financially distressed company. according to corporate renewal solutions (2012), informal turnarounds have the greatest success due to the informal nature of the process and the fact that it is not subject to legislation. as the process to rehabilitate the distressed company becomes more formal and legal, the situation becomes more inflexible and expensive. according to blazy, martell and nigam (2011:2), a private or informal restructuring is not always a preferred solution, albeit less costly and quicker than the legislative process to rehabilitate business. there are several reasons why stakeholders will sometimes prefer a costlier and formal legislative procedure. these relate to the ‘holdout problem’, when individual creditors will hold out from accepting an agreement in the hope that other creditors will accept an agreement for a proposal. there may also be different objectives between various creditors, leading to the formation of coalitions and conflicts of interest which prevent a common agreement on the rescue of a company. another reason for creditors preferring a formal court approved rehabilitation is the perception that there is a lack of transparency which can only be restored by a court (blazy et al. 2011:6–7). in recent years, there has been an increase in international insolvency systems that adopted formal mechanisms to aid financially distressed companies engaged in reorganisation (pretorius & rosslyn-smith 2014:109). bradstreet (2010:201) highlighted the importance of effectively managing a formal and legislated business rescue. his contention was that the functions and terms of appointment of the practitioner are of utmost importance when assessing the overall merit and success of the business rescue process. the appointment of a strong business rescue practitioner is a key success factor in business rescues (bezuidenhout 2012:25). his research established that the key success factors in a rescue are strong and strategic leadership, a strategic plan, a measureable action plan and a motivated management team. levenstein (2011) concurred with these views by emphasising the vital role of the business rescue practitioner in the success of a business rescue. the assertions about the practitioner’s contributions to the success of the business rescue are supported by international research. for example, research into the finnish restructuring of enterprises act identified management of the restructure, combined with cash generation, as being significantly more important in the successful rescue of a business (collett, pandit & saarikko 2014:134). section 138 of the companies act (no. 71 of 2008) deals with the qualifications of the business rescue practitioner and states that a person may only be appointed as a business rescue practitioner if that person is a member in good standing of a legal, accounting or business management profession accredited by the companies and intellectual property commission (cipc). in addition, a person can only be appointed as a business rescue practitioner if they are not disqualified from acting as a director and are not subject to an order of probation. currently, a business rescue practitioner’s appointment must be approved by the cipc that needs to issue an interim conditional licence for the specific company that has applied for business rescue (terblanche 2014:3). there are no clear criteria or prerequisites in terms of skill or experience for appointing a business rescue practitioner, other than those highlighted in the discussion on section 138 (pretorius 2013a:4). as the authority that regulates the appointment of business rescue practitioners, the cipc urgently needs to adopt a framework for the licensing of business rescue practitioners (pretorius 2013a:24). although the cipc is considering addressing this issue by establishing an accredited competency framework for the licensing of business rescue practitioners, a stipulated time frame has not been provided yet (terblanche 2014:3). given the emphasis on the importance of the management of business rescue and the focus on the business rescue practitioner, it is concerning that the south african regulatory authorities have not established a regulatory authority for the accreditation of business rescue practitioners. the regulatory authority can function on a similar basis to that of the auditing profession which has specific skills and practical experience requirements (pelser 2012:1). the appointment of a regulatory body is especially important in light of some of the complaints about certain business rescue practitioners who lack the skills to successfully rehabilitate a company that experiences financial distress (pretorius 2014:2). such a body could ensure that there is a well-defined set of accreditation criteria to ensure that the practitioner is equal to the task of the stipulated responsibilities. a major oversight in the appointment of business rescue practitioners is the absence of a procedure for their accreditation. an accreditation process will alleviate some of the concerns relating to the competency of business rescue practitioners, the exorbitant fees they charge, the inability to complete the task on time and shortcomings relating to practitioners adhering to the reporting requirements (voller 2011). literature review the lack of a proper accreditation system for business rescue practitioners has resulted in several criticisms of south african business rescue practitioners. as mentioned, these relate to poor quality of work and exorbitant fees charged (pretorius 2013a:2), the inability to complete tasks in a timely manner and a lack of adherence to reporting requirements (voller 2011). the business rescue practitioner has also been cited as a cause for failure to attract post rescue funding. du preez (2012:156), when analysing barriers to post commencement finance for a company undergoing business rescue, highlighted the concern of industry specialists over the inability of the business rescue practitioner to prepare an adequate business rescue plan that will attract funding. according to midanek (2002), successful turnaround managers require ‘war-zone’ experience. in order to turn around a financially distressed business, it is vital for the turnaround manager to have appropriate competencies (obiajunwa 2014:71). baird (2014), when highlighting the importance of a turnaround manager, linked the economic monetary value of a distressed business to the probability of a successful turnaround in the following equation: economic monetary value = probability of successful turnaround * value of the distressed business. the above equation demonstrates the value of appointing a successful business rescue practitioner to a financially distressed business. it illustrates the economic value created when a financially distressed company is successfully rehabilitated. due to the role of the business rescue practitioner in the success of a rescue, it follows that the appointment of a competent practitioner will enhance the monetary value of the distressed business. the appointment of a competent practitioner will be facilitated by the establishment of accreditation criteria. the benefit of establishing an accreditation framework, specifying the competencies of a business rescue practitioner, is that the risk of appointing an unsuitable professional as a practitioner is reduced. a suitably accredited practitioner will contribute towards the survival of a distressed firm, thereby enabling the continued existence of the firm (baird 2014:6). whilst it is concerning that the cipc has failed to establish sound criteria for the accreditation of practitioners in south africa, the difficulty in establishing these accreditation criteria must be acknowledged. the practitioner’s tasks are complex, vaguely stated and involve a wide range of competencies that the average business person does not have (pretorius 2013a:1). it is difficult to determine the optimal competence for a successful business rescue practitioner as it entails various characteristic, educational and experiential traits. white (1959, cited in delmarie de list & winterton 2005:31) is credited for introducing the term competence to describe personality characteristics associated with superior performance and high motivation. further recent research in relation to the effective performance of individuals in the workplace suggests that competencies include any individual characteristic that can be measured or counted reliably and that can be shown to differentiate between superior and average performers, or between effective and ineffective performers. examples of these characteristics include motives, traits or knowledge (spencer & spencer 1993:4). furnam and mansi (2011) described a competency as a state of being qualified, capable or proficient through skills, having the knowledge and ability for a specified assignment. a professional competency is described as a composite of personal attributes (capacities, motives, personality traits, self-image, aptitudes, values and personality) which complement themselves with knowledge, abilities, skills, values, actions and experience of the professional task being undertaken (guerrero & de los ríos 2012:9). the establishment of competencies for a successful business rescue practitioner will enhance the knowledge-based resources of a distressed firm. business rescue practitioner competencies in an effort to establish a set of characteristics that define a successful and high performing turnaround management professional (tmp), baird (2014:8) explored a missing link in the dynamic capabilities theory relating to human capital and its impact on competitive advantage. dynamic capability is defined as the firm’s ability to integrate, build and reconfigure internal and external competencies to address rapidly changing environments (teece, pisano & shuen 1997). an important component of the dynamic capabilities theory suggests that human capital of turnaround firms will provide a competitive advantage in the form of knowledge, skills and experience of individuals (baird 2014:33). baird (2014:83) undertook research to identify the characteristics of high performing, successful turnaround management professionals. he sought to expand on the work of the turnaround industry which identified knowledge in the areas of accounting, finance, legal and business acumen and, coupled with experience, as characteristics of successful turnaround practitioners (turnaround management association [tma] 2012, cited in baird 2014:4). the initial survey conducted with presidents of turnaround organisations identified the following characteristics as important measures of success in relation to a turnaround management professional (baird 2014:85): level of ability to communicate transparently and quickly with all stakeholders. ability to implement effective cash management strategies. amount of increase in the distressed company’s profitability achieved and speed with which results were achieved. the second phase of baird’s research involved the utilisation of a questionnaire completed by turnaround management professionals to identify characteristics of a successful turnaround practitioner. the results of his research are illustrated in figure 1 (baird 2014:125). figure 1: factors leading to turnaround manager success. figure 1 demonstrates that a successful turnaround manager requires a unique combination of educational, experiential and personality skills to be a successful turnaround management professional. due to the overlap in the objectives between turnarounds and business rescue discussed earlier, these findings can be used as a basis, after suitable adaptation to meet south african conditions, for the much-needed accreditation of a business rescue practitioner. in order to recommend competencies and educational requirements to achieve these competencies to the cipc, pretorius (2013a) initially focused on the important tasks and activities of the business rescue practitioner. he concluded that the five important tasks that must be undertaken by a successful business rescue practitioner are taking management control, investigating the affairs of the distressed firm, compiling a rescue plan, implementing this plan and complying with the statutory plan. thereafter, in an effort to identify the most important activities of a business rescue practitioner, he expanded each of the tasks into an activity. according to jarzabkowski, balogun and seidi (2007), a practice relates to the cognitive, behavioural, procedural, discursive, motivational and physical resources that practitioners combine and use in the performance of their responsibilities. the research indicated that there are five activities undertaken by business rescue practitioners that contribute to 55% of their total activity. these important activities are undertaking a viability analysis (14% of the total activity of a business rescue practitioner), conducting a feasibility analysis (9%), meeting with stakeholders (11%), preparing a rescue plan (8%) and following the rescue process (14%). further research, conducted by pretorius (2014:10) to identify the competencies required by the business rescue practitioner to successfully complete tasks and activities, concluded that the most important competencies are sense-making, decision-making and integration. these competencies are to be achieved through collaboration, which was considered to be the central competency. however, there is an absence of literature relating to the educational qualifications that will contribute towards a competent practitioner (table 1). table 1: focus of research. as reflected in table 1, there exists a research gap due to the absence of literature relating to the qualifications that a successful business rescue practitioner must possess. according to guerrero and de los ríos (2012:9), knowledge forms an important component of the successful execution of a professional task. according to section 138 (a) of the companies act (rsa 2008), a person may be appointed as a business rescue practitioner if they are a member in good standing of a legal, accounting or business management profession accredited by the cipc. a shortcoming of existing literature is that guidance is not provided on the most suitable educational qualification that will result in a competent practitioner. although research on business rescue practitioners indicated support for an examination and a formal qualification as a prerequisite for practitioner appointments, existing literature has provided no guidance on the suitable scope of the qualification or the content of the examination (pretorius 2015:92). research methodology a key finding of the literature review was an absence of academic literature on the qualifications of a successful business rescue practitioner and hence the need to undertake empirical research to develop knowledge in this field. this shortcoming in the literature has resulted in the inability to rank educational competencies required to be a successful business rescue practitioner. these limitations provided justification to engage in further research to extend the literature of business rescue. the empirical study therefore focused on developing a set of qualifications required to be a successful business rescue practitioner in south africa. research design in order to meet the objectives of the research and to harness and develop new knowledge in the field of business rescue, it was important to adopt a complementary mixed methods approach to satisfy the research objectives. a complementary mixed methods approach entails the use of both a quantitative and a qualitative approach. the usage of this approach is supported by creswell (2003:17) as a means to achieve research rigour. it is a sound principle of research to view qualitative and quantitative research as being complementary, rather than in competition with each other (malhotra 2004:137). the researcher therefore decided that the use of a mixed methods approach would follow different paths to establish the competencies that are required to be a successful practitioner (gerring 2008). having justified the need for a mixed methods approach to meet the research objectives, it was important for the research design to reflect a comprehensive strategy that would solve the research problem (leedy & ormrod 2001:91). quantitative research questionnaire design the questionnaire, comprising closed-ended questions, was used to address the objectives of this study. the questionnaire was answered by the members of the tma-sa, a group of turnaround and business rehabilitation experts. the questionnaire required the tma-sa membership to: rank the first and second most important qualification that a business rescue practitioner should possess. rank the first, second and third most important skill that a business rescue practitioner must possess. provide and explain their views on the necessity of an exam to become an accredited business rescue practitioner. the data were analysed using graphical statistics (bar graphs and frequency tables) and inferential statistics (chi-square tests of independence and non-parametric tests such as mann whitney u tests). qualitative research for the qualitative research, 7 of the top 10 business rescue practitioners were interviewed. an advantage of the interview was that the researcher could gain considerable insight from each business rescue practitioner based on their personal experience. there are disadvantages associated with using in-depth interviews as an instrument for data collection. the results are dependent on the researcher’s interpretation and it is an expensive process to conduct interviews (zikmund et al. 2013). a specific disadvantage of conducting interviews with business rescue practitioners for this study was that professionals do not have sufficient time and they are dispersed in different geographic locations. this difficulty could be overcome by conducting telephonic interviews (baird 2014). the interview schedule was emailed to the interviewees so that they could familiarise themselves with the questions. thereafter, a convenient time was agreed for the interview. research instrument the interviews with business rescue practitioners were able to establish information that could be utilised to meet the research objectives. the interview schedule was constructed in a manner that would obtain feedback from the top 10 business rescue practitioners relating to the competencies of a business rescue practitioner. the following questions were asked: what impact will the establishment of accreditation criteria for business rescue practitioners have on a business rescue? what are some of the competencies or qualifications that a successful business rescue practitioner should possess? who should establish the accrediting body? the duration of each interview was approximately 1 h and it was recorded for analysis. the data was analysed using content analysis. discussion of findings qualifications that a practitioner should possess the first question of the survey required responses to the two most important qualifications required to be a successful business rescue practitioner. the feedback is illustrated in figure 2. figure 2: important qualifications required to be a successful business rescue practitioner. according to figure 2, an accounting qualification had the highest average ranking of 38%. although the identification of an accounting qualification as the most important qualification for business rescue practitioners represents a new contribution to knowledge in business rescue, it does support the focus on effective cash management of a financially distressed business that was highlighted in existing literature (mindlin 2013; pretorius 2012). possession of an accounting qualification will also facilitate the development of an improved business rescue plan. pretorius (2012) noted that fewer than 50% of business rescue plans contained sufficient details relating to projected cash flow statements, balance sheets and income statements, which has negative consequences for the success of a business rescue plan and the business rescue. business rescue practitioners who have an accounting qualification will therefore contribute significantly to compiling the business rescue plan and the chances of raising post rescue finance. approximately 26% of the respondents ranked the accreditation of a turnaround management professional as the most important skill that a successful business rescue practitioner should possess. whilst section 138(a) of the companies act (rsa 2008) allows for the appointment of a business rescue practitioner if the person is a member in good standing of a legal, accounting or business management profession accredited by the cipc, it does not include turnaround management accreditation or experience. in order to successfully rehabilitate a financially distressed company, the practitioner requires ‘war-zone’ experience (pretorius 2013b:1). an accredited turnaround management professional will possess the necessary skills to restore profitability to financially distressed companies. baird (2014) noted that successful turnaround management professionals possess the necessary psychometric profile, educational, knowledge and experience to implement a successful turnaround strategy. his research findings acknowledge the vast spectrum of responsibilities relating to negotiation, cash flow management, strategy, conflict resolution and administration required by the business rescue practitioner. a levene’s test for the equality of variances was conducted to investigate if significant differences exist between an accounting qualification and accreditation as a turnaround management professional. the test statistic of 3.125 and a p value of 0.047 indicated that there was a significant difference between these variances. a legal qualification was ranked as the least important qualification. although the business rescue process is non-judicial and commercial in nature, there remains a high reliance on courts to ensure compliance (ensor 2014). there are concerns relating to the legal skills of south african courts to handle business rescue disputes (visser 2013). these concerns point to the need for special legal qualifications relating to business rescue during disputes or judicial matters rather than in the performance of a business rescue practitioner’s responsibilities. overall, it can be concluded that a successful business rescue practitioner must possess an accounting qualification or be an accredited tmp. in addition to a qualification, a successful business rescue practitioner must possess certain important skills, as discussed next. skills that a business rescue practitioner should possess the second question related to the three most important skills required to be a successful business rescue practitioner. the results of the most important skills are presented in figure 3. figure 3: important skills required to be a successful business rescue practitioner. according to figure 3, a strong sense of decision-making was ranked as the most important skill. the ability to implement effective cash management strategies and a strong aptitude for success were regarded as the second and third most important skill respectively. a levene’s test on the equality of variances was conducted on the second and third most important skill. the results indicated that there is no significant difference in the variance of these skills. effective cash management relates to the raising of post-rescue funding and the effective management and utilisation of cash resources during a rescue. existing literature supports the generation of cash as vital to a successful turnaround or business rescue (carter & van auken 2006; du preez 2012; mindlin 2013; vriesendorp & gramatikov 2010). in the usa, a feature of the chapter 11 rescue mechanism is the availability of funding, which is viewed as a reason for many successful rescues (bharath, panchaegesan & werner 2013:10). a business rescue practitioner who is skilled in implementing effective cash management strategies will contribute to the overall success of the rescue. this finding is highly consistent with the finding that a business rescue practitioner must possess an accounting qualification. another important skill that that was identified was the 5 to 25 years of experience as a turnaround management professional. it is consistent with the earlier finding on the importance of a qualification as a tmp. these findings, however, contradict earlier research which concluded that enhanced collaborative skills are the central and most important competency that a business rescue practitioner must possess (pretorius 2014). this study has ranked that skill as the least important. in an effort to develop a framework for the accreditation, a further question dealt with the need for a written examination. need for an accreditation examination the final quantitative question related to the necessity of a written examination as part of the accreditation process. the results are presented in figure 4. figure 4: need for a written examination. it is evident from figure 4 that the majority (56%) are in favour of a written examination to improve the competencies of business rescue practitioners. a written exam can be used as a mechanism in the accreditation process to address some of the concerns relating to the poor skills of practitioners (ensor 2014; pretorius 2013a). the finding that a written examination is necessary supports existing literature relating to this necessity (pretorius 2015:92). although the margin of 12% represented a small majority in favour of a formal accreditation examination, it must be noted that a test for the difference between the two proportions indicated a significant difference between those respondents in support of a written exam and those not in support. impact of establishing accreditation criteria for business rescue practitioners a consensus view of interviewees is that the establishment of accreditation criteria will have an extremely positive impact on the business rescue sector. this view was driven by a recognition that the responsibilities and tasks of a business rescue practitioner are distinctly different from any other profession. therefore, a separate skills set is required to become a successful business rescue practitioner. an accreditation framework consisting of strict criteria will equip business rescue practitioners with the necessary skills to ensure successful business rescues. some interviewees suggested that the accreditation process is essential and not negotiable. they pointed to their experience of many unsuitable practitioners that appear on the cipc panel. the establishment of accreditation criteria will rectify this adverse situation. there is thus no doubt that the establishment of accreditation criteria will have a positive impact on business rescue. it will legitimise the profession and increase the potential for successful business rescues. an improvement in the expertise and qualifications of business rescue practitioners will improve the effectiveness of practitioner performance. essential competencies for successful business rescue practitioners this question served to build on the previous question relating to the necessity of accrediting business rescue professionals. responses to this question can generate knowledge in support of the research objective to develop a set of competencies required to be a successful business rescue practitioner. the interviewees indicated that an individual who possesses only a single skill (such as only a legal or accounting skill) will not be a successful business rescue practitioner. it was evident that the interviewees view a successful business rescue practitioner as having a multitude of skills and qualifications. a successful business rescue practitioner must possess effective legal, restructuring, accounting, and mediation and conflict resolution skills (figure 5). figure 5: competencies required to be an effective business rescue practitioner. the legal skills must not be of a general nature or focused on an area that is not related to financial distress or corporate rehabilitation. the skills must be related to contractual, company and insolvency law. a person trained as a criminal lawyer only will not possess the necessary legal skills for business rescue. in addition to the legal skills, a successful practitioner must possess accounting and financial skills to sufficiently understand and assess the financial performance of the distressed business. the accounting skills must specifically relate to the rehabilitation of a business. the skills must enable the practitioner to facilitate the rehabilitation and to generate cash for the distressed entity. in addition to possessing relevant legal and accounting skills, it is important for a business rescue practitioner to have conflict resolution, mediation and negotiation skills. an interviewee referred to these skills as ‘political skills’, which include the ability to negotiate and mediate an outcome that considers the interests of various affected parties. conflict resolution, mediation and negotiation skills must be complemented by skills to effect a successful rehabilitation. the interviewees felt that restructuring and turnaround management skills are vital to successfully rescue a financially distressed business. four interviewees acknowledged the difficulty for an individual to possess these diverse skills. as a solution to this difficulty, they suggested a joint appointment for rescues where more than one practitioner is appointed. this will ensure that there is sufficient expertise devoted to a business rescue. there was considerable support for joint appointments so that one practitioner complements the weakness of another. the interviewees also suggested the enforcement of joint appointments at the initial phase of a career as business rescue practitioner which will encompass a joint appointment of an inexperienced practitioner with a more experienced managing practitioner. this arrangement will benefit the company in business rescue by ensuring that there are adequate skills for a successful rehabilitation and it will facilitate a transfer of skills to the newly appointed business rescue practitioner. an interviewee recommended that businesses comprising a single person, such as a one-man consultancy, must not be a business recue practitioner. in order to be successful, a practitioner must possess proper infrastructure, including office and administrative support. the practitioner must also have a proper support team to ensure that he has access to the necessary legal, accounting, turnaround and mediation skills. responsibility for establishing the accrediting body for business rescue practitioners an accrediting body is required to establish, implement and maintain the accreditation process for business rescue practitioners. a majority of four interviewees felt that the business rescue profession must be self-regulated. the self-regulatory body must be responsible for the establishment and implementation of accreditation criteria. these interviewees did not support an active role by the government or the cipc in the regulatory authority for the business rescue profession. they felt that the role of the cipc must be limited to facilitating the creation of the regulator. however, the cipc must not oversee the regulator or even serve on it. the regulator should be similar to the south african institute of chartered accountants (saica). the institute is created by an act of parliament, but government does not play an active operational role. the regulator must serve as the accrediting body and must be self-governing. one of the interviewees felt that there is no need for a separate accreditation body. his justification for not requiring an accreditation authority was that if the business rescue practitioner requires a professional qualification to be a practitioner, then that member is regulated by a professional body already. for example, if a practitioner plays a legal role, then he is already regulated by the law profession. it will be the same for the accountant. therefore, there would be no need for a separate accreditation body. however, this minority view does not give due cognisance to the fact that specialist legal and financial skills are required to be a successful business rescue practitioner. an accredited attorney or accountant will require more skills, focusing on corporate law, cash management and turnaround procedures, to be effective as a business rescue practitioner. in summary, although there are different views relating to the accrediting authority for business rescue practitioners, there is support for an independent authority to be established. the role of the government and the cipc must be limited to facilitating the establishment of the accrediting body. the regulating authority must be independent and self-regulating rather than managed by government. triangulation of quantitative and qualitative research establishing competencies of a successful business rescue practitioner this study utilised triangulation to facilitate the identification of common themes (leedy & ormrod 2001:105). common themes for this study were developed by an analysis and comparison of the results of the literature review, questionnaire and interviews. table 2 lists the competencies that can be utilised to accredit a business rescue practitioner. table 2: competencies of a successful business rescue practitioner. according to table 2, the two methods approach highlighted certain overlaps in the skills and qualifications that are required to become an effective business rescue practitioner. results of both methodologies indicate that the tasks of the business rescue practitioner are multidimensional and that it is not sufficient to only possess a single qualification. these findings contradict business rescue legislation that requires a person to have either legal, accounting or business management skills in order to be appointed as a business rescue practitioner (rsa 2008:sec. 138). the interviewees stressed how important it is that a successful business rescue practitioner should possess restructuring and turnaround skills. a primary objective of the business rescue legislation is to achieve the rehabilitation or turnaround of a financially distressed business. accordingly, the possession of effective turnaround skills will help to achieve the objective of the legislation. this finding is supported by the quantitative methodology results which indicated that accreditation as a turnaround manager is an important qualification for a successful practitioner. the interviewees also stated that legal and accounting skills are required to be a successful business rescue practitioner. however, they emphasised that these skills must not be of a general nature and must be focused on corporate recovery, which requires knowledge of corporate law. additionally, the accounting skills must facilitate the rehabilitation of a business. these skills must be focused on cash flow management and enable a practitioner to generate cash for the distressed business. the findings of the quantitative methodology rated the ability of a practitioner to implement effective cash management strategies as an important skill for a successful business rescue practitioner. the focus on cash management skills is warranted due to the lack of post rescue funding being rated as having the highest impact on a failed business rescue. in the current research setting, the quantitative and qualitative approaches both highlighted similar trends and principles. conclusion competencies required to be a successful business rescue practitioner the most significant contribution of this study is the identification of competencies required to be a successful business rescue practitioner. the responsibilities of business rescue practitioners are multidimensional and they require a variety of competencies. both the quantitative and qualitative research results emphasised the importance of the business rescue practitioner being competent in cash flow management and in the turnaround of financially distressed businesses. the quantitative methodology results indicated that the most important qualification required to be a successful business rescue practitioner is an accounting qualification and accreditation as a turnaround management professional. the important skills required to be a successful business rescue practitioner are the ability to implement effective cash management strategies and a strong sense of decision-making. the findings of the qualitative methodology indicated that both legal and financial qualifications are required to be a successful business rescue practitioner. however, the accounting and legal skills must not be of a general nature. they must be focused in the areas of cash flow generation, financial distress and company law. these competencies must be complemented by conflict resolution and mediation skills. overall, the core competencies of a successful business rescue practitioner must include effective turnaround management skills and they must have sound legal and accounting knowledge that focus on the rehabilitation of a distressed business. the financial competencies must extend to the ability to effectively manage and generate cash flows. acknowledgements competing interests the authors declare that they have 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http://www.biznews.com/thought-leaders/2014/02/06/success-rate-just-8-something-serious-amiss-business-rescue/ visser, a., 2013, ‘business rescue rate has some way to go’, business day live, 27 march. voller, r., 2011, business rescue licencing, companies and intellectual property commission, pretoria. vriesendorp, r. & gramatikov, m., 2010, ‘funding corporate rescue: the impact of the financial crisis’, insol international solvency review 19(3), 209–237. https://doi.org/10.1002/iir.188 wang, m. & shiu, h., 2014, ‘research on the common characteristics of firms in financial distress into bankruptcy or recovery’, investment management and financial innovations 2(4), 233–243. zikmund, w.g., babin, b.j., carr, j.c. & griffin, m., 2013, business research methods, cengage learning custom publishing, boston, ma. abstract introduction methodology results findings conclusion acknowledgements references about the author(s) engelina du plessis tourism research in economic environs and society, school of tourism management, north-west university, south africa melville saayman tourism research in economic environs and society, school of tourism management, north-west university, south africa annari van der merwe tourism research in economic environs and society, school of tourism management, north-west university, south africa citation du plessis, e., saayman, m. & van der merwe, a., 2017, ‘explore changes in the aspects fundamental to the competitiveness of south africa as a preferred tourist destination’, south african journal of economic and management sciences 20(1), a1519. https://doi.org/10.4102/sajems.v20i1.1519 original research explore changes in the aspects fundamental to the competitiveness of south africa as a preferred tourist destination engelina du plessis, melville saayman, annari van der merwe received: 08 dec. 2015; accepted: 24 oct. 2016; published: 24 mar. 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: tourism is an evolving and changing industry, and keeping up with these changes requires an understanding of the forces and changes that shape this industry’s outcomes. tourism managers struggle daily to stay ahead in the competition to attract more tourists to destinations. understanding the strengths and weaknesses of the past could shed light on the advantages of the future. aim: the aim of this study was to do a temporal analysis of the competitiveness of south africa as a tourism destination. setting: this research investigated the competitive position of south africa as a tourism destination just after the 1994 elections and compared those results to the results of a similar study in 2014. methods: in this article, a frequency analysis revealed south africa’s strengths and weaknesses, after which t-tests indicated the relationship between the strengths and weaknesses of the destination and the factors that contribute to south africa’s competitiveness. results: south africa’s strengths include the quality of the food and experience, scenery, variety of accommodation climate and geographical features. it is clear that respondents identified different attributes that contributed to the strengths of the destination in comparison with 2002, where the strengths were wildlife, scenery, cultural diversity, climate, value for money, variety of attractions and specific icons. conclusion: this research is valuable for south africa because it informs tourism role players about what respondents perceive to be south africa’s strengths. role players can then form strategies that incorporate the strengths to create competitive advantage. this article also indicates the areas in which the country has grown in the past decade as well as indicating which weaknesses remain a problem. introduction tourism has become one of the most important economic sectors in the world (heath 2002; salman & hasim 2012), and more and more countries recognise the value of tourism revenue (crouch 2010; heath 2003). international tourism ‘continuously transfers consumer tastes, cultural practices, business people, and capital’ to destinations across the world (salman & hasim 2012). thus, destinations are constantly in competition with one another to acquire their share of the foreign exchange that international tourists bring into the country (pavlic, perurcic & portolan 2011). because of the competition and economic welfare that international tourism creates, more destinations are focusing their attention on improving their competitive position (gomezelj & mihalič 2008; heath 2003; pavlic et al. 2011; ribes, rodríguez & jiménez 2011; salman & hasim 2012; zhang & jensen 2011). since 1994, south africa has also experienced a growing tourism sector and government identified tourism as an economic pillar which could stimulate employment, increase exports, endorse infrastructure development, generate tax income and could be seen as promoting world peace (bendixen & cronson 1996; briedenhann & wickens 2004; naudé & saayman 2005). however, remaining competitive in a very competitive global industry is a challenge for any country or destination. the competitive environment continuously changes, and destinations need to adapt to the changes (crouch 2007). porter (1990) adds to this and stated that competitiveness is a result of the effective management of the sources of competitive advantage in the country. in the last decade, south africa has been actively involved in the global tourism market, and although the annual number of overnight visitors to south africa has been steadily increasing (south african tourism 2012:9), south africa’s competitive position has been stagnating, according to the travel and tourism competitiveness report (blanke & chiesa 2013). south africa has undergone severe political, economic and tourism changes and being part of the global arena had certain impacts on our competitiveness. currently, south africa’s competitive position in the global tourism industry still has the opportunity to improve, and a position of 64th on the global competitiveness ranking remains a challenge for the south african government and all role players involved in the tourism industry (blanke & chiesa 2013, travel and tourism competitiveness report 2013). to ensure a better position on this ranking list, it is important for south africa and product owners to gain knowledge into which factors contribute to south africa’s competitiveness and what did change over the last 12 years. the question remains – what has changed and what is the implication thereof? in answering these questions, this study determined the strengths and weaknesses of the country and compares it to results found in 2002 in a study conducted by du plessis. literature study competitiveness is clearly a result of good management of the strengths and weaknesses of a destination (crouch 2007; ritchie & crouch 2003). destination competitiveness can be defined as a destination’s ability to increase tourism expenditure, to increasingly attract visitors while providing them with satisfying, memorable experiences, and to do so in a profitable way, while enhancing the well-being of destination residents and preserving the natural capital of the destination for future generations. (ritchie & crouch 2003:2) it is clear from this definition that managing competitiveness of a destination involves managing many attributes to provide memorable experiences. the management of these attributes can ensure a competitive advantage because competitive advantage relates to effectively consuming resources over the long term (crouch & ritchie 1999). simply, managing destination attributes so that they become a destination’s strength will give the destination a competitive advantage over others. strengths and weaknesses are positive or negative aspects of the external and internal environments. by definition, a strength can be used by an organisation to do something successfully, whereas a weakness makes successful action less likely (joyce & woods 1996). according to this definition, a strength can be a beneficial attribute of a business that contributes to the competitiveness of the business. this is also true for destinations since they have attributes that can ultimately ensure a competitive advantage. ritchie and crouch (2003:23) stated that ‘competitive advantages relate to destinations’ ability to use their resources effectively over the long term’ and companies gain competitive advantage by constantly innovating and upgrading, because of pressure and challenge experienced from their competitors (porter 1990). ritchie and crouch’s framework (2003) adds to this statement by portraying the determination of destination competitiveness by stating that a competitive advantage entails resource deployment. in other words, it involves the audit and inventory, maintenance, growth and development, and efficiency and effectiveness of a destination’s attributes. therefore, neglect in proper management of destination attributes can create a considerable obstacle in achieving competitive advantage, whereas effective management can produce a competitive advantage (shirazi & som 2011). achieving competitive advantage is inextricably linked to destination management. for this reason, a destination manager requires a management strategy based on knowledge regarding the strengths and weaknesses of a destination to systematically address and improve all the attributes at hand (dwyer & edwards 2009; porter 2009; shirazi & som 2011). porter states that compiling a competitive strategy requires a destination to develop its unique strengths to maintain parity with peers (porter 2009). for this reason, porter (1990) developed the attributes of a national competitive advantage – the diamond of competitive advantage. the diamond has four points, which, if managed interdependently, will ensure the competitiveness of a destination. the diamond as a system affects essential ingredients for achieving international competitive success: the availability of resources, the availability of information, the goals of the managers and individuals in companies and, most importantly, the pressures on companies to invest and innovate. these attributes, if managed correctly, will be a nation’s strengths, but each point of the diamond is often affected by or dependent on the state of others. porter (1990) highlights that any business needs a strategy that aims to improve firm strategy, understand structure and rivalry as well as demand and factor conditions and related and supporting factors. as stipulated by the definition of a strength, the correct management of these internal and external attributes will assist in achieving success and ensure a competitive advantage. according to porter, the internal environment of the company is about the choices the company makes such as marketing or reinventing a product. the external environment of the country relies on the physical location of the country as well as being part of a business cluster such as the accommodation industry. this means that the pressure experienced by a destination from its immediate competition in the immediate surroundings also contributes to competitiveness. keyser (2009) adds to this by stating that the external environment can include a range of factors including change in demand, shifting patterns in global tourism flows, changes in tourist motivation and expectation, reorganisation of the global tourism distribution system, increasing environmental awareness and activism, fluid international political relationships and security situations. (p. 154) although porter’s research is based on the competitiveness of firms and nations, it can also be applied in the tourism industry even though the tourism product is different in the sense that you sell an experience and not a physical product that can be viewed and tested. nonetheless, tourism destinations also have internal and external attributes that influence the tourism competitiveness of the destinations (blanke & chiesa 2013; hong 2009; ritchie & crouch 2003). managing these internal and external attributes of a destination is a difficult task for various reasons as indicated in figure 1 (crouch 2010). figure 1: complexity of destination management. according to crouch (2010), the competitiveness of tourism destinations is influenced by a variety of forces, influences and events, many of which are very difficult to manage. crouch (2010) states that the problem is made more difficult because destinations often do not set clear development goals against which competitive forces can be evaluated. because of the complexity of tourism destinations, the travel and tourism competitiveness report aims to provide insight and stimulate discussion among stakeholders on the best strategies to overcome the obstacles and to improve the competitiveness of destinations (blanke & chiesa 2013). the internal and external obstacles in the tourism industry as identified by the travel and tourism report toughen management practices by constantly challenging them to improve. therefore, the travel and tourism report provides the most extensive list of internal and external influences on tourism destinations. this report is based on three broad categories of variables that facilitate or drive travel and tourism competitiveness (blanke & chiesa 2013). these three categories are: (1) the travel and tourism regulatory framework, (2) the travel and tourism business environment and infrastructure and (3) the travel and tourism human, cultural and natural resources. the travel and tourism competitiveness report aims to take all the possible internal and external factors of a destination and use the current state of those factors to determine the competitive position of each destination. the internal and external influences as summarised by the travel and tourism competitiveness report (blanke & chiesa 2013) are illustrated in figure 2. figure 2: the internal and external attributes of competitiveness. the external influences that have an influence on competitiveness include: disruptive events, accelerating trends, inflation and exchange rates, digitalisation or mobile devices, ageing population, political instability, terrorism, natural disasters, economic downturn and regional demand shifts. the internal factors that influence competitiveness include: affinity for travel and tourism, cultural measures, prioritisation of travel and tourism, ict infrastructure, health and hygiene, air transport infrastructure, ground transport infrastructure, environmental sustainability, safety and security, tourism infrastructure, policy rules and regulations, natural resources and price competitiveness in the travel and tourism industry. for these attributes to be managed, destination management organisations require competitive strategies that consider the internal and external attributes of the tourism product as well as the changing nature of tourism trends. a strategy determines how a company or destination will compete in the industry, by focusing on improving what is in existence, while managing the functional areas and developing new capabilities as well as gathering resources to strengthen the company to ensure long term success (gamble, thompson & peteraf 2011; hill & jones 2008:200; zairi 1997:68). these strategies need to adapt as the environment changes to take into account the changing trends, threats and opportunities (dwyer & edwards 2009; shirazi & som 2011). in this regard, hong (2009) compiled a sustainable competitiveness model for tourism industries wherein he focused on the importance of the internal and external environments of the tourism industry as well as the changing trends in tourism. hong (2009) also gave a deeper insight into the reallocation of different tourism attributes to achieve competitive advantages. the study aimed to take into account ricardo’s competitive advantages, porter’s competitive advantages, tourism management and environmental conditions that influence the tourism industry. hong (2009) states that a destination should have a feasible strategy to use its competitive advantages or strengths and then developed the indicators of competitive advantage that can assist in determining the current competitive position of the destination. an indicator can be defined as a measurable variable used as a representation of an associated factor or quantity (business dictionary 2014). all the above studies focused primarily on first world countries, and the results of this research are not always applicable in the african context. heath (2002), however, developed a model for sustainable competitiveness for southern africa. the author stated that factors such as changing consumer preferences, the increasing involvement of host communities, safety and health concerns, globalisation of the airline industry, technological innovation and environmental pressures are changing the tourism industry; therefore, he focused on addressing the key challenges of the african continent. his model aimed to alleviate key african challenges such as poverty alleviation through tourism growth. the key attributes developed by heath (2002) and hong (2009) are different in the sense that the attributes by heath (2002) are more basic attributes that will attract tourists, whereas the key attributes by hong (2009) are more associated with a developed country. this highlights the fact that the level of development of countries has an impact on the various attributes that have an impact and that the african situation is unique as indicated by heath. heath (2002) proposes that a sustainable tourism strategy can alleviate poverty because tourism is a labour intensive industry that creates job opportunities; tourists spend money that goes into the rural areas; more tourists buy more curios from informal entrepreneurs and tourism diversifies economies (heath 2002). the challenges in south africa are similar to the challenges in other african countries. thus, it continues to be a priority to develop the tourism industry to attract more tourists. in 2002, du plessis did the first study to determine the competitive advantages of south africa as a global tourism destination since the 1994 democratic election which resulted in sanctions against the country being lifted. it was clear at that time that south africa’s competitive advantages did not lie in the natural resources of the country, but lie in how those resources were managed (du plessis 2002:6). the focus of du plessis’ research was to gauge the ranking of importance of the core factors in global competitiveness as identified by porter (1990) and ritchie and crouch (1993). du plessis (2002:102) found that the factors that were most important for south africa as a global tourism destination were safety and security, quality of service, value for money, geographical features and attitude towards tourists. although these factors were identified and managers and marketers could act upon them, du plessis (2002) found that the influence of external factors such as crime, political instability and diseases could have a great influence on these factors and could even change the importance of them. when acknowledging this, the question arises: how have external factors influenced the competitiveness of south africa from 2002 until now? some factors that could have played a role in south africa’s competitive performance since 1994 are post-apartheid influences, hosting of mega events and marketing. in the 1990s, south africa was promoted as a ‘world in one country’ because of the varied cultures and natural resources. this combined with the climate and undervalued currency made south africa a value for money destination and created great economic opportunities for south africa (briedenhann & wickens 2004:73). in terms of major events, various events put south africa on the international tourism map. after the successful hosting of the 1995 rugby world cup, south africa also recognised the economic value of sport-mega events such as international cricket and athletics, and used this as a signal to communicate ‘international recognition in terms of economic, social and political stability’ (cornelisen & swart 2006:109). driven by socio-economic and political objectives, south africa won the rights to host the 2010 fifa world cup (briedenhann & wickens 2004:74). the fifa world cup not only established that south africa was capable of hosting successful mega events and hosting millions of tourists, but it also demolished the perceived inadequate safety and security measures regarding tourists that had been present since the political instability in the early 1990s (george & swart 2012:219). blanke and chiesa (2013) adds that strengths that make south africa a desirable destination according to the travel and tourism report are natural resources, cultural resources, world heritage sites, fauna and flora, creative industries, international fairs and exhibitions, infrastructure, air transport, rail quality, policy and regulations, property rights and few visa requirements. the factors that are seen as undesirable in south africa include safety and security, level of hygiene, low physician density, access to improved sanitation, human resources, low life expectancy, high rates of communicable diseases, increased fuel prices and ticket taxes and airport charges that diminished price competitiveness. in the study by du plessis (2002), the author gave respondents a list of attributes that was compiled from studies by porter (1990) and crouch and ritchie (1999) and the respondents were asked to rate the attributes as strengths or weaknesses of south africa. du plessis (2002) compiled a strengths, weaknesses, opportunities, threats (swot) analysis based on the answers to the strength and weakness questions. du plessis (2002) also found that there were five aspects that were important for south africa’s attractiveness as a global destination. these were attractions, accessibility, scenery, safety and accommodation. additionally, the author found that south africa’s five biggest draw cards at that time were the attractions, accessibility, scenery, nature and wildlife and climate. methodology this section provides a brief description of the methods used to obtain, capture and analyse the data to achieve the goal of this study. study area this research was carried out by means of a structured questionnaire that was emailed to international tourism operators who were familiar with south africa as a tourism destination. the delegates who attended the tourism indaba 2013, held in durban during the month of may, were targeted as well as tour operators from the australian tour operators association, the european tour operators association, the german tour operators association and the american tour operators association as well as united kingdom tour operators. the questionnaire the questionnaire was divided into three sections. section a was a combination of open-ended and closed-ended questions that captured demographic and economic details. these included country of origin, main type of business and effect of price on business. section b captured 36 attributes that influence destination competitiveness on a 5-point likert scale where 1 = no opinion, 2 = no importance, 3 = some importance, 4 = important and 5 = very important. section b was based on studies by du plessis (2002), porter (1990), as well as ritchie and crouch (2003), heath (2002) and hong (2009). this section included internal and external attributes such as the location of the destination, quality of food, the friendliness of locals, marketing and communications systems. in section c of the questionnaire, respondents were asked to rate the same 36 attributes as strengths and weaknesses of south africa as a tourism destination. sampling method and survey the research was quantitative in nature. complete sampling was used for this research because a list of the sampling population is available and all members of the population were selected for the survey (jennings 2001). the survey was constructed using a web-based programme, namely adobe form central, and the link to the questionnaire was included in the email. the email stated who the researchers are, what the research is about and what the research is for. over a period of 3 months, a total of 2727 questionnaires were emailed to delegates of the tourism indaba in durban as well as tour operators from the australian tour operators association, the european tour operators association, the german tour operators association, and the american tour operators association as well as united kingdom tour operators. an amount of 271 usable questionnaires were completed and returned. according to cooper and emroy (1995), this is a representative sample because 10% of the sample population is an acceptable sample for research. data analysis microsoft excel was used to capture data and spss (spss inc. 2012) to analyse the data. firstly, frequencies were compiled to determine the strengths and weaknesses of south africa as a destination, and secondly, a factor analysis was performed to identify the factors, and lastly, t-test analyses were performed to determine significant relationships between the strengths and weaknesses of south africa and the factors that contribute to the competitiveness of the destination. for the t-tests, p-values were used to further identify any significant differences between the strengths and weaknesses of south africa and the factors that contribute to the competitiveness of south africa. the purpose of effect size is to establish whether any differences exist between the strengths, weaknesses and the factors. cohen (1988), ellis and steyn (2003) and steyn (2009) offer the following guidelines for the interpretation of the effect sizes: small effect (d = 0.2), medium effect (d = 0.5) and large effect (d = 0.8). statistically, significant differences are indicated as follows: p ≤ 0.05; effect sizes: **small effect (d = 0.2), ***medium effect (d = 0.5) and ****large effect (d = 0.8). ethical consideration the ethical process was followed within the university’s policy and an ethical number was provided to the master study. results this section provides a summary of the results. results of the demographic profile of respondents seventy-one per cent of respondents have been promoting south africa as a tourism destination for more than 7 years, and 78% of respondents felt that south africa is a competitive destination. the respondents could select from three main types of business regarding south africa, and it was clear that most of the operators promote leisure tourism, nature-based tourism as well as culture and history tourism. results of the strengths and weaknesses of south africa section c of the questionnaire captured the strengths and weaknesses of south africa as a tourist destination (see figure 3). figure 3: results of the strengths and weaknesses of south africa in 2013. the most significant strengths and weaknesses were identified and compared to the results of du plessis’s (2002) study and captured in figures 4 and 5. it is, however, clear from figure 3 that respondents consider south africa to have more strengths than weaknesses as a tourism destination. figure 4: comparison of south africa’s main strengths in 2002 and 2013. figure 5: comparison of south africa’s main weaknesses in 2002 and 2013. the opinions of respondents have changed slightly over the last decade. it is clear from the comparison that climate (100% – 2002/98% – 2013) and scenery (100% – 2002/97% – 2013) are still considered as the strongest draw cards or strengths for the country’s competitive advantage. in figure 4, it is also clear that respondents perceive value for money (down by 18%), ability to communicate (down by 16%), foreign exchange (down by 9%), historical and cultural features (down by 8%) and geographical features (down by 6%) not as strong as respondents has indicated in 2002, with the largest discrepancies between geographical features (97%/79%) and the ability to communicate (89%/73%). it was interesting to find that the availability and the quality of accommodation (up by 8%) play a more important role than in 2002. south africa’s quality food has become a greater strength as well as the country’s sport and recreational opportunities and accommodation. the moderate climate has always been one of the country’s best assets, which confirm findings by saayman and saayman (2008) and the travel and tourism competitiveness report (blanke & chiesa 2013) concerning climate, natural resources and cultural resources as south africa’s best attractions. perceptions towards the weaknesses as indicated in figure 5 show greater discrepancies as in the case of the perceptions towards strengths of the country. the greatest discrepancies were support service (up by 44%). although public transport could be considered as part of these support services, it was indicated that public transport (down by 24.67%) was perceived better in 2013. the introduction of the gautrain and the upgrading of public roads could have an impact on this perception. it is, however, clear the respondents felt that safety (82%) was still one of the biggest weaknesses of south africa. results of the factor analysis and t-test a factor analysis was conducted to identify factors of competitiveness of south africa as a tourist destination and to determine the relation of these factors with the various strengths and weaknesses using t-tests. as described in table 1, the following factors were indicated as the most important according to respondents: stability (mean value 4.36), economic benefits (mean value 4.33) and brand and image (mean value 4.21), and these results correlate with the studies conducted by heath (2002) and blanke and chiesa (2013). table 1: factor analysis of competitiveness factors of south africa as a tourist destination. a t-test was applied for comparisons of competitiveness variables, using the eight factors from the factor analysis and the strengths and weakness attributes from the questionnaire. the results, in general, showed that many constructs were significant (see table 2). p-values were used to identify any significant differences. table 2: results of the t-test for the strengths and weaknesses in relation to the competitiveness factors. respondents that rated south africa’s long haul status as a strength rated tourism services as more important, implying that respondents travelling a greater extent are more aware of service provided and expect more in terms of services related to their visit. as could be expected, the respondents who felt that value for money is one of south africa’s weaknesses also deemed the economic benefits that south africa holds as an important factor that contributes to the competitiveness of the destination (p = 0.002). according to the effect sizes as well as the p-values in table 2, respondents who felt that south africa’s geographical features were a weakness also feel that the tourism services and entertainment and activities are important for the competitiveness for the country. this supports studies by bendixen and cronson (1996:4), naudé and saayman (2005), gomezelj and mihalič (2008) and lee and king (2009) who found that geographical features are important to destination competitiveness. this is, however, the first time that the link has been made between geographical features and entertainment and activities. respondents who indicated that historical and cultural resources are one of south africa’s strengths are also of the opinion that the african experience contributes to the competitiveness of the destination. crouch (2007) also found that historical and cultural resources are one of the top 10 attributes that are the most important in contributing to the competitiveness of a destination. this also supports the research of gouws and roberts (2010), yeoman (2010) and fiorello and bo (2012) who stated that new tourists are more sensitive and curious about culture and history than they were in the past. based on the effect sizes, it is clear from table 2 that respondents who indicated that south africa’s climate is a strength rated attributes and entertainment and activities of a lesser importance than those who indicated it as a weakness. the same applies for variety of accommodation where attributes are seen as a lesser important aspect. respondents who indicated that scenery is one of south africa’s strengths had a significant relationship to the factor entertainment and activities (p = 0.018) with a large effect although it is seen as less important compared to those who identified it as a weakness. the same principle applied for quality and variety of food, local attitude towards tourists and quality of the experience on offer. findings the first finding is that attributes identified in 2002 by tour operators that had an influence on south africa as a tourism destination as strengths and weaknesses were confirmed in 2013. the most important remain climate (98%) and scenery (97%) and more important as in 2002 variety of accommodation (97%). although some of the percentages differ [value for money (18% down) and ability to communicate (16% down)] as strengths and [public transportation (24.67%), location (20%) and marketing (18.40%)] less as weak points, dependency on support services (44% up as a weak point) was indicated as a weakness in 2013. the implication of this finding is that destination marketing organisations and government authorities should investigate the opportunities to maximise and capitalise on these attributes in an attempt to improve the country’s competitive position. by cooperation between industry (tour operators, product owners, agencies and tourism organisations and government just to name but a few), the focus should be placed on policies and frameworks to address weak points as indicated. the second finding highlights the eight competitiveness factors that were identified in this study. the three most important factors, stability, economic benefits and brand and image, support literature by porter (1990) as well as du plessis (2002), heath (2002), ritchie and crouch (2003), and hong (2009). literature has stated various factors that influence destination competitiveness, but it is clear that factors are unique to destinations and can change over time as was in the case of south africa (du plessis 2002). this finding implies continued research towards competitiveness factors that are dependent on the changing perceptions of tourists, firm strategies, rivalry as well as demand and factor conditions and related and supporting factors as explained by porter (1990). the third finding reveals that external factors make the greatest contribution to south africa’s competitiveness such as climate, scenery and geographical features. from an internal point of view, accommodation (up by 8%) has increased in importance as a strength, and it is clear that the industry adapted over the last 12 years to provide for the needs of tourists. the implication is to focus on what is strong and keep attracting people through marketing campaigns that focus on the natural diversity of the country. results of this research could also provide destination marketing organisation with the knowledge of opportunities of the country to be addressed in future marketing plans. the fourth finding is that safety and security as well as uncertainty of political stability of the country remains the primary factor that threatens south africa’s tourism industry like many other tourist destinations competitiveness. these results were also indicated by du plessis (2002), heath (2002), saayman and saayman (2008) and blanke and chiesa (2013) (travel and tourism competitiveness report). in porter’s (1990) diamond of competitive advantage, safety and security is part of the demand conditions which constitute the standards of demand. this implies that safety and security is a standard that tourists expect from an experience just as they expect quality experiences, and it should be a priority to the government to ensure safety and security for all. the fifth finding highlights the significance of the various factors against the strengths and weaknesses of south africa as a tourist destination. it was the first time that the significance was indicated statistically using t-tests. these in-depth results could give better guidance in terms of the forces that change a destination’s competitive position over time. as shown in the results, the largest effect was between scenery and entertainment and activities (d = 086), climate and attributes (d = 071) and quality of the experience on offer and tourism services (d = 0.72) where, in all three cases, the respondents who indicated these factors as weaknesses felt that these attributes were more important to contribute to the competitiveness of the country. it was also evident from the results that tourism service, entertainment and activities and attributes have been indicated to have a greater effect on competitiveness as a weak point in relation to be considered as a strength. the implication is that, with better management approaches, these internal factors could be improved by placing more emphasis on them in management plans and treating them as very important in marketing approaches to change the image. the sixth finding highlights the importance of economic attributes such as value for money, foreign exchange and economic benefits to the competitiveness of the country. those respondents who indicated that south africa is a value for money destination were influenced by the economic benefits factor. the implication of this finding has a long term effect where the global economic situation will have an impact on price setting. in keeping loyal tourists and sustaining the growth of the industry, the philosophy of ‘think global act local’ could make a difference. ritchie and crouch (2003), haarhoff (2007) and briedenhann and wickens (2004:73) found that the value of a destination is a very important tourism motivating attribute. it also means that government should regulate inflation to ensure that prices do not fluctuate. conclusion the importance of knowing a destination’s strengths and weaknesses is continually stressed in literature concerning competitiveness (crouch 2007; dwyer et al. 2004:91; enright & newton 2005; haugland et al. 2011; lee & king 2009). knowing and managing a destination’s strengths and weaknesses can give a destination significant competitive advantage over its competitors. the uniqueness of the research lies in the temporal analysis of the country as a tourism destination. these results could emphasis the relevance not only to the tourism industry but on the society of the country also benefitting from the improvements made to infrastructure, more job opportunities and the overall well-being of south african residents. by focusing on improving weak points such crime, political instability and dependencies on support service as attributes to competitiveness could also have an influence on locals’ quality of life. conclusively, south africa’s competitive advantage still lies in the moderate climate, geographical features, scenery, the availability of tourism products, the cuisine, 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http://www.nwu.ac.za/p-statcs/index.html yeoman, i., 2010, ‘tomorrow’s tourist: fluid and simple identities’, journal of globalization studies 1(2), 118–127. zairi, m., 1997, ‘business process management: a boundaryless approach to modern competitiveness’, business process management 3(1), 64–80. https://doi.org/10.1108/14637159710161585 zhang, j. & jensen, c., 2011, ‘comparative advantage explaining tourism flows’, annals of tourism research 34(1), 223–234. https://doi.org/10.1016/j.annals.2006.08.004 abstract introduction related literature and hypothesis research method results robustness tests: different industries conclusion acknowledgements references about the author(s) hopewell hlatshwayo college of economic and management sciences, department of accounting, university of pretoria, south africa mbalenhle zulu college of accounting sciences, department of financial accounting, university of south africa, south africa citation hlatshwayo, h. & zulu, m., 2019, ‘pricing of fair value instruments reported under international financial reporting standards 7: south african setting’, south african journal of economic and management sciences 22(1), a2345. https://doi.org/10.4102/sajems.v22i1.2345 original research pricing of fair value instruments reported under international financial reporting standards 7: south african setting hopewell hlatshwayo, mbalenhle zulu received: 21 feb. 2018; accepted: 07 sept. 2018; published: 15 jan. 2019 copyright: © 2019. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: prior literature established that different fair value levels disclosed in terms of the international financial reporting standards (ifrs) 7 are value relevant. setting: this study investigates the market pricing of the different fair value levels, as well as the market reaction towards the fair value hierarchy levels reported in terms of ifrs 7. aim: prior research found inconsistencies in the market pricing of fair value levels. this study seeks to contribute to this debate. it also focuses on the period after comprehensive guidance on how to measure fair value levels was issued. methods: data from 2009 to 2015 were collected from the financial sector companies listed on the johannesburg stock exchange. the study uses the statement of financial position and the ohlson model to investigate the market pricing of the different fair value levels disclosed in terms of ifrs 7. results: the results of the study show that the fair value of assets level 1, 2 and 3, as well as the fair value of liabilities level 3 are value relevant while the fair value of liabilities level 1 and 2 are not value relevant. furthermore, the market pricing of level 2 and 3 fair value assets and liabilities is not lower for companies with a high debt equity ratio than for companies with a low debt equity ratio. the results further reveal that the pricing of level 3 assets improved with the introduction of ifrs 13 and post the 2008 financial crisis. conclusion: fair value assets across different hierarchy levels are value relevant. on the contrary, fair value liabilities are priced differently across the different hierarchy levels. introduction the reliability of the fair value measurement of financial instruments has been a long and still ongoing debate in the accounting fraternity (laux & leuz 2009; procházka 2011). this debate further gained motion during the 2008 economic crisis. prior literature has defined reliability as faithful representation of financial information in terms of the international accounting standards board’s (iasb) conceptual framework 2010 (barth 2007; kadous, koonce & thayer 2012). the conceptual framework further states that information is useful if it is both relevant and faithfully represented (iasb 2010). deaconu, buiga and nistor (2010) argued that there was a lot of criticism levelled against the reliability of fair value accounting (fv-a), but despite this, they suggested that prior research proves that fv-a is value relevant and is usually preferred over historic cost measures by investors. barth, beaver and landsman (2001) define value relevance as the association between accounting information and the market value of equity. in 2005, the iasb chairman, sir david tweedie, introduced the new international financial reporting standards (ifrs) 7 dealing with financial instruments’ disclosure. in his introduction, he stated: the board believes that the introduction of ifrs 7 will lead to greater transparency about the risks that entities run from the use of financial instruments. this, combined with the new requirements in ias 1, will provide better information for investors and other users of financial statements to make informed judgements about risk and return (iasb 2005a). this was particularly important for banks, finance and insurance companies due to their large exposure to financial risk (iasb 2005b). this exposure to financial risk led to an increased demand for additional information on risk exposure and how those risks are managed on financial instruments presented in the statement of financial position. in response to this, the iasb issued ifrs 7 and was applicable for all periods starting on or subsequent to 01 january 2007. ifrs 7 specifically addresses the information needs regarding credit risk, market risk and liquidity risk of financial instruments presented in the statement of financial position. subsequently, the iasb (2008) introduced fair value hierarchy levels accounting in october 2008 through an amendment to ias 39. therefore, the disclosure of fair value hierarchy levels as per ifrs 7 became applicable for all periods starting on or subsequent to 01 january 2009. this study deals with the pricing of fair value instruments (assets and liabilities) disclosed in terms of ifrs 7. given that the strength of the reliability of the inputs used to calculate the fair values on the different levels is not the same, investors are bound to price these instruments differently (deaconu et al. 2010). this is also supported by prior literature which found that fair values of non-traded (mark-to-model) financial instruments are significantly less value relevant compared to traded (mark to market) instruments (petroni & wahlen 1995). these fair value hierarchy levels as per ifrs 7 are based on the quality level of inputs used to measure the fair values of financial instruments (deaconu et al. 2010). ifrs 7.27 specifies 3 fair value levels: level 1 (mark to market), level 2 (mark-to-model) and level 3 (mark-to-model). level 1 fair value financial instruments have observable market prices and are quoted; hence they are also referred to as mark to market fair values (goh, ng & ow yong 2009). in contrast to level 1, level 2 financial instruments do not have quoted prices and are not traded in active markets (deaconu et al. 2010) but calculate the fair values based on observable data from quoted prices of similar items in active markets (song, thomas & yi 2010). additionally, level 2 financial instruments are also referred to as mark-to-model instruments. similar to level 2, level 3 financial instruments do not have quoted prices and are not traded in active markets (goh et al. 2009). in contrast to level 2 financial instruments, the model used to calculate fair values is based on unobservable or firm generated data and they are also referred to as mark-to-model instruments (song et al. 2010). in this article we specifically explore the effects of the requirements of ifrs 7 on the financial sector in south africa as other studies (for example, song et al. 2010 and goh et al. 2009) in this topic have produced inconsistent results. we examine the market reaction towards the fair value (assets and liabilities) hierarchy levels reported in terms of ifrs 7. a study in this regard is valuable in a south african setting where ifrs is mandatory for all firms listed on the johannesburg stock exchange (jse). the jse is relevant as it links the south african economy and the global economy. the jse is ranked with the largest stock markets in the world, as indicated in the global competitiveness index issued by the world economic forum (2016). using the balance sheet and ohlson (1995) model, the results of this study show that fair value of assets level 1, 2 and 3 as well as fair value of liabilities level 3 are value relevant while fair value of liabilities level 1 and 2 are not value relevant. the results also show that the market pricing of level 2 and 3 fair value assets (liabilities) is not lower for companies with a high debt equity ratio than for companies with a low debt equity ratio. further the results reveal that pricing of level 3 assets improved with the introduction of ifrs 13 and post the 2008 financial crisis. an added advantage of this article is that it examines the differential pricing accross the three fair value levels for ifrs companies when there was a comprehensive and mandatory (ifrs 13) standard on how to measure fair value accross the three hierachy levels and compares it to the pre-ifrs 13 period. deaconu et al. (2010) allude that before the mandatory application of ifrs 13, to disclose the hierarchy levels in ifrs 7, ifrs companies referred to the statement of financial accounting standard (sfas) 157. sfas 157 is the financial accounting standards board (fasb) equivalent to ifrs 13; sfas157 and ifrs 13 deal with measurement of fair value, and thus influence the ifrs 7 disclosures. it is possible that some of the sampled banks in deaconu et al. did not accurately disclose the hierarchy levels in terms of ifrs 7 during their sample period because there was no comprehensive and mandatory standard prescribing fair value measurement in line with the disclosure requirements of ifrs 7. this article argues that the introduction of ifrs 13 had an impact on investors’ perceived risk in respect of liquidity and the information asymmetry of level 2 and 3 fair value assets (liabilities), as there is now a comprehensive standard dealing with fair value measurements. the results of this study will be of interest to standard setters and investors and will assist in understanding the impact of ifrs 7 fair value hierarchy level disclosure in the financial sector in south africa. the rest of the article is organised as follows: section 2 provides the relevant prior literature and states the hypotheses. section 3 describes the sample selection procedure, data and research method to be used in the study, section 4 discusses the results of the study, section 5 deals with the robustness tests and, lastly, section 6 details the conclusion. related literature and hypothesis fair value fair value measurement is important in this study as the fair values of financial instruments presented in the statement of financial position influence the fair value hierarchy disclosure of ifrs 7. ifrs 13 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (iasb 2011). from the definition above, the challenge is the measurement of assets and liabilities that are not traded in active markets as the fair values have to be estimated using other models. ifrs 13 is of utmost importance to this study because ifrs 7 became effective before ifrs 13, and the principles on fair value hierarchy levels in ifrs 7 are driven by ifrs 13. prior to ifrs 13, the iasb did not have an accounting standard that comprehensively dealt with fair values and the arising measurement issues. this article argues that the effective application of the fair value hierarchy level disclosure requirements in ifrs 7 is dependent on ifrs 13. this is consistent with deaconu et al. (2010) who echo the same sentiments and further suggest that early ifrs 7 adopters referred to sfas 157 for guidance on applying the principles of ifrs 7 before ifrs 13 came into effect. sfas 157 is the fasb equivalent of the iasb’s ifrs 13. sfas 157 came into effect before ifrs 7 and 13. relevance and reliability of fair values barth et al. (2001) state that value relevance studies often examine the relevance and reliability of the amount in question. it is generally established among scholars in the accounting fraternity that the information content carried by fair valued amounts in the financial statements is relevant (barth, beaver & landsman 1996; carrol, linsmeier & petroni 2003; petroni & wahlen 1995). goh et al. (2009) state that one of fv-a’s objectives is to ensure transparency in the valuation of financial items, so as to empower investors to make sound economic decisions. similar studies that examine the value relevance of fv-a have produced inconsistent results. a study conducted by goh et al. (2009), using a sample of american banks, found that level 1 fair value assets are priced significantly differently from level 2 and 3 fair value assets. in addition, they do not record a significant difference between the pricing of level 2 and 3 fair value assets. a study conducted by song et al. (2010) on a sample of american banks found that level 1 and 2 fair value assets are priced significantly differently from level 3 fair value assets. however, they do not record significant differences in the pricing of level 1 and 2 fair value assets. another study conducted on a sample of european banks, (deaconu et al. 2010) found similar results to song et al. the prior research consulted in this study are value relevance studies and are based on the efficient market theory (deaconu et al. 2010). these prior studies cover the 2008 financial crisis period and deaconu et al. (2010) suggest that during that period markets were not efficient. therefore, the financial crisis might have had confounding effects on the results of these studies and by their own admission, deaconu et al. cite this as one of the limitations of their study. while these prior studies focused on periods before and during the 2008 financial crisis, this study focuses on the period after the 2008 financial crisis and also compares the period during the financial crisis to the after the financial crisis period. as management’s judgement is required to determine fair values to a certain extent (dechow, myers & shakespeare 2010), the fair values are inherently subject to measurement error and this creates an incentive for management to manipulate the figures (song et al. 2010). the combination of information asymmetry and susceptibility of fair values to management manipulation and error cast doubt on the reliability of fair values (song et al. 2010). although accounting scholars seem to reach consensus on the relevance of fair values, there is still a debate regarding the reliability of fair values. some scholars in support of fair value argue that the information content of fair values better captures real volatility and makes financial reporting easy (song et al. 2010), while other scholars contend that fair values are less verifiable by investors, as they are inherently prone to a greater estimation error and susceptible to manipulation by those charged with governance (penman 2007). the arguments against fv-a point to an information asymmetry challenge between management and investors or owners. information asymmetry occurs when people who manage an entity are different from the investors or owners (de klerk, de villiers & van staden 2015). therefore, investors or owners will require relevant information to assess and monitor the performance of management or companies (healy & palepu 2001). hypothesis development the first hypothesis looks at the value relevance of the three fair value hierarchy levels of ifrs 7. it was established that investors require relevant and reliable information on future earnings and cash flows. we also established that the aim of fv-a is to ensure transparency in the valuation of financial instruments. the requirement of ifrs 7 to disclose inputs and categories of fair valued instruments can be seen as a tool to achieve it. disclosure of the different fair value hierarchy levels in terms of ifrs 7 enables investors to assess how fair values were calculated and determine the liquidity of financial instruments and the related information risk (goh et al. 2009). therefore, they conclude that level 2 and 3 fair values possess a greater information risk to investors. this is due to the fact that level 1 instruments are traded in active markets and level 2 and 3 are not actively traded but are based on valuation models. it is against this background that goh et al. (2009) conclude that level 2 and 3 fair values possess a greater information risk to investors as the inputs to the models are not publicly available. goh et al. further infer that during any economic crisis liquid assets play a crucial role in raising capital and therefore have a price premium as they moderate liquidity surprises (holmström & tirole 2001). in contrast to liquid instruments (level 1), we argue that investors will mark down the fair values of illiquid instruments (level 2 and 3). this argument is supported by goh et al. who state that during the 2008 financial crisis, a number of banks were adamant that the fair values of their assets were below market value especially level 2 and 3, thus suggesting that investors most likely discounted those assets. the challenge of information asymmetry (information risk) coupled with fair value measurement error may render the amounts unreliable. therefore, this article argues that level 2 and 3 fair values are more prone to error because they use models to determine fair value, as was implied in similar studies on this topic (deaconu et al. 2010; dechow et al. 2010; goh et al. 2009). epstein and schneider (2008) allude that poor quality information may have a negative impact on prices, thus result in measurement error. we also argue that the information risk regarding level 2 and 3 fair values is high compared to level 1, as implied in similar studies on this topic (deaconu et al. 2010; dechow et al. 2010; goh et al. 2009; song et al. 2010). investors will discount the prices of assets and liabilities with a high level of information asymmetry (easley, hvidkjaer & o’hara 2002). we, therefore, predict that level 1 fair value assets and liabilities will have the strongest association with price per share (value relevance), as these are traded in active markets and subject to less or no estimation errors and information risk. for level 2 fair value assets and liabilities, we predict a lower value relevance compared to level 1, as level 2 assets and liabilities are based on models, but higher than level 3. lastly, we expect level 3 assets and liabilities to have the lowest value relevance as these are based on unobservable data, hence higher estimation errors and information risk. therefore, the first hypothesis is stated as follows: h1: the strength of the value relevance of financial instruments’ fair values is inversely related to the hierarchy level order in ifrs 7. the second hypothesis deals with the effect of capital adequacy on the pricing of fair value assets and liabilities’ hierarchy levels disclosed in terms of ifrs 7. deaconu et al. (2010) allude that banks with a deficient financial position have an incentive to manage earnings by using their discretion to improve their statement of financial position ratios. similarly, goh et al. (2009) found that investors price higher mark-to-model assets for banks with a stronger financial position. unlike level 1 fair value assets and liabilities, determination of fair values for level 2 and 3 assets and liabilities requires management’s discretion. thus, weaker capital adequacy increases the susceptibility of manipulation of level 2 and 3 fair value assets and liabilities as management’s discretion is applied in determining those fair values (deaconu et al. 2010). the second hypothesis is stated as follows: h2: the market pricing of level 2 and 3 fair value assets and liabilities disclosed in terms of ifrs 7 is predicted to be lower for companies with a high debt equity ratio than for companies with a low debt equity ratio. the third hypothesis focuses on the effect of the introduction of ifrs 13 on the pricing of financial instruments’ different fair value hierarchy levels disclosed in terms of ifrs 7. ifrs 7 became effective before ifrs 13 and prior research suggested that pre-ifrs 13, companies referred to sfas 157 for guidance to disclose the hierarchy levels in terms of ifrs 7. in this article we argue that there is a possibility that not all ifrs companies referred to sfas 157 and that has a direct bearing on liquidity and the information risk of fair value hierarchy levels disclosed in terms of ifrs 7 in the pre-ifrs 13 period. as level 1 fair value assets and liabilities are based on observable market prices (goh et al. 2009), the liquidity and information risk thereof is mitigated. consequently, we predict that the market will react differently to level 2 and 3 fair value assets and liabilities disclosed during the pre and post-ifrs 13 periods. the third hypothesis is stated as follows: h3: the market pricing of level 2 and 3 fair value assets and liabilities disclosed in terms of ifrs 7 is predicted to be different in the pre and post-ifrs 13 period. the fourth hypothesis deals with the effects of the 2008 financial crisis on the pricing of fair value hierarchy levels of assets and liabilities disclosed in terms of ifrs 7. similar studies on this topic have produced inconsistent results on the differential pricing across the three fair value hierarchy levels of ifrs 7. we argue that the 2008 financial crisis might have had confounding effects on the pricing of the different hierarchy levels of fair value assets and liabilities disclosed in terms of ifrs 7. consistent with our argument, deaconu et al. (2010) allude that during the 2008 financial crisis prices were not efficient and goh et al. (2009) go a step further and put forward that the 2008 financial crisis might have exacerbated the liquidity and information risk of level 2 and 3 fair value assets. consequently, these suggestions will impact the differential pricing across the three hierarchy levels during or in the period leading up to the 2008 financial crisis; thus our last hypothesis states: h4: the differential pricing of fair value assets and liabilities across the three hierarchy levels disclosed in terms of ifrs 7 is predicted to be different during and post the 2008 financial crisis period. research method sample selection our sample consists of companies from the financial sector listed on the jse which are also listed on the inet bfa website during the effective sample period. the study specifically targeted the financial sector because a large percentage of the assets in this industry consists of financial instruments. as detailed in table 1 panel a, the total sample consisted of 550 observations. the financial sector in south africa consists of different industries: banking, financial services, insurance, investment instruments and real estate. the robustness tests are stratified to cater for the heterogeneity of the industries as shown in table 1 panel b. if the test results were not further stratified it would have distorted the results due to the heterogeneity of the different industries in the financial sector. table 1: sample composition. sample period for hypothesis 1 and hypothesis 2 the effective application of ifrs 7’s fair value hierarchy disclosure requirements depends on ifrs 13 which became effective for all periods starting on 01 january 2013. it is therefore expected that companies would have started applying the fair value hierarchy disclosure requirements of ifrs 7 after 2013. the sample therefore covers the 2013–2015 period as per table 1 panel c. sample period for h3 to test whether the application of ifrs 13 had an impact on the market pricing of the fair value levels of assets and liabilities disclosed in terms of ifrs 7, we compared the reaction of the market to the different fair value levels in the preand post-ifrs 13 period to determine if investors were influenced by the pricing guidance in ifrs 13. our pre-ifrs 13 sampling period is from the date ifrs 7 became effective to the date ifrs 13 became effective: financial years starting on 01 january 2009 to financial years ending on 31 december 2012. the post-ifrs 13 period is all financial years starting on 01 january 2013 to financial years ending on 31 december 2015. the observations for the preand post-ifrs 13 period are captured in table 1 panel c. sample period for h4 with h4 we are interested in the impact of the 2008 financial crisis on the market pricing of fair value levels of assets and liabilities disclosed in terms of ifrs 7. to test the hypothesis, we compare the reaction of the market to the different fair value levels in the period during and post the 2008 financial crisis to determine whether investors were influenced by the effects of the 2008 financial crisis to price the fair value hierarchy levels of assets and liabilities differently. the period during the 2008 financial crisis sampling period consists of all financial years starting on 01 january 2009 to financial years ending on 31 december 2010. the post 2008 financial crisis period is all financial years starting on 01 january 2011 to financial years ending on 31 december 2015, as per table 1 panel c. we posit that the recession ended in 2009 (business cycle dating committee 2010), thus allowing a time lag of 1 year for accounting information to be communicated to the public. descriptive statistics the descriptive statistics of the main variables used in equation 3 and 4 are depicted in table 2 panel a. the number of observations utilised in the regression is 550 companies and the statistics show that a large percentage of the financial sector’s fair value assets (fva) consist of fair value assets hierarchy level 1 (fva1). the mean of fva1 is r31.1 billion compared to a mean of r18.62 billion for fair value assets hierarchy level 2 (fva2) and r6.783 billion for fair value assets hierarchy level 3 (fva3). on the other hand, fair value liabilities (fvl) do not display the same trend as fva; fair value liabilities hierarchy level 2 (fvl2) are making a large percentage of fvl. the mean of fvl2 is r22.83 billion compared to a mean of r11.13 billion for fair value liabilities hierarchy level 1 (fvl1) and r1.006 billion for fair value liabilities hierarchy level 3 (fvl3). the figures suggest that the fvl of the companies in the financial sector mainly consist of liabilities from financial institutions as opposed to liabilities raised in formal markets. in the financial sector, fva make up 43% of the total asset base and fvl make up 32% of total liabilities. the mean of the debt equity (de) ratio is 10.07. the value is tenfold the median value (0.914) which suggests that there are companies with excessive de ratios that distort the mean. net income (ni) has a mean of r1.778 billion which is a tenth of the market value of equity (mve). the means for all variables are greater than the medians, suggesting that there are companies with high variables that are distorting the means. this further necessitates the deflation of the figures. table 2: descriptive statistics – panel a: all observations. empirical model the most common models used in value relevance studies are the balance sheet and residual income approach (deaconu et al. 2010). the balance sheet approach assumes that fair value of assets (fva) less fair value of liabilities (fvl) is equal to market value of equity (mve) (landsman 1986). this approach can be stated as follows: although this approach is easy to understand and apply, the disadvantages of this approach are that it assumes that the fair values of all assets and liabilities can easily be determined which is not the case; secondly, not all assets and liabilities are measured at fair value; thirdly, not all assets and liabilities are recognised in terms of the ifrs 7 (deaconu et al. 2010). barth and landsman (1995) suggest that to capture the effect of off-balance sheet items, net income (ni) should be introduced into the equation to act as a proxy for those items. the residual income approach or ohlson (1995) model assumes that the mve equals the book value of equity (bve) plus residual income (ri) and other information dynamics (ʋ) (ohlson 1995). the equation can be stated as follows: α1 and α2 are valuation coefficients reliant on interest rates and information dynamics. deaconu et al. (2010) state that an advantage of this approach over the balance sheet approach is that it takes time value of money into account and other information that is not captured by accounting numbers. following song et al. (2010) and deaconu et al., we use the modified ohlson (1995) model to test our hypotheses. with the modified ohlson (1995) model we stratified the net assets as follows: non-fair value assets (n-fva) and liabilities (n-fvl) and the different fair value levels, fva1, fva2 and fva3 for assets and fvl1, fvl2 and fvl3 for liabilities. following barth and clinch (2009), we deflated all our variables with the number of ordinary shares at reporting date to mitigate scaling effects. the equation to test h1 can be stated as follows: in equation 3, pps represents price per share at financial year-end, ni is net income and έ represents the error of other information (song et al. 2010). to test h2, we expand equation 3 to include the variable highdebtequityratio. this variable acts as proxy for capital adequacy, the variable is 1 for all entities with a debt equity ratio higher than the median debt equity ratio and 0 otherwise. the equation to test h2 can be stated as follows: to test h3 we use the difference-in-difference test to determine whether the coefficients of β4 (β7) and β5 (β8) in equation 3 are different in the preand post-ifrs 13 periods. to test h4 we also use the difference-in-difference test to determine whether the coefficients of β3, β4 and β5 in equation 3 are different in the period during and post the 2008 financial crisis. results table 3 depicts the test results for equation 3 and tests h1 where the dependent variable is pps at financial year-end for the respective companies. with h1 we test whether the strength of fv instruments in relation to pps is directly related to the strength of the fv inputs as reported in terms of ifrs 7. a positive (negative) relationship between fva (fvl) and pps is expected and the coefficient estimate of fva1 (fvl1) is predicted to be significantly different and larger than the fva2 (fvl2) coefficient estimate, fva1 (fvl1) to be significantly different and larger than fva3 (fvl3) and lastly fva2 (fvl2) to be significantly different and larger than fva3 (fvl3). table 3: pricing of fair value hierarchy levels – dependent variable: price per share at year-end. the results show that fva1, fva2, fva3 and fvl2 are significant and positively associated with pps. the coefficients of fvl1 and fvl3 are positive but not statistically significant. table 3 shows that all the fva (fvl) levels are significantly priced differently from one another by investors with the exception of fva1 and fva3 where the differential pricing between the hierarchy levels is not significant. interestingly, the coefficients of fva are following an ascending order meaning that fva3 has a strong positive relationship with pps compared to fva2 and fva1. these results contradict prior literature (deaconu et al. 2010; goh et al. 2009) in respect of the strength of pricing of fva hierarchy levels as h1 was not confirmed. another anomaly per table 3 is that fvl2 has a significant and positive relationship with pps, contrary to our prediction. table 3 depicts the ordinary least square (ols) for equation 3. the first section details the coefficient estimates, standard errors, t-statistics and p-values. the second section details the adjusted r-squared and number of observations for the sample period 2013 to 2015. the last section depicts the tests for significant differences on the ols coefficient estimates between the different fair value assets (liabilities) levels. as equation 4 is a build-up from equation 3, it simply adds the de ratio to form equation 4. this equation tests the impact of high de ratio on the pricing of fva2 and fva3 as detailed in table 4. a negative relationship is expected between companies with high de and pps in terms of h2. table 4: pricing of fair value hierarchy levels: high debt equity companies – dependent variable: price per share at year-end. in comparison to the coefficient estimates of equation 3 (table 3) fva1, fva2 and fva3 coefficient estimates for equation 4 have remained the same. the statistical significance of all the variables has also remained the same as in table 3. the de ratio coefficient estimate is an insignificant 0. these results show that investors do not discount fva2 (fvl2) and fva3 (fvl3) of companies with high de ratios in the financial sector, thus h2 was not confirmed. table 4 depicts the ols for equation 4 and the first section details the coefficient estimates, standard errors, t-statistics and p-values. the last section details the adjusted r-squared and number of observations for the sample period 2013 to 2015. with h3 we are interested in the possible differential pricing by investors of fva2 (fvl2) and fva3 (fvl3) across the preand post-ifrs 13 periods. to test this hypothesis, we run equation 3 for the two periods to determine the differences in the coefficient estimates across the two periods and the results are shown in table 5 and figure 1. the coefficient estimates for the pre-ifrs 13 period are generally higher than the post-ifrs 13 period. across the two periods the coefficients estimates follow a similar trend except the coefficient estimates of fva3 which follow a downward trend for the pre-ifrs 13 period and the post-ifrs 13 period shows an upward trend. the adjusted r2 has increased in the post-ifrs 13 period, thus the explanatory power of the variables increased in the post-ifrs 13 period, compared to the pre-ifrs 13 period, implying that the introduction of ifrs 13 had a positive effect on the pricing of fva3. figure 1: depiction of pricing of fair value hierarchy levels preand post-ifrs 13. table 5: pricing of fair value hierarchy levels: preand post-ifrs 13. table 5 depicts the ols for equation 3 and the second column details the coefficient estimates of the pre-ifrs 13 period and the third column details the post-ifrs 13 period. the last column details the difference of the coefficient estimates between the two periods and the last section details the adjusted r-squared. with h4 we are interested in the possible differential pricing by investors of fva (fvl) during and in the period after the 2008 financial crisis period. to test this hypothesis, we run equation 3 for the two periods to determine the differences in the coefficient estimates across the two periods and the results are shown in table 6 and figure 2. the coefficient estimates for the period during the financial crisis are generally higher than in the period afterwards. across the two periods the coefficients estimates follow a similar trend except the coefficient estimates of fva3 which follows a downward trend for the period during the crisis and in the period after the crisis shows an upward trend. this evidence shows that during the financial crisis period investors discounted fva3 compared to the period after the financial crisis period, which is consistent with the assertion made by goh et al. (2009). the adjusted r2 has decreased in the period after the crisis period. the explanatory power of the variables decreased in the period after the crises. figure 2: depiction of pricing of fair value hierarchy levels during and after the 2008 financial crisis. table 6: pricing of fair value hierarchy levels: during and after the 2008 financial crisis. table 6 depicts the ols for equation 3 and the second column details the coefficient estimates of the period during the financial crisis and the third column details the post period. the last column details the difference of the coefficient estimates between the two periods and the last section details the adjusted r-squared. robustness tests: different industries to address the possible confounding effects on the testing of h1 and h2 due the heterogeneity of the sample, we stratified the sample into different industries within the financial sector. for fva we expect the coefficient estimates to be positive and for fvl, it to be negative; this arises from the theoretical construct of the accounting equation which assumes that equity is equal to assets, less liabilities. therefore, a positive (negative) fva (fvl) and statistically significant coefficient estimate means the concerned fva (fvl) hierarchy level has a positive (negative) effect on pps. the untabulated results for h1 in respect of the different industries show that the fva1 and fva2 coefficient estimates for the insurance and investment instruments industries are positive and significant, thus positively associated with pps. in the other industries, the coefficient estimates are not significant for fva1 and fva2. in respect of fva3, only the insurance, investment instruments and real estate have positive and significant coefficient estimates, thus positive association with pps. the fvl1, fvl2 and fvl3 coefficient estimates in the insurance industry are positive and significant, therefore positively associated with pps. the signs of the coefficient estimates for these variables contradict our prediction. for the investment instruments industry, fvl1 is significant and negatively associated with pps and for the financial services industry fvl3 is significant and negatively associated with pps. furthermore, the untabulated results show that the insurance industry has coefficient estimates that follow a descending order and are significant in respect of fva, confirming h1. all the fvl hierarchy levels coefficient estimates are significant for this industry; however, they are not following a descending order. h1 is therefore not confirmed in respect of fvl. for the investment instruments industry, the fva coefficient estimates are significant, but they are not in a descending order, thus h1 is not confirmed. for the other industries within the financial sector, h1 is not confirmed due to lack of significant coefficient estimates within all the fva and fvl hierarchy levels. for h2, we are mainly interested in the coefficient estimates for the de ratio and we expect a negative coefficient estimate, implying that investors discount pps of companies with high de ratios. the untabulated results show that the financial services industry with high de has a significant and positive association with pps, contrary to our expectation. further, the results show that the introduction of a high de ratio variable in the financial services industry leads to significant fva1, fvl2 and fvl3 coefficient estimates. consequently, fva1 and fvl2 (fvl3) become positively (negatively) associated with pps, implying that investors are affected by companies with high de ratios in respect of pricing fva2 (fvl2) and fva3 (fvl3). therefore, the results show support for h2 in respect of the insurance industry. it is also worthy to note that the regression results for equation 4 in respect of the banking, investment instruments and real estate industries are similar to the results of equation 3 in respect of fva and fvl. thus, a high de ratio has no impact on the pricing of pps and fva and fvl in these industries. conclusion this article investigates the pricing of fair value assets and liabilities hierarchy levels as disclosed in terms of ifrs 7. the article further investigates the effects of high debt equity ratio and possible differential pricing effects as a result of the introduction of ifrs 13 and the impact of the 2008 financial crisis. the h1 results reveal that fair value assets across the three hierarchy levels are positively associated with share price. contrary to the theoretical construct of the accounting equation, our results concluded that fair value liabilities hierarchy level 2 are positively associated with share price which presents a literature gap for future studies. all the fair value assets and liabilities hierarchy levels are priced differently, except the pricing for fair value assets level 1 and 3. h1 was not confirmed in respect of the financial sector as a whole, but was confirmed for the insurance industry in respect of fair value assets. our h2 results found that investors in the financial sector do not discount fair value assets and liabilities in respect of companies with a high debt equity ratio, but they place a discount on fair value assets and liabilities level 2 and 3 in the insurance industry. the h3 results reveal that the introduction of ifrs 13 had a positive pricing effect on fair value assets level 3 in respect of share price. to test h3 we examined the differences within the variables between the preand post-ifrs 13 period and considered trend analysis. the adjusted r2 for post-ifrs 13 increased, confirming that results have more explanatory power in comparison to the pre-ifrs 13 period. a limitation of this study is that the differences within the variables were not examined statistically but this can be addressed in future research. the h4 results reveal that in comparison to the period before and during the 2008 financial crisis, the pricing of fair value assets level 3 improved in the period after the 2008 financial crisis. however, the explanatory power of the variables used to test h4 decreased in the post-crisis period in comparison to the pre-2008 financial crisis period, as evidenced by the decline in the adjusted r2. these tests also involved a consideration of the differences within the variables between the periods during and after the 2008 financial crisis and trend analysis. the limitation stated for the h3 result is also applicable. acknowledgements all the reviewers for their comments and suggestions on the article. competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contribution h.h. was the main author of the study. m.z. was co-author and responsible for improving the quality of the study, as well as incorporating the reviewers’ comments. references barth, m.e., 2007, ‘standard-setting measurement 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world economic forum, 2016, global competitiveness index 2016–2017, viewed 27 august 2018, from http://reports.weforum.org/africa-competitiveness-report-2017/files/2017/05/southafrica.pdf sajems ns 7 (2004) no 2 341 appraisal of the fischer-dipasquale-wheaton (fdw) real estate model and development of an integrated property and asset market model ________________________________________________________________ h du toit and c e cloete department of construction economics, university of pretoria ________________________________________________________________ abstract this paper provides a concise overview of the development of an integrated property and asset market model (ipamm) for south african property markets, utilising the pretoria office market as case study. the ipamm simulates the interrelationships between property and asset markets in a diagrammatic quadrant model configuration. the fischer-dipasquale-wheaton (fdw) real estate model, arguably the most advanced diagrammatic quadrant real estate model available at present, served as basis for the development of ipamm. ipamm is essentially a regression model based on a system of stochastic equations that captures the interrelationships between property and asset markets. the model advances beyond mere conceptualisation of these relationships to a quantified interpretation and application of the theoretical premises that represent the micro-foundations of economic behaviour in property and asset markets. jel l85, r21, 31 introduction viezer (1999: 503) aptly states that, “(i)n the past, academics and investment managers have had difficulty in linking information from the markets for leasable space and asset ownership claims. the former is often referred to as the ‘space market’ and the latter as the ‘capital market.’ for almost fifteen years, academics have attempted to analytically integrate these two markets”. integration of these markets has been accomplished in the fischer-dipasqualewheaton (fdw) real estate model, which is arguably the most advanced diagrammatic quadrant real estate model available at present. this model served as basis for the development of an integrated property and asset market model (ipamm) for south african property markets, utilising the pretoria sajems ns 7 (2004) no 2 342 office market as case study. the value of such a model is that it provides a powerful conceptual instrument that integrates a spectrum of endogenous and exogenous economic and property market variables into a comprehensible framework, illustrating the potential effect of numerous market fluctuations on general equilibrium. coupled to the comprehensible schemata of stochastic equations incorporated in the model, an innovative heuristic device is rendered. background to the fdw model hendershott & ling (1984) co-authored the first article that attempted to integrate real estate space and capital markets. this model evaluated investment value responses to tax code alterations in a dynamic programming algorithm that used a traditional discounted cash flow equation with assumed parameters. in 1987, corcoran graphically illustrated the two interdependent markets and distinguished between shortand long-run supply of space. the next set of refinements comprised an “… elegant diagrammatic exposition in three similar articles: fisher (1992), dipasquale and wheaton (1992) and fisher, hudson-wilson and wurtzebach (1993)” (viezer, 1999: 504). the most recent formally published development is a quantitative version of the dipasquale-wheaton model (1992) that was published on the curtin business school website in 1999 with an accompanying description of the model, coauthored by fischer, dipasquale and wheaton (2001) hence the term fdw model. the fdw model, which utilised the perth office market as case study, conceptualises the interrelationships between the following four markets: market for space asset valuation construction sector stock adjustment. reconstruction of the fdw model defining the model the fdw model is a static, quadrant model that traces the relationships between real estate market and asset market variables, as well as the adjustments that take place to establish equilibrium in the supply of and demand for real estate (figure 1). sajems ns 7 (2004) no 2 343 the model is founded on the principles of demand and supply modeling: therefore, the demand for own real estate assets must equal its supply (dipasquale & wheaton, 1996: 6). hence, the primary objective of the model is to determine market equilibrium: i.e. the amount of floor space demanded and offered at a given price level or rent. figure 1 the quadrant fdw model asset valuation p = r/i rent 2 price ($) 1 stock (sq ft) market for space d(r, economy) = s construction sector p = f(c) 3 construction (sq ft) 4 stock adjustment s = c/d source: dipasquale & wheaton, 1996 in equilibrium, the supply of real estate space should be equal to demand at a specific price level (quadrant 1). the price paid for real estate assets by an investor is a function of real or imputed rent (achour-fischer, 1999: 34). rent is translated into property values when, in the capital market, rentals are capitalised at an appropriate capitalisation rate (quadrant 2). the difference between property values and replacement cost per unit triggers the supply of new development (quadrant 3). even in strictly static conditions, a certain level of construction is required to maintain stock at the required equilibrium: a portion of stock is always subject to demolition, withdrawal or deterioration (quadrant 4). adjusted stock, i.e. new construction less losses, is converted into a long-run stock of real estate space (back to quadrant 1). sajems ns 7 (2004) no 2 344 reconstruction of the fdw model the particular website on which the model was originally published, and more specifically the fdw excel model, could not be accessed. this meant that the fdw model had to be reconstructed. in addition, complete data sets are not shown in the literature. this problem is complicated by the fact that formulae quoted in the literature are shown in processed format. hence, figures and parameters could not be derived directly from these formulae. furthermore, literature sources are, in some instances, inconsistent and confusing (see e.g. achour-fischer, 1999: 40). the data problem was subsequently addressed by gleaning information from a combination of sources, including the textbook and relevant articles. data applicable to quadrant 1 was obtained from achour-fischer (1999: 40-41). in quadrant 2, an assumption had to be made concerning the market capitalisation rate. the second data limitation was encountered in quadrant 3, where an assumption had to be made concerning the minimum rate required to initiate new construction. the depreciation rate (quadrant 4) that had been applied to determine the total long term stock supply was obtained from dipasquale and wheaton (1996: 10). in most instances, the output from one quadrant provided input to the next. due to the fact that a relatively complete data set was available for quadrant 1, the model could be reconstructed quadrant for quadrant. in so doing, workable data sets were generated. model results table 1 summarises and compares the results obtained by means of the reconstructed fdw model and data on the perth (australia) office market, quoted in published literature. comparison with the perth office market was chosen because a complete set of results was available (achour-fischer, 1999: 40-41). the perth office market is in equilibrium at a rental rate of $201.78/m²/annum. at this rate, there is a total demand for 1.64 million square meters of office floor space. based on reconstructed data, market equilibrium was modeled at a rental rate of $199.69/m²/annum, which translates into a total demand for 1.65 million square meters of office floor space. model results that were obtained by means of the above mentioned exercise revealed a statistical variance of 0.6 per cent from the findings of the original perth office market example. based on these results, the pro forma spreadsheets sajems ns 7 (2004) no 2 345 were deemed to be sufficiently accurate to apply as basis for the development of an integrated property and asset market model (ipamm) for the city of pretoria. table 1 comparison of reconstruction results and data quoted in published literature variable literature fdw1 reconstructed fdw2 variance (%) total long run stock (m²) 1 644 444 1 650 295 0.35 annual rent per unit ($/m²) 201.78 199.69 1.05 price of construction ($/m²) not shown 1 815.32 n/a annual new construction (m²) 16 444 16 503 0.35 average 0.6 source: 1 achour-fischer (1999: 40-41) 2 reconstructed fdw model, april 2002 nature of applications it is important to note that the fdw model is designed for comparative static analysis. tracing the effects of single variate or multi-variate manipulations through the various quadrants of the model can simulate market conditions. the model does not account for time lags that invariably occur in the process of re-adjusting to market equilibrium. these dynamic aspects fall outside the ambit of the fdw model. concluding remarks on the fdw model 1. the model provides a framework that illustrates the relationship between real estate use and real estate assets. this framework illustrates, inter alia, the inverse relationship between short-term real interest rates and property values. 2. single variate shifts seldom occur and it is more likely the case that economic events cause several shifts to occur simultaneously. for example, if the economy contracts, employment creation slows down and short term interest rates tend to rise. it is, therefore, more likely that multivariate shifts will occur in the model. although this results in a more complex analysis, the net result is still a combination of the impacts of each individual shift. 3. the model presents a framework that illustrates the effect of exogenous changes on new equilibria. however, the model does not give an accurate account of the intermediate stages of market adjustment. hence, time lags that commonly occur are not accounted for. sajems ns 7 (2004) no 2 346 development of an integrated property and asset market model for south african markets the next phase of the research initiative applied the reconstructed fdw model framework to develop an integrated property and asset market model for the city of pretoria. for the purposes of this analysis, the pretoria office market was selected as case study. the study focuses on formal office space, including all grades of office floor space in the cbd and decentralised locations. the study excludes office space in the form of dwelling house offices, as well as office space ancillary and subservient to retail and industrial land uses. historic office market data was utilised for a specific time period (1997). the use of historic data facilitated comparison between model results and factual data, i.e. results of a modeling exercise could be compared to actual market conditions that were known to have prevailed at that particular point in time. hence, availability of secondary data facilitated model calibration. general assumptions and economic fundamentals in addition to the general assumption of perfect competition in the economy, diagrammatic quadrant models such as the fdw model and ipamm are generally based on the following assumptions that are more specific to the real estate environment: 1 the capitalisation technique provides a basic and acceptable mechanism to model the inverse relationship between interest rates and property values. 2 there is a definitive minimum rate, expressed as construction cost per unit (e.g. r/m2) that will trigger new development. 3 even in strictly static conditions, a certain minimum level of construction is required to maintain equilibrium in the supply of space. this can be ascribed to the fact that a portion of stock is always subject to demolition, withdrawal or deterioration. the model assumes that these losses can be measured and expressed in terms of a depreciation rate, which is a constant percentage of the existing stock in a static model (achour– fischer, 1999: 37). 4 the model assumes a straight-line simplification of the relationship between relevant variables in each quadrant. 5 in effect, the model is insensitive to the nature and structure of the construction industry and its local idiosyncrasies. 6 it is assumed that there is a determinable ratio of labour to floor space utilisation rate in each real estate market. for example, in the offices sector, the average office worker occupies 20m2. independent studies, for sajems ns 7 (2004) no 2 347 example hakfoort & lie (1996: 183-96), have verified that there is a distinct utilisation rate for each real estate market (e.g. offices and retail) and, furthermore, that these ratios differ for each geographic market area. 7 the model assumes that development is mainly private sector driven. the effects of land grants and other types of government incentives that impact on real estate markets are not factored into the model. it may, however, be argued that such grants and incentives influence local economic activity in a certain geographic area and that the indirect effects thereof are factored into the model via quadrant 1. 8 due to the interactive way in which the quadrants are linked, the model may create the impression that there are no time lags involved in the process of re-adjusting to equilibrium. 9 as far as the relevance and applicability of the model is concerned in a market dominated by owner-occupied real estate, it is assumed that the decisions of owner-occupiers and tenants are influenced by the same economic and capital market conditions; that these owner-occupiers have the same investment motives as tenants; and that the model therefore behaves identical in both types of markets (dipasquale & wheaton, 1996: 10-11). specific ipamm assumptions and delimitations the aim of the ipamm model development process was to test the model and subsequent results in terms of available data and not, per se, to test the validity of secondary data itself. in the context of the above, specific model assumptions were limited to the following: 1 the model incorporates an equilibrium vacancy rate of five percent (5.0 per cent). 2 the stock depreciation rate is assumed to be one percent (1.0 per cent) per annum. 3 for reconstruction purposes, the slope of the demand curve is assumed to be 0.5. a slope of 0.5 implies that market demand and supply conditions are perfectly elastic. 4 market impacts are distributed evenly throughout the geographic office market landscape, i.e. the model does not differentiate between impacts on the cbd versus decentralised office locations. 5 associated with point four above, market data with specific reference to rentals, property values, construction rates, vacancy rates, the capitalisation rate and depreciation rate, reflect market averages across a spectrum of office locations and grades. as such, the model does not distinguish between micro market differences. sajems ns 7 (2004) no 2 348 6 the model therefore, in effect, assumes a similar risk and return profile for all office locations and grades. 7 the static model portrays the 1997 pretoria office market in an equilibrium state, i.e. all internal and external forces have been fully accounted for in the model. data specifications and modeling table 2 summarises key source data variables utilised in the pretoria ipamm modeling exercise. a comparison of subsequent modeling results and actual market data is shown in table 3. table 2 pretoria ipamm key source data variables variable key source data variables number of office workers1 79 000 annual stock depreciation rate (%)2 1.00 space per office worker (m²)3 20.00 market capitalisation rate (%)4 13.44 minimum construction price (r/m²)5 2 150 source: 1 urban-econ (1998) 2 assumption, derived from fdw model 3 urban-econ (1998) 4 rode & associates (1997) 5 rode & associates (1998) key source data variables substituted in the pretoria ipamm include an office market labour force of 79 000 workers; a space utilisation rate of 20m² per office worker; a market capitalisation rate of 13.44 per cent; and a minimum construction price of r2 150/m². the annual stock depreciation rate was assumed to be 1.0 per cent per annum. main findings of the modeling exercise that were generated by substituting these variables in the pretoria ipamm are shown in table 3. prevailing market conditions (1997) include a total long run stock of 1 599 600m² at a weighted average rental rate of r30.04/m², with a standard deviation of r3.46 (calculated from rode, 1998). these market conditions compare favourably to pretoria ipamm results of 1 599 248m² at an average rental rate of r30.69/m². the pretoria ipamm model’s predicted rental differs 2.16 per cent from the weighted average of the market data and is well within a standard deviation of the market data. the long run stock prediction is within 0,02 per cent of the actual data. taking cognisance of the macro level at which the pretoria ipamm sajems ns 7 (2004) no 2 349 simulation occurs, the variance between model results and prevailing market data is deemed to be negligible. table 3 comparison of market data and pretoria ipamm results variable market data pretoria ipamm difference (%) rent per unit (r/m²) 30.04 30.69 2.16 annual new construction (m²) 22 491 15 993 not relevant total long run stock (m²) 1 599 600 1 599 248 0.02 average 1.2 concerning the estimated level of annual new construction, it should be noted that the estimated level of annual new construction (15 993m²) in terms of the pretoria ipamm will not necessarily equate to actual new construction that occurred in the office market during 1997 (22 491m²). this can be ascribed to a number of factors including, inter alia, the following: the pretoria ipamm, as is the case with the fdw model, assumes a straight-line simplification of the construction function. in practice, the construction sector reveals cyclical tendencies. the pretoria ipamm simulates an equilibrium level of annual new construction that is required to satisfy equilibrium demand. the equilibrium vacancy rate of 5.0 per cent does not reflect construction induced vacancy. furthermore, the construction sector is typified by phases of overbuilding as a consequence of, inter alia, speculative development. subsequent phases are characterised by reduced levels of building activity during which the take-up rate of available space increases. actual construction levels are therefore influenced by a number of factors to which the model is insensitive, including construction levels that are artificially inflated or deflated by subjective, end-user decision-making processes; and excess, construction-induced stock capacity in the market. the fdw model, and hence the pretoria ipamm, is not sensitive to the nature and structure of the construction industry and its local idiosyncrasies. the model does therefore not necessarily reflect the uniqueness of localised micro market conditions. in the context of the above, it follows that a direct comparison of estimated annual new construction and actual construction in the market should acknowledge the nature and structure of the construction industry. sajems ns 7 (2004) no 2 350 introducing impacts to ipamm and scenario modeling the objective of this section is to illustrate the combined effect of impacts that typically occur in, respectively, property and asset markets. these impacts occur as the result of a complex sequence of processes, linkages and decisions in the market. roulac (1996: 323-46) provides a strategic real estate framework that aims to identify and describe these processes, linkages and decisions. the property and asset markets reflect a series of strategic interactions between users and suppliers of space, resulting in real estate transactions (roulac, 1996). roulac argues that the “… confluence of the initiatives and decisions of those who utilise space with those who are involved in creating and controlling it are filtered through a series of transaction interaction forces, including: property market conditions space user strategies, resources and priorities competing investment performance service provider and developer/deal-maker initiatives capital market conditions economic activity business consumer confidence public sector policies, priorities and programmes” (1996: 337, 45). the net effect of these interacting forces can be traced to financial input-output relationships in the property and asset market. it is these aspects that the fdw model aims to illustrate. the above-mentioned study by roulac identifies important factors that affect property and asset market equilibrium. fisher (1992: 161-80) developed a framework that identifies and categorises a number of macro factors that influence this equilibrium state. the framework within which these macro changes occur, and its relation to user and capital market equilibrium is illustrated in diagram 1. in this diagram, fisher (1992: 163-6) identifies spatial and non-spatial macroeconomic impacts that influence the supply of and demand for real estate space and real estate assets. diagram 1 illustrates that these impacts on the model are influenced by, inter alia, aspects such as international oil prices, the level of industrial production, defense spending, export earnings, inflation, exchange rates, interest rates and tax law changes. sajems ns 7 (2004) no 2 351 diagram 1 factors affecting space and capital market equilibrium macro factors spatial non-spatial oil prices industrial production defense spending farm income net exports unexpected inflation change in term structure market risk structure exchange rates tax law changes spatial distribution employment, income, population demand for capital assets (with different risk characteristics) demand for space services by users land & improvements franchise agreements leases with other tenants, etc capital market equilibrium existing supply of all capital assets (covariance of return with factors) stock in corporations that own real estate direct investment in real estate equity (leases and residuals) mortgages and hybrid mortgages various types of real estate securities all other capital assets (bonds, government securities, etc in the us and rest of universe) investors hold optimal portfolios risk premium for relevant factors space market equilibrium expected return (discount rates and capitalisation rate) for real estate existing supply (type location) current vacancy equilibrium rental rate expected rents expected vacancy expected absorption riskiness of rent (covariance of rent with factors) construction or replacement cost (including land) fee simple value of property (unencumbered by leases) (market financing) value of existing leases value of residual (lease renewals and reversion) value of special financing expected new space equal in long-run equilibrium source: fisher (1992: 164) sajems ns 7 (2004) no 2 352 in addition to these macro aspects, the model is also influenced by local market real estate dynamics, including current rents, expected rents, vacancy, absorption rate, risk, return and investors’ portfolios (fisher, 1992: 164). according to dipasquale and wheaton (1992: 190-197 and 1996: 10-8), these aspects culminate in three broad impacts on the fdw model, as illustrated above. economic growth and the demand for real estate use long term interest rates and the demand for real estate assets short term credit availability, construction costs and the supply of new space. fluctuations in these variables can result in either a proportionate shift, a disproportionate shift or a unilateral shift in a specific quadrant of the model (cf. also airea, 1987: 34-39). each impact has different repercussions on the model. in each case, the quadrant that is initially affected should be identified. these impacts can then be traced through each of the other three quadrants. this comparison of different long-run solutions, also referred to as market equilibrium, in a model in called comparative static analysis (dipasquale & wheaton, 1996: 11). the impact of these external impacts on the model is subsequently discussed. economic growth and the demand for real estate use economic growth, in terms of the fdw model, translates into increased production, employment, household income or the number of households (dipasquale & wheaton, 1992: 190-193 and 1996: 11-13). depending on which of these variables define the parameters for the demand curve (quadrant 1), the curve will respond by means of a unilateral movement outwards. the term unilateral indicates that only the demand curve will shift. initially, only quadrant 1 is affected. an economic expansion of this nature will have the effect that more space is demanded at current rents. supply is relatively static over the short term. in terms of the laws of supply and demand, increased demand against fixed supply will therefore force rental upward. higher rentals translate into greater asset prices (quadrant 2) that, in turn, encourages new construction (quadrant 3). over time, new construction increases available stock (quadrant 4) and the market tends toward a new equilibrium state. sajems ns 7 (2004) no 2 353 the shift in equilibrium brought about by an economic expansion need not necessarily be a proportional shift: the nature of the shift that occurs is a function of the elasticity and hence, slopes of the various curves. an economic expansion therefore increases all equilibrium variables in real estate markets. in general, a recession is characterised by higher vacancy and lower levels of construction, whilst during an economic recovery, vacancy is lower and construction activity increases (dipasquale & wheaton, 1996: 13). caution should be taken not to generalise this statement. independent research (pyhrr et al., 1989: 485-89) indicates that a period of overbuilding in the real estate cycle, which typically follows an economic expansion, is initially accompanied by higher than normal vacancy rates. thereafter, as take-up increases, vacancy decreases. this state is maintained into the initial phases of an economic recession, when construction activity declines and space utilisation increases. these findings therefore suggest exactly the opposite: during an economic expansion, new construction leads to higher vacancy and vice versa. it should, however, be noted that prolonged periods of economic recession, accompanied by a general decline in business growth, will eventually lead to higher vacancy. the fdw model does, however, not give an accurate account of these intermediate stages of market adjustment. hence, models designed for the purpose of comparative static analysis do not describe the behaviour of variables during the transition from one equilibrium to another. this shortcoming needs to be borne in mind when interpreting and applying the fdw model. long term interest rates and the demand for real estate assets the demand for real estate assets is determined by real estate yields in relation to the after tax yield of fixed income securities and other investments. aspects such as long term interest rates, growth in rentals, risk and taxation influence real estate yields. these aspects are reflected in the capitalisation rate. these parameters influence the slope of the curve in quadrant 2. if interest rates in the economy rise, the capitalisation rate rises and investors demand a higher return from real estate. higher returns can not be realised from current rents and the yield from real estate becomes low relative to other investment options. investors will therefore shift their funds from real estate to other investments in their portfolios. under these conditions, the capitalisation rate rises and the curve in quadrant 2 rotates in a clockwise direction, lowering real estate asset prices. greater perceived risk and adverse tax changes have a sajems ns 7 (2004) no 2 354 similar effect on the curve in quadrant 2. the converse may also occur, causing asset prices to rise. due to lower asset prices, construction activity contracts (quadrant 3) and this decreases the annual supply of new construction. in the long run, less stock comes onto the market (quadrant 4), forcing rentals upward (quadrant 1). higher rent levels bring the market into equilibrium. the text book assumes that capital market efficiency adjusts the prices of particular assets and that each investment therefore earns a common, riskadjusted after-tax total rate of return (dipasquale & wheaton, 1996: 14). short term credit availability, construction costs and the supply of new space short term credit availability and construction costs influence the supply schedule for new construction (quadrant 3). construction costs may rise due to a number of factors. these factors include, inter alia, higher short-term interest rates, scarcity of construction financing, and stricter zoning and planning regulations. if any of these factors deteriorate, construction costs rise and profitability declines, resulting in a unilateral outward shift of the construction function (figure 4). therefore, the minimum value (r/m2) required to justify some level of new development increases. at current asset prices, construction activity will decrease, the annual level of new construction will decrease (quadrant 3); the long term supply of stock will be relatively lower (quadrant 4); rents will rise (quadrant 1); and asset prices will rise (quadrant 2), thereby bringing the market to a new equilibrium state. ipamm scenario modeling the preceding paragraphs predominantly focused on the simulation of an equilibrium state in property and asset markets. in practice, this equilibrium state is influenced by one or a combination of factors. three scenarios were subsequently generated by means of the pretoria ipamm to illustrate the effect of typical market fluctuations on an equilibrium state: scenario 1: demand shift scenario 2: shift in capitalisation rate scenario 3: shift in construction costs. sajems ns 7 (2004) no 2 355 each of these scenarios is subsequently discussed and conceptually illustrated. pretoria ipamm scenario 1: demand shift the impact of a demand shift on the model is a function of the mathematical definition of the demand curve. an increase in demand may be ascribed to, inter alia, economic growth; natural population growth and subsequent growth in the number of qualified service sector employees; and in migration of service sector employees to an economically prosperous region. in the pretoria ipamm, the demand curve is defined in terms of, inter alia, the number of office workers in the pretoria economy. a demand shift was subsequently by means of an increase in the number of office workers. all other factors being equal, an increase in demand for office space causes the demand curve to shift in an easterly direction, from d1 to d2. the net effect of this demand shift is illustrated in figure 2. the impact on market equilibrium can be summarised as follows: an increase in the number of office workers increases the demand for office space (quadrant 1) at fixed short term stock supply levels, higher rentals can be demanded (quadrant 1) higher rentals result in an appreciation of asset values and prices (quadrant 2) higher asset values stimulate activity in the construction sector (quadrant 3) new construction activity increases the long run supply of stock (quadrant 4) increased long run stock restores market equilibrium. pretoria ipamm scenario 2: shift in capitalisation rate in the second scenario, an increase in perceived investment risk in the market is factored into the pretoria ipamm by means of an increase in the market capitalisation rate. higher capitalisation rates may be the consequence of higher real interest rates, or an increase in perceived investment risk in a specific area due to spatial and/or a-spatial factors. an increase in the capitalisation rate rotates the asset valuation curve in a clockwise direction, from v1 to v2. the net effect of an increase in market risk on each of the pretoria ipamm quadrants is illustrated in figure 3. sajems ns 7 (2004) no 2 356 figure 2: demand shift in terms of the pretoria ipamm asset valuation p = r/i rent (r) 2 value (r) 1 d1 stock (m²) market for space d(r, economy) = s d2 constructio n sector p = f(c) 3 construction (m²) 4 stock adjustment s = c/d the pretoria ipamm illustrates the net effect of this shift in the market capitalisation rate on property and asset market equilibrium as follows: higher investment risk translates into a higher market capitalisation rate (quadrant 2) in the short term, asset prices depreciate as other types of investments present more secure and lucrative opportunities and subsequently siphon off potential investors from the property sector (quadrant 2) as a consequence, construction activity decreases (quadrant 3) additions to total long run stock diminish (quadrant 4) limited supply systematically inflates rentals (quadrant 1) increased rentals restore market equilibrium. pretoria ipamm scenario 3: shift in construction costs the third scenario illustrates the effect of increased construction costs on market equilibrium. construction costs are influenced by a number of factors, including macroeconomic variables such as interest rates, production price inflation (ppi) and import inflation; as well as by a spectrum of micro location factors such as the cost and availability of construction materials, soil type and the structure of local labour costs. sajems ns 7 (2004) no 2 357 figure 3 shift in capitalisation rate in terms of the pretoria ipamm asset valuation p = r/i v2 rent (r) v1 2 value (r) 1 stock (m²) market for space d(r, economy) = s construction sector p = f(c) 3 construction (m²) 4 stock adjustment s = c/d in response to an increase in construction costs, the minimum rate required to initiate new construction increases and the construction cost curve shifts in a westerly direction, from c1 to c2, as illustrated in figure 4. in terms of the pretoria ipamm, the effect of increased construction costs on market equilibrium can be summarised as follows: initially, the increase in construction costs stun construction activity (quadrant 3) additions to total long run stock diminish (quadrant 4) due to relatively fixed supply, market rentals escalate over time (quadrant 1) a combination of reduced supply and increased rentals, inflate existing asset values and prices (quadrant 2) inflated asset values justify new construction at the higher construction cost rate, thereby restoring market equilibrium sajems ns 7 (2004) no 2 358 figure 4 shift in construction costs in terms of the pretoria ipamm asset valuation p = r/i rent (r) 2 value (r) 1 stock (m²) market for space d(r, economy) = s construction sector p = f(c) c2 3 c1 construction (m²) 4 stock adjustment s = c/d interpretation of results and validity of findings the pretoria ipamm simulation results outlined above indicate that the model successfully simulated an equilibrium state in the pretoria office market. in the course of developing and adjusting the pretoria ipamm to simulate local property and asset market equilibrium, a number of factors were observed that merits comment. in this respect, interpretation of the above mentioned pretoria ipamm results should take due cognisance of the following: 1 the pretoria ipamm proved to be extremely sensitive to changes in certain key variables, in particular the minimum construction price, parameter ‘a’ and parameter ‘b’. these are calibration parameters that determine the demand curve slope in quadrant 1. the latter parameters therefore influence demand elasticity. this level of sensitivity suggests that the model is more suitable for macro analyses, for example a citywide office market analysis, than micro analyses, for example a neighbourhood or precinct analysis. 2 similar to the fdw model, pretoria ipamm assumes perfect demand elasticity. prevailing market conditions are not necessarily perfectly elastic. this implies that users of the model have to be particularly mindful of the assumptions on which the model is based. sajems ns 7 (2004) no 2 359 3 in practice, supply is relatively inelastic due to the fact that real estate is a fixed, non-liquid asset. assume, for instance, that the pretoria ipamm is manipulated by means of an increase in the market capitalisation rate. the net result suggests that total long run stock demand (quadrant 4) will decline from its previous level. in this particular instance, model results point to a relative decline in demand for stock, rather than an absolute decline in available stock levels. 4 pretoria ipamm is a static model that provides a snapshot of the market at a given point in time. as such, the model does not explicitly recognise and reflect the cyclical, and therefore dynamic nature of property and asset markets. interpretation of pretoria ipamm results should not loose sight of the cyclical nature of market demand and supply. 5 finally, in terms of the theory on which the fdw model and hence, the pretoria ipamm is based, static models do not attempt to explain the behaviour of variables during the transition from one equilibrium to another. the pretoria ipamm therefore does not recognise time lags that invariably occur in the market adjustment process. concluding remarks on the ipamm the following can be concluded with regard to the ipamm model development and application process: the pretoria ipamm modeling exercise indicate that the model has specific strengths and weakness that dictate its application possibilities. due to the great number of variables that influence market equilibrium and the intricate relationships between these variables, application of the model requires in-depth knowledge of the stochastic equations and interrelationships on which the pretoria ipamm is based. an understanding of the internal dynamics of the model is essential to ensure judicious data modeling. the objective of the modeling exercise was to empirically test the relevance of the principles on which the model is based and not, per se, to evaluate the accuracy of secondary data sources. hence, it should be noted that, prior to application of pretoria ipamm in practice, calibration parameters of the model need to be further refined, in particular parameters ‘a’ and ‘b’ of the construction function (quadrant 1) that portray demand elasticity. sajems ns 7 (2004) no 2 360 appraisal of the ipamm concept a critical assessment of the fdw model, and specifically the ipamm, reveals a number of assumptions and characteristics. recursive device ipamm is a short-run, period-by-period adjustment model based on regression principles that facilitates, by means of comparative static analysis, predictions of user market supply and demand relationships in the long run. as such, the model is a recursive device, based on an iterative process. due to these characteristics, the model tends to oversimplify dynamic market adjustment and subsequent lags that occur in the equilibration process. stock and flow characteristics the model portrays stock and flow characteristics. stock refers to existing space utilised for office (or other as defined) purposes, whereas flow relates to the provision of new space. in accordance with the scale and longevity of the stock of commercial buildings, new supply accounts only for a small proportion of total stock. it is this uneven flow characteristic, dictated by market forces, that introduces the cyclical dimension into the market. ipamm is ideally suited to simulate the stock scenario due to its static nature. modeling of flow scenarios is only possible by means of an iterative process of comparative static analysis, i.e. modeling a sequence of static stock scenarios. this requires user skill and judicious decision-making on sensible assumption scenarios. the number of variables combined into the model, coupled with the intricate relationship between variables suggest that even the most skilled property practitioner will find this task challenging. perfect market competition the integrated property and asset market model concept postulates perfect market competition. perfect market competition implies that all agents involved in the property market must base their investment decisions on perfect and complete market knowledge concerning market indicators such as rentals, asset values, returns on investment, availability of space by type and location, proposed new developments that will come on stream in the short term and, importantly, the cyclical nature of the building industry. sajems ns 7 (2004) no 2 361 the cyclical nature of the building industry introduces the concept of developer and investor expectations. such expectations can either be naïve or rational. naïve expectations imply a line of thinking that the future would be the same as the present. rational expectations, on the other hand, imply that developers use their knowledge of the property market, the wider economy and the best available theories of how the two function and interrelate. this dimension of the model places the responsibility squarely on the user of ipamm to accurately express variables, such as capitalisation rates, in expectational terms. ball, liziere & macgregor support this notion (1998: 36-39). property values, market prices and replacement costs the price determinant technique applied to estimate property values, uses rent as space market proxy for the capital market value of real estate assets (quadrant 2). in this instance, ipamm assumes that property values and market prices are synonymous, i.e. that valuations accurately reflect prevailing market prices. it should be noted that there are circumstances in which this assumption does not necessarily hold true. apart from minor discrepancies that may occur as a consequence of interplay between macroeconomic and building cycles, market prices may vary significantly from property values in precincts where environmental decay has a detrimental effect on achievable market prices. applications of the model should heed the potential pitfalls associated with modeling exercises involving highly centralised spatial urban markets. coupled with this aspect, is the occurrence of economic obsolescence and the translation of these environmental qualities into sensible modeling parameters. in conclusion, it should be recalled that, in terms of the ipamm, new construction will take place at the point where property values equal replacement costs (quadrant 3). replacement costs therefore serve as precursor to new development. in this respect, integrated property and asset market models define replacement costs comprehensively in order to include not only direct construction costs, but also other on-costs related to site clearance, financing and land costs. separate property development industry ipamm assumes that there is a separate property development industry that provides completed projects to investors. in reality, however, many developers are also investors who retain certain properties after the initial investment has occurred. in itself, this assumption does not have a direct influence on the model. the indirect effect, however, occurs when there is a marked increase in sajems ns 7 (2004) no 2 362 the occurrence of owner occupied buildings, as opposed to leasing, in the market area as a whole. in reality, this introduces complexities pertaining to market rentals versus bond installments, escalation rates and a distinction between direct vacancy, sub-lease vacancy and total vacancy. however, integrated property and asset market models assume that: the decisions of owner-occupiers and tenants are influenced by the same economic and capital market conditions; owner-occupiers essentially have the same investment motives as tenants; and annual rent per square meter is but one mechanism that can be utilised to express the utility value of real estate. owner-occupied commercial property has costs of use that implicitly constitute rent. this is often referred to as imputed rent (ball, liziere & macgregor, 1998: 19). in essence, it can therefore be concluded that integrated property and asset market models behave identical in owner-occupier and rental markets. indirect effect of government intervention in the property market in terms of south african public law, government sector is not permitted to speculate in the property market or, for that matter, to engage in activities aimed at attaining financial gain. government intervention in the property market, however, extends beyond direct intervention. indirect government intervention in the property market includes taxation measures and special development programmes that influence spatial property markets. the first mechanism at government’s disposal is taxation. capital gains tax (cgt) came into effect in south africa on 1 april 2002. in this respect, there appears to be general consensus among property practitioners that the impact of cgt on the property market will mainly be confined to an ‘add-on’ to property prices, as opposed to serving as deterrent to property investment. concerning the after tax rate of return, ipamm assumes that capital market efficiency adjusts the prices of particular assets and that each investment therefore earns a common, risk-adjusted after-tax total rate of return. these adjustments are accounted for in quadrant 2 of the model, the market for asset valuation. another sphere of government influence in the property market, involves spatial development programmes. in certain geographic locations, these programmes may distort the property market in terms of, inter alia, spatial settlement patterns, property prices and rentals. these programmes may induce large scale building activity at distorted market prices due to, inter alia, incentivised development and the fact that government does not necessarily adhere to the sajems ns 7 (2004) no 2 363 free market capitalistic premises on which integrated property and asset market models are based. application of the ipamm in a market characterised by such extraordinary conditions may yield distorted results. benefits of integrated property and asset market models as stated in the introduction, academics and investment managers have had difficulty in linking information from the markets for space and capital markets where real estate assets are valued. in other words, the distinction between use decisions and investment decisions, and the links that were conceptually known to exist between these markets, proved to be problematic in as far as its quantification was concerned. the fdw model that was initially conceived in 1992 provided not only a diagrammatic exposition, but also one of the first quantified mechanisms that captured the basic interrelationships between property and asset markets. as such, it advanced beyond mere conceptualisation of these relationships to a quantified interpretation and application of the theoretical premises of modernday economics that represent the micro-foundations of economic behaviour in property markets. diagrammatic integrated property and asset market models, such as ipamm and fdw, illustrate the potential effect of numerous market fluctuations on general equilibrium. although they do not explicitly account for time lags and dynamic adjustments that occur in the market equilibrium adjustment process, these models integrate a spectrum of endogenous and exogenous economic and property market variables into a comprehensible framework. the relatively simple layout of these diagrammatic quadrant models provides a powerful conceptual instrument which, coupled with its comprehensible schemata of stochastic equations, renders it an innovative heuristic device with, inter alia, pedagogical value. limitations of integrated property and asset market models general limitations of these models relate to its static nature and the subsequent inability to illustrate the dynamic process of adjustment to market equilibrium. in addition to these general limitations, viezer (1999: 503) advances three criticisms against diagrammatic integrated property and asset market models. first, these models assume the capitalisation rate is exogenously determined. instead, it is contended that a multi-factor asset pricing model should be used to determine the appropriate discount rate that, in turn, would determine both the sajems ns 7 (2004) no 2 364 market value and capitalisation rate. secondly, these models suggest that equilibrium is a natural state and that all values are determined simultaneously. however, as duly noted, in reality time lags do occur in market adjustment. thirdly, diagrammatic models can forecast general levels and changes in direction for real estate markets, but “… it can not be used to compare one market to another. to be useful to the practitioner, the diagrammatic model needs to be statistically estimated in individual markets.” (viezer, 1999: 503). the latter criticism offers, in itself, a relatively simple solution: to ensure optimum accuracy, the model needs to be statistically estimated for each individual market. a concluding remark, rather than a point of criticism, relates to the use of a depreciation factor to ‘capitalise’ annual flow of construction into a long-run total supply of stock (quadrant 4). once again, the quantitative result should ideally be interpreted as a static outcome based on prevalent market conditions, rather than a mean value of cyclical time series data. this aspect, once again, relates to the static nature of integrated property and asset market models and the imminent fact that a predictive time series can only be attained by means of an iterative process in which key variables are manipulated sensibly and knowledgably. application possibilities the ipamm matrix of application possibilities identifies a number of use options and potential user markets for each application of the model. ipamm provides useful application possibilities to each of the three core disciplines within the property sector, namely property development, property management and property valuation, as well as sectors that provide strategic services to property practitioners, namely banking and finance, and tertiary education. table 4 summarises these application possibilities and potential user markets in matrix format. in each of the above mentioned sectors, strategic planning and decision making actions are based on two factors, namely: historic market data; and subjective expectations on future market behaviour. ipamm, as analytical instrument, incorporates a broad spectrum of endogenous and exogenous variables in the most influential markets that impact on the property business, namely the market for space, asset valuation and the construction sector. as such, it provides an intelligible framework that adds sajems ns 7 (2004) no 2 365 structure to data. hence, ipamm is ideally suited to aid strategic decision making processes in the sectors identified in table 4. the list of ipamm application possibilities and user markets is by no means exhaustive. it merely serves to illustrate the multifaceted nature of ipamm and its subsequent relevance to a spectrum of property practitioners. an emphasis on the inclusive, integrated nature of ipamm, rather than its limitations, should serve as catalyst for exploring creative application possibilities. table 4 ipamm matrix of application possibilities user / sector property development property management banking and finance investment management tertiary education demand estimation definite probable definite probable limited geographic market analysis definite limited definite probable limited property type market analysis definite limited probable probable limited space utilisation analysis definite definite limited probable limited take-up and vacancy estimation definite definite probable definite limited market cycle simulation definite definite definite definite limited asset valuation movement probable limited definite definite limited rent reviews (escalations) limited definite limited probable limited risk management probable limited definite definite limited speculation and price movements definite limited probable probable limited a p p l i c a t i o n pedagogical instrument probable probable probable probable definite notes: definite: high degree of correlation between ipamm capabilities and the core business of this sector. probable: ipamm capabilities do not necessarily correlate with the core business of this sector but may, in certain instances, provide useful / insightful applications. limited: no definite correlation between ipamm capabilities and the core business of this sector. sajems ns 7 (2004) no 2 366 possible improvements and opportunities for further research an appraisal of ipamm, with due cognisance taken of its fundamental assumptions, benefits and limitations, suggests that the model accurately captures important interrelationships between key property and asset market variables. as such, ipamm is a useful multidimensional analytical and simulation instrument with diverse application possibilities. the following aspects can be identified as focus areas for future research: 1 demand elasticity and hence, the slope of the demand curve in quadrant 1. in this regard, calibration parameters ‘a’ and ‘b’ should be researched and refined. 2 the definition of minimum construction cost needs to be refined, specifically the significance and quantification of additional costs pertaining to site clearance, financing and land costs. 3 the depreciation factor utilised in quadrant 4 requires empirical testing. 4 ipamm is essentially a regression model based on a system of stochastic equations. a brief introduction to these econometric concepts, prior to further research and development on the model, may improve judicious manipulation of variables. 5 a comprehensive data pool should be created from which ipamm can be calibrated and empirically tested in various geographic markets and for various property types. 6 on a more fundamental level, the use of artificial intelligence techniques such as neural networks and fuzzy expert systems seems to hold considerable promise for the development of improved real estate market models (see, e.g., engelbrecht, 2002 and negnevitsky, 2001). it is concluded that ipamm, within the parameters specified in its relatively simplistic system of equations, establishes a comprehensible framework that could evolve into a powerful decision support mechanism for property practitioners in various sectors of the economy. references 1 achour-fischer, d. (1999) “an integrated property market model: a pedagogical tool”, journal of real estate practice and education, 2(1): 33-43. 2 airea (1987) the appraisal of real estate, american institute of real estate appraisers, ballinger publishing company: cambridge. sajems ns 7 (2004) no 2 367 3 ball, m., liziere, c. & macgregor, b.d. (1998) the economics of commercial property markets, routledge: new york. 4 corcoran, p.j. (1987) “explaining the commercial real estate market”, journal of portfolio management, 13: 15-21. 5 dipasquale, d. & wheaton, w.c. (1992) “the markets for real estate assets and space: a conceptual framework”, journal of american real estate and urban economics association, 20(1): 181-97. 6 dipasquale, d. & wheaton, w.c. (1996) urban economics and real estate markets, prentice-hall incorporated: new jersey. 7 engelbrecht, a.p. (2002) computational intelligence. an introduction, wiley: new york. 8 fisher, j.d. (1992) “integrating research on markets for space and capital”, journal of american real estate and urban economics association, 20(1): 161-80. 9 fisher, j.d., dipasquale, d. & wheaton, w.c. (1999) www.cbs.curtin.edu.au. accessed june 2001. 10 fisher, j.d., hudson-wilson, s, & wurtzebach, c.h. (1993) “equilibrium in commercial real estate markets: linking space and capital markets”, journal of portfolio management, 19: 101-7. 11 hakfoort, j. & lie, r. (1996) “office space per worker: evidence from four european markets”, the journal of real estate research, ii(2): 183-96. 12 hendershott, p.h. & ling, d.c. (1984) “prospective changes in tax law and the value of depreciable real estate”, journal of the american real estate and urban economics association, 12: 297-317. 13 negnevitsky, m. (2001) artificial intelligence. a guide to intelligent systems, addison-wesley: harlow, england. 14 pyhrr, s.a., cooper, j.r., wofford, l.e., kapplin, s.d. & lapides, p.d. (1989) real estate investment. strategy, analysis, decisions. (2nd ed.) wiley: new york. 15 rode & associates (1997) rode’s sa property trends, july. 16 rode & associates (1998) rode’s report on the sa property market: 1. 17 rode & associates (2000) rode’s report on the sa property market: 1. 18 roulac, s.e. (1996) “the strategic real estate framework: processes, linkages, decisions”, the journal of real estate research, 12(3): 323-46. 19 urban-econ (1998) pretoria inner city integrated economic development policy, december, urban-econ development economists: pretoria. 20 viezer, t.w. (1999) “economic integration of real estate’s space and capital markets”, journal of real estate research, 18(3): 503-19. abstract introduction literature review research methods and design results conclusion and recommendations acknowledgements references appendix 1 appendix 2 footnotes about the author(s) gizelle d. willows college of accounting, university of cape town, south africa thomas burgers college of accounting, university of cape town, south africa darron west department of finance and tax, university of cape town, south africa citation willows, g.d., burgers, t. & west, d., 2018, ‘a comparison of retirement saving using discretionary investment and regulation 28’, south african journal of economic and management sciences 21(1), a1995. https://doi.org/10.4102/sajems.v21i1.1995 note: this article is partially based on the second author’s dissertation for the degree of master of commerce specialising in finance (in the field of financial management) at the university of cape town, south africa, with supervisors gizelle willows and darron west, received january 2016, available here: http://open.uct.ac.za/bitstream/handle/11427/20507/thesis_com_2016%20_burgers_thomas.pdf?sequence=1 original research a comparison of retirement saving using discretionary investment and regulation 28 gizelle d. willows, thomas burgers, darron west received: 24 june 2017; accepted: 29 mar. 2018; published: 31 july 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: there is growing uncertainty in global society with regard to how retirement savings should be approached. the primary reason for this is that most societies do not save enough and their citizens run out of money during retirement. aim: this study investigates whether the limitations imposed by regulation 28 of the pension funds act of south africa encourage optimal asset allocation and reduce investment risk for retirement savings when contrasted with discretionary investment. setting: the study looks at hypothetical individuals who are subject to tax and retirement consequences as administered by south african legislation. methods: a quantitative risk and return analysis was performed while considering two hypothetical investors who are identical in all aspects other than their choice of investments. results: the findings indicate that regulation 28 is effective in reducing the investment risk of retirement savings; however, it may also force the investor to sacrifice wealth. conclusion: depending on the tax bracket in which the investor sits, discretionary investment may be preferential to investing in a retirement fund under the mandate of regulation 28. introduction saving for retirement is an area that has been thoroughly researched in recent periods (behrman et al. 2012; benartzi & thaler 2013). the primary reason for this is that most societies do not save enough and their citizens run out of money during retirement (skinner 2007). this has caused growing uncertainty in global society with regard to how retirement savings should be approached. in the south african context, there is limited research on retirement saving. the current proposed method for retirement saving is to invest in a pension, provident or retirement annuity fund. these funds are regulated investment vehicles which have specific rules governed by regulation 28 of the pension funds act (no. 24 of 1956). regulation 28 imposes limitations on the investments of such funds, that is, it limits investment in more risky assets and asset classes, with the aim to protect individuals’ earnings and ensure that their savings are invested in a properly diversified portfolio. a non-regulation 28 product will not have any of these limitations imbedded in it. the goal of this research is to determine whether or not the current proposals to invest in regulation 28 retirement funds are indeed the best option. the research is novel as it determines a quantifiable excess return required from discretionary investment in order to make discretionary investment the preferred choice for retirement saving. the research also adds practical value to investment houses who offer both regulation 28 compliant products and non-regulation 28 compliant products. literature review individual preferences may dictate the manner in which individuals choose to save for retirement. previous studies have focused on how individuals should save for retirement (pfau 2010) and contrasted these with empirical evidence. to date, no literature exists that indicates whether the incentives provided in south african taxation legislation coupled with regulation for retirement savings vehicles make sense from an economic and risk perspective. the purpose of this study is to determine whether these economic incentives provided in tax legislation encourage effective retirement saving. to do this it is necessary to present an illustration of the global understanding of the retirement saving puzzle while considering the south african regulatory environment and incentive structure. this literature review will begin by giving an overview of the south african regulatory framework surrounding retirement savings, with a specific focus on regulation 28 and its limitations based on academic research on asset allocation. following that, the relevant literature on savings, beginning with the keynesian consumption function (keynes 1936), will be reviewed. thereafter, behavioural biases present in retirement saving will be considered. pension fund regulation in south africa pension, provident and retirement annuity funds in south africa are governed by legislation, namely the pensions funds act as well as the regulations that are applicable to said act. in south africa, there are three predominant savings vehicles for retirement savings: pension funds, provident funds and retirement annuity funds. these funds operate with the main objective to accumulate savings during one’s career in order to maintain one’s lifestyle after retirement, and all operate in a similar manner. the promulgation of the taxation laws amendment act (no. 31 of 2013), which became effective 01 march 2015, permits all contributions to pension, provident and retirement annuity funds to be tax deductible, and will impose capital withdrawal limits on all three funds. this is explained later in the article. of particular relevance to this research is the amendment to regulation 28 of the regulations made under section 36 of the pensions fund act. regulation 28 imposes limits on the investments of retirement funds; the purpose of these limits is to protect the funds from making imprudent investments (national treasury 2011). the limits prescribe the maximum percentage of the fund assets that can be invested in any particular asset class, as well as per issuer or entity within that asset class. the effect is that these limits enforce diversification, and as a result are supposed to protect investors from poor investment decision and asset allocation. regulation 28 prescribes certain maxima per investment type based on the fair value of assets under management. the maxima are as follows (national treasury 2011): no more than 10% of total assets may be invested in hedge funds. no more than 10% of total assets may be invested in private equity funds. no more than 10% may be invested in unlisted companies. no more than 10% may be invested in any single listed company with a market capitalisation of between r2 billion and r20 billion. no more than 30% of south african liabilities plus 100% of foreign liabilities may be invested in foreign equity. the income tax act (no. 58 of 1962) provides tax benefits as it legislates that taxpayers may deduct any contributions to pension funds, provident funds and retirement annuity funds (s11[k]), subject to certain limits, from their income in the determination of taxable income, resulting in a lower tax liability. these funds are the same funds that are subject to the pension funds act. the benefits are as follows: contributions to pension funds are limited to the lesser of r350 000 or 27.5% of the greater of remuneration as defined or income in the determination of taxable income – s11(k). withdrawals from these funds are taxed in terms of the second schedule of the income tax act. the result is a lower effective tax rate than if the funds were to constitute normal income. these benefits are meant to provide an incentive to save for retirement; but the incentive is only provided if saving takes place in a fund that is subject to the constraints imposed by regulation 28 (‘regulation 28 compliant’). the manner in which these incentives work is to moderately increase the size of the initial investment as a result of the tax relief (attanasio & banks 2004). when comparing retirement regulation in south africa to other countries, differences are apparent. in the us, the 401(k) is the major retirement scheme used by employees. employees contribute to the plans either by electing ‘roth’ contributions (which are made after-tax by retirement withdrawals and are tax free), or pre-tax contributions (which reduce their taxable income by retirement withdrawals and are taxed; fidelity investments 2017). a unique feature of the 401(k) is the potential for a vesting schedule related to the employer’s contributions whereby an employee may not be fully entitled to them until after a particular period of employment (internal revenue service 2017). the 401(k) scheme has an automatic enrolment feature where employers can automatically enrol employees to increase participation. this scheme is different from the australian scheme which enforces employer contributions. australia utilises superannuation as its major retirement scheme, where employees and employers contribute to a superfund which invests the funds on their behalf. employers must contribute at least 9.5% of the employee’s earnings regardless of their type of employment but subject to exceptions (australian taxation office 2017). types of contributions are taxed differently. before tax (concessional) contributions are taxed at 15% which include employer contributions and contributions allowed as income tax deductions. after-tax (non-concessional) contributions are not subject to tax and include contributions made from after-tax income (australian taxation office 2017). given the differences in retirement schemes globally, further research is required to determine which combination of regulations is in the best interest of both the employer and employee. for this article, specific focus is placed on regulation 28 legislation in south africa, to isolate its effectiveness in maximising retirement wealth. asset allocation, volatility and offshore exposure the above section explains regulation 28, and its limitations. this section will address the two major weaknesses of regulation 28: asset allocation and offshore exposure. in saving for retirement, the optimal asset allocation is person specific, as it needs to consider labour income levels, and the risk of change to labour income (human capital risk). labour income is the income individuals are able to earn by employing their human capital. the presence of labour income allows an individual to have an age-varying investment strategy (cocco, gomes & maenhout 2005). this means that the investment can be changed over the course of one’s life, to allocate assets to suit one’s risk profile at a given point in time. upon investment in a regulation 28 fund, individuals cede the responsibility of their own asset allocation in retirement savings to that of a fund manager, within the regulation 28 mandated limits. wepener (2014) finds that the limits of regulation 28 do not encourage optimal asset allocation in a portfolio. equity has been shown to be more volatile than debt instruments (mehra 2003). in south africa specifically, over a period of 90 years from 1925, equity has earned a real return of 8.4% per year (luüs 2015). compared to the 1.6% earned by bonds and 0.9% by cash instruments over the same period (luüs 2015), the additional premium that can be earned from equity exposure is clear. considering the holding period of a regulation 28 fund, where members join at the beginning of their working career and withdraw upon retirement, mehra (2003) advocates a case for greater equity exposure. while this momentum in south african equity returns cannot necessarily be retained in the future, it has outdone countries such as the us, the uk, japan and germany (donnelly 2017). more recently, between 2000 and 2016, local south african equity performed even better, earning a real return of 8.2% (dimson et al. 2017). similarly, wachter (2010) finds that as the length of the investment horizon increases, so should the allocation to equities, yet regulation 28 retirement funds – which operate as long-term investment vehicles for their members – are restricted from maintaining equity exposure of more than 75%. wachter’s (2010) finding is supported by the findings of blanchett, finke and pfau (2013), who find that long-term investors should hold proportionately more equity than short-term investors. furthermore, there are restrictions placed on foreign investments. while the benefits of international diversification are widely accepted (ratner & leal 2005), most investors hold most of their wealth in domestic assets, a phenomenon known as home bias. despite the proven benefits of diversification, both historically and more recently, regulation 28 still imposes limits on fund exposure to foreign investments. with these restrictions in mind, the economic environment following certain market events has changed the fundamentals for regulation. much of the volatility that emerged from moments of market crisis have been unprecedented. these potentially influenced regulators to solidify laws such as regulation 28 to ensure pensioners’ savings were preserved. in particular, the 2008 financial crisis negatively impacted retirement security (miller 2011) which, in turn, influenced regulators to uphold tighter and more conservative retirement laws.1 theories of saving in order to address the issue of saving for retirement, it is necessary to discuss the major theories of saving. under this section the original savings and consumption function (keynes 1936) will be contrasted with the life-cycle hypothesis (modigliani & brumberg 1954), and the permanent income hypothesis (friedman 1957). these theories have arisen out of contentions on how individuals allocate their resources between saving and consumption, with each theory having its own merits and pitfalls. the original savings and consumption function was proposed by keynes (keynes 1936): a theory where households’ consumption was driven by real income, but an increase in real income would not result in the same increase in consumption (keynes 1936). this is known as the keynesian consumption function. modigliani and brumberg (1954) then proposed the life-cycle hypothesis of saving. under this theory, consumers were assumed to be rational, utility-maximising beings, and would, therefore, allocate their resources in order to achieve an optimal consumption pattern over the course of their life, which can be divided into several stages. this model thus asserts that the individual is aware of a lifetime budget constraint, and will use assets as a tool to shift consumption from one stage to another (bodie, treussard & willen 2007). if the keynesian consumption function were adopted, rather than the life-cycle theory, as wealth increased the value of savings would increase due to an increasing propensity to save, whereas under life-cycle theory, the individuals would adjust their forward-looking consumption and savings functions to account for this change. the savings behaviour predicted by the life-cycle theory can be contrasted with the permanent income hypothesis (friedman 1957). under the permanent income hypothesis theory, consumption is a function of permanent income (anticipated income) and thus saving is a residual. this is to say that any short-term (‘transitory’) changes in income are unlikely to result in large changes in consumption, but rather additions to assets. while all of these theories provide some degree of explanation as to how individuals save for retirement, none of the theories appears to be able to explain all factors. the preceding hypotheses all ignore important elements of human behaviour in the sense that they assume that human beings will always act rationally. therefore it is not possible to conclude that any one of these theories is entirely valid. for the purposes of this article, it is accepted that the method individuals use to accumulate capital is in line with the life-cycle hypothesis on the basis that recent empirical evidence has shown retirement fund asset allocation to be consistent with this hypothesis (bikker et al. 2012) although there are inherent limitations, which are discussed in the next section. human behaviour while the aforementioned theories of saving are relevant for understanding the economics involved in savings choices, they ignore elements of human behaviour. it is, therefore, necessary to obtain an understanding of the behavioural factors that influence how individuals save. this section will discuss issues regarding self-control (thaler & benartzi 2007), poor financial education (klapper, lusardi & van oudheusen 2015) and risk aversion (bodie et al. 2007), all of which are likely to influence savings behaviour in some manner. self-control saving for retirement requires a degree of rationality and self-control. this asserts that households are forward looking and are able to plan adequately over both the short term and the long term. knoll et al. (2010) describe how individuals behave too myopically to adequately view their long-term savings. this is supported by somaguda-nogantshi (2008) who found poor south africans discounting future needs for current needs. individuals often fail to save enough for retirement, as this would require that their present standard of living be reduced in order to have a better standard of living at a later stage (fernández-villaverde & krueger 2011). lusardi and mitchell (2014) further propose that very few consumers are capable of computing the complex financial calculations. to overcome the inability to calculate the amount of saving that is necessary, most people use heuristics or rules of thumb (thaler & benartzi 2007). thaler and benartzi (2007) recognise that self-control is an aspect that is difficult for individuals to deal with, and thus these consumers will often resort to using pension plans in order to force their own self-control. individuals will use a form of mental accounting (van zyl & van zyl 2014) and categorise money into current spendable income, current assets and future income. financial education klapper et al. (2015) suggest that many individuals lack the financial knowledge to make appropriate use of the financial products available to them. previously, institutional investors have been largely responsible for financial planning advice; however, it appears there has been a shift with households beginning to take a more active role and more responsibility for their retirement saving (bodie et al. 2007). a common problem that bodie and treussard (2007) point out is that, on average, an individual saving for retirement is not well educated in the field of finance and thus has a poor understanding of asset allocation, which would result in them making poor decisions. this was confirmed by willows (2015) who found that lower self-assessed levels of financial knowledge were negatively correlated to participation in collective investment schemes, in particular those with heightened equity exposure. historically, retirement funds in south africa were defined benefit plans (dbps), where employers contributed to a pension fund on behalf of their employees and such employees were guaranteed a pension upon retirement. when these dbps were replaced with defined contribution funds in the early 1990s in south africa, the responsibility for saving was shifted to the employee. this resulted in employees being exposed to different risks that they needed to manage, such as investment risk. given the limited financial knowledge of individuals (klapper et al. 2015), the ability to effectively manage these risks is questionable. this emphasises the importance of ensuring appropriate taxation legislation to assist individuals. risk aversion risk aversion, applied to a retirement saving context, would be investing in a low-risk low-yield asset class at an early stage in one’s career when they should rather be investing in a higher yielding asset class. retirement saving behaviour is driven by risk tolerance; an individual with low job security has high human capital risk and thus reduces overall risk by choosing low-risk financial assets. bodie and treussard (2007) describe human capital as the ability to earn income by utilising the skill set the individual has acquired. building on risk aversion, it is suggested that as human capital risk increases over the course of one’s career, due partly to increased salary and partly to fewer years remaining to recover from setbacks, the individuals should shift their asset allocation from high-yielding equity instruments (‘stocks’) early on in their career, to safer, lower-yielding instruments as they age (bodie et al. 2007). this reduces the overall volatility of their worth (being the sum of human capital and asset capital). this should result in a more certain final value for their retirement savings – as the lower-yielding instrument is associated with lower volatility. van rooij, lusardi and alessie (2012) suggest that there is a relationship between financial literacy and the decision to invest in equities. guiso, sapienza and zingales (2008) contend that those who are less financially literate distrust the equity market and are, therefore, less likely to invest in equities, and are less likely to diversify their asset holdings. this indicates that those who are less financially literate might be more inclined to accept an investment in a low-risk2 fund as a consequence of the human interaction they have with financial advisors. advances have been made to determine an individual’s risk tolerance before constructing an investment portfolio. however, despite the use of these diagnostic tools, complete accuracy is not guaranteed. using a sample of 386 financial advisors and 458 of their clients, roszkowski and grable (2005) found a weak positive correlation between the advisor’s rating and the client’s rating. advisors were shown to assign too much diagnostic value to particular demographic variables when estimating their client’s risk tolerance (roszkowski & grable 2005). this risk tolerance stereotyping has been found in prior literature relating to gender perceptions, as discussed by willows and west (2012). collectively, the behavioural influences on retirement savings behaviour are significant. it is possible to conclude that while an economic theory such as the life-cycle hypothesis may predict economic behaviour of a rational individual, the aforementioned behaviours show that individuals do not always act rationally, and are not always capable of maximising their own utility. conclusion an analysis of regulation 28 showed strong arguments to invest in regulation 28 retirement funds, as these funds provide tax benefits and relatively simple investment vehicles for their members to save for retirement. however, it has been shown that regulation does not necessarily result in increased returns, and that the active management required can be detrimental to the investors involved (basu & andrews 2014). the alternative to investing in regulation 28 funds is for an individual to make their own investment choices, discretionary investment, where the individual can choose their own asset allocation, and invest directly in the underlying instruments that a regulation 28 fund would. this would result in a loss of the tax benefit, but would also not limit the underlying investments that an individual could select. the potential advantages of discretionary investments include higher returns, easily accessible capital and lower tax rates upon disposal3. the asset allocation restrictions imposed on regulation 28 funds might result in suboptimal investments, which may result in members receiving significantly lower returns than if they were to invest in a discretionary manner. the literature also suggests that the life-cycle hypothesis (modigliani & brumberg 1954) best explains savings behaviour. furthermore, human beings do not always behave as economic models predict, due to inherent behavioural biases, which result in irrational behaviour. research methods and design the literature reviewed has highlighted a contrast between the optimal manner in which individuals should save for retirement and the structure of regulation 28 limits imposed on retirement funds in south africa. as a result, the research questions for this study are as follows: what is the differential nominal return that is required from discretionary, non-regulation 28 compliant investments over a career in order to account for the tax incentives received by regulation 28 compliant funds? is the return differential between compliant and non-compliant funds feasible given the historical performance of the south african stock market? is regulation 28 an appropriate tool for managing investment risk, considering the correlation of regulation 28 compliant fund returns with the johannesburg stock exchange (jse) and the variability of returns as measured by standard deviation? study design the research was undertaken by constructing a hypothetical quantitative model (‘the model’) which contrasts the results of discretionary investment into an index tracking investment fund and investment in regulation 28 compliant funds. for the purposes of this study, it is assumed that employers do not give employees the option to contribute to pension funds or provident funds. rather, the regulation 28 fund is assumed to be a retirement annuity fund. the model is created with two hypothetical individuals. these individuals are identical in terms of earnings capability, health, career length and life expectancy. the first individual will save for retirement in a regulation 28 compliant retirement annuity fund and will be termed the regulatory investor. the second individual, termed the discretionary investor, will save in a discretionary manner in assets that do not comply with regulation 28 and will therefore forego the tax deduction of contributions to retirement savings. both individuals’ saving behaviour will follow that of the life-cycle hypothesis whereby they accumulate capital over their working career and then dis-save from retirement until death. the effect of the south african tax legislation is that there is an incentive to save in a regulation 28 compliant fund. the manner in which these incentives work is to moderately increase the size of the initial investment as a result of the tax relief they afford the individual (attanasio & banks 2004). refer to appendix 1 and 2 for two illustrative examples. the model functions based on the input assumptions below. the regulatory investor contributes the maximum permissible 27.5% of their income to a regulation 28 compliant fund each year, from their first working year until the year of retirement. during each of these years, the investor earns a nominal return on the balance of their retirement savings equal to that of their selected investment vehicle. the model incorporates the tax liability of each hypothetical individual and is constructed in a manner such that the size of the contributions that are made by the discretionary investor are calculated, and will be less than those of the regulatory investor (i.e. the discretionary investor’s contributions are ‘after-tax’), so that both individuals have the same disposable income after settling their tax liabilities and contributing to their respective investments. the purpose of this is to ensure comparability of the standard of living of the two hypothetical individuals. an illustrative example is included in appendix 2. upon retirement, both investors know with certainty that they will live a further 20 years, and therefore will draw down the maximum annuity possible that will ensure that their retirement savings last until death. assumptions given the nature of the model, it is necessary for a variety of input assumptions to be made. these are briefly discussed below. career and life expectancy the individual will have a working (and saving) career of 40 years, and will live a further 20 years after retirement. the retirement age has been set at 65 years of age, this being the general retirement age in terms of south african generally accepted labour practice for formal employment. earning capacity and taxation in the initial base case, the individual does not experience any real salary growth and begins their working career in the lowest tax bracket. this initial case is then modified several times by placing the individual at the beginning of their career in each of the current distinct tax brackets. this results in seven base cases. the tax brackets and annual rebates are assumed to grow with inflation such that the study eliminates the effect of ‘bracket creep’ or fiscal drag4. based on the data provided, it is apparent that the south african revenue service (sars) does not have a consistent basis for the changes to tax brackets and annual rebates; hence, a modicum of uncertainty exists within this particular variable, which would need to be addressed with further research. the taxation laws amendment act (no. 31 of 2013) imposes a deduction cap of r350 000 on contributions. any contributions above this r350 000 will not result in a tax deduction. this implies that the salary cap for contributing 27.5% of one’s salary is r1 272 727 in 2016. for the purposes of this study, it is assumed that the salary cap, and consequently the deduction cap, will also grow at the inflation rate. the comments above in regard to bracket creep are also apposite for this variable. contributions and saving behaviour the regulatory investor will contribute the maximum deductible amount, being 27.5% of the retirement funding income, subject to the annual limit of r350 000, as per the taxation laws amendment act. the discretionary investor will contribute the amount that will result in his or her after-tax, post-contribution disposable income being equal to that of the regulatory investor. inflation, investment timing and returns inflation is assumed to be 6% per annum, the upper bound of the south african reserve banks inflationary target band (south african reserve bank 2015). the critical assumption is that investments will earn a consistent nominal annual return equal to the historic return on the selected investment vehicle – that being a regulation 28 compliant fund for the regulatory investor and a jse index tracking fund for the discretionary investor. the discretionary investor is assumed to incur additional tax on 10% of his or her annual investment return5; a portion of this is likely to be in the form of dividends, which are subject to withholdings tax, thereby modifying his or her overall tax liability. dividends withholding tax is levied at 15% on south african resident taxpayers in terms of s64 of the income tax act. historically, the dividend yield on the jse all share index (jse: alsi) has been between 2.5% and 3% (johannesburg stock exchange 2015). this equates to tax of approximately 0.045%6. therefore, the 10% used is overly prudent and prejudices the discretionary investor, as it has the effect of overstating his or her tax liability and thus understating possible real investment returns. the additional tax is calculated using 10% of the annual investment return, multiplied by his applicable marginal tax rate. post retirement, and for the sake of making a direct comparison of the differential effect on wealth accumulation, both investors will annuitise their portfolios entirely and earn inflationary returns on their remaining investment such that additional wealth is not created in the years of retirement. as these savings are growing at inflation, there will not be any effect on tax, as the tax brackets have been assumed to move at inflationary rates too; consequently, no real wealth is created nor additional taxes paid in real terms. succinctly put, both investors’ real wealth measured as their entire retirement savings remains constant and is only diminished by their withdrawals (‘drawdowns’) over their remaining lifespan. a further simplifying assumption for the sake of making a direct comparison is that both investors will have accumulated sufficient capital in absolute terms to be at the same marginal tax rate. retirement behaviour upon retirement, neither investor will withdraw one-third of their investment. the new legislation in the taxation laws amendment act legislates that should an individual have more than r150 000 saved in a fund regulated by regulation 28, two-thirds of these savings must be used to purchase an annuity, or be paid out as an annuity. therefore, the amount remaining in the respective savings vehicle will be drawn down as an annuity over 20 years. this assumption is simplifying, in order to remove the complexity and variability of the amount that could be withdrawn. the individual is assumed to have no bequest motive and to know that they will live, with certainty, for exactly 20 years post retirement. data analysis the nominal returns for regulation 28 investments are based on the best performing of 14 compliant funds. the ranking of these funds was performed by morningstar and profile data. the data for fund returns used in the model reflect a nominal return from october 1995 – october 2015. the best performing regulation 28 compliant fund had returned an average nominal return of 18.49% per annum over the period. the returns for discretionary investment are based upon indices of the jse, over the same period ending in october 2015. the primary results will be based on the jse: alsi. limitations this study does not take into account the transaction costs that would be involved in investing. as both regulation 28 funds and discretionary investors would incur these on different scales, it is assumed that the difference in the fees charged to the discretionary and regulatory investors would be minimal. furthermore, the asset allocation of the discretionary investor is likely to change as that investor approaches retirement and begins to diversify his or her asset allocation to adjust to a lower overall risk profile. it is noteworthy that regulation 28 attempts to mimic this posited behaviour by limiting the risk exposure of regulation 28 compliant funds to attain a more moderate risk profile. the exact time point that this takes place will vary from investor to investor based on their individual risk appetite. results in this section, each of the three research questions is presented with its corresponding results. thereafter, the results are discussed. research question 1 what is the differential nominal return that is required from discretionary, non-regulation 28 compliant investments over a career in order to account for the tax incentives received by regulation 28 compliant funds? table 1 displays the differential returns required by discretionary investment over the course of a career and reflects the answer to research question 1. table 1 only reflects the variation of one input variable, being the starting annual salary. table 1: differential return required. table 1 shows that the additional nominal return required by a discretionary investor varies depending on the investor’s particular tax bracket. the additional return varies from –0.85% to a maximum of 1.00% per annum over the course of the individual’s career. what is apparent from table 1 is that saving for retirement can be an effective vehicle to accumulate wealth. any investment that is earning a return in excess of inflation is creating real wealth for the holder. based on the input assumptions used in the model, either individual could be in a position where they would be able to withdraw approximately six times their final salary for each of the 20 years of retirement. this is not an aberration, as the purpose of the model is to calculate the differential return required by discretionary investment in order to be indifferent between regulatory investment and discretionary investment. while saving to withdraw six times the final salary is essentially unrealistic, given the human behavioural pitfalls highlighted in the literature review, it does indicate a potential problem with the current proposals for retirement saving. by allowing an individual a tax deduction for contributions to a retirement fund during their working career, the legislation essentially defers taxation from the working career until retirement. for individuals in the lower tax brackets, this is punitive, as their retirement savings value results in a large increase in their disposable income at retirement, which results in the individual moving to higher tax brackets, resulting in these individuals paying more tax in retirement for behaving exactly as the legislation intended. the largest additional nominal returns are required by discretionary investors in the fourth and fifth tax brackets. these investors are the ones who fiscal drag affects the most, with the greatest level of drag exhibited as they move from their respective tax brackets into the highest marginal tax bracket. research question 2 is this return differential feasible given the historical performance of the south african stock market? the jse: alsi (‘j203’) was formed in june 2002. consequently, the total return period available is limited to june 2002 to october 2015, a period of 13 years and 5 months. data also exist for the johannesburg stock exchange all share capped index7 (‘j303’), and the johannesburg stock exchange shareholder weighted all share index8 (‘j403’). when considering this 13-year period, the annual nominal return on the j203 is 16.23% per annum9. the best performing regulation 28 compliant fund over the same time period returned 15.63% per annum. the j303 returned 16.76% per annum and the j403 returned 17.75% per annum over the same period. therefore, depending on the tax bracket that an individual is in, it is feasible for an individual to achieve annual returns that would make discretionary investment beneficial to them. this is the case for individuals in the first two tax brackets if the j203 is used, and all individuals if the j303 or j403 is used as the discretionary investment vehicle. research question 3 is regulation 28 an appropriate tool for managing investment risk, considering the correlation of regulation 28 compliant fund returns with the jse and the variability of returns as measured by standard deviation? the top three regulation 28 compliant funds (‘funds’) over the period were compared to the jse: alsi. the comparison considered the mean annual return, the standard deviation and the correlation between movements in the monthly fund values and the jse. table 2 shows that discretionary investment surpasses the investments of the three best performing regulation 28 funds, as measured by mean annual return, whereas the results supra show the same on a compound annual growth basis. table 2 further indicates that the standard deviation of the j203, and thus its return variability, is higher than those of the regulation 28 compliant funds. table 2: mean returns and standard deviation. the purpose of regulation 28 is to limit any particular fund’s ability to make imprudent investment decisions (national treasury 2011). it is shown in table 3 that all three funds considered show low correlations to movements in the alsi. this is a good indicator that the limits imposed by regulation 28 are effective in limiting the exposure of the regulation 28 compliant funds to equities. table 3 indicates that while the regulation 28 compliant funds have low return correlation to the j203, these funds’ returns are highly correlated. this result may, prima facie, lead to the conclusion that these funds are exposed to the same or similar underlying investments. a finding that was prominent was that discretionary investors could accumulate between 65.5% and 68.2% of the retirement savings that a regulatory investor would require in order to have the same retirement savings withdrawals. this indicates that the additional taxes paid by regulatory investors in retirement account for approximately 30% – 35% of the total savings value at retirement. this can be attributed to the present value of additional tax in retirement outweighing the present value of the tax savings during the working career. table 3: correlation. robustness check sensitivity analyses were performed, using the same model as in table 1, while all variables remained constant other than the return earned by a regulation 28 compliant fund. the return was increased to a nominal return of 23% per annum and decreased to a nominal return of 13% per annum. the purpose was to test whether the differential return required by discretionary investors differs drastically based on the return earned by regulatory investors. the results showed that the differential returns required do not differ by a large quantum from the original results presented in table 1. conclusion and recommendations the findings of this study indicate that regulation 28 may be effective at reducing the investment (and, indeed, behavioural) risk to which an individual’s retirement savings are exposed. there is little doubt that regulation 28 exists, at least in part, to protect investors (particularly those with a high propensity for risk) from themselves. however, this is not what this study sought to address. judged only by the return differential between compliant and non-compliant funds (which is the only factor being assessed in this study), the limits imposed by regulation 28 may lead to suboptimal investment choices should individuals be motivated to reduce their current tax liability by investing in a regulation 28 compliant fund. this imposition burdens those persons who most need retirement funding without an added tax liability occasioned by the deferred tax liability as discussed above. further research is recommended to assess further outcomes when withdrawing post-retirement income and additional application on real examples. the results of this study offer initial evidence that discretionary investment offers higher returns, which indicates that individuals should opt for discretionary investment. however, these results have not been risk-adjusted. accordingly, individuals should invest in order to address their investment goal, which may be solely to maximise retirement wealth, in which case discretionary investment is preferred. if investors seek to maximise retirement wealth while minimising possible variability in that wealth, then a regulation 28 compliant fund may be the superior alternative. acknowledgements competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions g.d.w. was a supervisor of the master’s dissertation on which the article is based and was the primary author in conversion and re-work of the research into the article for journal publication. 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‘differential investment performance based on gender : a review of literature’, in saaa western cape regional conference: peer-reviewed conference proceedings, southern african accounting association, cape town, western cape, south africa, september 2012, pp. 72–95. appendix 1 reduced tax liability example persons a and b are hypothetical identical individuals. both have a pre-tax income of r1 000 000 per annum. a opts to contribute 27.5% of his pre-tax salary to a regulation 28 compliant pension fund. person b opts to invest 27.5% of his pre-tax salary in local equities. the effect of this is that person a will receive a deduction against their total income, whereas person b will not. the result is that person b will have less disposable income at year-end. assume further that the local equities have a nominal return 15% per annum, whereas the regulation 28 fund only earns a 10% return in the same year. for the sake of this illustration, we assume that the investment was made at the beginning of the financial year for both parties. both parties are in the same income tax bracket – thus they are taxed r208 587 + 40% of any amount exceeding r701 300 per the 2015/2016 tax regulations. at year-end we compare total assets assuming that tax has been paid in full. the result is that person a has higher total assets, primarily as a result of having to pay less tax (see table 1-a1). table 1-a1: reduced tax liability example. calculation e for taxable income of r701 300 and above, tax is charged at r208 587 + 41% of the amount above r701 300 (south african revenue service, 2015). therefore: person a = r208 587 + [r23 700 × 41%] = r215 304 person b = r208 587 + [r298 700 × 41%] = r328 054 appendix 2 increased contribution example assume the facts are the same as in example one, except that investor b reduces his investment amount such that they and investor a have the same after-tax disposable income (see table 1-a2). table 1-a2: increased contribution example. footnotes 1. thank you to an anonymous reviewer for this commentary. 2. regulation 28 compliant funds are accepted to be lower-risk funds, as will be explained in the next section infra. 3. certain discretionary investments are deemed to be capital in nature in terms of s9c of the income tax act, subject to a holding period of 3 years. consequently, upon disposal any gains in value are taxed at a maximum effective rate of 13.653%. 4. ‘the process whereby an income tax structure with marginal rate progression generates revenue growth faster than income growth, due to individuals crossing into higher marginal rate tax brackets if thresholds are adjusted at less than the rate of increase of nominal incomes’ (creedy & gemmell 2014). 5. assume the investor has a savings balance of r100 000 and their marginal tax rate is 38%. assume further their selected investment vehicle earns 15% in the current year. their pre-tax return would be r15 000. using the above restriction, 10% (r1 500) of the r15 000 would subject to tax at 38%. the result is that tax of r570 would be paid, and only r14 430 would be accumulated to the savings balance. 6. a tax rate of 15% multiplied by the dividend yield of 3% results in an effective tax of 0.0045% on the total return in a given year. 7. the all share capped index follows the same construction methodology as the alsi and only differs with regard to the capping of stock weightings to 10% per stock. 8. shareholder weighted (swix) indices have the same constituents as an existing market capitalisation weighted index. however, all constituents are weighted in the swix indices by applying an alternate free float, called the swix free float. the swix free float represents the proportion of a constituent’s share capital that is held in dematerialised form and registered on the south african share register, maintained by strate. the swix free float will not exceed the company free float. 9. based on a compound annual growth rate. 544 sajems ns 10 (2007) no 4 globalisation and global economic governance: contextualising the interpretations and the debate. a review of literature arno j van niekerk1 department of economics, university of the free state abstract as one of the most contentious and fascinating issues of modern times, globalisation is a notion in desperate need of conceptual clarification. by creating a theoretical framework and adding historical depth to the analysis of the globalisation thesis, this article attempts first to provide a contextual basis on which to weigh up the credence of globalisation as a process that is transforming the contemporary world economy. secondly, it highlights the significance of global economic governance in performing both a somewhat regulatory function and a rather stimulating role in the advancement of globalisation. in essence, the article provides a survey of the literature concerned with theories and the historical context for globalisation and global economic governance. the third aim is to emphasise the importance of the debate surrounding globalisation and global economic governance. the evolution and outcome of this debate is seen to be a factor that will make a significant impact on the future direction of the world economy, mainly in terms of helping to shape leading economic thinking. jel f01, 42 1 introduction the contemporary era is characterised specifically by global processes that are increasingly determining the greater part of social life. the world economy has internationalised as far as its basic dynamics are concerned in that it is presently dominated by perceived largely uncontrollable market forces. owing to the growing emphasis on the global context of economic actions, distinct national economies and therefore domestic strategies of national economic management have become less pronounced. as a result, there are continuous efforts to govern the world economy, in many cases with little success (hirst & thomson, 2003: 1). many regard the interrelated global processes of globalisation and global economic governance as leading catalysts of change in the world economy (see ohmae, 1995: 7; held & mcgrew, 2000: 31; dicken, 1992: 16). the modernday transformations brought about by these processes have highlighted the need for greater clarity regarding the meaning and disposition of globalisation and global economic governance. the economic doctrines and beliefs of multilateral institutions like the international monetary fund (imf), the world bank (wb) and the world trade organisation (wto), all central pillars of contemporary global economic governance, are becoming ever more influential in the international environment (varma, 2002: 1). governments around the world are increasingly adopting very similar ideologies as the world economy becomes more interdependent and these institutions of governance become more globally authoritative (castells, 1996: 13). with contemporary globalisation rapidly gaining momentum in a largely liberal global economic order2 (especially after the cold war), it is posing serious challenges to the governance of the world sajems ns 10 (2007) no 4 545 economy (strange, 1996: 71). this emphasises the relationship between these two processes. although they are very important determinants of current global developments, globalisation and global economic governance have, in modern literature, become buzzwords so popularised and generalised that their true meaning and application have essentially been diluted. it is therefore necessary for this study to offer greater clarity on the conceptualisation of globalisation and global economic governance. further, this will add value to the quality of the debate surrounding these two processes. the contentious characters of globalisation and global economic governance have made them core issues of dispute in global affairs, as they affect different countries and groups of people in very different ways (held & mcgrew, 2000: 30). as a primarily literature study, the aim of this article is twofold: first, to examine and clarify the conceptual interpretation of globalisation and global economic governance; and secondly, to investigate and highlight some of the most pressing issues of debate that give emphasis to the litigious natures of these two processes. 2 conceptualisation and context: interpreting global change exploring issues and concerns related to the governance of the world economy demands the question of what exactly needs to be governed. by implication, this requires a classified interpretation of the kind of “reality” or condition in which the contemporary world economy is asserted to be – which is, not surprisingly, an extremely contentious issue. however, before determining this, the meaning of what some consider to be “the defining issue of our time: globalisation” must be investigated (legrain, 2004: 4, 113). also known as “the globalisation thesis”, the concept characteristically does not attract universal agreement in terms of its meaning and application. although, historically, various forms of “globalisations” have been identified (see 2.4), the current debate3 focuses mainly on the merits and interpretation of contemporary globalisation. as many globalists would argue, contemporary globalisation encompasses a host of interwoven processes, which include: the increasing transnational movement of capital, goods, and people; closer ties via new communications technologies; a rapid turnover of patterns of objects of consumption; a growing awareness of the risks and dangers that threaten the world as a whole. to these can be added a quantitative increase and growth in the importance of transnational political and economic institutions, and globally interlinked civil and political movements. the interpenetration of these processes, both horizontally and vertically, and at the national, sub-national, and transnational levels, is significant. contemporary globalisation could be defined as: a process of interaction and integration among the people, companies, institutions and governments involving different nations, a process driven by international trade and investment and aided by information and telecommunications technology (center for strategic & international studies, 2002: 1). globalisation could be considered as a progressive increase in the scale of economic and social processes from a local or regional to a world level. in this respect, it is the growing economic dimension of contemporary globalisation that amplifies its impact around the world. hence, economic globalisation, as part of the broader process of contemporary globalisation, could be defined as: the process by which markets and production in different countries are becoming increasingly interdependent on account of the dynamics of trade in goods and services and flows of capital and technology (held, 2000: 92, 22). in terms of its implications for global economic governance, trade and productive investment, economic globalisation is becoming increasingly important as a feature of international economic relations. according to globalists, it has transformed the global economic landscape irreversibly – involving various measures of political-economic structural changes in the world economy (gill, 2003: 130). globalists point to the surfacing of a new global structure whose rules determine how countries, organisations and people operate. in this sense, globalisation is an inevitable trajectory of development, rendering futile any attempts at resisting it. 546 sajems ns 10 (2007) no 4 conversely, sceptics contend that the process at work in the world economy is merely that of extensive and intensifying international economic relations, and not globalisation (hirst & thomson, 2003: 4, 7). although they admit the existence of various degrees of internationalisation, sceptics interpret this process as conjunctural change towards greater international trade and investment within an existing set of economic relations. however, although there are tendencies towards internationalisation, there is still a major role to be played by national-level policies and economic actors (hall & biersteker, 2002: 45). although this implies some degree of change, with firms, governments and international agencies being forced to behave differently, they can, in the main, use existing institutions and practices to do so. hence, the sceptical interpretation does not include any structural changes in the world economy. the distinction between internationalisation and globalisation is also of particular significance to issues relating to global economic governance. internationalisation reflects a world order dominated by nation-states, with the emphasis consequently on strategic relationships for aid, development and exploitation. this is closely linked to and dependent on autonomous nationstates. in contrast, globalisation reflects global competitiveness between great market blocs and intensified collaboration and competition in the emergence of new regional blocs that are not only economic, but also social and political in nature (muller et al., 2001: 244). it suggests a less state-centric world order. as a further dimension of the terminological dispute, sceptics also consider regionalisation to be more closely associated with the present character of the world economy (especially trilateral (triad) regionalisation between the usa, europe and japan), than globalisation. regionalisation (or regionalism or regional integration) is generally understood as an integrative process occurring at a supranational level, but within a certain geographical area (anderson & blackhurst, 1993: 1) and characterised by significant coordinated economic interactions. importantly, it is seen as the process of reducing the economic significance of national boundaries within a geographic area, which encourages states to work together on a regional scale. in this sense, globalists view regionalisation and globalisation as complementary rather than opposing processes (lawson, 2003: 110). the basic issue is the relationship between forces of globalisation and forces of regionalisation. from the sceptical viewpoint, regionalism is one possible approach to “a new multilateralism”. in this sense, regionalism can be the concept of a world order consisting of regional groupings as the defining element. sceptics often use this interpretation to challenge the globalisation explanation, thereby suggesting that the process at work in the world economy is actually regionalisation, not globalisation. the sceptical argument is based on the view that the majority of economic activity remains essentially regional rather than truly global in spatial scale. they emphasise a higher degree of regional economic interdependence, economic homogeneity, and coherence (held & mcgrew, 2000: 157). in entering the next and most important stage of the debate on the interpretation of globalisation, a key feature is the fact that literature on the subject is confusing in its use of interchangeable descriptions like world economy, international economy, global economy and globalised economy. there is often a “missing link” in descriptions of the world economy as an international/internationalised economy or as a globalised economy. a major source of confusion is that the term “global economy” is very often used in both of these contexts. an international economy links distinct national markets, while a global economy fuses national markets into a coherent whole (hall & biersteker, 2002: 47). neither of these, however, should be confused with a fully globalised economy – a different beast altogether. according to hirst and thomson (2003: 8), an international economy is one in which the principal entities are national economies. trade and investment produce a growing interconnection between these still national economies. in this sceptical understanding, the emphasis is on the differential performance of separate national economies and the intensification of linkages between sajems ns 10 (2007) no 4 547 them. it ought to be emphasised that countries between which there are larger reciprocal flows of capital and trade (such as the triad) are playing a more important role than others (e.g. low-income countries) in making the global economy appear globalised, when, in fact, it has merely become more internationalised. this becomes clearer, particularly when the global impact of the triad’s sizeable multi-national corporations (mncs) and the large amounts of capital and trade flows they involve is taken into consideration. on the other end of the spectrum, extreme globalists/globalisers believe that the world economy is in fact a globalised economy – something closely associated with globalism (or new universalism) (ionov, 2003: 83). in their view, the international economic system becomes autonomised and socially disembedded, as markets and production become truly global. hence, extreme globalists argue, national economies are completely subsumed and rearticulated into the system by international processes and transactions (hirst & thomson, 2003: 10). as one of the key effects of this, globalists often insist that this leads to a kind of convergence in inequality which contributes to a narrowing of income differentials between countries, thus increasing labour mobility. a less extreme interpretation would, however, suggest that the world economy is a global economy. this study would prefer to distinguish between a fully globalised economy in which globalisation has served its purpose of fully integrating the world economy, and a global economy: a system that signifies the prevalence of globalisation as still being a process in progress, and where there remains some degree of resistance (in the form of anti-globalisation sentiment, divergence and disintegration). the world economy is indeed more than merely international; it is global in scope but is far from close to being fully globalised (hirst & thomson, 2003: 12). if economic globalisation is associated with the integration of separate national economies, so that the actual organisation of economic activity transcends national frontiers, then a global economy might be said to have emerged. in a global economy, world market forces take precedence over national economic conditions as the real value of key economic variables (production, prices, wages and interest rates) respond to global competition (held & mcgrew, 2000: 20). increasingly, this is proving very typical of the current world economy. in following a less radical globalist view, one can, to this end, conclude by stressing t h e i m p o r t a n c e o f “ s y s t e m i c e c o n o m i c interdependence” as a differentiating factor. hirst and thomson (2003: 10) describe it as the national level being permeated and transformed by the international. in this sense, the study would consider an “international economy” as enclosing a very small measure of systemic economic interdependence, a “globalised economy” as encompassing full systemic economic interdependence, and a “global economy” as possessing a significant degree of it. it is now clear that it is both the global economy and the overarching process of globalisation that have to be governed. there should also be more emphasis on delineating the kinds of governance processes involved. here the aim is to concisely define and distinguish between global economic governance and global governance. global economic governance could be defined as: the institutions, norms, practices and decision-making processes from which rules, guidelines, standards, and codes arise in order to manage the world economy (varma, 2002: 3). it includes the private sector, governmental and regional organisations and civil society. by transcending the state system in similar fashion, global governance could be defined as: a process of political coordination among governments and inter-governmental and transnational agencies (both public and private); it works towards common purposes or collectively agreed upon goals, through making or implementing global or transnational rules, and managing trans-border problems (held, 2000: 140). importantly, held (2000: 141) also emphasised that “it differs dramatically from a concept of world government that presupposes the idea of one central global public authority legislating for humanity”. global governance is based on the acceptance of divided sovereignties, the strengthening of the global rule of law, and the recognition of universally valid values and principles (messner & nuscheler, 1996: 31). 548 sajems ns 10 (2007) no 4 whereas global governance refers specifically to the political dimension of governance in the international system4, global economic governance refers to the governance of the global economy. inclusively, global economic governance also forms part of the larger process of global governance, which emphasises the interwoven nature of economic and political issues. in essence, the aim of global economic governance is to provide governance to the economic elements of globalisation. global governance, though, attempts to perform a governing function in the wider global system, which includes the process of contemporary globalisation. significantly, both processes operate within the framework of the global system. 3 historical identity: globalisation and global economic governance the globalisation of economic activity and the governance issues it involves are often thought to have appeared only after the second world war, and particularly during the 1960s. although, according to kilminster (1997: 257), the term “globalisation” first appeared in webster’s dictionary in 1961, its origins could arguably be traced back to the final stages of the first millennium. the opening period of globalisation is considered to be about 1000 ad when the moslem world was the nearest approximation to a worldwide political order. through their far-flung trade the moslems brought together the major centres of world civilisation (held & mcgrew, 2000: 49; modelski, 1972: 86). after 1500 and especially in the latter stages of what is called “archaic globalisations”, the moslem world was strategically outflanked by european naval operations (bell, 2003: 808). the work of political unification of the world and the expansion of the capitalist world economy now fell to europe. in one sense, the drive that produced it was a response to the prosperity of the islamic world and the threat that was perceived to emanate from it (lawson, 2003: 120). the europeans not only circumnavigated the globe, but followed up this feat with the establishment and maintenance of a permanent network of worldwide contacts. while archaic globalisations constituted the first phase of historic globalisation, its second phase consisted of three successive eras: “protoglobalisation” (1600-1800) in which political and economic institutions mutated throughout large part of the world; “modern globalisation” (18001820), which evolved alongside the modern state, nationalism and full-blown industrial capitalism; and “post-colonial globalisation” (1820-1920), characterised largely by a liberal economic order. it included the industrial revolution from which growing cross-border trade flows, greater internationalisation5 and high growth in the world economy emanated (bell, 2003: 807). the subsequent era (1920–present) marked the beginning of what today is called “contemporary globalisation” (bell, 2003: 807). this era saw, among other things, the formal entanglement of virtually the entire non-western world in the web of globalisation. moreover, it particularly signified the rise of the third-world voice in international affairs and, globally, there was growing attention to the notion of “humanity” and the recognition of an “international society” – especially after of the second world war. representing the “triumph of capitalism”, contemporary globalisation is considered to be the process that brought about an emergent “new global economy” (lawson, 2003: 119). this new global economy can arguably be recognised as the “latest progression” of contemporary globalisation. it is also considered to be the “third wave” (1980-today) of globalisation, which could be seen as quite distinctive when compared to the “first wave”6 (1870-1914) and the “second wave” (1945-1980) (king & king, 2005: 208-214). ohmae (1993: 81) argued that the development of this new global economy should not be considered as merely conjunctural change towards greater international trade and investment within an existing set of economic relations. one demonstration of this is the appearance of an unprecedented “network society” that is radically changing economic relations and is causing a structural transformation in the relations of production and power in the global economy. according to castells (1996: 93), it is centred on informational capitalism, where the internet is creating new rules as it induces the networking form. sajems ns 10 (2007) no 4 549 it is believed that the true “open world” was born (and globalisation reborn) at bretton woods shortly after world war ii, signifying the start of contemporary global economic governance (legrain, 2004: 104; moore, 1998: 71). although history played an important role, the existing world order (i.e. its structures and maintenance) is chiefly seen as the result of the decisions taken by the allied powers, during and immediately after the second world war (legrain, 2004: 90). hence, in the presence of 44 countries, a new, post-world war ii economic order was consolidated at the new hampshire conference in 1944 through the birth of the bretton woods twins: the world bank (then the international bank for reconstruction and development) and the imf (then the stabilisation fund). together with the international trade organisation (ito)7, the world economy was to be organised around these three cornerstones (södersten & reed, 1994: 349; driscoll, 2004: 59). coinciding with the third wave of globalisation, the main institutions of global economic governance arguably started to become more directly involved in the regulation and navigation of global economic activities. it was especially since the 1980s that the imf and the world bank enforced their stronghold within global economic governance through the advent of conditionality. the imf started with development financing accompanied by structural reform/adjustment programmes (saps). the world bank increased its role in providing loans for balance of payments support to developing countries, together with specific conditions concerning policy reform (varma, 2002: 9). notably, the imf’s agenda of anti-deficit and anti-inflationary policies collaborated with the world bank’s efficiency prescriptions for deregulation, privatisation and liberalisation. in addition, the lengthy uruguay round (1986-1994) of the gatt treaty has helped to keep the world trading system both open and at least potentially subject to calculable rules (hirst & thomson, 2003: 15). hence, corresponding with the expansion of the domains of the imf and the world bank, the world trade organisation (wto) was established in 1995 as an intergovernmental negotiating forum (kreinin, 2006: 141). this was important in strengthening the institution’s authority in international trade affairs and also reinforced its function of setting and regulating a code of international trade conduct. moreover, if the widespread consensus of the 1950s and 1960s was that the future belonged to a capitalism without losers, securely managed by national governments acting in concert, then the later 1980s and 1990s were dominated by a consensus based on contrary assumptions: that global markets are irrepressible and that the only way to avoid becoming a loser is to be as competitive as possible. markedly, these were also the neo-liberal8 principles on which the views of the imf, wb, and gatt/wto were based (varma, 2002: 12). the global spread of neo-liberal doctrines has everywhere reduced the ability of governments to autonomously formulate economic policies – a clear indication of the interwoven nature of economies around the world and, more importantly, the growing influence of global institutions of governance in international decision-making (wade, 2000: 488). finally, the fact that these institutions continue to follow a neo-liberal ideological approach is perhaps the best indication of the complementary role played by global economic governance in globalisation, as both processes advance according to the same principles. 4 issues of debate: global economic governance and globalisation9 the contentious natures of both global economic governance and globalisation mean that debate is difficult to avoid. triggered by abrupt and often baffling changes in the contemporary world economy, a critical dialogue has opened up that attempts to interpret the present form of the world economy, the kind of changes that are taking place, and the modes and effectiveness of contemporary economic governance. the debate is divided mainly between two schools of thought holding almost diametrically opposed views: the globalists10 and the sceptics (or traditionalists). a third perspective, that of the transformationists, takes a rather different stance and often places itself in the middle 550 sajems ns 10 (2007) no 4 ground between the other two. this section will focus on three primary issues of debate, thereby contextualising the arguments of each school of thought. it then outlines the view adopted in the article. the first issue of debate centres on the matter of whether globalisation should preferably be understood as internationalisation (or even regionalisation). as indicated in section 2.2, globalists are generally proponents of a radical form of globalisation, whereas sceptics are more in favour of internationalisation and regionalisation – especially trilateral regionalisation, which essentially involves the triad countries. although this issue has largely been dealt with, the transformationist perception remains an important constituent. this view recognises that there is evidence of new forms of intense interdependence and integration that are transforming the international economic system. according to held (2000: 90), transformationists argue that “international economic relations have changed to such an extent that, while the traditional view of a coherent national economy that can be managed in the interests of domestic objectives is no longer viable, the ubiquity of market forces could also be challenged and resisted, though with great difficulty and only in new forms”. they thus interpret this process of global change and transformation as a conditional form of globalisation that is constantly evolving (held, 2000: 90). in this sense, globalisation should not be understood as an inevitable or a fixed end point. the second issue of debate concerns the question of whether or not modern-day globalisation is unprecedented. globalists believe that, even though globalisation has been continuing for centuries, what is happening now is, in many respects, inevitable and historically unprecedented. they assert that globalisation is currently more genuinely global than before. whereas globalisation was essentially driven by europe and the americas in the late 19th century, it now involves japan, the east-asian countries, china, mexico, india and others – countries inhabited by almost two-thirds of the world’s population (legrain, 2004: 108). also, as part of the internet-led technology revolution, transport and communications are faster and cheaper than ever, thus further facilitating the expansion of globalisation. substantiating their argument, globalists contend that world trade is at record highs and that a wider range of products than before is being traded. cross-border trade rose to over 25 per cent of world output (gdp) in 2000, which is significantly above the previous peak of 18 percent in 1914 (legrain, 2004: 107). products traded are now more technology-driven than previously, not to mention the growth in services too: telecoms, finance, insurance, software and management consultancy. cross-border services trade, which previously hardly registered in world trade figures, was already in 1997 the fastest-growing component of world trade (contributing 25 per cent of the total) (obstfeld & taylor, 1999: 78; legrain, 2004: 108-109). in addition, globalists argue that foreign investment is also at an unprecedented high. assets owned by foreigners increased to 56.8 per cent of world income in 1995, compared to the earlier climax of 17.5 per cent in 1914 (hoogvelt, 2001: 70). globalists assert that, although foreign investment was quite substantial a century ago, its impact was limited. o p p o s i n g t h e s e c o n t e n t i o n s , s c e p t i c s argue that globalisation is, at any rate, much exaggerated as a distinctly new phenomenon, and they highlight continuities between the past and present. contending that the current highly internationalised economy is not unprecedented, they do not necessarily involve a move towards a new type of economic system. hirst and thomson (2003: 2) emphasise that “it is one of a number of distinct conjunctures or states of the international economy that have existed since an economy based on modern industrial technology began to be generalised from the 1860s”. sceptics claim that, in spite of increases in global flows of trade and investment, these are not substantially different from the economic and social interactions occurring among nations in previous historical times (held, 2000: 23). in a sense, sceptics argue, the current international economy is less open and integrated than the regime that existed from 1870 to 1914 (the belle époque). the exchange of goods and cultures dates back to early times. even in the sajems ns 10 (2007) no 4 551 19th century, open trading and liberal economic relations were customary world-wide. thus, we are witnessing merely a continuation and progression of earlier world trading links. from the sceptics’ viewpoint, the pre-1914 system was genuinely international, tied by efficient long-distance communications and industrialised means of transport. the current technology revolution in communications and information, they argue, has further developed a possibly more complex monetary and trading system, but did not create it. sceptics also prefer to compare different periods in terms of their openness and integration in order to support their argument (hirst & thomson, 2003: 27). in a study aimed at measuring financial openness, grassman (1980: 128) used the current account balance to gnp ratios of six leading countries (great britain, italy, sweden, norway, denmark and the us) and found no increase in openness between 1875 and 1975. there was actually a decline in capital movements for these countries. measuring it somewhat differently, howell (1999: 16) (as shown in figure 2.4) found that there was a decrease in openness among the g7 countries from a peak in 1913 (almost 6 per cent), but with a gradual increase after 1970 – reaching 3 per cent only by 1995. furthermore, although the net capital flows of the g7, as a percentage of world gdp (at purchasing power parity), increased from 0.34 per cent in 1995 to 0.94 per cent in 2000, there was a steady decrease in the five-year period after that, falling to 0.86 per cent in 2005 (imf, 2006: 2-6). source: howell, 1999: 17 figure 1 international capital flows among the g7 economies as a percentage of gdp, 1870-1995 also, in a study done by turner (1991: 17), comparing the pre-1914 gold standard period with the 1980s, he found that current account imbalances and capital flows, measured in relation to gnp, were larger before 1914 than during the 1980s. for this reason, sceptics contend that using gross figures for ratios of trade and capital flows relative to output confirms that “openness” was greater during the belle époque than even in the 1990s (hirst & thomson, 2003: 28, 60). all this, argue the sceptics, points to a similar or even greater degree of internationalisation during the earlier period, which suggests that modern-day processes and developments are not unprecedented. transformationists assert that there are some new and different issues of economic interdependence particular to the present era. from this perspective, the world economy has certainly not remained unchanged. owing to fundamental reorganisations in the global economy, they agree that (held, 2000: 90): • the world has entered a new phase in the internationalisation of economic activity; • the present era is one of unprecedented transformation in the patterns of international enmeshment – i.e. complex patterns of reciprocal inter-dependency and integration between economies; and • the process of transformation designated by the term globalisation is a contingent and historically specific one. 552 sajems ns 10 (2007) no 4 as economies have become interdependent and technologies connect societies around the world in an interwoven web of interaction, globalisation, according to transformationists, has been progressing intermittently throughout the modern age. they argue, though, that its most recent manifestation signifies a strong qualitative shift towards an unprecedented l e v e l o f i n t e r n a t i o n a l i n t e r d e p e n d e n c y , integration and cooperation. characteristically, transformationists are specifically cautious of the apparent “essentialism” of the globalists and the sceptics. instead they deliberately propose a via media, asserting that globalisation is a momentous phenomenon, novel in many respects– but there is also nothing that is a longterm historical process shaped by conjectural factors (bell, 2003: 805-806; held, 2000: 23). transformationists therefore agree that globalisation represents a significant shift, but question the inevitability of its impacts. to this end, it is necessary to highlight that, although the first two issues of debate focused mainly on globalisation, both of them hold important implications for global economic governance. regarding the first issue vis-à-vis the interpretation of globalisation, the sceptical understanding of internationalisation (as opposed to globalisation) reflects a world order dominated by nation-states (castells, 1997: 162). from the perspective of global economic governance, this involves a greater degree of emphasis by institutions like the imf, the world bank, and the wto on acting in a way that is supportive of governments’ efforts to govern cross-border economic activities more efficiently (thus respecting their sovereignty). conversely, the globalist position (and largely the transformationist view, too) insists that globalisation reflects a world order that suggests a lesser role for states and a greater role for regional blocs and global competitiveness. in essence, the governance of global economic activities, seemingly beyond the control and regulation of governments, is at issue here. according to transformationists, there is a distinct need for new forms of supra-national governance, which implies either a greater responsibility for the institutions of global economic governance in regulating cross-border economic activities, or an increased role for wellcoordinated regional governance to perform this function; or even some degree of both (muller et al., 2001: 244). as far as the second issue is concerned, although the sceptics are challenging the fact that globalisation is unprecedented, it is important to keep in mind that the pre1914 era was structurally different from the contemporary era. it was characterised by the pax britannica system in which britain owned almost a quarter of the world; and the gold standard, with its unique automatic adjustment mechanism, was the monetary regime of the time. the 19th century was a world of unilateral and discretionary policies, while, in contrast, the 20th century was a world of multilateral and institutionalised policy (legrain, 2004: 113). thus, by comparison, the globalists (and, in this case, the transformationists, too) perceive the existing world order to be in need of new forms of economic governance and rule owing to the unprecedented nature of globalisation. the third issue concerns the question first of whether or not it is globalisation that promotes global inequality and second of what the implications for governance are. although there is clearly some common ground between the three schools of thought about the fact that growing interdependence is associated with a more unequal world, they interpret it and respond differently to it. in the sceptics’ view, national factors are considered equally important as determinants of the pattern of global inequality (gilpin, 1987: 156), if not more so. however, the prospect of moderating, let alone eradicating, the growing north-south divide through coordinated international intervention is decidedly utopian and a categorical mistake, as it could undermine the principle basis of international order (woods, 1999: 53). in this respect, hierarchy (as headed by the most powerful states), and thereby inequality, is a vital ingredient of the sceptics’ understanding of world order, and the basis for effective international governance. globalists take issue with this understanding, arguing that, although there has been erosion of old hierarchies, the problem of global inequality can be diminished, if not resolved, sajems ns 10 (2007) no 4 553 with concerted global action. pessimistic globalists in particular consider neo-liberal economic globalisation to be the primary cause of growing global inequality. alongside world markets and international capital, hoogvelt (2001: 131) argues that the uneven nature of globalisation is creating a new social division that transcends the old core-periphery organisation of the world economy. yet optimistic globalists contend that governing the world economy in a manner that would make it less unequal would require exceptionally strong cooperation, involving all stakeholders, i n c l u d i n g : m n c s , i g o s , g o v e r n m e n t s , multilateral institutions of global governance, and the transnational civil society (held & mcgrew, 2000: 339). transformationists argue that global inequality is illustrated most noticeably by the unprecedented transformation in the patterns of marginalisation of third-world economies. this is resulting in a very uneven and complex relationship between territorial boundaries and transnational forms of economic activity, which is in turn increasing the divide between rich and poor countries. transformationists are very critical of the current system of multi-layered global governance and view its lack of democratic credentials and legitimacy as serious flaws that can divide nations and exacerbate inequalities (held, 2000: 175). in their view, the most effective way to minimise global inequality is to reform this system in a manner that would make it more accountable to contemporary principles of democratic governance. table 1 different perspectives on globalisation schools of thought globalists sceptics transformationists is su es o f d eb at e conceptualisation globalisation is occurring via rapid global flows internationalisation or regionalisation is occurring, not globalisation globalisation/global change is recognised and interpreted in terms of the transformation of the global economy unprecedentedness current globalisation is historically unprecedented and is now more genuinely global than before globalisation is much exaggerated as a distinctly new phenomenon and current change is seen as continuities between the past and present global economy has been fundamentally reorganised with some new and different economic interdependencies that can be observed in the present era, which is interpreted as a period of unprecedented transformation global inequality erosion of old hierarchies as neoliberal globalisation is creating a new social division a growing north-south divide where national factors are the primary determinants of global inequality the marginalisation of the 3rd world due to a lack of democratic multi-layered global governance which further divide nations and exacerbate existing inequalities as far as the view taken in this article is concerned, it recognises that there are arguments for each of the different positions, and there has to be cognisance of them all. while amply recognising both the globalist and the sceptic position in some respects, the study mostly concurs with 554 sajems ns 10 (2007) no 4 the transformationist assertion. globalisation is a reality, whether or not people contest it in one way or another. despite qualitative changes, especially in the post-cold war era, involving speed and space, globalisation should be seen as a persistently evolving historical process. although it is possible to differentiate between historic globalisation (1000ad-1920) and contemporary globalisation (1920-today), it should nevertheless be recognised that there exists an important relationship: the former led to the latter. moreover, it is essential to note that, although the current global economy is relatively open, it differs in many respects from what prevailed before 1914: • there is more generalised and institutionalised free trade through the wto; • foreign investment is different in its modalities and destinations (owing to a fairly high degree of capital mobility); • the volume of short-term financial flows is greater, involving a wider range of countries; and • the international monetary system has also changed quite considerably. taking these differences into consideration, direct comparisons between separate periods should be approached with more caution. in this respect, the writer agrees with hirst and thomson (2003: 28) that using gross figures for ratios of trade and capital flows might disguise important differences between the two main periods in dispute (pre-1914 and post-1973). notably, a telling comparative measure of world trade is that used by hoogvelt (2001: 68, 70), who compared the foreign trade portion11 of 1913 (33 per cent) with that of 2000 (43 per cent), and indicated that current world trade is now at a higher intensity level than ever before. iit has also become clear that there is a democratic deficit insofar as the institutions of global economic governance are unrepresentative of the world community. the point is: inequality has serious implications for global stability and world order. globalisation as a process is markedly amenable to influence, a process in which economic and political role players create the structure behind its dynamic and orientation. incidentally, global governance by corporate capital is arguably the most serious and urgent concern needing consideration, because it reinforces the unevenness that has characterised economic progression from the start of industrialisation. thus, as abrahamsson (2003: xviii) states, the two urgent challenges ahead are how to make globalisation more global and global economic governance more representative. the article, however, acknowledges that there are no easy answers, and that, most importantly, the responsibility rests largely on the shoulders of the developing world to become more proactive in closing the divide between themselves and the first world. even so, as held and mcgrew (2000: 339) emphasise, the fact is: “whether globalisation, through the combined efforts of the major institutions of global and regional governance, can be given a human face, or whether it will generate a more unruly world, are issues which will dominate the global agenda long into the 21st century”. 5 concluding remarks the study has highlighted the fact that there is a strong connection, especially in the present era, between globalisation and global economic governance. lawson (2003: 110) emphasises that many discussions of world order and global governance, especially those on economic dimensions, have revolved around the phenomenon of globalisation. thus, when attention is paid to global economic governance, it would be erroneous to exclude the closelyassociated dynamics of globalisation. the article has shown that these two processes are co-integrated and impact directly on each other. held et al. (1999: 7) emphasise that “at issue is a dynamic and open-ended conception of where globalisation might be leading and the kind of world order it might prefigure”. h o w e v e r , w h i l e r e c o g n i s i n g t h e a b o v e mentioned connection, it is essential to clarify the conceptual meaning and interpretation of globalisation and global economic governance. sajems ns 10 (2007) no 4 555 this was the first objective of the study. what became clear is that, apart from distinguishing globalisation from internationalisation and regionalisation, the former, as a process, should also be differentiated from the condition in which the world economy is asserted to be in, as this is a major source of conceptual confusion. in this regard, globalisation is specifically an interpretation of the changes taking place in the world economy, and not a description of what the world economy is perceived to be, i.e. a global economy. hence, globalisation refers to the integration of national markets in a global economy. alternatively, global economic governance refers exclusively to rules and guidelines used by institutions for managing the global economy. as far as the historical identity of the two processes is concerned, the article has called specific attention to the very under-emphasised and valuable role that historic globalisation played in laying the foundation on which contemporary globalisation could evolve, and includes important “learning curves” in the history of world economy. what also became clear was the influential nature of the imf, the world bank and the wto in directing the progression of the global economy and providing scope for globalisation, through neo-liberal doctrines, to progress even further. as the second objective, the issues of debate emphasised in the article are intriguing because they relate directly to how the two processes of globalisation and global economic governance have been developing, are currently doing so, and will be developing over time – in the real world. the debate is extremely important as it plays a key role in determining the direction in which the global economy is developing. as yet, the debate has, for instance, led to a growing recognition of pleas by the third world regarding global inequality (which is arguably worsened by globalisation) and for more efforts on the part of first-world countries to seek solutions. in the same way, critics of the imf, the world bank and the wto have, with some success, put pressure on these institutions to adjust a significant number of their policies in favour of third-world interests (stiglitz, 2003: 241). a persistent concern, though, is the third world’s growing disenchantment with globalisation and decision-making processes in global economic governance, which threatens to lead to a more nationalistic/insular reaction against these processes. what clearly arises from the article is the necessity for carrying out further research on both, and for seeking more solutions to the proper governance of the global economy. it is also imperative to open up new dimensions vis-à-vis the debate on globalisation and global economic governance to assist in the search for appropriate answers to the serious imbalances in the global economy. endnotes 1 i would like to thank my promoter, professor elsabé loots, for her invaluable contributions to this article, as well as the two referees for their very constructive comments. 2 implicitly, global economic governance is the process (or economic governance practice) that takes place within the inclusive framework of global economic order (the condition). 3 although section 2.3 explores the various issues related to the debate about globalisation and global economic governance, the first issue – that of its conceptual interpretation – is examined here. 4 note that the terms “international system” and “global system” are, for the purposes of this study, used interchangeably. 5 although particular attention was earlier paid to the distinction between internationalisation and globalisation, one should keep in mind that internationalisation forms part of globalisation’s historical identity, and more specifically, historical globalisation, which preceded contemporary globalisation. 6 the three “waves” of globalisation highlighted here are recognised as the periods in which the process has had its most significant impact on the world economy. for contextual purposes, the first wave is the latter part of historical globalisation, and the next two waves are part of contemporary globalisation. 7 the intended ito was never actually established at a conference in havana in 1947-48. it was replaced by the general agreement on tariffs and trade (gatt), which, in turn, was much later (in 1995) superseded by the world trade organisation (wto). 556 sajems ns 10 (2007) no 4 8 the neo-liberal ideology (also known as pluralism) could be seen as part of modernisation theory and, owing to its neo-classical nature, its central focus is the rule of the market. its principles are based on market liberalism, and therefore advocate freemarket reforms, which include (among others): privatisation, the deregulation of international capital and trade flows, financial liberalisation, and institutional transformation that complement market-orientated policies (öniş & şenses, 2005: 265). 9 note that, although the issues of debate emphasised in this section encapsulate some of the most important contentious matters related to globalisation and global economic governance, it does not, of course, include all the various debatable issues that can be related to these two themes. 10 globalists are, in fact, divided between positive and pessimistic globalists. whereas the former has a neo-liberal stance and focuses more on the opportunities created by globalisation, the latter is a neo-marxist version of the globalist position, which accepts the claim that a strong globalisation process has occurred, but thoroughly condemns it (held, 2000: 22, 89). unless otherwise indicated, the debate – when referring to the globalist perspective – chiefly emphasises the positive position. 11 the foreign trade portion is measured by the ratio of the volume of world trade (expressed as the sum total of world merchandise exports and imports at current prices) to the volume of world output (gdp). note: this comparison excludes world trade in services because it is a more contemporary development. references 1 abrahamsson, h. 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(1994) international economics (3rd ed.) macmillan: london. 34 strange, s. (1996) the retreat of the state: the diffusion of power in the world economy, cambridge university press: cambridge. 35 stiglitz, j. (2003) globalisation and its discontents, w.w. norton: new york. 36 turner, p. (1991) “capital flows in the 1980s: a survey of major trends”, bis economic papers, 30: 14–32. 37 wade, r. (2000) “national power, coercive liberalism and ‘global’ finance”, in r. art & r. jervis (eds.) international politics: enduring concepts and contemporary issues (5th ed.) addison wesley longman: new york. 38 woods, n. (1999) “order, globalisation and inequality in world politics”, in a. hurrell & n. woods (eds.) inequality, globalisation and world politics, oxford university press: oxford. abstract introduction the labour market component of mainstream theoretical macroeconomic models a mathematical three-segment barrier model conclusion and potential policy implications acknowledgements references footnotes about the author(s) philippe burger department of economics, university of the free state, south africa frederick fourie department of economics, university of the free state, south africa citation burger, p. & fourie, f., 2019, ‘a high unemployment and labour market segmentation: a three-segment macroeconomic model’, south african journal of economic and management sciences 22(1), a2103. https://doi.org/10.4102/sajems.v22i1.2103 original research a high unemployment and labour market segmentation: a three-segment macroeconomic model philippe burger, frederick fourie received: 17 sept. 2017; accepted: 11 oct. 2018; published: 25 feb. 2019 copyright: © 2019. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: south africa suffers from an unusually high unemployment rate – officially averaging 25% since 1999q3. in addition, depending on whether one uses the official or broad definitions of unemployment, since 2008 there are on average between 2 and 3.3 times as many unemployed people as there are people in the informal sector. hence the question: why do the unemployed not enter the informal sector to create a livelihood? aim: to fill this gap we propose a macro-economic framework that incorporates both formal (primary) and informal (secondary) sectors, as well as involuntary unemployment resulting from entry barriers to the labour market. we believe such a model provides a more suitable basis for macroeconomic policy analysis. setting: standard macroeconomic theories at best provide a partial explanation for the south african unemployment problem, focusing mostly on the formal sector. methods: the article uses a theoretical analysis. results: the article presents a macro-economic framework that incorporates both formal (primary) and informal (secondary) sectors, as well as involuntary unemployment resulting from entry barriers to the labour market. conclusion: if the assumptions on which the model draws hold in the south african reality, then a solution to the unem-ployment problem involve policies addressing product and labour market structures and behaviour in the primary sector, as well as policies addressing the numerous barriers to entry, such as borrowing constraints, that poten-tial entrants into the secondary sector face. introduction few countries have as serious an unemployment problem as south africa. in the pe-riod 2008q1–2018q2 the official unemployment rate averaged 25.1%, while the broad unemployment rate (which includes discouraged work-seekers) averaged 34.8% (statssa 2017). a well-known peculiarity of south africa is that, compared to peer-group countries, the infor-mal sector is small relative to total employment (kingdon & knight 2004). almost 17% of employed workers are in the informal sector (see table 1). in addition, and depending on which unemployment definition is used, since 2008 there have been between 2 and 3.3 times as many unemployed people as informal sector workers (figure 1). figure 1: the number of employed and unemployed workers (’000). table 1: composition of the employed (% of total employment). this raises the following question: if workers do not find employment in the formal sector, why do they become unemployed rather than enter the informal sector? kingdon and knight (2004) suggest that there are significant barriers to entry into the informal sector, possibly in the form of capital and skills shortages. south africa is not the only developing country where barriers to entry into the informal sector appear to exist. grimm, krüger and lay (2011a) and grimm, van der hoeven and lay (2011b) find significant barriers to entry into the informal sector of many west african countries, as well as madagascar. a characteristic of almost all the macroeconomic work on unemployment in sa is that it deals with the formal sector only (fourie 2011). meanwhile, evidence from unemployment research in the fields of labour economics and development indicate substantial segmentation in the south african economy: between the formal and the informal economies, within the informal sector, and between the unemployed and the informal and formal economies. moreover, several labour market barriers exist that prevent people from improving their employment and earnings situation. the objective of this article is to start bridging the divide between the macroeconomic discourse and the labour and development discourses on unemployment by developing a model that includes labour market segmentation and entry barriers into a theoretical macroeconomic model. a major result of this model is that, given these incorporated fea-tures, it explains the existence of persistent high involuntary unemployment in equilibrium. the labour market component of mainstream theoretical macroeconomic models modern macroeconomic theory largely focuses on the formal sector, ascribing unemployment mostly to product and labour market imperfections, as well as hysteresis (see cahuc & zylberberg 2004; carlin & soskice 2006: chapter 15 for textbook expositions). what these models do not consider or explain is why those who lose employment then become unemployed and not self-employed. in the south african case we can expand this question and ask: why do the unemployed not enter the informal sector? discussing the informal sector draws segmented labour markets into the discussion. agénor and montiel (1999) present a theoretical model incorporating a formal and informal sector. basically it represents a model with internationally traded and non-traded goods, with the former constituting the formal sector and the latter the informal sector. this model is of limited value in south africa, as its informal sector, being largely retail-based, is a sector of traded goods. another branch of the literature represents the attempts by layard, nickell and jackman (1991:41–44; also blanchard 2005), as well as the earlier, but theoretically more detailed model of bulow and summers (1986). these models include a primary and a secondary sector. the primary sector typically has new keynesian features (e.g. it is an efficiency wage or union bargaining sector). excess primary-sector labour supply flows to the secondary sector. while the primary sector in this model is new keynesian in nature, the secondary sector is surprisingly very new classical. the secondary-sector labour market is assumed to be market clearing ‘in the sense that wages are not high enough to attract a queue of job-seekers, nor do vacancies last long since skill requirements are low’ (layard et al. 1991:42). such a market-clearing secondary sector means that those who are not employed in either the primary or the secondary sectors are both voluntarily and involuntarily unemployed: they are ‘involun-tarily unemployed with respect to primary sector’ at the going wage there, but simultane-ously they are ‘voluntarily unemployed with respect to the secondary sector’ (i.e. not willing to work at the going wage in the secondary sector). thus, in the final instance they are voluntarily unemployed. therefore, the layard et al. and bulow and summers models still leave the question: if actual unemployment is high, why do those who become unemployed in the primary sector, stay unemployed and not all become (self-) employed in the secondary sector? kingdon and knight (2004), grimm et al. (2011a) and grimm et al. (2011b) suggest that those who wish to enter the secondary sector face significant barriers to entry, possibly in the form of capital and skills shortages. in the mathematical macroeconomic model presented below we incorporate some of these barriers. a mathematical three-segment barrier model this section develops a mathematical three-segment model for an economy such as that of south africa (for more background and explanation, see burger & fourie 2015). the section draws on the dual labour market model of bulow and summers (1986), which itself is an augmentation of an efficiency wage model – a prominent approach in the new keynesian class of models. following summers (1988) as well as knell (2014), pereau and sanz (2006), bulkley and myles (1996) and the suggestion by bulow and summers (1986), the article introduces union bargaining into the model to allow for the presence of strong labour unions in the south african economy. similarly, the presence of high economic concentration and imperfectly competitive product market conditions is an integral part of our augmented model. as mentioned, the bulow and summers (1986) dual labour market model explains the allocation of workers between the primary and secondary sectors – but not the existence of involuntary unemployment. drawing on kingdon and knight (2004) and grimm et al. (2011a), the model also incorporates barriers to entry into the informal sector to explain why the unemployed do not enter the informal sector, and remain unemployed. step 1: the two-sector model with no involuntary aggregate unemployment we derive a formal-sector job-offer relationship and an effort supply function.1 different from the analysis in bulow and summers (1986), this analysis is done in terms of the number of positions filled by firms rather than the number of workers demanded, which allows the introduc-tion of factors that will influence the number of positions being filled by firms in the two sectors. nevertheless, the model is presented in terms of both the number of positions and the positions filled (persons employed). in addition to these two relationships, the analysis below also presents wage-setting and price-setting relationships. these four relationships are then used to derive equilibrium condi-tions for the primary and secondary sectors. the effort supply function at any given moment firms in the primary sector fill a number of positions (jobs). the total number of jobs available in the primary sector is fp. those workers who do not obtain employ-ment in the primary sector are accommodated in the secondary sector (which is assumed to be without entry barriers). in the secondary sector there is equilibrium: the total number of jobs filled is fs. thus, although there might be involuntary unemployment in the primary sector, there will not be involuntary unemployment at the aggregate level. the total number of filled positions in the economy (which in this case amounts to the entire labour force) is: the allocation between the two sectors can be described in terms of the proportion of total positions filled by firms in the primary sector being p = fp/f, while the proportion filled by firms in the secondary sector is (1 – p) = fs/f. a worker who quits or is laid off in the primary sector, is assumed to move to the secondary sector. the quit rates in the primary and secondary sectors are qp and qs; d2 represents the probabil-ity of the worker being laid off when caught shirking (or e.g. low productivity2), while d1 represents the probabil-ity of being laid off for shirking while not actually shirking (a false positive). further-more, wp and ws represent the wage rates in the primary and secondary sectors. there-fore, (1 – qp – d1)wp represents the expected wage of those workers employed in the primary sector (i.e. who have not been laid off and have not quit the primary sector), while (qp + d1)ws represents the expected wage of primary sector workers who are laid off in or quit from the primary sector and move to the secondary sector. (shirkers are assumed to produce noth-ing, hence their pv = 0 and they are not included.) likewise, (1 – qs)ws represents the ex-pected wage of those workers in the secondary sector who remain in the secondary sector, while qswp represents the expected wage of those workers who quit the secondary sector for the primary sector. thus, the sum of the present value of expected primary and secondary sec-tor income in the economy is:3 in equilibrium, labour flows into and out of the primary sector need to be equal. thus p(qp + d1) = qs(1 – p), so that qp + d1 = qs(1 – p)/p. this equality also means that search for work in the primary sector occurs not from a position of unemployment, but from the secondary sec-tor (in the two-sector model there is no aggregate unemployment). following bulow and summers (1986), we define an effort supply function. the effort supply function is stated in terms of α, defined as the instantaneous gain in utility from not exerting effort, as follows: where (d2 – d1)(pvp – pvs) represents the gain from non-shirking/effort; pvp is the present value of primary sector work and pvs the present value of secondary sector work (recall that non-effort is only possible in the primary sector, the sector that pays a wage premium over the secondary sector wage). this conditional expression shows the premium that firms pay (the right-hand side of equation 3) to overcome the gain that workers derive from not exerting effort (the left-hand side of equation 3), thereby ensuring that they exert effort. as mentioned above, the model in this article com-bines an efficiency wage model (with its non-shirking component) with a labour union model. as a result α includes also the premium that companies have to pay to ensure the effort of unionised labour (i.e. to ensure that unionised workers limit their strike action or do not strike at all). this will render α = α1α2, where α1 is the instantaneous gain in utility from not exert-ing effort (i.e. from shirking), and α2 (which is ≥ 1) constituting the premium that unionised workers can extract.4, 5 the south african labour market is also characterised by significant spatial distortions result-ing from apartheid, where places of residence of black people very often were far removed from places of work (in the primary sector). these distances significantly raise travel costs, which need to be added to the premium that workers require before working in the primary sector. therefore: where d represents the distance between place of residence and place of work in the primary sector, and α3 represents the cost per unit of distance: unions having more power implies a higher value of α2 and therefore a higher value of α; consequently, the difference between the present values of primary and secondary sector wages will be higher. similarly, the larger α3 and d, the larger will be the value of α. the inclusion of the term α3d means that both distance and the cost per unit of distance impact the reservation wage of workers – and negatively affect job search. if people live far from places of work in the primary sector and have to travel to places of work, they may not be able to afford job search. note that this particular search and/or entry barrier can be seen as principally due to a financial market failure. job-seekers find it hard to borrow money to finance their traveling and search costs (intending to repay the loan upon finding a job). lenders might be unwilling to extend such loans due to both a low probability of finding a job and a low expected wage. rearranging equation 3: using equation 2, the present values of being employed in the primary and secondary sectors are: substituting equations 6.1 and 6.2 into equation 5 and normalising on wp yields: recalling that qp + d1 = qs(1 – p)/p and substituting into equation 7 yields: equation 8 represents the effort supply function (equations 3 and 5 above) in a different form that shows the relationship between the wage and the proportion of positions filled in the pri-mary sector: as p increases, wp decreases. it also expresses the primary sector wage as the secondary sector wage plus a mark-up. (it still is an effort supply function: the mark-up or premium is what needs to be paid to primary sector workers to ensure effort.) thus, the rela-tive proportion of positions allocated to primary sector jobs (p) has an impact on the size of the mark-up on the secondary sector wage rate. this is shown graphically in figure 2. figure 2: the relationship between primary and secondary sector wages. note that, as p increases the slope of the relationship becomes flatter, while the intercept decreases (i.e. as p increases, wp shifts and rotates from wp1 to wp2). the price-setting relationship to derive the price-setting relationship we use the standard textbook equation stating the relation-ship between wages, the marginal product of labour (and hence the level of employ-ment e) and profit mark-up of a monopolistically competitive firm. in equation 9 this is applied to the primary sector wage: with mpl being the marginal product of labour and ε the elasticity of product demand in a monopolistically competitive market, thus (ε – 1)/ε < 1, where ε > 1 to ensure that firms make a profit. mpl is defined as a negative function, b, of primary sector employment, ep. thus, holding ε constant, the primary sector wage becomes a negative function, g, of primary sec-tor employment: where the size of γ relates to the size of the mark-up of a monopolistically competitive form; the higher γ and therefore the closer it moves to 1 (i.e. the closer ε moves to infinity and therefore approaches the perfectly competitive model), the lower the mark-up can be and the less the firm can benefit from its monopolistically competitive position. equation 10 represents the standard primary sector price-setting relationship linking employ-ment and wages: given that g’ < 0, wp decreases as ep increases (but the wage cannot turn nega-tive). the job-offer relationship the number of positions (fp) and hence also the proportion of jobs or positions offered by firms in the primary sector, p, is a positive function of the marginal product of labour, which itself is a negative function of the level of employment (see the discussion of equations 9 and 10 above). suppose, for reasons of simplicity, that this relationship is linear with parameter h:6 thus, at higher levels of ep the real wage is lower (because the marginal product of labour is lower), and hence so is the proportion of positions filled by firms in the primary sector, p. of course, if, for a given level of employment, the marginal product of labour increases – for instance, due to an upgrade in skill levels – the number of positions offered in the primary sector will increase. thus, the positive sign of h means that if workers are more productive, more workers can be employed at a given wage. given the role of the marginal product of labour in equation 11a and its link to the proportion of positions offered, equation 11a is also a job-offer relationship – it links the proportion of jobs or positions being offered to wages. (below it will interact with equation 8, the effort sup-ply function, to establish the equilibrium wage and number of positions filled.) note that in terms of equations 10 and 11a there is a positive relationship between p and wp, but a negative relationship between ep and p (given that g’ < 0): as ep increases, wp decreases, causing p to also decrease. the wage-setting relationship substituting equation 11a into equation 8 yields equation 12: equation 12 is a primary sector wage-setting equation with its characteristic positive relation-ship between the level of employment and wages. as ep increases (and given that g’ < 0), wp increases, simply because, as employment in the primary sector increases (and hence as employ-ers offer more jobs), workers can get work easier elsewhere in the primary sector (the probability of getting a job in the primary sector is larger if a larger proportion of total jobs are filled in the primary sector) – hence firms need to offer a higher wage to ensure that they stay, exert effort and do not strike. equation 12 interacts with equation 10, the price-setting relationship between wages and employ-ment, to determine the equilibrium values of wages and employment in the primary sector. workers in the secondary sector are just paid their marginal product, which, for simplicity, is assumed to remain constant: with little capital and similar skills and each person more or less operating on their own, they are assumed to have the same marginal productivity. model summary the model can be summarised as follows. first, in p-wp space there are two relationships (the [ ] indicates the sign of the p-wp relation-ship): a job offer relationship: an effort supply function: secondly, in ep-wp space there are two relationships (with g’ < 0) (the [ ] indicates the sign of the ep-wp relationship): a price-setting relationship: a wage-setting relationship: equations 8 and 11a – or equations 10 and 12 – can be used to calculate the equilibrium values of wp, and to calculate the equilibrium values of p. the expressions for wp and p are: to calculate the equilibrium value of ep note that in equilibrium ep = fp and that p = fp/f. so, using equation 14 and given the value of f, equation 15 then produces the equilibrium value of ep: together with the effort supply function 8, the job offer relationship 11a then determines the equilibrium number of positions in the primary sector. since the proportion of filled positions in the secondary sector is (1 – p), the secondary sector absorbs all those who are not em-ployed in the primary sector and who are willing to work for wage ws. (this assumption will be relaxed in the next section). thus, in this model – as in the model of bulow and summers – there is no involuntary unemployment. step 2: the two-sector, three-segment model with involuntary aggregate unemployment in this section the model is expanded to contain a third sector or segment that comprises the unem-ployed. the preference hierarchy follows the model above: workers in the secondary sector prefer the primary to the secondary sector; the unemployed would prefer secondary sector employment to unemployment and primary sector employment to secondary sector employment. the effort supply function as in the previous section, we first consider the effort supply function. the effort supply func-tion introduces a role for entry barriers that imply that not all of those who are unable to find a job in the primary sector will be able to find one in the secondary sector. the model makes a few simplifying assumptions. first, those quitting and being laid off in the primary sector (at rate qp + d1), move to the secondary sector, while those quitting the secondary sector (at rate qs) move to unemployment (i.e. nobody moves from the secondary to the primary sector). those of the unemployed who quit their unemployed status (at rate qu) move either into the primary or the secondary sector. the unemployed, of course, receive no wage. as before, the proportion of filled positions (jobs) supplied in the primary sector is pp, while that of the secondary sector is ps. a critical difference is that, unlike the two-sector model with no unemployment (where everyone who is willing to work in the secondary sector for a wage equal to their marginal product, ws, finds employment), in this model the number of filled positions in the secondary sector, ps, is equal to or less than (1 – pp); ps being smaller than (1 – pp) would result from barriers to entry into the secondary sector. the barriers and obstacles may include physical, financial, human and social capital requirements. grimm et al. (2011a) present a small model in which the barrier to entry results from the borrowing constraint of the potential secondary sector entrant interacting with the minimum scale of capital, k*, needed to generate a higher return. note that the capital, k, typically includes physical capital, but the concept can also be expanded to include human capital (i.e. the basic education and training needed to be employed by or operate a small enterprise). thus, below the minimum scale the return to capital is very low. the question a potential entrant into the secondary sec-tor faces is whether or not the minimum scale of capital is lower than her borrowing con-straint. the borrowing constraint originates from asymmetric information: lenders do not know whether borrowers will in fact acquire the capital with their borrowed funds and thus be in a position to generate a return in excess of what the borrower needs to pay the lender for the borrowed funds. thus, if the borrowing constraint is lower than the minimum scale, then the return to capital is small, and the entrant will have to use her total return to cover the cost of capital, rk; there will be no profit left after paying the cost of capital. hence, investment will not take place and the entrant will not enter the secondary sector. if, however, the minimum scale is lower than the borrowing constraint, investment will take place and returns to capital will exceed capital cost (this high return will of course fall to zero as the scale of capital is expanded and the marginal product falls with the expansion in scale). in their model (grimm et al. 2011a:s30) the secondary market entrant would maximise her profit, π, subject to a borrowing constraint, with output produced by a simple production function where y = f(k), yielding output y pro-duced with capital k when k > k*, and capital producing just enough output to cover its cost when k ≤ k*: subject to: the capital stock is chosen so that f’(k) = r if b* > k*. if b* ≤ k*, that is, the borrowing constraint is binding, then the entrant is indifferent between different levels of capital, since capital has a zero profit when 0 < k < k* – hence, one can expect no investment to occur. thus, one could argue that those potential entrants whose borrowing constraint is lower than the minimum scale capital, b* ≤ k*, will not enter the secondary sector, and will move to unemployment. the proportion of potential entrants for whom b* > k*, will be defined as θ. note that in the two-sector model of the previous section all those workers who were unable to find jobs in the primary sector were able to find a job in the secondary sector if they were willing to work for a wage equal to the marginal product of their labour. however, in the three-segment model of this section, barriers to entry into the secondary sector means that only a fraction, θ, of those who are unable to find jobs in the primary sector are able to enter the secondary sector. therefore: that fraction, θ, is itself a function of the barriers of entry – the higher the barriers to entry, the lower the fraction. in terms of equations 16 and 17, the lower b* is and the higher k* is, the higher is the barrier to entry into the secondary sector and therefore the lower θ will be. this implies that (1 – pp – ps) is the proportion of positions that the primary and secondary sectors would have supplied, had there not been barriers to entry in the secondary sector. it also means that, in this model, pp and ps are expressed as ratios of fp + fs, + u (which now comprises the labour force), with u being the involuntarily unemployed. with the above, and similar to equation 2, the sum of the present value of expected pri-mary, secondary and tertiary sector income in the economy is (where the zeros represent the zero wage earned by the unemployed): in equilibrium, outflows from the primary sector need to equal inflows into the primary sec-tor from the third segment (unemployed). thus, (qp + d1)pp = qupp(1 – pp – ps), which also means that qu = (qp + d1)/(1 – pp – ps). in addition, the outflow from the secondary sector needs to equal inflow into the secondary sector from both the primary sector and the unemployed segment. thus, qsps = (qp + d1)pp + qups(1 – pp – ps), which (after reorganising) implies that (qp + d1)pp = qsps – qups(1 – pp – ps) (which also equals qupp(1 – pp – ps) – see previous paragraph). assuming that the unemployed receive no income, it means that in this case too α/(d2 – d1) = (pvp – pvs) (compare equation 5). the present values of primary and secondary work are: therefore: which after normalising on wp yields: using the equilibrium condition that (qp + d1)pp = qupp(1 – pp – ps) (which also means qu = (qp + d1)/(1 – pp – ps)), equation 22 simplifies to: now recall that ps= θ(1 – pp) and substitute it into equation 23 to yield: equation 24 represents the effort supply function in the three-segment model. as was the case with the two-sector model with no involuntary unemployment, an increase in pp would cause wp to decrease and the slope of the effort supply function becomes flatter the larger pp becomes. note that, unlike in equation 8, the quit rates do not disappear from equation 24. the reason for this is that the existence of barriers to entry into the secondary sector cause θ in equation 24 to be smaller than 1 (i.e. θ < 1).7 the job-offer relationship and the price-setting and wage-setting relationships equations 9 to 11a remain unchanged, with equation 11b subscripted for the primary sector: therefore, there is a positive relationship between p and wp, but a negative relationship (given that g < 0) between ep and pp (as ep increases, wp decreases, causing pp to also decrease). equation 10 represents, again, the price-setting relationship, while equation 11b represents the job offer relationship. substituting equation 11b into equation 24 yields the detailed wage-setting equation: as ep increases (and given that g’ < 0), wp increases. model summary the model can be summarised as follows. first, in p-wp space there are two relationships (the sign within [ ] indicates the sign of the p-wp relationship): a job offer relationship: an effort supply function: which is distinguished by the presence of θ (a function of barriers to entry) and quit rates. secondly, in ep-wp space there are two relationships (with g’ < 0) (the [ ] indicates the sign of the ep-wp relationship): a price-setting relationship: a wage-setting relationship: which is also distinguished by the presence of θ and quit rates. in a similar fashion as in the previous section, equations 11b and 24, and 10 and 25 can be used to calculate the equilibrium values for wp, pp and ep: note that, unlike their two-sector equivalents (equations 13–15), equations 26–28 contain θ (a function of barriers to entry) and the quit rates. the implications of these are discussed in the next section. together with the effort supply function, the job offer relationship then deter-mines the equilibrium number of positions in the primary sector. in addition, recalling that ps = θ(1 – pp), one can calculate the employment level in the secondary sector: in the three-segment model the unemployed are involuntarily unemployed. those who end up in the third segment and who cannot re-enter either the primary or the secondary sectors, due to the presence of barriers to entry into both the primary and secondary labour markets, find themselves involuntarily unemployed. using equations 28 and 29, one can calculate the total equilibrium employment level in the economy (ep + es), which equals the equilibrium level of positions filled, fp + fs. hence: is the number of involuntary unemployed. a comparison of the two models the two-sector, three-segment model shows how the two-sector model can be expanded from a model that merely explains the allocation of labour between the primary and secondary sec-tors, to a model that caters for the possibility of involuntary unemployment on the aggregate level. the key difference centres on the following. in the two-sector model, workers who quit or lose a job in one of the sectors, circulate back to a job in the other sector. in the three-segment model, workers who quit or lose a job in one of the two employing sectors do not necessar-ily find a job again and may end up being unemployed. some workers might also never have worked (and remain unemployed). the main reason why workers end up unemployed is the existence of barriers to entry such as a lack of physical and human capital as discussed above. (if there are no barri-ers to entry into the secondary sector, the three-segment model reverts to the two-sector model.) to compare the two models, compare equations 13–15 and 26–30. compared to the two-sector model, the presence of the quit rate qp in the three-segment model’s equations 26–30 implies higher equilibrium values for wp, pp and ep.8 in the literature (cf. campbell & orszag 1998:121), higher levels of employment and wages are associated with a higher quit rate – higher employment levels imply a higher probability of finding a job again once the worker quits. in two-sector model equilibrium, quit rates (as well as d1, i.e. the probability of being laid off for shirking while not actually shirking) do not affect wp, pp and ep because in equilibrium the flow into the primary sector equals the flow out of the primary sector – those who quit find jobs in the secondary sector and are replaced, in turn, by workers moving from the secondary to the primary sector. however, because of entry barriers in the secondary sector in the three-segment model, the flows into and from the primary sector are not necessarily equal. this implies a relationship between quitting and wp, pp and ep. in the three-segment model, barriers to entry mean that θ < 1 (θ being a function of barriers to entry b). if θ = 1, then all the terms containing qp in equations 26–28 would disappear by virtue of being equal to zero,9 which will also mean that qp would have no effect. thus, in this model the presence of barriers to entry (which cause θ < 1) also ensure that qp has an effect on wp, ps and ep. higher levels of employment in the primary sector imply that should a worker quit, the probability of ultimately finding a job again in the primary sector is higher, which, in turn, may engender a greater willingness on the part of primary sector work-ers to quit. hence the positive relationship between quit rates and pp and ep. unlike the two-sector model where all workers are employed either in the primary or the secon-dary sector, in the three-segment model pp + ps ≤ 1 with θ < 1. the higher the barriers to entry b, the lower pp and ps will be, hence (using equations 26, 27 and 28), the lower wp and ep will be.10 thus, barriers to entry mean fewer positions will be filled in both the primary and secondary sectors; employment will thus be lower. it also means wages in the primary sector will be lower than in the two-sector model. furthermore, note that the higher the quit rate qs from the secondary sector, the lower are wp, ps and ep. in the three-segment model, quitting from the secondary sector means that the worker moves towards unemployment, while in the two-sector model it means that the worker cir-culates back to the primary sector. for given quit rates from the primary and tertiary sec-tors (‘tertiary quitting’ being quitting from unemployment and thus moving back to either primary or secondary sector employment), a higher quit rate in the secondary sector means a higher probability of ending up without a job, even if one starts out in the primary sector. thus, a higher quit rate from the secondary sector depresses wages, employment and the num-ber of jobs in the primary sector. a graphical representation of the models figure 3 is a graphical presentation of the models discussed above. it shows employment in the two employing sectors on the horizontal axis and real wages w on the vertical axis. primary sector employment is measured rightward from the vertical axis (marked wp), while secondary sector employment is measured leftward from the vertical axis (ws). nn represents the working-age population. distance e shows those who are not economically active. figure 3: unemployment in the theoretical three-segment model. suppose, to start off, there is a perfectly competitive labour market with no market power and no efficiency wages. the wage paid in the primary and secondary sectors would be equal (i.e. there is no real distinction between the primary and secondary sectors). and represent labour supply and demand in a perfectly competitive (subscript c) labour market among firms in the primary sector, while and represent labour supply and demand in the secondary sector. is horizontal, following the simplifying assumption that the marginal product of labour in the secondary sector is constant.11 because the markets are perfectly competitive, wages in the primary and secondary sectors would be the same, wpc = wsc, with epc and esc being the corresponding employment levels in the primary and secon-dary sectors. the distance marked a represents those workers who would be voluntarily unemployed – they could always find work at the prevailing wage wsc (i.e. if they are will-ing to reduce their reservation wages). now suppose the economy is neo-keynesian, with market power and efficiency wages in the primary sector. this produces the two-sector neo-keynes-ian model (subscript k), still with no barriers to entry into the secondary sector. the wage-setting (wpp) and price-setting (psp) relationships in the primary sector will, due to effort behaviour, establish a wage wpk that is higher than wpc. employment in the primary sector, at epk, will be lower compared to the perfectly competitive case, at epc. the difference in the num-ber of workers being employed in the primary sector equals distance b in figure 3: b = epc – epk. workers who are not accommodated in the primary sector are diverted to and employed in the secondary sector. thus, labour supply in the secondary sector is and b’ (the horizontal leftward displacement from to ) equals distance b (the quantity of workers relocated from the primary sector). notice that in this model distance a equals distance b + c, since all these unemployed workers can find employment in the secondary sector at wage wsc should they wish to (i.e. if they lower their reservation wage); they are voluntarily unemployed. next we introduce barriers to entry into the secondary sector (for simplicity we ignore barri-ers to entry into the primary sector). given the nature of ‘effort behaviour’ in the primary sec-tor, as before a quantity of workers equal to b will not be accommodated in the primary sector (compared to the perfectly competitive case). however, the presence of barriers to entry in the secondary sector means that labour supply in the secondary sector will be at – lower than the previous case’s . a quantity of workers equal to distance d will be involuntarily unemployed. this constitutes the third sector or segment in the model. unlike the case of the perfectly competitive market where workers can simply offer their labour at a lower wage, in a market with efficiency wages (with firms paying a wage to ensure effort), firms in the primary sector set both wages and prices. hence, workers cannot increase employment in the primary sector by offering to work for a lower wage. in addition, even if unemployed workers are willing to work in the secondary sector for a wage equal to the marginal product of labour, barriers to entry prevent them from doing so. the workers represented by distance c still are voluntarily unemployed. even in the case of a perfectly competitive market, their reservation wage would have been above the market wage – they would have preferred unemployment even in the case of a perfectly competitive mar-ket. note that the quantity of workers b + d are willing to work in either the primary or the secondary sector at a wage of wpc = wsc, but are prevented from doing so due to the pay-ment of efficiency wages in the primary sector and the existence of barriers of entry in the secondary sector. conclusion and potential policy implications to create a theoretical model that explains the dual nature of the south african labour market (with its formal and informal sectors) and the simultaneous existence, indeed persistence, of very high unemployment, this paper draws on the dual labour market model of bulow and summers (1986) and the suggestion by kingdon and knight (2004), as well as work by grimm et al. (2011a) that show that barriers to entry into the informal sector exist. following the latter authors, such barriers are defined as the interaction of a borrowing constraint (itself the result of the asymmetric information faced by lenders in financial markets) and the mini-mum scale of capital needed to earn a high return. the model shows: how a primary sector characterised by efficiency wage and labour union behaviour, as well as a mark-up due to high transport cost, can explain the dual nature of the labour mar-ket. how barriers to entry faced by potential entrants into the secondary sector can prevent workers from entering the secondary sector. this constrains the effective supply of labour to the secondary sector. how, as a result, these workers end up being (involuntarily) unemployed in a long-term macroeconomic equilibrium. the secondary sector does not simply absorb all those who cannot find employment in the primary sector. from a policy point of view, the above suggests that there is no single or ‘silver bullet’ solution to address the unemployment problem. the solu-tion is not as easy as, for instance, simply decreasing wage levels to render labour cheaper. indeed, if the assumptions on which the above model draws hold in the south african reality, then a solution to the unem-ployment problem involve policies addressing product and labour market structures and behaviour in the primary sector, as well as policies addressing the numerous barriers to entry, such as borrowing constraints, that poten-tial entrants into the secondary sector face. acknowledgements the authors wish to thank redi3x3 for the generous funding of this project, as reflected in burger & fourie (2015), which is a more comprehensive source to consult. the usual disclaimers apply. competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contribution both authors contributed equally to the article. references agénor, p.r. & montiel, p., 1999, development macroeconomics, 2nd edn., princeton university press, princeton, nj. berry, a., 2001, the role of the small and medium enterprise sector in latin america: implications for south africa, tips working paper 5, viewed 05 june 2017, from http://www.tips.org.za/files/421.pdf blanchard, o. 2005, european unemployment: the evolution of facts and ideas, working paper 11750, national bureau of economic research, cambridge, ma. bulkley, g. & myles, g.d., 1996, ‘trade unions, efficiency wages and shirking’, oxford economic papers 48(1996), 75–88. https://doi.org/10.1093/oxfordjournals.oep.a028562 bulow, j.i. & summers, l.h., 1986, ‘a theory of dual labor markets with application to industrial policy, discrimination and keynesian unemployment’, journal of labor economics 4(3)(part 1), 376–414. burger, p. & fourie, f.c.v.n., 2015, macroeconomic policy and south african unemployment: developing a three-segment macroeconomic model, redi3x3 working paper 6, viewed from http://www.redi3x3.org cahuc, p. & zylberberg, a., 2004, labor economics, mit press, cambridge, ma. campbell, c. & orszag, j.m., 1998, ‘a model of the wage curve’, economics letters 59(1998), 119–125. https://doi.org/10.1016/s0165-1765(98)00018-4 carlin, w. & soskice, d., 2006, advanced macroeconomics, oxford university press, oxford. cde (centre for development and enterprise), 2013, ‘graduate unemployment in south africa: a much exaggerated problem’, cde insight, viewed april 2013, from http://www.cde.org.za/publications/jobs-growth/83-jobs-and-growth/403-graduate-unemployment-in-south-africa-a-much-exaggerated-problem fourie, f.c.v.n., 2011, the south african unemployment debate: three worlds, three discourses?, working paper 63, saldru, university of cape town or: working paper 1, redi3x3, viewed 05 june 2017, from http://www.redi3x3.org grimm, m., krüger, j. & lay, j., 2011a, ‘barriers to entry and returns to capital in informal activities: evidence from sub-saharan africa’, review of income and wealth 57, special issue, s27–s53. https://doi.org/10.1111/j.1475-4991.2011.00453.x grimm, m., van der hoeven, r. & lay, j., 2011b, unlocking potential: tackling economic, institutional and social constraints of informal entrepreneurship in sub-saharan africa: main findings and policy conclusions, international institute of social studies, erasmus university. kingdon, g.g. & knight, j.b., 2004, ‘unemployment in south africa: the nature of the beast’, world development 32(3), 391–408. https://doi.org/10.1016/j.worlddev.2003.10.005 knell, m., 2014, ‘efficiency wages, staggered wages, and union wage-setting’, oxford economic paper, 66(3), 848–870. layard, r., nickell, s. & jackman, r., 1991 and 2005, unemployment: macroeconomic performance and the labour market, oxford university press, oxford. pereau, j.-c. & sanz, n., 2006, ‘trade unions, efficiency wages and employment’, economics bulletin 10(4), 1–8. statistics south africa (statssa), 2009, labour force survey – historical revision: september series 2000 to 2007, statistical release p0210, pretoria. statistics south africa (statssa), 2017, qlfs data, excel datasheet viewed 01 june 2017, from http://www.statssa.gov.za/?page_id=1854&ppn=p0211&sch=7012 summers, l.h., 1988, ‘relative wages, efficiency wages, and keynesian unemployment’, american economic review 78(2), 383–388. van der berg, s. & van broekhuizen, h., 2012, graduate unemployment in south africa: a much exaggerated problem, working paper 22/2012, university of stellenbosch, viewed from http://resep.sun.ac.za/index.php/research-outputs/stellenbosch-working-papers/wp2012/ footnotes 1. concerning the microfoundations of the model, the model assumes a simple utility function, resembling the specification by bulow and summers (1986), with infinitely lived agents, where utility, ut, is a function, f, of consump-tion and shirking (or ‘non-effort’): ut = f(xp, xs + αl)/r, where x represents consumption of goods produced in the primary and secondary sectors (sub-scripts p and s denote the primary and secondary sectors). in addition, l is zero when the worker exerts effort and one if the worker does not exert effort. non-effort is thus considered to be a consumption good, and it is substitutable for secondary sector goods. furthermore, a is the instantaneous gain in utility from shirking/non-effort, while r represents the discount rate. following bulow and summers (1986) we assume risk neutrality (so that f(λxp, λxs) = λf(xp,xs)) and preferences are homothetic and normalised (so that f(0,0)=0). 2. for simplicity, quitting and being laid off are modelled to depend on shirking (insufficient work effort or productivity); other factors that determine quitting or being laid off can be modelled analogously. the simplification is not central to the main result of involuntary unemployment present in the full model, but merely facilitates it – involuntary unemployment will depend on the presence of barriers to entry into the secondary sector. nevertheless, because it is commonly used in international literature, the shirking model is used here. 3. for reasons of simplicity equation 6 assumes infinitely lived workers and as such uses the simple formula for the calculation of the value of a consol to calculate the present value. 4. the premium rate is (α2 – 1). 5. .the south african labour market is also characterised by a clear skills-related stratification of the unemployed, with an oversupply of unskilled workers and a shortage of skilled workers: the unemployment rate among individuals holding post-school degree qualifications is approximately 5%, and among those who have not completed school just below 50% (cde 2013; van der berg & van broekhuizen 2012). this article does not include these highly skilled workers into the model simply because when they quit or are laid off they typically do not move to the informal sector, but find employment relatively easily elsewhere in the formal sector. 6. note that h is divided by γ so as to ensure that in equation 11 p is purely a function of the marginal product of labour and not γ: wp = g(ep) = γb(ep), so dividing g(ep) by γ leaves b(ep) = mpl. 7. that the first term containing qp would equal zero if θ = 1 is straightforward to see. in the case of the second, recall that (qp + d1)pp = qupp(1 – pp – ps), which means (qp + d1) = qu(1 – pp – ps), with (qp + d1) appearing in the second term on the right-hand side of equation 24 that contains qp. if θ = 1 then pp + ps = 1, so that qu(1 – pp – ps) = 0, which also means (qp + d1) = 0.) in the literature (cf. campbell & orszag 1998:121), higher levels of employment and wages are associated with a higher quit rate – higher employment levels imply a higher probability of finding a job again once the worker quits (more about this in section 4, which compares the two models). 8. why is this so? with γ > h in all realistic scenarios, a higher qp means that the third term on the right-hand side of equations 26–29 that contains qp (4(qp + d1)θ wsγ/h) will always be larger than the second term that also contains qp, for instance –(qp + d1)(1 θ)ws)2 in equation 26, leaving the net effect of these two terms as a positive value. with the first term on the right-hand side also containing qp, the net effect of the three terms on the right-hand side containing qp will be positive, meaning higher equilibrium values for wp, pp and ep. (the only exception to this scenario would be the primary sector goods market approximates an almost perfectly competitive market, contrary to the assumptions of this model.) 9. why the first two terms containing qp would equal zero if θ = 1, is straightforward to see. in the case of the third, recall that (qp + d1)pp = qupp(1 – pp – ps), which means (qp + d1) = qu(1 – pp – ps), with (qp + d1) appearing in the third term on the right-hand side of equations 26–28 that contain qp. if θ = 1 then pp + ps = 1, so that qu(1 – pp – ps) = 0, which also means (qp + d1) = 0. 10. the logic is as follows: higher barriers mean a lower θ, and the lower θ, the higher will be the first term on the right-hand side of equations 26–28 containing θ, but also the lower will be the second and third terms on the right-hand side of equations 26–28 containing θ. the effect of the second and third terms will exceed that of the first, which means that the net effect of these three terms on wp, pp and ep in a case of a lower θ is negative. with both pp and θ being lower, ps will also be lower. 11. assuming a constant marginal product of labour for the secondary sector is not an altogether unrealistic assumption. berry (2001:7) argues that large and medium enterprises (in our model operating in the primary sector) usually have an amount of capital that complements a number of workers. as the number of workers increase, it might lead to a decrease in the marginal product of labour. however, by their very nature, firms in the informal sector are very small, and the capital needed is replicable on a small scale (i.e. in the extreme case of one-person firms – own-employment – it is not the case that for instance a second worker is added to a given set of capital in a single small firm, but rather that the second worker can set up his or her own firm and replicate the capital – each worker is therefore the first worker and there is not really a second worker that can decrease the marginal product of labour. a similar point can be made for firms employing say two or three workers since with two or three workers, there is not much scope to decrease the marginal product of labour, particularly if the capital is replicable on a small scale. berry (2001:7) argues that the flat marginal product of labour and thus the flat labour demand for informal sector workers has been well verified, given the expandability of the informal sector. of course, as the discussion below will indicate, there might be financial constraints on acquiring that minimal amount of capital, which might limit the size of the effective labour supply. abstract introduction local content requirements and the impact on economies specific aspects regarding setting of local content requirements the analytical framework (research methodology) data analysis and findings summary and conclusion acknowledgements references about the author(s) christopher ettmayr school of economics, development and tourism, nelson mandela metropolitan university, south africa hendrik lloyd school of economics, development and tourism, nelson mandela metropolitan university, south africa citation ettmayr, c. & lloyd, h., 2017, ’local content requirements and the impact on the south african renewable energy sector: a survey-based analysis’, south african journal of economic and management sciences 20(1), a1538. https://doi.org/10.4102/sajems.v20i1.1538 original research local content requirements and the impact on the south african renewable energy sector: a survey-based analysis christopher ettmayr, hendrik lloyd received: 19 jan. 2016; accepted: 24 apr. 2017; published: 25 aug. 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: economies aim to grow over time, which usually implies the need for increased energy availability. governments can use their procurement of energy to increase benefits in their economies via certain policy tools. one such tool is local content requirements (lcrs), where the purchase of goods prescribes that a certain value has to be sourced locally. the argument for this tool is that spending is localised and manufacturing, as well as job creation, can be stimulated because industry will need to establish in the host economy. however, this practice is distortionary in effect and does not create a fair playing ground for global trade. furthermore, if the local content definition is weak, or open to manipulation, the goals of such a policy may not be achieved at all. aim: the objective of this study was to determine how lcrs would ultimately impact on the overall procurement programme. setting: this study took place as south africa commenced with large scale development of the renewable energy sector. this was largely achieved via the state run renewable energy independent power producer procurement programme (reipppp). method: this study utilised opinion-based surveys to look into the lcrs of south africa’s reipppp and measure the impact of this policy on the renewable energy sector in general. the mixed method approach was utilised to analyse qualitative and quantitative data and this was then triangulated with an international peer group to arrive at certain conclusions. the delphi technique was then employed to achieve population consensus on the findings. results and conclusion: it was found that, in order to implement a policy such as local content without any negative welfare effects, the host economy had to show certain pre-existing conditions. because south africa does not hold all supportive pre-conditions, the impact and effect of lcrs have not been optimal, and it has not been found to be a sustainable mechanism to continue using indefinitely. the pricing of renewable energy was also found to be higher due to local content and such pricing is passed on to the energy consumer. the welfare created for south africa, which should be in a trade-off for the creation of jobs and manufacturing, is therefore diminished and coupled with unsustainability and potential manipulation of the system, the country does not seem to be benefitting as it should be from this specific application of a local content policy. introduction countries around the world are aiming to grow their economies, implying that the demand for energy from electricity sectors will increase. because of the increasing development, there are larger and more demanding power users; if power is not readily available it could place serious constraints on the economy. to add further complexity to this matter is the notion of developing a green economy that involves, on the one hand, growing the economy and, on the other hand, reducing environmental impact and improving human social development. this has been a trend in developed countries, now evident in developing nations too. the united nations environment programme (unep) is in support of this notion and defines the green economy as ‘one that results in improved human well-being and social equity, whilst significantly reducing environmental risks and ecological scarcities’ (unep 2011:2). this concept provides a dichotomy for governments, whereby the demand for energy is rising, but generation costs need to be low enough to remain attractive for inward investments. in addition, the increased provision of energy must not negatively impact the environment or human well-being. within the context of the green economy, governments are using green industrial policies to meet certain objectives, such as increased energy generation, higher employment and faster economic growth. this ultimately increases the associated energy costs (kuntze & moerenhout 2013:vi). local content requirements and the impact on economies local content in the south african renewable energy sector south africa has seen a similar trend as the scenario described above, whereby the economy has been growing and placing increased pressure on the electricity supply. to increase electrical supply in the country, renewable energy has been recognised as an essential part of a mix of energy carriers that offer a positive impact on environmental and human well-being (as compared to fossil fuel). the south african government announced that it was to procure renewable energy from independent power producers (ipps), according to the requirements of the integrated resources plan (irp) 2010 – promulgated under the electricity regulation act, 2006 (act no. 4 of 2006). the irp 2010 document committed government to having 17.8 gw of renewable energy installed by 2030 (department of energy 2011a:6). in an effort to meet the targets presented in the irp 2010 document, the minister of energy released a determination in 2011, stating that a total of 3725 mw would be procured by 2016 through one or more tendering processes. the energy to be procured from renewable sources would include wind, concentrated solar power (csp), solar photovoltaic (pv), biogas, biomass, landfill gas, small hydro and small (under 5 mw) projects (department of energy 2011b:118–119). then, in december 2012 an announcement of an additional 3200 mw of renewable energy to be purchased through the renewable energy independent power producer procurement programme (reipppp) was made by the doe, pushing the programme’s expected completion date from 2016 to 2020 [department of trade and industry (dti) 2015:xi]. the doe made further allocations of 1000 mw in round 4 of the reipppp, plus another 200 mw was allocated to csp projects. in addition, a request for further proposals was put forward by the minister of energy for 1800 mw, which would be allocated to bidders previously unsuccessful but able to revise their tenders and re-submit. the minister went further to announce that an additional 6300 mw was applied for through the national energy regulator of south africa (nersa), in accordance with provisions in the irp 2010–2030 (doe 2014b, 2015; engineering news article 2014a). the reipppp also included a portion of projects termed ‘small scale’ that was designed to include those between 1 mw and 5 mw. during the first small scale window application period, 102 projects were submitted with the potential for generating 450 mw. however, only 78 projects were successful, totalling 345 mw (engineering news article 2014b). the implications of such a large tender were significant to countries such as south africa. at the time of writing this paper, four rounds of the reipppp had been concluded: 92 projects were approved with a combined nameplate capacity of 5243 mw. this resulted in an investment value of r193 billion (bn) (engineering news article 2015). the doe noted that of this investment value, r53.4bn was from foreign sources that increased south africa’s inward foreign direct investment (fdi) in 2015 by just more than double with the other total fdi for the same period being r22.6bn (doe 2016:27). the dti created an industrial policy that complies with the south african laws but sets certain prerequisites for the use of policy tools such as local content. the doe identified key features of the reipppp that they felt would be catalytic for achieving economic development objectives, whilst aligning with the dti policies. these are as follows: develop projects that lead to new opportunities for local communities create job opportunities in certain technologies and especially in construction opportunity for procurement to be structured by government, emphasising certain economic development objectives formation of new companies combining emerging black enterprises with experienced, well-resourced companies (in terms of equity share and project management) promotion of broad based black economic empowerment (bbbee) potential via subcontracting and procurement to include large, medium and small enterprises, bringing benefit to target groups of people involvement of black equity and management skills through the extended time-frame ipps would operate in (doe 2011:92–93). based on the objectives above, the doe developed a table of socio-economic outputs that had to be met, or exceeded, in order for tenderers to become a ‘preferred bidder’ in the reipppp. the tender adjudication was based on the 70–30 principle where 70% would be evaluated on price and 30% would make up the socio-economic criteria. from the latter, there was a further breakdown (see table 1 in which certain points were obtainable based on the objectives provided in the bulleted points above). table 1: socio-economic criteria for the renewable energy independent power producer procurement programme. each renewable energy project required a minimum of 40% participation by a south african entity, a minimum ownership by black south africans of 12% (with the target set at 20%) and a minimum ownership of a local community of 2.5%, where the community lived within a 50-km radius of the project (baker & wlokas 2014:10). local content requirements (lcrs) featured in the economic development criteria and the government used this specific tool in an attempt to commit to industrial development. the national development plan (ndp) and the new growth plan (ngp) utilise local content as a policy tool to stimulate development and to try and maximise benefits for the immediate economy; this programme from the doe was aimed at doing the same (doe 2011). the term local content has been defined by the south african bureau of standards (sabs) as: that portion of goods, works and services that have been generated and produced in south africa. companies that import raw material and convert this raw material in south africa also contribute to local content to the extent that the south african value-add processes and additional inputs count as local content. (giz 2013a:27) the calculation of local content is illustrated in box 1. box 1: local content formula. in table 2, the levels required from the reipppp per technology are summarised. it is important to note that the levels generally increase with each round of bid submissions. table 2: reipppp local content requirement percentage levels. the difference between the threshold levels (above) and the target levels were defined in the reipppp tender documentation. bidders had to achieve the minimum requirement threshold levels to be compliant; they were, however, encouraged to attempt to reach target levels as the intention of the doe (in alignment with the dti industrial policies) was to maximise local benefits. the percentages were evaluated on a sliding scale where no points were allocated to bidders achieving threshold level. as higher percentages were achieved, more points were awarded until the maximum points were gained by those bidders able to reach target in their submission. local content impact on investment certain key drivers are needed to create a climate conducive to encouraging investment in the renewable energy sector and although lcrs create a drawcard for manufacturers to consider establishing in a new economy, there are additional drivers to support this move. abrahams (2012) argues that the drivers necessary for establishing a renewable energy manufacturing hub in south africa would include: a sustainable renewable energy market with growth prospects a strong supply-side support that would include established supplier relationships and manufacturer capabilities the presence of skilled labour physical location and infrastructure availability research and development (r&d) presence that is accessible the existence of incentives for manufacturers a supportive government. (p. iv) the first key driver to be tested in this research would be the market strength and potential growth of the sector. south africa has committed to a renewable energy programme that holds predetermined levels of energy to be purchased per technology. therefore, the market for ipps and manufacturers has been established, and demand has been shown to be present, with potential for future expansion. because a strong supplier support was listed as a key driver, the existence of local manufacturers and suppliers of renewable energy technologies, components and ancillary items would be conducive to investment attraction. domestic skilled labour is required for sector support, as there is currently criticism about the large influx of foreign labour used to erect and develop renewable energy projects in south africa. ipps have, however, indicated through media releases that the required skilled labour is not present in the country, and this represents challenges to ipps wanting to maximise their local content spend. there are studies, at the time of writing, which are testing the market in terms of being able to supply suitably qualified labour for work in renewable energy by original equipment manufacturers (oems). physical location of renewable energy projects is also important since ipps need to locate in areas with optimal renewable energy resources, and manufacturers need to be close to their customers so as to minimise logistical costs (these can be quite high for the larger and abnormal loads that characterise some technologies, e.g. large wind turbine blades and towers). electrical transmission infrastructure is equally important as this is needed to ensure grid connectivity and the ability of the system to evacuate and distribute the power generated on-site. manufacturing also relies largely on supportive infrastructure being present. the ability of south africa’s logistical and electrical infrastructure to support local manufacturers of renewable energy technologies and components was tested during the survey process. the fact of whether local suppliers are able to produce such manufactured goods at the right quality levels and price was also questioned in the survey. r&d is important to ipps and manufacturers alike as it can lower costs and improve efficiencies. however, due to technologies already tested and proven internationally, the ipps in south africa are generally installing and developing projects with very little r&d investment. r&d is more relevant to the manufacturing of renewable energy components and it is usually found that the country of origin of a particular technology will tend to keep this intellectual property and r&d local, whilst only allowing some manufacturing of the most basic subcomponents to be outsourced. the existence of incentives for ipps is important and south africa currently uses such for investment attraction. however, with the ipps looking to tender in the reipppp, the tender itself could be viewed as an incentive since it is a guaranteed take-off for energy to be produced over a 20-year period. lastly, a supportive government is important for manufacturers and ipps alike. government can indicate support via the procurement of renewable energy and can set targets and goals that show future demand continuing for the supply of such energy. national projects via south africa’s national state utility, eskom, as well as through the doe – previously done in south africa – send out positive signals of support. ultimately, throughout the conflicting debate on the impact of lcrs it is acknowledged that local content will have an impact on investment attraction, although this has not been determined in the case of the south african renewable energy sector. an increase in investment, especially from fdi, does have a positive association with economic growth and, therefore, benefit to the local economy. from literature and research based on econometric techniques and case studies, veloso (2001) refers to the impact of fdi where all indicators point to the fact that it contributes to economic growth and reinforces the learning processes of industrialising nations. there was also evidence that there was a spill-over effect from fdi, providing an increase in the economic growth rate (veloso 2001:21–23). this study, therefore, looks at the relationship between lcr levels and their impact on investment attraction; it is assumed that increased investment through foreign sources will naturally have a positive effect on the local economy. specific aspects regarding setting of local content requirements setting lcrs is complex and multi-faceted since, on the one hand, lcrs can add value to locally-produced goods and can stimulate r&d and innovation, but on the other hand lcrs can distort international trade and affect the efficient allocation of resources. it has been noted that ‘(g)lobally, lcr for renewable technologies in different forms have been used in rare instances and mainly in developing countries’ (ebrd blog 2012:1). one of the main justifications put forward by developing countries in defence of lcrs is that they are relevant when the type of industry is completely new to their economy. they therefore use lcrs in order to stimulate and develop an infant industry, which they intend to establish into a mainstream manufacturer that can compete globally. this argument can be justified, but countries do not always reduce or remove lcrs after a period, in which case this can become a trade barrier. therefore, countries are not always in a position to be able to select the highest quality of goods at a competitive price because lcrs have a direct influence on the procurement of these goods or services. a new phrase has been coined in this regard – ‘clean energy trade war’ – where countries use lcrs to justify the blocking of free trade in the name of transitioning to more environmentally-friendly means of developing energy (kuntze & moerenhout 2013:vi). when to use local content policy local content can achieve many successes in a host economy; however, there are certain pre-conditions that need to be present before implementing such a policy. kuntze and moerenhout (2013:1) identified these key conditions. firstly, there would have to be a ‘stable and sizeable market’ for which financial support should be available. this was seen as crucial, to avoid the crowding out of investment. in addition, the lcrs should not be set too high or be too restrictive and they should have a learning aspect tied into them in order to ensure skills transfer, thereby increasing efficiencies over the long term (kuntze & moerenhout 2013:1). the basic pre-conditions for effectively implementing lcrs in a particular economy are summarised in figure 1. figure 1: basic conditions needed for effective local content requirements in renewable energy. local content policy advantages kuntze and moerenhout (2013:6–9) found that lcrs increased the demand for certain products, which in turn increased the demand for staff, brought in new technologies and – because more manufacturing was taking place – the tax base for government increased. wu and salzman (2014:422–423) similarly concluded that local content increased the demand for domestically-produced goods, leading to higher levels of employment. lewis (2013:4) found an interesting spin-off from increased local manufacturing – as global competition increased in response to more market entrants, product costs were driven down and technological innovation increased. local content policy disadvantages local content requirements can bring about negative consequences such as inflationary pressure on prices, incentivising business to misallocate resources, and impacting on trade relations by using a form of protectionist measure. it was also found that because of local content, companies may employ fewer staff due to the increased expenses caused by the policy and this also restricts the transfer of technologies (kuntze & moerenhout 2013:6–9). the giz (2013b:29) found that local content limited the level of natural competition and nowicki (1997:363) found that it disrupted the production and planning choices of manufacturers, which led to higher prices. in the specific case of south africa’s renewable energy industry, local content was found to allegedly increase the cost of renewable energy equipment, which may encourage a strategy of reducing the amount of staff allocated to a project and less energy output would be available for the same investment amount. brazil noted that when implementing lcrs in their wind sector, manufacturers only shifted the low and medium content production to their country, whilst the high technology components of their manufacturing process remained in the country of origin (rennkamp & westin 2013). when analysing the automotive sector which has used lcrs extensively, there are numerous examples of the impact of this tool. barnes and black (2013:14–15) found that companies focused mainly on assembly, and not manufacturing, to reach the required levels of local content. second tier suppliers also used mainly imported goods over locally-manufactured goods and aspects such as advanced work and tooling, as well as technology investment, still took place outside of south africa (barnes & black 2013:14–15). the philippines found inefficiencies in their performance standards which included lcrs, embargoes on imported vehicles, and tariffs on import and export requirements. it was estimated that – due to the protectionist policy – the cost to the consumer was approximately 40% of the vehicle price. this effect was mostly attributed to the tariff and if lcrs and the export requirements were removed, the result would change by approximately 10% (veloso 2001:37). lcrs have been listed as being responsible for both successes and failures of certain projects in the chemicals and computer sectors, depending on the specifics of each project and technology. it was estimated that – because of lcrs – in brazil, computers cost up to 200% to 300% more than if sourced outside of the country and this has slowed the use of this technology and reduced the pace of upgrading to new systems (veloso 2001:38). negative criticism found by eberhard, kolker and leigland (2014:28–29) of lcrs in the reipppp were that: lcrs were expressed in value terms but the worth of each job in a particular value chain is not measured; lcrs could therefore be refined to focus rather on maximising jobs of high value than simply creating as many positions as possible. if there is no capacity-building of the local market to supply developers there is an increase in inefficiencies and little skills transfer from the programme, increasing the costs for the foreign operators and developers. lcrs are oblivious to market conditions and currently there is an oversupply of renewable technologies, which makes local manufacturing profits very difficult to achieve. well established and mature manufacturers need to observe a very strong and sustainable market in order to justify moving into a new region (eberhard et al. 2014:28–29). the analytical framework (research methodology) due to the scarcity of information on lcr impact in the renewable energy sector the mixed method approach, which combines qualitative and quantitative methodologies, was employed. this method lends itself well to this type of research problem as data can be gathered and analysed in a quantitative manner whilst simultaneously delving deeper into specific qualitative aspects. in areas with limited secondary research, the qualitative methodology can be brought in to bolster the research and allow exploration of the research problem. the mixed method approach results in more meaningful and reflective knowledge generated from the study. the surveys developed for this study used both openand closed-ended questions, with the latter employing a likert scale to record responses. the survey design used the delphi technique as this method of iteration would allow for respondents to answer the first survey and then – once presented with the total overall results – they could either agree or answer differently in subsequent rounds of surveys being administered. this allowed for consensus to be gained from a broad array of respondents with differing views on the subject. the delphi technique was also found to be very useful in exploring this type of research topic where limited information existed on the impact of lcrs. there were essentially two identified groups of survey respondents – the first was the local ipp and engineering, procurement and construction (epc) companies who were directly involved in the reipppp projects from rounds 1 to 4 and who therefore had direct exposure to working with a policy tool such as lcrs. their practical experience and challenges in working with this tool was questioned via the survey process. the second group was comprised of an international group of renewable energy experts. this group was used to test and compare the responses to the local respondents. the methodology of triangulating the data was employed, whereby the literature was compared against the data collected from the local survey respondents and then compared against the international respondents. this ultimately resulted in a well-rounded response to the research problem and provided increased robustness and confidence in the conclusions that were drawn. a pilot survey was administered on a select group of respondents whose responses were captured with the total group. this provided face validity of the survey questions and allowed for minor corrections to be made before administering the full survey. the study population is defined as all reipppp-successful bidders and their epc companies. during the first four rounds of the reipppp, 79 projects achieved preferred bidder status and this group forms the total population size (n pop). a total number of 43 ipps developed these 79 projects and some ipps held shares in more than one project (entering into joint venture partnerships with each other in certain instances). the number of epc companies (with some ipps also performing epc functions) from the four rounds of the reipppp was 23 in total. therefore the total population sample group was 66 (n sample). a total of 48% (56 of the 115 respondents) of the identified ipps answered the survey, 43% (11 of the 28 respondents) of the identified epcs provided answers and 39% (5 of the 13 respondents) of the international group responded. the data that was collected did not go through any reliability testing as there was no pre-existing data for the results to be tested against. because of the employment of information triangulation, it was determined that this technique would be sufficient to produce reliable data for analysis and interpretation. ethical consideration ethics clearance was obtained via the faculty research, technology and innovation committee. data analysis and findings based on the data that was analysed from the ipp/epc surveys and using the delphi technique, the results are discussed below. this includes triangulating the findings with the results from the international group against the ipp/epc data, and from the theory obtained relating to lcrs impact. therefore, the theory informed the development of the surveys, the results were tested locally and abroad, and the delphi technique allowed for a convergence of thinking towards one unified response to the impact of lcrs on the renewable energy sector in south africa. key determinants that may be impacted by lcrs were identified for testing and they were broadly categorised into six main sections, described below under each category heading. data analysis the data obtained from the survey underwent the first statistical test – the confidence interval. additional tests performed were the pearson’s chi-square, cross-tabulation and cramer’s v. the pearson’s chi-square test was found to be invalid for this study because the population was too small; however, cross-tabulation was employed to highlight the magnitude of the difference between answers from the local survey and the international findings and furthermore, the cramer’s v test was used to measure the practical significance of each particular finding. findings the renewable energy market it was found by 75.8% of respondents from the ipp/epc survey that the south african reipppp created a strong local demand for renewable energy projects, which encouraged investment in the sector. it was also observed that the first three rounds of the reipppp resulted in r120bn of total project costs locating in south africa (sapvia 2014) and when triangulated with the findings from the international survey where 80% agreed that the reipppp created sufficient market demand, this statement was accepted. however, the south african renewable energy market was not rated as particularly stable with the confidence interval levels being below the 0.6 cut-off limit and the fisher’s exact test value of 0.057. predicted future growth prospects were not rated very positively and the statement of south africa’s market being stable was rejected because the confidence interval’s upper and lower limits were below 0.6 and the cramer’s v of 0.051 showed small significance. stability and predicted future growth were issues regarded as important key determinants and from the international survey where 60% of respondents agreed with the need for long term future growth) and therefore south africa should look at improving this aspect. the market was perceived to be relatively open to free trade with 54.5% of respondents from the ipp/epc survey agreeing with this statement. a total of 60.6% of respondents from the ipp/epc survey felt that the market was free from manipulation, and although it is believed that the answers given were only marginally positive in suggesting a lack of manipulation, the statistical tests did not allow for the acceptance of the hypotheses. therefore, there may be some inclination to avoid admitting manipulation in the tender process as the ipps and epcs would be the same entities submitting false claims on local content in the reipppp process and would be liable for a fine. in terms of access to finance and rates charged, it was found that 68.2% of respondents from the ipp/epc survey felt that the cost of south african finance is higher than that from international sources and 78.8% of respondents from the same survey felt that the finance available is very difficult to access. the cramer’s v value of 0.115 places a medium significance on this finding so attention must be paid to improving access to finance. a matter that compounds the problem of finance for projects is exposure to exchange rate fluctuations (where 90.9% of respondents from the ipp/epc survey felt that exchange rate exposure increases project risk), which increases project risk. stabilising the south african rand is difficult to achieve but perhaps future projects could find a way to protect themselves from this market exposure as it was of significant concern to the ipps and epcs. the south african banking sector did however achieve a significant share in projects with the doe (2016:27) report noting that after bid windows 1, 2, 3, 3.5, 4 and 1s2, a total of r194.1bn had been committed to the reipppp of which r53.4bn was raised from foreign sources. it was however believed that with more innovative mechanisms, local banks should be able to gain access to increase financing whilst decreasing risk exposure. the recent trend of ipps financing themselves is providing a difficult platform for banks to compete against, but there may be ways in which to counter this and ensure that local financial institutions gain benefit from the reipppp. therefore, from a government perspective, south africa could look at announcing clear long term plans regarding how it aims to procure renewable energy from the market in order to signal long term commitment to the sector – something investors wish to see. furthermore, government must be consistent in its procurement process and must adhere to the timelines announced as this creates market stability, improving the investment climate further. from a banking perspective, more innovative, accessible and low cost financing mechanisms need to be offered to the renewable energy market. restrictiveness of local content requirements lcrs set in an economy that does not have existing pre-conditions conducive to accommodating such a policy tool have been found to result in a negative welfare effect, as experienced in the indian automotive sector or brazil’s information technology sector. similarly, lcrs that are too restrictive will cause a negative impact on investment. this section of the survey measured the impact of lcrs on investment, their restrictiveness, and their capacity to impact manufacturing and create jobs. the local ipps and epcs found that south africa’s renewable energy lcrs resulted in investment, but this was a perception suggested by only 53% of respondents. this finding was triangulated with the theory as well as the international survey finding where 80% of respondents were of the opinion that lcrs encourage investment into the sector. the fisher’s exact test value of 0.246 allowed for this statement to be accepted even with the low response rate from the ipp/epc survey. therefore, although lcrs would naturally result in increased investment in a host economy, it is because of the effects of a mandatory requirement and not because it is a sustainable market opportunity that is being exploited. the ipps and epcs did not believe lcrs in the country were set too high and so – although they may serve as a deterrent to investment – it was not seen as prohibitive to entering the south african market. in a qualitative survey response on the effect of lcrs on the project price, the opinion was that the average price increase attributable to the project from lcrs was 9.89%. a total of 80% of the international respondents were of the opinion that lcrs would increase manufacturing in south africa but in terms of perceiving sustainability, the response rate decreased to 60%, although still remaining positive. the confidence interval limits were 0.48–0.58 that were not higher than the 0.6 cut-off, and therefore lcrs were not seen to create sustainable manufacturing in south africa. furthermore, the cramer’s v of 0.763 showed a large practical significance meaning that this matter should receive priority attention from the south african government. if lcrs create the incentive for manufacturing to establish and if this is the only reason that manufacturing locates in an economy, it is likely to move if the lcr was removed, or if the procurement programme ceased to exist. also, if competing economies offer higher lcrs and more attractive markets it may result in a move for manufacturers. therefore, lcrs will create manufacturing and investment, but this effect may only last as long as the content requirement is in place. to add to this sentiment, it was found by 34.8% of respondents from the ipp/epc survey that they did not believe south africa would be globally competitive in renewable energy manufacturing, sending out a signal that perhaps the focus on manufacturers alone should change to be more inclusive of a broader value chain perspective. the ipp and epc entities did not believe that removing lcrs would increase investment (with only 30.3% agreeing). also, the removal of lcrs – in the opinion of both the local (100% agreeing) and international respondents (80% agreeing) – would not result in increased employment levels. therefore, although it was felt that lcrs did not provide sustainable jobs or manufacturing, removing them completely would impact negatively on jobs and investment in the host economy. the removal of lcrs would allow ipps to lower their pricing and thus their tariffs. however, with removing lcrs, a potential risk does arise whereby jobs may be lost and there would be a lack of a compulsory environment that dictates local investment has to take place. it was found from 71.2% of the ipp/epc respondents that lcrs increase the price of the energy supplied and that this is carried by the taxpayer and energy user in south africa. another factor adding to project costs is the fact that by insisting on lcrs, project risk increases, which raises price and this is passed onto the consumer once again. therefore, removing the lcrs would reduce project risk, which would further allow pricing of the energy to decrease as agreed by 66.7% of the ipp/epc respondents. another challenge lcrs pose is the difficulty in sourcing local suppliers and – once sourced – their goods are often more expensive than a comparative imported good as agreed to by 72.7% of ipp/epc respondents. it was found by 63.6% of ipp/epc respondents that there are insufficient numbers of local suppliers in the industry. furthermore, there was an almost neutral response to the question about local content values not necessarily being completely accurate which once again would point to the potential manipulation of local content figures being placed in tender bids. to summarise, according to the survey outcomes, lcrs do increase local investment levels, manufacturing and jobs. however, the benefits created are not sustainable, and they increase project risks and costs, which end users and taxpayers ultimately pay for. there are benefits created by lcrs, but the manipulation of the system and its definition have been observed, which means that this policy tool is not able to maximise its intended purposes. physical location and infrastructure south africa is a suitable location for the establishment of renewable energy projects in terms of the availability of resources, for example, wind and solar radiation. this was the consensus of 93.9% of the ipp/epc respondents and 100% of the international respondents. in terms of transport, south african road, sea and air infrastructure enables investment and allows for projects to establish easily. the rail system is not used extensively, but this may be a practical response as rail is only present in certain geographic areas, whilst renewable energy projects can be located in very remote areas and in difficult terrain (it would be impractical to expect rail to service these projects). furthermore, rail can only accommodate certain dimensions of goods and when considering abnormal loads, it may be unable to assist in their transportation, no matter how efficient. rail infrastructure did not score very well in the survey process from the ipp/epc respondents with 19.7% agreeing that rail allows for easy establishment of renewable projects. therefore, rail should not be focused on for development or support of the renewable energy generation projects, as it will not necessarily lead to increased investment attraction, even if it becomes more efficient and economical. although south africa’s general infrastructure was rated well, the existing electrical infrastructure and its availability for connecting renewable energy projects scored poorly. a total of 47% of respondents from the ipp/epc survey agreed that the electrical infrastructure attracts ipps to establish their projects in the country. this is an area the ipp and epc entities felt was actively discouraging investment in the sector and should be prioritised in terms of the country’s infrastructure upgrades. there are currently renewable energy projects in existence that are unable to connect to the grid and sell their energy, and this has a direct impact on an ipp’s profitability. further improvements to electrical infrastructure as well as connectivity to the grid must be established. government cooperation and subsidies it was agreed that government has a significant role to play in stimulating investment in the renewable energy sector with 68.2% of the ipp/epc respondents and 80% of international respondents believing that government could stimulate this sector via certain programmes. the confidence interval range of 0.63–0.72 allowed for this statement to be accepted. there was, however, a neutral response to the question on current government support encouraging investment, with a 50/50 split in responses. this may point to the need for further government assistance and when triangulating this response to the international survey it became apparent from 60% of respondents that – from an international perspective – it was felt that government incentives were needed to support the industry. on the question of government involvement in the development of a renewable energy manufacturing cluster, there was overwhelming support from all respondents (77.3% ipp/epc and 80% international survey respondents), in favour of government assistance. it was felt by 72.7% of ipp/epc respondents that government support for localising technology suppliers and increasing technology capacity was lacking and that more could be done in this respect. the governance of the sector and cooperation from the south african government was noted as positive (60.6% of the ipp/epc respondents agreeing), although not at a very high level. the policy support and a clear long term vision were perceived to be lacking as only 74.2% of respondents agreed or were neutral on this question. therefore, a clear long term plan with the roll-out of a cluster approach may turn this result around and create a more enabling environment to support investment in the sector. the question about a bidding tender system (which south africa adopted) versus a set feed-in tariff was probed during the study, together with a query about which mechanism might be better. there are instances where one would be preferable, but in general 53% of the ipp/epc respondents believed that a feed-in tariff would have resulted in higher investment in the sector. the certainty that a feed-in tariff offers could therefore be noted as removing some uncertainty and investment in renewable energy projects would only increase marginally. the level of competition in the market at the moment is very high and so projects are only locating in areas with optimal resource availability and ease of connection to the electrical grid. therefore, if the government and specific municipalities were to encourage investment in particular areas, the merits of using a feed-in tariff should be investigated more closely. this is also stated because of the findings from the international survey where 80% of respondents felt that a feed-in tariff may bring about higher investment levels. learning-by-doing and technical knowledge it would appear that south africa possesses some technical skills to support investment in the renewable energy sector, but not at a level sufficient to support it effectively (with 59.1% of ipp/epc respondents agreeing to this; however the confidence interval did not allow the statement to be accepted). the accessibility of readily available skilled persons to support localisation is difficult to obtain, and although there is capability in epc skills and o&m functions, the number of persons able to offer their services to the market is limited. in terms of manufacturers establishing in the economy, it was found that there is difficulty in locating in south africa because of the low level of technology intensity in the market (making it hard to source skilled persons). from the existing skilled persons available only 53% of respondents felt that their services were competitively priced. this leads to the conclusion that the demand is high, but the resource is scarce; therefore price could have the tendency to be above average due to scarcity. in terms of the capability of south africa to skill people in this industry, it would be important that they are educated to a relevant level in order to be able to adapt quickly with minimal additional training. however, the ipp/epc respondents were neutral in their response to the question about the level of education in south africa being conducive to supporting the renewable energy sector and the confidence interval range 0.45–0.54 did not allow for this finding to be accepted. another negative factor is that the country’s availability of r&d for the renewable energy level would not encourage investment in the sector with only 10.6% of ipp/epc respondents feeling that the current r&d levels would encourage further investment. the cramer’s v value of 0.61 indicated a large practical significance, and therefore this is an area that should receive attention from the government as it was also believed by 74.2% of the ipps and epcs that they should not be required to provide r&d funding as part of their tendering conditions, even if this was in place of lcr spend. furthermore, it was believed that investment in r&d would not result in more sustainable manufacturing jobs when compared with those lcrs were creating (with 36.4% of ipp/epc respondents believing r&d investment would create sustainable jobs). having said this, 80% of the international group felt that investment in r&d would certainly encourage investment in the sector. to summarise, it could be concluded that lcrs do create jobs and manufacturers are locating in south africa; however these jobs are not sustainable and r&d spend together with cluster formation would be a more sustainable path to develop. the responsibility of this development is, however, viewed as being the responsibility of the government and not that of the investors; south africa should consider this paradigm shift in its industrial policy under the dti which in turn will influence procurement programmes such as the reipppp. supply-side constraints the market pre-conditions for the effective use of lcrs also infer that there are sufficient local suppliers available to satisfy local demand for products. it was found though by 62.1% of the ipp/epc respondents, that there are not enough suppliers to achieve the levels of local content required by the reipppp. to further exacerbate the problem of limited suppliers, the goods available locally are not competitively priced (with only 12.1% of ipps/epcs agreeing that there are competitively priced goods available and a fisher’s exact test value of 0.024 allowed for this statement to be accepted) resulting in ipps and epcs being urged to purchase goods at a higher price than they would if they were able to import products. the local suppliers were also unable to produce the goods at the required volume (with only 15.2% of ipps/epcs stating that local suppliers could meet demanded volumes) and – in terms of quality of supply – only 47% of ipp/epc respondents believed that local suppliers could deliver the required standard. the risk of financial penalties and legal action that local manufacturers face in terms of supplying ipp and epc companies is significant. it was found by 18.2% of the ipp/epc respondents that the local manufacturers were able to absorb this risk. the penalties imposed in the reipppp are significant and if the local suppliers are small entities that are newly established, it would be logical to assume that there would be difficulty in ensuring consistency of supply and an inability to afford the penalties should supply obligations not be met. it was also determined that only 40.9% of the ipp/epc respondents believed that the local suppliers were bbbee compliant, which further penalised the ipps submitting bids. the question regarding a renewable energy manufacturing cluster was asked once again in terms of supplier development and it was strongly suggested (by 80.3% of ipp/epc respondents) that this would improve availability of local supply. it could also be inferred that if the clusters had a strong component of bbbee empowerment, as well as an emphasis on quality, volume and price, it would be more conducive to supporting ipp bids in sourcing local goods. summary and conclusion this research has been conducted with the view of researcher neutrality towards lcrs as a policy. there are cases where this policy requirement has led to new investment in a particular country and has created jobs, such as those experienced in south africa; yet in other instances it is very clear that the policy is openly manipulated, possibly due to weaknesses in definition, but also because companies are aiming to provide a project at the best possible price and in order to do this they take advantage of certain loopholes. this may be out of necessity from a shareholder return perspective, but it may also be because they are forced to comply with a policy that is very difficult to do in a market with non-existent enabling pre-conditions. without arguing for or against lcrs, it is clear that south africa has two solutions to embark on within the renewable energy sector, as well as when using national procurement that recommends local content conditions. if south africa chooses to utilise lcrs going forward, it will have to focus on improved market pre-conditions to ensure that they can be successfully implemented without negatively impacting on investment, price of goods and the creation of sustainable jobs. as stated previously, localising a particular good or product may not always be feasible and lcrs should enhance existing manufacturing opportunities as opposed to trying to create opportunities that could not be sustainably supported in the long run. south africa should also carefully consider the value of the content being localised and the question of higher end value goods being localised, versus cheaper and easier to manufacture goods, must be analysed in greater detail. this would then ensure that longer term and sustainable benefit could be accrued to the economy, and short term, low-value and low-skill components could be avoided. should lcrs continue to exist in their current form, dedicated monitoring and action against transgressions must be strengthened as foreign companies that have localised manufacturing are currently being disadvantaged against imported goods. the development of a monitoring and evaluation process should include the public so that a broad consensus is achieved and buy-in for the principle of lcrs can be obtained from all affected citizens. a focus should also be placed on increasing foreign inward investment with technology and skills transfer featuring more strongly in the tendering process. developed countries are increasingly avoiding lcrs, as they wish to ensure open and fair global trade and the avoidance of market distortions (bringing unintended repercussions). south africa should take note of this together with further investment and government support for the development of clusters and r&d centres, as this would bring in foreign manufacturers, and the country would be competing on a lower cost basis as well as offering new technologies and innovations. this would allow for the market to decide where to invest, instead of being dictated to by policy, and the country would be able to hold a much higher value portion of the renewable energy manufacturing value chain. lcrs could be phased out over time to allow the market to adapt and the cost of renewable energy would most likely come down, allowing south africa to transition towards a lower carbon energy source. the primary aim of this research was to analyse how lcrs impact on the south african renewable energy sector. this was achieved by firstly, determining the key drivers that could impact on investment attraction in the south african renewable energy sector. the drivers were identified and during the survey process the key drivers were tested with the simultaneous use of local content policy. the impact, as perceived by the survey respondents, on the renewable energy projects and investment was analysed. due to certain key drivers not being present in the economy, the impact and effect of lcrs has not been optimal and it has been determined to be an unsustainable mechanism to continue using into the future. the definition of lcrs is more focused on ‘spend’ rather than ‘content’ and this has led to a mismatch of the outcomes of the policy versus the original intended objectives. a secondary objective of this research was to investigate the impact of lcrs on the pricing of renewable energy. this was achieved and it is evident that lcrs increase the price of energy, which is passed on to the energy consumer. it was found that south african renewable energy resources do exist, providing good potential for investment in renewable energy projects, and that the logistics infrastructure was sufficient. the demand created by the reipppp provided a sufficiently large market but there was uncertainty in the long term planning and stability, so from a market perspective the stability and clear, predictable planning could be further enhanced. government had created a sufficient platform for investment but areas of development, such as manufacturing clusters and r&d and skills training would create a better support environment for lcr policy; and strict monitoring of lcrs would be required to prevent any manipulation. the use of lcrs increases project costs and risk, which is passed on to the energy consumers, but this could be reduced if local goods were more readily available, at the right price and at the right quality and quantity. focus on manufacturing clusters would once again assist in this regard as ipp and epc entities would be able to source components and goods locally in a more cost effective manner. as the lcrs currently stand in the reipppp it would seem that south africa is making renewable energy more expensive and although it is argued that this is done for the benefit of creating a new industry and jobs, these are not sustainable and therefore the current lcr policy will only create short term benefits. in terms of answering how lcrs may impact on the south african renewable energy sector, it could be suggested that there are suboptimal impacts on the welfare of the economy because of missing pre-conditions that would typically allow for the successful implementation of lcr policy. south africa must consider either strengthening lcr policy through the provision of improved market conditions as well as monitoring and evaluation, or withdrawing them from procurement over a certain time period with a more focused effort being placed on r&d and innovation, in combination with manufacturing cluster formations. this will allow local manufacturers to compete globally in an open trading field without artificial advantages created by protectionist measures. this will also allow for renewable energy tariffs to be driven downwards, accelerating market acceptance of the energy carrier. the jobs and manufacturing created will be competitive and more sustainable, compared to those created via lcrs. acknowledgements competing interests the authors declare that they have no financial or personal relationships which may have inappropriately influenced them in writing this article. authors’ contributions c.e. did the research for degree purposes. h.l. was the research supervisor and mentor. references abrahams, f., 2012, ‘the key requirements for the establishment of a successful renewable energy manufacturing hub in atlantis’, research report presented in partial fulfilment of the requirements for the degree of masters of business administration at the university of stellenbosch, viewed 15 april 2015, from http://scholar.sun.ac.za baker, l. & wlokas, h., 2014, south africa’s renewable energy procurement: a new frontier, working paper 159, june 2014, tyndall centre for climate change research, norwich, england. barnes, j. & black, a., 2013, ‘the motor industry development 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poverty eradication – a synthesis for policy makers, viewed 25 february 2014, from http://www.unep.org/greeneconomy veloso, f., 2001, local content requirements and industrial development – economic analysis and cost modeling of the automotive supply chain, massachusetts institute of technology, cambridge, ma. wu, m. & salzman, j., 2014, ‘the next generation of trade and environment conflicts: the rise of green industrial policy’, northwestern university law review 108(2), 401–474. abstract introduction financial valuation of investments in greenhouse gas mitigation technologies values, increasing taxes and consequences for the willingness to invest in greenhouse gas mitigation technologies and for emissions reduction example conclusion acknowledgements references footnotes about the author(s) heinz eckart klingelhöfer department of managerial accounting and finance, tshwane university of technology, south africa citation klingelhöfer, h.e., 2017, ‘unintended possible consequences of fuel input taxes for individual investments in greenhouse gas mitigation technologies and the resulting emissions’, south african journal of economic and management sciences 20(1), a1472. https://doi.org/10.4102/sajems.v20i1.1472 original research unintended possible consequences of fuel input taxes for individual investments in greenhouse gas mitigation technologies and the resulting emissions heinz eckart klingelhöfer received: 07 sept. 2015; accepted: 28 nov. 2016; published: 27 mar. 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: south africa is planning to introduce a carbon tax as a pigouvian measure for the reduction of greenhouse gas emissions, one of the tax bases designed as a fuel input tax. in this form, it is supposed to incentivise users to reduce and/or substitute fossil fuels, leading to a reduction of co2 emissions. aim: this article examines how such a carbon tax regime may affect the individual willingness to invest in greenhouse gas mitigation technologies. setting: mathematical derivation, using methods of linear programming, duality theory and sensitivity analysis. methods: by employing a two-step evaluation approach, it allows to identify the factors determining the maximum price an individual investor would pay for such an investment, given the conditions of imperfect markets. results: this price ceiling depends on the (corrected) net present values of the payments and on the interdependencies arising from changes in the optimal investment and production programmes. although the well-established results of environmental economics usually can be confirmed for a single investment, increasing carbon taxes may entail sometimes contradictory and unexpected consequences for individual investments in greenhouse gas mitigation technologies and the resulting emissions. under certain circumstances, they may discourage such investments and, when still undertaken, even lead to higher emissions. however, these results can be interpreted in an economically comprehensible manner. conclusion: under the usually given conditions of imperfect markets, the impact of a carbon tax regime on individual investment decisions to mitigate greenhouse gas emissions is not as straight forward as under the usually assumed, but unrealistically simplifying perfect market conditions. to avoid undesired and discouraging effects, policy makers cannot make solitary decisions, but have to take interdependencies on the addressee´s side into account. the individual investor´s price ceiling for such an investment in imperfect markets can be interpreted as a sum of (partially corrected) net present values, which themselves are a generalisation of the net present values known from perfect markets. introduction being one of the world’s most carbon-intensive economies, ‘ranked among the top 20 countries measured by absolute carbon dioxide (co2) emissions’ (national treasury 2010:16, 2013:19), and based on prior research examining different options and scenarios (scenario building team 2007; tyler & cloete 2015; vorster, winkler & jooste 2011; winkler 2007; winkler & marquard 2011), south africa is on the way to introduce a carbon tax as a pigouvian measure for the reduction of greenhouse gas (ghg) emissions from 2017. three tax bases were discussed (national treasury 2010:30–34, 2013:46–47): the actually measured ghg emissions: this allows for targeting pollution at the responsible source and would encourage investments e.g. in end-of-pipe technologies, but is quite complex in practice since it is difficult to measure and monitor the big variety of emissions sources. thus, it leads to high administrative costs. two proxy bases: upstream, as a fuel input tax, charging all the fossil fuels entering the economy, and downstream, as an energy output tax, levied at the emitters. because there are natural scientific relations between the amount of fuel input and the emissions of co2, usually leading to comparable results to those of taxing the emissions directly, south africa opted for the introduction of a fuel input tax (national treasury 2013:47). and in fact, research proves that this may be a viable solution for south africa (alton et al. 2014; devarajan et al. 2011; van heerden et al. 2006). thus, also the newly drafted carbon tax bill (republic of south africa 2015) considers this discussion proposing that, from 2017, taxes to reduce ghg emissions shall be levied with respect to the combustion of fossil fuels; fugitive emissions in respect of commodities, fuel or technology (i.e. the ghgs emitted when extracting, processing and delivering fossil fuels); and industrial processes and product use. starting at r120 per ton (t) co2 equivalent, a variety of tax-free thresholds and offsets as well as allowances will let the effective tax result between r6 and r48 per t co2 equivalent, and revenue recycling shall neutralise the revenue from a macroeconomic perspective (national treasury 2015; republic of south africa 2015:14–18). while previous proposals additionally planned to increase the tax at a rate of 10% per annum from the initially planned introduction in 2015 until 31 december 2019 (national treasury 2013:15, 58), this is no longer stated in the newly drafted current tax bill. in this context, this article examines the degree to which carbon taxes in form of a fuel input tax are actually able to provide incentives for ‘individual’ investments in ghg mitigation technologies, that is, the perspective is not on the whole economy, but on an individual investor. following the rationale laid down by pigou (1932:172, 174, 183, 224), economic literature agrees that taxes may be instrumental for environmental policy. setting a price for emissions makes them economically relevant: comparing the resulting emissions costs to the abatement cost, producers may decide to avoid pollution. because of the above-mentioned natural scientific relations between the amount of fuel input and the emissions of co2, this is supposed to be true as well for a carbon tax designed as a fuel input tax. hence, it is thought that because of carbon taxes, investments in emissions reduction technologies may become economically significant as well. as co2 emissions result from combustion processes, a financial assessment of such an investment will have to derive the required payments and constraints from production planning, with special regard to carbon taxes and joint production (klingelhöfer 2010:373). this allows for developing a valuation model and for investigating the factors determining the individual investor´s maximum payable for a ghg mitigation technology (i.e. his individual price ceiling). activity level–dependent and activity level–independent payments are taken into account – as well as the investment´s indivisibility and uncertainty, which may result from changes in politics and in ecological awareness. employing duality theory of linear programming allows for transferring and adjusting known results from perfect markets to the usually given situation on imperfect markets. in particular, it can be shown that the reaction of the (individual) price ceiling on changes of its determinants – that is, on imperfect markets: the (corrected) net present values of the payments and of the interdependencies due to changes in the optimal programme – is neither as predictable nor as straightforward as under the often assumed, but normally not realistic conditions of a perfect market. hence, as the effects of different tax rates are a usual object not only of academic discussions and, therefore, also earlier versions of the planned south african carbon tax regime provided for increases, employing sensitivity analysis helps to gain further information about the complex, sometimes even unexpected and undesired reactions of the maximum payable price and the ghg emissions on such changes. nevertheless, an economically comprehensible interpretation is possible. for better understanding, an example demonstrates these effects. finally, the main results are summarised. financial valuation of investments in greenhouse gas mitigation technologies background: financial evaluation on imperfect markets under uncertainty several studies have examined the consequences of environmental policy on investments in environmental protection technologies (alton et al. 2014; arguedas & van soest 2010; blanco & rodrigues 2008; buchner 2007; chakraborty et al. 2004; hart 2008; hyder 2008; knutsson, werner & ahlgren 2006; laurikka 2006; laurikka & koljonen 2006; mcgilligan, sunikka-blankb & natarajan 2010; reinaud 2003; scenario building team 2007; sekar et al. 2007; tyler & cloete 2015; vorster et al. 2011; winkler 2007; winkler & marquard 2011; yang & blyth 2007; zhao 2003; for an overview of different environmental tax schemes in the european union and other countries cf. cansino et al. 2010; markandya et al. 2009; national treasury 2010:43–49, 2013:36–39). while some of these refer to a single sector or to the whole economy, others take an enterprise point of view and employ different techniques for project appraisal such as cost-based approaches, discounted cash flow (dcf) models, which calculate the present value of an investment by discounting future cash flows at an appropriate discount rate, or real options analyses and simulations. however, the conditions of ‘perfect markets’ underlying these models are often not appropriate for individual investment decisions. this may already result from restricted and differing borrowing and lending conditions, and manufacturing companies may have other opportunities than the financial market – for example, investing in other technologies or increasing/reducing production. then, calculating ‘ordinary’ (net) present values by discounting expected cash flows with exogenous interest rates (even if adjusted to uncertainty) and real options values become inadequate for the financial valuation of technology investments. this becomes even more significant as other requirements for the application of real option pricing models usually are not fulfilled by the characteristics of ghg mitigating investments either.1 consequently, to examine the effects of any environmental policy on a company´s decision whether to invest in emissions reduction or not, it needs to be considered that every activity may interfere with other decisions. for instance, limited capital budgets may restrict the realisation of investment opportunities or the purchase of raw materials and, consequently, production (but also the ghg emissions). in the same way, production constraints and capped emissions may reduce revenues resulting from the sales of the desired products, hence, impact other investment or financing decisions (including investments into environmental protection). on the other hand, capped emissions and less fuel input will also reduce the amount of taxes to be paid. therefore, ‘a theoretically correct financial valuation’ of an investment into ghg mitigation technology needs to take into account these constraints and interdependencies. in particular, because both the emissions as well as the carbon taxes on the fuel input are determined by (joint) production, it will consider the links established by production planning. in other words, such a financial valuation cannot be adequately done under the simplifying conditions of perfect markets, but necessarily needs to account for the much more complex ones of ‘imperfect markets’. in the consequence, instead of calculating the investment´s value solely by discounting cash flows with a single market interest rate, a theoretically correct (partial) appraisal demands the endogenous marginal rates of return of the best alternatives. also, a mere calculation of the net present value of an additional object does not say much regarding its profitability, because such a net present value does not account for capacity shortages resulting from the realisation of this additional object, which, subsequently, may also alter the decision relevance of other objects or capacities (i.e. the binding restrictions of the company´s investment and production planning programme may change; klingelhöfer 2010:374). consequently, assessing the degree of profitability of an additional single investment or activity within imperfect markets means a comparison of the situation after investing [i.e. the ‘valuation programme’ (vp)] to the one before investing [i.e. the ‘basic programme’ (bp)] (hering 2006:57–59; jaensch 1966:664–665; klingelhöfer 2006:59–91; matschke 1975:253–257, 387–390). by doing so, a sensible approach implicitly considers (differently from neoclassical approaches) that such a technology investment is usually indivisible – it is either undertaken entirely or not at all. in case of a greater maximum value in the vp than in the bp, investing becomes reasonable. ensuring this by means of a minimum withdrawal constraint, the vp computes the price ceiling, that is, the highest possible price p the company could afford for investing in emissions reduction. ‘uncertainty’, as it results from either reiterative changes of environmental policy, shifts in ecological awareness or altered conditions on liberalised waste markets, etc., may be taken into account by using decision trees (magee 1964a, 1964b; mao 1969; and in the context of investment planning klingelhöfer 2006:59–83; laux 1971:19–22, 39–44). starting with s = 0 for the already realised and, therefore, known state in t = 0, the set s = {0; 1; …; s} also includes the s possible future states s until the time horizon t = t. although presenting itself graphically in a (two-dimensional) tree structure, this set may still be easily treated as a one-dimensional mathematical structure by consecutively numbering the states from s = 0 to s = s. hence, mathematically, the valuation under uncertainty does not differ from the one under certainty (where each point in time t would be represented by exactly one state s). however, in the economical interpretation, this means that all payments in all possible states are considered. nevertheless, because of the given mathematical structure, the decision maker does not need to know probabilities, means or variances, so that the restrictive assumptions of the bernoulli principle together with its axioms are no longer needed. instead, the decision maker only depends on information on which states may occur with positive probability, as simple dominance considerations are sufficient. payments determined by production planning taking the environment into account, every production is characterised as joint production: according to linear activity analysis of production (debreu 1959:37–49; klingelhöfer 2000:222–252, 417–442; koopmans 1957:71–83, 1959; nikaido 1968:180–185), employing the production process β once (e.g. for an hour), the so-called ‘basic activity’ b,β will transform m different kinds of inputs rμ (as fuel, labour, perhaps recycled waste) into n different kinds of desired and undesired outputs xν (like products, electric power, heat, emissions and waste). hence, each basic activity can be expressed by a vector of m input and n output commodities φε2: then, ‘every possible production’ of a technology set t is a linear combination of the q basic activities with non-negative coefficients, the activity levels λβ: the γ ‘production and environmental constraints’ can usually be converted into the following form (klingelhöfer 2000:310–416): then, the link to a financial valuation of production is established by the introduction of a ‘price system’ (klingelhöfer 2009:371): assigning positive prices pε to the targeted results of production like the input of waste3 and the output of products, prices equal to zero for neutral inputs and outputs (e.g. air and water in certain cases; co2 emissions, which were neither taxed nor regulated in any other way would fall under this category as well) and negative prices for the input of (traditional) production factors (primary commodities such as material, labour or fuel) and the output of waste and emissions delivers the ‘contribution margin’ cm: this contribution margin cm is process specific, because not only single, but all the ingoing and outgoing commodities of the production process are valued together; it grows proportionally with the level of production. taxes τε ≥ 0 on co2 emissions or fuel inputs φε lead to a slight modification: then, an ‘investment i in emissions reduction’ changes [without loss of generality (w.l.o.g.)] the input/output vector of process q to – with the amount of those components that are standing for the charged fuel inputs and the carbon emissions hopefully reduced compared to the very same ones in the original process q. therefore, for the ‘contribution margin’ cm of the new production, including process i instead of process q, we obtain instead of (eqn 5): for reason of generality, it should be pointed out that such a linear formulation of the production background does not restrict the model’s applicability. although especially in an environmental context one often finds nonlinear relationships, they can normally be approximated by piecewise linear functions. this is true for both the objective function and the constraint system. nevertheless, because the derived equations and inequalities (including the contribution margin) will only be part of the constraint system, but not of the objective function of the following linear programming approach, the approximation would be even easier. in addition, it should be taken into account that (variable) tax rates usually do not tend to change continuously with the quantity of the charged substances φε, but in intervals. this is especially true for the south african design of a carbon tax: until the threshold the tax is τe = 0, above τe = r120/t co2 equivalent. hence, like in most cases, for south africa a linear formulation is even more appropriate than a nonlinear one. model for the financial valuation of investments into greenhouse gas mitigation technologies as mentioned above, an investment appraisal on imperfect markets under uncertainty can be done by comparing the situation after investing (i.e. the vp) to the one before investing (i.e. the bp). an operationalisation of the maximum value to be calculated by the bp may be the maximisation of the sum sww of weighted withdrawals ws · ws subject to the constraints of investment and production – with s ∈ {0; 1; 2; …; s} denoting the s + 1 states from today (s = 0 in t = 0) to time horizon t = t and the weights ws expressing to which degree the decision maker prefers payments in the regarded states relative to payments in the other states.4 considering that ghg mitigation technologies are supposed to clean production, the contribution margins (including the carbon taxes) and limitations of production need to be integrated in the constraint system (klingelhöfer 2010:376): the production constraints (eqn 3) directly like any other restriction, the contribution margins cm (eqn 5) affecting the company’s liquidity, which must allow for covering all the payments: +  resulting from production and the carbon tax regime, +  zjs from other investment or finance projects invj (as credits or shares), +  uzs, which are independent from production quantities and the investment programme (e.g. additional individual deposits, fixed rents, payments determined in the past), and the withdrawals ws to avoid insolvency. hence, the bp results as a linear programming problem: subject to: liquidity/capital budget constraints for the s + 1 states s (cp. eqn 5]): γs production and environmental constraints γ for the s + 1 states s (cp. [eqn 3]): q activity level constraints for the s + 1 states s: maximum realisation of j other investment or finance projects: non-negativity conditions: its optimal solution swwopt serves as a benchmark for the profitability of an investment i in ghg mitigation technologies for process q (w.l.o.g.). this means that the vp has to ensure that – after realising the investment – the investor receives at least the same sum of weighted withdrawals again (minimum withdrawal constraint). then, surplus money allows either for consumption or could be used to pay for the investment (its price pi). hence, the vp calculates the highest price the decision maker could afford for realising the investment, that is, its ‘price ceiling’ . besides this different objective function val and the minimum withdrawal constraint, the vp resembles structurally the bp. however, it also includes all the activity level–dependent and activity level–independent payments caused by this investment. therefore, with respect to the liquidity, the replacement of the contribution margins (eqn 5) by (eqn 6), as well as the price pi of the investment and other activity level–independent payments zis (e.g. for its installation) have to be considered. then, the vp results as follows: subject to: liquidity/capital budget constraints for the s + 1 states s (cp. [eqn 6]): γs production and environmental constraints γ for the s + 1 states s (cp. [eqn 3]): minimum withdrawal constraint (ensuring that the sum of weighted withdrawals after investing is at least as high as the maximum swwopt before): q activity level constraints (including the cleaned one) for the s + 1 states s: maximum realisation of j other investment or finance projects: non-negativity conditions: pi ∈ ir while the variables pi for the investment’s price and for the activity levels on which the cleaned process i is employed (instead of ) differ from the bp, the remaining decision variables are the same: the activity levels of the q − 1 unchanged processes, the quantities invj of the other investment and finance projects and the withdrawals ws. the contribution margins (eqn 5) respectively (eqn 6) modify the liquidity constraints of the two programmes, while the restrictions (eqn 3) are part of the constraint systems. values, increasing taxes and consequences for the willingness to invest in greenhouse gas mitigation technologies and for emissions reduction (corrected) net present values and the maximum payable price for the investment if both the bp and the vp have an optimal solution that is finite and positive, applying duality theory of linear programming allows for obtaining information about the determinants of the maximum payable price. in order to do so, the optimal solution to the dual problem of either programme has to be inserted into the equal optimal one to the corresponding primal problem. using complementary slackness conditions leads to an economic interpretation of the mathematical formula: by the introduction of the dual variables: ls for the liquidity constraints (and the resulting endogenous discount factors ρs,0 = ls/l0 to discount payments in state s to state 0), πγs for the production and environmental constraints, and for the activity level constraints and ξj for the maximum realisation of the other investment and finance projects, and dividing the dual constraints of the decision variables by l0, we obtain the ‘(corrected) net present values’ npv(corr) of (cp. for this and the following analogously klingelhöfer 2009:375 f.)5: using the q processes β ∈ {1, 2, …, q} respectively β ∈ {1, 2, …, q − 1, i} in the states s: :=  discounted contribution margin (including carbon tax) –  discounted monetary equivalent of the required capacity of the production and environmental constraints realisation of the other investment and finance projects j: npvinv, j := discounted payments employing them allows for identifying the determinants of the price ceiling for an investment in ghg mitigation technologies. if, to both the primal and the dual problem, solutions exist that are positive and finite, then, according to duality theory of linear programming, both problems have the same optimal solution. hence, we can gain information concerning the price ceiling from the optimal solution to the vp’s dual problem. furthermore, via the withdrawal constraint in the vp, this optimal solution also considers the impact resulting from the one (swwopt) of the bp. ergo, if the bp also has an optimal solution, the equal one to its dual can substitute swwopt in the minimum withdrawal constraint of the vp. consequently, using the optimal solutions to both the dual problems, the equation of the maximum payable price contains a variety of corresponding dual variables of both programmes. nevertheless, an economic interpretation is possible by resorting to the (corrected) net present values (eqn 9) and (eqn 10). for positive primal variables and of the activity levels or invj for the maximum realisation of the other investment and finance projects, the ‘complementary slackness’ conditions force the corresponding inequality (eqn 9)–(eqn 10) to be satisfied as an equation. thus, all the ‘positive’ dual variables and ξj of the valuation (vp) and the bp can be substituted by the corresponding (corrected) net present values npv(corr).6 introducing the dual variable δ of the withdrawal constraint leads to an equation for the ‘maximum price’ ‘an investor can afford for ghg mitigation technologies’ as a sum of several (partly corrected) net present values7: =  npv of all activity level–independent payments zi,s of investing in ghg mitigation technologies (e.g. for its installation, but besides )  (a)  +  npvcorr of operating the cleaned process i at its maximum activity levels , when it is profitable  (b)  +  npv of the changes between vp and bp regarding the valuation of the payments uzs, which are independent from production quantities and the investment programme  (c)  +  npv of the changes between vp and bp regarding the monetary equivalents of the production and environmental constraints  (d)  +  npvcorr of the changes between vp and bp by operating the other profitable production processes β at their maximum activity levels ,  (e)  +  npv of the changes between vp and bp regarding the realised other investment and finance projects  (f) this price ceiling for investing in ghg mitigating technologies is determined by the (corrected) npvs of its payments and of the interdependencies resulting from adjusting the optimal investment programme. under uncertainty, the ‘discounted payments of all states’ are included – even if, in fact, they may not occur. at first sight, the economic interpretation (eqn 11) of the price ceiling resembles the known one from perfect markets. especially, the (partly corrected) net present values npv(corr), which were derived from the dual constraints of the two primal problems, represent the equivalent to the ‘ordinary’ npvs on perfect markets. however, on imperfect markets, they are ‘not’ calculated with capital market interest rates, but with the correct ‘endogenous’ interest rates of their respective optimisation problem bp or vp (expressing the individually different opportunity cost of capital), and they are corrected for the use of the restricted capacities in their programme (i.e. capital budgets, production, environment). thus, one can see that the maximum payable price for investing into ghg mitigation technologies is calculated in a much more complicated way than on perfect markets, but, in the end, may be expressed in a similar way. however, containing the corrections for the use of restricted capacities and, thus, taking into account the interdependencies occurring from: (1) the imperfect market conditions and (2) the changes between the situations before and after realising the investment, it gives already an indication that overcompensations between the various determinants may be possible. and in fact, this is the reason, that under the conditions of imperfect markets, one can get to much more complex, even unexpected and undesired, reactions of the maximum payable price on changes, for example, in the tax regime than the straightforward ones on perfect markets. the next section is going to examine them closer. increasing carbon taxes and consequences for the willingness to invest in greenhouse gas mitigation technologies and for emissions reduction as discussed in the introduction of this article, the new carbon tax in south africa shall start at r120 per ton (t) co2 equivalent, and even though no longer part of the current version, previous versions proposed an increase at a rate of 10% per annum until 31 december 2019. to examine the possible effects of such a development on the willingness to invest in ghg mitigation technologies, a closer look at (eqn 11) is helpful: the economic interpretation of the terms (b) and (e) of (eqn 11) in connection with (eqn 9) demonstrates that ‘carbon taxes’ affect the ‘maximum payable price’ for investing in ghg mitigation via the corrected net present values of the processes. therefore, it is easy to verify that equation (eqn 11) usually confirms long-term knowledge in environmental economics for a single investment, because an individual investor would consider to pay and is able to pay as much into environmental protection as he can save via reducing emissions (in this case, via reducing fuel inputs that are taxed because they lead most probably to co2 emissions). however, sensitivity analysis of the left-hand side coefficients of both the bp and the vp demonstrates that – under the relevant conditions of imperfect markets (according to the background section of this article, investments into environmental protection technologies imply that they are given) – rising carbon taxes may be ‘counterproductive for ghg mitigation investments’. the maximum payable price may increase, decline or remain constant if taxes change (cp. for this and the following klingelhöfer 2010:379 f.). mathematically, there are three reasons for this: taxes are coefficients for a decision variable, which is a basis or non-basis variable. this may differ between the bp and the vp. the optimal solution of the vp considers the one of the bp via the minimum withdrawal constraint. in both programmes, negative (corrected) npvs cannot be part of the optimal solution. this allows for (over)compensation of the effects of changing taxes between the two programmes. for instance, in the beginning rising taxes may affect especially the cleaner processes less than the chosen ones in the bp. this, indeed, encourages investing in ghg mitigation technologies. yet, with continuously rising carbon taxes, some of the processes chosen in the bp may lose their profitability faster than those in the vp. however, when the (corrected) npv of a process or any other object becomes negative, it ceases being part of the optimal solution and, therefore, stops diminishing swwopt. consequently, the optimal solution of the dual vp may decline – and, with it, as well. in particular, this may be the outcome when, as a result of rising taxes, production is stopped in the situation without emissions reduction and, therefore, no longer affected by rising carbon taxes (with the consequence that co2 emissions are reduced to zero), while it is still profitable when using ghg mitigation technologies. thus, in the vp there would still be production to cover fixed costs and, consequently, there would be still ‘ghg emissions’, while ‘profitability’ would be more and more affected by higher taxes. accordingly, as long as these cleaner processes using ghg mitigation technologies are not completely ghg emissions free (as it may be the case for some renewable energies), which would mean that they remain unaffected from tax changes, higher carbon taxes may sometimes even have ‘paradoxical effects’: (1) the investment in ghg mitigation ceases to be profitable, (2) the marginal incentive for investing becomes negative and (3) emissions increase. the following example may help to understand this result. to focus on the main outcomes as stated above and to allow for easier reproduction of the calculations, it is kept as simple as possible and will abstract from thresholds and offsets, which are supposed to be implemented in the south african carbon tax regime. the reader may also consider that some of the other assumptions of the example are not very realistic. however, one can still derive similar results on the basis of different quantities, more time periods and a big set of future states to consider uncertainty, other preferences for the withdrawals and additional borrowing and lending opportunities. example effects of increasing carbon taxes on the willingness to invest in greenhouse gas mitigation technologies and the resulting emissions currently, a producer can dispose of two production processes, described by their basic activities and to produce a product p as a desired output. taking into account an initial amount of cash uz0 = 150 [zar] in t = 0, the producer wants to employ these two processes in a way that will guarantee him or her the highest possible withdrawals in t = 1. credits may not be available, but the producer can invest any surpluses at the capital market at the lending rate il = 50% (investment object invl). hence, the producer is operating on an imperfect market, and certainty shall be assumed. the market prices of the two inputs (resource 1 and fuel), the product p and the co2 emissions may be given by the vector p = (pr1; pfuel; pp; pco2)′ = (−12; −6; 30; 0)′. therefore, driving the processes at the activity level λold = 1 allows for realising the following contribution margins cm: now, the government wants to reduce co2 emissions. because it seems that fuel and co2 emissions are in a proportional relationship, the idea is levying τfuel on the input of fuel. therefore, the producer considers an investment in a ghg mitigation technology. this will modify the vector of the first basic activity to the new one of inputs and outputs. this means that reducing the quantities needed of input 1 by 0.75 [qu] (quantity units) and of fuel by 1.5 [qu] not only leads to 1 product less but also decreases the co2 emissions by 3 [t] (thus, with still the same relationship between fuel and co2 emissions, government´s underlying assumption for a carbon tax regime using fossil fuel input taxes holds). consequently, producing at the activity level λi = 1 after having invested, the producer receives the contribution margin: all the processes, irrespective of whether these are cleaned by a ghg mitigation technology, can be driven up to the same highest activity levels at λold1,max = λold2,max = λi,max = 10. however, installing the new technology and changing production in t = 0 requires a once-off payment of zi,0 = −150 [zar]. then, even without further knowledge of linear programming techniques, the ‘maximum sum of weighted withdrawals’ of the basic programme can be calculated by compounding with the lending rate il = 50% – for example, if there are no carbon taxes levied, that is, if τfuel = τfuel,0 = τfuel,1 = 0 [zar/qu]8: to realise these withdrawals in t = 1, the investor needs to use the processes at their (maximum) activity levels in t = 0 and in t = 1. furthermore, in order to make both the currently (in t = 0) unneeded initial amount of cash as well as the surplus from production available in t = 1, he invests into the capital market opportunity. hence, because invl yields at il = 50% and available money in t = 1 can be withdrawn directly, the shadow prices of the liquidity constraints result with and . for this initial situation, it is obvious that investing into ghg mitigation is not sensible: not only the contribution margins of the cleaned process are 12 [zar] smaller than before (150 [zar] now in comparison to the 162 [zar] of old1 in the bp) but also the initial amount of cash (plus the earned interest on it) is foregone for installing the ghg mitigation technology and the change in production. therefore, the investment’s price ceiling is negative, that is, only if someone else pays for it, the investor will invest in emissions reduction. solving the vp confirms this result: it can be proven by eqn 11. with δ = 2/3 (the bp maximises withdrawals in t = 1, while would be paid in t = 0), (more funds available in t = 0 allow for higher payments to realise the investment) and (in t = 0, the investor does not need to provide as much for the future and, therefore, is allowed to reduce investing at the capital market at the lending rate il = 50% if more money is already available in t = 1), we obtain from (eqn 11) as long as the emissions of co2 are not subject to taxes, that is (because the carbon tax regime is designed as a fuel input tax), for τfuel = τfuel,0 = τfuel,1 = 0 [zar/qu]9: this requires full production with λi,max = λold2,max = 10 at both points in time again, and the surplus of production of 3060 [zar] in t = 0 needs to be invested together with the ‘subvention’ = −350 [zar] for doing the investment at the interest rate il = 50%. only then the investor receives the same sum of weighted withdrawals swwopt = 8175 [zar] as in the bp. however, rising carbon taxes changes this solution: according to (eqn 9), they will diminish the corrected net present values of the production in the terms (b) and (e) of equation (eqn 11) – although (e) faster than (b) because of more emissions. hence, rising fuel input taxes τfuel = τfuel,0 = τfuel,1 impacts the optimal solutions swwopt of the bp and of the vp as presented in figure 110: figure 1: effects of rising fuel input taxes on the optimal solutions of the basic programme and valuation programme. as may be expected, rising taxes τfuel affect (via the scientific relationship to emissions) the price ceiling for emissions reduction, although in some cases differently than politically desired. the introduction of fuel taxes diminishes the contribution margins of production in both the bp and the vp. however, as the new process i needs less fuel than the former old1, its contribution margin is less affected by rising taxes, so that ‘ghg mitigation becomes increasingly more interesting’, reaching break-even at τfuel = 14 [zar/qu] already. now, even under economic considerations alone, it makes sense to pay for it. indeed, because of a growing advantage with higher taxes, the investor is able to afford even higher prices for ghg mitigation, while still realising at least the same sum of weighted withdrawals as without cleaning production. however, for taxes τfuel > 32.4 [zar/qu], production with the uncleaned process old1 loses its profitability in the bp and, therefore, is stopped. only old2 continues contributing to swwopt. on the other hand, the investor would still employ both processes (old2 and i) in the vp. thus, while process old2 is used in both programmes equally, rising taxes τfuel lead to melting contribution margins of process i (without equivalent in the bp) – the ‘maximum payable price’ for investing in ghg mitigation technologies must ‘begin to decline’. for τfuel > 39 [zar/qu], also old2 loses its profitability, and the sum of weighted withdrawals swwopt remains constant (just uz0 = 150 [zar/qu] can yield interest at il = 50%). thus, because only the contribution margins of process i are diminished by increasing tax rates τfuel, while the withdrawals in the situation without investing into ghg mitigation remain constant, the ‘price ceiling’ for investing into the new technology ‘continues to fall’. for τfuel > 40 2/7 [zar/qu], investing into emissions reduction even ceases to have an economic advantage: though, in the beginning, it still makes sense to employ process i because its contribution margins remain positive, they are no longer sufficient to cover the payments zi,0 = −150 [zar] for installing the new technology and adjusting production in t = 0 entirely. if finally τfuel > 42 6/7 [zar/qu], even the contribution margins of the cleaned process become negative. hence, there will not be any production in the vp either. this means that, in comparison to the alternative of not investing, the investor ‘will have lost the installing and adjustment payments zi,0 = −150 [zar] overall’. nonetheless, though it has just been shown that increasing carbon taxes may even discourage individual investments in emissions reduction, one may be of the opinion that mitigation of climate change is such an important target that one should not always look at the related cost. however, as much as this argument may be true, ‘it cannot be supported for “blind” tax increases’: while being true in the beginning, starting at τfuel = 32.4 [zar/qu], investing in cleaner technologies leads to even ‘more undesired emissions’ (cf. light shading in figure 1), and for 40 2/7 [zar/qu] < τfuel < 42 6/7 [zar/qu], it ‘is disadvantageous in both dimensions: economically as well as regarding ghg mitigation’ (cf. dark shading in figure 1), that is, although an investment into ghg mitigation is realised, the overall ghg emissions rise.11 if one, furthermore, considers that the information furnished by figure 1 refers ‘only’ to the individual price ceiling for the investment in emissions reduction technologies, while the investor will usually have to pay more than just 0 [zar/qu] – meaning that in most cases he would only invest when his individual price ceiling is much greater than 0 because only then he is able to afford the demanded price (the difference between both measures the investment’s profitability for the individual investor)12 – this dark-shaded area displaying the investment’s disadvantage in both dimensions (economically as well as environmentally) will be even greater. conclusion from 2017 carbon taxes should be introduced in south africa. to allow industry for adjustment, it offers a variety of tax-free thresholds and offsets as well as allowances and will start at r120 per ton (t) co2 equivalent. in order to examine the theoretical consequences of such a tax regime for the ‘individual’ willingness to invest in ghg mitigation, this article has offered a two-step evaluation approach, taking imperfect market conditions and uncertainty into account. because emissions result as a by-product from joint production, carbon taxes modify the contribution margins, and the reduction of emissions affects production as well. thus, the usually applied approaches for investment appraisal, which implicitly require that the conditions of perfect markets are fulfilled, cannot be employed to determine the individual profitability of such investments. instead, one has to use more generalised approaches that are also applicable under imperfect market conditions and which also consider the interdependencies between production, investments and environmental protection. furthermore, the model presented in this article takes into account that some payments may depend on the activity level of production, while others do not, and (in difference to neoclassical approaches) that a technology investment is usually indivisible (either it will be undertaken entirely or not). employing duality theory of linear programming, the known results from perfect markets can be transferred. in particular, the determinants of the investor’s individual price ceiling for investing into ghg mitigation can be identified. on imperfect markets, this maximum price, which an individual investor is able to afford, may be interpreted as a sum of (sometimes corrected) net present values. although dealing with uncertainty, the investor does not need information on probabilities, means or variances. applying sensitivity analysis enables us to demonstrate that increasing taxes does not always encourage individual investments into ghg mitigation. because on imperfect markets the use of restricted capacities may lead to interdependencies, (over-)compensation effects between the various determinants of the maximum payable price for such an investment may be possible. therefore, changes in the tax regime may lead to much more complex, even unexpected and undesired reactions of this price ceiling than the straightforward ones that an investor would usually consider on perfect markets. in 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model (klingelhöfer 2006:76–77). 2. underlining a variable denotes a vector and the prime (the symbol ´) the transposition of a vector. 3. the objective of production may not only be to produce wanted products but also to destroy substances that may be recognised as unwanted by the economy. thus, it may be beneficial and desired to use waste as an input, and the producer may even be paid for doing so (e.g. by municipal service providers). 4. these weights need not sum up to 1. they are just a measure for individual preference and not necessarily expressing probabilities. thus, although similar at first sight, sww is normally ‘not’ an expected value. 5. all the following (corrected) net present values npv are able to be derived from both the basic programme (eqn 7) and the valuation programme (eqn 8). however, the dual variables, and consequently the endogenous discount factors ρs,0 = ls/l0, which allow for discounting payments in state s to state 0, are usually ‘not’ the same. in particular, if a finite positive solution pi > 0 of both the primal and dual valuation programme is existing, it can be deduced from the complementary slackness condition pi · (1 − l0) = 0 that l0 = 1 and, therefore, ρs,0 = ls for all the (corrected) npvs derived from the valuation programme. 6. compare footnote 5. 7. the dual variable δ of the withdrawal constraint calculates the value of a marginal increase in swwopt referring to the objective function of the valuation programme, that is, by how many zar the maximum payable price for the investment will change if the maximum sum of weighted withdrawals in the situation without realising the investment changes by zar 1. 8. employing the simplex algorithm needs 7 iterations to deliver the optimal solution swwopt and the values for and . eqn 15 can be proven true by some simple considerations: because lending is unrestricted, invl must be the marginal investment opportunity. therefore, compounding the contribution margins from production as well as the initial cash amount uz0 = 150 [zar] with invl provides swwopt. 9. the values for , and are part of the optimal solution of the valuation programme that results after seven dual simplex iterations. however, they can be proven by the given considerations in parentheses. because the lending opportunity is not limited and no additional constraint restricts production, the corrected net present values of the processes are equal to the discounted contribution margins, and the terms (d) and (f) of (eqn 11) do not exist. 10. in the following it is assumed that the taxes and their changes always refer to both points in time. 11. although the investment into ghg mitigation does not make sense economically at this tax level, the investor needs to run production on maximum activity level in both points in time to use the still positive contribution margins to cover at least some parts of the activity level–independent payments zi,0 = −150 [zar] for the installation of the new technology. this means that in the situation after realising the investment, there are emissions because of necessarily higher production (in comparison to the situation without investment into ghg mitigation) although, in total, the combination of investing and production is economically disadvantageous. 12. in perfect markets, a positive net present value npv of an investment can be interpreted as the investor’s profit in t = 0 when he simultaneously realises the investment and finances it to the conditions of the opportunity (which will normally be an equal borrowing and lending rate on financial markets, because a prerequisite of perfect markets is that this opportunity is unlimitedly available). therefore, one can interpret the similar difference between the actual price to be paid and the price ceiling (calculated according to the individual investor’s objectives and his decision field) on imperfect markets as an equivalent to the investment´s npv in perfect markets – as a measure for the individual investor´s profit resulting from realising the investment under the conditions of an imperfect market, taking into consideration his individual objectives and decision field. journal 2.indd � sajems ns 13 (2010) no 1 real exchange rate behaviour and economic growth: evidence from sierra leone abu bakarr tarawalie department of economics, university of sierra leone accepted january 2010 abstract the main focus of this paper is to examine the impact of the real effective exchange rate on economic growth in sierra leone. first an analytical framework is developed to identify the determinants of the real effective exchange rate. using quarterly data and employing recent econometric techniques, the relationship between the real effective exchange rate and economic growth is then investigated. a bivariate granger causality test was also employed as part of the methodology to examine the causal relationship between the real exchange rate and economic growth. the empirical results suggest that the real effective exchange rate correlates positively with economic growth, with a statistically significant coefficient. the results also indicate that monetary policy is relatively more effective than fiscal policy in the long run, and evidence of the real effective exchange rate causing economic growth was profound. in addition, the results showed that terms of trade, exchange rate devaluation, investment to gdp ratio and an excessive supply of domestic credit were the main determinants of the real exchange rate in sierra leone. keywords: economic growth, real effective exchange rate, johanssen cointegration, sierra leone jel e63, f31, 41, 43 1 introduction the relationship between the real effective exchange rate and economic growth is certainly an important issue, from both the descriptive and policy prescription perspectives. since the late 1980s, the sierra leonean economy has undergone significant changes. the switch to export-led growth from import substitution resulted in the lifting of major restrictions on the economy placed on it by the government, including the liberalisation of the current account and the implementation of a floating exchange rate regime. the major economic problems during the period were inflation and declining output. output growth performance was poor after the 1970s and 1980s, and remained negative in the 1990s. in recent years, policy discussions have increasingly included references to real exchange rate stability and correct exchange rate alignment as crucial elements in the improvement of economic performance in sierra leone. real effective exchange rate movement affects economic activity in sierra leone, mainly owing to its dependence on imported capital goods and specialisation in commodity exports. the country has experienced a series of exchange rate depreciations in an effort to improve output growth. the government has considered the exchange rate to be an important macroeconomic instrument for ensuring a low inflation rate and a stable financial system, promoting exports, controlling imports, and enhancing economic growth. in the literature, the real exchange rate1 serves as a better international price for determining the competitiveness of a given country than the nominal exchange rate. management of the nominal exchange rate depends on the real sajems ns 13 (2010) no 1 � exchange rate, which is influenced by, inter alia, the nominal exchange rate (montiel, 1997). studies have shown that misalignment of the real exchange rate occurs in markets in which actual exchange rates are not allowed to adjust to changes in economic fundamentals (prick & vollrath, 1994). an overvalued real exchange rate affects the pattern and level of production, the allocation and level of expenditure, the distribution and level of factor payments, the composition and size of trade flows, the level of international reserves and external debts, the parallel foreign exchange markets, currency substitution and capital flight. further, persistent real overvaluation also seriously erodes business and consumer confidence, thereby lowering the rate of savings and investment, with an adverse impact on economic growth. the empirical literature is replete with studies that link the real effective exchange rate with gdp. the literature identifies two channels by means of which real exchange rate affects gdp; these are the aggregate demand and aggregate supply channels. in the aggregate demand channel, a depreciation of the real effective exchange rate enhances the international competitiveness of domestic goods, boosts net exports and hence increases gdp. the aggregate supply channel posits that the depreciation of the real exchange rate increases the cost of production (and hence reduced gdp) and helps redistribute income in favour of the rich. while some of these studies argue that real depreciation has expansionary effects on real output growth (cooper, 1971; gylfson & schmid, 1983), others have argued that real exchange rate depreciation has contractionary effects (edwards, 1989; agénor, 1991; morley, 1992). in view of these conflicting results, it is clear that the impact of exchange rate devaluation on real output growth remains an unresolved issue in the empirical literature. this study therefore examines the relationship between the real effective exchange rate and output growth (gdp) in sierra leone. specifically, it determines the impact of the real effective exchange rate on real output growth (rgdp). this paper is not only an attempt to contribute to the empirical debate vis-à-vis the exchange rate devaluation and the real output growth nexus, but also differs from previous studies in several respects. first, this paper examines the econometric relationship between the real effective exchange rate and rgdp growth in sierra leone, a small open economy in sub-saharan africa (ssa) which experienced a declining output growth in the 1970s, 80s and 90s. second, sierra leone provides a unique context for an empirical investigation of the relationship between the exchange rate and real output growth because of its experience with foreign exchange rate devaluations since 1964. third, the paper identifies the determinants of the real effective exchange rate in sierra leone. in addition, the study employed a bivariate granger causality test to determine the direction of causality between real exchange rate and real gdp. finally, an investigation of the effectiveness of monetary and fiscal policies on real output growth under exchange rate regimes with considerable depreciation was also pursued. the test of the effectiveness of monetary and fiscal policies is important in ascertaining the validity and universal applicability of economic theory, which suggests that the monetary policy or fiscal policy effectiveness depends on the exchange rate policy. the remainder of the paper is organised as follows. section ii provides a brief overview of sierra leone’s economic performance, focusing on its exchange rate policy and real output growth since the 1970s. section iii discusses the determinants of the real effective exchange rate. in section iv, the relationship between the real effective exchange rate and real gdp growth is explored. the section presents the literature, methodology and discusses the empirical results. section v is devoted to the conclusions and lessons for policy arising from the study. 2 brief overview of sierra leone’s economic performance after sierra leone gained independence in 1961, its annual economy grew by nearly 4 per cent during that decade. the fiscal and foreign exchange position was healthy, as evidenced by low inflation, despite the first oil shock in the first half of the 1970s. however, its economic 10 sajems ns 13 (2010) no 1 growth slowed to about 1 per cent per year in the latter part of that decade because of falling incomes in the mining sector. in fact, sierra l eone’s economic decline started shortly after the first oil shock of the 1970s, after which the economy was characterised by severe imbalances due to inappropriate macroeconomic policies and negative external shocks. the sierra leonean economy lost its international competitiveness owing to unfavorable terms of trade, the deteriorating balance of trade, and an unsustainable balance of payment deficits. during this period, real gdp growth was anemic and was coupled with high inflation, high unemployment, and huge fiscal deficits, which were financed mainly by borrowing from the central bank. this led ultimately to increases in money supply, and consequently in high inflationary pressures. in the first half of the 1980s, economic conditions deteriorated sharply because of the massive drop in official diamond exports (from 16 per cent of gdp in 1980/81 to 5 per cent in 1985/86) and the reduction in the country’s tax base. economic conditions worsened during the 1990s, because the civil war resulted in capital outflow, while trade sanctions complicated the management of the exchange rate and blurred the objectives of macroeconomic policies. the sierra leonean economy rebounded after the civil war with a robust economic performance, especially during 2000–6, owing to the recoveries in the agricultural and mining sectors. since then, the country has been on a sustained, strong path of economic recovery with real gdp growth increasing from 3.8 per cent in 2000 to 7.4 per cent in 2004.2 2.1 exchange rate policy and real output growth in sierra leone, 1970-2006 as mentioned above, sierra leone provides a unique context for an econometric examination of the relationship between real exchange rate and real output growth because of its foreign exchange rate policy. sierra leone has experienced six exchange rate regimes since 1964.3 these regime changes are indicative of the importance attached to the exchange rate, possibly as one of the stable instruments for the monetary authority in its desire to achieve macroeconomic stability. in its first exchange rate regime, which spanned almost one and a half decades (between 1964 and 1978), the leone (le) 4 was pegged to the british pound sterling at the rate of two leones to the pound. the leone was devalued by 14.3 per cent in 1967, following the devaluation of the pound sterling in order to prevent capital flight and a drain on sierra leone’s external reserves. sierra leone entered its second exchange rate regime in november 1978, when the leone was delinked from the british pound and was pegged to the international monetary fund’s (imf) special drawing rights (sdr) at the rate of one leone to 0.731566 sdr. this peg to the sdr amounted to a 5 per cent devaluation of the leone. the justification for delinking the leone from the british pound was that the pound could no longer be considered a strong anchor for protecting the leone and the economy from adverse external shocks relating to the diversified trade patterns. thus, the link to the sdr was viewed as both timely and necessary, because the sdr represents a basket of major currencies, and was therefore less susceptible to external shocks. sierra leone’s third exchange rate regime began in december 1982, with the introduction of an auction system referred to as the “twotier” or dual exchange rate system. this system allowed two exchange rates – the official rate for government or capital transactions, which remained fixed, and a commercial rate for all other transactions, which was determined on the basis of biweekly auctions carried out by the central bank. sierra leone entered its fourth exchange rate regime in 1983, when it abolished the “two-tier” system and pegged the leone to the united states dollar at an official rate of le2.50 to the dollar (that is, le2.50 = $1). the link to the dollar was inevitable, as the us dollar was the most commonly-used currency in the parallel market for foreign exchange at the time. the fifth exchange rate regime started on 27 june 1986, with the introduction of a floating exchange rate (dirty float) structure. the floating exchange rate system stabilised sajems ns 13 (2010) no 1 11 at a rate of le53 to the dollar (le53 = $1) in april 1987, and was later revalued at le23 to the dollar (le23 =$1) by the end of august 1987. this move was influenced by the need to appreciate the leone with the intention of stemming down inflationary pressures in the economy. the sixth exchange rate regime in sierra leone began in the early 1990s, when the exchange rate was fully liberalised (clean float) after the adoption of sap in 1989. this was an attempt to restore macroeconomic stability and provide a solid foundation for private sector-led growth. the structural adjustment programme (sap) package included price liberalisation, exchange rate adjustment (market-determined exchange rate), trade policy reforms, public enterprise and fiscal reforms which involved the reduction in subsidies, increases in revenue collection, and rationalisation of public spending. exchange rate adjustments through devaluation5 were pivotal to sap, and the monetary authority used devaluation as a means of restoring macroeconomic stability through increases in real output growth and improvements in the external balances. the current “clean float” exchange rate, although determined by market forces, allowed the government to intervene periodically in order to regulate and prevent excessive depreciation of the leone. this was accomplished through the foreign exchange auction normally held by the central bank on a weekly basis. given the experience of sierra leone under the six exchange rate regimes discussed above, and based on the notion that persistent real overvaluation has adverse effects on economic growth, as well as the fact that the impact of real depreciation on real output is ambiguous. according to empirical findings, the main issue for empirical analysis is therefore whether a small open economy like sierra leone gained in terms of real output growth from its policy of exchange rate devaluations. this issue would be better handled with modern econometric analysis. however, before this is carried out in the next section, it is important to provide visual graphic perusals of both nominal and real exchange rate depreciations in figure 1 and real output growth in figure 2, to see how the real output growth responded to devaluations of the leone throughout the sample period. in figure 1, what appears to be co-movements of the nominal and real effective exchange rate depreciation can be seen. trends in the real exchange rate mimic the corresponding nominal exchange rate. the figure revealed a series of depreciation. however, the highest rate of both nominal and real exchange rate depreciations occurred during 1987 and 1991. figure 1 nominal and real exchange rate depreciation 12 sajems ns 13 (2010) no 1 figure 2 real gdp growth rate as for the growth of real gdp in figure 2, one can see that there have been positive and negative real gdp growth rates since the 1970s. a close look at figures 1 and 2 show that real gdp growth was above 5 per cent in 1987, when sierra leone had its highest real exchange rate depreciation. in addition, real gdp growth on average was noticeably negative in the 1990s, despite positive growth during 1992, 1993, 1994 and 1996 being recorded. the 1990s were marred by the civil war and the period also coincided with the introduction of the “clean float” in 1990. as a matter of fact (as shown in figure 2), fluctuations in the real gdp growth rate were more noticeable after the introduction of the market-based exchange rate system in 1986, which saw a series of exchange rate fluctuations. 3 determinants of the real effective exchange rate 3.1 literature review there is a diverse body of studies on the determinants of the real exchange rate. real exchange rate stability and its correct alignment are known to be necessary conditions for economic development. this agreement has resulted in numerous research works on the determinants of real exchange rate in both developed and developing countries. for instance, aron et al. (1997) investigated the determinants of the real exchange rate in south africa, using quarterly data for the period 1970:1-1995:1. they specified an errorcorrection model (ecm) and used ordinary least square (ols) estimation techniques with trade policy, terms of trade, capital inflows, government expenditure and per capita real gdp growth as explanatory variables. the long-run equilibrium result showed that all the exogenous variables had a depreciating effect on the real exchange rate and were statistically significant. the short run equilibrium ecm result showed that nominal devaluation and domestic credit are both statistically significant and had a depreciating effect on the real exchange rate. in a related study, parikh (1997) also examined the behavior of the real exchange rate in south africa between 1979 and 1994 using monthly data. he used a vector autoregressive (var) framework and employed the johansson maximum likelihood procedure. his findings showed that domestic debt, foreign debt, an increase in the gold price and change in productivity growth caused the real exchange rate to depreciate, and the coefficients were statistically significant. kemme and roy (2005) examined both the shortand long-run movements in the real exchange rate for poland and russia, using both the engel granger static ols procedure (for long-run estimation) and the johansson procedure (for the number of co-integrating vectors). they used terms of trade, openness, net capital inflow, the ratio of total government sajems ns 13 (2010) no 1 13 expenditure to gdp, nominal devaluation and excess supply of domestic credit as explanatory variables in an arima and garch error correction specification and employed ols estimation techniques to determine the values of the coefficients. they found all the estimated coefficients, except that of openness, to be statistically significant at the 5 per cent level in the long run for both countries. their results showed that an increase in government expenditure and capital inflow led to the depreciation of the real exchange rate, while the terms of trade had an appreciating effect. openness, on the other hand, was significant at 10 per cent and led to an appreciation of the real exchange rate in both countries. except for the terms of trade for russia, the ecm revealed that all the fundamentals were statistically significant for both countries. in addition, nominal devaluation and an excess supply of credit were significant in both countries and caused an appreciation of the real exchange rate. eita and sichei (2006) estimated an equilibrium real exchange rate and real exchange rate misalignment in namibia during the period 1970–2004. they used a var model employing the johansson (1988) fiml procedure. they included in their estimation terms of trade, openness and investment to gdp as explanatory variables, and found that an increase in openness and the ratio of investment to gdp caused an appreciation of the real exchange rate, while terms of trade caused depreciation. hyder and mahbood (2006) conducted a study on equilibrium real effective exchange rate misalignment for pakistan, using annual data from 1978-2005. using the engle granger cointegration technique, they estimated an ecm, employing an ols estimation technique. the exogenous variables in their model included openness, terms of trade, real investment to gdp, government consumption as a percentage of gdp, workers’ remittances as a percentage of gdp, long-term capital to gdp, and total factor productivity differential. the long-run result showed that openness, the increase in government consumption and capital inflow caused depreciation in the real effective exchange rate, while an increase in real investment to real gdp and improvement in the total factor productivity differential led to real effective exchange rate appreciation. as the review of studies above has indicated, different empirical results from researchers were due to differences in modelling frameworks (tradable goods model, the mundell-fleming model, the dependent economy model and the importable-exportable goods model) for their analyses. 3.2 model of real effective exchange rate in this study, the real effective exchange rate (reer) is used in the analysis, since sierra leone has four major export trading partners. the theoretical model for the reer determination is based on the importable– exportable goods framework, which is suitable for developing countries because it summarises the incentives that guide resource allocation across tradable and non-tradable sectors, but, more importantly, it allows for both nominal and real factors as determinants in the short run.6 to identify the determinants of reer for sierra leone during its exchange rate regimes, we follow the models used by edwards (1988, 1989) and elbadawi (1994). these models show that the real effective exchange rate dynamics are determined by three main factors: (a) the extent to which the actual reer deviates from its long-run equilibrium real effective exchange rate (erer) level, (b) macroeconomic policy impact, which reflects the deviation of the fiscal and monetary policies (z t *), and (c) the nominal effective exchange rate (e t ) changes. based on these determinants, the real effective exchange rate equation is expressed as: δ ln reer t = ln ln ln lnerer – reer – z – z e – e*t t t t t t1 1+i u x-^ ^ ^h h h 0 < , , and ω < 1 (1) where δ is the difference operator, ln is the natural log and t is time subscript. equation (1) can also be rewritten as follows, assuming (1 – ) = 0 ln reer t = ln ln lnerer – z – z e – e*t t t t 1i u x+ -] ^ ^g h h7 (2) 14 sajems ns 13 (2010) no 1 based on conventional macroeconomic fundamentals, the determinants of the equilibrium real effective exchange rate (erer) can be expressed in functional form as: ln erer = f(ln tot, ln open, ln inv, ln gcn) (3) where tot is terms of trade, open is openness of the economy, inv is the ratio of investment to gdp and gcn is the ratio of total government consumption to gdp. to derive an estimable reer equation for sierra leone, we substituted equation (3) into equation (2) and replaced the macroeconomic policy vector (z t –z t *) and the nominal exchange rate changes (lne t – lne t-1 ) with excess supply of domestic credit (esc) and the nominal effective exchange rate (ner) movements, respectively. it is important to point out here that esc is an important monetary policy variable in many developing countries in sub-saharan africa. the reer equation to be estimated in logarithmic form is expressed as: ln ln ln ln lnreer tot open inv gcn – esc ner dt t t t t t t t0 1 2 3 4 1= + + + + + + +a a a a a m nu x (4) where a 1 , a 2 , a 3 , and a 4 are ambiguous (that is, the coefficients of these variables could be positive or negative), , ω,  > 08, μ 1 is the error term that is identically and independently normally distributed with mean zero and constant variance, and d is a binary dummy variable to capture the effects of the war years on real exchange rate determination (where; d = 1 for war periods and 0 otherwise) in sierra leone. the data are from the international financial statistics cd-rom 2007. the data used include reer,9 terms of trade (tot),1 openness (open),1 the ratio of total investment to gdp (inv), the ratio of total government consumption to gdp (cons), and nominal effective exchange rate. the variables are expressed in natural logarithms. the results (reported in appendix a) are quite satisfactory and the signs of the coefficients were consistent with economic theory. the coefficients are correctly signed and statistically significant at the conventional level of significance. specifically, terms of trade (tot) were negative with a statistically significant coefficient. an improvement in the terms of trade increased the real income of the economy, which created an increase in the demand for non-tradables. the high domestic demand then caused an increase in the domestic price level, which resulted in an appreciation of the real exchange rate, indicating a dominance of the income effect over the substitution effect. a positive relationship was evident between nominal and real effective exchange rate, implying that a depreciation of the nominal effective exchange rate (ner) would generate real effective exchange rate depreciation. it shows that 10.0 per cent depreciation of the nominal effective exchange rate would lead to 2.9 per cent depreciation of the real effective exchange rate. the coefficient of investment to gdp ratio (inv) is positive and statistically significant at the 5 per cent level. this result showed that an increase in investment would lead to a depreciation of the reer. a plausible explanation for such a result is that an increase in investment would increase production of non-tradables, resulting in a decrease in their prices. the fall in domestic prices brought about by increased investment would result in a depreciation of the reer. the coefficient of excess credit (esc) is negative and statistically significant. this suggests that monetary variables tend to have an appreciating effect on the reer. intuitively, an increase in money supply will lead to an increase in the demand for non-tradables, resulting in an increase in their domestic prices, which ultimately causes reer appreciation. finally, the coefficient of the error correction term (ect), which measures the speed of adjustment, is statistically significant, with the expected negative sign and a magnitude of -0.1, denoting a slower speed of adjustment to longrun equilibrium. the general wisdom is that sajems ns 13 (2010) no 1 15 the closer the coefficient of ect is to zero, the lower the speed of adjustment and the closer it is to one, the higher the speed of adjustment. overall, the coefficient of determination as reported by the r2 value shows that about 47.0 per cent of the variations in the dependent variable can be accounted for by the explanatory variables. the f-statistics were robust, as was evidenced by a significant probability value, suggesting an overall goodness of fit of the model. in addition, a durbin-watson value of approximately 1.90 does not indicate signs of serial autocorrelation. 4 real effective exchange rate and economic growth 4.1 literature review given that the real exchange rate is one of the most important relative prices in an economy, it can be argued that a sound exchange rate policy is a crucial condition for improving economic performance in sierra leone. the adverse impact of rer misalignment on growth is stressed by cottani et al. (1990), who assert that, despite many channels through which policy affects performance, there are many instances in which rer is the main transmission mechanism. an overvalued exchange rate hurts the exports sector and exposes competing import industries to fierce competition from foreign companies. overvaluation may lead to tight monetary and fiscal policy (in an attempt by authorities to defend the currency), capital flight (in anticipation of devaluation), severe decline in foreign direct investment and technological transfers, and a chronic economic recession. edwards (1985) employed a reducedform equation for 12 developing countries using annual data for the period 1965–1980. he regressed real output on money growth surprises, government expenditure, terms of trade, and the real exchange rate. his empirical findings showed that the initial contractionary effects of real devaluation are reversed after one year and that devaluation is neutral in the long run. kamin and klau (1998) used an error correction technique to examine the relationship between real output and real exchange rate for a group of 27 countries. they did not find that devaluations were contractionary in the long term. additionally, through the control of the sources of spurious correlation, reverse causality appeared to alternate the measured contractionary effects of devaluation in the short term, although the effect persisted even after the introduction of controls. ghura and grennes (1993), based on pooled time series and cross-section data for 33 subsaharan african countries, found a negative relationship between rer misalignment and economic performance. they concluded that inappropriate domestic macroeconomic, trade and exchange-rate policies appeared to be one of the important factors that contributed to the economic distress in virtually all sub-saharan african countries. klau (1998) found that one of the main causes of poor economic performance in the cfa zone from the mid-1980s to the early 1990s was overvaluation of the cfa franc during that period. kuijs (1998) used quarterly data (1983:1– 1996:4) to analyse the behaviour and determinants of inflation, exchange rate and real output in a macro-econometric model of the nigerian economy. the ecm result for the real output equation revealed that an increase in the supply of foreign exchange increased output in the short run, while changes in real exchange rate were found to have no significant effect on short run output. in a similar study, odusola and akinlo (2001) used quarterly data (1970:1– 1995:4) to investigate the link between the naira depreciation, inflation, and real output in nigeria, employing the var approach. the variables in their var model included real gdp, money supply (m2), the official exchange rate, the parallel exchange rate, the consumer price index, and lending rates. their results showed that exchange rate depreciation had an expansionary effect on real output in both the medium and the long term. recently, studies like that of thapa (2002) examined the econometric relationship between the reer and economic activities (measured by gdp) in nepal. the study used annual data from 1978–2000 and included gdp, reer 16 sajems ns 13 (2010) no 1 government real total expenditure, and money supply as explanatory variables. the estimated ecm regression equation showed that the reer has a contractionary effect on economic activities. yu hsing (2005) employed the is-lm model to find a possible relationship between real gdp and selected macroeconomic variables, which included the real exchange rate for venezuela. using annual time series data from 1959–2001, his study revealed that real depreciation of the bolivar raises real gdp growth. in a related study, hsing and hsien (2005) conducted a study on the impact of monetary, fiscal, and exchange rate policies on output in china, using a var approach for the period 1980–2000. their explanatory variables included lending-interest rate, government debt ratio, inflation, and real gdp as explanatory variables; their result revealed that real appreciation of the exchange rate had a contractionary effect on output. 4.2 model and empirical results the main objective here is to investigate the link between the real effective exchange rate and economic growth (rgdp). an output growth model is thus specified by adding the reer to the set of explanatory variables generally included in empirical economic growth regressions. we specify the real output growth model using the basic is–lm model (gali, 1992; yu hsing, 2005) for an open economy. this has the advantage of tracing the impact of the real effective exchange rate on output. the real output growth equation to be estimated can be expressed as: ln ln ln lny m reer g p dt t t t t t0 1 2 3 4 5 2= + + + + + +b b b b b b n (5) where y t is real output growth, m t is broad money supply as a ratio of gdp, g t is ratio of government expenditure to gdp, p t is inflation rate; d t is a dummy variable for the war period and μ 2 is the error term. from equation (5), we expect the coefficients of monetary policy (b 1 ) and fiscal policy (b 3 ) variables to be positive. further, we expect the coefficients of inflation (b 4 ) and the war dummy (b 5 ) variables to be negative while the real effective exchange rate (b 2 ) variable is assumed to be ambiguous (that is, 0< > 2b ). the data for the study were sourced from the international financial statistics cd rom 2007 (published by the international monetary fund), and various issues of the bank of sierra leone bulletin. the sample consists of quarterly data from 1990q1–2006q4, owing to the availability of data. the quarterly data were obtained through interpolation of annual time series data using eviews 6.0. this was done using the low frequency to high frequency method and the quadratic match average and quadratic match sum for each observation of the low frequency series. data used in the analysis include: real gdp growth (y), broad money m2 as a ratio of gdp (m), government expenditure as a ratio of gdp (g) and inflation rate (p); measured as the change in consumer price indices (cpi). empirical results valid estimation of the model requires an examination of the time-series properties of the data. firstly, all time series data used in the estimation process were tested for stationarity. appendix b gives the results of the standard augmented dickey–fuller (adf) and the phillips and perron (1988) tests, in which a unit root null hypothesis is tested against a stationary alternative. empirically, the null hypothesis of nonstationarity could not be rejected for all the variables in their levels. in other words, all the variables are non-stationary in levels, but become stationary after taking their first difference – an indication that all the variables are integrated of order one, i(1) series. it is important to note that differencing a variable to achieve stationarity can lead to long-run information loss. thus, to determine whether a long-run relationship exists between the dependent and explanatory variables in the various models, we conducted a cointegration test. individual time series data might be non-stationary but their linear combination might be stationary, which implies the existence of cointegration. we employed the johansen maximum cointegration test (johansen & juselius, 1990), which is superior to the engle-granger (1987) two-step algorithm; sajems ns 13 (2010) no 1 17 and the short-run dynamics can be described by means of an error correction model (ecm), which can then be estimated using an ordinary least square (ols) estimation technique. both the maximum eigen values and trace statistics revealed the existence of one co-integrating vector as evident in appendix c. the existence of cointegration implies the estimation of an ecm, representing the short-run dynamics. however, in this paper, both long-run and short-run estimations were carried out in order to fully investigate the impact of the real effective exchange rate on output growth, as well as determining the effectiveness of both fiscal and monetary policies on output growth during these two periods. the long-run estimates of the real output growth are given in table 2. the parameters were estimated using the ols estimation technique and employing hendry’s general-tospecific modelling approach to arrive at a more parsimonious model. a lag length of one (1) was chosen as the appropriate lag length based on the akaike information criterion (aic) and the schwarz sc tests. the results indicated that the reer had a positive effect on real output growth with a statistically significant coefficient. it is implicit in the result that a depreciation of the reer would increase real output growth in the long run. intuitively, a real depreciation would increase the domestic price of imports and reduce the foreign price of domestic exports, thereby increasing exports and reducing imports, resulting in an increase in net export and correspondingly increasing output growth through the multiplier effect. the monetary policy variable (m) is statistically significant with a positive sign implying that an increase in money supply will increase real output growth in the long run. this result, which is consistent with economic theory, is predicated on the standard is-lm framework. the results validate the argument that an expansionary monetary policy (engendered by an increase in money supply) that reduces interest rates leads to output growth, partly because it spurs investment. this outcome works via the multiplier-accelerator effect. using a different approach, bangura et al. (2001) found a similar result for sierra leone. furthermore, a positive relationship was identified between government expenditure as a ratio of gdp and output growth with a statistically significant coefficient. an expansionary fiscal policy (i.e. increase in government expenditure) would increase output growth via the multiplier effect on the domestic economy. over the years, government expenditure has been mainly on infrastructure such as electricity, road maintenance and construction. this complements private-sector investment, resulting in increased output growth. table 2 long run dynamics of real output growth (y t ) variable coefficient std. error t-statistic prob. c 0.042780 0.005388 7.939847 0.0000 ln m t 0.295965 0.039785 7.439117 0.0000 ln reer t-1 0.049496 0.013007 3.805419 0.0002 ln g t-1 0.080993 0.016905 4.791009 0.0000 d t –0.107688 0.033114 –3.252027 0.0014 diagnostic tests r-squared 0.485129 mean dependent variable 0.063890 adjusted r-squared 0.469985 s.d. dependent variable 0.067056 s.e. of regression 0.048818 akaike info criterion –3.166624 1� sajems ns 13 (2010) no 1 sum squared residual 0.324113 schwarz criterion –3.062059 log likelihood 228.2470 f-statistic 32.03591 durbin-watson stat 1.815118 prob(f-statistic) 0.000000 ramsy reset test f-statistics 0.078699 probability (2,31) 0.7900 log likelihood ratio 0.090884 probability chi-square (2) 0.7548 an inverse relationship existed between the war dummy and output growth, with a statistically significant coefficient. this result was not surprising, as the civil war caused massive disruption to vital sectors of the economy, such as agriculture, manufacturing, and mining, notwithstanding the collapse of essential public services in health and education, with the resultant consequences of reduced output growth. moreover, the results showed that 49 per cent of the variations in the dependent variable are accounted for by the explanatory variables. the f-statistics revealed an overall goodness of fit of the model, with no evidence of serious serial correlation. the ramsey regression specification error (reset) test showed that the f-values are quite small and their corresponding p-values of 0.7900 and 0.7548 are well above the conventional significance level of 0.05. there is no evidence from the reset test to suggest that the longrun real output growth model is inadequate, so the model is well specified. comparison of the beta coefficients revealed that all the key variables had a positive effect on long-run output growth. however, the result showed that the reer had the least effect on output growth, while monetary policy was found to be more effective than fiscal policy in the long run, as is evident in table 3. table 3 beta coefficients for growth determinants12 variables beta coefficients rank ln m t 0.241201 1st ln reer t-1 0.013188 3rd ln g t-1 0.028047 2nd in the ecm, the lagged value of the error correction term (ect) was used as an independent variable to determine the speed of adjustment. the ecm estimation results as displayed in table 4 showed that output growth in the short run is partly explained by money supply, inflation rate, and civil unrest. the coefficient of money supply is positive and statistically significant, in line with the standard is–lm doctrine for an open economy. in addition, domestic inflation rate is negatively related to real income growth in the short run and statistically significant even at the 1 per cent significance level. thus, a higher inflation rate will lead to a fall in real output growth. a plausible explanation for such a result is that a rising inflation rate would cause inconvenience, distortions, inefficiency, misallocation of resources and menu costs, which would harm real output growth. sajems ns 13 (2010) no 1 1� table 4 short run dynamics of real output (y t ) growth variable coefficient std. error t-statistic prob. c 0.062592 0.005137 12.18551 0.0000 δln m t 0.329052 0.096878 3.396558 0.0009 ln p t-1 –0.393023 0.102179 –3.846428 0.0002 d t –0.052130 0.022645 –2.302082 0.0229 ect t-1 –0.292155 0.063186 –4.623728 0.0000 diagnostic tests r-squared 0.389409 mean dependent var 0.063902 adjusted r-squared 0.365925 s.d. dependent var 0.072068 s.e. of regression 0.057387 akaike info criterion –2.834887 sum squared residual 0.428123 schwarz criterion –2.706387 log likelihood 198.7723 f-statistic 16.58173 durbin-watson stat 1.224267 prob(f-statistic) 0.000000 as in the long-run equation, the war dummy variable had a negative impact on real output growth with a significant coefficient. the coefficient of the ect was negative and fell within the accepted region. a value of 0.29 implies that the short-run dynamic converges to its long run cointegrating relationship with a relatively low speed of adjustment. granger causality test the focus in this sub-section is to conduct a granger causality test between the reer and real gdp. the rationale is to detect the causality between the reer and real gdp in the context of a bivariate model, which is defined as follows: y t = y reeri i n t i i m t0 1 1 1 2 1 1 1+ + +b b b f = = -! ! (6) where  1 is a white noise error term, y is real gdp and the reer is the real effective exchange rate. equation (6) represents causality running from the reer to y. the null hypothesis to be tested would be that the reer does not granger cause y. the null would be accepted if i2b! was equal to zero simultaneously. the corresponding null hypothesis to the above will be that y does not granger cause the reer, and this is specified as follows, where the reer is the dependent variable: reer t = reer yi t k k q i t k p 0 1 1 2 1 1 2+ + +a a a f= = ! ! (7) where  2 is a white noise error term and other variables are as defined earlier. from equation (7), we say that the null hypothesis will be accepted if i2a! is equal to zero simultaneously. table 5 bivariate granger causality test results null hypothesis f-statistics p-value dependent variable y reer does not granger cause y 10.1884 0.00175 dependent variable reer y does not granger cause reer 0.60993 0.43614 20 sajems ns 13 (2010) no 1 the bivariate granger causality results in table 5 reject the null hypothesis that the reer does not granger cause real gdp at the 1 per cent level. the rejection of the null hypothesis is indicative that the reer causes growth in real gdp. however, the null hypothesis that real gdp does not granger cause the reer cannot be rejected even at the conventional level. 5 conclusions and lessons for policy this paper has attempted to provide empirical estimates of the relationship between the reer and economic growth in sierra leone, employing the johansson cointegration technique for the period 1990q1–2006q4. the formulation of the output model was anchored on sound economic theory. in addition to investigating the effect of the reer on output growth, the model has the advantage of establishing the relative effectiveness of fiscal and monetary policies on real output growth during the review period. identification of the determinants of the reer was also pursued in this study. the results of the long run indicate that the reer, monetary policy and fiscal policy all had a positive effect on output growth, while the civil war during the 1990s had an adverse effect on output growth in sierra leone during the review period. specifically, a depreciation of the reer increased output growth, while increases in both money supply and government expenditure caused an increase in output growth through the multiplier effect. however, the beta coefficient revealed that monetary policy is relatively more effective than fiscal policy in the long run, while the reer was found to have the least effect on output growth. this finding is consistent with the basic mundell-fleming model, which indicates that monetary policy is more effective than fiscal policy under a flexible exchange rate regime. in the short run ecm, while monetary policy was found to have a positive impact on output growth, inflation and the civil unrest had a dampening effect on output growth. based on the findings, some useful policy lessons can be drawn from this study. both fiscal and monetary policy increased output growth. thus, the objectives of monetary policy should be in consonance with that of fiscal policy in order to achieve macroeconomic stability consistent with sustainable real gdp growth and low inflation. in this regard, there should be a framework for effective co-ordination of fiscal and monetary policies. further, nominal effective exchange rate depreciation leads to reer depreciation, which tends to increase net export and hence output growth. however, nominal depreciation might be inflationary in a complete exchange rate pass-through scenario. it is therefore necessary to maintain a stable exchange rate by allowing the exchange rate to depreciate within a given band. this policy recommendation is consistent with the convergence criterion on the exchange rate set by the west african monetary zone (wamz)13 in which the exchange rate is expected to depreciate within a band of +/– 15 per cent for member countries. finally, political instability impedes output growth. thus, for a resurgence of investment, and hence output growth in sierra leone, a stable political environment is a sine qua non. endnotes 1 the real exchange rate is the nominal exchange rate (index) adjusted for price changes in the domestic economy relative to those of trading partners (fosu, 1992); that is, rer = ep*/p, where rer is real exchange rate, e is nominal exchange rate, p* is foreign price level, and p is domestic price level. 2 see world bank country briefing. 3 bank of sierra leone bulletin. 1997: 20. 4 the leone (le) is the domestic currency denomination in sierra leone. 5 devaluation involves a reduction in the value of the domestic currency vis-à-vis the currencies of its trading partners. 6 the model consists of exportable goods, importable goods and non-tradable goods (see dorbusch, 1974). 7 note that δln reer t = ln reer t – ln reer t-1 8 a negative sign implies the impact of a given variable on the reer and leads to an appreciation of the real effective exchange rate, while a positive sign means that the effect of a variable causes a depreciation of the reer. sajems ns 13 (2010) no 1 21 9 the reert is weighted by the trade shares of exporting partners, and this is computed as: reer t = cpi e cpi * i i i i t1 4 a = c m! where i represents the four major export partners of sierra leone, a i is the weight or share of the ith country in the total export of sierra leone, cpi i * is the consumer price index of the ith country, e i is the bilateral nominal exchange rate defined as leones per currency of the ith country, cpi is the domestic consumer price index. 10 terms of trade = (export price index/ import price index)*100. 11 open = (x+im)/gdp, where x is export and im is import. 12 beta coefficient (b) of a variable is defined as follows: b = (coefficient of the variable * standard error of the variable)/standard error of the regression. a higher beta coefficient means a stronger influence of that variable on the dependent variable. a lower beta coefficient means a weaker influence of the variable on the dependent variable. 13 countries of the wamz include gambia, ghana, guinea, nigeria and sierra leone. references agénor, p.r. 1991. output, devaluation and the real exchange rate in developing countries. review of world economies, 127(1): 18–41. aron, j., elbadawi, i.a. & kahn, b. 1997. determinants of the real exchange rate in south africa. centre for the study of african economies, wps/97–16, oxford: csae publishing. bangura, a., deen, a., thomas, y.; kwateng, f. & okonta, h. 2001. the relative effectiveness of monetary and fiscal policies in sierra leone. bank of sierra leone bulletin, july–december: 29–39. cooper, r. 1971. an assessment of currency devaluation in developing countries. essays in international finance, no. 86. princeton, n.j.: princeton university. dickey, d.a. & fuller, w.a. 1981. likelihood ratio statistics for autoregressive time series with a unit root. econometrica, 49(4): 1057–1072. edwards, s. 1989. real exchange rates, devaluation and adjustment: exchange rate policy in developing countries. cambridge, ma: the mit press. ——— 1985. are devaluations contractionary? nber working paper, no. 1676. cambridge, mass.: national bureau of economic research. eita, j.h. & sichei, m.m. 2006. estimating the equilibrium real exchange rate for namibia. university of pretoria working paper, 2006–08, february. elbadawi, i.a. 1994. estimating long-run equilibrium real exchange rates, in williamson, john (ed.) estimating equilibrium exchange rates, institute for international economics, washington, dc. engle, r. & granger, c. 1987. co-integration and error-correction: representation, estimation and testing. econometrica, 35: 251–276. gali, j. 1992. how well does the is–lm model fit postwar u.s. data? quarterly journal of economics, 107(2): 709–738. gylfason, t. & schmid, m. 1983. does devaluation cause stagflation? canadian journal of economics 16(4): 641–54. hendry, d.f. 1995. dynamic econometrics: advanced texts in econometrics. oxford university press. hsing, y. & hsien, w. 2005. impacts of monetary, fiscal and exchange rate policies on output in china: a var approach. journal of economic literature, e5, f4, h6. hsing, y. 2005. impact of monetary policy, fiscal policy, and currency depreciation on output: the case of venezuela. journal of economic literature, e5, f4. hyder, j. & mahbood, a. 2006. equilibrium real effective exchange rate and exchange rate misalignment in pakistan. sbp research bulletin, 2(1). johansen, s. 1988. statistical analysis of cointegration vectors. journal of economic dynamics and control, 12: 231–54. johansen, s. & juselius, k. 1990. maximum likelihood estimation and inference on cointegration with applications to the demand for money. oxford bulletin of economics & statistics, 52: 169–210. kamin, s.b. & klau, m. 1998. some multi-country evidence on the effects of real exchange rates on output. international finance discussion paper, no. 611, washington, d.c.: board of governors of the federal reserve system. kemme, d.m. & roy, s. 2005. real exchange rate misalignment: prelude to crisis? william davidson institute working paper, no. 797. kuijs, l. 1998. determinants of inflation, exchange rate and output in nigeria. imf working paper, wp/98/160 nov. montiel, p. 1997. exchange rate policy and macroeconomic management in asean countries. in hicklin, j. et al. (eds.) macroeconomic issues facing asean countries. washington, d.c.: imf. morley, s.a. 1992. on the effect of devaluation during stabilization programs in ldcs. review of economics and statistics, 74(1): 21–27. 22 sajems ns 13 (2010) no 1 odusola, a.f. & akinlo, a.e. 2001. output, inflation and exchange in developing countries: an application to nigeria. the development economies xxxix-2. parikh, a. 1997. determinants of real exchange rate in south africa: a short-run and long-run analysis. african journal of economic policy, 14(1). phillips, p.c.b. & perron, p. 1988. testing for a unit root in time series regression. biometrika, 75: 335–346. prick, d.h. & vollrath, t.u. 1994. real exchange rate misalignment and agricultural export performance in developing countries. economic development and cultural change. said, e.s. & dickey, d.a. 1984. testing for unit roots in autoregressive-moving average models of unknown order. biometrika, 71(3); 599–607. thapa, n.b. 2002. an econometric analysis of the impact of real effective exchange rate on economic activities in nepal. economic review: occasional paper, no. 14, april. sajems ns 13 (2010) no 1 23 appendix a dynamics of real effective exchange rate (parsimonious model) variable coefficient std. error t-statistic prob. c –0.036696 0.043013 –0.853133 0.4006 δln tot t-1 –0.294804 0.094004 –3.136069 0.0039 δln ner t 0.279821 0.077325 3.618760 0.0011 δln inv t-1 0.390786 0.161664 2.417274 0.0222 δln esc t-1 –0.144522 0.052516 –2.751935 0.0101 ecm t-1 –0.108546 0.050101 –2.166543 0.0378 diagnostic tests r-squared 0.465210 mean dependent variable 0.017023 adjusted r-squared 0.373005 s.d. dependent variable 0.235926 s.e. of regression 0.186814 akaike info criterion –0.362605 sum squared residual 1.012081 schwarz criterion –0.095974 log likelihood 12.34559 f-statistic 5.045383 durbin–watson stat 1.858284 prob(f-statistic) 0.001904 24 sajems ns 13 (2010) no 1 appendix b stationarity test – unit root (constant and trend included) variables augmented dickey–fuller test phillip–perron test order of integration levels 1st difference levels 1st difference reer –2.497 –5.773** –2.296 –5.724** i(1) tot t –2.678 –5.459** –2.488 –5.429** i(1) open t –1.825 –5.511** –1.115 –5.511** i(1) inv t –1.053 –5.752** –0.3507 –5.734** i(1) gcn t –3.016 –5.605** –2.111 –5.605** i(1) esc t –1.577 –5.1076** –1.553 –5.056** i(1) ner t –1.053 –5.459** –0.3507 –4.959** i(1) y t –1.339 –5.636** –1.358 –5.461** i(1) m t –0.2819 –4.966** 0.1705 –4.204* i(1) g t –0.1069 –5.867** –0.1364 –5.657** i(1) p t –0.7251 –5.046** –0.5076 –4.925** i(1) critical values level of significance 1% –4.535 –4.263 5% –3.612 –3.553 10% –3.209 –3.207 note: ** = 1 per cent level of significance, and * = 5 per cent level of significance. sajems ns 13 (2010) no 1 25 appendix c johansen cointegration test results (output equation) hypothesised no of ce(s) eigen value trace statistics 5 per cent critical value 1 per cent critical value none ** at most 1 at most 2 at most 3 0.426109 0.274104 0.086953 0.004741 56.34029 24.13198 5.551780 0.275656 47.21 29.68 15.41 3.76 54.46 35.65 20.04 6.65 *(**) denotes rejection of the hypothesis at the 5 per cent (1 per cent) level trace test indicates 1 cointegrating equation(s) at both 5 per cent and 1 per cent levels hypothesised no of ce(s) eigen value max–eigen statistics 5 per cent critical value 1 per cent critical value none * at most 1 at most 2 at most 3 0.426109 0.274104 0.086953 0.004741 32.20831 18.58020 5.276124 0.275656 27.07 20.97 14.07 3.76 32.24 25.52 18.63 6.65 *(**) denotes rejection of the hypothesis at the 5 per cent (1 per cent) level max–eigen value test indicates 1 cointegrating equation(s) at the 5 per cent level max–eigen value test indicates no cointegration at the 1 per cent level microsoft word 8 vivian sajems 16(3) 2013.docx sajems ns 16 (2013) no 3:347-364 347 ending the myth of the st petersburg paradox robert w vivian school of economic and business science, university of the witwatersrand* accepted: january 2013 nicolas bernoulli suggested the st petersburg game, nearly 300 years ago, which is widely believed to produce a paradox in decision theory. this belief stems from a long standing mathematical error in the original calculation of the expected value of the game. this article argues that, in addition to the mathematical error, there are also methodological considerations which gave rise to the paradox. this article explains these considerations and why because of the modern computer, the same considerations, when correctly applied, also demonstrate that no paradox exists. because of the longstanding belief that a paradox exists it is unlikely the mere mathematical correction will end the myth. the article explains why it is the methodological correction which will dispel the myth. key words: central limit theorem, deductive logic, inductive logic, law of large numbers, simulation of games, economic paradoxes, st petersburg game, st petersburg paradox jel: b3, c44, 9, d81, n00 1 introduction a game of chance, the st petersburg game, when applied to decision theory involving risk1, is believed to produce a paradox, the st petersburg paradox, which has been very influential, especially in economics fields involving theories of decision making. this belief has existed for nearly 300 years. this article explains the foundation of this belief, why in fact there is no paradox and then discusses the methodological considerations which gave rise to the belief and why it is anticipated the same methodological considerations will result in ending that belief. this article follows the chronological order in which the relevant events occurred. 2 probability theory – the expected monetary value rule (emv) de fermat and pascal (1654) how risk can be managed including how a game of chance can be valued has long drawn academic attention. this is of considerable practical importance as in the case of insurance where risk products routinely need to be priced.2 how to price risk resides in academic fields such as management science (or operations research). it is the application of quantitative techniques to assist management decision making. generally when facing risk, the decision maker has to make a decision but does not know what the appropriate decision is. mathematics, statistics and probability theory all can be employed to assist the decision maker to arrive at the appropriate decision. it can be accepted that these problems are too complex for the correct decision to be intuitively arrived at, hence the need to resort to a discipline like management science. today a standard quantitative method employed to arrive at an appropriate decision involving risk, in practice, is well-known. the probabilities (pi) associated with possible outcomes (ci) are multiplied and these products are summed to arrive at a value, referred to as the expected value.3 when expressed in monetary values, it is referred to as the expected monetary value (emv), with µ being used as the symbol for the emv; thus: emv = ∑pi.ci = µ (e1) abstract 348 sajems ns 16 (2013) no 3:347-364 pierre de fermat (1601-65) and blaise pascal (1623-62) are usually credited with formulating this solution4 dating back to 1654.5 a simple problem can be used to illustrate the calculation. the calculation is independent of the unit of currency used and over the centuries different currencies have been used for the st petersburg game so for simplicity sake only one unit of currency is used in the article; the dollar. assume $0m will be paid if on the flip of a coin a tail appears and $1m if a head appears. the question then is; what is the expected value of this game? there is an equal probability, ½ on the flip of a coin, of either a tail or a head appearing, with associated outcomes of $0m and $1m respectively. the ranked sequence of probabilities and outcomes is thus {½, $0m; ½, $1m,}. using the method described above the emv is calculated as: emv = ½ . $0m + ½ . $1m = $0.5m ... (e2) the emv calculation can also be shown in tabular form as indicated in table 1, below: table 1 calculation of the emv for the flip of a coin series 1 2 totals payout ($m) 0 1 probabilities 1/2 1/2 1 contribution ($) 0 0.5 0.5 empirically the game can be played, say, m times and an average of these games obtained. the average of m games with a sum of s is thus: 𝑆 =   ! ! .. (e3) if an attempt is made to measure the emv, as an empirical average, 𝑆, the empirical value is seldom exactly equal to the expected value as determined by the expected value formula (e1). the reason is simple to understand. if a coin is flipped say 10 times, it is unlikely that there will be exactly 5 heads and 5 tails, and it is even less likely that if a coin is flipped 100 times that there will be exactly 50 heads and 50 tails and so on. there is a wide range of possible outcomes with µ being simply one of those outcomes, albeit the most likely outcome. the range of possible outcomes for 𝑆 can be described by a distribution which can be determined from probability theory or simulation. figure 1 indicates the distribution of possible outcomes when the game is played m times, for three different values of m for an outcome of $1m being paid per game each time a head appears.6 four observations can be made regarding figure 1. first there is a family of distributions which are all symmetrical about µ. second, the apex of the distributions, µ = $0.5m is constant, that is, it is independent of m, the number of games played. third the probability of achieving a result exactly equal to $0.5m decreases as m increases; ie the probability value at which the apex occurs decreases as m increases. fourth as m increases the dispersion (λ), about µ, decreases. thus the empirical value, 𝑆, for any set of games played m times and its relationship to µ, the apex of the distribution, is more accurately described as: 𝑆 (m) = µ (independent of m) + λ'/2 (dependent on m and can be positive or negative) .. (e4) where λ'/2 is the difference between the empirical average and the expected value, µ, achieved after the game is played m times for any particular series of m games. the value of dispersion λ in figure 1, can be pre-selected, say, to include a predetermined area under the distribution curve, say 84 per cent in which case it is anticipated that λ'/2, the empirical result from any series of games played m times, usually will produce a value less than λ/2. as m tends to infinity, the probability of achieving exactly µ tends to zero and λ (m), the dispersion with a pre-selected area under the distribution, also tends to zero. in other words the probability of the emv equalling µ tends to zero and of being anything but µ also tends to zero. in this case it can be said that the flipping of a coin is subject to both the central limit theorem and the law sajems ns 16 (2013) no 3:347-364 349 of large numbers. it is subject to the first because the distribution is symmetrical, about a constant µ, and the second because the dispersion tends to zero as m tends to infinity. and thus when, in practice, the equation emv = µ is used to solve problems there are unstated and more often than not forgotten assumptions. these are that central limit theorem and law of large numbers apply and that a large number of games are involved. these assumptions usually produce a practical outcome approximating µ which is independent of m. these assumptions do not hold for all complex games (liebovitch & scheurle, 2000). as is shown below, these assumptions also do not hold for the st petersburg game. figure 1 probability distribution of a coin flipping game played 10; 50; 100 times having concluded that mathematics, statistics and probability theory can assist the decision maker, the enquiry becomes, what are the questions for which the decision maker requires answers? a casino operator, for example, will want to know if a specific prize is offered for a particular game, say an offer $1m for the coin flipping game, what amount should gamblers be asked to wager to play the game so as to produce an expected profit for the casino? this question is usually posed as what is the fair value of the game? the fair value, in this case is the breakeven value. it is the amount which if paid by gamblers to play games, then the sum of payments received by the casino as income will equal the sum of amounts paid by the casino to gamblers. thus take as an example the above flipping of the coin game. at $0.5m per game for a 100 games gamblers will pay $50m to the casino and the casino expects to pay back $50m to gamblers. the net expected profit of the casino is thus zero. there is a second question which can be asked; and that is, what amount is it anticipated that a gambler will be willing to pay (wtp), to play a particular game? it can be accepted that when dealing with complex games of chance that gamblers cannot intuitively determine the fair value (break-even value) of the game, but, the fair value can in many cases be calculated by applying probability theory. generally, as a rule of thumb, it is anticipated that gamblers should be willing to pay (wtp) an amount to the same order as the fair value, 350 sajems ns 16 (2013) no 3:347-364 or expected value, of the game. answering questions about gamblers’ willingness to pay resides more centrally in fields such as behavioural economics, or consumer behaviour, or psychology, not management science or operations research. how gamblers behave, usually cannot be determined objectively by merely examining the game. the decisions, however, can be observed to arrive at answers. there may well be a sort of weak link between the management science objective fair value and the behavioural economics wtp decisions which is the rule of thumb mentioned above. it is anticipated, from observation, that gamblers should be willing to pay amounts in the region predicated by the emv. 3 the birth of the st petersburg game nicolas bernoulli 9th september 1713 with this background the origins of the st petersburg game is examined. the above observations relate to the simple game of flipping a coin but the question then becomes: can the emv theory developed by pascal and de fermat be used with confidence for all games of chance? this was the issue which concerned the swiss mathematician nicolas bernoulli (1687-1759)7. nicolas devised five games which, in his opinion, clearly demonstrated that gamblers would not make decisions in line with the values determined by the emv formula. gamblers’ wtp did not in his view coincide with the fair value of the game. it should be noted that his enquiry had shifted from managerial science to behavioural economics. he sent these games in a letter dated the 9th september 1713 to the french mathematician pierre rémond de montmort (1678-1719)8. one of these games, once simplified, is what today is called the st petersburg game. in this game a coin is flipped until a head appears whereupon the game ceases. the payout starts with $1 and doubles with each flip of the coin. if it appears at the jth flip an amount of $2 j-1 is paid. the traditional emv for the game can be determined from the method described above giving the result indicated in table 2. table 2 traditional calculation of the emv of the st petersburg game series 1 2 3 4 … j totals payout ($) 20 21 22 23 … 2j-l probabilities 2-1 2-2 2-3 2-4 … 2-j 1 contribution ($) 1/2 1/2 1/2 1/2 … 1/2 infinite this gives the traditional solution of: emv = ½ + ½ + ½ + ... (e5) or emv = ∞ ... (e6) thus according to the traditional solution the expected value of the st petersburg game is infinite. however, it is accepted that ‘no prudent … man would be willing to pay even a small number of shillings [dollars]’ to play the st petersburg game (todhunter, 1865:220). the traditional managerial science solution to the st petersburg game indicates that the fair value of the game is infinite; suggesting that gamblers should be willing to pay a substantial amount, say $1m per game, but a behavioural economics observation indicates that gamblers are only willing to pay modest amounts. therein seemingly lies the paradox as explained by todhunter (1865:220), ‘the paradox then is that the mathematical theory is apparently directly opposed to the dictates of common sense.’ theory and behavioural observation thus point in different directions. that is the apparent paradox in decision theory.9 4 “cardinal” utility solution to the st petersburg paradox daniel bernoulli 1738 montmort, exchanged correspondence with nicolas but in the end did not resolve nicolas’ sajems ns 16 (2013) no 3:347-364 351 problems. in a letter dated 22nd march 1715 he indicated that he had already written 16 pages but had not completed the task and doubted if he had the strength to do so. in december 1716 in a letter it is clear he had given up. he died shortly thereafter in 1719. but nicolas’ letter had reached others who suggested solutions to the paradox. the game reached nicolas’ cousin daniel bernoulli (1700-82) who included the game in a paper which was published in the 1738 edition of the papers of the imperial academy of the sciences in petersburg. daniel bernoulli (1738/1954) accepted the traditional solution, emv = ∞ to be correct and turned his attention from the mathematics of the game to behavioural economics and set about explaining the behaviour of gamblers being only prepared to offer modest amounts. he suggested gamblers do not make a linear evaluation of their possible gains but evaluate possible incremental gains in terms of what he called their “moral expectation.” he argued that individuals who add additional incremental wealth to their current fortunes would value the increment as being inversely proportional to their existing wealth. this represents what today is called diminishing marginal utility of wealth. this function he suggested could be described by a natural log function. thus instead of multi-plying the probabilities and linear gains, he argued that probabilities should be multiplied by the moral expectation of incremental wealth. this approach produces what today is called the expected utility value (euv) theory. euv = ∑pi u(wi) or ∑pi ln(wi/wo) … (e7) using his new theory he worked out how much gamblers would be prepared to gamble as10: g = ∏ (wo+2 j-1)1/2^j wo … (e8) this gives an amount of $2 where wo = 0; and an amount of $3 where wo = 10, and an amount of $6 wo = $1 000 and so on (todhunter, 1865:220). this modest amount in is line with what was thought gamblers would be willing to pay to play the game. other solutions, at the time, included one from cramer who suggested a gambler would be willing to pay $13, again a modest sum. these low outcomes derived from the moral expectation calculations were consistent with what was thought gamblers would be prepared to offer to play the game. and hence daniel bernoulli concluded that a solution to the st petersburg paradox had been found.11 5 ordinal utility: adam smith (1776), david ricardo (1817), and jeremy bentham (1748-1832) et al. daniel bernoulli’s paper appeared to gather dust as a different thread of utility theory moved to centre stage in economics but this thread was derived from another source. adam smith in his wealth of nations drew attention to the fact that a distinction existed between value in exchange (price) and value in use (usefulness or utility). as illustration he used diamonds that are very expensive. they have a substantial value in exchange, but they are not very useful. on the other hand water is inexpensive but of great value in use. this enigmatic distinction however proved difficult to convert into a comprehensive economic theory despite the efforts of many of the great economists of the time. it was not until the 1870s that three economists, william stanley jevons (1835-1882), leon walras (1834-1910) and carl menger (1840-1921) working separately prompted what is known as the marginal revolution. by the turn of the century it was accepted that utility was difficult to measure and it was impossible to make interpersonal comparisons. a cardinal utility theory appeared to be elusive and it was reluctantly accepted that economics would have to be largely content with ordinal utility12 and preference curves were introduced to assist analysis. 6 rediscovery of daniel bernoulli’s cardinal utility von neumann and morgenstern (1947) interest in bernoulli’s “cardinal” expected utility hypothesis was rekindled by the publication of john von neumann (mathematician) and oskar morgenstern’s (economist) theory of games and economic behaviour (1947). they provided a method for individuals to reveal their certainty equivalents13, and by incorporating ordinal utility placed economics on the 352 sajems ns 16 (2013) no 3:347-364 promised utility foundation which had eluded economists since adam smith’s diamondwater enigma.14 bernoulli’s original 1738 paper then became a matter of considerable importance but since it was written in latin it was largely inaccessible to readers. it was translated for the first time into english in 1954. and thus the st petersburg paradox moved centre stage. 7 resolving the paradox – correcting the original mathematical error strangely in the 300 years which have elapsed since nicolas bernoulli set out the game virtually no-one questioned if the traditional derivation of the linear expected monetary value of the game is correct15. that a problem exists with the traditional solution is clear from the following quotation which appears in daniel bernoulli’s original 1738 paper16: “the number of cases [m] to be considered here is infinite: in one half (1/2) of the cases [m] the game will end at the first throw, in one quarter (1/22) of the cases [m] it will conclude at the second, in an eighth (1/23) part of the cases [m] with the third, in a sixteenth (1/24) part [m] with the fourth, and so on … ad infinitum.” that this statement contains an error was noted by karl menger (1902-85)17 who was the technical consultant to the 1954 translation of bernoulli’s paper from latin to english. he noted: “since the number of cases is infinite, it is impossible to speak about one half of the cases, one quarter of the cases, etc., and the letter [m] in bernoulli‘s argument is meaningless.” menger did not realise the significance of the error and did not fully correct it. it is a simple matter to correct since m cannot be infinite to derive a solution, m must be allocated a finite value say m=2k. if bernoulli’s method is applied to these games then 2k-1 games end after the first flip, 2k-2 games end after the second flip and so on. if 2k games are played then the following series of games is expected to evolve: 2k-1 + 2k-2 + 2k-3 ... 2k-k … (e9) the expected length of the above series is only k in length, not infinite. since each term in the series contributes ½ to the emv of the above series of games, the above series produces a total of k/2. to complete the determination of the expected value of m=2k games it must be established if all the games are expected to be within the above series of k terms. it must be checked to see if all the games are accounted for in the series k in length. the above series (e9) is a geometric progression which is easily summed. the sum of series (e9) is 2k 1. thus if 2k games are played one game is expected to end outside of the series which is k in length. this one game which progresses beyond the kth term can be any game in the series and can end anywhere after the kth term. if it ends at the kth + 1 term it will contribute 1 to the emv of the games and there is a 50 per cent probability that it will end at the k+1 term (vivian 2003). if it ends anywhere further from the kth + 1 term it will contribute a greater value to the emv but there is a declining probability that the game will progress further away for the kth term. this additional amount which is contributed to the emv from the game which ends after the k+1 term can be represented by λ, the value of which depends on where the game in fact ends beyond the k+1 term. the emv of playing st petersburg games once daniel bernoulli’s error is corrected is thus: emv = (k/2 + 1) + λ … (e10) or if expressed in the usual format of µ + λ emv (m = 2k) = µ + λ ... (e11) where µ = (k/2 + 1) and is as before the apex of the distribution in this case the distribution of st petersburg games as indicated in figure 2. the values of λ with associated probabilities are as follows: λ = {½, 0; ½2, 21; ½3, 22 … } in the st petersburg game µ = (k/2 + 1) represents the outcome at the apex of the distribution with a confidence level of 50 per cent. in the st petersburg game µ is not a constant, it is dependent of m the number of games played. this differs from the simple game of flipping a coin discussed above which produces µ, a constant, and thus independent sajems ns 16 (2013) no 3:347-364 353 of m. in the st petersburg game λ on the other hand is independent of m whereas in the game of flipping of a coin λ decreases as m increases. the distribution of the st petersburg game does not conform to either the central limit theorem or the law of large numbers. even if the st petersburg game is played an enormous number of times the expected value is relatively modest. thus for example if the game is played 264 (18 446 744 073 709 600 000) times the expected value is a mere $33 at a confidence level of 50 per cent. this expected value is nowhere near as large a figure as anticipated by the traditional solution. figure 2 probability distribution of the st petersburg game if the correct derivation of the emv is carried out then the expected value of the game becomes finite, modest, and subject to predicable levels of confidence. the modest figure is in line with what it is thought gamblers would be willing to pay to play the game. with the correct derivation, there is no paradox.18 once the error is realised, corrected and the correct value determined, and it becomes clear that no paradox exists it can be anticipated that the view that the st petersburg game leads to a paradox will disappear; the myth that the st petersburg game produces a paradox in decision theory will be dispelled. but entrenched views are resilient and the myth did not disappear. so the question becomes why should the belief in the existence of a paradox cease at this point of time? this article attempts to answer this question. the answer is to be found in a methodological twist to the story of the paradox which is now considered. 8 the methodological twist dispelling the myth of the paradox the methodological twist involves recalling the influential debate about what is the appropriate methodology to arrive at the truth. this debate started a few decades before the birth of the paradox, was influential at the birth of the paradox and has continued ever since19. two fundamental methodologies can be identified; the older being aristotle’s organon (deductive method). this ancient method was disputed and rejected by sir francis bacon in his novum organum (observation inductive method)20. the switch from the one to the other dominated scientific enquiry when nicolas was writing the letter to montmort and no doubt played a significant part in the reason for him formulating the problems in the first place. when any new theory is advanced how is the truth of this theory to be established? in terms 354 sajems ns 16 (2013) no 3:347-364 of aristotle’s organon truth could be found from reason or logic. sir francis rejected this as being sufficient to validate any theory. validity had to be established empirically; through observation preferably an observation of nature. pre-1620: aristotle’s organon before 1620 the dominant methodology was aristotle’s organon. this can be described as the deductive (syllogistic) or philosophical method of logic. this method rests strongly on belief and thus has a natural affinity with religion. the 1500s and 1600s brought the limitation of this methodology into focus. for what seemed at the time to be good reasons the almost universally accepted view, was that the sun rotated round the earth, the ptolemaic system.21 this view also appeared to have biblical support.22 this belief formed part of the aristotelian system of an unchanging celestial realm. this view was a product of organon. however, nicolaus copernicus (1473-1543), a polish astronomer began to form a different view, the heliocentric view, that it was the earth and the other planets which rotated around the sun. he ‘sought, with scanty instrumental means, to test by observation the truth it embodied.’23 his views were published contemporaneously with his death as de revolutionibus orbium coelestrium (libri vi) (1543)24. copernicus had found a new basis to discover the truth; observation of nature, not deduction. the tide however turned strongly against copernicus’ heliocentric view. in 1615 roman inquisition consultants examined the question and pronounced the copernican theory to be heretical. by this time galileo (1564-1642), an italian, and others became convinced that copernicus’ view was correct and with accepting this view that truth could be found from observation, measurement and the application of the mathematical sciences. he published his views in the assayer (1623). in 1630 he published his dialogue concerning the two chief world systems (ptolemaic and copernican) in which he inadvertently insulted and ridiculed the pope. the reaction was swift. he was brought before the roman inquisition and sentenced to lifelong house arrest. sir francis bacon’s novum organum (1620) to a perceptive observer it was clear that a new important method of discovering truth had been found, observation, specifically about nature, and then progression via the inductive method. this was the so-called scientific method. the perceptive observer in this case was sir francis bacon, who in england, in 1620 published his views in his novum organum. he specifically rejected aristotle’s organon method. he stated the essence of this new method is in the opening paragraph of the novum: ‘man, as the ... interpreter of nature ... understands as much as his observations ... permit him and neither knows nor is capable of more’ knowledge, about nature, comes from making observations of nature which man can understand, explain and interpret. observation of nature was where the truth was to be found. in doing so man is not to be bound or encumbered by preconceived conclusions arrived at from a purely deductive process. the new scientific age was ushered in as relying merely on aristotle’s organon deductive system was rejected. this new objective, impersonal observation based system began to dominate all scientific enquiries. any conclusions which were arrived at had to be validated by observation of nature. 8.1 the natural world of nicolas and daniel bernoulli in 1713 and 1730 understanding this debate, then, the question becomes what was the natural world observation sought by nicolas and daniel bernoulli in the early 1700s to validate by observation the correctness of the expected monetary value decision theory? a new theory had evolved, the expected monetary value theory, which was to be applied as a solution to making decisions involving risk. to decide if this theory was correct it had to be validated by observation. as pointed out above there are two basic issues involved in games of chance, the study of the game itself (management science) and the study of the behaviour of the gambler, the decision maker, (behavioural economics). in 1713 nothing could be observed about the game itself to validate the correctness of the theory. all that could be observed was the decision of the decision maker. daniel decided, from observation, that decision makers do not make decisions as sajems ns 16 (2013) no 3:347-364 355 predicted by the expected value theory when applied to the st petersburg game and hence because of this observation the emv as a general decision theory had to be rejected. that he rejected the emv as a general theory is clear from the title of his paper and his opening remarks to his paper. his title is “exposition of a new theory of the measurement of risk” and in paragraph 3 he states emphatically ‘the rule [emv] must be discarded.’ he applied the novum observation methodology to arrive at this conclusion. he argued that from observation of the behaviour of gamblers that it was clear that people do not make decisions in terms of the emv rule. therefore since observation trumps hypothesis the emv rule had to be rejected. the emv of the st petersburg game, as determined mathematically at the time was infinite, but the decision maker did not, in fact, make decisions as predicted by the calculation of the emv of the game. thus he concluded that the emv rule had to be discarded. having created a new solution, his diminishing marginal utility of wealth he triumphantly proclaimed in the novum observation terminology: ‘since all our propositions harmonize perfectly with experience [novum] it would be wrong to neglect them as abstractions resting upon precarious hypotheses [organon]’ observation had triumphed over hypotheses. of course his utility solution says nothing about the st petersburg game itself. it deals exclusively with observations and explanations about decision makers. what decision makers do however is not natural world observation such as observing the actual outcomes when games are played. it is thus the application of the novum observation methodology, to gamblers and not the game, which produced the utility solution to the st petersburg game. the methodology produced the paradox. it does not appear as if anyone took a different but equally possible interpretation of the observations of the behaviour of gamblers and that is that gamblers’ decisions were pointing to the fact that the mathematical solution to the game was incorrect and if correctly determined it would harmonise with the decisions of gamblers. some comments are directed at his approach of observing gamblers and not the game. first in “observing” gamblers daniel was clearly working in the field of behavioural economics and not that of the management science. this was different to what pascal and de fermat were dealing with. they were concerned with management science not behavioural economics. daniel says nothing about the game itself. in fact a purpose of his paper was to reject the notion that gamblers look only at the game; that is a central thesis of his paper. he concentrated on the observed behaviour of gamblers. second his observation about gamblers is not an observation of nature but about human behaviour. the novem methodology was focused primarily on observing nature. it is not clear that observing human behaviour falls within the purview of the novum methodology at all. finally although he refers to the modest amounts that gamblers are willing to pay his source on this point is not clear. it does not appear if any experiments were carried out to determine the amounts gamblers are willing to pay to play st petersburg games until quite recently (cox, vjollca & bodo, 2009; hayden & platt, 2009). 8.2 the natural world of 2013 in 2013 things are very different. with the advent of the modern computer outcomes from playing st petersburg games can easily be observed simply by simulating games. observations of nature are now available. what happens when games are simulated is indicated below. table 3 indicates the empirical emv determined from simulating st petersburg games when played from 1 game through to 1 048 576 games or a total of 2 097 151 games.25 the results are also shown graphically in figure 3 with a trend line added. these outcomes are, as noted, observations of nature unlike the observations of gamblers which involve observing human action or behaviour. the following observations can be made about the outcomes recorded in table 3 and figure 3. 356 sajems ns 16 (2013) no 3:347-364 table 3 simulation of st petersburg game. total of 2 097 151 games played 2k k m number of games played expected values as predicted by formula (vivian 2003) empirical bernoulli (1738)'s expected value of, say, $1 000 000 as a proxy for infinity confidence level (λ) emv 50% 75% 87,5% 93,75% ($) ($) ($) ($) ($) 0 1 1,0 2,0 4,0 8,0 1,000 1 000 000 1 2 1,5 2,5 4,5 8,5 1,000 1 000 000 2 4 2,0 3,0 5,0 9,0 3,000 1 000 000 3 8 2,5 3,5 5,5 9,5 5,500 1 000 000 4 16 3,0 4,0 6,0 10,0 1,938 1 000 000 5 32 3,5 4,5 6,5 10,5 3,188 1 000 000 6 64 4,0 5,0 7,0 11,0 5,203 1 000 000 7 128 4,5 5,5 7,5 11,5 4,617 1 000 000 8 256 5,0 6,0 8,0 12,0 4,223 1 000 000 9 512 5,5 6,5 8,5 12,5 8,096 1 000 000 10 1 024 6,0 7,0 9,0 13,0 6,844 1 000 000 11 2 048 6,5 7,5 9,5 13,5 6,901 1 000 000 12 4 096 7,0 8,0 10,0 14,0 6,256 1 000 000 13 8 192 7,5 8,5 10,5 14,5 6,395 1 000 000 14 16 384 8,0 9,0 11,0 15,0 6,888 1 000 000 15 32 768 8,5 9,5 11,5 15,5 9,589 1 000 000 16 65 536 9,0 10,0 12,0 16,0 7,929 1 000 000 17 131 072 9,5 10,5 12,5 16,5 10,545 1 000 000 18 262 144 10,0 11,0 13,0 17,0 9,345 1 000 000 19 524 288 10,5 11,5 13,5 17,5 11,408 1 000 000 20 1 048 576 11,0 12,0 14,0 18,0 11,243 1 000 000 1) no series of games produced a large empirical emv. the empirical emvs ranged from 1 to 11.408. the notion that st petersburg games produces large average values, say a mere r1 000 000 per game can be discounted as something which simply is not observed in nature. 2) this range of empirical outcomes is in line with amounts which gamblers are thought to be willing to play the game. there is no decision theory paradox. 3) from figure 3 it is clear that as the number of games increase, the trend produces a line which is upward sloping. unlike with flipping a coin, the emv is not constant, ie, it is dependent on m the number of games played. neither the central limit theorem nor the law of large numbers apply to the st petersburg game. 4) the results are consistent with the results predicted by the formula emv = (k/2 + 1) + λ. 5) the observation made by daniel bernoulli’s (1738/1954) with respect to his utility solution is equally true for the empirical results. the empirical results harmonise with the theoretical results. a further simulation was carried out this time with 226 games being played, ie 268 435 456 games. the predicted and empirical results are summarized in table 4. the expected length of the series is not the traditional infinite series but a series which is expected to contain 29 terms; ie k+1 or 28+1. the empirical length consisted of 25 terms. the expected value is not bernoulli’s infinite value (or a mere $1 000 000 per game, if you like) but a mere $15 (ie k/2+1) at a 50 percent confidence level. the empirical emv was $17.02. observation about the game and theoretical predictions harmonise. the detailed results of this simulation are indicated in table 5. sajems ns 16 (2013) no 3:347-364 357 figure 3 empirical and expected emv's of the st petersburg game table 4 expected and empirical results 2^28 games number of games played 268 435 456 two raised to the power of: 28 expected value: 50 % confidence level 15,000 expected value: empirical 17,020 length of series: expected 29 length of series: empirical 25 table 5 results when 2^28 games are played (268 435 456 games) empirical heads expected variance λ'/2 empirical payout empirical expected heads probabilities ($) contribution to emv contribution to emv 50% cl total 268 435 456 268 435 456 1 1,000 17,020 15 1 134 217 760 134 217 728 31 0,500 1 0,500 0,500 2 67 108 768 67 108 864 -96 0,250 2 0,500 0,500 3 33 555 680 33 554 432 1248 0,125 4 0,500 0,500 4 16 773 216 16 777 216 -4000 0,062 8 0,500 0,500 5 8 390 976 8 388 608 2368 0,031 16 0,500 0,500 6 4 195 936 4 194 304 1632 0,016 32 0,500 0,500 7 2 096 288 2 097 152 -864 0,008 64 0,500 0,500 8 1 048 608 1 048 576 32 0,004 128 0,500 0,500 9 522 880 524 288 -1408 0,002 256 0,499 0,500 10 262 592 262 144 448 0,001 512 0,501 0,500 11 130 240 131 072 -832 0,000 1 024 0,497 0,500 12 68 352 65 536 2816 0,000 2 048 0,521 0,500 358 sajems ns 16 (2013) no 3:347-364 13 31 744 32 768 -1024 0,000 4 096 0,484 0,500 14 16 192 16 384 -192 0,000 8 192 0,494 0,500 15 8 320 8 192 128 0,000 16 384 0,508 0,500 16 4 288 4 096 192 0,000 32 768 0,523 0,500 17 2 080 2 048 32 0,000 65 536 0,508 0,500 18 864 1 024 -160 0,000 131 072 0,422 0,500 19 256 512 -256 0,000 262 144 0,250 0,500 20 160 256 -96 0,000 524 288 0,313 0,500 21 64 128 -64 0,000 1 048 576 0,250 0,500 22 32 64 -32 0,000 2 097 152 0,250 0,500 23 64 32 32 0,000 4 194 304 1,000 0,500 24 64 16 48 0,000 8 388 608 2,000 0,500 25 0 8 -8 0,000 16 777 216 0,000 0,500 26 32 4 28 0,000 33 554 432 4,000 0,500 27 0 2 -2 0,000 67 108 864 0,000 0,500 28 0 1 -1 0,000 134 217 728 0,000 0,500 29 0 1 1 0,000 268 435 456 0,000 1,000 30 0 0 0 0,000 536 870 912 0,000 0,000 31 0 0 0 0,000 1 073 741 824 0,000 0,000 9 conclusion the desktop computer enables any schoolboy nowadays to simulate the st petersburg game and the game is increasingly being simulated.27 anyone observing the outcomes of these simulations will notice that the outcomes are never very large as predicted by bernoulli. it is now simply a matter of time before bernoulli’s solution that the st petersburg game has an infinite expected value even when a finite number of games are played will be rejected. the view that the st petersburg game produces a paradox in decision theory likewise will be abandoned, not because it is easy to prove mathematically that that view is incorrect but for the same reason that we no longer believe the earth is flat or the sun rotates around the earth. we can nowadays observe that these things are not true. we can observe that the st petersburg game does not produce large expected outcomes and hence does not produce a decision theory paradox. observations from results of nature will dispel the myth of the st petersburg paradox as observation has dispelled other myths about nature. it is now just a matter of time. if the bernoullis had the modern computer the paradox would never have seen the light of day. on the other hand, no doubt, the st petersburg game will be of continued interest for other reasons including the field of behavioural economics. 10 postscript – prior simulations of st petersburg games the thesis of the article is that as the st petersburg game is being simulated, increasingly, so the traditional view that a paradox exists will be abandoned. it would be incorrect, however, to believe that the st petersburg game has not been simulated. for the sake of completeness this postscript briefly discusses some of the attempts which have been made to simulate the st petersburg game. as will be seen the early simulations led to the conclusion that no paradox existed. buffon (1777) and earlier simulations buffon (1777) appeared to be the first to use simulations to validate probability theory which he applied to the st petersburg game (stigler, 1991). buffon’s original work was published in french which has conveniently, for the first time recently, been translated into english and is now generally available (hey, neugebauer & pasca, 2010). buffon hired a child to flip a coin and recorded the results. the child played 2 048 games. this experiment has been widely discussed (including de sajems ns 16 (2013) no 3:347-364 359 morgan, 1838, de morgan, 1847, de morgan, 1915, moritz, 1923; stigler, 1991, aase, 2001). de morgan (1847) added a further 2 048 games to give a total of 4 096 games (212 games) and the second edition of his work published in 1915 added even more games. buffon’s 2 048 games produced an average of $5 per game. later an average of $15.4 was determined for the 4 096 games. these combined results were discussed by moritz (1923). moritz accepted that if a game is played 2k times it produces what he calls a theoretical value of k/2 and compared this value with the average from the actual playing of the game taken from buffon’s simulation. he reproduces buffon and de morgan’s (1847) empirical results on a table on page 60 of his article.28 buffon’s simulations, now augmented by that of others produced modest average values which moritz noted increased as the numbers of games were played (moritz, 1923:61). moritz concluded that if 2k games are played this should yield an average of k/2 per game. he then concluded that in fact any pre-selected average for a series of games could be achieved simply by playing the requisite number of games but since it takes time to play the requisite number of games, he noted that insufficient time may exist to achieve the outcome. he noted for example that to secure an average of $18 would require 236 games which he pointed out exceeds the number of seconds in the christian era. this was of course before the age of the computer. in the face of the results produced by simulation, moritz concluded that the traditional infinite solution is meaningless (moritz, 1923: 61). it is suggested that this view is too extreme. more correctly the traditional view is a special case of being correct where an infinite number of games can be played, which is of little practical significance. a more appropriate comment would have been to note that the central limit theorem does not apply and thus that the expected value is dependent on the number of games played. it is clear that mathematicians at that time had rejected the idea that the st petersburg game produces a paradox. feller (1945:302), without reference to buffon’s experiment, specifically dismissed the idea that the st petersburg game produced a paradox: ‘instead of a paradox we reach the conclusion that the price should depend on k, that is to say [the price will] vary as the number of trials increases.’ feller (1968) repeated this view in his leading textbook. it should be clear from the propositions set out in this article, that mathematicians in the early to mid-1900s accepted that the average value of games played is a function of the number of games played, is finite and modest and no paradox exists. . these conclusions seemed not to have been noticed, or, were forgotten after the publication of von neumann and morgenstern’s (1947) textbook on game theory. these conclusions appear to have remained forgotten ever since despite more recent simulations. ceasar (1984) and more recent simulations more recently ceasar (1984) simulated st petersburg games using a computer, producing results for the average values and continued to produce results for bernoulli’s and cramer’s utility solutions. in his simulations the number of games were incremented from 100 to 20 000. he produced a graph for the average value which indicates modest finite outcomes increasing in value as the number of games increase. he demonstrated a wide discrepancy between the mathematical average and the utility solutions. the thrust of his article was to demonstrate that the computer could be used to simulate st petersburg games and to compare mathematical and utility solutions. the need to resort to manual flipping of the coin was passed. the age of the computer had arrived. the article contains little theoretical discussion. russon and chang (1992) russon and chang (1992) simulate st petersburg games and find such a wide discrepancy between the simulated average values and traditional predicted value that they suggest a ‘practical average’ be adopted. vivian (2004) re-examined their argument and concluded that if the expected value is correctly determined then theory and simulation could be reconciled. 360 sajems ns 16 (2013) no 3:347-364 klyve and lauren (2011) the above authors simulate st petersburg games from 1 000 to 1 000 000 times, producing finite, modest outcomes generally increasing as the number of games increase. they point out that the average per-game winnings depends rather strongly on the number of games played. this, they point out is however, well-known. they attempt to produce a distribution of the st petersburg game based on buffon’s 2 048 games and end up with a strange distribution which they admit they are at a loss to explain. behavioural economics simulations a large number of simulations has been carried out to test decision makers’ willingness to pay, many of which involve the st petersburg game. a discussion of these simulations falls outside the scope of this article but the article by neugebauer 2010 can be consulted for a detailed discussion on this line of research. conclusion re simulations it is clear that once st petersburg games are simulated, certain conclusions become inescapable; viz the average values are always finite, modest and increase as increasing numbers of games are played. these observations are at variance with the traditional single value infinite expected value solution to the game. oddly in the early 1900s once the game was simulated, the idea that the game produced a paradox was rejected, which conclusion seems to have been forgotten. it is this forgotten conclusion that will be rediscovered as the st petersburg game is increasingly simulated. these simulations, together with the correct derivation of the expected value, spell the end of the myth of the paradox. endnotes 1 risk is used in the sense frank knight used it; those situations where the outcomes and their associated probabilities are known. 2 historically property-casualty insurance products were not priced using probability theory. they were priced using the loss ratio. a relationship between the loss ratio and probability theory can be demonstrated. 3 a word of caution is in order. this method is applicable for games subject to the central limit theorem and law of large numbers. as the st petersburg game demonstrates, not all games of chance are subject to the central limit theorem and the law of large numbers. the standard method should not be blindly mechanically applied. 4 samuelson (1977:37) correctly points out that in giving them this credit; they are credited with too much. 5 this history has often been told and increasing detailed histories are appearing. to mention a few; todhunter (1865), maistrov (1974); samuelson (1977), stearns (2000), neugebauer (2010), peters (2011). the paper by neugebauer in particular is very comprehensive and worth consulting. the famous letters between pascal to de fermat were exchanged in1654. a detailed commentary on this correspondence was recently published by devlin (2008). 6 what happens when m increases, is explained by vivian (2003a). the distribution for the flipping of a coin is the binomial distribution which is a discrete not continuous distribution, which can approximate the normal distribution. figure 1 indicates the shape of the distribution as m increases. 7 nicolas can be spelt in number of ways. the spelling used in this article is taken from the english translation of daniel bernoulli’s 1738 article. 8 the correspondence is conveniently collected and published by richard j pulskamp (1999) at http://www.cs.xu.edu/math/sources/monmort/stpetersburg.pdf. 9 this was described to be the paradox by todhunter, 1865. it is important to make clear what constitutes the paradox since in more recent articles, authors have claimed to discover further paradoxes but do not indicate, clearly, what they consider to be the paradox; examples of this are the so-called pasadena and harmonic sequence paradoxes. for a discussion on these recent attempts to create st petersburg type of paradoxes see vivian (2006) and vivian (2009). 10 todhunter (1865:220), stigler (1950:374). 11 bernoulli did not offer any empirical evidence of decisions actually made. in fact empirical evidence had to wait several centuries. bernoulli (1738:§17) simply concluded, ‘… our propositions harmonise perfectly with experience...’ 12 the history of utility theory was set-out by stigler (1950) 13 even before the theory of games was available its importance was recognized by leading academics as in the case of friedman and savage (1948). 14 in the early 20th century the theory of indifference curves was developed by edgeworth and others. from this a type of cardinal utility analysis developed. however unlike the von neumann-morgenstern ‘certainty-equivalent’ techniques, that type of cardinal utility (despite the identical terminology) could not provide measurable interpersonal comparisons of utility. 15 the exception may be feller (1945;1968: 246) discussed below. 16 daniel bernoulli (1738/1954 footnote 10). 17 karl menger was the son of the carl menger mentioned earlier. the original text used n not m. it is changed to m for purposes of the article for the sake of consistency within this article. 18 vivian (2003) and the simulation verification vivian (2004). sajems ns 16 (2013) no 3:347-364 361 19 for a recent discussion see higgs’ (2011) discussion of samuelson’s (1952) support of the inductive method and unwarranted disparaging of the deductive method. 20 bacon’s work initiated considerable debate about how knowledge is acquired. see for example whewell (1837), whewell (1840), mill (1843/1872), de morgan (1847), jevons (1897). this article does not require any discussion of this debate since the issue of the st petersburg game is resolved simply by observation. the observation of outcomes of the natural phenomenon which appears when st petersburg games are simulated are at variance with the predicted traditional theoretical outcome of the st petersburg game. 21 galileo in his defence before the roman inquisition was able to refer to a surprisingly long list of eminent scientists who held the heliocentric view. 22 psalm 93:01, psalm 96:10, ecclesiastes 1:5 and 1 chronicles 16:30. 23 clerke (1911.) 24 copernicus did not live to see the impact of his work. he was seized with apoplexy and paralysis towards the close of 1542 and died on the 24th may 1543. he also did not live to note the preface sneaked in by andreas osiander insisting that the views in the work were purely of a hypothetical character and not factual. 25 the simulation program was written by richard j vivian using microsoft excel 2010. it is known that the random excel generator can be improved (knüsel 1998, mccullough et al., 2003 and 2008). knüsel (2010) more recently has opined that the deficiencies identified in earlier versions of excel are rectified in excel 2010. since the purpose of the simulations in this paper are merely to validate the theory, which the simulations achieve, any remaining limitations which may exist in the excel 2010 random generator are not regarded to be critical. 26 if the wikipedia entry of the st petersburg game is examined, a link will be found to an online simulation of the st petersburg lottery. 27 as pointed out above, theoretically, if the st petersburg game is played 2k times it produces a series which is expected to be k+1 in length. moritz’s table on page 60 produces a series k in length which moritz sums to indicate a total of 2k games but if the total is checked it will be noted that one game is missing. he probably could not work out how to account for the missing game, λ in the above theory, and thus simply ignored it. acknowledgement * this article is based on a senate lecture delivered on the 15th may 2012. a special word of appreciation is extended to prof reekie for comments made on earlier drafts of this article prepared for the senate lecture. the usual disclaimers apply references aase, k.k. 2001. on the st petersburg paradox. scandinavian actuarial journal, 1:69-78. bacon, f. 1620. the new organon or the true directions concerning the interpretation of nature. no publisher details. bernoulii, d. 1738/1954. exposition of a new theory on the measurement of risk. econometrica, 22(1):23-36. clerke, a.m. 1911. copernicus a short biography. encyclopaedia britannica. ceasar, a.j. 1984. a monte carlo simulation related to the st petersburg paradox. college mathematics journal, 15(4):339-342. cox, j.c. & vjollca, s. & bodo, v. 2009. on the empirical relevance of the st petersburg lotteries. economic bulletin, 29(1):214-220. de morgan, a. 1838. an essay on probabilities, green & longmans. de 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1977. st petersburg paradoxes: defanged, dissected, and historically described. journal of economic literature, 15(1):24-55. stearns, s.c. 2000. daniel bernoulli (1738): evolution and economics under risk. journal of biosciences, 25(3):221-228. stigler, g. 1950. the development of utility theory i & ii. journal of political economy, 58(4). stigler, s.m. 1991. statistical simulation in the nineteenth century, statistical science, 6(1):89-97. todhunter, i. 1865. a history of the mathematical theory of probability from the time of pascal to that of laplace new york, usa; chelsea publishing company 1949. vivian, r.w. 2003. solving daniel bernoulli’s st petersburg paradox: the paradox which is not and ever was. south african journal of economic and management sciences, ns 6(2):332-345. vivian, r.w. 2003a. considering samuelson’s ‘fallacy of the law of large numbers’ without utility. south african journal of economics, 72(2):363-379. vivian, r.w. 2004. simulating daniel bernoulli’s st petersburg game: theoretical and empirical consistency. simulation & gaming, 35(4):499-504. vivian, r.w. 2006. considering the pasadena ‘paradox’. sa journal of economic and management sciences, ns (2):277-284. vivian, r.w. 2009. considering the harmonic sequence ‘paradox’. sa journal of economic and management sciences, ns 12(3):385-390. whewell, w. 1837. history of the inductive sciences. no publisher details. whewell, w. 1840. the philosophy of the inductive sciences, founded on their history. no publisher details. von neumann, j. & oskar morgenstern. 1947. the theory of games and economic behaviour. no publisher details. abstract introduction research design results discussion acknowledgements references about the author(s) melinda du toit optentia research focus area, north-west university, south africa hans de witte optentia research focus area, north-west university, south africa work, organisational and personnel psychology unit, faculty of psychology and educational sciences, katholieke universiteit leuven, belgium sebastiaan rothmann optentia research focus area, north-west university, south africa anja van den broeck optentia research focus area, north-west university, south africa department of marketing and organisation studies, faculty of economics and business, katholieke universiteit leuven, belgium citation du toit, m., de witte, h., rothmann, s. & van den broeck, a., 2018, ‘contextual factors and the experience of unemployment: a review of qualitative studies’, south african journal of economic and management sciences 21(1), a2083. https://doi.org/10.4102/sajems.v21i1.2083 new perspective contextual factors and the experience of unemployment: a review of qualitative studies melinda du toit, hans de witte, sebastiaan rothmann, anja van den broeck received: 31 aug. 2017; accepted: 27 mar. 2018; published: 18 june 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract this study aimed to review qualitative studies on the contextual factors affecting the experience of unemployed individuals. from the analysis of the findings of 13 qualitative studies, the conclusion was reached that the contextual factors, namely the broader society, the surrounding community, and the individual as actor or agent, had a direct impact on the unemployment experience of individuals. it was recommended that unemployed individuals be organised into community subgroups, constructed to participate in projects aimed at empowering the community to improve cohesion, equality among members, and a collaborative attitude. social scientists ought to make an effort to advocate a marked improvement in society’s tolerance for, and understanding of, the realities faced by the unemployed person. one such reality was that a well-paying job that would take an individual out of financial hardship could be well out of reach of some individuals, which would mean a life of surviving without any regular income. introduction unemployment is a sociopolitical challenge worldwide. it is also a major challenge in south africa, with its national unemployment rate of 26.7%. unemployment has to be addressed to ensure economic growth in the country (national planning commission 2011; statistics south africa 2017). furthermore, unemployment is mostly a negative experience for the majority of unemployed persons because it has a negative impact on individuals’ psychological well-being (de witte, rothmann & jackson 2012; diette et al. 2012; nell et al. 2015; sage 2017). in a bid to understand this crippling socio-economic phenomenon faced by 5.88 million south africans (statistics south africa 2017), it may be necessary to thoroughly investigate all the contextual components that play a role in unemployment. in south africa, unemployment has steadily increased on a year-on-year basis over the past 9 years (yu 2012). kingdon and knight (2003:391) describe the widespread unemployment in south africa as a ‘beast’, with an ‘effect on economic welfare, production, erosion of human capital, social exclusion, crime and social instability’. existing research done in the south african context recognises the critical role played by contextual factors in experiences of unemployment (burger & fourie 2013; de witte et al. 2012; dieltiens 2015; griep et al. 2014; nell et al. 2015). nell et al. (2015), for instance, argue that factors such as community safety, educational support, and support networks of religious organisations can have an impact on the well-being of unemployed and poor individuals. de witte et al. (2012) suggest that contextual aspects such as quality education, adequate social security cover, sufficient government investment in unemployment well-being advancement programmes, and skills-training can influence the experience of unemployment. dieltiens (2015) agrees with the argument made by nell et al. and de witte et al. that various aspects that can be viewed as contextual factors can influence the experience of unemployment. contextual factors identified by dieltiens as barriers to employment are, among others, a limited functional network, lack of information channels or opportunities to access information channels, adverse structural conditions of the economy, as well as unfairness and injustice in state employment practices. according to fourie (2011), unemployment in south africa cannot be understood without considering factors such as mobility barriers, marginalisation, and the characteristics of labour market facets. the individual’s experience of unemployment may, furthermore, be affected by social and interpersonal contextual factors, such as stigmatisation, ignorance of authorities, and society’s unwillingness to understand unemployment and its effects (aldrich & dickie 2013; fowler & etchegary 2008; mckenzie 2013; patrick 2014; sherman 2013; strier 2014). some studies focused on contextual factors that could have an impact on experiences of unemployment. information is needed, however, regarding contextual factors influencing the experience of unemployment in different contexts. no study could be found that explored the qualitative findings from different countries to ascertain the experience of unemployment. such an exploration offers the possibility to ‘hear’ the voices of the unemployed interviewees from different countries and in different contexts. the aim of this study, therefore, was to investigate contextual factors associated with experiences of unemployment. defining context and contextual factors the word ‘context’ comes from latin, meaning ‘to knit together’ or ‘to make a connection’. a disentanglement of the individual, the phenomenon, and the context is impossible. individuals play an active role in shaping the context in which they live (shogren, luckasson & schalock 2014). for shogren et al. context is ‘the totality of circumstances comprising the milieu of human life and human functioning’ (2014:110). de souza (2014:12) describes context from a critical realist perspective. he defines context as ‘a micro-scaled version of society’. a person enters the world and encounters pre-existing conditions in the context that restrict or enable reaction possibilities. the first aspect of context is the social structure or the relationships in which the individual finds themselves. the individual has not created this social system or relationship; it is inherited. however, actions taken or conduct in response to these social structures can change or reinforce them. the social system can have an impact on the individual, but the individual also affects the social system or relational factors of context. the social structure is based on the individual’s relations with others. for this study, this part of the context is applied to refer to the community or subgroup to which the individual relates. the second aspect identified by de souza is structure, comprised of material, physical, and human resources. this functions on the level of culture and, for this study, it is postulated to refer to the broader society and culture. the third and last component of context is the person as agent. the individual is a separate figure posed against the backdrop of context, but is also an integral part of it. de souza points out that an individual enters reality with an inherited predisposition regarding aspects such as demographics, accessibility to resources, life, and chances that dictate the limits or possibilities of different life trajectories or roles. based on the description provided by de souza (2014), ‘contextual factors’ refer to a dynamic interplay between: (1) the structure and culture of the society, (2) relationships, community behaviour, and the environment surrounding the unemployed individual; and (3) the individual’s agency in the existing social structure. aim of the study this study aimed to analyse interpretively the results of qualitative studies that focused on the contextual factors relevant to the experience of unemployment and to determine how these factors affected experiences of unemployment. research design research approach to reach a broad and nuanced understanding of the lived reality and ascribed meaning of the experience of unemployment within the context of various countries, it was deemed necessary to source qualitative interview studies published in peer-reviewed articles. these documents are valuable resources to supply information on how interviewees experience unemployment in their context (prior 2011). furthermore, it was considered essential to review the findings of selected qualitative studies and to access direct quotes of interviewees. this design enabled the researchers to include unemployed individuals from different countries to ‘hear the voices’ of these marginalised, vulnerable, and often voiceless people across the globe. the philosophical assumption of the researchers was that sense-making and a deep understanding (‘verstehen’) in the context of a phenomenon had to rely on the participants’ views. therefore, this phenomenological document analysis study was executed in the framework of social constructivism (creswell & poth 2018; tracy 2013). research method given the goal of this systematic literature review, the authors performed a meta-synthesis: an integration of interpretive data sourced from qualitative research (onwuegbuzie & frels 2016). a review of qualitative studies was needed because qualitative studies are most suitable for ‘studying contexts which […] can uncover salient issues and […] provide insight into marginalised, stereotyped or unknown populations’ (tracy 2013:5). the search for relevant studies was done through web of science and ebscohost. for the search using web of science, three sets of keywords were used. the first set was as follows: ts = (‘qualitativ* research’ or ‘qualitativ* study’ or ‘ethnographic* research’ or ‘ethnographic* study’ or ‘narrativ* research’ or ‘narrativ* study’). the second set was ts = (‘job los*’ or unemploy* or ‘out of work’), with the third being ts = (culture*). the search was tailored to limit the results by choosing the disciplines of psychology, sociology, criminology, public and occupational health, social work, social sciences and behavioural sciences, family studies, religious studies, ethnic studies, anthropology, and urban studies. this process resulted in 123 studies. for the search through ebscohost, academic journal articles in english from econlit, psycarticles, psycinfo, and socindex were used. the subject terms search option was used, and the two subjects were ‘unemployed’ or ‘unemployment’ and ‘qualitative study’. the search results were made more focused on the aim of this study by choosing the age (young adulthood – 18–29; thirties – 30–39; and middle-aged – 40–64) and the method (interview; longitudinal; qualitative study; focus groups; and field studies). a total of 376 studies were identified through this process. the 123 studies from the web of science search and the 376 studies from the ebscohost search were compared, and the 116 duplicates, as well as 42 studies that employed mixed methods, were discarded. this resulted in 341 studies. subsequently, a selection process ensued on the grounds of inclusion and exclusion criteria. criteria for including articles were as follows: articles had to be published in english in peer-reviewed journals between january 2005 and december 2015. only qualitative research articles reporting results from data gathered by using qualitative interviews were used, so that the direct experiences of the interviewees could be tapped. participants in the studies had to be unemployed people. one of the study objectives had to include a focus on one or more contextual factors. the full-text article had to be accessible through the library services of either the north-west university or ku leuven. we applied one exclusion criterion, which was to disregard those articles with a strong focus on the relationship between physical health and unemployment. the second author reviewed the selection process, the selected studies, and the articles tentatively included, excluded or not yet decided on. a total of 12 studies met all the inclusion and exclusion criteria. because the original search did not produce a qualitative unemployment study in the south african context that met the above inclusion criteria, an additional search was conducted. for this search through the web of science, the first set of keywords was ‘unemploy*’ or ‘jobless’; the second search term was ‘south africa*’, and the third was ‘township youth’. the search resulted in three articles, of which one adhered to all the inclusion criteria stipulated above. finally, 13 articles were used for this review. table 1 depicts the context of each of the studies included in this review, the qualitative data collection method, and the sample size. table 1: country, qualitative data collection method, and sample size. research procedure attention was given to the more than 120 direct citations in the research articles as well as to each article’s discussions and findings (silverman 2011). to fully grasp the different contextual factors that have an impact on the experience of unemployment, the perspectives of the participants in these studies, as well as the interpretation and findings of the researchers, were considered. the first author mainly did the analysis. the first step of the analysis process involved a thorough synopsis of each article according to the research goal, the method used, findings, concepts or theories applied, and a list of the direct quotes. in the second step, flip-chart pages were put up on a wall to sort quotes under the three identified contextual factors. the third step was to take each contextual factor and identify themes for each of them. this was done by reading and rereading and then manually coding the direct quotes. this iterative exploration of the direct quotes resulted in themes (tracy 2013). the fourth step was to go through the findings of each of the 13 studies and add them to the relevant identified contextual factor themes. the fifth step was to have a panel discussion with the co-authors to corroborate the themes identified and to verify that nothing was missed. in the sixth step, the themes identified were cross-checked against each of the articles, and a structural description of the experience of the unemployed in their context was constructed. the use of such a systematic, iterative process ensured a rigorous analysis process and improved the credibility of the findings (silverman 2011). results next, the three identified parts of the context, namely the structure or culture of the broader society, the relationships, community, and environment, and, lastly, the individual agency, will be discussed. structure and culture of the broader society three predominant themes can be identified under this contextual factor. these are (1) unwritten rules or laws of society dictating the ‘normal’ and ‘right’ ways to live, (2) social stratification and socio-economic changes and realities, and (3) society’s ignorance and lack of understanding of the potential value of unemployed individuals as community care-contributing citizens. unwritten rules or laws of society to earn respect in society and to be seen as a contributing citizen, individuals should be employed; this is the national culture of countries such as the uk, the usa, china, canada, and south africa (björklund et al. 2015; fowler & etchegary 2008; giazitzoglu 2014; patrick 2014; sherman 2013). for a person to be a respectable and responsible citizen, they should be financially independent and should contribute to society through taxes and economic participation. this belief is so entrenched in the rhetoric of these countries that the unemployed themselves subscribe to this belief, causing them to become ashamed of, and disappointed in, themselves. governments, policymakers, institutions, the popular press, and the public perceive the unemployed as a liability and a threat to a country’s stability, progress, and image. unemployed people often experience a lack of care from broader society and political leaders (aldrich & dickie 2013; dawson 2014; mckenzie 2013; patrick 2014). senior politicians and respected media brand the unemployed as ‘morally bankrupt’ and ‘feral’ (mckenzie 2013:23). furthermore, they perceive the unemployed as lazy dependants who need to find formal employment as quickly as possible. consequently, the unemployed cannot rely on social sympathy and political support (mckenzie 2013; sherman 2013; sung-chan & yuen-tsang 2008). should a person be unemployed, it is expected of them to show definite and thorough job search actions or real efforts to upskill to become more employable. a strong work ethic is regarded as admirable and is rewarded (björklund et al. 2015; fowler & etchegary 2008; giazitzoglu 2014; patrick 2014; sherman 2013). in most cultures, masculinity and fatherhood are associated with the image of the provider of the family by way of an earned salary. unemployed fathers are, therefore, deemed to fall short of dominant sociocultural standards (dawson 2014; mckenzie 2013; nayak 2006; sherman 2013; strier 2014). there seems to be a convention in some societies that dictates that one shall be employed. therefore, a conceptual non-work stance is frowned on, and unemployed people are ostracised, shamed, stigmatised, and socially excluded. social stratification and socio-economic realities and changes change in the economic approach of a country may require new competencies and conduct from individuals. for example, research in the uk showed that change from a manufacturing-based to a service-based economy required new competencies of people. traditional work suited to tough and robust men during the industrial era has changed to service-sector and technology-based work, which requires individuals to be presentable, proficient in language usage, and client-oriented. this means that less sophisticated individuals who lack good social skills will battle to find a job in the more service-oriented economy (giazitzoglu 2014; nayak 2006). research from china provides an example of a change in economic approach that had a substantial effect on unemployment rates. change from a socialist economy, as reflected in systems such as the ‘danwei’ system (where a person was employed by a socialist state in a work unit for life, with limited choice), to a capitalist, free-market economy, was associated with challenges for unemployed people (sung-chan & yuen-tsang 2008; zeng 2012). people who would automatically have been employed in work units were now forced to compete for jobs in an open market. not used to this system, and not equipped or skilled, many people – women, in particular – became unemployed. unemployed women’s efforts to become self-reliant through entrepreneurship were viewed as a threat to community stability because such efforts were perceived as being against prevailing ways. these women were expected to improve their skills and enter formal employment (sung-chan & yuen-tsang 2008). officials in local government were, however, reluctant to support women to start businesses. some studies also shine a light on social-structural factors such as race, class, and gender (dawson 2014; giazitzoglu 2014; mckenzie 2013; nayak 2006; strier 2014; teti et al. 2012). classism has an impact on experiences of unemployment (dawson 2014; mckenzie 2013; nayak 2006). mckenzie (2013) illustrates how being unemployed and dependent on welfare benefits results in being classified as ‘underclass’ – that is, compared to the working-class. nayak (2006) states that unemployed young men trapped in generations of poverty, powerlessness, and unemployment are kept in place from one generation to the next through the class hierarchy. because of stigmatisation, disenfranchisement, and social exclusion over generations, opportunities to improve their situations are difficult to access (nayak 2006). black participants in the teti et al. (2012) study reported that they experienced daily struggles with racial microaggression. their perception was that society did not accept them, and that some people – white people, in particular – perceived them as being useless. in addition to classism and racism, gender discrimination is also prevalent in some societies. sung-chan and yuen-tsang (2008) report the effects of discrimination on unemployed women who had to fight a paternalistic sociocultural discourse to generate income and realise their abilities. society’s ignorance and lack of understanding society expects unemployed people to ‘do’ something with their time – to work towards greater employability (for example, to do volunteer work) or to actively apply for jobs. this expectation is unreasonable for two reasons. firstly, reality dictates that there are unemployed individuals who will never be able to obtain secure, stable employment that can take them out of poverty. secondly, many unemployed individuals are, in fact, ‘doing’ something with their time. they use their time to be creative in finding ways to survive and to render specific services in the community, which sometimes go unnoticed. there seems to be a lack of understanding in society of the fact that it is virtually inconceivable for many unemployed people to follow the so-called ‘normal’ route of school to formal employment (nayak 2006; giazitzoglu 2014; patrick 2014). both giazitzoglu (2014) and dawson (2014) found that the respondents in their studies chose to be unemployed rather than take demeaning jobs that would keep them in poverty. society tends to see these unemployed individuals as either too selective or too lazy to work. as a result, they feel misjudged, misunderstood, and frustrated because the inevitability of their situation is misconstrued and belittled. ignorance and a lack of understanding of unemployment keep society from realising that, for some individuals, it is virtually impossible to obtain employment due to a lack of social capital, a lack of opportunities, or a lack of skills (aldrich & dickie 2013; mckenzie 2013; patrick 2014; sherman 2013; strier 2014; zeng 2012). unemployed people stated that those in leadership positions were physically removed from them and did not acknowledge their lived experiences. patrick (2014), as well as aldrich and dickie (2013), describes surviving unemployment as a difficult task, requiring agency, ingenuity, and management skills. surviving unemployment can be time-consuming and typically includes activities such as collecting and selling scrap to get money and going to several shops to make sure that you pay the lowest price possible for day-to-day essentials. contributions such as caring for children, the sick, and the elderly and maintaining and forging social ties among neighbours and the community go mostly unnoticed (patrick 2014). relations, community behaviour, and environment communities, the spaces they occupy, and how they function in their unique sets of circumstances constitute another contextual factor with a direct impact on the unemployed individual (dawson 2014; fowler & etchegary 2008; mckenzie 2013; sherman 2013). three themes can be identified here: (1) disconnected places of exclusion, (2) non-cohesive communities, and (3) unwritten rules and laws of the community. disconnected places of exclusion unemployed individuals reported that they felt judged by others because they lived in areas associated with poverty, unemployment, and dependence on the government’s welfare benefits (dawson 2014; mckenzie 2013; nayak 2006; teti et al. 2012). dawson (2014) reports how participants described township space as a dead end where unemployed individuals desperately waited for change, which they hoped would bring an end to their confinement to township life. these spaces constitute disconnected places of exclusion far removed from ‘normal’ spaces where there is a more desirable life filled with options and facilities to access chances of developing (teti et al. 2012). non-cohesive communities and ‘othering’ in communities where the unemployment rate is high, where economic conditions are precarious, and resources are limited, competition sets in, and the community loses its unifying focus and strength. this often leads to a loss of cohesion in the community (dawson 2014; fowler & etchegary 2008; giazitzoglu 2014; nayak 2006; sherman 2013; teti et al. 2012). in a high-crisis community characterised by financial hardship, stigmatisation, and ostracism, groups turn on one another. two powerful dividing forces seem to be involved here: differences in ethics, social value judgements, and demographics (such as race, country of origin or ethnicity, or class). communities appear to be divided on grounds of differences in how they perceive and subscribe to specific ethical social values. one group of unemployed or precariously employed may try to make ends meet through informal and irregular income rather than claiming welfare funds. this group would rather face deprivation than apply for welfare aid. they look down on those unemployed individuals who are dependent and who are passively waiting for welfare benefits to survive without an income (aldrich & dickie 2013; björklund et al. 2015; dawson 2014; giazitzoglu 2014; mckenzie 2013; nayak 2006; patrick 2014; teti et al. 2012). then there is a group of unemployed people who do choose to claim social grants or welfare benefits. this group has negative experiences of a community that, to their mind, shows no compassion for people who may be incapable of survival without welfare benefits. these welfare-claimant unemployed people are ‘socially excluded’, ‘economically disenfranchised’, and ‘culturally despised’ (nayak 2006). in addition to the divide between groups not claiming welfare aid and those who do claim it, a divide exists within the group claiming financial aid. although individuals will themselves struggle with poverty and unemployment, it seems as if a type of social value judgement is applied according to which the self is viewed as of purer integrity than the ‘other’. nayak (2006) refers to this as a use of moral distinction to create symbolic borders between different groups of financially dependent people. personally burdened by a stigmatised label, many unemployed welfare recipients then discriminate between themselves and the ‘others’ who claim state aid – the ‘others’ being those deemed (by them) not deserving of this aid from state funds because they misuse the funds or they are cheating the system (fowler & etchegary 2008; giazitzoglu 2014; nayak 2006; patrick 2014; sherman 2013). groups classified by many in society as unscrupulously claiming welfare while not seizing all opportunities to work for an income are depicted in studies done by giazitzoglu (2014) and dawson (2014). unemployed men interviewed in these studies subscribed to a different value system from that of the groups discussed above. contrary to the values subscribed to by the group above (a strong work ethic), these men saw a low-paying, insecure, temporary job doing demeaning work as humiliating. therefore, they viewed ‘hustling’ (creatively securing income through illegal or underhanded dealings) as a better option. dawson (2014) illustrates how unemployed south african men would see many low-paying jobs as associated with social shame and how the men would rather remain unemployed than take up such jobs. communities sometimes become divided along racial and ethnic lines. for example, in the usa, african american unemployed people reported that society excluded and ostracised them (teti et al. 2012). sherman (2013) found that there was a common belief that specific groups, including hispanics, arabs, and eastern european immigrants, were dishonest and undeserving of the aid they were receiving. distrust among different groups comprised of different ethnic or racial groups can divide a community further (patrick 2014; sherman 2013; strier 2014; sung-chan & yuen-tsang 2008; teti et al. 2012). unwritten rules and laws of the community being unemployed can restrict and socially sanction social behaviour. one area where this is apparent is in the unemployed individual’s lack of the means and opportunities to reciprocate or repay financial assistance or sponsorship of social events. the principle of ‘you scratch my back, and i will scratch yours’ may be problematic for the unemployed individual (aldrich & dickie 2013; dawson 2014; zeng 2012). in times of financial need, it may be difficult to ask for, or receive, help from the community because of the expectation of repaying this ‘good deed’ when it may be the least affordable. dawson (2014) reports how relationships between men in a south african township are based on a set of social practices, of which the principle of reciprocity is one. even community activists know how to make use of this system by using unemployed youth to accelerate action through protest. in return, the leaders will give them opportunities to earn some extra money or promise preferential treatment if development were ever to occur in the township – termed ‘political entrepreneurialism’. in a group of friends, there is the unspoken agreement that those who are employed should help those who do not earn anything. the understanding is that every person will share what he or she has, even if it is just a small amount of money or a little food. wages should, thus, be enough to sustain more than one person (dawson 2014). in the chinese culture, there is strict adherence to the value of ‘guanxi’, which means ‘to reciprocate favour’ (zeng 2012). the unemployed will avoid social contact because of the social expectation of investing monetary funds to strengthen social ties and networks. because of an inability to do so due to lack of income, unemployed youth will not engage in social interaction. divisions in a community could also result from perceived imbalances in relationships between those with and those without resources. unemployed individuals do not feel comfortable around people who perceive them as needy and who may not understand their situation. this isolates them from a network of potential sources of information about opportunities to find work and alienates them from well-connected people (zeng 2012). unemployed individuals are cautious of owing anything to others because they lack the resources to reciprocate (aldrich & dickie 2013). another apparently accepted role with sanctioned social principles and values is the understanding that when people do not contribute to their community, they cannot earn the right to speak and voice an opinion on community matters. in the study done by fowler and etchegary (2008), being unemployed made men in a high-crisis community act passively, sit back, and let others speak for them; they seemed voiceless because they perceived themselves as not having the right to an opinion. this shows how being unemployed can render a person almost invisible in the community, without any voice or power. a further example is how unemployed women in china were rendered voiceless (sung-chan & yuen-tsang 2008). individual agency within an existing social structure the individual actively involved in, and in interaction with, the surroundings as a social agent and social actor constitutes the third part of the context (de souza 2014:148). confronted by unemployment, individuals react differently to available opportunities or constraints in their contextual reality. three themes can be distinguished: (1) making a choice, (2) constructing or joining subgroups to satisfy the need for social belonging, and (3) cultivating or constructing an own value system. making a choice two distinct views regarding choices in securing employment are evident. one view is that work is ‘normal’ and that a job offers more than financial gain (aldrich & dickie 2013; patrick 2014; sherman 2013; strier 2014; zeng 2012). according to sherman (2013), the aspiration of unemployed individuals receiving welfare aid was to be off welfare benefits one day because they saw their dependence on welfare as ‘not normal’ and undesirable. the unemployed weigh up the monetary gains of a job and compare these gains to what they earn through welfare benefits. participants also indicated that they would rather spend money they had earned through hard work than to have to spend money received from welfare funds. contrary to the previous view, dawson (2014) found that unemployed people would not accept just any job. low-paying jobs were regarded as socially undesirable because such jobs would not take them to where they aspired to be. promised rescue from a lower-class existence under a previous oppressing government, they were waiting to be given the opportunity to enter the perceived world of comfort and ownership of valuable consumer goods that the middle class enjoyed. from townships, they could see high-class urban residential areas and convenient amenities and services, underlining the fact that there were people with more comfortable lives. they placed a high value on consumerism to signify class and standing. constructing or joining subgroups to satisfy the need for social belonging it seems that unemployed individuals need a like-minded group; otherwise, they will become ‘weak nobody loners’ in society (dawson 2014; giazitzoglu 2014; mckenzie 2013; nayak 2006; strier 2014; sung-chan & yuen-tsang 2008; zeng 2012). because of their isolation from society, individuals value the ‘own’ group with its system of values, perceptions, and behaviour. shared experiences tend to bind individuals together: ‘we understand each other … she is unemployed like me’ (zeng 2012:90). being part of a subculture grouping gave the young men in nayak’s (2006) study meaning and a sense of belonging. the harshness and negative implications of the insecurity in the labour market and unemployment are mitigated by being part of a subculture. women in the study done by sung-chan and yuen-tsang (2008) could stand up against authoritative powers as a collective. on the street corners in the townships of south africa, the unemployed come together to be with those sharing the same troubles and challenges; they see this ‘ikasi’ (township) street corner social group as a type of ‘surrogate kin’. for some, these are the only people they feel understand the situation; they share in a collective struggle (dawson 2014). strier (2014) shows how unemployed people long for social belonging, especially in times of uncertainty and tension brought about by their situation of unemployment. individuals in the same position are experienced as being almost closer than family. although society has ostracised them, they find comfort in a like-minded group. giazitzoglu (2014) reports that, in their daily living in a community where the members despised them, the group of unemployed men in his study found kinship in the group (known in the uk as the ‘drifters’). the group, with their subculture in which different sets of values and norms applied, found validation for the logic behind their choice of the rejection of work, their anti-work ethic, and the ‘working’ of the welfare system. cultivating or constructing an own value system three examples can be identified of unemployed individuals cultivating their value system to cope with, or react to, their unemployment experience. firstly, ‘othering’ occurs to demonstrate welfare recipients’ discrimination against immigrants who are also recipients of state benefits (patrick 2014). participants in patrick’s (2014) study felt that immigrants took ‘their’ jobs and cheated the welfare system by claiming while working. sherman (2013) highlights how some unemployed individuals use ‘othering’ to see themselves as more deserving and of higher morality than those others who are in the same situation. it seems that, in reflecting the social stigmatisation they endure onto others whom they judge and criticise, they find some way of coping with their situation. a second example of an own value system constructed by the unemployed is the description of instances where people argue that all is fair when in survival mode – the end justifies the means (giazitzoglu 2014; mckenzie 2013; nayak, 2006). in the struggle to survive unemployment, one option is to turn to crime to make a living. the unemployed men in giazitzoglu’s (2014) study followed the already familiar path of the survival strategies of their unemployed fathers and went the route of making a living through so-called ‘streetwise labour’ – that is, a career in illegal business and crime. mckenzie (2013) also reports that a thriving underground criminal economy existed within the boundaries of the community she studied. success in making a living through illegal means gave one a particular value and standing in this community. a third example of how unemployed people deal with their situation by cultivating an own value system is to have a steadfast belief in a divine higher power. when overwhelmed by the challenges of poverty, strained family relationships, discrimination, and unemployment, unemployed individuals find solace in the belief that there is a god with a plan and that the situation in which they find themselves is part of god’s plan (teti et al. 2012). discussion this study aimed to explore the experiences of unemployed individuals from various contexts in different countries. through the integration and combination of these findings, three distinct fundamental aspects stand out that can aid in improving our understanding of the experiences of unemployment. irrespective of the country in which they are, unemployed individuals share three experiences. firstly, they experience the dominant perception of society and their communities as being that work-for-income constitutes a crucial and central part of healthy, responsible adult life. undeniably linked to this experience is the consequence of not complying with this ‘rule’ of society to earn an income through paid work, namely stigmatisation, resulting in emotional pain and shame. the second shared aspect is that the negative experience of unemployment is buffered when unemployed individuals are taken up in some kind of subgroup of individuals who share the same unemployment situation. the third conclusion has two sides. the first is that all the studies in this review found that unemployed individuals devised some strategy to deal with, or react to, their situation of unemployment. a surprising second side of this finding, however, is that individuals seemed to develop either constructive or destructive strategies to deal with the negative unemployment situation. these three principle conclusions will now be discussed and collated with the relevant literature. firstly, the results of this study indicate that unemployed individuals in all studies experienced pressure from broader society, as well as their communities, to conform to an acceptable code of conduct. this code of conduct dictates that unemployed people should never accept their situation and rely on welfare funds to assist them to survive unemployment because not to work is unacceptable. this observation reflects what ezzy (2001) has reported about the existence of a dominating perception that work equals life. in their study, shirani, henwood and coltart (2012) support this point of view by showing that a salaried occupation is seen as the predominant way to demonstrate adequate citizenship. rules governing so-called socially desirable behaviour, role expectations, and hierarchical class-structured societies result in a constructed world where a person without a job and few socio-economical means will find it almost impossible to fulfil their expected obligations as a member of such a society. as was emphasised by giazitzoglu (2014), nayak (2006), plattner and gonzo (2010), as well as spyridakis (2013), for individuals in precarious situations of inadequate education, low social capital, and long-term unemployment, it can be almost impossible to secure formal, well-paid employment. lifelong unemployment is highly likely for these individuals. therefore, it is crucial for our understanding of the experience of unemployment to realise that unemployed people need to negotiate constrained opportunities, while experiencing the reality that they will only be accepted by society and the community once they are employed. this scarring adds to the negative impact of the lack of financial independence with which the unemployed individual must already cope. in the face of this assumption that every person should work and contribute financially to the community, an inability to meet this expectation causes embarrassment and a feeling of worthlessness. the word ‘shame’ is quoted directly from the transcribed interviews with the unemployed in eight of the studies (björklund et al. 2015; dawson 2014; giazitzoglu 2014; patrick 2014; sherman 2013; strier 2014; sung-chan &yuen-tsang 2008; zeng 2012). a second finding was that unemployed individuals in almost all the included studies are positioned in relation to a specific subgroup. thus, although they experience their immediate environment and social ties to the community as mostly negative, they experience their self-constructed or organised subgroup as a type of psychological safeguard against the negative consequences of unemployment. this has a bearing on the relational, contextual aspect. the participants in the research done by strier (2014), for instance, described the men in the skills-training group as almost closer than family. various studies show how unemployed individuals desire some social belonging (björklund et al. 2015; dawson 2014; giazitzoglu 2014; mckenzie 2013; nayak 2006; strier 2014; sung-chan &yuen-tsang 2008; teti et al. 2012; zeng 2012). the third finding of this study concerns how the individual as a contextual factor exhibits their agency and actor status. individuals as actors and agents can make choices and cultivate an own value system in reaction to the impact of the influences of the other contextual factors, which are mainly experienced as negative. the actor or agent as a contextual factor is portrayed as a struggling, embattled individual, but with survivalist agency, who continuously tries to cope with their challenging situation without giving up. what is most thought-provoking is that certain individuals handle their situation of unemployment in a seemingly healthier, more positive way than others, who seem to engage in an almost destructive downward spiral. unemployed individuals who reported coping with their situation in a positive manner were all involved in an intervention programme of some kind (for example, the group of fathers in the studies done by björklund et al. 2015 and strier 2014; the men in the working-class group in the study by nayak 2006; and the group of women in the action research project in the study by sung-chan & yuen-tsang 2008) or were active in a religious church setup (the group of men in the study done by teti et al. 2012, who managed their precarious situation through religious activities). those unemployed individuals who reacted to their situation of unemployment by involving themselves in subgroups whose ostracism, stigmatisation, and segregation from society made them retaliate with deviant and socially unacceptable behaviour were generally without any respectful assistance or dignified aid from the broader society or community (for example, the communities in the studies by fowler & etchegary 2008 and patrick 2014, where the individuals turned on one another and generated conflict and social disconnection; the rioting and socially deviant groups in the studies of dawson 2014, giazitzoglu 2014 and mckenzie 2013; nayak’s under-class group 2006; the cultivation of a culture of crime in the study by teti et al. 2012; and the social withdrawal of the unemployed in the study of zeng 2012). the necessity of understanding the experience of unemployment to address the challenging situation in a respectful and dignified way, in consultation with the unemployed, is emphasised by this finding. communication of care and a thorough appreciation of the complex nature of the obstacles faced by the unemployed are crucial. it is essential to spread the notion in communities and society that the unemployment phenomenon is more complicated than simply expecting unemployed individuals to face this situation by themselves and to ‘just find a job’. spyridakis (2013) aptly describes the unemployed as: … living an indefinite downward spiral of material deprivation, trying to make ends meet in … off the books non-standard jobs, struggling to serve their status in social and cultural terms … attempting to survive by manipulating the cracks created by the state’s indifference and capital’s arbitrariness. (p. 241) a deep and nuanced understanding of the experiences of unemployment cannot be obtained without studying the impact of the various contextual factors. it is also necessary to consider the nature of the interaction or interrelationship among the different identified contextual factors and its consequences for experiences of unemployment. from the literature consulted, a graphical presentation has been designed to illustrate such interrelationships or interaction (see figure 1). figure 1: visual presentation of the contextual factors and the relationships among the factors. from the findings, the interrelationships among the three overarching contextual factors become apparent. as illustrated in figure 1, there seems to be a reciprocal relationship between the community or direct environment of the individual, on the one hand, and the individual as agent or actor on the other. the individual agent or actor has an impact on the community, and vice versa. how the individual copes with, or reacts to, their unemployment situation has a bearing on the community, and how the members in the community cope with, and react to, the unemployed person influences the individual and their experience of unemployment. a case in point is how the unemployed men in the studies of giazitzoglu (2014) and nayak (2006) experienced the disgust and contempt of the community surrounding them (community impact on the individual), but the unemployed men then retaliated by almost reinforcing what the community believed about them and destabilised the community through their non-conformist, perverse, and criminal behaviour (individual impact on the community). in contrast to such a reciprocal relationship between agent or actor and community stands the one-way relationship between the broader society and the other two main contextual factors. this was clearly illustrated by the fact that proof did not exist in any of the included studies that the broader society really understood the extremely complex nature of the experience of being unemployed. the influence and impact came from the broader society with its stratified groups, policies, culture, ethics, and ignorant attitudes that affect the community as well as the individual. there seems to be a barrier or a break in communication between the individual as well as the community on the one side and the broader society on the other side (see figure 1 where the arrows could not get through; communication is blocked). in the studies of both sung-chan and yuen-tsang (2008) and björklund et al. (2015), the unemployed are described as voiceless. it seems that if social scientists, researchers, and intervention programmes do not strengthen the collective voices of these people, broader society will not hear them. even from the community side, there is little evidence that this contextual factor has any real impact on the broader society. the broader society seems to have little to no understanding of the daily lived experience, struggles, or accomplishments of the unemployed person. social scientists should focus on breaking down the barrier to the broader society. the consulted literature highlights the critical role that contextual factors play in the impact on the unemployed individual (burger & fourie 2013; de witte et al. 2012; dieltiens 2015; griep et al. 2014; nell et al. 2015). this study raises intriguing questions about the nature and extent of the pressure on the unemployed to look for a paid job in formal employment, as well as the scarring effect of the lack of a nuanced understanding of the lived world of the unemployed person. limitations of the current study although studies from seven countries were included in this review, it could be seen as too limited. expanding the study to include more countries, especially developing countries, would be valuable. the ‘refutability principle’ (silverman 2011) was employed in this study; that is, the researcher went back to the consulted studies after the conclusions had been written down to see whether any study could refute the findings. it is recommended that quantitative studies be included in this ‘refutability’ process. the findings should be tested against quantitative studies from different countries, with a focus on the experience of unemployment. implications and recommendations for research future research should focus on the impact of the three main contextual factors, namely the broader society, the immediate surrounding community, and the individual as agent or actor, as well as their interrelationship and interaction. quantitative studies should be conducted to broaden the scope and to reach a more comprehensive conclusion on the role that contextual factors play in the experience of unemployment. research could specifically focus on how to assist government and policymakers to address challenges such as how to integrate the unemployed and poor in the centres of society, rather than in peripheral areas. also, intolerance towards, and misunderstanding of, the unemployed by the society should be studied. research should focus on how to strengthen cohesion, trust, and equality in communities. future research could also focus on best practices concerning welfare benefits – in terms of allocation, amounts, and recipients. most of the positive experiences involved close social ties with like-minded people in similar circumstances. when a specific meaningful goal or action was combined with this grouping, it transformed the experiences of unemployed people in a positive way (björklund et al. 2015; strier 2014; sung-chan & yuen-tsang 2008; teti et al. 2012). a suggestion would be to steer future research on the experience of unemployment in the direction of action research with groups of unemployed people assisted by professional social scientists. together, these groups and professionals could mobilise constant interaction with, among others, policymakers and leaders in the financial and media fields. implications and recommendations for practice professionals should focus on ways to guide unemployed individuals to find sustainable methods of occupying themselves outside the conventional job market. this process should be designed in a way that acknowledges the specific needs and capabilities of the unemployed. the importance of instrumental relationships would have to be acknowledged (zeng 2012). unemployed individuals should be empowered to build relationships with powerful people and forge linkages with individuals in the broader society. societies should promote a strong care ethic, as opposed to a work ethic (patrick 2014). such a mind shift would benefit south african communities and make them realise that there is space for people to do voluntary and caregiving work in communities. tolerance, empathy, and a greater understanding must be promoted (giazitzoglu 2014). creating and developing subgroups of unemployed individuals in a community could provide a support base for such individuals. efforts to address unemployment could start by empowering individuals in these groups to create community programmes in collaboration with powerful members of society in leadership positions. care and attention from ‘outside’ high-crisis communities would generate hope, expectation, and energy to positively influence others in these communities (fowler & etchegary 2008). acknowledgements we gratefully acknowledge the support of the flemish interuniversity council – university development cooperation (vlir-uos) for awarding funding that 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business was faced with the challenge of changing their traditional way of doing business to operate as a profitdriven entity. this research focuses on how privatisation has affected front-line service employees. both the front-line service employees and management were interviewed and included as cases to investigate changes that have occurred as a result of privatisation. these cases revealed that after privatisation front line service employees have received better training, appreciated a better system of communication, experienced a higher degree of empowerment and enjoyed an organisational culture that is more customer focused. the research, however, indicated lower levels of motivation, that employees do not appreciate an improvement in their reward system neither do they get feedback regarding their achievements and that they experience little job security. jel l16, 33 introduction this research analyses the effect of privatisation on front line service employees at a water supply organisation. the former government department was faced with the challenge of changing their traditional way of doing business to operate as a profit driven entity in the competitive market environment. the water supply organisation was faced with the challenge of shaping up to meet the service that the customer has come to expect in order to stay in business and to be ready in the face of globalisation. it is by satisfying customers that long-term success of a business can be guaranteed. due to the prevalent monopolistic situation in which the utility providers find themselves, rendering a quality service is an unknown phenomenon to customers. the customers have no choice but to accept this situation due to lack of sajems ns vol 7 (2004) no 1 2 mechanisms such as competition or effective consumer associations. competition could be effectively achieved through privatisation of the large public enterprises. in the next paragraphs an overview of privatisation will be given. thereafter the components of the service triangle will be outlined. to conclude the literature review, an overview of the business to be investigated, will be given. the intention of this article is to analyse the effect that privatisation had on the front line service employees. to investigate this, data has been obtained by means of a case study from two sources, the front line employees themselves and management. front line employees can directly comment on how privatisation has influenced them. management was included to obtain a broader perspective of how privatisation has impacted on the front-line employees. data analysis, conclusions and recommendations follow the discussion of the research methodology. literature review an overview of privatisation donaldson (1995: 03) defines privatisation as the transfer of ownership or control from public to private sector, which should be enough to give the private operators or owners, substantive independent power. lane (1997: 150), like donaldson, defines privatisation as the selling off of formerly publicly owned bodies to the private sector. martin and parker (1998: 172) point out that privatisation is popularly associated with a change from a bureaucratic, sluggish and badly managed organisation to one that is dynamic, entrepreneurial and customer focused. they stress that it involves cultural change and that the change in ownership leads to increased strategic choices, which in turn implies new forms of strategic implementation. donaldson (1995: 126) explains that for a public enterprise to privatise, it needs to go through two phases: first it should be corporatised, then commercialised. corporatisation is the creation of a state owned corporation by legislation. at this stage the emphasis stays with government because it is in control of the business. saunders and harris (1994: 134) define commercialisation as a process directed at establishing private sector management principles, values, practices and policies within private sector organisation. here the private sector will deliver the service while the business remains under the management of the public sector. during the pre-commercialisation phase, consumer dissatisfaction has manifested through non-payment of services. this lack of income, in turn, hindered the service sajems ns vol 7 (2004) no 1 3 provider’s ability to maintain the infrastructure and to respond to the demand for improved or extended services. martin and parker (1998: 186) argue that privatisation will lead to important changes in employment practices, including a much reduced role for trade unions as the union members change status from being ordinary workers to shareholders and focus their attention on increasing productivity and profitability. most privatised businesses have stated their desires to cultivate a consensus around the need for commercial operation and to move away from the ‘them and us’ mentality. this has been promoted through training and communications programmes and by encouraging staff to own shares in the business and partake in profit sharing schemes. employees also have increased managerial autonomy and a better remuneration. privatisation improves the managerial autonomy and initiatives while eliminating the political interference in the internal affairs of the business. this autonomy results in quick adoption and implementation of business principles, resulting in improved products and service (saunders & harris, 1994: 66). martin and parker (1998: 182) state that good leadership is an important factor in the successful adaptation of a business to changes in the external environment. it is top management that must aim to provide the new strategic direction by example and by implementing organisational and other changes which signal the new culture. privatisation would also lead to significant changes in the organisational structure. this would involve a movement away from a bureaucratic or mechanistic and functional structure towards a more organic and decentralised form, or away from a unitary (u-form) structure to one that is more multi-form (m-form) (martin & parker, 1998: 190). they also argue that, usually public sector organisations do not have the freedom that exists in the private sector to move into new areas of activity. privatisation is an opportunity for businesses to diversify and restructure with a view to repositioning both in terms of product range and geographical location. privatisation gives management a greater degree of freedom to develop new lines of business and close down old ones. a privatised business may use its freedom to restructure its business, diversify, merge and divest activities, and perhaps relocate operations. saunders and harris (1994: 55) argue that a privatised business is able to source funds from financial institutions for economically viable projects without the slow decision-making processes in government. donaldson (1995: 67) argues that privatisation does not benefit all people equally. there are often losers, at least in the short run especially when redundancies or loss of social assets are the key to improving efficiency and competitiveness. the short run social and political costs are often clearer than the long run overall economic sajems ns vol 7 (2004) no 1 4 benefits to the country, so many governments still hesitate to privatise. the political considerations involved in privatisation decisions usually require finding a way forward in which legitimate interests of effected parties are taken into account. saunders and harris (1994: 53) identify other forms of involving private sector participation in improving water and sanitation service delivery such as: service contracts service contracts are short-term commitments undertaken to address a shortage of a particular skill or for a specific project for which finance has been obtained. this type of service would include meter reading, design, construction of new projects, sewer cleaning and maintenance or the provision of staff for a short-term period to perform some particular function. with this contract, managerial control and funding is left with the public enterprise. management contracts management contracts are similar to the service contract except that it passes certain managerial responsibilities to the contractor. the services could involve the operation of the water works plant, the training of staff or the management of a water leakage control programme. the government owns the assets but the responsibility to source financing may be shared with the private sector business. the duration of such a contract can be from 2 to 20 years. this type of contract is being used in south africa, where government policy on privatisation is being formulated. renting of assets the rental (lease) contract enables the government to transfer the responsibility of operating a water or sewerage system to the private sector. responsibility may include the full operation and maintenance of a water works plant right down to billing of customers. such a contract is of a long duration, providing the contractor with the incentive to improve efficiency. new investments are the responsibility of government; thus this form of a contract should not be entered into without a detailed study beforehand based on a good knowledge of the system. customers are an obvious requirement for doing business, and the importance of customer service is emphasised by, amongst others, harris (1996: 2). businesses are fast realising that providing a product or service alone is not enough in today’s competitive economic environment. sajems ns vol 7 (2004) no 1 5 customers, services and customer service customers can be defined as individuals or businesses that provide revenue for your business (jenkins, 1997: 45). albrecht (1999: 38) defines customers as people or organisations who respond to a business presence by arriving at the doorstep ready to exchange money for goods or services. barlow and moller (1996: 3) on the other hand, argue that customer means not just the paying customer, but anyone who receives the benefit of goods and services, including patients in hospitals and students in schools. kotler (2000: 42) defines service as any act or performance that one party can offer to another that is essentially intangible and does not result in the ownership of anything. every service or product is designed for a user. it is therefore vital for the organisation to learn about the needs of its customers so that it can deliver the relevant products and services. customer services are secondary activities undertaken by an organisation to maximise customer satisfaction in its primary activities (peel, 1993: 26). these secondary activities include provision of information to customers before, during, and after sale; selling; order-taking and invoicing; packaging and presentation and finally, credit terms of payment and debt collection. according to harris (1996: 2) customer service is anything that is done for the customer that enhances the customer experience. harris (1996) argues that customers have varying ideas as to what they expect from customer interaction, therefore the service provider must know his or her customers, and strives to provide them with excellent customer service. kotler (2000: 45) defines customer services as a summary of all the activities involved in making it easy for customers to reach the right parties within the business and receive quick and satisfactory service, answers, and resolutions of problems. strong businesses are those that develop superior capabilities in this core process. for the purpose of this research, customer service will refer to the way frontline employees receive customers and how they deal with their requirements. this includes face-to-face dealings and excludes telephone encounters. the service triangle the service triangle is a customer-centered model created by albrecht (1999: 38) to emphasise the role of service systems, service strategies, and service people in a successful organisational program as indicated in figure 1.1. sajems ns vol 7 (2004) no 1 6 figure 1.1 the service triangle source: albrecht, 1999 figure 1.1 indicates that the service triangle has four parts that are interlocked and interrelated. each of the outer elements such as the strategy, the systems, and the people working together and separately to revolve around the most important member of the service triangle, the customer, will be discussed. customers albrecht (1999: 38) and harris (1996: 6) identify two types of customers namely, external and internal customers. external customers are the paying customers who come to a business from the outside. they respond to the business presence by arriving at the doorstep, telephone line, or mailbox ready to exchange their money for goods or services. internal customers are the people who work in the organisation and do business with each other. harris (1996: 6) argues that the idea of referring to employees as internal customers gives co-workers a sense of responsibility in the customer process. the importance of internal customers the importance of internal customers is overlooked by many businesses, particularly the small ones. harris (1996: 7) stresses the importance to the organisation’s success in providing the internal customer with the systems they need to do their work efficiently. if they do not see the importance of, for example, completing work promptly, and treating others with respect, it becomes difficult for the organisation to provide outstanding customer service to the external customers. any organisation that wants to serve the customer must start by making sure that the people who are “steering, fuelling, and cleaning the boat”, are having their own strategy systems people customer sajems ns vol 7 (2004) no 1 7 needs met (albrecht, 1999: 39). he insists that the way internal customers do business with one another affect the way they do business with the external customer. the front line service provider who can’t get help from the internal customers will not be able to effectively and efficiently serve the external customer. importance of the external customer the importance of the external customer cannot be overemphasised. external customers bring revenue for the business. this makes them potentially the most important strategic stakeholders. the volatility of revenue levels is driven by customer demand, and understanding these issues requires an understanding of customers and the nature of their situations (jenkins, 1997: 6). albrecht (1999: 30) describes the external customer as the lifeblood of any organisation. failure to notice that the health and happiness of the business relies on commerce, the exchange of money for goods and services would be a grave mistake that could see the business closing down. external customers may cost the business more to serve than is realised, as they may not be able to say what they want, or even worse, they may say one thing but behave in a totally contradictory manner (jenkins, 1997: 14). people one of the outer elements in the service triangle (see figure 1.1) is people. the service people should be the “right” people in the “right” jobs, doing the “right “things at the “right” time. albrecht (1999: 82) argues that the best products, the best location, the cleanest rest rooms and the lowest prices won’t mean anything if you’ve got the wrong people serving the customer. as the service people or front line employees are the crucial link between the customer and the business, it is important to ensure that they are satisfied with their jobs. this includes amongst others employee motivation, training and development, communication and rewards. employee motivation motivation is the willingness to exert high levels of effort toward organisational goals, conditioned by the effort’s ability to satisfy some individual needs (robbins, 1998: 168). mcshane and von glinow (2000: 66) argue that motivation refers to the forces within a person that affect his or her direction, intensity and persistence of voluntary behaviour. they argue that motivated employees are willing to exert a particular level of effort (intensity) for a certain amount of time (persistence) and toward a particular goal (direction). harris (1996: 84) simply defines motivation as the individual drive that causes us to behave in a particular way. it is clear from these definitions that motivation directly affects the amount of input that an sajems ns vol 7 (2004) no 1 8 employee is willing to put towards an organisational goal, and that the higher the level of motivation, the more the intended input. training and development training and development is a means to make every employee more valuable to the business by extending their skills and knowledge, modifying attitudes towards the job and adjusting patterns of behaviour in the organisation (pfeiffer, 1998: 76). given the problems with the sourcing and selection of staff, the training of front line employees must be absolutely vital. unfortunately, organisations often appoint employees to posts with extensive face-to-face customer contact without giving them training in the necessary customer contact skills. nobody is born with great service skills. service skills are a learned process, and what employees fail to pick up on their own through work experience, life experience, or on-the-job training, or in other less formal ways, the organisation has to give to them (albrecht, 1999: 210). he advocates putting all of the front line employees through a one-day workshop that explains the language and terminology of service management. this, he argues, helps them understand their role in the organisation and gets them to think in new and creative ways about how to best serve their customers. frontline employees need to be trained to have the attitudes, strategies, and skills of helping, fixing, and putting the customer's needs first. according to pfeiffer (1998: 182) training is an essential component of high performance work because organisations’ success relies on frontline employees' skill and initiative to identify and resolve problems, to initiate changes in work methods, and to take responsibility for quality customer service. gerber, nel and van dyk (1987: 75) mention that education, development and training are elements involved whenever a specific activity is undertaken to improve an employee's performance in an organisation. training, they argue, is a deliberate effort to teach specific skills and attitudes to serve a specific purpose. effective training is a learning experience activity, a planned business activity in response to identified needs. it is an attempt to further the goals of the organisation while simultaneously providing the opportunity for individual employees to learn and grow in the business. a well-trained work force according to harris (1996: 105) is one that is appropriately equipped to provide customers with excellent customer service. it is unfortunate that as time passes from the time of the original training session, some sajems ns vol 7 (2004) no 1 9 of the knowledge begins to be forgotten, especially if the learner did not have opportunity to use the knowledge frequently. training and development serves a dual role in the sense that it helps management meet its human resources requirements, while at the same time increasing the market value or marketability of those being trained. employees are encouraged to develop themselves to their full potential in the best interests of both the business and the employee. rewarding excellent service rewarding excellent customer service is a gesture of appreciation. albercht (1999: 173) argues that most employees will appreciate any gesture of appreciation, no matter what. he points out that recognition for one's accomplishment is an important motivator, and that it should, therefore, be used extensively. supervisors should, for example make sure that employees know that the supervisor is aware of employees' accomplishments. mcshane and von glinow (2000: 74) discourage the tendency by organisations to distribute the same reward, e.g. a salary increase or paid time off, to all employees with good performance. they argue that rewards that motivate some people have less effect on those with different needs. they therefore advise organisations to offer employees their choice of rewards. the result of a flexible reward system is that employees can create a reward package with the greatest value to them. the contemporary theories, unlike the early theories of motivation such as maslow’s, warn organisations against relying too heavily on financial rewards as a source of motivation. harris (1996) belongs to the same school of thought, and goes on to suggest several methods of encouragement that can be implemented to keep the enthusiasm of employees high. these programmes include recognition programmes such as extending the employee’s lunch hour, a personal note of thanks and giving the employee corporate tickets to a special event. albrecht (1999: 87) further suggests acknowledging the employee’s contribution in the company’s newsletter along with a picture. also, to afford the employee the opportunity to express his view on an important issue such as the running of the business and daily rewards such as praise especially when they go the extra mile. he also advocates non-financial and symbolic rewards to motivate employees. “a pay cheque isn’t enough; a pat on the back, a free lunch, an extra coffee break, a half-day off, or even a photo in the company’s newsletter can pay huge dividends for you, the employee who receives the accolade, and the other employees around him who see that hard work, good service skills, and concern for the customer are not only important here but worthy of reward” (albrecht 1999: 88). sajems ns vol 7 (2004) no 1 10 on the other hand, freemantle (1999: 116) challenges managers to come up with innovative rewards. he argues that deciding upon a reward is a creative opportunity for a manager to demonstrate appreciation in a unique way. he goes on to suggest that to reward successful employees, there must be an element of surprise, excitement and elation, that the process must be fun, inspirational, and motivating, as opposed to a bureaucratic chore run by personnel people, e.g. employee of the month awards. positive employee attitudes positive employee attitudes are a necessity in every organisation to keep customers happy and therefore see them return more business. freemantle (1999: 20) stresses the importance of positive employee attitudes. he argues that with sensitive and courteous handling, the few customers (about 1 percent) that behave in the most atrocious way, expecting the impossible and putting extreme pressure on the highly stressed front line employees, can become reasonable. he argues that positive employee attitudes are reflected in the simple things of life: a warm smile, a friendly word, a genuine display of interest, a sensitive glance, a welcome piece of unsolicited information, a thank you. he believes that they have a magical effect on customers, yet there is nothing magical about them. he further argues that all the sins of a defective support organisation, for example, excessive delays, an erroneous bill, faulty air conditioning system, can be forgiven by a customer, with a warm smile and real initiative used by a front line person. keeping in mind the fact that front line employees cannot display such attitudes unless they are fully supported by the other internal customers. management therefore has an important role in creating an environment that recognises the importance of internal customers. empowerment the idea of empowerment is a new approach that has significant implications in the customer service industry. as businesses continue to struggle to retain their current customers and to attract new ones, management is being challenged to look beyond traditional approaches, to empowerment, for instance. in customer service, empowerment is to enable or permit front line employees to make a range of decisions to assist their customers (harris, 1996: 52). front line employees are continuously faced with customer situations that are unique to the customer and that are somewhere beyond the boundaries of existing policies. through empowerment, front line employees are given the discretion to make decisions to assist their customers further. sajems ns vol 7 (2004) no 1 11 harris (1996: 53) continues to argue that empowerment is a true opportunity since front line employees who deal with many customers frequently know the solution to the most common questions and problems. if empowered, more time is available for the supervisors and for employees to handle the more unique situations and to be thorough with all of their customers. some utility organisations are empowering their front line employees by giving them the opportunity to hear a customer’s situation and be able to grant the customer a special payment arrangement. another way of thinking of empowerment in customer services is to empower the customer, a concept called co-production. harris (1996) argues that customers are often willing and interested in participating in the customer service process, and that co-production works because when customers participate in the process, they have some degree of ownership over the situation and they are not only contributing to the customer service experience but also staying occupied instead of feeling like they are having to wait endlessly or are being imposed on. the service strategy one of the outer elements in the service triangle (see figure 1.1) is strategy. the service strategy of a business should tell what the business is about and why it is in business or what it does for the customer (albrecht, 1999: 79). like albrecht, harris (1996: 44) argues that the most important step towards achieving excellent customer service is developing a service strategy. he argues that excellent customer service is not an accident but the result of a plan (strategy) that is well thought out. armistead and graham (1992: 37) add two features; clear objectives and a mission statement should accompany the strategy. the objectives set the targets for achieving the strategy, while the mission statement is a means of communicating it throughout the organisation in broad terms. the strategy and objectives may be presented within a business in a corporate business plan. the service systems another of the outer elements in the service triangle (see figure 1.1) is system. the service systems involve the way business are done and what is used to do it (albrecht, 1999: 80). all systems must be arranged to make it easier rather than harder for the service providers to help the customers, or for the customers to help themselves. armistead and graham (1992: 121) argue that for a business to deliver good service consistently there must be a service delivery system, which is designed rather than just evolved, and one that is designed bearing in mind the effect it has on the customer rather than the business. the design of systems requires, amongst others, to manage the link between front line staff and back room support. sajems ns vol 7 (2004) no 1 12 in order to change systems and make them user-friendlier, therefore more customer-friendly, albrecht (1999: 80) offers a few points: change at the front line level, for the most part, should come as a result of employee consensus, not because of some high and mighty management edict; sometimes its not the systems nor the way we do things that need changing, it’s the people who need changing; have a heart. humane people management is not a contradiction in terms. most people thrive on routine, stability and safety in their jobs, therefore drastic, overly frequent, or mindless changes should be avoided. an overview of the water supply business under investigation the water supply business was officially established in 1994. it took over the functions of an abolished government department. its main function is to provide water and sewerage services in the country. before commercialization, the government department was not run as effectively and efficiently as necessary. the demand on existing resources was too great and there was a need for rapid expansion of areas of supply and responsibility. failures were becoming apparent in the form of major water losses and disruptions of service due to the bursting of ageing pipes. the effluent from the wastewater treatment plants did not comply with the discharge standards prescribed by law. there were frequent water shortages in the low-veld, an area of the country that receives less rainfall. the quality of water needed improvement, and clearly, there was a need for the board to reduce the cost of the service. customer care was perhaps totally absent and consumer dissatisfaction was manifested through non-payment of services. this lack of income, in turn, hindered the service provider’s ability to maintain the infrastructure and to respond to the demand for improved or extended services. the estimated capital cost of remedying these deficiencies varied between r0.5 billion and r1 billion over a tenyear period. clearly, this amount of capital could not be supplied from government sources alone and not from financial markets unless the government department was operating efficiently and cost effectively, and the ability to recover costs was demonstrated. this called for commercialisation! after commercialisation, the business was faced with the challenge of changing their way of doing business to operate as a profit driven entity in the competitive market environment. to succeed in this endeavour, a focus on customer sajems ns vol 7 (2004) no 1 13 commitment cannot be over emphasised. as mentioned earlier, privatisation could bolster the customer service focus. the business appointed a new board of directors and is presently implementing a newly adopted strategic plan. whilst this is encouraging, there are limitations to this business in that government still has to make major policy decisions on retrenchments and sourcing of finance. the decisions to restructure has to have government approval and it cannot diversify or enter into mergers as the water corporation act of 1994 limits the business operations to water and sanitation. the business investment increased from r15 million to r43 million for the year 2000/2001 as a result of the implementation of projects that are outlined in the corporate plan of 1998 to 2003. the government, the world bank and business itself provided funds for the projects. the business had a net loss of r3.2 million for the 2000/2001 financial year. this loss was attributed to an increase in operating costs, loss of revenue as a result of closure of some major customers in the main industrial sites plus an increase in the cost of capital due to loan financing. the business plans to achieve excellence in the quality of service to its customers, meeting and exceeding customer expectations, by developing functions, roles and responsibilities for its employees, supported by appropriate technology and setting of standards which will reflect customers’ needs and expectations. its objectives are to: establish higher levels of customer satisfaction; establish higher levels of employee satisfaction; create enabling conditions for the overall contribution to improved performance of the business. the level of customer service or customer care clearly needs to be afforded some attention. the organisation’s attitude to customer needs is reminiscent of the past years, when people believed that the sole purpose of business was to make profit, when customers were a necessary inconvenience required to achieve this profit goal. it is only by satisfying the customers that you can guarantee the long-term success of your business. this business clearly has to address its customers’ needs and expectations to remain viable and this research will address this aspect. sajems ns vol 7 (2004) no 1 14 research methodology as the aim of this research is to investigate the effect of privatisation on front-line employees, a qualitative research method was employed. a case study method of research design has been selected for this research. it is dynamic and sensitive in capturing the complexity of action in the environment. the case study explores and probes in depth the circumstances of the organisation and the relation between organisational behaviour and its specific context. population and samples a population is the study object, which may be individuals, groups, organisations, human products and events, or the conditions to which they are exposed (welman & kruger, 1999: 18). saunders, lewis and thornhill (2000: 150) define a population as the full set of cases from which data can be sourced. cooper and schindler (2001: 769) on the other hand, define a population as the total collection of elements about which we wish to make some inferences. to collect information covering all aspects of the research question, data is sourced from two population groups. these are: the front line employees, and senior management of the organisation. the total population of the front line employees was used as cases, because it is a small population of thirteen staff members. this population was purposely selected because these are employees that are directly and constantly in contact with the customers. in selecting the senior managers to include as cases, purposive sampling was used. three directors were interviewed to gather information pertaining to the business and functional strategies on customer service. they include: director-operations, who is in charge of existing systems and managing the project teams director-hr, who is responsible for developing the skills required for employees, including the front line employees managing director, to get a feel of where the corporation will be in the next 5 years. the public relations officer was also interviewed to gather further information on customer perceptions of the business. sajems ns vol 7 (2004) no 1 15 data collection methods a structured questionnaire was used during the interviews with the front line employees and senior management. relevant organisational and managerial records, the policies, and procedures of the water supply organisation were also scrutinised. this was done to provide insight into the type of problems that existed in the organisation in terms of what the policies and procedures stipulated. this facilitated the compilation of the questionnaire used in the structured interviews. expert opinion was then sought to ensure the validity of the items included in the questionnaire (struwig & stead, 2001: 139). to ensure reliability in collecting data, special care was taken by the researcher to clearly explain the aim of the study to all respondents and ensure the confidentiality of their responses to the questions asked. this was done to enable the respondents to answer questions with honesty and objectivity. the research methodology provided a solid background to ensure that an in-depth analysis of the research problem could be made. research results the research results of the frontline employees on the evaluation of the components of the service triangle and interviews with management are outlined in the next paragraphs. results of the front line employees the results of the front line employees’ evaluation of the components of the service triangle, before and after privatisation, are provided in figure 1.2. the employees’ evaluation of the components of the service triangle as depicted in figure 1.2 revealed the following: service people figure 1.2 shows that employees appreciate an improvement after privatisation, in all the components, except in rewards. front line employees are also more motivated than before privatisation, receive more or better training, and appreciate a better system of communication in the organisation, a higher degree of empowerment and an organisational culture that is more customer-focused. it could be that employees do not appreciate an improvement in rewards because the sajems ns vol 7 (2004) no 1 16 executives and professionals are enjoying a much higher improvement in rewards after privatisation than themselves. figure 1.2 the results of front line employees’ evaluation of the components of the service triangle (before and after privatisation) 0 0.5 1 1.5 2 2.5 3 3.5 4 w ei gh te d m ea n sc or e m ot iv at io n t ra in in g c om m un ic at io n e m po w er m en t o rg . c ul tu re r ew ar ds st ra te gy sy st em s before after figure 1.2 further reveals a low improvement in motivation and communication levels since privatisation. though changes may be positive, they are rather small. management must rise to the challenge to make meaningful improvements to these components. further investigation on why the improvement in the two issues was so low, revealed that front line employees were motivated by public recognition before privatisation. the majority of respondents also believe that management does not give them feedback regarding their success and that they have little job security. nonetheless, the respondents feel that they are in the right job. this could be attributed to the fact that they have been trained only for this and no other job. a service strategy and system figure 1.2 indicates an improved customer service strategy and an improvement in service systems after privatisation. the improvement in these two components is, according to the employees, the most remarkable (largest improvement) since privatisation. sajems ns vol 7 (2004) no 1 17 results of the analysis of the responses of senior management the interviews with management were aimed at verifying the information obtained from employees. the aim of the interview with the assistant networks engineer was to gather information on changes in technology that have been put in place after privatisation, to address customer problems. for each customer problem put to him, the engineer first explained in detail exactly what the problem is or what it entails, and its causes, before explaining how the problem is addressed. it should be noted that management made extensive changes in support of its strategy to be customer focused. clearly, a lot of money has been invested in this exercise. the aim of this interview with the public relations manager was to establish if management has formulated a customer service strategy, and if so, whether there are systems in place to support the strategy. the main responses include that the organisation does have a customer services strategy, which is part of the overall strategy. it involves the decentralisation of operations in order to speedily and efficiently communicate customer problems, discuss them, make the necessary decisions, and implement them at regional level without involving headquarters. it was interesting to find that there are no major differences in the responses given by the public relations officer and the front line employees. they both acknowledged that a customer service strategy does exist, that employees are effectively informed of changes in the organisation, and that front line employees are trained to deal with customer problems effectively. however, employees are not as positive as management that they are indeed empowered. such discrepancies are normal since there are varying degrees of empowerment. one has to probe deeper to find out the extent of employee empowerment, and the extent of its adequacy. according to senior management the front line employees give feedback to the revenue administrator on a daily basis. discussions are held to analyse customer problems and come up with viable solutions. the organisation does indeed convert customer complaints to opportunities. classical examples include complaints on pipe breakages, brown or “dirty” water in a given area, unexplained high meter readings, and reduction in water pressure. the organisation does indeed have adequate systems in place to support the customer service strategy. it has increased investment on machinery after privatisation in order to facilitate the change from a previously labour intensive to a technology-intensive system. the organisation now has access to a wider range of sources of finance than when it was totally sajems ns vol 7 (2004) no 1 18 under government. senior management provided examples of newly acquired technology. there are no rewards awarded for outstanding performance. the organisation is, however, working on establishing annual performance related awards, which will be team based towards the lower end of the corporate ladder. the perceptions of the managers are not different from those of the employees themselves. both parties acknowledge that customer complaints are indeed converted to opportunities, that employees do give feedback on customer problems, that there are adequate service systems to support the service strategy, and that there are no rewards for outstanding performance at present. it is also encouraging that management has plans in the pipeline to introduce rewards for outstanding performance. conclusions this case study aimed to analyse the effect that privatisation had on front line employees. the level of motivation in the front line employees is unsatisfactory, even though it has improved somewhat since privatisation. the research conducted, confirmed that motivation is an essential component of high performance work because an organisations’ success relies on frontline employees' skill and initiative to identify and resolve problems, to initiate changes in work methods, and to take responsibility for quality customer service. the research also indicated that front line employees received better training, appreciated a better system of communication and received a higher degree of empowerment since privatisation. the research further established that employees do not appreciate an improvement in rewards because the executives and professionals are enjoying a much higher improvement in rewards after privatisation than they are. the majority of respondents also believe that management does not give them feedback regarding their success and that they have little job security. nonetheless, the respondents feel that they are in the right job. this could be attributed to the fact that they have been trained only for this and no other job. interviews with management revealed that the organisation has a customer services strategy that involved the decentralisation of operations in order to speedily and efficiently communicate customer problems. changes in the organisation are communicated to employees through written memos and circulars that are personally circulated by supervisors. front line employees are empowered to take decisions up to a certain level and trained to deal with customer problems sajems ns vol 7 (2004) no 1 19 effectively. lastly, the research established that there are no rewards for outstanding performance of employees at present. recommendations this case study aimed to analyse the effect that privatisation had on front line employees. the research recommends the following: • improving the employees’ working conditions, rewards, or training and developing them can improve employee attitudes. • management is advised to provide adequate training and development for its front line staff. training and development is vital to any organisation because it is a means to make every employee more valuable to the enterprise by extending skills and knowledge, modifying attitudes towards a job and adjusting patterns of behaviour in the organisation. inadequately trained front line staff can make customers lose confidence in the organisation or customers may hit back at the organisation by refusing to pay their bills timeously, thereby causing cash flow problems. furthermore, training and development serves a dual purpose in the sense that it helps management meet its human resources requirements, while at the same time increasing the market value of those being trained. this translates into higher levels of motivation. • management needs to improve employee motivation. motivation directly affects the amount of input that an employee is willing to put towards an organisational goal, and that the higher the level of motivation, the more the intended input. as with employee attitudes, employee motivation can be improved by improving the employees’ working conditions, rewards, or training and development. • recognition of accomplishments is an important motivator. management is advised to offer more rewards to customer services staff and further, to offer different rewards for excellent service to deserving candidates. • management is advised to foster a culture that recognises the importance of internal customers. the way the internal customers do business with one another affects the way they do business with the external customers. if the front line staff cannot get help from the internal customers, they will not be able to effectively and efficiently serve the external customer. sajems ns vol 7 (2004) no 1 20 • empowering customer service providers benefits everyone: customers don’t have to wait long while their situation is explained to a supervisor, the supervisors are left to do more important work, and the customer service staff is motivated to do their work. • management’s efforts to provide the necessary systems to support the service strategy are visible. the global information system (gis) has improved the efforts to locate customer meters, the computerisation of the customer service centers (revenue offices), the upgrade of the fault reporting system, etc. good service systems alone will not be enough. management must also focus on improving the other unsatisfactory factors, such as motivation, rewards, empowerment, training etc. references 1 albrecht, s. (1999) service, service, service. the growing business’ secret weapon, bob adams inc.: massachusetts 2 armistead, c. & graham, c. (1992) customer service & support. implementing effective strategies, pitman publishing: london. 3 barlow, j. & moller, c. (1996) a complaint is a gift, berrettkoehler publishers: san francisco. 4 cooper, j. & schindler, d. (2001) business research methods, mcgraw hill: boston. 5 donaldson, d. (1995) privatisation. principles and practice, the world bank and international finance corporation: washington d.c. 6 freemantle, d. (1999) incredible customer service, mcgraw-hill: london. 7 gerber, p. d., nel, p. s & van dyk, p.s. (1987) human resources management, southern book publishers: pretoria. 8 harris, e. (1996) customer service. a practical approach, prenticehall: new jersey. 9 jenkins, m. (1997) the customer centred strategy, pitman publishing: london. 10 kotler, p. (2000) marketing management analysis, planning, implementation & control (9th ed.) prentice-hall: new jersey. 11 lane, j. (1997) public sector reform. rationale, trends and problem, sage publications: london. 12 martin, s. & parker, d. (1998) the impact of privatisation, routledge: london. 13 mcshane, s. & von glinow, m. (2000) organisational behaviour, mcgraw hill: boston. sajems ns vol 7 (2004) no 1 21 14 peel, m. (1993) customer service: how to achieve total satisfaction, kogan page: london. 15 pfeiffer, j. (1998) the human equation: building profits by putting people first, harvard business school press: usa. 16 robbins, s. (1998) organisational behaviour (8th ed.) prentice hall: new jersey. 17 saunders, p. & harris, c. (1994) privatisation and popular capitalism, open university press: buckingham. 18 saunders, m., lewis, p. & thornhill, a. (2000) research methods for business students (2nd ed.) prentice hall: london. 19 struwig, f.w. & stead, g.b. (2001) planning, designing, and reporting research, pearson education: cape town. 20 welman, j. & kruger, s. (1999) research methodology for the business and administrative sciences, oxford university press: cape town. 21 zwane, z. (2000) ‘the effect of privatisation on customer services at swaziland water services corporation (swsc)’, unpublished mba dissertation, milpark business school, johannesburg. abstract introduction literature review and hypothesis development data and model specification findings and discussion conclusion acknowledgements references about the author(s) tapiwa dube department of financial management sciences, faculty of economics and management sciences, university of pretoria, pretoria, south africa leon m. brummer department of financial management sciences, faculty of economics and management sciences, university of pretoria, pretoria, south africa john h. hall department of financial management sciences, faculty of economics and management sciences, university of pretoria, pretoria, south africa mpinda f. mvita department of financial management sciences, faculty of economics and management sciences, university of pretoria, pretoria, south africa citation dube, t., brummer, l.m., hall, j.h. & mvita, m.f., 2022, ‘relationship between black ownership, capital structure and company performance’, south african journal of economic and management sciences 25(1), a4419. https://doi.org/10.4102/sajems.v25i1.4419 original research relationship between black ownership, capital structure and company performance tapiwa dube, leon m. brummer, john h. hall, mpinda f. mvita received: 25 oct. 2021; accepted: 25 apr. 2022; published: 04 july 2022 copyright: © 2022. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the notion that a company’s ownership structure may affect performance and capital structure has been the attraction, but few studies have looked at the effect of black ownership (bo). aim: this paper contributes to the literature by examining the possible interactions between bo, performance, and capital structure. within an agency cost framework, the study indicated that the distribution of equity ownership among black shareholders might significantly influence the performance and leverage of companies listed on the johannesburg stock exchange (jse). setting: altogether 187 companies on the jse were selected for the period of 2007 to 2014. method: data on the sampled companies were sourced from the iress database, a prominent source of financial data in south africa, as well as annual reports. the research used a pooled fixed-effects model, random effects model and two-step generalised method of moments in the analysis. results: the findings of the research provided support for the agency cost theory. the empirical findings indicated that bo was negatively correlated with debt ratio (long-term debt) and performance (tobin’s q [tq]). surprisingly, bo was positively and significantly correlated with return on assets. finally, the empirical findings indicated that the proportion of long-term debt and total debt based on market value was lower for bo than for total ownership, while tq was higher for bo than for total ownership. the finding supports the prediction that companies with a relatively small proportion of black ownership cannot support high leverage and high performance conclusion: although the introduction of bo by way of government intervention has been partially successful, more can be done to improve the relationship between the proportion of bo, performance and capital structure in a developing economy. keywords: black ownership; performance; capital structure, direct ownership; agency costs and developing economy. introduction the effect of ownership structure on a company’s capital structure, and therefore on company performance, was suggested for the first time in the agency theory of capital structure (jensen 1986; jensen & meckling 1976). according to this theory, there are at company level conflicting interests between managers and shareholders, generating agency costs (jensen & meckling 1976). more specifically, managers tend to prioritise personal gains, such as higher competitive remuneration and job security over the company’s overall welfare, as they do not stand to benefit from sharing in the profits. the need for shareholders to monitor the behaviour of these managers result in more agency costs. employing more debt to restrict funds available to managers is one strategy an organization may use to minimise managers’ inappropriate behaviour (jensen 1986). berger and di patti (2006) indicate that a high debt ratio forces managers to act in the best interests of the shareholders. the relationship between firm ownership structure and performance continues to attract the attention of scholars in the financial field (aluchna & kaminski 2017). previously, studies focused on ownership distribution and relationships between principals and agents, as illustrated in the conflict between shareholders and managers (aluchna & kaminski 2017; coles, lemmon & meschke 2012; kumar & zattoni 2014). subsequently, apart from the effect of a controlling shareholder and multiple large shareholders (jara-bertin, lópez-iturriaga & lópez-de-foronda 2008; maury & pajuste 2005), researchers dealt with the matters of concentrated ownership and concentrated control ownership (aluchna & kaminski 2017; hilli, laussel & van long 2013; krivogorsky & burton 2012; jara-bertin et al. 2008; maury & pajuste 2005) on company performance. in addition, the principal–principal conflicts have been indicated and highlighted in research on shareholders’ differences and their conflicting expectations in developing economies (su, xu, & phan 2008; young et al. 2008). it is worth pointing out that the classification of black ownership (bo), defined in this study as ownership by black ethnic individuals, is unique to this study and is important in the south african context. increasing bo in the economy’s private sector is government policy, instituted to redress the racial imbalances that existed prior to the country becoming a democracy in 1994. using the definition of direct bo, it was found that the proportion of direct bo out of the total ownership of companies listed on the johannesburg stock exchange (jse) presented a low 3%. indirect ownership, by way of membership of a retirement fund or any other fund, such as a unit trust fund, was therefore not included in the 3%. to better understand corporate governance models and their effects on companies’ strategies over the last three decades, researchers used the agency theory to provide an explanation of the correlation between ownership structure and performance (collin et al. 2013). according to saona and martin (2016), empirical studies on the impact of ownership concentration and ownership by different shareholders on company performance produced mixed findings. however, much is unknown of the effect of bo and performance in a developing market such as south africa, providing the authors with an opportunity to investigate how south african companies react to changes and allocation of rights in the structure of ownership. demsetz (1983) suggest that a change in the ownership structure of companies in developing economies is expected to create the company’s value (jones, kalmi & migind 2005). to the best of the authors’ knowledge, there has been limited research on the relationship between direct bo, performance, and capital structure in jse-listed companies. the objective of this study was to investigate the impact of bo on debt ratio and company performance of jse-listed companies. the paper fills the gap by investigating whether the structure of ownership, and in particular direct bo, could explain the changes in company performance and debt ratios. the remainder of the paper is structured as follows: the role played by ownership structure in performance and capital structure and the discussion of some of the control variables are presented in the second section, details of the data and the model specification in third section, while the empirical results are presented in fourth section with the summary in the fifth. literature review and hypothesis development black ownership, capital structure and performance black ownership and capital structure the relationship between ownership and capital structure continues to attract the attention of scholars in the financial field during the last couple of decades. jensen and meckling (1976) indicated that ownership structure must be defined as a capital contribution. therefore, jensen and meckling (1976) argued that ownership structure consist of inside equity (managers), outside equity, and debt, thus suggesting an extended form of ownership structure that goes beyond the debtholder and equity-holder perception (bokpin & arko 2009). however, ownership structure can be constructed, using variables such as foreign share ownership proportions, managerial ownership percentage, ownership of largest institutional shareholder, ownership of largest individual and equity ownership of government (zheka 2005). some authors suggest that ownership positively correlates with leverage (bajaj, chan and dasgupta 1998). according to brailsford, oliver and pua (2002), a well-diversified portfolio of assets investment is preferred by shareholders to minimise portfolio risk, based on the portfolio theory. however, because a large percentage of wealth comes from investment in non-diversifiable human capital relative to companies, managers will strive to achieve the same minimum level risk (brailsford, oliver & pua et al. 2002). according to crutchley and hansen (1989) non-diversifiable risks, lead to the reduction in welfare because risk-averse managers carry the burden of the unavoidable risk linked to the fortunes of the companies. to ensure the continuity of the company, the empirical findings by brailsford et al. (2002) suggest that when given an opportunity, managers decrease the company’s debt to lower the non-diversifiable employment risks (friend & lang 1988). prior research argues that the negative correlation between debt ratios and ownership structure suggest low agency costs which are associated with high ownership. this is in line with the findings by some authors (firth 1995; kocenda & svejnar 2003; nivorozhkin 2005). in contrast, other authors found a positive and significant relationship between debt ratio and ownership concentration (céspedes, gonzales & molina 2010; huang & song 2006). the positive relationship is supported by the narrative of failure to protect minority shareholders resulting in companies choosing debt as a financing source to the detriment of equity, because the new equity issue might imply the loss of company control. the introduction of bo, by way of government intervention, in subscribing the number of black employees, as is the case in south africa, may increase the opportunities available to a company suggesting an inverse relationship between the level bo and the capital structure, because south african companies may not need to borrow as they will be generating more revenue. in addition, if the lenders observe that the equity of a company is encumbered and subject to covenants, which may lead to higher levels of risk, they will either increase the interest rate or not lend to the company at all. in that case, the higher the bo of the company, the lower the debt the company is able to contract, suggesting an inverse relationship between the two variables (bo and the level of debt). in the context of a fraction of bo, the following hypothesis was formulated: h1: direct bo as a percentage of total ownership does not explain a company’s financing decisions. black ownership and performance according to aluchna and kaminski (2017), the fundamental assumption that ‘different ownership structures may result in different production possibility sets and performance’ informed studies on the relationship between ownership structure and company performance while the company’s institutional context could influence this relationship’s strength and direction (sánchez-ballesta & garcía-meca 2007). however, kapopoulos and lazaretou (2007) argue that research has found little evidence of a relationship between ownership structure and company performance. researchers focused on the separation of ownership and control which causes the principal– agent conflict and is heightened by the distribution of ownership structure (fama & jensen 1983; jensen 1986; jensen & meckling 1976). hilli et al. (2013) argue that costs generated by the conflicting interests between managers and shareholders are destructive in terms of the company value. hu and izumida (2008) suggest that medium concentration is likely to promote majority shareholder’s managerial engagement and generally has a positive effect on company performance, and in addition, medium concentration minimises the cost of coordination and increases supervision of opportunity-driven managers. minority shareholders may also benefit from improved performance and increased company value (maury & pajuste 2005). the agency theory expects a positive relationship between ownership concentration and firm performance in the case of high ownership concentration. there is evidence of lower agency costs and high firm value resulting from aligned interests between managers and shareholders. although some studies found no significant relationship between firm structure and firm performance, other studies found a positive relationship (shleifer & vishny 1986; stein 1989; thomsen, pedersen & kvist 2006), while a third group of studies found a negative relationship (aluchna & kaminski 2017). the overall effect of increased ownership concentration on firm performance is negative as it leads to an increased cost of capital because of declining market liquidity. the following hypothesis is formulated in the context of a fraction of blk structure as a percentage of ownership: h2: direct bo as a percentage of total ownership does not explain company performance. some of the control variables used in the study to overcome model misspecification are defined and explained in the following section. control variables company size: larger companies have a higher performance and are less likely to be bankrupt and may therefore contract debt more easily (bhaduri 2002; titman & wessels 1988). as a result, it is expected that the company size is positively correlated with debt ratio and company performance. company age: the age of a company is measured by the difference between observation year and establishment year. company age is used as a measure of the reputation in capital structure studies (abor & biekpe 2007). petersen and rajan (1994) argued that companies with higher debt ratios were more likely to be older, because they were supposed to be of a higher quality. the empirical results indicated that age correlated negatively and significantly with both total debt and short-term debt. age is also a measure of performance, and the empirical findings indicated that age positively correlated with performance (glancey 1998; lumpkin & dess 2001). this finding is supported by the explanation that older companies may enjoy the benefits of learning and experience, rely on a superior performance and a decrease in efficiency cost, while not being subject to all the liabilities of being new. liquidity: the trade-off theory suggests that an increase in liquidity will increase the ability of a company to borrow more, due to a high level of cash or liquid assets to service the interest and principal payment on time (shahar, adzis & baderi 2016). high liquidity ratios allow a company to have a high leverage ratio (debt as a percentage of total capital). this positive relationship is supported by some researchers (md-yusuf, yunus & supaat 2013; nadaraja, zulkafli & masron 2011). liquidity is also positively correlated with company performance (ayaz, zabri & ahmad 2021). the positive relationship liquidity and profitability suggests that companies have excess working capital for growth opportunities. this finding is supported by some authors (deloof 2003; goddard, tavakoli & wilson 2005; palazoo 2012; safdar et al. 2016). however, other researchers concluded that liquidity had a statistically significant negative effect on performance (eljelly 2004; jose, lancaster & stevens 1996; wang 2002) performance: each theory on capital structure states different relationships to company profitability. therefore, the ratio between debt and equity will differ (khan, bashir & islam 2020). for example, khan et al. (2020) argue that companies with positive earnings before taxes, should aim at higher debt ratios to benefit from tax shields as predicted by the trade-off theory. as a result, a positive relationship between leverage and profitability should be expected (khan et al. 2020). in contrast to this narrative, the information asymmetry and the pecking order theory, suggest that internal funds should be used first for companies with a positive income, because the market will not perceive this as a negative signal suggesting a negative relationship between the variables (khan et al. 2020). the majority studies in line with the pecking order theory suggested that profitability negatively correlated with debt ratios (hoque & pour 2018; sheikh & qureshi 2017; sheikh & wang 2013). leverage according to ayaz et al. (2021), the relationship between leverage and profitability has been at the centre of attraction for the past decades. researchers suggested three theories (the trade-off theory, the pecking order theory [pot], and the agency cost theory) which explain the relationship between capital structure and company profitability. these theories take different views on explaining the relationship between the capital structure and company profitability (ardalan 2017). for instance, the trade-off theory suggested by kraus and litzenberger (1973) argues that a company will create a balance between costs and benefits by using debt financing. as a result, managers are interested in increasing the use of leverage, which eventually maximises company performance, suggesting a positive relationship (ayaz et al. 2021; zeitun & saleh 2015). on the other hand, the pot proposed by myers and majluf (1984) indicates that a company prioritises its funding sources from internal (retained earnings and depreciation) to external (debt) and to equity, suggesting an inverse relationship between debt ratios and performance. data and model specification sample to investigate the effect of bo on performance and capital structure, data were sourced from the iress database, a prominent source of financial data in south africa, and annual reports for the period 2007–2014. this period is characterised by the 2008 financial crisis. one hundred and eighty-seven jse-listed companies, without any significant gaps over the sampled period, were selected from eight sectors (the basic materials, consumer goods, consumer services, healthcare, technology, telecommunication, industrials, as well as oil and gas). therefore, the data consisted of a panel of 187 companies observed over an 8-year period providing a total of 1496 observations. winsorisation was applied to the data at the first and 99th percentiles to minimise the problem of outliers in both cross-sectional and panel regressions. model specification the study was a deductive model based on an in-depth analysis of cross-sectional and time-series pooled data from the audited annual reports of jse-listed companies. it was also a causal study because it sought to demonstrate the effect of bo on performance and capital structure. to investigate the relationship, the research used fixed-effects and random-effects models. according to vieira, neves and dias (2019) panel data models have a number of benefits over other models. these advantages include greater variability of data, more information, more degrees of freedom, good control of the impact of omitted company’s, more accurate inference and greater control of the endogeneity (baltagi, bratberg & holmås 2005; hsiao 2007). however, according to some authors (ayaz et al. 2021; gaud et al. 2005; le & phan 2017), the fixed-effects model may generate estimates that are biased and inconsistent because of the endogeneity. some authors (ayaz et al. 2021; ullah, akhtar & zaefarian 2018) argue that not only will the results be biased and inconsistent, but they will also yield misleading conclusion and unsuitable theoretical understanding. as a result, in the research a dynamic two-step generalised method of moments (gmm) estimation technique was used to alleviate the endogeneity problem and produce consistent estimates (bänziger 2018). to determine the empirical impact of bo on capital structure and performance following prior research (ayaz et al. 2021), the following regression models are used: the variables are defined in table 1. table 1: definition of variables. findings and discussion descriptive statistics in this section, the results of the study are presented and discussed according to the literature review and the formulated hypotheses. table 2 provides a summary of descriptive statistics including minimum, maximum, mean, standard deviation, the 50th percentile and the 99th percentile values of all variables. the three measures of the capital structure (short-term debt, long-term debt and total debt based on market value) recorded overall means of 26%. (0.255), 14% (0.143) and 36% (0.358) respectively and dispersed from 0% to 91%, 0% to 65% and 0% to 100%. the finding suggests that most companies in the sample were more equity financed than debt financed. in addition, the finding suggests that south african companies listed on the jse used 36% of debt and were less indebted than companies in china (zou & xiao 2006), germany (abdullah & tursoy 2021) and vietnam (le & phan 2017). however, the debt ratio was higher than companies in france (lin et al. 2013). tobin’s q (tq) was 148% for the full sample. return on assets (roa) and return on equity (roe) recorded overall means of 10% and 12%. the performance measures indicated that south african companies performed poorly during the period 2007–2014. some of the reasons for the low ratios may be the 2008 financial crisis and low-rate participation of the proportion of bo. further, the market gap in performance was highlighted by maximum and the minimum. the average bo proportion out of the total ownership structure was 0.3% (029), suggesting that direct bo represented about 3% of the total ownership. the average company size in the sample was 6.239, calculated as the logarithm of total assets. the average age of jselisted companies in the sample was 25.037 years. the liquidity registered an overall mean of 2.189. the variable that presented the highest standard deviation is age. table 2: descriptive statistics of the variables used to determine the effect of direct black ownership on capital structure and performance. correlation matrix to check for multicollinearity problems, a correlation analysis was used. table 3 reports these results. the results in table 3 revealed that the coefficients were less than the value of 0.80, indicating that the variables were not highly correlated (ayaz et al. 2021). the correlation results show that debt ratios (short-term debt and total debt based), company size and roe had significant and inverse relationships with direct bo. performance measures inversely and significantly correlated with debt ratios. company age inversely and significantly correlated with the total debt ratio. liquidity negatively and significantly correlated with debt ratio. company size positively correlated with leverage and performance. this finding supports the notion that large companies have more assets for collateral and it is easier for them to negotiate better terms with lenders (butt & hasan 2009). table 3: correlation matrix of the variables. regression results to determine the effects of direct bo on debt ratios and performance, a fixed-effects model, a random-effects model and a two-step generalised method of moments were used. table 4 presents the results of the fixed-effects model (equation 1–3) and the random-effects model (equation 4–6) for the effect of bo on capital structure; table 5 presents the results of the fixed-effects model (equation 1–3) and the random-effects model (equation 4–6) for the effect of bo on performance. the fixed effect model is the best model for the interpretation and discussion based on the hausman (1978) test. the results of the two-step generalised method of moments are presented in tables 6 and 7 for the capital structure and performance, respectively, and their relationship with bo. many of the research results were virtually the same when using the different measures of capital structure and performance suggesting that the findings are robust and valid. furthermore, most of the coefficients estimated, had the expected signs and were significant. the results showed that bo was not significant in both the capital structure and performance equations in the fixed-effects and random-effects models. however, in the generalised method of moments, the coefficient of bo inversely and significantly correlated with long-term debt and tq. as a result, hypotheses 1 and 2 are rejected. this finding supports the prediction that companies with a relatively small proportion of bo cannot support high leverage and high performance. however, the negative relationship might have been caused by other reasons. for example, debt may be restricted to bo. surprisingly, the coefficient of bo positively and significantly correlated with roa. the coefficient of the dummy variable, bo and total ownership, indicated that the proportion of leverage was lower for bo than for total ownership. the dummy variable was insignificant in the performance equations in the fixedand random-effects models but significant in the generalised method of moments. this finding indicated that performance was higher for bo than for total ownership when the dependent variable was the tq. however, performance was lower for percentage of bo, than for total ownership, when roas was used as the dependent variable. profitability had a negative and significant relationship with all debt ratios, while long-term debt based on market value (llm) negatively correlated with all performance. the negative relationship suggests that south african companies prioritise their funding sources from internal to external, and debt to equity (ayaz et al. 2021). there was strong evidence that company size had a positive effect on leverage ratios and performance measures. the positive relationship may suggest that large companies may be more diversified and fail less often. age positively and significantly correlated with debt ratios and negatively and significantly correlated with performance. the positive relationship between age and leverage is in line with the narrative that older companies have higher debt ratios, because they feel somewhat obliged to present themselves as higher-quality companies, while the negative correlation between age and performance contradicts the notion that older companies are more experienced, enjoy the benefits of learning, are not prone to the liabilities of new companies and therefore enjoy superior performance and a decrease in costs. table 4: the effect of black ownership on capital structure (fixed-effects and random-effects models) of companies listed on the johannesburg stock exchange. table 5: the effect of black ownership on performance (fixed-effects and random-effects models). table 6: the effect of black ownership on capital structure (generalised method of moments). table 7: the effect of black ownership on performance (generalised method of moments). in the generalised method of moments, the empirical findings indicated that the coefficients of the lagged three measures of capital structure were positive, as expected. the adjustment coefficient of llm was relatively large (more than 0.5), possibly providing evidence that companies adjusted their debt ratio ratios faster to reach their target debt ratios. the cost of deviating from target debt ratios is a possible explanation for this adjustment speed. however, for short-term and total debt, the adjustment coefficient was smaller. the lagged coefficients of performance were positive and insignificant. the finding indicated that past realisation of performance was not significant in explaining future realisation of performance. the coefficient of company profitability inversely and significantly correlated with debt ratios. the findings also indicated that industry effects were significant in explaining financing decisions and performance in some sectors relative to other sectors. conclusion to explain the ownership structure, the capital structure and performance decisions, several theories were put forward. as a result, the relevance of these was sought empirically within an emerging market context. while empirical evidence of ownership, as a determinant of capital and performance, has been presented over the last decades, the impact of bo structure on debt ratios and performance in south africa remained under-researched. using panel data techniques (fixed-effects model, random-effects model and two-step generalised method of moments), this study sought to bridge the gaps by providing empirical evidence of the impact of direct bo percentage, out of total ownership, on performance and capital structure. the empirical findings revealed the direction and marginal effect of the impact of bo structure depended on the capital structure measures and performance measures. black ownership significantly and negatively influenced the choice of llm and tq. this study also observed other company-specific factors that were significant in predicting corporate capital structure and performance. age negatively and significantly influenced performance, while it significantly and positively correlated with capital structure. size positively and significantly correlated with capital structure and performance. companies listed on the jse may borrow more and generate more profit than their operational sizes increase. liquidity negatively and significantly correlated with capital structure. liquidity ratio positively and significantly correlated with performance. capital structure negatively and significantly correlated with tq. return on assets negatively and significantly correlated with short-term and llm. this research makes a number of contributions. firstly, it provides an understanding of how bo percentage affects performance and debt ratios. secondly, the research contributes to the debate by providing an understanding of how the proportion of direct bo, relative to total ownership, affects capital structure and performance. the study has various limitations. firstly, using secondary data, the research applied empirical methods to determine the impact of direct bo on capital structure and performance. to better understand the relationship between the variables, it is important for future research to use survey data or a combination of both. this will assist in understanding direct bo as a percentage of total ownership behaviour towards debt financing and performance decisions. secondly, many private companies and small to medium black-owned companies are not listed on the jse. their behaviour may be different from that of listed companies, especially in an emerging market such as south africa. as a result, it is important that future research considers such companies. acknowledgements competing interests the author(s) declare that they have no financial or personal relationship(s) that may have inappropriately influenced them in writing this article. authors’ contributions all authors contributed to this manuscript. ethical considerations this article meets all ethical standards for research without direct contact with human or animal subjects. funding information this research received no specific grant from any funding agency in the public, commercial or not-for-profit sectors. data availability data supporting the findings of this study are available from the corresponding author [m.m.] on request. disclaimer the views and opinion expressed in this article are those of the authors and do not 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https://doi.org/10.1016/j.bar.2006.04.008 sajems ns 12 (2009) no 3 353 issues surrounding the classification of accounting information huibrecht m van der poll department of management accounting, unisa daan g gouws department of financial management sciences, university of pretoria abstract the act of classifying information created by accounting practices is ubiquitous in the accounting process; from recording to reporting, it has almost become second nature. the classification has to correspond to the requirements and demands of the changing environment in which it is practised. evidence suggests that the current classification of items in financial statements is not keeping pace with the needs of users and the new financial constructs generated by the industry. this study addresses the issue of classification in two ways: by means of a critical analysis of classification theory and practices and by means of a questionnaire that was developed and sent to compilers and users of financial statements. a new classification framework for accounting information in the balance sheet and income statement is proposed. keywords: accounting information, attribute, classification, reclassification. jel m41 1 introduction classification plays a fundamental role in accounting science, so much so that the committee on terminology of the american institute of accountants (now aicpa) explicitly embeds classification in its definition of accounting, saying that accounting is “the art of recording, classifying and summarizing” (kam, 1990: 33). classification in accounting starts as soon as an event (such as a transaction) occurs, is observed by an accountant and is subsequently recorded. a transaction is first classified when it is recorded as a debit or a credit, after which it is classified as an asset, a liability, equity, income or an expense. this classification is evident in the fundamental accounting equation: assets = liabilities + owner’s equity. in this paper, we refer to groupings such as the asset, liability, equity, income and expense denotations as accounting classes because we attempt to develop a usable classification framework. they are therefore not referred to as elements of financial statements, as they are traditionally called when they are used uniformly by companies, and as is prescribed by general accepted accounting practices (gaap) and/or the international financial reporting standards (ifrs). a literature survey revealed a number of problem areas in the way in which accounting information is currently classified in financial statements. a questionnaire was developed to investigate the problems observed in the literature and this questionnaire was sent to a number of stakeholders. on the strength of the literature survey and the outcome of the questionnaire, we argue that a proper classification framework for accounting information needs to be developed. one possible approach may be to structure the information that is currently presented in financial statements differently in order to make the information more useful and accessible to all stakeholders. 354 sajems ns 12 (2009) no 3 the layout of the paper is as follows: in section 2, various aspects of the problem statement are analysed. in section 3, the research methodology that was employed is discussed. in section 4, the problem statement is set out, and in section 5, issues surrounding the classification of financial information in the balance sheet and the income statement (identified by means of the critical literature survey and the responses to the questionnaire) are discussed. section 6 contains a brief discussion of the synergy between the results of the research and accounting theory, while the proposed classification framework for the balance sheet and income statement is presented and discussed in section 7. the paper concludes with a summary and some pointers for future research in this field, in section 8. 2 perspectives surrounding the problem the perspectives surrounding the problem may be divided into three categories, namely • science, classification and accounting; • historical classification practices as a ritual; and • classification for the purpose of the user – the need to adapt. 2.1 science, classification and accounting the domain of science, which observes, classifies, quantifies, measures and analyses in order to create order from complex phenomena, is also applicable to the domain of accounting. in every science, classification is often one of the first activities to be performed. when one is comparing and classifying the variety of phenomena, structures, shapes and attributes in accounting, one can hardly take all the individual features into account – a few significant ones must be selected. classification is a human activity involving the identification of one characteristic or several characteristics which a number of disparate occurrences or phenomena have in common, and arranging them according to this characteristic or these characteristics. humans classify in order to identify the relationships between occurrences or phenomena and also to categorise the relationships between occurrences or phenomena and our own experience (goldberg, 2001). people essentially classify in order to understand, but through classification, they may also reduce or restrict the data. more comprehensive ways of classification may lead to the identification of other, more profound characteristics or relationships, which may prove more informative. 2.2 historical classification practices – habitual or not? the process of classification is one of the common activities of accountants since much of it may be done habitually (goldberg, 2001). one such example is the use of the current/noncurrent classification, which, according to foulke (1961), dates back as far as 1898. in the almost 20 years from 1898 to 1914, this classification became an established practice, and it is still in use, even though it is rather dated. classification continues to be a focus of research in accounting and has been debated since the early 1900s, (van der poll, 2007). the use of this now rather dated classification in modern times may have to be re-evaluated. as wolk, dodd and tearney (2004: 318) argue, “it is remarkable that the categoric[al] f r a m e w o r k u s e d t o c l a s s i f y a c c o u n t i n g transactions is virtually unchanged since pacioli’s time”. since the time of pacioli, which was the late 15th century (taylor, 1942), a vast number of changes have taken place in the industry and new types of transactions have been developed. although these new types of transactions have been included in the current framework (a framework which we regard as being outdated), they may have different attributes from the traditional transactions. the attributes of a transaction may also fit into two or more categories simultaneously, resulting in accounting hybrids. (in this paper, the term “attribute” is the technical name used for a property or a characteristic of an entity, for example, in the sense that a name is an attribute of a particular entity, namely a particular “person”.) sajems ns 12 (2009) no 3 355 2.3 classification for the purpose of the user – the need to adapt companies have to adapt their information systems and the types of information they use to manage the company (aicpa, 1994). there is an increasing risk that financial reporting may lag behind when changes (such as the introduction of new types of transactions, for instance, financial instruments) take place very rapidly, resulting in a failure to provide the relevant information that users need to make informed decisions. the aicpa (1994: 2) committee makes a clear statement about this threat: “today, more than ever, business reporting should keep up with the changing needs of users or it will lose its relevance.” it is therefore important to stay in touch with the needs of users when standard setters develop new standards for the reporting of financial information, and these needs should be taken into account when a classification framework for accounting information is developed. 3 research methodology the research methodology employed in this study can be divided into the following categories: • a critical analysis of classification theory and practices; • a questionnaire; • a content analysis of the balance sheet and income statement; and • an investigation of the necessity for a new classification framework for accounting information. 3.1 critical analysis to analyse the natural language arguments quoted in this article, critical natural language reasoning (nlr), as proposed by ryan, scapens and theobald (1992: 157-158), was employed. when reasoning about a claim, one normally starts with a premise or premises and then rationalises from the premise or premises to a conclusion. in the process, a number of assertions, justifications and explanations are formed, all aimed at justifying the conclusion (ryan et al., 1992). the analysis in this study focused on literature covering approximately the last 100 years, with reference to accounting statements and how they work. other disciplines, for instance, science, psychology and logic, were also consulted. 3.2 questionnaire a questionnaire was compiled based on the outcome of the critical analysis of the literature. it was sent to compilers and users of financial statements. the population sample consisted of 309 listed companies, eight analysts and 190 academics. in the case of most of the listed companies, the questionnaires were usually answered by the companies’ financial managers, who fulfil the role of compilers as well as users (when they make decisions). the remaining respondents indicated that they were users outside of their respective companies, namely, analysts. the questionnaire consisted of a total of 32 statements; and in this paper nine of these statements are reported on. in the discussion of the results for each of these nine statements, the claim made in the statement used in the questionnaire is presented, followed by an analysis of the responses from the participants. 3.3 content analysis a content analysis was performed on the financial statements of listed companies to establish current classification practices. a total of 93 companies formed part of the analysis, and only their balance sheets and income statements were used. in each case, the analysis covered company data spanning a period of three years. owing to the sheer volume of the data, it was decided to not analyse issues surrounding the cash flow statement as well. future work in this area could embark on an analysis of cash flow statements. the three year periods selected varied between the companies, depending on the availability of their year-end reports, but the analysis mostly included the data for the three years from 2003 to 2005. 356 sajems ns 12 (2009) no 3 3.4 new framework for the classification of accounting information ta k i n g a l l t h e a b o v e f i n d i n g s f r o m t h e questionnaire and the literature into account, the necessity for a new classification framework for accounting information was debated. 4 problem statement the act of classifying information generated by accounting practices is performed throughout the accounting process; from recording to reporting, it is almost second nature. the problem statement in this study centres on a number of issues, namely that the classification process • may become habitual and therefore subjective; • does not respond to the new financial constructs that have been created by in dustry practices, which contribute to accounting hybrids; and • does not keep up with users’ needs – different users may need different classifications to aid them in their understanding of complex accounting phenomena. furthermore, change influences accounting information and the usefulness of the financial statements portraying accounting information. l ev and zarowin (2003: 494) argue that “the increasing rate of change experienced by business enterprises, coupled with biased and delayed recognition of change by the accounting system, is a major reason for the documented decline in the usefulness of financial information”. according to lev and zarowin (2003), research and development (r&d) is often the primary driving force behind changes in companies, as it leads to the creation of new products and improved manufacturing processes. naturally, changes in terminology and accompanying systems also occur as a result of r&d. as change takes place, the classification framework for accounting information may need to keep pace with this change in order to report useful information. 5 issues surrounding the classification of accounting information in this section, perspectives mentioned in the literature on the current classifications of accounting information are presented. the subsections of the discussion are • different classifications for different purposes; • classification’s role in providing useful information; • how users may be misled by current classifications; • the inability to classify new developments; • classification challenges in the financial statements, namely the balance sheet and the income statement; and • the reclassification of accounting information at year end. 5.1 different classifications for different purposes users of financial statements often have conflicting needs. for example, the management of a company may require information in the income statement in a different format from that required by the receiver of revenue. however, sometimes the information content required coincides, even though the formats for presenting these could be different. this view is echoed by the ifrs (2004: 25): “while all of the information needs of these [differing] users cannot be met by the financial statements, there are needs which are common to all users.” stakeholders normally have different accounting and company backgrounds (hendriksen & van breda, 1992), and when classification and summarising occur, information and relationships valuable to certain users or groups of users could be omitted. developers of classification guidelines therefore need to take note of the informational requirements of all the users of financial statements. it follows that there are two possibilities for defining a classification framework for accounting information: sajems ns 12 (2009) no 3 357 • a first possibility is to try to accommodate all conflicting requirements by constructing a different classification system for different users in such a way that none of the requirements are in conflict with any other(s), given any one of these classifications. this would result in multiple classification frameworks for accounting information. • a second possibility is to construct a single classification framework for all users, recognising that not all requirements can be accommodated in such a framework. this is the approach followed in this paper and is briefly introduced below and is later expanded on. a comprehensive list of user requirements (including those that conflict with one requirement or several others) can be compiled through one or more joint application development (jad) workshops. in a jad workshop, all stakeholders come together and are consulted on what their needs are. ideas are then brainstormed by accountants, standard setters, users, and so on. jad is discussed in a number of texts, such as that by wood and silver (1995). once the various sets of user requirements have been formulated, these requirements can be merged into a larger set containing all the requirements. thereafter all those requirements that conflict with any other requirement(s) can be removed, leaving a comprehensive set of all the requirements without contradictions. a framework can then be constructed, based on the resulting requirements. conflicting requirements can be reported on as additional information to the financial statements of a company. an advantage of the jad approach is that a simpler classification framework for accounting information is likely to be created. a debate on the two alternatives mentioned above led to the formulation of statement 1 below, which was tested among the stakeholders who participated in the questionnaire. statement 1: a different classification system should be in place for different users analysis of results: statement 1 showed that the respondents were divided equally on this issue: 50 per cent of the respondents agreed with the statement. a flexible classification system may provide users with more information contained in the financial statements, as well as supplementary contributions (miller & bahnson, 2002). the respondents who agreed with this statement may be more open to the possibility that information portrayed in the financial statements may be useful to all decision-makers (via different classification systems), be they internal users (such as management within the company) or external ones (such as analysts). 5.2 classification’s role in providing useful information one of the goals of a user is to make decisions based on the accounting information portrayed in the financial statements. goldberg (1964) claims that this important function of financial statements – assisting users to make decisions – is often not performed, which implies, that this problem is evidently not acknowledged. the trueblood committee (wolk et al., 2004: 172) states that the “basic objective of financial statements is to provide information useful for making economic decisions”. an accountant is therefore faced with the task of supplying users with accounting information that will suit their needs. naturally, the information portrayed in these statements has to be classified in some or other way to satisfy these users; so, the challenge is to develop a classification framework that will best meet this need. accounting is also criticised by economists and analysts for not displaying useful information. according to lev (1974), economists view the financial information reported in financial statements as often being irrelevant to decisionmakers because there are serious inconsistencies between accounting and economic evaluation concepts. more recently, lev (2003: 520) again made a plea for the increased utility of information reported to users, writing that “it is widely recognized that the current accounting system does not convey relevant and timely 358 sajems ns 12 (2009) no 3 information about the value chain (business model)”. it is plausible that the quality of information could be enhanced through the development of a classification framework for accounting information. information that is relevant to users may assist them in making more informed decisions. decision usefulness is also emphasised by the financial accounting standards board (fasb, 2008a), when it states that those who provide capital to companies make use of the information reported in the financial statements for making decisions. decisions based on this useful information include whether capital should be provided to a company and whether the company has the ability to generate net cash inflows. therefore, it is important to request the opinion of capital providers when information is classified. users also indicated to the fasb (2008c) that they need additional information on financial assets that are transferred to enable them to make informed decisions, and they also need to know about the continued involvement of the transferor. by classifying only the most subordinated instruments as equity, the basic ownership approach distinguishes more clearly between the interests of different stakeholders. under current gaap, the interests of several different classes of stakeholders are commingled in equity (fasb, 2007). the way accounting information (such as accounts) is grouped into classes may influence its quality and usefulness. an example of such a class in financial statements is assets. when a group of ledger accounts are combined into a class, it makes sense to keep items with similar attributes together in one group to facilitate the classification of information in the financial statements. furthermore, it is plausible that the skill of the classifier plays a determining role in the quality of the groups or classes constructed. this argument led to the formulation of the following statement in the questionnaire. statement 2: the value of financial statements depends on the skill with which the ledger accounts are arranged into groups and classes (fitzgerald, 1938: 249) analysis of results: of the respondents, 64 per cent agreed with statement 2. this positive response shows that there is a fair amount of agreement that skill is necessary for the classification of financial information. the quality of financial statements depends on the quality of the information supplied (miller & bahnson, 2002), which in turn depends on the quality of the classification system used. one of the financial managers claimed that accounting statements are too complex, and that this means that less meaningful information is communicated to investors. it is hard to conceive of classification as being cast into a mere fixed structure, since it needs to be flexible enough (see the discussion in statement 5 below) to incorporate new items with new attributes. the accountant of the future has to be skilful and alert to opportunities for the reclassification of information as attributes change. to this end, lev and zarowin (2003) claim that information should be reclassified over time when, for example, a company has a restructuring exercise, to enable the statements to reflect economic reality. investors and other users need to make changes to the financial statements and the information they contain routinely to enable them to use such information for decisionmaking, according to the chartered financial analysts (cfa, 2005). a proposed classification framework addressing the needs of those who currently have reasons to reclassify information may lessen such reclassification needs. the preceding discussion led to the following statement in the questionnaire. statement 3: it is necessary to reclassify financial statements in order to reflect economic reality (lev & thiagarajan, 1991) analysis of results: of the respondents, 53 per cent agreed. the response shows that a classification of information and also a reclassification of information already published in financial statements might be necessary. new relationships may be revealed when sajems ns 12 (2009) no 3 359 reclassification takes place. economic reality is often a personal perception of each and every user. users need information to create their own economic reality and such information should be supplied by the classification system. reclassification may be necessary for some users and would normally be based on the information supplied by the classification system in use. 5.3 how users may be misled by current classifications users may often be misled by the information contained in financial statements. this notion is expressed clearly by riahi-belkaoui (2004: 364) with regard to the conventional accounting model: “its classification schemes are not always appropriate. the chart of accounts for a particular enterprise represents all of the categories into which information concerning economic affairs may be placed. this will often lead to data being left out, or classified in a manner that hides its nature from nonaccountants”. according to miller and bahnson (2002), information supplied in gaap financial reports often does not provide users with what they need – this may be due to the way in which the information is classified. the objective of financial reports is to provide useful information, but if the information is classified in a manner that hides the nature of the data or even omits data, this objective is not attained. this argument led to the following statement in the questionnaire. statement 4: the accountant’s classification may preclude or inhibit others from using much-needed information (goldberg, 2001: 42) analysis of results: of the respondents, 57 per cent agreed. this response indicates that there is indeed a need for the proposed classification framework for accounting information. wheatley (1993) points out that information is lost when it is collected and organised (in other words, classified), since the observer focuses on the accuracy of certain aspects and loses some information on other aspects that he or she does not focus on. a solution would be to draw up a balance sheet and to provide additional information to the users to enable them to make their own classification based on their own needs. 5.4 the inability to classify new developments accounting evolves continually as new types of transactions emerge. henderson and peirson (1994) point out that the form of accounting that was developed during the 13th and 14th centuries currently faces the challenge of new developments in business practices, the law and social attitudes. this was noted by wolk et al. (2004), who state that the framework that was used in the time of pacioli is virtually unchanged, although many changes have occurred in the industry since then. lev and zarowin (2003) also claim that the accounting system has a delayed recognition of change and this leads to the recording of information that is not very useful. accountants are therefore compelled to find new ways to classify new types of transactions and to compile reports within an accounting system that was developed in an environment very different from the present one. according to henderson and peirson (1994), opinions on how to handle new types of transactions vary considerably. examples of these new types of transactions include leases, company tax, inter-corporate investments and intellectual capital. any new classification framework that is proposed needs to be sensitive to possible future developments. to this end, using the attributes of a transaction gives the classification thereof a dynamic character and could, therefore, allow accountants to adapt to changes and new developments. the classification currently in use is based on a structure provided by wolk et al. (2004). this structure is based on the fundamental accounting equation (mentioned in the introduction) and is inherently static. since “structures” are intrinsically inflexible, it is hard to make (structural) changes. it is plausible that new kinds of transactions will introduce new attributes and relationships and that they may not fit into the 360 sajems ns 12 (2009) no 3 present classification structure. this may be the result of new transactions being forced into an existing structure. any classification framework for accounting information that is proposed has to be flexible enough to accommodate new kinds of transactions, possibly by incorporating the notion of time and moving beyond mere static structures. the perceived inadequacies of the current classifications led to the following claim in the questionnaire. statement 5: new types of transactions emerge continually, rendering the current classification system inadequate analysis of results: in this instance, 37 per cent of the respondents agreed. two main groups of responses were received, namely, those who believe that new kinds of transactions will not fit into current static structures (37 per cent), and those who believe that the new items should be forced into an inadequate structure (47 per cent). the rest of the respondents were undecided. the relatively higher percentage of respondents willing to maintain the status quo could be attributed to the human trait of resistance to change. the fasb (2003) opposes the creation of new classes, because it argues that before fas150 was issued, the statement of financial position classified certain financial instruments between the liabilities and equity section. concept statement 6 (below) does not permit classification outside the classes of assets, liabilities and equity. if an item does not fit into a class, that would require the board to define a new element (in the traditional sense) in the financial statements. however, the board has decided not to follow this course of action, partially because, among other concerns, an undesirable precedent would be set whereby classes are added whenever new instruments that are difficult to classify are developed. in essence, therefore, the fasb (2003) warns against following the apparently easy route of simply classifying an item into a new class whenever it becomes difficult to choose between equity and liabilities. however, the fasb’s classification rests on the current accounting equation, which may need to be revised to include a new class or new classes. the fasb (2007) also points out that although some problematic aspects surrounding the classification of accounting information have already existed for a number of decades, they are becoming increasingly contentious. the issue the board addresses is that of the classification of financial instruments, because the problem has become more prevalent since new and more complex financial instruments have been introduced and, as a result, current accounting classification and practices which were developed for relatively simpler financial instruments have become outdated. therefore, a new classification system should be able to accommodate new transactions as and when they are developed. 5.5 classification challenges in the financial statements the results from the content analysis suggest that companies follow the guidelines supplied by gaap and the ifrs very strictly. the static structures which we know as the balance sheet and income statement are followed almost to the letter, with some deviations in terminology. the balance sheet the balance sheet is a summary of various activities within a company. this view is shared by littleton (1958: 81), who claims that “the balance sheet is not a clear cut report on financial stewardship”. his argument is based on the fact that the balance sheet contains a combination of results from the financing as well as operating activities of a company. the balance sheet is therefore “not very informative about either one separately”. hendriksen and van breda (1992: 468) appear to support this claim when they state that “as a device for describing the operations of the firm, the current/non-current classification is defective”. an example of the point made by hendriksen and van breda (1992) is found in interest receivable, which does not arise from operating activities of the company. hence, the balance sheet may need to separate the financing activities from the operating activities. sajems ns 12 (2009) no 3 361 according to the fasb (2008a), the information supplied in financial reports should be useful in the assessment of the stewardship of a company. the management of a company is held accountable to the stakeholders, who provide capital to the company for the custody and safekeeping of the economic resources and for the way the capital is applied. the present classification system for accounting information results in accounting hybrids, in other words, items which do not wholly fit into any specific category. these hybrids have attributes which result in their possibly being classified into more than one group, but they do not have all the qualifying attributes to be classified into any one of these groups exclusively. in the balance sheet, the categories assets and liabilities are currently used, but there are items in the balance sheet which fall into neither of these two categories, as fitzgerald (1936) already observed. sprouse (1966: 46) calls some deferred credits in the balance sheet “what-you-may-call-its”. these are • purchasing a company at a cost less than the book value of equity acquired; • gains arising from sale-and-leaseback transactions; and • deferred investment credits. the above accounts represent items that are difficult to classify under the normal classification rules of accounting, because they have attributes of more than one class. the work of both fitzgerald (1936) and sprouse (1966) is now dated, but their claims are still valid, as the fact that these views are shared by goldberg (2001) shows. it follows that current classifications for accounting information ought to be revised to include these “what-you-maycall-its” or accounting hybrids. giving special consideration to the attributes of items could be a way forward to alleviate the problem of accounting hybrids. there is, furthermore, an ongoing debate as to whether some financial instruments should be classified as equity or as liabilities when they possess characteristics of both. the fasb (2003), in fas150, provides some guidelines in this regard, but there are some researchers, such as clark (1993), forker (2003), balsam (1994), bohan (2003) and kirschenheiter, mathur and thomas (2004), w h o h a v e a l l q u e s t i o n e d t h e o u t c o m e s of these guidelines. some of the items in question have attributes of both equity and liabilities. hence, the possibility exists for the creation of an entirely new class in which such items may be placed, since items classified together need to have the same attributes, and should not share attributes of two or more different classes. recently, the fasb (2007: 16-17) decided that the complexity of the reporting of financial instruments should be simplified and suggested that “the basic ownership approach” should be introduced, based on the same approach that is used for all derivatives that are classified as assets or liabilities. the discussion in this section led to statement 6 in the questionnaire. statement 6: classified facts may become distorted when unlike elements are classified in the same account (littleton, 1958: 45) analysis of results: this statement elicited a very positive response – 84 per cent of the respondents agreed. littleton is regarded as a “founder of [accounting’s] intellectual database”, as he did much for the development of accounting thought and theory (bedford & ziegler, 1975: 435). one respondent commented as follows: “clearly the summation of unlike items will lead to a dilution in the quality of the information.” a proposed classification framework for accounting information would be expected to classify items with similar attributes into one class, and those with different attributes into other classes. next we turn our attention to problems with the classification of items as current/non-current and working capital. the classification of items as current and non-current in the balance sheet has been a further area of critique for many years, judged by the work of gilman (1944), herrick (1944), kempner (1960), moonitz and jordan (1963), huizingh (1967), heath (1978), kam 362 sajems ns 12 (2009) no 3 (1990), hendriksen and van breda (1992) and wolk et al. (2004). the items currently classified together in the balance sheet do not originate from the same type of operations. for example, interest receivable and accounts receivable are grouped together as current assets. hendriksen and van breda (1992: 473) comment that “because of the difficulties regarding the interpretation of the operating cycle and because of the lack of evidence regarding the relevance of the current asset classification to any specific user’s needs, many believe that other methods of classifying assets should be investigated”. therefore, any proposed framework should address the problem of classifying current and non-current items. as before, paying attention to the attributes of a transaction could aid in the classification of current and non-current items. furthermore, including time in a proposed classification framework could, in a natural way, address the problem of categorising timedependent current and non-current items. according to heath (1978), the analyst is concerned with how much cash the company will receive and when, rather than whether the receivable is part of the working capital. the trueblood committee (wolk et al., 2004) also regards the supplying of information that can be used to predict, compare and evaluate future cash flows to be an objective of financial statements. as the working capital classification is part of the financial statements, it should provide the same information. this brings us to the next statement in the questionnaire. statement 7: working capital must be classified in terms of future cash flow realisation (heath, 1978: 73) analysis of results: a total of 65 per cent of the respondents agreed. working capital classification is not based on future cash flow realisation, since too many hybrids and evaluation methods are involved (schroeder, clark & cathey, 2005; wild, bernstein & subramanyam, 2001). the uncertainty of cash flows is based on the future, and there are degrees of uncertainty which lead to prudence. objective 3 in the trueblood report, referred to in wolk et al. (2004), recommends that useful information be provided to users for the prediction, comparison and evaluation of potential cash flows; this information should also enable users to take into account the amount, timing and related uncertainty of the cash flows. although the trueblood report may be dated – it was published in 1973 (wolk et al. 2004) – the recommendations of objective 3 seem reasonable and current, so much so that importance and relevance are attached to it in a recent work by wolk et al. (2004). most investment decisions are based on cash flow data, but accounting ratios are based on accrual accounting and not cash flow accounting (samuels, wilkes & brayshaw, 1999). it appears, therefore, that supplying information with regard to cash flows is much needed in order to assist users in making their own predictions concerning future cash flows. the fasb (2008a) also recognises the need for supplying useful information in the assessment of cash flow projects. they state that the capital providers of a company need information on the timing, amount and uncertainty of cash flows from dividends, interest and transactions surrounding securities or loans. these cash flows are, however, dependent on the current cash flow situation of the company and on the ability of the company to generate enough cash to pay their employees and creditors, and also on various other operational activities in the company. it is therefore very important to classify information in such a way that future cash flows can be predicted. furthermore, the fasb (2008b) also proposes that a company supply stakeholders with information regarding the likelihood, timing and amount of future cash flows associated with loss contingencies. these are recognised in the financial statements as liabilities. the income statement the financial health of a company can be measured by considering its cash flow. to be able to measure such financial or economic health, one needs to determine where cash is generated from, and how the company applies the cash (higgins, 2004). the income statement can supposedly be used to establish sajems ns 12 (2009) no 3 363 this flow of funds, but, as higgins (2004: 13-14) writes, “further reflection will convince you that the income statement is deficient in two respects”. the reasons he gives are that the income statement is compiled according to accrual theory, resulting in items being reflected that do not represent a flow of cash, and that only cash flows associated with the company operations are displayed, although there are many other cash receipts and disbursements that are absent from the income statement. since some items in the income statement do not reflect a flow of cash and non-operating cash flows are ignored, the classification of items in the income statement should, in our opinion, be according to • real cash and non-cash; and • cash flows associated with the operations, and cash flows not associated with any operation. the use of the point above in a classification system may reveal additional information to the users. sorter (1969: 17) claims that each event “should be described in a manner facilitating the forecasting of the same event in a future time period given exogenous changes”. the aicpa committee (aicpa, 1994: 33) suggests that “in an ideal world, the most relevant accounting data would be those that reported assets and liabilities in a way that would allow analysts to impute the future cash flows emanating from them individually and collectively”. the literature therefore seems to support the following statement, since (amongst other things) it may assist users in the prediction of future cash flows. statement 8: accounting information should be classified in such a manner that it facilitates the forecasting of future earnings and cash flows analysis of results: a total of 81 per cent of respondents agreed. analysts are concerned with a company’s future earnings and cash flows, and it would therefore be to the benefit of analysts if accounting information could be classified to facilitate this kind of forecasting. financial managers also need information about forecasting to enable them to make decisions about the future. in the trueblood report, one of the stated objectives of financial statements is the provision of information to investors and creditors in terms of the amount, timing and related uncertainty to enable the prediction, comparison and evaluation of potential cash flows (wolk et al., 2004). the aicpa (1994) suggests that management should supply enough information to enable users to perform their own forecasting of a company’s financial future. any proposed classification framework should facilitate in the forecasting of future cash flows and earning power. 5.6 reclassification of accounting information at year-end at year-end, companies perform a special classification exercise to display unrecognised classes of expense and revenue, which results in a reclassification and summation by the double-entry method (paton, 1962). littleton (1958: 56) argues that “the task of compressing a mass of transaction facts into an intelligible enterprise statement is too great to be fulfilled by initial classification”. initial classification, where data is classified into accounts at the time of recording (in other words, in the past, relative to the year-end) is based on kinds and qualities, whereas reclassification is based on fiscal periods or operating departments (littleton, 1958). in some instances, a preliminary classification of items is performed until a better picture can be formed as to where these items fit into the company’s activities. a clearer picture is obtained often because attributes that were not known at the time of recording become known at the reporting stage (in the present). in addition to the standard classification framework, clear guidelines should be provided to the accountant or the classifier for reclassification. the development of such guidelines warrants input from a number of stakeholders, which could be obtained through the use of jad workshops (see section 5.1). 364 sajems ns 12 (2009) no 3 each transaction has a set of attributes when recording (past) takes place. as time passes, these attributes may change, and when it is time to report (present) on this transaction the new set of attributes may lead to a new classification for this transaction. some transactions, for instance r&d expenses, may even have future benefits (lev, 2003) for the company, which will not be known at the time of recording, but which may be realised later and which may lead to a different classification. hence the following claim had to be verified in the questionnaire. statement 9: past, present and future-oriented recordings must be classified separately analysis of results: the response was mostly positive, as 57 per cent of respondents agreed. the respondents who disagreed may be inclined to think that, in practice, three different classifications would result in more complex reporting structures and a possible information overload. nevertheless, in accordance with statement 9, a proposed classification framework for accounting information may need to take time (past, present and future periods) into account; in other words, it may need to have a temporal component. 5.7 preliminary summary as is evident from the discussion of the responses to statements 1 to 9 above, present classification practices for accounting information do not supply useful information to the users of such statements, mainly because these structures may distort the information and may even mislead the users. present classifications may also fail to adapt to new developments, resulting in accounting hybrids – in other words, items that do not fit into one class only. the classification problems in the balance sheet – with specific reference to the current/non-current classification – are also of concern. the reclassification of accounting information at year-end needs clear guidelines. the outcome of the nine statements above also largely support the views put forward in the literature. all these criticisms suggest that a new classification framework for accounting information is called for. next, we present a brief discussion on the synergy between the results presented in section 5 and accounting theory. 6 synergy between the results of the research and accounting theory in the previous sections of this paper, the classification of accounting information was investigated by means of a literature survey to determine the issues which surround the classification of accounting information. a questionnaire was used to determine the validity of the thinking, and a content analysis was done on how information is classified in practice. several problems with the way accounting information is presented in financial statements were identified through the literature survey, and these views were largely supported by the outcomes of the questionnaire: seven of the nine statements that support views in the literature were agreed with, while one statement (statement 1) received a neutral (50 per cent) response, and one (statement 6) elicited a negative response. it is believed, therefore, that the current classification of accounting information requires revision. two important aspects emerged from the discussion of the problems with the way accounting information is currently classified: • the use of attributes of a transaction, when it is first recorded, as well as when it is reclassified later, may play an important role in (re)classifying accounting information correctly. • the introduction of a temporal component (time) to any proposed classification system for accounting information may further facilitate the usefulness of such a system. a temporal component will allow items to have past, present and future properties. sajems ns 12 (2009) no 3 365 next, we present a brief overview of a preliminary classification framework for accounting information. 7 towards a classification framework for accounting information one of the prerequisites for the classification of a transaction is the determination of the attributes of the transaction in question (nobes & parker, 2002; riahi-belkaoui, 2004) at the time of its recording. it is logical that only those attributes that are known at the time of recording can be taken into account. in this paper, such activity is called an initial measurement. an initial measurement is followed by an initial classification of the transaction when it is first recorded. in developing a classification system for accounting information, we make a basic assumption, namely, that reporting at year-end takes place in the present time. by implication, therefore, the recording of a transaction takes place in the past, while decision-making processes take place in the future, relative to the time of reporting. a comprehensive list of possible attributes for transactions was drawn up, and from this list a normative sub-framework, which is a table of valid attribute combinations known for transactions at the time of recording and reporting, was constructed. a user needs to work through the possible attributes of a transaction to establish the class and sub-class into which a transaction fits. the process can be repeated as new information or attributes become known as time passes until reclassification at year-end. an example of a normative sub-framework for the class assets in the balance sheet is given in table 1. table 1 extract from the developed normative sub-framework for assets normative framework – balance sheet c o re r ea li se d r es tr ic te d ta n gi b le c u rr en t m o ve ab le d is tr ib u ta b le im p ai re d c o n ve rt ib le p re d ic ta b le r eg u la r fi n an ci n g r es er ve sh o rt -t er m en tr y b en ef it im m ed ia te pe rm an en t r ec u rr in g sub entry entity y y n y y y y y fixed assets a ss et s n y n y y y y y fixed assets y y n n y y y y fixed assets n y n n y y y y fixed assets y n n y y y deferred assets y n n y y n y deferred assets y n y y y y other financial assets y n y y y y loans & security to directors and employees y n y y y n slow moving inventory and minimum inv level n n y y n n past due trade and other receivables y n n n y y deferred taxation – debit balances y y y y y y y inventory n y y y y n due trade and other receivables y n y y n y other current assets y y y y y n cash and cash equivalents y n y y y y cash and cash equivalents y n y y y y n investments y n n y y y deferred assets y n n y y n y deferred assets y y y y y n non-recurring receivables 366 sajems ns 12 (2009) no 3 an example of the use of table 1 in the classification of a transaction follows. example 1 let us suppose an accountant identifies the following combination of attributes for a hypothetical transaction. a ‘y’ in a column means that an attribute applies to the transaction, while ‘n’ indicates that the opposite of the attribute applies to the transaction. an example is given in table 2 (see also table 1 above): table 2 attribute combination for a hypothetical transaction core restricted current entry benefit immediate y y y y y n let us further suppose that the other attributes and opposites in table 1 are not applicable to the transaction in question. a comparison of the y/n row in table 2 with a corresponding row in table 1 reveals that the entity described by the above combination of attributes labelled ‘y’ and ‘n’ is an asset, and the particular sub-entity is cash and cash equivalents. once the relevant entity and its sub-entity grouping have been identified through the use of the normative sub-framework, a classifier may then use the decision sub-framework developed and built around the entities defined in the last column of table 1 above. a decision subframework has been designed as a flowchart structure, as suggested by hollander, denna and cherrington (2000), and it further classifies entities and sub-entities of a transaction to show how such items find their way into a static sub-framework, which is the last part of the comprehensive framework proposed in this article. note that only static frameworks have traditionally been the norm with regard to the classification of accounting information (wolk et al., 2004). we next define a decision sub-framework for each balance sheet entity. these entities are labelled assets, equity and liabilities, which is in line with the fundamental accounting equation. an example of a decision sub-framework for the balance sheet entity assets is shown in figure 1. a decision sub-framework assists the classifier in finally classifying a transaction into a static sub-framework. it is pointed out above that most of the classification proposals put forward in the literature are, in essence, static structures. examples of static frameworks are those currently in use and described by cilliers, mans, grobbelaar, stegmann, van schalkwyk and wesson (2004), wolk et al. (2004) and the aicpa (1994). these static frameworks simply show the final position of an item in the structure, and do not aid the classifier in understanding how the item found its way there. both the normative and decision subframeworks proposed above are remedies for this shortcoming. an example of a static sub-framework for assets is shown in figure 2. finally, then, the three sub-frameworks, namely, normative, decision and static are combined into a comprehensive framework for the classification of accounting information. this framework is presented in figure 3. sajems ns 12 (2009) no 3 367 figure 1 extract from the developed decision sub-framework for assets figure 2 extract from the developed static framework for assets 368 sajems ns 12 (2009) no 3 figure 3 a comprehensive framework for accounting classification 8 summary and future research the classification of information created by accounting practices has to meet the requirements and demands of a changing environment. in this article, some of the issues surrounding the classification of accounting information in the balance sheet and the income statement were explored. the results from the literature review, the questionnaire and the content analysis all show shortcomings in current classification practices. a discussion of the way forward and a proposed classification framework taking attributes and time into consideration are also presented. future work should entail the development of a classification framework for the cash flow statement and the classification of intellectual capital and items with attributes of both equity and liabilities. bibliography aicpa american institute of certified public accountants) 1994. meeting the information needs of investors and creditors, aicpa database. 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1969. an ‘events’ approach to basic accounting theory, the accounting review, january: 12–19. sprouse, r.t. 1966. accounting for what-you-maycall-its, the journal of accountancy, october: 45-54. taylor, r.e. 1942. no royal road: luca pacioli and his times. ayer: new hampshire. van der poll, h.m. 2007. towards a classification framework for accounting information. dcom thesis, university of pretoria: pretoria. wheatley, m.j. 1993. leadership and the new science, berret-koehler: san francisco. wild, j.j.; bernstein, l.a. & subramanyam, k.r. 2001. financial statement analysis, mcgraw-hill: new york. wolk, h.i.; dodd, j.l. & tearney, m.g. 2004. accounting theory, thomson south western: mason, ohio. wood, j. & silver, d. 1995. joint application development, john wiley & sons: new york. journal 5.indd sajems ns 13 (2010) no 2 177 ethics in economic and management sciences: a researcher’s resource jaco pienaar workwell: research unit for economic and management sciences, north-west university accepted december 2009 abstract in an international research climate of increasingly demanding ethical review, based on a biomedical model, reflection on best practices in social, behavioural and economic science research is necessary. it is widely believed that these sciences cannot be held to the same practical requirements as those for biomedical research, although the principles of ethical research are surely universal. this article considers the ethical requirements, principles and guidelines directing research in the social, behavioural and economic sciences, recognised in the national and international arena. by means of a systematic review of available best practices, it is anticipated that general guidelines for social, behavioural and economic science research could be developed and offered to researchers in these fields. specific consideration is given to the unique characteristics of social, behavioural and economic science research. keywords: guidelines, social sciences, human sciences, behavioural sciences, economic sciences, ethics, ethical, social desirability, deception jel m14 we do not ever seem to have killed, maimed or caused permanent mental disability to anyone in the name of science. – robert dingwall (2008: 3), speaking on the effects of human and social science research. …common sense and good scientific practices are vital first steps in ethical problem solving in social and behavioural research. – joan sieber (2004: 303), pleading for empirically-based ethical decision-making. the absence of data on risks and wrongs in social scientific research does not prove that subjects go unscathed”. – j. michael oakes (2002: 449), writing on risks and wrongs in social science research. 1 introduction: social, behavioural and economic science research and ethics the opening quotations in this manuscript outline three pertinent characteristics of social, behavioural (which covers most research under ‘management sciences’) and economic science (sbes) research. it is considered to be largely of a nature that is highly unlikely to permanently scar participants in any physically or psychologically meaningful way. good ethics is just good research; adhering to ethical principles is likely to improve the quality of research, not detract from it. however, good research is not necessarily ethical. finally, considering the previous statements, it would also be wrong to assume that there are no risks in sbes research. this document is an attempt to explore the 178 sajems ns 13 (2010) no 2 ethical issues faced by sbes researchers, to reconcile the seeming disparities mentioned, and to propose some basic guidelines towards better ethical research in the social, behavioural and economic sciences. overtly, it is precisely the non-physical nature of sbes research that causes unease for those who have to review such research. indeed, the probability of the appearance of physical harms, as in biomedical research, is much more easily estimated than the probability of the appearance of non-physical harms such as psychological discomfort (national bioethics advisory commission, 2001). sbes research is typically described as ‘minimal risk’ research (sieber, plattner & rubin, 2002; thompson et al., 2006). such minimal risk may be defined as where ‘…the probability and magnitude of harm or discomfort anticipated in the proposed research are not greater, in and of themselves, than those ordinarily encountered in daily life’ (code of federal regulations, 2005). researchers have responsibilities, including that of safeguarding the physical, social and mental well-being of the participants in their research. particularly relevant to sbes research is the anticipation that participants may gain new insight into themselves that they find disconcerting, that some action during participation makes them feel violated in some way, and the basic need that, where possible risks do exist, they should be avoided as far as possible (british sociological association, 2002). the belmont report (in sieber, 2004) outlined three basic principles for human subject research: beneficence, respect and justice. beneficence, simply defined, means maximising the good, minimising the bad and acting in a spirit of goodwill. if any benefits are to accrue from the research, the primary beneficiaries should be the participants. respect relates not only to respecting the wishes of potential participants, but also to protecting the interests of vulnerable participants (for example, the mentally or physically frail). respecting participants’ wishes implies, for example, that participants should be free to refuse to participate, or to decide to withdraw at any time, without reproach. justice relates mostly to a fair distribution of risks and benefits among researcher(s) and participant(s), if such risks cannot be completely avoided. although the principles outlined above originated in a longer history of biomedical research, it should be noted that sbes research is distinct in the sense that the extent of interaction (i.e. interference) of the researcher with the participant is often minimal. dingwall (2008: 3) argues that research methods employed in human and social sciences (hss) research are those employed by ordinary people in their normal daily lives (author’s emphasis): ‘… observing other people, asking them questions, reading documents or looking at pictures’. clearly, the threat posed by such sbes research cannot be linearly compared with biomedical interventions such as experimental gene therapy or drug trials. given a perceived rigid adherence to inappropriate biomedical models, this author set out to investigate, by means of a literature review, best practices and guidelines in existing frameworks to guide sbes research. this review took the form of several electronic and manual searches of available ethical codes and guidelines, which are discussed in this article. the objective of this work is thus to provide sbes researchers with a resource for considering and addressing ethical issues in their own research. 2 informed consent in sbes research lindegger and richter (2000: 313) describe informed consent as the ‘cornerstone of clinical trials’ and a ‘fundamental requirement’ in studies to test hiv/aids vaccines. ‘informed consent describes an interactive process in which individuals or their surrogates agree to voluntarily participate in a research study after the purpose, risks, benefits and alternatives have been thoroughly described and understood’ (marshall, 2007: 23). what must be assessed, however, is the meaning of informed consent in sbes research, and whether stringent adherence to this requirement is that fundamental to the so-called ‘soft’ sciences. wassenaar (2008) notes that sbes research must include some method or technique for ensuring informed consent. sajems ns 13 (2010) no 2 179 alsmadi (2008) draws an important distinction between the rights to privacy, confidentiality and anonymity. in providing informed consent, the participants waive their right to privacy, in the sense that they are volunteering information for public use. however, this does not imply a waiver of the rights to confidentiality and anonymity. informed consent relates to potential participants in the research being aware of ‘…reasonably foreseeable factors that may be expected to influence their willingness to participate such as potential risks, discomfort, or adverse effects’ (american psychological association, 2002). different authors have noted that consent should be seen as ongoing and evolving, rather than as a once-off event (brody, 2001; dingwall, 2008; smythe & murray, 2000). it is a matter to be continually negotiated with the participant as the project develops. haverkamp (2005) places the responsibility for monitoring and renegotiating ongoing consent on the researcher. informed consent has also been described as ‘preventive ethics’ (parker, 1995, in lindegger & richter, 2000: 313). clearly, the implication is that, by obtaining informed consent, certain general pitfalls in terms of research ethics are recognised, and can be avoided. a noted exception to written consent, informed consent means that a consent form would be the only identifying link between the participant and the data (common federal policy, 1991). the national science foundation (http://www.nsf.gov/bfa/cpo/policy/hsfaqs.htm) has interpreted the so-called ‘common rule’ (i.e. the common federal policy) to mean that ‘… when the subject can readily refuse to participate by hanging up the phone or tossing out a mailed survey, the informed consent can be extremely brief’. haverkamp (2005) also recommends that researchers make clear in what form data will be stored, and who will have access to it. in the same way that guests showing inappropriate behaviour are asked to leave, researchers in the social, behavioural and economic sciences run the risk of being asked to leave if participants deem their behaviour or questions inappropriate (dingwall, 2008). the best defence for normal, healthy, adult participants is a simple refusal to participate. marshall (2007) points out that language, literacy levels, beliefs about who has the authority for decision-making and beliefs about nature itself could be determinants in the process of obtaining informed consent. alsmadi (2008) also notes that special caution must be exercised in obtaining (parental) consent when working with children, or when working with students or employees, who may be more vulnerable to coercion. 2.1 what social, behavioural and economic sciences can learn from hiv vaccine trials lindegger and richter (2000) describe informed consent as that where a) all the relevant information regarding the proposed research is communicated; b) the information is understood sufficiently by the prospective participant for him to make an informed decision; c) there is no form of coercion; and d) the participant expressly agrees to participate, usually in written form. the fundamental aim of informed consent is to assist individuals in making a decision about participating or abstaining from specific research. the nature of this process should be to assist individuals in making decisions that ‘… are truly in their own best interest’ (lindegger & richter, 2000: 314). in sbes research, the aims and objectives of the investigation should be clearly outlined, as should issues such as who will have access to the data, where and how it will be stored, and what will be done with the results. possible risks associated with participation should be considered. these possible risks are described as an ‘…invasion of privacy, loss of confidentiality, psychological trauma, indirect physical harm, embarrassment, stigma, and group stereotyping’ (oakes, 2002: 449). other risks are those that threaten ‘…a subject’s personal standing, privacy, personal values and beliefs, their links to family and the wider community, and their position within occupational settings, as well as the adverse effects of revealing information that relates to illegal, sexual or deviant behaviour’ (economic and social research council (esrc), 2005: 21). given this broad definition of ‘risk’, participants 180 sajems ns 13 (2010) no 2 should be told what methods will be employed to obtain information from them. while full disclosure of the technical aspects of a research protocol during the process of obtaining informed consent would satisfy the legal requirements, this does not suggest that it satisfies the moral requirement. lindegger and richter (2000) rightly point out that, in the case of hiv vaccine trials, the participants ought to understand to a far greater extent the implications of participation (which could include, inter alia, the discovery of one’s own hiv status). in economic and management science research, obtaining written informed consent or full disclosure prior to commencing an investigation may also alter the behaviour the researcher is actually interested in studying. one may think here of examples such as purchasing behaviour or an investigation into deviant behaviours, such as organisational theft or bullying. clearly, outlining the purpose of the investigation beforehand and requiring express written consent may alter the very behaviour one is interested in studying. on the topic of coercion, it speaks for itself that it can never be tolerated or seen as acceptable. although this statement seems self-evident, one needs to critically consider the true extent of the freedom participants are allowed in, for example, an organised and scheduled survey in an organisation, or even in a classroom situation. 2.2 issues arising within culturally diverse settings important cultural differences exist in terms of individuals’ willingness to share what may be considered personal information. fuentes (2004) points out that what is considered a ‘benefit’ varies across cultures. dingwall (2008) also relates how obtaining signed consent forms in an asian culture was considered deeply offensive, presenting the researcher as disrespectful and lacking in trust. sieber, plattner and rubin (2002) maintain that having to sign an ‘agreement’ may be perceived as an indication that one’s word is not enough. they also relate previous bad experiences associated with signing forms – native americans lost land in precisely this fashion. the us national science foundation (http://www.nsf.gov/bfa/ cpo/policy/hsfaqs.htm) notes that cultural norms and lifestyles may have implications for obtaining informed consent. van den hoonaard (2001) also notes the important cultural characteristic continuum of individualismcollectivism. in collectivist settings, placing the interest of the individual before that of the group would probably be seen as an affront. where individuals are defined, for example in terms of group membership and social relations, the consent of individuals other than the actual participant might be indicated (for example the life partner, elders in the community or tribal leaders). however, researchers differ in their opinions on the extent to which these ‘significant others’ should be involved. while some insist on the principle of first-person consent with the possible supplemental approval of significant others (ijsselmuiden & faden, 1992; olivier, 1995), other consider wider participation to be essential (richter, lindegger, abdoolkarim & gasa, 1999). marshall (2007) calls for researchers to investigate the influence of cultural, social and political factors on community representatives’ decisions as far as participation in research is concerned. marshall (2007) notes important provisions for doing multinational health research in resource-poor settings, which seems applicable to the multi-cultural south african context. these provisions include respect for the cultural traditions of participants or participant communities, promoting collaboration between researchers from resource-rich and resourcepoor settings and continuous community involvement, training of stakeholders in research ethics as well as an ethical review of research protocols, developing participantappropriate ways of gaining informed consent (such as verbal and in the participant’s mother tongue), approaching consent as an ongoing process, providing feedback to participants and communities, anticipating possible conflicts and developing plans for their resolution. the esrc (2005) presents helpful case studies as part of their research ethics framework (ref), from which one important question arises: ‘how will you respond in explaining your research, if you are accused of being unethical?’ sajems ns 13 (2010) no 2 181 3 the axis of validity and being ethical 3.1 deception, concealment and covert observation as noted, there may be cases in sbes research where communicating the full extent or aims of the research to potential participants would jeopardise the research itself. the national science foundation in the united states (http://www.nsf.gov/bfa/cpo/policy/hsfaqs.htm, in sieber, plattner & rubin, 2002) outlines three conditions where concealment or incomplete disclosure is acceptable: (a) obtain permission to provide only a description of what the subjects will experience, with an agreement that the full details of the study will be disclosed afterward; (b) obtain permission to engage in concealment or deception with the understanding that peers of the subject do not find such concealment or deception objectionable and that a full explanation will follow participation; (c) to explain that the subject might be enrolled in one of several possible conditions as in placebo research. the academy of management (2009) in the united states, in its code of conduct, states that: deception should be minimized, and, when necessary, the degree and effects must be mitigated as much as possible. researchers should carefully weigh the gains achieved against the cost in human dignity. to the extent that concealment or deception is necessary, the researcher must provide a full and accurate explanation to participants at the conclusion of the study, including counseling, if appropriate. deception can be justified only when no physical or psychological harm will be caused (zikmund, 2003). harm, in this sense, may be taken to include, inter alia, ‘…harm to self-esteem, stress, (and) future employability…’ (alsmadi, 2008: 157). here, harm may also be seen as equivalent to risk, the meaning of which was clarified above. in south africa, the national department of health (2004) has issued specific research ethics guidelines. in these guidelines, research involving deception, concealment or covert observation is specifically addressed (under point 10). where research involves the deception of identifiable participants, covert observation or the nondisclosure of the purpose of the research, it can be said to be unethical to conduct such research. however, in instances in which deception, covert observation or the non-disclosure of the purpose of the research is essential to the research being conducted, the researcher must satisfy a research ethics committee that: full disclosure of the purpose and/or methodology would threaten the scientific validity of the project; the extent of deception can be defined; alternative methodologies would not achieve the same outcomes; additional risk is not introduced for participants; disclosure will follow the initial deception; and the relationship between researchers, research and participants should not be negatively affected by the deception. finally, participants should also have the opportunity to withdraw their results after the deception has been made known. 3.2 sensitive questions answers to sensitive questions in survey research are seen as being particularly prone to distortion and are simply wrong, and management of this phenomenon within the social sciences is desirable (barnett, 1998). an important distinction in survey research bears on whether the researcher is interested in behaviours or attitudes, as the associated responses to these two categories of items are quite different. for behavioural items, the response can theoretically be compared to some actual, objective behaviour. in contrast, attitudinal items often invoke a qualitative dimension, which cannot be compared with actual occurrences. in general, it can be seen that the more sensitive the question, the greater the underreporting of the intended measured attitude or behaviour (barnett, 1998). barnett presents four strategies for managing this phenomenon: a. guarantee anonymity. singer (1978, in barnett), found, for example, that requiring 182 sajems ns 13 (2010) no 2 signed informed consent in a sensitive survey decreased participation. b. adjusting questionnaire format. this is done, for example, by first stating that a particular sensitive behaviour is normal, or is simply asking about the frequency of occurrence. asking open-ended, longer questions and not placing threatening questions at the beginning of a survey are also said to be effective (sudman & bradburn, 1974, in barnett). c. adjusting the mode of administration. suggested alternative methodologies include administration via computer or the use of recorded surveys with answers indicated in a separate test booklet. however, millstein (1987, in barnett) has also indicated no effect for the mode of administration when comparing face-to-face interviews, interactive computer interviews or selfreported questionnaires. d. alternative methodologies, such as focus groups, the nominative technique, vignettes and randomised response techniques may also be employed. although one may state that ‘sensitivity is in the eye of the beholder’, barnett (1998) notes that ‘typical’ sensitive dimensions include sexual practices, alcohol and drug use, aids, income and criminal behaviour. in organisational research, it is noted that issues such as business ethics, bankruptcy and transgressions of organisational standards are sensitive. the final recommendation from barnett (1998) is that sensitivity should be defined by the participants, and within a particular context. sbes researchers would do well to consider beforehand the possible consequences of their research for all those (individuals, departments, and organisations) involved. employing focus groups prior to full roll-out can also assist in contextually defining the sensitivity and acceptability of questions. 3.3 the interview as instrument richardson and godfrey (2003) note the important distinguishing feature of an interview as being that of an emotional bond developing between the interviewer and the interviewee. in ensuring the protection of interviewees, the latter should be aware that they may stop the interview, that the researcher may choose to stop the interview, and that correct procedures ought to be applied in both closing an interview and referral to social or other mental health services (richardson & godfrey, 2003). it is also important to recognise that the interview is inherently exploitative – the researcher wishes to gain information from the interviewee for his or her own purposes, although this is obviously acceptable if it is correctly handled. reciprocity in the relationship is important in making sure of this (richardson & godfrey, 2003: 349). when it comes to interviews, richardson and godfrey (2003) also stress the ongoing nature of the informed consent process. interviewees may, for instance, give consent only at the end of the interview, or be allowed to view the specific content from the interview (the excerpts) that will be used in the research. in an interview setting, informed consent would entail the interviewee being assured of the purpose of the research; what the information gathered will be used for; how their anonymity will be protected; and who will have access to the information (richardson & godfrey, 2003). 4 the important differences between social, behavioural and economic and biomedical sciences the american association of university professors (aaup; thompson, elgin, hyman, rubin & knight, 2006) has expressed serious concern about the practice of requiring ethical approval for research involving human subjects that poses no serious risk of harm to participants. however, the recommendation is not that social science(s) be exempt from ethical review, because it is possible that social science research could pose serious psychological harm to participants. paradoxically, certain biomedical research poses no significant risk to participants (for example, data-gathering by survey). the call is to consider the methodology rather than the discipline to be evaluated. as such, sajems ns 13 (2010) no 2 183 the recommendation is that ‘…research whose methodology consists entirely of collecting data by surveys, conducting interviews, or observing behaviour in public places…’ be exempt from review (thompson et al., 2006: 3), even from applying for exemption from review. the only exceptions to the rule should be research in which participants are going to be identified, either directly or through other identifiable data, or in which ‘…the disclosure of responses outside the research could reasonably place the subjects at risk of criminal or civil liability or be damaging to the subjects’ financial standing, employability, or reputation’ (federal regulations, section 46.101 (b)(2), in thompson et al., 2006: 3). the aaup lashes out particularly at the ‘paternalism’ (thompson et al., 2006: 4) of institutional review boards for calling a halt to research where it is deemed that even the completion of sensitive items may be stressful to participants. rightly stated, also, autonomous individuals who provide informed consent should be able to opt out of the research if they find the survey items sensitive. naturally, the normal exemption of special or vulnerable populations (such as children, individuals in national service or incarcerated) still applies. solomon (2005), however, notes at least 10 contributions that the social sciences could make to bioethics. these are noted as recognising the gaps between practice and ideals; assisting in evaluating personal aptitude for ethical analysis; investigating and recognising the institutional/environmental context in which ethics takes place; encouraging moral accountability; investigating cause and effect relationships and predictive values assumed in bioethics; clarifying the applicability of ethical principles in multicultural contexts; recognising the relevance of ethical principles in new contexts and to social phenomena; and the implied new moral problems, and greater elaboration of existing, identified problems. solomon (2005: 40) notes that biomedical research can indeed benefit from social science research in that the latter can provide the role of ‘…context, intentionality, and outcomes…’ in research. 5 best practice guidelines 5.1 a european example freed-taylor (1994) outlines the following principles for social science research, which is a summary of various european codes. acceptance of responsibility implies that all parties to the research should carry equal responsibilities, and (possible) harms and benefits should be anticipated before the research starts. the conduct of research should be such that it contributes to both a positive relationship between researchers and participants and future research. issues like anonymity have to be clarified and (possible) harms avoided. compliance with legislation is an obvious essential. information gleaned should be presented to the scientific community, and the limitations in terms of its interpretation should be noted. cross-cultural research requires ethical approval (and legal compliance) in all participating countries. vulnerable groups raise special issues of informed consent and potential risk. ‘vulnerable’ participants are not clearly defined, but have been noted to include ‘…children, prisoners, pregnant women, mentally disabled persons, economically or educationally disadvantaged persons’ (common federal policy, 1991). in addition, this category includes ‘…racial minorities…the very sick, and the institutionalized’ (national commission, 1979). weijer and emanuel (2000) consider participants to be vulnerable if they are not in a position to provide informed consent owing to their position (such as being in prison), or not possessing adequate intellectual faculty (such as children or the mentally ill). resolution of conflicts, should they arise, should consider the contribution of relevant ethical bodies, professional associations or colleagues. 5.2 a canadian example the canadian tri-council policy statement (1998) presents a unique perspective on research involving human subjects that came about through collaboration between the medical, natural sciences and engineering, and social 184 sajems ns 13 (2010) no 2 sciences and humanities research councils of canada. the most important articles from the statement make it clear that all research involving living human subjects should be subject to ethical review prior to commencement (article 1.1). the article further extends to r e s e a r c h i n v o l v i n g h u m a n r e m a i n s , cadavers, tissues, biological fluids, embryos or foetuses. article 1.1 excludes from review research about a living individual where such research will entirely be conducted on publicly available information and ‘…quality assurance studies, performance reviews or testing within normal educational requirements…’.1 where research involves interviews, research ethics board (reb) approval of the proposed interviewing techniques must be sought, and the free and informed consent of the interviewee needs to be ensured. article 3.1 requires reb approval for the collection of information by means of personal interviews, which may be described as including such means as face-to-face, telephonic or electronic encounters, or individualised questionnaires which the researcher uses to gather materials for such purpose as a biographical study or other research involving specific personalities (canadian tri-council policy statement, 1998: 3.3). additionally, the policy defines personal information as … information relating to a relatively identifiable person who has a reasonable e x p e c t a t i o n o f p r i v a c y . i t i n c l u d e s information about personal characteristics such as culture, age, religion and social status, as well as their life experience and educational, medical or employment histories. however, article 1.1 (c) is excluded from reb review research that is exclusively based on publicly available information. this includes documents, records, specimens or materials from public archives, published works and the like, to which the public is granted access. as a general rule, the best protection of confidentiality of personal information and records will be achieved through anonymity. if the data being stored are truly anonymous, the research project will need only minimal reb scrutiny (canadian tri-council policy statement, 1998: 3.2). in an academic context, the following provision is important: … when records of prisoners, employees, students or others are used for research purposes, the researcher should not provide authorities with results that could identify individuals, unless the prior written consent of the subjects is obtained. researchers may, however, provide aggregated data that cannot be linked to individuals to administrative bodies for policy decision-making purposes (canadian tri-council policy statement, 1998: 3.4). 5.3 unesco the united nations educational, scientific and cultural organization developed a set of ethical guidelines for international research conducted under their programme entitled management of social transformations (most) (www.unesco. org/most/ethical.htm). importantly, these guidelines explicitly hold themselves as not an alternative to the ‘scientific and professional judgement’ of the researcher(s). the guidelines do, however, place ethical responsibility primarily on the principal researcher(s). they also require the principle of beneficence to be maintained, potential benefit to be a consideration in the initial choice of research topic and the consequences, and especially risks and use of the research to receive due consideration. the guidelines also call for competence in researchers and the explication of their personal ethical stance; compliance with ‘customs, standards, laws and regulations’; and respect for a host culture. the guidelines also include familiar requirements, such as informed consent; avoidance of harm and coercion; undue intrusion; confidentiality; and access to and preservation of results. lastly, sajems ns 13 (2010) no 2 185 the guidelines also make recommendations in terms of methodological issues, and stress reporting the results with integrity, respecting the work of other researchers and full disclosure in publication(s). 5.4 a south african example an example of clear and seemingly efficient ethical guidelines is provided by the south african national parks (www.sanparks.org). these principles were developed by the treehouse research programme for people and conservation (trppc), a collaborative research project between the universities of kwazulunatal (ukzn), the university of montana and south african national parks (sanparks). these ethical guidelines (www.sanparks.org/ people/social/resources/ethics.php) state that social scientists should ensure that: a. participation is voluntary; b. no harm is done. additionally, to empower participants at least in terms of confidence and understanding; c. informed consent is sought; d. data are kept anonymous and confidential; e. researchers and interviewers are trained in ethical responsibilities; f. findings of studies are peer reviewed before publication, limitations noted, and participants granted the opportunity to view the findings. additionally, the statement requires the researcher to anticipate and plan for any potentially negative consequences of the research. although deceptively simple, these guidelines are under-girded by sound ethical principles, such as a proper consideration of the context in which research will be taking place; respecting the autonomy and wishes of participants (such as non-participation); informed consent; ensuring scientific rigour in research; and adhering to professional codes. 6 proposing guidelines for management and economic sciences research 6.1 informed consent that informed consent should be obtained is not debatable. stated simply, people should know what they are getting themselves into! however, when research takes place with the participation of normal, healthy adult participants, informed consent may not necessarily be in the form of a formal, signed document. in anonymous survey research, the first line of defence available to (potential) participants is simply the decision not to complete the survey. the cover letter to the survey could, however, state something along the lines of: the survey you have received is interested in studying … (project description in layman’s terms). by completing this survey, you agree that the information you provide may be used for research purposes. know that you are free to decide not to complete the survey, although your data cannot be replaced by anyone else’s. the survey will, however, be completed anonymously, and we as researcher(s) will have no way of connecting the information you provide to you personally. we do not foresee that you are likely to experience any negative consequences due to completing this questionnaire or we foresee the following consequences in completing the questionnaire … (outline anticipated risks and harms). even so, the researcher(s) undertake to keep the individual information provided herein confidential, not to let it out of their possession, and to analyse results only at the group level. it is hoped that the information we gain from this survey will help us in … (state anticipated outcomes of the project). however, should you have questions or concerns, please contact the principal investigator … (provide a name and suitable contact information). 186 sajems ns 13 (2010) no 2 what should be included in a typical cover letter/ project description? according to the guidelines proposed by lindegger and richter (2000), it would entail giving participants a reason for the research, how the information would be used, the anticipated outcomes of the research, and its (possible) implications for participants personally. it has also been noted that obtaining informed consent may not necessarily be the first action taken in the process of the research, and could even be the last (see 2.1). however, when information gathered and used for research purposes is directly related to specific individuals (such as in qualitative research), written, informed consent should be applied as the golden standard. the reality is, though, that such consent may only be available verbally (such as in the case of illiterate participants), and should ideally be continuous in nature, while the research agenda develops in interaction. 6.2 cultural sensitivity given the plural character of south african society, special care should be taken to ensure cultural sensitivity, whether the research is qualitative or quantitative in nature. quantitative research, such as in surveys, should be made available in, and at a level of language that is appropriate to the potential respondent. as a general practice, english is the language of surveys, although only a small percentage of south africans speak it as a first language. in qualitative research, great care has to be exercised in obtaining informed consent. indications are that it is not the individual alone, but probably also the community that has to be considered. when participants are to be asked questions, there should be sensitivity to culture, religion, language, lifestyle and any other differences. 6.3 education in south africa, there is a two-fold responsibility in research ethics relating to education, and institutions of higher learning must accordingly provide (additional) training in ethics for researchers. ethics, especially in the way they relate to management and economic sciences is in all likelihood not treated with the earnest attention it deserves, on account of its ostensibly innocuous nature. further, graduates in these disciplines often register with professional bodies, and their practice as professionals is then overseen by an external ‘watchdog’ (e.g. industrial psychologists or chartered accountants). however, in academia, and given the much-less regulated south african context, a greater responsibility falls on institutions that initiate research, and professional training in the ethics of research remains the responsibility of the institution. researchers themselves, often working in settings characterised by great resource disparity and differences in levels of formal education, have a tremendous responsibility to educate participants not only about research and its value, but also about research ethics, if the good will of the community and the future of research are to be secured. in this case, the concept of education would include learning that the results of research should be communicated to participants, and are not solely for publication in a subject-specific academic journal. also in the academic context, consideration of who the ‘primary participant’ is would suggest that a more senior and experienced study supervisor should be aware of, and sensitive to, ethical issues, and be able to guide learners in this respect. 6.4 special issues the ethics of research is also enhanced by cognisance of issues relating to validity in terms of research execution. when it comes to asking difficult or sensitive questions, employing deception, covert observation or concealment and using interviews as a data-gathering instrument, all these issues were discussed under point 3 above. researchers are referred to this section for some basic guidelines on appropriate ethical considerations. 7 conclusion hunter (2008) notes the development of an increased awareness of the need for ethical sajems ns 13 (2010) no 2 187 review of research involving human subjects. this includes such considerations as journal requirements of ethical approval of publishable research; requirements of external funding agencies; the fear of liability; and a general increased awareness of the ethical implications of research. it has also been noted (de vries, de bruin & goodgame, 2004) that it is particularly researchers in the social, behavioural and economic sciences (sbes) who have lost patience with research ethics committees! given this climate, du bois (2004) rightfully acknowledges that compliance ‘for the sake of it’, or, even worse, in pursuit of the avoidance of penalty, in principle runs counter to ethical review. wolcott (1994) has also warned of the threat that a mechanistic adherence to rules poses to real ethical issues. it is the express intention of this paper to make research ethics more accessible to the management and economic sciences researcher. it is intended to bring about a greater understanding of the need for the ethical review of research, but ultimately to present guidelines for researchers that would encourage ethical consideration in the execution of research. dingwall (2008: 3) is of the opinion that humanities and social science (hss) research poses: ‘…at most…a potential for causing minor and reversible emotional distress or some measure of reputational damage … risks that research participants are well able to assess for themselves’. this attitude of placing responsibility solely on willing participants seems inadequate. it has been noted above (see point 5) that research ethics may also rest on factors such as the competence and professionalism of the researcher. oakes (2002) interprets the us code of federal regulations, title 45 part 46 (2005), as stating that all survey research is exempt from ethical review, unless identifying information is collected and harm may follow from its disclosure. the code of federal regulations, title 45 part 46, (2005) exempts research: … i n v o l v i n g t h e u s e o f e d u c a t i o n a l tests (cognitive, diagnostic, aptitude, achievement), survey procedures, interview procedures or observation of public behaviour, unless (i) information obtained is recorded in such a manner that human subjects can be identified, directly or through identifiers linked to the subjects; and (ii) any disclosure of the human subjects’ responses outside the research could reasonably place the subjects at risk of criminal or civil liability or be damaging to the subjects’ financial standing, employability, or reputation. other exempt research is ‘anonymous and harmless surveys’; ‘observational studies’; ‘surveys on groups; organizations and associations’; research that deals with the ‘collection or analysis of existing data’; and ‘publicly available data sets or those stripped of identifying information’ (oakes, 2002: 457–459). end notes 1 the esrc (2005: 7) defines ‘human participants’ as ‘including living human beings, human beings who have died recently (cadavers, human remains and body parts), embryos and foetuses, human tissue and bodily fluids, and human data and records (such as, but not restricted to medical, genetic, financial, personnel, criminal or administrative records and test results including scholastic achievements)’. reference list academy of management (2009) code of ethics, http://www.aomonline.org/aom. asp?id=268&page_id=240 (accessed 19 march 2009). alsmadi, s. 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(2008, june) reviewing the question, hsrc review, 6(2), http://www.hsrc.ac.za/ hsrc_review_article-103.phtml (accessed 19 march 2009). weijer, c. & emanuel, e.j. (2000) protecting communities in biomedical research, science, 289: 1142–1144. wolcott, h.f. (1994) transforming qualitative data. thousand oaks, ca: sage. zikmund, w.g. (2003) business research methods (7th ed.) ohio, usa: thomson, south-western. sajems ns 12 (2009) no 3 263 estimating the carbon emissions balance for south africa alan c brent resource based sustainable development, natural resources and the environment, csir, graduate school of technology management, university of pretoria, centre for renewable and sustainable energy studies, school of public management and planning, university of stellenbosch sibbele hietkamp energy and processes, material science and manufacturing, csir, russell m wise resource based sustainable development, natural resources and the environment, csir kenney o’kennedy centre for renewable and sustainable energy studies, school of public management and planning, university of stellenbosch abstract the carbon footprint of materials and products is becoming an increasingly important factor in international trade. at present the carbon emissions balance of the south african economy is not well understood, especially the carbon emissions associated with imports and exports. an investigation was done of known economic input-output and life cycle analyses models addressing this shortcoming. the results reveal that south africa is a major exporter of carbon; at least 129 per cent more carbon is associated with a dollar earned with exports than a dollar spent on imports, and the carbon footprint of the outflows on average, equates 37 per cent of the total carbon emissions of the economy. such figures have serious policy-related implications in a future where international climate-change trade limitations will become stricter and binding. jel 1 introduction trade and the environment are the two issues that are at the epicentre of the globalisation debate (williams, 2001; nordström & vaughan, 1999). with growing environmental awareness multilateral trade liberalisation may offer the global population access to less-polluting products and processes. however, there is evidence that liberalised trade and increased incentives for exports from developing countries leads to greater exploitation of natural resources (mukhopadhyay & chakraborty, 2005a). for example, the transformation of land to produce and export biofuels has not only destroyed native forests, but has also significantly increased the carbon footprint of some biofuels (fargione et al.., 2008). furthermore, free trade has been shown to promote and facilitate the translocation of polluting industries to developing countries with less strict environmental regulations (mukhopadhyay & chakraborty (2005b)1. a specific environmental concern, as part of the global climate change focus, is the carbon footprint2 of developing-country products that are bought by developed countries (shui & harriss, 2006; kejun et al., 2008). indeed, the observed decrease in the energy intensity, and therefore the associated co 2 equivalent 264 sajems ns 12 (2009) no 3 (co 2 e) emissions3, for developed countries may partly be attributed to an increase in the importation of ‘embodied’ carbon from developing countries (suri & chapman, 1998). to this end, environment-related issues may actually be used as trade barriers in terms of protecting local (foreign) markets (fontagné et al., 2001). studies have consequently been undertaken in developed (mongelli et al., 2006) and developing (machado et al., 2001) countries to understand the potential carbon embodied in the products that are traded with these countries. the paper applies a similar approach to the studies of mongelli et al. (2006) and machado et al. (2001) with the goal to provide an improved quantification of the carbon emissions balance of south africa, especially in terms of how the balance relates to imports and exports. it is expected that a better understanding of south africa’s carbon balance will inform government formulation of environmentallyrelated regulations and policies – carbon trading and carbon taxes in particular – that not only promote and protect its environment and people, but also the competitiveness of its economy. for example, regulations, standards, taxes, and possibly even subsidies or tax relief, need to be put in place to accelerate the implementation of carbon-credit schemes, within the voluntary and kyoto flexibility mechanisms, and to foster innovation and adoption of clean technologies in the south african economy (little et al., 2007). this is essential where stricter carbon-emission limitations are being set and enforced in developed countries and pressures are mounting on developing countries. 2 an input-output (io) analysis approach to carbon balances the contribution of international trade to global energy demand and greenhouse-gas emissions has been analysed by input-output (io) specialists, as listed by machado et al. (2001). io analysis is a well-established linear economic model often used to account for economic and environmental consequences or impacts following a change in the total output of an economy (suh, 2004). io approaches have played a central role in performing analyses of policy-driven material and product flows. giljum et al. (2007) note that these approaches open up the “black box” of economy-wide material flow analyses and therefore provide information on tariff groups and product-specific resource flows and resource productivity. by applying these approaches, environmentally important sectors and products (“hot spots”) can be identified and ranked. giljum et al. (2007) provide a history of the development of these techniques, and mongelli et al. (2006) describe the underlying mathematical principles. a major advantage of the io approach, compared to the conventional, standardised environmental life cycle analysis (lca) approach that focuses on a specific material or product (brent, 2003), is that it avoids imprecise definitions of system boundaries; the entire national economic system is the scope for the analysis. it also allows for the estimation of the total resource inputs for all types of products with less effort than the lca-based method (giljum et al., 2007). furthermore, it allows analyses at different spatial scales (munksgaard et al., 2005). the major disadvantage of the io approach, however, is the high level of aggregation of economic sectors, which impede the analysis of specific materials and products and lead to problems of heterogeneities within economic sectors. notwithstanding this, the io approach is argued to be a relatively robust way of obtaining estimates of the carbon footprint of materials and products, for the purpose of international trade investigation in both developed and developing countries (mongelli et al. 2006; machado et al., 2001). to this end tukker et al. (2009) call for the standardisation of the environmental io approach to allow analyses at global and multi-regional levels. at present no io model has been developed for the south african economy that can determine the total carbon emissions associated with exported products. and, on the import side, since south africa trades with many different countries no single available io database can accurately reflect the carbon emissions associated with imported products. the lack sajems ns 12 (2009) no 3 265 of appropriate io models for both exports and imports makes it necessary to modify and use models developed by others for other economies. the following countries were found to have recently conducted environmental io studies at sectoral and/or country-wide level: • australia (foran et al., 2004). • denmark (weidema et al., 2005). • portugal (ferrao and nhambiu, 2006). • brazil (lenzen & schaeffer, 2004). • united states and canada (hendrickson et al., 2006) in this study, we use the eio-lca model of the green design institute at carnegie mellon (2008) because it is readily available, transparent, is an example of a tried-and-tested combination of io and lca approaches, and has been applied to various countries (cicas et al., 2007). the details of the model are described by hendrickson et al. (2006). a consequence of there not being an io model for south africa, and all the countries it imports from, is the uncertainties associated with applying other models. where possible the uncertainties were reduced by utilising available lca data for south africa; otherwise the implications of the uncertainties were considered in the investigation summarised in this paper. 3 research method and results four steps were undertaken to estimate the carbon balance of south africa. step 1: rank all imported and exported products a comprehensive database of south african imports and exports was obtained from the south african revenue service (sars, 2008) and the list of flows was verified against the original input-output tables of statssa (1993); the flows are updated from time to time. the data provide details of the flows of these products for the 2007 fiscal year in terms of their tariff groups and descriptions, physical quantities, and economic values (south african rand (zar)). the import and export flows were then ranked based on their economic values to establish the products that substantially influence the south african international trade balance. the top twenty import and export products are listed in tables a1 and a2 in the annexure, respectively. these top 20 products make up about 62 per cent of the total imports and 79 per cent of the total export values. the remainder of south africa’s trade balance is made up of many, but relatively low-valued products, mainly because the quantities imported and exported4 are relative small. step 2: assign carbon emissions from the eio-lca database the eio-lca model of the green design institute at carnegie mellon (2008) defines carbon emissions factors for different industry sectors, as described by the united states department of commerce (hendrickson et al., 2006). for these sectors the carbon emissions are provided for specific products, in million tonnes of co 2 equivalent (mtco 2 e) emissions, per million dollars of output produced from the related products. the mathematical modelling of the sectors considers flows and prices in the national economy as dictated by, for example, scarcity. the products in the eio-lca database were mapped against the product descriptions in the sars database and the total co 2 e emissions were then assigned to the south african data based on the exported and imported rand values. an exchange rate of r7.86 to us$1, as of april 2008, was used for the calculations (see tables a3 and a4 in the annexure). step 3: addressing the uncertainties in the model-generated outputs the assigned co 2 e emissions were verified against available national values for the key imported crude petroleum products and some of the export products, e.g. the platinum group of metals (pgms), primary aluminium, and primary ferrochrome (as indicated in the tables of the annexure). the verifications were based on available lca calculations and studies, and companyand sector-specific reports. this verification process revealed the following: 266 sajems ns 12 (2009) no 3 • the import and export values are reasonably accurate and reliable as they are the basis for setting taxes; an uncertainty of 10 per cent was therefore assigned to these values. • the assigned carbon emissions are highly uncertain since some of the eio-lca data are considerably different to available lca and other data sources in south africa; also exchange rate fluctuations would greatly influence the assigned carbon emissions per rand value compared to a per dollar value. for example, for the imported crude petroleum products, the eio-lca data indicates 2.15 mtco 2 e, but calculations for south africa have shown a figure of 4.40 mtco 2 e to be more accurate (see table a3). for exported aluminium the eio-lca data assigns a figure of 8.2 mtco 2 e, but productspecific lca studies have estimated a figure of 16 mtco 2 e (brent et al., 2001) (see table a4). the discrepancies between these values are attributable to multiple factors, most notably the eio-lca model for the united states is not an accurate reflection of the carbon footprint associated with the south african economy. furthermore, lca related data for the south african industry has been found to be highly uncertain in general (brent et al., 2002). based on the verified and updated data an uncertainty of 50 per cent was therefore assigned to these values in general. step 4: estimate the carbon balance while accounting for uncertainty the uncertainties were used to obtain absolute minimum and maximum values for each of the parameters. then monte carlo simulations that assumed normal distributions were utilised to account for fluctuations in the uncertainties and calculate standard deviations for the median values of the parameters. for risk assessments, where the underlying probability distributions are unknown, such an assumption has been shown to be reasonable (hoffman & hammonds, 1994). the standard deviations were then used to calculate minimum and maximum carbon import/export ratios. the minimum and maximum carbon emissions for the top twenty ranked products can then be determined (within a 95 per cent confidence interval) by multiplying these ratios by the actual import/export carbon values; as shown in equation (1): c j,k = c j,k + r j,ave .(1 – p j ).v 3 (1) where the minimum, average and maximum values are indexed by k; j is the index counter for whether the products are imports or exports; c j,k is the total estimated k of co 2 e emissions associated with j; c j,k is the total estimated k of co 2 e emissions associated with the top twenty ranked j; r j,ave is the average co 2 e emissions to imports/exports ratio obtained form tables 3 and 4; p j is the proportions of the total j values (as shown in tables 1 and 2) made up by the top twenty ranked j; and v j is the total j value as shown in tables a1 and a2 of the annexure. the values that were estimated using equation (1) are summarised in tables 1 and 2. table 1 calculated minimum and maximum co 2 e emissions for the top 20 imports (i) import ranking import value std dev. co 2 e std dev. min co 2 e/i max co 2 e/i min co 2 e max co 2 e (billion rand/yr) (mt/yr) (t/r’000/yr) (mt/yr) 1 76.85 4.43 4.40 1.26 0.04 0.08 2.99 6.03 2 40.47 2.34 4.08 1.18 0.07 0.14 2.75 5.59 3 31.04 1.78 2.48 0.71 0.05 0.11 1.67 3.39 4 22.81 1.32 4.53 1.30 0.13 0.27 3.06 6.20 sajems ns 12 (2009) no 3 267 5 17.53 1.01 0.67 0.19 0.03 0.05 0.45 0.92 6 10.50 0.61 0.53 0.15 0.03 0.07 0.36 0.72 7 9.84 0.57 0.79 0.23 0.05 0.11 0.53 1.07 8 8.57 0.50 0.73 0.21 0.06 0.12 0.50 1.01 9 8.25 0.48 0.47 0.14 0.04 0.08 0.32 0.64 10 7.82 0.45 0.79 0.23 0.07 0.14 0.53 1.08 11 7.05 0.41 2.42 0.69 0.23 0.47 1.63 3.31 12 6.42 0.37 0.38 0.11 0.04 0.08 0.25 0.51 13 6.37 0.37 0.40 0.12 0.04 0.08 0.26 0.54 14 4.75 0.27 1.28 0.37 0.18 0.37 0.87 1.76 15 4.45 0.26 0.22 0.06 0.03 0.07 0.15 0.31 16 3.96 0.23 0.27 0.08 0.04 0.09 0.18 0.36 17 3.52 0.20 0.41 0.12 0.08 0.16 0.28 0.57 18 3.31 0.19 0.36 0.10 0.07 0.15 0.24 0.49 19 3.23 0.19 0.15 0.04 0.03 0.06 0.10 0.21 20 2.97 0.17 0.30 0.09 0.07 0.14 0.20 0.41 table 2 calculated minimum and maximum co 2 e emissions for the top 20 exports (e) export ranking export value std dev. co 2 e std dev. min co 2 e/e max co 2 e/e min co 2 e max co 2 e (billion rand/yr) (mt/yr) (t/r’000/yr) (mt/yr) 1 69.04 3.99 28.28 8.16 0.28 0.56 19.16 38.86 2 39.94 2.29 16.36 4.75 0.27 0.56 10.97 22.37 3 25.70 1.48 19.47 5.60 0.51 1.04 13.17 26.66 4 23.68 1.37 12.11 3.49 0.34 0.70 8.14 16.55 5 22.63 1.31 1.73 0.49 0.05 0.10 1.13 2.32 6 18.52 1.08 1.48 0.43 0.05 0.11 1.00 2.05 7 17.53 1.01 6.02 1.73 0.23 0.47 4.06 8.23 8 12.93 0.75 3.62 1.03 0.19 0.38 2.47 4.97 9 11.34 0.65 2.58 0.75 0.15 0.31 1.71 3.51 10 11.31 0.65 16.00 4.67 0.94 1.94 10.68 21.88 11 11.24 0.65 4.22 1.21 0.25 0.51 2.85 5.78 12 9.05 0.52 0.72 0.20 0.05 0.11 0.47 0.95 13 7.57 0.43 1.50 0.43 0.13 0.27 1.01 2.05 268 sajems ns 12 (2009) no 3 14 6.34 0.37 0.64 0.17 0.07 0.14 0.45 0.87 15 4.27 0.25 0.82 0.23 0.14 0.27 0.59 1.15 16 4.11 0.24 0.74 0.23 0.12 0.25 0.49 1.03 17 3.93 0.22 0.71 0.20 0.12 0.24 0.47 0.95 18 3.82 0.22 0.30 0.08 0.05 0.11 0.21 0.41 19 3.29 0.19 0.30 0.08 0.06 0.12 0.21 0.41 20 3.04 0.18 0.77 0.23 0.16 0.34 0.50 1.04 finally, the minimum, average, and maximum imported and exported carbon emissions and the total carbon emissions that are generated in south africa, as reported by the international energy agency (iea, 2006), were used in equation (2) to estimate the carbon balance for south africa (see table 3): ci n + cg = ce m + cu (2) where the minimum, average and maximum values for imports and exports are indexed by n and m respectively; ci n is the total estimated n (minimum, average or maximum) of co 2 e emissions associated with imported products; cg is a constant value of co 2 e emissions generated in and released from the south african economy to produce products and services; ce m is the total estimated m (minimum, average or maximum) of co 2 e emissions associated with exported products; and cu is a calculated value (to balance equation 2) of co 2 e emissions associated with products and services that are utilised within the south african economy. table 3 estimated carbon balance for south africa carbon balance (million tonnes) imported co 2 e internally generateda exported co 2 e internally utilised min i / min e 35.35 + 386.66 = 105.88 + 316.13 min i / max e 35.35 + 386.66 = 188.19 + 233.82 max i / min e 53.14 + 386.66 = 105.88 + 333.92 max i / max e 53.14 + 386.66 = 188.19 + 251.62 ave i / ave e 43.73 + 386.66 = 144.64 + 285.75 a reported by the international energy agency (iea, 2006) 4 discussion of the carbon balance outcomes the nature of south africa’s economy from a carbon footprint perspective is interrogated using the data in table 3 and estimating the ratios of imported and exported co 2 e emissions to: the internally generated co 2 e emissions; the internally utilised co 2 e emissions; and the exported and imported co 2 e emissions (table 4). for example, the total imported carbon is likely to be less than 14 per cent of the total internally generated co 2 e, and is also less than 21 per cent of the internally utilised co 2 e, within the south african economy. and, on average, the total imported carbon is approximately a third of the total exported carbon. expressed another way, the exported carbon is at least twice as much as the carbon imported. furthermore, when compared to the total carbon generated within the south african economy, on average sajems ns 12 (2009) no 3 269 about a third is exported. however, it is noteworthy that this value could exceed 50 per cent of the carbon associated with products and services utilised internally in the south african economy (table 4). table 4 calculated ratios from the carbon balance ratio of imported co 2 e to: minimum maximum average internally generated co 2 e 0.09 0.14 0.11 exported co 2 e 0.19 0.50 0.30 internally utilised co 2 e 0.11 0.21 0.15 ratio of exported co 2 e to: minimum maximum average internally generated co 2 e 0.27 0.49 0.37 imported co 2 e 1.99 5.32 3.31 internally utilised co 2 e 0.32 0.80 0.51 it is interesting to compare these ratios with another rapidly developing country such as brazil. machado et al. (2001) report that brazil is a net exporter of carbon with the inflows and outflows of embodied carbon equating to 10 per cent and 14 per cent of the total carbon emissions of the brazilian economy, respectively; the comparable (average) numbers of south africa are 11 per cent and 37 per cent. in brazil 56 per cent more carbon is associated with a dollar earned with exports than a dollar spent on imports. for south africa this number is a minimum of 129 per cent, if utilising the maximum imported co 2 e (r453.60 billion spent) and the minimum exported co 2 e (r393.04 billion earned). it is therefore undeniable that south africa’s economy is not only extremely carbon-intensive, but it is also a major exporter of this carbon. additional evidence of south africa’s carbonintensity are the mining sector and its associated value-addition manufacturing activities, which contribute around 5 per cent and 16 per cent of south africa’s gdp, respectively (statssa, 2008). in this study it is estimated (from tables a4 and 3) that at least 74 per cent of the exported carbon is attributable to these two economic activities, namely mining and primary manufacturing. the amount of exported carbon from these activities is more than 27 per cent of the internally generated carbon of the country. this profile is comparable to other developing countries with large mining sectors. for example, the exports of copper account for approximately 15 per cent of the chilean gdp (anderson, 2004). it is estimated (from velasco, 2000; kuckshinrichs et al., 2007; iea, 2005) that the carbon embodied in these exports is in the order of 25 per cent of the internally generated carbon of the chilean economy. 5 policy interventions to influence the carbon balance of south africa 5.1 south africa’s grand challenge – maintaining economic growth while remaining competitive in a future carbon-constrained global economy to have even a 50 per cent chance of making a stabilization target of a 2°c global temperature increase5, the ipcc (2007) estimates that global emissions will have to peak by 2015, and be reduced by between 50 and 85 per cent of 2000 levels by 2050. in line with this, south africa’s climate change strategy sets out to achieve a reduction in the rate of increase in its ghg emissions by between 2020 and 2025, then to stabilise the emissions for ten years, and then to reduce the emissions in absolute terms from 270 sajems ns 12 (2009) no 3 between 2030 and 2035 onwards. the strategy will result in south africa emitting 100 million tonnes of ghg above its 2003 level to reach a ceiling of 550 million tonnes by 2025. the strategy responds to internationally sanctioned limitations on ghg emissions that are likely to become stricter and will be increasingly enforced across the world (de boer, 2008; jackson, 2008; beunderman, 2008). a consequence of these stricter international requirements is that they will make imports with large associated carbon footprints uncompetitive. low-carbon products will be preferred because international buyers will be subjected to substantial carbon taxes – likely to exceed the existing €18.7 per tonne of co 2 e being paid in the european union emissions trading scheme (pointcarbon, december 2008) – when importing high-carbon products into those countries. this is likely to negatively impact on the south african mining and manufacturing sectors that rely on export markets. an example is the manufacturing of aluminium. manufacturing of primary aluminium in iceland may be preferred in european markets, because the carbon footprint of the iceland aluminium ingots is in the order of a third of that of the south africa ingots, based on international life cycle analyses (iai, 2007), due to renewable energy resources being used in that country. south africa’s grand challenge therefore is to decouple its economic growth from carbon emissions in order to remain competitive in a future carbon-constrained global economy and to ensure it meets its socio-economic targets of halving poverty, to less than one-sixth of households, and unemployment, to below 15 per cent, by 2014 (republic of south africa, 2006). 5.2 approaches to decouple growth in south africa’s mining and manufacturing sectors from greenhouse gas emissions (ghgs) there are three main approaches that south africa could pursue to help ensure it meets this challenge: 1. increase the beneficiation of mineral resources in ways that generate domestic economic activity and employment while reducing associated ghg emissions. the south african government has recognised the need to increase the beneficiation of mineral resources to increase the value of exports, stimulate economic growth, and provide employment (dme, 2008a). however, the implications of this on the carbon balance depend on the manner in which this beneficiation is done. beneficiation of metal ores to a metal, for example, is energy intensive and will lead to an increase in the carbon footprints of exported products due to the coal-based nature of south africa’s energy supply. for example, the carbon footprint of ferro-alloy products is more than five times that of the iron raw material, on a total co 2 e export basis, and a factor of two, on an export value basis (see table a4). but, the further beneficiation of the metals to metal products is less energy intensive and will reduce the carbon footprint of south african exports. examples are the iron, stainless steel and aluminium products in table a4. therefore, given the energy and carbon intensity of the south african economy, it would seem that government policy should focus on expanding its production and export of metal products instead of ores and metals only. 2. increase the efficiency with which energy is supplied and used in the south african mining and manufacturing sectors. the south african government approved an energy efficiency strategy that sets the target for improved energy efficiency in south africa at 12 per cent by 2015 (dme, 2005). much of these efforts should be directed to the metals beneficiation sector, where new technological interventions may result in substantial carbon footprint improvements. an example is the ferrochrome industry, where new technologies could reduce the energy intensity per tonne produced by as much as 40 per cent (naicker & riley, 2006). therefore, government policy should focus on incentivising such technological interventions in the south african metal product value chain. sajems ns 12 (2009) no 3 271 3. diversify south africa’s energy sources, primarily towards increasing the contribution of nuclear and solar energy. the south african white paper on renewable energy has set a target of 10 000 gwh of energy to be produced from renewable energy sources, mainly from biomass, wind, solar and small-scale hydro, by 2013 (dme, 2003). in addition, the south african government has introduced a nuclear policy (dme, 2008b). the policy, and associated strategy, is seen as key to the government’s climate response plans that follow on south africa’s “long-term mitigation scenarios” (ltms) study (scenario building team, 2007); the aim is that half of the new electricity generation, or 20 000 mw, must be based on nuclear resources by 2025 (creamer, 2008a). increased feed-in tariffs are also on the horizon to support an increased diversity of energy supply (van der merwe, 2008), and policy interventions should be considered to extend this diversity even further. the relative effectiveness, efficiency and equity of each of these approaches will vary depending on their objectives (economic, social or environmental), design, and date of implementation. the optimal mix of the approaches therefore needs to be urgently assessed based on how well they contribute to fulfilling government’s socio-economic goals and longer-term environmental criteria. also, the appropriate mix of policies for facilitating the implementation of any one or more of these approaches is not immediately obvious. therefore, the policies being developed and implemented to decarbonise economies elsewhere in the world (stern, 2006) should be considered in the south african context. 5.3 broad policy interventions to facilitate south africa’s move towards a decarbonised economy three broad policy interventions are required for south africa to remain competitive on the international scene and to make a meaningful contribution towards climate-change mitigation, and, in so doing, meet its ethical responsibilities. these three policy approaches need to address entire production and consumption value chains in the economy, namely, begin-ofpipe interventions, transformation process interventions, and end-of-pipe interventions; and involve: 1. ensuring the social costs of ghg emissions are included in economic decision making of such interventions through quantity (cap-and-trade) and/or price(taxes) based mechanisms and standards; 2. removing barriers to investment in valueaddition activities (primarily the production of metal-products), low-carbon energy sources, and energy-efficient technologies, through free-trade negotiations, i.e. doha round, subsidies and/or tax-breaks, good governance, and reducing risk and uncertainty for such investments; and 3. promoting behavioural changes by providing information and easier access to finance and markets. appropriate design and early implementation are pivotal factors that will drive the effectiveness of each of these policies. incentive-based mechanisms such as taxes, subsidies, cap-andtrade, and hybrid tax-and-trading systems are promoted as more efficient and effective ways to meet environmental goals compared with traditional command-and-control approaches (fisher et al., 1995; stern, 2006). these are promoted because theory indicates that they create real financial reasons to mitigate emissions, i.e. lower abatement costs, while providing flexibility on how to do so and stimulating innovation (kolstad and toman, 2001). initial indications are that the south african government6 is leaning towards the introduction of price-based mechanisms, i.e. carbon taxes and clean-technology subsidies/tax breaks, instead of quantity-based mechanisms, i.e. carbon trading (ensor, 2008), but no evaluation and assessment of the context-specific factors that determine their respective strengths and weaknesses has yet been undertaken. the delays in evaluating and selecting appropriate policies are due to numerous factors: • the lack of a clear, long-term, global policy framework within which to work; 272 sajems ns 12 (2009) no 3 • a lack of clarity and understanding of the obstacles and the opportunities (i.e. potential for profitable investment) to clean-energy investment and increased beneficiation; • t h e l a c k o f s u f f i c i e n t a c c u r a t e a n d reliable data relating to the quantities of emissions, and the costs and benefits of abatement; • insufficient understanding about the risks, uncertainties and tradeoffs associated with these issues; and • limited capacity/capability and expertise on how to quantify uncertainties and tradeoffs, evaluate the beneficiation opportunities and policy options, and how to implement these. 5.4 further research requirements urgent and directed research efforts are required to address these issues. a research agenda with the following key components is therefore proposed: 1. undertake a diagnostic study (gap ana lysis) to: a. identify the opportunities and constraints to increased beneficiation in the mining and manufacturing sectors of the south african economy, and to public/private investments in clean-energy tech nology. b. assess the information, data and modelling capabilities that are available and what is required. 2. refine an economic input-output model for south africa. 3. develop appropriate data monitoring, collecting, and collating capabilities (i.e., equipment, processes, databases) and access protocols. 4. develop and calibrate integrated assessment models for south africa and the southern african region that will allow for contextspecific policies to be evaluated to better inform government. 6 conclusions the outcome of the carbon balance study highlights the energy and carbon intensity of the south african economy and specifically its exports. the study also emphasises the requirement of an appropriate government policy mix that supports increased value addition within the economy, whilst also providing incentives for all stakeholders in the south african economy to decrease the carbon footprints associated with all production and consumption processes. specifically, the opportunity is identified to reduce the south african export carbon footprint by placing an emphasis on beneficiation beyond refined metals to end products, e.g. south africa should not export steel, but steel products; not platinum, but exhaust catalysts and jewellery. in terms of the latter there is a need for government to address the import tariffs that many developed countries still pose on south african products from platinum. furthermore, the diversification of the south african electricity mix, and a focus on energy efficiencies in the heavy industry sector, are essential if the carbon footprints of the country’s products are to be reduced. this will become increasingly important as international limitations will become stricter and binding, and developed countries will either not buy south african less-beneficiated high-carbon products or will demand discounts, in order to cover the taxes they may face for importing south african carbon. to facilitate an economic transition, the paper describes a number of challenging policy issues that require urgent attention in order to remove uncertainty in decision making and to prevent south africa from committing to a highcarbon, and possible extremely costly, future. an economics research agenda is therefore proposed for the south african scientific, policy and business communities that lead to earlier and better decision making through improved understanding and collaborative engagement of all stakeholders. principally, the research should focus on disseminating environmental information and building transdisciplinary sajems ns 12 (2009) no 3 273 capabilities, economic input-output (and other) modelling, policy assessment, risk/uncertainty analyses, and improving understanding of behavioural responses to various policy mixes. and finally, the urgency of this research needs to be re-emphasised, because delays in defining clear, long-term energy and climate policy frameworks are setting south africa on a high carbon-emissions trajectory, which is likely to result in substantial social and economic costs in the not too distant future. 7 acknowledgements the authors wish to thank the reviewers of the paper and the editor that provided valuable inputs to improve the paper. endnotes 1 mukhopadhyay and chakraborty (2005b) describe the conflicting pollution haven and the factor endowment hypotheses (phh and feh, respectively) that economists and environmentalists continue to debate. 2 the terms ‘embodied carbon’ and ‘carbon footprint’ are used interchangeably in this paper and refer to the greenhouse gases (ghgs) emitted at all stages of a good’s manufacturing process, from the mining of raw materials through the distribution process, to the final product provided to the consumer (kejun et al., 2008). 3 carbon dioxide equivalency is a quantity that describes, for a given mixture and amount of greenhouse gas, the amount of co2 that would have the same global warming potential (gwp), when measured over a specified timescale (generally, 100 years). carbon dioxide equivalency thus reflects the time-integrated radiative forcing, rather than the instantaneous value described by co 2 e 4 the top 20 prioritised imports account for 61.7 per cent, and the top 100 imports account for 86.2 per cent of the total import value. the top 20 prioritised exports account for 78.7 per cent, and the top 100 exports account for 96.5 per cent of the total export value. 5 missing the 2°c target is seen by many to be courting disaster that extends beyond the environmental and could lead to intolerable impacts on human well-being, in spite of all feasible attempts at adaptation (ipcc, 2007). 6 the south african government recently adopted an ambitious climate change policy framework that includes the consideration of market mechanisms to curb climate change (creamer, 2008b), which is in line with national treasury’s (2006) investigations into environmental fiscal reform, specifically environmental-related taxes and charges, to support sustainable development. 8 references anderson, s.t. 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(2003) sustainable development south and north: climate change policy coherence in global trade and financial flows, sustainable energy and economy network paper, env/epoc/ rd(2003)8, available from: http://www.oecd.org/ dataoecd/31/18/2510875.pdf. 276 sajems ns 12 (2009) no 3 annexure table a1 the top twenty imports of the south african economy prioritised based on their economic values (2007 zar billion per year) import ranking generic description* of products tariff group import value (br/yr) import quantity units per year 1 crude petroleum products 27090000 76.85 22.09a million tonnes 2 original equipment components 98010000 40.47 626.47 million units 3 automotive products 87030000 31.04 0.34 million units 4 refined petroleum products 27100000 22.81 4.74 million tonnes 5 telephone sets/equipment 85170000 17.53 19.20 million units 6 data processing equipment 84710000 10.50 14.47 million units 7 road transportation products (other) 87040000 9.84 0.08 million units 8 earth moving equipment 84290000 8.57 0.01 million units 9 pharmaceutical products 30040000 8.25 0.04 million tonnes 10 transportation sub-components 87080000 7.82 1619.00 million units 11 mineral commodities (other) 71020000 7.05 1.37 million carrats 12 air transportation products 88020000 6.42 0.002 million units 13 printing products/equipment 84430000 6.37 12.91 million units 14 paint-related chemicals 28180000 4.75 1.76 million tonnes 15 accessories (other) 84730000 4.45 85.82 million units 16 turbine products/equipment 84110000 3.96 0.30 million units 17 tyre products 40110000 3.52 6.28 million units 18 audio/visual storage products 85230000 3.31 362.60 million units 19 minor medical products/equipment 90180000 3.23 275.98 million units 20 minor production sub-components 84310000 2.97 462.47 million units total imports 453.60 billion rands percentage of total imports 61.7 % * a detailed description of each of these products is available from sars (2008) and statssa (1993) a verified with the energy statistics of the south african department of minerals and energy (dme), available from http://www.dme.gov.za/energy/statistics.stm sajems ns 12 (2009) no 3 277 table a2 the top twenty exports of the south african economy prioritised based on their economic values (2007 zar billion per year) export ranking generic description* of products tariff group export value (br/yr) export quantity units 1 platinum group of metals (pgm) 71100000 69.04 0.32a kilo tonnes 2 gold commodity 71080000 39.94 0.30 kilo tonnes 3 ferro-alloy products 72020000 25.70 4870.00b kilo tonnes 4 coal-related products 27010000 23.68 68730.0 kilo tonnes 5 processing equipment 84210000 22.63 31.43 kilo units 6 automotive products 87030000 18.52 143.93 kilo units 7 mineral commodities (other) 71020000 17.53 21470.0 kilo carats 8 crude petroleum products 27090000 12.93 3720.00 kilo tonnes 9 stainless steel products 72200000 11.34 502.72 kilo tonnes 10 aluminium commodity 76010000 11.31 870.00c kilo tonnes 11 iron commodity/concentrate 26010000 11.24 31550.0 kilo tonnes 12 transportation products (other) 87040000 9.05 357.72 kilo units 13 refined petroleum products 27100000 7.57 1570.00 kilo tonnes 14 transportation sub-components 87080000 6.34 105880.0 kilo units 15 citrus fruit products 8050000 4.27 1480.00 kilo tonnes 16 iron products 72080000 4.11 970.00 kilo tonnes 17 chromium commodity/concentrate 26100000 3.93 3940.00 kilo tonnes 18 precious metals by-products 71120000 3.82 2.56 kilo tonnes 19 precious metals/concentrate 26160000 3.29 0.98 kilo tonnes 20 aluminium products 76060000 3.04 120.00 kilo tonnes total exports 393.04 billion rands percentage of total exports 78.7 % * a detailed description of each of these products is available from sars (2008) and statssa (1993) a updated from the johnson matthey pgm market review: platinum 2008, available from http://www.platinum.matthey. com/publications/pt2008.html b updated from the south african department of minerals and energy (dme) report number r52/2006: south african production trends 1995 – 2004, available from http://www.dme.gov.za/minerals/documents.stm c updated from the statistical data of the aluminium federation of south africa (afsa), available from: http://www.afsa. org.za/ 278 sajems ns 12 (2009) no 3 table a3 assigned carbon emissions (tonnes of co 2 e) to the top twenty ranked imports based on their total economic values (2007 zar) import ranking generic description of products co 2 e (mt/yr) co 2 /import (t/r’000) co 2 /import (approx.) units 1 crude petroleum products 4.40a 0.06 0.20 t/t 2 original equipment components 4.08 0.10 6.52 kg/t 3 automotive products 2.48 0.08 7.32 t/unit 4 refined petroleum products 4.53 0.20 0.96 t/t 5 telephone sets/equipment 0.67 0.04 0.03 t/unit 6 data processing equipment 0.53 0.05 0.04 t/unit 7 road transportation products (other) 0.79 0.08 10.06 t/unit 8 earth moving equipment 0.73 0.09 59.60 t/unit 9 pharmaceutical products 0.47 0.06 12.91 t/t 10 transportation sub-components 0.79 0.10 0.49 kg/unit 11 mineral commodities (other) 2.42 0.34 1.77 t/carrat 12 air transportation products 0.38 0.06 172.99 t/unit 13 printing products/equipment 0.40 0.06 0.03 t/t 14 paint-related chemicals 1.28 0.27 0.73 t/t 15 accessories (other) 0.22 0.05 2.62 kg/t 16 turbine products/equipment 0.27 0.07 0.88 t/unit 17 tyre products 0.41 0.12 0.07 t/unit 18 audio/visual storage products 0.36 0.11 0.98 kg/unit 19 minor medical products/equipment 0.15 0.05 0.54 kg/unit 20 minor production sub-components 0.30 0.10 0.65 kg/unit a more accurate carbon emission data was obtained from pe international lca calculations, contact dr johannes gediga (j.gediga@pe-international.com) sajems ns 12 (2009) no 3 279 table a4 assigned carbon emissions (tonnes of co 2 e) to the top twenty ranked exports based on their total economic values (2007 zar) export ranking generic description of products co 2 eq. (mt/yr) co 2 /export (t/r’000) co 2 /export (approx.) units 1 pgm commodities/products 28.28a 0.41 87.83 kt/t 2 gold commodity 16.36 0.41 54.23 kt/t 3 ferro-alloy products 19.47b 0.76 4.00 t/t 4 coal-related products 12.11 0.51 0.18 t/t 5 processing equipment 1.73 0.08 55.04 t/unit 6 automotive products 1.48 0.08 10.28 t/unit 7 mineral commodities (other) 6.02 0.34 0.28 t/carrat 8 crude petroleum products 3.62 0.28 1.19 t/t 9 stainless steel products 2.58 0.23 5.14 t/t 10 aluminium commodity 16.00c 1.42 18.39 t/t 11 iron commodity/concentrate 4.22 0.38 0.13 t/t 12 transportation products (other) 0.72 0.08 2.02 t/unit 13 refined petroleum products 1.50 0.20 0.74 t/t 14 transportation sub-components 0.64 0.10 6.04 kg/unit 15 citrus fruit products 0.82 0.19 0.55 t/t 16 iron products 0.74 0.18 0.76 t/t 17 chromium commodity/concentrate 0.71 0.18 0.18 t/t 18 precious metals by-products 0.30 0.08 0.12 kt/t 19 precious metals/concentrate 0.30 0.09 0.30 kt/t 20 aluminium products 0.77 0.25 6.62 t/t a more accurate carbon emission data was obtained from a lca study that was conducted for lonmin platinum, available from: http://www.lonmin.com b more accurate carbon emission data was obtained from csir lca calculations (raghubir et al.., 2000) c more accurate carbon emission data was obtained from a csir lca study (brent et al.., 2001) sajems ns vol 7 (2004) no 1 117 a macroeconomic approach to estimating effective tax rates in south africa ________________________________________________________________ adedeji amusa department of economics, university of pretoria ________________________________________________________________ abstract using data contained in south africa's national accounts and revenue statistics, this paper constructs time-series of effective tax rates for consumption, capital income, and labour income. the macroeconomic approach allows for a detailed breakdown of tax revenue accruing to general government and the corresponding aggregate tax bases. the methodology used also yields effective rate estimates that can be considered as being consistent with tax distortions faced by a representative economic agent within a general equilibrium framework. correlation analysis reveals that savings (as a percentage of gdp) is negatively correlated with both capital income and labour income tax rates. investment (as a percentage of gdp) is positively correlated with the capital income tax rate, an outcome suggestive of the direct relationship between volatile capital inflows into south africa and capital tax revenue. jel h20, 21, 30, 50 1 introduction most analyses of tax policies has been geared towards the formulation of a tax system capable of providing, in the most efficient and equitable way possible, adequate revenue to finance the required level of government expenditure. the literature on public finance and macroeconomic effects of fiscal policies suggests that a key component of economic decision-making is the use and application of distortionary taxation (mendoza et al., 1994). given the phenomenal rise in the global integration of economies of single nations, it has become imperative that domestic tax policies (especially those of developing nations) play a critical role in stimulating investment and economic growth. as developing countries integrate with the global economy, the development of effective and efficient tax collection systems that generate sufficient government revenue will aid in the reduction of excessive public sector borrowing, while catering to perceptions of foreign investors (tanzi & zee, 2000; aaron et al., 1999). despite the wide acceptance of taxation as an sajems ns vol 7 (2004) no 1 118 important policy tool, limitations in measuring relevant tax rates have hindered in-depth analysis of the macroeconomic impact of alternative tax policies aimed at providing the required impetus for promoting economic growth. the provision of reliable measures of tax rates is essential for two main reasons. first, reliable tax rate estimates are required to develop quantitative analysis and applications of theories related to taxation, thereby helping in the transformation of theory into an adequate policy-making tool. second, the construction of reliable tax rate estimates are necessary for macroeconomic modelling, especially in the assessment of implications of significant fiscal policy changes such as tax harmonisation in economic blocs, fiscal deficit reduction and allocation of government expenditures aimed at providing socio-economic reforms (mendoza et al., 1994). most previous studies on the construction of effective tax rates and the extension of the rates in analysing implications of tax policy on growth and business cycles have however, been conducted for developed countries or a mix of developing countries (see for example, greenwood and huffman, 1991; easterly & rebelo, 1993 and mendoza et al., 1994). none of these studies has provided specific investigations into constructing tax rates for developing countries. yet, developing countries especially middle-income, emerging market economies such as south africa present a special case to test. given south africa's socioeconomic and political history, the efficient mobilisation and maximisation of tax revenue represents a critical policy objective. an effective tax system would aid the government's objectives of allocating investment funds towards improving levels of physical and human capital, and addressing the backlogs in delivery of socio-economic infrastructure, especially among previously disadvantaged groups. 1.1 outline of paper this study provides a number of contributions to the present literature. the paper seeks to compute time-series estimates of effective tax rates on consumption, capital income, and labour income for south africa using the methodology developed by lucas (1990) and razin and sadka (1993). the main advantage of this method lies in its simplicity, as it utilises readily available information contained in national accounts and revenue statistics. the use of available macroeconomic data ensures that (i) the net effect of existing rules related to credit, exemptions and deductions are taken into account; (ii) a distinction is made between taxes on labour income and taxes on capital income, and (iii) there is incorporation of such taxes as property taxes and social security contributions that are not included on individual income tax returns (mendoza et al., 1994). sajems ns vol 7 (2004) no 1 119 in addition, the construction of reliable estimates of effective tax rates will benefit empirical research geared towards contributing to policies seeking to enhance south africa's tax system. for example, empirical studies on modelling tax collection, forecasting tax revenues or analysing the implications of changes in tax revenue patterns on stimulating economic growth are indicative of the potential practical use to which reliable estimates of effective tax rates can be put to. to our knowledge, specific studies utilising macroeconomic data in constructing effective tax estimates for south africa do not exist at present. it is thus the intention of this paper to present estimates of effective tax rates on major taxes, covering the period between 1990 and 20021. the rest of the paper is organised into five sections. section 2 discusses relevant literature and describes the methodology used to compute effective tax rates, while section 3 introduces the theoretical foundation and methodology. section 4 presents model estimations of the relevant effective tax rates while section 5 deals with underlying data issues. section 6 reports the results of the estimated tax rates while section 7 concludes. 2 literature review a number of studies have advanced different methodologies in constructing time-series data for effective and average tax rates on income and consumption. using data from united states, united kingdom, west germany and sweden, king and fullerton (1984) developed a methodology that computed capital income tax rates as the difference between post-tax and pre-tax rates of return on specific investment projects. in their approach, the pre-tax rate of return is defined as the value of the marginal rate of return (mrr). the mrr of an investment project is calculated as the rate of return that equates the expected discounted present value of future after-tax profits with a project's costs (where the costs take into account grants, allowances and the rate of depreciation). to apply the methodology defined above, a detailed set of information is required. such information relates to statutory taxes on corporate and individual income, form of income (interest, dividend income etc,), tax exemptions and accounting for depreciation of investment/capital goods. reviewing studies that have applied the king-fullerton approach2, mendoza et al. (1994) acknowledges that the methodology provides accurate measures of effective marginal tax on investments carried out at the microeconomic level. however, a significant drawback of the approach lies in its difficulty to transform the method into an aggregate model that captures macroeconomic phenomena such as anticipated inflation, inflation indexing and exchange rates, all of which affect tax bases. sajems ns vol 7 (2004) no 1 120 analysing fiscal policies and economic growth for a cross-section of countries, easterly and rebelo (1993) computed average tax rates as ratios of tax revenues to taxable capacities (or the tax base), where average taxes are proxied by the ratio of total individual income taxes to personal income, and the ratio of total tax revenue from income, profits and capital gains to gdp. this method, however, fails to make a clear distinction between different sources of tax revenue and the corresponding tax bases. in terms of country specific estimates of tax rates, studies by joines (1981), seater (1985), and barro and sahasakul (1986) have provided estimates of aggregate individual tax rates for the united states. in general, these studies adopt a similar approach to king and fullerton by calculating aggregate marginal tax rates as a weighted average of tax rates per tax bracket, where the weights used are based on the share of income in each tax bracket’s total income. a significant drawback of this approach is the non-provision of data that gives a detailed breakdown of revenue and corresponding tax rates related to labour, and capital income (mendoza et al., 1994). 3 theoretical foundation and methodology 3.1 theoretical exposition the framework for computing effective tax rates is largely based on the approach of estimating marginal tax rates at the microeconomic level. the theoretical concept of extending this micro level analysis to the national or aggregate levels has been the major thrust of studies by lucas (1990) and razin and sadka (1993). this foundation has been modified and extended in mendoza et al. (1994) and begins by assuming that the economy can be aggregated into three goods: consumption (c), labour (l) and capital (k). government expenditure can be classified into transfer payments, wage payments, and purchases of goods while tax revenue is disaggregated into taxes on labour income, taxes on capital income, and taxes on consumption (or excise taxes). congruent with the disaggregation of expenditure and revenue, transfers (denoted as b) and purchases of goods by the government sector (denoted as g) can be represented as three-dimensional vectors. the allocation of each good to households' consumption is represented by the vector h = (hc, hl, hk) while exogenous government policy regarding consumption of each good is denoted by the vector g = (gc, gl, gk). this implies that to produce c, firms rely on households to supply k and l, while government finances its expenditures by imposing taxes on consumption, capital and labour income. sajems ns vol 7 (2004) no 1 121 the imposition of taxes by the government yields two price vectors: the consumer's post-tax price vector represented as p = (pc, pl, pk) and the producer's pre-tax price vector denoted by q = (qc, ql, qk) respectively. the difference between consumer and producer prices t = p q gives the specific tax rate vector t = (tc, tl, tk), where the specific tax rate is measured per unit of each of the three goods. if tc is assumed to be positive, it indicates that consumption is taxed rather than subsidised. when labour and capital incomes are taxed, the consumers’ after-tax price for both commodities is typically lower than their producer pre-tax prices thereby making both tl and tk negative i.e., wages and capital income before tax exceed wages and capital income after tax. ad valorem taxes can therefore be computed as τi = ti /qi (where i = c, l, k) and the corresponding vector for ad valorem taxes is denoted as τ = (τc, τi, τk). with the price vectors p and q not readily available, measures of the relevant tax rates are approximated by multiplying ti and qi by an appropriate quantity measure, thus allowing for the utilisation of figures relating to tax revenues and the tax base rather than prices. to obtain the appropriate quantity measures, an examination of the household’s budget constraint is required. this is represented schematically as: dpyqbehp c−=−− .)( (1) where the three-dimensional vectors h, e, b and y denote gross consumption, possible endowments, government transfers, and net output respectively. the net consumption (or purchase) vector on which the specific tax vector t applies, is captured by h e b. for labour goods, households' net purchase of labour denoted as hl el bl (= hl el) is negative 3. in addition, yc which represents private sector output of the consumption good, is positive while yl and yk representing labour and capital (production) inputs, respectively, are both negative. a lump-sum tax used to finance any government deficit4 is defined by pcd. subsequently, q.y represents the value of net output in producer prices, measuring profits that form part of household income. based on the theoretical exposition above, the relevant ad-valorem tax rates can be specified as: cc cccc c yq yqyp − =τ (2) )( )()( lll llllll l heq hepheq − −−− =τ (3) kk kkkk k yq ypyq − −− = )( τ (4) sajems ns vol 7 (2004) no 1 122 where the numerators in the above equations denote the difference between pretax and post-tax valuation of consumption, labour income and capital income, respectively. the denominators are valued at pre-tax prices and relate to measures of the tax base (i.e. consumption and income) affected by each tax. the use of preand after tax valuation of income and prices results in aggregate effective tax rates consistent with realised average tax rates. as these tax rates are sourced from national accounts and revenue statistics, they represent summations of information regarding statutory taxes, credits, exemptions and deductions, and therefore capture the overall burden of each tax (mendoza et al., 1994). 4 model estimation 4.1 effective tax rate on consumption n estimating the effective tax rate pertaining to consumption, this study follows studies by razin and sadka (1993) and mendoza et al. (1994) that utilise a representative agent framework. this framework assumes a representative household involved in purchasing an aggregate consumption good and paying an ad-valorem tax. the effective tax rate on sales of consumption goods is estimated as: 100×⎥⎦ ⎤ ⎢⎣ ⎡ −−+ = dtgsgwgc dtgs cτ (5) where dtgs5 = domestic taxes on goods and services c = private final consumption expenditure g = government final consumption expenditure gw = compensation of employees paid by producers of government services. the numerator captures revenue accruing from indirect taxation. by definition, the numerator equals the difference between the nominal value of total consumption at pre-tax and after-tax prices, and the denominator denotes pre-tax value of consumption, i.e. the tax base. as government payments of indirect taxes only apply to its purchases of goods and non-factor services, compensation of government employees is deducted from overall government expenditure. sajems ns vol 7 (2004) no 1 123 4.2 effective tax rate on labour income there are a number of factors affecting reliable computations of effective tax rate on labour income. for example, due to the fact that tax returns are filed to cover all of a tax payer's income, the manner in which data on income taxes are compiled do not take into account the origin of the income. also, income tax data fail to provide a detailed breakdown of individual income tax revenue in terms of labour and capital income (mendoza et al., 1994; easterly & rebelo, 1993). in south africa's case, the somewhat detailed separation of national accounts regarding the economic activities of households, business and government sector allows us to overcome some of these shortcomings. to compute the effective tax rate on income, we first calculate households' average tax rate on total income: ⎥⎦ ⎤ ⎢⎣ ⎡ ++ = wpeiospue thip hτ (6) where thip= taxes on income, profits, and capital gains of households ospue = operating surplus of private unincorporated enterprises pei = households' property and entrepreneurial income w = wages and salaries of households. the tax rate on the representative agent's total income is thus defined as the ratio of individual tax revenue to pre-tax household income. the individual's income tax revenue is obtained from the difference between (aggregate) post-tax and pre-tax individual income where the latter is defined as the sum of wage and non-wage individual income, i.e. the denominator in equation (6). estimating the revenue from income tax on wages and salaries as τhw , the effective tax rate on labour income is computed as: ⎥⎦ ⎤ ⎢⎣ ⎡ + ++ = ecsw tpwtscwh l τ τ (7) where tsc = total social security contribution tpw = taxes on payroll and workforce ecs = employers contribution to social security. from equation (7) above, calculation of effective income tax rates encompasses payroll taxes and expands the tax base to include all social security contributions as part of revenues obtained from taxing labour income. sajems ns vol 7 (2004) no 1 124 4.3 effective tax rate on capital income to estimate the tax rate on capital income, we first derive the capital income tax on individuals as τh(ospue+pei), where pei includes capital income in the form of dividends, interest, rents and royalties. the effective tax rate on capital income can thus be calculated as: 100 )( ×⎥ ⎦ ⎤ ⎢ ⎣ ⎡ ++++ = os tofttoiptocpeiospueh k τ τ (8) where toc= taxes on income, profits, and capital gains of corporations toip = taxes on immovable property toft = taxes on financial and capital transactions os = total operating surplus of the economy. in equation (8) above, the numerator captures payments of capital income by households' and corporations, revenue from taxes imposed on financial transactions and recurrent taxes on immovable property, and represents the difference between postand pre-tax levels of capital income. the operating surplus of the entire economy can be viewed as the pre-tax value (or tax base) of capital.6 5 data sources and data issues for the most part, many of the required macroeconomic data are readily available in the sarb's quarterly bulletin. however, since this study draws upon a methodology applied to oecd countries, there is a need to revise variables used when extending this study to south africa's case. from equation (6), the tax base of household income should include the operating surplus of private unincorporated businesses, and this implies that informal sector activities are accounted for in the compilation of national accounts statistics. with an estimated output of over r32 billion, the informal sector in south africa accounts for about 7 per cent of total gdp and employs about 1.8 million people. despite these figures, it is quite difficult to ascertain true profits from informal sector activities. as south africa's national accounts have no stated figures or estimates of informal sector economic activities, the study excludes from its analyses, the operating surplus of private unincorporated businesses. the calculation of the effective tax rate on labour income requires the inclusion of all social security contributions, employers' contributions to social security sajems ns vol 7 (2004) no 1 125 and payroll taxes. in practice, social security contributions are meant to provide a safety net and source of income for citizens either unable to find gainful employment, or temporarily unemployed. while the present government provides some form of social funding especially to old age persons and disadvantaged citizens, comprehensive welfare schemes are non-existent in south africa7. data related to the south african government's finance statistics of social security funds is used as a proxy for total social security contributions8. in the same vein, employers' contributions to social security are non-existent in south africa, and are, therefore, excluded from computations. payroll taxes are a relatively new occurrence in south africa. introduced at the beginning of the 2000/01 financial year, the payroll tax is intended to fund the skills development initiative (sdi) with the overall objective of the initiative being the provision of training and improving the employment prospects of previously disadvantaged persons9. one of the variables required in estimating the tax rate on capital income is the recurrent tax on immovable property. like employers’ contributions to social security and operating surplus of unincorporated household ventures, neither data nor proxies exist for taxes on immovable property. hence, this variable is excluded from the analysis. taxes on financial and capital transactions are proxied by taxes on retirement funds, donations, estate duties and marketable securities all of which are listed as “other” under taxes on income, profits and property in the south african national accounts statistics. given the above issues, this study acknowledges the possibility that estimates of effective tax rates of consumption, capital income and labour income for south africa may be overstated or understated. by using a macroeconomic approach that clearly isolates the different sources of tax revenues and tax bases, and utilising available data contained in revenue statistics, the derived tax rate estimates will at least approximate actual estimates if, data corresponding to all variables were complete and available for south africa. as such, the study retains its significance and remains a starting point upon which other studies could build. 6 results the estimates of south african effective tax rates for consumption, capital income, and labour income over the period 1990 2001 are plotted in figure 1. sajems ns vol 7 (2004) no 1 126 figure 1 effective tax rates of consumption, labour and capital: south africa, 1990-2001 0 5 10 15 20 25 30 35 40 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 years p er ce nt (% ) etc etl etk keynote: etc, etl and etk are effective tax rates for consumption, labour and capital respectively source: see table 1 the effective tax rates on consumption displays a constant trend averaging 14 per cent while the effective rates on labour income indicates a slightly increasing trend, averaging 15 per cent over the sample period. the effective tax rate on capital shows some fluctuations, which can be traced to a number of internal and external socio-economic and political events. in the years leading up to the 1994 general elections, negative sentiments on the part of domestic and international investors, wary of potential political instability and south africa becoming another failed african state, resulted in large capital outflows. the commitment of the new government in pursuing viable macroeconomic policies, a stable political environment, and liberalization policies (such as the gradual relaxation of capital and exchange controls) has had a positive impact on capital inflows into south africa (masters, 2001; nowak, 2001). however, as an emerging market-economy, south africa remains prone to investor sentiments and market contagion emanating from economic crises that beset other emerging market-economies10. in effect, south africa's emerging market status has led to significant increases in the volatility of capital inflows and, in turn, caused fluctuations in the revenue generated from taxes imposed on capital income. the increasing trend in income tax reflects the post-1994 increase in the employment of south africa's non-white population, an sajems ns vol 7 (2004) no 1 127 occurrence that has broadened the distribution of income, and the income base. in addition, the strengthening and enhancement of the south african revenue service (sars) administrative capabilities, especially in the area of income tax, has enabled higher revenues to be generated from income. the results obtained show that for south africa, taxes on capital income exceeded those of consumption and labour income (see appendix a). over the sample period, effective tax rates averaged 14, 15 and 28 per cent for consumption, labour income and capital income respectively. this finding seems to indicate that if labour and consumption are taxed less (more), south african authorities tend to tax capital more (less). using a common sample correlation exercise, it is noted that the tax rate on capital is negatively correlated with savings (-0.07) and positively correlated with investment rates (0.42). table 1 effective tax rates for consumption, labour income and capital income (in per cent) year consumption labour income capital income 1990 13.9 13.1 33.9 1991 13.3 13.6 27.7 1992 12.8 14.1 23.5 1993 14.0 13.5 22.0 1994 14.7 14.5 23.0 1995 14.6 14.5 22.2 1996 14.3 15.1 26.0 1997 14.4 16.0 27.7 1998 14.7 16.8 32.2 1999 14.9 17.0 33.3 2000 14.5 16.6 29.8 2001 14.5 17.7 32.2 source: author's estimates as described in the text the positive relationship between capital tax rates and investment might be a reflection of south african authorities’ increased utilisation of tax revenue towards investments in capital projects and infrastructure, a scenario that has complemented private sector investment and activities. however, it is more likely that the relationship reflects the positive correlation between capital taxes and capital flows, i.e. increased (decreased) capital (or investment) flows lead to increased (decreased) capital tax revenues. the correlation between taxes on labour income and savings is negative (-0.83), confirming theoretical sajems ns vol 7 (2004) no 1 128 expectations that taxes on labour income tends to reduce the savings of employees. 7 conclusions following studies by razin and sadka (1993) and mendoza et al. (1994), this paper presents a methodology for estimating effective tax rates for labour income, capital income, and consumption based on macroeconomic data contained in south africa's national income accounts and revenue statistics. the constructed time-series will serve as useful data in research related to dynamic macroeconomic models examining the implications of fiscal policies. covering the period 1990-2001, the constructed tax rates indicate that taxes related to capital have fluctuated sharply, where such fluctuations can be attributed to policies regarding transfers, exemptions and the gradual relaxation of restrictions on capital flows. with respect to labour income, taxes reflect an increasing trend in response to better tax administration regarding the collection of income taxes as well as the increased entry of previously disadvantaged groups into formal sector employment. only the effective tax on consumption exhibits a constant trend, a factor that can be attributed to the unchanged (since 1993) value added tax rate of 14 per cent and the zero rates imposed on basic foodstuffs. endnotes 1 comprehensive data covering consumption taxes, and taxes on labour and labour income, as compiled in the south african reserve bank (sarb) quarterly bulletins, are available from 1990 and this year is taken as the starting period for constructing the effective tax rates. 2 for examples of studies using the king-fullerton approach, see mckee et al. (1986) and the oecd (1991). 3 transfers related to labour (and income) are zero (i.e. b=0) as government is unable to create transfers per unit of labour (and capital) time. this point, combined with the fact that households are suppliers rather than consumers of labour services, means that the net consumption vector for labour is negative. 4 razin and sadka's (1993) discussion is based on a static model. they do, however, argue that in the single period (static period), savings (or future consumption) should be added to current consumption to obtain an indicator of lifetime consumption. similarly, the government deficit (or future taxes) must be added to current tax revenues to obtain an overall tax measure. under these conditions, razin and sadka postulate that the sajems ns vol 7 (2004) no 1 129 equilibrium of a dynamic economy will reduce to that of the static economy. 5 see appendix a for the list of corresponding four digit codes identifying listed variables as used in the sarb quarterly bulletin. 6 operating surplus is equal to the nation’s gross output (valued at producer prices) less consumption of fixed capital, compensation of employees (including contributions to social security) and subsidies. as such, this definition of operating surplus bears an implicit assumption of aggregate constant returns to scale and zero net profits (razin and sadka, 1993). 7 such comprehensive welfare schemes are taken in the context of western countries and include unemployment benefits, food stamps schemes, free or subsidised housing and education schemes. 8 this choice is informed by the fact that available funds for social grants are disbursed by governmental agencies. 9 disadvantaged persons refers to persons classified as non-white during the apartheid era. 10 the effects of external factors such as the asian crises of 1997 and the recent economic turmoil in latin america (especially in brazil and argentina) on south africa's exchange rate, asset (bonds and stocks) performance and capital flows serves to illustrate this point. sajems ns vol 7 (2004) no 1 130 appendix a domestic taxes on goods and services [dtgs]: sarb quarterly bulletin series 4582. private final consumption expenditure [c]: sarb quarterly bulletin series 6007. government final consumption expenditure [g]: sarb quarterly bulletin series 6008. compensation of employees [gw]: sarb quarterly bulletin series 6256. taxes on income, profits and capital gains of households [thip]: sarb quarterly bulletin series 6245. households' property and entrepreneurial income [pei]: sarb quarterly bulletin series 6241. wages and salaries of households' [w]: sarb quarterly bulletin series 6240. total social security contributions [tsc]: sarb quarterly bulletin series 4236. taxes on payroll and workforce [tpw]: sarb quarterly bulletin series 4574. taxes on income, profits and capital gains of corporations [toc]: sarb quarterly bulletin series 6230. taxes on financial and capital transactions [toft]: sarb quarterly bulletin series 4576 and 4572. operating surplus of the economy [os]: sarb quarterly bulletin series 6001. sajems ns vol 7 (2004) no 1 131 references 1 aaron, h.j. & slemrod, j. (1999) “the south african tax system: a nation in microcosm”, tax notes, the brookings institute: www.brook.edu. 2 barro, r.j. & sahasakul, c. (1983) “measuring the average marginal tax rate from the individual income tax”, journal of business, 56(4). 3 easterly, w. & rebelo, s. (1993) “marginal income tax rates and economic growth in developing countries”, world bank country economics department, series papers 1050. 4 greenwood, j. & huffman, g. (1991) “tax analysis in real business cycle model: on measuring harberger triangles and okun gaps”, journal of monetary economics, 99. 5 joines, d.h. (1981) “estimates of effective marginal tax rates on effective incomes”, university of chicago journal of business, 54(2). 6 king, m.a. & fullerton, d. (eds.) (1984) the taxation of income and capital: a comparative study of united states, united kingdom, sweden and west germany, nber, university of chicago press: chicago, illinois. 7 lucas, r.e. (1990) “supply-side economics: an analytical review”, oxford economic papers, 42(2). 8 masters, w. (2001) “the impact of capital flows to and from south africa”, southern african update, march: 9. 9 mendoza, e.g., razin, a., & tesar, l. (1994) “effective tax rates in macroeconomics: cross-country estimates of tax rates on factor incomes and consumption”, nber working paper no 4864. 10 nowak, m. (2001) “the volatility of capital flows in south africa: some empirical observations”, paper presented at the ber conference, johannesburg. 11 razin, a. & sadka, e. (1993) the economy of modern israel: malaise and promise, the university of chicago press: chicago, il. 12 seater, j. (1982) “marginal federal personal and corporate income tax rates in the united states: 1909-1975”, journal of monetary economics, 10(3). 13 south african reserve bank, quarterly bulletin, various years. pretoria. 14 tanzi, v. & zee, h.h. (2001) “tax policy for developing countries”, imf economic issue series, no 27. abstract introduction gaps in the current literature research hypotheses research methodology results discussion conclusion acknowledgements references about the author(s) mark bussin gordon institute of business science, university of pretoria, johannesburg, south africa hugo mouton gordon institute of business science, university of pretoria, johannesburg, south africa citation bussin, m. & mouton, h., 2019, ‘effectiveness of employer branding on staff retention and compensation expectations’, south african journal of economic and management sciences 22(1), a2412. https://doi.org/10.4102/sajems.v22i1.2412 original research effectiveness of employer branding on staff retention and compensation expectations mark bussin, hugo mouton received: 13 apr. 2018; accepted: 12 nov. 2018; published: 09 apr. 2019 copyright: © 2019. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: in a highly competitive, economically strained business environment it is essential for a business to balance the necessity of attracting and retaining top-performing employees and containing costs. employee branding is a management tool that can serve to retain staff and reduce compensation levels. aim: this study investigated the effects of employee branding on staff retention and compensation expectations. setting: five south african insurers participated in this research. methods: analysis of variance and correlational tests were used to test various hypotheses. results: the analysis indicated that increased perceptions of employer branding relate to staff with greater reports of retention and lower levels of compensation expectations. interestingly, demographic factors were not significant in the analysis, although trends were found in potential age differences and total years at an employer. conclusion: practically, the research provides a model to execute a successful employer branding strategy. the employer branding control cycle was developed to assist organisations to successfully execute an employer branding strategy. this model considers the design, implementation and monitoring phases of such a strategy. keywords: employer branding; retention; compensation; remuneration; effectiveness. introduction for south africa insurers, retaining top talent has been identified as the third highest risk in 2017, and the ninth highest risk for insurers globally (study of financial innovation 2017). there is a concerted effort to improve employer branding due to the recognition that this branding can improve retention, potentially increase performance and reduce compensation costs (biswas & suar 2016). however, little research on employer branding exists, even though its practices may be widespread in organisations (kucherov & zavyalova 2012). given the employer brand’s potential impact on business productivity and sustainability, the necessity of investigating the impact is evident. and, if positive, it is important to provide a framework for businesses to take a more strategic approach to organisational strategy to improve their competitiveness in difficult economic circumstances. businesses in south africa have to manage skill shortages (rasool & botha 2011) and high employee turnover (van zyl 2011), with talent scarcity affecting business success (biswas & suar 2016). this turnover increases organisational costs, with replacement costs for an entry-level position between 50% and 100% of the employee’s salary, and up to 200% for senior levels (clair 2016; porter 2011). often, what distinguishes a business in highly competitive sectors and economies is their staff – or top talent (pregnolato, bussin & schlechter 2017). retaining this top talent becomes an essential competitive strategy (biswas & suar 2016), which influences overall financial performance (smit, stanz & bussin 2015). employer branding conceptualised employer branding is composed of tangible and intangible benefits offered by an organisation to attract and retain employees (tanwar & prasad 2017). a competitive remuneration structure is traditionally the cornerstone of employer brand, but research has found that psychological factors such as work–life balance, work atmosphere (tanwar & prasad 2017) and more flexible work arrangements (hagel 2012) are increasing in significance for employees. techniques to improve employer branding include internal communication, training support, various leadership practices (such as the visibility of senior managers), reward programmes, recruitment practices, and feedback from clients and staff (vatsa 2016). social identity theory provides confirmation that employer branding increases organisations’ attractiveness and retention, as current and potential employees pursue membership in organisations that boost their self-concept (biswas & suar 2016). social identity theory inspects when and why people identify themselves as members of a group (zeugner-roth, žabkar & diamantopoulos 2015). a better employer brand might reduce recruitment costs as applications are received more easily, and retaining employees is cheaper than replacing them (biswas & suar 2016). better candidates might be attracted as the organisation appears to provide better career choices (ambler & barrow 1996) and employee turnover might be reduced because employee relations are enhanced (berthon, ewing & hah 2005). the success of an employer brand is considered through the attractiveness of the benefits provided and how accurately it is communicated (moroko & uncles 2008). the study also reveals that brand personality traits such as sincerity, excitement and sophistication are related to the affect and trust of the employer brand, which in turn predict employer brand attractiveness (rampl & kenning 2014). the current academic studies on employer branding relate more to the attraction of potential employees than their retention (kucherov & samokish 2016), although the employer brand is believed to enhance the retention of current staff (biswas & suar 2016; clair 2016). employer branding increases performance employer branding enhances both financial and non-financial performance (biswas & suar 2016; martin, gollan & grigg 2011; smit et al. 2015). the reason for this is that more engaged employees enhance financial returns (biswas & suar 2016). it may also be the case that direct costs are affected by the employer brand. berthon et al. (2005) argue that a strong employer brand may reduce salary expectations (berthon et al. 2005). it is well established that performance is positively affected by high levels of engagement in top talent (anitha 2014), and there is already a concerted research focus on what elements lead to greater employee retention (kucherov & zavyalova 2012). there is little evidence, however, to elucidate which elements of employer branding lead to greater retention (kucherov & zavyalova 2012). this is surprising, given that vatsa (2016) argues that employer branding should first focus on the retention of current employees because recruitment and replacement costs are so high (clair 2016). since it makes good business sense for organisations to focus on employer branding for retention purposes, this article provides empirical evidence of the impact of employer branding on staff retention. employer branding is a strategic action not all factors in employer branding are tangible. the work atmosphere, employee development, work–life balance, company’s ethical stance and financial rewards can all improve branding (tanwar & prasad 2017). these elements are also part of the less tangible ‘culture’ of an organisation. so the question posed is whether employer branding is identifiable by employees, and whether it influences their decision to remain with an organisation. if it is found that retention is increased with elements that employees consider to be part of employer branding, then this provides a practical framework within which a business can design a strategy for retaining top talent. as a specific example of the link between employer brand, employee retention and the result of increased productivity, consider that people may be willing to take a salary cut to work for a company with a good employer brand, such as google. google is considered to have a leading employer brand, treating employees like precious commodities (matsangou 2015). if staff turnover rates are reduced, the acquisition, resourcing and transition cost to the company is reduced. gaps in the current literature through a review of the current employer branding literature, three main areas that require further research have been identified. these gaps were identified through either statements from the current literature or the lack of literature on the topic. the first gap relates to the influence of employer branding on compensation (rampl & kenning 2014). it is believed that a strong employer brand could potentially reduce the salary expectations of employees (berthon et al. 2005), although this has not been proven by means of empirical evidence. the second gap relates to the retention of existing employees. although research was triggered by ambler and barrow in 1996, previous studies on employer branding focused more on potential employee attractiveness rather than the retention of current employees (kucherov & samokish 2016). with the development of tanwar and prasad’s (2017) employer branding scale, they questioned what impact employer branding has on job satisfaction, commitment to a current employer and employee retention. the scale can test these organisational outcomes. the third gap relates to the influence of various demographic factors on an employee’s perception of employer branding. current studies considered employee attractiveness in general rather than specific attributes or target groups (sommer, heidenreich & handrich 2016). with the development of tanwar and prasad’s (2017) employer branding scale, they questioned whether specific factors like gender, occupation or managerial level have an influence on employer branding perceptions. they believed, without empirical evidence, that different subgroups assign different levels of importance to the dimensions of employer branding. research hypotheses this study evaluated employer branding as a management strategy for retaining good-quality staff (biswas & suar 2016; clair 2016). three groups of hypotheses were developed to investigate the impact of employer branding on retention and compensation perceptions: h1a: employer branding perceptions differ between age groups h1b: employer branding perceptions differ between males and females h1c: employer branding perceptions differ between races h1d: employer branding perceptions differ between education levels h1e: employer branding perceptions differ for duration of employment groups h2a: employer branding perceptions of a current employer are correlated with the salary expectations to move to another employer with a perceived strong employer brand h2b: employer branding perceptions of a current employer are correlated with the bonus expectations to move to another employer with a perceived strong employer brand h2c: employer branding perceptions of a current employer are correlated with the leave expectations to move to another employer with a perceived strong employer brand h3a: employer branding perceptions of a current employer are correlated with how satisfied employees are with their current employer h3b: employer branding perceptions of a current employer are correlated with employees who are actively looking to move h3c: employer branding perceptions of a current employer are correlated with how likely employees are to consider moving to another organisation if they were approached research methodology the research followed a quantitative, cross-sectional research design. at the time of the study, there were 173 registered insurers in south africa. five insurance companies, which compete for the same labour market, participated in the survey and were selected by means of a non-probability sampling method. one of the participating companies was a large insurer with more than 2500 employees, of which 500 employees were selected to participate in a simple random-sample probability technique. for all the other companies, the request to participate in the study was sent to all employees in the company. the online questionnaire was sent to 1083 employees, of which 254 completed the survey anonymously, presenting a 23% response rate. the instrument was designed to measure perceived employer brand strength, compensation levels for which the respondent would consider moving to another organisation, and how likely the respondent was to consider moving. the employer brand portion of the questionnaire consisted of tanwar and prasad’s (2017) employer branding scale, a five-point likert scale measure from strongly agree to strongly disagree (table 1). table 1: employer branding scale. perceptions of compensation were measured by providing respondents with packages from two employees for comparison. salary, bonus (including short-term and long-term incentives) and annual leave were considered as dimensions for compensation. table 2 outlines an example of such a scenario. table 2: example of compensation-preference question. the final part of the questionnaire considered staff retention using three simple questions. the first question measured, on a five-point likert scale, how satisfied the respondent was with his or her current employer. the second question asked the respondent if he or she was currently looking for another job; a yes or no answer was captured. the third question also had a five-point likert scale where the respondent was asked if he or she would consider working for another organisation if approached. tanwar and prasad’s (2017) employer branding measure was found to have a cronbach’s alpha reliability score of above 0.7. when run on a small sample of 24 as a pilot, this finding was replicated except for two measures (‘work–life balance’, and ‘compensation and benefits’). of the 254 participants, 24% were below the age of 30, 29% were between 30 and 39, 29% were between 40 and 49, and 18% were aged 50 years or above. of the employees, 44% were male and 56% female. in terms of racial groups, 36% were white people, 32% black people, 16% mixed race people and 13% indian people. the remaining 3% of respondents did not disclose this information. finally, for education, 35% of respondents had a grade 12 or diploma, 25% had a graduate degree, 22% had a postgraduate degree and 18% had no tertiary education. for employment, 47% of the respondents had been with their employer for less than 5 years, while 23% had been with their employer for more than 15 years. on average, employees had been with their employer for 8.9 years, with a standard deviation of 9.3 years. results table 1 shows the means and standard deviations on each item of the tanwar and prasad (2017) employer brand scale. figures 1–3 show the frequency distribution for the questions relating to compensation. figure 1: frequency distribution for the level of salary for which an employee would consider moving to another organisation with a perceived strong employer brand. figure 2: frequency distribution for the level of bonus for which an employee would consider moving to another organisation with a perceived strong employer brand. figure 3: frequency distribution for the level of leave for which an employee would consider moving to another organisation with a perceived strong employer brand. all compensation variables were highly, positively and significantly correlated at p < 0.05. finally, on retention characteristics, most respondents were not looking for other jobs (71%), but 55% did say that they would consider moving if approached. hypothesis 1 – employer brand perceptions differ across groups h1a: employer branding perceptions differ between age groups h1b: employer branding perceptions differ between males and females h1c: employer branding perceptions differ between races h1d: employer branding perceptions differ between education levels h1e: employer branding perceptions differ for duration of employment groups a significant difference for age was found through an analysis of variance (f = 2.77, p < 0.05). post-hoc analysis indicates that the difference is between the younger group (up to 29 years) and the 50+ years group. overall employer brand perceptions increase with age. interestingly, a significant difference was found for the length of employment (f = 3.27, p < 0.05), with post-hoc analysis indicating that the difference was between the groups of 10–14 years’ worked and 15+ years’ worked. the only hypotheses supported are h1a and h1e, on age groups and length of service, respectively. no significant difference in the perception of employer brand was found for gender groups, education levels or racial groups. hypothesis 2 – relationships between employer brand perceptions and compensation expectations h2a: employer branding perceptions of a current employer are correlated with the salary expectations to move to another employer with a perceived strong employer brand h2b: employer branding perceptions of a current employer are correlated with the bonus expectations to move to another employer with a perceived strong employer brand h2c: employer branding perceptions of a current employer are correlated with the leave expectations to move to another employer with a perceived strong employer brand all three measures of compensation were significantly and positively correlated (see table 3). table 3: spearman’s rho tests for the compensation variables. employer branding was positively and significantly correlated with all the measures of compensation (see table 4). table 4: spearman’s rho tests for compensation and employer branding. hypothesis 3 – employer branding is related to retention h3a: employer branding perceptions of a current employer are correlated with how satisfied employees are with their current employer h3b: employer branding perceptions of a current employer are correlated with employees who are actively looking to move h3c: employer branding perceptions of a current employer are correlated with how likely employees are to consider moving to another organisation if they were approached employer branding was positively and significantly correlated with being satisfied in one’s position. it was also negatively and significantly associated with people who were actively looking for other employment or who would consider offers if approached for another position (see table 5). table 5: spearman’s rho tests for employee retention and employer branding. all hypotheses were upheld, and highly significant relationships were found. discussion the impact of demographic characteristics on perceptions of employer branding the research objective of these hypotheses was to consider the role demographic variables may have on perceptions of employer branding. experience, gender or racial background may influence perceptions of employer branding. total rewards studies have suggested that different reward structures appeal to different demographic groups (bussin & toerien 2015; pregnolato et al. 2017; smit et al. 2015). if this is the case, then one would expect that demographic factors would be important to perceptions of employer branding (sommer et al. 2016). the current study found no significant differences in gender, educational level or race on perceptions of employer branding. these demographic variables did not affect the perception people had of the branding. interestingly, years of service and age did have an effect on this perception, but in very specific groups. the finding of very few significant differences in perceptions of different groups of employees by personal characteristics is contrary to what is suggested in the literature (rampl & kenning 2014; tanwar & prasad 2016) for instance, maxwell and knox (2009) argue that employer branding is differently perceived by different groups, which led kucherov and zavyalova (2012) to recommend that messages should be adjusted for a particular target audience. previous research has also indicated that staff turnover does differ by demographic characteristics, mainly age and years of service (schlechter, syce & bussin 2016; smit et al. 2015). this study found that perceptions of employer brand were significantly different between the youngest employees and the oldest, with the scores increasing with age. also, in groups of employees with 10–14 years of experience, there was a difference compared to the 15+ years group. the former had lower perceptions than the latter. across all the years of experience, a general decline in employer brand perception occurs and is most pronounced and significant in employees with the longest tenure. this may be due to an ‘acclimatisation’ of employees over the years but could also be a factor of organisations focusing their main efforts on the attraction of staff rather than on factors that affect retention. additional research is required to determine the cause of this decline in perception. employer branding perceptions and compensation employees have specific compensation expectations. these expectations are a critical factor in employee engagement and are one of the features that employer branding could mitigate in ensuring resource costs are contained. the intention was to investigate if perceptions of employer brand were in any way related to compensation expectations. this would indicate a trend in the two concepts, which is worth investigating and considering when developing the employer brand. this portion of the study aimed to determine whether people would consider compensation to be a central factor when looking to move employers. for the salary, bonus and leave components of compensation, there was a moderately strong positive correlation between the overall employer branding score and the compensation components tested. the correlations demonstrate that as employees’ perceptions of employer branding of their own organisations increase, their willingness to work for a lower salary and benefits also increases. similarly, those with lower scores on the perception of employer branding chose higher compensation at their current employers compared to other organisations with a perceived strong employer brand. employer branding perceptions and staff retention retention is an important part of the concept of employer branding and its intended objectives to attract and retain staff (ambler & barrow 1996). biswas and sauer (2016) argue that the costs associated with replacing current employees are high and employer branding could be used to enhance employee relationships and ultimately reduce employee turnover (berthon et al. 2005). the current research found that employees with a high overall employer branding score were more satisfied with their employers, and employees with low overall employer branding score were less satisfied with their employers. also, people with high overall employer branding scores were less likely to be actively looking to move and were less likely to consider leaving the organisation if approached by another company. management application – the employer brand control cycle the employer brand control cycle (ebcc) is a practical representation of the continuous process that organisations should follow when employer branding strategies are considered (see figure 4). the first step is the identification of target groups within the organisation. this will inform the employer brand of elements to develop (moroko & uncles 2009). the employer branding dimensions that should be considered are the work atmosphere; training and development; work–life balance; ethics and corporate social responsibility; and compensation and benefits. the target group takes into consideration the age, education level and employment duration. the design process should consider the long-term strategy of the organisation to ensure that the appropriate target group is identified. figure 4: employer branding control cycle model. the next step is the implementation of the strategy. current employees’ testimony is the best form of employer value-proposition advertising through word of mouth (vatsa 2016). employer branding needs to be communicated to employees, training around the brand should be provided, leaders in the organisation need to set an example of the brand values, appropriate behaviour should be recognised and rewarded, recruitment processes should be built around attracting the right staff, and conscious actions should strengthen the sustainability of the brand (vatsa 2016). potential employees should then be targeted; the employer brand should be communicated by means of a devoted career page on the company’s website, the wide circulation of company newsletters, sponsorships and the appropriate use of social media (clair 2016; vatsa 2016). the next step in the ebcc considers the monitoring of the impact of employer branding. as shown in this study, staff turnover levels should decrease following the successful implementation of an employer branding strategy. the quality of employees attracted to the organisation increases as they receive favourable communication (vatsa 2016). this study also shows that the compensation expectations of both internal and external employees then decreases. the monitoring of the effects should then feed into the design of the employer branding strategy once again. this continuous process is required to ensure that the employer branding strategy aligns with the company’s long-term strategy (moroko & uncles 2009), as the competitive landscape, company needs and employee requisites change over time. limitations some of the dimensions in the employer branding scale had a low cronbach’s alpha. even though the employer branding scale was developed and verified (tanwar & prasad 2017), the original study was based on indian it firms. the scale was impacted, to some extent, by cultural and by industry differences. only five south african insurers were incorporated into the study, with responses dominated by two of the companies. the responses might therefore not reflect the views of the whole industry. the study was also limited to insurers only, and therefore inference to the whole of south africa was not possible. the sample size was small, relative to the population, suggesting a higher margin of error. there was insufficient data to perform a multivariate analysis of variance on the demographic factors, which considers the employer branding score per demographic factor and company. although the questionnaire touched on some of the principles of a conjoint analysis for the compensation-based questions, a full preference-based study was not performed. the analysis requested users to choose between the options in the questions, which did not encapsulate all considerations of a real-life situation. the questions also did not request an ultimate level for salary, bonus or leave that would convince an employee to move to another organisation. two respondents indicated via email that the questions in part 3 of the questionnaire were too sensitive to complete and therefore did not continue. the economic circumstances in south africa at the time of the study affected the choices of the respondents. choices might be more conservative due to the technical recession that took place during the year in which the study was conducted, and due to recent country downgrades by leading ratings agencies, as well as economic instability enhanced by political uncertainty. the research was limited to the insurance industry and the demographic profile of the research was not representative of south africa’s profile. therefore, care should be taken not to infer the results of the study to all industries and the whole of the country. employer branding preferences in other countries might also be different from south africa’s preferences due to cultural and economic differences. the research did not include the actual employer branding strategies of the participating companies, which might influence the interpretation of the results. suggestions for future research it would be interesting to perform the study in other countries to investigate the effect of culture on employer branding preferences. expanding the study to different industries might affect the study as the insurance industry is known to be conservative. the results might also be different in bullish economic circumstances where employees have a wider choice of employers. by including companies’ employer branding strategies and implementation methods, future research could determine if there is a difference between companies with strategies and those without. such research could also be extended to determine which of the strategies and implementation methods were the most effective. a longitudinal study could also be done to determine employer branding scores before the implementation of strategies and after, to determine the most successful strategies. the quantification of employer branding costs is critical in understanding its financial implications. such a study could be combined with the quantification of the overall reduction in compensation, to determine the net financial impact of employer branding on companies. conclusion this study considered employer branding as a management strategy for retaining current employees and attracting the right talent (biswas & suar 2016; clair 2016). five south african insurance organisations were surveyed on employer branding and retention intentions. the findings demonstrate that, in line with berthon et al.’s (2005) argument, employer branding can be used to reduce compensation and therefore direct costs. employer branding also serves to retain staff if positively perceived (ambler & barrow 1996; kucherov & samokish 2016). overall, biswas and suar’s (2016) findings were confirmed: that companies with different employer branding strategies are perceived differently. future research should focus on a larger variety of organisations, and consider additional measures of employer branding to validate the perception survey of employees. it is clear that business management must consider an evolving work environment to revise procedures and integrate better talent-management practices (schlechter, thompson & bussin 2015) in order to retain top-performing staff. to this effect, the ebcc model has been presented as a management tool to start developing the employer brand strategy. acknowledgements competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contribution the study was conducted by h.m. as part of his mba at gibs. m.b. was the supervisor and wrote the article. references ambler, t. & barrow, s., 1996, ‘the employer brand’, journal of brand management 4(3), 185–206. https://doi.org/10.1057/bm.1996.42 anitha, j., 2014, ‘determinants of employee engagement and their impact on employee performance’, international journal of productivity and performance management 63(3), 308–323. 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https://dspace.nwu.ac.za/bitstream/handle/10394/7273/vanzyl_ma.pdf?sequence=2 vatsa, m., 2016, ‘leveraging employer branding for organizational success’, review of management 6(1–2), 9–13. zeugner-roth, k.p., žabkar, v. & diamantopoulos, a., 2015, ‘consumer ethnocentrism, national identity, and consumer cosmopolitanism as drivers of consumer behavior: a social identity theory perspective’, journal of international marketing 23(2), 25–54. https://doi.org/10.1509/jim.14.0038 microsoft word 4.doc sajems ns 15 (2012) no 2 171 financial liberalisation and the dynamics of firm leverage in a transitional economy: evidence from south africa chimwemwe chipeta school of economic and business sciences, university of the witwatersrand hendrik p wolmarans and frans ns vermaak department of financial management, university of pretoria accepted: april 2012 this paper examines the dynamics of corporate capital structures for listed non-financial firms in south africa. the dynamic models of capital structure have been utilised to document several findings of empirical significance. first, transaction costs reduce dramatically in the post liberalisation regime, and the associated speed of adjustment is more pronounced, and statistically significant for the post liberalisation epoch. second, financial liberalisation has a significant impact on the capital structure speed of adjustment. third, the results confirm most of the theoretical predictions of capital structure theories; however, the relationship is more significant in the post liberalised regime. finally, new evidence has been revealed on what determines the debt maturity structure of firms in a transitional economy. key words: financial liberalisation, leverage, gmm jel: g32 1 introduction the effect of relaxing the modigliani and miller (1958) capital structure irrelevance assumption of perfect capital markets suggests that there are firm-specific impediments that constrain firms from achieving the desired level of the target leverage. such imperfections include taxes, flotation costs, adjustment costs and other constraints. in the context of financial liberalisation, a constrained economy is one which is characterised by an underdeveloped financial system with relatively fewer financing options. consequently, firms operating in such an environment may face high transaction costs. inevitably, firms operating in this environment will adjust to the optimal target with a relatively low speed of adjustment. conversely, firms operating in a liberalised economy should face fewer impediments in their efforts to adjust to a target level of leverage. the presence of an active and developed stock market, the re emergence of international financial institutions and an active public debt market promote competition in the domestic financial sector, thereby lowering borrowing costs. furthermore, demirguc-kunt and maksimovic (1996) argue that the development of the stock market improves transparency and the credibility of listed firms, thereby providing creditors the incentive to advance more debt to listed firms. in effect, the speed of adjustment to the desired target level of leverage should be higher. having said this, the issues to be investigated relate to whether firms operating in the period prior to and after financial liberalisation follow a long-run target adjustment to the desired levels of leverage. pursuant to this, the absence or presence of transaction costs needs to be established. furthermore, if transaction costs are present, the associated speed of adjustment to the desired level of leverage needs to be ascertained. in addition, very little literature has documented the determinants of financial structure in a closed economy (see boyle & eckhold, 1997; abstract 172 sajems ns 15 (2012) no 2 mutenheri & green, 2003), and how these determinants evolve with the transition to a more liberalised financial environment. this paper examines these issues for a panel of 70 non-financial firms listed on the johannesburg securities exchange (jse) for the period between 1989 and 2007. in order to establish the dynamics of firm capital structure in two dramatically different regimes, the arellano and bond (1991) and blundell and bond (1998) two-step generalised method of moments (gmm) techniques are utilised, and some interesting facts are revealed. first, transaction costs are documented for both the pre and post liberalisation regime. however, it appears that transaction costs reduce dramatically in the post liberalisation regime. the magnitude of the associated coefficient of adjustment increases accordingly. second, both episodes of financial liberalisation have a significant impact on the speed of adjustment towards the target leverage. third, the empirical relationship between firm-specific determinants and leverage in a closed economy appears to be weaker than that in the post liberalised regime. fourth, the results confirm most of the theoretical predictions of capital structure theories. fifth, new evidence has been documented on what determines the debt maturity structure of firms in a dynamic capital structure setting. the rest of the paper is organised as follows: section two discusses the factors that are correlated with firm leverage. section three discusses the relationship between financial liberalisation and firm-financing choices. section four discusses the data and its sources. section five estimates the dynamic model of capital structure. section six discusses the results, and section seven concludes the paper. 2 firm-specific determinants of capital structure 2.1 size size can be considered as an explanatory predictor for variations in firm leverage. larger firms are more likely to take on more debt than smaller firms. eriotis, vasiliou and ventoura-neokosmidi (2007) argue, firstly, that larger firms can negotiate for loans on more favourable terms. this provides an incentive for them to accumulate more debt at lower interest rates. secondly, because larger firms are less risky than smaller firms, banks are willing to loan them more funds. this lowers their probability of default. hence, a positive association is likely to be observed between size and leverage. on the contrary, drobetz and wanzenreid (2006) argue that large firms have sufficient analyst coverage and are subject to lower costs of information asymmetries. hence, they should access equity markets with relative ease. moreover, the fixed costs associated with equity issues should be smaller for large firms. on that account, size should be inversely correlated to leverage. the empirical evidence regarding size as a possible determinant of firm leverage is mixed. marsh (1982) examines the debt-equity choice for firms in the united kingdom and reports a positive relationship between the size of the firm and leverage. this direct relationship is later confirmed by bennet and donnelly (1993). booth, aivazian, demirguc-kunt, and maksomovic (2001) use the natural logarithm of sales to measure the importance of size in a sample of emerging-market economies, and they find size to be positively correlated with leverage for most of the firms in their sample. on the other hand, deesomsak, paudyal and pescetto (2004) use the natural logarithm of total assets, and they find a strong and statistically significant positive relationship between size and the debt-to-capital ratio for firms in the asia-pacific region. huang and song (2006) use the natural logarithm of sales as a proxy for size for chinese firms and they report strong and significant positive correlations between size and total leverage. similarly, eriotis et al. (2007) use the natural logarithm of sales and they confirm a statistically significant positive correlation between size and leverage for greek firms. alternatively, gwatidzo and ojah (2009) use the logarithm of total assets as a proxy for size. they confirm a statistically significant positive relationship between leverage and size for firms in south africa and zimbabwe.1 rajan and zingales (1995) examine a crosssection of firms in seven industrialised sajems ns 15 (2012) no 2 173 economies and find that size is negatively related to leverage for firms in germany and france. the plausible explanation for this inverse association is based on information asymmetries. according to the pecking order hypothesis, the information asymmetry between large firms and the capital markets should be low, thus enabling larger firms to issue informational sensitive securities such as equity with ease. this tends to lower the debt levels relative to equity. chen (2004) uses the natural logarithm of total assets and documents a negative association between size and the long term debt ratio for chinese firms. the author argues that the negative association may be due to larger firms’ reputation that enables them to access the equity markets with relative ease, and the fact that the chinese public bond market is virtually non-existent. delcoure (2007) documents a similar inverse relation between size, measured by the natural logarithm of total assets, and long term leverage for firms in european transition economies. nunkoo and boateng (2010) use the gmm technique to estimate capital structure determinants for 835 canadian firms. they also document a negative correlation between size, measured by the natural logarithm of total sales, and the long term debt ratio. to summarise, the picture that is emerging is that irrespective of the proxy being used, size tends to be strongly and positively correlated with leverage. however, in some studies, long term leverage is found to be inversely related to the size variable. this is due to the low information asymmetries associated with large firms. 2.2 profitability myers and majluf (1984) predict that a negative relationship should exist between firm profitability and leverage. they contend that firms that are more profitable will prefer to use retained earnings, and thus will have lower debt ratios. however, the trade-off theory posits that, in order to take advantage of the interest tax shields associated with higher leverage, more profitable firms will have higher debt ratios. similarly, the free cash flow theory hypothesises that profitable firms should issue more debt. this is a measure to bond the future cash flows and to discipline managers by paying out cash to bondholders instead of wasting the funds on negative npv projects. the pecking order theory hypothesises that profitability is inversely related to leverage. in contrast, the trade-off and the free cash flow theories suggest that profitability is directly related to leverage. a number of researchers have tested the effect of profitability on firm leverage. kester (1986) compares capital and ownership structure of manufacturing firms in the united states and japan. the author finds that there is a negative relationship between profitability and leverage, measured in terms of the total debtto-book and market value of equity. rajan and zingales (1995) and wald (1999) draw similar conclusions for the united states, united kingdom and japan. booth et al. (2001) find a negative correlation between leverage and profitability for a sample of firms in emerging markets. this relationship is, however, stronger than the rajan and zingales (1995) observation. mutenheri and green (2003) find no significant relationship between leverage and profitability for firms in zimbabwe. in fact, the observed coefficients for the fixed and random effects models are positive. bauer (2004) uses restricted ols models to test the effect of profitability on leverage for czech firms, and finds a negative and significant association between profitability and the debt ratio. delcoure (2007) uncovers statistically strong and negative correlations between profitability, measured as the return on total assets, and all measures of leverage. chang, lee and lee (2009) utilise the structural equation model to test the determinants of capital structure for firms in the compusat industrial files. they confirm a significant negative association between profitability (measured by the ratio of operating income to total assets) and all measures of leverage. strebulaev (2007) utilises dynamic trade-off models with adjustment costs and also shows that profitability is inversely related to book and market measures of leverage. likewise, gwatidzo and ojah (2009) find a negative and significant relationship for firms in south africa and ghana. the relationship for firms in zimbabwe is only negative and significant for 174 sajems ns 15 (2012) no 2 the short term debt ratio. the only exception is nigeria where the coefficients are positive and significant for the total and long term debt ratio. this positive association confirms the trade-off and free cash flow theories of capital structure. the evidence presented in the preceding discussion suggests that most firms in both developed and developing countries follow a pecking order in their financing decisions. these findings confirm the predictions of myers and majluf (1984). 2.3 asset tangibility the general consensus among researchers is that asset tangibility is directly related to leverage. jensen and meckling (1976) point out the possibility of risk shifting strategies whereby managers may shift to riskier investments at the expense of the bondholders. these agency costs of debt can be mitigated if the collateral value of assets is high. hence, asset tangibility is likely to be positively associated with leverage. furthermore, in the event of bankruptcy, a higher proportion of tangible assets could enhance the salvage value of the firm’s assets. the lenders of finance are thus willing to advance loans to firms with a high proportion of tangible assets. harris and raviv (1991) observe that nondebt tax shields and firm assets are usually regarded as proxies for asset tangibility. bradley, jarrell and kim (1984) use non-debt tax shields as a proxy for asset tangibility, and they find a statistically significant positive relationship between firm leverage and nondebt tax shields. alternatively, friend and lang (1988) use the ratio of net property, plant and equipment to total assets and they report a strong positive relationship between leverage and asset tangibility for both closely held and public corporations. on the other hand, titman and wessels (1988) incorporate the ratio of inventory plus gross plant and equipment to total assets and they confirm a positive association between collateral value and leverage. rajan and zingales (1995) use both the book and market values of leverage and they report a positive and significant relationship between leverage and asset tangibility for firms in most of their sampled countries.2 booth et al. (2001) observe a similar relationship for a sample of emerging market economies. in contrast, mutenheri and green (2003) examine the determinants of capital structure for firms in zimbabwe. they observe a strong negative association between asset tangibility and leverage for the pre reform period (1986-1990). however, a strong positive association is detected for the post reform period (1995-1999).3 the negative association observed for the pre reform period could be associated with the lack of proper contract enforcement systems associated with underdeveloped capital markets. therefore, asset tangibility may not be used actively as a criterion for advancing loans. abor and biekpe (2005) report a negative and significant relationship between asset tangibility and leverage for ghanaian firms. they attribute this observation to the higher operating risk associated with a higher proportion of fixed assets. huang and song (2006) perform robustness analyses by examining, inter alia, first difference regressions for chinese firms and a strong positive correlation is observed between asset tangibility and leverage. gwatidzo and ojah (2009) use fixed and random effects models and confirm a statistically significant positive relationship for firms in nigeria and south africa4 suggesting that financiers in these countries require collateral to issue long term debt. contrary to the predictions of the theory, sheikh and wang (2011: 127) document a strong negative correlation between book leverage and asset tangibility for listed manufacturing firms in pakistan. the authors note that the negative association could be due to the tendency for managers to ‘empire build’ at the expense of collateralised assets. overall, the empirical evidence discussed so far provides strong support for the positive association between asset tangibility and leverage predicted by capital structure theorists. a negative association is observed only in exceptional circumstances. 2.4 growth prospects capital structure theories suggest that growth opportunities are correlated to firm-financing behaviour. the general consensus among researchers is that growth opportunities are sajems ns 15 (2012) no 2 175 negatively related to leverage, principally because future growth prospects are intangible and hence cannot be easily collateralised (barclay & smith, 2005). however, the effect of growth is dependent on the measure used to capture growth. gupta (1969) uses the annual compounded growth rate in sales and finds that growth firms tend to have higher leverage than non-growth firms. this is partly due to their ability to access external finance in a relatively unconstrained manner. titman and wessels (1988) use the percentage change in total assets and they arrive at a similar conclusion for the ratio of long term debt to the book value of equity. this evidence is consistent with the prediction that growth firms add value to the firm and hence increase the firm’s debt capacity. delcoure (2007) pools data for firms in western european transition economies and fails to find a statistically significant association between firm growth prospects and leverage. a contrary view is pointed out by myers (1977) who argues that firms with growth potential will tend to have lower leverage. this is because firms with intangible growth prospects will generally avoid debt to mitigate the potential underinvestment problem associated with financial distress. eriotis et al. (2007) concur with this viewpoint by positing that growth causes variations in the value of the firm. larger variations are therefore interpreted as high risk. this presents a significant hurdle for growth firms to raise capital with more favourable terms. rajan and zingales (1995) use the market-to-book ratio of total assets to proxy growth opportunities and they find evidence supporting myers’ (1977) prediction. barclay and smith (1999) and ngugi (2008) reach the same conclusion for a sample of 6700 firms covered by compustat and kenyan firms respectively. on the contrary, al najjar (2011) finds a positive relationship between leverage and growth opportunities (measured by the market-to-book ratio) for jordanian firms. this finding is contrary to the predictions of myers (1977) suggesting that growth firms in jordan prefer to finance investments with debt. the preceding evidence shows that most studies that use the growth rate of assets as a proxy for firm growth opportunities tend to exhibit strong positive correlations. on the other hand, most studies that use some form of a market-to-book value of assets ratio reveal negative associations between growth and leverage. this is because growth in the asset base of a company provides an incentive for creditors to advance loans to growth firms. conversely, the market-to-book ratio reveals intangible growth opportunities which may not easily be collateralised. 2.5 corporate taxes the introduction of taxes to the modigliani and miller (1958) irrelevance model suggests that corporate taxes are a vital element in the determination of firm leverage. modigliani and miller (1963) demonstrate that the tax savings associated with interest tax shields induce firms to take on more debt. therefore, a positive association between tax and leverage should be observed. the bone of contention, however, has been to determine a reliable proxy for the tax rate. most studies use the ratio of taxes paid to total taxable income, and the empirical evidence has, at most, been conflicting. homaifar, zietz and benkato (1994) utilise a general autoregressive distributed lag model to test modigliani and miller’s (1963) tax relevance predictions for both the short run and the long run. they document a long-run positive relationship between leverage and corporate tax. however, no significant relationship is observed in the short run. graham (2001) uses a sophisticated simulation technique in an attempt to derive a more accurate measure of the effective tax rate and concludes that taxes affect leverage in a positive manner. negash (2002) argues that, where there is a change in the tax regime, the use of simulation to estimate the effective tax rate may not be appropriate. in his study of firms operating in a tax regime where firms are not progressively taxed, he finds that taxes are negatively associated with leverage. this finding is confirmed by abor and biekpe (2005) for ghana. however, ngugi (2008) and gwatidzo and ojah (2009) find insignificant correlations for kenya and south africa respectively. likewise, frank and goyal (2009) confirm strong negative correlations for the book value 176 sajems ns 15 (2012) no 2 measures of leverage. however, strong positive associations are observed for the market value leverage ratios. in summary, it appears that attempts to determine the effect of tax on leverage have yielded inconclusive results. while modigliani and miller’s (1963) prediction is confirmed by some studies, the negative association depicted in other studies cannot be ignored. it is therefore necessary to review the corporate tax debate in the context of non-debt tax shields. 2.6 non-debt tax shields the presence of non-debt tax shields such as depreciation, operating losses carried forward and investment tax credits in a firm’s financial statements reduces the firm’s tax bill, thereby lowering the effective tax rate. recall that figure 1 shows that the effective tax rates in south africa have been lower than the statutory rates. this observation can partly be explained by the use of non-debt tax shields in the south african corporate sector. deangelo and masulis (1980) have illustrated that the tax advantages of debt are lower for those firms with opportunities to avoid tax through other related non-debt tax shelters such as depreciation, investment tax credits and tax loss carry forwards. it follows that firms with higher non-debt tax shields are less likely to issue more debt. therefore, an inverse relationship is expected between non-debt tax shields and leverage. again, the empirical evidence regarding non-debt tax shields has yielded mixed results. for example, bennet and donnelly (1993), saa-requejo (1996), wiwattanakantang (1999), de miguel and pindado (2001), ozkan (2001) and ngugi (2008) confirm the prediction of deangelo and masulis (1980) that non-debt tax shields are a substitute for debt. however, bradley et al. (1984), barclay, smith and watts (1995) and boyle and eckhold (1997)5 provide evidence suggesting that non-debt tax shields have a positive impact on firm leverage. chang et al. (2009) confirm a positive association between leverage and nondebt tax shields for compustatlisted nonfinancial corporations. this contradiction is not surprising because of two main reasons provided by barclay and smith (2005). firstly, firms with higher nondebt tax shields have higher proportions of tangible assets in their balance sheet. this provides an increased potential to accumulate more debt. therefore, non-debt tax shields may not only be a proxy for low taxes, but rather a proxy for low contracting costs associated with debt. secondly, firms with tax loss carry forwards are often in financial distress. consequently, the market value of equity for such firms is eroded thereby increasing the debt ratio. it is therefore not clear whether tax loss carry forwards are a reliable proxy for non-debt tax shields. 2.7 dividend pay-out miller and modigliani (1961) have argued that dividend policy does not affect the value of the firm or the cost of equity. if this is true, then dividend policy is irrelevant. pursuant to this proposition, several financial theorists have argued otherwise, that dividend policy is relevant. lintner (1962) and gordon (1963) have argued that investors value the next dollar of dividends more than future capital gains. in effect, the perceived riskiness of a dividend paying firm should be lower than that of a nondividend payer. consequently, the required return of a dividend paying firm reduces with an increase in dividends. this proposition has been termed the ‘bird-in-hand theory’. on the other hand, the introduction of market imperfections such as taxes into this debate could sway the argument to the other side. boyle and eckhold (1997) reason that if capital gains are taxed lower than dividend income, then an increase in dividends will reduce the after-tax return of shareholders who may in turn require a higher pre-tax expected rate of return. consequently, the increased cost of equity may induce firms to issue more debt relative to equity. in this case, dividend payout may be positively correlated with leverage. from a south african perspective, inspection of figure 1 suggests two schools of thought. first, large dividend payments reduce firms’ free cash flows thereby reducing funds available for investment projects. this forces corporate managers to seek additional finance from the capital markets. this conjecture is consistent with jensen’s (1986) free cash flow hypothesis discussed earlier. sajems ns 15 (2012) no 2 177 second, many listed firms use dividends as a credible signal that their future earnings prospects are sound. this gives them the incentive to seek further borrowing from the capital markets. an inspection of figure 1 shows that there was an increase in the payouts in the year 1998. this spike in dividend pay-outs is followed by a general rise in the debt ratios in the following two years. similarly, for the 1991 to 1997 period, it can be noted that declining dividend pay-outs are associated with lower debt ratios. from this viewpoint, south african dividend policy may be positively associated with leverage. the literature documented in the preceding discussion suggests a strong support for the dividend signalling hypothesis which is consistent with the “bird-in-hand” theory. this empirical evidence suggests that dividend policy does matter. if this is the case, dividend changes may be negatively correlated with leverage. however, the south african perspective suggests that dividend pay-out may be positively associated with leverage. f i g u r e 1 a comparison of dividend pay-outs and market value total debt ratios source: authors’ calculations from study data set 3 financial liberalisation and capital structure the primary motivation for financial liberalisation is documented by bhaduri (2000) who argues that structural adjustments within the financial sector and the widening and deepening of capital markets have presented firms in developing countries an opportunity to optimally determine their choice of capital structure. moreover, prasad, green and murinde (2001:22) observe that ‘each country’s system of corporate finance retains some of its own distinctive features, partly because of its historical development, and partly because of current economic circumstances, particularly the existing regulatory regime’. these arguments concur with the economic developments in south africa. for example, the lifting of international sanctions by the end of 1992, and the official liberalisation of the jse in march 1995 are clear examples of how these events could have impacted in firms’ financial choices. furthermore, schmukler and vesperoni (2001) argue that globalisation of the financial markets develops the financial system and improves transparency, market discipline and financial infrastructure. this creates new investment and financing opportunities for domestic firms. for example, flavin and o’connor (2010) explore the effects of stock market liberalisation on firms’ financial structure in 31 emerging markets, including south africa. they conclude that stock market liberalisation lowers the debt-toequity ratio. these arguments suggest that the choice of financial structure is clearly affected by financial liberalisation. 4 data the sample consists of non-financial firms that were listed on the jse before and after the financial liberalisation phase. the i-net bridge database is used to source audited income statements, balance sheets and financial ratios 178 sajems ns 15 (2012) no 2 for a sample of firms that operated from 1989 to 2007. the data is split between the two regimes, that is the pre liberalisation period (1989-1994), and the post liberalisation period (1995-2007). there is reason enough to believe that the determinants and dynamics of capital structure in the pre liberalisation period may differ from the dynamics of leverage in a post liberalised regime. an underdeveloped financial and institutional setting may be characterised by higher transaction costs and market restrictions such as capital controls and economic sanctions. these impediments should have implications for capital financing decisions by domestic firms (see boyle & eckhold, 1997; mutenheri & green, 2003). table 1 reports the correlation coefficients on the variables used in the analysis. the correlations are not large enough to suggest that there may be a problem of multicollinearity. furthermore, most of the correlations presented in this table are confirming the predictions of some of the capital structure theories. growth is negatively correlated to leverage, a confirmation of the contracting cost theory. this relationship is statistically significant for the market value debt ratios. the tangibility variable is positive and significant at the 1 per cent level of significance for all the dependent variables. this shows that asset structure is an important criterion for assessing the firm’s ability to access loans. the non-debt tax shield variable is positive and significant at the 1 per cent level for all the dependent variables. the correlation coefficient for the non-debt tax shield and tangibility variables is positive and significant, signifying that firms with high non-debt tax shields have a high proportion of fixed assets. this may provide an incentive for firms to accumulate more debt. the profitability variable is negatively related to leverage. this negative relationship confirms the pecking order hypothesis. the size variable is positively correlated to the book value measures of leverage, indicating that larger firms have more debt in their capital structure. however, a negative association is observed between size and the market values of leverage, suggesting low information asymmetries associated with large firms. taxes and dividend pay-out are both negatively related to leverage. the correlations are significant at the 1 per cent level. the next step is to examine these relationships while controlling for other factors. t a b l e 1 correlation matrix for all the variables td/ta(b) td/ta(m) std/ta growth tang ndts profit size tax div td/ta(b) 1.000 td/ta(m) 0.786*** 1.000 std/ta 0.715*** 0.659*** 1.000 growth -0.012 -0.362*** -0.017 1.000 tang 0.188*** 0.202*** 0.008 -0.020 1.000 ndts 0.119*** 0.124*** 0.062** 0.066** 0.441*** 1.000 profit -0.215*** -0.323*** -0.175*** 0.409*** -0.114*** 0.069** 1.000 size 0.052* -0.071*** -0.051* 0.324*** 0.230*** 0.113*** 0.043 1.000 tax -0.210*** -0.295** -0.185*** 0.220*** -0.028 0.062** 0.402*** 0.073*** 1.000 div -0.139*** -0.166*** -0.112* 0.225*** 0.177*** 0.095*** 0.147*** 0.282*** 0.338*** 1.00 notes: this table reports the correlation coefficients for all the variables used in the paper. td/ta (b) is the book value of the ratio of total debt-to-total assets. td/ta (m) is calculated as (total debt/ (total assets – book equity + market equity). std/ta is the book value of the ratio of short term interest bearing debt-to-total assets. growth is calculated as the ratio of market value of equity to the book value of equity. tang is calculated as the ratio of fixed assets to total assets. ndts is calculated as the ratio of depreciation to total assets. profit is calculated as the ratio of earnings attributable to ordinary shareholders to total assets. size is calculated as the natural logarithm of total assets. tax is calculated as the ratio of taxes paid to earnings before tax. div is calculated as the ratio of ordinary dividends paid to earnings attributable to ordinary shareholders. *, **, *** indicate significance levels at 10 per cent, 5 per cent and 1 per cent respectively. sajems ns 15 (2012) no 2 179 5 methodology 5.1 model specification the proposed model can be estimated using the following general specification: (1) (2) where, is the target leverage for firm at time is the unobservable firm-specific effect, and is a vector of lagged characteristics of firm , including timespecific dummies. in equation 2, is the vector of unobserved disturbances, where is the unobservable firmspecific effect that varies across firms but is fixed over time. is the firm invariant time specific effect. is the white noise disturbance. bearing in mind that the presence of transaction costs presents an impediment for firms to automatically adjust their capital structure to the desired level, the following partial adjustment model is specified: (3) the parameter is the speed of adjustment. is the actual change in leverage and is the desired change in leverage. if transaction costs are zero, then = 1, meaning that firms will automatically adjust to their target capital structure. if transaction costs are 1, then = 0, meaning that transaction costs are so high that . from equation 3, the actual leverage level can be computed as: (4) substituting equation 3 into equation 1 gives the following specification: (5) where 1 is a measure of the transaction costs. the presence of the lagged dependent variable on the right hand side of the equation provides a statistical bias where will be correlated with the error term, even if are not serially correlated. this renders ols estimators to be inefficient. one way to resolve this problem is to first difference equation 5 in order to eliminate the firm-specific effects. ols may not consistently estimate the parameters ( ) and ( ) are correlated through and . this problem can be resolved by utilising an instrumental variable, on condition that the error term is not serially correlated. anderson and hsiao (1982) recommend = or as instruments for the first difference. the instrumental variable estimation technique may not be efficient due to lack of utilisation of all available moments. arellano and bond (1991) resolve this by using the gmm estimation technique. the gmm estimation utilises instruments that can be obtained from the orthogonality conditions that exist between the lagged dependent variable and the disturbance term. robustness checks are performed by estimating equation 5 simultaneously with its differenced form as a ‘system’. hence, this approach is known as system gmm. as noted by blundell and bond, (1998), this simultaneous approach to estimating the dynamic regression models provides significant efficiency gains. the wald test of joint significance for all regressions is satisfied at the 1 per cent level of significance. the wald test for the significance of the time effects is significant for all post liberalisation results. the time-specific effects for the pre liberalisation period are mostly insignificant. the significance of the time dummies for the post liberalisation period suggests that aggregate factors have a significant influence on firm-financing behaviour. the sargan test of overidentifying restrictions is valid for all regressions. the tests for firstorder serial correlation are not satisfied for the total debt ratio regressions and the short term debt ratio model. this is expected because according to ozkan (2001) transformation induces first order serial correlation in the first differenced residuals. the gmm estimators are consistent based on the assumption that e ( , ) are uncorrelated, hence second order serial correlation should not be present. second order correlation is absent in all the reported results. 5.2 mean reversion kayhan and titman (2007) and chang and dasgupta (2009) argue that the limiting of debt ratios between 0 and 1 could lead to mechanical mean reversion. this could bias the coefficient 180 sajems ns 15 (2012) no 2 estimates of the measure of transaction costs. to control for mean reversion, a two-step regression process is followed by estimating the target leverage (equation 1) in the first step using historical fixed effects. in the second step, the target leverage variable is included among the independent variables as shown in equation 6: (6) following hovakimian and li (2011), mean reversion is controlled by including the coefficient of the lagged dependent variable on the right hand side of the equation, and eliminating extreme leverage observations beyond 0.8. this modified partial adjustment procedure reduces the upward bias in the estimated coefficient of the speed of adjustment. 5.3 the impact of financial liberalisation on the speed of adjustment in order to estimate the effect of financial liberalisation on the speed of adjustment, two separate dummies are constructed. captures the effect of the first wave of financial liberalisation that occurred after the lifting of most economic sanctions in 1992. captures the effect of the second wave of financial liberalisation that occurred after 1995. the coefficient on the interaction term between the target leverage, and a financial liberalisation dummy, and , as shown in equation 7, provides an indication of the impact of the financial reforms on the speed of adjustment: (7) 5.4 industry effects the extant literature advocates for the effects of industry characteristics on the choice of capital structure. for example, harris and raviv (1991) posit that firms in an industry tend to retain their leverage rankings over time. furthermore, miao (2005) and antoniou, guney and paudyal (2008) allude to the relevance of the impact of industry effects on firm-financing decisions. it is further argued that firms operating in capital intensive industries such as manufacturing and mining firms should have higher leverage than firms characterised by intangible growth opportunities. for instance, long and malitz (1985) show that highly levered firms are asset intensive and mature. therefore, to control for industry effects, a dummy that takes the value of 1 is used for manufacturing and mining firms and 0 otherwise. 5.5 model specification tests the wald test of joint significance for all regressions is satisfied at the 1 per cent level of significance. the wald test for the significance of the time effects is significant for all post liberalisation results. the time-specific effects for the pre liberalisation period are mostly insignificant. the significance of the time dummies for the post liberalisation period suggests that aggregate factors have a significant influence on firm-financing behaviour. the sargan test of overidentifying restrictions is valid for all regressions. furthermore, the tests for first order serial correlation are not satisfied for the total debt ratio regressions and the short term debt ratio model. this is expected because according to ozkan (2001) transformation induces first order serial correlation in the first differenced residuals. the gmm estimators are consistent based on the assumption that e ( ) are uncorrelated, hence second order serial correlation should not be present. second order correlation is absent in all the reported results. 6 discussion of results this section reports the results of the dynamic models elaborated in the preceding discussion. 6.1 the book value of the total debt ratio (pre liberalisation) the results for the determinants of capital structure in the pre liberalisation period are reported in table 2 and discussed in this section. the growth variable is positively correlated to the book value of the total debt ratio. this relationship suggests that high growth firms operating in the pre liberalised regime accumulated more debt to finance their growth prospects. al najjar (2011) uses the same proxy for growth as the one used in this sajems ns 15 (2012) no 2 181 paper and finds a similar correlation for jordanian firms. the expected sign on the tax variable is positive and statistically significant at the 1 per cent level. this result confirms the prediction by modigliani and miller (1963) that the tax savings associated with interest tax shields induce firms to take on more debt. the coefficient on the target leverage variable is positive and significant, suggesting that the speed of adjustment in the pre liberalisation period is statistically significant. t a b l e 2 gmm estimates of target capital structure (book total debt ratio) arellano-bond/blundell-bond dynamic panel estimation (two-step results) pre liberalisation post liberalisation diff gmm sys gmm diff gmm sys gmm variable coefficient coefficient coefficient coefficient td/ta(b)i,t-1 0.8547*** 0.7290*** 0.4813*** 0.4447*** growth 0.00526* 0.0052*** -0.0090*** -0.0036*** tangibility -0.04814 -0.1467 -0.5515*** -0.4499*** ndts -1.12909 -0.3075 -1.7531*** -1.7380*** profitability 0.10582 0.1251 0.3394*** 0.2677**** size -0.00947 0.0172 -0.0354 -0.0539** taxes 0.01716*** 0.0154*** -0.0147*** -0.0131*** dividends 0.00130 0.0011 0.0165*** 0.0133*** 0.89975 1.0541*** 2.6922*** 2.3589*** wald (joint) prob>chi2 0.0000 0.0000 0.0000 0.0000 wald (dummy) 0.1080 0.1630 0.0000 0.0000 sargan prob>chi2 0.9422 0.1280 0.5276 0.5678 correlation 1 0.0038 0.0050 0.0001 0.0002 correlation 2 0.9505 0.9844 0.2256 0.1054 no. of observations 280 350 688 838 notes: this table reports the two-step arellano-bond/blundell-bond dynamic panel results for the book value measures of the total debt ratio. results are robust to panel specific heteroscedasticity and autocorrelation. the results are reported for the pre and post liberalisation periods. *, **, *** indicate significance levels at the 10, 5 and 1 per cent respectively. 6.2 the book value of the total debt ratio (post liberalisation) the results for the determinants of the book value of the total debt ratio in the post liberalisation period are reported in table 2 and discussed in this section. in contrast to the pre liberalisation epoch, firm growth prospects are negatively related to the book value of the total debt ratio. from this outcome, it can be concluded that growth firms in the post liberalisation era avoid debt to mitigate the potential underinvestment problem associated with financial distress. this observation confirms the prediction of myers (1977) and confirms the findings of rajan and zingales (1995), barclay and smith (1999) and ngugi (2008). in contrast to the literature, the asset tangibility variable is negatively related to leverage and the associated coefficient is significant at the 1 per cent level. this result could be attributed to at least two reasons identified in the literature. abor and biekpe (2005) document a similar relationship for firms in ghana, and they argue that it could be due to the high operating risk associated with a higher proportion of fixed assets. similarly, sheikh and wang (2011:127) document a strong negative correlation between book leverage and asset tangibility for listed manufacturing firms in pakistan, and they note that the negative association could be due to the tendency for managers to ‘empire build’ at the expense of collateralised assets. the other plausible explanation to this observation is that firms with high values of tangible assets are associated with high levels of debt (long & malitz, 1985). therefore, any 182 sajems ns 15 (2012) no 2 further increases of debt could increase the costs of debt, and the potential costs of financial distress. if this is the case, highly levered, asset intensive firms could find it cheaper to rebalance their capital structure by issuing equity. the profitability variable is positively correlated to the book values of the total debt ratio. the associated p-value is 0.001. the positive association reported here confirms the prediction of the trade-off theory that profitable firms will borrow more in order to take advantage of the interest tax shields. the size coefficient is negatively correlated to the book value measure of the total debt ratio. this observed relationship suggests that the information asymmetry between large firms and the capital markets in the post liberalisation epoch is low, thus enabling larger firms to issue informationally sensitive securities such as equity with ease. this tends to lower the debt levels relative to equity. these results corroborate favourably with chen (2004), delcoure (2007) and nunkoo and boateng (2010). the expected sign for the tax coefficient is negative and significant at the 10 per cent level. the evidence documented here suggests that taxes play a mildly significant role in the determination of leverage. the negative association observed in the post liberalisation regime confirms the results for negash (2002) who observes south african firms over a relatively similar period. given that tax rates in south africa were on a declining trend, there could have been little incentive for firms to take advantage of the tax deductibility of interest through the accumulation of more debt. frank and goyal (2009) draw similar conclusions for the book value measures of total leverage. the dividend pay-out variable is positively correlated to the book value of the total debt ratio. the correlation coefficient is statistically significant at the 1 per cent level. this positive association is consistent with two schools of thought; firstly, large dividend payments reduce firms’ free cash flows thereby reducing funds available for investment projects. this forces corporate managers to seek additional finance from the capital markets. this conjecture is consistent with jensen’s (1986) free cash flow hypothesis that increases in dividend and debt interest payments reduce the firm’s free cash flows. secondly, many listed firms use dividends as a credible signal that their future earnings prospects are sound. this gives them the incentive to seek further borrowing from the capital markets. furthermore, boyle and eckhold (1997) reason that if capital gains are taxed lower than dividend income, then an increase in dividends will reduce the after-tax return of shareholders, who may in turn require a higher pre-tax expected rate of return. consequently, the increased cost of equity may induce firms to issue more debt relative to equity. the coefficient on the target leverage variable is positive and significant, suggesting that the speed of adjustment in the post liberalisation era is statistically significant. furthermore, the magnitude of the coefficient in the post liberalisation epoch is larger than for the pre liberalisation era. 6.3 the market value of the total debt ratio (pre liberalisation) as shown in table 3, the only significant correlations in the pre liberalisation epoch are for the size and target leverage variable. size is negatively correlated to leverage, again confirming the conjuncture that large firms possess the reputational capital which enables them to issue informational sensitive securities such as equity with ease. the coefficient on the target leverage variable is positive and significant, suggesting that the speed of adjustment in the pre liberalisation era is statistically significant. 6.4 the market value of the total debt ratio (post liberalisation) in contrast to the book values of leverage, the growth coefficient is positive and significant at all conventional levels. overall, this direct relationship corroborates the empirical findings of titman and wessels (1988) and delcoure (2007), among others. the positive association suggests that growth firms operating in the post liberalisation period require external funding to finance their future growth prospects. sajems ns 15 (2012) no 2 183 t a b l e 3 gmm estimates of target capital structure (market total debt ratio) arellano-bond/blundell-bond dynamic panel estimation (two-step results) pre liberalisation post liberalisation diff gmm sys gmm diff gmm sys gmm variable coefficient coefficient coefficient coefficient td/ta(m)i,t-1 0.5124*** 0.5670*** 0.2026*** 0.2325*** growth 0.0001 0.0028 0.0063*** 0.0116*** tangibility -0.0590 -0.0013 -0.4093*** -0.4318*** ndts -0.2067 -0.7173 -2.0917*** -2.2546*** profitability 0.0759 0.0709 0.5289*** 0.4737*** size -0.0621 -0.0951*** 0.0102 -0.0139 taxes 0.0099 0.0107 0.0185*** 0.0130*** dividends -0.0010 -0.0010 0.0124*** 0.0090*** 0.7310 0.6916* 2.4189*** 2.3051*** wald (joint) prob>chi2 0.0000 0.0000 0.0000 0.0000 wald (dummy) 0.0580 0.0360 0.0000 0.0000 sargan prob>chi2 0.3500 0.1792 0.7951 0.1419 correlation 1 0.0010 0.0001 0.0400 0.0385 correlation 2 0.1600 0.2650 0.8687 0.9236 280 350 688 838 notes: this table reports the two-step arellano-bond/blundell-bond dynamic panel results for the market value measures of the total debt ratio. results are robust to panel specific heteroscedasticity and autocorrelation. the results are reported for the pre and post liberalisation periods. *, **, *** indicate significance levels at the 10, 5 and 1 per cent respectively. as alluded to in the earlier discussion on the book value debt ratio, the asset tangibility variable is negatively related to leverage and the associated coefficient is significant at the 1 per cent level. this result could be attributed the high operating risk associated with a higher proportion of fixed assets and the tendency for managers to pursue valuedestroying projects at the expense of collateralised assets. furthermore, firms with high values of tangible assets are associated with high levels of debt (long & malitz, 1985). therefore, any further increases of debt could increase the costs of debt, and the potential costs of financial distress. if this is the case, highly levered, asset intensive firms could find it cheaper to rebalance their capital structure by issuing equity. the non-debt tax shield coefficient is negative and significant at all conventional levels. this negative effect shows that firms with high depreciation charges have little incentive to access more debt. this relationship supports the deangelo and masulis (1980) hypothesis that tax advantages of debt are lower for those firms with opportunities to avoid tax through other related non-debt tax shelters. the dynamic panel data models employed by de miguel and pindado (2001) and ozkan (2001) also document the negative association found in this study. however, bradley et al. (1984), barclay et al. (1995) and chang et al. (2009), among others, provide evidence suggesting that non-debt tax shields have a positive impact on firm leverage. the coefficient on the tax variable is positive and significant at the 1 per cent level. the documented direct relationship is an indication that firms in the post liberalisation regime respond to increased effective tax rates by issuing more debt. the evidence documented here suggests that taxes play a significant role in the determination of leverage. these results confirm the finding by frank and goyal (2009) that there is a strong and positive correlation between taxes and the market value of total leverage for non-financial 184 sajems ns 15 (2012) no 2 firms in the united states of america. however, ngugi (2008) and gwatidzo and ojah (2009) find insignificant correlations between taxes and leverage for kenya and south africa, respectively. the dividend pay-out variable exerts a positive influence on the market value of the total debt ratio. the coefficient is statistically significant at the 1 per cent level, thus confirming jensen’s (1986) free cash flow theory that increases in dividend and debt interest payments reduce the firm’s free cash flows. this forces firms to seek funding from external markets. in this case, an increase in the market value of the debt ratio is observed. the coefficient on the target leverage variable is positive and significant, suggesting that the speed of adjustment in the post liberalisation era is statistically significant. furthermore, the significance of the coefficient in the post liberalisation epoch is stronger than for the pre liberalisation era. this observation can be attributed to the lower transaction costs depicted in the post liberalised regime. 6.5 firm-specific determinants of debt maturity t a b l e 4 : gmm estimates of target capital structure (short term debt ratio) arellano-bond/blundell-bond dynamic panel estimation (two-step results) pre liberalisation post liberalisation diff gmm sys gmm diff gmm sys gmm variable coefficient coefficient coefficient coefficient std/tai,t-1 0.5035*** 0.5710*** 0.3179*** 0.3745*** growth 0.0001 -0.0008 0.0023*** 0.0099*** tangibility -0.2379*** -0.0363 0.1931*** -0.0501*** ndts -0.1626 -0.1367 -0.4833*** 0.1040 profitability -0.1850*** -0.2676*** -0.0218*** -0.1012*** size -0.0031 0.0226*** 0.0699*** 0.0124*** taxes 0.0031 0.0090* 0.0016 -0.0093*** dividends 0.0000 0.0081 0.0009*** 0.0061*** wald prob>chi2 0.0000 0.0000 0.0000 0.0000 wald (dummy) 0.3190 0.0001 0.0000 0.0000 sargan prob>chi2 0.2684 0.1237 0.7502 0.2406 correlation 1 0.0174 0.0079 0.0005 0.0006 correlation 2 0.3342 0.3276 0.0920 0.2406 no. of observations 280 350 688 768 notes: this table reports the two-step difference and system gmm dynamic panel results for the book value measures of the short term debt ratio. results are robust to panel specific heteroscedasticity and autocorrelation. *, **, *** indicate significance levels at the 10, 5 and 1 per cent respectively. 6.6 determinants of debt maturity structure in the pre liberalisation regime the results for the determinants of the debt maturity structure in the pre liberalisation period are reported in table 4 and discussed in this section. the system gmm output generates significant results for profitability, size and taxes. the coefficients for profitability and size are negative and statistically significant at the 1 per cent level. profitability is associated with a longer debt maturity structure. this implies that profitability is a significant criterion for securing longer term finance in the pre liberalisation period. similarly larger firms have longer debt maturity structures. this indicates that larger firms possess the reputational capital to borrow on a longer term basis. on the other hand, taxes are positively sajems ns 15 (2012) no 2 185 related to the maturity structure of debt. however, the correlation coefficient is mildly significant at the 10 per cent level. this relationship suggests that firms that are subject to higher effective tax rates reduce their maturity structure of debt. 6.7 determinants of debt maturity structure in the post liberalisation regime the results for the determinants of the debt maturity structure in the post liberalisation period are reported in table 4 and discussed in this section. the coefficients of the growth variable for firms in the post liberalisation regime are all statistically significant at the 1 per cent level. growth prospects are associated with an increase in the short term debt ratio. this implies that growth firms are associated with shorter debt maturities. the plausible explanation to this observation is that the variability in earnings associated with growth firms makes it difficult for them to access long term debt. hence debt with shorter maturities is more accessible for these firms. as observed by barclay and smith (2005), high growth firms tend to borrow on a short term basis. the rationale given for this observation is that, in the event of financial distress, short term debt allows growth firms to reorganise their debt position easily. the asset tangibility variable has a negative sign. the coefficient is statistically significant at the 1 per cent level. this inverse relationship is an indication that firms with a high proportion of tangible assets increase the maturity structure of their debt. this relationship lends support to the theory that a high value of tangible assets allows firms to borrow on a longer term basis. in the event of bankruptcy, the tangible assets can easily be collateralised. the profitability variable is negatively correlated to the short term debt ratio. the coefficient is statistically significant at the 1 per cent level. this negative association indicates that profitable firms operating in the post liberalised regime increase the maturity structure of their debt. this is expected, since higher profits provide credibility for firms to take on longer term debt. the size variable is positively correlated to the short term debt ratio, suggesting that large firms operating in the post liberalised regime issue debt with shorter debt maturities. this finding contradicts the theoretical predictions that large firms have a lower probability of financial distress, and that they have lower information asymmetries associated with debt issues. this should allow them to borrow on a longer term basis. the tax variable has a negative coefficient which is statistically significant at the 1 per cent level. hence, it can be deduced that corporate tax rates are negatively associated with short term debt. this finding suggests that an increase in the effective tax rate is associated with longer debt maturities. this result supports the tax clientele argument of newberry and novak (1999) that firms that are subject to high effective tax rates will increase their debt maturity structure. the results reported here support the empirical work by antoniou, guney and paudyal (2006). they observe that the increase in the effective tax rate causes a statistically significant increase in the maturity structure of debt for firms in germany. furthermore, higher effective taxes could be associated with higher profitability.6 hence, the negative sign is not surprising. due to the increased profitability, firms that pay higher taxes will have easier access to longer term financing than firms with lower effective taxes. the dividend pay-out ratio is positively correlated with the short term debt ratio. the coefficient is significant at the 1 per cent level. the positive correlation suggests that an increase in the dividend pay-out is associated with a reduction in the debt maturity structure of firms. 6.8 financial liberalisation, transaction costs and the related speed of adjustment the results of the interaction between the financial liberalisation dummies and target leverage variables are shown in table 5. the coefficient on the interaction term between and , the book value of total target leverage, is positive and significant at all conventional levels. likewise, the coefficient on the interaction term between and the book value of total target 186 sajems ns 15 (2012) no 2 leverage is significantly positive at the 1 per cent level. the coefficients are also significant for the rest of the dependent variables. this outcome confirms that financial liberalisation has a significant impact on the costs of altering capital structure, thereby increasing the speed of adjustment towards the target leverage for the first episode of liberalisation. in the second episode of liberalisation, the speed of adjustment increases again only for the book value of total leverage. the opposite is observed for the market value total leverage and the short term leverage. t a b l e 5 the effects of financial liberalisation on the speed of adjustment dependent variable interaction term coefficient td/ta(b)i,t-1 0.0741*** td/ta(b)i,t-1 0.2493*** sargan 0.3526 correlation 1 0.0001 correlation 2 0.5317 td/ta(m)i,t-1 0.0380*** td/ta(m)i,t-1 -0.0973*** sargan 0.1450 correlation 1 0.0262 correlation 2 0.4043 std/tai,t-1 1.5419*** std/tai,t-1 -2.0236*** sargan 0.6241 correlation 1 0.0000 correlation 2 0.9829 notes: this table reports the two-step system gmm dynamic panel results for the book and market value measures of the total debt ratio. results are robust to panel specific heteroscedasticity and autocorrelation. *** indicates significance at the 1 per cent level. 7 conclusions this paper has examined the empirical association between firm-specific characteristics and capital structure in a transitional economy. the dynamic models of capital structure have revealed several important facts. first, the study documents evidence of a long-run target adjustment to the desired level of leverage. second, a reduction in transaction costs is observed for the post liberalisation regime. third, firms in a liberalised economy adjust to their optimal target of leverage much faster than firms in a constrained economy. the capital structure model has documented relationships that support most of the theories of capital structure. however, the empirical relationship between the firm-specific determinants of capital structure and leverage is statistically stronger for the post liberalised regime than the pre liberalised era. the same holds for the coefficient on the target leverage, thereby confirming the paper’s conjecture that transaction costs are lower in a post liberalised regime. furthermore, two episodes of financial liberalisation have been shown to have a significant impact on the speed of adjustment to the target leverage. finally, new evidence shows that the debt maturity structure is significantly affected by most of the firmspecific characteristics, especially in the post liberalisation period. endnotes 1 the only exception was for nigeria where there was a significant negative relationship between leverage and size. the coefficients for kenya were negative but insignificant with the exception of the long term debt ratio. sajems ns 15 (2012) no 2 187 2 there are two exceptions to this observation; when book values are used, the relationship is positive but insignificant for italy, and when market values are used, a positive and insignificant association is observed for france. 3 this strong relationship is found using the fixed and random effects models. the pooled least squares approach yields no statistically significant results. 4 the only exception for south africa is the short term debt ratio, which is significantly negatively related to asset tangibility. 5 boyle and eckhold (1997: 434) report a positive correlation for the long term debt ratio for the pre liberalisation period and insignificant positive correlation for the post liberalisation period. the short term debt ratio is positively correlated to leverage for the pre liberalisation period and negatively correlated to 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(2013:86-89) discuss possible approaches for subnational credit ratings by providing examples from canada, australia and india. interesting abstract sajems ns 19 (2016) no 2:192-214 193 observations are drawn from comparing the different, documented credit-rating methodologies. one observation is the five broad factors into which the information used by the three largest international credit-rating agencies to assess the creditworthiness of subnationals can be grouped (liu & tan, 2009:5). another is the difference in the importance of quantitative and qualitative information for developed and developing countries. typically, in a developed country, the quantitative and qualitative information will be equally important, as opposed to the situation in developing countries where the quantitative information only equates to 30 per cent of a credit rating and the qualitative information to 70 per cent of a credit rating (moody’s 2007:34). both of these observations apply for the remainder of this paper. with this work in place, we present only a reminder of the salient background, and, instead, investigate the requisite data and propose a possible coherent methodology for credit-rating subnationals with direct application to a south african provincial department. the remainder of the paper is structured as follows: in section 2, the data and the methodology used to develop the quantitative section of credit-rating methodologies are discussed. these include the compilation of the two health data sets and a brief overview of linear-regression modelling. section 3 provides the methodology used to develop the linear-regression models, also called payment-behaviour models, using the two data sets. in section 4, three model advancement techniques, that is, using subject knowledge as a variable selection method, including interactions between the independent variables in the models and excluding outliers from the data, are investigated. in section 5, subnational credit ratings and their policy implications in south africa are discussed, section 6 concludes this paper. 2 data and methodology liu and tan (2009:33-34) caution that data in inconsistent formats cause problems when developing a subnational credit-rating methodology. for this reason, much attention has been paid to the identification of reliable data sources. south africa’s provincial governments’ financial records and record keeping are regulated by the national treasury of south africa (national treasury), so most of the data used to develop the quantitative section of the credit-rating methodology for south africa’s subnationals (focusing on provincial departments) employ this source. the three largest international credit-rating agencies are fitchratings (fitch), moody’s investors services (moody’s) and standard and poor’s (s&p). the three largest international credit-rating agencies all generate generic, subnational credit-rating methodologies. these can be used to determine the creditworthiness of any subnational government, regardless of the area over which the subnational government presides. the rating criteria used by the three rating agencies can be divided into five broad factors (liu & tan, 2009:11-14). note that, theoretically, these can be applied to south africa’s provincial governments, departments and municipalities owing to the generic definitions of subnationals (local and regional governments). however, no provincial government or department in south africa has a moody’s/ fitch/s&p rating. section 2.1 will also show that not all of the data used in these methodologies are available in the south african subnational context. the data requirements for this study were based on the information used in existing subnational credit-rating methodologies, especially the broad factors. these five factors are the subnational’s economic conditions, the fiscal performance of the subnational, the financial and debt position of the subnational, the management quality and strength of subnational institutions, as well as the influence of the sovereign factors, intergovernmental relations and fiscal arrangements on the subnational (liu & tan, 2009:5). the aim was to include variables representing the four relevant broad factors (the fifth factor was omitted, since all the departments reside within the same country and the outcome of the factor will therefore be the same) in the final regression models. 2.1 data sources an investigation was conducted to identify possible sources of the required information. the sources used were confirmed by the national treasury and a financial institution as part of a 194 sajems ns 19 (2016) no 2:192-214 workshop held at the national treasury in 2013 (national treasury, 2013c). the reports used are compiled by four different institutions: the provincial departments, the national treasury, statistics south africa (statssa), and the auditor-general of south africa (auditor-general). 2.1.1 annual reports of provincial departments these reports are not compiled per provincial government, but per department positioned within the provincial governments. the matter was discussed during the workshop held at the national treasury in 2012 (national treasury, 2012). it was recommended that the focus should be on provincial departments instead of provincial governments. the department of health was selected as an exemplary department for this paper. this department was chosen since its total expenditure equates to a considerable portion of the provinces’ total expenditure. in the 2012/2013 financial year, the department of health’s total expenditure equated to 31 per cent of the provinces total expenditure (national treasury, 2013a:3). the annual reports of the provincial departments should be easily accessible, but problems were experienced in gaining electronic access to some of these. a total of 54 annual reports were collected and captured manually. 2.1.2 national treasury reports the following reports are assembled on a regular basis by the national treasury itself, and were also used: • fourth quarter year to date provincial budgets and expenditure report (preliminary outcome) 06/07-10/11 (national treasury, 2007 to 2011); and • provincial statements of receipts and payments for the 4th quarter (end march 2007 to 2011) (national treasury, 2007 to 2011). 2.1.3 stats sa the data needed to portray the economic conditions in the province as well as population information per province were sourced from information provided by stats sa. the data sourced from this institution were: • gross domestic product. annual estimates 2003-2012. regional estimates 2003-2012. 3rd quarter 2013 (stats sa, 2013); and • the interactive data set containing the mid-year population estimates by province, gender, age group and year in microsoft excel (stats sa, 2012). note that the data obtained from these sources were estimates and not final values. also, the associated dates did not correspond to the rest of the reports’ dates. the dates associated with these sources were calendar years (january to december), and the dates relating to the other sources were financial years (april to march). the data sets were constructed in such a manner that most of the months overlapped. for example, january to december 2006 will overlap with april 2006 to march 2007. 2.1.4 auditor-general’s consolidated general reports on the national and provincial audit outcomes the last data requirement, that is, the inclusion of information indicating management quality and institutional strength, was addressed by using reports compiled by the auditor-general. the reports used are: the consolidated general reports on the national and provincial audit outcomes of 2006/2007 to 2010/2011 (auditor-general, 2007-2011). 2.2 data characteristics and problems the required data were captured manually and data-error identification and rectification measures were applied as an iterative process throughout the data-compilation and the model-development phases. five years’ data were gathered from each of the sources, equating to 45 data points. sajems ns 19 (2016) no 2:192-214 195 the sourced data posed challenges when used to develop the quantitative section of a subnational credit-rating methodology. these challenges include: • the changing formats of the auditor-general’s reports limited the information that could be used from these reports. • credit ratings are typically updated on a regular basis to adjust for changing risk situations (liu & tan, 2009:14-15), yet most of the reports used are only made available on an annual basis (the only sources that are updated quarterly are the national treasury reports). ideally, all the required information should be available at least quarterly. • the outdated information contained in the available reports also posed a challenge. for example, if the developed credit-rating methodology is applied in 2014, the latest available annual reports (as at september 2014) contain information relating to the financial year april 2012 to march 2013. hence, credit ratings derived from these reports will be based on information up to two years old. • the annual reports are compiled per provincial department, not per provincial government. although it should be possible to aggregate these data, the aggregation and the data-gathering process pose difficulties mainly because of the difference in the number of departments that reside within the provincial governments. • south africa’s provincial departments use the cash-based accounting system. the application of the cash-based accounting system resulted in insufficient information available to provide an indication whether a department’s debt obligations were paid in full and on time. this is required, as it indicates a department’s capacity and willingness to repay debt obligations in full and on time, as per the definition of credit ratings provided by liu and tan (2009:4). instead, a proxy for the required information had to be used. these challenges could be alleviated by some amendments to government policies, and recommendations are provided in section 5. 2.3 data-set construction the required information, based on the literature study, was gathered from each of the data sources discussed earlier. two different data sets were created, one with the time variable included (ht) as an independent variable, and the other without the time variable (h). since no provincial-level annual reports were available, it was decided to focus rather on provincial departments instead – specifically the department of health. some of the other source data were on a provincial level. approximately 70 per cent of the information used is on a department level and the other information is at a provincial level. the constructed data sets contain only quantitative information. this relates to the principle of using only 30 per cent of quantitative information for rating purposes in developing countries (see fourie et al. (2013) for a detailed discussion regarding the 30 per cent quantitative as opposed to 70 per cent qualitative principle). therefore, the models developed based on the information discussed in this paper should only equate to 30 per cent of a final credit rating. the other 70 per cent of the final credit rating should be based on qualitative information, and this may be taken into account as an intuitive overlay. warner (2008:125) states that analysis based on data containing errors can lead to misleading results. since data were captured manually, special care was taken to identify and correct data errors. error identification and rectification measures were applied iteratively. the methodology, dependent variable and independent variables used to develop the models are discussed next. 2.4 methodology: linear-regression modelling several statistical methods are available for the development of credit-rating predictions (hwang, chung & chu, 2010:2). examples of these methods are linear-regression modelling, multiple discriminant analysis, ordered linear probit modelling, and linear logit modelling. linear-regression 196 sajems ns 19 (2016) no 2:192-214 modelling was chosen to predict the quantitative part of the credit ratings for south african provincial departments. obviously, other modelling techniques will be suggested as future research. see, for example, the study of novotna (2012:448) that compared the use of discriminant analysis, logistic regression and decision trees for the estimation of credit-rating models and found that all methods were suitable for credit-rating modelling, with discriminant analysis and logistic regression models being found to be relatively simple to use and to achieve a high classification ability (novotna, 2012:455). hair, black, babin, anderson and tatham (2006:169) describe linear regression as a general statistical technique that is used to analyse the relationship between one single dependent variable and a number of independent variables. pallant (2007:148) states that it is a family of techniques used to explore the relationship between one dependent variable and several independent variables. linear-regression models can be used to explain the variance of the dependent variable or for prediction purposes. it is important to note that, in order to forecast, the independent variables used to predict the dependent variable for the next year have to be lagging by a year. this also applies to this work, since the aim is to predict the provincial departments’ credit ratings for the next financial year (e.g. 2013/2014) based on this financial year’s data (e.g. 2012/2013). the principal advantage of linear regression is its simplicity, interpretability, scientific acceptance, and widespread availability (chambers & dinsmore, 2014:5). linear regression is also widely performed using statistical software packages and business intelligence tools (chambers & dinsmore, 2014:6). moody’s (2014:5) states that another advantage of using linear-regression modelling is that the parameter estimates are readily available. a further advantage of using linear regression is easy computation and implementation (moody’s 2006:2). however, a disadvantage of using linear-regression modelling is that intuition is lost when too many independent variables are included in the final model (moody’s, 2014:5). the results of a linear-regression model can be summarised as credit ratings that are graded by symbols such as aa-, bbb+ and caa1. these symbols are used by credit-rating agencies to indicate relative rankings of creditworthiness. an issuer or issue with a higher ranking is considered to have a better credit worthiness than an issuer or issue with a lower ranking; in other words, higher-ranked issuers or issues will default less frequently than issuers or issues ranked lower, assuming that everything else remains the same (s&p, 2009:4). the aim of the models developed in this paper is to rank south africa’s subnationals (specifically the departments of health) in terms of future payment behaviour. 2.4.1 dependent variable the ultimate aim of a credit-rating methodology is to predict default that can be grouped into credit ratings. a common definition of default used is that a client is unlikely to honour its credit obligation if such client is more than 30, 60 or 90 days in arrears with regard to its credit obligation. in order to align the developed credit-rating methodologies to this definition, the desired dependent variable is the number of days or months in arrears. the focus of the cash-based accounting system used by the provincial departments is not to make sure that bills are paid on time but of the amount of cash in the bank. therefore, the number of days or months in arrears is not reflected in the departments’ financial statements contained in the annual reports. a workshop was arranged with the national treasury to find an alternative measure which could be used as an indication for payment behaviour. it was suggested that the accruals in excess of 30 days figure that are currently reflected in the provincial financial statements should be used (national treasury, 2012). this number reflects the rand value of all invoices not paid within 30 days from the invoice date. this is of interest, since the regulations made in terms of the public finance management act 1 of 1999 stipulate that creditors have to be paid within 30 days of the receipt of the invoice (south africa, 2006:22). the rand value of the accruals (in excess of 30 days) are divided by total expenditure in order to make them comparable between departments. this is viewed as a proxy for payment behaviour, that is, to assess whether the departments have been meeting their debt obligations. a high value sajems ns 19 (2016) no 2:192-214 197 of this ratio indicates bad payment behaviour, since it points to a large portion of total expenditure that is still outstanding after 30 days. the lower the value of this ratio, the better the payment behaviour, since this, on the other hand, indicates that the accruals 30 days plus are proportionally lower than the total expenditure. thus an increase in this ratio indicates worsening payment behaviour and a decrease indicates improving payment behaviour. 2.4.2 independent variables the independent variables available for linear-regression modelling purposes are documented in table 1. the ht data set contained 41 independent variables and the h data set only 40, since the time variable was omitted from this data set. both data sets contained 45 data points. table 1 summary of the independent variables available for linear-regression modelling purposes source variable description broad factor constant indicator_ec 1 = eastern cape, 0 = all others indicator indicator_fs 1 = free state, 0 = all others indicator_gau 1 = gauteng, 0 = all others indicator_kzn 1 = kwazulu-natal, 0 = all others indicator_lim 1 = limpopo population, 0 = all others indicator_mpu 1 = mpumalanga, 0 = all others indicator_nw 1 = north west, 0 = all others indicator_nc 1 = northern cape, 0 = all others indicator_wc 1 = western cape, 0 = all others derived from financial year time 1 = financial year apr 06 – mar 07 2 = financial year apr 07 – mar 08 3 = financial year apr 08 – mar 09 4 = financial year apr 09 – mar 10 5 = financial year apr 10 – mar 11 time national treasury’s 4th quarter year to date provincial budgets & expenditure report (preliminary outcome) ln_x3 ln(departmental total expenditure / departmental adjusted budget) fiscal performance ln_x4 ln (departmental total expenditure / total provincial expenditure) ln_x8 ln(departmental personnel expenditure / departmental adjusted budget) ln_x9 ln(departmental personnel expenditure / total provincial personnel expenditure) ln_x13 ln(departmental capital expenditure / departmental adjusted budget) financial & debt position ln_x14 ln(departmental capital expenditure / total provincial capital expenditure) provincial departments’ annual reports ln_x27 ln(departmental annual appropriation of revenue / total departmental revenue) fiscal performance ln_x28_zmean ln(departmental own revenue / total departmental revenue) (missing mean) indicator_x28_z 0 if departmental own revenue = 0, 1 if departmental own revenue > 0 ln_x29 ln(departmental personnel expenditure / departmental total current expenditure) ln_x30 ln(departmental personnel expenditure / departmental total expenditure) ln_x31 ln(departmental total current expenditure / departmental total expenditure) ln_x32 ln(departmental capital expenditure / departmental total expenditure) ln_x33 ln(departmental surplus or deficit / departmental total revenue) provincial departments’ annual reports ln_x34 ln(departmental surplus or deficit / departmental total expenditure) fiscal performance ln_x36 ln(departmental net assets / departmental total expenditure) ln_x36_zmean ln(departmental net assets / departmental total expenditure) (missing mean) continued/ 198 sajems ns 19 (2016) no 2:192-214 source variable description broad factor indicator_x36_z 0 if departmental net assets = 0, 1 if departmental net assets > 0 national treasury’s 4th quarter year to date provincial budgets & expenditure report (preliminary outcome) ln_x39 ln(departmental own revenue actual collection / departmental adjusted budget) ln_x41 ln(departmental own revenue collection / total provincial revenue) national treasury’s provincial statements of receipts & payments for 4th quarter ln_x48 ln(provincial surplus or deficit / provincial receipts) ln_x49 ln(provincial surplus or deficit / provincial payments) ln_x50 ln(provincial total receipts / provincial total payments) auditor-general’s consolidated general reports on national & provincial audit outcomes x52 quality of department’s financial reports: 1 = clean audit outcome 2 = financially unqualified audit opinion 3 = qualified audit opinion 4 = adverse audit opinion and disclaimer of audit opinion management quality & institutional strength stats sa’s gdp. annual estimates 0312. regional estimates 03-12. 3rd quarter 2013. stats sa’s interactive data set containing mid-year population estimate ln_x57 ln(provincial gdp per capita) economic conditions ln_x58 ln(provincial gdp per capita growth) stats sa’s gdp – annual & regional estimates (p0441) ln_x59 ln(provincial gdp growth) stats sa’s interactive data set containing mid-year population estimate ln_x60 ln(provincial dependent population / total population) ln_x61 ln(provincial dependent population growth) provincial departments’ annual reports & stats sa’s interactive data set containing mid-year population estimate ln_x63 ln(departmental total revenue per capita) fiscal performance ln_x64 ln(departmental capital expenditure per capita) economic conditions ln_x65 2.4.3 broad factor representation seven of the independent variables used were indicators of the economic conditions within a province, 21 independent variables formed part of the fiscal-performance factor, two formed part of the financialand debt-position factor, and only one variable provided an indication of management quality and institutional strength. the rest of the independent variables were indicator variables and thus did not form part of any of the broad factors (see figures 1 to 4 for a list of independent variables per broad factor). figure 1 list of independent variables in respect of economic conditions within the province factor 1: economic conditions • ln(provincial gdp per capita) (x57) • ln(provincial gdp per capita growth) (x58) • ln(provincial gdp growth) (x59) • ln(provincial dependent population to total population) (x60) • ln(provincial dependent population growth) (x61) • ln(departmental capital expenditure per capita) (x64) • ln(departmental total expenditure per capita) (x65) sajems ns 19 (2016) no 2:192-214 199 figure 2 independent variables representing fiscal performance broad factors figure 3 the two independent variables representing the financial and debt position broad factor factor 2: fiscal performance • ln(departmental total expenditure to departmental adjusted budget) (x3) • ln(departmental total expenditure to total provincial expenditure) (x4) • ln(departmental personnel expenditure to departmental adjusted budget) (x8) • ln(departmental personnel expenditure to total provincial personnel expenditure) (x9) • grouped(departmental annual appropriation of revenue to total departmental revenue) (x27) • ln(departmental own revenue to total departmental revenue) (x28_zmean) • indicator_x28_z • ln(departmental personnel expenditure to departmental total current expenditure) (x29) • ln(departmental personnel expenditure to departmental total expenditure) (x30) • ln(departmental total current expenditure to departmental total expenditure) (x31) • ln(departmental capital expenditure to departmental total expenditure) (x32) • ln(departmental surplus/deficit to departmental total revenue) (x33) • ln(departmental surplus/deficit to departmental total expenditure) (x34) • ln(departmental net assets to departmental total expenditure) (x36_zmean) • indicator_x36_z • ln(departmental own revenue actual collection to departmental adjusted budget) (x39) • ln(departmental own revenue collection to total provincial revenue) (x41) • ln(provincial surplus/deficit to provincial receipts) (x48) • ln(provincial surplus/deficit to provincial payments) (x49) • ln(provincial total receipts to provincial total payments) (x50) • ln(departmental total revenue per capita) (x63) factor 3: financial and debt position • ln(departmental capital expenditure to departmental adjusted budget) (x13) • ln(departmental capital expenditure to total provincial capital expenditure) (x14) 200 sajems ns 19 (2016) no 2:192-214 figure 4 the variable containing the management quality and institutional strength information 2.5 summary of data and methodology although the construction of the data sets was not an initial goal of this paper, it was nevertheless an additional result. these data sets are available on request. these data and the methodology discussed were used to derive a number of different linearregression models for use as a credit-rating methodology within the south african subnational context in order to predict payment behaviour. again, the resulting models will contain only quantitative information and can, therefore, only be viewed as the quantitative part of a creditrating methodology. the number of provincial departments per provincial government differs. in theory, it should be possible to aggregate the data at a provincial government level so as to develop a provincial-level, subnational credit-rating methodology, but, in practice, the unequal number of departments poses difficulties in terms of data collection and aggregation. an additional observation from this investigation was that the formats of some of the reports used are non-static. this may pose problems with regard to the future use of the developed creditrating methodology. another key finding was that most data used are only made available on an annual basis. credit ratings, however, should be updated regularly in order to adjust for changing risk situations. also, the formats of some of the reports used change year on year. this, too, may pose problems with regard to the future use of the developed credit-rating methodology. finally, the application of the cash-based accounting system resulted in insufficient information being available to provide an indication whether a department’s debt obligations were paid in full and on time. this was required, as it indicates a department’s capacity and willingness to repay debt obligations in full and on time. instead, a proxy for the required information had to be used. 3 developing a linear-regression model for the department of health in order to apply linear-regression modelling to the data, the following steps were taken. firstly, variable clustering was performed to deal with multicollinearity among the independent variables. the next step was to deal with irrelevant independent variables by using scatter plots of spearman’s correlation versus hoeffding’s d ranks. lastly, linear-regression modelling based on four different variable-selection techniques was used to develop the payment-behaviour models. data analysis and output were generated using the sas institute inc. (2011) software. 3.1 health with time data set (ht) the ht data comprises 45 data points and 41 independent variables. variable clustering was used to deal with multicollinearity, and the varclus procedure of the sas institute inc. (2011) software was used to perform the analysis. one variable was chosen from each cluster of variables as the factor 4: management quality and institutional strength • quality of department's financial reports (52) sajems ns 19 (2016) no 2:192-214 201 cluster representative. the decision was based either on the lowest r2 – thus having a high correlation with its own cluster, but low correlations with the rest of the clusters – or on subject knowledge. decision making based on subject knowledge was recommended by sanche and lonergan (2006:91). this resulted in 19 variables, representing all four broad factors, which will be used for the rest of the analysis. the corr procedure of the sas institute inc. (2011) software was used to create a scatter plot of the ranks of the spearman’s correlation coefficients of each independent variable with the dependent variable versus ranks of hoeffding’s ds for each independent variable with the dependent variable. this was used to identify irrelevant variables, that is, independent variables with too low correlations with the dependent variable. this step decreased the number of possible independent variables to 14. four different variable-selection techniques were used to choose the final independent variables from the variables that remained after multicollinearity and irrelevancy were dealt with. the variable-selection techniques used were stepwise selection, forward addition, backward elimination, and best subset. note that a significance level of 0.1 was set for these variableselection techniques. the analyses were performed by using the reg procedure of the sas institute inc. (2011) software. in the case of the ht data set, the four variable-selection techniques resulted in exactly the same model. the detail of this model is provided in table 2. table 2 linear-regression results of the ht data set 𝑅" 0.51 adj. 𝑅" 0.45 variable description parameter standardised estimate 𝒑-value variance inflation factor intercept intercept −1.06 0.00 0.30 0.00 indicator_kzn 1 = kzn, 0 = all others −2.74 −0.62 <.001 1.09 ln_x28_zmean ln(departmental own revenue (missing mean)) 0.34 0.31 0.01 1.14 indicator_mpu 1 = mpu, 0 = all others −1.32 −0.30 0.01 1.09 indicator_lim 1 = lim, 0 = all others −1.18 −0.27 0.03 1.08 ln_x58 ln(provincial gdp per capita growth) 0.90 0.24 0.04 1.02 figure 5 scatter plot and normality plot of the residual of the ht data set’s linear-regression model this resulted in the following model: 𝑌% = −1.06 − 2.74 𝐼𝑛𝑑𝑖𝑐𝑎𝑡𝑜𝑟_𝐾𝑍𝑁< + 0.34 𝑙𝑛_𝑥28_𝑍𝑚𝑒𝑎𝑛< − 1.32 𝐼𝑛𝑑𝑖𝑐𝑎𝑡𝑜𝑟_𝑀𝑝𝑢< −1.18(𝐼𝑛𝑑𝑖𝑐𝑎𝑡𝑜𝑟_𝐿𝑖𝑚<) + 0.90(𝑙𝑛_𝑥58<) (1) -3 -2 -1 0 1 2 -3 -2 -1 0 1 2 r es id ua l predicted value -3 -2 -1 0 1 2 -3 -2 -1 1 2 3 r es id ua l quantile 202 sajems ns 19 (2016) no 2:192-214 where i = 1,2,…9. the model has an r2 of 0.51. thus it explains 51 per cent of the variance of the dependent variable. the r2 adjusted for the number of parameters within the model is 0.45 (table 2). the independent variables, excluding the intercept, are sorted according to importance based on the absolute values of the standardised parameter estimates. thus the most influential variable is indicator_kzn. all the 𝑝-values of the five independent variables chosen for this model are below 0.1. the variance inflation factors of the variables range between 1.02 and 1.09, which is well below the guideline value of 10 suggested by hair et al. (2006:230). the interpretation of the independent variables’ effects on the dependent variable is based on the parameter estimates. an independent variable’s parameter estimate indicates the change in the dependent variable per one unit increase of the corresponding independent variable when the other independent variables are held constant (kutner, nachtsheim, neter & li, 2005:307). therefore, when explanations are provided of the independent variables’ effects on the dependent variable, it is assumed that all other variables remain constant. the negative signs of the parameter estimates of indicator_kzn, indicator_mpu and indicator_lim indicate that the departments of health of kwazulu-natal, mpumalanga and limpopo are better payers than the other provinces’ departments of health. as ln_x28_zmean (departmental own revenue to total departmental revenue) increases, the payment behaviour of the departments worsen. this is indicated by the parameter estimate of 0.34. a possible explanation is that departmental own revenue is a more volatile source of income than that received directly from national government – depending on the original source of own revenue. fitch (2011:4) also reviews revenue sources in terms of volatility, diversity and predictability and states that reliance on economically sensitive revenue leads to a credit concern. thus, if a department’s own revenue is generated from an economically sensitive activity, an increase would influence payment behaviour negatively. the positive parameter estimate of gross domestic product (gdp) per capita growth (ln_x58) indicates than an increase in gdp per capita growth will worsen payment behaviour when considering this model. this contradicts moody’s (2008:15), which states that a high regional gdp per capita is considered a credit positive. however, the growth in gdp can be caused by a decrease in the number of residents in the province; hence the tax base or income base is shrinking and less money is available to pay creditors. this is supported by various other authors (fitch, 2011:6-7; s&p, 2010:19; australiaratings, 2014). the normality, linearity and homoscedasticity assumptions of a linear-regression model can be tested by means of a scatter plot and a normality plot of the residuals. it is evident from figure 5 that the linear-regression model resulting from the ht data set met the assumptions. 3.2 health without time data set (h) the h data comprise 45 data points, but one less independent variable than the previous data, since the time variable was excluded from the h data. thus 40 independent variables were available for modelling purposes. variable clustering was used to deal with multicollinearity among the 40 independent variables and resulted in 18 variables that will be used for the rest of the analysis. the scatter plot of the ranks of the spearman’s correlation coefficients versus hoeffding’s ds for each of the remaining 18 independent variables with the dependent variable was used to deal with irrelevant independent variables and decreased the number of independent variables available for modelling purposes to 14. the stepwise and forward selection techniques resulted in the same linear-regression model, and the other two methods resulted in another regression model. equation 2 describes this model: 𝑌% = −2.33 − 2.59 𝐼𝑛𝑑𝑖𝑐𝑎𝑡𝑜𝑟_𝐾𝑍𝑁< − 0.56 𝑥27_𝑔𝑟𝑜𝑢𝑝𝑒𝑑< − 1.35 𝐼𝑛𝑑𝑖𝑐𝑎𝑡𝑜𝑟_𝐿𝑖𝑚< + 0.88(𝑙𝑛_𝑥14<) (2) the r2 of 0.49 indicates that the model explains 49 per cent of the variance of the dependent variable. the r2 adjusted for the number of parameters within the model is lower at 0.44. sajems ns 19 (2016) no 2:192-214 203 table 3 stepwise and forward regression of the h data set 𝑅" 0.49 adj. 𝑅" 0.44 variable description parameter standardised estimate 𝒑-value variance inflation factor intercept intercept −2.33 0.00 0.16 0.00 indicator_kzn 1 = kzn, 0 = all others −2.59 −0.58 <.0001 1.13 x27_grouped departmental annual appropriation of revenue to total departmental revenue (grouped) −0.56 −0.33 0.01 1.11 indicator_lim 1 = lim, 0 = all others −1.35 −0.30 0.01 1.08 ln_x14 ln(departmental capital expenditure to total provincial capital expenditure) 0.88 0.22 0.08 1.12 figure 6 dataset h’s stepwise and forward models’ residual plot the absolute values of the standardised parameter estimates indicate that the independent variable indicator_kzn is the most influential (table 3). this corresponds to the results of the ht data set. the highest 𝑝-value (ignoring the intercept) is 0.08, and the highest variance inflation factor is 1.13, which is well below the respective guideline values of 0.1 and 10. the interpretation of independent variables and their effect on the dependent variable is documented next. again, one variable at a time will be explained, and it will be assumed that the other variables remain constant. the parameter estimates of variables indicator_kzn and indicator_lim, −2.59 and −1.35, respectively, indicate that these provinces’ departments of health are better payers than those of the other provinces. as departmental annual appropriation of revenue to total departmental revenue (x27_grouped) increases, the payment behaviour of the department improves. this is indicated by the negative parameter estimate of −0.56. one explanation is that revenue received directly from national government is unwavering as opposed to some sources of departmental own revenue. as stated earlier, fitch (2011:4) also takes the volatility, diversity and predictability of revenue sources into account, since overdependence on a volatile source would influence payment behaviour in a negative manner. thus a higher proportion of department annual appropriation of revenue would influence payment behaviour in a positive manner, since this is considered an unwavering source of revenue. an increase in the ratio departmental capital expenditure to total provincial expenditure, ln_x14, leads to a deterioration of payment behaviour. one possible reason for the increase in the ratio is an increase in the department’s capital expenditure. if this is the case, payment behaviour could be affected negatively, since capital expenditure is a long-term commitment and therefore may have an undesirable impact on future expenditure flexibility. -3 -2 -1 0 1 2 -3 -2 -1 1 2 r es id ua l predicted value -3 -2 -1 0 1 2 -3 -2 -1 1 2 3 r es id ua l quantile 204 sajems ns 19 (2016) no 2:192-214 the scatter plot indicates that the model met the underlying assumptions of linearity and homoscedasticity. the residuals are normally distributed (figure 7). table 4 backward and best subset regression model of the h data set 𝑅" 0.54 adj. 𝑅" 0.48 variable description parameter standardised estimate 𝒑-value variance inflation factor intercept intercept 0.07 0.00 0.92 0.00 indicator_kzn 1 = kzn, 0 = all others −2.43 −0.55 <.0001 1.17 x27_grouped departmental annual appropriation of revenue to total departmental revenue (grouped) −0.69 −0.41 0.00 1.13 indicator_lim 1 = lim, 0 = all others −1.22 −0.27 0.02 1.02 indicator_x36_z 0 = departmental net assets, 1 = other −1.11 −0.27 0.03 1.15 x52 quality of department’s financial reports 0.48 0.24 0.04 1.14 figure 7 residual plots of the h data set’s backward and best subset model this resulted in the following model: 𝑌% = 0.07 − 2.43 𝐼𝑛𝑑𝑖𝑐𝑎𝑡𝑜𝑟_𝐾𝑍𝑁< − 0.69 𝑥27_𝑔𝑟𝑜𝑢𝑝𝑒𝑑< − 1.22 𝐼𝑛𝑑𝑖𝑐𝑎𝑡𝑜𝑟_𝐿𝑖𝑚< −1.11(𝐼𝑛𝑑𝑖𝑐𝑎𝑡𝑜𝑟_𝑥36_𝑍𝑚𝑒𝑎𝑛<) + 0.48(𝑥52<) (3) the r2 and adjusted r2 of this model are marginally higher, at 0.54 and 0.48, respectively, than the previous model values. this is to be expected, since this model includes five independent variables as opposed to the four of the previous model. indicator_kzn is the most influential variable included in this model as well. all the p-values are below the cut-off of 0.1. the low variance inflation factors indicate that no multicollinearity exists among the five independent variables. the kwazulu-natal and limpopo provinces’ departments of health are thus better payers than the other provinces’ departments of health. again, as departmental annual appropriation of revenue to total departmental revenue (x27_grouped) increases, the payment behaviour of the department improves. the negative parameter estimate of indicator_x36_z reflects that departments with net assets are better payers than departments without net assets. generally, the existence of net assets, that is, where assets exceed liabilities, indicates good financial management; hence departments with net assets will be in a better position to make repayments in a timely manner. australiaratings (2014) also reviews assets management as part of its financial-management strategy assessment. the parameter estimate of 0.48 of x52 (quality of department’s financial reports) shows that, as the quality of financial reporting worsens, the department’s payment behaviour also worsens (1 = -3 -2 -1 0 1 2 -3 -2 -1 1 2 r es id ua l predicted value -3 -2 -1 0 1 2 -3 -2 -1 1 2 3 r es id ua l quantile sajems ns 19 (2016) no 2:192-214 205 clean audit, 2 = financially unqualified audit opinion, 3 = qualified audit opinion, or 4 = adverse audit opinion and disclaimer of audit opinion). good financial reporting indicates good financial management. three other ratings agencies also examine the quality, transparency, level of detail, timeliness, frequency and audit opinion of a subnational’s financial reports (moody’s, 2008:13-14; s&p, 2010:23-24; dbrs, 2011:10). figure 7 indicates that this model adheres to underlying linear-regression modelling assumptions. 3.3 summary section 3 documented the methodology used to develop the linear-regression models, or paymentbehaviour models, as well as the results of the models developed using the two data sets. attention was given to the dependent and independent variables used. the resulting linear-regression models were payment-behaviour models which can be used to derive the 30 per cent quantitative part of a final ranking or credit rating. the linear-regression models were developed in three steps. firstly, variable clustering was performed to deal with multicollinearity among the independent variables. then, irrelevant independent variables were dealt with by using scatter plots of spearman’s correlation versus hoeffding’s d ranks. lastly, linear-regression modelling based on four different variable-selection techniques was used to develop the payment-behaviour models. the aim of the models developed was to rank south african subnationals in terms of expected future payment behaviour based on quantitative information. 4 model advancements this section investigates whether certain model advancements can improve the 𝑅" values of the linear-regression models presented previously. in order to improve the linear-regression models, three advancements methods were investigated, namely using subject knowledge as a variable-selection method, including interactions between the independent variables in the models and excluding outliers from the data sets. these methods were only applied to the linear-regression models that resulted from the stepwise variable-selection procedure. 4.1 health with time data set (ht) the results of using subject knowledge as a variable-selection method, as well as outlier and interaction testing of the ht data set are presented next. 4.1.1 subject knowledge as a variable-selection method the four variable-selection techniques discussed in the previous section were based on the statistical properties of the independent variables. in other words, variables were selected based on their predictive power (measured in terms of significance levels) with regard to the dependent variable. alternatively, variables selection can be done by manually entering some independent variables selected by the researcher based on past work or subject knowledge (field, 2005:161; osborne, 2008:301). thus the model-advancement method investigated in this case entailed ensuring that independent variables from all four broad factors identified by the literature were included in the stepwise models. although this did result in an improvement of r2 from 0.51 to 0.53, such improvement should be tested in terms of prediction accuracy (see “suggestions for future research”). 4.1.2 outliers the treatment of outliers depends on the reason for the resulting outlier. if it is due to an error during the data-capturing phase, it should be corrected or deleted from the data set. if the outlier is valid, but is explainable by an exceptional situation, it should only be deleted if there are no 206 sajems ns 19 (2016) no 2:192-214 independent variables in the model that can explain the exceptional situation. if there is no explanation available for an outlier, the analyses should be undertaken with the outlier included and excluded, since neither the inclusion nor exclusion can be warranted (hair et al., 2006). identified outliers were treated in two ways. firstly, they were investigated during the datacompilation phase as well as in the model-building phase. if these outliers were caused by datacapturing errors, they were corrected. if they involved special circumstances, they were left unchanged. secondly, during the model-advancement phase, the m estimation and least-trimmed squares (lts) procedures of the sas institute inc. (2011) software were used to identify outliers. the m estimation procedure focuses on outliers in the dependent variable, and the lts procedure on outliers in the independent variables. since no reason to delete these data could be found, models were developed with the outliers included and excluded. the results of the models including the identified outliers were documented in section 3, and the results of the models excluding outliers are presented in this section. note that the process followed for models excluding outliers was as follows: once outliers were identified, they were deleted from the data sets and parameter estimates were recalculated. the effect of the outlier omission on parameter estimates must be assessed once parameter estimates have been recalculated. similar parameter estimates resulted from these cases. 4.1.3 interaction effects another way of improving a linear-regression model is to add interaction effects to the model. the specific interaction terms that formed part of this investigation were two-way interactions and polynomials of the second degree. the results of adding interaction effects to the stepwise model of the ht data set are presented in table 5. the consequential model contains only interaction variables, except for the intercept, and the r2 increased to 0.74. kutner et al. (2005:306-313) state that a model which includes interaction terms is considered to be a complex model, and sas institute inc. (2010:3-59) states that the inclusion of polynomial terms complicates interpretation. therefore, only high-level descriptions of the effects of the interaction terms on the dependent variable are provided (table 6). table 5 linear-regression model with interaction effects of the ht data set 𝑅" 0.74 adj. 𝑅" 0.68 variable parameter standardised estimate 𝒑-value variance inflation factor intercept 1.03 0.00 <.0001 0.00 indicator_wc_ln_x49 −19.85 −0.32 <0.01 1.11 x27_grouped_indicator_x36_z −0.62 −0.33 <0.01 1.26 indicator_lim_ln_x36_zmean 0.60 0.37 <0.01 1.18 indicator_kzn_ln_x48 −32.18 −0.60 <.0001 1.12 indicator_mpu_ln_x57 −0.15 −0.36 <0.01 1.13 indicator_lim_ln_x50 −65.09 −0.35 <0.01 1.13 indicator_fs_ln_x33 −22.70 −0.18 0.005 1.06 x27_grouped_ln_x34 −13.93 −0.29 <0.01 1.22 4.1.4 combining the effect of interaction effects and outliers a test was conducted to determine the effect of outliers on the model with interaction effects included. when applying the m estimation method, one data point was indicated as an outlier. the application of the lts method identified five data points as outliers. the deletion of these data resulted in models with r2s of 0.80 and 0.90, respectively. the adjusted r2s increased to 0.76 and 0.88, respectively. sajems ns 19 (2016) no 2:192-214 207 the resulting models are very similar to the previously discussed model. the deletion of the five outliers indicated by the lts method resulted in noteworthy changes in the parameter estimates of the independent variables indicator_lim_ln_x50 and indicator_fs_ln_x33 included in the interaction model without independent outliers. table 6 contains the parameter estimates and descriptions of the effects, included in all three models, on the dependent variable. it is assumed that all other interaction effects remain constant. table 6 descriptions of the interaction effects of the ht data set variable variable description parameter estimates – interaction model: description of effect overall without dependent outliers without independent outliers indicator_wc _ln_x49 ln_x49 = ln(provincial surplus or deficit / provincial payments) −19.85 −19.71 −18.54 negative parameter estimate shows that increase in ln_x49 (provincial surplus or deficit / provincial payments) leads to an improvement in payment behaviour for western cape x27_grouped_ indicator_x36_z x27_grouped = departmental annual appropriation of revenue / total departmental revenue (grouped) indicator_x36_z = 0 if departmental net assets = 0, =1 if departmental net assets > 0 −0.62 −0.66 −0.58 increase in departmental annual appropriation of revenue / total departmental revenue leads to an improvement in payment behaviour, provided that the department’s assets > liabilities indicator_lim_ ln_x36_zmean ln_x36_zmean = ln(departmental net assets / departmental total expenditure) (missing mean) −0.60 −0.59 −0.93 increase in this variable leads to a deterioration of payment behaviour for limpopo indicator_kzn_ ln_x48 ln_x48 = ln(provincial surplus or deficit / provincial receipts) −32.18 −31.99 −30.85 kwazulu-natal’s payment behaviour improves if the surplus or deficit / provincial receipts ratio improves indicator_mpu_ ln_x57 ln_x57 = ln(provincial gdp per capita) −0.15 −0.20 −0.15 increase in provincial gdp per capita is beneficial to mpumalanga’s department of health’s payment behaviour indicator_lim_ ln_x50 ln_x50 = ln(provincial total receipts / provincial total payments) −65.09 −66.26 −128.57 increase in ln_x50 leads to better payment behaviour; this only applies to the limpopo province indicator_fs_ ln_x33 ln_x33 = ln(departmental surplus or deficit / departmental total revenue) −22.70 −22.00 −34.79 free state’s department of health’s payment behaviour will improve if its surplus or deficit / total revenue improves x27_grouped_ ln_x34 x27_grouped = departmental annual appropriation of revenue / total departmental revenue (grouped) ln_x34 = ln(departmental surplus or deficit / departmental total expenditure) −13.93 −15.1 −13.69 payment behaviour will improve as ln_x34 increases, provided that x27 has high values (group = 1). where x27 has low values (group = −1) an increase in departmental surplus or deficit / departmental total expenditure leads to worsening payment behaviour. remainder of values of x27 (group = 0) have no effect due to multiplication by 0 4.2 health without time data set (h) the stepwise model of the h data set was used to test for improvements in the model if subject knowledge is used as a variable-selection method, if interaction effects are added to the model, and if outliers are deleted from the data set. these results are presented next. 208 sajems ns 19 (2016) no 2:192-214 4.2.1 subject knowledge as a variable-selection method the model including variables representing all four broad factors’ r2 improves from 0.49 to 0.53, but the prediction accuracy should be measured as well. 4.2.2 outliers three data points were identified as outliers in the dependent variable. the r2 of the model improved from 0.49 to 0.68, and the adjusted r2 from 0.44 to 0.65, when these data points were deleted. the lts technique indicated four data point as outliers. the deletion of these data points improved the model’s r2 and adjusted r2 even more to 0.72 and 0.69, respectively. the model improved considerably in terms of the increase in r2, that is, by 39 per cent and 46 per cent, respectively. however, the loss of data must be considered. again, the parameter estimates did not change much. 4.2.3 interaction effects the test done to determine whether the inclusion of interactions effects will improve the model was repeated for the h data set. the results are presented in table 7. table 7 model including interaction effects of the h data set 𝑅" 0.62 adj. 𝑅" 0.56 variable parameter standardised estimate 𝒑-value variance inflation factor intercept 0.91 0.00 <.0001 0.00 x27_grouped_ln_x57 −0.05 −0.32 <0.01 1.08 indicator_kzn_ln_x49 −34.78 −0.65 <.0001 1.08 indicator_lim_ln_x36_zmean 0.63 0.39 <0.01 1.12 indicator_mpu_ln_x58 0.51 −0.27 0.01 1.06 indicator_wc_ln_x13 −0.30 −0.31 0.01 1.06 indicator_lim_ln_x50 −53.33 −0.29 0.01 1.07 as in the case of the ht data set, the resulting model contains only interaction variables, except for the intercept. the r2 improved from 0.49 to 0.62. again, only high-level descriptions are provided seeing that the inclusion of interaction terms resulted in a complicated model (table 7). these descriptions are based on the assumption that all other variables stay constant. 4.2.4 combining the effect of interaction effects and outliers when applying the m estimation method to the h interaction model, six data points were indicated as outliers. the application of the lts method identified four data points as outliers. the r2 of the model increased from the original 0.62 to 0.85 once the data points with the dependent-variable outliers were deleted. the r2 increased from the original 0.62 to 0.82 when the four data points with outliers in the independent space were deleted. these models are similar to the interaction model. once again, the parameter estimate of the independent variable indicator_lim_ln_x50 included in the interaction model without independent outliers showed a large change. therefore, the outliers did have a noteworthy effect in this model. this relates to the ht interaction model without independent outliers. table 8 contains the high-level descriptions of the interaction terms, indicated by the parameter estimates, on the dependent variable. sajems ns 19 (2016) no 2:192-214 209 table 8 descriptions of interaction terms included in the h data set variable variable description parameter estimates – interaction model: description of effect overall without dependent outliers without independent outliers x27_grouped_ ln_x57 x27_grouped = departmental annual appropriation of revenue / total departmental revenue (grouped) ln_x57 = ln(provincial gdp per capita) −0.05 −0.05 −0.04 payment behaviour improves as ln_x57 increases, provided that x27 has high values (group = 1). where x27 has low values, (group = −1) increases in provincial gdp per capita lead to worsening payment behaviour. the remaining values of x27 (group = 0) have no effect due to multiplication by 0 indicator_kzn_ ln_x49 ln_x49 = ln(provincial surplus or deficit / provincial payments) −34.78 −31.05 −32.06 negative parameter estimate shows that increase in ln_x49 (provincial surplus or deficit / provincial payments) leads to an improvement in payment behaviour in kwazulu-natal indicator_lim_ln_ x36_zmean ln_x36_zmean = ln(departmental net assets / departmental total expenditure) (missing mean) 0.63 0.59 1.08 increase in ln_x36_zmean leads to a deterioration of payment behaviour for limpopo indicator_mpu_ ln_x58 ln_x58 = ln(provincial gdp per capita growth) −0.51 −0.63 −0.76 increase in provincial gdp per capita growth is beneficial to mpumalanga indicator_wc_ ln_x13 ln_x13 = ln(departmental capital expenditure / departmental adjusted budget) 0.3 −0.35 −0.33 increase in ln_x13 leads to an improvement in payment behaviour of western cape indicator_lim_ ln_x50 ln_x50 = ln(provincial total receipts / provincial total payments) −53.33 −44.66 −121.13 increase in ln_x50 results in better payment behaviour for limpopo 4.3 summary section 4 investigated linear-regression models to improve the r2 values via three modeladvancement techniques, that is, using subject knowledge as a variable-selection method, including interactions between the independent variables in the models and excluding outliers from the data. the inclusion of additional independent variables, based on the subject knowledge variable-selection method, improved the r2s of the models. the inclusion of interactions effects and the deletion of outliers improved the models. 5 subnational credit ratings and their policy implications in south africa given the contribution of a workable system to evaluating and assigning subnational credit ratings, government may well employ the developed models (sections 3 and 4) in order to assess the creditworthiness of its underlying subnationals. this may have policy implications. while the focus of this paper was not to recommend or direct specific government policy, this section nevertheless discusses potential policy implications. the problem of inconsistent reports or data formats exists in south africa. an example of data that were considered for this paper, but which could not be used because of changing report formats, is the information on unauthorised expenditure and irregular expenditure, as well as the fruitless and wasteful expenditure information found in the auditor-general’s reports. the consolidated general report on provincial audit outcomes from 2010 to 2011 (auditor general, 2011) contains summaries of this information on a departmental level (see table 23:49). although some of this information is also documented in the “consolidated general report on provincial audit outcomes 2009-10”, it was documented in a different format (fourie et al., 2013:95-96). another problem relating to the data sources used is the availability of data. in theory, the historical records should be easy to access. however, in practice, these are often difficult to 210 sajems ns 19 (2016) no 2:192-214 procure. also, these should ideally be available at least quarterly in order to update the credit ratings on a regular basis once the developed credit-rating methodologies are finalised. however, most of the data available to update subnational credit-rating methodologies in south africa are made available only once a year. national treasury could consider amending current policies to include more rigid guidelines on reporting so as to overcome the inconsistent reporting. it is also suggested that the policies on financial reporting be amended in such a manner that all information is available on a more regular basis, as well as being made available electronically. this is confirmed by rodden (2006) who observes that one of the most promising aspects of moving towards enhanced fiscal surveillance of regional and local governments is the collection of better data. another data problem that has been identified is that the information on the outstanding amounts on debt obligations and the number of days/months that they have been outstanding does not exist for provincial governments and departments (owing to the fact that south africa’s provincial governments and departments use a cash-based accounting system instead of an accrual-based accounting system). these data provide information on a provincial department’s willingness and capability to repay debt obligations in full and on time, which is the general measure used by credit-rating agencies when assessing creditworthiness. it would be best if this information were to be included in provincial governments and departments’ financial reports. it would also be preferable for provincial governments and departments to make use of the accrual-based accounting system, since this would result in more comprehensive and comparable financial statements. in 2001, the international monetary fund (imf) recommended that the accrual-based accounting system should be used for all government financials (imf, 2001). the national treasury confirmed in its budget review document that national and provincial governments employ a modified cash-based accounting system, while local authorities (municipalities) and public entities use the accrual-based accounting system. it declared its intention to follow the imf’s recommendation over time, but stated that government data would be presented on a cash basis for the immediate future (national treasury, 2013b:1-2). subnational governments could use the developed methodology and models (sections 3 and 4) to identify areas in which they can improve. an indirect benefit would be more effective management owing to the resultant competition among provincial governments. this may influence future departmental policies. additional possible policy implications are evident when considering specific variables that were important in most of the models developed. note that most of the variables used come from the broad factor, fiscal performance (see, for example, figure 2), and that the developed methodologies would therefore most probably influence fiscal policies. ter-minassian (2007:2-3) states that fiscal policies on a subnational level will be influenced greatly by the central government’s policy. fiscal rules are often seen as devices to ensure fiscal discipline. fiscal rules are neither necessary nor sufficient to ensure fiscal discipline at the subnational level. in principle, both financial markets and cooperative arrangements across government levels could promote such discipline and provide the right incentives for local politicians to be fiscally responsible. however, fiscal rules could be useful when these arrangements are not feasible or fully reliable. nevertheless, fiscal rules cannot secure fiscal discipline by themselves if the political will to adhere to them is lacking, or if the central government’s commitment to a no-bailout policy is not credible. for example, as the fiscal performance variable x27_grouped (departmental annual appropriation of revenue to total departmental revenue) increases, the payment behaviour of the department improves. the fiscal policy determining departmental appropriation of revenue should be reviewed in order to encourage departments to increase own revenue generation. ways to increase the department of health’s own revenue might be to implement departmental (or provincial) tax as opposed to national tax. this, however, should be undertaken with extreme caution. this warning is confirmed by the literature. rodden (2006) states that, as subnational governments in europe gain greater independence over larger shares of public-sector budgets, it may seem that they gain greater access to domestic and international credit markets too. as a sajems ns 19 (2016) no 2:192-214 211 result, subnational debt markets are expanding rapidly and an increasing number of subnational governments are being credit-rated. this may seem like a good opportunity to enhance the efficiency of local infrastructural investment and build a more central role for markets. however, scepticism about increasing market discipline among the subnational governments remains, since most of europe’s subnational governments are highly dependent on shared taxes and grants. rodden (2006) argues that credit markets are poorly suited to exercising discipline over the borrowing of subnational governments that do not have sufficient access to independent taxation. another fiscal performance variable indicator_x36_z reflects that departments with net assets are better payers than departments without net assets. generally, the existence of net assets, that is, a situation where assets exceed liabilities, indicates good financial management. thus departments with net assets will be in a better position to make repayments in a timely manner. australiaratings (2014) also views asset management as part of its financial-management strategy assessment. again, fiscal policies could be amended to address this, but the rating assigned to the subnational government is unlikely to be taken seriously by investors if there are considerable policy uncertainties and doubts about the strength and quality of the institutions and systems within which the credit analysis is conducted (liu & tan, 2009:29). the policymaking process is often less transparent and the likelihood of frequent policy changes much stronger in developing countries than in developed countries (liu & tan, 2009:32). 6 conclusions and suggestions for future research 6.1 conclusions although none of the defined south african subnationals are currently being rated, the three largest international credit-rating agencies do rate south africa’s national government. if the credit ratings resulting from the proposed methodology will not be used on an international level, the effect of the sovereign rating on the subnationals’ credit rating may be neglected, since the national government will have the same effect on all nine subnationals. it should be noted that municipal governments are credit-rated. all 278 south african municipalities are rated by municipal iq, a data and intelligence service specialising in the monitoring and assessment of south africa’s municipalities (municipal iq, 2013). fitch and moody’s also rate the municipalities, but only a few (less than 5 per cent). a concern when developing a subnational credit-rating methodology is data availability as well as data quality. section 2 revealed three possible data sources that could be used within the south african context: (1) the subnational government’s annual reports (south african government information, 2013); (2) the auditor-general’s reports (auditor-general of south africa, 2011); and (3) the section 32 reports (national treasury of south africa, 2013a) compiled by the national treasury. this paper’s main contribution is to develop the quantitative section of a credit-rating methodology for south african subnationals. the unique characteristics of the available data, the assembly of these data, and the selection of dependent and independent variables for the linearregression model chosen were presented and discussed in section 2. the second contribution is that the methodology was then applied to provincial departments of health. this resulted in three linear-regression models being built in section 3 explaining 51 per cent, 49 per cent and 48 per cent of the variation (measured by r2) of the payment behaviour of the department of health. the most influential variable was indicator_kzn indicating that the department of health of kwazulu-natal is a better payer than the other provinces’ departments of health. more complexed linear models were built in section 4, increasing the r2 to 74 per cent, 62 per cent, 82 per cent and 85 per cent, respectively, and clearly improving the models. some of the observations (measured by absolute value in estimates) included the following: 212 sajems ns 19 (2016) no 2:192-214 • increases in the ratio departmental net assets/departmental total expenditure leads to a deterioration of payment behaviour for limpopo’s department of health (table 6). • kwazulu-natal’s payment behaviour improves if the surplus or deficit/provincial receipts ratio improves (table 6). the third and last contribution is the construction of the data sets, which are available on request. the data used to develop the quantitative section of the credit-rating methodology were discussed in section 2. six different reports, compiled by four institutions, were used to gather five years’ data. this equated to 70 different reports and one interactive data set being used to compile two data sets. 6.2 future research the number of provincial departments per provincial government differs. in theory, it should be possible to aggregate the data at a provincial-government level in order to develop a provinciallevel, subnational credit-rating methodology, but, in practice, the unequal number of departments poses difficulties in terms of data collection and aggregation. this might be an avenue to investigate further in future. the improvements in the models built in section 4 should be tested by assessing the appropriateness of each model (in terms of prediction accuracy) when deciding whether the improvement in r2 is worthwhile. the increase in complexity of the models (when including interaction effects and the loss of data when deleting outliers) must also be taken into account. these improvements are planned for future research. the methodology developed in this paper was applied to the department of health. the methodology may be applied to other departments as well. once the imf’s recommendation is implemented (that the accrual-based accounting system be used for all government financials), more comprehensive financial statements should be available. this will enable the redevelopment of the methodology so as to include other data as well. owing to the nature of the data used, the subnational credit-rating methodologies developed in this study assess only quantitative information. it is therefore recommended that future research address the identification and quantification of qualitative information that could be used to determine the credit quality of south africa’s subnationals. in this paper, linear regression was chosen as the modelling technique. a further step could be to compare different modelling techniques with linear regression. endnote 1 this work is based on research supported in part by the national research foundation of south africa [reference number uid: tp1207243988]. the grant holder acknowledges that opinions, findings and conclusions or recommendations expressed in any publication generated by nrf-supported research are those of the author(s) and that the nrf accepts no liability whatsoever in this regard. references auditor-general. 2007 to 2011. consolidated general reports on the national and provincial audit outcomes 2006/07 to 2010/11. auditor-general of south africa, pretoria. australia ratings. 2014. state territory government methodology. available at: http://www.australiaratings.com/stateterritorygovernmentmethodology [accessed february 2014]. chambers, m. & dinsmore, t.w. 2014. predictive analytics techniques. new jersey: pearson education, ft press. dbrs. 2011. methodology: rating canadian provincial governments. toronto: dominion bond rating service limited, dbrs. 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accepted: 18 apr. 2018; published: 20 aug. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: a variant of the contingent convertible bond, first proposed in 2011, is investigated: the call option enhanced reverse convertible (coerc). although issued as a bond, it converts to new shareholder’s equity if a bank’s market share of capital falls below a pre-specified trigger point. aim: coercs avoid the problems with market-based triggers (e.g. sell-offs and death spirals) due to panic and market manipulation. banks that issue coercs have less incentive to choose investments that may be subject to large losses and disincentive problems, associated with the replenishment of shareholder’s equity after market declines (also known as debt overhang) are also avoided. setting: proposed amendments to the coerc structure are suggested for the african market. methods: the data used were simulated, stylised values for a standard coerc. no market parameters are required, such as equity or debt levels or market volatility. details of the stylised example are provided in table 4 and table 5 in the ‘results and discussion’ section. results: both examples of floating coupons for coercs would aid in the objective of issuing a security that is countercyclical in nature, as banks would avoid having to pay coupons in times of distress. conclusion: in addition to the recommendations of the basel frameworks, cocos have been considered and proposed as an additional measure to promote counter cyclicality in terms of capital composition in banks. introduction the credit crisis of 2008 triggered global financial distress – particularly in banks. as a direct result, regulators were mobilised to alter banks’ capital structure so that losses and bankruptcy costs could be shouldered by the banks’ creditors rather than by taxpayers as was the case in most developed markets for the 2008 crisis (sundaresan 2013). one of the many suggestions put forward by global regulatory authorities was the proposal that banks should implement and install contingent convertible debt (cocos), which automatically convert into equity when pre-specified trigger levels are breached. these triggers could be accounting information based, market price based, or wholly decided by bank supervisors. whatever the initiating event, the aim is to ensure the automatic recapitalisation of the bank when crises occur to liberate them from the ensuing debt service (and default) payments (albul, jaffee & tchistyi 2010). global coco issuance soared post the credit crisis (2009–2014): additional tier 1 capital coco issuance increased from us $2 billion in 2010 to $93 billion in 2014. tier 2 coco issuance was stable during these periods at around $10 billion, but increased to $82 billion in 2014. since then (between 2015 and 2018), both types of capital coco issuance have stabilised but diminished, additional tier 1 at around $60 billion and tier 2 at about $16 billion as shown in figure 1 (ainsworth 2017). figure 1: global contingent convertible issuance (in us $ billion). early proposals embraced cocos with regulatory triggers (e.g. glasserman & nouri 2012; pennacchi 2011; sundaresan & wang 2012). the idea was simple enough: when banks’ tier 1 capital ratios fall below a prescribed level, these convertible bonds will convert into equity and recapitalise the ailing bank. problems arise, however, because it is unattractive to issue cocos unless: regulatory authorities deem them sufficiently like equity to qualify as tier 1 capital. tax authorities judge them as sufficiently like debt to permit interest payments to be tax deductible (calomiris & herring 2013). although most european countries and their relevant regulatory and tax authorities recognise this, the internal revenue service (irs) declined to do so. as a result, united states (us) banks do not issue cocos (herring 2017). some of these issues were addressed by liebenberg, van vuuren and heymans (2016, 2017) with focus on the unique african financial milieu. the south african reserve bank (sarb), for example, deems that cocos do qualify as tier 1 capital and local tax authorities do judge them as sufficiently similar to debt to allow tax deductible interest payments. despite some early successes (bolton & samama 2012; flannery 2009a, 2009b), however, cocos based on purely regulatory triggers (or, indeed, market-based triggers) were plagued by problems (berg & kaserer 2015; sundaresan & wang 2012). in june 2017, the sixth largest spanish (banco santander) bank’s cocos experienced considerable losses (riskconcile 2017; unmack 2017). banco santander’s single resolution board (srb) transferred all shares and capital instruments of banco popular espanol (banco popular) to banco santander. the coco functioned exactly as it should: taxpayers did not pick up the bill for debt instrument investors and senior bond holders were rescued. for subordinated bond holders and coco bond investors, however, the srb decision triggered the decimation of value for coco bond investors who witnessed the value of their initial investment decline by over 60% in a few weeks. coco investors were painfully reminded of the high risks associated with cocos, masked in good times by the coco bond’s high coupon. other types of coco bonds have been proposed whose conversion is triggered when a market value capital ratio is breached, call option enhanced reverse convertibles (coercs). these instruments are promising alternatives as they have several desirable features which circumvent problems that arose with regulatory-based triggers cocos (pennacchi, vermaelen & wolff 2014). coercs are still (2018) relatively new and investors are unsurprisingly reluctant to purchase untested instruments, particularly so soon after the credit crisis and – more recently – so soon after the disastrous performance of banco popular (and other) cocos (riskconcile 2017; unmack 2017). coercs, though, have features which might work well in the african bank space – and in this article, some amendments are proposed and examined. implementation in african markets is subject to regulatory scrutiny and buy-in from both investors and banks, but given the theoretical success of the proposal to date, early signs are promising. the remainder of this article proceeds as follows, the ‘literature study’ reviews the available, relevant literature regarding cocos and the problem of procyclicality in banks. the regulatory response to the 2008 credit crisis is also reviewed here. the ‘data and methodology’ section presents existing coco pricing and valuation approaches and the proposed mechanisms that govern the behaviour of coercs. the relevant mathematics is dense, but explained elsewhere, so only a numerical example is provided for comparison purposes. the results of calculations are analysed and presented in the ‘results and discussion’ section, as well as a discussion regarding the theoretical ramifications of coerc implementation in african banks. the ‘conclusions and suggestions for future work’ concludes the article. literature study regulatory bank capital levels increased considerably after the credit crisis which began in 2007. the crisis arose from multiple causes, but an important one was the neglect of capital procyclicality. contingent convertible bonds were proposed to alleviate this problem. the relevant literature outlining the crisis, the problem of procyclicality and the need for contingent capital is presented below. the credit crisis during 2007 the global economy experienced a credit crisis which had disastrous effects on international financial markets. the reasons behind the crisis are plentiful, however, a principle driver of the widespread crisis was the existence, use and eventually the failure of complex derivative investment instruments (baily, litan & johnson 2008). these instruments caused an inflation of asset prices beyond their historic trends and due to their complex nature, they were also not priced correctly. as a result, the banks who invested and traded in these instruments held more risk than what was anticipated in financial models and the effect of this risk was exposed when many banks filed for bankruptcy. the first bank to tumble was lehman brothers who officially applied for chapter 11 bankruptcy in september of 2008 (de haas & van horen 2012). the effect of the lehman bankruptcy was a global mistrust between financial institutions leading to a drastic reduction in lending and a financial system whose member firms tried to sell off any securitised instruments at any cost. these effects are classic signs of a capital market which is procyclical in nature (nikolov 2010). in other words, when an economic indicator experiences an increase in value when the economy exhibits economic growth, it is deemed a procyclical indicator and is used as a metric to measure procyclicality. when the procyclicality methodology is applied in analysing the losses suffered during the credit crisis, it is evident that the losses that occurred during the credit crisis, exceeded the gains that were evident in periods when the economy grew, proving the procyclical nature of the financial models used to model the risk of global financial institutions, especially under the basel ii framework employed in the period preceding the financial crisis (basel committee on banking supervision [bcbs] 2010b; van vuuren 2012). when further examining the procyclical effects, it is evident that the supply side of the financial system, banks lending money, reacted especially negatively to the financial shocks that the global markets experienced (de haas & van horen 2012). banks dried up virtually all fund lending to clients, and as such, the broader financial system suffered, as there was no liquidity for businesses with which to operate. in response to this crisis, the bank for international settlements (bis) updated the basel ii regulation with an additional set of requirements, in order for banks to be more prepared for similar crises in the future and combat the procyclicality inherent in previous financial models to some extent (bcbs 2011). this new set of regulations is known as basel iii and is expected to be fully implemented by 2019. the main aim of the newer basel iii regulation is to bolster the amount, liquidity, consistency, transparency and quality of tier 1 capital (bcbs 2010a). additionally, basel iii also includes a reconstitution of acceptable regulatory capital, enhancements to the amount of capital required for the trading book and also completely new rules such as the amount of required capital buffers and a leverage ratio. these measures are aimed at increasing the required amount of capital from 8.0% to 10.5% (even to 13.5% in specially defined circumstances) (bcbs 2011). a noteworthy addition in requirements of basel iii is the countercyclical capital buffer (ccb) which aims to directly combat the procyclicality inherent in financial models. the ccb is a mechanism that is designed to bolster the capital ratio up to 13% when the economy is expanding. the ccb, thus, functions mainly at the height of an economic cycle and is designed to discourage excessive credit lending by banks. this measure, however, still remains (2017) a theoretical measure and has not been tested practically to the knowledge of the authors at the time of publication. real-world scenarios may disprove the theory behind this mechanism as it may not effectively motivate lending in economic cycle downturns, hence the pressing need for regulators to inspect additional countercyclical measures. contingent convertible bonds an example of an alternatively proposed countercyclical measure is the coco, a class of security that possesses both an underlying equity component, as well as a fixed-income producing component. these securities were designed to be loss-absorbing in the sense that they will be issued as bonds but will convert into equity after certain conditions are fulfilled (bcbs 2010a). cocos behave much like vanilla convertible bonds, but contain fundamental differences. a standard bond which is callable and convertible may be manually converted into a predefined number of the common shares of the issuer at any time, as required by the holder of the bond. this bond is usually also callable by the issuer, in the sense that the bondholder may be requested to surrender the bond to the issuer at a predefined price (huang 2009). thus, the bondholder or issuer may choose at will when the contract comes to an end. these bonds are popular due to the higher yields (to attract investors to what are considered non-standard instruments) they offer versus traditional non-convertible bonds (as they carry more risk due to the convertible clause attached to them) and the motivation for conversion (upside versus downside).1 the trigger mechanism that results in the conversion of the bonds is where cocos and vanilla convertible bonds differ. glasserman and nouri (2012) explored cocos characterised by accounting-based triggers (e.g. the book value of assets), using merton’s structural framework. the conversion to equity was just sufficient to meet the capital requirements and occurred whenever the trigger was reached (assuming the trigger point was greater than the bankruptcy barrier). albul et al. (2010) also employed merton’s (1974) structural framework to address capital structure decisions for cocos. assuming asset value triggers, closed-form capital structure solutions were derived and for simplicity, debt maturities were assumed to be infinite. cocos were found to provide the bulk of tax shield benefits of straight debt while providing similar protection as equity. albul et al. (2010) concluded that cocos should be substituted for straight debt in bank capital. pennacchi (2010), also using a structural approach, modelled a bank balance sheet comprising short-term deposits priced at par (long-term bonds were ignored for tractability reasons), common equity and cocos. the ratio of the asset value to the combined coco and equity value – assuming costless bankruptcy – was chosen as the coco trigger. cocos triggered by equity market values could lead to either multiple equilibria or no equilibrium, unless there is no value transfer between bank equity and contingent debt at conversion (see calomiris & herring 2013; pennacchi et al. 2011; sundaresan & wang 2012). a continuous-time framework indicated that the condition necessary and sufficient to guarantee a unique equilibrium was the no value transfer condition. in 2009, three banks issued securities that were considered to be cocos. these instruments had triggers that were activated based on regulatory capital values. lloyds bank was the first to issue a coco in november 2009 in a successful subscription offer. the second recognised coco was issued by rabobank in may 2010 and presented terms that dictated a 75% write-down on the principal value of the bond when the bank’s regulatory capital ratio fell to less than 7% with the remaining 25% stake being paid out in cash. the rabobank coco does not exhibit the classic features of a coco in the sense that there is no equity conversion. the third coco bond issued was the security issued by credit suisse which was open to subscription from the public and offered a 7.875% coupon rate (a large credit spread at the time2) and was heavily oversubscribed. this coco was also to be converted from a bond to equity with a conversion cap of $20 set to the amount at which it could be converted into shares. since their introduction, cocos have, however, not been tested under the very market conditions for which they were designed to perform as loss-absorbing instruments. theoretically there may be an untested weakness in the design of certain cocos, beginning with the choice of trigger mechanism. both the credit suisse and rabobank cocos employ regulatory capital triggers which may prove to be problematic (pennacchi et al. 2011). regulatory capital is an accounting measure which is calculated internally by the finance department of a bank, usually on a quarterly basis. in a situation in which financial markets take a sudden and rapid decline, these quarterly reviews may prove to be too late to be effective. consider, as an example, the mean and median tier 1 capital ratios for six banks in the us during the first four quarters of 2008, represented in table 1 below. table 1: tier 1 capital ratios for banks in the united states for the first four quarters of 2008. the variation in these capital ratios would have proved ineffective leading indicators to illustrate distressed conditions during the financial crisis. even with lehman brothers going bankrupt in q4 of 2008, it is evident that many of the capital ratios of these banks even increased from their levels in q1. it is thus highly improbable that cocos with regulatory triggers would have been activated during the 2008 financial crisis. a second shortcoming pertains to the risk that cocos may not convert from debt to equity while the bank is still a going concern. the regulatory nature of the triggers for the rabobank and credit suisse cocos may cause them to remain as debt even when the banks are no longer going concerns. the function of cocos in this study is to trigger debt into equity, prior to a non-viable condition of a bank to prevent liquidation rather than just softening the post-bankruptcy impact. the approach taken by flannery (2005) discusses securities suitable for this purpose, for which the coco trigger mechanism is linked to a market-based value of the issuing bank’s equity. as an example, the coco issued would convert into equity when the share price is at a certain level. the goal in setting up this specified share price is to obtain a share price, when historically, the bank was in a bad financial position, but not yet in a non-viable condition. flannery (2005) proposes that the coco investor receives several shares valued at the trigger price of the issued shares, equal to the bond’s par value prior to conversion. while the market-based trigger appears better suited to the notion of a coco, which will convert while a bank is still a going concern, it is not free from criticism. the risk of a market-based trigger lies in the potential for market manipulators to influence the share price of the issuing bank to trigger the coco conversion. it is theorised that coco investors will short-sell the stock of a company to drive the stock price down to a level well beneath their fundamental values for the sake of profiting from a coco trigger, thereby providing an incentive for certain coco investors to manipulate share prices (mcdonald 2010).3 to combat the weaknesses inherent to cocos, various solutions have been proposed. kashyap, rajan and stein (2008) propose that banks do not issue loss-absorbing securities such as cocos, but rather purchase insurance against falling capital levels. this would, however, require an insurer that is free from systemic risk which may be the case when a bank is irresponsible, but is not the case in a global financial crisis. such an insurer will most likely also be under stress in a financial crisis and may not be able to meet its obligations (duffie 2010). pennacchi et al. (2014) augment the pennacchi (2010) framework by introducing coercs, which permit the bank’s original shareholders to buy back the shares at the bond’s par value. modigliani-miller results are assumed to hold, so financial distress model costs were ignored. in this article, the application and structure (specifically the ideal trigger mechanism) of coercs in an african market context are explored. coercs may address most of the shortcomings of traditional cocos while still affording fixed-income investors the opportunity to invest in this security. call option enhanced reverse convertible bonds pennacchi et al.’s (2014) proposed coco design addresses the contradictory objectives of the relevant parties, namely regulatory authorities, coco investors and issuers. although covered in detail in pennacchi et al. (2014), a summary of these design features is given in table 2. table 2: summary and comparison of contingent convertible debt and call option enhanced reverse convertible design features. data and methodology the data used for the analysis that follows and the methodology required is discussed below. data the data used were simulated, stylised values for a standard coerc. no market parameters are required, such as equity or debt levels or market volatility. details of the stylised example are provided in table 4 and table 5 in the ‘results and discussion’ section. methodology coercs are different from other coco structures in the way new equity is issued and the volume of this new equity. this arises from the opposing way new equity is issued as shown in figure 3. figure 2: banco santander 8.25% contingent convertible price (us dollar). figure 3: principal benefits of call option enhanced reverse convertibles. criticisms levelled at coercs have been addressed (pennacchi et al. 2014). these criticisms and responses are presented in table 3. table 3: potential criticisms of call option enhanced reverse convertible issuance and measured responses. we note, however, that the coerc and market behaviour must be considered jointly. coercs are akin to a bond plus a short position in a knock-in call option, struck well below the knock-in level. assuming market behaviour which evolves in time by simple diffusion implies low risk, but market behaviour is characterised by occasional discontinuous jumps so coercs are not entirely default-free. the mathematics governing the pricing of coercs is covered in detail by pennacchi et al. (2014). the valuation of a coerc may be undertaken using a simple comparative example. this is detailed in the ‘results and discussion’ section, using a simple, stylised but realistic, numerical example. results and discussion all figures in this section stem from the stylised example assumptions set out in table 4 for cocos and then moving on to table 5 which sets out numerical assumptions governing coercs. table 4: assumptions underlying a numerical contingent convertible debt example. table 5: assumptions underlying a numerical call option enhanced reverse convertible example. scenario 1: conversion price (cp) = trigger price (tp) = 5 falls to st × n0, so and the coco is triggered, converting into 6 additional shares. the total amount of shares outstanding, nt = n0 + 6 = 13. if coco investors realise that the true value of the firm’s assets is still 1100, then they know that the combined value of coco investors’ and shareholders’ stakes is 100. the fundamental stock value per share is thus and the consequent gain to coco investors is 7.69 × 6 – 30 = 16.15 (a gain of 54% relative to the bond’s market value of 30 prior to conversion). this gain comes at the expense of the original shareholders who now own 7 shares trading at 7.69 rather than 10, that is, a loss of 16.15. scenario 2: cp (5) < tp (8) if investors again believe that cocos will convert into 6 shares, the number of shares will again increase to 13, implying a stock price of . as the 8 trigger is reached, conversion occurs and the 10 stock price is no longer a unique equilibrium price. at 7.69, the 6 shares owned by coco investors represent a wealth transfer of 7.69 × 6 – 30 = 16.15 at the expense of the original shareholders. this value transfer makes the stock price fall below the trigger price. two stock prices are thus possible, 10 and 7.69. this has also been discussed in liebenberg et al. (2016). note that some assumptions about investor behaviour have been imposed here. price manipulation beyond a fair value assumes the irrational behaviour of investors, while the assumption that shareholders will exercise their right to limit dilution argues for the rational investor behaviour. scenario 1: at time t, s0 has been manipulated down to 5 – the trigger price – so st = 5 the consequence of the conversion rate is that the coerc implied conversion price is significantly below the trigger price: that is, 1 rather than 5. the coercs convert into 30 new shares. combined with the 7 shares owned by initial shareholders, the number of shares outstanding is now 30 + n0 = 37. this results in a fundamental (non-manipulated) share value of . shareholders have the right to repurchase these shares at r1 (so that the total payment to coerc investors is 30) so they will do so. were shareholders not to invoke this right, their wealth would fall from 7 × 10 = 70 to 7 × 2.70 = 18.90, a loss of 51.10 (73%). this loss may be recovered by repurchasing the 30 shares at 1 from bondholders (which, at 2.70 per share is a gain of 51.10). the result is that coerc investors are paid their bonds’ par value. scenario 2: at time t, s0 has justifiably fallen to 5 (tp), so st = 5 this implies a fall in market value of equity from 70 to st × n0 = 35. coerc bondholders will convert into 30 shares. the fully diluted value per share is now per share. shareholders will again exercise the option to repurchase the shares back at r1, so that coerc investors continue to receive their bonds’ par value. shareholders will always repay coerc bondholders until the fully diluted stock price = 1. this will be the case when the combined value of coerc bonds and initial shareholders’ equity = 37. as coercs are repaid 30, equity is worth 7 and total value of the assets = 1000 + 37 = 1037. so, provided the total value of the firm is greater than 1037, coerc investors are repaid their par value. this explains why a larger proportion of shares are issued to coerc investors, which renders them less credit-risky. suppose, instead, that only 6 shares were issued to coerc investors at conversion (as with cocos, table 3), so that conversion and trigger prices are both 5. shareholders would not purchase the 6 shares from coerc investors for a total sum of 30 unless the fully diluted stock price were 5. for this to be the case, the total firm asset value must be 1000 + 13 × 5 = 1065. if a is less than 1065, shareholders will not exercise the option and coerc investors will retain 6 shares worth less than 5 (thus realising a loss from their bonds’ par value). with a 1 conversion price, so that 30 shares are issued to coerc investors, they would become shareholders only if firm value falls to less than 1037. lowering the conversion price thus reduces a coerc’s credit risk. figure 4 compares coerc versus straight debt payoff profiles, assuming conversion and that the option to repurchase only occurs at the coerc bond’s maturity. the bond payoff (par value 30) and shareholders payoff as a function of the firm’s total asset value at the bond’s maturity date are presented. the firm has senior debt of 1000, so other claims are rendered worthless if firm value is less than 1000. the solid line indicates payoffs for non-convertible bonds and the dashed line shows the payoff for coercs. figure 4: comparison of call option enhanced reverse convertible and straight debt payoff profiles: (a) subordinated bond value and (b) equity. the value v of non-convertible bonds is worth 30, provided the total firm asset value, a is greater than 1031. if a is between 1000 and 1030, shareholders lose everything, and bondholders receive a – 1000 (i.e. the value of equity, mve = max[a – 1030,0]).4 in the case of convertible bonds with cp = 1 when st = 5 or whenever firm value is greater than 1065, equity holders exercise the call option and repay the bonds at par (provided the fully diluted stock price > 1, or provided total firm value > 1037; until that point is reached, nothing changes compared to the case where the debt was not convertible). when the firm’s value is less than 1037, shareholders will not bail out coerc bondholders, who now end up with of max[a – 1000,0], that is, less than 30. shareholders obtain the residual, that is, of max[a – 1000, 0]. a fundamental change is that now shareholders seek to preserve firm value between 1000 and 1037 as a direct consequence of the fact that the coerc investors must share the value of the firm with the equity holders whenever firm value is between 1000 and 1037. we have again assumed that shareholders will behave rationally in this instance. by allowing the conversion price to be low (1) coerc bondholders’ risk should be only slightly higher than that of non-convertible bonds.5 for cp and tp = 5, shareholders would refuse to repay debt when firm value is less than 1065, not when firm value is less than 1037. in that case, bondholders’ risk would have been higher. the market value of equity, number of shares issued and fundamental stock values – as a function of the share price – are provided (for this example) in figure 5. figure 5a shows the gradual erosion of equity value (from r70 to r37) as the share price decreases and then, as the trigger price is reached (r5), conversion occurs and an accompanying sharp equity value increase (to r185 = 37 × r5). figure 5b shows the number of shares as a function of share price. as the share price decreases towards the trigger value, the number of shares (7) remains unaltered. at conversion, 30 new shares are issued, so the new number of shares is 37. figure 5c shows the decrease in fundamental stock value, from r10 per share prior to conversion to r2.70 after conversion. figure 5: (a) equity value, mve, (b) number of shares in issue and (c) fundamental share value, st as a function of underlying share price. all descriptive parameters as given in table 3. cp = tp = r5. figure 6 displays 3d results from the stylised example. in each case, the relevant parameter is on the vertical axis as a function of number of shares issued and coerc conversion rate. figure 6a demonstrates the influence of the number of shares in issue and the number of shares into which the coerc converts on the fully diluted share price, sp. the lower the number of these variables, the higher sp. figure 6: (a) fully diluted share price and (b) gain to call option enhanced reverse convertible investors as a function of the number of shares in issue and the call option enhanced reverse convertible conversion rate, (c) fundamental stock value and (d) option exercise threshold as a function of the number of shares in issue and the call option enhanced reverse convertible conversion rate, (e) implied conversion price, cp, as a function of the number of shares in issue and the call option enhanced reverse convertible conversion rate. figure 6b, c and e show that only the number of shares into which the coerc converts affects the gain to coco investors, the fundamental stock value and the implied conversion price. the number of shares in issue has no influence over these variables. figure 6d shows the effect of the number of shares in issue and the number of shares into which the coerc converts on the exercise intention if the asset value is below certain values. for low values for these variables, the conversion threshold is lowest. as the number of shares in issue increases, the conversion threshold increases dramatically, but only for low coerc to shares conversion rates. for high values of this variable, the conversion threshold is low and unaffected by the number of shares in issue. additional recommendations regarding call option enhanced reverse convertible structures developed economy corporate investment-grade bond yields and sovereign yields remain at historic low levels (e.g. ≈ 2.4% for corporate bonds, ≈ 2.3% for us 10-year treasury yields and ≈ 1.3% for uk 10-year gilt yields in november 2017): investors have thus been driven into equities and real estate, fuelling potential bubbles in both asset classes (mackintosh 2017). the prevalence of these low interest rates (see figure 7) in the current (2018) developed economy environment (which have persisted for about a decade since the onset of the 2008–2009 credit crisis) allows considerable flexibility for coerc issuance (and coco issuance in general). the implication of low interest rates is relatively low coco coupon rates: banks do not have to attach exorbitant coupons to cocos to render them more attractive to potential investors. figure 7: developed economy bond yields since 2008. in emerging markets, particularly african markets, government yields are high by global standards: figure 8 shows these yields for south african and nigerian government 10-year bond yields. figure 8: south african and nigerian government bond yields since 2008. corporate bond yields in these african countries are a few percentage points higher still. these attractive interest rates are tainted by low credit ratings (bb+ for south africa and b+ for nigeria): both countries currently (2018) have junk credit status (fitch ratings 2017a, b). large african banks are, however, relatively sophisticated and most are basel-compliant with strong capital levels (oduora, ngokab, & odongob 2017). coercs would provide all the benefits argued for in this article and have the added benefit of offering highly attractive yields. given the current paucity of global high-yield assets, such instruments could even attract foreign investors. from the examples provided in the ‘results and discussion’ section, it is evident that coercs hold significant advantages to both investors and existing bank shareholders, as there is an incentive for existing shareholders to repurchase shares that will be issued when the coerc converts. the inherent purpose of cocos (and coercs) is to bolster capital levels when the bank suffers financial distress. with this in mind, the coerc coupon could also be designed such that it also assists with the bolstering of the bank’s financial position, as the bank’s share price decreases towards the trigger share price. consider a coerc with a floating coupon mechanism, in which the coerc pays a reduced coupon to investors as the share price approaches the trigger price. as an example, assume the coerc was issued with a coupon rate of 8%, at a market share price of 50 and a trigger price of 25. assume the mechanism is constructed to decrease by 10 basis points at a share price of 38, and a further 10 basis points for every decline of 1 of the share price. in this scenario, once the price reaches 30 (coupon strike price), coupon payments will have been reduced to 0, even though the coerc has not yet been triggered. conversely, should the share price rise, coupon payments could restart using the same approach (an increase of 10 basis points) in the coupon payment for a share price of 21, with an increase of 10 basis points for every increase of 1 above the level of 21 – up to a ceiling level of 8% at a share price of 28 and upward. this structure could provide even further assistance to banks in financial distress and may even (depending on the volume of coercs that have been issued) assist the bank to avoid a coerc trigger entirely. such a mechanism would only work in a relatively high interest rate environment (and in which the coupon rate at the upper end of the range was attractive to investors) – that is, perfectly suited for current african markets. another example of a coerc with a floating coupon design could be one with a binary outcome in terms of the coupon rate. consider a coerc with the same parameters as above (current share price, trigger share price and coupon rate). the issuers may add a property to the coupon such that once the bank share price reached a level of 38 (coupon strike price), all coupon payments would become 0%. in such a scenario, a time-based contingency on the re-instatement of the coupon payment could be installed, for example resuming coupon payments after a set period such as six months, or the issuers could determine that coupon payment will resume as normal once the share price reaches a predetermined level (ideally higher than the coupon strike price) such as 45. both examples of floating coupons for coercs above would aid in the objective of issuing a security that is countercyclical in nature, as banks would avoid having to pay coupons in times of distress. in the volatile financial markets throughout africa, this may prove to be a vital addition to the existing benefits that coercs offer to banks. in considering the various stakeholders of a coerc, this design would also have benefits to all parties involved. for a coerc investor, apart from the attractive credit spread, the security will almost never convert to equity which makes it a feasible option for institutional fixed-income investors. from the perspective of the bank, the floating coupon is an attractive mechanism, as it further bolsters the financial position of a bank in periods of financial distress (see also liebenberg et al. 2016, 2017). regulators would approve of the fact that the coerc is countercyclical in nature and loss-absorbing and current shareholders would benefit from the fact that their equity would not be diluted if the coerc reached the trigger share price. conclusions and suggestions for future work the changes in regulation brought forth through both basel ii and basel iii, indicate the acute awareness that the bcbs has, regarding the ill effects of procyclical capital models which were prevalent within banks preceding and during the financial crisis. interventions to combat the drainage of capital from banks include measures such as the ccb, as well as adjustments to the quantity and quality of capital required from banks. a deeper study into the application of these measures, however, has indicated that in developing economies such as the markets in africa, the ccb in particular may not be completely adequate (burra et al. 2014; van vuuren 2012) as there is a substantial time lag that should be taken into account before requirements are relaxed. in addition to the recommendations of the basel frameworks, cocos have been considered as an additional measure to promote countercyclicality in terms of capital composition in banks. this is because cocos are loss-absorbing when banks are under financial stress, as a coco will convert from a bond into equity when certain predefined conditions are met. cocos have been criticised by academics (pennacchi et al. 2012)6, particularly from a trigger mechanism design point of view. under certain conditions, there may be incentives for speculators to short bank shares and artificially drive down the share price in order to profit from the conversion to equity when the coco triggers. coercs have been proposed as an alternative structure to cocos as they offer distinct advantages to all stakeholders involved. coercs are also a viable investment option to fixed-income investors who make up a large percentage of institutional investors who purchase the bonds that are issued by banks. coercs augment previous coco proposals (flannery 2009a, 2009b) to solve three outstanding problems: coercs avoid the problem of manipulating the issuing firm’s stock price or placing its stock in a death spiral tailspin, because of stock dilution concerns by providing shareholders an option to repurchase the shares from coerc investors at the conversion price. if coco investors are exposed to considerable risk, there will be few buyers. to reduce these risks, the relevant security must be so designed as to force shareholders to repay when financial distress becomes considerable. coercs set conversion prices very low, below the stock price that triggers conversion. not repaying coerc investors, dilutes shareholder stock value substantially and transfers wealth to coerc investors which then reduces coerc credit risk.7 coercs eliminate the problem of multiple equilibria (bond, goldstein & prescott 2010) by basing the conversion trigger on the market value of total capital to senior debt ratio, rather than the stock price.8 coercs are designed to exhibit a potentially low credit risk, and as such the possibility is there that these bonds may lower direct and indirect costs of financial distress. standard cocos and non-convertible bonds have higher default risk than coercs: coercs’ lower default risk mitigates the excessive risk-taking incentives typically present in levered firms. coercs reduce the possibility of wealth transfers between investors and shareholders and thus assist in the solution of the high leverage debt overhang problem (myers 1977). reductions in agency costs also make coercs attractive investments for corporations. regulatory authorities are not required to be part of the process of monitoring and managing coercs, and they force equity holders to repay debt to prevent dilution. this anticipated commitment benefits shareholders through lower coerc yields. that converts to equity in times of financial distress. we propose, in addition to the above, that the coupon payment mechanism of the coercs issued by banks in africa be altered so that they either cease to pay a coupon to investors, or reduce the amount (and burden) of coupon payments as the share price of the bank deteriorates. this alteration may prove to be a significant addition to the already attractive countercyclical and loss-absorbing properties that are inherent to coercs. in addition to the countercyclical nature of coercs, further studies need to investigate the quantum and optimal level at which coupon rates should be altered. an investigation into the inverse scenario in which the coupon rate of a coerc increases as the share price falls, may also yield useful results, as this could make coercs attractive to investors, who would receive a higher yield at times when there is a higher risk attached to the security. in addition, further research into the impact on the liquidity position of the bank as a result of lowered or ceased coupon payments may also yield valuable results. acknowledgements competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions f.j.n.l. was responsible for the literature study and article composition, g.w.v.v. for the quantitative analysis and modelling and a.h. for the proofreading and editing of the article. references ainsworth, s., 2017, global coco issuance in 2017 will be on a par with previous year, moody’s investor services, new york, viewed n.d., available from https://www.moodys.com/researchdocumentcontentpage.aspx?docid=pbc_1065162 albul, b., jaffee, d.m. & tchistyi, a., 2010, contingent convertible bonds and capital structure decisions, working paper, hass school of business, university of california, berkeley, ca, viewed n.d., available from http://faculty.haas.berkeley.edu/tchistyi/ccb.pdf baily, m.n., litan, r.e. & johnson, m.s., 2008, ‘the origins of the financial crisis, the initiative on business and public policy’, fixing finance, paper 3: november, the brookings institution, washington, dc. basel committee on banking supervision (bcbs), 2010a, basel iii: a global regulatory framework for more resilient banks and banking systems, bank for international settlements, basel, viewed n.d., available from http://www.bis.org/publ/bcbs189_dec2010.pdf basel committee on banking supervision (bcbs), 2010b, guidance for national authorities operating the countercyclical capital buffer, bank for international settlements, basel, viewed n.d., available from http://www.bis.org/publ/bcbs187.pdf basel committee on banking supervision (bcbs), 2011, global systematically important banks: assessment 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business, university of illinois, champaign, il, viewed n.d., available from http://business.illinois.edu/gpennacc/concap061811.pdf pennacchi, g., 2011, a structural model of contingent bank capital, working paper 10-04, federal reserve, bank of cleveland, cleveland, tn, viewed n.d., available from http://business.illinois.edu/gpennacc/concap061811.pdf pennacchi, g., vermaelen, t. & wolff, c., 2011, ‘contingent capital: the case for coercs’, lsf research working paper series 10-08, luxembourg school of finance, university of luxembourg. pennacchi, g., vermaelen, t. & wolff, c.c.p., 2014, ‘contingent capital: the case of coercs’, journal of financial and quantitative analysis 49(3), 541–574. https://doi.org/10.1017/s0022109014000398 riskconcile, 2017, when a coco cracks … banco popular case study, risk management solutions, newark, ca, viewed n.d., available from http://www.riskconcile.com/rc/rd/bancopopular.html sundaresan, s., 2013, ‘a review of merton’s model of the firm’s capital structure with its wide applications’, annual review of financial economics 5(1), 21–41. https://doi.org/10.1146/annurev-financial-110112-120923 sundaresan, s. & wang, z., 2011, ‘on the design of contingent capital with a market trigger’, federal reserve bank of new york staff report no. 448, may, viewed n.d., available from https://www.newyorkfed.org/medialibrary/media/research/staff_reports/sr448.pdf sundaresan, s. & wang, z., 2012, ‘on the design of contingent capital with a market trigger’, journal of finance 72(2), 881–920. thomson reuters, 2017, online database, viewed 13 may 2017, available from https://www.thomsonreuters.com/en.html unmack, n., 2017, ‘going, going gone: popular wipeout leaves coco bonds on drawing board’, reuters breaking views, 07 june, viewed n.d., available from https://www.breakingviews.com/considered-view/popular-wipeout-leaves-coco-bonds-on-drawing-board/ van vuuren, g., 2012, ‘basel iii countercyclical capital rules: implications for south africa’, south african journal of economic and management sciences 15(3), 309–323. footnotes 1. although yields decrease because of the embedded optionality, this decrease is outweighed by increase in yield due to the extra risk associated with the convertibility possibility. in totality, yields increase. 2. at the issue date, the 30-year treasury yield was 4.16%, the aaa corporate bond yield was 5.26%, and the bbb (which was fitch’s rating of the coco) corporate bond yield was 6.14%. 3. for a comprehensive overview of the issue surrounding market manipulation of coco trigger designs, refer to: albul et al (2012), bolton and samama (2011), calomiris and herring (2013), flannery (2009a), pennacchi et al. (2011), culp (2009) and sundarsen and wang (2011). 4. the bonds worth 30 are subordinated to the bonds worth 1000. 5. more empirical, market-based observations are required to establish this assertion conclusively. 6. for a comprehensive overview of the issue surrounding market manipulation of coco trigger designs, refer to: albul et al (2012), bolton and samama (2011), calomiris and herring (2013), flannery (2009a), pennacchi et al (2011), culp (2009) and sundarsen and wang (2011). 7. credit risk may be understated here because the market manipulation issue is overstated (investors are assumed to behave rationally). 8. multiple equilibria are always possible when comparing a security’s fair value versus its market value. microsoft word 1 final women in leadership mkhize & msweli 14 sajems ns 14 (2011) no 1 1 the impact of female business leaders on the performance of listed companies in south africa mkhethwa mkhize wits business school, university of witwatersrand pumela msweli graduate school of business leadership, university of south africa accepted november 2010 the purpose of this study is to determine the impact of female business leaders in jse-listed companies on the financial performance of those companies. this is as result of the proposition that women, over and above men, bring unique skills to the workplace. however, it is hypothesized in this study that jse-listed companies led by a high percentage of women do not outperform similar companies led by a low percentage of women. the lean modigliani and france modigliani measure (m 2 ) was used to test this hypothesis. results of this study indicate that companies led by women do not outperform similar companies led by men. as a result, the null hypothesis is not rejected. implications of these results are discussed. key words: financial performance, female business leaders, business women, employment equity. jel m50, p47 1 introduction the introduction of the employment equity act has resulted in an influx of females into the workplace. for example, as reported in the business women’s association census (2007:16), 42.9 per cent of total employed population in the republic of south africa are women. this success is partly as a result of a legal reform in the labour market and employment equity compliant employers. it could be implied that south african employers are starting to acknowledge the urgent need of fully utilising all of the human capital. claes (1999) summarises special benefits of recruiting, training and retaining females in senior management positions. he argued that women, over and above men, bring the following skills to the workplace: caring for fellow employees, an appreciation for teamwork, intuitive decision making and a sense of social responsibility. however, while 42.9 per cent of the total employed population are females, there are serious concerns that females are under-represented at the top management level. baxter (2007) argues that the statistics show that women in leadership and executive positions are still nowhere near representative of the potential female workforce. in fact, most of the top positions are still occupied by men. ‘most organisations have moved towards equal representation in their employment equity status, but the same can seldom be said of their management and executive positions’ (baxter, 2007:81). the purpose of this study is to determine the impact of female business leaders in jselisted companies on the financial performance of those companies. specifically, this study aims to determine if there are additional financial benefits derived from appointing a female at senior management level as initially suggested by claes (1999) and joy and wagner (2007). the sub-objective is to formalise a new way of maximising shareholder’s wealth, that is increasing the number of females in higher management abstract 2 sajems ns 14 (2011) no 1 positions especially in industries or sectors that are male-dominant. 2 review of related literature in terms of employment equity policies and guidelines, female candidates should be preferred to their male counterparts. in other words, authorities in south africa fully understand the need to urgently address gender imbalance in the labour market, especially at the top management level. some companies have already implemented a plan to break the glass ceiling by recruiting, training and retaining females in business leadership positions. according to the federal glass ceiling commission, the glass ceiling effect can be defined as an unseen barrier that keeps women and minorities from rising up the corporate ladder regardless of their achievements and qualifications (cotter, hermsen, ovadia & vanneman, 2001). cotter et al. (2001) explain that the inequalities in gender and race facing this barrier cannot be explained by any variables of education, experience, abilities, motivation, and other jobrelevant traits. according to maume (2004), as reported in mathur-helm (2006), failure of women and other minority groups in climbing up the corporate ladder, despite seeing the top jobs but still not reaching them due to discriminatory barriers, is what many think of as the glass ceiling. mathur-helm (2006) argue that the glass ceiling, considered a myth by many, is real and is nurtured by the organisational culture, policies and strategies besides women’s own inadequacies. mcdonald and hite (1998) argue that socialisation, stereotyping and prejudice are some of the many underlying causes of the glass ceiling. only the decentralised organisations, characterised by a culture that supports women’s top positions, will help in breaking down the glass ceiling, along with women’s effort to grow, develop and empower themselves through academic and career development (mathur-helm, 2006). dimovski and brooks (2006) critically analysed the change in the gender composition of the boards of large australian companies after public listing. results of their study show no significant change in the proportion of male and female directors holding directorships at the time of the initial public offer (ipo), and some five to eight years later when the company is recorded as a top 500 company (by market capitalisation) on the australian lists. this implies that the capital market is generally satisfied with the gender composition of boards from the time of the ipo. bernadi and weippert (2002) examined the differences in presentation of boards of directors in annual reports. the results of their study indicate that firms with a higher percentage of women on their boards signal this fact to shareholders, potential investors and other stakeholders by including pictures of their boards in their annual reports. implications are that management recognises the value that is created by employing women into higher positions and they claim this value by publishing in their annual reports that they have recruited, trained and retained women in executive positions. employment equity programmes (eeps) were conceived to eradicate employment discrimination, and organisations subjected to the employment equity act, are mandated to adopt them (leck, 2002). although a few women are in leadership positions, employers in south africa have come to realise that they neglect managerial talent in nearly half of their workforce if they do not appoint women to such positions. for example, women constituted only 14.7 per cent of all executive management and only 7.1 per cent of all directors in 2004; in 2006 these numbers for both executive management and directors had increased to 16.8 per cent and 11.5 per cent respectively (bwa, 2007). some scholars argue that this is as a result of feminine qualities of women, such as relationship building and teamwork that are valued in a more collaborative and creative management environment (claes, 1999). given the results of the bwa’s annual surveys (2004 to 2007), the number of women in top management positions is still below that of men. this could suggest that gender equality programmes have no substantial effect on female representation in sajems ns 14 (2011) no 1 3 leadership positions and that these programmes are symbolic rather than effective. however, a more appealing reason is that employment equity policies, in addition to the empowerment of women, clearly state that africans should be given first priority. as a result, low numbers of women in top management positions may be due to the fact that organisations are focusing on targeting and developing africans (male and female) for leadership positions. an interesting research article by joy and wagner (2007) shows that, according to return on equity, companies with more women board directors outperformed those with the least by 53 per cent. their study also shows that, according to return on sales and return on invested capital, companies with more women board directors outperformed those with the least by 42 per cent and 66 per cent respectively. these results support propositions by baxter (2007) that women bring an added dimension to the workplace because they have a unique management approach that adds significant value to the business. baxter (2007) adds that women are more intuitive and, in an age where business are increasingly realising that an intelligent approach to people management is needed in the drive towards greater efficiency and productivity, women are able to tap into their feminine side and bring out the best in people [adapted]. for south africa, it could be argued that eeps have resulted in some improvement in the number of women within the workforce, but their success, in terms of financial value, is yet not well known. as a result, it is the aim of this study to determine the financial performance of jse-listed companies which are regarded as top performers in terms of recruiting, training and retaining women in top management positions. 3 data and data manipulation permission to use the business women’s association (bwa) data set was granted by the bwa. the population was every company listed on the main board of the jse securities exchange south africa (the jse) as at 30 september 2006. the only companies that were excluded from the analysis by bwa are firms listed on the jse but with all operations overseas or in other african companies; also excluded were companies that were suspended as at 30 september 2006. the implications are that companies listed on the alternative exchange, development capital or venture capital, were also excluded. in order to control for the size effect, only the 25 largest jse-listed companies by market capitalisation formed the sample size of this study. the top 25 companies (by market capitalisation) is a suitable sample because they match the market proxy used in study which comprises the largest companies (by market capitalisation). these 25 companies were classified in two groups in order to construct two portfolios using the following variables: companies with 25 per cent or more of female directors were classified as ‘highs’. the bwa refer to the highs as the ‘top performing’ companies: they were ‘top performing’ companies in the sense that they employed more female directors than other companies listed on the jse, specifically because 25 per cent or more of their directors were women. companies with female directorship less than 10 per cent were classified as ‘lows’. the lows employed fewer female executives (if any) than other companies listed on the jse. the share price data of the highs and lows over the study period of 1 october 2005 to 30 september 2006 was obtained from profile data. profile data is a reliable company that maintains a comprehensive database of all companies listed on the jse. the south african reserve bank (sarb) database was used to collect risk-free rate over the same study period. the 90-day treasury bill was used as a risk-free asset. this bill is generally accepted by most financial economists as a risk-free asset proxy in south africa. after realising that one of the highs became a public company in 2006 and its share price data started from june 5, 2006, this particular company was dropped from the list of highs. the all share index (alsi) was used a market proxy. this proxy is generally regarded as the market portfolio on the jse. 4 sajems ns 14 (2011) no 1 index prices of alsi were supplied by the market data department of the jse. fabozzi (1999) believes that the performance assessment process involves two main steps. the first step is performance measurement and the second step is performance evaluation. in other words, one cannot engage in performance evaluation without conducting an objective performance measurement exercise. fabozzi (1999) adds that an evaluation process involves determining whether value is added by outperforming the well-established benchmark. for the purpose of this study, the all share index (alsi) is used as a proxy for a benchmark. as reported in msweli-mbanga and mkhize (2007), alsi is regarded as one of the commonly-used market proxies (market) in the republic of south africa. in order to measure performance, returns (ri) are computed by using a formula suggested by affleck-graves, burt and cleasby (1988). that formula is given as follows: (rindex) =                              100 0 01 x p pp ………………………… (1) where: p0 = is the previous value of an index, and p1 = is the current value of an index. daily returns of individual companies are averaged to form a daily return of the highs. similar procedure was repeated for the lows. in order to arrive at the effective risk-free rate over the study period, the repo rate at the beginning of a trading in october 2005 was rolled-over until the end of september 2006. in addition to this roll-over strategy, changes in this rate were effected. 4 hypothesis and research methodology as stated above, the purpose of this study is to determine the impact of female business leaders in jse-listed companies on the financial performance of those companies. in order to achieve the purpose of this research paper, the following hypotheses are tested: h0: there is no difference between the financial performance of listed companies with 25 per cent or more women in leadership positions (highs) and the financial performance of listed companies with 0 per cent to 9 per cent women in leadership positions (lows). in the alternative hypothesis: h1: there is a difference between the financial performance of listed companies with 25 per cent or more women represented in leadership positions (highs) and the financial performance of listed companies with 0 per cent to 9 per cent of women in leadership positions (lows). based on these hypotheses, an objective measure of financial performance is critical in order to achieve the purpose of this study. fabozzi (1999) defines the sharpe index (si) as a measure of the reward-to-risk ratio, and the risk of the share is measured by the standard deviation of the share. bodie, kane and marcus (2005) argue that the attractive feature of the si is that it divides the average return over the relevant time period by the standard deviation of returns over that period, thereby measuring the reward-to-volatility trade-off. msweli-mbanga and mkhize (2007) used this methodology when they were determining the value added to the business by women. in their study, they pointed out that another study using a different research methodology was necessary in order to further investigate the role of women in leadership positions. they added that this was necessary because it is a neglected area of research. in addition to this, bodie et al. (2005:869) argue that ‘while the sharpe ratio can be used to rank portfolio performance, its numerical value is not easy to interpret’. as put forward by bodie et al. (2005), a variant of sharpe’s measure was proposed by graham and harvey, and later popularised by leah modigliani and franco modigliani. this variant is known as the m squared (m 2 ) measure. in this study, m 2 is adopted as a research methodology and summarised as follows: sajems ns 14 (2011) no 1 5 m 2 = armm p erfarp erf                    …………….… (2) where: erf = the effective return of a risk-free asset, arp = the average return of a portfolio (highs or lows), arm= the average return of a market portfolio, δp = the standard deviation of a portfolio (highs or lows), and δm = the standard deviation of a market portfolio. standard deviation, not beta, is the appropriate measure of risk in this study because artificial portfolios, not real portfolios, are constructed for the purpose of this study. the higher the m 2 measure of a portfolio, the better the performance of that portfolio. implications are that companies will try to maximise this measure by recruiting, training and retaining female executives. companies will do so because females are expected to improve financial performance of companies because they bring feminine attributes into a company like team spirit, caring, intuitive decision making and corporate social responsibility (cutler & jackson, 2002). 5 results of the study table 1 (below) shows returns, standard deviations and m 2 of portfolios and risk-free asset. table 1 average returns, standard deviations and m 2 of portfolios portfolios average returns standard deviation m 2 (%) = {erf + [(arp – erf)/ δp] δm} arm ranking according to m 2 highs 17.7664% 2.083910 1.16479% 1 lows 14.0868% 1.511386 0.54951% 2 risk-free 6.70% n/a n/a n/a market 13.2601% 1.454672 n/a n/a according to table 1 (above), returns of highs, lows, risk-free and market are 17.7664 per cent, 14.0868 per cent, 6.7 per cent and 13.2601 per cent, respectively. table 1 displays standard deviations (not beta) of highs, lows and market as 2.0891, 1.511386 and 1,454672 respectively. theoretically, the standard deviation of a risk-free portfolio is assumed to be zero. from these average returns and standard deviations, m 2 of highs and lows are calculated and amounted to 1.16479 per cent and 0.54951 per cent respectively. the student t-test was performed and t-test results indicated that the p-value is far higher than 0.05. 6 discussion and summary results of this study show that listed south african companies with a high percentage of women in leadership positions do not outperformed similar companies with a low percentage of women in leadership positions. in other words, the null hypothesis that there is no difference in the performance of companies led by women and those companies led by men, is not rejected. the results of this study indicate that companies have not, as yet, recognised the impact women have on the company’s performance as a result of the feminine attributes they import into the organisation. these feminine attributes, namely caring, team spirits and intuition, are believed to improve the performance of the company. put differently, it is believed that a new strategy to partly maximise owners’ wealth is to recruit, train and retain capable women in leadership positions. this action will not only improve company’s performance but will make a significant contribution to social development by redressing imbalances of the past. historically, women have been neglected in the labour market as a result of male-dominant practices which saw the role of a woman in the kitchen only. sadly, most households in south africa are headed by a woman who is usually 6 sajems ns 14 (2011) no 1 the sole bread-winner. therefore, empowering a woman is equivalent to empowering the whole nation. consequently, appointing a woman into a leadership position could be thought of as a corporate social investment (csi). south african government encourages the appointment of women into leadership positions by giving tenders to companies that, among other things, appoint women into senior management positions. disappointingly, the results of this study are inconsistent with the propositions by baxter (2007) that women bring an added dimension to the workplace and that women are better managers of people and companies than their male counterparts. these results are also inconsistent with the findings of joy and wagner (2007). these authors concluded that companies with more women board directors outperformed those with the least women board directors over their study period. for the south african economy, the results of these studies are encouraging. implications are that south africa needs to create and maintain an enabling environment in order to realise the special benefits of appointing women into leadership positions. the results of this study are consistent with conclusions drawn by msweli-mbanga and mkhize (2007). their findings suggested that the adoption of a policy to appoint women into leadership positions is not perceived to have a positive effect on the company’s performance. their study was based on data dating back to the year 2003, unlike this study which is based on data as recent as year 2006. this consistency in these research results formalises the results of msweli-mbanga and mkhize (2007), and establishes sound empirical evidence that there is still a long way to fully realising the benefits associated with women’s unique attributes in south africa. implications are that south african companies have a lot of work to do, as a result of an entrenched maledominant business culture, in order to ensure that women perform to their best. in agreement with baxter (2007), corporate south africa should commit themselves to fast-tracking the advancement of women in the workplace by designing and adopting policies that will facilitate greater numbers of women in leadership positions. however, appointing women into leadership positions without good support mechanisms will destroy owners’ wealth. equally important is the creation of a supportive and enabling business environment for women to reach their full potential. this environment can be achieved through support strategies such as women-tailored training and development, partnerships and networking, and mentoring and coaching. the business women’s association in south africa is one of the existing support structures established for business women. 7 conclusions the purpose of this study was to determine the impact of female business leaders in jse-listed companies on the financial performance of those companies. results of this study show that companies led by female executives do not outperform similar companies without female executives. based on these results, a lot of work still needs to be done in order to realise special benefits associated with women unique attributes. in addition to appointing these females into executive positions, these appointed women need to be capacitated in terms of skills development and the creation of opportunities and a suitable working environment. there are several limitations in this study. one of them is that only top companies by market capitalisation formed a sample size for this study. although this kind of sample was necessary in order to control for the size effect which may have distorted the results of the study, the sample limits generalization in this study on small market capitalization companies. another limitation is that, because the new africa board’s, the alternative exchange’s, development and venture capital’s companies were isolated owing to their different characteristics from those of the main board, results of this study cannot be applicable to these companies. future research may be based on these isolated categories of companies within the jse. another limitation of this study is that it is short-term and it is believed that a longer-term study will paint a better picture of the financial performance of companies led by female executives. sajems ns 14 (2011) no 1 7 endnote we would like to gratefully acknowledge the two anonymous reviewers of this article and the editor of sajems for their valuable comments about the article, and norman blight for his excellent proofreading skills. references affleck-graves, j.f., burt, g.h. & cleasby, s.j.m. 1998. the premium on acquisition in south african mergers: an empirical evaluation, south african journal of business management, 19(4):55-60. baxter, g. 2007. empowering women in the workplace – walking the talk. celebrating excellence in organisations magazine. a special edition of ceo magazine, centurion: ceo communications (pty) ltd: 80-81. bernadi, r.a. & weippert, k.m. 2002. signaling gender diversity through annual report pictures: a research note on image management, accounting, auditing & accountability journal, 15(4):609-616. bodie, z., kane, a. & marcus, a.j. 2005. investments, 6th (int. ed.) new york: mcgraw-hill. bwa. 2007. business women 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[online] available at: http://www.catalyst.org/knowledge/files/bottom%20line%202.pdf [accessed: 2007-10-2]). leck, j.d. 2002. making employment equity programs work for women, canadian public policy, may, 28:s85-s100. mathur-helm, b. 2006. women and the glass ceiling in south african banks: an illusion or reality? women in management review, 21(4):311-326. mcdonald, k.s. & hite, l.m. 1998. exploring the glass ceiling: an exploration of gender differences in management-development experiences, journal of management education, 22(2):242-254. msweli-mbanga, p. & mkhize, h. 2007. the risk-adjusted performance of companies with female directors: a south african case, south african journal of economic and management sciences, ns 10(2):207-213. http://www.catalyst.org/knowledge/files/bottom line 2.pdf abstract background and introduction research objectives review empirical analysis results conclusion and recommendations acknowledgements references footnote about the author(s) cara thiart school of accountancy, university of stellenbosch, south africa george f. nel school of accountancy, university of stellenbosch, south africa citation thiart, c., & nel, g.f., 2018, ‘an exploratory study of the effect of country-by-country reporting ambiguities on johannesburg stock exchange-listed companies’, south african journal of economic and management sciences 21(1), a2129. https://doi.org/10.4102/sajems.v21i1.2129 original research an exploratory study of the effect of country-by-country reporting ambiguities on johannesburg stock exchange-listed companies cara thiart, george f. nel received: 05 oct. 2017; accepted: 07 may 2018; published: 25 june 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: south africa issued regulations implementing country-by-country (cbc) reporting standards for multinational enterprises (mnes) on 23 december 2016. country-by-country reporting will be applicable to all mnes with a group revenue in excess of r10 billion. aim: the aim of the study was twofold: to identify ambiguities that might influence the filing obligation and subsequent scope of cbc reporting in south africa and to quantitatively measure the potential impact of any identified ambiguities. setting: this study used data from johannesburg stock exchange-listed companies. methods: the study commences with a review of the relevant regulations and other applicable literature and continues with a quantitative analysis exploring alternative interpretations deduced from this review. results: the review identified conflicting interpretations of how companies can be categorised as an mne group or not, as well as in measuring the revenue threshold. an analysis of the group structures and annual reports of a selected sample of 78 companies showed that the scope of cbc reporting will depend on the definitions applied to an mne group and revenue. conclusion: further guidance is needed to determine whether non-controlling entities must be considered as constituent entities, as well as how to measure revenue (i.e. whether only the international financial reporting standards [ifrs] 15 revenue line item should be used or whether other income should also be included). background and introduction in his budget speech of 2017, the finance minister of south africa once again emphasised that tax avoidance or evasion schemes by multinational enterprises (mnes) should be curbed (national treasury 2017). the republic of south africa (south africa) is part of the international tax movement to eliminate base erosion and profit shifting (beps) through the base erosion and profit-shifting action project of the group of 20 (g20) and the organisation for economic co-operation and development (oecd) (the davis tax committee 2014a). the oecd/g20 beps project developed 15 key reform actions in the international tax arena to ensure that profits are reported where economic activities are carried out and where economic value is created. the beps assists governments in closing the tax gap created by profit shifting from higher to lower or no-tax environments, without transactions having underlying economic substance (the davis tax committee 2014a). the oecd published its final reports on the beps project, which included the final report on beps action 13, transfer pricing and country-by-country (cbc) reporting (the final report) (oecd 2015) in october 2015. action 13 of the action plan on beps requires the development of rules regarding transfer pricing documentation to enhance transparency for tax administration by taking into consideration the compliance costs for businesses. the rules include a requirement that mnes must provide all relevant governments with the required information on their global allocation of income, economic activity and taxes paid among jurisdictions (oecd 2013). the objectives of the transfer pricing reporting documentation rules are the following: to ensure that taxpayers can assess their compliance with the arm’s length principle to provide tax administrations with the information necessary to conduct an informed transfer pricing risk assessment to provide tax administrations with useful information to employ in conducting an appropriately thorough transfer pricing audit (oecd 2015). in order to achieve the above three objectives of the transfer pricing reporting documentation requirements, the oecd recommends that countries adopt a standardised approach to the compilation of transfer pricing documentation by following the suggested three-tiered structure (oecd 2015). such a structure should consist of: a master file a local file a cbc report. the master file should provide a high-level overview of the mne group business. this includes information regarding the nature of its global business operations, its overall transfer pricing policies and its global allocation of income and economic activity. the master file would be available to all relevant country tax administrations. this will assist the relevant tax administrations in evaluating the presence of a significant transfer pricing risk (oecd 2015). in contrast to the high-level overview provided by the master file, the local file should provide more detailed information, including specific intercompany transactions in each country or the jurisdiction in which the companies operate. detailed information will consist of the identification of relevant related party transactions, the amounts involved in those transactions, and the company’s analysis of the transfer pricing determinations they have made with regard to those transactions (oecd 2015). providing even greater detail than the local file, the purpose of the cbc report is to aggregate tax jurisdiction-wide, in-depth information relating to the global allocation of the income, the taxes paid and certain indicators of the location of economic activity among tax jurisdictions in which the mne group operates. the report also requires a listing of all the constituent entities for which financial information is reported. this list includes the tax jurisdiction of incorporation, if different from the tax jurisdiction of residence, as well as the nature of the main business activities carried out by that constituent entity (oecd 2015). action 13 requires the reporting entity of the mne group to collect and file the cbc reporting information in its country of residence. the cbc report provides tax authorities with information on the global allocation of the group income and stipulates where the management functions are performed, assets are used and risks are assumed. the cbc report is applicable to all oecd member countries (oecd 2015). although south africa is not a member country of the oecd, it was awarded oecd observer status in 2004 and is a member of the oecd beps committee. south africa has agreed to participate in the joint beps action project of the g20 and oecd (south african revenue services [sars] 2016). furthermore, the davis tax committee (2014a) noted that it is important for south africa to work together with the international community to identify a holistic approach to properly address the beps issues. consequently, modelling the guidelines and timeframe of the oecd on action 13 in the final report and the davis tax committee’s (2014b) evaluation on action 13, the minister of finance published changes to the cbc reporting standards for mnes. these standards are specified in paragraph (b) of the definition of ‘international tax standard’ in section 1 of the tax administrative act, no. 28 of 2011 (taa), promulgated under section 257 of the taa (the sa cbc regulations). the sa cbc regulations specify the changes to the cbc reporting standard for mnes required for south africa’s circumstances and were published on 23 december 2016 in the government gazette (republic of south africa 2016). the competent authority of south africa signed the multilateral competent authority agreement (mcaa) on the exchange of country-by-country reports on 27 january 2016, which is the implementing arrangement for the automatic exchange of cbc reports between south africa and the other signatories of the cbc mcaa (sars 2016). the sa cbc regulations were closely modelled on the model legislation related to the cbc reporting published in the final report (oecd 2015; sars 2017a). the adoption of the model legislation, that is, the standardised approach, for the compilation of transfer documentation suggested by the oecd in the domestic legislation of south africa leads to ambiguity regarding the interpretation and application thereof, which might influence the scope of cbc reporting, in a south african context. these ambiguities relate to the identification of a mne group and the determination of the total consolidated group revenue of that mne group. article 2 of the sa cbc regulations sets the filing obligation, that is, the scope of cbc reporting which prescribes that each ultimate parent entity of an mne group that is resident for tax purposes in south africa must file a cbc report if the total consolidated group revenue of that mne group is in excess of r10 billion (sars 2016). there seems to be no real consensus on how an mne group must be defined and total consolidated group revenue be determined for the purposes of cbc reporting in a south african context. the remainder of this study is structured as follows: a discussion of the research objectives. the review identifying ambiguities that might influence the scope of cbc reporting in south africa. the empirical analysis used to explore the impact of the identified ambiguities on johannesburg stock exchange (jse)-listed companies. discussion of the results of the quantitative analysis. a summary and conclusion of the study. research objectives the primary objective of this study is to identify and address ambiguities that might influence the filing obligation and subsequent scope of cbc reporting in south africa. the following research questions were developed from the primary objective: must non-controlling entities be considered as constituent entities of an mne group? how should revenue be defined and interpreted? how significant is the effect of the identified ambiguities on business practice in south africa? review the term ‘constituent entity’ as defined in article 1 of the south african country-by-country regulations article 1 of the sa cbc regulations provides an extensive definition of an mne group, including a definition of ‘group’. these definitions leave little room for uncertainty and can be summarised as a collection of enterprises, where two or more enterprises are tax residents in different jurisdictions, related through ownership or control such that it is required to prepare consolidated financial statements under applicable accounting reporting standards (sars 2016). article 1 of the sa cbc regulations defines consolidated financial statements as: … the financial statements of an mne group in which the assets, liabilities, income, expenses and cash flows of the ultimate parent entity and the constituent entities are presented as those of a single economic entity. (sars 2016:32) the definition that might cause ambiguity regarding the identification of entities qualifying as group entities of an mne group is that of constituent entity. this definition is contained in article 1 of the sa cbc regulations and reads as follows: the term ‘constituent entity’ means (i) any separate business unit of an mne group that is included in the consolidated financial statements of the mne group for financial reporting purposes, or would be so included if equity interests in such business unit of an mne group were traded on a public securities exchange; (ii) any such business unit that is excluded from the mne group’s consolidated financial statements solely on size or materiality grounds; and (iii) any permanent establishment of any separate business unit of the mne group included in (i) or (ii) above provided the business unit prepares a separate financial statement for such permanent establishment for financial reporting, regulatory, tax reporting, or internal management control purposes. (sars 2016:30) ambiguity exists as to whether non-controlling entities, such as associates and joint ventures, should be included as a so-called constituent entity of an mne group for cbc reporting purposes. when following this definition, one would have to determine whether the associated entity or joint venture is a separate business unit of the mne group included in the consolidated financial statements, as defined in the sa cbc regulations or an mne group for financial reporting purposes. in south africa, ifrs 10 outlines the requirements for the preparation and presentation of consolidated financial statements. in order to be included in the consolidated financial statements of an mne group, the entities would have to be controlled entities in the mne group (ifrs 10 2011:par. 5–6). control implies that the parent has power over the investee, has exposure or rights to variable returns from its involvement with the investee and has the ability to use its power over the investee to affect the amount of the investor’s returns (ifrs 10 2011:par. 5–6, par. 8). if a parent entity has control over another entity, the parent should combine items of assets, liabilities, equity, income, expenses and cash flows of the parent with those of its subsidiaries to present the parent as a single economic entity (ifrs 10 2011:b86). where a parent entity has no control, but significant influence over an entity, such an investment represents a non-controlling interest. in practice, an investment of between 20% and 40% in another entity generally implies significant influence. a parent presents non-controlling interests in its consolidated statement of financial position within equity, separately from the equity of the owners of the parent (irfs 10 2011:par. 22). international accounting standard (ias) 28 applies to all entities that are investors with joint control of, or significant influence over, an investee (associate or joint venture) (ias 28 2011:par. 2). one of the objectives of ias 28 is to set out the requirements for the application of the equity method when accounting for investments in associates and joint ventures (ias 28 2011:par. 1). under the equity method, upon initial recognition the investment in an associate or a joint venture is recognised at cost and the carrying amount is increased or decreased to recognise the investor’s share of the profit or loss of the investee after the date of acquisition (ias 28 2011:par. 10). the total assets, liabilities, income, expenses and cash flows of the associate or joint venture are not presented together with those of the parent as a single economic entity, and therefore do not conform with the definition of consolidated financial statements in article 1 of the sa cbc regulations. sars released an external business requirements specification (brs) on cbc and financial data reporting as recently as 23 july 2017. in the brs, sars extends the definition of a group by also including a collection of connected persons, as defined in section 1 read with section 31 of the income tax act 58 of 1962 (the ita) (the latter section regulating transfer pricing) (sars 2017a). the definition of connected persons, as per section 1 read with section 31 of the ita, can be summarised as follows: a company is a connected person in relation to another company that would form part of the same group of companies if the expression ‘at least 70%’ (with reference to shareholding in the definition of a group of companies) was replaced by the expression ‘more than 50%’. the first step is to determine the appropriate definition of a group of companies, and subsequently apply the 50% exception to that definition to determine whether or not one complies with the first test of the ‘connected person’ definition. the second test for a company in relation to another company is that the company will be a connected person if at least 20% of the equity shares in the company are held by that other company. these two tests apply to circumstances where there is direct shareholding. where there is no direct shareholding, a company will be a connected person in relation to another entity if such other entity is managed or controlled (more than 50% shareholding) by any person who or which is a connected person in relation to such company. a group of companies is also defined in section 1 of the ita as meaning two or more companies in which one company, the controlling group company, directly or indirectly holds shares in at least one other company, the controlled group company, to the extent that: at least 70% of the equity shares in each controlled group company are directly held by the controlling group company, one or more other controlled group companies or any combination thereof; and the controlling group company directly holds at least 70% of the equity shares in at least one controlled group company. in relation to a company, a person is a connected person if a person individually or jointly with any connected person in relation to that person, holds, directly or indirectly, at least 20% of the equity shares or voting rights in the company. despite the fact that investments in associates and joint ventures are accounted for in the consolidated financial statements in terms of ifrs, it may be concluded that these types of non-controlling investments should not be considered as constituent entities of an mne group for cbc reporting purposes in south africa. in contradiction, based on domestic income tax legislation in south africa, it may be concluded that investments in associates and joint ventures can, in fact, qualify as a connected person of a group with shareholding of at least 20%. on this basis, these types of non-controlling investments should consequently be considered as constituent entities of an mne group for cbc reporting purposes in south africa. it therefore appears as if sars requires information over and above what is contained in the modelled sa cbc regulations. the conflicting views derived from the different regulations can prove problematic for mnes when defining their mne group for cbc reporting purposes. the structure of an mne group is vital in the determination of the filing obligation, as only the aggregate revenue of constituent entities of the mne group should be measured against the revenue threshold. the interpretation of the concept ‘revenue’ the filing obligation and consequent scope of cbc reporting are dependent on the determination of the total consolidated group revenue of an mne group. the concept ‘revenue’ is not defined in the sa cbc regulations, nor in the guidance. consequently, ambiguity exists as to which amounts should be regarded as revenue when considering the reporting threshold of r10 billion. it is submitted that two possible interpretations exist. the first is derived from article 2 of the sa cbc regulations, the filing obligation regulation, and refers to the total consolidated group revenue of an mne group (as defined in ‘the term constituent entity, as defined in article 1 of the sa cbc regulations’ section – second paragraph). the latter implies that the amount of revenue must be determined with reference to the governing accounting principles regulating the measurement and recognition of revenue in the jurisdiction of the filing entity of the mne group. this view is supported by the guidance, in which the oecd refers to total consolidated group revenue as items that are included in total consolidated group revenue if those items are presented in the consolidated financial statements under the applicable accounting rules of the jurisdiction in which the filing entity is a tax resident (oecd 2017). ifrs 15, the accounting principles applicable to revenue in south africa, defines revenue as ‘income that arises in the course of an entity’s ordinary activities’. income is a broader term which encompasses revenue and is defined as: … increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in an increase in equity, other than those relating to contributions from equity participants. (ifrs 15 2014:appendix a) to be classified as revenue, income must therefore derive from ordinary activities. the concept ‘ordinary activities’ is not defined in ifrs. the oxford dictionary of accounting (law 2010) defines the term as ‘activities that are usually, frequently or regularly undertaken by the entity or a related activity engaged in by the entity in furtherance of, incidental to, or arising from activities usually, frequently or regularly undertaken by it’. hence, in practice, companies normally disclose revenue generated from their core business activities as a separate line item from which cost of sales is deducted to derive a figure for gross profit. amounts received from activities other than core business activities are disclosed as other income. the second interpretation of the concept of revenue in the context of cbc reporting is derived from the standard template set out in the oecd’s final report on beps action 13, transfer pricing and cbc reporting. article 4 of the sa cbc regulations prescribes that the cbc report must contain the information set out in, and apply the definitions and instructions contained in, the standard template in annex iii to chapter v of the final report. the final report includes revenues from sales of inventory and properties, services, royalties, interest, premiums and any other amount, but excludes payments received from other constituent entities that are treated as dividends in the payer’s tax jurisdiction (oecd 2015). this description seems to refer to the concept of income rather than revenue, but, for example, does not include foreign exchange gains. the brs remains silent on the interpretation of the concept when referring to revenue (sars 2017b). interaction with practitioners showed that they are of the opinion that the outline as per the guidance of what should be reported as revenue should also be applied to determine the total consolidated group revenue of an mne group, against which to measure the r10 billion threshold. this view is, however, in contradiction with the meaning assigned to the concept of revenue as per ifrs 15, as determined with reference to the sa cbc regulations. the contradictory views regarding the determination of revenue to determine the threshold and subsequent filing obligation may influence the scope of cbc reporting in a south african context. the significance of the impact of the identified ambiguities relating to both constituent entities and revenue was investigated and described in the next section. empirical analysis background in the ‘review’ section, reference was made to relevant legislation, terms used therein, international standards and further applicable literature. the ruling in cir v. stellenbosch farmers’ winery 13 satc 381 determined that, in south africa, the accounting treatment of amounts does not necessarily determine the tax consequences thereof. the cbc reporting regulations are effectively provisions prescribing and administering the reporting of information from an international tax point of view. the fact that the terminology in the sa cbc regulations is based on those provided by the oecd, which appears to be driven by accounting, rather than tax principles, justifies the analysis of applicable ifrss in this study. the outcome of the review forms the theoretical basis of the empirical analysis by identifying ambiguities that might influence the scope of cbc reporting in a south african context. as discussed, cbc reporting is only applicable to mnes with a group revenue in excess of r10 billion. for each of these prerequisites, that is, (1) an mne group (2) revenue, ambiguity exists in conflicting definitions. first of all, to be categorised as an mne group, ifrs requires that the entity must have at least one foreign subsidiary as opposed to sars that requires having at least one of a foreign subsidiary, associate or joint venture. for the purpose of this study, the former is called the narrow mne group definition and the latter the wider mne group definition. in addition, revenue can either be defined as revenue as calculated in terms of ifrs or the revenue line items plus income, as determined by ifrs. in a similar vein, the former is called the narrow revenue definition and the latter the wider revenue definition. defining the study population to answer the research questions, this study required financial data from jse-listed companies. based on a list received from the jse, there were 293 companies listed with ordinary shares on the jse main board on 31 december 2016 (excluding suspended companies). given the information needs of this study, 215 companies were removed as summarised in table 1 and discussed below. table 1: defining the study population. as a first step, the 101 companies listed in the financial industry were removed given their unique financial reporting structure (e.g. interest income instead of revenue) and additional disclosure requirements. another three companies were removed as these companies did not publish a 2016 annual report and no financial statement data were therefore available for 2016. the authors further argued that as companies with an ifrs reported revenue of less than r8 billion (i.e. narrow definition) were not at risk of misclassification if the wider definition is used, all companies with a reported revenue of less than r8 billion were removed. another 108 companies were therefore removed. finally, as cbc reporting is only applicable to companies with at least one foreign subsidiary (narrow mne group definition) or at least one foreign subsidiary or associate or joint venture (wider mne group definition), three companies were removed as these companies had neither a foreign subsidiary, associate nor joint venture and could therefore not be classified as an mne group. the result is a study population of 78 companies. methodology to ascertain whether the conflicting revenue and mne group definitions, as discussed, have a significant impact on business practice in south africa, a two-stage methodology is followed. firstly, the group structure of the study population is inspected to establish the impact of using respectively the narrow and the wider mne group definition. secondly, the 2016 annual reports1 of the study population are scrutinised to ascertain the bearing of using, respectively, the narrow and the wider revenue and mne group definitions. to ascertain the significance of the impact of the various definitions on revenue and therefore whether the company is cbc compliant or not, t-tests were performed to determine whether companies’ reported revenue (narrow definition) differs significantly from firstly revenue (wider definition) using the narrow mne group definition and secondly revenue (wider definition) using the wider mne group definition. based on an inspection of the normal p-plot of the revenue (narrow definition), revenue closely resembles a normal distribution (an assumption that is needed for using the t-test [keller & warrack 1997]). data collection revenue (narrow definition) and group structures were captured from the iress database (previously known as inet bfa). to calculate revenue (wider definition) and to confirm the multinational status of companies with no foreign subsidiaries according to iress, the 2016 annual reports of companies were used. the effective date of the cbc reporting regulations in south africa was year-ends ending on or after 31 december 2016. as such, the 2016 calendar year was seen as the turning point for this research. results results are discussed with reference to the two-stage methodology followed in this study (see the ‘methodology’ section). stage 1 of the 78 companies in the study population (see table 1), two companies did not have a foreign subsidiary, but their 2016 annual report did include at least one foreign associate or joint venture. using the narrow mne group definition 76 companies therefore qualify as opposed to the wider mne group definition where 78 companies qualified. table 2 summarises these results. table 2: multinational enterprise group categorisation – narrow versus wider multinational enterprise group definition. stage 2 of the above 78 companies included in the study population, 13 companies had a reported revenue of less than r10 billion, but more than r8 billion according to the narrow definition. however, if the wider revenue definition is including, for example, other income and interest received, but excluding the companies’ profit share from associates and joint ventures, 3 of the 13 companies will now have a revenue figure exceeding r10 billion. including the companies’ profit share from associates and joint ventures, based on the wider mne group definition, 4 of the 13 companies will have a revenue figure exceeding r10 billion. table 3 shows the number of companies that will have to comply to cbc reporting if either of the two wider definitions is used. table 3: comparison of alternative revenue definitions for companies with a revenue (narrow definition) more than r8 billion, but less than r10 billion. although it is admitted that the power of statistical tests will be severely restricted given the small number of companies, t-tests were performed to test whether the groups (based on revenue definitions) as reported in table 3 differed significantly from each other. the revenue (narrow definition) group differed significantly from both the wider definition groups at, respectively, the 1% level (p = 0.006) for the revenue wider definition group excluding associates and joint ventures and the 5% level (p = 0.039) for the revenue wider definition group including associates and joint ventures. these results therefore provide some statistical evidence that the ambiguities in defining mne group constituents and revenue, as discussed in this article, has a significant impact on business practice. whether companies will have to comply or be exempted from cbc reporting may therefore depend on whether the wider or narrow definitions are used for both revenue and mne group constituents. conclusion and recommendations the oecd’s objective with action 13 of the beps initiative was to create a global standard for cbc reporting, enabling data to be easily shared and compared by tax authorities when undertaking transfer pricing risk assessments. the inconsistent and uncoordinated implementation of the beps recommendations on action 13 in south africa may lead to failure to implement, or defaulting on, south africa’s international commitments. such failure or defaulting may result in a public non-compliant rating of south africa, which will result in other countries not being willing to exchange information with south africa. such an outcome may have an adverse impact on other international ratings. therefore, the objective of this study was focussed on the identification of the filing obligation and subsequent scope of cbc reporting in south africa. the review identified possible obstacles a south african mne group may face while determining whether they must comply with the cbc reporting documentation rules. the analysis of the terms constituent entity and group indicated that as a result of the influence of south african domestic income tax legislation, the structure of mnes is defined more broadly than that of the global standard by also including non-controlling entities like associates and joint ventures as constituent entities. the analysis of the concept ‘revenue’ indicated that two possible interpretations of the concept exist. the concept can either be interpreted by means of ifrs 15 to equate to income generated from transactions from the ‘ordinary activities’ of the entity or be interpreted through the much wider outline of revenue that must be disclosed as per the oecd. a quantitative analysis to explore the impact of conflicting mne group and revenue definitions, provided support for need for more precise guidance to companies on whether they have to comply. a comparison of the conflicting revenue definitions provides a compelling case for guidance on how revenue should be defined, as 4 of the 13 companies with a reported revenue between r8 and r10 billion face the risk of misclassification depending on the definition used. it should however be emphasised that it can merely be concluded that the application of alternative revenue definitions has a significant impact on the revenue amount of companies with a reported revenue (i.e. narrow definition) of between r8 and r10 billion. care should be taken that these findings are not generalised to conclude that a change in classification (i.e. whether the company is cbc compliant or not) is statistically expected, as such a reclassification also depends on the reported revenue before the application of the alternative revenue definitions (e.g. a company with a reported revenue of r8 billion compared to a company with a reported revenue of r9.9 billion). the exclusion of companies with a reported revenue of less than r8 billion can be seen as a possible limitation, as these companies may have significant amounts of other income and/or foreign associations and joint ventures. a further limitation may be the exclusion of companies listed in the financial sector. this warrants the need for future research through an application of a wider definition of the study population; for example, including companies with a reported revenue of less than r8 billion or companies listed in the financial sector. this study further focussed only on pointing out ambiguities, with no attempt to rectify such ambiguities. future research could therefore focus on how cbc compliance should be defined in an international context. acknowledgements the authors would like to thank the two anonymous reviewers for their time and input, which has been most helpful in refining and improving this article. the authors sincerely believe that the revised article is of a much higher standard after the recommended changes. competing interests this is a declaration to confirm that the views expressed in this article are those of the authors and that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions the review identifying the ambiguities regarding the filing obligation and subsequent scope of country-by-country reporting in south africa was performed by the corresponding author (c.t.). the measurement of the potential impact of the identified ambiguities in business practice, through the quantitative analysis, was performed by the second author (g.f.n.). references cir v stellenbosch farmers’ winery [1945] 13 satc 381. ias 28, investments in associates and joint ventures, 2011, international accounting standards board (iasb), london, viewed 05 february 2017, from https://www.iasplus.com/en/standards/ias/ias28-2011 ifrs 10, consolidated financial statements, 2011, international accounting standards board (iasb), london, viewed 05 february 2017, from https://www.iasplus.com/en/standards/ifrs/ifrs10 ifrs 15, revenue from contracts with customers, 2014, international accounting standards board (iasb), london, viewed 05 february 2017, from https://www.iasplus.com/en/standards/ifrs/ifrs15 keller, g. & warrack, b., 1997, statistics for management and economics, 4th edn., duxbury press, pacific grove, ca. law, j. (ed.), 2010, oxford dictionary of accounting, oxford university press, aylesbury. http://doi.org/10.1093/acref/9780199563050.001.0001 national treasury, 2017, budget speech by minister of finance, viewed 24 february 2017, from http://www.treasury.gov.za/documents/national%20budget/2017/speech/speech.pdf oecd, 2010, oecd transfer pricing guidelines for multinational enterprises and tax administrations, oecd publishing, paris, viewed 19 june 2017, from http://www.keepeek.com/digital-asset-management/oecd/taxation/oecd-transfer-pricing-guidelines-for-multinational-enterprises-and-tax-administrations-2010_tpg-2010-en#page4 oecd, 2013, action plan on base erosion and profit shifting, oecd publishing, paris, viewed 05 february 2017, from https://www.oecd.org/ctp/bepsactionplan.pdf oecd, 2015, transfer pricing documentation and country-by-country reporting, action 13 – 2015 final report, oecd publishing, paris. https://doi.org/10.1787/9789264241480-en oecd, 2017, guidance on the implementation of country-by-country reporting – beps action 13, oecd publishing, paris, viewed 20 june 2017, from http://www.oecd.org/tax/beps/guidance-on-the-implementation-of-country-by-country-reporting-beps-action-13.htm republic of south africa, 1962, income tax act 58 of 1962, government printer, pretoria. republic of south africa, 2011, tax administration act 28 of 2011, government printer, pretoria. sars, 2016, ‘regulations for purposes of paragraph (b) of the definition in “international tax standard” in section 1 of the tax administration act, 2011 (act no. 28 of 2011), promulgated under section 257 of the act, specifying the changes to the country-by-country reporting standard for multinational enterprises’, viewed 30 january 2017, from http://www.sars.gov.za/alldocs/legaldoclib/seclegis/lapd-lsec-reg-2016-07%20-%20regulation%20r1598%20gg40516%20-%2023%20december%202016.pdf sars, 2017a, draft public notice requiring the submission of cbc, master file and local file returns, viewed 23 june 2017, from http://www.sars.gov.za/alldocs/legaldoclib/drafts/lapd-lprep-draft-2017-27%20-%20draft%20public%20notice%20requiring%20the%20submission%20of%20cbc%20master%20file%20and%20local%20file%20returns.pdf sars, 2017b, external business requirements specification: country-by-country and financial data reporting, viewed 23 june 2017, from http://www.sars.gov.za/alldocs/legaldoclib/agreements/lapd-inta-eia-cbc-2017-03%20-%20final%20brs%20on%20the%20oecd%20cbc%20reporting.pdf (the) davis tax committee, 2014a, davis tax committee interim report: addressing base erosion and profit shifting in south africa, viewed 02 march 2017, from http://www.taxcom.org.za/docs/new_folder/1%20dtc%20beps%20interim%20report%20-%20the%20introductory%20report.pdf (the) davis tax committee, 2014b, davis tax committee interim report: addressing base erosion and profit shifting in south africa. action 13: re-examine transfer pricing documentation, viewed 02 march 2017, from http://www.taxcom.org.za/docs/new_folder/7%20dtc%20beps%20interim%20report%20on%20action%20plan%2013%20%20transfer%20pricing%20documentation,%202014%20deliverable.pdf footnote 1. the sa cbc regulations apply with effect from the reporting fiscal years of mne groups beginning on or after 01 january 2016 and, consequently, a qualifying south african-parented group with a calendar financial year will be expected to file its first report for 2016 with sars by the end of 2017 (sars 2016). abstract introduction literature review the case study background method results findings and implications conclusion acknowledgements references about the author(s) andrea saayman school of economics, faculty of economic and management sciences, north-west university, potchefstroom, south africa melville saayman tourism research in economics, environs and society (trees), faculty of economic and management sciences, north-west university, potchefstroom, south africa citation saayman, a. & saayman, m., 2019, ‘do wine tourists care about the labourer?’, south african journal of economic and management sciences 22(1), a2477. https://doi.org/10.4102/sajems.v22i1.2477 original research do wine tourists care about the labourer? andrea saayman, melville saayman received: 22 may 2018; accepted: 01 nov. 2018; published: 27 mar. 2019 copyright: © 2019. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: consumers worldwide have recently become more aware that their consumption preferences and habits influence not only the environment, but also other people’s lives. these ‘ethical’ consumers are therefore said to consider the moral features of the product or service in their consumption decision. the most prominent ethical consumption label is the fair trade label, which was established to enhance the living and working conditions of those working on small-scale farm cooperatives in developing countries. aim: this paper aims to determine wine tourists’ willingness to pay (wtp) for improved working and living conditions for wine farm workers. setting: the research was conducted at the largest wine festival in south africa, the wacky wine festival in robertson in the western cape, an area renowned for its wine and fruit products. method: the concept of a socially acceptable logo on the wine bottle – signalling fair wages to the farm workers – was assessed by using a double-bounded contingent valuation approach. wine tourists completed 397 questionnaires during the festival in june 2017. results: the results indicate that 80% of wine tourists are willing to pay more for socially responsible wines. the responsible wine consumer is typically younger and a premium of r11 per bottle of wine would be accepted if it signals fair treatment of workers. conclusion: the socially responsible wine tourist in south africa is more concerned about quality and the moral implications of the wine than the price. there is support for the implementation of a socially responsible label for wine products. keywords: wine tourism; ethical consumption; contingent valuation; wacky wine festival. introduction a key trend in the tourism industry is a change in consumer behaviour, and one of the attributes of the new tourist is ethical consumption, which is becoming increasingly important (saayman 2017). doane (2001) defines ethical consumption as the purchase of a product or service that concerns a certain ethical issue, such as human rights, labour conditions, environmental friendliness and wellbeing – to name just a few – which is chosen freely by an individual consumer. ethical consumption includes products that benefit the natural environment (such as items made from legally logged wood and products that promote animal health) and products that benefit people (such as items free from child labour and unsafe working conditions) (de pelsmacker, driessen & rayp 2005:363). de pelsmacker et al. (2005:364) also note that consumers can translate their ethical concerns into supporting, and therefore buying, certain products for their positive qualities (e.g. environmentally friendly products), or boycotting products for their negative qualities (e.g. those made by child labourers), or both. most research shows that ethical consumption is growing (hines & ames 2000). research conducted in europe showed that 46% of european consumers were willing to pay substantially more for ethical products (market & opinion research international 2000). the value of organic food and drinks globally was estimated at us$30 billion in 2005. in the us alone, this sector was valued at us$14.5 billion and in europe at us$14.4 billion in the same year (didier & lucie 2008:479). the global market for fair trade products was valued at us$900 million in 2005, with an estimated growth rate of 20% per annum (wright & mccrea 2007). arnot, boxall and cash (2006:555) also indicate that fair trade products represent a large and growing market in countries such as canada and the uk. from a tourism point of view it is therefore paramount that the industry at large take note of these changes in behaviour, since it can have far-reaching implications if these changes in purchasing behaviour are ignored or not addressed. bird and hughes (1997) identify three types of ethical consumer and highlight the complexity of this market: consumers who are primarily motivated by moral values. consumers who are primarily motivated by brand names and quality, for whom the ‘ethicalness’ of the product is an added bonus. consumers who are selfish and cannot easily be persuaded to buy ethical goods, since their buying behaviour is primarily driven by price and traditional quality concerns. most of the research on ethical consumption focuses on fair trade products and on consumers’ willingness to pay (wtp) for fair trade as opposed to traditional products (see arnot et al. 2006; basu & hicks 2008; de pelsmacker et al. 2005; van den broeck et al. 2017, to name a few). very few studies specifically address the working and living conditions of workers and even fewer studies have been conducted in the field of wine tourism and consumption. hence this article, which investigates wine tourists’ wtp for improved working and living conditions for wine farm workers. the research was motivated by a series of strike actions in the region of robertson in the western cape province of south africa during 2016. wine farmer workers downed tools and went on strike to secure better living and working conditions. the strike went on for 3 months before a settlement was reached. well known for its wine and fruit production, the area has been called the ‘valley of vines and roses’ (wines of south africa 2018). it is located along route 62, the longest wine route in south africa, with 48 wine cellars and estates forming part of the robertson wine region (kavonic 2017). the region traditionally produces some of the best white wines in the country, thanks to its high summer temperatures and cooling winds that blow through the valley (wines of south africa 2018). in addition, the robertson valley plays host to the largest wine festival in the country. therefore tourism, and especially wine tourism, plays a very important role in the local economy, which raises the question: would wine tourists be willing to pay more for a bottle of wine in order to secure better living and working conditions for wine farm workers? in other words, how ethical are wine tourists in their consumption behaviour? literature review as noted above, most of the research available on ethical products analyses fair trade products. this section therefore focuses on fair trade, with the notion that other ethical consumption labels and products could build on the fair trade concept. this is supported by shaw and clark (1999), who conducted a qualitative study in the uk and found that fair trade was the most important issue of ethical concern in consumer behaviour. fair trade has a long history, since it was established in the 1950s as an alternative trade concept (steinrücken & jaenichen 2007). it is defined as a trading partnership based on dialogue, transparency and respect, which seeks greater equity in international trade. it contributes to sustainable development by offering better trading conditions to, and securing the rights of, marginalised producers and workers, especially in the southern hemisphere (world fair trade organization 2017a). in plain language, fair trade aims to ensure that the benefits of trade reach smallholder producers in low-income countries (fairtrade labelling organizations international 2017). fair trade includes requirements on production practices, working conditions, labour remuneration, environmental management and social policies (van den broeck et al. 2017). it therefore takes social and environmental issues into consideration when products are imported from developing countries (loureiro & lotade 2005:130). the goals of fair trade are to (moore 2004:74; redfern & snedker 2002:11): improve the income and living conditions of producers. create opportunities for women and indigenous people while protecting children from exploitation. raise awareness among international consumers about the negative effects that international trade may have on less developed countries. set an example for other agents in international trade. change the rules of international trade. protect the rights of people in less developed countries. these goals are based on the 10 principles of fair trade (world fair trade organization 2017b): creating opportunities for disadvantaged producers. transparency in management and accountability to stakeholders. fair trading practices that are not at the expense of small producers. fair payment that entails fair prices and fair wages, which are at least the local living wage. no child or forced labour practices. a commitment to non-discrimination, equality, women economic empowerment and freedom of association. good working conditions. provision of capacity building to improve development. raising awareness of the aims of fair trade. respect for the environment to ensure sustainability. the effectiveness of the fair trade movement has been questioned: would consumers really pay more for a product with the fair trade label? a number of studies have been conducted to answer this question and they reveal the following: elliott and freeman (2003) found that 80% of us consumers polled in interviews said they would not pay more for products because they were produced in good living and working conditions. a study conducted in 1999 found that 76% of respondents were willing to pay an additional us$5 on a us$20 product that was free of sweatshop labour (program on international policy attitudes 2000). hicks (2006) found that respondents were willing to pay more for fair trade coffee as opposed to other coffees. a study conducted by the european union found that 93% of consumers who had already bought fair trade products would be prepared to buy these products at an equal price, and 70% were willing to pay at least 10% on top of the standard price for the product. basu and hicks (2008) and loureiro and lotade (2005) found similar results. de pelsmacker et al. (2005) also found that the fair trade label was the third most important attribute in coffee, after brand and flavour. a number of research articles have also investigated whether ethical consumers have certain characteristics that distinguish them from other consumers. the research by de pelsmacker et al. (2005) used cluster analysis and identified four clusters of consumers. they found that 11% of their research population were considered ‘fair trade lovers’, and together with the ‘fair trade likers’ – who were the biggest cluster – they made up 50% of the total population. the ‘fair trade lovers’ were predominantly in the 31–45 age category, and although they did not differ much demographically from respondents in other clusters, they were more idealistic. this research confirms the results of littrell and dickson (1999), who found that consumers of fair trade products were demographically quite homogenous – they were educated and well off, with a high percentage of females in their forties. this is further supported by an idea consult (2002) study, which also concluded that belgian fair trade consumers were highly educated and enjoyed higher incomes and social status than others. contrary to the above, anderson and cunningham (1972) found that younger consumers were more socially conscious and that income was of little relevance. age, income and employment status could not be verified to distinguish socially conscious consumers in research by dickson (2001). roberts (1995) found that the ethical consumer was female and in her forties, but, contrary to the research by littrell and dickson (1999) and idea consult (2002), they had slightly lower incomes. this is also contrary to other studies conducted before 1995, which found that gender was not an important determinant of ethical consumption (see sikula & costa 1994; tsalikis & ortiz-buonafina 1990). additionally, basu and hicks (2008) showed that nationality played a role, since german respondents were more inequality averse than their us counterparts. besides the demographic differences identified above, the values of consumers also play an important role in ethical consumer behaviour, in the form of enduring beliefs that a given behaviour or outcome is desirable (de pelsmacker et al. 2005). dickson (2001) defines values as abstract principles that reflect an individual’s self-concept. several researchers found that the values of people behaving unethically were significantly different from those who behaved ethically (see cowe & williams 2000; fritzsche 1995). values can also be seen as part of a person’s personality system and as determining specific attitudes. one aspect, however, that has not been evaluated much in the literature on this topic is behavioural issues, and this research therefore included behavioural variables in order to determine whether they influenced wtp for improved working and living conditions for wine farm workers. various ethical buying behaviour models have been proposed; however, according to de pelsmacker and janssens (2007), two models stand out. firstly, hunt and vitell (1986, 1993) proposed a model presenting various philosophical frameworks that underlie a decision-maker’s ethical judgement. in their model, two ethical evaluations might occur, namely deontological and teleological evaluation. deontological evaluation occurs when the consumer attempts to evaluate the inherent rightness or wrongness of different alternatives. teleological evaluation implies that consumers base their assessment on how much good and bad will result from the alternatives. vitell, singhapakdi and thomas (2001) showed that the deontological approach – less concerned about consequences – is a more critical or significant factor than perceptions of consequences (teleological) for ethical judgements, intentions and behaviour. the second model was proposed by shaw and clark (1999). at the core of this model is the beliefs-attitude-behaviour logic. besides concern about the issue at hand, the extent to which consumers were concerned that their personal action would contribute to a positive or negative outcome was added as a variable that determines intentions and behaviour. the latter is also referred to as perceived behavioural control. therefore, both negative and positive attitudes had a significant impact on buying behaviour and intentions (de pelsmacker & janssens 2007; shaw & shui 2002). from the above it is clear that when it comes to ethical buying behaviour, both positive and negative aspects should be considered. the case study background in 1952, the dutch east india company (voc) sent three ships to the cape of good hope to start a trading post that could supply fresh produce to ships on their route between holland and the east. the officials and workers experimented with a number of different crops, fruit and vegetables, but production was insufficient to meet the demand. nine of the company servants were released to start farming as free settlers on the land in proximity to the fort and with the arrival of 160 french huguenots in 1688, production finally reached satisfactory levels (fourie 2014). with some of the french huguenots from wine regions in france, it is not surprising that wine production was established in the cape from 1700 to 1773 (fourie & von fintel 2014). fourie and von fintel (2011) show that income inequality already existed during these early years of colonisation in south africa, and there was a marked division between the ‘wine making elite’ and the other farmers, who became impoverished. and then there were the slaves. although south africa is a water-scarce country with only 3% of its soil classified as fertile land, agriculture contributes almost 3% to the gross domestic product (gdp) of the country (a declining share) and is a large source of employment (goldblatt 2010). an agricultural minimum wage was first introduced in south africa in 2003 and resulted in a decline in the employment of seasonal workers, although permanent employment increased. the first unrest after the 2003 minimum wages occurred in the de doorns wine area when workers demanded a more than 100% increase in wages. this led to a revision of the minimum wage for agricultural workers in 2013 and although the workers did not get the more than 100% increase they demanded, the minimum wage increased by more than 50%. this time the wage increase led to a significant decrease in permanent employment (not seasonal employment) on farms in the country (bureau for food and agricultural policy 2015). the 2016 labour unrest in the robertson wine area therefore comes after the minimum wage of farm workers was increased in 2013. method in order to derive non-market values for environmentally friendly or other ethical consumption goods, either revealed preferences or stated preferences can be assessed. revealed preference methods entail the observation of the actions of consumers, for example their purchasing behaviour of eco-label goods compared to other goods. on the other hand, stated preference methods are more often used when the value of a certain attribute cannot be directly observed and respondents have to indicate the value they attach to it (tietenberg & lewis 2012). in the fair trade and ethical consumption literature, both revealed and stated preference methods have been used. arnot et al. (2006), for example, used a revealed preference analysis to derive the value of the fair trade label on coffee. stated preference methods are, however, much more popular and have been used by, among others, de pelsmacker et al. (2005), loureiro and lotade (2005), basu and hicks (2008) and didier and lucie (2008). there are various ways to derive stated preferences and the methods can be divided into direct and indirect. contingent valuation is the direct method. indirect methods include attribute-based models, conjoint analysis, choice experiments and contingent ranking (tietenberg & lewis 2012). the researchers on fair trade coffee have used a variety of direct and indirect valuation methods. for example, de pelsmacker et al. (2005) used conjoint analysis, while basu and hicks (2008) used a choice experiment. contingent valuation normally entails a survey in which respondents are asked how much they are willing to pay for a certain attribute or outcome (harris & roach 2009). alternatives are available to ascertain respondents’ wtp (makumbirofa & saayman, 2017), namely: open-ended questions. dichotomous choice. payment cards. loureiro and lotade (2005) used payment cards to elicit wtp for fair trade coffee, while didier and lucie (2008) used an experimental design and the becker-degroot-marschak mechanism to derive respondents’ wtp for organic and fair trade products. given that no ‘fair labour practices’ label yet exists, for this research we used stated preference valuation and, more specifically, contingent valuation. we employed the contingent valuation method, dichotomous choice, which according to lopez-feldman (2012:3) is the most efficient of the three alternative methods. more specifically, we used a double dichotomous valuation question, where a bid amount was given that varied randomly across the different respondents. the respondents were then asked a follow-up bid, based on their answer to the first bid. if their answer was no to the first bid, a lower bid amount was offered, while a higher bid amount was offered if the initial bid had been accepted (lopez-feldman 2012). each respondent’s reply could therefore be one of four possibilities, namely no-no, no-yes, yes-no or no-no. the initial bid amounts offered to respondents were a premium of (1) r5 (€0.33), (2) r10 (€0.66) or (3) r15 (€1) on every bottle of wine. the upper and lower bids were in r5 denominations, except for the initial r5 bid, for which the lower bid was r2.50. the question posed to respondents was: robertson was in the news last year due to strike actions by farm workers who felt that they did not receive a fair wage. internationally the ‘fair trade’ logo serves as proof that suppliers in poor countries receive a fair price for their produce. if a similar logo is developed for wine producers that pay their labourers fair wages, and this logo appears on the bottle, would you be willing to pay rx more for the bottle of wine? in line with previous research, we controlled for the socio-demographic characteristics of respondents, including gender, age, income and province of origin. respondents were also asked to indicate their assessment of the price and quality of robertson wines on a 3-point scale (cheap, the same and more expensive for price; and lower, the same and better for quality), allowing us to control for the subjective evaluation of the price and quality of the wine. in addition, we controlled for wine consumption behaviour, since respondents were asked to indicate the regularity of wine consumption on the following scale: daily, more than once a week, weekly and occasionally. the probit and doubled procedure in stata 14 were used to analyse the data and estimate wtp. the questionnaire was administered in 2017 by trained field workers during the wacky wine festival, which is held annually in june in the robertson valley. altogether 397 completed questionnaires were received. with 11 130 wine festival tickets sold, the sample size represents a 5% margin of error (95% confidence interval). results the sample reveals the following: 214 (or 53.9%) of the respondents are female, while the average age of respondents is 39.6 years. the average respondent earns between r300 000 and r550 000 per year, making them middle-income earners. the respondents are mainly from the western cape province (76.8%), with 13.9% of respondents from gauteng, the province that boasts the highest income per capita in south africa. almost 50% of respondents find wine from the robertson valley to be cheaper than wines from other regions in south africa and only 8.3% think it is more expensive. by contrast, 50.8% assess the wine to be of better quality than wines from other regions, with only 7% finding it of inferior quality. the festival-goers are also keen wine consumers with 24.1% consuming wine daily and 52.7% consuming it once or more than once a week (although not daily). in terms of their responses to the initial and follow-up bid amounts offered to them, table 1 shows that 56.22% of all respondents were willing to pay the initial bid amount. as expected, higher initial bids were less accepted than lower initial bids (i.e. 61.65% accepted r5 compared to 51.97% who accepted r15). in terms of the follow-up bids, almost half of the respondents accepted the follow-up amount offered, either lower or higher depending on their answer to the initial bid. while quite a large percentage accepted the initial bid of r10, the higher follow-up of r15 was the least accepted. interestingly, the higher bid from the initial r15 bid (i.e. r20) was accepted by 59.09% of the respondents to whom this bid was shown. only 19.69% of respondents did not accept any bids offered to them. table 1: responses to bids offered. taking just the initial bid into consideration, a probit model was estimated. the first column of table 2 reports the simplest model where the initial bid amount is the only independent variable. given the estimates in table 2, the wtp amount based on the initial estimate is r16.28. using a general to specific approach, the various control variables were included in the model. only very few turned out to be significant and the reduced model is shown in column 2. it is evident that only two variables are significant: the control variable for festival-goers from gauteng (a positive sign) and the control for quality, which indicates that those who rate the quality of the robertson wines as similar to those of other regions in south africa are less willing to pay. the estimated wtp, given these control variables, is close to that in the simple model, at r16.43. table 2: probit model estimates. the estimates in table 2 only take the initial amount offered to the respondents into consideration and not the follow-up. the double-bounded estimates take both amounts into consideration and the results are shown in table 3. three models were estimated, the first being the simplest model with only the bid amounts offered. since a general to specific approach was again followed, model 2 (column 2) is the model that contains all the control variables. as was the case with the probit model estimates, very few of the control variables proved to be significant and therefore a reduced model was estimated (column 3). table 3: double-bounded estimates. how willing festivalgoers were to pay for fair labour practices in robertson can also be determined with the model estimates. for the first model, the wtp amount is the beta intercept, r11.04. since many of the variables in the second model are insignificant, the wtp for the third model is determined instead and, accordingly, the wtp for fair labour practices is calculated at r11.05. the results above show that ethical wine tourists in south africa are younger than 50, reside in gauteng and consume wine more frequently (daily). their view of the price of robertson wine is insignificant, although quality does seem to play a role, with those viewing the quality of robertson wines as similar to those from other regions in the country displaying a lower wtp. these results about the ethical wine tourist differ from what roberts (1995) and littrell and dickson (1999) found, with no significant differences in wtp between male and female consumers. in terms of the age of ethical consumers, our research results confirm the findings of anderson and cunningham (1972), roberts (1995) and de pelsmacker et al. (2005), who all found younger consumers to be more socially responsible. however, we could not find support that only consumers in their late thirties to late forties are willing to pay more for socially responsible products, as littrell and dickson (1999) found. contrary to previous research, we also could not find support that income influences stated wtp for more socially responsible wine, although it should be noted that gauteng is moderately significant in some of the results and that it is also the province with the highest income per capita in the country. in terms of the influence of price and quality on wtp for socially responsible products, bird and hughes (1997) distinguished three different classes of ethical consumers. the results from our research indicate that ethical wine consumers are less concerned about the price of the product and more about the quality. therefore, ethical wine tourists in south africa can rather be classified into the first and second categories identified by bird and hughes: consumers who are motivated by moral values and, secondly, those who are motivated by brand names and quality. finally, it is important to know the reasons why people are not willing to pay. the respondents who chose ‘no’ on both the initial and lower bid amounts offered to them (i.e. 19.69% of all respondents), had to rank the reasons according to importance, with the following choices offered to them: all wine farms should treat their workers fairly. farmers must bear the cost of labour. it is not my responsibility. other. the most important reasons according to the respondents’ ranking are, firstly, that they expect wine farmers to treat their workers fairly and, secondly, that farmers should bear the labour cost. the other reasons cited include that everyone is expected to abide by the labour laws. a basic probit analysis of the respondents who are not willing to pay (no-no) reveals that respondents from the western cape have a higher probability of being unwilling to pay, while english-speaking respondents have a lower probability of choosing no-no. the results are, however, only significant at the 10% level. findings and implications based on the results, the first finding from this research is that 80.3% of all the wine tourists indicated a wtp an amount for more socially responsible wine. this is in line with research among european consumers, where it was found that 70% were willing to pay at least 10% on top of the standard price for a fair trade product (basu & hicks 2008; loureiro & lotade 2005). south african consumers are therefore more like european consumers in terms of their ethical consumption behaviour and less like american consumers, with only 20% of americans willing to pay more for ethical products. secondly, the amount that south african wine tourists are willing to pay to ensure better living and working conditions for wine farm workers is r11.04. given that the average bottle of wine in the robertson valley sells for r65, this implies a premium of 17%. this compares well with international studies, where pipa (2000) found that 76% of consumers were willing to pay 25% more for products that were not manufactured using sweatshop labour, while a european study indicated that 70% of consumers were willing to pay at least 10% more for fair trade products. the first two findings imply that there is scope for the development of a ‘socially responsible’ label in the south african wine industry – similar to the fair trade label – and that south african wine consumers are willing to pay a premium on wine with such a label. the fair trade label is already available for some wines internationally, for example in the netherlands. thirdly, concerning the characteristics of ethical consumers in south africa, the study found the following socio-demographic variables to be significant: (1) age, with those younger than 50 willing to pay significantly more, and (2) origin, with wine tourists from south africa’s wealthiest province (gauteng) willing to pay more. contrary to other studies conducted, gender and income are not significant predictors of wtp for socially responsible wine in south africa. for the future of ethical consumption in south africa, these results are positive, since the country has a younger population distribution, and these consumers are more likely to pay for socially responsible products. in addition to the socio-demographic variables, this research also included some behavioural variables and perceptions on quality and price to determine the extent to which they influence consumers’ ethical consumption. we could find support that those who consume wine more frequently (i.e. daily and more than once a week) were willing to pay more, which may be an indication that those who consume wine as part of their lifestyle are more concerned about the sustainability of wine production in the country. this can be loosely linked to the teleological approach in the model of hunt and vittell (1986, 1993), although the current ethical buying behaviour models do not fully make provision for lifestyle and sustainability, which are aspects for future research. finally, we found wine consumers in south africa to be less concerned about the price and more about the quality of the wine. consumers who do not find the quality of the wine better than that from other regions are willing to pay significantly less to ensure better working and living conditions for wine farm workers. therefore, we conclude that the ethical wine consumer typically falls in the first two categories identified by bird and hughes (1997), although it would be worthwhile to profile the different segments of ethical wine consumers in south africa better – also an aspect for future research. conclusion the purpose of this article was to determine wine tourists’ wtp for improved working and living conditions for wine farm workers. the research was conducted among wine tourists at the 2017 wacky wine festival in the robertson valley in south africa, which saw strike action in 2016 by wine farm labourers demanding better wages. altogether 397 questionnaires were completed and a double-bounded dichotomous contingent valuation design was used to determine the wine tourists’ wtp for more socially responsible wine. this article makes a contribution to understanding ethical consumption behaviour among south african consumers, about which very little is currently known. in this context, south african consumers show similarities to european consumers in ethical consumer behaviour. this is encouraging since research shows that europeans are the leaders in ethical consumer behaviour. the research is the first attempt in the country to identify ethical consumers, as well as the reasons why people would not be willing to pay more for ethical goods. while international research mainly identifies older people as more ‘ethical’, the south african situation seems to be different, with 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(eds.), 2007, the handbook of organic and fair trade food marketing, blackwell, oxford. abstract introduction literature review data and methodology results and discussions conclusion acknowledgements references about the author(s) monica v. achim department of finance, faculty of economics and business administration, babes-bolyai university, romania sorin n. borlea department of economics, faculty of economics, informatics and engineering, vasile goldiș western university of arad, romania andrei m. anghelina department of economics, faculty of economics, informatics and engineering, vasile goldiș western university of arad, romania citation achim, m.v., borlea, s.n. & anghelina, a.m., 2018, ‘the impact of fiscal policies on corruption: a panel analysis’, south african journal of economic and management sciences 21(1), a1970. https://doi.org/10.4102/sajems.v21i1.1970 original research the impact of fiscal policies on corruption: a panel analysis monica v. achim, sorin n. borlea, andrei m. anghelina received: 06 june 2017; accepted: 19 oct. 2017; published: 04 apr. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract this article seeks to complement the previous literature and clarify whether fiscal policy plays a role in the level of corruption of a country. the present work investigates whether the increase in fiscal pressure leads to a higher level of corruption and whether the results differ from developed to developing countries. this article examines a large sample consisting of over 185 countries, during the period 2005–2014. the technique employed was short panel data. five statistical models were used such as the pooled ols, pooled fgls, within model, between model and random-effects gls model. our main contribution consists in finding differentiated results of the influence of fiscal policy on the level of corruption among developed and developing countries. for developed countries, we found that, with high-quality institutions, low fiscal pressure leads to a lower level of corruption, which is in line with expectations. conversely, in developing countries, with low-level institutional quality, low fiscal pressure increases corruption, because of low governance efficiency under which people may easily circumvent the law. our findings suggest that governments and policy-makers need to acknowledge that the anti-corruption fight requires not only the right fiscal policies but also the right way of implementing these policies, recognising the role of quality institutions, which need to prevail in any country. introduction corruption is a phenomenon that has originated since ancient times. it is considered the worst and most widespread form of behaviour, perverting public affairs (conseil de l’ europe 1996:78). according to transparency international (2015), ‘corruption is the abuse of entrusted power for private gain. it can be classified as grand, petty and political, depending on the amounts of money lost and the sector where it occurs. a short definition is provided by the world bank (1997) according to which corruption is ‘the abuse of public office for private gain’. corruption undermines democratic governance and the rule of law and negatively affects economic development, being an impediment to increasing investment and growth (lambsdorff 2003; mauro 1995). fiscal policy is often linked with corruption, in which the bribing of officials is done by entrepreneurs in order to obtain private gains, such as avoiding taxation and regulations, or winning public contracts (fjeldstad 1996, 2003; kaufman 2010). the starting point of this study consists in finding few, inconclusive results in the literature regarding the influence of fiscal pressure on the level of corruption (dreher & schneider 2010; dreher & siemers 2009; mcgee 2012). thus, the objective of the present research consists in filling this gap, by analysing the influence of fiscal pressure on the level of corruption, using two main control variables, such as wealth and institutional quality. a panel analysis was conducted on a large sample of 185 countries over the period 2005–2014. our main contribution to previous work consists in finding differentiated results when the influence of fiscal burden on the level of corruption is controlled by income and institutional quality. thus, in developed countries with high-quality institutions, we found that lower fiscal pressure leads to a lower level of corruption, supporting expectations. on the contrary, we found that in developing countries with low-level institutional quality, low fiscal pressure increases corruption, because of low governance efficiency under which people may easily circumvent the law. our findings suggest that certain fiscal policies may work in some countries, but not in others. thus, governments and policy-makers need to acknowledge that the anti-corruption fight requires not only the right fiscal policies but also the right way of implementing these policies, whilst recognising the role of quality institutions prevailing in any country. the rest of this article is organised as follows: in the ‘literature review’ section, the theoretical considerations are laid out, according to which the main working hypotheses are set. in the ‘data and methodology’ section, the methodology and data sources are provided. in order to substantiate the econometric model of corruption, several control variables already validated by the literature were used. the ‘results’ section highlights the results and discussions of the main empirical findings. the article ends with the main conclusions of the study, including some limitations which could be the basis for future work in this area of research. literature review the problem of corruption and its explanatory factors are widely debated in the literature. it is important for policy-makers to know the causes of corruption, in order to open up the proper channels for fighting against it. the literature on corruption has typically focused on the administration of bribes or obtaining private gain by abusing public officials. this private gain is made by entrepreneurs in avoiding taxation and regulations, and winning public contracts. therefore, it is possible to derive some direct connections between various aspects of fiscal policy and corruption. to our knowledge, relatively few strands in the literature (dreher & schneider 2010; dreher & siemers 2005, 2009; mcgee 2008, 2012) have investigated the influence of fiscal pressure on levels of corruption, and the results are inconsistent. for instance, dreher and siemers (2005) analysed the relationship between corruption and capital account restrictions, using a panel data of 112 countries over the period 1984–1999. they found that heavy capital account restrictions involved higher corruption in the earlier years up to 1993, but reduced corruption in later years. later, dreher and schneider (2010) analysed a cross-section data of 120 countries and a panel data of 70 countries during 1994–2002. they also obtained results documenting that corruption is more severe in countries with smaller fiscal burdens, contradicting expectations. analysing the perception on tax evasion and corruption in denmark, mcgee (2008) revealed that danish people view tax evasion very negatively, even though their tax rate is one of the highest in the world; hence, the low-level of corruption in denmark could be explained. similarly, mcgee (2012) explained the situation in armenia, where, although the tax burden is substantially less than most other countries, people are not so strongly opposed to tax evasion, thus leading to a high level of corruption. another paradox can be found in china. various authors (huang 2016; jiang & nie 2014) empirically reported on the chinese miracle of continuing high growth in the gross domestic product (gdp), with the prevalence of government corruption. kumar (2011) noted the anomaly of emerging china, which is characterised by low economic freedom, high corruption and high growth. emerging from these inconclusive findings, questions may be asked concerning the higher fiscal burden will create opportunities for bribing officials, in order to avoid taxes or win public contracts. intuitively, bribes are paid to avoid paying taxes or following regulations; therefore, it can be assumed that a higher fiscal burden could increase corruption. thus, the following hypothesis may be posed: hypothesis 1: increasing fiscal pressure is associated with a higher level of corruption. an important strand of research (dreher & schneider 2010; graeff & mehlkop 2003; virta 2007) reveals differentiated behaviour among various economic variables related to corruption, depending on the stage of development. graeff and mehlkop (2003) found that some aspects of economic freedom deter corruption, whilst others do not. they discovered a strong relationship between economic freedom and corruption, and that this relationship differs between rich and poor countries. dreher and schneider (2010) demonstrated that the relationship between corruption and the shadow economy differs between highand low-income countries. they found that the shadow economy reduces corruption in high-income countries but increases corruption in low-income countries. also, some authors, such as virta (2007), investigated the relationship between corruption and the shadow economy by regions. among countries in tropical regions, a negative relationship was found between corruption and the shadow economy, because in such regions, public officials are commonly paid for remaining official, and thus the shadow economy decreases if corruption increases. according to these findings, we intend to test the following research question: research question 1: how do the results of testing hypothesis 1 differ between developed and developing countries? data and methodology variables and data sources the dependent variable: corruption to measure corruption, the corruption perceptions index (cpi) provided by transparency international was used. this index measured the perceived levels of public sector corruption in 175 countries. the scores range from 0 (highly corrupt) to 100 (very clean). the ranking of countries from 1 (lowest level of corruption) to 175 (highest level of corruption) was done during the period 2005–2014. the independent variable: fiscal pressure or fiscal burden according to schneider, buehn and montenegro (2010), the measurement of fiscal burden is not easy to define, because the tax and social security systems are vastly different among countries. a measure of fiscal burden is fiscal freedom, which is composed of three quantitative factors (j), namely: (1) the top marginal tax rate on individual income; (2) the top marginal tax rate on corporate income; and (3) the total tax burden as percentage of gdp (heritage foundation 2017). a fiscal freedom score is therefore calculated as follows: where: fiscal freedomij represents the fiscal freedom in country i for each factor j. factorij represents the value (based on a scale of 0–100) in country i for factor j. α is a coefficient set equal to 0.03. the higher the fiscal burden, the lower the fiscal freedom. this survey deals with the fiscal freedom variable (fif), as a proxy variable for tax burden. it includes both the direct tax burden in terms of the top tax rates on individual and corporate incomes, and the overall amount of tax revenue as percentage of gdp. the fiscal freedom index ranges from 0 to 100, where 0 is the least fiscal freedom and 100 is the maximum degree of fiscal freedom. the fif has been used by various authors in their research (dreher & schneider 2010; torgler & schneider 2009) in order to express the level of fiscal burden of a country. selected control variables the present study investigates the influence of fiscal pressure on the level of corruption. a number of other important factors, such as income and institutional quality of a country had to be controlled, and are discussed as follows. income various studies (de rosa, gooroochurn & gorg 2010; husted 1999; paldam 2001, 2002; treisman 2000) reported that high-income countries face a low-level of corruption. husted (1999) argued that ‘since the level of development is related to the overall level of resource munificence, one would expect that corruption would be more common in the less developed economies’. treisman (2000) and paldam (2001, 2002) found that corruption is a poverty-driven disease which vanishes when the country becomes richer. goel and ram (2013) substantiated these findings and documented that transition economies have more corruption than developed countries. gundlach and paldam (2009) pointed out that the cross-country pattern of corruption can be fully explained by the cross-country pattern of income, and de rosa et al. (2010) found a strong correlation of 0.81 between gdp and the level of corruption. however, huang (2016) found no significant causality between corruption and economic growth among most asia-pacific countries and concluded that, for these countries, the anti-corruption policies used by policy-makers to promote a country’s economic development may not be effective. based on the empirical findings stated above, the following hypothesis and research questions were formulated: hypothesis 2: increasing income of a country is associated with a lower level of corruption. research question 2: how do the results of testing hypothesis 2 differ between developed and developing countries? gross domestic product is a proxy for the level of development and prosperity of a region. next, the per capita gdp is used as a proxy for the income of a country. institutional quality various studies have highlighted the importance of providing a high level of confidence in governance institutions, in order to ensure the proper functioning of the state (fritzen, serritzlew & svendsen 2014; kirchler 2007; park & blenkinsopp 2011; torgler & schneider 2009). corruption and trust are two important determinants of the quality of public sectors (fritzen et al. 2014). better institutional quality encourages people to have trust in the state, and to be less interested in ‘playing tricks’. government has strong discretionary powers over the allocation of resources, and bribes may be paid to avoid paying taxes or following regulations (torgler & schneider 2009); hence, trusting societies demonstrate less corruption. trust in government or public services reflects citizens’ subjective judgements, based on their experience, in which they judge the government as being competent, reliable and honest, whilst also meeting their needs (park & blenkinsopp 2011). low institutional quality determines a low trust in governance, which fails to determine ways of circumventing the law (kirchler 2007). one of these consists in bribing officials to avoid taxes, and thus increases corruption. in this respect, dreher, kotsogiannis and mccorriston (2009) empirically found that an improvement in institutional quality reduced the shadow economy and affected the corruption market in 18 oecd countries. therefore, the following secondary hypothesis can be stated: hypothesis 3: a higher level of institutional quality reduces the level of corruption. research question 3: how do the results of testing hypothesis 3 differ between developed and developing countries? institutional quality is measured using the good government effectiveness (ge), as provided through the worldwide governance indicators by the world bank (2016b). according to various researchers (carden & verdon 2010; graeff & mehlkop 2003; kumar 2011), corruption can be analysed multi-dimensionally. following these findings, we intend to analyse the variation in corruption according to the simultaneous influences of fiscal freedom, institutional quality and richness of the country. therefore, the following hypothesis and research questions were proposed: hypothesis 4: higher fiscal pressure, lower institutional quality and lower degree of richness of a country are associated with a higher level of corruption. research question 4: how do the results of testing hypothesis 4 differ between developed and developing countries? the variables used and data sources for these variables are shown in table 1. table 1: variables and data sources. the current research was developed further in order to classify the countries, by level of development, in developed and developing countries. this classification is based on the data provided by the world bank report on ‘country and lending groups’ 2015 (world bank 2015), where countries are classified by high-income, upper-middle-income, lower middle-income and low-income. the classification of countries is based on the average value of gross national income per capita, as follows: high-income (gross national income per capita of $12 746 or more); upper-middle-income economies (gross national income per capita of more than $4126 but less than $12 736); middle-income economies (gross national income per capita of more than $1045 but less than $4125); and low-income economies (below gross national income per capita of less than $1045). therefore, the world bank (2015) classified the lowand middle-income economies as ‘developing’ economies and the high-income countries as ‘developed’ economies. the present study sample consists of 185 countries (49 developed and 136 developing countries), for which all the required data are available. in order to show the influence of the considered variables on corruption, the following baseline equation model was proposed, according to hypothesis 4: cpii reflects the level of corruption of a country i. fifi is the fiscal freedom variable (a negative sign is expected). gdpi is the wealth of a country, estimated by gdp per capita (a negative sign is expected). gei denotes the institutional quality reflected by good government effectiveness (a negative sign is expected). εi reveals the error term. methods the data organised in a short time panel are repeated in yearly measurements over the period 2005–2014 for 185 countries, for which all required data are available. all 185 countries have exactly 9 years of data and the panel is balanced. the dependent variable (cpi) and regressors (fif, gdp and ge) vary over both time and countries. all the variables are time-varying regressors. variation over time is called within variation, and variation across countries is called between variation. this clarification is very important, because the used estimators differ in relation to within and between variations. for this purpose, five statistical models were used: the ‘pooled ordinary least square’ (‘pooled ols’) model denoted as (1), the ‘population-averaged’ or ‘pooled feasible generalised least squares’ (pooled fgls) model denoted as (2), the ‘within’ model or ‘fixed effects’ (‘fe’) denoted as (3), the ‘between’ model (‘be’) denoted as (4) and ‘random-effects gls’ model (‘re’) denoted as (5). the five models used allowed us to capture the components of the variation of variables used in hypothesis testing. a natural starting point is the pooled ols regression with cluster-robust standard errors. the estimator ols is based on the total variance of the variables, not distinguishing between ‘within’ and ‘between’ variation. for any error correlation, given a model for error correlation, a more-efficient fgls estimation is possible. when ‘within’ variation is significant, the ‘within’ model is used in order to show how the testing hypothesis is affected. the ‘between’ model uses cross-section variation in the data and is based on average values of variables. it is interesting to know if the hypothesis is valid when the average values for each country are used. the ‘re’ model uses both between and within variation in the data. this model assumes that the time-invariant component of the error (caused by individual-specific-effects) and the time-varying component of error are independent and identically distributed. results and discussions firstly, hypothesis 1 examined the relationship between fiscal pressure and corruption. theoretically, there is a reason to believe that increasing fiscal pressure is associated with a higher level of corruption. the results of testing the hypothesis are shown in tables 2–4. the results are based on linear regressions including the dependent variable, cpi and one explanatory variable, fif, at the time. table 2: variation of corruption perceptions index depends on fiscal freedom variable, by stage of development: all. table 3: variation of corruption perceptions index depends on fiscal freedom variable, by stage of development: developed. table 4: variation of corruption perceptions index depends on fiscal freedom variable, by stage of development: developing. tables 2–4 show that fiscal pressure significantly affects the level of corruption, apart from model (3), having analysed all countries in the sample. the results of model (3) show that the impact of fiscal pressure on the level of corruption is statistically insignificant. perhaps, it would be interesting to see the result of model (3) for a long panel. the coefficients of fif determinant in models (1), (2), (4) and (5) are the most significant at 5% level of significance. however, the sign of fif coefficient contradicts hypothesis 1. for all countries, higher fiscal freedom (which involves a lower fiscal burden) implies a higher level of corruption, which does not support our hypothesis 1. rather, we got the opposite results, namely, that lower fiscal pressure leads to a higher level of corruption. research question 1 investigates how the results of testing hypothesis 1 differ between developed and developing countries. the results are listed in tables 2–4. it is found that, for developed countries, the results of models (1), (2) and (4) are also significant at 1% level of significance. the results of models (3) and (5) for developed countries are inconclusive (the influence is not statistically significant). models (1), (2) and (4) also show that fiscal pressure is a significant determinant of corruption but not in the expected way. the coefficient of determinant fif is positive; therefore, higher fiscal freedom (meaning lower fiscal pressure) implies a higher level of corruption. for developing countries, the hypothesis results are significant only in the case of model (2). this model takes into account the high correlation errors, thus leading to inconclusive results. for the other models, the impact of fiscal pressure is not significant and the sign of the fif determinant contradicts the hypothesis. concluding, our results do not support hypothesis 1. this means that in countries across the world, high fiscal pressure is not a real reason for corruption. moreover, we even found opposed evidence that lower fiscal pressure (reflecting higher fiscal freedom) may be a reason for corruption, and these results are statistically significant for all the countries sampled. when the countries were analysed by stages of development, the same results were generally maintained across the developed countries, with 1% level of significance in three of the five models: models (1), (2) and (4). for developing countries, the results have some consistency only for one model (2). our findings contradict the expectation that a higher fiscal burden induces a higher level of corruption. however, these results are generally supported by those of dreher and siemers (2005, 2009), dreher and schneider (2010) and mcgee (2008, 2012), who also found empirical evidence in this regard. secondly, hypothesis 2 investigated the influence of income on the level of corruption. tables 5–7 show the test results for all countries and separately classifies them by stages of development. table 5: variation of corruption perceptions index depends on gross domestic product, by stage of development: all. table 6: variation of corruption perceptions index depends on gross domestic product, by stage of development: developed. table 7: variation of corruption perceptions index depends on gross domestic product, by stage of development: developing. it was found that hypothesis 2 is validated over the entire sample, except in model (3). although, the gdp variable coefficient is significantly different from zero, the sign is not the expected one. for developed countries, the hypothesis is not accepted in the case of models (3) and (5) with doubts concerning the random-effects of countries. the same problem occurs when hypothesis 2 is tested for developing countries. estimators (3) and (5) are based on within variation and are small in relation to between variations. noteworthy is that this hypothesis is validated in all three cases through the use of models (1), (2) and (4), models based on between variation. the between variation and errors of correlation are relevant. it is worth noting that reduction in corruption because of increase in income is higher in developing countries than in developed ones. similar findings belong to treisman (2000) and paldam (2001, 2002), who found that eradication of poverty could reduce corruption (see the value of coefficients variable gdp for each model). overall, the findings of the present study are in line with theory showing that low-income countries face high levels of corruption (de rosa et al. 2010; gundlach and paldam 2009; husted 1999; paldam 2001, 2002; treisman 2000). thirdly, hypothesis 3 examined the influence of institutional quality on the level of corruption. the results are presented in tables 8–10. table 8: variation of corruption perceptions index depends on government effectiveness, by stage of development: all. table 9: variation of corruption perceptions index depends on government effectiveness, by stage of development: developed. table 10: variation of corruption perceptions index depends on government effectiveness, by stage of development: developed. the results of testing hypothesis 3 in relation to the development stage are homogeneous. the coefficients of ge determinant in all five models have 5% significance level. the negative sign of ge coefficient confirms our hypothesis 3. our findings are also supported by the studies of kirchler (2007), torgler and schneider (2009) and park and blenkinsopp (2011) who reported that high institutional quality involves few attempts to circumvent the law, and thus corruption decreases. moreover, a recent study conducted by forson et al. (2016) over 22 countries in sub-saharan africa from 1996 to 2013 found that ge and regulatory quality bred substantial corruption. they agreed about sources of corruption from the perspective of institutional ineffectiveness. moreover, kirchler (2007), torgler and schneider (2009) and park and blenkinsopp (2011) reported that high institutional quality involves few attempts to circumvent the law, and thus corruption decreases. it should be noted that the influence of institutional quality on corruption is much greater in developing countries than in developed countries. excessive bureaucracy, lack of transparency and ambiguous legislation highly affect poor people, who will succumb to the dictates of corrupt officials in order to achieve some immediate benefits. finally, hypothesis 4 and research question 4 involve analysis of the variation of corruption caused by simultaneous influence of fiscal freedom, institutional quality and income of a country. the results are listed in tables 11–13. table 11: variation of corruption depends on fiscal freedom variable and government effectiveness, by level of development: all. table 12: variation of corruption depends on fiscal freedom variable and government effectiveness, by level of development: developed. table 13: variation of corruption depends on fiscal freedom variable and government effectiveness, by level of development: developing. because the factors ge and gdp are not independent and are very much correlated (correlation coefficient is 0.76), only the variables fif and ge were considered as determinants in the model of corruption. the results show that for all the countries, the impact of governance efficiency is consistent, and the sign of ge coefficient is in line with hypothesis 4. the influence of fiscal freedom is statistically significant in models (2), (3) and (5). this fact is because of the errors in correlation and the change of tax freedom during the 9 years. it must be emphasised that the coefficient of fif is positive and unexpected. this means that increasing fiscal freedom leads to more corruption, which also contradicts the expectations. however, the running tests conducted separately on developed and developing countries lead to some interesting findings. thus, for developed countries, the hypothesis is valid in models (1) and (4), and the sign of the variable fif is, for the first time, in line with our expectations (e.g. negative). it means that high fiscal freedom (low fiscal pressure) reduces corruption in developed economies when controlling for governance effectiveness. in developed countries, the high level of institutions leads to strong control by the state, and thus low fiscal freedom (high fiscal pressure) increases corruption. thus, here the theory is supported. because model (2) is not convergent, it is not considered in the present analysis. for developing countries, the influences of fif and ge are significant, but the coefficient of fif is positive, again, contrary to our expectations, but in line with the previous results when the variation of cpi was analysed only under the variation of fif. for these countries, whether it controls or not for governance effectiveness, the sign of the fif determinant remains positive, meaning that a higher level of fiscal freedom (together with low fiscal pressure) leads to a higher level of corruption. in developing countries, the efficiency of institutions is lower in comparison to developed countries. in these countries, the government institutions are weak, and do not succeed in controlling corruption. thus, higher fiscal freedom (meaning lower fiscal pressure) leads to a higher level of corruption under weak-quality institutions. one can conclude that, for the first time in our analysis, the influence of fiscal freedom on corruption follows expectations when the developed countries are surveyed and this relation is controlled by institutional quality. thus, in well-developed institutions, high fiscal freedom (meaning low fiscal pressure) leads to a lower level of corruption, which is in line with expectations. for developing countries, higher fiscal freedom enhances corruption, because some regulations are effective in developed countries when ge is high but do not function in developing countries under weak levels of institutional quality. our mixed findings which resulted from testing hypothesis 4 show some similarity with those obtained by several authors (carden & verdon 2010; graeff & mehlkop 2003; kumar 2011). firstly, they multi-dimensionally analysed the relationship between corruption and fiscal freedom. secondly, they also found that the relationship between economic freedom and corruption varies according to the level of development of a country. more precisely, they stated that some types of regulations increase or decrease corruption, depending on whether countries are rich or poor (graeff & mehlkop 2003). in addition we have empirical evidence of the important role of quality institutions which need to prevail in order to achieve effective anti-corruption policies. conclusion the problem of corruption and its explanatory factors are widely debated in the literature. acknowledging the causes of corruption on the part of policy-makers could open up the proper channels for fighting against it. the present study investigates whether higher fiscal burden may create opportunities for bribing officials, thus enhancing the level of corruption. some control variables, such as richness and institutional quality were also used. a panel analysis on a large sample of 185 countries over the period 2005–2014 was used. a first and overall result was obtained after analysing the influence of fiscal burden on corruption and without considering other determinants. thus, we found a negative influence of fiscal burden on the level of corruption, which contradicts expectations. however, similar findings have also been obtained by other researchers, such as dreher and siemers (2005, 2009), dreher and schneider (2010) and mcgee (2008, 2012). the second result, also being our main contribution to previous work, consisted in finding differentiated results when the influence of fiscal burden on the level of corruption is controlled by income and institutional quality. in this respect, we found that, under high-quality institutions from developed countries, higher fiscal pressure leads to a higher level of corruption, which is in line with expectations. in the case of developing countries, the control of low-level institutional quality determines a strong and negative influence of fiscal pressure on the level of corruption. thus, in developing countries, the influence of low-level institutional quality enhances the negative role of fiscal pressure on corruption. here, low fiscal pressure increases corruption, because it is rather a matter of low governance efficiency under which people may easily circumvent the law. it can be concluded that the relationship between corruption and fiscal burden needs to be multi-dimensionally analysed, with income and the institution quality variable being a priority. the third result consists in finding a negative influence of people’s wealth and institutional quality on the level of corruption. this may explain why high-income countries with high institutional quality face low levels of corruption. these results are supported by a large strand of literature referring to the influence of wealth on the level of corruption (de rosa et al. 2010; gundlach & paldam 2009; husted 1999; paldam 2001, 2002; treisman 2000) or the influence of institutional quality on the level of corruption (forson et al. 2016; kirchler 2007; park & blenkinsopp 2011; torgler & schneider 2009). our findings suggest that certain fiscal policies may work in some countries, but not in others, and may explain the legal efficiency of various anti-corruption policies which occur, especially in low-income countries. thus, the present research may have important implications for governments and policy-makers in adopting the best decisions in the fight against corruption. they need to acknowledge the necessity to adopt differentiated tax policies, depending on the level of the country’s development under the various levels of institutional quality (bureaucracy, quality of public services, ability to collect taxes, produce and implement good policies and deliver public goods). low fiscal burden may reduce corruption in developed countries, and enhance it in developing countries under various levels of governance efficiency. thus, governments and policy-makers need to acknowledge that the anti-corruption fight requires not only the right fiscal policies, but also the best way of implementing these policies, recognising the role of quality institutions which should prevail in any country. the limitation of this research consists in not using some behavioural patterns of corruption, such as culture and religion. therefore, in order to reduce the limitations and substantiate the present findings, future work should be analysed multi-dimensionally, through the use of such behaviour variables. acknowledgements competing interests no potential conflict of interest was reported by the authors. authors’ contributions m.v.a. is responsible for the topic of research, performing the statistical methodology, compilation of the statistical and economical interpretation of the results, language and the general overview. s.n.b. is responsible for making the literature review, assessing the hypotheses and economical interpretation of results, and assessing the economic conclusions. a.m.a. is responsible for the compilation of the statistical and economical interpretation of the results and assessing the economic conclusions. references carden, a. & verdon, l., 2010, ‘when is corruption a substitute for economic freedom?’, the law and development review 3(1). https://doi.org/10.2202/1943-3867.1050 conseil de 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role of the world bank, world bank group, washington, dc. world bank, 2015, world bank report on ‘country and lending groups 2015’, viewed february 2016, from https://datahelpdesk.worldbank.org/knowledgebase/articles/906519-world-bank-country-and-lending-groups world bank, 2016a, indicators, viewed february 2016, from https://data.worldbank.org/indicator. world bank, 2016b, worldwide governance indicators, viewed september 2016, from http://info.worldbank.org/governance/wgi/#home abstract introduction brief overview of model risk from a validation perspective overview of the proposed model validation framework model validation framework discussion model validation scorecards conclusions and recommendations acknowledgements references appendix 1 appendix 2 footnotes about the author(s) pieter j. (riaan) de jongh centre for business mathematics and informatics, north-west university, south africa janette larney centre for business mathematics and informatics, north-west university, south africa eben mare department of mathematics and applied mathematics, university of pretoria, south africa gary w. van vuuren centre for business mathematics and informatics, north-west university, south africa tanja verster centre for business mathematics and informatics, north-west university, south africa citation de jongh, p.j., larney, j., mare, e., van vuuren, g.w. & verster, t., 2017, ‘a proposed best practice model validation framework for banks’, south african journal of economic and management sciences 20(1), a1490. https://doi.org/10.4102/sajems.v20i1.1490 original research a proposed best practice model validation framework for banks pieter j. (riaan) de jongh, janette larney, eben mare, gary w. van vuuren, tanja verster received: 21 oct. 2015; accepted: 27 mar. 2017; published: 23 june 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: with the increasing use of complex quantitative models in applications throughout the financial world, model risk has become a major concern. the credit crisis of 2008–2009 provoked added concern about the use of models in finance. measuring and managing model risk has subsequently come under scrutiny from regulators, supervisors, banks and other financial institutions. regulatory guidance indicates that meticulous monitoring of all phases of model development and implementation is required to mitigate this risk. considerable resources must be mobilised for this purpose. the exercise must embrace model development, assembly, implementation, validation and effective governance. setting: model validation practices are generally patchy, disparate and sometimes contradictory, and although the basel accord and some regulatory authorities have attempted to establish guiding principles, no definite set of global standards exists. aim: assessing the available literature for the best validation practices. methods: this comprehensive literature study provided a background to the complexities of effective model management and focussed on model validation as a component of model risk management. results: we propose a coherent ‘best practice’ framework for model validation. scorecard tools are also presented to evaluate if the proposed best practice model validation framework has been adequately assembled and implemented. conclusion: the proposed best practice model validation framework is designed to assist firms in the construction of an effective, robust and fully compliant model validation programme and comprises three principal elements: model validation governance, policy and process. introduction model validation is concerned with mitigating model risk and, as such, is a component of model risk management. since the objective of this article is to provide a framework for model validation, it is important to distinguish between model risk management and model validation. below, we define and discuss both these concepts. model risk management comprises robust, sensible model development, sound implementation, appropriate use, consistent model validation at an appropriate level of detail and dedicated governance. each of these broad components is accompanied and characterised by unique risks which, if carefully managed, can significantly reduce model risk. model risk management is also the process of mitigating the risks of inadequate design, insufficient controls and incorrect model usage. according to mcguire (2007), model risk is ‘defined from a sox (usa’s sarbanes-oxley act) section 404 perspective as the exposure arising from management and the board of directors reporting incorrect information derived from inaccurate model outputs’. the south african reserve bank (sarb 2015b) uses the definition of model risk as envisaged in paragraph 718(cix) of the revisions to the basel ii market risk framework: two forms of model risk: the model risk associated with using a possibly incorrect valuation methodology; and the risk associated with using unobservable (and possibly incorrect) calibration parameters in the valuation model. (n.p.) in its solvency assessment and management (sam) glossary, the financial services board (fsb) defines model risk as ‘the risk that a model is not giving correct output due to a misspecification or a misuse of the model’ (fsb 2010). in a broader business and regulatory context, model risk includes the exposure from making poor decisions based on inaccurate model analyses or forecasts and, in either context, can arise from any financial model in active use (mcguire 2007). north american chief risk officers (nacro) council (2012) identified model risk as ‘the risk that a model is not providing accurate output, being used inappropriately or that the implementation of an appropriate model is flawed’ and proposed eight key validation principles. the relevance of model risk in south africa is highlighted by the bank supervision department of the sarb in its 2015 annual report, where it is specifically noted that some local banks need to improve model risk management practices (sarb 2015a). model validation is a component of model risk management and requires confirmation from independent experts of the conceptual design of the model, as well as the resultant system, input data and associated business process validation. these involve a judgement of the proper design and integration of the underlying technology supporting the model, an appraisal of the accuracy and completeness of the data used by the model and verification that all components of the model produce relevant output (e.g. maré 2005). model validation is the set of processes and activities intended to verify that models are performing as expected, in line with their design objectives and business uses (occ 2011b). the basel committee for banking supervision’s (bcbs) minimum requirements (bcbs 2006) for the internal ratings-based approach require that institutions have a regular cycle of model validation ‘that includes monitoring of model performance and stability; review of model relationships; and testing of model outputs against outcomes’. in this article, we assess the available literature for validation practices and propose a coherent ‘best practice’ procedure for model validation. validation should not be thought of as a purely mathematical exercise performed by quantitative specialists. it encompasses any activity that assesses how effectively a model is operating. validation procedures focus not only on confirming the appropriateness of model theory and accuracy of program code, but also test the integrity of model inputs, outputs and reporting (fdic 2005). the remainder of this article is structured as follows: the next section provides a brief literature overview of model risk from a validation perspective. ‘overview of the proposed model validation framework’ section establishes an overview of the proposed framework for model validation and, in ‘model validation framework discussion’ section; this framework is discussed in more detail. guidelines for the development of scorecard tools for incorporation in the proposed best practice model validation framework are presented in ‘model validation scorecards’ section. some concluding remarks are made in ‘conclusions and recommendations’ section. examples illustrating the importance of proper model validation are given in appendix 1 and scorecards for the evaluation of the main components of the validation framework are provided in appendix 2. brief overview of model risk from a validation perspective banks and financial institutions place significant reliance on quantitative analysis and mathematical models to assist with financial decision-making (occ 2011a). quantitative models are employed for a variety of purposes including exposure calculations, instrument and position valuation, risk measurement and management, determining regulatory capital adequacy, the installation of compliance measures, the application of stress and scenario testing, credit management (calculating probability and severity of credit default events) and macroeconomic forecasting (panko & ordway 2005). markets in which banks operate have altered and expanded in recent years through copious innovation, financial product proliferation and a rapidly changing1 regulatory environment (deloitte 2010). in turn, banks and other financial institutions have adapted by producing data-driven, quantitative decision-making models to risk-manage complex products with increasing ambitious scope, such as enterprise-wide risk measurement (occ 2011b). bank models are similar to engineering or physics models in the sense that they are quantitative approaches which apply statistical and mathematical techniques and assumptions to convert input information – which frequently contains distributional information – into outputs. by design, models are simplified representations of the actual associations between observed characteristics. this intentional simplification is necessary because the real world is complex, but it also helps focus attention on specific, significant relational aspects to be interrogated by the model (elices 2012). the precision, accuracy, discriminatory power and repeatability of the model’s output determine the quality of the model, although different metrics of quality may be relevant under different circumstances. forecasting future values requires precision and accuracy, for example, rank ordering of risk may require greater discriminatory power (morini 2011). understanding the capabilities and limitations of models is of considerable importance and is often directly related to the simplifications and assumptions used in the model’s design (rma 2009). input data may be economic, financial or statistical depending on the problem to be solved and the nature of the model employed. inputs may also be partially or entirely qualitative or based on expert judgement [e.g. the model by black and litterman (1992) and scenario assessment in operational risk by de jongh et al. (2015)], but in all cases, model output is quantitative and subject to interpretation (occ 2011b). decisions based upon incorrect or misleading model outputs may result in potentially adverse consequences through financial losses, inferior business decisions and ultimately reputation damage: these developments stem from model risk, which arises because of two principal reasons (both of which may generate invalid outputs): fundamental modelling errors (such as incorrect or inaccurate underlying input assumptions and/or flawed model assembly and construction) and inappropriate model application (even sound models which generate accurate outputs may exhibit high model risk if they are misapplied, e.g. if they are used outside the environment for which they were designed). model risk managers, therefore, need to take account of the model paradigm as well as the correctness of the implementation of any algorithms and methodologies to solve the problem as well as the inputs used and results generated. nacro council (2012) asserted that model governance should be appropriate and the model’s design and build should be consistent with the model’s proposed purpose. the model validation process should have an ‘owner’, that is, someone uniquely responsible, and should operate autonomously (i.e. avoid conflicts of interest). the validation effort should also be commensurate with the model’s complexity and materiality. input, calculation and output model components should be validated and limitations of each should be addressed and the findings comprehensively documented (rajalingham 2005). as far as the model paradigm is concerned, the model needs to be evaluated in terms of its applicability to the problem being solved, and the associated set of assumptions of the model needs to be verified in terms of its validity in the particular context. example 1 in appendix 1 gives an illustration of the inappropriateness of the assumptions of the well-known black-scholes option pricing model in a south african context. clearly, all listed assumptions may be questioned, which will shed doubt on the blind application of the model in a pricing context. some models have been implemented using spreadsheets (whitelaw-jones 2015). spreadsheet use in institutions range from simple summation and discounting to complex pricing models and stochastic simulations. madahar, cleary and ball (2008) questioned whether every spreadsheet should be treated as a model, requiring the same rigorous testing and validating. spreadsheet macros require coding and may be used to perform highly complex calculations, but they may also be used to simply copy outputs from one location to another (galletta et al. 1993; pwc 2004). requiring that all macro-embedded spreadsheets be subject to the same validation standards can be onerous (pace 2008). example 2 in appendix 1 highlights some examples of formulas in excel that provide incorrect answers. in addition, the european spreadsheet interest group (eusig) maintains a database of such errors. eusig (2016) and gandel (2013) provide examples of high impact excel errors that occurred as a result of inadequate model validation. therefore, the validation of the code is of extreme importance, and should be validated using not only ordinary but also stressed inputs. model risk increases with model complexity, input assumption uncertainties, the breadth and depth of the model’s implementation and use. the higher the model risk, the higher the potential impact of malfunction. pace (2008) identified challenges associated with effective model risk management programmes. assigning the correct model definition to models is important, but challenging, because model types (e.g. stochastic, statistical, simulation and analytical) and model deployment methods (ranging from simple spreadsheets to complex, software-interlinked programmes) can sometimes straddle boundaries and defy easy categorisation (pwc 2004). several authors (e.g. burns 2006; epperson, kalra & behm 2012; haugh 2010; pace 2008) argue that model classification is an important component of model risk management. the model validation process is also considerably simplified if models are classified appropriately and correctly according to their underlying complexity, relevance and impact on businesses. haugh (2010) presents practical applications of model risk and emphasises the importance of understanding a models’ physical dynamics and properties. example 3 in appendix 1 illustrates a strong correlation between two variables that clearly does not share any causal relationship. incorrect inclusion of such variables in models can lead to nonsensical conclusions and recommendations. the dangers of calibrating pricing models with one type of security and then pricing other types of securities using the same model can be disastrous. model transparency is important and substantial risks were found to be associated with models used to determine hedge ratios. these conclusions, although specifically focussed on structured products (collateralised debt obligations) and on equity and credit derivative pricing models, could be equally applied to all models (haugh 2010; pwc 2004). example 4 in appendix 1 gives some risk-related loss examples. these examples clearly illustrate that even simple calculation errors and incorrect models and assumptions can result in devastating losses. actively managing model risk is important, but also costly, because not only does the validation of models requires expensive and scarce resources, but also the true cost of model risk management is much broader than this. the cost of robust model risk management processes includes having to maintain skilled and experienced model developers, model validators, model auditors and operational risk managers, as well as senior management time at governance meetings, opportunity costs (because of delays in time-to-market because of first having to complete the model risk management process before a new model supporting a new product can be deployed) and it development cost of the model deployment. although model risk cannot be entirely eliminated, proficient modelling by competent practitioners together with rigorous validation can reduce model risk considerably. careful monitoring of model performance under various conditions and limiting model use can further reduce risk, but frequent revision of assumptions and recalibration of input parameters using information from supplementary sources are also important activities (rma 2009). deloitte (2010) addressed internal model approval under solvency ii. model validation was identified as a key activity in model management to ensure models remain ‘relevant’, that is, they function as originally intended both at implementation and over time. ongoing monitoring to determine models’ sensitivity to parameter changes and assumption revisions helps to reduce model risk. deloitte’s (2010) proposed validation policy includes a review of models’ purpose and scope (including data, methodology, assumptions employed, expert judgement used, documentation and the use test), an examination of all tools used (including any mathematical techniques) and an assessment of the frequency of the validation process. independent governance of the validation results, robust documentation and a model change policy (in which all changes to the model are carefully documented and details of changes are communicated to all affected staff) all contribute to effective model management (pwc 2004; rajalingham 2005). overview of the proposed model validation framework despite the broad market requirement for a coherent model risk management strategy and associated model validation guidelines, the literature is not replete with examples. the basel accord and some regulatory authorities have attempted to establish this but, according to our knowledge, no definite set of global standards exists. however, although the literature places varying emphasis on different aspects of model governance, there are encouraging signs of cohesion and broad, common themes emerging. one of these common themes is the role of the three-lines of defence governance model, as developed by the institute of internal auditors in 2013 (iia 2013). in the context of model risk management, the first line of defence would be model development, the second line would be model validation and third line would be internal audit. a fourth line of defence is also suggested by the financial stability institute (fsi) as external audit and supervisors (fsi 2015). in addition, operational risk management has a second line duty in respect of model development and model validation. model validation embraces two generic views of the modelling landscape that should be considered to cover all possible validation elements (refer to figure 1), namely: the modelling life cycle, comprising three stages (development, implementation and operation) as well as the elements that form part of each stage and the modelling process elements namely input, output and process (rajalingham 2005). figure 1: model life cycle and process elements. as illustrated in figure 1, the model life cycle starts with the model development phase. this phase commences with the formulation of the problem and model, followed by the specification of the user requirements. this phase is usually followed by a prototyping phase, in which especially the more risky or uncertain modelling aspects are researched and tested. based on the results of this phase, the formulation phase may be re-assessed and various iterations may be possible before alignment with user requirements is achieved. once the modelling concept is clear, the development of the model can commence. in this phase, amongst others, the model outputs are defined and the inputs required clearly specified. the testing phase involves testing of functional components of the model. as soon as the model is completely assembled integration testing can start on the completed model. this could involve out of sample and backtesting in order to ensure that the model performs well for the purpose it was designed for. as soon as testing is completed, the model is reviewed internally and externally by independent experts and then accepted if it adequately meets all validation criteria (see ‘model validation framework discussion’ section for more details on the validation framework proposed as well as the validation criteria). after the model has been accepted, it should be implemented. depending on the complexity of the model and speed requirements it might entail the recoding of a model in computationally efficient programming language and using appropriate database query languages. this could entail a complete redesign and specification of the model in it terms, recoding, user acceptance testing (uat), review and acceptance. once the model is implemented and running the model is put into operation. in this phase, the model should be validated in terms of its performance against the original design specifications and tested on a regular basis. ownership of the model should be identified through the validation process, as should the appropriateness of the model governance. efforts to validate models should be proportional to model output materiality and complexity, and should involve validation of model components and relevant documentation as well as third-party validation where possible (elices 2012). a graphical representation of a proposed framework is presented in figure 2 below, by providing an alternative view of the model life cycle. figure 2: representation of the proposed framework. the framework presented in figure 2 consists of the following components. model governance this includes model governance (on the left of figure 2) and related management activities and will be discussed in more detail in the ‘model validation governance’ section and will be extended into a scorecard in the ‘model validation governance scorecard’ section. model validation policy note that seven main elements are covered in this (on the right of figure 2) namely, the scope, an independent review, the roles and responsibilities, relevant model documentation, proof of ongoing validation, details of performance standards and remediation plans and audit oversight. this will be discussed in more detail in the ‘model validation policy’ section and will be extended into a scorecard in ‘model validation policy scorecard’ section. the ‘validation process’ this consists of three distinct elements (in the middle of figure 2) namely: conceptual soundness and developmental evidence process verification and ongoing monitoring and outcomes analysis. this ‘validation process’, with its three elements, will be discussed in more detail in the ‘model validation process’ section and will be extended into a scorecard in ‘model validation process scorecard’ section. in ‘model validation framework’ section, each of the above-mentioned components are discussed in more detail. model validation framework discussion as stated at the end of the previous section, the model validation framework is discussed in more detail in the following subsections: model validation governance model validation policy model validation process. this subsection contains a discussion of conceptual soundness and developmental evidence, process verification and ongoing monitoring, and outcomes analysis. model validation governance as mentioned in ‘overview of the proposed model validation framework’ section, the fsi outlines that regulated financial institutions require a four lines of defence model (fsi 2015) to effectively manage the risk it is exposed to. model validation is seen as the second line of defence in the context of model risk management. under model validation governance, the adequacy of the governance structure should be evaluated. in the model validation policy, clear roles and responsibility should be assigned to role players and committees (occ 2011b). this includes identifying who amongst the stakeholders in the model risk management process should perform, for example, benchmarking, independent review and monitoring. model governance (which should involve the board of directors, senior management and line-of-business managers) requires that the organisation’s governance policies, procedures and processes support its controls and provide the requisite oversight to manage the model (glowacki 2012). in addition, there should be adequate oversight and participation by internal audit (occ 2011b; pace 2008). governance must be structured such that the validation unit functions independently in terms of remuneration (oversight) and reporting (controls) lines (occ 2011b). the validation governance structure should define the assignment of authority for approval and there should be adequate board and senior management involvement (cebs 2008). effective model governance can help reduce model risk by obtaining realistic assurance that the model produces results commensurate with its original design mandate. in addition, overseeing ongoing model improvement and recalibration and instigating a user-wide understanding of model limitations and potentially damaging assumptions – both functions of model governance – can help diminish model risk (burns 2006). scope, transparency, and completeness of model documentation are important and should be controlled by line-of-business management. documentation should be validated in terms of the ability of the independent reviewer to recreate the model as well as the results (fdic 2005; oenb/fma 2004). model documentation should provide a detailed description of models’ design and purpose, mathematical logic incorporated into models, descriptions of data requirements, operating procedure flow diagrams, change control and other security procedures as well as comprehensive validation documentation (burns 2006). ongoing monitoring should confirm that the model is appropriately implemented and is being used and is performed as intended. each model extension (beyond original scope) should be validated and placed under configuration control (occ 2011b; rma 2009). model validation policy seven main aspects are covered in the model validation policy namely, the scope, independent review, roles and responsibilities, relevant model documentation, proof of continuing validation, details of performance standards and remediation plans and audit oversight (rajalingham 2005). scope institutions should have a written, enterprise-wide policy for validating model risk (rma 2009). the rigor and sophistication of validation should be commensurate with the institution’s overall model use, the complexity and materiality of its models, and the size and complexity of the organisation’s operations (occ 2011b). independent review the validation process should be subject to independent review (occ 2011b; rma 2009) and should be organisationally separate from the activities it is assigned to monitor. the head of the validation function should be subordinated to a person who has no responsibility for managing the activities that are being monitored. remuneration of validation function staff should not be linked to the performance of the activities that the validation function is assigned to monitor (cebs 2008). roles and responsibilities the validation policy should be owned by the chief risk officer (rma 2009) and should identify roles and assign responsibilities based upon staff expertise, authority, reporting lines and continuity. according to occ (2011b) and green (2012), model validators should have appropriate incentives, competence and influence (e.g. authority to challenge developers and users or to restrict model use). model owners should ensure that models employed have undergone appropriate validation and approval processes and promptly identify new or altered models by providing all necessary information for validation activities (occ 2011b). model documentation documents detailing the model design are required which indicate that it was well informed, carefully considered, and consistent with published research and with sound industry practices (cebs 2008; occ 2011b). a comprehensive survey of model limitations and assumptions (occ 2011b) is needed as well as a record of all material changes made to the model or the modelling process. any overrides must be analysed and recorded (occ 2011b) and the validation plans and findings of the validation (fdic 2005) should be documented. ongoing validation validation activities should continue on an ongoing basis after a model enters usage, to track known model limitations and to identify new ones (occ 2011b). institutions should conduct periodic reviews, at least annually, but more frequently if warranted, of each model to determine whether it is working as intended and if the existing validation activities are sufficient (occ 2011b; rma 2009). performance standards and remediation plans backtesting, benchmarking and stress testing should be conducted and results assessed. model accuracy and precision should be evaluated and results should be compared with those provided by other models. model output sensitivity to inputs, model assumptions and stress testing should also be considered (green 2012; occ 2011b). if significant model risk is found remediation efforts should be prioritised. ongoing monitoring of areas of concern to ensure continued success is also required (mcguire 2007). audit oversight internal audit should verify that no models enter production2 without formal approval by the validation unit and should be responsible for ensuring that model validation units adhere to the formal validation policy (pace 2008). records of validation – to test whether validations are performed in a timely manner – should also exist and the objectivity, competence and organisational standing of the key validation participants should be evaluated (occ 2011b). model validation process as per figure 2, the model validation process comprises three distinct elements, namely conceptual soundness and developmental evidence, process verification and ongoing monitoring and lastly, outcome analysis. conceptual soundness and developmental evidence this first main element of the model validation process can be subdivided into nine sub-elements, which will be briefly discussed in table 1. table 1: conceptual soundness and developmental evidence. process verification and ongoing monitoring the second element of the model validation process can be split into two distinct stages, namely monitoring and test and evaluation as discussed in table 2. table 2: process verification and ongoing monitoring. outcome analysis the third and last element of the model validation process will be discussed under outputs and backtesting in table 3. table 3: outcome analysis. model validation scorecards model validation scorecards comprise three components (in line with the elements introduced in the previous section): the model validation governance scorecard, the model validation policy scorecard and the model validation process scorecard. these tools may be used to ascertain whether the proposed best practice model validation framework has been adequately assembled and implemented. all three scorecards use numerical scores ranking from 1 (no evidence) to 4 (fully evident). a four-grade scale, in line with that used by the regulatory consistency assessment programme (rcap) (bcbs 2016) was specifically chosen to avoid the midpoint. although most inputs in any kind of scorecard are subjective, there is a danger in using a 3-point or 5-point scale, as many respondents is likely to choose the midpoint or average. this might result in a failure to identify specific weaknesses.3 a typical use of these scores in a management information environment would result in a colour-coded dashboard, for example, associating a score of 1 with red, 2 with orange, 3 with yellow and 4 with green. this would be a powerful tool in highlighting validation areas in need of urgent attention (i.e. ‘red’). tracking individual scores, as well as the distribution of these scores, over time can give an indication of the model validation framework’s maturity within an institution. note that no weights were added to the scorecards, as the purpose is not to combine the elements together in an aggregate score. instead, the ultimate goal for each institution should be to achieve ‘compliance’ in each one of the suggested areas, that is, a score of 4 (fully evident) for each sub-element of each scorecard, similar to the grading methodology of the rcap programme. the three different scorecards can be applied at different levels. the policy scorecard could, for instance, be applied at the highest level for which an applicable validation policy exist, be that at enterprise, risk type or business unit level. the process scorecard, on the contrary, should be applied at model level. model validation governance scorecard this generic validation governance scorecard (table 1-a2) provides a tool that may be used to determine whether the firm’s validation governance is in place (according to the model validation framework discussed in ‘model validation governance’ section). the main elements of this scorecard are as follows: clear roles and responsibility assigned to role players and committees. adequate oversight and participation by internal audit. validation function independent in terms of remuneration. defined assignment of authority for approval. adequate board and senior management involvement. the rest of the validation governance elements are addressed in the validation policy scorecard (e.g. roles and responsibilities, independent review and audit oversight). model validation policy scorecard the generic validation policy scorecard may be used as a tool to check to what extent the firm’s validation policy is in place (according to the model validation framework discussed in ‘model validation policy’ section). this scorecard comprises seven elements, indicated in table 2-a2 and can be summarised as follows: scope: separate, enterprise-wide validation policy exists. validation policy provides guidelines for input validation, processing and reporting. vendor model validation included in policy scope. independent review: policy provides for models to be independently evaluated prior to implementation. independent review is performed by suitably skilled experts. roles and responsibilities: problems identified during the independent review are reported on. appropriate responsibility to act on such reports is assigned. necessary actions are scheduled and managed properly. model documentation: documentation is reviewed in terms of completeness, transparency and scope. a completely new model can independently be reproduced from documentation. ongoing validation: the existence of a monitoring plan for implementation is ascertained. a program for ongoing testing and evaluation of model performance has been designed. performance standards and remediation plans: documentation specifies tolerances/thresholds for implemented model performance. procedures for the management and control of remediation activities are in place. audit oversight: verification that no models enter production without validation unit approval. evaluation of objectivity/competence/organisational standing of key validation participants. verification that validation process is carried out according to policy in a timely manner. model validation process scorecard the generic validation process scorecard may be used as a tool to check if the validation process has been correctly established (according to the model validation framework discussed in ‘model validation policy’ section). validation process comprises conceptual soundness and developmental evidence, process verification and ongoing monitoring, and outcome analysis. the validation process scorecard comprises seven elements as indicated in table 3-a2. note that this is a generic scorecard and will change per product, per institution and also whether the model is in the development, implementation or monitoring phase. the main elements of this scorecard are: paradigm: was conceptual soundness of paradigm checked? was check/review performed by suitably skilled experts? methods/theory: is underlying model theory consistent with published research and accepted industry practice? were research publications considered of appropriate quality/standing? was methodology benchmarked against appropriate industry practice? are approximations made within agreed tolerance levels? design: was it ascertained that assumptions are clearly formulated? was the appropriateness and completeness of assumptions checked? was it checked that all variables employed have been clearly defined and listed? have the causal relationships between variables been documented? have input data been determined and assessed in terms of reasonableness, validity and understanding? has it been ascertained that outputs are clearly defined? has the design been evaluated in terms of model parsimony? has model builder benchmarked design against existing best practice models? was design independently benchmarked against existing best practice models? are special cases dealt with appropriately? (e.g. terminal conditions or products with path-dependent pay-off) data/variables: have input data been checked to gauge reliability/suitability/validity/completeness? have data that involve subjective assessment of expert opinion been appropriately incorporated? was the procedure for the collation of expert opinion scrutinised? has expert opinion been validated in terms of logical considerations? has expert selection process been assessed as sound? were data verified that they are representative of relevant (general and stressed) market conditions? was it verified that data are representative of the company’s portfolio? have inadequate or missing data been re-assessed and reviewed for model feasibility? algorithms/code: was the algorithms/code checked against the model formulation and underlying theory? were key assumptions and variables analysed with respect to their impact on model outputs? was an independent construction of an identical model undertaken? was the code rigorously tested against a benchmark model? was technical proofreading of the code performed? outputs: was model output benchmarked against best practice models (e.g. against a vendor model using the same input data set)? was the reasonableness and validity of model outputs assessed? has a comparison of model outputs against actual realisations been performed? (backtesting) has a range of outputs been examined versus a range of inputs – are solutions continuous or jagged? what is the behaviour of hedging quantities and/or derived quantities over the same range? are all results repeatable? (e.g. monte carlo simulations) monitoring: has the model been monitored for appropriate implementation and use? has the model been monitored to check whether it is performing as intended? conclusions and recommendations institutions should classify, design, implement, validate and govern their models robustly on an ongoing basis if they want to effectively minimise model risk. institutions that fail to implement a regular, consistent model risk management framework risk penalties from regulatory authorities and reputation risk in the contemporary era of strict model risk management standards. this research provided a comprehensive literature study, which provided a background to the complexities of effective model management and focussed on model validation as a component of model risk management. a best practice model validation framework for institutions has been proposed. the proposed best practice model validation framework is designed to assist firms in the construction of an effective, robust and fully compliant model validation programme and comprises three principal elements: model validation governance, policy and process. a set of scorecards – detailing the principles of model validation governance, model validation policies and model validation processes – was proposed. these scorecards may be used as tools to determine whether the proposed best practice model validation framework has been established and is effective. this includes the provision of detailed supporting documentation to substantiate assertions that models are aligned to business and regulatory requirements to supervisory authorities. acknowledgements the authors gratefully acknowledge the valuable input given by johan kapp, neels erasmus and anonymous referees. this work is based on research supported in part by the department of science and technology (dst) of south africa. the grant holder acknowledges that opinions, findings and conclusions or recommendations expressed in any publication generated by dst-supported research are those of the author(s) and that the dst accepts no liability whatsoever in this regard. competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions the article originated from a project that was carried out for a bank. all the authors, except e.m. and g.v.v. were part of the project team. the authors that were not part of the project team made valuable contributions on a draft version of the article. references anonymous, 2011, ‘king’s fund apologise for “error” in figures on health spending in wales’, viewed 16 august 2016, from http://leftfootforward.org/2011/05/kings-fund-apologise-for-error-on-health-spending-in-wales/ bbc news, 2013a, ‘reinhart, rogoff… and herndon: the student who caught out the profs’, 20 april, viewed 16 august 2016, from http://www.bbc.com/news/magazine-22223190 bbc news, 2013b, 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http://newsfeed.time.com/2012/05/11/top-10-biggest-trading-losses-in-history/slide/morgan-stanley-9b/ u.s. securities and exchange commission (sec), 2011, sec charges axa rosenberg entities for concealing error in quantitative investment model, 03 february, viewed 16 august 2016, from https://www.sec.gov/news/press/2011/2011-37.htm wailgym, 2007, eight of the worst spreadsheet blunders, cio, viewed 27 august 2015, from http://www.cio.com/article/2438188/enterprise-software/eight-of-the-worst-spreadsheet-blunders.html west, g., 2004, ‘calibration of the sabr model in illiquid markets’, insight document on riskworx website, viewed 27 august 2015, from http://www.riskworx.com/insights/sabr/sabrilliquid.pdf whitelaw-jones, k., 2015, capitalism’s dirty secret: a f1f9 research report into the uses & abuses of spreadsheets, viewed 22 august 2016, from http://www.f1f9.com/blog/tag/capitalisms-dirty-secret yalta, a.t., 2008, ‘the accuracy of statistical distributions in microsoft excel 2007’, computing statistics data analysis 52(2), 4579–4586. https://doi.org/10.1016/j.csda.2008.03.005 appendix 1 model risk examples example 1: real world calibration assumptions suppose a contingent claim on a south african equity within the black-scholes paradigm was required – table 1-a1 highlights the classical theoretical model assumptions used and details the practical reality ‘calibrated’ to the south african market environment. model validators typically need to assess the gap between theory and practise and understand the model misspecification. typically, a certain amount of capital could be set aside to cover the gap. the misspecification could also mean that a product is entirely unsuitable for a specific institution or lead to strict limits imposed on its use. significant losses can be incurred as a result of using the incorrect paradigm (see cont 2006). table 1-a1: black-scholes paradigm and south african calibration. example 2: spreadsheet-based implementation examples ‘let’s not kid ourselves: the most widely used piece of software in statistics is excel’ (ripley 2002). spreadsheet applications abound in the modern financial services industry. users generally understand the need for careful practices when using spreadsheets to ensure a control environment and avoid basic mistakes or logical errors. users might not always suspect that the functionality offered by a spreadsheet program has not been thoroughly tested. we highlight some examples from the literature. consider the simple problem of calculating the standard deviation of three numbers, say [m, m, + 1, m + 2]. the correct answer is trivially equal to m + 108; higham (2013), however, showed that google sheets produces a 0 answer for m = 108. sawitzki (1994) reports a similar problem for excel 4.0. mccullough and wilson (1999) assessed the reliability in excel 97 for linear and nonlinear estimation, random number generation and statistical distributions (e.g. calculating p-values) as inadequate. mccullough and heiser (2008) found that excel 2007 fails a set of intermediate-level accuracy tests in the same areas. yalta (2008) details numerical examples for excel 2007 where no accurate digits are obtained for the binomial, poisson, inverse standard normal, inverse beta, inverse student’s t and inverse f distributions. mccullough and yalta (2013) assess google sheets, microsoft excel web app and zoho sheet and show that the developers had not performed basic quality controls with the result that statistical computations are misleading and erroneous. more examples on the uses and abuses of spreadsheets can be found in a f1f9 research report (whitelaw-jones 2015). it is clear from the above that one should view spreadsheet-based analyses with some caution – in particular when the spreadsheet is used as an independent control for validation purposes. example 3: illustration of the necessity of confirming business sense figure 1-a1 demonstrates the need to explore the true causal relationship between variables. the wood index is plotted against the naspers index. the variables in the example exhibit significant positive correlation (+0.92), however, their economic relationship is entirely spurious. the wrong conclusion might be that naspers are highly correlated to the wood index because of the relationship of naspers to print media (i.e. paper), and paper again comes from wood. however, the real constitutes of naspers has very little to do with the wood index. naspers is a global platform operator with principal operations in: internet services, especially e-commerce (i.e. classifieds, online retail, marketplaces, online comparison shopping, payments and online services) pay television (direct-to-home satellite services, digital terrestrial television services and online services) print media. example 4: model error examples and associated loss impacts a few different model risk related loss examples will be explained next and summarised in table 2-a1 below. a computing error at the fidelity’s magellan fund resulted in a net capital loss of $1.3 billion (godfrey 1995). in march of 1997, natwest markets, an investment banking subsidiary of national westminster bank, announced a loss of £90 million because of mispriced sterling interest rate options (simons 1997). real africa durolink, a smaller bank in south africa, but major player in the equity derivatives market, failed within days of the introduction of the skew, as they were completely unprepared for the dramatic impact the new methodology would have on their margin requirements (west 2004). the number three on a list of the eight worst spreadsheet blunders are listed as the financial institution, fannie mae that discovers a $1.3 billion ‘honest’ mistake (wailgym 2007). time magazine listed morgan stanley’s $9 billion loss as the number one loss in a survey of ‘top 10 biggest trading losses in history’ (springer 2012). table 2-a1: model error examples and loss impacts. health think tank ‘the king’s fund’ has been forced to write to the welsh government to apologise for errors in figures it produced on health spending in wales (anonymous 2011). an error made on a spreadsheet, downgraded profits by £8.6 million (daily express reporter 2011). united states securities and exchange commission (sec) charged axa rosenberg entities ($242 million fine) for concealing error in their quantitative investment model (sec 2011). west coast main line franchise fiasco ‘to cost at least £50 m’ because of model incorrectly used (bbc 2013b), heineman (2013) described the jp morgan ‘whale’ report that discusses the $6 billion losses (of which the spreadsheet error was at least £250 million). a phd student found a spreadsheet error in two harvard professors’ paper that asserted that high public debt stifles economic growth, which then drove government policy decisions (bbc 2013a). almost one in five large businesses have suffered financial losses as a result of errors in spreadsheets, according to f1f9, which provides financial modelling and business forecasting to blue chips firms. it warns of looming financial disasters as 71 pc of large british business always use spreadsheets for key financial decisions (whitelaw-jones 2015). some of these examples are also summarised in ifoa (2015). appendix 2 model validation scorecards the detailed scorecards that are described in ‘model validation governance’, ‘model validation policy’ and ‘model validation process’ sections are presented tables 1-a2; 2-a2 and 3-a2. table 1-a2: model validation governance scorecard. table 2-a2: model validation policy scorecard. table 3-a2: model validation process scorecard. footnotes 1. although the credit crisis of 2008-9 (deloitte 2010) contributed to the current regulatory changes, other drivers of change include the bcbs articulation of improved comparability, simplicity and risk sensitivity of risk measures (see e.g. bcbs 2013), the introduction of the twin peaks regulatory framework (sarb 2015a) and the effects of shadow banking (fsb 2014; sarb 2015a). 2. to clarify this point further, the reader should note that internal audit is typically not in a position to police the day-to-day moving of models into production since they only do periodic audits of business areas. internal audit should therefore pick up that models entered production without following due process, however only sometime after the event. all the lines-of-defence (refer to the four-line of defence in ‘overview of the proposed model validation framework’ section) including operational risk managers need to play a role to ensure that models follow the correct process before entering production. 3. backtesting is not always possible, for example with capital models where the unexpected loss is modelled. here the modelled result typically represents a 1-in-1000 year annual loss and therefore backtesting is not practical due to needing several thousand years of data perform a credible backtest. in these cases benchmarking replaces backtesting (see table 1 for more information on benchmarking). abstract introduction macroeconomic theory on unemployment an empirical model linking formal and informal sector employment to unemployment conclusion acknowledgements references appendix 1 footnotes about the author(s) philippe burger department of economics, university of the free state, south africa frederick fourie department of economics, university of the free state, south africa citation burger, p. & fourie, f., 2019, ‘the unemployed and the formal and informal sectors in south africa: a macroeconomic analysis’, south african journal of economic and management sciences 22(1), a2104. https://doi.org/10.4102/sajems.v22i1.2104 original research the unemployed and the formal and informal sectors in south africa: a macroeconomic analysis philippe burger, frederick fourie received: 17 sept. 2017; accepted: 11 oct. 2018; published: 25 feb. 2019 copyright: © 2019. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: at 27.2% in the second quarter of 2018 the official unemployment rate in south africa ranks as one of the highest in the world. however, depending on whether one uses the official or broad definition of unemployed, since 2008 there are on average between 2 and 3.3 times as many unemployed people as there are people in the informal sector. aim: this article seeks to explore empirically, using time-series data, the extent to which an increase in the number of unemployed leads to increased entry of workers into the informal sector. method: we use a markov-switching vector error correction model. results: we find that such entrance is very limited, lending credence to the notion that significant entry barriers exist into the informal sector. conclusion: from a policy point of view these results suggest the need to consider measures that will ease entrance into the informal sector. introduction at 27.2% in the second quarter of 2018 the official unemployment rate in south africa ranks as one of the highest in the world. and this rate does not even include those who gave up looking for work, the so-called discouraged work-seekers. including them yields an unemployment rate of 37.2%. skills and education levels play a key role in explaining why the unemployed fail to find jobs. for instance, according to the cde (2013) and van der berg and van broekhuizen (2012), while the unemployment rate for people with a post-school degree qualification is roughly 5%, it is just shy of 50% for people who did not complete school. however, given that the formal sector typically is more skills intensive, one would expect that those who fail to find a job in the formal sector, would turn to the informal sector. the informal sector might not be a sector of preference, paying much lower remuneration, but presumably it requires significantly lower skills than the formal sector. nevertheless, at about 17% of total employment, the south african informal sector remains quite small compared to the informal sector in peer-group countries. depending on whether one uses the official or broad definitions of unemployed, since 2008 there are on average between 2 and 3.3 times as many unemployed people as there are people in the informal sector (kingdon & knight 2004; statssa 2017). using the official unemployment rate, there are twice as many people unemployed as are working in the informal sector in south africa. for the broad definition of unemployment, which includes discouraged work-seekers, this factor rises to 3.3 (statssa 2017). discouraged work-seekers alone exceed the number of people working in the informal sector. this raises the question: why do the unemployed not enter the informal sector to create a livelihood? according to kingdon and knight (2004), people wishing to enter the informal sector might run up against barriers to entry such as skills and capital shortages. in work focusing on the informal sector in madagascar and west africa, grimm, van der hoeven and lay (2011b) and grimm, krüger and lay (2011a) found significant entry barriers into the informal sector, with access to capital and finance being an important barrier. extensive recent quantitative and qualitative research on the informal sector in south africa (in a volume edited by fourie 2018) indicates a variety of obstacles and barriers that potential entrants face. entrant informal enterprises find it difficult to survive for a meaningful period. whereas most of the work on the informal sector and its role with regard to employment or unemployment has been done by labour economists or development economists (using survey data), almost no macroeconomic work has been done in this regard (see fourie 2011). typically, there is an assumption that the informal sector acts as a mop-up sector that absorbs surplus workers from the formal sector, for example during a downturn in the economy (national planning commission 2012:374; verick 2012:379). recent empirical analyses (burger & fourie 2018; rogan & skinner 2018) have indicated no consistent mop-up role for the informal sector in business cycles. moreover, the theoretical underpinnings for this presumed behaviour has been largely absent. addressing this knowledge gap, burger and fourie (2015) developed a theoretical macroeconomic model that includes both the formal and the informal sectors, together with barriers to entry into the informal sector, to explain the very high unemployment rate in the country. this article seeks to explore empirically, using time-series data, the extent to which an increase in the unemployed leads to increased entry of workers into the informal sector. we find that such entrance is very limited, lending credence to the notion that significant entry barriers exist into the informal sector. first, we consider a basic new-keynesian three-segment model to provide the necessary theoretical foundation for the empirical analysis of flows between a state of unemployment and employment in the two sectors, followed by the empirical analysis. macroeconomic theory on unemployment relevant literature on segmented models standard macroeconomic theory ascribes longer-run unemployment mostly to product and labour market imperfections. efficiency wages, labour unions and hysteresis all feature as explanations (see typical textbook explanations in cahuc and zylberberg 2004, as well as carlin and soskice 2006). however, while these mostly new-keynesian theories might explain why people do not get employed in sectors where efficiency wages and labour union behaviour apply, they still do not explain the presence of sustained, longer-run unemployment. these theories fail to explain the presence of unemployment, because, one would presume, people who fail to find employment in sectors where efficiency wages and labour union behaviour apply, can find a solution in self-employment. so the question remains: what explains their unemployment status? augmenting these standard new-keynesian theories, bulow and summers (1986) and layard, nickell and jackman (1991:41–44; also 2005) developed theoretical frameworks with primary and secondary sectors. in these models, the primary sector is characterised by typical new-keynesian features such as efficiency wages and labour union behaviour. due to these features, in equilibrium there are people who are willing to work at the prevailing market wage but who are nevertheless unable to find employment in the primary sector. as such, they are involuntarily unemployed in the primary sector. however, they then succeed in finding (self-) employment in the secondary sector, which (by assumption) is not characterised by such new-keynesian features. thus, although these workers are involuntarily unemployed in the primary sector, they do find work, albeit in the secondary sector. as a corollary, in these models people who are still unemployed once they have considered the options in both the primary and secondary sectors, would be voluntarily unemployed – they are unwilling to work at the prevailing wage in either sector, and the secondary sector in particular. these workers might be involuntarily unemployed in the primary sector, but there is no such thing as involuntary unemployment for the economy in the aggregate (i.e. including the secondary sector). these models go a long way to consider the presence of both formal and informal sectors, with the formal sector characterised by new-keynesian features and the informal sector not.1 yet they still fail to explain why many of those who cannot get employed in the primary sector also fail to self-employ (or find wage employment) in the secondary sector. they are unable to find employment in either the primary (formal) or secondary (informal) sectors, irrespective of the prevailing wage. they are not only involuntarily unemployed in the primary sector, but also in the economy in the aggregate. it is in this context that the noted work on entry barriers is relevant, as it indicates how factors such as skills and capital shortages, inter alia, may play a role as entry barriers, even in the informal sector. a model with entry barriers based on these suggestions, burger and fourie (2015) developed a theoretical macroeconomic model that (a) uses the two-sector distinction of bulow and summers (1986) and layard et al. (1991, 2005) between a primary (formal) and secondary (informal) sector, but (b) extends it by also including entry barriers into the secondary sector to explain the existence of aggregate involuntary unemployment (which can be seen as a third segment in the economy). here we use a similar model, slightly adapted to allow adjustments to occur sequentially (i.e. over time rather than simultaneously).2 equilibrium in the basic model without entry barriers figure 1 presents a graphical exposition of this extended, three-segment model, which shows both the primary and secondary sectors in one diagram, in the left-hand and right-hand segments of the diagram. the employed are to be found in both sectors (segments), but some people are left unemployed in the middle, either voluntarily or involuntarily. economic changes and shocks affect the distribution of people across these three segments. figure 1: unemployment in the three-segment model with involuntary unemployment. the entire x-axis represents the full working-age population (nn), while component e indicates those who are not active in the labour market (e.g. full-time students, stay-at-home parents, the early retired). the remainder in the diagram are all in the labour market. the left-hand side of the diagram represents the primary (or formal) sector, where the wage level (wp1) and the level of employment (distance 0p-ep1) are set by firms through the interaction of the wage-setting (wsp1) and price-setting (psp1) relationships. the positions of the wage-setting and price-setting relationships are a function of new-keynesian market features such as efficiency wages and labour union behaviour.3 as is typical in new-keynesian models, the product markets are oligopolistic markets, meaning that the firms are price setters and not price takers. thus, prices are set as a mark-up over costs (which constitutes the price-setting function). the wage-setting relationship might entail that wages are set either by the company (as in efficiency wage models) or by labour unions. the secondary (informal) sector, shown on the right-hand side of the diagram, is not characterised by new-keynesian features. hence, wages are set through the labour supply (ls) and demand (ld). in the secondary sector one finds labour supply, , and demand, setting the wage at ws and the number of employed people at 0s-es1. note that the informal sector labour demand schedule is horizontal, thus assuming that labour has a constant marginal product. this is not an altogether unrealistic assumption. for instance, according to berry (2001:7) large and medium enterprises (in our case, operating in the primary sector) more often than not have an amount of capital that complements a number of employees. as more workers are added, it might lead to a decreasing marginal product of labour. in the informal sector, though, firms are small and their required capital (e.g. simple tools) is operated and replicable on a small scale. thus, such capital does not necessarily allow another worker to be added without additional capital – for additional workers the enterprise needs to duplicate its capital. therefore, every worker is the first worker and there is no second worker who decreases the marginal product of labour. the same might be true for firms employing two or three workers since there is not much scope to decrease the marginal product of labour if the capital is operated and replicable on a small scale. the flat marginal product of labour (and hence the flat labour demand curve) for informal sector workers has been well verified empirically, according to berry (2001:7). of course, financial constraints might limit the ability of potential entrants into the informal sector from acquiring even the minimal capital goods required. this would limit the size of the effective labour supply. the discussion below will elaborate on this constraint. looking at the whole model, in equilibrium the distance a between ep1 and es1 represents the number of unemployed workers; they are voluntarily unemployed because they are not willing to work at the market wage set in either sector of the economy. the rest of the labour force is employed in the formal and informal sectors. our next step is to consider how a shock impacts this employment and unemployment equilibrium (still in the absence of informal-sector entry barriers). shocks in the basic model without informal sector entry barriers suppose a shock to profitability occurs that reduces the effective mark-up; in figure 1, this shifts the ps schedule from psp1 to psp2. this shock might be the result of a recession, or a shift in underlying product market conditions affecting the demand for the goods produced or the cost of other inputs. as a result, the primary sector wage adjusts to wp2 and employment in the primary sector drops to ep2. workers equal to distance b = ep1-ep2 lose their jobs. these workers now enter the informal sector, hence shifting its labour supply curve leftwards by the equivalent amount b (= ep1-ep2), that is from to . in the absence of barriers to entry into the secondary (informal) sector, employment in the informal sector will increase from es1 to es2. in shifting their supply of labour from the primary to the secondary sector, these former formal sector workers have to reveal their reservation wage (given the new-keynesian characteristics of the primary sector, they were paid more than their reservation wage when they were employed in the primary – formal – sector). the difference between the formal sector wage that they received before becoming unemployed and the wage they are willing to work for in the informal sector is the difference between wp1 and ws1. barring entry barriers all those entering the informal sector will get employed. thus, the number of unemployed people will not be higher than before the shock – the distance between ep1 and es1 (= a) is the same as between ep2 and es2 (= b+c). in terms of employment, the shock was absorbed 100% by the informal sector – total employment remained the same, but its allocation between the formal and informal sectors has changed. (this depicts, in a pure form, the conventional assumption about the shock-absorber or mop-up role of the informal sector.) how informal sector entry barrier changes the outcomes the presence of barriers to entry into the informal sector significantly changes this model outcome. given such barriers, not all the people who lose their jobs in the primary sector will be able to get employment in the secondary sector – there will only be partial absorption or mop-up. thus, instead of the labour supply in the informal sector moving from to , it might (due to entry barriers) only move from to , as former formal sector workers are unable to enter the informal sector. workers equal to d (= to ) might fail to enter the informal sector. the unemployed workers indicated by d are involuntarily unemployed, while those in b+c, are voluntarily unemployed. the latter are willing to work for wage ws1, while the former are not. so how might these barriers to entry work? grimm et al. (2011a) developed a small-scale model that explains the impact of entry barriers. in their model the potential entrant into the informal sector faces two possible constraints. the first is a borrowing constraint, while the second is the threshold amount of capital needed to generate a positive return. by capital is meant primarily physical capital, but also the cost of acquiring the human capital (skills) needed to operate a small firm. below the threshold, the return on capital is zero or so low that it does not justify the effort of investing (this might be the result of economies of scale not kicking in below the threshold). thus, to be viable requires an investment large enough that it exceeds the threshold of minimum capital needed to generate a positive return. the question that the potential entrant into the informal sector now faces is whether or not her borrowing constraint is lower or higher than the minimum threshold of capital needed. if it is lower, the potential entrant cannot borrow enough to finance capital on a large enough scale to reach the minimum threshold required to generate a positive return. in that case the potential entrant will not be able to enter the secondary sector and will remain unemployed. an alternative explanation for higher unemployment after the shock would be that the reservation wage of some of the workers who became unemployed is higher than the prevailing wage in the secondary sector. figure 2 presents this possibility, which entails that only some of the workers who lose their jobs in the primary (formal) sector, supply their labour in the secondary (informal) sector. at wage ws1 labour supply does not move leftward by distance b, but only by distance f, moving from to (only at higher informal sector wage ws2 would secondary – informal – sector labour supply increase by amount b). this yields a level of employment, es3, similar to level es3 in figure 1 with barriers, but in figure 2 employment level es3 is the result of workers unwilling to work for the prevailing wage in the secondary (informal) sector, rather than entry barriers. figure 2: unemployment in the three-segment model with only voluntary unemployment. note that in figure 2 distance d does not represent the involuntarily unemployed, but merely those added to the voluntarily unemployed – the involuntarily unemployed would be (b+c+d). thus, figure 1 explains involuntary unemployment, while in figure 2 all unemployment is voluntary and thus, presumably, less problematic. thus, should the unemployment rate increase after a shock, the question would be: did the workers not enter the informal sector because their reservation wages remained higher than the prevailing wage in the informal sector (in which case the newly unemployed are voluntarily unemployed), or because they faced barriers to entry? lloyd and leibbrandt (2014) provide some insight into this. using household survey data, they compared the levels of dissatisfaction reported by the not-economically active, the job searching, as well as the discouraged unemployed, and the employed. they found that the levels of happiness among both the job searching and the discouraged unemployed are much lower than among the employed and the not-economically active. this result suggests that large numbers of the unemployed are not voluntarily unemployed. accordingly, one can conclude that a shock-induced increase in the number of unemployed workers does not typically lead to workers happily withdrawing their labour supply because they consider the market wage too low compared to their reservation wage. an empirical model linking formal and informal sector employment to unemployment in the previous section it is argued that if unemployment increases in the face of an economic shock, barriers to entry into the informal sector would cause the informal sector to fail as a full shock absorber that employs all the unemployed. an increase in the unemployed will therefore, at best, only result in a partial absorption into the informal sector. this section seeks to establish empirically whether an increase in unemployment is followed by an equal or a smaller number of people flowing into the informal sector in south africa. if only a fraction enter the informal sector, it could be taken as an indication of the presence of entry barriers into the informal sector. specifying the model to model the relationship between formal and informal sector employment, as well as unemployment, this section uses a markov-switching vector error correction (ms-vec) model. the time-series data used covers the full period for which quarterly employment data is available – 2008q1 to 2017q1; these data originate from statistics south africa’s quarterly labour force survey (2017) – see figures 3–5. figure 3: formal employment (’000). figure 4: informal employment (’000). figure 5: the official unemployment rate. except for the period of the global financial crisis and the accompanying recession, the formal and informal sector employment series both display an upward trend over time. generally, as the population and labour force grows, more people will be employed. thus, the formal and informal sector employment series are not expected to be stationary time series. however, the unemployment rate, being a rate of change, is a series one would expect to be stationary over time. the evident non-stationarity of formal and informal sector employment requires the use of a vec model to ensure that long-run information about the relationship between these two variables is not lost. thus, the formal and informal sector employment series will enter the long-run component of the model, while the unemployment rate will enter the short-run component of the model. in other words, the long-run component captures the long-run relationship between the levels of formal and informal sector employment, while the unemployment rate influences the short-run changes in formal and informal sector employment. the long-run relationship is normalised on the informal sector employment variable. we therefore postulate that informal sector employment will adjust to shocks in the relationship between the formal and informal sector employment. (the extent of this adjustment is discussed below.) furthermore, as the labour force grows and more people are employed over time, one would expect this to reflect in increases in both formal and informal sector employment. thus, in the long run one would expect a positive relationship between the two. (if employment in the formal and informal sectors expands at the same rate, that would constitute a one-to-one relationship between formal and informal sector employment.) usually, assuming responsive wages, if the unemployment rate increases, one would expect it to put downward pressure on the real wage rate, which in turn is expected to lead to higher employment. thus, in terms of the model below, a higher unemployment rate might be expected to lead to more people entering formal and informal sector employment in later periods. therefore, we expect a positive relationship between the unemployment rate in period t-1 and the change in both formal and informal sector employment in period t. furthermore, although the formal sector is a sector of preference, workers who are unable to find employment in the formal sector would want to enter the informal sector. however, in terms of the theoretical model above, the presence of entry barriers would prevent them from doing so. moreover, the presence of entry barriers in the informal sector means that the sum of workers subsequently entering the formal and informal sectors would fall short of the initial increase in unemployment (number of unemployed workers). thus, although we still expect a positive relationship between the unemployment rate in period t-1 and the change in both formal and informal sector employment in period t, the presence of entry barriers in the informal sector implies that the size of its parameter will be too small to ensure that all those becoming unemployed in period t-1 are employed in the informal sector in period t. this is the hypothesis that we will test empirically. because the behaviour of economic agents may not remain constant over time, economists use a number of techniques to model such changing behaviour. the markov-switching technique, developed by hamilton (1989, 1996, 2008), is frequently used to distinguish behaviour during economic upswings from behaviour during economic downswings (which is how hamilton used it).4 the regimes used in the model below are driven by the cyclical behaviour of formal sector employment (more on this below, when reporting the results of figure 6). figure 6: markov-switching vector error correction model for employment growth. similar to the engle-granger co-integration method, the model below is estimated in two steps. using a simple ordinary least squares (ols) regression, the first step entails estimating the long-run component, as in equation 1. the second step plugs the lag in the long-run residual (εlr,t) into the short-run component of the model (equation 2) to serve as error correction term. unlike the engle-granger method, here the short-run model estimated is not a single equation, but a ms vector autocorrelation regression (var) model containing the residual of the long-run component as error correction term. estimating the var instead of a single equation deals with the possibility of endogeneity between the variables. in addition, the short-run component also includes lags in the unemployment rate. in this regard four possibilities were explored: (1) a model with only a one-period lag of the unemployment rate, (2) a model with a oneand a two-period lag in unemployment, (3) a model with a oneand a three-period lag in unemployment, and (4) a model with a oneand a four-period lag in unemployment.5 the earlier (i.e. second, third, and fourth period) lags were included to allow for the possibility that the impact of a change in the unemployment rate might take some time to register in formal and informal sector employment levels. as it turns out, none of the earlier lags was statistically significant, which means that the model presented below only contains a one-period lag in the unemployment rate. lastly, to allow for the possibility that behaviour might change over upand downswings of the business cycle, the short-run component is estimated as a markov-switching model, allowing the constants to take different values depending on whether the model is in regime 0 or 1. (the short-run component of the model also was estimated with three seasonal dummies to cater for possible seasonal effects.) thus, the long-run component of the ms-vec model: while the short-run component is: where: ie: informal sector employment fe: formal sector employment unempl: the unemployment rate β1 and β2: the long-run parameters relating the log-levels of informal and formal employment α11 and α21 the error correction parameters, with -1<α11<0 and α21≥0 st: denoting whether the constant is in regime 0 or regime 1. the data for 2008q1 to 2017q1 yield 37 observations. ideally one would prefer a longer sample, but juselius and toro (2005) have shown that even a sample of 31 observations can yield useable results. the formal and informal sector employment series enter the model in log-levels, while the unemployment rate enters it as a rate. the unemployment rate series used is the official unemployment rate and not the broad unemployment rate. (using the broad unemployment rate series did not yield significant results. the reason for this is probably that discouraged work-seekers are, by definition, not searching for work and therefore do not affect the labour supply in either the formal or informal sector as much as the searching unemployed.) results the formal and informal sector unemployment series are non-stationary series, while unemployment, after some further investigation, turns out as stationary.6 figure 6 presents the results. the uppermost panel of figure 6 presents the long-run results. it shows that there is an almost one-for-one relationship between formal and informal sector employment, with the parameter equal to 1.086. indeed, given that the standard error in the formal sector employment variable equals 0.136, the parameter value is not statistically significantly different from 1. thus, over the longer term a 1% increase in formal sector employment is associated with roughly a 1% increase in informal sector employment, meaning that formal and informal sector employment grow in tandem over the longer run. the residual series of the long-run component is also stationary, as can be seen from the kpss result reported in appendix 1 (which also shows the residual series graph). it subsequently enters the short-run component of the model as error correction term. the second panel contains the results for the short-run component of the model. it shows what proportion of a shock to the long-run relationship between formal and informal sector employment is corrected (reversed) in one time period (i.e. one quarter). this component was estimated in the second step of the model estimation process. first all the variables specified in equation 2 were included in the first round. then, to save degrees of freedom, those variables that were found to be statistically insignificant at a 10% level in both the short-run relationships were dropped in the second round. two of the seasonal dummies, as well as the change in formal sector employment were dropped.7 first note that the error correction term in both the short-run equations is statistically significant and has the correct sign.8 the value of -0.392 in the equation for the change in informal sector employment (first line of second panel) shows that 39.2% of a shock causing a deviation from the long-run component is corrected within one quarter, while the value of 0.162 for formal sector employment shows that 16.2% of a shock is corrected within one quarter. of interest is the impact of the lagged value of unemployment in both equations. the parameter of 1.294 in the equation for the change in informal sector employment and 0.693 for formal sector employment (second line of second panel), shows that a one percentage point increase in the unemployment rate leads to a 1.294% and 0.693% increase in informal and formal sector employment in the next period. to answer the question whether or not the unemployed are subsequently absorbed into formal and informal sector employment once they lose their jobs, consider the following example using labour market data for the first quarter of 2017. given the total number of unemployed of 6.214 million, a one percentage point increase in the unemployment rate would render 224 332 additional people unemployed. multiplying this number by 1.294% and 0.693% gives us an idea as to how many unemployed people would be absorbed by the informal and formal sectors in the following quarter. in the case of the formal sector it is 78 558, while for the informal sector it is 34 700. on average, about a third of the additional unemployed find work in the formal sector in the following quarter, and about half of that find work in the informal sector. thus, about half of the number of additional unemployed do not find employment at all in the following quarter. in addition, the impact of the unemployment rate on formal and informal sector employment is limited to the first lag (one quarter).9 the results of the empirical analysis above indicate that all the unemployed are not absorbed into the informal sector.10 this finding might be consistent with either of the models set out in figures 1 and 2. however, read together with the findings of lloyd and leibbrandt (2014) on the unemployed not being voluntarily unemployed, the above analysis appears to confirm the theoretical model of figure 1, and not that of figure 2. thus, the results show that a significant portion of the unemployed fail to find employment in the informal sector because of entry barriers. lastly, figure 7 indicates that, when the change in formal sector employment displays a significant drop, thus entering negative territory, the behaviour described by the short-run component of the model switches from regime 0 to regime 1. this occurred in the depth of the great recession (2009q3), and at the advent of the latest recession (2015q1). regime 1 thus has its advent in recession. figure 7: regimes for the formal and informal sector employment: (a) change in formal sector employment, (b) change in informal sector employment, (c) smoothed probabilities. conclusion south africa has been suffering from an inordinately high unemployment rate for quite some time. the discussion above highlighted that the number of unemployed people in the country is between 2 and 3.3 times as many as the number of people working in the informal sector. to provide an explanation for this high unemployment rate and the relatively small informal sector this article puts forward a theoretical framework linking employment in both the formal and informal sectors of the economy to involuntary unemployment. the model ascribes the failure of the informal sector to absorb the large number of unemployed to entry barriers in the informal sector. the empirical part of the article provides corroborating evidence for the existence of entry barriers into the informal sector. it shows that, indeed, once the unemployment rate increases, the ability of both the formal and informal sector to reabsorb the unemployed in the next period is very limited. from a policy point of view these results suggest the need to consider measures that will ease entrance into the informal sector. access to capital, credit and other financial services, as well as opportunities for owner-operators and workers to improve their skills (notably accounting skills) might serve as top agenda points in this regard. however, there are also other factors that could serve as entry barriers, and therefore also need specific attention. aspects such as location, premises, facilities and business services (including internet), transport cost, crime, as well as the physical distance between informal firms, their suppliers, and even in some cases their clients, are likely factors. this might require a broader rethink of the role of the informal sector. typically, policy tends to focus on formalising informal enterprises. viewed in this way the informal sector is seen as a problem sector, a sector from which enterprises must be assisted (or made) to exit. however, it is also possible to see the informal sector as a sector that can do what the formal sector is unable to do: provide work to low-skilled workers. in such a view, a resilient, buoyant informal sector that can, in the long term, absorb those workers who are unable to find employment in the formal sector will become part of the solution to the unemployment problem. but then the barriers to entry into the informal sector need to come down. acknowledgements competing interests the author declares that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contribution both authors contributed equally to the article. references beccarini, a. & gros, d., 2008, at what cost price stability? new evidence about the phillips curve in europe and the united states, ceps working document, 302/september, ceps, brussells. berry, a., 2001, the role of the small and medium enterprise sector in latin america: implications for south africa, tips working paper 5, viewed 05 june 2017, from http://www.tips.org.za/files/421.pdf burger, p. & fourie, f.c.v.n., 2018, ‘the informal sector, economic growth and the business cycle in south africa: integrating the sector into macroeconomic analysis’ in f.c.v.n. fourie (ed.), the south african informal sector: creating jobs, reducing poverty, hsrc press, cape town. burger, p. & fourie, f.c.v.n., 2015, macroeconomic policy and south african unemployment: developing a three-segment macroeconomic model, redi3x3 working paper 6, viewed from http://www.redi3x3.org bulow, j.i. & summers, l.h., 1986, ‘a theory of dual labor markets with application to industrial policy, discrimination and keynesian unemployment’, journal of labor economics 4(3)(part 1), 376–414. cahuc, p. & zylberberg, a., 2004, labor economics, mit press, cambridge, ma. carlin, w. & soskice, d., 2006, advanced macroeconomics, oxford university press, oxford. centre for development and enterprise (cde), 2013, ‘graduate unemployment in south africa: a much exaggerated problem’, cde insight, viewed april 2013, from http://www.cde.org.za/publications/jobs-growth/83-jobs-and-growth/403-graduate-unemployment-in-south-africa-a-much-exaggerated-problem fourie, f.cv.n. (ed.), 2018, the south african informal sector: creating jobs, reducing poverty, hsrc press, cape town. fourie, f.cv.n., 2011, the south african unemployment debate: three worlds, three discourses?, working paper 63, saldru, university of cape town. grimm, m., krüger, j. & lay, j., 2011a, ‘barriers to entry and returns to capital in informal activities: evidence from sub-saharan africa’, review of income and wealth 57, s27–s53. grimm, m., van der hoeven, r. & lay, j., 2011b, unlocking potential: tackling economic, institutional and social constraints of informal entrepreneurship in sub-saharan africa: main findings and policy conclusions, international institute of social studies, erasmus university. hamilton, j.d., 2008, ‘regime switching models’, in s.n. durlauf & l.e. blume (ed.), the new palgrave dictionary of economics, 2nd edn., palgrave macmillan, viewed 20 july 2017, from http://www.dictionaryofeconomics.com/article?id=pde2008_r000269 hamilton, j.d., 1996, ‘specification testing in markov-switching time-series models’, journal of econometrics 70, 127–157. hamilton, j.d., 1989, ‘a new approach to the econometric analysis of nonstationary time-series and the business cycle’, journal of econometrics 57(2), 357–384. holmes, m.j. & silverstone, b., 2006, ‘okun’s law, asymmetries and jobless recoveries in the united states: a markov-switching approach’, economics letters 92, 293–299. juselius, k. & toro, j., 2005, ‘monetary transmission mechanisms in spain: the effect of monetization, financial deregulation, and the ems’, journal of international money and finance 24(3), 509–531. https://doi.org/10.1016/j.jimonfin.2005.01.002 kingdon, g.g. & knight, j.b., 2004, ‘unemployment in south africa: the nature of the beast’, world development 32(3), 391–408. layard, r., nickell, s. & jackman, r., 1991, 2005, unemployment: macroeconomic performance and the labour market, oxford university press, oxford. lloyd, n. & leibbrandt, m., 2014, ‘new evidence on subjective well-being and the definition of unemployment in south africa’, development southern africa 31(1), 85–105. https://doi.org/10.1080/0376835x.2013.864513 national planning commission, 2012, national development plan: vision for 2030, our future – make it work, npc, pretoria. pagliaci, c. & barráes, d., 2010, ‘a markov-switching model of inflation: looking at the future during uncertain times’, análisis económico xxv(59), 25–46. simon, j., 1996, a markov-switching model of inflation in australia, research discussion paper 9611, reserve bank of australia. statistics south africa, 2017, quarterly labour force survey, quarter 1, 2017, excel datasheet viewed 01 june 2017, from http://www.statssa.gov.za van der berg, s. & van broekhuizen, h., 2012, graduate unemployment in south africa: a much exaggerated problem, working paper 22/2012, university of stellenbosch, viewed from http://resep.sun.ac.za/index.php/research-outputs/stellenbosch-working-papers/wp2012/ valadkhani, a., 2015, ‘okun’s law in australia’, economic record 91(295), 509–522. valadkhani, a. & smyth, r., 2015, ‘switching and asymmetric behaviour of the okun coefficient in the us: evidence for the 1948–2015 period’, economic modelling 50, 281–290. https://doi.org/10.1016/j.econmod.2015.07.001 verick, s., 2012, ‘giving up job search during a recession: the impact of the global financial crisis on the south african labour market’, journal of african economies 21(3), 373–408. appendix 1 the kwiatkowski–phillips–schmidt–shin test reported in table 1-a1 indicates that for the period 2008q1 to 2017q1 formal and informal sector employment, as well as the unemployment rate are i(1) variables. this is what is expected for formal and informal sector employment (which are upward-sloping variables), but not the unemployment rate. however, applying the kpss test to a longer series of the unemployment rate (biannual observations for the period 1999q to 2017q1) shows clearly that the unemployment rate is a stationary time series. lastly, the residual of the long-run relationship is also stationary. figure 1-a1: the residual of the long-run component. table 1-a1: kwiatkowski–phillips–schmidt–shin test (2008q1–2017q1). footnotes 1. in this article the primary sector is synonymous with the formal sector, while the secondary sector is synonymous with the informal sector. this, of course, need not always be the case, as one could also have two formal sectors, one with new-keynesian characteristics and the other not. however, in a country such as south africa with a rather concentrated formal sector and an informal sector defined as comprising small firms not registered for tax purposes, the small-firm nature of the informal sector and the concentrated nature of the formal sector render it possible to portray the primary/secondary sector nature of the model as synonymous with the formal/informal sector nature of the economy. 2. in burger and fourie (2015) the theoretical model is set up as a system of simultaneous equations, thus depicting equilibrium at a moment in time. the theoretical model in this article is set up sequentially, to explain the sequence from a (demand) shock, to increased unemployment, to increased absorption of the unemployed in either the formal or informal sectors. this is done to match this article’s empirical model, which is a vector error correction model, that is, where the reaction of formal and informal sector employment that returns the model to equilibrium occurs in a time period after the shock that took the relationship between them out of equilibrium. 3. if the labour market was free and not subject to new-keynesian features, the equilibrium wage would have been equal to the wage in the secondary sector (i.e. equals to wcs) – in fact, the primary and secondary sector distinction would fall away, given the absence of the new-keynesian features. 4. it is also used to explore the behaviour of inflation, employment and unemployment (cf. simon [1996], beccarini & gros [2008]) and pagliaci and barráes (2010) for inflation ms models and holmes and silverstone (2006), valadkhani and smyth (2015) and valadkhani (2015) for ms models of okun’s law). 5. all four lags were not included simultaneously to save degrees of freedom and because the unemployment rate series displays a high degree of serial correlation. high serial correlation would lead to multicollinearity and hence, cause the lags in the unemployment rate to turn up as statistically insignificant even if they are not. 6. the kpss stationarity test shows that all three variables (formal and informal sector employment and the unemployment rate) are i(1) variables, that is, they are non-stationary (see appendix 1 for the results). this is not what one would have expected for the unemployment rate series. however, using the same kpss test on a sample of the unemployment rate that covers two observations per year (march and september) for the period september 1999 to march 2017 (the longest period for which there are at least two observations of the unemployment rate available per year), clearly shows that the unemployment rate indeed is a stationary variable. hence the decision to enter it as a stationary variable into the short-run component of the model is warranted. (we use the kpss test because it is more robust that conventional tests such as the adf and pp tests.) 7. for purposes of brevity the first round results are not reported here, but are available from the author on request. 8. negative in the equation for the change in informal sector employment and positive (given the positive relationship between formal and informal sector employment in the long run) in the equation for the change in formal sector employment. 9. as mentioned earlier, the models estimated with earlier lags in the unemployment rate (i.e. second, third and fourth period lags) showed these lags to be statistically insignificant. 10. the model cannot show whether the unemployed left jobs in the formal sector (the data does not allow for this). nevertheless, the long-run relationship of the model has been set up with formal sector employment driving informal sector employment (the latter is the dependent variable in the long-run component). thus, if formal sector employment drops one percentage point, it correlates almost one-to-one with a one percentage point drop in informal sector employment. microsoft word 5 vzyl & dplessis sajems 15(4) 2012.docx 402 sajems ns 15 (2012) no 4 exploring coping strategies of business leaders during an economic downturn marlise van zyl and yvonne du plessis department of human resource management, university of pretoria accepted: september 2012 as a large part of south africa’s economy is based on the mining industry, this research focused on exploring the coping strategies of business leaders in the mining industry during an economic downturn. using qualitative research within a constructivist-interpretive paradigm, the researchers sought a deeper understanding of how mining leaders cope during an economic downturn. a purposive sample of seven executive mining leaders of different mining houses was interviewed and data was analysed using atlas.ti. a conceptual framework for understanding coping strategies at the individual, group and organisational levels for business leaders during an economic downturn was developed and is discussed here. this study contributed to theory and practice by focusing on coping responses to specific situations within a specific context instead of on general coping strategies. key words: coping, economic downturn, business leaders, coping strategies jel: l200 1 introduction when the global crisis unfolded during 2008, it initially seemed that south africa and other emerging market economies would be relatively unaffected. south africa’s banking system, according to the head of research and policy development at the south african reserve bank, ‘was only marginally exposed to the sublime assets that initiated the crisis’ (kahn, 2009:22), with the result that commodity prices continued to increase in the first half of 2008. this situation changed dramatically after september 2008, following the demise of lehman brothers, which led to the collapse in global confidence. this drastically decreased the capital available to emerging markets, coupled with a remarkable decline in commodity prices and a plunge in the demand for exports, particularly commodities from emerging markets (kahn, 2009:22). however, until well into 2009, business and political leaders in south africa seemed to ‘languish in a state of denial’ (marais, 2010:s.p.), continuing to predict positive economic growth. nevertheless, south africa did indeed experience its first official recession in 17 years in the first quarter of 2009, with a drop of 7.4 per cent in the country’s gross domestic product (gdp) (statistics south africa, 2009: 4). it must be noted that all figures are seasonally adjusted to reflect real annualised changes from the previous quarter. the gdp continued its negative growth in the second quarter, contracting at a rate of 2.8 per cent, after which it recovered marginally to show a very slight positive growth rate of 0.9 per cent in the third quarter of 2009 (statistics south africa, 2010a). as shown in figure 1 below, this positive growth rate continued in the fourth quarter of 2009. as a large portion of south africa’s economy is based on the mining industry, this research focused on exploring the coping strategies of business leaders in the mining industry during an economic downturn. in this paper we aim to discuss coping strategies that can be employed as a guiding framework for south african business leaders during an economic downturn. in order to reach this objective we have organised the paper as follows: first, we present an overview of the context of the study in order to clarify abstract sajems ns 15 (2012) no 4 403 the research problem. we then discuss the research design and method, explaining the qualitative process and data-collection method used. this is followed by an outline of the data-analysis method used. the results and findings are discussed. we conclude by discussing possible limitations, practical and theoretical managerial implications and suggestions for future research. f i g u r e 1 growth in gdp, year-on-year (y/y) and quarter-on-quarter seasonally adjusted and annualised (q/q) source: statistics south africa (2010b:4) 1.1 economic context in the mining industry according to the minister of mineral resources, ms susan shabangu (2009:s.p.), the south african mining industry, which is responsible for more than half of the country’s export earnings, was under particularly severe strain from 2008 to 2009. after a worldwide commodity price boom from 2003 to 2007, commodity prices declined drastically. this can be explained by the role of commodities as both a production input and a financial asset. a slowdown in global economic activities and the demand for commodities for production purposes, coupled with an increase in supply capacity, led to a decrease in prices. the financial crisis also contributed to the downward price momentum, as investors reduced their holdings of commodity assets (southern african resource watch, 2009:4). on the back of the drastic commodity price drop and the reduced value of mineral sales (figure 2), mining houses reduced production, as indicated in figure 3. mining is cyclical in nature and mining companies take a long-term view of their operations. however, historical evidence shows that, when a downturn looms, the first reaction of mining companies is to reduce costs by retrenching workers. this also proved to be the case during the downturn in 2009, when several mining organisations retrenched workers (southern african resource watch, 2009:21). with the mining sector declining by 32.8 per cent, the worst state of the industry since 1967 (statistics south africa, 2009:1), industry leaders faced a daunting challenge: how could they ensure that their company would weather the downturn? mining houses around south africa were cutting production and capital spending, retrenching employees, and restructuring, putting pressure on employee morale across their organisations, including executives. 404 sajems ns 15 (2012) no 4 f i g u r e 2 total value of mineral sales source: statistics south africa (2010c:5) f i g u r e 3 monthly indices of physical volume of total mining production (base: 2005=100) source: statistics south africa (2010c:3) sajems ns 15 (2012) no 4 405 with uncertainty about the depth, severity and duration of the downturn and its outcome, the mining industry and its leaders came under severe strain. an economic downturn has a severe impact on consumers, as well as a profound and far-reaching impact on the workplace (naiman, 2009:49). workplace morale typically goes into a downward spiral in response to the bombardment of negative information, job losses, fear and insecurity. increased work demands compete for the attention of a distracted workforce; and managers, who are grappling with the same pressures as their staff, must somehow motivate people, not only to do their own jobs, but also often to take on the responsibilities of former co-workers (naiman, 2009:49). all of the above mean that business leaders must be able to cope if they are to manage in an economic downturn. the research questions for the study presented in this paper are: • how do south african business leaders cope during an economic downturn? • how could organisations assist south african business leaders to cope better during an economic downturn? • what comprises a coping strategy framework for south african business leaders? the next section explores the concept of coping and coping research, outlining trends in this field of research as well as criticisms against more traditional methods of coping. 1.2 coping and coping research lazarus and folkman (1984:147) define coping as the ‘thoughts and behaviours that people use to manage the internal and external demands of situations that are appraised as stressful’. according to folkman and moskowitz (2004: 746), a large amount of coping research is based on richard lazarus’s 1966 book psychological stress and the coping process. coping as a distinct field of psychology emerged during the 1970s and 1980s (folkman & moskowitz, 2004:746); and coping research was greatly stimulated by the development of the ‘ways of coping checklist’ developed by folkman and lazarus (1980, in somerfield & mccrea, 2000:621). hobfoll, schwarzer and chon (1998:181) argue that stress and coping are the most widely studied phenomena in psychology, identifying over 29 000 research articles on stress and coping over the period 1984 to 1998. a more conservative search by somerfield and mccrae (2000:621), focusing primarily on coping behaviour and spanning the period 1967 to 1999, still produced 13 744 records. conversely, there is abundant criticism of coping research (see somerfield & mccrae, 2000:621 for a review). most of these critiques point out conceptual and methodological issues. in particular, measures to assess coping, particularly by means of checklists, are criticised; narrative approaches are suggested as an alternative to checklists (lazarus, 2000:666; folkman & moskowitz, 2004:750) to gain a deeper understanding of what an individual is coping with, especially when the stressful event is not a single event, such as coping with restructuring and organisational change. narrative approaches are also useful in identifying and studying ways of coping that are not included in existing inventories (folkman & moskowitz, 2004:751). coping is a process that unfolds in the context of a situation (lazarus & folkman, 1984). somerfield and mccrae (2000:624) appeal to researchers to focus on coping responses to specific situations within a specific context, instead of focusing on general coping strategies. folkman and moskowitz (2004:768) suggest that new methodologies and new ways of thinking about coping within a specific context will help this field of study to mature. this is because the field holds great potential to explain who flourishes under stress and who does not, and it also has potential when it comes to interventions for helping people cope with stress. in line with this, this paper delineates a strategic coping framework for south african business leaders in the mining context, using more narrative methodologies than are traditionally employed in coping research. 2 use of literature literature was used in this study for two main purposes. firstly, it was used as an orienting process. according to urquhart (2007:351), such a process allows the researcher to become aware of the current thinking in the field 406 sajems ns 15 (2012) no 4 without taking a position regarding the research to be done. this approach was useful in ‘nesting’ the problem, a term used by walcott (1990:17, in silverman, 2005:299). thus, part of the literature review was conducted prior to the data collection and data analysis, bearing in mind the reason for delaying a literature review, which is not forcing preconceived ideas onto the data. secondly, literature was used to explain data, showing the relevance of findings in relation to the existing body of knowledge (henning, 2004:27). stern (2007:123) uses the following quotation by robert burton (cited from bartlett, 1980:258) to explain this eloquently: ‘...a dwarf standing on the shoulders of a giant may see farther than the giant himself.’ stern (2007:123) notes that, while you may feel like a giant when you develop theory, you are, in fact, a dwarf, which makes it important to position your work within the body of related literature. this is because, first, it is academically honest to do so and, second, it demonstrates how you have built upon it to enable you to see further. 3 methodology it is important to highlight the paradigm applied in this paper in order to place the research design, methodology and approach in context. this is to avoid the pitfall that evered and louis (1981:386) so aptly warn researchers against: often ‘the quality of a piece of research is more critically judged by the appropriateness of the paradigm selected than by the mere technical correctness of the methods used’. a constructivist-interpretive paradigm is applied in this paper. interpretive research is based on the belief that a deeper understanding of a phenomenon is made possible only by understanding the interpretations of that phenomenon by those experiencing it (shan & corley, 2006:1823). the constructivistinterpretive perspective thus assumes that reality is constructed by the people (including the researcher) who participate in this reality. constructivists acknowledge that their interpretation of the studied phenomenon is in itself a construction (charmaz, 2006:187). in line with the research paradigm, a qualitative research approach was deemed most suitable, owing to the intense and enduring complexity of the leadership phenomenon studied and the search for deeper meaning. conger (1998) argues that qualitative research is the cornerstone methodology for understanding the ‘how’ and ‘why’ of leadership as opposed to its ‘what’, ‘where’ and ‘when’. 3.1 sampling purposive sampling was selected for this study as a sampling strategy. this selection was made based on the researcher’s knowledge of the population, its elements and the purpose of the study (babbie, 2007:184). sampling took place on an institutional level (mine), and on an individual level (mining leader). based on the researcher’s knowledge of the population and the purpose of the study, mines or mine groups were selected that are involved in beneficiating a variety of commodities, namely gold, platinum and uranium. individual leaders (executives) within each company were then selected purposively from the executive committees to form the unit of analysis for this study. the sample size was seven mining leaders, who were determined by data saturation. 3.2 data collection interactive interviews were used in this study. these were also referred under the term ‘intensive interviewing’ (charmaz, 2006:25). this author refers to ‘intensive interviewing’ as permitting an in-depth exploration of a particular topic. it is thus useful for interpretive inquiry. the aim of this type of interviewing is to obtain ‘rich data’ or ‘thick descriptions’ which are focused and detailed, fully revealing participants’ views, feelings, intentions and actions, as well as the context and structures of their lives (charmaz, 2006: 14), in this case, the way in which leaders cope during an economic downturn. field notes were made during the interviews to record observations. according to schurink (2004:11), field notes are ‘written accounts of what researchers hear, see, experience, and think in the course of collecting and reflecting on the data in qualitative research studies’. this, together with interview transcripts, formed part sajems ns 15 (2012) no 4 407 of the data. as an important part of the research process, field notes proved invaluable during data analysis. roughly two to three hours were spent writing field notes after each interview, including both descriptive and reflective notes, with sections on the research setting, the responses of the interviewee, and personal reflections on the interview. mason (2002:231) claims that it is not possible to conduct completely structure-free interviews, arguing that as a minimum the agendas and assumptions of both the interviewer and interviewee will impose a framework for meaningful interaction. charmaz (2006:26) holds a similar view, suggesting that researchers devise a few broad, open-ended questions in the form of an interview guide and then use their interview questions to invite detailed discussions on the topic. table 1 provides the interview guide used in this study. t a b l e 1 interview guide main focus probe for how does the economic downturn affect your organisation? specific examples and situations what was/is your role in the organisation during the downturn? not merely position, but role in downturn response how does the economic downturn affect you as a person? specific examples and situations of individual impact how did you handle a typical situation mentioned? other strategies used in other situations? how would you have done things differently (if applicable) in retrospect? specific examples what advice would you give to a fellow executive to cope with an economic downturn? does your organisation assist you in coping during the economic downturn? • specific actions • if so, how? would you like to add anything else that you feel might be relevant that we have not discussed? data collection for this study was carried out during november and december 2009, a period that was, at that stage, viewed as part of the downturn. although the mining industry (in terms of sales) started to recover, showing a positive trend, the total sales volume remained low during this period (refer to figure 2). 3.3 data analysis two types of coding were used in this study: • initial coding: initial coding adheres closely to the data and does not apply pre-existing categories to it. coding can be done per word, line or incident. • focused coding: this method of coding requires using the most significant and/or frequent earlier codes to sift through large amounts of data. this is done to assist the researcher in synthesizing and explaining larger segments of data (charmaz, 2006: 58-60). initial coding was refined to include both micro analysis and open coding. micro-analysis is the careful, often minute, examination and interpretation of data (strauss & corbin, 1998:58), similar to the word-by-word coding described by charmaz (2006:50). open coding refers to uncovering, naming and developing concepts that open up the data (strauss & corbin, 1998:102). these two coding actions were not done separately: micro analysis was used in naming concepts in open coding. figure 4 provides an example of open coding using atlas.ti employed in this study. secondly, focused coding was refined to two distinct ‘steps’ of increased focus. the first was reassembling data from open coding. this was followed by the integration and refining of categories into core categories. table 2 illustrates how core categories were refined from categories (based on open coding). 408 sajems ns 15 (2012) no 4 f i g u r e 4 example of open coding in atlas.ti t a b l e 2 core categories categories core category description of core category individual factors influencing factors factors that create a predisposition in respect of how organisational leaders cope during an economic downturn team factors organisational factors positive view of impact overall view of the impact of the economic downturn the overall view of the economic downturn and its effects/impact on the organisation negative view of impact individual stressors stressors aspects that contribute to the stress experienced by an individual during an economic downturn derived team stressors derived organisational stressors organisational plan organisational response to economic downturn how the organisation chooses to act in response to an economic downturn organisational goal organisational action individual strategies coping strategies coping methods an individual uses to cope with stressors during the economic downturn team strategies organisational rationalisation strategies sajems ns 15 (2012) no 4 409 4 findings and discussion based on various rounds of data analysis in the form of open and focused coding, a conceptual framework of coping strategies for leaders during an economic downturn was developed, as shown in figure 5. 4.1 influencing factors several factors could create a particular predisposition towards how organisational leaders cope during an economic downturn. firstly, there are individual factors, such as being optimistic and confident, thriving on the challenge of the economic downturn and focusing on the future. in addition, the individual’s experience, both general and specific, in dealing with an economic downturn and the extent to which the individual depends on (or in this case does not depend on) the organisation for identity also played a role in how leaders managed during the economic downturn. f i g u r e 5 conceptual framework of coping strategies for leaders during an economic downturn secondly, team factors influence how leaders cope during an economic downturn. team factors such as the maturity of the team and inter-team influence may play a role. for example, when the core team (referring to the executive team) within which the leaders operated during the downturn was mature, the leaders tended to draw on support from the team. when the team was less mature, the leader drew more on individual coping strategies. the dynamics within the core team (termed inter-team influencing) may influence both the mood within the team and the overall appraisal of the downturn (positive or negative). in addition, the extent to which leaders influence other team members, combined with the team’s maturity, could determine the extent to which leaders use team coping strategies as opposed to individual coping strategies. thirdly, organisational factors such as the organisational culture and the organisational level on which the leader operates create a predisposition towards how organisational leaders cope during an economic downturn. 410 sajems ns 15 (2012) no 4 when it comes to the organisational level, although all the respondents in this case were members of a mine or mining group’s south african executive committee, they were technically at different levels of the organisation. in the case of a south african mining organisation, the executive committee members are the ultimate authority in the organisation. they are responsible to the shareholders and are on a higher organisational level than that of their counterparts in international mining organisations. south african executive committee members in the international organi sations report to the mining organisation’s international executive committee. the latter are on a relatively lower level of their organisation, tending to focus more on individual stressors and less on derived stressors than do their counterparts, south african executive members of a south african mining organisation. organisational culture also played a role in this case. for example, one organisation did not retrench any employees, based on its strong organisational culture of ‘looking after each other’. not only could organisational culture affect the organisational response to the downturn, but it could also influence the proportion of the individual, team and organisational rationalisation coping strategies that leaders use. individual, team and organisational factors, as shown in the conceptual framework, may therefore influence: • the overall way in which the effect of the downturn on the organisation is viewed (for example, an individual factor such as thriving on the challenge or a team factor such as inter-team influencing, indicated by arrow a in the conceptual framework): • which stressors feature more prominently (for example, individual stressors and derived stressors influenced by organisational level, arrow b); • the organisation’s response to the downturn (for example, affected by organisational culture, arrow c); and • the proportion of individual, team and organisational rationalisation coping strategies leaders used (for example, organisational culture, or team maturity, where more individual strategies are likely to be used if the team is less mature or the culture is less supportive, arrow d). this, however, is not to suggest that all leaders experience the same specific influencing factors indicated here, but merely that individual, team and organisational factors may play a role in how leaders cope during an economic downturn. 4.2 overall view of the impact of the economic downturn the overall view of the impact of the downturn refers to how the leaders view the economic downturn and its effect on the organisation. leaders saw the effect on the organisation as negative, noting effects such as the loss of contracts, the negative impact on cash flow, a reduced ability to sustain capital projects, increased cost and decreased access to working capital. this list of negative impacts is not exhaustive, but reflects the views of the respondents. however, leaders also saw the effect of the downturn on the organisation positively, perceiving it, for example, as an opportunity for revisiting strategy and structure, gaining access to an increasing pool of human resources, optimising procurement and potentially engaging in discounted acquisitions. assessing the effect of the economic downturn on the organisation as positive or negative should not be seen as mutually exclusive. although leaders were aware of the negative effects, they also highlighted the positive effects of the downturn on the organisation. it is important to note that this refers to how the leaders saw the overall effect of the downturn on the organisation, and not on them as individuals. however, this overall assessment or view of the effects of the downturn on the organisation had an impact on how the organisation responded to the downturn. this referred, for example, to whether the organisation should retrench or not, hire from the extended resource pool and so forth (arrow h) and also to which stressors (individual, team or organisational, arrow g) feature more prominently for each individual. 4.3 stressors stressors refer to aspects that contribute to the stress experienced by individuals during an economic downturn. firstly, individual stressors sajems ns 15 (2012) no 4 411 are the specific aspects on an individual level that contribute to the leader’s stress. individual level stressors refer, for example, to doubting job security and, closely related, to worrying about financial security, aspects related specifically to the individual leader. secondly, leaders felt derived stressors which had an impact on a team. at the organisational level these were felt more acutely than the individual stressors. although the stressors (individual and derived) all refer to individual stress, individual stressors did not seem to be the greatest contributors to the individual leaders’ stress during an economic downturn, but rather stressors deriving from the distress of others. derived team stressors created stress experienced by individuals, not on account of themselves, but rather on account of the responsibility they felt for the team. leaders felt pressured to direct the team and the organisation. leaders often ‘pulled’ trusted colleagues from their past companies into new positions which meant they had a trusted team, but it also created or at least amplified the responsibility that the respondents felt for their team members during the downturn, contributing to their stress. derived organisational stressors include pressure from the company or the shareholders and their expectations of the leader, feeling responsible or to blame for what happens to the organisation and the individuals working there, and experiencing a dichotomy between values (personal and organisational values) and individual actions. a specific derived organisational stressor is evident in the fact that the respondents likened their individual experience and emotions to those of an executioner, an officer in a death camp during the holocaust or a participant in a war. these feelings are closely related to the stress of feeling responsible or to blame for what happens to the organisation and the people working there, but it also expresses a deeper sense of emotional stress experienced by the individual leaders: likening their influence on the organisation and its people to that of someone controlling life and death. once again, the leaders did not refer to it as an individual stressor, but rather as individual stress (in other words, distress experienced by the person) derived from others’ distress for which the leader perceives himself to be (at least partially) responsible. it was interesting to note that the derived stressors seemed to be more important and stressful to the leaders than the individual stressors influencing only themselves. this is also what they largely attempted to cope with during the downturn. note that, although all stressors (individual and derived team and organisational stressors) are individually experienced stressors, they stem from different sources, that is, the individual, team and organisational levels. 4.4 organisational response to economic downturn the organisational response to the downturn consists of actions taken to achieve a specific goal, based on a plan on how to deal with the organisational downturn. firstly, the shortand long-term organisational goals are considered. in the short term, organisations focus on surviving the critical, immediate actions that will ensure that the organisation is able to withstand the downturn. in the long term, the organisation needs to position itself to be ready for the upswing; it needs to have a vision and to ensure that the people in the organisation are prepared to be in business in the long run. secondly, an organisational plan is derived from how to achieve these shortand longterm goals. this plan of action should be based on facts: the state of the markets and industries, the core of the problem and so forth, focusing on specific problems in the organisation as opposed to the generic threat of the economic downturn. thirdly, the plan should be implemented by taking specific organisational actions, whether it is to reduce capital spending, reduce costs (for example, by means of retrenchment) or other, more strategic actions (such as attemptting to control the market). organisational action in response to the economic downturn is often defined in terms of retrenchment, often ex negativo. where organisations carried out retrenchments, respondents focused mostly on their coping with this organisational action. if organisations did not retrench, respondents were proud of this organisational ‘non-action’, but often also focused on coping with the threat of retrenchment in the organisation. 412 sajems ns 15 (2012) no 4 the organisational response to the downturn influences the choice of which coping strategies are used. for example, if retrenchment is an organisational action during the downturn, the leader in the organisation concerned may experience stressors (arrow e) that differ from those experienced by a leader in an organisation that does not retrench. this therefore influences the coping strategies that the leader might use in order to cope (arrow f), as well as subsequent organisational responses (arrow e). 4.5 coping strategies coping strategies are methods used for coping with stressors, in this case, during an economic downturn. different coping strategies that leaders might use in combination were identified. firstly, individual coping strategies refer to strategies that fall within the individual domain or level. this includes religion, the balance between work and life, spousal support in the form of providing a sounding board, or when, for example, a spouse takes over decision-making responsibilities at home, as well as emotional separation in an attempt to depersonalise actions. secondly, team coping strategies are methods whereby a person draws on the core team and/or the team reporting to him to cope better with stressors. this includes, first of all, the mere fact of having a core team and not facing all the challenges alone. trusting this core team is an important element in team coping, particularly because being part of a core team allows pressure to be shared. in addition, leaders also indicated the importance of trusting the team reporting to them, which enabled these leaders to focus on their own actions during the downturn. lastly, organisational rationalisation strategies refer to strategies that leaders use to cope with the stressors during the economic downturn by attempting to rationalise the actions brought about by the organisation’s response to the economic downturn. this may take several forms: for example, feeling compelled to act in the interest of organisational survival during the downturn, having to convince themselves that they are doing the right thing, seeking guidance, and believing in the organisational plan of action and then rationalising their actions against this plan. the specific coping strategies mentioned here are based on the experiences of the respondents in this study and the list may therefore not be exhaustive. however, the findings suggest that, in addition to individual coping strategies, leaders may also use team and organisational rationalisation strategies in order to cope with the stressors during an economic downturn. in addition, a combination of coping strategies seemed to be used to cope with a combination of individual and/or derived team and organisational stressors and one should not incorrectly presume that, for example, individual coping strategies are used merely for coping with individual stressors. 5 conclusion and recommendations the main objective of this study was to develop a guiding framework for use by south african business leaders to help them cope with adverse conditions like an economic downturn. this objective was reached by developing a conceptual framework of coping strategies for leaders during an economic downturn, as outlined in section 4 of this paper. we believe that this study contributes methodologically to the field of coping research by demonstrating that alternative methodologies (in this case, qualitative research) using narrative approaches (interviews) can uncover ways of coping that are not included in traditional coping inventories. this methodology also allowed for a more in-depth understanding of the phenomenon being studied in the particular context of an economic downturn, in answer to somerfield and mccrae (2000:624), who appeal to researchers to focus on coping responses to specific situations within a specific context rather than general coping strategies. in addition, the study contributes to coping theory at various levels (the individual, team and organisational levels), thus moving beyond the dominant individualist perspective of coping which has recently received increasing criticism (muhonen & torkelson, 2008:451). lastly, this study contributes at a practical level, providing leaders and organisations with a better understanding of how leaders cope in an organisational context during adverse condi sajems ns 15 (2012) no 4 413 tions like an economic downturn. this understanding facilitates several recommendations: • organisations, specifically managers and leaders, should be vigilant about maintaining a continuous proactive environmental analysis strategy whereby potential opportunities and threats in the environment are constantly identified and monitored (lynch, 2000:105). this will allow individuals within the organisation to prepare and act timeously in the event of an economic downturn or any other problem. more importantly, leaders should remain open to information gained from environmental analysis. • leaders should proactively attempt to develop positive attributes within the organisation, and specifically within themselves. luthans, youssef and avolio (2007: 213) propose that what they call positive psychological capital, which includes hope, optimism, self-efficacy and resilience, is open to development. these positive psycho logical capacities correspond to several individual influencing factors that create a predisposition in respect of how organisational leaders cope during an economic downturn, including being optimistic (optimism), being confident in their own capabilities (self-efficacy) and focusing on the future (hope, resilience). in light of this, organisations can develop these capacities to assist them and their leaders in coping with adverse conditions. for example, hope is said to be developed by means of goal-setting, participation and contingency planning for alternative pathways to attain goals (snyder, irving & anderson, 1991, cited in snyder, rand & sigmon, 2005: 258). • organisations should embrace the concept of workplace spirituality. according to duchon and plowman (2005:809), a workplace can be considered spiritual when it ‘recognizes that employees have an inner life that nourishes and is nourished by meaningful work that takes place in the context of community’. the present study has shown that belief systems, an important element of workplace spirituality, according to hicks (2002:384), can play an important role in coping during an economic downturn. giacalone and jurkiewicz (2003: 85) found that the degree of individual spirituality influences whether an individual perceives a questionable business practice as ethical or unethical, tying in with what we termed the “value dichotomy” as a derived organisational stressor and the belief that one is “doing the right thing” as an organisational rationalisation coping strategy used by leaders. • organisations and organisational leaders should carefully consider the selection, composition and team development of their executive teams owing to the important role that team coping strategies have been shown to play in coping during an economic downturn. in addition, the culture of the organisation and the team should support teamwork and trust. hence, active efforts should be put into place to develop this. a limitation of this study is that all the respondents were white males, so findings could not be generalised. the timing of the interviews and data collection, during november and december 2009, could have potential bias towards the recall of respondents’ thoughts, feelings and behaviour related to coping during the ‘heat’ of the downturn. several opportunities for future research have been identified: • the conceptual framework of coping strategies for leaders during an economic downturn can be tested in other industries for its relevance. comparative results may yield further insight into the model and may allow for its expansion. • the conceptual framework of coping strategies for leaders during an economic downturn can be elevated to a model in theory, focusing more on explaining concepts and their relationship to each other. • the conceptual framework can be researched at various levels in the organisation, comparing the coping strategies of leaders with those of employees in lower organisational levels. 414 sajems ns 15 (2012) no 4 references babbie, e. 2007. the practice of social research. 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(eds.) the sage handbook of grounded theory (pp. 339-362). los angeles: sage. journal 8.indd 98 sajems ns 13 (2010) no 1 accounting ethics – an empirical investigation of managing short-term earnings leonie jooste school of accounting, nelson mandela metropolitan university accepted august 2009 abstract short-term earnings are managed in most, if not all, companies. the management of short-term earnings is vulnerable to misinterpretation, manipulation or deliberate deception even if these misleading accounting practices are prohibited by accounting regulations. hence, the problem with managing short-term earnings is that it becomes an ethical practice, regardless of who is or may be affected by the practice or the information that flows from it. as a result of the publicity received by enron and worldcom on financial failures and fraud, and the subsequent legislation, the sarbanes-oxley act in 2002, students are expected to understand the morality issues of earnings-management practices. therefore, the ethics of earnings-management practices affect the accounting educator. accounting students and business managers were surveyed and the findings indicated that there is no significant difference between gender regarding the ethicality of twenty earning management practices. the results, however, show that there is a significant difference between the perceptions of business managers and students regarding the morality of earningsmanagement practices. however, no significant differences were found between genders. jel m41 1 introduction earnings-management can be defined as any action on the part of management which affects reported net income and which provides no true economic advantage to the organisation, even if it may be detrimental to the company in the long run (merchant & rockness, 1994:79). a survey was conducted of the readership of the harvard business review on the acceptability of practices in earning management (harvard business review, 1989). bruns and merchant (1990) characterised the results as ‘frightening’. the authors observed that where a practice is not explicitly prohibited or where there is a slight deviation from the rules, it seems that it becomes an ethical practice regardless of who might be affected by the practice or the information that flows from it. bruns and merchant (1990) agree that anyone who uses information on short-term earnings is vulnerable to misinterpretation, manipulation, or deliberate deception as some of the earnings-management practices can be immoral and unethical. many cases of financial fraud and failures in companies have emerged globally. after the major accounting scandal of enron and worldcom, and the subsequent demise of arthur andersen in america, the question of values and ethics in accounting has become a widely discussed and researched topic. for its 2002 annual meeting, the american accounting association chose the quality of earnings project as its main theme and, in turn, academic journals have invited research articles focusing on earnings-management practices (giacomino, bellovary & akers, 2006). following the scandals, the united states (us) congress passed the sarbanes-oxley act of 2002 (corporate governance in south africa), that holds executives personally responsible and criminally liable for certifying financial statements (elias, 2002). business ethics has sajems ns 13 (2010) no 1 99 not only revived academics’ and accounting practitioners’ interest in ethics and earningsmanagement practices but it also supports the view that there is a lack of ethics and ethical behaviour on the part of businesses and management (karassavidou & glaveli, 2006). the failure of a company is not simply a matter of accounting and auditing but the involvement of a convergence of factors including personal values, integrity and ethics (akers, eaton & giacomino 2004). hence, as a result of the consequences of earnings-management practices and surveys administered in previous studies in the us (bruns & merchant, 1990; merchant & rockness, 1994; rosenzweig & fischer, 1994; fischer & rosenzweig, 1995; clikeman, geiger & o’connell, 2001; kaplan, 2001; elias, 2002; giacomino et al., 2006), this study conducted a survey with students and business managers to determine their perceptions of the morality aspects of earnings-management and to determine if perceptions differ by gender. this study is similar to the study by giacomino et al. (2006) where the ethical perceptions of students, business managers and gender were compared. 2 literature review in 1990, bruns and merchant (1990) reported on a questionnaire regarded by auditors as short-term earnings-management situations. the harvard business review (1989) readers were asked to rate 13 earnings-management situations. the authors (bruns & merchant, 1990) observed that they were shocked with the result, as some of the earnings-management situations could be labelled as immoral and clearly unethical. despite the general utilisation of earnings-management, widespread confusion and disagreement remain over what the concept of earnings quality should include. prior to the study by bruns and merchant (1990), researchers and accounting practitioners paid little attention to the morality of short-term earnings-management. healy (1985) stated that reported net earnings may often be the product of deliberate choices between various accounting treatments and business options. these earnings-management actions can be harmful, and mislead financial statement users and may be precursors of more serious and illegal activities (healy, 1985:106–107). bernstein & siegel (1979) agreed that to assess the true earnings power of a company, a determination of the quality of earnings must be made. october 2001 saw the first of many reports on significant accounting irregularities in financial statements issued by enron, which at the time was the seventh largest company on the fortune 500. the scandal soon focused attention on arthur andersen, who signed off annual financial statements. the list of companies involved in investigations of financial irregularities increased and included companies such as worldcom, computer associates, global crossing, tyco, k-mart, xerox, halliburton, bristol-myers squibb, adelphia, lucent technologies, healthsouth, and freddie mac. every big 5 accounting firm has been involved in these investigations to some extent, of which arthur andersen was the only firm to receive a criminal conviction (comunale, sexton & gara, 2006). the scandals destroyed the credibility of financial analysts and led to the collapse of a big 5 accounting firm. with the highly publicised financial frauds and failures, compelling questions have been raised about the role of public accountants. therefore, the accounting profession has emphasised the importance of the concepts of earnings-management and, as a result, many accounting journals have invited and published research articles that deal with earnings management (elias, 2002). in response to corporate scandals and financial fraud, researchers embarked upon research in earnings-management practices and corporate ethical values, similar to that of bruns and merchant (1990). the questionnaire of bruns and merchant (1990) was used by merchant and rockness (1994) where general managers, staff managers, operation-unit controllers, and internal auditors were sampled. rosenzweig and fischer (1994) found that respondents with more years of experience and higher levels of responsibility (partners) judged practices less harshly than accountants with less than six years experience and at the entry and junior levels. 100 sajems ns 13 (2010) no 1 fischer and rosenzweig (1995) surveyed undergraduate students, mba students, and practising accountants on their attitudes on the ethical acceptability of earnings-management practices and found that operating manipulations were judged less ethically by accounting practitioners. clikeman et al. (2001) surveyed students and made comparisons by culture, based on national origin, and gender. however, in their study, no significant differences were found. elias (2002) surveyed students, faculty, accountants in industry and certified public accountants (cpas) and reported that accountants in practice were more lenient than accounting students and faculty were. in many companies, concern for the bottom line or ‘making the numbers’ seems to override any concern for ethical values (verschoor, 2002). priest (2002) notes that unethical earningsmanagement practices could be attributed to the failure of corporate ethics. furthermore, khaled elmoatasem abdelghany (2005) found that companies should apply more than one measure for the quality of earnings, as management may manipulate the earnings to achieve predetermined targets. karassavidou and glaveli (2006) investigated the ethical orientation of undergraduate business students in greece. the authors (karassavidou & glaveli, 2006) found that academic dishonesty is positively related to students’ attitudes towards unethical managers’ behaviour in the business context and that females appear to have higher ethical standards. deloitte and touche (2002) list the core values of a company as ‘integrity, objectivity, independence and technical excellence’ and that the foundation of a company is employees with strong values. they also highlight the importance of the individual values of employees. accordingly, deloitte and touche (2002) aims to employ outstanding professionals and instil in their employees the sense that they must always act with integrity and to do what is right. but, as scandals of public companies become exposed, it becomes evident that people and not accounting are responsible for the major losses suffered by innocent investors. where people are to blame, the assumption can be made that they are people with poor ethical values and integrity (akers et al., 2004). however, although a professional code of conduct exists to deal with the behaviour of the accounting profession, an individual’s behaviour is still affected by his or her personal values, because behaviour is influenced by personal values and not by a code of ethics (eaton & giacomino, 2000, 2001). therefore, having a code of ethics is not enough or has little meaning (verschoor, 2002; boyd, 2004). this is evident in the arthur andersen case (akers et al., 2004) where toffler, a former partner of arthur andersen, points out that most companies have codes of ethics and that corporate values are guided by honesty, integrity, trust, respect and possibly commitment or teamwork. however, the results turned out differently. woo (2003) agrees and states that knowing what is right is not the same as doing what is right. business ethics has consequences for the accounting educators as the values extolled by educators may also not necessarily be internalised by students. in this regard, many business schools have initiated new business ethics courses, developed cases, conducted workshops and held seminars in ethics. woo (2003), however, raises the question whether business schools can teach mba students right from wrong when the average student is between 26 and 28 years old. courses in ethics should be included in undergraduate studies. giacomino et al. (2006) surveyed students and business managers to measure their perception of specific earnings-management actions. the questionnaire was similar to that used by bruns and merchant (1990) but included 20 items relating to ten earnings-management practices. the aim was to propose a methodology to incorporate in accounting programmes to measure and change students’ personal values. this study proceeds with a similar study as giacomino et al. (2006) to survey short-term earnings-management practices. 3 research methodology the main objective of this study was to conduct a survey of students at the nelson mandela sajems ns 13 (2010) no 1 101 metropolitan university (nmmu), and of business managers to measure their perceptions about the morality of specific earningsmanagement actions. the aim of the study was to determine whether students and business managers have different views about the ethics of earnings-management practices and to determine if the perceptions of respondents differ by gender. 3.1 the research questionnaire the questionnaire involved practices of shortterm earnings-management and was completed by 360 respondents. the practices involved the choice and timing of operating events and the choice and timing of recognition of specific revenues and expenses. the same questionnaire was used as in the giacomino et al. (2006) survey. no additional questions were raised and no wording was changed, however, the currency ($) was changed to rand (r). the respondents were informed that the questionnaire referred to a r1 billion company consisting of different divisions. each division had a turnover of r100 million and net profits before taxation of r12 million with a januarydecember financial year. the respondents were required to rate each question on a five-point likert scale ranging from 1 to 5 as follows: 1 = ethical practice. 2 = questionable practice. i would not say anything to the person involved, but it makes me uncomfortable. 3 = minor infraction. the person should be warned not to engage in the practice again. 4 = serious infraction. the person should be severely reprimanded. 5 = totally unethical. the person should be fired. in table 1, 20 actions related to ten earningsmanagement practices are listed. annexure 1 depicts the actual questionnaire given to the respondents. table 1 short-term earnings-management practices action short-term earnings-management practices 1. paint ahead of schedule. 2a. defer discretionary expenses to meet quarterly budget. 2b. defer discretionary expenses to meet annual budget. 3. defer discretionary expenses to meet annual budget. 4a. credit that has more liberal terms to reach budget target. 4b. work overtime to reach budget target. 4c. sell excess assets to reach budget target. 5a. prepay expenses to reduce income by r60 000. 5b. increase reserve for inventory obsolescence; reduce income r700 000. 6a. reduce reserve for inventory obsolescence to continue work. 6b. reduce reserve for inventory obsolescence to meet budget target. 7. bury scrap costs in ‘other expenses’, no income effect. 8a. request deferred billing for supplier, r30 000. 8b. request deferred billing from supplier, r500 000. 9a. raise return forecast from 22% to 35%, actual 22%. 102 sajems ns 13 (2010) no 1 9b. raise return forecast from 22% to 35%, actual 35%. 10a. accelerate delivery to customer by 3 days. 10b. accelerate delivery to customer by 16 days. 10c. accelerate delivery to customer by 28 days. 10d. accelerate delivery to customer by 42 days. 3.2 research method this study is a descriptive study in which a questionnaire was used to determine the perceptions of two groups of people, business managers and students, and to determine if the perceptions of respondents differ by gender. as students are potential business managers, this has implications for accounting education as it is not enough to make students merely aware of ethical issues but to include ethics in accounting studies. it is, therefore, of interest to research the morality perceptions of students and business managers on specific earningsmanagement actions. table 2 provides a breakdown of the respondents by group and gender. a total of 96 business managers (including 15 chartered accountants) and 264 students were included in the survey. qualified chartered accountants in port elizabeth and mba students at the nmmu represented business managers, and the second group, the students, were represented by second and third year financial accounting students at the nmmu, enrolled in national diploma (nd) programmes with financial accounting as one of their major subjects. table 2 demographic data of the respondents respondents demographic data of the respondents groups students 259 business managers (bm) 94 not answered (5 students; 2 bm) 7 total 360 gender male 179 female 135 not answered 46 total 360 3.3 the results the frequency distribution of the responses were firstly calculated in total and then by group, for each of the twenty earnings-management actions. secondly, the mean value of each action was calculated and the responses categorised from ‘totally unethical’ to ‘ethical practice’. an analysis of variance (t-test) was then used to measure the differences between the respondents. the overall response showed a significant lack of agreement. secondly, the dispersion of ratings varied considerably. furthermore, based on the mean values and the frequency distributions of the responses in table 3, it was found that: sajems ns 13 (2010) no 1 103 • no practice was rated as ‘totally unethical’, with a mean above 4.5 • not one practice was found to be an ‘ethical practice’ with a mean below 1.5 • three of the 20 practices were rated as a ‘serious infraction’ with a mean between 3.5 and 4.5 • twelve practices were rated as a ‘minor infraction’ with a mean between 2.5 and 3.5 • five practices were rated as a ‘questionable practice’ with a mean between 1.5 and 2.5. table 3 rating of earnings-management actions ethical categories action mean std dev totally unethical none serious infraction bury scrap costs in ‘other expenses’, no income effect (7). 3.8902 1.2601 request deferred billing from supplier, r500 000 (8b). 3.7623 1.1813 defer supplies expenses by delaying recording invoice (3). 3.5356 1.2321 minor infraction accelerate delivery to customer by 42 days (10d). 3.2960 1.3144 increase reserve for inventory obsolescence, reduce income r700 000 (5b). 3.2229 1.1338 request deferred billing for supplier, r30 000 (8a). 3.2054 1.1729 defer discretionary expenses to meet annual budget (2b). 3.1838 1.2452 raise return forecast from 22% to 35%, actual 22% (9a). 3.1807 1.2157 accelerate delivery to customer by 28 days (10c). 3.0438 1.3840 defer discretionary expenses to meet quarterly budget (2a). 2.9848 1.1931 reduce reserve for inventory obsolescence to continue work (6a). 2.9554 1.1924 prepay expenses to reduce income by r60 000 (5a). 2.8905 1.3577 raise return forecast from 22% to 35%, actual 35% (9b). 2.8903 1.2377 accelerate delivery to customer by 16 days (10b). 2.8156 1.0566 reduce reserve for inventory obsolescence to meet budget target (6b). 2.7025 1.3021 questionable practice credit that has more liberal terms to reach budget target (4a). 2.4673 1.1404 accelerate delivery to customer by 3 days (10a). 2.4585 1.2105 sell excess assets to reach budget target (4c). 2.4000 1.3228 work overtime to reach budget target (4b). 2.1927 1.1838 paint ahead of schedule (1). 1.8720 1.0920 ethical practice none 104 sajems ns 13 (2010) no 1 based on the mean values, it seems that the respondents do not support the acceptability of these practices, since not one practice was deemed an ‘ethical practice’. for the five practices that were viewed as ‘questionable practices’, the respondents would not say anything to the person involved, although it made them uncomfortable. in addition, for the 12 practices categorised as ‘minor infractions’, the respondents believed that the person involved should be warned not to engage in the practice again. for the three practices rated as ‘serious infractions’, the respondents believed that the person involved should be severely reprimanded and, finally, not one practice was rated as ‘totally unacceptable’ and, therefore, no-one would be fired. some of the earnings-management actions are rated by the respondents as ethical, whereas others are unethical, some being to a certain degree unethical. giacomino et al. (2006) found that respondents were influenced by dollar amounts, timing of transactions and the methods used in the practices. in this study it was also interesting to find how respondents were affected by qualifiers in some of the practices. for many of the practices, it was found that respondents were influenced by the method, purpose, materiality and timing of the action. managing short-term earnings by accounting methods was viewed less favourably than changing operating decisions or procedures. painting ahead of schedule (action 1) was rated as ‘questionable’ whereas expenses postponed into the next quarter (action 2a) was rated as a ‘minor infraction’. furthermore, the method used by increasing profits by offering extended credit terms (action 4a; mean 2.4673) was viewed as less acceptable than increasing earnings by working overtime (action 4b; mean 2.1927) or selling off excess assets (action 4c; mean 2.4). the direction or effect on earnings was viewed less favourably if earnings increased than when earnings decreased. paint ahead of schedule (action 1) was rated more favourably than increasing earnings by postponing expenses to the next financial period (action 2b). in actions 8a (request deferred billing for supplier, r30 000) and 8b (request deferred billing for supplier, r500 000), materiality became a factor. where the amount involved is r30 000, the respondents rate action 8a as a ‘minor infraction’ (3.2054). however, where the amount is r500 000 in action 8b, it is rated as a ‘serious infraction’ (3.7623). similarly with the timing of transactions, where the delivery date was accelerated in excess of 3 days (action 10a), the earnings-management practice was viewed more seriously and rated as a ‘serious infraction’ in actions 10b (16 days), 10c (28 days) and 10d (42 days). similarly, managing short-term earnings at the end of an interim quarterly report is viewed as more acceptable (2.9848) than engaging in the same activity at the end of the financial year (3.1838). table 4 outlines the mean values of the survey to investigate significant differences by gender and by group. table 4 mean values of significant differences by group and by gender (t-test) action group gender s bm m f 1 paint ahead of schedule. 1.8529 1.9239 1.9709 1.7846 2a defer discretionary expenses to meet quarterly budget. 2.9091 3.0879 2.9880 2.9380 2b defer discretionary expenses to meet annual budget. 3.1360 3.2209 3.1768 3.1613 3 defer supplies expenses by delaying recording invoice. 3.4880 * 3.6596 3.5028 3.4853 sajems ns 13 (2010) no 1 105 4a credit that has more liberal terms to reach budget target. 2.4142 2.6444 2.4737 2.4077 4b work overtime to reach budget target. * 2.2586 2.0341 2.2426 2.1339 4c sell excess assets to reach budget target. 2.4292 2.3034 2.4162 2.3609 5a prepay expenses to reduce income by r60 000. * 2.6815 3.4022 2.8914 2.9407 5b increase reserve for inventory obsolescence, reduce income r700 000. 3.0905 * 3.5275 3.1618 3.2782 6a reduce reserve for inventory obsolescence to continue work. 2.7615 * 3.4333 2.8947 2.9466 6b reduce reserve for inventory obsolescence to meet budget target. 2.3857 * 3.4535 2.7250 2.7154 7 bury scrap costs in ‘other expenses’, no income effect. 3.7984 4.1648 3.9379 3.8284 8a request deferred billing for supplier, r30 000. 3.0886 * 3.5217 3.2670 3.1985 8b request deferred billing from supplier, r500 000. 3.7336 * 3.8409 3.8721 3.6504 9a raise return forecast from 22% to 35%, actual 22%. 3.0043 * 3.6889 3.0983 3.3030 9b raise return forecast from 22% to 35%, actual 35%. 2.7009 * 3.3750 2.8929 2.9440 10a accelerate delivery to customer by 3 days. 2.3421 * 2.7692 2.4524 2.5194 10b accelerate delivery to customer by 16 days. 2.7422 * 3.0337 2.8606 2.8031 10c accelerate delivery to customer by 28 days. 2.9333 * 3.2921 3.0904 2.9843 10d accelerate delivery to customer by 42 days. 3.2345 * 3.4270 3.2754 3.3622 * difference in mean values, using the t-test, is significant at 5 per cent level. 3.4 comparing differences between gender it was found that for most of the earningsmanagement practices, the males viewed the practices less favourably than the females did. when comparing the responses by gender, it was found that males have stricter views than females for 13 of the 20 practices (the mean values of male respondents were higher than the mean values of females). in seven of the 20 practices females had higher mean values than male respondents, and in six cases female 106 sajems ns 13 (2010) no 1 and male respondents rated the earningsmanagement actions the same. not one of 20 actions has a significant difference between genders. therefore, it can be said that there are no significant differences by gender regarding the ethicality of the 20 earnings-management practices. both clikeman et al. (2001) and giacomino et al. (2006) reach similar findings from their surveys. 3.5 comparing differences between groups with respect to group differences, the results show that for most of the short-term earningsmanagement practices the business managers tended to view the practices less favourably than the students did. business managers have a stricter view than the students do in 18 of the 20 practices, whereas students viewed only two practices more strictly. fourteen practices were significantly different (p>0.05). for the two practices where the students had the stricter views, only one was significant. therefore, the assumption can be made that there are significant differences between business managers and students regarding the ethicality of earningsmanagement practices. giacomino et al. (2006) found undergraduate students to be stricter than business managers were. a total of 360 respondents completed the survey and the greatest concern of the findings was the total lack of agreement. based on the mean values, not one action was unanimously rated as either ethical or unethical, but varied from ‘serious infractions’ to ‘questionable practice’. therefore, the judgements about all earnings-management practices varied considerably. 4 conclusions and recommendations earnings figures should have integrity and should not be the product of manipulations with the intention to purely increase the reported income of a company. they should also be reliable, in the sense that they must be an indication of the quality of earnings and future earnings (bernstein & siegel, 1979). casual observers of the financial reporting process may assume that time, laws, regulations and accounting standards have restricted accounting practices to those that are moral, ethical, fair and precise. but most managers know that managing short-term earnings can be part of their job (bruns & merchant, 1990). in this study, it was found that there is a high level of disagreement among business managers and students regarding which short-term earnings-management practices are ethical. business managers generally took a stricter position than students did. students tended to judge the practices more ethically than business managers did, whereas males were inclined to view the practices less favourably ethically than females did. the results of this study represent a case study only where accounting students and business managers have been surveyed. the results of this study may enable accounting educators to understand what students feel and how they may react to such earning-management practices. furthermore, the results of this study need to be interpreted in the light of possible weaknesses. first of all, the respondents in this study may not be representative of students and business managers in south africa. business managers were found to have stricter views than students do. this may be a due to the fact that students have fewer risks than business managers and also the possibility that students may not fully understand the wording of the questionnaire on earnings-management practices. furthermore, accounting students have no prior business ethics education. the results of this study, similar to those of other studies (fischer & rosenzweig, 1995; giacomino et al., 2006), have implications for academia. accounting students need more exposure and understanding of earningsmanagement. there should also be regular reports of fraudulent practices as a result of earnings-management by the media and academic journals. fischer and rosenzweig (1995) suggest that greater emphasis be placed in the accounting curricula on earningsmanagement practices. although difficult, it should be integrated into business courses or a separate business ethics course or an sajems ns 13 (2010) no 1 107 accounting course taught by accounting and ethics academia. in this regard the south african institute of chartered accountants (2007) states in their education policy that the education and training of professional accountants must provide a foundation of knowledge, skills and professional values and ethics that will enable students to continue to learn and adapt to changes throughout their professional lives. giacomino et al. (2006) suggest that the ‘real-world’ aspects of earnings-management practices be enhanced and that experienced business professionals become an integral part of accounting courses. differences between business managers and students should be minimised as conflicting opinions begin to develop during undergraduate business education. students appear to begin adopting the attitudes of their professional reference groups before they even commence their professional careers. by using experienced professionals during lectures and by making discussion of earning more realistic, the differences between students and business managers may be reduced. since the study by bruns and merchant (1990), research regarding the morality of earnings-management practices has increased. the importance of ethical practices has been recognised owing to the highly publicised financial failures and frauds such as enron and worldcom, and subsequent legislation to comply with, for example, sarbanes-oxley and corporate governance. this study can serve as a starting point and the survey can be repeated in later years to determine if there are changes in the ethical views of accounting students. furthermore, if courses are introduced to address aspects of earnings management, a survey can determine whether it contributed towards changing the ethical views of the students or if there is still room for improvement. however, woo (2003) questions whether ethical courses included in curricula will support accounting students to have the will to do what is right once they are in the corporate setting. the enron and worldcom scandals and the demise of arthur anderson have received worldwide publicity. since then, there has been a demand for sound accounting practices and corporate governance. however, it is also important to determine whether the scandals and pressures to adhere to corporate governance have changed views on moralities regarding earnings-management practices. in this regard, harmonising reward structures with ethical principles is an area where management accountants and financial managers can provide guidance (verschoor, 2002). bruns and merchant (1990) suggest the key to moral behaviour is the obligation to look beyond self-interest and to focus on the concerns of others. the morality of doing otherwise is questionable. deloitte and touche (2002) highlight the importance of the individual values of employees. values and responsible behaviour can be reinforced through a company’s procedures, policies and training so that when staff members encounter challenging situations at work, they should be guided by these values (messmer, 2003). references akers, m.d., eaton, t.v. & giacomino, d.e. 2004. measuring and changing the personal values of accounting students. journal of college teaching & learning, 1(4): 63–70. bernstein l.a. & siegel, j.g. 1979. the concept of earnings quality. financial analysts journal, 35:72–75. boyd, c. 2004. the last straw. business ethics quarterly, 13(3): 581–592. bruns, w.j. & merchant, k.a. 1990. the dangerous morality of managing earnings. management accounting, 72(2): 22–25. clikeman, p., geiger, m. & o’connell, b. 2001. student perceptions of earnings management: the effects of national origin and gender. teaching business ethics, 5(4): 389–410. comunale, c.l., sexton, t.r. & gara, s.c. 2006. professional ethical crises. a case study of accounting majors. managerial auditing journal, 21(6): 636–656. deloitte & touche. 2002. integrity & quality. new york: deloitte & touche llp. eaton, t.v. & giacomino, d.e. 2000. personal values of business students: differences by gender and discipline. research on accounting ethics, 7: 83–102. eaton, t.v. & giacomino, d.e. 2001. an examination of personal values: differences between 108 sajems ns 13 (2010) no 1 accounting students and managers and differences between genders. teaching business ethics, 5: 213–229. elias, r. 2002. determinants of earnings management ethics among accountants. journal of business ethics, 40(1): 33–45. fischer, m. & rosenzweig, k. 1995. attitudes of students and accounting practitioners concerning the ethical acceptability of earnings management. journal of business ethics, 14(6): 433–444. giacomino, d.e., bellovary, j.l. & akers, m. 2006. the ethics of managing short-term earnings: business managers and business students have few problems with earnings management practices. journal of college teaching & learning, july: 57–71. healy, p.m. 1985. effects of bonus schemes on accounting decisions. journal of accounting and economics, 7(1-3): 85–107. harvard business review. 1989. ethics test for everyday managers. harvard business review, march–april: 220–221. kaplan, s. 2001. ethically related judgements of observers of earnings management. journal of business ethics, 32(4):285–298. karassavidou, e. & glaveli, n. 2006. towards the ethical or the unethical side? an explorative research of greek business students’ attitudes. international journal of educational management, 20(5): 348–364. khaled elmoatasem abdelghany. 2005. measuring the quality of earnings. managerial auditing journal, 20(9): 1001–1015. merchant, k.a. & rockness, j. 1994. the ethics of managing earnings: an empirical investigation. journal of accounting and public policy, 13: 79–94. messmer, m. 2003. does your company have a code of ethics? strategic finance, april:13–14. priest, s. 2002. the disconnect in ethics training. across the board, 39(5): 51–52. rosenzweig, k. & fischer, m. 1994. is managing earnings ethically acceptable? management accounting, 75(9): 31–34. saica. 2007. saica in search of excelling accounting students. available at: https://www.saica.co.za/default. asp?redir=%2fdisplaycontent%2easp%3fcontentp ageid%3d979 [accessed 12 july 2007]. verschoor, c. 2002. it isn’t enough to just have a code of ethics. strategic finance, december: 22–24. woo, c.j. 2003. personally responsible. bized, may/ june: 22–27. acknowledgement professors don giacomino and michael akers are specially acknowledged for encouraging and initiating this study. sajems ns 13 (2010) no 1 109 annexure 1 questionnaire on ethics this questionnaire includes short descriptions of a variety of actions that individuals have taken. some of these actions are clearly ethical. others are judged by some or most people to be unethical, and the judgments as to the degree of severity of the infraction can vary widely. please indicate your judgment as to the acceptability of each of the practices using the following scale: 1. ethical practice 2. questionable practice. i would not say anything to the person involved, but it makes me uncomfortable. 3. minor infraction. the person should be warned not to engage in the practice again. 4. serious infraction. the person should be severely reprimanded. 5. totally unethical. the person should be fired. (assume that the divisions referred to are part of a r1 billion corporation, which has a january–december financial year. each division has annual sales of r100 million, with annual before-tax operating profit of r12 million.) answer each question separately. (assume the incidents are independent.) questionnaire on ethics ethical practice totally unethical action 1 2 3 4 5 1. the division’s buildings were scheduled to be painted in 2002. since the division’s profit performance was way ahead of budget in 2001, however, the division general manager (gm) decided to have the work done in 2001. amount: r150 000. 1 2 3 4 5 2. the gm instructed his employees to defer all discretionary expenditures (e.g., travel, advertising, hiring, maintenance) into the next accounting period so that his division could make its budgeted profit targets. expected amount of deferral: r150 000. a. the expenses were postponed from february and march to april in order to make the first quarter target. 1 2 3 4 5 b. the november and december expenses postponed to january in order to make annual target. 1 2 3 4 5 3. on december 15, a clerk in the division placed an order for r3 000 worth of office supplies and the supplies were delivered on december 29. this order was a mistake because the division gm had ordered that no discretionary expenses be incurred for the remainder of the fiscal year, and the accounting policy manual states that office supplies are to be recorded as an expense when delivered. the division gm learned what had happened, however, and to correct the mistake, he ordered the accounting department not to record the invoice until february. 1 2 3 4 5 110 sajems ns 13 (2010) no 1 4. in september, a gm realized that the division would need strong performance in the last quarter of the year in order to reach its budget targets. a. he decided to implement a sales program offering liberal payment terms to pull some sales that would normally occur next year into the current year; customers accepting delivery in the 4th quarter would not have to pay the invoice for 120 days. 1 2 3 4 5 b. he instructed manufacturing to work overtime in december so that everything possible could be shipped by the end of the year. 1 2 3 4 5 c. he sold some excess assets and realized profit of r40 000. 1 2 3 4 5 5. at the beginning of december 2001, a gm realized that the division would exceed its budgeted profit targets for the year. a. he ordered his controller to prepay some expenses (e.g., hotel rooms, exhibit expense) for major trades show to be held in march 2002 and to book them as 2001 expense. amount: r60 000. 1 2 3 4 5 b. he ordered his controller to develop the rationale for increasing the reserve for inventory obsolescence. by taking a pessimistic view of future market prospects, the controller was able to identify r700 000 worth of finished goods that conservative accounting would say should be fully reserved (i.e., written off), even though the gm was fairly confident the inventory would still be sold at a later date at close to full price. 1 2 3 4 5 6. the next year, the division described in question 5b sold 70 per cent of the written-off inventory, and a customer had indicated some interest in buying the rest of that inventory the following year. the gm ordered his controller to prepare the rationale for reducing the reserve for obsolescence by r210,000 (i.e., writing up the previously written-off goods to full cost). the gm’s motivation for recapturing the profit was: a. to be able to continue working on some important product development projects that might have had to be delayed due to budget constraints. 1 2 3 4 5 b. to make budgeted profit targets. 1 2 3 4 5 7. in july 2002, a gm noticed that scrap costs in the plant were running way ahead of plan. so that senior management would not become alarmed, he instructed his controller to “bury” most of the scrap costs in other expense accounts where they would not be noticed. over the remainder of the year, the controller buried approximately r60,000 of scrap costs. effect on net income: zero. 1 2 3 4 5 sajems ns 13 (2010) no 1 111 8. in november 2001, a division was straining to meet budget. the gm called the engagement partner of a consulting firm that was doing some work for the division and asked that the firm not send an invoice for work done until the next financial year. the partner agreed. estimated work done but not invoiced: a. r30 000 1 2 3 4 5 b. r500 000 1 2 3 4 5 9. a gm had an idea for a new product. she asked her marketing people to conduct some focus group interviews and a field study to determine the market potential, and she asked her controller to estimate the costs of entering the market. the projections promised only a 22 per cent return when the desired return for his business was 35 per cent. however, still convinced that the product was a good idea, the manager “jacked up” the sales projections and “shaved” the cost estimates to show a forecasted 35 per cent return. the gm’s superiors were preoccupied with other problems, and they did not question the projections. thus the new product was approved. a. after six months of sales, the product earned a 22 per cent return. 1 2 3 4 5 b. after six months of sales, the product earned a 35 per cent return. 1 2 3 4 5 10. at the end of december, a division was struggling to meet its profit targets. the gm told his production manager to ship some customer orders early so that the associated revenue and profits could be recognized in the current year. the items were in inventory, and expected delivery times were two days. the customers’ firm delivery dates were: a. january 3 1 2 3 4 5 b. january 14 1 2 3 4 5 c. january 28 1 2 3 4 5 d. february 12 1 2 3 4 5 demographics: gender: female male qualification: microsoft word 5 barros & wanke sajems 19(1) 2016.docx 64 sajems ns 19 (2016) no 1:64-81 how to cite doi: http://dx.doi.org/10.17159/2222-3436/2016/v19n1a5 issn: 2222-3436 cost efficiency of african insurance companies using a finite mixture model carlos barros iseg – lisbon school of economics and management; ulisboa and cesa – research centre on african, asian and latin american studies peter wanke coppead business school, federal university of rio de janeiro accepted: april 2015 this paper evaluates the operational practices by african insurance companies from angola and mozambique, using a finite mixture model that allows controlling for unobserved heterogeneity. more precisely, a stochastic frontier latent class model is adopted in this research to estimate the cost frontiers for each of the different technologies embedded in this heterogeneity. this model not only enables the identification of different groups of african insurance companies from angola and mozambique, but it also permits the analysis of their cost efficiency. the results indicate the existence of three different technology groups in the sample, suggesting the need for different business strategies. the policy implications are also derived. key words: africa; insurance companies; stochastic cost frontier; latent class model, technical efficiency; panel data jel:g22, 14, l1 1 introduction this study paper aims to contribute to the literature by analysing the efficiency of a sample of african insurance companies from angola and mozambique, as internalisation is a growing trend in this sector (outreville, 2008). in particular, panel data from 2002-2012 is used to analyse the cost efficiency frontier of the insurance industry in these countries, as well as the different production technologies embedded within them. traditionally, there are two major approaches to estimating efficiency levels with respect to productive frontiers: the parametric (stochastic frontier model sfa) and the non-parametric approach (data envelopment analysis dea). while the former is based on econometric techniques and has to specify a functional form for production technology, the latter does not demand the a priori use of a functional form. it is also capable of handling multiple outputs. the non-parametric approach, however, presents some restrictions, such as the vulnerability noted in its outcomes, which are a result of deviant observations. more precisely, the contributions of this research to the current body of knowledge on productive efficiency in the insurance sector are threefold. first, this research fills a gap in the literature by analysing insurance companies in angola and mozambique, because, to the best of our knowledge, no papers have been published on this subject. on the one hand, the relevance of filling this gap in the literature is based on the importance of these two countries in the world economy. according to grande and teixeira (2012), an analysis by the economist (2011) finds that, over the last decade, no fewer than six of the world’s ten fastest-growing economies are in sub-saharan africa, including angola, which is ranked in first place, and mozambique, which is ranked eighth. on the other hand, this literature gap contrasts with already published research on insurance companies in other african countries (munro & snyman, 1995; giesbert, steiner & bending, 2011; uche, 1999; chourouk, 2003; ibiwoye & adeleke, 2008; olaosebikan, 2012). abstract sajems ns 19 (2016) no 1:64-81 65 second, this research contributes to the literature on productive efficiency in the insurance sector by assuming that technology can vary within the analysed sample. this differs from what is to be found in previous studies. it is remarkable that all the current literature about insurance company efficiency assumes that insurance companies generally use the same technology, regardless of the approach followed, whether it be parametric, or non-parametric. if this assumption is incorrect, then it could lead to the overestimation of the inefficiency of some insurance companies, as technological differences could be interpreted as inefficiency (orea & kumbhakar, 2004). given this, a stochastic frontier latent class model is applied in this research to control for unobserved heterogeneity (orea & kumbhakar, 2004; greene, 2005). this model assumes that there is a finite number of classes using different technologies and that each unit can be assigned to a particular group, using the estimated probabilities of class membership. moreover, the number of different groups is also tested by estimation. this study therefore includes all the types of insurance companies, both life and non-life companies, that exist in the countries analysed, enabling a control for unobserved heterogeneity which underlies different productive technologies. third, this research contributes to the literature by proposing a model that accounts for the specifics of the insurance sector, using angola and mozambique as a base case. insurance is one of the industries in which capital presents the highest marginal productivity. under these circumstances, cost frontiers become quite sensitive to outliers (amores & raa, 2014). hence, sfa is adopted here, rather than dea, as the latter is more affected by influential observations than is the former. this occurs because sfa handles all the variations between production units in the form of random terms, contrary to the case of dea, where such variations are interpreted as inefficiency. these features are relevant for this research, as randomness is a primary property of several production processes, including insurance. the remainder of the paper is organised as follows. after this introduction, the contextual setting of angolan and mozambican insurance companies is presented, followed by a literature review of the previous studies conducted on productive efficiency in this sector. after this, the methodology is discussed, followed by the presentation of the data analysis and the major results. the paper ends with the conclusions. 2 contextual setting 2.1 insurance in angola the insurance industry in angola comprises eight companies: ensaempresa nacional de seguros de angola, a public company owned by the government; aaa, angola agora e amanhã, pensões, a company with public and private local capital; nossa seguros, a private insurance company owned by local angolans; global alliance seguros angola, a south african insurance company with offices in angola and mozambique; global seguros, a private company owned by angolans; mundial seguros; garantia; and universal. the last three are private companies owned jointly by local angolans and portuguese insurance companies. the insurance industry in angola is small, accounting for just 1.25 per cent of gdp in 2012. however, the number of companies has increased over the period under study and new agencies are opening in remote areas of the country. this growth has accompanied the growth rate of the angolan economy. in 2010, a total of 10 insurance companies were already established in angola, with a further five in the process of being licensed. in relative terms, non-life insurance represents 90 per cent of the total market. the publication of decree law nº35/09 requires compulsory motor general liability insurance, which boosted the growth of the market. this sector accounted for 27.8 per cent of the market total in 2010, followed by accident, health and travel insurance, which together account for 26.4 per cent. however, a decrease in the market share of non-life insurance companies is forecast, in line with other insurance markets, which is a result of the development of a rise in sales of products of a financial nature. furthermore, the share from petrochemical insurance has proportionally decreased with the growth in the other sectors. 66 sajems ns 19 (2016) no 1:64-81 2.2 insurance in mozambique the mozambican insurance industry comprises five companies: emose – empresa moçambicana de seguros, a public company; sim seguradora international de mozambique, a private company and; global alliance seguros mozambique, a private south african company which is also present in angola and has banks in angola and mozambique; hollard mozambique companhia de seguros, another south african insurance company; and finally mcs, mozambique companhia de seguros, a private company owned by local capital. the mozambique insurance industry is also small. in 2012 it represented 1.15 per cent of gdp, which is comparable, in relative terms, to the angolan market. the difference in the number of companies in both countries is directly linked to angola’s wealth in terms of oil and diamonds, which attracts more foreign companies. this can be seen in table 1 below, which presents some characteristics of the companies analysed. the mozambique insurance market grew by 2.5 per cent in 2012, with non-life premiums rising by 2.3 per cent. the non-life insurance market represents 55 per cent of the total market, 55 per cent of which is fire and car insurance, whereas life insurance accounts for a smaller share of the market (44.9 per cent). currently there are 17 insurance companies, some of which manage pension funds: sim, emose, global alliance, hollard seguros mozambique, companhia de seguros de africa and mozambique resseguros sa. table 1 mean values for the sample (2012) observation number country company number of employees 1 angola ensa 24 2 angola aaa 18 3 angola nassa 65 4 angola global alliance-angola 25 5 angola global 100 6 angola mundial 629 7 angola garantia 256 8 angola universal 150 1 moza emose 314 2 moza sim 157 3 moza global alliance-mozambique 108 4 moza hollard 61 5 moza mcs 29 3 literature review this section presents a synthesis of the studies previously conducted into the insurance industry in different countries, regardless of the approach adopted. as briefly mentioned in the introduction, two alternative approaches have been followed to analyse productivity and efficiency in insurance in the past: sfa (fenn, vencappa, diacon, klumpes & o’brien, 2008; ennsfellner, lewis & anderson, 2004; fecher, kessler, perelman & pestieu, 1993; cummins & weiss, 1993; gardner & grace, 1993) and the non-parametric dea (barros, nektarios & assaf, 2010; mahlberg & url, 2010; cummins & xie, 2008; barros, barroso & borges, 2005; cummins, rubio-misas & zi, 2004; mahlberg & url, 2003; diacon, starkey & o’brien, 2002; cummins, weiss & zi, 1999; cummins & zi, 1998; fukuyama, 1997; cummins, turchetti & weiss, 1996; biener & eiling, 2011). it is worth noting that the literature on productive efficiency in the insurance industry is scarce in comparison with other financial areas, such as banking. however, it presents a large heterogeneity, not only in terms of the models used within each approach, whether it be parametric sajems ns 19 (2016) no 1:64-81 67 or non-parametric, but also in terms of the research subjects analysed and the hypotheses tested, according to the comprehensive study conducted by eling and luhnen (2010). general-purpose and/or comparative studies on the efficiency of the insurance sector in a given country or region are the most numerous in the literature. for example, bertoni and croce (2011) applied dea to a panel of life insurance companies operating in five european countries (germany, france, italy, spain and the u.k.) between 1997 and 2004. the authors estimated productivity with a malmquist efficiency model, concluding that productivity increased on an annual basis by 6.71 per cent and that this increase was mostly owing to innovation (technological change) in best-practices (6.67 per cent), while best-practice management practices contributed a mere 0.04 per cent. nektarios and barros (2010) analysed the efficiency of greek insurance companies during the period 1994-2003 and found that greek life insurance companies’ productivity growth was 16.1 per cent, followed by non-life insurance companies, which had a productivity growth of 6.5 per cent. mixed insurance companies experienced a productivity growth of 3.3 per cent. mahlberg and url (2010) analysed the scale efficiency of the german insurance industry from 1991 through to 2006, showing that average productivity increased by 18 per cent. this growth was dominated by technical progress (+16 per cent) and higher scale efficiency (+11 per cent), while advances in pure efficiency turned out to be small (+5 per cent). studies on specific market niches in the insurance industry have attracted the attention of researchers, as have those which assess the impact of specific contextual, business-related variables on levels of efficiency. when it comes to specific market niches, such as property-liability and the non-life insurance sectors, luhnen (2009) analysed efficiency levels in the german property-liability insurance industry from 1995 to 2006. the author used a two-stage approach running dea in the first stage and then performing a bootstrapped truncated regression in the second, so as to analyse covariates which are able to explain efficiency. on the other hand, abdul kader, adams & hardwick (2010) studied the cost efficiency of non-life takaful insurance firms operating in 10 islamic countries. the author also adopted a two-stage approach, using dea first and then the tobit regression to test for the influence of corporate characteristics on these efficiencies. with respect to the impact of a specific contextual variable on efficiency scores, the role of corporate governance merited attention in two studies. xie, lu, reising & stohs (2011) used dea to examine the role of corporate governance in the u.s. life insurance industry during the 1990s and 2000s. their findings suggest that demutualisation is value-enhancing for firms being sold through initial public offerings (ipos), but is value-neutral for firms that convert, but remain private. firms converting into public companies experience increased ceo turnover that leads to efficiency improvement. corporate governance is also the subject of the study by hsu and petchsakulwong (2010), who examined its impact on the efficiency performance of public non-life insurance companies in thailand from 2000-2007. their results indicate that the characteristics of corporate governance influence the efficiency of the performance of non-life insurers. furthermore, the independence of the board, together with firm size has a positive impact on the efficiency of the performance of thai non-life insurance companies. however, the audit committee size, diligence, divergence between voting rights and cash flow rights, board tenure, board age, as well as board ownership have a negative impact on the efficiency performance. finally, there is an unclear relation between the efficiency of the performance by insurers and the size of their board, the proportion of financial expertise on an audit committee and the compensation to the board. specifically, with respect to african countries, fewer studies exist than expected and not even one discussed the insurance industry in angola and mozambique. these studies include those by: munro and snyman (1995), uche (1999), chourouk (2003), giesbert, steiner & bending, (2011) and chantarat, mude, barrett & carter, (2013). more recently, ibiwoye and adeleke (2008) applied a logistic regression to evaluate the participation in the nigeria national health insurance scheme by employees in the formal sector. the authors concluded that awareness was a major factor affecting participation in the scheme. olaosebikan (2012) examined the profitability of micro-life insurers in nigeria, using a dynamic panel data model, covering data from 2004 to 68 sajems ns 19 (2016) no 1:64-81 2009. the results indicate that the profitability of micro-life insurers is not influenced by factors such as ownership structure, leverage and the size of firms. profitability is found to be negatively related to the level of reinsurance. it is also interesting to note that the south african short-term insurance industry realises the importance of fostering consumer trust, which impacts its results (steyn, mostert & de jager, 2008). taking into account the scope of methodologies and the assumptions found thus far in the literature, this paper departs from previous studies in three respects. first, the method used here, to be discussed further in section 4, allows for the assumption of different production technologies within the sample. studies conducted so far within the ambit of the insurance industry have been based on the common ground of homogeneous production technology, making an assumption for a sector known to operate in several market niches. second, this study uses a more robust parametric methodology to handle simultaneously, in a one-step procedure, the impact of contextual and business-related variables on levels of efficiency. most previous studies relied on using nonparametric dea models with some regression procedure in a two-stage approach. third, this method also allows the clustering of companies, based not only on market-niche classifications, but rather on the distance of the cost efficient frontier. further details are given below. 4 methodology in this paper, we adopt the stochastic cost econometric frontier approach (kumbhakar & lovell, 2000). this approach, which was first proposed by farrell (1957), came to prominence in the late 1970s as a result of the work of aigner, lovell and schmidt (1977), battese and corra (1977) and meeusen and van den broeck (1977). a detailed presentation and discussion of their formulae can be found in ismail (2012). the frontier is estimated econometrically and it measures the difference between inefficient units and frontiers through residuals. this is an intuitive approach, which is based on traditional econometrics. if we assume that residuals have two components (noise and inefficiency), then the stochastic frontier model emerges. consequently, the main issue here is the decomposition of the error terms. let us present the model more formally. the general frontier cost function proposed by aigner et al. (1977) and meeusen and van den broeck (1977) is the following: 1,2, t n,1,2, i ; ).( texcc ituitvitit …=…== + (1) where cit represents a scalar cost of the decision-unit i under analysis in the t-th period; xit is a vector of variables, including input prices and the output descriptors present in the cost function; and εit = uit + vit is the error term. this term may be decomposed into two components: i) the error term vit is traditionally used in econometric models and is assumed to be independently and identically distributed, which represents the effect of random shocks (noise vit~n(0, σv²)) and is independent of uit ; ii) the inefficient term uit, represents technical inefficiencies and is assumed to be positive and normally distributed with a zero mean and variance of 2uσ . the positive disturbance uit is reflected in a half-normal independent distribution, truncated at zero, which signifies that each insurance company’s cost must lie on, or above, its cost frontier. this implies that any deviation from the frontier is caused by management factors controlled by the insurance companies. the total variance is defined as 222 uv σσσ += . the contribution of the error term to the total variation is as follows: )1/( 222 λσσ +=v . the contribution of the inefficient term is: )1/(. 2222 λλσσ +=u , where λ is defined as: sajems ns 19 (2016) no 1:64-81 69 v u σ σ λ = , which provides an indication of the relative contribution of u and v to ε = u + v. given that the estimation procedures of equation (1) merely yield the residual ε, rather than the inefficiency term u. this term in the model should be calculated indirectly (greene, 2001). in the case of panel data, such as those used in this paper, battese and coelli (1988) use the conditional expectation of uit, conditioned on the realized value of the error term )( ititit uv +=ε , as an estimator of uit. in other words, [ ]ititue ε/ is the mean productive inefficiency for the i-th insurance company at any time “t”. following orea and kumbhakar (2004), we can write equation (1) as a latent class frontier model: 1,2, t n,1,2, i ; .)( texcc jj it uitv jitjit …=…== + (2) where subscript “i” denotes the insurance company, “t” indicates time and “j” represents the different classes or groups. the vertical bar signifies that there is a different model for each class “j”, so each insurance company belongs to the same group during all the periods. assuming that v is normally distributed and that u follows a half-normal distribution, the likelihood function (lf) for each insurance company “i” at time “t” for group “j” is (cf. greene, 2004): ⎟ ⎟ ⎠ ⎞ ⎜ ⎜ ⎝ ⎛ φ φ == j jit j jjitj jjjitij xclf σ ε φ σ σελ λσβ . 1 . )0( )/.( ),,,( (3) where [ ] vjujjvjujjitjjitjit xc σσλσσσβε / , , 'ln 2/122 =+== − , while φ denotes the standard normal density and φ is the cumulative distribution function. the likelihood function for insurance company “i” in group “j” is obtained as the product of the likelihood functions for each period: ∏ = = it t ijtij lflf 1 (4) the likelihood function for each insurance company is obtained as a weighted average of its likelihood function for each group j, using as weights the prior probabilities of class j membership. ∑ = = j j ijiji lfplf 1 (5) the previous probabilities must be within the unit interval: 10 ≤≤ ijp . further, the sum of these probabilities for each group must be one: ∑ = j ijp 1 . in order to satisfy these two conditions, we parameterised these probabilities as a multinomial logit, which is: )exp( )exp( 1 i j j j ij ij q q p ∑ = = δ δ (6) where the qi is a vector of variables which are used to split the sample and δj is the vector of parameters to be estimated. one group is chosen as the reference in the multinomial logit. the overall log-likelihood function is obtained as the sum of the individual log-likelihood functions: ∑ ∑ ∏∑ = = == ⎟ ⎟ ⎠ ⎞ ⎜ ⎜ ⎝ ⎛ == n i n i t t ijt j j iji lfplflf 1 1 11 lnlnln (7) 70 sajems ns 19 (2016) no 1:64-81 the log-likelihood function can be maximized with respect to the parameter set ),,,( jjjjj δλσβθ = , using conventional methods (greene, 2004). furthermore, the estimated parameters can be used to estimate the posterior probabilities of class membership, using the bayes theorem: ∑ = = j j ijij ijij lfp lfp ijp 1 )( (8) an important issue in these models is how to determine the number of classes. the usual procedure is to estimate several models with different numbers of groups and then use a statistical test to choose the preferred model. greene (2005) proposed testing ‘down’, by which, beginning from a j* known to be at least as large as the true j, one can test down, given that the j-1 class model is nested with the j class model, imposing θj= θj-1, based on likelihood ratio tests 1. an alternative is to use information criteria, such as the akaike information criterion (aic), or the schwarz bayesian information criterion (sbic). these statistics are calculated using the following expressions: mnjlfsbic ⋅+⋅−= )log()(log2 (9) mjlfaic ⋅+⋅−= 2)(log2 (10) where lf(j) is the value that the likelihood function takes for j groups, m is the number of parameters used in the model and n is the number of observations. the preferred model will be the one for which the value of the statistic is the lowest. based on the panel data, this paper presents the maximum likelihood estimators of model (1), which are the same as those found in other authors’ recent studies (greene, 2001, 2004, 2005). 5 data and empirical specification frontier models require the identification of inputs (resources) and outputs (transformation of resources). several criteria can be used in their selection. the first of these, an empirical criterion, is availability. second, the literature survey is a way of ensuring the validity of the research, which represents another criterion that should be taken into account. the third criterion for measurement selection is that of the professional opinion of relevant individuals. in this paper, we abide by all three criteria and take into account the overview by cummins and weiss (2002). to estimate the cost frontier, we used balanced panel data for insurance companies in angola and mozambique, during the period 2002-2012. the data were obtained from the annual financial reports of the insurance companies, which are published by the chosen regulatory agencies (instituto de supervisão de seguros de angola and instituto de supervisão de seguros de mozambique). the insurance companies considered for this analysis were presented above in section 2 and were selected on the basis of the available data. they comprise 100 per cent of the insurance companies in angola and mozambique. their pooled sample densities are presented in figure 1. given the scarce guidance from the literature review as to which variables to use for the analysis, we rely on microeconomics (varian, 1987) to choose the outputs and inputs. outputs are variables that measure the results of production, such as dividends paid to stockholders and investments. examples of inputs are labour, capital and other relevant microeconomic prices. in our study, the cost equation includes two outputs (net profit and investments) and two input prices (the price of labour and the price of capital premises). whilst table 1 provides some values for 2012, table 2 shows the descriptive statistics for the variables used in the empirical analysis. we note that the average angolan and mozambican insurance company is characterised as having a high level of heterogeneity. sajems ns 19 (2016) no 1:64-81 71 figure 1 sample densities (2002-2012) 72 sajems ns 19 (2016) no 1:64-81 table 2 data descriptives (2002-2012) variable description min max mean sd ln (costs) ln of total costs in usd at constant price 2002=100 4.605 12.883 8.676 1.939 ln (pl) ln of price of labor, measured by dividing total wages by number of employees 3.408 6.840 5.289 0.644 ln(pk) ln of price of capital-premises measured by amortisations divided by the value of total assets 0.000 9.629 0.305 0.878 ln (inv) ln of investments at constant price 2002=100 14.56922 22.41980 19.69871 20.57378 ln (np) ln of net profits at constant price nan 20.26399 17.22604 18.17070 trend trend variable from 2002=1 to 2012=11 1.000 11.000 6.000 3.173 roi return on investments, calculated as the ratio between net profits and investments 3.777 0.476 0.629 angola whether the company operates in angola (1 yes/0 no) 1.000 0.615 0.488 the empirical specification of the average cost frontier used is the translog. we have chosen a flexible functional form in order to avoid imposing unnecessary prior restrictions on the technologies to be estimated. each explanatory variable is divided by its geometric mean. in this way, the translog can be considered as an approximation to an unknown function and the first order coefficients can be interpreted as the cost elasticities, evaluated at the sample geometric mean. we also included time dummies for each year, in order to obtain some temporal changes. thus, the equation used to estimate this is: ( ) ( ) ( ) uvangolaroinpinv pk pl np pk pl invnpinv npinv pk pl pk pl tt pk c itit it it it it ititit itit it it it it it it +++++ ⎟⎟ ⎠ ⎞ ⎜⎜ ⎝ ⎛ +⎟⎟ ⎠ ⎞ ⎜⎜ ⎝ ⎛ ++ ++⎟⎟ ⎠ ⎞ ⎜⎜ ⎝ ⎛ +⎟⎟ ⎠ ⎞ ⎜⎜ ⎝ ⎛ +++=⎟⎟ ⎠ ⎞ ⎜⎜ ⎝ ⎛ 2112 1110 2 9 2 8 76 2 54 2 321 )ln()ln( ln)ln(ln)ln(ln 2 1 ln 2 1 )ln(lnln 2 1 lnln ααβ ββββ βββββββ (11) where c is the endogenous variable, inv is the investment level, np is the net profit, pl is the price of labor, pk is the price of capital, t is a time trend, v is a random error which reflects statistical noise and is assumed to follow a normal distribution centered at zero, and, finally, u reflects inefficiency and is assumed to follow a half-normal distribution. 6 results the latent model in eq. (11) was estimated by maximum likelihood, starting from the r packages frontier (coelli & henningsen, 2013) and flexmif (leisch, 2004) and then observed the discussion in murillo-zamorano (2004) for separating the composed error term and for getting estimates on sigma and lambda, which is necessary for efficiency analysis. the preferred model was the one with three groups, in accordance with aic criteria. table 3 presents the results for the standard cost frontier, assuming that only one cost frontier represents all the data in the sample. table 4, in turn, displays the estimates of the three-class model, while figure 2 presents their distribution densities. as expected, total variance is smaller when three different groups are allowed. in fact, latent class models usually classify observations by reducing group variance in order to maximise the value of the total likelihood function. on the other hand, high lambda values for latent class model estimations tell us that randomness is less important than inefficiency, when we want to explain the distance of insurance companies to the frontier. insurance companies from group 3 could be characterised as capital intensive, in comparison. sajems ns 19 (2016) no 1:64-81 73 table 3 stochastic frontier analysis results translog cost function (dependent variable: ln cost) stochastic frontier analysis variables estimate std. error z value pr(>|z|) (intercept) 2.2036653 12.6084789 0.1748 0.861255 trend -0.1640797 0.1546889 -1.0607 0.288823 trend^2 0.021791 0.0124904 1.7446 0.08105 . ln (pl/pk) -1.9933053 1.2748459 -1.5636 0.11792 0.5 ln (pl/pk)^2 0.0026965 0.0035186 0.7663 0.443469 ln (investments/pk) 2.4728074 1.1843226 2.088 0.036802 * ln (net profits) -1.3347643 1.2548893 -1.0637 0.287487 ln (investments)^2 -0.1499526 0.0952105 -1.575 0.115266 0.5 ln(net profits)^2 0.0824711 0.0479575 1.7197 0.085492 . ln (investments)*ln(pl/pk) 0.0155644 0.0144503 1.0771 0.281436 ln (net profits)*ln(pl/pk) 0.0169311 0.019183 0.8826 0.377448 ln (net profits) * ln (investments) -0.007615 0.0697819 -0.1091 0.913103 roi -0.0943559 0.3538257 -0.2667 0.789721 angola -1.6750777 0.6115002 -2.7393 0.006157 ** sigma 5.365858 2.2712913 2.3625 0.018154 * lambda 0.7450211 0.1144171 6.5115 7.44e-11 *** significance codes: 0 ‘***’ 0.001 ‘**’ 0.01 log likelihood value: -240.6067 table 4 latent class model results translog cost function (dependent variable: ln cost) group 1 estimate std. error z value pr(>|z|) (intercept) -30.4745337 34.6722182 -0.8789 0.379438 trend 0.4141974 0.1539866 2.6898 0.007149 ** trend^2 -0.0117996 0.0118999 -0.9916 0.321407 ln (pl/pk) -7.7588760 1.0359525 -7.4896 6.908e-14 *** 0.5 ln (pl/pk)^2 0.0099944 0.0057916 1.7257 0.084405 . ln (investments) 6.8880091 0.9278930 7.4233 1.143e-13 *** ln (net profits) -0.2946262 4.6306727 -0.0636 0.949269 0.5 ln (investments)^2 -0.3305627 0.3095992 -1.0677 0.285651 0.5 ln(net profits)^2 0.2748919 0.3339636 0.8231 0.410440 ln (investments)*ln(pl/pk) 0.1001283 0.0235025 4.2603 2.041e-05 *** ln (net profits)*ln(pl/pk) 0.0199213 0.0266636 0.7471 0.454981 ln (net profits) * ln (investments) -0.2108435 0.3699178 -0.5700 0.568695 roi -1.6076798 0.7782598 -2.0657 0.038853 * angola -1.0703608 0.3543401 -3.0207 0.002522 ** group 2 estimate std. error z value pr(>|z|) (intercept) 18.9057150 7.8648334 2.4038 0.016224 * trend -0.1658689 0.2696543 -0.6151 0.538478 trend^2 0.0217726 0.0214912 1.0131 0.311016 ln (pl/pk) -3.3730282 1.8962044 -1.7788 0.075267 . 0.5 ln (pl/pk)^2 -0.0021575 0.0066371 -0.3251 0.745126 ln (investments) 4.3031972 1.7421309 2.4701 0.013508 * ln (net profits) -3.9649775 na na na 0.5 ln (investments)^2 -0.4589532 0.1065082 -4.3091 1.639e-05 *** 0.5 ln(net profits)^2 -0.0791694 0.0876910 -0.9028 0.366620 ln (investments)*ln(pl/pk) 0.0104630 0.0359250 0.2912 0.770864 ln (net profits)*ln(pl/pk) -0.0101695 0.0232096 -0.4382 0.661270 continued/ 74 sajems ns 19 (2016) no 1:64-81 estimate std. error z value pr(>|z|) ln (net profits) * ln (investments) 0.2444148 na na na roi 1.5108177 na na na angola -8.4097975 2.6472536 -3.1768 0.001489 ** group 3 estimate std. error z value pr(>|z|) (intercept) 4.2855364 19.6962919 0.2176 0.8277557 trend 0.0901902 0.2005511 0.4497 0.6529181 trend^2 -0.0012647 0.0163856 -0.0772 0.9384791 ln (pl/pk) -3.1192593 1.3027492 -2.3944 0.0166491 * 0.5 ln (pl/pk)^2 -0.0063855 0.0035337 -1.8070 0.0707614 . ln (investments) 2.1745936 1.2064724 1.8024 0.0714763 . ln (net profits) 0.0136010 2.1186422 0.0064 0.9948779 0.5 ln (investments)^2 0.2689546 0.0764459 3.5182 0.0004344 *** 0.5 ln(net profits)^2 0.5574715 0.1485227 3.7534 0.0001744 *** ln (investments)*ln(pl/pk) 0.0819763 0.0113040 7.2520 4.108e-13 *** ln (net profits)*ln(pl/pk) 0.0345453 0.0254326 1.3583 0.1743667 ln (net profits) * ln (investments) -0.5288206 0.0112142 -47.1563 < 2.2e-16 *** roi -0.5878676 0.4045617 -1.4531 0.1461967 angola 0.5983175 0.7589090 0.7884 0.4304677 signif. codes: 0 ‘***’ 0.001 ‘**’ 0.01 ‘*’ 0.05 ‘.’ 0.1 ‘ ’ 1 aic (2 groups): 471.8525 / aic (3 groups): 454.1377 / aic (4 groups): 429.1479 lambdas: group 1= 57.86, group 2 = 27.79, group 3 = 77.06 / sigmas: group 1 = 1.24, group 2 = 2.94, group 3 = 1.08 log likelihood value: -188.9262 figure 2 efficiency score densities for each group or latent class a perusal of the results of table 4 reveals that the estimated coefficients’ signs for the labourcapital price ratio are the same for all the groups. therefore, the higher the labour-capital price ratio (capital intensity), the lower the cost for obtaining a positive financial result in the insurance industry. an important result in support of the latent class model estimation is that the differences sajems ns 19 (2016) no 1:64-81 75 of the input price-ratio coefficients among the groups are statistically significant, especially with respect to group 3, which encompasses smaller insurance companies (lower total costs). these results suggest that at least three different technologies are used to generate financial results in the african insurance industry. furthermore, we verify that the labour-capital price ratio coefficients are lower than one in all the models, which verifies the homogeneity restriction that was not imposed on the function. in table 5, we show the means of some representative variables for the groups obtained with the latent class model. this verifies that large angolan and mozambican companies are concentrated in group 2, small angolan companies in group 3 and medium-sized companies, predominantly from mozambique, are in group 1. this means that insurance companies are not defined by cultural issues, but rather by their size. moreover, in all three groups, the efficiency with the latent class model tends to be higher than that of the pooled model (cf. figure 3). this result suggests that, to some extent, the standard stochastic frontier, which imposes only one technology, overestimates inefficiency as opposed to the case of the latent class model. besides, insurance companies were assigned into groups on the basis of the posterior probability of class membership. table 5 mean values for representative variables, computed within each group (2002-2012) latent group low efficiency intermediate efficiency high efficiency group number group 1 group 3 group 2 efficiency 29.82% 39.16% 44.60% angola 33.33% 100.00% 60.00% costs $ 421,930,336.55 $ 119,112,023.09 $ 1,052,094,452.42 employees 68.16 65.87 220.90 wages $ 40,031,477.17 $ 17,502,153.39 $ 34,457,664.91 investments $ 890,385,810.55 $ 46,955,403.94 $ 352,099,309.34 amortisations $ 5,475,974.03 $ 4,187,456.13 $ 12,282,060.17 assets $ 1,113,341,565.90 $ 285,471,402.80 $ 652,107,300.24 net profits $ 76,391,488.56 $ 12,266,055.10 $ 20,635,811.30 roa 24.14% 26.61% 28.21% roi 33.93% 52.82% 50.62% pk 0.19 0.46 0.22 pl 5.64 5.35 5.02 ln (average wages) 12.99 12.31 11.55 ln (cost per employees) 14.98 13.87 14.12 ln (cost/asset ratio) (0.27) (0.08) 1.02 ln (costs/pk) 6.66 5.45 5.32 ln (pl/pk) 5.69 4.49 4.29 76 sajems ns 19 (2016) no 1:64-81 figure 3 efficiency score means for each model group comparison 0.00.20.40.60.81.0 0. 0 0. 2 0. 4 0. 6 0. 8 1. 0 lcm efficiency scores sf e ffi ci en cy s co re s 1 g ro up 1 2 g ro up 2 3 g ro up 3 e m o s e 2 g ar an tia _s eg ur os 3 u ni ve rs al _s eg ur os 1 e n s a 3 a a a 1 g ob al _a lli an ce _m oz a 3 m c s 2 h ol la rd _m oz a 1 m un di al _s eq ur os 2 g lo ba l_ s eq ur os 1 n as sa 3 g ob la l_ a lli an ce _a ng 3 s m 1 sajems ns 19 (2016) no 1:64-81 77 figure 4 comparison between efficiency groups figure 4 presents a comparison between groups for selected variables and puts these different production technologies into perspective in terms of their levels of efficiency. although levels of efficiency appear to increase when traditional financial ratios are used, such as roi and roa (upper figure 4), the role of two major production inputs, measured in terms of labour and capital, cannot be neglected. while the impact of labour prices on efficiency lower labor prices imply higher efficiency levels is clearly in evidence, the impact of capital prices is more subtle (middle figure 4). the levels of efficiency tend to increase when capital prices account for larger proportions of the total cost (lower ln(cost/pk) ratios. furthermore, a quick inspection of the single-output, single-input measurement of capital productivity (ln(cost/asset ratio)) corroborates 0.00% 10.00% 20.00% 30.00% 40.00% 50.00% 60.00% low efficiency intermediate efficiency high efficiency roa roi efficiency (1.00) 1.00 2.00 3.00 4.00 5.00 6.00 7.00 8.00 low efficiency intermediate efficiency high efficiency pk pl ln(costs/pk) ln(cost/asset ratio) ln(pl/pk) 8.00 9.00 10.00 11.00 12.00 13.00 14.00 15.00 16.00 low efficiency intermediate efficiency high efficiency ln(average wages) ln(cost per employee) 78 sajems ns 19 (2016) no 1:64-81 the finding that the most efficient companies are those that deliver a greater number of outputs (costs), given a current level of assets (inputs). in summary, the results indicate that those insurance companies from mozambique and angola that belong to group 2 can be characterised as being large insurance companies, with capitalintensive production processes and lower labour costs, resulting in greater financial indicators and better levels of efficiency. group 3 consists of small angolan firms, without access to cheap capital prices, although the average cost per employee is similar to that of larger firms (figure 4). this constraint for accessing low-price capital sources may jeopardise this group in the long term. on the contrary, group 1 firms are middle-sized, with low capital-prices, similar to those of group 2. these companies, however, account for the largest wages paid by the industry, which contributes to lower financial indicators and levels of efficiency. 7 conclusions this paper proposes a simple framework for the comparative evaluation of african insurance companies located in angola and mozambique and also for the rationalization of their operational activities. the analysis was conducted by implementing a finite mixture stochastic frontier model, which allows the incorporation of a broad variety of inputs and outputs, while at the same time permitting researchers to account for segments in the sample and for the existence of heterogeneity in the data. the main result is that three groups are identified among the sample of insurance companies from angola and mozambique, adopting different production technologies to obtain the results for both countries. therefore, as long as general guideline policies can be defined for the whole sample, based on common value, such as the same sign for the variables between groups, no common policy can cater simultaneously for all the specificities embedded within each group. the main policy implication of the findings of this analysis is that heterogeneity must be considered a major factor for african insurance companies located in mozambique and angola. the insurance companies are not clustered according to their nationality, which signifies that nationality is not a crucial determinant of efficiency. this being the case, authorities could implement policies by defining groups by size, with the aim of regulating the insurance industry. besides, two out of the three groups identified indicate that most insurance companies are still relatively small in comparison with their peers in foreign, more-developed countries. future mergers and acquisitions thus appear to be the natural path for achieving gains in efficiency and for absorbing new production technologies. consequently, it is forecast that the frequency of mergers and acquisitions in the angolan and the mozambican insurance industry will increase in the near future. the results also give insight into the main causes of the differences in levels of efficiency. these are basically related to the differences between relative prices within groups. more specifically, levels of efficiency are lower in group 1, owing to higher relative labour prices in comparison with the two other groups, in both absolute and relative terms. capital prices, however, exert a beneficial impact on the levels of efficiency of group 2 companies, together with lower labour prices, which supports the perspective that insurance is one of the industries where capital presents the highest marginal productivity (amores & raa, 2014). regulatory policies and incentives could be designed to ensure access to cheap sources of capital for small-sized insurance companies in angola (group 3), which would foster competition is this country. ruling implications can also be derived according to these results. insurance companies in angola and mozambique should adopt a benchmark procedure as a means of evaluating their efficiency throughout the year and then could follow the same best practice procedures used by more efficient companies, especially when it comes to the labour prices observed in group 1. this exercise could be carried out by the association of those insurance companies that belong to the same group, in order to facilitate the adoption of procedures that will empower them to achieve an increase in efficiency. sajems ns 19 (2016) no 1:64-81 79 endnote 1 the statistic is constructed as – 2 (loglfr – loglfu), where lfr and lfu are the log-likelihood functions evaluated at the restricted and unrestricted estimates. the statistic under the null hypothesis, θj= θj-1, follows a chi-squared distribution, with degrees of freedom equal to the number of restrictions being tested. if the null hypothesis is rejected, then the preferred model is the one with j classes. references abdul kader, h., adams, m. & hardwick, p. 2010. the cost efficiency of takaful insurance companies. geneva papers on risk insurance-issues and practice, 35:161-181. aigner, d.j., lovell, c.a.k. & schmidt, p. 1977. formulation and estimation of stochastic frontier 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industry in south africa. geneva papers on risk and insurance issues and practice, 20(75):127-140. murillo-zamorano, l.r. 2004. economic efficiency and frontier techniques. journal of economic surveys, 18(1):33-77. nektarios, m. & barros, c.p. 2010. a malmquist index for the greek insurance industry. the geneva papers on risk insurance-issues and practice, 35:309-324. olaosebikan, o. 2012. the determinants of the profitability of micro-life insurers in nigeria. the geneva papers on risk and insurance-issues and practice, 38:140-159. sajems ns 19 (2016) no 1:64-81 81 orea, l. & kumbhakar, s. 2004. efficiency measurement using a latent class stochastic frontier model. empirical economics, 29(1):169-183. outreville, j.f. 2008. foreign affiliates of the largest insurance groups: location-specific advantages. the journal of risk and insurance, 75(2):463-491. steyn, t.f.j., mostert, p.g. & de jager, j.n.w. 2008. the influence of length of relationship, gender and age on the relationship intention of short-term insurance clients: an exploratory study. sajems ns, 11(2):139-156. the economist. 2010. south of the sahara, 22nd november. available at: http://www.economist.com/node/17493372?story_id=17493372 [accessed may 2015]. uche, c.u. 1999. government ownership of insurance companies in nigeria: a critique. the geneva papers on risk and insurance-issues and practice, 24:216-227. varian, h.r. 1987. intermediate microeconomics: a modern approach. new york: ny: w.w. norton & company. xie, x., lu, w., reising, j. & stohs, m.h. 2011. demutualisation, control and efficiency in the u.s. life insurance industry. the geneva papers on risk insurance-issues and practice, 36(2):197-225. sajems ns vol 7 (2004) no 2 368 duopoly competition for rational addicts1 _______________________________________________________________ steven f koch department of economics, university of pretoria _______________________________________________________________ abstract this paper provides an examination of an oligopoly market for addictive commodities, specifically cigarettes. the model is characterized by overlapping generations of consumers and differentiated products. a price equilibrium, which is both stationary and symmetric, is characterized. the model accounts for many of the features within the south african tobacco market. although excise taxes rose in south africa, and the actual price in the market rose by more than the increase in the excise tax, the model shows that the increase in the price beyond the excise tax was caused by factors other than the change in the tax rate. the model also points to potential empirical problems associated with estimating cigarette market outcomes, due to the fact that the combination of market structure and addiction may greatly impact the assumed exogeneity of the prices used in the analysis. jel d42, d92, i12 1 introduction until recently, addiction to a commodity was problematic; it appeared to rely upon irrational behaviour, e.g., it has been publicly stated, for decades, that smoking negatively affects health, yet many individuals continue to smoke and many more have become smokers during the succeeding decades. becker and murphy’s (1988) seminal paper on rational addiction provided a different view. they showed that rational economic agents might become addicted to a commodity even if that commodity was deleterious to their future health. the intuition behind the paradoxical result is that the benefits of current consumption, which includes the cumulative effects of beneficent experiences, must outweigh the cumulative deleterious effects of past and future consumption. becker and murphy provide conditions for which this result holds.2 rational addiction and the empirical examinations of that theory have, for the most part, ignored the potential importance of market organization and market structure, e.g., becker and murphy rely upon stable prices in their theoretical sajems ns vol 7 (2004) no 2 369 model to generate the majority of their results. empirically, chaloupka (1991), becker, grossman, and murphy (1994), and grossman, chaloupka, and sirtalan (1998) rely on an exogenous price trajectory for their models without specifying the supply side. below, it is shown that a constant price trajectory assumption is reasonable in those theoretical models because stable prices can be obtained in a more complicated market structure model of rational addiction, as long as the brand loyalty is exogenous to the consumer's decisions. however, the stable price trajectory is endogenous to the model calling into question the validity of their estimations. importantly, these empirical models instrument past and future prices for past and future consumption, respectively. the instruments used in these empirical examinations, however, are not truly exogenous, and, therefore, their results are likely to be biased. rational addiction models have also relied upon single consumer types in their formulations, although it is clear that the demand side can be split into many different types of cigarette consumers. for example, there are young nonsmokers, who may be interested in starting, and there are old addicted smokers, who may be loyal to certain brands. showalter (1999) examined a theoretical and empirical model of cigarette addiction with monopoly finding that a forward looking monopolist is more important in explaining the data than a forward looking consumer; however, he also relies on one consumer type in his model. this assumption is relaxed below. recent work in inter-temporal industrial organization has examined markets in which consumers have switching costs. for an excellent review of this literature, see klemperer (1995). the switching costs examined by klemperer (1995), beggs and klemperer (1992), caminal and matutes (1990), and padilla (1992) apply to brand loyalty. specifically, a consumer that has purchased groceries at one store would find it less costly to return to that same store than go to a different store because that consumer would be forced to spend additional time locating items in the new store. therefore, a switching cost could be associated with experience, e.g., posterior asymmetric learning costs. furthermore, switching costs can be used to model product differentiation, which is the primary form they take in this paper. markets in which consumers have switching costs can be inter-temporally competitive, but not necessarily competitive at any one point in time. for example, two firms would fight for market share initially and be willing to charge a price that is below average cost, because they know that these losses can be recouped in the future as they charge higher prices to consumers who would find it costly to switch to an alternate supplier. therefore, lifetime profits of the firm are zero because initial profits are negative and future profits are positive.3 sajems ns vol 7 (2004) no 2 370 however, lock-in exploitation results often rely upon one customer type, i.e., there is little discussion of how the results would be different if the firms could not discriminate between young, or potential new consumers, and old locked-in consumers. farrell and shapiro (1988), in a model that allows for consumer heterogeneity, found that firms face a trade-off between fighting for future market share by charging very low prices and earning rents from the old consumers that have switching costs. furthermore, they find conditions under which the firms may alternate their prices, i.e., a cyclical pricing scheme where firms charge a low price in one period followed by a high price in the next period; the firms alternately gain market share, and subsequently exploit that market share in the following period. the model presented here relies, in part, on klemperer’s (1995) proposition that addiction represents a psychological switching cost, perhaps synonymous with withdrawal. however, addiction is not the only switching cost in the model presented here. besides addiction, there is an additional switching cost associated with brand loyalty. however, it is very likely that addiction will reduce the strength of brand loyalty in the model, since consumers will understand that they are addicted to tobacco, first, and a particular brand of tobacco, second. although the standard switching cost model would impart brand loyalty on the consumer due to experience, the model presented here considers two separate experiences that are, however, potentially offsetting. the primary concern addressed in this paper is whether or not addiction affects the major results in inter-temporal industrial organization models. in particular, will duopolies compete differently between and across generations when the commodity they sell is addictive and differentiated in every period? if all consumers were the same, switching costs could enable firms to recoup their investments in addictive capital.4 however, different types of consumers will remove some of the investment incentive since consumers cannot be perfectly discriminated against. if, on the other hand, there were no switching costs, it would also be impossible for the firms to invest in addictive capital, since negative profits could not be recouped later. the results in the model provide a justification for the stable price trajectory assumed in rational addiction models, even when the price trajectory is endogenous. finally, the effect of exogenous factors on the price trajectory is considered. the remainder of the paper is organized as follows. in section 2, the economic environment is defined and compared to the situation in south africa. the behaviour of the firms and the resulting symmetric equilibrium is examined in section 3. conclusions, limitations, and possible extensions to the model are presented in section 4. sajems ns vol 7 (2004) no 2 371 2 the economic environment the economic environment examined here is concerned with potential smokers. due to the nature of smoking, these consumers will be from overlapping generations, such that there will be young agents (who were born in this time period) and old agents (who were born in the previous time period) alive during any one epoch. when the consumers are young, they decide whether or not they want to purchase cigarettes. their decision is determined by current prices, expected future prices, their perception of their own inherent addictive nature, and the degree of product differentiation within the market. due to the addictive nature of the good, those consumers who buy cigarettes as youths will have a higher willingness to pay for cigarettes when they are older. tn 1−tn the industry is a constant cost industry containing two firms. each firm is a rational profit maximizing entity, where profits are affected by the degree of lock-in or product differentiation, the degree of addiction, and the tax structure imposed upon them. the bertrand convention of profit maximization given all other prices is adopted for the analysis, and subsequently, nash equilibrium behaviour is examined. 2.1 consumers consumers are modelled as two-period lived rational addicts, i.e., utility maximizing potential smokers. although there are many interesting features incorporated in becker and murphy’s (1988) paper, the model presented here focuses on the supply side of the market. therefore, the consumer focus is on the complementary aspect of addiction and utility maximizing rational behaviour. according the becker and murphy model, a rational utility maximizing individual can become addicted to cigarette smoking; that premise is the basis for the following general individual demand curves. [ ] [ ]( ) ( otttttt y tttt tt qpqpzz qepeqpxx ω ω ;,,, ;,,, 11 11 −− ++ = = ) (1) the notation in the paper will continue along these lines; consumption by the newborns will be denoted by x, while consumption by the elderly will be denoted with z. prices in the market are denoted by p for one firm and q for the other firm. demands for the young consumers are determined by current prices in the market, future prices in the market, and other relevant information; o and y superscripts are used to denote information set knowledge by age group. the sajems ns vol 7 (2004) no 2 372 construction used in the model assumes that changes in the information set only affect the level of demand, and not the elasticity, or more specifically the slope, of demand. it is assumed that young people have only subjective information regarding their own inherent addictive nature, the possibility that cigarettes could adversely affect their health (or employment prospects), the degree to which products are actually differentiated, or the future regulatory environment surrounding the consumption of cigarettes in, for example, public places. in addition, the information set is assumed to include actual and expected future income. youths cannot be certain of future prices, so their demands must be determined by expectations over those future prices, although perfect foresight will be assumed in the analysis to simplify. demands for the aged are determined by past prices in the market, current prices in the market, and other relevant information. the law of demand is assumed to hold true, so that an increase in prices will lead to a decrease in demanded quantities. the complementary nature of addiction means that prices in different time periods will also negatively affect quantities, and, finally, the products from different firms are assumed differentiated, although substitutable. the exact interaction of the price effects within the demand structure, as it relates to firm behaviour is discussed in the subsection 2.2. aggregation of the individual demand curves is assumed possible, and those demands, aggregated to the market level, are explicated below. [ ] [ ]( ) ( 111 11 ,;,,, ,;,,, − −− ++ ω= ω= to tttt tt ty tttt tt nqpqpzz nqepeqpxx ) (2) the only differences between individual level demand and market level demand are the number of people in the market and the agglomeration of individual level information; as with information, the change in the number of consumers is modelled to influence only the level of demand and not, at least directly, the elasticity of demand. it is not assumed that every market participant knows every individual’s private information. rather, it is assumed that the important market level information is made available to everyone through the agglomeration.5 although the demands are reasonable approximations of cigarette consumption behaviour, there has been only one analysis, of which i am aware, using this type of demand function in south africa. the estimates by van der merwe and annett (1998) show that the rational addiction model is reasonable, and that the short-run effect of price changes is smaller than the long-run effect of price changes, although the difference in elasticity is very small, possibly because of sajems ns vol 7 (2004) no 2 373 their modelling of the price-tax relationship. other analyses of south african cigarette consumers have used the south african income and expenditure survey (saies), and, due to limited price data, cannot account for addiction effects. for example, van walbeek (2002) shows that fewer poor households than wealthy households, by income quartile, spend money on cigarettes in the 1990 and 1995 saies. ground and koch (2004) show a similar result using the 2000 saies.6 2.2 firms the supply side of the model is assumed to include just two firms denoted by 1, the target firm, and 2, the target's competition. in 2001, the south african cigarette market was a near monopoly; british american tobacco (bat) controlled nearly 90 per cent of the market as measured by sales, while rj reynolds (rjr) and phillip morris (pm) controlled approximately 10 per cent of the market between them in nearly equivalent shares (shafey, dolwick & guindon, 2003). for that reason, a pure duopoly is not, necessarily, the correct model of firm behaviour in the south african cigarette market. rather, a monopoly or collusive oligopoly model might be more reasonable.7 however, it is unlikely that bat can act as a pure monopoly, given the ability of rjr and pm to import cigarettes from other production sites, even though there remains a 45 per cent import tariff on cigarettes from outside sadc countries (and, either a zero or 36 per cent tariff from within sadc countries, depending on the tobacco content). the important feature of the behavioural model is the fact that neither firm can act as a pure monopolist, either by alone or through collusive efforts. in other words, although the analysed market is south africa, the primary firms in south africa are international firms, and, more importantly, there are very few firms producing cigarettes in the world. for that reason, a duopoly model is not unreasonable. each firm in the market faces many types of consumers, but is unable to differentiate between them, i.e., it is impossible for a firm to perfectly discriminate. due to the fact that there are old consumers and young consumers, as well as two different firms, there are three basic types of consumers considering cigarette purchases in any time period, and each basic type of consumer may have different preferences than others within the same category. there are two types of aged consumers, and one newborn type. of the elderly consumers, some purchased from the same firm, previously, while others purchased from the competing firm, previously. finally, there are first time consumers, who are currently trying to determine their level of market participation. not only are there many different types of consumers, the price choices of each firm in period t influences future consumption choices, and, because of past consumer expectations, today’s prices also have feedback sajems ns vol 7 (2004) no 2 374 effects on yesterday’s consumption choices. the influence of addiction, combined with overlapping generations of consumers, yields this complicated structure. finally, there are many potential histories leading up to today, due to the continual birth and death cycle in the market. the bertrand assumption in the model allows that at time t, the target firm chooses its price, p, to maximize profits taking all its own past and future prices, as well as all of its opponent's prices, q, through time, as given. due to the infinite nature of the game, the concept of nash equilibrium must be modified, and the adopted concept will be a steady-state nash equilibrium.8 2.2.1 elderly consumers each firm may have an installed base of cigarette consumers. for example firm 1 sold brand 1 to a portion, possibly zero, of the youth market. these consumers, who initially purchased brand 1, return to the market when they are older. by assumption, the fact that they smoked before makes them more likely to want to smoke again. in addition, product differentiation provides an incentive for old consumers, who originally purchased brand 1, to return to firm 1 to again purchase brand 1. although there is an incentive to return, aged consumers will not necessarily return, because they are addicted to tobacco, not just the brand; therefore, firms are limited in their ability to extract relationship rents from the old consumers. furthermore, because there are other old consumers in the market with a preference for brand 2 and those individuals have high demand for cigarettes, firm 1 may find it in their interest to pursue elderly consumers who purchased from firm 2 as youths. therefore, each firm faces two competing interests, in regards to elderly consumers. those competing interests will be set against each other. clearly, the degree of lock-in due to brand preference will greatly affect a firm’s desire to entice the other firm’s consumers to switch brands. 2.2.2 youthful consumers there are also youthful consumers considering their decision to become smokers. because addiction increases future demand, firms would like to invest in that future demand, which they might be able to exploit in future, through higher prices. importantly, however, youth demand is determined by expectations over future prices, i.e., youths are modelled as rational agents who realise the potential for higher future prices. the youths also are expected to realise that firms may compete in the future, depending upon the strength of brand preference, or consumer lock-in. youths are also influenced by other factors within their information sets. for example, cigarette advertising or other sajems ns vol 7 (2004) no 2 375 promotional behaviours by firms might influence brand choice. although explicit advertising is illegal in south africa, and there are other bans on tobacco use, firms can undertake many different activities, e.g., promotion of sports teams or encouraging cigarette smoking in movies. 2.2.3 firm profits although the focus within the paper is on the prices of cigarettes, the model does provide enough leeway to consider additional firm strategies, and the effects of those strategies on pricing behaviour. the inclusion of additional strategies would require a simple generalization of the costs of those strategies, as well as assumptions concerning the demand, and, therefore, revenue benefits of the strategies. below, these costs and benefits will be explicated. equation (2) defines the general structure of demand, in terms of prices, for the consumers, both old and young; therefore total revenues for any firm will be the multiple of their price and the quantity demanded, which is also determined by other market variables. however, profits today also depend upon profits tomorrow, and in the future. importantly, future profits are not completely separable from today’s decisions, because current prices affect future demand. combining, profits for firm i from selling brand i can be written as, using the demand curves from equations (2):9 ( ) ( ) ( ) ( ) ( ) ( ) 12122,2 1 1111 ,1 + + + + ⋅−⋅+⋅−+⋅−= ⋅−⋅+⋅−+⋅−= t t t t t t t t t t t t t t zcqzcqxcq zcpzcpxcp βπ βπ (3) firms discount future values at the rate of β, and firm’s face constant marginal costs of production, denoted by ci. 3 equilibrium behaviour in this section, the optimising behaviour of the firms is examined. given the bertrand assumption, firms are assumed to maximise their respective value functions simultaneously, i.e., without knowing their competitor’s price choice. due to the symmetric nature of the problem, it is convenient and reasonable to examine only one of the firms in the market. consideration of other factors influencing those strategies will also be discussed. 3.1 pricing behaviour each firm is assumed to maximise profits, taking the other firm’s behaviour as given. profits are assumed to be concave, and, therefore, the necessary sajems ns vol 7 (2004) no 2 376 conditions for profit maximisation are enough to characterize firm behaviour.10 the necessary condition for firm 1 follows; recall that replacement of p with q and c1 with c2 will yield the necessary condition for firm 2. for notation, partial derivatives of functions are denoted as subscripts to the functions; the actual subscript of the function is the variable used for partial differentiation.11 ( ) ( ) ( ) 01111,1 =⋅−⋅+⋅−++⋅−+= + tpttptttptttp tttt xcpzcpzxcpx βπ (4) the first two terms on the right hand side represent the marginal profits associated with selling the product only to current youths. the terms only represent the fact that a decrease in price is required to sell more of the product, due to competition from firm 2, as well as the law of demand. the second two terms are marginal profits for selling to the older individuals. because demand by the elderly, due to addiction, is higher than demand for the youths, the marginal profit for the elderly is assumed to be higher than the marginal profit for the youths, all other things equal. the final term on the right hand side is marginal future profitability. addiction is synonymous with complementary demand through time, and, therefore, an increase in current prices also reduces future profitability by reducing future demand. as can be seen in the first order condition, each firm faces multiple trade-offs. if firms were facing only addicted consumers, they would choose high prices, while a firm would choose lower prices if the market contained only youthful consumers.12 however, the existence of competition from the other firm limits the possibility to charge higher prices, which further mitigates the possibility for lower prices. firm 1 reacts to hypothetical prices by firm 2, based on the first order condition above. due to the fact that profits are assumed to be concave, the direction of the reaction is determined by the derivative of the optimising condition with respect to firm 2’s price.13 the derivative of the first order condition is written below, using the same notational devices. ( ) ( ) ( ) 11111,1 ++ ⋅−⋅+⋅−++⋅−+= t qptt qpttqt qpttqtqp tttttttttt xcpzcpzxcpx βπ (5) because brand 1 and brand 2 are cigarettes, although differentiated, an increase in brand 2’s price raises the demand for brand 1; therefore, the first and third terms are positive. the second, fourth, and fifth terms measure, approximately, the change in own-price elasticity resulting from a change in the cross-price. an increase in the cross-price is expected to result in less responsive demand; the higher cross-price reduces the substitutability between the two products. recalling that the slope of demand is negative, a reduction in responsiveness sajems ns vol 7 (2004) no 2 377 means a less negative slope, or an increase in the slope. therefore, all five terms are positive, and the reaction function is upward sloping, just as expected in a heterogeneous goods bertrand oligopoly. the symmetric nature of the two firms means that there will exist a symmetric steady-state nash equilibrium. that result is stated, without proof in theorem 114, and a representation of the equilibrium is illustrated in figure 1. figure 1 an illustration of the stationary equilibrium reaction function for firm 1, as a function of firm 2’s price. p1 p2 reaction function for firm 2, as a function of firm 1’s price. equilibrium price determined by intersection of reaction functions. theorem 1: there exists a steady-state nash equilibrium to this bertrand pricing game. 3.2 properties of the equilibrium price from the demand functions, as well as the profit functions, it can be seen that there are a number of exogenous factors that can affect the equilibrium price in the market. for example, government policies that raise the opportunity cost of smoking, through taxes or indoor clean air laws, will affect demand; new information concerning the health affects of smoking will affect demand; government policies affecting advertising behaviour will affect demand; the sajems ns vol 7 (2004) no 2 378 addictiveness of the cigarettes, or smoking in general, is also likely to affect demand. in a model of this nature, the equilibrium price will change as a result of a change in the reaction function. changes in the reaction function are determined in the same way as the actual slope of the reaction function, by the application of simple comparative statics. theorem 2 provides a summary of those comparisons. theorem 2: the equilibrium price in the market increases with increases in: the number of consumers (old or young) in the market and with increases in the costs of production (including taxes); however, the rate of increase in prices will be less than the increase in the tax. the equilibrium price in the market decreases in the relative importance placed on the future, announcements of deleterious health consequences, and the enactment of clean indoor air laws. proof: see appendix a for the mathematical derivation. intuitively, any factor that decreases demand will lower the price, while any factor that raises costs to the firm will raise the price. fewer smokers, for whatever reason, lowers demand, while an increase in taxes will raise costs to the firm. moreover, the fact that prices cannot rise faster than costs is due to the fact that the reaction functions are upward sloping. in the limit of horizontal reaction functions, the prices would increase the exact same amount as the increase in the excise rate. the effect of an advertising ban is, however, contentious. although such a ban would lower demand, suggesting a decrease in price, that same ban on advertising would raise the costs of brand promotion, on the assumption that advertising is a more cost effective way of meeting customers than any other activity.15 therefore, the outcome cannot be determined a priori. a similar result is true for the degree of addictiveness, for a slightly different reason. although addiction increases future demand, and thus leads to a desire for higher prices, the degree of addictiveness leads firms to want to charge lower prices for young consumers, to get them to buy more in the future. in addition, rational youth may be less inclined to participate in the market if they are afraid of becoming addicted to cigarettes. 3.3 relating to south africa according to van der merwe and annett (1998), the real gap between the final price of cigarettes and the cigarette excise tax in south africa was roughly constant between 1970 and 1988, at approximately 6 cents per cigarette. sajems ns vol 7 (2004) no 2 379 although the gap began to widen around 1988, following 1993, the gap widened significantly, leading van walbeek (2000b, 2002) to suggest that firms were passing through to the consumers more than just the excise taxes, due to a decrease in sales volumes. the model presented here predicts the result, although the result is not an increase in excise tax pass-through. rather the result is that youth interest in cigarette consumption fell significantly, forcing firms to focus more on their already addicted consumers. further proof obtains from the relationship between cigarette sales and population growth. between 1970 and 1993, the real price of cigarettes fell significantly, nearly 40 per cent. during the rest of the 1990s, on the other hand, the real price of cigarettes doubled, partially due to a 225 per cent increase in real excise taxes (van walbeek, 2002); real excise taxes were lowest, at 56 cents per pack, in 1991, and rose to 164 cents per pack by 1999 (van walbeek, 2000a). similarly, consumption peaked in 1991, and fell precipitously by the end of the decade. according to shafey, dolwick, and guindon (2003), per capita cigarette consumption per year fell from 1665 cigarettes in 1990 to 933 cigarettes in 2000, a reduction of 44 per cent; however, total consumption of cigarettes fell from 37.4 billion to 26.7 billion over the same time period, a reduction of only 28.6 per cent. back of the envelope calculations put the elasticity of cigarette demand at 0.22 per capita and 0.14 per cigarette.16 clearly, population growth is overstating the responsiveness of consumers to the price changes. more realistically, fewer young consumers are purchasing cigarettes, but there has been very little change in behaviour for the elderly addicts. further consideration of the growth in the price gap, the difference between the excise tax value and the final sale price, since 1988, agrees with the model presented here, as well. a reduction in the number of young consumers changes the relative weighting within any firm’s reaction function towards pricing for the elderly addicted consumers. such a change in the number of young consumers would have resulted from the spread of information regarding the adverse health consequences of smoking. the fact that the gap began to widen, in 1988, before the real excise tax rate increased in 1992, implies that there were factors in the marketplace, other than taxes, leading firms to rethink their pricing strategies. the increase in the price gap, in 1988, was due to the adverse change in youthful demand factors, not the increase in excise taxes. however, the increase afterwards included both the excise tax effect and the decrease in youth consumption. other authors have suggested that firms might have coordinated on price increases based on increases in the tax rates; harris (1987) has made this suggestion in the case of the us. barnett, keeler, and hu (1995) and sung, hu, sajems ns vol 7 (2004) no 2 380 and keeler (1994) provide empirical support using us data. using south african data, van der merwe and annett (1998) also show that prices rise faster than the rate of increase of the excise taxes. however, none of these empirical models attempt to capture a change in the consumption profile in the market, especially the age-consumption profile. for that reason, the hypothesis and empirical support of the hypothesis that taxes will, alone, lead firms to raise prices by more than the tax rate is unconvincing. 4 conclusions and extensions in this paper, a model of a market with brand loyalty, addiction and price competition has been presented. the model is representative of the south african situation in terms of structure, and, most importantly, in terms of findings. the primary result presented in the paper is that an oligopoly market over addictive and differentiated products can result in stable prices in equilibrium, thus validating the assumption used in a number of the theoretical and empirical models of rational addiction. in addition, the factors affecting the stationary equilibrium were discussed. the effect of those factors is, importantly, intuitive, despite the complexity of the model. firms in the market face trade-offs when they choose their prices. they would like to discriminate by age, or, more accurately, by experience. before the introduction of bans on firm give-aways of tobacco samples, firms could attempt to expand their markets by promotional activities attended by young people, who were not likely to be, as yet, smokers. the introduction of these bans, has eliminated an outlet for discriminatory pricing. on its own, the elimination of price discrimination should have reduced the market price of cigarettes; however, the increase in the excise taxes as well as the spread of information regarding the adverse health consequences of cigarette smoking, has overridden the expected effect of the promotional ban. most importantly, prices have risen faster than the rate of excise taxes. the result does not obtain because firms are colluding on price behaviour or because the market is monopolistic, but because the reduction in youth demand has led firms to focus more on the profitable, already addicted, smokers. the model shows that prices in the market do not follow an exogenous trajectory, because behaviour at one time depends on past behaviour as well as expected future behaviour. therefore, careful consideration must be taken when empirically estimating the demand for cigarettes, i.e. appropriate instruments need to be used, because demand cannot be estimated separate from supply. the logical choice, excise taxes, which are set by government and likely to be exogenous, may not be purely exogenous, since other demand sajems ns vol 7 (2004) no 2 381 factors determine the degree of pass-through of the excise taxes into the final sale price. the model is limited, in that it is only a duopoly model, although the nature of the south african situation makes this reasonable. furthermore, the exact nature of the branding decisions is not considered. firms in this model have an incentive to create new brands in every time period and sell them well below cost. this degree of differentiation would allow for price discrimination across time, which could lead to an increase in profits, if it were not too expensive to engage in brand proliferation. finally, the heart of the rational addiction model is that consumers choose to smoke of their own cognisance, and rationally understand they may die at an early age. for that reason, there is no reason to regulate cigarette sales in this model; excise taxes are welfare decreasing in the model.17 therefore, the model must be extended to allow for true externalities, e.g. the use of chemicals to enhance nicotine absorption in unknowing consumers. although the general framework presented here would allow for such an examination, the analysis presented here was only concerned with pricing behaviour, and therefore, was not able to address those considerations. endnotes 1 this research is based on a simplified version of koch (1997); the paper has been greatly modified over the years into its present form. the author would like to thank derek laing, michael baye, paul jensen, brad kamp and three anonymous reviewers for their comments on this paper. all normal disclaimers apply. 2 koch (2001) shows that the becker and murphy conditions are synonymous although less able to generate all the features of becker and murphy with an assumption of increasing marginal utility associated with smoking through time. 3 the results of consumer switching cost models depend upon the market assumptions. for example, in an infant market, firms compete for market share in early periods, which allows them to extract monopoly profits in the succeeding periods. the industry might then appear to be imperfect, when in fact, the future monopoly profits are exactly offset by marketshare competition losses resulting in perfectly competitive lifetime profits. 4 firms could choose a low price for consumers now to garner larger future demands. they could make up for these losses by charging a higher price tomorrow on the larger demand. the firm may not actually make losses; sajems ns vol 7 (2004) no 2 382 however, they will clearly lose compared to what they would make if they chose the price, while ignoring the future. 5 due to the different results that could arise in markets with private or asymmetric information, it might be interesting to consider the effects of such an analysis. however, the model here assumes that all consumers are atomistic, and, therefore, transactions are of the posted-price variety, where consumer’s take-it-or-leave-it. in that setting, although private information may upset the overall efficiency of the market, modelling it is unlikely to add any insight to the model, without adding unnecessary complexity to the analysis. 6 given the large number of brands of cigarettes, it is possible individuals of differing levels of wealth have different preferences for cigarettes or that cigarette manufacturers specifically market cigarettes to people of different categories of income. the model presented here does not examine that question specifically. future research into branding behaviour and marketing would greatly improve the understanding of the cigarette market. 7 i thank a reviewer for pointing out this concern. 8 nash equilibrium is a set of strategies that result in optimum payoffs for both firms, provided their competing firm is optimising profits as well. importantly, in an infinite game, without beginning or end, a set of strategies is difficult to characterize or examine. for that reason, a steady-state nash equilibrium concept is considered here. 9 in reality, profits are an infinite sum over the periods of the game. therefore, equation (3) only represents the value function, or the part of profits, dependent upon the current price choice. 10 an assumption of linear demand curves and future price effects that did not outweigh current price effects would be enough to guarantee concavity. the bigger concern is differentiability. in the standard bertrand game of homogeneous products, the profit function is not differentiable, due to large jumps in profits associated with small changes in prices. in this model, products are assumed differentiated, which will keep the profit function differentiable. 11 only profits, π, youth demand, x, and elderly demand, z, are functions of either firm’s prices or other market variables. 12 it may be possible for a cyclical steady-state equilibrium to exist, where firms take turns charging high prices in one period and low prices in another period. however, such a pricing strategy has never existed in practice, and, therefore, the possibility will not be examined. furthermore, the assumption of differentiable profit functions makes the cyclical result unlikely, due to the lack of lumpiness in profitability; see, for example, koch (1997). sajems ns vol 7 (2004) no 2 383 13 this result is merely an extension of the application of comparative statics. see appendix a for a more detailed description. 14 a proof is available from the author upon request. intuitively, symmetry of the equilibrium is guaranteed by the symmetry of the problem, while nash equilibrium is nearly guaranteed by the fact that each firm can maximise their respective profits. the final piece requires proving that an intersection of the reaction functions exist, which is accomplished by showing, for example, that there exists a firm 1 reaction that is below firm 2’s price, given some price for firm 2, and that there also exists a firm 1 reaction that is above firm 2’s price, given some other price for firm 2. 15 the ban on promotional give-aways, however, is less contentious. the fact that firms can no longer follow a useful price discrimination strategy (giving away the product at places, like dance clubs, attended by youths, while otherwise selling the product for a positive price) that might lead to increased future demand, they are left with no choice other than to lower the price of cigarettes to try to entice new consumption. 16 the calculations are based on a 200 per cent increase in the real price as reported in van walbeek (2002). 17 increased excise taxes reduce consumption quantities and profits, thus negatively affecting consumers and firms. the long-term effect is also negative, because, in the rational addiction model, consumers were assumed to choose positive consumption quantities taking into consideration the long-term negative effects of cigarette smoking. 18 the number of consumers that participate in the market is assumed to be exogenously determined in the market, while prices are assumed to influence that actual level of consumption of those consumers. sajems ns vol 7 (2004) no 2 384 appendix a a. proof of theorem 2 consider the first order condition from the text, which is, in its most basic form, . taking the total differential of the necessary condition with respect to own price and some other variable that also influences the necessary condition, while maintaining the assumption of optimality, results in: . recall from the text, if 0,1 =tptπ 0,1,1 =+ θππ θ ddp t pt t pp ttt tq=θ , the price charged by firm 2, then , due to the substitutability of the products. more formally, with the exception of a change in c or β, 0,1 >θπ θ d t pt ( ) ( ) ( ) 11111,1 ++ ⋅−⋅+⋅−++⋅−+= tpttptttptttp tttt xcpzcpzxcpx θθθθθθ βπ . (a.1) given an increase in the number of consumers in the market, which could be a result of a government information campaign or other regulation, but not because of a change in prices (by assumption),18 condition a.1 becomes . a change in the number of elderly consumers yields . 0,1 >= t n t np ttt xπ 011,1 >= −− tn t np ttt zπ in the case of a change in c, equation (a.1) becomes , due to the law of demand (the first term) and the complementary nature of demand (the second term). while, in the case of a change in β, equation (a.1) becomes . the result is also due to the complementary nature of demand. because each of these changes happens to each firm’s reaction function similarly, and, therefore, the change in market prices will be symmetric, as was the equilibrium, unless a change only affects one of the firms in the market. 0,1 1 >−−−= tp t p t p t cp tttt xzx βπ ( ) 0111,1 <⋅−= ++ tpttp tt xcpβπ sajems ns vol 7 (2004) no 2 385 references 1 barnett, p.g., keeler, t.e., & hu, t. (1995) “oligopoly structure and the incidence of cigarette excise taxes”, journal of public economics 57(3): 457-70. 2 becker, g.s.m. & murphy, k. (1994) “an empirical analysis of cigarette addiction”, american economic review 84(3): 396-418. 3 becker, g.s. & murphy, k. (1988) “a theory of rational addiction”, journal of political economy, 96: 675-700. 4 beggs, a.w. & klemperer, p.d. (1992) “multi-period competition with switching costs”, econometrica 60 (3): 651-66. 5 caminal, r. & matutes, c. (1990) “endogenous switching costs in a duopoly model”, international journal of industrial organization 8(3): 353-73. 6 chaloupka, f. (1991) “rational addictive behaviour and cigarette smoking”, journal of political economy, 99(4): 722-42. 7 farrell, j. & shapiro, c. (1988) “dynamic competition with switching costs.” rand journal of economics 19(1): 123-37. 8 grossman, m., chaloupka, f. & sirtalan, i. (1998) “an empirical analysis of alcohol addiction”, economic inquiry, 36(1): 39-48. 9 ground, m, & koch, s.f. (2004) “alcohol demand in south africa: a systems approach”, unpublished university of pretoria manuscript. 10 harris, j.e. (1987) “the 1983 increase in the federal cigarette excise tax,” in summers, l. (ed.) tax policy and the economy, vol. 1, nber and mit press journals: 87-111. 11 klemperer, p.d. (1995) “competition when consumers have switching costs”, review of economic studies 62(4): 514-540. 12 koch, s.f. (1997) “essays on intertemporal complementarity and market structure”, the pennsylvania state university ph.d. thesis. 13 padilla, j.a. (1992) “mixed pricing oligopoly with consumer switching”, industrial journal of industrial organization 10(3): 393-411. 14 roberts, m. j. & samuelson, l. (1988), “an empirical analysis of dynamic, non price competition in an oligopolistic industry.” rand journal of economics 19: 200-20. 15 shafey, o., dolwick, s. & guindon, g.e. (2003) “tobacco control country profiles”, uicc globalink. http://www.globalink. org/tccp/. 16 showalter, m.h. (1999) “firm behaviour in a market with addiction: the case of cigarettes”, journal of health economics, 18(4): 409-27. 17 sung, h., hu, t. & keeler, t.e. (1994) “cigarette taxation and demand: an empirical model.” contemporary economic policy, 12(3): 91-100. sajems ns vol 7 (2004) no 2 386 18 van der merwe, r. & annett, n. (1998) “the effects of taxation on consumption in south africa,” chapter 4 in the economics of tobacco control in south africa, report submitted to the international tobacco initiative, school of economics, university of cape town. 19 van walbeek, c.p. (2000a) “impact of the recent tobacco excise tax increases in south africa”, economics of tobacco control project, university of cape town, research release no. 1. 20 van walbeek, c.p. (2000b) “industry responses to the recent tobacco excise tax increases in south africa”, economics of tobacco control project, university of cape town, research release no. 2. 21 van walbeek, c.p. (2002) “the distributional impact of tobacco excise increases”, south african journal of economics, 70(3): 560-78. abstract introduction methodology results of the smart simulation conclusion acknowledgements references appendix 1 about the author(s) thembalethu m. seti department of economics, faculty of economic and management science, north-west university, mahikeng, south africa olebogeng d. daw department of economics, faculty of economic and management science, north-west university, mahikeng, south africa citation seti, t.m. & daw, o.d., 2022, ‘the implications of the african continental free trade area on south african agricultural trade: an application of the partial equilibrium mode’, south african journal of economic and management sciences 25(1), a4302. https://doi.org/10.4102/sajems.v25i1.4302 original research the implications of the african continental free trade area on south african agricultural trade: an application of the partial equilibrium mode thembalethu m. seti, olebogeng d. daw received: 20 aug. 2021; accepted: 09 mar. 2022; published: 25 may 2022 copyright: © 2022. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the african continental free trade area is currently a negotiated agreement that comprises 54 african countries and aims at eliminating trade barriers between its member states. advocates of the free trade area point to the numerous benefits of the agreement, though less has been said about the potential implications on economic strategic sectors such as the agricultural sector. aim: the study explores the potential economic impact of a full tariff liberalisation as proposed under the african continental free trade area on south african agricultural trade. setting: a 100% tariff cut on agricultural commodities was simulated among all 54 members of the african continental free trade area. methods: the study adopts the smart partial equilibrium model to simulate the potential impact of a full tariff liberalisation as proposed under the african continental free trade area on south african agricultural trade. results: the simulation revealed that south africa will gain a total trade value of approximately us$199 million, and the total trade diversion from third parties will stand at us$42 million. south african agricultural commodities with the greatest export potential to the african market include sugar cane, maize, citrus fruit, cigarettes and sauces. industries that are vulnerable to the free trade area include dairy, poultry, and vegetables. the full tariff liberalisation is projected to decrease south african’s export revenue. conclusion: the study recommends that south african infant industries that are vulnerable to the agreement be listed in an exclusive list and that government should enhance the competitiveness of the affected industries. keywords: african continental free trade area; trade liberalisation; smart partial equilibrium model; regional integration; tariff; export performance. introduction after many african countries achieved liberation and decolonisation during the late 1950s, they began a rough journey towards regional integration and a united africa. created by the independent african states in 1963, the organisation of african unity (oau) affirmed the desire of achieving regional integration in africa (ed. mkandawire 2005). in the early 1980s, the first executive secretary of the united nations economic commission of africa (uneca), adebayo adedeji, provided substantive meaning and programmatic guidance to achieving regional integration in africa (adebajo 2014). his leadership played an important role in establishing and launching the lagos charter, as well as the lagos plan of action in the late 1970s. the oau endorsed the lagos plan of action which supported integration based upon ‘self-reliance, endogenous development as well as industrialization’ of african member states. even though adedeji’s approach to integration was based upon the idea of ‘developmental regionalism’, the lagos plan of action was criticised for lacking a comprehensive implementation approach (bach 2016). ten years after the inception of the lagos plan of action, the oau tackled this gap in its regional integration framework by endorsing the abuja treaty which set out a step-by-step method of how regional integration in africa should be implemented. in addition, a path towards the creation of regional economic communities (recs) and an african economic community by 2028 was set forth. the initial step in this particular pathway was the development of free trade areas (ftas) in every region, followed by customs unions, monetary unions, and common markets. according to bach (2016), advancements towards establishing recs began in the early 2000s. as it stands, only eight recs are recognised by the african union (au), namely: eac (east african community); sadc (southern african development community); amu (arab maghreb union); comesa (common market for southern and eastern africa); ecowas (economic commission of western african states); eccas (economic community of central african states); igad (inter-governmental authority on development); and cen-sad (community of sahel saharan states). economic progression in each regional economic community subsequently led to the aspiration of creating and forming continental ftas. the aspiration of forming a continental fta was also motivated by low intra-african trade as compared to intra-regional trade in other continents. according to uneca (2015), intra-african trade is approximately 15%, while intra-regional trade is 68% in europe, 55 in america, and 59 in asia. the low level of trade between african countries resulted in policy initiatives that attempt to enhance intra-african trade, the construction of local value chains, as well as the diversification of african economies (unctad 2010). in 2012, the african heads of states and government endorsed the action plan and a pathway in establishing the african continental free trade area (afcfta), which would bring together 54 african countries by an indicative date of 2017 (dti 2010). due to delays and divergences in trade negotiations, the implementation of the afcta by the proposed date was not achieved. one of the reasons for this delay is associated with the rules of origin to be adopted in the fta. the african tripartite free trade area (comesa, eac, and sadc) is advocating specific rules of origin, while other recs are proposing a general rule of origin. moreover, some african member states like eritrea and nigeria were sceptical about the potential economic implications of the proposed fta for their domestic industry, which led to a lack of commitment and poor participation in general meetings of the afcfta. nevertheless, the establishment of the afcfta is among the paramount projects on the au’s agenda 2063, which typically strives to produce one continental market for goods and services in africa. proponents of this agreement support the idea that it is going to benefit the african continent to address dilemmas of food security, unemployment, poor infrastructure, industrialisation, and institutional development (uneca 2015). on 30 may 2019, 24 member states of the au deposited their instruments of ratification with the african union commission (auc), and the afcfta entered into force. this particular date marked 30 days after 22 nations had deposited their instruments of ratification to reach the minimum legal threshold for the afcfta to enter into force. as of june 2021, 36 countries have both signed and deposited their instruments of afcfta ratification. only 29 african member states have either signed or ratified the agreement. among the 55 au member states forming, only eritrea has not signed yet. it was proposed that operations and business under this agreement will commence on the 1st of july 2020. due to the impact of the national lockdown caused by covid-19, operations of the afcfta were further delayed, and the agreement eventually came into force on the 1st of january 2021. south africa is also a member of the afcfta and has expressed its commitment to the agreement since depositing its instrument of ratification in january 2019. the afcfta presents perhaps the greatest opportunity for south africa, in terms of diversifying its export basket, enhancing food security and agricultural development. despite the positive intent of the afcfta, which stems from liberalising trade by reducing and ultimately eliminating tariff barriers between au member states, its socio-economic consequences at the national and local level should not be overlooked. indeed, trade liberalisation does not benefit all countries (abbott, bentzena & tarp 2008; chang, kaltani & loayza 2009; nicita 2004). scholars in both developed and developing countries argue that trade liberalisation is harmful to less-developed nations because it forces domestic industries to compete with international markets and may further lead to the liquidation of domestic businesses and the loss of jobs (chang et al. 2009; rodriguez & rodrik 2001; stiglitz & charlton 2005). on the contrary, mainstream economic thought claims that trade liberalisation increases economic growth and leads to export diversification for both developed and developing countries (balassa 1965; chandran & munusamy 2009; chang et al. 2009; krugman & obstfeld 2006). the potential impact posed by the afcfta is not clear, because the agreement has not been operational yet. in addition, proponents of the proposed fta only point to numerous potential benefits, while less has been said about the potential cost of the agreement on strategic economic sectors like the agricultural sector. this study contributes to this debate by revealing the potential impact of trade liberalisation as proposed under the afcfta on south african agricultural trade. this study attempts to model the potential impact of a 100% tariff liberalisation as proposed under the afcfta on south african agricultural trade. to the best of my knowledge, this is the first study of its kind to explore the potential implications of the afcfta tariff liberalisation on the south african agricultural sector. theoretical literature the first economist to study the relationship between international trade and economic growth was adam smith. he developed the concept of comparative advantage and absolute advantage to explain why countries trade with each other. this has been followed by a number of research endeavours also in the pursuit to explain how free trade policies affect the economic development of both developed and developing economies. smith (1776) explained that both the specialisation and the division of labour are one of the main drivers of economic growth. ricardo (1987) shared the same sentiments adding that countries trading with each other could mutually benefit from specialisation, leading to a win-win situation. compelling findings from literature claim that international trade increases production output and consumption efficiency, resulting in welfare gains to trading regions or countries (bhorat & hodge 1999; birdi, dunne & watson 2002; edwards & golub 2003; fedderke et al. 2003). to the contrary, numerous researchers oppose these sentiments pointing that there is little evidence providing a positive relationship between trade liberalisation and economic growth. the main determinant of long-run economic growth in both developed and developing countries are technological advancements (abbott et al. 2008). this means that long-run economic growth is independent of the level of trade integration amongst regions, and highly dependent on the level of technological advancement in a region. thus, trade liberalisation influences total trade creation and consumer welfare but not the national economy (birdi et al. 2002). findings by anderson (2004) suggest that traditional trade theory is highly associated with the reallocation of scarce resources, determined by differences in factor endowment between nations. the efficient allocation of resources increases welfare gains and enhances the overall gdp of nations. equally, economic growth theories suggest that openness to international trade leads to higher economic growth, resulting from the increased production in major strategic sectors of the economy (heijman 1998). countries can also benefit from trade liberalisation if they take advantage of the opportunities presented by globalisation, such as technological and skills transfer, foreign direct investment, and increased export market. this does not translate into openness to trade benefits for all countries. in some instances, it has been found that trade liberalisation leads to an opposite effect, as cited above, that it distorts domestic industries in most developing countries (aghion et al 2005). consequently, opponents of trade liberalisation point to numerous examples of how openness to trade can harm domestic markets. for example, the failure of the cotton production project in zimbabwe and the decrease in maize farming in zambia are evidence of local farmers forced to abandon their farms due to unfair competition from international markets (alan 2002). the situation gets worse in countries where there are weak institutional structures in place and less financial support for farmers, as compared to farmers in developed countries. south africa is a member of various trade agreements including the proposed afcfta. contradicting views about the impact of trade liberalisation has led the researcher to ask questions like, ‘how will the free trade area affect the south african agricultural sector?’and ‘is there a relationship between agricultural development and trade liberalisation’? theoretical literature suggests that there is no consensus on the impact of trade liberalisation on economic growth and perhaps the agricultural sector. international trade-related studies conducted specifically on the south africa market are also mixed in results showing different outcomes (bhorat & hodge 1999; birdi et al. 2002; edwards & golub 2003; fedderke et al. 2003). in general, some studies indicate that a reduction in and removal of tariff duties resulted in increased trade creation, leading to improvements in the gross domestic product. on the other hand, other scholars argue that trade liberalisations lead to trade diversion in which efficient countries are replaced by inefficient countries, arising from the free trade area (achterbosch et al. 2013; baier & bergstrand 2007; bhagwati, krishna & panagariya 1999). adam smith and various scholars provide evidence of long-term benefits arising from the relationship between trade and economic growth. a study conducted by anderson (2004) shows that openness to trade enhances sustainable development in the long run by encouraging foreign direct investment, knowledge transfer, and the dissemination of technology. contrary findings by redding (1999) contested that trade liberalisation poses a threat to economic growth by dismantling infant industries that cannot compete with their foreign counterparts. moreover, rodriguez and rodrik (2001) agree to the ideas contested by redding. they argued that trade liberalisation increases inequality by driving small industries out of business and benefiting commercial businesses through subsidies and farm support. the arguments above clearly show that openness to trade does not benefit all countries. the section below provides empirical evidence of the impact of trade in both developed and developing countries. the conclusion drawn from the above theoretical and empirical literature is that trade openness has no clear-cut conclusion whether it increases economic growth or distorts domestic industries. this means that an fta has a dual consequence, firstly, it has the potential to boost a country’s national economy, and secondly, it has the potential to harm domestic production. thus this gap calls for prior research to fully investigate empirically the potential implications of the afcfta on the agricultural sector. to achieve this, a comprehensive methodology is carefully selected and summarised in the following sections. empirical literature does trade liberalisation benefit or harm local businesses? this is still an ongoing question providing an opportunity for researchers to explore the gap. numerous attempts have been made in the past to gauge the impact of free trade areas and the results found are still unconvincing. robinson and thierfelder (2002) investigated a vast body of empirical literature that analysed the welfare effect of trade liberalisation in developing countries using the smart partial equilibrium (pe) model. two general conclusions were found to be prevalent: (1) trade liberalisation increased the welfare of member states at the expense of domestic production, and (2) the total trade creation is much greater than the trade diversion. makochekanwa (2012) applied a pe model to assess the welfare implications of the tripartite fta to its member states. the results of the study indicated that trade creation will increase the amount to $2 billion, benefiting countries such as drc and angola. once import duties are eliminated, tariff revenue is expected to decrease by $1 billion. spence (2013) estimated the economic implications of tariff liberalisation in uganda, using the smart pe model. the study revealed that trade openness presented uganda with welfare gains of only $3 million, and a tariff revenue of $24 million. the losses in tariff revenue are balanced by a significant increase in exports to the democratic republic of congo, equally to $112 million. chiunjira (2020) investigated the trade liberalisation implications proposed under the afcfta on exports from the common market for eastern and southern africa (comesa). results of the study showed an increase in exports from comesa to african member states due to a full tariff liberalisation. most efficient exports will be affected due to trade diversion benefiting the comesa trading bloc. the study revealed considerable losses in tariff revenue and recommended that the afcfta should allow for special and differential treatment (sdt) provisions. saygili et al. (2018) focused on the costs and benefits of a full tariff liberalisation under the afcfta using a computable general equilibrium (cge) model of trade. the study revealed growth in intra-african trade and a substantial increase in welfare, employment and output in the long run. trade creation is not dispersed evenly amongst trading partners. in the short run, member states are projected to experience tariff revenue losses and adjustment costs which may not be distributed equally across trading partners. the study concluded that costs and benefits can only be minimised if sensitive products are exempted from trade liberalisation. south africa’s trade relation with african markets south africa has signed several preferential trade relationships with african countries both as regional and bilateral trade agreements (daya et al. 2006). the agreements provide deeper economic integration through the development of common policies on industry, investment, agriculture, and competition. some of the trade agreements include the south african customs union (sacu), sadc-fta. it is not clear whether south africa benefits from these trade arrangements or not. a study looking deeply into the implications of each agreement to south africa could deliver interesting results. the following section discusses south africa’s trade performance with the rest of africa since the inception of these trade agreements. figure 1 indicates south africa’s major agricultural exports and imports from africa between the years (2014–2018). south africa’s top three agricultural export products to africa were beverages, paper, and cereals each contributing an average of r7.2 million, r6.4 million, and r4.8 million to the total agricultural export revenue of south africa, respectively. the diagram also reflects the top three agricultural imports from africa destined to south africa which include sugar, live animals, and fish with a value of r3.4 million, r1.7 million, and r1.5 million, respectively. figure 1: south africa’s major agricultural, fisheries and forestry (aff) exports and imports from africa (a–b) (2014–2018). figure 2 depicts south africa’s major export destinations to the world between (2014–2018). south africa’s top three export destinations, outside africa, for agricultural products are the netherlands, united kingdom, and china contributing a total of r7.2 million, r6.4 million, and r4.8 million, respectively. furthermore, south africa’s key export destinations in africa include namibia, botswana, and mozambique. the results suggest that south africa’s major export destination for agriculture is the netherlands which accounts for almost 60% of south africa’s agricultural exports. this means south africa trades more with third parties outside the region than its neighbouring countries in africa do. the results also suggest that south africa’s major export destinations are concentrated in the southern african region. this trend could motivate the need for south africa to diversify its export basket to other parts of the african continent. figure 2: south africa’s major export destinations to the world (a–b) (2014–2018). figure 3 below indicates the trade balance of agricultural products between south africa and the rest of africa over five years (2014–2018). south africa has been having a trade surplus over the five-year period (2014–2018). south africa’s export of agricultural products to africa increased from r45 million in 2014 to r50 million in 2016 and decreased to r45 million in 2017. this decline is attributed to the prevalent drought in southern africa, distressing agricultural production and productivity. figure 3: south africa’s aff trade balance with africa (2014–2018). conclusively, the section above leveraged the international trade centre (trade map) database tools to investigate south africa’s trade performance with african countries. the results showed that south africa’s major agricultural exports to the african market include citrus fruit, cereals, beverages, fruit and vegetable, maize, sugar, and paper. south africa’s major agricultural imports from the african market include tobacco, livestock, fish, wood and bananas. south africa’s top export destinations for agricultural products include namibia, botswana, zimbabwe, lesotho, and mozambique. these findings suggest that south africa’s agricultural exports are concentrated in the southern african region and that trade with other regional blocks in north, east, and west africa is very minimal. given these findings, the study attempts to identity major factors influencing south africa’s agricultural exports to the rest of the african continent. methodology this study adopts the smart pe model to simulate the impact of a full tariff liberalisation under the afcfta. the united nations conference on trade and development (unctad), together with the world bank, developed the smart pe model as a basic methodology for quantifying the impact of changes in trade policy on international trade. the term ‘partial equilibrium’ refers to an analysis that only evaluates the consequences of a policy change in the market that is directly impacted. in other words, the smart pe framework ignores the macroeconomic relationship that exists between different markets in a single economy. this is contrary to a general equilibrium model framework, in which all markets are modelled concurrently, and the relationship that exists between the markets is considered. the key benefit of applying the smart pe model is that it requires very minimal data. trade flows, tariff values, and behavioural parameters are the only data required to run the model. as a result, the model can take advantage of the extensive world integrated trade solutions (wits) database, which contains all these data requirements. another advantage of using this model is that it permits analysis at a disaggregated level, a degree of aggregation that is difficult and impossible to acquire using the general equilibrium model or any other models used in international trade. nevertheless, it can be argued that the main strength of the smart pe model seems also to be its major limitation. the application of the smart pe model in the current study is limited by the following constraints. firstly, the smart pe model is static and only operational under rigorous ceteris paribus assumptions. secondly, the model offers a narrow overview of the anticipated impact of tariff liberalisation and does not take into account any indirect consequences that accompany the tariff change. secondly, the study is limited to trade flow projections, while ignoring changes in general prices and other macroeconomic factors. despite the limitations highlighted above, the smart framework was adopted by many scholars (chang et al. 2009), focusing on trade policy and several nations, including the united states, to prepare their negotiation stance during the uruguay round. thus, the smart pe model is still a useful tool in providing the implication of changes in trade policy. a derivation of the model from its theoretical framework is provided on appendix 1. data requirements trade data required for simulation in the smart pe model include: trade values by an exporting country which are regarded as trade quantity. tariff values, faced by each exporting partner, allowing for calculating domestic price, and elasticity parameters reflecting consumer and exporter behaviour, such as import supply elasticity, export supply elasticity, and substitution elasticity. the smart pe model is contained in the wits software which holds various trade information databases, such as the unctad comtrade, wto-idb, and trains. the model, therefore, uses the trains database for tariffs (applied tariffs). for trade values, trains and comtrade databases are used. the pe model also incorporates the three kinds of elasticities needed to calibrate the simulation, and the study utilises the ‘default’ elasticity parameters, which the literature suggests are a statistically significant estimate. it is also important to note that the availability of data on wits software varies across years and countries. thus, some of the west, east, and north african countries are not included in the analysis due to a lack of data. these countries include sierra leone, liberia, guinea, and cabo verde. results of the smart simulation this section provides the results of the smart pe model simulating a full tariff liberalisation of agricultural tariff lines in the african market. the results of the study commence by presenting the possible effect of a 90% tariff cut. given the 90% tariff cut, trade creation will stand at us$24 million in value, tariff revenue will decrease by us$3 million and welfare gain will stand at us$10 million. these results are interesting for policy makers, given the 90% level of ambition (category a) provided under the afcfta modalities. in the long run (5 years and 10 years) member states are aiming to liberalise category b (7% sensitive list) and category c (3% exclusive list), subject to a review, implying that it will be fully liberalised if trading parties agree. against this background, a detail of the benefits and challenges of a full tariff liberalisation are discussed in the following sections. total trade creation on the south african market this part of the study explores the implications of a potential increase in exports enjoyed by the au on the south african market. for negotiation purposes, it is interesting to look at which african countries are bound to benefit the most from the full tariff elimination by south africa. in total, 39 (excluding sadc) au member states could gain more than us$1.87 million of increased exports to the south african market. the root of this gain is two-sided. firstly, au member states will gain from total trade creation arising from the south african market (the elimination of import tariffs on agricultural products make them affordable, leading to an increase in demand). secondly, agricultural imports from the au will benefit from preferential treatment, a principle that is mandatory to all negotiating parties of the afcfta. this special treatment will result in efficient industries outside the fta being replaced by inefficient industries inside the fta (a scenario called the trade diversion effect). the net growth in au exports to the south africa market is equal to the sum of added trade creation and trade diversion. table 1 shows clearly that agricultural exports from egypt will increase by 56%, equating to a value of us$26 million, followed by export from kenya with 33% of the total export gain. together, these two countries plus benin (24%), nigeria (22%), ethiopia (12%), and tunisia (11%) will gain more than 50% of increased exports to the south african market. table 1: increase in african union export to south africa after the free trade area (us$). the highest export gains by both egypt and kenya reflect the large market size of these economies and relatively high tariff lines imposed by these markets before liberalisation. other member states that are not listed in table 1 will also see an increase in their exports to the south african market, just below 5%. trade creation and trade diversion on the south africa market one of the most significant features of the smart pe model is the ability to simulate the trade creation effect stemming from changes in trade policy. traditionally, total trade creation was perceived beneficial to consumers as it reflects extra amounts of agricultural products that consumers will be able to afford because of trade liberalisation. table 2 shows the top six leading countries that stand to gain from the south african market in terms of total trade effect. egypt is set to enjoy the highest total trade effect, recording a us$9 million increase in total trade. two other noticeable au member states that stand to gain on the south african market are kenya and benin, recording a us$3 million and us$1 million increase in total trade, respectively. table 2: total trade creation in the south african market (us$). trade creation on the african union market table 3 depicts the total trade creation gained by south africa on the au market when a full tariff liberalisation is implemented on all agricultural imports. the results of the smart model indicate that south africa stands to gain most from cameroon, recording a total trade creation of about us$74 million. the model also returned results pertaining to the impact of the agreement on trade diversion. in the context of this study, trade diversion is represented as the quantity of exports from non-members of the afcfta that will be replaced by sa agricultural products. south africa records a total trade diversion of about us$42 million, and the highest trade diversion of about us$8 million is set to take place in uganda, kenya, and nigeria. table 3: total trade creation for south africa on the african union market (us$). traditionally, trade diversion was deemed detrimental to global well-being as less productive industries are replaced by more productive industries. south africa is also set to benefit more from the growing markets in kenya and nigeria, gaining a total trade of about us$25 million and us$26 million, respectively. south africa stands to gain more than us$199 million in total trade from the afcfta. for export diversification purposes, it is often vital to examine the implications of the trade creation effect at the product level. the smart pe model allows for an observation of the impact of a tariff change at the hs-6 level (harmonised system). this is one of the reasons why the smart pe model was adopted in this study. table 4 below reveals the products for which trade creation is largest and the markets that have the highest export potential for the identified products. table 4: south african products with the highest export potential. the smart simulation revealed south african products that have the highest trade potential on the au market after full liberalisation. table 4 shows that south african exports of cigarettes, maize (corn), maize flour, apples, wood, cereal and cane sugar stand to gain more from the fta. the smart model also identified au markets that south africa will need to exploit in relation to the products highlighted. cameroon conveys the strongest demand for south african cigarettes, followed by togo and ghana showing the strongest demand for south african maize exports. nigeria, kenya, and uganda showed the strongest demand for cereal, wood, and sugar cane, respectively. impact in terms of revenues and welfare the proposed tariff liberalisation under the afcfta is revealed to harm the south african agricultural sector. in terms of other member states, the extent of revenue shortfall will vary across countries depending on the phase-down tariff approach as provided in the fta. as indicated in table 5, the results of the smart simulation suggest that south africa would experience a 7% decline in tariff revenue. table 5: revenue and welfare impacts on south african market after liberalisation (us$). the smart model also revealed the welfare impact of the tariff shock. welfare effects are beneficial material impacts on the domestic nation’s (importing) consumer sector as a result of the cheaper imported goods. the results of the simulation model project a welfare effect of about us$1 million to south african consumers. the welfare effect in this context is known as ‘consumers surplus’ and refers to the additional consumption possible by south african consumers. vulnerable agriculture, forestry, and fisheries products at the regional level using the results of the model, the study isolates south african agricultural products that may be exposed to the high influx of imports from the au market. this analysis will enable the south african negotiating team to consult with the private sector and formulate strategies that aim to reduce the potential harm of the tariff liberalisation and possibly to set up a list of products to be included under the exclusion list. table 6 below depicts south african products that stand to be highly vulnerable to imports from the au market. the table also conveys au markets that are responsible for the influx of imports to the south africa domestic market. table 6: south african vulnerable products from the free trade area. it is evident from table 6 that the domestic production of cereal groats, onions, peas and roses are vulnerable to imports from the au market. the smart model shows a 96% increase in onion exports from kenya to south africa and a 90% export increase in cereal groats from nigeria. the import increase in all the products above, will mostly benefit consumers from the reduction in commodity prices. south african consumers, especially those of cereal, roses, malt beer and peas will enjoy the benefit of reduced prices and greater quantities. on the other hand, domestic producers will be left out of business if they are unable to compete. conclusion the study aimed to investigate the implications of a full tariff liberalisation as proposed under the afcfta. it adopted a smart pe model to explore the impact of the fta on south african agricultural trade. the model’s results showed that the proposed fta’s impact on bilateral trade flows would most likely be unequal, indicating relatively large economic gains for developing economies like south africa and less gains for small economies. the magnitude of this anticipated imbalance will be determined by the actual details of the agreements, which are still being discussed at the time this study is completed. provided a full tariff liberalisation of agricultural tariff lines occurs, south africa is set to benefit a total trade creation of about us$199 million. the south african agricultural industry will enjoy an increased export market access and be able to diversify its export basket on the african continent. while enjoying the preferential access to the african market, south african farmers – particularly of edible vegetables, malt beer, peas, sugar cane, wood, and apples – are set to compete with exports coming from different regions of the continent such as kenya and nigeria. this will leave less competitive industries out of business and those that are competitive will become more efficient. south african consumers of most agricultural goods will reap the benefits of the fta through reduced commodity prices. this could translate into better food security for low-income and rural households who heavily rely on agricultural products for survival. to ensure that the benefits of the fta do not overweigh losses, the study recommends that the government should in the short run exempt the identified products from full liberalisation and list them under its exclusion list. in the long run, the government and businesses need to promote competitiveness in these industries. the south african government can improve competitiveness by reducing restrictive regulations, promoting innovation and technology, and providing tax incentives to encourage product expansion. lastly, the study recommends additional research on the overall impact of the fta in all sectors and sub-industries that this paper did not attempt to analyse. the application of the cge model would be most appropriate for such an analysis, because it measures not only the impact of tariff liberalisation on trade flows but also the indirect consequences in general prices and other macroeconomic factors. acknowledgements competing interests the authors have declared that no competing interest exists. authors’ contributions t.m.s. is the supervisor of o.d.d. he mentored the entire research project and contributed significantly to the completion of the research study. ethical considerations this article followed all ethical standards for research without direct contact with human or animal subjects. funding information the authors would like to thank the national research fund (nrf) and the southern africa – towards inclusive economic development (sa-tied) programme for financially supporting this study. data availability all of the data used in the model were accessed through the wits database. please see the link below to access the database. https://wits.worldbank.org/simulationtool.html disclaimer the views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of any affiliation of these authors. references abbott, p., bentzena, j. & tarp, f., 2008, ‘trade and development: lessons from vietnam’s past trade agreements’, world development 37(2), 341–353. https://doi.org/10.1016/j.worlddev.2008.04.005 abdelkmalki, l., jallab, m.s. & sandretto, r., 2007, the free trade agreement between the united states and morocco. the importance of a gradual and 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is the import demand function for product i from the related trading partner; mijk is the normal rate of import demand of the given products and and reflects tariff rates for product i at the initial and end periods, respectively. the prevailing volume of imports, the import demand function, and the relative change in tariff all influence the total trade creation. trade diversion has the potential to increase or decrease trade internationally, as opposed to trading creation. trade diversion is a process that happens in a free trade area when competitive industries from outside the free trade market are replaced in the preferential area by less efficient industries. laird and yeats (1986) developed the theory behind the estimation of trade diversion under the smart framework. to understand the derivation of the theory clearly, the elasticity of the substitution (σm) variable is first provided. the elasticity of the substitution function can be represented as a percentage difference in the relative shares of imports from two separate sources attributable to a 1% change in the relative prices of the same commodity from the following sources: where k denotes imports from other african countries in the free trade zone, and k symbolises imports from the rest of the world (rotw). equation (9) can be extended and modified according to laird and yeats (1986) to obtain the trade diversion formula as provided below: as a result of equation (10), the total trade diverted to other african nations within the fta can be described as follows: where mafr denotes the current imports into south africa from african nations; mrotw represents imports from the rest of the world; and , respectively, denote the initial and end periods of import tariffs levied on agricultural products from african nations exported to south africa with . an important observation from the equation is that tdfta increases with the value of σm. therefore, the addition of trade creation and trade diversion is equal to the total trade effect. without a doubt, trade liberalisation under the afcfta will have revenue implications, as tariff revenue is calculated by multiplying the tariff rate by the tax base, which is the value of imported goods. as a result, the tariff revenue prior to the introduction of the afcfta is represented as: following the change in tariff rate, the current revenue collection will be provided by: considering this perspective, the tariff revenue loss to south africa as a result of the afcfta will be calculated as follows: although the afcfta will lead to trade creation and trade diversion, there is no doubt that the free trade area is expected to benefit south african consumers through lower market prices. the free trade area will encourage consumers to replace expensive agricultural products with cheaper ones as a result of the tariff liberalisation on agricultural imports. thus, trade liberalisation will lead to gains in consumer welfare, which can be explained in the equation below: where wijk denotes consumer welfare and 0.5 denotes the average difference in tariffs before and after their removal. import prices in south africa will decline less than they would if markets were fully liberalised, assuming an unlimited elasticity of export supply. journal 1.indd sajems ns 9 (2006) no 3 285 the relationship between employee and customer satisfaction in the balanced scorecard d g gouws, a y habtezion, f n s vermaak and h p wolmarans department of financial management, university of pretoria abstract this paper reports evidence of a direct relationship between employee satisfaction and customer satisfaction as they are linked in the balanced scorecard. the objective was to propose a framework that shows the linkage between employee satisfaction and customer satisfaction and to undertake some preliminary testing of this framework. an empirical study was undertaken in an airline business which investigated these relationships between employee and customer satisfaction and the correlations between these performance measures. the relationship between the key drivers of employee satisfaction and the key drivers of customer satisfaction was also investigated. the study provides empirical evidence supporting several linkages. jel m14, 41 1 introduction collecting data from both employees and customers to measure performance in service businesses is not a new strategy. over the past decade there has been increasing empirical evidence linking employee factors to customer factors (schneider, parkington & buxton, 1980; tornow & wiley, 1990; fitzgerald, johnston, brignall, silvestro & voss, 1993). studies conducted to find possible relationships between the employees of a business and the customers of that business have in general been concerned with either employee factors or customer factors. despite consistent calls for more research to incorporate both types of factor, the number of studies that link customer satisfaction with employee satisfaction is still limited (baker & fesenmaier, 1997; zeithaml, 2000). personal interaction between customers and employees, particularly in relation to service businesses, is receiving increasing attention (bettencourt & gwinner, 1996). the activities of employees within a service business connect the business with its customers (gronroos, 1990). these activities are critical factors in developing effective working relationships with customers (gwinner, gremler & bitner, 1998). customers tend to demonstrate reactive behaviour influenced by the service provider and the quality of the service they receive. management of customer and employee interactions in service businesses and the manner in which customers evaluate individual service businesses therefore play an important role (bitner, 1990). customers who are satisfied with the service they receive are likely to remain loyal to the business. when analysing employee and customer relationships, it may be helpful to determine the specific issues and concerns that act as the key drivers of employee and customer satisfaction. once such a relationship has been recognised, it is possible to set targets for measures corresponding to each key driver, based upon the strength of the driver’s relationship with the satisfaction metric. once the strength of the relationship between each relevant pair of employee–customer issues has been established, targets can be set for key drivers of employee satisfaction, based on the targets established for the key drivers of customer satisfaction. 286 sajems ns 9 (2006) no 3 1.1 statement of the problem both employee satisfaction and customer satisfaction, respectively, have been extensively empirically tested (heskett, sasser & schlesinger, 1997). the link between employee satisfaction and customer satisfaction in the balanced scorecard has recently been given more emphasis by researchers. considerable evidence of such a link exists (schneider, 1991; organ & ryan 1995; heskett et al., 1997; fosam, grimsley & wisher, 1998; rucci, kirn & quinn, 1998; bernhardt, donthu & kennett, 2000). this is also supported by the findings of ronald, james and frank (2005), who find generally positive and statistically significant relationships between employee satisfaction and customer satisfaction. several studies have also proven that employee satisfaction is positively related to customer satisfaction (wiley, 1996; kilpatrick, 2000; tofani, 2000). bernhardt et al. (2000) claim that the relationship between customer satisfaction and employee satisfaction is one of the rare relationships in market research that do not appear to yield conflicting results, but other studies do not support this. silvestro and cross (2000) find no evidence of such a link in grocery retailing, and loveman (1998) finds only a very weak indication of this link in banking. schneider and bowen (1985) fail to find a significant relationship between employees’ general feelings of job satisfaction and customer satisfaction. the results from these two last studies are important in that they challenge the fundamental premise that there is a link between employee and customer satisfaction. these arguments suggest a number of research questions, which this study attempts to address with regard to an airline business. these questions are as follows: • does employee satisfaction correlate with customer satisfaction? • is there a significant relationship between the drivers of customer satisfaction and the drivers of employee satisfaction? • are the key drivers of employee satisfaction and customer satisfaction factors influencing employee satisfaction and customer satisfaction? • is there any correlation between employee satisfaction and the key drivers of customer s a t i s f a c t i o n ; a n d b e t w e e n c u s t o m e r satisfaction and the key drivers of employee satisfaction? the hypotheses derived from these research questions and tested in this study are the following: h1: there is no significant relationship between measures of employee satisfaction and employee satisfaction. h2: there is no significant relationship between measures of customer satisfaction and customer satisfaction. h3: there is no significant correlation between employee satisfaction and customer satisfaction. h4: there is no significant association between measures of employee satisfaction and measures of customer satisfaction. h5: measures of employee satisfaction and of customer satisfaction are not correlated. h6: there is no significant association between employee satisfaction and measures of customer satisfaction. 1.2 objectives the objective of this article is to investigate relationships between employee satisfaction and customer satisfaction in an airline business. an airline business was chosen because, in the context that the study was performed, the satisfaction of customers of this airline was deemed to be significant in terms of its impact on the transportation of foreign visitors to a developing country. a measurement model (framework) was developed for the relationship between employee satisfaction and customer satisfaction in this airline business. the relationship between the key drivers of employee satisfaction and the key drivers of customer satisfaction was also investigated. there are various measures of satisfaction. for this study of an airline business, the selected measures of employee satisfaction are economic factors, benefits, working environment and working conditions. pre-flight, in-flight and postsajems ns 9 (2006) no 3 287 flight factors were selected as the measures of customer satisfaction. (see appendices a and b). these questions are regarded as important for this study, because of the results of previous studies (baker & fesenmaier, 1997; bernhardt et al., 2000). the balanced scorecard is an ideal tool to indicate the relationships to be investigated, as they are represented in the balanced scorecards’ customers and learning and growth perspectives. the structure of this article is as follows: section two reviews the balanced scorecard and the relationships between customer and employee satisfaction. section three presents the methodology used for the empirical study, including the data collection procedure used in the study, information on the sample selection, research design, measuring instruments, data processing and analysis. section four outlines the results of the empirical investigation, and section five discusses these results. section six presents the conclusions, and section seven comments on the limitations of the findings and suggests new directions for future research. 2 theoretical analysis 2.1 balanced scorecard the balanced scorecard as an analytical framework translates a business’s vision(s) and high-level business strategies into specific, quantifiable goals. the methodology breaks high-level strategies down into objectives, targets, measures and initiatives, and then monitors performance against those goals. initially, the focus of the balanced scorecard approach was on developing performance measures to examine four unique but related perspectives: financial, customer, internal business processes and learning and growth (kaplan & norton, 1992). the argument is that learning is essential to improve internal business processes, improving business processes is necessary to improve customer satisfaction and improving customer satisfaction is necessary to improve financial results (garrison & noreen, 2005). the balanced scorecard approach gradually developed into a strategic management system (kaplan & norton, 1996; garrison & noreen, 2005) oriented towards describing the process for transforming intangible assets into tangible customer and financial outcomes. this system provides a framework for describing and managing strategy (kaplan & norton, 2001; horngren, bhimani, datar & foster, 2002; drury, 2005). the significance of performance measures lies in the fact that, if strategies and their supporting actions are to be successful, the performance of these actions and their contributions against strategic outcomes must be measured. the types of performance measures selected should vary according to structural level. the higher up the level of management in the business, the more important financial measures become. moving down to the functional and operational areas, the emphasis should shift from financial to more operationally focused measures. each measure of the balanced scorecard is embedded in a chain of cause and effect logic that connects the desired outcomes from the strategy with the drivers that will lead to strategic outcomes (kaplan & norton, 2001). thus every measure selected for the balanced scorecard should be an element in a chain of cause and effect relationships that communicates the meaning of the particular business unit’s strategy to the business (kaplan & norton, 1996). the balanced scorecard translates the often rather vague goals found in corporate mission statements into a strategic roadmap that employees can follow. because it details specific actions, and outlines the cause and effect relationships between these actions and key financial objectives, a balanced scorecard serves not only as a performance measurement system, but also as a means of communicating long-term strategic initiatives to business units and achieving long-term financial success. it combines important practices and concepts from various disciplines and theories into a single performance measurement system for the purpose of improving financial performance. the balanced scorecard can thus be used as a tool for translating strategy into performance measures that employees can understand and put into action. 288 sajems ns 9 (2006) no 3 2.2 relationships between employee and customer perspectives the learning and growth perspective of the balanced scorecard has long been considered its weakest link (drury, 2005). this was confirmed by an empirical study where kaplan and norton (2004) attempted to measure the strategic readiness of intangible assets. they found that, according to most managers in their study, this perspective is the “black hole” or the area most in need of improvement in their balanced scorecard. a third of the users of the balanced scorecard do not have a learning and growth perspective (speckbacher, 2003). some of these companies try to plug this gap either with human resources-related measures such as staff training or by attempting to address absenteeism (particularly in the engineering and technology sectors) through innovation measures such as research and development. several practitioners have abandoned this perspective altogether and have simply labelled it the employee or people perspective (marr, carlucci & schiuma, 2004). nevertheless, during this study the observation has been that few businesses can easily work out how to link this perspective with meaningful and strategically relevant performance measures. satisfied employees are more likely to engage in activities that assist customers (locke & latham, 1990; weatherly & tansik, 1993). there is some agreement that employee behaviour and attitude in critical moments of interaction with customers have a significant effect on customers’ perception of the quality of service delivery (schneider et al., 1980; schneider & bowen, 1985; bitner, 1990). an empirical study by schmit and allscheid (1995) shows that it is impossible to maintain a satisfied and loyal customer base without satisfied and loyal employees. on the other hand, crosby, grisaffe and marra (1994) point out that if employees are truly motivated by a desire to do quality work that meets customer needs, then achievement of that customer satisfaction outcome should contribute to the employees’ own satisfaction as well. the positive climate of the business will thus be exposed to the customer through higher levels of employee satisfaction (uhlrich, halbrook, meder, stuchlik & thorpe, 1991). for many customers, the employees are the actual business (barlow & mail, 2000). the effects of these positive encounter cycles are shown in the positive correlations between employees and customer attitudes (schneider et al., 1980; schneider & bowen, 1985). in this study both the employee and customer are examined to investigate the impact of the two work climate variables of job satisfaction and subsequent customer perceptions of the service quality of employees. 3 methodology 3.1 data collection data were first collected from respondents by means of a personal letter addressed to employees and customers individually, requesting them to give their opinion about the business selected for this study. a letter explaining the purpose of the research and a self-addressed, stamped envelope accompanied the personal letter. anonymity was assured, as no respondent was required to supply his or her name or other personal profiles. a total of 240 letters, together with structured questionnaires and self-addressed envelopes were sent out (160 to customers and 80 to employees), requesting both the employees and the customers to complete the questionnaire. of the 240 letters, 160 responses (110 from customers and 50 from employees) or 66.67 per cent were received. of these, only 150 questionnaires (100 from customers and 50 from employees) were usable. according to babbie (1973), a response rate of 60 per cent is good, but a response rate of 45-50 per cent is adequate for analysing and reporting. the response rate for this study was therefore more than satisfactory. 3.2 sample selection the study population was a simple random sample (n=50) of employees of the airline involved (n=400). geographically, the region involved is divided into two parts, and 70 percent of the members belonged to the main region sajems ns 9 (2006) no 3 289 and the rest belonged to the other region. approximately 65 percent of the participants were male. 70 percent had worked at the airline for more than eight years, 26 percent between five and eight years; and four percent had worked there for less than five years. a non-probability sample (n=100) of customers of the airline was selected. of these, 64 percent were citizens and 71 percent were male. in terms of the frequency with which these respondents had flown on the airline, 72 percent of the participants had flown between one and five times, and 28 percent had flown more than five times. 3.3 research design a survey design was used to reach the research objectives. the specific design is a crosssectional design, whereby a sample is drawn from a population at a given time (shaughnessy & zechmeister, 1997). this sample may also be used to assess interrelationships among variables within a population. this design is ideally suited to the descriptive and predictive purposes associated with correlation research . 3.4 measuring instruments two separate questionnaires were used in the empirical study, namely an employee questionnaire (19 items), used to measure e m p l o y e e s a t i s f a c t i o n , a n d a c u s t o m e r questionnaire (20 items), which measured customer satisfaction. the respondents were asked to rate each item in the questionnaire on a five-point likert-type scale, ranging from 1 (“high satisfaction”) to 5 (“low satisfaction”). a factor analysis was then conducted. a spss statistical software package (daniel, 2003) was used to extract factors, using principal component analysis with a varimax orthogonal rotation, which assumes that the factors are not related, and tends to be easy and clear to interpret (tabachnick & fidell, 1996). the 19 items of the employee satisfaction scale and the 20 items of the customer satisfaction scale were subjected to separate analyses. prior to performing principal component analysis, the suitability of the data for factor analysis was assessed. inspection of the correlation matrix revealed the presence of many coefficients above the recommended value of 0.3 (tabachnick & fidell, 1996). the kaiser-meyer-olkin values were 0.92 and 0.94 for the items of employee satisfaction measures and customer satisfaction measures respectively, exceeding the recommended value of 0.60 (kaiser, 1974). barlett’s (1954) test of sphericity reached statistical significance (p < 0.001) for both scales, supporting the factorability of the data. cronbach’s (1951) coefficient alpha is a measure of the internal consistency of a scale. a high alpha is desirable since it shows that the items are homogeneous and that they measure the same underlying property. if the inter-item correlations are high, then there is evidence that the items measure the same underlying construct. as a correlation, alpha ranges in value from 0 to 1. it can also be squared to identify the proportion of variance it shares with other items. nunnally and bernstein (1994) suggest that an alpha above 0.7 is acceptable. table 1 cronbach alpha reliability scores factors (employee) items cronbach’s  % of variance economic factors benefits working environment working conditions 1-5 6-10 11-14 15-19 0.95 0.94 0.95 0.96 30.87% 29.52% 22.45% 11.22% factors (customer) pre-flight in-flight post-flight 1-7 8-15 16-20 0.98 0.98 0.94 36.80% 30.55% 27.02% 290 sajems ns 9 (2006) no 3 four types of factor were extracted from the employees’ questionnaire, namely economic factors (items 1 to 5), benefits (items 6 to 10), working environment (items 11 to 14) and working conditions (items 15 to 19). the alpha coefficients of the four factors were 0.95, 0.94, 0.95 and 0.96 respectively. all these values are acceptable ( > 0.70, nunnally & bernstein, 1994), and thus indicate the internal consistency reliability of the questionnaire. the percentage of variance refers to the percentage of variance of the items constituting each factor, as explained by each factor. the four factors explained 30.87 percent, 29.52 percent, 22.45 percent and 11.22 percent of the variance respectively. three types of factor were extracted from the customer questionnaire, namely pre-flight (items 1 to 7), in-flight (items 8 to 15) and postflight (items 16 to 20). the alpha coefficients of these three factors were 0.98, 0.98 and 0.94 respectively. all these values are acceptable ( > 0.70), and thus indicate the internal consistency reliability of the questionnaire. the three factors explained 36.80 percent, 30.55 percent, and 27.02 percent of the variance respectively. 3.5 data processing and analysis the questionnaires returned by the respondents were inspected, edited, coded and analysed using appropriate microsoft excel and spss statistical software packages to determine: • cronbach’s alpha coefficients, to indicate the internal consistency of the measuring instruments; • descriptive statistics (skewness, kurtosis and variances) to analyse the normality of the data; • the t-value and the adjusted r2 of single and multiple regression to determine the proportion of variance in the dependent variable that is explained by the independent variables and the causality, if any, among them; • correlation coefficients to investigate the relationship (association) among measures of satisfaction; and • factor analysis to identify whether any subdimensions are operating within the groups of items, and to verify whether the selected items empirically form the scale as intended. 4 results of the study the data obtained from the questionnaire were used to construct the research model and to demonstrate the relationship between the dependent and independent variables. the dependent variables, employee satisfaction and customer satisfaction, were measured using items of each dimension, averaged into one single measurement. 4.1 descriptive statistics from table 2 it is clear that the scores for the measuring instruments had a relatively normal distribution. all measures demonstrated low skewness and kurtosis, except that the measures of customer satisfaction showed a slightly higher table 2 descriptive statistics of the questionnaire factors (customer) mean s. d skewness kurtosis variance pre-flight in-flight post-flight 2.65 2.84 2.39 1.40 1.37 1.23 0.424 0.199 0.376 –1.048 –1.114 –1.048 1.947 1.873 1.513 factors (employee) economic factors benefits working environment working conditions 2.58 2.24 2.40 2.38 1.30 1.29 1.28 1.21 0.609 0.907 0.477 0.581 –0.740 –0.125 –0.951 –0.590 1.677 1.656 1.633 1.465 sajems ns 9 (2006) no 3 291 negative kurtosis. it is also evident from table 2 that an acceptable cronbach alpha coefficient ( > 0.70) was obtained for all the measures (nunnally & bernstein, 1994). this ensured the internal consistency of the measuring instruments. the summary of the descriptive statistics for the two types of satisfaction measures reveals that all the mean scores vary from 2.24 to 2.84, indicating that the respondents agreed to some extent with the statements made in the questionnaire. the standard deviation results indicate no large deviation of the values of these variables from the mean. 4.2 inferential statistics 4.2.1 correlation coefficients the measures of the satisfaction of each domain were collected, and each was then tested against the rest in order to identify the associations among them. the minimum value of the correlation coefficient necessary to indicate significance was 0.81, given the small sample size (morris, 1993). table 3 results of correlation coefficients customer satisfaction pre-flight in-flight post-flight employee satisfaction 0.824** 0.809** 0.885** 0.835** economic factors 0.797 0.783 0.857** 0.863** benefits 0.787 0.762 0.913** 0.840** working environment 0.851** 0.836** 0.879** 0.850** working conditions 0.821** 0.798 0.874** 0.840** ** correlation was significant at the 0.01 percent level (1-tailed). as depicted in table 3, the in-flight measure of customer satisfaction was significant, correlating at the 0.01 percent level, with economic factors (r=0.857), benefits (r=0.913), working environment (r=0.879), and working conditions (r=0.874). the post-flight measure was also significant at the 0.01 percent level, with each measure of employee satisfaction being economic factors (r=0.863), benefits (r=0.840), working environment (r=0.850), and working conditions (r=0.840). however, the pre-flight measure of customer satisfaction was only significantly correlated with working environment (r=0.836). there was also a strong positive correlation, again significant at the 99.9 percent level, between the employee satisfaction measure and each of the customer satisfaction measures, that is preflight (r=0.809), in-flight(r=0.885) and post-flight (r=0.835). the results, moreover, demonstrated a clear and highly significant relationship between employee satisfaction and customer satisfaction (r= 0.824), whereas only two of the four measures of employee satisfaction, namely working environment (r=0.851) and working conditions (r=0.821), produced significant correlations with customer satisfaction. 4.2.2 single and multiple regression analysis the regression results presented in table 4 indicate that the level of the independent variables, employee satisfaction measures and customer satisfaction measures act as a factor of the dependent variables of employee satisfaction and customer satisfaction respectively. the results indicate a coefficient of determination of 0.969 and 0.965 for employee satisfaction and customer satisfaction respectively. this coefficient suggests that 96.9 percent of the variation in the employee satisfaction (the dependent variable) is explained by changes in the economic factors, benefits, working environment and working conditions (the independent variables). furthermore, 96.5 percent of the variation in customer satisfaction (the dependent variable) is explained by changes in the measures for pre-flight, in-flight, and postflight (the independent variables). 292 sajems ns 9 (2006) no 3 table 4 results of single and multiple regression analysis dependent variables independent variables regression coefficient t-value p-value adjusted r2 employee satisfaction economic factors benefits working environment working conditions 0.147 0.152 0.250 0.455 1.653 1.915 2.313* 3.940*** 0.105 0.062 0.025 0.001 0.969 customer satisfaction pre-flight in-flight post-flight 0.646 0.261 0.087 7.960*** 3.802** 1.385 0.001 0.001 0.169 0.965 significant at *p < 0.05 **p < 0.025, ***p < 0.01 which aimed to link employees and their customers in an airline business. therefore, figure 1 provides a framework that can be used to review where propositions have been tested and connections are empirically supported. when customer satisfaction is the dependent variable, there is a significant relationship between satisfaction and customer satisfaction on the one hand and the pre-flight (p-value< 0.001) and in-flight (p-value < 0.001) factors on the other. conversely, there does not appear to be a significant relationship between customer satisfaction and post-flight factors (p-value = 0.169). however, together the three factors explain 96.50 percent of the variance in customer satisfaction. another finding is that the correlation between employee satisfaction and each of the customer satisfaction measures, pre-flight (r=0.809), in-flight (r=0.885) and post-flight (r=0.835), is highly significant. this indicates that, as employee satisfaction increases, there is a likelihood that customer satisfaction measures will also increase. 6 conclusion the results of the study suggest that the working conditions factor (t-value = 3.940) is the factor which best relates to employee satisfaction. given that the other variables remain constant, a one-point increase in the value of the measures of satisfaction with the working conditions when evaluating each of the independent variables, only two variables, namely working environment (beta = 0.25) and working conditions (beta = 0.455), make a statistically significant contribution to explaining the variability in employee satisfaction. similarly, the pre-flight measures (beta = 0.646) and inflight measures (beta = 0.261) are significant in explaining the variability in customer satisfaction. 5 discussion regression tests were conducted between employee satisfaction and each of the employee satisfaction measures collected as part of the employee survey, with a view to identifying which of the particular aspects of employee satisfaction was linked to satisfaction. the results are reported in table 4. whilst there is no significant relationship between customer satisfaction and employee satisfaction with the economic factors (p-value = 0.105) and benefits (p-value = 0.062), there is a significant relationship with each of the remaining aspects, that is, working environment (p-value = 0.025) and working conditions (p-value < 0.001). together the four factors explain 96.90 percent of the variation in employee satisfaction. the relationships in figure 1 demonstrate the two domains of employee satisfaction and customer satisfaction and the key variables within them that have been used in this study, sajems ns 9 (2006) no 3 293 figure 1 model for the relationships between employee satisfaction and customer satisfaction variables correlation is significant at r > 0.80 significant at *p<0.05, **p< 0.025, ***p<0.01 the results of this study also show that m e a s u r e s o f e m p l o y e e s a t i s f a c t i o n a n d measures of customer satisfaction have positive associations, which supports h4. the correlation between customer satisfaction and the measures of employee satisfaction are positive, which supports h5. the hypothesis that there is a positive association between employee satisfaction and measures of customer satisfaction, h6, is thus also supported in this study. the emergence of working conditions and working environment as important dimensions of employee satisfaction, and the pre-flight and post-flight factors as important dimensions of customer satisfaction, indicate that management must address these dimensions. the results suggest that the business will also benefit from building customer satisfaction by setting and achieving targets in areas that facilitate employee satisfaction gained by doing the right things for customers and doing them well. once such a relationship has been recognised, it is possible to set targets for measures corresponding to each key driver, based upon the strength of its relationship with the measure of customer satisfaction. furthermore, it is also possible to set is related to a 0.455 increase in employee satisfaction. the pre-flight factor (t-value = 7.960), on the other hand, is the factor which best relates to customer satisfaction; a one-point improvement in the value of the measures of satisfaction with pre-flight factor predicts a 0.646 increase in customer satisfaction. the results from the empirical study indicate that there is a significant relationship between customer satisfaction and employee satisfaction with working conditions (t-value=3.940) and working environment (t-value = 2.313), which supports h1. however, the result does not indicate a significant relationship between customer satisfaction and employee satisfaction with economic factors (t-value = 1.653) and benefits (t-value = 1.915). measures of customer satisfaction were hypothesized to influence customer satisfaction. the empirical results from this study reveal that there is a significant relationship between satisfaction and customer satisfaction with the pre-flight (t-value = 7.960) and in-flight (t-value = 3.802) factors. h2 is therefore not rejected. t h e r e l a t i o n s h i p b e t w e e n e m p l o y e e satisfaction and customer satisfaction (r = 0.824) is significant. this provides support for h3. 294 sajems ns 9 (2006) no 3 targets for key drivers of employee satisfaction from the targets that have been established for the key drivers of customer satisfaction, given that the strength of the relationship between each relevant pair of employee–customer issues has been established. the unique contribution of this study is the finding that the only two variables that make a statistically significant contribution in explaining the variability in employee satisfaction, i.e. working environment and working conditions, are also the only variables that produce significant correlations with customer satisfaction. from this result, we can conclude that improvements in the working environment and working conditions variables of employee satisfaction will probably increase customer satisfaction. t h i s s t u d y p r o v i d e s a f o u n d a t i o n f o r additional studies that seek to use a customer satisfaction model for measuring and improving employee satisfaction. the application of this satisfaction measurement framework provides an opportunity for cross-disciplinary research, which can increase the level of understanding of the link between employee and customer satisfaction. 7 limitations of this study and future research the empirical results of this study offer insights into the unique contribution of the work climate to service quality issues and provide an improved understanding of the critical role of linking employee satisfaction and customer satisfaction. nevertheless, the findings should be read with caution, given several limitations. unlike income and profits, satisfaction is viewed as a latent dimension that cannot be observed directly and can only be estimated through variables. data on all the measures used in this study were collected with the same five-point scales at the same time, which raises validity concerns. we cannot be sure whether or not this approach has created any method bias which may have inflated relationships. there is also a time lag between a change in the climate of a business, particularly in employee satisfaction, and its effect on customer satisfaction. such time lags are not considered in this study. this study has taken a small step in exploring and understanding the two constructs of employee satisfaction and customer satisfaction, their relationship and their implications for the competitive world. the causal relationships between the two constructs have not been investigated, as they fell outside the scope of this study. further study of the research models that reveal the causal link between employee satisfaction and customer satisfaction would help to illuminate the area under discussion even more. finally, the present study indicates new possibilities for future research. the results 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(2000) “service quality, profitability, and the economic worth of customers: what we know and what we need to learn”, journal of the academy of marketing science, 28(1): 67-85. sajems ns 9 (2006) no 3 297 appendix a: customer sample survey questionnaire please indicate your level of satisfaction by indicating (x) in order of satisfaction, where 1 – very high satisfaction 2 – high satisfaction 3 – neutral 4 – low satisfaction 5 – very low satisfaction table a factors 1 2 3 4 5 pre-flight variables 1. price 2. booking 3. personal (ground) 4. check-in 5. care/information during delays 6. departure/arrival times 7. punctuality in-flight variables 8. safety standards 9. snacks and drinks 10. seat comfort 11. appearance of aircraft 12. personal (on board) 13. overhead luggage locker 14. noise level 15. entertainment post-flight variables 16. waiting time (on board) 17. delivery time (baggage) 18. baggage handling 19. reaction in case of baggage damage or lost 20. airport transfer 298 sajems ns 9 (2006) no 3 appendix b: employee sample survey questionnaire please indicate your level of satisfaction by indicating (x) in order of satisfaction, where 1 – very high satisfaction 2 – high satisfaction 3 – neutral 4 – low satisfaction 5 – very low satisfaction table b factors 1 2 3 4 5 economic factors variables 1. job security 2. wages 3. promotion policy 4. bonus plan 5. job training benefits variables 6. vacation policy 7. sick leave 8. health plan 9. retirement benefits 10. pension plan working environment variables 11. supervisors 12. physical environment 13. quality of environment 14. feedback from supervisors working conditions variables 15. interest in work 16. people at work 17. commuting to work 18. flexible time plan 19. co-workers abstract introduction research methodology ethical considerations empirical results and discussions conclusion acknowledgements references about the author(s) sikhulumile sinyolo economic performance and development, human sciences research council, south africa maxwell mudhara discipline of agricultural economics, university of kwazulu-natal, south africa edilegnaw wale discipline of agricultural economics, university of kwazulu-natal, south africa citation sinyolo, s., mudhara, m. & wale, e., 2017, ‘the impact of social grant dependency on smallholder maize producers’ market participation in south africa: application of the double-hurdle model’, south african journal of economic and management sciences 20(1), a1474. https://doi.org/10.4102/sajems.v20i1.1474 original research the impact of social grant dependency on smallholder maize producers’ market participation in south africa: application of the double-hurdle model sikhulumile sinyolo, maxwell mudhara, edilegnaw wale received: 09 sept. 2015; accepted: 23 mar. 2017; published: 26 may 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: social grants have become an increasingly popular means of improving the welfare of poor households in south africa and beyond. while the goals of these transfers are to alleviate current poverty as well as to improve human capital capacity, they also have unintended effects, positive or negative, on beneficiary households. a question that has not been adequately addressed in the literature is the role that social grants play in the efforts to commercialise smallholder farming. aim: the aim of this study was to examine the impact of social grant dependency on the incentives of smallholder maize producers to participate in the market. setting: the study was done in the rural areas of four districts (harry gwala, umzinyathi, umkhanyakude and uthukela) in the kwazulu-natal province, south africa. methods: the study adopted a quantitative research design. a total of 984 households were randomly selected from the four districts, of which 774 had planted maize in the previous season. the analysis was done on the 774 farmers who had planted maize. the double-hurdle model was used for statistical analysis. results: the results show a negative association between social grant dependency and market participation, suggesting that social grant-dependent households are more subsistent, producing less marketable surplus. moreover, households with access to social grants sold less quantities of maize in the market, indicating reduced selling incentives. conclusion: the study indicates that social grants reduce the incentives of smallholder farmers to commercialise their production activities. the results suggest that, while policies aimed at reducing transaction costs would increase smallholder market participation, attention should be paid on how to reduce social grants’ dis-incentive effects. to reduce spill over effects to unintended household members, the study recommends offering part of the grant as ‘in-kind support’, which is specific to the intended individual beneficiary. introduction there is a general consensus in the literature (e.g. alene et al. 2008; barrett & swallow 2006; carter & barrett 2006; de janvry, fafchamps & sadoulet 1991; von braun 1995) that promoting smallholder market participation is an important pathway towards poverty reduction, economic growth and development in developing countries. it has been argued that smallholder agriculture would contribute more to rural livelihoods if it breaks out of the subsistence trap into commercial agricultural production (barrett & swallow 2006; hazell et al. 2010). as a result, the transition from semi-subsistence to commercialised agriculture has been a core theme of rural development initiatives for many years across the developing countries (agwu, anyanwu & mendie 2012; barrett 2008). this also applies to south africa, which, on the one hand, is characterised by large-scale producers well connected to markets and, on the other hand, has a smallholder farming sector that is unprofitable and is characterised by weak links to markets (makhura, kirsten & delgado 2001; ortmann & king 2010; van der heijden & vink 2013). the general view is that smallholder farmers’ market participation should be improved to reduce rural poverty and household food insecurity in south africa (chikazunga 2013; khumalo 2013; senyolo et al. 2009). moreover, the high unemployment rates and limited prospects for labour absorption in the non-farm sector have led the south african government to prioritise the expansion of the smallholder sector as part of its broader job creation strategy [aliber & hall 2012; national planning commission (npc) 2012]. according to aliber and hall (2012), an important element of such a strategy is that it should promote the graduation of subsistence producers so that they can earn an income as commercial smallholder producers. accordingly, the south african government has identified increased commercialisation of smallholder farming as key in reducing rural poverty as well as stimulating rural economic development [department of agriculture, forestry and fisheries (daff) 2012; npc 2012]. for example, the new growth path sets target of establishing 300 000 additional market-oriented smallholder producers by 2020 [department of economic development (ded) 2011]. in line with these targets, the daff has been implementing the strategic plan for smallholder support (spss), aimed at supporting the smallholder farmers to graduate to commercial status (daff 2012). despite the concerted government efforts in the past, smallholder farmers’ market participation has not significantly improved in south africa (hlongwane, ledwaba & belete 2014). a range of constraints and barriers reducing smallholder producers’ market participation levels have been identified, with most of the studies highlighting the negative impact of transaction costs in this regard (biénabe & vermeulen 2011; hlongwane et al. 2014; jari & fraser 2013; makhura 2001; van der heijden & vink 2013). however, the question that has not been adequately addressed is the impact of social grants on the incentives of smallholder farmers to commercialise their production activities. south africa has social grants that benefited an average of over 16 million of the poor each month in 2014 (south africa social security agency 2014). most smallholder farming households are beneficiaries of at least one of the different social grants. even though the social grants are targeted to specific vulnerable groups such as the young, old or chronically sick among poor households, they generally benefit households as a whole (abel 2013; klasen & woolard 2008). on the one hand, social grants can be an important complement to the smallholders’ commercialisation agenda, as the extra income may relieve the credit and liquidity constraints of farm households, enabling them to overcome the transaction costs they face (barrientos 2012; bezu & holden 2008; boone et al. 2013; tirivayi, knowles & davis 2016). on the other hand, the economic theory predicts that social grants may induce negative behavioural changes and entrench a culture of dependency and entitlement, undermining the incentives of farmers to commercialise their production activities (barrett 2006; devereux 2001; gibson 2015; lentz, barrett & hoddinott 2005). the theoretical rationale is that increased household income because of unearned income like social grants, reduces the marginal benefit that households obtain from undertaking further income-generating activities such as farming (binger & hoffman 1998). descriptive statistics and anecdotal evidence from several studies in south africa (e.g. aliber & hall 2012; aliber & hart 2009; tshuma 2012; white & killick 2001) have highlighted the potential negative effect of social grants on smallholder farming activities. tshuma (2012) reported that many smallholder farmers are reducing the area under cultivation, even for subsistence purposes, as they depend more on social grants for their income. this has resulted in social grants becoming the greatest source of income for the majority of rural households in south africa, surpassing that of smallholder agriculture by far (tshuma 2012). however, the understanding of the linkages between smallholder market participation and social grants has not been based on in-depth empirical analyses. recent reviews of empirical literature on the potential linkages between social cash transfers and smallholder agriculture (e.g. bastagli et al. 2016; tirivayi et al. 2016) have indicated that the research on the issue is currently thin and the results are of a mixed nature. most of the studies (boone et al. 2013; covarrubias, davis & winters 2012; radel et al. 2016; todd, winters & hertz 2010), mainly in latin american and sub-saharan african (ssa) countries, evaluated the direct and indirect impact of social transfers on agriculture and focussed on agricultural outcomes such as asset accumulation, input use, output and labour allocation. while literature generally showed the positive role of social transfers in improving the productive capacity of beneficiaries, little is known about whether social cash transfers have positive or negative effects on the smallholder market participation. understanding the linkages between social transfers and smallholder commercialisation is important to improve the policy coherence between social protection and smallholder agriculture, as called upon in recent literature (e.g. boone et al. 2013; fao 2016; tirivayi et al. 2016). increased policy coherence would ensure that social cash transfers do not reduce the incentives for the poor to work themselves out of poverty through smallholder farming, which is the main income-generating activity in rural areas (gibson 2015; maluccio 2010). few studies, if any, have explicitly and systematically articulated the theoretical linkage and examined the empirical relationship between the two variables in south africa and beyond. this study, therefore, seeks to address this pertinent question by focussing on smallholder maize producers’ market participation. maize was chosen because it is the most important grain crop in south africa, and is the main crop grown by smallholder farmers (akpalu, hassan & ringler 2010; biénabe & vermeulen 2011; d’haese et al. 2013). the remainder of this article is organised into three sections. the next section presents the research methodology, introducing the theoretical framework, the study area, the sampling techniques adopted and the empirical models employed. the penultimate section presents results and their discussions, while the conclusions and implications for policies are contained in the final section. research methodology survey design and data the sample was randomly drawn from four purposively chosen districts across the kwazulu-natal (kzn) province: harry gwala, umzinyathi, umkhanyakude and uthukela. these districts have a significant number of rural communities engaged in farming activities and are among the poorest in terms of average household incomes (stats sa 2012). the kzn province is characterised by high poverty levels and lack of economic opportunities, particularly in rural areas. social grants and smallholder farming play important roles in the livelihoods of the rural dwellers. the lists of farmers were obtained from the extension offices of the respective districts, which also helped direct the enumerators to the selected farmers’ homesteads. a total of 984 households were randomly selected from the four districts, of which 774 had planted maize in the previous season. the analysis was done on the 774 farmers who had planted maize in the last season. data were collected between june and november 2014 using a pretested structured questionnaire. the questionnaire was administered by trained and experienced enumerators who had good knowledge of the rural farming systems and who could speak the local isizulu language. the questionnaire included information on basic household head characteristics, measures of household wealth endowment (such as household assets, livestock and land) and household income sources or amounts. the questionnaire also captured the crop production and marketing behaviour of the households, asking questions about types of crops the household planted in the previous season, quantities harvested and sold. furthermore, the questionnaire captured farmers’ membership to associations as well as their access to institutional support such as market access, social grants, credit and extension. conceptual framework and variables the households’ decision on whether or not to participate in the maize market was considered under the random utility framework (mcfadden 1974) and the theory of farm household decision-making under imperfect markets (de janvry et al. 1991). the random utility framework postulates that the smallholder maize farmers will decide to participate in the market if the perceived utility or net benefit from participation is greater than in the case without participation. the theory of farm household decision-making under imperfect markets indicates that a household’s market participation is mainly a function of market transaction costs. according to de janvry et al. (1991), market failure is household specific, not commodity-specific. this is because households who participate in the market are those with market gains that are higher than the transaction costs, while those with market gains less than the transaction costs will not participate. even though in some cases markets do not even exist (missing markets), the majority of the cases of market failure in developing countries are because of high transaction costs (alene et al. 2008; de janvry et al. 1991; goetz 1992; key, sadoulet & de janvry 2000; omamo 1998). in south africa, these transaction costs are because the smallholder farmers are located in rural areas which are remote and far away from major consumers of farm products. moreover, the rural areas are characterised by poor infrastructure, inadequate information and thin credit markets. as explained in de janvry et al. (1991) and other recent studies (e.g. alene et al. 2008; mather, boughton & jayne 2013), the household’s market participation is influenced by its economic position and institutional environment. the model estimated in this study included proxies for transaction costs, wealth endowment and human capital. table 1 shows the variables that were considered and their descriptions. table 1: variables description. the table presents the household head demographics (age, gender and household size), wealth endowment (farm size, asset values, livestock size, etc.), human capital (education level and farming experience), social capital (farmer groups membership) and farmer support services (access to extension, agricultural training, credit and markets) that were included in the model. district dummies were also included to capture the district-specific attributes that result in spatial variations in the political, social and agro-climatic environment of these districts which impact market participation. the quantities of maize produce harvested and sold as well as prices were based on the recall by the farmers. even though the individual prices the households faced were collected, the average ward price was used as an explanatory variable in the model, following previous studies such as alene et al. (2008) and komarek (2010). this is because if household specific prices were used, those households with zero sales would have been excluded from the analysis. total household income included the incomes that the household received from different sources, such as employment, remittances, social grants, farming, micro-businesses, and arts and culture. it was also hypothesised that access to social grants will have a negative effect on the smallholder market participation. this is because increased income from social grants may entrench a culture of dependency and entitlement among beneficiary households (abel 2013; bertrand, mullainathan & miller 2003; samson et al. 2004), reducing incentives by households to engage in income-generating activities. the influence of social grants was captured using two variables: a dummy variable showing whether or not a household has access to social grants and a proportional variable showing the contribution of social grants to total household income. the proportion variable captured the level of household dependency on social grants. the double-hurdle model the maize output marketing decision was modelled as a two-step decision process: (1) the household decides whether or not to participate in the market and (2) the household decides on the volume of transactions. the double-hurdle model (cragg 1971) was used to model this two-step decision process, following several other market studies (e.g. holloway, barrett & ehui 2005; komarek 2010; mabuza, ortmann & wale 2014; mather et al. 2013; ndoro, mudhara & chimonyo 2014). this model was chosen over the heckman sample selection model, which has been used by many studies (e.g. alene et al. 2008; bwalya, mugisha & hyuha 2013; geoffrey et al. 2013; goetz 1992; sebatta et al. 2014). the heckman approach addresses the statistical challenge posed by cases in which market sales equal zero as a missing data problem. however, the issue of zero market sales does not represent missing values as a zero amount of maize output sold is a valid economic choice to be explained (mather et al. 2013). the double-hurdle model produces more superior estimates than the heckman model when one is dealing with true zeros (dow & norton 2003). according to the double-hurdle model, a farmer faces two hurdles while deciding on maize market participation: whether or not to participate in the market and how much maize to sell in the market. this approach distinguishes between fixed transaction costs, which influence only the first decision of participation, and variable transaction costs, which can influence both decisions (key et al. 2000). for example, distance to the market was considered in both decision stages because farmers nearer to the market incur less information cost, thus reducing fixed costs, and they also incur lower transport costs, reducing variable costs. similarly, association membership was considered in both stages because group members may have higher access to information as they exchange information and experience. on the other hand, individual members would incur less variable costs (transport costs and risks) as they share these with other group members. however, access to different information sources only mitigates the costs of accessing information, which are fixed costs, but not the variable transaction costs. the double-hurdle model integrates and simultaneously estimates the probit model to determine the probability of maize market participation and the truncated normal model for the level of market participation. the binary variable of maize market participation (w), assumed to follow a probit model, was specified as follows: where p is the probability, w is the binary variable of market participation, φ is the cumulative normal distribution, x is the vector of household characteristics that includes an indicator of access to social grants and γ are the coefficients to be estimated. the level of maize market participation, y*, assumed to have a truncated normal distribution with parameters that vary freely from those in the probit model was estimated as follows: where y* represents the quantity of maize output sold in tons; x is the vector of household characteristics that included indicators of grant access and dependency, εi is the error term and β’s are parameters that were estimated. a log-likelihood test was done to justify the use of the double-hurdle model over the tobit model. based on the log-likelihood values obtained from a separate estimation of the probit, truncated regression and tobit models, the likelihood ratio statistic (λ) was computed as follows: where llprobit, lltrunc and lltobit are the likelihood values from the probit, truncated regression and tobit models, respectively. the test statistic has a χ2 distribution with degrees of freedom equal to the number of independent variables (including the intercept) (greene 2003). the tobit model is rejected in favour of the double-hurdle model if λ exceeds the appropriate χ2 critical value, as was the case in this study (burke 2009; mabuza et al. 2014). as social grants are not a random intervention but a targeted intervention, it was suspected that the estimated model may be affected by selection bias. selection bias may occur because farmers with higher intrinsic motivation and ability are more likely to have more income and assets, meaning that they are less likely to qualify to benefit from social grants. these motivated farmers are also more likely to participate in the maize market, resulting in selection bias. the probit model (equation 1) was first estimated using the heckman selection probit model (heckprob command in stata), with access to social grants as the selection variable. the likelihood ratio test of independent equations was done to indicate if there was evidence of selection bias at the conventional 10% significance level. the test showed that there was no evidence of selection bias. moreover, hausman test (hausman 1978) was conducted to test for potential endogeneity of dependency on social grants in the model. this is because it is possible that causality might flow from market participation to dependency on social grants, as increased market participation results in increased farm income. the increased farm income would result in decreased dependency on social grants, ceteris paribus. the test was implemented by firstly regressing social grants dependency on the exogenous explanatory variables as follows: where gd means dependency on social grants, z is the vector of exogenous variables, γ are the estimated coefficients and ui is the residual term. the second step involved obtaining the residuals (ui) and then adding these residuals in the truncated regression equation (equation 2). a statistically significant estimated coefficient of the residuals would mean endogeneity problems, while a statistically insignificant estimate (as was the case in this study) means no evidence of the endogeneity problem. the potential endogeneity of other variables such as prices and assets (boughton et al. 2007; mather et al. 2013), was not tested. therefore, the estimated coefficients of these variables should be interpreted as associations, not as causality relationships. ethical considerations all procedures performed in studies involving human participants were in accordance with the ethical standards of the human and social sciences research ethics committee of the university of kwazulu-natal (reference number: hss/0027/015d) and with the 1964 helsinki declaration and its later amendments or comparable ethical standards. empirical results and discussions descriptive statistics table 2 shows the socio-economic characteristics of the respondents per their market participation status. the moderate proportion of maize market participators is comparable to other studies in rural south africa. for example, biénabe and vermeulen (2011) reported a figure of 43% maize market participants in the limpopo province. table 2: socio-economic characteristics of the sampled households according to maize market participation status (n = 774). table 2 also shows some significant differences in wealth and institutional or organisational support between market participants and non-participants. households participating in the maize market had bigger family sizes, were richer in assets and had more farm income. the market participants had more access to extension and information and were members of associations. moreover, the market participants had less access to social grants and received less of their income from social grants, that is, they were less dependent on social grants. the table also shows that the market participants were nearer to markets, had higher maize output and were more productive in maize production. empirical results table 3 presents the results from the double-hurdle model. the likelihood ratio test of independent equations found no evidence of selection bias (χ2 [1] = 0.37, p = 0.54) at the conventional 10% significance level. the hausman tests found no evidence of endogeneity between social grant dependency and market participation level (f = 0.49, p = 0.48) at the conventional 10% significance level. the double-hurdle model was chosen instead of the tobit model because the log-likelihood test showed that it performed better than the tobit model (λ = 622 exceeded the χ2 [23] critical value = 35). this implies that the decision to participate in the market and the volume of maize sold in the market are governed by separate processes. the probit model correctly predicted 80% of the participation outcomes, and the wald test highly rejected the hypothesis that all regression coefficients are jointly equal to zero. this indicates that the model fits the data reasonably well. table 3: the impact of social grants dependency on maize market participation: the double-hurdle model results (n = 774). table 3 shows that increasing dependency on social grants (grantprop) was associated with decreasing probability of participation in the maize market. in other words, households who depended more on social grants were less likely to decide to enter the maize produce market compared with those who depended less on social grants. this result, coupled with the insignificant estimated coefficient of access to social grants (grantacess) in the market participation model, imply that the decision to enter the maize market is not dependent on access to social grants per se but on the importance of social grant income to total household income. this suggests that the social grant-dependent households are more subsistent, mostly producing for themselves and producing less marketable surplus. this is in line with mabugu et al. (2014), who found that social grant recipient households were more likely to be subsistent-oriented as the extra income from subsistence farming activities is generally minimal and thus does not disqualify the household from accessing the social grants. the significant and negative estimated coefficient of access to social grants (grantacess) in the maize marketed model suggests that households with access to social grants sell less maize quantities in the market than those without, ceteris paribus. this result implies that access to social grants, instead of helping households overcome the variable transaction costs, decreases incentives to sell more maize produce by the market participants. a plausible explanation for this result is that social grant recipient households are producing mostly for subsistence purposes, and enter the maize market targeting to raise a certain amount of income needed to maintain a desired consumption level. therefore, increasing household income through social grants decreases the need to sell more maize produce in the market. this result applies to both the highly and lowly social grant-dependent households, as dependency on social grants (grantprop) was not significant in the maize supply model. the results suggest that, while social transfers may increase the productive capacity of rural households, as has been reported in the literature (e.g. boone et al. 2013; covarrubias et al. 2012; todd et al. 2010), they are dis-incentives for these households to commercialise their farming activities. this result is consistent with studies such as those of radel et al. (2016) and todd et al. (2010) who found that beneficiaries of cash transfers in mexico were more likely to engage in semi-subsistence farming, even though they harvested more on average. the results support evidence from descriptive and anecdotal reports in south africa (e.g. aliber & hart 2009; mabugu et al. 2014), describing a potential dis-incentive effect of social grants on smallholder market participation. age (age) was positively related to market participation, implying that older farmers were more likely to participate in the market. this could be because older farmers would have developed greater market contacts and trust that would allow them to trade at lower transaction costs. this result is contrary to the majority of literature (e.g. alene et al. 2008; geoffrey et al. 2013), which has reported that increasing age is associated with decreasing chances of market participation as older farmers are less receptive to new ideas and are more risk-averse than younger farmers. the implication here is that the effect of increased contacts and/or networks dominates the risk aversion associated with older farmers, resulting in a positive relationship between age and market participation. the negative estimated coefficient of gender implies that female-headed households are more likely to sell more maize quantities in the market than male-headed households. this result is inconsistent with expectations and a number of studies in the past (e.g. boughton et al. 2007; geoffrey et al. 2013; hlongwane et al. 2014). the expectation was that male-headed households would be more likely to sell more because of their advantages in bargaining, negotiating and enforcing contracts. the result, which is in line with a few studies such as boniphace, fengying and chen (2014), suggests that female-headed households are not at risk of exclusion in the market for staples such as maize. while female-headed households may have disadvantages in the male-dominated high-value cash crop markets (boughton et al. 2007), the result implies that female-headed households have advantages in the low-value food crop markets. the results show that households headed by more educated heads (educat) were more likely to participate in the maize market. this result is consistent with a priori expectations and other studies (e.g. geoffrey et al. 2013). the explanation is that more educated people are able to understand and interpret market information better, resulting in less transaction costs. however, once the decision to participate in the market is made, education level had no significant impact. this implies that while education helps reduce fixed transaction costs such as search costs, it has no significant impact on the variable transaction costs such as transportation costs. increasing farm size (land) was found to be associated with higher chances of selling maize as well as selling more quantities of maize. this is because land is an important production factor that enables households to produce a surplus for the market. the result is also consistent with previous market participation studies (e.g. alene et al. 2008; boniphace et al. 2014; boughton et al. 2007; jagwe, machethe & ouma 2010; makhura et al. 2001) that have highlighted the critical role that access to land plays in motivating smallholder farmers to produce for the markets. increasing asset value (assets) was also found to be associated with increased likelihood of market participation. this is in line with the literature (e.g. barrett & swallow 2006; boughton et al. 2007) which has shown the importance of assets in enabling smallholder farmers to produce a surplus necessary for participating in markets as sellers. moreover, asset ownership facilitates access to credit and technology adoption, and wealthier households are more likely to undertake riskier activities such as market participation because of their capacity to bear risks. the results also demonstrate the importance of increasing production levels (mzoutput) in market participation. the households who produced more maize were more likely to participate in the market than households producing less. after the decision to participate in the market was made, those with higher output were likely to sell more. the explanation is that as market participation requires the smallholder farmers to produce a marketable surplus, those households with higher production levels are likely to have more than enough for family consumption. this result is in agreement with other market participation studies (e.g. bwalya et al. 2013; geoffrey et al. 2013; komarek 2010). consistent with a priori expectations informed by economic theory and literature (e.g. boughton et al. 2007; jagwe et al. 2010; key et al. 2000; komarek 2010), the study found a positive relationship between the maize producer price (mzprice) and both the decision to sell maize and quantity sold. this indicates that the producer price provides incentives for households to participate and sell more maize in the market, implying rational economic behaviour by smallholder farmers. however, it must be noted that many smallholder farmers sell their produce right after harvest to satisfy their immediate cash requirements, and their capacity to wait and take advantage of higher prices is low. as such, this result should be interpreted as indicating that smallholder farmers are responsive to price changes, at least in the short term. the results also show that access to extension (extension) was associated with increased chances of participating in the market. extension officers remain the main sources of agricultural market information among the rural households, and contact with extension agents keeps the farmers updated with information regarding market locations, prices and potential buyers and/or sellers. training (training) was also found to have a positive impact on the decision to participate in the market, implying that focussed farmer training may increase the chances of households participating in the market. while group membership (group) was insignificant in the market participation model, it was significant in the maize supply model. this implies that group membership played a less significant role as a channel of information exchange but a significant role as a means of sharing variable costs such as transport costs among the sampled households. this is consistent with previous studies (e.g. alene et al. 2008). as expected, and in line with the literature (bwalya et al. 2013; hlongwane et al. 2014), farmers who stay further away from the markets (mktdist) had less chances of participating in the market than those who stay nearer. this is because market information published in formal channels, such as newspapers, is not very relevant to farmers in rural areas as these channels mainly report national figures. the isolated nature of rural areas means that the local market situation could be very different from the national situation. as such, farmers have to physically go to the local market places to gather such relevant information. the insignificant estimated information access variable (inform) confirms this to be the case in the study areas, as increasing diversity of information sources was not very useful as the information may not be contextually relevant. consequently, the farmers located further from the market incur higher search costs than those nearer to the market. however, once the farmer has decided to participate, increasing distance was associated with increasing quantity of maize produce sold. this indicates that the higher transport costs that the farmers who stay farther incur make them strive to meet a certain supply threshold to make profits. the farmers who stay farther sell more to make the same amount of money compared to the ones who stay closer because of the additional transaction costs. this is in line with other studies (e.g. boughton et al. 2007). households where the heads have non-farm employment (employed) were less likely to participate than those where heads were unemployed. this may be because households where heads are employed depend on wages for income and only practice farming for subsistence. the results also show that owners of non-farm businesses (business) sold more in the market than non-business owners. this may be because the non-farm business owners have established more contacts or networks, resulting in declining transaction costs. the significant district dummies show that farming households from both umkhanyakude and umzinyathi were more likely to participate in the market than those in harry gwala district. in contrast, smallholder farmers in uthukela district were less likely to participate compared to the harry gwala smallholder farmers. these district dummies capture the political, social and agro-climatic variations in these areas that impact on market participation but were not captured in the model. a possible explanation of the higher maize participation rates in umkhanyakude than in harry gwala districts is that the umkhanyakude district has higher maize potential (i.e. higher chances of producing a surplus) as well as near-by market centres for farmers to sell their maize. the culture of selling maize seems to have been inculcated among smallholder farmers in umkhanyakude, particularly in and around the jozini town. while harry gwala district has equally high potential in maize production, particularly in the ubuhlebezwe local municipality, access to the market is a major problem because of poor roads. for example, the main road joining one of the high potential smallholder maize producing areas of hlokozi and the nearest main town ixopo is mostly a gravel road, which becomes impassable during the rainy season. a plausible explanation for the higher market participation rates in the umzinyathi district than in harry gwala is that because the high temperatures and low rainfall make it difficult for many households to produce crops, then for those who can produce a surplus there is a ready market from the surrounding communities. the lower maize market participation rates in the uthukela district than in the harry gwala district may be because the rural areas in uthukela are isolated and far from bigger urban centres. conclusion using the double-hurdle model on a sample of 774 maize producing households, the study concluded that social grants reduce the incentives of smallholder farmers to commercialise their production activities. the study results indicated that dependency on social grants was associated with decreased chances of maize market participation. moreover, households with access to social grants were likely to sell less maize quantities compared with households with no access to social grants. in other words, the smallholder farmers who have access to and are highly dependent on social grants are less likely to be market-oriented, and to sell less maize on the market, respectively. the fact that social grant-dependent households were more likely to produce only for subsistence purposes and depend on social grants for income suggests that social grants were spilling over to the undeserving household members, reducing recipient households’ incentives to engage in income-generating farming activities. the study findings suggest that the implementation of social welfare programmes among developing countries, such as south africa, may have negative implications on the drive to increase commercialisation levels of smallholder farmers. in south africa, this presents challenges in meeting the government’s target of establishing 300 000 additional market-oriented smallholder producers by 2020. while this study is not advocating for the removal of social support from poor households, it highlights the need to re-look at how these two interventions (social grants and smallholder commercialisation) may be synchronised in such a way that they complement each other as options for rural livelihoods. a policy option is to offer part of the grant as ‘in-kind support’, which is specific to the intended individual beneficiary, instead of cash which is fungible. this will help in reducing spillover effects and dis-incentives of recipient households to engage in economic activities. the study results also suggest that female-headed households may be successfully included in the market for staples. although there are concerns elsewhere that women are likely to remain subsistence farmers because of their exclusion from the market, this study indicates that there is potential of reversing that trend if women are encouraged to produce and sell staples such as maize. the study results also imply that policies aimed at reducing both fixed and variable transaction costs (such as improved road infrastructure and institutional support like extension, training and organising farmers into groups) should be prioritised to increase both rates 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washington, dc. https://doi.org/10.1596/0-8213-4867-1 abstract introduction literature review methodology findings conclusion acknowledgements references about the author(s) sa’diyah ebrahim department of business management, faculty of economic and management sciences, university of pretoria, pretoria, south africa wesley niemann department of business management, faculty of economic and management sciences, university of pretoria, pretoria, south africa theuns kotzé department of business management, faculty of economic and management sciences, university of pretoria, pretoria, south africa citation ebrahim, s., niemann, w. & kotzé, t., 2022, ‘sustainable supply chain integration: an exploration of south african fast-moving consumer goods manufacturers’, south african journal of economic and management sciences 25(1), a4192. https://doi.org/10.4102/sajems.v25i1.4192 original research sustainable supply chain integration: an exploration of south african fast-moving consumer goods manufacturers sa’diyah ebrahim, wesley niemann, theuns kotzé received: 31 may 2021; accepted: 01 mar. 2022; published: 23 may 2022 copyright: © 2022. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: manufacturers of fast-moving consumer goods (fmcg) are facing new challenges that compel them to outperform their competitors economically, and to consider environmental and social impacts. customer demands regarding sustainability are channelled upstream to these manufacturers through retailers. this resulted in manufacturers being very conscious of the sustainability of their production processes, as well as their packaging. to that extent, fmcg manufacturers are encouraged to integrate sustainability, with other supply chain partners, to improve sustainability performance across the supply chain. aim: the purpose of this study is to explore the extent to which fmcg manufacturers in south africa apply sustainability to their supply chain integration. setting: the study was conducted among south african fmcg manufacturers. method: the study applied a generic qualitative research design. altogether 12 semi-structured interviews were conducted with middle to senior supply chain managers. results: having a clear sustainability focus, supported by leadership and embedded into the corporate culture, is key to integrating sustainability internally and thus improving the sustainability performance. the findings indicate that customers do not pressure firms to adhere to their sustainability expectations. instead, sustainability expectations are driven internally. firms find it difficult to align the three sustainability aspects equally, due to the local variables and context in which they operate. therefore, economic sustainability is considered most important and firms act on environmental and social sustainability aspects within strict economic constraints. conclusion: academically, the study adds to the literature by creating an understanding of sustainable supply chain integration (ssci) from a south african perspective. for practitioners, the study encourages firms to collaborate with supply chain partners on sustainability, as this opens up opportunities to create shared value through joint sustainability problem-solving. keywords: sustainable supply chain management; sustainable supply chain integration; fast-moving consumer goods industry; generic qualitative research; south africa. introduction firms face new obstacles, which not only oblige them to outperform their competitors economically, but to also consider environmental and social responsibilities (azevedo et al. 2017:2271). stakeholders in firms are increasingly insisting that these firms address the social, environmental and economic issues caused by business operations; thus, sustainability is highly relevant to businesses (carter & easton 2011:46–47). supply chain managers are in the position to have positive or negative effects on environmental sustainability and social performance through decisions such as choosing suppliers and deciding where to locate factories (azevedo et al. 2017:2271). sustainability can be driven through the implementation of sustainable supply chain management (sscm), practices which will have a positive impact on performance (wolf 2011:222). sscm is: [t]he strategic, transparent integration and achievement of a firm’s social, environmental, and economic goals in the systemic coordination of key inter-organisational business processes for improving the long-term economic performance of the individual company and its supply chains. (carter & rogers 2008:368; seuring & müller 2008:1700) manufacturing businesses should integrate other partners in the supply chain and develop long-term business relationships with firstand second-tier customers and suppliers in sscm activities to improve the impact of sscm (gold, hahn & seuring 2013:16–17). the concept ‘sustainable supply chain integration’ (ssci) contains the elements of sscm such as the integration of sustainability with supply chain partners, and thus falls under the umbrella of sscm. sustainable supply chain integration (ssci) is the extent to which a manufacturer collaborates strategically with its supply chain partners and collaboratively manages intra-organisational and inter-organisational sustainability systems (wolf 2011:223). this implies that firms strategically collaborate to improve the environmental, social and economic effects of their internal organisational processes, and enhance the effect of their suppliers’ and customers’ processes, thereby improving the overall supply chain sustainability performance (gimenez, sierra & rodon 2012:150). manufacturers of fast-moving consumer good (fmcg) primarily deal with producing, distributing and marketing goods regularly purchased by consumers (economy watch 2010). consumers of fmcgs are increasingly concerned about the products they purchase. they need information about the origin of the product and the assurance that the product complies with a broad array of quality and ethical considerations (freidberg 2017:1390). the main challenge to these firms wanting to address sustainability, is the extension of sustainable strategies and practices to other supply chain partners (sancha, gimenez & sierra 2016:1934). stakeholders do not differentiate between all the different actors and their roles in the supply chain (seuring & gold 2013:1). therefore, a fmcg manufacturing firm’s sustainability performance may be tainted by other supply chain partners acting unethically (sancha et al. 2016:1934). there are two reasons why supply chain management (scm) has a pivotal responsibility in attaining sustainability. firstly, to acquire the resources necessary for producing goods and services, scm has a profound effect on the environment (dubey, gunasekaran & ali 2015:120). this factor addresses the significance of integrating sustainability into internal scm practices (wolf 2011:221). secondly, the buying practices of a firm could affect a supplier’s capability to better its sustainability. firms could influence smaller supply chain members to aim for good environmental and social standards by using their purchasing power (laari et al. 2016:1961). this factor highlights the importance of integrating sustainability into external scm activities with supply chain partners (wolf 2011:221). additionally, manufacturers could integrate sustainability goals and practices with their suppliers and customers, thereby better dealing with the impact of stakeholder influence on the firm (seuring & gold 2013:2). the application of integration to sustainability may improve the understanding of the actions which enhance supply chain sustainability and evaluate the effect of such actions on the sustainability performance (seuring & gold 2013:5). while many studies investigated singular activities related to sscm, such as corporate social responsibility in the supply chain (hsueh 2015:84–95; quarshie, salmi & leuschner 2016:82–97) and sustainable transportation (maheshwari et al. 2016:371–393; zhao 2010:236–243), only a few studies focused on all three aspects of sustainability (environment, economic and social) in a firm’s sustainability strategy and its extension to supply chain partners, as this is still quite novel (dubey et al. 2017:337). this represents a disconcerting gap in the body of knowledge, because such a holistic view of sscm has the potential to improve supply chain sustainability and to evaluate the outcome of sustainability practices with regards to sustainability performance (wolf 2011:222). integration improves sustainability performance in the supply chain (touboulic & walker 2015:178). as far as could be determined, no studies applied the concept of sustainability to supply chain integration in the context of a developing country such as south africa. wolf (2011:233) conducted a similar study in the german manufacturing industry which is highly developed. by replicating this study in the south african manufacturing industry, which is far less developed, it can be determined whether the findings still hold in emerging markets. replicating and expanding upon research, conducted by wolf (2011:231), in a different industry and country, will help to refine the model introduced by wolf (2011:231). the purpose of this generic qualitative study is to explore the extent to which fmcg manufacturers in south africa apply sustainability to supply chain integration. the study replicates and expands upon previous research by wolf (2011:221–235), by determining the transferability of his ssci model (wolf 2011:231) to the south african fmcg manufacturing industry through interviewing senior supply chain managers in the industry. the study aims to answer the following questions: to what extent do fmcg manufacturing firms incorporate sustainability into their internal supply chain strategy? how do fmcg manufacturing firms include sustainability in their integration with external downstream supply chain partners? how do fmcg manufacturing firms include sustainability in their integration with external upstream supply chain partners? to what extent does the supply chain integration with supply chain partners contribute to sustainability performance? this study makes three specific contributions to theory and practice. firstly, it adds to sscm literature by evaluating the transferability of the conceptual model, developed by wolf (2011:231), to the fmcg manufacturing industry in south africa, providing a developing-country context. this is important because it addresses the limitations found by wolf (2011:231), by collecting information from a different industry and country that could help refine the model. secondly, it focused on all three aspects of sustainability, providing a holistic view of sscm. this addresses the concerns that most studies focus on environmental or economic aspects of sustainability, but neglect social aspects (dubey et al. 2017:337). thirdly, it supports supply chain practitioners with an improved understanding of the requirements of ssci which could aid supply chain practitioners to improve sustainability performance (wolf 2011:232). literature review the south african fast-moving consumer good industry fast-moving consumer goods are common high-volume goods, such as food or cleaning supplies, frequently purchased by the average consumer (the logistics & supply chain management society 2014). examples of fmcgs manufacturers include uniliver, colgate-palmolive and nestle. in the fmcg manufacturing industry, customer demands regarding sustainability are channelled upstream through retailers to fmcg manufacturers (foerstl et al. 2015:81). this resulted in fmcg manufacturers being very aware of the sustainability of their production processes, as well as their packaging (foerstl et al. 2015:81). south africa remains one of southern africa’s most competitive economies with a global competitive index of 4.32/7 for 2017–2018, which ranked 61st out of the 137 countries compared (world economic forum 2018:13). however, south africa’s economic growth has lost momentum, with a projected annual gdp growth of 1.742% predicted for the years 2020–2021 (world bank 2018). challenges such as weak export demand, unsatisfactory commodity prices, coupled with domestic issues, such as political uncertainty, high unemployment, labour strikes and drought, create an unfriendly business environment for fmcg manufacturers (foodbev seta 2017:15; pricewaterhousecoopers 2016:73–74). south africa’s population is expected to grow from 57.39 million in 2018, to 64.57 million and 72.75 million in 2030 and 2050 (world population review 2018). this presents several opportunities and issues as fmcg manufacturers must upscale their capacities and capabilities to provide for the growing population. furthermore, south africa’s unemployment rate is expected to rise from 27.9% in 2018 to 35.3% in 2023 (south africa data portal 2018; statssa 2022). this is disconcerting to fmcg manufacturers, because it means that they must reduce the costs of their products to a level that the majority of unemployed people can also afford. sustainability sustainability is defined as meeting current needs without hindering the capability of future generations to meet their own needs (international institute for sustainable development n.d.). this definition may be extended by adopting an equivalent view of sustainability, ‘the triple bottom line’. this concept highlights the importance of analysing the impact of a firm’s decisions in three central sustainability areas, namely environmental, economic and social sustainability (christopher 2016:269). the economic aspects of sustainability include variables that handle financial performance, including profitability and cash flow (hall 2011:5). the environmental aspects of sustainability include measuring natural resources and the influences of the long-term viability and continuity of the environment, for example, measuring the carbon emissions associated with producing goods (hall 2011:5). the social aspect of sustainability includes the social dimensions of a community or geographic region. examples pertaining to businesses include equity and working conditions (christopher 2016:269). supply chain sustainability is concerned with two mutually supportive objectives: achieving the long-term viability and continuity of the firm, while concurrently contributing to the long-term well-being of society (christopher 2016:270). furthermore, the term ‘sustainable supply chain’ is described as a supply chain which constantly performs well regarding all three aspects of sustainability (pagell & wu 2009:36–56). for a firm to have a truly sustainable supply chain, it must genuinely implement business practices, strategies and measures that fully support the three aspects of sustainability (silvestre 2015:172). if a single part of the supply chain fails to implement and measure one aspect of sustainability, then that chain is considered unsustainable (silvestre 2015:172). overall improved firm performance could be viewed as a result of implementing and incorporating sustainability into business strategy and practices (meixell & luoma 2015:70). thus, effective scm may improve organisational effectiveness, competitiveness and customer service levels (azevedo et al. 2017:2254). the bulk of the literature, regarding sscm, focuses primarily on the environmental and economic aspects of sustainability (dubey et al. 2017:337). several studies focused on the environmental aspect of sustainability in the supply chain, such as zhu and sarkis (2004:265–289), who evaluated the relationships between specific green scm practices and firm performance in the chinese manufacturing industry. fahimnia, sarkis and davarzani (2015:101–114) found that the green scm field is growing and maturing. furthermore, zhao et al. (2017:1085–1097) present a multi-objective optimisation model for green scm plans that minimise risk. a literature review by dubey et al. (2017:337) found that researchers have not unequivocally studied and measured social sustainability aspects. there are growing concerns regarding sustainability among stakeholders of fmcg manufacturing firms (freidberg 2017:1390). large and popular firms may increasingly face substantial pressure from the end consumer to improve their sustainability performance, as opposed to smaller manufacturers or suppliers further upstream in the supply chain (lee et al. 2014:39–51). powerful buyers have the potential to dictate that suppliers comply with the buyer’s sustainability policies (laari et al. 2016:1961). supply chain integration to address the increasing sustainability concerns of stakeholders, firms need to expand their concentrations outside their internal operations to external supply chain partners, such as suppliers and customers (laari et al. 2016:1960). all firms are linked to their external supply chain partners by material, financial and information flows (seuring & müller 2008:1699–1710). production input and other resources, used for the firm’s operations and economic activity, have environmental effects that are not carried by the end users, and thus cannot be handled within the boundaries of only one firm. instead, it is necessary that all partners (internal and external) in the supply chain participate in sustainability initiatives and practices (laari et al. 2016:1961). supply chain integration is ‘the degree to which a manufacturer strategically collaborates with its supply chain partners and collaboratively manages intraand inter-organisation processes’ (flynn, huo & zhao 2010:59). the main idea behind supply chain integration is that core business processes are streamlined within and between firms. this streamlining will result in competitive advantages for the firms through improved customer service and value creation (leuschner, rogers & charvet 2013:34–57). the degree of upstream integration with suppliers, or downstream integration with customers, differs considerably between various firms which results in different capabilities and performance (ataseven & nair 2017:253). it is important to highlight that effective supply chain integration requires that firms have a well laid-out strategic plan and commitment from senior management (beheshti et al. 2014:28). there are two dimensions to supply chain integration – internal and external integration. while internal integration identifies the need for a manufacturing firm’s departments and functions to operate in an integrated manner, external integration identifies the significance of creating close, cooperative and interactive bonds with suppliers and customers. both perspectives are vital to enhance the value of the firm’s supply chain (flynn et al. 2010:59). internal integration internal integration refers to the synchronisation and collaboration of a firm’s internal organisational information, processes, and activities (chang et al. 2016:283). it calls for integrated activities such as joint planning, information sharing and cross-functional teams in which all functions work together in an integrated manner (flynn et al. 2010:60). internal integration correlates with firm performance because it tears down the functional barriers and promotes cooperation between different functions/departments to meet the needs of a firm’s customers (flynn et al. 2010:59–60). an example of internal integration in the fmcg manufacturing industry would include all functional barriers in a firm being removed, as all functional areas must be linked, using the same information technology systems and all functional areas must work together to achieve the same end goal. external integration external integration is the extent to which a manufacturer creates a partnership with its external suppliers and customers to establish structures for collaborative inter-organisational strategies, activities and processes (ataseven & nair 2017:253). the integration of a firm with suppliers refers to: [c]oordination and information sharing activities with key suppliers that provide the firm with insights into suppliers’ processes, capabilities and constraints, ultimately enabling more effective planning and forecasting, product and process design, and transaction management. (schoenherr & swink 2012:100) the ways in which firms relate with their suppliers changed significantly. since manufacturing firms are increasingly more focused on their core competences, their dependence on their strategic suppliers is greater (prajogo & olhager 2012:516). trends in supplier integration now call for firms to build long-term relationships with suppliers rather than transactional short-term contracts. this helps the firm’s suppliers to better understand and anticipate the firm’s needs (flynn et al. 2010:60). by creating a good understanding of a manufacturing firm’s operations, suppliers have the potential to attain improved levels of customer service, which also helps the manufacturing firm achieve its own higher levels of customer service (flynn et al. 2010:60). integration with customers refers to: [c]lose collaboration and information sharing activities with key customers that provide the firm with strategic insights into market expectations and opportunities, ultimately enabling a more efficient and effective response to customer needs. (schoenherr & swink 2012:100) customer integration considers the demand-side collaboration, cooperation and coordination activities of a firm with its customers (ataseven & nair 2017:253). integrating closely with customers allows a manufacturing firm to offer opportunities to enhance demand-information accuracy, reducing the manufacturing firm’s production planning time and the risk of inventory obsolescence. this allows the manufacturing firm to be more receptive to customer requirements, as a result costs are cut and customers are satisfied (flynn et al. 2010:60). supply chain integration and sustainability performance integrating with supply chain partners on sustainability has the potential to positively impact the overall sustainability performance (wolf 2011:229). this is because supply chain integration allows for all supply chain partners to share sustainability information and best practices, understand sustainability expectations, and work together to solve sustainability problems (wolf 2011:229). to improve sustainability performance, all partners in the supply chain must collaborate on sustainability initiatives and practices (laari et al. 2016:1961). given that stakeholders are increasingly insisting that firms address the social, environmental and economic issues caused by firm operations, sustainability is highly relevant to all firms (carter & easton 2011:46–47). manufacturing firms should therefore integrate with other partners in the supply chain regarding sscm activities to further improve supply chain sustainability performance (gold et al. 2013:16–17; seuring & gold 2013:1). sustainable supply chain management firms should encourage effective communication across the supply chain, as a method to share the same sustainability standards with all the other firms involved (azevedo et al. 2017:2254). cooperation between supply chain partners is ‘the only way’ for firms to enhance the competitiveness of the supply chain, while simultaneously reducing sustainability issues (seuring 2004:1059). when scm practices and activities include equally the three aspects of sustainability (social, economic and environment), the term sscm is used (mathivathanan, kannan & haq 2018:286). sustainable supply chain management is defined as the voluntary integration of the sustainability aspects with important inter-organisational business systems to create a coordinated supply chain to effectively manage the material flows, information flows and financial flows associated with the purchase, production and distribution of goods and services to fulfil the profitability and stakeholder requirements, competitiveness and supply chain resilience of the firm (ahi & searcy 2013:339). it is important to note that wolf (2011:223) developed a unique concept called ssci. this concept still contains the elements of sscm, such as the collaboration with supply chain partners, and the focus on sustainability, and thus still falls under the umbrella of sscm. wolf’s (2011:223) concept of ssci is presented in the following section. sustainable supply chain integration as far as could be determined, wolf (2011:221–235) is the only researcher who has specifically developed a model for ssci. therefore, literature on the topic is limited. ssci is defined as the extent to which a manufacturer collaborates strategically with its supply chain partners and collaboratively manages intra-organisational and inter-organisational sustainability systems (wolf 2011:223). the objective is to attain environmental, economic and social sustainability by integrating the flow of products, services, communication, finances and choices to deliver the most value to different stakeholders (wolf 2011:223). a model of ssci is illustrated in figure 1, followed by a brief discussion of the requirements of each aspect of the model. figure 1: a model of sustainable supply chain integration. internal sustainable supply chain integration to ensure strategy integration, leadership support is an important element to achieve effective sustainability strategies. this support may at times compensate for unclear sustainability goals (wolf 2011:229–230). wolf (2011) noted that: [s]ustainability strategies are most efficient when they create a strong stretch between what a firm can actually do in terms of existing resources and its aspirations. high aspirations appear to support and motivate employees to fully tap their potential. (p. 230) transparency, regarding sustainability performance metrics in order to measure sustainability performance, is needed. to ensure that sustainability is integrated internally, functional silos within the firm must be removed and responsibility for sustainability must be shared across functional lines. in addition, sustainability procedures and practices should also be integrated across functional lines. performance assessment should be tied to sustainability performance assessment (wolf 2011:230). external sustainable supply chain integration firms are under considerable pressure from external stakeholders to be sustainable, customers specifically (foerstl et al. 2015:81). yet, the perceived pressure from stakeholders is not enough for firms to be sustainable. to ensure that sustainability is integrated externally, with downstream supply chain partners, the firm must first understand the nature and range of sustainability expectations of stakeholder groups. the firm must also integrate the information gathered from stakeholder sustainability expectations into sscm strategy development and decision making. to be more effective, the sustainability integration with upstream supply chain partners must go beyond the tier-1 level to the tier-n level. additionally, ssci must include not only strategic suppliers, but all of the firm’s suppliers. finally, the firm should be aware that sustainability risk management is an important part of ssci. the firm can mitigate risks through sustainable supplier selection and full transparency of all suppliers (wolf 2011:231). sustainability performance sustainability performance is more complex than conventional economic performance, because it considers performance on environmental and social aspects as well. often, firms do not recognise the importance of acting on environmental and social aspects. instead of viewing these aspects as potential opportunities, managers see environmental and social aspects as an expenditure to the firm (wolf 2011:229). as part of sustainability performance, the firm should attempt to bring into alignment strategies or practices of the different sustainability aspects equally: environmental, economic and social. should any discrepancies in the performance of the aspects be discovered, the firm should try to balance these out as they are of equal importance (wolf 2011:231). the methodology that guided the study is presented in the next section. methodology research design the study was guided by a generic qualitative research design to discover the opinions, beliefs, experiences or perceptions of people regarding a particular topic being investigated (plano clark & creswell 2015:289). the data collected through semi-structured interviews allowed the researchers to expand upon the pre-existing body of knowledge by creating a thorough and detailed description of the extent to which fmcg manufacturers, with their supply chain partners, integrate sustainability, based on the opinions and the perspectives of the individual participants. semi-structured interviews are typically used to collect data from multiple participants, using purposive sampling techniques in a generic qualitative study (creswell 2012:218). the data collected were analysed using thematic analysis (plano clark & creswell 2015:289). sampling the unit of analysis for this study was fmcg manufacturers in south africa. twelve firms located across south africa participated in the study. only one individual from each participating firm was interviewed. the final sample size was based on the principle of data saturation by guest, bunce and johnson (2006:74) who state where the saturation point, when participants interviewed no longer provide new themes, new insights, or new information regarding the topic being investigated, is reached. in the case of this study, 100% of the codes were identified after the eighth interview and all main themes were established. a further four interviews were conducted but did not provide any new significant data. the study used homogenous sampling, a form of purposive sampling, to select the participating firms. the inclusion criteria that guided the selection of participating firms concluded that selected firms must have operations within south africa and must manufacture goods in one or more of the following categories: food, beverages, personal care and household cleaning. the inclusion criteria were used to ensure that selected firms had similar characteristics. homogenous sampling was also used to select the individual participants for the study. the individual participants for the study were selected, based on the following inclusion criteria: all individual participants were employed in fmcg manufacturing firms in middle to senior scm roles. the participants had awareness of sustainability and supply chain strategy development and were knowledgeable, as well as experienced in their fields. a profile of the individual participants of the study is presented in table 1. table 1: a profile of the study participants. data collection data for the study were collected through eight semi-structured telephonic interviews, three semi-structured face-to-face interviews and one semi-structured electronic mail interview. one individual from each participating firm was interviewed. semi-structured interviews were appropriate for the study because they used open-ended questions that required free-flowing answers from participants (creswell 2012:218). the use of semi-structured interviews allowed the researchers to acquire a deeper understanding of how fmcg manufacturing firms in south africa integrate sustainability with their supply chain partners. the individual participants provided the researchers with in-depth information relating to their firm’s supply chain sustainability strategies, which aided in the researcher’s understanding regarding the extent to which the fmcg manufacturers actually integrate sustainability, drawing in their supply chain partners. a discussion guide was developed from a thorough review of the literature and pre-tested on a participant who had similar characteristics to those in the target sample. minor adjustments were made, based on the results of the pre-test. the 11 verbal interviews lasted between 18 and 54 minutes, with an average of 34 min (see table 1). the interviews were transcribed by the researchers during the data collection period. to ensure that the completed transcripts were accurate, the researchers read the transcripts while listening to the audio-recordings and corrected any transcription errors. data analysis a thematic analysis was conducted on the data collected. thematic analysis involves analysing the data by recognising, classifying and reporting themes contained in a data set (braun & clarke 2012:57). initially an exploratory analysis was conducted by listening to the audio-recordings while reading the transcribed interviews so that the researchers could familiarise themselves with the data and to create preliminary inductive codes (creswell 2012:243). these inductive codes were combined with priori codes, identified from the literature, for a master code list to be drawn up. relevant segments of text from the transcriptions were then coded and refined after patterns of themes were identified which gave meaning to the data (braun & clarke 2012:63–65). the final themes were analysed and their applicability to the study’s research questions (rqs) determined. trustworthiness to ensure quality and rigour, the study was guided by the four trustworthiness criteria: credibility, dependability, confirmability and transferability. credibility deals with how well the findings of a study echo the real perspectives and experiences of participants (bloomberg & volpe 2016:162). site triangulation was used to ensure credibility. this involved recruiting participants from several firms to ensure that the themes identified, were not exclusive to a particular firm (shenton 2004:66). dependability questions whether the findings of a study would still hold true if the study was replicated in a similar context (polit & beck 2012:585). a thorough description was provided for the research design, the implementation of the research design and the data collection method, thus ensuring dependability. confirmability is concerned with verifying that the data collected actually represents the information the participant provided and that the data collected, does not reflect the influences of the researcher (polit & beck 2012:585). to ensure that the data did not reflect any biases or influences of the researcher, thus securing confirmability, the discussion guide before data collection was pre-tested and reviewed by more experienced researchers. furthermore, audio-recordings from the interviews were transcribed in their entirety without any additions or deductions, ensuring that the findings were accurate. transferability refers to the extent that findings of a study are applicable in and can be transferred to other settings and groups (polit & beck 2012:585). to ensure transferability, a detailed description of the background of the study, including the research design, data collection methods, discussion guide and other pertinent information, was provided (creswell 2007:209; polit & beck 2012:585). ethical considerations participants in the study were required to read and sign an informed-consent form before the interview commenced. this consent form explained the purpose of the study and articulated that participation was voluntary, that the participant could withdraw at any time and provided assurances of anonymity and confidentiality. pseudonyms were used in place of the participants’ names and participating firm names in the transcripts and in the final presentation of data. the findings of the study are presented in the next section. findings the findings of the study are reported for each rq in this section. as presented in table 2, four main themes relating to the study’s rqs were identified along with several sub-themes. to aid in understanding the findings, the main themes are guided by wolf’s (2011:231) model of ssci. table 2: a summary of themes and sub-themes. the themes and sub-themes summarised in table 2 are now discussed, starting with the first theme, ‘internal ssci’. theme 1: internal sustainable supply chain integration internal integration concentrates on synchronising a firm’s internal organisational information, processes, and activities (chang et al. 2016:283). therefore, ‘internal ssci’ calls for including the aspects of sustainability into integrated activities, such as joint planning and information sharing, across functional areas within the firm. internal ssci is linked to rq 1 because it considers the extent to which fmcg manufacturing firms incorporate sustainability into their internal supply chain strategy and organisational processes. this theme involves two sub-themes: strategy integration and organisational integration. strategy integration firms must clearly define strategic sustainability goals and direct strategic decisions, as well as organisational processes to achieving the sustainability goals (wolf 2011:224–225). the study finds that most firms have a strong sustainability focus and a clear supply chain sustainability strategy linked to the firm’s overall corporate strategy. in participating firms, the supply chain sustainability strategy is formulated by executive management and cascades down to functional areas across the firm. although supply chain sustainability strategy formulation is a very rigid and top-down process, there is some input from lowerlevel management as well. this can be supported by the following quotes: ‘… it’s part of the business, part of the way the organisation does business. so it’s set from the top of the organisation and goes through the entire organisation and therefore, as such, supply chain as a functional element within their organisation has a very strong sustainability focus and sustainability strategy embedded in everything that is done in supply chain ….’ (p5, male, supply chain director) ‘so their corporate strategy includes a planet portion and it gets cascaded [down] in your different divisions ….’ (p11, female, operations manager) support from leadership: effective ssci requires that firms have a well laid-out strategic plan and commitment from senior management. in instances where sustainability goals are unclear, support from leadership could direct employees to understanding the set goals (wolf 2011:231). the findings from the study indicate that support from leadership motivates employees to achieve sustainability by making resources available to employees so that they may engage in sustainability activities. furthermore, participating firms give employees freedom within bounds to act on the sustainability issues which may arise. this is supported by the following quotes: ‘yes, for sure [they have support from senior management] … [by] making resources available ….’ (p10, male, operations planning manager) ‘yes [they have freedom to act on sustainability], but within guidelines.’ (p8, male, chief procurement officer) sustainability performance: internal ssci tears down the functional barriers and promotes cooperation between different functions on sustainability. it improves sustainability performance by enabling all employees to clearly understand sustainability goals and how best to implement these goals (flynn et al. 2010:59–60). training employees in sustainability empowers and supports them to react better to sustainability concerns, thereby further improving sustainability performance (wolf 2011:231). the findings indicate that in most participating firms, supply chain employees undergo formal sustainability training sessions relevant to the particular area of the supply chain they work in. if an employee has the knowledge and is empowered to react to a particular sustainability problem, without needing to wait for direction from top management, an effective solution to the problem may be implemented faster, thus improving sustainability performance. this is supported by the following quotes: ‘it forms part of the ways of working and the ongoing training and sensitisation that goes on in the organisation through various forums, be it the formal training sessions, be it through communication problems from senior leaders, you know, be it sharing of best practices from across the supply chain.’ (p5, male, supply chain director) ‘yes, so they would receive sustainability training, they would even also have it within the individual performance goals.’ (p6, female, supply chain sustainability manager) it is important for firms to be transparent regarding metrics in order to effectively measure sustainability performance (wolf 2011:230). participating firms enable transparency regarding sustainability performance metrics by using reports, scorecards, standards, frameworks and roadmaps to monitor their sustainability performance and communicate it to relevant stakeholders as is noted in the following quotes: ‘… performance management or at a higher level, it’s measured on a roadmap ….’ (p10, male, operations planning manager) ‘… you will then have to fill in a scorecard on a monthly basis ….’ (p11, female, operations manager) ‘there is a global annual report that measures the achievements of the year.’ (p1, female, supply chain director) organisational integration to achieve organisational integration within the firms, responsibility for sustainability must be shared by all employees. furthermore, rewards should be aligned to sustainability performance assessment (wolf 2011:230). responsibility for sustainability: the findings indicate that participating firms do not sufficiently share the responsibility for sustainability among employees and across functional areas. as seen in the quote below, a sustainability team is set up to address all sustainability issues within the firm: ‘they have a whole team that focuses on that as their responsibility, so they consider everything. so i think from a local perspective, from running an affiliate of the global organisation, it’s purely responsible for making sure that the rules are followed.’ (p1, female, supply chain director) although a notable initiative, restricting sustainability concerns to a specific team, limits sustainability performance at the participating firm, as there are limited opportunities for collaboration and interaction between different functional areas and it limits the opportunities for improved idea generation, innovative process design and product design. rewards alignment: tying employee performance assessment to sustainability performance assessment may encourage employees to act more sustainably. internal sustainability integration should be in alignment with incentive and reward systems within the firms (wolf 2011:230). the findings indicate that firms set sustainability goals for employees to achieve. the rewards or incentives received by employees for sustainability at participating firms are linked to achieving the sustainability goals set by senior management as shown in the following first quote. employees in most participating firms are rewarded by financial means, recognition or gift vouchers for acting sustainably. as shown in the second quote, a participant indicated that employees at the firm are not adequately rewarded for acting sustainably. this potentially has a negative impact on the sustainability performance because employees lack the motivation to act sustainably: ‘because we work on a merit bonus system on certain levels of employees, which is normally management from certain levels up, and if targets are met or not met, they are rewarded or penalised.’ (p7, male, supply chain development manager) ‘yes, they are rewarded [for acting sustainably, but] not enough.’ (p11, female, operations manager) theme 2: downstream sustainable supply chain integration downstream ssci encourages effective communication across the supply chain, as a method to share the same sustainability standards with customers (azevedo et al. 2017:2254). the theme ‘downstream ssci’ is linked to rq 2 because it considers how fmcg manufacturing firms include sustainability in the integration of their downstream customers. downstream ssci takes into account how firms understand their customers’ sustainability expectations. furthermore, it focuses on the inclusion of customers in the firm’s sscm activities. understand expectations of customers powerful customers have the potential to dictate that suppliers comply with the buyer’s sustainability expectations (laari et al. 2016:1961). firms must understand the nature of customer sustainability expectation,s because this helps the firm to better address their customer needs by designing suitable strategies (wolf 2011:228). the findings indicate that most participating firms do not experience substantial pressure from their customers to be more sustainable. this may be due to customers themselves not experiencing any sustainability pressure from their customers or may also be due to the mind-set of ignoring sustainability to keep costs down. in some cases, sustainability expectations are internally driven as demonstrated in the following quote: ‘no, it’s all internally driven. so it’s actually the shareholder ….’ (p2, male, supply chain director) include customers in sustainable supply chain management activities firms must integrate the information gathered from customer sustainability expectations into sscm activities and strategy formulation to effectively implement ssci (wolf 2011:228). the findings indicate that the participating firms and their customers do not regularly engage in conversations regarding sustainability, and information regarding sustainability expectations is not regularly shared. aspects of sustainability in participating firms are only discussed when negotiating contracts. most participating firms do not involve their customers in supply chain sustainability strategy formulation and do not collaborate with customers on sustainability initiatives as shown in the first quote. this is especially true for local subsidiaries as opposed to the global subsidiaries highlighted in the second quote. instead, customers are included in sustainable strategy formulation and collaboration on sustainability initiatives in other firm subsidiaries around the world, particularly in europe. this may be due to the culture in developing countries such as south africa, where sustainability is not deemed important: ‘we don’t get involved. it’s because of the bigger factors, we can’t tell them from an economic perspective that they should do this and do that and, you know, we can’t tell them from a social perspective how to handle their labour issues. the only thing we have a bit of say in is, is obviously environmental factors.’ (p3, female, procurement officer) ‘from a south african perspective, i don’t think they are that involved … i think globally, they might be much better, especially in europe.’ (p11, female, operations manager) additionally, the findings indicate that customers often may not support the firms in their sustainability efforts, especially if efforts involve a price increase on the goods supplied. again, this may be due to the culture and the mind-set of managers in developing countries where sustainability is not deemed important as shown by the following quote: ‘so you know you need to be a responsible corporate citizen … and people don’t have that mind-set yet.’ (p11, female, operations manager) theme 3: upstream sustainable supply chain integration upstream ssci involves integrating firm suppliers by sharing sustainability information, collaborate on sustainability activities and to better understand supplier sustainability processes, capabilities and constraints leading to more effective planning (schoenherr & swink 2012:100). the third theme, upstream ssci, is linked to rq 3 as it considers how fmcg manufacturing firms include sustainability when integrating their upstream suppliers. this theme involves two sub-themes: supplier management and risk management. supplier management supplier management involves establishing supplier relationships with the firm and includes supplier selection and collaboration with suppliers on sustainability. supplier selection: during the supplier selection process in which suppliers are informed of firm sustainability expectations, suppliers are assessed and required to prove past sustainability experience (wolf 2011:230). the findings indicate that the participating firms put pressure on their suppliers to act more sustainably. the firms also inform their suppliers of their sustainability expectations and require suppliers to go through a formal supplier assessment process to mitigate sustainability risk as shown in the following quote: ‘i think it’s a formalised supplier assessment program, the supplier [is] assessed, it’s documented and it’s updated annually, and we do supplier audits to make sure that those things are happening. so it’s a formal program.’ (p1, female, supply chain director) suppliers often have no choice but to accept the sustainability pressures and expectations from participating firms. in some cases, suppliers are completely open to participating firms’ pressure and expectations, because they realise that it may benefit them in their dealings with other customers. this is supported by the next quote. however, it is important to note that where there is only one supplier at a vital input, participating firms do not have such a significant influence over supplier sustainability: ‘they are very open to change because if they see the benefits on their side … we [are] not the only people that they supply to … but if they save on us, they can do it for your other customers.’ (p11, female, operations manager) collaborating with suppliers on sustainability: manufacturing firms are increasingly focused on their core competences; therefore, they are more dependent on their suppliers (prajogo & olhager 2012:516). to support ssci, firms must build a close and collaborative relationship with their suppliers and work together to develop sustainable products, processes or initiatives (wolf 2011:230). information on sustainability must also be shared (wolf 2011:228). the study finds that participating firms see the benefit of having a close and collaborative relationship with their suppliers and often engage with them to improve the firms’ sustainability and work together to generate new ideas and improve product development as shown in the first quote. however, the same cannot be said about the suppliers, as in some cases, suppliers do not involve participating firms in their sustainability strategy formulation of initiatives. participating firms often do not play an active role in supplier sustainability, but will, nonetheless, support suppliers in their sustainability efforts, even if this may result in paying suppliers a higher price for more sustainably produced goods as supported by the second quote: ‘obviously if you’re working together, we get very positive effects from it. every now and then you’ll get a supplier who’s not interested in changing their ways, obviously you’ve then got a negative impact. but for the most part, everyone sort of wants to work together to make sure they keep the business going.’ (p4, female, process engineer) ‘so i say in certain areas, yes, because we are already currently doing that for some of our commodities because even being present in some of the international markets is something that will be required of us.’ (p6, female, supply chain sustainability manager) risk management sustainability risk management is an important part of ssci. firms can mitigate risks through sustainable supplier selection, supplier assessments and full transparency with suppliers (wolf 2011:231). the findings indicate that participating firms have formal supplier assessments and controls in place to ensure that suppliers meet the firms’ sustainability expectations. generally, if a supplier fails to meet sustainability expectations, or is implicated in any unethical practices, such as the improper disposal of toxic waste, there are penalties in place. often, these suppliers are blacklisted and cannot do business again with the firm. this is supported by the following quotes: ‘… formal supplier assessment process that includes sustainability, but also risk, because if they [are] doing the right things, they generally will have the right sustainability measures in place and that gives you some comfort in terms of the risk of using other raw materials ….’ (p1, female, supply chain director) ‘… by saying, ‘look if you are not going to conform on one, two, three, we are unfortunately going to have to walk away from our relationship and rather source from someone else, because you gonna become a risk to us as a business.’ (p6, female, supply chain sustainability manager) theme 4: sustainability performance for improved sustainability performance, all partners (internal and external) in the supply chain must participate in sustainability initiatives and practices (laari et al. 2016:1961). the fourth theme, sustainability performance, is linked to rq 4 because it deals with the extent that supply chain integration with supply chain partners contributes to sustainability performance. sustainability performance considers the alignment of all three sustainability aspects (environmental, economic and social) and also considers how sustainability performance may be improved. performance alignment to have truly sustainable supply chains, firms must genuinely implement business practices, strategies and measures that equally support the three sustainability aspects: environmental, economic and social (silvestre 2015:172). as part of sustainability performance, firms must try to align the strategies or practices of the different sustainability aspects as they are equally important. should any discrepancies between the aspects be identified, firms should attempt to balance these out (wolf 2011:231). the study indicates that although participating firms recognise that all aspects of sustainability are important, due to local variables such as economic conditions (e.g., the recession in south africa) and environmental issues (e.g., the drought), the participating firms find it difficult to focus equally on all three aspects. economic concerns are at the forefront. therefore, firms try to implement social and environmental aspects within strict economic constraints as shown by these quotes: ‘in a south african context, one has to put economic [sic] first because of affordability issues, whereas the other markets, [in] more developed markets, i would say that sustainability maybe driven by social [sic], might be more important or carry a very strong weight.’ (p8, male, chief procurement officer) ‘… so this is the new purpose i spoke about. so it’s about being socially responsible within economic constraints. it’s really about reducing our footprint and providing healthier food options for people but still making money.’ (p10, male, operations planning manager) improving performance the strategic attempts of firms to create competitive advantages in the market and to achieve better overall performance rely heavily on supply chain integration (chang et al. 2016:282). collaboration and cooperation between supply chain partners is essential for firms to enhance the competitiveness of the supply chain, while simultaneously improving sustainability performance by reducing sustainability issues (seuring 2004:1059). the study finds that collaboration with supply chain partners is key to improving sustainability performance for the whole supply chain. collaboration and cooperation with supply chain partners allows for the sharing of ideas and innovative practices that significantly impacts sustainability performance amongst participating firms as highlighted by these quotes: ‘i think it’s a high degree of correlation, in the entire chain. you know, sustainability cannot be a one shot or one companyinitiative. it has to be a broad-brushed approach, and everybody needs to be on the bandwagon, to really make a difference. so, i think to the question, i would say, there is a high degree of collaboration to drive sustainable performance and sustainability.’ (p5, male, supply chain director) ‘it affects the sustainability of supply chain positivity, there’s that continuous interaction and continuous new generation of ideas and you’re not limited to internal thinking and internal, you know, ideas.’ (p11, female, operations manager) conclusion summary of findings and theoretical implications the aim of this study was to expand upon the research of wolf (2011:221–235), by exploring the extent to which fmcg manufacturers in south africa apply sustainability to supply chain integration. it expands upon the research of wolf (2011:221–235), by focusing on supply chain sustainability integration in a developing country context. the first rq addresses the extent to which fmcg manufacturers integrate sustainability into their internal supply chain strategies. the study confirms findings by wolf (2011:224–224), indicating that having a clear sustainability focus and supply chain sustainability strategies, linked to corporate strategy and support by leadership, are key to integrating sustainability internally, and thus improving the sustainability performance. additionally, functional barriers within the firm must be eliminated so that responsibility for sustainability is shared among all employees, and so that the rewards systems are in alignment with the sustainability performance. the second rq investigates how fmcg manufacturers include sustainability when integrating downstream supply chain partners. in contradiction to wolf (2011:228), the study finds that customers do not exert much pressure on firms to adhere to their sustainability expectations. instead, sustainability expectations are driven internally. this may be due to customers not experiencing any sustainability pressure from their own customers, or the current mind-set of ignoring sustainability to reduce costs in the supply chain. additionally, wolf (2011:228) highlights that it is imperative for firms to include customers in their sustainability efforts by integrating customer sustainability expectations into sscm activities or strategy formulation. again, the findings contradict this as customers and participating firms do not regularly engage in conversations, regarding sustainability. this may be due to the culture in south africa where sustainability is still not considered important and is not something that firms need to pursue. furthermore, firms do not involve their customers in sustainable strategy formulation or sustainability initiatives. the third rq explores how fmcg manufacturers include sustainability in their integration with upstream supply chain partners. the findings corroborate those of wolf (2011:231), in that sustainable supplier selection, supplier assessments, information sharing and transparency are all key to mitigate sustainability risks; thereby, supporting ssci. furthermore, the study confirms the findings of wolf (2011:228), as collaborating with suppliers on sustainability, significantly does improve the sustainability performance. the final rq examines the extent that supply chain integration with supply chain partners contributes to sustainability performance in fmcg manufacturers. the findings of the study differ from those of wolf (2011:231), as firms find it difficult to align all three sustainability aspects equally, due to local variables such as economic conditions (e.g. recessions) and environmental issues (e.g. droughts). therefore, economic sustainability is currently considered most important for the continuity of firms operating in areas with harsh local variables. however, with regards to improving sustainability performance, the study confirms the findings of wolf (2011:229), as collaborating with supply chain partners on sustainability supports ssci and improves the sustainability performance. in conclusion, the final theoretical implication adds to the literature by exploring ssci in the context of a ‘developing country’. firms in developing countries are aware of the importance of sustainability, but are not yet at the point where they see the benefit of sustainability, compared to firms in developed countries. this may be due to additional variables facing firms in developing countries, such as unemployment, resource scarcity, economic uncertainty and political uncertainty. these variables lead firms to place greater importance on economic sustainability aspects over environmental and social sustainability aspects. this contradicts the sscm literature which highlights the importance of achieving true sustainability by treating all three sustainability aspects as equally important. managerial recommendations firstly, the findings contribute to the understanding of the importance for the firm to truly incorporate sustainability internally, from corporate culture to strategy development. there must be a shared understanding and responsibility for sustainability among all employees, and across functional areas in the firm, to achieve a genuinely sustainable supply chain. this can be implemented by having internal conversations regarding sustainability across functional areas to define and set clear sustainability objectives that all employees understand. furthermore, senior leadership should support and encourage sustainability commitment from employees through the use of rewards, sustainability training, sustainability workshops and the inclusion of employees in sustainability conversations. secondly, managers must not view sustainability as a cost in the supply chain, but rather as a way to improve the efficiency of supply chain activities. a change in the mind-set of managers in firms in developing countries is needed, to consider the benefit of including sustainability as a core competency, instead of a burden, as seen in firms in developed european countries. managers in developing countries often consider the social and environmental aspects of sustainability as contradictive or working against economic sustainability. however, supply chain mangers need to acknowledge the potential benefits of aligning profitability with the social and environmental aspects of sustainability, such as long-term cost reductions, greater efficiency and better utilisation of resources. finally, the findings confirm that collaboration with supply chain partners is key to achieving improved sustainability performance in the supply chain. collaborating with supply chain partners opens up the opportunity for shared value creation through continual interaction and idea generation to solve sustainability problems. this can be implemented by listening to supply chain partners’ sustainability expectations and concerns, as well as creating open and constructive conversations regarding sustainability. furthermore, firms must form partnerships with peers in the industry and work together to solve industry-wide sustainability problems. firms are not limited to internal patterns of thinking. limitations and directions for future research despite analysing several fmcg firms, ranging from food and beverage to personal care manufacturers, the study does not address the sustainability perspectives of other supply chain partners, namely, upstream suppliers and downstream customers. it would be beneficial to consider in future research the perspectives of all supply chain partners when exploring ssci; this could provide a more complete understanding of the way firms implement ssci. furthermore, the small sample size in this qualitative study limits the generalisability of its findings. additionally, due to the qualitative nature of the study, only the participants’ perspectives of the integration of sscm activities internally and externally were obtained. the study did not measure the participating firms’ integration of sscm activities internally and externally with supply chain partners, which a quantitative research design would allow. therefore, it would be valuable in future to make use of a mixedmethods research design to effectively measure the integration of sscm internally, as well as externally with supply chain partners. furthermore, limiting the study to one developing country restricts the generalisability of its findings and transferability of wolf’s model (2011:231) to other developing countries. therefore, future research should be conducted in other developing countries to increase generalisability and to confirm the transferability of wolf’s model (2011:231) to other developing countries. future research should also attempt to gain a deeper understanding of internal supply chain sustainability integration, because it creates the foundation for external supply chain sustainability integration, impacting sustainability performance across the supply chain as a whole. this can be done by interviewing a number of individuals at different levels of management at each participating firm to establish whether there is a shared understanding of and a joint responsibility for sustainability. thus, to determine if sustainability is indeed internally effectively integrated and what the value is that this brings to firms. acknowledgements competing interests the authors have declared that no competing interests exist. authors’ contributions this article is based on the mphil dissertation of s.e. who was the main researcher. w.n. and t.k. acted as supervisors with the conceptualisation, literature review, research instrument and development of this manuscript. ethical considerations university of pretoria, faculty of economic and management sciences research ethics committee reference number 4213207/2018. funding information this research received no specific grant from any funding agency in the public, commercial or not-for-profit sectors. data availability data is stored according to institutional policy. disclaimer the views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of any affiliated agency of the authors references ahi, p. & searcy, c., 2013, ‘a comparative literature analysis of definitions for green and sustainable supply chain management’, journal of cleaner production 52, 329–341. https://doi.org/10.1016/j.jclepro.2013.02.018 ataseven, c. & nair, a., 2017, ‘assessment of supply chain integration and performance relationships: a 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https://doi.org/10.1016/j.habitatint.2009.09.008 zhao, r., liu, y., zhang, n. & huang, t., 2017, ‘an optimization model for green supply chain management by using a big data analytic approach’, journal of cleaner production 142, 1085–1097. https://doi.org/10.1016/j.jclepro.2016.03.006 zhu, q. & sarkis, j., 2004, ‘relationships between operational practices and performance among early adopters of green supply chain management practices in chinese manufacturing enterprises’, journal of operations management 22(3), 265–289. abstract introduction theoretical framework: sen’s capability approach brief literature overview: day labouring and subjective well-being in south africa survey methodology model selection and empirical analysis key conclusions acknowledgements references footnotes about the author(s) phillip f. blaauw school of economic sciences, faculty of economic and management sciences, north-west university, south africa ilse botha department of accountancy, college of business and economics, university of johannesburg, south africa catherina schenck department of social work, faculty of community and health sciences, university of the western cape, south africa citation blaauw, p.f., botha, i. & schenck, c., 2018, ‘the subjective well-being of day labourers in south africa: the role of income and geographical location’, south african journal of economic and management sciences 21(1), a2087. https://doi.org/10.4102/sajems.v21i1.2087 original research the subjective well-being of day labourers in south africa: the role of income and geographical location phillip f. blaauw, ilse botha, catherina schenck received: 05 sept. 2017; accepted: 30 jan. 2018; published: 30 apr. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the informal economy in south africa provides employment to large numbers of people who would otherwise have no opportunity to earn a living. yet informal activities, such as day labouring, generate highly uncertain returns. although it seems reasonable to conclude that day labourers would be dissatisfied with their lives, this is not necessarily the case as several factors contribute to people’s subjective well-being. aim: this study is in response to a call for more research on the subjective well-being of marginalised groups in south africa’s informal labour market. setting: the day labour market in south africa, whose members congregate at hiring sites hoping to be picked up by passers-by in need of temporary, casual workers. methods: using sen’s capability approach, the study builds on earlier research conducted on the general well-being of day labourers in south africa, with specific focus on their subjective well-being and geographical location. the results from a countrywide survey of 3830 day labourers were used in a regression analysis to compare the subjective well-being among day labourers across the nine provinces of south africa. results: there are statistically significant differences in the well-being of day labourers across the nine provinces. economic variables play a role in both objective and subjective measures of well-being, while attitudinal and comparison variables are significant for the objective and subjective measures, respectively. conclusions: although they have to operate in harsh conditions, day labourers in south africa display agency by choosing to migrate to richer provinces in search of greater economic opportunity and reward. however, these potential gains are often negated by increased levels of competition and thus depressed wage levels. how to nurture marginalised groups’ abilities to exercise agency and take more control of their lives represents fertile ground for researchers in future. introduction it is commonly believed that people who are unable to find employment in the formal sector and need to fall back on low-skilled, informal work like day labouring and waste picking experience both financial and emotional deprivation. while the financial returns from these informal activities are often uncertain or inadequate, it should not be a foregone conclusion that the people performing this type of work are unhappy. there are a number of factors, other than straight earning power, that can possibly contribute to their relative satisfaction with life or their ‘subjective well-being’. subjective well-being (swb), together with the factors contributing to the phenomenon, constitutes a highly complex field of study. diener, oishi and lucas (2002:63) broadly define subjective well-being as ‘a person’s cognitive and affective evaluations of his or her life’. the cognitive dimension relates to a person’s views about their life in general as well as particular aspects of their life, such as work and personal relationships. ebrahim, botha and snowball (2013) and hirata (2011) consider the relationship between happiness and absolute income to be one of the most important topics covered in the literature. biswas-diener and diener (2001) expected people living in abject poverty in the slums of calcutta (india) to be ‘miserable’. surprisingly, the authors found people with relatively high levels of subjective well-being, in spite of their impoverishment. blaauw et al. (2015) were similarly surprised to find that the majority of the participants in their study on landfill waste pickers in south africa’s free state province were not filled with despair – which would have equated with low levels of subjective well-being. the fact that the results of blaauw et al. (2015) were unexpected lends weight to the conclusion reached by cramm, møller and nieboer (2010) that subjective well-being among marginalised groups in the informal sector in south africa is not well understood and receives sparse treatment in the literature. this gap in the literature is not surprising, since research on informal labour market activities, such as waste picking and day labouring, is difficult to conduct for various reasons. for example, day labour hiring sites in existence today may be gone tomorrow. the study outlined in this paper expands on previous research by blaauw et al. (2013) (which looked at well-being in a general sense) by focusing specifically on the subjective well-being of day labourers and by introducing a new dimension: day labourers’ geographical location, which is influenced by migration patterns. migration and geographical differences are important considerations in a study of subjective well-being as they reflect day labourers’ willingness to move from poorer to richer provinces in pursuit of greater economic opportunity and choice. within this construct we used sen’s capability approach (ca) to contextualise day labourers’ ability (or inability) to fully realise their potential and to achieve a satisfying existence. in line with the suggestion of alatartseva and barysheva (2015:37), we specifically measured day labourers’ material well-being in terms of the level and stability of income and other relevant indicators. personal income, we argue, is especially important for subjective well-being among poor people (cummins 2000; diener et al. 1993). the results from the first (and up until now only) countrywide survey of day labourers in south africa were used as the basis for the study. the paper uses the diener et al. (2002) definition of subjective well-being as the point of departure and then focuses specifically on the paradigm posed by alatartseva and barysheva (2015), which distinguishes between subjective and objective well-being. whereas objective well-being uses quantifiable measures to determine a person’s quality of life or well-being (such as access to water, electricity, education, and so on), subjective well-being relates to a person’s own perceptions of their life. while making an important and more nuanced contribution to the literature on subjective well-being among marginalised groups of people, the findings from this study also offer a number of practical insights into the factors that influence the ability of marginalised groups in the labour force, such as day labourers, to take control of their lives. armed with this knowledge, policymakers and other members of society will be in a better position to take steps to help these people live more meaningful lives, as envisaged by sen (1999, 2003). the rest of the paper is structured as follows. the next section examines sen’s capability approach, which provides the theoretical framework for the discussion. subsequent sections provide a brief overview of the literature on day labouring and subjective well-being in south africa, the survey methodology and results, the model selection and empirical analysis, the key conclusions, and avenues for further research. theoretical framework: sen’s capability approach sen’s (1999) capability approach (ca) was used in this study as the theoretical framework to assess the subjective well-being of day labourers in south africa. robeyns (2006) views the ca as a normative framework for evaluating and assessing the opportunities, freedoms and capabilities of people to make choices and live valuable lives, which then contributes to their well-being. this includes aspirations to be nourished, to be literate, to have shelter, and to experience good health, self-respect and dignity (alkire & deneulin 2002; robeyns 2005). according to sen (1999), the freedom to lead different types of life is reflected in a person’s capability set, which depends on factors such as educational level, health status and community involvement. an important component in a person’s capability set is ‘agency’, which is the ability to pursue and realise one’s own goals. the activity of day labouring is an example of agency in action. faced with the opportunity and freedom to do so, day labourers choose to stand on street corners every day, often having migrated from other provinces and leaving their families behind. sen (1999) explains that being free to make choices may be directly conducive to well-being. although the income earned by day labourers places them in the survivalist category (blaauw, louw & schenck 2006), the freedom to choose how and where they work might provide them with a sense of achievement. this phenomenon will be explored more fully in this paper in the context of day labourers’ choice of geographical location and the impact thereof on subjective well-being. brief literature overview: day labouring and subjective well-being in south africa as is the case in many other parts of the world, day labouring is on the increase in south africa (theodore et al. 2015). in countries like the united states, it is mostly immigrants (almost exclusively from latin america) who use day labouring as a means of gaining a foothold in the economy (valenzuela et al. 2006). in south africa, however, day labouring is the last resort for many who have lost their jobs or have been unable to secure employment in the formal economy. immigrants from the rest of southern africa compete with south african day labourers for the available casual employment on offer (theodore et al. 2015). day labourers are among the most marginalised and vulnerable groups in the south african informal economy (theodore et al. 2015). every day tens of thousands of men (and occasionally women) gather at hiring sites in towns and cities, seeking employment for the day or for a limited period (harmse, blaauw & schenck 2009). they have no guarantee of being hired on any of the six to seven days per week that they congregate at these sites. day labour work is decidedly uncertain, with many labourers working in sub-standard conditions (theodore, valenzuela & meléndez 2009). long spells of not being hired and consequently not earning an income are expected to negatively affect their level of subjective well-being. the economics literature provides a number of excellent reviews on the general determinants of well-being.1 however, literature on the subjective well-being of informally employed people in the labour market is much more meagre – both generally and in relation to south africa. blaauw et al. (2013) conducted an exploratory study on the possible determinants of subjective well-being among south africa’s informally employed, using day labouring as a case study. the results from this study corroborated the importance of employment and income for both the objective and subjective well-being of those living in abject poverty (blaauw et al. 2013). however, changes in income and the quality of jobs are also tied to the location of the hiring sites within an urban or rural context. large urban areas are located in those provinces where economic activity is more intensive. differences in the levels of economic activity and growth as well as income differentials between the various provinces are a driving force behind the internal migration of day labourers in south africa. recent findings by statistics south africa (2014:31) give impetus to this deduction. in 2006, the highest levels of poverty were found in limpopo (74.4%), followed closely by the eastern cape (69.5%) and kwazulu-natal (69.1%). by contrast, poor people were in the minority in the western cape (36.9%) and gauteng (32.4%) (statistics south africa 2014:31). it therefore comes as no surprise that the majority of the day labourers in the western cape at the time of the survey were from the eastern cape. with migration on the rise, location warrants more attention. conceptually, the precise impact of location on happiness is difficult to determine. more densely populated urban areas theoretically provide more opportunities to earn an income, and this could plausibly increase levels of well-being. the other side of the coin, though, is that increased levels of migration can lead to an oversupply of day labour and hence a reduction in income and consequently well-being. the question is, where do day labourers stand, especially given the precarious market conditions under which they operate? available data suggest that day labourers, similar to other urban migrants, come to the wealthier provinces to find work. however, high levels of competition could result in many people’s expectations exceeding their actual ability to achieve a better life. therefore, disappointment might set in and erode their subjective well-being. another study that dealt with the impact of geographical location on subjective well-being among migrants was that of knight and gunatilaka (2008). the authors set out to explain why the mean happiness score of rural-to-urban migrants in china is lower than that of those who stay behind in the countryside. they postulated that the aspirations of migrants rise when they get to the cities, but then their achievements fall short of expectations. south africa has also experienced significant rural-to-urban migration, with many day labourers in urban areas having originated in south africa’s rural districts (harmse et al. 2009). survey methodology sampling approach on the basis of the protocol established by valenzuela et al. (2006) in their nation-wide study of day labourers in the united states, the researchers conducted a census of day labourers in the various cities and towns in south africa in 2005 and 2006. the researchers recorded the names of the streets where the day labourers congregated and counted the number of day labourers at each site.2 an important inference to be made is that in a census of this nature, the numbers might not reflect the total size of the day labour workforce. for example, exclusions would be workers who were hired prior to the count and workers who regularly used the hiring site but for some reason did not search for work on the day in question (valenzuela et al. 2006:4). there were close to 1000 locations in south africa where people were picked up, while a minimum of 45 000, mostly african men, stood at these sites looking for work each day.3 table 1 provides a summary of the estimated number of day labourers in the nine provinces in south africa during the 2005–2006 research and counting process, compared with the provincial population distribution at the time. table 1: estimated number of day labourers in the nine provinces of south africa, 2005‒2006. table 1 shows that the provinces with the highest number of day labourers were the wealthier ones (gauteng, western cape and kwazulu-natal). the interviews conducted with the day labourers confirmed these provinces as the most popular destinations for foreign and south african day labourers alike. regarding the sampling procedure, the capitals of all provinces and important hubs in the rural areas had to be covered proportionally according to the number of day labourers present. a cluster sampling approach was used (rubin & babbie 1997), with clustering taking place in terms of both the number of day labourers interviewed in each centre and the size of the various hiring sites. had this not been done, there would have been an over-representation of rural versus urban areas and big hiring sites versus small hiring sites. aiming for a representative sample size of around 10% (to control for possible sampling error) meant that between 2500 and 4000 interviews had to be conducted across south africa (de vos et al. 2004:200). the fieldwork commenced in february 2007 and was concluded at the beginning of 2008.4 a total of 3830 questionnaires were accepted for the analysis, representing 8.5% of the estimated research population. from an ethical standpoint, it was crucial not to deprive any day labourer of work because he was participating in the interview process. in some cases, therefore, interviews were not conducted. this meant that the data had to be cleaned so that a cross-sectional regression analysis could be conducted. thereafter, the size of the sample was 2645. survey results: descriptive statistics on day labourers in south africa the following descriptive statistics were compiled on the participants in the study. demographic characteristics and employment history table 2 provides a summary of the basic demographic characteristics of the day labourers who participated in the survey. table 2: demographic profile and employment history of day labourers in south africa, 2007‒2008. the survey results for gender and age of the day labourers reflect the racial composition of the broader informal sector in south africa (saunders 2005). notably, the age distribution highlights the persistent unemployment and under-employment among the country’s youth (statistics south africa 2015). in addition, each day labourer supported an average of four people, excluding themselves. at least 170 000 people survived on the income generated through this type of informal employment. income earned a key element in the study of subjective well-being among day labourers is the income that they earn (blaauw et al. 2013). table 3 shows the average income earned by survey participants in a ‘good week’ and ‘bad week’ respectively, across the different provinces. table 3: average income earned in a good week and a bad week by day labourers per province, 2007‒2008 (zar). however, merely looking at the averages does not tell the full story. harmse et al. (2009) observed differences in attitude about income-earning prospects among day labourers in the various cities and towns across south africa. an analysis of income earned at a more disaggregated level is also necessary. table 4 and table 5 disaggregate the distribution of income earned by day labourers in south africa, in a good and bad week respectively, at the provincial level. table 4: distribution of income earned in a good week by day labourers per province, 2007 (percentages). table 5: distribution of income earned in a bad week by day labourers per province, 2007 (percentages). table 4 reveals that in (what survey participants perceived as) good weeks, the majority of day labourers earned in excess of zar 400 per week in 2007. this applied to south africa as a whole as well as to six of the nine provinces. income levels in good weeks were clearly lower in the free state, northern cape and limpopo provinces. table 5 reveals only one income category (less than zar 100 per week) applicable to the majority of day labourers in all provinces during a bad week. again, it seems that the situation in the free state, northern cape and limpopo provinces was worse than at the national level. this in turn appears to mirror general inequality patterns in south africa and highlights relative provincial economic performance at the time. this would have important implications for the power relations within the competitive day labour market. given the persistent depressed economic conditions in these provinces, day labourers had virtually no power to negotiate wages with prospective employers (theodore et al. 2015). theory would suggest that these factors have an undeniably negative influence on the subjective well-being of day labourers in south africa (sen 1999, 2003). this deduction constitutes one of the key building blocks for the model selection and empirical analysis described in the next section. model selection and empirical analysis research method to investigate the impact of geographical location on the well-being of day labourers in south africa, we employed a cross-sectional analysis using dummy variables for the nine provinces – which the exploratory study by blaauw et al. (2013) did not make provision for. the purpose of these dummy variables was to account for differences in the well-being of day labourers between provinces. the model can be specified as follows: yi is the dependent variable for a certain cross-section (i); d is the subgroup in the cross-section – in this case, a province – and β is a k × 1 vector of parameters to be estimated on the k × 1 observations of the explanatory variables (x); i is 1,…n (brooks 2008). as a robustness check, we also estimated a cross-sectional panel model. the results corroborated our findings. however, given that t = 1 in the panel analysis, we only report on the cross-sectional analysis in the ensuing paragraphs. model specification two functions were specified, namely a subjective and an objective function. the difference between these two functions was the dependent variable, which was a proxy for the subjective and objective measure of well-being. we based our choice of the dependent variable for the subjective function on the work of knight, song and gunatilaka (2009), which concluded that satisfaction with household income is one possible measure of subjective well-being (swb). the dependent variable for the subjective function was the satisfaction of the day labourer with their level of income (is your income worse, or good or better than expected?). this was a binary type variable with two categories (d = 0 if it is worse; d = 1 if it is good or better than expected). the variable may, at first glance, appear to be merely an income satisfaction variable. however, there is an argument that even if the actual income is as good as expected, it does not necessarily mean that the individual is satisfied or happy with it. the socio-economic construct of day labourers potentially counters this conclusion. since day labouring is a survival strategy, traditional economic considerations such as optimality and wealth creation do not feature directly. therefore, within this unique context, the dependent variable does not merely constitute a comparison between expectations and reality; indeed, it is a measure of subjective well-being among labourers. day labourers are well aware that the supply of their type of work is increasing constantly while the demand is not keeping pace. the proverbial cake must therefore be shared among an ever-growing day labour force, while a constantly diminishing level of real earnings is expected (blaauw et al. 2013). this view is supported by the fact that reservation wages are steadily falling in many informal labour markets (theodore et al. 2009). if a day labourer says his or her income is as good as or better than expected, it shows a level of subjective satisfaction, given the typical uncertainty and income variances in the day labour market. the fact that this was a recurring theme in discussions with the survey participants convincingly motivates the use of this variable in the subjective function. we therefore argue that the dependent variable does not merely mean a comparison between expectations and reality; it is a measure of subjective well-being among labourers. according to the literature, income is a very important indicator of well-being in poor communities (diener et al. 1993, 2002). the dependent variable for the objective function was the log of the best wage earned per day. when day labourers achieve their best income levels, it brings about a feeling of happiness and improved well-being (blaauw et al. 2013). table 6 and table 7 provide descriptive statistics of the dependent variables for the objective and subjective functions of the two models. table 6: descriptive statistics for the dependent variables. table 7: descriptive statistics for best wage in categories. the two dependent variables were the ‘best wage’ and ‘good or better expectations’, respectively. the highest mean best wage was in the western cape, followed by kwazulu-natal and gauteng. the maximum best wages recorded were in kwazulu-natal, gauteng and limpopo. the lowest mean best wage was in the free state. there was high dispersion in the data, as revealed in the large differences between the minimum and maximum best wages per province as well as the high kurtosis values. for the subjective measure (looking at the percentage of total day labourers per province), the eastern cape recorded the most labourers with good or better income expectations, followed by gauteng and the western cape. together these accounted for about 50% of the sample per province. limpopo recorded the lowest number of labourers satisfied with their income (only 3%), followed by the free state and kwazulu-natal. table 7 indicates the best wage divided into categories. in addition, it shows the number of day labourers whose income expectations were worse, or good or better, according to these wage categories. it is evident that the first two best wage categories were dominant with lower numbers recorded as the income levels increased. furthermore, it is in these two best wage categories that the income expectations were also the worst. looking at the full sample, 58% of day labourers were not satisfied with their income as opposed to 42% who were satisfied. the basic approach to specifying a well-being function is to include basic variables, conventional economic variables, comparison variables, community variables and attitudinal variables as explanatory variables (cummins 2000; kingdon & knight 2004; knight et al. 2009). the following variables from the day labourer survey were used and classified according to these broad categories: the basic demographic variables are standard throughout the literature. they include gender, education, marital status and age. in this survey, age was categorised and was not used as a continuous variable. see tables 8–11 below. table 8: basic demographic variables. table 9: economic variables. table 10: comparison variables. table 11: attitudinal variables. the comparison between current income and past circumstances and aspirations formed the subjective perception of the participants of their financial situation. these comparison variables were primarily a comparison of an individual at different times, or with other day labourers that the participant knew. the attitudinal variables were included to control for behaviour, which affected subjective well-being. the three attitudinal variables reflected the psychological state of mind or attitude shaping their perception of their job or situation. the community variables captured the unobserved provincial differences, which could have been related to government funding, infrastructure in rural areas, governance, environment and culture (knight et al. 2009). the variables were grouped according to the nine provinces in south africa. estimation results the objective and subjective functions were estimated on a cross-section with 2645 (n) observations within the dummy variable framework. the two-stage least-squares method (2sls) was used in the objective function, but due to the binary nature of the dependent variable for the subjective function a probit model was selected as the most appropriate model for this function. the income variable, log of the wage in a good week (goodweek), was instrumented because of endogeneity problems that occur with income when estimating swb functions (kingdon & knight 2004; senik 2005). the endogeneity test indicated that the income variable (goodweek and the change in income) was endogenous in the objective function, but not in the subjective function. the j-statistic probabilities were 0.0 and 0.58 for the objective and subjective functions, respectively. in the case of the objective function, the null hypothesis (exogeneity) was rejected, indicating the endogeneity of the variable. the log of the lowest wage (lowwage), change in the log of the lowest wage and the number of months working as a day labourer (months) were used as possible instruments. the orthogonality c-test confirmed the exogeneity of these variables where the probability of the j-statistic was >0.05 and showed acceptance of the null hypothesis (exogeneity). the weak instrument test showed that the number of months working as a day labourer was weaker than the other two instruments. the estimation results for the objective function and the subjective function are presented in table 12. table 12: results for the objective and subjective functions. objective function results most demographic variables were significant in the 2sls model, which estimated objective well-being across south africa. the twenties age group was significant. the education variables were significant with an unexpected sign for completed secondary school. the economic variables were all significant and the signs were according to expectations, except for previously having a full-time job which recorded a positive sign. possibly, former full-time workers were more confident of their future prospects at the time of being interviewed as opposed to being dejected or angry about losing their employment status. only the job opportunity and food variables were significant for the comparison variables – the signs were unexpected. for example, having enough food might reduce the opportunity cost of not standing on the street corner for days on end, leading to less employment and income. this might well be a cyclical and therefore non-linear relationship which needs to be tested in future research. the attitudinal variables were all significant, except for staying with family. when accounting for the differences in provinces in the sample (2sls with dummies), the significance of some of the variables changed. most of the variables that were significant in the 2sls model were still significant with the same sign, except for the economic variable turned down a job which became insignificant, and the comparison variables having food and better job opportunities at this site became insignificant. the attitudinal variable, staying with family, became significant. all the economic and attitudinal variables became significant (except turned down a job) in the dummy variable model. the dummy variables for the nine provinces indicating the geographical links and community variables were all significant. this shows that there were significant differences between the provinces and it confirms the importance of community variables as explanatory variables for well-being functions. the bigger size effects for provinces such as the western cape and gauteng possibly reflected their status as the powerhouse economic regions in south africa. subjective function results the subjective function was first modelled using the probit model to estimate subjective well-being in south africa, while the second probit model used dummy variables to account for the differences between the provinces in south africa. the results of the two models were very similar. only gender, primary schooling and the twenties age group (only in the first probit) were significant. the economic variables, income and whether the participant previously had a full-time job were significant with the expected sign. all the comparison variables were significant with the expected sign. no attitudinal variables were significant, except for the support variable in the dummy variable model with an unexpected sign. the support variable was only significant at the 90% confidence level and might reflect the fact that day labourers saw the need for support as detracting from their perceptions of their own capabilities and levels of agency. the dummy variables for the nine provinces indicating the geographical links and community variables were all significant. this shows that there were significant differences between the provinces and also confirms the importance of community variables as explanatory variables for well-being functions. the negative signs in the case of the subjective function might reflect the disappointment linked to anticipated better opportunities in the migrant destination provinces as well as the prevailing negative perceptions in the poorer provinces from which the migrants originated. comparing the objective and subjective functions, there were clear differences in the results. the attitudinal variables were significant in the objective function, whereas comparison variables were significant in the subjective function. the economic variables were significant in both functions; however, only two of the four variables were significant in the subjective function. this confirms what the literature says about income being an important factor in determining well-being within poor communities. the objective function was mainly driven by the tangible aspects of day labouring, such as staying with family, injuries occurring and being part of a support group, while the dependent variable was the actual income. the subjective function was mainly driven by comparison variables, including whether there were better job opportunities at the site, whether day labourers had enough food and changes in income. these variables were based more on perceptions and the function’s dependent variable was based on income expectations. the community variables and the dummy variables for the provinces were significant in both functions. the objective function’s coefficients were positive and indicated that the provinces differed in terms of income (knight et al. 2009). the subjective function’s coefficients were negative, showing that perceptions of well-being had a negative impact on subjective well-being – which was in contrast to the positive impact on well-being in the objective function. this possibly also explained the different signs for the full-time job variable in the two functions. this is because the perception of a full-time job was negatively perceived in terms of subjective well-being, in contrast to the positive sign in the objective function, which was linked to a certain income rather than the perception. mulcahy and kollamparambil (2016) found that rural-to-urban migration has a negative impact on subjective well-being in south africa due to unmet expectations and aspirations, and emotional fallout. for day labourers in south africa, this may also be the case. the richer provinces have more job opportunities but also more competition, and therefore the income may not be as good as day labourers expect. this is supported by the evidence presented in a study by krugell and blaauw (2011): in metropolitan areas, greater occupation density was negatively associated with the earnings of day labourers, which reflected the competition for jobs among day labourers in the big cities. a general increase in the number of day labourers in south africa’s major cities since the global economic downturn and slower growth in the construction industry have given rise to even greater competition. key conclusions objective and subjective well-being functions were used to determine whether the well-being of day labourers in south africa differed from one province to the next. the literature revealed broad categories of determinants (economic, comparison, attitudinal and communities) that influence well-being in general. the findings from this study confirmed that economic variables do play a role in both measures of well-being, and that attitudinal and comparison variables are significant in the objective and subjective measures of well-being, respectively. the results resonate with the work of sen (1999, 2003). income is a leading indicator of capability among day labourers. it allows them to provide for their dependants and to exercise agency in an often unforgiving labour market environment. the findings also confirmed that geographical links and community variables are significant in both functions, indicating that well-being is statistically different between the provinces. this seems a plausible result, given that migration to provinces that are doing better economically can potentially add to the freedom and capabilities enjoyed by day labourers. to reiterate, it is the agency that day labourers display in leaving family and familiar surroundings behind in search of better opportunities that makes such benefits possible. however, on a subjective level, these potential gains are to a large extent negated by increased levels of competition and an oversupply of day labourers in most urban labour markets. this often leaves day labourers disappointed with the returns from their ‘agency investment’, so to speak. furthermore, the impact of the community variables on the well-being of day labourers differs between the objective and subjective functions, confirming the importance of the measures of well-being. the impact of community variables on well-being for the objective function was positive due to its direct link to income, as opposed to the negative impact for the subjective function because of the subjective nature of perceptions. moreover, these findings are linked to the different degrees of prominence of the attitudinal and comparison determinants of well-being between these functions. avenues for further research on a methodological level, the results open up new avenues for refining the study of subjective well-being as it relates to the informal economy. the question arising from the application of sen’s ca is the extent to which it is not the income per se that influences the level of subjective well-being but rather what people can afford with the income and the welfare difference they feel afterwards (such as freedom from hunger and other forms of marginalisation) that determine their levels of subjective well-being. although the literature supports income as a measure of objective well-being, it cannot speak to the capabilities, functionings and freedoms it brings. measuring the dimensions of subjective well-being is the methodological challenge for future research flowing from this study. well-being in the informal economy is a multifaceted phenomenon. it is imperative to use both the objective and subjective measures of well-being when dealing with well-being among day labourers and, by implication, other marginalised groups. for many vulnerable groups such as day labourers, waste pickers and car guards, the informal economy offers both opportunities and certain freedoms to the unemployed. even with limited capabilities, these people are able to access work and income through some form of agency. this offers them at least some self-respect and provides an alternative to a life of begging or, worse, crime. a day labourer in port elizabeth summed it up very well: ‘we cannot sit at home and watch the hungry family’. finding ways to enhance and deepen the agency and capabilities offered by the informal economy will provide an important new field of research for academics and other research professionals. this in turn will lay the foundation for more robust urban and social development policies and implementation plans in south africa, and strengthen hopes for a much more equal society. acknowledgements the authors want to acknowledge the valuable comments and suggestions received from prof. john luiz as well as the anonymous referees of the journal. the same applies to the contribution in terms of editing by ms ali parry. the manuscript benefitted significantly from this. all mistakes remain our own. funding for the project was provided by the national research foundation (nrf). competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions p.f.b. was jointly responsible for the conceptualising of the research project, participated in the fieldwork and acted as first author on the various drafts of the article. i.b. assisted in the conceptualising of the article, handled the econometric 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vulnerability in south africa and the united states’, international journal of manpower 36(6), 807–823. https://doi.org/10.1108/ijm-01-2014-0036 theodore, n., valenzuela, a. jr. & meléndez, e., 2009, ‘worker centers: defending labor standards for migrant workers in the informal economy’, international journal of manpower 30(5), 422–436. https://doi.org/10.1108/01437720910977634 valenzuela, a. jr., theodore, n., meléndez, e. & gonzalez, a.l., 2006, on the corner: day labor in the united states, ucla, los angeles, ca. footnotes 1. see, for example, the work of frey and stutzer (2002) and dolan, peasgood and white (2008). 2. given the length restrictions for this paper, see blaauw (2010) for a detailed discussion on the choice of day and seasonal considerations and other operational arrangements. 3. see harmse et al. (2009) for all the locations at municipal level. 4. although this makes the data set 10 years old, it still remains the only data available. furthermore, the extent of day labouring is expanding continuously, making it important to utilise the available data while the follow-up survey is currently being conducted. sajems ns vol 7 (2004) no 1 132 modelling the impact of changes in the interest rates on the economy: an austrian perspective ________________________________________________________________ p le roux and b ismail department of economics, university of port elizabeth :vista campus ________________________________________________________________ abstract even though econometric models and yield curve analysis are useful in assessing the impact of interest rate changes on the economic structure, their power to predict the magnitude and direction of swings in the business cycle is often restricted to the use of short-term interest rates. from an austrian school perspective on interest rates, empirical evidence suggests that the profitability of heavy industries further downstream outperforms that of light industries in the initial stages of monetary easing, due to a rising demand for investment goods and a rise in capacity utilisation levels. this paper assesses the impact of interest rates changes on the productive structure of the economy by taking into account the effect thereof on sector earnings and ultimately share prices. jel e43, 52; n10 1 introduction conventional economic analysis assesses the impact of interest rate changes on the economy by evaluating its impact on the demand-side of the economy, and possibly potential output. it is argued that a reduction in interest rates increases liquidity, lowers the cost of consumption and induces an increase in aggregate demand. this demand expansion should lead to secondary effects such as accelerated investment and employment growth, so inducing a multiplier process in the economy. eventually, rising prices will reduce the real pool of funds, placing upward pressure on interest rates and bringing about a new equilibrium. conventional economic theory also suggests that lower interest rates will directly increase investment spending by lowering the cost of capital. in addition, it should raise production capacity and thus potential future output growth. the level of the new equilibrium for output, inflation and interest rates will depend on how the induced imbalances are corrected. relatively low sajems ns vol 7 (2004) no 1 133 interest rates will lead to sizeable potential output growth via an interest-elastic investment demand function, ensuring adequate wealth creation to accommodate rising demand. however, if investment does not respond adequately to lower interest rates and higher anticipated demand growth, wealth creation falls behind rising claims on the economy. pressure on prices and the current account builds up. this would induce rising interest rates, with the end result that the demand/supply equilibrium could very well be established at the same level of output than before. this is unfortunate, as the goal in any economy would be to establish a new equilibrium at a higher level of output, by ensuring that lower interest rates shift both the demand and supply curves to the right. a precondition for this to happen is high interest rate elasticity of investment demand. the sensitivity of investment to interest rates is therefore crucial to the potential impact of interest rate changes on the economy. empirical evidence suggests that, in south africa, private investment is more responsive to long-term interest rates than to short-term interest rates. as figure 1 below clearly indicates, the transmission mechanism between a decline in long-rates and a higher level of investment is rather long. figure 1 investment and long-term interest rates sajems ns vol 7 (2004) no 1 134 table 1 regression results of investment function dependent variable is real non-residential private investment sample (adjusted): 1986:1 1999:1 included observations: 53 (after adjusting endpoints) variable coefficient std. error t-statistic prob. dummy for 1986q1 4453 1398 3.185 0.003 lagged dependent variable 0.854 0.044 19.39 0.000 polynomial lag of long-term interest rates -200.7 63.6 -3.156 0.003 polynomial lag of domestic demand 0.011 0.003 3.539 0.001 r-squared 0.98 mean dependent var 44188 adjusted r-squared 0.98 s.d. dependent var 9959 s.e. of regression 1312 akaike info criterion 14.43 sum squared resid 84323439 schwarz criterion 14.58 log likelihood -454 f-statistic 982.65 durbin-watson stat 1.38 prob (f-statistic) 0 figure 2 goodness-of-fit of investment regression over a thirteen-year period, south africa’s investment function also shows considerable instability, making it even more difficult to model the impact of sajems ns vol 7 (2004) no 1 135 lower interest rates on investment and macroeconomic balance. table 1 and figure 2 above show the regression results of non-residential private investment as a function of long-term interest rates and domestic demand (gde) for the south african economy between 1986 and 1998. the regression is acceptable in terms of statistical and econometric criteria. however, the instability of the coefficients shows that the sensitivity of investment to both interest rates and domestic demand has been falling over time, particularly since 1994 (as depicted in figure 3). figure 3 coefficient stability of investment function this is further evidence of the unequal globalisation (in respect of the impact on imports and exports) experienced in the south african economy. the relatively unfavourable investment environment, in the light of increased global competition, has resulted in this deterioration. the low elasticity of private investment to domestic demand and interest rates, which constrains the longer-term growth potential in the economy, is cause for concern. it is indicative of the prevailing uncertainty among potential domestic investors, regarding their operating environment. this has led to merely marginal short-term adjustments in investment demand, to correspond with business cycle movements, in recent years. it is thus crucial for government to instil renewed confidence in the business community by introducing structural reforms. only when distortions in local factor markets and tax structures are addressed and government creates a favourable, enabling environment for sajems ns vol 7 (2004) no 1 136 business, will investment horizons broaden and investment spending grow again. even though econometric models and yield curve analysis are useful in assessing the impact of interest rate changes on the economic structure, their power in predicting the magnitude and direction of swings in the business cycle is inferior and restricted to the use of short-term interest rates on their own. whereas the econometric model tries to capture all possible linkages on the demand-side, yield curve analysis is useful in assessing the impact of interest rates on the economic structure, via its influence on the relative profitability of different sectors in the economy. its power to predict the magnitude and direction of swings in the business cycle is inferior and restricted to the use of short-term interest rates on their own (rothbard, 1970: 382; mises, 1963: 536). the yield curve only has leading indicator properties because it incorporates the transmission lag of monetary policy. furthermore, as yield curve analysis ignores the different interest rate elasticities of the individual gdp components, it is of little relevance for assessing the impact of interest rate changes on different types of investment on the various sectors in the economy and ultimately share prices. this shortcoming can be accommodated in a microeconomic framework, which is the topic of the next section. 2 the austrian school perspective to the impact of interest rates the conventional theory discussed above, suggests that lower interest rates could raise output levels in the economy via increased demand and higher potential production, following a higher level of investment. however, the macroeconomic analysis assumes investment to be homogenous. it therefore ignores the possibility, that a change in interest rates might have a different impact on different types of investment and thus cause divergent sector responses. the austrian school addresses this shortcoming by adopting a microeconomic framework. what follows is based on garrison’s (2001) and horwitz’s (2000) models of the austrian business cycle. according to these authors, the focus of the austrian school is on how a change in interest rates alters the structure of production in the economy. the starting point is the realisation that investment is not homogeneous. a single investment function, partly driven by interest rates, is therefore not capturing everything certainly not the impact on different types of investment or different sectors. the heterogeneity of capitalistic methods of production must be considered to fully comprehend the investment decision and thus the impact of interest rates. the austrian approach provides theoretical arguments for such an influence by relying on microeconomic principles of optimal investment allocation. the sajems ns vol 7 (2004) no 1 137 impact of interest rates, according to this theory, may be summarised by the following propositions: a change in interest rates alters the relative profitability of different types of investment − this argument is based on the differentiation of investment according to the length of the production process, as interest rates have a differentiated impact through the time dimension. lower rates increase returns across all production processes, but they have the greatest impact on the most heavily time-discounted processes. at a higher interest rate, a shorter production process is therefore more profitable – and as interest rates fall, the profitability of long production processes will increase, relative to shorter production processes. thus, as interest rates fall, the relative profitability of investment in long production processes will be higher. these should therefore attract more investment, relative to shorter production processes. lower interest rates result in higher investment across all sectors − the increase in demand for investment goods implies that the capacity utilisation of sectors further away from final consumption will initially tend to increase more, relative to sectors closer to final consumption. as sectors with longer production processes thus experience a higher level of investment relative to shorter processes in the initial stages of the cycle, their capacity utilisation levels will fall later on in the cycle. the relatively lower investment in shorter processes, by contrast, will raise capacity utilisation in the more mature stage of the cycle. lower interest rates induce differentiated levels of capacity utilisation, investment responses and complementary employment of labour in different sectors − the resource utilisation between sectors, as initially reflected by different capacity utilisation changes, is therefore altered by a reduction in interest rates. this is in addition to changes in response to relative factor costs, which is the more traditional implication of a change in interest rates on the relative utilisation of labour and capital. expansionary monetary policy, as reflected by falling interest rates, will have a permanent impact on the economy's future performance as it affects the productive structure through the profitability of different investments − this will alter the production stock in the economy and, given heterogeneous capital and rather limited substitutability, output potential and its nature could be changed permanently. this approach, therefore, implies that a monetary shock will permanently alter the business cycle. monetary policy is not neutral and there is no long-term deterministic trend around which gdp fluctuates. sajems ns vol 7 (2004) no 1 138 at this point it is useful to point out the significance of the above propositions as it relates to share prices. the implications are obvious: a fall in interest rates raises the demand for investment goods, from long production processes relative to shorter processes, which implies an initially greater response in earnings growth from companies involved in long processes. a higher level of capacity utilisation also raises the profitability of these firms as capital costs per unit of output fall and possible gains in economies of scale are materialised. both these effects should thus enforce relatively stronger earnings growth for shares in sectors with long production processes. both these effects require an initial improvement in capacity utilisation, either as a sign of improved profitability or as a sign of increased demand. the empirical test, whether capacity utilisation of sectors with long production processes rises relative to that of sectors with short processes when interest rates fall, is therefore crucial. the significance of the empirical confirmation of this theory lies in the timing of earnings responses. should the theory be confirmed, investors should give preference to those sectors with long production processes relative to sectors with shorter processes in the early stages of an interest-rateinduced upswing, as the former will experience superior earnings growth. this finding should be incorporated when assessing the outlook for earnings and share prices, as it represents a further influence by interest rates on the economy and ultimately share prices. increased investment demand, higher capacity utilisation and the longer time-discount of future returns will cause stronger earnings growth in sectors with long production processes when interest rates fall. this has profound implications for investment behaviour. the remainder of this paper is devoted to assessing the effectiveness of conventional economic analysis (the yield curve and basic econometric models) and the austrian microeconomic perspective as tools to predict the impact of interest rates on the business cycle of the economy. 3 the yield curve as a predictor of the impact of interest rates there are three economic arguments for using the yield spread as a leading indicator of economic activity: (i) the yield spread reflects the stance of monetary policy according to this view, a low yield spread (in absolute terms) reflects relatively tight monetary policy. this is based on the economic theory that long-term interest rates are a reflection of expected future short rates plus a possible risk premium. short-rates higher than long-rates would, sajems ns vol 7 (2004) no 1 139 therefore, suggest expectations of falling short-rates, implying prevailing tight monetary policy. a second theory supporting this interpretation is that short-rates tend to rise faster than long rates when monetary policy is tightened and, as a result, the yield spread declines (buse, 1965). (ii) the yield spread contains information on credit market conditions long yields are the outcome of demand and supply in the bond market. should the spread increase as a result of rising long-term interest rates, it could be a reflection of increased demand for funding and thus future real economic activity (malkiel, 1962). (iii) the yield spread reflects the direction of future inflation changes long-term interest rates are a reflection of future inflationary expectations. a narrowing of the spread will reflect a decrease in future inflation, if inflationary forecasts reflected by the curve are on average correct. this reasoning is linked to the first argument, as falling inflationary expectations cause a decline in expected future short rates (fama, 1975). all these arguments may be linked to the interplay of the business and interest rate cycles. during recessionary conditions, monetary policy will tend to loosen, resulting in falling short rates. as economic conditions respond with a lag, inflation (and thus long rates) will not follow immediately, thus leading to a steepening in the curve. as the economic recovery gains momentum, short rates will tend to stabilise while inflationary fears and thus long rates will tend to rise, resulting in a normal shape of the curve. finally, tighter monetary policy to restore balance in the economy will gradually induce a negative slope. therefore, the spread of the yield curve gives an indication of the influence of monetary policy, and thus short rates, on future economic activity. the leading indicator properties are the result of the transmission lag of monetary policy. the three possible reasons for the leading indicator properties of the yield curve reflect the demand channel of interest rates. as will be discussed below, a more appropriate way of modelling, measuring and assessing this impact is through the use of an econometric model. however, the yield curve is useful in assessing the austrian approach. any drastic change in the shape of the yield curve is a reflection of monetary policy. the extent of monetary stimulation may therefore be related to the steepness of the curve, which can be used as a measure of excessive monetary stimulation in the market-process approach. in essence, long-rates are considered as the true or natural interest rate in this case. sajems ns vol 7 (2004) no 1 140 3.1 empirical evidence figure 4 shows the relationship between the spread of the yield curve (lagged four quarters) and gdp growth. it provides visual evidence that the spread of the yield curve could be a leading indicator of economic activity. figure 4 yield curve and gdp after numerous regression specifications were tested, it was concluded that a four-quarter lag of the yield spread provides the best explanatory power of economic activity, both in statistical and in econometric terms. the regression results are provided in table 2 and figure 5 below. however, a closer examination raises numerous concerns. firstly, the coefficient of the above regression shows considerable instability. this is the result of aggregation, as the interest rate elasticities for individual gdp components differ. secondly, the explanatory power regarding turning points in the economic cycle is limited. while the r2 and the durbin-watson statistic might suggest that, it is also confirmed by the fact that the error term is a close reflection of the gdp growth trend. this is clearly evident from the goodness-of-fit in figure 6. in addition, the yield spread is also a poor indicator of the magnitude of swings in the business cycle. sajems ns vol 7 (2004) no 1 141 table 2 regression of yield spread on gdp dependent variable is the percentage change in real gdp sample (adjusted): 1990:1 1998:3 included observations: 35 (after adjusting endpoints) variable coeffic ient std. error tstatistic prob. constant 0.007 0.003 2.228 0.033 spread of the yield curve lagged four quarters 0.107 0.021 5.099 0.000 r-squared 0.44 mean dependent var 0.01 adjusted r-squared 0.42 s.d. dependent var 0.02 s.e. of regression 0.02 akaike info criterion -8.04 sum squared resid 0.01 schwarz criterion -7.95 log likelihood 93 f-statistic 26.00 durbin-watson stat 0.41 prob (f-statistic) 0.00 figure 5 coefficient stability of regression of yield curve on gdp sajems ns vol 7 (2004) no 1 142 figure 6 goodness-of-fit of regression of yield curve on gdp substituting short-rates for the yield spread in the regression analysis does not reduce the explanatory power of the regression (shown in table 3). the predicting power of the yield spread is therefore predominantly explained by movements in short-rates. this takes us back to conventional economic analysis. the coefficient of the short-rate in the regression is also much more stable than that of the yield spread. table 3 regression of short-rates on gdp dependent variable is the percentage change in real gdp sample (adjusted): 1990:1 1998:3 included observations: (35 after adjusting endpoints) variable coeffici ent std. error tstatistic prob. constant 0.270 0.037 7.217 0.000 3-months ba rate lagged by 4 quarters -0.096 0.014 -6.894 0.000 r-squared 0.59 mean dependent var 0.01 adjusted r-squared 0.58 s.d. dependent var 0.02 s.e. of regression 0.01 akaike info criterion -8.35 sum squared resid 0.01 schwarz criterion -8.26 log likelihood 98 f-statistic 47.53 durbin-watson stat 0.34 prob (f-statistic) 0.00 sajems ns vol 7 (2004) no 1 143 figure 7 goodness-of-fit of regression short-rates on gdp figure 8 coefficient stability of yield curve on gdp 3.2 assessment yield curve analysis has only limited information content, as it essentially reflects the transmission between a change in short-rates and its impact on gdp. given that the composition of gdp and that the differing interest rate sajems ns vol 7 (2004) no 1 144 elasticities of its demand components are ignored, the analysis is inherently unstable and of little relevance in assessing the impact on different sectors of the economy – and ultimately share prices. also, rather little can be learnt from determining how a change in short-term interest rates will impact on the shape of the yield curve – as an exercise to assess the impact of interest rates on the economy. the impact on long rates will still have to be determined, necessitating a comprehensive evaluation. 4 the use of an econometric model to measure the impact of interest rates an econometric model provides a comprehensive assessment of the impact of interest rate changes on the economy, by modelling dynamics and simultaneous impacts. an attempt is made to approximate the structure of the economy and with it, the elasticities of all components of the economy with regard to interest rate changes. these include consumption, investment, exchange rates, the demand for money or credit and international capital flows. an econometric model separates the impact of long-term and of short-term interest rates on the economy, as well as the relationship between the two. a structural model also allows policy simulations to determine the impact of a particular monetary policy response or long-term interest rate shock. top-down earnings forecast the need to capture all the demand-side aspects of interest rate impacts on sector-specific components of gdp or gde. this can be accomplished only through the use of an econometric model. 4.1 policy simulations numerous policy simulations have been carried out in south africa, each with relatively complex sets of econometric models. all these simulations measured the impact of a change in short-term interest rates, and thus monetary policy, on the economy. working papers by the south african reserve bank and the bureau of economic research (ber) provide adequate literature in that regard (see for example sarb occasional paper no 11, july 1998). differences in simulation results can be ascribed to different model specifications and assumptions made during simulation. there are many advantages of constructing econometric models. however, some of the most beneficial include the fact that the following impacts can be reported: sajems ns vol 7 (2004) no 1 145 table 4 impact of interest rate changes on the south african economy 1999 2000 variable base simulation base simulation gde growth -0.7 -0.5 5.1 6.0 pce growth 1.1% 1.0% 3.1% 3.7% current account (rbn) -2.3 -2.8 -12.0 -16.0 net balance of payments flows (rbn) 34.4 34.5 24.7 21.0 average long bond yield 13.8 14.0 14.3 14.5 policy shock: repo rate average 3 percentage points lower 2 percentage points lower r/us$ spot rate 6.16 6.17 6.5 6.52 inflation (core) 8.0 8.2 8.6 8.9 private non-residential fixed investment growth -4.10% -4.10% 9.20% 9.60% the greatest impact of the monetary relaxation is felt in 2000 and beyond. this is in line with simulations of the south african reserve bank’s (sarb) model and is the result of the transmission lag of monetary policy. the largely unaltered exchange rate forecast is due to the assumptions underlying the inherent strength or weakness of the exchange rate. with sizeable net capital inflows in both our simulations, the exchange rate remains predominantly driven by the assumption regarding its inherent strength or weakness. the demand pressure in the economy is predominantly felt through the current account, in line with the global integration of the economy. with the exchange rate remaining overall stable, pressure on import prices will remain subdued and core inflation only has a limited upward tendency. long-term interest rates increase due to fears of inflationary pressures, lower net inflows and the fact that short rates are not imposed on long rates due to their omission from our equation explaining long-term interest rates. the simulation results are time-dependent. over the forecast period, there are numerous components of gross domestic expenditure (gde) that are entirely policy insensitive. these refer in particular to the demutualisation assumption for private consumption expenditure (pce), which lowers the interest rate elasticity of pce for the simulation period and the assumption on the sizeable residual, which lowers the gde elasticity. sajems ns vol 7 (2004) no 1 146 4.2 assessment in virtually all models for south africa, investment is treated as homogenous. distinctions are generally made between private and public investment, as well as between residential and non-residential investment, but no distinction is made for the investment responses of different sectors of the economy to interest rate changes. and yet, microeconomic theory suggests that the impact of an interest rate cut on different sectors of the economy will differ (baird 1982: 310-312). the final section attempts to test this hypothesis empirically for south africa and to quantify the differentiated impact. 5 quantifying the impact of interest rate changes on investment according to the austrian school the theoretical analysis has shown that a change in interest rates causes a change in the allocation of investment resources, cumulatively in the structure of capital stock towards longer production processes. as the positive monetary shock has its effect, the early expansionary phase may be characterised by a fall in short-term interest rates relative to long-term rates. only later in the expansion will the rise in income and consumption demand, with the shortage in resources, raise short-term rates again. the change in the slope of the yield curve, therefore, captures the influence of monetary policy on the structure of production. this analysis also provides a complementary assessment of interest rate changes. it focuses on interest rates from the production side rather than giving the conventional interpretation regarding demand which, as pointed out earlier, is more appropriately assessed with an econometric model. the following regression results confirm the relevance of the austrian approach for south africa. the model is based on keeler’s (2001) analysis. capacity utilisation in heavy industries relative to light industries is modelled as a function of three key variables: the steepness of the yield curve − this variable reflects the stance of monetary policy. potential output relative to actual − this variable measures the stage of the prevailing cycle of real economic activity growth in money supply − this measures the amount of liquidity available to finance real economic activity. to quantify the dynamic impact of an expansionary monetary policy on interest rates, economic growth and relative capacity utilisation, a vector autoregression sajems ns vol 7 (2004) no 1 147 (var) model was specified with the above four variables. each variable had a lag length of three quarters. a var is essentially based on the principle that everything in the economy influences everything else. all variables feature in the equation and no specific structure is imposed. the following figures show the impact of a one-standard-deviation increase in money supply growth on the other three variables. the correctness of the direction of change is confirmed by the previous regression analysis, as well as by the theoretical discussion of the austrian approach. table 5 regression results dependent variable is capacity utilisation in heavy industries relative to light industries sample (adjusted): 1982:2 1998:1 included observations: 64 (after adjusting endpoints) variable coeffici ent std. error tstatistic prob. actual relative to potential output 0.810 0.217 3.733 0.000 shape of the yield curve (-2) 0.048 0.025 1.928 0.059 3 quarters moving average in m3 growth 0.376 0.139 2.701 0.009 change in m3 velocity 0.196 0.103 1.896 0.063 dummy for 1998 0.020 0.011 1.890 0.064 r-squared 0.456 mean dependent var -0.006 adjusted r-squared 0.419 s.d. dependent var 0.020 s.e. of regression 0.015 akaike info criterion -8.328 sum squared resid 0.013 schwarz criterion -8.159 log likelihood 180.69 f-statistic 12.400 durbin-watson stat 1.975 prob (f-statistic) 0.000 as can be seen from the impulse response functions below, an increase in the money supply leads to a steeper and positive yield curve, raises gdp growth relative to potential and increases capacity utilisation in heavy industries relative to lighter industries, in accordance with the theoretical discussion. sajems ns vol 7 (2004) no 1 148 figure 9 goodness-of-fit figure 10 impulse-response function of the yield curve sajems ns vol 7 (2004) no 1 149 figure 11 impulse-response function of relative capacity utilisation figure 12 impulse-response function of actual to potential output 6 conclusion demand-side analysis of the impact of interest rates on the economy is best done via an econometric model, to allow for the capturing of all linkages. the low elasticity of investment response to interest rates and domestic demand in south africa constrains the level of output in the economy. yield curve analysis is useful in assessing the impact of interest rates on the economic sajems ns vol 7 (2004) no 1 150 structure, via its influence on the relative profitability of different sectors in the economy. however, its ability to predict the magnitude and direction of business cycle swings is inferior to the use of short-term interest rates on their own. the yield curve only has leading indicator properties because it incorporates the transmission lag of monetary policy. because yield curve analysis ignores the different interest rate elasticities of the individual gdp components, it is of little relevance assessing the impact of interest rate changes on different sectors in the economy and ultimately on share prices. empirical confirmation of the theory suggests that the profitability of heavy industries outperforms that of light industries in the initial stages of monetary easing, due to a rising demand for investment goods and a rise in capacity utilisation levels. also, the further downstream an industry, the bigger the positive impact of a fall in interest rates, due to the longer time-discount of future returns. a comprehensive assessment of the impact of interest rates on sector earnings and ultimately share prices, therefore, has to take the impact of interest rates on the productive structure of the economy into account. it is essential to accommodate the changes in productivity or profitability that could result from a change in interest rates. references 1 buse, a. (1965) “the expectations hypothesis, yield curves and monetary policy” quarterly journal of economics. november: 664-68. 2 fama, e.f. (1975) “short-term interest rates as predictors of inflation”, american economic review, 65: 269-82. 3 garrison, r.w. (2001) time and money: the macroeconomics of capital structure, routledge: london. 4 horwitz, s. (2000) microfoundations and macroeconomics: an austrian perspective, routledge: london. 5 keeler, j.p. (2001) “relative prices and the business cycle”, paper presented at the southern economic association annual meetings in tampa usa. 6 malkiel, b. (1962) “expectation, bond prices and the term structure of interest rates”, quarterly journal of economics, 76: 197-218. 7 mises, l. (1963) human action. (3rd rev. ed.) contemporary book, inc.: chicago. 8 rothbard, m.n. (1970) man, economy and state, nash publishing company: los angeles. abstract introduction theoretical grounding theory of collaboration and integration supply chain collaboration and supply chain integration information technology south african definition of small, microand medium enterprises the roles of small and medium-sized enterprises in south africa enterprises information flow small and medium-sized enterprises’ information technology adoption problem statement empirical objectives methodology and design results findings of the study managerial implications limitation of the study conclusion acknowledgements references about the author(s) kenneth m. mathu gordon institute of business science, university of pretoria, johannesburg, south africa citation mathu, k.m., 2019, ‘the information technology role in supplier-customer information-sharing in the supply chain management of south african small and medium-sized enterprises’, south african journal of economic and management sciences 22(1), a2256. https://doi.org/10.4102/sajems.v22i1.2256 original research the information technology role in supplier-customer information-sharing in the supply chain management of south african small and medium-sized enterprises kenneth m. mathu received: 18 dec. 2017; accepted: 14 nov. 2018; published: 26 mar. 2019 copyright: © 2019. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the study background looked at the advent of supply chain management in the last generation which ushered in technology that drives information-sharing within, and across enterprises. the information flow facilitates synchronisation of business activities, such as relationship-building, supply chain management among others. aim: the aim of the study was to investigate how information technology (it) application in the south african small and medium-sized enterprises (smes) enhanced supplier-customer information sharing. setting: interviews were conducted with smes samples that comprised mixed owner-managers from food, and general trading smes in gauteng province of south africa. methods: a qualitative research methodology was used, and a non-probability sampling process was pursued. results: the results indicated that it application in the south african smes enhanced supplier-customer information-sharing, as it improved interaction through supply chain collaboration and integration. conclusion: the conclusion of the study highlighted that it application in enterprises as obtained from south african smes enhanced supplier-customer information-sharing. keywords: collaboration; information sharing; information technology; integration; small and medium enterprises; supplier-customer; supply chain management. introduction supply chain management (scm) links suppliers, manufacturers, and customers (coyle et al. 2017:53). the linkage implies that the suppliers of raw materials supply to the enterprises that manufacture products and services demanded by the customers. that includes the processes of transportation of raw materials, warehousing them at the ordering enterprise, manufacturing, or transforming the raw materials into finished products, and delivering the finished products or services to the customers. these processes are enabled by information sharing within and outside the enterprises involved: supplier and customer. the council of supply chain management professionals (cscmp) defines supply chain management as ‘the integrated managing, and control of the flow of information, materials, and services from the suppliers of raw materials through to the factories, warehouses, and retailers’ (pienaar & vogt 2012:8). the reference is a demand type of supply chain where customers demand products or services (demand side) from the manufacturing enterprises, who then receive raw materials from the suppliers (supply side) to manufacture the products or services demanded by the customer. this is another form of interaction between end users or customers, manufacturers, and suppliers. hence information sharing in a supply chain was reaffirmed by salam, panahifar and byrne (2016: 887–902) as the act of capturing, and disseminating knowledge, and data for decision-makers to plan and control supply chain operations. this entails the coordinated flow of raw materials from the suppliers, through the production process, up to the end customer or consumers. sharing accurate and timely information throughout a supply chain can yield significant performance improvements for the enterprise, and for the other members in the value chain (narkhede et al. 2013). indeed, it is the process of information sharing between supplier and customer. however, many enterprises are still reluctant to share information with their supply chain partners due to the unequal distribution of risks, costs, and benefits among the partners (salam et al. 2016:887–902). supply chain is a powerful source of competitive advantage for many enterprises as ‘it integrates manufacturing, operations, purchasing, transportation, and distribution into a seamless process’ (wisner, tan & leong 2016:462). better disclosure between enterprises and suppliers facilitates the identification of risks, and opportunities in the supply chain. the 2017 global supply chain report published data from some leading multinationals such as bmw, johnson & johnson, and walmart that indicated that the more intensively they invited suppliers to respond to their requests, the better the quality of their response (espinosa 2017:16). despite increasing complexity in the business environment, enterprises can transmit and share business information easily and effectively through human interactions and internet connections and can achieve virtual integration with the supply chain suppliers (hsu et al. 2009:102). the indication is that the internet facilitates faster business information sharing between the supply chain (sc) partners. yang and jung (2016:236–262) investigated ‘how supply chain service capabilities mediated the relationship between supply chain integration (sci) and multiple measures of firm performance in container shipping supply chain’. the outcome was that sci has a positive impact on sc service capabilities, which also enhanced market and financial performance (fp). the underlying objective of the enterprises in a supply chain relationship was to optimise profitability for their businesses (american production and inventory control society [apics] 2013:57). the study aimed to establish the role of information technology (it) applications in supply chain management in south african small and medium enterprises (smes) and how it impacted on supplier-customer information sharing. hence, the objective of the study was to establish the role played by it applications in south african smes in enhancing supply chain collaboration and integration. theoretical grounding this study was grounded on the theory of supply chain collaboration (scc) and sci that addresses the relationship between the supply chain partners, or value chain. the comprehensive description of the theory expresses how supplier-customer information sharing impacts on the supply chain management. theory of collaboration and integration wood and gray (1991:2–22) posited that collaboration stipulated ‘the relationship between individual participants’ self-interest, and the collective interests of all involved in the collaborative alliance’. the circumstances under which collaboration is convened and the roles of conveners are expressed as the collaborative planning, forecasting, and replenishment (cpfr). the cpfr concept was developed by the american association called voluntary inter-industry commerce solutions (vics) and adopted by the council of supply chain professionals (wisner et al. 2016:150). the comprehensive definition of cpfr states: … the cooperative management of inventory through joint visibility, and replenishment of products throughout the supply chain. information shared between suppliers, and retailers’ aids in planning, and satisfying customer demands through a supportive system of shared information. this allows for continuous updating of inventory, and upcoming requirements, essentially making the end-to-end supply chain process more efficient. in the process, efficiency is created through the decreased expenditures for merchandising, inventory, logistics, and transportation across all trading partners. (wisner et al. 2016:150–151) cpfr is an it-driven process (apics 2013:36). supply chain collaboration and supply chain integration the american production and inventory control society (apics 2013:171) described supply chain collaboration as ‘the establishment of working relationship with a supplier organisation, whereby two organisations act as one’. this entails different enterprises sharing information and work plans as it would occur in an individual firm. on the other hand, mangan et al. (2012:47) posited scc as ‘a relationship between supply chain partners developed over time’. in this situation the working relationship between different enterprises develops after both have familiarised themselves with the other over time. supply chain integration is the ‘alignment and interlinking of business processes’ (mangan et al. 2012:47). this implies that the business processes of the enterprises involved sharing their functionalities as if operating in a single firm. apics describes sci as ‘when supply chain partners interact at all levels to maximise mutual benefits’ (apics 2013:172). the reason for supply chain partners working together is to increase benefits for all members involved in the supply chain. according to yang and jung (2016) sci is the relationship within an enterprise, as well as with supply chain partners to streamline the flow of information, materials, and finished products and services to the final customers. in this case the operation process in sci is seamless as it happens in a single entity. silvestro and lustrato (2014) expressed four enablers of sci as supply chain coordination, cooperation, collaboration, information sharing, and information visibility. supply chain coordination entails the synchronisation of activities within an enterprise, and external relationships with other supply chain partners. cooperation entails working jointly towards the same end. supply chain collaboration involves two variables such as functions within an enterprise. for example, information sharing encompasses the systems integration within and between supply chain partners. integration entails, for instance, linkages such as sharing of browsers in different entities. furthermore, information visibility is essentially the use of it to enhance the supply chain relationship. visibility is generated by displaying the activities taking place within a supply chain on a computer screen. an example could be, following an order from issuing until delivery to the end user or customer. the four variables provide elaborate examples of intangible resources. information technology the advent of it during the last generation has ushered in a new era in the business world, and life in general. it has enhanced the quality of information and communication modes, making the world a global village, and easing operational issues (lee & joshi 2016:1–5). it through computers and the world wide web (internet) has increased the speed of communication tremendously, making it possible to reach any corner of the world. a key objective of entrepreneurial information management is to ensure that valuable information was acquired and exploited to its fullest (narkhede et al. 2013). the long-term cooperation and coordination of information sharing in supply chain leads to improvements in competitiveness of the enterprises involved (lotfi et al. 2013:298–304). information sharing entails the exchange of data between people, organisations, and technologies through activities such as creation, representation, organisation, maintenance, visualisation, reuse, sharing, communication, and disposal. the stated variables add value to information flow through the processes of exchange, sharing, and collaboration within and between enterprises up to the ultimate end users (tarek & mchirgui 2014). hence, it is crucial that these roles are performed effectively and efficiently to optimise the benefits accrued. south african definition of small, microand medium enterprises there are over 2.2 million small, micro and medium enterprises (smmes) in south africa, of which only around 600 000 are formal establishments (be research 2016). these numbers indicate that most of the south african smmes are informal, and not properly accounted for. according to the rmb morgan stanley report of 2017, the south african informal food market contributes 35% of the total food retail market in the country (tshandu 2017). however, the country has 2500 modern trade outlets including supermarkets, and 140 000 traditional trade outlets that include spaza shops (south african model of micro-sized enterprises) that contributed r316.5 billion (goko 2017). the legal requirements for south africa smmes comprise: business registration, registration for tax, learning about labour law, learning about the consumer protection act, learning about health and safety and municipal by-laws (small business site 2017). other descriptions of smes express their nature and purpose. the most common versions are those of the south african revenue service (sars) and the department of trade and industry (dti) (forum sa 2009). however, the legal definition of south african smmes was stipulated by the national small business amendment act 26 of 2003 covering five categories: sector and subsector in accordance with the standard industrial classification, size of class, equivalent of paid employees, turnover and asset value. hence, an sme bears the following characteristics: fewer than 200 employees annual turnover of less than r64 million capital assets of less than r10 million direct managerial involvement by owners. (act no. 26 2003) the department of trade and industry (dti) definition focuses on the number of employees: small-sized establishments of 20–49 employees medium-sized establishments of 50–199 employees. (ber 2016) the south african reserve bank on the other hand classifies smmes based on the number of employees as: microbusinesses (fewer than 5), very small businesses (6–20), small businesses (21–50), and medium businesses (over 200) (sa reserve bank 2015). the roles of small and medium-sized enterprises in south africa small and medium-sized enterprises account for nearly 90% of all registered enterprises, which constituted most of all the private sector establishments in south africa (jeppensen, kothuis & tran 2012:9). thus, most of the private businesses in south africa are smes. the smes play crucial roles in job creation, poverty alleviation, and contribution to the growth domestic product (gdp) (sohar & rostom 2013). indeed, this highlights their economic importance as well as socio-economic contribution to the country (stats sa, 2017). the national small business chamber (nsbc), a staunch supporter of smes, views small businesses as the fuel for economic growth and employment. simply put the dynamic role of smes makes them the engine through which growth objective are realised in south africa as in other emerging markets (nsbc 2012). the study by didonet and diaz (2012:1) posited that scm practice supported innovations in smes. other previous studies support the view that the implementation of scm has added a com-petitive advantage to smes, through enhanced relationships with suppliers (alhourani & saxena 2014:1). enterprises information flow in the past 30 years or so, large organisations owned some of their suppliers or some of their customers (vertically integrated) (wisner et al. 2016:5). currently this practice is much less common due to the cost involved in running such complex establishments. organisations prefer running lean businesses that focus on the core areas and other services such as transportation, inventory, warehousing, and information technology among others that are outsourced (hill & hill 2012). the use of enterprise resource planning (erp) systems enables enterprises to work more effectively and efficiently through enhanced communication, and information exchange (nigel et al. 2017:364). citing the complexity in a construction company, silvestro and lustrato (2014) point out that information plays a crucial role in enabling the smooth flow of the operations through coordination within partners, and integration across partners. the quality of the information received and the cost-effectiveness in obtaining it determine the efficiency of a project in supply chain management. small and medium-sized enterprises’ information technology adoption the advent of the internet has significantly revolutionised enterprises globally including smes. the emergence of electronic commerce (e-commerce), which could be expressed as it adoption, has been a remarkable value-add to all businesses. according to chan, chong and zhou (2012:329), the adoption of it by smes has significantly enhanced their operations. in united states of america, for example, research in e-commerce sales in 2016 indicated a growth of 14.6% (zaroban 2016:1). research on internet use indicates that a growing number of businesses continue to embrace technology innovations, and increasingly make it adoption decisions (heath 2017:1). the internet has significantly extended business influence and operations globally with some leading economies such as united states of america and europe having over 80% of their population involved (internet world stats 2017). the use of it makes the workforce agile, swift, and flexible, some of the qualities that are crucial for an effective agile supply chain (white & mohdzain 2009:69–84). it means that the use of internet enables the employees to work and respond to demands faster and more effectively. research by a south korean journal on internet banking alluded that the risk of internet banking indirectly influenced adoption behaviour (lee, lee & kim 2015). it means that internet use becomes addictive. in most cases, smes were forced to engage in electronic business when their dominant clients had adopted e-commerce in their businesses. the south african government’s electronic database for procurement forces smes and other suppliers to adopt the same system to be compatible (sa e-tender portal 2015). problem statement technology use is crucial for information flow within and between enterprises as demonstrated by it adoption in the last generation. hence, this study investigated how supplier-customer information sharing enhanced supply chain collaboration and integration in south african smes. empirical objectives the empirical objectives of the study aimed to establish the role it application played in supplier-customer information sharing in enhancing scc and sci in south african smes. methodology and design this study pursued a qualitative research approach to establish the role it played in supplier-customer information sharing in enhancing supply chain collaboration and integration of south african smes. kim (2009:328) posited that research methodology comprises processes undertaken by researchers in explaining, predicting, and describing selected phenomena. in this study, the phenomenon investigated was the potential impact on supply chain management of it application in supplier-customer information sharing in south african smes. neill (2007:4) defined research methodology as the study of methods by which knowledge was acquired. a qualitative methodology was adopted for the study. qualitative research entails the researcher’s process of interviewing participants to generate data (lee & lings 2008:247). the selected respondents were interviewed at arranged venues, and the interviews were recorded to generate the data. punch (2010:47) defined research design as the strategy and structure of conducting a research project as stipulated in the process undertaken in this study. in pursuit of the empirical objectives, the study reviewed literature on supply chain management, smes in south africa, and information flow within and across the supply chain partners. the role of it application and how it supported other technology applications such as internet use in supply chain management was examined. the resource materials comprised supply chain journals such as international journal of operations and production management, international journal of logistics management, journal of enterprise information management, south african government legislations for smes, and online journals on supply chain, it, and internet applications. the latest books published on supply chain management and logistics and operations management, such as coyle et al. (2017), nigel et al. (2017), wisner et al. (2016) and others, were consulted. the 25 participants were the owner-managers drawn from mixed formal smes in mid-2017 that comprised 15 food stores and 10 general traders selected from gauteng province from a population of 2.25 million smmes nationally (ber 2016). more than one type of sme was used to minimise bias from the population of the national database of 2500 modern trade outlets in south africa (goko 2017). hence, non-probability sampling was used (saunders, lewis & thornhill 2009). a semi-structured questionnaire was used; interviews lasted not more than 1 h and were recorded with a digital data recorder. following the guidelines of saunders et al. (2009:137) the respondents were well briefed on the purpose of the interview, and the interview location was arranged at their premises as it was the most convenient location, as owner-managers of businesses are usually busy. the researcher approached the enterprises via e-mails and telephone to arrange for interviews. a few of the enterprises required pre-interview briefings, which were provided. the briefing comprised a short powerpoint presentation stating the value proposition (the role of it in supplier-customer information sharing). if multinational corporations such as walmart and bmw could benefit from high-level relationships with their suppliers as cited in the global supply chain report (espinosa 2017:16), it could also be possible with smaller firms such as smes. the recorded data were transcribed, analysed, coded, and the emerging themes interpreted via content analysis using atlas.ti. the emergence of both major themes, and sub-themes were taken into consideration in the analysis. notes from a field notebook used to record the interviews were eventually compared with the transcribed data to ascertain the validity and trustworthiness of the study. kumar (2005:216) expresses the importance of undertaking research in an ethical manner. hence, the researcher presented to the respondents a written undertaking from the sponsoring institution, stipulating the confidentiality undertaking of non-disclosure, and anonymity of the respondent during the interview period and afterwards. results the themes and sub-themes that emanated from the interviews are expressed in table 1. table 1: themes and sub-themes that emerged from the data. findings of the study the data analysis of the study produced seven major themes and several sub-themes. the major themes comprised technology integration; supplier-customer collaboration; information flow, ease of documentation and product alignment; supply chain network, design and flexibility; 3pl/4pl and it adoption. according to the participants, these were the outcomes from the supplier-customer interactions that had a direct impact on their supply chain as interpreted from the themes that emanated from the data. those outcomes are expressed in detail under each major theme and examples from some participants provided in the detailed report that follows. indeed, the elaboration of the themes indicated that the study met its objective and shed light on the crucial role of technology (it application) in enhancement of information sharing which is essential for effective performance of supply chains. the study met the empirical objectives: ‘to establish that supplier-customer information sharing enhanced supply chain collaboration and integration in south african smes’. the elaboration of the themes supported the proposition of the study and the objective thereof, as argued below. technology/integration: the adoption of technology in smes enhanced the interand intra-organisational cooperation, coordination, and the integration of the supply chain, leading to effective, and efficient operations. this featured in at least 21 participants. one participant remarked: ‘i think in the material space and the supplier’s space we have embarked on a partner to win campaign and what that means is we have got a very close relationship with our key suppliers. and we have identified who the key suppliers are and therefore we have a very close understanding and relationships with their businesses. we have shared our forecasts with them very openly and they too have done a number of activities on their side such as holding stock, procuring extra raw materials et cetera to really get to a partner to win relationships with our company. that has made us responsive.’ (participant 17, male, grocery store owner) supplier-customer collaboration: this was expressed as a relationship built over a long period of time that was beneficial to both customer and supplier for developing their business. the respondents raised issues involving among others transportation, accounts handling, and warehousing. these functions were mutually handled among the parties that initiated collaborative relationships. over half of the respondents concurred with the sentiment expressed by a respondent: ‘other elements that we have, you may notice that our customers are more demanding on us in terms of slot times for deliveries and making sure that we deliver the product on the day that it ordered or i within a slot time, but we are not good at asking our suppliers to do the same thing. i think there is still an opportunity to get better at scheduling trucks coming in and running them against a roaster, it is fairly simple and also reducing spikiness of products coming in, so we still have 14 or 15 deliveries on a monday and one or two on a tuesday, so spread that through the week and i think we can be more efficient on our inbound side as well.’ (participant 5, male, store manager) it adoption: the adoption of it in modern times has been a game changer in business and society at large. the computer application has integrated and enhanced coordination and operations in most of the business processes. it speeds internal alignment of enterprises and cooperation with external partners. indeed, 15 participants alluded to this view as stated by a respondent: ‘from an it perspective we have sap as the base, we have a warehouse management system and we have planning tools. planning tools cover demand planning, production planning, production scheduling and deployment planning, the normal things that we do. we have fully integrated planning, transactional processing, finance, all that sort of stuff that is altogether. all integrated or all inter-phased i suppose i would say.’ (participant 5, female, warehouse manager) information flow: the computer network in business enhanced the information flow, for instance in out-of-stock situations, ordering and order-filling between customer and supplier, and facilitating timeous delivery. all the respondents were unanimous that connectivity among the value-chain partners via computers enhanced information flow, as articulated by a respondent: ‘in some cases faster moving products moving through the network are going to become a little bit more agile and a little bit more algorithm driven within our warehouse management systems, less about human intervention and more about systems doing the thinking for us. that is definitely going to become a big part of the process and a link between replenishment and what we do within the network is going to be critical.’ (participant 4, male, warehouse owner) ease of documentation and product alignment: this involved the integration of it systems between the supplier and customer to facilitate smooth ordering process and inventory replenishment in an effort to balance the demand capacity and production. the use of barcode and radio frequency identification (rfid) for the ease of product identification on receipt and dispatch at warehouses was mentioned. in addition, track and trace systems are also used for stock verification in store. a respondent said that: ‘in the distribution space we have embarked on number of continuous improvement projects, this talks to lane optimisation transport route optimisation; for warehousing within warehouses we have a number of projects that we run over the last year to decrease travelling time in the warehouse and ensure the fastest route for picking stock for outbound. we use barcode and to some extent rfid to check deliveries and dispatch. some trucks have [geographical positioning system] gps. we continue to challenge ourselves.’ (participant 23, male, logistics company owner) supply chain network, design and product alignment: all the respondents alluded to the critical need for supply chain design with elaborate networks to supply products and services demanded by the market or customers. the response of a respondent appealed to these fundamental requirements: ‘the fact is that it is not controlled by us. i use that term loosely because we have got to manage our own products. there are a lot of steps along this chain, it can go wrong at the distributor, at the store, at a number of a place where these delays can happen and that is where you will see the product. you cannot have individual elements in this value stream being coordinated by different people. one person needs to be the boss of it, i use that term loosely. one person needs to sit and have a look at what happening from literally the planning, the procurement of the first raw material, until it gets to the customer’s shelves. so that entire value stream needs to be owned; my view by supply chain.’ (participant 13, female, general store manager) 3pl/4pl: the respondents viewed transportation as a major cost component of the supply chain. they believed that this was better managed independently by a third-party logistics (3pl) or fourth-party logistics (4pl) company that outsources more supply chain services. in this regard, a respondent said: ‘in the distribution space we have embarked on number of continuous improvement projects, this talks to lane and transport route optimisation; for warehousing within warehouses we have a number of projects that we run over the last year to decrease travelling time in the warehouse and ensure the fastest route for picking stock for outbound. we use barcode and to some extent rfid to check deliveries and dispatch. some trucks have gps. we continue to challenge ourselves.’ (participant 1, male, logistics company owner) managerial implications the smes’ managers and the owner-managers of the enterprises interviewed expressed their experience and impact of supplier-customer information sharing as the interviews reflect. their real-time experience answered the objectives that were set up. the use of information technology, and internet connectivity enhanced the collaboration and integration within and outside the enterprises involved in the supply chain. statements such as systems aiding human thinking, and transport optimisation to and from warehouses demonstrated value-add from the cooperation between supplier and customer. they also mentioned the use of track and trace technology such as barcodes and rfid for identifying products at the warehouses and geographical positioning systems (gps) for monitoring delivery trucks’ movements to ensure timeous delivery of products to destinations. these are crucial management tools for logistics management which is the part of supply chain management responsible for warehousing and distribution processes. thus, use of technology enhanced the products and services flow in the supply chain of the enterprises involved. limitation of the study the manufacturing sector was not included during the investigation which could have made the study more inclusive. the study of smes from the country’s leading business hub of gauteng province excluded the network of retail chain stores, which would have given it a more comprehensive national outlook. however, the samples used testified to the crucial role played by it and other technologies such as internet and track and trace in enhancing information sharing between and within enterprises through coordination, integration, and collaboration in the supply chain. this was supported by the data that emerged from the study and the testimony highlighted by the participants. conclusion the study explored the supply chains of smes in food and general traders in gauteng province of south africa to establish how supplier-customer information sharing can enhance the supply chain of south african smes. a sample of 25 enterprises drawn from the food and general trading sectors was interviewed, and a qualitative research methodology was adopted. various definitions of smes were covered with more emphasis on south african smes. the it adoption by enterprises during the last generation or so was expressed as the medium for information flow among the enterprises. it was found that information sharing took place through cooperation, coordination, collaboration, and integration, and these terminologies were well defined, and distinguished in the literature. the underpinning theory of collaboration and integration, and cpfr concept were articulated. cpfr is adopted and recommended by supply chain council as an appropriate measure of inventory levels at retail stores to facilitate timeous replenishment. the cpfr role in speeding up stock replenishments in stores was expressed. after the interviews with the respondents, data were transcribed, coded and analysed through content analysis, whereupon seven major themes and several sub-themes emerged. the themes that emerged and the views expressed by the respondents concluded that the supplier-customer information sharing enhanced supply chain collaboration and integration. based on the study outcome, it is apparent that the use of technology such as it, and internet in enterprises enhanced supplier-customer information sharing, which is a medium for improved supply chain collaboration and integration. hence, technology use in enterprises continuously improves the body of knowledge as emergence of new innovations is experienced. recommendations as it emerged that it and related technologies enhanced supplier-customer information sharing through integration and collaboration upon which supply chain management thrives, it would be crucial for all smes to embrace technology. with the technology-centred fourth industrial revolution looming, it is crucial for smes to speed up skilling their employees in it and related technologies to remain competitive in the future. acknowledgements competing interests the author declares that he has no financial or personal relationships that may have inappropriately influenced him in writing this article. references alhourani, f. & saxena, u., 2014, ‘supply chain management 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potchefstroom, south africa citation parsons, r. & krugell, w., 2022, ‘policy uncertainty, the economy and business’, south african journal of economic and management sciences 25(1), a4422. https://doi.org/10.4102/sajems.v25i1.4422 new perspective policy uncertainty, the economy and business raymond parsons, waldo krugell received: 27 oct. 2021; accepted: 29 mar. 2022; published: 09 sept. 2022 copyright: © 2022. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract elevated policy uncertainty acts as a tax on investment. in 1921, frank knight made a basic conceptual distinction between risk and uncertainty. in a market context, risks can be hedged through the use of different instruments, yet in the policy context, uncertainty makes waiting and seeing an option with value. however, this can come at a high economic cost. the academic analysis of policy uncertainty is today an active field of research globally. some papers have been published in this regard, each using different approaches to measure macroeconomic and policy uncertainty. in 2015, the north-west university business school (in conjunction with the school of economics) pioneered the creation and publication of a policy uncertainty index (pui) for south africa, which has since then captured the impact of key events – from ‘nenegate’ to ‘ramaphoria’. this paper presents an analysis of policy uncertainty in south africa and how the pui has contributed to an understanding of the economic environment in which business operates, with a specific focus on investment. the paper’s contribution lies in the unique context that it creates – where policymaking is more performative than evidence-based and there is a perennial tug of war between the state and market forces, against the backdrop of south africa’s mixed economy. keywords: policy, uncertainty; business confidence; investment; south africa. the most distinctive characteristic of the businessman – the thing that most sharply distinguishes him from the lawyer, college professor or, generally speaking, the civil servant – is his capacity for decision. (j.k. galbraith) introduction background the role of policy uncertainty began to emerge in various economic analyses of the south african situation in the late 2000s, as the country’s economic performance began to deteriorate. yet it was not until 2015 that the authors of this paper sought to find a way to measure it, albeit by proxy, constructed from certain researched components. the impact of policy uncertainty had by then come to have important implications for business confidence and the investment climate in the country. at the time, hardly any economic assessment or media release about south africa from international or local financial institutions, business lobbies, economic analysts, financial journalists or credit rating agencies appeared without the words ‘policy uncertainty’ in them. it seemed that it was ‘an idea whose time had come’ and that the regular measurement of policy uncertainty needed to be pioneered in this country. there were already ample global precedents for taking such a step. it was possible to access substantial previous international research on the subject. therefore, not only was the calibration of policy uncertainty clearly relevant to south africa, but it was also spurred by the increasing academic and policy interest globally in the definition, cause, effect and measurement of policy uncertainty. innovative work in this field had already been done by academics at stanford university for the us and other economies in the world. indeed, there is now a ‘world uncertainty index’, launched in 2020 by stanford university academics and the international monetary fund (imf) to assess what were perceived to be rising levels of policy uncertainty in the global economy. while efforts have been made, at an academic level, to calibrate degrees of policy uncertainty, recent economic developments such as the great recession (and the failure of most economists to foresee it) have also prompted people to revisit and extend the debate on basic theories of risk and uncertainty. the poor track record of most economic forecasting attempts has been highlighted by several economists. the financial crisis of 2007–2008 drove home the intellectual failure of optimising models to apprehend the disruptive action resulting from encounters with an unknowable future. this has been the subject of several academic publications. notably, kay and king (2020) argue in a recent persuasive study that the world has paid a high economic price because so many scholars, investors and advisers have abandoned the precautionary insights that earlier economists like frank knight and j.m. keynes provided, while also making a clear distinction between risk and uncertainty. keynes, in particular, was insistent about the existence of inescapable, general uncertainty about the future and its implications for economic policy. uncertainty, for keynes, became a major issue in economics and business when livelihoods or prosperity depended on people taking a firm view of the future. following on from this, king and kay are adamant in their conclusion that the real world must now embrace both the notion and the reality of ‘radical uncertainty’, which presents both ‘shocks’ and ‘opportunities’. their research strikes a necessary and modern cautionary note about the role of uncertainty in decision-making. this overall broad and cumulative shift in focus at several levels in relation to policy uncertainty suggested that indeed the time had arrived to mobilise research efforts elsewhere and to craft a policy uncertainty index (pui) adapted to south african circumstances. with this in mind, a joint working group was set up in 2015, comprising academics from the north-west university (nwu) business school and the nwu school of economics, to interrogate existing international research and to develop a suitable domestic index. after several months of research, the first pui was eventually launched early in 2016, covering the 4q of 2015. in the construction of a pui for south africa, the following were determining factors at the time: the single universal driver of all similar indices to date had been media coverage that included the words ‘policy uncertainty’. there was no reason not to also accept this as one of the main components of south africa’s measurement of the phenomenon. however, the us model included two other factors: firstly, uncertainty arising from changes in the us tax code, and secondly, measurement of the dispersion among individual forecasters of certain economic variables in the us economy. regarding the tax code, the nwu working group thought that in south africa’s case it was not a relevant proxy for policy uncertainty. instead, the issue of political outlook and uncertainty contained in the quarterly survey of manufacturing industry, published by the bureau for economic research (ber) at the university of stellenbosch, was taken as a credible substitute component in south africa. as it was not possible to replicate the level of research capacity available in the us, the nwu working group decided that the views of a cohort of economists on levels of uncertainty in south africa would be solicited via a brief questionnaire. in addition, whereas almost all other national policy uncertainty indices are published monthly, both capacity limitations and the inclusion of an economic narrative embedded in the pui would make a quarterly index more appropriate in south africa. in passing, it should be mentioned that, rather fortuitously, the first pui for the 4q 2015 showed a huge initial spike. this was due to the entirely unexpected and controversial dismissal in december 2015 of respected finance minister nene by then president jacob zuma, which came as a big shock to the markets and the business community. in analysing the subject of policy uncertainty, the authors of this paper acknowledge, of course, that it cannot explain all the lapses or gaps in a country’s economic performance. it is also important to explore and determine the extent to which policy uncertainty has an independent impact on investment decisions and to assess its role when the other recognised factors, driving private fixed investment, are weighed. yet a number of authors revealed some interesting correlations – highlighting that economic outcomes and policy uncertainty do seem to have an impact on the willingness of business to invest, hire or act. there is increasing empirical evidence that when policy uncertainty is high, it may suppress investment, employment and output. indeed, elevated levels of policy uncertainty may inhibit meaningful investment and consumption. economic policy uncertainty, therefore, has potentially adverse consequences for an economy. given sa’s significant socioeconomic challenges, the role of policy uncertainty as a recurring theme in the country’s economic performance over the past few years needed to be assessed. more recently, the sa economy has also had to cope with the uncertainties generated by covid-19 and civil unrest, which reinforced interest in the subject both academically and practically. also requiring examination was what the phenomenon of policy uncertainty and its approximate measurement could mean conceptually and practically for decision-makers in both the public and private sectors in south africa. problem statement a valid criticism of most economic theories is that it is usually set against a background of ease and safety. events steadily dispelled this rather artificial sense of security, especially in emerging markets. it has become increasingly necessary to acknowledge that steering the economy is all about navigating poorly charted waters and avoiding rocks of uncertain location. what business and other decision-makers need is a reliable and identifiable peg on which to hang a number of key questions about the dynamics of policymaking, its impact on the economy and, where necessary, how the situation can be improved. that is why it was thought helpful to accompany the release of each pui with a narrative, discussing the reported performance from an economic perspective. a deeper understanding of how uncertainty induces ‘shocks’ and how persistent policy uncertainty affects economic performance could help to identify the remedies required to minimise such uncertainty, within an appropriate economic context. in 2021, policy uncertainty remains highly relevant to the economic and business outlook – even more so with the country still grappling with covid-19 and more recently having to deal with the fallout from civil unrest. as events unfolded, it was clearly the institutional setting and policymaking environment that influenced the extent to which negative ‘shocks’ and elevated uncertainty could either (a) be easily managed or (b) inhibited economic activity. there was an important interaction here which must still be explored in the light of experiences to date in south africa. to this end, this paper now addresses two problems: how well has the pui been measuring policy uncertainty in sa since its introduction in 2015? what are some of the implications for policymakers and the business community? objectives against the foregoing background on the pui in south africa, this paper, therefore, seeks to: provide a review of the literature on economic and policy uncertainty to show how the pui fits into this broader narrative; and compare pui trends against the backdrop of an analysis of the south african economy over the period 2015–2021 and compare the pui’s performance to measures of investment. the uncertainty discourse policy uncertainty: causes and consequences before conducting any analysis of uncertainty, it is useful to consider the concept of uncertainty and its measurement. mclean (2015:3) argues that policy uncertainty occurs when ‘economic agents experience doubt over the economic consequences of government policies’. this kind of uncertainty is subjective. the uncertainty occurs because of agents’ perception of some policy event that has unpredictable consequences. the unpredictability is key here and emphasises the distinction made between uncertainty and risk. in his work risk, uncertainty and profit, knight (1921) explains that risk can be calculated. for a risk, the distribution of outcomes is known from past experiences, and statistical analysis can be used to assign a probability to an outcome. in the case of uncertainty, the situation is to a large extent unique and the outcomes are unpredictable. mclean (2015:3) explains that the more complicated an event is, or the more it is perceived to be subject to unforeseeable and unpredictable outcomes, the greater is the uncertainty. this conceptual framework also resonates with g.l.s. shackle’s (1955) pioneering work on uncertainty in economics in the mid-20th century. according to his framework, when an individual is absolutely uncertain about the consequences of any of the courses of action available, uncertainty would be ‘unbounded’. however, when an individual is faced with the task of selecting from a number of mutually exclusive courses of action, and it is possible to visualise the outcome, it points to ‘bounded uncertainty’. shackle rightly thought at the time that the majority of decisions made by business would be in terms of ‘bounded uncertainty’ and confined most of his further analysis to that. what the recent literature and empirical evidence are now suggesting is that the phenomenon of ‘unbounded uncertainty’ has over the past few decades become a more dominant feature globally and domestically. in other words, the boundary between ‘unbounded’ and ‘bounded’ uncertainty shifted, with important consequences for business. there appear to be at least four main causes of this increased uncertainty: (1) the decision-maker can still only afford to devote a limited amount of resources to the process of gathering and compiling information; (2) individuals and institutions are still limited in their ability to predict the future; (3) there are imperfections in the communication systems that human beings employ to transmit information to one another, even with the help of modern technology; and (4) there is an increased prevalence of discretionary, arbitrary or inconsistent actions by governments. the development of ‘policy uncertainty indices’ is, therefore, an effort to address these phenomena and throw new light on the impact of ‘unbounded’ uncertainty on an economy in the 21st century. there are two main channels through which such uncertainty may influence the economy. the first channel draws on real options theory, based on bernanke (1983) and leads to what bloom (2014) calls the ‘wait-and-see’ effect. when the actions of firms, such as investment or hiring, are characterised by a high degree of irreversibility, uncertainty will cause them to delay their actions. over time, firms receive new information that reduces uncertainty and informs optimal actions. so, when the benefit of new information is greater than that of committing to a sub-optimal investment or hire, the value of waiting increases and this dampens economic activity. the second channel has to do with risk aversion and risk premia. when investors are risk averse, a high level of uncertainty will increase risk premia; this causes borrowing costs to increase and suppresses growth. an official commitment to policy reform can nevertheless also generate its own uncertainties: even policy reforms … can involve a serious dilemma, especially when they include structural and microeconomic features. on the one hand, entrepreneurs, workers and farmers must respond to signals generated by the reform to be successful. on the other hand, rational behaviour by the private sector calls for the withholding of investment until much of the residual uncertainty regarding the eventual success of the reform is eliminated … even a moderate amount of policy uncertainty can act as a hefty tax on investment and that otherwise sensible reforms may prove damaging if they induce doubts as to their permanence. (rodrick 1991:229) measuring policy uncertainty internationally the literature that sets out to measure policy uncertainty has its recent roots in the work of baker, bloom and davis (2015). there are different versions of the first paper, but the brief discussion that follows here draws on their 2015 national bureau of economic research (nber) working paper titled measuring economic policy uncertainty. the index is a news-based measure reflecting the frequency of articles in 10 leading us newspapers that contain the following triple-word group: ‘economic’ or ‘economy’; ‘uncertain’ or ‘uncertainty’; and one or more of ‘congress’, ‘deficit’, ‘federal reserve’, ‘legislation’, ‘regulation’ or ‘white house’. the paper reports that the index was then extended to cover a longer time period and more countries and to reflect policy categories, such as health care policy uncertainty and national security policy uncertainty. to address concerns about accuracy, reliability and consistency, baker et al. (2015) evaluated the index in various ways. they found a strong relationship between the index and other measures of policy uncertainty, such as implied stock market volatility. they similarly found a relationship between the index and mentions of policy uncertainty in the federal reserve system’s beige books. they also asserted that the left-leaning or right-leaning slant of a newspaper does not distort the overall index. finally, they did an audit of 12 000 randomly selected articles to evaluate the performance of the computer-automated methods used and found a high correlation between the indices compiled by human evaluators and the computer-generated indices (baker et al. 2015). since the early work of baker et al. (2015), their economic pui has expanded to include 26 countries. the authors also produce a number of other indices, including a world uncertainty index, a firm-level political risk index and a twitter-based uncertainty index – all published via the web site: www.policyuncertainty.com (see also ahir, bloom & furcer 2018). other recent research has also been done specifically on the effect of world economic policy uncertainty on the foreign direct investment of 138 countries over the period 1996–2018. overall it suggests that world economic policy uncertainty reduces foreign direct investment and that the magnitude of the effect is greater in emerging and developing economies than in advanced ones (avom, njangang & nawo 2020). the south african literature there have been a number of academic contributions to the policy uncertainty literature in the south african context. redl (2015) set out to measure macroeconomic uncertainty in south africa over the period 1990–2014 and constructed an index from three sources: (1) the measure of disagreement among professional forecasters about macroeconomic variables, which uses data from the economist of the year competition (run by media 24); (2) a media-based measure which counts articles mentioning economic uncertainty in south africa in national and international newspapers; and (3) mentions of uncertainty in the reserve bank’s quarterly economic review. he found that the index is positively correlated with other measures of uncertainty, specifically the realised and option-implied volatility of the stock market. the index reflected high levels of uncertainty at the time of the democratic transition and the depreciation of the rand in 2001, and during the global financial crisis in 2008. a structural vector autoregression (var) model was used to measure the impact of uncertainty shocks in the economy. the results showed that uncertainty is a leading indicator of recession and that uncertainty shocks are inflationary. hlatshwayo and saxegaard (2016) examined the role of policy uncertainty in reducing the responsiveness of exports to relative changes in the real effective exchange rate. they constructed a ‘news chatter’ measure of policy uncertainty, using a number of search algorithms to search the dow jones factiva news aggregator to compile the index of economic policy uncertainty. hlatshwayo and saxegaard (2016) then used a regression model with the pooled mean group estimator to analyse the determinants of export volumes, including economic policy uncertainty. the results showed that increased policy uncertainty diminishes the responsiveness of exports to the real effective exchange rate and reduces export performance over the short and the long run. adopting a more specific focus, kotzé (2017) examined fiscal policy uncertainty and economic activity in south africa. his work had two empirical parts. the first identified fiscal volatility shocks. kotzé (2017) considered consumption taxes, labour income taxes, capital gains taxes, and government expenditure, as well as specified policy rules for the individual fiscal instruments. he then used a stochastic volatility specification to model independent shocks to the fiscal rules and examined the volatility processes. the second part then combined the measures of an unexpected increase in the volatility of a specific instrument with other macroeconomic variables in a var model. this was aimed at estimating the effects of an aggregate fiscal volatility shock on output, consumption, investment, prices, interest rates, labour productivity, wages and labour cost. the results showed that shocks may lead to persistent reductions in output, consumption and investment, and cause price increases. in related work, aye (2019) undertook an asymmetric analysis of fiscal policy uncertainty. the garch (1.1) conditional variances in consumption tax, labour income tax, capital tax and government spending were used to measure fiscal policy uncertainty. linear projection models that allow for asymmetry showed that a high level of fiscal policy uncertainty had a negative impact on real gdp. in general, high volatility (bad news) had a larger effect than low volatility (good news). more recently, kirsten (2020) examined the link between economic policy uncertainty and macroeconomic variables in south africa. he constructed an economic pui following hlatshwayo and saxegaard (2016) and used it in constant parameter and time-varying parameter var models, together with industrial production, inflation, the 10-year government bond yield and the real effective exchange rate. the results showed that an unanticipated increase in the uncertainty index caused a decline in industrial production and a depreciation in the exchange rate. it also caused an increase in inflation and the 10-year government bond yield. the impact of such shocks declines systematically over time. binge and boshoff (2020) constructed a measure of economic uncertainty for south africa. their focus was on using microdata from business surveys conducted by the ber. it is argued that survey-based indicators based on the opinions of key agents are a more direct measure of uncertainty. the survey-based indicators were then combined with text mining data and financial data to calculate a composite measure of economic uncertainty. binge and boshoff (2020:116) explain that three composite survey-based indicators were calculated: (1) the scaled, weighted, cross-sectional standard deviation of forward-looking responses, (2) the weighted, cross-sectional mean of individual firm forecast errors; and (3) the weighted, cross-sectional standard deviation of firm forecast errors. they then combined the survey-based indicators with alternative indicators to incorporate information from different sources of uncertainty. more specifically, they used the first principal component of five standardised uncertainty proxies as an overall measure. the results showed that an increase in uncertainty is significantly related to a decrease in real economic growth over the period 1992–2017. the policy uncertainty index and analysis the pui compiled by the nwu business school is published quarterly. the index number is a composite of a news-based uncertainty measure, a survey of economists and their views on policy uncertainty, as well as inputs from manufacturers surveyed by the ber for their views on political constraints facing business. the pui is the net outcome of positive and negative factors influencing the perceptions of policy uncertainty over the relevant period. an increase beyond 50 reflects heightened policy uncertainty; a decline in the pui means reduced uncertainty. the news-based measure draws on a google search for news articles that mention ‘policy uncertainty’ in ‘south africa’. the operator around (10) is used to ensure that these terms are captured in conjunction with one another. these mentions are then normalised using mentions of ‘economy’ around (10) ‘south africa’. the economists are asked five questions. the first is whether they think that the level of policy uncertainty increased, stayed the same or decreased compared to the previous quarter. the second, third and fourth questions relate to foreign investors, local investors and consumers respectively, and whether the economists think that the uncertainty they face has increased, stayed the same or decreased. the fifth question is whether they think that politics have become more uncertain, less uncertain or stayed the same, compared to the previous quarter. the ber survey asks business a number of questions as part of a bigger confidence survey, but the pui uses only the one response to the question about whether business managers think that there are political constraints facing their business. the three components of the index are equally weighted in the calculation of the index number. this quarterly average is then expressed relative to the base of the third quarter of 2015. a brief analysis reveals that, over time, the views of the economists show the greatest variation, followed by the media data. the respondents in the ber survey reveal less variation in their responses and report a high level of political constraints facing businesses. over the past 5 years, the pui has tracked major events, as shown in figure 1. the index spiked at the times of ‘nene-gate’ in the fourth quarter of 2015, in the run-up to the anc elective conference in the fourth quarter of 2017, and again at the start of the covid-19 pandemic in the first quarter of 2020. it also captured the ‘good news’ of ‘ramaphoria’ in 2018 and that of the recent economic reforms. figure 1: the policy uncertainty index and major events. what does policy uncertainty mean for business? for a small country, south africa is on the whole well served by a credible spectrum of economic and business indices, from both official and private sector sources. in a ‘mixed’ economy, in which government inevitably plays a significant role, the private sector in particular needs appropriate analytical tools to unpack the policy environment. these tools should now include those that help to calibrate the level of policy uncertainty in the economy during any one period. to the degree that rising levels of policy uncertainty have recently been revealed, the pui emerged as another useful analytical device capable of filling the gap in policy uncertainty assessment. furthermore, as mentioned earlier, the accompanying narrative is intended to create an economic perspective on each pui number. what the empirical evidence so far suggests is that business can adjust even to weak policies; alternatively, it can work around them where necessary. business is capable of less-than-optimal responses, but not if faced with persistent uncertainty or inconsistency. this tends over time to cause the corrosion of many business decisions, especially investment ones. the following comment by a leading business publication on the government’s recent proposal regarding the possibility of a basic income grant illustrates this point: here, it’s a question of affordability, and the government should know at this point whether it’s doable or not. yet, it hasn’t said, either way. this helps nobody. what confuses investors is the absence of certainty – not necessarily whether the decisions are right. unfavourable choices can be prepared for, or ‘priced in’. what investors want, more than the wisdom of einstein or gimmicky slogans (think ‘new dawn’) is certainty. (mkokeli 2021:1) to the extent that investment decisions are not always fully reversible, open-ended and uncertain policies make a ‘wait-and-see’ attitude an option with value – in other words, to delay and wait for more information before firm commitments are made or other opportunities sought. as figure 2 illustrates, there is no perfect fit between the pui and investment, but the relationship is indicative and corresponds with the link found in other parts of the south african literature. for example, the decline in the pui in 2016 was followed by increases in gross fixed capital formation in 2016 and the first half of 2017. the picture in 2018 and 2019, before the covid-19 pandemic is less clear. the value of the index increased over that period, but investment initially proved resilient before declining later on. figure 2: policy uncertainty and investment. there may well also be other factors explaining the weak performance of private fixed investment in recent years. yet it is difficult to overlook the unequivocal symptoms of policy uncertainty playing a key role. for example, the build-up of corporate cash reserves to what appear to be excessive levels is not, as critics often say, a sign that south african investors are ‘on strike’. this ‘liquidity preference’ should rather be seen as one likely barometer of reactions to excessive policy uncertainty. cash reserves then rise until certain policies are clarified and more certainty is provided. ‘for as long as you have that heightened policy uncertainty you will have companies sitting on cash and not investing’, the governor of the south african reserve bank, lesetja kganyago cautioned (donnely, 2021:1). if policy uncertainty remains too high for too long, it can even lead to disinvestment or businesses seeking investment opportunities outside the borders of south africa. the national treasury growth document (august 2019) acknowledges that policy uncertainty could reduce domestic investment and outlines some policy steps to address it. it is likely that the same uncertainty factors applying to domestic investment would apply to foreign direct investment. a special world bank ([2017] 2018:32) report published in 2018 on ‘foreign investor perspectives and policy implications’ confirmed that: … [p]redictable government conduct is at least as important to multinational corporations as countries’ laws and regulations. investors cited the importance of transparency and predictability in the conduct of government agencies as the most important among investment climate factors. investors also look at implementation and administration of those policies’. [emphasis added] what chronic policy uncertainty therefore does, is constantly increase the risk that the best forecasts made by businesses about their future plans will turn out to be wrong. if policy is subject to continual and uncertain changes, then business confidence will be shaky. the confidence with which businesses make their predictions, depends on their estimates of the seriousness of these imperfections and limitations. business confidence then becomes a potential transmission instrument of policy uncertainty to investment decisions. investor confidence is likely be more affected because of its long-term nature, while the daily mood in business circles is probably less affected. load-shedding and a lack of energy security, for example, are damaging to long-term investment because of the uncertainty that they create. in the short term, of course, it is also extremely disruptive to day-to-day business activity, but coping strategies can be and are adopted by many businesses to adjust to recurrent phases of load-shedding. generally, if alerted by the pui – and depending on the nature of the uncertainty or ‘shock’ – businesses may decide whether to adopt ‘hedging’ or ‘rebalancing’ strategies to deal with the new situation. a firm’s response to a ‘shock’ may be a question of financing versus adjustment. this will be decided by the firm’s degree of flexibility and adaptability, as well as its access to resources and its market position. it also depends on whether business decision-makers see the ‘shock’ or uncertainty as temporary or chronic. it can be added here that a large firm may hope that by averaging perceived risks among many ventures – some doing better and others doing worse in the face of elevated policy uncertainty – it will still be able to take positive decisions and pull through. a small firm is more vulnerable and may easily face disaster if caught unawares, as it is operating on a much narrower base. the risk of disaster means that a small firm must give special attention to addressing the impact of policy uncertainty, where that is possible. overall, however, persistently elevated levels of policy uncertainty dampen what keynes (1936) calls business persons’ ‘animal spirits – of spontaneous urge to action rather than inaction’. it seems better to keep policy uncertainty to a minimum and out of negative territory, wherever possible. as previously emphasised, if decision-makers find themselves in a situation in which they believe that the future is too uncertain to commit resources, they may simply delay or even abandon the decision to invest. it then inhibits the potential of sa becoming a preferred investment destination. officialdom in south africa has not ignored the problem. government increasingly recognised policy uncertainty as a serious challenge and emphasised the issue, such as in the state of the nation addresses, budget speeches and key policy statements, and at official investment conferences. business spokespersons increasingly found it also important to cite policy uncertainty in their public statements and in their advocacy about the economy to the authorities. the fact that the government recently again announced an economic reconstruction and economic recovery plan for south africa may be seen as a serious effort to respond to these concerns and to seek to inject more certainty and direction into the economy. the problem is not so much that the government at the highest level does not acknowledge the value of policy certainty. indeed, former minister of finance tito mboweni tweeted (23 november 2020): i don’t know how to explain this anymore economic agents: investors, businesses, consumers, buyers and sellers of goods, farmers, the market etc, need policy certainty. fundamental. i invest because i will harvest in x years in the forward market. confidence! (nwu business school pui, 2q 2021 [emphasis in original]) it is rather that the inconsistency and implementation risks are still high, despite the commitment to new economic ‘plans’. policy uncertainty in south africa remained at elevated levels for too long. not knowing what the government may do next has become a serious negative factor in the macroeconomic environment, now aggravated by uncertainties arising from phenomena such as covid-19 and civil unrest. conclusion the emergence of greater policy uncertainty both globally and domestically in recent times is a strong reminder that, in their day, both knight and keynes believed that pervasive ‘radical uncertainty’ was essential for an understanding of how a capitalist economy worked and that its role should not be underestimated. the distinction between risk and uncertainty, however, has become lost in subsequent economic theory and analysis, as more faith has been placed in probabilistic reasoning and modelling than in assessing an uncertain future. as to why and how this has happened must be explored in a different paper. against this background, this paper, nonetheless, offers the following five insights. firstly, the paper accepts that much of the previous academic literature on uncertainty and investment, especially that dealing with management theory, was tied to the conventional notions of the possible future behaviour of competitors and consumers in shaping business strategies. however, an additional dimension is created when official policy and a changing macroeconomic environment become more dominant in the economic context. hence, this paper examines the extent to which elevated levels of policy uncertainty have now increasingly come to revolve around who will make the broad economic policy decisions, what policy decisions will be taken and when, and the economic effects of policy action (or inaction). both recent economic analysis and empirical evidence suggest that high levels of policy uncertainty or ‘shocks’ may act like a tax on investment, while also inhibiting other business decision-making. therefore, a country’s policy environment can either offer the degree of predictability that minimises uncertainty for business decision-makers or it can instead operate in ways that strongly elevate policy uncertainty. the level of policy uncertainty, therefore, matters and emerges as one of the key elements shaping the dynamics of private capital formation. the complexity of the policy analysis in these situations, nonetheless,s needs to be further interrogated, especially the criteria for better governance and other decision-making processes that might minimise policy uncertainty. secondly, the paper argues that unless business decision-makers are willing to make random choices, they must make an effort to predict possible outcomes. in doing so, they are faced with three kinds of uncertainty: (1) uncertainty about their current environment; (2) uncertainty about the course of future events; and (3) uncertainty about the reliability of the data they possess. it depends, as keynes (1936) put it: [o]n the confidence (emphasis in original) with which we rate the likelihood of our best forecast turning out to be quite wrong. if we expect large changes but are very uncertain as to what precise form these changes will take, then our confidence will be weak. (p. 148) thirdly, the paper outlines how the recent emergence of policy uncertainty indices globally, and in south africa, helps to fill a gap in the assessment of policy environments and how policy uncertainty may be better managed. it provides another analytical tool with which to understand the policy environment. a pui captures the ‘bad news’ not attributable to other factors or variables. calibrating policy uncertainty has the potential to act as an ‘early warning system’ to decision-makers about both negative and positive developments in the policy environment in which they operate. it therefore creates a new intersection of thought between management theory, economic analysis and the need for effective institutions. fourthly, the paper highlights the extent to which the universal element in the different proxies used to track levels of policy uncertainty lies in media reporting. it also emphasises the importance of asking business people about the degree to which official policy decisions and actions, taken by governments, are perceived by business to be unpredictable, unique or unforeseeable. this creates scope for further development of the pui in the direction of big data. a number of studies already linked the big data generated by social media to stock market movements and investor sentiment. similar methods can be used to further explore policy uncertainty. recent developments in south africa appear to reinforce the need for an expanded narrative. finally, although a robust relationship between policy uncertainty and investment plans appears to have been established, this paper suggests that further research on the role of policy uncertainty in general and the pui in particular may throw more light on the response of firms as adaptive organisations. on the upside, it was knight who believed that it was ‘radical uncertainty’ that also created positive opportunities for entrepreneurs and that it was their skill and luck in navigating radical uncertainty that drove technical and economic progress. this might be seen to be aligned with joseph schumpeter’s (1942) subsequent view of ‘creative destruction’ as an inevitable phenomenon driving the capitalist system. nonetheless, as a defensive strategy, further interrogation may also help to identify new options available to business people to allow them to plan their affairs so as to make their firms less vulnerable to (what may be perceived as) highly uncertain policy conditions. in other words, uncertainty is not just accepted by businesses as a given quantity; instead, businesses choose appropriate alternatives to mitigate uncertainty, in line with their best interests. in this regard, business people may follow policies that increase their knowledge of, and control over, variables that are potential sources of serious disturbance. they may also organise their operations, relying on flexibility and adaptability, so that uncontrollable variables or uncertainties cannot have too damaging an influence. in short, coping is an entirely rational response to the accepted reality that the world is uncertain. this paper, therefore, ultimately seeks to move the debate forward on how a pui and its future refinements may assist in tracking and framing the socioeconomic issues with which business and political leaders are faced, particularly ‘unbounded’ or ‘radical’ uncertainty, and identifying possible ways to understand and manage policy uncertainty better. acknowledgements the authors would like to thank anton van wyk for his research assistance in the policy uncertainty index project and participants at the essa 2021 conference for their inputs. all errors and omissions remain our own. competing interests the author(s) declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions prof parsons conceived the idea of the index, supervised the work and contributed significantly to the final manuscript. prof krugell collected the data and compiled the index numbers. he also contributed to the final manuscript. ethical considerations this article followed all ethical standards for a research without direct contact with human or animal subjects. funding information this research received no specific grant from any funding agency in the public, commercial or not-for-profit sectors. data availability the data that support the findings of this study are available on request from the corresponding author. disclaimer the views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of any affiliated agency of the authors. references ahir, h., bloom, n. & furcer, d., 2018, world uncertainty index, imf paper, the imf, washington. avom, d., njangang, h. & nawo, l., 2020, ‘world economic policy uncertainty and foreign direct investment’, economics bulletin 40(2), 1457–1464. aye, g.c., 2019, fiscal policy 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cambridge university press, cambridge. shackle, g.l.s., 1961, decision order and time in human affairs, cambridge university press. skidelsky, r., 2009, keynes – the return of the master, allen lane. taleb, n., 2007, the black swan: the impact of the highly improbable, allen lane, london. world bank, [2017] 2018, global investment competitiveness report – foreign investor perspectives and policy implications, the world bank, washington. microsoft word 6 vvuuren sajems 15(3) 2012.docx sajems ns 15 (2012) no 3 309 basel iii countercyclical capital rules: implications for south africa gary van vuuren department of economics, north-west university accepted: june 2012 the financial crisis has been blamed on many entities, institutions and individuals as well as the basel ii accord which had just begun to be implemented globally when the crisis erupted. the criticisms resulted in the construction of basel iii, a series of measures designed to augment and repair (but not replace) the basel ii accord. one of these adjuncts addresses the problem of economic procyclicality and suggests ways to mitigate it through capital charge increases when economies overheat and capital charge reduction in economic contractions. the consequences of this proposed measure's introduction for south african banks is explored. key words: basel iii, procyclical, countercyclical, buffer capital jel: c134, 16, 53 1 introduction the financial crisis that has wreaked havoc in global financial markets since august 2007 had its origins in an asset price bubble that interacted with new kinds of financial innovations that masked risk (baily, litan & johnson, 2008). the crisis precipitated, inter alia, a calamitous reduction of bank lending and the widespread destruction of the securitysation and structured product markets. later (2010 through 2012) the crisis manifested itself through sovereign insolvency (among the worst affected were greece, ireland, portugal, spain and italy) and it heralded an ever deepening distrust of the accuracy of credit ratings and the efficacy of regulatory capital directives (sorkin, 2010). the (then – 2008) new set of regulatory capital rules called basel ii had been finalised by the basel committee for banking supervision (the bcbs) under the auspices of the bank for international settlements (the bis) in 2006 and sections of the accord had begun to be implemented globally by the time the crisis erupted (ayadi, 2008). this basel ii accord was designed, like its predecessor basel i, to prevent (at best) and forewarn (at worst) impending economic disasters by ensuring the safety and soundness of the global banking system (bcbs, 2006). when the scale and duration of the credit crisis became apparent, however, the market perception of this flagship accord was that of spectacular failure. national governments, credit rating agencies, bankers, regulators, central banks and quantitative models which employed unrealistic assumptions were among those at whom blame for the crisis was levelled (us financial crisis inquiry commission, 2010). whatever the truth of the accusations, each alleged accomplice quickly set about rectifying mistakes in their own way, adapting and amending procedures and approaches and – in the biss case – devising a comprehensive repair kit to existing regulatory measures (bcbs, 2010a). this repair kit came to be known as basel iii and this is an important point worth emphasising: basel iii does not, nor was it ever intended to, replace basel ii. the vast bulk of basel ii rules remain intact: basel iii aims to repair those parts of the accord deemed inadequate (e.g. reconstitute the composition of acceptable regulatory capital), augment and adapt several accord components (e.g. revisit the capital required for the trading book) and introduce novel abstract 310 sajems ns 15 (2012) no 3 themes to revitalise the accord (e.g. introduce a leverage ratio and a handful of capital buffers which effectively increase the capital ratio of 8.0 per cent to 10.5 per cent and, under certain circumstances, to 13.0 per cent).1 one of these novel introductions – the procyclical capital buffer – is the focus of this paper. the paper proceeds as follows: section 2 interrogates the literature regarding economic procyclicality, its origins and implications on a broad global scale. the bcbs’s choice of procyclical measure is dealt with in section 3. the bcbs have argued convincingly in favour of this measure as a means of dampening uncontrolled economic expansion and have enjoyed some success in applying it to financial indicators in highly developed economies such as the us and uk. it is by no means conclusive that an identical metric will be as effective when applied to smaller, developing economies, such as south africa’s. the bcbs's chosen procyclicality metric requires the calculation of two components: a calibrated measure of regional economic activity and this measure’s long run trend. the procyclicality metric operates by activating a staggered increase in regulatory capital based upon the difference between these two components. the hodrick prescott (hp) filter has been selected by the bcbs to determine the economic activity measure’s long run trend. section 4 introduces and discusses the hp filter, assesses its relevance and applicability to financial data and points out the pros and cons of its use. some problems associated with the filter – among them end point problems – exist and these are also presented in this section. the hp filter is then applied to south african data and the results analysed and presented in section 5. some supporting evidence regarding the periodicity of some of south africa's financial indicators is also presented in this section using fourier analysis. the article concludes with section 6. 2 literature review procyclicality refers to those economic quantities that are positively correlated with the overall state of the economy. the credit losses that banks suffer during recessions are generally higher than those experienced during economic expansions. these losses negatively impact bank funds because, during downturns, maximum lending capacities decrease (the numerator of the capital ratio) and risk weighted assets (the denominator of the capital ratio) increase simultaneously. this combination of effects results in the intrinsic procyclicality of capital requirements – a fact deduced even before the implementation of the basel ii capital accord. academics, practitioners and policy makers warned that capital requirements under the internal ratings based (irb) approach would amplify procyclicality since banks tend to kerb lending in response to recessions and increase lending during economic expansions (e.g. heid, 2003; catarineu-rabell, jackson & tsomocos, 2003; goodhart & taylor, 2006). the basel ii accord would thus thwart policy maker's efforts to maintain macro-economic stability (gordy & howells, 2004). heid (2003) argued that the procyclical effects of the (then yet to be introduced) basel ii accord could be manifest in two ways. first, if asset risk (or even the mere perception of asset risk) were correlated with business cycles, capital charges would be subject to large swings leading to further asset price and interest rate volatility. second, an increase in financial sector volatility could spread to the real sector. the surge in credit risk would lead to an increase in banks’ credit risk capital, and a portion of these charge increases would be passed on to borrowers who in turn would reduce investment spending and aggravate the downturn even further. the bank of england (boe) asserted that every regime that adopted a minimum capital requirement framework could stimulate financial procyclicality: during recessions banks face a combination of amplifying pressures: higher regulatory capital requirements, increased provisions and greater defaulted loan write offs (catarineu-rabell, jackson & tsomocos, 2003). the analysis, which preceded the implementtation of the basel ii accord, showed that the procyclical impact of the new internal ratings based (irb) methodology could be dampened by adopting a through-the-cycle (ttc) rating system which would dampen the sensitivity of borrower probabilities of default (pds) to macroeconomic conditions despite this sajems ns 15 (2012) no 3 311 rating system’s notoriety for being a poor internal pricing and risk-management tool. the authors used a multi-period general equilibrium framework to study market interactions and identify channels affected by policy parameter changes. they found that, although the use of a ttc method would not reduce procyclicality, using the alternative (a point in time (pit) rating scheme) would considerably magnify procyclical effects. with the benefit of hindsight, a purely ttc approach ignored the contribution of securitisation and the vast, incorrect assignment of aaa ratings to senior securitised tranches to required capital levels (brunnermeier, 2009). in addition, although most rating agencies claim a strong ttc approach underpinning their ratings, some research has found otherwise (lowe, 2002). saurina and turcharte (2007) constructed and tested a pd model for spanish mortgage loans to calculate different types of pds: pit, ttc, average across the cycle and acyclical and found that minimum regulatory capital under basel ii was highly sensitive to the risk measurement methodology employed. ttc measures, for example, showed less variability but more capital on average than the pit approach and acyclical ratings produced stable and relatively low requirements. the authors concluded that the procyclicality of regulatory capital requirements under basel ii would thus depend upon the way internal rating systems were implemented and how the output was utilised (saurina & trucharte, 2007). research conducted prior to the implementtation of the basel ii accord (end 2006) and the ias 39 accounting guidelines (january 2005) found that the informational and allocative efficiency benefits of these reforms could increase procyclicality as well as market volatility (goodhart & taylor, 2006). the research concluded that losses on tradable assets incurred during economic downturns and booked at fair value could increase both income and profit volatility. in addition, the authors advocate that regulatory rules requiring banks to hold more capital during recessionary periods (reflecting increased potential credit losses), may result in loan book reductions and an increase in capital funding costs. the resulting credit rationing, or the higher credit costs could then result in reduced investment and consumption (goodhart & taylor, 2006). a flexible simulation engine was constructed by gordy and howells (2004) to explore the cyclical behaviour of regulatory capital under different rating philosophies and various assumptions on how bank lending behaviour responds to the business cycle. the simulation results obtained in this research demonstrated that the extent of capital requirement cyclicality depends strongly on how new bank lending varies with macroeconomic conditions. the methodology did not allow regulatory rules applicable to new lending to be endogenous to the bank’s capital position. rather, these rules were modelled to depend exogeneously on the macroeconomic milieu. the authors’ simulation results were not sufficient to convince them that procyclicality in the basel ii accord would require corrective measures. they argued that, even were regulatory capital to be smoothed in some way, it would not be possible to dampen economic capital requirement procyclicality by regulatory sanction (gordy & howells, 2004). repullo and suarez (2008) investigated the cyclical effects of moving from risk-insensitive (basel i) to risk-sensitive (basel ii) capital requirements using a dynamic equilibrium model of relationship lending. the authors assert that current levels of bank capital determine future lending since banks anticipate that earnings shocks during economic down-turns may impair their capacity for future lending. as a precautionary measure, banks hold capital buffers (repullo & suarez, 2008). the authors demonstrated through an endogenous, dynamic capital-structure model and with the assumption that banks have limited access to capital markets in stressed periods that basel ii would change the behaviour of these buffers from countercyclical to procyclical. in addition, results showed that higher buffers during periods of economic expansion would be insufficient to counteract the increased requirements during recessions. these effects would lead to a significant contraction in the supply of credit (repullo & suarez, 2008). rochet (2008) was not convinced that the impact of basel ii and ias 39 on bank lending would be sizable. even if the effects were considerable, to compensate through regulatory intervention (make target capital ratios countercyclical) ‘would be a disaster’ for bank 312 sajems ns 15 (2012) no 3 incentives (rochet, 2008). a study conducted by the banque de france found that banks should be able to smooth regulatory ratio fluctuations by making use of their economic capital buffer. if this were the case, and despite the inherent procyclicality introduced by basel ii, the volume of credit to the economy should not be dramatically affected in economic downturns (rochet, 2008). in addition, pillar ii of the basel ii accord could mitigate the procyclical effects of the capital ratio if regulators imposed additional capital charges on banks holding insufficient economic capital (rochet, 2008). should governments wish to dampen economic fluctuations, appropriate policy instruments (such as fiscal and possibly monetary policy) should be used rather than prudential regulation and financial intermediary supervision (rochet, 2008). the basel committee has decided to address procyclicality in a number of ways including: the introduction of a noncyclical pd proxy in internal rating models; encouragement for provisioning policies to move to a forwardlooking expected loss methodology rather than the incurred loss approach currently applied under ifrs and us gaap and the introduction of capital buffers, proactively adjusted to take macroeconomic factors into account (barnes, de toytot, sprinzen & chan, 2010). the collective aim of these proposals is to address detrimental trends such as lending growth, liquidity mismatches and increasing leverage before they exceed historical long run averages i.e. before they ‘overheat’. although some regulators are able to adjust minimum capital requirements and alter underwriting criteria, the track record of the application of this influence has been mixed. this could be due in part to a reluctance of local regulators to penalise domestic banks relative to international competitors but the credit crisis may strengthen resolve (barnes et al., 2010). having investigated the origin and effect of procyclicality in finance, as well as the effects – intentional or otherwise – of the basel ii accord on procyclicality, the next section addresses the bcbs proposals to introduce a countercyclical capital measure. 3 mitigating procyclicality regulators have long been aware of problems posed by procyclicality of the financial system, but the financial crisis contributed to the acceleration in efforts to provide frameworks and tools to address these. the bcbs’s principal objective underlying the introduction of countercyclical capital standards is to encourage banks to increase capital buffers in times of economic expansion that may be then drawn down during economic contractions (bcbs, 2010b). these buffers are not to be considered as prudential minimum capital requirements, but rather unencumbered capital in excess of that minimum. the idea is that this capital should be available – in times of economic stress – to absorb losses. building up buffer capital accumulation in times of economic expansion should strengthen individual banks’ defences (and thus the system as a whole) thereby addressing the fact that risks accumulate rapidly in favourable economic conditions, but the consequences of these risks become manifest only after significant lags (bcbs, 2010b). in designing a functional countercyclical capital buffer scheme, the bcbs aimed to fulfil two related objectives (drehmann, claudio, gambacorta, jimenez & trucharte, 2010), namely to limit system-wide risk by strengthening the banking system’s resilience against shocks and to limit the banking system from amplifying economic fluctuations. desirable features of the effective scheme would need to include: 1) correct timing: of buffer capital accumulation and release. this equates to identifying economic expansions and contractions correctly. 2) suitable capital buffer size: accumulating during economic expansions, this capital must be able to absorb losses adequately in recessionary periods without triggering further stresses. 3) robustness against regulatory arbitrage. 4) international enforceability. 5) rule-based: thereby acting as an automatic stabiliser. sajems ns 15 (2012) no 3 313 6) low implementation costs. 7) simplicity and transparency. the bcbs considered setting a target buffer capital ratio above the minimum capital ratio, with the gap between the two either at a fixed level (which is fixed during expansionary or recessionary economic periods but takes on different [fixed] values depending on the prevailing economic milieu – figure 1a) or moving countercyclically (i.e. increasing [linearly] in expansionary economic periods and declining [linearly] in recessionary periods – figure 1b). in the former scheme, a fixed buffer ratio of %x is chosen when the prevailing economic conditions are favourable so that the capital ratio = minimum capital ratio %x+ . the value of %x drops instantaneously to 0 per cent in recessionary periods, so the regulatory minimum capital ratio becomes the relevant constraint (bcbs, 2010b). fixed capital targets can be automatically stabilising because their incidence varies over the economic cycle, but these fixed targets require careful construction to avoid inducing the very procyclicality they are designed to prevent. for example, although punitive minimum capital requirements can constrain risk-taking during economic expansions, they can also encourage the rapid disposal of risky assets at times of tighter credit conditions (drehmann et al., 2010). f i g u r e 1 proposed countercyclical capital ratio buffer schemes. under (a) a fixed scheme, the target is fixed at x% above the minimum during positive economic conditions and 0 per cent above the minimum otherwise and (b) a variable scheme in which the target increases linearly to a maximum of y% during expansionary conditions and declines linearly back to the minimum during contractionary conditions the latter scheme considers a linearly increasing target in expansionary periods until an upper limit of %y is reached with the accumulation related to a conditioning variable (e.g. credit growth, earnings or credit spreads). release of the buffer when recessionary conditions arise would be gradual (and, ideally, linked to the same conditioning variable). bottom-up (bank-specific) and top-down (system-wide) conditioning variables were considered by the bcbs in the construction of a countercyclical capital scheme. bottom-up approaches produced sizeable idiosyncratic components, implying considerable differences in the values of bank adjustment factors, even after broad financial stability pressure accumulation. bank-specific factor persistence was also found to be minimal under this approach, resulting in substantial target countercyclical capital buffer volatility (drehmann et al., 2010:20). top-down approaches fared better (and were eventually adopted by the bcbs), in particular the aggregate credit growth-to-real gdp growth ratio, despite some concern that the optimal variables2 used to signal the timing and rate of buffer accretion were not always optimal for signalling buffer depletion timings and rates. top-down data are available in all jurisdictions; in contrast to bottom-up approach variables (e.g. cds spreads) which are bankspecific and not always available. an additional expansionary conditions contractionary conditions ca pit al rat io minimum ratio target ratio expansionary conditions contractionary conditions ca pit al rat io minimum ratio target ratio (a) (b) 314 sajems ns 15 (2012) no 3 benefit of using the credit growth-to-gdp growth ratio as a conditioning variable is that a time-varying target on credit expansion in favourable economic conditions may also kerb credit booms (drehmann et al., 2010:21). in the construction of a countercyclical buffer scheme, a persistent problem was how to measure the financial cycle. several variables were considered, including measures of bank performance (e.g. earnings, losses or asset quality, cds spreads), financial activity (e.g. credit growth) and the cost and availability of credit (e.g. credit spreads). some problems which arose included the fact that financial and real (output) cycles do not necessarily coincide: the relationship between these variables often varies over time, severe financial stresses do not necessarily arise in each recessionary period and leads and lags between financial indicator output peaks and troughs are often significant and highly variable (brunnermeier, 2009). measures of aggregate output and credit growth were considered the most natural indicators for the state of the financial cycle.3 even though the collective behaviour of the banking sector may still influence aggregate macro indicators, they offer the advantage that they are immune to strategic manipulation by individual banks (saurina & trucharte, 2007). widespread availability of most macroeconomic series was also taken into account by the bcbs in their final decision regarding input variables of which two were particularly interesting. 1) real gdp growth was considered by the bcbs to be “the most natural indicator” of a specific economy’s aggregate business cycle. business and the financial cycles however, although interconnected, are not always synchronised. 2) aggregate real credit growth was considered to be a “natural measure of supply”, (all sources of credit are taken into account, not only bank credit) since historical boom periods have been characterised by rapid credit expansion and credit contraction has typically heralded credit crunches (drehmann et al., 2010). the deviation of aggregate real credit growth from its long run trend was considered a possible informative variable to use to evaluate the state of the financial cycle. the final decision (and the measure adopted by the bcbs as part of the basel iii amendments) was not these deviations, but rather deviations from the long run trend of the aggregate creditto-real gdp growth ratio (hereafter the “creditto-gdp ratio” and the difference between this ratio and the long run trend the “credit-to-gdp gap”) due to financial deepening, for example. the credit-to-gdp ratio normalises the aggregate credit growth variable to take into account the synchronised movement of credit demand and supply with the size of the economy. there is, in addition, a strong historical link between enhanced4 credit-togdp growth and crises that have erupted in the banking sector. it is important to note that even though the credit-to-gdp gap normalises the volume of credit by gdp and corrects for changes in the long run trend, it remains a statistical metric and may not, therefore, fully take into account the equilibrium level of lending given the state of the economy. the next problem to be solved – how to ascertain and measure the long run trend of the credit-to-gdp gap – is explored in the next section. 4 the hodrick prescott filter a popular method of trend-extraction from data is the hodrick-prescott (hp) filter (ley, 2006). the hp filter was first introduced by hodrick and prescott in 1980 (hodrick & prescott, 1980) in the context of estimating business cycles, but the research was only published in 1997 after the filter had gained widespread popularity in macroeconomics (hodrick & prescott, 1997). the bcbs also chose the hp filter to detrend relevant macroeconomic ratio data and thus extract the information required to evaluate excessive growth in economies (see section 3). the hp filter has been criticised for a number of limitations and undesirable properties (ravn & uhlig, 2002). canova (1994 and 1998) agreed in principle with the use of the hp filter to extract business cycles (of average duration between 4 to 6 years) from macroeconomic data, but doubted the methodology for determining key parameter inputs. spurious cycles and distorted estimates of the cyclical sajems ns 15 (2012) no 3 315 component when using the hp filter were obtained by harvey and jaeger (1993) who argued that this property may lead to misleading conclusions regarding the relationship between short-term movements in macroeconomic time series data. cogley and nason (1995) also found spurious cycles (and extreme second-order properties in detrended data) when using the hp filter on differencestationary input data. application of the hp filter to us time series data was found to alter measures of persistence, variability and comovement dramatically (king & rebelo, 1993). many of these critiques do not provide sufficient compelling evidence to discourage use of the hp filter. as a result, it remains widely-used among macroeconomists for detrending data which exhibit short term fluctuations superimposed on business cyclelike trends (ravn & uhlig, 2002). the idea which on which the hp filter rests is that an observable macroeconomic time series ( tx ) may be decomposed into its long run, non-stationary secular trend ( tτ ) and a stationary residual, or cyclical, component ( tc ): cycle trendrun longseries observed ttt cx += τ (1) neither the long run trend nor the cycle is directly observable so detrending approaches generally define these elements somewhat arbitrarily. the hp filter extracts the cycle by solving equation 2, a standard-penalty program:  ( ) ( ) ( )[ ] 0 min deviationsfor penalty 1 2 2 11 fit of goodness 1 2 >−−−⋅+− ∑∑ − = −+ = λττττλτ τ    t t tttt t t ttx t (2) where the parameter, λ , controls the smoothness of the adjusted trend series, tτ̂ , i.e., as 0→λ , the trend approximates the actual series, tx , while as ∞→λ the trend becomes linear and the procedure converges to a standard least squares solution (mise, kim & newbold, 2005). the optimisation procedure in equation 1 maximises the fit to the trend of the series, i.e. minimise the cycle component tc by minimising changes in the gradient of the trend tτ . note that both tτ and tc are unobservable and since tc is a stationary process, tx may be thought of as a noisy signal for the non-stationary trend tτ . hodrick and prescott (1980) originally suggested an exogenous and subjective value of 1 600 for the value of λ for quarterly data, but backus and kehoe (1992) proposed adjusting λ based upon the square of the frequency of observations relative to quarterly data. the relative frequency is 3 for monthly data and 0.25 for annual data, so the corresponding λ s are 14 400 and 100, respectively. despite on-going research (e.g. ravn &uhlig, 2002; marcet & ravn, 2003) who derived endogenous values for λ by solving equation 1 as a constrained minimisation problem) the values for λ discussed above are still in common use (mise, kim & newbold, 2005). the optimal value for λ for south african business cycle data was explored by du toit (2008) who argued that the optimal smoothing constant was that value of λ that least distorts the frequency information of the time series (in this case, 524=λ for quarterly data used to evaluate a business cycle with a frequency of ~7 years – see figure 2). the hp filter has been used to (e.g.) explore south african business cycles and estimate long-run output levels (see woglom, 2003; kaseeram, nichola & mainardi, 2004; fedderke & schaling, 2005; burger & marinkov, 2006). drehman et al., (2010) found 6001=λ and 00025=λ performed poorly on historical data whilst 000125=λ and 000400=λ performed well with quarterly data. the higher value of 000400=λ is considered important from a policy perspective as it provides both a greater range and more time when the indicator provides strong and reliable signals. the solution to equation 2 has been shown by danthine and girardin (1989) to be: [ ] xkki 1ˆ −ʹ′⋅+= λτ where [ ]ʹ′= ,1 txx …x (i.e. the observed time series), [ ]ʹ′= ,1 tτττ … , i is a tt × identity matrix, and [ ]ijk=k is a ( ) tt ×−2 matrix with elements: 316 sajems ns 15 (2012) no 3 ⎪ ⎩ ⎪ ⎨ ⎧ +=− +== = otherwise 0 1 if 2 2or if 1 ji jiji kij which results in ⎟ ⎟ ⎟ ⎟ ⎟ ⎠ ⎞ ⎜ ⎜ ⎜ ⎜ ⎜ ⎝ ⎛ − − − = 12100000 0 00001210 00000121     k the hp filtering procedure optimises the fit to the data series, but this optimality is based on the application of the filter to an infinitely long time series. for practical purposes, the estimation of the trend and cycle components works well for a moderately long series (mise, kim & newbold, 2005), but at the end points the hp filter is demonstrably suboptimal. the twosided, symmetrical filter applies large symmetrical weights to the end points of the observed values5 to determine the corresponding trend value (ley, 2006) disproportionately distorting the filtered values at the most recent time period (baxter & king, 1995; apel, hansen & lindberg, 1996; st-amant & van norden, 1997). kaiser and maravall (1999) also investigated the end-point problem and found considerable improvement performance if the filter was applied to a data series which had been extended with arima forecasts and backcasts. problems with the two-sided filter are also alleviated by implementing a single-sided filter, a procedure which employs the standard two-sided hp filter incrementally for the construction of the long term trend. the trend is determined using only information available at the time the assessment was made (drehmann et al., 2010) and is implemented by running a loop over time and retaining the final value from the standard hp-filtered output at each point in time (mehra, 2006). the bcbs’s proposed countercyclical buffer ratio requires the use cycle and trend data generated from a one-sided hp filter which can differ considerably from two-sided filtered data as shown in figure 2. f i g u r e 2 one-sided and two-sided filtered data showing the significant variations between them 5 the hp filter applied to south african data the data chosen were monthly nominal gdp and credit extended by all monetary institutions to the domestic private sector, since 1965. these data are prescribed by the bcbs (bcbs, guidance for national authorities operating the countercyclical capital buffer, 2010b) and obtained from the reserve bank of south africa. from these data, growth rates were determined and the credit growth/gdp ratio determined. for ease of comparison, the 3.20 3.22 3.24 3.26 3.28 3.30 3.32 3.34 mar-­‐09 jun-­‐09 sep-­‐09 dec-­‐09 mar-­‐10 jun-­‐10 sep-­‐10 va ri ab le one-­‐sided  hp  filtered   series  as  at  09/10 two-­‐sided  hp  filtered  series  as at   12/09,  03/10  and  06/10  respectively two-­‐sided  hp  filtered   series  as  at  09/10 sajems ns 15 (2012) no 3 317 growth rates in figure 3 of these two components were normalised to 100 at january 2000 and plotted on the same timescale. note that although the difference between these two variables declined after the lehman brothers collapse in september 2008, this is due to a flattening of credit growth while gdp continued to increase. the former has begun to increase (2011), but the south african gdp growth is increasing at a greater rate – narrowing the gap between them. f i g u r e 3 application of the oneand two-sided hp filters to credit growth/gdp ratio for south african data commencing january 2000. note the marked differences over the period preceding the credit crisis, i.e. january 2005 onwards south african data from january 1966 were used to determine the credit growth/gdp growth ratio as well as this ratio's long-run trend. initial examination of these data, using standard fourier analysis, indicates that they exhibit cyclical behaviour. this result is not unexpected since they comprise several macroeconomic components (such as the economic – or business – cycle) which are inherently cyclical (figure 4a). further analysis isolates the major frequency components. the frequency spectrum in figure 4b indicates that the main component has a frequency of approximately 7 years. this is the duration of south africa's business cycle, found previously (botha, 2004). f i g u r e 4 (a) residual cycles after the long-run trend has been removed from south african credit/gdp growth data and (b) the frequency spectrum of these data showing the prominent peak at ~7.1 years -­‐20 0 20 40 60 80 100 100 150 200 250 300 350 400 jan-­‐00 jan-­‐01 jan-­‐02 jan-­‐03 jan-­‐04 jan-­‐05 jan-­‐06 jan-­‐07 jan-­‐08 jan-­‐09 jan-­‐10 jan-­‐11 n or m al is ed  p ar am et er s gdp  growth  [jan-­‐01  =  100] credit  growth  [jan-­‐01  =  100] difference lehman's collapse:   september   2008 right  axis jan-­‐68 jan-­‐75 jan-­‐82 jan-­‐89 jan-­‐96 jan-­‐03 jan-­‐10 ra tio  -­‐ tre nd ratio  -­‐  trend fourier  cycles (a) 1.0 4.3 4.7 6.1 7.1 8.5 14.2 po w er  (a m pl itu de ) frequency  (years) (b) 318 sajems ns 15 (2012) no 3 using these macroeconomic data, the credit growth/gdp growth ratio was constructed as well as the long run trend using both the one and two-sided hp filters. the results obtained – and they are very different for the two possible choices of hp filter – are shown in figure 5 from january 2000 to january 2011. in each case, the value of λ used was 14 400. f i g u r e 5 application of the oneand two-sided hp filters to credit growth/gdp growth ratio for south african data commencing january 2000. note the marked differences over the period preceding (i.e. jan-04 to mid-08) and during (post sep-08) the credit crisis the difference between the ratio and its long run trend (estimated by both oneand twosided hp filters) is shown in figure 6 below, spanning the same period as figure 5. the cycles – although similar in shape – differ markedly in magnitude and in many instances over the time period represented have opposite signs. these factors are of considerable import in the determination of countercyclical capital charges (section 3). f i g u r e 6 difference between the credit growth/gdp growth ratio and its long run mean estimated using both oneand two-sided hp filters for south african macroeconomic data commencing january 2000 table 1 summarises the proposed basel iii countercyclicality capital rules. note that the last column (‘total capital ratio’) refers to the capital ratio after the full implementation of basel iii as it currently stands (june 2011). the minimum capital ratio of 8 per cent increases under current proposals to 10.5 per cent by 2017 – the extra 2.5 per cent arising from the new 'capital conservation buffer'. the rules presented in table 1 are displayed graphically in figure 7. 220% 240% 260% 280% 300% 320% 340% 360% jan-­‐00 jan-­‐01 jan-­‐02 jan-­‐03 jan-­‐04 jan-­‐05 jan-­‐06 jan-­‐07 jan-­‐08 jan-­‐09 jan-­‐10 jan-­‐11 c re d it  g ro w th /g d p  g ro w th ratio trend  (two-­‐sided  hp  filter) trend  (one-­‐sided  hp  filter) -­‐40% -­‐30% -­‐20% -­‐10% 0% 10% 20% 30% jan-­‐00 jan-­‐01 jan-­‐02 jan-­‐03 jan-­‐04 jan-­‐05 jan-­‐06 jan-­‐07 jan-­‐08 jan-­‐09 jan-­‐10 jan-­‐11 cr ed it  g ro w th /g d p   gr ow th gap  (two-­‐sided  hp  filter) gap  (one-­‐sided  hp  filter) sajems ns 15 (2012) no 3 319 t a b l e 1 proposed basel iii countercyclical rules difference between credit/gdp and long run trend ( )d additional regulatory capital total capital ratio %2+≤d 0% 10.5% %10%2 +≤<+ d increases linearly from 0.0% à 2.5% %0.13%5.10 +<<+ cr %10+>d 2.5% 13.0% f i g u r e 7 the basel iii procyclical capital rules showing the linear increase in buffer capital when the credit growth/gdp growth ratio minus the long run trend exceeds 2 per cent these rules were then applied to the south african credit/gdp data to determine what the capital charges would have been had the new countercyclical rules been in place historically. the results are shown in figure 8 for the capital charges using both a one-sided and two-sided hp filter and using a λ of 14 400 in each case. f i g u r e 8 capital charges using the (a) two-sided and (b) one-sided hp filter 0.0% 0.5% 1.0% 1.5% 2.0% 2.5% -­‐2% -­‐1% 0% 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 11% 12% ca pi ta l  c ha rg e   in cr ea se credit/gdp  -­‐ long  run  mean 0.0% 0.5% 1.0% 1.5% 2.0% 2.5% jan-­‐00 jan-­‐01 jan-­‐02 jan-­‐03 jan-­‐04 jan-­‐05 jan-­‐06 jan-­‐07 jan-­‐08 jan-­‐09 jan-­‐10 jan-­‐11 ca p   ch ar ge :  t w o-­‐ sid ed  h p   fil te r (a) 0.0% 0.5% 1.0% 1.5% 2.0% 2.5% jan-­‐00 jan-­‐01 jan-­‐02 jan-­‐03 jan-­‐04 jan-­‐05 jan-­‐06 jan-­‐07 jan-­‐08 jan-­‐09 jan-­‐10 jan-­‐11 ca p   ch ar ge :  o ne -­‐s id ed  h p   fil te r (b) 320 sajems ns 15 (2012) no 3 the bcbs’s implementation of the basel iii countercyclical rules aims to discourage banks from excessive credit extension (relative to local gdp growth) through increasing capital charges. some pertinent features emerge from this analysis. the onesided hp filter misses the economic expansion experienced towards the end of the last millennium (which preceded the dotcom crisis of 2000), but this is detected by the two-sided hp filter. both the one and two-sided hp filters detect the 2003 – 2004 acceleration in credit extension. although south africa largely escaped the worst excesses of the financial fallout, the effects were felt nevertheless. had the basel iii rules been in place, capital charges would have increased to the 2.5 per cent maximum of extra capital required during this period. interestingly, even without the actual introduction of punitive capital charges in place – the ratio quickly returns to levels at which the difference between it and its long run trend would have resulted in a 0 per cent capital add-on. the global build up to the credit crisis is missed entirely by the two-sided filter until early 2007 when capital charges jump from 0 per cent to 2.5 per cent within a single month. had countercyclical measures been in place using the one-sided filter, a gradual build-up of supplemental capital would have already begun to occur in late 2004. as before, these capital buffers would have fallen briefly, had they been in place, towards the end of 2005 – but they would have quickly picked up again after only a brief respite. the capital charges indicated here are not entirely realistic. the fact is that the basel iii countercyclical rules had not been implemented in the historical periods indicated in figure 6, so bank behaviour was not modified as a result. an entirely different scenario may have played out had the countercyclical rules actually been implemented at these times. nevertheless, it is instructive to identify periods of overheated economic activity so as to be able to estimate – even roughly – the extent of the supplemental capital charges. a further interesting feature of this investigation shows that supplemental capital charges would have remained at their maxi mum 2.5 per cent for much of the duration of the credit crisis, diminishing to 0 per cent only in mid-2009 for the one-sided filter (and even later in 2009 for the two-sided filter). this could herald a conflict for south african banks in the future (when the basel iii countercyclical rules are implemented in full). the rules have a dual purpose – increase capital in times of economic overheating and release these when the economy is contracting. whilst these aims are desirable, the current rules would have forced banks to hold a minimum capital ratio at punitive levels (13 per cent)6 for far too long. while it is true that most banks enjoy capital ratios in excess of these levels, in severe economic downturns, capital is depleted and ratios plummet. forcing banks to hold extra capital (up to 2.5 per cent) for a prolonged period after a market crisis seems counterproductive: banks (and hence, the economy at large) would benefit from the release of this capital into the system in the form of loans, for example. in addition, south african regulatory authority – the south african reserve bank (sarb) – may also face the practical problem of having to force banks to raise this extra equity through (e.g.) rights issues, but it is not clear that shareholders would be willing to participate in these issues to further bank recapitalisation. authorities would need to establish in advance that banks would be permitted to reprice lending and customer fees sufficiently to generate substantial equity returns (and be able to distribute up to 100 per cent of those profits in dividends over time if balance sheet growth remained anaemic). if this were not successfully communicated, subscription to a rights issue could be seen as wasting money on a losing proposition (walters, 2011). were the countercyclical buffer in place, however, it would currently (2012) be set at nil (figure 8), with credit growth the furthest below trend in at least 50 years (figure 6). the sarb could thus be amplifying the effect of the crisis by focussing on and overreacting to only the most recent data (ryan & crutchley, 2012). sajems ns 15 (2012) no 3 321 other questions have arisen from affected parties. banks are concerned by the speed of the increase in capital required: would the increased capital be required immediately after the thresholds have been breached (table 1), for example? if so, does the reverse apply when economic conditions allow the extra capital to be released back into the system? what of the lag between the variables (credit growth and gdp)? there is evidence that these variables are out of sync in south africa and thus would miss crucial indicators of economic overheating. gdp figures are also frequently revised – up and down – how might this affect the capital increases? the bcbs have been silent on these issues, despite the consultation period for comments having passed in 2010 and to our knowledge, the sarb has not addressed these issues either. 6 conclusions the bcbs have deliberately structured a gradual phase-in of the basel iii rules for banks. several years have been granted for full basel iii implementation: some rules need only be completed by 2018 and beyond. the idea supporting this staggered approach is to prevent a further collapse in the (still fragile) global economy. some rules, such as those governing the new minimum liquidity requirements, have attracted criticism from banks who argue that, even under the most benign conditions, they will still be unable to comply. the short term minimum liquidity standard, for example, requires banks to maintain a liquidity coverage ratio (defined as the ratio of high quality liquid assets to net 30 day cash outflows under a prescribed (and arguably severe) stress scenario) of 100 per cent. many banks have countered that, in certain jurisdictions, there are insufficient high quality liquid assets available for the banking sector as a whole in that jurisdiction. banks could face penalties for these shortcomings by regulators (increased capital requirements) and rating agencies (downgrades). the countercyclical buffer capital requirement adds to the debate. whilst the idea to implement a flexible capital requirement that increases in favourable and decreases in unfavourable economic conditions, is sensible – the current ideas proposed by the bcbs are no panacea. tests conducted on large, developed economies indicate that the proposals are robust, reproducible and relevant (i.e. they appear – using historical data – to measure a fair amount of supplemental capital required by banks in an economically overheating region), but this may not hold for smaller economies where insufficient investigation has taken place to date. unlike other global central banks, the sarb did not experience any pressure to alter its monetary operations since the onset of the financial crisis (sarb, 2011). however, other measures might yet have to be considered by the sarb, for example, ratios or metrics that reflect local economic conditions accurately, or at least more accurately than the credit/gdp metric currently proposed. lagging and leading indicator times must also be addressed, as must the frequent revision to the relevant metric inputs – even in developed economies, before the metric acquires widespread acceptance. the sarb might also alter its focus from bank stability, to the amount of leverage in the south african household sector. this leverage is high and could pose a fundamental risk to south africa if the need arose to substantially raise interest rates to rein in inflation. however, seeking to reduce the level of debt of south african households through (house) price controls would be a contentious move for the sarb and even if it did so, a focus on leverage alone may constitute a step in the wrong direction (walters, 2011). the bcbs could also be clearer about the choice between the oneand two-sided hp filters. in the main document detailing the implementation of the measure, only a footnote covers this important distinction, here shown to affect the difference between the credit/gdp ratio and its long run mean (and hence capital charges) significantly. the fact that the metric is a jurisdictionwide measure operating on individual banks 322 sajems ns 15 (2012) no 3 is also cause for concern. the idea that culprit banks will be reined in by victim banks if the metric is applied regionally is laudable but may not work efficiently in practice and may force many banks into default and obscurity. endnotes 1 the capital ratio requirements under basel ii will thus potentially increase by up to 62.5 per cent after the full transition to the basel iii rules. 2 in particular, the difference between the credit growth/real gdp growth ratio from its long run trend. these values have been shown to be a leading indicator for financial distress. 3 asset prices were also considered to be useful aggregate indicators as they tend to rise strongly ahead of systemic banking crises, but these were eventually abandoned. 4 faster than average. 5 that is, the 2-sided hp filter uses past and future data to estimate the components of equation 1, so cycle data generated using it could be biased. 6 basel ii capital rules require banks to maintain a capital 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financial stability. banque de france, financial stability review #12. ryan, a. & crutchley, j.p. 2012. uk banks monitor: regulatory overstretch. ubs investment research, april:1-55. sarb, 2011. the international banking crisis and domestic financial intermediation in emerging market economies: issues for south africa, bis papers, #54, 365-376. available at: http://www.bis.org/publ/bppdf/ bispap54w.pdf [accessed 2012-04-21]. saurina, j. & trucharte, c. 2007. an assessment of basel ii procyclicality in mortgage portfolios. documentos de trajabo banco de espana #0712. sorkin, r. 2010. answers on credit ratings long overdue, new york times. available at: http://www.nytimes.com/2010/06/01/business/01sorkin.html?src=busln. . [accessed 2011-06-19]. 324 sajems ns 15 (2012) no 3 st-amant, p. & van norden, s. 1997. measurement of the output gap: a discussion of recent research at the bank of canada. technical report of the bank of canada. us financial crisis inquiry commission. 2010. financial crisis inquiry report: final report of the national commission on the causes of the financial and economic crisis in the united states. new york: us public affairs. walters, s. 2011. note on recent developments in the household balance sheet, south african reserve bank, quarterly bulletin, december:69-72. woglom, g. 2003. how has inflation targeting affected monetary policy in south africa? south african journal of economics, 71(2):380-406. yakhim, y. 2001. business cycle fluctuations and the hodrickprescott filter. available at: http://www.bgu.ac.il/~yossiya/teaching/macro_graduate/ln1_bc_hpf.pdf [accessed 2011-02-12]. sajems ns vol 7 (2004) no 1 22 a socio-economic analysis of african female street traders in the johannesburg cbd ________________________________________________________________ pinky lalthapersad-pillay department of economics, unisa ________________________________________________________________ abstract in recent years the informal sector in both less developed countries and in developing countries, including south africa, has undergone rapid growth. in south africa, high levels of unemployment and poverty have pushed many of the unemployed into self-employment activities in the informal sector. the informal sector is a highly diversified segment, and street trading is one type of survivalist activity. in south africa, street trading is conducted mainly by african women, who sell mostly fruits, vegetables and cooked foods. the quintessential feature of informal sector work is its precarious nature, especially as it evades the ambit of social security and labour legislation. this article explores the nature of street trading undertaken in the johannesburg cbd, characterised by poor working conditions, low income, extremely long hours and overcrowding. jel j 81, 23 introduction in many developing and developed countries, the informal sector is increasingly becoming a major contributor to gdp. south africa is no exception; the informal sector is an important one, given the high levels of unemployment and poverty in the country. however, the informal sector is not a homogenous entity; enterprises differ in respect of size, scope, nature of activities and income-earning potential. many people operate in the informal sector as hawkers, vendors and subsistence farmers, and tend to generate income way below the poverty line. this article is an attempt to develop a profile of african women street traders in the johannesburg cbd and to analyse the inherent characteristics of street trading. definition of the informal sector the informal sector includes all those who work in small, unregistered enterprises, both employers and employees, as well as self-employed persons sajems ns vol 7 (2004) no 1 23 who work in their own family businesses (wiego, 2001). despite such a clear definition, the generation of statistical information on this sector has proved arduous, given its diversity and wide ranging activities. according to charmes (2000: 3) the salient features of the informal sector include: ease of entry; small scale activity; little capital and equipment; labour-intensive technology; low skills; low level of organisation; and limited or no access to formal credit, organised markets, education and training; services and amenities. the 1995 white paper on national strategy for the development and promotion of small business in south africa (as cited in lund, 1998: 15) identifies four categories of informal sector activities, namely: survivalist; micro enterprises; small enterprises; and medium enterprises. the survivalist sector comprises of street traders and home-based workers. the view that the informal sector is an avenue for the development of emerging entrepreneurs has been challenged. many researchers have argued that the informal sector does not comprise of entrepreneurs, but, rather workers (horn, 1995: 34). thus the informal sector is not a hive for entrepreneurial activities, and it contains many contradictions, namely: • participation in the informal sector is not temporary, and people do not traverse between the formal and informal sectors. rather, those in the informal sector have nowhere else to ply their skills. • its activities are highly survivalist in nature. • it involves long work hours, low levels of income, no social security and inadequate safety measures, all of which economically marginalise its participants. • whilst it does generate income, it cannot obviate poverty and low standards of living (pcr, 1996: 55). growth of the informal sector in south africa we begin by examining reasons for the rampant growth of the informal sector. the growth of the informal sector is inextricably tied to the state of the formal labour market. this is especially true in case of south africa, where high levels of unemployment and an absence of social security, drew many people into the informal sector. the south african labour market witnessed spiralling unemployment in the post-apartheid era due to the restructuring of the public sector and poor economic growth rates. these events provoked considerable job losses during the period 1994-1998, with 284 837 jobs being shed in the formal labour market (143 00 in the public sector alone). thus in 2002, unemployment according to the expanded definition (excluding search activities), stood at 30 per cent (ssa, 2002). these job losses inflicted a heavy toll on african women sajems ns vol 7 (2004) no 1 24 as 140 000 female jobs were lost in the service sector, which is a major employer of african women (bhoorat, 2002: 41). the pcr (1996:49) contends that it is mass unemployment that generates low earnings in the informal sector. size of the informal sector recent estimates of informal sector activities indicate that informal sector employment accounts for one half to three-quarters of non-agricultural employment in developing countries. specifically, in 1998 it comprised 48 per cent of non-agricultural employment in north america; 51 per cent in latin america; 65 per cent in asia and 72 per cent in sub-saharan africa. if south africa is excluded, the figure rises to 78 per cent. home-based workers and street vendors are two of the main subgroups of the informal workforce. taken together, they represent an estimated 10 to 25 per cent of the non-agricultural workforce in developing countries, and over 5 per cent of the total workforce in developed countries (wiego, 2001). determining the actual size of the informal sector in south africa is problematic; as different definitions have been employed in past surveys, rendering comparisons impossible. there are many estimates of the size of the informal sector. bhorat (1999: 326) estimates that there were 569 000 informal sector participants in 1995. in 1997, the figure stood at 965 669; in1998, it rose to 1.3 million and in 1999, it increased to 1.9 million (ssa, 1998; 1999; 2002). in 2001, it was estimated that there were 1.8 million people in the informal sector (ssa, 2002). estimates of the number of street traders are also contestable. xaba et al. (2002: 45) maintain that in 1998 there were 3.5 million people within the entire survivalist sector. the community agency for social enquiry (case) study of the johannesburg cbd found that there were 3 176 street traders in 1995 (case, 1995). the durban metropolitan area (dra) study estimated there were 19 000 street traders in the whole durban metropolitan area in 1997 (dra study as cited in lund, 1998: 21). the johannesburg metropolitan council estimated that there were 8000 street traders in the johannesburg cbd (city of johannesburg website, 2003). characteristics of street trading most self-employment activities in the informal sector are survival strategies that are extremely low-paying. the growth of informal work is epitomised by the activities of street vendors and homeworkers. globally, street vending is a common activity in which people earn a living by selling an array of goods and services on the street (wiego, 2001). despite the general perception that street sajems ns vol 7 (2004) no 1 25 trading tends to decline as economies develop, research indicates that it is actually on the increase. street vending has become an inherent part of the urban informal sector, and it is mainly women that operate as street traders. street vending is sometimes the only occupational option for many poor people and is the only means of earning some income, however low (wiego, 2001). lund (1998: 21-22) argues that street trading in south africa differs from that in other african countries, especially in terms of the types of goods traded. among south african street traders, manufacturing and services are relatively negligible and trade is skewed in favour of fresh produce, clothing, cosmetics and food. in addition, most south african street traders sell produce not produced by themselves. the dra study (as cited in lund, 1998: 22) found that only 3 per cent of women were selling goods or food produced by themselves. the study also found that each trader sold a very limited range of goods: seven out of ten of those who sold food or other products were selling fruits and vegetables, or meats and poultry. the case study of the johannesburg cbd in 1995 recorded similar trends, that is, the most common goods sold were: food (41 per cent), fruit and vegetable (37 per cent) and clothing (30 per cent) (case, 1995). besides a lack of skills, unfavourable dependency burdens, and high levels of unemployment, a crucial reason why african women turn to the informal sector resides in its easy access. ease of access rests on the fact that not much start-up capital is necessary. lund (1998: 23) argues that most women can utilize their own money or borrow from relatives. in nair’s study (1996:74), most of the women started their ventures with less than r200. in the isipingo study, the figure was less than r50 (mbona, 1997: 37). the majority of women in the survivalist, or poor end of street trading are independent traders, who work for themselves and rarely employ others. the working conditions of street traders are precarious, as they endure harsh physical environments, limited or no infrastructure, no shelter against the elements, or access to water, sanitation and storage facilities (lund, 1998: 30). african women predominate in the informal sector, especially street trading, due to a host of factors. it is a well-documented fact that african women have the lowest activity rates, are the least likely to be employed in formal employment and have low levels of formal education and skills (bhorat, 2002: 41). the need to survive in the face of long term unemployment, coupled with heavy dependency burdens are factors that may push african women to the informal sector. sajems ns vol 7 (2004) no 1 26 nature of study the study was descriptive in nature and aimed to develop a profile of african street traders, focusing on the nature of street trading, the income generated, the living conditions of street traders, their dependency burdens, hours worked and the presence of gender parameters in task allocation. in compliance with this approach, a structured questionnaire was administered to eighty african female street traders in the johannesburg cbd in august 2002 (see appendix a). the questionnaire focused primarily on qualitative information, and little quantitative data was sourced. a process of triangulation made it possible to probe issues from an array of perspectives. since the study was essentially qualitative in nature, a non-probability convenience sampling method was adopted. once data was collected, it was coded into conceptual categories and themes. the main statistical techniques applied were descriptive statistics (mean, median, standard deviation), frequencies and cross tabulations, using statistical package for social services (spss) and sas. nature of trading activities the study focussed only on african women street traders that sold foodstuffs, namely, fruits, vegetables, nuts and cooked foods. the streets of most cbds in south africa are speckled with informal traders, sitting in close proximity to each other and selling similar goods at uniform prices. in street trading across the country, the selling of fresh produce is what most people do, most sellers are women and incomes earned are very low (lund, 1998: 33). the trading activities that these women engage in is the very simplistic act of buying a relatively large quantity of fruit or vegetable (approximately a 10 kg pack), subdividing it and re-selling it in smaller volumes. the unsold stock is usually kept at the premises of formal traders, who charge a fee of r15 per week for storage. street trading appears to be a highly individualistic endeavour, as women purchase supplies individually rather than as part of a larger group. thus, there was no evidence of networking among women traders. regarding the frequency at which supplies were bought, 29 per cent of respondents bought supplies daily, 18 per cent bought once a week, 53 per cent bought twice a week. almost 90 per cent of respondents said they paid in cash for supplies. of the women selling cooked food, 45 per cent used a gas stove and 55 per cent a paraffin stove to prepare food. the job creation ability of street trading was limited, as only 10 per cent of respondents employed any workers on a part-time basis. sajems ns vol 7 (2004) no 1 27 age in terms of the age distribution of the sample, one-third were under the age of 30 and two-third’s over the age of 30. the higher proportion of older women undertaking informal sector work could imply that their lack of skills limits their participation in the formal sector. thus it can be concluded that women are more likely to start trading when they are older. level of education in terms of the educational level of respondents, 21 per cent could be regarded as being functionally illiterate (had less than standard 4 (grade 6)), 34 per cent had completed junior secondary schooling (between standards 5 and 7 (grades 7 and 9)) and 34 per cent had senior secondary schooling (between standards 8 and 9 (grades 10 and 11)). thus, almost 89 per cent of respondents had no matric, a trend that is in keeping with most previous studies that record low levels of education (lund, 1998; mbona, 1997). there is a strong link between poor education and participating in the survivalist sector. cross tabulating age with education shows that younger women traders have more years of education than their older counterparts. number, age and status of children the majority of women were mothers and whilst one-third of women had 2 children, a quarter had 3 children. answers to questions on the age distribution of children of women traders indicates that the dependency ratio of these women was quite substantial: 77 per cent of children were under the age of 18 and 28 per cent above 19 years of age. furthermore, 60 per cent of their children aged over 19 were unemployed, which reaffirms the acuteness of youth unemployment in south africa (ssa, 1994). family living arrangements need to be analysed in terms of whether families remained as intact units or were fragmented, a general practice arising from the past policy of influx control. almost 52 per cent of respondents had all children living with them, 29 per cent said that all children lived elsewhere, and 19 per cent said some children lived with them and other children lived elsewhere with grandparents. in bedford’s (1995) study, it was mostly children of school going age that were sent to live elsewhere, with 55 per cent of traders endorsing this practice. factors that contribute to splintered family units could be the lack of adequate housing and the high cost of school fees in urban areas, economic factors that make it impossible for women to sustain the dual responsibilities of earning a living and childcare simultaneously. sajems ns vol 7 (2004) no 1 28 only 17 per cent of women reported bringing their children to work, either because they did not have anybody to care for their children (9 per cent) or because children helped with selling (9 per cent). the dra study found that 26 per cent of women looked after their children at their place of work (cited in lund, 1998: 35). the status of male partners the status of male partners revealed that they either worked full-time (44 per cent), worked part-time (9 per cent), were pensioners (14 per cent) or unemployed (33 per cent). the duration of unemployment varied: 15 per cent had been unemployed for less than one year, 46 per cent for between 2 to 5 years and 39 per cent for a period exceeding 5 years. the unemployment patterns of male partners succinctly illustrates the nature of long-term unemployment that south africa is undergoing. among the unemployed males, only 10 per cent engaged in piece jobs to earn income. bhorat (2002) contends that income inequality is worsened by extremely low earnings in the informal sector, coupled with an absence of wage income. this in turn tends to perpetuate intra-household income inequalities and differences in poverty rates. only 3 per cent of the unemployed male partners received unemployment benefits, a factor that highlights the limited role of such transfers as a safety net for the poor. in the absence of social security, the practical reality facing families is that the impact of unemployment and poverty can only be cushioned by other family members undertaking additional work. the informal sector remains the only means to gain access to income earning activities. accommodation patterns table 1 indicates the nature of accommodation. only 12 per cent of women were home owners, whilst practices such as renting a room either in a house or flat (35 per cent) and informal settlement occupancy (36 per cent) were common. the mushrooming of informal settlements is due to the shortage of housing that was inherited from the apartheid era and the exclusion of african women from housing in the urban areas. the high proportion of people in informal settlements implies a widespread inability to meet the basic requirements of a minimum standard of living in terms of the provision of shelter. living conditions in informal settlements are dire, with overcrowding, unhealthy environments and sub-standard infrastructures. furthermore, the occupancy of old buildings in the city is dangerous, since most of the buildings have been condemned as structurally unfit for occupation. sajems ns vol 7 (2004) no 1 29 table 1: place of abode place of abode % own house 12 rent a room in a house or a flat 35 occupy an old building in the city 9 rent entire flat in the city 4 occupy an outbuilding in a backyard 2 live in an informal settlement 3 share a house with relatives 2 source: own data information on the state of habitation can be gleaned from the number of bedrooms per dwelling. at least 19 per cent of respondents lived in places that had no bedroom, 68 per cent had one bedroom, and 13 per cent had two bedrooms. inadequate living space forced 75 per cent of all respondents to utilize the lounge as a bedroom. this limited living space has to be set against the fact that the average household consisted of four individuals, and a maximum of nine persons. the provision of basic services was satisfactory: 67 per cent of respondents had electricity and 63 per cent water-borne sewerage. some households relied on other forms of energy, for example, gas (2 per cent), paraffin (27 per cent) and coal or wood (2 per cent). in terms of teledensity, only 2 per cent of respondents had a telephone. migrationary trends respondents were asked about their previous place of residence in order to determine migratory trends. almost 72 per cent of respondents had migrated to the gauteng province, which is the wealthiest of all nine provinces in south africa. it is a well documented fact that urban areas have higher levels of employment and wage levels compared to rural areas (bhorat, 2002). respondents rated a number of factors which had influenced their decision to migrate: finding a job (72 per cent); improving their standard of living (51 per cent); availability of better opportunities (23 per cent); availability of better social services like schooling (11 per cent); while 13 per cent said they saw little chance for improvement in their previous residential area. bhorat et al. (2002: 29) found that moving to an urban area increased the probability of labourmarket participation by 14 per cent and earnings by 18 per cent. sajems ns vol 7 (2004) no 1 30 work-related data regarding the reasons advanced for working in the informal sector, respondents rated the following options: the need to support family (83 per cent) and the inability to find a job (81 per cent). other factors included the unemployment of male partners (26 per cent) and the need to earn extra money (10 per cent). table 2 previous occupation previous occupation % domestic worker in private household 42 sales person 9 never worked 26 machinist 2 cashier 6 cleaner in factory 11 shop assistant 2 nursing aid 2 source: own data table 2, which lists the type of jobs that women previously undertook, highlights two peculiarities, that is: a high proportion of women (42 per cent) had been domestic workers in private households; and 26 per cent of respondents had never worked. domestic work tends to be the occupational choice of a large proportion of african women, given their low levels of formal labour market experience and the scarcity of jobs in the labour market. furthermore, the fact that only 45 per cent of respondents had previously been in full-time employment, 41 per cent in part-time jobs and 13 per cent were casually employed, highlights the preponderance of african women in irregular, secondary sector jobs. an important finding is the movement of women away from domestic work in private households to the informal sector. the presence of a high proportion of individuals who have never been employed complies with the finding by the fafo survey that showed that nearly 50 per cent of those looking for work had never worked before (as cited in bhorat, 2002). these individuals have been denied formal labour market experience and will in future have to be supported to undertake more lucrative and secure alternatives in the informal sector. of the women whose previous occupation was domestic worker in private households, 91 per cent were over the age of 30, and 9 per cent under the age of 30. thus, domestic work did not appear to be popular among younger women. cross tabulating previous occupations with education shows that 27 per cent of sajems ns vol 7 (2004) no 1 31 domestic workers had less than standard 4 or grade 6, 36 per cent had between standards 4 and 7 or grades 6 and 9, whilst 31 per cent had between standards 8 and 9 or grades 10 and 11. thus, the fact that women with quite high levels of education had been undertaking domestic work highlights the seriousness of unemployment in the labour market and the extent of poverty at a family level. most studies show that people delve in the informal sector out of necessity rather than choice. in the johannesburg cbd study of 1995, more than 80 per cent said they entered because they were redundant, they had no other skills or they couldn’t find another job (case, 1995). in fadane’s study (1998: 21), most women had come to durban from rural areas because of rural poverty and unemployment. south africa’s high rate of landlessness among rural people is a strong push factor towards seeking employment in urban areas. the work experience of women is such that most of them are far more likely to have never been employed or to have been employed as domestic workers or to start trading when they are widowed. in nair’s study (1996: 58) six out of ten of the women traders had never had a steady job. a study by pentz study (1992) showed that 85 per cent of the women had either never been employed or had been employed, only as domestic workers. household income levels regarding the number of income earners per household, 74 per cent of respondents said they were the main breadwinner. this factor has to be analysed in terms of the number income earners per household and other sources of income accruing to the household. in 57 per cent of households, there were no other income earners besides the respondent; 38 per cent had one other income earner aside from the respondent; 4 per cent had two income earners and 2 per cent had four income earners. these circumstances are consistent with bhorat’s finding that africans have the greatest likelihood of living in a household with no regular income earners (bhorat, 2002: 19). in poor households, government transfer payments are a major source of support for the rest of the family. in this study, however, only 12 per cent of households received old age pensions. this could be attributed to the fact that most of the families in urban areas tend to live as nuclear families, as opposed to extended family units in rural areas. each respondent supported on average four other people, the maximum being twelve people. the frequency was such that 43 per cent of respondents supported between 1 to 3 other persons; 46 per cent supported between four and six other people and 11 per cent supported between seven and twelve other people. high dependency burdens point to the urgency of government’s providing some sort of a safety net for the unemployed. sajems ns vol 7 (2004) no 1 32 the study by bedford (1995) indicated that three quarters of the members (75 per cent) were the main breadwinners in their households and two thirds of their households had no other earner at all. thus street vendors are more likely to be household heads, to be the main breadwinner and to have no other earners in the household (bedford, 1995). income levels respondents earned an average of r45 on slack days, ranging from a minimum r2 to a maximum of r150 per day. the frequency distribution is shown in figure 1. figure 1 income on slack days 0 5 10 15 20 25 0 49 50 99 100 149 150 199 200 249 250 299 > = 350 income categories a bs ol ut e fr eq ue nc y source: own data respondents were asked how much income they would make if business was good. the average was r99.72, ranging from a minimum of r20 to a maximum of r250 per day. sajems ns vol 7 (2004) no 1 33 figure 2 income on good business days 0 5 10 15 20 25 30 0 39 40 79 80 119 120 159 160 199 > = 200 income categories a bs ol ut e fr eq ue nc y source: own data respondents were asked what was the total gross income they took home per week, before deducting costs such as supplies, transport and storage fees. the average income taken home was r270.38, ranging from a minimum of r60 to a maximum of r550. figure 3 shows the frequency distribution. figure 3 total gross income 0 2 4 6 8 10 12 14 16 18 0 99 100 199 200 299 300 399 400 499 >=600 income categories a bs ol ut e f re qu en cy source: own data the above analysis points out that income was very erratic and below the sajems ns vol 7 (2004) no 1 34 minimum living level (mll) of r950 a month (bmr, 1999). the precariousness of the situation becomes more apparent when one bears in mind that each household supported, on average, four other persons. compounding the problem was the fact that 28 per cent of women reported that there were days when they did not take home any income. thus, the absence of regular income is a factor engendering hardship and suffering. correlating the number of dependents to the level of income, the study found that 11 per cent of respondents took home between r60 to r100 a week and had an average of 5 dependents; 30 per cent of respondents took home between r120 to r200 a week and had an average of four dependents; 17 per cent of respondents took home between r220 to r250 a week and had an average of 4 dependents; 19 per cent took home between r300 and r380 and had an average of 3 dependents. an important question is whether higher levels of education are commensurate with high levels of income in the informal sector. there appeared to be a positive correlation between the level of education and the level of income obtained. those with higher levels of education did take home more income. for example, women with less than standard 4 took home an average of r238 a week, and those with matric, an average of r458 a week. thus, education appeared to play an imperative role in terms of the type of goods retailed and the organization of the trading venture. most studies show street traders’ incomes at well below r600 per month, with an income of lower levels for women. r600 per month was the approximate minimum living level in 1995. in the johannesburg cbd, 54 per cent of street traders had made up to r600 per month (case, 1995: 30). work patterns regarding the length of the workday, the average hours worked per day was 10 hours, the minimum being 5 hours and the maximum being 13 hours. the distribution was such that 13 per cent of respondents worked between 5 to 8 hours per day, 60 per cent worked between 9 to 10.5 hours per day and 27 per cent worked between 11 to 13 hours per day. only 15 per cent worked over the weekend. the work day continued at home in terms of making preparations for the next day’s trading. almost 78 per cent of respondents undertook such preparations, with 42 per cent spending one hour, 30 per cent two hours, 15 per cent three hours, 3 per cent four hours and 2 per cent five hours on such activities. thus the average hours worked in the informal sector exceeded those in the formal sector. sajems ns vol 7 (2004) no 1 35 most studies concur that street traders work long and usually regular hours, over all months of the year (lund, 1998: 34). most street traders work an average of ten hours a day, except sunday (case, 1995). in terms of sleep patterns of respondents, the average time that most respondents woke up was 5:20 and went to sleep at 21:05. this analysis explicitly indicates that women’s time budgets were overstretched and that working long hours left little time for leisure and rest. this is consistent with most studies that indicate that women in poor households devote much more time to income-generating activities (world bank, 1990: 31). the considerable effort that women have to put in to earn a little income is indicative of the type of deprivation they have to bear. spending patterns only 23 per cent of respondents possessed a savings account at a bank and only 9 per cent belonged to a stokvel or savings club. stokvels and savings clubs are community-based initiatives that enable groups of women to purposefully save money. low participation rates in such schemes are tantamount to a low level of social networking among individuals. women appeared to have wide control over household decision-making. women decided how money was spent: namely 62 per cent of respondents said they decided, themselves, on how to spend their income. most studies on gender allude to the fact that women in poor households devote a greater portion of earned income to the household than men do (world bank, 1990:36). regarding the sums of money given to male partners, 28 per cent said that they gave their male partners money for cigarettes, 15 per cent for alcohol, 23 per cent for gambling or lotto, 6 per cent for supporting children from other marriages and 36 per cent for clothing. this is consistent with the general finding that women contribute a larger portion of their income to the household budget and to financing the expenditure of male partners. gender parameters whilst there was no gender bias with respect to the education of children and which children helped with trading activities or household chores, it appears that daughters were saddled with more dual roles and responsibilities. almost 31 per cent of respondents said that daughters helped in caring for other children, 41 per cent undertook cooking and cleaning and 28 per cent assisted with the next day’s preparations. sajems ns vol 7 (2004) no 1 36 table 3 division of tasks task % trading activities 31 cooking 19 cleaning 19 seeing to the children 11 transporting goods to trading area 8 preparations for the next day 12 source: own data the sexual division of household chores appeared to be rigorous, with males contributing little in this regard. for example, 31 per cent said that their male partners helped in their trading activities, 19 per cent said they helped with the cooking and cleaning, 11 per cent said they helped to look after the children, 8 per cent said they helped to transport goods to the trading location and only 12 per cent said they helped with preparations for the next day’s trading. regarding the execution of household chores, 94 per cent of respondents said they themselves undertook cleaning, 49 per cent cared for the children and 26 per cent helped children with homework. a survey on time use in south africa in 2001 found that women spent three times as much time on unpaid work (cooking, cleaning and caring for other household members) compared to men (budlender, et al., 2001: 5). thus even though women spent an average of ten hours trying to earn income, they could not escape performing household and childcare tasks for the family. this additional unpaid labour in the household makes that the dual burden of these women arduous. future research needs it has to be accepted that street trading comprises a significant portion of the urban informal sector, and is likely to expand rapidly in future, given worsening economic scenarios. however, very little is known about the dynamics of this sector and statistical evidence is clearly lacking. information is required on a host of variables, for example, the actual number of participants, the sectors wherein they operate, their contribution to gpd and employment, their links to the formal economy and the supply and distribution procedures that they trigger across national borders. such information will assist policymakers to make informed decisions that will harness and support this often misunderstood entity. sajems ns vol 7 (2004) no 1 37 conclusion whilst it is difficult to formulate an incisive picture of the hardship experienced by women in the informal sector, it is hoped that such information would accentuate the predicament of african women street traders. it is an inescapable fact that growing economic adversity, with the resulting unemployment and poverty, will serve to thrust more people into the informal sector, an area that is already overcrowded. in south africa, the burden of unemployment falls disproportionately on african women. informal sector work is no replacement for formal employment. yet, the practical reality of being unemployed means that if one cannot find a job in the formal labour market, then informal sector work becomes the only alternative, especially for older african women that lack the human capital to gain entry to the formal labour market. however, informal sector work is highly subsistent in nature and offers extremely low levels of income. this is exacerbated by an absence of unemployment benefits for the bulk of the unemployed. african women in the informal sector display all the manifestations of poverty, not only in terms of low and irregular income, but in terms of the nature of deprivation they have to bear. they have little choice of and access to resources, they endure dismal living standards, an absence of decent housing, overcrowded and unhealthy environments and long work hours. moreover, the ability of the informal sector to offer a livelihood to the unemployed will be further constrained by south africa’s huge illegal immigrant population, which also looks to the informal sector as a means of generating income. thus, overcrowding will drive income levels further down. the economic crisis that south africa finds itself in can only be addressed by stimulating economic growth, reducing unemployment and inequality, alleviating the plight of the poor and improving living standards. references 1 bedford, l. (1995) the self employed women’s union survey: members and their situation, independent development research: durban. 2 bhorat, h. (1999) “the october household survey and the informal sector − a note,” south african journal of economics, 67(2): 320-26. 3 ______ (2001) “explaining trends in sa 1993-1998,” new agenda, 4: 21-38. 4 ______ (2002) “is a universal income grant the answer,” south african labour bulletin (salb), 26(2): 19-24. sajems ns vol 7 (2004) no 1 38 5 budlender, d., chobokoane, n. & mpettsheni, y. (2001) a survey of time use, statistics south africa: pretoria. 6 bureau of market research (1999) minimum and supplemented living levels in the main and other selected urban areas of the rsa, unisa: pretoria. 7 charmes, j. (2000) gender and informal sector, united nations: new york. 8 community agency for social enquiry (case) (1995) our daily bread: earning a living on the pavements of johannesburg. part 2: the survey, case: johannesburg. 9 fadane, n. (1998) “women street vendors in durban” in larsson, a., mapetla, m and schlyter, a. (eds.) changing gender relations in south africa, the institute of southern african studies: roma. 10 horn, p. (1995) “self employed women’s union – tackling the classgender intersection,” salb, 19(6): 34-38. 11 city of johannesburg official website (2003) http://www.joburg.org.za/ 2004/jan/jan21-traders.stm. 12 lund, f. (1998) women street traders in urban south africa: a synthesis of selected research findings, school of development studies: durban. 13 mbona. d. (1997) isipingo street traders survey, report prepared for south local council, durban metropolitan area. 14 nair, y. (1996) “women and survival: trading in crafts and curios at the durban beachfront”, university of natal: masters thesis, durban. 15 pentz, d. (1992) informal street trading: a case study of warwick avenue, university of natal masters thesis, durban. 16 world development report (1990) poverty, oxford university press: washington. 17 wiego (women in informal employment: globalising and organising) (2001) “addressing informality, reducing poverty”, http://www. wiego.org. 18 xaba, j., horn, p. & motala, s. (2002) the informal sector in sub-saharan africa, ilo: geneva. rsa government publications president’s council report (pcr) (1996) report of the commission to investigate the development of a comprehensive labour market policy : restructuring the south african labour market. pr 83/1996. government printer: pretoria. statistics south africa (ssa) (1998) october household survey (ohs): pretoria. _____ (1999) ohs: pretoria. sajems ns vol 7 (2004) no 1 39 _____ (2002) labour force survey: pretoria. dept of labour (2000) the national skills development strategy, govt printer: pretoria. sajems ns vol 7 (2004) no 1 40 appendix 1 questionnaire a. biographical data 1. what is your age? under 19 between 20 29 between 30 39 between 40 49 between 50 59 over 60 2. what is the highest schooling that you completed? less than std 4 std 5 to std 7 std 8 to 9 matric matric and diploma degree 3. what is your marital status? never married married living together widowed divorced b. children 1. how many children do you have? ________ 2. how many of you children fall in following age categories? under 6 between 7 to 11 between 12 to 18 over 19 3. with regard to your children, do they? all live with you all live elsewhere with family some live with you and some elsewhere 4. how many of your children attend school ? _________________ sajems ns vol 7 (2004) no 1 41 5. the children that attend school are they: boys girls both boys & girls 6. do you bring any of your children to work with you? yes no 7. if yes to question 8, why? ______________________ 9. which children help you at this job? boys girls boys & girls 10. are any of your children employed?_____________ 11. do any of your daughters help with the following: looking after the children cooking & cleaning preparations for the next day c. husband/ partner 1. what does your husband/partner do? has a full-time job works part-time unemployed pensioner 2. if your husband/ partner is unemployed, for how long has he been unemployed? less than a year between 2 to 5 years over 5 years 3. does your husband/ partner collect uif ?___________________ 4. what does your unemployed husband/partner do to earn some income ________ 5. does you husband/partner help with any of the following activities? your trading activities cooking cleaning seeing to the children transporting goods to trading location preparations for next day’s trading sajems ns vol 7 (2004) no 1 42 d. household size: 1. where do you live presently? rent a room in a house or flat an old building flat in the city building in a backyard informal settlement share a house with relatives 2. how long have you been staying at this place? _______________ 3. in which region did you live previously? gauteng eastern cape western cape kwa-zulu natal mpumpalanga limpopo northern cape northern province free state 4. if you lived previously elsewhere, why did you move to johannesburg? to find a job to improve your standard of living saw better opportunities here better social services (schooling, housing, health care) little chance for improvement in the area you left 5. how many people are there in your household? ________ 6. how many bedrooms do you have? ________________________ 7. is the lounge also used as a bedroom? yes no 8. are any of your parents or in-laws living with you?____________ 9. do you have any electricity at home?_______ 10. what is your main source or energy at home? gas electricity paraffin coal/wood 11. do you have water-borne sewerage in your home? 12. do you own: telkom cell phone sajems ns vol 7 (2004) no 1 43 e. work related data: 1. why did you start this venture? to support my family couldn’t find a job husband unemployed to earn extra money other specify 2. in what occupational capacity were you previously employed ?__________ 3. was your previous job a full-time, part-time or casual job? ________________________ 4. do you employ any workers ? yes no 5. how many people do you have working on: full-time part-time f. household income: 1. are you the main breadwinner in the household ?_______ 2. how many other people earn income in the household ? ________________________ 3. how many people depend on your income? ____________________ 4. do you parents or in-laws receive a pension?__________ g. work patterns: 1. at what time do you start working?_________________ 2. at what time do you finish working?_________________________ 3. do you work over weekends? _____________________ 5. at what time do you wake up in the morning?______________ 6. at what time do you go to sleep at night? __________________ h. purchasing patterns 1. do you buy your supplies: individually as part of a group that pools money 2. how often do you buy supplies? daily once a week twice a week once every 2 weeks 3. how do you pay for your supplies? cash credit i. organization of trading venture 1. what do you use to prepare your food? gas stove paraffin open fire sajems ns vol 7 (2004) no 1 44 j. income data 1. how much income do you make per day when business is good?______________ 2. how much income do you make per day make when business is bad? ____________ 3. what is the average income you take home in a week?__________________ 4. are there times when you do not take home any income? yes no k. household dynamics: 1. do you do any of the following when you get home after work: cooking cleaning seeing to the children helping kids with homework making preparations for the next day’s trading 2. how many hours at night do you spend making such preparations? ___________ l. spending patterns 1. do you have a savings account at a bank? yes no 2. are you a member of a stokvel? yes no 3. who decides how to spend the money you make? yourself only you and your husband/partner your husband/partner only 4. do you give your husband money for any of the following things? cigarettes alcohol gambling/lotto support children from another marriage clothing microsoft word 1 witte et al sajems 15(3) 2012.doc sajems ns 15 (2012) no 3 235 the psychological consequences of unemployment in south africa hans de witte department of psychology, k.u. leuven, belgium and north-west university, vanderbijlpark sebastiaan rothmann optentia research programme, north-west university, vanderbijlpark leone tb jackson potchefstroom business school, north-west university, potchefstroom accepted: may 2012 the objective of this study was to investigate the affective experiences, attitudes to work, and job application behaviour of unemployed people. a survey design was used and samples (n = 381) were drawn from unemployed people in the north west province. the experiences of unemployment questionnaire was administered. regarding affective experiences, being unemployed was described as very unpleasant and it was associated with boredom, loneliness, uncertainty about the future, concerns about financial matters, emptiness and conflict. when it came to the participants’ attitudes to work, the results showed that almost 96 per cent of them regarded work as important, particularly because it provides meaning. regarding job application behaviour, the results showed that most of the participants would like to find a job within the month, and they expected to do so. almost 78 per cent of the participants were asking people for a job at least once a week or more often. most of them asked friends and acquaintances for employment information, but unemployed people also reported that they looked out for advertisements. people with poor education had the most negative experiences of unemployment and saw work as more important than did those with better education. key words: unemployment, experiences, attitudes, behaviour, well-being jel: j640 1 introduction unemployment is a serious issue in most countries in the world, but for some countries (e.g. the united states, new zealand, spain and taiwan) the problem has become severe because of the financial crisis that developed after 2007 (wanberg, 2012). unemployment has also been a serious problem facing south africa (contogiannis, 2007; kingdon & knight, 2004; national planning commission, 2011). according to contogiannis (2007), the unemployment rate in south africa increased from 13 per cent in 1993 to 26 per cent in 2007 (excluding discouraged workers, that is, people who had opted out of the labour market). unemployment affects economic welfare, production, the erosion of human capital, social exclusion, crime and social instability (dollard & winefield, 2002; kingdon & knight, 2004). the negative consequences of unemployment for well-being have been well documented (creed & watson, 2003; mckee-ryan, song, wanberg & kinicki, 2005). hanisch (1999) separates the negative effects of unemployment into individual and family effects. individual effects include physical and psychological effects. physical effects include an increase in headaches; stomach aches; sleep problems; lack of energy; hypertension; heart disease and kidney disease. psychological effects include increased hostility, depression, abstract 236 sajems ns 15 (2012) no 3 anxiety, stress, anger, fear, despair, loneliness and social isolation, and decreased self-esteem, life satisfaction, aspiration levels, concentration and personal identity. family effects include an increase in spousal abuse, marital friction, spousal depression, family conflict, and child abuse and a decrease in family cohesion, and the well-being of children. lucas, clark, georgellis and diener (2004) showed that, although life satisfaction is moderately stable over time, unemployment affects this in the long term. research comparing unemployed with employed people has consistently found higher levels of psychological distress and depression, and lower levels of self-esteem among the unemployed (mckee-ryan et al., 2005; waters & moore, 2001). poor well-being in the unemployed has also been demonstrated to be largely a concern and a consequence of unemployment, and not the result of those with poorer health “drifting” into that situation (waters & moore, 2001). although unemployment seems to have predominantly negative effects, factors such as the employment commitment, coping resources, cognitive appraisal and coping strategies might increase the effects of unemployment on individual well-being (mckee-ryan et al., 2005). while it is crucial to understand and document the psychological experiences of the unemployed in south africa, there seem to be few studies on the topic. van der merwe and greef (2003) investigated the coping mechanisms of 82 unemployed african men, while ribton-turner and de bruin (2006) studied stressors and support in a group of eight unemployed adults in mid-career. møller (1993) points out that unemployed people often “just sit around”, and most of them admitted that they were bored. boredom and despair often featured in the respondents’ descriptions of their own activity schedules (møller, 1993). unemployment (or experiences thereof) in south africa might be different from that in europe. this is for the following reasons: a) in europe, there are social security systems, while no such system currently exists in south africa. unemployed people in europe still receive a reasonably good income, which cannot be said of unemployed people in south africa. b) the south african culture is more collective than in other countries and work might be less important for individuals in this country. masango (2005) suggests that being unemployed in south africa might thus be less problematic .   however, based on the above description of the problem, unemployment is clearly a serious problem in the country. furthermore, there is a lack of information on the attitudes to work, affective experiences and job application behaviour of unemployed individuals. we aim to fill the gap in the literature with results from a large-scale representative sample of unemployed people in the potchefstroom area of the north west province of south africa. information on the experiences of unemployed individuals could be used by local, provincial, and national governments to plan and implement strategies for assisting them. 2 experiences, attitudes and behaviours of unemployed people according to the international labour office (ilo), the unemployed comprise all those above a specific age who were without work during the reference period (i.e. they were not in paid employment or self-employment), were available for paid employment or selfemployment, and had taken active steps to seek paid employment or self-employment (ilo, 2000:429). unemployment is a complex and multifaceted construct which involves situational (non-employment), motivational (seeking work) and medical and legal aspects (being available for work) (paul & moser, 2006:597). unemployed people are therefore those who are able to work, are allowed to work, and prefer to work. given the above definition, unemployed people should be studied not only in terms of experiences (associated with being unemployed), but also in terms of their availability for work (employment commitment), and job application behaviour (paul & moser, 2006). de witte, hooge and vanbelle (2010) developed a model which focuses on unemployed people’s affective experiences (wellbeing), cognitions (attitudes towards work), and behaviours relating to unemployment (job application behaviours). the model by de sajems ns 15 (2012) no 3 237 witte et al. (2010) was applied in europe to aid understanding of the attitudes to work, affective experiences, and behaviours of unemployed people, but it has not yet been applied in south africa. 2.1 affective experiences of unemployed people the affective experiences of unemployed people are relevant to their well-being. the latent deprivation theory (jahoda, 1982) is the most influential for understanding the affective experiences of unemployed people (wanberg, 2012). jahoda argued that employment has not only the manifest function of earning a living, but also five latent functions. deprivation of the latent functions has a negative impact on psychological well-being. these latent functions, which are associated with the satisfaction of basic human needs, include the establishment of a daily time structure, provision of regular shared experience and contacts outside the nuclear family, information on personal identity, a link with the collective purpose and the enforcement of regular activity (jahoda, 1982). according to jahoda (1982), adults need clear time structures and the possibility of filling their days with planned activities. the absence of such a structure results in boredom and waste of time. people also need regular shared experience and contacts outside the nuclear family. these cannot be replaced by the intensification of family life, because they provide more information and more opportunities for judgement and rational appraisal of other human beings with their unique perspectives. information about personal identity is shaped by people’s social status, which depends on the society in which they live. people tend to see themselves as others see them, but unemployed people see themselves as having no status at all, which is detrimental to their well-being. furthermore, people need a collective purpose that transcends individual purposes, as well as the feeling of being useful, and being needed by other people. if there is no collective purpose, the result will be purposelessness and meaninglessness. finally, regular activity is an important determinant of personal well-being. studies have shown that unemployed people tend to report less access to the latent functions than do those employed, while those with less access generally experience lowered physical and psychological well-being (creed & macintyre, 2001; creed, muller & machin, 2001; evans & haworth 1991; haworth & ducker 1991; mckee-ryan et al., 2005; paul & batinic, 2009; wanberg, griffiths & gavin, 1997). it seems that the latent functions might be partially provided in activities other than employment, such as meaningful leisure activities or attending work-related training (creed, hicks & machin, 1998). warr (1987) has developed the vitamin model, which is similar in many respects to jahoda’s (1982) model. according to warr (1987), insufficiency or excess of nine environmental features are responsible for psychological wellbeing. the nine features, which largely mirror jahoda's six consequences, are: opportunity for control; use of skills; interpersonal contact; external goal and task demands; variety; environmental clarity; availability of money; physical security; and valued social position. based on warr’s (1987) approach, it would be inappropriate to suggest that unemployment is inevitably destructive or that employment is inevitably constructive: “... the impact of the transition from paid work to unemployment will be a function of changes which occur in the nine primary environmental features. in most cases, these shifts will impair mental health, but the transition can sometimes be neutral or even beneficial in its effect” (warr, 1987:355). according to herbert, drebing, mueller and van ormer (2006), the effects of employment and unemployment can be analysed in terms of benefits and costs. the benefits of employment include income benefits; having structured time; contact with other people; and a sense of identity, both individual and collective (jahoda, 1982). potential costs associated with working include increased stress and the loss of leisure time. on the other hand, some benefits of unemployment include increased leisure time or time for other life activities. the costs of unemployment include financial stress, isolation and low self-esteem (feather, 1990; price, choi & vinokur, 2002; winefield, winefield, tiggeman & goldney, 1991). comparative analyses indicate that the type of job search motivation people experience is 238 sajems ns 15 (2012) no 3 an important predictor of their unemployment experience and well-being (vansteenkiste, lens, de witte & feather, 2005). feather and bond (1983) found a positive association between levels of self-esteem and the structured, purposeful use of time. further, unemployed respondents (in comparison with employed respondents) showed less engagement, less direction, and less routine in their use of time. winefield, tiggeman and winefield (1992) also found that engaging in purpose ful activities relieves the stress associated with both unemployment and unsatisfactory employment. 2.2 unemployed people’s attitudes towards work unemployed people’s attitudes towards work can be studied in terms of the importance they attach to work. in the unemployment literature, this has been studied in terms of work involvement or employment commitment (warr, cook & wall, 1979), the protestant work ethic (mirels & garrett, 1971), and the valence of work (feather, 1990). warr et al. (1979:130) define employment commitment as “the extent to which a person wants to be engaged in work”. employment commitment (also referred to as work-role centrality) indicates the importance of work to an individual’s sense of self (mckee-ryan et al., 2005). work-role centrality may stem from protestant work ethic socialisation or from a belief that engaging in activities such as work has a lasting effect on an individual’s life satisfaction (paul & moser, 2006; seligman, 2002). work gives people the opportunity of using their strengths in the service of something larger than the self, which contributes to meaning in life (peterson, park & seligman, 2005; seligman, 2002; wrzesniewski, mccauley, rozin & schwartz, 1997). paul and moser (2006) found that the employment commitment of both employed and unemployed people was high. however, employed people showed a marginally stronger level of employment commitment. basing their approach on consistency theory (grawe, 2004), paul and moser (2008) explain the unwellbeing, psychological distress and dissatisfaction of unemployed people in terms of the incongruence between their goals and their perceived goal attainment. individuals who are strongly committed to work will see their job search as incongruent if it is unsuccessful, with detrimental consequences. employment commitment could mitigate or buffer the negative consequences of unemployment (fryer & fagin, 1993; fryer & payne, 1984). 2.3 job application behaviours of unemployed people studies of the predictors of job search among unemployed people have often used an attitude-behaviour model (van hooft, born, teris, van der flier & blonk, 2004). according to the theory of reasoned action, the immediate antecedent of job search behaviour is the intention to look for a job (van hooft et al., 2004). job search intention in turn is predicted by a person’s adhering to a positive or negative evaluation of job search behaviour and the perception that there is social pressure to look for a job. furthermore, in the context of job seeking, individuals’ perceived control over their actions affects their perceptions of control over job seeking behaviour, such as when people are not sure how to apply for a job or even how to write a letter of application (van hooft et al., 2004). active job search is a form of problemfocused coping (mckee-ryan et al., 2005), and is an important predictor of reemployment (kanfer, wanberg & kantrowitz, 2001). mckee-ryan et al. (2005) point out that active job seeking behaviour is often associated with decreased well-being, particularly because job seeking is often discouraging, with its associations with rejection and uncertainty. individuals who are actively seeking a job might feel pressured to accept almost any job, including one of low quality. according to de witte et al. (2010), reducing the value of work might become a coping strategy for decreasing the negative experiences associated with unemployment. 2.4 the effects of demographic factors the demographic group in which unemployed people find themselves might affect their experiences, attitudes and behaviours (kingdon & knight, 2004). six demographic factors were relevant to this study: gender, race, age, sajems ns 15 (2012) no 3 239 qualification, time unemployed and employment history. race might affect the experiences, attitudes and behaviours of unemployed people, especially because african, coloured and indian people have traditionally been the victims of discrimination in south africa. according to the national planning commission (2011), decades of racial discrimination have confined black people to menial labour, poor wages, poor-quality schooling and low levels of income. as pointed out by wanberg (2012), differential skills, location and discrimination by employers affect unemployment rates, which could also impact on the experiences, attitudes and behaviours of those discriminated against. according to kingdon and knight (2004), young and uneducated african people living in rural areas are the most vulnerable to unemployment. the writers point out that rural unemployment rates are higher than urban rates, which is atypical of other countries and is explained by historical policies restricting mobility. also, many unemployed people in south africa have never held a job. however, expanding education and skills development will reduce overall unemployment (wanberg, 2012). unemployed males and females might differ regarding experiences, attitudes and behaviours for various reasons. first, males might be more inclined to experience unemployment negatively because of the sex role stereotypes that make males the breadwinners. second, females might find it more difficult to get jobs because of gender discrimination, which could affect their affective experiences (wanberg, 2012). when it comes to age, older people might experience unemployment more negatively than younger people do, especially if they find it difficult to get a job (wanberg, 2012). according to a diagnostic overview by the national planning commission (2011), unemployment is experienced mostly by young people (15-34 years), who are also poorly prepared for work. de witte et al. (2010) found that people who were unemployed in the short term experienced more psychological distress, showed more employment commitment and applied for jobs more often than those who were unemployed in the long term. they attributed these findings to an adaptation process that took place in long-term unemployed people whereby their psychological well-being increased after a while. however, these findings should be interpreted with caution, given that the unemployment contexts in south africa and belgium differ. for instance, unemployment in south africa is accompanied by poverty and the absence of social grants and other forms of support from the government. previous employment experience is an important factor affecting the experiences, attitudes and behaviours of unemployed people. such experience might have empowered the individual with job-specific skills and competencies, but could also have resulted in the level of knowledge and skills required to work with others in an organisational context (national planning commission, 2011; wanberg, 2012). 3 research objective the objective of this study was to investigate the attitudes to work, affective experiences and job application behaviour of unemployed people in the potchefstroom area of the north west province. the following hypotheses are set, based on the discussion above: hypothesis 1: people in various race groups differ in their experiences of unemployment, the importance of work and job application behaviours. hypothesis 2: males and females differ in their experiences of unemployment, the importance of work and job application behaviours. hypothesis 3: people with different qualifications differ in their experiences of unemployment, the importance of work and job application behaviours. hypothesis 4: people in different age groups differ in their experiences of unemployment, the importance of work and job application behaviours. hypothesis 5: people with different employment histories differ in their experiences of unemployment, the importance of work and 240 sajems ns 15 (2012) no 3 job application behaviours. hypothesis 6: people who have been unemployed for a longer period differ from those who are unemployed for a shorter period in their experiences of unemployment, the importance of work and job application behaviours. 4 method 4.1 research design a cross-sectional survey design was used to investigate the psychological experiences of unemployed people (howell, 2008). the research is exploratory and descriptive because very limited research has been carried out on the experiences of unemployed people in south africa. 4.2 participants the total population is a stratified sample of individuals who were unemployed at the time of the study (n = 381). the participants were sampled from three areas: potchefstroom (mainly white = 21 per cent), promosa (coloured = 54 per cent) and ikageng (african = 24 per cent). the population consisted of both females and males, whether married, single, divorced, widow or widowered. the majority of the respondents fell between the ages of 17 and 30 years (54.4 per cent), with the minority (7.0 per cent) of respondents being older than 50 years. the participants’ characteristics are reported in table 1. t a b l e 1 characteristics of participants (n=381) variable item percentage gender male 53.5 female 45.7 language afrikaans 65.4 african 33.8 english 1.8 qualification grade 8 and lower 22.8 grade 9-10 31.8 grade 11-12 36.2 diploma and/or degree 9.2 age 17-30 years 57.3 31-40 years 24.9 41-50 years 11.6 51years and older 6.27 employment history almost always employed 24.1 occasionally employed 24.9 as much employed as unemployed 7.9 almost always unemployed 20.5 unemployed most of the time 20.2 time unemployed 1 year or less 26.5 2 years 23.9 3 years 16.0 4 years 10.2 5 years 6,6 6 years 5.5 7 years or more 11.3 the majority of the participants were male (53.5 per cent), preferred afrikaans as the language of communication (65.4 per cent), and were single (70.6 per cent). a total of 57.3 per cent was between 17 and 30 years of age. further, 24.9 per cent of the participants were sajems ns 15 (2012) no 3 241 occasionally employed and 20.5 per cent of them were almost always unemployed. a total of 11.3 per cent had been unemployed for longer than 7 years. 4.3 measuring instrument the experiences of unemployment questionnaire (euq) was developed to measure the participants’ experiences, behaviour and wellbeing for the purposes of this study. the euq was developed according to the model and questionnaire by de witte et al. (2010). in line with the conceptualisation in this study, the euq included questions concerning unemployed people’s affective experiences, attitudes towards work, and job application behaviour. the questionnaire was divided into four sections. section 1 gathered demographic information, including gender, home language, marital status and highest qualification. the three dimensions (i.e. affective experiences, the attitude to work, and job application behaviour) were measured in the next three sections by a short-cut to the variable (i.e. a brief question summarising the issue), a list of items, and a question on the evolution of the specific concept, in order to establish whether or not it remained stable over time. section 2 focused on the affective experiences of the unemployed person. the items were developed on the basis of jahoda’s (1982) model, and adapted according to research in the netherlands and belgium (de witte et al., 2010). the participants were asked to indicate the extent to which their typical day was filled with content or activity (regular activity); their life was temporally organised and structured (time structure); they were meeting people and socialising (shared experience); they felt they were useful members of society (collective purpose); they were appreciated by other people (status); and felt confident and self-respected (personal identity). for instance, one question was: “how does it feel to be unemployed?” which should be answered on a scale ranging from 1 (very pleasant) to 5 (very unpleasant). another question was: “how often do you experience the following?: feelings of boredom; difficulty surviving financially; uncertainty about the future; saving on personal expenditure; feeling lonely and empty; experiencing conflict; decreased self-confidence and self-esteem; how to use time; extent of social support; not feeling part of society; and feeling relaxed. a three-point scale was used, varying from 1 (often) to 3 (never). also included was a question that tapped into the temporal dimension of unemployment (“how do you feel about being unemployed?”), on a scale ranging from 1 (feel better than before) to 4 (never felt bad). section 3 focused on the importance of work. the participants’ desire to be in paid employment was assessed through the employment commitment scale of warr et al. (1979). typical questions were: “how important is it to have a job?” with an answer scale ranging from 1 (very important) to 5 (very unimportant) and “how do you feel about not having a job at this moment?” with an answer scale ranging from 1 (job became more important) to 4 (job was never important). section 4 focuses on job application behaviour. questions include: “when would you like to find a job?” with an answer scale ranging from 1 (within a month) to 7 (never), and “when do you expect to find a job?” with an answer scale ranging from 1 (within a month) to 7 (never). job application behaviour was measured by presenting five different behaviours (e.g. “search for advertisements”) which had to be scored according to the frequency of behaving in this way in the recent past (scale ranging from 0 (never) to 5 (10 times or more). 4.4 procedure the study, which formed part of a larger project on experiences of unemployment in the north west province, was initiated during 2005 after discussions with the executive mayor of potchefstroom (in the north west province). the project was planned during 2006 and funding was obtained from the national research foundation. during june 2006, the researchers implemented the project. literature searches were conducted, while there were interviews and focus groups to develop the questionnaire in english. it was then translated into afrikaans and setswana by professional translators. a process of backtranslation ensured that the meaning of the 242 sajems ns 15 (2012) no 3 words in the different languages was the same throughout. thereafter, questionnaires were presented to experts to be checked for face validity and final changes were made. three fieldworkers (who were able to speak afrikaans, english and/or tswana) were used to administer the questionnaires. the researchers, assisted by language practitioners, trained the fieldworkers prior to the data gathering. fieldwork took place during july 2006. unemployed people were randomly selected via door-to-door selection in different areas of the town and neighbourhoods. given the poor educational qualifications of most unemployed people, field workers conducted structured interviews with all the participants and their responses were recorded on the questionnaires. the data were captured by a computer program and checked for mistakes. finally, the data set was prepared for statistical analysis. 4.5 statistical analysis the statistical analysis was carried out with the help of the spss program (spss inc., 2009). descriptive statistics (frequency tables) were used to analyse the data. a frequency table lists items together according to the number of times, or frequency, the items occurred. exploratory factor analyses and cronbach alpha coefficients were used to assess the validity and reliability of the constructs measured in this study. one-way analysis of variance (anova) was used to determine the significance of differences between the scores of the demographic groups. 5 results 5.1 descriptive statistics, factor analysis and reliability affective experiences of unemployed people most of the participants (59.6 per cent) experienced unemployment as very unpleasant. only 8.7 per cent of the participants reported that it felt pleasant or very pleasant to be unemployed. furthermore, 72.7 per cent of the participants reported that they felt worse than before because they did not have a job. a total of 5.2 per cent of the participants reported that they never felt bad about being unemployed. table 2 shows the experiences of unemployed people in more detail. t a b l e 2 specific experiences of unemployed people item often (%) sometimes (%) never (%) feelings of boredom 70.6 21.5 4.2 difficulty in surviving financially 68.8 22.0 7.3 saving on personal expenditure 64.8 21.0 12.6 uncertain about the future 61.9 26.5 8.9 feel life is empty 54.3 30.4 12.9 feel lonelier since unemployed 53.3 28.3 13.9 have conflict at home 52.5 24.6 17.3 know how to spend time 51.7 28.9 17.8 decreased self-worth/self-esteem 49.1 31.5 16.8 lost self-confidence 45.9 24.7 27.3 no longer part of society 44.9 31.5 16.3 spend time with family 36.4 42.0 15.5 can finally do things 38.8 37.5 21.0 feel relaxed 29.7 31.5 36.5 social support 22.8 24.7 50.4 like the leisure time 21.8 37.5 38.6 table 2 shows that a large percentage of participants experience boredom; difficulty in surviving financially; saving on personal expenditure; and uncertainty about the future. a relatively large number of participants experienced feelings of emptiness and lonesajems ns 15 (2012) no 3 243 liness; poor social support; conflict at home; and low self-esteem and self-confidence. interestingly, a substantial percentage of the participants felt that they were no longer part of society; never felt relaxed when unemployed; and did not know how to spend their time since being unemployed. advantages of being unemployed included doing things they wanted to do and spending time with their families. unemployed people’s commitment to work a total of 74.8 per cent of the participants reported that having a job became more important than before, while only 8.9 per cent reported that it was less important. table 3 shows the evaluation of the items measuring employment commitment. t a b l e 3 employment commitment on the part of unemployed people item agree partly agree disagree work contributes to a meaningful life 87.7 7.6 3.9 find it important to have work 85.3 10.0 3.1 work is the most important aspect of life 71.1 5.5 5.5 better to accept any job than to be unemployed 70.6 21.8 6.0 enjoy leisure time only if you have worked for it 68.8 15.7 13.6 have to work to be really part of society 62.5 23.9 11.3 do not have to work to be constructively occupied 33.1 36.7 27.8 table 3 shows that most of the participants reported that work contributed to a meaningful life. a large percentage of the participants found it important to have work. indeed, a large number of participants regarded work as the most important aspect of life. in fact, 70.6 per cent agreed that it was better to accept any job than to be unemployed. in addition, most of the participants reported that they could enjoy leisure time only if they had worked for it and that they had to work to be part of society. job application behaviour of unemployed people a total of 62.5 per cent of unemployed people looked for work at least once a week, while only 6.6 per cent were not looking for a job at the time of the interview. furthermore, 60 per cent of the participants were making more effort than before to find jobs, while 15.2 per cent were making less effort, and 3.7 per cent had not looked for a job at all. the job-seeking behaviours of unemployed individuals are reported in table 4. t a b l e 4 job application behaviour of unemployed people (past three months) item category percentage asked anyone if work is available 10 times or more 47.5 6-9 times 11.5 3-5 times 20.5 once or twice 12.3 never 16.3 searched for advertisements 10 times or more 45.9 6-9 times 12.9 3-5 times 12.6 once or twice 13.4 never 13.4 submitted applications 10 times or more 42.0 6-9 times 13.1 3-5 times 17.1 244 sajems ns 15 (2012) no 3 once or twice 16.5 never 8.9 enquired whether work was available 10 times or more 39.9 6-9 times 14.7 3-5 times 21.8 once or twice 16.5 never 4.2 spontaneously presented myself to potential employers 10 times or more 33.1 6-9 times 9.5 3-5 times 18.6 once or twice 28.9 never 9.2 table 4 shows that 47.5 per cent of unemployed individuals had inquired whether work was available 10 times or more. a total of 45.9 per cent of the participants had searched for advertisements 10 times or more. only 42.0 per cent of the participants had submitted applications 10 times or more. table 5 indicates unemployed individuals’ expectations as to finding a job. t a b l e 5 unemployed individuals’ expectations as to finding a job item category percentage time preferred working within a month 87.1 within 3 months 7.1 within 6 months 1.3 within 6 months to 1 year 1.0 within 1 year to 2 years 0.8 after 2 years 0.5 never 2.1 expecting to work within a month 75.6 within 3 months 11.5 within 6 months 3.1 6 months to 1 year 2.4 within 1 year to 2 years 0.8 after 2 years 1.6 never 3.9 anything to find during the last month every day go out and ask for a job 42.3 once, twice or three times ask for a job 34.6 once or twice a month ask for a job 15.5 not looking for a job 6.3 table 5 shows that 87.1 per cent of the participants would prefer to find a job within a month. further, 75.6 per cent expected to find work within a month. 42.3 per cent of the participants asked for a job every day, with 34.6 per cent asking once, twice or three times, while 6.3 per cent were not looking for a job at that time. only 4.2 per cent of the participants never enquired about the availability of work, while 9.2 per cent never presented themselves for work. factor analysis exploratory factor analysis was used to explore the factor structure of the euq. a simple principal component analysis was carried out on the 26 items of the euq. an analysis of the eigenvalues (> 1.00; sajems ns 15 (2012) no 3 245 tabachnick & fidell, 2007) indicated that four factors explained 45.65 per cent of the variance. the scree plot confirmed that four factors could be extracted. a principal factor analysis with a direct oblimin rotation was then performed. the results of the principal factor analysis with loadings of variables on factors and communalities (h2) are shown in table 6. items were retained for further analyses if their factor loadings were higher than 0.30 (tabachnick & fidell, 2007). t a b l e 6 pattern matrix of the euq item factor 1 factor 2 factor 3 factor 4 h2 decreased self-worth/self-esteem 0.72 -0.00 -0.00 -0.01 0.52 lost self-confidence 0.70 0.06 -0.03 0.01 0.48 is no longer part of society 0.69 -0.04 0.01 -0.10 0.51 feel life is empty 0.67 -0.07 0.13 -0.05 0.54 uncertain about the future 0.66 0.01 -0.07 -0.08 0.43 have conflict at home 0.61 -0.10 0.06 0.08 0.44 feel lonelier since unemployed 0.51 -0.05 0.09 -0.03 0.30 feelings of boredom 0.34 -0.12 0.12 -0.15 0.22 enquired if work is available -0.14 0.82 0.03 -0.07 0.69 asked anyone if work available -0.06 0.69 0.09 0.03 0.48 spontaneously presented myself to employer -0.21 0.67 0.03 -0.15 0.49 submitted applications 0.11 0.63 -0.10 0.14 0.46 searched for advertisements 0.11 0.41 -0.06 0.20 0.24 work contributes to a meaningful life -0.08 -0.06 0.60 -0.08 0.36 better to accept any job than to be unemployed 0.14 0.10 0.60 0.04 0.42 work is the most important aspect of life 0.12 -0.02 0.59 0.07 0.40 enjoy leisure time only if you have worked for it 0.16 0.07 0.57 0.02 0.40 find it important to have work -0.11 0.04 0.46 -0.16 0.40 have to work to really be part of society 0.37 0.07 0.42 0.20 0.41 save on personal expenditure 0.01 -0.05 0.15 0.05 0.03 social support -0.00 0.18 0.05 0.60 0.44 can finally do things -0.05 -0.06 -0.03 0.50 0.26 like the leisure time 0.06 0.18 0.01 0.50 0.31 feel relaxed 0.05 0.04 -0.08 0.47 0.24 spend time with family -0.14 -0.04 0.08 0.36 0.15 know how to spend time -0.16 -0.05 -0.02 0.22 0.08 eigenvalue 4.99 3.00 2.01 1.87 per cent of variance 19.20 11.53 7.72 7.20 table 6 shows that four factors were extracted. the first factor, negative experiences, included items such as decreased selfworth/self-esteem; loss of self-confidence; feeling disconnected from society’; feelings of emptiness; uncertainty; conflict; loneliness; and ;boredom. the second factor, application behaviour, included items which described behaviours triggered by unemployment, e.g. enquiring whether work was available and spontaneously presenting themselves to possible employers, submitting applications and searching for advertisements. the third factor, importance of work, referred to the value of work in a meaningful life and to feeling part of society. the fourth factor, positive experiences, included items about the benefits of unemployment in terms of social support, time for family, relaxing and leisure time. two items, “know how to spend time” and “save on personal expenditure”, showed low communalities, indicating that these items 246 sajems ns 15 (2012) no 3 were not well-represented by the extracted factors. descriptive statistics the descriptive statistics, alpha coefficients and pearson correlations of the scales of the euq are reported in table 7. the minimum and maximum values are included to facilitate the interpretation of the mean scores. further, internal consistencies and correlations of the scales are reported to assist in forming reliable dimensions that could be used when comparing demographic groups. further, the correlations between dimensions were computed to assess whether multivariate analysis of variance (manova) or one-way analysis of variance (anova) should be used to study differences between demographic groups. manova is recommended when the scales are at least moderately related (tabachnick & fidell, 2007). t a b l e 7 descriptive statistics, alpha coefficients and correlations of the scales item mean sd min max α 1 2 3 1. negative experiences 1.56 0.48 1.00 3.00 0.85 2. positive experiences 2.02 0.48 1.00 3.00 0.60 -0.16* 3. importance of work 1.31 0.38 1.00 3.00 0.73 0.42*+ -0.00 4. application behaviour 2.63 1.02 0.00 4.00 0.78 -0.19* 0.25* -0.05 * p < 0.01 table 7 shows that the alpha coefficients of the scales were acceptable, except for positive experiences, which was lower than the cut-off value of 0.70 (nunnally & bernstein, 1994). the pearson correlations show a statistically significant correlation between the importance of work and negative experiences. statistically, application behaviour is significantly and negatively related to negative experiences of unemployment. application behaviour is related to positive experiences of unemployment. given the small correlations between some of the scales, it was decided to use anova rather than manova in the subsequent analyses. differences between biographical groups anova followed next to investigate the relationship between affective experiences, the importance of work and application behaviour of various groups, including race, gender, age, qualification, time unemployed and employment history. the results of these comparisons are reported in table 8. t a b l e 8 anova of the unemployment experiences of biographical groups negative experiences positive experiences importance of work application behaviour item f p f p f p f p gender 0.01 0.92 1.19 0.28 0.60 0.44 0.96 0.33 race 0.93 0.40 1.97 0.14 2.37 0.10 0.40 0.67 age 1.65 0.18 0.23 0.88 2.80 0.04 2.29 0.08 qualification 4.79 0.00* 2.61 0.05 7.08 0.00* 2.64 0.05 time unemployed 0.86 0.53 2.75 0.02 2.25 0.04 2.51 0.02 employment history 1.62 0.17 2.93 0.02 1.32 0.26 1.57 0.18 * p < 0.01 table 8 reflects the significant effect of qualification on the negative experiences of unemployment (f(3, 317) = 4.79, p < 0.01; η 2 = 0.04). although the extent of the effect was small (4 per cent of the variance explained), the results showed that people with a qualification of grade 8 and lower (mean = 1.42, sd = 0.39) experienced unemployment sajems ns 15 (2012) no 3 247 more negatively than did people with grade 11 and 12 (mean = 1.68. sd = 0.50). qualification also had a statistically significant effect on the importance of work (f(3, 317) = 7.08, p < 0.01; η2 = 0.06). although the effect size was small (6 per cent of the variance explained), the results showed that people with grade 8 and lower (mean = 1.18. sd = 0.32) and people with grade 9 and 10 (mean = 1.29. sd = 0.38) found work to be more important than did people with grade 11 and 12 (mean = 1.40, sd = 0.40). based on these findings, only hypothesis 3 is partially accepted. table 8 shows that no statistically significant differences were found between the affective unemployment experiences, the importance of work and application behaviour of different race groups (hypothesis 1), males and females (hypothesis 2), different age groups (hypothesis 4), different employment history (hypothesis 5) and different periods of time unemployed (hypothesis 6). these hypotheses are rejected. the reason why few differences between affective unemployment experiences, importance of work and application behaviour demographic groups were found is that most unemployed people experience unemployment intensely negatively, they regard work as important and they reported strong application behaviour. 6 discussion the objective of this study was to investigate the attitudes to work, affective experiences and job application behaviour of unemployed people in the potchefstroom area of the north west province. exploratory factor analysis resulted in four factors, i.e. negative and positive experiences of unemployment, the importance of work and job application behaviour. qualification affected negative experiences of unemployment and the importance of work. compared with people who had higher schooling levels, those with less schooling experienced unemployment more negatively and found work to be more important. when it came to the participants’ affective experiences, the results showed that more than 80 per cent of them experienced unemployment as unpleasant. boredom, uncertainty about the future, concerns about financial matters, emptiness, and conflict seemed to contribute to the unpleasantness. regarding the participants’ cognitive experiences (importance of work), the results showed that almost 96 per cent of them regarded work as important, especially because it gave meaning. the results clearly indicated that participants would like to find jobs within a month. the results of this study showed that four factors, negative experiences of unemployment, positive experiences of unemployment, the importance of work and job application behaviour represented the constructs in this study. these factors, which correspond to the three factors reported by de witte et al. (2010), can be defined as follows: negative affective experiences of unemployment refer to decreased self-worth/self-esteem; loss of selfconfidence; feeling disconnected from society; and feelings of emptiness, uncertainty, conflict, loneliness and boredom. such negative affective experiences are associated with the deprivation of latent functions, such as the establishment of a daily time structure; provision of regular shared experience and contacts outside the nuclear family; information on personal identity; a link with the collective purpose; and enforcement of regular activity (jahoda, 1982). studies (creed & macintyre, 2001; creed et al., 2001; evans & haworth, 1991; haworth & ducker, 1991; mckee-ryan et al., 2005; paul & batinic, 2009; wanberg et al., 1997) showed that unemployed people reported less access to the latent functions than those who were employed, and that those with less access generally experienced lowered psychological well-being. the negative affective experiences of unemployed people in this study correlate with the abovementioned theoretical explanation and empirical results. the results showed that unemployment was experienced as unpleasant by almost all the participants, and only a small percentage experienced it as pleasant. negative affective experiences included boredom, finding it difficult to survive financially, uncertainty, loneliness and emptiness. positive experiences included spending time with family and doing things that were valued (but only 40 per cent of the participants). these findings correlate with international findings on the topic (e.g. de 248 sajems ns 15 (2012) no 3 witte et al., 2010; wanberg, 2012). the profile for the affective experiences of unemployment in south africa is thus not much different from that found internationally. jahoda (1982) maintained that time structure is an important latent benefit of work. indeed, boredom proved to be the experience with the highest frequency in this study. a study by møller (1993) also concluded that some respondents often or sometimes “just sit around”, while most of them admitted that they were bored. boredom and despair were often associated with the descriptions of respondents’ own activity schedule (møller, 1993). the loss of self-esteem was another issue experienced by the participants in this study. the loss of self-esteem among the unemployed is thought to be a reflection of both society and the individual, and the loss of it may be felt more intensely when one’s self-definition is derived mainly from one’s occupation (møller, 1993). the study confirmed that people need to work if they are to save on personal expenditure and, according to møller (1993), some people had a regular source of income from either employed relatives or self-employment. they stated that their household expenditure was limited to basic necessities (møller, 1993). the financial implication of unemployment was also a very important theme. a high percentage of the participants reported that they found it difficult to survive financially and that they had to save on personal expenditure. this was because they had no money to fulfil their basic needs. the example is illustrated by møller (1993), who argues that the respondents described how unemployed people borrowed, begged and stole to make ends meet, while reference was made to “borrowing” from family members with the intention of returning the loan. however, it appeared that loans would effectively become gifts when the unemployed were not in a position to repay the amounts borrowed (møller, 1993). singer, stacey and ritchie (2001) have argued that, if a person is unemployed, they have little money, they cannot afford to do things and they cannot provide financial help for others. the study also established that social support was experienced negatively. in the study by kelvin and jarrett (1985), it is stated that the family sees the male unemployed as ‘having a problem’, to which extent he is a problem to them and they may see him as ‘less-than-the-man-he-was’, sympathetically or disdainfully, depending on earlier issues. however, other people who are unemployed receive support from friends and seek help from them. studies also concluded that, in general, unemployment stress is exacerbated by a low sense of social support (linn, sandifer & stein, 1985). gore (1978) found that the rural unemployed evidenced a significantly higher level of social support than did the urban unemployed. where domestic circumstances were positive, the family could continue to provide loving support for its members, regardless of the bad times (møller, 1993). participants in the current study showed that they felt worse than on the previous occasions when they were unemployed, and only a few never felt bad about it. in her study, møller (1993) argued that the euphoria and short-lived feeling of freedom after losing one’s job may be perceived as a feeling of independence and liberation from the many constraints of working life. however, when work is a central value and gives meaning to all the other aspects of life, job loss may have devastating effects (møller, 1993). that is why most of the participants felt worse at being unemployed. the importance of work is defined as unemployed people’s cognitions of the value of work in terms of a meaningful life and the feeling of being part of society. the results of this study showed that most unemployed people indeed wanted to be engaged in work (warr et al., 1979). work does not just give people the opportunity of using their strengths in the service of something larger than the self (peterson et al., 2005; seligman, 2002; wrzesniewski et al., 1997). a total of 70 per cent of the participants reported that they would do any job rather than be unemployed. it is seen as important to work in order to enjoy leisure time and to be part of society. jobs have become more important than before, according to the participants. almost all the participants regarded work as important, and most saw it as meaningful. to them, it meant that they had to work in order to find purpose in life and they were motivated by the determination to find meaning. victor frankl sajems ns 15 (2012) no 3 249 (1985), the well-known holocaust survivor maintained that finding meaning in life is important for the individual’s well-being. work is thus regarded as an important factor in finding meaning in life. the above findings show that most of the participants had made more effort than before to find work, which means that people search desperately for a job, regardless of what kind. some of the participants had asked anyone they could came across whether work was available. other studies also confirmed that people in search of a job had stated that their search would become as important as they wanted it to be (van hooft et al., 2004). in addition, there is the ‘contact’ in the shape of a third person, a relative or a mutual acquaintance, who becomes an intermediary between the job-seeker and the employer (kelvin & jarrett, 1985). this is true, because in the current study, people had asked their friends, as well as presenting themselves to possible employers in the effort to find a job. application behaviour includes efforts by unemployed people to enquire whether work is available, spontaneously presenting themselves to possible employers, submitting applications for work and searching for advertisements. when it came to job application behaviour, the results showed that most participants would have liked to find a job within the following month, and they also expected to do so in that time. most of them had asked friends and acquaintances for employment information, but they also reported that they looked for advertisements. there are four possible interpretations of this puzzling finding. first, it is possible that participants answered the question in a socially appropriate way. second, they might have experienced unrealistic optimism. third, they might possibly have felt that others and society in general expected that they should find a job soon. fourth, time might be seen from a different perspective in the african context, and may have a different meaning. the analyses showed that qualification was the only demographic factor affecting experiences of unemployment and the importance of work. more specifically, people who had 10 years of schooling or less found work to be more important than those with 11 to 12 years of schooling. further, people with eight years or less schooling experienced unemployment more negatively than those with more than eight years of schooling did. people with poor education were more inclined to experience decreased self-worth; loss of self-confidence; not being part of society; emptiness; uncertainty about the future; conflict at home; loneliness and boredom than were people with better education. furthermore, people with poor education were more inclined to believe that work contributed to a meaningful life, and that it was better to accept any job at all rather than be unemployed; work is the most important aspect of life; one could enjoy leisure time only if one had worked for it; it was important to find a job; and one had to work if one was to really be part of society. although access to and participation in education have improved since 1994, many individuals had poor educational opportunities and the quality of education is also problematic (national planning commission, 2011). the fact that gender, age, employment history and the length of time unemployed did not affect experiences of unemployment, the importance of work and job application behaviour indicates the pervasive effects of unemployment in the south african context. this study had various limitations. first, the study was conducted in the potchefstroom area of the north west province. the findings can therefore not be generalised to other towns in the province or south africa as a whole. second, this study made use of a cross-sectional design to study the effects of unemployment on people. longitudinal studies are needed to study the causal effects of unemployment on individuals. unemployed individuals with lower levels of mental health than those of the employed comparison group do not necessarily have lower levels of mental health as a consequence of the unemployment (mckeeryan et al., 2005). instead, it is possible that individuals with lower levels of mental health are more likely to lose their jobs or that individuals with higher levels of mental health are more likely to find new jobs (warr, jackson & banks, 1988). therefore, while the causal relationship between unemployment and poor well-being has been documented, more research is needed to verify such relationships. 250 sajems ns 15 (2012) no 3 7 recommendations based on the results of this study, three recommendations are made. first, there is an urgent need to expand the cover of social security in south africa. the injection of cash into poor households is probably one of the most empowering ways of assisting poor people to strengthen their own coping mechanisms. second, programs should be implemented to stimulate economic growth, job creation and skills development. investment in infrastructure has a huge potential to redress the high unemployment and poverty levels in south africa and also to correct the skills shortages (thwala, 2008). third, programs should be implemented to assist unemployed people in coping with unemployment and improving their application behaviour. wanberg (2012) showed that poorer psychological health reduced the speed of reemployment. the government could also provide training for people who really want employment in order to enhance the skills necessary in the work situation, which would assist them in coping better with unemployment. productive activities are lacking in the lives of the unemployed, and if they were given 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hargarter, gary van vuuren received: 06 aug. 2015; accepted: 13 jan. 2017; published: 30 mar. 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the substantial penalties imposed on banks in the recent past for various conduct irregularities have given rise to a new type of risk called conduct risk. conduct risk comes about when financial services companies conduct themselves in an inappropriate way towards their customers, resulting in a negative (economic) outcome for the customer. what makes the management and mitigation of conduct risk by banks so different is that it cannot be easily integrated into a bank’s standard risk management framework. so far, the concept of conduct risk has not been formally covered by the basel accords. aim: there are, however, global efforts by international organisations and local regulators to control it – with little clarity on the ‘how’. the aim of this study is to explore this ‘how’. setting: while regulators need to protect customers, resulting in a positive outcome for the customer, they must also ensure that banks take conduct risk management and its mitigation seriously. at the same time, any regulatory model for conduct risk needs to be incorporated into the existing bank regulatory strategy and methodology and assimilated with the profile of a country. methods: an exploratory model that regulators could use to keep conduct risk at bay is developed based on primary and secondary data and this is then applied to the south african, kenyan and malaysian milieus to determine what can be learnt about conduct risk in emerging economies. results: the model investigates the interrelationships between different goals that regulators ideally need to achieve and the findings show that regulators have a difficult task balancing these goals and at the same time achieving a positive outcome. conclusion: based on the model, the recommendation for regulators in the developing world would be to collaborate in their approach to conduct risk, as they might face similar difficulties and operate in a comparable context. introduction banking can be traced back to the 18th century bc when the first records of loans were found (gascoigne 2001). banking institutions fund themselves with public deposits, and they then lend out these funds to debtors. this is one of the reasons that the regulation of banks, more so than other industries, is crucial. the bank for international settlement’s basel committee on banking supervision (the bcbs) works globally to establish minimum global regulatory and supervisory standards, with the goal of enhancing financial stability (bis 2014). the risks covered by the various iterations of the so-called basel accords (i, ii and iii) are credit, operational and market risk – liquidity risk was recently added (bcbs 2006, 2011). the concept of conduct risk has not been formally covered by the basel accords. there are, however, global efforts by international organisations and local regulators to control it. conduct risk surfaced after the global financial crisis of 2008/2009 (national treasury 2011). one example that highlights how important the concept of conduct risk has become globally is that the organisation for economic cooperation and development (oecd) expects all its members to integrate conduct risk into their regulatory approach (oecd 2011, 2013). in the standard approach to risk management, banks ask whether the risk is within appetite, whereas in the approach to conduct risk, banks ask how a scenario will look when risk appetite is breached (management solutions 2016). because the approach is slightly different, this new type of risk cannot be covered under operational risk only; it needs to be added to the general risk framework of banks and managed and mitigated accordingly (raj and sindhu 2013). in the last 3 years, many banks have received considerable fines based on conduct failure (fca 2015). as part of the eu-wide 2016 stress test, banks had to forecast operational risk losses using their internal models. fifteen european banks estimated the aggregate potential loss from conduct risk to be 71 billion euros for 2016–2018 (ccp 2016). this article presents the necessary background to the topic of conduct risk regulation for banks. a model is then constructed to show how regulation should be approached by the regulator in order to ensure effective market conduct regulation. case studies of developing countries are used to indicate whether such a model could be successful. in most countries, conduct risk regulation has either not been implemented at all or not for an extensive period. this research will provide direction, rather than pinpointing exact results. this article is organised as follows. the ‘introduction’ section presents an introduction to the concept of conduct risk and related concepts. the ‘literature review’ section covers the literature review. assembling an appropriate banking conduct regulatory model is covered in the ‘constructing an effective model for banking conduct risk regulation in developing countries’ section, and the model is then tested in the ‘testing the model: specific developing country examples’ section. the ‘conclusion and recommendations’ section provides a conclusion as to whether the proposed model could work, as well as recommendations for furthering this research. definitions conduct risk, from a bank’s point of view, is defined as ‘… the risk that detriment is caused to the bank, [our] customers, clients or counterparties because of the inappropriate execution of [our] business activities’ (barclays 2012:189). a distinction should be made between the conduct of business and financial market integrity, sometimes referred to as retail versus wholesale conduct risk (national treasury 2014). regulators differentiate between market conduct and consumer empowerment/protection. within market conduct, the focus is on the institutional framework and supervision, sales and marketing practices, fees and charges, lack of transparency and disclosure and responsible lending; whereas in terms of consumer empowerment/protection, the focus is on consumer financial literacy and awareness and avenues for help and redress (alliance for financial inclusion 2015). for the purpose of this research, effective bank conduct risk regulation means the following: the bank conduct risk regulation model is developed, with consideration to all relevant influencing criteria, and leads to a situation where banks are compliant (manage and mitigate conduct risk according to the laws and regulations set out). as a result, the outcome for customers is positive in the sense that they receive financial products/services that suit their needs. it should be mentioned at this point that the measurement of this outcome is challenging. the term ‘customer’ is used to refer to the client of a bank. the term ‘consumer’ is used in the context of consumer protection and education across industries. research philosophy, question and relevance the research methodology suggested for this type of research is inductive and exploratory (trochim 2006), as a model is developed that could constitute a new approach/theory. the main research question is: which influencing factors should regulators in developing countries take into consideration when constructing a (country-specific) regulatory approach for conduct risk in the banking sector in order to ensure that conduct risk is managed and mitigated by the banks in a way in which the outcome for customers will be positive? this research will help stakeholders understand banking conduct risk regulation as a new concept and how it can be implemented successfully in developing countries to the benefit of both the customer and the bank. literature review bank regulation as a necessity banks have to comply with more specific laws and regulations than companies from other sectors: it is likely that, in the absence of prudential regulation, deposit-takers, insurers and investment firms would be less resilient against failure, and risk more disruption to the continuity of financial services, than is in the public interest. (bank of england 2012:5) however, ‘it is an illusion to believe that there is a single, superior model of institutional structure that is applicable to all countries’ (llewellyn 2006:7). in addition to other criteria, the structure of the banking sector and the financial sector as a whole would need to play a role in the selection of a suitable model (sum 2016). another topic of interest is the question of whether institutions or financial products should be regulated by the same entity. for example, in south africa, the market conduct authority will in future be responsible for regulating how banks design and price their products; however, the prudential supervisor also needs to ensure that the financial products that are sold are consistent with prescribed principles, even though their focus is on the supervision of institutions (national treasury 2013). this may prove challenging if both entities do not work together closely. prudential regulation versus market conduct regulation within bank supervision and regulation, prudential regulation and market conduct regulation can be differentiated. on the one hand, the prudential regulator is typically responsible for ensuring the safety and soundness of banks and minimising the adverse effects that they can have on the stability of the financial system. on the other hand, the market conduct regulator usually ensures that relevant markets function well, and that banks conduct themselves appropriately (bank of england 2012). čihák and podpiera (2008) have discovered that there is some support for the twin peaks approach, which integrates supervision across sectors and, at the same time, separates business conduct and prudential supervision. generally: financial consumer protection should be an integral part of the legal, regulatory and supervisory framework, and should reflect the diversity of national circumstances and global market and regulatory developments within the financial sector. (oecd 2011:5) dias (2013) also recommends that bank supervisors leverage positions in the existing institutional landscape to advance and add financial consumer protection topics to existing oversight practices. he puts forward a risk-based approach to consumer protection, in line with prudential regulation, to strengthen the banks’ existing risk management framework. when it comes to conduct risk, some countries have regulated credit-related products separately from investment-related products. for example, south africa introduced the national credit act in 2005, to ensure credit providers do not encourage customers to take on loans to the point where they become over-indebted (basa 2016). this raises the question of whether there should be a single piece of conduct regulation or not. in many countries, conduct risk spans across various different regulations and is not captured in one piece of regulation. bank regulation in different countries south africa as an example of twin peaks: after the global financial crisis, and partly on account of the competition commission banking enquiry (competition commission 2008), south africa decided to change its financial sector legislation and is currently moving towards a new twin peaks approach that separates prudential regulation and market conduct regulation. the south african financial services board (sa fsb) has implemented the treating customers fairly (tcf) approach to supervision across the financial services industry in preparation for the new conduct regulation (national treasury 2014). the new financial sector regulation (fsr) bill which the national assembly voted on in late 2016, prescribes two new authorities – the prudential authority (pa) and the financial services conduct authority (fsca) – to be established. until the new conduct of financial institutions act (cofi act) comes into effect (likely to occur in 2017), the fsca will work with existing laws that already require specific conduct from financial services companies (national treasury 2015). malaysia as an example of non-twin peaks: in malaysia, financial consumer protection and market conduct supervision are the responsibility of the central bank, and they need to leverage existing internal synergies. however, there is an internal twin peaks structure that promotes ‘checks and balances’ and a strong focus on safety, soundness and consumer protection objectives. the enforcement function is separated from prudential and conduct supervision and resides with the financial intelligence and enforcement department of the bank (ali 2014). other developing banking market examples: kenya: kenya follows neither a twin peaks nor a one peak model. the country’s current approach is to keep banking supervision separate within the central bank of kenya (cbk), but to integrate both prudential supervision and conduct of business supervision of all the other regulators in the financial services council (capital markets authority kenya 2014; cbk 2014, 2015). in 2013, the cbk, as the main banking regulator in kenya, published a new set of prudential and risk management guidelines, which includes a specific section on consumer protection and a specific section on reputational risk. the cbk is using remedial actions provided for under certain sections of the banking act and may take other action as it deems appropriate (cbk 2013a, 2013b). financial crises and regulation the global financial crisis has resulted in many countries reviewing and reinventing their financial sector policy priorities as a whole (national treasury 2011). nichols, hendrickson and griffith (2011) suggest that every major financial crisis in the usa has brought about some new legislation, and that the same regulatory response is likely to have an influence on the next financial crisis. ojo (2010) pointed out a growing global trend in 2010 (after the global financial crisis) towards enforced self-regulation in the sense that regulators no longer prescribe strict rules, but rather encourage firms to use their own approach (meta-risk regulation). sepe (2012) argues that crises are erroneously held responsible for managerial moral hazard. instead he recommends a contractarian approach to bank regulation, where ‘[…] regulators act as debt holders, and [would] offer lower capital requirements and lower deposit insurance premiums while demanding the same governance concessions’. (sepe 2012:328) profitability, sustainability and socioeconomic realities ‘the post-crisis pressure on firms to rebuild prudential soundness, attract new funding and maximise profits could lead to short-sighted strategies that have unintended conduct consequences’ (fca 2013:48). the challenge presented in this statement is particularly important for banks that are operating in developing economies, where consumer protection, financial inclusion and education are more important concepts than in the developed world. the united nations environment programme (unep) (2015) is convinced that sustainable behaviour and practice (economic, environmental and social) can drive economic profits. culture and other intangible factors that influence regulation it would seem as though cultural norms that prevail in certain countries influence the effectiveness of specific regulatory approaches. this should be even more distinct when one considers conduct risk, as it is influenced by values and culture. according to cohen, pant and sharp (2001) a strong uncertainty-avoidant culture requires extensive rules and regulations for various situations, while weak uncertainty-avoidant cultures are more tolerant of ambiguity. chen, danbolt and holland (2014) insist that intangible factors do in fact have relevance for systemic risk and bank regulation. alemanno (2015) argues that many oecd countries are becoming aware of how important public engagement is in policymaking. finally, trust between the regulated and regulators is vital for regulation to function effectively (ugeux 2014). customer responsibility and complaints resolution the financial crisis: highlighted the importance of financial consumer protection for the long-term stability of the global financial system. at the same time, rapid increases in the use of financial services have pointed to the need for strengthened financial regulation and consumer education to protect and empower consumers. (the world bank 2012:1) this quote makes reference to a consumer who is educated and able to take responsibility for his actions and decisions. however, one of the challenges is that bank customers might not behave rationally with regard to their financial choices at all times (azis & shin 2015). constructing an effective model for banking conduct risk regulation in developing countries regulators will try to influence banks’ conduct with regard to their complete value chain (figure 1), from the agenda of top management to product design and after-sales, with the ultimate goal of creating a positive outcome for the customer. concepts similar to conduct need to be considered when constructing the model, as they may be influencing factors with regard to the outcome the regulator is trying to achieve. figure 1: value chain of banks. model proposal although regulatory approaches, and the question of whether they are effective, mainly require a qualitative mindset, it is important to explore relationships and interdependencies between different influencing factors (figure 2). figure 2: relationships and interdependencies between influencing factors in the model. the end goal of all conduct regulation is that the outcome for the customer should be positive. what exactly does this mean and how will it be measured? a positive outcome for a customer should, at minimum, mean that he has a positive customer experience; his financial needs are evaluated; and he is sold a product that is suitable for his financial needs. it is difficult to measure this outcome because the bank alone cannot take responsibility for the measurement thereof. although banks can compile customer surveys, the response rate is often poor and customers might not always communicate their discontent. furthermore, customers might be sold a product, but never use it. although regulators might think that a suitable regulatory model is all that is needed to achieve a positive outcome for the customer, the reality is more complex. various factors influence this final outcome, as shown in figure 2 by o1 to o4 (examples of possible factors such as these will be covered in the ‘reviewing (seemingly) indirect influencing factors (cs and os) for effective conduct risk regulatory model’ section). one of the influencing factors (shown as o2) is the full compliance with the conduct risk regulation on the part of the banks in the sense that appropriate management and mitigation techniques need to have been applied. it also means that the bank is managing conduct throughout the value chain; that processes are in place to ensure that each customer’s needs are analysed and a suitable product is recommended; and that the utilisation of the product is tracked. full compliance by the banks will be influenced by various factors, shown in figure 2 as c1 to c4 (examples of these are presented in the ‘reviewing (seemingly) indirect influencing factors (cs and os) for effective conduct risk regulatory model” section). one of the influencing factors is likely to be a suitable regulatory model (shown as c2). a regulatory model will be suitable if it leads to a situation where banks will comply with the regulation, and if the end goal of a positive outcome for customers is achieved. the suitability of the model depends on certain influencing factors, shown in figure 2 as m1 to m4 (some possible factors are presented in the ‘reviewing direct influencing factors (ms) for effective conduct risk regulatory model’ section). first and foremost, these factors need to be managed by the regulators as effectively as possible to achieve the end goal. apart from this, the regulator also needs to understand, interpret and potentially influence the (independent) influencing factors of banks’ compliance (cs) and positive outcomes for customers (os) as well. for ease of reading, figure 2 only shows four influencing factors for each case; in reality, however, there could be more or fewer influencing factors. also, the factors might not be stable over time and could be subject to change. developing an effective banking conduct risk regulatory model reviewing direct influencing factors (ms) for effective conduct risk regulatory model table 1 indicates possible influencing factors in the banking conduct regulatory model, based on the literature review (in the first column) and questions regulators should ask themselves to best manage those influencing factors (in the second column). table 1: decision-making criteria and questions (ms). reviewing (seemingly) indirect influencing factors (cs and os) for effective conduct risk regulatory model as mentioned previously, in order for regulators to achieve the end goal of a positive outcome for the customer, they also need to examine and understand the variables shown in table 2. table 2: cs and os for consideration by the regulator. understanding the relationship between direct influencing factors (ms) and a suitable regulatory model the relationship between the direct influencing factors and a suitable regulatory model is straightforward in the sense that the better the regulator’s grip on the influencing factors, the more suitable the regulatory model should be. figure 3 highlights this relationship. figure 3: suitability of regulatory model and the factors that influence it. understanding the relationship between direct influencing factors (cs) and full compliance on the part of the banks as the regulatory model becomes more and more suitable, banks’ compliance should increase: the relationship should be positive. firstly, however, as other factors (cs) influence the compliance of banks – introduced in the ‘reviewing (seemingly) indirect influencing factors (cs and os) for effective conduct risk regulatory model’ section (for example, whether banks are actually willing to comply) – the relationship is not linear. secondly, banks need to first understand what is required in terms of compliance, and so they need time to adapt. in order to ensure banks comply with ease, regulators need to attempt to influence the cs as well, which will ideally shift the curve in the direction of the arrow, as shown in figure 4. figure 4: suitability of regulatory model and level of compliance. understanding the relationship between direct influencing factors (os) and a positive outcome for customers figure 5 shows that the customer outcome will be negative if minimal or no implementation occurs. the customer will be at risk. as conduct risk is managed and mitigated effectively by the bank, the customer outcome becomes more positive. however, there is a lag here: for every customer who feels a real positive impact, banks first need to perfect the implementation across the organisation for every single staff member. regulators would need to create a model that can secure ‘quick-wins’ for banks in terms of compliance so that customers will feel the benefit immediately. figure 5: compliance of banks versus positive customer outcome. in their regulatory approach, regulators should make provision for banks to use existing processes and data to measure whether outcomes are positive, instead of having to ‘re-invent the wheel’. the more burdensome regulatory approaches and processes are, the more negative the sentiment towards compliance will be. this will result in a negative outcome for the client. in order to shift the curve dramatically (figure 5), regulators need to attempt to influence the other os. the more educated customers are, and the better the complaints resolution process is, the more independent they are in terms of whether banks comply with conduct risk regulation or not. for example, if a customer is sufficiently educated about financial products, it will be more difficult for the bank employee to conduct himself unethically and sell an unsuitable product to the customer. regulators should also attempt to create positive feedback forums, instead of only focusing on complaints resolution. the ideal world in an ideal world then, what results would a perfect model achieve? the perfect model would achieve 100% in all three factors, as shown in figure 6. somewhere in between, the customer would be sufficiently educated to not have to rely too much on conduct risk regulation. banks would be convinced of the importance of conduct risk and approach its management and mitigation in the best way possible, even if the regulatory model were not as perfectly suitable. this would be partly as a result of their ability to conduct themselves accordingly, while still maintaining their profitability. figure 6: three-dimensional graph to show regulatory model interdependencies. testing the model: specific developing country examples appendix a offers a detailed evaluation of whether the constructed regulatory model could work in south africa, malaysia and kenya. this is presented in table format, including references – based on the model constructed in the ‘constructing an effective model for banking conduct risk regulation in developing countries’ section. in table 3, a short summary evaluation of the effectiveness of the approach of the different countries is provided. table 3: evaluation of assembled model using south africa, malaysia and kenya as developing country examples. conclusion and recommendations this research attempts to construct a model that points regulators in developing markets in the right direction. regulators need to take challenges specific to developing markets into account. regulators also need to influence the sentiment of the banking sector around conduct risk regulation, as well as consumer education. lastly, it is of utmost importance that the regulatory model is set up in a way that allows banks to run profitable businesses. examples of three developing countries show that regulators are approaching the regulation of conduct risk in a way that is unique to each country. country-specific issues, such as the mobile banking trends in kenya and the low savings rate in south africa, are influencing the way regulators think and operate. the recommendation for regulators would be to cooperate with other developing countries in designing banking conduct risk regulation and financial education and inclusion strategies. certain ideas could be implemented successfully in various developing market scenarios, such as introducing young schoolchildren to the study of financial education or approaching the extension of credit to lower economic profile customers in a way that ensures customers can actually afford the repayment. over and above this specific research, it would be interesting to explore more case examples of other developing countries, such as countries in south america, asia and africa. the collection of information might present challenges for some of these countries. it would be beneficial to measure the efficiency of some of the regulatory approaches to banking conduct risk in more detail once they have been implemented fully and more time has passed. other research areas related to this specific study and worth exploring could focus on how both banks and customers have reacted to the introduction of the new conduct regulation. this could provide some direction to the banks as to how they should position themselves from a financial success and business point of view. finally, researchers could investigate how banks prepare themselves in order to comply with conduct regulation, and whether customers will value these preparations. acknowledgements competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions a.h. constructed the article as part of her phd in risk management and g.v.v. is the supervisor and guided a.h. in all aspects of the article. references alemanno, a., 2015, ‘stakeholder engagement in regulatory policy’, in oecd regulatory policy 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sector, pers. comm., 03 february 2015. kenya bankers’ association (kba), 2013a, kenya’s banks chart way forward to promote sustainable finance and build industry-wide capacity, viewed 22 march 2015, from http://www.kba.co.ke/sfi/news.html kenya bankers’ association (kba), 2013b, about us, viewed 29 march 2015, from http://www.kba.co.ke/overview/about-us nedbank, 2015, long-term goals, viewed 29 march 2015, from http://www.nedbankgroup.co.za/fairshare2030ourgoals.asp south africa. national treasury, 2014, treating customers fairly in the financial sector: a draft market conduct policy framework for south africa, viewed 28 february 2015, from http://www.treasury.gov.za/public%20comments/fsr2014/treating%20customers%20fairly%20in%20the%20financial%20sector%20draft%20mcp%20framework%20amended%20jan2015%20withap6.pdf south africa. national treasury, 2015, ‘treating customers fairly in the financial sector: a draft market conduct policy framework for south africa’, public workshops, march 2015, [powerpoint presentation], (unpublished). abstract introduction research methodology research findings conclusion acknowledgements references about the author(s) j. orpha cilliers department of entrepreneurship, supply chain, tourism, transport and logistics management, college of economic and management sciences, university of south africa, south africa citation cilliers, j.o., 2018, ‘high inventory levels: the raison d’être of township retailers’, south african journal of economic and management sciences 21(1), a1962. https://doi.org/10.4102/sajems.v21i1.1962 original research high inventory levels: the raison d’être of township retailers j. orpha cilliers received: 01 june 2017; accepted: 20 feb. 2018; published: 23 may 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: this study investigates the cardinal role of optimal inventory decision-making in the performance of small formal retailers in soweto, constituting a projected, lucrative retail environment. aim: the research question was how soweto small retailers make inventory decisions to promote their income growth and age of the business. for this study, a descriptive research design was followed. setting: the universe of the study comprised all the formal small, medium and microenterprises located in soweto township. methods: using probability sampling, the sample size was set at 650 businesses. of the 650 completed questionnaires, the responses of 297 respondents operating in the retail grocery and retail general stores sectors were analysed quantitatively using exploratory factor analyses, cluster analysis and cross-tabulation. results: this study showed that being more inclined to proactively maintain a high level of inventory could result in positive business performance in terms of both growth in income and age. younger businesses (less than 5 years) could grow if they decide to stock up on sale items, purchase more items for sale, provide for customers’ fluctuating demands and buy more stock to save on transport costs. purchasing less or the exact amount of stock as what can be sold within a month could be detrimental to the performance of general and grocery retailers in soweto. conclusions: the results also show that if retailers want to grow and exist for 5 years and more, they should consider both proactively maintaining a high level of inventory and doing so with ease. in this study, the older (5 years and older) business groups were mostly owned by older people, who showed a tendency to establish themselves in stand-alone shops or smaller shopping centres. older businesses also tend to buy stock daily or weekly, or when stock is low. these older businesses without income growth were mostly family businesses who displayed contentment with the status quo of business performance and seemed to lack entrepreneurial skills. introduction the retail sector is critical in a community’s economic and social welfare, by providing consumers with choices and services (ligthelm 2008:37). in south africa, population growth forms the key driver behind retail growth (prinsloo 2014:6). retail intermediaries have the vital role of being the final businesses in a supply chain and linking manufacturers to consumers, while performing various value-adding activities which are mostly driven by customers’ need for convenience (prinsloo 2014:1). value-adding influences the market offering and thus the inventory decisions made by retailers. for example, retailers provide consumers an assortment (in terms of brands, designs, colours, prices) of products and services to choose from, at one location. they also perform bulk-breaking by satisfying consumers’ need for goods in smaller quantities. another value-adding activity relates to on-shelf availability, which allows consumers to purchase products when the need arises, thus allowing households to keep small inventories at home. finally, retailers add value by providing services to customers that make the buying decision easier and more informed, such as credit, product information and display of merchandise (ligthelm 2008:38; prinsloo 2014:1). according to hatten (2016:177), small retailers compete on operational excellence (best or lowest price), product leadership (best product, high quality) and customer intimacy (long-term relationship through superior service). allen (2012:330) confirms that successful retailers realise that the ultimate goal of supply chain management is to be customer driven, that is, to provide the exact level of service that the customer expects at a minimal cost and understand what is important to customers, what level of service they expect and what performance level they are willing to pay a premium for. effective supply chain management can potentially lower the costs of inventory, transport, warehousing and packaging, while increasing customer satisfaction (longenecker et al. 2014:414). unfortunately, worldwide, most new entrants to retailing have no experience of retail selling and learn through experience and replicating what others do (honig, karlsson & hägg 2014:97; yang 2016:2; yordanov 2015:50). lebusa (2013:76), choto, tengeh and iwu (2014:93–94), as well as malebana and swanepoel (2015:109) note that south africa is faced with a need for more skilled entrepreneurs to run these businesses efficiently. new entrants thus need the mentorship of older, established business people (matabooe, venter & rootman 2016:2). kesavan and kushwaha (2014:2118) found that retailers in general benchmark their inventory performance against other organisations in the same industry or against their competitors to guide decisions; thus the need to learn from and emulate counterparts is confirmed. with regard to opportunities to learn from competitors, badenhorst-weiss and cilliers (2014:13) found that older, growing sowetan small businesses tended more than younger, stagnating businesses to perform regular competitor analysis. this study attempts to identify what the owners of younger sowetan businesses can learn from their older, more established counterparts with specific reference to inventory decision-making. the research question thus emerging is how small retailers in soweto make inventory decisions to promote income growth and become older (mature or established). the subsequent secondary objectives are (1) to identify possible profiles among soweto grocery and general small retailers with regard to inventory decision-making, (2) to determine the relationships between cluster membership and demographic (education and owner age) and business variables (location, frequency of inventory purchases, future perspective, and reasons for starting) and (3) to provide retailers in soweto showing negative (or no) growth with guidelines on inventory decision-making based on the inventory decision patterns displayed by older counterparts with income growth. background in this section a short overview of the history, opportunities and challenges of the township retail environment is provided to illustrate the circumstances behind inventory decision-making by township retailers in their quest for survival. in the pre-1994 south african retail landscape, choices in townships were limited and dominating small, often informal, convenience businesses offered basic household necessities to relatively low-income earners. lebusa (2013:76) explains that most small retail outlets (including formal traders) were historically established out of desperation, rather than by identifying and exploiting a gap in the market; thus, such business owners lacked the business skills required when the country moved to a new promising dispensation. lebusa (2013:77) describes a survivalist mentality that originated (and still drives business decision-making) during those years, where a lack of focus on return on investment stemmed from a lack of business skills training – by not being truly entrepreneurial, those businesses’ prospects for growth were diminished. at that stage only a small portion of consumer spending was done in townships. this worldwide phenomenon, where residents prefer to shop elsewhere is called ‘outshopping’ (see papadopoulos 1980:41). prior to the development of local retail centres, township dwellers travelled long distances and spent a substantial part of their disposable income on transport costs, causing a leak of income from townships (gauteng quarterly bulletin 2012:26). the lack of efficient retail infrastructure in townships thus had a far more negative impact on poorer households than more affluent ones (ligthelm 2008:37). the progression of many south african consumers into middle-income groups postapartheid changed the dynamics of township shopping patterns, leading to substantial growth in retail infrastructure and facilities in townships, and expanding retail choices offered by formal businesses (ligthelm 2008:39, 51). lebusa (2013:76) and beneke (2014:22) report that post 1994, the majority of inhabitants refused to leave the townships, which resulted in substantial market potential in these areas for consumer goods and services. consequently, entry into this previously untapped emerging market of ‘inshoppers’ not only proved lucrative to national retailers, especially supermarkets (ligthelm 2008:37, 41), but also positively impacted consumers by cutting down on travel costs and time (gauteng quarterly bulletin 2012:26). with the entrance of bigger retail stores, many owners of small retail businesses lost market share, struggling to adapt, compete and survive due to lack of business skills (lebusa 2013:76; ligthelm 2008:52). township customers who used to support small grocery retail shops due to convenience and smaller quantities being offered started to support the supermarkets and malls, which offered more variety and lower prices based on increased affluence and higher mobility (strydom 2015:467). at that stage survival for township small businesses seemed to lie in changing the small business model towards effective customer service, with a small dedicated assortment of merchandise, satisfaction of emergency needs, selling in small units and extension of credit facilities (ligthelm 2008:52). when assessing retail growth trends and township consumer preferences (for the period relevant to this study), growth reports on the south african retail performance for the period 2013/2104 showed that retailers experienced lower growth than in 2012 (stanlib 2013), which was attributed to slowing consumer income, lack of job growth and eroding consumer spending power. statssa (2015) confirmed that retail growth declined to 4.5% in 2012, 2.5% in 2013 and 2.4% in 2014. beneke (2014:21) and prinsloo (2014:6) state that since the typical township resident can be categorised in the lower end of the living standards measure (lsm 1–5), this vast population forms a viable market for fast-moving retail consumer goods and township shopping centres. prinsloo (2014:2) notes that despite the increased number of convenience stores in townships over the past decade, major gaps exist for small centres (up to 3000 m) within walking distance from large residential communities, since larger community-type centres tend to focus on taxi ranks and pedestrian areas. prinsloo (2014:7) further foresees shopping centre development accelerating, especially in bigger, trendsetting townships. however, the resultant strong commitment of grocery retailers to be better represented will require small, independent formal retailers to become more competitive. according to gauteng’s provincial treasury (gauteng quarterly bulletin 2012:34–35), growth and survival in retailing depends, among others, on balancing the challenges and opportunities posed by lower sales retail figures due to rising food prices, major retail skills shortage, consumers’ increased demand for convenience, and potential growth in the food industry. beneke (2014:21) describes the typical township retailer as being small, underequipped with a point-of-sale system and refrigeration facilities, carrying low levels of stock and, most importantly, often being geographically dispersed. such geographic dispersion makes it increasingly challenging and expensive for suppliers to deliver, which in turn leads to higher prices, lower customer satisfaction, limited variety and low stock levels (beneke 2014:21). not being able to deliver on convenience will inevitably cause township retailers to lose their grip on competitiveness (see also narayan & chandra 2015:22 who researched indian food and grocery retailers). beneke (2014:22) reports that 75% of township residents continue to buy from spaza shops on a daily basis, due to their convenience and proximity, despite having access to general dealers, situated in both business and residential areas, which carry a wider range of products and encourage self-service. in summary, the development of retail centres, population growth, the viability of the consumer goods market, the need for convenience, the entrance of supermarket chains, the increased costs of distributing products to widespread retailers and the resultant low levels of stock have seen spaza shops evolved into being the main retailers in townships due to their convenience and location. this has put increased pressure for survival on formal independent grocery and general dealers, and coupled with their reported lack of skills their continued survival is in doubt. from the above, the reason for focusing on formal small, medium and microenterprises (smmes) is evident, which is confirmed by the findings from previous studies in soweto by ligthelm (2008, 2009) stating that since survivalist businesses lack true entrepreneurialism and do not contribute to wealth creation, research should rather focus on formal, independent businesses. furthermore, the focus on formal smmes in this study also supports the aim of the 2013 sme growth index, namely to understand the driving forces behind the formal sector as a more transformative contributor to wealth creation, economic growth and innovation than informal survivalist businesses (sbp 2013:1). the aim here is to determine what inventory-related decisions could contribute to the survival of formal township grocery and general small retailers. literature review: inventory-related decisions made by small retailers according to literature, small retailers base their decisions about the level and type of inventory items to keep not only on balancing costs and service delivery, but also on consumers’ preference (in terms of convenience shopping, the different elements of the product offering, and on-demand availability of items). the discussion below confirms the interrelationship between these variables. convenience having inventory items available conveniently is influenced by complex location decisions. a key location factor for retail businesses is the point of maximal demand for products and services, which is described by sevtsuk (2014:375) as a location in close proximity to both customers in need of the offering and other retailers selling complementary items. since retailers are the last point of contact with final consumers in the supply chain, they should be located conveniently near the place where customers want to purchase items (scarborough 2012:539). prinsloo (2014:2) stresses that convenience shopping is the result of more frequent shopping of quality and variety products in smaller grocery baskets at local retailers. retailers who mainly offer so-called convenience goods require a location close to their target customers to prevent customers easily substituting competitive brands when the need arises (petty et al. 2012:264). few customers are willing to repeatedly travel long distances just to shop. the role of the transport network is crucial: if customers are inconvenienced, the store’s trading catchment area is reduced; therefore, any retailer’s prime consideration is sufficient customer traffic (allen 2012:309; scarborough 2012:546). sevtsuk (2014:374) proposes the availability of retail and service establishments within walking range from homes and workplaces key to achieving sustainability – environmentally, socially and economically – within these neighbourhoods the small business retailer should have a thorough understanding of the scope of its trade catchment area from which customers can be drawn over a reasonable timespan. the primary variables influencing the scope of the trading catchment area are the type and size of the business and the type of closely located competitors. a convenience store with a general line of merchandise, which can be found almost anywhere, has a small trading catchment area because it is unlikely that customers will drive across town to purchase items that are available closer to their home or business. on the other hand, if a retailer offers specialised products and a wide selection, and also has knowledgeable salespeople, it may draw customers from a great distance. as a rule, the larger the store, the greater its selection and the better its service, the broader its trading catchment area. businesses that offer a narrow selection of products and services tend to have smaller trading catchment areas (scarborough 2012:549). according to the soweto retail strategy (city of johannesburg 2005:36), the ideal for a township (like soweto) lies in locating retailers conveniently close to the households they serve, to improve the overall functioning of the city: there is less need to commute, better use of land and a more equitable balance in the distribution of value-add across the metropole. in township areas characterised by low vehicle ownership and underdeveloped transport systems, poorer inhabitants either walk or use taxis to go shopping. in the absence of retail outlets, township dwellers shop at nearby urban retail outlets rather than in township shops, or workers tend to shop close to their places of work, which are primarily located outside townships. this unique situation fosters an environment where local residents buy from local stores, which are typically owned by familiar fellow residents. the locations of such outlets are based upon the business founders’ proximity to their homes (stokes & wilson 2017:349). schaper et al. (2014:44) state that small business owners and their businesses are often attached to a specific place for historical, practical and symbolic reasons which makes the local (and regional) socio-economic environment a major determinant and outcome of the entrepreneurial activity. small business owners get to know their customers and neighbourhood on a personal level and build personal networks (tornikoski, gerbasi & molecke 2015:243–244), which allows them to provide individualised service and to obtain first-hand knowledge of customers’ wants and needs. the competitive advantage of speciality products, personalised service and quality, could enable them to compete with bigger businesses’ lower prices (hatten 2016:14). also, the rapport retailers build with their customers is vital, causing customers to be willing to pay more for a product when they know the business owner is a good steward in the community. scarborough (2012:545) points out the synergistic advantage when a small business’s image fits in with the surrounding community or character of a town, and the needs and wants of its residents. in this regard, kwon, heflin and ruef (2013:980, 1000) confirm that the social trust stemming from the community to which entrepreneurs are connected contributes substantially to entrepreneurship. product offering when deciding on the type and quantity of product offerings, scarborough (2012:72–75) advises small businesses to consider the characteristics of the products they sell (uniqueness, savings in terms of time, money and energy, environmental friendliness, and convenience), and the pricing they offer (low prices or value). hatten (2016:296–297) adds that small businesses can excel by offering superior product selection, service and variety (this aspect being one way a business can outshine it competitors, but product proliferation increases the need for tight inventory control to avoid a cash crisis). in terms of townships, ligthelm (2008:52) previously promoted a change to a small business model offering effective customer service with a small, dedicated assortment of merchandise and limited number of units, even at reduced turnover. petousis (2014), from tgi at ask afrika (an independent local market researcher), however, states there is no one-fits-all approach to serving modern township shoppers, who enjoy owning quality goods and are prepared to pay extra for those goods. increased competition exposes township residents to greater variety, making them more selective buyers (petousis 2014), thus it is a misconception for retailers to believe township communities would purchase downscaled products. on-demand availability of products and customers’ confidence the availability of product items is one of the crucial variables in developing an overall store image (koul & mishra 2013:84). on-demand or on-shelf availability refers to retailers’ ability to respond to customers’ demand for products immediately (moussaoui et al. 2016:516–517). this means the desired inventory items must be in store to meet customers’ expectations, that is, in a saleable condition (right goods) during convenient business hours (right time) and at a convenient location (right place). the service level retailers provide will determine the level of inventory. balancing varying retail demand levels (discussed below) while fulfilling the on-demand availability of customers is challenging. key in customer service is not only the probability of having the product available upon demand, but also the reliability of the retailer to deliver the promised service. if demand and supply planning is ineffective, retailers will have to resort to expensive ad hoc logistics arrangements or marking down the oversupply of goods (moussaoui et al. 2016:517). inventory levels inventory is essential in a supply chain to address the imbalance between the supply and demand of products (chopra & meindl 2016:61). inventory is also critical for retailers’ financial performance, comprising a substantial portion of their balance sheets (katz & green 2014:522; kesavan & mani 2013; monczka et al. 2016:621–622; wisner, tan & leong 2016:209). as mentioned earlier, depending on the service levels retailers wish to render, they adjust their inventory levels: higher service levels imply that customers can be confident that sufficient inventory items are available. although inventory decisions differ based on the type of inventory (cycle, safety and seasonal), the decision ultimately depends on the levels of inventory needed in store. when ordering cycle inventory, the amount and frequency of inventory required should be considered (islam et al. 2013:3–4). purchasing cycle inventory in bulk should be traded off against increased carrying and opportunity costs. beneke (2014:30) reports that township retailers are unique, requiring smaller volumes at higher delivery frequencies at lower cost, while the world bank (2014:173), by contrast, found that some township businesses coordinate when purchasing inventory in bulk, to gain the advantage of economies of scale – something they would not be able to do on their own. discounts (or markdowns) are commonly used by small businesses to reduce levels of old, slow-moving or damaged stock, rewarding customer loyalty, launching new products or services and matching competitors’ prices (scarborough 2012:375). however, discounts, special offers and sales to help improve demand and cash flow are often misused by small businesses, who overlook the real increase in volume that is required to make up for discounted prices. since it is more profitable to sell fewer items at a higher price, stokes and wilson (2017:432) argue that sales seem not to be ideal for small businesses. in contrast, scarborough (2012:375) states that experienced business owners understand the importance of shedding slow-moving inventory during end-of-season sales, even if they must resort to markdowns. balancing the level of safety inventory to prevent a loss of sales on the one hand (coyle et al. 2013:324), and buffer against unpredictable customer demand on the other hand (baker & canessa 2009:425; bowersox et al. 2013:48) remains challenging (baily et al. 2008:164). the world bank (2014:207) reported that almost 20% of business owners in townships cannot purchase excess (safety) inventory due to insufficient storage space. although the purchase of grocery items is usually limited to small quantities (especially in townships), demand in retailing varies depending on the day of the week and the time of year. a retailer will, therefore, carry additional seasonal inventory in anticipation of future customer demand or in preparation for an event. the challenge lies in finding a balance between the number of inventory items needed to satisfy unpredictable demand seasonality, and the cost of carrying such additional inventory (pienaar & vogt 2012:218). unfortunately, retailers worldwide seem to lack the skills to incorporate demand seasonality into their store ordering and shelf replenishment (ehrenthal, honhon & van woensel 2014:527). in order to remain competitive, inventory items should rather be bought daily or weekly. the problem is that even when businesses start growing, business owners do not have sufficient resources to purchase goods for sale in sufficient quantities to trigger significant discounts. even if they purchased the required quantities, they often lack the space to store the inventory (allen 2012:332), as mentioned above. although inventory generally represents the largest capital investment for small businesses, few owners use formal methods for optimal inventory management. as a result, some small businesses carry not only too much inventory, but also too much of the wrong kind of inventory (scarborough 2012:618). from a macroeconomic view, retail inventory investments (and levels) increase during economic expansion periods and decrease during contraction periods (kesavan & kushwaha 2014:2118). the main finding of these authors’ research among public retailers in the united states was that stock out and the inventory holding costs facing retailers have significant explanatory power over the observed differences in inventory investment behaviour across retailers during economically turbulent times. the influence of economic changes should thus be considered when retailers make inventory-related decisions as higher inventory costs would imply smaller profits and eventually lower inventory levels. kesavan and kushwaha (2014:2120) concluded that retailers can improve inventory management by benchmarking inventory performance, preferably against similar retailers. similarly, retailers in townships can learn to improve inventory performance from other township businesses which value rendering high service levels – the focus of this study. research methodology research design soweto, a township in the greater johannesburg area of gauteng province in south africa, served as the research area in this study for the following reasons. gauteng is the economic hub of the country, contributing the largest share (26.5%) of the country’s retail industry. the province houses 45% of the country’s shopping centres and contributes (together with the wholesale sector) to addressing the unemployment problem by employing about 27% of the country’s youth (gauteng quarterly bulletin 2012:36). as the most populous area in south africa, with 1 271 628 inhabitants, soweto is a key retail growth point (as prinsloo 2014:6 mentioned, population growth is a key driver of retail growth). johannesburg, as the biggest metropole, is boosted by the 3.7% that soweto contributes to the gross domestic product (gdp) of the province. according to statssa (2012), in 2011 soweto consisted of 355 331 households and the economically active residents (15–64 years) constituted 71% of inhabitants. based on spending power of r5 billion annually, this area emerged as a lucrative business opportunity for large retailers and a resultant increase in formal smmes (steyn 2013). in fact, the smmes in the township form the backbone of development initiatives by the city of johannesburg’s mayoral committee for economic development. despite showing the third-highest absolute increase in population, this area has also been described as the third poorest in the growth and development strategy 2040 (city of johannesburg 2011). for this study, a descriptive research design was followed, using a multidimensional approach to investigate various aspects related to the functioning of small businesses. the study area encompassed all formal business areas and stands, including shopping malls, large shopping areas (outside shopping malls) and all smaller shopping centres and single demarcated business stands in the township and its industrial areas. the universe of the study comprised all the formal smmes located in soweto. formal businesses form part of the official economy of the country and operate from permanent structures with relatively sophisticated infrastructural, financial and technological systems, and are incorporated into the country’s formal economic and fiscal reporting structures. the inclusion criteria used for the sample were that the business be: (1) independent, with any of the following ownership structures: sole proprietor, partnership, cooperative, close corporation or company, and (2) located on a business stand or conducting business from a fixed brick-and-mortar structure. sample elements the sample elements of each smme were either the owner or manager of the business who was responsible for the business decision-making. sample plan design the lack of an up-to-date list of formal small businesses in soweto made determining the exact population size for the study impossible. as a result, probability sampling using a stratified sampling method was followed. the lack of a properly defined population resulted in the use of central limit theory, which postulates that using a sufficiently large number of respondents will result in an approximately normal distribution (van zyl 2014:178–180). within the research budget limits, the sample size was set at 650 businesses. the total sample was allocated according to the following smme segments. shopping malls in total, up to 100 formal smmes were to be interviewed in any or all of the following large shopping malls (primary shopping centres): bara mall, maponya mall, jabulani mall, dobsonville mall, naledi mall and protea mall. all smmes meeting the inclusion criteria and who were willing to participate were interviewed. smaller shopping centres (outside malls) smaller shopping centres in the survey area were selected randomly, with the instruction that at least 50 smmes be interviewed in each of the following stratified segments: shopping centres with two to five businesses, with no more than two businesses interviewed per centre. stand-alone shops were included in this segment. shopping centres with between 6 and 10 businesses, which were selected at random, and every second business after that in the specific centre. tertiary shopping centres with between 11 and 20 businesses in the centre; any business was selected at random, and every third business after that in the specific centre. secondary shopping centres with more than 20 businesses in the centre; any business was selected at random, and every third business after that in the specific centre. industrial areas at least 50 manufacturers were to be interviewed in industrial areas. due to the relatively small number of industrial smmes in the study area, all respondents willing to participate were interviewed. research instrument (questionnaire) the questionnaire covered a multidisciplinary range of functional areas in business management and the demographics of the respondents. research findings of the 650 completed questionnaires, the responses of the 297 respondents operating in the retail grocery and retail general stores sectors were analysed using a quantitative approach. this group constituted 45.6% of the study population. according to the central limit theory, for sufficiently large samples (n = 30), the sample means will be distributed around the population mean approximately in a normal distribution. even if the population is not normally distributed, the distribution of sample means will be normal if there is a large enough set of samples (cooper & schindler 2014:366–376). the reasons for focusing on these two retail types are based on the history of retailing in soweto, the basic needs of mainly inshoppers being satisfied by these retailers, the high demand for food and clothing products, the dire need for small retailers to be more competitive due to the foreseen, increasingly high representation of major grocery retailers in soweto, and the role of general dealers in serving inshoppers with a wider variety and more advanced self-service facilities, as discussed in literature. profile description of the smmes interviewed in soweto regarding the key profile aspects of the retail general store and retail grocery respondents, the following can be observed: age: the majority (30%) of business owners or managers were between 31 and 40 years of age. overall, 87.6% of respondents were in the category 18–60 years (the general age of economically active individuals). level of education: the majority of respondents (54.5%) had some form of secondary schooling up to grade 12; 32.4% had a tertiary qualification. status of the business: the majority (77.4%) were involved as sole proprietors. distance to nearest shopping mall: a mere 3% were situated in a shopping mall, whereas 17.9% were more than 3 km from the nearest shopping mall. the majority (48.5%) preferred a location of between 1 km and 3 km from the nearest shopping mall. reason for starting the business: the main reason was seizing a business opportunity (35.7%), followed by 30.6% who indicated unemployment as the main reason. a substantial number (22.9%) of respondents cited taking over a family business. physical location: the majority of retailers (47.2%) were established in smaller shopping centres (with between two and five adjacent businesses). only a few respondents were situated in a stand-alone shop (15.8%) and other smaller shopping centres with between 6 and 10 surrounding businesses (17.2%). the results clearly showed that these businesses tend to refrain from opening shop in the bigger shopping centres and malls. age of the business: the majority of respondents (55.6%) had been involved in the business for more than 5 years, that is, successfully operating an smme. the findings are in line with the general rule of thumb used by practitioners, as well as international statistics, that most small businesses fail within 5 years of start-up. small business administration (2014), a united states government agency supporting small businesses, as well as official statistics in the united kingdom (as quoted by deakins & freel 2012:19), shows that 50% of small business cease trading by the fifth year. ligthelm (2008:49) also used 5 years to indicate business maturity, while lebusa (2013:76) concurs that local small retail outlets tend to fail within the first 3 to 5 years. growth in turnover or sales: the growth pattern in the preceding year of 23.6% of respondents was positive, while 76.1% managed to remain the same size or experienced a decrease in turnover (sales) in the past year. inferential analysis after descriptive analysis, the owner or managers’ inventory decision patterns were analysed by studying selected inventory statements. exploratory factor analyses became necessary to reduce the data in an attempt to identify whether any clear factors emerged. a cluster analysis followed for identifying possible profiles within the data. finally, cross-tabulation was performed to determine the relationships between cluster membership and education, age of the owner, location of the business, frequency of inventory purchases, future perspective, and reasons for starting the business. inventory statements several inventory statements – self-designed and with different ordinal scales – were included in the questionnaire. on some statements, respondents had to indicate whether they ‘never’, ‘sometimes’ or ‘always’ performed the specific activity, and on others they had to indicate the extent to which they agreed with a statement or had to rate the importance of a statement regarding inventory decisions. to investigate the possibility of data reduction on the different inventory statements, exploratory factor analyses were done to identify any clear factors. principal component extraction with varimax rotation was thus conducted on four groups of statements: (1) inventory in the business, (2) marketing aspects related to inventory, (2a) product offering and (2b) convenience level, and (3) availability of products to consumers. the appropriateness of conducting factor analyses was confirmed with the kaiser–olkin measure of sampling adequacy that ranged between 0.5 and 0.756, and was the same or above the recommended threshold of 0.5. bartlett’s test of sphericity significance was p = 0.000 for all four analyses conducted. the factor analysis identified three factors for the inventory in the business statements and one factor respectively for product offering, convenience level and availability of products to customers, based on the eigenvalue criterion of values larger than 1, and it explains respectively 61.49%, 77.46%, 59.22% and 63.1% of the variance. for the values of the final factor loading, see table 1. table 1: final factor loadings. five of the six factors were labelled (see table 2) as maintaining a low inventory level, ease of maintaining higher stock levels, proactively maintaining higher stock levels, product offering, and convenience level. for the sixth factor, the cronbach’s alpha value was below 0.6 (0.41); therefore, it was decided to rather consider the two items separately, as on-demand product availability and customer confidence in sufficient stock levels. factor-based scores were subsequently calculated as the average value for the items included in each factor. table 2: results of the factor analysis, reliability and descriptive statistics. cluster analysis after performing factor analyses, five main inventory factors and two items were identified. a cluster analysis was subsequently performed to identify possible profiles within the data. with this exploratory analysis technique, a set of objects can be grouped so that clusters can be identified that show similar characteristics. the variables considered in the cluster analysis were the five factors, two items, business growth and the age of the business. in this case, a two-step cluster analysis was performed using the spss v23 software package. four clusters were identified (see figure 1). the two elements crucial in forming the clusters were the growth pattern and the age of the business. the decision to focus on these elements are in line with strydom’s (2015:473) research on soweto businesses, where surviving businesses were characterised by income growth and years in operation. it can be safely assumed that business size and age are related variables. although the relationship between size and age is by no means linear, deakins and freel (2012:221) suggest that in general the more the business grows (i.e., the bigger it is), the more likely it is to survive another period (i.e., the older it is). deakins and freel (2012:220) stress the accepted wisdom that small businesses grow faster than large businesses, and that younger businesses grow faster than older businesses. figure 1: cluster analysis. the silhouette measure of cohesion and separation was 0.3, which indicated a fair cluster quality. cluster 2 represents 41.5% of the respondent group, and although this group of retailers showed a negative growth pattern (staying the same or contracting during the past year) they managed to survive for 5 years and longer (100% of cluster respondents in both cases). cluster 3, which represents 24.6% of the respondent group, not only contracted or stayed the same during the past year, but were also young, that is, in business for less than 5 years (again 100% of respondents in both cases). the same pattern was seen with cluster 4 (constituting only 10.9% of respondents), but in this case they represented 87.1% of this cluster group in terms of negative or no growth and 93.5% in terms of young businesses (age < 5 years). cluster 1, which formed 22.9% of the respondent group, was the only cluster to show an overall positive performance, with 98.5% of the group showing growth in income during the past year, and 55.4% being in businesses for 5 years and longer. when comparing cluster 3 (showing no or negative growth and existing for less than 5 years) with cluster 1 (showing positive results on both income growth and business age), the biggest contrast is in the inclination to proactively maintain high inventory levels. overall, cluster 3 had the highest mean values on almost all variables, except proactively maintaining a high inventory level. cluster 1 showed the second highest mean values on four variables among all the cluster groups, and the highest mean value (2.74) of all clusters showed on the factor labelled proactively maintaining a high inventory level. in terms of maintaining low inventory levels and customers’ confidence in having sufficient stock, cluster 1 showed similar values (though marginally different) compared to other clusters. thus, being more inclined to proactively maintain a high level of inventory could result in positive business performance (in terms of growth in income and age). a negative or no growth picture for young businesses (cluster 3 and cluster 4) can be turned around if these retailers decide to focus on the following inventory-related aspects: stocking up on sale items from suppliers, purchasing more items for sales held at the store, making provision for customers’ fluctuating demands and buying more stock to save on transport costs. when comparing mean values within clusters, note that although cluster 3 shows marginally higher mean values (2.36 and 2.41) for proactively maintaining a high level of inventory and ease of maintaining a higher level of inventory respectively than maintaining a low level of inventory (2.24); the substantial inclination of the successful cluster 1 in terms of proactively and easily maintaining high levels (2.74 and 2.26 respectively) instead of low levels (1.82) is proof of the importance of making the correct decision of maintaining high levels of inventory. therefore, an inclination to purchase less than or the exact amount of stock that can be sold within a month (due to being too expensive) could be detrimental for the performance of small general and grocery retailers. when comparing clusters 1 and 2, both groups existed for 5 years and longer, but group 2 showed no or negative growth, while group 1 showed positive growth. the differences in terms of the mean values between proactively maintaining a high or a low level in inventory highlights the difference between these clusters. cluster 2 is marginally more (mean value of 1.96) inclined than cluster 1 (mean value of 1.82) to maintain a low level of inventory. this is in line with cluster 1 being the more inclined (mean value of 2.74) than cluster 2 to proactively keep a high level of inventory (mean value of 2.31). the same pattern is seen with the differences between these clusters regarding the ease with which high levels of inventory are maintained. both clusters 1 and 2 are inclined to focus more on proactively maintaining high levels of inventory and maintaining such high levels with ease, although cluster 1 stands out as the overall cluster which is most inclined to proactively maintain high levels. the conclusion is that if retailers want to grow and exist for 5 years and more, they should proactively maintain a high level of inventory and do so with ease (i.e. keep more stock than is sold monthly, easily obtain more stock from suppliers, have the capacity to store and access stock, and collaborate with a competitor to bargain for lower prices). despite clusters 2 and 3 both showing no or negative growth during the past year, they differ in terms of years in existence, with cluster 2 the older of the two groups. when analysing the mean values, cluster 2 (age 5 years and more) is less inclined to focus on the following three aspects: (1) product offering (a variety of quality products) – a mean value of 4.64, compared to 4.89 for cluster 3; (2) ease of maintaining higher stock levels (more stock than is sold monthly, easily obtaining more stock from suppliers when out of stock, the capacity to store and easily access excess stock, collaborating with a competitor to bargain for lower prices) – a mean value of 2.06, compared to 2.41 for cluster 3; and (3) maintaining a low level of inventory (buying less stock or the exact quantity that can be sold monthly, not buying more stock as it is expensive) – a mean value of 1.96, compared to 2.24 for cluster 3. despite the younger group 3 not showing growth, they seem to focus on the right aspects, which might give them the opportunity to grow in future. the lower values obtained by the older group 2 may reflect this group’s tendency to be satisfied with their status quo to survive, who do not necessarily pay attention to the aforementioned aspects which could potentially result in growth. there was a marginal difference between mean values of clusters 2 and 3 in terms of convenience (4.82 and 4.93 respectively), on-demand product availability (4.78 and 4.83 respectively), proactively maintaining high levels of inventory (2.31 and 2.36 respectively), and customers’ confidence in having sufficient stock levels (4.69 and 4.74 respectively). group 4, which sketches the bleakest picture of all four groups, scored the lowest mean values on all seven variables. this shows that, for these young businesses, their inventory decisions contributed to their poor performance in growth in income. they were the least inclined to focus on convenience, their product offering, on-demand product availability or customers’ confidence in having sufficient stock levels, and this negatively influenced their performance. although having also scored the lowest mean value on maintaining a higher level of inventory, proactively (1.94), and easily (1.73), and maintaining a low level of inventory (1.82), the marginal difference between the mean values on these variables within this group could indicate indecisiveness about the number of items to be kept in store. the relationship between cluster membership and demographic and business characteristics three of the four groups showed no or negative growth, with two groups being young businesses. although similarities existed between groups (groups 3 and 4 were young businesses with negative or no growth; groups 1 and 2 were able to survive for 5 years and longer despite opposite growth patterns), these groups had different answers on the inventory variables that resulted in the different clusters. contingency table analysis was performed to determine the relationships between cluster membership and education, age of the owner, location of the business, frequency of inventory purchases, future perspective, and reasons for starting the business. strydom (2015:473) specifically highlights the importance of business age, operating an established business in a small existing shopping centre with 10 or more stores, being further away from large malls, a higher educational level, and owner’s maturity in age as predictors of small business longevity. the results of this study indicate statistically significant relationships between all variables and cluster membership. since both variables in the cross-tabulation are nominal, the pearson chi-square test was used. where it could not be used (i.e. where more than 20% of cells had an expected frequency of < 5), the cramer’s v value – a measure of the strength of the association between the two variables – and its associated significance value were used (see table 3). table 3: results of pearson chi-square test and cramer’s v values when determining cluster membership and selected variables. education and cluster membership the results indicate that a statistically significant relationship, at the 1% level of significance, exists between education and cluster membership. across the groups, all members without schooling (100%) and those with grade 1–3 schooling (100%) fell in group 4 (businesses showing no or negative growth and being in business for less than 5 years). the bigger group 3 (70 members) who showed the same performance pattern as group 4 represented a relatively higher level of education, with group 3 representing 32.4% of the groups in grades 4–6 and 25.3% in grades 7–12, compared to the 11.8% and 9.1% of group 4 in the respective schooling categories. in terms of level of education, group 2 (older businesses with a negative or no growth pattern) showed the highest representation of all groups in three levels of education: grades 4–6 (47.1%), grades 6–12 (42.2%) and technical, trade or training of less than 3 years (49.2%). group 1 (older businesses with a growth pattern) had the majority (41.4%) representation of all groups in the schooling level of university, college or training of more than 3 years. groups 1 and 2 (who had survived for 5 years and more, despite showing opposite growth patterns), together represented 70.7% of the respondents on the level of technical, trade or training of less than 3 years, 65.5% on the level of grades 7–12 and 58.6% on the level of university, college or training of more than 5 years. in summary, survival of 5 years and more seems to be associated with higher education levels. age of the owner and cluster membership the results indicate that a statistically significant relationship, at the 1% level of significance, exists between the age of the owner and cluster membership. when comparing the groups, the younger businesses (< 5 years) seem to be in the hands of relatively young owners, with the majority (42.2%) of those aged 31–40 in group 3 (young businesses with no or negative growth patterns). this is confirmed by the small representation of older age groups (> 51) in both groups 3 and 4. if one assumes that the economic activity of humans takes place between the ages of 18 and 60, 41.4% of group members aged 18–30 fall in group 2 (survival of 5 years and more, but no or negative growth pattern), which might indicate younger people who are continuing with a family business or doing business as it has always been done. group 3 represents 42.2% of members aged 31–40, while group 2 represents 41.3% of members aged 41–50, 50% of members aged 51–60 and 75.8% of members 61 years and older. in group 1 (older businesses showing growth) the members are similarly spread in the age brackets of 31–60, with 29.2% aged 31–40, 27.7% aged 41–50 and 28.3% aged 51–60. the pattern observed when comparing groups is that the older respondents mainly form part of the group of surviving businesses that show no or negative growth (i.e. group 2). this finding could indicate that older business owners, who might be set in their ways, have managed to survive their businesses, but might be reluctant or unskilled to make business decisions that may lead to growth. location and cluster membership the results indicate that a statistically significant relationship, at the 10% level of significance, exists between location and cluster membership. the majority (66.7%) of businesses in group 3 (younger businesses with no or negative growth) are located in shopping malls. they possibly face not only intense competition, but also the high costs typically associated with doing business in a big mall. group 2 (older businesses with negative or no growth) represent the majority (43.6%) of businesses in stand-alone shops. given that group 2 represents the older generation of business owners, with the majority of 73.5% older than 41 years of age, these owners’ preference for stand-alone shops can be attributed to their traditional ways. however, group 2 also has the highest occupancy of all groups in the category being located in a shopping centre with two to five adjacent businesses or a shopping centre with 6–10 adjacent businesses (42% and 45.7% respectively). group 2 also represents 50% of members located in shopping centres with more than 20 surrounding businesses. in centres with 11–20 and more than 20 surrounding businesses, group 1 represents 66.7% and 50% of the groups respectively. group 1 members, however, seem cautious of moving to the big malls as they represent only 16.7% of groups in this category. in group 1, almost 60% (59.4%) are established in shopping centres with two to five adjacent businesses. as with group 2, group 1 represents the other 50% in the category of businesses located in shopping centres with more than 20 surrounding businesses. neither group 3 nor 4 (younger businesses with no or negative growth) is represented in the categories of shopping centres with 11–20 or more than 20 surrounding businesses. across the groups, younger businesses tended to strongly prefer to establish themselves in big, well-known malls. some were located in shopping centres with fewer than 20 surrounding businesses. while groups 3 and 4 mainly preferred being located in big malls, groups 1 and 2 (surviving businesses) were established in stand-alone shops and shopping centres with few surrounding businesses. frequency of inventory purchases and cluster membership the results indicate that a statistically significant relationship, at the 5% level of significance, exists between frequency of inventory purchases and cluster membership. all groups had the highest number of respondents buying on a weekly basis (67.7% in group 1, 62.7% in group 2, 48.6% in group 3 and 48.4% in group 4). group 2 had the highest representation in terms of the following: it represented 36.7% of groups purchasing daily, 44.3% of groups purchasing weekly and 44.6% of groups purchasing when stock levels are low. group 3 (younger businesses showing no or negative growth) stood out as purchasers of stock on a monthly basis (45.5%). together, groups 1 and 2 represented 60% of groups purchasing daily, 70.6% weekly and 58.4% when stock is low, whereas groups 3 and 4 together represented 63.6% of groups buying monthly. the older businesses (groups 1 and 2) preferred to buy daily, weekly or when stock is low, whereas the younger businesses (groups 3 and 4) preferred to buy monthly. main reason for starting a business and cluster membership the results indicated that a statistically significant relationship, at the 1% level of significance, exists between the main reason for starting a business and cluster membership. group 2 represented 74.6% of members who had taken over a family business (confirmed by the subsequent findings related to owners’ future perspective, which explains their inclination to do business the tried and tested way, and survive despite no or negative growth). among the younger groups (2 and 3) showing no or negative growth, group 3 represented 46.6% of all members who had started their business while unemployed or having no income. group 1’s success (being older and growing) is proof of their ability to seize an opportunity (38.8%), while 62.5% of respondents indicated seizing an opportunity as the main reason for initially starting the business. the desperation of having no income or being unemployed could explain why 59.4% and 53.3% in groups 3 and 4 respectively started their own business, and now own businesses with no or negative growth. group 2 also represented the majority (54.5%) who stated that supplementing their income was the main reason for starting a business, that is, it is not their main source of income, which could explain why their status of merely surviving without growth or even tolerating negative growth would suffice. future perspective and cluster membership the results indicate that a statistically significant relationship, at the 1% level of significance, exists between future perspective and cluster membership. here, respondents were asked to indicate where they see their business in 2 years’ time. in all four groups, the majority of members preferred to continue with their businesses, which makes sense especially within group 1 (growing, older businesses) (87.7%). however, group 2 represented the majority of groups wishing to continue with business as is (41.5% of groups), stop the business to take up a waged job (100%), switch to another line of business (58.3%), hand the business to children and retire (80%) and sell the business and retire (75%). the general future perspective of this group seems to show signs of despondency and a readiness to retire. the high representation with plans to hand over the reins to the next generation and retire confirms that these businesses are owned by older businesspeople, who themselves inherited the business. conclusion against the backdrop of the history and current potential of township retailing, as well as the cardinal role of optimal inventory decision-making in small business performance, the research question addressed here was how soweto small retailers make inventory decisions to grow their income and age of the business. the secondary objectives were (1) to identify possible profiles among soweto grocery and general small retailers, with regard to inventory decision-making, (2) to determine the relationships between cluster membership and demographic (education and owner age) and business variables (location, frequency of inventory purchases, future perspective, and reasons for starting), and (3) to provide retailers in soweto showing negative (or no) growth with guidelines on inventory decision-making based on the inventory decision patterns displayed by older counterparts with income growth. the data was analysed using exploratory factor analyses, cluster analysis and cross-tabulations. the literature review shows paradoxical viewpoints on small retailers’ inventory decision-making: arguments for and against smaller volumes and buying in bulk (see discussion of beneke 2014:30; scarborough 2012:375; stokes & wilson 2017:432; world bank 2014:173), limited and broad variety (see allen 2012:332; baker & canessa 2009:425; bowersox et al. 2013:46; coyle et al. 2013:324; hatten 2016:296–297; lighthelm 2008:52; petousis 2014; scarborough 2012:549; world bank 2014:207), and selling fewer items at higher prices and resorting to markdowns (see scarborough 2012:375; stokes & wilson 2017:375). despite this, the research results showed that being more inclined to proactively maintain a high level of inventory could result in positive business performance (in terms of both growth in income and age of the business). younger businesses could thus turn around a negative or no growth picture if they move from indecisiveness about the number of inventory items to hold in store to a focus on stocking up on sale items from suppliers, purchasing more items for sales held at the store, making provision for customers’ fluctuating demands and buying more stock to save on transport costs. an inclination to purchase less than or the exact amount of stock that can be sold in a month, due to it being too expensive, could harm the performance of small general and grocery retailers. the results also show that if small retailers want to grow and exist for 5 years and more, they should consider proactively maintaining a high level of inventory and maintaining such higher inventory levels with ease (i.e. keeping more stock than they sell monthly, easily obtaining more stock from suppliers, having the capacity to store and access excess stock, and collaborating with a competitor to bargain for lower prices). carrying higher inventory levels requires good inventory management, which implies the following actions. it is recommended that small business retailers set par levels for stock items (i.e. the minimum number of items that should be on hand at all times) and closely monitor items with expiry dates to avoid unnecessary wastage. seasonal items and items that might go out of style could also become dead stock resulting in lost income. retailers should balance the variable cost of storage by ensuring that the right amount of the right items are stored. in order to determine optimal levels, cash flow and inventory management systems should be implemented and used. a basic first-in first-out system to move older items first or an abc analysis to prioritise attention to higher value items can easily be implemented. exact knowledge of items in stock, sales figures, projections of periods of low stock, demand predictions and replacement dates would guide retailers in determining the timing and amount of cash needed during reordering. in this study, older respondents mainly ran surviving businesses, which showed no or negative growth. it can be concluded that older business owners might have succeeded in sustaining their businesses by doing business in the traditional way, but they might be reluctant or unskilled to make decisions that may lead to growth. younger businesses should therefore expand their horizons and exploit opportunities to learn and implement modern management skills in order to succeed. across the groups, the owners of younger businesses strongly prefer to establish themselves in big, well-known malls. however, surviving (older) businesses were rather established in stand-alone shops and shopping centres with few surrounding businesses – township business owners prefer to be part of the community. further, the owners of older businesses conservatively prefer to buy daily, weekly or when stock is low, whereas those of younger businesses prefer to buy monthly. depending on their roots in local communities and the type of items kept, younger businesses should determine optimal location and order quantities. older businesses showing no or negative growth constituted the majority of respondents who had taken over a family business, as confirmed by their future perspective of retiring and handing over the business to their descendants, and with an inclination to do business the tried and tested way, surviving despite no or negative growth. the owners of older businesses (with no or negative growth) stated supplementing their income as the main reason for starting a business. that could explain why they proceed despite no or negative growth – the business is not their main source of income. older entrepreneurs with growing businesses mainly started their venture by seizing an opportunity. again it is recommended that younger business owners expand their horizons to identify lucrative business opportunities. this would require a perceptive mind, creativity and a drive to transform opportunities into sustainable businesses. this study confirmed the findings in the literature (see discussion by yang 2016:2; matabooe et al. 2016:2; kesavan & kushwaha 2014:2118; yordanov 2015:50; honig et al. 2014:97) that retailers can improve their inventory management by following the example of similar retailers. younger (and older) businesses with no or contracting growth can therefore benefit from emulating maturing businesses experiencing income growth. formal and informal mentorship and business training sessions could benefit the less experienced business owners. this article presented a platform where successful inventory practices can be shared, since retailers tend to function in isolation within a shared community, without realising the benefit of collaboration or interaction. the value of collaboration and good relationships with suppliers to promote adaptability, inventory problem-solving and good inventory management should also not be underestimated. the study showed the benefits of carrying larger volumes of inventory in small grocery retail and general retailing outlets, where high customer service levels are demanded (even during economic decline) and highlighted how both young and established small businesses could forfeit growth if they refrain from adapting their inventory decision-making to benefit from lucrative retailing opportunities in townships. acknowledgements competing interests the author declares that she has no financial or personal relationships that may have inappropriately influenced her in writing this article. references allen, k.r., 2012, new venture creation, 6th edn., south-western cengage learning, 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department of economics, slu, uppsala, viewed 09 november 2017, from http://urn.kb.se/resolve?urn=urn:nbn:se:slu:epsilon-s-4637 abstract introduction economic background and monetary policy: an overview of malawi formal and informal financial markets methodology estimates and inferences summary, conclusions and policy implications acknowledgements references appendix 1 about the author(s) harold ngalawa school of accounting, economics and finance, university of kwazulu-natal, south africa citation ngalawa, h., 2018, ‘informal financial transactions and monetary policy in low-income countries: interpolated informal credit and interest rates in malawi’, south african journal of economic and management sciences 21(1), a1531. https://doi.org/10.4102/sajems.v21i1.1531 original research informal financial transactions and monetary policy in low-income countries: interpolated informal credit and interest rates in malawi harold ngalawa received: 25 dec. 2015; accepted: 09 nov. 2017; published: 23 apr. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: official monetary data usually exclude informal financial transactions although the informal financial sector (ifs) forms a large part of the financial sector in low-income countries. aim and setting: excluding informal financial transactions in official monetary data, however, underestimates the volume of financial transactions and incorrectly presents the cost of credit, bringing into question the accuracy of expected effects of monetary policy on economic activity. methods: using ifs data for malawi constructed from two survey data sets, indigenous knowledge and elements of friedman’s data interpolation technique, this study employs innovation accounting in a structural vector autoregressive model to compare monetary policy outcomes when ifs data are taken into account and when they are not. results: the study finds evidence that in certain instances, the formal and informal financial sectors complement each other. for example, it is observed that the rate of inflation as well as output increase following a rise in either formal financial sector (ffs) or ifs lending. further investigation reveals that in other cases, the ffs and ifs work in conflict with each other. demonstrating this point, the study finds that a rise in ffs interest rates is followed by a decline in ffs lending while ifs lending does not respond significantly and the response of ffs and ifs loans combined is insignificant. when ifs interest rates are raised, total loans decline significantly. conclusion: the study, therefore, concludes that exclusion of ifs transactions from official monetary data has the potential to frustrate monetary policy through wrong inferences on the impact of monetary policy on economic activity. introduction the principal objective of malawi’s central bank as stipulated in the reserve bank of malawi (rbm) act of 2013 is: to implement measures designed to influence the money supply and the availability of credit, interest rates and exchange rates with the view to promoting economic growth, employment (and) stability in prices. (malawi government 2013:5) it is important, therefore, that the monetary authorities understand the process through which monetary policy affects economic activity, in order to achieve this objective. as in most low-income countries, monetary authorities in malawi do not include informal financial transactions in official monetary data. for the purposes of this study, informal finance is defined as legal but unregulated financial activities that take place outside official financial institutions and are not directly amenable to control by key monetary and financial policy instruments (see chipeta & mkandawire 1991; ngalawa 2014; soyibo 1997). the primary reason for the omission of informal financial transactions in official monetary data is the absence of the data. in some instances, data are available but from once-off surveys. in other instances, where the data are available from more than one survey, the surveys are at irregular intervals and the data may not be comparable (ngalawa 2016). in most high-income countries, the informal financial sector (ifs) is practically non-existent. in nearly all low-income countries, however, the ifs is very large (see for example african development bank 1994; chipeta & mkandawire 1991). there is also evidence that the sector has been growing relative to the formal financial sector (ffs) in some of these low-income countries (see for example aryeetey 1994; bagachwa 1995; chipeta 1998; chipeta & mkandawire 1991; soyibo 1997). to the extent that official monetary data do not include informal financial transactions, the volume of aggregate financial transactions is underestimated and the cost of credit is incorrectly reported, bringing into question the timing and effect of monetary policy on economic activity (ngalawa 2014, 2016). the primary objective of this paper, therefore, is to investigate the difference in the impact of monetary policy when ifs data are included and when they are excluded. the paper employs ifs data constructed by ngalawa (2014) using two survey data sets, elements of indigenous knowledge and principles of the friedman method of interpolating time series from related series (friedman 1962). this is the first study that the author is aware of that examines the impact of monetary policy on economic activity taking into account the ifs. the study argues that exclusion of ifs transactions in official monetary data has the potential to frustrate monetary policy through wrong inferences on the impact of monetary policy on economic activity. the rest of the paper is organised as follows: the ‘economic background and monetary policy: an overview of malawi’ section is an overview of malawi’s economic background and monetary policy framework. the ‘formal and informal financial markets’ section reviews the literature on the interaction of formal and informal financial markets. the ‘methodology’ section presents a structural vector autoregressive (svar) model used for analysis. estimation results are discussed in the ‘estimates and inferences’ section and a summary and conclusion follow in the last section, namely, ‘summary, conclusions and policy implications’. economic background and monetary policy: an overview of malawi malawi is a small landlocked country (118 000 km2) in south-east africa bordered by mozambique to the south, east and west, tanzania to the north-east and zambia to the north-west. when the country attained independence from the british (empire) in 1964, three resources were identified as primary sources of economic growth: fertile agricultural soils, abundant unskilled labour and plentiful water supply (see ngalande 1995). the malawi government put the first two resources into use by developing the agricultural sector and exporting unskilled labour to the mineral rich countries of northern rhodesia (zambia), southern rhodesia (zimbabwe) and south africa. malawi’s economy is dominated by the agricultural sector, which accounts for nearly a third (27.89%) of the country’s gross domestic product (gdp) (2016 estimate). agriculture, in turn, is for the most part driven by smallholder farming. it is estimated that 84% of agriculture value-added in malawi comes from smallholder farmers, who on average own only 1 ha of land, still cultivate using hoe technology, and rely heavily on family labour (chirwa & matita 2012). the large smallholder agricultural sector partly explains the existence of a large informal sector in the country, which is a domicile of large informal financial transactions that tend to have an important influence on the country’s financial system. according to the malawi national statistical office (2005), an estimated 98% of the household loans in the country in 2005 originated from the ifs while only 2% were from the ffs. in 2011, the proportion of household borrowing from the ifs declined to 88% while household borrowing from the ffs increased to 12% (malawi national statistical office 2012). underlining the large size of the ifs in the country, a study by chipeta and mkandawire (1991) revealed that in 1989, the ifs in malawi was larger than the ffs when measured in terms of credit extended to the private sector. chipeta and mkandawire (1991) arrived at the same conclusion by comparing savings mobilised by the formal and informal financial sectors. monetary policy plays an important role in the management of the malawi economy. the rbm act stipulates that one of the principal objectives of the central bank is to influence money supply, credit availability, interest rates and exchange rates in order to ultimately promote economic growth, employment and price stability (malawi government 2013). monetary policy in malawi can be compartmentalised into three distinct regimes, namely financial repression (1964–1986), financial reforms (1987–1994) and financial liberalisation (post 1994). the first phase described as a period of financial repression starts at independence in 1964 when the country’s monetary authorities imposed direct controls on credit and interest rates. in line with government’s policy of promoting the agricultural sector, authorities in malawi accorded preferential lending rates and quota credit allocations to the agricultural sector. the country also adopted a fixed exchange rate system and imposed price ceilings on selected commodities. during the period of financial reforms (1987–1994), the country embarked on a phased financial liberalisation programme targeted at enhancing competition and efficiency in the financial sector. this was a response to the country’s failure to adjust quickly to a deep recession early in the 1980s, which exposed structural weaknesses in its macroeconomic framework (see gondwe 2001). the reforms included partial deregulation of lending rates in july 1987 and deposit rates in april 1988, abolition of credit ceilings in 1988, abolition of preferential lending rates to the agricultural sector in january 1990, complete deregulation of interest rates in may 1990 and repealing of the rbm act of 1964 and banking act of 1965 in may and december 1989, respectively. the financial liberalisation phase can be generalised as the post-february 1994 period. throughout the 1980s to the early 1990s, the country undertook extensive financial sector reforms, which culminated in the floatation of the local currency, the malawi kwacha (mwk), in february 1994. thereafter, the monetary authorities removed exchange control regulations, allowed for the establishment of foreign exchange bureaux, introduced foreign currency denominated accounts, established a forward foreign exchange market and started the trading of foreign exchange options and currency swaps (see ngalawa & viegi 2011). the first available estimates of the ifs in malawi were from the chipeta and mkandawire (1988) survey. chipeta and mkandawire (1988) revealed that in 1988, the ifs was larger than the ffs as measured by credit extended to the private sector or savings mobilised by the formal and informal financial sectors. in 2005, the malawi national statistical office reported that 98% of all household loans in the country were from the ifs. this figure dropped to 88% in 2011 (malawi national statistical office 2012). formal and informal financial markets many studies have demonstrated that the formal and informal financial sectors in low-income countries are interlinked (see for example bolnick 1992; bose 1998; chipeta & mkandawire 1991; hoff & stiglitz 1993, 1994; khoi et al. 2013; ngalawa & viegi 2013). using a dynamic stochastic general equilibrium (dsge) framework calibrated on malawi data for the period 1988 to 2005, ngalawa and viegi (2013) showed that total formal and informal sector loans are complementary in quasi-emerging market economies (qemes). formal and informal sector credit are complementary when an increase in demand for credit in one sector is accompanied by an increase in demand for credit in the other sector for the economy to remain in equilibrium (see also chipeta & mkandawire 1991; ngalawa 2016). accordingly, increasing investment financed by ffs credit will lead to additional productive capacity that can only be utilised with investment financed by ifs credit (see aryeetey 1994; chipeta & mkandawire 1992). thus, increasing the use of ffs credit increases demand for ifs credit (ngalawa & viegi 2013). ngalawa and viegi (2013) demonstrated that while formal and informal financial sector credit are complementary in the aggregate, they are substitutes in a borrowing firm’s utility function. khoi et al. (2013) found similar results in a study of vietnam. using 2011 survey data from a sample of households selected out of 15 villages in 13 communes that had microcredit programmes operating at least since 2002 in the mekong river delta of vietnam, khoi et al. (2013) showed that an increase in demand for informal credit increases the probability of borrowing from the formal sector, which is consistent with the complementarity hypothesis of formal and informal financial markets. khoi et al. (2013) further argue that the high interest rate differential between the two markets leads households that borrowed in the informal market to take out a formal market loan to repay or roll over the informal debt. underscoring the high interest rate differential, they point out that ifs interest rates in vietnam are five times higher than ffs interest rates. some studies have gone further to show that interest rates in the formal and informal financial sectors do not necessarily change together in the same direction. ngalawa and viegi (2013) have shown that under certain circumstances in qemes, interest rates in the formal and informal financial markets respond to a monetary policy shock by moving in diametrically opposed directions, with the implication that monetary policy may be frustrated by the nature of interest rate interaction between the two sectors (see also ngalawa 2016). studies carried out by chipeta and mkandawire (1991, 1992), chimango (1977) and bolnick (1992) also report that interest rates in the ifs in malawi are not driven by the ffs. in some countries, governments have intervened in the formal sector in an attempt to provide cheap credit to households, usually in the agricultural sector. the expectation is that farmers would shift from the ifs as their primary source of credit to the ffs, which would force ifs interest rates down. this, however, has not happened (see for example basu 1994; bell 1990; siamwalla et al. 1990). in a theoretical exposition conducted between 1995 and 1997, bose (1998) maintains that there is evidence that interest rates charged by the ifs have been relatively unaffected by ffs interest rates, which are substantially below those charged by the ifs. hoff and stiglitz (1993, 1994) have argued that the cheap credit in the ffs may result in an increase, rather than a decrease, in the ifs interest rates. several studies have also found that funds flow between the formal and informal financial markets (see bolnick 1992; bose 1998; ngalawa & viegi 2013). often, creditors in the ifs have access to funds in the ffs. as suppliers of loans, ifs creditors usually possess enough assets to qualify as creditworthy to the lending institutions in the formal sector and in many countries, credit from suppliers is routinely financed with bank loans or overdrafts (bose 1998). funds have also been observed to flow in the reverse direction, from the informal to the formal financial sector (ngalawa 2016). a study carried out in 1992 on malawian data by bolnick (1992), for instance, reports that even the moneylender stores liquidity in the bank. it is clear from the foregoing discussion that while nearly all low-income countries do not include informal financial transactions in official monetary data for policymaking, the literature is awash with studies arguing that the formal and informal financial sectors interact (see chipeta & mkandawire 1991; khoi et al. 2013; ngalawa & viegi 2013). clearly, the formulated policies are unlikely to achieve their intended objectives if policy outcomes are different depending on whether monetary data include ifs transactions or not. unfortunately, none of the studies that the author is aware of has attempted to investigate the differences in the impact of monetary policy when ifs data are included and when they are excluded. this is the knowledge gap that this study attempts to fill. employing ifs data constructed by ngalawa (2014) using two survey data sets, elements of indigenous knowledge and principles of the friedman method of interpolating time series from related series (friedman 1962), this study argues that exclusion of ifs transactions from official monetary data has the potential to frustrate monetary policy through wrong inferences on the impact of monetary policy on economic activity. methodology introduction since sims’s (1980) pioneering work, vector autoregression models (vars) and structural vector autoregression models (svars) are considered benchmarks in econometric modelling of monetary policy transmission (borys & hovarth 2007; ngalawa & viegi 2011). while natural experiments would be ideal, the real world does not provide for this option and svars are the only other way experiments can be performed (christiano, eichenbaum & evans 1998). svar experiments aimed at measuring the effect of monetary policy on economic activity have traditionally involved setting apart monetary policy shocks and tracking the response of macroeconomic variables to the monetary policy impulses. since the objective of this study is to understand monetary policy outcomes, tracing them through the inclusion and exclusion of the ifs alongside the ffs within a country’s monetary policy framework, the svar stands out as the most appropriate method for analysis. structural vector autoregression model following ngalawa and viegi (2011), the monetary transmission process in malawi can be described by a dynamic system whose structural form equation is given by: a is an invertible (n × n) matrix describing contemporaneous relations among the variables; yt is an (n×1) vector of endogenous variables such that yt= (y1t, y2t, …, ynt); ω is a vector of constants; φi is an (n × n) matrix of coefficients of lagged endogenous variables (∀i = 1,2,3, …, p); b is an (n × n) matrix whose non-zero off-diagonal elements allow for direct effects of some shocks on more than one endogenous variable in the system; and mt are uncorrelated or orthogonal white-noise structural disturbances. thus, the covariance matrix of μt is an identity matrix e(μt, μt)=1 (see ngalawa 2016). feedback inherent in the svar equation makes it impossible to directly estimate equation 1 (see enders 2004). nonetheless, the information in the system can be recovered by estimating a reduced-form var implicit in the primitive equation. pre-multiplying equation 1 by a−1 yields a reduced-form var of order p, which in standard matrix form is written as: ψ0 = a−1ω, ψi = a−1φi and εt = a−1 b μt is an (n × 1) vector of error terms assumed to have zero means, constant variances and to be serially uncorrelated with all the right-hand-side variables as well as their own lagged values although they may be contemporaneously correlated across equations. the variance-covariance matrix of the regression residuals in equation 2 is defined as σ = e(εt, εt). given the estimates of the reduced-form var in equation 2, the structural economic shocks are separated from the estimated reduced-form residuals by imposing restrictions on the parameters of matrices a and b in equation 3: equation 3 is derived from equation 2. to identify matrices a and b, the study adopts structural factorisation, an approach that uses relevant economic theory to impose restrictions on the elements of matrices a and b (see bernanke 1986; bernanke and mihov 1998; sims 1986; sims & zha 2006). seven variables are included in the svar, namely output (gyt), consumer price level (cpt), commercial bank loans (blt) (experiments are also carried out with ifs loans (ifslt) and total loans (totlt), which is the sum of bank loans and ifs loans), exchange rates (xrt), aggregate money supply (m2t), bank rate (brt) (experiments) are also carried out with ifs interest rates (ifsirt) and reserve money (rmt). the structural shocks in equation 3 are identified according to the following scheme: the non-zero coefficients aij and bij in matrices a and b, respectively, show that any residual j in matrices εt and mt, in that order, has an instantaneous impact on variable i. output and consumer prices in the first two equations are assumed to be sluggish in responding to shocks to monetary variables in the economy. this proposition is based on the observation that most types of real economic activity may respond only with a lag to monetary variables because of planning delays and inherent inertia (karame & omedo 2002; ngalawa & viegi 2011). proposed by bernanke and mihov (1997), the validity of this argument has been supported by a number of studies (see for example becklemans 2005; cheng 2006; karame & olmedo 2002; vonnak 2005). in the third equation, commercial bank loans are presumed to be contemporaneously affected by all variables in the system. according to blundell-wignall and gizycki (1992), expectations of future activity form an important determinant of credit demand. assuming current output, price level, exchange rates, interest rates and money supply provide an indication of what is expected in the future (becklemans 2005) and because economic agents are indeed forward-looking, commercial bank loans may respond contemporaneously to all variables in the system. the financial sector in malawi lacks depth and is weakly integrated into global markets. it is safe, therefore, to assume that information delays will be prevalent, forcing players in the foreign exchange market to respond with a lag to changes in interest rates, commercial bank loans and monetary aggregates. this study, therefore, postulates that exchange rates respond contemporaneously to changes in the level of output and consumer prices only and with a lag to movements in interest rates, commercial bank loans and aggregate money supply. besides being an asset price, the exchange rates also account for movements in external factors such as oil prices and interest rates on the international market. the fifth equation is a standard money demand function. the equation postulates that demand for money in the country makes aggregate money supply respond contemporaneously to changes in consumer prices, output and interest rates, but not to changes to other variables in the system, akin to sims and zha (2006). the last two equations constitute the monetary policy feedback rule. consistent with ngalawa and viegi (2011), the study assumes that the country employs hybrid operating procedures, with the bank rate and reserve money as operating targets of monetary policy. in this framework, both interest rates and reserve money are expected to contain information about monetary policy (bernanke & mihov 1997; ngalawa 2016; ngalawa & viegi 2011). the monetary policy feedback rule is based on the assumption that information delays impede policymakers’ ability to react immediately to economic activity and price level developments (karame & olmedo 2002). both the bank rate and reserve money, therefore, do not respond immediately to output and consumer prices. the bank rate, specifically, responds contemporaneously to changes in the exchange rates only. while exchange rate data are available in real time, data on other variables, including commercial bank loans and monetary aggregates, are usually available to the monetary authorities with a lag. reserve money, on the other hand, is assumed to respond contemporaneously to all monetary variables because, by its definition, this information is inherent in the monetary aggregate (see ngalawa 2016). interpolation of informal financial sector credit and interest rates for malawi the study employs interpolated ifs credit and interest rates from ngalawa (2014). using two survey data sets, namely the second integrated household survey for malawi (ihs2) carried out in 2005 by the malawi national statistical office (nso) and the chipeta and mkandawire survey of 1988, ngalawa starts with a linear interpolation of ifs credit between the two periods followed by a split of the ifs credit data into agricultural and non-agricultural components. to introduce trend into the agricultural sector component of the ifs credit, ngalawa constructs weights describing agricultural sector activity using rainfall data from six weather stations purposely selected to cover a lowland area and a highland area in each of the country’s three regions. the non-agricultural component of ifs credit, on the other hand, is separated into rural and urban components. a weighted average of tobacco production and the index of industrial production are used to construct weights for trending the rural and urban components. to account for changes in the ratio of industrial production to agricultural production during the sample period, annual proportions of tobacco production and manufacturing (as proxies for agricultural and industrial production, respectively) in gross domestic product (gdp) are used to calculate a weighted average of the two weighting variables. the agricultural and non-agricultural components of ifs credit are aggregated into the final interpolation of ifs credit. the data are seasonally adjusted using time series regression with autoregressive moving average (arima) noise, missing observations, and outliers (tramo) and signal extraction in arima time series (seats), with a forecast horizon of 12 months. interpolation of ifs interest rates is based on four stylised facts. interest rates in semi-formal and formal financial sectors are believed to change together in the same direction; interest rates on loans given by moneylenders, friends, relatives, neighbours, traders, grocers, local merchants and grain millers, according to chipeta and mkandawire (1991) and chimango (1977), are determined by custom and traditional values; friends, relatives, neighbours, traders, grocers, local merchants and grain millers do not charge interest on loans (see chipeta & mkandawire 1991) and moneylenders charge 100% interest per period of time, usually a month, described by chimango (1977) as ‘every pound makes another pound’ (see ngalawa 2014). six credit market segments are identified from ihs2 and the chipeta and mkandawire (1988) survey, namely friends, relatives and neighbours; grocers, traders, merchants and grain millers; moneylenders; community funds; microfinance; and employers (see ngalawa 2014). assuming that total credit in the ifs varies according to the interpolated data, the proportion of credit attributed to each market segment is assumed to change from the position reported in the chipeta and mkandawire survey to the position in ihs2 following a linear trend. a weighted average of the interest rates in each market segment makes up the interpolated ifs interest rates. the weights are constructed from the size and interest rates of each market segment. data, data sources and measurement of variables the study employs monthly time series data for the period january 1988 to december 2005. the starting date has been chosen to capture the period when monetary authorities in malawi migrated from using direct measures of monetary control to using indirect measures. the cut-off date corresponds to the date when the interpolated ifs data are available. major sources of data include the rbm, the nso of malawi, the malawi meteorological department and the university of malawi. data for ifs credit and interest rates are obtained from ngalawa’s (2014) interpolation summarised in section ‘interpolation of ifs credit and interest rates for malawi’. the bank rate (brt) is defined as the rate at which the central bank provides short-term loans to commercial banks and discount houses in its function as a lender of last resort. the variable enters the svar as an instrument target of monetary policy. experiments are also carried out with ifs interest rates (ifsirt). reserve money (rmt) is also employed as an instrument target of monetary policy in the svar. components of rmt are identified as total cash reserves held by the central bank, vault cash in commercial banks and currency held by the non-bank public. the variable blt captures commercial bank loans and advances and it enters the svar as an intermediate target of monetary policy. experiments are also carried out with ifs loans (ifslt) and total loans (totlt), which is the sum of commercial bank loans and ifs loans. similarly, the exchange rate (xrt) enters the svar as an intermediate target of monetary policy. middle nominal exchange rates of the malawi kwacha vis-à-vis the united states dollar are used as a measure of xrt. aggregate money supply (m2) is measured by the sum of currency in circulation, demand deposits and time deposits. the variable also enters the svar as an intermediate target of monetary policy. consumer prices (cpt) are measured by the all-items national composite consumer price index with the base year 2000. the variable enters the svar as a monetary policy goal. a measure of output (gyt) enters the svar as a monetary policy goal as well. real gdp data (used as a proxy for gyt) for malawi is, however, only available in annual frequency. this presents a case for interpolation. several studies have used interpolated monthly gdp series in svars. among them, cheng (2006) used monthly production data of key sectors in kenya to interpolate the country’s annual gdp to monthly frequency, and borys and hovarth (2007) used the quadratic-match average procedure to interpolate gdp from quarterly to monthly frequency in the czech republic. this study employs the friedman method of interpolating time series by related series to compute the required monthly gdp series from annual data. all variables, with the exception of interest rates, are expressed in natural logarithms. they are also seasonally adjusted using tramo and seats with a forecast horizon of 12 months. estimates and inferences estimation results the estimations are carried out in five modular experiments. in the first experiment, only ffs data are used in a seven-variable svar. the variables include reserve money (rm), aggregate money supply (m2), bank rate (br), aggregate output (gy), exchange rate of the malawi kwacha vis-à-vis the us dollar (xr), consumer prices (cp) and commercial bank lending (bl). this estimation is used as a basis for comparison with other scenarios. in the second experiment, the svar is re-estimated with commercial bank loans replaced by ifs loans. the third experiment is a re-estimation of the svar with commercial bank loans replaced by ifs loans (ifsl) and the bank rate replaced by ifs interest rates (ifsir). in the fourth experiment, the svar is re-estimated with commercial bank loans replaced by total loans (totl), an aggregate of ffs and ifs loans. the final experiment is a re-estimation of the svar with the bank rate replaced by ifs interest rates (ifsir) and bank loans replaced by total loans (totl), a sum of ffs and ifs loans. impulse responses from these experiments are presented in figures 1-a1–5-a1 in appendix 1. the choice of an appropriate lag length in a svar is an empirical issue (see gujarati 2003). given the various criteria for choosing the lag length, this study settled for the schwarz information criterion (sic) for the simple reason that it imposes a harsher penalty for adding more lagged terms than other criteria, such as the akaike information criterion. the model with the lowest sic is deemed the most appropriate. a lag length of 2 was identified as the most appropriate in all the experiments that were carried out. at the chosen lag length (of order 2), all the eight inverse roots of the characteristic autoregressive (ar) polynomial have modulus less than 1 and lie inside the unit circle, indicating that the estimated svar is stationary or stable. experiment 1 figure 1-a1 (in appendix 1) presents impulse response functions of selected variables with ffs data only. the figure shows that a monetary policy shock characterised by an unanticipated increase in the bank rate leads to a significant decline in money supply, commercial bank loans and output, which is consistent with a priori theoretical expectations. the bank rate shock, however, is observed to have no significant impact on consumer prices. figure 1-a1 (in appendix 1) further shows that an unexpected increase in commercial bank lending causes output to increase significantly, peaking after about 2 years. aggregate money supply and consumer prices also increase following the commercial bank lending shock. the figure also shows that monetary authorities respond to an unanticipated increase in consumer prices by increasing the bank rate. in addition, it is observed that money supply increases following a positive consumer price shock, which is a surprising result. a possible explanation for the money supply increase is that the monetary authorities may be attempting to accommodate the consumer price increase by increasing money supply. there is no evidence, though, that monetary authorities respond to an output shock characterised by a sudden increase in output. experiment 2 impulse response functions of selected variables with ffs data plus ifs loans are presented in figure 2-a1 (appendix 1). the figure demonstrates that a monetary policy shock characterised by an unanticipated increase in the bank rate has no significant effect on ifs loans and consumer prices. the shock, however, leads to a significant decrease in aggregate money supply and national output. a monetary policy shock identified as a sudden increase in money supply leads to a significant decline in the bank rate and increase in output. there is, however, no significant change in ifs loans and consumer prices. an unexpected increase in informal financial sector loans, on the other hand, leads to a significant increase in output and consumer prices. experiment 3 figure a3 (appendix 1) shows impulse responses of selected variables, including ifs credit and interest rates. it is shown in the figure that an unexpected increase in ifs interest rates causes an instantaneous increase in ifs credit. output also increases following the shock. consumer prices and aggregate money supply, however, do not respond significantly to the shock. the figure further reveals that ifs interest rates do not respond significantly to shocks to any of the variables in the model (output, consumer prices, ifs loans and aggregate money supply). experiment 4 figure a4 (appendix 1) presents impulse responses of selected variables with aggregated formal and informal financial sector loans (total loans). it is observed in the figure that a bank rate shock has no significant impact on the total loans. similarly, a shock to aggregate money supply attracts a weak response in the aggregate loans, which is barely significant only in about the third period. the total loans, however, increase significantly from about the fourth period and remain significant for all periods in the experiment, following a positive consumer price shock. experiment 5 figure a5 (appendix 1) shows impulse responses of ifs interest rates and total credit (the sum of ffs and ifs credit) plus other selected variables. the figure reveals that total loans increase significantly and instantaneously following a shock to ifs interest rates. ifs interest rates, however, do not respond significantly to a total credit shock. inferences several inferences can be drawn from the results of the five modular experiments. the impulse response functions in the experiments show that while a positive bank rate shock is followed by a decline in commercial bank loans, it has no significant effect on either ifs loans or total loans, and a positive aggregate money supply shock has no significant impact on either ifs credit or ifs interest rates, although it is followed by a decrease in ffs interest rates. this provides evidence that monetary policy may have no significant effect on ifs credit and interest rates. the impulse responses further reveal that a positive ifs interest rate shock leads to an instantaneous increase in ifs credit and total loans. it must be, therefore, that the non-responsiveness of ifs credit to a bank rate shock coupled with the positive relationship between interest rates and credit in the ifs outweigh the inverse relationship between commercial bank loans and a bank rate shock, so that, on balance, total credit does not respond significantly to a bank rate shock. the positive relationship between ifs interest rates and ifs credit occurs probably because of a high positive correlation between ifs interest rates and real output. in the ifs, interest rates are perceived as a profit-sharing arrangement between a lender and a borrower. an increase in output, therefore, reflects higher expected returns and hence higher interest rates. the impulse responses indicate that a positive output shock is followed by an instantaneous and significant increase in ifs credit and total credit, which feeds back into higher output, which is reflected in higher ifs interest rates. it is also observed that positive shocks to commercial bank lending and ifs credit lead to a significant increase in output. not surprisingly, total output increases significantly following a positive shock to aggregate credit (the sum of formal and informal financial sector credit). it is, therefore, tempting for the monetary authorities to formulate and implement policies that will increase domestic credit, with the ultimate objective of stimulating economic growth. if the authorities choose to loosen monetary policy by reducing the bank rate in order to increase domestic credit and consequently accelerate the growth of real output, the results will be unexpected. as observed in the foregoing discussion, aggregate credit does not respond significantly to a bank rate shock if the ifs is taken into account. accordingly, there is no reason to believe that output will be significantly affected (see ngalawa 2016). the impulse responses also reveal that consumer prices increase following a sudden increase in either commercial bank lending or ifs credit (or the sum of both). this suggests that credit (formal, informal or both) can be used as an intermediate target of monetary policy in the fight against inflation. the problem, as observed previously, is that if the ifs is taken into account, total loans do not respond to a monetary tightening characterised by a positive bank rate shock or a negative money supply shock. if the monetary authorities are unaware of the impact of the ifs, they may be misled into believing that an increase in the bank rate or a decrease in aggregate money supply will be followed by a decline in total lending, consequently easing pressure on consumer prices. if, on the other hand, they understand the role of the ifs, they will realise that increasing the bank rate will have no significant effect on total credit, and there will subsequently be no significant impact on consumer prices. it is further observed in the impulse responses that output decreases significantly following a positive bank rate shock. this is consistent with a priori theoretical expectations. the impulse responses also reveal that output initially increases in response to an ifs interest rate shock. as argued previously, increasing ifs interest rates are associated with increasing output because they reflect increasing productivity or production. when productivity or production in the ifs is increasing, the return on investment is also increasing, which may be reflected in ifs interest rates. thus, in an economy with a large ifs, the impact of interest rates on aggregate output cannot be generalised. a positive interest rate shock in the ffs depresses output, while in the ifs a positive interest rate shock (ifs interest rates) has a positive impact on output. it is also demonstrated in the impulse responses that consumer prices do not respond significantly to either a bank rate shock, an ifs interest rate shock or an aggregate money supply shock. this confirms the findings of ngalawa and viegi (2011) that monetary factors may not be primary determinants of inflation in malawi. the representative basket of commodities used for measuring national consumer price indices in malawi puts a preponderant weight on food costs (45.2%), which indicates that structural rigidities in food production may be a more important determinant of inflation than monetary variables. the impulse responses, however, reveal that consumer prices increase significantly following a positive commercial bank lending shock, an ifs lending shock and a total lending shock. this finding provides evidence that fluctuations in lending in the two sectors complement each other in influencing consumer prices. against the foregoing discussion, the study concludes that while the formal and informal financial sectors may complement each other in certain instances, they can also lead to diametrically opposing outcomes. it follows, therefore, that exclusion of ifs transactions in official monetary data may frustrate monetary policy through wrong inferences on the impact of monetary policy on economic activity. summary, conclusions and policy implications in nearly all low-income countries, official monetary data exclude informal financial transactions even though the ifs forms a large part of the financial sector. this exclusion occurs due to the non-existence of ifs data. however, excluding informal financial transactions in official monetary data underestimates the volume of financial transactions while the cost of credit is incorrectly reported, bringing into question the accuracy of expected effects of monetary policy on economic activity. using ifs data for malawi constructed from two survey data sets, indigenous knowledge and elements of friedman’s data interpolation technique, this study employs innovation accounting in a svar model to compare monetary policy outcomes in the country when ifs data is taken into account and when it is not. consistent with conventional theories, the study finds that output increases following a rise in either ffs or ifs lending. similarly, inflation rates increase when lending rises in both sectors. in addition, it is observed that consumer prices in malawi do not respond significantly to lending in either sector. these findings provide evidence that the two sectors complement each other. however, further investigation shows that ffs lending declines when the bank rate increases, while ifs loans are not responsive to bank rate variations and an aggregation of the two is unaffected by bank rate changes. when ifs interest rates are raised, total loans decline, suggesting that lending in the ifs responds to ifs interest rates and not to ffs interest rates. the study also finds that output declines following an increase in ffs interest rates, but increases when ifs interest rates go up. the study, therefore, concludes that exclusion of ifs transactions in official monetary data has the potential to frustrate monetary policy through wrong inferences on the impact of monetary policy on economic activity (see ngalawa 2016). going forward, it is recommended that low-income countries with large informal financial sectors should start compiling data for informal financial transactions. these data may include ifs interest rates and loans, among others. however, this is a long-term solution. in the short term, the study recommends that monetary authorities can interpolate data for the ifs using the available pieces of data (e.g. surveys), tradition, indigenous knowledge and elements of friedman’s method of interpolating time series from related series, as suggested in this study. adding the ifs and ffs data together as official monetary data is expected to improve policy formulation and implementation in these countries. acknowledgements this article is based on a paper that was delivered at the ninth asia-pacific conference on global business, economics, finance and banking held in hong kong sar 11–13 august 2016. i gratefully acknowledge the comments received at the conference, as well as from south african journal of economic and management sciences (sajems)’s anonymous reviewers, and the associate editor, who contributed to transforming the paper into a fully-fledged accredited manuscript. competing interests the author declares that he has no financial or personal relationships that may have inappropriately influenced him in writing 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viewed 14 may 2017, from http://globalbizresearch.org/hongkong_conference_2016_aug/conference_paper.php ngalawa, h. & viegi, n., 2011, ‘dynamic effects of monetary policy shocks in malawi’, south african journal of economics 79(3), 224–250. https://doi.org/10.1111/j.1813-6982.2011.01284.x ngalawa, h. & viegi, n., 2013, ‘interaction of formal and informal financial markets in quasi-emerging market economies’, economic modelling 31, 614–624. https://doi.org/10.1016/j.econmod.2013.01.005 siamwalla, a., pinthong, c., poapongsakorn, p., satsanguan, n., nettayarak, p., mingmaneenakin, w. et al., 1990, ‘the thai rural credit system: public subsidies, private information, and segmented markets’, the world bank economic review 4(3), 271–295. https://doi.org/10.1093/wber/4.3.271 sims, c., 1980, ‘macroeconomics and reality’, econometrica 48, 1–49. https://doi.org/10.2307/1912017 sims, c., 1986, ‘are forecasting models usable for policy analysis?’, federal reserve bank of minneapolis quarterly review 10(1), 2–16. sims, c. & zha, t., 2006, ‘does monetary policy generate recessions?’, macroeconomic dynamics 10(2), 231–272. https://doi.org/10.1017/s136510050605019x soyibo, a., 1997, ‘the informal financial sector in nigeria: characteristics and relationship with the formal sector’, development policy review 15(1), 5–22. https://doi.org/10.1111/1467-7679.00023 vonnak, b., 2005, estimating the effects of hungarian monetary policy within a structural var framework, mnb working paper no. 2005/1, magyar nemzeti bank, budapest, pp. 1–37. appendix 1 figure 1-a1: impulse responses with formal financial sector data only. figure 2-a1: impulse responses with informal financial sector loans. figure 3-a1: impulse responses with informal financial sector credit and interest rates. figure 4-a1: impulse responses with aggregated formal financial sector and informal financial sector loans. figure 5-a1: impulse responses with informal financial sector interest rates and total credit (aggregated formal and informal financial sector credit). 331 sates nr vol 1 (1998) nr 2 the job involvement construct and its measurement c hoole and a b boshoff graduate school of business, university of pretoria abstract job involvement is an important construct from both the individual and organizsational perspective and has therefore received considerable attention from researchers over the last three decades. numerous definitions of job involvement exist and it is still not clear of what job involvement is and how it should be viewed, despite the multitute of studies investigating job involvement. under these circumstances, the focus of the paper is on a review of job involvement, its conceptualisation and measurement. the literature is reviewed, main streams of thought are identified and recommendations for research are stated. job involvement is an important construct from both the individual and organizational perspective. from the individual perspective job involvement has been linked to other key concepts such as job satisfaction and to job-related actions such as expenditure of effort and intention to quit. from the organizational perspective, job involvement has been considered as an important activator of employee motivation (lawler, 1986; pfeffer, 1994). job involvement has therefore received considerable attention from researchers over the last three decades. several definitions of job involvement were developed before 1980. allport (1943) stated that job involvement is defined in terms of the degree to which employees are participating in their jobs, meeting needs such as prestige and autonomy. wickert (1951) and bass (1965) supported this view. dubin (1956) defined job involvement as the degree to which the job situation is a central life-interest, that is, where the individual perceives his job, rather than non-job activities, as the main source for the satisfaction of important needs. this was similar to the views of lodahl and kejner (1965) and later lawler and hall (1970), who defined job involvement as the degree to which the satisfaction derived from a job is central to the person and his psychological identity. gurin, veroff and feld (1960) and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 2 332 french and kahn (1962) defined job involvement as the degree to which an employee perceives job performance as central to his self-esteem. other terms which have been used in almost synonymous fashion with job involvement are egoinvolvement performance (vroom, 1962), intrinsic motivation (lawler and hall, 1970) and protestant work ethic (weber, 1947). a review of the literature seems to indicate that the main stream of research in the job involvement field has been derived from the work of lodahl and kejner (1965) and kanungo (1982) and the measuring instruments developed by these researchers. although other job involvement instruments were developed and several other definitions of job involvement have been offered, the lodahl and kejner (1965) and kanungo (1982) instruments have been the most widely used (and also criticised). according to morrow (1983) job involvement should be seen as one of the facets of work commitment. morrow (1983) stated that the literature regarding job involvement is ambiguous, resulting in inconclusive findings and inconsistent measuring of job involvement. in an update of the work commitment literature, morrow (1993) also reviewed other related concepts of job involvement such as specialized commitment as defined by jans (1985) and job commitment developed by farrell and rusbult (1981). her conclusions imply that the job involvement construct should be seen as a wider construct than had been the case previously. a lack of clarity on what job involvement is and how it should be viewed from the perspective of it being part of the work commitment construct, appeared to exist. however, morrow (l993) concluded that it should be seen as a non-redundant facet of the work commitment construct. under these circumstances it was decided that a review of the construct and its measurement should be undertaken. the focus of this paper is therefore on job involvement, its conceptualisation and measurement. early conceptualisation and opera tionalisa tion of the construct lodahl and kejner (1965) were the first to attempt to define job involvement precisely and to develop an instrument to operationalise the construct. they defined job involvement as "the degree to which a person is identified r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 333 sateb nr vol i (1998) nr 2 psychologically with his work" and as "the degree to which a person's work perfonnance affects his self-esteem" (lodahl and kejner, 1965:25). lodahl and kejner (1965) developed a 20-item scale to measure job involvement as defined by themselves. they originally assembled 110 statements from interview protocols, existing questionnaires, other researchers and self-composed items. all duplicate items were eliminated until 87 items remained. judges, who were asked to rate each item on a scale of one to eleven (one representing a very low degree of job involvement and eleven representing a very high), reviewed the items. fortyseven items were eliminated as a result of this process. the remaining forty items were cast into a four point likert scale and distributed among 13 7 nursing employees. a total job involvement score was calculated for each respondent. the total score and the data from the 40 items were intercorrelated and factor analyzed. lodahl and kejner (1965) extracted seven factors (using varimax rotation) containing at least more than two items each loading .30 or higher. the seven factors accounted for 77% of the commonality. the last two factors had zero loadings for the total job involvement score and, consequently they were not interpreted. the items were further reduced to 20, based on the item-total correlations, the commonality of an item and the factorial clarity of the item. the items were then administered to a sample of engineers (n=70). for comparison purposes, the responses to the final 20 items were rescored for the nurses. the total and item scores were then intercorrelated and factor analysed. lodahl and kejner (1965) found in both samples that the most variance in the total job involvement score appeared on the first axis (.99 for the nurses and .96 for the engineers respectively), indicating a general job involvement factor. however, for the nurses only six items had their highest loadings on this general factor and for the engineers eleven items. more factors were extracted and a three factor solution was preferred for the data obtained from the nurses and a four factor solution for the responses of the engineers. the first two factors were very similar (although the second and third factor for the engineer sample had opposite signs). the first factor was interpreted as high job involvement, the second factor as an indifferent response to work, and the third factor as the "rejection of extra duties and of the general notion of work as a measure of self' (lodahl and kejner, 1965:30). the fourth factor for the engineers seemed to deal with boredom and the unimportance of work. lodahl and kejner (1965) considered their scale to have adequate reliability (corrected split-half correlations for the total scale in different samples ranged between .72 and .89) with some discriminant ability. they further stated that job r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 2 334 involvement was multidimensional and probably not a very internally consistent attitude. later conceptualisations and opera tionalisa tions of the construct kanungo (1982) stated that the main cause of conceptual ambiguity regarding the definition of job involvement, is the excess meaning attached to the construct. as a result, the measurement instruments lack construct validity. according to kanungo (1982), the excess meaning of job involvement can be seen in past conceptualizations. job involvement was, according to him, confused with intrinsic motivation, the antecedent conditions with the state of job involvement and its subsequent effects and the terms work and job were used interchangeably (kanungo, 1982:341). in an attempt to try arid diminish the previous shortcomings in the conceptualisation of job involvement, kanungo defined job involvement as the degree to which one psychologically identifies with one's job, that is, a cognitive or belief state of psychological identification with a particular job (kanungo, 1982:342). he further argued that a person's psychological identification with the job depends on both need saliency and perceptions about the job's potential for satisfying the salient needs. kanungo (1982) made ii very important distinction between work and job involvement. he stated that, due to the conceptual confusion between work centrality and job involvement evident in the literature, instruments designed to measure these constructs suffer from construct validity problems. later researchers agreed with this view. pauley, alliger and stone-ramero (1994) indicated that some instruments measure involvement with the present job, others involvement with work in general but most measure both of these constructs without distinguishing between the two (e.g. measures developed by lodahl and kejner, 1965; saleh and hosek, 1976). some of the items in the lodahl and kejner (1965) scale clearly illustrate this. items such as "i live, eat, breathe my job" refer to the importance of a job while other items such as "most things in life are more important than work" refer to the importance of work in general (pauuey, alliger and stone-ramero, 1994). work involvement is seen as a relatively enduring belief about the value of work in one's life, transcending a specific job (kanungo, 1982) and involving psychological identification and engagement with one's career or work in general. job involvement should be seen as including the worker's psychological identification with a specific job context (blau, 1985; kanungo, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 335 sateb nr vol 1 (1998) nr 2 1982). evidence for the distinction between job and work involvement was obtained when kanungo (1982:344) found two clearly separate factors when the items in his job and work involvement scales were factor analysed together. however, the independence of the kanungo (1982) work involvement scale has been doubted (blau, 1985; morrow, 1993; hoole, 1997). it has been suggested that the protestant work ethic developed by blood (1969) and kanungo's (1982) work involvement scale, measures the same concept namely a general work ethic. empirical findings by blau, paul and st. john (1993) and hoole (1997) seem to support this view. kanungo (1982) proposed a ten-item measure of job involvement which he felt was more representative of the psychological identification conceptualisation of job involvement. kanungo's (1982) scale built on lodahl and kejner's (1965) work and included four of the items of the original scale that appeared to tap the "psychological identification" dimension unambiguously (kaplan, 1990:78). kanungo seems to have eliminated several dimensions of excess meaning which was encountered in the lodahl and kejner (1965) scale such as the mixing of items tapping cognitive and affective states, the individual's involvement in work in general and in a specific job, and intrinsic motivation as well as job involvement (brown, 1996:236). kanungo's (1982) scale can be considered as a refined form of the lodahl and kejner (1965) scale. kanungo (1982) used three different measurement formats in the development of his job involvement scale namely a questionnaire, semantic differential and a graphic technique. questionnaire items that reflected a cognitive state of psychological identification with one's job were judged by 10 graduate students. there was complete agreement on 12 items. based on subsequent item analyses, two of these items were not included in the final scale. for the semantic differential scale, six graduate students identified ii bipolar items (using available literature and dictionaries for synonyms and antonyms) on which there were total agreement. three of these items were dropped on the basis of inter-item and item-total correlations. two graphic items representing psychological identification were selected for the graphic scale. the final instrument was administered to 900 french and english speaking employees who were enrolled for extension courses at three different universities. seven hundred and three questionnaires were returned. responses from these were analysed statistically. a parallel study (n=63) was performed at two of the universities to establish test-retest reliabilities of the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 2 336 measures. the questiolmaires were in this part of the study administered three weeks apart. the alpha coefficients for the three measures of job involvement were .81 (semantic differential), .87 (questionnaire) and .70 (graphic items). the test-retest coefficients were, in the same order, respectively .74, .85 and .82. after further analysis of his data, kanungo reported that his job involvement scale had acceptable convergent and discriminant validity. he concluded that job involvement proved to be a unidimensional construct. evaluative studies of the conceptualisations and measuring instruments researchers seem to agree that the psychological identification with one's work is part of job involvement (lawler and hall, 1970; saleh and hosek, 1976) but disagree whether the performance self-esteem element is a dimension of job involvement. the literature indicates a conceptual overlap between performanceself-esteem job involvement and protestant work ethic. blau (1985) investigated the possible overlap between intnnslc motivation (as measured by lawler and hall (1972», job involvement as the psychological identification with one's job (as proposed by kanungo, 1982), and job involvement as proposed by lodahl and kejner (1965) where the performance self-esteem contingency and psychological identification dimensions are operationalized. principal factor analysis was carried out on the responses of the participants and a two factor solution was obtained. blau (1985) found that all kanungo's items except for the one negatively worded item loaded on one factor. the items of the lodahl and kejner (1965) scale were confounded with the intrinsic motivation items. in order to retest his initial findings, blau (1985) conducted a second study where he investigated the possible overlap among the performance-self-esteem contingency dimension of job involvement (as proposed by french and kahn, 1962), active participation dimension (developed by allport, 1943), central lifeinterest dimension (lawler and hall, 1970), protestant work ethic (weber, 1947), skill variety (measured by means of the job characteristic inventory by sims, szilagyi & keller, 1976), participative leadership (measured by means of the leader behaviour description questionn!iire developed by hemphill and coons, 1957) and intrinsic motivation (lawler, 1969). a series of factor analyses were carried out to determine the discriminant validity of the various dimensions and to r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 337 sateb nr vol 1 {i 998) nr 2 test their independence. multiple loading problems were found between the performance-self-esteem job involvement dimension and intrinsic motivation, and between participative leadership and decision influence job involvement items. blau (1985) reported that only the psychological identification job involvement conceptualization was empirically independent and clearly identifiable. this result supports the view developed by brown (1996) that, due to the lack of a clear conceptual definition of job involvement, the lodahl and kejner (1965) 20item scale was not developed to operationalise a single clearly defined conceptualisation of the construct. according to morrow (1983), this low epistemic correlation (weak link between its conceptual definition as proposed by lodahl and kejner (1965) and its operationalisation (northrop, 1959» which existed in earlier definitions led to confusion in related research resulting in inconclusive findings and the development of poor measuring instruments. kaplan (1990:76) suggested that for research to be cumulative and directed, a clear definition and a common purpose are necessary. this is in accordance with the views expressed in this regard by kerlinger (1986). the lodahl and kejner (1965) scale therefore has been the source of some confusion and the cause of some of the lack of progress in this area. the lodahl and kejner (1965) scale has often been under scrutiny and subjected to criticism. according to rabinowitz and hall (1977), lodahl and kejner never clearly named the dimensions of job involvement (lodahl and kejner (1965) never indicated whether they recommended a three or four factor solution). researchers such as lefkowitz (1967), schwyhart and smith (1972) and wood (1974), who all used the lodahl and kejner scale, offered support for the multidimensional nature of job involvement. in these studies, the scale's factor structure was not stable across different samples. schwyhart and smith (1972) found three interpretable factors of which only one factor was similar to the factors found by lodahl and kejner (1965). wood (1974) found five factors using the 20-item scale of lodahl and kejner (1965). a possible reason for the factorial instability is the sample size used by lodahl and kejner (1965). the generally accepted rule (kerlinger, 1986) is that the item-respondent ratio must be at least five times the number of respondents to the number of items. the validation sample of lodahl and kejner (1965) consisted of 137 nurses and the scale included 40 items which gives an itemrespondent ratio of 1 :3.425. the ratio of the second sample (70 engineers and 20 items) was i :3.5. factor loadings also tend to be more stable in large samples, for instance 300 or more (thorndike, 1982). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 2 338 according to morrow (1983), the measures resulting from lodahl and kejner's (1965) definition were not deductively fonnulated in order to operationalise either conceptual notion included in the original definition. they arrived at their measures inductively through factor analytic procedures. the lodahl and kejner measures were thus not based on any a priori definition or theoretical framework. shortened versions of the lodahl and kejner (1965) scale, with six and four items respectively, have often been used in practice (brown, 1996). the six-item scale was composed by using the six items with the highest loadings on the first factor from the 20-item scale developed by lodahl and kejner (1965). lodahl and kejner (1965) reported a correlation of .87 between the 20-item and the six-item scale. the six-item version had in later studies multiple loading problems on psychological identification of job involvement and intrinsic motivation (cummings and bigelow, 1976; lawler and hall, 1970). ramsey, lassk and marshall (1995) critically evaluated the use of the lodahl and kejner (1965) scales (20-, 6-, and 3-item scales respectively) by means of the lisrel 7 programme (joreskog and sorbom, 1989) on a sample of 290 salespeople employed by an insurance company. the cronbach alphas for the three versions were .79, .70 and .69 for the 20-item, 6-item and 4-item versions respectively. in order to assess the dimensionality of the three scales, the sample was split in halves and the results were cross validated. hypothesis tests by means of chi-square for the twentyand six-item scale led to the rejection of the null hypothesis but the null-hypothesis could not be rejected for the four-item scale. it seemed as if the four-item scale was more representative of a unidimensional construct of job involvement than the other two versions and provided the best fit of the three scales. the fit indices obtained from the subsample were at comparable levels and the scales therefore all appeared to be stable. in order to assess the validity of the three scales, the correlations among job involvement, job satisfa~tion, job perfonnance (using the behnnan and perreault (1982) five-dimension measure of salesperson job perfonnance), motivation and the seven dimensions of a reduced version of the indsales scale (comer, machleit & lagace, 1989) were calculated. the twenty-item job involvement scale was significantly correlated with all seven dimensions of the indsales scale. the six-item scale correlated significantly with all the dimensions of the indsales scale except satisfaction with co-workers and the four-item scale correlated significantly with all the dimensions with the exception of two dimensions of job satisfaction (le. pay and co-workers). none of the job involvement scales correlated significantly with the job perfonnance dimension of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 339 sa teb nr vol 1 (1998) nr 2 providing input to the company. however, the twenty-item job involvement scale correlated significantly positively with three dimensions of the job performance scale i.e. meeting objectives, technical expertise and controlling expenses. the sixitem scale correlated significantly with four dimensions of job performance i.e. meeting objectives, technical expertise, controlling expenses and customer interaction. the four-item scale correlated significantly with the meeting objectives and customer interaction dimensions of job performance. the six and four-item scales correlated significantly with intrinsic and extrinsic motivation, and the twenty-item scale correlated significantly with intrinsic motivation. the authors did not provide the values of the correlation coefficients. with n=290, a correlation coefficient could be indicating very little common variance and still be statistically significant. use of the shorter versions of lodahl and kejner's (1965) scale has itself been under attack. brown (1996) pointed out that the shortened versions of the lodahl and kejner (1965) scales were generally used without a rationale being given for deciding which subset of the 20-item scale to include in the measurement. ramsey et al. (1995) concluded that the assessment of the three versions of the lodahl and kejner (1965) scale yielded generally acceptable reliabilities, unstable dimensionalities and mixed results in terms of validities. they further concluded that although more studies would be needed, the results strongly implied that caution should prevail when the lodahl and kejner (1965) scale is used. support for kanungo's (1982) results was offered by several studies (blau, 1985; ~ blau, paul & st john, 1993; brooke, russel & price, 1988; kaplan, 1990; kamfer and venter, 1997; boshoff and hoole, 1998). the reported internal reliabilities for the kanungo scale are uniformly high, generally above .80. kaplan (1990) further reported that kanungo's (1982) job involvement scale's factor structure seemed to be stable across samples and even cultures. similar factor structures were obtained using french and english canadian employees (kanungo, 1982), american nurses and several categories of university employees (blau, 1985) and english and afrikaans south african professionals (boshoff, bennett & kellerman, 1994; kamfer and venter, 1997; kaplan, 1990). in her review of work commitment measures (morrow, 1993) reported that over 11 studies, with one exception, cronbach alpha estimates for kanungo's scale have met or exceeded .70. the testretest estimates of .63 (blau, 1985) over seven months are somewhat lower but consistent with the assumption that job involvement is subject to job situation changes. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 2 340 some studies reported that one of the items (item 7) made a poor contribution to the job involvement scale (paterson and o'driscoll, 1990; blau, 1985). blau et al. (1993) reported that items 3, 6, and 7 respectively exhibited multiple loading problems in their study. kanungo's work was further criticized for the fact that his sample consisted of mainly educated people (patterson and 0' driscoll, 1990; paul\ey, alliger & stoneramero, 1994). paulley et al. (1994) further argued that the theory behind kanungo's framework that job involvement is the cognitive aspect of job satisfaction, was somewhat problematic and that his results pointed to a redundancy possibility between job involvement and job satisfaction rather than the distinction between the two constructs. patterson and 0' driscoll (1990) also considered that kanungo's study did not offer sufficient information on the criterion validity of the scale. in order to address some of these limitations, patterson and 0 'driscoll (1990) conducted a study where kanungo's (1982) job involvement scale was empirically assessed. their sample consisted of 157 full-time workers from 32 new zealand organizations. individuals with formal qualifications were, unfortunately, again over represented in their sample. removal of the negative worded item in the scale improved the alphas from .83 to .86 and the test-retest coefficients from .87 to .88. when the two educational groups (low versus high) were compared with each other, the biggest improvement in eliminating the negative worded item was in the low educational group. the value for cronbach's alpha improved from .86 to .89 for the lower educational group at the two test periods but little difference was seen in the case of the high educational group. this seems to indicate that the negative worded item is not portable across different and diverse samples, as blau (1985) suggested. the results of the patterson and o'driscoll (1990) study also offered some support for the criterion validity of kanungo's (1981) job involvement scale. job involvement was in this study related to job satisfaction (.32 and .39 at time 1 and time 2 respectively) and job preference (.38 and .43 at time 1 and time 2 respectively) as well as to numbers of hours worked weekly (.34 and .35), amount of unpaid overtime worked (.20 and .27) and effort put into the job (.34 at both time intervals ). studies of kanungo's (1982) scale have therefore shown this instrument to be superior to previous measures of job involvement (blau, 1985; boshoff and bennett, 1991; morrow, 1993; paterson and o'driscoll, 1990; paulley, alliger & stone-ramero, 1994). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 341 sateb nr vol 1 (1998) nr 2 the conceptualisation of job involvement has therefore received several questions, especially regarding the conceptual ambiguity and operational multidimensionality of the lodahl and kejner (1965) scale. different versions of the scales have been used without a proper rationale for using certain subsets of the scales. the results of studies on the kanungo (1982) job involvement scale generally presented a more favourable picture of the representativeness of the items in the scale of the construct as seen by the author of the instrument. a meta analysis carried out by brown (1996) which included data from 212 studies provided the opportunity to assess the effect of using the different job involvement scales on the magnitude of relationships among scores on the instruments and other variables. results from brown's (1996) study indicated that the concern regarding the conceptual and mea~urement issues in the job involvement literature was somewhat overstated. when, for instance, results from various versions of the lodahl and kejner (1965) scale were compared with results obtained with the kanungo (1982) scale, very little effect of measure was evident. only for the relationships between job involvement and role perceptions did the use of the lodahl and kejner (1965) versus kanungo (l982) scale influence the strength of the relationship. brown (1996) found no significant difference in any relationships between the mean correlation for all studies that used some version of the lodahl and kejner scale and those that used the kanungo scale. the results obtained by brown (1996) suggested that the two scales measure the same phenomenon and have approximately equal empirical validity with regard to a range of related variables. in the first phase of a large study on work commitment conducted by boshoff, hoole, bennett and jillings (1997), the lodahl and kejner (1965) and kanungo (1982) scales were combined in order to determine the underlying dimension of the job involvement facet. the sample consisted of 1019 south african respondents from approximately 50 organisations. exploratory and confirmatory factor analysis were conducted using the bmdp (1993) and sas (1994) statistical analysis programme. all items not loading .30 and cross loading on more than one factor were eliminated. a one factor structure seemed to provide the best solution. the newly constructed scale consisted of 22 items. eight items originally included in the scales were therefore eliminated. in order to revalidate the job involvement scale in a south african context the job involvement facet, amongst the other work commitment facets, were psychometrically and factorially investigated in a further study (hoole, 1997). the second sample consisted of 1527 members of a large r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 2 342 financial service company and a university. the sample was for the purpose of the analyses divided into several subgroups, i.e. the financial institution, academic, university administrative and total university employees subgroups. the responses to the 22 job involvement items were again subjected to exploratory and confinnatory factor analysis. an oblique rotation of axes (direct quatennin) was utilised as it was thought unlikely that the dimensions measured would be independent from each other. a one and a two factor solution were specified. the one factor solution explained 32.32% of the total variance and had an alpha coefficient of .902. the alpha coefficients of the two factor solution were .886 and .772 respectively. the two factors explained 31.26% and 7.44% of the total variance. confinnatory factor analysis was carried out to detennine which solution provided the best fit. the fit indices showed that the one factor solution was to be preferred. the same procedures were carried out for the various subgroups of the sample and very similar results were obtained. the one factor structure seemed to provide the best solution for the financial, university administrative and the total university subgroups. although the one factor solution provided the best solution in tenns of fit indices and amount of explained variance, the two factor solution was somewhat easier to interpret. a scrutiny of the items in the one factor solution suggests that the problem of interpretation is due to the referents used. in the case of the job involvement items obtained from the scale developed by lodahl and kejner (1965) the work and job tenns were used interchangeably. kanungo (1982) made a very clear distinction between work and job involvement. refinement of the items so that only one referent is used would certainly increase the interpretability of the scale. these findings also suggest that job involvement is a broader concept than measured by kanungo's (1982) scale. conclusion in the light of the various results discussed in this paper, it seems as if the conceptual confusion in the job involvement literature might be coming to an end although more work needs to be done. the meta-analytical study conducted by brown (1996) provided some valuable insight into the real significance of reported relationships in the past. it seems to be clear that job involvement as measured by the currently available instruments tends to be unidimensional, but that more attention must be given to the referent problem. there seems to be general r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 343 satebnr vol 1 (1998)nr2 acceptance that job involvement can be defined as the psychological identification with one'sjob as proposed by kanungo (1982). in tenns of the measurement of job involvement, the psychometric qualities of the unidimensional scale resulting from the boshoff et aj. (1997) study are at acceptable levels. for future research purposes it would be beneficial to revise the wording of some of the items of the newly combined scale of lodahl and kejner (1965) and kanungo (1982) that emerged out of the studies conducted by boshoff, hoole, bennett, and jiiiings (1997) and hoole (1997). it is recommended that the job involvement concept be examined in other than western (e.g. african and eastern) cultures in order to further investigate the portability of the job involvement construct as it is currently defined and the content of the concept in different cultures. the one question that remains is whether the contents of the phenomenon are adequately covered by the currently available instruments and the conceptualisations on which they are based. this review indicated that the currently available scales, especially the one developed by kanungo (1982), seem to be psychometrically acceptable. this obviously does not mean that the scales encompass all the elements of the phenomenon which is to be measured. it seems as if it may be profitable to examine the job involvement concept further, using data gathering methods other than questionnaires, in an exploratory fashion. a study in which individuals from different cultures, organisations, occupations and jobs are interviewed (and data gathered in other ways) in order to detennine the elements which are capable of making them involved with a job or reduces involvement with a job, is envisaged. this seems to be especially important in the light of change which are taking place in the nature of work, careers and in organisations. it seems doubtful that job involvement can still be seen as the same phenomenon with the same content as a decade and a half ago. in tenns of measuring instruments, the question therefore is: are we still asking the right questions? r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 2 344 references 1. allport, g.w. 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(1974). effect of worker orientation differences on job attitude correlates. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction theoretical considerations methodology study results discussion limitations of the study conclusion acknowledgements references about the author(s) thandukwazi r. ncube department of entrepreneurial studies and management, faculty of management sciences, durban university of technology, south africa robert w.d. zondo department of entrepreneurial studies and management, faculty of management sciences, durban university of technology, south africa citation ncube, t.r. & zondo, r.w.d., 2018, ‘influence of self-motivation and intrinsic motivational factors for small and medium business growth: a south african case study’, south african journal of economic and management sciences 21(1), a1994. https://doi.org/10.4102/sajems.v21i1.1994 original research influence of self-motivation and intrinsic motivational factors for small and medium business growth: a south african case study thandukwazi r. ncube, robert w.d. zondo received: 23 jun. 2017; accepted: 01 mar. 2018; published: 29 may 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: this study investigates the influence of intrinsic motivational factors for small and medium enterprise (sme) growth in the ethekwini district municipality in south africa (sa). aim: it examines whether self-motivation of business owners operating in the furniture manufacturing sector has an influence on sme growth. setting: of the 127 smes operating in the ethekwini district municipality, 112 participated in the study representing 88% of the target population. methods: descriptive, chi-square and correlative analyses were used to test the two objectives. that is, to determine the influence of self-motivation of business owners for sme growth, as well as to establish the intrinsic motivational factors that stimulate creativity for sme growth. results: the study revealed that the intrinsic motivational factors of business owners do influence sme growth in sa. these factors include exerting effort for business growth interest, finding new solutions to business problems to achieve growth, growing business for recognition, belief to produce the desired outcomes, taking responsibilities for business expansion, the need for advancement, and growth aspiration that enables the business owner to take risks in order to grow the business. conclusion: the outcome is that a self-motivated business owner has the ability to grow the business. the study provides valuable data relating to intrinsic motivational factors. such factors are the enablers of creativity and business growth. it provides initial baseline data upon which to base future work. introduction when exploring the failure of businesses in both the private and public sector to absorb the growing number of job seekers in sa, increased attention is focused on entrepreneurship and its potential in contributing to economic growth as well as job creation (ramukumba 2014). despite the contributions of new small and medium enterprises (smes), their failure rate in sa is among the highest in the world. about 75% of new smes do not become established formal businesses (snyman, schutte & leipzig 2014). according to olawale and garwe (2010), the probability of a new sme surviving in the early stages of its existence, is less than any other global entrepreneurship monitored (gem) sampled country, as listed in the 2015/2016 global report. grouping by geographic region and economic development level, these include botswana and morocco (in africa), india, china and australia (in asia and oceania), argentina (in latin america and caribbean), bulgaria and belgium (in europe), as well as canada (in north america). while the gem reports, among others, presents the entrepreneurial behaviour and attitudes of individual business owners, it raises a question as to whether running a small business leads to the fulfillment of personal goals. arguably, this may depend, on one hand, whether there is a link between small business owners’ goals and motivations or, on the other hand, the business outcomes. hence, this study examines whether small business growth is a function of the small business owner’s personal ability to grow the business. it investigates the intrinsic motivational factors that influence sme growth in sa. according to nieman and nieuwenhuizen (2014), growth and the desire to grow should be embedded in the mindset of the person starting or creating a new business venture. growth will intensify the demands made on the resources, which can only be countered by an ability to attract resources. growth and performance are generally seen as substitutes for each other. a growing business is usually considered to be a successful business that performs well (nieman & nieuwenhuizen 2014). however, this study considers the following objectives: to determine the influence of self-motivation of business owners for sme growth and to establish whether the intrinsic motivational factors of business owners influence sme growth. sme owners are likely to be intrinsically motivated if they attribute their business growth to factors under their own control, believe that they have the skills to be effective agents in reaching their desired goals, and are interested in growing a business, not just in achieving wealth (grant & berry 2011). wiklund, patzelt and shepherd (2009) add that self-motivation is the need for self-fulfillment. theoretical considerations this section presents an overview of motivation, its influence on sme growth, the intrinsic motivation in smes as well as motivation and creativity in smes. overview of motivation motivation is a process that accounts for an individual’s intensity, direction and persistence of effort towards attaining a goal (robbins, odendaal & roodt 2011). intensity is concerned with how hard a person tries. however, high intensity is unlikely to lead to job performance outcomes unless the effort is channeled in a direction. robbins et al. (2011) add that the persistency dimension measures how long a person can maintain their effort. motivated individuals stay with a task long enough to achieve their goal. hence, the needs theory of mcclelland and koestner (1992) contends that individuals are motivated by three basic drives: achievement, affiliation and power. tu and lu (2014) argue that these needs not only motivate individuals but also include many of the most important human goals and concerns. this research attempts to demonstrate that each of these need dimensions affects the level of accountability a person feels for himself or herself and others. however, this section will only focus on the achievement and power needs as they are relevant to sme growth (pinder 2014). achievement needs the need for achievement describes a person’s drive to excel with respect to some established set of standards (bande et al. 2016). it refers to the motive to do well and achieve a goal relative to a set of standards. the inclusion of measures of achievement orientation within the framework of entrepreneurs’ personal characteristics is consistent with this research. the need to achieve reflects individuals’ orientation, the willingness and drive for satisfaction or a sense of accomplishment (pinder 2014). this is demonstrated by the exertion of intense, prolonged and repeated efforts to accomplish something difficult, whether by skill, practice or perseverance. this is accomplished by a future-oriented dedication to the task involving prioritisation of accomplishing the task and frequently sacrificing other activities and personal time (royle & hall 2012). individuals’ achievement needs are satisfied when they are able to actualise their own purposes relative to and regardless of the situations of others (pinder 2014). individuals with high achievement needs do not like to prosper by chance but rather seek personally identifiable sources for their success and cannot leave the outcome to probability (royle & fox 2011). such individuals experience joy or sadness contingent upon the identifiable outcomes of their efforts (mcclelland & koestner 1992). power needs the need for power denotes individuals’ desire to be influential. this could manifest itself in attempts to make others behave as one would like or in a manner that they might not have done otherwise (mcclelland & koestner 1992). in other words, the individuals that are high in this need seek position power so that they can compel the actions of others. those high in power needs prefer being in competitive, status-driven situations, and actively seek the trappings of status (royle & hall 2012). they are concerned with ensuring that the methods they choose to influence others are within their control (csikszentmihalyi & wong 2014). however, in order to maintain viable interdependent relationships with others, individuals with high power needs must often restrain these desires (royle & hall 2012). central to one’s need for power is gaining influence over others. individuals with influence can then parlay informal accountability for others into the accumulation of additional resources that serve to enhance their status. consequently, this study examines business owners’ influential behaviour that is related to sme growth. motivation and its influence on small and medium enterprises growth in work settings, productivity can be increased by using extrinsic rewards such as bonuses, but the actual quality of the work performed is influenced by intrinsic factors (pinder 2014). if one is doing something that one finds rewarding, interesting and challenging, one is more likely to come up with novel ideas and creative solutions (csikszentmihalyi & wong 2014). management’s motivation, creativity and skills have an influence on the way a business is managed or mismanaged. insufficient and inappropriate skills of management could cause failure in businesses (arasti, zandi & talebi 2012). motivation, in this case, refers to a process that elicits control and sustains certain behaviours (zimmerman & chu 2013). it can either be extrinsic or intrinsic in nature. extrinsic motivation has a stronger relationship with material factors, while the individual in the intrinsic position attempts to fulfill his or her aims in life (becchetti, castriota & tortia 2013). this study determines whether intrinsic motivation influence sme growth. it must be noted that human motivation plays a critical role in the entrepreneurial process (antonites & van vuuren 2014). grant and berry (2011) have stressed the importance of entrepreneurial intentions as a forerunner to establishing a new venture, thus highlighting the importance of what motivates a person to grow a business. consequently, tu and lu (2014) provide clarity in that motivation plays an important part in the creation of new businesses. they indicate that theories of business creation that fail to address this notion are incomplete. motivation can also be defined as a driving force that causes the flux from desire to will in life (zimmerman & chu 2013). for example, a plant with no water still desires water to sustain life. however, due to its incapability to move and get water, the plant cannot get water, thus suffering from a break in the driving force of motivation. it is not to say, however, that the plant necessarily lacks driving force. therefore, all life can be said to have, at its very minimum, the igniting spark of motivation. hence, it can be considered a psychological state that compels or reinforces an action towards a desired goal (tu & lu 2014). for example, hunger is a motivation that elicits a desire to eat. thus, motivation is an action directed towards something specific, and this something is a need to be intrinsically motivated (grant & berry 2011). therefore, the need is an internal motive (i.e. intrinsic) for acting, leading to the set of actions (e.g. to grow the business). motivation can also be described as behaviour towards the achievement of a goal. it is an action directed towards something specific, and this something is a need to be intrinsically motivated. thus, the need is the motive (the reason) for acting. consequently, this study determines whether sme owners are driven by intrinsic motivational factors in growing their businesses. intrinsic motivation in small and medium enterprises intrinsic motivation occurs when one acts without any obvious external rewards (zimmerman & chu 2013). it refers to the reason why one performs certain activities for inherent satisfaction or pleasure (hennessey 2010). it arises from the individual’s positive reaction to the task itself such as interest, involvement, curiosity, satisfaction, or positive challenge, which serves as a type of reward for the work (grant & berry 2011). from the self determination theory, intrinsic motivation is central to the proactive, growth-oriented nature of human beings, which is the basis for learning and development (deci & ryan 2011). grant and berry (2011) confirm that intrinsically motivated business owners are more likely to pursue enjoyment, interest, satisfaction of curiosity, self-expression, or personal challenge in business. intrinsic motivation is a natural motivational tendency and a critical element in cognitive, social, and physical development (hennessey 2010). according to bande et al. (2016), sme owners who are intrinsically motivated, are more likely to engage in the business willingly and work towards improving their skills. grant and berry (2011) state that sme owners are likely to be intrinsically motivated if they attribute their business growth to factors under their own control (also known as autonomy), believe that they have the skills to be effective agents in reaching their desired goals (also known as self-efficacy), and are interested in growing a business, not just in achieving wealth. motivation and creativity in small and medium enterprises creativity is one of the most important factors in developing and growing businesses (csikszentmihalyi & wong 2014). the emphasis of this study is to examine the conditions under which intrinsic motivation promotes creativity. coon and mitter (2010) believe that intrinsic motivation is an important enabler of creativity. according to hennessey (2010), intrinsic motivation is the desire of interest and the enjoyment of work that is being performed. coon and mitter (2010) identify the three interrelated psychological mechanisms through which intrinsic motivation may stimulate creativity. firstly, the emotional theorists proposed that when business owners are intrinsically motivated, they experience positive effect (becchetti et al. 2013). this stimulates creativity by broadening the range of cognitive information available, expanding the scope of attention towards assimilating a wider set of ideas and encouraging cognitive flexibility for identifying patterns and associations between ideas (grant & berry 2011). secondly, deci and ryan (2011) propose that when business owners are intrinsically motivated, their curiosity and interest in learning enhances their cognitive flexibility, willingness to take risks, and openness to complexity, which, in turn, expands their access to ideas and potential solutions. thirdly, both the emotion and self-determination theorists suggest that intrinsic motivation promotes creativity by encouraging persistence. by fostering a positive effect, intrinsic motivation enhances psychological engagement and builds energy for sustaining effort, increasing the amount of time that sme owners are willing and able to work on their tasks (coon & mitterer 2010). this relates to the emotional theories of motivation. on the other hand, by fostering confidence and interest, the intrinsic motivation encourages sme owners to persist with challenging tasks, as well as to concentrate their attention more effectively on these tasks (hennessey 2010). this relates to self-determination theories of motivation. however, this study is designed around the following questions: does self-motivation of business owners influence sme growth? do intrinsic motivational factors of business owners influence sme growth? methodology the study methodology will be discussed under the following headings: the target population, profiles of respondents and sample size, data collection method, as well as the measurement and analysis. target population this study had a target population of 127 sme owners of furniture manufacturing businesses operating in the ethekwini district municipality. furniture manufacturers is one of the most labour-intensive industries in south africa (department of trade and industry 2014). they were selected to participate in this study based on their potential of contributing to the reduction of unemployment, increased exports and the development of smes. brief profiles of respondents and sample size of the 127 smes, 112 participated in the study. the majority of smes at 60% have been operating for more than 5 years. seventy-eight per cent of the participants were male and twenty-two per cent were female business owners. the following table 1 provides the total turnover and gross asset value of furniture manufacturing industry in relation with their size classes. table 1: total turnover and gross assets of furniture manufacturing industry. data collection method a list of the furniture manufacturers was obtained from the durban chamber of businesses. recruitment of respondents was undertaken with the aim of ensuring that all the 127 furniture manufacturing smes would participate in the study. the questionnaires were forwarded through electronic mail to the owners of smes who represented their businesses. however, 78 completed questionnaires were returned via electronic mail and the remaining 34 were physically collected from their businesses, representing an 88% response rate, considered high compared with the norm for survey responses (baruch & holtom 2008). the main reason for this high response rate was due to the invitation letter sent to all the sme furniture manufacturing owners and consistently follow-up of questionnaires through telephone calls. measurement and analysis in line with the research framework, the study measured 13 variables using the questionnaire. it employed a likert scale ranging from 1 (strongly agree) to 5 (strongly disagree). self-motivation of business owners for small and medium enterprise growth six items listed in this variable (as informed by antonites & van vuuren 2014; csikszentmihalyi & wong 2014; tu & lu 2014; zimmerman & chu 2013) are: self-motivated sme owners are likely to grow their businesses even bigger, when business owners are self-motivated they experience positive effect, being self-motivated is the reason behind sme growth, sme growth is regarded as an important goal of the business, interest in learning enhances sme owners’ willingness to take risks, and sme growth increases a business’s sustainability. a reliability analysis cronbach’s alpha of 0.676 was achieved. this value is close to 0.7 and indicates an internal consistency and reliability of the variables in this objective. intrinsic motivational factors of business owners for small and medium enterprise growth the variables in this objective were measured by seven items and based on the intrinsic motivational factors of business owners for sme growth (grant & berry 2011; pinder 2014). these include: as a self-motivated business owner i exert effort based on business growth interest, i find new solutions to business problems because i want to achieve business growth, i grow my business because i want to be recognised, i am driven by belief to produce the desired outcomes of my business, the aim of expanding the business is to take responsibility, my need for advancement is the personal attribute that has great impact on the growth of my business, and my growth aspiration enables me to take risk in order to grow my business. a reliability analysis cronbach’s alpha of 0.626 was achieved. this value is also close to 0.7 and indicates an internal consistency and reliability of the variables in this objective. descriptive statistics, chi-square and correlation tests were used to analyse data. in addition, spss (version 23.0) was used for data analysis. study results self-motivation of business owners for small and medium enterprise growth this section presents findings on the influence of self-motivation of business owners for sme growth. descriptive analysis the result in table 2 shows that the sme owners are self-motivated to grow their businesses. percentage agreement ranges from 93.3% to 96.7%. eighty per cent of the owners indicated that their interest in learning enhances willingness to take risks and 95% indicated that sme growth increases business sustainability. these high agreement percentage responses affirm that self-motivation is a veritable tool in the growth and development of smes. this is confirmed by gay-perret and mainali (2012) who state that self-motivation is much better than simple motivation that involves financial incentive. it also concurs with the views of shepherd and wiklund (2009) who agree that motivation behind venture creation is the need for self-fulfillment. table 2: self-motivation of business owners for small and medium enterprise growth. the chi-square test for each variable was also performed. hence, table 3 presents test results for determining whether the scoring patterns across the different statements were similar. table 3: chi-square statistics for self-motivation of business owners for small and medium enterprise growth. the p-values of all the variables in table 3 are less than the 0.05 level of significance. this implies the significant relationship of the variables on self-motivation of business owners for sme growth. correlation test the bivariate pearson correlation analyses were used to examine the strength of the identified association between variables (dawson 2009). these tests were used to find any significant relationship between study variables. they include the relationship of both the self-motivation and intrinsic motivational factors of business owners with sme growth. the bivariate pearson’s correlation can reveal the significance of the correlation and, if it is significant, whether it is positive or negative (i.e. the direction of the correlation) as well as the strength of the correlation. the relationship in table 4 for determining whether self-motivated sme owners are likely to grow their businesses even bigger was analysed: the self-motivation of a sme owner variable has a directly proportional correlation with the four variables relating to business growth. these variables include the positive effect of self-motivated business owners, the naturally motivated business owner as the reason for sme growth, sme growth as an important goal of the business, as well as the sme growth as a variable that increases business sustainability. they have coefficient r-values of 0.681; 0.505; 0.503 and 0.285, respectively (at p > 0.05). this analysis indicates that self-motivated sme owners have the potential to grow their businesses. the variable relating to self-motivated sme owners who are likely to grow their businesses does not have a significant relationship with the variable on sme owners’ interest in learning to enhance willingness to take risks (at p < 0.05). this analysis indicates that an interest in learning by self-motivated sme owners has no relation to business growth. table 4: correlation tests for self-motivation of business owners for small and medium enterprise growth. intrinsic motivational factors of business owners for small and medium enterprise growth this section presents findings on the influence of intrinsic motivational factors of business owners for sme growth. descriptive analysis table 5 presents results (in percentages) of intrinsic motivational factors for sme growth. table 5: intrinsic motivational factors for small and medium enterprise growth. the result in table 5 indicates that the intrinsic motivational factors of business owners have an influence on sme growth. the high percentage agreement values on intrinsic motivation factors range from 88.3% to 98.3%. the response with low percentage agreement at 58.3% is when business owners indicate that they want to grow their businesses because they want to be recognised. the majority of respondents confirmed the position held by gay-perret and mainali (2012) who stated that business owners with an internal locus of control should exert effort and persistence towards achieving their goals and grow businesses. such business owners are able to control outcomes, and their actions do determine the achievement of rewards. in addition, the chi-square test per each variable was also performed. table 6 presents test results for determining whether the scoring patterns across the different statements were similar. table 6: chi-square statistics of intrinsic motivational factors for small and medium enterprise growth. the p-values for all the variables in table 6 are less than the 0.05 level of significance. this implies the significant relationship of the variables, thus indicating that the business owners are influenced by intrinsic motivational factors for sme growth. correlation test the bivariate pearson correlation analyses were also conducted to test any significant relationship between study variables. the relationship in table 7 for determining the variables of self-motivated business owners who exert an effort based on business growth interest was analysed: the self-motivation of business owners has a directly proportional correlation with the four variables relating to them exerting effort based on their interest for business growth. they include the sme owners who find solutions to business problems because they want to achieve business growth, the sme owners who are driven by a belief to produce the desired outcomes of their businesses, the need for advancement that has great impact on business growth and the sme growth aspirations that enable business owners to take risk in order to grow their businesses. they have coefficient r-values of 0.467, 0.338, 0.319 and 0.394, respectively (at p > 0.05). this analysis indicates that self-motivated sme owners exert efforts based on their business growth interest. the variable relating to self-motivated business owners who exert effort based on their interest for business growth does not have a significant relationship with the variable of sme owners who take responsibility to grow their businesses for recognition purposes (at p < 0.05). this analysis indicates that the growth of sme businesses does not depend on business owner recognition. table 7: correlation tests of intrinsic motivational factors for business growth. discussion this article investigated the influence of self-motivation and intrinsic motivational factors of business owners for sme growth. one hundred and twelve sme owners of furniture manufacturing businesses operating in the ethekwini metropolitan area in kwazulu-natal participated in the study. the findings indicate that if sme owners are intrinsically motivated, they exert effort based on business growth interests. they find solutions to business problems because they want to achieve growth. this gives an indication that the level of sme owners’ motivation is crucial for sme growth in sa. in addition, it reveals that sme owners are self-motivated in growing their businesses. this is in line with the assertion of abor and quartey (2010) that sme growth is closely associated with overall business success and survival. the need to achieve success is the motive to do well and achieve a goal to a set of standards (royle 2013). thus, when sme owners are intrinsically motivated, their desires to learn, explore their interests, and engage their curiosity lead to the focus of novel ideas that help them grow their businesses even bigger. furthermore, the intrinsic motivation is an important enabler of creativity. it enhances self-motivation for business growth. hence, the creative potential of smes will eventually lead to a better support of national goals for sa. they will thus be the enablers of economic growth for the country. the effort to stimulate creativity by broadening the range of cognitive information available, expanding the scope of attention towards assimilating a wider set of ideas and encouraging cognitive flexibility for identifying patterns and associations between ideas, will influence business growth (barringer & ireland 2010). intrinsic motivation enhances psychological engagement and builds energy for sustained effort (grant & berry 2011). this increases the amount of time that sme owners are willing to work for business growth. in addition, the results obtained during the study imply that the intrinsic motivational factors that stimulate the creativity process of the sme owners play a role in sme growth. the following conclusions relating to intrinsic motivational factors can be made: self-motivated business owners have the ability to grow their businesses. an interest in leaning enhances sme owners’ willingness to take risk. smes find new solutions to business problems because they want to achieve business goals. the need for advancement is the personal attribute that has greater impact on business growth. limitations of the study the study was conducted in the ethekwini metropolitan area. only smes in the furniture manufacturing sector participated. however, the respondents were geographically dispersed within the metropolitan area. conclusion this article examined the influence of intrinsic motivational factors on business growth. it was established that the relationship between self-motivation and business growth is quite complex. this is consistent with the theory of planned behaviour, the importance of access to resources, as well as the access to opportunities for business growth. in addition, the intrinsic motivational factors that stimulate the creative process sustain business growth of smes. this helps the business to survive and grow in the early years of establishment. acknowledgements competing interests the authors declare that they have no 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corruption and multinational companies’ entry modes − do linguistic and historical ties matter? marlene grande faculdade de economia, universidade do porto aurora ac teixeira cef.up, faculdade de economia, universidade do porto; inesc porto; obegef accepted: november 2011 the literature on fdi entry modes and corruption tends to convey the idea that corruption leads to a choice between low equity modes, i.e. joint ventures with local partners, and non-equity modes, namely exports and contracting, in order to avoid contact with corrupt state officials. recently, some studies have argued that despite corruption, linguistic and historical ties between home and host countries lead mncs to prefer high-equity modes. focusing on a rather unexplored setting, the african countries, most specifically the portuguese-speaking ones (palop – países africanos de língua oficial portuguesa), which include countries where levels of corruption are very high (e.g., guinea-bissau and angola), high (e.g., mozambique, sao tome and principe), and intermediate (e.g., cape verde), maintaining also close linguistic and historical ties with portugal, we found that the fdi entry mode is associated with the less corrupt markets. thus, our results do not support the recent contention that cultural and historical links are likely to perform a mediating role, by fostering foreign direct investment, in supporting african countries to overcome the dismal growth some have been facing in the last few decades. on the contrary, our findings highlight the pressing need for these countries to combat corruption if higher economic growth via fdi attraction is envisioned. key words: corruption, emerging economies, entry mode jel: f21, 23, k42 1 introduction africa is becoming the new frontier for emerging-market investors (santiso, 2007). an analysis by the economist (2011) finds that over the last decade, no fewer than six of the world’s ten fastest-growing economies are in sub-saharan africa, including angola in first place in the ranking and mozambique in eighth. this evolution of formerly underdeveloped markets makes it increasingly more difficult for foreign investors to ignore these markets, despite their (justified) reputation as a tough place for business owing to political uncertainty, corruption, weak infrastructure and inconsistent regulation (the economist, 2010). multinational companies (mncs) are increaseingly influenced by institutional instability, perceived risk and uncertainty in their process of investing in emerging economies (uhlenbruck, rodriguez, doh & eden, 2006). in corrupt and risky contexts, there is evidence that firms prefer joint ventures to wholly-owned subsidiaries (rodriguez, uhlenbruck & eden, 2005; uhlenbruck et al., 2006; straub, 2007; javorcik & wei, 2009; demirbag, mcguinness & altay, 2010). regardless of whether firms face petty bureaucratic or high-level political corruption (straub, 2007) and of the level of the pervasiveness and arbitrariness of corruption (rodriguez et al., 2005; uhlenbruck et al., 2006), existing empirical studies suggest that corruption influences the entry mode, particularly in the choice of non-equity modes or partnering. according to some more recent studies (e.g., cuervo-cazurra, 2008; demirbag et al., 2010; jiménez, durbán & de la fuente, 2011), abstract 270 sajems ns 15 (2012) no 3 the growing attractiveness of emergent regions allied to strong cultural and historical ties between home and some host countries have progressively led to a higher propensity for fdi despite the existence of corruption. studies that analyse the relationship between corruption and its impact on the mncs’ choice of entry mode have focused mainly on eastern europe (javorcik & wei, 2009) and asia (demirbag et al., 2010), or provide a general overview based on cross-country compositions (uhlenbruck et al., 2006; straub, 2007). similar analyses focusing on african countries have been rather neglected in this regard. aiming to test the role of corruption in the firms’ choice of entry mode in contexts where there are significant historical and cultural linkages, our analysis is focused on the portuguese mncs investing in the palop, a set of countries characterised by levels of corruption which are very high (e.g., guineabissau, and angola), high (e.g., mozambique, sao tome and principe) and intermediate (e.g., cape verde) (transparency international, 2009). given the close ties between portugal and the palop based on linguistic and historical factors, and following the reasoning of cuervo-cazurra (2008), demirbag et al. (2010) and jiménez et al. (2011), it would be scientifically pertinent to analyse the extent to which the palop’s corruption levels influence the entry modes of portuguese mncs in these countries. to this end, a direct questionnaire was built and applied to 562 portuguese firms that have internationalised to the palop, from which we obtained 147 responses representing 334 firm-market observations. the empirical analysis undertaken contributes to the lack of literature on corruption and the mncs’ entry modes by analysing an under-explored context, the palop countries. this paper is structured as follows. in section 2 we review the literature on the theories and determinants of mncs’ entry modes and on corruption, broadening the analysis of existing articles on the impact of corruption on mncs’ entry modes. section 3 details the study’s methodological considerations: data gathering procedures, questionnaire, target firms (portuguese firms that have internationalised to the palop), and the specification of the econometric model which aims to quantify the net impact of corruption on entry mode choice. in section 4, the results of the econometric estimations are discussed and, finally, conclusions summarises the main points of the research. 2 corruption and mnc entry modes − literature review international entry modes represent the third most-researched field in international management, being directly related to the international activity of mncs (canabal & white, 2008). entry modes vary largely in their scale of entry (peng, 2009), and are generally divided into two categories: equity and non-equity (tian, 2007). equity entry modes include joint ventures and wholly-owned subsidiaries. the former consist in a sharing arrangement between a foreign mnc and a local firm, where resources, risk and operational control are divided between the partners (julian, 2005), whereas the latter may involve both greenfield investments, which include establishing a new firm, and acquisitions of already existing firms (razin & sadka, 2007). equity modes require a very high resource commitment, i.e. the scale of entry, because direct establishment takes place in the foreign market (hill & jones, 2009). non-equity modes include exports and contractual agreements like licensing, franchising, turnkey projects and r&d contracts. in this case, the scale of entry is lower because relations with the foreign market do not imply direct establishment (peng, 2009). a mnc’s choice of market entry mode depends on several determinants. it is thus important to review the theories on fdi and mncs that intend to explain why firms become involved in several types of internationalisation processes. in general, the highly diversified theoretical approaches (e.g. early studies on fdi; the neoclassical trade theory; ownership (o), location (l) and internalization (i) framework – cf. faeth, 2009), do not directly and explicitly aim to explain mnc entry modes but they focus instead on highlighting key determinants of foreign direct investment.1 by adapting the existing theoretical sajems ns 15 (2012) no 3 271 approaches to fdi and internationalisation, we intend to provide a distinct approach, mixing existing contributions with transaction cost analysis (tca) and dunning’s eclectic paradigm or oli model. the latter is an integrated internationalisation model that draws inspiration from three different strands of business theory, namely competitive theory, in terms of ownership of strategic assets, international business theory, in terms of location advantages, and finally, tca, in terms of internalisation issues. according to dunning’s eclectic paradigm, only by integrating the three perspectives can the international activities of mncs be fully understood (aspelund & butsko, 2010) and their choice of entry mode rationalised (cf. figure 1). f i g u r e 1 choice of entry mode overall tendency legend: tca – transaction cost approach; ia – institutional approach; oli – ownership dimension; oli – location dimension; oli – internalization dimension from the eclectic paradigm note: authors’ compilation in grande and teixeira (2011) based on the firms’ abilities, it may be possible to connect the firm’s competences, skills and assets from the resource-based theory (hill & jones, 2009) to dunning’s eclectic paradigm or the oli framework (luo, 1999). accordingly, to take advantage of firmspecific assets (madok, 1998; sreenivas & pangarkar, 2000), such as technology-intensive resources (sun, 1999; javorcik & wei, 2009) and inventive/r&d-intensive activities (bhaumik & gelb, 2005; chung, 2009), the most common entry mode is the establishment of whollyowned subsidiaries (wos). this is justified on the basis that firm-specific resources and activities need a high level of control (edwards & buckley, 1998; chen & hu, 2002), which would not be possible in a joint venture (jv), where knowledge has to be transferred to the partner (chiao, lo & yo, 2010; yiu & makino, 2002; martin & salomon, 2003). therefore, we put forward that: hypothesis 1: the higher the mnc’s r&d intensity, the higher the likelihood of entry via fdi. in line with garcía and fernández (2009), who found a positive correlation between serviceproviding companies and entry through fdi, we maintain that service-related companies, as opposed to manufacturing ones, would be more inclined to opt for the fdi entry mode, given the nature of services -– immaterial, often information-intensive; hard to separate production from consumption; consumerintensive, hard to store or transport (toivonen & tuominen, 2009). hypothesis 2: mncs from the services sector are more likely to enter a foreign host country through fdi rather than through other nonequity modes. mncs with accumulated experience in internationalisation are less likely to rely on the tca: market imperfections ia: ipr protection, costs and local content requirements non equity modes equity modes ia: corruption ia: government intervention oli/rbt: (in)/tangible assets tca/oli: direct costs and trade ia: international/political risk oli: cultural differences oli: industry/location-specific assets 272 sajems ns 15 (2012) no 3 support of a joint venture partner, because they already have the required know-how to conduct business abroad (mutinelli and piscitello, 1998). in contrast, when mncs do not have any experience, jvs can be used to complement internal r&d resources and to exchange knowledge on an inter-firm basis (mutinelli & piscitello, 1998). consequently, we put forward that: hypothesis 3: the higher the mncs’ international experience, the more likely the choice for fdi entry modes. although some studies did not find a statistically significant relationship between firm size and entry mode choices (evans, 2002; esperança, hill & valente, 2006), demirbag et al. (2010) found that the larger the size of the operation, measured by the number of employees, the more likely the foreign investor will choose wholly-owned subsidiaries to enter a foreign market. according to mutinelli and piscitello (1998), small firms with a lack of resources, experience and information face a high level of uncertainty, which can be mitigated by lower levels of involvement in the host market, such as, for example, through non-equity modes. on the contrary, larger firms, usually possessing a higher amount of valuable tangible or intangible assets, may attract opportunistic joint venture partners or intermediaries, which may lead them to establish on their own. to test this argument, we put forward that: hypothesis 4: the larger the mnc, the more likely it will opt for fdi entry modes. besides the fact that most of the studies in this literature stream did not obtain a statistically significant correlation between the openness of the host economy and a specific entry mode (e.g. javorcik & wei, 2009), there are studies that suggest a positive correlation between openness and fdi (chang & rosenzweig, 2001). they argue that trade barriers (i.e. a low level of economic openness) should lead to a lower share of exports in the market, and consequently, the market share of imports in a host country can be seen as a factor that encourages high resource-commitment modes. therefore, we put forward that: hypothesis 5: the more open the host economy, the more likely the mnc’s choice for fdi entry modes. some studies on the determinants of mncs’ entry modes find a positive correlation between the host market size and fdi inflows. cuervo-cazurra (2008) obtained high levels of correlation among the variables related to the characteristics of a country (such as gdp and population). in line with these results, uhlenbruck et al. (2006), when analysing 220 telecommunication projects in 64 emerging economies, also controlled for gdp per capita and obtained a positive correlation with fdi inflows. accordingly, we put forward that: hypothesis 6: the larger the host market, the more likely the mnc will opt for fdi entry modes. cultural distance is a dominant determinant of entry mode choice. according to chen and hu (2002:196) “[c]ulture is shared values and beliefs. cultural distance is the difference in these values and beliefs shared between home and host countries. large cultural distances lead to high transaction costs for multinationals investing overseas”. studies focusing on fdi flows and/or entry mode choices often obtain a statistically significant correlation when it comes to culture-measuring variables. cornelius (2005) attempted to shed some light on the quality of governance practices in a large sample of countries and the extent to which that quality could offset perceived weaknesses in the institutional framework in which companies operate. and indeed the perceptions of the quality of corporate governance appear to be consistent with his assumptions. most importantly, though, he identified important outliers, suggesting that other factors such as political, cultural and historical roots also play an important role. moreover, strange, filatotchev, lien & piesse (2009), when examining the fdi location strategies of firms from taiwan in a rapidly emerging market (china), found that the efficacy of firms’ external linkages varies according to the strength of the cultural and historical ties between the location of the foreign affiliate and the home country. sajems ns 15 (2012) no 3 273 hypothesis 7: when the home and host country share linguistic and historical ties, the more likely foreign investors are to enter via fdi rather than through non-equity modes. jiménez et al. (2011) aimed to analyse the impact of political risk variables in the location strategy of spanish multinational enterprises (mnes) in europe. in this study, they collected evidence on the relevance of lower political constraints to attract investments. however, the results also highlighted the importance of cultural and geographical proximity, which may serve to overcome obstacles derived from higher corruption or lower economic freedom levels. in line with these findings, which suggest that the effect of cultural links may exceed the impact of other determinants, such as corruption, cuervo-cazurra (2008), when controlling for cultural similarities, found a positive correlation between a common language in host and home countries and fdi inflows, even when there is corruption in the host country. the findings of demirbag et al. (2010) confirmed this correlation, when analysing 104 turkish mncs which invest in the culturally close republics of central asia. they found that even in the presence of corruption, foreign mncs reveal a preference for high levels of involvement in the host market, which they enter by means of wholly-owned subsidiaries. thus, we put forward that: hypothesis 8: the higher the importance mncs attribute to institutionally-related factors (e.g. legal restrictions and political stability), the higher its fdi propensity tends to be. since corruption is one of the most pervasive political problems worldwide, there has been considerable empirical research on its causes and effects in recent years (frischmann, 2010; goel & nelson, 2010).2 the world bank has estimated that more than 1 trillion usd is paid in bribes each year and that countries that fight corruption, improve governance and the rule of law, potentially increase per capita incomes by 400 per cent (dreher, kotsogiannis & mccorriston, 2007). a large amount of research on the impact of corruption on the mncs’ choice of entry mode has found that corruption discourages the establishment of wholly-owned subsidiaries (wos). the analysis by uhlenbruck et al. (2006) of 220 telecommunications development projects in 64 emerging economies found that firms adapt to the pressures of corruption via short-term contracting and joint ventures, avoiding wos. javorcik and wei (2009) studied how entry modes were affected by the extent of corruption in 22 eastern and central european countries and found that corruption reduces inward fdi and shifts the ownership structure towards joint ventures, to avoid excessive transaction costs related to corrupt government officials. rodriguez et al. (2005) confirm this tendency arguing that, in the presence of both arbitrary and pervasive corruption, mncs tend to enter by means of non-equity modes or joint ventures to avoid direct contact with corrupt government officials and to achieve legitimacy through networking activities. furthermore, demirbag et al. (2010), when analysing 104 turkish mncs investing in central asian countries, found that corruption generally leads to entry through joint ventures with local partners. an analysis of 231 entries by dutch mnes in 48 countries by slangen and van tulder (2009) offers support for these findings, arguing that mncs often choose joint ventures over wos to protect themselves from external uncertainties. this assumption is supported by straub (2007) who state that countries with high political corruption are most frequently entered via non-equity modes. however, not all empirical studies have found a clear-cut negative relationship between corruption and entry through wos. for example, taylor, zou and osland (2000) and ahmed, mohamad, tan and johnson (2002) argue that mncs tend to opt for high control modes (wos) when the risk of doing business in the host country is high. henisz (2000) also found that in the presence of political risks, mncs tend to choose woss to protect themselves from potentially manipulative joint venture partners. another approach by li and rugman (2007) showed that mncs prefer to enter markets with high uncertainty levels through woss because they contribute to reducing uncertainty. therefore, we put forward that: hypothesis 9: the higher the host country’s corruption level, the more likely foreign investors will opt for entry through non-equity modes. 274 sajems ns 15 (2012) no 3 3 methodological considerations similarly to other studies which analyze the role of the several determinants of the mncs’ choice of entry mode (e.g. uhlenbruck et al., 2006; straub, 2007; slangen & van tulder, 2009), our study makes use of a multivariate econometric model, more specifically, a logistic regression to assess how corruption affects the firms’ entry modes in countries characterised by widespread levels of corruption (the palop), and which maintain historical and linguistic affinities with the mncs’ home country (portugal). based on the literature, the mncs’ choice of entry mode depends on four main groups of determinants, namely on the three dimensions of dunning’s eclectic paradigm (or oli model) and the institutional approach. our ‘dependent’ variable, mnc entry mode, is a dummy which assumes the value 1 in cases where the firm opts for entry (in a given market) through fdi and 0 otherwise (nonequity modes).3 given the nature of the dependent variable (binary), the empirical assessment of the mncs’ fdi propensity is based on the estimation of the general logistic regression, which in turn is based on the existing literature on the determinants of entry modes, surveyed in section 2. in order to obtain a more straightforward interpretation of the logistic coefficients, a rearrangement of the logistic model’s equation has to be considered, and it is rewritten in terms of the odds of an event occurring. writing the logistic model in terms of the log odds, we obtain the following logit model: i contextnalinstitutiolocation ationinternalizownership corruptionβstabilitypolitβstlegalβoxculturalsizemarketβ opennessβintfirmβsizefirmβintrdβ equitynonob fdiob εβ β ++++++ +++++=⎟⎟ ⎠ ⎞ ⎜⎜ ⎝ ⎛ −         _ 98765 43210 _re_pr__ exp____ )(pr )(pr log the logistic coefficient can be interpreted as a change in the log odds associated with a oneunit change in the independent variable. then, e raised to the power βi is the factor by which the odds change when the ith independent variable increases by one unit. if βi is positive, this factor will be greater than 1, which means that the odds are increased; if βi is negative, the factor will be less than one, which means that the odds are decreased. when βi is 0, the factor equals 1, which leaves the odds unchanged. in the case where the estimate of β9 emerges as positive and significant for the conventional levels of statistical significance (that is, 1 per cent, 5 per cent or 10 per cent), this means that, on average, all other factors remaining constant, the ‘preferred’ entry mode by portuguese mncs in countries/markets with higher perceived corruption levels is fdi, which would be in line with hypothesis 9. the descriptive statistics of the variables model and the matrix of correlations are presented in table 1. the estimates of the βs are given in table 2. our unit of analysis is not the firm or the market but rather the firm and the market – the same firm can internationalise to a single country or to all the (5) countries (angola, cape verde, guinea bissau, mozambique, and sao tome principe) in analysis. the population surveyed included all (562) the portuguese firms that have internationalised to the 5 palop countries, according to aicep portugal global (a government business entity focused on fdi and the internationalisation of portuguese companies).4 a direct email questionnaire was built and sent to all these firms. questions covered not only the firms’ main characteristics but also aspects regarding their entry modes in each market under analysis (depending on whether they had in fact entered) and their perceptions of some key institutional factors (specifically, the importance of legal restrictions, linguistic and historical ties, and the impact of corruption in the choice of entry mode). around a quarter of the surveyed firms answered the questionnaire and, considering that 65 per cent had internationalised to more than one palop country, 321 valid responses were obtained. sajems ns 15 (2012) no 3 275 t a b l e 1 correlation matrix the descriptive results (cf. table 1) based on the survey’s sample suggest that the portuguese mncs’ ‘propensity’ for fdi as the ‘preferred’ entry mode in palop countries is positively and significantly related to firm size and the importance attributed to legal restrictions and political stability. that is, in a bivariate statistical analysis, larger mncs and 276 sajems ns 15 (2012) no 3 those that perceive legal restrictions and political stability as key factors when choosing their entry mode, tend on average to opt for equity-based entry modes (i.e. fdi), instead of exports and/or contracting. in contrast, firms with higher international experience, as measured by the number of countries to which they have internationalised or the number of years since they first internationalised, tend to opt for non-equity entry modes, namely exports. regarding the relationship between the independent variables, the results show that the years of internationalisation experience and number of countries to which the firm has internationalised are positively and significantly related, revealing that firms which have internationalised to a larger number of countries tend to have started their internationalisation processes much earlier. given this high correlation, it was advisable to estimate the ‘theoretical’ model using one of the two proxies of internationalisation experience. thus, we estimated model i (cf. table 2) using ‘number of countries in which the firm is present’ as the proxy for internationalization experience, whereas in model ii, the ‘number of years of internationalisation experience’ was used. although some correlations between the independent variables are strong (namely, between the corruption perception index and the openness indicator – see table 1), these are not high enough to undermine the estimation of the proposed model. 4 econometric results according to the goodness-of-fit measures (hosmer & lameshow test and percentage corrected), the two estimated models represent ‘reality’ quite well. table 2 presents the results of our logistic estimates. considering the results related to the control variables included in our models, statistical evidence was not found to sustain a correlation between the mncs’ r&d intensity and a specific entry mode (i.e. hypothesis 1 is not corroborated). in contrast, sector dimension emerged as a statistically significant variable. thus, our results support hypothesis 2. specifically, estimates indicate that mncs from the services sector tend to present an odds for fdi 3 times higher (e1.194=3.301) than that of their manufacturing counterparts. quite unexpectedly, and in contrast to the literature (e.g., mutinelli & piscitello, 1998; chiao et al., 2010), hypothesis 3 was not supported. the international experience of portuguese mncs is negatively related with the (log odds of) fdi ‘propensity’, meaning that firms with higher international experience tend to enter the palop markets mainly by way of exports. as noted by slangen and van tulder (2009) in their study, this may be due to the fact that mncs tend to enter new markets by the same method/mode with which they entered other markets previously i.e. when a firm has experience in entering markets via exports, it is more likely that subsequent internationalisation processes will take the same path. as expected, the larger portuguese mncs tend, on average, ceteris paribus, to choose fdi as their preferred entry mode in the palop. thus, hypothesis 4 is corroborated, which reflects the finding of demirbag et al. (2010) that the higher the number of employees (in their case, as a proxy for the size of operation), the more likely the foreign investor will choose an equity entry mode. in contrast to some of the existing literature (e.g. javorcik & wei, 2009) where the economy’s openness does not appear to have a statistically significant effect on the choice of entry mode, in this study, the country’s openness indicator emerges as quite relevant. the estimate coefficient of market openness, which stands as a proxy for the host countries’ reception of trade and commerce, reveals that, on average, all other factors remaining constant, markets which are relatively more open (reflecting lower transaction costs) tend to be associated with fdi modes of entry. summing up, hypothesis 5 holds. the location dimension received median support from our data. indeed the size of the market, proxied by the host country’s gdp per capita, emerged as negatively and significantly related with fdi propensity, which contradicts hypothesis 6. this suggests that, on average, portuguese mncs entering larger markets tend to fall back on non-equity modes (namely exports). such results contradict findings in the existing literature (horstmann & markusen, sajems ns 15 (2012) no 3 277 1996; eicher & kang, 2005), which in general claim that the larger the market size the higher the probability of entering via high equity modes. cultural proximity (hypothesis 7), reflected by the proportion of mncs that stated that linguistic and historical ties between home and host country were important or very important in the decision to enter the market, failed to emerge as significant. t a b l e 2 mncs’ entry mode and corruption: logistic estimates (dependent variable: log odds of fdi vs. non-equity) determinants proxy model i model ii b eb b eb eclectic paradigm: ownership r&d intensity r&d to sales ratio 0.913 2.492 0.641 1.898 services vs. manufacturing service=1 vs. manufacturing=0 1.194 *** 3.301 1.332*** 3.789 international experience number of years of internationalisation experience (ln) -0.241 1.273 number of countries in which the firm is present (ln) -0.991 *** 2.694 firm’s size number of employees (ln) 0.642*** 1.901 0.394*** 1.483 eclectic paradigm: internalisation openness of the host economy (exports+imports)/gdp (ln) 16.275 * 11.7mio 17.155** 28.2mio eclectic paradigm: location host market size gdp per capita -3.300* 27.113 -3.340* 28.219 cultural proximity proportion of firms that stated that linguistic and historical ties between home and host country were important or very important in the decision to enter the market -0.230 1.259 -0.144 1.159 institutional approach legal restrictions proportion of firms that stated that the entry mode choice was influenced by legal restrictions in the country 0.773** 2.166 0.615** 1.850 political stability proportion of firms that stated that the entry mode choice was influenced by political stability 0.473 1.605 0.531 1.701 corruption corruption perception index (cpi)/transparency index (ln) 10.061 * 40538.2 10.370** 31888.5 constant 10.892 53744.7 10.461 34926.5 number of observations (n) 334 334 fdi 89 89 non-equity 245 245 goodness of fit hosmer and lameshow test (p-value) 6.080 (0.638) 8.163 (0.418) % observations corrected 73.8 73.8 note: *** (**)[*] statistically significant at 1 per cent (5 per cent)[10 per cent]; n=334=no. of firms (147)*no. of markets. the estimations put forward highlight the crucial role of institutional factors (hypothesis 8) in explaining the mncs’ entry modes. indeed, legal restrictions and, most importantly, the host country’s level of corruption are statistically significant elements related with the mnc’s choice of entry mode. in effect, the portuguese mncs that perceive legal restrictions as very important in their choices regarding the entry mode in the palop tend, on average, to have a higher propensity for fdi entry modes. finally, the estimations support hypothesis 9, indicating a positive correlation between the cpi (transparency index) and an fdi entry. this means that, controlling for all the other factors which are likely to affect entry mode choices, portuguese mncs tend to opt for 278 sajems ns 15 (2012) no 3 direct investment in the more transparent/less corrupted markets. thus, our results are in line with the general tendency conveyed in the literature (e.g., rodriguez et al., 2005; uhlenbruck et al., 2006; straub, 2007; paul & wooster, 2008), which contends that mncs should prefer non-equity entry modes in corrupt contexts. 5 conclusions the present paper intended to analyse how portuguese mncs’ choice of the most appropriate entry mode is affected by the level of corruption in host countries, namely with regard to the palop countries. based on a multivariate econometric model, we found that services and larger firms have a preference for high-equity entry modes, which contrasts with the size dimension in the study of esperança et al.’s (2006), and may be explained by the fact that they analyzed a set of different host countries. while esperança et al. (2006) focused on portuguese mncs which invest in spain, our study analysed firms from the same home country but which have internationalised to emerging african countries with very different characteristics, namely the levels of corruption, political restrictions, and economic and political instability. these and other factors, such as physical proximity, may explain why the results point in different directions. additionally, we found that the openness of the host market favours entry via fdi, which is somewhat surprising, since this determinant did not appear to have a statistically significant effect in previous studies focusing on other (central and eastern european) emerging markets like, for exemple, javorcik and wei (2009). also in contrast with the existing literature (e.g. horstmann and markusen, 1996), the host market size emerged as negatively related to the equity mode propensity, such that a (portuguese) mnc is more likely to enter via exports in larger (palop) markets. finally, we found that international experience is not, as would be expected, associated with high equity modes. as noted by slangen and van tulder (2009), this may be due to the fact that mncs tend to enter new markets by the same method/mode with which they entered other markets previously i.e. firms with experience in entering markets via exports are more likely to follow the same path in subsequent internationalisation processes. in line with prior studies that point out the firms’ general preference for non-equity modes when entering corrupt markets (e.g. rodriguez et al., 2005; uhlenbruck et al., 2006; straub, 2007; paul & wooster, 2008), our results show that, on average, portuguese firms opt for nonequity modes, most specifically exports, when entering more corrupted countries. recall that, according to uhlenbruck et al. (2006), mncs use non-equity modes as an adaptive strategy because this entry mode provides an opportunity to participate in economies where corruption is high while avoiding some of the costs related to corruption. non-equity modes also enable the mncs to avoid direct contact with corrupt practices, such as bribes (rodriguez et al., 2005). apart from bribes and extra taxes, direct establishment in a corrupt market may affect the mncs’ investment through their interaction with corrupt state officials. this increases the risk of expropriation and reduces the informational advantage a firm entering via fdi may have (straub, 2007). based on these results, we failed to corroborate the arguments put forward in the studies mentioned previously. indeed, despite the fact that the vast majority of the firms (about 90 per cent of our sample) underlined the importance of cultural ties with the palop countries, perceived corruption emerged negatively and significantly correlated with the fdi propensity. in other words, the palop countries characterised by a lower level of perceived corruption tend to be the most successful in attracting foreign direct investment. thus, we have shown that in the palop too, high levels of institutional quality tend to foster economic growth and development through its positive effects on fdi attraction. summing up, our findings highlight that, despite the existence of strong cultural ties between home (portugal) and host countries (palop), corruption stands as a critical obstacle to foreign direct investment. recall that, with the exception of cape verde, all the other palop countries present very low levels of transparency (with a cpi below 3 out a sajems ns 15 (2012) no 3 279 maximum of 10). given the perceived widespread corruption among the palop, our findings reflect a rather troubling scenario for these countries’ prospects for future growth. our study clearly emphasises that historical and cultural ties are not sufficient to overcome the costs of institutional weaknesses, namely the perceived widespread corruption. we draw on lawal’s (2007) words when she maintains that corruption has been an impediment to the true and real development of african society. thus, in order to benefit from the potential benefits of foreign capital, which contributes to economic development and integration in the global economy (shrestha, smith & evans, 2010), african countries in general, and the palop in particular, should implement serious measures to combat corruption, building a strong political system that inspires confidence and attracts foreign investors. endnotes 1 in an earlier research proposal from the authors (grande and teixeira, 2011) these literature approaches are surveyed and presented with further detail and scope. although in this paper no empirical tests are pursued, the authors provide an indepth account of the determinants of mnc’s entry mode choices according to each theoretical approach (transaction cost approach, ecletic paradigm – ownership, location, internalisation, institutional) which help to support/rationalise figure 1. 2 there are many definitions of this phenomenon (detzer, 2010). however, there is relative consensus among authors (dey, 1989; mauro, 1998; treisman, 2000; dietrich, 2010; reiter & steensma , 2010) that corruption refers to acts in which the power of public office is used for personal gain in a manner that contravenes the rules of the game (jain, 2002). 3 we opted to compare fdi versus non-equity modes instead of considering each entry mode (acquisition, greenfield investment, joint venture, etc.) given that the majority of the firms surveyed had very few observations for each specific equity-entry mode. 4 the original database had 653 firms but 46 firms claimed they did not have any presence in the palop countries, and in 45 cases the email did not reached the recipient. thus, our ‘effective’ population is 562 firms. references ahmed, z.u., mohamad, o., tan, b. 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prolonged effect on the south african mining sector. this may be the result of the strike action already having been discounted into the price of mining shares, implying that the market was only reacting to the unusually violent (but short-lived) protest. alternately, the results could be indicative of investor confidence in the corporate social responsibility initiatives of the south african mining industry as a whole. this paper is the first to examine the potential impact of the marikana incident on the share prices of mining companies listed on the jse. it should be of interest to both academics and practitioners wanting to understand how share prices react to exogenous events. it is also relevant for corporate-governance researchers concerned with the relevance of social and governance practices in a south african setting. this research is faced with the limitations associated with most statistical research: that causality cannot be ascribed to tested relationships. notwithstanding these limitations, it is argued that these findings are important, given the significant coverage of the marikana incident and the ongoing debate on the need for corporate social responsibility. key words: corporate social responsibility, corporate governance, event method, marikana, south africa jel: g14, m48 1 introduction on 16 august 2012, police units deployed in marikana to manage an increasingly violent wildcat strike by mineworkers at lonmin plc’s (lonmin) operations in rustenburg, south africa, opened fire, killing 34 and wounding an additional 78 people (nkosi, 2012). in addition to the social and political implications (evans, 2013; marikana commission of inquiry, 2013; van graan, 2013), the incident had a material financial impact for lonmin, which reported significant production stoppages and a material decline in share price (reuters, 2012c), coupled with the risk of additional losses due to adverse reputational consequences (see, for example, the comments of frankel, 2012). the ramifications of the marikana incident for the south african platinum-mining industry as a whole are, however, less clear. as such, the purpose of this research is to examine the relationship between the marikana incident and the potential impact on the value of platinum-mining stocks listed on the jse by identifying and measuring abnormal returns over a defined event period, using event methodology1. there are similar studies which have examined the effect of unusual events on share prices (for examples, see hamilton, 1995; chen & siems, 2004; capelle-blancard & laguna, 2010). to the best of our knowledge, few studies have, however, examined the possible impact of labour unrest on equity returns. furthermore, despite the significant coverage in both the local and international press of the events unfolding at marikana (mabuse, 2012; nkosi, 2012), there has been no formal academic work on their financial ramifications. consequently, this research makes an important contribution to the corporate-governance literature by providing abstract sajems ns 18 (2015) no 4:586-607 587 initial evidence on the possible share price impact of this widely publicised example of wildcat strike action in the south african platinum-mining sector. in addition to stakeholders concerned with the possible implications of marikana for lonmin’s share price, these findings should also be of interest to a broader corporate-governance community. “marikana” has become infamous as possibly the most violent demonstration in postapartheid south africa (bond & mottiar, 2013), thereby pointing to political strife, growing social and economic inequality and, possibly, the beginning of the decline of south africa’s famous mining industry (cawadas & mitchell, 2012; evans, 2013; marikana commission of inquiry, 2013; van graan, 2013). the labour unrest may also be indicative of poor corporate social responsibility (csr) practices on the part of the country’s mining houses (cf. frankel, 2012). given the growing body of research which points to a link between csr and financial return (kumar, lamb & wokutch, 2002; lamb, kumar & wokutch, 2005; de klerk & de villiers, 2012), the shooting of mineworkers on 16 august 2012 may have led to a crisis of confidence for the mining fraternity (cf. patten, 1992; patten, 2002), investor dissatisfaction and a decline in share prices across the jse’s mining sector. on the other hand, if the initial effects of marikana on share prices were limited, this would suggest2 that, in general, effective csr strategies by south african mining companies played an important role in limiting the financial impact of the strike action. as such, exploring the correlation between share prices and the marikana incident makes an important contribution to the body of literature dealing with the relevance of sound corporate social behaviour, while adding to the limited research on how south africa’s capital market reacts to significant labour-related issues. at this point, it must be stressed that the aim of this paper is not to assign blame or offer insights into the causes of the marikana incident. the circumstances leading up to the demonstrations were very complex (cf. marikana commission of inquiry, 2013; lonmin plc, 2012). labour relations between lonmin and its employees were only a part of the events taking place on 16 august 2012 (evans, 2013; marikana commission of inquiry, 2013; van graan, 2013). there were a host of complex social, political and economic forces which were also at work (cf. lonmin plc, 2012; marikana commission of inquiry, 2013). examining each of these contributing variables is beyond the scope of this research. in addition, the study is restricted to considering the potential financial impact of the marikana incident, defined in terms of the abnormal and cumulative abnormal returns on share prices. related to this, the time period under review is very short to avoid the impact of confounding events, with the result that the research cannot draw conclusions concerning the long-term implications of marikana for the local mining industry. the remainder of this paper is organised as follows: section 2 provides a theoretical framework, discusses the application of event methodology and summarises the developments at marikana, culminating in the event under review (the marikana incident). section 3 explains in more detail the use of the event method for the purpose of this study. section 4 presents results and section 5 analyses the results and discusses possible implications. section 6 contains the conclusion and identifies areas for future research. 2 literature and background the “frictionless” system predicted by the efficient-market hypothesis (emh) may only be theoretical, but the characteristics of efficient markets have been found, at least to some extent, “in real world markets” (fama, 1965; malkiel & fama, 1970:387-388). consequently, although there have been criticisms of the simplifying assumptions of the emh (see, for example, basu, 1977; clarke, jandik & mandelker, 2001), the theory is generally accepted as providing a reasonable basis for describing changes in share prices (malkiel, 2003). in particular, the ability of capital markets to respond efficiently to publicly available information has allowed for a plethora of research, using event methodology, on the market’s reaction to the release of potentially pricesensitive information (schwert, 1981). 588 sajems ns 18 (2015) no 4:586-607 2.1 event-study methodology studies using event methodology provide interesting accounts of how markets, which are at least semi-strong form efficient, react to specific events (kothari & warner, 2006; donnelly, 2008). rosen (2006), for example, identifies how the announcement of a merger (a single event) can trigger a short-term movement in stock price based on investor sentiment. other papers have considered the relationship between share prices and earnings announcements (chambers & penman, 1984), new equity issues (barclay & litzenberger, 1988), and disclosures of changes in bond prices by rating agencies (hand, holthausen & leftwich, 1992). from a broader perspective, event method studies have also been successfully applied when exploring the possible impact on share prices of events beyond an organisation’s control. worrell and davidson (1987), for example, examined the impact of chief executive officer (ceo) succession on the wealth of shareholders following the death of their predecessors. dealing with the relevance of environmental issues, white (1996) examined the potential impact of the exxon valdes oil spill on stock prices, while kalra, henderson & raines (1993) considered the implications of the chernobyl nuclear disaster on utility share prices. more recently, hovav and d’arcy (2003) successfully applied event methodology to highlight the possible implications of “denial of service” attack announcements on affected firms’ stock prices. likewise, chen and siems (2004) assessed the immediate impact which terrorist attacks had on the united states of america’s (usa’s) capital markets. event methods have also been applied to examine the relevance of accounting information. donnelly (2008), for instance, examined the behaviour of share prices of irish companies at the time of the wall street journal publishing criticisms of the accounting practices of a local pharmaceutical company. event methods have also been successfully applied in a south african setting. although there may be some opportunities for exploiting market inefficiency, the conclusion is that the jse is at least semi-strong form efficient (glass & smit, 1995; jefferis, okeahalam & matome, 1999; magnusson & wydick, 2002; jefferis & smith, 2004). consequently, several studies have been able to demonstrate how south african equity instruments react to market announcements such as management buyouts (bhana, 2005), unbundling transactions (bhana, 2006), and share repurchases (bhana, 2007) using event methodology. the technique has also been successfully applied in examining the connection between csr and share price returns. 2.2 corporate social responsibility, event methodologies and marikana there is a large body of literature dealing with the relationship between csr and the financial performance of organisations (cf. griffin & mahon, 1997; roman, hayibor & agle, 1999; ullmann, 1985; de klerk and de villiers, 2012). as pointed out by mcwilliams and siegel (1997) and by wood and jones (1995), a key challenge has been that of clearly demonstrating the mechanisms by which favourable or unfavourable corporate social behaviour translates into financial returns. this problem has often been addressed using event methodologies (or similar techniques) to match plausibly the relationship between specific actions or events and changes in share prices (kumar et al., 2002). in particular, event methodology has been successfully employed to highlight the possible interconnection between boycotts against south african firms during apartheid (as an example of a social corporate action) and share price returns. meznar, nigh and kwok (1994), for example, report on the effect of announcements by american firms to disinvest in south africa during the 1980s. this investment decision met the social expectations of certain stakeholder groups, thereby placing pressure on american business to boycott south african investments, but also resulted in a loss of value for shareholders due to forgone business opportunities (cf. wright & ferris, 1997)3. this effect was more pronounced for earlier withdrawal announcements, in line with the variability of the perceived costs and benefits of boycotting south african investments during the 1980s (meznar et al., 1994; meznar, nigh & kwok, 1998). although the precise effect of withdrawal announcements on share values is difficult to determine (meznar et al., 1998) – and is subject to some debate (mcwilliams & siegel, sajems ns 18 (2015) no 4:586-607 589 1997; teoh, siew, welch & wazzan, 1999) – the general consensus is that there was at least a negative correlation between the announcement of a decision to divest from south africa and equity returns (wright & ferris, 1997; meznar et al., 1998). in turn, this has important implications for the traditional position that, in the absence of material agency problems, managers ought to operate in the best interest of shareholders (berle & means, 1932; jensen & meckling, 1976; freeman, 1984). faced with mounting public criticism on account of their business relationships with south african entities, many american organisations engaged in a pluralistic investment decision-making process which was mindful of the interests of multiple stakeholder groups. this culminated in disinvestment from south africa, even if this resulted in an initial loss of value for shareholders (meznar et al., 1994). in the long run, however, firms which continued to remain invested in south africa were increasingly penalised by a socio-ethical investment movement taking hold as social activism during the 1980s and early 1990s gained momentum (kumar et al., 2002). in other words, the initial costs of withdrawing from south africa (meznar et al., 1994) were eventually exceeded by the negative implications (including the detrimental effect on share prices) of remaining invested in the country (meznar et al., 1998; kumar et al., 2002). there is also evidence to suggest that withdrawing from south africa resulted in a type of social legitimacy reserve which contributed to the share prices of companies (which committed to social activism against apartheid) outperforming peers in the days following the end of sanctions against south africa in 1993 (lamb et al., 2005). in this way, “social/ethical investing can be a powerful force in the stock market based strictly on the investment decisions made by social/ethical investors themselves” and can “be an even stronger force by influencing the decisions of other investors in general” (kumar et al., 2002; lamb et al., 2005:12). this logic remains valid in post-apartheid south africa. the evolution of responsible investment has been influenced significantly by the country’s codes on corporate governance, which have engendered a stakeholder-centric model for corporate reporting (institute of directors in southern africa [iod], 2009; solomon, 2010). complementing this is the country’s drive to promote integrated thinking and reporting by companies which recognises the need to balance financial performance with a broad range of sustainability indicators (integrated reporting committee of south africa [ircsa], 2011; jse 2013). this has gone hand in hand with: the commitment of certain south african institutions to the principles of responsible investment (backed by the united nations) (iod, 2011); the publication of the code for responsible investment in south africa to drive the integration of sustainability issues in strategic investment decision making (iod, 2011; solomon & maroun, 2014; atkins and maroun, 2015); and the development of the jse’s responsible investment index to identify those listed companies with good social and environmental credentials (ernst & young, 2012; solomon & maroun, 2012; atkin and maroun, 2014). in this context, there is an emerging body of academic work which has concluded that csr practices – including corporate responsibility reporting (crr) – are value-relevant in capital markets (de klerk & de villiers, 2012; flammer, 2013; chen, wang & wang, 2014). carroll and shabana (2010), for example, argue that crr has a positive effect on the financial performance of an organisation, benefitting shareholders (and other stakeholders) mainly in the form of increased competitive advantage, gains from risk reduction, and reputational benefits for the reporting entity (cf. solomon, 2010; king, 2012). analogously, gregory, tharyan and whittaker (2013) find that firms with sound governance practices generally have better longer-term growth prospects, coupled with slightly lower costs of equity. de klerk and de villiers (2012) reached a comparable conclusion in a south african context, finding that firms which actively report on csr issues tend to enjoy higher share prices. these findings are consistent with evidence suggesting that south african companies complying with the global reporting initiative (gri) reporting guidelines enjoyed superior financial performance – measured in terms of earnings per share, headline earnings per share, return on assets, and returns on equity – than those organisations which did not comply with the guidelines (buys, bosman & van rooyen, 2009). although some researchers 590 sajems ns 18 (2015) no 4:586-607 have disputed the positive correlation between crr and share prices (cf. hassel, nilsson & nyquist, 2005; jones, frost, loftus & van der laan, 2007), the active management of and reporting on environmental, social and governance (esg) issues is generally regarded as an imperative for investment analysts dealing with south african companies (cf. de klerk and de villiers, 2012; king, 2012; solomon & maroun, 2014). ultimately, the growing social pressure to incorporate esg metrics into investment decision making reinforces the business case for socially responsible investment practices (cf. lamb et al., 2005; iod, 2011; solomon & maroun, 2014) and implies that there should be a positive relationship between the sound csr practices of an organisation and its share price returns (meznar et al., 1994; meznar et al., 1998; kumar et al., 2002; lamb et al., 2005; de klerk & de villiers, 2012)4. in other words, with an increased emphasis on the importance of non-financial metrics, an event which is perceived to impact negatively the csr practices of an organisation should lead to negative investor sentiment and a decline in share prices (cf. meznar et al., 1994; meznar et al., 1998; patten, 2002; de klerk & de villiers, 2012). the same should apply to the events leading up to the shooting of mineworkers on 16 august 2012. given the semi-strong form efficiency of the jse (glass & smit, 1995; choudhry, 1999; jefferis et al., 1999; magnusson & wydick, 2002), this event had a direct effect on lonmin’s operations (reuters, 2012c) and would have been taken into account by market participants when pricing the company’s shares (cf. malkiel & fama, 1970; brealey, myers & allen, 2008). the marikana incident may also have been indicative of labour relation problems in the platinum and south african mining sector as a whole (cf. frankel, 2012; lonmin, 2012), leading to a withdrawal from the sector in response to a perception of poor csr practices. before exploring the potential impact of the marikana incident on the share prices of south african platinummining companies, a brief background of the events taking place at marikana is provided. 2.3 the marikana incident the marikana incident is considered a significant event in south african history, with parallels drawn between the marikana shootings and the sharpeville and soweto uprisings of 1960 and 1976, respectively (sorensen, 2012). the event attracted significant attention from local and international media due to the number of casualties, as well as the historical sensitivity associated with the south african police service’s (saps’s) use of force (marinovich, 2012). marikana also evoked a response from the investor community, with many questioning whether the industrial unrest was indicative of widespread problems with labour relations and the beginning of the end of the south african mining industry (cawadas & mitchell, 2012). the marikana incident was the climax of a year of strike action in the south african mining industry. which witnessed the highest number of protests per month since the end of apartheid (mcclenaghan, 2012). unrest in the mining sector was first started by rock drill operators (rdos) at the impala platinum mine in january 2012 (chinguno, 2013). the mandate from the rdos was a wage increase of 200 per cent because of a decision made by management to award mine blasters an 18 per cent increase in retention allowances. the rdos wanted to prevent the involvement of their union – the national union of mineworkers (num) – which had taken the position that workers’ demands were unattainable. as such, they (the rdos) rejected any approach for representation by num and opted instead to form an independent committee to present their demands to management. this rejection of num allowed the association of mining and construction union (amcu) to emerge as a competitor in the industrial relations arena (onslow, 2012). trade union rivalry was, therefore, inseparable from the economic demands of the striking mineworkers. the strike gained notoriety because of acts of violence and levels of worker activism (onslow, 2012). additionally, it saw the demise of the old collective-bargaining process, which the workers perceived to be outdated and unable to meet their aspirations (cawadas & mitchell, 2012). management ultimately conceded to worker demands and offered a 22 per cent increase in the sajems ns 18 (2015) no 4:586-607 591 gross package (bond & mottiar, 2013), which, inadvertently, made wildcat strike action more attractive for workers and set a precedent for future wage dispute strategies (chinguno, 2013). born out of the success of the independent bargaining wage negotiations at impala mines, the workers at lonmin saw an opportunity for their own wage negotiations. this thinking was based on disillusionment with formal union representation (cawadas & mitchell, 2012; mcclenaghan, 2012). workers felt that wages were failing to meet their living costs, since stop-order loan repayment systems (microcredit lending facilities) (bateman, 2012) were significantly reducing their take-home pay (bond & mottiar, 2013). inspired by the previous strike action by mineworkers at the impala mine, workers at lonmin (in marikana) embarked on a wildcat strike on 10 august 2012 (marinovich, 2012). workers rejected attempts by num to mediate the conflict and followed the model of the lonmin strikers, forming independent committees to champion their cause (chinguno, 2013). lonmin management was aware of the failure of impala management to engage with the workers via the old collective-bargaining approach and, instead, elected to respond to the workers outside of the traditional negotiation framework. num disagreed with the process, something which angered workers, who felt that the union was interfering. clashes ensued between protesting workers and union officials, the first of which took place on 11 august 2012. marching strikers were met with gunfire from num members, resulting in the death of two workers (bond & mottiar, 2013). continuing unrest resulted in an increase in the police presence in the area. on 16 august 2012, the police units were deployed to move the striking miners from a hill where they had been gathering for a number of days. the police positioned barbed-wire fencing and fired tear gas in an attempt to disperse the striking workers. as the workers descended from their position, the saps opened fire on the miners, killing 34 and wounding an additional 78 (nkosi, 2012). the motives of the saps officers were unclear, but it has been suggested that one of the workers was carrying a pistol and fired the first shots, causing the saps to retaliate (bond & mottiar, 2013). in the aftermath of the incident, the marikana commission was established to investigate (evans, 2013; smith, 2013), but – at the time of analysing the data was yet to conclude its work (bond & mottiar, 2013). what the marikana incident has confirmed is that mining companies need to pay attention to csr initiatives and, in particular, strategies for managing labour relations (cf. frankel, 2012; lonmin, 2012). in the aftermath of the strike action, lonmin announced that industrial unrest had resulted in an immediate loss of 15 000 ounces of platinum production (reuters, 2012c). marikana has, as discussed above, also contributed to the growing status of wildcat strikes (mcclenaghan, 2012), something which may have an impact on investors’ assessment of operational risks in the platinum-mining industry. as the incident could be pointing to broader csr challenges, it is also possible that marikana resulted in a general withdrawal of investment and a short-term reduction in share prices across the jse’s platinum-mining sector. 3 method 3.1 event methodology event-study methodology is a forward-looking, generally accepted approach which identifies abnormal returns associated with a particular event (bowman, 1983; kothari & warner, 2006). economic models – such as those making use of the capital asset pricing model (sharpe, 1964; lintner, 1965) or arbitrage pricing theory (ross, 1976) – are not widely applied, as the benefit of enhanced accuracy seldom justifies the costs of using more complex statistical techniques (brown & warner, 1985; mackinlay, 1997). more common are the constant mean return and market model – which do not yield significantly different results from econometric models (brown & warner, 1985; chen & siems, 2004; corrado, 2011). mackinlay (1997) recommends the use of the market model, as it removes abnormalities in the return, associated with market variations, and incorporates a measure of systematic risk (fama, fisher, jensen & roll, 1969; corrado, 2011). the model has frequently been applied by more 592 sajems ns 18 (2015) no 4:586-607 recent event studies providing a comparative base of use (chen & siems, 2004; donnelly, 2008). in terms of this model, the expected return on a particular share at a specified time, using an equally weighted index (brown & warner, 1985), is given by equation 1: equation 1 𝑅!" = 𝑎 + 𝑏×𝑅𝑀! + 𝑒! rit and rmit are the returns on a specified share and the return of the overall market at time (𝑡). this method removes the effect of the economy-wide (market) returns on the stock (i), while dissecting just the return related to firm-specific information. the firm-specific return isolated from that of the market is et. the market model parameters of a (the excess of return, relative to a specific benchmark index) and b (the measure of correlation in change of a specified share in relation to a designated index) are determined by ordinary least squares regression of firm-returns rit and market rmit over a defined estimation window (brown & warner, 1985; kothari & warner, 2006; corrado, 2011). it is assumed that these coefficients will remain constant during the event and estimation windows (binder, 1998). the abnormal return (arits) determined as the difference between the predicted return and the actual return (brown & warner, 1980). the cumulative abnormal return (car) is then computed by aggregating the difference between the actual and expected returns over the event window and, in theory, provides a measure of the sustained impact of the marikana incident on the returns of platinum-mining companies (cf. harvey & sticht, 2014) under the assumption that the jse is semi-strong form efficient. the cross-sectional mean abnormal return for 𝑁 securities over a multiperiod interval (t1,t2) is determined using equation 2 (fama et al., 1969; kothari & warner, 2006): equation 2 𝐶𝐴𝑅(!!,!!) = 𝐴𝑅! !! !!!! the main hypothesis, in the null form, is that the marikana incident should have had no impact on abnormal returns, given that the market was at least semi-strong form efficient (bhana, 2007). this is consistent with the fact that wage negotiations between south african mining houses and labour usually take place during the months of june to august. the financial effects of the marikana strike action (which occurred during the traditional “strike season”) would, therefore, have already been taken into account by market participants. the first hypothesis is supplemented by two additional hypothesis tests dealing with the cumulative abnormal returns over threeand five-day periods (adapted from chen & siems, 2004). these hypotheses are stated as follows: (1) h1: art = 0 ha: art ≠ 0 (2) h2: cart+2 = 0 ha: cart+2 ≠ 0 (3) h3: cart+5 = 0 ha: cart+5 ≠ 0 to determine the significance of event-date abnormal returns (h1) and the cumulative abnormal returns three (h2) and five days (h3) after the event, the t-tests proposed by patell (1976), kothari and warner (2006), and mackinlay (1997) are used. the null hypotheses (that abnormal and cumulative abnormal returns on the event date have an expected value of zero during the event period) are rejected if the test statistics exceed a critical value below a 5 per cent level of significance (kothari & warner, 2006; capelle-blancard & laguna, 2010). this threshold is widely accepted in event-study methodology literature as an appropriate level of confidence for accepting or rejecting the null hypothesis and minimising the possibility of a type i error (rejecting a null hypothesis that is actually true) (kothari & warner, 2006; capelle-blancard & laguna, 2010). the sign and rank test for event studies proposed by corrado (1989) is used to sajems ns 18 (2015) no 4:586-607 593 supplement the parametric t-tests. the sign and rank test is regarded as more robust when there are deviations from normality, data outliers and date-variance increases (donnelly, 2008; kolari & pynnönen, 2010; corrado, 2011)5 and is important for confirming the initial results from the ttests. nevertheless, it must be stressed that event methodology does not prove a causal relationship between an event and changes in share prices. while this is an inherent limitation of noneconometric techniques, the chosen market model is useful for highlighting trends in share prices over a defined event period to enable additional, albeit normative, analysis by researchers. 3.2 population, sample and data the expected, abnormal and cumulative abnormal returns were determined for all companies listed on the jse’s mining index during the period 1 january 2012 to 23 august 2012 (i.e. a period of five days’ trading after the marikana incident). share prices and daily volume trades were obtained from the bloomberg database for the observation period and were adjusted for the effects of share splits, rights issues and share consolidations. a total of 54 companies were included in the analysis. the small sample size makes generalisation of the findings problematic and is an inherent limitation of the study given the limited number of mining companies listed on the jse6. at this point, it should also be noted that the study does not concentrate on all companies listed on the jse in order to avoid the risk of additional variables contributing to abnormal returns (if any). instead, the research is focused on examining the possible connection between share prices of platinum-mining companies and marikana due to the fact that the strike directly impacted the country’s platinum producers (cf. lonmin plc, 2012; nkosi, 2012). 3.3 test period the test period is divided into two sections: the estimation window and the event window. the complete test period begins on 3 january 2012 (beginning of the 2012 trading year) and runs for 145 trading days (up until 31 july 2012). this period is consistent with that used by chen and siems (2004) and should provide a sufficiently long period for the determination of expected and abnormal earnings (donnelly, 2008). it should, however, be stressed that the relatively short event period means that the long-term implications of the marikana incident are not addressed and must be deferred for future research. the event window begins on 16 august 2012 (the date of the marikana incident), defined as 𝑡!, and runs for a period of five days subsequent to the event (t+5) for a total window of six days (adapted from chen & siems, 2004; bhana, 2005; bhana, 2006). this is consistent with the event window used in comparable studies (chen & siems, 2004; donnelly, 2008) and is in line with the recommendation that long time horizons be avoided to improve the reliability of the findings (kothari & warner, 2006; sprenger, sandner, tumasjan & welpe, 2014). although a longer event window is preferred in order to address the problems posed by thin trading, this increases the risk of developments, other than those under review, impacting returns and obscuring results. to address thin trading, the researchers also ensured that none of the companies included in the test reported a zero share price movement during the event period (donnelly, 2008). 4 results 4.1 abnormal returns (ars) and cumulative abnormal returns (cars) table 1 shows the ars and cars for each platinum-mining company listed on the jse. the ars are calculated on the date of the marikana incident and the cars are calculated at both two-day and five-day intervals post the event. abnormal returns which are significant at the 10 per cent, 5 per cent or 1 per cent level (per the t-tests) are marked with an asterisk. 594 sajems ns 18 (2015) no 4:586-607 table 1 platinum-mining sector share code company name ar cars 3-day cars 6-day ams anglo american plat ltd −1.008% −1.126% 2.871% aqp aquarius platinum ltd 0.973% 6.242% 19.932%* atl atlatsa resources corp. −11.122% 3.128% 7.479% bau bauba platinum ltd 0.166% −16.279% 1.657% eps eastern platinum ltd −8.076% −6.534% 3.981% imp impala platinum holdings ltd −1.642% 1.351% 2.462% jbl jubilee platinum plc 0.198% 2.336% −0.190% lon lonmin plc −8.402%*** -−10.856%* −7.302%* nhm northam platinum ltd −2.480% −1.703% 6.324% pll platfields ltd −29.524% 1.469% 0.456% rbp royal bafokeng platinum ltd −2.236%* −4.239%* −4.976%* wez wesizwe platinum ltd −2.997% 0.186% 12.166% *significant at a 90% confidence level; **significant at a 95% confidence level; ***significant at a 99% confidence level table 1 shows that only lonmin experienced a significant abnormal return on the date of the incident. the cars three and six days after the event are only significant at the 10 per cent level. as the initial results in table 1 suggested that the marikana incident had a limited effect on the platinum mines, the researchers decided to confirm this by running the event-method tests described in section 3 for all companies included in the jse’s mining sector (see appendix a). table 2 shows only those mining houses which experienced significant abnormal returns (ars) on the event date or showed a significant three-day or six-day cumulative abnormal return (“cars 3day” and “cars 6-day”) after the event. the t-test values are shown in brackets below the abnormal return results. table 2 summary of significant results company name mining sector ar cars 3-day cars 6-day wesizwe platinum ltd plat. −2.997% (−0.91) 0.186% (0.03) 12.166%* (1.50) pan african resources plc gold 2.466%* (1.82) −6.460%* (−2.76) −2.619% (−0.78) keaton energy holdings ltd coal −1.667% (−0.62) −5.046% (−1.09) −12.268%* (−1.85) royal bafokeng platinum ltd plat. −2.236%* (−1.71) −4.239%* (−1.87) −4.976%* (−1.54) coal of africa ltd coal −1.220% (−0.44) −4.686% (−0.97) −10.346%* (−1.50) central rand gold ltd gold 20.696%** (2.27) 29.555%* (1.87) 12.841% (0.57) great basin gold ltd gold −20.171%*** (−4.29) −19.151%* (−2.35) −13.007% (−1.12) aquarius platinum ltd plat. 0.973% (0.27) 6.242% (1.00) 19.932%* (2.23) randgold & exploration company ltd gold −0.260% (−0.05) −24.230%* (−2.67) −24.786%* (−1.91) harmony gold mining company ltd gold 1.516% (0.86) −10.177%* (−3.32) −4.116% (−0.94) northam platinum ltd plat. −2.480% (−1.64) −1.703% (−0.65) 6.324%* (1.69) lonmin plc plat. −8.402%*** (−5.74) −10.86%* (−4.28) −7.302%* (−2.01) petmin ltd iron −0.172% (−0.09) −4.378% (−1.35) −8.850%* (−1.92) *significant at a 90% confidence level; **significant at a 95% confidence level; ***significant at a 99% confidence level sajems ns 18 (2015) no 4:586-607 595 as shown in table 2, of the platinum-mining companies, only lonmin experienced abnormal returns which were significant at the 1 per cent level. the only other mining company with significant abnormal returns at this level was great basin gold ltd (gbg) (discussed in detail in section 5). these results were confirmed by non-parametric testing. the sign test statistic measures the significance of the signs of the population tested in terms of the event date (ar) and the event windows for two (car 3) and five days post the event (car 6) (appendix b). the rank test was then applied across the entire population for the duration of the event window (car 6). the untabulated results were not significant when compared with the entire population of companies listed in the jse mining sector. taken together, the information presented in table 1 and table 2 suggests that the marikana incident had a limited impact on the south african mining industry. for robustness, the researchers expanded the test to consider all companies listed on the jse. comair ltd (which was entering business rescue) was the only other company with a significant ar (at the 1 per cent level)7. in addition, table 3 shows only five listed companies (out of 432 observations) with significant threeand six-day cars using a 99 per cent confidence interval. table 3 significant cars: all companies company cars 3-day test statistic cars 6-day test statistic african & overseas ent-n shs −0.15144 13.67021 buildmax ltd 0.074174 −5.02571 silverbridge holdings ltd −0.07571 −9.86149 ah-vest ltd 8.257911 6.854913 african eagle resources plc −6.63171 −4.59455 as a final check on the limited impact of the marikana incident, the researchers tested the net equity sales to or from foreign investors (denominated in usd) for significance. the untabulated results show significant cash outflows (at the 1 per cent level) only on the event date. similarly, while there was a net sale of south african bonds by foreign investors on the date of the marikana incident (untabulated), significant cash flows were only reported the day after the incident (and then only at the 5 per cent level). despite these robustness tests, it is important to note a key limitation of the event method discussed above before proceeding with an analysis of the results. in addition to using short time periods to avoid incorporating the effect of additional information on share prices (section 3), event studies typically include multiple events of the same type. this addresses the risk of unrelated developments resulting in a significant statistical relationship under the assumption that confounding news emerges randomly (cf. chen & siemens, 2004; bhana, 2007). in this case, there are no suitable comparable events and the discussion below must be read in the light of this inherent limitation. 5 discussion the event methodology does not test for a causal relationship between a specific event and the share price. nevertheless, the significance of the t-test statistics – coupled with the fact that lonmin employees were directly involved in the marikana incident – makes it reasonable to conclude that the event had a significant negative impact on the company’s share price. abnormal returns on the event date (16 august 2012) are significant at the 1 per cent level. the abnormal return is strongly negative, with an 8.42 per cent abnormal return observed for lonmin on the day of the marikana incident. over a single trading day, from 15 to 16 august 2012, the share price declined 7.34 per cent from r90.33 to r83.70 (bfa mcgregor database). this went hand in hand with a high volume of trade volatility where the event date volume traded was 253 per cent of the average volume of the trades over the estimation window (appendix c). 596 sajems ns 18 (2015) no 4:586-607 what is less expected is the absence of significant results for the remaining platinum and other mining companies listed on the jse. a notable exception is gbg, which was the only other company to report abnormal returns at the 1 per cent level (table 2). this company also reported the highest volume of share trades at 734 per cent (appendix c). a review of the financial press by the researchers highlighted no direct links to the marikana incident but did reveal that the company was in the process of applying for business rescue (reuters, 2012a). although the event method was not expanded to test for the statistical relevance of the announcement of goingconcern challenges, it would be reasonable to conclude that looming business rescue was a likely determinant of the share price, rather than the marikana incident which, as per appendix a, did not appear to have a widespread significant impact at the 1 per cent level. this was confirmed by a rank test (appendix c) which identified the abnormal returns of lonmin and gbg as the most significant at the 1 per cent level. positive abnormal returns, significant at a 95 per cent confidence level, were also experienced by central rand gold ltd. these were not expected, given the adverse nature of the marikana incident (table 2). a review in the financial press suggested that this was the result of the release of favourable analyst reports (stanley, 2012). as with gbg, this company was not directly involved in the marikana incident and is not a platinum producer. together with the fact that there were no other mining companies which reported significant abnormal returns at the 1 per cent level (appendix a), this finding implies a limited reaction to marikana by investors. although some companies experience significant abnormal returns at the 10 per cent level, this was regarded as insufficient for the purpose of concluding that the marikana incident was meaningfully correlated with the returns quoted by these companies (cf. kothari & warner, 2006; capelle-blancard & laguna, 2010). this is consistent with the findings from the t-tests on the cars for the threeand six-day periods. results were only significant at the 10 per cent level (table 3) and were also regarded as inadequate for drawing conclusions regarding the correlation between the marikana incident and the abnormality of reported cumulative returns (cf. kothari & warner, 2006; capelle-blancard & laguna, 2010). therefore, it appears that the marikana incident had little effect on the returns of the south african mining sector as a whole. this was corroborated by a sign and rank test (appendix b) applied to the entire population of mining companies on the event date. the relevant test statistics are not significant at the 1 per cent or 5 per cent level, implying that the mining sector did not treat this event as significant. this is consistent with the fact that – as discussed in section 4 – there was no significant net sale of south african equities and bonds by foreign investors post 16 august 2012. once again, only lonmin reported a significant change in returns which appeared to be related to the marikana incident, albeit that the effect was limited to a short time period (the cars are only significant at a 10 per cent level). a possible explanation for this is the containment measures which the company implemented in order to mitigate initial losses (cf. lonmin plc, 2012). in particular, an announcement by lonmin’s management on 20 august 2012 (four days post the event) of a rights issue could have contributed to a partial recovery of the share price (reuters, 2012b). although the exact amount of the recovery caused by the rights announcement was not determinable from the event method applied, a general recovery of the car from the original event date to the six-day car (ar: −8.402 per cent; car three-day: −10.86 per cent; car six-day: −7.302 per cent) was noted. a possible explanation of why the marikana incident did not adversely affect other mining companies (table 1; appendix a) is that the south african mining sector had already seen strike action before the event date (mcclenaghan, 2012). a wildcat strike broke out at lonmin’s mines on 10 august 2012 and on 11 august 2012 (five days before the event date), and the company applied for a court interdict giving workers until 16 august 2012 to return to their posts (nkosi, 2012; bond & mottiar, 2013). consequently, labour unrest had already been taken into account when pricing the equity instruments of the south african mining organisations given that the jse was at least semi-strong form efficient (glass & smit, 1995; choudhry, 1999; jefferis et al., 1999; magnusson & wydick, 2002). therefore, the researchers decided to expand the analysis by testing sajems ns 18 (2015) no 4:586-607 597 for abnormal returns five days before the marikana incident. table 4 shows companies with fiveday cars significant at the 5 per cent and 1 per cent level. (for robustness, the cars were calculated for all companies included on the jse). table 4 summary of significant results pre marikana row labels car 5 days pre marikana significant at the 95% confidence level? significant at the 99% confidence level? included in the mining sector? resilient property income −5.04% yes no no allied electronics cor-a shr 10.95% yes no no mas real estate inc −6.19% yes no no rebosis property fund ltd −14.18% yes no no pan african resources plc 9.69% yes no no synergy income fund ltd-b −3.74% yes no no african & overseas ent-n shs −3.12% yes no no sb copper etn 13.59% yes no no newwave pound sterling etn 13.79% yes no no great basin gold ltd −58.70% yes no yes alert steel holdings ltd 72.86% yes no no pan african resources plc and gbg were the only mining companies reporting cars for a fiveday period before the event date which were significant at 5 per cent, but only gbg experienced a significant abnormal return at the 1 per cent level. this would suggest that earlier strike action five days before marikana did not have a material effect on the south african mining industry. in turn, this implies that it was only the unusually violent nature of these worker demonstrations which was taken into account by the market. in addition, many of the happenings on 16 august 2012 were associated directly with lonmin. other mining houses were not directly involved in the worker unrest and shootings on that day (see evans, 2013; smith, 2013). this also sheds light on why the cars (post the event) are only significant at the 10 per cent level (table 3) and why there was no significant sale of south african equities and bonds by foreign investors post 16 august 2012 (section 4). although the marikana incident was an extraordinary event, it did not, as such, have a prolonged effect on share returns (see chen & siems, 2004). a more optimistic (and very normative) assessment is that, paradoxically, the marikana incident was a vote of confidence in the south african mining industry. limited social responsibility practices (including labour relations) were a possible factor contributing to the marikana incident8. in line with the findings of de klerk and de villiers (2012), investors – interpreting the incident as a possible indicator of limited csr practices – may have chosen to revise their projected earnings, leading to a significant reduction in the share price of affected companies (cf. king, 2012; solomon & maroun, 2014). with the jse being only semi-strong form efficient, the initial adjustment to the share price was imperfect (cf. malkiel & fama, 1970) and was revised over the six days following the event, leading to a reduction in cumulative abnormal returns (table 1). the importance of csr for the south african mining sector is, however, not a recent phenomenon, with the mining industry taking significant steps to improve its esg practices (hamann, 2004; carels, maroun & padia, 2014). although there is room for improvement (hamann & kapelus, 2004), king-iii and the integrated reporting initiative have served to reiterate the importance of csr-related matters for the country’s mining houses, including the effective and ethical management of labour (solomon & maroun, 2012; carels et al., 2014). when the happenings of 16 august 2012 make the news and the effect on mining company’s share prices is limited, this suggests that investors had confidence in the csr policies of the sector as a whole. for markets which are at least semi-strong form efficient, investors are predicted to react to new 598 sajems ns 18 (2015) no 4:586-607 information by adjusting their assessment of the current and future prospects, not just of lonmin, but for all mining companies listed on the jse (cf. fama et al., 1969). had investors felt that poor labour relations (and social responsibility practices) were widespread, and that the marikana incident was indicative of a more pervasive challenge to the mining industry, the market would have reacted by discounting the price of all shares in the mining sectors. similarly, there would have been a significant and prolonged exit of foreign investors from the south african bond and equity markets. this was, however, not the case (section 4). accordingly, marikana does not appear to have characterised the relationship between the mining houses and labour in the long term, suggesting that the efforts at good corporate governance in south africa’s mining industry are having a positive effect. 6 conclusion the objective of this paper was to examine the potential effect of the marikana incident on the share prices of mining companies listed on the jse. labour unrest, culminating in the death of several mineworkers on 16 august 2012, made both local and international news and led to a material decline in the price of lonmin shares. the unprecedented violence (post democracy) also led some to questioning whether the marikana incident marked the beginning of the decline of south africa’s legendry mining industry (cawadas & mitchell, 2012). the findings of this study suggest that this was not the case. although event methodology cannot be used to prove a causal relationship, lonmin was directly affected by the event under review. the company’s staff were involved in labour unrest and the mine reported significant lost production because of the strike action. as a result, it is reasonable to conclude that the significant decline in share price (and level of cumulative abnormal returns) was a result of the marikana incident. the event has not, however, had a prolonged effect on the company’s share price, as indicated by the threeand six-day cars, which are not significant at the 1 per cent and 5 per cent level. similarly, the cars and results from a sign and rank test confirm that the platinum and entire mining sector did not treat the event as a significant incident, with only two gold-mining companies reporting variances which were significant at the 1 per cent or 5 per cent level. in both instances, a review of the financial press suggested that it was more likely that these variances were attributable to factors other than the event under review. this research also offered possible explanations for the lack of sustained and widespread market reaction to the marikana incident. most notably, labour disputes are not uncommon in the south african mining industry. given that the jse is semi-strong form efficient, the probability of strike action would have already been included in share prices. in other words, the market was reacting only to the unexpected (and short-lived) violence which erupted. the results of this study may also be interpreted as a vindication of the csr initiatives of the south african mining sector as a whole. carels et al. (2014) and solomon and maroun (2012; 2014) propose that there has been a concerted effort by south african mining companies to manage actively their social, environmental and ethical obligations. although there is still room for improvement (hamann, 2004; carels et al., 2014), the absence of significant and abnormal and cumulative abnormal returns implies that investors have confidence in the csr initiatives of the mining industry and do not regard marikana as an indicator of a widespread csr crisis in the south african mining sector. the researchers acknowledge that this conclusion is very normative and not supported by an econometric analysis of the value relevance of csr and the extent to which this may have offset the market’s initial reaction to marikana. this is an inherent limitation of the study. nevertheless, it is submitted that the positive assessment of governance practices by the mining houses is, at the very least, a plausible explanation for why share prices did not lose significant value in the immediate aftermath of marikana. in the light of this, the paper makes an important contribution, not by quantifying the financial impact of investors’ perceptions of csr, but by adding to the debate on the importance of these sajems ns 18 (2015) no 4:586-607 599 practices for organisational sustainability. additional research will be needed to reach more definitive conclusions. most notably, more needs to be done to understand the extent to which csr reporting and disclosure impacts share prices, given the limited south african-specific research and the mixed results from international studies (cf. de klerk & de villiers, 2012). this should be complemented by more rigorous statistical modelling of the multiple variables which may have contributed to changes in the share price immediately after the marikana incident, and how these variables impacted the share price over a longer time period. as part of this assessment, the relevance of the country’s sociopolitical context, including significant levels of poverty, cannot be overlooked (cf. lonmin plc, 2012). the research also stops short of carrying out detailed interviews with key stakeholders to highlight more clearly the views on the relevance of the marikana incident. it would be very interesting to ask analysts how exactly they adjusted their investment strategies in response to marikana, and what impact the event has had on their assessment of the mining houses’ prospects. this should be complemented by detailed interviews with representatives from lonmin and worker unions in order to reach a more informed conclusion on the state of labour relations in south african mining and the relevance of csr practices on the part of the leading mining houses. endnotes 1 we concentrate on companies included in the platinum-mining sector, given the direct impact of the strike action on lonmin plc, the world’s third-largest producer of platinum. 2 we say “suggest” to emphasise the normative tone of this statement. we offer effective csr strategies as a possible explanation for any null finding (section 5), but cannot state that there is a causal relationship between csr and share prices or that effective csr resulted (in a positivist sense) in a limited market reaction to marikana. 3 no statistically significant correlations are to be found on the date of the withdrawal announcements, but the cumulative abnormal returns are significantly negative over 41-, 31-, 21and 13-day periods (meznar et al., 1994). 4 it is possible that impression management influences the value relevance of crr, which may be disconnected from actual sustainability practices. exploring this line of thinking is, however, beyond the scope of this research. 5 owing to the fact that the entire population of mining companies was tested, cross-sectional variance adjustments to the test data were deemed unnecessary (corrado, 2011). 6 the isolated nature of the incident also negates the need for testing the entire population of jse-listed companies. similarly, the fact that only a limited number of companies reported statistically significant changes in share prices during the event period meant that testing for the effect of company-specific variables (such as company size, composition of the board, length of trading, and reported results) was not necessary. 7 the ib top40 tri etn oct17 and bettabeta eq weight top40 reported signif-icant ars at the 1% level. exchange-traded notes, exchange-traded funds and indices were, however, excluded from the analysis. as they would indirectly include the effects of changes in share prices on the underlying assets. 8 the researchers would like to stress that factors contributing to the marikana incident were very complex. we are suggesting that possible csr practices (including labour relations challenges) at lonmin may have contributed to the events taking place on 16 august 2012. it is not, however, our intention to make normative 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resources ltd −0.171% −0.880% −1.516% keh keaton energy holdings ltd −1.667% −5.046% −12.268%* rbp royal bafokeng platinum ltd −2.236%* −4.239%* −4.976%* cza coal of africa ltd −1.220% −4.686% −10.346%* fse firestone energy ltd −0.615% 0.667% −12.112% vil village main reef ltd −0.188% −3.481% −0.548% cmo chrometco ltd 0.302% −13.187% −12.321% eps eastern platinum ltd −8.076% −6.534% 3.981% mmh miranda mineral holdings ltd 4.588% 5.305% −0.011% bdm buildmax ltd −7.772% −7.575% −0.939% crd central rand gold ltd 20.696%** 29.555%* 12.841% dmc diamondcorp plc 0.852% 1.024% 3.067% fseo1 firestone energy ltd 1.126% 1.039% 3.633% fmc forbes and manhattan coal corp. 0.712% 0.830% 2.527% hwa hwange colliery company ltd 0.636% 0.438% 1.852% pzg pamdzi gold ltd 0.000% 0.000% 0.000% gbg great basin gold ltd −20.171%*** −19.151%* −13.007% jbl jubilee platinum plc 0.198% 2.336% −0.190% ira infrasors holdings ltd −8.261% −13.245% −5.383% rdi rockwell diamonds inc. 0.117% 0.516% 0.923% bil bhp billiton plc 0.651% 2.010% 2.155% exx exxaro resources ltd −2.465% −0.632% −2.585% aqp aquarius platinum ltd 0.973% 6.242% 19.932%* sah south african coal mining holdings 0.909% 3.499% 1.146% kbo kibo mining plc 0.740% 1.734% 0.374% uuu uranium one inc. 5.151% 6.549% 6.517% pll platfields ltd −29.524% 1.469% 0.456% ggm goliath gold mining ltd −0.204% 0.318% −2.513% 1 randgold & exploration company ltd −0.260% −24.230%* −24.786%* rsg resource generation ltd 0.000% 0.000% 0.000% bau bauba platinum ltd 0.166% −16.279% 1.657% wsl wescoal holdings ltd. 1.045% −2.421% −3.659% taw tawana resources nl −0.643% −0.880% −2.457% wgr witwatersrand consolidated gold resources −0.157% 1.011% 1.037% sep sephaku holdings ltd 0.753% 3.181% 1.476% tsx trans hex group ltd −1.452% 2.926% −3.515% drd drdgold ltd −1.144% 1.130% 1.061% gdo gold one international ltd −2.507% 0.169% −0.982% ang anglogold ashanti ltd 2.436% 2.009% 1.589% har harmony gold mining company ltd 1.516% −10.177%* −4.116% gfi gold fields ltd 1.379% 0.798% 0.599% sajems ns 18 (2015) no 4:586-607 605 share code company name ar cars 3-day cars 6-day imp impala platinum holdings ltd −1.642% 1.351% 2.462% nhm northam platinum ltd −2.480% −1.703% 6.324%* ams anglo american plat ltd −1.008% −1.126% 2.871% agl anglo american plc 0.403% 0.876% 2.262% ari african rainbow minerals ltd 1.811% 1.379% −0.911% asr assore ltd −0.485% 2.971% 5.035% mrf merafe resources ltd −0.191% 0.406% 0.161% lon lonmin plc −8.402%*** −10.86%* −7.302%* atl atlatsa resources corp. −11.122% 3.128% 7.479% pet petmin ltd −0.172% −4.378% −8.850%* snu sentula mining ltd 0.082% 0.611% −2.008% *significant at a 90% confidence level; **significant at a 95% confidence level; ***significant at a 99% confidence level appendix b sign and rank tests table b1 sign t-tests company name 𝒑 ar car 3 car 6 wesizwe platinum ltd. 0.57931 − + + pan african resources plc 0.468966 + − − delrand resources ltd 0.055172 − − − keaton energy holdings ltd 0.627586 − − − royal bafokeng platinum ltd 0.482759 − − − coal of africa ltd 0.544828 − − − firestone energy ltd 0.468966 − + − village main reef ltd 0.510345 − − − chrometco ltd 0.772414 + − − eastern platinum ltd 0.482759 − − + miranda mineral holdings ltd 0.510345 + + − buildmax ltd 0.4 − − − central rand gold ltd 0.593103 + + + diamondcorp plc 0.717241 + + + firestone energy ltd 0.696552 + + + forbes and manhattan coal corp. 0.717241 + + + hwange colliery company ltd 0.641379 + + + great basin gold ltd 0.496552 − − − jubilee platinum plc 0.517241 + + − infrasors holdings ltd 0.503448 − − − rockwell diamonds inc. 0.931034 + + + bhp billiton plc 0.475862 + + + exxaro resources ltd 0.510345 − − − aquarius platinum ltd 0.572414 + + + uranium one inc. 0.475862 + + + platfields ltd 0.531034 − + + goliath gold mining ltd 0.475862 − + − randgold & exploration company ltd 0.365517 − − − bauba platinum ltd 0.77931 + − + wescoal holdings ltd 0.42069 + − − tawana resources nl 0.262069 − − − witwatersrand consolidated gold resources 0.593103 − + + sephaku holdings ltd 0.455172 + + + trans hex group ltd 0.482759 − + − 606 sajems ns 18 (2015) no 4:586-607 company name 𝒑 ar car 3 car 6 drdgold ltd 0.524138 − + + gold one international ltd 0.6 − + − anglogold ashanti ltd 0.489655 + + + harmony gold mining company ltd 0.475862 + − − gold fields ltd 0.468966 + + + impala platinum holdings ltd 0.489655 − + + northam platinum ltd 0.537931 − − + anglo american plat ltd 0.489655 − − + anglo american plc 0.510345 + + + african rainbow minerals ltd 0.489655 + + − assore ltd 0.503448 − + + merafe resources ltd 0.489655 − + + lonmin plc 0.489655 − − − petmin ltd 0.475862 − − − sentula mining ltd 0.544828 + + − w 22 28 24 𝒏𝒑 0.524419 generalised sign test statistic −1.057419484 0.658914 −0.48531 table b2 rank tests 2012/08/16 2012/08/17 2012/08/20 2012/08/21 2012/08/22 2012/08/23 wesizwe platinum ltd 23 138 40 126 127 149 pan african resources plc 145 1 4 129 149 59 delrand resources ltd 108 41 53 134 143 9 keaton energy holdings ltd 28 125 9 61 26 6 royal bafokeng platinum ltd 11 62 12 17 103 95 coal of africa ltd 45 73 15 30 66 19 firestone energy ltd 60 32 128 45 103 24 village main reef ltd 70 76 14 145 53 32 chrometco ltd 103 57 7 122 54 106 eastern platinum ltd 4 121 54 130 27 147 miranda mineral holdings ltd 134 98 87 41 101 15 buildmax ltd 6 145 13 38 150 17 central rand gold ltd 148 61 126 109 3 95 diamondcorp plc 109 41 56 136 39 112 firestone energy ltd 109 42 56 135 39 111 forbes and manhattan coal corp. 110 41 56 136 38 114 hwange colliery company ltd 108 44 56 132 41 110 great basin gold ltd 1 17 137 87 138 66 jubilee platinum plc 77 87 113 3 125 112 infrasors holdings ltd 10 25 49 41 147 57 rockwell diamonds inc. 47 114 99 21 117 44 bhp billiton plc 116 146 68 49 89 102 exxaro resources ltd 7 145 51 107 73 5 aquarius platinum ltd 86 148 43 149 61 146 uranium one inc. 141 129 41 19 139 46 platfields ltd 7 94 146 41 95 57 goliath gold mining ltd 55 105 98 34 108 14 randgold & exploration company ltd 55 107 1 39 109 52 bauba platinum ltd 55 3 95 148 27 128 wescoal holdings ltd 96 36 56 99 54 58 tawana resources nl 44 110 96 16 113 40 sajems ns 18 (2015) no 4:586-607 607 2012/08/16 2012/08/17 2012/08/20 2012/08/21 2012/08/22 2012/08/23 witwatersrand consolidated gold resources 53 108 97 28 109 50 sephaku holdings ltd 94 105 95 37 108 54 trans hex group ltd 47 138 62 79 121 2 drdgold ltd 44 137 55 42 77 109 gold one international ltd 16 142 42 31 110 40 anglogold ashanti ltd 139 136 14 130 46 39 harmony gold mining company ltd 121 2 1 148 114 107 gold fields ltd 126 123 17 38 82 110 impala platinum holdings ltd 17 138 124 112 96 57 northam platinum ltd 8 97 90 56 144 151 anglo american plat ltd 30 12 139 127 104 141 anglo american plc 101 61 117 130 8 148 african rainbow minerals ltd 142 73 62 47 29 46 assore ltd 53 99 145 27 105 143 merafe resources ltd 66 94 87 26 44 138 lonmin plc 1 106 4 133 10 150 petmin ltd 70 49 7 36 16 40 sentula mining ltd 87 121 36 12 34 128 average rank 68.02 85.81 62.71 76.69 81.91 77.55 population mean rank 76 d 151 generalised rank test statistic −0.875769667 appendix c volume of shares traded the volume of daily share trades serves as an indicator of the level of active trading (responsiveness) and can provide insight into the quality of information transferred by share price changes (blume, easley & o’hara, 1994). presented in table c is the volume of trade of those shares which experienced significant abnormal returns at the 90 per cent confidence level or above (table 3). the table shows an average volume of shares traded per day over the event window (145 days). the volume of shares traded on the date of the marikana incident is also provided. the final column shows the event-date volume of shares traded as a percentage of the average shares traded during the estimation window. table c event volumes of shares traded company name mining sector average shares traded during estimation window (a) event date (b) b/a wesizwe platinum ltd plat. 664 173 613 045 92% pan african resources plc gold 2 311 713 870 972 38% keaton energy holdings ltd coal 74 095 6 870 9% royal bafokeng platinum ltd plat. 88 155 3 279 4% coal of africa ltd coal 688 332 67 208 10% central rand gold ltd gold 350 088 1 000 0% great basin gold ltd gold 68 831 505 476 734% aquarius platinum ltd plat. 840 481 249 322 30% randgold & exploration company ltd gold 9 906 0 0% harmony gold mining company ltd gold 1 451 072 634 351 44% northam platinum ltd plat. 978 508 867 466 89% lonmin plc plat. 795 811 2 011 243 253% petmin ltd iron 568 745 314 746 55% abstract introduction literature review methods model specification key findings conclusion acknowledgements references appendix 1 about the author(s) roscoe b. van wyk university of stellenbosch business school, university of stellenbosch, south africa cliff s. dlamini university of stellenbosch business school, university of stellenbosch, south africa citation van wyk, r.b. & dlamini, c.s., 2018, ‘the impact of food prices on the welfare of households in south africa’, south african journal of economic and management sciences 21(1), a1979. https://doi.org/10.4102/sajems.v21i1.1979 original research the impact of food prices on the welfare of households in south africa roscoe b. van wyk, cliff s. dlamini received: 09 june 2017; accepted: 09 nov. 2017; published: 09 apr. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background and setting: the global food price surge of 2006 to 2008 has negatively impacted south african households. rising food prices adversely affect food security in south africa. the ever-increasing prices for food commodities and lack of access to finance make it very difficult to strengthen food security amongst households in south africa. aim: the aim of the study is to examine the impact of food prices on household welfare in south africa. additionally, the study attempts to analyse the shortand long-run relationship between food prices and household welfare in south africa. this is done by determining how real household welfare responds and/or reacts whenever there is a shock in food prices and its fundamental determinants. finally, the study attempts to distil recommendations toward a conceptual framework for the mitigation of the impact of high food prices on households in south africa. method: the vector error correction modelling (vecm) technique is utilised to estimate a regression model. results: the results reveal that a 1% increase in food prices would reduce household welfare by 21.3%. the study, therefore, confirms a negative correlation between food prices and welfare. conclusion: short-run policy recommendations include: (1) subsidising staple food baskets for households in south africa, (2) reducing prices of staple foods through the reduction of food tariffs and (3) reducing household expenditure on basic needs through subsidisation. these policy options could lessen the burden on households when there is a rise in the prices of staple food sources and therefore improve household welfare. long-run policy recommendations include: (1) improving the unemployment rate in south africa and (2) improving access to finance and credit for south african households. by addressing the rising unemployment rates and improving access to finance and credit in south africa through job creation initiatives and improving micro-credit strategies, an environment can be created where households improve their disposable income. introduction rising food prices have an adverse effect on food security in south africa. the literature thus suggests that food insecurity has been a major contributing factor to poverty in south africa (bonti-ankomah 2001; du toit 2011; van der merwe 2011). the global and national food price surge of 2006 to 2008 had a negative impact on south african households. according to maunder and wiggins (2007), rising food prices came at a time when south africa was experiencing a chronic food security crisis and the population was extremely vulnerable to food insecurity. the ever increasing prices of food commodities and the lack of access to finance make it very difficult to strengthen food security among households in south africa. global trends suggest that food prices will increase year on year and thus affect the welfare of households. according to attanasio et al. (2013:136), the considerable rise in global food prices over the last decade has concerning effects on the welfare of poorer households. the instability caused by price hikes is not a short-term problem and can have a lasting effect on poverty. whether the consumers are poor or wealthy, the amount and quality of a consumer’s food basket depend on its affordability, related to the consumer income. south african households depend on household income for consumption. according to ssebagala (2016:1), rising living costs have caused south african households to focus more on utilisation of income for consumption expenditure instead of savings. survey data have indicated that south african household consumption expenditure was recorded at an average of r16 122 per month (statistics south africa 2016:177). in view of the vast income inequality and limited food sources, south african households are unable to satisfy their unlimited want for food commodities from their limited financial resources. according to the world bank (2010:1), rising food prices not only affect macroeconomic stability, but also the welfare of net buyers of food, which impact significantly on poorer households that use a larger proportion of income for food spending. the overall aim of the study is to establish the relationship between household welfare and food prices in south africa and what measures can bring about sustainable food prices in south africa. the primary objective of this study is to examine the impact of food prices on household welfare in south africa covering the period of 1990 to 2015. the sub-objectives related to the primary objective are: to examine the relationship between food prices and household welfare in south africa by determining how real household welfare responds/reacts whenever there is a shock in food prices and its fundamental determinants. to analyse the long-run relationship between food prices and household welfare in south africa by determining how real household welfare responds/reacts whenever there is a shock in food prices and its fundamental determinants. to distil recommendations toward a conceptual framework for the mitigation of the impact of high food prices on households in south africa. literature review market failure, household income and food prices clarity on the causes of market failure by policymakers is important. von braun, teklu and webb (1993:76) stated that it was critical for the government to have an encompassing knowledge of the correlation between market and price behaviour in times of food crises. the government is the custodian of policymaking and implementation and thus needs to support remedial action in order to address the welfare impacts of rising food prices. rocha (2006:5) argues that food insecurity should be included as a market failure, as it occurs when free markets are seen to be socially inefficient, when the market outcomes prove social benefits to be below the costs of society in respect of that outcome, or when benefits are not fully utilised via social resources. hence, the market clearing variables do not maximise net social benefits (kahn 1998:14). the presence of public goods and of negative externalities are the two most important causes of market failure in food security. the relationship between relative and nominal prices forms the causal nature of changes in food prices and can be attributed to relative demand and supply conditions of both non-food and food commodities, resulting in a net increase in relative food prices (belongia 1983:5). rising food prices increase the risk faced by lower-income households and subsequently transfers real income from lower-income consumers (newbery 1989). rising food prices have an adverse effect on purchasing power. poor households spend the majority of their household income on food, making food prices an important factor in the well-being of the poor (pinstrup-andersen 1985:69). hence, the changes in price of food commodities influence the ability of households to purchase food items (jacobs 2009:413). rising food prices consist of a combination of variables influencing the welfare of the poor. factors such as supply and demand, inventories, macroeconomic factors, exchange and interest rates, global economic activity, oil price volatility, global weather patterns, financial investment and agricultural policy all attribute to the volatility of food prices (roache 2010). prices of food commodities continue to increase over time, leaving the poor vulnerable to food insecurity. a study done by the food and agriculture organization of the united nations in 2008 indicated that global nominal prices of all major food sources were at their highest levels in 50 years and continue to increase (reyes et al. 2009:1). the poor are vulnerable to food price hikes, but policymakers can alleviate the burden suffered by the poor. karfakis, velazco and covarrubias (2011:3) stated that approximately 70% of the global poor population reside in rural areas and are dependent on agriculture for the possibility of improving their livelihoods, welfare and decreasing poverty rates. south african urban households spend more toward food than do rural households. as demonstrated by bonti-ankomah (2001), rural households’ food expenditure is approximately 23% of their total household spending at r588.00 whereas urban households spend approximately 15% of their household expenditure at r945.00. the difference between urban and rural food expenditure can be expected, as rural households may supplement spending toward food by subsistence farming or own food production. international evidence related to food prices there is diversity in the international empirical evidence that relates to food prices across the globe, with clear distinctions from country to country. in order to evaluate the impact of food prices on household welfare clearly and effectively in south africa, it is crucial to understand how other countries have responded to the same impacts and the effectiveness of their reforms. the literature discusses the experience and reforms of three countries: ghana, india and the usa. these countries differ in terms of income distribution, poverty levels and food security. however, each country has developed policy reforms and programmes to enhance food security and the welfare impact associated with food prices. in 2008, ghana imposed import duties on yellow corn, rice and wheat in an effort to lessen the burden on consumers from the adverse impacts of further rising food prices (osei-asare & eghan 2014:28). however, a study in ghana suggested that the current policy reform of protecting domestic rice producers by means of import taxation did not contribute to the reduction of national poverty, as there is a tendency for rice growers in ghana to remain poor (minot & dewina 2013:v). it is challenging for ghana’s government to implement an effective policy due to tight market conditions for important agricultural commodities. for the government to make the correct policy decisions, an understanding of the causes of rising food prices, the implications of future rising food prices and how members of society are impacted by these effects is necessary (organisation for economic co-operation and development 2008:2). the understanding of these variables allows governments to improve decision-making which contributes to effective policy formation. india has one of the highest rates of rising food prices among the developing economies. according to bhattacharya and gupta (2015:2), during the period of 2006 to 2013, india experienced food inflation at an average rate greater than 9%, which was nearly double than the previous decade. given that the rural poor households in india spend large portions of their total income toward food commodities, they are unable to divert additional resources to suppress the impact of rising food prices, thus strengthening food insecurity in the country. three patterns can be distinguished in india’s food price trends as compared to global food price trends. according to dev (2009:3), when global food prices increased in 2005 to 2007, the first pattern of inflated food prices emerged. the rate at which food prices were inflated was a lot lower in india at the time. the second pattern saw india’s food prices decrease during 2007–2008 when compared to 2006–2007, which is when global food prices significantly increased. the third pattern illustrated that global food prices declined at the end of 2008, but india’s food prices escalated during this time, which was an indication that global food price increases had a marginal impact on india due to less exposure. the indian government adopts a wide range of policy instruments to combat rising food prices. in 2007–2008, the indian government arranged its intervention measures into two groups: first, economic policies, which included pricing policies, trade policies, stock management policy and public distribution; and second, social programmes. the social programme policy instruments included cash transfers, food for work, food rationing, school feeding schemes and rural employment schemes. the programmes and policies targeted trade and consumption, with little emphasis on a supply response. according to the world bank (2010), high rising food prices turned the political economy of food into an important catalyst for short-term economic policy in south asia and highlighted the transformation of food security into an important strategic tool for policymakers. the usa is heavily reliant on food subsidies and tariffs for food security. empirical evidence illustrates that more than 22% of children living in the usa live below the official poverty line and half will be on food stamps before they reach the age of 20 years (kairos 2015). food subsidies are included in price supports by the government, which guaranteed a price for a farmer’s crops, whereby the state would purchase the excess crops. the usa farm bill of 2002 introduced payments for certain crops which are independent of price, also known as direct payments. the usa has experienced lower food tariffs on fruit and vegetable imports and also experienced higher tariffs from food-exporting countries around the world, resulting in the fact that export growth for the usa did not keep pace with import growth (johnson 2014:5). the increase in imposed tariffs could have an effect on food prices, and thereby impact the food security and welfare of citizens of the usa. food prices, household welfare and policy interventions market information is a key factor when trying to correct price instability, especially in food markets. according to keech, munger and simon (2012:8), without market data on the value of the damage caused by price hikes to markets, the state cannot determine its effects on households and thus lacks credible data and information. literature detailing the causal relationship between increases in food prices and the adverse impact on households represents varying opinions. a number of empirical studies have indicated that there is a positive correlation between the increase in the price of food commodities and adverse welfare effects on the poor. however, there is also empirical literature that indicates that long-term price increases assist in agricultural development, which in turn impacts positively on employment and brings poverty relief. jacobs (2009:413) suggests that the poorer households cope with rising food prices by reducing their purchases of food items and changing their consumption behaviour, which could change a household’s status from one that is food secure to one that is not. literature also confirms that prices in agricultural food markets are much more inclined to volatility than in other industries. this is due to the supply of food commodities being inelastic in the short term, the demand for food being price inelastic and the unpredictability of food supply due to climate changes (pettinger 2014). in 2008, south africa had a projected total transfer cost, inclusive of agricultural subsidies, of between 2% and 4.5% (demeke, pangrazio & maetz 2009:21). this is a substantial proportion of gross domestic profit (gdp) allocated to assisting the burden suffered by the poor. however, the literature suggests that approximately 80% of south african rural households are unable to afford a basic nutritional basket of food, which would cost approximately r262.00 per month per person on average (altman, hart & jacobs 2009:351). a study done by aliber (2009:397), using engel’s law, established that the total share of expenditure on food is higher the poorer the household is. in mexico, a similar study indicated that changes in local food prices from the beginning of 2005 to the end of 2007 proposed a 1.7% rise in extreme poverty in rural households (wood et al. 2011:78). recent studies have shown that policymakers are making strides with innovative mechanisms and legislation to accommodate rising food prices. policymakers should implement demographical or geographical targeting in order to direct limited resources to households whose welfare is largely impacted by food price shocks (rodriguez-takeuchi & imai 2013:233). the current economic environment indicates sharp increases in food prices. policymakers have attempted to lower food prices, while also limiting the signalling of higher global prices to domestic markets. governments across the world have tried to formulate policies and legislation to overcome the adverse effects of food price hikes. galtier (2009:2) states that since the 1980s, governments have tried to manage risks without affecting prices of food commodities, which affect a host of variables such as crop insurance and future markets, as well as influencing trade behaviour of food commodities. there is a desperate need for government intervention to curb seasonal food insecurity that affects the rural poor by deepening and widening social safety net programmes (akter & basher 2014:161). policymakers require strong legislation and policy to assist the poor in the face of the adverse effects of food price increases. according to gouel (2013:1), the state must intervene when there is a lack of credibility in food market liberalisation due to a shortage of effective policy to protect the poor. the current policy barriers are the challenges regarding policy design that will build confidence in global markets and develop positive relationships between private and public agents. methods study design a deductive and/or inferential approach to research was used in this study, making use of a variety of literature concerning food security and insecurity aspects, especially regarding food price increases. further, the vector error correction modelling (vecm) technique was utilised to estimate a regression model. the vecm technique is known to be advantageous over the ordinary least square and the generalised methods of moments techniques, since it analyses both the shortand long-run relationship between variables. it is also well suited to handle the problem of endogeneity in the model. data collection the study employed annual time series data derived from secondary sources such as the world bank and the organisation for economic co-operation and development, covering the period 1990–2015. since time series data is more concerned with ordering and listing of observations as the dependency, it offered this study several advantages over studies that use quarterly and monthly data. due to the lack of welfare measurement in south africa, the study employs household disposable income as a proxy. furthermore, the study incorporates variables such as household final consumption expenditure, food prices, consumer price index and unemployment. all the variables in exception of food prices are collected in percentages and are not subjected to the natural logarithm since it would yield biased estimation. data analysis the study employs the vecm approach quantified under the vector auto-regressive (var) framework. this study adopted a quantitative nature since it produces descriptive data and, from an econometrics point of view, it is essential to utilise statistical packages such as the e-views 9 package which was utilised for the analysis. the vecm technique incorporates procedures such as testing variables for an order of integration, using the augmented dickey fuller (adf) and phillip perron (pp) methods, determining the maximum lag length, and assessing the long-run association between variables using the johansen cointegration technique in the estimation of both the shortand long-run relationships. subsequent to the longand short-run estimations, the study performed the stability and diagnostic test, using techniques such as the jarque-bera test of normality, the white heteroskedasticity test and the breusch-godfrey lm (lagrange multiplier) test of serial correlation. furthermore, the study performed the variance decomposition and general impulsive response function to detect the behaviour of shocks in the variables employed toward household welfare in south africa. model specification this study develops a regression model as follows: where: hdi household disposable income as a proxy of welfare un unemployment lnfp food prices in a logarithm form hfce household final consumption expenditure cpi consumer price index the model can be transformed into a linear form as follows: where: β0– constant β1, β2, β3, β4 – coefficients μt – error term estimation techniques the study employed the vecm econometric approach to analyse the relationship between household welfare and food prices in south africa. the vecm technique requires that the data be tested for stationarity or order of integration. the study adopted the adf and pp test of unit roots. the adf test is applied using the following: using the ar (ρ) process, the hypothesis for the adf test is quantified as follows: h0: δ = 1 implies that the variable has unit root (non-stationary), and h1: δ = <1 implies that the variable does not have stationarity (stationary) once the stationarity is established using the adf, the pp test of stationarity can be performed to check the robustness of adf results. the test can be performed using the following equation: table 1 demonstrates that when the adf test is applied to variables at first difference, that none of the variables are stationary at 1%, 5% and 10% level of significance. as a result, the study fails to accept the null hypothesis of non-stationarity and concludes that variables are stationary and integrated at order i (see eqn 1). table 1: augmented dickey fuller test at first difference. according to philip-perron, table 2 tests the variables at first difference. all variables are stationary at 1%, 5% and 10% level of significance. the variables are tested at same models, which are trend and intercept, intercept and none. therefore, the study fails to accept the null hypothesis of non-stationarity and concludes that the variables are integrated at the same order of i (eqn 1). since there was evidence of stationarity in the variables, the study therefore proceeds estimating a non-spurious model of food prices and welfare impacts for south african households. table 2: philip-peron test of stationarity at first difference. lag length selection results it is vitally important to conduct a lag length selection criterion to establish the number of lag to use. the lag selection can be done on the basis of final prediction error (fpe), akaike information criteria (aic), schwartz bayesian information criteria (sbic), and hanna and quinn information criteria (hqic). the test was conducted and a lag of 2 was selected as reflected in table 3. the lag of 2 was selected based on the final prediction error (fpe), akaike information criteria (aic) and, hanna and quinn (hq) results and it is used throughout the analysis of the study. table 3: selection of lag length used in the study at level form. cointegration test results a cointegration test is essential in examining the long-run economic equilibrium relationship between variable x and variable y. therefore this study employs the johansen maximum likelihood estimation process because of its ability to test for multiple cointegrating vectors. the procedure also permits for testing both restricted and unrestricted forms of cointegrating vectors and the speed of adjustment parameters. according to asteriou and hall (2011), the johansen approach is concerned with two assessments, namely the trace test and the maximum eigenvalue. the tests represent the probability ratio test for the proposition that there are at most ‘r’ cointegrating vectors. the trace test and the maximum eigenvalue test can be conducted using the following formula: where t is the sample size and λ is the ith largest canonical correlation. the trace test results as reflected in table 4 suggest that there is one cointegrating equation. the results obtained show that in the case of the trace test, the null hypothesis of no cointegrating equation is rejected since the test statistics of 96.844 are greater than the 5% critical value of 95.753 at none. this was a clear indication that there was one cointegrating equation at the 5% level. table 4: trace test results. the maximum eigenvalue test in table 5 also indicated that at none, the maximum eigenvalue statistics of 46.589 are greater than the critical value of 40.078. as a result, the maximum eigenvalue also suggested one cointegrating equation at the 5% level. since both trace test and maximum eigenvalue suggest one cointegrating equation, the study fails to accept the null hypothesis of no cointegration. this concludes that there is a long-run relationship among the variables. table 5: maximum eigenvalue results. the vector error correction modelling estimation result the study estimated a vecm to capture both the longand the short-run effect between the variables. the relationship reflected in table 6 can be presented in a linear form as follows: hdit= −197.761 – 0.054unt – 21.318lnfpt – 1.481hfcet + 0.516gdpt – 0.389cpit+ εt. table 6: long-run regression results: household disposable income. the long-run relationship between the variables as explained in the above equation suggested that there was a negative long-run insignificant relationship between un and hdi in south africa. the study also proved a long-run negative relationship of lnfp, hfce and cpi toward hdi and a long-run positive relationship between gdp and hdi. all explanatory variables in exception of un and gdp were statistically significant in explaining the dependent variable since they have absolutely had a t-value greater than two. the implication of the negative relationship between un and hdi was that a 1% increase in un would deteriorate hdi by 0.05% in south africa. furthermore, a 1% increase in lnfp, hfce and cpi would also reduce hdi by 21.3%, 1.5% and 0.4%, respectively. gdp is found to be positively correlated with hdi since it is observed that 1% increase would improve the hdi by 0.5%. as indicated in table 7 below, the coefficient of the depended variable is −0.071 and is statistically significant with a t-value of −2.045. this suggests that about 7% of the variation in the real gdp from its equilibrium level is correlated within a year. based on this result, the adjustment of the gdp to restore long-run equilibrium is weak at 7% per annum. table 7: short-run regression results. general impulsive response function it is traditional to interpret the vars using the impulsive response function (irfs). according to sims (1980), the irfs are useful in the var framework since they allow for tracing out the time path of the numerous shocks on the variables. plotting the irf is a useful technique for visual representation of the behaviour of the series in response to the various shocks. mujuta (2013) pointed out that impulse responses trace out the response of the present and forthcoming value of one var error, assuming that this error returns to zero following periods and that all other errors are contemporaries to zero. in the estimation, irfs are used to interpret results because it is very difficult to use individual coefficients, as was stated by bjonness (2012). the study applied the general impulsive response function to trace the magnitude of one-time shock to one of the innovations on the present and forthcoming values of the endogenous variables. the general impulsive response function over the 10 years for the vecm estimation is shown in appendix 1. results in appendix 1 suggest that hdi responds positively to the impulse coming from itself, lnfp and gdp throughout the period of 10 years. furthermore, it responds negatively to impulse coming from cpi starting from period 3 until period 10. the impulse coming from un, hfce were fluctuating between negative and positive toward hdi. the study therefore concludes that household disposable income responds positively to shocks coming from food prices. food prices affecting household welfare the results of the vecm estimation reveal that a shortand long-run relationship exists between food prices and household welfare in south africa. similar findings by galtier (2009) reveal that rising food prices have shortand long-run effects on household welfare. the results of this article reveal that rising food prices negatively affect the welfare of households in south africa and, similarly, a study completed by mackinnon (1998) acknowledges the decline in household welfare that occurred in ethiopia during 1984 and 1985 due to excessive increases in food prices. a similar proxy used in a study conducted in india by de janvry and sadoulet (2010), who utilised changes in real income as the first estimate to changes in welfare of households. this indicated a money-metric loss in welfare, caused by changes in income and consumption prices. the study confirmed similar findings similar to those of this article, where rising food prices negatively affected household welfare (de janvry & sadoulet 2010). the study by schreitter (2016) suggested that heterogeneity tests had indicated that the correlation between food prices and household welfare was even lower for poor households. the theory and analysis were strengthened by a study undertaken alem and soderbom (2012:146) who also conducted research in ethiopia related to the impact of rising food prices on household welfare and suggested that welfare of the poor living in ethiopia was sensitive to food price changes. the vecm estimation results were in agreement with the both studies done by schreitter (2016) and alem and soderbom (2012), namely, that poorer households were adversely affected by rising food prices. the study also revealed a strong positive correlation between food prices and household welfare and further, that there was a strong negative impact on household welfare when food prices increased. a similar outcome was obtained in a study completed by adom (2013), which concentrated on the microeconomic impacts of rising food prices and assessed the potential welfare effects of increasing food prices on households residing in ghana. key findings the study adopted the vector error correction modelling procedures to answer the question whether food prices had an impact on household welfare in south africa and analysed the behaviour of variables such as unemployment, household final consumption expenditure, food prices and the cpi toward household welfare. the cointegration analysis confirmed a long-run relationship among variables. a significant negative relationship between food prices and household welfare was discovered, which implied that an increase in food prices would result in household welfare reduction in south africa. the short-run model estimated revealed convergence toward equilibrium in the long-run, although the adjustment was weak at 7% per annum. the results confirmed that the model did not suffer from heteroskedasticity, serial correlation and normality challenges. the polynomial test confirmed the stability of the model since all ar polynomial had roots with a modulus which were <1 and they lay within the unit circle. based on the above results, this study concludes that food prices are detrimental to household welfare in south africa. these results are believed to be efficient and consistent, based on the diagnostic and stability test undertaken. conclusion the welfare impacts on south african households have largely been negative when there were increases in food prices. the study revealed that a shortand long-run relationship exists between food prices and household welfare in south africa through determining the response of real household welfare when a shock in food prices occurred. confirmation of a largely negative correlation between food prices and household welfare was revealed, which found that household welfare declined when there was a rise in food prices in south africa. the study implies that an increase in food prices results in a reduction of household welfare in south africa and the results revealed that household welfare responded to shocks in food prices. the study, therefore, confirms a negative correlation between food prices and welfare in the short-run. the results of the study revealed that household welfare responded to shocks in food prices in the long run and therefore confirms a negative correlation between food prices and welfare. the study, based on results of the model, confirmed that food prices impacted on household welfare in south africa and the results are credible, efficient and consistent due to the diagnostic and stability tests that were performed. the policy options in the short run to address the impact of food prices on household welfare in south africa could include the following: subsidising staple food baskets for households in south africa; reducing prices of staple foods with the reduction of staple food tariffs; reducing household expenditure on basic needs through subsidisation. long-run impacts on household welfare can be stabilised through the following policy mechanisms: improving the unemployment rate in south africa; improving access to finance and credit. the successful implementation of recommendations by the south african government to implement policy options, such as food subsidies and tariffs for staple food sources, will provide south african households with the following: sustainable food prices for south african households improvement of household welfare by reducing staple food prices; reduction of total household expenditure. however, through fiscal constraint, the government is hesitant to engage in projects that will take up large amounts of fiscal resources. agriculture and food security are, however, government priorities and are prioritised within the national development plan. hence the recommendations of this research provide a provisional strategy toward creating an environment for sustainable food prices in south africa. further research on creating sustainable food prices in south africa is necessary to reduce the implications on household welfare in south africa, especially the poor. acknowledgements competing interests the author declares that he has no financial or personal relationships which may have inappropriately influenced him in writing this article. authors’ contributions r.b.v.w. is the corresponding author and c.s.d. reviewed and supervised the first author in writing this article. references adom, k.p., 2013, the impact of rising food prices on household welfare in ghana, department of economics, university of ghana, accra. akter, s. & basher, s.a., 2014, ‘the impacts of food price and income shocks on household food 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welfare impacts of food price increases: evidence from rural ethiopia, viewed 10 january 2017, from https://editorialexpress.com/cgi-bin/conference/download.cgi?db_name=csae2016&paper_id=855. sims, c.a., 1980, ‘macroeconomics and reality’, econometrica journal 48(1), 1–48. https://doi.org/10.2307/1912017 ssebagala, r., 2016, what matters more for south african households’ debt repayment difficulties, center for social science research, university of cape town, cape town. statistics south africa, 2016, general household survey, 2015, statistical release, pretoria. van der merwe, c., 2011, key challenges for ensuring food security in south africa’s inner cities, africa institute of south africa, pretoria. von braun, j., teklu, t. & webb, p., 1993, ‘famine as the outcome of political production and market failures’, ids bulletin 24(4), 73–79. https://doi.org/10.1111/j.1759-5436.1993.mp24004008.x wood, b.d.k., nelson, c.h. & nogueira, l., 2011, ‘poverty effects of food price escalation: the importance of substitution effects in mexican households’, journal of food policy 37(1), 77–85. https://doi.org/10.1016/j.foodpol.2011.11.005 world bank, 2010, food price increases in south asia, national responses and regional dimensions, the international bank for reconstruction and development, washington, dc. appendix 1 figure 1-a1: general impulsive response function. abstract introduction literature review methodology results and analysis conclusion acknowledgements references appendix 1 footnotes about the author(s) busani moyo department of economics, university of south africa, south africa citation moyo, b., 2018, ‘an analysis of competition, efficiency and soundness in the south african banking sector’, south african journal of economic and management sciences 21(1), a2291. https://doi.org/10.4102/sajems.v21i1.2291 original research an analysis of competition, efficiency and soundness in the south african banking sector busani moyo received: 14 jan. 2018; accepted: 13 june 2018; published: 13 sept. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the banking sector plays an important role in economic activity: it mobilises savings and channels them to productive sectors thus encouraging the efficient allocation of resources. the competitive nature of the environment under which the banking sector operates is of paramount importance. aim: the main aim of this study was to investigate the relationship between competition, efficiency and soundness in the south african banking sector. setting: the setting for this study was the south african banking sector. methods: we used a data set of 17 local and international banks for the period 2004–2015 and stochastic frontier models to analyse efficiency. results: results show that the impact of competition on efficiency depended on the measure of competition used. when using the lerner index there was a negative effect of competition on efficiency while the opposite was true when using the theoretically robust boone indicator. conclusion: in the case of bank soundness, competition using the boone indicator is negatively related to the z score, implying that competition enhances bank soundness and these results supported the prudent and efficient management hypothesis. introduction competition is the main driver of strong and effective markets, encourages firms to innovate, enhances productivity, and results in the efficient allocation of resources. a competitive environment ensures that companies compete fairly and puts businesses under constant pressure to offer the best possible range of goods at the best possible prices. this makes competition the essential drive of productivity growth in any economy. in addition to improving quality, competition creates a wider choice for consumers and, therefore, by removing distortions to competition, we will reduce opportunities for corruption and rent seeking, thus helping markets to work better and maximising economic benefits. industrial organisation theory argues that the level of concentration in a market determines the degree of competition among firms. the structure conduct performance (scp) paradigm, proposed by bain (1951), argues that markets dominated by a few large firms are less competitive than markets that are lowly concentrated. this implies that the higher the level of concentration in a market, the lower the level of competition. however, the contestable market theory emphasises that a highly concentrated market can be highly competitive, even if a few firms dominate it (baumol 1982). thus, there is no strong theoretical support for the notion that in markets that are more concentrated, market power is higher, and competition is lower. one undisputable fact, however, is that competition is important in enhancing efficient allocation of resources. competition pushes firms to produce goods at the lowest possible costs in a way that accounts for consumer preferences. the theoretical literature is awash with a number of hypotheses that seek to explain the relationship between competition and efficiency (demesetz 1973; hicks 1935; liebenstein 1966; peltzman 1977). the quiet life hypothesis, developed by hicks (1935), argues that in highly concentrated markets, there is less pressure to compete, which results in reduced efforts by managers to operate efficiently. thus, increased market concentration weakens market competition, and this affects productive efficiency. this hypothesis is synonymous with the competition-efficiency hypothesis and argues that increases in competition precipitate increases in profit efficiency since banks are forced to engage in proper screening and monitoring of borrowers resulting in lower levels of non-performing loans (schaek & cihak 2008; williams 2004). thus, according to the quiet life hypothesis, increased competition improves efficiency, implying that the relationship between these two variables is positive and runs from competition to efficiency. the efficient structure hypothesis proposed by demesetz (1973) takes the argument further and argues that efficient banks will increase in market share and size at the expense of the inefficient banks, leading to a higher market concentration. in this hypothesis, efficiency leads to higher concentration, suggesting low levels of competition. the alternative to the competition-efficiency hypothesis is the competition-inefficiency hypothesis which argues that competition leads to a decline in efficiency (schaek & cihak 2008). the argument is that higher competition is likely to be associated with unstable and shorter bank client relationships since clients tend to have a high propensity to switch to other service providers. this creates information asymmetry and requires banks to spend more on the screening and monitoring of borrowers. banks in turn will likely reduce relationship-building programmes and this affects the reusability and value of information. in this case, banks will incur greater expenses in keeping old and attracting new clients through investments into atms, new information systems and aggressive marketing (schaek & cihak 2008). in this case, competition reduces bank efficiency. according to simbanegavi, greenberg and gwatidzo (2015), a well-functioning banking sector contributes to economic growth via the more efficient allocation of resources and risk diversification. the competitiveness and efficiency of the banking sector is critical to the well-being of the economy because it helps facilitate the efficient movement of funds from surplus to deficit units, thereby encouraging savings and the optimal allocation of resources. maredza et al.’s (2013) study also identified that lack of competition in banking is one of the aspects that is related to low levels of efficiency of commercial banks in africa. the study noted that interest rate spreads, profits and overhead costs are high in african banking compared to other regions of the world. this competition-efficiency nexus is of importance to south africa given that the country’s banking sector is dominated by four major banks that account for over 80% of total banking assets. this high level of concentration suggests low level of competition and hence inefficiency as per the quiet life hypothesis or the high levels of concentration do not necessarily suggest lower levels of competition as per the contestable market theory. given these conflicting theoretical positions, the objective of this study is to investigate empirically the nature of the relationship between competition and efficiency in the south african banking sector and look at how these variables ultimately affect bank soundness.1 although there are so many studies that have examined these relationships in the banking sector, there is none on south africa. most of the studies on south africa have looked at the competitive conditions in the banking sector, all finding that the sector is monopolistically competitive (mlambo & ncube 2011; simatele 2015; simbanegavi et al. 2015). if the competitive conditions are good, we expect to see an improvement in the level of efficiency and financial stability.2 the competitiveness of the south african banking sector was under the spotlight recently, in 2017, after the competition commission investigated allegations of price fixing and market allocation (in the trading of foreign currency) by 17 banks including three south african banks (national treasury 2017). these allegations are not entirely surprising given that the country’s banking sector is highly concentrated with five banks holding close to 99% market share (see table 1). in addition, the recent (march 2018) placement under curatorship of vbs mutual bank by the south african reserve bank (sarb) because of imprudent banking practices also compromises the stability of the banking sector. it is, therefore, of interest to understand how the concentrated nature of the sector has affected efficiency and bank stability. the promotion of efficiency in the pricing and delivery of financial products is very important, especially given the devastating effects of the 2008–2009 global financial crisis. this study will also partly serve as an indirect test of the contestable market theory and its applicability to the south african banking industry. our results show that the impact of competition on efficiency depends on the measure of competition used. when using the lerner index, there is a negative effect of competition on efficiency, while the opposite is true when using the boone indicator. in the case of bank soundness, the boone indicator is negatively related to the z score, implying that competition enhances bank soundness and these results support the prudent and efficient management hypothesis. table 1: main banking indicators. this article is organised as follows: the next section discusses some basic stylised facts about the south african banking sector, while section two covers literature review, followed by section three on methodology. section four covers results analysis and the last section then concludes the article. some stylised facts about south african banking the south african banking system is well developed and effectively regulated, comprising a central bank, the sarb, a few large banks and investment institutions, and a number of smaller banks, as well as lending and savings organisations (south african reserve bank [sarb] 2017). the banking sector is well developed and compares favourably with those of the developed world, and ranked 11th out of 138 countries in terms of financial market development in the global competitiveness report. in terms of bank soundness, the country is ranked at number 2 out of 138 countries but ranked number 27 in terms of affordability of financial services. the financial sector together with real estate and business services for the past 10 years until 2016 has been contributing on average about 19% to gross domestic product (gdp), growing at 2.2% per year (stats sa 2017). the banking sector is comprised of 64 institutions and close to half of these are foreign bank representatives with locally controlled banks constituting 16% of the total (sarb 2017). the high number of players in the sector suggests an improved level of competitiveness in the market and this could be good for consumers. the total banking assets have been increasing over the years, moving from zar2.5 trillion in july 2008 to zar5 trillion in the same month in 2017. other banking depth indicators also show an improvement in financial deepening since the year 2000. bank deposits to gdp ratio increased from 50.1% in 2000 to 59.7% in 2015 and domestic credit to the private sector as a percentage of gdp also increased to 147% from 130% for the same period. the same pattern is replicated when looking at broad money to gdp, which increased from 53% in 2000 to 74% in 2015 (see table 2). table 2: financial market indicators. banking structure indicators support some of the findings on competitiveness found by many researchers in the sector. the five banks concentration ratio calculated by the world bank increased from 94.8% in 2000 to 98.99% in 2015 suggesting a heavily concentrated industry (see table 2). however, the intensity of competition is encouraging as the panzar rose h statistic increased from 0.79 in 2010 to 0.86 in 2015, still supporting the generally held view that the sector is monopolistically competitive. the lerner index moved from 0.22 in 2000 to 0.17 in 2010, while the bonne indicator changed from –0.09 in 2000 to +0.03 in 2015 (global financial development 2017). the lerner index suggests that there is some level of competitiveness in the banking sector but the boone indicator suggests that the level of competitiveness is falling, although the changes are marginal. however, looking at bank access and efficiency indicators calculated by the world bank, bank lending deposit spreads have been falling since 2000 and the same is true for bank non-interest income to total income. this could suggest that competitive conditions are intensifying or efficiency is improving, resulting in banks reducing their prices. this trend is repeated even when looking at bank return on assets which has been falling since 2000. however, the bank z score values have been increasing, supporting bank soundness and low risk profile of the sector. finally, in terms of access, the number of bank branches to 100 000 adults has been increasing gradually from 7.3 in 2005 to 10.5 in 2015, and atms per 100 000 adults also increased from 25.5 in 2005 to 69.3 in 2015 (see table 1). given that the banking structure and efficiency indicators in table 1 point to improved levels of competition and efficiency, does this, therefore, suggest that there is a positive relationship between these two variables? thus, given that z score values (standard indirect measure of bank soundness) are increasing, does this mean competition or efficiency positively influence bank stability? these questions form the core objectives of this study. literature review a handful of studies have been done on the south african banking sector. these studies are of two strands: one strand looked at the competitive settings in the sector while another group analysed efficiency conditions. ncube (2009) used stochastic frontier analysis (sfa) to calculate the cost and profit efficiency of four large and four small banks in south africa for the period 2000–2005. his results show that banks are generally 85% cost efficient with investec being the most efficient bank while standard bank was the least. profit efficiency levels were relatively lower at 55% for the banking sector with the most profit efficient banks being capitec and standard bank with nedbank and absa being the least (ncube 2009). using the krusral-wallis analysis of variance tests, he found that there has been a significant change in cost efficiency over this period but no change in profit efficiency. a study by erasmus and makina (2014) analysed technical efficiency in the south african banking sector using the five largest banks. they used standard and alternative approaches to data envelope analysis (dea) for the period before and after the financial crisis, that is 2006–2012. their results show that barclays bank and nedbank were the most technically efficient banks using the two approaches and they conclude that the global financial crisis did not have a significant impact on the technical efficiency of the major banks in south africa. the results found by erasmus and makina were contrary to those obtained by maredza and ikhide (2013). using data for the four largest commercial banks for the period 2000–2010 and calculating total factor productivity or efficiency using dea’s hicks-moorsteen index, maredza and ikhide found technical efficiency scores to have been affected by the financial crisis. results from their stage two tobit model showed that efficiency was 17% lower during the crisis compared to the pre-crisis period. mlambo and ncube (2011) carried out another study on south african banks where they analysed the evolution of competition and efficiency of 26 banks between the years 1999 and 2008. using dea for measuring technical, allocative and cost efficiency and that the panzar rose model for estimating competitive conditions, they found that even though the number of efficient banks was falling, average efficiency was increasing and that the banking industry was monopolistic in nature. this study is an extension of what mlambo and ncube did and extends the analysis further by looking at the impact of competition and efficiency on bank soundness. simbanegavi et al. (2015) also tested for competition in the south african banking sector employing the panzar rose and the bresnahan models and using a data set of 14 banks over the period 1998–2008. they found the banking sector to be monopolistic in nature using the panzar rose model but could not reject the null hypothesis for perfect competition using the alternative bresnahan approach. they conclude that these findings suggest that even though the banking sector is highly concentrated, this has not affected competition in the sector. it appears that studies that have analysed the competitiveness of the south african banking sector using the panzar rose methodology arrive at the same conclusion. simatele (2015) also used a time varying panzar rose methodology to examine the relationship between bank structure and competition in south africa for the period 1997–2014. using a data set of 35 banks, she also found the sector to be monopolistically competitive, confirming the results found by mlambo and ncube, as well as simbanegavi et al. in africa, a number of studies have also investigated the relationship between competition and efficiency using various competition and efficiency measurement techniques and finding mixed results. a study that employed dea done in ghana by alhassan and ohene-asare (2016) found competition to improve cost efficiency, supporting the quiet life hypothesis; similar results were found for the middle east north africa (mena) region by apergis and polemis (2016), concluding that increases in competition do not precede increases in cost efficiency. however, saka, aboagye and gemegah (2012), also using dea, found that in ghana competition improves technical efficiency, supporting the efficient structure hypothesis. their results were partly supported by buchs and mathisen (2005) who found that banks in ghana behaved in a non-competitive manner and this may not be good for financial intermediation efficiency. sarpong-kumankoma, abor and aboagye (2017) also looked at competition and bank efficiency in sub-saharan africa, employing sfa and finding results inconsistent with the quiet life hypothesis. they found that increase in market power leads to greater bank cost efficiency, but the effect is weaker with higher levels of financial freedom. in the case of stability, amidu and wolfe (2013) analysed competition and stability in 55 emerging market countries, of which 22 were from africa including south africa. their core finding was that competition increases stability, as diversification increases across and within both interest and non-interest income-generating activities of banks. their results show a positive and significant relationship between competition and stability, supporting the competition stability view. another study was done by hope, gwatidzo and ntuli (2013) using 10 african countries and they found that there is a robust positive relationship between market power and financial stability. this result suggests that there is a trade-off between bank competition and financial sector stability in these african countries, as per the competition-fragility view. studies on the relationship between competition and efficiency in the banking sector in non-african countries also abound. most of these studies use the granger causality tests to analyse the relationship between competition and efficiency. they only differ in the way they measure efficiency: one group of this literature uses dea while the other employs sfa. they all measure competition using non-structural measures like panzar rose h statistics, the lerner index and the boone indicator. regardless of the efficiency technique used, there is no consensus on the nature of the relationship between efficiency and competition. rahim (2016), using the malaysian commercial banking sector, found the same relationship as schaek and cihak (2008) who used banks in europe and the united states. rahim found a positive effect of competition on technical efficiency while schaeck and cihak found competition to be positively related to both profit and cost efficiency. schaek and cihak also found that increased competition increases bank soundness via the efficiency channel. casu and girardone (2009), using banks from selected european union (eu) countries for the period 2000–2005, found a negative relationship between market power and efficiency and the same results were obtained by fernandez de guevara, maudos and perez (2005), also using eu data for the period 1993–2002. the latter rejected the quiet life hypothesis in the same manner that podpiera, weill and schobert (2008) rejected it using czech republic data for the period 1994–2005. using sfa, fungacova, pessarossi and weill (2013) studied whether bank competition is detrimental to efficiency in china using data for the period 2002–2011. their finding is inconsistent with the quiet life hypothesis that market power has a negative impact on cost efficiency. maudos and solis (2009) performed a similar analysis for mexican banks by considering separately the lerner index for deposits and loans. while they observe a negative link between competition and efficiency on the deposit market, they find an opposite result for the loan market. all these studies show that the relationship between competition and efficiency is not clear cut and thus varies from one country to another. methodology the approach followed in this article to analyse the relationship between competition, efficiency and soundness is divided into three parts. we first measure the level of competition using the lerner index and the boone indicator, and after that we compute various efficiency scores (technical, cost and profit). lastly, we then compute bank soundness using the z scores and non-performing loans. measuring bank competition there are a number of techniques developed to measure competition in any industry. these measures are grouped into structural and non-structural and the former are based on the scp paradigm developed by mason (1939) and bain (1951). the scp model explains the aspects of conduct and performance of firms in terms of the structural characteristics of the markets in which they operate and argues that the more concentrated an industry is, the easier it is for firms to operate in an uncompetitive manner (leon 2015). structural measures include the number of firms, the concentration ratios and the herfindahl hirschman index (hhi).3 the first generation of non-structural measures include the lerner index developed in 1934 and the conjectural variation models like the panzar rose h statistic developed in 1987, the bresnahan-lau test in 1982 and the boone indicator in 2008. in this study, since we use bank level data, we use a measure of market power that is calculated at bank level like the lerner index. this index captures the divergence between product prices and marginal cost of production. the price and marginal cost are equal in perfect competition but diverge in less competitive markets. in equation 1, pit is the output price of bank i at time t and is defined as total revenue4 divided by total assets. marginal cost is calculated by differentiating the translog cost function with one output (total assets) by output. this index ranges between 0 and 1, and a bigger wedge between price and marginal cost suggests greater market power. we can alternatively present this as follows so that it becomes clear how this index is calculated: . qi is the quantity produced by firm i, q is total quantity and p(q) is the market price. c(qiwi) is the total costs of firm i and wi is the vector of the prices of inputs used. the differential of total costs with respect to qi gives us marginal cost. we follow the approach adopted by fungacova et al. (2013) by formulating a translog cost function where output is measured using total assets or loans and three input prices, namely price of labour, price of borrowed funds and price of capital.5 we also estimate one cost function for all the periods and symmetry and linear homogeneity restrictions in input prices are imposed. the translog cost function that will be estimated is specified as follows: in equation 2, q is a measure of output and equal to total assets, w is the price of inputs, with price of labour measured using the ratio of personnel expenses to total assets; the price of capital is the ratio of other non-interest expenses to fixed assets and the price of borrowed funds is the ratio of interest paid to total funding. total cost is the sum of personnel expenses, other non-interest expenses and interest paid (fungacova et al. 2013). the coefficients of this cost function are used to compute marginal costs values as follows: using marginal costs and price, we are able to calculate the lerner index for each bank and for each year and thus obtain a direct bank level measure of competition. we also go further and use the adjusted lerner index6, calculated as follows: . q is total output. although the lerner index has been widely used in the empirical literature, the theoretical foundations of the index as a competition measure are not robust (boone 2008). amir (2000), bulow and klemperer (1999), rosenthal (1980) and stiglitz (1989), for example, present models where more intense competition leads to higher instead of lower lerner index values. corts (1999) shows that the estimates of the lerner index will typically underestimate the price-cost margin and the level of market conduct itself. boone (2008) argues that their competition measure is theoretically more robust and does not pose more data that are stringent requirements than the lerner index. even though they found the lerner index and the boone indicator highly correlated on average, the lerner index tends to misrepresent the development of competition over time in markets with a few firms and a high concentration (markets most relevant for competition policy and regulation) and is thus less reliable (boone, van ours & van der wiel 2007). however, the empirical applicability and robustness of the boone indicator is still unknown.7 we use the boone indicator to measure market power and this measure is argued to capture directly the relationship between competition and efficiency. the premise on which it is built is that banks that are more efficient attain better performance or higher profits and that this outcome increases the degree of competition (schaek & cihak 2008). it is modelled as a relationship between profits and marginal costs because an increase in costs reduces profits, but in competitive markets the impact of changes in costs is relatively high since in this market inefficiency is heavily punished (cummins et al. 2017). we construct this indicator from a regression model as follows: in equation 4, p is profit and mc is marginal costs. the parameter bt is the boone indicator measured for each year and is expected to be negative, showing that increases in competition raise the profits of more efficient banks. we run this model for each year across all banks to estimate the boone indicator parameter. measuring efficiency in banking efficiency measures used in banking analysis are varied. we use allocative efficiency, technical efficiency, cost efficiency and profit efficiency. allocative efficiency is the extent to which resources are being allocated to the use with the highest expected value, while a firm is technically efficient if it produces a given set of outputs using the smallest possible amount of inputs (ncube 2009). a firm is also said to be cost efficient if it is both allocatively and technically efficient (berger & mester 1997). cost efficiency measures how close a bank is to its optimal cost when producing the same bundle of outputs (fungacova et al. 2013). profit efficiency measures how close a bank gets to the efficiency frontier, which denotes the maximum achievable profit, given a particular level of input and output prices (berger & mester 1997). this profit measure takes into account performance from both the cost and revenue side of bank business, and the argument is that profit efficiency is superior as it embraces cost efficiency (schaek & cihak 2008). in this study, we employ sfa to generate different efficiency scores (technical, cost and profit) for each bank in the sample during the period under analysis. we use the battese and coelli (1995) model which provides estimates of efficiency in a single step in which bank effects are directly influenced by a number of variables and is assumed to be superior to a two-step procedure, in which the estimated efficiency scores obtained from the stochastic frontier are then regressed during a second step on a set of explanatory variables. the sfa has the advantage of separating random noise from efficiency, while dea assumes that everything not accounted for by inputs (random noise) is efficiency. the banking sector is affected by different economic and industry-specific regulations and these can affect performance and be difficult to capture when estimating productivity models. in the case of sfa these kind of factors will be captured in the error term but will be ignored by the dea approach. the battese and coelli (1995) model is expressed as follows: in equation 5, yi is output for firm i, x is a set of inputs, b is a set of parameters and vi is a random error term assumed to be iid is a non-negative random variable representing inefficiency, independently distributed and truncated at . the mean of this distribution is assumed to be a function of a number of explanatory variables and given as ui = dizi. this gives the following inefficiency term: in equation 6, zi is a vector of variables that may affect firm efficiency, d is also a vector of parameters to be estimated and wi is a random variable defined by the truncation of the normal distribution with zero mean and constant variance (s2). in this case the point of truncation –zid is where wi > – zid. these assumptions are consistent with ui being a non-negative truncation of the n(zids2) distribution (battese & coelli 1995). the production function parameters b and the inefficiency coefficients dj are estimated using maximum likelihood techniques together with the following variance parameters. since technical efficiency is the ratio of observed production over the maximum possible technical output (a case of zero inefficiency), the efficiency measure te of firm i in any period could be expressed as follows: the above efficiency scores (equation 8) will assume the value of 1 when the firm is fully efficient and less than 1 otherwise. to estimate technical inefficiency scores we will use a translog production function because of its flexible nature. the stochastic frontier translog production function to be estimated is specified as follows: in equation 9, k represents capital, l is labour and bf equals borrowed funds used in production. we assume a half-normal distribution for the inefficiency term.8 in addition to technical efficiency, we also measure cost and profit efficiency. in the case of banks, cost efficiency is the minimum cost needed to produce the bank’s output vector if the bank was as efficient as the bestpractice bank in the sample that is facing the same exogenous variables. profit efficiency on the other hand measures how close a bank gets to the efficiency frontier, which denotes the maximum achievable profit, given a particular level of input and output prices (ncube 2009; schaek & cihak 2008). profit efficiency9 has the benefit of taking into account not only the cost side but also the revenue side of bank business and this distinction is important because banks compete not only through cutting costs but also through adjustments in revenues (schaek & cihak 2008). the efficiency channel is sometimes the conduit through which competition affects stability. therefore, in this study we want to identify the type of efficiency important for encouraging stability. cost and profit efficiency levels will be estimated using equations 10 and 11: in these equations, c is total cost and w and z are prices of inputs and output quantity. p is profit and q is a constant added to avoid taking the log of a negative number (in the case where profits are negative). vi and ui represent the white noise and the efficiency term. we impose standard homogeneity conditions by scaling profits and cost functions with one of the input prices (borrowed funds). the resulting efficiency effects are specified as follows: equation 12 is an expanded version of equation 6. equations 5 and 6 will be estimated simultaneously using frontier 4.1 model. the data used in this article are sourced from bankscope and sarb. measuring bank stability or soundness bank stability is the absence of the macro-economic costs of disturbances in the system of financial exchange between households, businesses and financial service firms. a sound banking system ensures the optimal allocation of capital resources to prevent costly banking system crises and their associated adverse feedback effects on the real economy (sarb 2017). the standard approach used in the literature to measure soundness is to use the z score, calculated as follows: this method has the advantage of being easy to compute as it only uses accounting information, combining bank buffers (capital and profits) with the risks they face (standard deviation of returns) in a way that is grounded in theory (schaek & cihak 2008). in equation 13, roa is the bank’s return on assets, ear is the equity to assets ratio while sroa is standard deviation of return on assets calculated over the sampling horizon. a higher z score implies a lower probability of insolvency (schaeck & cihak 2008). we also alternatively measured soundness using ratio of non-performing loans as a percentage of total loans. to investigate bank soundness, we estimate the following model: in equation 14, bsfu captures bank-specific features like age, size and foreign ownership while comp is bank competition measured using the lerner and boone indicators. the last variable, eff, is bank efficiency. we also control for macro-economic stability and economic performance using inflation and gdp. data the bank level data used in this study is from bankscope and covers 17 local and international banks and spans the period 2004–2015. what influenced the sample size is the availability of comparable data on the variables of interest as well as the timeline. some banks did not have data spanning 2004–2015 and were therefore excluded. the bureau van dijk, which compiles bankscope, now publishes financial statements covering the past five years and this again affected the inclusion of a number of banks in the study. the sample included commercial banks, a mutual bank and an infrastructure bank. our sample size is similar to the one used by simbanegavi et al. (2015) of 14 banks to investigate the level of competition. results and analysis descriptive or stylised facts about the sampled banks in the first part of this section we computed competition and efficiency scores and a summary of these statistics is presented in tables 3, 4 and 5. what is clear from these statistics is that efficiency levels are generally high, above 80%, and that these banks are more profit efficient than they are cost and technically efficient (see table 5). however, all these different measures of efficiency appear to have decreased over time, though the decline is marginal. there is also very little difference between the average efficiency levels of the big four banks and those of the 17 banks used in this study. this suggests that the computed efficiency scores are driven largely by the big four banks rather than the other 13 small banks included in the sample. these results are similar to those found by maredza and ikhide (2013) using the four largest south african banks and technical efficiency scores of around 98%. ncube (2009) using eight banks and okeahalam (2006) using bank branches in all the nine south african provinces, as well as obeholzer and van der westhuizen (2004) all found efficiency scores of 84%. mlambo and ncube (2011) using 25 banks found technical efficiency scores of around 67% and cost efficiency of 42%. the size of the sample and the sample period could be one of the reasons driving these differences in efficiency scores in these south african studies. in the case of competitiveness, the lerner index shows that competitiveness deteriorated between 2004 and 2007 and improved during the periods 2008–2010 and 2014–2015. in the case of the boone indicator, the more negative the value, the higher the degree of competition, because the effect of reallocation is stronger. this indicator has consistently been more negative from 2011 until 2015, suggesting that competitive conditions improved during this period. in the case of competition, most studies on south africa used country level indicators like the panzar rose (mlambo & ncube 2011; simatele 2015; simbanegavi et al. 2015) and the bresnahan (simbanegavi et al. 2015). however, statistics from global financial development (2017) show that using the lerner index (period 2000–2010) suggests that there is some level of competitiveness in the banking sector but the boone indicator (period 2000–2015) suggests that the level of competitiveness is falling. table 3: summary of statistics for all banks. table 4: summary of statistics for big four banks (standard bank, nedbank, amalgamated banks of south africa [absa]/barclays and first national bank). table 5: firm characteristics, efficiency and competition. the change in competitive conditions between 2004 and 2015 juxtaposed with the changes in efficiency levels over the same period show that the relationship between these two variables is not clear and is something that should be investigated using econometrics. we also went further and used descriptive statistics to explain how bank characteristics like age and size relate to bank efficiency and competitiveness. table 5 shows that older and bigger banks (in terms of total assets) are less efficient than younger and smaller banks. foreign-owned banks are slightly more efficient than local banks. in terms of competition, banks whose total assets size is greater than r173 100 million have more market power than smaller banks and this is the case even when looking at locally owned banks. banks older than the average age of 52 years appear to have less market power than younger banks.10 the correlation matrix (see table 2-a1) also adds some insights into how these variables move together. the size and age variables appear to move negatively with all efficiency variables and this is the case with the competition indicators like the lerner index. the z score, which is our measure of bank soundness, is positively correlated with efficiency variables suggesting prima facie that efficiency may be good for bank soundness. analysis of regression results the first model looked at the relationship between technical efficiency and different indicators of competitiveness (see table 6). we also included bank-specific variables like age, size measured using total assets and a foreign ownership dummy. these results partly confirm what is presented under descriptive statistics (table 5): that larger banks are less efficient than smaller banks. bank size has a consistently negative but significant relationship with technical efficiency. this could be explained by the fact that small banks have to be very innovative in order to survive and be able to attract clients by offering products or financial services at prices below what big banks are charging. this probably explains why even though the south african banking sector is dominated by a few large banks, this has never stopped new entrants into the sector and bank turnover has also been low. these results are contrary to what was found by hauner and peiris (2005) in uganda, ataullah, cockerill and le (2004) and chen, skully and brown (2005), but in line with what isik and hassan (2003), girardone, molyneux and gardener (2004) and weill (2004) found. bank age also appears to have a negative and significant relationship with technical efficiency. thus, older banks are less technically efficient than younger banks. in a highly concentrated banking environment like the one in south africa, new banks can only enter and survive longer if they innovate or offer products that are not offered by the existing banks and if they offer the same products at lower prices. albert (2012), however, found that age has a positive effect on efficiency using egyptian banks, while karim, chan and hassan (2010) found age to be positive and insignificant when related to efficiency and stability in malaysia and singapore. the correlation matrix (table 2-a1) shows a relatively high level of association between age and size, something that could indicate multicollinearity and affect the impact of these variables. to control for this, we ran the efficiency models again, dropping either the age or size variable. in all the models, the sign of the age and size variable as well as competition indicators did not change.11 being foreign owned does not appear to be important in enhancing technical efficiency in south africa. this could be explained by the fact that foreign technologies have to be adapted to local conditions before they can be successfully implemented. thus, you need to fully understand the local consumer market first before you can introduce new financial products or technologies. foreign financial innovations or technologies may not be successful locally unless adapted to local conditions. this result, however, is not consistent with what hauner and peiris (2005) found in uganda where efficiency was found to increase with foreign ownership. karim et al. found foreign ownership to be negative and insignificant when related to efficiency in malaysia and singapore. table 6: efficiency results. to analyse the relationship between competition and efficiency, we used the lerner index and the boone indicator. using the lerner index, the results show a negative and significant relationship between these variables supporting the efficient structure hypothesis. this result is similar to that found by casu and girardone (2009) using eu banks. the boone indicator and adjusted lerner results, however, support the quiet life hypothesis and show a positive relationship between technical efficiency and competition. we also used the generalised methods of moments (gmm) model and the instrumental variable technique to take care of possible endogeneity problems in the model. this is because the quiet life model hypothesises that competition increases efficiency while the competition-inefficient model assumes that competition reduces efficiency. results do not change much and still show a negative relationship between competition and efficiency and the same pattern with other bank characteristics.12 the shortcoming of using the gmm in this case is that it assumes that efficiency in the previous year affects efficiency in the current period. this assumption may render the competition indicator impotent. thus, if competition affects efficiency, its lagged value already contains this information and this could be the reason why it is insignificant. we followed the same approach as the one used in analysing technical efficiency in table 6, in analysing the determinants of cost and profit efficiency in the south african banking sector. the results (see table 7) are generally similar to what we found under technical efficiency. foreign ownership, bank size and bank age are all negatively related to cost and profit efficiency except that age is no longer statistically significant. the lerner and adjusted lerner indices are all significant and negatively related to these two efficiency variables while the boone indicator still show a positive relationship. thus, using the lerner indices, these results support the competition inefficiency hypothesis while the boone indicator is in support of the quiet life hypothesis or the competition-efficiency hypothesis. the relationship between competition and profit efficiency using the boone indicator also support what schaek and cihak (2008) refer to as the competition-efficiency hypothesis, which is adapted from the efficient structure hypothesis proposed by demesetz (1973). under the competition-efficiency hypothesis, increases in competition precipitates increases in profit efficiency. on the contrary, the results using the lerner index support the alternative, which they called the competition inefficiency hypothesis. in this case, competition leads to a decline in bank efficiency. according to boone (2008), the theoretical foundations of the lerner index are not robust and some theoretical papers have found more models where intense competition leads to higher lerner index values. the fact that the boone indicator also performs better in a highly concentrated market like the one in south africa reduces the attractiveness of the lerner index results. table 7: cost and profit efficiency determinants. in table 1-a1 (in the appendix), we also estimated a model using competition indicators as dependent variables. the results generally confirm what we found above: that there is a negative relationship between competition and efficiency using the lerner indices but a positive relationship using the boone indicator. thus, the lerner index results support the efficient structure hypothesis that efficient banks reduce bank competition. competition, efficiency and bank soundness the final section of this article looks at the impact of competition and efficiency on bank soundness. we measure bank soundness here using z scores. the objective is to find out which bank level characteristics affect bank stability. schaek and cihak (2008) argue that the popularity of the z score as a measure of bank soundness stems from that fact that it combines bank’s capital and profits with the risk they face in a way that is grounded in theory. the z score is inversely related to the probability of a financial institution’s insolvency and the higher this value, the lower the probability of insolvency. the other advantage of this measure is that it is easy to compute because it only requires each bank’s accounting information compared to market-based measures such as distance to default. the bank soundness results are presented in table 8 and the impact of competition indicators appear mixed. the lerner indices show a positive and significant relationship with bank soundness, while the impact using the boone indicator is negative though insignificant. what is, however, clear in these results is that efficiency indicators have a positive and significant effect on bank soundness. this result supports what is referred to in the literature as the ‘prudent and efficient management hypothesis’ (koetter & porath 2007; petersen & rajan 1997; schaek & cihak 2008). the argument is that more efficient banks have lower risks and are sounder than their less efficient counterparts. the negative value of the boone indicator and the positive value of the lerner index support this hypothesis in this south african banking sample. schaek and cihak, using data from europe and the united states, as well as cummins et al. (2017), using european life insurance markets found similar results. thus, an increase in the lerner index signals a fall in the level of competition and since we found a negative relationship between competition and efficiency, this means an increase in efficiency which increases bank soundness. the negative and significant effect of the adjusted lerner index supports the presence of what schaeck and cihak refer to as the ‘poor and inefficient management hypothesis’. in this hypothesis, competition adversely influences bank efficiency, resulting in a negative effect on bank soundness. thus if bank efficiency declines, these banks will do whatever it takes to retain old clients and attract new customers and by so doing may end up not employing sophisticated credit scoring systems and may also lack skills in assessing the value of collateral. this may result in a high proportion of non-performing loans and this negatively affects bank soundness (schaeck & cihak 2008). using non-performing loans (see table 3-a1 in the appendix) all competition and efficiency indicators show a negative effect on stability, partly supporting some of the results found using the z score values. table 8: z score results. results in table 8 also show that bank age and foreign ownership variables are negatively related to the z score but the effect is insignificant. however, in the case of bank size, there is a positive relationship and this is significant. this suggests that bigger banks have a lower probability of insolvency than smaller banks. karim et al. (2010), however, found age to be positive and foreign ownership to be negatively related to financial stability in malaysia and singapore. we also introduce two macro-economic variables and they appear to carry expected signs. inflation has a negative effect on the z score while gdp per capita carries a positive sign. conclusion the main aim of this study was to investigate the relationship between competition and efficiency in the south african banking sector, then go further, and see how these variables affect bank soundness. results show that the impact of competition on efficiency depends on the measure of competition used. when using the lerner index there is a negative effect of competition on efficiency while the opposite is true when using the boone indicator. results also show that bank size measured using total assets is significantly negatively related to efficiency. in the case of bank soundness, our results are partly consistent with what other researchers (cummins et al. 2017; schaeck & cihak 2008) have found. thus, competition using the boone indicator is negatively related to the z score, implying that competition enhances bank soundness and these results support the prudent and efficient management hypothesis. this is also the case when using the lerner index. although boone (2008) argued that their new theory-based measure of competition performs better than the traditional lerner index, especially in markets with a few firms and a high concentration, a feature characteristic of the south african banking landscape, the empirical robustness of this indicator remains questionable. however, given that our five-bank concentration ratio estimated for year 2015 was around 99% (see table 1), the south african banking sector is undoubtedly highly concentrated and a measure that takes this into account, as is the case with the boone indicator, is ideal. our conclusions are therefore in line with the boone indicator results, suggesting that the competition-efficiency relationship in south africa supports the quiet life hypothesis in which competition enhances efficiency. the improvement in the level of competition since 2011 partly supports the contestable market theory. other macro-economic variables used in the study also show consistent results. these results mean that the relationship between competition and efficiency in the south african banking sector supports the efficient structure hypothesis and the competition inefficiency hypothesis when using the lerner index, but when using the boone indicator results confirm the competition-efficiency hypothesis or the quiet life hypothesis. since the relationship between competition and bank soundness is generally unambiguous, there is therefore need for the regulatory authorities to weed out anti-competitive practices or barriers to entry into the banking sector. they should also ensure that the big four banks do not abuse their market dominance but that contestable market conditions are promoted. the enactment of the financial sector regulation bill, which intends to put in place an intensive, intrusive, and effective regulatory framework that will help in the implementation of the twin peaks model, is a welcome move. the prudential authority at sarb will enhance safety and soundness while the financial sector conduct authority (current fsb) will protect financial customers and ensure they are treated fairly. for future research, it would be informative to examine non-linearities between competition and soundness to ascertain whether there is an inflection point as found by fernandez and garza-garcia (2015), berger, klapper and turk-ariss (2009), tabak, fazio and cajueiro (2012) and fu, lin and molyneux (2014). there is need for more studies to investigate empirically the robustness of the boone indicator as a better measure of competition. acknowledgements besides thanks to the national research foundation (nrf) for funding and the anonymous reviewers, 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non-performing loans. footnotes 1. the south african reserve bank defines bank stability as the absence of the macro-economic costs of disturbances in the system of financial exchange between households, businesses and financial service firms. a sound banking system ensures the optimal allocation of capital resources, and efficient management of risks to prevent costly banking system crises and their associated adverse feedback effects on the real economy. 2. this, however, also depends on which efficiency hypothesis, as discussed in the first part of the introduction, characterises what is happening in the south african banking sector. 3. for more information on these structural and non-structural measures and their shortcomings, see leon (2015). 4. total revenue is equal to total interest and non-interest income 5. this approach of determining inputs and outputs variables is based on the intermediation approach. in this approach banks are treated as collectors of funds, which are then intermediated to loans and other assets. the total balance of deposits and loans is used as a measure for outputs, while operating and interest costs are used to measure total costs. in the production approach a bank is viewed as a producer of deposits and loans using labour, capital and materials. according to kaparakis, miller and noulas (1994), this approach seems more appropriate when the sample contains large banks, who fund a larger share of their assets from non-deposit sources. berger and humphrey (1997) suggest that the intermediation approach is best suited for analysing firm level efficiency, while the production approach is suited for measuring branch level efficiency, as at this level employees have little influence over funding and investment decisions (ncube 2009). 6. the criticisms of the standard lerner index is that it implicitly assumes banks are fully efficient. koetter, kolari and spierdijk (2012) show that by ignoring both cost and profit inefficiencies, the lerner index would lead to an even larger bias in price-cost margin, as well as in consumer and producer welfare losses. they propose a correction in the form of an efficiency adjusted lerner index. 7. van leuvensteijn (2008) found empirical support for the boone indicator using american sugar industry data, while schiersch and schmidt-ehmcke (2010) used german manufacturing data and showed that the indicator fails to correctly indicate competition compared to the traditional lerner index. 8. there are no a priori reasons for choosing one distributional form over another. all have advantages and disadvantages but the exponential and half-normal have a mode of zero ideal when many firms are perfectly efficient and are easy to compute compared to the truncated normal and gamma distributions (coelli, rao & battese 1998). 9. berger & mester (1997) consider the profit efficiency concept to be superior to the cost efficiency concept for evaluating the overall performance of a firm. firstly, profit efficiency is based on profit maximisation, which requires that the same amount of focus is placed on maximising marginal revenue so as to reduce marginal costs. secondly, the profit function deals with both input and outputs inefficiencies while the cost function accounts for only inefficiencies in inputs (vivas 1997). finally, a bank can be inefficient if it produces too few, or a nonoptimal mix of, outputs given the inputs it uses and the prices it faces. as highlighted by isik and hassan (2003), ‘cost efficiency models ignore this possibility and thus can misrepresent the nature and extent of efficiency of banks’. 10. we used the bank size mean and bank age mean to divide the banks into small and large, as well as older and younger respectively. the mean size using total assets was r173 100 million and the mean age was 52 years. there are no studies in south africa that looked at these bank level characteristics to compare with. 11. these results are not included here but are available on request. 12. we also ran another set of gmm models using lags of different efficiency variables and this did not change the general sign of the two competition indicators. the lerner index was however significant only when using cost efficiency but insignificant with profit efficiency. abstract introduction dividend taxation in south africa research methodology sample selection descriptive statistics and univariate investigations detailed regression findings additional analyses and robustness tests summary and conclusion acknowledgements references footnotes about the author(s) wessel m. badenhorst department of accounting, university of pretoria, south africa citation badenhorst, w.m., 2017, ‘tax preferences, dividends and lobbying for maximum value’, south african journal of economic and management sciences 20(1), a1476. https://doi.org/10.4102/sajems.v20i1.1476 original research tax preferences, dividends and lobbying for maximum value wessel m. badenhorst received: 16 sept. 2015; accepted: 15 feb. 2017; published: 24 mar. 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the value of equity investments depends to some extent on the tax consequences for investors. when groups of investors have different tax preferences, this can lead to conflicting pressures on firms to either retain earnings or pay dividends. the findings of this study will be of interest to researchers of taxation and corporate governance alike, as they highlight the role that corporate shareholders play in the decisions of the firm. investors and regulators will also be interested in the findings as they reveal more about the interaction between shareholders with conflicting interests. lastly, changes in behaviour as a result of changes in tax legislation are of interest to those with fiscal responsibility. setting: a 2012 dividend tax change in south africa, which simultaneously altered the tax preferences of individual and corporate investors, provides a unique opportunity to investigate firms’ reaction to their investors’ tax preferences. aim: this article seeks to determine whether firms respond to changes in their investors’ tax preferences in their decisions to either retain earnings or pay dividends. method: the article investigates the responses of firms to the 2012 dividend tax change using multivariate regressions. results: findings show that firms consider changes in the tax preferences of their investors in setting dividend policies. in addition, it appears that corporates have greater success in lobbying for beneficial dividend changes than individuals. conclusion: changes in investors’ tax preferences impact on firms’ dividend policy decisions. these decisions ultimately affect the value of the firm to its investors. introduction a general finance principle holds that the value of an investment is the present value of its future post-tax cash flows (ilmanen 2011:66; shrieves & wachowicz 2001). it follows, firstly, that maximising future cash flows maximises the value of an investment. a second implication is that minimising future tax outflows can improve value outcomes. when the tax consequences depend on the nature of the cash flow (e.g. income or capital), investors develop a preference for the lower tax alternative. however, groups of investors (e.g. individuals vs. corporates) frequently have different tax preferences, as tax consequences also depend on the identity of the investor. when investors with differing tax preferences invest in the equity of the same firm, this can lead to conflicting pressures on management to either retain earnings or distribute profits to investors. this article, therefore, investigates the response of firms when their investors have conflicting tax preferences. the setting for this article is a recent change in south african dividend tax on 1 april 2012, which replaced a 10% tax on firms with a 15% tax on shareholders. importantly, this tax change altered the tax preferences of two groups of investors, namely, individuals and corporates, simultaneously. toerien and marcus (2014) provide descriptive evidence that, subsequent to the tax change in south africa, corporate investors prefer dividends from a tax perspective. similarly, they find that individual investors prefer capital gains when tax is the only consideration. the south african situation, therefore, allows for an investigation of the impact of changes in tax preferences on dividends and also of the relative influence of corporate and individual shareholders. this is important, as prior research provides limited insights when tax preferences of shareholders alter in a conflicting manner. bond, devereux and klemm (2005) found that tax reforms affecting institutional investors in the united kingdom altered the form of dividends, but not their level. other research shows that norwegian and finnish firms increased dividends prior to tax increases for individuals (alstadsæter & fjærli 2009; kari, karikallio & pirttilä 2008). however, the tax changes in these countries affected only one investor group, and it is not possible to determine whether conflicting tax preferences of another investor group limited dividend increases. using a multivariate regression approach, this study considers the impact of corporate shareholding on growth in dividends prior and subsequent to the 2012 tax change for a sample of south african firms. this approach effectively tests the significance of changes in dividend growth before and after the tax change (related to a difference in difference approach). in addition, findings are cross-checked against an earlier tax change during 2007 (the control sample). although this tax change aligned the tax preferences of individual and corporate investors, the south african government simultaneously announced its future intentions in respect of dividend tax changes. findings show a significantly positive (negative) association between corporate shareholding and growth in dividends after (before) the 2012 tax change. in other words, after (before) this tax change, firms with higher corporate shareholding grew their dividends significantly faster (slower) than other firms. these findings imply that corporate shareholders had sufficient influence to align dividend policies of their investees with their tax preferences. this could be because of the size of their holdings or merely reflect that corporate investors tend to be better at organised lobbying than individuals. by contrast, findings for the control sample show that corporate shareholding had a limited impact on growth in dividends as a result of the 2007 tax change. in summary, this study, therefore, concludes that tax preferences of investors affect dividends. in addition, when tax preferences conflict, corporates appear to have greater influence over their investees than individuals. this study contributes to the existing literature by revealing that investors place pressure on firms to minimise their own tax burden and that firms adjust their dividend policies in response. in addition, it shows that, in the face of conflicting tax preferences, corporates appear to have greater influence than individuals. the findings of this study will be of interest to researchers of taxation and corporate governance alike, as they highlight the role that corporate shareholders play in the decisions of the firm. investors and regulators will also be interested in the findings, as they reveal more about the interaction between shareholders with conflicting interests. lastly, changes in behaviour as a result of changes in tax legislation are of interest to those with fiscal responsibility. the remainder of this article is organised as follows: the next section reviews the prior literature, followed by a discussion of dividend tax in south africa. then, the research methodology is set out, followed by the sample selection, descriptive statistics and univariate investigations. the detailed multivariate regression results are discussed in a separate section, followed by the results of additional analyses and robustness tests. the final section summarises and concludes the article. literature review investors are concerned with maximising the value of each of their investments, which is affected by the tax consequences associated with it. as a result, investors have an incentive to pressure firms to alter their decisions to improve tax outcomes. firms have an incentive to comply, as greater investor demand increases their market value, which in turn reduces the risk of takeovers and increases executive compensation. some research findings support such a conclusion. ayers, cloyd and robinson (2002) found that a dividend tax increase in the united states during 1993 affected stock returns, depending on the dividend policy of a firm and the tax status of marginal investors. similarly, a number of researchers found that firms in the united states increased their dividend payments after a tax cut during 2003 (blouin, raedy & shackelford 2011; chetty & saez 2005). by contrast, amromin, harrison and sharpe (2008) contended that the 2003 dividend tax cut in the united states affected a minority of investors (i.e. individual investors). they found no aggregate impact on the stock market and concluded that the tax cut affected individual investors, but not the dividend decisions of firms. this view is supported by edgerton (2013) who argued that several contemporaneous events led to the increase in dividends during 2003. research on tax changes in norway and finland finds that firms in these countries increased dividends prior to dividend tax increases on individuals (alstadsæter & fjærli 2009; kari, karikallio & pirttilä 2008). in respect of institutional shareholders, bond et al. (2005) found that tax reforms for pension funds in the united kingdom changed the form of dividends, but not the level thereof. however, the tax changes in these countries affected only one investor group, and it is not possible to determine whether conflicting tax preferences of another investor group limited dividend increases. in summary, prior researchers find that tax preferences of investors affect their own investment decisions. however, the impact on the dividend decisions of firms is less clear. this problem is exacerbated by the fact that most of the tax changes investigated by prior research affected only individuals. although prior research shows that corporate shareholders have a significant impact on dividend policy (bond et al. 2005; moser 2007; short, zhang & keasey 2002), the question is whether changes in their tax preferences affect growth in dividends. this question is especially relevant when changes in tax preference of corporates correspond with simultaneous, but opposite, changes in the tax preferences of other investors. in this context, recent changes in south african dividend tax legislation provide a unique opportunity for further investigation. dividend taxation in south africa in most countries, dividends are taxed in the hands of the recipient. however, from 1993 to 2012, firms in south africa were taxed on dividends they declared under a system known as ‘secondary tax on companies’ (stc). during this time, dividends were collected as tax free income by recipients. in the main, all dividend declarations were subjected to stc, regardless of the identity or nature of the recipient, although subsidiaries had a choice to exempt dividends paid to their parents. however, if the recipient was also subject to stc, it reduced its own stc liability based on dividends received (if the dividends received had been subject to stc). the rate of stc initially fluctuated but remained stable at 12.5% from 14 march 1996 to 30 september 2007. during 2007, the south african government announced its intention of aligning south african dividend tax practices with international norms. this entailed that stc (a tax on the dividend payer) would be replaced with dividend tax (a tax on the dividend recipient). as an initial step in this direction, the stc rate was decreased to 10.0% for dividends declared on or after 1 october 2007. an important aspect of dividend tax is its interaction with capital gains tax. simply put, the south african capital gains tax is levied on the difference between the proceeds received upon the sale of an investment and the price initially paid for it (base cost). as the tax regimes for dividends and capital gains differ, this may affect investors’ tax preferences for receiving dividends or retaining income in the firm. as toerien and marcus (2014) illustrate, capital gains tax would have been lower than stc for most south african equity investors prior to 1 october 2007. as a result, with the exception of individuals, south african investors preferred to retain income (as opposed to receiving dividends) if tax considerations were the only relevant factor. with the change of the stc rate in 2007, toerien and marcus (2014) calculated that all investors, including individuals, subsequently preferred to retain income from a tax perspective. however, on 1 april 2012, stc was finally replaced with dividend tax in respect of dividends declared on or after that date. this change altered the tax preferences of investors yet again. dividend tax is levied at a rate of 15.0% and is a tax on the dividend recipient. importantly, some recipients are exempt from the tax, notably south african firms (i.e. corporate investors) who receive the income tax free (they withhold dividend tax from their own dividend payments). toerien and marcus (2014) calculated that dividend tax was lower for corporate investors than capital gains taxes after this tax change, while the opposite was true for individuals. although toerien and marcus (2014) speculate that this would lead corporate investors to prefer dividends over retained income, they do not investigate this empirically. in another study related to this tax change, coetzee and de wet (2014) used an event study approach and found that the share prices of south african firms who increased their dividend pay-out ratios in response to the tax change reacted abnormally positively to dividend announcements. however, their paper does not shed light on the role that conflicting tax preferences of shareholders played. from the above discussion, it is clear that the south african situation allows for unique empirical investigations. prior research on dividend tax changes has been criticised by some, as these tax changes only affected individuals who make up a minority of shareholders (amromin et al. 2008). by contrast, the south african tax change caused a tax preference for higher dividend payments amongst corporates and simultaneously introduced a tax preference for retained earnings amongst individuals. as all taxpayers were affected by the tax changes, a broader investigation than that of prior research is possible. research methodology this article uses a multivariate regression approach to investigate the impact of changing tax preferences on dividends. to reduce the effect of contemporaneous changes, investigations focus on the impact of corporate shareholding on growth in dividends prior and subsequent to the tax change in 2012. this approach effectively tests the significance of changes in dividend growth (related to a difference in difference approach). it firstly eliminates omitted correlated variables that remain constant over time and secondly removes omitted correlated variables that change by a constant factor over time. in addition, findings are cross-checked against an earlier tax change during 2007 (the control sample). the following model is regressed for firm i, period t in the year immediately before and after each tax change: where dps is the growth (change) in total dividends per share declared from the previous period (excluding special dividends).1 roa is the change in return on total assets, calculated as earnings before interest and tax divided by average total assets (deangelo, deangelo & stulz 2006). it controls for profitability, as more profitable firms pay higher dividends. loss, an indicator set to one if a firm reports a basic loss per share and zero otherwise, is included for similar reasons. re is the change in retained earnings as a percentage of common equity. prior research finds that firms with a greater percentage of retained earnings to equity are more mature and tend to pay higher dividends (brockman & unlu 2011; deangelo et al. 2006). cash on hand is an important limiting factor for dividend payments. following prior research (al-ajmi & hussain 2011; brockman & unlu 2011; deangelo et al. 2006), the model controls for changes in cash and cash equivalents per share (cash). for similar reasons, the model includes an indicator variable (cf) set to one if a firm reports negative cash flow generated by operations and zero otherwise. leverage, including debt and preference share capital, limits dividends to ordinary shareholders because of contractual restraints. de is the change in the ratio of total assets to total common equity, calculated using book values (deangelo et al. 2006). firms with greater growth opportunities tend to reinvest earnings, rather than distribute it. gth represents the change in the 3-year annual compound growth rate in sales between period t and period t-1 (deangelo et al. 2006). dividends tend to be persistent (goncharov & van triest 2011; moser 2007) and pd controls for the change in dividend per share of the previous year. a number of studies found that shares held by employees affect the likelihood that dividends will be paid (brown, liang & weisbenner 2007; minnick & rosenthal 2014). consequently, the model controls for the percentage of common shares held by employees (emp).2 the variable of interest is corp, which is defined as the percentage of common shares held by corporate investors (i.e. the shares held by one company in another). if corporate shareholders have greater (less) influence than individual investors on firm’s dividend policies, corp will be significant and positive (negative) after the 2012 tax change. by contrast, insignificance for corp would indicate that firms ignore the tax preferences of their investors in determining dividend policies or that they treat all their investors alike. to compensate for the impact of outliers, all variables, other than indicator variables, are winsorised at the 1% and 99% levels. sample selection the initial sample to assess the impact of the 2012 tax change consists of firms with a primary listing on the johannesburg stock exchange (jse) in south africa on 31 march 2012 (the day before the tax change). this sample is reduced to include only those firms that were still listed on 31 march 2013 and for which all data items are available. the control sample is selected in a similar manner, using the firms with a primary listing on the jse on 30 september 2007 (the day before the tax change). once again the sample is reduced to include only those firms that were still listed on 30 september 2008 and for which all data items are available. in both instances, only firms that paid a dividend in the year before the tax change are included in the final sample. real estate investment trusts are eliminated from the sample, as these firms are not subject to dividend tax. the final sample numbers and industry composition are detailed in table 1. although sample numbers appear small, they represent approximately 67% (58%) of the available firms in the initial sample subject to dividend tax in 2007 (2012). no industry appears to dominate the sample, although retailers and financial services firms each comprise a little over 10% of the sample. all data items required for the purposes of this study are collected from datastream. in isolated cases, missing values on the database are hand-collected from publically available financial statements. table 1: sample composition. descriptive statistics and univariate investigations the descriptive statistics contained in table 2 show that the mean growth in dividend per share increased subsequent to the 2012 tax change from 11.8% in the previous year to 16.8%. however, the median growth declined during the same period from 8% to 5%. this implies that the observed increase in growth rates of dividends was not uniform and therefore that growth in dividends is influenced by a combination of different factors. the descriptive statistics also show that both the mean and the median growth in dividend per share decreased in the control sample subsequent to the 2007 tax change. this is in line with a change in tax preference for retaining earnings by all investors (toerien & marcus 2014). however, without controlling for other factors, this offers limited insights because of the global financial crisis at the time. table 2: descriptive statistics. the descriptive statistics in table 2 also confirm that ownership structures tend to be relatively stable over shorter periods. the difference in mean shareholding by employees (emp) and corporates (corp) is marginal between sequential years, while the median shareholdings are unchanged. for the main sample, mean (median) corporate shareholding is 16.2% (7.0%) in 2012 and 16.3% (7.0%) in 2013. by implication, most firms in the sample have corporate shareholders, although the extent of their holding differs. untabulated statistics show that the maximum corporate shareholding is close to 90% in each of the sample years. to investigate the impact of corporate shareholding on dividend per share, the sample is stratified into firms with corporate shareholding above and below the median in each of the sample years. panel a of table 3 shows that the mean dividend per share (level) does not differ significantly between the subsamples in any of the sample years. however, subsequent to the 2012 tax change, corporate investors prefer dividends to capital gains. the growth in dividends (change) for firms with corporate shareholdings above the median (30.9%) is significantly higher than the rest of the firms (2.8%) in 2013 at the 10% level of significance (p = 0.088). interestingly, 2013 is the only sample year in which the growth in dividends is higher for firms with high corporate shareholding. these comparisons, therefore, suggest that corporate investors successfully lobbied for higher dividends in line with their new tax preference after the 2012 tax change. table 3: results of univariate investigations. the pearson correlations in panel b of table 3 further support this conclusion. higher corporate shareholding is associated with significantly higher growth in dividends subsequent to the 2012 tax change at the 5% level (p = 0.013). in addition, these results suggest that corporate investors were holding back growth in dividends in anticipation of the tax change during 2012. for this year, higher corporate shareholding is associated with significantly lower growth in dividends at the 5% level (p = 0.014). by contrast, prior to the announcement of impending changes in tax policy during 2007, the degree of corporate shareholding had an insignificant impact on growth in dividends (p = 0.368). in addition, correlations for 2008 suggest that corporate investors were holding back growth in dividends in anticipation of the tax change for a considerable period of time. higher corporate shareholding is associated with significantly lower growth in dividends during 2008 at the 1% level (p = 0.007). the above findings, therefore, offer some preliminary evidence that changes in the tax preferences of corporate investors because of the 2012 tax change affected growth in dividends. however, this study relies on the results of multivariate investigations for its conclusions. these results are detailed in the sections that follow. detailed regression findings table 4 details the main results for this study from ordinary least squares regression. these results reflect that more profitable firms consistently have higher growth in dividends, with roa positive and significant at the 10% level or better in every sample year. none of the other control variables affect growth in dividends with the same level of consistency, although growth in cash (cash), changes in growth rates (gth) and restructuring (restr) all affected growth rates significantly in one or more sample years. table 4: main regression results. more importantly, the results in table 4 show that higher corporate shareholding subsequent to the 2012 tax change resulted in significantly higher growth in dividends at the 5% level (p = 0.040). these facts imply two important conclusions. firstly, firms consider the tax preferences of their investors in determining dividend policies. secondly, corporate investors appear to be more successful at applying pressure on their investees than individual investors in the face of conflicting tax preferences. interestingly, findings also imply that corporate investors lobbied successfully for slower growth in dividends prior to the tax change, as corp is negative and significant at the 5% level (p = 0.040) in 2012. in addition, a chow-test (chow 1960) shows that the factors affecting dividend growth during 2013 differ significantly from those in 2012 at the 1% level (p = 0.004). in contrast, findings from the control sample show that corporate shareholding had an insignificant impact on dividend growth prior to the announcement of impending tax changes during 2007 (p = 0.476). the results also suggest that corporate investors successfully lobbied for slower dividend increases by their investees for a considerable period of time prior to the tax change. corp is negative and significant at the 10% level (p = 0.099) for the 2008 sample. in addition, a chow-test (chow 1960) shows that the factors affecting dividend growth during 2008 differ significantly from those in 2007 at the 1% level (p < 0.001). results for the control sample, therefore, suggest that corporate shareholding does not have an impact on growth in dividends independently of known or anticipated changes in tax legislation. overall, the main regression results, therefore, imply that firms consider the tax preferences of their investors in determining dividend policies. in addition, corporate investors appear to have greater influence over their investees than individual investors when tax preferences conflict. this could be because of the size of their holdings or merely reflect that corporate investors tend to be better at organised lobbying than individuals. additional analyses and robustness tests determining independent results for each year the main regression results reveal that growth in dividends is affected by the degree of corporate shareholding. however, it is possible that corporate shareholding affects the dividend itself (i.e. the level thereof) independently of changes in tax preferences. for this reason, the regression is also run using a levels specification. the results from this model specification are presented in table 5. table 5: regression results determined independently per year. table 5 reveals that corporate shareholding (corp) is insignificant in all of the sample years, with the exception of 2013 (the year subsequent to the tax change). in this year, higher corporate shareholding is associated with significantly higher dividends per share at the 1% level (p = 0.009). these findings, therefore, imply that corporate shareholding does not affect the dividend levels independently of changes in tax preferences. in addition, results from a chow-test (chow 1960) show that the determinants of dividends per share for the control sample of 2007–2008 are statistically indistinguishable between years (p = 0.704). by contrast, the determinants of dividends per share changed significantly after the 2012 tax change (p < 0.001). in other words, higher corporate shareholding played a unique role in setting dividend pay-outs subsequent to the 2012 tax change, which it did not do previously. results from this robustness test, therefore, imply that corporate shareholding does not affect dividends independently of changes in tax preferences. in addition, the findings also confirm that corporates successfully lobbied for higher dividends subsequent to the 2012 tax change, despite their new tax preferences conflicting with those of individuals. controlling for cross-sectional correlation the main regression results do not control for cross-sectional correlation between firms, mainly because the tax change is itself severely cross-sectionally correlated in nature. in other words, decisions based on the tax change cannot be independent between firms. however, to investigate the impact of cross-sectional correlation, the regression is also run with robust standard errors clustered by firm. these results are presented in table 6. table 6: controlling for cross-sectional correlation. findings show that higher corporate shareholding continues to be associated with higher dividend growth subsequent to the 2012 tax change, albeit at the 10% level (p = 0.066). in addition, results continue to suggest that corporate investors successfully lobbied for slower dividend growth in anticipation of the tax changes, with corp negative and significant at the 5% level (p = 0.033) during 2012. however, in the control sample of 2007 to 2008, corp is now insignificantly associated with growth in dividends in both sample years. therefore, the main findings in respect of the 2007 tax change are not robust to controlling for cross-sectional correlation. in summary, controlling for cross-sectional correlation does not alter the main conclusions of this study. results continue to imply that firms consider the tax preferences of their investors in determining dividend policies and that corporate investors have greater influence over their investees than individual investors when tax preferences conflict. however, it appears that lobbying in anticipation of future tax changes could be weaker than what the main results suggest. ethical consideration this study was approved by the research ethics committee of the university of pretoria. it uses only secondary data that are publicly available. summary and conclusion when investors with differing tax preferences invest in the equity of the same firm, this can lead to conflicting pressures on management to either retain earnings or distribute profits to investors. this article investigates the response of firms when their investors have conflicting tax preferences using a change in south african dividend tax on 01 april 2012 as its setting. importantly, this tax change allows for unique investigations as it altered the tax preferences of two groups of investors, namely, individuals and corporates, simultaneously. using a multivariate regression approach, this study considers the impact of corporate shareholding on growth in dividends prior and subsequent to the tax change during 2012 for a sample of south african firms. this approach effectively tests the significance of changes in dividend growth (related to a difference in difference approach). in addition, the findings are cross-checked against an earlier tax change during 2007 (the control sample). findings show a significantly positive (negative) association between corporate shareholding and growth in dividends after (before) the 2012 tax change. in other words, after (before) this tax change, firms with higher corporate shareholding grew their dividends significantly faster (slower) than other firms. these findings imply that corporate shareholders had sufficient influence to align dividend policies of their investees with their tax preferences. this could be because of the size of their holdings or merely reflect that corporate investors tend to be better at organised lobbying than individuals. by contrast, findings from the control sample show that corporate shareholding had a limited impact on growth in dividends as a result of the 2007 tax change. in summary, this study, therefore, concludes that tax preferences of investors affect dividends. in addition, when tax preferences conflict, corporates appear to have greater influence over their investees than individuals. this study contributes to the existing literature by revealing that investors place pressure on firms to minimise their own tax burden and that firms respond to this pressure through their dividend policies. in addition, it shows that, in the face of conflicting tax preferences, corporates appear to have greater influence than individuals. the findings of this study will be of interest to researchers of taxation and corporate governance alike, as they highlight the role that corporate shareholders play in the decisions of the firm. investors and regulators will also be interested in the findings, as they reveal more about the interaction between shareholders with conflicting interests. lastly, changes in behaviour as a result of changes in tax legislation are of interest to those with fiscal responsibility. however, the findings of this study are limited to tax changes that altered the tax preferences of corporate and individual investors simultaneously. in addition, the findings cannot be extrapolated to conflicting tax preferences between other groups of investors. such questions are left to future research. acknowledgements the author would like to thank marna de klerk, petri ferreira and lizette kotze for their helpful comments and suggestions. competing interests the author declares that he has no financial or personal relationships that may have inappropriately 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value (npv): a reconciliation of variations of discounted-cash-flow (dcf) valuation’, engineering economist 46(1), 33–52. https://doi.org/10.1080/00137910108967561 toerien, f. & marcus, m., 2014, ‘the effect of south african dividend and capital gains taxes on share prices and investor expected returns’, journal of applied business research 30(3), 895–908. https://doi.org/10.19030/jabr.v30i3.8574 footnotes 1. note that the worldscope data item on datastream is adjusted for events such as stock splits and share consolidations. this ensures the comparability of the data across sample years. 2. ownership structures tend to be relatively stable over shorter periods of time, which the descriptive statistics of this paper confirm. for this reason, the ownership percentages in this paper are not specified as changes therein. journal 7.indd sajems ns 13 (2010) no 1 85 capital budgeting practices used by selected listed south african firms john hall department of financial management, university of pretoria sollie millard department of statistics, university of pretoria accepted february 2009 abstract this article investigates the application of capital budgeting techniques and the incorporation of risk into the capital budgeting process among a sample of south african industrial firms listed on the jse securities exchange for at least ten years. previous international and local research on this topic indicated a preference for the internal rate of return (irr) as a capital budgeting method over the net present value (npv), and that risk incorporation was relatively rarely incorporated into the capital budgeting process. the results of this study indicate that the npv is just as popular as, and sometimes more so than, the irr. furthermore, compared to previous studies, risk is incorporated into evaluating capital budgeting projects more often. sensitivity analysis is the most popular method, but adjustments to the cash flows and discount rate are becoming more popular. during the last decade the use of non-financial criteria to accept or reject a project has also increased in south africa. key words: capital budgeting practices; net present value; internal rate of return; risk in capital budgeting; sensitivity analysis in capital budgeting jel g31 1 introduction the importance of capital budgeting for capital formation and the growth of a country’s gross domestic product is undoubtedly one of the most important topics in economics today. capital budgeting is not only a popular corporate finance topic, but it is also amongst the topics most widely researched by academics. a capital budgeting project is a decision to make a cash outlay in order to receive future cash inflows. if the present value of the cash inflows exceeds that of the outlay, shareholder value is created. a number of stages, calculations, evaluation methods and refinements to the capital budgeting process can be used. it is these aspects of the capital budgeting process that are investigated in this study. the importance of the capital budgeting process for the firm lies in the fact that relatively large amounts of money are committed for a long time. once the decision to start a project has been made, the process cannot be reversed unless a value destruction decision is taken to salvage what has been invested. the purpose of this paper is to present evidence on capital budgeting practices based on a survey of a number of carefully selected companies listed on the jse securities exchange (jse). the first objective of this study was to investigate the capital budgeting techniques applied by the respondents. the second objective was to investigate the incorporation of risk in the capital budgeting process. this paper adds to a large collection of papers and research material on this topic, but it differs in a number of ways from previous surveys, especially from those on south african data. firstly, the 86 sajems ns 13 (2010) no 1 sample used in this survey is not a broad-based one, but it was chosen specifically to target a particular type of listed company. secondly, the questionnaires were completed by means of personal interviews. whilst this method has some disadvantages, it also has a number of advantages, such as a high response rate. this paper specifically evaluates the following hypotheses in order to address the stated objectives: hypothesis 1: the stages in the capital budgeting process were not all equally important. hypothesis 2: the stages in the capital budgeting process were not all equally difficult. hypothesis 3 the listed cash flow forecasting methods were not all equally important. hypothesis 4 the listed capital budgeting techniques were not all equally important. hypothesis 5 the listed non-financial criteria used in major financial decisions were not all equally used. hypothesis 6 the listed risk stages were considered not to be equally risky. hypothesis 7 the listed risk analysis techniques were not all equally likely to be used. hypothesis 8: the listed risk adjustment options were not all equally likely to be used. the purpose of this paper was not to imitate or replicate previous studies, but to add to the body of knowledge by not only reporting on the findings with regard to this particular sample, but also comparing and contrasting its findings with those of other international and local studies in order to interpret any differences, if and wherever they are found. the paper is organised as follows: in the next section, previous research on this topic is addressed; next, the research methodology is discussed, after which the empirical results are presented and evaluated; and, lastly, conclusions are drawn, recommendations are made and ideas for further research are presented. 2 previous research 2.1 south african studies previous research on capital budgeting practices based on south african data includes that of andrews and butler (1986). they received 132 responses out of 500 companies and they found that larger firms tended to employ more sophisticated capital budgeting techniques. the uses of capital budgeting techniques in south africa were also investigated by hall (2000). in his studies, useable responses from 65 respondents out of a total population of 300 provided similar results to those of previous south african studies. a recent study by du toit and pienaar (2005) also found that companies that undertake relatively large capital expenditures tend to prefer the irr and the net present value (npv) method. the latter study was based on 64 useable responses from a population of 524. there are a number of studies on risk incorporation in the capital budgeting decision by south african firms. parry and firer (1990) found that 18 per cent of their respondents had no response to any technique, but that 61 per cent sometimes or often used sensitivity analysis. hall (2001) found that 25 per cent of the larger firms (and approximately 40 per cent of smaller firms) who responded to his survey at that time did not use any formal risk adjustment technique. in his study, sensitivity analysis was also found to be the most popular and it was used by 40 per cent of the larger firms that responded. however, sensitivity analysis can be regarded as a relatively unsophisticated risk adjustment tool, compared to techniques like decision trees, simulation (including monte carlo simulation) and real option analysis. 2.2 international studies international studies over four decades on capital budgeting practices, show that there has been a definite shift in the capital budgeting sajems ns 13 (2010) no 1 87 evaluation techniques employed by companies. a study by ryan and ryan (2002) indicated that financial managers have never been in full agreement as to the choice of the best capital budgeting method. according to ryan and ryan (2002), earlier studies by miller in 1960, by schall, sundam and geijsbeek in 1978 and by pike in 1996 reported the payback technique to be the preferred method and discounted cash flow models to be the least popular. this may be attributed to lack of financial sophistication (and even training or education in corporate finance) and the limited use of computer technology in that era. ryan and ryan (2002) reported more recently, that a decrease in the use of the accounting rate of return was found by jog and srivastava in canada in 1995 and by pike in the united kingdom in 1996. a very similar pattern can be noted in the capital budgeting practices of multinational firms. kim and ulferts (1996) summarised the results of five studies from 1980 to 1993. the results of these five empirical studies revealed that discounted cash flow techniques were more popular than other techniques and that the irr was the most popular capital budgeting technique. at least half of the respondents in all the studies they summarised used discounted cash flow techniques. in one study, 81 per cent of the respondents used either the npv or the irr. in a study on the same topic, following eight research projects from 1959 to 1981 stanley and block (1984) found that not only were the npv and the irr the most popular capital budgeting evaluation techniques for a multinational corporation, but also over time, these techniques had become more popular. it can be assumed that this trend will continue in future. graham and harvey (2001) found that ceos with mbas are more likely to use the npv method than those without mbas, possibly because the npv method is regarded as a more sophisticated capital budgeting method than some other methods. a detailed analysis of a number of past studies on capital budgeting techniques by cooper et al. (2002) confirmed the shift towards discounted cash flow techniques over time. in their analysis of various research projects, they found that as a primary capital budgeting method the irr had increased in popularity from 10 per cent in 1959 to 41 per cent by 1975 and to 57 per cent by 1990. however, the npv did not enjoy either the same popularity or the same spectacular increase in use over time. on the other hand, there were indications in a study by kim and farragher (1983) that, while most business executives understand the new analytical techniques and recognise the importance of these methods, there seems to be a time lag in the practical implementation of these methods. recent surveys revealed an increased effort to use sophisticated risk analysis techniques for capital budgeting projects. these new techniques will probably be used increasingly as more standardised and sophisticated computer programs become readily available. parry and firer (1990) reported that in a study by petty et al. in 1975, a surprisingly high percentage of 77 per cent of firms used an adjustment of the payback period to adjust for risk. they also reported that 42 per cent of the respondents in a study by buler in 1982 used this method to compensate for risk. gitman and forrester (1977) found that 71 per cent of their respondents gave explicit consideration to risk. they argued that these results were confirmed by a study by fremgen in 1973 in which 67 per cent of fremgen’s respondents incorporated risk in the evaluation of their capital budgeting projects. it seems therefore that empirical studies covering several decades, indicate that for a long time the npv trailed the irr as preferred capital budgeting method and the incorporation of risk in the capital budgeting process varies both in the methods applied as well as in the rate of application of these methods. 3 research method the way the sample of this study was constructed from the total population lies at the heart of this research project. the database of the bureau of financial analysis (bfa) at the university of pretoria was used to assist in the compilation of this sample. in order to select the sample of 88 sajems ns 13 (2010) no 1 companies, a number of guidelines were set. firstly, it was decided to use only industrial companies, as the nature of their activities complies best with the nature and objectives of this study. at the end of 2005, a total of 177 industrial companies was listed on the jse securities exchange (jse). secondly, in order to obtain more meaningful results and to add more weight to the responses, only companies that had been listed for at least ten years were included in the sample. thirdly, companies were also questioned on the discount rate used in the evaluation of the capital budgeting decision. because the cost of equity can be calculated by means of the capital asset pricing model (capm), where the beta (β) plays an important role in the actual calculation, companies whose shares traded less than 500 000 shares per year were excluded from the sample, since the beta calculation might be distorted. this left 67 companies in the final sample. at each of these companies, one decision-maker was interviewed using a structured questionnaire. once the sample had been selected, the design of the questionnaire was undertaken. the questionnaire consisted of four sections. the first section dealt with the company and decision-maker profile, which was necessary to categorise the data of the various responses. it gave an indication of the seniority and level of education of each decision-maker surveyed. it also indicated the size of the company and its capital budget. eight questions were asked in section one of the questionnaire. section two dealt with the stages of the capital budgeting process, as well as the various capital budgeting techniques employed for different types of projects by the various respondents. this section consisted of ten questions. section three dealt with the incorporation of risk in the capital budgeting decision and consisted of five questions. the last section investigated the use and various aspects of a discount rate in the capital budgeting process. the results of this section will be discussed in a subsequent paper. the statistical analysis includes a basic descriptive analysis as well as chi square tests for uniformity. 4 empirical analysis 4.1 introduction the data was collected by means of personal interviews with the person responsible for the capital budgeting process at each of the identified companies. in the end, 41 usable responses were gleaned from the 67 sample companies, which were used in the empirical analysis. 4.2 company and decision-maker’s profile the profile of the company and the company decision-maker provide some indication of the level of experience and education of the capital budgeting decision-maker in the firm, as well as the size of the firm. this information places in perspective the results of the actual capital budgeting processes and techniques that individual firms apply in practice. the first question dealt with the job title of the respondent. in 50 per cent of the cases, the job title of the capital budgeting decision-maker was given as that of ‘financial manager’, and in 18 per cent of the cases it was ‘financial director’. the next three questions were designed to establish the level of education and expertise of the respondents. it was established that 68 per cent of the respondents had been employed by their companies for more than five years, while 18 per cent had been employed between two and five years. the balance had been employed for less than two years. of the respondents, 40 per cent had been in their current positions for more than 5 years, 30 per cent have been in their current positions for between two and five years, and 30 per cent had been in these positions for less than two years. with regard to the academic qualifications of the respondents, it was determined that 65 per cent had a postgraduate qualification (an honours or master’s degree), 16 per cent had a basic bachelor’s degree, and 19 per cent had other qualifications (diplomas, certificates or other training). from these results one can deduce that the majority sajems ns 13 (2010) no 1 89 of the capital budgeting decision-makers had a good academic grounding and sufficient experience in their decision-making capacity with their firms. there was a relatively even distribution of the 41 companies within the 15 applicable industrial sub-sectors of the jse. no particular sub-sector dominated substantially, attracting more respondents than any other sub-sector. these results therefore support those on the capital budgeting practices. an even distribution of representation amongst various industries is preferable to a situation where responses from one or two sectors or industries dominate the overall responses. tables 1 and 2 illustrate the respondents’ total assets, the amount of annual sales and the size of the annual capital budget. the results of the firms’ sizes according to their total assets show that by far the majority of the respondents (73 per cent) had assets of more than r1 billion. a relatively even distribution amongst the other monetary ranges represented the balance. table 1 amount of total assets total assets % less than r100 million between r100 million and r200 million between r200 million and r500 million between r500 million and r1 billion more than r1 billion 7.3 9.8 2.4 7.3 73.2 100 a similar pattern can be found in table 2, which suggests that more than 90 per cent of the firms in the sample have sales in excess of r200 million. an analysis of the results of the firms’ annual capital budgets revealed two main categories. in the first place, 25 per cent of the respondents had a capital budget of less than r50 million. secondly, and more importantly, 60 per cent of the respondents had an annual capital budget in excess of r200 million. the importance of the capital investment decision is clear, as one can extrapolate that if 60 per cent of 41 respondents spend more than r200 million, the total capital expenditure of this sample is more than r5 billion annually. table 2 annual sales and size of annual capital budget range annual sales % annual capital budget % less than r50 million between r50 million and r100 million between r100 million and r150 million between r150 million and r200 million more than r200 million 4.9 0.0 2.4 2.4 90.3 25.0 2.5 7.5 5.0 60.0 100 100 90 sajems ns 13 (2010) no 1 the results of the company and decision-maker profiles for this sample were to be expected, given the nature of the sample of companies for this study. industrial companies listed for at least ten years created a sample that gave specific meaning and weight to the results of the importance of the stages in the capital budgeting process, as well as the capital budgeting techniques that these firms apply in practice. 4.3 stages in the capital budgeting process as one can see from table 3, the majority of the respondents regarded project definition and cash flow estimation as the most important and the most difficult (p-values of 0.0008 and 0.0005 respectively). financial analysis was regarded as the second most important, but not as difficult. this could stem from the fact that the respondents are well educated, with a relatively high level of work experience. project implementation was regarded as the most difficult jointly with the cash flow estimation. table 3 most important and most difficult stages in the capital budgeting process stage most important % most difficult % project definition and cash flow estimation financial analysis and project selection project implementation project review 57.1 33.3 9.6 0.00 41.5 9.8 41.5 7.2 p-value for uniformity 100 0.0008 100 0.0005 it was very interesting that in this analysis the respondents gave project review such a low rating. project review and follow-up after implementation are now regarded as playing a much more important in the capital budgeting process than in the past. the last phase in an integrated capital budgeting system is post-auditing the project. it first involves the examination of the project’s progress in its implementation phase, and second, an in-depth analysis of the actual costs and benefits to date, the likely future prospects of the project and a comparison of these prospects to the initial expectations. the core aims of a post-audit system are usually to improve capital budgeting decision-making, to assess management expertise in evaluating, implementing and operating a project, and to identify and correct discrepancies early in a project’s life. post-completion auditing is both part of the capital budgeting system and its regulator. if any deviations from the budget emerge during this process, investigators may suggest one of three possible actions: fine-tuning the project to get it back on course, a significant change in the future development of the project, or outright abandonment of the project. the adoption of the post-completion audit by companies over three decades was tabled by neale (1994). these past surveys revealed clear but apparently shrinking disparities between us and uk companies over time. it seems, however, that on average us companies have a higher post-audit adoption rate (seldom below 80 per cent in seven surveys) than the uk companies (in the region of a 60 per cent adoption rate over seven surveys). capital budgeting post-audits play a potentially critical role in helping firms to learn from their past experiences and in providing a mechanism for transferring knowledge relevant to improving procedures and therefore more effective decision-making throughout an organisation. sajems ns 13 (2010) no 1 91 4.4 cash flow forecast method used the question which cash flow forecasting method the respondents used, provided the respondents with four alternatives, as set out in table 4 below. the results from this question are somewhat disturbing, since using management’s subjective estimates was the most popular cash flow forecasting method having a p-value of less than 0.0001. this method was chosen above formal quantitative measures, which was used in only 33.3 per cent of the cases. if management’s subjective estimates are added to the responses of respondents who ‘cannot say’ what method they used, we find that 50 per cent of respondents appeared not to use a formal cash flow forecasting methods to estimate their future cash flows. table 4 cash flow forecasting methods used cash flow forecasting method % management subjective estimate quantitative methods consensus of expert’s opinions cannot say 46.3 33.3 14.8 5.6 p-value for uniformity 100 < 0.0001 4.5 capital budgeting techniques one of the most important questions that needs to be answered by any study on capital budgeting practices is what the respondents’ preferences are regarding the most important capital budgeting technique to be used. the results for this question are set out in table 5 below. from the results it is clear that the null hypothesis can be rejected having a pvalue = 0.0004. the statistical results indicated that return on investment (roi) was the most popular method, with a third of the respondents choosing this method. the npv was second, with nearly 29 per cent, and the irr came third with nearly 24 per cent. the profitability index, present value payback and the accounting payback did not appear to play any significant role in the capital budgeting decision-making process, with the latter method receiving no responses at all. table 5 preferences regarding the most important capital budgeting techniques technique % return on investment net present value internal rate of return profitability index present value payback accounting payback other 33.3 28.6 23.7 4.8 4.8 0.0 4.8 p-value for uniformity 100 0.0004 92 sajems ns 13 (2010) no 1 the fact that the roi was selected as the most popular capital budgeting evaluation technique is in line with the results of previous research on south african companies by hall (2000). the question arises, however, how exactly the respondents defined ‘return on investment’. b o t h t h e ‘ r e t u r n ’ a n d t h e ‘ i n v e s t m e n t ’ components of the term are subject to different interpretations and definitions. nevertheless, the fact that it remains a popular method cannot be denied. the findings of this study show that the preference for the npv as a capital budgeting evaluation technique is not significantly (pvalue=0.7165) above the irr and is in contrast with the findings of previous studies. as has already been mentioned above, research results from a number of south african and international studies indicated that the irr is more popular than the npv. academics prefer the npv above the irr as a capital budgeting method, especially when they are evaluating mutually exclusive projects. the npv has better re-investment rate assumptions and provides a more value-enhancing decision when there is a conflict in the ranking of projects between the npv and the irr. in this study the preference of the npv and irr as capital budgeting techniques can possibly be attributed to the fact that the sample companies are large, well-established concerns with well-educated decision-makers. with regard to the capital budgeting techniques used, respondents were asked whether they applied different techniques when they assessed different types of projects. six different types of projects were identified, namely the expansion of existing projects, the expansion of new projects, foreign projects, the abandonment of projects, general or administrative projects and social projects. a summary of the various responses is given in table 6 below. table 6 techniques most often used in assessing different operations irr % npv % pi % pvp % apb % roi % other % capital investment projects in general expansion of existing projects expansion in new projects foreign projects abandonment general/administrative projects social projects 21.4 18.5 15.8 15.5 7.9 7.5 5.4 31.0 27.9 29.6 18.8 39.5 25.0 8.1 7.1 7.0 9.1 3.1 18.4 2.5 2.7 7.1 7.0 4.6 6.3 5.3 15.0 8.1 0 0 2.3 0 2.6 15.0 8.1 31 32.6 31.8 43.8 15.8 20.0 8.1 2.4 7.0 6.8 12.5 10.5 15.0 59.5 from these responses, a number of very definite trends emerge. roi is still the most popular method for the first four more traditional capital budgeting operations (namely projects in general, expansion of existing and new projects and foreign projects). as a matter of fact, the popularity of the roi reached a very high 44 per cent for foreign projects. after the roi, the npv was rated the second most popular method for evaluating these projects, even more than the irr. this is in line with the findings set out in table 5 above when the overall most important capital budgeting method was chosen, but contrasts with the results of previous studies, which cited the irr as more popular than the npv in most cases. when the abandonment of projects and administrative projects was evaluated, the npv was the most popular method. there seems therefore to be some correlation between the use of the roi as a capital budgeting sajems ns 13 (2010) no 1 93 evaluation method when it comes to tradi tional, value-creating types of projects. the rise of the popularity of npv as evaluation method to almost as popular as the roi in these types of project is also noteworthy. in addition to this trend, the irr seems to have lost some of its appeal amongst the respondents of this study in favour of the npv as a capital budgeting method. table 7 non-financial capital budgeting evaluation criteria item % legal requirements necessity of maintaining existing projects safety of employees or public social concern pollution control contractual commitments investments never accepted on non-financial grounds employee’s convenience 20.6 16.5 16.5 13.4 12.4 10.3 6.2 4.1 p-value for uniformity 100 0.0204 table 7 provides a summary of the non-financial criteria that can be applied when evaluating a capital budgeting project. it is interesting to note that in only 6.2 per cent of the cases investments were never accepted on non-financial grounds (p-value 0.0204). this is in sharp contrast to a previous study by hall (2000), where it was found that nearly 34 per cent of respondents never accepted investments on non-financial grounds. as one can see from the above table, legal requirements were the biggest non-financial factor when respondents evaluate capital budgeting projects. it can be argued that maintaining existing projects is often a case of ‘in for a penny, in for a pound’. it is however still a situation where additional (unforeseen) outlays in an investment project may be undertaken without financial evaluation. it therefore seems that over time, especially amongst the respondents of the current study, there is a tendency for non-financial criteria to play a more important role in the evaluation of investment projects. 4.6 the incorporation of risk in the capital budgeting process the importance of incorporating risk in the capital budgeting process has been preached by academics for years. as indicated above, a number of studies, both local and international, have been conducted in order to establish the use of risk adjustment techniques in capital budgeting by practitioners. table 8 gives an indication as to what the respondents regard as the highest risk stage in the capital budgeting process. it seems that project definition, cash flow estimation and project implementation are considered to be of equal risk (p-value = 0.5836). this finding corresponds with what the respondents considered to be the most difficult stage in the capital budgeting process (see table 3 above). 94 sajems ns 13 (2010) no 1 table 8 highest risk stage in capital budgeting process item highest risk % project definition and cash flow estimation financial analysis and project selection project implementation project review* 35.0 25.0 37.5 2.5 p-value for uniformity *excluded from test since only 1 respondent selected this item. 100 0.5836 this finding contrasts with previous conclusions by hall (2000), who found that the project definition and cash flow estimation were considered to be significantly more risky (46.2 per cent) than any other stage. there therefore seems to be a marked increase in the risk consideration that especially the project implementation stage carries. the fact that the financial analysis was considered to be relatively less risky could stem from the fact that the respondents are academically well educated with a high level of experience and are therefore at ease with the actual financial calculations and analysis of the project. respondents were then asked to indicate the specific risk analysis technique that they used. these results are summarised in table 9 below. the statistical analysis indicates that the risk analysis techniques are not equally likely to be used, having a p-value < 0.0001. from this table it is clear that only 7 per cent indicated that they used no formal technique. this is in sharp contrast to the results of previous studies where it was found that up to 40 per cent of respondents did not use any formal technique to incorporate risk in the capital budgeting process. the trend that more respondents actually do incorporate risk in their capital budgeting decision can be ascribed to a number of reasons, such as the compilation of the specific sample of this study, as well as the fact that we live in an increasingly uncertain world where more risk factors have to be incorporated in any financial decision. table 9 risk analysis techniques risk analysis technique % sensitivity analysis adjusting required rate of return scenario analysis adjusting cash flows no formal technique in use monte carlo simulation sophisticated mathematical modelling (option analysis) decision trees other 29.2 22.2 13.9 12.5 6.9 4.2 4.2 2.8 4.1 p-value for uniformity 100 < 0.0001 sajems ns 13 (2010) no 1 95 sensitivity analysis was indicated as the most popular method to incorporate risk in the capital budgeting decision. whether sensitivity analysis is an actual technique to quantify risk is debatable. sensitivity analysis per se does not quantify risk, but it can be used by companies as a relatively simple and cost-effective way to determine the sensitivity of the npv or irr to changes in key input variables. in this way, it facilitates more prudent decision-making. changing the discount rate or the cash flows in order to incorporate risk in the capital budgeting process was considered by many respondents to be a sufficient way of dealing with uncertainty in capital budgeting. a total of 35 per cent of the respondents used one of these methods. option analysis was regarded as a relatively sophisticated way of dealing with risk, and it is disappointing that only 4 per cent of respondents reported using this method. lastly, respondents were asked to indicate adjustments to accommodate fluctuations in the inflation rate. the survey responses are set out in table 10 below. table 10 adjustments to accommodate fluctuations in the inflation rate item % no allowances are made for inflation use various inflation rates for different annual cash flows use a single inflation rate for different annual cash flows 16.7 42.9 40.4 p-value for uniformity 100 0.0712 from this table one can see that only 16.7 per cent of the respondents did not make any adjustments for inflation. in the previous study by hall (2000), it was found that 23 per cent did not make any adjustments for inflation. once again, there seems to be an improvement in the way the whole capital budgeting process is being conducted, although the results are not statistically significant with a p-value = 0.0712. while south africa is in a period of relatively high inflation, one would like to see the trend of more companies incorporating inflation in their analyses continuing. conclusion the objectives of this study were to investigate the capital budgeting practices of listed south african industrial firms and to compare the results to those of other international and south african studies. in order to give weight and meaning to the results of this study, the sample of companies was carefully constructed to target large, well established listed firms. the decision-maker profile of the respondents of this study indicates that nearly 70 per cent had been employed by their company for more than five years, and that more than 80 per cent had a bachelor’s or post-graduate qualification. it therefore seems that the respondents are suitably qualified, both in terms of their academic training and their work experience, to make well-informed capital budgeting decisions and to apply prudent capital budgeting evaluation techniques. the respondent companies were evenly distributed over the industrial sub-sectors of the jse. of the respondents’ companies, 73 per cent had assets of more than r1 billion and 60 per cent had an annual capital budget of more than r200 million. the stage was set for very meaningful and interesting results. project definition and cash flow estimation were regarded as the most important and most difficult stages in the capital budgeting process. financial analysis was considered to be important, but not difficult at all to the respondents – a clear indication of their level of 96 sajems ns 13 (2010) no 1 education and work experience. however, what was disappointing was the fact that the majority relied on management subjective estimates as cash flow forecasting methods, as opposed to quantitative methods. one of the most interesting results came from the capital budgeting techniques used by the respondents. as with previous studies, it was found that the roi is the most popular method, with one third of the respondents using this method. a new trend that emerged from this study, however, was the fact that the npv was considered to be more popular than the irr. in the majority of previous studies, both local and international, the irr was more popular than the npv. academics prefer the more theoretically and mathematically sound npv to the irr, and the fact that this was also the choice amongst the practitioners responding to this study may indicate a major shift in capital budgeting practices amongst the respondents of this study. non-financial criteria seem to play a more important role in the evaluation of capital budgeting projects than in the past. in this study, legal requirements accounted for nearly 21 per cent of the non-financial selection criteria, with only 6 per cent of respondents never selecting investments on non-financial criteria, as opposed to 34 per cent never considering non-financial factors in a previous study. this trend can possibly be ascribed to the fact that the south african economic, financial and social landscape is being increasingly stringently regulated by government. regarding the incorporation of risk in the capital budgeting process, it was found that the project implementation stage is considered to be the most risky. this is in contrast to a previous study, in which respondents considered the project definition and cash flow estimation to be riskier. this change can be ascribed to not only the relatively high experience of the respondents, but also to the ever-changing south african economic environment. as a matter of fact, the world has become an increasingly difficult place in which to conduct business at an acceptable level of risk. whilst the majority of respondents used sensitivity analysis to account for risk in the capital budgeting process, 35 per cent of respondents used either changes in the cash flows or the discount rate to account for uncertainty. lastly, it was noted that the trend is for more respondents than in previous studies to incorporate inflation in their capital budgeting process. this trend may be ascribed to the fact that more sophistication is introduced. the fact that more respondents in this study than in previous ones prefer the npv to the irr, as well as the greater level of risk incorporation in the capital budgeting process, is an indication of the use of an improved capital budgeting selection process by the respondents of this study. further research on the capital budgeting process might include a more detailed exposition of the roi and how respondents define this method. in addition, the use amongst practitioners of methods such as the modified internal rate of return (mirr), as well as economic value added (eva), in their capital budgeting process could provide interesting results. references andrews, g.s. & butler, f. 1986. criteria for major investment decisions. the investment analysts journal, 27: 31–37. cooper, w.d., morgan, 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�/.�� ������� ��� �'��!!� ��� ?����� 7�e� � �5����% 7* �//0� (�$���� ��� �� ���!% ?������ �2������ �� ���& ���!��* �' h97���4% f*�*�* 1 67��;9% 6*;* ����� �3 � �������� ��������� �� � ��!��!��� ���!�2���! ��� �2����!��� ! � �������� ��� ����������! �� ����2�!��� ��2��!��� �� ��2! ������$% ��������� ����� �� �� ��������% /& ��( ��* �0 a�33�% 4* �������c�!!��� �� ! � ��!$% ������!�� � ���� )� 0�* sajems ns vol 7 (2004) no 1 45 the introduction of service fees by travel agencies: a case study in bloemfontein ________________________________________________________________ a j strydom school of tourism, hospitality and sport, technikon free state ________________________________________________________________ abstract travel agencies normally receive commission from airlines, tour operators, accommodation establishments and car hire companies in exchange for bookings. global trends in this commission structure indicate dramatic changes, especially regarding airlines. the majority of them have introduced a system of commission capping, whereby commission paid to travel agencies has been reduced and expectations are that it might even become zero in future. against this background, travel agencies are considering introducing a system of service fees. it implies that clients will have to pay for services such as the preparation of quotations for national and/or international holidays or business trips. this paper discusses the results of research that was undertaken amongst the middle to higher income classes of the residents of bloemfontein regarding the introduction of service fees by travel agencies. jel l90 introduction travel and tourism is a vast, complex network of business which may include activities and travel carried out for leisure, family or business reasons, and usually has the following purposes: rest, entertainment, conducting business and/or personal development (elliot, 1997: 4). according to geldenhuys (2000: 1) travel (and tourism) has existed since time immemorial. the global travel and tourism industry has developed rapidly since world war 11 and is currently regarded as one of the fastest growing industries in the world (van niekerk, 1997: 1; buhalis, 2003). according to the world tourism organisation (wto, 2001) almost 715 million international tourist arrivals were registered in 2002, compared to 25 million in 1950. tourism to and from south africa also experienced rapid expansion in the recent past. according to south african tourism (satour, 2002) total international arrivals (africa included) to south africa increased by 70 percent sajems ns vol 7 (2004) no 1 46 between 1994 and 1999. also, the total number of south african citizens (334 509) who “departed” temporarily during march 2002, increased by 16,4 percent compared to the same period of 2001 (ssa, 2003). the latter figure constitutes one of the major sources of a travel agency’s income in the form of commission. there is a worldwide trend by airlines to cut travel agencies’ commissions, and it seems as if it may even drop to zero in future. according to feldman (2002: 62) the american society of travel agents reported that the average base commission rate declined from a high of 11,8 percent in 1994 to 6,24 percent in 2001, while domestic base commissions have been eliminated entirely. kiesnoski (2002: 4) and milligan (2002: 8) confirm this tendency, and the latter is of opinion that it coincides with the growth of sales via the internet (also compare travel weekly, 2003: 4). personal interviews with asata (association of southern african travel agents) members in bloemfontein confirmed that the commission structure has undergone dramatic changes, especially with regard to airlines. the majority of them introduced a system of commission capping, whereby commission to travel agencies has been reduced, and expectations are that it might even become zero in future. as a result, it is imperative that travel agencies restructure their revenue base through the introduction of service fees. this implies that clients will have to pay for services like the preparation of quotations for national and/or international holidays or business trips, booking of air tickets, issuing of visas and hotel reservations. the argument is that a client should pay for a professional service consultation at a travel agency, in the same way as he or she would for the medical profession, for instance. although service fee models have been implemented at several international and national travel agencies (successful meetings, 2002: 36; feldman, 2002: 62), they are still a relatively new and untapped concept in parts of south africa. against the above-mentioned background, the purpose of this article is to discuss the results of research that was undertaken amongst the middle to higher income classes of residents of bloemfontein regarding the introduction of service fees by travel agencies. this includes their willingness to pay for professional travel services, as well as the amount payable and types of services that should be subjected to service fees. sajems ns vol 7 (2004) no 1 47 objectives the objectives of this article are to discuss the results of research undertaken amongst middle to higher income residents of certain suburbs in bloemfontein regarding their awareness (as clients) and perception of the introduction of service fees. would they be willing to pay for professional travel services, as this was an inevitable way to ensure a sustainable income to the travel industry. an additional objective was to identify what services should be subjected to service fees and to determine suitable fees for delivering these professional services by travel agencies. the research is applicable in two ways: it gives an indication of local market reactions to the introduction of service fees, and it can be used as a point of departure by travel agencies in other regions of south africa who also want to introduce this system in an environment where income sources are decreasing. specific amounts and preferences may differ according to macro-environmental variables such as income levels, needs and personal taste. research methodology the research was undertaken in bloemfontein during june 2002. two suburbs were targeted, namely universitas, representing the middle class tourist, and waverley, representing the higher-class tourist. a nine percent (243 out of a possible 2 666 households) sample was determined in the abovementioned suburbs and information was collected through personal interviews by means of a structured questionnaire. the questionnaire was compiled from inputs received from all the asata-travel agencies in bloemfontein, regarding their research needs regarding the introduction of service fees and related components, as described in the objectives of this article. a 90 percent (220 correctly completed questionnaires) response rate was obtained. limitations of the study the study focused on middle to higher income residents of two suburbs in bloemfontein. lower income categories and townships were not included. only houses were included in the sample and no town houses, flats or other forms of sajems ns vol 7 (2004) no 1 48 residence. the research results only reflect the views of a specific section of the general public and not the corporate market of bloemfontein. research results theoretical analysis: recent changes in travel retailing lubbe (2000: 39-45) indicates the following areas as having the biggest impact on the way in which travel is distributed in south africa in the past three years: deregulation of the airline industry. this factor increased competition and led to declining yields amongst airlines. from the airlines’ point of view the deregulation brought about several changes such as: the formulation of alliances − according to lubbe (2000: 40) the aim of alliances is “mainly to extend the market reach of airlines, controlling costs, and possibly limiting competition in the global transport sector. these alliances include collaborative pacts from equity stakes to code-sharing agreements, joint services, block seat or block booking arrangements, joint marketing agreements, joint fares and franchise agreements”. these alliances caused changes in ticket distribution methods and affect the retail travel industry in terms of preferred supplier relationships and revenue. lower distribution costs − airlines are continuously looking for ways to offset declining profit margins. this resulted in the implementation of a system of commission capping, whereby commission rates to travel agencies were decreased, with a consequent loss in revenue for the latter party (compare milligan, 2002: 8; kiesnoski, 2002: 4; feldman, 2002: 62). in-house reservations − some airlines allow clients to book directly through their own in-house reservations systems. the result is a lack of potential income to travel agencies. airline loyalty programmes − frequent flyer programmes such as the voyager mile programme of south african airways (saa) tend to motivate clients to book directly with the airline at the cost of the local travel agent (lewis and talalayevsky as in lubbe, 2000: 41). technological advancements − the following two technological advancements are, amongst others, dominant on the travel retail scene: the internet − as more people become computer literate, clients do their own travel bookings via the internet, with a consequent loss of income to travel agencies. sajems ns vol 7 (2004) no 1 49 electronic ticketing − saa recently introduced a system of electronic ticketing whereby travellers are offered the option of booking flights without tickets. the airline seats are sold directly to the clients by the airlines. changes in consumer demands − lubbe (2000: 47) indicates major changes between “new” and “old” tourists in the sense that: “new tourists are more experienced, more environmentally aware, more independent, more flexible, more quality conscious and harder to please than before”. one way in which travel agencies reacted in this regard was to restructure their revenue-base with a move towards the introduction of service-fee models in an attempt to become an agent for the client instead of the travel provider. joselyn (as in lubbe, 2000: 51) proposes three types of fees to be charged by travel agencies in future: professional fees in exchange for experience and expertise; penalty fees in cases where work needs to be redone; service fees for performing services for which inadequate revenue is anticipated. a more detailed analysis of the types of fees to be charged by travel agencies is provided in a journal called successful meetings (2002: 36). according to this journal, service fees may be charged by travel agencies in the following instances: provision of all travel and airfare possibilities; reissuing of tickets at cheaper prices; cancellation of travel arrangements; explanation of travel restrictions and security requirements to clients; recommendation of good accommodation and restaurants; availability during trips via telephone as well as after-hour availability for emergency purposes. empirical research results: demographic statistics the demographic statistics of the respondents are as follows: just over half the respondents (52 percent) were males. the majority (29 percent) of the respondents are in the age category 36 to 45 years old and form part of a family consisting of three to four members (54 percent). almost three-quarters (73 percent) of all respondents are married. the average monthly gross income per household differs substantially between the middle class (universitas) and higher class (waverley) sajems ns vol 7 (2004) no 1 50 suburbs. in universitas, the majority of households (50 percent) earn between r6 000 and r12 000 per month, whereas in waverley 60 percent of households earn above r12 000 per month. the introduction of service fees in bloemfontein research results revealed that: in both suburbs husbands predominantly pay for holidays. more than half (56 percent) of the respondents use the services of travel agencies once or more times a year. all respondents accepted the fact that they have to pay for professional services rendered by a medical practitioner or lawyer. almost 80 percent of the respondents also agreed that professional travel advice by a qualified travel agent is essential when they plan to travel. more than 80 percent of the respondents are prepared to pay for professional advice from travel agencies, although less than a quarter of them were aware of the possible introduction of such a system by travel agencies in bloemfontein. services at travel agencies for which a service fee may be charged figure 1 sets out services for which a service fee may be charged. figure 1 services to be included in a service fee model 61% 64% 75% 60% 61% 0% 10% 20% 30% 40% 50% 60% 70% 80% percentage of respondents q uo ta tio ns a ir ti ck et s (b oo ki ng s) v is a ar ra ng em en ts h ot el re se rv at io ns c ar re nt al travel services sajems ns vol 7 (2004) no 1 51 it is evident from figure 1 that the majority of respondents from both suburbs agreed that service fees may be charged for the following services (based on personal preferences): a complete quotation of travel costs (61 percent). it is interesting to note that only 41 percent of the respondents in waverley agreed to this, while the majority of respondents in universitas (65 percent) are willing to pay for travel quotations; booking of air tickets (64 percent); issuing of visas (75 percent); hotel reservations (60 percent); car rental (61 percent) the suggested amounts to be charged for the services mentioned in figure 1, are shown in figure 2. please note that the results in figure 2 are based on service fees related to national travel arrangements. figure 2 service fees for national travel arrangements r 70 r 80 r 65 r 60 r 0 r 10 r 20 r 30 r 40 r 50 r 60 r 70 r 80 r an d (r ) quotations air tickets hotel reservations car rental travel services from figure 2 it is clear that the highest service fee should be apportioned to booking of air tickets, and the lowest to booking car rental services by a travel agency. current average service fees charged by travel agencies in bloemfontein represent approximately 1,5 percent of total travel costs, compared to the 3.0 percent suggested by respondents in this research study. sajems ns vol 7 (2004) no 1 52 the suggested amounts for services to be rendered with regard to international travel, are indicated in figure 3. the highest service fee may be awarded to the issuing of visas, while the lowest fee, as in the case of figure 2, may be charged for organising car rental services. current average service fees charged by travel agencies in bloemfontein represent approximately 0,5 percent of total travel costs, compared to the 2.3 percent suggested by respondents in this research study. service fees are still far lower than amounts of commission received by travel agencies, and the introduction thereof is only an attempt to fill the gap between previous (between 10 and 15 percent) and current levels (9 percent) of commission. figure 3 service fees for international travel arrangements r 140 r 140 r 185 r 130 r 100 r 0 r 20 r 40 r 60 r 80 r 100 r 120 r 140 r 160 r 180 r 200 r an d (r ) quotations air tickets (bookings) visa arrangements hotel reservations car rental travel services services that should be excluded from service fees the majority of respondents in both suburbs indicated (based on personal preferences) that service fees should not be charged for the following services rendered by travel agencies: the provision of additional information on tourism destinations (69 percent); issuing of free voyager tickets (76 percent). sajems ns vol 7 (2004) no 1 53 services for which the introduction of service fees may be considered the research results from both suburbs did not give a clear indication on the possible introduction of service fees with regard to the services, indicated in figure 4. figure 4 services to consider for inclusion in a service fee model 52% 52% 50% 46% 44% 0% 10% 20% 30% 40% 50% 60% p er ce nt ag e of r es po nd en ts booking changes cancellation fees travel insurance after hours road and city maps travel services figure 4 shows that respondents made no clear distinction between services included in a service fee scenario: • changes of bookings (52 percent yes); • cancellation of reservations (52 percent yes); • travel insurance (50 percent yes). • it is interesting to note that 68 percent of the respondents in waverley agreed on the introduction of service fees regarding the organisation of travel insurance by the travel agent on behalf of the tourist. • after hours consultation and reservations (46 percent yes); • the provision of detailed road and city maps (44 percent yes). if travel agencies do consider the implementation of service fees on the services mentioned in figure 4, it could be considered according to the suggested sajems ns vol 7 (2004) no 1 54 amounts as outlined in figure 5. please take note that figure 5 is based on national travel arrangements. figure 5 suggested service fees (national travel) r 80 r 120 r 80 r 80 r 55 r 0 r 20 r 40 r 60 r 80 r 100 r 120 r an d (r ) booking changes cancellation fees travel insurance after hours road and city maps travel services the most interesting deduction from figure 5 is that respondents consider the cancellation of travel arrangements a huge burden to travel agencies and feel they are entitled to a substantial service fee in such cases (r 120). the suggested amounts of service fees in the case of international travel, are indicated in figure 6. as in figure 5, a relatively high fee is proposed in the case of cancellation of travel arrangements. the respondents proposed the same fee when international travel insurance is organised by a travel agency. research results from respondents who made use of services of travel agencies in the past year as mentioned earlier in this document, just more than half of all respondents (56 percent) make use of travel agencies at least once a year. it was decided to analyse the results of these respondents as a method of check-and-balance against the overall results. the assumption is that these respondents have a better understanding and knowledge of travel agency operations and may be in a sajems ns vol 7 (2004) no 1 55 better position to supply information on service fees. the results showed exactly the same tendencies and even suggested specific amounts to be charged for certain services, with the following exceptions: cancellation of client reservations travel insurance. figure 6 suggested service fees (international travel) r 150 r 190 r 190 r 110 r 85 r 0 r 20 r 40 r 60 r 80 r 100 r 120 r 140 r 160 r 180 r 200 r an d (r ) booking changescancellation feestravel insurance after hours road and city maps travel services more than 60 percent of the respondents in both suburbs indicate a willingness to pay for the above-mentioned services. even the suggested fees (compare figures 5 and 6) are also applicable in this regard. conclusion and recommendations it is evident from the research that travel agencies in south africa may consider the introduction of service fees as a future option to expand their income bases. it is also clear from the empirical research that the target population in bloemfontein is in principle willing to pay service fees for particular professional services from travel agencies. travel agencies in bloemfontein who already introduced service fees, currently charge lower fees than the recommended fees of this research study. therefore, the research results should sajems ns vol 7 (2004) no 1 56 be used as a guideline for travel agencies over the medium to longer term, especially when further reductions in commission structures from airlines take place again. it is interesting to note that the travel agencies in bloemfontein charge basically the same service fee for international and domestic travel, while the research indicated a willingness by respondents to pay substantially more in the case of international travel. a similar approach may be considered by travel agencies. more research amongst a wider variety of clients is necessary before specific service categories mentioned in figure 4 are considered as a definite option. the research results regarding respondents who made use of travel services in the past year may, however, convince managers of travel agencies to include travel insurance and cancellation of client reservations amongst the services for which a service fee may be charged. references 1 buhalis, d. (2003) e-tourism information technology for strategic tourism management, pearson education limited: united kingdom. 2 elliott, j. (1997) tourism: politics and public sector management, routledge: new york. 3 feldman, j.m. (2002) “changing the rules. air transport world”, 39 (10): 62, ebscohost http://search.epnet.com. downloaded: 2003-10-11. 4 geldenhuys, s. (2000) “career profiles for the travel sector of the tourism industry”, m com-dissertation. potchefstroom university for christian higher education. 5 kiesnoski, k. (2002) “finnair cuts retailers pay to 5%, no cap”, travel weekly, 61 (37): 4, ebscohost: http://weblinks2.epnet.com. downloaded 2003-11-30. 6 lubbe, b. (2000) tourism distribution: managing the travel intermediary, juta: cape town. 7 milligan, m. 2002. amtrak ends agent pay on several services. travel weekly, 61 (46): 8, ebscohost: http://search.epnet.com. downloaded: 2003-11-06. 8 satour see south african tourism. 9 south african tourism (2002) http//www.satour.com. downloaded: 2003-03-28. 10 statistics south africa. (2003) http//www.statssa.gov.za. downloaded: 2003-02-12. 11 successful meetings (2002) vnu emedia inc., 51(9): 36, august. ebscohost http://search.epnet.com. downloaded: 2003-11-10. sajems ns vol 7 (2004) no 1 57 12 travel weekly (2002) northstar travel media, llc & thomson gail group, 62(20): 4, ebscohost http://search.epnet.com. downloaded: 2003-11-06. 13 van niekerk, m. (1997) “development of a core curriculum on tourism as an ace secondary school subject”, ma-dissertation. potchefstroom university for christian higher education. 14 world tourism organisation (2001) http://world-tourism.org/ newsroom/releases/2003/jan/numbers2002.htm. downloaded: 2003-0518. abstract introduction the south african listed property sector and south african real estate investment trusts an overview of sustainable growth rate and firm value data and methodology results conclusion acknowledgements references appendix 1 about the author(s) riëtte carstens department of business management, stellenbosch university, stellenbosch, south africa nicolene wesson university of stellenbosch business school, stellenbosch university, cape town, south africa citation carstens, r. & wesson, n., 2019, ‘the impact of south african real estate investment trust legislation on firm growth and firm value’, south african journal of economic and management sciences 22(1), a2257. https://doi.org/10.4102/sajems.v22i1.2257 original research the impact of south african real estate investment trust legislation on firm growth and firm value riëtte carstens, nicolene wesson received: 20 dec. 2017; accepted: 16 jan. 2019; published: 25 apr. 2019 copyright: © 2019. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: through the introduction of the south african real estate investment trust (sa reit) structure, listed property investment firms are required to conform to international reit standards, thereby making reits more attractive to investors. despite the exponential growth of the sa reit industry over the past decade, sa reit legislation – effective from 2013 – has imposed regulations with regard to financial leverage and profit retention, which may affect these firms’ sustainable growth rate and firm value. aim: by deconstructing the sustainable growth rate, we investigated the potential impact of sa reit legislation on growth rate components and considered the impact of each growth component on firm value. setting: the introduction of sa reit legislation provides an opportunity to investigate how regulation has affected reit growth and value. methods: we investigated changes in the respective sustainable growth rate components using a mixed model analysis of variance. additionally, we employed a panel regression to assess the impact of each component on firm value (proxied by tobin q). results: we found empirical evidence of decreased leverage and profit retention, as well as increased profit margins, in the reit period, which may be indicative of firms’ reaction to regulation. in addition, we found that profit retention had a significant positive impact on firm value, while leverage showed a significant negative effect on firm value post-legislation. conclusion: this study confirmed a significant change in growth components, with higher average profitability and sustainable growth in the reit period, suggesting that the reit industry responded positively to the reit regime introduction. keywords: reit; real estate investment trust; sustainable growth; firm value; south africa. introduction since their inception in 1960 in the united states, real estate investment trusts (reits) have become a global standard for listed property investment firms and have been introduced in more than 34 countries (brounen & de koning 2012). following the global precedent, reit legislation was adopted in south africa in 2013, bringing about legislative changes that affect the ability of sa reits to retain profits and incur debts. real estate investment trusts are characterised as being capital-intensive and highly leveraged firms (case, hardin & wu 2012), which raises the question as to whether reit legislation has had an impact on firm growth and firm value. given the high-growth environment and global competitive scope, south african (sa) reits experience increasing pressure to grow. high growth may result in sa reits growing at an unsustainable rate, while low-growth reits may be seen as attractive for takeovers (ashta 2008). the sa reit industry-specific regulations on profit retention and financial leverage may, however, affect the ability of reits to grow sustainably. with real estate investments defining the core business of reits, financial leverage and retained profits enable reits to acquire these investments. as such, the expectation exists that firm value will be affected by changing regulation that informs debt and dividends in particular. the purpose of this study was to investigate reit growth, using the sustainable growth rate (sgr) measure, in the pre-reit and reit periods by evaluating changes in the four sgr components, namely the profit retention rate, financial leverage, profit margin and asset turnover. additionally, focusing on the sgr components directly affected by reit legislation, we evaluated the effect of financial leverage and profit retention on firm value (measured in terms of tobin q) in the pre-reit and reit regime. while existing literature emphasises reit-specific capital constraints (ott, riddiough & ha-chin 2005; stein 2003), the impact of leverage and profit retention on reit value, specifically in the south african context, is under-researched. we reduced this gap in reit literature by investigating the impact of retention rates and leverage on firm value. our study may benefit reit managers and practitioners in emphasising the potential impact of reit legislation on firm growth and firm value. furthermore, our findings may assist in assessing and developing appropriate capital structures and dividend policies in the sa reit regime. the study is organised as follows: in the upcoming section, recent changes in the south african listed property sector are examined and the potential impact of the reit structure on reit growth and firm value are discussed. the data and methodology are then defined, the results explained and a conclusion drawn. the south african listed property sector and south african real estate investment trusts prior to the introduction of reits, the property sector listed on the johannesburg stock exchange (jse) consisted of two property investment structures, namely property unit trusts and property loan stock companies. property unit trusts were governed by trust deeds and were subject to financial services board (fsb) regulations in terms of the collective investment schemes control act (national treasury 2012:66), while property loan stocks adhered to the companies act and jse regulations. as a result, the regulation of the listed property sector was fragmented and tax treatment between the two structures differed (kantilal 2016), adversely affecting investment confidence. with the implementation of the reit structure in may 2013, property unit trusts converted to trust reits and property loan stocks to company reits (jse n.d.). the introduction of the sa reit structure brought about regulatory requirements to better align the south african listed property industry to international standards and to transform the industry to become more globally competitive (naidoo 2014). real estate investment trusts own and manage rental property and offer investors the opportunity of investing indirectly in a variety of property types managed by property professionals. as such, reits are highly capital-intensive firms that grow their businesses through real estate acquisitions, improving the efficiencies of their real estate investments, or by developing new properties. the increased prominence of sa reits is evident from their 5.8% representation on the ftse/jse all share index, which, in terms of market capitalisation in august 2015, exceeded the market capitalisation of both the retail sector (at 5.7%) and the healthcare sector (at 3.9%) (sa commercial prop news 2015). during 2014 and 2015, the market capitalisation of sa reits increased by about 43% (rapp 2015). this brought the total market capitalisation for sa reits to r340 billion towards the end of 2015. south african real estate investment trusts increased their presence even further in 2016, when three additional sa reits were included in the jse ftse top 40, bringing the total number of reits represented in the top 40 index to five (financial times n.d.). it is approximated that 23% of commercial property in south africa, estimated at a total value of r1.3 trillion, is owned by sa reits (sa reit association 2016b). the requirements for a firm to be listed as a reit on the jse include owning property investments of at least r300 million, deriving at least 75% of the firm’s income from rental or property investment income, distributing at least 75% of the firm’s annual distributable taxable earnings, and maintaining debt levels that do not exceed 60% of the gross asset value (sa reit association 2016a). an overview of sustainable growth rate and firm value the introduction of the reit structure imposed debt limitations and set minimum dividend payment levels, constraining capital in a capital-intensive industry (ott et al. 2005). with sa reit legislation influencing internal and external capital funding – and in line with the international study by ott et al. (2005) – we expect sa reit growth and firm value to be affected in the post-legislation period. sustainable growth rate components high industry growth is positively received by reit shareholders and owners alike. however, the increased jse-listed footprint of sa reits needs to be underpinned by long-term sustainability, ensuring long-term survival. the sgr portrays a firm’s ability to grow sustainably. sustainable growth rate is defined as the profit retention rate (or profit retention) multiplied by the return on equity (roe), with roe determined by multiplying the net profit margin, asset turnover and financial leverage (investopedia n.d.). firer et al. (2012) explain the importance of each of these components. the profit retention rate displays the firm’s dividend policy, which affects retained income and the equity available to attain sustainable growth. the profit margin displays operating efficiency and the ability to generate profit that will contribute to the ability to grow sustainably. total asset turnover shows the ability to use assets efficiently to generate turnover, because an increased asset turnover implies a lower capital intensity, resulting in a higher sgr. lastly, an increase in available financial leverage results in a higher sgr, all things being equal. empirical evidence shows that high-growth firms generally prefer a lower payout ratio (therefore a higher profit retention rate) in order to reinvest earnings in investment opportunities that display positive net present values (liow 2010). however, reits are subject to high mandatory dividend payments, implying low retention rates. in fact, retained earnings have only contributed 7% towards investment financing of reits – in contrast to approximately 70% for industrial companies (fama & french 1999; ott et al. 2005). consequently, long-term investments of reits are funded mainly with debt and equity, and not with retained earnings (feng, ghosh & sirmans 2007; ott et al. 2005). increased profitability is expected to accompany sustainable growth (holliday 2001). liow (2010) found a significantly positive relationship between a firm’s growth rate and its profitability. however, the impact of profitability on financial leverage must also be considered, as the pecking order theory suggests that profitable companies will prefer financial leverage over issuing equity, owing to the negative signal that is associated with issuing equity (harrison, panasian & seiler 2011). contrarily, giambona, harding and sirmans (2008) found that more profitable companies display lower debt ratios. feng et al. (2007) agree that more profitable firms have more internal cash available, which leads to less borrowing and a positive relationship between profitability and equity finance (hada & avram 2014). in respect of asset turnover, evidence suggests that it is predominantly determined by the firm’s products, competitive strategy and management’s capability to manage assets effectively (higgins 1992). the effective use of real estate assets is essential to grow reits sustainably as assets that do not deliver the expected yield can be considered an ineffective application of financial resources. firm value real estate investments trusts are characterised by high mandatory dividend payouts (therefore low profit retention rates), which emphasises the importance of external capital to grow their capital-intensive business (case et al. 2012). however, the use of external capital by reits is limited in terms of reit legislation, which may limit the ability of reits to make real estate investments and as a result affect firm value (stein 2003). the impact of financial leverage on firm value has been investigated for non-real estate industries (lin & chang 2011), but similar studies on reits are lacking – particularly considering the impact of changing industry legislation on leverage and profit retention levels. this investigation complements existing literature on the impact of financial leverage on firm value, using tobin q as a proxy for firm value from the investor’s perspective, in line with previous investigations (farooq & masood 2016). furthermore, our study ascertains the significance of the relationship between financial leverage and firm value, focusing on the sa reit industry. tobin q is generally used in studies investigating real estate firm performance and value (feng, price & sirmans 2011; lin & chang 2011). in line with existing literature, we proxy firm value using tobin q, which represents the stock market value relative to the underlying property market value of firm assets (capozza & seguin 2000). as an ex ante measure, the q ratio is also indicative of the expected future performance (capozza & seguin 2000) of reits. data and methodology data collection the study included all firms that transformed into reits, as well as newly listed reits, following the reit introduction. these firms were listed as reits, a sub-sector of the jse financials sector. to avoid survivor bias, all delisted reits were included in the analysis. financial information required for the sgr component analysis was obtained from the inet bfa database, which contained 53 reits (42 listed and 11 delisted) for the period of analysis. since the data set included recently listed reits as well as reits that were delisted during the period under review, the panel data set was unbalanced. based on available financial information, a total of 13 reits (10 listed and 3 delisted) were included in the pre-reit period and 22 reits (18 listed and 4 delisted) in the reit period analysis. appendix 1 displays the final sample of reits used for the analysis. the pre-reit period was defined as january 2009 to april 2013, with may 2013 to december 2016 as the reit period. data from 2013 were allocated to the pre-reit or reit period depending on the financial year ends of the reits. data were obtained from annual financial reports, as reported via the iress database. the annual profit retention rate and profit margin per reit were obtained from the iress database (the financial ratios product module) and the asset turnover and financial leverage ratios were calculated using available financial data from iress (the financial statement product module). for asset turnover, sales (inet bfa line item 02020060) were used as the numerator with total assets (inet bfa line item 02010050) as the denominator, while leverage was calculated using total assets (inet bfa line item 02010050) as numerator and equity (inet bfa line item 02010013) as denominator. in addition, tobin q figures and market capitalisation data were sourced from the iress database (the financial models and price data modules). the data were collected in data panel format, and a panel regression was performed using the plm package in r. additionally, a mixed model analysis of variance (anova) was performed using the vepac module in statistica 13. data cleaning and methodology outliers were subject to winsorising by changing the values to the trimmed mean plus or minus three standard deviations. a 10% trimmed mean and standard deviation was used. tolerance indices were calculated for all the independent variables and none were found to be less than 0.2, indicating no multicollinearity among the predictor variables (table 1). additionally, adjusted p-values were calculated to adjust for heteroscedasticity. table 1: tolerance indices. first, we compared the change for each of the sustainable growth components from the pre-reit period to the reit period, using a mixed model anova. second, we determined the impact of these four components on firm value (proxied by tobin q). the hausman test for random effects was performed to determine if a fixed or random effects model was appropriate. according to this test, if the null hypothesis is rejected, the fixed effects model must be applied. alternatively, if the null hypothesis is not rejected, the random effects model is appropriate (belgrove & van der merwe smit 2016). the null hypothesis was rejected at a 5% significance level for all periods analysed, leading to a fixed effects model being used. the generalised regression model in equation 1 was applied to the pre-reit and reit periods: in equation 1, tqit is tobin q for reit i in year t, x is the set of sgr components and y is a firm-level control variable. the model controls for firm size using the log of firm market capitalisation. results changes in sustainable growth rate components over time the profit margin and sgr displayed increased means from the pre-reit period, with the asset turnover remaining unchanged (table 2). conversely, retention rates and financial leverage decreased on average (table 2), which may be indicative of the effect of reit regulation that limits debt levels and mandates high dividend payments. table 2: descriptive statistics for the pre-real estate investment trust and real estate investment trust periods. using a mixed model anova, we investigated significant changes between the pre-reit and reit periods. a higher average sgr, albeit less prominent at 10% significance, is evident in the reit period (table 3). one explanation may be the lower investor confidence in the pre-reit period in an industry that was only partly regulated owing to different investment structures, namely property unit trusts and property loan stocks (kantilal 2016). a significant decline in the average financial leverage is shown at the 1% level, which is most likely attributable to the debt limitation in the post-reit period. additionally, as reits become more globally competitive, maintaining an acceptable investment grade credit rating becomes increasingly important, affecting leverage ratios as a result (feng et al. 2011). in line with case et al. (2012), periods of higher leverage were associated with lower dividends as higher profit retention assisted in reducing going-concern risk. as expected, a reduction in the average retention rate is evident at 5% significance, implying higher dividend payouts in the reit period. conversely, wang, erickson and gau (1993) suggest that higher dividend payments may be enabled by higher debt levels. however, given significant lower debt levels during the reit period, our findings suggest that the higher dividend payouts are facilitated by significantly higher profit margins. with lower average financial leverage levels in combination with higher dividend payout rates, improved profitability becomes more important for firm growth, diminishing the ability of the firm to use retained funds to grow. the average asset turnover remained unchanged, indicating similar efficiencies in using its assets to generate revenue (pellika 2009) across periods. consistent efficiency is not surprising because reits rely on their real estate assets to perform and produce revenue to achieve the desired yield for their investors. table 3: mean differences between the pre-real estate investment trust and real estate investment trust period. using fisher least significant difference (lsd) post hoc tests, we investigated the statistical difference between the means of pairs. figures 1 and 2 display the most significant independent variable changes, namely in the mean financial leverage and mean profit margin. in line with expectations, financial leverage showed a significant decrease as financial leverage levels were capped with the introduction of reit policy. however, higher profitability in the reit period showed the increasing prominence of profitability that may indicate the improved ability of reits to control costs (ma & michayluk 2014; pellika 2009). our finding was consistent with studies which suggest that high growth of reits enables firms to decrease costs by means of economies of scale as revenue increases (ambrose, highfield & linneman 2005; feng et al. 2011; linneman 1997). however, it is noteworthy that the average profitability of sa reits increased significantly despite extreme increases in costs like rates and taxes, and electricity. with rising rates and taxes negatively affecting gross rentals and operating costs, and becoming an increasing industry concern, the south african property owners association appointed specialists to actively monitor rates policies (propertywheel 2017). additionally, municipal electricity tariffs increased by 86.5% from the beginning of 2008 to july 2016 (property news 2016). lower average financial leverage levels furthermore imply that interest expenses decreased in the reit period, contributing to firm profitability. figure 1: fisher least significant difference results for financial leverage. figure 2: fisher least significant difference results for profit margin. the exact reasons for significant higher profitability in the reit period are beyond the scope of this study, but may be partially attributed to increasing rental income over time, to higher quality property portfolios that justify higher rentals or to more effective management of property expenses. however, our findings confirm those of earlier studies (barclay, smith & morellec 2006; fama & french 2002; ma & michayluk 2014; titman & wessels 1988) that more profitable firms display lower levels of financial leverage. the effect of sustainable growth rate components on firm value significant pairwise correlations between the retention rate and financial leverage and firm value (proxied by tobin q) is evident in the pre-reit period (table 4). our findings suggest that, during the unregulated pre-reit period, high-leveraged reits retained more funds by reducing dividends (case et al. 2012). however, the correlation of retention rates with firm value weakened in the reit period to an insignificant level as reits became subject to high dividends that significantly reduced profit retention rates (table 3). similarly, the tobin q correlation with financial leverage became insignificant in the regulated reit period. the negative correlation between financial leverage and profit margin in the pre-reit period suggests that the interest expense that accompanied higher debt levels lowered firm profit. significant correlations were found in the reit period between asset turnover and financial leverage, and asset turnover and profit margin, indicating reits’ use of leverage as they use their real estate assets to generate turnover. the negative correlation of asset turnover with the profit margin in the reit period was expected, owing to the capital intensiveness of reits, suggesting that the increased growth and profitability in the reit period increased capital intensity, which lowered asset turnover. table 4: pairwise correlations of sustainable growth rate components with tobin q for the pre-real estate investment trust and real estate investment trust periods. our regression model tested the impact of the sgr components on firm value in the pre-reit and reit periods. the regression results (table 5) confirmed that neither asset turnover nor the profit margin had a significant impact on firm value in either of the periods. however, we expect the effect of financial leverage and profit retention on firm value to change over time as these sgr components were directly affected by reit legislation. this study provides evidence (table 5) that financial leverage had a significant impact on tobin q in the reit period. owing to the capital intensity of reit investments, access to funds affects their ability to acquire or improve real estate assets; that is, to grow their asset base (ambrose et al. 2005). consequently, the importance of financial leverage for firm value is expected to increase as the reits continue to grow their real estate investments. another explanation may be that financial leverage is less expensive than equity financing, especially considering the decreasing prime interest rates over the period, with interest rates at 15% in january 2009 decreasing to 10.5% in december 2016 (trading economics n.d.). in addition, sa reits are increasingly investing in global real estate that is financed at even lower foreign interest rates. this is in line with the pecking order theory that firms use the least expensive funding to finance growth (feng et al. 2011). with sa reit legislation prescribing lower leverage levels, firm value worsens (improves) as financial leverage increases (decreases) after legislation has been introduced. as legislation penalises high debt levels in the reit period, high leverage diminishes firm value. however, financial leverage displayed a positive, albeit insignificant, relationship in the pre-reit period. this pre-reit finding is in line with lin and chang (2011), who report that the significant relationship between leverage and firm value disappeared at higher debt levels. table 5: regression results for tobin q for the pre-real estate investment trust and real estate investment trust periods. the effect of profit retention on firm value weakened in the reit period as reits became subject to mandatory minimum dividend payments. this finding is in line with previous studies that emphasise the inability of retained earnings to drive reit growth owing to high payout ratios (rozeff 1982; wang et al. 1993), thus reducing its impact on reit value. surprisingly, the mean value of tobin q (not reported) decreased from 1.110 in the pre-reit period to a significantly lower level (at 1% significance) of 0.994 in the reit period. in line with lin and chang (2011), who report a significant decrease of tobin q during times of economic recession, lower reit period q levels may be as a result of lower domestic economic growth. with higher tobin q levels also indicative of growth opportunities (lang, ofek & stulz 1996; pavlov, steiner & wachter 2016), lower tobin q levels may suggest that the growth opportunities, and the domestic opportunities in particular, of reits are increasingly difficult to find, as reits explore and increase their offshore real estate holdings. the higher pre-reit tobin q level may also be associated with an increased requirement for external capital (ghosh & sun 2014), which agrees with our finding of higher leverage in the pre-reit period (table 3). tobin q also suggests easier capital market access (hardin & hill 2008), which aligns with lower financial leverage levels (table 3) during the lower tobin q reit period. additionally, increased growth opportunities are also linked to a preference for debt over equity, leading to higher financial leverage (feng et al. 2007), as shown in our pre-reit results. conclusion this study investigated the effect of reit legislation on the components of firm growth, using the sgr as a growth proxy. with reit legislation introducing legislative limits on financial leverage and dividend retention, we expected that the new structure may have significantly altered the components of sustainable growth and their impact on driving reit value (as represented by tobin q) from the pre-reit to the reit period. with legislation informing reit dividend distributions and leverage levels, the capital capacity of firms is potentially constrained. hereby, a firm’s ability to grow its real estate investment portfolio may be adversely affected, influencing firm value. the results of this study display an increase in sustainable growth and profitability since the introduction of the sa reit structure in 2013, which has enabled reits to offer shareholders long-term stable and even increasing returns. as a result, reits appear to have become more attractive to shareholders, making them more competitive and stimulating future shareholder investment, which in turn may increase future profitability and growth. this study also confirms that leverage and profit retention diminished after the introduction of legislation, suggesting that the new legislation may limit capital availability. additionally, our investigation of the impact of these changing sgr components on firm value reveals that increasing leverage is associated with lower firm value in the reit period. our regression results emphasise the positive impact of retention rates on firm value, particularly in the unregulated pre-reit period. the significance of financial leverage in determining firm value is evident in the reit period, with increasing debt levels associated with lower firm value, suggesting that, relative to the pre-reit period, high levels of debt are less advantageous to reits because they are penalised by legislation, with an adverse effect on firm value. the significance of the study for reit practitioners lies in: (1) providing an understanding of the impact of legislative changes on sustainable growth in the reit industry, and (2) revealing key drivers of firm value for this particular industry. as a result, practitioners may be better equipped to evaluate and improve sustainable growth and firm value in the sa reit industry. the present study did not evaluate the growth opportunities available to sa reits when assessing firm value. considering the changing macro-environment and regulatory landscape of sa reits, this is an avenue that can be addressed in future research. acknowledgements we thank prof. martin kidd (stellenbosch) for his assistance with this study. competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contribution n.w. was the project leader of the research project and r.c. collected and analysed the data. references ambrose, b.w., highfield, m.j. & linneman, p.d., 2005, ‘real estate and economics of scale: the case of reits’, real estate economics 33(2), 323–350. https://doi.org/10.1111/j.1540-6229.2005.00121.x 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http://www.sacommercialpropnews.co.za/property-investment/7730-reits-excel-among-south-africa-top-listed-companies.html. sa reit association, 2016a, what is sa reit?, viewed 02 november 2016, from http://www.sareit.com/101_whatisreits.php. sa reit association, 2016b, real estate investment trusts (reits) shine among the jse’s most empowered companies, viewed 02 november 2016, from http://www.sareit.com/news-302.php. stein, j.c., 2003, ‘agency, information, and corporate investment’, in g. constantinides, m. harris & r. stulz (eds.), handbook of the economics of finance, pp. 111–153, elsevier/north-holland, boston, ma. titman, s. & wessels, r., 1988, ‘the determinants of capital structure choice’, the journal of finance 43(1), 1–19. https://doi.org/10.1111/j.1540-6261.1988.tb02585.x trading economics, n.d., south africa interest rate 1998–2017, viewed 02 february 2017, from http://www.tradingeconomics.com/south-africa/interest-rate. wang, k., erickson, j. & gau, g.w., 1993, ‘dividend policies and dividend announcement effects for real estate investment trusts’, journal of the american real estate and urban economics association 21(2), 185–201. https://doi.org/10.1111/1540-6229.00607 appendix 1 table 1-a1: sample of real estate investment trusts used for analysis. microsoft word 4 farrington sajems 15(4) 2012.doc 382 sajems ns 15 (2012) no 4 does personality matter for small business success? shelley m farrington department of business management, nelson mandela metropolitan university accepted: july 2012 personality traits influence occupational choice and are valid predictors of managerial success. the primary objective of this study was to investigate whether a relationship exists between possessing certain personality traits and small business success. the personality dimensions of the five-factor model of personality, extraversion, conscientiousness, openness to experience, agreeableness and neuroticism were the focus of this study. convenience sampling was employed and 383 usable questionnaires were returned. the validity and reliability of the measuring instrument was assessed. multiple regression analysis was undertaken to establish relationships between the independent variable (the five dimensions of personality) and the dependent variable, business success. the findings of this study show that individuals who have high levels of the personality traits extraversion, conscientiousness and openness to experience are more likely to have successful small businesses. openness to experience is of specific importance as it demonstrates the strongest influence, and is the only trait that has a positive influence on both the financial and growth performance of the business. as such, insights are provided into the personality profile most suited to successful small-business ownership. key words: entrepreneurship, small business, personality, five-factor model of personality jel: l260 1 introduction personality dispositions are associated with happiness, physical and psychological health, and the quality of relationships, as well as occupational choice, job satisfaction and performance (ozer & benet-martínez, 2006; judge, higgins, thorsen & barrick, 1999). the relationship between personality and performance is well supported by several meta analyses (bergner, neubauer & kreuzthaler, 2010; barrick, mount & judge, 2001), and personality traits are agreed to be valid predictors of managerial performance (bergner et al., 2010). for example, nadkarni and herrmann (2010:1050) contend that the personality of a business leader influences the strategic decision processes and strategic actions of a firm, ultimately having implications for the firm’s performance. finkelstein and hambrick (1996) conclude that the personality of a business leader has consequences for a firm. according to mccrae and costa (1980), personality traits influence a person’s tendency to act, and different tendencies can enable or hinder a business owner’s behaviour. in their study among project managers, davir, sadeh and malachpines (2006) have found that when the personality type of the project manager matches the project type, more successful projects result. similarly, douglas (n.d.) suggests that personality has a great deal to do with being a successful entrepreneur. according to burger (2008:4), personality is the consistent behaviour patterns and intrapersonal processes that originate from within an individual, whereas haslam (2007:4) describes personality as characteristics that give a person their individuality. it is widely accepted that five broadly defined dimensions of personality exist. these five dimensions serve as a suitable method for classifying personality attributes and make up what is known as the five-factor model of personality abstract sajems ns 15 (2012) no 4 383 (bergner et al., 2010; llewellyn & wilson, 2003; costa & mccrae, 1992; barrick & mount, 1991). the five-factor model of personality, often termed the ‘big five’ (costa & mccrae, 1992), can be used to describe the most salient aspect of personality (judge, heller & mount, 2002) and consists of five broad dimensions of personality, namely extraversion, conscientiousness, openness to experience, agreeableness and neuroticism, (bergner et al., 2010; cooper & pervin, 1998). these dimensions and their measures have proved to be a reliable and valid measure of personality and are among the most robust in existence (hetland, mjeldheim & johnsen, 2008; barrick & mount 1991). the dimensions of the five-factor model are widely used in the personality and prediction literature (ozer & benet-martínez, 2006), and have been researched in many areas of industrial-organisational psychology, most often with regard to job performance (barrick & mount, 1991). it is possible that many small-business owners are not suited, based on their personality disposition, to the occupation of ‘self-employment’. a high failure rate exists among small businesses in south africa (small business development in south africa, 2009) and a lack of suitability could be an explanation for the low levels of business performance and ultimate business failure. over the last two decades personality has increasingly been investigated and used as a means of personnel selection and human resource development (bergner et al., 2010; barrick & mount, 1991). the question arises why personality cannot be used to ‘select’ or identify individuals who would be suitable for small-business ownership. this study attempts to establish whether a specific personality disposition can be associated with successful ‘self-employment’ and ultimately a successful business. more specifically, this study investigates the influence of a small-business owner’s personality on the success of his/her small business. previous efforts to investigate the relationship between personality traits and entrepreneurship have centred on the use of narrow traits such as risk-taking, locus of control and need for achievement (llewellyn & wilson, 2003). these studies have confirmed that further research is needed to evaluate the role of personality in relation to entrepreneurship (llewellyn & wilson, 2003). similarly, calls have recently arisen to make use of comprehensive and valid psychological frameworks to investigate the relationships between a business leader’s personality attributes and firm performance (hiller & hambrick, 2005; cannella & monroe, 1997). as far as can be established, no studies using the five-factor model of personality exist attempting to investigate whether the personality dispositions of small-business owners have an influence on the success of their business. against this background, the primary objective of this study is to investigate whether a relationship exists between possessing certain personality traits and small business success. by identifying the personality traits associated with business success, proactive steps can be made to identify individuals who are more likely to be successful at self-employment. in an effort to guide future entrepreneurs, the ultimate goal is to identify the trait profile most common to successful small-business owners. for the purpose of this study, a small business is defined as one that does not employ more than 50 full-time employees. in addition, the business should have been in operation for at least one year and the owner must be actively involved in the business. according to judge, bono, ilies and gehardt (2002), the five-factor model of personality is a framework that provides a valid, robust and comprehensive way of representing fundamental personality differences between individuals. in the present study, personality is represented by the personality dimensions of the five-factor model, namely extraversion, conscientiousness, openness to experience, agreeableness and neuroticism. 2 literature overview 2.1 personality and personality traits defining ‘personality’ is a complex task (gordon, 2002) and several descriptions are evident in the literature. ‘personality’ refers to the qualities that form a person’s character (waite & 384 sajems ns 15 (2012) no 4 hawker, 2009:681), or the characteristic patterns of thought, feelings and behaviours that make a person unique (cherry, n.d). ‘personality traits’ are more specific constructs that explain consistencies in the way people behave, and help to explain why different people react differently to the same situation (llewellyn & wilson, 2003). personality traits determine a person’s words, deeds and role in life (cooper, 1998), and as such, an individual’s actions and thinking are derived from the personality traits they possess (costa & mccrae, 1992). personality traits differ in type and degree for everybody (costa & mccrae, 1992). 2.2 the five-factor model of personality (the big five personality dimensions) several researchers (norman 1963; fiske 1949, cattell 1946) have contributed to the development of a framework consisting of five personality factors. this five-factor model demonstrates that personality consists of five relatively independent dimensions which provide a useful means for studying individual differences (thal & bedingfield, 2010; costa & mccrae, 1992; barrick & mount, 1991). it categorises the many personality traits into a more manageable number and has thus made personality a more easily accessible topic (bergner et al., 2010). furthermore, the model provides a framework for understanding how traits combine to form the way in which people think, feel and behave in the world (foulkrod, field & brown, 2009:422) and is therefore suitable for measuring individual personality traits (chen & lai, 2010). the five broad factors or personal trait dimension, extraversion, conscientiousness, openness to experience, agreeableness and neuroticism, have been identified through empirical research (goldberg, 1993) and have consistently been replicated as dimensions of enduring personality characteristics (foulkrod et al., 2009:422). although opinion is not yet unanimous, there is increasing agreement among researchers that the traits identified in the five-factor model of personality capture the most important aspects of personality (nadkarni & herrmann, 2010; judge et al., 2002; mccrae & costa, 1997). the big five are five broad domains or dimensions of personality which have been scientifically accepted as defining human personality at the highest level of organisation (goldberg, 1993). barrick, mount and gupta (2003:46) assert that the five-factor model describes the basic dimensions of personality at a global level, and that specific personality traits are likely to connect with at least one of the five dimensions. these five factors provide a rich conceptual framework for integrating all research findings and theory in personality psychology (costa & mccrae, 1992). the five factors are broad personality constructs, with each capturing a unique set of psychological traits (nadkarni & herrmann, 2010:1052), several of which will be identified in the paragraphs below. the trait of extraversion represents sociability and expressiveness (nadkarni & herrmann, 2010; judge et al., 2002) and is frequently associated with individuals being sociable, assertive, talkative and active (llewellyn & wilson, 2003; costa & mccrae, 1992; barrick & mount, 1991). individuals high in extraversion are described as outgoing, gregarious, optimistic and upbeat (weiten 2010; barrick et al., 2003), as well as energetic, enthusiastic and adventurous (john, 1990). costa and mccrae (1992) describe extraverted people as frank and cheerful as well as being inclined to experience positive emotions. typically, people high in extraversion seek out the company of others and enjoy environmental stimulations, whereas those low in extraversion prefer to spend time alone and are more reserved, quiet and independent (foulkrod et al., 2009:422). extraverted leaders tend to take the initiative in social settings, to introduce people to each other and to be socially engaging by being humorous, introducing topics of discussion and stimulating social interactions (house & howell, 1992). conscientiousness, also sometimes referred to as ‘a conscience’, reflects dependability, being careful, thorough, organised and responsible. in addition, people who are conscientious are hardworking and achievement orientated, and persevere in their endeavours (nadkarni & herrmann, 2010; judge et al., 2002; mccrae & costa, 1997; barrick & mount, 1991). john (1990) describes conscientiousness as relating to issues of control and constraint, which includes traits such as sajems ns 15 (2012) no 4 385 efficiency and deliberation. costa and mccrae (1992) report behaviours of highly conscientious individuals as fussy, tidy, scrupulous, strongwilled and punctual, whereas foulkrod et al. (2009) include aspects such as the ability to organise, goal-directed behaviour, holding impulsive urges in check, and working diligently. according to barrick et al. (2001), individuals who score high on conscientiousness are orderly and hardworking, and have a tendency to be self-disciplined, act dutifully, aim for achievement, and plan ahead rather than act spontaneously. furthermore, conscientious individuals have a strong need to reduce uncertainty and to receive specific feedback on their performance (judge et al., 2002). openness to experience, also sometimes referred to as ‘intellect’ (ozer & benetmartínez, 2006; barrick & mount, 1991) is associated with traits such as originality and open-mindedness as well as being artistic, insightful, imaginative and intelligent (barrick et al., 2003; john, 1990). weiten (2010) as well as barrick and mount (1991) also include traits such as being cultured, curious and flexible and having an unconventional attitude, whereas costa and mccrae (1992) refer to independence and an inquiring intellect when describing this personality dimension. being perceptive and thoughtful are also traits associated with openness to experience (nadkarni & herrmann, 2010). openness to experience determines whether one is likely to seek out new ideas and think creatively or whether one is more practical-minded, efficient and conservative in outlook (douglas, n.d). costa and mccrae (1992) are of the opinion that individuals who score high on openness to experience show social poise and are polished, while mccrae (1990) contends that these individuals are associated with a high tolerance of ambiguity and an affinity for unconventional ideas. ‘open’ individuals have a strong need for change and are highly capable of understanding and adapting to the perspectives of others (costa & mccrae, 1992). leaders who are open to new experiences actively seek out excitement and risks (judge et al., 2002), whereas individuals who score low on openness to experience tend to have a conservative outlook and prefer the familiar to the unusual (mccrae & costa, 1980). according to foulkrod et al. (2009:423), agreeableness describes a cluster of personality traits such as altruism, nurturance, or caring at the high end of the spectrum, and hostility, indifference and egocentrism at the lower end. agreeableness represents the tendency to be altruistic (empathetic, kind, cooperative, trusting and gentle) and compliant (modest, having a values affiliation and avoiding conflict) (bono & judge, 2004). agreeableness has also been labelled as likeability or friendliness, and includes traits such as being courteous, considerate, flexible, trusting, good-natured, forgiving, soft-hearted and tolerant (barrick et al., 2003; barrick & mount, 1991), affectionate, generous and sympathetic john (1990), as well as modest and straightforward (weiten, 2010). highly agreeable people are easy to get on with and will probably be widely liked (llewellyn & wilson, 2003). they are friendly and eager to help others and have a tendency to be compassionate rather than suspicious and antagonistic towards others (costa & mccrae, 1992). furthermore, behaviour associated with highly agreeable individuals includes being good-natured, mild, emotionally mature, selfsufficient and attentive to others (costa & mccrae, 1992). neuroticism refers to the tendency of an individual to experience unpleasant emotions easily. common traits displayed by neurotic individuals include anxiety, depression, anger, embarrassment, worry and insecurity (costa & mccrae, 1992; barrick & mount, 1991). neurotic individuals are prone to mood swings, are emotionally unstable, highly excitable (llewellyn & wilson, 2003; costa & mccrae, 1992) and self-conscious (weiten, 2010). the reverse of neuroticism is referred to as emotional stability (barrick & mount, 1991) which reflects the capacity of an individual to adjust their emotional state to the demands of the situation and being able to remain calm and balanced when faced with adversities and stressful situations (nadkarni & herrmann, 2010; foulkrod et al., 2009; mccrae & costa, 1997). individuals who have low emotional stability are moody, melancholy and apprehensive (raab, stedham & neuner, 2005), as well as hostile, envious and impulsive (foulkrod et al., 2009; costa & mccrae, 1992). according to barrick et al. 386 sajems ns 15 (2012) no 4 (2003:51), individuals who are low in emotional stability are prone to stress, suggesting that these people would prefer stress-free jobs. 2.3 entrepreneurial personality the entrepreneurship literature identifies numerous attributes (traits, characteristics and skills) associated with entrepreneurial behaviour and entrepreneurial success (deakins & freel, 2009; ramana, aryasri & nagayya, 2008; mahadea, 2001). hornaday (1982) identifies as many as 42 different characteristics common to entrepreneurs, however, those most commonly cited are the need to achieve, ability to take risks, tolerance for ambiguity, good locus of control, creativity and innovation (chen & lai, 2010; deakins & freel, 2009; venter, urban & rwigema, 2008). according to soetanto, pribadi and widyadana (2010), an abundance of literature exists attempting to define the attributes that distinguish entrepreneurs from others (raab et al., 2005; cromie, 2000). as such various personality attributes are associated with successful entrepreneurs and small-business owners. according to barrick et al. (2003), the various attributes or personality traits associated with successful entrepreneurs are likely to be associated with at least one of the five broad dimensions of the five-factor model. as an example, table 1 attempts to categorise several well-known entrepreneurial traits into the dimensions of the five-factor model. t a b l e 1 entrepreneurial attributes categorised into five dimensions conscientiousness hardworking, leadership, motivated, need for achievement, perseverance, commitment, responsibility. scarborough, 2011; barringer & ireland, 2010; calvasina, calvasina & calvasina, 2010; scarborough, wilson & zimmerer, 2009; timmons & spinelli, 2009; kuratko, 2009; van aardt, van aardt, bezuidenhout & mumba, 2008; kuratko & hodgetts, 2007; kroon, 2004; bolton & thompson, 2004; burns, 2001; nieman, hough & nieuwenhuizen, 2003. agreeableness nurturing quality, get along with others. timmons & spinelli, 2009; van aardt et al., 2008. openness to experience independence, tolerance of ambiguity, opportunism, courage, initiative, creative and innovative, overcome failure, tolerance of risk. scarborough, 2011; chillemi, 2010; barringer & ireland, 2010; timmons & spinelli, 2009; scarborough et al., 2009; kuratko, 2009; nieman & nieuwenhuizen, 2009; van aardt et al., 2008. venter, urban & rwigema, 2008; kuratko & hodgetts, 2007; kroon, 2004; bolton & thompson, 2004; nieman et al., 2003; burns, 2001. extraversion dynamic, self-confidence, high energy level. scarborough, 2011; van aardt et al., 2008. neuroticism locus of control scarborough, 2011; chillemi, 2010. 3 hypotheses development research relating to the relationship between personality and job performance has largely been framed by the five-factor model of personality (bergner et al., 2010; barrick & mount 1991). meta-analytic research (rothstein & goffin, 2006; barrick & mount, 1991; tett, jackson & rothstein, 1991) has confirmed the use of the five-factor model to predict performance in the workplace. several researchers (barrick et al., 2001; barrick & mount, 1991) have found strong correlations between job performance and the five-factor model of personality. according to foulkrod et al. (2009), compelling evidence exists supporting the ability of the five-factor model of personality to predict professional achievement. 3.1 dependent variable little agreement exists on an appropriate measure for small business success (acs, glaeser, litan & fleming, 2008) and previous sajems ns 15 (2012) no 4 387 research has mainly focused on variables for which information is easy to gather (cooper, 1995). although several researchers advocate growth as the most important performance measure for small businesses (brown, 1996; chandler & hanks, 1993; tsai, macmillan & low, 1991), others consider performance to be multidimensional in nature, adding that it is advantageous to integrate different dimensions of performance in empirical studies (lumpkin & dess, 1996). according to zahra (1991), financial performance and growth performance represent different aspects of performance and each reveals important performance information. taken together, growth and financial performance provide a richer description of the actual performance of the firm than each does on its own (zahra, 1991). for the purpose of this study, the success or performance of the small-business owner is measured in terms of the success of his or her business, and this is measured in terms of both growth and financial indicators. business success refers to the business being successful, profitable and financially secure, and showing growth in turnover, profits and number of employees. 3.2 independent variables the personality dimensions of the five-factor model, namely extraversion, conscientiousness, openness to experience, agreeableness and neuroticism, are the independent variables to be investigated in this study. these five traits have consistently been replicated as dimensions of enduring personality characteristics (foulkrod et al., 2009). barrick and mount (1991) report that conscientiousness appears to reflect traits which are important to the accomplishment of tasks in all jobs, and that measures associated with conscientiousness are most likely to be valid predictors of job performance for all jobs. barrick and mount (1991) report extraversion to be a valid predictor of job performance for positions in management and sales. interacting with others is a significant part of these types of jobs. traits such as being sociable, gregarious, talkative, assertive and active would lead to effective performance in these types of jobs. however, extraversion would be less important in jobs such as skilled/semi-skilled and professionals (barrick & mount, 1991). barrick and mount (1991) found no relationship between openness to experience and job performance and concluded that this trait was not a valid predictor of job performance. low correlations were reported between emotional stability and job performance (barrick & mount, 1991). for professionals, emotional stability produced a negative correlation, suggesting that individuals who are worrying, nervous, emotional, and high-strung are better performers in these jobs (barrick & mount, 1991:20). barrick and mount’s (1991:21) results for agreeableness suggest that this trait is not an important predictor of job performance, implying that being courteous, trusting, straightforward and soft-hearted have a smaller impact on job performance than being talkative, active and assertive. in their later meta-analysis investigating the relationship between the personality dimensions of the five-factor model and job performance, barrick et al. (2001) found that in addition to conscientiousness, emotional stability (inverse of neuroticism) is also positively correlated with performance criteria in virtually all jobs across organisations and countries. the other dimensions, agreeableness, extraversion and openness to experience also proved to be valid predictors of performance but their relationship to job performance varies depending on criteria and occupational groups. once again extraversion was found to be a valid predictor but only for occupations typically requiring interactions with others (e.g. managers and sales). openness to experience and agreeableness displayed weak relationships with overall job performance (barrick et al., 2001). in their study investigating the ability of personality to predict project manager success, thal and bedingfield (2010) found that conscientiousness and openness to experience are strongly correlated with perceptions of performance. a positive correlation between conscientiousness and job performance is well supported in the literature (salgado, 2003; barrick & mount, 1991). the findings of thal and bedingfield (2010) regarding openness to experience, however, contradict those of barrick et al. (2001) who found openness to experience to have a weak relationship with job performance. consistent with the literature, thal and bedingfield (2010) found that emotional 388 sajems ns 15 (2012) no 4 stability is a good predictor of project success. thal and bedingfield (2010) found little support for extraversion and agreeableness being able to predict success. in contrast to thal and bedingfield (2010), witt, burke, barrick and mount (2002) found extraversion to be positively correlated with performance among highly conscientious workers and negatively correlated with less conscientious workers. as reported by thal and bedingfield (2010), agreeableness has consistently been shown to have little influence on performance. more recent meta-analyses (bergner et al., 2010), show that the relationship between personality traits and performance differs to some degree among people in executive positions. according to judge et al. (2002), extraversion produced the highest correlations with managerial performance across different criteria and across different vocational settings. following extraversion, conscientiousness displayed the strongest and most stable correlations across managerial performance criteria and across management settings. the correlations of neuroticism and openness to experience with managerial performance showed that these two personality factors were of equal importance, whereas agreeableness appeared to be the least relevant of the big five traits. similarly, bergner et al. (2010) report extraversion and conscientiousness as being the most consistent correlates with success across different criteria. bergner et al. (2010) conclude that within a group, individuals who are extraverted and conscientious as well as emotionally stable and open to experience will emerge as leaders. in their study investigating ceo personality and firm performance, nadkarni and herrmann (2010) found that extraversion, emotional stability and openness to experience enhanced firm performance by fostering strategic flexibility, whereas conscientiousness undermined firm performance by inhibiting strategic flexibility. the results of nadkarni and herrmann (2010) for emotional stability, extraversion and openness to experience are consistent with published psychology and leadership research (bono & judge, 2004; judge et al., 2002). however, their results for conscientiousness and agreeableness differ somewhat from those of existing studies. their results indicate that conscientiousness undermines firm performance by inhibiting strategic flexibility, whereas a medium level of agreeableness maximises strategic flexibility and consequently firm performance. nadkarni and herrmann (2010) conclude that very high levels of conscientiousness may result in inertia and adverse performance, whereas very low levels of conscientiousness may create instability and uncertainty for firms, and as a result firm performance may be maximised at medium levels of conscientiousness. given the contradictory findings elaborated on in the paragraphs above, it was decided to subject the following hypotheses to empirical testing: h1 there is a positive relationship between possessing the trait extraversion and the business success experienced by a smallbusiness owner. h2 there is a positive relationship between possessing the trait conscientiousness and the business success experienced by a small-business owner. h3 there is a positive relationship between possessing the trait openness to experience and the business success experienced by a small-business owner. h4 there is a positive relationship between possessing the trait agreeableness and the business success experienced by a smallbusiness owner. h5 there is a negative relationship between possessing the trait neuroticism and the business success experienced by a smallbusiness owner. 4 research methodology 4.1 measuring instrument this study makes use of an existing measuring instrument to collect the necessary data, namely the ‘big five inventory’’ (bfi). the bfi is a self-report inventory designed to measure the big five dimensions of the fivefactor model of personality, and consists of 44 statements (srivastava, 2010). the questionnaire also contains six items to measure the dependent variable business success. these six items have been used in previous studies sajems ns 15 (2012) no 4 389 (eybers, 2010; farrington, 2009; cowie, 2007) and relate to perceptions of success, profitability and financial security as well as increasing turnover, profits and number of employees. the measuring instrument consisted of a covering letter and two sections. the cover letter stipulated the objective of the study, detailed the criteria for participation, and provided assurances of confidentiality. section 1 of the questionnaire requested general demographic information from respondents and section 2 contained 44 statements describing various aspects of a person’s nature. several of these items were negatively phrased and were reverse-scored for the statistical analysis. section 2 also contained 6 items relating to business success. a 5-point likert-type scale (1 = strongly disagree and 5 = strongly agree) was used, requesting respondents to indicate the extent of their agreement or disagreement with the statements posed. 4.2 sampling and data collection as far as can be established, no national database or list of small businesses exists in south africa or in the eastern cape. therefore, a convenience sampling technique was employed in this study. the focus of the study was on small businesses in the eastern cape province. to be eligible to participate in the study, respondents had to meet specified criteria, namely, operate a business in the eastern cape province, the business had to have been in operation for at least one year, did not employ more than 50 full-time employees and the owner of the business had to be actively involved in the business. during the months of march and april 2010, fieldworkers from the nelson mandela metropolitan university approached small-business owners in the eastern cape and invited them to participate in the study. the questionnaires were personally delivered to the small-business owners and collected upon completion. a total of 383 usable questionnaires were returned. 5 empirical results the data collected were subjected to various statistical analyses using spss (spss inc, 2008). an exploratory factor analysis was undertaken and cronbach-alpha coefficients (ca) were calculated to assess the discriminant validity and reliability of the measuring instrument respectively. descriptive statistics were calculated to summarise the sample data and the hypothesised relationships were assessed by means of multiple regression analysis. multiple regression analysis was considered appropriate for this study because it allows a researcher to predict the score of one variable (business success) on the basis of scores reported on several other variables (five personality dimensions). 5.1 sample description the majority of the respondents participating in this study were males (69.7 per cent) and 28.5 per cent were females. most (35.0 per cent) respondents were between 40 and 49 years old and 57.4 per cent were white. of the respondents, 66.8 per cent held a tertiary qualification. tenure referred to how long the respondent had owned the business. in this study, the majority (81.5 per cent) of respondents had owned the business for more than 3 years. the majority (75.7 per cent) of respondents employed fewer than 10 people. industry referred to the nature of the business, or the industry in which the business operated. most (45 per cent) respondents were in the service industry, followed by the retail and wholesale industries (21 per cent). 5.2 discriminant validity and reliability results an exploratory factor analysis was conducted to identify the unique factors present in the data, and to assess the discriminant validity of the measuring instrument. principal axis factoring with an oblimin rotatin (oblimin with kaiser normalisation) was specified as the extraction and rotation method. in determining the factors (constructs) to extract the percentage of variance explained and the individual factor loading were considered. bartlett’s test of sphericity reported a kaisermeyer-olkin measure (kmo) of 0.791 (p<0.001) confirming that the data were factor-analysable. seven factors were extracted by means of the exploratory factor analysis. these seven factors explained 55.75 per cent of the 390 sajems ns 15 (2012) no 4 variance in the data. the seven factors were identified as the theoretical dimensions of financial performance, growth performance, conscientiousness, extraversion, openness to experience, agreeableness and neuroticism the factor structure is presented in table 2. t a b l e 2 results of the factor analysis (rotated factor matrix) items finperf open extra cons groperf agree neuro succ6 .802 -.067 -.058 -.036 -.045 -.004 -.025 succ5 .725 -.015 -.010 .012 -.187 .082 .007 succ4 .681 .100 -.030 -.005 -.177 .002 -.003 open2 .017 .657 .024 .016 -.007 -.024 -.038 open4 -.177 .639 -.120 -.043 -.111 .035 .036 open5 .080 .615 -.088 -.012 .016 -.028 .025 open3 .106 .479 .151 -.058 .039 -.058 -.043 open8 -.040 .432 -.048 -.024 .012 .177 .008 extra5 -.011 -.101 -.795 -.122 .009 -.048 .000 extra7 .074 -.001 -.570 -.088 .061 -.105 -.157 extra2 -.038 .043 -.542 .087 -.027 -.051 .028 extra1 .147 -.003 -.527 .131 -.027 .118 .070 extra8 -.044 .080 -.417 .030 -.035 .178 -.019 cons7 .126 .157 .043 -.549 -.008 .153 .111 cons9 -.040 .004 .005 -.547 -.031 -.038 -.102 cons8 .005 .161 -.108 -.520 -.110 .061 .194 cons4 -.068 -.116 .069 -.494 -.043 -.010 -.171 cons1 .119 .096 -.039 -.469 .123 .047 .082 cons2 .022 -.064 .052 -.467 .012 -.001 -.210 succ3 .096 -.071 -.041 -.018 -.816 .078 .035 succ1 .199 -.081 .032 -.091 -.784 -.030 .026 succ2 .089 .217 .036 .083 -.387 -.095 -.128 agree7 .026 .001 .033 -.065 -.026 .686 -.019 agree2 .003 -.083 -.042 -.082 -.008 .558 -.018 agree4 .015 .065 .028 .062 .028 .483 -.055 neuro4 -.032 -.003 .001 -.037 -.020 -.011 .646 neuro3 .040 .011 .024 .039 .043 -.135 .516 neuro1 -.039 -.129 .128 .175 .044 .057 .355 key: finperf=financial performance; groperf=growth performance; cons=conscientiousness; extra=extraversion; open=openness to experience; agree=agreeableness; neuro=neuroticism six items were developed to measure business success. three of these items loaded onto one construct named financial performance and the other three items loaded together onto a different construct, named growth performance. despite the items measuring the personality dimensions being sourced from the bfi self-report inventory which has been proved valid and reliable (srivastava, 2010), several items relating to each of the personality dimensions did not load as expected. items that did not load or which loaded onto more than one factor were eliminated from further analysis. factor loadings of ≥ 0.35 (hair, black, babin, anderson & tatham, 2006) were reported for all items, providing evidence of construct and discriminant validity for the measuring scales. based on the results of the factor analyses, the hypotheses relating to business success were reformulated to reflect both financial and growth performance. these hypotheses are listed below: h1a – 1b there is a positive relationship between possessing the trait extraversion and the financial and growth performance sajems ns 15 (2012) no 4 391 of the small business. h2a – 2b there is a positive relationship between possessing the trait conscientiousness and the financial and growth performance of the small business. h3a – 3b there is a positive relationship between possessing the trait openness to experience and the financial and growth performance of the small business. h4a – 4b there is a positive relationship between possessing the trait agreeableness and the financial and growth performance of the small business. h5a – 5b there is a negative relationship between possessing the trait neuroticism and the financial and growth performance of the small business. cronbach-alpha coefficients were calculated to assess the reliability of the measuring instrument. the operationalisation of the various constructs identified as well as the cronbach-alpha coefficients for each of these constructs are summarised in table 3. cronbach-alpha coefficients of greater than 0.7 (nunnally, 1978) were reported for the two dependent variables. the scales measuring these factors were thus considered reliable. similarly, the coefficients reported for extraversion (0.704) and openness to experience (0.708) suggest that the scales measuring these independent variables were reliable. however, coefficients reported for conscientiousness (0.666) and agreeableness (0.600) were less than the lower limit of 0.70. this lower limit may be reduced to 0.60 in certain cases (hair et al., 2006). therefore, satisfactory evidence of reliability for these factors was reported. the cronbachalpha coefficient for neuroticism was 0.528, suggesting that the scale measuring this factor showed evidence of poor reliability. however, because this scale had been sourced from an existing measuring instrument, which was shown to be reliable in previous studies, it was decided to retain this factor for further analysis to avoid jeopardising content validity. t a b l e 3 measurement instrument analyses operationalisation of factors items* ca financial performance refers to the business being successful, profitable and financially secure. 3 0.859 growth performance refers to the business having experienced growth in sales turnover, employees and profits in the past two years. 3 0.747 extraversion refers to being talkative, uninhibited, outgoing, energetic, loud and sociable. 5 0.704 conscientiousness refers to being thorough, careful, organised and not easily distracted, as well as following through on plans made, and doing things efficiently. 6 0.666 openness to experience refers to being ingenious, inventive and reflective, as well as having an active imagination and liking to play with ideas. 5 0.708 agreeableness refers to being considerate, kind, helpful, unselfish and forgiving in nature. 3 0.600 neuroticism refers to worrying a lot, as well as being depressed and tense. 3 0.528 *see appendix a for a detailed description of multiple item scales measuring factors 5.3 descriptive statistics and correlations for discussion purposes response categories on the 5-point likert-type scale were categorised as disagree (0.0-2.9), neutral (3.0-3.9) and agree (4.0-5.0), with disagree corresponding with options 1 and 2 on the 5-point likert-type scale, neutral corresponding with option 3 and agree with options 4 and 5. from table 4 it can be seen that agreeableness produced the highest mean score (4.36), which implies that the respondents participating in this study perceived themselves as individuals who were kind, helpful and forgiving in nature. neuroticism (2.65), on the other hand, produced the lowest mean score. the respondents in this study were more likely to disagree with regard to being neurotic. conscientiousness and openness to experience produced mean scores of 4.12 and 4.11 respectively, implying that the respondents in this study agreed to possessing these traits. extraversion produced a mean score of 3.60, implying neutrality in terms of possessing this trait. 392 sajems ns 15 (2012) no 4 t a b l e 4 descriptive statistics factor n mean standard dev. financial performance 383 4.27 0.770 growth performance 383 3.67 1.030 extraversion 383 3.60 0.856 conscientiousness 383 4.12 0.645 openness to experience 383 4.11 0.649 agreeableness 383 4.36 0.656 neuroticism 383 2.65 0.838 with regard to the dependent variables, mean scores of 3.67 and 4.27 were reported for growth performance and financial performance respectively. for these dependent variables, a t-test revealed that no significant differences exist in the mean scores reported by owners of small businesses that had been operating for more than 3 years and those that had been operating for less. the respondents participating in this study were neutral regarding their business showing growth, but agreed that their business was profitable and financially secure. from table 5 it can be seen that all the personality dimensions, except for agreeableness and neuroticism, showed statistically significant positive correlations with financial performance. statistically significant correlations were also returned between all the personality dimensions, except for agreeableness and growth performance. neuroticism produced a negative relationship, whereas the other dimensions showed a positive correlation with growth performance. although these correlations are statistically significant, the low r values indicate weak to negligible relationships. a statistically significant strong positive relationship is, however, reported between financial performance and growth performance. t a b l e 5 correlation coefficients factor 1 2 3 4 5 6 7 1 financial performance 1 2 growth performance .607*** 1 3 extraversion .161** .109* 1 4 conscientiousness .180*** .107* .026 1 5 openness to experience .192*** .188*** .153** .201*** 1 6 agreeableness .091 .038 .118* .172** .139** 1 7 neuroticism -.095 -.156** -.117* -.298*** -.072 -.076 1 * p<0.05; ** p<0.01: *** p<0.001 5.4 multiple regression analysis multiple linear regression analysis was performed to assess whether the personality dimensions extraversion, conscientiousness, openness to experience, agreeableness and neuroticism, exerted a significant influence on the dependent variables, financial performance and growth performance. the personality dimensions investigated in this study explained 7.7 per cent of the variance in financial performance (see table 6). the independent variables extraversion (2.557; p<0.05), conscientiousness (2.533; p<0.05) and openness to experience (2.702; p<0.01), had a positive linear relationship with the dependent variable financial performance. no relationship was returned between agreeableness and neuroticism, and financial performance. support is thus found for hypotheses h1a, h2a and h3a but not for h4a and h5a. the personality dimensions investigated in this study explained 6.1 per cent of the variance in growth performance. from table 7 below it can be seen that a positive linear sajems ns 15 (2012) no 4 393 relationship was found between openness to experience (3.134; p<0.01) and the growth performance of the business. a negative linear relationship was, however, found between neuroticism (-2.386; p<0.01) and the growth performance of the business. against this background, the hypotheses h3b and h5b are supported, whereas h1b, h2b and h4b are not. t a b l e 6 personality dimensions and financial performance dependent variable: financial performance r-square = 0.077 independent variables sc. beta t-value sig.(p) constant 5.401 0.000 extraversion 0.129 2.557 0.011* conscientiousness 0.135 2.533 0.012* openness to experience 0.139 2.702 0.007** agreeableness 0.031 0.613 0.541 neuroticism -0.027 -0.514 0.608 (*p<0.05; **p<0.01; *** p<0.001) t a b l e 7 personality dimensions and growth performance dependent variable: growth performance r-square = 0.061 independent variables sc. beta t-value sig.(p) constant 4.208 0.000 extraversion 0.069 1.356 0.176 conscientiousness 0.037 0.682 0.496 openness to experience 0.162 3.134 0.002** agreeableness -0.009 -0.0167 0.868 neuroticism -0.065 -2.386 0.018* (*p<0.05; **p<0.01; *** p<0.001) 6 discussion the primary objective of this study was to investigate whether relationships existed between possessing certain personality traits and small business success. personality was measured using the dimensions of the five-factor model of personality, namely extraversion, conscientiousness, openness to experience, agreeableness and neuroticism. small business success was measured in terms of both the growth and the financial performance of the small business. evidence of construct and discriminant validity for the measuring scales was ascertained, and satisfactory evidence of reliability was found for all factors except neuroticism. results pertaining to this personality dimension should be interpreted with caution. the small-business owners participating in this study perceived themselves to be agreeable, conscientious and open to experience. they were neutral with regard to being extraverted, but disagreed about being neurotic. the respondents reported being neutral regarding their business showing growth, but agreed that their business was profitable and financially secure. apart from agreeableness and neuroticism, the other personality dimensions were significantly and positively correlated to financial performance. except for agreeableness, all the personality dimensions investigated in this study were significantly correlated to growth performance, with all correlations being positive except for neuroticism. the results of the multiple regression analysis show a significant positive relationship between possessing the personality traits extraversion, conscientiousness and openness to experience and the dependent variable financial performance. in other words, the more extraverted, conscientious and open to experience smallbusiness owners are, the more likely they are to perceive their business as being successful, profitable and financially secure. smallbusiness owners are more likely to have a 394 sajems ns 15 (2012) no 4 business that performs financially if they are talkative, uninhibited, outgoing, energetic, loud and sociable; thorough, careful, organised, not easily distracted, follow through on plans made and do things efficiently, as well as those who are ingenious, inventive, reflective, have an active imagination and like playing with ideas, than are those who do not possess these personality traits. no relationship was reported between the personality traits agreeableness or neuroticism and financial performance. whether small-business owners possess these traits or not has no influence on their business performing financially. barrick and mount (1991), and barrick et al. (2001) report extraversion to be a valid predictor of successful performance in managerial occupations. similarly, barrick and mount (2005) have found extraversion to be linked to job success in occupations where a substantial portion of the job involves influencing others. given that small-business owners operate in managerial positions and have influence over others (employees), the positive influence of extraversion on financial performance reported in this study supports previous findings. the findings of this study do, however, contradict those of thal and bedingfield (2010), who found little support for extraversion being able to identify successful future project managers. that conscientiousness is a valid predictor of performance is well supported in the literature (thal & bedingfield, 2010; barrick et al., 2001; barrick & mount, 1991). according to judge et al. (2002), among the five personality dimensions of the five-factor model, conscientiousness has returned the strongest and most stable correlations across managerial performance criteria and across management settings. the findings of this study in the context of small business management add to this support. the results show that openness to experience has a positive influence on both the financial and growth performance of the small business. the more ingenious, inventive and reflective the small-business owner is, as well as being active in imagination and liking to play with ideas, the more likely the business is to be profitable and financially secure as well as experiencing growth in terms of sales turnover, employees and profits. openness to experience also demonstrated the strongest influence on both the financial and growth performance of the small business. these findings concur with those of thal and bedingfield (2010) as well as nadkarni and herrmann (2010) who report that openness to experience is strongly correlated with perceptions of performance, and enhances firm performance. openness to experience can thus be considered one of the most important personality traits for small business success. taking cognisance of the operational definitions of the five personality dimensions (see table 3) investigated in this study, it could be suggested that openness to experience, namely being ingenious, inventive and reflective, as well as having an active imagination and liking to play with ideas, is the personality dimension most describing that of an entrepreneurial personality. this finding infers that successful small-business owners are entrepreneurial in nature. the findings of this study, however, contrast with those of barrick and mount (1991) who found no relationship between openness to experience and job performance, as well as barrick et al. (2001), who reported a weak relationship. the finding of this study do, however, concur with barrick et al. (2001), who concluded that the relationship between openness to experience and job performance varies depending on criteria and occupational groups. neuroticism demonstrates no influence on the financial performance of the small business. this finding is in contrast to existing research. although barrick and mount (1991) only reported low correlations between emotional stability (inverse of neuroticism) and job performance, thal and bedingfield (2010) found emotional stability to be a good predictor of project success, and barrick et al. (2001) found emotional stability to be positively correlated with performance criteria in virtually all jobs across organisations and countries. a negative linear relationship is, however, reported between neuroticism and the growth performance of the business. the more neurotic the small-business owner is, the less likely his or her business is to experience growth. small-business owners who worry a lot as well as being depressed and tense, are less likely to have businesses that experience sajems ns 15 (2012) no 4 395 growth in terms of sales turnover, employees and profits. the finding concerning neuroticism having a negative influence on growth performance is supported by nadkarni and herrmann (2010), who report that emotional stability, the reverse of neuroticism, enhances firm performance by fostering strategic flexibility. a small-business owner who is strategically flexible is more likely to adapt to future changes that are necessary for growth. similarly, emotional stability has been shown to be a strong predictor of overall leadership performance, whereas neuroticism has been found to have a significant negative impact on leadership (barrick & mount, 2005). smallbusiness owners who display leadership are more likely than those who do not, to lead their small business into the future by adapting and growing accordingly. a possible explanation for the findings concerning neuroticism and the dependent variables financial and growth performance could lie in the nature of these success measures and the operational definition of neuroticism. in this study, financial performance is the result of how successfully the business is functioning, whereas growth performance is possibly more the result of the strategic thinking and risk-taking propensity of the small-business owner. a small-business owner who is emotionally stable (not tense and depressive or often worried) is more likely to take advantage of opportunities for change and growth that arise, as well as being positive about the future, than a small-business owner who is neurotic. no relationship was reported between possessing the personality traits extraversion, conscientiousness and agreeableness, and the dependent variable growth performance, implying that whether the small-business owner possesses these personality traits or not, has no influence on the growth performance of the business. the findings of this study find no relationship between agreeableness and the dependent variables investigated. in the literature, agreeableness has consistently been reported as having little influence on performance (thal & bedingfield, 2010; barrick et al., 2001), and judge et al. (2002) conclude that this personality dimension appears to be the least relevant of the big five traits. despite some evidence (barrick et al., 2001) that agreeableness is a valid predictor of performance among certain occupational groups, it appears that being ‘nice’ is not a necessity for small business success. 7 implications the findings of this study have important implications for researchers, potential and existing small-business owners, and career counsellors. the results pertaining to validity and reliability of the measuring instrument should be noted by researchers. the factor analysis revealed that the items measuring business success loaded onto two factors, financial performance and growth performance. this result supports the contention of zahra (1991) that financial performance and growth performance are different aspects of performance, and each reveals important information. to consider growth and profitability as independent measures of business performance is not uncommon in the literature (geringer, frayne & olsen, 1998; cubbin & leech, 1986) and researchers need to take cognisance of both aspects of business performance when measuring business success. the results of this study suggest that smallbusiness owners high in extraversion and conscientiousness, and who are open to experience are more likely to have successful businesses than those who are not. more specifically, openness to experience demonstrates the strongest influence on both the financial and growth performance of the small business, and is the only trait that has a positive influence on both these measures of success. although personality traits are found to remain stable over an individual’s lifetime (llewellyn & wilson, 2003) and as such are not easily developed, existing small-business owners would do well to develop these traits as far as possible. where personality traits cannot be developed or changed, small-business owners could employ people with personality traits that complement their own to assist them in managing their business. future small-business owners should consider the results of this study and decide whether, based on their personality, 396 sajems ns 15 (2012) no 4 they are really suited to business ownership. a basic understanding of the general personality profile of a successful smallbusiness owner also has important implications for career counsellors. by identifying the gaps between a future small-business owner’s personality and the personality ideal for a successful small-business owner, steps can be undertaken to manage these discrepancies or close these gaps. it is the role of career counsellors to guide people into suitable career directions, and having knowledge of the personality type most suited to business ownership will enable counsellors to encourage and guide people appropriately. 8 limitations and future research several limitations should be considered when interpreting the results of this study. firstly, the use of convenience sampling introduces a source of potential bias into the study, as the risk of unintentionally getting responses from a particular group is higher. for example, smallbusiness owners who are more emotionally stable, extraverted, open to experience and agreeable, may possibly be more willing to participate in a survey than those who do not have these personality traits. furthermore, only small businesses from the eastern cape province participated in the study. convenience sampling does not lead to representative samples, and therefore the findings of this study cannot be generalised to the entire small business population. in order to make the sample more representative, future studies should attempt to obtain databases from which probability samples of small-business owners throughout south africa can be drawn. another limitation of this study is that the results are based on one-time self-reporting, which potentially leads to common method bias. meade, watson and kroustalis (2007) are of the opinion that common method bias does not necessarily jeopardise the validity of the results of a study. however, it is acknowledged that common assessment methods as well as individual perception, interpretation and opinion could have influenced the results of this study for the purpose of measuring the five personality dimensions in this study, the bfi inventory (srivastava, 2010) was used. however, the factor analysis revealed that several items intended to measure the various personality dimensions did not load as expected. furthermore, neuroticism returned poor evidence of reliability. questions as to the validity and reliability of the bfi are thus raised. future studies could make use of other inventories to measure the personality dimensions of the five-factor model. the five-factor model is only one of many potential ways to operationalise personality (nadkarni & herrmann, 2010), and other measures could be considered in future studies. this study is limited to five broad personality dimensions. disagreement exists as to whether broad personality factors like the big five incorporate all the relevant information to predict performance (bergner et al., 2010). each of these broad dimensions is comprised of a small number of narrow traits which can also be used to predict behaviour. however, no consensus exists on the number and nature of these narrow traits (ozer & benet-martínez, 2006; llewellyn & wilson, 2003). it may be that narrower traits will provide a better understanding and more accurate prediction of the relationship between personality and business success. future studies should strive to identify these narrow traits and investigate whether they are better able to predict business performance than the broad traits used in this study. this study has investigated the influence of personality on business success. however, many other factors also influence the success of a business, factors relating to the business itself and the conditions under which it operates, such as economic conditions and access to resources, as well as factors relating to the owner as a person, such as education and experience. as such, in addition to personality, other personal influences should be considered when trying to determine whether an individual will be a successful small-business owner or not. despite the limitations, the results of this study provide insights into the personality profiles best suited to successful smallbusiness ownership, as well as insights into the relationship between personality and business sajems ns 15 (2012) no 4 397 success. the study lays the foundation for future research into the role of personality in entrepreneurship and as such makes a contribution to this field of study. in conclusion, ‘yes, personality does matter for small business success’. references acs, z., glaeser, r., litan, l. & fleming, s. 2008. entrepreneurship and urban success. kansas city, missouri: ewing marion. barrick, m.r. 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careless (reverse) cons4 i am someone who tends to be disorganized (reverse) extraversion extra5 i am someone who tends to be quiet (reverse) extra7 i am someone who is sometimes shy, inhibited (reverse) extra2 i am someone who is reserved (reverse) extra1 i am someone who is talkative extra8 i am someone who is outgoing, sociable openness to experience open2 i am someone who is curious about many different things open5 i am someone who is inventive open4 i am someone who has an active imagination open3 i am someone who is ingenious, a deep thinker open8 i am someone who likes to reflect, play with ideas agreeableness agree7 i am someone who is considerate and kind to almost everyone agree2 i am someone who is helpful and unselfish with others agree4 i am someone who has a forgiving nature neuroticism neuro4 i am someone who worries a lot neuro3 i am someone who can be tense neuro1 i am someone who is depressed abstract introduction theory and literature methodology and data results and discussion of citing papers analysis results and discussion of cited papers analysis conclusion acknowledgements references about the author(s) yi cui school of economics and management, xidian university, china yanping liu school of economics and management, xidian university, china jian mou school of economics and management, xidian university, china citation cui, y., liu, y. & mou, j., 2018, ‘bibliometric analysis of organisational culture using citespace’, south african journal of economic and management sciences 21(1), a2030. https://doi.org/10.4102/sajems.v21i1.2030 original research bibliometric analysis of organisational culture using citespace yi cui, yanping liu, jian mou received: 30 july 2017; accepted: 28 sept. 2017; published: 03 apr. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: as organisational culture plays an important role in forming a sustained competitive advantage, numerous studies about organisational culture have been completed. however, few studies have been conducted by analysing the references of publications with a visual pattern. moreover, this subject has reached a certain degree of maturity; hence, a review that analyses the trends of organisational culture is urgent. aim: the aim of this study was to provide broad information on organisational culture, including authors, journals, countries and references. in addition, the evolution of organisational culture is depicted and potential future research focuses are predicted. setting: using the web of science as a data source, we captured 1479 publications in science citation index (sci) and social science citation index (ssci) from 2005 to 2016 with 63 682 corresponding references for analysis. methods: a bibliometric approach using citespace software was applied to quantitatively and visually analyse organisational culture. results: (1) the usa is the most productive country followed by the uk and then australia in terms of publication; (2) scholars are mainly focused on ‘performance’, ‘innovation’ and ‘knowledge management’ aspects; (3) most fundamental theories and frameworks were created from the 1980s to the 1990s; (4) the journal of business ethics is the most appropriate journal for contributions, whereas the academy of management review is suitable for scholars to do a literature review, construct a theoretical framework and develop a research design; and (5) future research on this field has been justified accordingly. conclusion: these findings not only provide basic background knowledge about organisational culture for new researchers but also provide a framework for visual and quantitative research to management scholars and fill the gap between organisational culture and bibliometric analysis. introduction thirty-five years ago, a focus on the enterprise competition model of the usa and japan arose, which led to fervent research and even a revolution in management concepts, eventually resulting in a new management trend called ‘organisational culture’. the usa had been a global leader in management theories and institutional research in the field with the classic rational management style of the 1970s and 1980s until the us economic recession; in the meantime, the prominence of the japanese economy challenged the usa and even all western countries (pascale & athos 1982). so, the mechanisms of organisational management that compelled opposite developmental roads in american and japanese economies became a concern for american managerial scholars and corporate managers. pascale and athos (1982) found the crucial elements generating this difference between american and japanese companies in their study of japanese management. apart from the rigid management methods and institutions of the classic american style, japanese companies paid more attention to flexible spiritual factors and long-term collective value (pascale & athos 1982). meanwhile, japanese companies established organisational cultures that facilitated business innovations and also integrated value and psychological factors. in general, the success of japanese companies in organisational performance and competitive advantage surpassed even the usa (pascale & athos 1982). this trend highlighted the significance of organisational culture, called for the re-examining of corporate soft factors and also emphasised the influence of soft factors on corporate development. nowadays, organisational culture is treated as the key factor for business success and it has been empirically verified to promote organisational effectiveness (gregory et al. 2009), organisational innovation (hogan & coote 2013), organisational identity (ravasi & schultz 2006) and organisational performance (gregory et al. 2009). currently, organisational culture is thought to be a crucial factor associated with innovation in business success, especially in the context of the knowledge economy (büschgens, bausch & balkin 2013). although organisational culture has been well studied and has become a mature branch of management science, few studies have been conducted in this field using quantitative and visualised bibliometrics to analyse references instead of original papers. hence, we use a quantitative method instead of the traditional citation counts and personal, qualitative, narrative-based method to obtain a more comprehensive understanding of the evolution and development of organisational culture. moreover, organisational culture has reached a certain degree of maturity, where it is now treated as an exclusive field of study; therefore, identifying new potential future trends is urgent. as organisational culture in practice and academia has become so significant, a deep analysis of the implications, hot topics and research directions of this term is necessary. this paper uses a bibliometrics method through citespace to provide an overview of the studies in the organisational culture field. apart from the historical development of organisational culture in the next section, growth trends, core authors, top journals, countries, institutions and important reference articles are shown. based on these results, future trends are predicted. altogether, this paper not only supplies basic background knowledge about organisational culture for new researchers but also provides a framework of visual and quantitative research for management scholars and fills the gap between organisational culture and bibliometric analysis. in addition, compared to other methods of research in this field, such as systematic literature review and meta-analytic review, our study has three advantages over others. firstly, the results displayed in tables and figures are easier for researchers to understand. secondly, citespace provides broad analytic information, such as author, institution, country and reference, rather than just analysing the contents of publications on organisational culture. thirdly, potential future trends do not focus on just one aspect through statistical analysis, which may help researchers in different areas to extend their research and help practitioners understand whether their business challenge is related to organisational culture. this paper begins with a brief overview of the development of organisational culture and is then followed by the information about the tool used for the analysis (citespace) and the searching procedure. next, the results of citing papers (i.e. papers searched in this study) and cited papers (i.e. references of searched papers in this study) are displayed. the last section of this paper concludes with the findings in the research, represents practical and methodological contributions, and demonstrates some limitations. theory and literature the concept of organisational culture was initiated in cultural anthropology and has been widely applied in the study of organisational behaviours, management and marketing (gregory et al. 2009; schein 1992). organisational culture is defined as a set of values, beliefs, assumptions and symbols that is shared by all members and that directs their decisions and organisational behaviours (schein 1985). although this term appeared in the early 1970s, it was not analysed or adopted by management scholars until the 1980s (hatch 1993). because of diversity of the researchers’ backgrounds and the notability of this popular topic in management, hundreds of definitions were constructed. organisational culture could refer to, for instance, group norm (kilmann, saxton & serpa 1987), organisational climate (schneider, brief & guzzo 1996), ideology (goll & sanbharya 1990), shared beliefs (lorsch 1985), mental mode (hofstede 1998), basic assumptions (schein 1985), organisational strategies (weich 1985) and organisational symbols (pettigrew 1979). in the early 1980s, four masterpieces associated with organisational culture made waves in management academia in the usa: theory z by ouchi (1981), corporate culture by deal and kennedy (1982), the art of japanese management by pascale and athos (1982) and in search of excellence by peters and waterman (1984). these four publications enlightened organisational culture and pushed it towards a higher theoretical and practical level. in the 1980s, academics were mainly focusing on the definition, connotation, structural elements and type classification of organisational culture, and most of these studies were qualitative. even though the definitions and connotations of organisational culture could not reach a consensus at that time, schein’s idea and theory were representative ones in academia to some extent. schein (1992) shaped organisational culture in his book organisational culture and leadership. he explained it as the norms of expected behaviour that employees would follow, provided by organisational values and beliefs; moreover, it was a very important and invisible social force. the original text of schein’s (2004) book defined organisational culture as: … the pattern of basic assumptions that a given group has invented, discovered, or developed in learning to cope with its problems of external adaptation and internal integration, and that have worked well enough to be considered valid, and therefore, to be taught to new members as the correct way to perceive, think, and feel in relation to these problems. (p. 17) according to schein’s (1985) model of organisational culture, three layers of culture were constructed, which were artefacts, values and basic assumptions from outer to inner levels. further, schein (2004) investigated these three levels by the degree of visibility to observers. schein’s (1985) model of organisational culture made him particularly influential, as he articulated and provided a qualitative framework for analysing and intervening in culture management fields. there was no doubt that schein laid the basis for organisational culture models and qualitative research, and he believed that it was the subconscious that formed the most invisible layer, which would make it difficult to measure; hence, organisational culture investigations should mainly depend on qualitative research. however, in the 1990s, quantitative studies gradually permeated this new management field despite many still agreeing with schein’s idea that quantitative investigations made no contribution to the understanding of culture at a deep level. scholars constructed a quantitative index system from diversified dimensions that could better interpret the relationship between organisational culture and corporate outputs, such as business performance (o’reilly et al. 2014), employee satisfaction (gillespie et al. 2008) and innovation ability (tellis, prabhu & chandy 2013). quantitative studies of organisational culture from o’reilly, chatman and caldwell (1991), hofstede (1998), cameron and quinn (1998) and denison and mishra (1995) were typically representative. o’reilly et al. (1991) used the q-sort method on 54 value indicators acquired from the existing literature to develop an ‘organisational culture profile’ (ocp). seven dimensions, which were innovation, outcome orientation, respect for people, team orientation, stability, aggressiveness and attention to detail, and 54 items were covered in the ocp scale to measure the fitness of person-organisation (o’reilly et al. 1991). hofstede (1998) was the academic authority on cross-culture management, and he proposed the multidimensional model of organisational culture, which consists of the following scales: process oriented to results oriented, employee oriented to job oriented, parochial to professional, open system to closed system, loose control to tight control and normative to pragmatic. the competing values framework (cvf) was built by quinn and spreitzer (1991) as a two-dimensional framework in which the dimensions were structure and focus. these two dimensions separated organisational culture into four types, flexible external focus, control external focus, flexible internal focus and control internal focus, represented by adhocracy, market, clan and hierarchy types, respectively. recently, kokt and merwe (2011) have applied cvf as a quantitatively diagnostic tool in a leading private security company to investigate the organisational culture type; furthermore, according to the statistical results, they have offered some recommendations to balance the organisational culture orientations to help corporate future development. based on cvf, the organisational culture assessment instrument (ocai) was published by cameron and quinn (1998). this instrument contains six dimensions that are dominant characteristics, organisational leadership, management of employees, organisational glue, strategic emphases and criteria of success (cameron & quinn 1998). the ‘denison organisational culture survey’ (docs) was also based on cvf; however, using grounded theory on five organisations and chief executive officers from 764 organisations as samples, denison constructed a ‘theoretical model of culture traits’ (tmct). akin to cvf, tmct contains four cultural traits: adaptability, mission, consistency and involvement (denison & mishra 1995); additionally, each trait includes three sub-dimensions to make a total of 12 dimensions (fey & denison 2003). organisational culture could be a source of sustained competitive advantage (barney 1986), and a large number of empirical research about organisational facilitation of employee retention (sheridan 1992), knowledge management (alavi & leidner 2006), effectiveness (denison & mishra 1995; fey & denison 2003; gregory et al. 2009), innovation (büschgens et al. 2013), creative output (kessel, oerlemans & stroe-biezen 2014) and performance (hogan & coote 2013) were mainly documented. barney claimed that to achieve these beneficial attributes in terms of sustained competitive advantages, organisational culture must meet three conditions: be valuable, rare and difficult to imitate (barney 1986). several important functions of organisational culture were identified. firstly, organisational culture can serve as a source of distinctions among organisations and can transmit a perception of identity for organisation members (ravasi & schultz 2006). secondly, it can promote the generation of commitment (peters & waterman 1984). thirdly, it can strengthen the stability and consistency of the organisation (louis 1980). finally, it can manage the behaviours of the members of the organisation by shaping their shared values and beliefs (schein 1992). hence, a large amount of empirical evidence suggests that there are positive correlations between organisational culture and market performance (homburg & pflesser 2000), financial performance (homburg & pflesser 2000), employee attitudes (gregory et al. 2009), knowledge management and organisational effectiveness (zheng, yang & mclean 2010). because organisational culture has some specific characteristics such as being mostly invisible and hard to quantify, as well as creativity or uniqueness, and because of the width and depth of the research perspectives, there is no doubt that quantitative research cannot substitute for qualitative research. therefore, we believe that the integration of both methods can foster high-level achievements. methodology and data bibliometrics is a statistical analysis of extant literature and is used to provide quantitative analysis of publications in a given field (mayr & scharnhorst 2014). the main categories of information analysed with respect to bibliometrics are the authors, keywords, references, journals, countries, institutions and the trends in a special field (abramo, d’angelo & viel 2011). bibliometrics originated from the quantitative research of literature that emerged in the early 1900s, and since then literature analysis based on bibliometrics has been widely applied in academic research (diem & wolter 2013). graphical research and visualisation studies of bibliometrics can be managed with the help of computer technology. ma and xi (1992) emphasised that graphical visualisation studies based on co-citation analysis could provide more information and make data more comprehensive. additionally, this method could help researchers determine the most recent developments in a special field and forecast the possible direction of such a field (chen 2006). co-citation analysis considers that any new theory comes from an existing one, and two articles are defined as having a co-citation relationship if they are cited by one or more articles at the same time; to what extent they are close to each other is called the co-citation degree, which is calculated by the number of citations (small 2003). citespace is a free java-based application for analysing co-citations and generating visual maps, as well as finding trends and patterns. this powerful and popular tool is designed for finding critical points in the development and evolution of a field, especially turning points and pivotal points. it provides various functions to help with identifying fast-growing topical areas, finding citation hot spots, decomposing a network into clusters, automatically labelling clusters with keywords from citing articles, finding geospatial patterns of collaboration and unique areas of collaboration and so forth (chen 2006). in building the network image, three types of views – cluster view, timeline view and timezone view – can be used for analysing different information including knowledge structure, time span of a topic and evolution trends, respectively. the primary source of input data for citespace is the web of science (chen 2013). this paper uses citespace version v and java viii as a visual and analytic research tool that is freely available online and was founded by chaomei chen, the inventor of citespace (http://cluster.cis.drexel.edu/~cchen/citespace/). the web of science is one of the most excellent literature databases containing citation information sources crucial for this study (chen et al. 2016). hence, it was used as a data resource website and was also recommended by citespace. to obtain the original target articles’ information, ‘organisational culture’ and ‘corporate culture’ were used as a whole phrase in the topic search. several restrictions were set before the topic search. firstly, the web of science core collection was used rather than all databases so that articles would be of high quality and influential in this field. secondly, the time span was set from 2005 to 2016 because some core journals associated with organisational culture in social science were collected from 2005, such as academy of management journal, academy of management review, organisation science and so on. thirdly, the science citation index expanded (sci-expanded) and social sciences citation index (ssci) were used as citation indexes to make the samples more comprehensive. finally, 3488 articles were selected from the database, and ‘management’, ‘business’ and ‘psychology applied’ were set as the categories for further restriction to refine the sample size to 1479, limiting the sample to the main discipline and the nature of ‘organisational culture’. even though web of science does not include all papers about organisational science, the references from collected records cover almost every important article in this field; therefore, crucial points can be highlighted on the map of cited reference, author or institution. the search details are listed in table 1. table 1: summary of search details. results and discussion of citing papers analysis document information journal articles were identified as the most common document type, which accounts for 90.96% (n = 1318) of all papers in this study, followed by reviews (n = 82). almost all papers were published in english (n = 1454) as the database of sci-expanded and ssci mostly consists of english journals rather than journals in other languages, and scholars tend to publish their articles in english as they want them to be widely accepted. there is an obvious sudden increase in publications in this field, from 75 articles in 2007 to 118 articles in 2008, and the number of articles continued to increase until peaking at 163 articles in 2012, followed by a decrease to approximately 130 articles in subsequent years (shown in figure 1). the doubling in the number of articles published from 2007 to 2012 illustrates that organisational culture has still been an active topic in recent years; however, it does not mean that research in this field is hot or is increasing compared to other bibliography studies, such as ‘emergy’ research increasing from 5 articles in 1993 to 93 articles in 2014 (chen et al. 2016). the 1479 papers in this study have been cited 19 982 times, and the steady linear pattern of growth rate shown in figure 2 for each year also proves that research in organisational culture reached a plateau at approximately 130 articles each year and will probably remain the same in the future. nevertheless, it is now a mature subject, and there are still many works (130 articles per year) on this topic compared to other studies (chen et al. 2016; feng et al. 2015). unfortunately, a clear pattern from 1970 to 2004 cannot be captured through web of science because of the collection deficiency; however, this shortcoming does not affect our results in the subsequent analysis, and the 1479 articles’ references cover almost every important article in this field for this study. figure 1: number of publications on organisational culture for each year from 2005 to 2016 in the web of science. figure 2: number of citations about organisational culture for each year from 2005 to 2016 in the web of science. authorship based on the database from 2005 to 2016, there are 2557 authors contributing to 1479 articles. the top 27 most active authors, with more than 3 articles each, are listed in table 2. the number of publications for the top 27 authors is relatively small and disperse, and only accounts for 8.42% of the 1479 articles; however, some cooperative pattern can be seen among these top authors in figure 3. nine collaborative groups can be found, which are presented by nodes linked by lines. the size of the nodes represents the number of articles, whereas the lines represent the collaborative relationship. all four papers from flatten (brettel, chomik & flatten 2015; engelen et al. 2014; strese et al. 2013, 2015) are associated with the top-ranked scholar brettle, and they mainly focused on how organisational culture and innovation culture could influence new product developmental performance, in other words, how culture impacts innovation. engelen (2010) was investigating the effect of organisational culture, especially cross-national culture, on entrepreneurial orientation or innovation orientation; therefore, the key point that these three scholars captured was the relationship between innovative performance and cross-national organisational culture (engelen et al. 2014). studies by ogbonna and harris (2007) dealt with various topics such as websites, the internet and organisational behaviours; however, they emphasised that organisational culture played a key role in the operation of an organisation (e.g. harris & ogbonna 2007; lloyd & ogbonna 2011; ogbonna & harris 2007, 2014). baruch and he highlighted the importance of organisational culture in organisational learning and organisational identity (e.g. he & baruch 2009; hong et al. 2016). eddleston and kellermanns (e.g. eddleston, kellermanns & sarathy 2008; eddleston, kellermanns & floyd 2013; kellermanns et al. 2012) were also studying how organisational culture affects innovative performance, but in family firms. chatman and caldwell (e.g. chatman et al. 2014; o’reilly et al. 2014) claimed that organisational culture had a positive empirical effect on firm performance in their studies. the relationship between firm performance and organisational culture was further improved by denison and gillespie (e.g. boyce et al. 2015; kotrba et al. 2012). huhtala and feldt discussed organisational culture from an ethical aspect and highlighted the perceptions of ethical organisational culture affecting management style and the well-being of leaders (e.g. huhtala et al. 2015a; huhtala, kaptein & feldt 2015b; kangas et al. 2014; lamsa et al. 2013). menguc and auh depicted the function of organisational culture and leadership in marketing (e.g. menguc & auh 2008a, 2008b, 2010; menguc, auh & shih 2007), whereas hult, slater and cavusgil discussed the impacts of cross-national culture on market orientation and cooperation (kirca, cavusgil & hult 2009; slater, hult & olson 2010). considering the relationship between organisational culture and the various aspects that the top productive authors focused on, it could be predicted that these topics, such as innovation, firm performance and market orientation, might be continually explored in the future. figure 3: map of the most productive authors with collaborative links. table 2: the top 27 most productive authors. journals the number of organisational culture articles in the top 10 journals is displayed in table 3. obviously, most of these journals are in management and business fields, and one, human relations, is correlated to the fields of psychology and sociology. the publishing trends of these journals were analysed through web of science. the top journal journal of business ethics showed a downtrend in article publications with respect to organisational culture, whereas the journal of business research and the african journal of business management showed an uptrend. in summary, the information in this section provides a general view that scholars from certain categories are more suitable for organisational culture investigations and directs new researchers to journals that are better choices for article submission. table 3: the top 10 journals for organisational culture publications. countries and institutions there are 77 countries contributing the 1479 articles in this study, and the top 10 most productive countries producing 85.92% of all articles are listed in table 4. there is no doubt that the usa, as the place of origin, contributes the most and accounts for one-third of the total articles. most of these countries or territories are developed except for china; however, it should be noted that the rate of economic growth in china has been high since 1990 (wan, morgan & barro 2016). additionally, the introduction of the idea of organisational culture to china occurred in the 1990s (tsui, wang & xin 2016); therefore, there may be a potential relationship between economic growth and the practical significance of organisational culture. moreover, much of the literature associated with organisational culture is linked with innovation, which could lead to the success of companies and even countries. table 4: the top 10 countries for organisational culture publications. collaborative patterns have been analysed by citespace, and the image shows that almost all countries have a cooperative relationship with the usa and england. in figure 4, each node represents a country, and nodes with the same colour are grouped as a cluster, implying a special and major research focus. a country linked with another cluster is involved in another focus with partial attention. cluster information is displayed in table 5 and named by the countries associated with neighbouring clusters; moreover, the research focuses are labelled by the keywords of the articles. it can be observed that several countries tend to work together for a major cluster and that each cluster usually has one or two core countries depending on the size of the node. figure 4: cluster map of productive countries or territories. table 5: analysis of cluster information by country. it is easy to determine the top-level research groups of organisational culture worldwide through institutional analysis by citespace. more than 1000 institutions are identified in 1479 articles. to make the results comprehensive, the most important institutions were used for analysing the research direction (more than 10 articles) and the cooperative patterns (more than seven articles). as shown in table 6, michigan state university ranked first with 16 publications, followed by arizona state university with 15 publications and northeastern university with 14 publications. the top three institutions are all from the usa, and it should be noted that 10 out of 13 institutions are from the usa, 2 from australia and 1 from the uk. it can also be observed from figure 5 that american institutions are more important and are widely linked through the network. the research directions are not obviously separated, and they are mainly associated with performance, innovation and knowledge sharing. important institutions are displayed with purple rings. arizona state university is the core institution in the network and two central institutions are linked to arizona state university. it can also be observed that arizona state university holds the centre position in the network, connecting with the most institutions. figure 5: map of the most productive institutions with collaborative links. table 6: the top 13 institutions for organisational culture publications. keywords the top 20 keywords are listed in table 7, and two modifications were applied to ensure the comprehensiveness of the keyword information. firstly, keywords with the same meaning were combined, such as organisational culture and corporate culture. secondly, keywords that were not associated with the research directions such as firm, model, value and so on were put into the exclusive list. apart from the topic words ‘organisational culture’, the most emerging word is ‘performance’, followed by ‘management’, and ‘innovation’; this rank remains the same from 2005 to 2016 and can be seen in figure 6. to view the trends in organisational culture studies, 12 years, from 2005 to 2016, were divided into three time periods: 2005–2008, 2009–2012 and 2013–2016. the top 3 keywords remain at the same rank, which indicates that performance, management and innovation are all closest to the topic. the rank for other keywords is roughly the same with some mild perversion. despite some of these words being above the top 20 in different periods, they do not exceed the top 30. from the result, it can be concluded that this field is mature in organisational discipline and that there are not any new branches that form another direction apart from the extant ones. hence, it is predicted that the research trend will be relatively stable in the future, focusing on ‘performance’, ‘management’ and ‘innovation’; however, to detect tiny changes or a small propensity for topics to shift along with time, the keywords co-citation is used for the analysis shown in figure 7. the whole 12-year period is divided into six equal slices, and the top 30 keywords from each slice are extracted to form the keywords co-citation network. then, the keywords with different colours, which represent the first year that they were co-cited, are linked through their co-citation relationship. the cold colour stands for early years, whereas the warm colour is for recent years. as the field of organisational culture progress is relatively mature, the pattern seems intricate and crowded together without obvious branches. therefore, nodes with the same colour links were pulled to the edge of the network manually and laid anticlockwise from cold colour to warm colour, and the nodes with links throughout the network remained in the centre. performance is still the pivotal point penetrating into all the topics, and at the bottom of figure 7, several keywords are connected in recent years. therefore, the topics of knowledge transfer, work engagement and dynamic capability are assumed to be more important or to form a new branch in the near future. additionally, we have applied burst detection to search for the words trending upwards in recent years. apart from ‘dynamic capability’, ‘decision making’ is identified as another burst keyword from 2013 until now, and it may become a future hot topic. figure 6: the frequency of the top 20 keywords from publications (excluding organisational culture) in three time periods. figure 7: the map of keywords in co-citation relationship. table 7: the top 20 keywords from publications. results and discussion of cited papers analysis reference articles with the support of citespace, 63 682 references from 1479 articles were analysed. the top 10 reference articles according to their citation frequency are listed in table 8. books from hofstede (1980) and schein (1985) are both ranked first, followed by o’reilly et al.’s (1991) work. among the top 10 reference articles, three articles belong to hofstede and two are from schein; therefore, it can be assumed that hofstede and schein are the base founders of the organisational culture field and that their works play an important role in the development of organisational culture. table 8: the top 10 references in this paper. it is evident that hofstede focuses more on quantitative research, whereas schein focuses on qualitative research; moreover, most of hofstede’s studies (e.g. hofstede 1980, 1998, 2001) tend to investigate the cultural differences of cross-national or cross-organisational culture, whereas schein’s studies (e.g. schein 1985, 1992, 2004) tend to analyse the deep levels of organisational culture within an organisation, such as how it is formed and how it works. culture’s consequences is hofstede’s (1980) best-known book, and the four dimensions of organisational culture he proposed, ‘individualism’, ‘power distance’, ‘uncertainty avoidance’ and ‘masculinity’, have become a milestone in cross-national quantitative culture research and help in understanding the differences among cultures (hofstede & geert 1980). schein has defined organisational culture in his book as the norms of expected behaviours that employees would follow, provided by organisational values and beliefs. on this basis, schein’s three-level model was built up and well interpreted. schein also gave these assumptions different dimensions, such as ‘external adaptation issues’, ‘managing internal integration’, ‘reality and truth’, ‘the nature of time and space’, ‘human nature’, ‘activity’ and ‘relationships’. in addition, the function of the leader and the relationship among leadership members, culture building, culture embedding and evolving were described. the third most frequently cited reference is from o’reilly et al. (1991). in o’reilly’s research, q-sort measurement was applied to analyse organisational culture; rather than assessing the leadership, o’reilly emphasised the behaviours of organisational members and developed an instrument for assessing person-organisation fit called the ‘organisation culture profile’ (o’reilly et al. 1991). it should be noticed that the fourth most cited reference from podsakoff et al. (2003) is recognised as a burst reference by citespace analysis. looking at podsakoff et al.’s (2003) study, we found that instead of studying organisational culture or other associated topics, podsakoff’s work focused on the method of the research; moreover, podsakoff (2003) summarised the potential source of common method biases to measure constructs in behavioural research and recommended methods of avoiding these biases (podsakoff et al. 2003). this result suggests that scholars are increasingly emphasising quantitative research in the organisational culture field and methodology. in reference to co-citation analysis, the same slice configuration as keywords was used. the top articles are displayed by nodes with large sizes and are linked through almost the whole network in figure 8. the result of the cluster analysis is not significant and therefore is not included in this study. there are two reasons for this situation. firstly, the organisational culture field is a well-studied and developed theme and is developed. moreover, the structure or content of this field is interconnected such as leadership, performance, innovation, hr management, knowledge management and so on. secondly, the studies in this field still focus on the ideas and theories built in the past; this can be observed in the timezone map in figure 9, which shows that all of the important papers cited in our database (2005–2016) were from 2005; therefore no new theories or branches have formed after 2005. the only point after 2005 in the timezone map is regarding the relationship between organisational culture and organisational effectiveness using spreitzer and quinn’s cvf theory (hartnell, ou & kinicki 2011). the timeline map shows that the most important studies are concentrated in a certain period between the 1980s and the 1990s, except podsakoff’s work in 2003 and hofstede’s work in 2001, which is the second edition of his work from 1980 (hofstede 2001), and that these works will still be the basis in the near future (figure 10). in addition, it can also be found that knowledge sharing topics along with organisational culture will continue to be the focus. because most fundamental works were conducted in the 1980s, almost all articles cite these papers for their own theoretical construction or background review, which makes the map messy. therefore, we restricted the reference years from 2000 to 2016 rather than including all years (figure 11). the result shows a clearly separated structure by time slice. the paper from tellis is the most important point in figure 11. tellis et al. (2013) asserted that radical innovation was the key factor for the growth, success and wealth of a company; moreover, organisational culture played a key role in innovative behaviour. it is also a turning point that links performance and innovation around 2009. as shown in figure 11, most studies displayed on the left are associated with performance and leadership, whereas innovation-related articles are on the right, and this result is consistent with the future orientation predicted in the keywords section above. figure 8: map of references: cluster view. figure 9: map of references: timezone view. figure 10: map of references: timeline view. figure 11: map of references: cluster view. restricting reference years from 2000 to 2016. reference authors the most influential authors from the 63 682 references are analysed using the same slice configuration as keywords and are shown in table 9. there is no doubt that schein (mit sloan school of management) ranks the first, since his three-level theory of organisational culture and his well-known book organisational culture and leadership were widely spread and well applied. hofstede ranks second with 393 citations. the third most influential author is denison; his work focused on the correlations between quantified organisational culture and dependent variables based on cvf. with denison’s organisational culture model, 4 dimensions (adaption, mission, consistency and involvement) and 12 sub-dimensions are used to measure organisational culture. denison indicated that each of these traits had its own advantages and shortcomings. however, successful organisations are those that could resolve these contradictions without relying on simple trade-offs. table 9: the top 10 authors of reference articles. apart from schein and hofstede, barney is another important author in the management field that has not been analysed deeply in this study. his study in 1986 about the significance of organisational culture in forming a sustained competitive advantage for a company is the 11th most cited reference after hofstede’s work, as shown in table 8. rather than focusing on organisational culture, barney and hansen (1995) searched all corporate sources associated with competitive advantages, including organisational culture. he highlighted the importance of the capabilities and behaviours of business firms operating in a market environment. barney suggested that three types of trustworthiness (weak, semi-strong and strong) could be a source of competitive advantage. in summary, he concluded that sustained competitive advantage could not be created simply by evaluating the market environment such as with an analysis of strengths, weaknesses, opportunities and threats (swot) analysis; leaders must search for their unique resources and capabilities that are valuable, rare and hard to imitate (barney 1995), for instance, organisational culture (alavi & leidner 2006). similar to the previous reference analysis results, the most important authors in this field were from earlier years, which may imply that no author has conducted groundbreaking work in recent decades. by looking at the key nodes in figure 12, studies from fornell and podsakoff have burst in recent years. fornell focused on the drawbacks of the commonly applied chi-square test in structural equation models (sem) with unobserved variables such as organisational culture and measurement error; in addition, he analysed and highlighted that a type ii error could be substantial even though the sample size was large (fornell & larcker 1981). in the end, fornell developed a testing system based on the measures of shared variance of structural and measurement models to overcome those problems (fornell & larcker 1981). together with podsakoff’s works (e.g. podsakoff et al. 2003), as the organisational culture field develops, more and more research not only uncovers the potential relationship between organisational culture and resources of corporate successes but also pays more attention to the methods of discovering such relationships to make the results robust and the explanations powerful. figure 12: map of reference authors: timezone view. reference journals the top 10 cited journals with their impact factors (2016) are listed in table 10. the academy of management review is the most cited journal, with 908 citations, and it is also the top-level journal in the management field, with an impact factor of 7.288; moreover, this journal mainly focuses on the review of basic theories and extant research, therefore providing a theoretical framework for studying organisational culture. compared to the journals of citing papers shown in table 3, only human relations exists at the same time. human relations is a monthly peer-reviewed academic journal covering research on business, management, organisation, sociology and psychology. it is noteworthy that this journal and the journal of management studies are the only two journals from the uk, whereas the others are from the usa. hence, it is believed that the significance of organisational culture theories is important to british scholars. however, by comparing the journals from tables 3 and 9, reference journals are more influential than the citing journals; on one hand, it may imply that this field is relatively mature and is gradually fading from the major concerns of managerial academia. on the other hand, it may indicate that the field of organisational culture is moving towards practical applications from theoretical construction. table 10: the top 10 journals of the references. conclusion this article begins with a brief review of the developmental history of organisational culture and the core scholars with their studies and research methods. based on 1479 publications published between 2005 and 2016, significant points emerged and a systematic overview of organisational culture was presented. we have identified the key authors, journals, countries, institutions, keywords and references, as shown in the tables and figures above. furthermore, we have predicted that knowledge transfer, work engagement, dynamic capability and decision making may become future research focuses for organisational culture research. this paper has shown a method supported by citespace for deeply and quantitatively investigating an interesting topic. in some ways, this paper can be considered as a demonstration for studying a new field briefly and quickly. in this case, organisational culture was used as an example, which provides a methodological contribution. compared to simply reviewing extant literature, this method not only shows the development of a subject, important authors and critical papers visually but also provides future trends of this subject. furthermore, reference analysis by citespace can overcome a lack of literature reading, because even though the reviewed literature is limited, their references contain enough information about the key papers in a field; hence, it directs further suitable papers to review. to avoid misunderstanding and to guide future investigations, three main limitations of this study should be noted. firstly, even though our data cover the most important articles in the field of organisational culture, the database of recommended source website (web of science) by citespace is not comprehensive and some important journals are excluded. ssci collections in the web of science are from 2005; hence, the number of years of study for analysis is reduced. secondly, the content of both citing and cited articles cannot be processed directly by citespace; therefore, the details of important articles were analysed and interpreted manually, which is a time-consuming and relatively fallible procedure. finally, information provided by both the web of science and citespace is just a brief introduction to the publications, so we may lose some of the critical details in the full papers. therefore, 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comparison revisited shelley m farrington department of business management, nelson mandela metropolitan university danie jl venter unit for statistical consultation, nelson mandela metropolitan university christine r schrage department of marketing, university of northern iowa peter o van der meer utrecht school of economics, entrepreneurship and innovation, utrecht university accepted: july 2012 in 2001/2002 a study was undertaken to establish whether significant differences existed between the levels of development of several entrepreneurial attributes, as perceived by undergraduate business students from three universities in three different countries. the rationale was that, if entrepreneurial attributes could be identified as more developed in one country than in another, solutions could be provided for developing these attributes in others. the primary objective of this study is to investigate and compare the levels of development of entrepreneurial attributes of undergraduate business students in the present study (2010) to the levels of development reported by undergraduate business students in the 2001/2002 study. cronbach alpha coefficients were calculated to assess the reliability of the measuring instrument and ttests to establish significant differences. cohen’s d statistics were calculated to establish practical significance. the findings suggest that the educational environment and entrepreneurship education policy of the dutch university participating in this study could provide solutions as to how entrepreneurial attributes among students could be developed further. key words: entrepreneurship, entrepreneurial attributes and entrepreneurship education jel: l260 1 introduction and research objectives according to mueller (2004) and shane (1992), the prevalence of entrepreneurial attributes varies across countries and cultures. factors contributing to these differences are culture, level of economic development of the country, and political-economic traditions (mueller, thomas & jaeger, 2002). against this background in 2001/2002 van eeden, louw and venter (2005) undertook a study with the main objective being to report on the levels of development of undergraduate business students’ entrepreneurial attributes (personality traits, characteristics and skills) in three different countries. they also wanted to establish whether significant differences exist amongst these countries in respect of the development of these attributes. the reasoning was that if entrepreneurial attributes could be identified as more developed in one country than another, that country could provide solutions as to how to develop such attributes in other countries. the results of that study (2001/2002) reported that the order of the four most developed entrepreneurial attributes differed for each of the three participating countries. two attributes, however, overcoming failure and high energy level, were among the four abstract 334 sajems ns 15 (2012) no 4 most developed attributes in all three countries. south african students and students from the united states of america (usa) had three of the top four most developed attributes in common. although for the netherlands the order of the least developed attributes differed slightly, the four lowest scoring attributes in all three countries were the same, namely continuous learning, knowledgeseeking, initiative and responsibility, and communications ability. furthermore, for nine of the entrepreneurial attributes under investigation, significant differences existed between the mean scores reported by all three countries, with the american sample scoring significantly higher means than the other countries on the levels of development (van eeden et al., 2005). given the increased attention over the last decade to the development of entrepreneurship, entrepreneurship education and entrepreneurship as an academic discipline (haase & lautenschläger, 2011; nishimura & tristán, 2011; soetanto, pribadi & widyadana, 2010; herrington, kew & kew, 2009), the aim of this study is to revisit the levels of development of entrepreneurial attributes among undergraduate business students so that improvements to these levels, since 2001/2002, can be established. by using the same measuring instrument and a sample of students from the same three universities as to the study done in 2001/2002, it is hoped that where improvements or changes are evident, didactical solutions can be identified and shared among all. furthermore, few studies have investigated entrepreneurial characteristics collectively to profile individuals within countries (tajeddini & mueller, 2009:7), whereas this study attempts to do just that. to advance entrepreneurial activity in a country it is essential for the population to possess a particular set of attributes (i.e. personality traits, skills, aptitudes and desires) (thomas & mueller, 2001; krueger & brazeal, 1994) and as the prevalence of these attributes among a given population increases, so too will the likelihood of entrepreneurial behaviour and in turn entrepreneurial activity in that country (mueller, 2004). according to gurol and atsan (2006), these entrepreneurial attributes can be developed through educational programmes. for example, mahadea (2001: 193) suggests that an individual’s capacity to take risks can be nurtured and developed through appropriate training. according to chen and lai (2010), potential entrepreneurs should be developed while still students. fostering entrepreneurship among students has become an important topic among universities, governments and researchers (venesaar, kolbre & piliste, 2006). through entrepreneurial education the necessary skills and confidence to undertake entrepreneurial activity can be developed (fatoki, 2010:92; urban, botha & urban, 2010:135), but it is important for educational institutions to know which skills and competencies to develop when educating future entrepreneurs (venesaar et al., 2006). against this background, the primary objective of this study is to investigate and compare the entrepreneurial attributes of undergraduate business students in three different countries at two different points in time. the levels of development of entrepreneurial attributes of undergraduate business students in the present study (2010) are compared to the levels reported by undergraduate business students in a previous study (2001/2002). for the purpose of this study entrepreneurial attributes refer to personality traits, characteristics and skills commonly associated with entrepreneurs, whereas ‘undergraduate business students’ refers to students completing business-related modules at undergraduate levels. for convenience, the three countries chosen to participate in the study were the same as those that participated in the 2001/2002 study, namely south africa, the usa and the netherlands. the purpose of this study was not to develop and test hypotheses, but to establish the extent to which entrepreneurial attributes evident among the undergraduate business students of 2010 have changed compared to those of undergraduate business students of 2001/2002. thus, this study explores the extent to which business students possess more or fewer entrepreneurial attributes and consequently entrepreneurial potential than their counterparts in 2001/2002. sajems ns 15 (2012) no 4 335 2 entrepreneurial attributes numerous attributes (traits, characteristics and skills) are associated with entrepreneurial behaviour and entrepreneurial success (deakins & freel, 2009; ramana, aryasri & nagayya, 2008; mahadea, 2001; entrialgo, fernandez & vazquez, 2000; mcclleland, 1961). it is these entrepreneurial attributes that distinguish entrepreneurs from others, and individuals who possess them may be predisposed or more likely to engage in entrepreneurial activities (raab, stedham & neuner, 2005; cromie, 2000). in recent years there has been considerable interest and debate over entrepreneurial character (traits) as a predictor to engage in entrepreneurial activity (tajeddini & mueller, 2009; mueller, 2004). attempts to predict entrepreneurial behaviour using trait approaches have delivered poor results (kristiansen & indarti, 2004; krueger, reilley & carsrud, 2000) and there has been little support for a relationship between personality traits and entrepreneurial activity (autio, keeley, klofsten, parker & hay, 2001). venesaar et al. (2006) assert that it is methodically limiting to focus only on personality traits to explain entrepreneurial initiative. similarly, kristiansen and indarti (2004) contend that although attributes are a factor in predicting entrepreneurial behaviour, an individual’s attitude most likely plays a bigger role. t a b l e 1 literature pertaining to entrepreneurial attributes entrepreneurial attributes references planning and perseverance scarborough, 2011; barringer & ireland, 2010; wilner, 2009; timmons & spinelli, 2009; scarborough, wilson & zimmerer, 2009; nieman & nieuwenhuizen, 2009; wickham, 2006; nieman & bennet, 2005; bowler, 1995. persuasion and networking mugshot, 2010; timmons & spinelli, 2009; van vuuren, 1997. communication ability marvin & jones, 2010; nitikina, 2007; barrier, 1995; marx, van rooyen, bosch & reynders, 1998. commitment calvasina, calvasina & calvasina, 2010; timmons & spinelli, 2009; marx et al., 1998; siropolis, 1990. overcoming failure de angelis & hayes, 2010; barringer & ireland, 2010; pryor, toombs, anderson & white, 2010; kuratko, 2009; goodman, 1994; burns & dewhurst, 1993; gerdes, 1988. self-confidence and locus of control scarborough, 2011; nieman & nieuwenhuizen, 2009; kuratko, 2009; scarborough et al., 2009; chillemi, 2010; timmons & spinelli, 2007; nieman & bennet, 2005; cromie, 2000; kreitner & kinicki, 1998; goodman, 1994. risk-taking ability kuratko, 2009; nieman & nieuwenhuizen, 2009; scarborough et al., 2009; timmons & spinelli, 2009; kaluwasha, 2009; wickham, 2006; cromie, 2000; mariani, 1994; casson, 1991; siropolis, 1990. initiative and responsibility scarborough et al., 2009; kreitner and kinicki, 1998; marx et al., 1998; goodman, 1994; gerdes, 1988. high energy level scarborough, 2011; timmons & spinelli, 2009; thomas & mueller, 1999; marx et al., 1998; mariani, 1994; goodman, 1994; casson, 1991. tolerance for ambiguity and uncertainty scarborough, 2011; scarborough et al., 2009; timmons & spinelli, 2009; nieman & bennet, 2005; entrialgo et al., 2000; bowler, 1995. creativity and flexibility timmons & spinelli, 2009; nieman & bennet, 2005; kreitner & kinicki, 1998; casson, 1991; gerdes, 1988. knowledge-seeking julienti, bakar & ahmad, 2010; mushonga, 1981; bowler, 1995. continuous learning ribeiro, 2010; ming, 2009; hellriegel, jackson & slocum, 1999; kroon & moolman, 1991. financial proficiency mankelwicz & kitahara, 2010; scarborough et al., 2009; wickham, 2006; marx et al., 1998. money sense cudmore, patton, ng & mcclure, 2010; burns & dewhurst, 1993; burch, 1986; kroon & moolman, 1991. business knowledge scarborough et al., 2009; gerry, marques & nogueira, 2008; barringer & ireland, 2008; marx et al., 1998, van vuuren, 1997. (source: farrington, venter, neethling & louw, 2010) irrespective of this criticism, the ‘attribute’ approach, focusing on personal characteristics, has dominated attempts to understand entrepreneurs, and whether an individual’s characteristics predict entrepreneurial behaviour (tajeddini & mueller, 2009; raab et al., 2005). although attitude towards entrepreneurship has emerged as the most important factor influencing intentions to become self-employed, personality traits have an indirect influence on the readiness 336 sajems ns 15 (2012) no 4 of the individual to undertake such activities (lüthje & franke, 2003). in recent times an interest in personality traits and whether these traits affect the intention to engage in entrepreneurial activity, has resurfaced (mueller, 2004). furthermore, psychological characteristics are being recognised as being of great importance in understanding and fostering entrepreneurship, and in assessing entrepreneurial potential (raab et al., 2005). nevertheless, many consider the identification and investigation of entrepreneurial attributes a worthless exercise (ramana et al., 2008; cromie, 2000), yet the perspective of this article supports those that disagree. although several attributes (traits, characteristics and skills) have been identified in the entrepreneurship literature as being associated with entrepreneurial behaviour and success, the focus of this study is on the attributes identified by van eeden et al. (2005). this was necessary so that the same entrepreneurial attributes assessed in the 2001/2002 study could be assessed in this (2010) study. as such, an elaborate theoretical overview of the various entrepreneurial attributes associated with entrepreneurs was deemed beyond the scope of this article. the attributes investigated in this study, together with supporting references, are summarised in table 1. 3 research design and methodology 3.1 sample and sampling method in assessing the entrepreneurial attributes of undergraduate business students, a positivistic research paradigm was adopted. all undergraduate students studying business modules at the participating universities were given the opportunity of voluntarily participating in the study. the sample obtained can thus be described as a convenience sample. 3.2 measuring instrument and data collection an existing measuring instrument (van eeden et al., 2005; louw, du plessis, bosch & venter, 1997) was used to assess the levels of development of several entrepreneurial attributes in the present study. section a of the questionnaire consisted of 104 statements relating to the entrepreneurial attributes under investigation. the statements were phrased with a possible response continuum linked to a t a b l e 2 operational definitions of the entrepreneurial attributes entrepreneurial attributes operational definition planning and perseverance having goals, plans and the determination to follow through. persuasion and networking having the ability to convince others and build relationships. communication ability having the ability to communicate ideas to others. commitment having the ability to meet commitments in a timely manner. overcoming failure having the ability to overcome failure and regard it as a learning experience. self-confidence and locus of control having belief in oneself and believing that personal actions determine success. risk-taking ability having a predisposition for taking moderate, calculated risks, providing a reasonable chance for success. initiative and responsibility having the willingness to take initiative and be responsible. high energy level having the ability to work long hours and stay focused. tolerance for ambiguity and uncertainty having the ability to live with modest to high levels of uncertainty concerning job and career security, being able to perform different tasks simultaneously. creativity and flexibility being able to think originally and creatively while flexible enough to handle changing or multiple circumstances. knowledge-seeking being willing to seek information, ideas, expertise and the assistance of others. continuous learning having the desire to expand personal knowledge and enhance level of expertise. financial proficiency having the ability to understand and/or interpret financial transactions and results. money sense recognising that money is an important factor, and having the ability to correctly use this resource. business knowledge having a basic understanding of business operations and terminology. (source: farrington et al., 2010; van eeden et al., 2005) sajems ns 15 (2012) no 4 337 likert-style five-point scale (1 = strongly disagree to 5 = strongly agree). using an existing measuring instrument required that the existing operational definitions (van eeden et al., 2005) for the various entrepreneurial attributes under investigation be adopted. in some instances the attributes named by van eeden et al. (2005) were renamed and the operational definitions rephrased. this was done to more accurately describe the personality traits, characteristics and/or skills being measured. however, the items in the 2010 survey were exactly the same as those used in the 2001/2002 survey. these operational definitions are summarised in table 2. in section b of the questionnaire demographic information relating to the gender and age of the respondent, as well as the university attended, was requested. as in the survey carried out in 2001/2002, in 2010 the measuring instrument was distributed among students at the participating universities during a business class. students willing to complete the questionnaire could do so during class time or they could return it at a later date. 4 data analysis and empirical results 4.1 describing the samples in 2001/2002, 1 528 undergraduate business students participated in the study. the respondents included 758 south african (sa), 379 american (usa) and 391 dutch (ned) students. from table 3 it is evident that for sa and the usa the sample consisted of a satisfactory spread between males and females. this figure is, however, slightly skewed in the dutch sample, with more males than females participating in the study. in all three countries, the majority of participants fell into the 20-25year old age group. t a b l e 3 composition of the samples 2001/2002 sample sa n % usa n % ned n % total 758 100% total 379 100% total 391 100% male 319 42.1% male 182 48.0% male 247 63.2% female 439 57.9% female 197 52.0% female 144 36.8% <20 299 39.5% <20 8 2.1% <20 109 27.9% 20-25 419 55.3% 20-25 363 95.8% 20-25 273 69.8% >25 40 5.3% >25 8 2.1% >25 9 2.3% 2010 sample sa n % usa n % ned n % total 199 100% total 200 100% total 224 100% male 95 48.2% male 119 60.1% male 114 52.3% female 102 51.8% female 79 39.9% female 104 47.7% <20 78 39.8% <20 7 3.6% <20 36 16.7% 20-25 109 55.6% 20-25 179 90.9% 20-25 167 77.3% >25 9 4.6% >25 11 5.6% >25 13 6.0% in 2010, 623 undergraduate business students participated in the study. a more or less even number of respondents from each country participated. in contrast to the 2001/2002 sample, the distribution of males and females in the usa was uneven, whereas in 2001/2002 this was the case in the dutch sample. in 2010, both the south african and the dutch samples contained a satisfactory number of male and female participants. as in the 2001/2002 sample, the majority of participants from all three countries fell into the 20-25-year old age group. south africa did, however, have a much higher number of respondents in the under 20 age group (40%) relative to the usa (4%) and the netherlands (17%). 4.2 item analysis in order to make a comparison between the 2001/2002 results and the results of the current 338 sajems ns 15 (2012) no 4 study, the exact items measuring the attributes under investigation had to be used. an exploratory factor analysis was therefore not undertaken and the validity of the measuring instrument based on the 2010 results was not established. however, cronbach alpha coefficients were calculated for the scales to determine whether the observed scale scores were reliable (internal consistency). cronbach alpha coefficients (ca) less than 0.50 are deemed unacceptable, while those between 0.50 and 0.60 are regarded as sufficient, and those above 0.70 as acceptable (nunnally, 1978). according to sekaran (1992), ca values greater than 0.80 can be regarded as good. table 4 shows that low cronbach alpha coefficients (less than 0.50) were reported for risk-taking (g), tolerance for ambiguity and uncertainty (j), and money sense (o). these attributes were consequently excluded from further analysis. although self-confidence and locus of control reported a ca of below 0.50 for the american sample, it was decided to retain this attribute because of its close proximity to 0.50 and because of the satisfactory ca levels reported by sa and the netherlands. there was thus evidence of sufficient reliability for the measuring instrument. t a b l e 4 reliability of attribute scores (cronbach alpha coefficients) category sa usa ned all a: planning and perseverance 0.80 0.74 0.71 0.77 b: persuasion and networking 0.56 0.72 0.70 0.68 c: communication ability 0.68 0.67 0.63 0.66 d: commitment 0.66 0.56 0.71 0.67 e: overcoming failure 0.59 0.57 0.69 0.64 f: self-confidence and locus of control 0.50 0.47 0.59 0.52 g: risk-taking 0.16 0.00 0.46 0.20 h: initiative and responsibility 0.82 0.76 0.72 0.77 i: high energy level 0.58 0.53 0.58 0.61 j: tolerance for ambiguity and uncertainty 0.49 0.32 0.19 0.39 k: creativity and flexibility 0.74 0.50 0.70 0.69 l: knowledge-seeking 0.74 0.60 0.71 0.72 m: continuous learning 0.81 0.79 0.78 0.81 n: financial proficiency 0.64 0.77 0.75 0.72 o: money sense 0.20 0.24 0.44 0.38 p: business knowledge 0.69 0.66 0.71 0.68 4.3 descriptive analyses: the levels of development of entrepreneurial attributes respondents were requested to assess themselves in terms of the entrepreneurial attributes defined in table 2. descriptive statistics relating to these attributes, such as the mean, standard deviation and frequency distributions were calculated to summarise the sample data distribution. this was carried out for both the individual items and the summated attribute scores. attribute scores were categorised as low (less than 2.6), average (between 2.6 and 3.4 inclusive) and high scores (above 3.4). these categories were established to facilitate discussion, and were based on dividing the scale scores so that the low category corresponded with options 1 and 2 of the fivepoint likert scale, the average category with option 3 and the high category with options 4 and 5 of the response scale. attribute categories that score low on average can be considered as underdeveloped, those scoring average as developed, and those that score high can be considered well-developed. a summary of the descriptive statistics reported for the various attributes is reported in annexure a (2001/ 2002) and annexure b (2010). a detailed discussion of all the entre-preneurial attributes under investigation is not offered in this paper. however, attention will be given to the four most developed attributes, as well as the four sajems ns 15 (2012) no 4 339 least developed attributes. from table 5, it is evident that in 2001/ 2002 the order of the four most developed entrepreneurial attributes differed for each of the three countries participating in the study. it is interesting to note that two attributes, overcoming failure (e) and high energy level (i), were among the four most developed attributes in all three countries. south africa and the usa had three of the top four most developed attributes in common, commitment (d), overcoming failure (e) and high energy level (i). the mean scored by dutch students for their most developed attribute, financial proficiency (n), was lower than the means of any of the other four most developed attributes of both sa and the usa. financial proficiency (n) was also not among the four most developed attributes for either the sa or the usa sample. persuasion and networking (b), on the other hand, was among the four most developed attributes in the netherlands and the usa, but not in south africa. t a b l e 5 summary of the four most developed attributes 2001/2002 versus 2010 2001/2002 sample sa usa ned d: commitment 4.05 d: commitment 4.32 n: financial proficiency 3.68 e: overcoming failure 3.93 i: high energy level 4.06 e: overcoming failure 3.65 i: high energy level 3.94 b: persuasion and networking 3.98 i: high energy level 3.64 a: planning and perseverance 3.82 e: overcoming failure 3.96 b: persuasion and networking 3.61 2010 sample sa usa ned d: commitment 4.17 d: commitment 4.35 d: commitment 3.92 i: high energy level 4.07 n: financial proficiency 4.12 f: self-confidence and locus of control 3.77 a: planning and perseverance 4.05 i: high energy level 3.96 k: creativity and flexibility 3.66 e: overcoming failure 3.97 b: persuasion and networking 3.94 a: planning and perseverance 3.66 although the order was slightly different, the 2010 south african sample reported the same four attributes as most developed as the 2001/2002 south african sample did, namely commitment, high energy level, planning and perseverance and overcoming failure. commitment was once again perceived as the most developed entrepreneurial attribute. three of the most developed attributes reported by the 2001/2002 usa sample were also reported as most developed by the 2010 usa sample, namely commitment, high energy level and persuasion and networking. as in the sa sample, commitment was also once again perceived as the most developed entrepreneurial attribute by the 2010 usa sample. in contrast with the 2001/2002 usa sample, the 2010 sample perceived financial proficiency as one of the four most developed attributes, whereas overcoming failure was not. interestingly, none of the top four attributes perceived as most developed among the 2001/2002 dutch sample were among the top four in the 2010 dutch sample. as in the 2010 sa and usa sample, commitment was also perceived as the most developed attribute among the 2010 dutch sample. the four least developed attributes in all three countries are summarised in table 6. from table 6 it is evident that, during the 2001/2002 study, three of the 13 entrepreneurial attributes investigated obtained mean scores of below the threshold value of 3.4 on the fivepoint likert scale for the south african sample, namely continuous learning (m), knowledge-seeking (l) and initiative and responsibility (h). on the other hand, in the usa, only two of the 13 attributes obtained mean scores of below 3.4, namely continuous learning (m) and knowledge-seeking (l). in the netherlands four of the 13 entrepreneurial attributes investigated obtained mean scores of below the threshold value of 3.4, namely knowledge-seeking (l), continuous learning (m), initiative and responsibility (h), and communication ability (c). these observations 340 sajems ns 15 (2012) no 4 suggest that the attributes that scored below the threshold of 3.4 were regarded by the respondents as not being well-developed. although the order differed slightly for the netherlands with regard to the least developed attributes, the four lowest scoring attributes in all three countries were the same, namely continuous learning (m), knowledge-seeking (l), initiative and responsibility (h), and communication ability (c). t a b l e 6 summary of the four least developed attributes 2001/2002 versus 2010 2001/2002 sample sa usa ned m: continuous learning 3.14 m: continuous learning 2.95 l: knowledge-seeking 2.74 l: knowledge-seeking 3.18 l: knowledge-seeking 3.19 m: continuous learning 2.96 h: initiative and responsibility 3.32 h: initiative and responsibility 3.49 h: initiative and responsibility 3.08 c: communication ability 3.42 c: communication ability 3.54 c: communication ability 3.22 2010 sample sa usa ned m: continuous learning 3.45 m: continuous learning 2.81 l: knowledge-seeking 2.90 l: knowledge-seeking 3.47 l: knowledge-seeking 3.13 m: continuous learning 3.16 h: initiative and responsibility 3.57 h: initiative and responsibility 3.41 h: initiative and responsibility 3.37 c: communication ability 3.60 c: communication ability 3.49 c: communication ability 3.48 interestingly, the four attributes perceived as least developed by the 2010 samples from all three countries were exactly the same and in the same order as perceived by the 2001/2002 samples. none of these attributes were reported as less than the threshold value of 3.4 for the south african 2010 sample, whereas two attributes were reported as less than the threshold value of 3.4 for the american sample and three for the dutch sample. 4.4 significant differences between development of entrepreneurial attributes between 2001/2002 and 2010 the extent to which differences in levels of development of entrepreneurial attributes, as perceived by students participating in the 2001/2002 study versus those in the 2010 study, were significant was established by t a b l e 7 significance of differences between time periods – sa sample south africa 2001/2 2010 change t-test cohen’s d category mean mean statistic p-value a: planning and perseverance 3.82 4.05 0.23 4.88 .000*** 0.39# b: persuasion and networking 3.78 3.96 0.18 4.01 .000*** 0.32# c: communication ability 3.42 3.60 0.18 4.02 .000*** 0.32# d: commitment 4.05 4.17 0.12 1.80 .071 n.a. e: overcoming failure 3.93 3.97 0.04 0.84 .400 n.a. f: self-confidence & locus control 3.76 3.91 0.15 3.50 .000*** 0.28# h: initiative and responsibility 3.32 3.57 0.25 5.11 .000*** 0.41# i: high energy level 3.91 4.07 0.16 3.47 .001** 0.28# k: creativity and flexibility 3.61 3.89 0.28 6.07 .000*** 0.48# l: knowledge-seeking 3.18 3.47 0.29 5.52 .000*** 0.44# m: continuous learning 3.14 3.45 0.31 5.06 .000*** 0.40# n: financial proficiency 3.49 3.82 0.33 4.93 .000*** 0.39# p: business knowledge 3.55 3.90 0.35 5.95 .000*** 0.47# n.a. = not applicable, not statistically significant; statistical significance: * p<0.05; ** p<0.01; *** p<0.001; practical significance: # small 0.2<d<0.5; ## moderate 0.5 <d< 0.8; ### large d >0.8) sajems ns 15 (2012) no 4 341 means of calculating t-tests. in addition, cohen’s d statistics were calculated to establish practical significance. with the exception of the attributes commit ment and overcoming failure, the level of development of all the other entrepreneurial attributes subjected to statistical analysis showed significant (albeit of small practical significance) improvement between the 2001/ 2002 and the 2010 south african samples (see table 7). this implies that south african undergraduate business students in the 2010 sample perceived themselves as possessing these attributes to a greater extent than did those in the 2001/2002 sample. the results of this study show that for nine of the 13 entrepreneurial attributes subjected to statistical analysis, there was no difference in mean scores between the 2001/2002 and 2010 american samples (see table 8). t a b l e 8 significance of differences between time periods – usa sample united states 2001/2 2010 change t-test cohen’s d category mean mean statistic p-value a: planning and perseverance 3.95 3.88 -0.07 -1.60 .111 n.a. b: persuasion and networking 3.98 3.94 -0.04 -0.88 .380 n.a. c: communication ability 3.54 3.49 -0.05 -1.23 .220 n.a. d: commitment 4.32 4.35 0.03 0.44 .663 n.a. e: overcoming failure 3.96 3.79 -0.17 -4.08 .000*** 0.36# f: self-confidence & locus control 3.86 3.84 -0.02 -0.64 .525 n.a. h: initiative and responsibility 3.49 3.41 -0.08 -1.64 .102 n.a. i: high energy level 4.06 3.96 -0.10 -2.41 .016** 0.21# k: creativity and flexibility 3.84 3.85 0.01 0.15 .884 n.a. l: knowledge-seeking 3.19 3.13 -0.06 -1.14 .254 n.a. m: continuous learning 2.95 2.81 -0.14 -2.24 .026** 0.20# n: financial proficiency 3.85 4.12 0.27 4.51 .000*** 0.39# p: business knowledge 3.69 3.73 0.04 0.70 .483 n.a. n.a. = not applicable, not statistically significant; statistical significance: * p<0.05; ** p<0.01; *** p<0.001; practical significance: # small 0.2<d<0.5; ## moderate 0.5 <d< 0.8; ### large d >0.8) in other words, the 2010 american sample perceived themselves as possessing these entrepreneurial attributes to the same extent as the 2001/2002 sample of students did. three of the entrepreneurial attributes, namely overcoming failure, high energy level and continuous learning, however, reported a significant (albeit of small practical significance) decrease in the level of development between the 2001/2002 and 2010 samples. in other words, students from the 2001/2002 american sample perceived themselves as possessing these attributes to a greater extent than did the 2010 sample. the attribute financial proficiency was the only attribute that showed a significant (albeit of small practical significance) improvement from 2001/2002 to 2010. the 2010 sample of students perceived themselves as possessing a greater level of financial proficiency than the 2001/2002 sample did. eight of the 13 entrepreneurial attributes under investigation showed significant improve ments between the 2001/2002 and the 2010 dutch sample (see table 9). two of them reported the improvements as being of moderate practical significance. in other words, the 2010 sample of dutch students perceived themselves as possessing these eight attributes to a greater degree than their 2001/2002 counterparts did. 342 sajems ns 15 (2012) no 4 t a b l e 9 significance of differences between time periods – ned sample netherlands 2001/2 2010 change t-test cohen’s d category mean mean statistic p-value a: planning and perseverance 3.43 3.66 0.23 5.74 .000*** 0.48# b: persuasion and networking 3.61 3.65 0.04 0.87 .387 n.a. c: communication ability 3.22 3.48 0.26 7.46 .000*** 0.63## d: commitment 3.60 3.92 0.32 4.23 .000*** 0.35# e: overcoming failure 3.65 3.62 -0.03 -0.68 .497 n.a. f: self-confidence & locus control 3.60 3.77 0.17 4.33 .000*** 0.37# h: initiative and responsibility 3.08 3.37 0.29 7.17 .000*** 0.60## i: high energy level 3.64 3.63 -0.01 -0.29 .770 n.a. k: creativity and flexibility 3.44 3.66 0.22 5.72 .000*** 0.48# l: knowledge-seeking 2.74 2.90 0.16 3.23 .001** 0.27# m: continuous learning 2.96 3.16 0.20 3.38 .001** 0.28# n: financial proficiency 3.68 3.63 -0.05 -0.87 .385 n.a. p: business knowledge 3.50 3.58 0.08 1.66 .097 n.a. n.a. = not applicable, not statistically significant; statistical significance: * p<0.05; ** p<0.01; *** p<0.001; practical significance: # small 0.2<d<0.5; ## moderate 0.5 <d< 0.8; ### large d >0.8) 5 discussion the primary objective of this study was to investigate and compare the entrepreneurial attributes of undergraduate business students in three different countries at two different points in time, more specifically to compare the levels of development of these attributes as perceived by a sample of undergraduate business students in 2010 with the levels reported by a sample of undergraduate business students in 2001/2002. the findings of this study show that the four attributes perceived as most developed by the 2010 south african sample were the same as those reported by the 2001/2002 south african sample. in the case of the usa sample, three of the four attributes perceived as most developed by the 2010 sample were also reported as most developed by the 2001/2002 sample. financial proficiency was perceived as the second most developed attribute by the 2010 usa sample, but as only the seventh most developed by the 2001/2002 usa sample. none of the top four attributes perceived as most developed among the 2010 dutch sample were among the top four for the 2001/2002 dutch sample. when it came to the four most developed attributes, it appears that, in contrast with the 2001/2002 sample, the 2010 south african sample reported no changes; the 2010 usa sample reported one change, whereas the 2010 dutch sample reported four completely different attributes as being the most developed. this finding suggests that in comparison to the students participating in the 2001/2002 study, some change had occurred in the educational environment of dutch students participating in the 2010 study, but not in that of the 2010 south african or american students. interestingly, commitment was reported in the 2010 study as being the most developed attribute among the samples from all three countries. commitment refers to an ability to meet commitments in a timely manner. students exist in an academic environment which places several demands on them in terms of submitting tasks and assignments according to specified deadlines. one would expect the majority of students at university to possess this attribute. although the ability to meet commitments in a timely manner is an important entrepreneurial attribute, farrington, venter and neethling (2012) found no relationship between commitment and entrepreneurial intentions. they concluded that commitment is not an attribute unique to students with entrepreneurial intentions. the four attributes perceived as least developed by the 2010 samples from all three countries were exactly the same and in the same order as those perceived by the 2001/ sajems ns 15 (2012) no 4 343 2002 samples, namely continuous learning (m), knowledge-seeking (l), initiative and responsibility (h), and communication ability (c). this implies that students in all three countries perceived the desire to expand personal knowledge and enhance their level of expertise (continuous learning); the willingness to seek information, ideas, expertise and the assistance of others (knowledge-seeking); the willingness to take initiative and be responsible (initiative and responsibility); and the ability to communicate ideas to others (communication ability) as the least developed attributes. although not investigated empirically in this study, it is well supported in the literature (see table 1) that the aforementioned attributes are associated with successful entrepreneurs. furthermore, in their study among south african business students, farrington et al. (2012) report significant relationships between possessing the entrepreneurial attributes continuous learning, knowledge-seeking, initiative and responsibility and communication ability, and the intentions of students to start their own businesses. they conclude that students who possessed these attributes were more likely to embark on entrepreneurial careers than were those who did not possess them. the need for addressing these underdeveloped attributes is thus highlighted. instilling the desire to expand personal knowledge and enhance one’s level of expertise (continuous learning), and creating a willingness to seek information, ideas, expertise and the assistance of others (knowledge-seeking), among business students is a challenging task. it is only when the value of knowledge is internalised that a willingness and desire to pursue it can be stimulated. educators should strive to develop these attributes by means of practical assignments that require students to seek additional information and assistance from others. in addition, entrepreneurial role models could be invited to address students on the value of continually expanding their personal knowledge and of seeking the assistance and expertise of others. in doing this they would reinforce what students are hearing in their academic studies. unfortunately the value of knowledge received during academic studies is often recognised by students only retrospectively, once they enter the world of work, where that knowledge is required in practice. the ability to communicate ideas to others (communication ability) can be developed among business students by increasing the use of interviews, orals and presentations when assessing students. students should, however, be made aware that the ability to communicate ideas to others requires not only the ability to speak in public, but also the ability to communicate the right information, using the right medium. furthermore, initiative and responsibility can be encouraged by rewarding those who are willing to take initiative and be responsible, through either recognition or improved results. although the top four developed attributes reported by the 2010 and the 2001/2002 south african sample were the same, the level of development of all but two showed significant improvements from 2001/2002 to 2010. in other words, participating south african under graduate business students in 2010 perceived themselves as possessing these attributes to a greater extent than the earlier sample. this implies that the levels of confidence of students in terms of possessing these attributes, was higher and that educational efforts to improve these levels had met with some success. the increase was, however, of small practical significance, and further investigation would be recommended to shed some light on possible explanations for this finding. although the 2010 american sample perceived themselves as possessing most of the attributes to the same extent that the 2001/2002 sample of students did, the attributes over-coming failure, high energy level and continuous learning revealed significant decreases in the level of development between the 2001/2002 and 2010 samples. this implies that the students in the 2010 samples perceived themselves as having the ability to overcome failure and regard it as a learning experience, having the ability to work long hours and stay focused, and having the desire to expand personal knowledge and enhance level of expertise, to a lesser degree than the students participating in the 2001/2002 study. however, the 2010 sample of students perceived themselves as possessing a greater level of financial proficiency than the 2001/2002 sample. the severe economic crises experienced in 344 sajems ns 15 (2012) no 4 the united states during the period 2008-2010 could provide a possible explanation for the findings of this study. in the midst of a recession, it comes as no surprise that students would have a more negative outlook and consequently be less able to deal with failure, and be less motivated to work long hours and expand their knowledge. although there is still a focus on developing entrepreneurs in the united states, two long-drawn-out wars, considerable economic distress, and budget cuts at public universities have resulted in decreased positive energy for new business start-ups. most students in the united states now tend to look for more secure career choices by taking jobs in established companies rather than considering an entrepreneurial venture during or shortly after leaving university. furthermore, given the financial problems facing the american people, one could expect that students would be more exposed to matters of financial concern, hence raising their knowledge in terms of understanding the financial aspects of business. these circumstances of financial turmoil also provide a possible explanation as to why, in contrast with the south african and dutch samples, the development of most entrepreneurial attributes investigated in this study remained unchanged between the 2001/2002 and 2010 american samples. despite the four most developed attributes being completely different in the 2010 and the 2001/2002 dutch samples, the majority of attributes under investigation showed significant improvements between the 2001/2002 and the 2010 samples. two of these attributes, communication ability and initiative and responsibility, showed the differences as being of moderate practical significance. interestingly both the willingness to take initiative and to be responsible, and the ability to communicate ideas to others were reported by farrington et al. (2012) as being significantly related to the entrepreneurial intentions of students. the dutch university participating in this study had no independent economics department prior to 2001, and the students participating in the 2001/2002 study were required to complete a business module as part of other studies (mainly dutch law). these students were therefore not specifically students of business or economics. this particular economics department has grown significantly since 2001, and it now offers several business and entrepreneurship modules. the dutch students participating in the 2010 study were from the economics department or else they came from various other fields of study through out the university and had undertaken the business module voluntarily. given that they were business students or had taken the business module because they were interested in the field provides a possible explanation as to why the dutch students participating in the 2010 study showed higher levels of development of the entrepreneurial attributes under investigation. another possible explanation for the results of this study could be the recent increased interest in entrepreneurship as a whole in the nether-lands. not only has the number of business start-ups grown since 2001, but a focus on entrepreneurship also seems to have increased in the popular media. becoming an entrepreneur (self-employment) has become more popular as a career choice. the findings of this study seem to suggest that the educational environment and entrepreneurship education policy of the dutch university participating in this study should be investigated further. it is hoped that, by identifying changes implemented during the period 2001/2002 to 2010, possible explanations for the increased levels of entrepreneurial attributes among dutch students could be found. once identified, the changes implemented could be of value to educators in entrepreneurship worldwide. looking at the demographic profiles (table 3) of the students participating in the 2010 and the 2001/2002 studies, it can be seen that the south african samples were more or less the same in terms of age and gender, yet the majority of attributes were reported by the 2010 sample as being more developed. it appears that age and gender have not contributed to the changes reported. in contrast, more males formed part of the 2010 usa sample and more females were part of the 2010 dutch sample than in the 2001/2002 samples. the ages reported by the 2010 usa sample were approximately the same as those in the 2001/2002 sample, whereas more students in the 2010 dutch sample were over the age of 20 sajems ns 15 (2012) no 4 345 than those in the 2001/2002 sample. it is possible that these differences in demographic profiles could have contributed to the differences in the levels of development of several attributes reported by these two sample groups. it must be pointed out that more males participated in the 2010 us sample, yet several attributes were reported as being less developed by this sample than by the 2001/2002 sample. similarly, fewer males participated in the 2010 dutch sample, yet most attributes were reported as being more developed by this sample than by the 2001/2002 group. this could imply that the respondents’ gender accounted for the changes in the levels of development reported by these sample groups. however, these claims are not supported empirically in this study, and in seeking explanations for the findings of this study, age and gender together with other demographic factors, such as ethnicity and culture, present an avenue for future research. 6 implications according to fatoki (2010: 93), there is a mismatch between the skills that students develop in higher education and those that they need for survival in the business world. the findings of this study support this suggestion, in that the four least-developed attributes reported by the student respondents from all three countries are attributes commonly associated with successful entrepreneurs. given the importance of entrepreneurship to the economies of countries, the low levels of development of these attributes are a source of concern. universities face a considerable challenge in developing programmes that prepare students for starting new businesses immediately after graduation (soetanto et al., 2010:34). however, entrepreneurial attributes can be developed by means of educational programmes (drost, 2010:29; gerry et al., 2008; gurol & atsan, 2006) and it is the responsibility of educational institutions to foster an environment in which these attributes can be developed in students as well as to identify those attributes that are necessary for entrepreneurial success. it is the role of educational institutions not only to equip students with the knowledge to embark on entrepreneurial ventures, but also to develop entrepreneurial attributes, talent and initiative among students. an environment in which students are able to observe and report on successful entrepreneurial role models, undertake business simulation games, and set up business plans for actual businesses as part of their academic studies would be a step in the right direction. attendance at workshops on entrepreneurship and entering entrepreneurial competitions offered by both academic and non-academic institutions should also be encouraged among students. the best recommendation is to incorporate and integrate into entrepreneurial education as many different learning experiences as possible that would contribute to the development of traits, characteristics and skills associated with successful entrepreneurs, and to do this as often as possible. however, the most important challenge facing educators of entrepreneurship is not to identify practical ways of developing entrepreneurial attributes among students, but to implement these recommendations within the framework of a traditional academic environment. 7 limitations and future studies the findings of this study must be interpreted in light of several limitations. the use of a convenience sampling introduced a source of potential bias into the study and the findings can thus not be generalised to the entire population. furthermore, when data are collected using self-reporting measures, common method bias could potentially occur. however, meade, watson and kroustalis (2007) contend that the use of self-reporting does not necessarily lead to bias, and in many cases the bias may be so small that it does not jeopardise the validity of the results. the authors acknowledge that common method bias could have influenced the results of this study. several limitations can also be identified with the measuring instrument itself. welldocumented entrepreneurial attributes, such as internal locus of control, the need for achievement, problem-solving ability, emotional stability, team ability and innovativeness (raab et al., 2005; tajeddini & mueller, 2009), as well as 346 sajems ns 15 (2012) no 4 desire for immediate feedback, future orientation and skill at organising (scarborough, 2011: 22), are not accounted for or measured in the instrument. given the objectives of this study, van eeden et al.’s (2005) instrument, with its limitations, had to be used. further, the attributes risk-taking (g), tolerance for ambiguity and uncertainty (j) and money sense (o) obtained low cronbach alpha coefficients and were excluded from further statistical analysis. in comparing the levels of development of the entrepreneurial attributes at two different points in time, namely in 2001/2002 and 2010, some interesting findings were brought to light. however, given that the samples from the two different time periods were completely different, the findings of this study should be interpreted with caution. in addition, a test of configural invariance did not precede the use of t-tests to assess differences in mean scores. as indicated earlier, establishing whether demographic factors provide an explanation for the findings in this study presents an avenue for future research. measuring the levels of development of entrepreneurial attributes of the same sample of respondents at different points in time during the course of their university studies is recommended for future research. however, the methodology associated with longitudinal studies is problematic. the curriculum and study environments of the participating universities were not specifically considered when undertaking this study. these may, however, be relevant to the interpretation of the findings. according to tajeddini and mueller (2009), social context must be considered when explaining differences between entrepreneurs and should be considered in future studies. in this regard, investigating whether significant differences exist between the levels of development of the entrepreneurial attributes reported by the 2010 sample of students in the three different countries, as was done in the 2001/2002 study, would also make for interesting results. however, these findings fall beyond the scope of this article. the attribute (trait theories) approach has been shown to be useful in explaining why some individuals become entrepreneurs and others do not. however, according to cromie (2000), personal attributes are important but they are not all-important determinants of behaviour. similarly, kiggundu (2002) contends that individual characteristics are inadequate to explain the nature of entrepreneurial success or failure. several authors propose (gird & bagraim, 2008; krueger & carsrud, 1993; ajzen, 1991) that intentions are the best predictors of behaviour, and future research should therefore focus on the entrepreneurial intentions of students as predictors of entrepreneurial activity rather than on entrepreneurial attributes, as has been the case in this study. notwithstanding the limitations identified, the findings of this study add to the field of 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3.78 0.58 24 3.2% 143 18.9% 591 78.0% c 758 3.42 0.56 54 7.1% 308 40.6% 396 52.2% d 758 4.05 0.8 33 4.4% 135 17.8% 590 77.8% e 758 3.93 0.57 18 2.4% 148 19.5% 592 78.1% f 758 3.76 0.55 11 1.5% 190 25.1% 557 73.5% h 758 3.32 0.6 88 11.6% 337 44.5% 333 43.9% i 758 3.91 0.57 12 1.6% 114 15.0% 632 83.4% k 758 3.61 0.56 19 2.5% 263 34.7% 476 62.8% l 758 3.18 0.63 160 21.1% 296 39.1% 302 39.8% m 758 3.14 0.76 185 24.4% 312 41.2% 261 34.4% n 758 3.49 0.85 145 19.1% 227 29.9% 386 50.9% p 758 3.55 0.75 83 10.9% 233 30.7% 442 58.3% usa – 2001/2002 mean frequency distribution attribute n sd low average high a 379 3.95 0.5 3 0.8% 47 12.4% 329 86.8% b 379 3.98 0.46 3 0.8% 26 6.9% 350 92.3% c 379 3.54 0.48 12 3.2% 122 32.2% 245 64.6% d 379 4.32 0.7 10 2.6% 31 8.2% 338 89.2% e 379 3.96 0.47 2 0.5% 51 13.5% 326 86.0% f 379 3.86 0.44 5 1.3% 46 12.1% 328 86.5% h 379 3.49 0.52 16 4.2% 143 37.7% 220 58.0% i 379 4.06 0.5 4 1.1% 30 7.9% 345 91.0% k 379 3.84 0.46 2 0.5% 63 16.6% 314 82.8% l 379 3.19 0.61 66 17.4% 168 44.3% 145 38.3% m 379 2.95 0.7 115 30.3% 177 46.7% 87 23.0% n 379 3.85 0.68 23 6.1% 73 19.3% 283 74.7% p 379 3.69 0.62 14 3.7% 103 27.2% 262 69.1% ned – 2001/2002 mean frequency distribution attribute n sd low average high a 391 3.43 0.47 12 3.1% 167 42.7% 212 54.2% b 391 3.61 0.48 12 3.1% 106 27.1% 273 69.8% c 391 3.22 0.41 21 5.4% 245 62.7% 125 32.0% d 391 3.6 0.92 54 13.8% 109 27.9% 228 58.3% e 391 3.65 0.49 11 2.8% 129 33.0% 251 64.2% f 391 3.6 0.44 6 1.5% 125 32.0% 260 66.5% h 391 3.08 0.46 53 13.6% 242 61.9% 96 24.6% i 391 3.64 0.5 7 1.8% 117 29.9% 267 68.3% k 391 3.44 0.43 6 1.5% 192 49.1% 193 49.4% l 391 2.74 0.54 169 43.2% 176 45.0% 46 11.8% m 391 2.96 0.73 129 33.0% 158 40.4% 104 26.6% n 391 3.68 0.59 21 5.4% 119 30.4% 251 64.2% p 391 3.5 0.56 24 6.1% 137 35.0% 230 58.8% a: planning and perseverance; b: persuasion and networking; c: communication ability; d: commitment; e: overcoming failure; f: selfconfidence and locus control; h: initiative and responsibility; i: high energy level; k: creativity and flexibility; l: knowledge seeking; m: continuous learning; n: financial proficiency; p: business knowledge. sajems ns 15 (2012) no 4 351 annexure b descriptive statistics of entrepreneurial traits: south africa, usa and netherlands 2010 sa 2010 frequency distribution attribute n mean sd low average high d 199 4.17 0.83 10 5.0% 14 7.0% 175 87.9% i 199 4.07 0.55 5 2.5% 10 5.0% 184 92.5% a 199 4.05 0.65 7 3.5% 16 8.0% 176 88.4% e 199 3.97 0.61 5 2.5% 17 8.5% 177 88.9% b 199 3.96 0.55 4 2.0% 24 12.1% 171 85.9% f 199 3.91 0.58 6 3.0% 17 8.5% 176 88.4% p 199 3.90 0.69 5 2.5% 29 14.6% 165 82.9% k 199 3.89 0.62 5 2.5% 33 16.6% 161 80.9% n 199 3.82 0.74 11 5.5% 39 19.6% 149 74.9% c 199 3.60 0.57 12 6.0% 42 21.1% 145 72.9% h 199 3.57 0.69 14 7.0% 61 30.7% 124 62.3% l 199 3.47 0.78 29 14.6% 47 23.6% 123 61.8% m 199 3.45 0.86 34 17.1% 43 21.6% 122 61.3% usa 2010 frequency distribution attribute n mean sd low average high d 200 4.35 0.63 2 1.0% 8 4.0% 190 95.0% n 200 4.12 0.66 3 1.5% 19 9.5% 178 89.0% i 200 3.96 0.43 0 0.0% 17 8.5% 183 91.5% b 200 3.94 0.54 4 2.0% 20 10.0% 176 88.0% a 200 3.88 0.50 2 1.0% 20 10.0% 178 89.0% k 200 3.85 0.40 1 0.5% 12 6.0% 187 93.5% f 200 3.84 0.46 1 0.5% 20 10.0% 179 89.5% e 200 3.79 0.49 3 1.5% 21 10.5% 176 88.0% p 199 3.73 0.60 6 3.0% 32 16.1% 161 80.9% c 200 3.49 0.47 6 3.0% 62 31.0% 132 66.0% h 200 3.41 0.54 13 6.5% 81 40.5% 106 53.0% l 200 3.13 0.58 39 19.5% 96 48.0% 65 32.5% m 200 2.81 0.75 86 43.0% 65 32.5% 49 24.5% ned 2010 frequency distribution attribute n mean sd low average high d 223 3.92 0.86 19 8.5% 23 10.3% 181 81.2% f 219 3.77 0.51 6 2.7% 18 8.2% 195 89.0% k 222 3.66 0.53 7 3.2% 40 18.0% 175 78.8% a 222 3.66 0.50 7 3.2% 36 16.2% 179 80.6% b 224 3.65 0.53 8 3.6% 53 23.7% 163 72.8% n 219 3.63 0.73 14 6.4% 58 26.5% 147 67.1% i 220 3.63 0.51 9 4.1% 53 24.1% 158 71.8% e 224 3.62 0.57 8 3.6% 37 16.5% 179 79.9% p 220 3.58 0.66 14 6.4% 54 24.5% 152 69.1% c 224 3.48 0.44 6 2.7% 65 29.0% 153 68.3% h 224 3.37 0.52 17 7.6% 83 37.1% 124 55.4% m 222 3.16 0.70 39 17.6% 84 37.8% 99 44.6% l 224 2.90 0.66 88 39.3% 85 37.9% 51 22.8% a: planning and perseverance; b: persuasion and networking; c: communication ability; d: commitment; e: overcoming failure; f: selfconfidence and locus control; h: initiative and responsibility; i: high energy level; k: creativity and flexibility; l: knowledge seeking; m: continuous learning; n: financial proficiency; p: business knowledge. microsoft word 6 ziallah et al sajems 18(4) 2015.docx sajems ns 18 (2015) no 4:519-533 519 how to cite doi: http://dx.doi.org/10.17159/2222-3436/2015/v18n4a6 i s s n : 2 2 2 2 3 4 3 6 the synergistic and complementary effects of supply chain justice and integration practices on supply chain performance: a conceptual framework and research propositions muhammad ziaullah school of management and economics, university of electronic science and technology of china and ghazi university, dera ghazi khan, pakistan yi feng & shumaila naz akhter school of management and economics, university of electronic science and technology of china accepted: may 15, 2015 in recent years, firms have been using their supply chain integration (sci) as a competitive weapon in the intensive, globalised competitive arena. the contingent perspective in supply chain management maintains that it is necessary to observe the interaction between sci practices and supply chain justice. a critical issue to be resolved is whether this fit leads to synergistic and complementary effects on supply chain performance. in order to contribute to this research problem, we analysed supply chain justice instances in order to determine the importance of supply chain justice, as well as highlights complementary role in sci and its influences on supply chain performance. a conceptual framework has been developed and five propositions established to verify the contents of a theoretical study. accordingly, balancing the adoption of sci practices and supply chain justice will lead to the generation of greater benefits relative to the effect of both independent driving forces on supply chain performance. furthermore, the proposed framework has been analysed in order to examine its applicability in the south african context. the study thereby suggests the empirical research guidelines and the paper concludes with a discussion of future research. key words: supply chain, supply chain justice, supply chain integration, supply chain performance jel: m1 1 introduction with the fierce competition in the market companies have been required to participate in sci. this concept has gained much attention as a result of changing manufacturing and supply chain strategies (cousins & menguc, 2006). sci, customer-supplier collaboration and partnerships have been highlighted as emerging, substantial and attractive business practices and trends across diverse industries (shou, feng, zheng, wang & yeboah, 2013). the firm’s supply chain should be agile, adaptable and aligned to meet the fast-changing requirements of competitive markets (lee, 2004). what is required is the articulation of a closely integrated relationship between manufacturers and their supply chain partners (armistead & mapes, 1993). sci refers to the degree to which a manufacturer strategically collaborates with its supply chain partners and collaboratively manages intraorganisational and interorganisational processes. the goal is to achieve effective and efficient flows of products and services, information, capital and decisions, thereby providing maximum value for the customer (frohlich & westbrook, 2001), while, at the same time, making contributions to supply chain performance (narasimhan & kim, 2002) and the firm’s operational performance (frohlich & westbrook, 2001). the literature on supply chain management (scm) specifies the practices of sci, such as information sharing, process integration (yeung, selen, zhang & huo, 2009) and relationship abstract 520 sajems ns 18 (2015) no 4:519-533 commitment (benton & maloni, 2005; zhao, huo, flynn & yeung, 2008). investigations have shown that different kinds of sci initiators serve to facilitate and enhance integration processes, for instance information technology (it) implementation, e-business technologies, and human resource involvement in service roles and socialisation (armistead & mapes, 1993; cousins & menguc, 2006; li, yang, sun & sohal, 2009). for many years researchers have, investigated and explored the theoretical benefits of sci, but adopting sci as a common practice has become a great challenge (frohlich, 2002). supply chain partners have distinctive objectives that create barriers with regard to sci. more specifically, members of a supply chain compete for control (cox, sanderson & watson, 2001), as well as being concerned about chain difficulties and the incurring costs (krause, 1999). customers refuse to participate in upward sci for fear of supply disruptions, and the leaking of confidential information (corbett, blackburn & van wassenhove, 1999). ketchen and giunipero (2004) suggested that scm literature often seems to assume that “a rising tide lifts all boats’’. thus when the chain is successful all members mutually prosper. crook and combs (2007), however, argue that, while strong members reap most of the direct benefits, weak members can often gain by building switching costs with strong members. the above therefore highlights the critical phenomena and clearly illustrates the important role of justice in sci. research on justice in the context of sci has been incomplete. the justice concept has deep roots in organisational literature and serves as the foundation for all types of social economic exchanges and relationships (adams, 1965; lind & tyler, 1988). recently, justice has been examined in the context of supply chain relationships (griffith, harvey & lusch, 2006; liu, huang, luo & zhao, 2012), and it has been recognised that perceptions of justice are of particular importance in long-term relationships, because two parties need to collaborate to some extent in order to leverage each other’s capabilities and resources to achieve mutual goals. a failure to develop perceptions of justice may result in harm to, or termination of, the relationship (liu et al., 2012). importantly, justice has played a critical role in improving supply chain relationship performance and each category of justice has unique contributions to make to the significance of supply chain relationships (liu et al., 2012; narasimhan, narayanan & srinivasan, 2013). the literature on justice (both at the individual and organisational levels) has mainly examined three dimensions namely procedural, distributive and interactional justice (colquitt, conlon, wesson, porter & ng, 2001; luo, 2007). “supply chain procedural justice” refers to supply chain partners’ perceptions of the fairness of formal procedures in the context of sci; “supply chain distributive justice” refers to supply chain partners’ perceptions of the fairness of the distribution outcome in this context of sci; and “supply chain interactional justice” is the extent to which supply chain partners’ consider that there is fair treatment in respect of interpersonal and informational aspects in the context of sci. problems related to interactional justice may occur when supply chain partners believe that they are not being treated with respect and dignity by other members of the supply chain. griffith et al. (2006) found that perceived procedural and distributive justice have improved long-term orientation and relational behaviour, have reduced conflict, and have increased satisfaction. researchers studying sci from a practical point of view have examined sci practices such as information sharing, process integration and relationship commitment and found that these practices make significant contributions to a firm’s supply chain and operational and business performance. sci practices and characteristics have strong theoretical roots, but, in practice anecdotal evidence organizations is scare. beugré and acar (2008) construe justice as a mechanism that enhances relationships between partners and creates a fundamental bond in inter organisational relationships. to the best of our knowledge, there is no prior research on scm, including the research by liu et al. (2012), that has examined the direct and complementary effect of sci practices and justice on supply chain performance (scp). the present study is therefore a step towards filling this gap. sajems ns 18 (2015) no 4:519-533 521 firstly, the study demonstrates the direct effects of sci practices and justice on firms’ scp. secondly, it considers the complementarities between supply chain justice and integration practices as being crucial from the point of view of their influence on scp. hence, we argue that firms have a greater likelihood of achieving scp if they have both strong sci practices and a strong perception of justice with regard to sci. the purpose of this paper is thus to develop a conceptual framework and a series of propositions based on a literature review and an examination of practical situations in order to describe the main effects of sci practices and justice dimensions on scp. this research also attempts to indicate how sci practices and justice dimensions may interact in impacting scp. a general assertion of this paper is that firms have a greater likelihood of achieving scp if they have a strong conscience in implementing of sci practices and justice dimensions. the two constructs are expected to have independent, and often complementary and synergistic effects, on scp. the remainder of this paper is organised as follows. section 2 presents the conceptual background. in section 3, the relationship between sci practices and scp is set out. the relationship between supply chain justice and scp is presented in section 4. then, in section 5, we demonstrate the synergistic and complementary effects of sci practices and supply chain justice on firms’ scp. section 6 discusses the implications of research in the context of south african firms. finally, section 7 describes the guidelines developed for empirical research, and in section 8, conclusions are reached and future research directions are given. 2 conceptual background 2.1 complementarities and main effects edgeworth (1881) originally introduced the concept “complementarities”, describing the activities concerned as complementary if doing (more of) any one of them increases the returns of doing (more of) the others. ennen and richter (2010) proposed that some activities and practices of firms are mutually complementary and tend to be adopted together, with each enhancing the contribution of the other. a complementary interaction of a firm’s practices and resources could create super-additive synergies. hence, the inter-firm design variables and practices contribute maximally to the overall success of integration (barua & whinston, 1998). ranganathan, teo and dhaliwal (2011) suggest that complementary or interacting of capabilities and practices are the core motivations for supply chain relationships, as they help to create value that cannot be generated independently. many researchers have investigated the indirect effect of supply chain integration practices (yang & burns, 2003; schloetzer, 2012; wiengarten, humphreys, cao, fynes, & mckittrick, 2010) and justice (liu et al., 2012) on performance by using various types of mediating variables. for instance, liu et al. (2012) examined the effects of justice aspects on dyadic relationship performance through a mediating variable of mutual coupling behaviours. our point of departure is the shared concern of previous studies for supply chain integration practices and justice dimensions. however, unlike liu et al. (2012), we use the complementary effect and argue that neither sci practices nor justice components by themselves are sufficient to sustain sci and achieve superior scp. instead, these phenomena need to operate in tandem in order to achieve the desired outcomes of sci. therefore, this study is concerned with conceptually proposing the direct and complementary effects of sci practices and justice on firms' supply chain performance. thus, we argue that complementarities between supply chain justice and integration practices will be greater than the sum of their parts because of the synergistic effects of bundling both together. further, the complementary association of sci practices and justice components will develop and sustain the relationships, which, in turn, will culminate in scp. the complementary concept offers a useful perspective for understanding the complex relationships between supply chain justice and integration practice. in our study, complementarity 522 sajems ns 18 (2015) no 4:519-533 indicates a condition of increasing returns in which adopting (doing more of) integration practices have a greater payoff when simultaneously adopting (doing more) a complementary activity (e.g. ensuring high levels of justice perception) in sci. 2.2 conceptual framework this study considers three dimensions of supply chain justice namely procedural, distributive and interactional dimensions, and three aspects of sci practices, like information sharing, process integration and relationship commitment in the context of scp. as the literature suggests, the competitive priorities (i.e. cost, quality, speed and flexibility) are critical in the measurement of scp (hult, ketchen, cavusgil & calantone, 2006). we intend to apply the concept of organisational justice in inter-firm analysis of the supply chain. we use the term “inter-firm supply chain justice” to refer to supply chain partners’ perceptions of the fairness of one another’s actions in supply chain relationships. moreover, we use scm literature and practical instances to develop the conceptual model and research propositions. hence, we propose a conceptual framework for describing their interrelationships in figure 1. the model indicates that supply chain justice dimensions and sci practices may each directly affect scp, and that they may also interact synergistically in their impact on scp. figure 1 conceptual framework 3 the relationship between sci practices and supply chain performance (scp) yeung et al. (2009) consider sci practices as information sharing and process integration, while other researchers have highlighted the importance of another practice, namely relationship commitment (benton & maloni, 2005; zhao et al., 2008). “information sharing” refers to the extent to which critical and proprietary information is communicated to supply chain partners (mohr & spekman, 1994). it is key to establishing a seamless supply chain to ensure undistorted and real-time market data access at every node within the supply chain (towill, 1997). information sharing is an essential requirement (sheu, yen & chae, 2006), is the foundation of sci (lee & whang, 2001), and improves firms’ overall performance (yang & burns, 2003). “process integration” refers to the extent to which a firm can structure its operational processes, as well as the sharing of resources, rewards and risks across organizations, into consensus agreements in order to achieve competitiveness (yeung et al., 2009). it integrates the processes of § information sharing § process integration § relationship commitment § procedural justice § distributive justice § interactional justice interaction supply chain performance direct effect direct effect supply chain integration practices supply chain justice dimensions sajems ns 18 (2015) no 4:519-533 523 different functions within a company or different firms within a supply chain (kanda & deshmukh, 2008) and also refers to the extent to which partners standardise and synchronise inter-firm processes (zhou & benton, 2007). process integration has contributed to reduced production costs through economies of scale, reduced lead time, inventory savings, and improved asset utilisation (maloni & benton, 2000). it has also enriched firm-effectiveness and innovation related capabilities (frohlich & westbrook, 2001). investigations have shown that overall process integration has positively influenced sales growth, sales productivity and partnership profitability, has facilitated mutual value creation and has generally favourable financial implications for supply chain partners (schloetzer, 2012). “relationship commitment” may be defined as a situation where an exchange partner believes that an ongoing relationship with another is so important as to warrant maximum effort at maintaining the relationship, that is, the committed party considers the relationship to be worth working on so as to ensure that it endures indefinitely (morgan & hunt, 1994). such commitment also results in mutual gains for suppliers and buyers in a supply chain relationship (jaros, jermier, koehler & sincich, 1993). such a stable and long-lasting relationship has become critical in realizing long-term benefits for supply chain partners (anderson &weitz, 1992; moore, 1998). moreover, it has been proven that relationship commitment to the customer is positively related to customer and supplier integration (zhao et al., 2008). most researchers who have studied sci from the perspectives of suppliers and customers (e.g. kim, 2006) refer to this aspect as external integration (danese, romano, & formentini, 2013), which is directly related to operational performance (wiengarten et al., 2010).therefore, we formulate the following proposition. proposition 1: in the context of supply chain integration (sci), there is a positive relationship between sci practices (information sharing, process integration, and relationship commitment) and supply chain performance (scp). 4 the relationship between supply chain justice dimensions and supply chain performance (scp) the first justice dimension is procedural and is derived from the idea of instrumentality (luo, 2007). it refers to the fairness of decision making procedures (phillips, douthitt & hyland, 2001) and is based on the processes or procedures by means of which resources are allocated and decisions are made (hendrix, robbins, miller & summers, 1998). “distributive justice” is the second dimension of justice and is derived from the idea of equity. equity theory suggests that rewards should be distributed equitably among the transacting parties in relation to their contribution (adams, 1965). such theory is integral to developing, sustaining and improve the stable and cooperative interorganisational relationships (ring & van de ven, 1994; scheer, kumar & steenkamp, 2003). luo (2007) defined distributive justice as the extent to which interparty sharing of the rewards of cooperation is fair in view of each party’s contribution, commitment, and assumption of responsibility and stated examples of outcomes such as knowledge acquisition, profit, reputation enhancement, and dividends. distributive justice means that firms will always receive economic rewards proportionate to their input contributions in the relationship (kumar, scheer & steenkamp, 1995). “interactional justice” is the third dimension of justice and is extracted from the idea of social exchange. it refers to the extent to which interpersonal treatment and information exchange between boundary spanners representing each party, is fair. it complies with social sensitivity to partners and includes courtesy, openness, feedback, honesty, mutual understanding, and demonstrations of great respect for each other’s social norms in the sphere of interpersonal treatment (luo, 2007). “interactional justice” also refers to the extent to which people receive quality interpersonal treatment during the implementation of procedures. four rules or criteria relating to interactional justice are explored, namely truthfulness, justification, respect and property. in the supply chain context, “interactional justice” can also be defined as the degree of openness shown by the transacting parties in communicating relevant information and in 524 sajems ns 18 (2015) no 4:519-533 managing conflict (narasimhan et al., 2013). it is focused on aspects of fairness related to interpersonal issues and information exchange in social context (colquitt, 2001; ariño & ring, 2010), although it relates to the openness of communication among supply chain partners (luo, 2007). openness relates to greater sensitivity in managing conflict and disparities (lu, 2006). narasimhan et al. (2013) found that justice is important for improving supply chain relationship performance and that each category of justice has unique contributions and an important part to play in supply chain relationships. griffith et al. (2006) stated that perceived procedural and distributive justice have improved long-term orientation and relational behaviour, have reduced conflict and have increased satisfaction. liu et al. (2012) reported that all justice categories have significant influence on dyadic relationship performance in the context of the supply chain. it is suggested that mutually perceived justice by partners contributes to enhanced performance owing to the coupling link of knowledge sharing, relational investment and continuous commitment. justice is important for accomplishing superior performance in all economic exchanges (narasimhan, nair, griffith, arlbjørn & bendoly, 2009). therefore, we formulate the following proposition. proposition 2: in the context of sci, there is a positive relationship between supply chain justice dimensions (procedural, distributive and interactional) and supply chain performance (scp). 5 the synergistic and complementary role of supply chain justice together with sci practices in supply chain performance (scp) luo (2007) defined procedural justice in the context of strategic alliances in china as “the extent to which the strategic decision making process and procedures that impact each party’s gains and interests are impartial and fair as perceived by the boundary spanners representing each party in an alliance”. the intention is to produce a sense of procedural justice as a partner assesses the fairness of the formal procedures governing the creation and functioning of the collaborative arrangement. however, the absence of these procedures may result in perceptions of procedural injustice. in the absence of procedural justice, partners may exert pressure on the other party to follow existing procedures or may threaten to leave the strategic arrangement (beugré & acar, 2008). investigations have shown that a party may perceive low procedural justice as tending to deliver low commitment to the joint venture (johnson, korsgaard & sapienza, 2002). similarly, luo (2005) found that alliance profitability was higher when both parties perceived higher rather than lower procedural justice. cropanzano, bowen and gilliland (2007) stated that process actually encourages an individual‘s willingness to serve in the greater interest of a relationship. this phenomenon is true in the context of the organisation (narasimhan et al., 2013). hald and ellegaard (2011), in their case study on the supplier-evaluation process and consequent price quotes by suppliers found that, where suppliers perceived a process to be unfair, they quoted a higher price in subsequent interactions. narasimhan et al. (2013) noted the comments of a senior procurement executive in a leading oil-producing firm about supply chain procedural justice. the executive stated that, in the past, they had negotiated a framework agreement with a supplier about market commercial terms. the supplier was then bound to do the initial work (which was fairly extensive) at cost, based on the expectations that, if the supplier did the work well, such supplier would be rewarded for the next phase of the project. however, the inconsistencies found during implementation of the agreement had led to frustration that was not conducive to a sustainable relationship. as a result, the firm had introduced some changes to ensure fair compensation for work done that had led to a stronger relationship of openness and trust. liu et al. (2012) pointed out that some long-term suppliers such as cofco (the largest supplier of diversified agricultural products in china’s food industry) and master kong (a food and beverage company) had claimed that the annual contract-negotiation process with carrefour had been extremely difficult and that subsequent execution of consent terms was often not guaranteed. similarly, the french automaker, peugeot terminated its venture relationship and participation with its partner in china, the reason being that it had realised that local partners were procedurally undercutting its managerial sajems ns 18 (2015) no 4:519-533 525 autonomy and participative power in the alliance compared with its contribution. this decision was, therefore, taken in the context of perceived procedural injustice (harwit, 1997). sometimes, even procedural injustice on the supplier’s part will be regarded as injustice within the company. nike’s asian subcontractors, for instance, have compelled their employees to work long hours (about 10.5 hours per day) for six consecutive days for the equivalent of only $10. though nike was not directly involved in these violations of justice, such violations actually tarnished the reputation of nike. it can thus be argued that nike engaged in procedural injustice as a result of its suppliers failing to adhere to proper and fair work procedures (beugré & acar, 2008; beugr, 2007). turning to process integration, this may be defined as the degree of overall coordination of business processes and activities between supply chain partners. it involves effective division of tasks across units and consequent coordination in order to execute the task within the firm or between partners (van de ven, delbecq & koenig, 1976). where both buyer and supplier perceive high levels of procedural justice, they will recognise that their benefits are protected through policies and will accordingly be willing to invest in the relationship. for instance, wal-mart china and its suppliers mutually perceive a high level of procedural justice, which signifies consistency in exchange processes and the likelihood of outcomes (liu et al., 2012). kumar et al. (1995), indicating that trade channel members’ perception of their partner’s procedural justice has a strong effect on their willingness to invest in the relationship. similarly, procedural justice is also essential for the purpose of information sharing (liu, liu, kwok-kee & hua, 2014). from the aforementioned practical examples, it is clear that supply chain procedural justice between members of the supply chain has become integral to the success of sci. thus, even though there have been situations where sci practices have prevailed, the relationship between partners has been terminated on account of procedural injustice. procedural justice and sci practices may therefore be synergistic and complementary in their impact on scp. the model thus indicates that procedural justice and sci practices could interact in impacting scp. thus we formulate the following propositions. proposition 3a: complementarities between supply chain procedural justice and the integration practice of information sharing are necessary for supply chain integration (sci), and, therefore, for supply chain performance (scp) improvement. proposition 3b: complementarities between supply chain procedural justice and the practice of process integration are necessary for supply chain integration (sci), and, therefore, for supply chain performance (scp) improvement. proposition 3c: complementarities between supply chain procedural justice and the integration practice of relationship commitment are necessary for supply chain integration (sci), and, therefore, for supply chain performance (scp) improvement. it should be pointed out that partners strive to achieve the common objectives of their multi-partner alliances, even though they may differ with respect to their individual interests and may compete for their share of alliance benefits (lavie, lechner & singh, 2007). it is proposed that a firm invests in a relationship with the expectation of receiving some rewards in terms of outcomes such as profit, access to technology, or access to new markets. each partner desires to compare their input output ratio with that of the other partner in the relationship. a sense of fairness arises as partner actions meet expectations. however, where such actions fall short of expectations, feelings of unfairness are experienced (beugré & acar, 2008). according to barden steensma and lyles (2005), partners in a cooperative relationship will expect the outcomes of the cooperative arrangement to be distributed in proportion to the partner contributions. violations of this principle may lead to mistrust, conflict, dysfunction, self-serving behaviour, and, ultimately, the dissolution of the relationship (scheer et al., 2003; ring & van de ven, 1994). importantly, equity is essential to the development of stable and productive inter-firm relationships (barden et al., 2005). it is suggested that, where a partner believes that positive returns are not occurring or that they are not being fairly rewarded relation to their contributions, they may find ways to divest themselves of the unprofitable venture (beugré & acar, 2008). 526 sajems ns 18 (2015) no 4:519-533 in this regard, jusko (2011) quotes the words of the chief executive officer (ceo) of talan products, a cleveland based metal stamping company: “if a relationship is cannibalistic, some day dinner is going to run out. you’re going to eat the [company] up”. narasimhan et al. (2013) quote the words of a senior procurement executive of an offshore oil-drilling-equipment firm: “risk and reward sharing have a visible financial impact” on supply chain relationships. perhaps it could be stated that distributive injustice can lead to opportunistic behaviours. beugré and acar (2008) note that, in case of a united states based company which subcontracts its operations to a firm located in asia, the subcontractor has experienced distributive justice owing to the fact that contracting company has bought its output at a reasonable price. liu et al. (2012) state that, in the case of carrefour, suppliers have in fact complained about their lean profits, in addition to slotting fees and promotion fees. it is maintained that carrefour, has contrived a wide range of reasons to levy surcharges on suppliers, that is, anniversary fees, store-grand-opening fees and holiday celebration fees. in view of this, suppliers have chosen to terminate their relationship with carrefour, citing severe injustice issues with respect to the supply chain. morgan and hunt (1994) state that “relationship commitment” can be seen as the willingness of a party to invest financial, physical or relationship-based resources in a relationship. in the context of the supply chain, partners require the development and maintenance of a stable, long-lasting mutual relationship (anderson & weitz, 1992). distributive injustice, it would seem, could lead to opportunistic behaviours where the exchange parties even engage in behaviours that can sabotage the relationship (narasimhan et al., 2013). however, risk and reward sharing, in particular can be important in mitigating opportunistic behaviour (eisenhardt, 1989). distributive justice is also important for supply chain information sharing integration (liu et al., 2014). in fact sci practices like information sharing, process integration and relationship commitment have provided a particular mechanism for sci. however, this does not necessarily a guarantee the success of supply chain relationships among partners in the chain. in particular, it is assumed that, without supply chain distributive justice, sci would fail even where there is a mechanism of sci practices existing between participating firms in the supply chain. we would argue that along with sci practices supply chain distributive justice is essential and complementary, for the better establishment of sci and will contribute significantly to scp. the model indicates that distributive justice and sci practices may interact in their impact on scp. thus we formulate the following propositions. proposition 4a: complementarities between supply chain distributive justice and the integration practice of information sharing are necessary for supply chain integration (sci), and, therefore, for supply chain performance (scp) improvement. proposition 4b: complementarities between supply chain distributive justice and the practice of process integration are necessary for supply chain integration (sci), and, therefore, for supply chain performance (scp) improvement. proposition 4c: complementarities between supply chain distributive justice and the integration practice of relationship commitment are necessary for supply chain integration (sci), and, therefore, for supply chain performance (scp) improvement. luo (2007) state, in a study of a strategic alliance in china, that local executive felt unjustly treated by their foreign counterparts when they received neither courtesy and respect, nor experienced cultural sensitivity and mutual understanding. it is suggested that interactional injustice will occur when boundary spanners do not share valuable information and do not consider other important inputs. this has been observed, for instance, where a partner does not provide explanations for important decisions. meanwhile perceptions of improved interactional justice may offer a better social environment in strategic alliances, as well as improved information sharing and personal relationships between boundary spanners representing different parties. in fact, high interactional justice increases solidarity, reduces interparty conflict and improves organisational attachment (mohr & spekman, 1994; nooteboom, 1996). narasimhan et al. (2013) note the comments of a senior executive about interactional justice. such executive, they sajems ns 18 (2015) no 4:519-533 527 state, maintains that it contributes to openness and trust in a relationship, and that, without openness and trust, the parties are more likely to “fight” for positioning and “gaining the upper hand” as they rationalise the relationship as being competitive in nature where only one can win. liu et al. (2012) have found that the personnel of carrefour suppliers often complain about the way they have been treated by their contacts, and how they have often been kept in the dark as the result of carrefour changing pricing or the location of their products in the store. currently, suppliers have chosen to terminate their relationship with carrefour on account of such relationship causing severe problems in the supply chain. interactional justice, therefore, can develop greater trust and relationship commitment between transacting parties (narasimhan et al., 2013), and can also encourage supply chain information sharing integration (liu et al., 2014). it is possible that, without information sharing and relationships, the firms might experience difficulties in carrying out the operational activities arising from the relationship, which can then lead to poor performance. besides the sci practices, there are various forces that contribute to the establishment of sci between firms. similarly, supply chain interactional justice has become quite critical to the successful operation of sci and to the relationship between firms participating in the supply chain. we argue that supply chain interactional justice has become complementary and integral among sci practices for establishing sci and will contribute more significantly to scp relative to their independent role in sci. the model indicates that interactional justice and sci practices may interact in their impact on scp. thus we formulate the following propositions. proposition 5a: complementarities between supply chain interactional justice and the integration practice of information sharing are necessary for supply chain integration (sci), and, therefore, for supply chain performance (scp) improvement. proposition 5b: complementarities between supply chain interactional justice and the practice of process integration are necessary for supply chain integration (sci), and, therefore, for supply chain performance (scp) improvement. proposition 5c: complementarities between supply chain interactional justice and the integration practice of relationship commitment are necessary for supply chain integration (sci), and, therefore, for supply chain performance (scp) improvement. furthermore, we argue that once both foundational components are in place, potential synergies between sci practices and supply chain justice as complementary elements can be exploited in order to gain additional performance. the findings from supply chain relationship terminations reflected in the case studies concerned illustrates that firms whose sci is currently good have, however, not yet paid much attention to supply chain justice between supply chain partners. these organisations are likely to find that implementing sci practices without reinforcing supply chain justice will not sustain supply chain relationships and bring about significant performance. such firms should, therefore, focus attention simultaneously on supply chain justice and sci practices in their supply chain integration. 6 discussion and research implications we have developed propositions that may serve as guidelines for empirical study. these propositions recognise that sci practices and justice independently and positively affect scp. what is also clear from the above is that supply chain injustice has caused the termination of relationships between supply chain partners. for instance, wal-mart canada made a decision to terminate its business relationship with the lego group because lego refused to reduce its prices in the canadian market to bring them in line with its pricing structure in the united states market. wal-mart considered such refusal to be unfair and perceived the lego group as being unwilling to share the benefits they were reaping from the appreciation of the canadian dollar. what had transpired prior to wal-mart request to lower prices was that the canadian government had called on retailers to lower their prices as a result of appreciation of the canadian dollar, and retailers, in turn, had asked suppliers to lower wholesale prices. the report detailing this sequence of events quoted a wal-mart canada executive as saying that they had told suppliers that they “would not 528 sajems ns 18 (2015) no 4:519-533 tolerate unfair pricing” for their canadian customers (georgiades, 2008). a similar relationship termination occurred between the two chinese firms gome (a leading chinese home-appliance retailer) and gree (a leading air conditioner manufacturer in china) in the summer of 2004. gree believed that gome had demanded additional summer-promotion fees which were absolutely unfair and therefore decided to withdraw its entire product range from gome stores (asia info services, 2004). this situation, led gree to decide to open its own exclusive stores in order to sell the products. thus, notwithstanding the circumstances, gree was able to make good the loss of market share due to the termination of the relationship with gome (liu et al., 2012). considering the situation in south africa, it is evident that fair-trade standards have been reworked and implemented. fair-trade standards specifically, have two interconnected objectives, namely to stabilise supply chain relationships and the social development of communities (hughes, mcewan, bek & rosenberg, 2014). in south africa firms have been experiencing supply chain injustice issues. however, economic fairness may nevertheless be questionable owing to unequal market selling power (ras & vermeulen, 2009). for instance eksteenskuil agricultural cooperative (eac) is the world’s first fair-trade-certified raisin producer, with four fair-trade smallholders operating in south africa. eac, however, has been facing challenges with regard to ensuring an equitable distribution of benefits (hughes et al., 2014). the theoretical framework proposed in the paper could, therefore be helpful to south african managers in understanding how justice and sci practices help firms to improve performance. this study demonstrates that supply chain justice can be regarded as an important stimulus along with integration practices. therefore, managers should move in the direction of recognising the supply chain justice as well as the viable implementation of integration techniques along with their supply chain partners. this way they can leverage supply chain justice and integration practices in a synergistic way so as to improve performance. the justice perceptions shared by supply chain partners, along with simultaneous implementation of sci practices can drive better performance. in fact, justice contributes to a fair and just atmosphere with respect to the buyer-supplier relationship, and, in such an atmosphere, firms are more likely to engage in integration practices that lead to superior performance on the part of the firm. yet, despite this, there are the chronicled instances of supply chain injustice leading to the termination of supply chain relationships. what our model does acknowledge is that simultaneous complementary implications of sci practices and justice produce greater benefits for firms relative to their independent consequences. it is strongly suggested, therefore, that, as for as supply chain integration is concerned, participating firms should realise and understand the importance of supply chain justice and its complementary effect on performance. members of participating firms should consider it a top priority during their transactional interactions with their partners. in order to manage sci and inter-firm relationships, supply chain members should strive for a convergence of their own justice expectations and those of their partners. this can be done by developing a common code of conduct that clearly spells out the responsibilities and rights of each participating firm. in fact, since various partners have varying perceptions of, and expectations regarding justice, the development and implementation of a code of conduct are important. further, perceptions of procedural justice are important for sustainability and the stability of the relationship (luo, 2005). accordingly, supply chain partners could therefore design a justice system and ensure its implementation so as to may help them effectively manage their inter-firm relationships. thus, as suggested by luo (2007), supply chain partners need justice with regard to procedures, distribution and interaction in order to foster repeated economic exchanges that are gradually embedded in a social-exchange context. this study, sets out not only to provide new insights concerning justice and sci practices in supply chain management (scm) theory, but also has implications for managers to assist them in recognising the synergistic and complementary role between partnering firms in the sci. it emphasises the principle that managers should promote justice as complementary to sci practices sajems ns 18 (2015) no 4:519-533 529 in their firms. the synergistic and complementary view of justice and sci practice drives relationship performance significantly. liu et al. (2012) found that, when both parties simultaneously perceive a high level of justice, a profitable and stable relationship becomes possible. this is in line with the bilateral theory that justice and sci practices complement one another in enabling a firm’s performance. thus, it is recommended that managers examine how supply chain justice and integration practices interact with one another and ensure their complementarities. 7 guidelines for empirical research 7.1 research design the main purpose of the study is to reveal the relationship between variables that is, supply chain justice dimensions and integration practices as the independent variables and supply chain performance as the dependent variable. for this study, the most appropriate method of analysis is a quantitative research approach, with data being collected through a survey undertaken with a representative sample. 7.2 measurement issues to empirically test our proposed conceptual framework, interested researchers could develop and refine appropriate measures for the constructs in our model. we present the various constructs used in our model and guidelines for their measurement. the scales for measuring supply chain practices are: information sharing (cai, jun & yang, 2010; prajogo & olhager, 2012), process integration (wu, chiag, wu, & tu, 2004), relationship commitment (wu et al., 2004), supply chain procedural, distributive (narasimhan et al., 2013; griffith et al., 2006), interactional justice (narasimhan et al., 2013; luo, 2007) and supply chain performance (scp) (cousins & menguc, 2006; panayides & venus lun, 2009). furthermore, the questionnaire could comprise questions about the demographic profile of the company. all the items can be measured on a seven-point likert scale ranging from strongly disagree to strongly agree (i.e. 1=strongly disagree and 7=strongly agree). we suggest these measures as potential starting points for comprehensive empirical work in this area. our model contains two sets of variables: one set is associated with the specific dyadic relationship, while the other is not under the control of the dyad. it could be worthwhile to test the dyadic factors of the model using the data collected from a single industry (or closely related industries) and to test the other factors by collecting data from diverse industries. 7.3 unit of analysis researchers can consider the dyad as a unit of analysis. although some independence will be lost between samples, that is, the same organisation could have multiple suppliers and distributors, and vice versa. moreover, the detailed research could be adapted to address different objectives. as mentioned, some factors are not specific to the dyads but may be common for entire industries; hence to examine the relationships, data must be collected from several industries. we recognise that modifications to the data-collection procedures will be necessary based on the specific nature of the empirical testing, or the nature of the industry (industries) that will be the focus of the analysis, as well as some other data-collection constraints and limits. 8 conclusions and future research directions in this study, we have proposed a theoretical framework to explain the complementary effects of sci practices and supply chain justice on firms’ scp. this framework simultaneously incorporates sci practices and justice that address the sci relationships. it also lays a solid base for future empirical research on the complementary effects of both important driving forces of sci. the 530 sajems ns 18 (2015) no 4:519-533 model contributes to the extent of supply chain literature in two ways. first, the model introduces the complementary concept of supply chain justice and sci practices to the study of sci and performance. in so doing, the model focuses on the role of supply chain partners in helping to understand the dynamics of sci. because, in some ways, perceptions of the complementary role tend to be subjective, an understanding of sci should include an analysis of the attitude, behaviours and perceptions of those who represent the respective partners in sci. second, the conceptual framework highlights the implications of complementary effects of sci practices and supply chain justice on performance. it explores the simultaneous consideration of both forces in sci. this complementary concept has required operationalisation as supply chain partners’ perceptions. our study creates an avenue for future studies. our work represents an important attempt at the conceptualisation of complementarities of sci practices and justice dimensions, something that presently has remains as an empirical question. we believe that researchers can develop a normative model for investigation of our conceptual framework. this will allow certain questions to be answered such as: “what is the quantitative impact of combinations of various propositions on firms’ scp?”; “which combination of sci practices and justice 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chain. international journal of production research, 41(9):2075-2090. yeung, j.h.y., selen, w., zhang, m. & huo, b. 2009. the effects of trust and coercive power on supplier integration. international journal of production economics, 120(1):66-78. zhao, x., huo, b., flynn, b.b. & yeung, j.h.y. 2008. the impact of power and relationship commitment on the integration between manufacturers and customers in a supply chain. journal of operations management, 26(3):368-388. zhou, h. & benton jr, w.c. 2007. supply chain practice and information sharing. journal of operations management, 25(6):1348-1365. abstract introduction theoretical framework and hypotheses methodology results managerial and theoretical implications conclusions, research limitations and future research acknowledgements references footnotes about the author(s) mornay roberts-lombard department of marketing management, university of johannesburg, south africa mercy mpinganjira department of marketing management, university of johannesburg, south africa göran svensson department of marketing management, university of johannesburg, south africa department of marketing, kristiania university college, norway citation roberts-lombard, m., mpinganjira, m. & svensson, g., 2017, ‘antecedents and outcomes of satisfaction in buyer–supplier relationships in south africa: a replication study’, south african journal of economic and management sciences 20(1), a1497. https://doi.org/10.4102/sajems.v20i1.1497 original research antecedents and outcomes of satisfaction in buyer–supplier relationships in south africa: a replication study mornay roberts-lombard, mercy mpinganjira, göran svensson received: 09 nov. 2015; accepted: 26 may 2017; published: 27 oct. 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: there is a clear difference of opinion amongst researchers on the interrelatedness of the variables trust, commitment, satisfaction, coordination, cooperation and continuity in a business-to-business (b2b) environment. the reason is that in previous studies much emphasis has been placed on creating and testing new theories, and not on providing practical generalities. aim: the aim of this study was to determine how the variable satisfaction is positioned in relation to trust and commitment, and how satisfaction relates to the variables coordination, cooperation and continuity in a south african b2b environment. setting: this study replicates a similar study conducted in 2013 in a b2b environment in south africa and hopes to validate the outcome of that study by determining the relationship between the constructs postulated in the current study. the relationships between the different constructs in the proposed model will, therefore, provide a longitudinal perspective which is unique in terms of b2b research in south africa. methods: both the original and replication studies followed a quantitative approach and targeted large companies in south africa. in the original study, data were collected from 500 large south african companies, while in the replication study data were collected from 250 large companies. structural equation modelling was used to analyse the data. results: the findings specifically point to the need for organisations to direct resources towards the establishment of relationships that are founded on trust and commitment. doing so will help ensure increased satisfaction, which, in turn, will result in greater coordination and cooperation in b2b relationships as well as long-term continuation of the relationship. conclusion: the foundation for strong b2b relationships is to secure customer satisfaction. business managers ought to understand that when business customers are dissatisfied, it can result in the discontinuation of the business relationship. introduction the literature on relationship marketing proposes that a business focused on the establishment of relationships with their customers has a long-term orientation that is founded on continuity. the employees of a business that understands the theory of relationship marketing will be more inclined towards a long-term orientation for the retention of existing customers (ndubisi et al. 2016:373). considering this, the growing competition in the business environment has resulted in a renewal of interest in business-to-business (b2b) relationship marketing. this is because the development of strong relationships between buyers and suppliers is known to contribute significantly to business by reducing risks in exchange relations (segarra-moliner, moliner-tena and sánchez-garcia 2013:196–197). researchers such as segarra-moliner et al. (2013), vesel and zabkar (2010), skarmeas et al. (2008) and morgan and hunt (1994) have highlighted the importance of elements such as trust, commitment and satisfaction in the relationship-building process. nevertheless, researchers do not agree on how these three concepts relate to each other. kundu and datta (2015:23) state that satisfaction is an affirmative, emotional state that is the result of an assessment of all facets of the working relationship between parties. han and hyun (2015:20) stipulate that the level of trust that a customer has in a business, will have a direct influence on its level of satisfaction expectation, which ultimately will influence its satisfaction experience. salleh (2016:184), kashif et al. (2015:28) and taylor, donovan and ishida (2014:129) concur by stating that trust is a critical factor in the creation of value to the customer and directly contributes to customer satisfaction. bojei and abu (2014:174) further contend that commitment is also an antecedent of satisfaction and argue that the more committed a customer is to a supplier, the higher the level is of satisfaction expectations. chang et al. (2015:868) concur and argue that commitment is an important indicator of the strength of a relationship with a supplier and is driven by previous experiences of satisfaction. sanchez-franco (2009:248) also argues that satisfaction can be perceived as an antecedent of both trust and commitment. theron, terblanche and boshoff (2011:188) perceive satisfaction as a predictor of trust, while hau and ngo (2012:225) are of the opinion that trust generates satisfaction. considering this, there is a clear difference of opinion amongst researchers on the interrelatedness of the variables trust, commitment and satisfaction. the reason is that in previous studies much emphasis has been placed on creating and testing new theories, and not on providing practical generalities (geyskens, steenkamp & kumar 1999:231). hair et al. (2010) address the relevance of validating the findings in the development of theory. further, hair celsi et al. (2011:33) state that theory development is a cumulative process and that the validation in one study with another through findings is needed so as to develop valid and reliable theory. the substantiation of findings can, therefore, be performed through replication and/or pure validation studies. this argument is supported by gummesson, kuusela and närvänen (2014:229–230) and grönroos (2006:38–40) who argue that the focus of research in marketing is changing towards a stronger emphasis on marketing strategy with practical recommendations over a longer period of time. there is a movement away from studies that makes a one-time contribution towards longitudinal studies with definite substantiations and contributions (skarmeas et al. 2008:33). nyaga, whipple and lynch (2010:112) also argue that relationships build on two-way engagement are characterised by a long-term approach. thus, a longitudinal study of the relationship approach between a buyer and a supplier might deliver different results from a pure cross-sectional study. this study aims at determining the relationship between trust, commitment, satisfaction, coordination, cooperation and continuity in a south african b2b environment. the authors propose that satisfaction is an outcome of trust and commitment on the one hand, and an antecedent of coordination, cooperation and continuity on the other. the importance of this study is in the re-testing of the different relational constructs in the theoretical model within a south african b2b environment. most studies on b2b relationships are based on findings of studies conducted in developed countries (e.g. ata and toker 2012; ashnai et al. 2009; gounaris 2005; lages, lancastre & lages 2008; lamprinopoulou & tregear 2011; ndubisi 2009). however, no study has previously been conducted to test the constructs in the proposed model, from a social exchange theory (set) and relationship marketing theory (rmt) perspective in a developing market environment such as south africa. by testing the proposed model in a developing country context, this study contributes to literature by bringing findings from a geographical different context. in testing the proposed model, this study replicates a similar study1 conducted in a b2b environment in south africa and hopes to validate the outcome of that study by determining the relationship between the constructs postulated in the current study. the relationships between the different constructs in the proposed model will, therefore, provide a longitudinal perspective, which is unique in terms of b2b research in south africa. keeping in mind that the business contextual factor is ever static over time (hu, wu & chen 2013:492) as competition tends to get stiffer with time and new business models may be adopted by some in order to ensure business success in the face of changing business environment. the present study will, thus, assist in uncovering if changes that have taken place in the south african business environment including growing levels of competition demands a relook at relationship-building strategies. this is specifically in relation to ensuring satisfaction, coordination, cooperation and continuity in business relationships. the structure of the article is as follows. firstly, a theoretical argument is provided for the development of the conceptual model proposed in the study and the related hypotheses. secondly, a discussion on the methodology used and the data analysis and results follows. lastly, the conclusions, limitations and implications are considered. theoretical framework and hypotheses figure 1 illustrates the conceptualised model proposed for this study. as shown in the figure, satisfaction is positioned as an outcome of trust and commitment and the precursor of cooperation, coordination and continuity. figure 1 further indicates that all the paths are hypothesised to be positive. the following discussion provides a literature perspective in support of the formulated hypotheses. figure 1: conceptual model. theories grounding the study the study is founded on the principles of the set and the rmt in relation to the constructs explored and the proposed relationships between the constructs. set is founded on the principle of voluntary exchange of value between individuals (business-to-consumer) and organisations (b2b) in the relational process. as a result, it (set) embraces the norm of mutual exchange, where value creation is to the benefit of all parties involved (tanskanen 2015:579). set further proposes that the building of relationships is founded on the basis of a subjective cost–benefit analysis as well as the evaluation of options (liu et al. 2016:54). this implies that the parties to a relationship will evaluate the future of a relationship on the value that is still to be accrued from a partner (e.g. financial rewards, the trustworthiness of a partner and the level of future satisfaction from the relationship) (sierra & mcquitty 2005:393). chen and choi (2005:2) and ward and berno (2011:1557) concur and state that social exchange is not always founded on financial rewards, although the continuation of the relationship will be based on views regarding the comparative costs and benefits of the relationship, past experience of satisfaction and its implication(s) for future relationship satisfaction. considering this, set has been found to produce outcomes such as trust, informal commitment and satisfaction (lawler 2001:326; lioukas & reuer 2015:1826, 1829). in terms of rmt, stavros and westberg (2009:308) and lui, wong and liu (2009:1216) argue that relationship marketing embraces a customer-centric approach with the primary outcomes being increased customer retention, greater loyalty, lower marketing costs and increased profit levels. ballantyne (2003:1255) argues that a relationship improvement strategy is initiated by the following question: ‘what is of value and to whom?’ nicholson, lindgreen and kitchen (2009:195) state that the manner in which a relationship is managed by the parties involved will have a direct influence on a partner’s perception of trust in the relationship, which ultimately will influence the level of commitment towards the continuation of the relationship. this is an argument that has been posited in the seminal work of morgan and hunt (1994) in their trust-commitment model, perceived as one of the most applied models in inter-organisational relationship-building in relationship marketing. therefore, the theory of relationship marketing is founded on the principles of trust between parties, the cultivation of mutual understanding between such parties, the ability to deliver on expectations based on previous cooperative history, to eventually secure customer cooperation as an outcome (chang et al. 2015:869–870). considering the discussion above, the authors draw on the foundations of these theories to hypothesise the relationships between the constructs of the study, in the south african b2b environment. no previous study in the context of the south african b2b environment has applied the set or the rmt to propose that satisfaction is an outcome of trust and commitment on the one hand, and an antecedent of coordination, cooperation and continuity on the other. a relationship marketing approach to business-to-business markets the current, competitive business environment necessitates an understanding of the changing nature of b2b relationship-building dynamics. the supplier no longer has the principal influence in the relationship because the buyer or customer is increasingly playing a key role in the establishment and management of relationship commitment and trust to secure satisfaction (brodie 2017:22). knox and gruar (2007:115) concur and argue that rmt proposes the establishment and building of mutually beneficial value-add relationships between all relevant stakeholder groups, based on the principles of trust and commitment, to secure long-term satisfaction. rmt, therefore, argues that a continuous focus on customer relationship development secures the development of customer value strategies. such strategies create a platform for the creation of a sustainable competitive advantage and increased profitability in the long-term (theron & terblanche 2010:384). relationship marketing is perceived as an influential strategy for companies aiming to distinguish their product offerings in the market environment. it has also become a growing area of international research considering the globalisation of markets (samaha, beck & palmatier 2014:93). the supporters of the relationship marketing philosophy argue that business survival is no longer dependent on traditional marketing approaches of developing, selling and delivering products to customers without securing their retention for future purchases. relationship marketing is encompassing a more inclusive focus that is founded on the establishment, growth and management of relationships that are both beneficial and satisfying to all parties involved (leahy 2011:1). according to malhotra, uslay and ndubisi (2008:213), relationship marketing is the foundation on which b2b relationships are built and is a growing area in the domain of business relationships. theron and terblanche (2010:386) also argue that the relevance of a relationship-orientated approach to marketing was highlighted in 2004 by the american marketing association (ama) with the introduction of a new definition of marketing management: marketing is an organizational function and a set of processes for creating, communicating, and delivering value to customers and for managing customer relationships in ways that benefit the organization and its stakeholders. (harker & egan 2006:217) sheth and parvatiyar (1995:399) further posit that in a b2b relationship, it is key for all parties to secure elevated levels of satisfaction with every single business interaction. the key focus of a relationship marketing strategy is, therefore, to establish relationships at all points of interface with the customer. the outcome of this should be to establish benefits for both the organisation and the customer (theron & terblanche 2009:384). managing b2b relationships is intricate because these relationships are often close, complex and long-term (sarmento, simões & farhangmehr 2015:131). therefore, an understanding of the management of b2b relationships can be attained once clarity has been obtained on the different elements contributing to them (theron, terblanche & boshoff 2010:198). in the marketing literature, there is wide recognition of the importance of trust, commitment and satisfaction in the relationship-building process (brito, brito & hashiba 2014; jarratt & ceric 2015; ndubisi 2011; morgan & hunt 1994). table 1 serves as a support for this statement reflecting current studies on trust, commitment and satisfaction and why trust is an antecedent of commitment. table 1: current research on the topics of trust, commitment and satisfaction. altinay et al. (2014:724) and laeequddin et al. (2012:551–552) state that in a buyer–seller relationship, trust is perceived as a key element in the relationship-building process. if the level of trust between partners is perceived as high, the willingness to commit to such a relationship is also stronger, eventually leading to higher levels of satisfaction. despite this, there is limited knowledge on how to manage b2b relationships from a comprehensive perspective to secure positive relationship-building with the outcome of coordination, cooperation and continuity. the reason for including coordination, cooperation and continuity as outcome variables of interest in this study is that they are key characteristics of strong relationships in b2b marketing (payan et al. 2016:64; razzaque & boon 2003:30–31; shamdasani & sheth 1995:8–9; theron & terblanche 2010:389–390). rmt argues that strong exchange relations are key to business success (ng 2012:161; wilson & nielson 2001:3). according to chang and chuang (2016:519), cooperation represents an engaging process whereby the buyer actively interacts with the product innovation processes of the supplier to drive participation. satisfied engagement experiences, therefore, become a driver for further cooperation between a buyer and a supplier. coordination reflects engagement in joint activities relating to structure or process, between organisations (keung et al. 2015:1). coordination is key to ensuring high levels of efficiency and achievement of objectives in b2b relations. it helps to reduce conflict and disagreements, thereby ensuring smooth working relations. continuity, on the other hand, is concerned with the duration of the business relationship. success in relationship marketing is therefore characterised by loyalty, which includes commitment to continued business relations (gaurav 2016:5). the various constructs depicted in figure 1 form the focal point of this article, and different hypotheses are formulated that relate to these constructs. the relationship between trust and satisfaction rauyruen and miller (2007:24) state that trust is a key component in the relationship-building process when companies make promises to customers and then keep to their promises as well. wang et al. (2014:1) emphasise that the increased acknowledgement of relationship marketing in the buyer–supplier relationship-building process has enhanced interest in the area of buyer trust. from a b2b perspective, trust is perceived as the degree to which a company views a business partner as being honest. trust is also considered as the conviction of one partner that the other partner will conduct business that will secure positive benefits to the company and not conduct activities that will create a negative outcome to the business relationship (hung, cheng & chen 2012:667). according to fullerton (2011:95), the willingness of one party in a relationship to be associated with another will be guided by the principle of shared values such as trust. laeequddin and sardana (2010:355–356) concur and argue that a partner’s level of satisfaction with a relationship will be influenced by previous engagements based on trust expectations. satisfaction with previous experiences will influence the trust expectation of one partner to another in the b2b relationship, and the ultimate decision to continue or discontinue with the relationship (sarmento et al. 2015:133). voldnes et al. (2012:1082) confirm that trust is an antecedent of satisfaction because higher levels of trust between parties enhance overall satisfaction expectations and strengthen long-term commitment. jiang, henneberg and naudé (2011:6) concur and state that trust is a primary precursor of satisfaction. they argue that when high levels of trust exist between the buyer and the seller, the former is usually satisfied with the relationship as there is trust that the activities of the supplier will secure positive results for all parties involved. this argument is further supported by izogo (2016:377) who states that customers are more willing to be supportive of an organisation that establishes trust. therefore, trust has a positive relationship with satisfaction. farrelly and quester (2005:211) state that a customer with a strong trust in the supplier will expect the company to have open communication channels to enhance satisfaction experiences. such open communication is critical in creating and sustaining positive buyer–supplier exchanges. kaur, sharma, and mahajan (2012:282) concur and argue that buyers are more willing to continue with a relationship if the level of trust between the buyer and the seller is increased. this argument is further supported by hansen, morrow and batista (2002:45) who state that satisfaction is a direct outcome of trust and increased levels of trust in the supplier can lead to higher levels of buyer satisfaction. considering the discussion above, it is argued that trust can be perceived as an antecedent to satisfaction. therefore, the ensuing hypothesis is formulated: h1: trust positively influences satisfaction. the relationship between commitment and satisfaction commitment is seen as a key element in securing long-term b2b relationships. it is described as a partner’s willingness to establish a long-term relationship with another partner and to continue with such an association, inclusive of an emotion of psychological attachment (sung & choi 2010:1051). however, the level of commitment of a customer will depend on the customer’s perception of the amount of effort that the seller puts into the relationship (human & naudé 2014:921). dai, haried and salam (2011:4) state that the growth of continuous exchange relationships with customers offers a supplier a customer base that secures reliable income. in the field of relationship marketing, the significance of establishing, developing and maintaining the commitment of the customer to the supplier is highlighted (wu, zhou & wu 2012:1760). kaur et al. (2012:285) and theron and terblanche (2010:388) state that the stronger the level of commitment becomes in a seller–buyer relationship, the more stable the relationship becomes. espejel, fandos and flavián (2011:209) agree and propose that customer satisfaction is a direct outcome of buyer’s commitment to the relationship with the seller, based on evaluating the difference between expectations and results. in addition, the commitment of employees towards the relationship-building initiatives of the supplier will strengthen customer relationship management initiatives, which could increase customer satisfaction levels (ata & toker 2012:504). kim (2014:2) also established that commitment has a substantial influence on customer satisfaction. this argument is supported by richard and zhang (2012:573) asserting that a satisfied buyer has a stronger commitment towards a supplier than an unsatisfied customer, which enhances loyalty in the long-term. akman and yörür (2012:220–221) concur and argue that a buyer will remain committed to the supplier if the former is satisfied with the value offered in the relationship. therefore, a high level of commitment gives rise to increased satisfaction with the relationship. there is general agreement by some researchers in the field of relationship marketing that commitment can be perceived as an antecedent to satisfaction (anderson & narus 1990; johnson, sividas & garbarino 2008; mohr & spekman 1994; wong & zhou 2006). fullerton (2011:95) concur and state that satisfaction can only be secured if both parties are fully committed to the relationship. therefore, committed can be perceived as an antecedent of satisfaction in a buyer–supplier relationship. morgan and hunt (1994:22), in their seminal work on the trust-commitment theory, argue that commitment is central to the establishment and management of supplier–customer relationships. the reason is that it motivates customers not to consider short-term options as being more beneficial than the long-term opportunities that a relationship with an existing supplier might provide. therefore, for the purpose of this study, commitment is defined as an ‘implicit or explicit pledge of relational continuity between exchange partners’, involving an ‘enduring desire to maintain a valued relationship’ (sarmento et al. 2015:133). rutherford (2012:961) also notes that a higher level of commitment towards a supplier can result in higher levels of customer satisfaction, a lower propensity by the buyer to spread negative word-of-mouth opinion, and lower levels of customer defection. richard and zang (2012:573) concur and state that the level of customer satisfaction experienced is determined by the level of commitment between a buyer and a seller. it is, therefore, theorised that commitment is an antecedent of customer satisfaction in b2b relationships: h2: commitment positively influences satisfaction. trust as an antecedent to commitment hong and cho (2011:473) and hess et al. (2011:15) state that trust is a central element in buyer–supplier relationship-building strategies. it is a key antecedent to commitment and is perceived as the most influential instrument available to a supplier in the relationship-building process. hartmann, klink and simons (2015:110) support this argument by stating that a direct relationship exists between trust and commitment, because a higher level of trust between parties in a relationship implies greater commitment of one party to the other. read (2009:27) also argues that a buyer will only commit to a trustworthy supplier as commitment involves vulnerability and could expose the buyer to opportunism. nguyen and mutum (2012:401–402) concur by arguing that trust is directly related to commitment because a buyer will be more willing to commit, if the supplier delivers on its promises and can, therefore, be trusted. the strengthening of customer commitment in a relationship can result in the buyer developing more trust in the supplier. hung et al. (2012:667) further argue that when trust is formed between the buyer and the seller, there is a greater willingness to commit, securing a long-term orientation towards the relationship. this implies that being committed to a supplier is positively related to customer trust (chang et al. 2012:942; watkins & hill 2009:994). hasche, linton and öberg (2017:33) highlight the relationship between trust and commitment by stating that trust is a key construct influencing buyer commitment. these authors further state that the existence of trust between parties in a buyer–seller relationship implies a greater willingness between the parties to commit to the relationship. this will enable the parties to develop a relationship that goes beyond economic exchange and that could secure long-term partnering even when the economic benefits are no longer existing (parra et al. 2011:608). stein, smith and lancioni (2013:856) also note that the interrelatedness of the parties in a buyer–seller relationship will define their level of commitment and the eventual duration of the relationship. morgan and hunt (1994:23) state clearly that ‘the major differentiation of these exchange relationship types … is the mutual social trust and the resultant commitment on the part of the individuals to establish and maintain exchange relationships’. this argument by morgan and hunt (1994) supports the view proposed in this article that the construct trust is an antecedent to commitment. the following hypothesis is therefore formulated: h3: trust positively influences commitment. the relationship between satisfaction, cooperation, coordination and continuity customer satisfaction has been a topic of research interest for academics over the past two decades (akman & yörür 2012; bejou, ennew & palmer 1998; bowden-everson, dagger & elliot 2013; cheng et al. 2017; garbarino & johnson 1999; ndubisi 2012). a reason for this is the benefits that customer satisfaction holds for an organisation, such as relationship continuity and an increased willingness to remain with the organisation (naumann, williams & sajid khan 2009). since the early 1990s research has emphasised a shift in focus from a transactional to a relational approach towards relationship-building (grönroos 1994; morgan & hunt 1994; sheth & parvatiyar 1995). this has resulted in customer satisfaction being identified as a key element in the development of relationship marketing strategies (sun & kim 2013:68). in the context of this study, satisfaction is defined as ‘a positive affective state resulting from the appraisal of all aspects of a firm’s working relationship with another firm’ (sarmento et al. 2015:133). satisfaction is largely acknowledged in the academic literature as an antecedent of behavioural outcomes such as customer retention (trasorras, weinstein & abratt 2009), customer loyalty (bowen & mccain 2015); seto´-pamies 2012) and word-of-mouth ulaga and eggert (2006). satisfaction has also been identified as a key variable in the decision of a business to remain in a b2b relationship, where parties secure high levels of satisfaction during each business transaction (sheth & parvatiyar 1995; theron & terblanche 2010; ulaga & eggert 2006). in addition, this study also hypothesises that cooperation, coordination and continuity are outcomes of satisfaction. biggemann and buttle (2009:551) state that coordination in a relationship will be present when both parties understand the act of exchange, empowering them to believe that the establishment of interaction is a possibility. skinner, gassenheimer and kelley (1992:180) concur by arguing that there is a positive relationship between satisfaction and cooperation and that cooperation can be an influential factor on the level of satisfaction experienced through a buyer–supplier interaction. mohr and spekman (1994:139) also agree and state that the satisfaction of mutual expectations in the relationship strengthens the need for enhanced cooperation between parties. in terms of coordination, guiltinan, rejab and rogers (1980:41) already argued in the beginning of the 1980’s that coordination can only be secured if optimal system performance (inclusive of satisfaction) is secured. mohr, fisher and nevin (1996:105) and payan (2007:218) established that satisfaction is a precursor to coordination and the probability of continuity. this finding supports the illustration in figure 1 showing that both coordination and continuity are proposed outcomes of satisfaction. the study further posits coordination as a behavioural outcome because of its conceptual similarity to both cooperation and continuity. woodside and baxter (2015:104) propose that in both new and established relationships, coordination through social bonding assists in strengthening the relationship, thereby securing its continuity expectancy. this argument is in line with the study of palmatier et al. (2006:138–139) stating that satisfaction can be viewed as an antecedent to both coordination and continuity in the relationship-building process. therefore, to strengthen relationship continuity through coordination and a positive satisfaction experience, both parties must illustrate a desire to continue with the relationship, the relationship must be important to both parties and it must provide a growing basis for personal and business satisfaction to the parties involved. shamdasani and sheth (1995:8) concur and state that the willingness of parties in a relationship to continue with the alliance depends on the level of satisfaction experienced with the partnership. faryabi, sadeghzadeh and zakeri (2015:39) also agree and state that satisfaction is perceived as a direct influencer of the decision to continue with the relationship. therefore, for the purpose of this study, the concept ‘continuity’ relates to the duration of the relationship, and the communal undertakings by both parties are mirrored by coordination. in addition, the willingness of one party to work with the other will be the basis of cooperation (evensen & hansen 2016; faryabi et al. 2015; samaha, palmatier & dant 2011; voldnes et al. 2012). the academic argument proposed by this study is that the three outcomes of satisfaction, namely cooperation, coordination and continuity, are a reflection of the intent and actions that relate to the interactions between two organisations. considering this, three hypotheses are formulated: h4: satisfaction positively influences coordination. h5: satisfaction positively influences continuity. h6: satisfaction positively influences cooperation. methodology research context and samples when conducting research, one can take the cross-sectional time horizon or the longitudinal time horizon. the cross-sectional time horizon data on variables of interest are collected only at a single point in time. the longitudinal time horizons involve collection to data with the purpose of observing the same variables over time to determine whether trends can be identified (chisnall 2005). while in some longitudinal studies the same individuals serve as respondents over time, in business research, it is not always feasible to ensure that the same individual respondents take part in a study over time. this is because of varied reasons including movement of individuals to different positions or changes in company circumstances that make them fall out of the target population. the target population of interest in this study was top companies in south africa by revenue. both the original and replication study followed a quantitative approach. the replication study was conducted in 2014/2015, while the original study was conducted in 2011/2012. in both cases, a total of 500 largest companies in south africa were included in the sample frame. this frame was derived from a topco list of the top 500 companies operating in the private sector of south africa, based on their turnover. the topco list was chosen because it was the only list that provides details of all the top 500 companies in south africa. either the purchasing manager or the procurement manager was contacted by phone to establish the suitability of the respondent to answer the questionnaire. the reason for selecting the purchasing or procurement managers as respondents is that the study focused on business relationships with suppliers. purchasing or procurement managers are the individuals who deal with suppliers in a company, which makes them more knowledgeable about relationship issues with their company suppliers. however, in a case where the respondent was not qualified to answer the questionnaire, another individual who was better qualified to answer was identified and used as a respondent. computer-assisted telephone interviews were conducted with the respondents. respondents were asked to keep one supplier that they were familiar with, in responding to the questions. in the current study, a total of 250 usable questionnaires were returned, which produced a response rate of 50.0%. this compares well with the original study in which 232 usable questionnaires were returned, representing a response rate of 46.4%. two items, namely, (1) how much the respondent knew about his or her company’s perspective on the study topics and (2) how much the respondent knew about specific experiences with the supplier, were included for the purpose of checking the competency of the respondents used in both the original study and the replication study. this is in line with campbell’s (1955) recommendations that respondents used in a study need to be competent enough to answer questions relating to the subject matter under investigation. the findings of the original study and the replication study, respectively, showed that 96.6% and 94.8% of the respondents had knowledge of their company’s perspective regarding the study topics and that 98.7% and 98.4% had knowledge regarding experiences with the supplier. the mean value for the first item in the original study was 4.24 and for the replication study it was 4.26. regarding the second item, the mean value of the item in the original study was 4.31 and for the replication study it was 4.33. the mean values for both the original and replication studies illustrate that the respondents had appropriate knowledge about their company’s perspective on the topics under study and their company’s experiences with a supplier. the question on specific experiences with the supplier was aimed at capturing levels of knowledge through specific and not just general experiences with the supplier that the respondents considered when answering the questionnaire. measures and scale items measures that support the proposed conceptual model are depicted in figure 1. both the original and replication studies were based on exactly the same items used by svensson, mysen and payan (2010) and others as discussed next. the choice to make use of pre-existing scales was because such scales help to enhance validity (churchill 1979; peter 1979). the items used to measure satisfaction were borrowed from the original work by andaleeb (1996). items used to measure commitment were borrowed from the original work by morgan and hunt (1994) and anderson and weitz (1992), while items used to measure trust were borrowed from the work of zaheer, mcevily and perrone (1998). the items each to measure each of the proposed outcomes of satisfaction, namely, continuity, cooperation and coordination, were developed as follows: (1) continuity – the items for this construct were borrowed from the work of lusch and brown (1996); (2) cooperation – the items for thisconstruct were borrowed from skinner et al. (1992); and (3) coordination – the items for this construct were borrowed from the works of guiltinan et al. (1980) and heide and john (1988). a five-point likert-type scale was used for all items in the original study and the replication study, using ‘strongly agree’ (5) and ‘strongly disagree’ (1) as the end points (refer to table 2). table 2: scale items: original study and replication study. results measurement models the researchers used confirmatory factor analysis (cfa) and structural equation modelling (sem) (jöreskog & sörbom 1976) to test the measurement model and assess the structural relationships. initially, the researchers performed cfas of the measurement model (i.e. 18 indicator variables as in figure 2) based upon six constructs, applying the spss/amos 22.0 software. our testing of the model in the original study and the replication study generated consistent and satisfactory findings through time. the goodness-of-fit measures in the original study and the replication study were all acceptable (hair et al. 2006:745–749), as shown in table 3. figure 2: six-construct structural model. table 3: goodness-of-fit measures of the measurement model in the original and replication studies. results on testing of construct reliability and validity are presented in table 4 for the original study and in table 5 for the replication study. according to the results, the variance extracted from items of all constructs exceeds 50% in both the original study and replication study, which indicates convergent validity through time. the average explained variance is slightly higher in the original study (75.2%) compared with the replication study (68/2%). the composite trait reliability levels of all included constructs are also above 0.7 (hair et al. 2006) in both the original study and the replication study. table 4: squared inter-construct correlations and summary statistics: original study. table 5: squared inter-construct correlations and summary statistics: replication study. furthermore, the researchers compared the variance extracted to the squared inter-construct correlations to examine whether the model measures different constructs (hair et al. 2006). in the original study, the variance extracted for all constructs was equal to or greater than the corresponding squared inter-construct correlations (see table 4), while it was not greater for all constructs in the replication study (see table 5). the reason is that the constructs were more strongly correlated to each other in the replication study than in the original one, which is a limitation. the researchers therefore argue that the tested structural model indicates satisfactory discriminant validity in the original study (see figure 2), while it is less satisfactory in the replication study. the hypothesised relationships of the model were all significant in both the original study and the replication study as expected by theory, which indicates consistent and satisfactory nomological validity through time. our testing of the model in the original study and replication study based upon south african business relationships accomplishes satisfactorily the requirements for convergent and nomological validity, as well as for construct reliability. discriminant validity between constructs is, however, not fully accomplished in the replication study because of stronger relationships between each of them. the researchers therefore conclude that the measurement and structural metrics of the model do not indicate full consistency of validity and reliability between the original study and the replication study. structural models the researchers decided to test the structural model as illustrated in figure 2 because of the satisfactory results from running the cfa of the measurement model in the original study and the replication study based on the south african business relationships. the results of the goodness-of-fit measures of the structural model in the original study and the replication study are illustrated in figure 2 (see table 6). the results are consistent and satisfactory through time. table 6: goodness-of-fit measures of the structural model. furthermore, the structural model’s hypothesised relationships (see figure 2) were all significant in the original study and the replication study, as presented in table 7. accordingly, the results support consistently all six hypotheses of the model tested on south african business relationships in the original study and the replication study. table 7: tests of hypotheses. managerial and theoretical implications diverse contributions were made by this study to the domain of b2b relationship-building. firstly, this study provided insights to guide organisations in an emerging economy on the different relationship marketing variables that should be included when developing relationship-building strategies. different relationship marketing constructs (trust, commitment, satisfaction, cooperation, coordination and continuity) do influence buyer–supplier relational success and eventually the long-term survival of the organisation. it is also not often that the relationship marketing constructs of trust, commitment, satisfaction, coordination, cooperation and continuity are measured in a longitudinal study from an emerging market perspective. secondly, this study established that organisations operating in a b2b environment need to understand that the creation and establishment of long-term supplier–buyer relationships do not occur in a vacuum. the reason is that numerous variables could influence the durability of a relationship between two business partners (chang et al. 2012:940; segarra-moliner et al. 2013:196). high levels of competition that characterise the south african business environment have a direct influence on the survival of organisations. this makes it imperative for business managers to identify and apply strategies aimed at enhancing their competitiveness so as to increase their business success (saini, bick & abdulla 2011:311; theron & terblanche 2010:387). a strategy for business managers to consider is the creation of a positive working relationship with all role players in the value chain, which is supported by all parties in the relationship. this proposition is in line with the strategy recommendations of ndubisi and nataraajan (2016:228–229; perez, whitelock & florin 2013:434) whereby securing high-quality relationship-building practices between parties should be a priority amongst business managers. thirdly, organisational success can be strengthened through the establishment of more intimate working relationships between partners in a b2b environment. securing closer cooperation within the value chain is increasingly understood and supported by business managers in south africa. this argument is supported by crain and abraham (2008), who state that: a value-chain analysis helps a supplier distinguish between the activities of the customer’s firm that directly support its competitive strategies – for its products and for enhancing key capabilities – and ordinary operations. (p. 33) the business managers of corporate south africa, therefore, need to create and develop a relational approach towards business partners that will enhance the value proposition to their respective organisations. this study established that to ensure that positive satisfaction is an outcome in the relationship-building process, greater attention must be paid to securing the establishment and strengthening of trust, and eventually commitment, in the relationship with a business partner. this argument is supported by negi and ketema (2010:114) and jumaev et al. (2012:41), who hold that trust and commitment, as antecedents to customer satisfaction, are linked to and direct predictors of customer loyalty. therefore, business managers must become more aware of the different aspects that influence satisfaction in a b2b relationship-building process. the findings that emanate from this study have indicated, as in the original study, that both trust and commitment, and not the one or the other, are critical elements in securing positive satisfaction. it is therefore important for managers to understand that the foundations of trust are threefold: that there should be fairness when engaged in negotiations with a business partner (i.e. they do not act unscrupulously towards the other to drive its own profit motive); that both parties to the relationship can be perceived as reliable, based on the promises made to each other; and that they can be perceived by each other as trustworthy. furthermore, trust is strengthened when both parties to the relationship are convinced that they cater for the well-being of the other party. this can be ensured by determining exactly what the needs of each party are, having knowledge and understanding of the other party’s expectations and making sure that all efforts are put in place to surpass such expectations. che and salleh (2016:184) concur by stating that trust is a critical element in the relationship-building process, where parties to the relationship have confidence in each other and in the future of the collaborative relationship. chow, cheung and wa (2015:1) also state that where parties to a relationship illustrate a caring interest towards the goodwill of the other party, the chance of withdrawal from the relationship is lowered. commitment also influences satisfaction directly. the primary reason for this is that commitment is illustrated by being pre-emptive in the taking of steps to both initiate and sustain a relationship. in this way, both parties to the relationship will experience higher levels of satisfaction. this argument is supported by farrellya and quester (2005:212) and nyaga et al. (2010:102–103) who state that commitment is an important element of a relationship to secure a positive relationship outcome. business managers, therefore, need to take greater cognisance of the importance of commitment in securing and increasing satisfaction. managers can specifically enhance satisfaction levels by being willing to make adjustments to suit the needs of the business relations; being willing to offer personalised services to meet the needs of the other party and displaying flexibility towards the other in the delivery of services. from the results of this study, it should be noted that satisfaction should be perceived only as a pointer towards prospective cooperation, coordination and continuity. this is a further illustration of the importance of building sound b2b relationships to secure increased business success. brito et al. (2014:953) refer to collaboration as a cooperative approach between business partners to attain mutually agreed goals. to achieve such collaboration there has to be a positive cooperative attitude between the manufacturer and the supplier. it is therefore imperative to note that the nurturing of such a positive cooperative attitude is vital because of the powerful association between attitude and behaviour. therefore, when the parties in a b2b relationship are working together, it illustrates confirmation of coordination. to strengthen cooperation, there has to be a joint agreement between business partners on implementation plans, and processes and/or procedures are coordinated between the manufacturer and the supplier. cheng and tang (2014:379) concur with this finding by stating that increased coordination will enhance the level of understanding between parties, resulting in a stronger, market-oriented relationship. it remains important, however, for business managers to note that coordination is not always an outcome of cooperation. finally, this study established that a positive relationship exists between satisfaction in b2b relations and the relationship continuity. a long-term relationship orientation can be achieved by securing customer satisfaction. therefore, if any of the partners in a b2b relationship (such as a manufacturer–supplier relationship) becomes dissatisfied, it will result in the dissolution of the relationship with no recourse for future continuation. in conclusion, parties to a b2b relationship should develop relational plans that will secure an approach of inclusivity and collaboration. engagement between all parties in a b2b relationship must be the starting point in the establishment and management of the relationship-building process. conclusions, research limitations and future research the study investigated the interrelationship of different relational constructs of a conceptualised b2b relationship. the relationship model reflects the constructs of trust and commitment as positive precursors to the variable satisfaction. in addition, satisfaction is posited as a positive precursor to the variables coordination, cooperation and continuity. the findings of the study illustrate satisfactory fits between the different relational constructs and the proposed b2b model, as well as satisfactory reliability and validity for this purpose. in addition, all the hypotheses formulated for the study and tested through the proposed b2b model were supported by the results. the study applied the use of a convenience sample to select the companies used in the study. the implication of this is that the findings obtained cannot be generalised to other large companies in the country of study or companies operating in different countries globally. another limitation is that the study did not focus on all the different types of b2b relationships; only relationships between large companies and their suppliers in south africa were tested. in addition, it is also important to note that the study explored the applied constructs (trust, commitment, satisfaction, cooperation, coordination and continuity) only from the viewpoint of the buyer. the limitation that results from this is that suppliers and buyers may perceive their level of relational trust, commitment and satisfaction towards each other differently. emanating from the limitations are opportunities for further research. firstly, the study on b2b relationships can be replicated in other emerging or developed economies of the world. secondly, a broader spectrum of supplier and buyer types can be included in the study (e.g. companies of different sizes). thirdly, a further suggestion for research in b2b relationships is to assess contending models that encompass different relationship marketing aspects of satisfaction, trust and commitment, with these aspects reflecting different relational outcomes over a wide contextual range. this type of research could strengthen the research focus in the field of relationship marketing. this could be achieved through a better understanding of how to enhance the positioning of relationship quality constructs to secure improved relational building outcomes. finally, the contribution made by the study is twofold. the theoretical nature of the contribution is that the study provides a robust argument based on the testing of the relational constructs in the theoretical model. this argument can be of benefit to other services where marketing researchers want to test the interrelationship of the different relational variables from an emerging economy perspective, especially considering that this study was conducted amongst the largest south african companies. in both the original study and the replicated study, it is evident that trust and commitment influence levels of satisfaction, which in turn influences coordination, cooperation and continuity. it is furthermore important for the management of a business setting to understand that satisfaction may be the outcome (rather than a precursor) of activities to establish trust and commitment in a supplier–buyer relationship. satisfaction also underwrites three important elements of the relationship management process: coordination, cooperation and continuity. these three elements are therefore perceived as outcomes of a successful relationship. the practical nature of the contribution is through the empirical findings of the study. these findings clearly state that for suppliers to strengthen the satisfaction experience of their buyers (i.e. to make the satisfaction experience more positive), there has to be a greater focus on the establishment of both trust and commitment. both variables, not just the one, are important in ensuring a positive satisfaction experience in a supplier–buyer relationship. the ability of a supplier to reduce marketing costs and secure a viable and stable customer grouping will depend on its ability to have 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https://doi.org/10.1016/j.ijresmar.2013.06.001 zaheer, a., mcevily, b. & perrone, v., 1998, ‘does trust matter? exploring the effects of inter-organizational and interpersonal trust on performance’, organization science 9(2), 141–159. https://doi.org/10.1287/orsc.9.2.141 footnotes 1. authors of previous study. the name of the authors of the original study cannot be provided as they are also involved in the duplication study. abstract introduction literature review hypotheses research methodology results discussion conclusion ethical consideration acknowledgements references about the author(s) robin snelgar department of industrial and organisational psychology, nelson mandela metropolitan university, south africa stacy a. shelton department of industrial and organisational psychology, nelson mandela metropolitan university, south africa anne giesser department of industrial and organisational psychology, nelson mandela metropolitan university, south africa citation snelgar, r., shelton, s.a. & giesser, a., 2017, ‘a comparison of south african and german extrinsic and intrinsic motivation’, south african journal of economic and management sciences 20(1), a1552. https://doi.org/10.4102/sajems.v20i1.1552 original research a comparison of south african and german extrinsic and intrinsic motivation robin snelgar, stacy a. shelton, anne giesser received: 01 mar. 2016; accepted: 22 dec. 2016; published: 26 apr. 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: various researchers have identified a trend of individuals shifting their preference from extrinsic to intrinsic motivation. the authors aimed to research this phenomenon specifically within the context of two different cultures as to date, this had not been done. this research explored the differing levels of extrinsic and intrinsic motivation in germans and south africans. aim: the main objective of this study was to investigate similarities and differences concerning extrinsic and intrinsic motivation in the workplace between german and south african cultures by examining individuals with working experience and tertiary education specifically. in addition, the research investigated differences in the motivation of respondents with regard to demographics such as gender, age and income. setting: the setting took place in south africa and germany. methods: in the study, exploratory factor analysis was utilised to prove validity of cinar, bektas and aslan’s two-dimensional measure of extrinsic and intrinsic motivation. moreover, analysis of variance and t-tests were used to show differences among demographic variables. descriptive statistics such as means, central tendency and cronbach’s alpha were also utilised. results: the results revealed preferences for intrinsic motivational factors for the whole sample with higher levels of intrinsic motivation for the south african respondents compared to german respondents. demographic characteristics played a minor role in determining levels of intrinsic motivation within individuals. culture, however, played the biggest role in determining one’s levels of intrinsic or extrinsic motivation. conclusion: these findings play an important role in explaining differences in motivation between the two countries germany and south africa. it highlights the important role that cultural differences play in shaping one’s form of motivation. introduction to ensure job satisfaction in employees, it is important to know what motivates them to perform optimally. motivation influences performance and for that reason has an impact on the productivity within a company (halepota 2005). on the one hand, in the global economy, geographical borders seem to matter less than in the past, while on the other hand cultural and social differences continue to influence people’s motivation. academic research thus far has focused mainly on the theoretical characteristics of motivation but has not taken into consideration the differences in the cultural and economic environments of various countries (vaitkuviene, balvociute & stoskus 2010). employee motivation depends predominantly on the organisation; however, the impact of both the economic and social conditions in a country on an employee’s motivation need to be considered as well (vaitkuviene, balvociute & stoskus 2010). in the past organisations concentrated on financial factors as incentives for employees. nowadays a shift has taken place, and non-financial rewards such as praise and recognition have become increasingly important, especially in the long term (zani et al. 2011). non-financial motivation is also needed, as the offer of financial incentives alone is likely to fail in attempting to motivate employees (prendergast 2008). nawab, bhatti and shafi (2011) claim that motivation is the most crucial element of an employee’s performance in general and, therefore, cannot be ignored. anyim, chid and badejo (2012) state that it is crucial to understand that employees and companies are interdependent in the sense that employees require the organisation to reward them, both financially and non-financially, and the organisation requires the employees’ services in return to make a profit. furthermore, molander (1996) highlights the important role that employees play in an organisation by saying that an organisation requires individuals who strive towards the achievement of the organisation’s goals and have a strong commitment to the organisation, thus resulting in the organisation operating more efficiently and attaining success. the required level of dedication and commitment can be stimulated through increasing employees’ motivation (mundhra & jacob 2011). a rise in motivation and work commitment leads to an increase in both personal and organisational development as well as increased efficiency in the workplace (ciorbagiu-naon 2010). south africa and germany differ in terms of social norms, culture and standard of living (francesco & gold 2005). therefore, this research aims to investigate sources of motivation in an international context, specifically looking at south africa and germany. this could be useful for international organisations when designing, implementing or revising their reward system. based on the above background, the purpose of this study is to investigate the importance of extrinsic and intrinsic motivation in an international context, using germany and south africa as sample countries. additionally, the research aims to investigate differences between types of motivation respondents possess with regard to demographics such as gender, age and income. literature review robbins and judge (2011) define motivation as the processes which account for an individual’s intensity, direction and persistence towards reaching a particular goal. before the development of human resource management roles, personnel were regarded merely as an input in manufacturing goods and providing services and as an asset rather than an investment, whereas nowadays the motivation of employees is considered an integral part of organisations’ optimal functioning (perkins & white 2009). the change in thought was as a result of the hawthorne studies, which examined productivity and working conditions (robbins & judge 2011). the results of this study revealed that the positive working relationships and interactions affected productivity more so than the working environment did (khan, riaz & rashid 2011). thus, this suggested that management could effectively influence employees’ motivation through interactions and rewards rather than through the adjustment of the working environment. the earliest research on motivation concentrated on two main types of explanations for behaviour: natural desires or ambitions linked to existence and reproduction (e.g. hunger, thirst and sex) and extrinsic rewards or penalties. both approaches propose that behaviour is driven by the necessity for aspiration to accomplish specific results (e.g. a reward, or escaping punishment). motivation accordingly invigorates and channels behaviour to achieve a specific goal (sansone & harackiewicz 2000). the early theories of motivation built the foundation for research in motivation. they are maslow’s hierarchy of needs, theory x and y, the twofactor theory by herzberg and mcclelland’s theory of needs (robbins & judge 2011). the earlier theories are classified as content theories, which pinpoint causes or needs connected with motivation. these theories limit the description of motivation to a specific number of factors and only explain how to motivate people under these circumstances (francesco & gold 2005). despite current research, which has produced new insights into motivation, the early theories are still used in practice by many managers and so form an important base (udechukwu 2009). process theories, such as reinforcement theory, goal setting theory, expectancy theory and equity theory, pay more attention to the activity than to the content (francesco & gold 2005). process theories help one to understand how behaviour is started, guided, sustained and stopped (jalilvand & ebrahimabadi 2011). the approach of self-determination theory is important for researching motivational theories; even if it sometimes differs from existing motivational strategies. there are two main categories of motivation which are focused on in this study, namely extrinsic and intrinsic motivation. extrinsic motivation extrinsic motivation describes the effect of external factors on an employee’s motivation level (qayyum & sukirno 2012). it is motivation which originates from outside a person and motivation in this context can be considered extrinsic rewards, for example, financial incentives and status. these rewards should compensate for the lack of fulfilment and enjoyment regarding the actual task (thomas 2009). when extrinsic motivation is used incorrectly, this may result in employees shifting their focus towards only achieving financial gain. this may, therefore, divert their attention away from developing his or herself to being mainly focused on completing a task purely for financial gain (zobal 1999). furthermore, this author states that financial rewards may lead to negative effects on employees when goals are not achieved, such as a lack of confidence or being demotivated. zobal (1999) states that financial rewards may strip employees of the pride associated with their work. salary, benefits and incentives are examples of extrinsic motivators (qayyum & sukirno 2012). researchers disagree about the role of money as a motivator (khalid, salim & loke 2011). although financial rewards can have a number of negative impacts, organisations still look for some monetary opportunities to motivate their employees (prendergast 2008). taylor (2007) claims that money is the best motivator. however, anyim et al. (2012) point out that motivation depends on various factors and is fairly complex. for example, the economic conditions of a country affect the significance of money to its people. these same authors maintain that although cash is an important stimulus for low-income groups, it does not have the same importance for high-earning individuals, who have already satisfied their basic needs. in contrast, darling, arm and gatlin (1997) claim that nowadays researchers and practitioners are aware of several drawbacks of monetary rewards, as monetary driven motivation is often short-lived. according to mundhra and jacob (2011), extrinsic motivation is built on external factors and is only temporary. extrinsically motivated behaviours are linked to basic ambitions, which normally work in the form of a cycle that disturbs intrinsically motivated behaviour (deci & ryan 1985). for this reason, money is usually only the means to an end, and which has negative consequences. referring to 128 experiments ryan and deci (2000) claim that tangible rewards seem to have a considerably undesirable influence on intrinsic motivation. pink (2009) claims that autonomy, mastery and purpose are three elements which enable a workforce to be motivated, more so than extrinsic monetary rewards. intrinsic motivation intrinsically motivated undertakings are the ones for which the action itself is the reward. individuals appear to participate in the activities because of the enjoyment derived from the task and not because of the expectation of receiving an extrinsic reward (deci 1975; ryan & deci 2000; deci & ryan 2008). the task itself or the related target satisfies a direct need in its own right. intrinsic motivation reveals an individual’s core aspiration for meeting internal needs, and it originates from emotions (qayyum & sukirno 2012). frey and osterloh (2002) claim that intrinsic motivation is highly important for every action in the business world. intrinsic motivation is considered to be the main influential dynamic behind the creative process in business (hennessey 2000). it is unimaginable that employees are only or even mostly motivated by extrinsic rewards and it is for this reason that intrinsic rewards are so essential (pink 2011). if intrinsic motivation develops as a consequence of self-determination and a feeling of ability combined, then a reward can motivate individuals to manage tasks which are original and observed as extremely difficult at the outset. as the individual’s knowledge increases over a period of time, new intrinsic motivation is encouraged (frey & osterloh 2002). osterloh and frost (2002) claim that the management of intrinsic motivation has been neglected. present management systems have also failed to address this matter. instead these management systems have concentrated on extrinsic financial remuneration systems (osterloh & frost 2002). relationship between extrinsic and intrinsic motivations the fulfilment employees develop from the intrinsic features of their work, such as responsibility and task attraction, is imperative for intrinsic motivation and retention in the organisation more so than extrinsic rewards (for instance, monetary benefits) (burke, arkowitz & dunn 2002). according to arnolds et al. (2010), it is still uncertain which intrinsic and extrinsic factors in particular motivate employees. occasionally a verbal ‘thank you’ is sufficient, whereas with some individuals this may not be the case. the difficulty in rewards is that unrewarded accomplishments on the jobs can be de-motivating to employees (ciorbagiu-naon 2010). previously it was assumed that extrinsic and intrinsic motivation acted independently of each other. however, various socio-psychological researchers have revealed that an interchange between intrinsic and extrinsic motivation can be found. for example, children, who are enthusiastic about their schoolwork in the beginning, show less interest in the activity itself after being offered a reward (frey & osterloh 2002). ryan and deci (2000) provided evidence that individuals in general, and not necessarily only school children, show less interest in something which was previously only intrinsically rewarding as soon as an extrinsic reward is introduced. motivation in the context of demographics variables such as gender, age, literacy, work experience, relationship status and the number of children can influence the perception and preference of employees regarding certain rewards (ciorbagiu-naon 2010). the section that follows discusses the differences according to gender, age, income and culture with regard to intrinsic motivation. gender and motivation research regarding the relationship between gender and motivation is contradictory. while worthley, macnab, brislin, ito and rose (2009) found that gender has an influence on motivation, stettes and zimmermann (2013) state that gender has a minimal influence on motivation as women are only slightly more motivated than men. age and motivation each generation has its own values and is influenced by different external conditions. for this reason, they are motivated by different rewards (smith 2010). thus, motivation and reward strategies should be modified and orientated towards these groups of the workforce (grobler, wärnich, carell, elbert & hatfield 2011). truxillo (2009) and inceoglu, bartram and segers (2012) showed that mature individuals (i.e. individuals 50–59 and 60+) were more motivated by intrinsically rewarding work attributes than by extrinsically rewarding ones. however, snelgar, renard and venter (2013) report that in their study investigating reward preferences, older employees showed a stronger preference for base and variable pay when compared to their younger counterparts. income and motivation the results of the research conducted by del mar, salinas-jimenez, arte and salinas-jimenez (2010) reveal that the higher the life satisfaction of an individual, the more likely the individual will be to switch from extrinsic to intrinsic motivation. these authors revealed that this occurred irrespective of income. nowadays two entirely contradictory opinions of the motivational influence of pay exist. the first approach states that a rise in pay has an encouraging effect on the worker, who then willingly puts more effort into his work. the second approach claims that a rise in pay essentially undermines motivation and could lead to a decrease in performance (deci 1975). del mar et al. (2010) note that it is generally the higher level income groups which experience the most intrinsic motivation. renard’s (2015) study on a sample of 587 employees within the non-profit sectors in south africa, usa, australia and belgium revealed the same result that higher income groups experience higher levels of intrinsic motivation. this may be because of the fact that their external, physical needs have already been fulfilled as they are earning more extrinsic rewards (i.e. more money and better benefits). culture and motivation culture can be described as the personality of a region and incorporates objective (e.g. cuisine, art and dressing) as well as the subjective (e.g. attitudes, beliefs and values) criteria (worthley et al. 2009). factors influencing motivation differ between countries and cultures (francesco & gold 2005). according to hofstede’s cultural framework (hofstede 2001), germany and south africa do not seem to have many differences. francesco and gold (2005) state that germany has a smaller power distance than what south africa does, and has a higher level of uncertainty avoidance. hofstede (2001) defines power distance as the extent to which less powerful individuals within an organisation existing within a particular culture accept and expect an unequal distribution of power, whereas uncertainty avoidance is defined as the degree to which members of a culture feel comfortable in unstructured situations. germany and south africa seem to be similarly individualistic and demonstrate a similar level of masculinity in their cultures, however. hofstede (2001) describes masculine cultures as cultures which emphasise achievement and accomplishment in technical performance, whereas more feminine cultures place greater emphasis on interpersonal relationships and communication. the most important difference between south africa and germany, however, is that standards of living are different (francesco & gold 2005). these differences might have influences on motivational factors. to date there is no study which compares the difference in motivation between south africa and germany. however, a recent study which took place in germany specifically on public sector employees revealed that these german workers were highly intrinsically motivated (kaiser 2014). in addition, research by schmuck, kasser and ryan (1999) portrays germans as being more motivated by intrinsic goals, especially those which improve well-being. generally they are less extrinsically motivated than other cultures (e.g. the usa). pay is not the most important thing for german employees. an important need for german employees is the opportunity to influence, to be able to put forward their own ideas, to be involved in decision-making and to help shape guidelines and targets agreements (stettes & zimmermann 2013). thus, this suggests that german employees place more importance on intrinsic rewards and are intrinsically motivated. south african research, on the other hand, shows that adequate pay was the most important issue for south african employees. this was closely followed by the desire for development opportunities, equality and recognition (van rooyen, du toit, botha & rothmann 2010). however, nujjoo and meyer (2012) have found that in south africa the positive influence of non-monetary and particularly intrinsic rewards can lead to highly skilled individuals becoming more committed and intrinsically motivated. renard’s (2015) study revealed too that south african employees in general exhibit higher levels of intrinsic motivation than other countries (this study investigated differences in intrinsic motivation between south africa, usa, belgium and australia). hypotheses from the above literature review, the following research questions were generated: what are the differences between the german and south african cultures in the context of extrinsic and intrinsic motivation in the workplace? what correlations exist between motivation and various demographical data? thus, the hypotheses which result from the literature and are relevant to this research are listed below: h1: a difference in extrinsic and intrinsic reward motivation exists between south african and german cultures. h2: the correlation between culture and motivation is stronger than the correlation between gender and motivation. h3: the correlation between age and motivation is stronger than the correlation between culture and motivation. h4: the higher the income, the greater the preference for intrinsic motivation. research methodology this research is non-experimental, descriptive and quantitative in nature. data collection occurred during may and july 2013. pilot study the researcher conducted a pilot study to ascertain language problems with the questionnaire or scales, and to conduct a trial of some of the analysis procedures to be undertaken in the main study. the pilot study included 20 working individuals and was conducted in april 2013. the pilot study produced satisfactory cronbach’s alpha results (0.83–0.84). however, in the pilot study the results of the exploratory factor analysis were not satisfactory enough. the statistics specialist pointed out that there might be different factors for the two different countries, but unfortunately the sample size did not permit an exploratory factor analysis per country (d. venter [statistician, unit for statistical consultation, nelson mandela metropolitan university] pers. comm., 16 august 2013). for this reason, the researcher and the statistical expert agreed to proceed with the research instrument and to work with the results of the main study. research method and respondents non-probability sampling was used in the form of convenience and snowball sampling. the researcher made use of existing contacts and distributed the questionnaire by means of email. the following control measures had to be put in place for the target population. the respondents had to be either german or south african. these two countries were selected so as to have one european country represented and one african country. it allowed for a comparison between developed and non-developed countries. this was verified by a mandatory question in the demographic section. the respondents were also required to have work experience and a tertiary education. additionally, the respondents were asked questions pertaining to their gender, age, marital status, managerial position at work and annual income. a total of 256 people were contacted via email and asked to participate in this study, as well as to forward the questionnaire to colleagues who fit the relevant criteria. in total, 374 individuals fully completed the online questionnaire, including 193 germans and 181 south african respondents. this sample size was deemed adequate for this research by the researchers’ statistician. table 1 shows the characteristics of the sample with regards to nationality, gender, age, marital status, and annual income. as can be gleaned from the table, 52% of respondents were german and the remaining 48% are south african. as evident from table 1, the majority of the sample was male (52%), and female respondents made up the remaining 48%. table 1: sample characteristics (n = 374). age was split into five categories: 20–29, 30–39, 40–49, 50–59 and 60+. from table 1, it can be seen that the majority of the sample was made of respondents between the ages of 30 and 39 (38%), followed by respondents between the ages of 40 and 49 (21%) and 20 and 29 (20%). table 1 shows that the vast majority of the sample is married (57%), followed by those in a relationship (26%). finally, table 1 shows the characteristics of the sample according to annual income. however, as the sample incudes respondents from germany and south africa, and these two countries have different currencies and the euro is a stronger currency than the rand; respondents had to be grouped into similar annual income groups for ease of comparison. table 2 provides the breakdown of the income groups. as is evident from table 1, the majority of the respondents in this sample fall into income group 6 (above r600 000 or above €60 000 annually), followed closely by income group 2 (r120 000–r239 000 or €12 000–€23 999 annually). table 2: overview of income groups. finally, the table shows that 48% of the sample is not in a managerial position, with 42% in a managerial position and 10% in a supervisory role more than a managerial position. measuring instrument the questionnaire was designed by cinar, bektas and aslan (2011) as a two-dimensional measure of extrinsic and intrinsic motivation. questions 1–9 dealt with intrinsic motivation and questions 10–24 with extrinsic motivation. the researcher obtained permission from the developer regarding the questionnaire to use it and adapted it accordingly. as the questionnaire would be answered by both english and german speakers, the researcher felt it was necessary to adapt the level of english to accommodate both countries. the specific rating scale that was used in the questionnaire was the likert scale, which forces the respondents to reveal their degree of agreement or disagreement with each of a number of statements about the stimulus object (malhotra 2010). a five-item scale was decided upon, which had five response categories ranging from ‘not at all motivating’ to ‘highly motivating’. the questionnaire is divided into two sections consisting first of questions about intrinsic motivation, followed by extrinsic motivation. these sections were followed by the demographic questions. research procedure once the questionnaire had been selected, the researcher chose to use an electronic survey method, as this was the easiest and most convenient method for reaching the wide spread target group. data analysis both inferential (analysis of variance, t-tests) and descriptive statistics (measures of central tendency, mean scores, and cronbach’s alpha) were used for data processing. the statistical package statistica, version 11.0, and spss 9.0 were utilised for this purpose. results descriptive statistics and cronbach’s alpha coefficients table 3 shows the descriptive statistics for the sample. the means, standard deviation, minimum and maximum are all included for intrinsic factors, extrinsic factors and overall. as is evident from this, the levels of intrinsic motivation were the highest (mean of 4.17 out of 5), with extrinsic motivation being rated as moderately high. table 3: descriptive statistics for sample (n = 374). table 3 also provides the cronbach’s alpha coefficients for the study. these scores show an acceptable level of reliability as they are above the 0.60 level (maholtra 2010). table 4 shows the intervals for the means so that one may interpret how strong the motivation is for that particular type of motivation. table 4: intervals for motivation. validity the validity of a scale can be defined as the determination of whether the scale measures what it is intended to measure (phillips & gully 2012). in order to show that the questionnaire demonstrated acceptable validity, the researcher conducted an exploratory factor analysis. the results of this are presented in table 5 the table shows that the questionnaire comprised of five factors as five of the factors are above the 1.0 level cut-off (maholtra 2010). table 5: exploratory factor analysis results. once established that there were five factors, the researchers established which questions loaded onto which factors. a factor loading of 0.30 is considered as significant for a sample size higher and larger than 350 (hair, black, babin & anderson 2010). table 6 shows which items loaded onto which factor, by highlighting the questions above the 0.30 level for that factor. based on table 6, the questions have been grouped into factors as shown in table 7. table 6: factor loadings. table 7: summary of factors and related questions. it is important to note that questions 6, 7 and 11 do not load onto any factor. questions 14, 18 and 21 load into more than one factor, with question 14 loading onto factors 1 and 2, question 18 loading onto factors 1 and 3, and question 21 loading onto both factors 3 and 5. however, for question 14, factor 2 had a higher loading, for question 18, factor 3 had a higher loading, and for question 21, factor 3 had a higher loading. this then determined the factor loading for these questions. moreover, it is important to note that the questions which pertained to pure intrinsic rewards related to factors such as autonomy, and mastery which renard (2015) previously identified as ‘pure intrinsic rewards’ in that they link entirely to the job itself and not to any other external sources. hypotheses hypotheses this section will discuss the set hypotheses and present the tables which show whether they may be accepted or rejected. hypothesis 1 table 8 reveals that overall the sample demonstrates moderately high levels for intrinsic motivation and moderately high levels for extrinsic motivation. these differences are statistically significant (p <0.05). table 8: t-test results across the sample (n = 374). table 9 provides evidence that german respondents are intrinsically motivated at a moderately high level and extrinsically motivated at a moderately high level as well. however, they are slightly more intrinsically motivated than extrinsically motivated. table 9: t-test results for germany (n = 194). table 10 shows that south african respondents are highly intrinsically motivated and moderately highly extrinsically motivated. based on this, it is evident that the south african respondents are more intrinsically and extrinsically motivated than their german counterparts. table 10: t-test results for south africa (n = 180). hypothesis 1 stated that a difference in motivation exists between the south african and german cultures. as is evident from the tables above, all the p-values are below 0.01, which indicates significant differences between south africa and germany in terms of motivation. based on the means provided in the table, it is clear that south africans are more motivated by intrinsic and extrinsic motivation than what germans are. therefore, h1 can be accepted. hypothesis 2 hypothesis 2 stated that the correlation between culture and motivation is stronger than the correlation between gender and motivation. table 11 shows the differences between the two countries in terms of motivation as characterised by gender. one can glean from the table that german females were more motivated by intrinsic and extrinsic factors than what german males were. south african females were also more motivated by intrinsic and extrinsic factors than south african males. overall, females in the sample were more motivated by intrinsic and extrinsic factors than the males were. however, in all instances the difference was not large enough to be significant (p > 0.05). consequently, cultural differences are more significant than gender difference as table 8 previously provided evidence which showed that there was a significant difference between cultures with regard to motivation, both intrinsic and extrinsic. thus, h2 can be accepted. table 11: t-test results according to age. hypothesis 3 hypothesis 3 stated that the correlation between age and motivation is stronger than the correlation between culture and motivation. table 12 shows the mean scores according to age, whereas table 13 shows the anova results according to age for intrinsic and extrinsic motivation. table 12: mean scores according to age. table 13: anova results according to age. as is evident from the table, the group with the highest mean score for intrinsic motivation is the age group 50–59 years, and the group with the highest mean score for extrinsic motivation, interestingly, is also the same age group. this, therefore, suggests that this age group has the highest levels of intrinsic and extrinsic motivation. table 13 shows that there is a statistically significant difference according to age with regard to intrinsic motivation only. there is no statistically significant difference according to age with regard to extrinsic motivation across the sample (p > 0.05). referring to table 8, this shows differences according to culture. from this it is clear that both intrinsic and extrinsic motivations had statistically significant differences for both countries, whereas there is only a statistically significant difference according to age with regard to extrinsic motivation. thus, h3 is partly accepted. hypothesis 4 hypothesis 4 stated that the higher the income, the greater the preference for intrinsic motivation. in table 14 the means of the different income groups for intrinsic and extrinsic motivation are presented. from the table it is evident that interestingly, the lowest income group had the highest mean score for intrinsic motivation and also the highest mean score for extrinsic motivation. table 14: income statistics for the sample (n = 374). table 15 shows the marked differences according to the various income groups. the p-value for intrinsic motivation is above 0.05 and therefore is not statistically significant but the p-value for extrinsic motivation is below 0.01 and therefore is statically significant. this shows that a preference for intrinsic motivation does not increase as income increases; instead it is extrinsic motivation that increases. it is the lowest income group which shows the highest level of extrinsic motivation. therefore, h4 can be rejected. table 15: anova results according to income group. discussion differences in motivation between south africa and germany the main finding of this study showed that significant differences did exist in terms of motivation between south africa and germany. this was found in the case of both intrinsic and extrinsic motivations. in fact, cultural factors were shown to be the strongest influence on employees’ motivation. the differences in terms of power distance and uncertainty avoidance, and differences in terms of masculinity/femininity between south africa and germany may account for this. as previously mentioned, culture is defined within the context of this study as the personality of a region and incorporates objectives and the criteria of a particular group of people (worthley et al. 2009). furthermore, the study has revealed that south africans show higher levels of intrinsic motivation than their german counterparts. the results show that south africans demonstrate higher levels of intrinsic motivation than they do extrinsic motivation. this supports the findings of nujjoo and meyer (2012). with regard to german respondents it was found that they too showed higher levels of intrinsic motivation than they did extrinsic motivation. this aligns with the findings of stettes and zimmermann (2013). impact of gender on motivation the results of the study showed that in both countries females were more intrinsically motivated than what males were. this aligns with what was suggested by stettes and zimmermann (2013). the researchers believe that females may be slightly more intrinsically motivated than their male counterparts because of women often being tuned into their emotions and thus more able to be rewarded by them. the results show that south african females have not only the highest levels of intrinsic motivation but also the highest levels of extrinsic motivation. it is, however, interesting to note that these differences were not found to be statistically significant, which, therefore, suggests that motivation is influenced more so by culture than it is by gender as culture was found to be a statistically significant difference. impact of age on motivation the results show that intrinsic motivation at its highest within individuals of the ages 50–59. while this was a statistically significant difference, there were no statistically significant differences between age groups in terms of their extrinsic motivation. the works of truxillo (2009) and inceoglu et al. (2012) align with the findings of this study in that these authors also found that older employees (50–59) were more intrinsically motivated than their younger counterparts. the researchers suggest that this may be because of the fact that older employees are entering the final stage of their career leading up to their retirement and are often no longer interested in working long hours to earn more money and feel less of a desire to climb the corporate ladder. owing to this, older employees may be likely to be more motivated by intrinsic factors rather than extrinsic ones. impact of income level on motivation in this study it was found that, contrary to what was suggested by del mar et al. (2010) and renard (2015), the lowest income group actually demonstrated the highest levels of both intrinsic and extrinsic motivation. this, therefore, suggests that when designing these employees packages, consideration should be given to increasing both the intrinsic and extrinsic forms of reward as this group is demonstrated by both intrinsic and extrinsic sources. implications for future research in this section, recommendations for further research are provided. an area for potential research could be the effects that extrinsic and intrinsic motivation have in organisations. this could explore the effects of intrinsic and extrinsic motivation on productivity, company success or even retention and engagement. in particular, intrinsic motivation does not happen in a vacuum. in this study, it was not possible to compare motivation in different stages of a process or determine if motivation changes over time. a possible research question could be to ask how an organisation can increase and maintain motivation over time. in order to achieve this, a questionnaire could be sent to the same respondents over a period of time or several times. furthermore, motivation in relation to demographic variables should be researched in detail. in particular, the role of the management as a demographic variable could be looked into in more detail as management occupies a key role when it comes to motivation. limitations of the study the researchers only limited the target group by a few characteristics, namely, working experience, nationality and tertiary education, for the participation of this research. the reason for this decision was to achieve a reasonable sample size. further research could be undertaken with an increased number of limiting characteristics such as industrial field, managerial position or age group to make more specific assertions and inferences. in addition, this research was limited to two countries. other countries could be taken into consideration to receive further insights. furthermore, although the online questionnaire had the advantage of being easy to access by the respondents and the data could be processed easily, the researchers had little control over composition of the sample or the industry to which the respondents belonged. it was not possible to calculate an accurate response rate because it was difficult to determine how many questionnaires were distributed. although the respondents were provided with written instructions and the offer to contact the researcher in case of questions, misunderstandings may also have taken place. implications for management this study has highlighted the importance of intrinsic motivation within employees and additionally has highlighted the essential role that culture plays in shaping one’s motivation. as a result of these findings, management should have a well-formed and clear understanding of the culture within which their employees exist so that they are easily able to find manners of motivating their employees in accordance with this. in order to fully develop intrinsic motivation, management could introduce four things into employees’ work: meaningfulness, a sense of choice, a sense of competence and a feeling of progress or mastery, according to thomas (2009). meaningfulness involves showing employees that the work they are performing is valuable and is contributing to a larger overall purpose. increasing employees’ sense of choice occurs when employees are given autonomy and freedom to schedule their own work tasks, whereas increasing employees’ sense of competence involves adequately developing employees’ skills so that they may feel proud, satisfied and motivated when they are able to perform their work well. finally, thomas (2009) states that a feeling of progress is introduced into employees’ work by allowing them to see what they have accomplished and by providing feedback when tasks are performed well so that the employee may feel that he or she is mastering a particular skill. conclusion this study focused on the differences between south africa and germany with regard to intrinsic and extrinsic motivation. it was chosen as there were no studies, to date, which focused on these countries and their intrinsic and extrinsic motivation levels. the findings of this study are, therefore, of importance as they attempt to address an empirical gap and they also provide insights into the role that culture plays in determining intrinsic and extrinsic motivation levels, as compared to other demographic variables such as gender, age or income. as some of the findings were inconclusive, more research is required to fully explore this topic. ethical consideration prior to the study being conducted, the researchers obtained the relevant permission to use the motivation instrument. this was done by contacting the author of the instrument in order to obtain a copy of the research instrument. furthermore, participation in the research was completely voluntary and the respondents’ anonymity was ensured. acknowledgements the authors would like to acknowledge the valuable contribution of the respondents in this study, without which this study would not have been possible. competing interests the authors have no competing interests which may have influenced the findings of this article. authors’ contributions a.g. completed the data collection, data analysis and literature review of this study during her masters, under the supervision of r.j.s., s.a.s. compiled an article from the findings and literature, and edited the work. r.j.s. was involved in the editing of this article and the overseeing of this process. references anyim, c.f., chid, o.c. & badejo, a.e., 2012, ‘motivation and employees’ performance in the public and private sector’, international journal of business administration 3, 31–40, https://doi.org/10.5430/ijba.v3n1p31 arnolds, c., boshoff, c., mazibuko, n. & klemz, b., 2010, ‘the motivational impact of job 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africa leward jeke department of economics, nelson mandela university, south africa citation mhaka, s. & jeke, l., 2018, ‘an evaluation of the trade relationships between south africa and china: an empirical review 1995–2014’, south african journal of economic and management sciences 21(1), a2106. https://doi.org/10.4102/sajems.v21i1.2106 original research an evaluation of the trade relationships between south africa and china: an empirical review 1995–2014 simbarashe mhaka, leward jeke received: 18 sept. 2017; accepted: 30 may 2018; published: 22 oct. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: south africa’s (sa) largest trading partner is china. the bilateral trade flows between these two economies have been increasing since the end of the global financial crisis. there are several factors that determine the trade flows between these two economies. aim: the research studies the impact of the real exchange rate, market size and economic size on the trade flows between sa and china, applying the gravity model of trade. time series data for the period of 1995–2014 have been used and a multiple linear regression model was employed in the evaluation process. methods: to determine the impact of the three underlying variables on the bilateral trade flows of sa and china, the ordinary least squares method was used. the explanatory variables consist of the product of sa’s gross domestic product (gdp) and china’s gdp, which act as the proxy for economic size, the product of south africa’s population and china’s population, which act as the proxy for market size, and the real exchange rate between sa and china. results: results revealed that the economic size and the market size have a strong positive impact on trade flows between sa and china and this is consistent with economic theory. on the other hand the real exchange rate has a negative impact on trade flows between sa and china. conclusion: if two countries each have a large economic and population size trade, this results in high trade flows between the countries as compared to trading with smaller economies. trade volume is also reduced if the countries trading have a highly volatile exchange rate. based on the findings of the research, the article recommends that the department of trade and industry should target trade with countries of big economic and market size. the research also shows that the absolute and comparative advantages are not the only basis of trade but other factors should be considered, such as exchange rate, economic size and market size. the central bank should maintain a stable exchange rate between the sa rand and partner countries’ currencies before trading. this enhances trade and leads to strong economic growth. introduction most countries are linked with each other through trade and financial agreements. some african countries are becoming successful because of the strong economic links they hold with other countries in the world. according to the organisation for economic co-operation and development (oecd 2017), south sudan, chad and angola make the biggest contribution of most traded export in total exports. morocco, south africa (sa) and tunisia have the largest number of products constituting 75% or more of total african exports (oecd 2017). this makes these countries very competitive in external markets. exports expansion, imports substitution and international capital movements have all been important in the development of the sa economy (mohr & fourie 2008:369). international trade is a major driver of economic growth in all countries. the growth in transport and communication networks has promoted trade in africa. south africa has expanded its trading routes and is trading with countries in the north american free trade agreement (nafta), united states (us), germany, india, china, brazil and countries within the southern african development community. recently, sa has signed the economic partnership agreement (eu sadc) which is going to replace the trade, development and cooperation agreement. south africa’s trade of goods and services has been increasing since 1992 (department of trade and industry [dti] 2010). this is illustrated in figure 1. figure 1: south african trade volumes in goods measured in current united states dollars. net trade is the difference between exports and imports. figure 1 shows net trade conducted in sa from 2005 to 2014. in figure 1, the net trade in goods in 2005 was very low, with a negative balance. there was a slight increase in net trade from 2006 to 2008, although the net balance remained negative. a sharp increase in trade was recorded from 2009 to 2011. in those years, the net trade became positive; that means that sa recorded a trade sur-plus. the decline in net trade began in 2008 as a result of the global financial crisis. since then, sa has been facing a trade deficit: it needs to finance from its savings or from borrowings to stabilise the economy. dornbursh, fischer and startz (1998:265) argue that national economies are becoming more closely interrelated and the notion of globalisation is increasingly accepted. globalisation occurs when economies are moving towards a global economy (dornbursh et al. 1998:265). bhagwati (2010) defines economic globalisation as the integration of national economies into the international economy through trade in goods and services. expansion in trade shows evidence of this process of globalisation. east asian countries like china, japan and taiwan have always been sa’s largest trading partners (tips 2011). according to tips (2011), in 1990, 17% of the south african imports were from east asian countries and in 2009, 21% of south africa’s imports were from east asian countries. south africa exports to east asia amounted to 13% of total exports in 1990 but by 2009 it was about 21% of total exports. it is very interesting to study the trade between sa and china. china is sa’s largest trading partner. china’s economic performance is higher than that of all other economies. china is regarded as both the top exporter and top importer for sa (dti 2010). this research will apply the gravity model to investigate the bilateral trade between sa and china and will highlight the impact of economic size, market size and exchange rate on the trade flows. the gravity model has been used intensively in literature to investigate factors influencing the level of trade between vietnam and 23 european countries (ec23) in the oecd and to evaluate whether there are potentials for growth in trade between vietnam and those countries (thai 2006). the results by thai (2006) indicated that the bilateral trade flows between vietnam and ec23 are driven by economic size, market size and exchange rate volatility, but distance and history seem to have no effect on the bilateral trade between vietnam and ec23 (thai 2006). hilbun (2003) used the gravity model framework to analyse trade in the western hemisphere. according to hilbun, of the five regional trade agreements analysed (nafta, andean community, mercosur, latin american integration association, and central american common market), none were significant in its explanation of significant increases in agricultural bilateral trade flows. weckstrom (2013) used the gravity model of trade to test russia’s exports to its main trading partners. the results have shown that the distance between russia and its trading partners does not really affect the russia exports; the population of the export market seems to be a bad variable to explain russian exports (weckstrom 2013). there is a strong correlation between russian population and russian exports but there is still no reason to believe that a decline in russian population would cause an increase in russian exports (weckstrom 2013). an overview of south africa and china trading south africa’s bilateral trade with china increased from r205 billion in 2012 to r270 bn 2014, which is a 32% increase, but the composition of the trade was a matter of concern as sa’s exports comprised mainly raw materials (ensor 2014). according to ensor (2014), china became sa’s single largest trading partner in 2009, but the trade balance has been in favour of china. south africa and china have been working together according to various trade agreements, and these to some extent have led to increased trade between these two countries. china is the top importer from and top exporter to sa (dti 2010). in short, china has been considered sa’s fastest growing trading partner (dti 2010). the question is: what is determining the trade between sa and china? south africa, a leading economy on the african continent, and china, the largest developing country in the world, have forged a unique partnership and are operating at bilateral, continental and multilateral levels; their governments are actively striving to realise the comprehensive strategic partnership envisaged in 2010 (alden & yushan 2014). with the pace of trade and investment picking up, coupled with closer international cooperation with beijing through the g20 and the brazil, russia, india, china, south africa (brics) grouping, sa–china ties are assuming a significant position in continental and even global affairs (alden & yushan 2014). there is clear evidence that there is a strong relationship between sa and china. the existence of a chinatown in most parts of south africa confirms this evidence. it all started when the south african mining companies organised a formal labour recruitment scheme in what was to become the union of south africa, which brought several thousand chinese workers to the country (alden & yushan 2014). some of these individuals formed the chinese community in sa, and set up a chinatown in central johannesburg (alden & yushan 2014). south africa exports to china the sa exports to china comprise mainly raw materials. about 90% of sa’s top 10 exports to china are raw materials. hence the dti is promoting the export of value-added manufactured products to china, mainly by means of trade exhibitions (ensor 2014). alden and yushan (2014) show that sa has an abundance of mineral resources. china is importing mostly natural resources as inputs for their manufacturing industries; the output from these industries is sold back to sa (workman 2015). according to workman (2015) sa’s exports to china amounted to $8.7 billion or 9.6% of its overall exports in 2014. the top 10 of sa exports to china made in 2014 are shown in table 1. table 1: south africa top 10 exports to china. sa–china relations are strengthened by the comparative advantage between these countries, which forms a basis for trade. south africa has a comparative advantage in various primary sector commodities (metal ores, gold and coal). in many years, sa’s exports performance to china has been fluctuating but remained positive except during 2008–2010 as shown by figure 2, which shows the annual percentage growth of sa exports to china. the graph uses export data from the years 1995 to 2013 obtained from the world bank (2017). figure 2: percentage growth of south africa exports to china. south africa’s export growth to china has been positive in all years from 1995 to 2013 but it was negative during the years 2008–2010. during this period the economy was affected by the global financial crisis and hence the balance of trade worsened into a deficit. the financial crisis affected many economies including the sa economy. the economy performance started diminishing, price inflation was growing and there was high unemployment adding to the crisis. south africa imports from china about 100% of the top south african imports from china are manufactured products (workman 2015). it is now clear that china sources some of its materials for manufacturing in africa, converts and sells these products all over the world (workman 2015). according to workman (2015), china’s exports to south africa amounted to $15.4 billion or 15.5% of its overall imports in the year 2014. the top 10 sa imports from china made in this year are tabulated in table 2. table 2: top 10 south africa imports from china. the comparative advantage theory is very useful in explaining sa and china trade. china seems to have a comparative advantage in various secondary sector commodities (textiles and certain foodstuffs, for example). due to specialisation china will export these commodities to sa. they will accumulate as imports to the sa side. figure 3 shows sa import growth expressed as an annual percentage for the years 1995–2013. figure 3: percentage growth of south africa imports from china. sa import growth has been positive most years 1995 to 2013, falling to negative only in 1999 and 2009. the 2008–2009 financial crisis also dampened the growth of sa’s imports from china. this shows that the crisis reduced trade overall. in all years import growth has been above export growth in sa. this resulted in a negative trade balance between sa and china. south africa–china relations the growth of bilateral, multilateral and south-south relations has tightened the relationship between sa and china. these relationships influence trade. following diplomatic recognition of the people’s republic of china (prc) in 1998, south africa and china have exchanged a number of high-level visits that resulted in a range of agreements covering various issues including economic cooperation (grimm et al. 2014). according to the pmg (2010, in grimm et al. 2014), south africa had a one china policy in december 1997 and the diplomatic relations were established in january 1998. the pretoria declaration on partnership was issued in april 2000, a bi-national commission was established in 2001, a strategic partnership was declared in 2004 and a programme for a deepening strategic partnership was established in june 2006 (pmg 2010, in grimm et al. 2014). a comprehensive strategic partnership was agreed upon in principle during 2010 and a state visit by president jacob zuma to china in august 2010 was proposed (pmg 2010, in grimm et al. 2014). in terms of multilateral partnerships there was support for south africa’s non-permanent seat on the united nation security council (unsc) from 2011 to 2012, a common vision on climate change (basic grouping), south-south cooperation (g77 and china) new africa-asia strategic partnership (naasp), support for south africa’s bric membership and cooperation in the g20 (pmg 2010, in grimm et al. 2014). south africa–china political relationship sa–china relations did not just start with trade. history proves that there is political interest between china and sa. in sa, beijing supported the pan-african congress (pac); this was because the ussr had already secured relations with the anc, thus precluding closer anc-china relations (grimm et al. 2014). according to grimm et al. (2014), in 1999, president mandela made the first state visit to china after the formal diplomatic relationship had begun and in 2000, president jiang zemin visited south africa; at that time, the two heads of state signed the pretoria declaration on the partnership between the prc and the republic of south africa which, for the first time, highlighted enhancing the partnership from both sides. all these political relationships created a foundation for the development of the bilateral relations. south africa has a significant impact on china’s economy. the support from south africa has provided china with a base in the international community and international organisations and agencies. according to niu (2011, cited in grimm et al. 2014), china’s approach to sa is sometimes seen as china’s africa strategy in the broader context: south africa, albeit just one state among 54 african countries, arguably provides china’s african engagement with legitimacy. hence china’s invitation to south africa to join the bric club in 2011. many chinese officials have shown that china is willing to deepen their bilateral relations with sa (niu 2011, in grimm et al. 2014). south africa–china economic relations for china, sa is the most significant trade partner on the continent and bilateral trade makes up nearly 20% of china’s total trade with the continent (shinn & eisenman 2012:349–350, in grimm et al. 2014). multilateral ties it is clear that the relations between sa and china are strengthened by the multilateral relations they hold. according to molepolle (2015), the relations between china and sa at a multilateral level include the forum on china-africa cooperation (focac), g20, world trade organization and the g77. alden and yushan (2014), highlight that, in 2012, the outgoing chinese president jintao stated that china and sa shared common interests in many international affairs, and that china hoped to cooperate with sa in the united nations (un), g20, brics and other international forums to reinforce the collective voice of developing countries and propel the international political and economic order into a more fair and reasonable direction. the mutual support between china and sa has been given concrete meaning through four multilateral forums, namely the unsc, the focac, brics and the g20. alden and yushan (2014) show that sa worked together with china under the unsc. this was a security council that tried to maintain peace in african countries. alden and yushan gave the case of zimbabwe and sanctions as an example of where sa worked cooperatively with china to block western inspired sanctions. of particular significance from a south african perspective was the experience of working with china on african security, which for one diplomat involved with the sa mission underscored the willingness of the chinese to genuinely seek out, consult and integrate south african (and african) views in formulating unsc positions (alden & yushan 2014). according to alden and yushan (2014), sa is also in a multilateral relationship with china through the focac forum. with regard to focac, sa involvement in the focac process has from the outset been marked by a desire to ensure that african, or at least south african, perspectives are incorporated in the ministerial meetings (alden & yushan 2014). meanwhile, alden and yushan show that south african officials in china, for example the ambassadors, are regularly lauded by chinese officials as being the most active of delegates among the african ambassadors based in beijing. in an effort to upgrade to the comprehensive strategic partnership between china and sa, china invited sa to join the bric group (xiong 2012). in 2006, this group officially became a diplomatic political entity called bric; sa officially joined in 2011 and the acronym was extended to brics. according to the global sherpa, cited in provincial treasury (2013), the formation of brics is an effort by its members to foster cooperation in order to meet global challenges, especially those faced by emerging economies. these countries’ collaboration is aimed at meeting the economic needs of this century which include infrastructure development, consumption and increased trade (provincial treasury 2013). through the brics grouping, sa has managed to work together with china. regarding brics and global issues, the various summit declarations highlighted the fact that the brics countries shared similar needs, for example, for the democratisation of international institutions and an approach to climate change that took into account developing countries’ interests (alden & yushan 2014). on controversial foreign policy issues such as libya (and later crimea), while no conformity of position was expected, disagreements were expressed behind closed doors and not for the world to hear, to retain the image of brics unity; regular consultation, such as the meeting of brics foreign ministers at the hague in the midst of the ukrainian crisis in early 2014, reinforced this approach (alden & yushan 2014). these issues contributed towards a stronger relationship between sa and china. finally, as the only african member of the g20, the south african government has a privileged position to work with other leading economies in shaping a coordinated response to the global financial crisis (alden & yushan 2014). bilateral relations it can be concluded that currently sa’s participation in brics is to a certain degree implicitly reliant on and intertwined with its bilateral relationship with china. south africa and china’s relationship became strong after the formation of their bilateral relations. the relations at a bilateral level were created for example as a result of the bi-national commission (bnc) and its committees. xiong (2012) shows that since the formal establishment of relations in 1998 and the creation of the bnc in 2001, trade and investment between china and sa have grown exponentially. according to xiong (2012), in december 2001, the president of sa inaugurated the first plenary session of the bnc where separate talks were held between the ministries and departments of foreign affairs, economic cooperation and trade, science, technology, energy and tourism. since the inception of the pretoria declaration, there have been four bnc meetings from 2001 to 2010 (xiong 2012). at the end of the second bnc meeting in 2004, the joint communique issued announced that the south african customs union would enter into free trade negotiations with china, further reintegrating the commitment to enhance south-south cooperation to safeguard the rights and interest of the developing world in multilateral forums such as the world tarde organization (wto) and the un as well as mutual support for focac and the new partnership for africa’s development (nepad) (xiong 2012). according to the previous president of sa both countries shared common perspectives on the restructuring of the un, the reform of the global trading system, and enhanced south-south cooperation, hence similar diplomatic sentiments were reiterated in subsequent bncs with the business and investment forum growing a larger presence (xiong 2012). although the bnc was clearly a mechanism to process and organise the dialogue for technical cooperation, its existence provides both the countries a coordinated opportunity in which to hone, revise and further develop bilateral relations on specific issues. china and sa seek to increase trade between one another. both governments seek to further solidify and coordinate bilateral engagements through forming the comprehensive strategic partnership in 2010, which may be assumed to be one of the determining factors in the prelude to sa’s invitation into brics at china’s insistence (xiong 2012). from 23 to 26 august 2010 china and sa further developed bilateral relations by upgrading to adopt a comprehensive strategic partnership. according to alden and yushan (2014) the rapid growth in trade has been the result of a combination of the burgeoning bilateral friendship and of global factors, and these include china’s joining the wto in 2001 and, with pretoria’s formal recognition of china’s market economy status, its upgrading to a strategic partnership in 2004. in 2005, negotiations to create a free trade agreement (fta) – reportedly initiated by beijing – began with sa’s dti and hence the proponents of the fta with china argued that it would help sa to correct the trade imbalance, improve employment and draw new sources of investment into the mining sector while others pointed out that it would offer more economic gains to sa and china while disadvantaging the other southern african customs union countries, whose existing exports already enter china duty free, or nearly so (alden & yushan 2014). it was the latter concerns, coupled with the anticipated outcry by the trade unions aligned with the anc, that caused the issue to languish and drop off the agenda; more recently; however, the fta has again become a talking point between beijing and pretoria (alden & yushan 2014). alden and yushan (2014) show that china became the largest bilateral trading partner of both sa and the southern african region, overtaking countries such as the us. in 2013, the president of china visited sa in march and both countries signed the terms of reference for the joint inter-ministerial working group, the purpose of which was to supplement mechanisms and coordinate the implementation of major projects and bilateral agreements (alden & yushan 2014). according to the presidency (2014), sa has signed several strategic agreements with the government of the prc which aim to strengthen bilateral relations, trade cooperation and create sustainable investment opportunities between the two countries. according to the presidency (2014) the following agreements were signed: a 5–10 year strategic programme on cooperation between the people’s republic of china and the republic of south africa: this agreement focuses on various bilateral cooperations including political mutual trust and strategic coordination, mutual beneficial economic cooperation and trade, people-to-people exchanges and cooperation, african affairs and china-africa relations as well as cooperation in international affairs and brics-related issues (the presidency 2014). agreed minutes on further improving economic cooperation in trade and investment between the ministry of trade and industry of the republic of south africa and the ministry of commerce of the people’s republic of china (the presidency 2014). action plan on agriculture cooperation between republic of south africa and the people’s republic of china (2014–2016) (the presidency 2014). protocol of phytosanitory requirements for the export of maize from the republic of south africa to the people’s republic of china (the presidency 2014). protocol of phytosanitory requirements for the export of apple fruit from the republic of south africa to the people’s republic of china (the presidency 2014). protocol of phytosanitory requirements for the export of dates from the people’s republic of china to the republic of south africa (the presidency 2014). theoretical and empirical review markusen (2005:1) shows that trade theory consists of a portfolio models. there are many underlying motives for trade, and it is probably productive to have a series of models analysing just a few of these at a time, rather than to attempt one grand model, which includes all possible bases for trade (markusen 2005:1). theories of trade are grouped into traditional and new theories. theories of international trade comparative advantage theories of trade in goods (traditional theories) one of the traditional trade theories is mercantilism. this theory shows that national wealth is reflected by the country’s holding of precious metals and trade is a zero sum game (appleyard et al. 2010:18). a zero sum game is one in which one country benefits at the expense of its trading partners (a zero sum game is a game such as poker where one person’s winnings directly match another player’s losses) (appleyard et al. 2010:19). appleyard et al. (2010:19) explain that the acquisition of precious metals thus became the means for increasing wealth and well-being and the focus of emerging european nation states, and hence a strong army, strong navy and merchant marine, as well as a productive economy were critical to maintaining and increasing the power of the state. this theory shows how countries used to trade. trade was done by the use of power; rich nations tried to benefit at the expense of poor nations. it also shows that trade is not a mutually benefitial process. according to levich (2001), the theory of mercantilism states that the world only contained a fixed amount of wealth and that to increase a country’s wealth, one country had to take some wealth from another, through having a higher import or export ratio. so, this tendency, to export more and import less and to receive in exchange gold (the deficit is paid in gold), is called mercantilism (levich 2001). however, david hume and his price specie flow model and adam smith and his invisible hand challenged the basic tenets of mercantilism. according to appleyard et al. (2010:22), david hume and the price species flow mechanism challenged the mercantilism views of long-time trade surplus. he argued that the accumulation of gold by means of trade surplus would lead to an increase in the money supply and therefore to an increase in prices and wages and the increase would reduce the competitiveness of the country with a surplus (appleyard et al. 2010:22). hume argued that one country could not maintain a trade surplus for a long time since this surplus leads to an increase in money supply, which will increase domestic prices and hence lower exports and raise imports (appleyard et al. 2010:22). this theory is important to this research, since it shows the automatic adjustment of the trade disequilibrium within a country. the theory states that a trade surplus (or deficit) automatically produces internal repercussions that work to remove that surplus (or deficit) (appleyard et al. 2010:22). therefore, upon engaging in trade, a nation will end up with a zero trade balance. adam smith also critisised the mercantilism views and stated that a nation’s wealth is reflected in its productive capacity and trade is a positive sum game (appleyard et al. 2010: 24). a positive sum game occurs when both countries benefit from their trade. appleyard et al. (2010:24) indicates that smith concluded that countries should specialise in and export those commodities in which they have an absolute advantage and should import the commodities in which the trading partner has an absolute advantage. each country should export those commodities they produce more efficiently because the absolute labour required per unit was less than that of the prospective trading partner. according to kilic (2002), if a country or individual is absolutely more efficient at the production of a good than another country or individual, then we say that they have absolute advantage in the production of that good. this theory shows that both countries engaging in trade will benefit from that. this theory is important to this research because it shows that trade is determined by the set of natural resources that a country has. these natural resources will determine the country’s absolute advantage. moreover, as the country start trading, this model will show how commodities will flow to and from one country. according to appleyard et al. (2010:24), it is clear that adam smith argued that countries could trade, based on an absolute advantage in the production of only one set of commodities that the two countries are to exchange. therefore, absolute advantage forms the basis of trade. the question is what if only one country has absolute advantage for both goods? according to smith in that case there is no basis for trade because trading in these circumstances has no mutual benefits (appleyard et al. 2010:26). ricardian comparative advantage challenged these statements made by smith that there is no trade if one country has an absolute advantage in the production of both commodities. this theory does make it clear that even if a country is absolutely more or less efficient in the production of all commodities, a basis for trade still exists if there is a difference in the degree of relative efficiency across commodities (appleyard et al. 2010:39). a comparative advantage exists whenever the relative labour requirements differ between two countries; this means that, the internal opportunity cost of the two commodities is different for the two countries prior to trade and both countries may gain if they undertake to trade using this base (appleyard et al. 2010:33). ricardian comparative advantage demonstrated that countries could trade using the basis of comparative advantage and gains from trade (appleyard et al. 2010:40). according to kilic (2002), if a country or individual is relatively more efficient in the production of a good than another country or individuals then we say that they have comparative advantage in production of that good. david ricardo’s theory gave solutions to adam smith’s shortfalls. this theory is important to this research because it encourages a theoretical discussion of what determined trade in the past decades. this theory also shows the flows of commodities between two countries, triggered by the comparative advantage principle. the theory also shows that trade is a mutually beneficial transaction, where all parties engaging in trade come to benefit. the heckscher-ohlin theory also supported the ricardian comparative advantage theory. heckscher-ohlin assumes that relative factor intensities are different across commodities and that these differences are consistent across countries, which leads to pre-trade price differences (appleyard et al. 2010:1310). the theory suggests that the country with abundant capital will be able to produce relatively more of the capital-intensive good, while the country with abundant labour will be able to provide to produce relatively more of the labour intensive good (appleyard et al. 2010:133). the heckscher-ohlin theory states that a country will export the commodity that uses relatively intensively its relative abundant factor of production and it will import the good that uses relatively intensively its relatively scarce factor of production (appleyard et al. 2010:135). the heckscher-ohlin theory states that countries trade because of differences in the factor abundance and the factor intensities of the goods they produce (markusen 2005:3). the differences determine which countries have comparative advantage over others. in a case where country (a) is capital abundant and country (b) is labour abundant, this is represented by: [(k/l)*a > (k/l)*b]. k represents capital factor, l represents labour factor, a represents country a and b represents country b. the inequality shows that the ratio of capital to labour in country a exceeds the ratio of capital to labour in country b. therefore, appleyard et al. (2010:128) argues that if the inequality is like that, then country a will produce and export capital-intensive goods while importing labour-intensive goods from country b. this model is important to this research because it explains the basis for trade. it modifies ricardo’s comparative advantage theory and shows the flows of commodities between two countries. non-comparative advantage theories of trade (new trade theory) the new trade theory shows that trade happens not because of comparative advantage but the principal motives for trade are scale economies, imperfect competition and product differentiation (markusen 2005:3). the new trade theories divert from the traditional theory assumptions that there were constant returns to scale, perfect competition and homogenous products. the theory of intra-industry trade assumes that because of intra-industry specialisation, each country will import some products even in industries in which it is a net exporter, and vice versa; that is, there will be intra-industry trade (krugman 1983:344). countries that export and import items in the same product classification are engaging in intra-industry trade (iit) (appleyard et al. 2010:186). according to appleyard et al. (2010:185) iit was also an aspect of the linder theory, since it argues that one country can have a comparative advantage and a comparative disadvantage regarding same product due to product differentiation. this theory helps us to show if any trade agreements between china and sa are effective. the effectiveness of trade agreements is shown by the presence of iit. the other model is the krugman model. this model rests on two features, that is, economies of scale and monopolistic competition (appleyard et al. 2010:187). appleyard et al. (2010:187) shows that in krugman, labour is assumed to be the only factor of production and the economies of scale (which are internal to the firm) are incorporated into the equation for determining the amount of labour required to produce given levels of output by a firm, as shown here: l = a + bq. l stands for labour needed by a firm, a represents a constant (technologically determined) number, q represents the output level for the firm and b specifies the relation at the margin between the output level and the amount of labour needed. appleyard et al. (2010: 187) argue that the world market is characterised by the existence of the monopolistic competition market structure. in monopolistic competition, there are many firms operating, there are no barriers to entry and exit. in addition, firms earn zero amounts of profits in the long run. however, the output for these firms is not homogenous products. appleyard et al. (2010:187) shows that the products differ from each other and each firm’s product possesses a certain amount of consumer brand loyalty. this product differentiation leads to advertising and sales promotion as firms attempt to differentiate their products in the minds of consumers (appleyard et al. 2010:187). to introduce international trade, suppose the home country is country x and the other country is country y. country y is identical to country x in terms of its tastes, technology and other characteristics of factors in production (country y might be identical in size) (appleyard et al. 2010:188). traditional theories could conclude that, with these same general supply and demand conditions (and hence relative prices), the two countries would have no incentive to trade with each other; however, krugman (and linder) would disagree (appleyard et al. 2010:188). appleyard et al. (2010:189) show that when the two countries open up to trade, the important point to note is that the market size is being enlarged for each representative firm in each country, because there are now more potential buyers for every firm’s goods. when the market size is enlarged, economies of scale may come into play and production costs fall for all goods. if the firm being considered is in country x, the opening of the country to trade with country y means that consumers in both countries are now consuming this product and country y’s consumers now add country x products to their consumption bundles, just as country x’s consumers add country y’s products to their consumption bundle. as krugman’s theory of trade patterns makes several very strong simplifications compared to the real world, it cannot be directly applied to empirics, as it is (weckstrom 2013). however, this theory is useful to this research since it gives a more theoretical discussion that will assist us in understanding the international trade flows. it also explains the basis of trade if countries have economies of scale and if they are in a monopolistic competition market structure. the linder theory has also an important implication regarding trade. linder is concerned only with manufactured goods. linder implies that international trade in manufactured goods will be more intense between countries with similar per capita income levels than between countries with dissimilar per capita income levels (appleyard et al. 2010:183). trade, according to linder’s theory, will occur in goods that have an overlapping demand (appleyard et al. 2010:182). linder’s theory is important to this research because it explains the composition and pattern of a country’s trade. appleyard et al. (2010:183) show that the determination of the trading pattern by observing overlapping demands has important implications for the types of countries that will trade with each other. the most important theory of trade that is relevant to the study is the gravity model of trade. according to weckstrom (2013), the gravity model was first discovered in physics, when newton found out that the gravity between two objects correlates with the masses of these objects and the distance between the objects. the same principle was found to work in international economics by jan tinbergen in 1962; he was interested in international trade flows that would prevail if no trade barriers were being used (weckstrom 2013). the economic watch (2010) explains that the gravity model of trade predicts the bilateral trade flows based on the economic sizes of (often using gross domestic product [gdp] measurements) and distance between two countries. the aim of this thesis is to predict the trade volume between sa and china and thereby use these results to test the trade balance hypothesis. kowalski, lattimore and bottini (2009:35) show that in order to assess sa trade performance in a comparative framework, an econometric model based on the gravity model of international trade was developed. the basic form of the gravity model is given as: fsc = g (msmc ÷ dsc) fsc is the trade flow between sa and china, ms and mc are the gdp of sa and china, dsc denotes the distance between sa and china and g is a constant. economic watch (2010) argues that while the model in its basic form consists of factors that have more to do with geography and spatiality, the gravity model is used to test hypotheses rooted in purer economic theories of trade as well. the gravity model estimates the pattern of international trade. the gravity equation of international trade is often motivated using new trade theory models, which are models of increasing returns (economic watch 2010). nowadays there is more trade between countries. the research uses this model to show trade flows between sa and china. it is important in modelling and understanding international trade flows. economic theories of trade agreements the theory of second best according to lipsey and lancaster (1956–1957) in snorrason (2012:15), the general theory of the second best states that if a constraint is introduced into a general equilibrium setting which prevents the attainment of one of the pareto conditions, other pareto conditions, although still attainable, are in general no longer desirable. free trade means that there are no distortions in trade. snorrason (2012:15) indicates that pareto optimality is achieved exclusively under free trade so that other cases where there are distortions, for example tariffs, subsidies, taxes or monopolies, are suboptimal. the theory of second best addresses this by stating that, in the presence of distortions, if not all the conditions for pareto optimality can be satisfied, then the removal of some of the distortions does not necessarily increase welfare, nor does the addition of other distortions necessarily decrease it (snorrason 2012:15). one suboptimal situation is replaced by another suboptimal situation and thus welfare may remain unaffected, increased or decreased. in a system with several distortions, the removal of any single distortion cannot be presumed to be improving welfare; thus, if an economy is prevented from attaining all the conditions for maximum welfare simultaneously, the fulfilment of one of these conditions will not necessarily leave the economy better off and this is the general theory of second best (snorrason 2012:16). the traditional approach to trade agreements the world trade report (2009:21) states that the main logic of the terms-of-trade (or traditional) approach is that countries that have market power (that can influence their terms of trade) cannot resist the temptation to act in their own interests. according to jonhson (1954) in the world trade report (2009:21), in a situation where each country sets trade policy in an attempt to improve its terms of trade and increase national income, the result is a ‘non-cooperative equilibrium’ (known as nash equilibrium) which is inefficient as the unilateral actions of countries cancel out one another. this situation, which is often referred to as a ‘prisoners’ dilemma’ driven by terms of trade, can be avoided through a trade agreement between countries allowing them to cooperate rather than act unilaterally (world trade report 2009:22). by cooperating in binding agreements to reduce their trade restrictions, countries overcome this inefficiency (mayer 1981 in the world trade report 2009). the commitment approach to trade agreements the commitment theory focuses on a domestic source of inefficiency. when setting trade policy, a government may be unable to make credible economic or political commitments to the private sector or the parliament (world trade report 2009:23). the lack of economic commitment leads to a so-called time-inconsistency problem and this is a situation where the decision of the government to implement a certain policy at some future time is not optimal when the future period arrives (world trade report 2009:23). in these models, the government wishes to use a discretionary trade policy to increase social welfare (for example, in response to unexpected events, or to allow temporary protection to an infant industry). however, the use of trade policy changes the behaviour of participants in the economy, that is, if agents anticipate the policy that the government will implement, they can react to it in a way that will reduce the impact that it has on them (world trade report 2009). this implies that the government will not be able to use a discretionary trade policy as intended, and this results in a socially inefficient trade policy. empirical literature on the determinants of trade according to melitz and ottaviano (2007), larger and more integrated markets exhibit higher productivity and lower mark-ups and through the comparative advantages there will be high trade between these markets. bigger markets exhibit higher levels of product variety and host more productive firms that set lower mark-ups (hence lower prices) and these firms have higher output and high sales (melitz & ottaviano 2007). this creates the basis of trade between countries with big markets. melitz and ottaviano (2007) indicated that trading partner size have an influence on trade flows. on the export side, a larger trading partner represents increased export market opportunities and on the import side, a larger trading partner represents an increased level of import competition (melitz & ottaviano 2007). khumalo, mishi and dlodlo (2013) argue that trade in sa increases with the size of the economy and trade increases more than proportionately with the size of the economies. as sa becomes more developed, its trade with trading partners will increase. the larger the economic size of the exporting and importing countries, the larger the quantity of goods the exporting country can produce as well as sell (khumalo et al. 2013). the market size of countries has influence on international trade. the market size of a particular country is measured using the country’s population size. the higher the population the, higher the productivity and less the cost of production since there will be abundant labour. hence, countries with a high population tend to trade more with other countries. according to matha (2000), one main implication is that country size differences also serve as one of the factors that determine the emergence of international trade. matha goes on to say that the total variable trade costs, incurred in trade, are smaller for the individual firms in the larger country. according to dell’ariccia (1998:7), the exchange rates experience significant and persistent deviations from the purchasing power parity, adding an exchange risk component to import and export activities. then an increase in exchange rate uncertainty may lead risk-averse firms to reduce their foreign activity, reallocating production to their own domestic markets and a negative correlation between exchange rate volatility and trade exists (dell’ariccia 1998:16). dell’ariccia analyses the effects of exchange rate volatility on bilateral trade flows. this study employs a gravity model and panel data from western europe. the results show that the exchange rate uncertainty has a negative effect on international trade. however, the results from the hausman test rejects the hypothesis of the absence of simultaneous causality. baak (2004) investigates the impact of exchange rate volatility on exports among 14 asia-pacific countries, where various measures to raise the intra-region trade are being implemented. the empirical tests, using annual data for the period from 1980 to 2002, detect a significant negative impact of exchange rate volatility on the volume of exports. in addition, various tests using the data for subsample periods indicate that the negative impact had been weakened since 1989, when the asia-pacific economic cooperation (apec) launched, and surged again from 1997, when the asian financial crisis broke out. also, the test results show that the gdp of the importing country, the depreciation of the exporting country’s currency value, the use of the same language and membership of apec have positive impacts on exports, while the distance between trading countries has negative impacts. nicita (2013) investigates the importance of exchange rates in international trade by analysing the impact that exchange rate volatility and misalignment have on trade and then by exploring whether exchange rate misalignments affect governments’ decisions regarding trade policies. the methodology consists of estimating fixed effects models on a detailed panel data set comprising about 100 countries and covering 10 years (2000–2009). the findings of this study are generally in line with those of the recent literature in supporting the importance of exchange rate misalignment while disregarding that of exchange rate volatility. in magnitude, exchange rate misalignments result in trade diversion quantifiable in about 1% of world trade. this article also shows evidence supporting the argument that trade policy is used to compensate for some of the consequences of an overvalued currency, especially with regard to anti-dumping interventions. the relative distance between the trading partners should also have a negative impact on trade patterns. trade costs tend to increase together with distance. the longer the distance between the two trading partners, the higher the trading costs. assuming that the countries have a fta, the cost of trade includes the cost of transportation and the cost of insurance, storage cost and other costs. the longer the distance, the higher these costs. distance has a negative coefficient as expected which means that trade is higher for two countries that are closer to each other (khumalo et al. 2013). distance (or transport costs) is shown to play an important role in determining the volume of exports and imports. while trading partners closer to sa have a comparative advantage, exports from sa experience a greater impact on the volume traded than imports into sa (holden & mcmillan 2013:10). this finding is explained by the composition of trade in exports and imports. exports from sa are high bulk and expensive to transport while imports are largely high value and proportionately cheaper to transport; furthermore, over time the impact of distance on south african exports is shown to be declining while its impact on imports into sa remains relatively unchanged (holden & mcmillan 2013:10). binh, duong and cuong (2006) apply the gravity model in order to analyse bilateral trade activities between vietnam and 60 countries from 2000 to 2010. the research exploits panel data on international trade in vietnam taken from the databanks of the international trade centre, international monetary fund and world bank. the estimated results reveal that economic size of vietnam, economic size and market size of foreign partners, distance and culture have huge effects on bilateral trade flows between vietnam and these 60 countries. by applying the method of speed of convergence, the study also finds that vietnam has trade potential especially with some new markets such as africa and western asia. sisaki (2013) builds a two-country, two-sector, non-scale growth model and investigates the relationship between trade patterns and the growth rate of per capita real consumption. the study considers negative population growth as well as positive population growth. the results show that as long as the population growth rates of the two countries are different, if the country that accumulates capital stock has negative population growth, trade patterns are sustainable in the end. this is true irrespective of the population growth rate of the other country. moreover, we show that, if the country that accumulates capital stock has a positive population growth, two trade patterns are sustainable in the long run. in this case, each country’s per capita growth is determined either by the population growth of the capital-accumulating country or by the population growth of both countries, depending on which of the two trade patterns is realised. according to doumbe and belinga (2015) the purpose of their empirical analysis is to investigate, based on the gravity model, cameroon’s bilateral trade flows with 28 european union countries, signatories of the eu-cameroon fta on 15 january 2009. although said agreement enforcement day was scheduled for 4 august 2014, it is important to analyse the trade trends among these 29 countries. the research findings reveal that cameroon’s bilateral trade with european union countries is affected positively by economic size and per capita gdp and influenced negatively by the distance between the trading partners. the result of applying the gravity model reveals that the product of two countries’ gdps has positive and significant impact on bilateral trade; indeed, a 1%-point increase in product of the gdps leads to an increase in the bilateral trade volume of cameroon with the concerned trade partners by 1.2808% and about the distance factor, 1% point increase in distance leads to decrease in the bilateral trade volume of cameroon by 2.0306%. nuroglu (2010) investigates bilateral trade flows and their determinants among six big organization of the islamic conference (oic) economies by using panel data analysis and cross sectional data. the paper extends the original gravity model of bilateral trade with population and volatility of exchange rates, and then uses the modified gravity model in panel data analysis. it shows how the income and population of a country, distances between two countries and volatility of exchange rates affect bilateral trade flows among six big countries of the oic. the paper gives special emphasis to the influence of the population on a country’s trade flows and approaches the issue of population size from a scientific perspective. it is shown that the impact of population on bilateral trade flows is positive for the exporter country, while it is negative for the importer country. there are few studies that are aimed at evaluating the bilateral trade relationships between sa and china. the article is therefore aimed at covering this gap. data methodology and research methodology the model from all the trade theories, the gravity theory of trade is used to evaluate the bilateral trade flows between south africa and china. the gravity model has been widely used to analyse bilateral trade flows between country pairs. according to teweldemedhin and van schalkwyk (2010:158), the gravity model was successfully applied for over 40 years to explain trade flows in empirical literature and, thus, using the gravity model, the magnitude of trade flows is estimated among trading countries. in examining the impact of market size, economy size and real exchange to sa–china trade flows the explanatory variables are the gdp (proxy for economy size), the population size (proxy for economic size) and real exchange. according to thai (2006) the estimated gravity model has the following form: log (tijt) = a0 + a1 log(yit yjt) + a2 log(nit njt) + a3erijt + eijt. in this model: j = china i = south africa t: years of target log tijt: log of the sa trade with china in year t a0: the intercept log yit: log of sa gdp in year t log yjt: log of china gdp in year t log nit: log of sa population in year t log njt: log of china population in year t erijt: log of the real exchange rate between sa and china in year t eijt: error term this gravity model will be estimated with ordinary least squares (ols) regression analysis. the multiple linear regression model will be used since the model consists of more than two variables. the equation consists of logarithms both sides, leading to a log log model. the above equation shows the natural logarithm and the error term eijt has been added. this has produced a linear relationship which will allows the interpretation of the coefficients as elasticity. the coefficient can be interpreted as follows: if sa’s gdp in year t (yit) or china’s gdp in year t (yjt) increases by 1%, the trade volume (tijt) will increase by a percent, everything else held constant. likewise, the gdp and population variables have a positive coefficient, showing that if the population or gdp between sa and china increases by 1%, then trade flows will increase by a percent, ceteris paribus. data and definition of variables the gravity model of trade is used to determine the bilateral trade flows between two or more countries (thai 2006). the model can be used to determine the effect caused by the economy size, market size and exchange rate towards the volume of trade between two or more countries. the research thesis will estimate the bilateral trade between sa and china while at the same time showing the positive and negative effect caused by several variables within these two countries. the model contains the sa–china annual trade flows to the left, that is, the dependent variable (y-variable) shows the logarithm of the sa trade with china in year t represented by log(tijt). this is the annual trade (imports plus exports of sa obtained from the world bank database). the aim is to explore the relationship between trade volume and economy size, market size and exchange rate (explanatory variables). the right-hand side of the equation starts with the a0 variable, which is a constant variable. hence, a0 becomes the b0 of the model, the intercept. the right-hand side of the model contains four different types of data to be inserted. the data shows the gdps for both countries (these act as proxy for economy size), the population for sa and china (which act as a proxy for market size), and the exchange rates between sa and china. the results will show the relationship between the annual trade flows between sa and china with these three variables. the first group of data gives the product of sa’s and china’s gdp and is measured in current us dollars. a1 becomes the b1 of the model and it is the coefficient for the two countries’ gdp. gdp measures the total output that is produced within a country by both the citizens and the foreign people who reside in a given country. the economy size of each country is given by the country’s gdp. the economy size of two countries is supposed to have a positive impact towards trade; this is a proxy, which tells us what economic theory states in this regard. the higher the product of two countries’ gdp, the higher the volume of trade between those countries. the gdp data used shows the percentage annual change of gdp in a particular country. the next set of data shows the product of the two countries’ population. a2 becomes the b2 of the model and it represents the coefficient for the two countries’ population. the population represents the country’s market size. the market size is supposed to have a positive effect towards trade. the higher the product of the market size, the higher the volume of trade between the two countries concerned. the exchange rate between two countries also affects trade. according to sibanda (2012), the real exchange rate is the nominal exchange rate that takes the inflation differentials among the countries into account. a3 becomes the b3 of the model and represents the coefficient for the exchange rate between two countries. exchange rate is included in the gravity model of trade as an explanatory variable. the data of the real effective exchange rate between sa and china will be inserted into the model. according to thai (2006) the effect of real exchange rate on bilateral trade is expected to be negative, that is, if the sa rand appreciates (represented by a rise in exchange rate), exports will be made more expensive and imports will be cheaper. hence, in short, an increase in exchange rate will lead to a decrease in the volume of trade between the two countries concerned. the nominal exchange rate is calculated as official exchange rate (local currency units relative to us dollars) of china divided by the official exchange rate of sa. the nominal exchange rate is then multiplied by china’s gdp deflator and divided by sa’s gdp deflator to obtain the real exchange rate. in order to estimate the influence of gdp, population and exchange rate that are hypothesised to influence the trade volume between sa and china, the ols estimation method has been employed. robustness and diagnostic checks of the model the robustness checks the dynamic fit of the variables to the model in relation to whether their presence will affect the outcome of the results. the individual relationship of the variables and the interaction effects help to show the overall relevance of the variables and their worth in ascertaining that the previous gdp, population and exchange rate largely contribute to the volume of trade between two countries the diagnostic tests on the other hand test for heteroscedasticity, autocorrelation and normality of the variables which help to examine the relationship between trade flows and influential variables so as to validate the parameter evaluation outcomes achieved by the estimated model. these checks test the stochastic properties of the model such as residual autocorrelation, heteroscedasticity, normality and goodness of fit. heteroscedasticity the sequence of random variables is heteroscedastic if the random variables have different variances. on the other hand, a sequence of random variables with a constant variance are said to be homoscedastic. there are a number of formal statistical tests for heteroscedasticity. one such popular test is the white test for heteroscedasticity. the test is useful because it has the secondary advantage of testing for specification bias which helps us assess whether the model is spurious or well fitted. after running the regression the residuals are obtained and then the test regression is established by regressing each product of the residuals on the cross products of the regressors and testing the joint significance of the regression. the null hypothesis for the white test is homoscedasticity and if we fail to reject the null hypothesis then there is homoscedasticity. if the null hypothesis is rejected then there is heteroscedasticity: h0: homoscedasticity h1: heteroscedasticity reject h0 if the white test result () is greater than the chi-square critical value. autocorrelation the lagrange multiplier (lm) test centres on the value of the r2 for the auxiliary regression. if one or more coefficients in an equation are statistically significant, then the value of r2 for that equation will be relatively significant, while if none of the variables is significant, r2 will be relatively low (gujarati & porter 2008). the lm test operates by obtaining r2 from the auxiliary regression and multiplying it by the number of observations, t. the test can be done by using the following identity: tr2 ≈ x2 (m). in this identity, m is the number of regressors in the auxiliary regression (excluding the constant term), equivalent to the number of restrictions that would have to be placed under the f-test approach (gujarati & porter 2008). estimation issues the aim is to use stationary data. stationary data means that the series evolves around the constant mean or the zero mean. unfortunately, time series data is inherent to this principle. time series data result in stationarity problems. in other words, the data do not evolve around the constant mean. if this data are used without making it stationary, it will produce biased results. the results will not be accurate. hence, the model was turned into a log log linear regression model the data turned to logarithms. in this study we have taken explicit account of non-stationarity and have applied the augmented dickey-fuller unit root test in which we tested for unit root in the second difference. it is worth knowing that there is no multicollinearity between the variables used in this model. estimation results the estimation results of bilateral trade between sa and china using the linear gravitational model equation are given in table 3. the first column shows the three variables plus the constant; this is followed by a column that shows the coefficients of the variables and then the standard error column, t-statistic column that shows if the variables are significant or insignificant, and the last column shows the probability that the estimation is wrong. table 3: estimation results. the gravitational equation of trade runs through the ols method in this study. however, after the tests were made, the estimated coefficients have the expected signs. the determinants of bilateral trade between sa and china, according to this study, are the economy size, the market size and the real exchange rate. the results from the ols method show that there is a positive relationship between trade flows and economy size. if the sizes of the economies (measured by the two countries’ gdp) increase by 1%, the bilateral trade flows between sa and china will increase on average by 1.66%. it can be concluded that although the results show a positive relationship, the increase of the economic size has no huge effects on the trade flows of these two trading partners. according to the world bank (2017), the average annual gdp growth rate for china from 2000 to 2016 is 9.49088%. for sa, the annual gdp growth rate is 2.970282%. the average annual gdp growth rate for the two countries is 6.230581% (world bank 2017). if these two countries maintain their average growth rate, trade flows are expected to increase by 10.34% on average. the market sizes of sa and china have a significant and strong positive effect on their bilateral trade flows. if market sizes of sa and china (measured by the population size) increases by 1%, the bilateral trade will increase by 9.57% on average. market size has quite huge effects on the two countries’ bilateral trade as compared to the economy size. based on the previous years’ (2000–2016) data, population growth rate for china on average was 0.553267% (world bank 2017). for sa, average annual population growth rate in the same years was 1.406316% (world bank 2017). therefore, the average population growth rate for the two countries is 0.979791%. assuming the two countries maintain this growth rate, the trade flows between these countries is expected to increase by almost 9% on average. the estimated coefficient for the real exchange rate is significant but negatively correlated with trade variation between sa and china. what this means is that a 1% depreciation of sa currency will increase bilateral trade by about 0.88% on average. the south african rand is losing its value. the rand value is falling. hence, according to the results, if the rand continues to fall, the trade flows between sa and china will also decline. the findings of this article are consistent with other empirical work in explaining bilateral trade variation using the gravity model. according to thai (2006), the economy size and market size have a strong influence on trade as a larger country can produce more goods and services for export; high income together with big market size will increase the demand for importing goods and the negative coefficient of the real exchange rate on bilateral trade is also in line with other papers such as that of dell’aricaca (1998). figure 4 plots the time effects of bilateral trade between sa and china; these effects are all individually significant. there has been a steady increase in trade between sa and china from 1995 to 2002. trade volume between sa and china increased sharply after 2000–2008 and decreased in 2009. it rose sharply again after 2009–2011, after which it started decreasing. figure 4: time effects of trade between south africa and china. figure 4 shows that the volume of trade between sa and china increased from 1995 until 2015. summary of the study and conclusions the purpose of this research is to evaluate the impact of economy size, market size and real exchange rate on trade flows between sa and china for the period 1995–2015 applying the ols method. the results revealed a positive relationship between trade flows and the two variables tested, namely economy size and market size. the results of the last variable test have proven a negative relationship between trade flows and exchange rate. there is a positive relationship between economy size and bilateral trade flows between sa and china. this indicates that trade improves with increase in gdp between these two countries or decreases as the gdp between these countries falls. the other variable tested for was market size which is determined by the size of the population. the bilateral trade flow increases together with growth in population. there is a positive relationship between population size and bilateral trade flow between sa and china. the results show evidence of a small but significant negative effect of the real exchange rate on bilateral trade between sa and china. exchange rate volatility has an impact on trade but its contribution to trade is quite limited. the results computed from this model are in line with the theoretical findings. the empirical results have a number of policy implications. china seem to be the fastest growing sa trading partner. several studies indicate that with the current economic performance in china, china will be the most powerful and leading state in economic performance and is likely to be a controlling state in the whole world. therefore, sa must maintain and also make efforts to strengthen the bilateral relations with china so that as the economy grows there are spillover benefits from trading. since there is a positive relationship between economic size and bilateral trade flows between sa and china, policies to boost economic growth in sa should be implemented so as to increase the volumes of trade. female-owned business could be a source of job creation, generating diversity of the business population, stimulating innovation and change in production and marketing practices; therefore, the government must promote policies that create a more gender balanced economy to expand growth (imf 2014). lazzaro (2014) argues that there is a lot of work that women do in society that is not compensated. child-rearing and homemaking are good examples. these contribute to the gdp. according to lazzaro’s argument, sa government should introduce a parental compensation fund, which will improve gdp. on the other hand, a growth in population also increases trade volume. population is a proxy for market size. a high population entails a high market for both foreign and local goods. the government of sa must raise the value of their child support grant, they must make primary education free for all and subsidise secondary and tertiary education. this boosts the population and has a long-term positive effect on trade. real exchange rate volatility has negative impacts on trade. the south african reserve bank must manage the exchange rate movements more efficiently in order to encourage trade. a fixed exchange rate policy must be adopted. the government should keep enough reserves in order to remain secure when the exchange rates moves from its controlled level. this can work only if the government has sufficient foreign reserves to control any disturbance to the fixed exchange rate. the department of trade and industry should target trading with countries with larger economies and markets. the government should loosen trade restrictions on countries with 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http://www.wiredspace.wits.ac.za/bitstream/handle/10539/12020/xiong.thesis.pdf? abstract introduction methods findings discussion conclusion acknowledgements references about the author(s) frans cilliers department of industrial and organisational psychology, school of management sciences, college of economic and management sciences, university of south africa, south africa citation cilliers, f., 2018, ‘the experienced impact of systems psychodynamic leadership coaching amongst professionals in a financial services organisation’, south african journal of economic and management sciences 21(1), a2091. https://doi.org/10.4102/sajems.v21i1.2091 original research the experienced impact of systems psychodynamic leadership coaching amongst professionals in a financial services organisation frans cilliers received: 07 sept. 2017; accepted: 11 july 2018; published: 29 oct. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: systems psychodynamic leadership coaching is a depth psychology perspective that provides opportunities for coachees to explore their leadership identity as it manifests in their conscious and unconscious role behaviour. aim: the research aim was to explore the experienced impact of systems psychodynamic leadership coaching amongst professionals in a financial services organisation, and to report on how this impact can be understood in the context of the literature guidelines on coaching and leadership effectiveness. setting: the research was undertaken in a large south african financial services organisation where individual leadership coaching forms part of the leadership development programme (ldp). methods: the research was qualitative, explorative and descriptive in nature. a multi-case approach was used. sampling was convenient and opportunistic and comprised of 15 charted accountants who attended six 90-min coaching sessions over 12 weeks. data gathering comprised field notes and coachee essays during and after coaching. hermeneutic phenomenology was used as the interpretive stance. results: anxiety, task, role, boundaries, authorisation and identity manifested as themes. coachees explored how their leadership identity was informed by their anxiety and defence mechanisms, how they took up their leadership role, authorised themselves and their colleagues, and managed their boundaries effectively. compared to the general guidelines for leadership coaching effectiveness and the general indicators for effective leadership, systems psychodynamic leadership coaching seems to add value to leadership effectiveness. conclusion: professionals in this financial services organisation experienced systems psychodynamic leadership coaching as demanding, challenging and yet fulfilling towards the exploration of their leadership identity. it seems that systems psychodynamics, as coaching stance, created a safe and good-enough container for these financial professionals to explore their own unconscious leadership behaviour and to gain a significant level of understanding and awareness of their own anxiety and defensive behaviours in their interaction with followers. introduction as a field of study, leadership has an extensive and voluminous 100-year-old literature base, containing an overwhelming proliferation of paradigms, definitions, models, theories, concepts, terms, outcomes, competencies and measurement instruments (nohria & khurana 2010; northouse 2014; veldsman & johnson 2016). according to bennis (2007), this gives evidence of the complexity, dynamics and elusiveness associated with leadership, which creates confusion amongst researchers and practitioners. in general, leadership can be defined as the activity to willingly involve oneself, influence, coordinate and guide people’s organisational activities towards attaining positive goals and outcomes for the organisation, according to the existing context and set strategy (cooper 2005; leonard et al. 2013; meyer & boninelli 2007). research on the psychology of leadership is mostly informed by a humanistic conceptualisation and positivist operationalisation. leadership research gives evidence of the psychometric relationship between leadership styles and behaviours, and organisational outcomes (kaiser, hogan & craig 2008). for example, a task orientation is applicable where there is control over a situation, a people orientation where control is moderate, consideration where job satisfaction is desirable, structure where effectiveness and containment are needed and a transformational stance where inspiration and commitment are needed. presently, the leadership literature focuses strongly on transformational leadership in a quest to understand how leaders need to cope in the 21st century and postmodern era (veldsman & johnson 2016), amidst never-before-experienced complexity such as the new economy, globalisation, mergers and acquisitions, chaos, paradox, diversity, power, risk and limited resources (bennis & sample 2015; crevani & endrissat 2016; elkington & booysen 2015; klein, rice & schermer 2009). leadership coaching has developed as a way of assisting leadership in coping with its complexity (passmore, peterson & freire 2013). coaching’s importance is reflected in it being referred to as the fastest growing profession and the single most influential input in the modern organisational and corporate environment (kahn 2014). leadership coaching is generally defined as a regular, short-term, highly focussed, contractual organisational learning opportunity. it involves a facilitating (helping) relationship between a coachee, who has managerial and leadership authority and responsibility in an organisation, and a coach, who uses psychological and behavioural paradigms, models, techniques and methods to assist the coachee to develop relevant leadership behaviours and thereby improve organisational effectiveness (brunning 2006; hawkins & smith 2013; kets de vries, korotov & florent-treacy 2007; mckenna & davis 2009; paice 2012). of the demands on leadership (nohria & khurana 2010), coaching focusses on the people aspects of insight, learning, growth and change in the self and between the self and the other. thus, the goal of leadership coaching can be framed as to significantly optimise the leader’s effectiveness on the intrapersonal and interpersonal levels. this refers to self-leadership, leadership of the other (colleagues and followers in dyads and teams) and leadership in the organisation as a system (greif 2007). coaching effectiveness is seldom linked to indicators for effective leadership, such as those formulated by the kellogg foundation (development guild 2015). although the merit and value of leadership coaching are accepted in practice (page & de haan 2014), it lacks solid research evidence to establish its identity as a scientific intervention in the field of organisational development (od) (kahn 2014). theoretically, all the major psychological paradigms have been applied to leadership coaching, for example, psychodynamics, behaviourism, cognitive psychology, humanism, existentialism and neuropsychology (bachkirova 2011; bluckert 2006; brown & brown 2012; passmore et al. 2013; peltier 2009). however, in practice, research mostly reports on coaching programmes linked to positive psychology constructs (cilliers 2011; page & de haan 2014; western 2012), such as those applied in the goal, reality, options, will (grow) model (stout rostron 2009). specifically, emotional intelligence (dippenaar & schaap 2017), happiness (biswas-diener & dean 2007), resilience (maddi & khoshaba 2005) and flourishing (grant 2007) are included in positive psychology coaching programmes. the published coaching research on the aforementioned positive psychology constructs show face validity in terms of enhancing the behavioural constructs it sets out to develop (dippenaar & schaap 2017). in the present research project, the authorities of a financial services organisation wanted to extend their leadership coaching offering with (amongst others) a model that ‘helps leaders understand the complexity of leadership’s individual and organisational systemic role identity explored from an unconscious perspective’. the researcher was invited to make a presentation on systems psychodynamic leadership coaching (splc), which was accepted with the request to report back to the organisation about the impact of this coaching stance. thus, the problem statement of this research project was formulated as follows: what is the experienced impact of splc amongst professionals in a financial services organisation, and how can this impact be understood in the context of literature guidelines on coaching and leadership effectiveness? the motivation for systems psychodynamic leadership coaching because of the huge pressure on and insecurities in financial services organisations in terms of performance and ethics (kahn 2014), it is difficult to single out one of the mainstream leadership theories (kets de vries et al. 2007) as the most appropriate basis for the coaching of its leaders. mainstream theories include the contingency, personal attribute, trait, competency, situational and transactional or transformational leadership perspectives (nohria & khurana 2010). systems psychodynamic leadership coaching offers an open-systems approach focussing on the exploration of conscious and unconscious behaviour relevant to how the coachee takes up the role of leader as part of the larger systemic dynamic, while authorising the self and others and managing the relevant boundaries in service of the leadership task (newton, long & sievers 2006). next, splc was contrasted to other leadership coaching models with the following arguments. many leadership coaching programmes are not based on any informing leadership framework or definition (beck 2012). the learning approach in the mainstream leadership coaching programmes is simplistic, linear (working from normal to optimal), reductionist (focussing on evidence-based outcomes) (western 2012) and focussing on behavioural change, thus excluding the holistic, systemic, existential experiences, characteristic of the complexity of human experience in organisational and social systems (western 2012). furthermore, traditional models focus mostly on rational and conscious behaviour, thus ignoring the impact of irrational and unconscious behaviour (nohria & khurana 2010). a structured step-wise approach is followed, thereby limiting the coachee’s movement towards their specific learning dynamic (passmore et al. 2013). especially in programmes presented from a positive psychology perspective, leadership is defined from one selected theory and then framed as an individual phenomenon, thus ignoring leadership as a systemic phenomenon (bennis 2007; kahn 2014). positive psychology coaching programmes focus on positive behaviour, thereby excluding leaders’ negative experiences, such as loneliness, attacks, envy, narcissism and performance anxiety. these programmes also accentuate personal development, thus denying the shadow side of leadership and toxicity, which often leads to the derailment of leaders (western 2012). systems psychodynamics systems psychodynamics (sp) has its roots in depth psychology, freudian systemic psychoanalysis, group and object relations theory and systems thinking (kets de vries et al. 2007). systems psychodynamics is defined as the scientific study towards the understanding of the manifestation of unconscious and dynamic behaviour in organisations, especially about leadership and authorisation (colman & bexton 1975; colman & geller 1985; cytrynbaum & noumair 2004). the sp leadership philosophy is conceptualised in terms of the systemic identity, taking up the role of leader, working on a given primary task and being authorised to manage the self and the other on the boundary between what is inside versus outside (huffington et al. 2004; stapley 2006). systems psychodynamics interprets the present voluminous amount of leadership theories and its constant deconstruction as compulsiveness and an unconscious defence against the anxiety of facing the complexity of the leadership role, its relationships and relatedness (czander 1993; french & simpson 2015). systems psychodynamics sees leadership as not belonging to an individual or a group and states that it cannot be confined to a set theory of interactions, rules, guidelines or habits. rather, leadership is seen as a psychosocial influencing dynamic (kets de vries 2006). western (2013) explains that (1) ‘psycho’ refers to the psychodynamics of leadership happening within and between people – leadership and followership stimulate intrapsychic, unconscious and emotional responses within and inter-relational dynamics between employees; (2) ‘social’ refers to the social construction and relational dynamics of leadership, power and authority, control of material and symbolic resources, use of knowledge and technology as manifesting in organisational history, discourses, culture and politics; (3) ‘influencing’ refers to the agency to influence the other, drawing on a wide array of resources such as personality and coercive power; (4) ‘dynamic’ refers to the forever fluid movement of the social leadership–followership process, which can’t be reduced to skills, competencies or a way of being. systems psychodynamic leadership coaching the primary task of splc is to provide psycho-educational and developmentally focussed learning opportunities for coachees, to explore the self and the prevailing organisational dynamics as an open system (including structural aspects such as design, division of labour, boundaries, the primary task, levels of authority, reporting relationships and relatedness) and the manifestation of their own unconscious systemic behaviour (primitive, social and system domain defences) (armstrong & rustin 2015; beck 2012; brunning 2006; kets de vries 2006; neumann, kellner & dawson-shepherd 1997; newton et al. 2006; sandler 2011). systems psychodynamic leadership coaching focusses on conscious–rational, unconscious–irrational and the congruence–incongruence between these, the manifesting anxiety and its defensive structures on the systemic micro(individual), meso(group) and macro(organisational) levels (campbell & huffington 2008; hirschhorn 1993; kets de vries 2014). anxiety is accepted as the driving force (dynamo) of the relationship and relatedness between leadership and followership. defensive structures manifest in the systemic social unconscious as basic assumptions of dependence, fight–flight, pairing (bion 1961), me-ness and one-ness or we-ness (fraher 2004), as well as defences such as splitting, introjection, suppression, denial, projection, projective identification and transference (blackman 2004). the coachee’s leadership identity as observed, experienced and represented in the mind, is informed by how the role is taken up and the nature of the experienced authorisation, while managing the boundaries between the self and the other in the service of the primary task (cytrynbaum & noumair 2004). ‘task’ refers to the basic component of work and can manifest as adhering to the primary task (indicating contained anxiety) or as diversions into off-task and anti-task behaviour (indicating, e.g., performance anxiety) (czander 1993). ‘role’ refers to the boundary surrounding work and position and between the coachee and the other (stapley 2006). ‘authorisation’ refers to the formal and official right to perform a task, bestowed from above (the organisation, manager, leader), the side (colleagues), below (subordinates) and from within (self-authorisation) (hirschhorn 1997). ‘boundary’ refers to the physical or psychological demarcation and differentiation, observable or subjective, acting as the space around and between parts of the system (e.g. time, space and task) (cytrynbaum & noumair 2004). transactional analysis adds the constructs of the systemic ego states of parent, adult and child, script development and games (erskine 2010; tangolo 2015; tudor & summers 2014), explaining the coachee’s communication in significant relationships. operationally, the sp coach provides an emotionally contained and transitional space to the coachee’s experiential exploration of the self in the role as leader (clarke, hahn & hoggett 2008). the coach attends to the coachee’s reality testing, cognitive functioning (abstractions, differentiations), affective functioning (emotional relatedness to the self and the other), experienced anxiety and use of individual, social and system domain defensive (differentiated between the neurotic, psychotic and the perverse) and object relations, vertical with authority (based on the transference from parental figures), and horizontal with colleagues (based on the transference from siblings) (newton et al. 2006). the coachee’s role is analysed by differentiating between the three role parts of normative (the rational, objectively measureable content), existential (how they believe they are performing based on their introjections (their unconscious internalised and transferred feelings, attitudes and values that belong to the external environment) and phenomenal roles (how they believe they perform as experienced by colleagues and others based on their received projections) (obholzer & roberts 1994). incongruence between the three role parts indicates role anxiety, which could manifest as free-floating, survival, performance, paranoid or persecutory anxiety (blackman 2004). at the same time, their valence is studied, defined as one’s unconscious tendency or propensity to internalise, collude with and respond to the projections of the other and to take on a similar informal role repeatedly in groups dependant on one’s object relations and social identity (beck 2012; sandler 2011). typically, sessions start with an open invitation such as: ‘tell me about your present experiences in your role as leader’. sessions do not have specific agendas – rather, they follow the coachee’s conscious and unconscious exploration and stay as close as possible to the coachee’s immediate role experiences (armstrong & rustin 2015; kets de vries 2014). storytelling and drawings may also be included (western 2012). the coach needs to be systems psychodynamically informed, which refers to a high level of training and competence in working with systemic unconscious material, as well as having a dynamic self-insight and being prepared to use the self as an instrument (huffington et al. 2004; kets de vries et al. 2007). the role of the coach is to not take on a guru position but rather a reflective stance from a meta position (schafer 2003), alert to the coachee’s conscious and unconscious behaviour and the manifestation of defensive behaviour without judgement, memory or desire (beck 2012; campbell & huffington 2008; sandler 2011). the coach formulates working hypotheses, defined as an integrative statement of ‘searching into’ the coachee’s experiences, which are constantly revisited in the light of further or new evidence (campbell 2007). coachees are encouraged to be curious, to free-associate, to explore a variety of related feelings, patterns, defences and representations, including the transferences between coach and leader, and to move between different levels of abstraction in thought (jaques 1990). research on coachees’ experiences in splc reports in general on coachees’ raised awareness of, insight into and understanding of their leadership role identity in their relationships with and relatedness to the organisational system (chapman & cilliers 2008; cilliers & terblanche 2010; huffington et al. 2004; kahn 2014; motsoaledi & cilliers 2012; passmore et al. 2013). coachees experience a change in their thinking about their representative nature and value in the organisational system and how they authorise themselves and their followers in their complex matrix systems with its constantly changing organisational context and conscious and unconscious psychological boundaries within and between conflicting subsystems (kets de vries 2006, 2014; kets de vries et al. 2007). coaching gives them the opportunity to explore the dynamics of taking up their leadership role and the accompanying levels of survival anxiety, feeling disorientated, lost, lonely, doubtful, not good enough and performance anxiety to perform their primary task and manage their relationships with followers effectively (passmore et al. 2013). coachees report on working through very real experiences and behaviours as they never expected to play an important role in leadership (cilliers 2005; motsoaledi & cilliers 2012). these include their unconscious beliefs, fantasies, wishes, conflicts, defences, preferences, competition, rivalry, jealousy, envy, hostility, narcissism, aggression, regression, repetition of previous relationship patterns, valence for attracting specific projections, collusion with and responses to others’ projections and containing feelings or objects on behalf of the system (beck 2012; brunning 2006; kets de vries et al. 2007; neumann et al. 1997; newton et al. 2006; obholzer & roberts 1994; sandler 2011; stapley 2006). research aim and contribution the research aim was to explore the experienced impact of splc amongst professionals in a financial services organisation and to report on how this impact can be understood in the context of the literature guidelines on coaching and leadership effectiveness. the contribution of this study lies firstly in a rich description of the splc experiences of professionals in a financial services organisation. secondly, this study contributes towards an understanding of the experienced impact of splc as a coaching stance, as well as on leadership effectiveness. thus, the research has intrinsic (in the understanding of the coachees’ experiences) and instrumental value (to provide the coaching fraternity with meaningful data about the nature of splc as a depth psychology leadership developmental input) (denzin & lincoln 2005). methods research design and approach the research was qualitative, explorative and descriptive in nature (thorne 2016). participatory action research was performed (wagner, kawulich & garner 2012) to ensure continuous connectivity, effective communication and good working relationships in the research system, as well as to ensure active researcher involvement. hermeneutic phenomenology was chosen as the interpretive research paradigm (clarke & hoggett 2009). a multi-case approach was used (mcleod 2012; wilson & maclean 2011), focussing on coachees’ experiences while undergoing splc, delimited in time, place and task, and then studied through observation, documented self-report and comparison (hollway & jefferson 2010). setting the study was set in a large south african financial services organisation where the od division provides professional, logistical and administrative opportunities to financial professionals in need of individual leadership coaching. the researcher was requested to serve on the coaching panel to conduct chemistry meetings (stout rostron 2009), followed by splc with interested professional staff members, according to a standard coaching contract consisting of six 90-min sessions over 12 weeks. all sessions were conducted in a boardroom during office hours. sampling fifteen professionals voluntarily completed the coaching contract. this number became the purposive and convenient sample (thorne 2016) for this study. the sample comprised charted accountants appointed on associate director level. there were nine males and six females, five black people, four indians and six white people, and all were younger than 40 years of age. data collection, recording and analysis two data collection methods were used, namely coaching field notes (thorne 2016) and coachee essays (wolcott 2001). the field notes, recorded by the coach during and after each session, provided a detailed rendition of the coachees’ verbatim and non-verbal behaviour during each coaching session. the common objection against field notes, namely the researcher’s subjective perceptions, was compensated for by the researcher’s attention to detail during recording (denzin & lincoln 2005). halfway through and at the end of the coaching contract, each coachee wrote an essay of about five a4 pages on the question: ‘what do you experience and what are you learning through coaching in your role as leader in this organisation?’ the two methods in combination provided the text for analysis of the coachees’ lived experience (thorne 2016). simple hermeneutics allowed for the understanding of the content of coachees’ experiences during coaching and double hermeneutics allowed for the critical interpretation of their experiences from the sp stance (clarke & hoggett 2009) as it manifested in themes. ethicality during each individual chemistry meeting the relevant coaching and research ethical aspects were explained to the coachees (terre blanche, durrheim & painter 2006). these aspects were informed consent, voluntary participation and withdrawal, privacy and confidentiality. participants also gave consent for their data to be included in this research project. strategies employed to ensure quality data trustworthiness was based on the following aspects (wagner et al. 2012). in terms of credibility, the researcher is qualified as a systems psychodynamically informed coach. during the research project the researcher received coaching supervision (kets de vries et al. 2007) to ensure objectivity and self-authorisation. the coaching research was approved and authorised by the organisation, and the od division assisted in ensuring consistency in logistics and practical arrangements. the research evidenced strong and believable validity in its psychological description, which revealed the complexities of how the sp constructs of task, role, authorisation and boundaries manifested and how the dynamic interaction between the constructs informs the coachees’ leadership identity. in this research, triangulation was defined as the process of assessing the outcome of research by viewing it from different perspectives and methods, resulting in a convergence of the data to present rich and valid data (creswell & plano clark 2011; denzin & lincoln 2005; mcleod 2012; wilson & maclean 2011). methodological and data triangulation referred to the inclusion of field notes and essays as raw data to avoid interpreting already interpreted data. investigator triangulation (wagner et al. 2012) was ensured in using peer reviewers (thorne 2016). two independent psychologists, not associated with the research project, both sp informed coaches, were asked to review the database and the qualitative findings using their own criteria (creswell & plano clark 2011). their positive feedback on the data analysis gave evidence of dependability. their feedback on saturation provided evidence of internal generalisability (denzin & lincoln 2005). theory triangulation was attended to by including transactional analysis (as another interpretive stance within the sp paradigm), which added to the richness of ego states operating in the data (see wagner et al. 2012). findings the emerging themes were anxiety, task, role, boundaries, authorisation and identity. anxiety coachees experienced free-floating anxiety (blackman 2004). they referred to the organisation’s demand to ‘become more involved in leadership’ – a ‘job that i know nothing about’ and ‘i am not even sure i want it’. they expressed performance anxiety (blackman 2004) about leadership (‘something i have no training in’) and existential and separation anxiety in the fear of giving up ‘my professional role in thinking about and working with numbers – not with people’). in terms of their dependence on authority figures, they tended to split their authority in the mind (armstrong 2005) between the coach as the good object (klein 1997) (‘the guru’ that ‘must help’ and ‘understand’, ‘help me make sense out of the confusion of relationships’ and ‘save me’ from not knowing) and their organisational leadership role as the bad object (‘they are not helping in this chaos’, ‘they don’t seem to know themselves’, ‘i doubt if they had any leadership training themselves’). they used fight as a defence against the ‘cruel’ system for ‘allowing them to not know’ and ‘to struggle’ with difficult clients and colleagues. they used flight as a defence to get away from difficult relationships (‘i avoid getting involved in issues with people’). they exhibited we-ness when they expressed strong feelings (referred to as ‘frustration’ and ‘annoyance’) and me-ness when the individual wanted to distance the self from the larger system, who was supposed to be impressed with his or her professional performance. their defensive structures (armstrong & rustin 2015) consisted of splitting between the (introjection of the) good professional track record, versus the (projection of the) bad of the ‘people issues’ associated with leadership and regression (‘i wish i was still a clerk who [could] just be busy with auditing tasks all the time’). during the sessions coachees explored these anxieties towards differentiating between their own introjected feeling and thinking behaviour, and what the system was projecting onto them. this resulted in projective identification (klein 1997), which was an awareness they had never felt before (‘i realise more and more that i take on so much of other people’s stuff’, ‘it is not easy to do this work’). they explored how their awareness of their dependence and ‘my blaming of the firm for my issues’, ‘stand in my way to develop my own potential’. task coachees split their known professional (charted accountant) task from their unknown task of leading people. originally, they attached (sievers 2009) to the ‘simplicity’ of the management of client projects while they detached from what they experienced as the ‘extremely demanding’, ‘complex’ and ‘unpredictable’ leadership task. they realised their inclination to avoid the complexity of leadership by using ‘flight into control’ of the task (‘i feel more productive when i check my team’s work on paper’ vs. ‘i feel so out of control when i need to address the conflict in my team’). they learned to differentiate between the primary task of a project and when they ‘go off-task’, especially when they feel out of control (‘i realise that when i am anxious, i want to control even the uncontrollable and then i lose perspective of the [primary] task’). role coachees experienced conflict between their normative, existential and phenomenal roles (obholzer & roberts 1994), indicating their role anxiety. intellectually they understood their normative role as a combination of and balance between their professional and leadership roles. emotionally they ‘struggled because i wanted to keep them apart’, especially in difficult interpersonal situations ‘when i feel my stress skyrocketing’. in their existential role, they were proud of how the firm had recognised their work, their career background, accomplishments, values and personality characteristics as professionals (‘what i was trained to do’, ‘what i prefer’ and ‘love to do’). they started to realise their regression (blackman 2004) into the known role was an indication of the anxiety caused by their leadership role. in their phenomenal role, they explored the projections they received from ‘the other’, such as colleagues, partners and family. this included expectations of being heroes to save the system with their intelligence, ‘professionalism’, emotional strength and ‘resilience’, as well as their interpersonal competence and ‘empathy’. they learned to become aware when these projections onto them occurred (‘when it is not my stuff’, ‘i am learning that if it feels unreal, i know it is not mine’, ‘i do not see myself that way’, ‘it is what people want me to be for them’). the existential–phenomenal role difference indicated to them that their ‘identity [was] under attack’, which caused them high levels of anxiety. towards the end, coachees could start to differentiate between what belonged to them (their introjections) and what systemic projections they received from the other. boundaries coachees consciously understood the role of organisational time, space and task boundaries. yet they were often surprised at how their unconscious boundaries (in the mind) influenced their leadership behaviour. this included the boundary between their personal self and their organisational role (‘these roles are so different’), between financial professional and leader of others (‘it is a totally different ball game’), the psychological boundaries between associate director and partner in the firm (‘we are treated as professionals’ and then ‘act like children towards the parents’) and the boundaries between professional leader and client (‘they treat me so differently when i am in my leader role’). some coachees explored their valence (huffington et al. 2004) to contain ‘feelings and stuff’ for the other (‘it may be part of the role, but it is very difficult’ to carry others’ projections). a few coachees processed how they moved from being over-bounded (and having impenetrable boundaries) (czander 1993), which served to contain their performance anxiety, towards using their systemic awareness to ‘relax’ and try to function with permeable boundaries. authorisation coachees understood how they consciously self-authorised (hirschhorn 1997) and how they were authorised from above by the partners in the firm, from the side by colleagues and from below from their team members. their ‘most significant learning’ was the realisation of the frequency and intensity of being unconsciously de-authorised in the system. in their existential role, this happened as a parental transference dynamic (hindle & sherwin-white 2014) in how they heard their superiors (partners in the firm) ‘as if he is my controlling father’ (‘i can hear my parents’ voices telling me that i am not good enough’, ‘i have often been told by my teachers that i will not make it far’). in their phenomenal role, this happened through the processing of their received projections of incompetence (‘they withhold important information from me’ ‘about rules’ and ‘the right way of doing’). this was often experienced as management’s ‘type of power play’. coachees explored the unconscious power dynamics and could start to process their individual systemic valence to play ‘the victim’ and ‘underdog’ roles. good insights were gained from studying how they collude (armstrong & rustin 2015) with systemic power games. for most coachees significant learning took place in self-authorisation based on the differentiation between what belongs to the self and what not and ‘not to take responsibility or guilt for the others’. one coachee mentioned, ‘i now understand that what i often see as incompetence is much more a case of not being authorised by leadership’. identity coachees struggled to differentiate between and integrate their personal, professional and leader part-identities (vansina & vansina-cobbaert 2008). they experienced ‘confusion’, ‘being overwhelmed’ and high levels of performance anxiety in their new leadership role. this role contained a complexity of irrational expectations – introjections of having to be a ‘super competent’ ‘people’s person’, as well as unrealistic projections onto them from the organisational system. as young leaders, they became aware of the unconscious dynamic of ‘being used’ by the organisational system (campbell & groenbaek 2006) to contain and process the organisation’s leadership and succession anxiety. although this caused free-floating anxiety (‘it is very confusing’, ‘i can’t process this by myself’), the coachees move towards exploring, disentangling and differentiating between illusion and fantasy on the one hand, and their reality of taking up a leadership role in the context of their own unique personality styles. they were brave to explore and relinquish their ignorance in favour of heightened awareness. they experienced ‘relief’, ‘insight’ and authorisation to face the ‘below the surface stuff’ that ‘play such a big role’ in their relationships ‘at work and at home’. discussion the research findings are discussed with reference to three sets of data seen as significant for coaching effectiveness in this research, namely (1) the experienced impact of splc amongst professionals in this financial services organisation, (2) the experienced impact of sp as a coaching stance and (3) the experienced impact of splc explored against the kellogg foundation’s indicators for effective leadership (see kets de vries et al. 2007; nohria & khurana 2010; passmore et al. 2013; western 2012). the experienced impact of systems psychodynamic leadership coaching amongst professionals in a financial services organisation in their normative role coachees had cognitively reconstructed leadership into an accessible and workable behavioural repertoire. this reconstruction was made possible by relinquishing the need to study the voluminous amount of literature on leadership theories and models (‘mba style’) and to instead experience leadership as a role with many facets such as rational versus irrational, conscious versus unconscious behaviour on the self–other boundary. to work with and learn about the self through the exploration of anxiety as an unconscious driving force and its defences was surprising to most coachees (‘i thought anxiety and defences were for sick people’, and ‘here we have spent a whole session on trying to understand my defences against my primitive anxiety’). in their existential role coachees explored their introjections about leadership as the impossible task (cytrynbaum & noumair 2004) often linked to negative past experiences with ‘my so-called leaders’. their introjected values, feelings, thinking and expressive behaviours that manifested as their psychological valence contributed to their most profound learning. the exploration of their transferences of relationships with parental figures and siblings from their family of origin into their present leadership role (winnicott 2006), brought surprising insights in terms of repeated patterns and parallel processes. in their phenomenal role, many coachees explored projection as a phenomenon for the first time in their lives. they were intrigued by the power of their own and their received projections and its capacity to influence one’s behaviour through projective identification. applied to their leadership role, they reported on their significant learning about how they formed unconscious ideas and biases in their relationships with and about their colleagues, direct reports and partners in the firm, based on their family of origin experiences. they gave examples of their growing awareness about how they projected their own unconscious emotional survival and performance anxieties onto their colleagues during meetings and in project management. for many the breakthrough came when they could, in the here-and-now moment, realise and own the projection as ‘my own stuff’ and even offer an explanation and ‘take back my own stuff’. these findings have also been reported in other south african sp coaching research (chapman & cilliers 2008; cilliers 2005; cilliers & terblanche 2010; kahn 2014; motsoaledi & cilliers 2012). the coachees learned about their object relations through the transactional analysis interpretations (tudor & summers 2014). they reported how they have framed the construct leadership as the demanding and controlling parent in the mind and how they then, in a defensive reaction, took on a rebellious-child response. it took hard work to disentangle from the hooked parent–child engagement in the mind and to shift to adult–adult communication to ensure a balanced and realistic conceptualisation of leadership. they also reported on using their coaching insights to diagnose their project and team cultures. they realised that the firm’s prevailing culture was mainly experienced as the critical parent with almost no caring-parent behaviour manifesting. a few coachees started to address this awareness in their projects by stimulating positive storytelling about leaders and leadership, to deconstruct the negative projections onto leadership as a role, as well as onto leaders as people. no research could be traced where transactional analysis was used as an interpretive stance in leadership coaching. the experienced impact of systems psychodynamics as a coaching stance in order to understand the experienced impact of sp as coaching stance, the findings were compared to the following literature on coaching and leadership effectiveness: bain (1998); campbell and huffington (2008); french and simpson (2015); meyer and boninelli (2007); nohria and khurana (2010); passmore et al. (2013); and sternberg (2007). coaching is imbedded in contemporary leadership thinking. systems psychodynamic leadership coaching facilitated aspects of transformational leadership (avolio 2007) with reference to individualisation and intellectual stimulation as intrapersonal aspects. systems psychodynamic leadership coaching did not directly address inspirational and idealised influence as interpersonal leadership dimensions. rather, splc focussed on containment leadership (kilburg & diedrich 2007) where leaders become aware of their unconscious representation as the leader in the mind of the system. coaching provides a reflectional space. systems psychodynamic leadership coaching provided opportunities for reflection about leadership (not as only a theory or as competencies, but) as a systemic role managing the boundaries between the rational and irrational, the conscious and unconscious and between the self and the other. furthermore, splc provided a transitional space (winnicott 2006) for coachees to (1) develop their awareness of and insight into systemic individual (micro-), group (meso-) and organisational (macro-level) behavioural dynamics and (2) to explore their leadership identity in terms of self-representation, behaviour and relationships. coachees moved from being mostly ignorant unconscious containers of system domain, socially constructed and personal defences, to an openness to experiment with unconscious personal and leadership behaviour. they learned to take up their leadership roles with significantly more self-authorisation and to manage their boundaries with consciousness and rationality. they started to integrate their normative, experiential and phenomenal roles and reported on experiencing more congruence between their introjections and received projections. this indicates a heightened awareness of anxiety as it happens (in the here and now) and the differentiation between ‘what [emotionality] is mine and what is not mine’. they illustrated an increased capacity to create new thoughts, to process relatively deep feelings and to venture into conscious and rational action (as part of their adult ego state). thus, leaders developed a dynamic awareness of their individual identity, how they related to others, what they individually represented in the organisational system and the competence to ask critical questions about the dynamic experiences of the other. these behavioural outcomes are congruent to how splc is described in the literature (beck 2012; kets de vries 2014; macaux 2014; newton et al. 2006; passmore et al. 2013; peltier 2009; sandler 2011). some of the reported insights can be framed as moving towards leadership wisdom (kilburg & diedrich 2007), defined as taking up the role with an openness to experience and a creative exploration of own, team and organisational behaviours towards a cognitive understanding, a strong sense of self and a systemic awareness of process and dynamics. coaching enhances an understanding of organisational dynamics. systems psychodynamic leadership coaching facilitated leaders’ macro-level insight into the dynamics of the system domain defences of financial organisations, such as narcissism, envy, competition, rivalry and greed (long 2008). on the meso-level they explored socially constructed defences such as the compulsive dependence on rules, regulations and customs (e.g. in auditing as a profession and in the firm’s partner structure). on the micro-level they explored the complexities of their own defensive leadership behaviour, especially their use of denial and projection, and how these dynamics permeated below the surface of consciousness and, as such, influenced their leadership relationships. they explored how they contained emotionality on behalf of the meso-system and practised ways of owning what they experienced as their own. coaching facilitates understanding of leadership dynamics and complexity. systems psychodynamic leadership coaching frames the leadership task as the execution of a dynamic and systemic relational process between leader and follower (kets de vries 2014). coachees started to integrate dynamic concepts into their daily work, for example, the primary task, off-task and anti-task behaviour. this allowed for increased rational self-regulation (campbell & groenbaek 2006) and a here-and-now awareness and realisation of when they were unconsciously colluding or being seduced into serving irrational systemic agendas. coaching facilitates the conceptualisation of leadership and its complexity. systems psychodynamic leadership coaching facilitated coachees’ experiential conceptualisation of leadership as consisting of social and political conscious and unconscious dynamics. as leaders, their self-awareness and authorisation facilitated their more effective boundary management between self, other and organisational system (kets de vries et al. 2007). in terms of jaques’ (1990) stratified systems theory, postulating how leaders need to deal with increasing levels of complexity as they get promoted up the hierarchy, splc seems to have stimulated fourth-order complexity and decision-making. systems psychodynamic leadership coaching facilitated coachees’ conceptualisation of leadership as a dynamic relationship with others and an unconscious relatedness with the system as a whole. systems psychodynamic leadership coaching stimulated third-order complexity and decision-making. it seems that the clearer explication of leadership as a construct in sp was advantageous in coachees’ systemic conceptualisation and dealing with leadership complexity. coaching facilitates the construction of a leadership identity. systems psychodynamic leadership coaching facilitated a systemic awareness and strong efforts to establish an own leadership role boundary enhanced with self and others’ authorisation towards realising the coachees’ leadership identity (campbell & groenbaek 2006). coaching facilitates the transference of leadership competencies and virtues. systems psychodynamic leadership coaching addressed cognitive, personal and social characteristics and universal leadership virtues such as humanity (kindness, social intelligence) and courage (emotionality, authenticity, bravery, persistence) (kets de vries 2014). systems psychodynamic leadership coaching facilitated leaders’ movement from dependence and the denial of their own systemic impact towards working with their independence and ownership in their leadership roles, with some evidence of interdependence (stapley 2006). they became more robust in their exploration of their own and other’s behaviours as they explored the effect of their defensive behaviours. the kellogg foundation’s indicators for effective leadership the kellogg foundation indicators (development guild 2015) are categorised as individual, organisational, community, field (outcome) and systemic. systems psychodynamic leadership coaching facilitated behavioural awareness in various aspects of all five indicators. one outstanding element was the coachee’s openness to use the self as instrument (kets de vries et al. 2007) in the systemic context, meaning to recognise defences such as projections and transferences as they happen. in terms of sibson consulting’s (o’malley & baker 2012) 12 criteria of effective leadership, splc stimulated intent, focus and human significance. systems psychodynamic leadership coaching additionally stimulated form, representation, imagination, human significance, context and criticism. less evidence occurred about authenticity, engagement and pleasure (which one would expect to be addressed in positive psychology coaching). it seems that splc impacted leadership functioning in terms of self-leadership, leadership of the other (colleagues and followers in dyads and teams) and leadership in the organisation as a system (greif 2007). conclusion professionals in this financial services organisation experienced splc as a demanding as well as a fulfilling activity. they explored their own dynamic conscious and unconscious leadership behaviour, how they take up their leadership role, authorise themselves and their colleagues, as well as how they are authorised by the organisational system, manage their boundaries and develop insight into their leadership identity. systems psychodynamic leadership coaching as methodology created a good-enough container for these professionals to explore, gain a significant level of understanding of and insight into their own anxiety and defensive behaviours to work towards the optimisation of their leader–follower relationships. the organisation’s request for feedback about the impact of sp as a coaching stance is encapsulated in the discussion section of this article. measured against guidelines for leadership coaching effectiveness, splc seems to comply with most of the set criteria. although splc does not subscribe to a specific leadership theory, it seemed necessary to report back in this manner because of the corporate need to compare coaching inputs for purposes of return on investment. the limitations of this research are as follows. the literature on sp in leadership coaching is limited, which makes the comparison and confirmation of findings difficult. in terms of design, the contractual restriction of working with only six coaching sessions limited the possibility of a deeper study of coachees’ transference of learning to more actual leadership interactions. the thickness of the data may imply that this study reported on too many phenomena in the coachees’ experiences, as opposed to focussing on fewer phenomena and giving a deeper rendition of their manifestation. it was recommended that future research include coaching with other professional fraternities and the experienced difference between professions and that different leadership coaching stances be compared in order to illustrate the strengths and most appropriate application of various models. for this specific organisation, it was recommended that the data from this study should be followed up, for example, in interviews to ascertain the long-term impact of splc. a last recommendation is that leaders at partner level be included in the splc programme. apart from providing them with the opportunity to learn about their individual and team dynamics, it would also give a gestalt view of the manifesting sp of this kind of financial services organisation. acknowledgements competing interests the author declares that he has no financial or personal relationships that may have inappropriately influenced him in writing this article. references armstrong, d., 2005, organisation in the mind. psychoanalysis, group relations and organisational consultancy, karnac, london. armstrong, d. & rustin, m., 2015, social defences against anxiety, karnac, london. avolio, b.j., 2007, ‘promoting more integrative strategies for leadership theory-building’, american 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of results conclusions and recommendations acknowledgements references about the author(s) noxolo e. mazibuko department of business management, nelson mandela metropolitan university, south africa elroy e. smith department of business management, nelson mandela metropolitan university, south africa eddie tshuma harare professional updating centre, zimbabwe republic police, harare, zimbabwe citation mazibuko, n.e., smith, e.e. & tshuma, e., 2018, ‘management perceptions regarding factors impacting privatisation of parastatals in a developing country’, south african journal of economic and management sciences 21(1), a1543. https://doi.org/10.4102/sajems.v21i1.1543 original research management perceptions regarding factors impacting privatisation of parastatals in a developing country noxolo e. mazibuko, elroy e. smith, eddie tshuma received: 02 feb. 2016; accepted: 12 feb. 2018; published: 26 apr. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: worldwide, the ownership of public organisations has been transferred to the private sector through privatisation. the poor performance of public organisations has necessitated privatisation of these organisations. aim: this article explored management perceptions regarding factors impacting the privatisation of parastatals in a developing country, namely zimbabwe. setting and method: a comprehensive literature study provided the theoretical framework for this research. primary data were collected by means of a survey obtaining 301 self-administered structured questionnaires from 27 parastatals in zimbabwe. seven null-hypotheses were tested using advanced statistical techniques such as regression and correlation analyses. results and conclusions: factors identified in this study that could impact privatisation of parastatals in zimbabwe are stakeholder consultation, stable macroeconomic conditions, government transparency and a well-developed privatisation process plan. if privatisation is implemented effectively, it could lead to increased organisational performance, effective governance and economic empowerment. it also appeared that variables such as union consultation, role ambiguity, political intervention, attractiveness to foreign investment and government commitment do not exert a significant influence on perceptions of privatisation. practical guidelines were also provided to enhance the implementation of privatisation in parastatals. introduction governments all over the world took over the control of organisations after the second world war through nationalisation. however, many countries have since reversed this trend and the ownership of nationalised organisations has been transferred to the private sector through privatisation (burns, katsouros & jones 2004:66). according to dore et al. (2008:186), in 2006, zimbabwe had 76 public organisations of which 60% had been inherited from the rhodesian administration. these parastatals were adopted or created to provide essential social services to the public, economic stabilisation and the equitable distribution of resources. state ownership of these organisations was also linked to the government’s socialist ideology and an inward looking economic strategy (tambudzai 2003:165). dore et al. (2008:189) note that over the years, parastatals in zimbabwe have suffered huge losses. lack of profitability by these organisations has resulted in their low capacity to sustain their operations financially. parastatals are usually an uneconomical way of doing business as they are characterised by heavy losses, budgetary burdens, poor services, mismanagement and political interference (akpan 2002). nellis (2007:11) argues that in an effort to address the poor performance and financial losses of public organisations, proponents of privatisation accelerated the privatisation process without sufficiently addressing the fundamentals on which a successful privatisation programme would be based. government, as the provider of essential services to the public, has been left with no option but to subsidise their operations so that they continue to provide necessary services to the public. the growth rate of these subsidies has not matched the growth of the economy, thus raising government concerns (sikwila 2010:1). the impact of privatisation on performance in low-income countries requires the improvement of a wide range of institutional issues such as the political, legal management and financial capacity in these countries (parker & kirkpatrick 2007:526). the failure to deal with these constraints prior to privatisation may lead to imperfect markets, or a monopoly, at the expense of a competitive and dynamic economy, as argued by the proponents of privatisation. in zimbabwe, the privatisation process has been criticised for its slow pace, its impact on the general public and the economy, as well as the efficiency and transparency of the process (tambudzai 2003:166). furthermore, there are about 12 stakeholders who are involved in the privatisation and commercialisation of parastatals in zimbabwe. this situation has created confusion in the privatisation programme through the promotion of clientelism, patronage and the quest of rent-seeking actions (dore et al. 2008:197). the aim of this article is to test the hypothetical model of the study by investigating management perceptions regarding five possible factors impacting privatisation of 27 parastatals in zimbabwe. the first part of the article covers the introduction and background to the study, problem statement and research objectives. this is followed by a literature overview of privatisation, hypotheses and the research methodology adopted for this study. the last part covers the empirical results and highlights the main conclusions and recommendations. problem statement according to parker and saal (2003:25), throughout history, the ownership of production and commerce has always been provided by the public and private sector. this arrangement has raised the question whether the means of production or directing commerce should be under the ownership of the state or under private control. clifton, comin and fuentes (2003:5–6) are of the opinion that underperforming public organisations should be privatised; this could lead to the private sector having the sole responsibility of doing business. still, a vast amount of literature both for and against privatising public services has been developed. a growing field of enquiry around alter-natives has emerged, albeit in a fragmented and inconsistent way. the literature in this regard tends to be highly localised and sector-specific and lacking conceptual and methodological consistency (mcdonald & ruiters 2012:1). however, the focus of this study will be on factors impacting successful privatisation in zimbabwe. the privatisation process in zimbabwe has been criticised for its slow pace, its impact on the general public and the economy, as well as the efficiency and transparency of the process (tambudzai 2003:166). akpan (2002) notes that privatisation finds african governments unprepared and – considering poor conditions such as deteriorating economies, high unemployment, underdeveloped markets, inexperienced professionals and unstable political systems with weak bureaucracies – incapable of designing and implementing the privatisation process. privatisation thus becomes a very difficult affair. pamacheche and koma (2007:12) argue that many african politicians and public officials benefit from parastatals as they are offered gifts, board memberships and future jobs for themselves and engage in corrupt activities such as procurement kickbacks. all these may no longer be possible after privatisation; hence, such governments resist the move to privatise organisations. the privatisation process in zimbabwe has raised a great deal of criticism in the press by politicians, professional organisations and civil society. although some research has been done on parastatals in zimbabwe, the main contribution of this study is to add to the existing body of knowledge by developing a theoretical model which can be utilised in other developing countries. a total of 27 parastatals and 301 respondents was investigated to assess the impact of five factors on privatisation of parastatals in zimbabwe. this could shed light on the complex and changing landscape of privatisation in developing countries. as this is a perceptual study of managers of parastatals, it assesses their perceptions of possible factors that could impact on successful privatisation in zimbabwe. this led to the following research question to be addressed in this study: what are management perceptions regarding factors impacting the privatisation of parastatals in zimbabwe? objectives the primary objective of this article is to assess management perceptions regarding factors impacting the privatisation of parastatals in zimbabwe. the following secondary research objectives will assist to achieve the primary objective of the study: to critically review the literature pertaining to various aspects of privatisation. to empirically assess factors impacting the successful implementation of privatisation of parastatals in zimbabwe. to provide managerial guidelines and recommendations on privatisation that need to be improved in zimbabwe. theoretical overview of privatisation clarification of key concepts privatisation according to yonnedi (2010:537), privatisation can be defined as the change in the production of goods and services from the public sector to the private sector. similarly, von weizsacker et al. (2005:4) posit that privatisation can be defined as all the activities which are meant to increase the participation of the private sector in the production of goods and services by decreasing government’s participation in such matters. mudambi (2003:583) defines privatisation as the adoption of any activity which reduces the role of government and increases the function of the private sector in the economy. parastatals according to adeyemo and salami (2008:402), parastatals or public organisations are organisations which are owned by the state or in which the state holds a majority shares, provide goods and services, has a separate management structure and carries out business activities. macleod (2004:33) states that parastatals are organisations that collaborate with the state without forming part of its administration. stakeholder consultation according to felsinger (2011:22), stakeholder consultation is a less formal process through which themes and policies of interest are discussed within or across stakeholder groups. pamacheche and koma (2007:19) state that the idea is to gather information on stakeholder views and to encourage them to participate in the process of formulating policy. business conditions according to hough et al. (2008:53), the operations of all organisations are influenced by the external environment, which is characterised by government actions, different cultures of societies, population demographics, economic activities, legal issues, technological factors and the level of competition in the industry. equally, gomez-mejia, balkin and cardy (2008:62) point out that the business environment of any country comprises factors which have an effect on the benefits, costs and risks associated with doing business in that country. government considerations intervention by governments becomes severe when foreign ownership of businesses is shifted to government or citizens of a country through confiscation, expropriation and domestication. governments throughout the world have used laws, regulations and institutions to influence and control business transactions in the economy (rodriguez, uhlenbruck & eden 2005:383). similarly, governments have a duty to determine the policies of doing business within its boundaries. according to pamacheche and koma (2007:18), governments must be very clear on the objectives of privatisation in order to put in place the necessary conditions for their successful achievement. institutional framework paterson, blewett and karimi (2006:2) state that the government should address structural reforms to ensure adequate investment legislation, improved security and infrastructure as well as streamlined and strengthened regulation. according to pamacheche and koma (2007:18), the lack of a proper institutional and regulatory framework, and not improper execution, has contributed to the failure of many privatisation programmes to achieve their intended objectives. it is important to design a suitable institutional and regulatory framework which will enhance the successful implementation of the privatisation process. privatisation in developing countries nellis (2005:7) notes that many of the privatisations in africa have targeted small, less valuable and declining organisations in the manufacturing and industrial sectors as well as the service sectors of the economy. in comparison, the privatisation of infrastructure utilities has always made little to no progress as most african leaders prefer to address the problems facing parastatals through means other than a change of ownership. in addition, african governments usually hold on to a substantial amount of shares from the few infrastructure privatisations they would have done on the pretext of protecting the public interest from mischievous and poorly performing new buyers. moreover, the governments hold back these shares with the hope of selling them when the new buyer has improved the value of the organisation. parker and kirkpatrick (2007:526) further argue that the lack of enthusiasm to privatise these high potential organisations, sluggish pace of sales, poor business and legal environments, shortcomings of government regulation and administration as well as the failure to sell all stakes has contributed to a lack of foreign investment in infrastructure privatisations. according to zhou (2000:200), in zimbabwe, as in most african countries, public enterprise reforms were implemented as a major component of structural adjustment programmes. the policy goals in zimbabwe included the need to: reduce the budget deficit (emanating from loss-making parastatals), improve the operational viability of public organisations (through operational, organisational and managerial restructuring), and rectify historically-induced tilted ownership patterns in the economy – by economically empowering indigenous groups. the impact of privatisation on performance in low-income countries requires the improvement of a wide range of institutional issues such as the political, legal, management and financial capacity in these countries (parker & kirkpatrick 2007:526). according to wohlmuth et al. (2004:328), privatisation transactions have increased in africa, both in terms of the number and value of these transactions. sikwila (2010) concurs that most of these parastatals have one thing in common: they have benefited from government subsidies extended to cover the costs resulting from their loss-making, non-specialised and misplaced managers, inefficiencies and inability to make sustainable profits. notwithstanding the important role played by some of the parastatals in the provision of essential services such as energy and communications, their performance might have created a financial constraint to both public and private sector performance. although estrin and pelletier (2015) argues that very few privatisation deals have occurred in post-2008 in africa, there are a few success stories, such as benin with the privatisation of the cotton and public utility sectors, such as benin telecom, nigeria sold 15 electricity generating and distributing companies in 2013 and chad sold 80% of the telecommunication sector. privatisation: the zimbabwean experience godana and hlatshwayo (1998:10) state that zimbabwe inherited a large number of parastatals at independence – more than 60% were established before independence. the parastatal sector encompasses a wide variety of activities such as agriculture, manufacturing, mining, transport, energy, communication and finance. according to mcdonald and ruiters (2005:226), privatisation started being debated upon in zimbabwe in the 1990s as part of a series of neoliberal economic reform packages; namely, the economic structural adjustment program (esap) in 1990–1995 and its follow-up policy, the zimbabwe program for economic transformation (zimprest) in 1995–2000. privatisation was then implemented after multilateral donors, business people and some individuals perceived of it as a universal remedy for the increasing economic challenges being faced by zimbabwe and a decline in service delivery from many sectors. zhou (2001:252) argues that from 1996 to 1998, privatisation was implemented without any legally constituted privatisation plan of action. parastatals which were privatised by the end of 1999 included dairiboard zimbabwe limited (dzl), the cotton company of zimbabwe (cottco), the commercial bank of zimbabwe (cbz), the zimbabwe reinsurance company of zimbabwe (zimre) and the zimbabwe tourism group of companies (rtg). the privatisation agency of zimbabwe the criticisms of the bit-by-bit approach to privatisation in zimbabwe resulted in the establishment of the privatisation agency of zimbabwe (paz), in september 1999, which had a mandate of driving the privatisation process (dore et al. 2008:196). furthermore, in 2005, paz was renamed the state enterprises restructuring agency. it is the responsibility of state enterprises restructuring agency (sera) to prepare an initial commercialisation and restructuring plan meant to highlight the reasons of restructuring and privatisation. this plan suggests the method of privatisation to be adopted and these recommendations were then submitted to the inter-ministerial committee on commercialisation and restructuring of public enterprises (imccr) for approval by cabinet. thus, key decision making on the privatisation of organisations remained the prerogative of cabinet and the imccp. methods used during privatisation according to moyo (2011:4), the current thrust throughout the world has shifted from wholesale privatisation to a more conservative government shareholding dilution through strategic partners, engagement of joint venture partners, listing on capital markets and public private partnerships. waigama (2008:34) posits that professionals who have the capacity of forging a link between objectives, on the one hand, and strategies, on the other, should be used to formulate privatisation strategies. experience has also shown that the involvement of professionals in strategy formulation has paid dividends as higher sale prices have been realised. in most cases, the approaches and methods used in privatising public organisations will depend on the privatisation policy objectives as well as the nature and operational status of parastatals to be privatised (tambudzai 2003:178). the economic and financial environment, the size of the organisation, its strategic importance, the needs of the organisation in terms of capital and technology, the state of its debt as well as management know-how have a bearing on the privatisation programme. the most common methods which have been successfully used in zimbabwe include: public share offering or floatation, trade sales, collective investment schemes, sales to employees or management teams (internal privatisations), private and targeted placements, management contracts/contracting out or leases, and liquidation. similarly, public share offering was used in the privatisation of cottco, dzl, cbz and rtg in order to create wider share ownership in zimbabwe. furthermore, other methods such as management buy-out schemes and employee share ownership schemes have also been used in the privatisation of cottco and dzl so as to achieve the objective of economically empowering the indigenous people. advertising in foreign media and foreign missions have also been used to target zimbabweans living abroad. criticism of privatisation in zimbabwe according to mohammed (2008:13), privatisation as a policy option has created a deep economic disruption in africa leading to a socio-ethnic crisis and political instability. similarly, masunungure and zhou (2006:6) contend that privatisation policy prescriptions were embraced in zimbabwe and other african countries in the early 1990s, largely as conditionalities for accessing the balance of payments under the esap. consequently, in zimbabwe, privatisation resulted in the retrenchment of many employees thereby deteriorating their wellbeing as a result of a lack of social network mechanisms. in addition, the privatisation of organisations in zimbabwe resulted in more funds being drained than it generated. as a result of the lack of an autonomous privatisation institution to monitor the privatisation process, private financial intermediaries were paid undisclosed amounts during the valuation and listing of the organisations which were privatised (masunungure & zhou 2006:6). zhou (2000:215) argues that the weakness of policy documents in zimbabwe is that they do not clearly spell out the strategies that will be used to ensure the economic empowerment of indigenous groups during the privatisation process. tambudzai (2003:188) claims that the trade unions have, however, criticised the programme for lack of proper legislation dealing with workers’ issues and transparency when it comes to government and management teams. similarly, masunungure and zhou (2006:7) argue that zimbabwe did not put in place a consistent legal framework and specific defence schemes to support the indigenous agenda. dore et al. (2008:195) postulate that the framework for reforming public organisations in zimbabwe is a minefield as it is characterised by a multiplicity of pieces of legislation, institutions and, at times, policies which contradict each other, and even policy reversals. proposed hypothetical model in light of the secondary sources analysed in this study, and particularly the models offered by donaldson and wagle (1995), aboujdiryha (2011) and mudambi (2003), a hypothetical model regarding management perceptions of factors impacting privatisation of parastatals in zimbabwe was constructed (figure 1). the proposed theoretical model shows that the perceptions of privatisation are influenced by five independent variables, namely stakeholder consultation, business conditions, government considerations, the institutional framework and management of the privatisation process. these perceptions then impact on the two dependent variables, namely economic benefits and organisational performance. figure 1: proposed hypothetical model. hypotheses in an effort to address the objectives of this study, the following research hypotheses were formulated. there are five factors (independent variables) impacting perceptions regarding privatisation and two outcomes (dependent variables): h01: stakeholder consultation does not influence perceptions of privatisation. h02: business conditions as measured by attractiveness to foreign investment and macroeconomic conditions do not influence perceptions of privatisation. h03: government consideration as measured by perceptions of trust, political intervention, role conflict and role ambiguity does not influence perceptions of privatisation. h04: the institutional framework as measured by transparency, two-way communication as well as the speed and replicability of the privatisation process does not influence perceptions of privatisation. h05: management of the privatisation process does not influence perceptions of privatisation. h06: perceptions regarding privatisation do not influence the economic benefits as measured by perceptions of investments, competition, improved services, effective corporate governance and economic growth. h07: perceptions regarding privatisation do not influence organisational performance as measured by perceptions of customer satisfaction, organisational efficiency and innovation. research methodology research paradigm this study has adopted the positivist research philosophy. quantitative study emphasises the measurement and investigation of underlying relationships between factors, not processes. it is concerned with examining numerical data. the approach draws a large and representative sample from the population under study and attempts to generalise to the whole population. population the population of this study was all parastatals operating in zimbabwe. according to zimbabwe government online (2011), there are 69 parastatals operating in zimbabwe. they represent a wide spectrum of sectors, which include agriculture, transport, energy, finance, environment, education, telecommunications, health, industry and trade, information, commerce, science and technology, tourism, water and mining. the study was conducted in june 2012. sampling in this study, a sample of 27 parastatals was selected from the study population using a probability sampling technique, namely simple random sampling. the simple random technique was used because it gave every parastatal an equal opportunity of being selected. within each parastatal, respondents were then selected on the basis of convenience and accessibility. a total of 700 questionnaires were distributed and 301 usable questionnaires were received (effective response rate of 43%). questionnaire design a survey by means of self-administered questionnaires was used to collect primary data from managers of the selected parastatals. the questionnaire was pilot-tested before collecting data. the pilot study was conducted among 39 respondents who were not part of the final empirical study. some minor changes were made to the questionnaire regarding the wording of some of the statements. the questionnaire consisted of four sections: section a investigated the impact of five factors on perceptions regarding privatisation in zimbabwe. a seven-point likert-type ordinal scale was used. a total of 50 statements were used. section b assessed the perceptions regarding privatisation. a seven-point likert-type ordinal scale was used (9 statements). section c examined the outcomes of privatisation. a seven-point likert-type ordinal scale was used (22 statements). section d assessed the demographical characteristics of respondents by means of a nominal scale; nine categorical variables were used. items to measure each variable were developed by using self-developed items based on literature and items whose reliability and validity have been confirmed in previous research studies (e.g. mohd 2011; mosavi, amirzadeh & dadmehr 2011:5910; vo & nguyen 2011; yonnedi 2010). data collection secondary data were collected from books, journals, and internet as well as library databases. self-administered structured questionnaires were used to collect primary data from managers in the selected parastatals during a survey. these questionnaires were completed by the participants without the assistance of an interviewer. primary data were collected by the researcher with the assistance of two fieldworkers who were recruited for this exercise. data analysis this study employed quantitative methods of data analysis, such as descriptive statistics, frequencies, factor analysis, regression analysis and correlation analysis. validity and reliability of the measuring instrument construct validity (convergent and discriminant validity) was used to measure whether the constructs of the study measured what they intended to measure by means of exploratory factor analysis. both face and content validity were also ensured by means of conducting a pilot study and using the expert judgement of a managerial and economics researcher and statistician. reliability of the measuring instrument refers to its consistency – that is, the degree to which a measuring tool will produce the same results when applied more than once to the same group under similar conditions. the assessment of the internal reliability of the instrument was done by means of calculating cronbach’s alpha values. empirical results the empirical results were analysed and presented based on the measuring instrument (questionnaire), the layout of which is presented in table 1. table 1: variables used in measuring instrument (questionnaire). demographic profile of respondents the demographic profile of the sample is summarised in table 2, which indicates the frequency distributions for the nine categorical variables (data classification) used in this study. table 2: demographic profile of respondents. the results indicated that most of the respondents occupied middle management and supervisory positions (34% and 39% respectively) and were mainly male (77%). the results also indicated that the respondents were mainly aged between 31 and 40 years and 41 and 50 years (27% and 38% respectively) and had attained ‘a’ level/diploma or a bachelor’s degree (32% and 30% respectively). thirty-one per cent of the respondents had been employed at their parastatal for 21 years or more. most of the respondents were employed in the infrastructure development industry (24%) and communication industry (23%) and what could be regarded as larger parastatals (86%), employing more than 200 people and have been in existence for more than 21 years (85%). reliability and validity of the measuring instrument the first stage of the data analysis was to evaluate the discriminant validity of the instruments used to measure the variables. this was done by means of exploratory factor analysis. the exploratory factor analysis was done by using the computer program statistica (version 10). in this study, a loading of 0.5 and above was considered significant to confirm convergent validity. a cut-off point of three (3) items loading in a factor was considered significant in this study. the individual exploratory factor analyses are not included in this article, but the combined factor matrix is (table 3). as some items were deleted (below cut-off point of 0.5) and some variables loaded onto different factors, some factors had to be renamed or new factors formed as a result of the discriminant validity assessment during the exploratory factor analysis. the original theoretical model therefore had to be adapted and the reliability of the new and adapted variables had to be reassessed. as a result of the renaming and re-specification of the variables, some of the hypotheses also had to be renamed and subjected to empirical verification. table 3: cronbach’s alpha coefficients of the latent variables. the following construct labels of the re-specified model are: stakeholder consultation loaded as stakeholder participation (sp) and union consultation (uc). business conditions loaded as attractiveness to foreign investment (afi) and stable macroeconomic conditions (smc). government considerations loaded as role ambiguity (ra) and political intervention (pi). institutional framework loaded as government transparency (gt) and government commitment (gc). management of the privatisation process loaded as the privatisation process plan (ppp) and privatisation process implementation (ppi). perceptions of privatisation (pp) loaded as one factor. economic benefits loaded as effective governance (eg), competitive advantage (ca) and economic empowerment (ee). organisational performance (op) loaded as one factor. the cronbach’s alpha coefficients of the latent variables based on the comprehensive exploratory factor analysis were all above the cut-off point of 0.6 (table 3) and, as such, all the variables were considered for further analysis (blaikie 2003). the removal of individual items used to define constructs from any of the variables did not improve their internal reliability and therefore the individual items were all retained (table 3). regression analysis results multiple regression analysis was used to investigate whether the identified independent variables had a considerable influence on management perceptions regarding privatisation. factors influencing perceptions of privatisation in zimbabwe as indicated in table 4, the coefficient of multiple determination (r2) of 0.536 points out that 54% of variability in the model is explained by perceptions of privatisation. results showed that stakeholder participation (sp) (b = 0.114, p < 0.044), stable macroeconomic conditions (smc) (b = 0.093, p < 0.047), government transparency (gt) (b = 0.098, p < 0.034) and privatisation process plan (ppp) (b = 0.400, p < 0.000) are all positively related to perceptions of privatisation. privatisation process implementation (ppi) (b = −0.116, p < 0.026, r = −0.106) has a negative influence on perceptions of privatisation. the variables union consultation (uc) (0.03), role ambiguity (ra) (0.002), political intervention (pi) (0.003), attractiveness to foreign investment (afi) (0.030) and government commitment (gc) (0.042) do not exert a significant influence on perceptions of privatisation. table 4: regression analysis: factors influencing perceptions regarding privatisation. the results of the regression analysis of influence of perceptions regarding privatisation on dependent variables (table 5) show a moderate relationship between perceptions of privatisation (t = 2.695) and effective governance (eg). they also indicate that perceptions of privatisation do not exert a significant influence on competitive advantage (ca) (b = −0.010). perceptions of privatisation have a strong influence (t = 5.288) on economic empowerment (ee) and a moderate influence (t = 2.577) on organisational performance (op). table 5: regression analysis: influence of perceptions regarding privatisation on dependent variables (outcomes). correlation analysis of the hypotheses a correlation analysis was conducted to show whether relationships existed between two variables and also to show the overall strength of the relationships (burns & burns 2008:342; cramer 2003:16; hair et al. 2007:367). a statistical correlation coefficient (r) takes values which are between −1.0 and +1.0 (burns & burns 2008:343). a detailed correlation matrix falls beyond the scope of this article. all the variables had positive correlations with one another. descriptive statistics in analysing the mean scores of variables obtained from the empirical study (table 6), it appears that most of the scores cluster around point four (neutral) on the scale. table 6: descriptive statistics for the variables. for political intervention, it appears that respondents tend to somewhat agree (point five) with the statements. for privatisation process implementation, effective governance, competitive advantage and organisational performance, it appears that respondents agree (point six) with the statements. the standard deviation score for all the variables (table 6) seem to be relatively high (above one), indicating some variability around the mean score. results of the hypotheses testing as a result of the formulation of the adapted model, the seven null-hypotheses initially tested had to be reformulated (table 7). table 7: results of hypotheses testing. discussion of results the empirical results show that there is a significant correlation between stakeholder participation and management perceptions of privatisation (h01.1 rejected). the empirical results indicate that management perceives that not all employees, managers and customers participate in the privatisation process, that there are not shared goals and that privatisation is not done within a framework that ensures access to information pertaining to privatisation. stakeholder participation is thus important during privatisation because these stakeholders can easily disrupt the process if they do not actively participate and reduce opposition to the process. stakeholders could offer valuable input when designing and implementing privatisation processes, and the participation of stakeholders fosters government commitment, while the availability of relevant information could lead to a credible process. the empirical results also reveal that there is a significant positive correlation between stable macroeconomic conditions and management perceptions of privatisation (h02.2 rejected). findings indicate that parastatals do not operate in a stable macroeconomic environment that encourages government to privatise its organisations and government is implementing macroeconomic stabilisation policies that assist in achieving successful privatisation. government should ensure that there is limited financial sector distress in order to achieve successful privatisation so that the country can attain its anticipated economic growth. the findings of this study show that government transparency has a significant positive correlation with management perceptions of privatisation (h04.1 rejected). information regarding the bidding process, policies and guidelines regarding privatisation should be accessible to all parties involved in the privatisation process. transparency should be enhanced by informing and educating the public so that they can be active participants in the privatisation process as well as engaging professional institutions to look into the backgrounds of the potential investors. the empirical results further show that the privatisation process plan has a significant positive correlation with management perceptions of privatisation (h05.1 rejected). the results indicate that the privatisation process is guided by a formal plan of action and that the schedule of all parastatals identified for privatisation is equally accessible to all stakeholders. whenever governments embark on a privatisation programme, it is important that a clear plan, accompanied by proper implementation, supervision and an effective evaluation process, is put in place so that the privatisation objectives can be achieved. the study revealed that the privatisation implementation process has a negative relationship with management perceptions of privatisation (h05.2 rejected). the results indicate that there is a lack of structural capacity to enhance the privatisation process and that there is no autonomous institution to lead and manage the privatisation process. the results also indicate that there is a lack of proper valuation of assets to enhance the credibility of the privatisation process. successful privatisation could be achieved through the engagement of professional institutions in the valuation of organisations identified for privatisation. the empirical results also indicate a statistically significant relationship between perceptions of privatisation and effective governance (h06.1 rejected). government should be aware that privatisation improves service delivery by offering high-quality goods and services through the employment of qualified employees and put in place all the critical factors of implementing successful privatisation so as to realise economic growth. it appears that there is a statistically significant relationship between perceptions regarding privatisation and economic empowerment (h06.3 rejected). it is therefore important for citizens to participate in the economic activities of their country, such as privatisation, so as to economically empower them. it appears also that there is a statistically significant relationship between management perceptions of privatisation and organisational performance (h07 rejected). government should employ qualified staff or engage them in training sessions so that they can develop their competencies to deliver better services to their customers, and competent managers who have the capacity to plan for the operations of their organisations so that they become innovative and proactive. if privatisation is properly implemented, it seems that these could be positive outcomes of this process. based on the empirical results and revised hypothetical model of this study, eight of the 14 tested variables showed statistically significant relationships. three independent variables, namely stakeholder participation, stable macroeconomic conditions and government transparency, could impact the privatisation process plan and implementation of the privatisation process, which ultimately have an impact on effective governance, economic empowerment and organisational performance. conclusions and recommendations the main research question of the study was to assess management perceptions regarding factors impacting the privatisation of parastatals in a developing country such as zimbabwe. this study has contributed to the existing body of knowledge by developing a theoretical model which can be utilised in other developing countries, where capital markets are underdeveloped, to test perceptions regarding the privatisation of parastatals. the model identified five factors that could impact on privatisation of parastatals, namely stakeholder consultation, business conditions, government considerations, institutional framework and management of the privatisation process; if correctly implemented, these factors could lead to economic benefits and increased organisational performance. this model will act as a foundation for other studies investigating the factors influencing perceptions of privatisation and the outcomes of privatisation in a developing country. the empirical results of this study led to the conclusion that management perceived the privatisation of parastatals as being implemented without adequate participation of stakeholders or union consultation; as a result, their roles in privatisation were not clear. management also perceived the macroeconomic conditions prevailing in zimbabwe as unstable, hence failing to attract foreign investment could decrease the chances of successful privatisation. furthermore, management perceived political intervention as hindering progress during the privatisation process. the empirical results also indicate that management underestimated the importance of a privatisation process plan and that there was a need for an autonomous institution to manage privatisation in zimbabwe. management was of the opinion that information regarding issues such as the bidding process, regular feedback to stakeholders, clear guidelines and policies regarding privatisation as well as upward and downward communication processes were not accessible to all parties involved in the privatisation process. furthermore, management indicated that the lack of government commitment has slowed down the privatisation process and that there were many key role players in the privatisation process in zimbabwe. the national center for policy analysis (2013) alleges that, although governments increasingly embrace privatisation, they often underestimate the benefits arising from it. when implemented with care, due diligence and with a focus to maximise competition, privatisation is an approach that put results, performance and outcomes first to deliver high-quality public services at a lower cost. some general guidelines for implementing privatisation in parastatals are provided in table 8. table 8: general guidelines for implementing privatisation in parastatals. limitations of the study the following limitations of the study are acknowledged: the study was carried out during a time when zimbabwe was experiencing an unstable macroenvironment as a result of a fragile government of national unity. this situation could have contributed to respondents having to provide biased responses in an effort to secure their jobs. there were challenges in obtaining permission to carry out research in some parastatals for security reasons. there is a possibility that the respondents could have answered the items in the way in which they viewed the items and not in the way in which the items were intended to measure the variables of the study. the use of a self-administered questionnaire did not allow the researcher to explain the items to the respondents. suggestions for future research this study investigated management perceptions regarding the privatisation of parastatals in zimbabwe. the model and measuring instrument developed in this study could also be used to assess privatisation in other developing countries. other researchers could explore the impact of privatisation in respect of social issues, such as employment in zimbabwe, as this study concentrated primarily on the economic outcomes of privatisation. other studies could investigate privatisation methods that are suitable for use in zimbabwe and other developing countries, as some of the methods previously used garnered criticism because they are viewed as favouring the rich. as this was mainly a perceptual study regarding privatisation in zimbabwe, other studies could include a case study or desktop study of successful privatisation in zimbabwe. acknowledgements the authors would like to thank the respondents of parastatals in zimbabwe and dr eddie tshuma for conducting the literature and empirical study. competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions e.t. conducted the literature and empirical study, n.e.m. wrote the article and e.e.s. provided guidance throughout the study and finalisation of the article. references aboujdiryha, a.a.a., 2011, ‘privatisation processes and firm performance, the libyan industrial sector’, phd thesis, university of twente, enschede, the netherland, viewed 28 march 2011, from 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accepted: 22 oct. 2018; published: 25 mar. 2019 copyright: © 2019. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the south african public sector faces numerous internal and external risks that limit the performance of its entire supply chain. an understanding of these risks and their effects is an important milestone in overcoming them. aim: this article tested the relationship between supply chain risks, flexibility and performance in the south african public sector. method: a survey questionnaire was administered to 307 supply chain practitioners who were based in the public sector in gauteng. a structural equation modelling procedure was utilised in testing the proposed relationships. results: the results of the study showed that six supply chain risk factors, namely government policies, supply complexity, availability of skills, supplier performance monitoring, information security and process efficiency exert significant influences on supply chain flexibility. in turn, supply chain flexibility exerts a positive influence on the performance of the public supply chain. conclusion: managers in government may be able to improve the public supply chain management function through the suitable management of the supply chain risk factors considered in this study. introduction and background in south africa, supply chain management (scm) in the public sector has emerged as one of the most topical issues among both management practitioners and researchers. this trend is largely attributable to the role of public scm on the fulfilment of socio-economic imperatives by the government. it is widely acknowledged that public scm is an important tool for the development of society through its contribution to both microand macroeconomic developments in the country (dzuke & naude 2015; gurría 2016; harland, telgen & callender 2013). public scm involves the spending of monetary resources by non-financial public enterprises such as state-owned enterprises, provincial and local governments (ismail et al. 2014). for instance, it was projected that the south african government’s total expenditure would be at least r1.5 trillion between 2016 and 2019, across all spheres of government (south african national treasury 2016). these funds would be directed to the procurement of goods, services and infrastructural improvements aimed at developing the country in different ways. the department of public enterprises (2017) further reports that by the year 2020, the south african government would have invested in large-scale projects related to water, transport, electricity, telecommunications and infrastructure at an estimated cost of r3.2 trillion. moreover, data provided by the world bank showed that by the end of 2016, approximately 20.47% of the gross domestic product (gdp) in south africa was attributed to public procurement spending (global economy 2017). several authors (ambe 2016; khoza & adam 2005; mantaris 2014) add that the south african public sector has a significant impact on the economy, particularly the larger public companies that operate in key sectors of the economy, such as energy, telecommunications and transport. it is important, then, for public sector organisations in south africa to continuously explore ways of improving the performance of their respective supply chains to ensure that their contributions to the national economy are maintained. in spite of its fundamental contributions towards socio-economic development, public sector scm in south africa faces high levels of turbulence and uncertainty. as observed by some scholars (dlomo 2016; mafini & pooe 2013; munzhedzi 2016a) public organisations in south africa operate in a highly unstable environment, which is both volatile and imperfect, which tends to limit their performance. according to fourie (2015), unethical conduct involving fraud and corruption cost the south african government large amounts of money each year as fruitless and wasteful expenditure. for instance, in 2014, the south african government spent over r26.4 billion in ways that contravened laws and regulations, including corruption (smart procurement world 2014). further exacerbating this situation is the lack of availability of a skilled scm workforce, which remains one of the key constraints to the expansion of business operations in south africa (department of higher education and training 2016; heyns & luke 2012). policy also remains a major barrier to scm in the south african public sector, particularly the fragmented and sometimes ambiguous legal status of the different legislative instruments for general and specific scm practices (sewpersadh & mubangizi 2017; smit 2015). this unclear legal framework creates uncertainty during the application of legal priority, regarding regulatory interpretation in cases of litigation involving scm (south african national treasury 2016). other notable challenges facing public sector scm include ineffective monitoring and evaluation, the lack of compliance with existing policies, poor planning and too much decentralisation of the procurement system (ambe & badenhorst-weiss 2012a). as a result of these challenges, many south africans do not trust the scm processes in the public sector, and the general perception is that the public sector is failing to fulfil its mandate due to systemic problems in the entire public supply chain (o’regan 2012; south african national treasury 2016). service delivery protests that have become commonplace in south africa over the past few years demonstrate the feeling that people are not receiving the quantity or quality service that they need (reddy 2016; sartorius & sartorius 2015). these issues provide a basis for further scientific inquiries to find relevant solutions. since public scm has important socio-economic implications; it is essential to ensure that its processes are both efficient and effective (ambe & badenhorst-weiss 2012b). it is necessary to develop an understanding of the risk factors that act as both constraints and barriers to the successful performance of public supply chains before applying solutions to improve both the efficiency and effectiveness of public sector scm. as mentioned by khoza and adam (2005:16), getting the south african public sector to perform optimally depends on a host of factors. such factors include but are not limited to the involvement of government (through government policies), the risk of supply, supply chain disruptions, lack of suitable or available suppliers, product performance, information security and internal business processes (kelman n.d.; tucker & gilfilian 2013). an understanding of the effects of these individual risks on other scm functions can be a tool for the mitigation of these risks, which leads to improved public sector supply chain performance (south african national treasury 2015). this article aims to test the relationships between supply chain risks, supply chain flexibility and supply chain performance in the south african public sector. the two specific objectives of the study are to determine the influence of supply chain risks on supply chain flexibility and to establish the influence of supply chain flexibility on supply chain performance. it is notable that despite the availability of extensive literature on supply chain risks, supply chain flexibility and supply chain performance (e.g. ganga & carpinetti 2011; hoffman, schiele & krabbendam 2013; sánchez & pérez 2005; stevenson & spring 2007; thome et al. 2014), the links between these factors remain largely untapped, especially in the african context. additionally, previous studies focusing on scm in the south african public sector (e.g. ambe 2016; ambe & badenhorst-weiss 2012b; bolton 2006, 2016; dlamini 2016; mantaris 2014; munzhedzi 2016b; watermeyer 2011) overlooked these dimensional factors, as well as the possible links between them. this disregard for such a relationship is surprising, given the commitment of a lot of organisational resources to minimising the impact of supply chain risks. this study intends to address this existent research gap. it focuses on supply chain flexibility as a response to supply chain risks and assesses whether supply chain flexibility contributes to supply chain performance in the south african public sector. the study is important in that its results can be used by supply chain practitioners in the public sector to manage various risks experienced in the sector as a way of improving supply chain flexibility and performance. theoretical overview public supply chain management in south africa in south africa, the government spends a lot of resources on various payments to many suppliers who provide numerous products and services (scott 2016). there are over 300 public organisations that make use of public finances (fourie 2015). the finances are channelled towards the procurement of services that include among other things the provision of education, health care services, communication and postal services, power generation and distribution, and water and sanitation (dzuke & naude 2015). the major governing policy frameworks that control scm activities in south africa include the public finance management act of 1999, the preferential procurement policy framework act (pppfa) act (no. 5 of 2000) and the municipal finance management act (no. 56 of 2003). in addition to these is the broad-based black economic empowerment (bbbee) act (no. 53 of 2003), which also provides guidance on how public resources may be used as government acquires products and services. in 2012, the office of the chief procurement officer was also created at the national treasury to superintend the implementation of the available legislative policies in public scm (south african national treasury 2015, 2016). according to the pppfa and the bbbee act, previously disadvantaged individuals and groups are given preference in the allocation of contracts by public sector organisations (smit 2015). these laws further permit all service providers that do not qualify for preferential points to partner with qualifying service providers, which should result in the development of previously disadvantaged service providers (nkuna & nemutanzhela 2012). this process is aimed at promoting fairness and balance in the appointment of service providers. however, the public scm management process remains inhibited by numerous risks, constraints and pressures that include skills shortages, corruption and fraud, policy inconsistencies, management malpractices, political interference and dissatisfied stakeholders (franks 2014; mabelebele 2017). consequently, the south african public supply chain continues to perform below expectations, which in turn limits the performance of the larger south african economy. supply chain risks supply chain risks refer to the threat of injury, damage, loss, liability or any other negative occurrences that result from internal or external vulnerabilities within the supply chain and that may be avoided through pre-emptive action (grose & richardson 2014). in its risk index report, the chartered institute of procurement and supply (2017) identified government policies, supply complexity, availability of skills, supplier performance monitoring, information security and process efficiency as some of the most common supply chain risks in the public sector. there is no single standard instrument for measuring these supply chain risks, as various authors have developed and used different scales to suit their contexts. government policies refer to the regulatory framework within which scm is implemented, as set by the national government (colyvas 2014). for the measurement of government policies, tummers and knies (2014) developed and validated the public leadership questionnaire, which uses five scales, namely accountability, lawfulness, ethical and political loyalty and network governance, to measure public leadership behaviours. some of the individual questions in each of these five scales address policy related issues such as communication of policies and encouraging management and employees to follow them. supply complexity is characterised by a dynamic supply market, unreliable suppliers and an unreasonably high number of suppliers with whom business is conducted, as determined by various factors that include political, economic, technological and social factors, among others (blome, schoenherr & eckstein 2014). hieber (2002) developed a 19-item instrument for measuring supply chain complexity in terms of collaboration, coordination and configuration. the instrument was subsequently adapted and used by hashemi, butcher and chhetri (2013) in their study that developed a framework for building a better understanding of supply chain complexity, which includes questions for checking the complexity of supply mechanisms in both product-oriented and service-oriented organisations. skills availability pertains to circumstances in which employers are able to fill or have considerable ease in filling vacancies for an occupation, or specialised skills needed within that occupation at prevailing levels of remuneration and conditions of employment, and reasonably accessible locations (cappelli 2015). there are numerous instruments developed by different researchers to measure the availability of skills in organisations. for instance, gibson and cook (2001) developed an instrument for hiring practices in third-party logistics firms in the usa. min and emam (2003) created an instrument for developing the profiles of logistics truck drivers for their successful recruitment and retention. mitra (2006) developed questions for use in a survey of the third-party logistics (3pl) service providers in india. in these three instruments, specific aspects concerning the availability of skills, such as the ability of the organisation to fill vacancies, the motivation of employees and levels of turnover are emphasised. supplier performance monitoring involves measuring, analysing and managing a supplier’s ability to comply with, and preferably exceed, their contractual obligation (lysons & farrington 2012). for the measurement of supplier performance monitoring prajogo et al. (2012) used a multidimensional perspective to test the relationship between supplier management and operational performance in different firms. their instrument also tested for the efficiency of the systems and procedures in place to monitor the performance of suppliers, using parameters such as site visits to supplier premises, training of suppliers, providing feedback to suppliers and rewarding suppliers, among others. information security is the preservation of confidentiality, integrity and availability of information (spears 2006). measures developed by herath (2008) dwell on the importance of information security in organisations, capturing issues such as information security awareness in organisations and the role of communication in enhancing this awareness, the development of policies and the provision of training to the managers and employees. process efficiency is intended to ensure that more outputs are achieved using fewer resources in all sets of steps or tasks that the organisation repeatedly employs to create a product or service, reach a specific goal or provide value to a customer or supplier (dohmen & moormann 2010). to measure process efficiency, a comprehensive instrument was developed by betts and tadisina (2009) who integrated issues such as supply, demand and technology into organisational processes to overcome environmental uncertainties. the above individual risks, in different ways, affect the public sector’s day to day supply chain business. according to some scholars (ellis, shockley & henry 2011; maestrini et al. 2017; vanichchinchai 2014) one of the areas where the impact of these individual supply chain risks is highest is with respect to the flexibility of the supply chain, or the extent to which the supply chain can adapt and return to its normal state after being subjected to turbulence. this leads to the following hypotheses: h1: effective government policies lead to increased flexibility of the public supply chain h2: increased supply complexity leads to decreased flexibility of the public supply chain h3: availability of skills leads to increased flexibility of the public supply chain h4: monitoring of supplier performance leads to increased flexibility of the public supply chain h5: effective information security leads to increased flexibility of the public supply chain h6: process efficiency leads to increased flexibility of the public supply chain supply chain flexibility supply chain flexibility is the ability to respond to short-term changes in either the demand or supply situations of other external disruptions, coupled with the adjustment to strategic and structural shifts in the environment of the supply chain (grigore 2009). it is concerned with the organisation’s ability to effectively manage or react to changes with little penalty in time, cost or quality of performance (agus 2011). supply chain flexibility can be considered to be a solution for avoiding most of the common business disruptions by timely and responsive reactions to changes in the supply chain environment (tang & tomlin 2008). one of the popular research instruments available to measure supply chain flexibility was developed by fantazy, kumar and kumar (2009), who empirically tested relationships between strategy, flexibility and performance in the supply chain context. their instrument addresses flexibility issues such as involvement of suppliers, management of time and costs when switching between suppliers and information flow management. moreover, the cultivation of flexibility is viewed as a risk management initiative that enables the organisation to respond rapidly to marketplace changes, as well as to potential and actual disruptions, resulting in performance improvements throughout the supply chain (braunsheidel & suresh 2009). accordingly, flexibility is of value for both risk mitigation, response and supply chain performance enhancements (charan 2012). these views lead to the following hypothesis: h7: supply chain flexibility leads to increased performance of the public supply chain supply chain performance supply chain performance is a monitoring process of undertaking a retrospective analysis to determine whether proper processes have been followed and if the desired objectives have been achieved within the supply chain (beamon 1999). one of the basic objectives of scm is to increase total supply chain performance, which is sometimes referred to as supply chain effectiveness (supply chain service level) and efficiency (supply chain cost) (christopher 2012). according to hult, ketchen and slater (2004), scm is not a support function for implementing business strategy, but is specifically meant to drive an organisation’s performance and become a key element of the overall strategy for the entire chain. supply chain performance and the effective management of a supply chain have increasingly been recognised as critical factors in enhancing organisational performance (agus 2011). supply chain performance can be measured using different metrics, such as supplier performance, operational performance, customer satisfaction and financial performance, among others. in some cases, it is possible to use these metrics objectively, if the actual statistical data are made available. however, in a study by betts and tadisina (2009), supply chain performance was measured subjectively, using five parameters, namely customer satisfaction, delivery speed, procurement costs, quality of services, delivery reliability and consistency, as well as supplier performance. these measures were adapted for use in the present study. conceptual model the conceptual model presented in figure 1 was developed for this study. the model identifies six supply chain risk dimensions that are the predictor variables (constructs). these are government policies, supply complexity, skills availability, supply performance monitoring, information security and process efficiency. the mediating variable is supply chain flexibility, which in turn connects to supply chain performance, which is the outcome variable. the relationships are connected using seven hypotheses (h1 to h7) that were tested in this study. figure 1: conceptual model for supply chain risks, supply chain flexibility and performance. research methodology research design and sample the study submitted to the positivist paradigm since it was intended to test several apriori hypotheses to determine relationships between the independent and dependent variables (taylor & milton 2013). to test these relationships, a quantitative approach was used, as this allows generalisation of the results of the study to other public supply chains in different environments. a survey design, which involved the collection of data using questionnaires, was utilised for this study since it is associated with representativeness, impartiality, being systematic, reliability and objectivity (creswell 2014). a cross-sectional strategy, which involved the collection of data from respondents once in a specific period (denscombe 2014), was used to conduct the research. the sample was composed of supply chain professionals in the south african public sector drawn from state-owned enterprises and government departments based in gauteng. the province of gauteng was deemed appropriate because it houses the head offices of most south african public sector organisations. to select the sampling elements from the target population, this study adopted the non-probability sampling approach using the convenience sampling technique. the convenient sampling approach was deemed appropriate for the study because there was no single sample frame or list from which the names and details of supply chain professionals in the south african public sector in gauteng could be obtained. using the suggestion by altunisik et al. (2004) that sample sizes between 30 and 500 at 5% confidence level are generally sufficient for most quantitative studies, the sample size was initially pegged at n = 500 respondents. instrumentation and procedures for data collection a survey questionnaire was distributed to supply chain professionals in the south african public sector in gauteng between march and may 2017. a combination of the drop and collect method and emails were used to distribute the questionnaires. measurement scales were operationalised using questionnaires that were validated in previous studies. the measurement scales and items used, as well as their sources, are indicated in table 1. table 1: measurement scales and their sources. response options for sections measuring supply chain risks were presented on five-point likert-type scales anchored by 1 = strongly disagree and 5 = strongly agree. for the sections measuring supply chain flexibility and performance, response options were presented in a five-point likert-type scale anchored by 1 = much worse than the industry average and 5 = much better than the industry average. data analysis after the screening of all received questionnaires, data were then captured on a microsoft excel spreadsheet. the spreadsheet with the captured data was also cleaned to identify and correct missing entries. this was followed by importing the data into the statistical package for social sciences (spss version 24.0) format. once the data were formatted, the next step was to use descriptive statistics to analyse the data about the demographic profile of the respondents. the last stage of data analysis included the use of structural equation modelling (sem) using the analysis of moments structures (amos version 24.0) statistical software. research results demographic profile of respondents after administration of the questionnaires, a total of 307 usable questionnaires were recovered, giving a satisfactory response rate of 62%. an analysis of the demographic distribution of these respondents revealed that a majority of them (89%; n = 274) were male while the largest group (37%; n = 112) were aged between 34 and 41 years of age. with regard to educational qualifications, the majority of respondents (73%; n = 223) were in possession of a diploma. regarding work experience in scm, most of the respondents (55%; n = 168) had been working in the public sector for between 10 and 15 years. almost all of the respondents (99%; n = 304) were black while the largest group (87%; n = 265) were employed as specialists in various scm-related jobs. measurement scale accuracy analysis this study was intended to test the relationships between supply chain risks, supply chain flexibility and supply chain performance in the south african public sector. to achieve this, a sem approach was adopted to test for these relationships. according to anderson and gerbing (1988), this involves a two-step approach, which begins with the testing of the psychometric properties (reliability, validity and model fit) of the measurement instrument through confirmatory factor analysis (cfa). a testing of the hypotheses through the path analysis approach then follows. the results of the cfa tests are reported in table 2. table 2: accuracy analysis statistics. in testing for reliability, scale purification was conducted using item-total correlations. as recommended by nunnally and bernstein (1994), all items with item-total correlations below 0.3 were removed to improve the reliability of the measurement scales. two items were subsequently removed from the supplier performance monitoring scale, one item was removed from the information security scale and two items were removed from the supply chain performance scale. as shown in table 2, item-total correlations for all retained scale items were above the recommended minimum value of 0.3, which resulted in a scale with acceptable reliabilities. further tests for reliability included two measures, namely the cronbach’s alpha coefficient and composite reliability (cr). cronbach’s alpha values for the measurement scales ranged from 0.72 to 0.83, which are well above the recommended threshold of 0.7 (cho & kim 2014). the composite reliability test is an alternative to the cronbach’s alpha test in testing for reliability and is directed to examine the internal steadiness of each research construct (raykov 2012). composite reliability values were well above the recommended 0.7 threshold, as they ranged between 0.75 and 0.85. this demonstrates that reliability, as measured by these indicators, was satisfactory in this study. in the study, content validity was ascertained through a pilot test of the questionnaire since the measurement scales used in this study were adapted from scales developed for other studies. the pilot study was conducted using 50 conveniently selected supply chain practitioners drawn from various public sector departments in gauteng. respondents that participated in the pilot study were excluded from the main survey. feedback obtained from the survey was used to adjust the questionnaire to improve its content validity. improvements made to the questionnaire related to the wording of the questions, arrangement of questions and the length of the questionnaire. in addition, a reliability test of the pilot data was conducted, which ensured that all data fell within recommended thresholds. the third type of validity ascertained in this study is construct validity, as measured by its two variants, namely convergent validity and discriminant validity. convergent validity refers to the degree to which two measures of constructs that theoretically should be related are in fact related (kline 2011). in contrast, discriminant validity tests, whether concepts or measurements that are supposed to be unrelated are, in fact, unrelated (henseler, ringle & sarstedt 2015). convergent validity was measured using factor loadings and the average variance extracted (ave). the recommended threshold for individual factor loadings of all the items in a measurement scale is 0.5 (westland 2015). as indicated in table 2, factor loadings for all items in the measurement scales were above the minimum threshold of 0.5, which demonstrates that convergent validity was satisfactory in this study. the ave measures the level of variance captured by a construct versus the level due to measurement error; values above 0.7 are considered very good, whereas the level of 0.4 is acceptable (alumran et al. 2014). as indicated in table 2, ave values were above the suggested 0.4 threshold value for all measurement scales. this further shows that convergent validity was acceptable in this study. two procedures were used to measure discriminant validity. firstly, it was expected that the ave values for each construct would be higher than the corresponding highest shared variance (hsv). shared variance is the extent to which the variations between two correlated variables of a construct tend to overlap (gefen & straub 2005). in this study ave values for each construct were higher than the hsv for these constructs, thereby demonstrating that discriminant validity was adequate. secondly, discriminant validity was ascertained through the use of correlations between constructs, as derived from the cfa model. positive correlations less than 0.8 are more acceptable for testing for discriminant validity (fornell & larcker 1981). as indicated in table 4, inter-factor correlations were lower than 0.8, which attests that discriminant validity was adequate in this study. model fit analysis according to anderson and gerbing (1988), model fit analysis is a process that assesses how well the model represents the data. in this study, model fit was tested by using the following indices: chi-square/degrees of freedom, comparative fit index (cfi), incremental fit index (ifi), tucker-lewis index (tli), normative fit index (nfi), goodness of fit (gfi), adjusted goodness of fit (agfi) and random measure of standard error approximation (rmsea). the acceptable thresholds should be equal to or higher than 0.90 for cfi, ifi, rfi, nfi, gfi and agfi. for chi-square/degrees of freedom a ratio of 3:1 or less is recommended and rmsea value should be equal to or less than 0.08 (lysons & farrington 2012). the general model fit indices for both the cfa and sem models are presented in table 3. table 3: model fit statistics. as revealed in table 3, the chi-square test showed values of 2.701 and 2.634 for the cfa and sem models, which were both lower than the recommended highest cut off value of 3.0, and were thus acceptable. the values for the ifi, tli, cfi, nfi, gfi, agfi indices were acceptable since they fell above the recommended minimum threshold of 0.9 for both the cfa and sem models. for the rmsea, the values for the cfa and sem models were 0.065 and 0.074, which were acceptable since they were lower than the recommended maximum cut off value of 0.08. therefore, all thresholds were satisfied for both the measurement and the structural models, thereby confirming the acceptability of model fit in this study. the correlations between all constructs used in this study are shown in table 4. table 4: inter-factor correlations. in addition to their usefulness in testing for discriminant validity, inter-factor correlations are also important in determining the strength and direction of associations between the constructs. table 4 indicates that the inter-factor correlations (r) were significant and ranged between −0.722 (p < 0.01) and 0.836 (p < 0.01). the positive correlations show that an increase in one factor leads to a positive increase in the other factors. for instance, an improvement in government policies would lead to improvements in other factors such as skills availability, supplier performance monitoring, information security, process efficiency, supply chain flexibility and performance within the public sector. conversely, the negative correlation between supply complexity and other factors suggests an inverse relationship between them. thus, an increase in the complexity of supply is likely to lead to either decreases or negative growth in the other factors. results for hypotheses tests hypotheses were tested using the sem procedure. the results are reported in table 5. table 5: structural equation modelling hypotheses testing results. the first column in table 5 represents the structural path that was tested, or the proposed relationship between any two constructs. the second column shows that a total of seven hypotheses, labelled as h1 to h7, were tested in this study, with each hypothesis being linked to a specific path. the third column contains the path coefficients, which are the beta (β) values that show the predictive power (effect or influence) of the independent construct on the dependent construct. the fourth column represents the statistical significance of the relationship, measured at a level of 0.05, which depicts that should this statistic be satisfied, there is a 95% probability that the result of that test is true. the hypothesis is only accepted if the significance level is less than 0.05. the fifth column represents an alternative statistical significance measured through the t statistic, which should also be significant for a hypothesis to be accepted. the final column shows that all hypotheses were supported, since they were statistically significant, as supported by the path coefficients, p-values and t-values. all relationships were positive, except the second hypotheses which proposed that increased supply complexity leads to decreased flexibility of the public supply chain. discussion of the results the first hypothesis of the study (h1) suggested that effective government policies lead to increased flexibility of the public supply chain. this hypothesis was supported in this study since government policies were statistically significant (β = 0.531; p = 0.008; t = 2.681) in predicting supply chain flexibility. this result implies that effective government policies act as a catalyst for supply chain flexibility in the public sector. an enabling policy framework (hanks, davies & perera 2008; turley & perera 2014) usually supports public supply chains that can adapt and respond to changes with minimum costs regarding time, cost, quality and performance. despite the availability of the various legislative frameworks, the public supply chain in south africa remains inflexible and continues to face many challenges. although public scm in the country aims to promote principles of good governance and introduce a fair preferential procurement system (ambe 2016), this has not been achieved. the public sector scm system is highly decentralised, which is meant to allow managers within the different arms of government to control it. this has, however, made the scm system highly fragmented, making it difficult for the government to obtain maximum value in the purchase and use of goods and services (south african national treasury 2016). the second hypothesis of the study (h2) suggested that increased supply complexity leads to decreased flexibility of the public supply chain. this hypothesis was supported because supply complexity was statistically significant (β = −0.137; p = 0.026; t = 2.232) in predicting supply chain flexibility. the negative beta result implies an inverse relationship between supply complexity and supply chain flexibility, such that the latter decreases as the former increases. thus, it would be expected that a public supply chain exposed to a highly complex mix of supply would be unable to respond positively to any disruptive changes occurring in that supply chain. the third hypothesis of the study (h3) suggested that availability of skills leads to increased flexibility of the public supply chain. this hypothesis was supported because skills availability was statistically significant (β = 0.820; p = 0.000; t = 3.455) in predicting supply chain flexibility. this result illustrates that the availability of qualified, knowledgeable and well-experienced human resources in the public sector improves the flexibility of that supply chain. a supply chain that is equipped with adequate and appropriate human resources can easily adapt and respond to any changes occurring within the market (gómez-cedeño et al. 2015). it also has to be noted that among the six supply chain risk factors considered in this study, skills availability scored the highest beta value. this demonstrates that the availability of skills is the most important and critical supply chain risk factor in determining the degree of flexibility within the south african public supply chain. the fourth hypothesis (h4) proposed that the monitoring of supplier performance leads to increased flexibility of the public supply chain. this hypothesis was supported in this study because supplier performance monitoring was statistically significant (β = 0.236; p = 0.002; t = 3.100) in predicting supply chain flexibility. this result denotes that a public supply chain is likely to be highly flexible, provided the performance of suppliers to that supply chain is monitored. lack of monitoring and evaluation across the entire south african public sector is a key area of deficiency (nelson 2016). the deficiencies in monitoring and evaluation are linked to the absence of an effective control environment, and departments are placed in a difficult position to give effect to or implement monitoring and evaluation (fourie 2011; govender 2013). this has resulted in deviations or non-compliance that typically goes undetected or are identified after the fact (nkuna & nemutanzhela 2012). the fifth hypothesis (h5) proposed that effective information security leads to increased flexibility of the public supply chain. this hypothesis was supported in this study because information security was statistically significant (β = 0.503; p = 0.041; t = 2.056) in predicting supply chain flexibility. this result validates that the more secure the information used in the public sector is, the more adaptable to changes the supply chain will be. information security pertains to the prevention of unauthorised access, use, disclosure, disruption, modification, inspection, recording or destruction of information (spagnoletti & resca 2008). it is a general term that can be used regardless of the form the data may take. the chief area of concern for the field of information security is the balanced protection of the confidentiality, integrity and availability of data while maintaining a focus on efficient policy implementation without hindering organisation productivity. given the high information technology illiteracy among many supply chain professionals in the south african public sector (mkhize 2015; sebake & coetzee 2013), information security remains a major threat and could emanate from any of the available potential sources. the sixth hypothesis (h6) suggested that process efficiency leads to increased flexibility of the public supply chain. this hypothesis was supported in this study because process efficiency was statistically significant (β = 0.473; p = 0.034; t = 2.313) in predicting supply chain flexibility. by implication, the adoption and implementation of efficient processes and procedures within the public sector lead to better supply chain flexibility. process efficiency itself is the capability of human resources to conduct a certain process in the way that ensures minimised consumption of effort and energy (malakooti 2013). process inefficiency was identified by several authors (ambe & badenhorst-weiss 2012a; crous 2002; fourie & poggenpoel 2017) as a major factor affecting the implementation of scm in the south african public sector. it thus remains that process efficiency still has to be addressed since it is a major risk facing public scm in the country. the seventh hypothesis suggested that supply chain flexibility leads to the increased performance of the public supply chain. this hypothesis was supported by this study because supply chain flexibility was statistically significant (β = 0.624; p = 0.026: t = 2.237) in predicting supply chain performance. this result suggests that the higher the flexibility of a public supply chain, the greater the performance of that supply chain. the result also shows that supply chain flexibility mediates the relationships between each supply chain risk and supply chain performance. limitations and suggestions for future research the first limitation of the study is that the respondents were based in gauteng only. the second limitation is that the study did not consider all supply chain risks that exist in the public sector since this would have been beyond the scope of a single study. in addition, the use of the convenience sampling technique increased the susceptibility of the research sample to sampling bias. several suggestions for future research can be put forward. firstly, since the study was inclusive of various public sector departments, future studies should consider specific government entities separately, such as state-owned enterprises, municipalities, government departments and constitutional entities. the scope of the study could be expanded to other supply chain risks excluded from this current study, such as among other things economic factors, social factors, political factors, environmental risk, human behaviour risk and legal risk. since the current study was conducted using the quantitative methodology, a different view would be to conduct a similar study using a mixed method approach, which also involves the qualitative methodology where interviews are conducted. the results of the study could be more informative if the views of consultants working in the public sector were included and compared. this presents the need for conducting similar studies using perceptions of consultants working temporarily in the public sector’s supply chain departments. since data were collected from supply chain professionals based in gauteng, future samples could also include those provinces that were excluded from this study. conclusions, theoretical and managerial implications the results of this study provide statistical evidence that there is a relationship between supply chain risks, supply chain flexibility and supply chain performance in the south african public sector. while there is a lot of literature on supply chain risks, supply chain flexibility and supply chain performance, information on their relationship, specifically in the south african public sector, is rare. the study validates that supply chain risks, in this case government policies, supply complexity, availability of skills, supplier performance monitoring, information security and process efficiency exert significant influences on supply chain flexibility, which in turn influences supply chain performance in the public sector. the study further reports that supply chain flexibility can be improved through the management of the individual risks considered in this study, which, in turn, leads to superior supply chain performance. the present study is important in several ways. theoretically, the study is an addition to the available literature on supply chain risks, supply chain flexibility and supply chain performance. it is also an important source of information on research methodologies for future studies in scm. furthermore, the study provides a specific conceptualisation of the relationship between supply chain risks, supply chain flexibility and supply chain performance within the south african public sector, where no similar study had been conducted before. practically, the study provides information to supply chain professionals in the south african public sector regarding the improvement of supply chain performance. it underscores that the performance of public supply chain in south africa can be improved by managing the six risk factors considered and their contribution to supply chain flexibility. this denotes that where supply chain underperformance is a challenge, such as when service delivery is inadequate, the solution is to minimise the effects of the risks mentioned in this study, which improves the flexibility of that supply chain. this, in turn, will lead to better supply chain performance. in this fashion, this study provides an important solution to the services delivery challenges facing the south african public sector. the solution is to mitigate the available supply chain risks, which fuels the flexibility of that supply chain, leading to better performance. acknowledgements the authors thank the research directorate at vaal university of technology for providing funding for the conducting of this study. competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this 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stellenbosch, south africa, 25 october. westland, j.c., 2015, structural equation modeling: from paths to networks, springer, new york. microsoft word 11 rothmann & baumann sajems 17(4) 2014.docx sajems ns 17 (2014) no 4:515-530 515 employee engagement: the effects of work-home/homework interaction and psychological conditions sebastiaan rothmann north-west university, vanderbijlpark candice baumann university of namibia, windhoek accepted: may 2014 the aim of this study was to investigate the relationships between work-home/home-work interaction, psychological conditions and employee engagement. a cross-sectional survey was used. the participants were 292 employees of a uranium mine in namibia residing in towns distant from their workplace. the following measuring instruments were used: survey work-home interaction – nijmegen, psychological conditions scale and work engagement scale. positive work-home interaction and negative home-work interaction had direct positive and negative effects on psychological meaningfulness and psychological availability respectively. psychological meaningfulness, psychological availability, positive work-home interaction and positive home-work interaction had direct effects on employee engagement. an analysis of the indirect effects showed that positive work-home interaction affected employee engagement via experiences of psychological meaningfulness and psychological availability. negative home-work interaction affected employee engagement negatively via low psychological meaningfulness and low psychological availability. implementing policies to promote meaningfulness and availability at work, to build positive workhome interaction and to protect employees against negative home-work interference, will contribute to personal engagement at work. key words: work-home interaction, home-work interaction, psychological meaningfulness, psychological availability, employee engagement jel: j240 1 introduction engaging employees is an important strategy for organisations, for various reasons: engagement may contribute to the psychological wellbeing of individuals at work (rothmann, 2013). furthermore, engaged employees are less inclined to be absent from work (harter, schmidt, killham & asplund, 2006), present a better service to the clients, and contribute to organisations’ productivity and profitability (harter, schmidt & hayes, 2002). various definitions of employee engagement are found in the literature. maslach, schaufeli and leiter (2001) define employee engagement in terms of energy and involvement, while schaufeli and bakker (2004) regard vigour, absorption and dedication as central concepts in their definition of work engagement. kahn and heaphy (2014) define personal engagement as bringing in one’s self to one’s work-role performance. whilst employee engagement research seems to be flourishing in the united states and europe, rothmann (2014) stresses the importance of conducting such research in other countries. personal engagement is defined by simpson (2008) as physically, cognitively, and emotionally employing or articulating oneself during work role performances. when engaged, an employee is understood to be physically involved, cognitively alert, and emotionally attached (kahn, 1990; kahn & heaphy, 2014; may, gilson & harter, 2004). the physical component of engagement refers to having high levels of energy and mental flexibility while working, being willing to put extra effort abstract 516 sajems ns 17 (2014) no 4:515-530 into one’s work, and persisting in the face of difficulties. the emotional component entails a strong involvement with one’s work and also when one experiences a sense of worth, interest, self-importance, and challenge. the cognitive component refers to being completely focused and contently immersed in one’s work, but experiencing difficulty to disconnect from the work as time draws nearer to leave one’s work until the next day. in his model of engagement as an extension of the self, kahn (1990) identified three psychological conditions (i.e. psychological meaningfulness, psychological availability and psychological safety) that shape personal engagement through contexts at work (kahn & heaphy, 2014; may et al., 2004). psychological meaningfulness is defined as the feeling that one is receiving a return on investment of one’s self in a currency of physical, cognitive, or emotional energy, while psychological availability refers to the readiness and confidence of an individual to engage in his/her work role (kahn, 1990; may et al., 2004). activities outside the workplace could draw away individuals’ energies from their work and make them less psychologically available for their work roles. these activities – and the time demands associated with them – are likely to distract an individual’s attention so that he/she is unable to focus on his/her role tasks. psychological safety refers to the experience of being able to act in a way that is natural, and to be able to use and employ all skills and knowledge in a role without having to fear ridicule or negative consequences (kahn, 1990). little information is available on the effects of positive work-home and home-work interaction on employee engagement via psychological conditions. the understanding of the effects of workhome and home-work interaction on employee well-being has grown (geurts, taris, kompier, dikkers, van hoof & kinnunen, 2005). however, most studies focused on married working mothers who had to balance work and family (e.g. childcare) responsibilities (munn, 2013). although family responsibilities are often regarded by employees as one of the top demands leading to work stress (bakker, ten brummelhuis, prins & van der heijden, 2011), work can also energise people and contribute to experiences of psychological meaningfulness, competence and availability to work, and personal engagement. previous research showed that work-home and home-work interaction affect the engagement of employees (bakker et al., 2011; lingard, brown, bradley, bailey & townsend, 2007; mostert, cronjé & pienaar, 2006; mostert, peeters & rost, 2011). two psychological conditions, namely psychological meaningfulness and psychological availability, seem relevant for transferring the effects of work-home/home-work interaction to employee engagement (kahn, 1990; kahn & heapy, 2014; may et al., 2004). however, no studies focused on the psychological conditions which mediate between work-home/home-work interaction and employee engagement. the organisation in this study, which is located in the namib desert in namibia, started operations in 1976 and is the fifthlargest uranium mine in the world, with 8 per cent of the global output. the mine is located close to arandis, a small town which is mostly occupied by mine workers. a total of 76 per cent of the employees live in two other towns, swakopmund and walvis bay, which are respectively 70 and 100 kilometres from the mine. these towns have relatively good infrastructure (e.g. schools, housing, and shopping centres), while arandis lacks the infrastructure to accommodate employees. in addition, transport facilities to the mine are limited to buses and own vehicles. people living in the two towns and working at the mine spend between two and three hours per day travelling to and from their work. due to the distance from home to work and the required work schedule, there is clearly interaction in terms of personal hours lost due to travel time to and from the job. a large percentage of the employees have to leave their homes early in the morning and arrive home late in the afternoon. parents might experience practical problems regarding care of their children during working days. for instance, mothers who work at the mine cannot leave their jobs to attend to the needs of their children. another form of interaction is that some employees and their families live close to their work (in arandis) in a small community which is relatively isolated from non-mining sajems ns 17 (2014) no 4:515-530 517 communities. on the positive side, the mine creates jobs and provides various benefits associated with corporate employers (e.g. competitive salaries, training and development opportunities, and good working conditions). these factors make it interesting to study both positive and negative interactions from work to home and from home to work. no relevant literature regarding work-home and home-work interaction, psychological conditions and employee engagement was found pertaining to the mining sector specifically in the context of a developing country in africa. people often seek employment at mines as they know that salaries, fringe benefits, human resource management and the nature of the work are attractive. but these are not the only factors that would keep them engaged. work-home and home-work interaction might affect employees’ engagement (may et al., 2004). furthermore, employees want more from their jobs than salary and fringe benefits; they want to feel competent and experience their work as meaningful (munn, 2013). in addition, both positive and negative work-home and home-work interaction might affect employee engagement specifically via experiences of psychological meaningfulness and psychological availability. therefore the research question for this study is as follows: do work-home and home-work interaction affect employee engagement at a uranium mine and can specific psychological conditions (that precede engagement) explain such effects? the information gathered in this study is required to plan interventions to manage the work/life integration and engagement of employees. 2 literature review 2.1 psychological conditions and employee engagement according to lewis (2011), employee engagement is a state that resides within the person rather than the job. understanding of the contribution of psychological conditions to personal engagement is important because employee engagement varies among individuals in the same job and from task to task. the experienced psychological conditions of meaningfulness, availability and safety lie at the heart of many engagement models (crawford, rich, buckman & bergeron, 2014). research regarding the mediating effects of psychological conditions between work-home/ home-work interactions and employee engagement is necessary to understand how engagement can be managed and increased (olivier & rothmann, 2007). at work, psychological meaningfulness refers to the value of a work goal or purpose, judged in relation to an individual’s own ideals or standards (renn & vandenberg, 1995; rothmann & welsh, 2013) and the coherence that he/she experiences (ryff, 1989). experiences at work contribute to psychological meaningfulness, not only because people spend a large part of their lives at work (holbeche & springett, 2004), but also because people expect more from their jobs than just a salary and benefits. studies showed that psychological meaningfulness predicts large percentages of the variance in employee engagement (may et al., 2004; rothmann & rothmann, 2010; rothmann & welsh, 2013). factors which are associated with psychological meaningfulness at work include using one’s strengths, work role fit, a values-based culture, caring about employees, social support, opportunities to learn, the organisation’s mission and employee socialisation (may et al., 2004; munn, 2013). psychological availability (also referred to as competence by spreitzer, 1995) refers to the ability to engage as a result of having the necessary cognitive, emotional and physical resources (may et al., 2004). individuals who are psychologically available feel capable and prepared to invest their resources into role performances at work, while individuals who are not available lack resources or feel distracted from investing them into role performances (crawford et al., 2014). as members of social systems, employees experience distractions (e.g. from non-work demands) to the point that they have less energy to invest in role performances. employees feel less psychologically available when activities outside the workplace draw their energies away, resulting in disengagement from their roles. based on social exchange theory, employees feel obliged to 518 sajems ns 17 (2014) no 4:515-530 engage as repayment for the resources they receive from their organisation (saks, 2006). individuals protect themselves from exposure to emotional, cognitive and physical demands when they feel overwhelmed (kahn & heapy, 2014). they become distant towards their roles and other people, which imply that the authentic selves become unavailable for performance in a specific role. 2.2 work-home and home-work interaction work-family conflict has been defined as a form of inter-role disagreement in which the work and family domains are incompatible, resulting in role strain (greenhaus & beutell, 1985). there are three forms of work-family conflict, namely time-based conflict, strainbased conflict, and behaviour-based conflict (geurts & demerouti, 2003). time-based conflict refers to the demands from one domain, which are associated with the accomplishment of one role, that make it physically impossible to meet demands from the other domain – or being preoccupied with one role while attempting to fulfil the demands of another role (bartolome & evans, 1979). strain-based conflict refers to strain (e.g. tension, anxiety, fatigue, depression, irritability) caused by the contribution in one domain (role) that makes it complicated to meet the terms of the other domain (another role). behaviour-based conflict refers to particular forms of role behaviour that are in contrast with the prospects of behaviour in another role. geurts et al. (2005) distinguish between two concepts – role scarcity and role enhancement – which can be studied to unravel work-home and home-work interaction. role scarcity refers to work-home interaction as a type of inter-role conflict in which role pressures from the work and family domains are mutually incompatible (geurts et al., 2005). it is difficult to juggle multiple roles (partner, father and employee) with limited time and energy. role enhancement implies that fulfilling multiple roles may produce resources (e.g. energy mobilisation, skill acquisition, greater self-esteem) that facilitate functioning in both life spheres (geurts et al., 2005). this means that balancing one’s home and work domains in an effective manner could save an individual a lot of energy, and could help one to acquire optimal skills in both domains and to feel more in charge of the situation. in short, work-life balance is seeking to obtain an optimal balance between one’s work and one’s life in general (bratton & gold, 2003). geurts et al. (2005) found a fourdimensional structure of work-home/homework interactions, consisting of positive workhome interaction (e.g. a good/fair working environment), negative work-home interaction (e.g. a poor salary and work overload), positive home-work interaction (e.g. emotional support from family), and negative home-work interaction (e.g. no support from family). this means that if a person loves his/her job and there is no support from his/her family, it may cause a negative home-work spillover, but if the family supports him/her, it could result in a positive home-work spillover. the same is true for work-home spillover. a negative workhome spillover could be caused by an unfavourable working environment and a positive work-home spillover could be due to good and fair relations at work. contrary to the role strain hypothesis, it is possible that developing one’s skills at work to optimally utilise one’s energies might enhance one’s productivity in the non-work domain. this process is referred to as positive spillover or role enhancement (grzywacz & marks, 2000). in maintaining a work-life balance, there may be some positive outcomes in terms of work circumstances that may benefit non-work circumstances, and the other way around. concerning positive work-home spillover, crouter (1984) found that training in decisionmaking skills at work resulted in individuals employing the newly acquired tactics at home to deal with their children more efficiently. studies also showed that when individuals get support from their spouses and have the platform at home to discuss work issues, they tend to manage the pressures at work better (gattiker & larwood, 1990). employed married mothers generally enjoy a greater sense of happiness and better physical health than unemployed married mothers or employed single mothers without children (geurts & demerouti, 2003). the study by grzywacz and marks (2000) showed that both resources at work (e.g. decision latitude, support from cosajems ns 17 (2014) no 4:515-530 519 workers and supervisors) and at home (e.g. support from a spouse) were associated with lower levels of negative spillover and higher levels of positive spillover between work and family. barriers at work (e.g. a demanding job) and at home (e.g. disagreement with one’s spouse) were associated with higher levels of negative spillover and lower levels of positive spillover between work and family (geurts & demerouti, 2003). spillover is one of the six recurring linking mechanisms between work and non-work roles depicted by edwards and rothbard (2000) in the work-life literature. two other important mechanisms are compensation and segmentation (demerouti & geurts, 2004). compensation refers to a non-work and work relationship where individuals over-involve themselves in one role to make up for deficiencies in another role; this in turn allows for a negative relationship between constructs in the two roles. an example or evidence of compensation is shown in a study done by rothbard (2001) which showed that women who experienced negative affect from family were more engaged at work. segmentation differs from spillover and compensation in that it suggests no logical relationship between work and non-work roles. the segmentation model describes the non-association of the two roles in that work and family do not influence one another (edwards & rothbard, 2000). according to eckenrode and gore (1990), segmentation is an active psychological process, which means that when it comes to work and family, people may choose to maintain a boundary between the two roles. park, fritz and jex (2011) found that employees with a preference for segmenting the work from the home domain experienced greater psychological detachment from work during nonwork time. the mediating effects of psychological conditions the various types of inter-role conflict (timebased, strain-based and behaviour-based) and role enhancement could affect employee engagement indirectly via experiences of psychological meaningfulness and psychological availability. research on positive psychological functioning (keyes, 2007; ryff, 1989) has shown that basic psychological needs associated with living a meaningful life must be satisfied if optimal functioning of individuals is to be achieved. matuska and christiansen (2008) also linked meaningful lifestyles to psychological meaningfulness. munn (2013) suggests that positive and negative work-home and home-work interaction affect employees’ expe riences of psychological meaningfulness of work. delle fave, brdar, freire, vellabrodrick and wissing (2011) found that family life has a strong effect on experiences of psychological meaningfulness. interaction between individuals’ work and home roles affects their sense of a balanced life (sirgy & wu, 2009), which impacts their experiences of psychological meaningfulness at work. according to munn (2013), positive work-home/ home-work interaction contributes moderately to psychological meaningfulness. work is an important context to engage individuals in goal-directed activities, and to provide meaning (cameron, dutton & quinn, 2003). therefore psychological meaningfulness is expected to be related to engagement (fairlie, 2011). furthermore, various studies confirmed that negative work-home and homework interaction is negatively related to employee engagement, while positive workhome and home-work interaction is positively related to employee engagement (marais, mostert, geurts & taris, 2009; mostert et al., 2006). research has shown that individuals are willing to engage in their work when they experience psychological meaningfulness (kahn, 1990; may et al., 2004; rothmann & welsh, 2013). employees who experience negative work-home/home-work interactions could there fore experience less meaningfulness in their work, which could result in reduced engagement at work. conversely, employees who experience positive work-home/homework interactions could experience more meaningfulness in their work, which could result in increased engagement. therefore psychological meaningfulness may mediate the relationships between work-home/home-work interaction and employee engagement. psychological availability (i.e. feeling competent as a result of having the necessary cognitive, emotional and physical resources) could mediate the relationship between work520 sajems ns 17 (2014) no 4:515-530 home and home-work interactions and employee engagement (kahn & heaphy, 2014). when work-life conflict occurs, it means that there is more than one role that needs satisfying and that there is some form of imbalance between the roles. in both work and family there needs to be some measure of consistency between the roles with regard to the input of psychological availability for a proper balance to be achieved between the two roles. this can be related to marks and macdermid’s (1996) finding that role balance will only occur when all the roles in the role system of an individual have been equally satisfied. according to hall and richter (1989), individuals’ energies at work may be strained by outside activities, which will in turn make them less psychologically available in their work roles. conversely, psychological availability and employee engage ment can be influenced positively by family engagement (rothbard, 2001). 3 aim and hypotheses the aim of this study was to investigate the relationship between work-home and homework interaction, psychological conditions and employee engagement. the following hypotheses are set based on the discussion above: hypothesis 1: negative work-home and home-work interactions are inversely related to psychological availability. hypothesis 2: positive work-home and home-work interactions are positively related to psychological availability. hypothesis 3: negative work-home and home-work interactions are inversely related to psychological meaningfulness. hypothesis 4: positive work-home and home-work interactions are positively related to psychological meaningfulness. hypothesis 5: psychological meaningfulness is positively related to employee engagement. hypothesis 6: psychological availability is positively related to employee engagement. hypothesis 7: work-home and home-work interaction indirectly affect employee engagement via psychological meaningfulness. hypothesis 8: work-home and home-work interaction indirectly affect employee engagement via psychological availability. 4 method 4.1 research design a cross-sectional survey design was utilised in this study (huysamen, 2004). within the crosssectional design, latent variable modelling was used to investigate the fit of the hypothesised models as well as indirect effects (muthen & muthen, 2012). 4.2 participants the participants were employees of a uranium mine who are residents of swakopmund, walvis bay and arandis. the total population of the study at the end of april 2010 comprised 1468 employees. the sample was stratified based on rank and gender. a stratified random sample was taken (n = 300). all females in some ranks were targeted to ensure sufficient sizes of sub-samples. a total of 291 individuals completed the questionnaires. with regard to the respondents’ fluency in english, a grade 12 certificate had to be presented. table 1 illustrates the characteristics of the sample. table 1 characteristics of participants items category frequency % gender male female 220 72 75.3 24.7 work level subordinate supervisor manager 249 32 11 85.3 11.0 3.8 parental status yes no 214 78 73.3 26.7 marital status married single 212 80 72.6 27.4 sajems ns 17 (2014) no 4:515-530 521 4.3 measuring instruments the survey work-home interaction – nijmegen (swing; geurts et al., 2005) was used to measure the work-home interaction experienced by participants. the swing is a 30-item work-home interaction measure which assesses four types of interactions, namely (1) negative work-home interaction (nwhi), which refers to the negative impact of the work situation on one’s functioning at home (eight items; e.g. ‘how often does it happen that you are irritable at home because your work is demanding?’); (2) negative home-work interaction (nhwi), which refers to the negative impact of the home situation on one’s job performance (five items; e.g. ‘how often does it happen that the situation at home makes you so irritable that you take your frustrations out on your colleagues?’); (3) positive work-home interaction (pwhi), which refers to the positive influence of the work situation on one’s functioning at home (five items; e.g. ‘how often does it happen that you come home cheerfully after a successful day at work, positively affecting the atmosphere at home?’); and (4) positive home-work interaction (phwi), which refers to the positive impact of one’s home situation on one’s job performance (five items; e.g. ‘how often does it happen that you manage your time at work more efficiently because at home you have to do that as well?’). all items are scored on a four-point frequency rating scale, ranging from 0 (never) to 3 (always). baumann (2011) showed evidence for the construct validity of the swing in a sample of mine employees in namibia. geurts et al. (2005) report cronbach alpha coefficients of 0.84 for nwhi and 0.75 for pwhi, as well as 0.75 for nhwi and 0.81 for phwi. in a south african police sample, marais et al. (2009) provided evidence of the construct validity, construct equivalence and reliability of the scales. they reported the following cronbach alpha coefficients for the swing: nwhi = 0.90, pwhi = 0.84, nhwi = 0.87, and phwi = 0.82. the psychological conditions scale (pcs; may et al., 2004) was used to measure psychological availability and psychological meaningfulness. for all the items, an agreement/disagreement likert format ranging from 1 (never) to 5 (always) was used. an item that measures psychological availability is ‘i am confident in my ability to deal with problems that come up at work’. an item on the questionnaire that measures psychological meaningfulness is ‘my job activities are personally meaningful to me’. psychological availability is measured by six items (α = 0.90) drawn from the research of may et al. (2004). these items measure the degree of availability (cognitive, emotional and physical) that individuals discovered in their work-related activities. psychological meaningfulness is measured by six items (α = 0.90) drawn from the research of spreitzer (1995) and may et al. (2004). these items measure the degree of meaning that individuals discovered in their work-related activities. baumann (2011) showed evidence for the construct validity of the pcs in a sample of mine employees in namibia. the work engagement scale (wes; may et al., 2004, as adapted by diedericks & rothmann, 2013) was used to measure employee engagement. for all items, a likert scale ranging from 1 (never) to 5 (always) was used. the items reflect each of the three components of kahn’s (1990) conceptualisation of employee engagement, namely cognitive (2 items; e.g. ‘i am very absorbed in my work’), emotional (3 items; e.g. ‘i am passionate about my job’) and physical engagement (3 items, e.g. ‘i am full of energy in my work’). in their research, olivier and rothmann (2007) found evidence for a onefactor engagement model consisting of cognitive, emotional and physical engagement (α = 0.72), which is consistent with the findings of may et al. (2004). 4.4 procedure the researcher engaged the support of three human resource practitioners from different sections of the mine’s human resources department to assist with the administration of questionnaires. the researcher followed up with the selected employees to personally explain the purpose of the research and to request voluntary participation in the research. the objective of the study was explained to the human resource practitioners so that they could have more insight when giving the information to the potential participants, to ensure that they 522 sajems ns 17 (2014) no 4:515-530 would be able to make informed decisions about their involvement in the study. the instruments used simple questions in english which study participants with a basic literacy rate should be able to understand. after obtaining informed consent, the human resource practitioners distributed the questionnaires, allowed time for the questionnaires to be returned, and finally returned the completed questionnaires to the researcher. 4.5 statistical analysis the analysis of the data was carried out by means of mplus version 7.11 (muthén & muthén, 1998-2012). items of the three questionnaires were defined as categorical and the weighted least squares with corrections to means and variances (wlsmv) were used as estimator. the following indices produced by mplus were used in this study: a) absolute fit indices, including the chi-square statistic which is the test of absolute fit of the model, and the root mean square error of approximation (rmsea), and b) incremental fit indices, including the tucker-lewis index (tli) and the comparative fit index (cfi) (kline, 2010). tli and cfi values higher than 0.90 are considered acceptable. rmsea values lower than 0.08 indicate a close fit between the model and the data. composite reliabilities (ρ) of scales were computed by means of a formula based on the sum of squares of standardised loadings and the sum of standardised variance of error terms (raykov, 2009; wang & wang, 2012). 5 results first, the results of tests of competing measurement models are reported. second, the results of tests of alternative structural models are reported. 5.1 testing the measurement model using confirmatory factor analysis (cfa), an eight-factor measurement model as well as alternative models were tested to assess whether items would load significantly onto the scales with which they were associated. four measurement models were tested. model 1 consisted of seven latent variables, namely a) nwhi (measured by 10 observed variables); b) pwhi (measured by five observed variables); c) nhwi (measured by 10 observed variables); d) phwi (measured by five observed variables); e) psychological meaningfulness (measured by six observed variables); f) psychological availability (measured by eight observed variables), and g) employee engagement (measured by eight observed variables). all the latent variables in model 1 were allowed to correlate. models 2, 3, and 4 followed the same template: model 2 was specified with 14 observed variables measuring psychological conditions (without the two first-order latent variables, namely psychological meaningfulness and psychological availability); model 3 was specified with 20 observed variables measuring nwhi and nhwi (without the two first-order latent variables, namely nwhi and nhwi) and 10 observed variables measuring pwhi and phwi (without the two first-order latent variables, namely pwhi and phwi); model 4 was specified with all items loading on a single factor (measured by 52 observed variables). two fit statistics, namely the akaike information criterion (aic; a comparative measure of fit, is meaningful when different models are estimated) and bayes information criterion (bic; an index of model parsimony) were used to compare alternative measurement models (kline, 2010). table 2 presents the fit statistics of the various models. table 2 fit statistics for the competing measurement models model χ2 df cfi tli rmsea aic bic model 1 1787.96* 1253 0.96 0.96 0.04 28445.94 29515.88 model 2 2048.02* 1259 0.94 0.94 0.05 28667.53 29715.40 model 3 2347.35* 1264 0.92 0.92 0.05 28947.42 29976.91 model 4 6317.80 1274 0.12 0.63 0.62 31302.07 32294.79 * p < 0.001 sajems ns 17 (2014) no 4:515-530 523 comparison of the aic and bic values indicates that model 1 fitted the data best. the χ2 (1253, n = 292) = 1787.96 of the hypothesised model was statistically significant (p < 0.001), but the other fit indices indicated good fit of the model to the data: cfi = 0.96, tli = 0.96, rmsea = 0.04. standardised coefficients from items to factors ranged from 0.61 to 0.91. the results also indicated that the relationship between each observed variable and its respective construct was statistically significant (p < 0.01). 5.2 testing the structural model reliabilities and correlations among workhome/home-work interaction, psychological meaningfulness, psychological availability and employee engagement are reported in table 3. table 3 reliabilities and correlations of the scales variable ρ 1 2 3 4 5 6 1 nwhi 0.93 2 pwhi 0.89 -0.16** 3 nhwi 0.90 0.21** -0.04 4 phwi 0.92 0.24** 0.50** -0.07 5 meaningfulness 0.92 -0.18** 0.14** -0.12** 0.10** 6 availability 0.92 -0.11** 0.14** -0.16** 0.14** 0.40** 7 employee engagement 0.93 -0.16** 0.24** -0.14** 0.23** 0.42** 0.43** nwhi = negative work-home interaction; pwhi = positive work-home interaction; nhwi = negative home-work interaction; phwi = positive home-work interaction **p < 0.01 table 3 shows that the reliabilities of the constructs were acceptable, compared to the guideline of 0.70 (wang & wang, 2012). statistically significant (p < 0.01) relationships exist between all the variables, except nhwi and pwhi, as well as nhwi and phwi. the measurement model formed the basis of the structural model. the hypothesised relationships shown in the model were tested, using latent variable modelling as implemented by mplus (muthén & muthén, 1998-2012). an acceptable fit of the model to the data was found: χ2= 1787.96, df =1253, tli = 0.96, cfi = 0.96, and rmsea = 0.04. table 4 shows the standardised regression coefficients estimated by mplus for the structural model. hypotheses 1 and 2 for the portion of the model predicting psychological availability, table 4 indicates that the path coefficient of pwhi (β = 0.20, p < 0.01) was statistically significant and had the expected sign. psychological availability had a positive relation with positive work-home interaction. furthermore, the path coefficient of nhwi (β = -0.34, p < 0.01) was statistically significant and had the expected sign. psychological availability had a negative relation with negative home-work interaction. the wlsmv estimated equation accounted for a moderate proportion of the variance in psychological availability (r2 = 0.17). hypotheses 1 and 2 are partially supported. hypothesis 3 and 4 for the portion of the model predicting psychological meaningfulness, table 4 indicates that the path coefficient of pwhi (β = 0.18, p < 0.01) was statistically significant and had the expected sign. psychological meaningfulness had a positive relation with positive work-home interaction. furthermore, the path coefficient of nhwi (β = -0.19, p < 0.01) was statistically significant and had the expected sign. psychological meaningfulness had a negative relation with negative home-work interaction. the wlsmv-estimated equation accounted for a moderate proportion of the variance in psychological meaningfulness (r2 = 0.14). hypotheses 3 and 4 are partially supported. hypothesis 5 and 6 for the portion of the model predicting employee engagement, table 4 reveals that the path coefficients of pwhi (β = 0.17, p > 0.01), phwi (β = 0.17, p > 0.01), psychological meaningfulness (β = 0.35, p > 0.25) and psychological availability (β = 0.17, p > 0.01) 524 sajems ns 17 (2014) no 4:515-530 were statistically significant and had the expected signs. the wlsmv-estimated equation accounted for a large proportion of the variance in employee engagement (r2 = 0.46). hypothesis 5 and 6 are supported: employee engagement was positively related to psychological meaningfulness and psychological availability. table 4 standardised regression coefficients of the variables nwhi = negative work-home interaction; pwhi = positive work-home interaction; nhwi = negative home-work interaction; phwi = positive home-work interaction ** p < 0.01 figure 1 wlsmv estimates for the hypothesised model of employee engagement (standardised solution) ** p < 0.01 note: only statistically significant paths are included in the figure given the cross-sectional nature of the data, two other competing models were also tested: model 1.2 included paths from psychological meaningfulness and availability to employee engagement and from nwhi, pwhi, nhwi and phwi to psychological availability, but nwhi pwhi nhwi phwi availability r2=0.17 meaningfulness r2=0.14 employee engagement r2=0.46 β=0.20* (0.08) β=-0.34* (0.07) β=0.19* (0.07) β=0.15* (0.05) β=0.17** (0.06) β=-0.35** (0.10) β=-0.25* (0.06) variables estimate se est/se p engagement on nwhi 0.01 0.06 0.22 0.829 pwhi 0.17 0.06 2.89 0.004** nhwi -0.06 0.06 -0.90 0.368 phwi 0.15 0.05 2.84 0.005** meaningfulness 0.35 0.05 7.07 0.000** availability 0.25 0.06 4.38 0.000** meaning on nwhi -0.13 0.07 -1.88 0.060 pwhi 0.18 0.07 2.49 0.013** nhwi -0.19 0.07 -2.79 0.005** phwi 0.03 0.07 0.37 0.709 availability on nwhi 0.08 0.07 1.10 0.270 pwhi 0.20 0.08 2.62 0.009** nhwi -0.34 0.06 -5.76 0.000** phwi 0.08 0.08 1.12 0.264 sajems ns 17 (2014) no 4:515-530 525 the paths from nwhi, pwhi, nhwi and phwi to psychological meaningfulness were constrained to zero. model 1.3 included paths from psychological meaningfulness and availability to employee engagement and from nwhi, pwhi, nhwi and phwi to psychological meaningfulness, but the paths from nwhi, pwhi, nhwi and phwi to psychological availability were constrained to zero. model 1.2 showed the following fit statistics: χ2 (1257, n = 292) = 2084.54; p < 0.001; cfi = 0.94, tli = 0.94 and rmsea = 0.04 (90% ci 0.04-0.05). model 1.3 showed the following fit statistics: χ2 (1257, n = 292) = 2084.54; p < 0.001; cfi = 0.94, tli = 0.94 and rmsea = 0.05 (90% ci 0.04-0.05). the following changes in chi-square (δχ2) were found: models 1.1 and 1.2 (δχ2 = 74.93, δdf = 4, p < 0.0001), and models 1.1 and 1.3 (δχ2 = 72.96, δdf = 4, p < 0.0001). 5.3 indirect effects to determine whether any relationships in the model were indirectly affected by workhome/home-work interaction, the procedure explained by hayes (2009) was used. bootstrapping was used to construct two-sided bias-corrected 95 per cent confidence intervals (cis) so as to evaluate indirect effects. lower and upper cis are reported (see table 5). table 5 indirect effects of work-home/home-work interaction variable estimate se 95% bc ci lower upper psychological meaningfulness nwhi -0.05 0.03 -0.11 0.02 pwhi 0.06 0.03 0.01 0.12 nhwi -0.06 0.03 -0.13 0.01 phwi 0.01 0.03 -0.04 0.06 psychological availability nwhi 0.02 0.02 -0.02 0.06 pwhi 0.05 0.02 0.01 0.09 nhwi -0.09 0.04 -0.16 -0.02 phwi 0.02 0.02 -0.02 0.06 note: se = standard error; 95 per cent bc ci = 95 per cent bias-corrected confidence intervals nwhi = negative work-home interaction; pwhi = positive work-home interaction; nhwi = negative home-work interaction; phwi = positive home-work interaction p < 0.01 regarding the indirect effects of phwi on employee engagement, the 95 per cent cis for psychological meaningfulness did not include zero. hypothesis 6 is partially supported: positive work-home interaction impacts employee engagement via psychological meaningfulness. regarding the indirect effects of pwhi and nhwi on employee engagement, the 95 per cent cis for psychological availability did not include zeros. therefore positive work-home interaction and negative home-work interaction indirectly affect employee engagement via psychological availability. hypotheses 7 and 8 are partially supported. taken together, the results suggest that the relationships posited in the model account for a substantial amount of the covariation in the data. the model accounts for 46 per cent of the variance in employee engagement, 14 per cent of the variance in psychological meaningfulness and 17 per cent of the variance in psychological availability, lending more empirical support for the model’s fit. 6 discussion the aim of this study was to investigate the relationships between work-home and homework interaction, psychological conditions and employee engagement. the results showed that psychological meaningfulness and availability as well as work-life balance accounted for a large proportion of the variance in employee 526 sajems ns 17 (2014) no 4:515-530 engagement. positive work-home interaction was positively associated with experiences of psychological meaningfulness and availability at work, while negative home-work interaction impacted psychological availability negatively. an analysis of the indirect effects showed that psychological meaningfulness partially mediated the relationship between positive work-home interaction and employee engagement. psychological availability mediated the relationship between positive work-home interaction as well as negative home-work interaction and employee engagement. negative home-work interaction was negatively associated with psychological availability, while positive work-home interaction was positively associated with psychological availability. psychological availability indicates whether employees feel ready or confident to engage in their work roles, given that they are also engaged in other life activities (kahn, 1990; may et al., 2004). low psychological availability associated with a lack of positive work-home interaction and negative homework interaction were associated with an inability to personally engage at work, presumably because employees lack cognitive, emotional and physical resources and they feel distracted from investing into role performances (crawford et al., 2014; may et al., 2004; spreitzer, 1995). employees feel less psychologically available when activities outside the workplace draw their energies away. they become distant towards their roles and other people, which imply that their authentic selves become unavailable for performance in a specific role. given the physical distance between the employees’ work and homes, it is understandable that psychological availability is negatively associated with negative home-work interaction. when children are small, ill or experience difficulties, a guardian is not in town, and support is not available, then employees will not feel ready or confident to engage in their work. positive work-home interaction impacted psychological meaningfulness positively, while negative home-work interaction impacted meaningfulness negatively. given that family life has an effect on psychological meaningfulness (delle fave et al., 2011; munn, 2013) it is understandable that low negative homework interference contribute to employees’ experiences of meaningfulness at work. further more, based on the role enhancement principle, positive work-home interaction resulting from support and learning in the workplace seems to contribute to psychological meaningfulness. employees who experience psychological meaningfulness feel that they are receiving a return on investment of themselves in a currency of physical, cognitive, or emotional energy (kahn, 1990; kahn & heapy, 2014). interaction between individuals’ work and home roles affects their sense of a balanced life (sirgy & wu, 2009), which impacts their experiences of psychological meaningfulness at work. concerning work-home/home-work interaction, the results showed that positive workhome interaction (e.g. a good/fair working environment) and a negative home-work interaction (no support from family) play an important role in affecting the dependent variables in the structural model of employee engagement. positive work-home spillover does not only affect psychological availability and psychological meaningfulness, but also employee engagement (geurts et al., 2005; grzywacz & marks, 2000). moreover, negative home-work spillover also affects experiences of psychological availability, psychological meaningfulness and engagement of employees. because of distances between work and home, the lack of (family) support plays an important role in affecting employees’ feelings of competence, their experiences of psychological meaningfulness and their engagement at work. if employees are not affected by negative home-work interaction and they experience positive work-home interaction, they tend to be more engaged in their work (marais et al., 2009; mostert et al., 2006). the results regarding negative interactions from home to work may be related to the depletion argument (edwards & rothbard, 2000; rothbard, 2001) and the resource drain perspective (greenhaus & beutell, 1985). depletion is based on the notion that an individual has only a certain fixed amount of physiological and psychological resources to spend or utilise and that he/she makes exchanges or substitutions in order to accommodate those fixed resources (rothbard, sajems ns 17 (2014) no 4:515-530 527 2001). the results are also closely linked to the strain-based conflict perspective, which argues that strain in one role affects performance in another role (edwards & rothbard, 2000; greenhaus & beutell, 1985). regarding positive experiences, the results showed that positive work-home interaction impacted employee engagement directly as well as indirectly (via psychological meaningfulness and psychological availability). specific positive experiences that happen at work, spill over to the home domain, and promote both meaningfulness and employee engagement. interestingly, positive home-work interaction did not have any direct effects on psychological meaningfulness and psychological availability. however, positive home-work interaction did affect employee engagement significantly. these results are related to the enrichment process by rothbard (2001) on the concepts of role accumulation and multiple roles. the enrichment process suggests that engagement in one role may be related to another role. this is seen in the results of this study whereby positive spillover from one domain results in a positive outcome in the other domain. the enrichment argument implies that more role commitments can be beneficial to an individual, rather than putting strain on or draining him/her (rothbard, 2001). this study showed that psychological meaningfulness and availability are important psychological conditions to consider in promoting the engagement of employees (matuska & christiansen, 2008). the results also confirm that psychological conditions make an important contribution to explaining the effects of positive work-home and negative home-work interaction on employee engagement. low negative home-work interaction and high positive work-home interaction contribute to employees feeling available and competent to engage in their work. also, low negative workhome interference and high positive workhome interaction contribute to the experience of psychological meaningfulness at work, which in turn impacts employee engagement positively. psychological meaningfulness, psycho logical availability, and work-home/homework interaction explained a large percentage of variance in personal engagement at work. this study had various limitations. the study did not include the entire mining sector of namibia, but focused on a particular mining company. furthermore, a cross-sectional survey was used in this study; therefore, causality of relationships could not be proven. in this regard halbesleben, harvey and bolino (2009) argued for a reversed causal ordering between engagement and work-life interference, i.e. that employees might create the interference with their family roles because they are too engaged in their work. longitudinal studies are necessary to assess the indirect effects of work-home and homework interactions on employee engagement. 7 recommendations managers and employees should become aware of the concepts of engagement and work-life balance, and the relation of the concepts. implementation of programmes directed at the attainment of a work-life balance will prove vital to the organisations and their bottom line. such training and development programmes are necessary to ensure that employees remain healthy and competent as well as engaged. the implementation of a performance management system based on task agreements between managers and employees should be investigated. if used properly, a performance management system could provide information regarding work-home/home-work interaction and engagement. future research needs to explore the worklife balance 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accepted: 11 nov. 2021; published: 24 jan. 2022 copyright: © 2022. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: predictions suggest africa’s combined gross domestic product (gdp) will be amongst the fastest growing on earth in the next two decades. an expectation is that the majority of african homes will enter the consumer class, and educational performance will improve significantly within the next two decades. nonetheless, organisations competing in africa face numerous challenges. these include its size and complexity, transformational population growth, an abundance of talent but a lack of skills, a scarcity of large companies, the relatively small size of big companies, a poorly understood business environment, conflict, poverty and corruption. to successfully address these challenges, entrepreneurial energy and a strategy to develop leadership skills at scale is required. aim: the purpose of this study was to develop and assess whether a leadership skills development model which integrates six conceptual constructs is valid as a model for developing leadership skills in african fast-moving consumer goods (fmcg) business-networks. method: the study took a pragmatic approach and followed an explanatory sequential design typology. an initial quantitative stage was conducted. using inductive thematic interpretation methodology, the qualitative results helped explain the initial quantitative results. applying confirmatory factor analysis, three data-model fit tests gave empirical evidence that the leadership skills development model was a good model fit. findings: the outcomes and practical value of this study included a theoretically relevant, empirically validated leadership skills development model, super-cube® for african fmcg (fast moving consumer goods) business-networks, as well as a range of recommendations on how to develop leadership skills throughout africa. conclusion: leadership skills development is complex, especially in a rapidly changing environment. this study is the first that proposes a leadership skills development model for african fmcg business-networks that directly contributes to the discipline of leadership and leadership development. keywords: leadership; leadership skills; skills development; model; africa; fmcg; business network; supply chain. introduction optimism about africa’s prospects remains widespread and decisive throughout the region (chironga, desvaux & leke 2018). africa offers significant opportunities for development to global and local businesses. however, with the continent’s complexities, success is not certain: considered strategies are required to transform africa’s future growth opportunities into beneficial and sustainable organisations. such plans must comprise a thorough approach to its geographical mark, novelty to tackle africans’ unmet requirements, the development of solutions that create resilience in business operations and taking confident and innovative moves to develop the necessary leadership skills amongst local talent. given the continent’s growing population and gross domestic product (gdp), africa is likely to become the most potent territory for several industries, particularly the fast moving consumer goods (fmcg) industry, including packaged food, consumer electronics, beauty and personal care (leke, chironga & desvaux 2018). the fmcg industry is a strategically important contributor to economic growth (jacobs & mafini 2019). africa’s consumer spending will exceed the global average in the years to come. most of the increase in africa’s consumer expenditure will come from rapidly growing smaller markets, such as ethiopia and kenya, which are both expected to record a consumer spending compound annual growth rate (cagrs) of 8% over the 2017–2030 forecast period. the lack of big businesses in africa is not solely a problem for shareholders, but predominately for society, as these organisations are catalysts for economic growth. big companies are like baobab trees: they tower above others, have deep roots, and have a longer life expectancy. generally considered, the tree of life, the baobab creates healthy food that maintains several areas. organisational baobabs promote local industry: they provide financial resources for wages and taxes, operational improvements, innovation, and the adoption of technological advancements. similar to baobabs, big organisations create ecosystems, promoting small-business creation throughout their supply chain. these large firms are generally better positioned to attract investment, helping them to compete globally. africa has space, the need, and a growing population to nurture billion-dollar companies across the continent (leke et al. 2018). ‘africa rising’ refers to a rising middle class, although a vast opportunity still exists at the ‘bottom of the pyramid’ (bop) (euromonitor international 2018:7). the bop refers to households with an annual disposable income of usd2500 or less (euromonitor international 2018). the bop represented more than a third of sub-saharan african (ssa) households in 2017, and in south africa, bop discretionary expenditure is the highest in the region and will likely increase to 46% by 2030 (euromonitor international 2018). fast-moving consumer goods products such as food and beverages account for the largest share of bop households’ expenditure across the african continent. however, many of the products purchased are from informal, open-air markets. reaching these markets requires creative distribution strategies from fmcg businesses. in africa, partnering with established brands is generally the best way to expand market presence; and gaining access to bop consumers in africa usually requires an unconventional distribution network. however, the fmcg industry offers excellent potential (euromonitor international 2018). the overarching challenge faced by organisations in the african fmcg industry is to innovate their business model and develop skills to build sustainable and resilient businesses. africa comprises consumers whose economic activity is greater than india’s and will soon have twice the number of smartphone users as north america (leke et al. 2018). capitalising on opportunities offered by both the bop and the growing middle-class consumer bases will be critical in african countries with bespoke product and service offerings for each segment. companies will require an in-depth understanding of africa’s diverse consumer profiles to be able to offer products and services to local, regional and country-specific preferences. growth in modern retailing requires a business to understand the distribution model and consumer preferences for informal retailing, which is likely to remain dominant for some time (euromonitor international 2018). although poverty in africa remains prevalent, by reassigning challenges as an invitation for innovation, organisational leadership can help their businesses and africa to prosper (euromonitor international 2018; leke et al. 2018; swaniker 2018). leadership is likely the most critical yet complex challenge facing humanity. although widely discussed, there is a distinct lack of consent regarding the evolving concept of leadership (eberly et al. 2013; landis, hill & harvey 2014). despite significant investment, a growing concern for organisations is that leadership development initiatives are not building the necessary leadership skills (cohen 2019; cullen-lester, maupin & carter 2017; eberly et al. 2013). cohen (2019) states that the prevailing logic behind leadership programmes appear to be drawn from questionable assumptions, unlike established disciplines such as philosophy, economics and sociology (burns, diamond-vaught & bauman 2015; cohen 2019; eberly et al. 2013). dansereau et al. (2013) suggests that an opportunity exists in unifying traditional and contemporary leadership theories. cullen-lester et al. (2017) recommends a need for interventions that employ collaborative, multi-level techniques as an approach to increase leadership capacity in organisations. bolden, witzel and linacre (2016) suggest the adoption of interconnected, interdependent, synergistic, holistic, and globalised perspectives in turbulent times. these studies indicate research gaps, needs and opportunities for the integration of leadership theories in which concepts, models and principles unify into a more coherent, holistic, theoretically relevant and empirically validated model (cullen-lester et al. 2017; dansereau et al. 2013; eberly et al. 2013; heath, martin & shahisaman 2017; kim & mclean 2015; shrivastava et al. 2014). holt, hall and gilley (2018) suggest that leaders should be at all levels of an organisation and that everyone contributes towards organisational performance. for an organisation to remain competitive and thus sustainable, organisations need to ensure that leadership skills development initiatives are coherent and provide a multifaceted effort to respond to ongoing internal and external challenges. as such, it seems reasonable to suggest that a gap exists to unify traditional and contemporary leadership theories which employ collaborative, multi-level techniques to increase leadership capacity. businesses that succeed in africa need to invest in talent, and that investment will reap significant rewards for them as they grow. developing talent is a strategic role, which should be considered part of the value chain and not outsourced to the national university system. africa has an abundance of talent. converting this raw talent may only require a short training program that could be enough to unlock the skills that businesses need. notably, a company that wants to expand into africa should have a plan for doing good, while doing well (chironga, desvaux & leke 2019; leke et al. 2018; swaniker 2018). furthermore, african fmcg businesses need leadership development interventions (jacobs & mafini 2019). therefore, it seems fair to suggest that a gap exists for african fmcg businesses to improve leadership capacity to realise their potential. to address the leadership challenges and the business prospects in fmcg businesses in africa, an opportunity to cultivate the next generation of leaders and build the required leadership capability for doing good while doing well in africa. considering the above, research gaps concern: the need for the unification of traditional and contemporary leadership theories into a more coherent approach. the need for african fmcg businesses to improve leadership capacity to realise potential. as such, the research problem statement is as follows: leadership skills development initiatives are built on questionable assumptions (cohen 2019; eberly et al. 2013) and are not building the necessary leadership skills to improve the leadership capacity required in african fmcg businesses (chironga et al. 2019; cohen 2019; cullen-lester et al. 2017; eberly et al. 2013; jacobs & mafini 2019; leke et al. 2018). the study has two major research objectives: theoretical objectives: conceptual model development (to determine theoretically relevant leadership constructs; theoretically relevant approaches to leadership skills development; and to conceptualise a model for leadership skills development). practical objectives: conceptual model assessment (to perform a quantitative assessment of the appropriateness of the leadership constructs within a conceptual model for leadership skills development; perform a qualitative assessment of leadership skills and the leadership skills development requirements to critically explore how the conceptual model for leadership skills development could develop leadership skills in the african fmcg sector). the outcomes and practical value of this study included a theoretically relevant, empirically validated leadership skills development model for african fmcg business-networks, as well as a range of recommendations on how to develop leadership skills throughout africa. leadership skills development is complex, especially in a rapidly changing environment. this study is the first that proposes a leadership skills development model for african fmcg business-networks which directly contribute to the discipline of leadership and leadership development. the remainder of this article is organised as follows: a review of the applicable literature, developing the conceptual model, a summary of the method followed and the rationale for using an explanatory sequential mixed-methods approach in this study. then the findings are discussed followed by the conclusion and ideas for further research. literature review leadership research extends throughout the behavioural, social, and physical sciences, management, the disciplines of psychology, anthropology, politics, sociology, biology, along with evolutionary studies. in contrast to the comparatively large account of leadership theory and research, the orderly analysis of leadership development (generally defined to also include leader development) has a relatively short history. the ancient egyptian hieroglyphs also portrayed the leader, follower, and leadership (yammarino 2017). more than a century of leadership study has resulted in some paradigm shifts and much confusion. on numerous occasions, leadership scholars have grown frustrated with minor theoretical advances and contradicting results. bennis (1959) stated six decades ago that: of all the hazy and confounding areas in social psychology, leadership theory undoubtedly contends for the top nomination … probably more has been written, and less is known about leadership than about any other topic in the behavioural sciences. (pp. 259–260) equally, hackman and wageman (2007) established that the subject of leadership is ‘curiously unformed’ (p. 43). for the last half-century, leadership scholars have battled to construct an integrated and theoretically cohesive view of leadership. as such, leadership remains an expansive and essential field of study (bass & bass 2008; day et al. 2014; day & thornton 2018; yammarino 2017; yukl 2012). leadership is central in the managerial and mainstream media world. corporate, government, military, and not-for-profit organisations all require the development of effective leadership, which is currently a major concern for all kinds of organisations (day et al. 2014). despite significant growth and investment in leadership development, there is little proof that leadership is improving and being more effective. leaders at the wheel of various religious, financial, corporate, educational, and government institutes have been responsible for huge failures that eroded public trust and have damaging social, economic, political and environmental consequences (cohen 2019). to find solutions to the complex problems faced by our global society, we need leaders who have the necessary skills to transform our current social, economic, political and ecological realities (burns et al. 2015). leadership is possibly the most critical event in the field of human behaviour, as almost nothing gets done without it. leadership is also one of the social sciences most significant studied phenomena, in which the scrutiny afforded is, not surprisingly, taking into consideration that it is a widespread action marked in both humanity and the animal species (bass & bass 2008). reference to leadership is evident in western and eastern texts, with a general consensus that leadership is essential for social, economic and environmental development (antonakis & day 2018; yammarino 2017). while leadership may be simple to recognise in practice, it is often hard to define. considering the multifaceted study of leadership, a generally agreed definition of leadership does not presently exist. also, antonakis and day (2018) points out that learnings in the social sciences remain not cohesively integrated, and the perspective that leadership researchers operate from, is uncertain. fiedler (1971) notes: ‘there are as many definitions of leadership as there are leadership theories – and there are almost as many theories of leadership as there are psychologists working in the field’ (p. 1). it is, therefore, problematic to get leadership researchers to settle on a definition. in the absence of consensus, the following description of leadership is made by antonakis and day (2018): leadership is a formal or informal contextually rooted and goal-influencing process that occurs between a leader and a follower, groups of followers, or institutions. the science of leadership is the systematic study of this process and its outcomes, as well as how this process depends on the leader’s traits and behaviors, observer inferences about the leader’s characteristics, and observer attributions made regarding the outcomes of the entity led. leadership dimensions, attributes, and constructs following the establishment of theoretically relevant leadership dimensions and attributes, six constructs were conceptualised. the six leadership constructs are choices, principles, mental (cognitive), emotional, physical, and spiritual, which are perceived as humancentric, multidimensional and inherently incorporate the notion of being developmental, that is, they can be developed. table 1 provides a summary of the six leadership constructs, the associated construct theories, as well as examples of the related leadership skills for development. table 1: leadership constructs, associated theories, and skills. a conceptual leadership model the researchers conceptualised a six-construct leadership model from the leadership theory discussed and presented previously. the conceptual leadership model was represented as a cube and named super-cube®. the super-cube® model implies that each side of the cube integrates to create a holistic, coherent, multifaceted, human-centric perspective. foti and hauenstein (2007) argue that ‘the person is considered as an integrated totality rather than a summation of variables’ (p. 347). leadership scholars argue that progressing research on traits or personal characteristics and their effects on leadership require more multifaceted models and approaches (bass 1990; lord & hall 1992; zaccaro, laport & jose 2012). taking the above into consideration, the researchers conceptually developed a leadership model which comprised six leadership constructs grounded in academic literature. in the conceptualisation and naming of the conceptual model, the word cube refers to ‘you’, where the letter ‘u’ in the word cube represents you – a leader. the word super is an adjective, in which case it implies you are wonderful, fantastic, great, marvellous, fabulous, excellent, splendid, superb, brilliant, superior, enhanced, and outstanding, etcetera. the objective is to provide a model that promotes and enables superior leadership (you) capability, that is you (from a multidimensional perspective) are super. the conceptual model proposes buber’s i-thou relation, which appreciates people as equals (morgan & guilherme 2012). the i-thou relation highlights the mutual and holistic existence of two entities. morgan and guilherme (2012) describe the i-thou approach as an encounter of equals who value each other as such. the ethical nature of the i-thou relation suggests that if someone is unable to respect fellow human beings as persons and see them merely as objects, that person, too, will be considered an object (morgan & guilherme 2012). this approach represents a person as a means to an end, which ceases to ascribe rights and duties to both parties. however, buber encouraged people and communities to see fellow human beings as thous, with the same psychological, intellectual, emotional, and spiritual attributes. in this study, the conceptual model appreciates people as holistic entities, comprising multidimensional capabilities, capable of being both leaders and/or followers in certain contexts. the first two theories of the conceptual leadership model represent the choices and principles constructs. choice theory is the notion that making choices is a process of evaluating available options, requiring multiple skills, and then choosing the preferred option based on a consistent criterion (levin & milgrom 2004). levin and milgrom (2004) suggest that real-world choices often appear to be highly situational and context-dependent, such as the social context, the emotional state of the decision-maker, and a variety of other environmental factors which influence choice behaviour. from the conceptual model perspective, the choice construct represents the primary function, influenced by the cognitive, emotional, physical, and spiritual dimensions, yet conceptually guided by the principles construct. principle theory provides a foundation of guiding principles that relate to a person’s ability to act by the rules or standards (caldwell, karri & vollmar 2006). furthermore, johns (2006) suggests that context is a phenomenon external to the individual, yet it affects leadership decision-making. in the context of this study, the principle construct represents the rules and standards of social, economic, and natural laws, e.g. science, technology, engineering, and mathematics (stem). in essence, the principles construct represents ethics (decision-making foundations) and, thus, ethical leadership development for the greater good of humanity (wilson & mccalman 2017). based on the principles in these two theories, it seems reasonable to suggest that choice and principle theory support and guide one another as established in the conceptual model for leadership skills development. the following four theories represent the remaining (cognitive, emotional, physical, and spiritual) constructs of the conceptual leadership model. concerning the conceptual leadership model, the cognitive construct represents a leader’s mental intelligence. cognition faculties refer to a person’s knowledge, skills, and ability to solve problems, to plan, to reason, to think conceptually, to grasp complex concepts, and to learn quickly, as well as learn from experience, and the ability to teach; these cognitive skills are essential aspects of critical importance within and throughout the leadership context (mumford et al. 2017; prinsloo & barrett 2013). mumford et al. (2017) argue that mental intelligence ultimately refers to the speed and depth of leaders’ information processing skills and abilities when working to solve complex problems. furthermore, evidence suggests that mental intelligence can be developed to provide people with the knowledge and skills they need to perform complex leadership tasks (mumford et al. 2017). emotional intelligence theory comprises of a four-branch ability model of a person being able to perceive, use, understand and manage emotions (mayer, salovey & caruso 2004). each branch of emotional intelligence can be developed and is a critical aspect of effective leadership (doe, ndinguri & phipps 2015; mayer et al. 2004). heath et al. (2017) state that great leaders can develop the following five emotional intelligence skills: namely, self-awareness, self-regulation, motivation, empathy, and social skills. the first three skills are considered part of personal competence, while the last two skills are considered social competence, all of which determine how leaders handle relationships (doe et al. 2015). the physical construct of the conceptual model for leadership skills development represents a leader’s physiological well-being and is conceptualised as physical intelligence. the ‘wheel of wellness’ theory concerns a person’s physical health and the fact that stress management, nutrition, and exercise are all vital aspects of the physiological well-being of a leader (hattie, myers & sweeney 2004). harms et al. (2017) suggest that stress and leadership are inextricably linked to one another and argue that stressful events especially require good leadership. leaders who can handle stressful events effectively are generally more inclined to good decision-making and group fitness (harms et al. 2017). edwards (2006) maintains that regular exercise for an average of 30 min a day, at least three times a week, is associated with significant improvements in a person’s physical well-being, as well as aspects of mood, coherence, fortitude, and stress management. the spiritual construct of the conceptual model for leadership skills development conceptually represents the conduit between the leader’s choice construct and the principle construct. the construct also symbolises the fusion between the mental, emotional, and physical aptitude of a leader. delaney’s (2005) ‘spirituality scale’ is a method used to assess a person’s beliefs, values and choices. maslow (1972) contends that ‘the spiritual life (the contemplative, religious, philosophical, or value-life) is … part of the human essence … a defining characteristic of human nature …’. avolio (2007) suggests that spiritual intelligence is central in leadership as it unites the four innate aspects of a person’s existence (mind, heart, body and spirit), so that people are who intrinsically motivated to achieve important goals, are more committed to achieving organisational objectives and experience higher levels of personal joy, peace and fulfilment. research findings in south africa established that higher levels of spirituality were generally associated with improved health, fewer mental health problems, and better health-related physical, psychological and environmental aspects of life outcomes (edwards 2012). based on the conceptual leadership model, the researchers define: leadership is a multidimensional, human-centric and principled approach towards the progression of humanity. a conceptual leadership skills development model the above section discussed the topic of leadership and presented a six-construct conceptual leadership model. this section provides a review of leadership development literature towards the conceptualisation of a leadership skills development model. researchers suggest that leadership development is inherently a multi-level process (avolio 2007; day & dragoni 2015). there are within-person and between-person levels; higher dyadic levels involving relationships with followers, peers, and subordinates; and team and organisational levels. it appears that cross-level research approaches will further the understanding of leadership skills development. leading and leadership development is a dynamic and longitudinal process, which involves the consideration of time (day 2014). the development of organisational leadership in general, and leaders, in particular, is a process occurring throughout the entire adult lifespan (day et al. 2012). furthermore, leaders do not develop all in the same way with identical growth patterns (day & sin 2011). people learn different things from the same experience, and some learn the critical lessons of experience quicker than others (day & thornton 2018). a notion exists that leaders are ill-prepared to handle future challenges. drucker (1995) noted that no more than one-third of executives selection decisions turn out right, approximately one-third are marginally useful, and the final one-third outright failures. a concern regarding these estimates is that while leadership development is a strategic human capital issue in many organisations, both current and past data suggest that it is not enough. one issue that undermines the effectiveness of leadership development initiatives is the focus on generally short-term, episodic-based thinking of how development occurs. typically, the notion of leadership development has been viewed as a series of unconnected, discrete programmess with minimal assistance in integration across the development episodes (vicere & fulmer 1998). in contemporary views of leadership development, it is considered a continuous and ongoing process throughout the adult lifespan (day et al. 2012). mccauley et al. (2010) suggest that just about all experience has the potential to enhance learning and development and will likely do so to the extent that it includes aspects of assessment, challenge, and support. the focus in the field relates to developing individual leader skills, although there is no assurance that improved leadership will result. as such, leadership involves collaboration within a given situational context. thus, effective followers are required, along with effective leaders (hollander 2009). furthermore, real collective leadership development will possibly require intervention at the group, team, or organisational levels. despite the distinction between leader development and leadership development, it is not an either/or proposition. instead, advanced initiatives seek to establish ways to combine individual leader development with collective leadership development to further overall leadership capacity in teams and organisations (day & dragoni 2015). table 2 presents the leadership skills development findings from the review of leadership development theory, concepts, terms, definitions, and models from the leadership skills development categories reviewed. table 2: leadership skills development summary. the unification of the conceptual leadership model (discussed and presented in section 2.2) and the leadership skills development findings in table 2, a model for leadership skills development was conceptualised as shown in figure 1. figure 1: a conceptual model for leadership skills development. in the conceptual model for leadership skills development, the leadership skills development process is considered inherent in each of the six leadership constructs in the model. the leadership skills development rationale follows that (1) leadership can and does develop over time (de neve et al. 2013); (2) structure programmes and experiences best promote leadership development (conger 2010; day & thornton 2018; kegan & lahey 2016) ; and (3) it adheres to the theory of learning during the developmental process (illeris 2018). based on the conceptual leadership skills development model, the researchers define leadership skills development: inherent skills developed by structured methodologies concerning the learning theory, regarding the development of multidimensional, human-centric and principled approaches towards the progression of humanity. the following section reviews the research design and methodology to help address the research questions. research design and methodology pragmatism is typically associated with mixed-methods research as an overarching philosophy (tashakkori & teddlie 2003). in studies with a pragmatic worldview, the importance of the research concerns is finding practical results. it is recognised that single perspectives may not provide the solutions, and that there may be multiple realities (saunders & tosey 2012). from a pragmatic worldview, the focus is on research outcomes and the importance of the question asked rather than the methods (creswell & plano clark 2018). due to the complex nature of the research problem addressed in this study, an overarching philosophy of pragmatism has been embraced, as it combines two worldviews that provide the benefit of addressing the research problem from multiple perspectives, that is pragmatism is one philosophy that includes post-positivism and constructivism (mcmillan & schumacher 2010). in this study, the researchers used both quantitative and qualitative research methodologies, known as mixed-methods research. in mixed-methods research, three core typologies exist, namely: (1) convergent designs; (2) explanatory sequential designs; and (3) exploratory designs (creswell & plano clark 2018). this study required that the qualitative results would further explain the initial quantitative results, regarding the deductive analysis of a conceptual model for leadership skills development. as a result, this study took an explanatory sequential design typology which started by conducting a quantitative stage and following up on the results at a qualitative stage an in-depth case study was done to develop a leadership skills development model. this was based on a quantitative research method, in which the results were used to assist with further questions during the interviews, as a qualitative research method in an explanatory sequential mixed-methods design. quantitative strand for the quantitative research, ordinal scales were used to develop response options. scales were developed to measure, inter alia, the knowledge, beliefs, attitudes, judgements, and sentiments concerning the six constructs of the conceptual leadership skills development model. terre blanche and durrheim (1999) state that a scale measures the intensity, direction and level of potency of the variable being measured. three questions, relating to each of the six constructs were used as the scales. the questions originated from the leadership theory associated with dimensions and attributes pertaining to each construct in the conceptual model for leadership skills development. when developing the electronic questionnaire survey, the researchers took the following into account (cooper & emory 1995; creswell & plano clark 2018; terre blanche & durrheim 1999): strengths: the ability to access many participants; an economic process; an ability to ensure anonymity; and the potential to generalise to large populations. limitations and weaknesses: possible high non-response rate; possible potential misinterpretation of questions; and excluding questions that may have been of value. following the conceptualisation and operationalisation of the six constructs in the conceptual model for leadership skills development, the researchers developed a questionnaire survey. the questions aimed to evaluate the constructs of the conceptual model for leadership skills development. the questionnaire consisted of the following sections: research project overview; informed consent; and leadership question evaluation: 3.1 choices construct: three questions; 3.2 principles construct: three questions; 3.3 mental construct: three questions; 3.4 emotional construct: three questions; 3.5 physical construct: three questions; and 3.6 spiritual construct: three questions. the questionnaire was subsequently converted into an electronic format (using the online google forms application). the electronic questionnaire was designed to ensure each question had to be answered, negating the risk of missing values. also, as the questionnaire was to be completed anonymously, the risk of bias (if the survey was not anonymous) offset the multiple-submission risk and additionally, participants had no incentive to complete the survey. the last step in the measurement development phase included a pre-test. the target population (or unit of analysis) was contextualised within a leading fmcg company that operates exclusively in african countries. the target population was further defined as employees who had a company email address and thus had access to email. an invitation to participate in the research study was emailed to the target population. over 10 weeks, one hundred thirty-two (132) responses were received, corresponding to a 43.9% response rate. statistical analysis was undertaken by the statistical consultation services of the north-west university using the statistical package for the social sciences (ibm spss/amos statistics version 25) consisting of descriptive and multivariate techniques. this research followed non-parametric statistical techniques as the focus of the study was on the order and ranking of ordinal scales (distinct and ranked) (terre blanche & durrheim 1999; terre blanche, durrheim & painter 2006). to further address the research problem, validation of the conceptual model for leadership skills development was required. a multivariate confirmatory factor analysis (cfa) technique was followed in this study as a cfa is a theory-testing approach, as opposed to a theory-generating approach (stapleton 1997). in order to establish the internal consistency reliability of the constructs, cronbach’s alpha coefficients were calculated for each construct as a method of determining the reliability and internal consistency amongst the constructs (cooper & emory 1995; field 2009). qualitative strand the primary intent of a mixed-methods explanatory sequential design is for the qualitative phase to explain the initial quantitative results (creswell & plano clark 2018). the researchers invited 14 ‘key decision-makers’ from the fmcg company to participate in a one-on-one, face-to-face in-depth interview. the term ‘key decision-makers’ refer to the company directors who are ultimately responsible for leadership in the organisations within the fmcg company and are likely the most informed. the sampling methodology for the qualitative strand of this study was purposeful sampling, by which all 14 ‘key decision-makers’ were invited to participate in the study. creswell and plano clark (2018) propose that a case-study sample size should be between 4 and 10 participants, and in this study, 10 of the 14 key decision-makers were willing and able to participate, which is a response rate of 71.43%. the data analysis comprised of thematic interpretation and aimed to explore and elaborate on the results from the quantitative results. the validity of the qualitative data was assured by applying the four criteria used to ensure a trustworthy study, namely credibility, transferability, dependability and conformability (shenton 2004). the credibility of the findings was secured by triangulating multiple perspectives to interpret a single set of data, as well as that the research findings could be combined on a more analytical macro-level of inference (groenland & dana 2019; terre blanche & durrheim 1999; terre blanche et al. 2006). conceptual model-fit terre blanche and durrheim (1999) argue that theories are general truth statements that researchers put to the empirical test by deriving hypotheses about observations. the motive for this modelling is that the real world is generally so complex that it typically requires to be conceptually simplified to understand it. to further address the research problem, validation of the conceptual model for leadership skills development was required. a multivariate cfa technique was followed in this study as a cfa is a theory-testing approach, as opposed to a theory-generating approach (stapleton 1997). in cfa, the researchers begin with a hypotheses or conceptual model, in this case, a conceptual model for leadership skills development, and specifies which variables will be correlated with which factors, and which factors do indeed correlate. confirmatory methods, following the specification of the priori factors, seek to optimally match the observed and theoretical factor structures for a given data set in order to determine the ‘goodness of fit’ of the predetermined factor model (stapleton 1997:7). findings the quantitative results of the appropriateness of the leadership constructs in a conceptual model for leadership skills development include the response rate, descriptive statistics of the organisation, construct validity and construct reliability. the online quantitative questionnaire had a 43.9% response rate. the age group with the highest population is those 36–45-year old, at 36% of the population. the second highest age group population is those 25–35-year old, at 28%. there is a small population of below 25 years old at 4%, and only 1% at over 65 years old. the gender population is relatively equal; however, there were slightly more female participants at 53% versus 47% of the male population. thirty per cent of the population had an undergraduate qualification, 26% a postgraduate qualification, 12% of the population have a secondary qualification, 5% a certification and 5% a trade certification. twenty-two per cent of the population did not indicate their qualification status. table 3 shows the online survey questionnaire results. the results present the mean and standard deviation for each of the survey questions. while descriptive statistics results provide information regarding each question, i.e. the mean and standard deviation, this information alone does not provide enough insight into the overall meaningfulness of the constructs in the conceptual model. table 3: online survey questionnaire results. confirmatory factor analysis was used as it provides a viable method for evaluating construct validity (stapleton 1997). figure 2 provides a graphical representation of the construct-to-construct relationship. figure 2: confirmatory factor analysis. to determine the relative contribution of each variable, i.e. each question, a standardised regression weight analysis was performed. table 4 presents the standardised regression weight results. table 4: standardised regression weight results. the results from the standardised regression weights analysis determined the relative contribution of each variable (research question), and in this case, are noted as the estimate. estimates values between 1.0 and 0.5 are acceptable; however, values of 0.3 are also considered acceptable. the choices construct had an estimate of 1.071, 0.776 and 0.377. while an estimated value of 1.071 is marginally higher than 1.0, it is deemed acceptable. the principles construct results of 0.713, 0.622 and 0.529, are deemed acceptable. the results for the cognitive construct were 0.710, 0.614 and 0.495, all considered acceptable. the emotional construct results were 0.804, 0.518 and 0.509, all deemed acceptable. the results of the physical construct were 0.969, 0.955 and 0.386, which are all acceptable. the spiritual construct results were 0.773, 0.736 and 0.572, and all were deemed acceptable. table 5 shows the construct-to-construct correlation results. table 5: construct-to-construct correlation results. the p-value results of the choices and cognitive (0.247), choices and physical (0.481), and spiritual and choices (0.295) reported low construct-to-construct statistical significance correlation. however, the majority (83%) of the construct-to-construct correlations were statistically significant. behr (1983) provides a construct correlation strength description (see table 6) that the researchers used to interpret the construct-to-construct correlation results. table 6: construct correlation strength description. the highest, near-perfect correlation exists between the mental and emotional constructs. these findings suggest that an almost perfect relationship occurs in participants’ perception of leaders’ abilities to think, to learn, and their self-awareness, with their ability to perceive, use, understand and manage emotions. in relation to the conceptual model, the mental and emotional constructs are presented as being side-by-side, both acting as conduits between the choices and principles constructs. the spiritual and principles construct-to-construct correlation is the next strongest with a 0.792 result, defined as having a substantial relationship. the results support the construct operational definitions in which the spiritual construct is defined as a leader’s ability to act according to principles; and the principles operational definition being a leader’s ability to understand the rules and standards of social, economic, and natural laws. in the context of the conceptual model, the spiritual construct is considered the overall/primary conduit between the choices and principles constructs. this implies that a leader’s ability to choose should be based on principles, and that principles should influence a leaders’ decision-making ability or choice. the principles and emotional construct-to-construct correlation is the third strongest correlation at 0.761. in the context of the leadership model, the principles construct represents a leader’s decision-making foundation; which, in this case, has a strong relationship with a leaders’ ability to manage their emotional intelligence, i.e. how they are to perceive, use, understand and manage their emotions. the next strongest construct relationship occurs between the spiritual and mental constructs. in relation to the leadership model, the spiritual construct is defined as a leader’s ‘ability to understand the rules’, which has a strong relationship with that leader’s ‘ability to think and learn’ from the mental construct. the spiritual and emotional construct-to-construct correlation is the next strongest and defined as having a high and substantial relationship. while the spiritual construct is considered the primary leadership conduit, mainly the fusion between a leader’s choices and principles, the emotional construct plays a significant role in a leader’s ability to manage emotions during interactions as either a leader or a follower. the principles and mental relationship are considered moderate. in the context of the leadership model, the result suggests that the principles construct can moderately influence a leader’s mental capacity to learn and understand. the next strongest relationship exists between mental and physical constructs. in relation to the leadership model, a leader’s ability to ‘think and learn’ has a moderate relationship with a leader’s ability to manage their physical intelligence, i.e. the ability to manage stress. the spiritual and physical construct-to-construct relationship is the next strongest with a result of 0.491. the principles construct represents the ‘rules and standards’ which has, in the context of the leadership model, the ability to influence the physiological well-being of a leader. the next strongest construct-to-construct relationship is the moderate relationship between emotional and physical constructs. the emotional construct represents a leader’s ability to manage their emotions. this result suggests that participants perceived that leaders’ emotions can moderately influence their stress and overall physiological well-being. a definite relationship exists between the principles and physical constructs. in the context of the leadership model, the physical dimension of a leader is influenced by the principles construct, that is the physical domain is influenced by natural laws. the choices and emotional construct-to-construct relationship are considered definite. in this context, leaders can make a choice to manage their emotions. the next strongest construct-to-construct relationship is the relationship which exists between the choices and principles constructs. the relationship is considered definite, and in the context of the leadership model, the two constructs are opposite one another, implying that they support one another. the results of this study support the relationship. the results from this study suggest that there is an indifferent or average relationship between the choices and mental constructs. similar results were found in the construct-to-construct relationship between the spiritual and choices constructs. the choices and physical construct-to-construct was the lowest relational strength amongst the construct relationships. the model fit statistics evaluate a model in relation to the fixed parameters applied to postulate the model and the approval or dismissal of the model (stapleton 1997). table 7a and table 7b presents a summary of the conceptual model-fit results. the results provide empirical evidence that the conceptual model for leadership skills development is considered a good model fit. cronbach’s alpha coefficient values ranged between 0.604 and 0.803, which indicate acceptable and satisfactory reliability. table 7a: model-fit and construct reliability distribution. table 7b: model-fit and construct reliability distribution. based on the quantitative results, it seems reasonable to suggest that the leadership constructs within the conceptual model for leadership skills development, as a case in the african fmcg sector, are statistically valid and reliable and are therefore considered appropriate. concerning the conceptual model, the results indicate that the mental construct had the most words at 31%, with the emotional construct marginally lower at 29%. the mental and emotional constructs, therefore, represent 60% of the words described by participants in the interview process regarding the leadership skills required by the fmcg. the principles and spiritual contribute 30%, with 18% and 12% respectively. choices contribute 9% to the total word count and physical only 1%, with two words used from a total of 321 words. with the qualitative results and findings, it seems reasonable to suggest that the qualitative phase in this explanatory mixed-methods study explains and elaborates on the initial quantitative results obtained from the quantitative strand. figure 3 shows the construct distribution results from the qualitative thematic analysis. figure 3: construct distribution results. table 8 presents the results of how the qualitative results compliment the initial quantitative results concerning the leadership constructs in the conceptual leadership skills development model. table 8: summary of results. the six leadership constructs concern how the leadership skills integrate with the conceptual model. choices empirical evidence discussed in the quantitative strand notes the choices construct as the second most reliable (0.74) construct and this was supported and explained in the qualitative strand with an overall word count of 9%. the choices construct concerns the primary construct in the leadership model. in this study, the ability to make choices is described as a process of considering available options, requiring multiple skills, and then choosing an option based on principles (levin & milgrom 2004). as the skill in making good choices develops, decision-making may improve decision-making speed, accuracy, and consistency. principles the empirical results presented in the quantitative strand state that the principles construct is the third most reliable (0.65) and this was confirmed and explained in the qualitative strand with an overall word count of 18%. the principles construct concerns the foundational and guiding principles which relate to the ability to make decisions according to rules or standards (caldwell et al. 2006). in this study, principles concern the following: social principles: the skills and abilities to care for other people, putting their needs first, serving others and acting as a servant for the good of another person, i.e. embracing the principles of servanthood leadership. economic principles: the skills and abilities to operate efficiently and effectively in business operations. for example, a business should adhere to economic principles and should make a profit to ensure continuity – to pay employees, suppliers, and fund other business-related activities. importantly, the business must adhere to ethical principles, that is, the rules and standards concerning statutory and regulatory requirements in the context in which they manifest and where the business operates. natural law principles: the skills and abilities to understand and apply the stem etcetera and natural law, that is gravitational principles. the understanding of principles will inevitably vary based on personal circumstances, e.g. education and experience; however, improving the understanding and adherence (choices construct) to principles is considered foundational, and intentionally designed as the foundation of the leadership skills development model. mental empirical evidence discussed in the quantitative strand notes that the mental construct is the least reliable (0.60), yet was supported and explained in the qualitative strand with the highest word count of 31%. the mental construct represents the skills and ability to solve problems, to plan, to reason, to think, to grasp complex concepts, to learn quickly, learn from experience, and the ability to teach and impart knowledge (mumford et al. 2017; prinsloo & barrett 2013). in this article, the mental construct refers to the speed and depth of information processing skills when solving complex problems. evidence suggests that mental intelligence can improve to provide the knowledge and skills required to perform complex leadership tasks (mumford et al. 2017). emotional the empirical results presented in the quantitative strand state that the emotional construct is the fifth most reliable (0.62), yet was explained in the qualitative strand with an overall word count of 29%, the second highest. the emotional construct represents the skills to perceive, use, understand and manage emotions (mayer et al. 2004). the emotional construct concerns the skills of self-awareness, self-regulation, motivation, empathy, and social skills. the first three skills are regarded as personal competence, and the last two skills are considered social competence. all five skills determine how relationships are handled and are skills that can be improved (doe et al. 2015; heath et al. 2017; mayer et al. 2004). physical empirical evidence discussed in the quantitative strand note that the physical construct is the most reliable (0.80), yet was hardly discussed in the qualitative strand with the lowest overall word count of 1%. the physical construct represents the physiological well-being of a person. the management of stress, nutrition, and exercise are considered essential aspects of physical well-being (hattie et al. 2004). edwards (2006) suggests that regular exercise is associated with significant improvements in physical well-being, including aspects of mood, coherence, fortitude, and stress management. harms et al. (2017) note that stress and leadership are inextricably linked. spiritual the empirical results presented in the quantitative strand state that the spiritual construct is the fourth most reliable (0.63) and was confirmed and explained in the qualitative strand with an overall word count of 12%. the spiritual construct represents the conduit between the choices and principle constructs and unites the four innate aspects of a person’s existence (mind, heart, body and spirit), so that people are intrinsically motivated to achieve important goals (delaney 2005; maslow 1972). the concluding findings from this research indicate that leadership can be developed through a series of events to complete the overall wholeness of a person. conclusion africa is huge with an abundance of space to build scalable business-networks. given the continent’s rapidly growing population and gdp, africa is likely to become the most compelling territory for the fmcg industry. the vast unmet needs of africa and its unfulfilled demand make it a continent ripe for entrepreneurship and innovation at scale. a smart and original approach to expanding into africa calls for an innovative business model to unleash talent at scale, as well as find operational solutions to improve business resilience in order to cultivate business leaders of a new nature in the century ahead. it was demonstrated that african fmcg businesses require urgent leadership interventions to improve performance. importantly, businesses wishing to grow in africa should have a plan for doing good, while doing well. this study, therefore, addressed the following two gaps: the need for the unification of traditional and contemporary leadership theories into a more coherent approach. the need for african fmcg businesses to improve leadership capacity to realise potential. in this study, the aim was to create a leadership skills development model for african fmcg business-networks, to contribute toward developing talent to improve business potential in the african fmcg sector. the first three research questions and objectives aimed to address the research gap concerning the unification of traditional and contemporary leadership theories into a more coherent approach. the last three questions aimed to address the research gap concerning the need for african fmcg businesses to improve leadership capacity as to realise potential. in this study, ordinal scales were used to develop response options. scales were developed to measure, inter alia, the knowledge, beliefs, attitudes, judgements, and sentiments concerning the six constructs in the conceptual leadership skills development model. terre blanche and durrheim (1999) state that a scale measures the intensity, direction and level of potency of the variable being measured. three questions relating to each of the six constructs were used as the scales. a thorough review of leadership and leadership development literature resulted in the conceptualisation and operationalisation of a multidimensional conceptual model for leadership skills development comprising six constructs. the key contribution of the conceptual model to leadership skills development was that it effectively incorporates traditional and contemporary leadership theories into a holistic, integrated, coherent and universal approach to leadership skills development. the leadership skills development model, if adopted by an organisation, will result in a leadership skills development initiative being built on theoretically relevant and empirically validated constructs. this approach should help organisations build the necessary leadership skills to improve leadership capacity and ultimately improve business potential. this perspective should also challenge fmcg (and other) organisations and learning institutions to look toward a new approach to leadership skills development. africa implementation offering leadership programmes beyond the fmcg alliance is a fundamental objective. the end-goal is to offer leadership skills development programmes to everyone; that is, from early childhood development, general education, further education, and higher education, i.e. throughout a person’s lifecycle, and across the african continent. study limitations various concepts of leadership and leadership skills development were discovered during the review of the literature. while the researchers are confident that this study contributed to the creation of a leadership skills development model, it was completed in a leading case study on fmcg in africa and the results cannot be generalised to other type of organisations in other industries. future research the opportunity for future research is vast. as leadership is a complex and evolving concept with many variables, opportunities for future research exist, particularly in evaluating the effectiveness of leadership interventions. based on this study, future research could include, for example, research at an individual level, business level, fmcg group level, fmcg alliance level, and an industry and african continent level. research opportunities exist for longitudinal studies in which subjects are assessed over a period. opportunities also exist to assess subjects in the various contexts in which they operate, for example, at home, and with their family in the contexts in which people live. final remarks this study not only presented a leadership skills development model, but also provides a wide range of recommendations on how leadership skills could be developed from an individual, business, group, alliance, and african continent perspective in the fmcg industry. this study should also broaden the debate concerning the evolving concept of leadership and leadership skills development throughout the african fmcg industry. furthermore, this study should allow leadership skills development institutions to enhance leadership skills development interventions, incrementally, and in a coherent way. fast-moving consumer goods businesses in africa need to work towards developing africa’s talent at scale to unlock the skills that businesses require to promote local economies and create ecosystems throughout the supply chain. the researchers hope to continue research in the field of leadership, particularly relating to the effectiveness of leadership interventions. acknowledgements competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions this article forms part of a dba study at the university of kwazulu-natal by c.r.m. with t.g.p. as the supervisor assisting with the conceptual construction of the study and manuscript writing. ethical considerations this article followed all ethical standards for research with direct contact with human subjects. the humanities & social sciences research ethics committee at ukzn had granted full approval for this research protocol with reference number: h.s.s./1893/018d. funding information this research received no specific grant from any funding agency in public, commercial or not-for-profit sectors. data availability the data that support the findings of this study are available from the corresponding author, t.g.p. upon reasonable request. disclaimer the views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of any affiliated agency of the authors. references antonakis, j. & day, d.v., 2018, ‘leadership: past, present, and future’, in j. antonakis & d.v. day (eds.), the nature of leadership, 3rd edn., pp. 3–24, sage, london. avolio, b.j., 2007, ‘promoting more integrative strategies for leadership theory-building’, american psychologist 62(1), 25–33. https://doi.org/10.1037/0003-066x.62.1.25 bass, b.m., 1990, ‘from transactional to transformational leadership: learning to share the vision’, organizational dynamics 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handbook of leadership, pp. 11–36, oxford university press, new york, ny. abstract introduction implied volatility in a fractional black–scholes market arbitrage-free, fractional black–scholes-inspired volatility surfaces calibrating fractional black–scholes-inspired surfaces and implied hurst exponents empirical fractional black–scholes-inspired surfaces and hurst exponents: a south african experiment conclusion acknowledgements references footnotes about the author(s) emlyn flint department of mathematics and applied mathematics, university of pretoria, south africa eben maré department of mathematics and applied mathematics, university of pretoria, south africa citation flint, e. & maré, e., 2017, ‘fractional black–scholes option pricing, volatility calibration and implied hurst exponents in south african context’, south african journal of economic and management sciences 20(1), a1532. https://doi.org/10.4102/sajems.v20i1.1532 original research fractional black–scholes option pricing, volatility calibration and implied hurst exponents in south african context emlyn flint, eben maré received: 26 dec. 2015; accepted: 21 sept. 2016; published: 29 mar. 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: contingent claims on underlying assets are typically priced under a framework that assumes, inter alia, that the log returns of the underlying asset are normally distributed. however, many researchers have shown that this assumption is violated in practice. such violations include the statistical properties of heavy tails, volatility clustering, leptokurtosis and long memory. this paper considers the pricing of contingent claims when the underlying is assumed to display long memory, an issue that has heretofore not received much attention. aim: we address several theoretical and practical issues in option pricing and implied volatility calibration in a fractional black–scholes market. we introduce a novel eight-parameter fractional black–scholes-inspired (fbsi) model for the implied volatility surface, and consider in depth the issue of calibration. one of the main benefits of such a model is that it allows one to decompose implied volatility into an independent long-memory component – captured by an implied hurst exponent – and a conditional implied volatility component. such a decomposition has useful applications in the areas of derivatives trading, risk management, delta hedging and dynamic asset allocation. setting: the proposed fbsi volatility model is calibrated to south african equity index options data as well as south african rand/american dollar currency options data. however, given the focus on the theoretical development of the model, the results in this paper are applicable across all financial markets. methods: the fbsi model essentially combines a deterministic function form of the 1-year implied volatility skew with a separate deterministic function for the implied hurst exponent, thus allowing one to model both observed implied volatility surfaces as well as decompose them into independent volatility and long-memory components respectively. calibration of the model makes use of a quasi-explicit weighted least-squares optimisation routine. results: it is shown that a fractional black–scholes model always admits a non-constant implied volatility term structure when the hurst exponent is not 0.5, and that 1-year implied volatility is independent of the hurst exponent and equivalent to fractional volatility. furthermore, we show that the fbsi model fits the equity index implied volatility data very well but that a more flexible hurst exponent parameterisation is required to fit accurately the currency implied volatility data. conclusion: the fbsi model is an arbitrage-free deterministic volatility model that can accurately model equity index implied volatility. it also provides one with an estimate of the implied hurst exponent, which could be very useful in derivatives trading and delta hedging. introduction contingent claims on underlying assets are typically priced under the framework introduced by black and scholes (1973). this framework assumes, inter alia, that the log returns of an underlying asset are normally distributed. however, many researchers have shown that this assumption is violated in practice. cont (2001) put forth several ‘stylised facts’ of empirical asset returns, defined as ‘statistical properties found to be common across a wide range of instruments, markets and time periods’. these include the properties of the so-called heavy tails, volatility clustering, leptokurtosis and long memory. while many authors have studied the implications of these stylised facts across a variety of market applications, this article addresses an issue which has previously not received much attention. more specifically, this article considers several theoretical and practical issues in the pricing of contingent claims when the underlying is assumed to display long memory. hurst (1951) proposed a statistical metric – and its estimation methodology – for measuring the long-term memory embedded within a given system. this metric is now commonly referred to as the hurst exponent, index or parameter and is denoted by h ∈ [0,1]. for a given time series, h < 1/2 implies that the series displays a negative, long-term autocorrelation (or anti-persistence), h = 1/2 implies zero long-term autocorrelation and h > 1/2 implies that the series displays a positive autocorrelation. in financial calculus parlance, this would be equivalent to a stochastic process displaying mean-reversion, no memory or momentum, respectively. a stochastic process with high h > 1/2 will also be smoother than the same process with low h < 1/2 because it is less likely to move against the underlying trend. mandelbrot and van ness (1968) were the first researchers to suggest the use of the hurst exponent in financial markets. specifically, they suggested that financial asset prices displayed some form of long memory and introduced fractional brownian motion (fbm) – a new class of gaussian random functions – for modelling the log increments in asset price processes. the fbm for a given hurst exponent h (see, e.g. biagini et al. 2008) is the continuous gaussian process {bh(t), t ∈ r+}, with from equation 1, it is clear that the standard brownian motion is simply a special case of fbm where h = 1/2. for all other values of h though, the fbm process will have dependent increments. mandelbrot (2013), as well as the references contained therein, provides an excellent summary of the early applications of the fbm theory in financial markets. a sample of the more recent studies is given below. karuppiah and los (2005) consider the long-term dependence of asian currencies finding empirical hurst exponents between 0.3 and 0.5 and thus implying anti-persistent behaviour. in contrast, they note that equities typically exhibit persistent behaviour, with hurst exponents estimated between 0.6 and 0.7 (see also, e.g. peters 1989, 1994). simonsen (2003) demonstrates that nordic electricity spot prices can be modelled using fbm with a hurst exponent of approximately 0.4. alvarez-ramirez et al. (2002) conclude that crude oil price formations are stochastically persistent with long-term memory processes at work. a long-term dependence (as well as heavy tailed distributions) in financial data has been established by andersen and bollerslev (1997) and müller, dacorogna and pictet (1998) using high-frequency financial data. more recent work by tzouras, anagnostopoulos and mccoy (2015) employs the hurst exponent to model memory-dependent properties in share indices and oil prices (see also alvarez-ramirez et al. 2008; serinaldi 2010). cajueiro and tabak (2004), as well as rejichi and aloui (2012), use the hurst exponent to test the evolving efficiency of emerging equity markets. hu and øksendal (2003) derived closed-form solutions for contingent claim valuation in a fractional black–scholes market, where the standard brownian motion in the asset price process is replaced with an fbm (see also necula 2002). their work was extended by elliott and van der hoek (2003). specifically, for a market with a risk-free asset a and a risky stock s, a fractional black–scholes market is defined as where 0 ≤ t ≤ t, r and μ are constant drift parameters and σ is a constant scale parameter. from this, hu and øksendal (2003) derive the fractional black–scholes value of a european call option cf(·) at time t with strike k and term r = t − t as where φ is the standard cumulative normal distribution function and as with the seminal black–scholes option pricing formula (black & scholes 1973), one can infer the valuation formula for a european put option pf(·) with strike k and term τ via put-call parity. furthermore, a dividend yield q can be added to the above equations in a similar manner to merton’s (1973) extension of the standard black–scholes framework. although already stated above, equation 3 makes it clear that setting h = 1/2 simply gives one the classical black and scholes (1973) option pricing formula. therefore, assuming that the risk-free rate and dividend yield are known, fbm option prices are fully described by two parameters: the hurst exponent h as a measure of long memory and the volatility of the stock σ after controlling for long memory. this article is organised as follows: the section ‘implied volatility in a fractional black–scholes market’ is devoted to the links between standard black–scholes (1973) volatility and fractional black–scholes volatility. we also demonstrate how to calculate realistic implied volatility surfaces by assuming parameterisations of the fractional volatility and the hurst parameter. in sections ‘arbitrage-free, fractional black–scholes-inspired volatility surfaces’ and ‘calibrating fbsi surfaces and implied hurst exponents’, we demonstrate how arbitrage-free calibration would be conducted. the section ’empirical fbsi surfaces and hurst exponents: a south african experiment’ deals with the south african equity index and currency examples – we provide market-implied hurst parameters. we conclude the article in the ’conclusion’ section. implied volatility in a fractional black–scholes market since the early 1970s, option pricing has been characterised by the seminal black–scholes option pricing formula, which gives a simple bijective mapping between an option’s price and the formula’s volatility parameter σbs, termed the option’s ‘implied volatility’. under the idealised, theoretical assumptions of the black–scholes framework, implied volatility is constant. however, when implied volatility is plotted against option strikes for a fixed expiry, one observes a ‘skew’ or ‘smile’ pattern in practice, largely driven by the non-normality of the underlying asset return distribution and the supply–demand dynamics within the selected derivatives market (dupire 2006). furthermore, when implied volatility is plotted against option term for a fixed strike, one observes a non-constant relationship, referred to as the term structure of implied volatility. in reality, then, implied volatility is a function of an option’s strike and term. the practitioner’s convention in derivatives markets is to speak of separate implied volatility skews (or smiles) for individual option expiries. a collection of implied volatility skews is referred to as an implied volatility surface, which in itself is dynamic, changing with the underlying market conditions (see, e.g. cont & da fonseca 2002). the implied volatility surface at time t is denoted as σbs(k,τ,t). hu and øksendal (2003) showed that the variance of the log returns of the stock process in a fractional black–scholes market is given by where σf is the volatility parameter specific to the fractional setting, hereafter referred to as fractional volatility. equating this expression with the equivalent formula in the standard black–scholes market (i.e. substituting in h = 1/2 above and dropping strikeand time-dependence for now) yields the relationship equation 5 has three clear implications. firstly, even for constant fractional volatility and hurst parameters, the black–scholes implied volatility term structure is described by a power function rather than a constant. this is the same functional form used in heston’s (1993) stochastic volatility model and is also the deterministic term structure function postulated by many market practitioners (gatheral 2006). as shown in figure 1, h > 0.5 gives an up-sloping term structure, h = 0.5 gives a constant value and h < 0.5 gives a downward-sloping term structure. figure 1: possible implied volatility term structures in a fractional black–scholes market for different hurst exponents and σf = 20%. secondly, the standard and fractional black–scholes models give the same implied volatility – and thus option price – for τ = 1, regardless of the specified hurst exponent. this is also evident from figure 1. it follows that if one assumes constant fractional model parameters, then it must be that σf = σbs (1). thirdly, there is no implicit strike dependence in the fractional black–scholes model. this means that the single volatility term structure would apply to all option strikes, which is not consistent with reality. at the very least, one would need to introduce strike dependence into the fractional volatility parameter in order to match the τ = 1 implied volatility skew, which is independent of hurst exponent by construction. the simplest deterministic model used in practice that gives a reasonable description of the implied volatility skew around current spot levels is a quadratic equation (dumas, fleming & whaley 1998):1 where x is the ratio of the option strike k to the current spot price st, generally termed ‘moneyness’. the βi parameters account for the level, slope and curvature of the volatility skew, respectively. figure 2 shows how different hurst exponents can affect the constructed implied volatility surface for a fractional volatility skew (i.e. 1-year implied skew) indicative of equity index option markets. figure 2: indicative implied volatility surfaces for a given 1-year volatility skew for h = {0.4, 0.6}. while the surfaces shown in figure 2 are generally quite realistic, neither captures the universal property that all implied volatility surfaces based on martingale models flatten out with term (rogers & tehranchi 2010). this inconsistency is particularly evident for the h = 0.6 surface, which displays increasing skew and curvature across term. in general, for the majority of index volatility surfaces the hurst exponent would need to be below 0.5 for low strikes and above 0.5 for high strikes to ensure that the surface levels off across term. in contrast, for currency implied volatility surfaces which show considerably more convexity than their equity index counterparts, one would expect the hurst exponent to be below 0.5 for both very high and very low option strikes. while these expectations stem purely from the mathematics of equation 5 and the shape of volatility surfaces observed in practice, given the stylised facts already known about each asset class, it would seem plausible to assume that there is an underlying economic rationale to the strike profile of the hurst exponent. this point will be revisited later but for now, we simply observe that realistic index and currency volatility surfaces would require a strike-dependent hurst exponent. figure 3 shows the implied volatility surface constructed when using a similar deterministic quadratic function as per equation 6 for the hurst exponent. notice the significant level of skew achieved at very short option terms – a feat which many stochastic volatility models struggle to achieve (gatheral 2006) – in combination with a substantially flatter surface at longer terms. figure 3: indicative implied volatility surface for fractional volatility and hurst exponent modelled as a quadratic function of strike. while the quadratic formulations used here are purely for pedagogical purposes, it is evident that even these simple parameterisations provide one with a high degree of flexibility for modelling realistic volatility surfaces in the fractional black–scholes framework. moreover, the idea of using strike-dependent fractional parameters in equation 5 provides one with the basis for a robust but simple volatility surface model. arbitrage-free, fractional black–scholes-inspired volatility surfaces creating arbitrage-free parameterisations of the implied volatility surface is extremely important for derivatives trading and risk management in practice and has been given considerable attention in the literature (damghani & kos 2013; gatheral & jacquier 2014; lee 2004; roper 2010, and the references therein). in this section, we consider a fractional black–scholes-inspired (fbsi) parameterisation of the volatility surface: a combination of the fbm framework outlined in the ’implied volatility in a fractional black–scholes market’ section and the stochastic volatility-inspired (svi) model of gatheral (2004) for the strike-dependent fractional volatility parameter. carr et al. (2005) introduced the idea of static arbitrage, and carr and madan (2005) identified the sufficient conditions – eliminating call spread, butterfly spread and calendar spread arbitrages – for ensuring that a set of option prices excludes all static arbitrage. roper (2010) extended this line of research to find the corresponding set of necessary and sufficient conditions to ensure that the volatility surface was free from all static arbitrages. following the notation of gatheral and jacquier (2014), we outline these conditions – no calendar spread arbitrage and no butterfly spread arbitrage – below. let us define k = ln(k/f) as the log moneyness measured relative to the forward f and as the total implied variance surface. then, assuming that dividends are proportional to the underlying asset price, the volatility surface w is free of calendar spread arbitrage if and only if furthermore, each time slice of the volatility surface w(k) is free from butterfly spread arbitrage if and only if the corresponding density function is non-negative, or equivalently and note that w′(k) and w″(k) refer to the first and second derivatives, respectively. damghani and kos (2013) give a necessary but not sufficient butterfly spread condition which they state is commonly used in practice: let us now consider the fractional black–scholes framework as per the ’implied volatility in a fractional black–scholes market’ section. it follows from equation 5 that the total implied variance surface at a given time can be written as where the formulations for fractional variance and hurst exponent remains fully general. applying the condition in equation 7, we have that equation 1 is free from calendar spread arbitrage if and only if given that h ∈ [0,1] by construction and vf > 0, it is trivial to see that equation 12 will hold true at all times. therefore, regardless of the parameterisations specified for fractional volatility and hurst exponent, the fractional black–scholes volatility surface is always free from calendar spread arbitrage. the same conclusion cannot be easily discerned for butterfly spread arbitrage. as mentioned above, we limit our focus to gatheral’s (2004) svi model as a candidate for the fractional variance function. the svi model is one of the most widely used deterministic volatility functions in the equity derivatives market and is also commonly used by foreign exchange derivatives practitioners. although gatheral and jacquier (2014) have recently proposed several alternative formulations of the model parameters, we consider the original ‘raw’ parameterisation for simplicity. for a given parameter set χ = {a, b, ρ, m σ}, the svi model for total implied variance is given by where gives the overall level of variance, b ≥ 0 gives the angle between the left and right asymptotes, |ρ| < 1 determines the orientation of the curve, controls the horizontal positioning of the curve and σ > 0 adjusts the smoothness of the curve vertex. gatheral (2004) also imposes the condition that in order to ensure that w(k; x) ≥ 0 for all . gatheral further states that in order to meet the necessary (but not sufficient) condition for no butterfly arbitrage as per equation 10, one must have although roper (2010) showed that a parameter set which satisfies equation 14 can still breach the more stringent equation 8 and thus admit butterfly arbitrage, gatheral (2004), among others, suggests that the svi parameter sets calibrated to real market data are arbitrage-free. as noted in the ’implied volatility in a fractional black–scholes market’ section, fractional variance is equivalent to 1-year total implied variance and is thus independent of the hurst exponent. therefore, one can directly apply equations 13 and 14 in order to find the necessary arbitrage-free svi parameter ranges. specifically, for the τ = 1 fractional variance time slice, the necessary condition for no butterfly arbitrage is . similarly ensuring no arbitrage across all volatility time slices is not easy because of the strike-dependent hurst exponent. taking the derivative with respect to strike of the total variance surface as per equation 11, we have even for simple h(k) functions, it is not obvious what the necessary arbitrage-free parameter ranges should be. however, it is a straightforward, if somewhat long-winded, exercise to directly calculate the values of g(k) for a given hurst parameterisation and thus enforce the necessary hurst parameter ranges during calibration to remove any butterfly spread arbitrage. calibrating fractional black–scholes-inspired surfaces and implied hurst exponents building from the ’implied volatility in a fractional black–scholes market’ and ‘arbitrage-free, fractional black–scholes scholes-inspired volatility surfaces’ sections, we formally define the fbsi parameterisation of total implied variance as follows: motivated by the observations in sections ’implied volatility in a fractional black–scholes market’ and ‘arbitrage-free, fractional black–-scholes scholes-inspired volatility surfaces’, and in the absence of prior knowledge, the choice of a quadratic function for the hurst exponent seems a reasonable guess. in this case, β0 ∈ [0,1] represents the at-the-money (atm) level, β1 the slope and β2 the curvature of the hurst exponent.2 the function g(k) can be calculated analytically from equation 16 and used to ensure that, in conjunction with the svi parameter bounds given in the ’implied volatility in a fractional black–scholes market’ section, the calibrated βi parameters do not introduce butterfly arbitrage at any time slice. the complete volatility surface is thus a function of eight parameters, xf = {a, b, ρ, m, σ, β0, β2, β3}. given the reliance on the svi model to parameterise the fractional variance, it makes sense to augment existing svi calibration algorithms for the additional hurst exponent parameters. de marco and martini (2009) outline a robust quasi-explicit calibration process for the svi model which produced a reliable and stable parameter set. through a clever change of variables, the initial five-dimensional svi minimisation problem is recast into a much simpler two-dimensional problem, with the remaining three variables having (quasi-) explicit solutions within the new framework. this ‘2+3’ procedure is robust to initial guesses and provides stable, arbitrage-free svi parameters. in a similar vein, we reformulate the raw eight-parameter fbsi model calibration into a ‘5+3’ procedure, with the three hurst parameters supplementing the two svi parameters as per de marco and martini (2009). testing shows that this procedure is also generally robust to initial guesses and fast to implement. the fbsi model and calibration procedure thus give one a robust means of modelling the full volatility surface and also of deriving the implied hurst exponent across the full moneyness range at any given time. to the authors’ best knowledge, the only other research to date that considers similar fbm-based volatility surface parameterisations is the fbm variance term structure model posited by li and chen (2014).3 based on the relationship between implied volatility in the black–scholes framework and implied volatility in the fbm framework, li and chen (2014) show that one can estimate both the fractional volatility and the hurst exponent from traded option data via linear regression. consider the logarithm of the power function given in equation 5: li and chen (2014) suggest using ordinary least squares (ols) to estimate the fractional volatility and implied hurst exponent by regressing the logarithm of atm implied volatility against the logarithm of term. in this way, one is able to calculate a single fractional volatility and hurst exponent from the option data. li and chen further suggest replacing the black–scholes implied volatilities in equation 17 with the model-free implied volatilities of britten-jones and neuberger (2000), which can be calculated in practice by applying the standard vix methodology at all observed option terms. the use of model-free implied volatility as the dependent variable has the benefits of removing dependence on any specific pricing model and of using information from all traded options rather than only atm options.4 however, despite incorporating information from the full volatility surface, this method still only allows one to model the term structure of implied volatility. empirical fractional black–scholes-inspired surfaces and hurst exponents: a south african experiment the fbsi and li and chen (lc) model are calibrated to two sets of south african option market data. the first data set consists of 529 weekly observations of implied volatility skews for listed futures options on the ftse/jse top40 index (top40) over the period 5 september 2005 to 30 november 2015. top40 options are the most actively and liquid traded derivative contracts in south africa. these options trade on the south african futures exchange (safex) on the basis of implied volatility and the option price is calculated using the black (1976) option pricing formula. the weekly implied volatility skews were obtained from peregrine securities and generally, cover a strike range of 75% – 125% of the forward price. the second data set consists of 146 weekly observations of implied volatility skews for listed futures options on the united states dollar to south african rand (usd/zar) exchange rate over the period 11 february 2013 to 30 november 2015. the volatility skews initially cover a range of 80% – 120% of the forward price up to november 2014 and thereafter cover a 70% – 130% range. these data were also obtained from peregrine securities. fractional black–scholes-inspired index volatility surfaces let us first consider the results for the index volatility surfaces. figure 4 shows the comparison of the top40 index performance since september 2005 with the fractional volatility and hurst exponents from the calibrated fbsi volatility surface model and the lc volatility term structure model. figure 4: top40 index performance plotted with the atm fractional volatility and hurst exponents from the calibrated fbsi and lc models, respectively, september 2005 to november 2015. visual inspection confirms the well-documented inverse relationship between index performance and fractional volatility (i.e. 1-year implied volatility) and also suggests a positive relationship between index performance and the hurst exponent, particularly evident during the 2008 financial crisis. this is confirmed by the moderately positive correlation values of 0.47 and 0.45 displayed for each model respectively, in table 1. there are also times when one sees significant changes in the hurst exponent without any large, associated downturns in the index. for example, the hurst exponent fell materially from a high of 0.67 down to 0.46 during the first half of 2013, while the index remained range-bound around the 35 000-level. over the same period, fractional volatility also remained fairly stable between 16% and 18% and only picked up briefly around the middle of 2013. this suggests that the hurst exponent and fractional volatility capture somewhat different aspects of the uncertainty within the index and thus provide one with more detailed information on the underlying price process. table 1: correlation matrix of weekly log returns on top40 index and associated implied volatility parameters, september 2005 to november 2015. this suggestion is borne out by the correlation between fractional volatility and the hurst exponent shown in table 1. although it is negative as one would expect, it is considerably lower in absolute terms than the correlations displayed between the respective parameters and the underlying index returns. therefore, deconstructing the single implied volatility number into a long memory component and a long memory-conditioned volatility component may well have useful application in a wide range of financial applications, including derivatives trading, risk management and dynamic asset allocation. for example, discrete delta-hedging strategies could potentially be improved by incorporating the hurst exponent as a means of identifying how rough or smooth the index returns are likely to be and also whether the index is currently more likely to mean-revert or continue trending. for now, we leave application of the implied hurst exponent for future research. notice that the atm fbsi fractional volatility time series is nearly identical to the lc fractional volatility series, with a correlation of 0.99. the atm hurst exponent time series is also very similar across models with a correlation of 0.96, although slight deviations are evident in the final 2 years of the sample period. this high degree of equivalence indicates that the fbsi model provides sufficient flexibility to model the atm term structure accurately even while fitting the complete index volatility surface. figure 5 confirms this by displaying the top40 traded volatility surface and its calibrated fbsi counterpart as at 30 may 2011. the modelled surface mirrors the market surface very well at most terms and moneyness levels, although there are a couple of small areas on the market surface where the power law model assumption is violated. figure 5: (a) top40 and calibrated, and (b) fbsi implied volatility surface as at 30 may 2011. the reason why the fbsi model fits the equity surfaces so well is shown in figure 6. the calibrated fbsi parameter curves are compared to those obtained from separately fitting the lc term structure models at each moneyness level. for our data, this equates to running 51 independent regressions, which ensures a very accurate fit of the surface thanks to the use of 102 parameters. although clearly not a viable candidate for modelling the surface directly, this lc ‘multi-model’ provides one with an excellent means of evaluating whether the quadratic and svi functions provide sufficient flexibility for capturing the required strike dependence in fbm volatility parameters. figure 6: calibrated (a) fractional volatility and (b) hurst exponent skews from the fbsi and lc models as at 30 may 2011. as figure 6 shows, the fractional volatility curves from both models are essentially equivalent, while the fbsi hurst exponent shows a slight deviation from the lc multi-model curve above the 105% moneyness level. this discrepancy is responsible for the difference at high moneyness levels and very short terms between the traded and fitted volatility surfaces shown in figure 5. fractional black–scholes-inspired currency volatility surfaces figure 7 shows the fbsi and lc model parameters from february 2013 in comparison with the underlying usd/zar foreign exchange rate. in contrast to the results given in the ‘fbsi index volatility surfaces’ section, there are significant differences between the fbsi and lc hurst exponents evident across the full sample period. the fbsi hurst exponent is almost always lower than its lc counterpart and the positive correlation of 0.36 is much lower than one would expect given that both time series represent the same parameter. fractional volatility is far more similar across the two models, with a correlation of 0.83. there are still noticeable differences though, with fbsi fractional also generally lower than lc fractional volatility across the period. figure 7: usd/zar performance plotted with the atm fractional volatility and hurst exponents from the calibrated fbsi and lc models, respectively, february 2013 to november 2015. table 1 also shows the expected positive relationship between exchange rate and fractional volatility (ρ = 0.44). interestingly, a similar but negative relationship is evident between exchange and lc hurst exponent (ρ − 0.44) but not for the fbsi hurst parameter (ρ = − 0.16). furthermore, note that while the usd/zar has consistently trended upwards over the sample period, both hurst exponent and fractional volatility parameters remained largely range-bound for most of the period. only over the last year has one seen a slight decline in hurst levels and a concurrent increase in fractional volatility levels as the size of the weekly exchange rate moves has grown. finally, table 1 shows that the correlation between lc parameters is weak and negative, while that between the fbsi parameters is instead mildly positive. this again suggests a certain level of independence between the two implied volatility components. table 2: correlation matrix of weekly log returns on usd/zar and associated implied volatility parameters, february 2005 to november 2015. the large differences between the fbsi and lc parameters indicate that, in its current form, the fbsi model is unable to adequately replicate the currency implied volatility surface. figures 8 and 9 show the problem for an example currency surface as at 28 april 2015. the traded volatility skews are significantly sloped for strikes above the forward level and remain so even for longer terms. in contrast, the surface is less sloped for strikes below the forward level and flattens off a fair degree with term. however, because the short-term implied volatility skew flattens out at lower moneyness levels, so does the curvature of the respective term structures. figure 8: (a) top40 and calibrated and (b) fbsi implied volatility surface as at 30 may 2011. figure 9: calibrated (a) fractional volatility and (b) hurst exponent skews from the fbsi and lc models as at 30 may 2011. combining these observations implies that the hurst exponent would not only need to be convex but also include inflection points at low moneyness levels and possibly also at high moneyness levels, as shown in the lower panel of figure 9. the assumed quadratic function is not capable of this, and thus the calibrated hurst function represents a trade-off between matching the required level of atm convexity and minimising the mismatch for far out of the money volatility points. therefore, we would suggest using a different functional form for the hurst exponent in the currency derivatives space. given the need for an inflection point in the hurst exponent curve, the most obvious starting point would be a third-order polynomial. for now, we leave this remark as an avenue for future research. the calibrated fbsi volatility surface shown in figure 8 still manages to capture most of the traded surface’s characteristics with the added benefit of being fully analytic; an important consideration when valuing exotic derivatives under local volatility. conclusion this article addresses several theoretical and practical issues in option pricing and implied volatility calibration in a fractional black–scholes market. we start off by discussing how options can be priced when the noise component of the underlying risky asset is driven by an fbm. we then describe the links between standard black–scholes volatility and fractional black–scholes volatility and highlight two important observations. firstly, the fractional black–scholes model admits a non-constant implied volatility term structure when the hurst exponent is not equal to 0.5. more specifically, this term structure is described by a power function and is up-sloping (down-sloping) when the hurst exponent is greater (less) than 0.5. secondly, 1-year implied volatility is independent of the hurst exponent and equivalent to fractional volatility. building on these two observations, we show how one can construct realistic implied volatility surfaces by assuming simple parameterisations for the fractional volatility and hurst exponent. in particular, we introduce the eight-parameter fbsi model. this novel deterministic volatility surface model is based on the fractional black–scholes framework and uses gatheral’s (2004) svi parameterisation for the fractional volatility skew and a quadratic parameterisation for the hurst exponent skew. one benefit of this model is that it provides us with a parsimonious decomposition of the implied volatility surface into an independent long memory component and a conditional volatility component. such a decomposition could be usefully applied in a wide range of financial applications, including derivatives trading, risk management and dynamic asset allocation. we address the issue of arbitrage-free calibration for the fbsi model in depth and prove in general that any fbsi volatility surface will be free from calendar spread arbitrage. although one cannot make a similar statement about butterfly spread arbitrage, we show that it is simple to control for this during the calibration process because of the fully analytical form of the surface. finally, we test the fbsi model empirically against li and chen’s (2014) volatility term structure model using implied volatility surfaces on south african listed top40 index futures options and on listed usd/zar currency futures options. we find that the fbsi model fits the equity implied volatility surfaces very well and, furthermore, that the decomposition of implied volatility into its long memory and fractional volatility components provides one with more detailed information on the true uncertainty in the underlying asset price process. the currency implied volatility surfaces provide more of a calibration challenge for the fbsi model because of a flattening in the term structure at far out of the money strikes. the calibrated fbsi volatility surface still manages to capture most of the traded surfaces’ characteristics with the added benefit of being fully analytic; an important consideration when valuing exotic derivatives under local volatility. acknowledgements the authors wish to express their gratitude towards the editorial staff as well as the two anonymous referees for their helpful comments and suggestions. competing interests the authors declare that they have no financial or personal relationships that may have 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(roper 2010), it is still widely used in practice (kotzé & joseph 2009). 2. at the money, or atm, refers to when the option strike is equal to the underlying forward price, i.e. k = 0. 3. although the concept of fractional volatility models has been around since the work of comte and renault (1996, 1998) and baillie, bollerslev and mikkelsen (1996), this is essentially a subfield of the much larger stochastic volatility literature – continuous and discrete – where fractional noise rather than gaussian noise is used within the volatility process. in comparison, this work differs in three aspects. firstly, the use of fractional noise is restricted to the stock price process. secondly, this work falls within the deterministic rather than stochastic volatility modelling literature. thirdly, the hurst exponent is assumed to be a non-constant function of strike and time rather than a constant parameter in a volatility process. 4. this second benefit stems from the fact that model-free implied volatility is calculated using the complete volatility skew at each term. abstract introduction literature review methodology results and discussion conclusion acknowledgements references about the author(s) liya lakhani college of accounting, faculty of commerce, university of cape town, cape town, south africa shelly l. herbert college of accounting, faculty of commerce, university of cape town, cape town, south africa citation lakhani, l. & herbert, s.l., 2022, ‘theoretical frameworks applied in integrated reporting and sustainability reporting research’, south african journal of economic and management sciences 25(1), a4427. https://doi.org/10.4102/sajems.v25i1.4427 original research theoretical frameworks applied in integrated reporting and sustainability reporting research liya lakhani, shelly l. herbert received: 29 oct. 2021; accepted: 18 june 2022; published: 22 aug. 2022 copyright: © 2022. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: over the last few decades, with the emergence of integrated reporting (ir) and sustainability reporting (sr) as new reporting methods, corporate reporting practices attracted substantial interest as a topic of research. throughout the literature, many theories have been adopted to explain ir and sr practices and there is currently an increased focus on non-financial reporting. aim: the purpose of this study is to identify and analyse the theories used in the growing body of ir and sr research, to gather insight into current trends in the use and dominance of these theories in the related literature. setting: research articles in the scopus database for the period spanning from 2010 to 2019 were included in the study. method: using a systematic review methodology, 574 articles on ir and sr published in the scopus database for the period spanning from 2010 to 2019, were systematically searched for the presence of theories that may be used to explain these practices. results: the results show that the most dominant theories in the last decade are the legitimacy, stakeholder, institutional, agency and signalling theories. conclusion: supported by extensive numerical data, this research provides insights into the theoretical perspectives used in the study of ir and sr and contributes to the existing discourse surrounding applicable theoretical frameworks for studying corporate reporting practices. these insights can be used to study ir and sr as the world grapples with changes in the reporting and business environment. keywords: integrated reporting; sustainability reporting; legitimacy theory; stakeholder theory; institutional theory; agency theory; signalling theory; theoretical perspectives. introduction as the world moved into 2020, there was a gradual understanding that life, as we knew it, was changing forever. the coronavirus disease 2019 (covid-19) pandemic has changed the lives of individuals and how organisations operate, and there has been an increased call for non-financial reporting by organisations, due to the significant social impact of the pandemic, and the the origin of the disease apparently linked to climate change (lodhia, sharma & low 2021). before the pandemic, the nature of sustainability-related disclosures communicating the economic, environmental and social impact of an organisation’s activities to its stakeholders had already been evolving (hahn & kühnen 2013). sustainability reporting (sr), which focuses on the impact of organisations on the environment and society, has become increasingly complex due to more significant informational needs by a growing range of stakeholders (de villiers, rinaldi & unerman 2014). stand-alone sustainability reports received increasing criticism for their inability to effectively meet report users’ informational needs (kannenberg & schreck 2019). as a result, there were calls to combine sustainability disclosures and financial disclosures in a single report, leading to the emergence of integrated reporting (ir) (de villiers et al. 2014). an integrated report communicates an organisation’s strategy, governance, performance and prospects concisely, relative to its external environment (including society and the natural environment), with the primary audience being the providers of financial capital (international integrated reporting council [iirc] 2021). despite key differences in ir and sr objectives, the global reporting initiative (gri) considers sr an integral aspect of ir and the link between corporate reporting and sr (gri 2013). in addition to the covid-19 pandemic, 2020 saw moves in the global reporting arena towards increased reporting on non-financial matters, and the creation of bodies such as the value reporting foundation (vrf), and then in 2021 the international sustainability standards board was formed, under the international financial reporting standards foundation, into which the vrf and the climate disclosures standards board (cdsb) were consolidated (ifrs foundation 2021; impact management project, world economic forum & deloitte 2020). as researchers examine the impacts of these changes on the reporting practices of organisations, it is helpful to consider how the theories that have been used in the past to explain ir and sr behaviour, apply in the current context. because of the related nature of the two forms of reporting, they are considered alongside each other in this study. a vast number of theoretical perspectives used independently and in combination have been employed in the literature to understand and explain organisations’ reporting practices (haji et al. 2016). many of these theories are complementary and may overlap in their explanations for organisational reporting practices (fuhrmann 2020). benefits have been observed in both a mandatory and voluntary regime for ir and sr (loprevite, ricca & rupo 2018). integrated reporting and sr are mandatory in some countries, such as ir for south african listed companies (johannesburg securities exchange limited 2018). however, at present, ir and sr disclosures are primarily voluntary in most countries (hahn & kühnen 2013; velte & stawinoga 2017), and many of the theories used to explain ir and sr have been applied to explain voluntary disclosures in general (fuhrmann 2020). past research suggested that the legitimacy, stakeholder and institutional theories (dagilien 2018), or signalling theory, used in conjunction with the legitimacy theory (cho et al. 2015), are the most commonly employed theoretical perspectives in the sr literature. the legitimacy theory (kannenberg & schreck 2019) and the institutional theory (velte & stawinoga 2017) are the most commonly utilised theoretical approaches for investigating the determinants and implications of ir. there appears to be no consensus about which theory or theories dominated either the sr or ir literature. furthermore, there seem to be no recent studies that offer a broad review of the different theoretical perspectives utilised in the study of either sr or ir. the existing studies provided limited insights and have observed and summarised the different theoretical approaches researchers use in the ir and sr literature by focusing only on specific ir and sr discourse topics, and examining a limited number of theories (kannenberg & schreck 2019). thus, the sample of studies included in these reviews is limited and does not provide a broad view of theories used in sr or ir. this study aims to address the identified gap in the literature by using a broad approach to identifying which theories are used in papers addressing ir and sr in the literature during the last decade, using a systematic review design and comparing and contrasting these two forms of reporting at a granular level. it also provides a starting point to study the changing reporting behaviour of organisations due to covid-19, as called for by lodhia et al. (2021), and other changes in the reporting landscape, most notably the attempts to converge the reporting requirements for organisations. the objective of this study is to investigate any notable trends in the utilisation and prevalence of different theoretical perspectives and the reasons for these trends. this objective will be achieved by conducting a comprehensive and systematic review of all existing ir and sr literature in the scopus database from 2010 to 2019. although sr has been practised widely since the gri released their first set of guidelines in 2000 (gri 2022), ir is a relatively newer form of reporting (vaz, fernandez-feijoo & ruiz 2016). the period to be examined was when both forms of reporting were prevalent. the results will be analysed to garner insight into the frequency of the use of the identified theories in the literature and any annual trends in using them over the last 10 years. it is expected to find that the most prevalent theories currently utilised in the literature to explain ir and sr will continue to be the stakeholder, legitimacy, institutional, agency and signalling theories. other less common theories will also be identified and highlighted. by investigating the application patterns of different theories developed over 10 years, the paper will provide unique insight into the theoretical perspectives from which ir and sr were explained in the existing literature. this paper contributes to the existing discourse surrounding applicable theoretical frameworks employed in the study of corporate reporting practices. the findings will provide researchers with a resource for considering what theoretical frameworks are relevant in explaining reporting behaviour currently. the most common theories may continue to apply in the years to come, but lesser-used theories presented here may prove more useful in explaining the changes observed. literature review there is no single theory that may explain either ir or sr, and several theoretical perspectives have emerged over the years regarding the study of both. identifying the most appropriate theory to adopt for a research project is thus largely dependent on the particular context of the research at hand and can be quite a complex endeavour to undertake. with the dramatic changes in the current reporting environment, this becomes increasingly challenging. in the realm of sr, when the focus of this kind of reporting was on social and environmental disclosures, the stakeholder theory and the legitimacy theory were relied on heavily as explanatory theoretical perspectives (deegan 2019). more recently, however, the institutional theory has emerged as an increasingly popular theory in sr and ir research (dagilien 2018). while using a single theory is often the norm, some researchers adopt more than one theoretical perspective to explain organisations’ social and environmental disclosure practices. due to the overlapping and often complementary nature of certain theoretical perspectives, a more extensive understanding of organisational practices may be achieved through a multi-theoretical lens (fernando & lawrence 2014). theories used to explain integrated reporting and sustainability reporting the most dominant theoretical perspectives utilised to explain sr and ir practices in the literature follow. specifically, the legitimacy, stakeholder, institutional, agency and signalling theories are outlined in this section. legitimacy theory the legitimacy theory is one of the more popular theories that has been used to explain social responsibility and sustainability disclosures by organisations (dagilien 2018). the legitimacy theory builds on principles of the theory of political economy, which acknowledges the power dynamics within society and the various conflicts that emerge between different societal groups. the view extended by this theory is that society, politics and economics are interconnected. it is impossible to make a meaningful assessment of economic issues without considering the impact of the broader political, social and institutional factors influencing such issues (deegan 2002). the legitimacy theory is concerned with the interactions between an organisation and society at large (fernando & lawrence 2014). the legitimacy theory posits the existence of a ‘social contract’ (deegan 2002) between an organisation and society. it suggests that in order for an organisation to continue its activities, which invariably rely on community resources utilisation, it must be deemed by society as having a legitimate position (amran & haniffa 2011). an organisation may be perceived as having a legitimate position when its actions align with the value system of the broader social system of which the organisation forms part (dube & maroun 2017). an organisation’s legitimacy and its continued existence are threatened if it is seen to be operating in a way inconsistent with societal values (spence, husillos & correa-ruiz 2010). in this way, the legitimacy theory overlaps with the resource dependence theory in that legitimacy may be considered a resource upon which an organisation depends for survival. in terms of the resource dependence theory, organisations will pursue strategies to ensure the continued supply of resources fundamental to their continued existence (chen & roberts 2010). organisations attain legitimacy by demonstrating to society that they are, in fact, operating within the acceptable bounds of society, and one way to accomplish this is to publish integrated or sustainability reports (kuzey & uyar 2017). in this vein, the practice of integrated or sr can be seen as a strategic endeavour undertaken by organisations to obtain this essential resource of legitimacy and ensure the continuity of their operations (amran & haniffa 2011). stakeholder theory the stakeholder theory has, in the past, been described as the dominant and most useful theory for explaining sr practice (daher & bashatweh 2018). the stakeholder theory, like the legitimacy theory, draws on the political economy theory in its assessment of an organisation in the context of the broader environment in which it operates. consequently, it would be incorrect to view the stakeholder theory as entirely distinct from the legitimacy theory because stakeholders effectively grant organisations this highly sought after legitimacy (chen & roberts 2010). the stakeholder theory suggests that organisations are morally obligated to consider and appropriately balance the interests of all stakeholders (freeman 1984; wangombe 2013) and acknowledge the profound influence that different individuals and groups may have on the success and longevity of an organisation’s operations (chatelain-ponroy & morin-delerm 2012). in other words, in order for an organisation to survive, it must adeptly manage the relationships with its various stakeholders who have different and often contrasting expectations of an organisation (chen & roberts 2010). the stakeholder theory branches out in the ethical and managerial aspects (amran & haniffa 2011). the ethical branch proposes that all stakeholders have the right to equal and fair treatment by an organisation. according to this branch, all stakeholders may hold organisations accountable, regardless of their level of power or influence over the organisation (fernando & lawrence 2014). in contrast to this, the managerial branch of stakeholder theory suggests that different stakeholder groups should be managed differently, depending on their varying expectations of the organisation (amran & haniffa 2011). in terms of this branch of the stakeholder theory, organisations focus on meeting the expectations of the stakeholders who have the most influence over the organisation’s ability to keep going (fernando & lawrence 2014). in social and environmental accounting, specifically regarding sr and ir practices, more evidence has been found to support the managerial branch of the stakeholder theory (fernando & lawrence 2014). as with the legitimacy theory, the stakeholder theory proposes that a ‘social contract’ exists between an organisation and society whereby its stakeholders may permit an organisation to consume community resources if it upholds its promise to create wealth for its various stakeholder groups (garcia-sánchez, rodriquez-ariza & frías-aceituno 2013). therefore, sr and ir serve as a powerful means by which an organisation manages its various stakeholders’ informational needs (kuzey & uyar 2017). by disclosing information about the economic, social and environmental impact of their activities, in the form of sustainability and integrated reports, organisations may demonstrate how they are creating value for their various stakeholder groups and, in this manner, obtain their continued support (vaz et al. 2016). institutional theory as with the legitimacy and stakeholder theories, the institutional theory has its foundations in the theory of political economy (deegan 2002). similar to the legitimacy and stakeholder theories, the institutional theory acknowledges the impact of the external environment, such as the political, social and economic systems, on an organisation’s behaviour (vaz et al. 2016). the institutional theory suggests that organisations will alter their practices to attain legitimacy in the context of the broader environment in which they operate (amran & haniffa 2011), and the concept of ‘legitimacy’ proposed by the legitimacy theory is fundamental to understanding and applying the institutional theory. under the institutional theory, organisations operating in countries or regions subject to similar institutional influences are expected to adopt similar behaviour to gain legitimacy (velte & stawinoga 2017). this tendency toward behavioural congruence is known as isomorphism (deegan 2002). according to the institutional theory, organisations’ adoption of ir or sr practices can be explained by three types of institutionalisation mechanisms: mimetic, normative, and coercive isomorphism (vaz et al. 2016). each of these institutionalisation mechanisms will now be discussed in further detail. mimetic isomorphism is the tendency of an organisation to imitate the behaviour of other model organisations that it deems more successful (vaz et al. 2016). thus, where well-established organisations in an industry are seen to have adopted certain practices, for example, the publication of integrated or sustainability reports, other organisations in that industry tend to follow suit (martínez-ferrero & garcia-sánchez 2017). normative isomorphism explains how organisations adopt certain institutional practices to conform to group norms or meet professional expectations. an example of a normative influence would be the culture and working practices within an organisation (amran & haniffa 2011). lastly, in coercive isomorphism, organisations change their behaviour to comply with the rules and regulations imposed upon them by external forces (amran & haniffa 2011). for example, in south africa, the publication of an integrated report is a requirement for listing on the johannesburg stock exchange (vaz et al. 2016). in this way, the mechanism of coercive isomorphism can be seen to overlap with the stakeholder theory, in that organisations may utilise sustainability and integrated reports in order to meet the expectations of their most influential stakeholders (amran & haniffa 2011). the practices institutionalised by organisations resulting from these processes of isomorphism are closely linked to society’s expectations of those organisations (velte & stawinoga 2017). the institutional theory can thus explain how organisations adopt practices such as the publication of integrated or sustainability reports through isomorphism and the overarching need to conform to societal norms and values (velte & stawinoga 2017). as alluded to previously, the legitimacy theory forms an integral part of the application of the institutional theory. by embracing these institutional structures, an organisation can maintain its legitimacy in its key stakeholders’ eyes, thus enabling its continued existence, access to resources, and stability as an entity (velte & stawinoga 2017). agency theory the agency theory is based on the principal-agent relationship between the ‘insiders’ and ‘outsiders’ of an organisation (jensen & mecking 1976; kuzey & uyar 2017). per this theory, there is a separation of ownership and control within an organisation, whereby managers act for owners. the stakeholder-agency theory extends the agency theory to include not only the owners of an organisation but all of its stakeholders – particularly those who control the resources necessary for the organisation’s survival (frías-aceituno, rodríguez-ariza & garcia-sánchez 2014). an agency problem occurs when the managers of an organisation fail to act in the best interests of its owners, resulting in conflicts of interest (vitolla, raimo & rubino 2019). as a consequence of this agency problem, agency costs arise, which are information asymmetry costs resulting from the principal– agent relationship (kuzey & uyar 2017). agency costs include those costs associated with monitoring, bonding and residual losses. monitoring expenditures are costs incurred by the principal to prevent the agent’s actions, which could cause the principal harm. bonding costs are costs incurred by the agent to provide the principal with the assurance that the agent is not behaving in a way that does not align with the principal’s interests. lastly, residual losses are costs incurred due to misalignment between the interests of principal and agent despite monitoring and bonding efforts. the larger the extent of the information asymmetry that exists, the higher the agency costs (raimo, vitolla & rubino 2020; vitolla et al. 2019). the rationale for adopting ir and sr practices by organisations can thus be explained by the need to reduce the cost of this information asymmetry (vitolla et al. 2019). organisations that disclose financial and non-financial information about their activities can reduce the cost of acquiring funding from investors and other providers of capital by giving these parties access to the information that will facilitate an informed assessment of the organisations’ investment opportunities (iredele 2019). thus, by preparing quality integrated and sustainability reports, organisations can reduce the information asymmetry between principals and agents and so lower their agency costs (frías-aceituno et al. 2014). signalling theory like the agency theory, the signalling theory acknowledges the information asymmetry between an organisation’s insiders and outsiders (albertini 2018). in this situation, one party tries to reduce the asymmetrical distribution of information by credibly conveying important information about itself to the other party (daher & bashatweh 2018). thus, signalling responds directly to information asymmetry (nurkumalasari, restuningdiah & sidharta 2019). disclosing inside information about an organisation to the broader public may attract investments in the market, consequently reducing the cost of raising capital for the organisation and enhancing its reputation (frías-aceituno et al. 2014). thus, the signalling theory suggests that organisations produce sustainability and integrated reports to send signals to the market about their social, economic, and environmental performance (daher & bashatweh 2018). the disclosure of reliable information in integrated and sustainability reports signals to the organisation’s stakeholders that it effectively manages its key business risks (albertini 2018). in this vein, organisations may take advantage of the inherent information asymmetry in the market by utilising disclosure methods, such as integrated and sustainability reports, to emphasise their good performance (daher & bashatweh 2018). integrated and sustainability reports are, in fact, a powerful tool for organisations seeking to signal their higher quality to the market (girella, rossi & zambon 2019). other theories although not as common as the theories discussed previously, there are a number of other theories used to explain ir and sr. a selection of these theories is discussed briefly. the theory of proprietary costs suggests that organisations may limit the voluntary disclosure of certain information to reduce the costs associated with information disclosure (girella et al. 2019). these costs, known as proprietary costs, include both the internal costs associated with the preparation and disclosure of voluntary information, as well as the external costs which may be incurred as a result of an organisation’s competitors using to their advantage information voluntarily disclosed by the organisation (cotter, lokman & najah 2011). this theory thus offers insight into an organisation’s incentives for disclosing, or not disclosing, specific information in the integrated report (girella et al. 2019). the diffusion of innovation (doi) theory is an emerging theory in the ir literature. this theory is used most frequently as a theoretical framework in studies that aim to investigate the adoption of ir practices and those aiming to explain the spread, or diffusion, of ir amongst organisations. as a relatively new corporate reporting practice, the doi theory provides valuable insights into the factors that impact ir’s adoption (robertson & samy 2020). the voluntary disclosure theory suggests that, when an organisation is given a choice to disclose information, it will only disclose information favourable to itself to signal its superiority (daher & bashatweh 2018). thus, organisations with superior sustainability performance are more willing to disclose this information to the market in the hopes of driving up the organisation’s market value (hummel & schlick 2016). the political economy theory suggests that the political, economic and social activities of a business cannot be viewed in isolation of each other. thus, organisations disclose financial and non-financial information to meet their broader stakeholders’ informational needs, thereby ensuring continued support (cotter et al. 2011). the accountability theory suggests that an organisation has a duty to inform its stakeholders about its activities, regardless of whether they may be detrimental to the organisation (comyns et al. 2013). thus, this theory implies that organisations should produce sustainability reports to provide their stakeholders with reliable information regarding the organisation’s activities, despite the potential for this disclosure to have a negative impact on the organisation (comyns et al. 2013). the resource dependence theory posits that organisations pursue strategies to ensure the continued supply of resources fundamental to the organisation’s continued existence (chen & roberts 2010). this theory suggests that organisations produce sustainability reports to manage their relationships with key stakeholders, as these stakeholders are essential for allocating resources to the organisation (al-shaer 2020). previous studies in the following section previous studies that have examined the different theoretical perspectives relating to sr and ir are discussed. while many papers investigated ir and sr and utilised different theoretical perspectives, few focused on the empirical aspect of the utilisation of these theories throughout literature. wangombe (2013) analysed the different theoretical perspectives used in the study on corporate environmental reporting (cer). the purpose of wangombe’s paper was to identify the overlapping areas between the various theoretical perspectives used to explain cer to support the case for a multi-theoretical approach to cer research. in achieving the research objective, wangombe analysed the frequency of the legitimacy, stakeholder, institutional and shareholder theories in the existing literature on cer. the study found that, amongst the four theories, the most commonly used theory is the legitimacy theory, followed by the stakeholder theory, institutional theory, and shareholder theory (wangombe 2013). camilleri (2018) and omran and ramdhony (2015) looked at the different theoretical perspectives relating to ir and sr practices in their respective research papers. they each provide in-depth discussions of the agency, stewardship, institutional, legitimacy, stakeholder, signalling, and social contract theories. however, this research is more discursive, focusing on explaining these theories in the context of ir and sr, rather than providing insight into the pervasiveness of these different theories in the literature. the prior research has been narrowed in scope or is discursive in nature. therefore, further research is required to provide deeper insight into the utilisation and prevalence of the theories used in ir and sr papers in the literature. at this hinge-point, it is also relevant to reflect on past practices to better understand and explain the future of ir and sr reporting practices. methodology this study aimed to identify which theories were used in papers discussing ir and sr in literature during the previous decade. furthermore, it investigated any notable trends in the utilisation and prevalence of different theoretical perspectives in the study of ir and sr. the research design was a systematic review, using data collected from prior literature. it employed a search function to search through and identify the presence of theories relating to ir and sr in a sample of academic literature. elements of this methodology were based on a similar study conducted by wangombe (2013). the research period was limited to 10 years, from january 2010 to december 2019. this period was chosen due to the ir concept’s relative newness. the iirc was formed in 2010 (accounting for sustainability project 2014), and the first international <ir> framework was released in 2013 (iirc 2013). as a result, ir literature was sparse before the selected research period, but began to be seen increasingly from 2010 and gained momentum following the release of the framework. research in 2020 begins to examine a new phase in global reporting. the findings for the period under examination will be helpful for future research in a changing environment. this study looked at both ir and sr literature, and the chosen research period was needed to offer sufficient availability of articles about both research areas in the existing literature. sample selection a structured electronic search for relevant articles was conducted in the scopus database to identify the use of specific theories in the study of ir and sr. scopus was chosen due to the quality of the filtering criteria applied in selecting journals to be included in the scopus database (rinaldi, unerman & de villiers 2018). given the interdisciplinary nature of ir and sr research, the vast breadth of disciplines in the scopus database further contributed to the decision to utilise scopus in the current study. the search comprised the following keywords: ‘integrated reporting’ and ‘sustainability reporting’. the title, keywords and abstract of these articles were then analysed to identify studies that dealt with ir, sr or both. the rationale for this method was that the authors of articles are expected to highlight the paper’s key focus in its title, keywords, and abstract (rinaldi et al. 2018). thus, articles in which the author had deemed the focus to be ir or sr should have this reflected in the title, keywords or abstract. the search was restricted to articles and peer-reviewed conference papers, as the most common document types, as per the search done. other document types such as book chapters, reviews and books were excluded from this search. the search was not confined to accounting specific journals, as the ir and sr literature relevant to this study appeared under a number of different subject areas in the scopus database. this was due to the aforementioned multidisciplinary nature of ir and sr as research areas. theory identification articles identified as relevant were inspected for references to theories. the find function was used to systematically search through each article for the appearance of the word fragment ‘theor*’. using this word fragment ensured that the words ‘theory’, ‘theories’, and ‘theoretical’ were identified during the search. articles identified as having referred to a theory or theories to explain ir or sr were further analysed to observe the specific theory utilised. this involved observing the specific theory to which the word ‘theory’, ‘theories’, or ‘theoretical’ related as identified by the search process. the paragraph containing the identified theory was also read to contextualise the study’s theory. this ensured that the theory or theories identified in each study in the sample explained ir or sr practices. the data collected were summarised in a spreadsheet, noting the paper’s name, the journal, the year of publication, and the theory or theories identified, if any. analysis of these findings provided insight into the frequency of use of the identified theories in literature and trends in papers published in the scopus database over the 10-year research period. research using the keyword ‘integrated reporting’ in the scopus database returned 417 results during the 10 years under consideration. this sample was reduced by journal articles and conference to which access could not be obtained through the institutional licence, as well as articles not in english. this sample was then further reduced to studies that were determined to not pertain to ir after an analysis of their title, keywords and abstract, or to a limited aspect of ir. these steps resulted in a final sample of 182 papers on ir. of the total ir papers, four were conference papers, and the remainder were journal articles. an initial search using the keywords ‘sustainability reporting’ in the scopus database returned a different set of 417 results. the sample was adjusted in the same way as the ir sample resulting in a reduced sample of 392 papers on the subject of sr, of which 380 were journal articles, and the remainder were conference papers. in certain instances, the same article relates to both reporting practices, and such an article would be included in the sample for both ir and sr. an initial analysis of the 569 papers in the combined ir and sr samples, excluding duplicate articles, revealed that, of the total identified papers, 253 papers did not utilise any theories to explain ir or sr. an analysis of the papers containing theories revealed that the theories listed alphabetically in table 1 below were utilised in the literature during the period examined to explain ir and sr. table 1: theories identified to explain integrated reporting and sustainability reporting between 2010 and 2019. the resulting data were analysed to determine trends across the period examined. the findings for ir and sr were further compared and contrasted. the pearson’s correlation coefficient (ly, marsman & wagenmakers 2018) was calculated to determine the statistical significance of changes observed. all assumptions for these statistical methods were met. limitations it is important to note several limitations associated with the methodology presented above. the restriction of the search to articles and conference papers and the use of only one database, scopus, were other study limitations. any insights in academic research that were not encapsulated by articles and conference papers in scopus would have been omitted from the study. the limitation of the filtering method utilised to identify relevant articles was that some papers would not have been identified because it was possible that the paper’s key focus was not reflected in its title, keywords or abstract, the language was not english, or the papers were not available through the institutional licence. furthermore, several different terms have been used interchangeably for sr in the literature. although these limitations may have had the effect of reducing the completeness of the sample of articles selected for this study (rinaldi et al. 2018), the results from those papers included, may be used to draw conclusions from the prevalent theories. furthermore, given that the search for theories was performed manually, without the aid of computer software, and based solely on the word fragments discussed above, there was a potential bias and the risk of human error, which would have negatively affected the quality of the data collected. to mitigate this risk the sample papers were read more than once, in order to accurately capture the theories used. funding information this research received no specific grant from any funding agency in the public, commercial or not-for-profit sectors. results and discussion this research aimed to identify and analyse the different theoretical perspectives used in papers addressing ir and sr between 2010 and 2019. furthermore, it investigated the trends in the utilisation and prevalence of different theoretical perspectives and the reasons for these trends. the following section presents the research findings and a discussion of these findings. as is evident from this analysis, there is a substantial overlap between the theories used to explain ir and sr. this overlap is, in part, because, as mentioned above, ir and sr practices are, for the most part, still voluntary. thus, the theoretical explanations utilised to explain these two phenomena largely draw from the existing body of theory regarding voluntary disclosure practices. furthermore, as sr is an integral part of the ir practice, it is unsurprising that many of the same theories are used to explain ir and sr. integrated reporting the following discussion relates to the sample of 182 articles found to pertain to ir. the total sample was separated into those articles that mentioned a theory and those that did not. of the sample of articles collected on ir, 92 papers made no mention of any theories for explaining ir, while 90 papers did. of the four conference papers included in the sample only three included a theory. this demonstrates the difference in focus between journal articles and conference papers. table 2 shows the number of ir articles over the last 10 years. the data has been broken down into papers that mentioned theories and those which did not. table 2: integrated reporting papers with and without theories in each year. in 2010, there were no papers published in the scopus database relating to ir. this lack of papers is likely because of the widespread adoption of ir as a means of corporate reporting and the awareness that it was influenced mainly by the promotion of ir by the iirc (rinaldi et al. 2018). the iirc was only formed in 2010, and from 2010 to 2012, ir had yet to generate substantial interest as a research area. from 2013 onwards, however, following the release of the first international <ir> framework (iirc 2013), the number of papers published on ir began to increase each year considerably, indicating the growing interest surrounding the topic of ir. a more significant percentage of papers published did not employ a theoretical perspective during most years. in the initial years of ir research, from 2012 to 2015, research employing a theoretical perspective appeared to be favoured while, later on, a more significant percentage of papers per year did not mention a theory. however, from 2016 onwards, a relatively more significant percentage of published papers began utilising theoretical perspectives once more, apparently. a possible reason for this trend is that, in recent years, a more considerable amount of ir research focused on empirical research that relies on utilising a theoretical perspective to interpret the research findings (wangombe 2013). table 3 reflects the theories used to explain ir and the cumulative number of times each theory has appeared throughout literature during the period under review. table 3 also shows each theory as a percentage of the total theories utilised per year to identify trends in the application of different theories over the 10 years. table 3: occurrence of each theory in integrated reporting literature in total, and as a percentage of the total per year. it is worth noting that of the 90 ir papers mentioning a theory, 36 papers utilise more than one theoretical perspective, resulting in the total reflected in table 3 being higher than the total of the sample. this finding aligns with earlier studies, suggesting that a multi-theoretical perspective is often the most useful for explaining and understanding organisational practices, such as reporting (fernando & lawrence 2014). the most commonly used theory for explaining ir is the stakeholder theory, followed closely by the legitimacy theory. of the 90 papers, 39 papers use the stakeholder theory, while 34 use the legitimacy theory, with an overlap of 16 papers that mention both theories. the dominance of these theories is aside from an anomaly in 2012, when the only paper on ir published in that year utilised the institutional theory. to determine whether there is a significant relationship between the use of the legitimacy theory and the stakeholder theory in the ir literature, the correlation coefficient between the two variables was calculated. pearson’s correlation coefficient was determined to be 0.876 (p-value: 0.00087617), indicating a strong positive linear relationship between the application of the stakeholder theory and that of the legitimacy theory. this finding confirms the complementary nature of ir’s explanations according to the stakeholder and legitimacy theories. early on in the development of ir, eccles and saltzman (2011) quoted the stakeholder theory to support the case for ir. this emphasis may, to an extent, explain the proliferation of the stakeholder theory in the ir literature. however, given the complementary nature of the stakeholder and legitimacy theories, the results do not warrant the conclusion that the stakeholder theory is the best or most prominent theory for explaining ir. the arguably insignificant difference in the number of times the stakeholder theory appeared in the literature compared to the legitimacy theory further emphasises this conclusion. rather, it appears that a combination of both theories provides the preferred theoretical explanation for ir. although the stakeholder theory is the most frequently utilised theory for explaining ir, it fell below the legitimacy theory in 2016 and 2017 for the first time in the entire research period. this drop may be explained by the publication of john flower’s widely cited paper, ‘the international integrated reporting council: a story of failure’ in 2015. in his paper flower criticises the iirc’s framework for prioritising investors’ reporting needs over those of the broader stakeholders in the reporting entity (flower 2015). flower’s paper consequently undermines the ability of the stakeholder theory to successfully explain ir due to the iirc’s seemingly shareholder-centric framework. this opinion may have given rise to the apparent decline in the application of the stakeholder theory in the ir literature in the years following the paper’s publication. however, this downward trend reversed in 2018, with a further increase in 2019. going forward, the prominence of the stakeholder theory in the ir literature is likely to continue due to the revisions to the iirc’s framework, published in 2021, which aims to encourage increased recognition of other stakeholder groups (iirc 2021). these revisions thus serve to reconfirm the adequacy of the stakeholder theory in the study of ir. although not as dominant, the institutional theory has held a consistent place in the literature every year since 2012. the institutional theory was used in conjunction with another theory in 52% of the papers. there is no clear trend in the theories that are used together, with those overlapping the stakeholder theory in 58% of these papers, the agency theory in 42%, and the legitimacy theory in only 33% of papers. this appears to indicate that the institutional theory generally stands alone, and when it is paired with another theory, it doesn’t have a natural counterpart. to determine whether the prevalence of the institutional theory has increased or decreased over time, the correlation coefficient between the year and the percentage utilisation of institutional theory was determined. pearson’s correlation coefficient was determined to be -0.099, indicating a weak, negative linear relationship between the two variables. the p-value of 0.785309183 also indicates insufficient evidence to conclude that there is a significant correlation between the passage of time and the utilisation of the institutional theory. thus, it is impossible to conclude with confidence that the utilisation of the institutional theory in the ir literature has either increased or decreased over the last 10 years. however, as ir becomes institutionalised, the institutional theory may provide greater insights into adopting ir practices (robertson & samy 2020) and may become increasingly utilised in ir research in the years to come. the agency theory and the signalling theory are also commonly used to explain ir in the literature, with the theory of proprietary costs and theory less frequently used. sustainability reporting the following discussion relates to the sample of 392 articles about sr. further analysis revealed that, of the total sample, only 229 papers utilise a theory to explain sr. table 4 shows the sr articles over the last 10 years, broken down into articles that mentioned theories and those which did not. table 4: sustainability reporting papers with and without theories in each year. as with ir, there is an upwards trend in the number of articles published regarding sr over the last 10 years. this analysis also shows that most published papers on sr use a theory during 6 of the 10 years, and that there is a clear upwards trend. however, similarly to the ir findings, the conference papers covering sr were again predominantly not found to use a theory, with only 2 of the 12 papers mentioning a theoretical framework. sustainability reporting is an extensively studied area of research with many well-established theoretical perspectives employed in the study of sr for many years. this observed upwards trend might thus be due to a renewed interest by researchers seeking to discover new theoretical perspectives applicable to the study of sr. table 5 shows the theories used to explain sr and the cumulative number of times each theory appeared in the literature during the period under review. the table also shows each theory as a percentage of the total number of theories utilised per year in the sr literature for each year reviewed. table 5: occurrence of each theory in sustainability reporting literature in total, and as a percentage of the total per year. of the 215 sr papers applying a theory, 138 papers (64%) use more than one theoretical perspective. as with ir, this analysis provides evidence of the usefulness of a multi-theoretical lens in studying corporate reporting practices. table 5 shows that, of the 229 articles referencing a theory, 143 mention the legitimacy theory, with 114 (80%) of these papers quoting the legitimacy theory together with another theory. as with the ir literature, many papers name the legitimacy theory in conjunction with the stakeholder theory, with 83 papers on sr using both theories to explain sr. other theories frequently mentioned with the legitimacy theory, were the agency theory (27% of papers), the institutional theory (27% of papers) and the signalling theory (22% of papers). unlike ir, the stakeholder theory is mentioned less frequently than the legitimacy theory in the sr literature, with 119 papers utilising this theory to explain sr. again, demonstrating the multi-theoretical lens that is frequently used, 94 of these papers (79%) touched on more than one theory. as previously mentioned, the most common overlap was with the legitimacy theory (88% of papers). however, the institutional theory was also applied in 31% of papers, as well as the agency theory in 27% of papers. to determine whether the legitimacy theory’s dominance has increased or decreased over time, the correlation coefficient between the year and the percentage utilisation of the legitimacy theory was determined. pearson’s correlation coefficient was determined to be -0.605, indicating a moderate, negative linear relationship between the two variables. however, the p-value of 0.063688 is not significant at the 5% significance level, indicating insufficient evidence to conclude that there is a significant correlation between the passage of time and the utilisation of the legitimacy theory. thus, it is impossible to conclude with confidence that the percentage utilisation of the legitimacy theory has either increased or decreased over time. instead, it appears that, while the legitimacy theory has remained the most dominant theoretical perspective, its usage has fluctuated, seemingly at random, over the last 10 years. to determine whether a significant relationship exists between the use of the legitimacy theory and the stakeholder theory in the sr literature, the correlation coefficient between the two variables was calculated. pearson’s correlation coefficient was determined to be 0.958, indicating a strong, almost perfect, positive linear relationship between the utilisation of the stakeholder theory and the utilisation of the legitimacy theory. the p-value of 0.00001278 also indicates that there is sufficient evidence to conclude a significant correlation. this finding, once again, reaffirms the notion that the legitimacy theory and the stakeholder theory cannot be viewed as two opposing theories but rather as complementary theoretical perspectives in the study of corporate reporting practices. as indicated by the results, the dominance of the legitimacy theory in the sr literature is a departure from earlier literature that made extensive use of the stakeholder theory to explain social and environmental reporting (spence et al. 2010). the increasing popularity of the legitimacy theory amongst researchers comes from a growing body of evidence suggesting that organisations produce corporate social disclosures to legitimise organisational activities (van der laan 2009). as with ir, after the legitimacy theory and the stakeholder theory, the institutional, agency and signalling theories are the most frequently employed theories for explaining sr. the preoccupation with these particular five theoretical perspectives throughout the literature may be because, together, these theories may provide different but complementary explanations for corporate reporting practices. furthermore, the results reveal that the voluntary disclosure theory, political economy theory, accountability theory and resource dependence theory appear to be somewhat popular in the sr discourse. these theories are outlined briefly: this analysis reveals that usage has mostly fluctuated throughout the 10 years, with no clear trends emerging in the results for all identified theories in sr literature. the results also show that the stakeholder, legitimacy, institutional, and agency theories are the most consistently employed theories in the last 10 years. these theories each appear during at least 9 years out of the 10-year research period. conclusion this study aimed to identify which theories are used in papers discussing ir and sr in the literature prior to the current changes observed in the non-financial reporting environment. furthermore, the trends in the utilisation and prevalence of different theoretical perspectives in ir and sr were investigated. both sr and, more recently, ir garnered substantial interest as research areas over the last few decades. the choice of an appropriate theory to be employed in the study of either sr or ir is research-specific mainly, and no single theory may be espoused to explain either reporting practice wholly. as a result, different researchers adopted various theoretical perspectives over the years, independently and in combination, to explain and understand corporate reporting practices. it was found that the most dominant ir and sr literature theories are the legitimacy, stakeholder, institutional, agency, and signalling theories. it is noteworthy that of these theories the legitimacy, stakeholder and institutional theories all have their roots in the political economy theory. the results reveal that while the stakeholder theory and the legitimacy theory remain the most frequently utilised theories for explaining ir, the institutional theory is also prevalent. furthermore, it was found that the doi theory and the theory of proprietary costs may also be utilised to explain ir. regarding sr, the accountability theory, resource dependence theory, voluntary disclosure theory, and political economy theory have also been popular among researchers. the release of the international <ir> framework (iirc 2013) saw an increase in the amount of research on ir, and the critical work of flower (2015) saw a shift away from the stakeholder theory during 2016 and 2017. regarding sr there was no clear trend, apart from a general increase in the amount of research on the topic. further research may expand the literature sample included in the current study to include literature published on other databases. further studies could also examine specific theories explaining ir and sr within different geographical regions, and later periods of time affected by the covid-19 pandemic. this study contributes a systematic review and comprehensive analysis of the theories utilised in ir and sr literature. unlike the existing research, this study provides deeper insight into the trends emerging in the existing sr and ir literature and the reasons as to why different theories are prevalent at different times. this study contributes to the prior research discussing the theoretical perspectives employed in sr and ir. it will be valuable in future ir and sr studies to enable researchers to identify the most relevant applicable theoretical frameworks utilised within the scope of their research. furthermore, as researchers begin studying the effects of current events in earnest, the choice of theoretical frameworks may change from prior periods. the dominant theories may remain the most useful, but less prominent theories may come to the fore in this new era. acknowledgements competing interests the authors declare that no competing interest exists. authors’ contributions the research 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quality lukas i. ehlers received: 05 apr. 2016; accepted: 30 nov. 2016; published: 15 may 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: a typology of desirable social conditions in supervisory relationships suggested that such conditions may also be desirable in other forms of labour relationships. a literature review confirmed that trust, compliance, fairness and good faith can be confidently regarded as universally desirable social conditions in all forms of individual or collective labour relationships between employers and employees. aim: the purpose of this study was to determine if primary labour relationship quality (plq) can be confidently conceptualised as a social construct that strongly relates to the perceived levels of compliance, fairness and good faith in supervisory or primary labour relationships. setting: a combination of random and convenience sampling approaches was implemented to collect plq related data from 454 voluntary respondents, who were subordinate employees in the tshwane region. methods: a quantitative research methodology was adopted. this included conceptual definition of the plq construct, objective measurement of plq levels of voluntary respondents in an adequately sized sample, factor analysis and testing for relationships and differences in means between variables. results: data analysis results confirmed that it can be confidently concluded that the conceptual definition of plq was valid, and that positive plq perceptions of subordinate employees were significantly related to at least two other forms of desirable organisational outcomes. conclusion: plq perceptions can be confidently defined as a distinct subjective quality estimate that is assimilated from unique expectations and perceptions of the levels of compliance, fairness, good faith and trust that a supervisor displays in a labour relationship with an immediate subordinate. introduction background labour relations is a field of study that examines all forms of relationships that occur between any number of people who are related through some or other form of labour, and the internal and external environmental variables that influence the expectations, perceptions and behaviour of primary and secondary relationship stakeholders. labour relations can occur at different levels, for example, supervisory, departmental, organisational, industrial, national or international. however, most individual labour relationship exchanges will typically occur between individual subordinates and their supervisors within their unique workplace environment. such relationships can subsequently be regarded as primary labour relationships, which are different from secondary labour relations that occur between groups of employees, or their representatives, and their employers, or their representatives. it should be noted that authors often use the term employment relations to describe primary and secondary labour relationships. however, the term primary labour relations will be preferred in this study to ensure focus on labour relationship behaviour in supervisory relationships. in this context, tertiary labour relations will be regarded as relationships between organised groups of employees and employers, or their representatives and the state, as well as other macro-level stakeholders (bendix 2015; nel et al. 2016; venter & levy 2015). the work-related expectations, values, attitudes, perceptions and behaviour of subordinates can be influenced by supervisory behaviour in a variety of ways (robbins & judge 2013). perceived organisational support (pos) theorists believe that subordinates in supervisory relationships regard the values and behaviour of their immediate supervisors as the values and behaviour of the employer as a whole (shanock & eisenberger 2006). in addition to their routine supervisory duties, south african supervisors are also expected to deal effectively with a variety of dynamic and unpredictable labour relationship challenges emanating from a socially sensitive, politically aware and economically challenging labour market, (moloto, brink & nel 2014; soko & belchin 2014). they should thus be highly alert and cautious when dealing with labour relations challenges, and be especially aware of the negative consequences that socially undesirable behaviour holds for the organisations in which they are employed, as well as the society in which they live (ntimba 2015). however, supervisors are not the sole custodians of good-quality labour relationship behaviour. the elimination of undesirable and promotion of desirable relationship behaviours at the organisational-, industrialand societal-level labour relations should be regarded as a critically important responsibility and competency of all labour relations stakeholders, irrespective of their unique roles or relationship environments. the question that subsequently begs to be answered is: ‘which desirable labour relationship behaviours and social conditions are typically present in good quality labour relationships?’ ehlers (2013) found that trust, justice, fairness and good faith were typically desirable social conditions in supervisory relationships. however, in a subsequent paper, ehlers (2014) considered the formal, normative and psychological dimensions of employment contracting, and then proposed that trust, compliance, fairness and good faith are universally desirable social conditions in labour relationships. the ambiguous term ‘justice’ was thus replaced by ‘compliance’, which more specifically denotes observance of applicable laws, agreements, contracts, policies, codes and procedures. it can therefore be confidently expected that perceptions of the levels of compliance, fairness, good faith and trust in labour relationships will be strongly related to assessments of the quality of labour relationships, and for purposes of this study, primary labour relationships between individual subordinates and supervisors. research objective gay and weaver (2011) believed that research into the nature and validity of theoretical constructs can facilitate incremental understanding and explanation of a theory. they were of the opinion that any advance in the definition, expansion or validation could be regarded as an advancement of knowledge that is aimed at the eventual revelation of scientifically founded truths, and encouraged researchers to undertake more quantitative, qualitative and mixed method research studies relating to theory building. these views confirmed that quantitative research into validity of the primary labour relationship quality (plq) construct would advance scientific knowledge on labour relationship and organisational behaviour in south african organisations, to some or other extent. a survey of labour relationship and supervisory behaviour articles in leading south african labour relations and human resource management journals, confirmed that no unique theory on the quality of employment or labour relationship behaviour in supervisory relationships was published in the last 10 years. it was therefore decided to consolidate and build on the work of ehlers (2013, 2014) by developing a conceptual definition of plq as a theoretical construct, and testing the validity of a newly conceptualised theoretical construct in accordance with a reliable validation methodology (cresswell 2014; friedman 2003; gay & weaver 2011; snow & thomas 1994). overview the contention of this article is that plq is a distinct theoretical construct that relates to unique individual labour relationship expectation, perceptions and behaviours in supervisory relationships. the nature and validity of the plq construct, and related concepts, will subsequently be investigated and discussed in the remainder of this article. the following sections contain a literature review on the nature of labour relationship exchanges in good-quality primary labour relationships, and a discussion of the research methodology. these sections will be followed by a discussion of findings on the validity of plq as a theoretical construct. limitations, recommendations and final conclusions will be discussed in the closing section. literature review poor-quality labour relationships supervisors are key leaders and change facilitators in organisations, and need to ensure that subordinates perform their duties at expected levels, by effectively planning, organising, leading and controlling their activities. they also need to ensure that a variety of formal and psychological contracting expectations of subordinates with diverse demographic characteristics are met, in order to establish and maintain good-quality labour relationships (botha & moalusi 2010; robbins & judge 2013; tepper 2007). numerous empirical studies confirmed that employees respond negatively to abusive or negative supervisor behaviour by engaging in deviant behaviour forms that could be harmful to the organisation and its members, such as poor work performance, deviant work behaviour or resignation outcomes (guest 2004; tekleab & taylor 2003; theledi 2015). positive supervisor treatment, on the contrary, promotes job satisfaction, employment relationship satisfaction, organisational trust as well as a host of other positive organisational (robbins & judge 2013). many south african supervisors, unfortunately, do not appreciate; respect; or promote trust, compliance, fairness and good faith in their relationships with subordinates. such neglect can result in negative subordinate perceptions of their job security, transparency, job satisfaction and the quality of labour relationships with supervisors and their employers (ntimba 2015). the commission for conciliation, mediation and arbitration (ccma) (2011) identified numerous forms of illegal and unfair supervisory behaviour since its inception. these behaviours are believed to be causes of workplace tension, workplace conflict, formal grievances and labour disputes. these negative outcomes are mostly related to some form of non-compliant, unfair or bad faith behaviour of a supervisor or manager (theledi 2015). the following behaviour forms are examples of undesirable supervisor behaviour: mental bullying of subordinates; ridiculing subordinates in the presence of others; preferring a less deserving candidate for promotion; not considering employees for progress on grounds of race, gender, language, culture, religion, union affiliation or age; victimising subordinates; allowing privileges to selected employees on subjective grounds; and allowing special privileges to selected employees or intentionally blocking promotion and progress (ccma 2011). the mere presence of the aforementioned undesirable behaviours in the south african labour market confirms the need for theories, measures, strategies, policies and practices aimed at improving plq in the south african labour market (ntimba 2015; soko & belchin 2014). labour relations dimensions labour relationship exchanges occur in formal and psychological contracting dimensions (guest 2004; navarro & cabrera 2009). grogan (2014) defined a formal employment contract as a voluntary agreement between two legal parties in terms of which an employee undertakes to place his or her personal services at the disposal of the employer for an indefinite or determined period of time in return for a fixed or ascertainable remuneration. formal employment contracts empower employers to define an employee’s duties and to control the manner in which the employee discharges them, provided that reasonable support is given to an employee. employers and employees should, however, not exploit each other, and both parties are under a legal obligation to comply with explicitly defined legal and contractual provisions (overell et al. 2010). the parties to an employment contract may not change contract provisions without the consent of the other contracting party, and may terminate the contract by serving agreed notice or for other legally sound reasons (grogan 2014). psychological contracting rights and duties are, unfortunately, not as clearly defined as formal contracting rights and duties. psychological contracts can be defined as a set of mostly subjective beliefs, expectations or perceptions of what an employee, or employer, should be receiving in a labour relationship, and what the labour relationship partner should be receiving in return. they are based on unspoken needs and expectations that fall outside the scope of formal labour contracts and collective agreements (guest 2004; overell et al. 2010). psychological contracts encapsulate vague and subjective perceptions on the nature and quality of trust, honesty, respect, constructivity, consideration, fairness, good faith and reciprocity in work relationships. employers and employees form subjective perceptions on the degree to which their expectations in the aforementioned aspects were met by their relationship partners. a perceived breach of a psychological contract can result in relationship tension, relationship conflict, undesirable relationship behaviour and the eventual termination of an employment contract (botha & moalusi 2010; gerlach et al. 2007; guest 2004; tekleab & taylor 2003). desirable social conditions in primary labour relationships trust, compliance, fairness and good faith were identified as four primary desirable social conditions in labour relationships (ehlers 2014; ehlers & jordaan 2016). all four of these social conditions are explicitly or implicitly regulated by south african labour law and related case law emanating from labour court rulings and ccma awards (grogan 2014). each of these social conditions encapsulates five distinctive but interrelated behaviour forms that are indicative of the prevalence of each respective social condition in supervisory relationships (ehlers & jordaan 2016). the following sections contain discussions on the nature of each of the four desirable social conditions in labour relationships. trust in primary labour relationships perceptions of trust, consistency, fairness, equity and good faith are strongly interrelated and stem from relationship expectations and exchanges which occur in the formal and psychological dimensions of labour contracting (cropanzano, bowen & gilliand 2007). trust can be simply defined as the willingness of a party (trustor) to be vulnerable to the actions of another party (trustee) based on the expectation that the trustee will perform one or more actions that are important to the trustor, even if the trustor is unable to monitor or control the trustee (sparrow & cooper 2003). coyle-shapiro and shore (2008) concluded that employees with high levels of trust in their organisations are thus more likely to put greater effort into their roles and co-operate better with others in the workplace, while employees with low levels of trust in their organisations are likely to interact and work less effectively. even though trust is regarded as a foundation for effective and harmonious labour relationships, there are no laws that require high levels of trust in a labour contract, rule or regulation to make it valid (williams 2007). employers, however, are under an implied obligation to create certainty, fairness, equity and consistency in workplace relationships, which mostly requires compliance with labour laws and contractual stipulations, legitimate labour policies and legitimate labour procedures (grogan 2014). trustworthy relationship partners are more likely to be convinced of relationship objectives and partner bona fides, devoted to relationship objectives and duties, tolerant of partner shortcomings and unforeseen relationship duties, supportive of relationship partners and loyal to relationship partners (tekleab & taylor 2003; williams 2007). it should also be noted that employees need to perceive employer behaviour and procedures as justified and fair in order to have trust in them, and to behave in accordance with related employer expectations (linde, schalk & linde 2008; williams 2007). low levels of trust in labour relationships are strongly related to negative relationship outcomes, but a climate of trust facilitates open and constructive relationship interaction which can prevent personal differences from evolving into negative or dysfunctional forms of workplace conflict (flanagan & runde 2009; williams 2007). ehlers and jordaan (2016) were of the opinion that conviction, devotion, support, tolerance and loyalty are core indicators of trust in good-quality labour relationships. trust, or perceived trust, is subsequently expected to be strongly related to positive plq perceptions of subordinates in supervisory relationships. compliance in primary labour relationships actual levels of legal or contractual compliance can rarely be objectively assessed by supervisors or subordinates because of their limited knowledge and understanding of applicable labour laws, contracts and often complicated legal principles (ntimba 2015). compliance with the constitution, labour legislation, labour contracts or collective agreements, workplace directives and formal procedures provides foundations and boundaries for labour relationship behaviour (bendix 2015; ehlers & jordaan 2016; grogan 2014). figure 1 reflects the relationship between the various sources of labour law, contracts and workplace procedures. figure 1: labour relationship compliance framework. holtz and harold (2009) concluded that there is a strong relationship between procedural justice perceptions of employees and organisational trust levels. these perceptions relate to the implementation of formal labour relationship rules and regulations. research also confirmed that perceived procedural compliance can create powerful mutually beneficial social conditions in labour relationships such as trust and commitment, improved job performance, positive citizenship outcomes, improved customer satisfaction and diminished conflict in organisational relationships (cropanzano et al. 2007; linde et al. 2008). compliance, or perceived compliance, is accordingly expected to be strongly related to positive plq perceptions of subordinates in supervisory relationships. fairness in primary labour relationships fair labour relationship exchanges are more likely to occur when relationship partners are informed, objective, equitable, consistent and reciprocal (ehlers & jordaan 2016; salamon 1987). a labour relationship partner could subsequently perceive unfair treatment when these expectations are not met during relationship exchanges. kickul, gundry and posig (2005) found that employees are likely to be more sensitive to issues of fairness and equity when trust levels in the labour relationship are low. perceived unfairness and low trust levels can trigger undesirable subordinate conduct (southey 2010). gerlach et al. (2007) found that subordinate employees who experience unfair treatment may deliberately restrict output or even resort to sabotage, and that employees who feel fairly treated are more likely to perform above minimum requirements. dimatteo, bird and colquitt (2011) further found that procedural or substantive unfairness in the termination of labour contracts were positively related to increased propensities to retaliate and litigate. the effect on propensities of employees to retaliate or litigate was also amplified when a termination was perceived to be procedurally and substantively unfair. fairness, or perceived fairness, is therefore expected to be strongly related to positive plq perceptions of subordinates in supervisory relationships. good faith in primary labour relationships good faith can be defined as an honest and sincere intention to create mutual benefit for all parties in a relationship by displaying interested, sincere, respectful, considerate and constructive behaviour in relationship exchanges (ehlers & jordaan 2016; heap 2009; riley 2009). bad faith will become evident when disinterested, insincere, disrespectful, selfish or obstructive behaviour is adopted in relationship exchanges (shimanskaya 2010). positive perceptions of good faith are related to higher levels of trust in organisational relationships, which in turn strongly relate to a number of positive organisational behaviour outcomes (botha & moalusi 2010; guest 2004; tekleab & taylor 2003). the research of searle and skinner (2011) further confirmed that employee trust levels are determined by individual relationship experiences and subjective perceptions related to management behaviour and other social variables in a labour relationship. it can thus be confidently expected that general plq perceptions will be strongly related to the perceived good faith in their relationship with immediate supervisors. summary the literature review confirmed that formal and psychological contract expectations, such as trust, compliance, fairness and good faith influence labour relationship perceptions and behaviour in labour relationships. lower levels, or absence, of trust, compliance, fairness and good faith are related to negative or undesirable primary labour relationships or organisational behaviour forms or outcomes. each of the four desirable social conditions in primary labour relationships encapsulates at least five distinct, yet interrelated, behaviour forms. these behaviours promote positive subordinate perceptions of the quality of trust, compliance, fairness and good faith in primary labour relationships (see table 1). the aforementioned social conditions and related behaviours can thus be confidently expected to be significantly related to general subordinate estimates of plq. table 1: facilitators of good-quality labour relationships. research methodology a quantitative research design that could facilitate the validation of a theoretical construct and a related measure was required for this study (cresswell & plano clark 2007). a literature review and a questionnaire survey were consequently undertaken and quantified responses were captured and statistically analysed from a modernist perspective. the following chronological steps were followed in this study (babbie 2011; bless, higson-smith & kagee 2013; cresswell 2014; field 2009; kumar 2011): the background to the research problem and theoretical constructs were conceptualised. a literature review on the nature of labour relationships, supervision and desirable labour relationship behaviour was conducted, and the theoretical construct under investigation was clearly defined. a reliable theoretical construct development and validation procedure was identified. the aforementioned procedure will be comprehensively discussed in the following section. a valid and reliable measure of labour relationship quality was identified and included in a survey questionnaire along with a number of general biographical items (ehlers & jordaan 2016). in addition, the survey questionnaire also included valid and reliable measures of workplace self-esteem (wse) and quit intention for a related research study. the availability of trustworthy measurements of the latter variables, however, provided an ideal opportunity to test hypotheses on the relationship between plq and other organisational variables (see section ‘experimentation and hypothesis testing’). a combination of random and convenience sampling approaches was implemented to collect data from voluntary respondents in the tshwane region (bless et al. 2013). a group of field workers were briefed on the nature of the research study, the survey questionnaire and the ethical aspects of survey questionnaire methods. field workers were requested to approach potential respondents randomly, explain the nature of the research study and then request potential respondents to read and accept an ethical compliance statement in the preamble of the questionnaire, if they were willing to complete the questionnaire as an anonymous, informed and consenting volunteer. a total of 454 completed questionnaires were returned (219 males and 235 females; 368 african race respondents and 86 from other race groups). a sample size of 454 was deemed to be large enough to conduct a meaningful exploratory factor analysis of questionnaire data (hair et al. 2006). questionnaire responses were then captured and analysed on a personal computer using spss version 20. a variety of general, descriptive and inferential statistical procedures were applied to structure and analyse data. discussion of theory development and validation process a number of general guidelines for effective development and validation of a theoretical construct were reported in literature (cresswell 2014; friedman 2003; gay & weaver 2011; snow & thomas 1994). the following list contains the most important general requirements for effective theory development and validation: identify key constructs, concepts and variables describe relationships between phenomena and theoretical rationales determine boundary conditions of the theory develop a valid and reliable measure of key concepts and constructs establish the nature of relationships between variables test theory validity through critical experimentation and hypothesis testing. procedures and findings pertaining to each of the aforementioned requirements will be described in the following sections. identification of key constructs and variables primary labour relationship quality was initially conceptualised as a construct that refers to a distinct subjective quality estimate that is assimilated from unique expectations and perceptions that an individual subordinate holds on the quality or levels of compliance, fairness, good faith and trust that an immediate supervisor displays in an individual labour relationship. the specific components of the above mentioned theoretical assumption should be understood as follows (adapted from general definitions in oxford press (2010), and literature views relating to the plq theory under investigation): primary means first level or most important labour means to perform physical or mental work relationship refers to a unique association between two or more people distinct means unique and clearly different from other things or behaviours subjective means vague personal feelings, tastes or opinions quality refers to the standard of something as measured against other things estimate means an imprecise valuation of a value, number, quantity or extent assimilated means to integrate something that was obtained from other sources unique means different and other expectations and perceptions expectations are strong beliefs that an event or behaviour will occur perceptions are unique ways of regarding, understanding or interpreting behaviour individual subordinate refers to a specific person that works under instruction of a specific supervisor level refers to a specific position on a real or imaginary scale compliance means that relationship partners comply with formal relationship guidelines in all of their relationship exchanges fairness means that relationship partners treat each other in an even-handed manner in all relationship exchanges good faith means that relationship partners sincerely promote mutual relationship benefits in all relationship exchanges trust means that relationship partners are willing to risk vulnerability by relying on their relationship partner to behave in an expected manner immediate supervisor refers to a person who directly oversees the work of another person display means to show, demonstrate or exhibit behaviour individual labour relationship refers to a work-related relationship between two different persons. relationships and theoretical rationales south african supervisors are expected to deal with a multitude of distinctive labour relationship challenges that emanate from transforming social, economic and political systems, in addition to their routine supervisory duties (bendix 2015; ccma 2011; nel et al. 2016; ntimba 2015; soko & belchin 2014; venter & levy 2015). they should therefore be especially attentive to the promotion of good-quality labour relationships, and make all efforts to avoid undesirable sociopolitical conflicts with subordinates. displays of compliance, fairness, good faith and trust by supervisors have been found to promote good-quality labour relationships with subordinates (ehlers & jordaan 2016). at least five distinctive but interrelated behaviour forms can contribute to positive subordinate perceptions of compliance. the same applies to positive perceptions of fairness, good faith and trust in primary labour relationships. twenty desirable labour relationship behaviour forms can thus be regarded as typical facilitators of good-quality primary labour relationships (table 1). supervisors should subsequently be ably encouraged to display these core desirable labour relationship behaviours to establish, maintain and promote good-quality primary labour relationships. neglect of such behaviours can be expected to result in negative subordinate perceptions of plq and related negative organisational behaviours and outcomes (cropanzano et al. 2007; dimatteo et al. 2011; flanagan & runde 2009; gerlach et al. 2007; grogan 2014; holtz & harold 2009; kickul et al. 2005; linde et al. 2008; overell et al. 2010; searle & skinner 2011; tekleab & taylor 2003; williams 2007). boundary conditions of the primary labour relationship quality theory under development any new theory should be investigated in the context where it will be applied. such investigations should be preceded by a clear conceptual definition (cresswell 2014; friedman 2003; snow & thomas 1994). a conceptual definition of plq was provided in the section ‘identification of key constructs and variables’. analysis of the conceptual definition and related literature, suggested that the following initial boundary conditions be respected: plq perceptions are related to individual expectations and experiences in the formal and psychological dimensions of labour relations (botha & moalusi 2010; dimatteo et al. 2011; ehlers 2014). plq perceptions are distinctly different from subordinate perceptions of the quality of routine supervisory behaviours such as communicating, planning, organising, leading and controlling (botha & moalusi 2010; guest 2004; robbins & judge 2013). plq perceptions result from very specific subordinate perceptions of compliance, fairness, good faith and trust in labour relationship exchanges that are distinctively rooted in the fields of labour relations and labour laws (botha & moalusi 2010; ehlers 2014; grogan 2014; guest 2004; overell et al. 2010). plq perceptions are uniquely individual and can be estimated by any subordinate, regardless of race, gender, age, seniority, union affiliation or qualification among others (botha & moalusi 2010; ehlers & jordaan 2016; robbins & judge 2013). positive plq perceptions can be confidently expected to be positively related to numerous desirable organisational phenomena. for example, high productivity, job satisfaction, high workplace-based self-esteem, engagement, good citizenship behaviour, good work-life balance, positive diversity attitudes, lower stress levels, weak quit intention and wellness, among others. conversely, negative perceptions are expected to be negatively related to desirable organisational phenomena (botha & moalusi 2010; delobelle et al. 2011; joubert & roodt 2011; linde et al. 2008; robbins & judge 2013; searle & skinner 2011). negative plq perceptions can be confidently expected to be positively related to numerous undesirable organisational phenomena. for example, low productivity, job dissatisfaction, low workplace-based self-esteem, workplace deviance, disengagement, poor work-life balance, negative diversity attitudes, higher stress levels, absenteeism, strong quit intention and turnover, among others. conversely, positive perceptions are expected to be negatively related to undesirable organisational phenomena (botha & moalusi 2010; delobelle et al. 2011; joubert & roodt 2011; linde et al. 2008; robbins & judge 2013; searle & skinner 2011). a valid and reliable measure of primary labour relationship quality the psychometric properties of the measure of plq that were applied in this study were comprehensively described by ehlers and jordaan (2016). the measure was reported to be more than adequately valid in light of the fact that all plq items were directly derived from a validated typology of desirable social conditions in supervisory relationships, and related labour relations literature. the chronbach’s alpha coefficient of items in the plq measure (0.961) far exceeded the minimum acceptable level of 0.7 (field 2009), which confirmed that the internal reliability and consistency of the instrument is far higher than adequate (kumar 2011). establishing the nature of relationships between variables bartlett’s test of sphericity confirmed that variances between plq items can be assumed to exist at a confidence level of 0.000. the kaiser-meyer-olkin (kmo) test of sampling adequacy returned a highly desirable value of 0.971. the aforementioned results confirmed that factor analysis was possible, and a principal component analysis was subsequently conducted (brown 2009; field 2009). only one underlying component with an eigenvalue of 11.906 emerged from a principal component analysis. this component accounted for 59.530% of all variances which far exceeds the 50% minimum accounting level that was suggested by hayton, allen and scarpello (2004). furthermore, only two communality values (0.328 and 0.431) were lower than the 0.5 level that was recommended (costello & osborne 2005). the other 18 communality values were all higher than 0.5 and fell within a range of 0.517 to 0.726. communality values, however, do not address the relationship between components and the principal component. values in the component matrix confirmed that all 20 components were very strongly related to the principal component, with highly desirable factor loadings ranging from 0.573 to 0.852 (costello & osborne 2005). it was therefore concluded that all 20 of the items in the plq questionnaire were strongly related to at least one underlying primary component, namely ‘primary labour relationship quality (plq)’ (costello & osborne 2005; field 2009). the highly positive factor loading that confirmed strong relationships between the 20 components and plq confirmed that additional factor reduction procedures were unnecessary (brown 2009; costello & osborne 2005; field 2009). confirmatory factor analysis falls outside of the scope of the current study and was subsequently not conducted. appendix 1 contains more specific information on the principal component and factor loadings. experimentation and hypothesis testing the plq measure formed part of a more comprehensive survey questionnaire that also included measures of wse and quit intention, in addition to a number of biographical questionnaire items. however, plq was the main focus of this study and no literature review was subsequently conducted on wse and quit intention. the availability of the aforementioned additional measurements, however, allowed the researcher to formulate and test five hypotheses on the nature of plq perceptions, which satisfied the experimentation and hypothesis testing requirement in the theory validation procedure. the five hypotheses and related findings are discussed below: h1: plq perceptions of subordinates are an integrated perception encapsulating interrelated perceptions of the levels of compliance, fairness, good faith and trust in primary labour relationships. this hypothesis was confirmed. a single component (plq) with a very high eigenvalue of 11.906 emerged from the principal component analysis, and factor loadings between plq and each of the 20 individual plq components were also above the desirable level of 0.5 (0.573 to 0.851). h2: plq perceptions of subordinates of different gender, race and age groups are significantly different. this hypothesis was rejected. an independent samples kruskal–wallis test confirmed that there are no statistically significant differences in the plq perceptions of subordinates from different gender (p = 0.150) or race groups (p = 0.078). an independent samples mann–whitney u test confirmed that there is no statistically significant difference between the plq perceptions of subordinates who are younger than 35 and subordinates who are 35 years or older (p = 0.192). the relative significance of these findings, however, suggests that further research should be conducted in this regard. h3: plq levels of subordinates reporting to supervisors from a different gender, race and age group are significantly different. this hypothesis was rejected. an independent samples mann–whitney u test confirmed that there is no statistically significant difference between the plq perceptions of subordinates who report to a supervisor that belongs to a different age group, which were defined as those under 35 and those who are 35 years or older (p = 0.650). the same test confirmed that there were no statistically significant differences in the plq perceptions of subordinates reporting to a supervisor belonging to a different gender (p = 0.511) or different race group (p = 0.461). h4: the wse levels of subordinates are positively related to their plq perceptions. wse can be defined as a mental state, or personality trait, that an employee develops in accordance with numerous personal experiences within his or her immediate workplace environment over a relatively lengthy time period (david & vivek 2012; heatherton & wyland 2003). this hypothesis was confirmed. a spearman correlation test (rs = 0.230) confirmed that there is a highly significant positive correlation between wse and plq perceptions (p = 0.000). positive perceptions of plq are therefore strongly related to higher levels of wse, and vice versa. h5: plq levels of subordinates will be negatively related to their intention to quit. intention to quit can be defined as an employee or organisational member’s intention to leave the organisation in which he or she is currently employed or active (cho, johanson & guchait 2009). this hypothesis was confirmed. a spearman correlation test (rs = –511) confirmed that there is a highly significant negative correlation between quit intention and plq perceptions (p = 0.000). negative perceptions of plq are therefore strongly related to stronger quit intentions, and vice versa. limitations and recommendations the plq theoretical construct can be regarded as valid for purposes of investigating and analysing labour relations behaviour in supervisory relationships. however, it will not necessarily be valid for analysing the behaviour of groups of employees or managers who are engaged in secondaryand tertiary-level labour relationships. further related research on the validity of theories on secondary labour relationship exchange quality (slq) and tertiary labour relationship quality (tlq) is subsequently recommended. this study of plq theory was approached from a subordinate’s perspective. it should, however, be kept in mind that supervisors also harbour perceptions on plq in relationships with their subordinates. the measurement and investigation of supervisor expectations and perceptions on plq is therefore recommended. even though the factor analysis confirmed that only one underlying factor is present, it is recommended that further statistical analysis of the sub-scale scores on trust, compliance, fairness and good faith be undertaken. this may facilitate further research into the relationships between the aforementioned constructs and other labour relations and organisational variables (brinkman 2009; rattray & jones 2007). the relationship between plq perceptions of subordinates and two desirable organisational behaviour forms or outcomes were investigated to satisfy the minimum requirements for theoretical construct validation. however, further investigation into relationships between plq and other labour relations and organisational behaviour should be undertaken to test the consistency of relationships between positive plq perceptions and other desirable organisational variables. a limited sample was required to achieve the purpose of this study. caution should thus be displayed when analysing and generalising current research findings for purposes other than theory development and testing (hair et al. 2006). concluding remarks the validity of plq as a theoretical construct was investigated in this study. a comprehensive literature review was conducted and a valid and reliable measure was implemented to measure plq levels of 454 subordinate employees in the tshwane region. literature review and statistical analysis findings were integrated, and the following final conclusions were drawn: all subordinate employees, irrespective of age, gender or race, have expectations on formal and psychological contracting outcomes. these expectations inform their perceptions of plq. this limited study revealed no statistically significant differences between the plq perceptions of respondents with different age, gender or race characteristics. primary labour relationship quality is a theoretical construct that refers to a distinct subjective quality estimate that is assimilated from unique expectations and perceptions of the levels of compliance, fairness, good faith and trust that a supervisor displays in a labour relationship with an immediate subordinate. plq perceptions of subordinates are significantly related to at least two desirable organisational behaviour forms or outcomes. the study confirmed a statistically significant positive relationship between the plq perceptions of subordinates and their wse, as well as a statistically significant negative relationship between plq perceptions of subordinates and their quit intentions. it can be confidently assumed that there are significant positive relationships between positive plq perceptions and a variety of desirable labour relationship and organisational behaviours and outcomes, and negative relationships between positive plq perceptions and undesirable relationship behaviour. accordingly, it can also be confidently assumed that there are significant positive relationships between negative plq perceptions and a variety of undesirable labour relationship and organisational behaviours and outcomes, and a negative relationship between negative plq perceptions and desirable relationship behaviour. the findings from this study can provide a solid foundation for future research into other variables that influence plq perceptions, and the relationships between plq and other labour relations and organisational behaviour phenomena, such as union affiliation, qualification, position, length of service, deviant organisational behaviour, organisational commitment, organisational culture, organisational values, organisational structure, conflict style, motivation, remuneration level, leadership style, pos, leader–member exchange, personality type, personal values, employee engagement, citizenship, job satisfaction, absenteeism, age, race and gender, among others (chartered institute of personnel and development 2012; de silva 2014; ghosh & ray 2012; overell et al. 2010; robbins & judge 2013; searle & skinner 2011). the plq construct also encapsulates a reliable set of behaviour criteria that can be used for objective assessment of plq perceptions of subordinates. such measurements can facilitate effective identification of behaviour development needs of supervisors operating at different levels in organisations. furthermore, it provides a reliable foundation for developing pro-active labour relations strategies, structures, policies, procedures and behavioural interventions that are needed to effectively prevent and manage labour relations behaviours and outcomes. the author would like to acknowledge and thank all fieldworkers, colleagues, family and friends that provided support, encouragement, feedback and many other forms of assistance during this project. acknowledgements competing interests the author declares that he has no financial or personal relationships that may have inappropriately influenced him in writing this article. references babbie, e., 2011, introduction to social research, 5th edn., cengage learning, wadsworth, oh. bendix, s., 2015, labour relations: a southern african perspective, 6th edn., juta academic, cape town. bless, c., higson-smith, c. & sithole, s.l., 2013, fundamentals of social research methods: an african perspective, juta, cape town. botha, l. & moalusi, k.p., 2010, ‘values underlying perceptions of breach of the psychological 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(eds.), 2014, labour relations in south africa, 5th edn., oxford university press, cape town. williams, m., 2007, ‘building genuine trust through interpersonal emotion management: a threat regulation model of trust and collaboration across boundaries’, the academy of management review 32, 595–621. https://doi.org/10.5465/amr.2007.24351867 appendix 1: factor analysis results table 1-a1: kaiser-meyer-olkin and bartlett’s test. table 2-a1: total variance explained. table 3-a1: principal components analysis communalities and component matrix. abstract introduction empirical model the data and description of the sites results and discussion conclusions acknowledgements references footnotes about the author(s) kidanemariam g. gebrehiwot college of economics and management sciences, university of south africa, south africa department of economics, mekelle university, ethiopia citation gebrehiwot, k.g., 2017, ‘the impact of agricultural extension on farmers’ technical efficiencies in ethiopia: a stochastic production frontier approach’, south african journal of economic and management sciences 20(1), a1349. https://doi.org/10.4102/sajems.v20i1.1349 note: the author, kidanemariam g. gebrehiwot, is a research associate at the college of economics and management sciences, university of south africa, south africa. original research the impact of agricultural extension on farmers’ technical efficiencies in ethiopia: a stochastic production frontier approach kidanemariam g. gebrehiwot received: 25 mar. 2015; accepted: 20 mar. 2017; published: 29 june 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: to address the structural food deficit and top down extension system that persisted for decades, the government of ethiopia has introduced a new extension system, called participatory demonstration and training extension systems, which serves more than 80% of the total population. as the program was streamlined to fit the different agro-climatic condition of the country, the extension approach practiced in the tigray region (research area) was called integrated household extension program. aim: this article reports on research aimed at measuring the technical efficiency levels of extension participants and non-participants; measuring the impact extension service on technical efficiency. setting: the research was conducted in the northern part of the country, where agriculture is the main sources of livelihoods. moisture is the most critical factor in the production system. the land holding size averages 0.5 ha per household compared to above three ha 30 years ago; indicating the high population pressure in the area. methods: a sample of 362 agricultural extension service participants and 369 non-participant farm households from the northern part of ethiopia, participated in the study. the stochastic production frontier technique was used to analyse the survey data and to compute farm-level technical efficiency. results: the results showed an average level of technical efficiency of 48%. it is suggested that substantial gains in output and/or decrease in cost can be attained with the existing technology. all the variables included in the model to explain efficiency were found significant and with the expected sign, except education and number of dependants. conclusion: the research tried to assess the impact of a new extension service (participatory in nature) on farmers’ productivity in a semi-arid zone, as compared with the conventional extension service and found in the literature areas with relatively better climatic conditions. hence, if extension administrators could work to uplift the average and below average farmers into better performing farmers level, the overall production and living condition could improve substantially in the research area, and more or less in the rest part of the country. introduction ethiopia has a land mass of 1.1 million square kilometres and a potential of l4.03 million hectares of arable land, 85% of its labour is engaged in agriculture, and there is sufficient rainfall with an annual average precipitation of over 848 mm per year. in terms of government attention, the sector receives more than 17% of the annual budget of the country. however, ironically, the country is unable to feed its population; neither can the sector generate a surplus that can be used to finance the development of other sectors [abrar, oliver & tony 2004; byerlee et al. 2007; central statistical agency (csa) 2011; makombe, dawit & aredo 2007; the world bank 2013]. the main reasons include among other things, an extreme susceptibility to weather variability because of predominantly rain-fed agriculture, poor infrastructure and high population pressure, out-dated production technology and a high illiteracy rate among the farming population (shiferaw & holden 1999). as a result, the sector’s performance in terms of output per worker is 60% lower and output per hectare is 15% lower than the sub-saharan african averages (pratt & yu 2008). to the contrary, ethiopia’s average fertiliser intensity is 13.2 kg per hectare and the agricultural labour input is 2204 man days per 1000 ha, which are 46% and 126% higher than the sub-saharan african averages, respectively (pratt & yu 2008). it was against these realities, after a change of government in 1991, that a new economic policy was formulated and agriculture was given top priority in terms of resource allocation and macro-economic policy [ministry of finance and economic development (mofed) 2010; spielman et al. 2010]. the policy framework is known as the agriculture development led industrialization (adli) strategy. as part of the broader agricultural development strategy, a new extension system called participatory demonstration and training extension systems (padetes) was introduced in 1995 at national level. later on, the programme was modified by each regional state to fit their situations and the tigray regional state, in the northern part of ethiopia, came up with an extension approach called the integrated household extension program (ihep) in 2003 [tigray bureau of agriculture and natural resource development (tboanrd) 2003]. in the formulation process of the new extension programme, an attempt was made not to replicate the shortcomings of the previous extension system (see alene & hassan 2003b; gebremedhin, hoekstra & tegegne 2006). accordingly, the new extension programme was thus developed taking account of the past shortcomings and included the provision of extension services to neglected agro-ecological zones, so as to improve the productivity of smallholder farmers. moreover, the government has taken policy measures to create a favourable production environment. the most important economy-wide policies have been the devaluation of the domestic currency (the ethiopian birr1), the privatisation of state farms and the withdrawal of preferential treatment in providing subsidised credit and fertiliser, improved seed distribution, deregulating food grain markets and other reform measures focused on ‘getting the price right’ (abrar et al. 2004). it is, therefore, timely to assess how the extension service has affected farm productivity (technical efficiency), especially focusing on the semi-arid agro-ecological part of the country. with this as background, the objective of the research on which this article is based was twofold. firstly, it aimed to estimate the efficiency levels of farm households in the research areas, in the northern part of ethiopia. secondly, it aimed to identify (if any) the determinants of inefficiency variables. estimating the degree of inefficiency at household level can provide policy makers with information to design programmes and introduce cost-effective efficiency improving measures (in the presence of inefficiency) and long-run development strategies in research and technology generation capacity, so as to address farm productivity in smallholder households. moreover, it also served as input for development intervention so as to ensure an equitable distribution of income as well as an effective demand structure for other sectors of the economy (bravo-ureta & pinheiro 1993, 1997). the article covers the following: a brief review of relevant literature, an empirical model used (a stochastic production frontier approach), discussion of the data sources, area description of the research sites, results and discussion, and conclusions. literature review the literature on the agricultural extension service and its impact on farm efficiency are mixed. according to dinar, karagiannis and tzouvelekas (2007), the literature dealing with the impact of extension on the performance of farms has followed two different directions. on the one hand, several studies (e.g. huffman 1977; jamison & moock 1984; owens, hoddinott & kinsey 2003) have been based on the estimation of a production function in which extension service is considered as a separate input, assuming producers are producing on the same production frontier. in this approach, the impact of extension service on farm performance is evaluated through its marginal product and, in a sense, its direct effect on output is captured. on the other hand, by relaxing the full efficiency assumption, extension service has been used as a factor explaining the differences in the technical efficiency levels among groups of farmers rather than as an input in the production function (e.g. bravo-ureta & everson 1994; seyoum, battese & fleming 1998; young & deng 1999). thus, extension service has been included along with other socio-economic and demographic variables as a factor influencing technical efficiency in farming. as such, the impact of extension service on farm production is indirect and may be evaluated through the potential output gain arising from the elimination of technical inefficiency in farming. previous research on the impact of agricultural extension service on efficiency in ethiopia has produced mixed results. an insignificant effect of extension service on efficiency has been found by alene and hassan (2003a), alene and zeller (2005) and bogale and bogale (2005), but none of these studies were carried out in the highland areas of tigray. also, alene and hassan (2003a) found an insignificant impact of padetes in two sites in the eastern part of the country. however, when the extension service was captured via a continuous variable (the number of years the farmer participated in extension programmes), its effects on technical efficiency became positive and significant. yohannes and garth (1993) reported higher technical efficiencies for extension participants, but lower allocative efficiencies compared with the non-participant group. haji (2006) estimated determinants of technical efficiencies for smallholders’ vegetable-dominated farming system in eastern ethiopia. the impact of an agricultural extension service on technical efficiency was found to be negative. several variables, including demographic, plot level and institutional variables, are likely to affect the efficiency of smallholder farmers (alene & hassan 2003a; mathijs & vranken 2001). the demographic variables included in our estimation are age, gender and level of education of household head and number of dependants. except for the number of dependants, the three variables (age, gender and education) are expected to affect efficiency positively. age as proxy for farm experience, higher education level and gender (male) is expected to have a positive effect on farm efficiency (haji 2006; mathijs & vranken 2001; tiwari et al. 2008). the second groups of variables are iddir2 and number of crops grown by the farmer. while the effect of iddir by enhancing households’ access to information is expected to be positively related with efficiency, the effect of crop diversity is difficult to hypothesise a priori. farmers can grow different crops as a hedge against risks that could occur because of natural calamities (haji 2006) or, alternatively, growing more crops could add managerial complexity and reduce efficiency. hence, in view of the educational level and managerial capacity of the rural households in our research areas, it is hypothesised that crop diversity is negatively related with efficiency. finally, by transferring new skills and information, extension service is expected to affect efficiency positively (haji 2006; seyoum et al. 1998). despite the high number of studies to assess the impact of agricultural extension on productivity in ethiopia, we could not find a study that had been conducted in the research sites to assess the impact of the new extension service system on farmers’ productivity. empirical model farmers always operate under uncertainty (caused, e.g. by drought, pests and floods) and it is important to account for this uncertainty in the production process. therefore, our study employed the stochastic production frontier approach introduced by battese (1992). following his specification, the stochastic production frontier can be written as: where: yi is aggregate output, xi is actual input vector, bi is vector of production function parameters to be estimated, σβi lnxi is the deterministic part, and ε is the error term. the total error term ε in equation 1 can be further decomposed into two error components as: where vi is a symmetrical two-sided normally distributed random error that captures the stochastic effects outside the farmers’ control (weather, natural disaster, luck, etc.), measurement errors, and other statistical noise. it is assumed to be independently and identically distributed . thus, vi allows the production frontier to vary across farms and, therefore, the production frontier is stochastic. the term ui is a one-sided (ui ≥ 0) efficiency component that captures the technical inefficiency of the ith ≥ 0 farmer. this component can follow different distributions such as truncated-normal, half-normal, exponential and gamma (aigner, knox lovell & schmidt 1977; greene 2003; meeusen & broeck 1977; stevenson 1980). for the purpose of this article, it is assumed that ui follows a half-normal distribution . following jondrow et al. (1982), technical efficiency (te) can be estimated as: where ui ≥ 0 equation 3 expresses technical efficiency as the ratio of observed output to maximum feasible output, given the random factors experienced by smallholder crop producers. equation 3 can be functionally specified in its general form as: where zi contains all the variables explaining inefficiency at farm operator level. finally, the extension service variable is endogenous, that is, whether extension is affecting efficiency and/or inefficiency or efficient and/or inefficient farmers are joining the programme is not clear. hence, it is suspected that the results suffer from a potential endogeneity problem, so that results should be interpreted with caution. the linearised cobb-douglas production function of equation 1 was specified as in equation 5 below and the maximum likelihood was used to estimate input elasticity (battese & coelli 1995): where: labour = total person days, seed = total quantity of seeds in birr, fertiliser = total value of fertilisers in birr, manure = total quantity in quintal, land = land in tsemad, oxen = total oxen days, capital = estimated value of farm equipment during the survey period in birr, βij is a vector of k unknown parameters, εij is an error term, and yij denotes the gross value of crop output of the ith farmer. to control the price difference farmers are facing for their produce, one common price (mekelle’s3 main market price) is used. all the specified inputs are hypothesised to influence the level of output positively. likewise, technical inefficiency (ui) can be estimated by subtracting technical efficiency from one (1–te). based on the literature, the function of technical inefficiency can be specified as follows: where: age = age of the household head (years), gender = gender of the household head (1=male), education = education level of household head in years, ndependants = number of dependants living in the household, ncrops = number of crops farmers produce, iddir = 1 if the household is a member of the social network, and 0 otherwise, and extension = household participation in agricultural extension. finally, after conducting all the necessary model selection testing steps, i adopted a cobb-douglas stochastic production function for model estimation. the data and description of the sites the data were gathered in a survey conducted during may–june 2009. the entire sample consisted of 731 households of extension participants and non-participants. the research site, the geba catchment,4 is located in tigray region5 in the northern part of ethiopia (tboanrd 2003). the altitudes in the region lie between 300 metres above sea level (masl) in the east to above 3000 masl in the northern and central part. hence, it covers three agro-climatic zones: lowland (kolla) which falls below 1500 masl, medium highland (woinadega) 1500–2300 masl and upper highland (douga) 2300–3200 masl (tboanrd 2003). the geba catchment is one of the catchments in the region and covers an area of 46 000 ha, 10 districts (two highland, two lowland and six mid-highland) and 168 sub-districts. to ensure representativeness, the districts were clustered based on their agro-climatic conditions. we randomly selected two districts from the mid-highland, one from the highland and one from the lowland. two sub-districts were randomly selected from each district. households were selected from sub-districts based on population size and farmers’ participation status in the agricultural extension service. accordingly, 360 participants and 371 non-participant households were selected. questionnaires were tested and validated before the main survey work. using the survey questionnaires, demographic, socio-economic, land use and farming system, extension service and other related data were collected. simple statistical description and econometric models were used to address research objectives, and derive conclusions on the level of technical efficiency and its determinants. the variables used for the analysis are indicated in table 1. table 1: summary statistics of the variables used in the analysis. results and discussion both descriptive and econometric results are discussed in this section. descriptive results on comparing the value of crop production of participant and non-participant households, it was seen that participant households produced 66% more (birr 13 447 compared with birr 8111) than non-participant households. in terms of input application, participant households used birr 536 worth of seed, birr 235 of fertilisers, 75 person days, 5 tsemad of plot size and birr 808 worth of agricultural equipment during the production year. the corresponding figure for non-participant households is birr 414 worth of seed, birr 185 of fertiliser, 56 person days, 3.79 tsemad of plot size and birr 736. using a simple statistical comparison of input intensity per output of the two groups, it was seen that participant households consistently showed higher levels of input application than non-participant households. it is very difficult to say anything regarding the efficiency level of the two groups by looking at the absolute volume of production only, as the two groups differed in terms of their input application. however, using the average productivity of each input, it can be inferred that participant households were producing higher levels of output per each unit of input compared with non-participant households. the variables that are hypothesised to influence farm-level production efficiency are demographic factors such as gender, age, education, number of dependants, agricultural extension service and social network participation status, and number of crops grown by the household. the average age of a farmer was 44 years, indicating that most farmers had a reasonable amount of experience in farming. the average number of years of schooling of the household head was 0.88 years (less than first grade level). this educational level is very low by any standard, which indicates the limited availability of educational facilities in the research sites. in terms of household heads’ gender composition, 73% of the households were headed by men. participant households grew more diversified crops, on average 3.26 crops, than their counterpart households with an average of 2.78 crops. social network membership was higher among extension participant households, 29% compared with 17% for non-participant households. econometrics results the first section of table 2 gives the production functional coefficient estimates which measure the proportional change in output when all inputs included in the model are changed in the same proportion. the functional coefficient for the maximum likelihood estimation (mle) is 0.65, which indicates that returns to scales are decreasing. table 2: ordinary least square and maximum likelihood estimates of the stochastic production frontier analysis (n = 731). the inputs of fertiliser, manure, oxen and farm equipment (capital) were found to be significant, indicating their importance in crop production in the area, and all were between zero and one (except labour). based on the estimated coefficients, fertiliser, manure, oxen and farm equipment inputs were the most important variables that affected the level of output in the area. seed and land size also contributed positively to productivity, although their contributions remained marginal and insignificant. on the contrary, labour was found to be insignificant and negative. in the light of the over-populated rural subsistence sector furnished with nearly zero marginal product of labour and working with traditional farm technology, the insignificant and negative coefficient for labour is not surprising (lewis 1954). my objective was to understand which variables were the most important factors affecting farmers’ production inefficiency. accordingly, i estimated the technical inefficiency model specified in equations 3 and 4 using mle. all my results, except the variable dependants, are consistent with our expectations. the results show that extension and farming experience (age of the household head as proxy) and number of crops were negatively related with inefficiency, implying that participant households in the extension programmes, farmers with higher farming experience and diversified crop growers were more efficient compared with non-participants households, younger farmers and less diversified crop growers, respectively. our results for extension are in agreement with seyoum et al. (1998) for maize producers in ethiopia, solis, bravo-ureta and quiroga (2008) for hillside farmers of el salvador and honduras, and dinar et al. (2007) for crete farmers. as indicated in table 3, technical indices ranged from 0% to 84%, with an average of 48%. it is evident from these results that the production and income level of the farming communities can be almost doubled by simply improving farm management practices and without the introduction of new technologies. compared with the resultsof other similar studies in africa and other developing countries, myresult is very low. the low level of efficiency can be explained by the low level of education of the farming community, and it indicates that the rural sector is characterised by a traditional, over-populated rural subsistence sector furnished with zero marginal product of labour (lewis 1954). moreover, education in my case cannot serve as an ideal indicator for human capital, as the formal education provided in schools does not have practical relevance to the farming system and instead pushes the young and productive forces away from the farm, to seek off-farm employment opportunities (gedara et al. 2012). seyoum et al. (1998), comparing technical efficiency between farmers participating in the sasakawa-global 2000 project and non-participant farmers in ethiopia, found 74% and 88% inefficiency level, respectively. alene and zeller (2005) found an average farmers’ efficiency level of 79% in multiple crop farming in eastern ethiopia. table 3: frequency distribution of technical efficiency indices. haji (2006) reported an average of 91% level of efficiency for smallholder vegetable producers in eastern ethiopia, which is relatively high compared with other studies. a study by binam et al. (2004) on three crops in cameroon reported an average efficiency level of 73%. mochebelele and winter-nelson (2000), studying the impact of migrant labour on the technical efficiency of coffee farmers in lesotho, found 36% for households with no migrant member and 24% for households with a migrant member. weir and knight (2000), analysing the impact of education externalities on production and technical efficiency of cereal crop farmers in ethiopia, found a mean efficiency level of 55%. however, the results of this study contradict those of haji (2006), alene and hassan (2003a) and bogale and bogale (2005), whose studies were all conducted in ethiopia. the positive coefficient and significant effect of education on inefficiency are not surprising. given that the average educational achievement in the research is below first grade, the stated educational level is too low to bring productivity difference among farmers (weir & knight 2000). my negative and significant estimated coefficient for the age of the farmer indicates that experienced farmers are more technically efficient compared with their younger counterparts. similar results were also conveyed by alene and hassan (2003a), but our results contradict those of seyoum et al. (1998). another interesting finding is the positive coefficient for the number of crops grown by the farmer. growing diversified crops could contribute to productivity and output level, serving as a hedge against different farm risks and reducing risks, or alternatively diversification could reduce output through its diseconomies of scale effect. this result concurs with the results of haji (2006) for ethiopia and linde-rahr (2005) for vietnam and contradicts those of solis et al. (2008) for central america and udry (1996) for burkina faso. hence, the effect of diversification on productivity cannot be known beforehand. in this study, we found a negative relationship with inefficiency, implying that crop diversification6 contributes positively to efficiency. similarly, iddir (a social capital variable) negatively and significantly affected inefficiency. this could be because of the effect of this variable on access to information and technology, which in turn might have brought differential farm management and efficiencies among the farm households. the negative sign of the dependants’ variable is unexpected but, in the context of an agrarian society where dependants actively participate in cattle herding, fetching wood and water and generally contributing positively to the household’s economy, the result could be justifiable. gender has a negative and statistically significant effect on technical inefficiency, suggesting that male-headed households are more efficient than their female counterparts. the efficiency difference could stem from gender inequalities and female household heads’ additional domestic responsibilities (child-rearing and care, cooking and cleaning), which compete for women’s time and effort. conclusions this article addressed two main questions. the first question is whether farmers were producing and managing their farms efficiently, given the available technology. according to the te estimates, output levels could have been maintained while reducing overall input use by an average of 52% for the average farmer in the sample and 100% for the most technically inefficient farmer. the second question that was addressed is which variables explain efficiency differences among farm households. based on the stochastic frontier estimates, the differences in efficiency were explained by variables such as gender, the number of crops grown and the number of dependants. extension was found to have a significantly positive effect on efficiency, suggesting that encouraging farmers to participate in the extension programme can enhance productivity and thereby improve the livelihoods of participant households. this study showed that smallholder farmers’ production could potentially be increased by 52% without increasing other inputs and using current technologies. although not all factors affecting technical efficiency can be controlled (e.g. age and gender), several areas were identified where policy changes can make an impact. in particular, promoting vocational education (with special emphasis on agricultural skills training) and developing social capital such as iddir and farmers’ associations so as to bridge the gap between technology centres and farmers could help the efficiency level of farm production. to ameliorate the gender-induced efficiency difference, the extension service delivery system needs to be gender-streamlined. it is suggested that in addition to increasing the availability of technologies and providing quality extension services, access to these aspects should be given due consideration in the future. however, because of the potential endogeneity of extension, this result is only tentative, not conclusive. acknowledgements the author wishes to express his profound gratitude to vlir-uos (belgium) for the full and generous financial support of his phd study through the mu-iuc programme. the author also sincerely and duly recognises and appreciates the all-round support, profound technical comments and advice received from his phd study advisors erik mathijs and mietmaertens, and his mentor as postdoctoral fellow, daniel makina, at the university of south africa (unisa). finally, all the research site farmers who sat patiently for hours to answer the detailed interviews and the enumerators who worked tirelessly to collect the data are also sincerely thanked. the author also wished to thank two phd advisors who have provided him with guidance and technical support during 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efficiency and agricultural technologies in the ethiopian agriculture, munich personal repec archive paper no. 404, viewed 29 april 2012, from http://mpra.ub.uni-muenchen.de/404/ young, d. & deng, h., 1999, ‘the effects of education in early-stage agriculture: some evidence from china’, applied economics 31(11), 1315–1323. https://doi.org/10.1080/000368499323193 footnotes 1. us$ was approximately birr 10.2, in 2009 (http://www.freecurrencyrates.com/exchange-rate-history/etb-usd/ : accessed june 2010). 2. iddir is an association made up by a group of persons united by ties of family and friendship, living in the same district, etc., and has an objective of providing mutual aid and financial assistance in certain circumstances (aredo 2010). 3. mekelle is the capital city of tigray regional state (the northernmost part of ethiopia). 4. a catchment selected by joint research project between mekelle university and inter-university cooperation (vlir-uos) flemish project that lasted for 10 years. 5. region is an administration territory equivalent to province. district is the next administration layer/stratum and equivalent to district. sub-district is the lowest government unit. 6. diversification is measured by the number of crops grown by the household. journal 4.indd 322 sajems ns 9 (2006) no 3 managerial competencies among first-line newsroom managers at small to medium-sized mainstream media enterprises in south africa elanie steyn school of communication studies, north-west university tfj steyn school of entrepreneurship, marketing and tourism management, north-west university abstract changes in the south african media and management environment have had distinct influences on especially small to medium-sized mainstream media enterprises (media smes) which often have to compete with bigger media organisations for the same news stories. moreover, these media organisations are commonly faced with unique challenges related to human and other resources. this situation adds to the importance of effective and efficient management practices at these media sites. the management practices of first-line news managers in media smes are qualitatively and quantitatively evaluated in this paper by considering six managerial competencies found in general management theory. these competencies relate to communication, planning and administration, teamwork; strategic action, global awareness and self-management. jel m54 1 introduction at the turn of this century, south africa hosted an estimated 3 million small enterprises (including informal businesses) (south africa yearbook, 2004/05: 173). the importance of these enterprises cannot be underestimated in terms of their contribution to the country’s economy. however, as elsewhere in the world, in south africa the failure rate of small businesses is high. moreover, these enterprises often operate under severe restrictions related to human and other resources, which probably contributes to the high failure rate. apart from this problem, as venter, van eeden, king and sharp (2003: 3) indicate, the majority of failures are rooted in a lack of proper management skills. that managers in small and medium-sized enterprises need proper managerial competencies is thus fairly obvious. since the dawn of democracy in south africa, a number of new smalland medium-sized enterprises (smes) have been added to the country’s mainstream media scene. legislation on media enterprises was relaxed, and a number of new role players entered the (previously restricted) mainstream media market. also, new entrants appeared on the media scene in attempts to diversify the media’s voice. while some of these enterprises specifically aimed at and operated within a development and community media framework, others were established in the country’s mainstream media context. in an environment characterised by tough competition, increased bottomline profitability and rapid technological development, it is evident that media smes competing with bigger counterparts face enormous challenges (see berger, 2004; kupe, 2004). however, media smes are not the only ones who need to address the above challenges. criticism from a variety of sources (e.g. the government, owners and audiences) also sajems ns 9 (2006) no 3 323 necessitates that the mainstream counterparts of these smaller companies also reflect on these issues (see kupe, 2004; berger, 2004; von bormann, 2004). this situation caused the south african n a t i o n a l e d i t o r s ’ fo r u m ( sa n e f ) t o commission two journalism-skills audits in the past five years. the first, which we can call audit 1, focused on levels of reporting, writing and accuracy skills among reporters (see steyn & de beer, 2002, 2003, 2004), while the second, which we will call audit 2, investigated the importance and implementation of managerial competencies among first-line newsroom managers (see steyn, de beer & steyn, 2005a).1 this article draws on audit 2, and delineates the importance and implementation of these competencies among first-line newsroom managers at media smes included in the sample. 2 problem statement results from audit 1 suggest that an adjustment in newsroom management styles and approaches could improve human resources management in newsrooms (see steyn & de beer, 2002). while this implies that newsroom managers are trying to improve the human aspects of management (see rue & byars, 2000), these approaches are not traditionally associated with newsroom management (see peters, 2004; underwood, 1995; rankin, 1986). by applying general management theory (see hellriegel et al., 2004; lussier, 2003; daft, 2003) to newsroom management (see peters, 2004; graham & thompson, 2001), this study aims to determine the attitude of first-line newsroom managers2 and reporters in south african mainstream media3 to six important managerial competencies, namely communication, planning and administration, strategic action, teamwork, global awareness and self-management (identified by hellriegel et al., 2004). it also aims to ascertain how these competencies are currently implemented in south african newsrooms. as indicated above, this article focuses on the media. smes4 were included in the sample. 3 theoretical framework 3.1 managerial competencies kroon (1995: 7-8) describes management as a process by which people in leadership positions (managers) apply human and other resources as efficiently as possible to deliver need-satisfying products or services and to eventually realise a business enterprises’ predetermined goals. this implies the implementation of basic (i.e. planning, organising, leading and control) and additional (decision making, communication, motivating, co-ordinating, delegating and disciplining) management functions (ivancevich, lorenzi, skinner & crosby, 1997). it also implies that managers are skilled in managerial competencies (hellriegel, et al., 2001: 5). these requirements also apply to media newsroom management. however, the study of the phenomenon of media management is still a fairly new field in south africa. results from audit 1 underscore the necessity of improving journalists’ skills and performance through improving human resources management (see steyn & de beer, 2002; also hellriegel et al., 2001: 5). changed organisational environments further heighten this need (see gade, 2004; cameron, 2003; rensburg & cant, 2003). to achieve this improvement in skills and performance, managers require managerial competencies (hellriegel et al., 2001; oosthuizen, de bruyn, jacobs & kruger, 2002: 29-32) in the following fields 5: • communication: managers are required t o p r o m o t e u n d e r s t a n d i n g b e t w e e n themselves and staff members through proper communication. unfortunately, newsrooms are often notorious for poor internal communication (see peters, 2004: 5; fink, 1996: 96). in the context of a multi-cultural south african newsroom, proper internal communication is even more important (see de beer & steyn, 2002: 70). • planning and administration: managers are also required to plan properly in order to effectively and efficiently achieve 324 sajems ns 9 (2006) no 3 organisational goals and objectives (see kroon & van zyl, 1995). in the increasingly competitive media environment, proper planning and administration skills are critical (see hollifield, 2003; fink, 1996: 78; rankin, 1986: 33). these skills include the ability to utilise time and financial resources wisely (see berger, 2004; de beer & steyn, 2002: 63). • strategic action: managers must understand both the microand macro-contexts in which they work (see lussier, 2003; kungshankleman, 2000). this enables them to manage change effectively (see gade, 2004) and improve organisational output (see jones, 2003). • teamwork: managers (also in the media) are increasingly challenged to accomplish o r g a n i s a t i o n a l g o a l s a n d o b j e c t i v e s through small, interdependent and jointly responsible groups of employees (lussier, 2003; thompson, 2001: 7). however, the traditional notion that journalists work independently makes this a difficult task for media managers (see fink, 1996: 80). • global awareness: trends related to globalisation and increased cross-border business activity require managers to be wellversed in cultural differences (see hellriegel et al., 2004). however, the multicultural nature of the south african society additionally requires media managers to be sensitive towards these differences in the local context (see nsidi, 2002). • self-management: managers are not only responsible for the development of their own professional and private lives, but also those of their staff members (see hellriegel et al., 2004; montgomery, peeters, schaufeli & den ouden, 2003). this implies the ability to admit mistakes and act in an ethically acceptable manner (see de beer & steyn, 2002: 72; gaziano & coulson, 1988: 871). 3.2 south african smes 3.2.1 definition of media smes the national small business act (102/1996) defines a south african sme in the transport, storage and communication industries as having 200 or fewer full-time or equivalent paid employees, realising a total annual turnover of r26 million or less and disposing over a total gross asset value (fixed property excluded) of r6 million or less. the schedule containing this definition was replaced in 2003 by section 7 of the national small business amendment act (26/2003). the 2003 substitution, however, maintains the exact parameters for a transport, storage or communication sme specified in the 1996 act. this is unfortunate, as the values for annual turnover and asset value must be adjusted to take the changing value of money into account. hoag (2005) defines media entrepreneurship as “the creation and ownership of a small enterprise or organisation whose activity adds at least one voice or innovation to the media marketplace”. this includes new entrants, existing small enterprises, and for-profit and non-commercial forms of enterprise, but excludes big media. the result of successful media entrepreneurship which adds voices to the media marketplace is eventually the creation of small and medium-sized media enterprises. this was illustrated in the south african media landscape with the commercialisation of the radio stations operated by the south african broadcasting corporation (sabc) in the mid-1990s. as part of its unbundling process, the sabc sold off a number of radio stations to private owners. while this was positive in the sense that new voices were added to the south african media environment, it left these new radio station owners and staff with the challenge of competing with well-established voices in the market. moreover, they were forced to find innovative ways through which they could manage the stations to the benefit of all those involved, including owners, staff members and audiences. one specific challenge they had to overcome was related to human resource management. after a station was sold, its employees lost all the benefits they enjoyed when their station was part of the sabc (e.g. medical aid schemes, pension funds). over and above these, they also had to address challenges related to physical infrastructure and technology (see steyn & steyn, 2003). nevertheless, today sajems ns 9 (2006) no 3 325 the majority of these radio stations are now playing an important role in setting and covering the country’s news agenda. in this context and for the purposes of this article, therefore, media smes are defined as media enterprises not forming part of the big media organisations in south africa (i.e. media 24, johnnic, independent and caxton), but that operated (at time of audit 2) as independent smes or as independent sme business units in investment portfolios of larger conglomerates. this implies that the small business act guidelines are taken into account. media enterprises that originated from the commercialisation of sabc radio stations as well as radio stations that originated from greenfield licensing initiatives of the former independent broadcasting authority (iba) are also included (given hoag’s 2005 definition), even though these radio stations might form part of the investment portfolios of larger conglomerates. 3.2.2 managerial competencies at south african smes the important contribution made by the estimated 3 million small enterprises in south africa (including informal enterprises) (south africa yearbook, 2004/05: 173) to the south african national economy in terms of creating employment and contributing to gross domestic product (gdp) is undisputable. more than 50 per cent of the people formally employed and 42 per cent of south african gdp can be attributed to small and medium-sized enterprises (south africa yearbook, 2000/01: 158). unfortunately, the failure rate among smes is high; it is estimated that between 70 per cent and 80 per cent of south african smes fail (moodie, 2003: 9; barron, 2000: 1) compared to 85 per cent in the rest of africa (gaomab, 2004: 2). external (socio-economic and institutional) factors as well as internal factors (personal characteristics of the entrepreneur) directly affect enterprise success (guzman & santos, 2001). however, glueck (1980: 65) and anon (1998: 1) agree that more than 90 per cent of failures can be attributed to “a lack of abilities to perform managerial functions” (venter, et al., 2003: 3). wright (1995: 75) concurs, arguing that poor management is one of the main contributors to small business failure. clover and darroch (2005: 244) list management skills as one of the constraints to small business survival and growth, while kyambalesa (1994: 174) regards managerial competencies as paramount for the success of small business owner-managers. visagie (1997) found in a study of 116 south african small, micro and medium enterprises (smmes) that communication and issues related to strategic action are important managerial competencies required to manage an smme in a changing environment. from a study among 242 small businesses in the nelson mandela metropole, venter et al., (2003) conclude that the managerial competencies most evident in a successful small business are planning and administration, strategic action and self-management. they also establish that the competencies most in need of improvement include communication, planning and administration, financial planning and teamwork. in a study of 44 agribusiness smmes in kwazulu-natal, clover and darroch (2005) identify, amongst others, “management capacity in the enterprise” as a constraint on agribusiness smme survival and growth. the dimensions of this constraint are related to factors constituting the strategic action competency described in section 3.1. it is therefore evident that managerial competencies (as identified in section 3.1) are important for sme success. this is also true for media smes as defined above. the next section of the article outlines the purpose, objectives and design of the study investigating managerial competencies as implemented in south african media smes. 4 research purpose, objectives and methodology 4.1 research purpose and objective given the general research purpose described above (also see steyn, de beer & steyn, 2005a), the objective of this article is to report on the importance and implementation of the six managerial competencies by first-line news 326 sajems ns 9 (2006) no 3 managers in south african mainstream media smes. 4.2 research methodology increasing agreement exists that a combination of qualitative and quantitative research designs (despite their differences) provides more reliable and valid research results than a single methodology, as it helps overcome the biases of both methodologies (see neuman, 2004: 82; babbie & mouton, 2001: 275-276; du plooy, 2001: 39; struwig & stead, 2001: 19). as a result, this study combines qualitative and quantitative designs triangularly in order to obtain the best possible insight into the research problem (also see section 4.2.2). more specifically, data triangulation, investigator/researcher triangulation, methodological triangulation and interdisciplinary triangulation are used (janesick, 1994: 214-215; also see steyn, de beer & steyn, 2005a, 2005b). 4.2.1 sample frame and sampling considerations in determining the sample frame of south african mainstream media (n=106 of which 20 represent smes) from which the sample was drawn, two fixed variables were considered, namely media type and media ownership type. important considerations relating to these variables include the following: • all national media types producing and distributing news had to be included in the sample frame. therefore, using the knowledge and previous research experience of the researchers and members of sanef and considering the requirements of a systematic random sample, a sample of 47 media was selected to include all media types. this included 12 media smes, representing two weekly newspapers, eight radio stations and two news agencies. • media ownership had to be considered, especially given the widespread changes in south african media ownership since 1994. these changes include deregulation, foreign media ownership, the presence of community and commercial media and black economic empowerment. subsequently the sample of 12 media smes included (given the parameters discussed in section 3.2.1) seven unlisted and five johannesburg securities exchange (jse) listed companies. the jse listings were obtained through a media sme owned by a listed holding company (see section 3.2.1 above). • the sample needed to be nationally representative. no comparisons of data were, however, made on the basis of geographical location. the geographical distribution of media smes in the research sample included two enterprises from cape town, six from johannesburg/pretoria, one from durban, one from port elizabeth, one from bloemfontein and one from nelspruit. • the aim of the sampling procedure was to compile a representative sample of the country’s mainstream media from which valid and reliable research results could be obtained and generalised across the sample frame. the sampling procedure thus entailed the following: – compiling the research population of media (n=106 including 20 smes); – calculating a proportional sample according to media type and media ownership type; – drawing a systematic random sample of media sites (n=47, including 12 smes); – dividing the sample into geographical areas; – drawing a volunteer and availability sample of first-line news managers at the identified media sites during real time fieldwork visits and – drawing a volunteer and availability sample of reporters (reporting directly to the above managers) available at t h e m e d i a s i t e s d u r i n g r e a l t i m e fieldwork visits. 4.2.2 research instruments the research used tree research instruments, namely: • quantitative self-administered questionnaires for first-line news managers: these questionnaires were administered to sajems ns 9 (2006) no 3 327 gather information about the first-line news managers’ professional profiles, their attitudes towards specific professional issues and the importance and implementation of the six managerial competencies. a total of 13 first-line managers from media smes completed questionnaires at the sites visited (n=13); • quantitative self-administered questionnaires for reporters: in a similar fashion, questionnaires were used to compile data on reporters’ professional profiles, their attitudes towards specific professional issues, the importance they attach to the six managerial competencies and their perception of how well their first-line news managers implement these competencies. a total of 59 reporters from media smes completed questionnaires at the sites visited (n=59). respondents (first-line news managers and reporters) included in the volunteer and availability sample were issued with questionnaires at the start of the fieldwork visit. they returned the questionnaires at the end of the fieldwork session. respondents were assured of anonymity in an attempt to ensure the most reliable responses possible. professional profiles were determined using closed questions, while attitudes and perceptions (about the importance and implementation of the six managerial competencies by first-line news managers) were measured using items arranged on a 5 point likert scale (1 representing the most negative attitude/perception, and 5 representing the most positive attitude/ perception). finally, open-ended questions encouraged respondents to identify factors hampering or promoting first-line news managers’ professional performances. • interviews: to obtain qualitative research data, semi-structured interviews were arranged with people in charge of the media sites (e.g. editors, news editors, regional editors or current affairs editors). in cases where these editorial managers were unavailable for interviews, another staff member was delegated as interviewee. observational research played a particularly important role in these interviews; in other words (see denzin & lincoln, 1994: 378), the researchers noted and recorded, amongst others signs, verbal and non-verbal communication related to newsroom management and the implementation of the six managerial competencies. conducting fieldwork in real-time and natural newsroom situations facilitated this process. a total of 13 interviews were conducted at media smes (n=13). 4.2.3 data analysis quantitative data was analysed through sas software (sas institute, 1999). both quantitative research instruments were tested for validity using confirmatory factor analysis (cfa) and for reliability using cronbach’s alpha (ca) coefficients. the cfa indicated that both questionnaires were valid by retaining at most two factors per construct (according to the mineigen criterion). this explains at least 70.5 per cent of the variance. the ca coefficients indicated that the questionnaire for first-line managers was reliable, ranging between 0.84 and 0.98 for the respective constructs, and that the questionnaire for reporters was also reliable, ranging between 0.94 and 0.98 for the respective constructs. effect sizes (ellis & steyn, 2003: 52; cohen, 1988: 20-27) 6 were calculated to test for significant practical differences between reporters’ opinions and those of the managers, about firstly, the importance of the identified managerial competencies, and secondly, the managers’ implementation of these competencies. these calculations were done across media types. the research data in the form of interviews and notes made as part of the observational research process were analysed through qualitative content analysis (see hocking, stacks & mcdermott, 2003: 172). 5 research results the results obtained from the media smes included in the national sample for audit 2 will now be discussed. 328 sajems ns 9 (2006) no 3 5.1 communication as a managerial competency the empirical results for communication as a managerial competency are reported in table 1. (d=0.73) between weekly newspapers and radio stations. managers at the radio stations (x=3.82) achieve better results than those at the weekly newspapers (x=2.84). a moderate effect (d=0.41) is also seen between weekly newspapers and news agencies, with reporters rating managers at news agencies (x=3.39) better than those at weekly newspapers. the same applies for managers at radio stations compared to those at news agencies (d=0.46). from the perspective of managers in the different media types,7 there is a moderate difference (d=0.49) in their judgement of the implementation of communication between weekly newspapers and news agencies. managers at the newspapers (x=3.61) regard themselves as better at implementing this competency than those at news agencies (x=3.28). a content editor at a radio station admitted table 1 empirical results for communication as a managerial competency reporters managers respective effect sizes for difference between importance and implementation d=0.47 d=1.50 effects size for difference between implementation (reporters) and implementation (managers) d=0.08 respective means for implementation x=3.33 x=3.42 effect sizes and means for difference in implementation across media types (reporters’ perspective) radio stations news agencies weekly newspapers (x=2.84) d=0.73 d=0.41 radio stations (x=3.82) d=0.46 news agencies (x=3.39) effect size and means for difference in implementation across media types (managers’ perspective) news agencies weekly newspapers (x=3.61) d=0.49 news agencies (x=3.28) comparing the effect sizes for the differences between importance and implementation as judged by reporters (d=0.47) and managers (d=1.50) clearly shows that managers feel more acutely aware than reporters do of their inability to communicate as well as they think they should. the effect size of 0.08 indicates no significant difference between the implementation of communication competencies of reporters and managers. generally, reporters and managers thus agree on managers’ implementation of communication, with managers rating themselves marginally higher (x=3.42) than reporters rate their managers (x=3.33). looking at the implementation of communication among reporters across the three different media types (i.e. weekly newspapers, independent radio stations and news agencies), it is interesting to note a significant difference sajems ns 9 (2006) no 3 329 that communication can be problematic even though these newsrooms are run by small teams. generally, however, the respondents stress the importance of being available to reporters in an attempt to guide them through the news gathering and writing processes as well as to give feedback. managers also say that open communication is important in helping to clarify misunderstandings with and between reporters. 5.2 planning and administration as a managerial competency t h e e mpirica l re sult s f or pla nning a nd administration as a managerial competency are reported in table 2. table 2 empirical results for planning and administration as a managerial competency reporters managers respective effect sizes for difference between importance and implementation d=0.41 d=0.52 effects size for difference between implementation (reporters) and implementation (managers) d=0.05 respective means for implementation x=3.50 x=3.55 effect sizes and means for difference in implementation across media types (reporters’ perspective) radio stations news agencies weekly newspapers (x=3.08) d=0.68 d=0.42 radio stations (x=3.90) d=0.34 news agencies (x=3.59) effect size and means for difference in implementation across media types (managers’ perspective) news agencies weekly newspapers (x=3.42) d=0.42 news agencies (x=3.80) as far as the planning and administration competency is concerned, there is a moderate but significant difference in the opinions of both reporters (d=0.41) and managers (d=0.52) between importance and current implementation. comparing the opinions of reporters and managers about the implementation of the planning and administration competency yields an effect size of 0.05, which indicates no significant difference. generally, reporters and managers thus agree on managers’ implementation of this competency. however, managers rate themselves marginally higher (x=3.55) than reporters rate their managers (x=3.50). reporters’ views of the implementation of planning and administration differs moderately between both weekly newspapers and radio stations (d=0.68) and weekly newspapers and news agencies (d=0.42). no significant difference exists however between reporters from radio stations and news agencies (d=0.34). reporters at radio stations (x=3.90) again award their managers higher scores than do their counterparts at news agencies (x=3.59) and at weekly newspapers (x=3.08). from the managers’ perspective, there is a moderate difference (d=0.42) of opinion about the implementation of this competency between weekly newspapers and news agencies. managers at news agencies (x=3.80) perceive themselves as better implementers than those at weekly newspapers (x=3.42). managers at radio 330 sajems ns 9 (2006) no 3 stations complain about a lack of time to plan in advance what they expect of reporters and what they expect of themselves. the managers mainly ascribe the situation to the amount of time they spend “on air” themselves. another contributing factor is the nature of the product which complicates medium to long-term planning, as breaking news cannot always be planned for. 5.3 strategic action as a managerial competency the empirical results for strategic action as a managerial competency are reported in table 3. table 3 empirical results for strategic action as a managerial competency reporters managers respective effect sizes for difference between importance and implementation d=0.32 d=1.03 effects size for difference between implementation (reporters) and implementation (managers) d=0.13 respective means for implementation x=3.64 x=3.49 effect sizes and means for difference in implementation across media types (reporters’ perspective) radio stations news agencies weekly newspapers (x=3.11) d=0.82 d=0.77 radio stations (x=4.08) d=0.07 news agencies (x=4.02) effect size and means for difference in implementation across media types (managers’ perspective) news agencies weekly newspapers (x=3.79) d=0.42 news agencies (x=3.20) as can be seen in table 3, managers regard this competency as an area in which they perform significantly below (d=1.03) what would be expected for the importance they attach to it. reporters, on the other hand, do not regard their managers as failing to implement strategic action tasks compared to the importance they attach to it (d=0.32). for the implementation of strategic action, a comparison of the opinions of reporters and managers indicates no significant difference (d=0.13). generally, reporters and managers thus agree on managers’ implementation of strategic action, with reporters rating their managers marginally higher (x=3.64) than managers rate themselves (x=3.49). the opinions of reporters at the different media types show significant differences for their managers’ implementation of strategic action. this is the case between weekly newspapers and radio stations (d=0.82), as well as between weekly newspapers and news agencies (d=0.77). an insignificant difference was also found between radio stations and news agencies (d=0.07). managers at radio stations (x=4.08) again achieve better results than their counterparts at news agencies (x=4.02) and weekly newspapers (x=3.11). a moderate but significant difference was also calculated for the implementation of strategic action among managers from weekly newspapers as opposed to among those at news sajems ns 9 (2006) no 3 331 agencies (d=0.42). managers at the newspapers (x=3.79) regard themselves better implementers than do managers at news agencies (x=3.20). managers at radio stations generally indicate that they (and their newsroom staff) are aware of the expectations of their target audience concerning the news product. one news editor, however, admitted that “he has a general sense of what they are about”, and that since joining the newsroom he has not actively used available information on audience characteristics. two other news editors felt that the newsroom “is an island in the bigger organisation” and should be purposefully integrated into the wider organisation to a greater extent. 5.4 teamwork as a managerial competency t h e e m p i r i c a l r e s u l t s f o r t e a m w o r k a s a managerial competency are reported in table 4. table 4 empirical results for teamwork as a managerial competency reporters managers respective effect sizes for difference between importance and implementation d=0.47 d=0.26 effects size for difference between implementation (reporters) and implementation (managers) d=0.42 respective means for implementation x=3.35 x=3.87 effect sizes and means for difference in implementation across media types (reporters’ perspective) radio stations news agencies weekly newspapers (x=3.11) d=0.67 d=0.31 radio stations (x=4.08) d=0.38 news agencies (x=4.02) effect size and means for difference in implementation across media types (managers’ perspective) news agencies weekly newspapers (x=3.79) d=0.04 news agencies (x=3.20) table 4 indicates that reporters regard teamwork as an area in which their managers perform moderately worse (d=0.47) than would be expected for importance they attach to it. managers, on the other hand, do not regard themselves as failing to implement teamwork tasks compared with the importance they afford it (d=0.26). comparing the opinions of implementation of teamwork between reporters and managers shows a moderate difference (d=0.42) between them. reporters (x=3.35) believe that their managers (x=3.87) implement teamwork slightly more poorly than managers believe to be the case. reporters at the different media types believe that a moderate difference exists between managers at weekly newspapers and radio stations (d=0.67). insignificant differences were found between radio stations and news agencies (d=0.38), as well as between weekly newspapers and news agencies (d=0.31). reporters at radio stations (x=3.82) once again regard their managers as better at teamwork than do their counterparts at news agencies (x=3.34) and at weekly newspapers (x=2.91). 332 sajems ns 9 (2006) no 3 managers at weekly newspapers and those at news agencies highlighted an insignificant difference (d=0.04) for their implementation of teamwork. managers at news agencies (x=3.94) regard themselves as marginally better than their peers at weekly newspapers (x=3.91). managers at radio stations seem split over the issue of teamwork. some dismiss it outright, while others regard it as “highly important” and as fulfilling “a crucial role”. managers see sharing recognition for the team effort among all the contributors as their biggest management challenge. reporters, however, are more concerned with other aspects of teamwork (see section 6.4). 5.5 global awareness as a managerial competency the empirical results for global awareness as a managerial competency are reported in table 5. table 5 empirical results for global awareness as a managerial competency reporters managers respective effect sizes for difference between importance and implementation d=0.47 d=1.07 effects size for difference between implementation (reporters) and implementation (managers) d=0.04 respective means for implementation x=3.61 x=3.66 effect sizes and means for difference in implementation across media types (reporters’ perspective) radio stations news agencies weekly newspapers (x=3.17) d=0.73 d=0.11 radio stations (x=4.16) d=0.77 news agencies (x=3.32) effect size and means for difference in implementation across media types (managers’ perspective) news agencies weekly newspapers (x=3.63) d=0.07 news agencies (x=3.69) comparing the difference in opinions about the importance and implementation of global awareness as a managerial competency of reporters (d=0.47) and managers (d=1.07) clearly shows that managers regard this as an area in which they perform significantly worse than they think they should. reporters, on the other hand, regard their managers as only failing moderately in implementing global awareness tasks compared to the importance they afford it. comparing opinions of the implementation of global awareness among reporters and managers yields an effect size of 0.04, indicating an insignificant difference. both groups agree on managers’ implementation of global awareness, with managers rating themselves marginally higher (x=3.66) than reporters do (x=3.61). reporters across the three media types i n d i c a t e s i g n i f i c a n t d i f f e r e n c e s f o r t h e implementation of global awareness by their respective managers. this is the case between both weekly newspapers and radio stations (d=0.73) and radio stations and news agencies (d=0.77). an insignificant difference was found between weekly newspapers and news agencies (d=0.11). reporters at radio stations (x=4.16) once again regard their managers as better at sajems ns 9 (2006) no 3 333 implementing global awareness than do their counterparts at news agencies (x=3.32) and weekly newspapers (x=3.17). managers at weekly newspapers (when compared with those at news agencies) indicate an insignificant difference (d=0.07) on their implementation of global awareness tasks. managers at news agencies (x=3.69) regard themselves as marginally better than those at weekly newspapers (x=3.63). managers at radio stations believe that ethnic and multi-cultural issues do not create newsroom conflict. as one news editor put it, “ten years ago you did not discuss some issues among people, [but now these] differences become humorous”. radio newsrooms also display interesting demographics reflecting their target audiences. some are exclusively english and afrikaans (although not exclusively white), others have a mixed composition and others are “all black”. 5.6 self-management as a managerial competency the empirical results for self-management as a managerial competency are reported in table 6. table 6 empirical results for self-management as a managerial competency reporters managers respective effect sizes for difference between importance and implementation d=0.51 d=1.07 effects size for difference between implementation (reporters) and implementation (managers) d=0.37 respective means for implementation x=3.61 x=4.05 effect sizes and means for difference in implementation across media types (reporters’ perspective) radio stations news agencies weekly newspapers (x=3.18) d=0.64 d=0.33 radio stations (x=4.06) d=0.45 news agencies (x=3.64) effect size and means for difference in implementation across media types (managers’ perspective) news agencies weekly newspapers (x=4.08) d=0.04 news agencies (x=4.06) comparing opinions about the importance and implementation of self-management as a managerial competency among reporters (d=0.51) and managers (d=1.07), it is evident that managers regard this as an area in which they perform significantly more poorly than they think they should. reporters, on the other hand, only regard their managers as failing moderately in implementing self-management tasks compared to the importance they afford this competency. in terms of implementation, an effect size of 0.37 indicates an insignificant difference between the two groups. generally, reporters a n d m a n a g e r s a g r e e a b o u t m a n a g e r s ’ implementation of self-management, with managers rating themselves only slightly higher (x=4.05) than reporters do (x=3.61). reporters across the three media types believe moderately differently about the implementation of self-management by their managers. this is the case between weekly 334 sajems ns 9 (2006) no 3 newspapers and radio stations (d=0.64) as well as between radio stations and news agencies (d=0.45). an insignificant difference is found between weekly newspapers and news agencies (d=0.33). reporters at radio stations (x=4.06) once again regard their managers as better at this competency than do their counterparts at news agencies (x=3.64) and at weekly newspapers (x=3.18). an insignificant difference (d=0.04) of opinion can be found about the implementation of self-management between managers at weekly newspapers and those at news agencies. the newspaper managers (x=4.08) regard themselves as marginally better than do the managers at news agencies (x=4.06). for managers at radio stations, the biggest challenge seems to lie in helping their reporters to develop a well balanced work–life attitude. all the interviewees stated that their staff work hard and do many hours of overtime for which they do not necessarily get paid. managers mostly see themselves as having a good work–life balance, while acknowledging that they can never switch off completely from what is going on in the newsroom. they can be called at any time to help solve problems with stories for the next morning. interestingly, most managers admit that their newsrooms do not function according to a formalised code of ethics, but only according to “broad guidelines” formulated from their own experiences in the industry. 6 conclusions and managerial implications a number of the findings reported above are very interesting, and yield the following conclusions and managerial implications. 6.1 communication as a managerial competency the results shows that first-line newsroom managers at mainstream media smes in south africa do not communicate with their subordinate reporters as well as they themselves would like to. reporters, however, do not feel as concerned about this issue as their managers. as far as the implementation of communication is concerned, both reporters and managers agree on managers’ competence. reporters perceive a practically significant difference between the way managers at radio stations communicate with them as compared to those at weekly newspapers. reporters also believe that these newspaper managers most urgently need to brush up on their communication skills, followed by managers at news agencies and then managers at radio stations. interestingly, however, managers at weekly newspapers distinguish themselves as communicating better with a moderate effect size from their colleagues at news agencies. taking into account the items for which reporters indicate a moderate effect size (no practically significant effect sizes were indicated), managers might be able to improve reporters’ perception of their communication competency as managers by • using technological resources (e.g. e-mail) more to communicate with reporters. this is important, as managers seem unaware that their failure to do so is a problem for reporters. managers at radio stations are, however, especially aware that e-mail communication is not suitable in every circumstance. people can be offensive on e-mail because they do not have to confront each other personally. one duty editor informed the research team that her station has adopted a policy stating how people should address each other, especially when writing e-mails; • m a i n t a i n i n g s o u n d i n t e r p e r s o n a l relationships with reporters; • taking reporters’ feelings and emotions into account during communication; • negotiating resources that reporters need to perform their jobs and • improving their language skills to facilitate communication and address multi-lingual differences in the work environment. this is especially important since only 24.56 per cent of reporters name english as their mother tongue, while 75 per cent of them say they communicate in english most of the time at work. only 18.52 per cent of sajems ns 9 (2006) no 3 335 reporters say they are able to communicate 100 per cent of the time at work in their mother tongue, while nearly half of them (48.15 per cent) indicate that they spend only 50 per cent or less of their time at work communicating in their mother tongue. 6.2 planning and administration as a managerial competency both reporters and first-line managers regard planning and administration as a managerial competency of moderate importance. reporters highlight a moderate difference between the way in which managers at weekly newspapers implement the planning and administration competency compared to those at radio stations and news agencies respectively. reporters once again believe that managers at weekly newspapers should improve on their planning and administration competency most urgently, followed by managers at news agencies and then managers at radio stations. managers at weekly newspapers accept this, as they evaluate themselves lower at implementing planning and administration than do managers at news agencies. taking into account the items for which reporters indicate a moderate effect size (no practically significant effect sizes were indicated), managers might be able to improve reporters’ perception of their planning and administration competency as managers by • d e f e n d i n g m o r e t e n a c i o u s l y t o t o p management the consequences of financial and other risks taken in order to develop the news product; • pro-actively developing plans to improve levels of professional output; • obtaining the resources needed to deliver the news product (also see section 6.1) and • organising these resources more effectively. 6.3 strategic action as a managerial competency first-line managers are aware to a significant extent that they do not implement strategic action as a managerial competency as well as they would like to. reporters, on the other hand, do not consider this to be a problem. reporters again highlight a practically significant difference in the implementation of this competency by managers at weekly newspapers compared to their peers at both radio stations and news agencies. reporters overall believe that managers at weekly newspapers most urgently need to improve their strategic action competency, followed by managers at news agencies and then those at radio stations. interestingly, however, the managers at weekly newspapers again distinguish themselves with a moderate effect size from their colleagues at news agencies in terms of implementing the strategic action competency better. taking into account the items for which reporters indicate a moderate effect size (no practically significant effect sizes were indicated), managers might be able to improve reporters’ perception of their strategic action competency as managers by • monitoring changes in the department/ section more closely to identify the strengths, weaknesses, opportunities and threats that influence the performance of the section/ department; • making a deliberate effort to understand the concerns of reporters better and • making a deliberate effort to understand the nature of the news product in the context of the target audience better. 6.4 teamwork as a managerial competency as far as teamwork as a managerial competency is concerned, reporters are clearly more aggrieved by their first-line managers’ implementation of this competency than managers themselves are. this is substantiated by the moderate effect size indicated between reporters’ and managers’ evaluation of managers’ implementation of the competency. from the reporters’ point of view, there is only a moderate difference between the way in which managers at weekly newspapers implement teamwork and the way in which managers at radio stations do. practically insignificant 336 sajems ns 9 (2006) no 3 differences exist between news agencies and weekly newspapers, as well as between news agencies and radio stations. this once again confirms that teamwork as a managerial competency among first-line managers in south african media smes is a weakness throughout the industry. reporters again believe that managers at weekly newspapers most urgently need to improve their teamwork competency, followed by managers at news agencies and then those at radio stations. managers at weekly newspapers agree, as they indicate that their implementation of teamwork is inferior to that of their colleagues at news agencies. taking into account the items for which reporters indicate a moderate effect size (no practically significant effect sizes were indicated), managers might be able to improve reporters’ perception of their teamwork competency as managers by • structuring the department/section to implement teamwork principles; • a s s i s t i n g r e p o r t e r s i n a c q u i r i n g t h e knowledge needed to function within a teamwork structure; • defining individual objectives within the teamwork environment; • coaching, mentoring and counselling reporters throughout a team project; • u n d e r s t a n d i n g r e p o r t e r s ’ i n d i v i d u a l strengths and weaknesses within a teamwork structure; • sharing recognition and credit with team members; • sharing the responsibilities associated with implementing teamwork; • creating an environment where teamwork is rewarded and • praising reporters in the department/ section. attending to these steps could also help to address managers’ concern with their inability to optimally manage team conflict. if reporters are more satisfied with their manager’s implementation of teamwork, less team conflict may result, alleviating the load of conflict managers have to handle. 6.5 global awareness as a managerial competency as far as global awareness is concerned, managers are clearly more disappointed by their own implementation of this managerial competency than reporters are, compared to the importance both groups attach to it. when only taking implementation into account, both groups agree on managers’ implementation, as shown by an insignificant effect size. reporters indicate practically significant differences between the implementation of global awareness by managers at radio stations compared to managers at weekly newspapers and news agencies. a practically insignificant difference is indicated between news agencies and weekly newspapers. reporters therefore believe that managers at weekly newspapers and news agencies should most urgently improve their global awareness competency. managers at radio stations are rated significantly higher for the implementation of this competency than their counterparts in the other two media types. managers at weekly newspapers agree with this judgement, as they see their implementation of the global awareness competency as inferior to that of their colleagues at news agencies. taking into account the items for which reporters indicate a moderate effect size (no practically significant effect sizes were indicated), managers might be able to improve reporters’ perception of their global awareness competency as managers by • acquiring multi-lingual skills. in a country like south africa, which has 11 official languages, managers cannot realistically be expected to converse perfectly in all these languages. however, reporters will appreciate attempts to communicate with them in their mother tongue (given the situation discussed in section 6.1); and • cultivating a sensitivity for ethnic and cultural differences and a willingness to understand, adapt to and adjust behaviour according to these differences. sajems ns 9 (2006) no 3 337 6.6 self-management as a managerial competency managers seem more disappointed with their own implementation of self-management than reporters, given the importance both groups attach to it. when taking only implementation into account, both groups agree on managers’ implementation, as is shown by the insignificant effect size between these variables. reporters highlight moderate differences between the implementation of self-management by managers at radio stations compared to that of managers at weekly newspapers and news agencies. only a practically insignificant difference exists between managers at news agencies and weekly newspapers. reporters again believe that managers at weekly newspapers should most urgently improve their selfmanagement competency, followed by managers at news agencies and then those at radio stations. interestingly in this case, managers at weekly newspapers regard themselves as implementing the competency better than do their colleagues at news agencies. taking into account the items for which reporters indicate a moderate effect size (no practically significant effect sizes were indicated), managers might be able to improve reporters’ perception of their self-management competency as managers by • conducting themselves according to clearly defined personal values; • accommodating differing personal values in their reporters; • upholding the ethical code of the news enterprise; • admitting to personal mistakes; • taking responsibility; • maximising individual strengths; • addressing individual weaknesses; • l e a r n i n g f r o m p a s t m i s t a k e s a n d experiences; • working diligently; • persevering under conditions of failure and stress; • finding ways to cope with secondary trauma in the newsroom and • taking reporters’ mental states into account. 7 summary this article investigates the managerial competencies of first-line newsroom managers in south african mainstream media smes as evaluated by the managers themselves and by their subordinates, the reporters. managers regard themselves as implementing the communication, strategic action, global awareness and self-management competencies more poorly compared to the importance they attach to these competencies, than do reporters compared to the importance they attach to them. as for the planning and administration competency, reporters and managers agree that managers in general fail to a moderate degree to implement this competency. however, for the teamwork competency, reporters are more dissatisfied with managers’ performance than the managers are themselves. when comparing the implementation of these managerial competencies across media types, reporters evaluate managers at weekly newspapers as worst at implementing these competencies, followed by managers at news agencies. managers at radio stations are held to implement all six managerial competencies best. evaluating the implementation of these competencies across different media types shows that managers at news agencies regard themselves more highly than do their colleagues at weekly newspapers in the case of the planning and administration, teamwork and global awareness competencies. surprisingly, managers at weekly newspapers regard themselves as more successful in implementing the communication, strategic action and self-management competencies than do their counterparts at news agencies, despite reporters’ indicating the opposite. managers at radio stations indicate a number of issues pertaining to all six competencies that they would also like to implement better. 338 sajems ns 9 (2006) no 3 endnotes 1 sanef provided the first author permission to use the qualitative and quantitative research data obtained from audit 1 and audit 2 for purposes of further research. 2 for a definition of this term see steyn, de beer & steyn (2005b: 214). 3 for a definition of this term see steyn, de beer & steyn (2005b: 214). 4 see section 3.2 for a discussion on the definition of media smes as applied in this article. 5 for a detailed discussion of the theoretical framework used, see steyn, de beer & steyn (2005b: 214-216). 6 the effect sizes (d-values) were calculated by using the following formula (cohen, 1988: 20-27; also see steyn, de beer & steyn, 2005a: 44): d = where: • d = effect size; • is the difference between means of two compared groups (e.g. first-line managers and reporters); and • is the maximum standard deviation of the two compared groups. effect sizes were interpreted as follows (ellis & steyn, 2003: 52; cohen, 1988: 20-27): • d ≈ 0.2 indicating a small effect with no practical significance; • d ≈ 0.5 indicating a moderate effect; and • d ≈ 0.8 or larger indicating a practically significant effect. 7 results from radio station managers on this issue are not reported quantitatively, as only one manager from a small to mediumsized independent radio station completed a questionnaire. this is due to the flat organisational structures primarily found at these radio stations. interviews were, however, conducted with eight managers at these stations. these are interpreted qualitatively. due to the sensitive nature of the issues discussed it was agreed that interviewees would remain anonymous. interviewees are therefore not identified in the qualitative assessment of their input. references 1 acts see south africa. 2 anon (1998) “limited skills in management”, http://www.billrobb.co.za/smallbusiness 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(1995) successful small business management in south africa, zebra: sandton. microsoft word 2 pretorius sajems 19(4) 2016.doc sajems ns 19 (2016) no 4:479-496 479 how to cite doi: http://dx.doi.org/10.17159/2222-3436/2016/v19n4a2 issn: 2222-3436 the debtor-friendly fallacy in business rescue: agency theory moderation and quasi relationships marius pretorius department of business management, university of pretoria accepted: april 2016 tension often arises when chapter 6 business rescue practitioners (brps) are appointed by directors to rescue their distressed businesses. regulating by means of standard agency contracting becomes irrelevant in the resulting multiple relationships. looking through the agency lens, using analytic autoethnography and compiling narratives, this paper explains the perceptions of what appear to be quasiagency relationships and obtains a better understanding of these. the findings suggest that the apparent principal-agent relationships suffer from asymmetries of goals, information access, informal power and diverging perceptions of moral hazard, transaction costs and adverse selection. as a solution, contracting has been shown to have limited value owing to outcome uncertainty and measurability. this is because the tasks of the brp are non-programmable and term-dependent. the findings provide filing directors, shareholders, creditors, regulatory authorities and brps in this newly instituted regime, with enhanced understanding of how the relationships manifest in practice and overcome the non-contractibility of the newly formed relationships. key words: business rescue, conflict, turnaround, agency dilemma, auto-ethnography jel: d74, 23: 1 introduction meet john and jane. last week they were the decision-makers in their seven-year-old business, with a turnover of r10 million ($1 = r15.5) per year. they believed that their business was viable and had recently appointed a new manager. today they are the powerless audience for a business rescue practitioner (brp) who is controlling their business and making “illogical” decisions. it seems, in this nightmare, that they are going to lose everything they have worked for so hard. how could this have happened? this is their story as participants in a show that they are now watching from the sidelines, powerless to intervene. when both their lawyer and their accountant proposed business rescue as an option for addressing the financial distress of their business, this is not what they had understood the process would be like. “filing voluntarily for business rescue under the new act will protect the business from uncooperative creditors till you can solve the problem”, is what they were told; now this has turned out to be an empty promise. they had understood the process to be: file for rescue with the regulator through the prescribed process, appoint a brp (expert), obtain the moratorium as protection under the act and let the brp sort out the problem. there was a prescribed hourly fee for this. it had been fourteen days since they started the process. the lawyer drove the prescribed filing process while they searched for a brp. this turned out to be a somewhat chaotic process. how could they know whether the brp they had chosen would have the relevant competencies? what options did they have other than to search marketing brochures and websites, investigate reputations and follow up on various references from their accountant and lawyer networks? the list of over 200 licensed brps provided by the regulator contributed little information and actually added to a data overload, hampering their choice. after shortlisting three possible candidates, interviewing each one and scrutinising the different contractual agreements they proposed, the five-day time pressure from filing to appointment forced them to make a quick choice of brp. the decision as to whom to choose abstract 480 sajems ns 19 (2016) no 4:479-496 was finally swayed by a brp with hourly fees lower than those prescribed by the act, rather than opting for a staged success fee. this would mean that the brp would present the plan after saving the business. the successful candidate professed that he wanted to save their business and protect their interests and employees optimally. basing his statement on his experience, he was certain there was a reasonable prospect of saving the business if they acted quickly. after the licence was granted to the brp by the regulator, john and jane underwent severe interrogation from the brp and his staff, during which they disclosed everything while fending off severe demands from creditors. they attended the first creditors’ meeting, where it dawned on them what had really happened to them. when they reflected on some of the statements the brp had made to the creditors, such as: ‘i (as the brp) have taken full control of the bank account and operations and will make all the decisions. i believe that there is a reasonable prospect of overturning the damage done by management (who now report to me) and saving the business. however, if this does not work out, there should be a better return obtained for creditors and shareholders than during liquidation. john and jane’s disillusionment about the process and the future of their business reached a new low when they left the meeting. even after contracting with the brp, they now realised they had none of the “powers” they believed they had captured in the contract. the complexity of the above narrative may appear chaotic to insiders and outsiders alike, probably because of the liability of newness of the business rescue regime. what appeared to be legislation to assist debtors and protect employees and the economy seems not to have materialised. conflict among the debtors, creditors, practitioners and affected parties is the order of the day. given all this, how should john and jane proceed? a chinese proverb states: if you must play, decide on three things at the start: the rules of the game, the stakes and the quitting time. directors who file “voluntarily” for business rescue in their businesses have to specifically understand the effect of the legislation (which constitutes the rules of the game) on their rights (stakes). creditors seem to understand the rules and stakes very clearly, while the regulator (cipc) has a specific interest in the practical consequences for the rescue regime, as unintended consequences may signal a quitting time (revision of the act). brps have to choose whether they still want to play once they understand that the standard agency theory is rendered irrelevant owing to a change in the rules of the game (legislation). this paper aims to understand more fully how the legislation moderates the resulting relationships. i look through the lens of “agency theory” (explored later) to explain the various actor dynamics. section 129(1)a in chapter 6 of the companies act 71 (2008) in south africa (hereafter the “act”) obliges directors of businesses to file for business rescue proceedings when their companies experience financial distress. br portal (2013) reported the reputation of business rescue as being a regime acting as a critical scenario driver, as it appears to dictate the overall rescue industry’s future. currently, the industry is tainted with conflict and allegations of abuse and a high number of rescues that end in protracted court battles. weyers and elliot (2014) report on the associated abuse in the br legislation, which adds to the conflict. appointing someone (believed to be “your” agent) to lead the rescue of a distressed venture, is, therefore, an immensely important decision. accordingly, practice shows high levels of conflict between brps and creditors about goals, interests, incentives, neglect, processes, outcomes, fees and costs. it appears that the elements of agency relationships do exist, but they are uniquely modified when entering formal business rescue to render several quasi-agency relationships. this study aims to investigate how these elements manifest in practice and the associated consequences, in line with the call by thrahms, ndofor and sirmon (2013) for future research into agency relationships in turnaround situations. this paper expands the existing theory (colquit & zapata-phelan, 2007) on the agency relationships by demonstrating how legislation moderates their manifestation in practice. the paper also briefly summarises the relevant aspects of the new act and its dictated obligations and rights to the affected persons involved. secondly, it reports concisely on the sajems ns 19 (2016) no 4:479-496 481 relevant key aspects associated with the agency phenomenon as generally known and understood, in order to use it as a framework (lens) for the research analysis. it focuses on what is manifested in practice and does not seek compliance with the legal aspects and correctness associated with chapter 6. it then presents the researcher’s role as that of observer-participant within analytic autoethnography as the research methodology. fourthly, using the agency lens, it describes three “quasi” agency relationships brought about by the legislation. it then presents a framework that describes the development of the subsequent dominant relationship and thereafter reports the consequences with narratives and a comparative outlay of the elements. finally, the paper presents the underlying boundary conditions for how the relations manifest in practice and describes why contracting is not a solution for addressing the associated conflict. 2 research questions currently, the cipc, as regulator of the rescue industry, is inundated with complaints about each other from directors, creditors and brps. interviews conducted with parties affected directed the researcher to investigate the agency relationship as it manifests under the business rescue regime. the associated conflict in the relationship was used to gain insight into the practical manifestation of the relationship. the research questions are thus: 1) how are the agency relationships moderated during business rescue? 2) what are the consequences? 3 background of rescue, rescue practitioners and creditors this paper aims to address the practical problems in a young industry and to build theory for industry actors. this section briefly summarises for the reader the context of business rescue, introduces how conflict develops and contextualises the rescue industry. this leads to the research questions. under chapter 6, business rescue prescribes specific obligations for directors, practitioners and creditors. the act sets out complex obligations for these parties. while chapter 6 does acknowledge, and indeed intends to address, the need to balance the interests of affected persons (loubser, 2013), the practitioners are ultimately the executors of the process. despite the guidelines in section 7(k), this execution is subject to the agency dilemma that exists while they are taking managerial and financial control (in practice) of the distressed business. bradstreet, pretorius and mindlin (2014) confirm this when they state that the legislature, instead of dealing with these problems in the text of chapter 6, has instead “dumped” them on the office of the practitioner, which means that the brp and the bank consequently become opposing parties. while the act attempts to balance the relationship in the so-called “debtor friendly” regime, the practical power distribution has resulted in conflict becoming a reality and rescue success an uncertainty. applying the act leads directly to the following interpretations relevant to the agency relationship: • directors are obliged to file for business rescue if the business experiences financial distress (s 128(1)f). one aspect of the prescribed voluntary filing process entails the selection of the brp. • after appointment and licensing, the brp takes managerial (s 140(1)a) and financial control (in practice) of the business. • the brps must provide for the efficient rescue and recovery of distressed companies …. (s 7(k), investigate the affairs and report their belief that there is a reasonable prospect of saving the business by reorganisation (s 141(1)). alternatively, if a better return than immediate liquidation could be achieved, it should/could be pursued (s 128(1b)(iii)). if none of the above is possible, the brp must file for liquidation (s 141(2a)(ii)). 482 sajems ns 19 (2016) no 4:479-496 • both reorganisation and better return options depend on a rescue plan that is presented to the creditors, requiring a supporting vote of at least 75 per cent (s 152(2)). bradstreet et al. (2014) report that without the support of creditors, particularly where the bank is a majority or significant precommencement creditor holding security, any attempt by the practitioner to mediate between all the affected parties could become futile when such creditors lack faith in either the brp or the procedure itself. it would, of course, be unreasonable to expect a creditor to have faith in a dubious business rescue application or brp appointment, but when other affected persons, or particularly a debtor company, makes a bona fide rescue attempt, it would be a shame for uncertainty to be the impediment to creditor co-operation. creditors are categorized with affected persons, including shareholders, employees and unions (s 128(1)(a)), with a voting interest (s128(1)(j). this vote gives creditors the power to support (or not) the rescue plan compiled by the brp (snyman-van deventer & jacobs, 2014). the powers associated with this vote have proved to contribute to the conflict between brps and banks. this conflict in the various agency relationships is explored in the next section. 3.1 agency theory agency theory (also known as the principal-agent dilemma) is an established theory and has been a dominant paradigm since the 1990s (hill & jones, 1992). it is briefly described in this paper as benefitting the uninformed reader. an agency relationship is a contract whereby one or more persons (principals) engage another person (agent) to perform some service on their behalf, which may involve delegating some decision-making authority to the agent (jensen & meckling, 1976). a relationship, which could be a contract, is constituted as a result. agency theory added the “agency problem”, which occurs when seemingly cooperating parties to the relationship have different goals and different divisions of labour (eisenhardt, 1989; kulik, 2005). agency theory is maintained by three underlying assumptions. first, people are selfish, have restricted rationality and are risk-averse. secondly, there are goal conflicts among the stakeholders of the organisation. finally, information is a commodity which can be purchased (eisenhardt, 1989; mehrotra, 2011. if both parties are utility maximisers, there is good reason to believe that an agent will not always act in the best interests of the principal (jensen & meckling, 1976), lui, 2011). agency theory, therefore, suggests the potential for “mischief” when the interests of the principals and agents differ (nyberg, fulmer, gerhart & carpenter, 2010; lui 2011). it is this mischief that requires better understanding. the cornerstone of the agency problem is the assumption that the interests of the principal and the agent diverge (hill & jones, 1992). while contracting is the way to address the divergence, conflict in such relationships persists, even in the face of the contracting. fundamentally, the conflict arises from self-interested behaviour, bounded rationality and risk-aversion (eisenhardt, 1989), which underlie human assumptions, resulting in goal conflict. it appears that, in the business rescue context, the agency dilemma arises uniquely, despite the legislative obligations on parties to the relationship, as will be explored later. agency theory attempts to address two main problems: the conflicting goals of the principals and the agents and the difficulty for the principal in verifying or authenticating the agent’s actions (eisenhardt, 1989). this was demonstrated by john and jane’s perceptions as discussed in the introduction. the agency problems occur because the agent is not risk-neutral (mehrotra, 2011). imperfect information (hidden action) and misaligned incentives (hidden information) result in the fear that agents may pursue their own interests (lui, 2011). hence, in the face of the risks which agents face, there will be conflicting desires and it will be difficult to verify the agent’s actions in the light of whether they were in the best interests of the company. the principal-agent theory is useful for determining the most efficient contracts for aligning the interests of both the principals and the agents (lui, 2011). agency theory is therefore the chosen lens through which all the relationships in this paper are judged. sajems ns 19 (2016) no 4:479-496 483 the agency problem of inducing the “agent” to behave as if he were maximising the “principal’s” welfare, is quite general. it exists in all organisations and in all cooperative efforts (jensen & meckling, 1976). it contains two elements: moral hazard and adverse selection. moral hazard is the choice taken by an agent to pursue the needs of the principal. the agent has the resources, the information and the powers to do so, but chooses against this for various reasons, which originate from divergent goals. adverse selection means that the principal does not have the financial resources, information or knowledge to screen the agent before appointment, despite wishing to do so. the principal faces this risk, and throughout the vetting process needs to assess the agent’s ability to execute the contract. the literature (dominated by articles from 1970-1990) demonstrates the core conflict characteristics/issues associated with principal-agent relationships, including: goal difference, risk orientation (seeking vs aversion), information asymmetry, adverse selection, moral hazard, information systems and incentive types (outcome vs behaviour-based contracts). contextual issues of relevance that may moderate the characteristics are part of the interest in this research, as it appears to render agency theory non-existent despite several of its aspects being apparent in the quasi relationships. 3.2 the nature of agency conflict conflict appears to be a natural by-product of agency relationships and leads to tension. in this paper, i use conflict in alignment with webne-behrman’s (2009) definition, which refers to disagreement between parties that escalated to being perceived as a threat to the needs, interests and concerns of the parties. the key notion is that it is perception-based and underlies the existing tension. 3.3 the dominant moderations to the apparent agency relationships under business rescue in a general agency relationship, the decision-making process is in the hands of the professional manager as agent, whose interests are not necessarily identical to those of the residual claimants (fama & jensen, 1983). in business rescue, a brp is obligated by the act and is held accountable for all the decisions to be made in the organisation under rescue. ownership is not transferred to the brp, only custodianship. hence, the separation of “ownership” and “control”, more precisely, the separation of residual risk-bearing from the decision-making functions. the brp, as officer of the court, makes the decisions but does not bear any direct financial risk in the event of the company closing down. the brp has the functions of an agent but “being an agent” is questionable, considering the above role of the court. imperfect information generally arises for the appointed agent because the act requires independence (s 138) from previous involvement with the filing company. the directors (who believe themselves the principal) who file have full information. the bank, which has the powers of a principal, and which has a history with the company, has information (but of a different nature), while the brp has little information and is tasked by the act (s 141) with investigating the affairs of the company. general conflict, which results from the relationships, gives rise to the non-sharing of information, so there is imperfect information or information asymmetry. the term transaction costs in business rescue generally refers to the fees of the brp, the incentives, the direct costs in the execution of duties, the cost of expert investigators used and the specialist advisor costs, such as legal contingencies. the brp’s costs take priority over the claims of all the secured and unsecured creditors (s 141 (2)(a)) if reorganisation/rescue fails and the end result is liquidation. thus, in the event of the company being liquidated, the brp’s costs are paid first. brps do face reputational risk in the event of disagreements and potential objection and removal by any “affected person” under section 130. this may result in the loss of future appointments. failure to implement the proposed rescue plan may further tarnish relationships with key players in the industry, such as revenue services, banks, suppliers, customers and 484 sajems ns 19 (2016) no 4:479-496 investors, among others. in terms of the separation of ownership and control, the agency problem is controlled by decision systems that separate management (initiation and implementation) and control (ratification and monitoring) of important decisions at all levels of the organisations, in line with fama and jensen (1983). how do the principals (who, in practice are really the banks as creditors and not the appointing directors) control the agency problem in the business rescue scenario? 4 moderation effects a moderator, in this text, refers to the presence of a factor or a moderating condition that alters the relationships between elements when it is present or introduced. moderating effects refer to the variation in outcomes (directional deviations) of the elements as a result of the presence of the moderator. such effects on the elements include a variation in importance, relevance and manifestation under the introduced condition. such variations bring about various consequences for the environment. classic agency relationships exist at different levels in businesses that perform well, such as a healthy going concern. a ‘new’ act came into effect in 2011, which is the moderator / moderating condition in this study. once a business has filed for rescue under the act, the presence of the moderating conditions alters the relationships between variables (the elements of the classic agency relationship). moderating effects can be observed in how the elements respond to the presence of the moderator. in this instance, the focus is on goal conflict, information asymmetry and systems, risk approach, adverse selection, moral hazard and transaction costs. 5 research methodology table 1 explains the research design in a summarised format, followed by an extensively detailed first person account of the execution of the analytic auto-ethnographic (aae) study. table 1 research design components based on the adapted design description by yin (2003) component description problem when directors (as principal) voluntarily file for business rescue, they practically lose total control of their business to the brp and ultimately the creditors. they end up with little or none of the expected benefits when they filed. tension within the altered agency relationship develops during business rescue. it appears that the “standard” agency relation is modified as a result of legislative obligations. research questions how are the agency relationships moderated? with what consequences? research aim to better understand the interrelations and level for action created by the moderating effect of the legislation. agency theory is the lens for the investigation. context business rescue regime that is young and developing. propositions* 1. the agency relationship is fundamentally moderated under business rescue legislation. phenomena investigated primary — agency and perceived agency relationships. secondary—issues/elements associated with the manifested relationships. unit of observation industry role players, including directors, brps, bankers working with business rescue in their organisations and affected persons. methodology analytic auto-ethnography. logic linking the data to the propositions brps and bankers are the determining agents and principals in the practice relationship under the act. their conscious and unconscious cognitive arguments/motives to pursue their goals can inform how the new relationships unravel. making sense of their lived experiences could lead to a conceptual framework for understanding how the agency relationship is moderated in the business rescue context. if contracting is not a viable solution to this relationship, alternatives can be proposed. criteria for interpreting the findings differences from and/or manifestations of the agency dilemma as reported in the mainstream literature. * the propositions were set purely to structure the research process and support the research question. sajems ns 19 (2016) no 4:479-496 485 6 context of the research the project started with action research, as it addresses a practical problem triggered by conflict within the industry. as i wanted to make sense of the lived experiences of actors, i used my own turnaround experiences and previous research and applied analytic auto-ethnography. i wanted to make sense (berniker & mcnabb, 2011) of moderating effects and to propose a framework that may lead to guidelines for role players. this therefore involves description (of issues) and understanding (causality), but mainly sense-making and interpreting the multiple narratives describing the experiences. table 1 condenses the thinking underlying the research. i chose a multiple-source setting, because it accumulates extreme contributions from various contexts and examining these extremes may be helpful, because reasons for differences often only become clear under extremes/under extreme conditions (mcclelland, 1998). the unique qualities of this industry make this setting ideal for direct theory building (yin, 2003), “because the dynamics being examined tend to be more visible than they might be in other contexts” (pratt, rockmann & kaufmann, 2006). 7 researcher qualities in analytic auto-ethnography, the researcher plays a dominant role. therefore, in attempting to answer the research questions, i was aware of my own methodological values, beliefs and philosophical assumptions. these assumptions could influence how the research was conducted and are stated in order to understand the ‘intellectual climate’ in which the research was conducted. the theory of knowledge (epistemology) of a researcher describes how one can discover underlying principles about social phenomena and how one can demonstrate knowledge. from my personal experience with critiquing strategies for businesses and taking the role of devil’s advocate when doing so, the research process emerged naturally. during the research, i was further influenced by the role that i have come to play as a strategy consultant when facilitating strategic critiques and analyses to guide company boards and management: that of the “devil’s advocate”. being the devil’s advocate depends heavily on challenging conventional thinking, assumptions, reasoning, accepted principles and rules. i do this deliberately by applying aae as a technique. the end result of such a process is often a framework that depicts the key issues that integrate the context and the problem addressed. i therefore applied the same reasoning to understand and interpret the moderating effects when i identified them. it is important to clarify that i have an informal agreement with the regulator not to apply for a brp license in order to maintain independence in the industry, which allows for neutral research, such as the industry status quo report (pretorius, 2015). at the same time, as an academic and experienced turnaround consultant, i have a preference for factual directives. to mitigate my biases and subjectivity, an aae in the interpretivist philosophy was applied to capture the issues, perceptions and experiences after systematic reflection on each of the “actor cases” to establish the moderating effects resulting from the legislation. a researcher’s ontological position comprises his/her view on the very nature and essence of the research reality. i am an objective realist who believes that knowledge comes from the facts associated with real-life cases and their context. thus, proper research methodology is crucial for eliciting insight from such facts. as a positivist who is forced by the context of my research field to conduct qualitative research, i embarked on this research design with caution, focusing on delivering trustworthiness. while every individual element may be unique within its own context, when i found repeated appearances of issues and relationships covering the cases, i could “generalise” from them. my interest was mainly in identifying directives to guide those who depend on my opinion as a researcher in business rescue. 7.1 data collection procedures i recently completed research for the regulator on the state of the rescue industry. it involved interviews with brps, banks, directors who filed, academics working in rescue, staff of the 486 sajems ns 19 (2016) no 4:479-496 regulator, lawyers and accountants working in the field. i also held a public workshop and ran three different surveys. i considered the issues in general and then those relevant to specific cases of individual subjects, making conceptual notes that i captured on an ipad because of its quick and easy accessibility. like dyson (2007), i sought new understandings rather than the truth only. 8 analytic auto-ethnography (aae) and data collection i pursue an analytic auto-ethnographical approach (fine, morrilli & surianarain, 2009). anderson (2006) identifies five key features of aae and i follow closely the process described by venter and de villiers (2013): firstly, “complete member researcher” status; in other words, the researcher is a complete part of the social world under study (anderson, 2006). specifically, membership of a particular social group precedes the decision to conduct research on the group. i was involved with turnarounds in various forms for over 20 years before starting this study. the catalyst for the study was the unprecedented number of requests for advice from role players for my “independent” opinion as an academic researcher. i realised from my own perspectives that i should “take stock” of what is happening. this allowed me not only to record events i had experienced and conversations in which i had participated since becoming sensitised, but also to reflect on ongoing events. i spent a period of approximately two years, starting in october 2011, collecting data as an analytic ethnographer. this included observations from my day-to-day experiences, as well as the collection and analysis of a number of conversations ranging from informal to formal. in terms of the four categories of observer described by gold (1958), namely complete participant, participant-as-observer, observer-as-participant, or complete observer, i can best be described as an observer-participant. secondly, aae is characterised by analytic reflexivity. as an observer member researcher, as opposed to an ordinary participant observer, a researcher has more interest in the beliefs, values and actions of other participants (anderson, 2006). in fact, “auto-ethnographic interrogation of self and other may transform the researcher’s own beliefs, actions and sense of self” (anderson, 2006). i found this to be true in this case. while i was immersed in the sense-making process, my role as auto-ethnographer transformed my views of my perceived status quo. during the process, as the observer participant, i became increasingly aware of the lived sensitivities of participants in the rescue process. this also led to occasional role conflict (observer versus consultant), but, as an academic, i had to continue. this process led me as observer-participant to gain a sense of perspective and additional data and insight. thirdly, it is acknowledged that aae takes into consideration that the researcher’s own feelings and experiences would be incorporated into the text and are considered to be important data for understanding the social phenomenon under review (anderson, 2006). such a process should be devoid of “self-absorbed digression” (anderson, 2006) and it is imperative that an autoethnographer engages with others in the social worlds they are trying to understand. the fact that i was enacting participant and researcher (observer) roles, fostered helpful and unique perspectives. in addition, i compared the data and findings during interviews, with formal research results (pretorius, 2014b). fourthly, aae is based on dialogue with informants beyond the self in order to guard against “self-absorption” (anderson, 2006). analytic auto-ethnography is based on self-experienced evidence, but it also reaches beyond it. in this regard, anderson (2006) argues that in-depth interviews are a useful tool. as an additional step, once i had gained preliminary insights for the framework, i tested its elements by means of structured questionnaires (descriptive) during the workshops, as well as those of my masters and phd students. during this phase of the data collection, i took on the role of observer. the triangulated data sources and research design increased the trustworthiness and credibility of the research, because it enabled checking and rechecking the data and analysis among several different sources (own observations and insights, interviews and surveys) (yin, 2003). thus, i was sajems ns 19 (2016) no 4:479-496 487 able to mitigate tendencies towards fundamental attribution error, inherent cultural prejudice and self-fabrication (woodside, 2010). finally, aae calls for a commitment to an analytic agenda. anderson (2006) uses the word analytic “to point to a broad set of data-transcending practices that are directed towards theoretical development, refinement, and extension”. this distinguishes analytic auto-ethnography from evocative ethnography or first-person narrative. in this paper, my own observations on the moderating effects lead to a better understanding of broader social phenomena elucidated through institutional theory. 8.1 data analysis once the elements had been identified, i converted them into the three narratives. the appointing director narrative (john and jane) has already been offered in the introduction. thereafter, the elements were structured in a framework. elements were framed as a diagram depicting role allocation during the process of business rescue (see figure 1). table 2 reports the analysis outcome and describes how the elements relevant to agency relationships differ for the perceived principals and agents. the research style was initially exploratory but also explanatory, to identify and describe the issues and how legislation moderated them. eventually, after understanding how components relate and to make sense of the issues, i then asked a senior practitioner with banking experience and a regulator official to read the narratives and confirm their accuracy. this served as “member checking”. 9 findings writing the actor narratives allowed me to include and express the most recent and urgent issues that came to my attention. seminal issues that repeatedly surfaced became readily visible. the quotations used in the narratives are from the subjects and are used to enrich the trustworthiness of their lived experiences. i could write from an unbiased perspective with a neutral stance as i had heard all sides of the story and was impartial. this allowed for reporting the lived experiences in real time. in this section, i first extend the narrative of john and jane, who appointed the brp. next, i present the narratives of apparent principals and the agent as perceived in practice. this addition completes the triad of key actors in business rescue. thereafter, i describe the moderated agency relationships framework (figure 1) and present the different elements for the triad (table 2). 9.1 the directors’ extended narrative extending the opening narrative of john and jane, the following can be added. keeping in mind that le roux and duncan (2013) had already reported that small business owners had limited knowledge of business rescue legislation. their directors and shareholders alike are generally under pressure (from creditors and otherwise under the act) when selecting or being advised to pursue voluntary rescue (s 129) and resolve to file. their situation forces them to become risk seekers (kahneman, 2011) when they file. mostly, they believe (and hope) that there is a reasonable prospect of saving and reorganising the business in the face of the financial distress. at the same time, they believe that the brp they select will pursue the rescue with consideration for their own interests and goals and , while they have several obligations, filing for business rescue effectively has stripped them of all their powers and rights (gribnitz & appelbaum, 2014), to the extent that they have become an audience to their own “play”. often, on realising their status, they resort to covert tactics that oppose the actions of the brp. in severe cases, where their previous actions (sometimes unlawful) are exposed, this often leads to deliberately undermining the efforts of the brp. within a short time, the brp becomes the enemy of the directors and they blame him/her for being a “servant of the creditors” and even for being responsible for the demise of their business. 488 sajems ns 19 (2016) no 4:479-496 9.2 the practice (new) principal’s narrative meet petra. she is the banker responsible for this account after rescue started. someone else was the relationship manager as bank representative when they financed the business with a loan and contracted strict payment conditions as determined by the bank. at the time of filing, we (banks) know that the business has gone past the point of no return unless new finance is granted, which we are reluctant to allow. we refer to it as the “first cut is the last cut”, as we do not want to throw new (good) money after old (bad). previous management could not address the business’ problems, “so what makes the newly appointed brp think s/he can do it anyway?” this will probably raise the bank’s risk and exposure, thereby opposing our “goal and mandate”. it all has to do with our overall institutional goals, which are associated with risk:return ratios (risk aversion). after all, “banks are businesses too”. “brps therefore blame us (the banks) for being pro liquidation and entering the rescue with “predetermined goals”. the bank was therefore a loan principal to john and jane (loan agents) during the pre-rescue period when they were not distressed, albeit it may have been only for a portion of the total loan capital. bank contracts and securities are, for the most part, failure proof during this phase. john and jane reported financial information within the confines of the debt contract, fulfilling the role of agent while their business was not in financial distress. by virtue of the bank’s historical involvement, the bank believes and argues that, when directors file, they (the banks) have already exhausted all the possible remedies (financial restructuring) for saving the distressed business, so the last resort for achieving solvency is to infuse post commencement finance. also, as banks appear to have unlimited resources, they prefer the legal route (legal orientation) to curb brp actions, and are thus seen to be forcing the brp into the “underdog” position, disempowering the agent’s freedom in decision-making and “manipulating” the intended agent role. as there is a large divide between the interpretation and determination of reasonable prospect, banks typically perceive the brp’s ability to navigate a successful reorganisation as suspect. they ask: “how long will he take to see there is no prospect?” this perception of incompetence is infused with the brp’s time constraints, access to information and so-called “calling” (hope) to rescue the business. bankers specifically highlighted the brp’s inability to cooperate and communicate, along with an absence of empathy for the opposing view. this aggravates the perception of incompetence. practice research shows that banks respond to early warning signals long before directors do and they institute measures (mainly financial restructuring) early in the decline. by the time brps are appointed, most of the avenues to accessing any potential “slack” in the form of free assets (smith & graves, 2005) have often been exhausted. the competence requirements for performing the navigation assignment of a brp give some insight into the differences in perception between principals and agents. the brp is required to determine the “best future position” for the distressed business to pursue. after investigating the affairs of the business, the brp has to determine what this best future position is, include it in the rescue plan and obtain a majority vote (75 per cent+) by the creditors. if there is disagreement on the reasonable prospect, this agreement is hardly possible and therefore seems to be at the heart of the conflict. no easy and generalizable measures to determine whether there are reasonable prospects of rescue are agreed on, as different banks and brps claim these as their potential competitive advantages. unfortunately, at this point the brp has been appointed and unless the bank is willing to spend resources, the brp can be removed by means of a legal process (s 139). even if brps are not perceived as incompetent, subjects from banks suggested that the intention of the brp is doubtful and questionable. if there is no prospect, the only possible reason for not pursuing liquidation must be that the brps are “writing fees” (incentives) for as long as they could. bank subjects feel that brps know there is no prospect (because banks know it) but act unethically (moral hazard) in pursuing the so-called better return alternative allowed for in the sajems ns 19 (2016) no 4:479-496 489 act. brp remuneration (agency costs) is a contentious issue, as bank subjects indicate this to be the main malpractice by brps who extend prescribed periods in the process. the “longer the rescue goes on, the less the security of the banks is protected”. brp fees (remuneration) and costs incurred during rescue take priority over the secured claims in the eventual liquidation. 9.3 the brp as agent’s narrative meet gerry. i only take rescues i think could work. the directors need my knowledge and expertise to pull this one off. without me, they stand no chance, so my contract with them contains fees as prescribed, costs, consultant fees and a success fee. john and jane know it was their poor decisions that got them into trouble, so if the company cannot afford it, they must foot the bills in their personal capacities. anyway, i take financial control, so i “make the payments when i think it important”. the least of my problems as brp is the directors; rather, the problem is the bank. the power of the banks is lopsided compared with that of the brp, despite no contracting at any stage. holding the voting power, banks close all the facilities immediately after filing or alter the conditions, such as factoring collections to benefit them – thus leaving us (the brps) “powerless without the cash to continue basic operations”. if they advance any monies, “they consider it as post commencement finance (pcf),”thereby changing old credit to pcf, which has a higher priority in rescue. banks renege on their promises and agreements about pcf and support. they do so by extending loan periods and altering recoveries to benefit “factoring”. cases have been reported in which banks renege on supporting the rescue plan as they arrive at the second creditors’ meeting, despite supporting it during the negotiations. the brp knows that blaming the previous management (at the first creditors’ meeting) for the distress assists him in appearing knowledgeable and gathering creditor support – one thing they have in common with the bank. the brp takes management control of the business on appointment and therefore becomes executor (agent) to the contract. the final decision-making rests with the brp until voting for the rescue plan takes place. despite this dominant position relative to the directors as “appointing” principal, the brp “takes the underdog position” in the new agency relationship established with the practice principal, as the “banks are notified of new filings before anybody else”. this information asymmetry benefits the bank, as it has access to critical financial information, which it does not share under the “excuse of confidential information protected by bank-client privilege”. thus, the brp faces the liability of information “confidentiality”. this further entrenches the practice principal in the power position. furthermore, “banks continuously demand information” from us while “they have more than we brps have” and it takes time to gather sufficient data to make a decision on the reasonable prospect. at the same time, we need to spend additional time answering their queries and are then blamed for “inflated fees”. brps believe that banks prefer liquidation, as it is “best for the bank’s security”. alternatively, they want to see a rescue plan ensuring that their assets are protected. brp subjects often maintain that “banks are over-secured most of the time” by a factor of three. banks come to the creditor meetings and inform us that they will vote against the plan. brps depend on their reputation for future appointments. they will therefore do almost anything to protect their “name in the industry”. to pursue a better return than is found in liquidation as an alternative to reorganisation is an option that is easier to pursue and even incompetent brps can do so by pursuing simple extended debt restructuring plans or by selling assets similar to those in liquidation. typically, this absence of a turnaround intention is negatively considered by the banks. thus, bank subjects equate the choice to pursue better return rather than reorganisation with brp incompetence and lack of turnaround intention, despite its being an alternative within the act. this issue relates to brps being blamed for not performing at the required standard, which in itself is a vague issue. brps ask why this is so. 490 sajems ns 19 (2016) no 4:479-496 figure 1 depicts the comparative status changes of role players (perceived relationships) under the conditions brought about when chapter 6 voluntary filing is affected. three relationships of relevance for this study are affected. first, the initial director-bank relationship (can be multiple principals) that governed the loans before filing comes to an end. secondly, the appointing directors-brp (principal-agent) relationship changes to effectively eliminate the appointing directors from the relationship. finally, the practice creditor-brp (principal-agent) relationship comes into existence. this specific relationship is the one that will drive the industry, as will be shown. the appointing director-brp relationship is explained, but the focus of the remaining discussion will be on the practice principal-agent relationship. figure 1 perceived agency relations that come into existence during the transition from a going concern to a business in rescue under chapter 6 (own compilation) companies act 71 practical moderating effects a.r.o business rescue legislation g o i n g c o n c e r n liquidation director p creditor (principal) a brp (agent) director (perceived principal) chapter 6 regulator insolvency act master 1 2 3illiquid perform well d e c l i n ed i s t r e s s f a i l u r e insolvent decline the directors (appointing principals) appoint the brp (agent), who effectively brings an end to their rights and powers (unknown to them at the time) but not their obligations (gribnitz & appelbaum, 2014). this effect is directly contradictory to that found in the us chapter 11 debtorin-position situation, as the directors’ roles become subject to that of the brp in decision-making under chapter 6 (mindlin, 2013). the practice principals (creditors and the banks) are given formal rights (over and above protection of their investment) by the act (gribnitz & appelbaum, 2014) to pursue their goals and informal powers (voting interests) to govern the brp (inherited) and, specifically, the proposed rescue plan. the constructed narratives provide rich descriptions of the changes in and conflict points of the quasi agency relationships. within each narrative, the quotations from the different subjects act to support the sense-making. 9.4 the consequence of the moderating condition one key consequence of legislative change is the extensive conflict that initiated this research. associated with this conflict, if not resolved, is declining trust, more blame, more opposition to the other party, installing systems to block opposing decisions, legal challenges and more, but the worst for the brp is the lack of support at the vote. the banks are in a better position and growing sajems ns 19 (2016) no 4:479-496 491 in power during the process, as they have more resources than the distressed company has to pursue legal avenues. the consequences of the conflicts and actions are interwoven within the discussion of the findings that follows. the quasi principal-agent relationship (between creditor and brp) under chapter 6 voluntary filing brought to light several additional complexities. first, the practice principal (banks as creditors) suffers total adverse selection, as the directors appoint the brp. as creditors, they inherit the appointee and, while they can oppose the appointment by means of a court application (s 139), this seems to occur only irregularly and is both costly and time-consuming. it appears that banks take the decision not to cooperate if the brp is considered weak. second, by controlling all the financial access to short-term finance and pcf, the banks control the transaction costs associated with the agency relationship. this is a major factor contributing to the conflict. third, despite the practice agent (brp) being given many obligations and powers, a brp’s task of proposing a rescue plan for the vote is ultimately governed by the practice principal. significant conflict underlies the opposing views between practice principals and agents, although, in the end, the agents appear powerless and subject to the narrow views and goal centrism of the practice principal. table 2 summarises the element manifestations for the appointing and practice principals, as well as for the agent after filing. it covers the elements (variables / characteristics) used to describe a classic agency relationship. table 2 effects on agency perceptions in business rescue driving the conflict within the relationships agency element directors brp bank perception in practice perceive / believe themselves to be the principal by appointment. assume the role of agent perceived to have the powers of a principal in practice. goals, goal difference / expectation / conflict to save the business and own capital (if shareholders). to successfully execute the rescue and protect reputation (future income stream). to protect the invested capital at the lowest risk while remaining “independent”. risk orientation become risk-seeking when filing in the face of adversity and uncertainty (kahneman, 2011:315). risk averse to protect reputation. risk averse to protect security. cannot be seen to be part of the br decision process other than the vote. information asymmetry full information of the venture distress but deficient on legal process and consequences. potentially deficient on causality. information deficient and largely dependent on appointing principal and own ability to analyse and make sense. suffers time implication to investigate properly. historical, financial and managerial behaviour information based on banking verifiers (pretorius & holtzhauzen, 2013). will exploit the asymmetry to maximise own interests. information systems to authenticate the agent actions desperate need for control system but unable to achieve under chapter 6 (see rights). not supported, as it inhibits autonomy. prefer opposite. no need – has own verifier system and historical records of behaviour. demand continuous information from agent. adverse selection suffer from hidden information about the agent (shapiro, 2005:243). benefit from “despair” of appointing principal. inherit the agent from the appointing principal actions requiring high cost to reverse. moral hazard depend on it as only “useful” contractual model. depends on individual ethical values. assumes/expects the agent will do the right thing. reputation determines bank support. transaction costs / incentive agree to almost anything. negotiates fee structure and outcome (success) remuneration – sometimes exorbitant. opposes what is termed “exorbitant costs”. reason for entering the exchange held for use (kahneman, 2011:294). held for exchange (kahneman, 2011:294). held for exchange. goal centrism to protect business and personal investment. to completely successful rescue. to protect investment at lowest risk. reference point equity saving. success reputation. security protection. rights allocated in act no rights after filing (gribnitz & appelbaum, 2014). 24 37 obligations prescribed in act 206 583 7 potential bias escalation of commitment. 492 sajems ns 19 (2016) no 4:479-496 10 discussion of findings, key theoretical components and insights from the study the research set out to understand more fully the moderating effects of the new legislation and explain its consequences for the industry, especially the regulator but also the future principals and agents in practice. to enhance meaningful coverage of the findings, this section deliberates each aspect of the findings as they appeared during the analysis process and uses the elements of classic agency theory as its lens. the findings, the first in this field, are then elaborated and explored for improved understanding to guide the proposal of a framework for agency relationships that unfold in practice under business rescue. 10.1 boundary conditions created by the moderator based on the differences described in table 2, the moderating condition (when under business rescue in chapter 6) is characterized by several drivers that influence the consequential principalagent relationship in practice. each condition may lead to several outcomes, which, when present, influence the participant’s willingness to contract. these are now explored: first, there is “outcome uncertainty”, as the industry success of business rescue is punted at approximately 5 per cent (loubser, 2013) in the us and at 9.4 per cent in south africa (pretorius, 2015). with uncertain outcomes, the agent is less willing to contract, especially when the uncertainties originate from mostly external factors. second, associated with uncertainty is the “outcome measurability”, which is not determinable, as the act provides for two possibilities, reorganisation (s 128(1)(b) rehabilitation) or pursuing a better return than that in immediate liquidation (s 128(b)(1)iii). the act also provides for compromise (s 155); alternatives such as sales, mergers and takeovers may also be relevant as potential measures of outcome success, as they conserve jobs and benefit the economy (pretorius, 2015). outcome measurability that is difficult to define diminishes parties’ willingness to contract. third, if “task programmability” is low, particularly as in the case of business rescue, then agents are unwilling to contract their behaviour while principals are generally insufficiently informed about the tasks. pretorius (2013) identified 17 activities culminating in five tasks associated with the brp. the act, in s 140, explicitly identifies four broad tasks for the brp that are all subject to low outcome measurability. fourth, the duration of the created relationship in business rescue is relatively short, leaving less opportunity for trust to develop. longer-term relations tend to function with informal “rules” and behaviours. complicating this is the fact that banks, as the practice principals, “inherit” the brp and would prefer not to have such a relationship in the first place. they therefore take a strict stand by withholding their support (as power base) when there is any disagreement. finally, while principals want to govern agent behaviour with a contract, they are typically incapable of doing so. in the first place, they are hiring a specialist to optimise expertise. driven by moral hazard and adverse selection, “contractibility” is vague, as shown in the previous points and in figure 1. ultimately, the contract which is the solution to classic agency situations seems not to present a solution during the business rescue. not only have banks realised that they cannot contract the brp behaviour, but they also understand that, within the act, they hold significant powers in the practice principal-agent relationship. practically – none of the perceived relationships are true agency relationships, despite containing several elements supporting them. 10.2 contracting as governance structure in the practice agency relationship the cornerstone of agency theory is that the assumption that the interests of principals and agents diverge (hill & jones, 1992), and the proposed solution is contracting as governance structure to address it. such contracts can be implicit or explicit in describing incentives, monitoring devices, bonding and other forms of social contracting to minimise agency costs (shapiro, 2005). as already shown in the boundary conditions and element manifestations, contracting in the practice principal-agent relationship is difficult and the contracting cost to establish it might not sajems ns 19 (2016) no 4:479-496 493 equal the value gained. at first glance the differences between the practice principals and the agents may seem to constitute “irreconcilable principle differences”, which render it not contractible. however, in order to move forward, these differences must be overcome. future research should propose alternatives for addressing this impasse. 11 implications and recommendations to industry first, while chapter 6 has been dubbed a debtor-friendly regime, comprehension of the legislative tension and its practical outcome points to it instead as de facto creditor-friendly. the perceived principal-agent (bank-brp) relationship that takes place in practice, as described in this paper, is clear proof that chapter 6 is not debtor-friendly. legally, this relationship does not exist. the disproportionate powers of the banks in the altered agency relationship are cumbersome and, in my opinion, not what the law intended, and they are difficult to regulate. second, the results of this study specifically highlight that contracting associated with classic agency relationships appears inadequate to address the conflict. banks suffer completely adverse selection and have no opportunity of influencing the selection. however, to oppose the brps they deem unfit they withhold their support. loubser (2010) alludes to differences in perception of reasonable prospect, where the goal difference between actors originates (pretorius, 2014a) as a contentious issue. the practical value of the research was found mainly in the enhanced understanding of the unintended or unforeseen practical consequences of the act in a debtor-friendly fallacy namely: what could be achieved by appointing directors? first, these results show that they should not file for rescue despite being compelled to file if they experience financial distress. however, as this may constitute reckless trading even though they have no choice, then the best advice is to file much earlier and overcome “denial”, potentially by using early detection mechanisms. all the previous research suggests that early action in the face of distress improves the probability of turnaround. what could brps do? first, they should focus on enhanced collaboration, especially when dealing with the banks. many of the conflict issues identified hinge on the clarity of the brp intentions to reorganise rather than find a return better than is found in liquidation. the second option, which is related to collaboration, would be to forge close relations with the banks when establishing reasonable prospect. this may also enhance access to information for the brp. the importance of enhancing skill levels through training for brps has also been suggested by banks. what could creditors do? banks have the dominant power in the reorganising strategies available to brps and they hold several of the “aces” in a rescue. if banks could find ways of assisting the brps to overcome their information asymmetry, this could have a dramatic effect on reducing the time it takes to investigate the firm’s affairs and reaching a conclusion on the status of reasonable prospect. banks appear not to appreciate the brp’s tasks in relation to their complexity, the number of tasks or the time limitations, as described by pretorius (2013). their focus is their investment in the business, limiting their ability to cooperate (vested interests) with the brp despite the act making provision for the functioning of a creditors’ committee. what could the regulator do? first, the regulator could investigate amendments to the act that may alter the exclusive powers of secured creditors in business rescue. under uk administration, secured creditors are excluded from voting. this research exposed the debilitating powers of the banks, especially in the vote at the second creditors’ meeting, where the plan must be supported or rejected for implementation. second, amendment could consider expanding the use of the creditors’ committee and build on adversarial collaboration as a principle. third, the accreditation of brps based on competencies needs to be addressed urgently. in classic agency theory, the assumption is that equal information exists and that it can be addressed by the principals and the agents. however, as shown, this is not the case in business rescue. the regulator could therefore consider investigating requirements for the creditors to enhance the business process. one of the 494 sajems ns 19 (2016) no 4:479-496 suggestions put forward was that the regulator should create a litigation fund for brps to challenge the banks’ actions, thereby testing certain practices and creating case law. finally, banks also blamed the regulator for licensing incompetent practitioners. there is thus a need for an improved accreditation process by the regulator. some research in this field has been reported by jacobs (2012) and pretorius (2013). 11.1 implications for theory – a researcher observation this research demonstrated three “variants” of the agency dilemma when the context is voluntary filing in business rescue. in comparison with a board-manager or firm-consultant agency relationship, where the principals and agents are clearly identified and stable, with clear hazards and costs, the rescue context results in the creation of different relationships and simultaneously ending the initial relationship between banks and directors governed by the loan contracting. in business rescue, the unique situation occurs where the directors as the believed principals agree, select, appoint and contract with the brp as agent. immediately after appointment, the act empowers the brp to take full management control and decision-making, which includes the powers over the directors, whose powers diminish completely and result in zero rights, barring the contributing value of their potential vote as shareholder-creditors. in business rescue, on the appointment of the brp, a “practice” principal appears, namely, the creditor body, which is driven and controlled by banks as the primary creditors. this body’s powers are prescribed in the act and it functions mainly through the voting interest they have when supporting or opposing the proposed rescue plan (or not). while the brp can effectively do almost anything until presenting the rescue plan that s/he must propose, the outcome depends solely on the support of this practice principal. thus, the bank can indirectly control the actions of the brp through the threat of removal or support of the plan (or not). 11.2 implications for research researchers could benefit from this paper mainly by understanding the complexities created when a business goes into business rescue. future research should pursue the extension of the creditor committee as a potential avenue to using alternatives like adversarial collaboration or alternative dispute resolution as solutions. 11.3 limitations and future research despite data being directly obtained from the primary sources, namely brps and bank subjects, the main limitation of this research is my potential bias as auto-ethnographer. i therefore pursued data source triangulation by using narratives, a framework and a comparative table with elements of the classic agency relationship to pursue trustworthiness. secondly, potential subject bias has also been pointed out, so the results should serve as guideline insights rather than as concrete facts. member checking also supported the findings and interpretations. the proposed recommendation for an adversarial collaboration process should be considered by the regulator as a starting point for addressing the potentially debilitating conflict. the proposed solution must therefore be evaluated with this in mind, as other interpretations might have been overlooked. finally, the perceived relationships described are subject to legal challenge and interpretation. potentially, court appointments of the brp may alter how the relationships are perceived, especially from the legal perspective. understanding the perceived interrelations between agents and principals is only the starting point in this complex web of issues. future research should seek specifically to investigate alternative solutions. identifying and comparing the legally-constituted agency relationship with these quasi relationships could also enlighten the regulator during amendments to the act. declaration the author declares that he has no financial or personal relationship(s) which may have inappropriately influenced him in writing this paper. sajems ns 19 (2016) no 4:479-496 495 references act 71. republic of south africa. 2008. companies act 71 of 2008. government gazette no 32121 volume 421. pretoria: government printer. anderson, l. 2006. analytic auto ethnography. journal of contemporary ethnography, 35(4):373-395. berniker, e. & mcnabb, d.e. 2011. dialectical inquiry: a structured qualitative research method. the qualitative report, 11(4):643-664. bradstreet, r., pretorius, m. & mindlin, p. 2014. business-driven rescue in south africa: 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(december) [accessed december 2014]. webne-behrman, h. 2009. conflict resolution skills – part 1. http://www.aipc.net.au/ articles/conflictresolution-skills.-part-1/ [accessed march 2015]. woodside, a.g. 2010. case study research: theory, methods, practice. uk: emerald, bingley. yin, r.k. 2003. case study research: design and methods (applied social research methods (3rd ed.) applied social research methods series, 5. london: sage publications. sajems ns vol 2 (1999) no 1 21 small, medium and micro-sized enterprises (smmes) and the housing construction industry: a possible solution to south africa's socioeconomic problems c s joubert, n j schoeman and j n blignaut i department of economics, university of pretoria abstract south africa as a developing country faces many socio-economic problems like high unemployment, low levels of working skills, poverty and rampant crime. in this paper it is argued that by targeting smmes both in general and specifically in the housing construction industry, there is meaningful scope for the creation of jobs in the south african economy. this is mainly because smmes are labour intensive. using endogenous growth theory as a basis, it is argued that by employing greater numbers of workers the level of skills in the economy can be raised too. jel055 --------.. ---.. ~-1 introduction as a developing country, south africa is faced with several daunting problems such as high unemployment, a labour force with low levels of skill as well as the resultant problems of poverty, crime and many more. it was estimated that the level of unemployment in south africa in 1995 was 29 per cent. this rate has increased in the last three years due to the fact that the economy has continued shedding jobs (bepa, 1998: 12). in this paper it will be examined whether small, medium and micro-sized enterprises (smmes) as an institutional framework and the housing construction industry as a r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 22 sajems ns vol 2 (1999) no i sub-sector of the economy could help to alleviate some of the socio-economic problems in south africa. two hypotheses will be tested in the paper. the first is that there is in fact scope for the creation of jobs in the south african economy, if smmes and the housing construction industry are explicitly targeted. the second hypothesis is that the level of skills of south africa's labour force can be raised, if smmes and the housing construction industry are thus targeted. as a point of departure endogenous growth theory will be briefly discussed. then, smmes will be defined and discussed in the south african context. next, the housing-construction industry in south africa will be examined. finally, the role of the informal sector will be discussed. 2 endogenous growth theory the aggregate production function for the economy as a whole can be expressed as y, = f (k" n" at) where y, is level of output in the economy; k, and nt are the levels of capital and labour in the economy; and at is the level of technology. technology includes not only physical technology but also knowledge (froyen, 1996: 411). the production function ofan individual firm (i) in the economy can be expressed as yit = f (kit. lih at) where yit is the level of output of the individual firm; kit and lit are the levels of capital and labour in the economy; and at is the level of technology in the economy as a whole (froyen, 1996: 412). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 23 the relationship between output and technology differs from that between output and other inputs, because although each fum's output depends on its own levels of labour and capital, its output is dependent on the level of technology in the whole economy. improvements in technology (knowledge) in the economy as a whole raise the productivity of all firms (froyen, 1996: 413). in some models of endogenous growth theory, advances in technology (knowledge) are assumed to depend on growth in capital. the reason for this is that new investment promotes new inventions and improvements in machinery. this in turn raises the level of knowledge in the economy. in other models, increased use of labour as an input also increases the stock of knowledge. stadler (i 990: 763) expresses this process as follows: the greater the level of labour input, the greater is the scope for learning and acquisition of new skills. arrow (1962: 155), expresses the importance of knowledge as follows: the acquisition of knowledge is what is usually termed "learning'~ ... learning is the product of experience. learning can only take place through the attempt to solve a problem and therefore only takes place in activity. endogenous growth theory has certain very important implications. consider what would happen to output in the economy if all fums were to increase their use of both capital and labour by a certain percentage. the increase itself would usually lead to a percentage change in output of the same magnitude as the original percentage change in capital and labour. from the discussion above, however, it follows that increases in capital and labour serve to raise the level of technology (knowledge and skills) in the economy as a whole. this increase in technology again leads to a greater than proportional increase in the level of output in the economy, that is, increasing returns to scale (froyen, 1996: 414). there is a very important lesson to be learnt from the above discussion. south africa, as a country with abundant unskilled labour, could raise its levels of skill by employing and training workers. although a certain amount of specific training is r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 24 sajems ns vol 2 (1999) no i necessary, endogenous growth theory points to the fact that simply by employing people, levels of skill can be raised. having noted the importance of raising skills by increased employment of labour, the discussion now turns to the areas in the south african economy which have the greatest potential for labour employment. 3 smmes, employment and gross domestic product in south africa smmes are defined in the national small business act of south africa (nsbasa) as distinct business entities, which are not part of a group of companies. if an smme does have subsidiaries and branches, they must all be included when measuring its size. an smme should be managed by its owner or owners, and can therefore be a natural person, a sole proprietorship or partnership, or a legal person like a close corporation or a company (ntsika, 1997: 8). any business can be categorised according to three criteria, namely, employment, tumover and assets. although all three criteria are applicable to a business firm, for practical purposes, the number of employees is regarded as the most important criterion when defining smmes. according to nsbasa, small businesses can be classified into one of four categories. firstly, there are survivor enterprises, which generate income less than the minimum income standard or poverty line. a second category is that of micro enterprises. in this case the major criterion is that turnover is less than the vat registration limit ofrl50 000 per year. in the third category of small enterprises, called "very small enterprises", employment per enterprise is less than ten paid workers. finally there are those enterprises, where fewer than 50 people are employed. these categories are to be compared with a medium enterprise, which employs between 51 and 100 people (ntsika, 1997: 9). smmes play an important role in the south african economy, particularly with regard to the creation of jobs. the contribution of smmes to employment is approximately 44 per cent. in table 1 employment figures are broken down according to the sectoral contributions of smmes. from these statistics it follows r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 25 that small enterprises make a significant contribution to employment in the agricultural, trade, construction and manufacturing sectors of the south african economy. these figures reflect the large number of people employed by farmers as well as the many small traders operating in formal and informal markets. they also indicate that large numbers of people are employed by small contractors in the construction industry and by small factories. as far as medium-sized enterprises are concerned, it is evident from table 1 that they are mostly active in the manufacturing and construction sectors. in the manufacturing sector, sl\.1mes are concentrated in eight economic sub-sectors. in order of importance, these are metal products, machinery, printing, food, furniture, other manufacturing, non-metal mineral products and clothing. some economic activities clearly accommodate the relatively smaller entrepreneur more readily than others, and with some financial assistance (from financial institutions and the government) there are many opportunities for new entrepreneurs to exploit in the manufacturing sector. table 1: sectoral contribution (percentage) to employment by size of business: 1995 sector small medium large enterprise enterprise enterprise manufacturing 17 25 58 construction 39 i==i 37 mining 2 95 electricity 0 0 100 agriculture 56 19 25 transport 12 3 85 finance 5 1 94 trade 50 14 36 source: ntsika 1997. the contribution of sl\.1mes to the gross product of the various sectors of the south african economy is shown in table 2. as one would expect, there appears a direct correlation between the percentage contribution of sl\.1mes to sectoral output and employment. as in the case of employment, sl\.1mes in the agriculture, trade, construction and manufacturing sectors contribute the most to gdp. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 26 sajems ns vol 2 (1999) no 1 table 2: contribution of smmes towards gdp by sector (as a percentage of the total contribution of eacb sector): 1995 sector smmes larae enterprises manufacturing 31 69 agriculture 67 33 transport 15 56 construction 56 24 mining 3 97 trade 65 35 electricity 0 100 finance 7 93 source: ntslka 1997. well-founded economic reasoning supports the case for employment creation by smmes. small businesses are usually labour intensive, need relatively little capital and use local resources. by channeling scarce capital resources to the small business sector, particularly in a developing economy such as south africa's, employment opportunities can be maximised and the unemployment rate reduced. there is, moreover, another way in which smmes would have a positive effect on employment. given the fact that smmes are highly labour intensive, increasing numbers of smmes would mean that increasing amounts of labour would be employed. this calls to mind the statements by stadler (1990: 763) and arrow (1962: 155) quoted in section two of this paper: "the greater the level of labour input, the greater is the scope for learning and acquisition of new skills" and "learning is the product of experience." promotion of labour-intensive smmes would raise the level of knowledge in the south african economy as a whole and lead to increased output. by promoting labour intensive smmes, the level of skills in the south african economy would be raised too. the importance of this conclusion is stressed by the discussion of the role of smmes in the home construction sector that follows. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 27 4 housing provision and construction smmes the link between productivity, motivation and living conditions should not be underestimated. as far as the latter is concerned, housing is and has always been a critical factor. informal slum settlements have often been established near places where work is available in a particular factory or trade. the existence of an extended family system with group-based support and contact networks, facilitates the entry of new urban migrants into the urban economy. these circumstances have influenced and still influence the decision of many households to live in informal settlements despite crowded conditions and lack of amenities. thus, although such settlements offer "affordable accommodation", which has facilitated the access by the urban poor to income-earning job opportunities, they are characterised by unhygienic living conditions, which are not conducive to improvements in human capital. the implication of this is that improvement in housing conditions for the millions of people living in informal settlements, should also improve the quality of their labour, and hence general welfare and economic conditions. according to figures provided by the department of housing, there is currently a shortage of almost 2.2 million formal housing units in the urban areas of south africa. it is estimated that this shortage increases by 200 000 houses per year (newton, 1997: 19&37). this means that by the end of 1999, the shortage may have reached 2.4 million units. nedlac estimates that a further 400 000 houses might be needed in rural areas (nedlac, 1997). data from central statistical services (css, now known as statistics south africa) and the building industries federation concerning the construction of homes in 1994, point to the fact that 40 751 workers were employed to build approximately 25 500 houses (css, i 997a: 15). using this data as a rough estimate, a ratio for houses per worker can be obtained, which proved to be 0.625 houses per worker, ceteris paribus. the reason for adding a ceteris paribus clause is that this ratio does not take into account that there may be increases in productivity as workers become more accustomed to their jobs. given the limited data, it is however not possible to take increases in productivity into account. according to newton (1997: 1), the government plans to supply 350 000 houses per year. to do so approximately 560 000 workers would be needed, given the above ratio. it must r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 28 sajems ns vol 2 (1999) no 1 be remembered that 200 000 of the 350 000 houses per year are needed to keep up with the demand for new houses. only 150000 houses per year would therefore go towards reducing the backlog. this means that 350 thousand houses would have to be built every year for 13 years, in order to reduce the backlog and make provision for the annual increase in this backlog. after the backlog has been eliminated, the number of new houses needed per year would be 200 000 if the present rate of population growth remains unchanged. given the ratio of 0.625 mentioned above, approximately 320 000 workers would be needed to build these houses. in 1994 there were 3 141 residential home construction enterprises in south africa. these enterprises employed a total of 40 751 workers (css, 1997a: 9). table 3 contains information pertaining to the sizes of these enterprises. as can be seen from the data, a large percentage of workers, namely 75.5 per cent, worked for enterprises which employed less than 50 workers (that is, small enterprises). there were 2 328 enterprises, that is 74 per cent of the residential home construction firms, which employed less than 50 labourers. medium-sized enterprises on the other hand, employed 13.2 per cent of all the workers in the home-construction industry. the data therefore indicate that small and medium-sized home construction enterprises employ the most labourers. table 3: employment size group of residential home construction enterprises, 1994 employment size number of total number of group enterprises workers 0-4 714 2198 5-9 1207 8816 10-19 769 9898 20-49 352 9865 50-99 80 5472 100-199 11 1443 200-299 2 300-399 4 400-499 500-999 2 3059 total: 3141 40751 source: css 1997a: 15. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 29 the discussion above indicates that there is significant scope for job creation in the construction industry, given the large housing shortage which exists in south africa. it also clearly indicates that small-scale enterprises in the home construction industry employ the largest number of workers and create the most employment in this sector in contrast with larger enterprises. the construction industry's job creation potential could be fully exploited if smmes in this industry were targeted and supported. the discussion above indicates that there is significant scope for job creation in the construction industry, given the large housing shortage which exists in south africa. it also clearly indicates that small-scale enterprises in the home construction industry employ the largest number of workers and create the most employment in this sector in contrast with larger enterprises. the construction industry's job creation potential could be fully exploited if smmes in this industry were targeted and supported. it clearly follows from the above discussion that smmes in the construction industry employ more people than large enterprises. promotion of smmes in the construction industry would therefore mean that greater numbers of workers would be employed there. increased employment of labour would in turn increase the scope for the generation of skills and knowledge in the south african economy. it should also be note that smmes are active not only in the formal sector of the economy; in many instances they play an active role in the informal sector too. 5 the role of smmes in the informal sector statistics south africa has defined the informal sector as follows: "it includes all types of market economic activity which conceptually are to be included in the flows of the national accounts but which are underestimated or not measured at all, due to the informal business styles of vendors and enterprises that are not known of officially. it consists of those economic activities which generate factor incomes, that is wages, salaries and profits, arising from the production of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 30 sajems ns vol 2 (1999) no 1 goods and services which cannot be estimated from statistical sources used to compile income measures ofgdp." (css, 1997b). according to the world bank, the annual ejl1ployment growth rate within the south african informal sector in 1995, was 24 per cent (sairr, 1997). this clearly indicates that the informal sector creates many jobs within the south african economy. in 1995, an estimated 1.74 million people were working in the informal sector. roughly 72.9 per cent of them were involved on a part-time basis. moonlighters thus represent a significant portion of the total number of persons working in the informal sector. housewives and students comprised almost 40 per cent of total employment in this sector. this implies that the informal sector serves as a means for enterprising people to improve their standard of living, and does not just provide jobs for the unemployed. in 1990, the transport industry's contribution to estimated informal gdp amounted to 21.8 per cent. the contribution of manufacturing is relatively small due to the high level of skills required in order to be successful in this sector. most people in the informal sector are involved in rudimentary work (a total number of 846 000), followed by 185 000 working in the craft and related trades. the remaining informal workforce consists of managers (94 000), professionals (15 000), technicians (46 000), clerks (4 000), service workers (89 000) and skilled agricultural workers (25 000). expressed as a percentage of the total number of workers in the informal sector, people working in rudimentary occupations account for 70 per cent (css, 1997b). a large proportion of participants in the informal sector is therefore engaged in elementary work which does not require a high level ofskil!. there are a number of reasons why the informal sector should be targeted and promoted for employment creation: a) it provides jobs for the unemployed. b) it serves as a safety net during periods of cyclical unemployment when many people cannot find formal employment. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no i 31 c) it teaches prospective small formal entrepreneurs to develop their skills in areas of management and business operations. d) it appears to have a greater capacity to absorb large numbers of people seeking employment, whereas formal sector business only has a limited capacity to provide jobs for the unemployed and new labour market entrants. this is mainly due to the fact that the informal sector is comparatively labour intensive. e) it provides a large number of jobs which do not require high levels of training and skill. due to the fact that the informal sector is labour intensive, promotion of this sector would lead to higher levels of labour employment, and this would in turn raise the level of knowledge and skills in the south african economy. 6 conclusion at the beginning of this paper it was said that two hypotheses would be tested here. the fust is that there is meaningful scope for the creation of jobs in the economy if smmes in general and particularly in the housing-construction industry are targeted as job-creators by the government. the second is that the level of skills of the labour force can be raised if smmes and the housing-construction industry are targeted in this way. in section 3 it was concluded that smmes are labour intensive and that there is scope for the creation of jobs if smmes are supported by the government. it was also concluded that increased use of labour in smmes would, according to endogenous growth theory, serve to increase the skills of the south african labour force. in section 4 it was again concluded that there is significant scope for the creation of jobs by attempting to eliminate the housing backlog that currently exists. it was also concluded that smmes in the home construction industry are labourintensive and currently employ more people than large enterprises in the industry. for this reason, job-creation could be maximised and levels of skill would be raised if home-construction smmes were to be targeted. finally, it was concluded in section 5 that given the labour intensive nature of the informal sector, employment r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 32 sajems ns vol 2 (1999) no 1 would be maximised and levels of skill raised, if this sector were to be targeted for job-creation. given the conclusions drawn in these three sections of the paper, it clearly follows that neither of the above two hypotheses can be rejected. the evidence in this paper does not disprove that smmes and the home construction industry could be profitably used to create jobs in the south african economy. nor does the evidence disprove that increased employment of labour in smmes would raise the level of skills in the south africa economy. in his theory of economic development (1911), schumpeter describes the economy as a circular flow , and adds that economic development takes place through new technology, which causes a marginal movement away from a previous state of equilibrium. schumpeter describes five factors which would cause such a movement and two of these are "the introduction of a new method of production, that is one not yet tested by experience, in the industry concerned ... " and "the carrying out of the new organisation of any industry ... " (rostow 1991: 406-407). targeting smmes in general and in the home construction industry in particular, can indeed be regarded as the introduction of a new way of organising this area of the economy. by doing so, there is scope for the generation of employment as well as improvements in the level of skills of south african workers. this should in turn, hopefully, lead to reduced poverty and crime. endnotes views expressed in this paper are those of the authors and do not necessarily . reflect the views of any organisation with which they are associated. 7 references 1. arrow, k.j. (1962), "the economic implications of learning by doing". review of economic studies, 39: 155-73. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 33 2. bureau for economic policy and analysis. (1998), improving the labour absorption capacity of the south african economy, bepa economic paper, 29, university of pretoria; bepa. 3. central statistical services. (1997), census of construction. pretoria: css. 4. central statistical services. (1997), october household survey 1995, pretoria: css. 5. department of housing (1997), housing statistics. pretoria: department of housing. 6. froyen, r.t. (1996), macroeconomics: theories and policies, 5th edition, new jersey: prentice hall. 7. nedlac. (1997), report to annual summit. johannesburg: nedlac. 8. newlun, j. (1997), the south african housing capital subsidy scheme: can it work? unpublished research report. 9. ntslka enterprise promotion agency. (1997), the state of the small business in south africa, second edition, pretoria: ntsika. 10. rostow, w.w. (1991), "technology and the economic theorist: past present and future", in higonnet, p. et a.1 (eds), favorites of fortune: technology, growth, and economic development since the industrial revolution, cambridge: harvard university press. 11. south african institute of race rela nons. (1997), south african survey 1996197, johannesburg: sairr. 12. stadler, g. (1990), "business cycle models with endogenous technology". american economic review: 763-68. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction literature review methods results conclusions acknowledgements references appendix 1 appendix 2 appendix 3 appendix 4 appendix 5 appendix 6 about the author(s) jonty tshipa department of financial management, faculty of economic and management sciences, university of pretoria, south africa leon m. brummer department of financial management, faculty of economic and management sciences, university of pretoria, south africa hendrik wolmarans department of financial management, faculty of economic and management sciences, university of pretoria, south africa elda du toit department of financial management, faculty of economic and management sciences, university of pretoria, south africa citation tshipa, j., brummer, l.m., wolmarans, h. & du toit e., 2018, ‘the effect of industry nuances on the relationship between corporate governance and financial performance: evidence from south african listed companies’, south african journal of economic and management sciences 21(1), a1964. https://doi.org/10.4102/sajems.v21i1.1964 original research the effect of industry nuances on the relationship between corporate governance and financial performance: evidence from south african listed companies jonty tshipa, leon m. brummer, hendrik wolmarans, elda du toit received: 02 june 2017; accepted: 18 jan. 2018; published: 18 apr. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: premised on agency, resource dependence and stewardship theories, the study investigates empirically the existence of industry nuances in the relationship between corporate governance and financial performance of companies listed in the johannesburg stock exchange. aims: the main objective of the study is to understand the relationship between internal corporate governance and company performance from the perspective of three distinct economic periods, as well as industry nuances, cognisant of endogeneity issues. setting: south africa, as an emerging african market, offers an interesting research context in which the corporate governance and financial performance nexus can be examined empirically. method: a sample of 90 companies from the five largest south african industries, covering a 13-year period from 2002 to 2014 (1170 firm-year observations) was examined with three estimation approaches. results: two key trends emerged from this study. first, the relationship between corporate governance and company performance differed from industry to industry. second, the association between corporate governance and company performance also changes during steady and non-steady periods, which is an indication that the nexus is driven by the state of the global economy and the type of the industry. conclusion: evidence from the study suggests that companies should be allowed to optimise rather than maximise their corporate governance options. this finding questioned the approach of the recently published king iv code of good corporate governance, which requires johannesburg stock exchange-listed companies to ‘apply and explain’ as opposed to ‘apply or explain’ as pronounced by king iii code of good corporate governance. introduction the subject of corporate governance and corporate performance has been widely discussed and examined over the last two decades. this is so because compliance to corporate governance practices may influence the value of the firm (tshipa et al. 2018a). the interest was heightened by corporate scandals such as enron corporation (corp.), worldcom incorporated (inc.) and global crossing limited (ltd). the collapse of these companies was supposedly a result of lapses in corporate governance (ntim et al. 2012; vinten 2002). as a result of these scandals, investors demanded reforms in both corporate structures and practices in exchange for their infusion of capital (kakabadse & korac-kakabadse 2002). given the importance of corporate reforms, codes of corporate governance have attracted much attention from policy-makers and academics (aguilera & cuervo-cazurra 2009; tshipa & mokoaleli-mokoteli 2015). in africa, south africa was the first to develop a corporate governance code of best practices in 1994 (mangena & chamisa 2008). recently, corporate governance has also been in the spotlight following the global financial crisis in 2007. proponents of corporate governance argue that corporate governace provides a hedging mechanism during-crisis periods (johnson et al. 2000; tshipa et al. 2018b). on the other hand, critics of corporate governance attribute the global financial crisis squarely to corporate governance (kirkpatrick 2009; kumar & singh 2013). internal corporate governance attributes are expected to enhance company performance during normal economic times by effectively monitoring directors and ensuring that their interests and those of shareholders are in tandem (afrifa & tauringana 2015). however, the cogency of such claims in abnormal economic times such as a financial crisis and for different types of industries has been questioned (van essen, engelen & carney 2013). the literature review indicates that research to date has an inconclusive record regarding good corporate governance and financial performance nexus. in the main, the lack of congruence has been credited to inadequate estimation methods, endogeneity inherent in corporate governance studies, economic periods, industry nuances and country differences (tshipa et al. 2018b). therefore, the objective of the study is to understand the relationship between internal corporate governance and company performance from the perspective of three distinct economic periods, as well as industry nuances, cognisant of endogeneity issues. distinct from other studies, both domestically and globally, a unique contribution of this study is the introduction of the industry-specific characteristics in the corporate governance and company performance relationship. this is because the one-size-fits-all approach may not capture the pertinent nuances in corporate governance across different industries (ammann, oesch & schmid 2013; bruno & claessens 2010). board characteristics should vary systematically across industries, either because of systematic differences in costs and benefits or because of some other commonality. for instance, in south africa and globally, the size of the board in banks is twice as large as in other industries. this could be because the benefits reaped by banks from having a larger board may outweigh the increased communication and co-ordination costs, as highlighted in the study by guest (2009). therefore, by inference, it is expected that a larger board size as practised in banks should have a positive impact on company performance, irrespective of whether the proxy for company performance is accounting-based or market-based. thus, the culmination of this study is the unique models for the association of corporate governance and company performance across all major south african industries. comparing corporate governance among industries may lead to a more complete understanding of the subtleties that characterise the pervasive relationship between corporate governance and company performance across industries. the period of this study is also unique, because it covers a relatively stable economic period before the financial crisis, a challenging and unstable period of time when the financial crisis materialised, and the aftermath of the financial crisis. in addition, the examination period of the study also covers the two corporate governance reforms in south africa, king ii in 2002 (institute of directors in southern africa 2002) and king iii in 2009 (institute of directors in southern africa 2009), as well as the new companies act no. 71 of 2008 (republic of south africa 2008). literature also attributes the mixed results of corporate governance studies to potential endogeneity problems, which may significantly affect empirical corporate governance findings (afrifa & tauringana 2015). in order to overcome the problem of endogeneity, this study employs several robust alternative specifications and estimation techniques for the analysis purposes, which include generalised methods of moments (gmm), two-stage least square (2sls) and generalised least square (gls) – the latter being the preferred estimator for this study. in addition, to reduce the potential endogeneity problem of simultaneity, which is found to be the most common endogeneity problem in corporate governance research (larcker & rusticus 2010), the study lags all independent variables and investigates the association between changes in the independent variables and the dependent variable, taking a leaf from studies of afrifa and tauringana (2015), tshipa et al. (2018b) and mina, lahr and hughes (2013). another big challenge in corporate governance empirical studies is the consideration of the dynamic nature of corporate governance, which is also considered as another source of endogeneity, namely dynamic endogeneity (wintoki, linck & netter 2012). to obviate this problem, and similar to the studies of ayadi et al. (2015), tshipa et al. (2018b) and schultz, tan and walsh (2010), the effect of historical performance on current governance is considered when running the estimation models. literature review this section discusses the relevant extant theories that attempt to link internal corporate governance structures and company performance. theories underlying corporate governance have been drawn from a variety of disciplines, such as accounting, economics, finance and law (durisin & puzone 2009). in this study, corporate governance is approached from a financial perspective, using a quantitative research methodology. similar to past studies (aduda, chogii & magutu 2013; filatotchev & boyd 2009; gartenberg & pierce 2017; haniffa & hudaib 2006; tshipa & mokoaleli-mokoteli 2015; wagana 2016; tshipa et al. 2018a; tshipa et al. 2018b), this study adopted a multiple theoretical orientation by combining several key theoretical perspectives, such as the agency, stewardship and resource dependence theories. the choice to use multiple theoretical perspectives is further motivated by the complementary nature of each theory. for instance, cohen, krishnamoorthy and wright (2008) and nelson et al. (2013) state that the agency theory on corporate governance should be complemented by additional perspectives such as the resource dependence, stewardship and stakeholder theories. agency theory and corporate governance agency theory-based research focuses largely on the relationship between board structure, control over management behaviour and strategic decision-making (hafsi & turgut 2013). agency theorists use the term corporate governance to interrogate the role of agents (managers) in fulfilling part of their contractual agreement with the principal (investor). the rudimentary view held by agency theorists of corporate governance is that at any given time, managers have self-interest and may not act to maximise shareholder returns, unless appropriate internal governance structures and controls (to monitor costs) are put in place to protect the interests of shareholders (jensen & meckling 1976). the agency framework suggests that corporate governance seeks to create and monitor the mechanisms that are put in place by shareholders to ensure that managers maximise shareholders’ wealth by reducing agency loss (adegbite, amaeshi & amao 2012; bonazzi & islam 2007). in the absence of strong corporate governance, management can use the additional control, not for long-term profitability, but instead, for their own personal wealth, status and goals (gartenberg & pierce 2017). rebeiz (2015) describes the monitoring mechanisms as internal corporate governance structures. sternberg (1998) asserts that the solitary role of corporate governance is to ensure that the company’s financial and human capital resources, as well as assets, are directed so that it achieves the corporate mandate and objectives to shareholders’ satisfaction. accordingly, this simply means that agency theorists regard corporate governance as a mechanism to reduce agency loss. one such mechanism would be the deployment of the board of directors to act as monitors on behalf of investors. the agency cost has gained prominence in the corporate governance literature as a result of the shortcomings of the stewardship theory (rebeiz 2015). the agency theory states that chief executive officer (ceo) duality is bad for company performance as it compromises the monitoring and control of the ceo. however, in the last few years, many companies have converted from the dual ceo leadership structure to a non-dual structure, while a much smaller number of companies converted in the opposite direction (moscu 2013). hence, the problem of separating the roles of ceo and chairman of the board still seems unresolved. interestingly, yang and zhao (2014) report that duality companies outperform non-duality companies by 3% to 4%, which underscores the benefits of ceo duality in saving information costs and making speedy decisions. one aspect in relation to the board internal structure is board activity (arosa, iturralde & maseda 2013). board activity is defined as the frequency of board meetings in a year (pamburai et al. 2015). the frequency of board meetings allows the board to be apprised of activities of the company and thus manage the agency relationship on behalf of the shareholders. the more frequent the meetings, the more detailed the control of the managers, and the greater the shareholder wealth (arosa et al. 2013). board committees are the critical aspect of monitoring and, therefore, of the board. this is because critical processes and decision-making are not done at board level but at committee level, such as the nomination, audit and risk, and remuneration committees (dalton et al. 1999). to this end, the establishment of board subcommittees has been strongly recommended as a suitable mechanism for improving corporate governance, by delegating specific tasks from the main board to a smaller group and harnessing the contribution of non-executive directors (spira & bender 2004). essentially, the board delegates certain functions to these well-structured committees but without abdicating its own responsibilities. the purpose of establishing the committees is to alleviate its workload and to create committees that can function more effectively due to its composition consisting of a smaller grouping that can focus on key areas. board committees enable directors to cope with two of the most important problems they face: the limited time they have available, and the complexity of the information with which they must deal (dalton et al. 1999). stewardship theory and corporate governance stewardship theory arose from the seminar work by donaldson and davis (1991). stewardship theorists trace their origins back to the human relations school of management (hung 1998), the organisation theory (clarke 1998), and sociology and psychology (muth & donaldson 1998). unlike the agency theory, the stewardship theory assumes that management are stewards whose interests are aligned with those of the owners (shareholders). therefore, managers are motivated to make decisions that correspond with those of the shareholders that would maximise financial performance. corporate governance under the stewardship model is premised on the logic that managers work diligently to maximise shareholders’ returns by virtue of being good stewards of corporate assets (donaldson 1990). therefore, this view leads to the assumption that management performance is not necessarily influenced by self-interest, but is more likely to be affected by the governance structural impediments that inhibit effective action (davis, schoorman & donaldson 1997). consequently, it could be argued that corporate governance, under the banner of the stewardship theory, is associated with ‘structure’ and hierarchy. this is corroborated by whittred (1993), who asserts that corporate governance should provide facilitating and empowering structures to managers, which should enable managers to deliver superior returns to shareholders. hence, the stewardship theory seeks to underscore the importance of combining the ceo and chairman roles to attain financial performance for the company. the stewardship theorists rationalise that in order to reduce agency costs, companies should not split the dual role of ceo and chairman (abels & martelli 2013). proponents of the stewardship theory contend that better financial performance is likely to be associated with internal corporate governance practices that grant managers greater autonomy and power. the power should be centralised in the hand of the managers because of their intimate knowledge of the business (rebeiz 2015). these powers include combining the positions of chairman and ceo (donaldson & davis 1991). in this situation, power and authority are vested in a single person and there is no room for uncertainty as to who has authority or responsibility. it is believed that a single leadership structure, having combined the ceo and chairman roles, will assist the company to attain superior performance to the extent that the ceo exercises complete authority over the company and that the ceo’s role is unambiguous and unchallenged. resource dependence theory and corporate governance nguyen, locke and reddy (2015) describe the resource dependence theory as an association between board characteristics and the company’s critical resources, including aspects such as the companies’ ‘prestige and legitimacy’. the resource dependence theorists trace their origins to the school of sociology (clarke 1998). it was developed by pfeffer (1972) to emphasise that the board, particularly the composition of the non-executive directors, can provide the company with resources that can enhance company performance. first, the board and non-executive directors can offer essential resources, such as expert advice, requisite experience, independence and knowledge (haniffa & cooke 2002). second, they can provide reputation, credibility and critical business contacts (haniffa & hudaib 2006). finally, the board can facilitate access to business or political network, information and capital (nicholson & kiel 2007). finally, the board provides a critical link to a company’s external environment and significant stakeholders such as creditors, suppliers, customers and competitors. as a result, it has been argued that a greater level of links to the external environment is associated with better access to resources (nicholson & kiel 2007). in other words, the resource dependence theory postulates that apart from the monitoring function, the board of directors also serves as a resource provider. hillman and dalziel (2003) refer to the ability of the board to solicit essential resources to the company as ‘board capital’. as stated by hung (1998), companies depend on one another for access to valued resources. the resource dependence theory posits that companies are interrelated and depend on the external environment for survival. according to pfeffer (1972), the board of directors could be seen as the requisite link between the company and the external environment. a board’s ability to fulfil this function is linked to a director’s connections to other entities – that is, the board interlocks as the latter is frequently regarded as a conduit between companies (shropshire 2010). when a member of a board of directors also sits on other boards of directors, a director interlock is created. hence, hung (1998) states that there are indeed benefits to director interlocking. this could impact financial performance positively. proponents of diversity in corporate boardrooms usually base their arguments on agency, resource dependence, human capital and signalling theories (taljaard, ward & muller 2015). first, the agency theory states that diversity in the boardroom increases board independence and improves executive monitoring (van der walt & ingley 2003). second, it brings diversity in ideas, perspectives, experiences and business knowledge to the decision-making process in boardrooms (baranchuk & dybvig 2009). this can better aid appreciation of the intricacies of the external environment and global marketplace. board diversity can also increase creativity and innovation in boardrooms due to diversity in cognitive abilities, which can also facilitate effective decision-making (carter, simkins & simpson 2003). research hypothesis accordingly, the hypotheses for this study are on the effect of board size, board independence, board activity, board diversity, leadership structure and presence of key board committees on financial performance. the foregoing variables are all internal structures and processes within the control of the company’s shareholders and the board of directors. brown, beekes and verhoeven (2011) refer to these as internal corporate governance structures. the focus of this study is thus on the impact of internal corporate governance structures on financial performance. the corporate governance variables chosen were based on prior studies as well as the johannesburg stock exchange (jse) listing requirements as recommended by king iii. the independent variables were: board size, board independence, board committees, board diversity, board activity and leadership structure. therefore, the following research hypotheses are formulated: h1a: there is a positive significant relationship between board size and financial performance. h2a: there is a positive significant relationship between board independence and financial performance h3a: there is a positive significant relationship between the presence of key internal board committees and financial performance. h4a: there is a positive significant relationship between board activity and financial performance h5a: there is a positive significant relationship between board diversity and financial performance. h6a: there is positive significant relationship between leadership structure and financial performance. methods the data used in the study to investigate the impact of corporate governance on company performance was sourced from the inet bfa database. the study ended with a sample of 90 companies from five major industries, covering the period 2002 to 2014. this number of companies and the period of examination translated into 1170 firm-year observations. the examination period of 2002 to 2014 was critical to the study because during this period, king ii (institute of directors in southern africa 2002), king iii (institute of directors in southern africa 2009) and the companies act no. 71 of 2008 (republic of south africa 2008) were implemented. in addition, the global financial crisis occurred. consequently, companies that made the sample needed to have been exposed to all the domestic reforms as well as the global financial crisis. to this end, similar to the study of vintilă and gherghina (2013), the unbalanced multiple regression panel data analysis was used as the main tool. three estimation methods, the generalised method of moments, two-stage least squares and generalised least squares (gls) fixed effects, were considered. similar to the study of habib (2016), among others, gls emerged as the preferred statistical method based on the explanatory power and the goodness of fit. model specification as mentioned in the ‘introduction’, one of the most daunting tasks in corporate governance empirical studies is dealing with the endogeneity of corporate governance independent variables. being oblivious to endogeneity may result in spurious and unreliable causality inferences (roberts & whited 2013). in light of this, wintoki et al. (2012) and tshipa et al. (2018b)recommend that the appropriate empirical model for the corporate governance and performance nexus should be a dynamic model instead of a static model, in which lagged performance is used as one of the independent variables. therefore, this study also adopts a dynamic modelling approach to investigate the relationship between corporate governance and company performance. by doing so, this study responds to recent calls by arora and sharma (2016), nguyen, locke and reddy (2014), nguyen et al. (2015), schultz et al. (2010) and waweru (2014) to use dynamic panel models in corporate governance and finance studies. in view of the preceding, the model specification for this study is as follows: where yit measures company performance indicators, return on asset (roa) and tobin’s q, yit-1 represents the performance lag of one year. bsit, biit, bcit, bait, bdit and lsit are corporate governance variables, namely board size, board independence, presence of key board committees, board diversity and leadership structure respectively, of company i at period t. age, size, leverage (lev) and growth (g) are used as control variables for company age, company size, leverage and growth prospects. the intercept is α0, the error term is ɛit and α1 is the unknown estimated coefficient. the following models are thus used for the entire period (2002–2014), pre-financial crisis (2005–2007), during the crisis (2008–2010) and post-financial crisis (2011–2013), for the whole sample as well as for each industry. model 1 model 2 as already mentioned, for corporate governance measures, the study considers board size, board independence, board committees, board activity, board diversity and leadership structure, while the control variables are company age, company size, leverage and growth prospects. data for the performance measures, roa and tobin’s q are not manually calculated but retrieved from the inet bfa database. inet bfa database is south africa’s leading provider of financial data feeds as well as organisation information including annual reports and financial statements (bussin & modau 2015). the construction of these variables for the empirical analysis is presented in table 1. definitions of variables are largely adopted from existing literature with the aim of making a meaningful comparison with earlier empirical studies. table 1: description of variables used in the study. results the following section discusses the descriptive statistics and preliminary data analysis, as well as the regression results for each of the five industries. for ease of comparison, in each industry, two tables are presented for all hypotheses. the first table shows the hypotheses and tobin’s q and the second table presents the hypotheses and roa. one of the objectives, as highlighted in the ‘introduction’, is to develop a corporate governance and performance model for each industry. in the light of this objective, the analysis for each industry culminates in a customised corporate governance model for roa and tobin’s q (also see appendix 1). preliminary data analysis before conducting the regression analysis, various preliminary tests are conducted (haniffa & hudaib 2006; pamburai et al. 2015). the following subsection discusses the assumptions of the ordinary least squares regression method to determine which estimation technique is appropriate for the study. these assumptions include normality, linearity, homoscedasticity, multicollinearity, auto-correlation and presence of outliers. assumption of auto-correlation the durbin watson statistic indicates independence between the residuals when the statistic encompasses values between 1.5 and 2.5 (diebold 2016; greene 2002), where values near 2 indicate the lack of auto-correlation (schwarz 2015). in this study, such a condition is met for all dependent variables, which indicates that the data are not autocorrelated. panel data unit root test for this study, the levin, lin and chut test is applied and the test gives absence of unit roots by rejecting the null hypothesis. using variables without taking the first difference in the estimation model may give spurious results. therefore, the study uses the first difference to obviate unit root. assumption of normality an analysis of the skewness and kurtosis indicates that most of the variables used in this study do not meet the assumption of normality – only the board committee independent variable meets the assumption of normality, with a skewness of 0.625 and kurtosis of 1.39. consequently, the non-normal distribution of the variables indicates that an ordinary least squares regression is not appropriate for the study. an alternative is to use a gls model, which will provide more robust estimates (olsson et al. 2000; wahba 2015). assumption of outliers a box-plot was conducted to identify the presence of outliers in the data. there are a few outliers, though not significant. the presence of outliers may give rise to heteroskedasticity (gujarati 2004). unequal variances may exist due to the presence of outliers and skewness. a gls regression with a robust standard error was carried out to test the research hypotheses. the gls method is applied when the variances of the observations are unequal or in the presence of heteroskedasticity (gujarati 2004). while the ordinary least squares method assigns equal weight or importance to each observation and does not use information relating to the unequal variability of the dependent variable, gls can produce more accurate estimators in the presence of outliers or heteroskedasticity, because it clearly takes such information into account (aslam & pasha 2007; gujarati 2004). assumption of multicollinearity to detect this problem, the pearson correlation matrix is used to test the multicollinearity problem (sheikh & wang 2012). similar to the studies of mohammed, che-ahmad and aljaaidi (2012) and pamburai et al. (2015), the fact that the correlation coefficients are below the 0.8 threshold indicates that multicollinearity is not a problem in this study. further, similar to the studies of muchemwa, padia and callaghan (2016), pamburai et al. (2015) and rodriguez-fernandez, fernandez-alonso and rodriguez-rodriguez (2014), in addition to the correlation matrix, this study also assesses the variance inflation factors to check the level of multicollinearity for each dependent variable against all six independent variables. chatterjee and hadi (2012) posit that a value of variance inflation factors larger than 10 should be considered an indication of the presence of multicollinearity. the results indicate that multicollinearity is not a problem because all variance inflation factors values are well below the cut-off point of 10 as stated by chatterjee and hadi (2012). selection of the appropriate estimation method for the study based on displaying the smallest residuals (s²) and highest adjusted r², as well as the f-value as guided by the studies of rad (2014) and tshipa et al. (2018b), gls estimator emerged as the estimation method which best fits the model (more so than generalised method of moments and two-stage least squares). this estimation technique allows for potential sources of endogeneity inherent in the corporate governance and company performance relationship, including dynamic endogeneity, simultaneity and unobserved time-invariant heterogeneity across companies. corporate governance and financial performance nexus in the financials industry appendix 2 presents the descriptive statistics for the financials industry. notably, the descriptive statistics reveal that both performance measures, tobin’s q (roa) dropped from 1.544 (2.355) (pre-crisis) to 0.984 (2.304) (during the crisis) but recovered again after the crisis to 1.097 (3.578). this demonstrates the significant decline in company performance as a result of the financial crisis. the recovery after the crisis indicates the resilience of the financials industry to the aftermath of the global financial crisis. notably, roa was higher (3.578) after the crisis than it was before the crisis (2.355) and during the crisis (2.304), implying that the increased corporate governance compliance levels may have acted as a hedging mechanism for the south african financials companies as concluded in the study of tshipa et al. (2018b). the compliance levels in terms of all corporate governance increased during the transition from the pre-crisis to the crisis period. on average, financials companies had 11.1 board members pre-crisis and 12.4 during the crisis, with 16% representation of non-white women before the crisis and 21% after the crisis. there were 45.9% of independent non-executive directors pre-crisis, which increased to 49.4% during the crisis. the number of companies having all three board committees increased from 40% to 60% during the crisis. on average, the board met 5.05 times pre-crisis and 5.18 times during the crisis. companies that have separated the roles of ceo and chairman increased from 90% to 95% during the crisis. for the pre-crisis period, the size of the board, the presence of board committees and board diversity all had a positive impact on tobin’s q, while board independence and leadership structure had a negative influence. however, during the crisis period, board committees, board activity and leadership had a positive influence on company performance. after the financial crisis, board independence, board committees and board diversity had an inverse relationship, while board size had a positive nexus with tobin’s q. overall, all corporate governance variables, except board independence had a positive influence on tobin’s q in varying periods. this indicates that corporate governance is contingent on economic periods, even during a cross-sectional analysis. with regard to roa, before the crisis period, board committees, board activities and leadership structure had a positive impact, while the size of the board, board independence and board diversity had a negative impact before the crisis. during the crisis, the signs of the board size and board diversity changed from negative to positive, indicating that the increase noted in both parameters yielded positive results. similar to erkens, hung and matos (2012), this study found an inverse relationship between the proportion of independent directors and company performance. this indicates that companies that have more independent directors perform worse than their counterparts during the crisis period. after the crisis period, contrary to orazalin, mahmood and lee (2016), who found a negative relationship between board size and roa for russian banks, this study documents a positive association. similar to tobin’s q, all corporate governance variables but board independence had a positive influence on roa in varying periods. this indicates that regardless of the performance measure used, the proportion of independent non-executive directors had a detrimental effect on the financial wellbeing of the financials industry. therefore, the corporate governance-performance model specific for the financials industry is as follows (see appendix 1): pre-crisis period roa = − 0.5586(bs) − 6.3982(bi) + 4.4321(bc) + 0.1021(ba) − 15.268(bd) + 4.7332(ls) tobin’s q = 0.0751(bs) − 1.0817(bi) + 0.4614(bc) − 0.0527(ba) + 0.7191(bd) − 0.7126(ls) during-crisis period roa = 0.4090(bs) − 11.355(bi) + 3.8661(bd) + 3.0567(ls) tobin’s q = 0.1341(bc) + 0.0180(ba) + 0.2851(ls) post-crisis period roa = 0.1126(bs) + 0.6882(bc) − 0.2617(ba) − 5.6558(bd) tobin’s q = 0.0155(bs) − 0.1213(bi) − 0.0832(bc) − 0.3182(bd) corporate governance and financial performance nexus in the consumer services industry while most industries experienced a drop in terms of performance metrics, in contrast, the consumer services industry seems to have benefitted from the financial crisis (see appendix 3). tobin’s q increased by 92% from 1.57 (pre-crisis) to 3.01 (post-crisis). similarly, roa increased by 24% from 15.96 (pre-crisis) to 19.81 (post-crisis). the compliance levels also increased during the transitional periods, with the exception of the board activities. contrary to the expectations that the board would meet frequently during-crisis periods, in this industry, the board met fewer times during the crisis period (4.28 times less) than in other periods. table 2: regression results of the impact of corporate governance attributes on tobin’s q and return on asset for the financials industry. the results show that board size had a positive impact on tobin’s q regardless of the economic period. this supports the agency theory, namely that larger boards make more effort to reach consensus and reduce uncertainty during a recession period. in respect of roa, during normal times (preand post-crisis), board size had a positive impact on roa and inverse relationship during the abnormal times (crisis period). regardless of the performance measure used, the proportion of independent non-executive directors, convening board meetings at least four times a year and separating the roles of chairman and ceo generated negative accounting and market returns for companies in the consumer services industry. therefore, the corporate governance and performance model specific for the consumer services industry is as follows (see appendix 1): table 3: regression results of the impact of corporate governance attributes on tobin’s q and return on asset for the consumer services industry. pre-crisis period roa = 0.6181(bs) − 2.2630(bi) + 3.3026(bc) − 1.8567(ba) + 17.835(bd) − 9.0618(ls) tobin’s q = 0.0827(bs) + 0.2169(bc) − 0.1948(ba) + 3.0690(bd) − 0.6286(ls) during-crisis period roa = − 0.1800(bs) − 5.0278(bi) + 1.6685(bc) − 13.656(bd) − 5.6960(ls) tobin’s q = 0.0252(bs) − 1.2270(bi) + 0.4653(bc) − 0.1109(ba) + 1.0601(bd) − 0.6744(ls) post-crisis period roa = 0.6494(bs) − 1.5451(bc) − 1.1409(ba) + 7.7731(bd) − 2.4317(ls) tobin’s q = 0.1394(bs) − 0.8561(bi) − 0.3502(bc) − 0.2363(bd) − 0.1999(ls) corporate governance and financial performance nexus in the consumer goods industry appendix 4 reveals that while tobin’s q declined by 28% from 3.11 (pre-crisis) to 2.21 (post-crisis), roa did not suffer the same feat as it increased by 12% from 15.96 (pre-crisis) to 17.8 (post-crisis). there was an increase in corporate governance compliance levels in all respects. it is noteworthy that after the global crisis, in all companies in this industry, the positions of ceo and chairman were occupied by different people. notably, board committees had a positive influence on tobin’s q throughout the three economic periods, supporting the agency theory that constant monitoring reduces agency costs and improves performance. the committees are important to ensure that the financial procedure is carried out well and the directors are appropriately compensated, hence mitigating any agency problems and improving performance (fauzi & locke 2012). all corporate governance variables except for leadership structure had a positive impact on tobin’s q in varying periods. this implies that separating the roles of chairman and ceo does not generate any market returns in any intervening periods. considering roa, board size, board activity and board diversity had a positive correlation with the performance parameter, pre-crisis period. notably, board diversity had a positive influence on the accounting-based measure in all economic periods. the positive relationship between board diversity and financial performance is predicted by both the agency theory and the resource dependence theory (nguyen et al. 2014). notably, all corporate governance variables except board independence are positively correlated to the accounting returns. the inverse relationship between board independence and roa supports the stewardship theory, namely that management have the requisite experience and skills more than independent non-executive directors to generate positive returns for the company. therefore, the corporate governance and performance model specific for the consumer goods industry is as follows (see appendix 1): pre-crisis period roa = 0.6755(bs) − 4.4861(bi) + 0.4983(ba) + 12.748(bd) − 7.1772(ls) tobin’s q = 0.1706(bs) + 1.7962(bc) − 0.2575(ba) − 9.8164(bd) during-crisis period roa = − 4.9820(bc) + 13.998(bd) + 10.249(ls) tobin’s q = 0.1228(bs) + 1.0213(bc) + 0.1809(ba) post-crisis period roa = 0.7694(bs) + 13.327(bd) tobin’s q = 0.7935(bi) + 0.2231(bc) − 0.0608(ba) + 1.9226(bd) corporate governance and financial performance nexus in the industrials industry in terms of tobin’s q, the industrials companies were modestly affected, with a drop of 3.7% from 1.08 (pre-crisis) to 1.04 (post-crisis) (see appendix 5). the accounting-based performance measure declined by 37% from 13.58 (pre-crisis) to 8.58 (post-crisis). with regard to compliance levels in terms of king iii, industrials companies improved their compliance levels, particularly during the crisis period. the average board size increased from 10.34 (pre-crisis) to 10.77 (during the crisis) and went down to 10.45 (post-crisis). in the same vein, the board met frequently (5.27 times) during the crisis period and reverted to meeting 4.9 times after the crisis. companies within this industry also increased the proportion of non-white women representation from 13.8% (pre-crisis) to 27% (during the crisis) and reduced the composition to 19.3% (post-crisis). table 4: regression results of the impact of corporate governance attributes on tobin’s q and return on asset for the consumer goods industry. corporate governance variables, such as board independence, board committees, board diversity and leadership structure, all had a positive impact on tobin’s q, pre-crisis period. during the crisis period, board size and board committees had a positive relationship with the performance measure, while after the crisis period, there was a positive nexus between tobin’s q and both board size and board independence. notably, during normal times, board independence appears to be associated positively with tobin’s q, in support of the resource dependence theory. interestingly, all corporate governance variables appear to have a positive impact on tobin’s q in varying periods, an indication that the market sees value in corporate governance structures for the industrials industry. the finding supports the study of tshipa et al. (2018b) which posits that market returns favour agency and resource dependence theories. while the size of the board was correlated positively to roa during non-crisis periods, it had an inverse relationship during-crisis periods. in support of the stewardship theory, during the crisis period, board independence was correlated negatively with roa, which indicates that the presence of independent non-executive directors is detrimental to the accounting returns. all corporate governance variables except for board activity had a positive impact on roa during varying periods. the board activity had an inverse relationship, which could mean that the frequency of board meetings had a negative impact on accounting returns. this may be because board members are paid for all the extraordinary meetings and more often than not management are removed from their workstations to attend these meetings. this could be opportunity costs for management, which may potentially lead to negative accounting returns. therefore, the corporate governance and performance model specific for the industrials industry is as follows (see appendix 1): pre-crisis period roa = 0.1431(bs) − 1.5514(bc) + 1.5559(ls) tobin’s q = − 0.0096(bs) + 0.1867(bi) + 0.0277(bc) + 0.1652(bd) + 0.2652(ls) during-crisis period roa = − 0.1097(bs) − 4.4120(bi) + 2.1420(bc) − 0.4913(ba) + 1.8578(bd) − 1.3179(ls) tobin’s q = 0.0067(bs) + 0.1368(bc) post-crisis period roa = 0.2012(bs) + 4.8484(bi) − 1.7845(bc) − 0.3986(ba) tobin’s q = 0.0049(bs) + 0.5680(bi) − 0.1466(bc) − 0.2498(bd) table 5: regression results of the impact of corporate governance attributes on tobin’s q and return on asset for the industrials industry. corporate governance and financial performance nexus in the basic materials industry appendix 6 presents the descriptive statistics for the basic materials industry. the basic materials industry was the most severely hit by the global financial crisis, with tobin’s q plummeting by 87% from 8.76 before the crisis to 1.11 after the crisis. similarly, roa plunged by 80% from 14.47 pre-crisis to 2.87 post-crisis. the descriptive variables also demonstrate that all corporate governance characteristics improved during the three economic periods. in particular, the average leadership structure was 100% during the crisis, indicating that companies within this industry completely complied with the king iii recommendation of separating the roles of ceo and chairman. the size of the board had a positive impact on tobin’s q, before the crisis and after the crisis, indicating that board size only influenced company performance during non-crisis times. during crisis times, board committees and board activity had an inverse influence on the market-based performance measures, while board independence had a positive impact, supporting the resource dependence theory, namely that independent non-executive directors are resourceful and assist in reducing the agency costs. therefore, of the six corporate governance attributes, only board size, board independence and board committees had a positive impact on the market returns at specific economic periods. this indicates that for the basic materials industry, diversifying the board in terms of race and gender, separating the roles of chairman and ceo, as well as convening at least four times a year, did not generate market returns. regarding the accounting-based measure, board size had a negative influence on roa during the pre-crisis period and during the crisis period, with the direction of influence changing after the crisis period. consistent with the resource dependence theory, board independence had a positive impact on company performance during the crisis period. one reason for this result could be that in a recession, independent outside directors, due to interlocking and their web of network, could be providers of timely information and resources which are beneficial to the performance of a company. in support of the agency theory, board activity had a positive relationship during the entire period and pre-crisis period, while board diversity had a positive association in all intervening periods, which is an indication that diversifying boards in this industry is critical regardless of the period. however, separating the roles of chairman and ceo as well as establishing nomination, remuneration and audit/risk committees did not exhibit positive accounting returns for the basic materials industry. therefore, the corporate governance and performance model specific for the basic materials industry is as follows (see appendix 1): pre-crisis period roa = − 1.0329(bs) + 0.5359(ba) + 6.9678(bd) − 13.107(ls) tobin’s q = 0.3898(bs) during-crisis period roa = − 3.5881(bs) + 19.029(bi) + 13.899(bd) tobin’s q = 0.3420(bi) − 0.2505(bc) − 0.0283(ba) post-crisis period roa = 0.5673(bs) − 6.8687(bi) − 6.8954(bc) + 10.539(bd) tobin’s q = 0.0327(bs) + 0.1039(bi) − 0.5823(bd) table 6: regression results of the impact of corporate governance attributes on tobin’s q and return on asset for the basic material industry. conclusions the objective of this study was to investigate empirically the existence of industry nuances in the relationship between corporate governance and financial performance of companies listed in the johannesburg stock exchange. findings of this study concluded that the relationship between corporate governance and company performance differed from industry to industry as well as from period to period and should not be replicated. for instance, in line with the stewardship theory and during the pre-crisis period, board independence had an inverse relationship to performance for the financials industry, which could imply that due to the nature and complexity of the financials industry, independent non-executives added no value as they did not understand the business better than executive management. these findings are important given the increasing trend towards boardroom independence around the globe. in this case, and contrary to king iii, it would make sense to have more executive management members than independent board members. in the same vein, board independence had no impact whatsoever on the basic materials industry. the study is novel because it is the first to explore the relationship of corporate governance to company performance using a dynamic modelling approach for the south african market during three economic periods having taken industry nuances into account. the findings of the study significantly contribute towards a better understanding of international diversity in corporate governance by providing empirical evidence from the african emerging markets. the study also extends the corporate governance literature by enriching the understanding of the interaction between industry and economics dynamics and corporate governance and performance nexus. consequently, the findings of the study have the following implications: policy implications the implications of the study findings are manifold. first, all south african companies listed on the jse are legally required to report on the application of the king iii on corporate governance, as required by section 8.63 of the jse listings requirements. to this end, several implications can be drawn from the level of compliance by south african listed companies to the king iii and jse listings requirements. the analyses of the levels of corporate governance compliance indicated that corporate governance standards generally improved over the period of examination, specifically during the crisis period. incidentally, the crisis period coincided with the implementation of king iii in south africa. this implies that concerted effort of improving corporate governance in south africa by the various stakeholders, notably the institute of directors of south africa, financial services board and the jse, among others, has yielded some benefits. however, this study cautions the move from ‘apply or explain’ by king iii to ‘apply and explain’, as advocated by the recently published king iv (institute of directors of south africa 2016), because the study showed that compliance levels and performance differed on the basis of the timing and the industry classification. for instance, during the crisis periods, board independence was vital for the basic materials industry and unfavourable for the consumer services industry. hence it would be detrimental to prescribe to the consumer services industry to have more independent non-executive directors in their boardroom. finally, the results also indicated that south african companies with a greater number of board members exhibited higher accounting and market returns during non-crisis periods. however, the study found that the maximum board size should be 14 board members with the minimum being four, depending on the economic period and industry type. therefore, regulators should give companies latitude in terms of the size of the board. limitations despite the findings, this study, like any other study, had limitations. first, the results were based on south african listed companies covering only the five major industries. while focusing on south africa is beneficial in giving more detailed results on the relationship between corporate governance and company performance, these results may not be generalisable as they are specific only to south africa and to the five industries. consequently, future studies should focus on other african countries in order to provide global comparability of the corporate governance literature. few studies that look at the impact of corporate governance and performance during crisis and non-crisis consider only the financial sector. to enrich the empirical literature and allow for comparison, similar studies to this study should be replicated on a global scale. arguably, excluding other companies introduces survivorship bias. however, the sample selection criteria generated comparatively larger firm-year observations in relation to those of prior south african studies to the extent that the generalisation of the research results may not be substantially impaired. notwithstanding, these weaknesses could potentially limit the generalisation of the research findings. therefore, the research findings must be interpreted in the light of the above limitations. also, these limitations potentially represent avenues for future research. the next section points out potential avenues for future research and improvements. avenues for further studies based on the results of this study, some future research work is recommended. first, this study examined the effect of corporate governance on company performance from the perspective of agency, resource dependence and stewardship theories. this study could be enhanced by investigating the relationship between corporate governance and company performance using other established corporate governance theories such as human capital, signalling and institutional theories. the media play an important role in corporate governance promotion (lauterbach & pajuste 2017) and market returns are sensitive to public opinion. future research could consider how the media also play a monitoring role to curb agency costs. most corporate governance studies produce inconclusive results. to obviate this, future studies could employ other methodologies such as triangulation. mixing hermeneutic and quantitative methods could mitigate methodological artifacts and assist in establishing a clear link between corporate governance and company performance (rebeiz 2015). acknowledgements competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions j.t. conducted this study in pursuit of his doctoral degree. l.m.b., h.w. and e.dt. were his supervisors. all authors contributed to the writing of this 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5 table 1-a5: descriptive statistics for the industrials industry. appendix 6 table 1-a6: descriptive statistics for the basic materials industry. microsoft word 1 lopez-perez et al sajems 16(3) 2013.doc sajems ns 16 (2013) no 3:231-243 231 ownership governance and performance in spanish-moroccan joint ventures maria victoria lopez-perez, maria carmen perez-lopez and lazaro rodriguez-ariza department of accounting and finance, university of granada accepted: march 2013 this paper analyses the impact of ownership on performance by smes formed as spanish-moroccan international joint ventures (ijvs). in such smes, the functions and persons involved at different levels of governance – ownership, board and managers – often overlap. the results obtained from 210 smes suggest that owners often exert control by participating in the other mechanisms of governance. their participation as members of the board has a positive influence on performance and thus the success of the ijv, but when owners form part of the management team (a less frequent situation), the influence on performance is negative and not significant. participation by owners in the management team is not associated with the ijv’s performance. key words: international joint ventures, smes, corporate governance, ownership, performance jel: c35, f23, g32, m16 1 introduction the international joint venture (ijv) is one of the most important means by which companies, including smes, expand their activities and exploit opportunities to do business abroad (morh & puck, 2005). the foreign firm seeks a local partner who knows the market, the culture, the financial institutions and possible tax advantages and ensures that the resulting ijv is considered a local firm. thus, the creation of an ijv is a means of achieving entry into a new market. few studies of ijvs, however, have focused on smes, although this is a very common means by which such firms seek access to new markets (donckels & lambrecht, 1995; kirby & kaiser, 2003), while their circumstances and characteristics are different from those of large firms (hollenstein, 2005). one such difference is that smes are more likely to fail on account of limited resources (buckley, 1989; kirby & kaiser, 2003). accordingly, it is important to analyse which factors in smes constituted as ijvs determine the success or otherwise of this relationship. in this paper, we focus specifically on their organizational structure. an ijv can be established as either an equity-based relationship or as a contract between partners (berra, piatti & vitali, 1995; donckels & lambrecht, 1995); in the present study, we examine the first of these cases, in which there are at least two partners from different countries. the question of owners’ strategies in ijvs is an important issue in studies on international business affairs (gomes-casseres, 1989; hennart, 1991), and may be addressed from diverse theoretical standpoints; here, we consider the transaction cost theory (tce). smes have few shareholders, who are usually closely involved in the day-to-day affairs of the company. this situation makes it unlikely that the classical agency problem of large companies, i.e. conflicts between principal and agent, will occur. therefore, we examine a broader scenario in which contractual arrangements are established: the tce. the basic idea of tce is to recognize that, in a world of positive transaction costs, exchange agreements must be governed and that some forms of governance are better than others (macher & richman, 2006). with respect to ijvs, tce has been applied mainly in examining forms of entry to markets and agreements on capital structure (brouthers, 2002), but no detailed abstract 232 sajems ns 16 (2013) no 3:231-243 research has been carried out on the question of governance structure and ownership. from the tce standpoint, the complexity and composition of governance structure respond to the risks of opportunism and the existence of possible conflicts. the risks of opportunism can lead owners to establish different levels of governance. in the case of smes resulting from ijvs, the organizational structure chosen could include the participation of partners in some or all of the firm’s governance mechanisms: ownership, board and managers (rediker & seth, 1995; zhara & pearce, 1989). from an agency perspective, in respect of ownership, studies have examined, firstly, how factors such as the degree of concentration impact on performance (demsetz & villalonga, 2001). secondly, the existence of a board of directors may align the interests of managers and owners (adjaoud, zeghal & andaleeb, 2007) and its activity may influence company performance (huse, 2000; zhara & pearce, 1989). thirdly, the characteristics of the management team could explain organizational outcomes (finkelstein & hambrick, 1996). in the context of smes, another type of governance structure more suitable to this reality might be considered. owners can control activities and influence company performance by monitoring managers or by participating at different levels of governance. in many companies, and especially among smes, the same people can be found at different levels of governance and their functions often overlap (huse, 1990). sometimes companies are managed by their owners, or the latter form part of the board, and then governance functions are unified. the case of owner-directors and owner-managers frequently occurs in smes. in the case of ijvs, an additional factor is the interaction among partners, who may not necessarily share the same goals (schaan & beamish, 1988) and one or several of them may act opportunistically (williamson, 1991). the governance structure finally adopted should reflect these aspects. control is an important issue in the success of any ijv, and presents specific characteristics in smes. the aim of this research is to analyse how the mechanisms of control exerted by the owners of an sme created as an ijv may enhance company performance. to do so, we first considered the different ways in which partners exert control over firms, specifically, through their participation in different mechanisms of governance. the idea is that the model proposed for large companies may not be suitable for smes. in the latter case, there are few shareholders and the roles of ownership, board and managers usually overlap. therefore, what is needed is a model that takes these aspects into account. secondly, we examine which of these mechanisms of owners’ control impact on performance. this question is one of great importance, as the continuity of such an alliance depends on whether the expected outcomes are achieved. in this paper, we study the case of smes set up as joint ventures between companies from spain and morocco. various trade agreements exist between these two countries, and morocco enjoys a strategic location that facilitates access to markets in the middle east and the rest of africa (economic and commercial office of spain in rabat, 2010). the results of this study could be extended to other ijvs between partners from european and african or arab countries, or between those with similar characteristics (in cultural or trade agreements or agreements with emerging countries). the rest of this paper is organised as follows: in the next section we discuss previous research and introduce our hypotheses. section 3 presents the research methods applied and sections 4 and 5 set out the results achieved and discusses their implications. our conclusions and the limitations acknowledged are stated in section 6. 2 literature review and hypotheses the goal of this study is to analyse how ownership affects company performance, via the different mechanisms of governance. accordingly, we examine how the concentration of ownership and the participation of owners on the board and in management impact on performance. 2.1 ownership the relation between performance and ownership structure has been widely addressed in the sajems ns 16 (2013) no 3:231-243 233 literature on corporate governance. ownership constitutes an important element in the control of ijvs (hill & hellriegel, 1994). the risk of opportunistic behaviour on the part of one or more partners (williamson, 1991) has led to the adoption of diverse control mechanisms. in this respect, the degree of concentration of ownership is a factor in the risk of expropriation of resources (oviatt & mcdougall, 1994); in addition, it reflects partners’ capacity to influence managers. the presence of significant shareholders in ownership facilitates the process of controlling day-to-day management; this concentration of power enables owners to limit managers’ discretionality and to eliminate inefficiencies arising from their actions (shleifer & vishny, 1997). with respect to the effects of ownership structure on company performance, some empirical studies have concluded that the control exercised by owners tends to improve the quality of management decisions and performance (shleifer & vishny, 1997; wiklund, davidsson & delmar, 2003). another question that should be taken into account is that of the specific relations arising when an ijv is established. each partner may have different requirements or objectives, and these may be divergent or in conflict with those of the other partners (perrini, rossi & rovetta, 2008). a high concentration of ownership could enable one partner to control the decision-making process (blodgett, 1992; killing, 1983), to appoint managers (mjöen & tallman, 1997) and to reduce the scope for opportunistic behaviour on the part of the other partners. on the other hand, an equally-shared ownership can be an indicator of the degree of collaboration and commitment on the part of each partner (mjöen & tallman, 1997). a situation of balance among the partners could increase the level of perceived security and minimise the fear of exploitation or opportunism (steensma & lyles, 2000). we hypothesise that there is no relationship between ownership concentration and performance, since both ownership concentration and equally-shared ownership may have a positive effect on performance. the ownership structure depends on the possibility of opportunism, collaboration relationship or cultural differences between partners (nakamura, 2005). sometimes a concentration of ownership is necessary for the company to achieve its objectives, and at other times it is not. in every situation, the partners must determine the structure that will optimise their outcomes. accordingly, we establish the following hypothesis 1: hypothesis 1. in spanish-moroccan ijvs, the existence of ownership concentration has no effect on company performance. 2.2 owner directors in ijvs between spanish and moroccan firms, the existence of a board can be related to the establishment of formal, coercive channels in the organizational structure to control performance (lopez-perez, gomez-miranda, rodriguez-ariza & benghazi-akhlaki, 2009). a single partner may be in a weak position against opportunistic action by top managers or other partners, and the board can constitute an effective channel of communication between partners and management (adjaoud et al., 2007). in ijvs and smes, the representation by partners on the board is a reflection of the ownership composition (huse, 1990; killing, 1983; schaan & beamish, 1988). in the field of ijvs, governance mechanisms provide a means of satisfying the (sometimes conflicting) interests of the partners in the alliance. the board performs different roles, including advisory, strategic, control and monitoring functions (raheja, 2005; zhara & pearce, 1989); many studies have focused on the control function performed by boards in ijvs (bjorkman & lu, 1999; child & yan, 1999). in the context of smes, the different governance mechanisms frequently overlap (brunninge, nordqvist & wiklund, 2007; mustakallio, autio & zahra, 2002). in this context, the role of the board and the arrangements between partners are different from those found in large firms. the participation of owners at different levels of governance enables them to defend their own interests and to control opportunism. the agreements between partners can lead owners to be present at different levels of governance. thus, the participation of owners on the board could enhance performance, by controlling the 234 sajems ns 16 (2013) no 3:231-243 risks of opportunism and preventing conflicts. it can also provide an effective means of controlling directors’ actions (the possible entente between management and board (carver, 2000)), enabling owners to obtain internal information and hence influence decisions. the advisory role played by ownerdirectors on behalf of shareholders could also improve the performance of the firm (walsh & seward, 1990). when the board is independent of management, it is better able to monitor managers (shleifer & vishny, 1997), which can lead to better performance. finally, the board’s possession of direct, detailed information on internal processes may stimulate managers to better perform their tasks (cowling, 2003; kim & sorensen, 1986). wagner, stimpert & fubara (1998) observed a positive relation between owners’ presence on the board and company performance, while many studies have reported the existence of such a positive relation in emerging markets (klapper & love, 2004). furthermore, in smes in which board members hold a higher proportion of equity, these boards tend to be more active in developing company objectives (huse, 1990) and achieving a better performance (keasey, short & watson, 1994). within smes constituted as ijvs, the existence of owner-directors ensures that partners’ interests are defended and the risk of opportunism is reduced. therefore, the effect on performance is expected to be positive. accordingly, hypothesis 2 is proposed as follows. hypothesis 2. in spanish-moroccan ijvs, the presence of owner-directors has a positive effect on company performance. 2.3 owner managers the characteristics of the management team account for a significant proportion of the outcomes achieved by an organization (finkelstein & hambrick, 1996), so its actions can affect the functioning of the ijv (hambrick, 1994). company performance is thus a reflection of the characteristics and actions of the firm’s executive managers, or top management team (hambrick & mason, 1984). the effect of this management team on performance may be closely related to its position vis-à-vis the partners. in ijvs, the managers’ power is influenced by the control structure established by the partners (geringer & hebert, 1989), whose expectations sometimes differ (schaan & beamish, 1988) and managers have to look for a balance between the priorities and goals of the different partners (petrovic, kakabadse & kakabadse, 2006). in an ijv, the selection of the managerial team is usually agreed among the partners involved. ownership can be concentrated in one or two partners, and in this case there exists the risk that any conflicts between them may be translated to the managers who represent their interests. top managers contribute their experience and knowledge, but, in addition, they usually represent their respective partners (newman, 1995; ensley & pearson, 2005). in a context of smes, owners may act as managers, thus creating an identity between ownership and management, a situation that may or may not improve performance. the personal aims of such owner-managers will be aligned with those of the company, which should have a positive effect upon performance. in this sense, we would expect a positive relation between the presence of ownermanagers and company performance. however, if only one of the partners takes responsibility for management decisions, there might more readily be situations of conflict, and there would be a greater possibility of opportunistic behaviour. a management team comprised of owner-managers could have personal interests and non-independence in its actions (raheja, 2005). the managers would seek to attain their own objectives, which would not necessarily have a positive effect on performance. several empirical studies have provided insights into the relationship between owner-managers and performance in large companies, but their results are not transferable to the context of smes (huse, 2000) or ijvs. in the present study, we seek to determine the extent to which the identification of the management team with the ownership enhances company performance. thus, we propose the following hypothesis: hypothesis 3. in spanish-moroccan ijvs, the existence of owner managers has a direct and positive effect on company performance. sajems ns 16 (2013) no 3:231-243 235 2.4 performance in the literature on the influence of corporate governance mechanisms on company performance, the latter is normally measured using objective variables based on accounting data and market information. the instruments used include return on assets, return on equity, return on sales, tobin’s q or market to book (dehaene, de vuyst & ooghe, 2001; demsetz & villalonga, 2001; villalonga & amit, 2006). in many countries, including morocco, financial information on small companies is not normally available, and databases including this information are often non-existent. consequently, researchers commonly use financial measures based on perception, which is also the case in the field of ijvs (killing, 1983; rauch, wiklund, lumpkin & frese, 2009). furthermore, studies have shown that objective and subjective measures are correlated (geringer & hebert, 1991; glaister & buckley, 1998). in the present study, we use the degree of satisfaction attained (covin & slevin, 1989), a subjective measure. following the approach adopted by the above authors, we measured performance by the importance and satisfaction expressed by partners about the ijv’s sales, sales growth, cash flows, gross and net profit margin, return on sales and return on investment. 3 data and methods 3.1 sample selection this study was designed to analyse ijvs between spanish and moroccan companies carrying out their activities in morocco. following the methodology adopted in other studies of ijvs (bjorkman & lu, 1999; child & yan, 1999; geringer & hebert, 1991), a structured survey was addressed to the ceos of companies constituted as equity-based ijvs between spanish and moroccan smes. in accordance with the information provided by the moroccan ministry of foreign trade, in september 2009 there were 645 smes formed as spanish-moroccan ijvs. in this study, we used the definition of smes proposed by the european commission, i.e., a company that employs fewer than 250 employees (commission recommendation 2003/361/ec). the questionnaire was comprised of 33 questions in which a total of 52 issues were addressed. the questionnaire was presented telephonically during october 2009. we received 231 replies, which represented a response rate of 32.5 percent. of these, 21 replies were discarded because they were incomplete, incorrectly expressed or else they corresponded to large companies. the final sample was comprised of 210 valid surveys of smes, of which 65 percent were small and 35 percent medium-sized; 30 percent were controlled by a board of directors and 70 percent by a single director. the confidence level was established at 95 percent, with a sampling error of 5.6 percent. 3.2 variables and measures dependent variable. the dependent variable used was performance. as stated above, the covin and slevin scale (covin & slevin, 1989) was employed as a subjective measure of financial performance. we measured financial performance according to perceptions of sales, sales growth, cash flow, gross and net profit margin, return on sales and return on investment, with all data referring to 2009. we thus obtained a weighted average performance index for each firm. the mean score was 11.94; the standard deviation was 3.75, with a range of 3.8 to 24.5 and a cronbach alpha score of 0.94 was recorded. in countries such as morocco, where there is usually no legal obligation to disclose financial information, a subjective variable must be used to measure business success. prior to our analysis, however, we examined the relationship between subjective and objective measures. the correlations between the objective and subjective variables were calculated for 76 data items, corresponding to the number of firms for which objective measures of financial performance were available (dess & robinson, 1984). the results obtained (table 1) show that the subjective and objective variables used to measure performance do indeed correlate, so the subjective measure can be used to measure performance. 236 sajems ns 16 (2013) no 3:231-243 t a b l e 1 correlations for objective and subjective variables (pearson coefficient) objective performance measures (n = 76) growth in sales return on assets return on equity overall company performance subjective performance measures (n = 76) growth in sales 1 return on assets 0.63** 1 return on equity 0.54 0.60** 1 overall company performance 0.30 0.43* 0.67* 1 ** p< 0.01 * p< 0.05 independent variables. ownership is described by means of three variables: one for ownership concentration and two for the presence of ownership in other governance mechanisms. these variables enable us to study the possible correlation between ownership and board, and between ownership and management. the measure of ownership concentration (blockholder) is calculated using the percentage of shares held by the partners. a categorical variable was constructed, with three possible values: 0 in the case of no blockholders; 1 for balanced holdings among the partners; and 2 for a majority holding by one of the partners. to describe the shareholdings of the top executives and other board members, two dichotomous variables were used (linck, netter & yang, 2008); the first, director_ owner, addresses whether members of the board and their families are owners. this variable takes a value of 0 when board members are not owners (21 percent of the cases) and a value of 1 otherwise (79 percent of the cases). the second variable, management-owner, takes a value of 0 when the ceo, the top management team and their families are not owners (78 percent of the cases), and 0, otherwise (22 percent of the cases). control variables. although in smes the board of directors usually exists only on paper, there are companies that have active boards which are strongly engaged in the company’s activities. in any case, smes normally have small boards of directors (cowling, 2003). the participation and involvement of the board may be studied in relation to its size, board size, measured by the number of directors (linck et al., 2008; markarian, parbonetti & previts, 2007), and by board meeting, measured by the number of board meetings held annually (sapienza, manigart & vermeir, 1996). the size of the top management team can also influence performance. in the context of smes, the fact of a small number of executives might promote efficiency, via greater proximity to the owners. on the other hand, the existence of a large number of managers might reflect conflicting interests among partners. in the case of joint ventures, each partner may try to influence management and defend its interests; but the existence of a more powerful partner could decisively influence the size and composition of the management team and alignment (child & yan, 1999). moreover, the size of the top management team provides a measure of the greater or smaller quantity of resources and skills available for decisionmaking. in companies with small management teams (as may occur in smes), it is more difficult to distribute responsibilities and to establish diverse functional areas (bantel & jackson, 1989). on the other hand, large management teams may enjoy greater possibilities for problem-solving, owing to the existence of a greater volume of data, more critical judgements in the analytical process, an increased number of possible strategies to achieve solutions and a larger range of perspectives to bring to bear upon a problem (hoffman & maier, 1961). however, although large groups present considerable advantages, their size may also bring about problems of coordination and communication, which do not affect small groups (blau, 1970). top management team was recorded as the sajems ns 16 (2013) no 3:231-243 237 number of members of the top management team (ensley & pearson, 2005). other control variables included were the company size (firm size), measured by the number of employees, its maturity (firm age), determined by the number of years the company has been active, and the industry (industry), distinguishing between manufacturing and trading companies. 4 analysis and results table 2 shows the correlations and the descriptive statistics for the variables analysed in this study. there is a negative correlation between performance and board size and the number of board meetings, and a positive relation between performance and firm age, and firm size and the existence of ownerdirectors. we found a negative correlation between the existence of owner-directors and board size, and also with the number of board meetings. moreover, the existence of ownermanagers is negatively associated with the size of the management team. finally, the existence of blockholders is negatively associated with the number of board meetings. we found a correlation between firm size and board size, the number of board meetings, the size of the top management team, firm age (maturity) and the industry sector. table 3 shows the multiple linear regression analysis results used to test the hypotheses. t a b l e 2 descriptive statistics and correlations for variables variables mean s.d. correlations 1 2 3 4 5 6 7 8 9 10 1 performance 13.11 4.22 1 2 board size 1.50 2.67 -0.20* 1 3 board meeting 1.48 3.81 -0.24** 0.66** 1 4 top management team 3.96 4.68 -0.03 0.02 0.02 1 5 firm age 13.76 8.83 0.14* 0.07 0.08 0.10 1 6 firm size 65.36 15.21 0.15* 0.20* 0.19* 0.33** 0.24** 1 7 sector 0.75 0.43 -0.04 -0.02 0.08 -0.08 0.05 -0.16* 1 8 director owner 0.80 0.40 0.18* -0.21* -0.15* 0.07 -0.13 -0.01 -0.07 1 9 management owner 0.22 0.42 -0.05 -0.15 -0.09 -0.15* -0.07 -0.07 -0.12 0.03 1 10 blockholder 1.45 0.78 -0.08 0.01 -0.08* 0.11 0.05 0.01 0.01 0.06 0.01 1 ** p<0.01 * p<0.05 initially, the control variables included were those for industry, and company maturity and size (model 1), in order to analyse the aspects accounted for by these variables. of these, only company size was found to be a significant variable. the explanatory capacity of these control variables amounted to 14 percent of the variance. subsequently, the control variables related to governance, board size, the number of board meetings and top management team size were incorporated (model 2). the table shows that this set of control variables accounts for 19 percent of the variance. the significant variables were the number of board meetings and company size. the first of these presented an inverse relation, i.e. greater numbers of board meetings were associated with poorer performance, while company size was found to have a positive effect, i.e. large companies tend to achieve better levels of performance. the number of board meetings constitutes an explanatory variable, and board size is not significant. a certain degree of correlation was observed among the variables addressing the activity of corporate governance, which might account for the fact that only the number of board meetings is explanatory in the model. this fact suggests that the number of board meetings is more explanatory of company performance than is the board size. the other variables – industry, company maturity and board size – are not statistically significant. 238 sajems ns 16 (2013) no 3:231-243 t a b l e 3 regression coefficients and statistics dependent variable: performance model 1 model 2 model 3 independent variables director_owner 0.18 (0.00)** management_owner 0.05 (0.51) blockholder 0.09 (0.25) control variables firm size 0.20 (0.00)* 0.20 (0.00)* 0.21 (0.01)** firm age 0.13 (0.10) 0.15 (0.05) 0.17 (0.03)* industry 0.04 (0.67) 0.02 (0.85) 0.03 (0.75) governance control variables board size -0.12 (0.25) -0.09 (0.36) board meeting -0.24 (0.00)** 0.22 (0.00)** top management team -0.05 (0.51) 0.07 (0.27) adjusted r square 0.14 0.19 0.29 f-statistic 6.514 8.131 6.671 probability 0.01 0.00 0.00 ** p <.01 * p < .05 in the following step (model 3), the independent variables were introduced in order to test hypotheses 1, 2 and 3. the inclusion of these variables in the model increases the amount of variance accounted for by the initial model. examination of the regression coefficients shows that the presence of owners on the board does influence performance, so hypothesis 2 is confirmed. as we hypothesised, the influence of block holders does not explain performance, and thus hypothesis 1 is accepted. when ownership and management coincide, the relation with performance is inverse and non-significant. thus, hypothesis 3 is rejected. on the other hand, the control variables of maturity and size were found to be significant elements in accounting for company performance. the industry variable is not significant. in relation to the governance control variables, board meeting is a significant variable and presents an inverse relationship with respect to performance. finally, neither the top management team variable nor that of board size was found to be significant. 5 discussion in this study, we examine the influence of ownership and its involvement in management on business performance. the context of ijvs between spanish and moroccan partners is characterised by the existence of a number of smes in which ownership is concentrated in a small number of partners. the owners normally participate in other mechanisms of corporate governance, mainly as members of the board. we must therefore analyse the influence of ownership, both directly and via participation in other governance structures, on performance. the results of the regression analysis show that company performance is indeed affected by ownership, although its influence is exerted indirectly, through the board. on the one hand, when it comes to ownership, the results show sajems ns 16 (2013) no 3:231-243 239 that the relation between a high concentration of ownership and performance is positive, but not significant. accordingly, hypothesis 1 is accepted. in the spanish-moroccan ijvs analysed in this study, in most cases (66 percent) there was a blockholder. only in 11 percent of ijvs was ownership shared 50 percent. in this context, it can be appreciated that the ownership structure adopted has no effect on performance. each firm adopts the most appropriate ownership structure for the objectives of the partners, according to the agreement and the contributions to be made by each partner. our sample consists of mature and successful firms (average firm age 14). the current ownership structure is suited to the interests of the owners. the owners use different control mechanisms to direct the decisions and also participate in other mechanisms of governance (hill & hellriegel, 1994). there is a tendency to opt for a concentrated form of ownership, as in other emerging countries, possibly in order to protect owners from the dangers of expropriation and opportunism (oviatt & mcdougall, 1994). nevertheless, the form of ownership structure does not affect performance. when the owners act as members of the board, this affects performance; in other words, the influence of owners on performance is effected through their participation on the board (cowling, 2003; sheiler & vishny, 1986). according to the results obtained from this study, boards of directors are usually relatively small, although this is not indicative of a less active board (markarian et al., 2007), at least as far as performance goes. the proximity of owners enables them to exercise day-to-day supervision of the firm’s activities, to control opportunism and to propose remedial action when necessary. our study highlights the effectiveness of these actions. this role enables them to obtain internal information and to influence the decisionmaking process (walsh & seward, 1990). our study reveals that owner-directors act in the same ways as owners do when it comes to achieving their goals (linck et al., 2008). indeed, this explanatory variable was found to be the most significant of all those analysed. thus, the task of these members of the board is to control and supervise the management of the firm. the results also demonstrate the independence of these board members from the top management team, as the latter exert a contrary effect on performance (carver, 2000), although it is not a significant variable in the model. in our sample, the proportion of ownermanagers was not very high (18 percent) with respect to owner-directors (80 percent). most of the ijvs sampled maintained a separation between ownership and management. the correlation analyses performed show that the existence of owner-directors was associated with smaller management teams, which could be indicative of a certain proximity to the ownership (child & yan, 1999). however, the participation of owners in the management team, though infrequent, is not associated with an improvement in the ijv’s performance, which might reflect the existence of conflicts and opportunism on the part of the partner responsible for management activities (morh & puck, 2005) who does not act independently (raheja, 2005). thus, the manager who is at the same time an owner will seek to attain his/her own goals, and take less account of the performance achieved by the ijv. we found that the actions by owner-managers were not aligned with those of the partners, and the relation, although not significant, was negative, so hypothesis 3 cannot be accepted. this conclusion could reflect different interests among owner-managers and other partners. regarding the impact of board size and the number of board meetings on performance, we found the effect of both parameters to be negative. these variables correlate with performance, but their relationship is not significant in the regression model. smes normally have small boards of directors. the activity of the board and its influence, measured via the number of interactions (sapienza et al., 1996), has a negative effect on company performance. the lack of positive results, or the perception of this, could imply a that more meetings were being held to find solutions. in addition, large boards might be related to the conflicts taking place between partners in the ijv. in relation to the influence of the size of the top management team on company performance, the results obtained show that this factor is not significant, and it does not seem to 240 sajems ns 16 (2013) no 3:231-243 affect the performance of ijvs (finkelstein & hambrick, 1996; hambrick & mason, 1984). thus a large top management team does not imply positive effects on performance. the coefficient of the top: control may be exercised by owners through other mechanisms of governance; or the coefficient might be negative because efficiency in these firms is related to supervision by the ijv partners, and to the small number of top managers. this effect might also arise from the fact that the aims of top management do not coincide with those of owner-directors and owners; in this case, the power and predominant control of management are exercised by the board. this control mechanism then tends to replace managerial action. when performance is measured via the degree of satisfaction achieved, it is apparent that the parties’ interests are disparate. the existence of partners with possibly divergent interests would induce the management team to act in accordance with its own aims and objectives or in favour of one partner over the others. this might explain the negative relation between the size of the top management team and company performance. finally, company performance is positively related to its size and age. thus, in a longerestablished firm, the partners have overcome their possible differences and have agreed upon common goals. firm size is also related positively to performance. larger companies present greater partner satisfaction, perhaps because they are able to distribute functions and avoid conflicts in this way. firm size is related to the presence of a larger board, to larger top management teams and to a higher frequency of board meetings. we found an inverse relationship between industry sector and firm size. 6 conclusions in smes, the role of ownership is very significant, to the extent that owners often intervene directly or through other governance management mechanisms (board and top management team). in ijvs between spanish and moroccan companies, the ownership is often highly concentrated, with a strong presence of owners on the board, which facilitates the alignment of goals between owners and managers, thus favouring satisfaction with the outcomes achieved. the two mechanisms of corporate governance coincide in focusing mainly on control of management in order to achieve objectives and produce a positive effect on company performance. smes normally have small boards of directors, an organizational structure that has a positive influence on performance. the board size and the number of board meetings might be related to the existence of problems between partners or to the need to resolve conflicts and find solutions. although studies have been conducted on the effects of ownership on the different mechanisms of governance, they have mainly examined separately the effects on performance of the existence of owner-managers and of owner-directors. diverse effects on performance have been observed in this respect; potential differences between partners may be transferred to the management team, or management may exploit the partners’ weaknesses in order to achieve its own goals. the present study highlights the important role played by owners in smes in the case of companies formed as ijvs. according to the results obtained in this study, it is necessary to make a separation between control and management in order to ensure the satisfactory development of company activity, as these mechanisms have inverse effects on performance. in areas where there is a strong concentration of ownership and a limited number of partners, the control exercised over company activity is a deter-mining factor, and the role of top management then becomes subsidiary and has no significant effect on company performance. this control is more effective when owners are involved as board members. our results show that the top management team is not aligned to owners. when owners cannot trust management, they develop other mechanisms of governance (for example, via a strong board or direct control) or else they become involved as ownerdirectors. experience and size are related to performance. with greater experience, an organizational culture can accumulate to solve conflicts and to avoid opportunism, thus sajems ns 16 (2013) no 3:231-243 241 improving performance. a positive effect on performance is also obtained by greater firm size, enabling it to allocate functions and avoid possible conflict. the results obtained in this study could be extended to other ijv experiences with similar cultural characteristics, such as those involving european and arab or african companies. let us point out some limitations of the present study. in the first place, the fact that results were obtained by means of questionnaires means that a certain degree of subjectivity was introduced. we attempted to overcome this by using generally-accepted tests to ensure reliability and by using objective performance data, but there is always the possibility of some bias affecting the results. furthermore, we examined companies that are active in different sectors and with different systems of governance, which enabled us to increase the generalization of our results, but also led to some heterogeneity that would have been avoided by the use of totally uniform samples. it should also be observed that, although the model obtained provides a good account of the variance, the mechanisms of governance and its goals constitute a complex issue for study, and that further examination of various aspects is required, such as the strategic objectives, which might be more representative of the fundamental justification for the ijv. finally, we have focused on ownership, but there may be many other mechanisms (outsiders, ceo duality) that could provide a more 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performance: a review and integrative model. journal of management, 15:291-334. microsoft word 3 hough & serfontein sajems 14(4) 2011.doc sajems ns 14 (2011) no 4 393 nature of the relationship between strategic leadership, operational strategy and organisational performance kobus serfontein psg konsult, cape town johan hough department of business management, university of stellenbosch accepted: september 2011 since the mid-1980s a growing body of leadership research has focused on strategic leadership, in contrast to managerial and visionary leadership. it focused on how top leadership makes decisions in the short term that guarantees the long-term viability of the organisation. the best performing organisations are consciously strategic in their leadership planning. these top leaders also have the ability to align human resources in an effective way directly to the business strategy. this article identifies some of the direct and indirect pathways in which strategic leadership influences the operational strategy and performance of business organisations in south africa. this research pinpointed theoretical and substantively meaningful endogenous organisational capabilities that mediated this relationship and exogenous organisational factors that moderated this relationship. key words: strategic leadership, operational strategy, organisational performance jel: m14 1 introduction wheeler, mcfarland & kleiner (2008:1) argue that: a rapidly changing world has created a society craving for speed and action. future leaders, therefore, face incredible pressures to deliver immediate results, to do more with less and to manage an ever-increasing personal workload. the pace and urgency of daily demands can make it difficult to be more than the step ahead into the future. but in a world of changing conditions and priorities, leaders and individual contributors alike must be able to look beyond the ‘now’ and take a more strategic leadership approach to their work and responsibilities. without effective strategic leadership, the probability that an organisation can achieve superior, or even satisfactory, performance when confronting the challenges of the global economy will be greatly reduced (hitt & ireland, 1999). what, then, is strategic leadership? wheeler, mcfarland & kleiner (2008:1) have explained it as follows: it is nothing more than the ability to anticipate, prepare and get positioned for the future. it is also the ability to mobilise and focus resources and energy on the factors that make a difference and will position one for success in the future. it is the courage to think deeply about what one wants to do. applied strategic leadership is about creativity, intuition and planning to help one reach one’s destiny. great leaders are judged as much by what they leave behind as by what they achieve during their tenure. a vibrant, vital organisation that is fiercely competitive and driven to excel is, of course, an important legacy for a leader (boal & hooijberg, 2001). this means having in place a high-performing1 team, a thinking abstract 394 sajems ns 14 (2011) no 4 organisation and managers and employees at all levels passionately committed to getting things done. in this context, this study identifies the direct and indirect pathways to strategic leadership practices from the literature, with an empirical survey of the top 200 listed south african organisations of 2008 in order to ascertain how these antecedents influence the success of these organisations. 2 importance of the research the importance of improving economic growth and international competitiveness, and building south africa’s capacity to implement high performing strategic leadership practices was discussed in the introduction. government, the private and public sectors view the capacity to implement strategic leadership as a crucial initiative towards the future success of south africa. however, because of various complexities, business organisations in south africa find it particularly difficult to implement strategic leadership practices (see human capital management, 2005/6). on a practical level, business leaders need guidelines to identify and overcome obstacles that stand in the way of strategic leadership practices. the stratified systems theory of jacobs and jaques (1987) classifies the performance requirements for leaders in organisations as direct, general and strategic. distinct elements define the leadership environment within each level. unmistakable differences among the three levels include complexity, time horizons and focus (see guillot, 2003). most leaders spend their careers leading at the direct or tactical level. in this environment, the leader interacts directly with the same people every day by maintaining a direct span of control. the time horizon is very short – normally less than one year. at the direct level of leadership, communications generally occur with the same organisation and focus exclusively on the internal audience. because business leaders spend more time at this level than any other, it becomes familiar and comfortable (guillot, 2003). some business leaders however, will mature and move to the general or operational level, where performance requirements begin to change. from the perspective of budding strategic leaders, performance requirements for the strategic level change the most and are least familiar. it is important for those leaders to use integrative thinking as the challenges are great, the stakes are high and the performance requirements are stringent. it is therefore very important to convince south african business leaders to use their integrative thinking to comply with the stringent performance requirements in our business organisations and country. the impetus and importance for the research can be divided into three main areas: • the importance of building organisations’ capability to implement high performance strategic leadership practices. • the practical value thereof to business leaders in south africa. • the lack of research in south africa on the impact of strategic leadership on the operational strategy and performance of south african business organisations. 3 literature review/background few leaders allow themselves to think about strategy and the future. leaders should give direction to every part of the organisation – from the corporate office to the loading dock. strategic leadership is therefore the ability of the leaders to create and recreate reasons for the organisation’s continued existence. the leader must have the ability to keep one eye on how the organisation is currently adding value and the other eye on changes, both inside and outside the organisation, that either threaten its position or present some new opportunity for adding value (montgomery, 2008). 3.1 explaining strategic leadership rowe (2001:82) defined strategic leadership as: ‘the ability to influence others to voluntarily make day-to-day decisions that enhance the long-term viability of the organisation, while at the same time maintaining its short-term financial stability.’ amos (2007:3) has a similar view to rowe and defines strategic leadership as: ‘the ability to sajems ns 14 (2011) no 4 395 understand the entire organisation and the environments within which they operate and using this understanding to create strategic change through other people so as to position the organisation in the environment for both short-term stability and long-term viability.’ hitt, ireland and hoskisson (2007) conceptualise strategic leadership as the ability to anticipate, envision, maintain flexibility and empower employees to create strategic change as necessary. boal & hooijberg (2001) take an individual competence level focus. they suggested that effective strategic leaders must create and maintain absorptive and adaptive capacity in addition to obtaining managerial wisdom. absorptive capacity involves the ability to learn by recognising new information, assimilating it and applying it in a disciplined manner. adaptive capacity involves the ability to change due to variations and conditions. 3.2 operational strategy and the impact of strategic leadership on the strategy of an organisation the primary task of high performance leaders is to provide strategic direction to the organisation, various departments and divisions within the organisation, and to the people who ultimately implement strategic leadership. people at ‘the top’ of the organisation, normally in executive leadership positions, have tended to control over strategic processes. they have tended to make decisions, crate policies, and inform people who report to them about the tasks and objectives that must be fulfilled. in essence, they have exercised ‘power over others’ as the main means of getting things done. in the process they have often become alienated from the realities of operational demands and challenges. to compete, survive and perform in a highly competitive environment, an organisation's strategy must be aligned with that of its environment and at the same time the organisation must have the capabilities that fit its strategy. this is to say that ‘fit’ (see beer, voelpel, leibold & tekie, 2005) must be achieved within the organisation as well as with the business environment. to accomplish this alignment, leaders have to be open to learning about how their decisions and behaviours fit the environment, strategy and organisation. this suggests that effective leaders enable their organisations to confront the tensions that prevent alignment and, through a collaborative process, reshape alignment at several levels: between environment and strategy, strategy and organisation, organisation and the leadership team, and between key people (porter, 2008). many organisations deploy the latest approaches to organisational efficiency in hopes of achieving fit, but too often find that they are unable to reap the full benefits from such activities (baden-fuller & stopford, 1994). one of the main reasons for this is the lack of an integrated approach that changes multiple dimensions of the organisational system, particularly key organisational capabilities and leadership behaviour. porter (2008) confirms the viewpoints above, stating that understanding the forces that shape industry competition is the starting point for developing strategy. every organisation should already know what the average profitability of its industry is and how it has changed over time. most importantly, an understanding of industry structure guides leaders towards fruitful possibilities for strategic action, which may include any or all of the following: positioning the organisation to cope better with competitive forces; anticipating and exploiting shifts in the forces; and shaping the balance of forces to create a new industry that is more favourable to the organisation. the best strategies exploit more than one of these possibilities (porter, 2008). as the best practices and new competencies start to become entrenched, the organisation and its people become increasingly ready to make a quantum shift that is capable of transforming the organisation. this is the step where it becomes possible to expect and demand the wide-spread execution of strategic leadership and competitiveness practices, and to require leaders across all levels to live the values that accompany this shift. in change leadership terms, it is the time when it is both possible and desirable to increase the pressure to practice the strategic leadership requirements (rowe, 2001). 396 sajems ns 14 (2011) no 4 by this stage all policies and procedures, as well as practices that contribute to organisational development and culture, should be aligned to the shift towards good strategic leadership practices (see figure 1). f i g u r e 1 organisational performance and managerial, visionary and strategic leadership organisational performance managerial leadership capability lo hi hi visionary leader strategic leader managerial leader high low source: rowe (2001:84) montgomery (2008) further stated that it is the responsibility of the executive leadership to formulate a challenging view of the future, providing the organisation with a clear idea of where threats could come from and how the organisation is positioning itself to cope with them. having some certainty, amidst the uncertainty of the future, is crucial. while endless scanning and assessing of all factors cannot pre-empt future threats completely, all employees in the organisation have to know that there is a plan to cope with some eventualities. 3.3 the leader’s responsibility for the implementation of strategy in the past, strategy execution tended to be top down; in future, strategy execution rests with everyone. the ‘what’ of strategy will always come top down, so it is the execution that is different in future organisations. organisations can all go about their business brainstorming and creating something they call strategy, but the institutional capacities and capabilities of driving it through onto ground level is a totally different challenge. leadership fluctuates. in the past leadership was clear – they knew who the leader was and who the followers were. in future, the leader sometimes needs to be a follower. collins (2005:9) has brilliantly put it forward that: ‘we cannot see something from the perspective of another if we do not have deep humility, because without it we impose our own perspective or analyse things from our own perspective only; we will not see the other person’s viewpoint.’ what this means is that the leaders of an organisation need to readdress their role in terms of practices and power. organisations need to consider whether their leaders recognise, appreciate and embrace their power (nel & beudeker, 2009). 3.4 organisational performance many organisations can appear to be high performers in the short run – by riding favourable market conditions, for example, or by being fortunate with a single product or market position – only to decline quickly when business conditions turn against them. to be a true high performer, an organisation must survive and thrive across economic and market disruptions. to measure the sajems ns 14 (2011) no 4 397 performance of organisations, it is important not to only use a single measurement, but to use different dimensions. breene and nunes (2006) proposed, after many years of qualitative and quantitative research towards the performance of organisations, that the following five dimensions (critical success factors) can be used as measurement, grading each on a curve against competitors in a carefully considered peer set: • growth as measured by revenue expansion. • profitability as measured by the spread between the return on assets and cost of capital. • positioning for the future – as represented by the position of share price that cannot be explained by current earnings and by the position of the industry total each organisation’s future value represents. • longevity as measured by the duration of out-performance in total return to shareholders. • consistency as measured by the number of years out of seven the peer set median in profitability, growth and positioning for the future was beaten. the role of leadership is of fundamental importance to the performance and success of organisations. this includes many aspects like visionary, motivator, enabler, facilitator as well as mentor and coach. its importance has been identified in the work of fawn and leavy (see breene & nunes, 2006). their research aimed to establish the portfolio of attributes exhibited by leaders in two groups of organisations. the attributes with the highest ranking are those which are intuitive and require exceptional leadership skills. they are direction, vision, selection of key personnel, people motivation and communication. the leader must also understand the critical interplay between capabilities and value creation, a relationship that goes to the heart of high performance in business organisations (breen & nunes, 2006). to create value, each high-performing organisation develops a formula for doing business – either at the enterprise or business unit level – that successfully translates a big idea regarding customer needs into a unique set of connected business processes and resources that costeffectively satisfy those needs. innovation and talent management are also two of the essential capabilities needed for high performance in a business organisation. the investment in training and leadership development to enhance innovation and the development of talent has been observed as a crucial strategic focus in high-performing business organisations (nel & beudeker, 2009). every high performing business organisation also has a high performance culture. if you spend any amount of time with leaders and employees of a high-performance business organisation, you will get an almost palpable sense of the organisation as a distinctive community. nel and beudeker (2009:12) call this a ‘village of leaders’ as a unique way to approach the core and common business elements related to culture, leadership and workforce. a culture of performance embodies an organisation’s unique approach to managing those elements common to every organisation, and is therefore crucial to long-term effectiveness, the quality and speed of decision making and the mastery of change and innovation. so how do organisations harness this to optimise performance? nel & beudeker (2009) suggest that: they have developed an integrated framework that is specifically engineered to achieve optimal performance. although each of the frameworks can be used as a standalone tool, it is only when they are used in conjunction with one another that organisations will truly be able to achieve the type of turn-around required to take them to worldclass status. there is, however, a practical challenge that an organisation will have to consider at all times. this study provides insights into the best operating practices that sustainably competetive organisations have entrenched through many years of exquisite effort and focused leadership. it is impossible to achieve success with one great leap and there is no evidence at all of any organisation that has ever achieved world class performance in a short period. 398 sajems ns 14 (2011) no 4 4 research methodology 4.1 hypotheses against the backdrop of the literature review provided, it is expected that operational strategy and organisational performance will be influenced by strategic leadership practices. strategic leadership can, therefore, be viewed as a competency, that is, creating capabilities within an organisation by the acquisition, recombination and renewal of these activities and resources (eisenhardt & martin, 2000; miller, eisenstat, & foote, 2002). following from the above, these two hypotheses were tested: h1: strategic leadership is directly and positively associated with operational strategy. h2: strategic leadership is directly and positively associated with organisational performance. the purpose of this quantitative study was to determine how strategic leadership is associated with operational strategy and organisational performance in business organisations in south africa. 4.2 survey and sample a cross-sectional survey design consisting of two phases was used: a pilot study to test the measuring instrument and the administration of a telephone survey. the results of the pilot study determined the refinement of the questionnaire. the telephone survey was conducted by an independent organisation from january to march 2009. the sample selected for this study consisted of the 200 top-performing organisations that were part of the financial mail survey of 2008. the organisations represent all major industry groups. financial and industry performance information has been used from the 2008 financial mail survey. in this survey, the performance of these organisations was measured over a five-year period to ensure consistency in their performance. the respondents in the survey were the chief executive officer (ceo) or a member of the senior executive group. their responsibilities in their organisations give them a unique and comprehensive view of strategic leadership activities. all 200 top performing organisations in south africa for 2008, as published in the financial mail survey, were part of the sample. a total of 118 valid responses were received, or a response rate of 59 percent. data was captured electronically during the interview. 4.3 measurement instrument a measurement instrument was developed to measure the impact of strategic leadership on operational strategy and organisational performance. items of existing measurement instruments were combined, expanded, adapted or reduced as required to achieve the goals of the study, taking the prerequisites of validity and reliability into account. the measurement instrument needed to measure: • strategic leadership (independent variable) o action o coherence o discipline • strategy orientation (dependent variable) o strategy creation and formulation o strategy execution • operational excellence (dependent variable) o cost management o product differentiation o integration • organisational performance (dependent variable) o roa (return on assets) o eps (earnings per share) o self-reported performance to measure strategy orientation in the sample companies the two scales of strategy creation and strategy execution were used based on treacy and wiersema’s (1995) strategy model. organisations were asked: ‘to what extent do the following statements best describe your workplace’s competitive strategy?’ porter (1996) argues that operational excellence can be seen as a particular type of cost-management positioning. he also states that organisations can only attain a competitive advantage and earn superior returns if they pursue a dedicated positioning strategy. treacy and wiersema (1995) include more than costsajems ns 14 (2011) no 4 399 management as operational effectiveness. they refer to practices that allow a company to better utilise its inputs by developing better products faster and reducing defects in products. the effective integration of functional areas is a key factor for operational effectiveness and offers different advantages in successful management of industry change (kaplan & norton, 2004). organisational performance was measured using the two financially based measurements of roa en eps, as published in the financial mail (2009) survey, listing the 200 top performers in south africa in 2008. in addition to financial measures, self-reported performance measures were used in this study. organisations were asked to indicate their current level of performance relative to their competitors for each of the six performance measures. these performance measures were adaptive leadership, autonomy, communication, processes and systems, knowledge and values. these were enhanced by questions formulated by the researcher and based on the literature to ensure that each variable in the measuring instrument was represented by at least three items. 4.4 cronbach alpha coefficients cronbach alpha coefficients were computed and used to assess the internal consistency of the measuring instrument on responses obtained from the pilot study. the estimated cronbach alpha coefficients for the independent variable of the strategic leadership constructs of action, coherence and discipline were 0.77, 0.76 and 0.75 respectively. the cronbach alpha coefficients of the dependent variables of strategy orientation were 0.76 and 0.66 respectively. with regards to the dependent variable of operational excellence, the cronbach alphas were 0.71, 0.87 and 0.72. all the researched coefficients would appear to satify nunnally’s (1978) suggested minimum criterion for internal reliability. the data were analysed by using the statistica (stratsoft, 2008) programme. exploratory data analysis (eda) was used to assess individual variables, and descriptive statistics – such as means and standard deviations – were used to describe the data. additionally, inferential statistics were employed to determine the relationships between the constructs of strategic leadership and operational strategy as well as organisational performance. 5 results corporate characteristics and a descriptive analysis are presented in this section. the profile of the sample is discussed in terms of two characteristics: annual turnover and the size of the organisation. thereafter a comparative analysis of the specific dimensions will be discussed. 5.1 corporate characteristics of respondents the corporate characteristics of the respondents are discussed in terms of the two variables: number of employees and annual turnover. as seen from figure 2, the largest proportional category was organisations with 1-1000 employees, which represented 38.3 percent of the respondents. the majority of the organisations (72.61%) had a staff complement of between 1 and 5000 employees. the study also revealed that the majority of the organisations (67.57%) reported a turnover of between 1 and 15 billion rands. 400 sajems ns 14 (2011) no 4 f i g u r e 2 number of employees and annual turnover 5.2 descriptive analysis of the dimensions a descriptive analysis of the dimensions was conducted as part of the exploratory approach to analysis of data. a profile of the respondents participating in the study is shown in table 1, using mean, standard deviation and cronbach alpha. the respondents answered all the questions pertaining to strategic leadership, operational strategy and organisational performance. all the questions were measured on a nine-point scale. the mean of strategic leadership (action, coherence and discipline) constructs were calculated from both the operational strategy and organisational performance constructs. the standard deviation shows how the observations are spread around the mean. t a b l e 1 descriptive statistics of constructs n = 118 dimension min/max values mean (sd) cronbach alpha strategic leadership action 4/36 27.07(4.14) 0.77 coherence 3/27 21.72(3.42) 0.76 discipline 5/45 35.40(5.02) 0.75 operational strategy creation and formulation of strategy 3/27 19.54(3.89) 0.76 execution of strategy 3/27 20.42(3.11) 0.66 organisational performance cost management 3/27 21.31(3.08) 0.71 product differentiation 4/36 28.23(4.43) 0.87 integration 4/36 26.74(4.11) 0.72 adaptive leadership 3/27 20.67(3.33) 0.72 autonomy 3/27 21.52(3.04) 0.72 communication 3/27 19.00(4.12) 0.90 process & systems 4/36 28.24(3.88) 0.72 values 3/27 22.41(3.25) 0.77 knowledge 3/27 21.18(2.88) 0.43 sajems ns 14 (2011) no 4 401 5.3 comparative analysis in this section the aim is to determine whether certain key variables are significantly associated, and furthermore whether certain sub-groups are significantly different. correlations among certain variables were calculated and the p-values were used to determine whether the differences among the constructs were significant. the focus is on the following specific dimensions: • strategic leadership and operational strategy • strategic leadership and organisational performance figure 3 illustrates the influence of strategic leadership re-conceptualised as three interrelated constructs of action, coherence and discipline as exogenous constructs (serfontein, 2010:223-225). f i g u r e 3 an illustration of the conceptual correlation model of strategic leadership, strategy orientation, operational excellence and organisational performance endogenous constructs of strategy orientation, operational excellence and organisational performance are also displayed. strategy orientation is measured by the ability to create a strategy as well as to execute the strategy effectively. operational excellence is measured by cost management, product differentiation and integration. finally, organisational performance is measured by roa, eps and selfreported measurements. as discussed in this study, strategic leadership literature highlights these characteristics as having an impact on the operational strategy and performance of business organisations. 5.3.1 the influence of strategic leadership on operational strategy theoretically speaking, the three constructs of strategic leadership (action, coherence and discipline) should exert a strong effect on strategy orientation and its dimensions. these relationships were examined by means of correlation analysis. the results of the correlation analysis are shown in table 2. the spearman correlation coefficients (ρ) and p-values of the separated action coherence discipline organisational performance strategy creation strategy execution cost management product differentiation integration roa eps self reporting strategy orientation operational excellence strategic leadership 402 sajems ns 14 (2011) no 4 dimensions of strategy orientation are shown with the strategic leadership constructs. saunders et al. (1997:321) remark that a correlation of +0.3 indicates a weak positive correlation and +0.7 a strong positive correlation. t a b l e 2 a summary of the correlation analysis (r) and p-values as well as the spearman correlation coefficient comparing the dimensions of strategy orientation with the constructs of strategic leadership (n= 118) dimensions of strategy orientation correlation analysis (r) correlation analysis (p-value) spearman correlation (ρ) spearman correlation (p-value) action versus execution of strategy 0.71 0.0000 0.64 0.00 coherence versus creation of strategy 0.76 0.0000 0.74 0.00 coherence versus execution of strategy 0.76 0.0000 0.68 0.00 discipline versus creation of strategy 0.62 0.0000 0.62 0.00 a) action versus execution of strategy the data from the study shows a strong positive relationship between action and the execution of strategy (r = 0.71; p = 0.0000). the spearman correlation coefficient also indicates the same relationship (ρ = 0.64; p = 0.00). as indicated earlier, hitt, ireland and hoskisson (2007) defined action as the component of strategic leadership that determines strategic direction and exploits core competencies. these aspects are both crucial in the process to execute the strategy of the organisation. if the organisation does not have a strategy and people do not have the necessary competencies it will be impossible to effectively execute the strategy. as discussed above, this study has confirmed a strong, positive relationship (r = 0.71) in the sample organisations between action and the execution of the strategy, which is indicative of the theory discussed in this study. 5.3.2 the influence of strategic leadership on organisational performance t a b l e 3 a summary of the correlation analysis (r) and p-values as well as the spearman correlation coefficient, comparing the dimensions of self-reported organisational performance with the constructs of strategic leadership (n = 188) dimensions of organisational performance correlation analysis (r) correlation analysis (p-value) spearman correlation (ρ) spearman correlation (p-value) action versus adaptive leadership 0.69 0.0000 0.65 0.00 action versus processes and systems 0.67 0.0000 0.58 0.00 action versus knowledge 0.58 0.0000 0.48 0.00 coherence versus autonomy 0.72 0.0000 0.66 0.00 coherence versus communication 0.69 0.0000 0.69 0.00 coherence versus knowledge 0.69 0.0000 0.66 0.00 discipline versus adaptive leadership 0.69 0.0000 0.64 0.00 discipline versus processes and systems 0.61 0.0000 0.53 0.00 discipline versus values 0.65 0.0000 0.57 0.00 the second hypothesis in this study is that strategic leadership (action, coherence and discipline) is directly and positively associated with organisational performance. strategic leadership should, therefore, also have a positive effect on organisational performance and its dimensions. these relationships were examined in this study by means of correlation analysis and spearman’s correlation coefficient. the results of the correlation analysis on the relationship between strategic leadership and organisational performance are shown in table 2. the spearman correlation coefficients and p-values of the separated dimensions of organisational performance are shown with the sajems ns 14 (2011) no 4 403 strategic leadership constructs. saunders et al. (1997:321) remark that a correlation of +0.3 indicates a weak positive correlation and +0.7 a strong positive correlation. a) action versus adaptive leadership, processes and systems and knowledge the data from the study showed a strong positive relationship existed between action and adaptive leadership (r = 0.69; p = 0.0000); action and processes and systems (r = 0.67; p = 0.0000) as well as action and knowledge (r = 0.58; p = 0.0000). the spearman correlation coefficient indicates an equally strong relationship (ρ = 0.65; p = 0.00) towards action and adaptive leadership; action and processes and systems (ρ = 0.67; p = 0.00) as well as action and knowledge (ρ = 0.67; p = 0.00). based on the cronbach alphas, the correlation analysis as shown in tables 2 and 3, both hypotheses one and two can be assessed. null hypothesis one and two (h01 and h02) contends that no relationship exists between strategic leadership and operational strategy orientation as well as strategic leadership and organisational performance. the alternative hypothesis (ha1 and ha2) is, therefore, that a positive relationship exists between strategic leadership and operational strategy as well as between strategic leadership and organisational performance. this study has indicated there is a strong, positive statistically significant relationship between strategic leadership and operational strategy. there is also a positive relationship between strategic leadership and organisational performance. based on these findings, the hypothesis is rejected. by implication, the literature and the respondents who participated in this study confirmed that strategic leadership is directly and positively associated with the operational strategy and organisational performance in business organisations in south africa. the empirical research done in this study supplemented the theory surrounding strategic leadership by suggesting that if leadership in organisations formulate and execute their strategies effectively, this strategic competitiveness will give them an advantage to survive in a turbulent and uncertain economy. it also suggested that if organisations manage their costs effectively and focus on product differentiation and the integration of their people, they will perform well and yield above-average returns. 6 discussion of results the discussion of results in this section will focus on the relationship between strategic leadership and operational strategy as well as the relationship between strategic leadership and organisational performance. 6.1 the relationship between strategic leadership and operational strategy as mentioned in this study, operational strategy includes strategic (directional) orientation and operational excellence of the organisation. the relationship between strategic leadership and strategy orientation was found to be statistically significant as the dimensions of strategic leadership (action, coherence and discipline) all measured between 0.62 and 0.76 with p-values of 0.0000 as indicated by the correlation analysis. the spearman coefficient correlation analysis confirmed this relationship (ρ = between 0.62 and 0.74; p-values of 0.00). the creation and formulation of a compelling strategy is extremely important for any business organisation as it determines the future direction of the organisation as well as exploits the core competencies of the employees. in this study it was also confirmed that organisations need to develop their human capital in order to perform according to the new goals and direction (serfontein, 2010: 223). the respondents in the study also confirmed the importance of establishing effective strategic controls and to sustain a corporate culture that emphasises ethical practices (serfontein, 2010:223). according to stewart (2007) the sobering fact is that less than 10 percent of strategies effectively formulated are effectively implemented. the execution of the strategy is, therefore, critically important. in this study the very important relationship between strategic leadership and the execution of the strategy was confirmed by the respondents. through this, the sample organisations acknowledged that they need to establish strategic controls to 404 sajems ns 14 (2011) no 4 make sure that the strategy is effectively executed. there also needs to be a corporate culture that all the employees understand the strategy and also know what their role is to make the strategy work. this study confirmed the relationship between strategic leadership and operational excellence in business organisations in south africa as the results of the correlation analysis showed strong positive relationships between strategic leadership and cost management as well as strategic leadership (hypothesis 1). the study did, however, reveal a weak positive relationship between strategic leadership and product differentiation. the price-leader position seems to be a danger as it can quickly become a commodity seller position, which leads to a lower roa. this is consistent with porter’s (1996) contention that operational effectiveness is not strategy. therefore operational excellence is best seen as a basis, and perhaps a prerequisite, for the growthorientated strategies of product leadership and integration of the functional areas of the organisation. cost management has always been one of the major challenges in business organisations and it has a direct and indirect impact on the operational effectiveness of the organisation. even if the organisation has an acceptable or high turnover and it does not have the ability to manage and control the costs, the organisation will find it very difficult to survive. this is even more applicable in the current turbulent environment where the global economy is heading towards a recession. the strong positive relationship between strategic leadership and cost management was confirmed in this study. finally, it was confirmed in this study that leadership must have the discipline to create a culture and environment where all people and departments in the organisation have the ability to integrate their competencies, initiatives and skills. 6.2 the relationship between strategic leadership and organisational performance the literature in this study asserted that highperformance strategic leadership practices will help organisations to enhance their performance while competing in changing environments. the literature was empirically confirmed in south african business organisations with the correlation analysis done in this study on the relationships between strategic leadership constructs and selfreported organisational performance dimensions. all the constructs of strategic leadership and self-reported organisational performance measured a strong, positive statistically significant relationship. adaptive leadership showed a positive association with strategic leadership, which confirms the importance of leaders engaging in adaptive work by providing direction, and protects the employees by managing the rate of change (serfontein, 2010:225). the respondents also confirmed the importance of the leaders’ ability to orient people to their new roles and responsibilities. the leader should also help the people in the organisation to maintain those norms. autonomy, also referred to as work discretion, showed the strongest significant relationship with strategic leadership of all the self-reported performance dimensions. this means that the leadership’s ability and discipline to permit employees to make decisions about performing their work in a way they believe is most effective is extremely important. this is even more challenging in a diverse south african business environment, where strategic leaders of the sample organisations confirmed the importance of this relationship. the data from this study confirmed the statistically significant and strong relationship between strategic leadership and effective processes and systems in the organisation. the literature in this study suggested that the business is a complex, adaptive system populated by purposeful, interdependent people. the leadership, therefore, needs to understand the whole system in the organisation as one system concept in an organisation contains the others. the study suggested that it is therefore, no longer just the products that are important, it is the process that is important. the cronbach alpha for communication was measured as the highest in the study at sajems ns 14 (2011) no 4 405 0.90, which confirms the reliability of this construct. the importance of good communication in business organisations was suggested by the literature and confirmed by this study for business organisations in south africa. in order to perform, people at all levels need to be informed as all planning processes are, at the core, vehicles for communication. the literature in this study found that the category of values is especially relevant not just for top-level executives, but for all employees. employees need constantly to balance demands from their stakeholders, the market, because it highlights the leader’s and all the people in the organisation’ capability to change. the empirical data in this study confirmed this notion as values showed a consistent positive relationship with strategic leadership. the test for first-rate leaders in business organisations in south africa is, therefore, the ability to exhibit contradictory or opposing behaviours while still maintaining some measure of integrity, credibility and direction. 7 summary and conclusion the main contribution of this study was the assessment that strategic leadership is directly and positively associated with operational excellence and performance in business organisations in south africa. the managerial implications of the proposed model constructed in the study are that leadership and executives in business organisations are able to implement high-performing strategic leadership practices to enhance the strategy orientation and operational excellence in their organisations. this study also supplemented the theory surrounding strategic leadership by suggesting that if organisations formulate and execute their strategies effectively, this strategic competitiveness will give them an advantage to survive in a turbulent and uncertain new economy. it also suggested that if organisations manage their costs effectively and focus on a product differentiation and the integration of their people, they will perform well and yield above-average returns (serfontein 2010: 225). the study identified several avenues for further research by using different research methods and examining the impact of strategic leadership in different contexts. future researchers should examine the impact of strategic leadership on the operational strategy and performance in different business sectors, as well as in public organizations, in order to have a holistic view of the impact of strategic leadership on the performance of organisations in south africa with its diverse and uncertain environment. competition in the remainder of the 21st century’s global economy will be complex, challenging and filled with competitive opportunities and threats. this study asserts that effective strategic leadership practices could help organisations enhance their performance while competing successfully in the turbulent and unpredicted south african environment. endnote 1 high performance is defined as the enduring or out-performance of peers, across business and economic cycles, often across generations of leadership (breene & nunes, 2006:11). references amos, t. 2007. strategic leadership: key driver for strategic implementation. management today. may. baden-fuller, c. & stopford, j. 1994. rejuvenating the mature business. boston: harvard business school press. beer, m., voelpel, s.v., leibold, m. & tekie, e.b. 2005. strategic management as organisational learning: developing 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accepted: 06 july 2017; published: 11 dec. 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: economic institutions are considered as the fundamental cause of economic growth. economic institutions affect economic growth through allocation of resources like physical and human capital. unfortunately, there is dearth of empirical studies showing the impact of economic institutions on growth of the economic community of west african states (ecowas). aim: this study investigates the impact of economic institutions on economic growth of the ecowas. setting and method: the study applied cause and effect relationship. the study used econometric research techniques of unit root and co-integration tests to establish the time series properties of the data; the vector error correction and co-integration regression models to estimate the population parameters. the research data comprised data obtained from the united nations conference on trade and development (unctad), the transparency international (ti) and heritage foundation databases. the variables employed were the real gross domestic product (gdp) per capita (rgdppc), corruption perception index (cpi), property rights protection (proprgt), private investment per capita (invespc), government expenditure per capita (goexppc) and trade openness (traopn). results: the results of the data analysed showed that economic institutions represented by the property rights index engender rgdppc growth in ecowas. the cpi could not stimulate rgdppc growth in ecowas. the results also show that all the other variables stimulated growth except trade openness. conclusion: the study concludes that good economic institutions, private investments, and government intervention by providing security, economic and social infrastructural facilities are conducive for economic growth in the ecowas region. the study recommended that more efforts be made at curbing corruption in the region. introduction economic institutions are regarded as fundamental causes of economic growth (acemoglu 2003; rodrick, subramanian & trebbi 2002). the contribution of economic institutions to economic growth far outweighs the availability of natural resources, the supply of factors of production and technological progress (acemoglu, johnson & robinson 2001; kloomp & de hana 2009). several reasons have been advanced for the importance of economic institutions in stimulating economic growth. one of the reasons is that economic institutions determine the incentives given to the main performers in the economy; the outcomes of economic processes are influenced by the economic institutions. through these incentives, economic institutions influence investment in physical and human resources, research and development (r&d), technology and the organisation of production (acemoglu, johnson & robinson 2005; north 1990; weil 2008). it is posited that economic institutions influence several aspects of economic outcomes, such as the distribution of resources. these resources are income, wealth, and physical and human capital. this means that economic institutions determine not only the aggregate economic growth but the distribution of resources in the country and these in turn, contribute to maintaining order in the country. it has also been argued that economic growth causes good economic institutions. valeriani and peluso (2011) acknowledged the bi-causality between economic institutions and economic growth. the rationale for causality from economic growth to quality economic institutions stems from the simple logic that economic growth implies a high living standard with greater awareness. the higher the level of awareness is, the higher the sense of discipline and the demand for decency from the public. the demand for decency brings about high-quality institutions, for example, the rule of law, property rights, good judicial practices, less harassment from the police, etc. the economic community of west african states (ecowas) formulated the objective of ‘striving to enhance the well-being of its citizens and to promote growth’, among other goals. the economic community is aware of the need to have good economic institutions to realise this objective. to achieve good economic institutions, it encourages the member states to embrace democratic practices, promote rules of law and property rights. to encourage democratic practices in the region, ecowas intervened in côte d’ivoire in 2011 and gambia in 2017 after the incumbent presidents, president laurent gbagbo and president yahya jammeh called elections, lost and decided not to hand over. this study is therefore undertaken to ascertain to what extent has the promotion of these good economic institutions impacted on per capita growth in the ecowas states? to answer the above question, this study is designed to test the alternative hypothesis that economic institutions and some approximate factors stimulating economic growth have promoted economic growth in the region. existing empirical works on the impact of economic institutions on the economic growth of ecowas are sparse and most of them are based on individual countries. for example, the work of okoh and ebi (2013) examined the impact of economic institutions on economic growth in nigeria. this study is therefore designed to bridge the existing gap by investigating all the ecowas countries. the remainder of this paper is organised as follows: the ‘theoretical and empirical literature review’ section reviews both theoretical and empirical literature; the ‘research methodology’ section explains the research methodology applied in this study, the sources of data employed, the measurement of variables applied, the statistical methods of analysis employed and the model used in the analysis. the ‘results and analysis’ section presents and interprets the results of the data analysed, and conducts diagnostic tests on the results to establish their reliability. the ‘summary and concluding remarks’ section summarises and concludes the study. theoretical and empirical literature review this section reviews the theoretical literature as well as the existent empirical research relating to the role of economic institutions in promoting economic growth. theoretical relationship between economic institutions and growth researches, such as north (1988); rodrick et al. (2002) and petrunya and ivashina (2010) have shown that economic institutions are primary causes of economic growth, far more than the natural environment, the supply of factor inputs and technological progress. economic institutions that are important for growth include those that protect property rights (acemoglu et al. 2001; north & thomas 1973); those that mobilise savings and make them available for investment (tchouassi 2014) and those that cause rulers to be subjected to the ruled or hold the rulers accountable to the majority of the people (acemoglu & robinson 2012; keefer 2005). przeworski and curvale (2007) stated that economic institutions that promote economic growth are institutions that absorb, and peacefully process likely conflicts of interest and values under any conditions. these institutions are political institutions and they must be self-sustaining. the solution that is attained using these political institutions should be preferred to the solution that would be achieved through the use of force by each of the parties involved. acemoglu et al. (2005) argued that economic institutions determine long run causes of economic growth. adam smith (1776) once put forward the same argument. acemoglu et al. (2005) concluded that the traditional neoclassical economic growth models of solow (1956), swan (1956), cass (1965) and koopmans (1965) explained the differences in the per capita incomes across countries in terms of differences in capital accumulation. in these models, cross-country differences in factor accumulation are either explained by differences in savings rates (solow 1956; swan 1956), preferences (cass 1965; koopman 1965) or other exogenous parameters like the total factor productivity or technological progress. these models accept that institutions do exist. the models are based on representative agents who are assumed to be well behaved and have property rights and agents exchange goods and services in the markets. however, the models do not acknowledge that differences in income and growth rates are not explained by differences in institutions or variations in institutions. acemoglu et al. (2005) acknowledged the emergence of the first wave of more recent growth theories of romer (1986) and lucas (1988), which are different from the frameworks of the neoclassical growth theories. these are different in the sense that the new theories emphasise that externalities from physical and human capital accumulation have the tendency to sustain unlimited, steady state growth or long-term per capita growth rates. acemoglu et al. (2005) further argued that this approach remains within the neoclassical tradition by using preferences and endowments to explain long-run growth. the second wave of the more recent growth models, particularly those of romer (1990), grossman and helpman (1991), aghion and howitt (1992) and barro (1990), endogenised economic growth and technological progress. however, their explanation of differences in per capita income across countries is in tandem with those of the neoclassical school and the first wave of endogenous growth models. romer (1990) argued that one country may grow faster than another country by investing more resources in research and innovation. barro (1990) argued that a country may prosper by making sure that public goods grow at the same rate as the growth rate in private investment per labour head. romer (1990) did not explain what determines the preferences and the prospect of the technology for creating ideas. barro (1990) did not explain what causes government to expand the provision of services in line with the growth rate of capital per labour head. the neoclassical and the endogenous models have become the traditional tools for economic growth explanation (acemoglu et al. 2005). this traditional approach provides insight into economic growth mechanisms. however, acemoglu et al. argued that the approach has failed to explain the fundamental cause of economic growth. this is the reason north and thomas (1973) posited that innovation, technology, human capital development, physical capital, economies of scale and government provision of services are growth in itself and they cannot explain growth. the arguments in favour of institutions in promoting economic growth are many. economic institutions matter for economic growth because they influence the incentives for the key performers in the economy (easterly 2008). to be more specific, economic institutions influence investments in physical and human capital, technology and the organisation of production (acemoglu et al. 2005). it is further suggested that geographical and cultural factors also matter in terms of economic growth, but that institutions are more fundamental in explaining long-run economic growth (weil 2008). institutions are not only significant in explaining aggregate economic growth, but they are also important in explaining an array of economic outcomes, such as the distribution of resources (wealth, physical capital and incomes). this means that economic institutions also influence how economic wealth is distributed among members of the society, be it output, income, physical capital or human capital (acemoglu et al. 2005). based on this, it can be contended that economic institutions determine the economic performance and distribution of resources in a society. empirical studies a review of the empirical literature is presented in this section. lehne, mo and plekhanov (2014) researched the determinants of the quality of economic institutions in cross-country settings. the study was based on the observation that the relationship between a good political system and economic growth is not linear but a ‘u’-shaped curve. the study listed democratic institutions, geography, history, ethnic factionalism and natural resource endowments as the determinants of the rule of the game. using the appropriate measures of some factors affecting economic institutions, the study found that democracy improved economic institutions and that history had a significant impact on economic institutions. other findings were that geographical factors such as economic openness and resource abundance had a substantial impact on economic growth. the study further found that resource abundance tends to encourage bad economic institutions. okoh and ebi (2013) examined the impact of infrastructural development and the quality of economic institutions on economic growth in nigeria. in estimating the impact of corruption and infrastructural development on economic growth, several specifications were used to test the robustness of the results. the results generally showed that infrastructural development and contract enforcement had a positive and significant effect on economic growth. corruption exacted a negative effect on economic growth. valeriani and peluso (2011) investigated the institutional framework under which economic growth takes place and how economic institutions explain growth and differences of growth across countries. the regression model used by the study stated that economic growth is determined by education (edu), infrastructure (infra), dummy variables (representing economic institutions) and regions (reg). the results of the study showed that the quality of economic institutions impact positively on growth. the study also showed that investment stimulated economic growth. tamilina and tamilina (2014) explained the uniqueness of economic institutional effects on economic growth in post-communist countries. their study showed that the collapse of communism in the communist countries led to radical changes in political, social and economic systems of the former communist countries. the introduction of capitalist economic institutions was dysfunctional (polterovich 2008). the relationship between the quality of economic institutions and economic growth in the former communist countries appeared to differ from the patterns in advanced and developing countries. the study revealed that the revolutionary process rather than evolutionary process accounted for the poor functioning of the former communist economic systems. the study found that economic institutions that are evolutionary, affected economic growth in relation to their quality ratings. good economic institutions promoted growth. in revolutionary methods, the effect of the quality of economic institutions on growth does not reflect their index in the short run, but in the long run they do. davis and hopkins (2006) investigated the interaction between economic institutions, inequality and economic growth. the study was designed to establish whether economic institutions significantly stimulated economic growth. the study was also designed to test the hypothesis that inequality does not stimulate economic growth positively. the statistical analytical method employed five yearly sets of data for eight periods starting from 1961/1965 to 1996/2000. it employed a regression model which stated that the per capita income is a function of years of schooling plus the gini coefficient representing inequality, plus a variable for economic institutions which is property rights. the results of the study showed that economic institutions promoted growth but that income inequality depressed growth. the study further demonstrated that investment also promoted economic growth. zouhair (2012) studied the effects of institutional factors on investment and growth in the middle east and north america (mena). the study covered 11 countries for a 9-year period from 2000 to 2009 and made use of dynamic panel data. the theoretical perspective of the study emphasised the fact that the empirical literature examining the impact of institutions on economic growth is increasing since the seminal work of north (1991). good economic institutions encourage economic agents to invest. conversely, poor institutional quality creates uncertainty, unpredictable environments, instability and corruption and thereby increasing the cost of transacting. in such an environment, private investments are discouraged and thus retard growth (zouhair 2012). the estimation of the model applied in the study used the generalised method of moments (gmm) of arellano and bond (1998). the key findings of their study showed that political institutions and investment stimulated growth. the study also showed that interaction between political institutions and investment promoted growth, while political instability depressed growth. docquier (2014) identified the impact of institutions on economic growth. the study stated that the past century had come and gone but only a few poor countries had caught up with the rich countries. the study was designed to explain convergence across countries. data used for the study spanned the period from 1870 to 2010. it found no evidence of convergence of economic institutions among the countries studied and did not find any evidence of convergence in growth. ferrini (2012) examined the interaction of economic institutions to stimulate economic growth. this is achieved through considering four aspects of economic institutions. the first aspect is the reduction in the cost of economic transacting (exchange). economic institutions enhance development by encouraging people to enter into contracts. contract enforcement uses common commercial law codes and the sharing of information. this reduces transaction cost, risk and uncertainty. secondly, economic institutions determine the degree of appropriation of returns to investment. property rights, fundamental human rights, and the rule of law encourage investment, employment, output and incomes. thirdly, economic institutions determine the expropriation of state resources by the ruling elite. unequal opportunity provided by economic institutions discourages investment and economic exchanges. fourthly, economic institutions determine the degree to which the investment environment is conducive to cooperative behaviour and this increases social capital. inclusive and participative economic institutions increase the free flow of information and the extent to which resources can be pooled and invested in collective properties (education, health and infrastructure), reduce risks and ensure sustained wealth creation. pereira and teles (2009) employed an econometric model based on the gmm and used the autoregressive distributed lagged model for 109 countries for a 9-year period, from 1975 to 2004. the key dependent variable was the gdp per capita; political institutions were taken as explanatory variables. the political institutions used were the electoral rules (plurality vs. proportional representations), form of government (parliamentary vs. presidential systems) and political regime (dictatorship vs. democratic leaders). when economic variables were controlled or moderated, the study demonstrated that political institutions matter for recipient democracies, and not for consolidated democracies. consolidated democracies have already internalised the effects of the political system on their economic growth. in recipient democracies, there is a need to internalise good political institutions that will promote economic growth to ensure the continued growth of the economy. research methodology this section discusses the research methods applied. it presents the data sources, explains the measurements of variables, the statistical methods applied in the study and the model used in estimating the model. sources of data this study applied data obtained from the united nations conference on trade and development’s (unctad) database. the data collected spanned the period from 1990 to 2015. the data obtained from unctad comprised data for the real gross domestic product per capita (rgdppc), government expenditure per capita (goexppc), investment expenditure per capita (invespc) and trade openness (traopn) per capita. data were also obtained from transparency international (ti)’s corruption perception index (cpi) for the period from 1996 to 2015, and the heritage foundation’s property rights index from 1995 to 2015. measurement of variables the variables used in this study are rgdppc, goexppc, invespc, and traopn. the rgdppc is measured in thousands of us dollars at 2005 constant prices. the goexppc and invespc are also measured in us dollars and at 2005 constant prices. traopn is computed as the value of imports plus the value of exports in a given year and the result is divided by the real gdp of the year in which it is computed. economic institutions are measured based on the cpi as published by ti and the property rights index published by the heritage foundation. the range of values used is from 1, indicating very high corruption or very low level of property rights protection, to 10, indicating complete absence of corruption or complete property rights protection. regression methods applied this study applied combinations of both cross-sectional data and time series data, and as a result, it estimates the parameters of the regression using vector auto-regression and co-integrating regression models. the study investigates the impact of economic institutions on economic growth. it is a well-known fact that good economic institutions promote economic growth, which in turn, causes good economic institutions. there is a bi-causality between the two variables. to establish this bi-causality, this study applied the vector error correction (vec) model. because the study applied panel data which involves data that may be co-integrated, the employment of this method may yield consistent and efficient estimated parameters (baltagi 2014). the estimated vec regression model is presented in equation 1 below. where rgdppc, cpi, proprgt and invespc are real gdp per capita, cpi, property rights index and private investment per capita, respectively. goexppc, traopn and ε refer to government expenditure per capita, trade openness and the random error term, respectively. the symbols ∆, i and t are used to indicate the first difference; cross-sectional units, i, taking the values 1, 2, 3, 4, …, 15 for benin, burkina faso, cape verde, cote d’ivoire, …, togo, in alphabetical order, and t, taking the values 1990, 1991, 1992, …, 2015. the error term is assumed to be uncorrelated with the regressions. the regression model is assumed to have regressors that are not highly correlated and that there is constant variance over time. to test for bi-causality between the dependent variable and the regressors that represent economic institutions, this study estimated two more regression models using cpi and proprgt as dependent variables. these are stated in equations 2 and 3 below. the expected signs of the estimated parameters are: this study also used fully modified ordinary least square (ols) (fmols) and dynamic ols (dols) co-integrating regression models in estimating the parameters of the study. as there is co-integration among the variables studied, the co-integrating regression models may yield consistent and efficient estimated parameters. the co-integrating regression method of dols makes use of the past, present and future values of the regressors. the dols regression is estimated using the formula (eqn 4): where y is the dependent variable and x is the independent variable. the u is the random error term which is assumed to be uncorrelated with the explanatory variables. θ and δ are the estimated parameters and θ and δ are the cross-sectional units and the time series periods, respectively. the fmols also uses related features of dols in estimating the parameters of the regression. the panel co-integrating relationships are designed to study long-run relationships that are featured in macroeconomic settings. such long-run relationships are predicted by economic theories. researchers seek to find out whether the predictions of the theories largely hold. two approaches have been recommended for estimating panel co-integrating regression models. phillips and moon (1999) and pedroni (2000) advocated employment of fmols estimating technique, while kao and chiang (2000) suggested the application of dols estimating method. this study adopts the co-integrating regression methods because of their ability to give estimated parameters that are consistent and efficient in the presence of endogeneity (yardimcioglu, gurdal & altundemir 2014), where the dependent variable explains the regressors and vice versa. the method is also able to give efficient estimation of parameters in the presence of trending variables that time series data are prone to have. in view of the time series elements of the panel data applied, this study applied panel unit root tests to examine the time series properties of the data. as the data have the usual times series properties, trending over time, the study applied the (kao 1999) co-integration test to examine if the variables are co-integrated before the data are subjected to the vec regression model and co-integrating regression models. before applying the results of regression models in testing the hypothesis of this study, the study carries out diagnostic tests to ascertain that the results are not spurious regression. the diagnostic tests are tests for multi-collinearity and the test for autocorrelation and heteroscedasticity. the tests applied for multi-collinearity are un-centred variance inflation factors (vif). the joint test applied for autocorrelation and heteroscedasticity is autoregressive conditional heteroscedasticity (arch) in the residuals as suggested by newey and west (1987) and as elaborately explained in greene (2012) and west (2008). results and analysis this study applied time series analytical methods. the time series analytical techniques applied are unit root tests, co-integration tests, the vec regression model and the co-integrating regression models. the study also conducted diagnostic tests to check the reliability of the regression models applied. statistical results this section presents the results of data estimated using unit root tests, co-integration tests and regression models using the vec and co-integrating regression model. the regression results are subjected to second-order tests to ascertain the degree of reliability that can be placed on them. the second-order tests conducted are mainly of two types – coefficient diagnostic tests using vif and coefficient variance decomposition and residual-based tests. tables 1 and 2 present the results of the unit root tests using the augmented dickey–fuller (adf), im–pesaran–shin (ips), phillips–peron (pp), levin–lin–chu (llc) and breitung tests. table 1: unit root test. table 2: unit root test. tables 1 and 2 show that all the variables are not stationary, except private invespc, but the variables become stationary after the first differencing. this means that the variables are first difference stationary (integrated of degree one). the implication of this finding is that the bulk of the data used in this study is not stationary. it is, therefore, advisable to employ time series or another related relevant method in estimating the parameters of the population. because the data applied are co-integrated, this study applies co-integration test. the co-integration test is estimated applying the kao test in table 3. table 3: kao residual co-integration test. table 3 shows that there is co-integration among the variables used in the analysis. the reason is that the computed adf statistic is significant at 5%. the null hypothesis that there is no co-integration among the variables applied in this study cannot be accepted. from the results of the unit root tests in tables 1 and 2 and co-integration test in table 3, it is clear that the variables used in this study are co-integrated. it is therefore important to apply an appropriate regression model in estimating the parameters of the population under study. the reason is to avoid the situation of having spurious regression results. this study used the vec method and co-integrating regression methods of fmols and dols to estimate the parameters of the population of the study. the vec method is adopted to establish whether bi-causality exists between the dependent variable and the regressors. the co-integrating regression methods are adopted because of the co-integrating nature of the variables used in estimation and to avoid the problem of endogeneity that exists between economic growth and economic institutions. table 4 shows the estimated regression results. equations 1, 2 and 3 estimate the parameters of the population using the vec regression model with rgdppc, cpi and proprgt as the dependent variables, respectively. equations 4 and 5 applied co-integrating regression models of fmols and dols, respectively. table 4: panel data regression results (real gross domestic product is the dependent variable, except models 2 and 3). the results of equation 1 show that four of the variables exhibit their expected signs. these are cpi, proprgt (second lagged value), goexppc and the invespc. these exhibited the sign that the estimated parameters are positive. the remaining variables rgdppc lagged values and traopn does not exhibit the expected signs. the expected sign of these variables is greater than zero, but the sign they exhibit is less than zero, the opposite expected sign. table 4, equations 1–3 also show that there is a one-way causality between real gross domestic product per capita (rdgppc) and cpi and between rgdppc and proprgt. a unit improvement in cpi is likely to increase rgdppc by over 0.5 for the first year and by over 0.4 during the second year, all other things remaining equal. a unit increase in proprgt is liable to increase rgdppc by a little less than 0.03 in the second year following the increase, holding other factors constant. the results of the equation 1 also tend to show that goexppc exerts the greatest impact on the rgdppc followed by improvement in cpi. a unit increase in goexppc is liable to increase rgdppc by over 1.4 units while an improvement in cpi stimulates rgdppc by a little over 0.5 units of the rgdppc. another feature of the vec results is that if there is a temporary deviation of the ecowas economy from its long-run equilibrium path, it will recover about 28% of the deviations every year. this conclusion is derived from the coefficient of the error correction term. the results of equation 4 indicate that all the variables under equation 4 exhibit the expected signs except traopn, which shows a negative sign instead of a positive sign. in equation 5, however, all the variables exhibit their a priori signs. equations 4 and 5 also show that goexppc has the highest contribution to rgdppc in ecowas, holding other factors constant. the second highest contributor is improvement in property rights (proprgt). a unit increase in goexppc is likely to increase rgdppc by over 4.7 based on fmols regression model and 5.7 based on dols regression model, holding all other factors constant. however, before subjecting the results of the estimated equations to hypotheses testing, it is important to subject each of the regression results to diagnostic testing to ensure that the results are efficient. the regression models to be tested are equations 1, 4 and 5. the reason is that the study is interested in explaining the impact of economic institutions on economic growth which is represented by rgdppc and not the other way round. the diagnostic tests for the vec regression model applied are mainly residual tests. the first is the likelihood multiplier (lm) residual test for serial correlation. the lm null hypothesis states that the computed vec regression model has no serial correlation. the computed lm statistic using 1 lag value is 38.27 with a probability value of 0.00. the probability value shows that the lm value of 38.27 is unlikely to happen by chance. this study concludes that the vec model suffers from serial correlation. the computed q-statistic residual test for serial correlation also confirms that there is serial correlation based on computed q-statistic of 22.53 having a probability value of 0.03. the test for vec residual heteroscedasticity states that the vec results are homoscedastic in their residuals. the computed chi-square value using 132 degrees of freedom (df) is 382.957 with the probability of 0.00. thus, this study cannot accept the null hypothesis that the computed residuals are homoscedastic. this study concludes that the computed residuals are heteroscedastic and by extension the estimated vec regression model has a heteroscedasticity problem. the diagnostic tests for the two co-integrating equations are presented in this section. from the results of coefficient diagnostic tests using vif and coefficient decomposition, the computed un-centred vif is less than 3.0 for both fmols and dols regression models. thus, both fmols and dols are unlikely to exhibit multi-collinearity problems. the vif of less than 3.0 cannot cause collinearity among regressors. the computed condition numbers show that no two variables meet one of the requirements of having multi-collinearity with two conditional numbers below 0.001. however, none of the two variables has associated eigenvalues that are in excess of 0.5. for multi-collinearity to exist, at least two condition numbers must be less than 0.001 and at least two associated eigenvalues must be greater than 0.5. the lowest two computed condition numbers for fmols are 5.4e-5 (0.000054) and 0.00011, and for dols 1.4e-5 and 0.0007. the highest associated eigenvalues are 0.99 and 0.16 for fmols, and 0.99 and 0.12 for dols. thus, both fmols and dols have no problem of multi-collinearity. therefore, there is no substantial evidence of linearity among the regressors. the tests for autocorrelation and heteroscedasticity applied, make use of arch in the residuals. this study uses q-statistics and its probabilities for testing the null hypothesis that states no autocorrelation and heteroscedasticity exist in the residuals of the regression. the computed q-statistic for the first lagged value of the fmols and the dols are 1.26 and 3.28 with their respective probabilities of 0.19 and 0.07. thus, this study cannot reject the null hypothesis of no autocorrelation and heteroscedasticity in the residuals of both the fmols and dols regression models. the above diagnostic tests show that the vec regression model did not only have a serial correlation but also a heteroscedasticity problem. the consequence thereof is that the computed t-statistic and f-statistic of the vec regression do not follow the normal t-statistic and f-statistic. the use of the t-ratios in testing hypotheses of this study will lead to wrong conclusions. for this reason, this study does not apply the vec regression model as an instrument of drawing conclusions about this study. the vec regression models, however, give an indication of the nature of the data used in this study. the vec results show the line of causation. the co-integrating regression methods are, however, not wanting. having satisfied the requirements of exhibiting no significant evidences of serial correlation, heteroscedasticity and multi-collinearity, the models are applied to test the hypothesis formulated to guide this study. this study hypothesised in its null hypothesis that corruption exerts no significant impact on rgdppc. the computed t-statistic of the cpi is 1.70 for fmols and 0.55 for dols. given the degrees of freedom from the panel data for both fmols and dols to be 295 which is greater than 120, the critical t-statistic using 5% significance limit is 1.96. as the computed statistic is less than 1.96, this study cannot reject the null hypothesis that corruption has no significant influence on economic growth in ecowas countries. this study also hypothesised that property rights protection has not promoted rgdppc in ecowas. the computed t-statistic for the index of property rights using fmols is 2.57 and for dols 3.85. because the computed t-statistics of both are greater than the critical t-ratio, the null hypothesis is rejected. the study concludes that property rights protection has significantly enhanced per capita gdp in ecowas. the study also tested the hypothesis that goexppc has not stimulated rgdppc growth in ecowas. the computed t-statistic is 24.10 for fmols and 52.73 using dols. given the critical statistic value of 1.96, this study rejects the null hypothesis and concludes that goexppc stimulated per capita gdp growth in ecowas member countries. it is also hypothesised that private investments have no significant impact on rgdppc growth in ecowas countries. comparing the computed t-ratios of 2.95 and 1.87 for fmols and dols, respectively, with the critical t-value of 1.96, this study rejects the null hypothesis based on fmols and concludes that private invespc has stimulated rgdppc growth in ecowas. however, using dols, this study cannot reject the null hypothesis and the conclusion in this case is that private invespc has no significant impact on rgdppc of ecowas. the study has also tested the hypothesis that traopn has no significant impact on the real gdp growth rate in ecowas. from the computed t-ratios of both fmols and dols of -1.22 and 1.33, respectively, this study concludes that traopn exerts no significant impact on the ecowas rgdppc. summary and concluding remarks in this study, an attempt was made to establish the link between economic institutions and rgdppc in ecowas member countries. to carry out the investigation, it was necessary to establish the theoretical linkages between economic institutions and economic growth. in the theoretical arguments, it was stated that economic institutions are the fundamental cause of economic growth that explains income and productivity differences across countries of the world. it was further argued that economic institutions are by far better determinants of growth than technology, an increase in investment, government provision of services, among others. the reason is that economic institutions serve as the bedrock on which economic growth takes place. once there are solid economic institutions in a country, other approximate determinants of growth fall in place. the study also reviewed related empirical literature that established the impact of economic institutions on economic growth in several countries, to see how the theoretical postulations applied to real-world situations. the study explained the method of research applied in the study. the data used for the analysis were obtained from the unctad database, ti and the heritage foundation. the independent variables used in the analyses were combinations of both approximate and fundamental causes of growth. the approximate causes of growth were represented by goexppc, invespc and traopn. the fundamental causes of growth were represented by the corruption perception index and the property rights index. the dependent variable used is the rgdppc. the results of data analysed established that goexppc made the highest contribution to rgdppc growth in ecowas countries, followed by the protection of property rights (proprgt). the results also showed that private invespc stimulated rgdppc growth under fmols but not under the dols regression model. on the basis of these findings, this study presents a number of policy implications of the study in this section. the study established that government provision of services as measured by the goexppc has made a significant impact on economic growth in ecowas. this means that government expenditure is below the optimal spending limit; hence, this is the main condition to be met for government spending to have a significant positive impact on growth. governments in ecowas can increase their spending within the range of their fiscal limit. however, it is important for each of the ecowas member countries to compute its optimal government size so that the size is not exceeded. the study also showed that property rights protection has stimulated rgdppc growth in ecowas. the reason for this may be attributed to the fact that property rights protection encourages people to work hard and own properties. it also encourages investment. there is the need to continue to ensure continuous proprgt as this can attract foreign investment into the region and foreign investments can help to diversify ecowas economies out of the primary products. the study established that the corruption index has no significant impact on per capita gdp in ecowas countries. this does not mean that the resources ecowas countries used in fighting corruption are wasted. the implication of this finding is that if there are no significant efforts in fighting corruption, corruption can affect the quality of publicly provided services and this can retard economic growth. moreover, if there is no sufficient effort in tackling corruption, corruption can adversely affect the reward system in the society. the consequence of this is that human efforts that are engaged in producing productive goods and services will be diverted into rent seeking. traopn has not stimulated economic growth of the ecowas countries. this finding is probably a reflection of the international arrangement in which developing countries are engaged in the production of primary products with the attendant fall in the terms of trade against them. if ecowas countries must overcome this problem, they have to learn how to process their primary products into at least semi-processed goods before exporting them. this study has also established that private invespc stimulated economic growth in ecowas based on the fmols estimation method but not on the basis of the dols regression model. private investments, particularly from international companies, are also the means of transferring technologies from more advanced countries to less developed countries. ecowas countries must not overlook the opportunities private foreign investments present. the ecowas countries must not only encourage them but also encourage their citizens to acquire the technique of production with the aim of diffusing them in the ecowas region generally. this is very important if private investments must become more useful to ecowas countries. acknowledgements competing interests the authors declare that they have no financial or personal 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investment and economic growth’, international journal of economics and finance 4(2), 152–162. https://doi.org//10.5539/ijef.v4n2p152 abstract introduction literature review research methodology and data collection method ethical consideration research results discussion conclusion and managerial implications acknowledgements references appendix 1 green purchasing about the author(s) chengedzai mafini department of logistics, faculty of management sciences, vaal university of technology, south africa welby v. loury-okoumba department of logistics, faculty of management sciences, vaal university of technology, south africa citation mafini, c. & loury-okoumba, w.v., 2018,’ extending green supply chain management activities to manufacturing small and medium enterprises in a developing economy’, south african journal of economic and management sciences 21(1), a1996. https://doi.org/10.4102/sajems.v21i1.1996 original research extending green supply chain management activities to manufacturing small and medium enterprises in a developing economy chengedzai mafini, welby v. loury-okoumba received: 24 june 2017; accepted: 20 feb. 2018; published: 22 may 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the implementation of green supply chain management activities as a business strategy remains unfamiliar to many small and medium enterprises (smes) in developing countries such as south africa. setting: implementation of green supply chain management activities by south african smes is necessary, given both the high failure rate of such enterprises in the country and the proven ability of such activities to promote the success of businesses. aim: the aim of this study was to investigate the relationship between green supply chain management activities, operational performance and supply chain performance in manufacturing smes in south africa. methods: data were collected from 219 manufacturing smes operating within gauteng. a confirmatory factor analysis was conducted to assess the psychometric properties of measurement scales. hypotheses were tested using structural equation modelling. results: four green supply chain management activities, namely green purchasing, reverse logistics, environmental collaboration with suppliers and green manufacturing, exerted a positive influence on operational performance. environmental collaboration with suppliers exerted the highest influence on operational performance when compared to green purchasing, reverse logistics and green manufacturing. in turn, operational performance exerted a strong positive influence on supply chain performance. conclusion: the results of the study suggest that manufacturing smes in developing countries could benefit by adopting green supply chain management activities, with improvements being realised in terms of increases in both operational and supply chain performance. introduction small and medium enterprises (smes) are widely recognised as an important contributor to economic development in most countries throughout the world. the economic impact is most noticeable in areas such as employment creation and wealth creation (baumann et al. 2013). in the context of south africa, smes have been acknowledged to account for roughly 52% to 57% of south africa’s gross domestic product (gdp) and poured in an estimated 61% of employment generation in the past few years (sme south africa 2017). however, pressure has mounted on smes to reengineer their business activities and processes in line with global developments (kraus et al. 2012). this pressure stems from the high failure rate of most smes, part of which is attributable to their preoccupation with outdated business models. as mentioned by vivier (2013), smes cannot afford to continue moving along conventional business trajectories, but need to innovate and realign their strategies in line with global currents. this is experienced more in south africa, where the sme failure rate is very high, with most business start-ups closing down within less than 5 years of existence (cant, erdis & sephapo 2014). as mentioned above, smes intending to overcome the unpredictable dynamics in the global marketplace of today are under pressure to adopt and implement more effective business models. green supply chain management (gscm) has emerged as one of the most topical emergent business best practices, perhaps based on its microeconomic and macroeconomic significance (geng, mansouri & aktas 2017). implementation of gscm activities has been identified by a number of authors (govindan et al. 2014; hsu et al. 2013; thiell et al. 2011; williams & schaefer 2013) as one of the innovative business strategies that can enable businesses such as smes to survive and succeed in their operations. as suggested by spence and painter-morland (2010), environmental awareness and concerns across most business spectrums have become an important topic in the modern world. businesses today are expected to be mindful of their environmental obligations towards a safer and more sustainable reduction of pollution activities (hoskin 2011). this then calls for more environmentally driven supply chain activities among business enterprises, which has compelled large businesses to adhere to and comply with the global demands for better implementation of gscm activities (orlitzky, siegel & waldman 2011). however, smes have been lagging behind in the implementation of such activities, despite their ability to stimulate economic growth (bürgi 2010). the pressure to reform is greater on manufacturing smes, whose activities have a greater environmental impact than those in other industries, such as retail and services (sunjka & emwanu 2015). it becomes important then to investigate how manufacturing smes can be motivated to explore innovative business strategies that benefit not only themselves but all stakeholders as well. the aim of this study is to investigate the relationship between gscm activities, operational performance and supply chain performance in manufacturing smes in south africa. specifically, the study is intended to address two objectives, namely (1) to determine the influence of gscm implementation on operational performance and (2) to determine the influence of operational performance on supply chain performance. despite the large body of literature on gscm, it appears that most previous studies have focused their emphasis on large corporations while disregarding smes (luthra et al. 2012). moreover, since countries such as south africa are still developing, and hence the levels of environmental mindfulness among smes in these countries may still be low, there is a need to conduct more studies on issues such as gscm within such enterprises. several studies (coetzee & bean 2016; craiggs 2012; mvubu & naude 2016; niemann, kotze & adamo 2016) have investigated gscm within various industries in south africa. among smes, evidence of previous studies on gscm in smes in south africa is available through hoskin (2011), ojo, mbowa and akinlabi (2014), van rensburg (2015) and mafini and muposhi (2017). however, none of these studies tested the relationship between gscm activities, operational performance and supply chain performance in manufacturing smes. still, given that smes are the most prominent form of businesses and have a greater economic impact than large businesses in developing economies (chrysostome & molz 2014), continuous research is necessary to generate new information that supports their productivity and success. this study is intended to address these research gaps. the study is significant in that it can be used as a future reference source for gscm research in smes. owners and managers within smes in developing countries can also use the results of this study as a diagnostic tool when addressing operational and supply chain performance-related problems. the remaining sections of this article are organised as follows. the next section is a brief review of literature on the research constructs. thereafter, the conceptual framework is provided and hypotheses are formulated. the research methodology section follows next, succeeded by the research results and discussions. the article closes by highlighting the limitations and suggestions for future research, conclusions drawn and the managerial implications. measurement scales used in the study are found in appendix 1. literature review this section briefly analyses literature on the constructs used in this study. these are gscm activities, operational performance and supply chain performance. green supply chain management activities over the past years, businesses have become aware of the strategic importance and critical nature as well as the role of the environment in shaping today’s competitive market (lai, wong & cheng 2010). this has subsequently driven manufacturing businesses to revise their corporate business strategies as well as core supply chain activities towards a greener environmental approach (sarkis, zhu & lai 2011). as such, gscm is viewed as an extension of supply chain activities that focus on minimising the environmental impact of products throughout their life cycle, such as green design, resource saving, harmful material reduction and product recycle or reuse (holt & ghobadian 2009). the core objective of gscm is to eliminate or minimise harmful effects originating from operational activities such as extraction and acquisition of raw materials and use or disposal of products (eltayeb, zailani & ramayah 2011). according to diabat and govindan (2011), gscm embodies a large number of activities such as green design, green sourcing and procurement, green operation and manufacturing, green distribution, and green logistics as well as marketing. a study by lee, kim and choi (2012) identified green purchasing, eco-design and cooperation with customers as gscm activities. environment management, reverse logistics, environmental collaboration with suppliers and product recovery are among other activities singled out in a study by diabat, khodaverdi and olfat (2013). this study reports on the results of four gscm activities, namely green purchasing, reverse logistics, environmental collaboration with suppliers and green manufacturing. another gscm activity (green design) was eliminated from the study due to non-performing data in the confirmatory factor analysis. scholars such as wisner, tan and leong (2012) acknowledge that although gscm is a multidimensional construct, those constructs considered in this study are the most relevant operational dimensions required by smes to sustain their competitive advantages. green purchasing green purchasing has been defined by eltayeb, zailani and jayaraman (2010) as an environmentally oriented purchasing activity based on the purchase of products or materials that meet the concern of the environment in terms of reduction of wastage, promotion of recycling, reuse, resource reduction and substitution of materials. supply chain management literature identifies several drivers of green purchasing. these include environmental collaboration, top management commitment, regulatory pressure, environmental investment and customer pressure (yen & yen 2011). social influence, environmental concerns, perceived seriousness of environmental problems, perceived effectiveness of environmental behaviour, perceived environmental responsibility and concern for self-image in environmental protection have also been identified as key antecedent factors to green purchasing (sinnappan & rahman 2011). other drivers of green purchasing include awareness about government actions and support, beliefs about product safety and use, beliefs about product friendliness to the environment and availability of product and product information (kaufmann, panni & orphanidou 2012). reverse logistics according to diabat et al. (2013), reverse logistics refers to the movement of products from the point of consumption to the business manufacturing sites. reverse logistics has the objective of recycling, reusing, repairing or remanufacturing and careful disposal of products as well as materials (das & chowdhury 2012). it is acknowledged that reverse logistics is a key contributor to ensuring customer after-sale satisfaction since its implementation leads to better optimisation of aftermarket processes such as recycling and proper waste disposal (bernon, rossi & cullen 2011). khor et al. (2016) advance that the repair, remanufacturing and reconditioning of products and materials are precondition determinants of effective implementation of reverse logistics activities. furthermore, the critical value resulting from executing reverse logistics has been well documented. examples of such benefits include an increased business environmental image, cost reduction as well as sustainable customer satisfaction and aftersales services (wong et al. 2012). environmental collaboration with suppliers environmental collaboration with suppliers can be defined as any form of formal or informal collaborative activity taking place between two or more parties with the objective of engaging in mutual exchanges to solve environmental problems (crane 1998). green et al. (2012) in their study on environmental collaboration and organisational performance established that supplier decisions that embark on environmental collaborations are based on factors such as a business’ internal environment management and green information systems. in addition, zhu, sarkis and lai (2008) advocate that sound collaboration among businesses ensures internal gscm activities, which are vital in achieving better environmental performance. this singles out the core value attached to proper strategic alliance between business partners. in their study on environmental collaboration and business performance, green et al. (2012) established that internal environmental management and green information systems are determinant factors of environmental collaboration with suppliers. these authors further suggest that effective and sound collaborative environmental activities with supplying businesses result in improved supplier selection. this indicates that businesses that are concerned about the environment ensure that their interactions with business partners reflect their concerns. green manufacturing green manufacturing is widely regarded as an emergent topic which has attracted attention because of its relevance and role in sustaining the environment (reich-weiser, vijayaraghavan & dornfeld 2010). it refers to the ability of a business to adopt green strategies and techniques designed to reduce or minimise the negative effects of production processes on the ecosystem. it further involves the provision of products and procedures that require minimal consumption of hazardous materials and energy (deif 2011). the implementation of green manufacturing processes enables businesses to become more conscious of their duty to protect the environment by redesigning their operation systems and restructuring their disposal strategies to adhere to environmental sustainability regulations (mittal & sangwan 2014). sezen and cankaya (2013) argue that it is important that manufacturing businesses evolve their production strategies to be more environmentally driven by including the proper recycling of waste, efficient disposal of hazardous products and protection of the labour force, thereby providing a conducive working environment. this view is supported by flammer (2013), who concluded that green manufacturing is a twofold approach which is aimed at not only protecting the ecosystem, but meeting societal and economic expectations as well. operational performance in the world of business, the term ‘performance’ generally relates to the accomplishment of a given task as measured against predetermined standards of accuracy, cost, speed and completeness (bennett, lance & woehr 2014). operational performance may be perceived as the degree to which a business is able to function within prescribed standards in specific areas of its operations and processes (prajogo et al. 2012). inman et al. (2010) conceptualise operational performance in terms of the ability of a business to do things better, faster, more efficiently and more cheaply. traditionally, there were five operational performance measures that are generic to most forms of operations, namely speed, quality, flexibility, dependability and cost (prajogo et al. 2012). however, more measures have to date been added to this list, with productivity, reduction of waste and compliance with regulations being among the most notable ones (belekoukias, garza-reyes & kumar 2014). the widely-acclaimed balanced scorecard indicators, customer satisfaction, financial performance, internal processes and learning and growth, are also applicable to operational performance (kaplan 2010). other measures that have been applied in measuring operational performance include effectiveness, defect date, efficiency and value-added time ratio (karim & arif-uz-zaman 2013). in a study conducted by dora et al. (2013), productivity was measured using indicators such as inventory reduction, cycle time or lead time reduction, quality improvement and on time delivery. this shows that different researchers have developed and applied various indicators in the assessment of operational performance, depending on the context of their research. as suggested by belekoukias et al. (2014), operational performance is important to businesses since it is a major indicator of the health and success of the business. in this study, operational performance was measured using a subjective scale anchored on the delivery of goods, inventory levels, wastage, quality, quantity of goods produced and capacity utilisation (zhu et al. 2008). supply chain performance supply chain performance can be defined as the overall evaluation of an entire business’s supply chain activities in terms of its effectiveness and efficiency (akyuz & erkan 2010). supply chain performance includes tangible products and materials as well as intangible aspects such as services and relationships (akyuz & erkan 2010). a supply chain operating at an adequate level of its performance objectives is highlighted by performance outcomes such as sustainable cooperation among networks partners, which is characterised by seamless information sharing (banomyong & supant 2011). one of the key indicators of a performing supply chain is its effective integration and flexibility of different supply chain units (qrunfleh & tarafda 2014). as such, a proper integrated supply chain results in more improved information conveyed across the whole chain. this subsequently contributes to an increase of business performance through a reduction of inventory and delivery lead time (qrunfleh & tarafdar 2014). furthermore, chang, tsai and hsu (2013) advance that partner relationships, information sharing and integration are important determinants of supply chain performance. this gives prominence to the strategic significance of supply chain performance in contributing to the success of a business. conceptual framework and hypotheses development the conceptual framework presented in figure 1 highlights the relationships under investigation. the framework consists of four predictor constructs, which are green purchasing, reverse logistics, environmental collaboration with suppliers and green manufacturing. operational performance is the mediating construct and the outcome construct is supply chain performance. figure 1: conceptual framework linking green supply chain management activities to. green purchasing and operational performance the importance and critical value of green purchasing has been well documented. dubey et al. (2013) described green purchasing as a means of ensuring cleaner production technologies. green purchasing is further regarded as critical in monitoring and controlling supplier performance objectives in terms of meeting the expectations and requirements of a business through its capability to provide materials that are in line with environment specifications (eltayeb et al. 2011). as indicated by dubey et al. (2013), effective employment of green purchasing strategies enables businesses to diligently manage their supplier environment performance, which can result in improved operational performance. blome, hollos and paulraj (2014) further highlight that green purchasing is instrumental in achieving superior supplier performance, since it ensures that only quality material is processed. this serves as an indicator of the importance of green purchasing to environmental success. thus, the following hypothesis is formulated: h1: green purchasing exerts a positive influence on operational performance in manufacturing smes. reverse logistics and operational performance significant improvement of waste management and disposal has been identified as a key enabler of operational performance (khor et al. 2016). this is linked to environmental concerns by businesses, especially with regard to the proper handling of hazardous materials and products. ye et al. (2013) mention that the application of reverse logistics typically results in improved buyer-supplier relationships across supply chain networks, highlighted by corporate social responsibility traits. huscroft et al. (2013) advocate that adequate reverse logistics activities play a significant role in ensuring the return of products, which facilitates effective remanufacturing processes. moreover, eltayeb et al. (2011) suggest that the implementation of reverse logistics relates to operational performance outcomes in terms of cost reduction. still, reverse logistics activities such as product repair, remanufacture, recondition, as well as recycling and proper good disposal, lead to increased sales and profitability (khor et al. 2016). in light of these insights, the following hypothesis is put forward: h2: reverse logistics has a positive influence on operational performance in manufacturing smes. environmental collaboration with suppliers and operational performance environmental collaboration with suppliers is an important enabler of green purchasing strategies that contribute effectively to an improved supplier environmental performance (eltayeb et al. 2011). adequate collaboration between businesses is critical in their ability to attain the required level of operational performance (lai et al. 2011). collaborative efforts among supply chain partners characterised by synergistic exchanges and engagement contribute swiftly to improved operation activities (yang et al. 2013). environmental collaboration with suppliers has further been regarded as essential in reducing information distortion between green supply chain members, which leads to better performance across the supply chain (inman, sale & green 2009). therefore, the following hypothesis is advanced: h3: environmental collaboration with suppliers has a positive influence on operational performance in manufacturing smes. green manufacturing and operational performance green manufacturing calls for a collaborative engagement between the stakeholders of a business to develop and implement sound operational activities which result in the improvement of both operational and environmental performance (green et al. 2012). this is exhibited through reductions in cycle time, consumption of toxic raw material and negligent waste disposal. wong et al. (2012) found that environmentally driven production has a positive and significant influence on operational performance. these authors further suggest that operations that are process-oriented towards the environment enable businesses to produce and redesign their production capabilities to satisfy environment-related concerns. this ensures a decrease in pollution, which is linked to increases in both employee productivity and operational performance (fu, viard & zhang 2017; zivin & neidell 2012). the greening of production processes allows firms to reduce their energy consumption and integrate more lean activities to minimise operations wastage and to speed up production, therefore contributing to the provision of organic products (hajmohammad et al. 2013). this leads to the following hypothesis: h4: green manufacturing has a positive influence on operational performance in manufacturing smes. operational performance and supply chain performance according to trkman et al. (2010), operational performance characterised by continuous information exchanges and alliance activities is a major determinant of supply chain performance. sezhiyan, page and iskanius (2011) mention that operational performance outcomes anchored by logistics capabilities facilitate the improved performance of supply chain networks, which subsequently leads to competitive advantages. govindan et al. (2015) further state that operational performance contributes to the sustainable success of a business’s entire supply chain. linton, klassen and jayaraman (2007) add that operational performance is a critical determinant of competitive advantage and better supply chain performance in fierce and highly competitive markets. in view of these views, the following hypothesis is suggested: h5: operational performance has a positive influence on supply chain performance in manufacturing smes. research methodology and data collection method instrumentation the study is quantitative in nature, making use of a structured survey questionnaire to collect data from the respondents. a quantitative study was chosen since the study was testing relationships between different constructs. measurement scales were operationalised from previous studies. green purchasing was measured using six items adapted from a study by zhu et al. (2008). reverse logistics was measured using six questions adapted from ye et al. (2013) while environmental collaboration with suppliers was measured using five questions adapted from vachon and klassen (2006). green manufacturing was measured using five items adapted from zhu and sarkis (2004). operational performance was measured using six questions adapted from zhu et al. (2008), and supply chain performance was measured using a 10 item-scale adapted from li et al. (2005) and li et al. (2006). response options for the green purchasing, reverse logistics and green manufacturing scales were measured on a five-point likert-type scale ranging from not considering it (1) to implementing successfully (5). for environmental collaboration with suppliers, operational performance and supply chain performance scales a different likert-type scale, which was anchored by (1) not at all and (5) significant, was used. sample and data collection the target population of the study was manufacturing smes across all industries in gauteng, south africa. the list of operating smes was obtained from the gauteng enterprise propeller (gep), sme databases from the municipalities in the region and from the small enterprises development agency (seda). according to seda (2016:13), the number of smes in gauteng is 676 831. using the raosoft sample size calculator for this population, a 5% margin of error and a 90% confidence interval and a 50% response distribution, the recommended sample size was 271 respondents. with this recommendation in mind, 400 questionnaires were initially distributed to smes. out of these, 257 were returned, of which 38 were discarded because they had errors. accordingly, 219 questionnaires were used in the final analysis, giving an acceptable response rate of 54%. the actual respondents consisted of either owners or managers of these smes. to ensure that smes from the various regions of the province were represented in the sample, the quota sampling technique was used. this involved splitting the smes into four distinct regions (north, south, east and west) of gauteng and then randomly selecting smes from each region. data were collected between january and may 2016 with the aid of two trained research assistants who were postgraduate students at a south african university of technology. a summary of the demographic characteristics of the respondents indicated that 51.1% (n = 112) of smes that participated in the study were sole proprietorships, 27.2% (n = 60) were partnerships and 21.7% (n = 47) were private companies. with regard to the type of industry, 24.1% (n = 53) of the participating smes were in the agri-processing industry, 23.5% (n = 52) were in the chemicals industry, 14.3% (n = 31) were in the wood, paper and leather industry, 13.7% (n = 30) operated within the metals industry, 13.3% (n = 30) were in the computer and electronics industry and 10.7% (n = 23) were in the clothing and textiles industry. furthermore, 42.9% (n = 94) of smes were owned by white people, 35.6% (n = 78) by black people, 17.5% (n = 38) were owned by indians or asians and 4% (n = 9) were owned by people of mixed race. in terms of sme representation by region, 22.1% (n = 48) of the smes were drawn from northern gauteng, 31.0% (68) were drawn from the south, 19.4% (43) were drawn from the east and 27.5% (n = 60) were drawn from the west. data analysis after screening the returned questionnaires, the data collected from smes were captured on an excel spreadsheet. thereafter, the same data were analysed with the aid of the statistical package for social sciences (spss version 23.0) software to obtain the descriptive statistics, cronbach’s alpha values and correlations. for testing the psychometric properties of the measurement scales and testing the hypotheses, the analysis of moment structures (amos version 23.0) statistical software was used. ethical consideration in administering the questionnaire, various ethical considerations that include the respondents’ right to confidentiality and anonymity, privacy or non-participation, informed consent, protection from harm and victimisation were followed. respondents were not given any incentives for participating in the survey. research results the results section focuses on the outcomes of the confirmatory factor analysis (cfa), hypothesis tests conducted through structural equation modelling (sem) and the discussions. a cfa is a special form of factor analysis used to test whether the measures of a construct are consistent with the nature of that construct (kline 2011). the sem procedure is used to assess relationships between latent (unobservable) factors such as dependent and independent constructs (bagozzi & yi 2012). psychometric properties of measurement scales the analysis of psychometric properties of the measurement scales was conducted through a cfa to ascertain the reliability, validity and model fit of the constructs. the results of the cfa analysis are presented in table 1. table 1: psychometric properties of measurement scales as shown in table 1, all five constructs under consideration in this study were reliable, since cronbach’s alpha values were greater than the minimum threshold of 0.7 suggested by nunnally (1978). scale purification was conducted using item-total correlation values. as shown in in table 1, all item-total correlation values were greater than the recommended minimum value of 0.3 (field 2005), which further demonstrates that scale reliability was satisfactory in this study. three types of validity were ascertained in this study. the first is face validity, which was ascertained through a review of the questionnaire by three academics whose research interests lie within supply chain management. suggestions from these academics were considered and factored into the questionnaire. the second type of validity considered in the study is content validity, which was ascertained by pilot-testing the questionnaire using a conveniently selected sample of 30 smes. these smes were subsequently excluded from the final survey. using the feedback obtained from the pilot study, the questionnaire was modified to make it clearer. the third validity determined in this study is construct validity, which was measured through its two variants, namely convergent and discriminant validity. convergent validity was satisfactory, since factor loadings for all items within the measurement scales surpassed the 0.5 minimum threshold suggested by hair et al. (2006). convergent validity was also satisfactory, since average variance extracted (ave) values for five of the constructs exceeded the minimum threshold of 0.4 suggested by anderson and gerbing (1988), with the exception of green manufacturing whose ave score was below the required threshold of 0.4. however, the green purchasing factor was still retained in the study, since all of its factor loadings were above the recommended minimum value of 0.5 and the scale reliability was acceptable (borsboom, mellenbergh & van heerden 2004). to measure discriminant validity, correlations between the constructs were used. according to fornell and larker (1981), correlation values less than 0.85 depict that discriminant validity exists between the scales since the constructs do not overlap each other and are measuring different things. the results of the correlation analysis are shown in table 2. table 2: correlations between constructs. as shown in table 2, correlations between all constructs were positive, ranging between r = 0.112 and r = 0.737. this reveals that discriminant validity within the scales was satisfactory. in addition, these results show that constructs under consideration in this study are positively associated such that they fluctuate by either increasing or decreasing together. the strongest association was observed between environmental collaboration with suppliers and supply chain performance (r = 0.737). overall, the results after testing indicate that all measurement scales eventually used in the study were both valid and reliable. it has to be mentioned that one of the initial constructs (green design) was eliminated in the cfa. although the green design construct initially had four scale items, two of them had item-total correlations below 0.3 and factor loadings below 0.5 and the cronbach’s alpha value of that scale was 0.42, even after scale purification; hence the decision to purge the construct from the study. mean scores for all constructs (table 1) in the measurement scale ranged between 3.02 and 3.81. the mean score values for green purchasing ( = 3.24) and reverse logistics ( = 3.13) depict that smes were currently considering implementing these activities. the mean score value for environmental collaboration with suppliers ( = 3.81) demonstrates a relatively significant involvement in this activity by smes. for green manufacturing, the mean score was 3.02, showing that smes were currently considering implementing it. the mean score value for operational performance ( = 3.02) illustrates that smes had to some degree managed to achieve the operational performance indicators measured in the scale. the mean score value ( = 3.54) calculated for supply chain performance shows that smes had significantly achieved the supply chain performance indicators measured in the scale. standard deviations for the scales ranged between 0.67 and 1.23. the fact that these values are low portrays that data points for all scales were clustered closely around their respective means, which reduces any uncertainties in the results of the study and makes them more authentic. model fit analysis as recommended by anderson and gerbing (1988), model fit must be tested to determine how well both the cfa and sem models fit the observed data. schreiber et al. (2006) suggest that in order to meet the level of acceptability, the chi-square (cmin/df) value must be confined between 1 and 3. further to that are values of the goodness of fit index (gfi), comparative fit index (cfi), incremental fit index (ifi), and tucker-lewis index (tli), which should be equal to or greater than 0.90 in order to be acceptable (bollen 1990; hu & bentler 1995). moreover, in order to be accepted, the root mean square error of approximation (rmsea) must be equal to or less than 0.08 (browne & cudeck 1993). the results for model fit analysis are presented in table 3. table 3: model fit statistics. the results of the model fit for both the cfa and the sem (table 3) show that all model fit indices were satisfactory. this confirms that there was acceptable fit between both models and the underlying data structures. testing the hypotheses hypotheses were tested using the sem procedure technique. the results are reported in table 4. table 4: hypotheses tests results. an analysis of the results of the hypotheses tests (table 4) indicates that the beta coefficients for all the hypotheses were statistically significant at a level of at least p < 0.01. thus, all five hypotheses put forward in this study were accepted. discussion the first hypothesis (h1) proposed that green purchasing exerts a positive influence on operational performance. this hypothesis was accepted because there was a positive and significant relationship (β = 0.654; p = 0.007; t = 2.445) between green purchasing and operational performance. this result implies that implementation of green purchasing by manufacturing smes predicts their operational performance. this result is supported by a previous study by bjorklund (2010), which established that green purchasing contributes to waste and hazardous product reduction. this results in improved adherence to environmental regulations in terms of efficient operations and production processes. dubey et al. (2013) add that implementation of green purchasing promotes the implementation of eco-friendly operational strategies, which again correlates with sound and safe operational outcomes. furthermore, green purchasing has been found to be a key tool designed at improving operational performance through lowering production costs and sustaining the reduction of pollution (green et al. 2012). in line with these results, manufacturing smes will be able to succeed in their operations when they adopt green purchasing strategies. the second hypothesis (h2) proposed a positive relationship between reverse logistics and operational performance. this relationship was supported and accepted because a positive and significant relationship (β = 0.612; p = 0.008; t = 2.395) was observed between reverse logistics and operational performance. this result demonstrates that implementation of reverse logistics by manufacturing smes results in improved operational performance. this result has been echoed by el korchi and millet (2011), who found that reverse logistics results in competitive advantages through its role in enhancing operation capabilities. for instance, poor quality raw materials may be identified and returned to the supplier and exchanged for better quality ones, which results in better quality products. moreover, systems and processes for facilitating tend to promote the effective utilisation of business resources in the production phase (khor et al. 2016). this is because putting in place an effective chain of product returns enables the operations process to be leaner and facilitates better repair and recondition of defective goods (yang, hong & modi 2011). this improves the performance of the operations process by enhancing the repurchase value of the returned goods. in this manner, implementation of reverse logistics activities by manufacturing smes enhances the operational performance of their value chain. the third hypothesis (h3) proposed that there exists a positive relationship between environmental collaboration with suppliers and operational performance. this hypothesis was accepted, since the relationship between environmental collaboration with suppliers was positive and significant (β = 0.781; p = 0.000; t = 3.315). this result demonstrates that operational performance will improve when manufacturing smes collaborate with their suppliers and form long-lasting relationships. this result resonates with a study by yang et al. (2013), which stressed that collaborative engagement between businesses and suppliers is important in improving operational performance. yang et al. (2013) reiterate that collaborative efforts between businesses and suppliers aid their combined ability to share environmental risks and problem-solving expertise, which is vital in leveraging competitive advantage. luo et al. (2014) further add that environmental collaboration efforts between businesses contribute to achieving operational performance objectives. accordingly, environmental collaboration with suppliers in manufacturing smes contributes significantly to the attainment of their operational objectives. the fourth hypothesis (h4) proposed that there is a positive relationship between green manufacturing and operational performance. this hypothesis was accepted, since there was a positive and significant relationship (β = 0.433; p = 0.000; t = 3.624) between the two constructs. this result implies that operational performance is likely to be higher in smes that have implemented green manufacturing. this result is synchronous with a study conducted by dubey, gunasekaran and ali (2015), which concluded that the implementation of green manufacturing activities increases the efficiency of operations processes. this, in turn, enables businesses to improve their operational performance in terms of waste and pollution reduction as well as shorter life cycles of products. in another study by lai and wong (2012), environmentally driven production exerted a positive influence on operational performance in businesses. this was attributed to decreased expenditure realised through the implementation of lean production activities such as recycling, recuperation and the reuse of component parts and other materials critical in the provision of quality products. the results of the current study, therefore, showcase the adherence by manufacturing smes to their corporate social responsibility to the environment and their willingness to adopt green activities to reduce the negative effects of negligent manufacturing activities on the ecosystem (paul, bhole & chaudhari 2014). the fifth hypothesis (h5) proposed that there is a positive relationship between operational performance and supply chain performance. this hypothesis was accepted because a positive and significant relationship (β = 0.762; p = 0.005; t = 2.562) was observed between the two constructs. this result illustrates that higher operational performance by a manufacturing sme leads to superior performance of the supply chain in which that sme operates. the results of this study correlate with a study by trkman et al. (2010), which concluded that proper operational performance ensures that the supply chain of a business is able to meet the demands and expectations of customers. furthermore, jakhar (2015) posits that business enterprises that can improve their operational performance are more likely able to minimise their operation costs and to boost the effectiveness of the whole supply chain. thus, manufacturing sme supply chains are likely to improve significantly whenever smes can sustain their operational performance. limitations and suggestions for further research the study is limited in that data were collected from smes based in gauteng only. in line with this, future studies could be conducted in other provinces, which is likely to provide the results of the study within a broader context. the other limitation of the study pertains to the inclusion of smes from various industries without catering for the heterogeneity within these different industries. in view of this, future studies could be conducted in specific sme industries, such that the results thereof will have a more defined context. another limitation is the restriction of the study to only four gscm activities, since green design was eliminated in the cfa. this provides opportunities to conduct the study again and include green design and any other gscm activities that were not included in this study as this will provide more holistic results. in the same vein, future studies could include other dimensions of organisational performance that were excluded in this study, such as environmental, social and economic performance. a mixed method approach could be adopted in future studies as it enables the capturing of both objective (quantitative) and subjective (qualitative) views of respondents to provide a more comprehensive set of results. conclusion and managerial implications the aim of this study was to investigate the relationship between gscm activities, operational performance and supply chain performance in manufacturing smes. all five hypotheses formulated in the study were accepted. the study confirms the view that implementation of gscm activities, namely green purchasing, reverse logistics, environmental collaboration with suppliers and green manufacturing, positively contributes to operational performance in manufacturing smes. the study further concludes that operational performance in manufacturing smes in south africa positively influences supply chain performance. in this manner, the study provides validation of similar research results from other environments to the south african manufacturing sme sector, where such a study had not been conducted before. the study therefore constitutes a reference source for future researchers on gscm in similar environments. to managers in manufacturing smes, implementation of gscm activities is key to increasing both operational and supply chain performance. likewise, the inability to implement gscm activities in manufacturing smes could account for some of the challenges related to both operational and supply chain performance. when applying gscm activities, more emphasis should be placed on collaborating with suppliers, which exerts a greater influence on operational performance than do green purchasing, reverse logistics and green manufacturing. to improve the implementation of gscm activities in manufacturing smes, state of the art technology solutions should be put in place. utilisation of such solutions may offer various paybacks such as data accuracy, easy integration with other tools and reduction in paperwork, which facilitates better sustainability. reductions in packaging costs through the use of recyclable plastic materials in place of wood and paper-based materials could lead to the decline in carbon production, making these enterprises more environmentally friendly. the periodic maintenance of fleet vehicles as well as production equipment is likely to improve their cost-effectiveness through reductions in the use of energy (fuel and electricity) and emissions. the methodical management of returned goods through the repair of both damaged and unwanted products in order to restore them to their original form and then resending them to the market can lead to improved financial returns. it is further important that the concept of gscm be sold to the entire workforce in order to increase awareness within the business. in this regard, regular training and development programmes aimed specifically at promoting environmental awareness should be implemented to enable all human resources to understand the roles they have to play. a budget should be set aside for implementing the gscm programme, so that financial resources can be provided when needed. acknowledgements the authors would like to thank the faculty of management sciences at vaal university of technology for providing the resources used in undertaking this study. the research was funded by the faculty of management sciences at vaal 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(five-point scale: 1 = not considering it; 2 = planning to consider it; 3 = considering it currently; 4 = initiating implementation; 5 = implementing successfully). gp1: eco labelling of products gp2: cooperation with suppliers for environmental objectives gp3: environmental audit of suppliers’ internal management gp4: suppliers’ iso 14001 (environmental management) certification gp5: second-tier supplier environmentally friendly practice evaluation gp6: providing design specification to suppliers that include environmental requirements for purchased item reverse logistics please indicate the extent of reverse logistics implementation in your business (five-point scale: 1 = not considering it; 2 = planning to consider it; 3 = considering it currently; 4 = initiating implementation; 5 = implementing successfully). rl1: accepting product returns from customers rl2: recalling products with quality problems rl3: returning products to suppliers rl5: recycling scrap and used items rl6: repairing, recondition and remanufacture component parts from returned, defective, or damaged products supplier environmental collaboration please indicate the extent to which your business engaged in the following activities with its suppliers: five-point scale: 1 = not at all; 2 = a little bit; 3 = to some degree; 4 = relatively significant; 5 = significant). ecs1: achieved environmental goals collectively ecs2: developed a mutual understanding of responsibilities regarding environmental performance ecs3: worked together to reduce environmental impact of our activities ecs4: conducted joint planning to anticipate and resolve environmental-related problems ecs5: made joint decisions about ways to reduce overall environmental impact of our products green manufacturing please indicate the extent of reverse logistics implementation in your business (five-point scale: 1 = not considering it; 2 = planning to consider it; 3 = considering it currently; 4 = initiating implementation; 5 = implementing successfully). gm1: cross-functional cooperation for environmental improvements gm2: total quality environmental management gm3: environmental compliance and auditing programs gm4: iso14000 series certification gm5: environmental management systems exist operational performance please indicate the extent to which you perceive that your business has achieved each of the following during the past year. (five-point scale: 1 = not at all; 2 = a little bit; 3 = to some degree; 4 = relatively significant; 5 = significant). op1: increase in the amount of goods delivered on time op2: decrease in inventory levels op3: decrease in scrap rate op4: increase in product quality op5: increase in product line op6: improved capacity utilisation supply chain performance please indicate the extent to which you perceive that your business has achieved each of the following during the past year. (five-point scale: 1 = not at all; 2 = a little bit; 3 = to some degree; 4 = relatively significant; 5 = significant). scp1: ability to handle nonstandard orders scp2: ability to meet special customer specification requirements scp3: ability to produce products characterised by numerous features options, sizes and colors scp4: ability to rapidly adjust capacity so as to accelerate or decelerate production in response to changes in customer demand scp5: ability to rapidly introduce large numbers of product improvements variation scp6: ability to handle rapid introduction of new products scp7: fast customer response time scp8: characterised by a great amount of cross-over of the activities of our business and our trading partners scp9: characterised by a high level of integration of information systems in our business scp10: short order-to-delivery cycle time abstract introduction development of technology acceptance model decision-making and trial evaluation laboratory method case study analysis and result discussion conclusion acknowledgements references about the author(s) jih k. chen school of management, xiamen university tan kah kee college, china citation chen, j.k., 2018, ‘the influence of behavioural intention on third-party e-commerce payment’, south african journal of economic and management sciences 21(1), a2157. https://doi.org/10.4102/sajems.v21i1.2157 original research the influence of behavioural intention on third-party e-commerce payment jih k. chen received: 21 oct. 2017; accepted: 12 apr. 2018; published: 13 june 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: third-party e-commerce payment has been used by many businesses and consumers, enabling customers to easily access the payment platform during e-commerce transactions. thus, the emergence of such new technology has become a major topic for organisations to study factors that have influenced the people’s adoption and acceptance of new technology as well as mutual influence. setting: the technology acceptance model is one of the most studied models of behavioural intention to use new information technology. aim: however, in terms of the causal relationship of variables in the model, one variable is considered independent, ignoring the possibility of mutual influence, and many samples are required for statistical empirical research. this study aims to resolve these above two deficiencies. methods: this study adopts the decision-making and trial evaluation laboratory method, and applies the latest technology acceptance model (tam3) to examine. results: the results found several extra causal relationships which are not present in the tam3 model, and understood that experience and computer playfulness are the driving factors of third-party e-commerce payment, and computer anxiety is the core factor. conclusion: the feasibility of this approach was demonstrated through an empirical study, and these results could be used to guide management direction and marketing strategy. introduction with the continued development of the internet, traditional business models have changed significantly. for the flourishing development of e-commerce, online payment plays a key role because trust establishment is difficult as both parties of the transaction are ‘virtual’ individuals. third-party e-commerce payment is the most successful model at present. compared to traditional payment methods, third-party e-commerce payment offers advantages such as efficiency (saving transaction costs and time), convenience (paying bills at any time and any place), and flexibility (providing payment control and management) (huang, dai & liang 2014). additionally, it allows clients to transfer money into an online account and make payments from that account without exposing their real credit card or bank account information (jim 2007). with the help of operational convenience and functional expansion, guaranteed intermediary third-party payment methods have effectively solved the problem of credibility, logistics, and cash flow. this method is now used by many businesses and consumers, enabling customers to easily access the payment platform during e-commerce transactions. there are many available online third-party e-commerce payment services. well-known systems include paypal, which cooperates with the ebay online marketplace, and alipay, which cooperates with taobao.com. new third-party e-commerce payment services have been developed and are used on various websites. the emergence of acceptance of such new information technology (it) is a major focus of researchers studying factors that influence the adoption and acceptance of new it and mutual influence. the technology acceptance model (tam) is one of the most studied models of behavioural intention to use new it. tam is a theory of reasoned action and was applied to user information system acceptance by davis (1989). tam can allow study of the effects of external variables between perceived usefulness, perceived ease of use, and behavioural intention, and thus can guide the implementation and application of a technology system (riemenschneider, harrison & mykytn 2003). for this reason, tam has been widely used in efforts to promote the acceptance of various information technology, for example e-mail systems by szajna (1996), internet banking by lai and li (2005), customer usage and consumer-to-consumer behaviour (c2c) by he, lu and zhou (2008), broadband by irani, dwivedi and williams (2009), online games by zhu, lin and hsu (2012), social media by dutot (2014), and retail services of an internet bank in south africa by maduku (2016). however, since the establishment of tam theory, scholars have expanded and modified this prototype from tam1, tam2, to tam3, for improved explanatory ability. many scholars have adopted the recently developed tam3 model to study the influence of behavioural intention. for example, agudo-peregrina, hernández-garcía and pascual-miguel (2014) proposed a tam3-based model with two additional variables: personal innovativeness and perception which enable study of the factors influencing the acceptance of e-learning systems. akman and mishra (2015) examined diversity between public and private sector establishments in green it adoption using a tam3 model. ooi and tan (2016) proposed an extension of tam3 that included mobile usefulness and mobile ease of use to determine smartphone credit card adoption. mathu and tlare (2017) explored the influence of it adoption of small and medium enterprises (smes) in two provinces of south africa, and ascertained the it influence of supply chain integration and collaboration of the smes. here, this study aims to adopt the tam3 model to analyse the influence of behavioural intention for third-party e-commerce payment. however, tam models have two important assumptions and deficiencies: (1) in terms of the causal relationship of variables in the model, one variable is considered independent, ignoring the possibility of mutual influence, and (2) empirical study typically relies on survey questionnaires and hypothesis testing by statistical analysis, requiring many samples. because some variables do not meet the independent assumption, tam will not be able to correctly analyse the overall causal relationships, resulting in the wrong conclusion (lee et al. 2010). hence, this study adopted a new method, the decision-making and trial evaluation laboratory (dematel) method, instead of the statistical analysis method. dematel is an analysis technology for complex problems that applies expert opinions to evaluate the influence level of the mutual interactions of variables to determine the core factor. this approach not only effectively addresses the above-mentioned two deficiencies, but also allows determination of the driving factors and core factors in the acceptance and adoption of behavioural intention for adoption of third-party e-commerce payment technology. these results could be used to guide management direction and marketing strategy. development of technology acceptance model tam is a mature model that has been validated in different contexts. this section describes the variation of tam theory in recent years. original and amended technology acceptance model the theory of reasoned action (tra) was one of the first models that studied the acceptance of technology. this model analyses the determinants of conscious behaviour from the perspective of social psychology (aizen & fishbein 1980; fishbein & ajzen 1975). according to this theory, the specific behaviour of a person is determined by their intention to carry out a behaviour, a process called behavioural intention. davis (1989) adopted and expanded tra to develop tam to evaluate people’s acceptance of new information technology. tam maintains that the use of information technology is determined by behavioural intention, and employs two technology acceptance measures to predict system usage: perceived usefulness and perceived ease of use. in this model, both perceived usefulness and perceived ease of use influence attitudes toward a technology, which in turn influences behavioural intention to use the technology. davis and venkatesh (1996) found that attitude toward is only a user emotion, and the preference of information technology cannot completely convey the impact of perceived usefulness and perceived ease of use on behavioural intention. with this argument, davis and venkatesh amended the model by abandoning the attitude toward from the original model, as shown in figure 1. figure 1: technology acceptance model 1. technology acceptance model 2 the next extension of tam, tam2, was developed by venkatesh and davis (2000). tam2 incorporates additional theoretical constructs spanning social influence processes including image, subjective norm, voluntariness, and experience, and also a cognitive instrumental process including job relevance, output quality, and result demonstrability. these were treated as the determining variables of perceived usefulness, instead of perceived usefulness being only decided by external variables and perceived ease of use in the previous model, as shown in figure 2. figure 2: technology acceptance model 2. unified theory of acceptance and use of technology model venkatesh et al. (2003) found task-technology fit (ttf), innovation diffusion theory (idt), tra, the theory of planned behaviour (tpb), motivational model (mm), combined tam and tpb (c-tam-tpb), model of pc utilisation (mpcu), and social cognitive theory (sct) also have relevant explanatory ability in different categories. therefore, these authors integrated these models and proposed a unified theory of acceptance and use of technology (utaut). utaut integrates the arguments of eight models into four core determinants, performance expectancy, effort expectancy, social influence, and facilitating conditions, and four regulated variables, gender, age, experience, and voluntariness, as shown in figure 3. figure 3: unified theory of acceptance and use of technology model. technology acceptance model 3 venkatesh (2000) developed a model of the determinants of perceived ease of use, which builds on the anchoring and adjustment framing of human decision-making. the anchors suggested by venkatesh are computer self-efficacy, computer anxiety, computer playfulness, and perceptions of external control. in addition, two system characteristic-related adjustments, perceived enjoyment and objective usability, were suggested to play a role in determining the perceived ease of use after individuals gain experience with a new technology. computer self-efficacy is the degree to which an individual believes that they have the ability to perform a specific task or job using the computer. perception of external control is the degree to which an individual believes that organisational and technical resources exist that can support the use of the system. computer anxiety is the degree of an individual’s apprehension, or even fear, when faced with the possibility of using computers. computer playfulness is the degree of cognitive spontaneity in computer interactions. perceived enjoyment is the extent to which the activity of using a specific system is perceived to be enjoyable in its own right, aside from any performance consequences resulting from system use. objective usability is a comparison of systems based on the actual level of effort required to complete specific tasks. later, venkatesh and bala (2008) combined tam2 and the model of the determinants of perceived ease of use to develop an integrated model of technology acceptance, tam3, shown in figure 4. tam3 is the latest theoretic framework for analysis of usage behaviour and user acceptance. in the theoretic framework of tam3, the anchors and adjustments were significant predictors of perceived ease of use. however, the effects of computer anxiety, computer playfulness, perceived enjoyment, and objective usability on perceived ease of use can be influenced by experience. at the same time, experience can affect perceived ease of use toward perceived usefulness and behavioural intention. in addition, output quality does not directly affect perceived usefulness, but instead can influence the effect of job relevance toward perceived usefulness. figure 4: technology acceptance model 3. decision-making and trial evaluation laboratory method dematel was developed by the battelle memorial association of the geneva research center (fontela & gabus 1976; gabus & fontela 1973) to study the disjointed and antagonistic phenomena of world societies and search for integrated solutions. in recent years, dematel has been widely adopted because it is useful and practical to visualise the structure of complex causal relationships with matrices or digraphs that portray the contextual relationships between the elements of the system, where a numeral represents the strength of influence. therefore, dematel can convert the relationship between the effects and causes of criteria into an intelligible structural model of the system. there are several successful applications of this model in many fields. for instance, chiu et al. (2006) adopted dematel to study marketing strategy based on customer behaviour related to lcd tvs. lin et al. (2011) used dematel to explore the interrelationships of the core competences in the ic design service company. fu, zhu and sarkis (2012) used dematel to evaluate the influence relationships of green supplier development programmes. tzeng (2014) explored the subjective factors that parole board members consider in parole decisions by dematel. briefly, the structure of dematel is as follows. suppose that a system contains a set of variables c = {c1, c2, …, cn}, and the particular pair-wise relations are determined for modelling with respect to an influence relation. the evaluation and calculation procedure is: evaluate the mutual influence of all variables. integrate the opinions of all experts. establish direct-relation matrix. calculate normalised direct-relation matrix. calculate total-relation matrix. calculate the total influence degree of each variable and the degree of being influenced. calculate the prominence and relation of all variables. indicate the position of each variable on 2d causal diagram. evaluate the mutual influence of all variables evaluate the influence relationships among variables by pair-wise comparison by using a questionnaire, brainstorming, or professional opinions. the evaluation scales are levels 0, 1, 2, and 3, which respectively represent ‘no effect’, ‘low effect’, ‘middle effect’ and ‘high effect’. integrate the opinions of all experts arithmetic average or geometric means are usually adopted. establish direct-relation matrix with the opinion integration of all experts, the direct-relation matrix, x, of n × n can be obtained. in the direct-relation matrix, x, xij represents the variable, the level of i affects variable j, and the diagonal variable xij of the direct-relation matrix, x is set to 0. calculate normalised direct-relation matrix the method of normalised direct-relation matrixes uses the biggest sum of the row vector as the normalised base, set: from the calculation of equation 2 and equation 3, λ is divided by the direct-relation matrix, x, to obtain the normalised direct-relation matrix, n. calculate total-relation matrix the total-relation matrix, t, can be obtained from equation 4: i is an identity matrix. calculate the total influence degree of each variable and the degree of being influenced set tij as the variable of the total-relation matrix, t, and i and j from 1 to n. the total influence degree of each variable and the degree of being influenced can be calculated from equation 5 and equation 6. set di as the sum of row i, which represents the variable i, and is the cause that affects the sum of other variables. rj is the sum of column j, which represents the variable j, and is the result and the sum of being affected by other variables. di and rj include direct and indirect influences. calculate the prominence and relation of all variables define dk + rk as the prominence, and set k, i and j to range from 1 to n, which shows the overall level of this variable being affected and its influence on others. this score shows the core level of variable k in this case. dk – rk is defined as the relation, which means the gap level of the variable being affected and its influence on others. indicate the position of each variable on 2d causal diagram prominence is used as the x axis and relation is used as the y axis, and the mean of prominence and relation can be divided into four quadrants. after separate calculation of the coordinate score (dk + rk, dk – rk) of various variables, they can be drawn in a 2d causal diagram. when the dk – rk score is positive, the variable k is attributed as a cause attribute; if the dk – rk score is negative, the variable k is attributed as an effect attribute. after construction of the 2d causal diagram and plotting the coordinate score (dk + rk, dk – rk) of various variables, it can be seen that if dk – rk is negative and the score of dk + rk is very small, the variable k is more independent, and it is an effect attribute and there are fewer variables that affect the variable. if dk – rk is negative and the score of dk + rk is very big, it means that the variable k is the core factor that must be solved or managed; however, it is not required to directly improve this variable. when the dk – rk is positive and the score of dk + rk is very small, this means that the variable k is also independent, but it can affect a few other variables and sometimes it can be used to solve or manage. if dk – rk is negative and the score of dk + rk is very big, it means that the variable k is the driving factor to solve or manage the core problem, and should be listed as the priority. therefore, dematel can evaluate the interaction influence level among variables and represent complex causal relationships among variables in a visible structural model. this reveals the driving factors of the core problem in complex systems, providing valuable insight for problem-solving. case study research design to analyse the influence of usage behavioural intention on third-party e-commerce payment services, this study approached six managers and cadres staffs of industry and eight users with rich experiences in third-party e-commerce payment services from three different cities (xiamen, guangzhou, and shanghai). a total of 30 experts assessed the mutual influence of each variable in tam3 (a total of 17 variables) and separately scored the influence level of each variable from no influence (0) to high influence (3). dematel was adopted to analyse the causal relationships and interaction influence level among these 17 variables of tam3. analysis and result according to the arithmetic average, we collected information and reached a conclusion after integrating the assessments from the 30 experts. we then established a direct-relation matrix, x, according to equation 1. according to equation 2, the biggest sum of the row was obtained as 22.07. as the normalised base, λ, was divided by the direct-relation matrix according to equation 3, and to obtain total-relation matrix according to equation 4. this is shown in table 2. the dematel analysis of a third-party e-commerce payment service uses subjective norm (x3) as the example. it can be seen from table 2 that subjective norm (x3) directly affects image (x4), with an influence level of 0.100, subjective norm (x3) directly affects perceived usefulness (x14) with an affect level of 0.121, and subjective norm (x3) directly affects intention to use (x16) with an influence level of 0.133. the row and column sum of the total-relation matrix, t, can be calculated from equation 5 and equation 6. di is set as the sum of row i, and the represented variable i is the cause and the sum of the effect of the other variables. rj is the sum of column j, and the represented variable j is the effect and is the sum of being affected by other variables. using subjective norm (x3) as the example: the sum of the influence of subjective norm (x3) on other variables can be calculated from equation 5: d3 = 0.100 + 0.121 + 0.133 = 0.354. the sum of the influences of other variables on subjective norm (x3) can be calculated from equation 6: r3 = 0.101 + 0.107 = 0.208. then, di + ri is calculated as the prominence, which refers to the total level of the variable affecting others and being affected. di – ri is calculated as a relation that refers to the gap level of the variable affecting others and being affected. according to the scores, the causal attribute of variables can be obtained. if it is positive, the variable is attributed to a cause attribute, and if it is negative, the variable is attributed to the effect attribute. taking subjective norm (x3) as an example again: the prominence (d3 + r3) is 0.354 + 0.208 = 0.562 and the relation (d3 – r3) is 0.354 – 0.208 = 0.146. thus, we next calculated the di and ri, prominence (di + ri), and relation (di – ri) of all the tam3 variables according to equation 5 and equation 6 and all the calculation results are summarised in table 3. table 1: direct-relation matrix, x. table 2: total-relation matrix of technology acceptance model 3. table 3: causal influence level summarised of technology acceptance model 3. after summing the prominence (di + ri) and relation (di – ri), we then divided by the 17 variables to obtain the mean, for results respectively of 0.512 and 0.005. the values can be used to divide the causal matrix into four quadrants, and plot the coordinate scores (dk + rk, dk – rk) of the variables in the 2d causal diagram, as shown in figure 5. figure 5: 2d causal diagram. according to the analysis of figure 5, considering the interaction influence relationship of tam3 variables, the variables with high prominence and relation in quadrant i are experience (x1) and computer playfulness (x11), which means these variables have the highest interaction influence level with other variables and are driving factors. quadrant iv has high prominence but low relation, indicating these variables are core factors: computer anxiety (x10), perceived usefulness (x14), perceived ease of use (x15), and intention to use (x16). both driving factors and core factors must be solved or managed carefully. quadrant iii has low prominence and low relation: computer self-efficacy (x8), objective usability (x13), and usage behaviour (x17). these variables have the lowest interaction influence level with other variables. other variables are in quadrant ii, with low prominence but high relation: voluntariness (x2), subjective norm (x3), image (x4), job relevance (x5), output quality (x6), result demonstrability (x7), perceptions of external control (x9), and perceived enjoyment (x12). it can be understood from the causal diagram that experience (x1) and computer playfulness (x11) are causal factors that affect third-party e-commerce payment service. experience (x1) gave the highest d factor, and directly affected subjective norm (x3) with an influence level of 0.101, computer anxiety (x10) with an influence level of 0.127, computer playfulness (x11) with an influence level of 0.120, perceived enjoyment (x12) with an influence level of 0.111, objective usability (x13) with an influence level of 0.124, and perceived ease of use (x15) with an influence level of 0.164. experience (x1) directly affected perceived usefulness (x14) with an influence level of 0.114 and directly affected perceived ease of use (x15) with an influence level of 0.114. computer playfulness (x11) directly affects perceived ease of use (x15) with an influence level of 0.139; in addition, computer playfulness (x11) also directly affected computer self-efficacy (x8) with an influence level of 0.119, perceptions of external control (x9) with an influence level of 0.103, and computer anxiety (x10) with an influence level of 0.101. the whole structure is shown in figure 6. figure 6: influence structure. discussion based on the above-mentioned analysis, most causal relationships relating to tam3 are in agreement. the variables in the social influence process include experience, voluntariness, image, and subjective norm. experience (x1) has a significant effect on subjective norm (x3), computer anxiety (x10), computer playfulness (x11), perceived enjoyment (x12), objective usability (x13), and perceived ease of use (x15). voluntariness (x2) significantly affects subjective norm (x3). subjective norm (x3) has a significant effect on perceived usefulness (x14) and intention to use (x16). image (x4) has a significant influence on perceived usefulness (x14). the result shows that for people’s acceptance and use of a third-party e-commerce payment, the behaviour intention conforms to tam3, and is greatly affected by the variables in the social influence process. more specifically, experience (x1) and subjective norm (x3) have greater effects on perceived ease of use (x15) and experience (x1) has greater direct effect on intention to use (x16); therefore, due attention should be paid to the user’s experience and feelings for the promotion of a third-party e-commerce payment. the advertising effect should be carefully targeted to address these factors. some extra causal relationships not present in the tam3 model were found with the dematel method. experience (x1) will directly affect perceived usefulness (x14) and intention to use (x16), and voluntariness (x2) will also affect intention to use (x16). this result shows that organisations should pay more attention to people’s willingness to use a product to achieve better results. in addition, job relevance (x5) and result demonstrability (x7) have significant effects on perceived usefulness (x14), and output quality (x6) has a significant effect on job relevance (x5). the causal relationships in tam3 are in agreement. however, the 2d causal diagram of dematel indicates these three variables are in quadrant ii, meaning that the variables in the cognitive instrumental process are more independent variables but affect a few other variables. hence, organisations should enhance the usage interface, usage accessibility, and usage universality to increase behaviour intent. the variables in anchors include computer self-efficacy, perceptions of external control, computer anxiety, and computer playfulness. they all show significant influence on perceived ease of use (x15). however, the extra causal relationships were also found but not in the original tam3. the results show that the variable of anchors has complex essential interactive relationships, as shown in figure 6. hence, when adopting the statistical empirical approach, more attention should be paid to the influence of these four variables on perceived ease of use (x15). similarly, the variables in adjustments: perceived enjoyment (x12) will directly affect objective usability (x13). the major variables of tam3 include perceived usefulness (x14), perceived ease of use (x15), intention to use (x16), and usage behaviour (x17). the analysis result of dematel shows that the interaction relationships between perceived usefulness (x14), perceived ease of use (x15), intention to use (x16), and usage behaviour (x17) are consistent with the original tam3 model structure. however, the 2d causal diagram of dematel shows that perceived usefulness (x14), perceived ease of use (x15), and intention to use (x16) are factors of high prominence and low relation, which means that they are greatly affected by other variables. conclusion tam3 is a popular model to study the effects of external variables, causal relationships, and the influence level between perceived usefulness, perceived ease of use, and intention to use. this study adopted the dematel method instead of a statistical empirical approach to overcome two important limitations of the tam3 model: (1) lack of ability to evaluate mutual influence relationships and (2) the requirement of many samples for statistical analysis. by integrating expert opinions, calculations and analysis were used to identify the causal relationships of variables and their influence level of third-party e-commerce payment systems. we found that experience (x1) directly affects computer anxiety (x10), computer playfulness (x11), perceived enjoyment (x12), objective usability (x13), and perceived ease of use (x15). voluntariness (x2) directly affects subjective norm (x3). subjective norm (x3) directly affects image (x4), perceived usefulness (x14), and intention to use (x16). perceived usefulness (x14) is also affected by image (x4), job relevance (x5), result demonstrability (x7), and perceived ease of use (x15). perceived ease of use (x15) is also affected by computer self-efficacy (x8), perceptions of external control (x9), computer anxiety (x10), computer playfulness (x11), perceived enjoyment (x12), and objective usability (x13). intention to use (x16) is also affected by perceived usefulness (x14) and perceived ease of use (x15). intention to use (x16) affects usage behaviour (x17). however, our study also found extra causal relationships, not present in the tam3 model, including that experience (x1) will affect perceived usefulness (x14) and intention to use (x16), and that voluntariness (x2) will affect intention to use (x16). additionally, the anchor variables have complex interactional relationships, and perceived enjoyment (x12) will affect objective usability (x13). the influence levels of all causal relationships were obtained with the dematel method and the results could aid organisations in formulating marketing plans, improving product quality, or enhancing customer satisfaction. of course, additional causal relationships and their influence level require further empirical study. this method is complementary to the 2d causal diagram for observing the quadrant of each variable, and exploring which variables are core factors and which are driving factors. results show that experience (x1) and computer playfulness (x11) are the driving factors of the third-party e-commerce payment service, and should be the primary goals in management and marketing. additionally, the results demonstrate that computer anxiety (x10) is the core factor, playing an important role in the promotion of this new technology. limitations and future research due to the fact that information from only eight experienced users from three cities and six experts of industry were used in this study, it may lack representative conclusions. therefore, future research should concentrate on increasing the number of experts and expanding the regional scope. the arithmetic average method was adopted to integrate and collect expert opinions, but may fail to obtain an accurate result. integration of fuzzy theory could be an alternative direction. in addition, further empirical research can be conducted on additional causal relationships. acknowledgements competing interests the author declares that he has no financial or personal relationships that may have inappropriately 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general, the results show a strong relationship between the two variables in a way that may give support to the application of ‘flexible inflation targeting regime instead of strict inflation targeting regime’. key words: inflation, inflation targeting, exchange rate, pass-through effect jel: e31 1 introduction egypt has recently decided to adopt price stability as an explicit monetary policy objective. since june 2005, the central bank of egypt has taken several steps to develop its monetary policy framework with the intention to implement an inflation targeting regime in the medium term (al-mashat, 2008). the transition to this regime was justified by the negative effects of exchange rate targeting and the successful experience that many emerging countries had achieved through the application of an inflation targeting regime since 1990s.under this regime, the exchange rate fluctuations have become an important issue in economic policy debate. on one hand, a floating nominal exchange rate represents, at least from a theoretical standpoint, a requirement for a pure inflation targeting regime. its rationale is based on the policy dilemma of the ‘impossibility of the holy trinity’ (berganza & broto, 2011). the idea is that even with good planning and economic management it is impossible for the central bank to achieve free capital mobility, an independent monetary policy and fixed exchange rate simultaneously. on the other hand, one of the costs of fully floating in developing economies with their greater financial and real vulnerabilities is the higher volatility of exchange rates. this can entail the problem of having a high inflationary effect of the exchange rate, known as exchange rate pass through (erpt). developing countries may suffer even more than developed ones due to lack of credibility of their monetary authorities. this leads to a general belief among agents that any temporary fluctuation of exchange rate behaviour is indeed permanent (eichengreen, 2002; edwards, 2006). this problem constitutes a base of the fear of floating behaviour, which implies interventions in the foreign exchange market through changes in the international reserves and interest rates. the high erpt is a point of concern for developing countries which consider adopting an inflation targeting regime. this is due to the risk of seeing the exchange rate becoming the main objective of the central bank, thus dominating the supposed primary objective of the monetary authorities, which is the inflation rate (youssef, 2007). in the case of egypt, realising this problem in its developing economy, its current challenge is how to compromise between the monetary policy target that focuses on price stability and the high volatility of the exchange abstract 326 sajems ns 15 (2012) no 3 rate. in other words, it faces the dilemma of choosing between fulfilling the theoretical conditions of ‘strict inflation targeting’, which imply a fully flexible exchange rate or applying a “flexible inflation targeting”, which entails a de facto managed floating exchange rate. some studies which have been performed on egypt to show the correlation between the exchange rate and inflation depended only on the cpi as an indication of inflation. the egyptian cabinet study (the egyptian cabinet, 2004), which measures the elasticity of consumer prices to the exchange rate and uses the var model with daily data during the period of 2001-2004, found that there was a weak relationship between the two variables. in another study, neaime (2008) uses quarterly data during the period of 1990-2006 for each individual country of the middle east and north africa (mena) region. using the var model, the results indicate that prices have responded quite swiftly to exchange rate shocks in egypt. given the inconclusive results of the previous studies and their limitations as they concentrate on one indicator, the objective of this paper is to present new empirical evidence regarding the relationship between exchange rate changes and inflation, using two indicators of it: cpi, wpi. the rest of the paper is organised as follows: section 2 briefly reviews the theoretical and empirical studies that show how the inflation and exchange rate affect each other. section 3 presents an overview of the development of inflation indicators and exchange rate movements in the egyptian economy during the period of the research. section 4 presents the research methodology of the granger-causality test applied to egypt. a summary of the results and the policy implications are provided in section 5. 2 literature review economic theory suggests that inflation and exchange rate changes can affect each other. from one side, inflation is a determinant of the exchange rate according to purchasing power parity (ppp) theory. it states that the exchange rate between currencies is in equilibrium when the domestic purchasing power is the same in each of the two countries. therefore, the nominal exchange rate represents an offsetting factor to changes in relative prices. using this definition, a high inflation in one country should be accompanied by depreciation of its exchange rate in order to return to ppp (mungule, 2004). there are two versions to express the ppp equation. in absolute ppp, the nominal exchange rate is equal to the ratio of the domestic price level to the foreign price level and, therefore, the real exchange rate is equal to one. in relative ppp, the rate of change in the nominal exchange rate is equal to the domestic inflation minus the foreign inflation rate so the real exchange rate remains constant. the basis for ppp is the ‘law of one price’. in the absence of transportation and other transaction costs, competitive markets will equalise the price of an identical good in two countries when the prices are expressed in the same currency. there are three caveats with this law: (1) transportation costs, barriers to trade, and other transaction costs can be significant. (2) there must be competitive markets for the goods and services in both countries. (3) it only applies to tradable goods. empirical evidence has shown that in the short run ppp does not hold (ahmad & ali, 1999). but studies on the long-run behaviour of exchange rates have found that it can take four to ten years to equalise the purchasing power of currencies and that ppp therefore describes the long-run behaviour of exchange rates (antweiler, 2011). on the other side, exchange rate change is one of the external factors that determine inflation in open markets. the inflationary effect of the exchange rate can be explained by two kinds of channels. the direct channel, which is connected to the aggregate demand refers to the effect of exchange rate change on the import prices of final consumption goods that the domestic consumers pay. the indirect channel, which is related to aggregate supply refers to the effect of exchange rate change on the import prices of capital and intermediate goods, which in turn influence the cost of production that the producers pay. there are different factors that determine sajems ns 15 (2012) no 3 327 the erpt. at the microeconomic level, it is determined mainly by market structure, industry’s share of imports, degree of product differentiation and elasticity of marginal cost (dornbusch, 1987; yang, 1997). at the macroeconomic level, it is determined by import prices, output growth, inflation persistence and credibility of the monetary authority (campa & goldberg, 2005; karim, 2005). since the 1990s the degree of eprt has declined significantly in economies that applied an inflation targeting regime due to credibility gains (nogueira, 2007; kara & ogunc, 2008). as a result, it can be assumed that lower inflation decreases erpt and this in turn helps in keeping inflation low (taylor, 2000). the mutual interaction between inflation rate and exchange rate as shown above was tested by some studies and the results seem mixed. ndungu (1997) agrees with this mutual interaction using the granger-non causality test based on kenyan data during the period of 1970-1993. nogueira (2007) shows that there was no evidence of endogeneity in a sample of some emerging and developed economics using the granger-causality test during the period of 1983-2005. using the same test based on annual data from asia, the eu and north america during the period of 1991-2005, achsani et al. (2010) found that there was a significant one-way causal relationship from the exchange rate to the rate of inflation for asia, while the causal seemed to be in the opposite direction for non-asian regions. 3 developments of exchange rate and inflation in the egyptian economy there were significant milestones in the path of the exchange rate and inflation in egypt during the period of the study (1990-2008). in order to spot these developments and their causes, this part will be divided into four episodes. 3.1 from january 1990 to december 1999 at the beginning of the 1990s, egypt adopted a pegged exchange rate regime, where the authorities set the official exchange rate regardless of the market forces. in february 1991, the country applied a dual exchange rate containing a primary market and a free market and few months later these markets were unified into one market. the exchange rate was stabilised through this period and it ranged between egyptian pound (ep) 3.33 per us dollar in 1991 to ep 3.39 per us dollar in 1999, which meant that the rate of change didn't exceed 1.8 per cent during all these years (national bank of egypt, 2002). as a result of this stabilisation and in addition to the contractionary demand policies that followed in the first stage of the economic reform and structural adjustment program (ersap), the inflation rates had a declining path. the cpi inflation was between 20 per cent in 1991 and 3 per cent in 1999 and the wpi inflation decreased from 18 per cent to 1 per cent within the same period according to imf international financial statistics (ifs). 3.2 from january 2000 to december 2001 the exchange rate had faced persistent pressures in the late 1999 mainly due to the reduction of foreign reserves as a result of substantial balance of payments deficits and the increase of informal demand for the us dollar for speculation (the egyptian cabinet, 2003). these pressures caused series of gradual devaluations of egyptian pound until it recorded 3.69 per us dollar in june 2000. in january 2001, the exchange rate was set to crawl within a band of + 1 per cent around the central rate which was set at 3.85 per us dollar. in august 2001, the band was widened to + 3 per cent. nevertheless, the egyptian pound devaluation problem exacerbated further, given that the supply of foreign exchange in the official market dropped sharply as exporters and holders of foreign currency sought more attractive rates in the black market to satisfy the excess demand. this caused the activity in the black market to expand significantly to the extent of trading at a 15 per cent premium over the official rate in 2002. during this period, the domestic currency lost about 29 per cent of its value (almashat & billmeier, 2007). meanwhile, the cpi inflation and wpi inflation rates were relatively low, ranging 328 sajems ns 15 (2012) no 3 around 2.5 per cent and 1.4 per cent respectively. this reduction was due to the persistence of the pegged exchange rate regime that slowed the degree of erpt, in addition to the prevailing low international commodity prices at the time (central bank of egypt, 2009/2010). 3.3 from january 2002 to december 2004 after the formal devaluations of the domestic currency in 2001 and 2002, the egyptian government announced in january 2003 the adoption of a floating exchange rate regime. it was introduced mainly because of the deteriorating situation in the foreign exchange market. however, the lack of credibility in this new system and public expectations of a further drastic devaluation led to a severe shortage of foreign exchange. as a result, the egyptian pound depreciated and lost 50 per cent of its value (youssef, 2007). the inflation rates have increased significantly due to high erpt of egyptian pound depreciation. the wpi was able to show the primary effects of exchange rate shock on the economy more strongly than cpi in 2002 and 2003 (fares & ibrahim, 2008). depending on ifs data for year 2004, the cpi inflation reached to 11 per cent while the wpi recorded 17 per cent when the exchange rate of the egyptian pound was 6.40 to the us dollar. 3.4 from january 2005 to april 2008 this period was characterisedby a stable exchange rate due to the establishment of the interbank foreign currency market in december 2004, and therefore the egyptian pound strengthened. in march 2005, it appreciated for the first time since the starting of the ersap to reach 5.79 to the us dollar, and then it continued to improve until it recorded 5.37 to the us dollar in april 2008 according to ifs data. this improvement was reflected in a decrease in the inflation trend through 2005 until may 2006. the trend was reversed by the effects of a set of internal factors (oil subsidy cuts and accelerating economic growth) and external factors (the rise in international food prices). during fy 2007/2008, the cpi inflation reached double-digit levels around 20 per cent (central bank of egypt, 2009/ 2010). figures (1) and (2) trace respectively the exchange rate movements with the cpi and wpi inflation rates of egypt during the period of study. in general, they showed a close link between the exchange rate and inflation, especially for wholesale prices. f i g u r e 1 cpi inflation and exchange rate fluctuations, 1990-2008 (12month percentage change) source: author's calculations -10,00 0,00 10,00 20,00 30,00 40,00 50,00 60,00 70,00 80,00 19 90 m 1 19 91 m 1 19 92 m 1 19 93 m 1 19 94 m 1 19 95 m 1 19 96 m 1 19 97 m 1 19 98 m 1 19 99 m 1 20 00 m 1 20 01 m 1 20 02 m 1 20 03 m 1 20 04 m 1 20 05 m 1 20 06 m 1 20 07 m 1 20 08 m 1 exchange rate cpi sajems ns 15 (2012) no 3 329 f i g u r e 2 wpi inflation and exchange rate fluctuations, 1990-2008 (12month percentage change) source: author's calculations 4 applied model in this section, the granger-causality test is applied to explore the nature of relationship between the exchange rate change and inflation. data for egypt was collected from the imf international financial statistics database. the period of estimation corresponded to the interval from 1990m1 to 2008m4. to express inflation, this paper used both cpi and wpi. exchange rate data is the change of the egyptian pound per unit of us dollar (end of month). a positive variation means depreciation of the domestic currency, and a negative one means appreciation. before running the causality, the data set becomes significantly stationary using ducky-fuller test. the granger causality test involves estimating the following regression model: ∑ +δ+∑ δ= = − = − n 1i titi n 1i itit )1..(....................upbeαδp ∑ +δδ+∑ δθ= = − = − n 1i titi n 1i itit )2..(....................vp eδe where: δp is the inflation rate measured as the rate of change in each of the price indices (first as δcpi, second as δ wpi). δ e is the nominal exchange rate change. ut and vt are disturbances. equation (1) postulates that the inflation rate is related to lagged values of itself as well as of exchange rate change. equation (2) postulates that exchange rate change is connected to past values of itself in addition to the inflation rate. the results of the granger-causality test between exchange rate and the two indices of inflation are shown in tables (1) and (2). t a b l e 1 results of granger-causality test between exchange rate and cpi inflation direction of causality lags no. f-statistic p-value δe doesn't granger cause δcpi 2 0.5386 0.5843 δcpi doesn't granger cause δe 2 4.5237 0.0119 δe doesn't granger cause δcpi 6 2.3017 0.0359 δcpi doesn't granger cause δe 6 1.7479 0.1116 δe doesn't granger cause δcpi 8 3.4971 0.0008 δcpi doesn't granger cause δe 8 2.2417 0.026 source: author’s calculation -200,00 -100,00 0,00 100,00 200,00 300,00 400,00 500,00 600,00 19 90 m 1 19 91 m 1 19 92 m 1 19 93 m 1 19 94 m 1 19 95 m 1 19 96 m 1 19 97 m 1 19 98 m 1 19 99 m 1 20 00 m 1 20 01 m 1 20 02 m 1 20 03 m 1 20 04 m 1 20 05 m 1 20 06 m 1 20 07 m 1 20 08 m 1 exchange rate wpi 330 sajems ns 15 (2012) no 3 t a b l e 2 results of granger-causality test between exchange rate and wpi inflation direction of causality lags no. f-statistic p-value δe doesn't granger cause δwpi 2 2.5178 0.0831 δwpi doesn't granger cause δe 2 1.2087 0.3007 δe doesn't granger cause δwpi 6 1.81097 0.09 δwpi doesn't granger cause δe 6 1.0886 0.3707 δe doesn't granger cause δwpi 8 2.897 0.0046 δwpi doesn't granger cause δe 8 0.8056 0.5983 source: author’s calculation depending on the rate of change of cpi as a measure of inflation, table (1) points to a unidirectional causality running from the price growth to the exchange rate change when considering two lagged periods and 1 per cent of significance. the unidirectional causality moves in the opposite way from exchange rate change to price growth with six lagged periods and 5 per cent of significance. this reflects the appearance of erpt effect. meanwhile, there is a bi-directional causality between the two variables at 8 lagged periods and 5 per cent of significance. it means that the nominal exchange rate depreciation will increase inflation and the inflation will result in exchange rate depreciation. the quick response of exchange rate changes to price growth shows that inflation plays an important role in exchange rate fluctuations on the short run. this matches the open economy of egypt, while the relatively slower exchange rate erpt effect could be attributed to some distortions resulting from the interference of the egyptian government with price control and subsidies. consequently the interference may be an obstacle in the variability of consumer prices. this explanation agrees with al-mashat & billmeier (2007) who showed a sizeable share of administered prices in cpi, around one third of the items. to examine the relation between exchange rate and inflation at another stage of commodity distribution, table (2) runs the regression between exchange rate change and wpi change. it shows that the causality moves from exchange rate change to price growth. this direction of causality does not change under different lag periods. also, it can be seen that wpi reflects the impact of exchange rate change on inflation more rapidly than the cpi. while the impact needs only 2 lagged periods to start with regard to wpi, it takes 6 lagged periods with regard to cpi. this may reflect the different composition of the two indices. wpi is driven mainly by prices of tradable goods, whereas cpi has large distribution between tradable and non-tradable goods (bailliu & fuiji, 2004). this means the larger the share of tradable goods in a certain price index, the more likely the effect of exchange rate on price level. there is indeed an inflationary mechanism running from exchange rate change in both tables, thus reinforcing the existence of the erpt phenomenon. this may be caused by the low price elasticity of import demand and high propensity to import in egypt as a developing country. according to its import structure, there is a significant dependence on intermediate and capital goods in order to satisfy the requirements of economic development. in year 2008, the intermediate goods accounted for 66 per cent of total import, while the capital goods accounted for15 per cent (ministry of foreign trade and industry, 2010). this means any exchange rate depreciation will be reflected in higher import costs without the ability to decrease import demand significantly. therefore, the domestic price level will increase specially in the presence of a pricewage spiral. the results of this study proved the presence of the erpt phenomenon in the egyptian economy. by adopting the inflation targeting regime, erpt will be tamed. the monetary authority will gain credibility from its role in targeting this regime. therefore after a period of low inflation, the effect of the exchange rate on the formation process of agents’ expectations is likely to fade. sajems ns 15 (2012) no 3 331 5 concluding remarks the analysis in this paper was based on the granger-causality test for monthly data during the period of 1990-2008. it showed a strong relationship between exchange rate changes and inflation. both indicators of inflation succeeded in reflecting a clear erpt phenomenon, but wpi showed a faster response to exchange rate changes than cpi. this is due to the distortions of cpi as many basic goods in egypt have been subjected to price control and explicit or implicit subsidies (e.g. basic food stuffs, energy). this in turn ensures the insufficiency of cpi in reflecting the inflationary effect of the exchange rate. the result that the exchange rate is a significant determinant of inflation has an interesting implication for egypt’s economic ability to attain an effective inflation targeting regime. it gives a clear justification for applying this regime to limit the erpt phenomenon but there will be some challenges for consideration. first, the rise in the inflation rate is mainly due to the effect of the egyptian pound’s depreciation. with uncertainty about future price trends in the transient period of applying the regime, the monetary authorities not only have to deal with high levels of inflation, but also with a surge in inflation expectations. second, the monetary authority may need to intervene more frequently in the foreign exchange market to decrease its fluctuations. third, with regard to the clarity of erpt effect and its consequences, there is the risk that the exchange rate becomes the main focus of the central bank, thus confusing the public about the priorities of the central bank, which distorts expectations. accordingly, to face the dilemma between applying a ‘strict inflation targeting’, or applying ‘flexible inflation targeting’, the central bank may choose to smooth short-run exchange rate movements to attain its target inflation rate. this does not mean that the central bank does not allow the currency to adjust to a new longrun equilibrium following a shock, but that it will not let this movement interfere with its attainment of the inflation targets. this implies that possible transparent interventions in the foreign exchange market are required for the attainment of the inflation target. this may justify applying ‘flexible inflation targeting’ by policymakers. in this context, a recent study has shown that although the inflation targeting regime has led to higher exchange rate instability than alternative regimes, foreign exchange interventions in some inflation targeting countries have been more effective to lower volatility than in non-inflation targeting countries (berganza & broto, 2011). the main policy recommendations may also include: 1. to limit the over-vulnerability of the economy to exchange rate fluctuations by increasing the openness of the economy and improving the exporting ability. 2. to activate sufficiently developed channels beside exchange rate to guide monetary policy choices. references achsani, n., fauzi, a. 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mungule, k. 2004. the determinants of the real exchange rate in zambia. african economic research consortium research paper, 146. national bank of egypt. 2002. development of exchange rate in egypt. economic bulletin, 55(1). neaime, s. 2008. monetary policy transmission and targeting mechanisms in the mena region. economic research forum working paper series, 395. nogueira, r. 2007. inflation targeting and exchange rate pass-through. econ. aplic., 11(2). ndungu, n. 1997. price and exchange rate dynamics in kenya: an empirical investigation (1970-1993). aerc research paper, 58. taylor, j. 2000. low inflation, pass-through and the pricing power of firms. european economic review, 44(7). the egyptian cabinet. 2003. early warning system for crises of currency markets. the information and decision support center. the egyptian cabinet. 2004. the effect of exchange rate change on inflation rate in egypt: passthrough effect, the information and decision support center. yang, j. 1997. exchange rate pass-through in us manufacturing industries. review of economics and statistics, 79(1). youssef, h. 2007. towards inflation targeting in egypt: fiscal and institutional reforms to support disinflation efforts. european commission economic papers, 288. microsoft word 6 de beer et al sajems 19(3) 2016.doc 400 sajems ns 19 (2016) no 3:400-412 how to cite doi: http://dx.doi.org/10.17159/2222-3436/2016/v19n3a7 issn: 2222-3436 job crafting and its impact on work engagement and job satisfaction in mining and manufacturing leon t de beer workwell research unit, north-west university maria tims department of management and organization, vrije university amsterdam arnold b bakker center of excellence for positive organizational psychology, erasmus university rotterdam accepted: march 2016 the purpose of this study was to investigate job crafting and its relationship with work engagement and job satisfaction within the south african context. this research is important as job crafting has been shown to have a positive influence on employee motivation. a cross-sectional survey design was used to collect primary data from organisations in the mining and manufacturing industries of south africa (n = 470). the results of multi-group structural equation modelling showed that the original four-factor structure of the job crafting scale was supported by the data, but that a three-factor structure was necessary due to a discriminant validity concern regarding two job crafting dimensions. regression results revealed that increasing structural job resources with challenging job demands, and increasing social job resources were significant predictors of work engagement in both groups. contrary to expectations decreasing hindering job demands was a negative predictor of job satisfaction in the mining group. furthermore, increasing social job resources was also a significant predictor of job satisfaction in both groups. this study indicates the importance of job crafting for work engagement and job satisfaction in organisations. key words: job crafting, work engagement, job satisfaction, job design, proactive behaviour jel: m54 1 introduction in south africa, mining contributes to about 18 per cent of gross domestic product (gdp) and to over 50 per cent of foreign exchange earnings (smit, 2013). similarly, manufacturing has been said to contribute to about 17 per cent of gdp (statssa, 2015) – indicating that both sectors are invaluable to the growth and success of the south african economy. however, in recent years these sectors have been impacted by frequent labour unrest (legal and wildcat strikes) and uncertainty surrounding employment (layoffs and retrenchments) and production are a great concern. for example, in platinum mining, a r 24 billion loss was estimated due to strike action (steyn, 2014). therefore, employees and organisations can benefit from employees who are proactive as organisations depend on their employees’ proactivity in order to maintain competitive advantage due to constant changes in the market (wagner & hollenbeck, 2015). this can be accomplished by having optimally motivated employees within a climate that takes the organisation forward. in the organisational behaviour literature employee motivation of this nature is most often referred to as work engagement – a positive, work-related frame of mind that is characterised by high levels of energy (vigour) and dedication in and to one’s work (schaufeli & bakker, 2004). furthermore, in line with the job demands-resources model (jd-r; bakker, demerouti & sanz-vergel, 2014), employees who receive the necessary job resources and have an optimal level of job demands (work characteristics) are not only motived and engaged, but are also overall more likely to be satisfied with their jobs. job satisfaction can be defined as “a positive (or abstract sajems ns 19 (2016) no 3:400-412 401 negative) evaluative judgment one makes about one's job or job situation” (weiss, 2002:175). if employee work engagement and job satisfaction are not optimal, it can lead to various detrimental outcomes for the organisation, such as reduced commitment, lower productivity and increased employee turnover intention (bakker & demerouti, 2007; de beer, rothmann jr. & pienaar, 2012) – all of which are undesirable to an organisation as productivity and retention of talent are important aspects for business success which impacts the bottom-line. traditionally, from an organisational perspective, employees have been considered as passengers in their jobs and job (re)design was considered a reactive task – but an alternative has been posited that enables job (re)design at the individual level (see tims & bakker, 2010). employees who experience work engagement have been shown to create their own great places to work (bakker, 2010). organisations would therefore (and do) benefit from employees who take proactive initiatives in moulding their work characteristics (demands and resources) to best fit their needs and requirements (parker, williams & turner, 2006). in this sense, the organisation itself is not the sole proprietor of employee motivation and well-being, but employees themselves take action to increase their engagement and satisfaction with work by taking responsibility for altering job characteristics of their own volition (tims, bakker & derks, 2013). an employee therefore enters a job and proactively changes task-aspects of the job to better suit him or her (bakker, tims & derks, 2012). this proactive behaviour and personal initiative has been coined: job crafting (wrzesniewski & dutton, 2001). job crafting is, in the context of the jd-r model, about moulding a job according to the employee’s preferences, skills, and abilities – and thereby making actual changes in levels of job demands and job resources (berg & dutton, 2008; tims, bakker & derks, 2012). it is important to note that job crafting and job (re)design are not interchangeable terms. job redesign considers changes to the job as a whole and is a top-down approach, while job crafting is more concerned with task-related aspects of the job and is a bottom-up approach (berg & dutton, 2008; tims et al., 2012). thus, in line with the jd-r model, job crafting addresses job demands and job resources (tims & bakker, 2010), which can positively influence employee motivation, work engagement and job satisfaction. currently, no studies have been conducted on job crafting within the south african context. due to its importance to organisations, a gap has been identified that needs to be addressed. therefore, the present study aims to determine the factor structure of a recently proposed job crafting scale. in addition, we investigate the relationship of job crafting with work engagement and job satisfaction – two important indicators of employee motivation within mining and manufacturing organisations in south africa. 2 literature review 2.1 deconstructing job crafting initially, it was hypothesised that job crafting comprises three components: i) increasing job resources, ii) increasing challenging job demands, and iii) decreasing hindering job demands (cf. tims et al., 2012). specifically, increasing one’s level of job resources may have an impact on overall work engagement and motivation, as job resources have been shown to be the most important indicators of employee motivation as presented in the motivational process of the jd-r model (bakker & demerouti, 2007). demerouti, bakker, nachreiner and schaufeli (2001) describe job resources as the organisational aspects of the job that are instrumental in achieving work goals and may also reduce job demands. some examples of job resources are social support, increased autonomy and participation in decision-making processes (burke & richardsen, 1993). conversely, demerouti et al. (2001:501), and schaufeli and bakker (2004:296) define job demands as “those physical, psychological, social, or organisational aspects of the job that require sustained physical and psychological effort and are therefore associated with certain physiological and psychological costs”. however, in terms of challenging job demands, research has shown that stimulating and challenging job tasks impact employee motivation positively (crawford, lepine & 402 sajems ns 19 (2016) no 3:400-412 rich, 2010; lepine, podsakoff & lepine, 2005), whereas hindering job demands have been shown to be related to employee exhaustion and cynicism (lepine et al., 2005; van den broeck, de cuyper, de witte & vansteenkiste, 2010). hindering job demands contribute to the eroding of energy and health impairment that leads to burnout and eventually being unwell (tadic, bakker & oerlemans, 2015). job crafters therefore address their job demands and job resources in a variety of constructive ways, like seeking resources (e.g., more autonomy on certain tasks, asking supervisors for more feedback regarding their performance), seeking challenges (e.g., challenging job demands to increase their mastery and personal growth), and reducing demands (e.g., hindering demands such as role conflict) (cf. petrou et al., 2012). the original development and validation study of the job crafting scale by tims and colleagues revealed a four-factor structure for job crafting. two of the original hypothesised factors were retained: i) increasing challenging demands and ii) decreasing hindering job demands; and two ‘new’ factors both represented the hypothesised concept of increasing job resources-behaviour and were labelled: iii) increasing structural job resources (e.g. autonomy, learning opportunities and variety) and iv) increasing social job resources (e.g. feedback, colleague support and supervisory coaching) (see tims et al., 2012). the current study aimed to confirm this four-factor structure in a southafrican sample of miners and manufacturers. therefore the following hypothesis was stated: h1. the job crafting scale consists of a four-factor structure. 2.2 work engagement and job crafting work engagement is classically defined as a “positive, work-related state of mind in employees characterised by vigour, dedication, and absorption” (schaufeli, salanova, gonzalez-roma & bakker, 2002:74). the core components of engagement comprise vigour and dedication (bakker, albrecht & leiter, 2011; schaufeli & bakker, 2004), whereas absorption has been considered a more divergent component resulting from having the necessary vigour and dedication in one’s work (see langelaan, 2007). vigour reflects high levels of energy and mental resilience at work (bakker & demerouti, 2007; schaufeli & bakker, 2010), whilst dedication reflects “a sense of significance, enthusiasm, inspiration, pride, and challenge” (schaufeli & bakker, 2004:295). proactive behaviour and work engagement have shown a positive relationship, i.e. the act of being proactive has shown to increase work engagement (bakker et al., 2012). indeed, broadenand-build theory posits that positive affect broadens attention, cognition and action, which, in turn, leads to an increase in resources (fredrickson, 2001; fredrickson & branigan, 2005). job crafting is an example of proactive behaviour and longitudinal research has found that job crafting is a mediator in the process of increasing work engagement and person-environment fit (lu, wang, lu, du & bakker, 2014). job resources have also been shown to be the strongest predictors of work engagement (bakker, hakanen, demerouti & xanthopoulou, 2007). therefore, proactive actions by an individual that mobilises (and increases) job resources, decreases hindering job demands, and increases challenging aspects of a job, leads to work engagement (bakker et al., 2012; petrou et al., 2012; tims et al., 2012; tims et al., 2013). based on the above the following hypothesis was stated: h2. job crafting has a positive relationship to work engagement 2.3 job satisfaction and job crafting job satisfaction is an affective state and indicates the overall level of satisfaction that an employee has towards his or her job situation (weiss, 2002). it has also been argued that job satisfaction is a more passive state compared to work engagement, which is considered a more active one (warr & inceoglu, 2012). this can be explained in the context of the circumplex model of emotion (russell, 1980, 2003), which positions job satisfaction as characterised by low activation with positive (pleasant) affect – and work engagement having this positive affect but with high arousal (activation). research has also shown that adequate job resources improve the job satisfaction levels of employees (sousa-poza & sousa-poza, 2000). for example, increasing the quality of the exchange relationship with the supervisor (supervisor support a social resource) has shown to sajems ns 19 (2016) no 3:400-412 403 increase job satisfaction and organisational citizenship behaviour (li, liang & crant, 2010). therefore, the act of crafting can also increase the job satisfaction of employees (tims et al., 2013). the following hypothesis is stated: h3. job crafting has a positive relationship to job satisfaction. the purpose of this study was to investigate the psychometric properties of the job crafting scale and its relationship with work engagement and job satisfaction within the south african context. 3 research methods this study consisted of a cross-sectional design (struwig & stead, 2001). cross-sectional research collects data at one point in time and considers the relationships between variables at that time (struwig & stead, 2001; welman, kruger & mitchell, 2011). therefore, primary data was collected from the organisations via survey implementation. 3.1 research participants the participants (n = 470) comprised of 260 employees in the mining sector (55.7 per cent of the sample), and 210 employees in the manufacturing sector (44.3 per cent of the sample). the mean age of the participants was 37.92 (sd=11.4). male participants numbered 263 (56 per cent) while females numbered 207 (44 per cent). the majority of the participants stated that they were married or living with a partner (63 per cent), whereas the minority indicated that they were remarried (3 per cent). the participants who were employed on a full-time basis numbered 451 (95.9 per cent), with 19 (4.1 per cent) employees indicated they were employed on a part-time basis. a total of 267 participants indicated their home language as being an african-language (56.8 per cent), whereas 199 participants’ language was of western-germanic (english / afrikaans) origin (42.3 per cent). 3.2 measuring instruments the measuring instruments used for the current study are described below. please note that the reliability coefficients of the current study scales are provided in the results section below. 3.2.1 biographical questionnaire standard biographical questions were used to determine the biographical characteristics of the participants, such as year of birth and gender. 3.2.2 job crafting job crafting was measured with the job crafting scale (jcs) developed by tims et al. (2012). this scale uses a 5-point rating scale ranging from 1 (never) to 5 (often). the jcs posits four underlying factors measured by 21 items (e.g. ‘i make sure that my work is mentally less intense’ and ‘when there is not much to do at work, i see it as a chance to start new projects’). this scale reported cronbach’s alpha coefficients of above 0.70 for all of the factors (tims et al., 2012). 3.2.3 work engagement work engagement was measured with items from the utrecht work engagement scale (uwes17; schaufeli, bakker & salanova, 2006). this measure classically consists of 17 items that are all scored on a 7-point rating scale ranging from 0 (never) to 6 (always). in this study only the 11 items measuring the two core components of work engagement were used: vigour, (e.g. ‘i can continue working for very long periods at a time’) and dedication (e.g. ‘i find the work that i do full of meaning and purpose’) (schaufeli & bakker, 2004). the uwes has been used in south africa with acceptable reliability (α = 0.78-0.89; storm & rothmann, 2003). 3.2.4 job satisfaction job satisfaction was measured with the scale developed by hellgren, sjöberg and sverke (1997). this three-item measure uses a 5-point scale ranging from 1 (strongly disagree) to 5 (strongly 404 sajems ns 19 (2016) no 3:400-412 agree), to measure the individual’s satisfaction with his or her job (e.g. ‘i enjoy being at my job’). within the south african context a cronbach’s alpha coefficient of 0.80 was found for this scale (pienaar, sieberhagen & mostert, 2007). 3.3 statistical analysis multi-group confirmatory factor analysis (cfa; brown, 2015) with structural equation modelling methods were implemented with mplus 7.31 (muthén & muthén, 2015). the weighted least square (wls) estimation method, specifically the mean and variance adjusted weighted least squares (wlsmv) estimator was used. the justification for this implementation is based on the ordered categorical nature of the items (and not continuous nature as would be assumed by maximum likelihood estimation). a recent study has also shown that wlsmv can perform better with categorical data, compared even to bayesian implementations, when sample size is 200 or above (liang & yang, 2014). this approach was therefore considered appropriate to reach the objectives of the current study. the wlsmv estimation method provides the well-known global fit statistics for structural equation modelling methods: comparative fit index (cfi; satisfactory values of 0.90 and above), tucker-lewis index (tli; satisfactory values of 0.90 and above), and root mean squared error of approximation (rmsea; satisfactory value below 0.08) (van de schoot, lugtig & hox, 2012). even though a polychoric correlation matrix is used between items in the estimation process of wlsmv, a zero-order correlation matrix is generated for the latent variables as latent variables are estimated to be continuous variable values from the ordered categorical indicators. in terms of the effect sizes for the correlation values, r ≥ 0.30 was considered a medium practical effect, and r ≥ 0.50 was considered a large practical effect (cohen, 1988). problematic discriminant validity between latent variables would be investigated for high correlational values, i.e. r ≥ 0.85 (brown, 2015). any potential concern of discriminant validity would be addressed by the average variance extracted (ave) versus the shared variance between the constructs (farrell, 2010). this technique assumes sufficient discriminant validity only if the ave of each latent factor is larger than the shared variance between the two constructs being compared. to determine the reliability of the constructs, alpha coefficients are normally calculated (cronbach, 1951). however, cronbach’s alpha has been shown to be an inaccurate estimate of internal consistency and in some cases a gross overestimate (revelle & zinbarg, 2009). peters (2014) suggests abandoning cronbach’s alpha in psychological research altogether for other alternatives like the omega coefficient (ω) with bootstrapped 95 per cent confidence intervals (cis). this study heeded that call and calculated omega reliability coefficients with 10 000 bootstrap replications which provides 95 per cent confidence intervals for the reliability estimates (reported in the results section below). finally, a structural model was specified by adding regressions to the cfa (measurement) model in order to determine the standardised beta coefficients (β) and standard errors (s.e.) for the direction of relationships between the latent variables. statistical significance for all parameters in the study was set at the normal 95 per cent level (p < 0.05). 4 results results of the structural equation modelling with mplus, revealed the following: 4.1 measurement models (cfa), discriminant validity and reliability indicators the cfa results indicated that the four-factor measurement model for the components of job crafting showed a good fit to the data (cfi = 0.95; tli = 0.95; rmsea = 0.05). however, upon closer inspection it was found that two of the four factors (increasing structural job resources and increasing challenging job demands) had a correlation of 0.86 in both the mining and manufacturing groups, which is above the set cut-off of 0.85 for discriminant validity (brown, 2015). this then necessitated an investigation into the discriminant validity of these two constructs sajems ns 19 (2016) no 3:400-412 405 in the sample, i.e. whether these two factors could indeed be meaningfully distinguished from each other or if they needed to be combined as one factor in order to continue with the study investigations. the ave and the shared variance between the two constructs in the two groups showed that in mining it was a borderline case while in the manufacturing group more shared variance was explained between the factors than in each individual latent variable. this indicated that there were indeed concerns with discriminant validity and it was decided to combine these two factors into a new factor labelled: increasing structural job resources and challenging demands (increasing s-jr and c-jd), to investigate the remaining two hypotheses. h1 was therefore partially supported. the fit of the adjusted three-factor model to the data was also acceptable with deviations only occurring at the thousandth decimal (cfi = 0.95; tli = 0.95; rmsea = 0.05). in this instance, no inordinate correlations were found in the correlation table, i.e. rs < 0.85 in all instances (see table 2). the bootstrapped replicated omega reliability indicators showed that all three factors had acceptable reliability, i.e. internal consistency. more specifically, increasing s-jr and c-jd (mining: ω = 0.77, 95% ci[0.71, 0.82]; manufacturing: ω = 0.83, 95% ci[0.79, 0.86]), increasing social resources (mining: ω = 0.73, 95% ci[0.68, 0.77]; manufacturing: ω = 0.79, 95% ci[0.72, 0.83]), and decreasing hindering job demands (mining: ω = 0.76, 95% ci[0.70, 0.80]; manufacturing: ω = 0.80, 95% ci[0.74, 0.84]) all had values above 0.70 in both groups (dunn, baguley & brunsden, 2014). 4.2 factor loadings and explained variance of the latent factors table 1 presents the standardised factor loadings and variances explained of the individual items for each of the job crafting factors. table 1 standardised factor loadings, standard errors and explained variance of the items for the job crafting factors sector factor item loading s.e. r2 sector loading s.e. r2 mining increasing s-jr with c-jd 1 0.57 0.05 0.33 manufacturing 0.76 0.04 0.57 2 0.71 0.04 0.50 0.76 0.04 0.57 3 0.85 0.04 0.72 0.82 0.04 0.68 4 0.81 0.04 0.65 0.84 0.03 0.70 5 0.27 0.04 0.07 0.34 0.06 0.12 17 0.62 0.04 0.58 0.56 0.05 0.54 18 0.53 0.04 0.38 0.60 0.05 0.36 19 0.55 0.04 0.47 0.72 0.04 0.46 20 0.43 0.05 0.31 0.52 0.05 0.51 21 0.59 0.04 0.25 0.66 0.04 0.42 increasing social job resources 12 0.64 0.04 0.41 0.68 0.05 0.48 13 0.71 0.04 0.41 0.77 0.04 0.47 14 0.60 0.05 0.51 0.68 0.05 0.58 15 0.65 0.04 0.37 0.76 0.05 0.47 16 0.56 0.05 0.42 0.56 0.05 0.60 decreasing hindering job demands 6 0.76 0.04 0.31 0.73 0.03 0.31 7 0.62 0.04 0.38 0.60 0.04 0.31 8 0.68 0.04 0.29 0.68 0.03 0.35 9 0.56 0.05 0.31 0.71 0.03 0.52 10 0.50 0.05 0.18 0.65 0.04 0.27 11 0.64 0.05 0.35 0.69 0.04 0.44 notes: s-jr = structural job resources; c-jd = challenging job demands; all loadings significant at the p < 0.001 level; r2 = variance explained by the latent factor in indicator 406 sajems ns 19 (2016) no 3:400-412 results of the three-factor model revealed that all the items of the individual job crafting factors had statistically significant factor loadings (λ). for example, for increasing s-jr with c-jd the item with the highest factor loading was item 3 in the mining group (“i try to learn new things at work”; λ = 0.85) and item 4 (“i make sure that i use my capacities to the fullest”; λ = 0.84) in the manufacturing group. for the second factor, increasing social job resources, the item with the highest factor loading in both groups was item 13 (“i ask whether my supervisor is satisfied with my work”; mining: λ = 0.71; manufacturing: λ = 0.77). the final factor, decreasing hindering job demands, also had the same item with the highest loadings in both groups, i.e. item 6 (“i make sure that my work is mentally less intense”; mining: λ = 0.76; manufacturing: λ = 0.73). all in all, the factor loadings had significant loadings to their corresponding factors, with acceptable variances explained by the latent variables in the corresponding observed indicators. 4.3 correlation matrix for the study variables table 2 presents the zero-order correlation matrix for the three-factor model with work engagement and job satisfaction included. table 2 correlation matrix for the latent variables in both groups variables 1 2 3 4 5 1. increasing s-jr with c-jd 0.45* -0.07 0.46* 0.67** 2. increasing social job resources 0.73** 0.16 0.32* 0.49* 3. decreasing hindering job demands 0.56** 0.47* -0.15 -0.05 4. job satisfaction 0.51** 0.57** 0.36* 0.70** 5. work engagement 0.52** 0.53** 0.25 0.68** notes: mining below-left of the diagonal and manufacturing above-right of the diagonal; * = medium practical effect; ** = large practical effect in terms of the job crafting factors, it was interesting to note that in the mining group all of these factors correlated with each other with at least medium practical effect (rs = 0.47-0.73). furthermore, work engagement was positively correlated with increasing s-jr with c-jd (r = 0.52; large effect), increasing social job resources (r = 0.53; large effect) and decreasing hindering jd (r = 0.25; small effect). all three of the job crafting factors in the mining group also correlated positively to job satisfaction. in the manufacturing group decreasing hindering job demands did not correlate with practical effect with increasing social job resources (r = 0.16, p = 0.042) and didn’t at all correlate significantly with increasing s-jr and c-jd (r = -0.07, p = 0.281). increasing s-jr with c-jd and increasing social job resources correlated positively practically significantly with work engagement (r = 0.67; r = 0.46) and job satisfaction (r = 0.49; r = 0.32). however, decreasing hindering job demands did not statistically significantly correlate with work engagement and correlated negatively with job satisfaction (r = -0.15). 4.4 structural model results structural regression paths based on the hypotheses were added to the three-factor measurement model to establish the structural model. table 3 presents the results of the structural model’s implementation. as can be seen from table 3, in terms of work engagement in both groups: increasing s-jr with c-jd had a significant positive relationship to work engagement (mining: β = 0.33, s.e. = 0.11, p = 0.002; manufacturing: β = 0.56, s.e. = 0.05, p ≤ 0.001). similarly, increasing social job resources had a significant positive relationship to work engagement in the mining (β = 0.33, s.e. = 0.11, p = 0.002) and manufacturing group (β = 0.24, s.e. = 0.06, p ≤ 0.001). in terms of decreasing hindering job demands, there was no significant relationship to work engagement in either the mining (p = 0.211) or the manufacturing groups (p = 0.402). therefore, h2 was only partially supported. sajems ns 19 (2016) no 3:400-412 407 table 3 regression results for the structural model sector structural regression path β s.e. p mining increasing s-jr with c-jd → work engagement 0.33 0.11 0.002 increasing social jr → work engagement 0.33 0.11 0.002 decreasing hindering jd → work engagement -0.09 0.07 0.211 increasing s-jr with c-jd → job satisfaction 0.17 0.12 0.151 increasing social jr → job satisfaction 0.41 0.11 0.001 decreasing hindering jd → job satisfaction 0.07 0.09 0.423 manufacture increasing s-jr with c-jd → work engagement 0.56 0.05 0.001 increasing social jr → work engagement 0.24 0.06 0.001 decreasing hindering jd → work engagement -0.05 0.06 0.402 increasing s-jr with c-jd → job satisfaction 0.37 0.07 0.001 increasing social jr → job satisfaction 0.17 0.07 0.018 decreasing hindering jd → job satisfaction -0.15 0.07 0.020 notes: β = beta coefficient; s.e. = standard error; p = two-tailed statistical significance; s-jr = structural job resources; c-jd = challenging job demands; jd = job demands; jr = job resources in terms of job satisfaction in the mining group, increasing s-jr with c-jd did not have a significant relationship to job satisfaction (p = 0.151), and the case was the same for decreasing hindering job demands and job satisfaction (p = 0.423). however, increasing social job resources did have a significant positive relationship to job satisfaction (β = 0.41, s.e. = 0.11, p ≤ 0.001). for the manufacturing group, increasing s-jr and c-jd (β = 0.37, s.e. = 0.07, p ≤ 0.001), and increasing social job resources (β = 0.17, s.e. = 0.07, p ≤ 0.001) both had significant positive relationships to job satisfaction. however, decreasing hindering job demands had a significant negative relationship to job satisfaction (β = -0.15, s.e. = 0.07, p = 0.020). h3 was therefore also partially supported. 5 discussion the aim of this study was to investigate job crafting and its impact on both work engagement and job satisfaction in mining and manufacturing within the south african context. structural equation modelling methods were applied to investigate the hypotheses. hypothesis 1 was partially supported as the four-factor model could be confirmed in both groups, but due to a discriminant validity issue it was necessary to combine increasing structural job resources and challenging job demands in order to offset the potential of multicollinearity in the model, which would distort results. the newly formed three-factor model was also a good fit to the data, did not contain discriminant validity concerns, and consisted of the following factors: increasing structural job resources with challenging job demands (increasing s-jr with c-jd), increasing social job resources, and decreasing hindering job demands. interestingly, tims et al. (2012) originally hypothesised a three-factor model, but the final three-factor model operationalised in the current study did also not reflect their original three-factor expectation. as to why increasing structural job resources and challenging job demands combine as one-factor in this study, a potential explanation is that when employees increase their level of autonomy, their perceptions of responsibility and challenge increase as well. in addition, when actively seeking challenging and complex new projects, one may also increase opportunities for growth and development (i.e. a structural job resource). hypothesis 2 was also partially supported; it was found in both the mining and manufacturing groups that increasing s-jr with c-jd and increasing social job resources had significant relationships to work engagement. this is in line with research that has stated that challenging job demands can increase employee motivation and work engagement levels (bakker & sanz-vergel, 2013; christian, garza & slaughter, 2011). furthermore, previous studies have also shown that 408 sajems ns 19 (2016) no 3:400-412 social support (e.g. colleague support and supervisory coaching) leads to an increase in employee work engagement (bakker & demerouti, 2008; bakker, schaufeli, leiter & taris, 2008). however, in both groups decreasing hindering job demands did not have a significant relationship to work engagement. classically, the jd-r model presents no direct relationship to job demands (e.g., work overload) work engagement (bakker & demerouti, 2007), and increased work engagement has only been associated with challenging demands at work (langelaan et al., 2006; schaufeli et al., 2001). therefore, the finding that decreasing hindering job demands does not significantly affect work engagement, in these two groups, is not necessarily a counter-intuitive finding and is in line with other studies (see tims, bakker & derks, 2015; tims, bakker & derks, 2014). additionally, reducing workload may have a protective effect on well-being but also lessen employee urgency to action (petrou et al., 2012). in terms of job crafting and job satisfaction, hypothesis 3 was also only partially supported. in the mining group there was only one significant relationship, and that was the relationship indicating that increasing s-jr may positively relate to job satisfaction. similarly, this relationship was also significant in the manufacturing group. this is in line with research that has found that social support such as colleague support and immediate supervisor support is related to job satisfaction (baruch-feldman, brondolo, ben-dayan & schwartz, 2002; ducharme & martin, 2000; ellinger, ellinger & keller, 2003). tims et al. (2013) found that job satisfaction is fuelled by resources such as autonomy and financial rewards. furthermore, increasing s-jr with c-jd also had a significant relationship to job satisfaction, which is in line with research that has shown that an increase in job resources and challenging demands may lead to increased job satisfaction (lepine et al., 2005; sousa-poza & sousa-poza, 2000). conversely, decreasing hindering job demands had a significant but negative relationship to job satisfaction. this result was unexpected, but also interesting. previous research has stated that decreasing hindering job demands can be a potential negative aspect of job crafting – i.e. it may result in task avoidance and procrastination (oldham & hackman, 2010; wrzesniewski & dutton, 2001), and this may then lead to lower levels of job satisfaction. furthermore, the current research did not measure how successful employees are at achieving their job crafting goals, and as such we can only speculate why this relationship was evident. perhaps the mere act of having to decrease hindering job demands could also be at such a level (and perhaps so unsuccessful) that it affects employee job satisfaction levels negatively – perhaps due to the rigidity of the regulated environment they find themselves in. as previously shown, hindrance demands affect job satisfaction negatively (lepine et al., 2005), and unsuccessful attempts at addressing these demands might lead to job dissatisfaction because the proactive behaviour is ineffective. more specifically, the appraisal of demands as being threatening or hindering evokes a negative emotional response and passive style of coping that can lead to avoidance and withdrawal (lepine et al., 2005). 5.1 limitations and recommendations the key limitation of this study was its cross-sectional nature and therefore assumptions of causality are cautioned. although longitudinal research has been conducted in other contexts it remains necessary to investigate job crafting and its related outcomes within a south african context, over time. furthermore, the results of the factor structure of job crafting in the current sample were interesting: while the original four-factor model could be confirmed with acceptable fit, a three-factor model was necessitated due to a discriminant validity concern between increasing structural job resources and increasing challenging job demands which had to be combined into one factor for thus study. researchers in future studies of job crafting in south africa should therefore ascertain if they face a similar situation by first considering the original four-factor model – in line with established literature and investigate whether they face a similar situation in terms of discriminant validity as was the case in this study in order to elucidate the state of affairs within the south african context. this may also have been due to the interpretation sajems ns 19 (2016) no 3:400-412 409 of the items (language used), and an item bias study could also be conducted in order to investigate the parameters, i.e. within and between person fit. a further limitation worth mentioning is that the current study only considered organisations in the mining and manufacturing sectors of south africa which are very important to the gdp of the south african economy, but somewhat limits the external validity of the findings. future researchers should therefore also consider samples from other sectors such as information technology, higher education, and health care to answer questions surrounding job crafting. finally, this study only considered positive consequences of job crafting but recent research has shown that detrimental effects (such as negative spill over to colleagues) are also possible (demerouti, bakker, & halbesleben, 2015; tims, bakker & derks, 2015) – indicating further possibilities for future research. 5.2 conclusion in conclusion, this study provided psychometric evidence for the factor structure and reliability of the job crafting scale. job crafting was positively related to work engagement and job satisfaction in the mining and manufacturing industries. specifically, increasing job resources and challenging job demands were positively related to work engagement and job satisfaction, whereas decreasing hindering job demands was unrelated or negatively related to these employee outcomes. our findings suggest that supporting and enabling employees to craft their jobs by increasing their challenging job demands and resources (but not decreasing hindering job demands) may have a positive impact on both work engagement and job satisfaction. references bakker, a.b. 2010. engagement and job crafting: engaged employees create their own great place to work. in s. albrecht (ed.) handbook of engagement: perspectives, issues, research and practice (pp. 229244). northampton, ma: edwin elgar. bakker, a.b., albrecht, s.l. & leiter, m.p. 2011. key questions regarding work engagement. european journal of work and organizational psychology, 20(1):4-28. bakker, a.b. & demerouti, e. 2007. the job demands-resources model: state of the art. journal of managerial psychology, 22:309-328. bakker, a.b. & demerouti, e. 2008. towards a model of work engagement. career development international, 13(3):209-223. bakker, a.b., demerouti, e., & sanz-vergel, a.i. 2014. burnout and work engagement: the jd– r approach. annual reviews in organizational psychology and organizational behavior, 1:389-411. bakker, a.b., hakanen, j.j., demerouti, e. & xanthopoulou, d. 2007. job resources boost work engagement, particularly when job demands are high. journal of educational psychology, 99(2): 274-284. bakker, a.b., schaufeli, w.b., leiter, m.p. & taris, t.w. 2008. work engagement: an emerging concept in occupational health psychology. work & stress, 22(3):187-200. bakker, a.b. & sanz-vergel, a.i. 2013. weekly work engagement and flourishing: the role of hindrance and challenge job demands. journal of vocational behavior, 83(3):397-409. bakker, a.b., tims, m. & derks, d. 2012. proactive personality and job performance: the role of job crafting and work engagement. human relations, 65(10):1359-1378. baruch-feldman, c., brondolo, e., ben-dayan, d. & schwartz, j. 2002. sources of social support and burnout, job satisfaction, and productivity. journal of occupational health psychology, 7(1): 84-93. berg, j.m. & dutton, j.e. 2008. crafting a fulfilling job: bringing passion into work. 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has moved from an industrial to a knowledge economy. consequently, basic factors of production now no longer comprise only natural resources, capital and labour, but also intellectual capital. despite the shift from an industrial to a knowledge economy, the accounting framework and financial reporting have not changed sufficiently to include intellectual capital. the research problem attempts to explore whether the theory of accounting should be modified for a standardised and comparable approach when accounting and reporting on intellectual capital. to solve the research problem, a literature review and content analysis on corporate annual reports were used. the results of this study indicate that the theory of accounting should be modified to ensure a standardised and comparable approach when accounting and reporting on intellectual capital in corporate annual reports. key words: intellectual capital, measurement, recognition, financial reporting, corporate annual reports jel: m410 1 introduction the business environment has seen and experienced a dramatic increase in the number of companies that hold intellectual capital in the form of knowledge, brands, competitive advantage, patents, customer relationships, human capital, research and development, and trademarks (roslender, 2000:35). the major part of the market values of these companies lies in these intangible assets with relatively little value being associated with their tangible assets (seetharaman, sooria & saravanan, 2002: 128). research shows that there is a growing awareness that intellectual capital adds significantly to the value of a business. however, the value in these assets remains hidden, and is not disclosed in the financial records of the organisations. intellectual capital is classified as consisting of human, structural and relational capital (abeysekera, 2003:422). this research focuses on these three classes of intellectual capital. the reasoning behind the non-recognition of some of the intellectual capital is that these assets do not meet the recognition and measure ment criteria in respect of their classification as intangible assets (iasb, 2011:a160-a161). the conceptual framework for financial reporting (iasb, 2011:a34) further states that the reason for non-recognition of these assets is the fact that there exists a degree of risk that the information about these assets will be a less than faithful representation of what the information purports to represent. this is as a result of inherent difficulties in either identifying the transactions and/or other events to be measured, or in devising and applying measurement and presentation techniques capable of conveying a message that is in line with those transactions and/or events. however, the framework does allow the use of reasonable estimates to determine the amount to be disclosed. in this case, measurement and presentation may be performed through the use of reasonable estimates without undermining the reliability of the information. nevertheless, when a reasonable estimate is not possible, then the item concerned will not be recognised in the statement of financial position (iasb, 2011:a35). as a result, a significant portion of a company’s assets may not be reported in the financial statements of that company. the iasb applies very strict requirements if an item is to be recognised as an asset in the abstract 2 sajems ns 16 (2013) no 1 financial statements. these requirements are necessary in order to ensure that it is possible to compare the financial information of different companies and to prevent management’s manipulation of this information. the increasing importance of intellectual capital and the growing number of companies that rely on these assets to create value have created a need to inform the market, the investors and the other stakeholders of the existence of intellectual capital (oecd, 2006: 5). both the accounting and reporting of intellectual capital are, therefore, important if the stakeholders of a company are to be allowed the opportunity to make informed investment and other decisions. 2 research problem the research problem attempts to explore whether the theory of accounting should be modified for a standardised and comparable approach when accounting and reporting on intellectual capital. to solve the research problem, a literature review and content analysis on corporate annual reports of 40 companies listed on jse ltd were performed. 3 research method 3.1 the literature review the research focuses on prior literature of which the main focus has been on the measurement, recognition and disclosure of intellectual capital in financial reporting. different south african and international journals, dissertations and books were used for this purpose. studies on the analysis of the different values attributed to a business by the various users of the financial statements of the business were also reviewed. 3.2 content analysis to complement the literature review, a content analysis on the corporate annual reports of 40 companies listed on jse ltd on 12 may 2009 in terms of their market capitalisation was performed. table 1 below provides a list of the 40 companies researched through content analysis. t a b l e 1 the 40 largest south african jse listed companies as at 12 may 2009 rank company sector market capitalisation (zar billions) 1 british am tobacco plc tobacco 445.5 2 bhp billiton plc. diversified natural resources 425.3 3 anglo american plc mining holding and houses 279.5 4 sab miller plc beverages 251.1 5 mtn group ltd telecommunications 206.1 6 sasol ltd chemicals, oil and plastics 193.3 7 standard bank group banks, financial services 12+ 9.3 8 anglo platinum ltd platinum 118.6 9 anglogold ashanti ltd gold 111.4 10 impala platinum holdings ltd platinum 107.9 11 compagnie fin richemont luxury goods (jewellery etc) 88.4 12 naspers ltd pharmaceuticals 76.0 13 firstrand ltd banks, financial services 75.2 14 gold fields ltd gold 73.9 15 absa group limited banks, financial services 66.0 16 telkom sa ltd telecommunications 59.4 17 kumba iron ore ltd iron 59.4 18 old mutual plc insurance, financial services 49.5 19 nedbank group ltd banks, financial services 42.0 20 arcelormittal sa ltd steel 40.7 21 harmony g m co ltd gold 38.5 22 sanlam ltd insurance, financial services 38.2 sajems ns 16 (2013) no 1 3 rank company sector market capitalisation (zar billions) 23 remgro ltd diversified industrial 31.4 24 bidvest ltd ord diversified industrial 31.4 25 african rainbow minerals diversified mining & minerals 28.3 26 shoprite holdings ltd ord retail, supermarkets 28.2 27 lonmin plc. platinum 27.4 28 rmb holdings ltd diversified 26.9 29 exxaro resources ltd steel 26.8 30 tiger brands ltd ord diversified 22.9 31 african bank investments financial services, retail, banks 22.1 32 reinet investments sca investment 20.0 33 growthpoint prop ltd property investment 19.7 34 liberty holdings ltd ord insurance, financial services 19.5 35 investec plc banks, financial services 18.5 36 liberty international plc banks, financial services 18.3 37 pretoria portland cement cement 17.8 38 aspen pharmacare hldgs pharmaceuticals 17.3 39 truworths international retail 16.4 40 pick n pay stores ltd retail, supermarkets 16.3 the content analysis framework used in this research is based on the approach of april, bosma and deglon (2003:166), while the data are analysed in order to draw inferences on the way in which south african companies recognise and report on intellectual capital. the research will show how the companies investigated recognise and report the existence of the intellectual capital in their organisations. the analysis is based on the three categories or classes that have been identified by other researchers, namely human, structural and relational capital, and their performance indicators. according to abeysekera (2003: 423), the identification of the intellectual capital that a company possesses is based on the intellectual capital attributes and performance indicators that are relevant to a specific intellectual capital category. the intellectual capital attributes of the three categories and their performance indicators reported on in the 40 corporate annual reports were analysed and illustrated. the overall reporting on the attributes of the three intellectual capital categories was further analysed and compared. intellectual capital performance indicators that are used to t a b l e 2 intellectual capital attributes human capital attributes structural capital attributes relational capital attributes knowledge education level of qualifications skills talent work-related competencies work-related expertise innovativeness proactiveness entrepreneurial spirit other attributes o professionalism o experience intellectual property patents copyrights trademarks license agreements other business rights infrastructure assets management philosophy corporate culture management processes information processes network systems research and development leadership financial relations other attributes o technologies o business processes o key management attributes brands customer list customer loyalty business collaborations market share supply chain distribution channels reputation stakeholder relations communication and information mergers and acquisitions joint ventures other attributes o strategic partnerships o corporate image source: april et al. (2003:168) (adapted) 4 sajems ns 16 (2013) no 1 measure intellectual capital, like personnel cost/revenue, intellectual property/total assets, market share and marketing cost/ revenue, were also researched and reported. some extracts from the annual reports were reproduced in order to illustrate the nature and extent of the reporting on intellectual capital and its attributes by the companies researched. the research also included comparisons between the three categories of intellectual capital and their attributes. table 2 above shows the framework used in the research. 4 literature review the term ‘intellectual capital’ is sometimes used interchangeably with intangible assets. however, financial reporting refers only to those intangible assets that are recognised by the international accounting standards board (iasb), with these assets forming part of intellectual capital. abeysekera (2003:422) further suggests that the definition of intellectual capital refers to intangibles not recognised in the financial statements. however, part of structural capital, namely intellectual property, is recognised in financial statements as it satisfies the separability requirement of the iasb (2011:161-162). brännström and giuliani (2009:23) describe intellectual capital as follows: intellectual capital = identified intangible assets + purchased goodwill the above description of intellectual capital supports the view that intangible assets form part of intellectual capital. thomas (1997:5) argues that human capital refers to the capacity of individuals to provide solutions for their customers, while structural capital transforms expertise into the property of the group, and customer capital allows relations with customers to be perpetuated. in the early 1990s, writers and scholars identified the growing importance of intellectual capital as a source of long-term value creation for organisations (roslender & fincham, 2004:179). during this time, literature on intellectual capital focused mainly on the need to report this type of capital as a separate asset in a business. this trend resulted in a debate on how best to do this in an accurate and reliable way in order to complement the financial information on strategic reporting. other researchers, like seetharaman et al. (2002:140) and van der meer-kooistra and zijlstra (2001:456), proposed a voluntary reporting that would support the financial reporting and assist investors in their decisionmaking. varying views and debates emerged from different studies on intellectual capital accounting and reporting. 4.1 accounting debate on intellectual capital the debate on the existence of intellectual capital within a business was initially explained by means of the recognition and definition of the goodwill that is part of a business (seetharaman, balachandran & saravanan, 2002:131). the iasb (2011:a941-a943, a152), however, makes a distinction between the goodwill acquired in a business combination and internally generated goodwill. during the iasb fieldwork and round-table discussions aiming at obtaining feedback on ifrs 3 business combinations project (iasb, 2008:382 and iasb, 2010:a97), there were debates in favour of and those against recognising intellectual capital in the annual financial statements of organisations. the iasb project resulted in the amendments to the treatment of goodwill acquired in a business combination and internally generated goodwill. the iasb (2011:a152) refers to the goodwill acquired in a business combination as representing a payment made by an acquirer in anticipation of future economic benefits from assets that are not capable of being individually identified and separately recognised. the value of acquired goodwill is, therefore, determined by business combination transactions, and is recognised as an intangible asset in the statement of financial position of a company. the acquirer  includes in goodwill the value of an acquired intangible asset that is not identifiable as of the acquisition date. for example, an acquirer may attribute value to the existence of an assembled workforce, which is an existing collection of employees that permits the acquirer to continue to operate an acquired business from the acquisition date. because the assembled workforce is not an identifiable asset to be recognised separately sajems ns 16 (2013) no 1 5 from goodwill, any value attributed to it is included in the goodwill acquired. internally generated goodwill, on the other hand, refers to the expenditure incurred in order to generate future economic benefits that do not result in the creation of an intangible asset (iasb, 2010: a941). accordingly, these assets are not recognised as assets in the financial statements, thus forming part of the intellectual capital that is expensed as a periodic cost in the statement of comprehensive income. an example of internally generated goodwill is the expenditure incurred in order to service a key customer so as to gain the customer’s loyalty to the company’s product. the result of incurring this expenditure is the customer’s loyalty that may result in future economic benefits flowing into the company. however, these future economic benefits will not result in an identifiable intangible asset, because the company will have control neither over customer loyalty gained nor over future economic benefits that may flow from this gain. in addition, the measurement of intangible assets is also problematic. views by researchers such as olsen, halliwell and gray (2007:2), who are against reporting the value of intellectual capital in the financial statements, are based on the above facts from the iasb. furthermore, the iasb states that intellectual capital does not meet the definition of an asset and the recognition criteria thereof. as part of the recognition criteria, the cost of an item to be recognised should be reliably measured (iasb, 2011:a847). therefore, measurement is fundamental to the iasb asset recognition rule. the debate in favour of recognising intellectual capital in financial statements is based on the fact that the value of intellectual capital remains unreported to the users of company information (rodov & leliaert, 2002: 323). the non-recognition of these assets in the financial statements therefore creates a gap between reported accounting and capital market values. according to swart (2006:137), unlike other assets, the value of internally generated goodwill is created over a period through a series of activities and it is not possible to link this value to a specific transaction. intellectual capital therefore forms part of this internally generated value of the business, and therefore should be reported to capital providers and users of information. it emerged from the literature review that the argument in favour of recognising intellectual assets in financial reporting involves recognising that the true value of a company may be assessed only by taking intellectual capital into account (marr, schiuma & neely, 2004:553). it has also become clear from the above debate that there is both a need and a drive to establish new measures and ways in which to report on intellectual capital, in order to complement the financial reporting. kukec (2007:28) refers to this kind of reporting as broad-based business reporting. broad-based reporting provides investors and other stakeholders with both mandatory and contextual information and assists them to make informed decisions. 4.2 measurement of intellectual capital intellectual capital assets are strategic resources that should be properly managed in order to derive maximum benefits from them. effective management of these assets helps in their recognition, measurement and reporting (holmen, 2005:2). measuring the benefits gained from possessing intellectual capital and the value of these assets has both internal and external purposes. in terms of internal purposes, a company would measure intellectual capital in order to manage its resources more effectively, and will, thereby, minimise costs. on the other hand, measuring intellectual capital for external purposes would require verifiable information that signals the expected growth of the company to existing and potential investors, and to other external users of the information (hunter, webster & wyatt, 2005:3). the process of measuring intellectual capital for both internal and external purposes involves using financial and non-financial measurement methods. 4.2.1 financial measurement models for intellectual capital the existing financial measures used to assess the market value of an asset address the financial contribution made through intellectual capital. researchers have identified a number of financial measures that include, inter alia, the discounted cash flow technique 6 sajems ns 16 (2013) no 1 (dcf), relief-from-royalty, comparable transactions, avoided cost, adjusted present value, economic value added, value chain scoreboard, market-to-book ratio, and the capital asset pricing model. these financial techniques are used to measure the market value of a company for different purposes, and involve assigning a value to a company although the resultant value is not disclosed in the financial statements (olsen, halliwell & gray 2007:2). the value determined using some of the above models involves some degree of subjectivity, as some of these models involve the application of estimates such as cost of capital and rate of royalty. therefore, these models are unsuitable for use to determine a value to be disclosed in the annual financial statements. the iasb encourages objectivity, as well as reliable and verifiable measurement in order to promote comparability across companies (iasb, 2009:9-16). nevertheless, resultant values may be reported in the contextual disclosures of the corporate annual reports to communicate the unreported value of the organisation. 4.2.2 non-financial measurement models for intellectual capital in view of the difficulties in finding financial measures suitable for measuring the value of intellectual capital, researchers like robert kaplan and david norton, as well as leif edvinsson (starovic, cima & marr, 2005:811), developed non-financial measures such as the balanced score card and skandia navigator in order to balance the need to report on these assets and the challenges involved in measuring them. accordingly, the information obtained using these non-financial measures complements the information disclosed in the financial statements. some of these non-financial measurements relate to measuring the different categories of intellectual capital, thereby making it easy to report the value pertaining to each category. the measures developed include the balanced score card, skandia navigator, value chain scorecard, and human capital accounting. effective non-financial measures of intellectual capital will complement financial measures, provide both a feedback mechanism for actions and the information to develop new strategies, assist in weighing different courses of action, and enhance the management of the organisation (holmen, 2005:2). non-financial measures of intellectual capital provide information that will assist potential investors and other stakeholders as well as other users of the information, to make informed financial decisions relating to the company. 4.3 recognition of intellectual capital the cost of an item is recognised and disclosed in the annual financial statements, either in the statement of comprehensive income or in the statement of financial position, based on the minimum requirements set by the iasb for the presentation of financial information (iasb, 2011:a46-a49). the cost of acquiring intellectual capital should, therefore, be recognised in the financial statements if the financial statements are to meet these requirements. 4.3.1 recognition of intellectual capital in the statement of financial position financial reporting operates around strict requirements that are statement of financial position biased. the process of recording a transaction in the accounting records commences with an analysis of its nature for the purposes of the statement of financial position recognition. any item that does not meet the statement of financial position recognition requirement is immediately expensed in the statement of comprehensive income. iasb (2011:a48) notes that, in some cases, expenditure is incurred in order to generate future economic benefit, but still does not result in the creation of an intangible asset that meets the recognition criteria. such expenditure is classified as internally generated goodwill, and is immediately expensed in the statement of comprehensive income. 4.3.2 recognition of intellectual capital in the statement of comprehensive income cost incurred in the creation of an intellectual capital asset, but that does not result in the creation of an intangible asset as defined by the iasb, is recognised in the statement of comprehensive income. this cost is accounted for and disclosed as part of the administrative costs or as part of the operating costs of the sajems ns 16 (2013) no 1 7 company. intellectual capital cost forms part of cash outflow and may be regarded as a depletion of assets (iasb, 2011:a45). in other words, costs of intellectual capital are regarded as contributing to the generation of revenue for a business, instead of adding to the value of the business. because intellectual capital cost is expensed in the period in which it was incurred, it is difficult to trace this cost back to the book value of the company. however, the cost may, to some degree, be traced back to the value of the product or service that the company either produces or renders. intellectual capital categories, their attributes and, sometimes, their performance indicators are used as the main account description for cost allocation, for example human resource or employee costs, research and development costs, and marketing costs. 4.4 intellectual capital disclosure and reporting the existence as well as the importance of intellectual capital as value drivers and strategic assets should be clearly communicated to the different users of company information. the different users of financial information have different needs and, therefore, financial reports are prepared in such a way as to satisfy these different needs. these different users include employees (including management), suppliers, customers, current and potential capital providers, government and the general public. these users may be grouped into internal and external users of information with the grouping influencing the type of information to be disclosed by an organisation (cronjé, 2008:50). accordingly, financial information is prepared for both internal and external reporting purposes. according to cronjé (2008:112-116), there are two areas of disclosure in respect of company information with one being based on the information produced by the mandatory financial information system (mfis), as required by the various statutory bodies, and the other comprising the discretionary information system (dis). in other words, the mfis generates mandatory information, while the dis generates contextual information based on the information needs of the different users (cronjé, 2008:112-116). in addition, companies disclose information that supports the strategic objectives in their corporate annual reports. as a strategic asset, intellectual capital is used by some companies as a marketing tool to promote and enhance the reputation of the company. companies also include intellectual capital attributes and performance indicators in their internal reports in order to assist management in their decision-making role. the scope of financial reporting is, therefore, broader than just the financial statements, and includes information about the management stewardship of an entity’s resources (iasb, 2011:a27). in addition to the capital providers, financial reporting is also aimed at all users of information about an entity’s business and operations. this requires, in addition to financial statements, the disclosure of other financial information. accordingly, information on an entity’s financial performance and operations is disclosed in the corporate annual reports. in december 2010, the iasb issued ifrs practice statement management commentary to accompany financial statements prepared in accordance with ifrs. one of the proposed principles for the preparation of management commentary is a report on the way in which those resources that are not presented in the financial statements may affect the performance of an entity (iasb, 2010:8). the ifrs practice statement also proposes that management commentary should include information that complements the financial statements, including information on relationships with major customers, and performance measures and indicators. however, it is essential that consistency in the reporting the performance measures and indicators be maintained in order to enhance the comparability of information within the industry (iasb, 2010:9-16). the issue of the ifrs practice statement paves the way for companies to report information on their intellectual capital. the proposed information that should be disclosed or presented in management commentary is similar to that which would be contained in the strategy document of the company. this statement will provide a balance between internal and external reporting. the disclosure of information in the corporate annual reports may be either mandatory or 8 sajems ns 16 (2013) no 1 discretionary. mandatory disclosures are governed by statutory and rule-making bodies and legislation including the companies act, the iasb, and the jse ltd. the discretionary disclosures are, inter alia, determined by the strategic objectives of the company and the needs of the different users of information. figure 4.1 illustrates the two areas of disclosures in the annual corporate reports. f i g u r e 1 the disclosures in corporate annual reports corporate annual report mandatory (statutory) disclosure discretionary disclosure source: stanton & stanton (2002:479) the king iii report (iod, 2009:103) refers to annual corporate reporting as integrated sustainability reporting and disclosure. in terms of this report, reporting should be integrated across all areas of performance reflecting strategic decisions taken by a company. one of the code of governance principles refers to the importance of effective communication with stakeholders. according to bukh (2002:53), the report on intellectual capital should communicate management’s understanding of the company’s strategy and value creation and should not only disclose performance indicators of general interest. as a result of the challenges in respect of disclosing information on intellectual capital under statutory disclosures, discretionary disclosures should be used for this purpose. the next section deals with the content analysis results of the 40 companies listed on the jse ltd on 12 may 2009 and covers the current state of intellectual capital rating and reporting for these companies. 5 results of the content analysis the results of the content analysis research show how the companies investigated recognise and report the existence of the intellectual capital in their organisations. these results are summarised in table 3 below, and cover the number of intellectual capital attributes reported by south african companies per each category. t a b l e 3 number of attributes reported per intellectual capital category human capital structural capital relational capital number of attributes in the model 12 15 14 number of companies 40 40 40 number of attributes reported 321 197 280 average number of attributes reported per company 8 4.9 7 maximum number of attributes reported 11 11 11 minimum number of attributes reported 1 1 1 april et al. (2003:167) (adapted) sixteen companies made reference to human capital when referring to their employees, while eleven companies referred to human resources. the rest of the 40 companies researched reported on individual human capital attributes without referring to either sajems ns 16 (2013) no 1 9 human capital or to human resources. knowledge, levels of education and qualifications, skills, talent and experience were the most frequently reported human capital attributes in most of the corporate annual reports. workrelated competencies and expertise, innovativeness and professionalism were reported on an average level, while professionalism and experience were included under ‘other attributes’. this, in turn, means that a total of twelve attributes were researched under human capital. a total of eleven structural capital attributes, three intellectual property attributes, and eight infrastructure capital attributes were reported on in the various corporate annual reports. however, there were additional attributes included in the ‘other attributes’ category with these being attributes that had not been included in the predetermined framework, resulting in fifteen attributes in total being researched. technologies, license agreements and other rights, business processes and key management attributes were later included in the research. for the purpose of this study, license agreements and other rights were included under intellectual property, with the other two being included under infrastructure capital. the reason for this specific framework was to separate the intellectual assets recognised by the iasb from process assets. this was done in order to ensure comparability of the information presented. leadership proved to be the most reported infrastructure capital attribute, with thirty-six of the forty companies reporting on either the good or strong leadership that existed within their organisations. information processes, network systems and financial relations were the least reported attributes. corporate culture was the second most reported infrastructure capital attribute with some organisations referring to organisational, company or group culture. these different terms were all accepted as referring to corporate culture. a total of fourteen relational capital attributes were researched in the forty corporate annual reports. two more attributes, namely strategic partnerships and corporate image, were added to the initial twelve attributes researched based on the information presented in some of the corporate annual reports. brand proved to be the most reported relational capital attribute with twenty-eight companies reporting on the different brands they possessed. market share was the second highest reported attribute with twenty-five companies reporting on the level of their market share. however, based on the framework used and the fact that market share is always reported as a percentage, market share was recorded as both an attribute and as a performance indicator. figure 2 below depicts the breakdown in the reporting in terms of average percentage of reporting per intellectual capital category, namely human, structural and relational capital. f i g u r e 2 average percentage of reporting per intellectual capital category source: own 40% 25% 35% human capital structural capital relational capital 10 sajems ns 16 (2013) no 1 the analysis on the extent to which the intellectual capital categories and their attributes were reported has indicated that, on average, human capital did receive significant attention in the annual reports of the 40 companies. overall, the companies in the study rated human capital at 40% (321/798), structural capital at 25 per cent (197/798) and relational capital at 35% (280/798 per cent). these results are slightly different from the results of similar previous studies. studies conducted by april et al. (2003:172-173) showed that there was more focus on relational capital than on the other two categories, with relational capital reported at 40 per cent and human capital at 30 per cent. this difference may be attributable to the fact that the framework used in this study for the intellectual capital attributes included other attributes not listed by other studies. there were more attributes included in the human capital category than in the other two categories. the framework used by april et al. (2003) was based on six human capital attributes and nine relational capital attributes, respectively, compared to the twelve and thirteen used in this study. a greater emphasis on the reporting on human capital provides assurance to capital providers and other stakeholders that the company is in the hands of capable, highlyskilled and competent employees. some of the companies referred to human capital and human resources when referring to their employees. the higher rate of relational capital may be attributable to the fact that most of the companies researched compete globally and, consequently, human and relational intellectual capital drivers are critical in order to give these companies a competitive advantage. structural capital received less attention when compared to the other two, with this rate being further reduced when intellectual property assets were excluded. the research results of this study overall indicate that the theory of accounting should be modified to ensure a standardised and comparable approach when accounting and reporting on intellectual capital in corporate annual reports. the above conclusion is drawn as a result of the following factors: • the nature of intellectual capital assets makes it difficult to trace the costs relating to their acquisition. accordingly, their nature creates significant challenges in both the financial reporting and the management of these assets. nevertheless, these challenges do not prevent companies from reporting on the existence, value and importance of these assets to both the users of financial information and other stakeholders. • it was found that those arguments that favour the recognition of intellectual capital revolve around the acknowledgement of a need to capture the nature and value of intellectual capital and other intangible assets that add value to the overall value of the business in financial reporting. the arguments against the recognition of intellectual capital are mainly from an accounting perspective, based on the iasb framework for the preparation and presentation of financial statement, ifrss, and iass. however, it emerged clearly from both these sets arguments that there is a need to develop a reporting framework that will assist to strike a balance between gaining the advantages of reporting on intellectual capital and achieving the fair presentation of financial information. • it may, therefore, be concluded that measuring, recognising and disclosing information on intellectual capital is not limited by the requirements of statutory or mandatory disclosures. financial statements fall under these disclosures but, in addition to these disclosures, there are also several disclosures that may be used to communicate information to the users that are within management’s discretion. these discretionary disclosures form part of the corporate annual reports of a company and companies should, therefore, be encouraged to use these discretionary disclosures in order to communicate information on intellectual capital. • although the cost of intellectual capital is immediately expensed and is regarded as a reduction in the asset value (cash and cash equivalents), the cost incurred in respect of these assets and their attributes contribute to the market value of the company concerned. it may also be concluded that, sajems ns 16 (2013) no 1 11 as a result of its flexibility and the fact that the discipline is less constrained, it is the management accounting discipline that should be used to report the value of intellectual capital using financial and nonfinancial measurement models. in addition, the discipline should also be used to report the performance of these assets and their attributes. • the results of the content analysis showed that intellectual capital reporting still lacks prominence. when reported, intellectual capital assets are referred to in qualitative terms and in terms of their attributes. the reason for this is partly because there has been little progress made in measuring intellectual capital assets. this view is supported by the fact that, because it is not possible to measure intellectual capital assets reliably, these property assets were explicitly reported upon in the annual financial statements of those companies holding them. references abeysekera, i. 2003. intellectual accounting scorecard: measuring and reporting intellectual capital. journal of american academy of business, 3(1):422-427. april, k., bosma, p. & deglon, d. 2003. ic measurement and reporting: establishing a practice in sa mining. journal of intellectual capital, 4(2):165-180. brännström, d.b. & giuliani, m. 2009. intellectual capital and ifrs3: a new disclosure opportunity. journal in knowledge management, 7(1):21-23. bukh, p.n. 2002. commentary: the relevance of intellectual capital disclosure: a paradox. accounting, auditing & accountability journal, 16(1):49-56. cronjé, c.j. 2008. corporate annual reports (cars): accounting practices 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reporting standards (ifrss). 2011: including international accounting standards (iass) and interpretations as at 30 november 2010. vol. 1a. london: iasb. conceptual framework for financial reporting. ifrs 3: business combinations. ias 38: intangible assets. institute of directors in southern africa (iod). 2009. code of governance principles for south africa. king committee on governance. kukec, s. 2007. accounting for the non-tangibles. charter, 78(1):28-29. marr, b., schiuma, g. & neely, a. 2004. intellectual capital: defining key performance indicators for organizational knowledge assets. business process management journal, 10(5):551-569. olsen, m.g., halliwell, m. & gray, r.p. 2007 intangible value: delineating between shades of grey. journal of accountancy, 203(5):66-71. organisation for economic co-operation and development, corporate affairs division, directorate for financial and enterprise. 2006. intellectual assets and value creation: implications for 12 sajems ns 16 (2013) no 1 corporate reporting. paris: oecd. available at: http://www.oecd.org/dataoecd/2/40/37811196.pdf. [accessed 2008-09-24]. rodov, i. & leliaert, p. 2002. fimiam: financial method of intangible assets measurement. journal of intellectual capital, 3(3):323-336. roslender, r. 2000. accounting for intellectual capital: a contemporary management accounting perspective. management accounting, 78(3):34-37. roslender, r. & fincham, r. 2004. intellectual capital accounting in the uk. accounting, auditing & accountability journal, 17(2):178-209. seetharaman, a., balachandran, m. & saravanan, a.s. 2002. accounting treatment of goodwill: yesterday, today and tomorrow: problems and prospects in the international perspective. journal of intellectual capital, 5(1):131-152. seetharaman, a., sooria, h.h.b.z. & saravanan, a.s. 2002. intellectual capital accounting and reporting in the knowledge economy. journal of intellectual capital, 3(2):128-148. stanton p & stanton, j. 2002. corporate annual reports: research perspectives used. accounting, auditing & accountability journal, 15(4):478-500. starovic, d., cima & marr, b. 2005. understanding corporate value: managing and reporting intellectual capital. london: cranfield university. swart, j. 2006. intellectual capital: disentangling an enigmatic concept. journal of intellectual capital, 7(2):136-159. thomas, a.s. 1997. intellectual capital: the new wealth of organisations. knowledge management, 67: 1-10. van der meer-kooistra, j. & zijlstra, s.m. 2001. reporting on intellectual capital. accounting, auditing & accountability journal, 14(4):456-476. sajems ns vol i (1998) no 3 422 an economic case 'for regulating against the use of non-deposit carrying glass containers of beverage in south africa shosking department of economics, university of port elizabeth abstract as a result of minimal private cost many people dispose of non-deposit bearing glass containers in ways which cause glass pollution: hazardous broken bottles and litter. this pollution imposes costs on users of the affected environment and on municipalities, which have most of the responsibility to clean up, although in south africa the two main glass packaging producers also play a role by operating a recycling system. a case study was carried out in the port elizabeth area in which exploration is made of the glass that does not get recycled and an intuitive analysis is made of the costs of different options for managing recyclable glass waste. it is concluded that the case deserves further investigation for introducing legislation in south africa making bottle deposits mandatory. jelk200 introducnon from an environmental perspective one of the most promising ways to deal with glass packaging pollution is to recycle it. if reprocessed and used again, alcoholic and soft drink container bottles do not deface the landscape or add to the mound of refuse generated by the modem industrial 'throwaway' society ultimately requiring burial in municipal tips. fortunately, under some circumstances it is profitable to recycle glass bottles, and as a result, a recycling glass bottle industry has evolved. despite the development of this industry, the problem of glass bottle waste still remains an acute environmental problem in south africa. for this reason the question arises of whether the government should not step in and help remedy a problem the market is failing to, by introducing more regulation in the beverage bottling industry. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 423 sateb nr vol i (1998) nr 3 it is not an option to be adopted on weak grounds, because this type of regulation can undermine economic freedom (barry, 1994': 6). specifically, if the government legislated a mandatory deposit-refund system covering all soft and alcoholic drinks, the freedom to enter into contracts for beverages contained in non-refundable glass bottles would be lost. this paper will explore the economic case for this option, using port elizabeth as a case study the nature of the problem this type of regulation is not new in the world. it is usually called container deposit legislation elsewhere. in the united states discussion of container deposit schemes can be traced back to the 1930s (w.d. scott and company pty. ltd., august, 1983: 10). the legislation encompasses containers of all types of beverage. (the type of regulation being considered in this report merely relates to glass.) the following states of the united states of america had introduced bottle bill (container deposit) legislation by 1989: california, connecticut, delaware. iowa, maine, massachusetts, michigan, new york, oregon and vermont (tietenberg, 1992: 206). there is similar legislation in canada (turner, pearce and bateman, 1993: 259-260). in australia, south australia introduced container deposit legislation in 1977 (business regulation review unit, june, 1989: 11 ). there has also been strong support for various aspects of container deposit legislation on the continent of europe. the following european countries have product charge or deposit-refund legislation covering beverage containers: austria, sweden, finland, gennany, norway, switzerland and denmark (turner, pearce and bateman, 1993: 259-260). in south africa legal protection of the environment can only be justified if it is in human interests; the legal principle being, cum igitur hominum causa ius constitulio sit (law is an institution for the sake of men) (rabie, 1973:1). currently, legal protection against careless disposal of glass bottles is justified in terms of this legal principle on the grounds that, like other littering, it is an eye-sore and or health risk for other human users of the environment. the protection takes the form of litter deterring provisions in the environmental conservation act (no. 73) of 1989. in terms of section 19 of the act a fme of rl 000 and/or 3 months imprisonment may be imposed on a person for littering a public attraction. in sections 20-24, regulations and directions of waste management are dealt with. they provide for the imposition of fmes of up to rloo 000 and/or 10 years imprisonment on people who dispose of waste illegally. is this enough, or should the government be doing more? r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 3 424 of the representatives spoken to in the beverage industry in s<1uth africa, few were prepared to commit themselves on the desirability of container deposit legislation in south africa. most representatives spoken to did not foresee it as likely in the near future and redirected inquiries on the issue to owen bruyns, executive director, packaging council of south africa (pac sa), johannesburg. telephonic and face to face discussions were held with mr. bruyns on the topic during second half of 1996. he is of the view that the case for regulating against non-returnable bottles is weak because: • regulation is unnecessary • the bottle manufacturers are already addressing the problem, by administering non-profit making glass recycling systems (e.g., bottle banks), • the impact of the proposed regulation has been researched in other countries (usa and australia) and shown to be an inefficient solution to the problem of glass litter, • it will not solve the relevant problem but merely change the nature of it the relevant consumers will simply switch from disposable glass containers to disposable tinplated steel and aluminum cans and to disposable plastic pet bottles, • it will reduce consumer surplus by reducing choice and pushing up the prices of the relevant beverages (because they will be more costly to produce), and • it will reduce jobs and income (and thereby tax receipts) in the glass bottling and beverage industries and/or divert capital to the distribution and cleaning sectors. the first of these arguments is the one primarily addressed in this paper. the second is addressed in sections 2 and 3, but the following issues are not addressed: • possible consumer substitutions of glass for plastic, aluminum and tinplated containers, • possible changes to beverage prices, and • possible changes to employment and income totals in different industries, e.g., due to reductions in some types of bottle production and increases in other, and to increases in recycling activities. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 425 sateb nr vol i (1998) nr 3 findings of selected other studies into the economics of legislating against non-returnable bottles the studies to which pacsa refer are those on container deposit legislation by w.o. scott and company pty. ltd. (august, 1983) and the business regulation review unit (june, 1989) both relate to the case of australia. they are discussed under (a) and (b) below. (a) w.o. scott and company pty. ltd. (august, 1983) analyzed the probable economic impact of introducing container deposit legislation throughout australia and concluded that: • it would increase the cost of soft drinks and beer in cans and plastic containers, and for this reason also their retail prices, as well as the retail price of drinks in multi fill containers (to help cover these increased costs), • skilled or semi-skilled manufacturing jobs would be replaced by unskilled bottle sorting and handling jobs, with the result that employee earnings would decline, • government revenue would decline because sales would decline, profits would decline, employee income would decline and production plants would be written off, as unprofitable plants were closed down, e.g., tinplated steel can producers, • overall energy consumption would decrease, but more scarce primary energy sources would be used due to increased transport requirements (less hydroelectricity, coal and natural gas, but more oil), • the raw materials used in the beverage container industry of australia are abundant in the country, • the experience of south australia with mandatory deposit legislation was that the reduction in costs of litter management were insignificant only a 3% reduction in total litter, and • alternatives to mandatory deposits are more cost effective in reducing litter and conserving resources than mandatory deposits, e.g., improving return rates on existing multifill packages, improving recycling rates and funding comprehensive litter reduction campaigns. (b) the business regulation review unit (june 1989) considered the same topic as w.o. scott and company pty. ltd. (august, 1983), but a few years later. it noted that between 1973 and 1978 counts of litter fell by 80% in the state of south australia and that container deposit legislation was introduced there in 1977. in south australia mandatory deposits apply to all beer, wine cooler, soft drink and milk containers. the business regulation review unit were not of the view that this reduction r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 3 426 was purely and simply due to the introduction of the relevant legislation, because some years prior to 1977 there had been vigorous anti-litter media campaigns in the state and the introduction of on-the-spot fines for littering. moreover, impressive reductions in litter also occurred in states where there was no container deposit legislation, e.g., 63% in new south wales between 1979 and 1985 and 50% in victoria between 1983 and 1988. some of the negative features of container deposit legislation were: • it imposes a particularly high deposit on cans, which cannot be reused, thereby raising the overall price of the product and reducing demand, • it increases production and retailing costs (bottle washing plants, storage of bottles at retailers, slower bottle filling compared to cans and increased distribution costs), • it increases consumer costs by making them return bottles, and • it increases the cost of market entry (e.g., beer from western australia) thereby facilitating local monopolies. the conclusion of the business regulation review unit was that the cost savings, brought about by container deposit legislation as a result of reduced garbage disposed, were far outweighed by the increased costs this legislation imposed on consumers and producers. the unit suggested that more efficient ways of reducing costs would be privatizing waste disposal operations, media campaigns, increased littering fines and appealing to beverage and container producers to avoid ring tops (on cans) and other devices that can add to the problem of litter. one of the well known cost benefit studies carried out on bottle deposit legislation in the united states is that of porter's (1978). (c) porter (1978) conducted a cost benefit study of a proposal to legislate, in the state of michigan in the usa, for the introduction of mandatory deposits on beer and soft drinks containers. the proposal was to make all beverage containers sold in the state of michigan subject to a returnable deposit of 10 cents. at the time only 27% of the containers were returnable. his conclusion was that it depended upon the relative valuations of the average citizen's time sacrifice cost and willingness to pay for a reduction in container litter. for instance, he calculated that a desirability of mandatory deposits equated to an aggregate willingness to pay about $200 million per annum (by the 9,1 million citizens), or $27.26 per annum per citizen (assuming the average citizen's time return cost r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 427 sateb nr vol 1 (l998)nr3 were equal to the 10 cents deposit proposed). porter suggests that this sum may be higher than what the citizens would be prepared to pay for a reduction in container litter. however, it is noted that his justification for a return cost estimate equal to 10 cents per returnable bottle is based on a rather extreme assumption; that the return cost of the non-returnable bottle is trivial and can be ignored. what porter's analysis strongly suggests is that no general answer may be given to the question of whether mandatory deposits are desirable. (d) based on the findings of a cross-section of cost benefit studies done on deposit-refund systems in europe and the united states, turner, pearce and bateman (1993: 264-265) conclude that they do not generate significant net social gains. the problem, as they see it, is that they do not reduce the overall volume of municipal waste enough to offset the additional administrative costs. (e) although little support has been found amongst industrial groups in the united states for government legislated deposit-refund systems, the general public have been very supportive of them (turner, pearce and bateman ,1993:255). there is evidence that the public respond positively to changes in the pricing of waste disposal. the examples of highbridge and seattle show how changing the incentives to dispose of litter have worked in the united states (tietenberg, 1992). • in january, 1988, the town of highbridge in new jersey, usa, replaced its flat 280 dollar annual fee for the collection of refuse with a fee that varied with the amount of trash (new york imles. 24 november, 1988, bi,b7). each household was given 52 stickers for 140 dollars. additional stickers could be bought at 1.25 dollars each. as a result peoples attitudes towards wastes changed rapidly: the amount of refuse required to be collected went down 25% as residents began to compost food and yard wastes and recycling programmes flourished in glass, newspapers and cans. in 1989 the base sticker rate was increased to 200 dollars and additional stickers to 1.65 dollars each. this increase gave rise to concerns that the new pricing strategy for refuse removal was going to place a greater burden on the poor. however, that concern was apparently misplaced. under the old system every household paid the same fee for refuse collection, regardless of how much refuse was put out, and as poorer households were producing less refuse, they were in effect subsidising the wealthier ones. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 3 428 • seattle. washington instituted a similar system. but with higher prices. they too experienced a dramatic decline in refuse disposal and increase in recycling. the lesson learned is that when the incentive not to waste is made direct. people change their behavior and waste less. the refund system is similar in its effecl a deposit must be paid by the consumer, on the purchase of the recyclable item. which reflects the cost of recycling or disposing of il glass bottles and aluminum cans are good examples of such items. but there are also many others to which the system has been successfully applied. including cars and car parts (bohm. 1981. pp.120-124). on returning the item to a designated dealer a refund is given. this refund creates the incentive for someone. not necessarily the purchaser. to collect the item and transport it to the designated dealer. if the purchaser considers the incentive insufficient to return it. an opportunity for others. probably poorer people. is created to make money out of the system by returning it. the market determined efficient level of glass recycling investigations of the literature on recycling confinn that in an efficient market. devoid of any imperfections, there is no need for intervention because the interaction of supply and demand bring about an efficient level of recycling (tietenberg, 1992). in this kind of market the rising costs of virgin materials and of waste disposal increase the attractiveness of recycling from both the demand and supply sides of the market. products relying exclusively on virgin raw materials would be subject to higher prices than those drawing on recycled materials. consequently, consumers would switch from products relying exclusively on virgin raw materials to ones drawing on recycled materials; a switch known as the composition of demand effect (tietenberg, 1992). the theory that there is an efficient level of recycling glass waste in south africa does not relate to all glass but only to that which is potentially profitable to recycle; mainly to glass used as packaging (bottles and jars). there are many private economic incentives to recycle glass. glass containers of beverage are almost 1 wig recyclable. which means they can be recycled with minimal loss of material, or emission of toxic waste. over and over again. moreover, recycled glass melts at lower temperatures than the raw materials used for glass production. for each 10% increase in recycled glass containers r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 429 sateb nr vol 1 (1998) nr 3 added to the mix, the melting en~ required is reduced by about 2,5%. as a result both energy usage and wear and tear on capital (the t\imaces) are reduced; two of the main costs incurred in producing glass (glass recycling association, november, 1996). in the furnaces, molten glass is heated up to a temperature of between 1 260 and 1 480 oc. notwithstanding these energy and capital saving incentives, there are limits to the amount of glass that it is profitable to recycle. the main limiting factors are the collection, processing and transport costs. at some point the energy and capital saving of using recyclable glass is outweighed by the greater acquisition cost of cullet (crushed used glass packaging) over that of the virgin raw materials used in the glass mix (pers. comm., owen bruyns, 1996). it is a point which is reached fairly quickly in south africa, because the virgin raw materials used to make glass are plentiful: silica sand (58,1% of the mix required), soda ash (18,2%), limestone (15,6%), feldspar (4,4%) and dolomite (3,7%). there is also a quality deterioration problem (increased bubbles in the finished products) if more than 40% of the input material used to make glass is made up of cullet (vogler, 1981:173). this limiting factor is also relevant in australia (business regulation review unit, june, 1989: 35). of potentially recyclable glass about 65% recycles in south africa: about 43% in the form of returnable bottles and about 22% through bottle bank and buy back systems set up by the glass recycling association (glass recycling association, november, 1996). glass recycling with returnable bottles is generally found to be more cost effective than with non-returnable ones (vogler, 1981: 178). it is deduced that the market choice in south africa is to recycle 65% of packaging glass. if efficient markets are assumed it is deduced that of the potentially recyclable glass 35% is inefficient to recycle (the profit incentive is insufficient). recycling by selected botiling companies in south africa softdrinla according to pacsa, as a proportion of the total volume packed in returnable and non-returnable containers, the volume of soft drinks packed in returnable (voluntary deposit) containers in south africa increased from 65% to 67,4% between 1990 and 1993. of the returnable bottles in 1993: 54% were 1 litre glass bottles, 7,3% were 1,5 litre plastic bottles and 6,1% smaller glass bottles. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 3 430 of the non-returnable containers: 65% were metal cans (as against 40% in 1990) and 27% plastic bottles. by comparison with the united states a much higher proportion of soft drinks are packaged in returnable containers in south africa. in the united states this proportion is only about 8% (pac sa, 1996). the main bottling company of non-alcoholic beverage (coca cola) in south africa, the south african bottling company (sabco), has its head office in port elizabeth. in november 1996 it reported that 67% of the packaging done by it was in glass containers, and 57,11% of the glass packaging was in returnable containers (ernie van vuuren, manager sabco, november, 1996). about 6% of the returnable bottles are damaged in the return process. whereas non-returnable bottles are merely rinsed, returnable ones first have to be sorted (which is very labour intensive), the caps removed, and then washed. dave davies, also of sabco (production manager), is of the view that consumer preferences are shifting from soft drinks packed in returnable containers to ones packed in non-returnable containers, but no evidence was offered to support this view (november 1996). the converse appears to be true in the beer market. beer for the period, june 1986 to january 1994, south african breweries reported to pacsa that as a proportion of total sales of all malt beer in south africa, the market share of: • returnable re-usable voluntary deposit containers increased from about 72% to 79010 (and the 750ml specifically, from 64% to 75%), • non-returnable metal cans increased from 6% to 10%, and • non-returnable dumpies decreased from 9% to 7%. it appears that since 1993 the swing away from non-returnable to returnable containers has continued in the beer market. in november, 1996, south african breweries port elizabeth office (owen kingwall, production manager, november, 1996) reported that of its total sales, market shares by types of container were roughly as follows: • 80% in 750 ml 'quarts' (returnable), • 10% in 375 ml 'pints' (returnable), • 5% in 340 ml 'dumpies' (non-returnable), and • 5% in cans (non-returnable). a returnable beer bottle can be re-used up to 30 times per bottle (owen kingwall, south african breweries, production manager, november, 1996). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 431 sated nr vol 1 (1998) nr 3 recycling in pracdce in south africa in south africa the glass recycling association administers glass recovery systems. this association was fonned in 1986 by the main two glass packaging producers in south africa, consol glass and metal box glass. the rationale this association provides for its activities is 'to promote the concepts of a clean environment and a healthy community' ('a message from the glass recycling association', november 1996). it employs two methods of glass recovery: a bottle bank system and the buy back system. the bottle bank system works by consumers putting their unwanted glass jars and bottles into one of about 1490 glass bottle banks set up in 11 s cities and towns in south africa, and agents of the company collecting this glass from these banks. traffico is the agent appointed to administer the bottle banks in port elizabeth. there are currently about s4 of them in the city. it collects about % ton of glass per week from these s4 bottle banks (willem jordaan, operations manager, traffico, november 1996). the buy back system is a repurchase arrangement with 120 appointed agents in designated areas in south africa. the arrangement is for the purchase by consol glass of crushed used glass packaging. known as cullet. to qualify as cullet and be repurchased by these companies: • only bottle and jar glass should be used • glass should be separated by colour (into amber, green, flint or mixed), and • no contaminants should be mixed in amongst the jar and bottle glass any other type of material, including other types of glass (such as window, light bulb, drinking and crystal), and • the glass should be crushed (culled) and transported to either of the johannesburg or cape town consol glass plants. in port elizabeth, traffico sees to it that these requirements are met. the bottle banks only make up part of its supply. sabco supplied it with 29 tons of glass in 1996; bottles damaged in the process of production (ernie van vuuren, sabco, january, 1997). 'totting rights' to collect glass waste at the municipal tip site in port elizabeth also yield it a supply (ken kendel. pe municipality, november, 1996). as does south african breweries in the fonn of their damaged bottles (owen kingwall. production manager, south african breweries, november. 1996). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajemsns vol i (1998) no 3 432 where the market (and consumer morality) fails the motivation provided by the glass recycling association for its recycling activities is moral (rather than profit). it suggests implicit acceptance of a weak . version of the producer pays principle by the two main glass packaging producers in south africa, i.e., acceptance that part of the disposal cost relating to the non-returnable bottles is their responsibility. we may deduce that they feel that the other part lies with the consumer, in the form of a moral obligation to take the non-returnable bottle, from which they consume the contents, to one of the many bottle banks they provide. this position is a reasonable one in an era when the public is continuahy urged to be environmentally conscious, and environmental education and awareness campaigns are regularly conducted. however, in many circumstances, taking a bottle to the bottle bank is neither the most efficient action to take, nor the one people will necessarily be inclined to take. for a self-interested person, the most efficient action with respect to non-deposit bearing glass containers is to discard them as soon as possible after the consumption of their contents, because this imposes the lowest private cost on them. minimizing the return cost is undoubtedly the main reason why people would want to purchase this type of bottle instead of the returnable one. on privately owned land, this means in a general refuse bin, and on common or government land, this means in the park, on the beach, alongside the walkway, or on the street. for people who are more sensitive to the social benefits of responsible behaviour with respect to litter, one would expect them to make the effort to take their non-returnable bottles to the bottle banks. however, even for these people, there are circumstances where they may not do this. for instance, if they perceive large numbers of others about them not making the effort, they may deduce that their actions are of so little consequence that they cease to bother themselves (i.e., the public good 'assurance' problem). for these reasons (despite public education and awareness campaigns) 35% of the glass packaging industry's total output of about 125 000 tons per annum ends up either being buried in landfills, together with other refuse or left on the ground, frequently in broken pieces (glass recycling association, november. 1996). in landfills the external cost is passed on to the municipal rate payers (estimated at rl5 million per annum for south africa) and to refuse workers who are injured in the process of transporting it pieces (glass recycling association, november. 1996). when left on the ground the external cost of packaging glass waste is more difficult to estimate, but it may be even greater than for the landfill case. left broken on the ground it is time consuming to r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 433 sateb nr vol i (1998) nr 3 pick up, it detracts from the visual appeal of the environment and is physically dangerous to those barefoot. the problem is particularly evident at places where picking up glass must be done by hand, litter spoils the look and feel of the place, and where it is natural for people to want to walk barefoot, for instance, the beach. recreational values are reduced. significantly, on many beaches glass litter is simply left by the administering authorities, presumably because the cost of cleaning up is prohibitively high (see port elizabeth case study below). to sum up: an important cost is left out of the calculus that underlies the market outcomes on what is recycled in south africa, namely, the cost that is incurred in disposing of the 35% of glass produced per annum, not recycled. currently part of this external cost problem is bome by local governments, in the form of refuse collection, cleaning operations and municipal tip management, and part by the citizens living and using the environments where the glass packaging is disposed. the question this paper addresses is whether this external cost can be reduced by making a deposit-refund system mandatory for glass beverage packaging, without increasing other costs by more than what is saved. aspecfs of glass waste disposal in port elizabeth glass waste a municipal perspective the city of port elizabeth collects about 1 000 tons of solid waste per day from households and firms (ken kendell, chief cleansing officer, november 1996). the costs of refuse collection amount to about &23,5 million. in addition about r15,3 million is spent on cleaning up streams and beaches. the cleansing division of the pe municipality employs about 730 people and spends more than rl million per week in total on cleaning. a domestic refuse analysis conducted in 5 suburbs in port elizabeth (summerstrand, hollard park, newton park, sydenham and framesbury) for the city of port elizabeth shows that glass accounts for about 7 % of the weight of the refuse and 2% of the volume (table 1). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 3 434 table 1: cumulative constituents analysis of 5 samples of domestic refuse in port elizabetb. constituents sample weigbt weigbt%of volume 0/. of (kes) lsj!sample total paper 249,85 38,04 glass 99,3 7,9 2,36 metal 43 3,ll 3,97 plastic 50,5 3,66 13,96 veg. & putrescible 497,55 36.04 11,62 garden refuse 373 27,02 25,85 rags 13,5 0,98 1,41 unclassified 29,6 2,14 0,68 wood & combustible 24,25 1,76 2,11 totals 1380,55 100 100 source: city of port elizabeth, chiefcleansmg officer, november 1996. as a result of broken glass bottles being placed in black refuse bags, about 2 injuries per week are sustained by refuse collectors firms (ken kendell, chief cleansing officer, november, 1996). mostly these injuries are superficial cuts, but there also have been deep leg cuts and kidney damage reported. the presence of glass is also dangerous for those who seek to collect specific items from the refuse at the municipal tip site; which is the reason why the pe municipality is currently considering installing an expensive a conveyer belt system at the tip site. glass waste on the beaches the highest concentration of port elizabeth's glass pollution is found on its beaches and recreational areas, especially on its northern beaches, where the highest numbers of beach-visitors are found (ken kendell, chief cleansing officer, november, 1996): on new year's day, 1994/5, about 132000 people visited pes northern beaches of joorst park, st. georges, and wells estate, and about 92 000 pes southern beaches of kings, humewood, hobie and pollock (95196 summer season lifesaving report, city of port elizabeth). of the incidents reported by the lifeguards at humewood and hobie beaches during the 1995196 summer season lifesaving report: • 8 were for cuts, • 39 for 'helpouts', • 2 for sprains or fractures, and • 3 for stings. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 435 saleb nr vol 1 (1998) nr 3 there were 10 injuries reported as being the result of broken glass by lifeguards on the northern beaches of port elizabeth (1oorst park, wells estate and st. georges strand); two of which were considered serious. the senior lifeguard for the area (armand) was of the view that excessive use of alcohol was a contributing factor to the problem of glass litter on the beach. he deduced that inebriated people did not to think or care about the health risk imposed on other beach users resulting from the disposal of glass on the beach. one of the most common types of glass litter found on the beaches of the port elizabeth (pe) area is the non-returnable beer dumpie; mainly containers sold by south african breweries. the buyers of these containers constitute a niche market for south african breweries. 10% of the total market (owen kingwall, south african breweries, november 1996). these consumers are happy to pay a bit more for their beer in order to avoid the time and transport cost of returning the bottles after consuming their presumably the more affluent section of the market beer bought in single-fill bottles is a bit more expensive than that bought in returnable ones, after the deposit for the bottle has been claimed· usually between 3 and 8%. the problem of glass litter is also evident on other beaches near pe, but outside pe municipal control. during 1996 jean spearpoint and david brown monitored solid waste litter on a 100 square metre section of the beach adjacent to the van stadens mouth resort. the cleaning up of the beach is the responsibility of the department of culture and recreation, eastern cape, and the eastern cape conservation department. access to the van staden mouth resort and beach is controlled and takes the form of a r15 entry fee per car levied by the department of culture and recreation, eastern cape, at the entrance to the resort. they recorded details of any litter they found in random walks during the 6 months from may to october 1996. the results of this study are presented in tables 2 to 4 below. table 2: composition of pollution according to the material of items of litter picked up in random walks may to october, 1996, on a 100 metre stretch of beach at van stadens gorge. material littered number of items % of total glass 507 86 metal cans 76 13 plastic 6 1 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 3 436 table 3: number of units of glass and weight of broken glass picked up in random walks may to october 1996, on a 100 metre stretcb of beach at van stadens gorge. month in 1996 number of units weight of broken glass in kgs may 53 1,82 june 67 5,45 july 94 2,84 august 131 1.14 september 114 3,64 october 48 2,39 total 507 17,28 table 4: proportion of items of glass pollution made up of deposit bearing containers and non-deposit bearing. % 7 93 the particularly interesting aspect of this research is that it indicates what litter one could expect to come across on the beach after organized cleaning has taken place. glass is the litter one is most likely to come across and 93% is in the form of non-deposit bearing glass containers. mike bentall, chief environmental officer for the east london municipality, reported that similar problems are encountered in east london's public places (august 1996). the public's view on the disposal of glass bottles in port elizabeth during november 1996, h. gous carried out a limited public survey of people's views in port elizabeth on the disposal of glass bottles. the survey method employed was personal interviews with people randomly selected from the more affluent suburbs of port elizabeth. the selection of people from the more affluent suburbs was motivated by the smail scale of survey proposed and the observation that in the beer market, non-returnable bottles were targeted at the wealthier consumers poorer ones (the majority) preferring the returnable containers because the beer is cheaper out of them. had poorer people been included in the survey we would have expected a far smaller proportion of the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 437 sateb nr vol 1 (1998) nr 3 sample to indicate that they purchased non-retmnable bottles. a total of 100 people, aged from 18 to 57 years, were interviewed. of those interviewed (l00): • 96 knew which beverage containers were deposit bearing, • 45 buy returnable g1ass bottles only, if the option exists, • 85 purchase between 1-5 bottles of beverage per week, 10 purchase 6-10 bottles and 5 were unsure, • 60 disposed of their non-returnable bottles in the bottle banks provided by the glass recycling association, and • 35 regarded the use of bottle banks as too inconvenient. m. akkerman undertook a similar survey in the northern suburbs of cape town during november, 1996, but asked some additional questions ones focusing on why people do not use the recycle systems currently available. he interviewed 16 people. of these people: • all thought that the recycling of g1ass was a good idea in principle, • 13 knew which beverage containers were deposit bearing and which not (although some expressed confusion with respect to bottles containing beverages other than soft drinks and beer), • 10 regarded returning non-returnable bottles for recycling as inconvenient, and • 13 thought that they should be compensated monetarily for time and costs incurred in returning bottles for recycling. g/ass as hazardous waste much of the g1ass collected in port elizabeth is not recyclable (see oliver, 1975, on the making and using of glass other than for packaging). this glass is disposed of by being treated with chemicals to immobilize heavy metals, compacted and covered at a hazardous landfill site. waste tech gives assistance in the process on request (susan alcock, waste tech, november, 1996) and also itself disposes of some hazardous g1ass waste. it removes glass waste from shatterpruff'e, elmosa and associated glassworks. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 3 438 tow arbs a case for regulation the object of regulation a model is provided in figure i (below) where the aim of regulation is described. figure 1: a single market model of the case for regulation () % of recyclable glass waste disposed into me environment 100 in figure 1 two functions are shown: mcr and mc •. the negatively sloped one (mcr) shows the marginal social cost of reducing the amount of glass packaging disposed into the environment. the positively sloped one (mci) shows the marginal social cost of increasing glass packaging disposed into the environment. the object of regulating glass packaging disposal is to bring about an optimal level of waste disposal, which, assuming convexity in the damage and abatement functions (perman, ma and mcgilvray, 1996: 200-212), is where: mc r = mc,. in order to achieve this r.,rz glass packaging waste must be diverted from the environment. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 439 sated nr vol i (1998) nr 3 the relevance of all this for government is that, if market generated recycling only induces a diversion of rori waste from the environment, the government needs, some way or other. to effect an additional diversion of rir2 waste, in order to facilitate an optimal level of glass waste disposal. instruments of regulation there are various ways governments may set about this objective. the most popular four economic instruments are : • increasing the imposition of waste disposal charges (a curbside charge on consumers based on volume or weight) and fmes for litterirlg, • levying a product charge (packaging tax) on the sales of producers of non-refimdable beverage containers, to cover the costs expected to be incurred in final disposal, • subsidizing recycling production, and/or • legislating a deposit-refimd system with respect to all containers (turner, pearce and bateman, 1993: 259-260). each option has problems associated with it (turner. pearce and bateman, 1993: 260-266). for instance, increasing curbside waste disposal charges can lead to people either disposing of their waste in other ways which negatively impact on the environment, or adding theirs to someone else's bundle, and it can be administratively costly. a packaging tax does not directly discourage irresponsible waste disposal, only indirectly, by raising prices and so reducing demand. its main attribute is that it raises revenue to cover the environmental costs of the waste disposal. subsidizing recycling systems requires tax payers to bear part of the consumers disposal cost and so in effect is an income transfer. the main problem with respect to the deposit refimd system is the cost benefit studies have not shown it to generate significant net social benefits. thecostbenejitapproach the desirability of the above listed littering abatement measures depends upon the marginal cost of damage from final disposal being greater than the marginal cost associated with implementing that particular measure. the issue reduces to one of whether the marginal cost of damage to the final environment is greater than the marginal cost of implementing a deposit-refimd system for glass bottle containers of beverage. one approach to shedding light on the issue is to conduct a cost benefit analysis of the proposed legislation at the margin, i.e., using incremental costs. in this r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . samms ns vol i (1998) no 3 440 context the cost benefit model advocated by porter (1978) is popular (common, 1996:347). the approach is one of using the net present value (npv) decision rule the legislation is only deemed to be desirable if the npv is positive. for the case this paper is investigating the npv would need to be defined as follows: t npv =l (bu + bli + b3l cii c21 c31 )/(1 +rtl t-i where, bit = the social valuation of the cost saving benefit of the municipality and other government institutions in collecting and disposing of glass waste, bli = the cost saving benefit in reduced inputs required to produce the glass containers for soft and alcoholic drinks, b31 = the social valuation of the benefit of fewer glass litter related accidents and less amenity (or eye-sore) damage, cit = the increased cost of inputs used to put soft and alcoholic drinks into containers and of collecting and administering the expanded refillable container system, cli = the increased cost of greater litter related accidents and amenity (or eyesore) damage caused by non-returnable non-glass container substitutes for glass ones purchased by consumers, c 31 = the social valuation of the increased time cost to households in returning empty refillable bottles, r = the discount rate, and t = number of years after legislation is implemented; t = l .. t. there is little doubt that this approach has the potential to yield useful information, but the information requirements of it are considerable (see porter, 1978); beyond the terms of reference of this exploratory study. the estimation of b3l and c31 would require contingent valuations to be carried out amongst residents and visitors to the area. many cost benefit studies conducted overseas on the issue have not yielded significant positive net present values (turner, pearce and bateman, 1993: 264-265). an intuitive approach this paper does not use a cost benefit analysis approach in order to weigh up the case for bottle deposit legislation, but an intuitive reasoning approach. for this purpose an expanded version of the model in figure 1 is adopted see r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 441 sateb nr vol 1 (1998) nr 3 figure 2 (overleaf). in it four marginal social cost functions are incorporated: me;, me .. men! and mem • the me; curve in figure 2 is as it was for figure i, but the mer curve is defined differently. in the model described in figure 2, the recycling of non-returnable bottles is distinguished from that of returnable bottles; the reasons being that the costs of recycling and the target consumer markets differ. south african breweries described the market they provide non-returnable containers for as a niche one (see section 6 above). presumably niche markets are catered for by beverage suppliers because the economies of scale benefit of producing beverage in standard packaging is outweighed by the increased sales revenue benefit gained by dividing up the beverage market through different packaging and advertising. a more complex mer curve is defined when this division is taken into account: mer = men!, from ro to r. (for the returnable share of the glass container market), and = memt from r. to it. (for the non-returnable share of the glass container market), where, men! = the marginal social cost of recycling deposit bearing refillable bottles, and mem = the marginal social cost of recycling non-deposit bearing single fill bottles (e.g., through the bottle bank system). the return cost of different types of bottle is assumed to be equal from the consumer's point of view (implying ell = 0, or that the cost of returning a bottle to the bottle bank is equal to returning one to a beverage bottle retailer), but not from the beverage supplier's. as most of the profitable glass packaging recycling is done in refillable bottles, and the recycling which is being done in single fill bottles is mainly sustained on moral rather than commercial grounds, it is deduced that: the division between the recycling market for returnable and non-returnable bottles is shown in figure 2 by the vertical dotted line above r2• r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 3 figure 2: a split market model of the case for regulation. ~ vl 0 u mc,.! i a' i o 7 r, r, markci: non-~clumablc i markcl: aelurnable i glass conlaiucrs i glass containcrs mcm 1 35 57 % of recyclable glass waste disposed into the envlronment 442 100 ro the case for a mandatory deposit-refund system rests on the benefit of removing the market division between non-returnable containers and returnable ones. with the removal of this market division, the efficient level of recycling increases from r."r2 to r."r). as a result, total costs equal to the shaded area abcd are saved; the vertical difference between the mcrd and the lesser of the mc j and mcm curves. it is a cost which is quite likely to increase steadily in the future. as citizen opposition mounts to the siting of existing and new tips. so pushing up tipping costs (goldstein, 1995: 358). in principle it is conceivable that this gain through regulation could be offset by the loss in profits and income gained by the beverage seller and others (like advertisers) in servicing niche markets. however. as the beverages can be r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 443 sateb nr vol i (1998) nr 3 purchased cheaper from refillable bottles, it appears that much of the profit and income gained through niche market creation, may be a transfer of consumer surplus to advertisers and the beverage producing companies, rather than reflect a net social benefit. trends in south african beer and soft drink markets are consistent with this interpretation. south african breweries, being overwhelmingly dominant in the beer industry in south africa during the 1980s and early 1990s, displayed a diminishing interest in promoting product differences based on differences in glass packaging options more and more of their beer was sold in refillable bottles. (it is conceivable that this trend may be reversed if new competitors enter the industry and challenge their market dominance.) in the soft drink market, by comparison, where competition is more evident, more attention is focused on differences in packaging. to sum up: the case for regulating that a deposit-refund system operate in south africa for all glass bottle containers of beverage is based on the external cost saving exceeding the profit gain lost in niche markets. it is a plausible case because the costs of recycling refillable bottles is less than that of non-refillable bottles and the profit and income loss in the non-refillable bottle market is mainly a transfer of consumer surplus to the beverage producers and the advertisers they commission. conclusions on regulating against non-deposit bearing glass containers of beverage in principle there are many solutions to the problem of glass pollution: educating consumers to be more responsible, encouraging producers to bear the burden of the external cost, and placing the burden of this cost on consumers, by restricting their choice only to glass containers which are deposit bearing. the latter approach provides consumers with an income incentive to recycle the glass containers, and so harnesses self-interest as its primary driving force. the disposal cost of the container is thereby internalized. it is concluded that it is an efficient option because: • private costs would be brought into equivalence with social costs and most bottle glass waste (over 90%) would never reach final environments. in principle a litter tax on glass bottle producers can bring about the same end result (after cleaning up operations) but it would not prevent glass from reaching final environments. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 3 444 • the potential external cost saving is uncontroversial. besides being an efficient option, mandatory glass bottle deposit legislation for alcoholic and soft drinks also may advantage the following: • local businesses over foreign ones, because imported beverages (like beer, wine and whisky) would probably need to be packaged locally instead of abroad in order to fit in with the requirements of the local deposit-refund system, and • labour over capital, because a labour intensive production system is favoured over a capital intensive one in an economy with a huge surplus of labour. in reaching this conclusion several potential negative spin-offs of the proposed regulation were not investigated. the most important of these spin-offs are increased product prices and substitutions in production and consumption that aggravate other types of pollution problem, e.g., those of plastic, tinplated steel and aluminum waste. the prices of beverage in returnable containers could be raised as a result of reduced physical sales volumes or the need to recoup forgone profit on the non-returnable containers. however, it also bears noting in this connection that: • physical sales volumes of refillable containers of beverage could be expected to increase, thereby making it possible to derive greater economies of scale in production, and • plastic. tinplated steel and aluminum waste problems could (and perhaps should) be simultaneously addressed, as is commonly done in european countries where container deposit legislation has been introduced, e.g., through the levying of charges on products using these types of packaging. the latter approach would also have the merit of being less distorting with respect to the market for packaging material. for the above reasons it is recommended that further investigation be conducted into the merits of introducing mandatory bottle deposit legislation into south africa. endnote funding from the human sciences research council (hsrc) for this investigation is gratefully acknowledged, as is the assistance with field work by mr. m. akkerman, mr. h. gous, mrs. j.g. hosking, mrs. j. spearpoint and mr. d. brown, and the comments of the anonymous referees of the hsrc. this paper is drawn from a research report submitted to the hsrc on 9 february 1998. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 445 sateb nr vol i (1998) nr 3 references 1. barry, n. (1994) 'the market, liberty and regulatory state'. journal of the institutefor economic affairs, 14 (4), 5-12. 2. bohm, p. (1981) deposit-refund system: theory and application to environmental, conservation and consumer policy. baltimore: john hopkins. 3. business regulation review unit (june, 1989) 'container deposit legislation and the control of litter and waste', information paper no. 14. report for the ministry of industry, technology and commerce, australia. 4. common, m. (1996) environmental and resource economics: an introduction. (second edition.) london: longman 5. goldstein, e.s. (1995) economics and the environment. new jersey: prentice hall 6. oliver, d.s. (1975) the use of glass in engineering. oxford: oxford university press. 7. porter, r.c. (1978) 'a social cost benefit analysis of mandatory deposits on beverage containers', journal of environmental economics and management, 5, 351-375. 8. rabie, a. (1976) south african environmental legislation. pretoria: the institute of foreign and comparative law, unisa. 9. scott, w.o. and company pty. ltd. (august, 1983) 'study of the economic impact of beverage container deposit legislation'. commissioned by brewers, soft drink fillers and container manufacturers in australia. 10. tietenberg, t.h. (1992) environmental and natural resource economics (third edition) new york: harper collins. 11. turner, r.k., pearce, d. and bateman, i. (1993) environmental economics: an elementary introduction. baltimore: john hopkins. 12. vogler, j. (1981) work from waste. london: intermediate technology publications limited. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . journal 5.p65 ��� ������ � � � ���� � � ��������������������� ������� �������� ���� ������ � ��� � ������������������� ���� ���������� ������������� ����� ���� ��� � �� ���������� � ��� ����� ��� ���� �� � ����� �� ������������ �� ���� ������� � ��������� ������ � �������� �������� � ���� ������� �� � ���� ������� �� ����� ������������������ ������������������ �� ����������� �������� ���� � ����������������������������������� ���� ������ � ���� � ���� �� ���� ������������ � ��� � � �� � � ��� ��� ����������� ������������ ���� ������ � ����� �� �������� �� � ��� �� ����� ��� ������������ ������ ���������� �� ������������ � �������� � �������� � ���� ��� ������������� �� ��� ���!� ���������������� ����������� �������"##$� � ���� � ���� ��� �������� �� ���������������%���� ��� ��� ������ � ���� ����� ���������� �� ���� ����� �� ����� �������������������������� �������� � ������� ������� ������� �� ������������������� %�� � � �������������� � � �������������������� ��� ������������ &������� �� ���������� ������ �� ��� ���� �� ��� �������������� ���� ������������� ���� � ��� � �������� � �������� ������������� ���� ������� ��������� ����� ����������� ������������� � ���� �� ���� ���'����� ���� �������� ��� � ���� � ����� ��� �� ���� ������� ��������������������� � ����� ��� ���������� ����� �� ���� ���������������� � ������� �������%��� ��������� � ���%�������������������� �� �� ������ � ������ � � �������� ������ ����� ��� ������� � � ���������� � ������ ���������� ������������ ��������������"(� ������������)*#� �������� ��� ��� ����+�� ������ ���������� ���������������������������������,�������������� �����%� ������� �������������� ���� � ���� ���� ��� ������� ��������� ��������������� � �������� ����� ������ ����� ��������� ������������� ������ ���� ����� ��� ���� �� � ���� ������������������ ������ ���� ��� �������������������� ��� �� �������� ���������� ������ �� ������� ��������� �� � �� �������� ������ �������������������� � �������� � ������� � �� ��� �� ������� �� ����� ��� �������� �������� ����������� ������������� ������������������� ��������������������������������������� ����� ������������������������� ����������� ������� ����� ������ ��� � ������� ���� ��� ������ ��� �� ����� ���� ������� ��������� ���������������� ��������������� �������������������� �� !!" #������ �$%%&'��(� ������ � ��������������)� *��� ��� ��� ����� ���������� �������� ����������� ��� ������ ������������������� � � �+���������������� ����� ����� ��� ������ � ����������������������������� �������,���� ���� ������� ��� ������ ��� ������� ���� � ���� ������������������ ����� ����� � ������-������ �� ������ ����-�� �� �� ������� ������� ���� � ��� ��������������� ��� ��� ��������� )��� � ������ ����� ������ ����� ������������� �������� �� ������ �������� ���(����� �� . 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���"8������������$��6�-������1��$�$ ����������������'%����������/��.���������� ,� /0���������/�� �e��������/�� ��2,� !�� �������� �� � ������ �� � �������� �����������.��;�%$��"�������6�������6�� .��;�%$��"�!%�$$)����6���� �'�%��)�,<��9� ,, /!�����0���� ���,��� ������ � �� � ��������� =���"���6����$��&�����$��%)� �7���%g)�,+��,*<� ,9 /��0�#� �/���� ����>�?�0���1� � a�/���� ���.>�������/�� ���+��3a���%����� ��6������$�����������6�$�%��������;�������� �'�%��8���1!��7�%g��'�����%��2)�2��@� ,< �1��0��#�a���� �1/##��� ��c@� � �������� ��� � ����� �� �� ���������� -��� ������� ���� ���� �� $���� ���� ����������-�a%�7�e��� >��g�&� ���"�����)�0��6��)�<,@�<,+� ,+ 1��=/������?�/=/0�#�:���/���?��� �� 0���?���������/�?����0/������� ����>/0�� /�/�� ,@@@��31�������'������$$�$$ ���������� �����%�6����������/$�����6�/�6��$����$��� �'�%��8����������������,@)�,�+�,,9� abstract introduction literature review data methodology analysis conclusion and suggestions for future research acknowledgements references footnotes about the author(s) kavir patel school of economics, university of cape town, south africa ashfaaq mohamed school of economics, university of cape town, south africa gary w. van vuuren business school, university of the free state, south africa citation patel, k., mohamed, a. & van vuuren, g.w., 2018, ‘a regression and comparative study of united states and south african yield curves using principal component analysis’, south african journal of economic and management sciences 21(1), a1626. https://doi.org/10.4102/sajems.v21i1.1626 original research a regression and comparative study of united states and south african yield curves using principal component analysis kavir patel, ashfaaq mohamed, gary w. van vuuren received: 28 june 2016; accepted: 29 sept. 2017; published: 26 mar. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract volatile markets and economic environments can significantly distort the shape and smoothness of yield curve movements. this study explores the influence of movements in united states interest rates on south african interest rates. this study aims to identify the main underlying movements present in the united states and south african yield curves and to further determine the dominant factors that are responsible for driving south african interest rate movements. the principal settings for the study were the united states and south african markets representing, respectively, a developed and developing market. principal component analysis was used to discern the major drivers of developing and developed market interest rates. the findings show that the principal component analysis technique is able to effectively classify and quantify the movements of yield curves across both markets in terms of three main factors, namely level, slope and curvature shifts. during certain periods, south african yield curve changes were largely driven by variations in united states interest rates and the rand/dollar exchange rate. results also demonstrated that a volatile market and economic environment can significantly distort the shape and smoothness of yield curve movements. introduction explaining the volatility of financial assets has become a crucial part of portfolio management. fund managers and investors retain a substantial amount of risk when they do not understand the volatility of their assets. in the fixed-income market, the main contributing factors to the volatility in bond prices are yield curves. yield curves illustrate the relationship between bond yield rates at particular times and bond maturities with the same credit quality. this relationship is commonly known as the term structure of interest rates. portfolio managers and investors seek to quantify yield curve changes to protect, or immunise, the fixed-income assets in their portfolios. the absolute level of the yield curve is generally considered less important to investors than changes of the curve (baygun, showers & cherpelis 2000) as the variations in the yield curve describes the volatility of the bond market. this helps to illustrate whether the bond market is a safe investment during certain economic periods (johnson 2005). empirical analysis of yield curve changes shows that the structure of the variation in yield curves has not changed much since 1970, even though interest volatility has done so (bliss 1997; nath 2012). however, changes are difficult to quantify because they may affect several highly correlated maturities. in addition to affecting the bond price, investors have frequently used yield curves as a reference to forecast interest rates, which have also become a useful indicator of current and future economic activity (nath 2012). yield curve shifts occur when the market revises their expectations on future interest rates. these rates fluctuate in response to variations in inflation expectations, risk premium and output growth. empirical studies have revealed that yield curve movements can be characterised in terms of three factors, which are often termed as the ‘level’, ‘slope’ and ‘curvature’ factors. these terms describe how yield curves shift or change shape in response to a shock. figure 1 illustrates the effect of level, slope and curvature shocks on a yield curve. figure 1: yield curve shifts. a parallel or level shift arises when interest rates across all maturities change by the same amount. slope shifts develop when short-term expectations change but long-term rates remain the same, or vice versa (phoa 2000). these shocks alter the steepness of interest rate curves. curvature movements occur when rates at intermediate maturities change with respect to those at short and long maturities (colin 2006). this results in yield curves becoming humped. principal component analysis (pca) is a common approach considered to not only classify and quantify these yield curve movements but also to further manage the risk arising from groups of highly correlated market variables. in simple terms, the technique takes historical data on changes in market variables and attempts to define a set of uncorrelated components or factors that can effectively explain these movements in the most economical manner (hull 2012). principal component analysis quantitatively describes yield curve variations by determining the percentage of variance each factor contributes in explaining these movements. this analysis turns out to be remarkably successful because the technique considers the variability present in the entire data set (hull 2012). this study employs the pca technique to identify and quantitatively describe the main underlying movements present in yield curves. an established market and an emerging market will be used for this analysis, namely the united states and south africa, respectively. this analysis also aims to relate fluctuations in the variance explained by each of these factors to macroeconomic influences. in addition, because pca has the ability to explain a large proportion of yield curve variations in terms of only three uncorrelated factors, the technique allows regression analysis to be performed. in doing so, this study further attempts to ascertain the dominant factors responsible for driving south african interest rate movements. the rest of this article proceeds as follows: section ‘literature review’ explores the relevant literature, section ‘data’ discusses the data, and section ‘methodology’ examines the pca methodology. the results obtained are reviewed and discussed in section ‘analysis’, and section ‘conclusions and suggestions for future research’ concludes. literature review the quantitative decomposition of yield curve changes into sub-movements that can easily be described and analysed by investors and analysts is of fundamental importance in today’s financial markets (colin 2006). such an analysis allows investors to understand the dynamics of yield curves and the risk their portfolios are subject to because of the variability of these curves. traditional interest rate risk management focuses on duration, a technique which assumes that only parallel yield curve shifts are important (phoa 2000). using duration-based strategies to manage interest rate risk is also known as immunisation (redington 1952). although this is a common measure of bond risk, it is well known that non-parallel shifts in yield curves often occur. this is supported in the literature. shiu (1987), for example showed that duration-based strategies do not work as well as past research had reported. reitano (1992) demonstrated that duration-based strategies fail in practice, largely because of the assumption of parallel interest rate shifts. litterman and scheinkman’s (1991) approach identified and classified these non-parallel yield curve movements. most variation on bond returns could be explained in terms of three factors (termed level, steepness and curvature factors, respectively). the level factor relates to a parallel movement in the interest rates, and the last two factors explain the non-parallel shifts which occur in yield curves. the slope factor results from a shift that causes a change in the yield curve’s gradient and the third factor was shown to originate from a change in the curve’s curvature. although the level factor accounted for on average 90% of the observed variation in yield changes (which explains why duration-based strategies are commonly used), litterman and scheinkman’s (1991) study revealed that investors can achieve a better hedged position by considering the effect on a portfolio of each of the three factors rather than simply holding a duration-based hedged portfolio. zero-coupon yields can be estimated using function-based methods including the form proposed by nelson and siegel (1987) which relies on fitting a single mathematical model to bond yield data with different maturities. the nelson and siegel (1987) specification assumes that the instantaneous forward rate at maturity is given by an exponential function and continuous compounding of the instantaneous forward rate to maturity generates the zero-coupon (or spot) interest rate. diebold, ji and li (2004) reformulated nelson and siegel’s (1987) proposed parsimonious yield curve model into the level-slope-curvature (lsc) three factor model (again, a level factor, a slope factor and a curvature factor). diebold et al.’s (2004) findings reiterated that variations in yield curves are a result of level, steepness and curvature movements. litterman and scheinkman (1991) as well as diebold et al. (2004) used an empirical approach to derive the factors responsible for interest rate variations. this contrasts with the traditional approach used to describe yield curve dynamics. in this approach, a stochastic process that drives one or more state variables is defined (cox, ingersoll & ross 1985; longstaff & schwartz 1992; vasicek 1977). heath et al. (1992) suggested volatility structures to determine the dynamics of the initial term structure. the disadvantage of using these traditional approaches was highlighted by bierwag, kaufman and toevs (1983), who argued that as these stochastic processes need to be predicted, investors may incorrectly predict them, which may lead to poorly hedged portfolios and an incorrect analysis drawn on the dynamics of interest rate variations. although the three-factor model performs admirably, the factors still have a degree of correlation between them (su & knowles 2010) which results in factor relationship risk and which may be problematic for investors managing interest rate risk. su and knowles (2010) argue that this model tends to underestimate yield curve risk as a result of model fitting and bypassing of the residual variances. an alternate method to model yield curve dynamics is pca. this method identifies the fewest number of new explanatory variables to account for almost all the variability of yield curve changes (su 2002). similar to the three-factor approach, pca quantifies movements of yield curves in terms of the same three factors (baygun, showers & cherpelis 2000). unlike the three-factor approach, pca has an advantage of factor independence, that is, principal components are uncorrelated. this is helpful for real investment analysis because this independence eliminates the factor relationship risk which is present in the three-factor approach. another significant benefit is that the pca methodology considers the variance of the entire data set (knowles & su 2005) while the three-factor approach only considers the variance attributable to the factors, so interest rate risk tends to be underestimated. pca allows researchers to assess components of risk in isolation, thereby allowing for a robust assessment of individual risk components (tracey 2009). johnson (2005) suggests that the most important practical application of pca is in its ability to construct more complete hedges for a bond portfolio. pca allows almost all of the risk faced by a given bond portfolio to be explained by only a small number of factors. a portfolio can hedge against any shock driven by those key factors. this provides superior protection when compared with a more naïve immunisation approach, such as simple duration matching (johnson 2005). principal component analysis works well in analysing yield curve changes; using three principal components explains up to 95% of bond yield variance, for example in the us market (knez, litterman and scheinkman [1994], barber and copper [1996], phoa [2000], colin [2006] and hull [2012]). maitland (2002) found that most of the variability in the south african yield curve could be explained by just two factors (yield levels and yield changes). maitland (2002) used the south african johannesburg stock exchange (jse)-actuaries yield curve, that is, zero-coupon curves of differing maturity, not swap curves as in this research. thomas (2008) used pca to explore the factors that affect the south african swap curve and found four significant factors using data from august 2000 to march 2007. phoa (2000) applied pca to us treasury bond yield data. like previous work, phoa (2000) found that the dominant shift (the first principal component) was virtually a parallel shift, which explained over 90% of the observed fluctuations in bond yields. the slope and curvature shifts were identified as the second and third most important factors, respectively. apart from these results, phoa (2000) also analysed different sub-periods and found that the form of the curvature shift varied over time (the level and slope shifts were consistent across the sub-periods). this suggests that the curvature shift is less robust and may be of limited use in risk management. phoa (2000) related the principal components to macroeconomic factors, suggesting that the level could be caused by inflation expectations and the slope could be caused by monetary policy changes. tracey (2009) reported that each of the fundamental pca factors could be attributed to macroeconomic factors with the parallel component caused by inflation expectations, the slope by long-term inflation changes or market risk premiums and the curvature by changes in the volatility of interest rates. tracey (2009) recommends that this type of analysis would be useful to examine individual risk with regard to non-parallel shifts that result from monetary policy. in addition, macroeconomic events could also illuminate the explained variance of the level, slope and curvature during historical periods. rakotondratsimba and jaffal (2012) observed that after the 2007/2008 financial crisis, non-parallel shifts became more dominant. this could be investigated if pca were instituted across a range of historical time periods, including the financial crisis. morita and bueno (2008) associated the level and slope with inflation and gross domestic product (gdp) growth, respectively. in another investigation, morita and bueno (2008) compared the fundamental pca factors relative to a period which included a financial crisis and found that components are smoother during economic stability while during a financial crisis, the volatility increases. briere and ielpo (2007) performed a similar analysis by examining the variation of european yield curves with respect to macroeconomic news and found that the impact of economic announcements on yield curves displays different patterns according to the nature of the news (positive or negative). principal component analysis thus appears to enjoy an advantage over traditional duration-based approaches and factor analysis. pca could identify and explain the fundamental variation of yield curves across a range of countries and historical periods. however, a research gap was identified with regard to explaining the relationship of yield curve changes between an established market and an emerging market in terms of principal components and macroeconomic factors across a range of historical time periods. data data selection according to su (2002), the us government bond market is the most efficient and liquid interest rate market in the world. us market data are also reliable and reasonably complete in comparison to emerging markets, which often suffer from illiquidity and incomplete data. according to potelwa (2015a), foreign investors are buying south african bonds at a record pace. the article reports that us and europe yields were at record lows in 2015, so investors sought elsewhere for yields. south african bond yields remain high in comparison to 24 emerging economies and are thus viewed as good investments according to cadiz asset management ltd (potelwa 2015b). for these reasons, us and south african yield curves were considered for this analysis. to determine if any relationship exists between us and south african yield curves, the following rates were selected: the jpmorgan emerging market bond spread rate (jpembs); the south african rand to us dollar exchange rate; the us federal funds rate; south african repo rate. the jpembs provides an indication of the yield spread between the jpmorgan emerging markets bond rate (denominated in us dollars) relative to the us treasury bond rate. it could therefore identify relationships between the us market and an emerging market, such as south africa. monetary policies, such as the federal funds rate and the repo rate, will also affect yield curves and therefore it has been selected to aid in the analysis. data acquisition the respective swap curve rates were extracted from bloomberg. different time periods were used to perform certain investigations under specific economic conditions or because of restrictions with regard to the acquisition of data. the time period chosen for the analysis ranged between 1990 and 2014 so as to compare time periods of pre-financial crisis and post-financial crisis. one of the main obstacles in a quantitative analysis was acquiring reliable and complete data. us sovereign curves were used, comprising six maturities between 1990 and 1999 as this time period resulted in a complete data set for various maturities. the data comprised 1-year, 2-year, 3-year, 5-year, 10-year and 30-year yield to maturities. thereafter, us swap data spanning from 2000 to 2014 was extracted because of the availability of data. these comprised 1-year, 2-year, 3-year, 4-year, 5-year, 7-year, 10-year, 12-year, 15-year and 20-year maturity rates. according to phoa (2000), swap rates are an alternative source for government bond yields, which are par yields by definition and therefore the results of the analysis will be similar. unfortunately, data for south african maturity rates could not be acquired from 1990 because of non-availability. therefore, south african swap rates were acquired between 1995 and 2014, comprising 1-year, 2-year, 3-year, 4-year, 5-year, 7-year, 10-year, 15-year, 20-year and 30-year maturity rates. maturities comprising short-term and long-term maturities were acquired to approximate the shape of yield curves. maturities of less than a year were avoided to remove the idiosyncratic risk associated with those maturities. these data were extracted at a daily frequency. the daily frequency is also beneficial when performing an analysis on a short time period. the jpembss were acquired from i-net expert, consisting of daily rates ranging between 2000 and 2014. additional rates such as the south african rand to us dollar exchange rate, repo rate and the federal funds rate were acquired from fred economic data (fred 2015). the exchange rate was extracted at a daily frequency, whereas the repo and federal funds rates were extracted at a monthly frequency. data preparation data preparation is a cumbersome task of structuring a large data set into a particular structure to conduct quantitative analysis. the data structure involved merging various maturity rates according to time (24-h period) and any missing maturity rates with respect to time were linearly interpolated. daily rates vary by a small amount and as this analysis uses daily data, linear interpolation should closely approximate the true value. python’s1 powerful package pandas provides tools for time-series data manipulation and was used to efficiently prepare the data. figure 2 displays the swap rates for 1-year and 30-year maturities of both countries. figure 2: one-year and 30-year swap rates for both countries. figure 3 shows the relevant us treasury data used in this study. treasury rates are considered for the period prior to 2000 because of a lack of swap curve data available during this period. figure 3: united sates treasury rates. methodology principal component analysis theory principal component analysis summarises complex data sets by creating new, artificial variables called principal components. these are linear combinations of the original data and are constructed by exploiting the variability (i.e. spread) of each variable and the correlation between the variables. in addition, each of these new variables are assembled such that they are uncorrelated with one another. the components are derived by finding the eigenvectors and corresponding eigenvalues of the correlation or the covariance matrix between the variables in the original data set. these components effectively represent a rotation of the original data onto new axes. this new set of axes reveal more easily discernible patterns within the data. the components are ordered according to the magnitude of their variance. the component with the largest corresponding eigenvalue is the first principal component – the linear combination that encapsulates most of the data variability. this component represents a rotation of the data along the axis representing the largest spread. the component with the second largest variance explains most of the remaining variability while being uncorrelated (perpendicular) to the first component. the same concepts apply to the remaining principal components. in the last step of this technique, pca determines the number of ‘real’ dimensions present in the data. eigenvectors are chosen such that the sum of the variances explained by these eigenvectors is sufficient to explain most of the variation present within the original data.2 the goal of pca is to reduce the number of variables in data while still accounting for the majority of total variation embedded therein. applying principal component analysis to yield curve changes the theoretical insights gained from pca can be used to make sense of yield curve dynamics. eigenvectors and their corresponding eigenvalues are derived from a covariance matrix based on time-series data of daily or monthly interest rate changes at each reference maturity.3 the eigenvectors can be interpreted as independent ‘fundamental’ yield curve shifts as they characterise different forms of yield curve changes. the relative size of the corresponding eigenvalues determines which fundamental yield curve shifts dominate. according to pca, the first three components explain almost all of the variation in yield curve changes (phoa 2000).4 the following sections explain the algebraic and graphical interpretation of pca. algebraic view of principal component analysis suppose there are p variables (term to maturities) and n observations (daily basis point shifts). let x denote a (n × p) matrix of input data, where the columns represent the variables and the number of rows relate to the number of observations. let μ be a (1 × p) vector consisting of the mean of each variable, then it follows that (x – μ) are the centred data. let ∑ represent the covariance matrix of the input data. from the definition of a covariance matrix: principal component analysis is a decomposition of the covariance matrix. equation 2 demonstrates this decomposition. where p is a (p × p) orthogonal matrix (i.e. ptp = i), and λ is a (p × p) diagonal matrix. because p is orthogonal, the determinant of p = 1, so p defines a rotation in p dimensions. because λ is a diagonal matrix, the rotated variables are uncorrelated. the diagonal entries of λ are the variances of the rotated variables. from ∑ = pλpt, λ = pt ∑ p. the trace of λ is tr(λ) = tr(pt ∑ p) = tr(∑ ptp)= tr(∑).5 therefore, the sum of the variances of the rotated variables is equal to the sum of the variances of the original variables. let c be a (n × p) matrix representing the rotated variables. because p defines a rotation, accordingly, (x – μ) = cpt. from this expression, equation 4 demonstrates that any row in (x – μ) can be expressed as a linear combination of the eigenvectors. where ei is the ith eigenvector. the variance of each column in c is equal to the diagonal entries in λ, that is, the eigenvalues. a dimensionality reduction from p to m dimensions involves the projection of the input data (x – μ) (p dimension) onto the first m < p principal components. this is achieved by setting eigenvectors m + 1 to p = 0 and applying equation 5: graphical interpretation of principal component analysis suppose there exists a history of yield curves, each curve can be represented as a vector of p points (or nodes) and each node represents a specific term to maturity. a yield curve shift can therefore be described by a vector of p elements, that is, one for each node/term to maturity. accordingly, a yield curve shift history can be thought of as a history of p dimensional vectors. if it is possible to visualise p-dimensional space (yield curve with few nodes), the yield curve shift may then be represented as a single point in space, where its value on each of the p axes is determined by the values at each of the p nodes. figure 4 displays the projection of a 10-dimensional data set6 (yield curve shifts across 10 maturities) onto a three-dimensional space.7 the three eigenvectors represent a new system of axes and each point’s position (yield curve shift) can now be expressed relative to these new axes. in this data set, most of the variation is explained along the first three principal component axes, hence the projection onto a three-dimensional space. figure 5 shows all three components with explained variances.8 the components characterise specific forms of yield curve shifts, namely level, slope and curvature shifts which account for over 98% of yield curve movements. figure 4: projection of yield curve shifts across 10 maturities onto a three-dimensional space. figure 5: three principal components of yield curve shifts for entire sample. analysis figures 6 and 7 illustrate the first three principal components derived for us and south african swap rate shifts for the period between 2000 and 2014. the plots further depict the percentage of variance explained by each factor. all pca results are generated using a daily frequency of interest rate movements. figure 6: the three most important factors driving movements in united states swap rates: 2000–2014. figure 7: the three most important factors driving movements in south african swap rates: 2000–2014. the simulation results agree with the literature. firstly, pca can effectively derive three components that can explain most yield curve variations.9 the literature shows the same findings about us and emerging market yield curves, namely that there are three main components, but these are distorted for emerging markets relative to developed markets. secondly, pca is able to characterise these movements in terms of level, slope and curvature shifts. lastly, slope changes and curvature shifts are more volatile in south africa and are not consistent over annual intervals. developing economies (such as south africa) are more prone to noise, where these markets are politically unstable and interest rates are far more volatile, which feeds into unstable monetary policy. there were also multiple financial crisis events during this period, which could influence the shape and distortion of the principal components. this led to the investigation between the periods of preand post-2000. economic interpretation of principal component analysis results in the united states and south africa interpretation of us results figures 8 and 9 present a three-dimensional representation of each principal component generated on an annual interval for the preand post-2000 periods, respectively. figure 8: three-dimensional representation of annual us principal components for the period 1990–1999: (a) us annual pc1; (b) us annual pc2; and (c) us annual pc3. figure 9: three-dimensional representation of annual us principal components for the period 2000–2014: (a) us annual pc1; (b) us annual pc2; and (c) us annual pc3. the form of the slope and curvature components during the 1990s are significantly smoother when compared with the components post-2000. this could be because the 1990s were characterised by strong economic growth that resulted from a combination of rapid technological advancements and sound central monetary policy. in contrast, the market suffered with multiple crisis periods post-2000 (e.g. the dot-com and credit crisis). the economic instability during this period is reflected in the variation of the federal funds rate, as shown in figure 10. figure 10: united states federal funds rate post-2000. figure 11 depicts the percentage of variance explained of each principal component for each year during the post-2000 period. figure 11: variations in percentage of variance explained for each united states component for period: 2000–2014. the changes in variance over the sample period, explained by the components, may be related to macroeconomic factors. such an explanation may not be sensible during this unstable period, where movements in the term rates might have been attributable to many unexplained factors. however, extreme monetary policy changes might have been a possible factor contributing to increased slope shifts during certain years.10 as confirmed in figure 10, there was a sharp rise in interest rates during 2000, a considerable decline in rates during 2001 in an attempt to spur growth during the recession and a further decline in rates during the credit crisis of 2008. during these periods, the slope factor played a more dominant role in comparison to previous years. in periods where the federal fund rate remained stable, the slope is a less dominant factor, whereas during crisis periods it is dominant. the slope factor is slightly more prominent post-2010, a period devoid of monetary policy shocks. this suggests that during this quantitative easing phase, the slope factor is now rather explained by movements in long-term interest rate expectations. interpretation of south african results figures 12 and 13 depict annual principal components for preand post-2000 periods, respectively. in contrast to the united states, the 1990s were a time of considerable upheaval for emerging markets. many developing economies suffered from the tightening of bond markets as stock markets fell. this may explain the volatility in the form of the principal components during this period. figure 12: three-dimensional representation of annual south african principal components for the period 1995–1999. sa, south africa: (a) sa annual pc1; (b) sa annual pc2; (c) sa annual pc3. figure 13: three-dimensional representation of annual south african principal components for the period 2000–2014. sa, south africa: (a) sa annual pc1; (b) sa annual pc2; (c) sa annual pc3. figure 14 illustrates the percentage of variance explained of each principal component during the post-2000 period. figure 14: variations in percentage of variance explained for each south african principle component: 2000–2014. although the level shift is still dominant, south africa’s level factor plays a minor role in comparison with the us level factor. as a result, the slope and curvature factors are observed to play a greater role in driving south african interest rate movements. this may be attributable to greater market volatility present in emerging markets as they are more vulnerable to external shocks. in addition, south africa’s inflation expectations are more erratic than market inflation expectations in the united states.11 as an emerging market, south africa also presents a challenging array of long-term political, economic and financial risk to investors. consequently, south africa has a high-risk premium which fluctuates enormously and plays a significant role in the demand for its fixed-income securities. this high and volatile risk premium is likely to be a significant factor in increasing the dominance of slope shifts.12 over the period 2000–2004, slope shifts explain a relatively high proportion of interest rate movements. this may be because of severe changes (substantial increases and decreases) in the repo rates (which in turn alters inflation expectations). these extreme changes are depicted in figure 15. these movements coupled with markets’ volatile perception on emerging markets risk may help explain this slope shift dominance. figure 15: south african repo rate post-2000. based on the findings displayed in figure 15, similarly to the united states, the slope factor was more dominant during periods when there were sharp increases and decreases in the repo rate. on an interesting note, post-2009 reveals a period where the slope component was significantly less dominant. this may be attributable to quantitative easing in the united states. with short-term rates in the united states remaining stable, rates in south africa did not fluctuate as much during this period.13 consequently, there were less monetary policy shocks during this period, which may have played a prominent role in explaining why slope movements were less dominant post-2009. correlation and regression analysis on principal component scores the previous section illustrates the effect of us interest rates on the south african currency and interest rates. a relationship might thus exist between the changes of us yield curves and the changes of south african yield curves. the problem with performing a correlation and regression analysis on yield curve changes is that maturities in each data set are highly correlated. a few maturities can instead be selected and these used for correlation and regression analysis. however, those maturities will only explain a limited amount of variance. the advantage of pca is that it provides a reduced number of uncorrelated principal components that explains most of the variance in the entire data set. the scores of the uncorrelated principal components can therefore be used in a correlation and regression analysis. the jpembs could identify relationships between the us market and an emerging market, such as sa. if the spread increases, the risk premiums of emerging markets are increasing. this could be because of risk-averse investors taking investments out of emerging markets and placing them in established markets. it has also been suggested (morita & bueno 2008; phoa 2000) that changes in monetary policy could affect the resultant slope and curvature components of pca on yield curve changes. this result could be investigated by correlating the slope and curvature of the united states and south africa to the changes in the repo rate and the federal funds rate. model preparation and variables under consideration the following variables were used in the correlation and regression analysis: scores of principal components 1, 2 and 3 of us yield curve changes; scores of principal components 1, 2 and 3 of south african yield curve changes; changes in the jpembs rate; changes in the federal funds rate and repo rate; percentage changes in the south african rand to us dollar exchange rate. to build the multivariate regression models, a correlation analysis is first performed. note that performing correlation over daily data is not sensible as correlation tends to under-perform when applied to high-frequency signals. in addition, daily data are prone to more noise, which can affect the accuracy of correlation results considerably. to overcome these limitations, principal component scores were derived based on monthly mean swap rate changes. monthly mean values are considered ahead of values occurring on the first or last day of each month as these values may themselves be outliers. using mean values of each month allows average shifts to be encapsulated over that period. this in turn alleviates the problem of noise. furthermore, using monthly values will overcome the issue of selecting accurate lag or lead values.14 sampling data using monthly mean values encapsulates the daily observations and hence would be a good approximation to an analysis done on daily observations. accordingly, for the correlation and regression analysis to follow, all relevant data are resampled based on monthly mean values. in contrast, the federal funds rate and the repo rate data are based on actual monthly percentage changes. the correlation results based on a monthly frequency for the period between 2000 and 2013 can be seen in table 1. table 1: correlation results for period between 2000 and 2013. table 1 illustrates that there is a 34% correlation of the scores relating to level and a 24% correlation of the scores relating to the curvature between the united states and south africa. there is also a 32% correlation between the scores of the level in south africa and the exchange rate. also of interest is the negative correlation of 20% between the jpembs and the scores of the us level component. this could be because of risk-averse investors shifting investments to established markets. tracey (2009) suggests that monetary policy changes affect the curvature component, whereas phoa (2000) suggests that it could have an impact on the slope component. table 1 shows that changes in the repo rate had a 32% correlation to the scores of the curvature component and 31% correlation to the scores of the slope component in south africa. in addition, changes in the federal funds rate had a 42% correlation to the scores of the curvature component and 37% correlation to the scores of the slope component in the united states, confirming the results of past literature. the significant correlations with respect to the scores of the south african principal components suggest a multivariate regression. in addition, correlation does not indicate causality. therefore, a multivariate regression analysis needs to be performed to determine which rates drive south african yield curve changes. the analysis was performed using the ordinary least squares (ols) method and a 95% confidence interval was selected. two regression models were constructed based on the correlation results from table 1, as shown in table 2. table 2: regression models. the independent variables with resulting p-values greater than 5% were removed and the analysis was thereafter repeated. this prevents the model from over-fitting owing to the addition of insignificant dependent variables. in addition, if any of the regression models displayed insignificant results, they were neglected and only the significant results were presented. results for the period between 2000 and 2013 the multivariate regression results for the period between 2000 and 2013 is shown in table 3. note that model 2 resulted in insignificant results and hence has been neglected for this period. table 3: regression results for the period between 2000 and 2013. table 3 presents a multivariate regression model with an adjusted value of 0.26. this model suggests that during this period, movements in us level shifts, the exchange rate and the repo rate can explain up to 26% of variation in south african level shifts. the model infers that over the long term (2000–2013), south african rates were not affected by us interest rate and exchange rate movements. there might have been periods during certain economic cycles or crises where these relationships might have been more significant. as a result, regression models for different sub-periods are now considered. the sub-periods are derived according to substantial fluctuations present in the emerging markets spread. because the spread determines the risk premium present in emerging markets, it may serve as a good indicator in determining the effect us interest rate movements have on south african rates. the change in the gradient of this curve can therefore indicate different economic cycles of emerging markets. a regression analysis was therefore conducted on the different economic cycles of emerging markets. the following sub-periods correspond to different economic cycles over the period 2000–2013. sub-period 1: 2000–2002 (characterised by the dot-com crash of 2000–2001). sub-period 2: 2003–2007 (the us recovery period). sub-period 3: 2008–2009 (includes the credit crisis of 2008). sub-period 4: 2010–2013 (characterised by us quantitative easing). results for sub-period 1 table 4 summarises the multivariate regression results for sub-period 1. table 4: multivariate regression results: sub-period 1. the results in table 4 indicate that in a sub-period where the risk premium of emerging markets was volatile, the following deductions can be made: forty-one per cent of level shifts in south africa were explained by the south african rand to us dollar exchange rate and the repo rate. eighteen per cent of south african slope shifts were explained by the jpembs rate. results for sub-period 2 table 5 illustrates the multivariate regression results for sub-period 2. table 5: multivariate regression results: sub-period 1. the results in table 5 indicate that in a sub-period where the risk premium of emerging markets were decreasing, the following deductions can be made: fourteen per cent of south african level shifts were influenced by exchange rate and repo rate fluctuations. during this period, movements in the repo rate drove 20% of south african slope shifts. results for sub-period 3 table 6 displays the multivariate regression results for sub-period 3. table 6: multivariate regression results: sub-period 3. the results in table 6 indicate that in a sub-period where the risk premium of emerging markets were increasing rapidly, the following deductions can be made: fifty-four per cent of level shifts in south africa were explained by us level shifts. results for sub-period 4 table 7 presents the multivariate regression results for sub-period 4. table 7: multivariate regression results: sub-period 7. the results in table 7 indicate that in a sub-period where the risk premium of emerging markets was stable, it can be deduced that 45% of level shifts in south africa were explained by us level shifts and the jpembs rate. sub-period deductions sub-period 2 relates to a period of economic recovery in the united states. in addition, the period was characterised by protracted periods of strength in the rand (figure 16). the low adjusted r2 value suggests that during this stable period, movements in south african term rates may have been driven to a large extent by internal market factors. figure 16: rand/us dollar exchange rate post-2000. in contrast, sub-period 1 resembles a period where the rand was severely weakened (figure 16). a possible cause in the rand deterioration may have been attributable to the slowdown in global economic activity that began in 2000, where the demand for south african goods and services moderated. accordingly, when the exchange rate volatility increases, investors require a larger yield compensation for holding emerging market bonds. this volatility coupled with a sharp decrease in the repo rate (figure 15) supports the statistically significant adjusted r2 values in explaining south african level shifts during sub-period 1. during the last two sub-periods, the regression results suggest that movements in the us term rates played an important role in driving south african interest rates. this could largely be because of the impact of the credit crisis of 2008. in addition, the significant relationship seen during sub-period 4 (post-2010) may stem from quantitative easing, a time when us investors are pushing funds to emerging markets that offer higher attractive yields. conclusion and suggestions for future research this study used the pca technique to identify and quantitatively describe the main underlying movements present in both us and south african yield curves. the analysis was further aimed at relating fluctuations in the percentage of variance explained by each of these factors to macroeconomic influences or events. the study further intended to determine dominant factors, if any, which were responsible for driving south african interest rate movements during certain economic periods. the pca technique classifies and quantifies yield curve movements across both markets with respect to three main factors, namely level, slope and curvature shifts. these factors encapsulate most of the yield curves variability, with the level shift representing the dominant component. curvature movements only contribute a small change in yield curve variations. in terms of relating these factors to macroeconomic variables, the findings revealed that monetary policy shocks across both markets played a prominent role in affecting the form and importance of slope and curvature shifts. in addition, the results illustrated that the shape and importance of each factor deviated during periods of economic instability. in particular, the form of the slope and curvature movements were erratic and distorted during these periods. in contrast, the shape of the slope and curvature shifts were significantly smoother during periods of economic stability. in the light of this, it can be argued that a volatile market and economic environment can significantly distort the shape, smoothness and percentage of variance explained of yield curve movements. in terms of a brief comparison between the markets, the level shifts in south africa were observed to play a far less dominant role, resulting in the slope and curvature factors driving south african interest rate movements to a greater degree. furthermore, it was noticed that the form of south african slope and curvature shifts were far more erratic. these differences were suggested to be because of factors such as political instability, unstable monetary policy and volatile interest rate expectations, which are known to be prominent in emerging markets. a regression analysis revealed that over the long term (2000–2013), south african rates were not largely driven by us interest rate movements. however, during certain sub-periods, movements in the us term rates played a dominant role in driving south african rates. as an example, during the credit crisis period the regression models suggested that 54% of south african level shifts were driven by us level shifts. the results further illustrated that during certain periods, movements in the rand/dollar exchange rate played an important role in driving south african level shifts. in addition, the regression results were able to confirm the significant relationship between monetary policy shocks and corresponding slope and curvature movements across both markets. further research could involve the comparison of the impact of the credit crisis on the volatility of interest rates in both markets. an f-test could be performed based on principal components scores (derived from yield curve changes) preand post-crisis to compare the variances of yield curve movements during these periods. further research could also aim to verify the relationship suggested by the regression models between us and south african rates during certain periods. alternate statistical methods can be researched to compare daily us and south african principal component scores, where methods such as auto correlation, co-integration or dynamic time warping could be used to accurately determine the lag between us and south african yield curve changes. principal component scores for each sub-period using weekly mean changes in yields could also provide a possibility. lastly, an investigation could be performed on the factor loadings of the principal components across different sub-periods. this will indicate the degree to which various interest rates affected the level, slope and curvature movements during certain economic periods. acknowledgements competing interests the authors declare that they have no financial or personal relationship(s) that may have inappropriately influenced them in writing this article. authors’ contributions k.p. and a.m., the principal authors, instituted the study and undertook analysis and interpretation. g.w.v.v., the supervisor, recommended the project and oversaw the robustness of the results 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t.w., 2010, ‘measuring bond portfolio value at risk and expected shortfall in us treasury market’, asia pacific management review 15(4), 477–501. thomas, m., 2008, ‘long-term extrapolation and hedging of the south african yield curve’, unpublished msc thesis, university of pretoria, south africa. tracey, m., 2009, principal component value at risk: an application to the measurement of the interest rate risk exposure of jamaican banks to government of jamaica (goj) bonds. financial stability department, research & economic programming division, bank of jamaica, kingston, jamaica. vasicek, o., 1977, ‘an equilibrium characterization of the term structure’, journal of financial economics 5(2), 177–188. https://doi.org/10.1016/0304-405x(77)90016-2 footnotes 1. general purpose and high-level programming language. 2. formally, for dimensionality reduction. in a data set where there are m eigenvectors, a reduction from m dimensions to k dimensions occurs by choosing k eigenvectors related with the k largest eigenvalues. in mathematical terms, choose k when the percentage of variance explained pov > 90%, where, , is sorted in descending order and refers to the eigenvalue corresponding to the eigenvector. 3. a covariance matrix can be used since each variable (term to maturity) is measured in the same units and the variances between the variables (changes in yields across different maturities) do not vary greatly. 4. because of the high correlation present in yields across different maturities, the first three components generally account for almost all the variability in yield curve changes. 5. the trace of a square matrix is the sum of the main diagonal elements. 6. the sample data considered are us treasury rates for the period 2000–2011. 7. this projection represents a dimensionality reduction from 10 dimensions to 3 dimensions. 8. see footnote 2 for percentage of variance explained equation. 9. swap rates serve as an acceptable proxy for yield curves. 10. a slope shift can occur when short-term rates change but long-term rates remain the same, or vice versa. 11. changes in long-term inflation expectations will alter long-term interest rate expectations. this in turn affects the slope of interest rate curves. 12. the risk premium affects both the long and short ends of a yield curve. however, it is greater at longer durations because of more uncertainty and a greater chance of catastrophic events that can impact investments. fluctuating risk premiums will therefore alter the slope of interest rate curves. 13. south african interest rates mostly follow movements in the us interest rates with a lag. this is confirmed by comparing figures 8 and 15. 14. financial markets worldwide do not have the same working hours. as a result, the study of correlation or causality between financial market indices becomes highly dependent on the issue of lagging or leading data. a lag of 1 day, for example may be chosen between us and south african time series data (i.e. when the us markets close, south african markets react the following day based on movements in the united states). abstract introduction literature review methodology results and analyses conclusion acknowledgements references footnotes about the author(s) zhen-jia liu department of accounting, school of business, changzhou university, china yi-shu wang department of accounting, school of business, changzhou university, china citation liu, z-j, & wang, y-s., 2017, ‘effect of earnings management on economic value added: g20 and african countries study’, south african journal of economic and management sciences 20(1), a1247. https://doi.org/10.4102/sajems.v20i1.1247 original research effect of earnings management on economic value added: g20 and african countries study zhen-jia liu, yi-shu wang received: 31 oct. 2014; accepted: 13 july 2016; published: 25 oct. 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: economic value added (eva) may reflect true performance compared with other conventional accounting indices, it is still measured through financial statements. it is highly probable that eva motivates managers to manipulate earnings. aim: the main contribution of this study is the analysis of the association between earnings management and eva. this study provides shareholders, lenders and creditors (or other categories of investors) with a method for analysing the value of enterprises. setting: we analyse the association between earnings management through real earnings management (rem) or discretionary accrual (da) activities and the eva by african and the group of twenty (g20) nations. methods: the sample for this study was obtained from the compustat database between 2009 and 2013. this study also adopted the ordinary least squares (ols) method. results: the results indicate that a significantly positive relationship exists between earnings management through da items and eva in african nations. in addition, a significantly negative relationship exists between earnings management through da items or rem activities and eva in g20 nations. conclusion: our results provide critical implications for managers, researchers, investors and regulators of various nations; for example, managers may determine whether to increase the eva through earnings management, researchers may analyse varying degrees of rem activities and das existing in the same nation groups or regulators may determine how to establish laws or rules to prevent earnings management because it is likely that differences in national development, culture or politics exist in these nations. introduction conventional accounting indices are used for measuring firm performance (allgood & farrell 2003; bailey & helfat 2003; neumann & voetmann 2005; peng 2004; shen & cannella 2003). such measurements are determined in accordance with generally accepted accounting principles (gaap), requiring conservatism in preparing financial statements. economic value added (eva) was proposed as an estimate of a firm’s economic profit. the basic concept of eva is that economic profit is created when the return on a firm is higher than the firm’s capital cost (mahdavi & rastegari 2007). therefore, eva is used to calculate shareholder value (kaur & narang 2008). earnings management is when managers exercise judgement in financial reporting and in structuring transactions to adjust financial reports (healy & wahlen 1999). several studies have focused on determining whether earnings management exists and on identifying the motive for managing earnings (e.g. anjum et al. 2012; brown & higgins 2001; caton et al. 2011; chang, hsin & hou 2013; chiu et al. 2013; datta, iskandar-datta & singh 2013; degeorge et al. 2013; essid 2012; farrell, unlu & yu 2014; francoeur, amar & rakoto 2012; habib, bhuiyan & islam 2013; hansen 2010; he, yang & guan 2011; jha 2013; kangarluei, motavasse & abodllahi 2011; karampinis & hevas 2013; kim & sohn 2013; lin & wu 2014; nagata 2013; salteh & valipour 2012; shu & chiang 2014; wu, lin & fang 2012; zhang & he 2013). although eva may reflect true performance compared with other conventional accounting indices, it is still measured through financial statements. therefore, it is highly probable that eva motivates managers to manipulate earnings. the main contribution of this study is the analysis of the association between earnings management and eva. this study provides shareholders, lenders and creditors (or other categories of investors) with a method for analysing the value of enterprises. the group of twenty (g20) is an international forum from 20 major economies. collectively, the g20 economies account for approximately 85% of the gross world product (gwp), 75% of world trade (if all european union intra-trade is excluded) and two-thirds of the world’s population. africa is the world’s poorest and most underdeveloped continent. the 2003 united nations human development report indicated that the bottom 25 ranked nations were all african. because countries have relatively distinct governments, cultures, laws and economic conditions, enterprises operate in unique systems and environments; therefore, they cannot be considered equivalent. in this study, we developed a regression model and compared the relationship between earnings management and eva among organisations in african1 and g202 nations. literature review economic value added stewart (1991) revised the computation of residual income and established a methodology for computing eva. however, parvaei and farhadi (2013) reported that historical eva offers low predictability for performance measured using return on equity (roe), return on assets (roa) or other metrics, and free cash flow has slightly superior predictability compared with other measures. huynh, gong and nguyen (2013) investigated the integration of activity-based costing (abc) with eva as an approach to measure firm performance. they proved that the eva–abc method is an innovation management accounting approach. regarding the factors influencing eva, burja and burja (2010) revealed that eva and resource management are interdependent. moradi, ghomian and fard (2012) indicated that profitability, firm size, growth ability and intangible assets are significantly positively related to eva, whereas capital structure is significantly negatively related to eva. nikbakht and moghimi (2011) demonstrated that the active debt ratio is inversely related to eva in manufacturers of non-metallic mineral products, construction machinery and industrial equipment. altendorfer and jodlbauer (2011) have indicated that fewer changes in a firm’s operational personnel yield higher eva. haque et al. (2013) reported that dividend payout has a significantly negative relationship with eva; this is because shareholder value theory discourages the distribution of earnings in the form of dividends because it implies management inefficiency towards maximising shareholder wealth. earnings management the tools of earnings management are detailed as follows. firstly, managers can make discretionary accrual (da) item choices that are allowed under gaap to reach a desired level of earnings. das are a component of accounting accruals and include items indicating a manager’s forecasts of uncertain events. they can also be misleading when manipulated to distort public information for private gain. dechow, saloan and sweeney (1995), islam, ali and ahmad (2011) and chang et al. (2013) have provided related models to measure da items. secondly, managers can engage in earnings management by altering the time and scale of operating decisions. these actions deviate from normal business practices, with the primary objective of misleading stakeholders regarding a firm’s economic performance. researchers refer to the second type as real earnings management (rem) activities. on the basis of recent rem studies (e.g. cohen, dey & lys 2008; roychowdhury 2006), we considered the following three types of rem activities: (1) sales manipulation, (2) overproduction and (3) discretionary expense reduction. the literature on accounting reports several motivations for earnings management; such motivations include mergers and acquisitions (m&a) (francoeur et al. 2012), exchange rate exposure (chang et al. 2013), r&d (zhang & he 2013), product market pricing (datta et al. 2013), distressed firm (habib et al. 2013), board interlocks (chiu et al. 2013), free cash flow (kangarluei et al. 2011), investor stock returns (wu et al. 2012), firm profitability (anjum et al. 2012), initial public offerings (nagata 2013), equity-based compensation (essid 2012), seasoned bond offerings (caton et al. 2011), private placement issuers (he et al. 2011), tax (karampinis & hevas 2013), seasoned equity offerings (shu & chiang 2014), debt covenant (jha 2013), financing constraints (farrell et al. 2014), analyst coverage (degeorge et al. 2013), earnings benchmark (hansen 2010) and corporate governance (lin & wu 2014). datta et al. (2013) revealed that firms with inferior product market pricing power in competitive industries frequently report discretionary earnings accruals. habib et al. (2013) found that managers of distressed firms engage more in income-reducing earnings management practices than do managers of financially stable firms. kangarluei et al. (2011) revealed a significantly positive relationship between earnings management and free cash flow, and they reported that the relationship is more significant for firms with high free cash flow, thus indicating that a firm’s free cash flow can motivate managers to engage in earnings management behaviour. wu et al. (2012) reported a negative relationship between earnings management and investor stock returns in taiwanese firms; they attributed this phenomenon to the investment decisions made by taiwanese stockholders, who are traditionally concerned about the quality of a firm’s financial statements. anjum et al. (2012) used a modified jones model to calculate the das of companies in various sectors listed on the karachi stock exchange. their results showed that earnings management has a negative effect on firm profitability. because they elucidated the manipulation of company profits, their study is of vital importance to managers, investors and analysts for decision-making and analysis. caton et al. (2011) showed that issuers tend to inflate earnings performance before an offering (seasoned bond offering). he et al. (2011) reported that earnings management serves as a likely source of investor over-optimism during private placements; moreover, they showed that income-increasing accounting accruals made during private placements predict post issue long-term stock underperformance. degeorge et al. (2013) reported that in countries with high financial development, increased intra-firm analyst coverage engenders low earnings management. hansen (2010) reported that firms prefer to avoid a loss benchmark (i.e. managed earnings is above zero in time t); however, he did not consider firms just below the loss-avoidance benchmark that might be using das to avoid missing an alternative benchmark. karampinis and hevas (2013) reported that tax pressure is a significantly negative determinant of das in the pre-international financial reporting standards (ifrs) period relationship between earnings management and capital costs salteh and valipour (2012) indicated a significantly inverse relationship between das and the weighted average cost of capital. managers attempting to avoid loss are likely to have stronger incentives to exaggerate their earnings to present a higher growth rate to generate a more positive picture of their business, which subsequently leads to diminished weighted average capital costs. moreover, wang, jiang, liu and wang (2015) demonstrated that managers of listed firms consider that investors cannot identify earnings management through das; therefore, to generate a favourable image of businesses among investors, such as reduced capital cost, they are highly likely to attempt to adopt earnings management through da items, inducing eva to increase: h1: earnings management through da manipulation of earnings has a significantly positive relationship with eva. kim and sohn (2013) determined that cost per capita is positively associated with the extent of rem activities aimed at earnings manipulation. specifically, they argued that rem activities increase the cost of equity because of two major reasons. firstly, rem introduces noise into reported earnings because it affects accruals in addition to distorting the cash flow through real operation-manipulating activities. secondly, rem is more difficult to detect than accrual earnings management (aem) and rem activities are typically less subject to external monitoring or scrutiny. moreover, rem is more difficult to detect using internal monitors such as the board or audit committee. because rem might not be curtailed by effective governance mechanisms, external investors experience difficulty when evaluating firm performance. brown and higgins (2001) also observed that rem is positively associated with capital costs because rem distorts the fundamentals of a business. furthermore, it increases noise or errors in earnings and reduces investor expectations on future cash flow levels. therefore, managers of listed firms attempt to adopt earnings management through rem, which may increase the capital cost and then reduce eva: h2: earnings management through rem activity manipulation has a significantly negative relationship with eva. methodology the sample for this study was obtained from the compustat database between 2009 and 2013. this study also adopted the ordinary least squares (ols) method. the variables and model of this study are discussed in the subsequent sections. independent variables: earnings management discretionary accruals discretionary accruals has been used as a proxy for earnings management, where the absolute value of εit was adopted to measure where maccit denotes the total accruals calculated as the change in non-cash current assets minus the change in current liabilities minus the depreciation expense for year t, assetit-1 denotes the assets for year t−eno δnetrevit denotes the change in net revenue for year t and ppeit denotes the gross fixed assets for year t (wang et al. 2015). the absolute value of εit for equation 1 denotes the jones (1991) model for year t. where accit represents the total accruals calculated as the continuing operating net profit minus the cash flow from operations for year t, assetit-1 represents the assets for year t−ep δsalesit and represents the change in sales for year t, δarit represents the change in account receivables for year t and ppeit represents the gross fixed assets for year t. the absolute value of εit for the results of equation 2 denotes the modified jones model (dechow et al. 1995) for year t. where cacit is the change in income before extraordinary items minus operating cash flow minus depreciation and amortisation expenses, assetit-1 is the assets for year t−s δrevit is the change in the net revenue for year t and δrecit is the change in account receivables for year t. the absolute value of εit for equation 3 denotes the current accruals model (louis 2004) for year t. real earnings management roychowdhury (2006) developed empirical models for estimating the typical levels of real business activities, as reflected in the cash flow from operations, production costs and discretionary expenditures. we used models 5–7 to estimate the absolute value of εit to measure the abnormal level (namely, rem). where cfoit is the cash flow from operations for year t; prodit is the sum of the cost of goods for sale and change in inventory for year t; disexpit is the discretionary expenses according to the sum of advertising, r&d and sales, as well as general and administrative expenses for year t; tait-1 is the assets for year t−s t salesit is the sales for year t; δsalesit is the change in sales for year t; δsalesit-1 is the change in sales for year t−s the salesit-1 is the sales for year t−s t the absolute value of εit for equation 4 denotes the abnormal level of cash flow from operations for year t, the absolute value of εit for equation 5 denotes the abnormal level of production costs for year t and the absolute value of εit for equation 6 denotes the abnormal level of discretionary expenditures for year t. dependent variables: economic value added evait,1 (unadjusted eva): nopatit–(waccit×icit) nopatit = net operating profit after tax for year t= pretaxoiit × (1-ctrit) waccit = weight average capital cost for year t icit= invest capital for year t = assetit – apit – npit – aeit – perit – oapit – atpit – oclit – ssiit – cipit where pretaxoiit is pre-tax operating income for year t, ctrit is the cash tax rate for year t, assetit is the assets for year t, apit is the account payable for year t, npit is the notes payable for year t, aeit is the accrued expense for year t, perit is the pre-earned revenue for year t, oapit is the other account payable for year t, atpit is the account tax payable for year t, oclit is the other current liabilities for year t, ssiit is the short securities investment for year t and cipit is the construction in process for year t (huang & liu 2010; wang et al. 2015). evait,2 (adjusted eva, join adjusted items): nopatit–(waccit×icit) nopatit = net operating profit after tax for year t = pretaxoiit × (1-ctrit) + unardit + unameit + alarit + allinvit + allssiit waccit = weight average capital cost for year t icit = invest capital for year t = assetit–apit–npit–aeit–perit–oapit–atpit–oclit–ssiit–cipit+unardit+unameit+alarit+allinvit+allssiit where pretaxoiit is pre-tax operating income for year t, ctrit is the cash tax rate for year t, unardit is un-amortisation research and development expense3 for year t, unameit is un-amortisation marketing expense for year t,4 alarit is the allowance for account receivable for year t, allinvit is the allowance for loss on inventory for year t and allssiit is the allowance for loss on short-term investment securities for year t. assetit is the assets for year t, apit is the account payable for year t, npit is the notes payable for year t, aeit is the accrued expense for year t, perit is the pre-earned revenue for year t, oapit is the other account payable for year t, atpit is the account tax payable for year t, oclit is the other current liabilities for year t, ssiit is the short securities investment for year t and cipit is the construction in process for year t. evait,3 (adjusted eva, (join adjusted items and economic depreciation adjusted items): nopatit–(waccit×icit) nopatit = net operating profit after tax for year t = pretaxoiit × (1-ctrit) + unardit + unameit + alarit + allinvit + allssiit ± econdeprit waccit = weight average capital cost for year t icit = invest capital for year t = assetit – apit – npit – aeit – perit – oapit – atpit – oclit – ssiit – cipit + unardit + unameit + alarit + allinvit + allssiit where pretaxoiit is pre-tax operating income for year t, ctrit is the cash tax rate for year t, unardit is un-amortisation research and development expense for year t, unameit is un-amortisation marketing expense for year t, alarit is the allowance for account receivable for year t, allinvit is the allowance for loss on inventory for year t and allssiit is the allowance for loss on short-term investment securities for year t. econdeprit is the economic deprecation adjusted items for year t,5 assetit is the assets for year t, apit is the account payable for year t, npit is the notes payable for year t, aeit is the accrued expense for year t, perit is the pre-earned revenue for year t, oapit is the other account payable for year t, atpit is the account tax payable for year t, oclit is the other current liabilities for year t, ssiit is the short securities investment for year t and cipit is the construction in process for year t. in addition, weight average capital cost for year t: where ieit is the interest expense for year t, debtit is the liabilities for year t, assetit is the assets for year t, taxit is the tax rate for year t and equityit is the equity for year t. coeit is the cost of equity measured using the capital asset price model for year t through rf +β(rm–rf), rf is the risk-free fixed deposit interest rate in 1 year for year t, β is the risk coefficient for year t and rm is the return of market portfolio for year t (i.e. a section of the stock market index). control variables moradi et al. (2012) demonstrated that capital structure, profitability, firm size, firm growth and intangible assets have significantly effect on eva. we used debt ratio (i.e. capital structure), roe (i.e. profitability), sales (i.e. firm size), asset growth (i.e. firm growth) and intangible assets (i.e. firm innovation) to measure control variables. empirical model where dajoit denotes the jones model for year t (equation 1), damjit denotes the modified jones model for year t (equation 2), dacait denotes the current das for year t (equation 3), abcfoit denotes the abnormal level of cash flow from operations for year t (equation 4), abpcit denotes the abnormal level of production costs for year t (equation 5), abdeit denotes the abnormal level of discretionary expenditures for year t (equation 6), evait,n = 1,2,3 denotes the eva (n = 1 for unadjusted eva; n = 2 for adjusted eva, join adjusted items and n = 3 for adjusted eva, join adjusted items and economic deprecation adjusted items), debtit denotes a firm’s debt ratio for year t, roeit denotes the equity of average assets for year t, fsizeit denotes the sales for year t, growit denotes the asset growth rate for year t and intit denotes the intangible assets for year t. robustness test to avoid possible bias from extreme values, this study adopted the sample data of each variable from the 5th percentile to the 95th percentile (huang & liu 2011). results and analyses descriptive statistics the mean das in african and g20 nations are positive, indicating that nations use da items to manage earnings to increase their adjusted income (table 1) because a positive εit denotes income-increasing, performance-adjusted items (chen et al. 2011). overall, the das of the jones model are higher in african nations, whereas those of the modified jones model are higher in g20 nations. the mean of rem activities in african and g20 nations is also positive. the african and g20 nations thus adopt rem activities to manage earnings to increase their adjusted income. consequently, the difference in earnings management is manifested through das or rem activities in these nations.6 table 1: descriptive statistics: all samples (average value). according to the performance index (us$ billion), eva2 is higher and eva3 is lower in african nations, whereas eva1 is higher and eva3 is lower in g20 nations. the proportion of debt and equity return shows that financial conditions have been conservative in these nations since the 2008 global financial crisis. empirical test tables 2–7 showed that the discretionary accruals (das) of the jones model, modified jones model, discretionary current accruals of louis model and discretionary expenditures model of g20 and african countries. das (jones model) have a significantly positive relationship with eva1 and a non-significant relationship with eva2 and eva3 for all firms in african nations (table 8). these findings support hypothesis 1. compared with the da items, an abnormal level of discretionary expenditures has a non-significant relationship with eva. these findings do not support hypothesis 2. the absolute value of εit was obtained using the jones model, and the value indicated that african nations use da items to increase their income because the market structure or government policies (e.g. related rules or external monitoring) are not completely capital markets in these nations; therefore, investors cannot identify earnings management behaviour. outside investors may then consider that enterprises have generated a favourable image of businesses, such as higher performance, and may willingly provide more funds to enterprises or accept a lower return of funds (i.e. corporates acquire external funds easily or at cheaper rates), which subsequently, leads to a reduction in the weighted average cost of capital and an increase in eva. moreover, a high likelihood exists that managers in african nations attempt to adopt earnings manipulation through discretionary expenditures; however, this type of behaviour does not affect investors’ willingness to provide funds; therefore, capital cost and eva are unchanged. table 2: descriptive statistics of the estimated cross section of the jones model. table 3: descriptive statistics for the estimated cross section of the modified jones model. table 4: descriptive statistics for the estimated cross section of current discretionary accruals. table 5: descriptive statistics for the estimated cross section of abnormal cash flow from operations. table 6: descriptive statistics for the estimated cross section of abnormal production costs. table 7: descriptive statistics for the estimated cross section of abnormal discretionary expenses. table 8: regressions of earnings management with economic value added: africa. das (modified jones) have a significantly negative relationship with eva1 and a non-significant relationship with eva2 and eva3 in g20 nations (table 9). these findings do not support hypothesis 1. compared with the da items, an abnormal level of discretionary expenditures exhibit a significantly negative relationship with eva1 and a non-significant relationship with eva2 and eva3; these findings support hypothesis 2. compared with african nations, the market structure or government policies (e.g. related rules or external monitoring) are more completely capital markets in g20 nations; therefore, investors can identify earnings management. table 9: regressions of earnings management with economic value added: group of twenty (g20). furthermore, the absolute value of εit was obtained using the discretionary expenditures model, and this value indicated that g20 nations use discretionary expenditures to increase their income. investors may consider that the financial statements are false because earnings management has distorted the real performance; hence, investors may be unwilling to provide additional funds to the enterprise or accept a lower return of funds (i.e. corporates acquire external funds at higher rates), which subsequently leads to an increase in the weighted average cost of capital and reduction in eva. moreover, it is likely that the listed firms in g20 nations (most samples in nations are significant partners of the united states) were affected by the 2008 global financial crisis; since then, outside investors have focused more on the true value of enterprises. therefore, managers have attempted to adopt earnings management through da items or rem activities, which generates an unfavourable image of businesses. variance inflation factors can be calculated to explain the correlation of variables. therefore, a correlation problem did not exist in this study (variance inflation factors < 10).7 debt ratio has a significantly negative relationship with eva in the african and g20 nations, profitability (roe) has a significantly positive relationship with eva in the african and g20 nations, size (sales) has a significantly positive relationship with eva in the african nations, growth (asset growth rate) has a significantly positive relationship with eva in the african and g20 nations and intangible assets has a significantly positive relationship with eva in the african and g20 nations. these results are consistent with those reported by moradi et al. (2012). however, size (sales) has a non-significant relationship with eva in g20 nations. overall, earnings management (through da items or rem activities) has a significantly positive or negative relationship with eva in the african and g20 nations because of the 2008 global financial crisis. moreover, earnings management (through da items) has a significantly positive relationship with eva in the african nations because of the lack of government policies or immature market structures. consequently, earnings management (through da items or rem activities) has a significantly negative relationship with eva in the g20 nations because the market structure or government policies are completely the capital markets in these nations. conclusion several nations have incurred severe losses since the 2008 global financial crisis. managers attempting to adopt earnings management through da items or rem activities for generating a more unfavourable or favourable image of businesses and acquiring external funds at cheaper (easier) or more expensive rates may have affected business capital costs and eva. there is a lack of related literature on the association between earnings management and eva. the results indicate that a significantly positive relationship exists between earnings management through das and eva in african nations. we conclude that the enterprises operate in environments that lack government policy and have an immature market structure. comparing the aforementioned nations reveals a significantly positive relationship between earnings management through das and eva in african nations. on the basis of our analysis results, we conclude that a significantly negative relationship exists between earnings management through das or rem activities and eva in g20 nations. the enterprises in these nations were affected by the 2008 global financial crisis. managers in african nations should increase eva through earnings management; however, eva can be reduced in g20 nations through earnings management. the differences in national development, culture or the magnitude of losses possibly result from the financial tsunami in these nations. for researchers, our empirical findings show that rem activities and das are substitutes. investors can analyse the true value of enterprises. in addition, researchers may consider refining the measurements of earnings manipulation. governments must establish stricter security laws and rules for listed firms to prevent earnings management. future studies may consider establishing a theory for examining the relationship between earnings manipulation and eva. acknowledgements competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions z-j.l. was the project leader, y-s.w. performed some of the experiments. z-j-l. prepared the samples and calculations were performed by y-s.w. references 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https://doi.org/10.1108/cms-09-2013-0176 footnotes 1. we considered egypt, nigeria and south africa because these nations have the top three gross domestic products and largest stock exchanges (i.e. egyptian, nigerian and johannesburg stock exchanges) in africa. 2. we only selected argentina, japan, korea, russia and saudi arabia because these nations do not belong to other groups such as the nafta, asean, eu and newly industrialised country nations. 3. it is based on r&d expenses in each business, every year, and is used as a straight-line method for 5 years; thus, we can calculate un-amortisation in the next 5 years. 4. it is based on marketing expense in each business, every year, and is used as a straight-line method for 5 years; thus, we can calculate ‘un-amortisation’ in the next 5 years. 5. economic depreciation adjusted items are measured using the funds method because it is superior to all other methods. 6. all of the εit was measured using equations 1–6 and passed the t-test. 7. in order to shorten the tables, we omit the solution. abstract introduction data and methodology structure of the micro-simulation model validation of the micro-simulation model results tax reform – the impact of changes in the number of income tax brackets and threshold levels conclusion acknowledgements references footnote about the author(s) yolande jordaan department of economics, university of pretoria, south africa nicolaas j. schoeman department of economics, university of pretoria, south africa citation jordaan, y. & schoeman, n.j., 2018, ‘the benefit of aligning south africa’s personal income tax thresholds and brackets with that of its peers using a micro-simulation tax model’, south african journal of economic and management sciences 21(1), a1650. https://doi.org/10.4102/sajems.v21i1.1650 original research the benefit of aligning south africa’s personal income tax thresholds and brackets with that of its peers using a micro-simulation tax model yolande jordaan, nicolaas j. schoeman received: 18 aug. 2016; accepted: 26 july 2018; published: 30 oct. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: this article is based on a phd study in which a microsimulation (ms) tax model was constructed to measure the revenue and tax efficiency effects of adjustments to marginal tax rates on individual income. aim: the main aim with this analysis is to determine the advantages of adjustments to the thresholds and taxable income brackets in sa on revenue collected, tax efficiency, and progressivity as part of a broader tax reform effort. setting: currently such changes mainly consist of adjustments to tax brackets and thresholds to account for inflation, although since the 2017/2018 budget, such adjustments have been minimised as a result of the widening in the budget deficit. methods: the tax brackets and thresholds for the 2005/2006 fiscal year are used as a base from which changes are implemented. besides the base scenario, two other scenarios are simulated, based on that of south africa’s peers (lower levels). simulations are done with the ms tax model. results: the research shows that instead of only allowing for inflation adjustments, the alignment of income brackets and thresholds to levels closer to those of south africa’s peers could be beneficial with an improvement in the efficiency of the income tax regime. more individuals could be included into the tax net, albeit at (on average) lower tax scales resulting in a marginal loss in revenue. although such an adjustment could be interpreted as being more regressive and, therefore, negative from a ‘tax fairness’ perspective, the personal income tax (pit) burden expressed as the pit and gross domestic product (gdp) ratio would be slightly lower. conclusion: the possible result would be an improvement in tax liability and economic growth which could in turn fuel personal income and, therefore, revenue collected from this important tax source. this would compensate for the initial loss in pit. introduction according to keen (2012:10), personal income tax commonly accounts for less than 10% of all tax revenue in low-income countries – compared to an average of more than 25% in organisation for economic cooperation and development (oecd) countries. in south africa, personal income tax accounts for approximately 37% of total tax revenue (tax statistics 2017). theoretically, an important advantage of personal income tax is the use thereof to improve on ‘fairness’ in terms of progressivity of the tax. however, indications are that there has been limited success with the use of personal income tax in order to improve on progressiveness. keen (2012:10) ascribes the limited success to both political and technical failures. he points out that entrenched owner structures and corruption are powerful obstacles to taxing elites and many high income and/or wealth individuals. the problem is that there are many ways in which much of taxable income can be avoided and/or evaded. for example, by shifting income into a wealth portfolio with capital gains tax at a lower tax rate and many opportunities for rent-seeking and the concealment of income by placing it offshore. furthermore, administrative weaknesses and errors of design, contribute towards inefficiency regarding the collection of income tax due. typical problems encountered are thresholds that may have been set too low. this is especially the case in developing countries where the initial tax base relies on a very narrow set of taxpayers. in addition, tax schedules which determine the levels of progressivity and thereby the ‘fairness’ of the tax regime are adjusted without quantifying the actual impact thereof on progressivity with adjustments (in south africa for example) mainly based on inflationary trends. income tax practices also rely heavily on some form of self-assessment which is featured by many malpractices regarding the concealment of income. as a result, it is important that countries continuously assess the efficiency of their tax regimes in order to adjust and align accordingly to international trends in this regard within a very competitive tax environment. hence an attempt in this article to focus on one aspect of this problem, namely, threshold levels and optimal income tax schedules. a large literature exists regarding the role of tax schedules in tax reform programs. such schedules can be described by various measures, such as effective average tax rates that allow for comparing the total tax burden, effective marginal tax rates that are used in the design of optimal tax schedules and different progressivity measures which inform about the extent to which tax schedules are redistributive (roller & schmidheiny 2016). the basic rule seems to be that tax reform should be revenue neutral. the simple mantra is that the base must be expanded to become more economically neutral and that marginal tax rates must be lowered. in this research we attempt to measure the change in progressivity and efficiency in the south african tax regime by adjusting both the upper levels of income tax brackets and threshold levels in order to quantify the effect thereof on the efficiency and progressivity of the tax structure. we also measure the change in the income tax burden as a result of tax changes expressed as a ratio to gdp. a voluminous number of studies show a close relationship between taxable income and tax paid with taxpayers sensitive to taxes and willing to alter their taxable income in response to tax rate changes. for example, in a article by arnold et al. (2011), the authors indicate that for a sample of 21 oecd countries over the 1971–2004 period, tax revenue is significantly associated with per capita gdp (baiardi et al. 2017). as a result, tax rates have to be applied carefully within a very competitive tax environment (saez 2003). using elasticity coefficients to determine the response of taxpayers to rate adjustments also allows for the estimation of deadweight losses of income taxes. obviously, the channel along which taxable income responses occur, may affect the efficiency losses induced by income taxes (doerrenberg, peichl & siegloch 2015). however, in this study, such channel effects have been negated due to a lack of sufficient data. tax reform over the past 30 years in oecd countries has been featured by lower marginal tax rates and a reduction in the number of tax brackets. however, it is important not to compare different tax structures only by their marginal rates, but also to look at the threshold levels, as well as the number of tax brackets (oecd 2010:32). musgrave (1987:59) states that reforming the income tax structures for individuals starts by increasing the level of the tax threshold, creating horizontal equity (all individuals dealt with equally within similar economic conditions), and by reducing the number of tax brackets with lower marginal tax rates. according to tanzi: … setting up an efficient and fair tax system is, however, far from simple, particularly for developing countries that want to become integrated in the international economy. the ideal tax system in these countries should raise essential revenue without excessive government borrowing, and should do so without discouraging economic activity and without deviating too much from tax systems in other countries … (tanzi & zee 2001:1) empirical research by peter, buttrick and duncan (2010:457) links tax thresholds to gdp per capita (gdp/capita) ratios. for example, they use gdp/per capita ratios to compare different countries’ tax-free thresholds and their top taxable income brackets. they conclude that, in order to improve the equity of the tax system, the tax-free thresholds should be set equal to the gdp per capita or twice the gdp per capita in the case of developing countries where tax administration is less efficient. these findings are supported by saunders (2007) and the world bank (1991:2–6). peter et al. also states that the proxy for the highest taxable income brackets for high income, upper-middle income, and low-income countries should be 3, 18, and 83 times the gdp per capita, respectively. the authors conclude that the average number of tax brackets for upper-middle income countries should be set at 4–6 brackets, making the tax systems simpler to understand and administer. a tax-free threshold in excess of the gdp/per capita ratio increases progressivity, but should be considered with care (saunders 2007; world bank 1991:2–6). given the relevance of the gdp/per capita ratios regarding linkages to thresholds and marginal tax rates, it is interesting to compare such gdp/per capita ratios between countries at different levels of development and income. figure 1 illustrates the actual gdp/per capita values for lower and upper-middle income economies for the 2009/2010 fiscal year. for upper-middle income countries, the average gdp/per capita was us$5390. chile, an upper-middle income country, had the highest gdp/per capita ratio of almost $10 000. thus, if the tax-free threshold is set to equal the gdp/per capita, the brazilian and chilean tax systems seem to be more progressive than that of other countries in this category. figure 2 illustrates the gdp/per capita ratio of high income economies for the 2009/2010 financial year. the average gdp/per capita ratio for these countries amounted to $37 171, which was much higher than in developing countries. in new zealand, spain and the united kingdom gdp/per capita was less than the average gdp/per capita for high income countries with the result that the tax systems of these three countries seem to be less progressive than that of the other higher income countries. the figure also shows that the gdp/per capita ratios for the united states, ireland and australian tax systems were higher than the average gdp/per capita, therefore the tax systems seem to be more progressive. figure 1: gdp/per capita for lowerand upper-middle income countries, 2009/2010. figure 2: gdp/per capita for high income countries, 2009/2010. table 1 shows two indicators (expressed as a multiple of gdp/capita) for the tax-free threshold (personal income tax minimum level [pitminl]), as well as the highest income group where the top marginal tax rate is applied (personal income tax maximum level [pitmaxl]). as mentioned before, the benchmarks set for upper-middle income countries in the study by peter et.al. suggest levels of three times the gdp/per capita as a threshold and 18 times the gdp/per capita as the income level from where top marginal rates should be applied. the relevant numbers in table 1 show a mixed picture with most countries well below these benchmarks (especially at the upper level for top marginal rates). from the countries included in the table, india seems to be closest to the benchmark as far as threshold is concerned, while chile (12.08) is closest to the upper level benchmark. on average, the threshold level ratios for upper-middleincome countries amount to 1.30 with the upper level for top marginal rates at 3.91, respectively. it should be mentioned though that the averages also include upper-middleincome countries where a flat tax rate is applied (with no or very small thresholds) (united states agency for international development [usaid] 2010). table 1: lowest and highest level of income indicators for 2009/2010. furthermore, extreme variation in these indicators can be observed especially in the case of china with a ratio of only 0.27 as a threshold and 52.99 for the top marginal rate income level (pitminl). however, in china pit as a percentage of total tax income is relatively low compared to other oecd countries where pit is a major source of tax revenue. china also has relatively high marginal tax rates at the upper income tax brackets but also high tax rebates and fewer income tax brackets (brys et al. 2013:30). this article does not allow for a full outline of the evolvement of tax policy in south africa, safe to mention that tax policy in south africa has been affected by numerous amendments over the past number of years with the most prominent being the recommendations made by the franzsen commission (1970), the margo commission (1987), and the katz commission (1999). in 2013, the davis tax commission (n.d.) was appointed, ‘to assess our tax policy framework and its role in supporting the objectives of inclusive growth, employment, development and fiscal sustainability’. this commission is still in the process of making recommendations that informs tax policy in this country. a main feature of tax reforms thus far was the restructuring of the south african revenue service (sars) in order to improve on the collection of taxes and also the shift towards value-added tax in support of income tax. however, literature on tax policy adjustments and the quantification thereof is extremely limited and this research is unique, regarding the adjustment of thresholds and tax brackets in particular and should be helpful to the revenue authorities in determining future tax policies. since the country became a democracy in 1994, the tax system in south africa has gone through several tax reforms including adjustments to threshold levels and schedules. the katz commission (1999) recommended that the income brackets and threshold be adjusted to compensate for inflation and that the number of marginal rate brackets be reduced. thus, in an attempt to provide relief for inflation-related earnings increases (fiscal drag), all income brackets and thresholds have been adjusted continuously (south african reserve bank [sarb] 2017). table 2 shows the tax-free threshold and top income brackets as a multiple of gdp/per capita for south africa, from 2005/06 to 2010/11. on average, the ratio for the tax threshold level amounted to 1.06 with the top income bracket at 10.44, respectively. thus, the tax threshold level of south africa is more in line with that of upper middle-income countries (table 1) while the top income brackets are closer to that of lowerincome countries. table 2: tax-free threshold and top income bracket indicators. figure 3 illustrates the gdp/per capita and tax threshold levels for south africa from 2005/2006 to 2010/2011. throughout this period the differences between gdp/per capita and the tax threshold levels have been marginal, except for 2009/2010 when it reached about 10.4%, (sarb 2017; tax statistics 2017). figure 3: gdp/per capita and tax threshold. figure 4 shows the inflation rate, percentage change in the tax thresholds and top income brackets for the period 2007–2011. the gdp/per capita ratio between 2008/2009 and 2009/2010 increased by 5.7% and the tax-free threshold by 17.9% which exceeded the inflation rate of on average 6% during this period. as a result, more lower-income taxpayers were excluded from the tax base. national treasury’s explanation for this increase in the tax-free threshold is that it provided some fiscal stimulus with tax relieve to taxpayers in view of the onset of the global financial crisis. the percentage change in the top income brackets in 2006/07 and 2007/08 was 33.3 and 12.5 respectively, reflecting an adjustment rate that far exceeded the inflation rate. over the years income brackets have been reduced in number from 10 to 6. thus, it seems that thresholds have been too low compared to that of the county’s peers and the income tax brackets also not aligned to gdp/per capita levels as outlined, (tax statistics 2017). figure 4: inflation and percentage change in the tax threshold and top income bracket the layout of the rest of the article is as follows: section 2 explains the data base and methodology. in section 3 the structure of the micro-simulation (ms) model is outlined and in section 4 the model is validated. section 5 outlines the simulation exercises reflecting the impact of changes in the number of income tax brackets and threshold levels on revenue and tax efficiency. section 6 concludes with a summary of the findings and some policy recommendations. data and methodology ms models are mainly based on individual and household data, as is the case with the model structured in this article. in the case of south africa, the most representative survey is conducted by the central statistics income and expenditure survey (ies) but unfortunately the information shows a high level of versatility (statistics south africa [stats sa] 2008:1–2). income levels are calculated on an individual base with the profile of individuals explained by categorical variables, such as gender, age group, education level, population group and settlement. some of the categorical information is unspecified, but these values cannot be excluded from the dataset because the individuals are included in the weights of the survey and will affect the population total. to improve the data, the problem of unspecified values has been addressed through the imputation technique of peichl and schaefer (2009:3). the technique replaces unspecified values in each categorical group by the mean value of the specified values in the categorical groups. figure 5 reflects the general structure of the ms model used in section 3. figure 5: structure of a micro-simulation model. for the categorical variables in the ies survey containing unspecified data, a frequency table was obtained for each variable to determine the distribution of the unspecified values. when computing values for the unspecified categorical variables the frequency distribution of the original responses remained unchanged. this methodology is available in the sas program known as ranuni (uniform random number generator). briefly, the algorithm is as follows: in equation 1, ri is the ith random number, a is the multiplier and c the percentage increase. the ranuni function then generates a random number using a generator developed by lehmer (1951) from a uniform (0, m) distribution, and turns it into (0.1) by dividing by m. the number in parentheses is the seed/random number of the random number generator. if the seed is adjusted to a non-zero number, the same random numbers are being generated every time the program is activated (fan, felsovalyi & keenan 2002:26). furthermore, the ies and 2005/2006 sars filer data (tax statistics 2017) databases differ in terms of base years (calendar versus fiscal year); and to be able to compare, the ies data had to be adjusted to fiscal year 2005/2006 data using the calmar reweighting program (sautory 1993). this program recalculates the weights according to control totals, gender, race and age group to match the population totals produced by stats sa. the calmar method is also used by stats sa and the modellers of the euromod (immervoll & o’donoghue 2009:2) and samod (ntsongwana, wright & noble 2010:2) models. structure of the micro-simulation model income tax liability is affected by thresholds levels and the structure of income tax brackets. changes in tax liability are therefore determined by changes in such structures, as well as in personal income. in our model we attempt to quantify such changes by simply making pit a function of different levels of taxable income (equation 2) given the tax structure in that particular financial year. however, in the case of taxable income data not being freely available a rough calculation is made by using national income as reflected in the gdp of the country. thus, the elasticity (εt,tby) of tax liability (t) to taxable income (tby) is estimated. if the elasticity of tax liability is greater than unity, the tax system is progressive (marginal tax rates increase with taxable income). thus, tax liability is positively correlated with taxable income (girouard & andré 2005:7). the function used to estimate pit is expressed in logarithmic form: girouard and andré (2005:7) compares tax elasticities for various countries. the authors estimate the average elasticity coefficient for tax revenue relative to taxable income for 28 oecd countries to be between 1.5 and 2.0 (thus, relatively elastic). a coefficient in excess of 1 indicates a progressive tax. as mentioned earlier another progressivity measurement is the gdp/per capita multiple of the top income bracket. if the multiple of the top income bracket increases, then progressivity decreases. higher income brackets cause more taxpayers to fall into lower-income groups and as a result their tax burden declines (steenekamp 2012b:45). these progressivity measurements are applied in tax reform scenarios, to estimate and compare the progressivity of taxes. the elasticity of taxable income is then used as an indicator of tax efficiency changes as reflected in changes in deadweight loss. however, this article does not allow for an elaborate explanation of the elasticities and the deadweight loss methodology, used in this research, safe to mention that the elasticities are used to determine the progressiveness of the pit structure and the deadweight loss (tax efficiency) of the tax structure. in the case of measuring deadweight loss the consumer surplus approach is used. the elasticity coefficient, therefore, varies between different income levels, showing the progressivity of the tax structure and the efficiency of tax reform as measured by deadweight loss (girouard & andré 2005:7). the elasticity coefficient for south africa amounts to 0.38 for the lowest-income group and increases to 0.79 for the highest income group. these elasticities are within the range of other empirical studies. validation of the micro-simulation model results after simulating tax liability with the ms model, the results are compared to published sars data, ies, and the bureau of market research of the university of south africa to validate the model. table 3 shows that the ms model’s tax liability of r132 billion exceeds the sars assessed tax liability of r111 billion (the actual amount collected was r125 billion). this is plausible since the ms model accounts for the whole of the south african population and not only for assessed taxpayers. the results for gross income and tax liability are very similar to those of the bureau of market research bundles (2000:17). it should be noted, though, that the ms model only calculates tax liability, which differs from the actual amount collected due to advanced and lagged payments table 3: comparison of income and expenditure survey, micro-simulation model and south african revenue service for the survey year 2005/2006. table 4 shows a summary of the number of taxpayers, taxable income, and tax liability by taxable income group, comparing sars data and the ms model. a large number of taxpayers (almost 50% of total taxpayers) fall within the lower income group (less than r80 000). the income groups (less than r130 000) in total earn 40% of taxable income and pay 19% of total tax liability. the highest income group, above r300 000, earns 29% of taxable income and contributes 48% of total tax liability. tax liability is highly skewed to the higher income groups, indicating sensitivity to policy changes. the income group r180 000 to r230 000 comprises only 5% of total taxpayers, but earns 9% of taxable income and pays 9% of total tax liability. table 4: comparison of micro-simulation model and south african revenue service data by taxable income group. it is evident from table 4 that the number of taxpayers, taxable income, and tax assessed per taxable income group (excluding standard income on employees tax (site) individuals) in the two different databases are close to each other, indicating that the adjusted ies data is sufficient for use in the ms model. the data shows that the survey income data seems to be biased towards the lower income groups, with their taxable income 8% more than in the sars data. in the case of the other income groups, the difference in taxable income between the two datasets only varies between 1 and 5%. the ms model results shows that almost half of the population has unspecified gross income, while approximately 19 million fall under the tax threshold of r35 000. about 1.8 million individuals earn income between r35 000 and r60 000. those earning less than r60 000 only qualified for site, and were not liable to file a tax return. tax reform – the impact of changes in the number of income tax brackets and threshold levels as mentioned before, the main objective with this analysis is to determine the impact of adjustments to the thresholds and taxable income brackets on revenue, tax efficiency and progressivity (equity and fairness). the tax brackets and thresholds for the 2005/2006 fiscal year are used as a base from which changes are implemented. besides the base scenario, two other scenarios are simulated: one where the income tax brackets and thresholds are only adjusted with the inflation rate from the 1998/1999 levels, and a second where income tax brackets and thresholds are adjusted to the gdp/per capita levels as discussed and which are based on that of south africa’s peers (lower levels). the different scenarios for the adjustment in tax brackets and the thresholds per taxable income group can be seen in table 5. the scenarios are as follows: table 5: income brackets and thresholds of different scenarios. scenario a (tax liability as a base scenario): the base year is 2005/2006, and the marginal tax rates are between 18% and 40%, as recorded in the official tax tables during that period. the lowest and highest income brackets are r80 000 and r300 000, respectively. in scenario b: the impact of tax reform on individual tax liability over the period 1998/1999 to 2005/2006 is measured by changing the parameters underlying the tax structure (rebates and threshold levels). again, the 1998/1999 figures have been used due to the fact that the tax brackets in that year had been reduced from 10 to 6. it is assumed that between the 1999 and 2006 fiscal years, fiscal policy has remained unchanged other than adjustments for bracket creep. in order to do this, the six income brackets and the thresholds in the 1998/1999 tax structure have been adjusted only by the inflation rate. thus, this scenario shows what the rebates and thresholds and therefore revenue would have been in 2005/2006, had the tax structures only been adjusted for inflation based on the 1998/1999 levels. finally, scenario c reflects the potential revenue change if the threshold and income brackets had been adjusted to levels on par with that of south africa’s peers. the threshold for taxpayers below the age of 65 years is set to equal the gdp/per capita1 (r33 787) in 2005/2006. the lowest income bracket is double the gdp/per capita, and the highest income bracket is 18 times the gdp/per capita ratio. the rest of the income brackets are evenly distributed, with the marginal tax rates equal to those of the 2005/2006 tax structure. table 6 reflects the results of changes in the income tax brackets and threshold levels, compared to the base model. in scenario a the total deadweight loss amounts to r38.8 billion, with total tax liability at r132.8 billion. scenario b, applying the inflation-adjusted tax codes for 1998/1999 to the taxable income of 2005/2006, shows an estimated tax liability of r152 billion, which is 15% more than in scenario a. the deadweight loss increases to r48.6 billion (25% more than in scenario a), thus lowering the efficiency of the tax system as a result of the lowering in the levels of the tax brackets in scenario b. more individuals are included (363 057) because of the lower threshold; and more individuals fall within the higher income groups, with tax elasticity measuring an increase in the deadweight loss. thus, by adjusting the tax brackets and threshold levels only by the full amount of inflation rates, tax liability would have increased but at the cost of a loss in tax efficiency and proportionality as reflected in the increase in deadweight loss. in scenario c, with tax brackets structured substantially more proportional, tax liability decreases to r128 billion, but the deadweight loss now only amounts to r28.5 billion, which is, respectively, 4% and 26% less than in the base scenario. thus, by adjusting the tax brackets and threshold levels to margins comparable with that of south africa’s peers both tax liability and tax progressivity would decrease. table 6: income brackets, number of taxpayers, tax, and deadweight loss. the impact of the three scenarios of tax policy adjustments on elasticities and, therefore, on progressivity is outlined in table 7. tax elasticity for the base scenario amounts to 1.35, and increases to 1.38 with inflation-adjusted tax brackets, but then decreases again to 1.36 when income tax brackets are adjusted to those of south africa’s peers. thus, both scenarios b and c are slightly more progressive than the base scenario. progressivity is also measured by quantifying the gdp/per capita multiple of the highest income bracket. in scenario a the highest taxable income bracket is 8.9 times the gdp/capita, and it decreases to 3.6 in scenario b with inflation-adjusted income brackets. in scenario c the highest taxable income bracket is adjusted to that of south africa’s peers, which is 18 times the gdp/per capita. therefore, progressivity increases from scenario a to b, but decreases in scenario c mainly because of smaller differences between the higher and lower income brackets and many more taxpayers falling within the lower income brackets. table 7: elasticities. as indicated previously, literature suggests a close relationship between income tax and gdp and although this relationship has not been tested in this research, jordaan and schoeman (2015) indicate that for economic growth to be optimal the pit/gdp ratio should not exceed the 6.7% level. based on this margin for optimal growth (although not the central objective with this research) it is therefore also interesting to measure the outcome of the different tax scenarios on this ratio for optimal growth. in scenarios a and b the pit/gdp ratios amount to 8.2 and 9.5%, respectively, which are higher than the optimal pit/gdp ratio of 6.7%. with threshold and income brackets adjusted to levels equal to those of south africa’s peers (scenario c), the pit/gdp ratio is 8% – the lowest in all three scenarios and closer to the optimal ratio. conclusion tax reform has received substantial attention in the international literature, as well as in south africa, outlined in the various reports referred to. given the budget challenges to the treasury in this country, sustainable fiscal policy is only possible through a continuous process of tax reforms. such reforms should not only address the broadening of the tax base by adding more taxable sources and the adjustment of tax rates. there should also be reforms involving the most important source of income, namely income tax, the proper adjustment of income tax schedules and threshold levels in order to reduce the excessive tax burden and improve on efficiency and progressivity. compared to a scenario with only inflation-adjusted taxable income brackets the adjustment of income brackets and tax-free thresholds to levels similar to those of south africa’s peers shows marginally lower revenue (decrease by 3.5%) but an improvement in efficiency (35% improvement). the broadening of the tax brackets as suggested in scenario c results in an increase in the number of individuals in the lower taxable income group compared to the base scenario. the increased margins for those in the highest income bracket reduces the number of individuals in that group thereby reducing progressiveness somewhat but the efficiency of the tax structure improves substantially together with a pit/gdp ratio closer to the optimal ratio for the enhancement of economic growth. albeit at a lower ratio, the suggested adjustments to the tax structures still portray progressiveness with elasticity coefficients in excess of unity but with more potential taxpayers included into the tax net with the average tax ratio at a lower level. although total tax liability is reduced which would result in some revenue loss, the research suggests that such revenue losses would be compensated for by an improvement in economic activity with increased income levels that in turn would fuel the income base from which income tax is levied. future research in this field of study should expand the ms model to become a dynamic model that also captures features such as population ageing and other demographic changes. the model should then be even more useful in simulating the impact of important policy changes such as health care and retirement incentives. this study is limited to individual income tax, using income data from the stats sa ies. however, the same database also contains rich data on household expenditures, and so the model could be expanded to include an analysis of the impact of taxes not only on disposable income but also on expenditure patterns. given the structure of an ms tax model, such changes in expenditure patterns as a result of changes in tax policy could be very helpful in determining not only the efficiency but also the fairness of such tax initiatives, given the skewness of income and the resultant tax liability. another shortcoming of the static ms model used in this analysis is that it is not linked to a macro model that could also estimate the impact of changes in disposable income and tax liability on consumption and saving, and eventually on the full circle throughout the economy, with changes in the income base. for example, linking this model to a computable general equilibrium (cge) model would allow for a better calibration between the parameters of both models, and thus for a more accurate measurement of the effects of fiscal policy reforms. finally, the ms model used in this research is based on 2005/2006 ies data. however, data for the 2010/2011 fiscal year has just been released and another more recent benchmark would be helpful in judging the quality of the research outcomes. this means that the model would have to be re-calculated to accommodate structural changes since the 2005/2006 base year. acknowledgements competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions y.j. did the analysis, calculations and writing of article. n.j.s. contributed to corrections, making the article clearer and more focused, and wrote the abstract and conclusion. references arnold, j.m., brys, b., heady, c., johansson, a., schwellnus, c. & vartia, l., 2011, ‘tax policy for economic recovery and growth’, the economic journal 121(550), 59–80. https://doi.org/10.1111/j.1468-0297.2010.02415.x baiardi, d., profeta, p., puglisi, r. & scabrosetti, r., 2017, tax policy and economic growth: does it really matter? cesifo working paper no. 6343, category 6: fiscal policy, macroeconomics and growth, center for economic studies and ifo institute (cesifo), munich. brys, b., matthews, s., herd, r. & wang, x., 2013, tax policy and tax reform in the people’s republic of china, oecd taxation working papers, no. 18, oecd publishing, paris. bureau of market research bundles, 2000, personal disposable income in south africa by population group, income group and district, research report no 279, university of south africa, bureau of market research, 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findings and concluding remarks acknowledgements references appendix 1 footnotes about the author(s) marianne matthee school of economics, north-west university, south africa maria santana-gallego department of applied economics, university of the balearic islands, spain citation matthee, m. & santana-gallego, m., 2017, ‘identifying the determinants of south africa’s extensive and intensive trade margins: a gravity model approach’, south african journal of economic and management sciences 20(1), a1554. https://doi.org/10.4102/sajems.v20i1.1554 original research identifying the determinants of south africa’s extensive and intensive trade margins: a gravity model approach marianne matthee, maria santana-gallego received: 04 mar. 2016; accepted: 10 jan. 2017; published: 24 mar. 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the significance of the paper is twofold. firstly, it adds to the small but growing body of literature focusing on the decomposition of south africa’s export growth. secondly, it identifies the determinants of the intensive and extensive margins of south africa’s exports – a topic that (as far as the authors are concerned) has not been explored before. aim: this paper aims to investigate a wide range of market access determinants that affect south africa’s export growth along the intensive and extensive margins. setting: export diversification has been identified as one of the critical pillars of south africa’s much-hoped-for economic revival. although recent years have seen the country’s export product mix evolving, there is still insufficient diversification into new markets with high value-added products. this is putting a damper on export performance as a whole and, in turn, hindering south africa’s economic growth. methods: a heckman selection gravity model is applied using highly disaggregated data. the first stage of the process revealed the factors affecting the probability of south africa exporting to a particular destination (extensive margin). the second stage, which modelled trade flows, revealed the variables that affect export volumes (intensive margin). results: the results showed that south africa’s export product mix is relatively varied, but the number of export markets is limited. in terms of the extensive margin (or the probability of exporting), economic variables such as the importing country’s gdp and population have a positive impact on firms’ decision to export. other factors affecting the extensive margin are distance to the market (negative impact), cultural or language fit (positive impact), presence of a south african embassy abroad (positive impact), existing free trade agreement with southern african development community (positive impact) and trade regulations and costs (negative impact). in terms of the intensive margin (or the factors influencing the volume of exports), there are strong parallels with the extensive margin, with the exception being that the time involved in exporting has more of an impact than documentary requirements. conclusion: among the factors contributing to south africa’s exports having largely developed in the intensive margin are a general lack of market-related information, infrastructural weaknesses (both of a physical and technological nature) and a difficult regulatory environment – all of which add to the cost and time involved in exporting. policymakers have long spoken about the need for the country to diversify its export basket, but now talk about needs to give way to action. the government and its economic partners need to arrive at a common vision of an export sector that will be able to expand into new products and markets, be an active participant in global value chains and deliver sustainable jobs. introduction since the first democratic elections were held in 1994, the south african government has been intent on boosting employment in the country by encouraging higher and more inclusive economic growth. industrialisation and export diversification have been part and parcel of this goal (viviers et al. 2014). the department of trade and industry (dti) (2013:16) states: … the growth and diversification of south african exports has been weak, with over half of all exports derived from the mining value chain. in order to stabilise growth it is important to diversify exports, including into higher value-added activities, and to improve overall competitiveness. the world bank (2014), in its analysis of south africa’s export competitiveness, states that it may be difficult for the country to revitalise its export sector. firstly, south african exports have been underperforming, especially compared with its emerging market peers. secondly, while the composition of south africa’s exports is changing, there is insufficient diversification into new and higher value products. indeed, matthee, idsardi and krugell (2016) reveal that since 1994, the highest export growth has been in non-fuel primary commodities (38%), while medium-skill, technology-intensive manufactures have grown by 22%. resource-intensive manufactures have shown a serious decline in exports (around 50%). furthermore, the bulk of south africa’s export growth (more than 70%) has been in the intensive margin (i.e. exports to existing trade partners) and the remainder in the extensive margin (i.e. diversification in terms of exporting firms, products or destinations) (bezuidenhout et al. 2015; matthee et al. 2016). the above scenario is the result of both broad structural problems in the south african economy and largely uncontrollable global influences, such as the continuous decline in commodity prices in recent years and waning demand in traditional markets. in addition, various market access barriers, including the distance to export markets and high transport costs, have conspired to erode south africa’s export competitiveness and weakened the country’s export growth potential (steenkamp, grater & viviers. 2015). this paper aims to investigate a wide range of market access determinants that affect south africa’s export growth. the significance of the paper is twofold. firstly, it adds to the small but growing body of literature focusing on the decomposition of south africa’s export growth. secondly, it identifies the determinants of the intensive and extensive margins of south africa’s exports – a topic that (as far as the authors are concerned) has not been explored before. the study’s empirical framework is derived from the influential melitz (2003) model, which is based on assumptions of firm heterogeneity in productivity and fixed costs when trade margins are analysed. more productive firms self-select into export destination markets (i.e. the extensive margin). in this regard, as firms exhibit heterogeneity in their productivity, only the more productive ones are able to generate sufficient operating profits in a destination market to cover the associated fixed costs and serve the market through exports (see also chaney 2008; crozet & koenig 2010; helpman, melitz & rubenstein 2008). chaney (2008) states that a decrease in the fixed bilateral costs of trade (e.g. start-up costs) would positively affect the extensive margin (number of firms), while a decrease in the variable trade costs (e.g. transport costs) would increase both the extensive and intensive margins. this paper uses the gravity model to analyse the pattern of south african exports at the product-level. detailed product-level data are used to determine the impact of trade costs and barriers on the number of firms exporting to different markets and the volume of exports to each market. to this end, the product-level data are decomposed per industry, and the impact of different aspects relating to market access (i.e. market capacity, trade facilitation and trade barriers) are assessed in terms of the authors’ gravity model definition. this specification is estimated using the two-stage sample selection procedure proposed by heckman (1979). the rest of the paper is structured as follows: the next section discusses a brief literature overview. the ‘empirical specification’ section presents the data and methodology used in the study. the ‘extensive and intensive margins of south african exports’ section summarises the results of the empirical analysis and the ‘summary of key findings and concluding remarks’ section summarises the key findings and provides some concluding remarks. brief literature overview the heterogeneous nature and performance of firms has become a key focus area in international trade research (melitz & redding 2012). according to chaney (2008), firms are heterogeneous in their productivity levels. moreover, when firms decide to export, they face both fixed and variable costs. given that there is a threshold productivity level below which zero profits are yielded, only the more productive firms will find it profitable to export. on the one hand, a reduction in variable trade costs will affect both the intensive and extensive margins positively, because the threshold productivity level will drop and both the volume of export of existing exporting firms and the number of new exporting firms will increase. on the other hand, a reduction in fixed trade costs will not affect the intensive margin (the existing exporters have already paid this cost), but will induce new firms to enter the export field. in other words, it will have a positive effect on the extensive margin. consequently, zero trade flows result from the impossibility of overcoming fixed costs that are necessary to establish trade. the melitz (2003) model makes it possible to endogenously calculate the number of firms that decide to export, which has created a new way of decomposing the observed trade flows into the extensive margin of trade (the number of exporting firms) and the intensive margin of trade (the volume of trade per exporter). this decomposition offers a coherent explanation for why only the most productive firms are involved in international trade. because the study considers product-level exports to importing countries, zero trade flows arise when no firms in south africa are productive enough to export to a particular destination. a gravity model approach is used in the empirical analysis presented in this paper. the gravity model has been used in a plethora of empirical studies involving trade margins (see, e.g. amurgo-pacheco & pierola 2008; crozet & koenig 2010; felbermayr & kohler 2006; to name a few). these studies have used different adaptations of the model, estimators and focus points. for example, lawless (2010) focuses on trade costs, debaere and mostashari (2010) on tariffs, dutt, mihov and van zandt (2011) on the world trade organization, baier, bergstrand and feng (2013) on economic integration agreements and johannsen and martínez-zarzoso (2014) on international arms transfers. of more relevance to this particular study, greenaway, gullstrand and kneller (2009) apply a heckman sample selection gravity model to control for possible self-selection into exporting using firm-level data on the swedish food and beverage sector. crozet and koenig (2010), in turn, examine the impact of distance on the probability of exporting and on export levels, using french manufacturing firm-level data. belenkiy (2010) applies the two-stage heckman procedure to estimate determinants of the extensive margin of exports from organisation for economic cooperation and development (oecd) countries to non-oecd countries and portugal-perez and wilson (2012) apply it in terms of export performance of developing countries. finally, christen, wolfmayr and pfaffermayr (2013) examine the determinants of service exports in austria at the firm/destination country-level using a heckman sample selection gravity model. finally, there are a few papers that have studied the determinants of african trade using a gravity model. however, none of them has explored the role of extensive and intensive trade margins. eita (2008) analyses the determinants of namibian exports using a gravity model framework. similarly, jordaan and eita (2011) investigate the determinants of south africa’s exports of wood and articles of wood using a gravity model approach. the results of the latter analysis suggest that there is unexploited trade potential among some of south africa’s trading partners such as canada, the united states, comoros, germany, greece, italy, ireland, new zealand, russia and tanzania. márquez-ramos (2007) explores the determinants of trade for south africa and ghana, respectively, using disaggregated data by sector. the author asserts that technological innovation and geographical and social factors play a key role in south africa’s trading relationships with other countries. empirical specification data this paper uses south african exports disaggregated by product in 2012, with the data sourced from the united nations’ comtrade database. this database provides export data from a particular exporting country to an importing country disaggregated by product up to harmonised system 6-digit level (hs6). export data are classified per hs cluster, similar to the approach in smet (2007). the groupings of hs6-level products are listed in table 1. table 1: varieties of products exported by industry (2012). table 1 presents the range of products that south africa exported in 2012, classified by industry and export value. it can be observed that south africa exports more than 95% of the 5039 products classified in chapters foodstuff and plastics and rubbers and exports less than 78% of mineral products and raw hides, skins, leather and furs. although south africa exports a wide variety (around 87%) of products according to the hs6 classification, the value of many of the products in the export mix is very low. indeed, only 53.7% of the products exported are valued at more than us$100 000, while only 24.8% of products are valued at more than us$1 000 000. table 2 presents the percentage of positive export flows by product category. given a total of 196 importing countries and 5039 products (987 644 possible export flows), south africa delivers only 93 592 positive export flows (9.5%). table 2: percentage of non-zero export flows by industry (2012). detailed results of export flows in terms of products and destinations show that other african countries such as zimbabwe, zambia, mozambique and the democratic republic of congo are the recipients of more than 67% of south africa’s exports, while countries such as yemen, puerto rico, sudan and palau are not among south africa’s export destinations.1 indeed, south africa exports more than 20% of the product categories to only 27 out of 196 countries and less than 5% of the product categories to 111 importing countries – pointing to a varied export product mix but a concentrated collection of export destinations.2 clearly, there is potential for south africa to expand the number of export markets. to this end, the determinants of south africa’s extensive margin should be identified. methodology the gravity model has been the empirical approach to analysing the determinants of bilateral trade flows. the basic form of this model assumes that trade between countries can be equated to the gravitational pull between two objects because it is directly related to countries’ size and inversely related to the distance between them. similar to the approach in greenaway et al. (2009) and christen et al. (2013), the empirical model in this paper is derived from the seminal paper of helpman et al. (2008) whose model is based on the premise that firms are heterogeneous (as theorised by melitz 2003), without using firm-level data. the gravity model is estimated with a two-stage sample selection model using the estimation procedure proposed by heckman (1979). for implementation purposes, two different equations are defined. the first equation (selection equation) addresses the zeros directly by modelling trade participation. this equation provides the variables that affect the extensive margin of trade, that is, factors that affect the probability that south africa will export a product to a particular country. the second equation (outcome equation) models trade flows conditional on participation. this equation is specified as a traditional gravity model and explores the variables that affect the intensive margin of trade, that is, volume of export of a product to a particular country. moreover, the heckman procedure requires an identification variable that influences the probability of exporting, but not the volume, to comply with the exclusion restriction. in line with helpman et al. (2008) and supported by martin and pham (2008), an independent variable associated with the fixed trade costs of establishing trade flows (such as country-level data on regulations for establishing a new firm) was omitted from the outcome equation.3 specifically included, though, were the cost (as a % of countries’ gdp per capita), the number of documents and the time required to establish a new firm. the first stage in the model consists of a probit regression which explains the probability that south africa will export to country i (selection equation), where the dependent variable is a dummy that is equal to 1 if south africa exports to country i. a latent variable is defined to declare that south africa is exporting () or not () a particular importing country i. the second stage consists of a gravity equation estimated in logarithmic form, which explains the volume of exports from south africa to i (outcome equation) and incorporates a term based on estimates of the first stage, the inverse mills ratio (imr), to correct for the non-random prevalence of zero trade flows. in this second stage, the dependent variable is lnexpi, – that is, the logarithm of the volume of exports from south africa to an importing country i. the database used in the study covers 196 importing countries in the year 2012.4 the selection (eqn 1) and the outcome (eqn 2) equations are as follows: where wi is a set of explanatory variables of the outcome equation with its corresponding parameters γ ′ while zi are the explanatory variables included in the selection equation with the corresponding set of parameters β ′. included in vector zi are both the explanatory variables in wi plus an exclusion restriction that affects only the fixed costs of exporting, not the variable trade costs – that is, a variable that determines the probability of exporting to a particular destination but not the volume of exports. as in previous studies, this study uses (as an exclusion restriction) a variable relating to firm entry cost in the importing country.5 finally, εi and ηi are independent and identically distributed disturbance terms in the selection and outcome equations, respectively. the error terms have a bivariate normal distribution with zero means, standard deviation σε and ση and correlation ρ. for exporting firms, the conditional expectation of the volume of exports can be derived as follows: where λ(β`zi) is the imr. by including λ in the outcome equation, there is control for sample selection bias. in particular, the proposed two-stage heckman procedure adjusts the second stage of the regression for sample selection bias by incorporating the imr to the gravity equation. table 3 presents a summary of the variables included in the analysis. the explanatory variables have been classified into eight categories: (1) economic variables, which include importing country real gdp per capita and population to control for the extent of demand in the country; (2) geographical variables, which affect trade costs such as the distance between south africa and the importing country, whether the importing country shares a common land border with south africa and whether it is an island or landlocked; (3) cultural variables, which are used as a proxy for the cultural affinity between south africa and the importing country. as the three main official languages in south africa are zulu, afrikaans and english but the first two are largely only spoken within the country, the common language dummy variable considers countries where english is one of the official languages. moreover, sharing a colonial background (i.e. with namibia, the netherlands and the united kingdom) and a religion similarity index are included6; (4) political variables, which consider an instability index in the importing country. this variable reflects perceptions about the likelihood of political instability and/or politically motivated violence, including terrorism, in the importing country. the existence of a south african embassy in the importing country, which could help facilitate new trade relationships and provide support to existing exporters, is also considered; (5) regional trade agreements (rtas), which control for existing trade agreements to which south africa is a party; (6) trade regulations, which influence the time and cost involved in moving a standard consignment of goods by sea from south africa through the port of an importing country, and the number of documents needed to effect the transaction. because the impact of the explanatory variables on south african trade margins is being estimated, it is not possible to add country-pair or importing country fixed effects to the equation because all explanatory variables are importing country-specific, so they would be absorbed by these fixed effects. an alternative is used, that is, (7) regions, which denote various regions’ fixed effects, using the united nations’ classification and with east europe as the excluded category. table 3: variable definitions and sources. finally, the heckman procedure depends on a prior assumption of the validity of the exclusion restriction which is included in wi ut not in zi. as with helpman et al. (2008) or portugal-perez and wilson (2012), fixed regulation costs of firm entry are used (in the importing country), which should not affect a firm’s export volumes and, furthermore, satisfies the exclusion restrictions of the two-stage heckman estimation method because it is excluded from the outcome equation in the second stage. thus, a final category is included, called (8) entry costs, which are considered in the selection equation only. entry costs are measured by their effect on the number of days, the number of legal procedures and the relative cost (as a percentage of gdp per capita) involved in an entrepreneur legally starting up a business. cost is defined as a binary indicator that equals 1 if the relative cost of starting a new business is greater than the median for the importing country i, 0 otherwise. days and documents is defined as a binary indicator that equals 1 if the sum of the number of days and procedures needed to start a business is greater than the median for the importing country i, 0 otherwise. the results of the empirical analysis are presented according to this disaggregation. the heckman procedure used in this paper, as in helpman et al. (2008), presents the main limitation that is estimated for a cross-section. consequently, time variation is not addressed, which may yield interesting results in terms of evaluating different trade policies such as reducing regulations or signing new trade agreements. martinez-zarzoso, vidovic and voicu (2014) adapt the helpman et al. (2008) procedure to a panel data framework, and this can be considered as an extension for further research. extensive and intensive margins of south african exports as mentioned in an earlier section, products are classified by hs cluster, giving rise to 15 different sectors. given a total of 987 644 country-pair observations (3059 products × 196 countries), 93 592 of these present positive export flows (9.5% of the sample). although south africa exports around 87% of the products, these are concentrated in just a few countries that vary depending on the type of product exported. so, a challenge for south africa is to increase the number of export destination countries. as a starting point, the heckman procedure is applied to estimate export flows from south africa disaggregated by industry. the model is estimated by maximum likelihood, and robust standard errors are computed. tables 4 and 4 bis show the results of the estimate from the first stage (selection equation) of the heckman procedure for all sectors pooled to the sample and the results disaggregated by sector. marginal effects are reported. in general, the sign and significance of the coefficients are as expected. the economic variables that affect the extent of demand, namely gdp per capita and population, show a positive impact on the probability of exporting for all industries. indeed, for all industries, a 1% increase in gdp per capita or population in the importing country would increase the probability of exporting to that country by 0.034% and 0.038%. in terms of geographical variables, the distance variable (suggesting higher transport costs) presents the expected negative sign. however, for some industries, distance either has no impact or even has a positive impact, such as plastics and rubbers or textiles. this result can be explained by the fact that the main trading partners for these products (such as china and the united states) are located far from south africa. moreover, when it comes to regional variables, the fact that the importing country is an island has a positive impact in some sectors, but if it is a landlocked country, there is the expected negative impact on the extensive margin. south africa uses sea transport extensively for export purposes, so if an importing country has no port, the probability of south africa exporting to that country is greatly reduced. table 4: extensive margins of trade (selection equation). in terms of cultural variables, cultural proximity (expressed in terms of language and religion) has, for almost all sectors, a positive impact on the extensive margin. however, having a shared colonial history has no impact or even a negative impact on the probability of south africa exporting goods from a range of sectors. when it comes to political variables, political stability in an importing country has a negative effect on the probability of exporting to that country. such results can be somewhat controversial because they imply that south africa is more likely to export to countries that are perceived to present a lower likelihood of political instability and/or politically motivated violence. however, on closer inspection of the data, it is evident that some of south africa’s main trading partners are in fact countries that have political instability episodes, including china, india, zambia, zimbabwe and mozambique. an analysis of the impact of rtas on the extensive margin of south african exports yields interesting results. only the sadc free trade agreement has had a significant and positive impact on the probability of south africa exporting to other sadc members. this is not surprising, given their close proximity. trade agreements with the eu and efta, in contrast, have not had a positive effect on the extensive margin. considering that the excluded category is east europe, countries located in asia and oceania show a higher probability of importing from south africa. trade regulation variables generally have a negative impact on the probability of exporting. the more time-consuming and costly it is to export, the more difficult it is for local companies to be competitive and to access international markets. the time it takes to export is a decidedly negative factor for almost all industries, yet documentary requirements are not a significant obstacle for many industries. moreover, it can be observed how the exclusion restriction in terms of time and documentation has the expected extremely negative impact on export-extensive margins in almost all industries. a trade facilitation drive aimed at shortening the time to export and reducing the documentary burden would generate new trading partners for south africa. the estimation results for the second stage, the outcome equation, are presented in tables 5 and 5 bis. the significant correlation (ρ) highlights that the selection of firms for export purposes is systematic and needs to be considered in the econometric specification to consistently estimate the export flows. sigma (σ) is the estimator of the standard error of the residual in the outcome equation. the imr is computed as imr = ρ * σ. as can be observed, ρ is significant for 6 out of 15 industries. the mills ratio is positive for all industries combined, as well as for 5 individual industries, while the ratio is negative for the remaining 10 industries. it is important to note that when the coefficient of the mills ratio is positive, ‘positive selection’ is said to have occurred; if the coefficient is negative, then ‘negative selection’ is the result. indeed, positive selection means that, without the correction, the estimate of the parameters of the outcome equation would have been upward biased, while negative selection would have resulted in a downward-biased estimate. in any case, the significance of the mills ratio is that sample selection bias exists and needs to be controlled. table 5: intensive margins of trade (outcome equation). in general, the variables that affect the extensive margin of trade also affect the intensive margin, although many of these variables are not significant, depending on the industry considered. as predicted by the gravity model, the economic size of the importing country, measured in terms of gdp per capita and population, is an important factor in explaining the volume of south africa’s exports. however, these variables produce a negative impact on some sectors, such as mineral products, plastics and rubbers or machinery and electrical products. in this regard, the main trading partners for these industries are not necessarily countries with high per capita income levels, that is, china, india, georgia, hungary or czech republic. when all industries are considered, geographical variables present the expected negative sign; however, differences in the significance of the coefficients can be observed by industry. as for the extensive margin, distance and being an island present the expected negative sign when the variables are significant, while being a landlocked country (which rules out sea transport) negatively affects the volume of exports. regarding cultural variables, having a common language or religion has a positive effect on the volume of exports if the variables are significant. sharing the same colonial background has a negative impact when all industries are considered, but interestingly, the sign of the coefficients changes for some industries when the sector classification is used. political instability has a negative effect on all industries when the variable is significant, while having an embassy in the importing country has no effect or even a negative effect on export volumes. in similar vein to the extensive margin, the only trade agreement that delivers a positive effect on export volumes is the sadc free trade agreement, and only in respect of some industries. jordaan and eita (2011), for example, found that the eu and nafta trade agreements have not led to an increase in south african exports. finally, trade regulations that influence the time to export have a negative impact on the volume of exports if the variable is significant. conversely, the number of documents required to export has a positive impact on some industries where the variable is significant. this contradictory result might be because of both the trade regulation variables being highly correlated, suggesting that the most important variable affecting the volume of exports is time to export. consequently, the south african government should give priority attention to streamlining the regulatory aspects of export logistics. the analysis reveals the most relevant determinants of exports by industry, offering a useful platform from which policymakers can formulate appropriate strategies for what they consider to be high-priority sectors and products. summary of key findings and concluding remarks south africa’s dti has long been of the view that south africa needs to boost and diversify its exports – in other words, expand exports in both the intensive and extensive margins. the paper set out to reveal the key determinants influencing south africa’s extensive and intensive trade margins, thereby highlighting key opportunity areas and overarching shortcomings in the country’s policy, regulatory and physical environments. this was done by employing a heckman selection gravity model, using highly disaggregated data for 2012 (at hs6 level). the first stage of the process revealed the factors affecting the probability of south africa exporting to a particular destination (extensive margin). the second stage, which modelled trade flows, revealed the variables that affect export volumes (intensive margin). the key results from the study indicate that south africa exports an extensive range of products to a limited number of countries, which reinforces the benefit of performing a trade (and especially export) margin analysis. the specific results, in turn, reveal how a wide range of market access determinants affect south africa’s export growth and potential exporter profitability. in terms of the probability to export, or the extensive margin, economic variables such as the importing country’s gdp and population have a positive impact on the firms’ decision to export. this highlights the importance of firms focusing their exporting endeavours on export markets with growing demand. in order to do so, it is important that they have access to reliable and affordable information about export opportunities in growing markets. here information support systems such as the decision support model, which identifies realistic export opportunities for south african exports, is a useful tool for both regional and national export promotion agencies (for details, see cuyvers, steenkamp & viviers 2012). other factors affecting the extensive margin are distance to the market (negative impact), cultural/language fit (positive impact), presence of a south african embassy abroad (positive impact), existing free trade agreement with sadc (positive impact) and trade regulations and costs (negative impact). these results firstly emphasise the importance of investing in transport infrastructure in order to reduce the transport cost burden of exporting to distant markets. at the same time, trade facilitation initiatives (e.g. more streamlined trade regulations) should be rolled out to stimulate export growth in south africa. this would also contribute to the deepening of trade within sadc and help to exploit ‘the untapped potential to develop a system of regional value chains’, as proposed by the world bank (2014:37). finally, industry-specific assistance from embassies based in foreign markets, especially those that are culturally distant, would help to give momentum to firms’ export efforts. in terms of the intensive margin (or factors influencing the volume of exports), there are strong parallels with the extensive margin, with the exception that the time involved in exporting has more of an impact than documentary requirements. this is also heavily dependent on the state of the infrastructure, the complexity of the regulatory apparatus and other factors such as congestion at ports and borders. this is in line with the world bank’s recommendations in 2014 that south africa needed to seriously tackle its infrastructural bottlenecks [both of a physical and ict (information and communication technology) nature] if it was to enhance its export competitiveness from a time and cost perspective and provide an environment in which small and medium-sized exporters could flourish and grow. in conclusion, the dearth of adequate market-related information and other noted shortcomings in south africa’s infrastructure and regulatory environment (which add to the cost and time to export) could explain why the country’s exports have largely developed in the intensive margin. if south africa is to make sustainable inroads into more markets and expand its product offerings, the government and its economic partners need to seriously address the obstacles standing in the way, while also adopting an industry-based approach to export policymaking and promotion. dissecting the industry-specific results would be an important part of this process and future research would involve developing counterfactual scenarios to assess the expected reaction of potential exporting firms’ trade flows to changes in key exogenous determinants. additionally, industry-specific research (that focuses on obtaining firm-level information) on market access and trade barriers would help industry-based approaches in policymaking as suggested above. acknowledgements this work is based on the research supported in part by the national research foundation of south africa (grant number 90709). any opinion, finding and conclusion or recommendation expressed in this material is that of the authors and the nrf does not accept any liability in 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tenreyro, s., 2006, ‘the log of gravity’, the review of economics and statistics 88, 641–658. https://doi.org/10.1162/rest.88.4.641. smet, k., 2007, stuck in the middle? the structure of trade between south africa and its major trading partners, viewed 8 august 2015, from http://epub.wu.ac.at/876/ steenkamp, e., grater, s. & viviers, w., 2015, ‘streamlining south africa’s export development efforts in sub-saharan africa: a decision support model approach’, viewed 5 february 2017, from https://www.wto.org/english/res_e/booksp_e/trade-costs-incl-growth_chap2_e.pdf the central intelligence agency, 2015, the world factbook, viewed 1 june 2015, from https://www.cia.gov/library/publications/the-world-factbook/ viviers, w., cuyvers, l., steenkamp, e.a., grater, s., matthee, m. & krugell, w.f., 2014, ‘identifying new product and service export opportunities for south africa using a decision support model’ international business and economics research journal, 13(6), 1403–1418. https://doi.org/10.19030/iber.v13i6.8930 world bank, 2014, south africa economic update: focus on export competitiveness, issue no. 5., the world bank, washington, dc. world bank group, africa regional poverty reduction and economic management, the world bank, washington, dc. world development indicators, 2011, the world bank, washington, dc, views 10 june, from http://data.worldbank.org/data-catalog/world-development-indicators world trade organization, 2012, the regional trade agreement database, viewed 1 june 2015, from http://rtais.wto.org/ui/publicmaintainrtahome.aspx appendix 1 table 1-a1: list of importing countries. table 2-a1: main importing countries by industry. footnotes 1. these results are available on request. 2. table a2 in the appendix presents the main trading partner by industry. 3. santos silva and tenreyro (2006) propose the poisson pseudo-maximum likelihood estimator to deal with heteroscedastic residuals and the prevalence of zeros in the dependent variables, which are undefined when the dependent variable is converted into logarithmic form. however, as shown by martin & pham (2008), the heckman sample selection procedure provides better estimates when an appropriated excluded variable is used in the first stage, such as the cost of establishing a new firm. 4. list of importing countries are presented in table a1 in the appendix. 5. the main difficulty in this approach is to find an exclusion variable for the probit model (selection equation) that is exogenous to the trade value. alternatively, religious similarity has also been considered as exclusion restriction and results are very similar. estimates are available upon request. 6. religion similarity index is where r is the percentage of affiliated population to each of the five major religions in south africa and each importing country, respectively. abstract introduction and background methodology results conclusion acknowledgements references footnotes about the author(s) simone nieuwoudt department of agricultural economics, university of the free state, south africa johannes i.f. henning department of agricultural economics, university of the free state, south africa henry jordaan department of agricultural economics, university of the free state, south africa citation nieuwoudt, s., henning, j.i.f. & jordaan, h., 2017, ‘entrepreneurial competencies and financial performance of farmers in south africa’, south african journal of economic and management sciences 20(1), a1640. https://doi.org/10.4102/sajems.v20i1.1640 original research entrepreneurial competencies and financial performance of farmers in south africa simone nieuwoudt, johannes i.f. henning, henry jordaan received: 04 aug. 2016; accepted: 30 june 2017; published: 15 dec. 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract aim: the main objective of this study was to explore the relationship between the entrepreneurial competencies of farmers and their financial performance. setting: the study was conducted in south africa among farmer clients of a commercial financial organisation. methods: the financial performance of the farmers was calculated by means of financial ratios which were used to compile a single performance indicator: operating efficiency. the operating efficiency indicator was calculated using a financial-based data envelopment analysis. an entrepreneurial competencies instrument was used to measure the entrepreneurial competencies of the farmers. ordinary least squares regression was used within the principal component regression framework to explore the relationship between entrepreneurial competencies and financial performance. results: the results indicate there is a positive relationship between entrepreneurial competencies and financial performance of farmers. each of the individual competencies also indicated positive correlation between the entrepreneurial competencies and financial performance. conclusion: an increase in specific entrepreneurial competencies behaviour may increase the operating efficiency of the farm. educational opportunities exist to educate farmers on the potential benefits of using entrepreneurial behaviour to their advantage (to benefit their operating efficiency). sectors involved with agriculture, for example agricultural advisors, financial advisors and educational institutes, should emphasise the importance of utilising the competencies of farmers. introduction and background agriculture is one of the most important sectors within the south african economy, as it contributes to the economy in terms of employment, gross domestic product (gdp) and rural development, among others. in 2015, the direct contribution of primary agriculture to the south african gdp was 2.1% (statistics south africa 2015). agriculture also provides employment, especially within rural areas, creating job opportunities for the educated and uneducated populations of the south african labour force. the agricultural sector also creates opportunities for domestic growth, employment expansion and foreign exchange income. taking these opportunities into consideration, a focus on expanding the agricultural sector (i.e. growth, business integration and employment) is thus expected to contribute significantly towards growing the economy of south africa. increasing costs, for example production costs or operating costs, within the south african agricultural sector have been limiting growth opportunities. increasing input prices within the agricultural sector, together with decreasing commodity prices, have created a cost price squeeze in agriculture (absa 2015). the cost price squeeze puts the profitability of farmers under increased pressure. in addition to shrinking profit margins, farmers also face increased pressure to produce more in order to survive within a volatile market. the price volatility and underfunding from financial institutions have placed more pressure on farmers to become innovative within their farming business to increase performance (asfaha & jooste 2007). therefore, farmers need to be innovative to ensure that their farming enterprises remain profitable and competitive within the dynamic environment. a farm’s performance is measured by how successful it is within the market and is determined by financial and non-financial measurements. non-financial measurements include employee growth, job satisfaction, self-sufficiency and so forth (walker & brown 2004). financial performance is focused on minimising costs, increasing business growth and sustainability to increase profitability. there is a link between a farm’s financial performance and the skills of the manager or owner, creating a need for improved decision-making skills (man, lau & chan 2002). the decision-making ability of an entrepreneur has been identified as being an important skill for gaining profitability and increasing business success. an entrepreneur is a person who takes more risks, provides capital within the business, is innovative and has the ability to seek opportunities in order to increase profits (bergevoet 2005). to achieve business success, a farmer needs to make strategic, as well as innovative, decisions concerning all levels of the business. therefore, farmers rely on entrepreneurial competencies and characteristics to enable them to become more successful. the topic of entrepreneurial competencies has increased in popularity as a way for determining entrepreneurial behaviour among individuals. man et al. (2002) identified competencies that line up with the literature on which characteristics an entrepreneur needs to have in order to exhibit entrepreneurial behaviour. the entrepreneurial competencies, linked with behaviour and decision-making skills, have been proven to positively influence the financial performance of a business. the topic of entrepreneurial competence has received little attention in the context of financial performance, despite the fact that profit margins are under pressure in the agricultural sector and the view that entrepreneurial skills are expected to have a positive influence on decision-making. however, the importance of entrepreneurial skills for sound business decision-making is evident from literature (e.g. ketelaar-de lauwere, enting, vermeulen & verhaar 2002; bergevoet 2005). the link between entrepreneurship and financial performance is reflected in the decision-making abilities of the farmer, and this topic has received little attention from researchers in the context of decision-making in agriculture. financial performance in agriculture, however, has received ample attention over the last few decades. swenson (2003) explains that financial records are set in a structured format that allows producers to summarise their financial information so that it eases the decision-making process. researchers have focused on increasing profit (production) by decreasing costs (input costs). this means that a farming business needs to pursue liquidity and profitability to improve its financial performance (sebe-yeboah & mensah 2014). therefore, recommendations centre around improving the financial performance through increasing both liquidity and profitability. this is, however, done by making sound business decisions, which requires some level of entrepreneurial skills. researchers have explored the relationship between entrepreneurial skills and technical efficiency of farms in south africa (jordaan 2012; jordaan & grové 2012). a positive relationship was found and recommendations were made to place more emphasis on extending the entrepreneurial skills of smallholder farmers to improve their performance. however, to this researcher’s knowledge, little to no research has been done proving the relationship between entrepreneurial competencies of farmers and their financial performance in a south african context. the main objective of this study is to explore the relationship between the entrepreneurial competencies of farmers and the financial performance of their farms in order to determine whether entrepreneurial characteristics positively influence the financial performance of the farm. to achieve the objective, financial performance of the farmers was determined by making use of financial ratios in the following categories: liquidity, solvency, profitability and financial efficiency. to measure the entrepreneurial competencies of farmers, the entrepreneurial competency instrument developed by man (2001) was used. methodology data the research is based on financial data of clients from a commercial financial organisation in south africa, and a questionnaire survey administered to measure entrepreneurial competencies of the respondents. the financial data were obtained from credit application forms by the clients. as per the formal agreement between the authors and the financial organisation, all data were treated as confidential and no information or interaction was allowed between the authors and clients. all information was received from relationship executives (bankers) from the financial organisation. to protect the clients, the executive representatives replaced all client names with respondent numbers before submitting the data to the authors. this was to ensure the anonymity of their clients. the financial organisation kept track of the respondents and their corresponding respondent numbers. respondent numbers allowed the financial organisation’s executive representatives to complete the entrepreneurial competency instrument according to the respondents. the entrepreneurial competencies instrument (man 2001) was completed by executive representatives of the financial organisation who work closely with the clients, and who assisted the clients with their credit applications. the survey was conducted between july and november 2015. from a possible 160 respondents1 available for the research, 99 questionnaires were completed and returned to the researcher. only 94 of the 99 respondents had sufficient financial data and entrepreneurial competencies data required for inclusion in this research. measuring financial performance of respondents financial performance measures the ratio measures were used to quantify the financial performance for the respondents. ratio measures eliminate the economies of size (currency values), thereby making it possible for different farms to be compared against one another (henning, strydom & willemse 2011). the financial measures used in this research are shown in table 1. table 1: measures of financial performance according to ratios used in the study in the study four financial measures were used to determine the financial performance of respondents. liquidity measures the ability of the farm to meet financial obligations, while solvency measures the ability of the farm to repay debt if all the assets are sold. profitability is used to measure how the farm is generating profits and financial efficiency is a measure of how efficiently capital is used on the farm. these four financial measures are used to determine the operating efficiency score. the financial-based data envelopment analysis (dea) model is used to determine an operating efficiency score for each farm to be used as the dependent variable in the regression analysis. deriving a single financial performance indicator specification of the dea model to quantify financial performance as operating efficiency: the adapted financial ratio-based dea model provides an indication of the efficiency of the farms by considering multiple financial ratios simultaneously and providing a single measurement of operating efficiency. according to henning, strydom, willemse and matthews (2013), every farm is seen as a decision-making unit (dmu), which is a term for the assortment of firms or departments that have the same goals and objectives, using the same inputs and outputs to reach their goals (al-shammari & salimi 1998). the financial ratio-based dea model combines multiple financial measurements into a single operating efficiency (henning et al. 2013). the output-orientated financial ratio-based dea model, with variable returns to scale, is defined as: z0 specifies the ratio expansion rate for dmu0 and λn represents the multiplier weights used to determine the efficiency frontier (henning et al., 2013). the total number of dmus is represented by n and is judged on m which represents the financial measurements (al-shammari & salimi, 1998). ri0 represents the total number of observed measurements for dmu0. the mathematical model is calculated and solved for every individual farm, thereby calculating the relative operating efficiency for every dmu (ablanedo-rosas, gao, zheng, alidaee & wang 2010). the interpretation of the z0 value can be confusing; therefore, to ease the interpretation, an interpretable efficiency score (a) was estimated (henning, 2011; henning et al. 2013). the higher the z0 value (estimated ratio expansion rate), the lower the efficiency level will be. the efficiency score (a) allows for the ranking of dmu0 or the current dmu. the efficiency score of 1 is considered to be efficient and a score less than 1 is inefficient (ablanedo-rosas et al. 2010). the efficiency score (eqn 5) determined with the financial ratio based dea model will be used in determining the relationship between the entrepreneurial competencies of farmers and their financial performance. measuring entrepreneurial competencies instrument used to explore entrepreneurial competencies the instrument used to measure the entrepreneurial competencies was developed by man (2001). the instrument consists of 53 statements related to the abilities of an individual (as an owner or manager of a business) that are used to measure 10 competencies as determined by man. the statements are answered on a seven-point anchored likert scale, where 1 is ‘strongly disagree’ and 7 is ‘strongly agree’ with the respective statement. nieuwoudt (2016) explains in detail the 10 entrepreneurial competencies identified by man (2001). these competencies are: opportunity competencies, relationship competencies, conceptual competencies (analytical competencies and innovative competencies), organising competencies (operational competencies and human competencies), strategic competencies, commitment competencies, learning competencies and personal strength competencies. determining the entrepreneurial competencies following man (2001), factor analysis (fa) was used to determine the entrepreneurial competencies. byrant, yarnold and michelson (1999) summarise that factor analysis is a multivariate statistical procedure that is used to decrease a large number of variables into a smaller set of variables (factors). this establishes underlying dimensions between measured variables and latent constructs and it provides construct validity evidence of reporting scales (byrant et al., 1999). when making use of fa, tinsley and tinsley (1987) mention that the minimum number of cases per item must be at least five. however, there remain different opinions on the exact number of cases per item. the research therefore followed the procedure of man, where items were divided into three categories as discussed at a later stage. the analysis was performed with a varimax rotation, kaiser normalisation and principal component analysis (pca). statements included in the determined components had to fulfil certain criteria, described below. the first step is to determine the communalities. the communality value for each statement should be 0.50 or higher or the statement should be removed. once communalities with a value less than 0.50 have been removed, the factor loadings determine the variables included in each component. costello and osborne (2005) suggest that a factor loading of 0.50 is enough to be considered ‘strong’. however, if there are cross-loadings between components, the statement should be removed. lastly, components with an eigenvalue greater than 1 are included in accordance with the kaiser-guttmann rule (fekedulegn, colbert, hicks & schuckers, 2002; williams, brown & onsman, 2012). the kaiser-meyer-olkin test of sampling adequacy (kmo) indicates the degree of variance and the kmo value needs to be above 0.49. the bartlett test of sphericity is statistically significant if the value is less than 0.001. a cronbach’s alpha of 0.7 or higher will confirm that there is an existing strong internal consistency between the items measuring each of the related competencies. man (2001) divided the entrepreneurial competencies instrument into three distinct parts, namely q01–q17, q18–q40 and q41–q53. all of the criteria above were applied to the factor analysis of the three parts of the entrepreneurial competencies instrument, following the procedure of man. exploring the influence of entrepreneurial competencies on financial performance regression analysis was used to explore the relationship between entrepreneurial competencies and financial performance of the respondents. the dependent variable in the regression analysis is a vector of efficiency scores estimated to represent the level of financial performance of the respondents, making use of the ordinary least squares (ols) regression approach within principal component regression (pcr). mcdonald (2009) argues that the properties of ols, parallel those of ols in the linear probability binary discrete choice model. ols estimates of β are consistent and asymptotically normal under general conditions. following the recommendation of mcdonald, the dependent variable in this research is the logarithm of the financial efficiency scores calculated in the dea model. a correlation matrix (table 2) was calculated for all the independent variables, namely the entrepreneurial competencies. from the correlation matrix it was evident that multi-collinearity is present between the independent variables (due to all the correlation coefficients being less than 0.9). the multi-collinearity supports the use of the pcr model for determining the relationship between the entrepreneurial competencies and operating efficiency. table 2: correlation matrix for entrepreneurial competencies the pcr is a data analysis tool that is used to reduce the dimensionality (number of variables) of a large number of interrelated variables, while retaining variation. pcr offers the chance to discover the most significant directions among data and to eliminate ‘noise’ directions. pcr offers new filtered information on an orthogonal or even orthonormal basis (pfisterer 2006). this new set of information is known as eigenvectors and eigenvalues. therefore, because of orthogonality, the eigenvectors are uncorrelated and the basic vectors corresponding to the maximum variance can be extracted without distracting the analysis in other directions (pfisterer 2006). principal component regression the application of the pcr here is based on magingxa (2006) and khaile (2012). estimating principal components: in order to calculate the pcr, the eigenvectors of the variables need to be calculated; the vectors can be used to construct the principal components (pcs). the decisive factor for determining which factors needed to be included in the model (components) is an eigenvalue greater than 1. this method is known as the kaiser-guttman rule (fekedulegn et al. 2002; williams et al. 2012). very small eigenvalues indicate that there is severe multi-collinearity; therefore, small eigenvalues are removed from the analysis (liu, kuang, gong & hou 2003). the statistical analysis program spss 23.0 (spss 2015) is used to determine the eigenvectors and eigenvalues from the original independent variables. a correlation matrix is used to determine eigenvalues φ1, φ2, … … …, and equivalent eigenvectors vj, making use of standardised and non-standardised variables. the following equations 6 and 7 are used to determine the eigenvalues and eigenvectors: eigenvectors are organised to create the matrix shown in equation 7. v is acknowledged to be orthonormal, because v columns act in agreement with the conditions and for ≠ j: the important step in this section is the extraction of components. the common rule for selecting principal components is to select those with eigenvalues greater than 1. regression with principal components: the principal components scores denoted by σ are calculated by matrix multiplication of eigenvalues. these eigenvalues were obtained from equation 7. therefore, the next equation describes the principal components’ σ scores as follows: in equation 8, as is the n × k matrix of the variables. v is eigenvector matrix as determined in equation 7. the component σ scores are calculated in a matrix multiplication product form, with a dimension of k components equal to k variables. the evaluation of the components is regressed against the original dependent variable a. this is where equation 9, the linear unit model, is presented as: asv and ε are independently distributed with zero means, 0 ≤ yi ≤ 1, with the limit point yi = 1 possessing positive probability. also, and bs are estimated by the ols model, and are standardised coefficients for the constant and the independent variables respectively. since the eigenvectors are orthogonal to one another, as defined by the eigenvector matrix v where vv′ = i, equation 9 can be reformulated in the form: or σ = asv and ρ = v’bs. σ is the n × l matrix of the retained components, v is a k × l matrix of eigenvectors equivalent to the l retained components and as is the standardised dependent variables (magingxa 2006). ρ is an l × l vector of new coefficients associated with l components. standard errors of the estimated coefficient ρ as symbolised by an l × 1 vector are calculated in the form of (fekedulegn et al. 2002; magingxa 2006): is the variance of the residuals that were calculated in equation 10. the elimination of some principal components does not change the magnitude of the variance (fekedulegn et al. 2002). however, the elimination of one or more components will ultimately reduce the total variance, resulting in a better model. the elimination of components can be done based on their significance from the regression results (magingxa 2006). presume that r principal components are eliminated due to insignificance; then equation 11 can be reformulated to use k – r components. the 0 symbol on ε0 is used to differentiate it from ε determined in equation 11. the residuals differ because the vectors of coefficients have been reduced to k – r components. identifying the significance of individual explanatory variables within the principal components: the advantage of a pcr exercise is that all hypothesised independent variables can be manually calculated. the recollected components are transformed back into the original independent variables: vk – r is the matrix of eigenvectors for the retained principal components, is a vector of coefficients (except for the intercept) estimated in equation 13 and is a vector of coefficients (except for the intercept) of the parameters in vector βs estimated in equation 10. variance of the principal component estimators in the form of standardised variables is calculated by: indicates the squares of the eigenvector elements of in equation 7 and ks indicates the squares of the elements of the matrix of standard errors of the coefficient matrix ρ in equation 13. the equivalent standard errors for the estimators of principal components of standardised variables are specified by: in the same context as fekedulegn et al. (2002) and magingxa (2006), standardised variables are transformed back to natural non-standardised variables bj.pc of ai. the results are given by: sai is the standard deviation of the ith original variable ai and are coefficients of the standardised variables. the original non-standardised dependent variable (efficiency score) is used in the ols model when estimating principal component significance. it therefore follows that the natural non-standardised variables bi.pc can be correctly calculated when the standard deviation sai is calculated by 1/sai as shown in equation 18. results operating efficiency as indicator of financial performance the operating efficiency scores are restricted to an interval between 0 and 1, where a farm with a score of 1 is considered to be efficient, and a score below 1 is considered inefficient. an important aspect to remember is that the operating efficiency scores are determined in comparison with the other farms in the sample. the weights, determined with the dea model, for each farm differ from one another in such a way that the individual farm’s performance compares the farm’s highest efficiency score to the other farms (henning 2011). the efficiency scores of the farms are calculated relative to one another and an inefficient score indicates that a farm has room for improvement relative to the more efficient farms. each farm’s operating efficiency has the highest possible score for the financial data used, and this score is used to compare the other highest possible scores of the other farms included in the study. farms that are identified as being efficient are the ones with the highest possible scores from the given financial measurements, as explained in the methods. therefore, the reason for farms being calculated as inefficient is due to the farm not performing as effectively in the financial measurements as a farm that has been calculated to be efficient. the results from the operating efficiency measures exhibit a range of operating efficiency scores, ranging between 0.749 and 1. the distribution skews towards the right with a very high average operating efficiency of 0.877. an inefficient score (i.e. a score less than 1) is only an indication that the farm is less efficient when compared with the efficient farms in the study (henning et al. 2013). the cumulative distribution of the operating efficiencies indicated the spread of the efficiency scores between 0.749 and 1, as shown in figure 1. figure 1: cumulative probability distribution of operating efficiencies for the farmers. an operating efficiency score of 1 indicates that the farm is efficient; in the study 13 (13.82%) of the farms were calculated as being efficient. therefore, the remaining sample farms (inefficient farms) were compared to the efficient farms. from figure 1, it is evident that 50% of the farmers have efficiency scores of below 0.855, where an efficiency score of 0.855 indicates that compared to other farms in the study the majority of the farms are operating at 85.5% level of efficiency. an 85.5% level of operating efficiency indicates that a farm with this score is only achieving 85.5% of the financial performance potential compared to an efficient farm in the same sample. in figure 1, three distinct inclines in the inefficient groups are observed. between the operating efficiency scores of 0.749 to 0.810, a sharp incline of the operating efficiencies is experienced. the next group of operating efficiency scores has a steady incline from 0.820 to 0.900. lastly, from 0.910 to 0.999 there is a sharp incline between the operating efficiencies. nieuwoudt (2016) identifies that the financial measurements used to determine the operating efficiencies of the farms contribute to the different scores for each farm. when determining the financial ratios of farms the ratios are divided into three groups, namely ‘vulnerable’, ‘stable’ and ‘strong’. these three groups contribute to the different inclines seen in figure 1, highlighting the more effective use of financial measures on the farm to ‘better’ perform among the rest of the sample. when the financial measures of an inefficient farm are compared to an efficient farm, the efficient farms financially performed ‘better’ in comparison to an inefficient farm. nieuwoudt (2016) explains the financial ratio score distribution for efficient farms and inefficient farms. taking the financial ratios ratings into consideration the overall ratings of the efficient farms were rated more ‘strong’ compared to the inefficient farms that rated more ‘stable’ or ‘vulnerable’, thus explaining why these farms are considered efficient and inefficient respectively (nieuwoudt 2016). in the next section, the entrepreneurial competencies of the farmers are explored. an entrepreneurial competency score is calculated for each farmer, which is then used to determine the influence of each of the competencies on the financial performance (operating efficiency) of the farmers. entrepreneurial competencies identifying the entrepreneurial competency of respondents the results from the pca are used to determine the specific competencies, as well as the statements that are significant in determining these competencies. the three parts of the factor analysis are done following the procedure of man (2001) and also applied by henning (2016). the first part, factor analysis for q01 to q17, is grouped as ‘interaction and exploring’; the second part, factor analysis for q18 to q40, is grouped as ‘business management’ and the last part, factor analysis for q41 to q53, is grouped as ‘personal improvement’. the group names for the three factor analysis parts are in accordance with henning (2016). interaction and exploring: the factor analysis for statements q01 to q17 consists of three components. statements q04, q05 and q09 had communality below 0.50, and they were therefore removed, while q10, q12 and q14 were removed due to cross-loadings. the level of significance for the bartlett’s test of sphericity is less 0.001, thereby indicating the factor analysis to be significant. the kmo value, 0.847, is greater than 0.49 and thus the factors are significant. in table 3, the rotated component matrix indicates the statement with high factor loading in three components. the components have eigenvalues greater than 1, and the overall cumulative percentage of variance for all three components explains 70.11% of the variance. each of the three components identified has a cronbach’s alpha greater than 0.7 confirming that there is strong existing internal consistency between the items that relate to the individual competencies. table 3: rotated component matrix for interaction and exploring components the first component with high factor loadings is for statements q15, q17, q11 and q16. the statements relate to the abilities of farmers to form ideas that can be implemented in their farming business. q11 relates to the farmers’ ability to apply innovative ideas, knowledge and issues in new ways. because agricultural markets are volatile and agricultural products are dependent on weather conditions, farmers need to think and apply new ideas to ensure success. q15, q16 and q17 deal with looking at old problems in new ways, finding new ideas and treating problems as opportunities. this is essential in the unpredictable sector of agriculture. as the component relates to the conceptualising abilities of the farmers, the component was named conceptual competencies. the statements with high factor loadings in the second component are q06, q07, q08 and q13. q06 and q07 are related to negotiating and interacting. for farmers, it is important to be able to negotiate the best price for crop or livestock (even though a farmer is a price-taker, benefits or extras can be negotiated), while still being able to maintain good business relationships with processors. thus, this links with q08, which is related to maintaining a personal network of work contacts. however, in order for farmers to grow their business, they need to take reasonable risks in terms of their crop production, deliveries, which producers they sell to and which companies they buy inputs from. this relates to q13 (job-related risks) having a high average score, where farmers assess and take risks to increase business size and profitability. therefore, this cluster of competencies relates to communicating abilities and relationships, and accordingly it will be called relationship competencies. the last component consisted of high factor loadings for q01, q02 and q03. q01 is related to identifying goods specifically needed in the agricultural market, while q02 and q03 are more related to consumer needs. the focus of these statements is on seeking or identifying gaps and needs within the market. these needs and gaps represent possible business opportunities for farmers. therefore, the last component is called opportunity competencies. business management: three components were extracted for statements q18 to q40. the bartlett’s test was less than 0.001 and the kmo value, 0.873, was greater than 0.49. in the test for communalities, none of the statements needed to be removed. in order to determine the components, the component structure was used and cross-loadings for q20, q21, q26, q29, q30, q33, q37, q38 and q39 were identified. these statements were removed accordingly and the factor loadings are reported in table 4. table 4: rotated component matrix for business management components as shown in table 4, the eigenvalues for each component are greater than 1 and the cumulative percentage of variance for all three components explains 65.43% of the total variance. the strategic component had a cronbach’s alpha of 0.907, the operational component had a cronbach’s alpha of 0.861 and the commitment component had a cronbach’s alpha of 0.760. the cronbach’s alpha values above 0.7 confirm that there is strong existing internal consistency between the different items. the first component consists of eight statements with high factor loadings, namely q26, q28, q31, q32, q34, q35, q36 and q40. in terms of setting, aligning and determining the costs and benefits of strategic goals, q32, q35 and q36 are needed. for farmers, strategic goals are needed to ensure that they achieve the long-term goals determined for their farming business. farmers need to plan for the future, due to factors outside their control affecting their production, crop rotation, land rotation and so on, which are all factors for long-term planning. q28 relates to the long-term planning required to avoid problems by identifying them beforehand, as well as identifying opportunities. to achieve these opportunities, commitment is needed, which is measured by q40. the last statement that plays a role is q26, which relates to motivating people. to achieve long-term goals is to motivate the people who will help the farmer achieve goals. this component relates to the strategic planning of business activities and is therefore called strategic competencies. q18, q19, q20, q21, q22 and q23 are the statements with high factor loadings in the second component. q18 and q19 are concerned with the planning of operations, and the organisation of the business and resources. this is important as farmers need to determine what they are going to produce, what resources they need to have available, how they will utilise the resources, what tasks need to be completed and how they will ensure that the tasks run as smoothly as possible. this all relates to q20, q21 and q23. however, in order to ensure the smooth running of tasks, a farmer needs to supervise employees to make sure tasks are completed in a correct and timely manner. as the statements are related to the daily operations of the farming business, the component was named operational competencies. high factor loadings for statements q37 and q38 were determined in the third component. q37 is related to how dedicated the farmer is to see the venture work and q38 to the refusal to see the venture fail. this indicates that farmers are very committed in seeing their ventures succeed and this component was therefore called commitment competencies. personal improvement: according to the factor analysis for q41 to q53, all the contributing factors for the appropriateness of factor analysis were sufficient for the bartlett’s test and latent root test. the kmo value, 0.913, is above 0.49 indicating a sufficient degree of variance. the test for communalities indicated no communalities with values below 0.5. in the component structure test, statements q48, q50 and q52 were removed due to cross-loadings. the factor loadings are reported in table 5. table 5: component matrix for personal improvement component in table 5, the component with factor loadings above 0.5 for each statement, the eigenvalue and percentage variance for the component are shown. the component has an eigenvalue greater than 1, and the cumulative percentage of variance for the component explains 58.66% of the total variance. the cronbach’s alpha indicates that there is internal consistency between the statements. all the statements with high factor loadings, q41, q42, q43, q44, q45, q46, q47, q49, q51 and q53, are only one component. q41, q42, q43, q44 and q45 relate to farmers keeping up-to-date in their field of business by making proactive decisions to learn and apply the relevant skills and knowledge. due to the rapid expansion in agricultural technologies, this is a critical part of farming. changing weather and climate patterns, together with increasing input costs, force farmers to apply new skills so as to enable them to continue producing. q51 states that a farmer should be able to identify his or her strengths and weaknesses to match them with opportunities and threats, which also relates to q53 in recognising shortcomings and finding ways to work on them. farmers need to employ knowledgeable advisors where they have shortcomings, should they are not able to learn the skills needed. maintaining a positive attitude and high energy levels will help with learning and adapting a new skill into day-to-day living, so that the skill can be mastered. this is essential in an expanding market. q46, q47 and q49 all measure the level of optimal performance required to be successful. the factors included in the component relate to the capabilities of the farmers to encourage confidence and deal with difficulties; thus this component is called support competencies. entrepreneurial competencies scoring: figure 2 shows the distribution of the entrepreneurial competencies identified by the factor analysis of the farmers between the lower, mean and upper values. the lower and upper values are indicated by the lines to show the spread, while the histogram indicates the mean values of the competencies. in order to make the figures easier to interpret, the average scores were converted into percentages in order to compare the different competencies with each other. figure 2: distribution of scores for entrepreneurial competencies among the farmers figure 2 shows that all of the competencies identified for the farmers are near the upper bound (higher end of the distribution), with all of the average scores being above 70%. the weakest average score identified is in opportunity competencies, indicating the greatest room for improvement lies there. commitment competencies (91%) represent the strongest competencies identified, followed by operational competencies (87%). both of these competencies have average scores above 85%, which still leaves room for improvement. as the opportunity scores are higher, this is an indication that the farmers’ behaviour does indeed illustrate that they are actively seeking new opportunities. these new opportunities can be used as strategies to increase their market, production, efficiency or to decrease production costs, thus positively benefiting their financial performance. the results correspond with the literature, where vik and mcelwee (2011) state that in the changing agricultural markets, the identification of new opportunities is an essential requirement for farmers. however, compared with the other entrepreneurial competencies, opportunity competencies has the lowest average score, indicating room for improvement through identifying new opportunities, such as vertical or horizontal integration in the market, or decreasing input costs by searching for new vendors. in terms of the relationship competencies, the average scores for the farmers were above 80%, illustrating that the farmers’ behaviour is tending towards negotiating, interactions and personal networks with others, as well as showing their ability to take reasonable job risks. the use of these relationship behaviours in their day-to-day business may open doors to new opportunities in terms of reasonable risk, as well as improving the farmers’ abilities to negotiate. farmers are considered to be price-takers, although they are still able to negotiate the terms of delivery or transport cost to ensure that they receive the most out of their product. this links with interacting with others and creating a personal network. the higher scores for the conceptual competencies highlight the fact that the farmers think conceptually about how they analyse problems. this indicates that a farmer’s behaviour reflects the focus on his or her decision-making ability. the results indicate that farmers do indeed have the ability to analyse, assess and react to situations. problems can occur at different stages in the dynamic agricultural sector and farmers need to take their time in thinking about what they need to achieve and what decisions need to be made in order to achieve their goals. thus, the farmers conceptualise the way they think about and analyse problems. this relates to the literature where conceptual thinking is concerned with decision-making in regard to innovation, risk, problems and seeking possible solutions. operational competencies relate to the way a farmer organises his or her business operations. these competencies form part of the underlying competencies of organising competencies, which are directly aimed at the operational part of organising. the high average score greater than 85% indicates that the farmer’s behaviour is focused on the operations of the business. most farmers are ‘hands-on’ with the day-to-day running of the business, which links to why these competencies have a high score. farmers need to be present in coordinating tasks and making sure that the appropriate resources are used in order for the tasks to be completed correctly. therefore, this behaviour indicates that the strategy of the farmer is to ‘run’ the farm. strategic competencies have an average score greater than 75%, thereby illustrating that farmers are actively setting, evaluating and implementing strategies on their farms that relate to organising and operational competencies. because strategic competencies relate to the implementing of strategies, it is expected that farmers have higher scores, as this determines whether or not they reach goals and increase sales, thereby increasing profitability. commitment competencies scored the highest average score of all the competencies. this illustrates that the farmers’ behaviour is mostly orientated towards seeing that any venture they take on is successful. as the agricultural market is very volatile, this behavioural aspect is a necessity in order to guarantee success. commitment competencies are the factors that encourage entrepreneurs to start, grow or expand their businesses. for farmers, this is an important aspect due to farmers mostly being owners as well as managers, meaning that the farmers are responsible for a wide variety of tasks, spread over a wide area. support competencies rated an average score greater than 75%, meaning that the farmers’ behaviour suggests that they do use these competencies, but there is still room for improvement. this grouping of competencies is based on how farmers, as entrepreneurs, see their own strengths and ability to adapt and learn. the average score is closer to the upper score, indicating that the majority of farmers are rated high in their ability to learn and adapt. this links with the unpredictability and volatility of the market of the agricultural sector, where crops and livestock may be lost due to factors outside a farmer’s control, through drought or disease, for example. farmers accordingly need to be able to adapt in order to survive. the following section evaluates the influence of each of the entrepreneurial competencies on the efficiency scores of the farmers. entrepreneurial competencies influence on financial performance the non-standardised data were imported into spss (statistical software) to obtain eigenvalues and eigenvectors. the eigenvectors calculated are needed to compute the pcs. an un-rotated procedure of components was selected to compute the eigenvalues and eigenvectors. this method was chosen because the components were not the primary objective. the pcs were calculated through a matrix multiplication between the variables and the eigenvectors. thus, uncorrelated pcs were manually calculated. a correlation matrix was used to determine whether any correlation exists. table 6 shows the eigenvalues of the components selected for the regression at the production stage. two of the variables were removed in the determining of the pcs due to commonalties less than 0.50. table 6: eigenvalues for entrepreneurial competencies efficiency regression model. following the kaiser-guttmann rule, only one pc was extracted, since only one had an eigenvalue equal to or greater than 1 (fekedulegn et al. 2002; williams et al. 2012). pc1 explained 72.69% of the variation in the underlying variables. to determine the significance of the identified variable (zpc1) on operating efficiency, an ols model was estimated. the result of the regression analysis, as calculated with spss, shown in table 7, indicates that entrepreneurial competencies index is significant with a very small positive coefficient. a positive value indicates that if entrepreneurial competencies increase, operating efficiency will also increase, as was expected. table 7: significant principal component for the operating efficiency. evidence from literature indicates that an increase in entrepreneurial competencies will increase the financial performance (operating efficiency). the relationship between the operating efficiency and entrepreneurial competencies is, however, very small, indicating that the entrepreneurial competencies as a whole (all the competencies combined into one index) have a very small positive effect. a possible reason might be that a farmer is trying to over-commit in all aspects measured in terms of competencies, thereby neglecting the focus on individual competencies. therefore, a more in-depth look into the individual competencies is needed to determine the effect of the individual entrepreneurial competencies on operating efficiency. however, if farmers concentrate on their individual competencies, they will be able to identify where they are lacking and then make use of necessary measures to counter this. accordingly, the management of a farm requires that the farmer should be competent in all of the competencies. this increases the need to concentrate on the competencies that need to be focused on individually in order to ensure that the competition for a farmer’s time and effort is directed towards increasing the competencies where he or she is lacking. this is, however, difficult if all the competencies are grouped together, creating a small positive relationship between competencies and operating efficiency. t-tests were used to test the significance of the correlation between each of the individual entrepreneurial competencies scores and operating efficiency scores, making use of simetar. the results of the t-tests are shown in table 8. table 8: results from the t-test of the relationship between entrepreneurial competencies and operating efficiency. the correlation coefficients of each of the competencies in relation to the operating efficiency score indicate that there is a positive correlation between the competencies and the operating efficiency. however, the relationship competencies and operational competencies are statistically non-significant. each of the competencies has an individual positive relationship with operating efficiency, even though when combined in the group of entrepreneurial competencies there is a very small positive value. therefore, the focus should be on individual competencies and not necessarily on entrepreneurial competencies as a whole. the opportunity competencies indicate that those farmers who are actively seeking new opportunities in order to increase farm business, ways to integrate other sectors in the market, new gaps within the market, or even opportunities to decrease production costs, will be able to increase their operating efficiency in a positive way. the farmers’ average score for these competencies showed the lowest score for all of the competencies, indicating the largest room for improvement. thus, if farmers were to expand their businesses horizontally or vertically within the value chain, they would increase the size of their businesses, thereby creating more revenue opportunities within the businesses. the increase in income could improve the profitability of the farming business. thus, actively seeking opportunities can benefit the operating efficiency of a farm. the conceptual competencies of farmers are also expected to have a positive influence on their operating their farms efficiently. these competencies are closely related to opportunity, which presents the innovative ideas or knowledge needed to think of problems in new ways. however, this group of competencies achieved the second-lowest average score, indicating more room for improvement. usually, the need to seek an opportunity arises owing to problems or lack of a solution. thus, if farmers become innovative with their problem-solving efforts, this might create opportunities for new products or services within the market. for example, if a farmer decides to plant maize instead of farming with livestock, he will need a combine harvester, and although this is an expensive implement, the farmer could make the combine available for hire to other farmers facing the same need, thereby helping with the payments for the implement. this could increase the farmer’s income and help decrease the debt used to acquire the implement, while being innovative and seeking a new opportunity. strategic competencies can increase the operating efficiency of the farm in a positive way, when there is a focus on increasing the farmer’s strategic competency behaviours. the competencies focus on setting and determining the cost–benefits for reaching strategies or goals. thus, if a farmer has a well-planned business strategy with a clear vision and mission, he or she will be able to determine the short-term, reachable goals that will determine the success of the business plan. if a farmer, for example, endeavours to increase the production area of crops in each planting season, while maintaining the same input costs, he will be able to grow the business and increase income at the same time. this will, however, require commitment to the goal in order to achieve success. the average score for commitment competencies was the highest among all the competencies. if there is an increase in how committed the farmer is in ensuring that a venture is successful, the operating efficiency will increase. the positive relation between commitment and operating efficiency is similar to that described in literature, which suggests that being committed to the business will ensure business growth. if there is an increase in the business size or opportunities, there will be an increase in income. for any goal or strategy to be achieved, is important that there be a commitment to the strategy, with belief in own capabilities to achieve strategy. this links with the support competencies of a farmer. the support competencies are the competencies with the largest relation with operating efficiency, when there is an increase in this group of competencies behaviour. these competencies are closely related to the personal strengths and learning capabilities of the farmer. self-efficacy is important in order for farmers to believe in their own capabilities to learn and apply new knowledge and to be successful in their operations. if a farmer has a higher belief in him or herself, he or she will be willing to work harder and be more committed in seeing a venture through. if a farmer does not believe in his or her own capabilities in terms of crop knowledge, he or she will doubt him or herself and not commit to ensuring the success of the crop. this might decrease the production yield, thereby negatively effecting operating efficiency. in the literature review, it is suggested that to ensure an increase in business growth, farmers should constantly increase their knowledge, thereby increasing their self-efficacy and self-belief. conclusion for the original problem identified, there was no or little evidence available in south africa that proved that entrepreneurial competencies may contribute to the improvement of the financial performance of farmers. the literature suggests that a positive relationship exists between financial performance and higher levels of entrepreneurial competencies. therefore, the objective of this study was to explore the relationship between the entrepreneurial competencies of farmers and the financial performance of their farms in order to determine whether entrepreneurial characteristics positively influence the financial performance of the farm. the results of this research showed a positive relationship between operating efficiency and the entrepreneurial competencies for the farmers included in the research. a positive value indicates that if entrepreneurial competencies increase, operating efficiency will also increase, as was expected. a positive relationship was, however, very small for the entrepreneurial competencies index. further investigation was done to determine the individual relationship between each of the entrepreneurial competencies and the operating efficiency. the results showed that each of the individual entrepreneurial competencies have a positive relationship with the operating efficiency. therefore, an increase in specific entrepreneurial competencies behaviour may increase the operating efficiency of the farm. entrepreneurial competencies, as a whole, indicate that a farmer needs to focus on several competencies at the same time, in consequence of which certain competencies will be neglected. farmers need to be owners, managers and workers, at the same time, which creates an increased demand on the farmer to perform well on several levels within the business. however, if farmers concentrate on individual competencies, they will be able to identify where they are lacking and make use of necessary measures to counter this. therefore, the management of a farm means that a farmer needs to be competent in all of the competencies. from the individual entrepreneurial competencies analyses, it was identified that the farmers scored the strongest for the commitment competencies and the operational competencies. however, operational competencies were non-significant with regard to the operating efficiency. commitment competencies on the other hand were significant at a 5% level of significance, thus emphasising the importance of commitment. commitment competencies are the factors that encourage entrepreneurs to start, grow or expand their business; as the agricultural market is very volatile, this behavioural aspect is a necessity in order to guarantee success. opportunity competencies had the lowest score among the farmers, indicating room for improvement. the opportunity competencies are farmers who are actively seeking new opportunities in order to increase farm business, ways to integrate other sectors in the market, new gaps within the market, or even opportunities to decrease production costs. vertical and horizontal integration are only two of the factors identified that farmers can use to increase their opportunity competencies, but by using value chain integration as a negotiation tool, farmers will combine conceptual competencies with their opportunity competencies. to achieve the factors mentioned, strategic planning will be needed, thus highlighting the importance of the strategic competencies of the farmers. educational opportunities exist to educate farmers on the potential benefits of using their entrepreneurial behaviour to their advantage. the focus should be on educating farmers on ways to integrate the business (vertically or horizontally), planning and evaluating their opportunities as well as committing to the success of the venture. sectors involved with agriculture, for example agricultural advisors, financial advisors and educational institutes, should emphasise the importance of utilising the competencies of farmers. it is important to note that the focus of this study is based on a specific group of farmers, with a small sample. the farmers in this study have diverse farming practices and they produce differing products. therefore, the variability in efficiency scores can be influenced by these factors. research can be repeated to confirm the results of the procedure, due to the small sample size. further research can be done to investigate and explore different alternative measures in determining the entrepreneurial competencies. acknowledgements this work is based on research supported in part by the national research foundation (nrf) of south africa by the grant unique grant no. 94132. any opinion, finding and conclusion or recommendation expressed in this material is that of the authors and the nrf does not accept any liability in this regard. competing interests the authors declare that they have no financial or personal relationship(s) that may have inappropriately influenced them in writing this article. authors’ contributions s.n. was the principle researcher involved in all stages of the research and wrote the article. j.i.f.h. assisted with conceptualisation and writing of the article and provided financial assistance through the nrf grant for the research as well as supervision to the main researcher. h.j. assisted with conceptualisation and writing of the article and provided supervision to the main research. references ablanedo-rosas, j.h., gao, h., zheng, x., alidaee, b. & wang, h., 2010, ‘a study 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february 2016 the st petersburg paradox revolves round the determination of a fair price for playing the st petersburg game. according to the original formulation, the price for the game is infinite, and, therefore, paradoxical. although the st petersburg paradox can be seen as concerning merely a game, paul samuelson (1977) calls it a “fascinating chapter in the history of ideas”, a chapter that gave rise to a considerable number of papers over more than 200 years involving fields such as probability theory and economics. in a paper in this journal, vivian (2013) undertook a numerical investigation of the st petersburg game. in this paper, the central issue of the paradox is identified as that of fair (risk-neutral) pricing, which is fundamental in economics and finance and involves important concepts such as no arbitrage, discounting, and risk-neutral measures. the model for the st petersburg game as set out in this paper is new and analytical and resolves the so-called pricing paradox by applying a discounting procedure. in this framework, it is shown that there is in fact no infinite price paradox, and simple formulas for obtaining a finite price for the game are also provided. key words: discounting, fair no-arbitrage price, martingale probability measures, pricing paradox jel: a1, 2 c00, 6 1 introduction the famous st petersburg game pricing paradox has, over the last 275 years, occupied many great minds, including economists such as paul samuelson and j.m. keynes, and has directly or indirectly influenced some of the work of mathematicians such as borel (1949), and even john van neumann. 1.1 the st petersburg game (pg) the paradox surrounding this very famous game goes back to the early 1700s. bernoulli presented the paradox to the st petersburg academy in 1738, and it has attracted attention ever since. samuelson (1977) states that the paradox “enjoys an honoured corner in the memory bank of the cultured analytic mind”. the pg concerns a single game (between a player and a bank or casino) which may last arbitrarily long, has infinite expected payoff and, according to the paradox, an infinite price. one play of the game proceeds as follows: a coin is flipped repeatedly at times t = 1, 2, 3, … until the first tails t appears, when the payoff is paid out and the game ends. the accumulated payoff st, if the game ends at time t, consists of doubling up initial amount s0 = 1 for each successive heads h, and has possible values st = 2; 2 2; 23; … 2t ; …, with respective probabilities ½; (½)2; (½)3; … (½)t ;… ; and so on. the run of heads can be arbitrarily long, and the expected payoff for one play of the pg is infinite: e[final payoff] = 2(½) + 22(½)2 + 23(½)3 + … + 2t(½)t + … = ∞. (1.1) the argument for finding the fair price fp for the st petersburg game given in the literature (bernoulli 1738; samuelson 1977; mackinnon 1990; vivian 2013) then proceeds as follows: a fair price implies that the expected profit should be zero. that is: e[profit] = e[final payoff − fp] = 0 (1.2) if one writes: e[final payoff − fp] = e[final payoff] − e[fp] (1.3) abstract 322 sajems ns 19 (2016) no 2:321-329 it follows that: fp = e[final payoff] (1.4) this pricing argument, together with (1.1), then implies that the “fair” price fp is infinite: fp= ∞ (1.5) what makes the pg so interesting is that the length τ of the st petersburg game, that is, the number of hs before t appears, is a random variable. the pg may have an arbitrarily long run, but may also end after only 1 coin flip, with payoff 1, or after 2 flips with payoff 4, and so on. it is rather a shock to calculate the expected value of the length τ of the st petersburg game. noting that τ = 1 with probability ½; τ = 2 with probability (½)2; and so on, it follows that: e[τ] = 𝑛(1/2)'(')* = 2 (1.6) the paradox is this: it appears that the correct, fair price is infinite, but no player will pay this upfront for an expected, infinite final payoff, especially for a game that is expected to end after 2 tosses. also, the probability of winning amount 2τ for very long τ is only (½)τ − for example, there is a 0.098 per cent chance of winning 1,024 units of money and about a 0,0000009 per cent chance of winning a million units. is there a way out of the paradox? an immediate objection to (1.1) and (1.5) could be that an infinite amount of money has no meaning in a real-life situation. however, this does not resolve the paradox on a theoretical level where economics and mathematics apparently show that the price of the pg is infinite. for the sake of investigating the paradox, it is therefore assumed that player and bank have unrestricted resources. in sections 1.2 to 1.3, we present some important observations on the st petersburg paradox, observations that are not mentioned elsewhere in the literature. 1.2 mathematical issues the pricing argument in respect of (1.2) to (1.4) is flawed mathematically. for any random variable x, the expression e[x] = ∞ may be defined in probability theory, but working with infinity needs care. for example, e[x − y] = e[x] − e[y] is not true if both e[x] = ∞ and e[y] = ∞ (durrett, 1996). this simple fact (though not mentioned in the literature relating to the pg) already dispels the “paradox” presented by the simplistic reasoning in equations (1.2) and (1.3). writing e[payoff − price] = e[payoff] − e[price] implies that either e[payoff] or price must be finite. and, if either is finite, then, by assumption (1.2), they must be equal and both will be finite. therefore, applying fair pricing and formula (1.3) means there can be no paradox: both expected payoff and price must be finite. an appropriate model for the pricing of our games should reflect this, and relationships (1.2) to (1.4) do not. 1.3 issues of time and risk firstly: even if one is guaranteed to have a very long run of successive heads, it makes no economic sense to pay an infinite (or even finite but large) amount now, for a large amount paid out only after a very long time. secondly: suppose it is agreed that the game lasts for a maximum of k flips with a maximum possible final payoff of 2k (if there are k successive heads). then: e[payoff at time k] = 2(½) + 22(½)2 + 23(½)3 + … + 2k(½)k = k (1.7) the “fair” price for this truncated game then has a finite value k and there is no apparent paradox. but, to break even in this truncated pg, the player must have an immediate run of x number of successive heads such that 2x ≥ k. solving for x gives us: x ≥ log. 𝐾. as an example, assume the rule is that the game stops after k = 28 flips, so that the price is 28. an immediate run of at least log22 8 = 8 successive heads is needed just to break even, and the probability of this happening is only (½)8 = 0.39 per cent. the probability of making a profit of only 4 units is about 0.01 per cent (0.0001). this is too risky for the player. sajems ns 19 (2016) no 2:321-329 323 from the point of view of the bank, it is unlikely that the pg can be hedged by a portfolio with the same outcome space and price k. there is a probability – however small – that the bank may have to pay out a massive amount of 2k, and this may be far too risky for the bank. in conclusion: the economics of “infinite payoffs and prices”, without taking time and risk into consideration, makes little sense. the “fair” pricing formula (1.4) for st petersburg games does not appear to satisfy all the criteria of fair pricing. this brings us to the concepts of no arbitrage, discounting, and true fair pricing, which we will show resolves the paradox. 1.4 fair pricing, no arbitrage, and discounting the “no-arbitrage” assumption is basic to all pricing theory. it is also known as the “no-freelunch” assumption and implies that there should be no expectation of riskless profit when entering into a financial transaction. the expected present value (pv) of the profit must be zero in order to ensure a fair price (pliska, 1997; björk, 2004): e[pv of profit] = e[pv(final payoff) − fair price] = 0 (1.8) the pv of a quantity is obtained by discounting it to time t = 0 or when the price is paid, most commonly using factor ( * *01 )t, where r is the benchmark risk-free bank rate and t indicates time. this then yields the true fair pricing formula: for any investment v over time interval [0, t], its fair price v(0) is determined from (1.8) by relationship: e[ * (*01)2 v(t) – v(0)] = 0 that is: fair price v(0) = * (*01)2 e[v(t)] the important roles of time and discounting in ensuring a risk-neutral price are now clear. none of the previous papers that deal with the st petersburg game mention this. the present contribution is to use the above insights and replace the simplistic and incorrect “fair” pricing of section 1.1 with a mathematically and economically sound model, along the lines implied by (1.8). in summary: the “fair” pricing formula (1.4) for st petersburg games does not satisfy all the criteria in respect of fair pricing. here, the problem will be placed within a martingale framework and it will be shown how to apply discounting in particular to the pricing model for the pg so that time value and risk considerations are introduced and fair pricing can be shown to yield finite prices. the notion of a pricing paradox is dispelled, and a formula for the actual value of the (finite) fair price of a game will be given. 2 literature review samuelson (1977) provides a detailed discussion of the history of the game and of the efforts at solving the paradox. this is in effect a literature review in itself. vivian (2013) also provides a good overview. the next sections give brief summaries of some of the attempts at resolving the st petersburg paradox. 2.1 utility functions some authors (see samuelson’s discussion (1977)) suggest the use of an equilibrium framework and utility functions to determine a price that would satisfy both agents, that is, a utility price rather than a fair price. the basic idea is that players base decisions on an expected (concave) utility function of wealth rather than on the expected value (a linear function) of wealth. this presents one way of resolving the pricing paradox and reveals fascinating applications of utility theory (menger, 1934). we prefer to stay within the fair price framework in which the pricing paradox was originally formulated. 324 sajems ns 19 (2016) no 2:321-329 2.2 truncating the game one can consider the variant st petersburg game with the rule (mackinnan, 1990) that, if prespecified throw number k still shows heads (i.e. you have successive hhh … hh for k throws), you will accept cumulative payoff (2k) and the game will stop. in other words, the game is restricted to k flips at most (but may, of course, end much sooner). this case was discussed in section 1.3 above − the “fair” price for this truncated game is finite k (equation (1.7)) and there is no apparent paradox. but, as pointed out there, problems arise even in this case, and, furthermore, the truncation is not really a satisfactory solution, since it does not apply to the true pg. 2.3 playing the st petersburg game repeatedly the idea, here, is to consider a large number of plays of the pg, and then take the average value as the price per game. to formalise this framework something like the weak or strong law of large numbers is needed. neither law can be used for the pg, but there is, however, a weak law for triangular arrays that can be applied to the pg. the discussions in feller (1945, 1968) and durrett (1996) provide the solid basis for this method. we give the result without the proof (which can be found in durrett (1996:44-46): let sn denote the cumulative payoff after playing the st petersburg game n times. then it can be shown that 3 4 '5678' → 1, in probability, as n → ∞. this means that, for large n, the average payoff per game, namely 3 4 ' , is close to log. 𝑛 in probability. the price for playing n games is nlog. 𝑛, and the fair price per game, when playing n games, is: fpn=log. 𝑛 (2.1) this is an intriguing result. the “fair” price for playing the pg only once (n = 1) is zero. clearly, no bank will accept this price and will insist on the player playing a larger number of times. the price for playing 2k times is 2klog. 29 = 2 k*k, or k units per game. there is no fixed fair price per game – it all depends on how many games you agree to play. this pushes up the cost of playing. remember, also, that the convergence leading to result (2.1) is in probability only, and the result is therefore a weak one. 2.4 simulating the st petersburg game count buffon proposed this method as far back as the 18th century (buffon, 1777). he employed a child to play the game repeatedly and then tabulated the results. according to him, there would always be a finite run of heads, and, therefore, a finite price and no paradox. apart from this questionable methodology, both buffon and d’alembert (see samuelson, 1977) made another astonishing statement: they agreed that any probability smaller than, say, 10−4 could simply be set equal to zero, in this way guaranteeing a finite payoff and price! more recently, the use of computers has been suggested to simulate and examine the paradox. in this case, a virtual coin is flipped a very large number of times and the payoff is then calculated. the process (game) is repeated a large number of times and the average of payoffs is taken. this value is then offered as the expected final payoff – and thus price – for playing the pg once. this can be seen as a practical implementation of the discussion in section 2.3. the paper of vivian (2013) follows this path and we can compare his computer results with the theoretical price given by (2.1). it appears that his simulated values for the price per game when playing large numbers of times are roughly of the order of the theoretical values predicted by feller (1945). for example: for 210 repeated computer plays, the price per game is 6.84, while feller’s price is 10. see table 3 in vivian (2013). all his simulated pgs ended after a finite run of heads. vivian’s conclusion is that numerical experiments show that the st petersburg paradox is resolved: there is no paradox, since his computer simulations show finite lengths of games, and finite prices can be computed as the average of a large number of plays. although his paper is very insightful and a valuable way of investigating the paradox, computer experiments still amount to a truncation of the repeated plays after some (however long) time. from a mathematical or statistical sajems ns 19 (2016) no 2:321-329 325 point of view, it is also not quite satisfactory to state that a finite number of experiments shows that all pg games will have a finite length. another problem with the simulation method is that it does not produce a unique, feasible price per game for practical use: repeating the simulations will yield different payoffs and different prices. 3 research methodology for solving the original st petersburg game the research methodology is to develop the ideas presented in sections 1.2 to1.4 and to show that the concept of discounting can be used to introduce time value and risk considerations into games such as the pg, which then leads to finite expected payoffs and finite prices. the pricing paradox is thus resolved. we will also attempt to place the problem within a martingale framework. fair pricing involves determining the expected values of terminal payoffs, and, in the case of the pricing paradox, includes instances where we have possibly infinite payoffs and infinite exercise times. we first explain pricing concepts in an accessible way, but using the necessary mathematics and correct pricing procedures. these ideas will then be used to give alternative analytical solutions to the st petersburg paradox which are not based on numerical experiments such as those of vivian (2013). we start with some definitions to set up the general risk-neutral framework for fair pricing in economics and finance − it is essential to understand the foundations of fair pricing, since failure to do so may lead not only to our pg paradox, but also to serious mispricing of financial assets, and may play a role in financial crises. 3.1 the assumption of no arbitrage as mentioned in section 1.4, this assumption is the basis of pricing theory. there should be no riskless profit, so that today’s price should equal the present or discounted value pv of the expected final payoff. discounting is done via a discount factor or discount rate: the pv of a payment made at time t is obtained by discounting it to t = 0 when the price is paid. usually, a risk-free bank rate r is assumed, and the factor ( * *01 )t, or 𝑒;1< in the case of continuous compounding, is applied to the final payment. for any investment v over time interval [0, t], therefore, its fair price v(0) is determined by relationship: price v(0) = * (*01)2 e[v(t)] (3.1) note that the final values v(t) are random variables representing all possible outcomes at time t, while v(0) is the deterministic price at time 0 when the transaction is entered into. it seems obvious that the expected value in (3.1) is taken with respect to the probability measure p, which describes the real-world probability distribution of v at t. however, this is not the case: the fair price is determined by an artificially constructed risk-neutral measure q which assures zero risk-less profit and is linked to the discounting factor. we discuss this next. 3.2 martingales the no-arbitrage condition for a market with risky price process s(t) and risk-free bank rate r is most clearly stated as follows (pliska; 1997; björk 2004): there are no arbitrage opportunities if – and only if – there exists a probability measure q with the following properties: q> 0; and for any time t = 1, 2, …, tin [0, t] s*(t) = eq[s*(t)|ft] (3.2) for discounted price process s* (t) = * (*01)= s(t) (3.3) note: eq[s*(t)|ft] is the expected value of s*(t), conditional on filtration f at time t. without going into the mathematics, one can think of the filtration ft as “information generated by all observed events regarding s up to time t” (bjőrk, 2004). specifically, time-0 fair values or prices are given by: 326 sajems ns 19 (2016) no 2:321-329 s(0) = s*(0) = eq[s*(t)] (3.4) statement (3.4) is the “first fundamental theorem of mathematical finance”. in economic terms, it states that today’s price is the expected value under measure q of the discounted future price. in the risk-neutral (no-arbitrage) q-world where fair prices are constructed, price processes s* (t) (= * (*01)= s(t)) are called martingales, and q is a martingale measure. it is not identical to realworld probability distribution p, but is equivalent to p. the modern framework for the pricing of financial products is based largely on martingale methods. measure q is unique if – and only if – the market is complete. (in a complete market, investments can be hedged or replicated so that, if two contracts or games v1 and v2 have the same final payoffs, they will also have the same prices.) in the case of an incomplete market where there is no unique q and the seller of a contract cannot hedge the contract, finding q is not just a mathematical exercise. the choice of q is equivalent to choosing the market price of risk. one can do no better than quote björk (2004:221): “in an incomplete market the price is also determined, in a nontrivial way, by aggregate supply and demand on the market. supply and demand are, in turn, determined by the aggregate risk aversion on the market, as well as by liquidity considerations and other forces.” these remarks are important, since it is not clear that the st petersburg game (a possibly perpetual contract) can be hedged by the bank or casino (see section 1.3). the framework presented above will form the basis of our solution to the pricing paradoxes. to summarise the important points: discounting is necessary, since pricing is not absolute but relative; time plays a role; no-arbitrage pricing should imply finite prices even for perpetual products; and, especially in incomplete markets, the risk preferences of parties are needed to determine the price. see also bru, bru and chung (2009) and mazliak and shafer (2009) for discussions on martingales. 4 results: resolving the st petersburg paradox we consider the original st petersburg game, played once, as discussed in the introduction, section 1.1. 4.1 a fair solution to pricing paradoxes using discounting our submission is that the usual formula (1.4) used in the literature on games does not give a fair price for games with a large or possibly infinite time horizon, and that the pricing principles with discounting discussed in section 3 should be followed. looking at pricing formulas (3.1) and (3.4), it is clear that discounting is an essential component of fair pricing, but this is ignored in the literature on games, as shown by the application of (1.4). the fair, no-arbitrage price is determined by the present values of expected payoffs, and the payoff process under consideration should be as in definition (3.3): st* = (β tst) (4.1) where st is the accumulated payoff considered in section 1.1, and β is a discounting or deflating factor. the discounter β can be negotiated by both player and bank. (in financial portfolio or asset pricing, β = * *01 with r the benchmark risk-free bank rate.) factor β should be positive (β> 0) and satisfy β< 1 for all terms, or for all but a finite number of terms where one can take β = 1 if one so wishes (see (4.2) below). the function of parameter β is to reflect risk (including market price of risk) and/or time considerations. if it is felt that initial terms need not be deflated, since the first (say k) flips do not add up to much time, a better choice for β could be: β = β(t); with β(t) = 1 for t≤k and β(t) = β< 1 for t>k, with k being an agreed-upon time value (4.2) sajems ns 19 (2016) no 2:321-329 327 or, more generally: β = β(t); with β(t) = β1 for t≤k and β(t) = β2 for t>k, with k being an agreed-upon time value (4.3) 0 <β1≤ 1 and 0 <β2< 1 more sophisticated choices for β(t) can be negotiated between player and bank. 4.2 a finite price for the st petersburg game payoffs for the pg should be discounted – in its simplest form, payoffs at each step t are discounted with factor βt where β< 1. the fair price for the st petersburg game is then: fp = e[discounted payoff] = 2(½)β + 22(½)2β2 + 23(½)3β3 + … + 2τ (½)τβτ + … = 𝛽<(<)* = ? *;? (4.4) the fair price is finite and fixed once the value of β has been negotiated. (formula (4.4) also gives the price of a perpetual annuity of a stream of unit payments with β = * *01 .) discounting makes sense of both the mathematics and economics for cases of large or infinite time and gets rid of any “infinite price paradox”. if the agents involved cannot agree on a value for β, there is simply no supply and no demand, and, therefore, no game. pricing formula (4.4) has a simple analytical form and provides, at least theoretically, a more satisfying solution to the “infinite price paradox” than just limiting the wealth of players and banks or the number of flips of the coin. formula (4.4) can also be made more dynamic, as suggested above, by applying different discount factors over different time periods. for example, the fair price using discounting factor (4.2) is: fp = k+ ?@ab *;? (4.5) and, using (4.3) as the discounting factor: fp = 𝛽*<9<)* + 𝛽.<(<)90* = ?b;?b @ab *;?b + ?8 @ab *;?8 (4.6) 4.3 the price using a martingale measure adapted to β in the above discussion, probability measure q = {½; ½} was used as a risk-neutral measure. the risk-neutral measure and the discounting factor are usually linked, as shown in the martingale theory for section 3.2, equation (3.4). different risk-neutral measures are also possible in incomplete markets. the accumulated payoff process s(t) can be represented by a tree structure (pliska, 1997), and one can then easily show that the following martingale property (the one-step version of (3.2)) holds at each t: s*(t) = eq[s*(t + 1)|ft] i.e.: s(t) = βeq[s(t + 1)|ft] (4.7) martingale measure q = {qu; qd}, consistent with deflator β, can now be constructed: application of (4.7) at any time t, together with the probability condition, respectively yields equations: 1 = β [2qu + 1qd] and qu + qd = 1 the solution is: qu = = *;? ? and qd= .?;* ? since we must have both qu> 0 and qd> 0, the restriction on β is: ½ <β< 1. 328 sajems ns 19 (2016) no 2:321-329 then, for ½ <β< 1, we have, for the simplest pricing case: fp = e[discounted payoff] = 2( *;? ? )β + 22(*;? ? )2β2 + 23(*;? ? )3β3 + … + 2τ (*;? ? )τβτ + … = [2(1 − 𝛽)]'(')* = .(*;?) .?;* (4.8) negotiating a specific value of β implies a new risk-neutral probability measure. note: for β= ⅔, formula (4.8) gives fp = 2, and formula (4.4) also gives fp = 2. (4.9) the fair price of 2 is thus consistent with martingale measure {qu; qd} = {½; ½}. the bank will probably not be happy with this price and will want to negotiate a value of β closer to ½ in pricing formula (4.8)! 4.4 other simple solutions to the paradox? our final suggestions for resolving the pricing paradox are very simple, and are also not mentioned in the literature. suppose that the notion of discounting is ignored and we return to the original formula (1.4). in equation (1.6), we saw that the expected time for the game to stop is τ = 2, and so the expected payoff for the pg should be no more than the expected time 2-payoff, namely e[s2]. since e[s2] = 1+ . . = 2, the “fair” price fp according to (1.4) should be: fp =e[s2] = 2 (4.10) this accords with the price given in (4.9) above. it is also interesting to consider a variation of the original pricing formula (1.4) using utility functions u(w), where w is the final payoff. thus, assume formula: fp = e[u(final payoff)] = e[u(w)] for u(w) = log.(𝑊) and w = 2 t, we have: e[log.(2<)] = e[t] the equivalent of expected payoff (1.1) is: e[u(final payoff)] = 1(½) + 2(½)2 + 3(½)3 + … + t (½)t + … = 𝑡(1/2)<(<)* , so that the fair price is once again: fp= 2 5 summary over the last 300 years, various analyses of, and solutions to, the st petersburg paradox have been offered. applying the concept of discounted no-arbitrage pricing − based on the accepted model for obtaining fair prices for financial assets − to the st petersburg game shows that there is indeed no infinite price paradox. in this new framework, the price per game is finite, and there is a simple formula for pricing the game that depends on a discounting factor that can in theory be negotiated between bank and player. finally: although one may see the original st petersburg paradox as a case of a nonsensical question leading to a nonsensical answer, there is much to learn from the pricing exercise and the solutions to the “paradox”. references bernoulli, d. 1738 (1954 translation). exposition of a new theory on the measurement of risk. econometrica, 22:23-36. björk, t. 2004. arbitrage theory in continuous time. new york, us: oxford university press. borel, e. 1949. le paradoxe de saint-pétersbourg. c.r. acad. sci. paris, 228:404-405. sajems ns 19 (2016) no 2:321-329 329 bru, b., bru, m.-f. & chung, k.l. 2009. borel and the st petersburg martingale. electronic journal for the history of probability and statistics, 5(1):1-58. available at: www.jehps.net [accessed june 2014]. buffon, g.l.l. 1777. essai d’arithmétique morale. supplement l’historie naturelle, vol. iv. durrett, r. 1996. probability: theory and examples. california, usa: duxbury press. feller, w. 1945. note on the law of large numbers and “fair” games. annals of mathematical statistics, 16(3):301-304. feller, w. 1968. an introduction to probability theory and its applications. new york usa: john wiley & sons. mackinnon, n. 1990. a lesson on the st petersburg paradox. the mathematical gazette, 74:51-53. mazliak, l. & shafer, g. 2009. the splendours and miseries of martingales. electronic journal for the history of probability and statistics, 5(1): introduction. available at: www.jehps.net [accessed june 2014]. menger, k. 1934. das unsicherheitsmoment in der weltlehre. z. nationalökon, 51:459-485. pliska, s.r. 1997. introduction to mathematical finance. oxford, uk: blackwell publishers. samuelson, p.a. 1977. st petersburg paradoxes: defanged, dissected, and historically described. journal of economic literature, 15(1):24-55. vivian, r.w. 2013. ending the myth of the st petersburg paradox. sajems ns, 16(3):347-364. abstract introduction literature review method findings conclusion acknowledgements references about the author(s) lonell coetzee air traffic and navigational services s.o.c. ltd (atns), johannesburg, south africa sanchen henning department of leadership and organisational behaviour, school of business leadership, university of south africa, johannesburg, south africa citation coetzee, l. & henning, s., 2019, ‘a tale of two ships: follower attributions of leadership with reference to team morale in an air traffic control centre’, south african journal of economic and management sciences 22(1), a2109. https://doi.org/10.4102/sajems.v22i1.2109 original research a tale of two ships: follower attributions of leadership with reference to team morale in an air traffic control centre lonell coetzee and sanchen henning received: 20 sept. 2017; accepted: 25 june 2019; published: 26 aug. 2019 copyright: © 2019. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: air traffic controllers are a unique set of individuals operating in a safety-critical environment requiring interaction with and responsiveness to an elevated load of constantly changing information. the management of such a workforce is often challenging, specifically the maintenance of sufficiently high levels of morale to prevent a high controller turnover and safety related consequences. low morale poses a latent safety risk to aviation organisations. aim: this study demonstrates that discrepancies between leader perceptions of follower attributions and actual follower attributions influence team morale. setting: the study was completed in a large operational air traffic control centre, operated by an air navigation service provider company in south africa. it included four teams of air traffic controllers and their direct managers. method: a quantitative design was adopted to collect and analyse quantitative data from a total population of 105 followers and four team leaders. the leadership style inventory was developed to collect data regarding twelve follower attributions ascertained from literature. results: discrepancies between leader perceptions of follower attributions and actual follower attributions were identified in all four teams at the selected air traffic control centre. in each of the teams, leaders over-estimated follower attributions, which negatively affected air traffic controller team morale. the higher the perceived discrepancy between leaders and followers, the lower the team morale. the attributions displaying the highest levels of discrepancies between leaders and followers across all teams were morality, communication and openness while professionalism and encouragement displayed the highest level of matching between leaders and followers. conclusion: there is limited published research on leaders’ perceptions of follower attributions and the actual follower attributions as well as the effect of this discrepancy on team morale in air traffic control centres. this study provides a tangible way for air traffic control managers to navigate the risk of low morale by ascertaining their attributional developmental areas from a follower perspective. to assist in preventing latent system failures from leading to aviation incidents, the human factor as expressed in this study should considered by navigation service providers. keywords: followership; attribution theory; air traffic control; morale; safety; leadership. ‘aviation in itself is not inherently dangerous. but to an even greater degree than the sea, it is terribly unforgiving of any carelessness, incapacity or neglect’ (captain lamplugh, world war 1). introduction in the air traffic management industry, safety is the most important driver of operations. the increased in-flight demands globally necessitates continuous research to improve aviation safety and to decrease the occurrence rate of accidents. a study on job stress and turnover tendency among air traffic controllers reported 1.08 accidents per million flight hours worldwide (jou, kuo & tang 2013). the study also confirmed that human error was the primary cause of 90% of flight safety-related events in taiwan from 2000 to 2009, followed by environmental factors and aircraft mechanical error. information is exchanged via technological equipment during in-flight interactions between pilots and air traffic controllers. pilots follow instructions from air traffic controllers who are responsible for the direction, orderly flow and maintenance of safe distances between aircrafts. poor situational awareness seems to be the key driver of near accidents (jou et al. 2013), which in turn could be the consequence of fatigue and mental stress. when anything is likely to compromise safety, air traffic management providers go to major lengths to mitigate the risk. in addition, when failures in the system lead to incidents or accidents, rigorous investigations are performed to ascertain the causes and to prevent them from reoccurring. according to the american airline captain, chesley ‘sully’ sullenberger, celebrated for the january 2009 water landing of us airways flight 1549 in the hudson river off manhattan, ‘there is simply no substitute for experience in terms of aviation safety’. although experience is a critical factor in aviation safety, it takes more than human experience to ensure safe takeoffs and landings. in safety-critical industries, staff with vast experience but low morale may present a latent safety risk to the workplace (reason 1995). an operational environment where all employees take responsibility and continuously consider the impact of their decisions on safety relies on a high degree of mutual trust, respect and effective communication between employees and their leaders. a positive organisational climate depends on the quality of the relationship between its leaders and followers (cilliers 2018). followers seem to be more influenced by their perceptions of a leader’s skills and traits than by the actual skills or traits of the leader (meindl 1995). a large discrepancy between leaders’ perceptions of themselves and their followers’ perceptions of them, as well as the relationship of the discrepancy between these perceptions with perceived team morale, may erode the organisational climate to such an extent that it becomes a safety risk. the aviation industry is particularly unforgiving of safety lapses, and latent safety risks pose severe dilemmas that require mitigation or resolution as a matter of urgency. several authors highlight the importance of team morale (ivey, blanc & mantler 2014; minor et al. 2014; rimmer 2017) as well as perceived attributions of leaders – from their own viewpoint as well as from the viewpoints of their followers (collinson 2006; derue & ashford 2010; singh & bodhanya 2013). comparisons between followers’ perceptions of their leaders and leader comprehension of such perceptions have been studied (derue & ashford 2010; singh & bodhanya 2013). however, within the context of air traffic control (atc) centres, research relating to the relationship between perceived leader and follower attribution discrepancies and team morale seems to be ‘off the radar’ and not available. such research is vital, because of the risks posed to a safety-critical environment through human error and system failures (reason 1995). reason (1995) categorises two types of failures that lead to aviation incidents, namely active and latent failures. he argues that every incident contains both human (active) and organisational (latent) contributions which, when combined with local conditions, lead to failure of the system. while active failures describe actions taken by pilots or air traffic controllers at the time of the incident, they combine with latent failures (which relate to organisational conditions or procedures) to cause the event, which could simply be a minor safety incident, but might also result in a disastrous accident. every incident or accident follows a pathway through many layers of system defences designed to prevent them, as the ‘holes’ in these defences line up and allow the pathway to find its way through them all. such a pathway could start with management activities that lead to certain workplace conditions (latent failure), which, in turn, may cause a person or team to err or violate procedures (active failure), resulting in an accident. latent failures may occur slowly over time and are present long before the event occurs. reason (1995) observes that management decisions on issues such as company policy, financing and operations can cause latent failures when they lead to outcomes such as fatigue, low morale, or less-than-optimal staffing levels. these decisions contribute directly via the latent failure pathway to the gradual eroding of the system’s defences, as procedures, administrative controls and standards are frequently circumvented to get the job done (reason 1995). while this study does not claim that low team morale is the cause of all safety risks, it suggests that it may have an undetected but significant effect on safety in the researched environment, as it intensifies the latent failures eroding system defences against catastrophe (mowday, porter & steers 2013). there may be a variety of different factors in the latent failure pathway that, over a period of time, may cause an aviation incident or accident to occur, of which low team morale could possibly be only a single factor. against this background, it was important to determine the possible discrepancies between leader-follower attributional perceptions within an atc centre, which is a safety-critical environment. the participants in the present study comprised four teams, each with one leader. leadership and followership are inseparable concepts in organisational behaviour theory and cannot exist in isolation (agho 2009; kupers & weibler 2008; stech 2008). without a leader, there is no follower; without a follower, there is no leader. thus, the two positions go hand in hand. if leadership involves actively influencing others, then followership involves allowing oneself to be influenced (uhl-bien & pillay 2007). insight into the dynamic flow between leadership and followership and its relationship with team morale is therefore imperative, especially in the aviation industry where the safety of aircrew and passengers is critical (reason 1995). the purpose of this research was to determine the difference in the way leaders think they are being perceived by their followers and how they are actually being perceived, and the relationship of this discrepancy with the followers’ team morale. the research question, objectives and hypotheses were formulated as follows: research question: what are the possible discrepancies between follower attributions of leaders and leaders’ perceptions of follower attributions in an air traffic control centre and how can the relationship of discrepancies with team morale be described? to answer the research question the following research objectives were formulated: objective 1: to determine the discrepancies between follower attributions of leadership and leader perceptions of follower attributions within the various teams in an air traffic control centre. objective 2: to determine the statistical relationship between measured attributional discrepancies and levels of perceived team morale. the hypotheses for this research were formulated as follows: h1: a statistically significant negative discrepancy (ax_d) exists between leader perception of follower attributions and follower attributions of the leader. h2: a negative relationship exists between attributional discrepancy values (ax_d) and levels of perceived team morale. literature review experience is not only a matter of what happens to you; it also entails how experiential events are perceived, how they are interpreted and how one’s own emotions, as well as those of others, are managed (hughes, ginnet & curphy 2015). the authors further postulate that human beings are not passive receivers of experiences; they actively interpret and construct their experiences. perception is an inherently interpretative and meaning making activity, and attribution is part of this process. attributions differ from mere perceptions since they are the explanations we develop for the behaviour or actions we attend to (hughes et al. 2015:49). the present study aimed at integrating key concepts related to the attribution theory of leadership and followership as a lens to explore the attributional perceptions of leaders and followers in an atc centre. attributions describe the qualities that leaders ascribe to themselves to explain their own behaviour and include the evaluations of followers regarding those attributions. attribution theory of leadership heider (1958) introduced attribution theory and explained that attributions are the outcomes by which people determine cause and effect to solve problems and become more effective in their exchanges with their surroundings. in short, an attribution is defined as a fundamental designation for a positive or negative result. it is the act of ascribing or attributing specific qualities to someone and is different from an attribute, which is a characteristic or quality of a person. jones and harris (1967) expanded on this theory to describe the fundamental attribution error, which is the tendency of humans to ascribe events to people rather than situations and contexts (hughes et al. 2015). for example, if a colleague fails to achieve sales targets, their failure may be ascribed to dispositional attributions or internal factors, such as personality or intelligence and not on challenging economic conditions. on the other hand, if you attempt to deliver on targets and fail, you would be more likely to blame external factors in the situation for the failure, such as limited time or resources. this reflects a self-serving bias, which is the tendency to blame the situation for failures and take credit for one’s successes (hughes et al. 2015). the psychoanalyst freud (1921:123–124) believed that ‘the leader himself needs to love no one else and is an individual whose main interest is self-preservation, suffering from a narcissistic personality’. characteristics of a narcissist include a grandiose sense of self-importance, lack of self-insight and an exaggeration of their own achievements and talents (de vries 2019). a preoccupation with status, power, beauty and superiority may therefore have negative implications for the leader-follower relationship. self-serving bias is a typical characteristic of a narcissistic leader and higgs and rowland (2009) conclude that there is a positive link between the absence of an enabling climate for sustainable team morale, team performance and narcissistic leadership. bar-on et al. (2007) describe the terms ‘self-awareness’ and ‘accurate self-assessment’ and relate these terms to team performance. leaders with high self-awareness display a gracefulness in learning about their shortcomings and welcome follower attribution feedback (goleman 1995). the same authors argue that the success of leaders and their teams is based on characteristics such as the ability to empathise, communicate and get along with others, their persistence in the face of frustration and their ability to adapt, rather than to depend on the analytic intelligence of the leader. the four pillars of the goleman model represent the ability to accurately perceive one’s own and others’ emotions, the ability to generate emotions to facilitate thought and action, the ability to accurately understand the causes of emotions and the meanings they convey and the ability to regulate one’s own emotions (goleman 1995). the subjective nature of follower perceptions (meindl 1995) implies that the effectiveness of leaders is influenced not only by skill and behaviour, but even more by their followers’ perception of them (singh & bodhanya 2013). the attributions that followers make about leaders have important implications for leaders either retaining their position by being perceived as competent or losing such position due to being perceived as incompetent (yukl 2013). in addition, eberly and fong (2013) suggest that co-dependent followers are sensitive to leaders’ emotional inconsistency when making attributions about such leaders. similarly, the predictive power of attributions in organisational contexts was presented by harvey et al. (2014) who conducted a meta-analysis of existing attributional theory research. the authors explain how the effect sizes of attributions have consistently been comparable to any of the more commonly used predictor variables in an organisational context. the same authors further indicate that attribution theory has been consistently under-utilised in organisational research. the inclusion of attribution theory as part of the theoretical framework for the present study contributed to a deeper understanding of leader-follower relational dynamics, often described as the antecedent of followership, which signifies a readiness to submit to another person in some way (derue & ashford 2010). followership the nature and dynamics of leadership remain a mystery despite the vast amount of theorisation on the topic. stogdill and bass (1990) state that if a theory of leadership is to be used for diagnosis, training and development, it must be grounded in the concepts and assumptions that are acceptable to and used by managers and emerging leaders. in the modern organisation, employees often switch between followership and leadership roles daily, which demonstrates the relevance and dynamic flow of both concepts (agho 2009; kupers & weibler 2008; stech 2008). changes to the modern work environment renewed emphasis on followers. the customary power distance between leaders and their followers has been gradually eroded due to simpler access to information and ever-expanding social networks (bagraim et al. 2011). the interaction of attributions and the behaviours of both leaders and followers may thus co-create team morale, while operational efficiency requires an organisational climate of trust and collaboration where staff are engaged and motivated. cilliers (2018:3) defines this co-creation process from a systems psychodynamic perspective and explains that ‘there is a forever fluid movement of the social leadership-followership process which cannot be reduced to skills, competencies or a way of being’. literature on leadership and followership and the nature of the relationship between the two is limited (greyvenstein & cilliers 2012). yet, it has been shown that the leader-follower relationship appears to be of a dynamic nature, while trust and collaboration seem critical in the achievement of goals (cappelli & keller 2013). this is especially true in an atc centre where compliance with safety regulations depends on good communication and positive trust relationships between team members. ideally, the interactions between leaders and followers in this high-risk context should contribute to high team morale and operational efficiency. authors indicate that followership receives comparatively less attention as the object through which organisational goals are to be realised (chen, belkin & kurtzberg 2007). yun, cox and sims (2006), for instance, refer to this phenomenon as the forgotten follower. in the same vein, greyvenstein and cilliers (2012) conclude that research on leadership focuses more on business issues than on follower matters and that this leads to followers feeling disenfranchised, de-authorised and disregarded. a focus on followership thus requires new ways of thinking, new types of theorising and the operationalising and testing of different kinds of variables (uhl-bien et al. 2014). a relevant theory is the leader-member exchange (lmx) (bauer & green 1996) as it integrates concepts from both the leadership and followership scholarly discourses. leader-member exchange is said to affect team morale in many different areas of organisational functioning and refers to the quality of the relations between leaders and group members (i.e. followers). high-quality lmx indicates high levels of information exchange, interaction, trust, respect, support, mutual influence and rewards. the applicability of the traditional lmx conceptualisation is challenged by the new work relationships and often completely irrelevant, especially in high autonomy working environments such as knowledge workers, freelancers or outsourced workers (chernyak-hai & rabenu 2018). however, in a safety-critical environment such as an atc centre where high levels of authority, trust, cooperative interactions and information sharing are important the lmx theory is still applicable. method research design a quantitative, survey-based methodology was utilised to conduct the research, with one of the researchers personally explaining and administrating questionnaires to participants. setting the research was conducted at a large operational atc centre. the centre consisted of four teams, referred to as pools, with each pool comprising between 25 and 26 team or pool members and a pool manager (leader). sample a convenience sampling technique, and specifically a census approach was followed aiming to include all the employees at the atc centre in the study. the total researched population comprised 105 follower respondents and four leaders. three follower questionnaires were refused, resulting in a realised sample of 102 team members and four leaders, as illustrated in table 1. table 1: realised sample framework. measuring instruments and data collection two self-developed questionnaires, namely the leadership style inventory (lsi) for leaders and the lsi for followers, were used to collect the data. the questionnaires were constructed based on relevant leadership and followership theory (bar-on 1996; bauer & green 1996; eberly & fong 2013; goleman 1995; green & mitchell 1979; hollander 1992a, 1992b; kelley 1973; kent & martinko 1995; martinko, harvey & douglas 2007; mitchell 1982; weiner 1986; zuckerman 1979). in total 12 attributions were measured in both questionnaires, namely: (1) conscientiousness, (2) consistency, (3) encouragement, (4) fairness, (5) leadership, (6) loyalty, (7) morality, (8) openness, (9) professionalism, (10) reputation, (11) communication and (12) trust. the two questionnaires measure the same attributions to enable meaningful comparison between the responses of leaders and followers. while the same attributions are measured in both questionnaires the questions are posed slightly differently in order to collect the perceptions of leaders as well as perceptions of followers. five-point likert scales were used to collect data from leaders and followers, where 1 = never, 2 = almost never, 3 = sometimes, 4 = almost always and 5 = always. in addition, both questionnaires included a question that measures team morale, using a five-point likert scale, where 1 = poor, 2 = below average, 3 = average, 4 = above average and 5 = excellent. the questionnaire design therefore enables comparison of follower attributions to the corresponding team leader perceptions of follower attributions, as well as provides a measure of both leader and follower perceptions regarding team morale. construct validity of the questionnaires was obtained through a review of the attributions as well as the team morale constructs by a panel of subject matter experts. subsequently. a pilot study was conducted with one leader and five followers at a small atc centre to ensure that the questions correctly represent the attributions to be tested. two items rendering incorrect data were removed after the pilot study phase before the main study was conducted. the questionnaires were individually distributed to all respondents and completed in the presence of one of the researchers. reliability and validity reliability and validity in research refer to the consistency and accuracy of data. the reliability of a study refers to the expectation that similar results will be found when the study is repeated (adams & lawrence 2019) and is often expressed in a cronbach’s α metric. reliability of the research process was enhanced by one of the researchers providing standardised instructions and directions to all participants as well as making participation voluntary and administering the instrument in person. data analysis data were statistically analysed in two phases, corresponding to the two research objectives. firstly, the likert scale rating for each follower per question on the lsi for followers was compared to the ratings for the same question in the lsi for leaders and a discrepancy value obtained. this provided an indication of the attributional discrepancy (ax_d) for each follower attribution. a one-sample t-test was calculated to examine the differences between the follower attributions of leadership and leader perception of follower attributions. secondly, the perceived follower morale rating was correlated with the obtained attributional discrepancy for each attribution to describe the relationship of the ax_d value on team morale. spearman rho correlations, a non-parametric measure for ranked variables, were calculated to indicate the direction of association between the average discrepancy values (ax_d) for each attribution and team morale. in addition, cohen’s d values were calculated to determine the practical significance of the discrepancies. ethical consideration ethical clearance was obtained for the research from the relevant institution (school of business leadership, university of south africa). findings to provide meaningful research results the reliability of the data set needs to be determined as depicted in table 2. table 2: descriptive statistics. the cronbach’s α was calculated at 0.97, which is higher than the minimum accepted threshold of 0.70 (pallant 2013), indicating very good internal consistency and reliability of the constructs in the questionnaire. for each of the 12 attribution constructs a cronbach’s α was calculated and all values were above 0.70 (see table 3). table 3: attribution cronbach’s alpha scores. the first objective was to determine the discrepancies between follower attributions of leadership and leader perceptions of follower attributions within the various teams in the atc centre. table 4 indicates the average team or pool rating, the leader rating and the difference or discrepancy between the two ratings (ax_d value) for each attribution. table 4: leadership style inventory attribution criteria and attributional discrepancy (ax_d) values. in the case of all four teams (pools), the average follower attribution values were consistently lower than leader perceptions of follower attributions. stated differently, leaders perceived follower attributions consistently higher than how follower attributions were actually rated. this resulted in significant attributional discrepancies (ax_d) for all 12 follower attributions, as illustrated in figure 1. h1: a statistically significant negative discrepancy (ax_d) is observed between follower attributions of leadership and leader perception of follower attributions. figure 1: discrepancy between leader perception of follower attributions and actual follower attributions (ax_d). effect size values are a natural way to comment on the practical significance of a data set and implies the standardised difference between the means of two populations (ellis & steyn 2003). effect size values were depicted by cohen’s d values and calculated for all the attributions. all values exceeded the 0.80 value as per cohen’s guidelines (table 5), confirming a large effect between follower attributions of leadership and leader perceptions of follower attributions. table 5: one sample statistics and test (test value = 0) (n = 102). h1 is therefore supported and the finding supports the statements by kets de vries (2019) that leaders tend to inflate their own capabilities and may not have the insight to understand the impact they have on their followers because of their narcissistic tendencies. self-awareness as well as social awareness are indicators of emotional intelligence (bar-on 1996; goleman 1995; higgs & rowland 2009), which include self-leadership, leadership of followers in dyads or teams, and leadership in the organisation as a system (greif 2007). the second research objective was to determine the relationship of the measured attributional discrepancies of leaders and followers with team morale. the spearman’s rs signifies the direction of an association between x andy, with a positive number signalling that y tends to increase when x increases and vice versa (ellis & steyn 2003). if the spearman rho is rs = 0, it is an indication that there is no tendency for y to either increase or decrease when x increases, while rs = 1 indicates a perfectly monotone relation between y and x. the follower rating of team morale, obtained from the lsi for followers, was compared to the average attributional discrepancy (ax_d) of each follower attribution (the discrepancy between leader attributional perception and actual follower attributional perception). a distinct negative relationship was clear: the larger the value of the discrepancy (both positive and negative), the lower the perceived morale. by implication, both an under and over-estimation of follower attributions results in lower morale, as illustrated in figure 2. as a two-tailed correlation, statistical significance of a spearman’s rs value was obtained at rs ≥ 0.05. figure 2: discrepancies (ax_d) versus level of perceived team morale: (a) conscientiousness; (b) communication. in the case of all four pools, the average follower attribution values (the perception that followers have of leaders) were consistently lower than what the leaders perceived them to be. stated differently, leaders rated follower attributions, that is, how they thought their followers perceived them, consistently higher than how their followers rated their leadership qualities. this is reflected in the average rs values for each team, obtained by averaging the rs values for every question in the lsi (numbered from lsi1 to lsi42) and illustrated for pool a in table 6. values indicated in italics are statistically significant at p < 0.05. table 6: spearman’s rho values per lsi question for pool a. pool b had an average rs value of –0.214825, pool c of –0.470991 and pool d of –0.621079, which confirm that all four leaders were overrating their followers’ perceptions on each item in the lsi by various degrees. once the lsi items are collated into attributions (as described in table 4), the attributional discrepancy (ax_d) between follower attributions and leader perception of their attributions is obtained. once again, on each of the 12 attributions (except a2, which was underrated) leaders were overrating their follower attributions. this finding, illustrated in figure 1, confirms the statements by kets de vries (2017) that leaders tend to inflate their own capabilities and may not have the insight to understand the impact they have on their followers because of their narcissistic tendencies. self-awareness as well as social awareness are indicators of emotional intelligence (bar-on 1996; goleman 1995; higgs & rowland 2009), which includes self-leadership, leadership of followers in dyads or teams and leadership in the organisation as a system (greif 2007). in figure 2, a value of 0 for the x measure (ax_d) indicates identical leader and follower perceptions of follower attributions. a negative value denotes a larger leader rating than follower rating, indicating a leader over-estimation of follower attributions. on the other hand, a positive value signifies a larger follower rating than leader rating, indicating a leader under-estimation of follower attributions. all the attributions reflect the same pattern except the attribution consistency which was underrated by leaders. similar to the other 11 attributions (where leaders consistently overrated their follower attributions) the larger the attributional discrepancy, the lower the level of perceived morale becomes. h2: a significant negative correlation is observed between attributional discrepancy values (ax_d) and perceived levels of team morale. h2 is supported and confirms the higher the value of ax_d, the lower the level of perceived team morale. it is therefore evident from the data that, in the context of the present study, atc pool managers overrate the way they think their followers perceive their leadership qualities. furthermore, the leader-follower discrepancy has a negative effect on perceived team morale as higher measures of discrepancies between the perceptions of leaders and followers are associated with lower perceived team morale. conclusion follett (1949) reminds us of the self-serving bias of the great man theory in the leader-follower dynamic: can you not remember the picture … of the man in the swivel chair? a trembling subordinate enters, states his problem; snap goes the decision from the chair. this man disappears only for another to enter. and so it goes. the massive brain in the swivel chair all day communicates to his followers his special knowledge. (p. 311) the attributional process between followers and leaders is a complex process and beyond the scope of this research. this article presented an analysis of the difference in the way leaders think they are being perceived by their followers and how they are actually being perceived, and the relationship of this discrepancy with the followers’ team morale in an atc centre. traditionally the leader role was idealised, as was evident in businesses following the model of the great man leadership theory where the follower was overshadowed (baker 2007). the present research firstly confirms how the historically idealised concept of leadership is projected into the perceived self-image of individual leaders, noticeable in the overestimated leader attributions. secondly, there is a negative relationship between the discrepancies of leader perceptions of follower attributions and actual follower attributions of their leaders and perceived team morale. the results of the study support scholarly dialogue relating to aspects of leadership and followership. kets de vries (2019) stated that the creation of highly motivated followers depends mostly on understanding others which is not possible if leaders and followers are alienated from each other. to involve oneself willingly to influence, coordinate and guide people’s organisational activities towards attaining positive goals and outcomes for the organisation requires both self-awareness and social awareness (cilliers 2018). the implication of the results is that the idealised perception that leaders have may have of follower attributions may not only be true for the aviation industry, but be relevant for other working environments as well. discrepancies between follower attributions of leadership and leader perceptions of follower attributions in any office may have a negative influence on the perceived team morale. the implementation of individual as well as group coaching sessions may create an improved office culture and remove ‘blind spots’ that leaders and followers may have regarding the perceptions of their own capabilities and their colleagues. different atc centres have different working environments. this heterogeneity has not been considered in the research, as the study population included one specific atc centre. the study suggests further research to include a cross-sectional and longitudinal study to investigate low perceived team morale as a latent safety risk in atc centres as well as in other safety-critical organisations. acknowledgements competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. author’s contributions the article was co-written by both authors. the authors are also indebted to the two anonymous referees for their valuable suggestions and comments. funding the article was produced at a writing retreat sponsored by the university of south africa’s school of business leadership. data availability statement data available from the authors on request. disclaimer the views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of any affiliated agency of the authors. references adams, a.a. & lawrence, e.v., 2019, research methods, statistics and applications, 2nd edn., sage publications, los angeles, ca. agho, a.o., 2009, ‘perspectives of senior-level executives on effective followership and leadership’, leadership & organisational studies 16(2), 159–166. https://doi.org/10.1177/1548051809335360 bagraim, j., cunningham, p., pieterse-landman, e., potgieter, t. & viedge, c., 2011, organisational behaviour – a contemporary south african perspective, 3rd edn., van schaik publishers, hatfield, pretoria. baker, s.d., 2007, ‘followership: the theoretical foundation of a contemporary construct’, journal of leadership & organizational studies 14(1), 50–60. https://doi.org/10.1177/0002831207304343 bar-on, r., 1996, the emotional quotient inventory (eq-i): a test of emotional intelligence, multi-health systems, toronto. bar-on, r., maree, k., maree, j.g. & elias, m.j. 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and management sciences 20(1), a1545. https://doi.org/10.4102/sajems.v20i1.1545 original research non-bank financial institutions and economic growth: evidence from africa’s three largest economies ronald rateiwa, meshach j. aziakpono received: 08 feb. 2016; accepted: 28 feb. 2017; published: 15 may 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: in order for the post-2015 world development agenda – termed the sustainable development goals (sdgs) – to succeed, there is a pronounced need to ensure that available resources are used more effectively and additional financing is accessed from the private sector. given that traditional bank lending has slowed down, the development of non-bank financing has become imperative. to this end, this article intends to empirically test the role of non-bank financial institutions (nbfis) in stimulating economic growth. aim: the aim of this article is to empirically test the existence of a long-run equilibrium relationship between economic growth and the development of nbfis, and the causality thereof. setting: the empirical assessment uses time-series data from africa’s three largest economies, namely, egypt, nigeria and south africa, over the period 1971–2013. methods: this article uses the johansen cointegration and vector error correction model within a country-specific setting. results: the results showed that the long-run relationship between nbfi development and economic growth is relatively stronger in egypt and south africa, than in nigeria. evidence in respect of nigeria shows that such a relationship is weak. the nature of the relationship between nbfi development and economic growth in egypt is positive and significant, and predominantly bidirectional. this suggests that a virtuous relationship between nbfis and economic growth exists in egypt. in south africa, the relationship is positive and significant and predominantly runs from nbfi development to economic growth, implying a supply-leading phenomenon. in nigeria, the results are weak and mixed. conclusion: the study concludes that in countries with more developed financial systems, the role of nbfis and their importance to the economic growth process are more pronounced. thus, there is need for developing policies targeted at developing the nbfi sector, given their potential to contribute to economic growth. introduction in order for the post-2015 world development agenda – termed the sustainable development goals – to succeed, there is a pronounced need to ensure that available resources are used more effectively and that additional financing be accessed from the private sector (international monetary fund 2015a). however, given the lingering fragility of financial markets in the wake of the recent global financial crisis, the availability of long-term financing required to support productive investment has been constrained (world bank 2015a). specifically, traditional bank lending has slowed down substantially as banks recover from the financial crisis and adjust to tighter regulatory controls – mostly emanating from the stricter basel iii capital and liquidity requirements. to this end, the development of non-bank financing has become imperative (world bank 2013a). this article accordingly explores the role of non-bank financial institutions (nbfis) as a source of long-term funding. in doing so, the article investigates the linkage between nbfi development and economic growth (the finance-growth nexus) using time-series data from africa’s three largest economies (egypt, nigeria and south africa) over the period 1971 to 2013. non-bank financial institutions are financial institutions that do not have a full banking licence and thus cannot take deposits. however, they both compete with and complement traditional banking institutions by providing alternative financial services such as contractual savings (pension funds and insurance companies), investment intermediaries (finance companies, mutual funds and money market funds), microloan organisations and venture capitalists (mishkin 2007; world bank 2015c). the three main categories of nbfis in egypt (egyptian financial supervisory authority 2017), nigeria (ndugbu et al. 2015) and south africa (faure et al. 2006) are insurance companies, pension funds and investment institutions. a cursory look at figure 1 suggests a strong and positive relationship between the growth in nbfi assets and gross domestic product (gdp) trend in the three countries. thus, this study is motivated to explore the actual relationship that exists between nbfi development and economic growth, using rigorous econometric methods. figure 1: co-movement of non-bank financial institution assets and gross domestic product for egypt, nigeria and south africa: 1971–2013. the recent global financial crisis clearly demonstrates that if the development of nbfis is too rapid and is not properly regulated and monitored, it may create conditions susceptible to a financial crisis. specifically, liang and reichert (2012) warned that if nbfis are not properly regulated, they allow excessive risk appetite, which may have disastrous consequences for both the financial sector and the real economy. this was further emphasised by the shadow banking monitoring report at the end of 2015 (financial stability board 2015). the report argued that although nbfis contribute to the financing of real economy, they can become a source of systemic risk when they perform ‘bank-like’ functions and also when their interconnectedness with banks is strong. furthermore, recent studies raise very profound questions about the finance-growth debate – especially in africa where both financial development (fd) and economic growth have remained subdued – leaving the debate unresolved. specifically, recent studies found that the relationship between fd and economic growth is weakening in both developed and developing countries and that ‘financial depth is no-longer a significant determinant of long-run economic growth’ (demetriades & rousseau 2015; rousseau & wachtel 2011). in africa, demetriades and james (2011:1) argued that ‘at worst’ the relationship between fd and long-run economic growth does not exist in africa. in respect of the countries under scrutiny, our survey of literature revealed a dearth of studies investigating the impact of nbfis on economic growth. for the few that are available, some focused only on a certain component of nbfis, such as pension funds, which may have the effect of underestimating the influence of nbfis on economic growth in these countries. other studies focused on the impact of regulation on stability and performance of nbfis (ofoeda gariba & amoah 2016), while some others focused on the impact of nbfis on access to credit (kabia, conteh & jalloh 2015) and investment in certain sectors (hamdi 2015). however, given the potential of nbfis to fund long-term growth, and risks arising from the linkages between nbfis and other financial institutions, and the conflicting results on the relationship between fd especially in africa, this article accordingly uses country-specific time-series econometric techniques to re-investigate whether or not nbfis – as a source of long-term funding – matter for economic growth, and if so, how. the three hypotheses to be tested are whether the relationship between nbfis and economic growth is (1) demand-following, (2) supply-leading (patrick 1966) or (3) a simultaneous two-way causality, which can be either a vicious or a virtuous cycle (berthelemy & varoudakis 1996). the analysis in this article will be carried out using the johansen cointegration and error correction modelling techniques within a country-specific setting. analysis in this article is restricted to the aggregate figures of nbfis because of the unavailability of data for the different categories of nbfis, such as pension funds, insurance companies and mutual funds for all the three countries over the relevant period. the choice of these three countries, egypt, nigeria and south africa, is based on their significance to africa’s economy and its financial system (kpmg africa limited 2013; world bank 2015b). in addition, these three countries comprise approximately 60% of all infrastructure investments in africa, which are predominantly funded through nbfis (mo ibrahim foundation 2013). lastly, these countries have the oldest capital markets in africa, thus implying that they have data available over a period longer than other african countries. thus, studying these countries will not only provide useful insight for policy in these three countries but also in the rest of african countries and other african economies. the remainder of this article is organised as follows: the ‘nbfi development and economic growth’ section provides the theoretical framework linking nbfi development to economic growth. the ‘methodology’ section presents the methodology applied in this study. the ‘estimation results’ section presents the empirical results and the ‘conclusion’ section concludes the article. non-bank financial institution development and economic growth the literature shows that the linkage between nbfi development and economic growth can be both direct and indirect (alderman & yemtsov 2013; davis & hu 2008; haiss & sumegi 2008; holzmann 1997; liang & reichert 2012; meng & pfau 2010; nassr & wehinger 2014; sufian & majid 2009; vittas 1997). it can be direct in the sense that nbfis can directly influence savings, investment, risk allocation and total factor productivity, thus enhancing economic growth. on the contrary, the linkage can be indirect through the influence of nbfis on the development of banks and capital (stock and bond) markets, which, in turn, influences economic growth (haiss & sumegi 2008; meng & pfau 2010; sufian & majid 2009). however, if the growth in the volume of loanable funds is too rapid and is not properly regulated and monitored, it may create conditions susceptible to a financial crisis. liang and reichert (2012) accordingly warn that if nbfis are not properly regulated, they allow excessive risk appetite which may have disastrous consequences for both the financial sector and the economy. however, literature suggests that the relationship between fd (using various indicators) and economic growth is by no means simple or apparent. patrick (1966) proposed the demand-following or supply-leading hypotheses. a demand-following scenario implies that causality runs from economic growth to fd. in this case, nbfis would develop in response to the demand for their services by the real economy. contrastingly, however, a supply-leading scenario arises when causality runs from fd to economic growth. thus, the development of nbfis precedes the demand for its services by the real economy. the argument is that fd leads to economic growth by facilitating the mobilisation of savings and efficient allocation of capital (levine 2004). therefore, the a priori expectation is that the development of nbfis (in this case) positively influences economic growth. an opposing view, however, is that fd eliminates liquidity constraints and thus reduces the incentive to save, which may further inhibit economic growth (aziakpono 2011; levine and servos 1998). lastly, the causality between fd and economic growth can also take the form of a simultaneous two-way causality. the simultaneous two-way causality can be either a vicious or a virtuous cycle (berthelemy and varoudakis 1996). a vicious cycle occurs when economic growth is too low; so low that it prevents the development of the financial sector, which, in turn, prevents economic growth. in this instance, the long-run coefficient of nbfi development on economic growth (or vice-versa) is expected to be negative. on the contrary, a virtuous cycle arises when a high level of economic growth supports the development of the financial sector, which, in turn, stimulates further economic growth. thus, the long-run effect of nbfi development on economic growth (or vice-versa) is expected to be positive. empirical evidence on non-bank financial institution development and economic growth a cross-reading of the literature revealed that very few studies have investigated the effect of nbfi development on economic growth within a specific country setting. only two studies focused on nigeria. no country-specific studies were found in respect of egypt and south africa. the two studies for nigeria (ndugbu et al. 2015; osuala & odunze 2014) covered the periods 1996–2010 and 1992–2012, respectively, using different indicators for finance companies, insurance companies and discount houses. both studies only found a positive relationship between assets of insurance companies and economic growth, while there was no evidence of any relationship between assets of finance companies and discount houses, and economic growth. osuala and odunze (2014) used the autoregressive distributive lag (ardl) model, while ndugbu et al. (2015) used the ordinary least squares methodology in their study. this article uses a different econometric approach (i.e. the johansen cointegration and vector error correction model) covering a longer period (1971–2013) to re-investigate the relationship between nbfi activity and economic growth. another empirical study including african countries showed that if nbfis facilitate excessive risk appetite, their influence on economic growth can be negative. more specifically, a cross-country panel study which included egypt, nigeria and south africa found a negative relationship between nbfi development and economic growth for both developed and emerging market countries (liang and reichert 2012). a possible reason provided for their finding was that nbfis are not properly regulated; hence, they allow excessive risk appetite, which may have disastrous consequences for both the financial sector and the economy. other studies related to the intermediary functions of nbfis but not directly investigating the link between nbfis and economic growth include kabia et al. (2015), hamdi (2015) and ofoeda et al. (2016). kabia et al. (2015) relied on data from a case study of 150 respondents in sierra leone to conclude that nbfis helped increase access to finance by poor communities, thereby reducing poverty. the data used in the analysis covered the period 2001–2005. in a report based on evidence obtained from sudan, hamdi (2015) argued that because of the ‘smallness’ of the nbfis and tight regulatory controls by the central bank in that country, there has rarely been any investments by nbfis into extractive industries such as mining, oil and gas. lastly, ofoeda et al. (2016) relied on evidence from ghana over the period 2006–2010 to conclude that effective regulation enhances the stability and profitability of nbfis in that country. given the dearth of studies focusing on the impact of nbfi development on economic growth in africa, and the conflicting results from the previous studies, it becomes imperative that the relationship be reassessed using time-series evidence within a country-specific setting. this approach will minimise heterogeneity of country characteristics from influencing the results, thus improving the reliability of conclusions obtained therefrom. in the following section, we present the methodological framework used in assessing the relationship between nbfi development and economic growth. methodology model specification in this article, we adopt the traditional approach to investigate the finance-growth nexus, according to which we regress economic growth (y) on fd together with other control variables, that is, y = f (fd, control variables) (aziakpono 2008; levine 2004). economic growth is proxied by log of per capita real gdp. our decision to use log of per capita real gdp is consistent with most time-series studies, whereas cross-country studies use the growth rate of per capital gdp (arestis, luintelc & luintel 2010; yeh, huang & lin 2013). as indicated above, fd will be proxied by nbfis (assets of nbfis expressed as a percentage of gdp), because it is the objective of this study to establish the importance of nbfis in the finance-growth debate. this article uses a trivariate model following the approach used by luintel and khan (1999), aziakpono (2008) and arestis et al. (2010). in the trivariate model, one control variable is added at a time. economic growth and nbfi development variables remain constant in the model because they are the variables of interest. the main advantage of using this approach is that adding one variable at a time helps to address the possible misspecification problem inherent in a bivariate model, which may result in erroneous causal inferences (luintel & khan 1999). secondly, it helps to test the robustness of the long-run relationship between economic growth and nbfi development, and how such long-run relationship is affected by the control variable used (aziakpono 2008). econometric procedure to empirically examine this relationship, this study uses the johansen cointegration and vector error correction model within a country-specific setting. this approach provides a framework for testing the existence of a long-run equilibrium relationship between y and fd, and the causality thereof. as explained above, the three hypotheses to be tested are whether the relationship between nbfis and economic growth is: (1) demand-following, (2) supply-leading (patrick 1966) or (3) a simultaneous two-way causality, which can be either a vicious or a virtuous cycle (berthelemy & varoudakis 1996). based on the approach by aziakpono (2008) and arestis et al. (2010), the multivariate vector error correction model with k lags can be expressed as follows: where xt = f (y, fd, control variable) is a 3 × 1 vector. the variables are integrated of order 1, that is, i(1). ∆xt is i(0); ┌i represents 3 × 3 short-run coefficient matrices and εkt is the error term and is normally and independently distributed. the full rank of ∏i matrix is r. in a trivariate model (where n = 3), if r = 3, then the variables xt are i(0). however, if the rank of the ∏ matrix is zero, then there are no cointegrating relationships between the variables. the ∏ matrix can also have a reduced rank in the order of r ≤ (n – 1). thus, in a trivariate model, two reduced ranks are possible: r = 1 (one cointegrating vector) and r = 2 (two cointegrating vectors). in carrying out the analysis, only models that satisfied the serial correlation and heteroscedasticity tests, with a certain level of explanatory power, were reported. specifically, only models with adjusted r2 values greater than 30%, are reported. this is to ensure that the model has a relatively high explanatory power and good fit. data and sources data used in estimating the model are annual and cover the period 1971–2013, but were not available for the entire period for some of the variables. the period of study was chosen solely because of data limitations; a problem which is generally associated with african countries. data were obtained from the world development indicators (wdi), global development finance database (gdf), international financial statistics (ifs), united nations statistics (un stats) and the central banks of egypt, nigeria and south africa. the description of variables used in the analysis is presented in table 1. table 1: description of control variables. the development in nbfis in the selected countries is shown in figure 2. figure 2: assets of non-bank financial institutions expressed as percentage of gross domestic product for egypt, nigeria and south africa: 1971–2013. ethical considerations we believe that this work complies with all ethical requirements for academic work. estimation results this section presents and discusses the results. the results are presented in four sections: (1) results from the unit root test, (2) cointegration results, (3) weak exogeneity test results and (4) the long-run relationship between nbfi development and economic growth. unit root test results in order to test the stationarity of the variables, we use two test methods, namely the augmented dickey fuller and the breakpoint unit root test as a confirmatory test. for egypt and nigeria, the unit root and breakpoint unit root tests results show that most of the variables are first difference stationary, that is, i(1) series. the only exception was oil rents and interest rate spread that were stationary at level for both countries. similarly, for south africa, the unit root tests results also show that most of the variables were i(1) series. the only variables that were level stationary are lending and deposit rates, spread, exports, imports and net taxes. the next step is to carry out the cointegration test and the vector error correction model estimation to determine whether or not a long-run relationship exists among the variables. cointegration cointegration suggests the existence of a long-run equilibrium relationship between economic variables (brooks 2014; engle & granger 1987; geda, ngungu, & zerfu 2012; kennedy 2003). we use the johansen cointegration technique to test for cointegration. table 2 presents the cointegration test results. in the table, ‘k’ indicates the vector autoregression order that produces a white noise residual and ‘a’ indicates the deterministic trend assumption for each particular model. the cointegration test results are presented in table 2. table 2: cointegration results: egypt, nigeria and south africa. of the 22 models estimated for each country, the trace test and the max eigenvalue test show that there is a cointegration between nbfi development and economic growth in eight models each for egypt and south africa. however, only two models show evidence of cointegration between these variables in nigeria. this clearly shows that in nigeria, there is a weak relationship between nbfi development and economic growth. the relationship between nbfis and economic growth in egypt and south africa is relatively stronger compared with that in nigeria. causality between non-bank financial institution development and economic growth given the conflicting views in respect of the causal link between fd and economic growth, what prevails within each particular setting becomes an empirical issue. if cointegration exists, there must be causality from at least one of the variable to the other. in this article, we use the weak exogeneity approach to test the direction of causality between nbfi development and economic growth. the nature of the causal effect (i.e. whether positive or negative) is presented in table 4 in the section below. the weak exogeneity results and the direction of causality thereof, are reported in table 3. table 3 reports the chi-square statistic and the probability value of the test. specifically, it presents three null hypotheses: (1) the two-way causality between economic growth and nbfi development, (2) causality running from economic growth to nbfi development and (3) causality running from nbfi development to economic growth. a ‘yes’ indicates that the null hypothesis could not be rejected, whereas a ‘no’ indicates that the null hypothesis is rejected. the results are discussed separately for each country. table 3: weak exogeneity test for egypt, nigeria and south africa. egypt results presented in table 3 show a predominantly two-way causality between economic growth and nbfi development in egypt. only two models reported causality running from nbfis to economic growth, only without a reverse causality. this suggests that, at least in egypt, the relationship between nbfi development and economic growth would be a virtuous cycle if the two systems positively and significantly influence each other. in this case, the long-run coefficients are expected to be positive. however, if the long-run coefficients are negative, it implies that the relationship between nbfi development and economic growth in egypt follows a vicious cycle. thus, the low level of economic growth leads to underdevelopment of nbfis, which, in turn, hinders economic growth. nigeria with regard to nigeria, evidence of causality between nbfi development and economic growth is both weak and mixed. one of the two models reported shows that the direction of causality runs from economic growth to nbfi development, while the other one shows causality in the opposite direction. south africa the weak exogeneity test results presented in table 3 show that causality between nbfi development and economic growth in south africa predominantly runs from nbfi development to economic growth. this suggests that the relationship is likely to be supply-leading, whereby the nbfis create financial products required by the real economy in advance, thus facilitating economic growth. the concomitant question that follows is: what is the nature (direction and significance) of the causal effect between nbfi development and economic growth? we present our findings in respect of the nature of causal effect in the following section. long-run relationship between non-bank financial institution development and economic growth once the direction of causality has been established using the weak exogeneity test, the next step is to assess the nature (whether positive or negative and the economic significance) of the long-run relationship that exists between nbfi development and economic growth. if causality runs from nbfi development to economic growth, it means economic growth is endogenous. we then normalised on economic growth in order to obtain the effect of the long-run coefficients (elasticities) of nbfi development on economic growth. if the long-run coefficients are positive and significant, this is in the right direction as nbfis are expected to spur economic growth. policies must therefore be implemented to strengthen the development and efficiency of the financial sector. on the contrary, if causality runs from economic growth to nbfi development, it means nbfis are endogenous. we would therefore need to normalise the model to obtain the effects of the long-run coefficients of economic growth on the development of nbfis. positive and economically significant coefficients suggest that the growth of the economy leads to the development of the nbfis. however, if the evidence shows that the nature of the relationship is weak, it suggests that factors beyond nbfi development and economic growth are at play. in this case, there is urgent need to create an enabling environment to support the development of nbfis, which, in turn, will stimulate economic growth. the long-run coefficients and the coefficients of the error correction term (ecm) are presented in table 4. the coefficients of the ecm describe the ‘proportion of disequilibrium from one period that is corrected in the next period’ after a shock (engle & granger 1987:254). in this case, a low value of ecm term suggests a low adjustment back to equilibrium after a shock, thus suggesting inefficiencies in the non-banking financial system in facilitating economic growth or rigidities within the economy. thus, the focus on policy intervention must be to improve efficiency of nbfis and to reduce rigidities existent within the economy. table 4: long-run parameters of models with causality running from non-bank financial institutions to economic growth. the long-run coefficients and the ecm for nbfi development and economic growth are reported separately for the two scenarios: (1) where causality runs from nbfi development to economic growth and (2) where causality runs from economic growth to nbfi development. long-run relationship between non-bank financial institution development and economic growth when economic growth is endogenous this section presents the long-run parameters and the ecm when causality runs from nbfi development to economic growth. in this case, economic growth is normalised on in the model in order to obtain the elasticity of economic growth in relation to changes in nbfi development. the results are reported in table 4. egypt: of the eight models reported for egypt, six show a positive relationship between nbfi development and economic growth. five of the six models with a positive effect show that the influence of nbfi development on economic growth is statistically significant at least at a 5% level of significance, while the remaining model shows that the effect is not significant. the other two models reported a negative effect of nbfi development on economic growth, although such effect is not significant. the long-run coefficients of nbfi development on economic growth range from 0.01 to more than 3.4. this shows that the elasticity of economic growth in response to changes in nbfi development is significant depending on the factors controlled for. overall, the weight of the evidence shows that the effect of nbfi development on economic growth in egypt is both positive and significant. in respect of the models that reported a positive and significant effect of nbfi development on economic growth, the three models have the coefficients of the ecm ranging from 0.12 to 0.18. this shows that on average about 15% of disequilibria is corrected in a year, thus it would take close to 8 years for full equilibrium to be restored after a shock. the remaining two models with a positive effect have the coefficients of the ecm of 0.01 and 0.03. on the contrary, the two models that reported a negative effect of nbfi development on economic growth have the coefficients of the ecm between of 0.01 and 0.05. this evidence suggests that the efficiency of nbfis in correcting disequilibrium in egypt is relatively low. nigeria: although the evidence of a relationship between nbfi development and economic growth is weak for nigeria, the only model reported in table 4 shows a positive and significant relationship. the model shows that the elasticity of economic growth to changes in nbfi development is 0.21 and the ecm is 0.37. these results are encouraging as they suggest that the development of nbfis will spur economic growth. south africa: of the eight models reported for south africa, five show a positive effect of nbfi development on economic growth, while three show a negative effect. two of the five models that reported a positive relationship show that the effect of nbfi development on economic growth is significant at a 1% significance level, while the other three show that the effect is not significant. on the contrary, of the three models that reported a negative effect, two show that the effect of nbfi development on economic growth is significant at 1% and 5% significance levels. however, the model that is significant at 1% reported an unusually high elasticity of more than one (65) and a zero coefficient of the ecm. if we discount the model with the extreme elasticity, the weight of the evidence would suggest that the effect of nbfi development on economic growth in south africa is positive. the coefficient of the ecm for south africa ranges between 0.02 and 0.16 for models that reported a positive and significant relationship between nbfi development and economic growth. this shows that there is need to improve the efficiency of the nbfis if south africa is to fully capitalise on the economic benefits emanating from the development of nbfis. long-run relationship between non-bank financial institution development and economic growth when non-bank financial institution development is endogenous this section presents the long-run parameters and the ecm when causality runs from economic growth to nbfi development. in this case, nbfi development is normalised in the model in order to obtain its elasticity in relation to changes in economic growth. we present the results in table 5. table 5: long-run parameters of models with causality running from economic growth to non-bank financial institutions. egypt: four of the six models reported for egypt show that economic growth positively influences the development of nbfis, and significantly so. on the contrary, the remaining two models show a negative effect of economic growth on nbfi development, of which one model shows that the effect is significant. the elasticities of nbfi development to changes in economic growth are more than one for all the six models reported. this shows that growing the economy will generate far more growth in the financial sector, which should in turn influence economic growth as demonstrated above. in addition, the results also show that the coefficient of the ecm for egypt is between 0.01 and 0.11. this is reflective of possible rigidities within the egyptian economy. accordingly, in order to realise greater development of the financial sector as the economy grows, policies should be put in place to minimise rigidities that may exist within the economy. overall, the evidence in egypt suggests that a virtuous cycle exists, wherein nbfi development and economic growth are mutually reinforcing each other. nigeria: although the results presented in table 5 show that the effect of economic growth on the development of nbfis is positive, such effect is not significant and the evidence is weak. the elasticity of nbfi development to changes in economic growth is 0.74 and the ecm is 0.22. south africa: when nbfis is endogenous, only one model shows that the effect of economic growth on the development of nbfis in south africa is both significant and positive. although weak, the evidence suggests that the relationship between nbfi development and economic growth in south africa is predominantly supply-leading, as discussed above. lastly, we show in table 6 the summary of findings from this article on the relationship between nbfis and economic growth. ultimately, the results show that there is a positive long-run relationship between nbfi and economic growth. table 6: summary of findings in respect of the relationship between non-bank financial institutions and economic growth in egypt, nigeria and south africa. conclusion this article investigates the long-run relationship between nbfi development and economic growth in egypt, nigeria and south africa – the three largest african economies. the study employs the johansen cointegration and error correction modelling framework within a country-specific setting. the results of the study can be summarised as follows: firstly, cointegration tests reported in this article show the existence of a long-run relationship between nbfi development and economic growth in egypt and south africa. evidence of such a relationship in nigeria is weak, as only two models (out of a possible 22) were reported. these findings are in line with previous empirical studies, which also found that countries with relatively more developed financial systems exhibit evidence of a long-run relationship between nbfi development and economic growth (cheng & degryse 2007; haiss & sumegi 2008; meng & pfau 2010). secondly, the direction of causality between nbfi development and economic growth in egypt is predominantly bidirectional, while such relationship in south africa predominantly runs from nbfi development to economic growth. the relationship is generally both positive and significant in the two countries. thus, in egypt, the evidence suggests a virtuous cycle in the relationship between nbfi development and economic growth, while in south africa, nbfi development appears to be supply-leading phenomenon. the relatively stronger results in egypt and south africa, compared with nigeria, are not surprising, given the level of development of nbfis in south africa and egypt. the two countries have arguably the most developed financial systems in africa. to this end, well-developed nbfis are expected to mobilise savings and provide mechanisms for risk management and efficient allocation of capital, thus enhancing economic growth. thirdly, the coefficients of the ecm for all three countries suggest inefficiencies in the three countries’ financial systems and rigidities within their economies. specifically, the ecm reported very low values (sometimes close to zero), which suggest that shocks emanating from either the economy or the financial system may not be quickly corrected to restore full equilibrium. as indicated above, there is a dearth of studies investigating the relationship between nbfis and economic growth in africa. to the best of our knowledge, this study is the first one which uses the johansen cointegration and vector error correction model covering such a long period (1971–2013). therefore, the results from our article significantly add to the literature and provide useful insight to policy-makers on the potential of nbfis to stimulate economic growth in the respective countries. on the basis of the empirical results discussed above, the following suggestions emerged for policy consideration in each of the countries. egypt it is suggested that policies be developed and implemented to improve efficiency of the financial system. this will enable the egyptian financial system to efficiently carry out its intermediation role. more efficient intermediation is likely to enhance economic growth, given the existence of significant positive causal link between nbfi development and economic growth. nigeria weak evidence of long-run causality between nbfi development and economic growth in nigeria suggests that factors exogenous to the finance-growth nexus may be at play. in this regard, it is suggested that relevant policies be developed to create an enabling environment which supports the development of the financial sector and growth of the economy. once growth of the economy reaches a certain threshold, both systems may start reinforcing each other, thereby resulting in a positive relationship. specific emphasis may be put on improving the legal systems to guarantee property right as well as improving infrastructure such as roads and electricity. it is also necessary to diversify the economy to put less emphasis on the petroleum sector. south africa based on the low coefficient of the ecm, we suggest that financial sector policies focus on improving the efficiency of nbfis in carrying out their financial intermediary role in that country. therefore, given that traditional bank lending has declined while nbfis have emerged as a potential source of long-term capital, results from this study should be invaluable to policy formulation pertaining to the importance and development of nbfis. however, the weak results maybe emanating from the weak regulatory framework prevailing in most african countries, resulting in nbfis weakly contributing to economic growth. therefore, there is a need to improve the regulatory systems to prevent excessive growth and risk appetite by nbfis, which may have catastrophic consequences in some cases. acknowledgements the authors would like to thank prof. cornelia pop and the two anonymous reviewers for their comments and guidance in drafting this article. competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions r.r. was responsible for data gathering, analysis and providing the initial draft. m.j.a was responsible for designing the econometric framework for the analysis, overseeing the empirical analysis and interpretation of the results as well as general review of the article. references alderman, h. & yemtsov, r., 2013, how can safety nets contribute to economic 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africa marna de klerk department of accounting, university of pretoria, south africa johan g.i. oberholster department of accounting, university of pretoria, south africa citation zulu, m., de klerk, m. & oberholster, j.g.i., 2017, ‘a comparison of the value relevance of interim and annual financial statements’, south african journal of economic and management sciences 20(1), a1498. https://doi.org/10.4102/sajems.v20i1.1498 original research a comparison of the value relevance of interim and annual financial statements mbalenhle zulu, marna de klerk, johan g.i. oberholster received: 12 nov. 2015; accepted: 22 nov. 2016; published: 30 mar. 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: this study tests the value relevance of interim accounting information. the study also explores whether the value relevance of annual and interim financial statements has changed over time. aim: it explores whether the value relevance of interim financial statements is higher than the value relevance of annual financial statements. finally, it investigates whether accounting information published in interim and annual financial statements has incremental value relevance. setting: data for the period from 1999 to 2012 were collected from a sample of non-financial companies listed on the johannesburg stock exchange. method: the ohlson model to investigate the value relevance of accounting information was used for the study. results: the results show that interim book value of equity is value relevant while interim earnings are not. interim financial statements appear to have higher value relevance than annual financial statements. the value relevance of interim and annual accounting information has remained fairly constant over the sample period. incremental comparisons provide evidence that additional book value of equity and earnings that accrue to a company between interim and annual reporting dates are value relevant. conclusion: the study was conducted over a long sample period (1999–2012), in an era when a technology-driven economy and more timely reporting media could have had an effect on the value relevance of published accounting information. to the best of our knowledge, this is the first study to evaluate and compare the value relevance of published interim and annual financial statements. introduction dontoh, radhakrishan and ronen (2004) state that there is a commonly held view that annual financial statements have lost their value relevance because of a shift from a traditional-based economy to a highly technological economy. earlier studies conducted in a traditional-based economy already provided some support for this notion, suggesting that annual financial statement information is not a timely reporting medium (ball & brown 1968), and that interim reports pre-empt some of the information in the annual report (mcnichols & manegold 1983). thus, our overall objective is to evaluate and compare the value relevance of annual and interim accounting information. we develop three distinct objectives with different hypotheses to achieve our overall objective. accounting information is value relevant if it has a predicted association with market value of equity (barth, beaver & landsman 2001; francis & schipper 1999). most prior research has tested the value relevance of accounting information using annual data instead of interim data (six-monthly or quarterly data). yee (2004:2) indicates that academic research into interim reporting is ‘surprisingly sparse’. this appears to be true. examples of studies that use annual financial statement information to test for value relevance include the following: chen and zhang (2007), clarkson et al. (2011), collins, maydew and weiss (1997), dimitropoulos and asteriou (2008), filip and raffournier (2010), francis and schipper (1999), hellstrom (2006), liu and liu (2007) and venter, emmanuel and cahan (2014). compared to the above, no prior study could be found that examines the value relevance of interim financial statement information. four related studies used either a survey design (taylor 1965) or focused on quarterly earnings announcements with an event study methodology (brown & niederhoffer 1968; opong 1995; vieru, perttunen & schadewitz 2006). the above-mentioned studies only tested the value relevance of annual financial statements and did not control for the value relevance of financial statements at interim reporting date; thus, we argue that the value relevance of annual financial statements can be a function of the value relevance of interim financial statements. it is this gap in the accounting literature that the study attempts to fill in. given the extensive evidence provided in prior research of the value relevance of annual financial statement information, our first objective is to investigate the value relevance of interim financial statement information (earnings and book values of equity). the second objective is to explore whether the value relevance of interim financial statement information and annual financial statement information has changed during the sample period. there are a number of studies that use annual accounting information to test for a change in value relevance and they provide mixed results, for example, gjerde, knivsfla and saettem (2011), goodwin and ahmed (2006) and thinggaard and damkier (2008). relevant to this study is the study by landsman and maydew (2002), who evaluated the changes in the value relevance of quarterly earnings announcements (not interim financial statements) using data from the 1980s. hence, our study is the first study to investigate the changes in the value relevance of interim accounting information. the third objective of this study is to investigate if accounting information in interim and annual financial statements is incrementally informative. early studies suggest that the annual report is not always a timely communication medium and that quarterly interim reports may allow investors to pre-empt some of the information in the annual report (ball & brown 1968; firth 1981; rippington & taffler 1995; shores 1990). similarly, mcnichols and manegold (1983) conclude that the marginal information content of an annual report is greater when it is not preceded by an interim report. following biddle, seow and siegel (1995), incremental comparisons are relevant when one or more accounting measures are taken as given and, thus, where it is necessary to assess the incremental contribution of the measures (also see venter et al. 2014). we argue that incremental comparisons are relevant to both book value of equity and earnings. we argue that although book value of equity is measured cumulatively at a specific point in time (cumulative value at reporting date in either the interim financial statements or the annual financial statements), it is possible that companies are considering measurement issues relevant to property, plant and equipment and other assets more at annual reporting date than at interim reporting date. reported earnings figures represent earnings for a specific period (in the context of this study, either for the 6-month period ending at the interim reporting date or the 12-month period ending at the annual reporting date). we argue that incremental comparisons between interim earnings and additional earnings that accrue to a company between interim and annual reporting dates are relevant to the study. there is currently no prior evidence on the incremental value relevance of earnings and book values of equity reported in interim and annual financial statements. thus far, no previous study could be found that has examined the value relevance of interim accounting information. our study is also the first to investigate changes in the value relevance of interim accounting information, if any. we also contribute to the debate regarding changes in the value relevance of annual accounting information. finally, to the best of our knowledge, this is the first study to test the incremental value relevance of interim and annual accounting information. we use the available data of all non-financial listed companies on the johannesburg stock exchange (jse) for the period 1999–2012 to test our hypotheses. the jse is the largest stock exchange in africa with a market capitalisation of r10.5 billion on 31 december 2014 (jse 2014), thus making the results relevant to the global economy and investors interested in investing in a south african company. according to the global competiveness report, issued by the world economic forum (2015), the jse compares well with some of the largest stock exchanges in the world in terms of market efficiency. the jse requires all listed companies to publish interim financial statements on a six-monthly basis (jse 2012). our sample enables us to test the value relevance of accounting information for small and large companies in an efficient market (also see prather-kinsey 2006). using the ohlson (1995) model as a basis, the results show that interim accounting information has a higher explanatory power for market value of equity than annual accounting information (88.2% compared to 52.5%). the results also show that the value relevance of both interim and annual accounting information has remained fairly constant over the sample period, except for the years 2006 and 2007 where there was a structural break in the relationship between market values of equity and book values of equity and earnings. incremental comparisons provide evidence that book value of equity at interim reporting date has a positive and significant association with market value of equity, and the movement in book value of equity between the interim and annual reporting date has a positive and significant association with market value of equity. incremental comparisons between interim earnings and earnings that accrue to a company between interim and annual reporting dates show that interim earnings are not value relevant in comparison with additional earnings that are value relevant. the results are robust when loss-companies are eliminated from the sample as well as for alternative specifications of the regression models used. the results of the study will be of interest to investors when considering financial statement information for purposes of investment decision-making, and preparers of financial statements when considering the cost–benefit decisions regarding the level of detail to be disclosed or recognised in interim reports. the results may also be of interest to standard setters and regulatory bodies as the results show that additional book value of equity and additional earnings which accrue to a company between interim and annual reporting dates are value relevant. finally, the results will be of interest to accounting academics interested in the value relevance of published financial statements. the remainder of this article is organised as follows: the next section provides study backgrounds, while the ‘prior literature and hypotheses development’ section reviews the relevant prior literature and states the hypotheses. the ‘research method’ section describes the sample selection procedure, data and research method used. the ‘results’ section presents the results of the study and the ‘conclusion’ section concludes the article. background to the study prior research on the value relevance of accounting information published in annual financial statements, conducted in different settings (e.g. international financial reporting standards (ifrs) adoption countries versus countries where locally developed generally accepted accounting practices were applied, common versus code law countries, etc.), provides evidence that annual accounting information is value relevant to market participants (see barth et al. 2001; cahan et al. 2000; clarkson et al. 2011; collins et al. 1997; devalle, onali & magarini 2010; dontoh et al. 2004; filip & raffournier 2010; francis & schipper 1999; gjerde et al. 2011; goodwin & ahmed 2006; hellstrom 2006; holthausen & watts 2001; kothari 2001; prather-kinsey 2006; thinggaard & damkier 2008). not much prior research has been conducted on the value relevance of interim accounting information. prior literature on the value relevance of interim accounting information is discussed in the next section. the jse listing requirements mandate the publication and distribution of interim reports ‘after the expiration of the first six-month period of a financial year, by no later than three months after that date’. international accounting standard (ias) 34, interim financial reporting, applies when an entity prepares an interim financial report; it was issued in june 1998 and is operative for periods beginning on or after 01 january 1999. south africa formally adopted ifrs in 2005 and interim reports are prepared in accordance with ias 34. prior to 2005, interim financial statements were prepared in accordance with the south african accounting standard ac 127, interim financial reporting, which was almost identical to ias 34 (oberholster 2014). prior literature and hypotheses development value relevance of interim financial statements previous literature summarised in the ‘background to the study’ section provides extensive evidence that accounting information published in annual financial statements is associated with share prices or market value of equity. in comparison, little research has been conducted using interim accounting information. taylor (1965) published one of the early studies on the usefulness of interim reports. he surveyed the united states’ financial analysts on the usefulness of the interim report and its ability to provide information that may affect share price and found that over 84% of the analysts indicated a strong positive feeling regarding the usefulness of such a report. another early study conducted by brown and niederhoffer (1968) provided evidence that quarterly earnings as conveyed by the interim report are useful as a predictor of annual earnings. these studies suggest that interim reports can be useful for investors but do not show if the information contained in the reports is associated with market values of equity. in addition, opong’s (1995) event study investigated whether a public release of an interim financial report in the united kingdom led to a share price reaction on the day of release. the study found that interim accounting information has information content that leads to a share price reaction on the day of the release. our study however does not focus on the release of interim accounting information and the effect on share prices; rather, it focuses on the association of interim accounting information published in interim financial statements with share prices – it is an association study. another study by vieru et al. (2006) investigated investors’ trading behaviour around interim earnings announcements and found that trading increased before the interim earnings announcement. quarterly or interim earnings announcements have also been found to be associated with higher share price volatility (alegria, mckenzie & wolfe 2009). rahman et al. (2007) examined the advantages and disadvantages of quarterly reporting in a voluntary setting and found that quarterly reports are associated with higher analyst following and higher share price volatility. based on the prior literature that shows that interim reports and interim earnings announcements are associated with share prices and higher share price volatility on the day of release, we expect there to be an association between market values of equity and interim earnings and book values of equity; hence, the first hypothesis is stated as follows: h1: interim earnings and book values of equity (published in interim financial statements) are associated with market values of equity. prior literature as described in the ‘background to the study’ section provides evidence that annual reported earnings and book value of equity are associated with market value of equity. a study by prather-kinsey (2006) found that on the jse, annual earnings and the book values of equity are value relevant in explaining share prices. that study used data for the years 1998–2000 when south africa was still moving towards convergence with ifrs. in contrast, this study cuts across both the pre-ifrs adoption period (1999–2004) and the post-ifrs adoption period (2005–2012), as it is possible that the association between annual accounting information and the market value of equity may have changed over time. with our overall objective in mind, we evaluate in an additional test whether this holds true over our extended sample period. changes in the value relevance of annual and interim financial statements over time the increased use of technology has made it possible for users of financial statements to have access to information on a timelier basis. following dontoh et al. (2004), there is a commonly held view that annual financial statements have lost their value relevance because information is now more readily available than it used to be. previous empirical research provides mixed results on whether the value relevance of annual accounting information has changed over time. previous research was conducted in different countries, used different (and often much earlier) sample periods, and yielded mixed results. the results range from a decline in value relevance to an increase in value relevance. previous studies are discussed in more detail below. firstly, one group of studies shows a decline in the value relevance of the annual accounting information over time. these studies examine the value relevance of earnings, book values of equity and change in the value relevance of earnings and book values of equity, and view the r2s as a reflection of value relevance (brown, lo & lys 1999; dontoh et al. 2004; lev & zarowin 1999). these studies show that the value relevance of accounting information has declined over time. secondly, one study by thinggaard and damkier (2008) reports no change in the value relevance of annual accounting financial information over time. the study investigated whether the financial statement information became less value relevant in denmark in the period from 1982 to 2000. thirdly, another group of studies suggest that the value relevance of annual financial information has increased over time. gjerde et al.’s (2011) study investigated the changes in the value relevance of financial reporting in norway during the period from 1995 to 2004 and reported an increase in the value relevance. hellstrom (2006) examined the value relevance of accounting information in czech republic during the period 1994–2001. using an adjusted r2 as a measure of value relevance, the study found that the value relevance has increased during the sample period. furthermore, goodwin and ahmed’s (2006) study investigated the value relevance of earnings and book values of equity over time in australia during the period from 1975 to 1999. comparing r2s, their results show that the value relevance of both earnings and the book value of equity have increased. lastly, it has been argued that the value relevance of the accounting data in europe after the introduction of the ifrss strengthened as a consequence of adopting the ifrss (devalle et al. 2010). based on the prior literature that provides a range of mixed results on the changes in the value relevance of the annual accounting information, this hypothesis is stated in its null form as follows: h2(a): the association of reported annual earnings and book values of equity with market values of equity has not changed over the sample period. landsman and maydew (2002) used beaver’s (1968) abnormal trading volume and abnormal return volatility to examine the changes in the information content of quarterly earnings announcements over the period 1972–1988. using a random sample of 108 000 firm-quarter observations, they reported that the informativeness of quarterly earnings announcements increased over time. landsman and maydew’s (2002) study is different from our study as that did not empirically test the changes in the value relevance of interim accounting information published in interim financial statements but only tested the changes in the value relevance of quarterly earnings announcements. hence, our study is the first to investigate the changes in the value relevance of interim accounting information published in interim financial statements. because of the lack of prior literature that investigates the changes in value relevance of interim accounting information, the next hypothesis is stated in its null form as follows: h2(b): the association of reported interim earnings and book values of equity with market values of equity has not changed over the sample period. no prior study has compared the value relevance of interim financial statements with that of annual financial statements although some studies suggest that such a hypothesis might hold true. for example, an early work by ball and brown (1968) shows that the annual income report is not a timely medium because 85%–90% of its content is captured by more prompt media which may include interim reports. similarly, an early study conducted by mcnichols and manegold (1983) also suggests that interim financial reports pre-empt some of the information contained in annual reports and thus reduce the informativeness of annual reports. in addition, shores (1990) reports on the association between the interim information and security returns around the earnings announcement dates using a sample of firms whose securities trade over-the-counter over a period of 1 year (1983–1984). he shows that the amount of information content of annual earnings announcement is negatively associated with the level of interim information, while the extent of pre-emption of that information content is positively associated with the level of interim information. following this line of arguments, the next hypotheses are stated as follows: h2(c): interim earning and book values of equity have a stronger association with market values of equity than annual earnings and book values of equity over the sample period. incremental value relevance of accounting information in interim and annual financial statements firth (1981) conducted an early event study on the information content of financial results and argues that the interim report has information content as a result of it being timelier than the annual report. rippington and taffler (1995) confirm firth’s (1981) findings, stating that the interim report is more useful to investors than the annual report. if six-monthly reported interim earnings pre-empt the annual earnings and are useful to the markets as indicated by earlier research, we expect interim earnings to be associated with market value of equity. in addition, we would expect earnings which accrue to a company between interim and annual reporting period not to be associated with market value of equity. however, it is also possible that a six-monthly interim report does not allow an investor to pre-empt annual earnings as well as quarterly earnings. in this case, we would expect additional earnings to be associated with market value of equity measured at financial year end. we argue that the same concepts are relevant to book value of equity at interim reporting date and the movement in book value of equity from interim reporting date to annual reporting date. if interim book values represent to a large extent the book values at financial reporting date, then they would be positively and significantly associated with market value of equity at year end, and the movement between book value of equity from interim reporting date to annual reporting date would not be value relevant. however, if this is not the case, the movement in book value of equity between these two dates would be value relevant, that is, associated with market value of equity. the hypothesis is developed to test whether interim financial statements and annual financial statements contain value relevant information incremental to each other and is stated as follows: h3: accounting information (earnings and book values of equity) in interim financial statements as well as the changes in these values between interim and annual reporting dates are (are not) associated with market value of equity at financial year end. research method data and sample selection we began our sample selection with 367 listed or dual-listed companies on the jse mainboard with company data on the mcgregor bfa database (as per the report downloaded from the mcgregor bfa database on 11 june 2014). all the required data (i.e. annual, interim financial statements and share price data) are available from the mcgregor bfa database. following prior research, we excluded 69 financial companies because the nature of their financial ratios is different from other companies. we further excluded 40 companies which were listed on the jse during 2011 and 2012 as these companies did not have published annual and interim financial statements during the sample period. this yielded a potential sample of 258 companies. from a potential sample of 3612 observations (258 companies*14 years), we lost some observations because of the fact that some companies had a shorter listing period, that is, listed during the sample period or delisted during the sample period (we do not eliminate companies with shorter listing periods – sample companies are required to have one financial year where both an interim and an annual report were published). a final sample of 2296 annual and interim observations has been used in our analysis, with a total of 4592 observations for our pooled analysis. table 1 shows the sample composition. the industrial sector has the most representation (30.6%) in our sample, followed by the basic materials sector with 26% and the consumer services sector with 16.7% of the total number of companies included in the sample. table 1: sample composition. method value relevance of interim financial statements previous research using the ohlson (1995) model provides evidence that accounting information (book value and earnings) in annual financial statements (see the background to the study section) is value relevant. following prior research, we use the ohlson (1995) model to test our hypotheses. our objective is to test whether interim earnings and book values are associated with market values of equity (hypothesis 1). our secondary objective relevant to this section of the paper is to confirm prior findings in the literature that annual accounting information is associated with market values of equity. the unscaled ohlson (1995) model is specified as follows: where mveit is the market value of equity (share price times number of shares outstanding) for firm i measured 3 months after the reporting period (t); bveit is the book value of equity for firm i at the end of the reporting period (t), earnit is the net profit after tax for firm i for the period under examination (t),and ɛit is the error term. following barth, landsman and lang (2008), devalle et al. (2010), hellstrom (2006) and venter et al. (2014), we used a levels approach and winsorised all the variables at a 95% level to mitigate the effects of outliers in the sample (barth et al. 2008). we recognise that size could have an effect on the inferences drawn from level specifications and scaled all our variables with number of shares 3 months after reporting date (see barth & clinch 2009). a 3-month lag period was used to allow time for accounting information to be communicated to the public. following chen, liu and ryan (2008), gow, ormazabal and taylor (2010) and peterson (2009), we corrected for cross-sectional and time-series dependence in our data by clustering standard errors by firm and by year. peterson (2009) argues that clustering standard errors on multiple dimensions (by firm and by year) will yield correct inferences and correct for correlated residuals in the dataset. the ordinary least squares regression (ols) results are presented in table 3 and discussed in the ‘hypothesis 1’ section. for robustness purposes, we estimated the ols regressions for equation 1 using share price data at the end of the reporting period instead of a 3-month lag to control for the possibility that the financial results could have been anticipated by shareholders before the reporting date. in addition, following the recommendation by barth and clinch (2009), we used an unscaled model of the ohlson (1995) model and measured market value of equity with a 3-month lag after the interim and annual reporting periods as well as at the end of the reporting periods. following filip and raffournier (2010), we also controlled for the possibility that loss-making firms could have different associations with market value of equity. the untabulated results of the robustness tests are reported in the ‘hypothesis 1’ section. changes in the value relevance of annual and interim financial statements over time we have two overall objectives related to hypothesis 2. firstly, to explore (we do not test this statistically) whether the value relevance of annual (see hypothesis 2[a]) as well as interim (see hypothesis 2[b]), financial statements has changed from year to year during our sample period. secondly, to explore whether interim information has higher value relevance than annual accounting information, or vice versa (see hypothesis 2[c]). following prior research, we used the ohlson (1995) model and compared the adjusted r2s of regression results from year to year (see collins et al. 1997; devalle et al. 2010; dontoh et al. 2004; francis & schipper 1999; goodwin & ahmed 2006; hellstrom 2006). we used the ohlson (1995) model as specified in equation 1 and estimated it per year for annual and interim financial periods, respectively. as the ols regressions results are estimated per year, serial correlation is not a concern; hence, we do not cluster standard errors per year. the combined ols results for the value relevance of annual and interim financial statements over the sample period (using r2s as measure) are presented in figure 1 and discussed in the ‘hypotheses 2(a), (b) and (c)’ section. year-to-year comparisons enabled us to evaluate hypothesis 1(c). figure 1: exploratory evidence on hypotheses 2(a), (b) and (c): comparing adjusted r2s of annual and interim regressions using the ohlson model. for robustness purposes, we estimated the ols regressions using share price data at the end of the reporting period instead of a 3-month lag. in addition, we used an unscaled model of the ohlson (1995) model, and measured market value of equity with a 3-month lag after the interim and annual reporting periods as well as at the end of the reporting periods. the untabulated results are reported in the ‘hypotheses 2(a), (b) and (c)’ section. incremental value relevance of accounting information in interim and annual financial statements we follow two steps to test hypothesis 3. the objective of the first step is to confirm whether accounting information, in general (published in annual and interim financial statements, using a pooled dataset), is value relevant to market participants. the objective of the second step is to evaluate the incremental value relevance of the changes in book value of equity and changes in earnings between interim and annual reporting dates. in step 1, we run a pooled ols regression for equation 1. we argue that pooling data in this manner is similar to pooling data for large and small listed companies in one sample and thus similar to other studies that employed the ohlson (1995) model. if the coefficients of α1 and α2 in equation 1 are associated with market value, we can infer that accounting information in general is value relevant to shareholders. the results are presented in table 4 and discussed in the ‘hypotheses 3’ section. the approach that we follow for step 2 is similar to that followed by venter et al. (2014), where the authors tested whether headline earnings (i.e. non-ifrs earnings as measured based on certain criteria specified by the jse) have incremental value relevance. venter et al. (2014) focused on information available in annual financial statements. in this study, we argue that incremental comparisons are relevant to both book value of equity and earnings as measured at interim and annual reporting dates. we are interested in whether book values of equity measured at interim reporting data as well as the movement in book values of equity between interim and annual reporting dates are value relevant to shareholders. we are also interested in whether earnings at interim reporting date and the additional earnings that accrue to a company between interim and annual reporting dates are value relevant. we respecified the unscaled equation 1 as follows: where mveit is the market value of equity 3 months after annual reporting date, bve_intit is the book value of equity for firm i at the end of the interim period (t), bve_addit is the book value of equity for firm i at the end of the annual reporting period (t) minus bve_intit; earn_intit is the net profit after tax for firm i for the interim financial period under examination (t), earn_addit is the net profit after tax for firm i for the annual period under examination (t) minus earn_intit, and other variables are as specified earlier. the sum of bve_intit and bve_addit represents the aggregate value of book value of equity at annual reporting date, bveit. similarly, the sum of earn_intit and earn_addit represents the aggregate value of earnings at the annual reporting date. variance inflation factors (vifs) for equation 2a range between 1.44 and 5.56, and for equation 2b they range between 1.08 and 1.11. the vifs are below 10, which is lower than the maximum acceptable level of 10 (marquardt 1970). therefore, multicollinearity is not a concern in our regression results. all variables are scaled with number of shares measured 3 months after the annual reporting period and standard errors are clustered per firm and per year. we evaluate whether α1 = α2 in equation 2a, to consider the incremental value relevance of the book value of equity as measured at interim reporting date and the movement in book value of equity from the interim reporting date to the annual reporting date. similarly, we evaluate whether α3 = α4 in equation 2a, and whether α2 = α3 in equation 2b, to consider the incremental value relevance of the earnings as measured at the interim reporting date and the additional earnings accrued between the interim and the annual reporting dates. results descriptive statistics panel a of table 2 presents the descriptive statistics of the undeflated variables used in the ohlson (1995) model for the annual data during the 14 years of observations. the currency is south african rand (zar) for all the variables. the mean (median) market value of equity (mve) 3 months after the annual reporting date is r11.3 billion (r821.7 million). the mean (median) for book value of equity (bve) is r4.3 billion (r531.1 million), while the mean (median) for earnings (earn) is r957.7 million (r73.8 million). table 2: descriptive statistics for the ohlson (1995) model. panel b of table 2 presents the descriptive statistics of the undeflated variables used in the ohlson (1995) model for the interim data during the 14 years of observations. the mean (median) for mve 3 months after the interim reporting date is r10.3 billion (r792.4 million). the mean (median) for bve is r3.3 billion (r431.1 million); while the mean (median) for earn is r435.3 million (r33.2 million). panel c of table 2 presents the descriptive statistics of the undeflated variables used in the ohlson (1995) model for the pooled dataset (i.e. where interim and annual information is combined into one dataset) during the 14 years of observations. the mean (median) for pooled market value of equity 3 months after the annual reporting date and interim reporting date is r10.8 billion (r808.7 million). the mean (median) for bve is r3.8 billion (r449.5 million), while the mean (median) for earnings is r700.9 million (r48.2 million). hypothesis 1 table 3 presents the results for testing whether interim (hypothesis 1) and annual accounting information are value relevant. for interim data, bve at interim reporting date is significant at 1% level, while net income at interim reporting date is not significant. this could mean that shareholders place more reliance on bve at interim reporting date, which is a cumulative figure than interim earnings which are due to change. interestingly, the interim model exhibits a higher adjusted r2 of 88.2% than the annual model with an adjusted r2 of 52.5%. these results show that bve at interim reporting date is value relevant; however, net income at interim reporting date is not value relevant, hence hypothesis 1 is partially supported. the results also show that both bve and net income at annual reporting date are significantly associated with market values of equity, hence confirming prior findings (barth et al. 2001; kothari 2001). table 3: ols estimation with time and firm clustered standard errors of equation 1: hypothesis 1: (mveit = α0 + α1bveit + α2earnit + ɛit). following filip and raffournier (2010), we run additional separate regressions to test the effect that loss-making companies have on the value relevance tests. the untabulated results show a significant increase in the adjusted r2 of the annual data model to 88.8% compared with 52.5% for the model including negative earnings (as reported in table 3). for the interim data, the adjusted r2 slightly increases to 88.3% for positive earnings only compared with 88.2% for the whole sample (see table 3). this is not surprising because losses have been found to reduce the value relevance of earnings and therefore reduce the value relevance of the model containing negative earnings (collins et al. 1997; hayn 1995; venter et al. 2014). a similar finding was observed in a study conducted by filip and raffournier (2010), where they found an increase in the explanatory power of the model when negative earnings were excluded from the analysis. they attribute this finding to the view that negative earnings are more transitory than positive earnings. the coefficients for bve and earn as reported in table 3 remain qualitatively similar when loss-companies are excluded from the sample for both interim and annual reporting periods. the untabulated results of the additional robustness tests for hypothesis 1 are qualitatively similar to those obtained in the main model and support the results presented in table 3. hypotheses 2(a), (b) and (c) figure 1 reports the results of hypothesis 2(a), namely that the association of annual earnings and book values of equity with share price has not changed over the sample period; and hypothesis 2(b), namely that the association of interim earnings and book values of equity with share price has not changed over time. the darkest-shaded region represents the explanatory power of the annual yearly regressions, while the lightest-shaded region represents the explanatory power of the interim yearly regressions. the adjusted r2 of the yearly regressions ranges between 19.3% (2007) and 89.9% (2002) for the annual data; and 13.5% (2007) and 98.9% (2000) for the interim data. the adjusted r2 of both models appear to be fluctuating throughout all the years under observation. a similar finding was observed by thinggaard and damkier (2008) that the value relevance of annual accounting information has not changed over the years. an interesting observation to note is that the explanatory power of the interim model is higher than the explanatory power of the annual model in 8 years out of a total of 14 years under observation, thus providing support for hypothesis 2(c). hypothesis 2(c) is also supported when we compare the adjusted r2 of interim accounting information with the adjusted r2 of annual accounting information as presented in table 3 (88.2% compared with 52.5%). interesting to note from the inspection of figure 1 is that the explanatory power of the interim model was at its lowest in 2007 (13.5%), as well as the explanatory power of the annual model was at its lowest in 2007 (19.3%). we argue that this could have been because of the global financial and economic crisis that hit the world, including south africa in december 2007 until mid-2009 (steytler & powell 2010:3). this crisis led to a slower economic growth, combined with lower commodity prices and a slowdown in capital flows to developing countries. all these negative factors could have negatively affected earnings and book values of equity for jse listed companies (baxter). the crisis was so severe that the jse stock exchange devalued by almost 20% and the rand depreciated by almost 37% against the us dollar during june/july 2008 (viegi 2008). we argue that a devalued share price associated with decreased earnings for the period could have resulted in the drop in the explanatory power of both models. following badenhorst, brummer and de wet (2015), devalle et al. (2010) and gu (2007, we performed the chow test (chow 1960) to establish if there was a structural break in the relationship between market values of equity and interim and annual accounting information between the years 2005, 2006, 2007 and 2008. the chow test (p-values) (untabulated) is significant at the 1% level for annual accounting information between the years 2005 to 2006, 2006 to 2007 and 2007 to 2008. this indicates that there was a structural break in the relationship between market values of equity and interim earnings and book values of equity during the above-mentioned years. the explanatory power decreased from 72.6% in 2005 to a low 29.4% in 2007 and further decreased to 19.3% in 2007. for interim data, the chow test (p-values) (untabulated) is not significant between the years 2005 and 2006 and it is positive and significant at the 1% level between the years 2006 and 2007. this indicates that there was a structural break in the relationship between market values of equity and interim earnings and book values of equity in 2007. the explanatory power of the interim regression decreased from 93% (2006) to a low 13.5% (2007) and subsequently increased to 81.9% (2008). the untabulated results of the robustness tests are qualitatively similar to those obtained in the main model and support the results presented in figure 1. hypothesis 3 table 4 contains the results of the ols pooled regression, testing whether accounting information published in annual and interim financial statements is value relevant (step 1 to test hypothesis 3). as our data are subject to cross-sectional and time-series dependence, we report results for the coefficient estimates and t-values that are calculated using firm and time-clustered standard errors (chen et al. 2008; gow et al. 2010; peterson 2009). as expected, the coefficients of bve and earn are both positive and significant at the 1% level. the model exhibits a high explanatory power of 88.5% as measured by the adjusted r2. these results show that accounting information in general, using one combined dataset for annual and interim reporting values, is value relevant as predicted in prior literature (see the background to the study section). table 4: ols estimation with time and firm clustered standard errors of equation 1: hypothesis 3, step 1 (mveit = α0 + α1bveit + α2earnit + ɛit). table 5 presents results of the ols regression, testing the incremental value relevance of the changes in book values of equity and changes in earnings between interim and annual reporting dates (equation 2a). the first coefficient of interest, bve_addit, is positive and significant at 5% level, while the second coefficient of interest, earn_addit, is positive and significant at 1% level. the coefficient of bve_intit is positive and significant, while the coefficient of earn_intit is positive and not significant, suggesting that earnings which accrue to a company between interim and annual reporting periods are more value relevant than interim earnings. it appears as if shareholders place more emphasis on additional earnings than on earnings at interim reporting date. table 6 presents results of the ols regression for equation 2b. the coefficient of earn_addit estimate (0.086) is higher than the coefficient estimate (significant at 1% level) of earn_intit (0.037) (not significant), supporting the results found in equation 2a, namely, that interim earnings is not value relevant to market participants. overall, these results show that both bve_intit and bve_addit are significantly associated with market values of equity. table 5: ols estimation with time and firm clustered standard errors of equation 2a: hypothesis 3, step 2 (mveit = α0 + α1bve_intit + α4bve_addit + α2earn_intit + α5earn_addit + ɛit). table 6: ols estimation with time and firm clustered standard errors of equation 2b: hypothesis 3, step 2 – additional analysis (mveit = α0 + α1bveit + α2earn_intit + α5earn_addit + ɛit). for robustness purposes, we scaled all the variables with number of shares at reporting date and used an unscaled model where market value of equity is measured 3 months after reporting date, as well as at reporting date. the untabulated results of the ols two-way clustered standard errors regressions for equations 2a and 2b are qualitatively similar to the main model, where all the variables are scaled by the number of shares 3 months after reporting date. conclusion the overall objective of the study is to evaluate and compare the value relevance of annual and interim accounting information. the study examines the value relevance of interim accounting information and is, to the best of our knowledge, the first study to explore if this value relevance has changed over the sample period. in addition, this is the first study to evaluate whether accounting information (earnings and book values) published in interim and annual financial statements, respectively, has incremental value relevance. the sample consists of non-financial listed companies on the jse over the period from 1999 to 2012. the jse mandates companies to publish interim reports on a six-monthly basis. the jse is the largest stock exchange in africa and has an efficient stock market (world economic forum 2015); thus, it provides a strong setting for testing the value relevance of accounting information that will be of interest to the global market. firstly, our results show that interim book values of equity are positively and significantly associated with market values of equity, while interim earnings are not significant. secondly, the results provide exploratory evidence that the value relevance of both annual and interim earnings and the book values of equity have not changed over the years. in addition, the incremental evaluations show that additional bve and earnings, which accrue to a company between interim and annual reporting date, are value relevant. the results do not provide support for the notion that interim earnings allow investors to pre-empt annual earnings (see firth 1981; rippington & taffler 1995) as it is not associated with market value of equity, whereas earnings that accrue to a company between interim and annual reporting dates have a positive association with market value of equity as measured at financial year end. the results are robust for various model specifications. the findings will be of interest to managers when making disclosure decisions, as well as investors and financial analysts when analysing published accounting information. the findings will also be of interest to standard setters and regulatory bodies as the results show that earnings figures in interim financial statements are not associated with market value of equity. this is particularly interesting considering that ias 34, interim financial reporting, requires jse listed companies to publish and distribute interim financial statements. the questions which the results of this study raise are as follows: is the cost of preparing an interim report worth the perceived benefits? if interim earnings are not associated with market value of equity, why should companies continue doing so? future research could possibly address these questions. future research is also needed to establish whether there are differences in the value relevance of interim accounting information prior to ifrs adoption (2005) and after ifrs adoption (2006), although the evidence presented in figure 1 seems to indicate that the differences would be negligible. in addition, future research could test the market reaction of interim earnings and bve using a market return specification, similar to the research design of an event study. finally, future research could conduct a similar study in countries where it is voluntary to prepare and publish interim financial reports or, alternatively, where it is mandatory to publish interim reports on a quarterly basis instead of a six-monthly basis. acknowledgements 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literature study data and methodology results and discussion conclusions and suggestions for future work acknowledgements references appendix 1 footnotes about the author(s) dirk visser department of risk management, school of economics, north-west university, south africa gary w. van vuuren department of risk management, school of economics, north-west university, south africa citation visser, d. & van vuuren. g.w., 2018, ‘procyclicality in tradeable credit risk: consequences for south africa’, south african journal of economic and management sciences 21(1), a1706. https://doi.org/10.4102/sajems.v21i1.1706 original research procyclicality in tradeable credit risk: consequences for south africa dirk visser, gary w. van vuuren received: 20 nov. 2016; accepted: 23 feb. 2018; published: 24 may 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: tradeable credit assets are vulnerable to two varieties of credit risk: default risk (which manifests itself as a binary outcome) and spread risk (which arises as spreads change continuously). current (2017) regulatory credit risk rules require banks to hold capital for both these risks. aggregating these capital amounts is non-trivial. aim: the aim was to implement the bubble value at risk (buvar) approach, proposed by wong (2011) to overcome the risk aggregation problem. this method accounts for diversification and for procyclicality and operates by inflating the positive side of the underlying return distribution, in direct proportion to prevailing credit spread levels (usually liquid credit default swap spreads). setting: the principal setting for the study was the south african credit market which represents a developing market. previous work by wong (2011) focussed only on developed markets. methods: using south african data, closed form solutions were derived for free parameters of wong’s formulation, and the relationship between the spread level and the response function was developed and calibrated. results: the results indicate that the original calibrations and assumptions made by wong (2011) would result in excessive capital requirement for south african banks. estimates obtained from this work suggest further calibration is required to cover the unique features of the south african milieu. considerable differences compared with other markets were also found. conclusion: the application of buvar to south african government bond credit default swaps spreads highlighted the metric’s countercyclical properties that would potentially have countered bubble developments had they been implemented during the credit crisis of 2008/2009. regulatory authorities should take this important metric into account when allocating south african bank’s credit risk capital. introduction credit losses experienced in the financial crisis of 2008–2009 emphasised the complexities surrounding tradeable credit instruments. in their fundamental review of the trading book, the basel committee on banking supervision (bcbs 2013) asserted that credit-related products had been a major source of losses and the approach and treatment of these positions were severely flawed. the crisis also prompted financial institutions to change their evaluation and management of credit risk substantially (bcbs 2015). a 2013 global survey conducted by the joint forum on banking firms and supervisors revealed that since the crisis banks have improved governance and risk reporting and that risk aggregation has become far more sophisticated (bcbs 2015). modelling enhancements driven by regulatory requirements stress testing and crisis experience has significantly shifted institutions’ reliance to internal models as the ‘search for yield’ intensifies in a post-crisis low interest rate environment (bcbs 2015). despite these promising developments, the bcbs has attempted to align the requirements of the trading book1 more closely with those of the banking book (bcbs 2013). the bcbs (2013) proposes substantial revisions to many aspects of the treatments of market risk – these have now (2018) been reviewed by market participants and approved for implementation (bcbs 2014). in the trading book, tradeable credit instruments are associated with two sources of risk. firstly, default risk in which there is a probability that the underlying issuer may forfeit its obligation through contractual non-compliance (brown & moles 2014) and, secondly, spread risk in which losses arise from changes in an instrument’s credit spread. this spread can be defined as the instrument’s yield relative to that of a comparable-duration default free instrument and is not attributable to defaults or credit migrations (bcbs 2009). the complicated relationship between credit and market risk and the aggregation of these risks are emphasised by the fact that approximately two-thirds of financial crisis (2008–2009) losses were attributable to spread risk with only a third of the losses stemming from actual defaults (bcbs 2011). sophisticated financial instruments based on securitisation played a pivotal role in the financial crisis masking risk and increasing the interconnectedness of financial markets. a downward spiral of the quality of the securities backing these instruments caused several rating downgrades of these instruments and precipitated chaos within globally interconnected financial markets. further, the procyclical nature of these markets, albeit contributing significantly to the pre-crisis market euphoria, fuelled one of the biggest busts in financial history (bank for international settlements 2008; papaioannou et al. 2013). procyclicality – defined as those economic quantities that are positively correlated with the overall state of the economy (van vuuren 2012) – leads to institutions reducing lending capacity throughout market busts. regulatory capital models using data from busts would recommend banks keep higher levels of capital as well (this is also influenced by stress testing of models); the opposite is true in financial booms. this procyclical characteristic of markets, methods and metrics has been countered by the introduction of the countercyclical capital buffer (ccb) by the bcbs in 2010 which is based on the aggregate credit-to-gdp gap ratio (bcbs 2010). the buffer is mostly untested in emerging and developing markets and thus the complexities regarding its implementation and timing have not been comprehensively divulged. value at risk (var) has been the preferred market risk measurement tool since 1994 (bcbs 1994), but suffers from significant shortcomings, many of which played a significant role in the crisis. these problems were partially ameliorated by the replacement of var with expected shortfall (es) in 2018 (bcbs 2013). although var is relatively simple to calculate, it does not account for risk aggregation and is also procyclical in nature. further, var models used in credit risk measurement are mostly dependent on regulatory information such as rating transition matrices making these models slow to reflect current market conditions. es solves some of var’s shortcomings as it embraces not only the likelihood of losses, but also the size of losses beyond the var confidence level, thus accounting for risk in a more comprehensive manner (bcbs 2013). however, procyclicality remains an issue as es uses the same historical data produced by markets as var does. this necessitates the use of a ccb. however, further analysis of the proposed buffer components has suggested alternatives to the credit-to-gdp gap. the research includes that of barrell et al. (2010), shin (2013) and behn et al. (2013) who all proposed alternatives to this metric. drehmann and tsatsaronis (2014) review these studies and argue that the credit-to-gdp gap is the best standalone early warning indicator over forecast horizons of 2 to 5 years. they further find that the debt service ratio (dsr) is the best single indicator for forecast horizons shorter than 2 years. drehmann and tsatsaronis assert that both judgement and quantitative analysis are required by policymakers as there are no foolproof models that provide an effective rule-based countercyclical measure. further, although the credit--to-gdp gap ratio was found to be optimal, drehmann and tsatsaronis found that a combination of other indicators may work better for certain jurisdictions. applying conventional var to tradeable credit instruments poses challenges, as all the risks pertaining to these instruments are not adequately captured in the measurement (amato & remolona 2003; elton et al. 2001). further, under the basel market risk framework, it is also not a requirement to measure multiple risks in one model. spread and default risk are currently simply added together after being individually measured without accounting for diversification possibilities as prescribed. although aggregation issues present problems regarding diversification and even compounding of risks, wong’s (2011) bubble var (buvar) proposes a unified method of combining these two forms of risks avoiding the problem of risk aggregation. further, the model relies on credit spread data avoiding transition matrices or ratings information. credit default swap (cds) data are forward-looking and highly liquid as they are readily available daily (huang, zhou & zhu 2009). using these data, wong illustrates the asymmetry between defaults and spread movements and asserts that spread widening will always precede defaults. although wong calibrated the buvar credit risk model for several countries, south africa was not among them. this article explores that calibration, estimates potential standardisation and provides deeper insight into the model’s applications in the south african milieu. the remainder of this article proceeds as follows: the ‘literature study’ section explores tradeable credit instruments and the regulatory treatment thereof. the section also highlights difficulties in the measurement of credit risk under regulatory recommendations. the choice of data and relevance thereof is explained in ‘data and methodology’ section along with the mathematics of the metrics being assessed. the logic behind wong’s (2011) credit buvar and how the metric may sufficiently account for diversification possibilities when spread and default risk are combined into one metric are also discussed here. results obtained from analysis and scenario simulations are then illustrated and discussed in the next section and the final section concludes. literature study regulatory treatment of tradeable credit instruments conventionally, a bank’s trading book is predominantly affected by market risk, with the banking book being mostly susceptible to credit risk (bcbs 2009). however, tradeable credit instruments introduce credit risk to the trading book and the regulatory capital calculated for these in the crisis were woefully insufficient. these tradeable credit instruments do, however, provide for price discoveries in secondary markets through credit spreads. institutions holding portfolios of debt securities or derivatives to hedge risk stemming from their securities, face several forms of risk. spread movements is one such risk, while the possibility of issuer defaults of tradeable credit instruments is another. correlated defaults between issuers of securities pose further risk to banks and financial institutions (wong 2011). spread risk spread risk is traditionally modelled using historical simulations and applying a var approach. simulated returns are generated from the spread variable over an observation period – between 1 and 3 years under the basel formulation. the return vector is and each portfolio position is mapped to benchmark issuer risk factors, so if the portfolio is subject to n risk factors, there are n return vectors. return vectors are combined to derive a portfolio profit and loss distribution. under the basel ii formulation, spread var is the var over a 10-day period at a 99% confidence level as it is for standard market risk instruments and portfolios (bcbs 1994). in what has been informally labelled basel iv, the bcbs have suggested changes to the trading book/banking book boundary by addressing issues such as the trading book definition, trading book components and ineligible trading book instruments (bcbs 2013). such rigorous proscriptions were limited to mere footnotes in the revisions of the basel ii market risk framework (bcbs 2011) – now, they have become standard features of the way banks will need to treat trading books. a summary of the current boundary definitions compared to proposals are highlighted in table 1. table 1: boundary definitions of basel ii and basel iv trading book. default risk because entities only default once, an historical simulation approach is impossible since there is no time series of observable default history available. monte carlo simulations are used instead. possible occurrences of ratings migration (of which default is a special case) are generated over a 1-year simulation horizon. the monte carlo simulation assumes that credit default driver follows a particular distribution: simulated values are mapped to an end-state rating (upgrades, downgrades or a default). the probabilities of these trajectories from the current rating to the end-state ratings (including default) are embedded within the rating transition matrix. these matrices are populated with single-year transition rates assembled by credit rating agencies using empirical historical statistics of defaults and upgrades or downgrades in selected benchmark sectors. the portfolio positions are mapped to relevant sectors before the simulation begins. correlation coefficients are determined independently and used to capture correlation risk between the sectors. regulatory capital rules require that the var of this distribution is determined at a 99.9% confidence level and a time horizon of 1 year – this is known as credit var. crouhy, galai and mark (2000) provide a comprehensive overview of contemporary, available credit risk models. the responses received by the bcbs from commentators mostly suggested that integrating the default component of the trading book into market risk models, presents several challenges and complexities. the bcbs thus decided that the total credit risk capital charge for both the standardised and models-based approaches would comprise two components: an integrated credit spread risk capital risk charge and an incremental default risk (idr) charge (bcbs 2013). aggregation problems the complex relationship between market and credit risk gives way to aggregation issues including the inability to clearly identify diversification issues and related compounding effects. this challenge also fuelled the perception that adding separately estimated risk components for market and credit risk will most certainly be conservative, due to not all diversification possibilities being considered. however, the bcbs suggests from the financial crisis learnings that non-linear interactions between market and credit risk may reinforce each other and lead to even more severe losses. the bcbs further suggests that under a top-down aggregation approach (as commonly used in practice) diversification benefits should be approached with caution (indeed, the bcbs now restricts the use of negative correlations in portfolio assembly and construction, bcbs 2013). adding independently estimated risk measurements in a top-down approach is flawed in that it assumes that perfect correlations between market and credit risks exist. since both risk forms are affected by the same economic factors, some diversification benefits are expected. however, non-linear interactions between market and credit risk may lead to instances where the combined total risk is higher than the sum of individually measured components.2 these compounding effects often arise when market and credit risks are inseparably connected, that is, default losses from instruments depend on the movements in market risk factors or conversely when the values of instruments affected by market risk factors are dependent on defaults or rating changes. diversification benefits are, however, not unobtainable and the bcbs highlights this by showing the interactions between interest rates and credit risk in the banking book. creating a hypothetical bank, drehmann, sorensen and stringa (2008) place emphasis on modelling the entire banking book including assets, liabilities and interest sensitive off-balance sheet items. drehmann et al. argue that non-linear effects created by the interaction between interest rates and default probabilities may be difficult to capture outside of integrated models measuring total risk. alessandri and drehmann (2007) further assess aggregate risk and required capital by using a set of stylised assumptions to calibrate the model to the profile of a typical uk bank. through this they show diversification benefits such that the capital kept for an integrated risk measurement for interest rate and credit risk is less than would have been kept for credit risk if measured separately. diversification benefits are not guaranteed when using var, since the market risk measure is neither coherent nor sub-additive. coherent risk measures such as es guarantee the diversification benefits if an integrated measurement of total risk is measured. if separate measurements are done for market and credit risk, diversification benefits cannot be guaranteed even if coherent measurements are used. the choice of metric is not the only challenge related to integrated risk measurement. the metrics used in credit and market risk are not entirely comparable. for example, market risk models capture complete return distributions whereas credit risk models account mostly for losses stemming from defaults and ignore gains. a further challenge emerges in the different horizons that the risks are measured in, despite credit risk becoming more tradeable in the 21st century because of financial innovations such as securitisation. the bcbs conclude that although integrated risk models have high data and technological demands, the aggregation and integrated measurement of market and credit risk should be done consistently in such a way that a common horizon is imposed, and all income, profits and losses are accounted for. however, the challenges mentioned, as well as the fact that a top-down approach is favoured by most banks with these approaches involving simple correlations ignoring non-linear interactions, suggest that even under integrated measurements diversifications benefits are not guaranteed. data and methodology data the data employed in the credit buvar risk metric were daily credit spreads for 5-year and 10-year south african government cdss, from january 2000 to november 2016. south african credit ratings were obtained from fitch ratings (fitch ratings 2016). the south african risk-free rate (3-month johannesburg interbank agreed rate [jibar]) used in this analysis is sourced from the south african reserve bank (sarb 2016). other data were simulated where necessary. methodology spread risk credit buvar combines both spread and default risk and wong (2011) asserts that the all-in credit loss measure lies between spread var and a logical upper bound. this upper bound represents the default event where the difference between the principal amount and the recovery is lost. spread var is thus calculated as usual, but the inflator allows default risk to also be accounted for. default risk compared with conventional default risk measures, the way in which default risk in the credit buvar model is accounted for contrasts with spread var. the reliance on slow-reacting, backward-looking rating transition matrices is entirely replaced by the derivation of the cap on the spread level used in the subsequent inflator. this inflator imposed on the spread var measurement ensures a forward-looking, all-in credit loss measurement. aggregation problems the credit buvar model allows for credit and market risks in a diversifiable manner while solely relying on credit spread data. wong (2011) asserts that credit spread is the most forward-looking and direct indication of an issuer’s probability to default. wong also suggests that rapid spread widening (rsw) is the dominant forerunner for default and presents evidence from the financial crisis. using data from issuers including lehman brothers and american international group (aig), wong illustrates how spreads throughout the crisis period increased to such an extent that potential default could be detected weeks earlier than if relying on credit var alone. through this wong deduced that a credit model conditional on rsw could be forward-looking and may overcome shortcomings of conventional credit models. this straightforward method using an historical simulation approach does not produce a statistically precise method, but neither do other var approaches (wong 2011). credit buvar, like other var approaches, is affected by the subjective choice of parameters and has a free parameter calibrated by the user. credit buvar’s ability to account for both default and spread risk in one regulatory capital calculation is made feasible when the calculation metric aims to detect widening of the issuer’s credit spreads. wong (2011) suggests that credit spreads are arguably one the most direct and forward-looking measures of an issuer’s default probability. to penalise increasing default probability wong asserts that an inflator (δ+) is used to increase the var measure as required. since increased spreads precede defaults, long positions incur losses due to these changes while negative changes in spreads cause losses for short positions. however, defaults only affect long positions and thus the inflator is only applied to the positive side of the distribution. to incorporate the inflator the original return distribution undergoes a transformation when the returns are positive as shown in equation 1. in equation 1, the inflator (δ+) is always greater than 1, so it amplifies the positive returns (positive returns in this case represent an increase in spreads which represent a loss scenario), and n is the scenario numbers in the historical var simulation. wong (2011) proposed the inflator in equation 2 to rapidly penalise the initiation of rsw: s is the benchmark cds spread while ω1 and ω2 are free parameters. a pricing function is used to cap the inflator as spreads cannot widen indefinitely without the benchmark bond entering default at some stage. wong (2011) suggests that the pricing function such as that from an excel spreadsheet will suffice: yield = (today, maturity, coupon rate, bond price, redemption price coupon frequency). to calculate the spread cap, scap, wong (2011), using the lehman brothers bankruptcy as a guide, assumes that the recovery rate in the event of a default will be 10%. most bonds are assumed to be issued close to par when the outlook of the issuing company is attractive, so much so that the coupon rate can be set to (or close to) the risk-free rate. the final assumption is that bonds give the same quarterly cash flows like a cds, to be consistent with cds quotes. the assumptions allow for the spread of the bond at the point of default to be stated as: ydefaulted is the yield of the bond at the point of default. wong (2011) illustrates a basic example on how to perform this calculation using a standard discounted pricing function (e.g. the yield function in excel outlined above) and defines the maximum inflator (δ+) as an adjustment that will inflate two standard deviations of spread returns up to the percentage loss at the point of default, calculated as scap. this two standard deviation in equation 4 represents a 97.7% var under a normal distribution (chosen because it simplifies the formulation; in principle, any level would suffice). however, scap satisfies equation 3, thus: substituting into equation 2 produces the response function: equation 6 still has the free parameter ω2 which must be calibrated. wong (2011) argues that ω2 = 0.5 is the most suitable as it produces an inflator that increases rapidly to penalise rsw; however, it decreases in such a way that the spread inflated through the inflator will never exceed scap. this ensures that the holder of the bond will never lose more than the principal amount, less the recovery amount. an advantage of ω2 as a free parameter is that it can be adjusted and calibrated as required by a regulator, depending on the requisite level of conservatism. results and discussion current (2018) south african milieu the credit buvar model relies integrally on the simulation of scap indicating the moment of default. this is fundamental to the model as it enables the aggregation of spread and default risk. central to scap is the risk-free rate of the market as well as the assumed bond recovery rate in the event of default. firstly, compared with the us, south africa is a high interest rate environment and thus the risk-free rate used to calibrate scap is considerably elevated. jibar (november 2016) is used as the risk-free rate for calibration. in addition, the lack of cds data for the south african market complicates the assumption of a recovery rate, since no noteworthy government or corporate bonds for which there are cds data defaulted in the analysis period. simulation results – calibration assumptions figure 1 shows the performance of spread var and credit buvar relying on var for the calculation of credit buvar on sa 5-year government bond cds spreads. figure 1 assumes the same recovery assumption (10%) and more importantly the same ω2 = 0.5 as that of wong (2011). the risk-free rate has, however, been calibrated for south africa. figure 1: credit risk measures on 5-year credit default swap spreads using standard deviation as a measure of volatility (risk-free rate = 7.00%, bond recovery rate = 10%, ω2 = 0.5). the uncalibrated buvar output in figure 1 shows significantly elevated capital estimations compared to spread var throughout the observation period. the purpose of buvar, as a countercyclical measure, is to assist banks in their determination of the ‘correct’ amount of credit risk capital during different stages of the business cycle. however, capital requirements under buvar are excessive and would require institutions to keep between two and seven times more capital than measured using conventional var (as observed during the observation period indicated in figure 1), placing an onerous burden on capital requirements and diverting liquidity to less-profitable operational areas. this highlights the necessity of appropriate model parameter calibration. wong (2011) advised that each jurisdiction should calibrate its own model input parameters. for the south african market, a bond recovery rate of 50% was assumed (j. esterhuysen pers. comm., 2016) – far more than the 10% used in wong’s (2011) exposition. south africa’s historical experience of corporate defaults has been less detrimental than that faced in developed economies, partially due to the stringency of the national credit act which curtailed institutions’ reckless lending activities (sa nca 2005). the bond recovery rate assumption is implemented first as it is based on empirical market data and insight, whereas the free parameter ω2 is calibrated to a suitable level and chosen at the discretion of the user. a ω2 of 1.0 (c.f. wong 2011: ω2 = 0.5) reduces the increase of buvar over conventional var to levels that may be acceptable to banks: between 1.0 and 2.5. figure 2 illustrates a calibrated buvar model output based on assumptions for the south african market. figure 2: credit risk measures on five-year credit default swap spreads using standard deviation as a measure of volatility (risk-free rate = 7.00%, bond recovery rate = 50%, ω2 = 1.0). assuming better bond recovery rates and applying a larger ω2 produces results that are still elevated – but more sensible using buvar – as shown in figure 2. the spike in cds spreads in 2015 was a direct result of the political instability (which led to economic instability) caused by the removal of the minister of finance (nhlanhla nene) in december 2015. subsequently, rating agencies warned of further downgrades – possibly to junk status – still faced by the country (moody’s investor services 2016).3 figure 3 concentrates on the crisis period from figure 2 and shows the elevated capital requirements (which would have been required under the buvar metric). this reinforces buvar’s countercyclical objective. figure 3: credit risk measures on five-year credit default swap spreads using standard deviation as a measure of volatility in the months preceding the credit crisis. arrows indicate focus regions. figure 3 illustrates the end of the non-volatile pre-crisis period and subsequent crisis period in which spreads increased significantly. buvar reacts more quickly and to a greater extent than spread var to what wong (2011) described as ‘rapid spread widening’. this results in a quicker increase in capital requirements which further motivates the use of buvar because of its potential countercyclical capabilities. both indicated areas might have curbed rapid expansion and potentially avoided bubble formation. estimating these higher capital requirements cannot be back-tested, so hindsight does not offer much benefit. the choice of volatility measure may influence buvar’s suitability. it is well known that better, more reactive measures of volatility are frequently used in practice, such as generalized autoregressive conditional heteroskedasticit (garch) and exponentially weighted moving average (ewma) models. figure 4 shows spread var and buvar using an ewma volatility methodology. the difference in required capital under an ewma volatility approach and a standard deviation volatility approach (figure 2) is not material. figure 4: credit risk measures on five-year credit default swap spreads using the ewma approach as a measure of volatility (ω2 = 1.0, λewma = 0.95). calibration of required parameters to south african market the ewma approach in figure 4 places reliance on more recent data when estimating volatility. credit buvar and spread var provide more reactive measurements to time series changes under ewma. the choice of var measure may also influence buvar’s suitability. despite var being widely used in finance, the bcbs has decided to replace it with es or ‘conditional var’ (bcbs 2013). recall that the es – the probability-weighted average of losses beyond a specified value of var – is calculated as follows: σ is the portfolio standard deviation and α is the var value beyond which the es is desired. the two metrics were used in the buvar model and the results are compared in figure 5. figure 5: credit bubble value at risk using value at risk and expected shortfall. figure 5 illustrates that buvar using es is more reactive than buvar using conventional var. es provides a more conservative measure compared with spread var because it considers not only the likelihood of losses, but also their magnitude, leading to a more coherent measure. this is illustrated by the severe fluctuations of es buvar in the post-crisis period because es measures the loss severity, while var provides an estimate of loss frequency. figure 6 applies the buvar model to 10-year south african government bond cds spreads. the calibration of ω2 (= 1.0) remains identical to that chosen for five-year south african government bond cds spreads as this value produces similar capital retention levels (c.f. figure 2). figure 6: credit buvar for 10-year credit default swap spreads (risk-free rate = 7.00%, bond recovery rate = 50%, ω2 = 1.0). figure 7a illustrates the effect of changing spread levels, s, on the inflator, δ+. each line represents δ+ versus s at various ω2 values (these ω2 values are the numbers on the graph at the maximum value of δ+ for each fixed ω2). figure 7b shows the spread after application of δ+ versus the current spread, s. see equation 4. figure 7: (a) the effect of the spread level, s, on ∆+ (as well as an indication of the maximum ∆+ for different levels of ω2 and (b) the effect of spread level, s, on value at risk for various levels of ω2. the first derivative of equation 6 (see appendix 1) gives the rate of change of δ+ with respect to s. setting this derivative to 0 determines the value of s where δ+ is a maximum (i.e. the open circles in figure 7a). lower ω2 values generate inflators which elevate spreads early, that is, far from levels at which the bond would default. wong (2011) asserted that δ+ should penalise excessive growth as soon as possible and thus applies an ω2 = 0.5. higher ω2 values elevate spreads more slowly than lower ω2 values, so excess growth is only penalised severely enough at spread levels close to those that would result in a bond default. figure 8 shows a surface plot of δ+ for various levels of ω2 and s. figure 8: surface plot showing the impact of ω2 and spread level, s, on ∆+. figure 8 illustrates the importance of calibrating the buvar model for the market to which it is applied. as shown in figure 1, wong’s (2011) ω2 value of 0.5 would apply too harsh a capital requirement for institutions as buvar is five times higher than spread var during crisis periods. this quantity of capital retention would be too punitive for most institutions. at low ω2 values, the inflator imposes severe liquidity constraints on institutions. a higher ω2 is thus preferred in this study. using figure 8, the inflator can be calibrated to the bank’s relevant, acceptable value. figure 9 illustrates the rate of change of the δ+ (its first derivative) with respect to s. figure 9: first derivative of ∆+ with respect to spread level, s. the rate of change of δ+ is considerably elevated in the pre-crisis period. this highlights the model’s ability to anticipate market bubbles and subsequently elevate buvar through δ+ to potentially retard or halt the bubble’s development. figures 10a and b illustrate the effects of model components, rf , and the assumed bond recovery rate on scap. figure 10: impact of (a) the risk-free rate on the inflator as a function of s and (b) the bond recovery rate on scap. an increase in rf increases scap as well as the value of s at which δ+ experiences a maximum. using equation 3, as rf increases, the yield at default, ydefaulted, increases at a faster rate, so scap = ydefaulted − rf increases. this influence is trivial compared with the impact of the recovery rate on scap (figure 10b). low recovery rates result in dramatically elevated levels of scap. denzlera et al. (2006) showed that probabilities of default could be derived from credit spreads using: s is the credit spread level in basis points, t is the maturity of the cds in years, pd is the probability of default and lgd is the loss given default of the cds instrument – both expressed as percentages. etf (2011) showed equation 8 could be approximated using: figure 11 illustrates the market-implied pd’s as derived using equation 9 in conjunction with the south african credit rating (supplied by fitch ratings) and the five-year cds spreads. figure 11: market-implied probabilities of default (using equation 9 and five-year credit default swap spreads from figure 1), south african credit rating (mapped to relevant probability of default) and bubble value at risk on the same timescale. south africa’s credit rating is currently (november 2016) just above junk and has a negative outlook (moody’s investor service 2016) as shown in figure 11. this suggests that political actions (removal of minister nene), rather than only market-implied pds, weigh heavily on the opinions and confidence of rating agencies. were only the latter considered, the current lower spreads (relative to credit crisis levels) imply that south africa should be assessed at a better (higher) credit rating. unsurprisingly, there is a strong correlation between credit buvar (using data from figure 1) and market-implied annual pds. consequences for south african banks and regulators implementation of a buvar-like model in the banking environment would require significant cooperation between the regulator and regulated institutions. bubble var models effectively attempt to replace the bcbs countercyclical buffer and thus thresholds and parameters would have to be tested and agreed upon. what would be an evident advantage of such a model is that it would not be burdened by complicated timing issues regarding the retention and release of capital buffers. these timing issues under the current bcbs formulation would be a key focus area, as they would have to be analysed and compared with continuous capital estimates under buvar models. initial research between regulators and banks could focus on the optimal value for ω2, as a comparison of this work with wong’s (2011), shows considerably different results for different values of this parameter. this research could analyse banks’ portfolios to ensure that the model would perform consistently across the market. in jurisdictions where data are scant for both cds spreads and historical defaults, regulators would have to cooperate with market experts on defaults and recovery assumptions. wong (2011) highlighted that under a buvar model environment there would be macro-prudential advantage in that institutions not affected by buvar capital requirements could price more competitively, thereby transferring credit risk from the banking sector to other global investors as well. conclusions and suggestions for future work regulatory capital recommendations for financial markets are constantly evolving. a combination of several bcbs publications4 has been informally labelled as basel iv (nooman 2016). these recommendations aim to regulate the banking environment where complex interconnected financial instruments have historically masked risk and exhibit considerable measurement complexity. wong’s (2011) buvar model provides a risk metric combining both spread and default risk. relying on liquid forward-looking cds spread data, the model bypasses the problem of risk aggregation by employing a single model under the historical var/es approach. wong (2011) stressed that, like all var approaches, the model is influenced by subjective choices of parameters and thus does not provide a statistically precise measurement. this emphasises the necessity for regulators and banks to cooperate to ensure the ‘correct’ parameters are used in their jurisdiction. bubble var results using wong’s (2011) original calibrations and assumptions, illustrate excessive capital requirement estimates and suggest further calibration requirements. a higher bond recovery assumption after default and a higher ω2 produces more feasible estimates. applying buvar to 5 and 10-year south african government bond cds spreads produced results showing that buvar is more responsive and conservative prior to periods of severe cds spread increases. this highlights the metric’s countercyclical properties that would potentially have countered bubble developments. depicting buvar results on the same timescale as market-implied pds and the south african credit rating shows that buvar does ramp up significantly in the pre-crisis bubble development period. however, the model is robust when shocks occur such as the removal of the minister of finance in late 2015. a tractable solution is provided in equation 2-a1, which simplifies the selection of the free parameter, ω2. within any jurisdiction, institutions and policymakers will have local knowledge of bond recovery and risk-free rates which, in turn, determine scap using this information in conjunction with the results from equation 8, the inflator level can be quickly calculated for any ω2 and, thus, the associated increase in capital can be ascertained. this can be used as a guide for regulatory and institutional capital calibration. the procyclical nature of financial markets and the way in which its participants react to fuelling this phenomenon are well documented. the bcbs proposed the implementation of a ccb, but this has raised concerns regarding uncertainty whether the right data are used for estimation: the credit-to-gdp ratio may not be optimal for jurisdictions with unique markets (drehmann & tsatsaronis 2014). further timing issues are a concern as capital for the buffer can be released immediately, but retention notices must optimally be made 12 months in advance. the credit buvar model provides a continuous forward-looking metric that is not burdened by timing issues and is not subject to procyclicallity, as it does not rely on credit ratings or transition matrices. future research opportunities include the optimal calibration of the free parameter ω2. this parameter has a significant impact on the buvar model and appropriate guidance is required if it is to be implemented. research on the parameter would include analysis across multiple economies, markets and scenarios to ensure suitable implementation guidelines are created. further research may also include investigation on the relationship between model outputs, cds spreads and actual credit ratings as it was not the central focus of this study. finally, as capital requirements for tradeable credit instruments arise both from default and spread risk, further research may analyse combined capital requirements from separate conventional models to that of aggregating buvar-like models. acknowledgements competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions d.v. was the principal author and analyst and g.v.v. responsible for model design and implementation of the article. references alessandri, p. & drehmann, m., 2007, an economic capital model integrating credit and interest rate risk in the banking book, working paper no. 1041, april 2009, european central bank, frankfurt. amato, j.d. & remolona, e.m., 2003, ‘the credit spread puzzle’, bis quarterly review 2003, 51–63. https://doi.org/10.2139/ssrn.1968448 bank for international settlements, 2008, addressing financial system procyclicality: a possible framework, note for the fsf working group on market and institutional resilience, viewed 11 november 2016, from http://www.fsb.org/wp-content/uploads/r_0904e.pdf?page_moved=1 barrell, r., davis, e., karim, d. & liadze, i., 2010, calibrating macroprudential policy, niesr discussion papers, no 354, national institute for economic and social research, london. bcbs, 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viewed 15 november 2016, from http://www.pwc.com/gx/en/services/advisory/basel-iv.html sa nca, 2005, south african national credit act 34 of 2005, viewed 22 october 2016, from http://www.justice.gov.za/mc/vnbp/act2005-034.pdf sarb, 2016, south african reserve bank, viewed 15 november 2016, from https://www.resbank.co.za/research/rates/pages/currentmarketrates.aspx shin, h.s., 2013, procyclicality and the search for early warning indicators, wp/13/258, international monetary fund, washington, dc. van vuuren, g., 2012, ‘basel iii countercyclical capital rules: implications for south africa’, south african journal of economic and management sciences 15(3), 309–324. https://doi.org/10.4102/sajems.v15i3.235 wong, m., 2011, ‘credit buvar: asymmetric spread var with default’, journal of risk management in financial institutions 5(1), 86–95. https://doi.org/10.2139/ssrn.1627689 appendix 1 first derivative of equation 6: this function = 0 (since when the function is at its maximum value of ∆+) where: footnotes 1. the trading and banking books are accounting terms that refer to assets held by a bank that are regularly traded and the bank’s balance sheet assets expected to be held to maturity respectively. 2. the interaction of market and credit risk (imcr) working group established by the bcbs give several examples where this can occur. 3. south african credit ratings relative to spreads and buvar are provided in figure 11. 4. basel iv comprises: bcbs 306, bcbs 319, bcbs 347, bcbs 362, bcbs 303, bcbs 279, bcbs 352, bcbs 355, bcbs 325, bcbs 349 (pwc 2016). abstract introduction problem statement aim of the study and research questions research design research findings conclusion and recommendations limitations to this study acknowledgements references about the author(s) shaneen conradie school for accountancy, stellenbosch university, south africa christiaan lamprecht school for accountancy, stellenbosch university, south africa citation conradie, s. & lamprecht, c., 2018, ‘what are the indicators of a successful business rescue in south africa? ask the business rescue practitioners’, south african journal of economic and management sciences 21(1), a1726. https://doi.org/10.4102/sajems.v21i1.1726 original research what are the indicators of a successful business rescue in south africa? ask the business rescue practitioners shaneen conradie, christiaan lamprecht received: 09 dec. 2016; accepted: 28 nov. 2017; published: 11 apr. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: business rescue, in terms of chapter 6 of the companies act no 71 of 2008, is still relatively new to the south african business environment. the need for a successful business rescue regime is beyond doubt. however, a consistent manner to measure the success of the regime has not been determined. previous research into possible indicators of business rescue success was based on a review of international business rescue regimes that share the same underlying philosophy as the south african business rescue regime. aim and setting: this study extends previous research efforts by soliciting the opinions of 16 south african, senior business rescue practitioners on the indicators of business rescue success. method: the researchers used a qualitative research approach. the delphi research technique was used to gather qualitative and quantitative empirical data from business rescue practitioners. results: the experts reached a high level of consensus on various indicators of a successful business rescue. most notable are that business rescue should save as many jobs as possible and that the actual outcome should be compared to that estimated in the business rescue plan. a novel indicator of success is the business rescue points saved or rescued, when using the public interest score. conclusion: the study makes a valuable contribution to the debate on what constitutes a successful business rescue by adding the considered opinion on indicators of success by one group of experts in the field of business rescue, namely senior business rescue practitioners. introduction the south african business rescue regime was introduced with the enactment of the new companies act, act 71 of 2008. various financially-troubled south african companies have since used this lifeline in an attempt to survive and avoid liquidation. the success of business rescue as a lifeline is important to numerous stakeholders in the business, such as employees, creditors, lenders, post-commencement financiers and shareholders. furthermore, the effectiveness of the regime in successfully achieving its goals is also important to the legislative authority. however, exactly what constitutes a successful business rescue is not clear (pretorius 2015:33) and has proven to be elusive. current statistics on success have been described as ‘inconsistent with unreliable validity’ (pretorius 2015:32). conradie and lamprecht (2015:18) researched the international business rescue arena for indicators of success. based on the similarities of the international regime to the south african regime, they suggested a broad list of indicators that could be used to measure success in the south african context. however, conradie and lamprecht did not specifically research the suitability of these business rescue success indicators in a south african setting and against the opinions of one of the most important parties in a rescue attempt, the business rescue practitioner. furthermore, several research papers on the south african business rescue model, which may contain further success indicators, have appeared as from 2015. the aim of this study is therefore first, to add any success indicators, sourced from the latest research on the topic, to the current list of international-based success indicators, and second, to engage with south african senior business rescue practitioners, as experts in this field, in order to obtain their opinions on those indicators that would be suitable in the south african business rescue environment. their specialist knowledge in business rescue could add significant insight with regard to identification of a local context-specific list of success indicators that can be used to further develop a set of business rescue success verifiers. these verifiers can serve as a useful management tool in order to measure business rescue success rates in south africa with accuracy. problem statement south africa has unique economic and employment conditions. chapter 6 was written with these socio-economic conditions in mind (swart 2014:419). the indicators that conradie and lamprecht (2015) identified from international literature may not all be perceived as equally important in south africa. in this sequential study it was therefore important to first, review current research on the topic of business rescue success for any additional indicators of success, and second, consult south african business rescue practitioners, as experts in this field, to assist with compiling a south african relevant set of business rescue success indicators. in this study, an ‘indicator’ refers to that which indicates the state or level of something (oxford dictionary 2017), for example, the substantial implementation of an approved business rescue plan may be an indicator of success. if such a relevant list of indicators could be created with input from experts in the field, related verifiers may paint a more accurate picture of business rescue success. accurate business rescue statistics would, in turn, lead to better decision making by stakeholders in business rescue. aim of the study and research questions the aim of the study was to reach a high level of consensus on what top business rescue practitioners, the experts who are actively involved in the application and execution of the business rescue legislation in south africa, would consider as indicators of a successful business rescue in south africa. therefore, the following research questions were formulated in order to achieve the research aim: what, according to business rescue practitioners, are the goals of business rescue? what, according to business rescue practitioners, are the indicators of a successful business rescue? research design in order to answer the research questions and achieve the research aim, the research was designed as indicated in table 1. table 1 is followed by a brief discussion of the research design. table 1: research design components. the previous section indicated that the research was aimed at establishing the indicators of a successful business rescue. research questions were formulated to achieve the research aim. the research aim and questions were exploratory in nature and the study followed an inductive mode of reasoning to generate new insights. the conceptualisation was a-theoretical, and achieving the research aim would contribute to the theory discovery as the research concepts emerge gradually during the data collection process (mouton 2001:152; olalere 2011:22). in this study, the researchers fulfilled the instrument of research role. the researchers engaged with the research participants during the primary data collection process, allowing the gathering of rich, deep data. the researchers acted as open-minded keen observers of the data in order to derive meaning from it in a business rescue context. the research approach was therefore qualitative and grounded theory principles were applied in search of any themes and patterns that may have emerged from the data (olalere 2011:18, 22). both researchers come from an interpretivist epistemology stance searching for a better understanding of true indicators of business rescue success in a world that is constructed socially. as an instrument of research and gatekeepers of the data collected, the researchers are aware of their own power and bias. ethics, trustworthiness and rigour were therefore considered paramount. ethical clearance for the study was obtained and this paper clearly explains the data collection and analysis processes followed. being two researchers was helpful with regard to ensuring trustworthiness and rigour. interpretation of the data was cross-checked and research rigour was achieved through a strong emphasis of rigour in documentation, procedures and ethics (naidoo 2017:17). documentation rigour was achieved by ensuring the existence of a correlation between the various steps in the research process, as explained later in the paper. procedural rigour was attained by closely following the processes in the delphi research technique, also elaborated on later in the paper. regarding ethical rigour, the participants were reminded of their rights and confidentiality during the research process. the research question of what the indicators are of a successful business rescue in the south african context is complex, as the perceived success of the regime has a financial, social, political and environmental impact. a study on business rescue success would therefore need to include experts who would understand the wider impact that business rescue might have. experts are more likely to be correct about complex questions in their field than non-experts. since it was important to obtain the data from experts in the field of business rescue, a specific research technique that involves experts, namely the delphi research technique, was employed. application of the delphi research technique the delphi research technique can be seen as a virtual panel discussion among experts. the objective of the delphi research technique is to obtain a satisfactory degree of consensus from a group of experts. this method works well in a situation where it is necessary to obtain information that is subjective (okoli & pawlowski 2004:16). according to gordon (1994:1), bringing experts together in a normal conference room, apart from its practical challenges, has certain drawbacks. sometimes the ‘loudest voice rather than the soundest argument’ may win. the delphi research technique removes these traditional conference room weaknesses. the technique is therefore almost like a normal conference meeting where experts discuss a certain topic, but with the added benefit that panellists do not have to meet at one place, and panellists contribute anonymously to the topic under discussion. the strength of the delphi research technique is the effort made to obtain a satisfactory degree of consensus among the experts. this aim is achieved by administering two or more rounds of research questionnaires (skulmoski, hartman & krahn 2007:11). researchers also often make use of pilot studies in drafting a questionnaire. according to skulmoski et al. (2007:4), pilot studies can be effective for various reasons, two of which are to help with the design of the study and to improve the research instrument, in this case, the research questionnaire. in a delphi study, the respondents consist of a panel of experts selected based on their expertise. the idea is therefore not to have a sample that is representative of a population, but rather to select those with expert knowledge in the area of consideration (skulmoski et al. 2007:4). a panel size of 10–18 individuals is deemed appropriate in a delphi study (okoli & pawlowski 2004:19). once a panel is selected, questionnaires are sent out to each participant, and individual data are gathered. skulmoski et al. (2007:10) state that the first questionnaire can be very broad, or it can be narrowed down to guide panellists toward a certain aim. in order to obtain the most data from panellists, an open-ended questionnaire is deemed most appropriate. furthermore, the first questionnaire of a delphi study is often seen as the ‘brainstorming’ stage (okoli & pawlowski 2004:24). as soon as experts return the first questionnaire, the researchers analyse the responses received and, based on the feedback received in the first questionnaire, design the second questionnaire. questionnaires are sent out repeatedly until the research questions are answered, a certain degree of consensus is obtained, or ‘theoretical saturation’ is accomplished (skulmoski et al. 2007:11). it is important to note that at no stage will an expert know the identity of other panel members. only the researchers possess this information. however, the panel members will receive the (anonymous) responses or comments made by other panel members in the previous round, and will have the opportunity to respond to these responses or comments. the fact that the researchers know the identity of the panel members means that the researchers can clarify vague responses. the data obtained in such a way is perceived to have more ‘richness’ (okoli & pawlowski 2004:18). the final step of the delphi research technique is to document the results of the data obtained from the panel of experts through the various questionnaire rounds. data verification is inherently done by the panellists each time a new questionnaire is distributed. figure 1 summarises the delphi research technique as it was applied in this study. figure 1: application of the delphi research technique in this study. in this study, saturation was achieved after two rounds of questionnaire distribution. the next section describes the execution of the delphi research technique in this study. execution of the delphi research technique in order to draw reliable conclusions from the research findings, the research should be executed with rigour and in line with the particular technique followed. this section briefly describes each of the steps – as indicated in figure 1 – that was followed in conducting the research. business knowledge and literature review the authors of this paper have a keen academic interest in the business rescue industry. as researchers, over the years they have gained a collective understanding of the business rescue industry in south africa by attending various workshops and courses in the field of business rescue and turnarounds. the comprehensive literature review used by conradie and lamprecht (2015) provided a valuable starting point for this study. in particular, the limitations of their study, as indicated in the introduction to this paper, exposed the research gap and research problem addressed in this study. conradie and lamprecht (2015:20) identified international success criteria, with some only used in the united states of america (usa). six of the indicators relate to the ‘going concern’ criterion, the main indicator being the number (or percentage) of going concern entities that exit the reorganisation, restructuring or rescue. other indicators identified under the going concern criterion were indicators measuring success after the reorganisation, that is, to establish economic viability in the shortto long term. two indicators related to maximising the ‘creditor return’ criterion were found, namely, substantial implementation of the plan, and the comparison of the actual return to the liquidation return. the final two indicators referred to the criterion to consider the impact on all stakeholders, and here, change in asset size and whether key operation was still in one company were considered. in addition to the above indicators of success, local literature on chapter 6 business rescue success for the period january 2011 to september 2017 were also reviewed with the aim to extend the list of possible indicators of success. interestingly, loubser (2013:442) states that chapter 11 successes might be regarded as failure in south africa. moreover, searle (2013:15) talks about the perceived success of chapter 11, indicating that we cannot rely blindly on success indicators used by foreign researchers. a summary of our review of local literature, that mention the definition of success or indicators of success, are presented in table 2. table 2: summary of local literature referring to business rescue success. in additional to the above, calitz and freebody (2016), du preez (2013), noomé (2014), prior (2014:71), reineck (2015) and vanderstraeten (2016:25) all looked at the importance of post-commencement finance for business rescue success. however, the implied success indicator in this instance is assumed to be a solvent, liquid, going concern. naidoo (2016:6, 66) concludes that a ‘lack of clarity’ in the definition of success still exists, which may result in the legislation to be underestimated. as observed from the above literature, consensus on the definition of chapter 6 success is not yet reached, which leaves room for further investigation. the success indicators documented in table 2 were already directly or implicitly included in the list of potential indicators identified from the international literature, resulting in no addition of new indicators of success from local literature. the first round of the delphi questionnaire therefore included success indicators identified from literature as well as the result of a pilot study. research question in order to answer the main research question, the goals of business rescue first needed to be established, followed by the potential success indicators to measure achievement of the goals. two business rescue goals are indicated in chapter 6. the act states that business rescue provides proceedings to facilitate the rehabilitation of a financially distressed company. the proceedings allow for temporary supervision in order to develop and implement a plan that maximises the likelihood of the company continuing in existence on a solvent basis (goal 1) or, if that is not possible, results in a better return for the company’s creditors or shareholders than would result from the immediate liquidation of the company (goal 2) (republic of south africa 2008). however, conradie and lamprecht (2015:18, 22), identified a third implied goal, namely that the impact on all stakeholders should be beneficial, and that especially in south africa the interest of employees should be protected. in view of the above-mentioned goals of business rescue, the main research question, namely, ‘what, according to business rescue practitioners, are the indicators of a successful business rescue?’, was formulated using the researchers’ own knowledge and insights gained from studying the above-mentioned literature. deciding on research design as indicated in figure 1, the next step in applying the delphi technique is to decide on the research design. see ‘research design’ and table 1 for an explanation of the research design followed within the context of the delphi technique. pilot study since the delphi research technique allows the first questionnaire to be narrowed down to guide panellists toward a certain aim, which is to establish what expert business rescue practitioners would consider as a successful business rescue, a pilot study was first performed. two experts in the business rescue industry were invited to participate in the pilot study interview. the experts were identified from the companies and intellectual property commission [cipc]’s list of business rescue practitioners (see the next section on the selection of the panel of experts) and are well known in the industry. their selection was further complemented by reports in the printing media on their appointment to high level business rescue cases. the purpose of the pilot study interviews was to ascertain the relevance of the main research question, to establish the appropriateness of the draft list of success indicators as a point of departure, and to discuss the best way to present and communicate the first research questionnaire. individual meetings were held with each of the two expert business rescue practitioners. both experts confirmed the relevance of the research questions and applicability of the draft list of success indicators as a point of departure. however, the experts suggested a few additional business rescue success criteria for inclusion in the first questionnaire (anonymous expert a 2016; anonymous expert b 2016). selection of the panel of expert practitioners a database with names and contact details of all registered and licenced business rescue practitioners was obtained from the cipc’s website (cipc 2015). the database of practitioners consisted of junior, experienced, and senior practitioners. because the intention of the study was to obtain insight from expert practitioners, only senior business rescue practitioners were considered for inclusion in the panel. recent media reports on business rescue cases were further scrutinised to identify individuals or firms that were involved in the rescue of listed companies, as these types of rescues are more complex and require the most experienced practitioners. the various business rescue practitioners that were identified through the use of media reports were matched with the cipc’s list of senior business rescue practitioners. a short list of 18 experts of the most experienced senior business rescue practitioners was prepared and these experts were invited to form part of the delphi panel, including both practitioners from the pilot study. the final panel consisted of 16 business rescue experts. the panel members included chartered accountants, accountants, engineers and lawyers. furthermore, the experts represented various boutique business rescue firms and three of the ‘big four’ accounting firms in south africa. these senior business rescue practitioners have proven business rescue and turnaround experience, as evidenced from them being vetted by the cipc, as well as a wide-ranging knowledge of the financial, social, political and environmental impact of business rescue in south africa. questionnaire 1: design the main disadvantage of the delphi technique is that a multi-round study requires more time and, as a result, some participants will drop out during the process (gordon 1994:9). in order to make the best use of the experts’ time, and in line with the insights gained from the pilot study interviews, the researchers decided that the option of a guided questionnaire for round one would be better suited than an open-ended questionnaire type. the rationale was that if consensus on certain success indicators could already be reached in questionnaire 1, the number of questionnaire rounds would be reduced, resulting in less of the experts’ time being needed to conclude the study and a higher panel retention rate. according to dudley, plumly and knoblock (1999:58), a measurement tool should be based on an organisation’s goals. once the goals are established and agreed on, the measurement criteria can be formulated. jones (2012) points out that an indicator can serve as a useful proxy until a measure is developed. the aim of this study was just that, namely to establish those indicators of business rescue success that could be used in future research to develop a scorecard or measurement tool. in order to establish the goals, present the preliminary business rescue success indicators and obtain new indicators, questionnaire 1 was divided into three sections. in the first section, panellists were asked to indicate whether they ‘agree’ or ‘disagree’ with the three indicated goals (two from chapter 6 and one implied goal) discussed earlier. additional space was provided with each goal to allow for any suggestions or amendments that the panellists believed were necessary. the second section of the questionnaire presented the preliminary indicators of a successful business rescue. with respect to each of the success indicators, the panellists had to respond by choosing one of the following four options: ‘agree’, ‘completely agree’, ‘disagree’ or ‘completely disagree’. furthermore, an open-text box was available for every success indicator where the panellist could enter any comments. the third section of the questionnaire was an open-ended question, where panellists were asked to list any other additional indicators that should be included when the success of a business rescue is considered. this section was included in order to ensure that any other possible indicators of a successful business rescue that may not already be on the questionnaire is identified for inclusion in the second questionnaire (see ‘questionnaire 2: design’). questionnaire 1: distribution questionnaire 1 was distributed to each of the 16 panel members by way of an electronic web-based survey system. all the completed questionnaires were received within three weeks. questionnaire 1: analysis and verification of responses the feedback received from each of the 16 panellists was evaluated and some vague comments noted. these comments were clarified with the specific panellist via e-mail or telephonically as far as possible. all responses and comments were summarised and documented in a report, including additional success indicators suggested by the panel members. the researchers noted that consensus was already reached on a number of indicators of a successful business rescue. questionnaire 2: design the delphi research technique allows panellists to change their opinion, should they wish to, once they learn what the summarised opinions of other panel members are, as well as to consider additional success indicators suggested by the panel members in previous questionnaires (skulmoski et al. 2007:4). questionnaire 2 was therefore based on the data obtained from questionnaire 1 and included the additional measurement criteria that were suggested by panellists in questionnaire 1. an individual report was prepared for each panellist indicating his or her response and the aggregate percentage of panellists who strongly disagreed and disagreed and those who strongly agreed and agreed for each of the success indicators in questionnaire 1. in order to maximise the panellists’ available time, a separate report was also prepared with excerpts of those success indicators where the panellists did not reach consensus. the excerpts also included the summarised comments for each of the success indicators. the rationale for including the summarised comments was to give all panellists the opportunity to evaluate the arguments of other panel members, and then to change their own statement now that they had seen the arguments made by other panel members, should they wish to do so. it should be noted that the identity of panellists remained anonymous to the other panellists at all times. questionnaire 2: distribution questionnaire 2 consisted of two sections, namely a full report and an excerpt with the new criteria identified by other panellists. the full report indicated the panellists’ individual responses as opposed to the aggregate responses for each of the business rescue success criteria. the rationale for the second section was to focus the panellists’ time on the new criteria as well as only those criteria from questionnaire 1 where consensus had not been reached. with respect to the second section, the panellists were requested to: respond to the new criteria identified by other panellists in the same manner as in questionnaire 1, namely to indicate whether they ‘completely disagree’, ‘disagree’, ‘agree’ or ‘completely agree’; review the areas where their own opinion differed from the others panellists by assessing the comments other panellists made, and to change their original response, should they wish to do so. the panellists were also given the opportunity to review their answers for those criteria where consensus had already been reached, should they wish to do so. the response time for questionnaire 2 was much longer than the response time for questionnaire 1. the researchers had to follow up with various e-mails or telephonic requests to obtain the feedback of all panellists. questionnaire 2: analysis and verification of responses the individual responses made by each panellist were evaluated by the researchers and again clarified where necessary. twelve of the 16 panellists reviewed their responses. after the second round it was noted that theoretical saturation and a high level of consensus were reached, and no further questionnaire iterations were deemed necessary. documentation of research findings the value of the delphi method rests with the ideas it generates (gordon 1994:3), and the documentation of research findings is the last step of the delphi research technique. in the process of analysing and documenting responses, miscommunication between the researchers and the panellists can be a limitation. some of the ideas (success indicators) could have been misunderstood by the panellists when they completed the questionnaires. equally, some of the comments received from panellists could have been misunderstood by the researchers. the above limitation was minimised due to the fact that the researchers followed up on unclear comments before documenting the final results. the research findings are presented below. research findings the results below represent the views of the panellists after they had the opportunity to revise their original opinion. findings related to proposition 1: the goals of business rescue are clear the first section of questionnaire 1 dealt with the first research question, namely ‘what, according to business rescue practitioners, are the goals of business rescue?’. table 3 summarises the results with respect to the first research question. table 3: the goals of business rescue. note 1 81% of the panel supported this statement. the three dissenting panellists indicated that the legal entity is of little concern, and that the emphasis should not be on ‘company’ but rather on ‘business’; in other words, on the staff and its trading assets. the rest of the panel supported this statement (also refer to note 14). note 2 one expert commented that the: ‘rescue should give a better return to the creditor.’ (expert 105523, 2016) according to the letter of the law, a ‘better return than immediate liquidation’ is acceptable, but this expert argued that the only goal is to rescue the business, and not to end up in liquidation. note 3 it was interesting to note that all the experts agreed with goal 3, since it is an implicit goal. the above results show that most of the experts were in agreement with respect to the two business rescue goals found in chapter 6. the panel of experts also agreed that the job opportunities should be protected, which is very important. it also provides evidence for conradie and lamprecht’s non-evidence-based suggestion that it should also be considered a goal in measuring the success of business rescue in south africa. however, since it is not an explicit goal, the protection of employee job opportunities has been considered a criterion of success for which the saving of a substantial number of jobs would be an indicator for business rescue success. since the goals had been confirmed, the next step was then to establish the indicators of a successful business rescue. the results with respect to the business rescue success indicators are presented and discussed below. findings related to proposition 2: business rescue experts can reach consensus on indicators of a successful business rescue the second, but main research question to be answered was: ‘what, according to business rescue practitioners, are the indicators of a successful business rescue?’. it was interesting to note that a high level of consensus was already reached on some of the success indicators after the first questionnaire. the panel submitted valuable feedback on the success indicators. the success indicators and panel responses were sub-categorised under the respective goals they intend to measure, and are summarised in the tables to follow (tables 4–7). table 4 summarises those indicators that may deem a business rescue successful under goal 1. table 4: business rescue success indicators for goal 1. table 5: business rescue success criteria for goal 2 (better return to creditors). table 6: business rescue success criteria for goal 3 (employees’ job opportunities should be protected). table 7: additional business rescue success criteria. the notes below refer to the applicable indicators in table 4. if a high level of consensus was not reached between panellists, the comments and arguments presented by the panellists were briefly summarised for further consideration, followed by a conclusion on whether or not the indicator should be included in the final list of success indicators. note 4 the panellists mainly disagreed with this indicator, arguing that as business rescue fees are paid first, the inability to settle business rescue fees and costs could indicate that the business is still in distress, therefore, there could not have been a return to solvency. furthermore, the damage to the reputation of a business rescue practitioner with such a mind-set would negatively affect his or her ability to obtain future assignments. on the contrary, a minority of the experts argued that if the economics do not measure up for business rescue practitioners, quality business rescue practitioners will not be attracted to the profession, and the risk for the profession would simply be too high to ignore adequate compensation. the researchers concluded that this indicator was not supported by the panel and should therefore be excluded from the final list of success indicators. note 5 the results show that the panellists mainly disagree on the matter. those in favour of the indicator argued that it is likely that it may indicate success; however, acceptance by creditors is only the first step in the process and the business rescue plan must be substantially implemented for the rescue to be a success. furthermore, without an approved plan, the business rescue practitioner will not be able to implement anything. those against the inclusion of the indicator used the same argument, namely that acceptance by creditors is only a step in the business rescue process, not an indicator of its success. since the panel did not reach consensus on the indicator, and based on the above arguments, the researchers concluded that the acceptance of the plan is one of the procedures of business rescue, but not an indication of business rescue success. the indicator should therefore be excluded from the final list of success indicators. note 6 the results show that the panel was divided on whether the business rescue can be considered a success if the approved plan was only partially implemented. those in favour of this success indicator argued that if a partial implementation beat liquidation, the business rescue was worthwhile. on the contrary, one expert said: ‘in order to achieve success the business rescue practitioner must submit an amended plan to creditors. the amended plan should then reflect the partial implementation and ask creditors for approval of the amended plan. only if that amended plan is approved by creditors may the implementation of that amended plan be regarded as a success.’ (expert 104957, 2016) one panellist bluntly said: ‘you can’t be half pregnant! either it (the plan) is implemented or not.’ (expert 104946, 2016) although the researchers could see the merit in considering a partial implementation if it beats liquidation, the panel could not reach consensus on the matter. the researchers therefore concluded that it should be excluded as an indicator of success under goal 1. however, if partial implementation beats liquidation, it may indicate a success under goal 2 (better return to creditors) as opposed to goal 1 (going concern). note 7 the panel unanimously agreed that it indicates success if a plan was substantially implemented. note 8 the panel unanimously agreed that if the company exited business rescue as a going concern, it indicates success. one expert referred to this as a ‘super success’. note 9 all of the panellists, except one, agreed with this indicator. the expert commented that: ‘this is not enough, the business model needs to demonstrate viability as a business.’ (expert 105536, 2016) in essence the expert agreed that business rescue is not just about delivering a going concern upon exiting business rescue, but delivering an economically viable business that will survive in the foreseeable future. the indicator is therefore included in the list of business rescue success indicators. note 10 three of the experts disagreed with the indicator. two experts argued that business rescue practitioners do not drive the final outcome after they step away. furthermore, if the business has a chance of sustainability, the business rescue was successful. the researchers understand that, after termination of business rescue, the performance of the company is no longer in the hands of the practitioner. however, this is irrelevant. business rescue success is not intended to measure the quality of the practitioner, but rather the effectiveness of the business rescue legislation. one should therefore be able to evaluate the company separately from the practitioner. one expert commented that: ‘… it depends on the type of business.’ (expert 105536, 2016) for example: ‘… a mining project would need to show viability over a longer period.’ (expert 105536, 2016) the latter comment can be interpreted as showing that the expert actually agrees that performance after business rescue termination should be evaluated, but that the time period should be carefully considered. although the remaining two experts did not agree with this success indicator, a high level of consensus was still reached on this indicator, and the researchers concluded that the indicator should be included in the final list of success indicators. note 11 two panellists did not agree with this indicator. the one expert argued that ‘the company could perform in tandem with the market and still fail. equally, it could lag the market but still survive’. the other expert argued that in the long term the company will have an opportunity to become successful once again, thereby indicating that performance over the long term is disassociated from its initial successful going concern exit from the business rescue proceedings. although the above-mentioned two experts did not agree with this success indicator, a high level of consensus (88%) was still reached, demonstrating that the majority of panellists deemed this indicator to be appropriate. the indicator should therefore be included in the final list of success indicators. table 5 presents the responses to the success indicators with respect to goal 2, namely a better return to creditors than under immediate liquidation. the notes below refer to the applicable indicators in table 5 and state the reasons for instances where the panellists did not reach 100% consensus. note 12 the panel agreed unanimously that if the approved plan (to maximise the return to creditors) were implemented substantially, it would indicate success. one expert suggested that the indicator should read ‘to optimise the return to creditors’ and explained as follows: ‘maximising may see a higher dividend, but it could be payable on a never-never basis. it would be preferable for creditors to receive a smaller dividend but receive the cash earlier and bring about certainty.’ (expert 104957, 2016) the authors agree that the optimisation of the return to creditors takes cognisance of the time value of money, an aspect that could be significant given the lengthy period it takes to conclude the business rescue proceedings. however, since the questionnaire-circulated indicator referred to ‘maximise’, the indicator will be included as such but with a note indicating that it should include a consideration of the time value of money. note 13 all of the experts, with the exception of three, agreed to this indicator of success. the three dissenting experts argued that if a plan presupposes the liquidation of the business as the rescue, the business rescue practitioner should rather terminate business rescue and apply for liquidation. one expert said that a: ‘liquidation under a plan or immediate liquidation is still liquidation’. (expert 104957) the expert suggested that the business rescue plan should be to: ‘realise assets and then to de-register the company’, [because] ‘that is totally different to liquidation’. (expert 104957) the same expert agreed that: ‘if the proceeds realised from the implementation of a business rescue plan exceeds that of a liquidation, then there is success according to the act (i.e., chapter 6).’ (expert 104957) it is evident that the word ‘liquidation’ may have been misleading to some experts, as ‘liquidation’ in its true sense means that the company is forced to cease operations and liquidate its assets at usually low fire-sale prices (accounting tools 2016). the suggested change in wording is valid, and will be incorporated in the final list of success indicators. note 14 the panel of experts, except one, agreed that this route enables the business to survive as a going concern, safeguards some employment, and allows continued trading in a different company. one agreeing expert mentioned that chapter 6 is called ‘business rescue’, not ‘company rescue’. therefore, preserving the business should be regarded as success. the dissenting expert argued that: ‘… there is no legal requirement for the key operations to remain alive, provided the other objective of business rescue is met, namely to realise value better than in liquidation.’ (expert 105536, 2016) due to the high level of consensus reached, the indicator will be included as an indicator of business rescue success. table 6 presents the results on the one implicit goal of business rescue, namely to save a substantial number of jobs. all the experts agreed regarding the above-mentioned indicator of success. the dissenting expert commented as follows: ‘the number of jobs saved alone is not an indicator. the company could shed the majority of the jobs but still emerge sustainable thereafter. perhaps saved as many jobs as possible or preserved some jobs and future job opportunities for employees.’ (expert 105536, 2016) the comment is indeed valid. what the researchers actually had in mind was that this measure should not be used on its own, but with the other ‘going concern’ measures, and that some jobs (or as many as possible) should be saved. it is clear that it was only the wording of this statement that misled this expert, but that he or she in essence agreed that the number of jobs saved should be considered in the measurement of success. the researchers therefore conclude that consensus was reached and that the indicator will be included in the final list of indicators. the next section addresses the additional indicators of success that were proposed by the business rescue experts. additional success indicators some of the panel members suggested two new success indicators, which had not been identified in either the literature or the pilot interviews before. these indicators were included in questionnaire 2, and feedback from the rest of the panel members was requested. a few panellists, unfortunately, did not respond to the questions on these additional success criteria. although the original panel size consisted of 16 participants, only 12 experts responded on the two additional indicators listed in table 7. however, even though only 12 experts responded, the panel size was still big enough to draw adequate conclusions from, since it fell within the range of acceptable panel sizes for a delphi study, namely a panel size of 10–18 individuals (okoli & pawlowski 2004:19). note 15 one of the two experts who suggested this indicator, posited that: ‘… a business rescue with a pi score of 2000 at the start cannot be equated to one with a pi score of say 100 at the outset. there is a weighting in terms of the pi score that needs to be taken into consideration.’ (expert 104831, 2016) the pi score is determined by allocating points based on the number of employees, turnover, liabilities and beneficial security holders (republic of south africa 2011). a total of 64% of the experts agreed that an indicator based on the pi score should be used. experts who disagreed commented that the measure is limited to the legal entity, and if the business is sold and all jobs are transferred to a new entity the remaining pi score would be zero. furthermore, a rescue usually includes the compromise of debt and staff retrenchments, and as such would reduce the pi score. they argued that the rescue of a business cannot be measured on the pi score which is a measurement tool to measure something totally different from business rescue. the idea is novel and unique in a south african context and for this reason, supported by some experts, the researchers decided to include the pi score (points saved or rescued) as an indicator of a successful business rescue. however, for this type of indicator to be accepted with more confidence, additional research is needed to develop a customised pi scorecard or verifier with guidance on how it should be interpreted in a business rescue context. note 16 this indicator of success drew 83% agreement from the business rescue experts. one expert said this is ‘… useful if only to avoid plans promising the earth but delivering less.’ (expert 104984, 2016) the expert further suggested that, as an alternative, the delta between liquidation estimated return and actual business rescue return might work as well, but warned that liquidation calculations may be stated at artificially low levels to justify support for the plan. those against the indicator argued that a comparison to liquidation would be better, but such an approach also negates other issues such as jobs saved, ongoing customer support and how the split is made between different classes of creditors. another argument was that an estimation is just that – a potential view based on assumptions with most projections that will deviate over time due to market forces and unexpected changes integral to the business environment. the high level of consensus among the experts who commented on the indicator shows that ultimately the return to creditors is an important indicator and therefore the indicator should be included in the final list of success indicators. after taking all of the feedback received from the panel into consideration, the researchers were able to answer the research questions and reach a conclusion on the research aim. the conclusion and recommendations are documented in the next section. conclusion and recommendations the aim of the study was to reach a high level of consensus on what the expert business rescue practitioners would consider to be the indicators of a successful business rescue. by using the delphi research technique the opinions of senior business rescue practitioners were obtained, corroborated and evaluated in the relevant context. the results of this study show that, at the date of termination of business rescue, a successful business rescue under goal 1 (going concern) is indicated when: the business rescue plan was substantially implemented; the distressed company exited business rescue as a going concern; the rescue saved as many jobs as possible; business rescue points are saved or rescued (when using the public interest score); and the actual outcome of the business rescue compares well to that estimated in the business rescue plan, taking into account the time value of money as well. furthermore, the results show that success also includes evaluating the performance of the company after substantial implementation. ultimately, a successful business rescue is indicated when: the company, after exiting business rescue, proves to be profitable in the short to medium term (e.g. based on verifiers such as profit margins, return on assets and cash flows); the company, after exiting business rescue, proves to be economically viable in the short to medium term (e.g. measured by whether the company subsequently re-filed for business rescue); and the company, after exiting business rescue performs in the long term on par with market expectations (if listed), or it matches the performance of peer companies (if it is an unlisted company). when a business rescue practitioner pursues goal 2 (better return to creditors), the results show that if a company’s assets were realised under a business rescue plan and the company was then deregistered, it is an indicator of success if: the approved plan (to maximise return to creditors) was substantially implemented, and the return received under the business rescue proceedings (cents or rand dividend) proves to be more than the return that would have been received under immediate liquidation. it should be noted that when business rescue procedures are used merely to bring about a piecemeal sale of assets and deregistration of the company, the completion of this plan cannot be considered an indication of success. such a strategy indirectly adds to the liquidation statistics, and is not in line with the spirit of chapter 6. the results of the study were able to show that international indicators of success could also be used to indicate the success of business rescue in a south african context. furthermore, additional indicators have been identified, of which one could be unique to the south african context. this study makes a valuable contribution to the theory of what constitutes a business rescue success. the research revealed that business rescue experts are in need of a business rescue scorecard or measurement tool. further research into developing specific measures, or verifiers, of these success indicators is needed that can form the basis of such a scorecard or measurement tool. moreover, the scorecard or measurement tool can also rank the verifiers to assist with the calculation of relevant success rates in a consistent and comparable manner. limitations to this study the study investigates success from the viewpoint of senior business rescue practitioners, being experts actively engaged in business rescue endeavours on a day-to-day basis. however, the authors acknowledge that there may also be expert viewpoints of other stakeholders, such as restructuring specialists at major lending institutions. further research into their views and opinions of success could only add to measures that can be used to develop the above-mentioned scorecard or measurement tool. ‘measure what is measurable, and make measurable what is not so’ galileo galilei acknowledgements we would like to thank the anonymous reviewers whose comments and suggestions have helped to strengthen the article. competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions c.l. focused on the strategic direction and structure of the article. s.c. developed the research instrument, analysed the data and wrote the first draft of the manuscript. both authors worked on the data collection and interpretation of the results. references accounting tools, 2016, viewed 25 october 2016, from http://www.accountingtools.com/going-concern-principle anonymous expert a, 2016, personal 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methodology results conclusions and recommendations for future research acknowledgements references footnotes about the author(s) chimwemwe chipeta school of economic and business sciences, faculty of commerce, law and management, university of the witwatersrand, south africa moses m. muthinja department of finance, risk management and banking, college of economic and management sciences, university of south africa, south africa department of business, faculty of business and communication studies, st pauls university, kenya citation chipeta, c., muthinja, m.m., 2018, financial innovations and bank performance in kenya: evidence from branchless banking models’, south african journal of economic and management sciences 21(1), a1681. https://doi.org/10.4102/sajems.v21i1.1681 original research financial innovations and bank performance in kenya: evidence from branchless banking models chimwemwe chipeta, moses m. muthinja received: 25 oct. 2017; accepted: 20 apr. 2018; published: 03 oct. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: kenya has become the epicentre of branchless banking financial innovations in the last decade, effectively attracting global research interest. aim: this article examines the relationship between financial innovation and the financial performance of 42 commercial banks in kenya. setting: the financial innovations covered are the branchless banking models, which represent a departure from the traditional branch-based banking. more specifically, the financial innovations covered are: mobile banking, agency banking, internet banking and automated teller machines. methods: we use the koyck dynamic distributed lag model to estimate the relationship between financial innovations and bank financial performance. the model has been using dynamic panel estimation with system generalised method of moments. results: the results show that financial innovations significantly contribute to bank financial performance, and that firm-specific factors are more important in determining the firm’s current financial performance than industry factors. conclusion: we provide evidence that financial innovations generate good results for the shareholders, suggesting that shareholders are the primary beneficiaries of financial innovations used by commercial banks. background and motivation financial innovation is an area of economics that has attracted significant research interest in academia as well as in corporate circles (lerner 2006; lopez & roberts 2002). for instance, laeven, levine and michalopoulos (2015) argue that new financial arrangements have historically emerged following the successful introduction of technological innovations. the financial arrangements include new financial instruments, the emergence of new financial institutions, or application of new reporting techniques (laeven et al. 2015). these assertions are consistent with frame and white’s (2014) work, which observes that technological developments have significantly changed commercial banking business in the last 30 years. they argue that, in general, technological developments have contributed to the entrenchment of commercial banks in the network of global financial institutions undertaking a range of financial activities. in particular, frame and white’s (2014) study provides evidence that firstly, financial innovations have been catalysed by technological developments in the telecommunications sector, and secondly, financial innovations have altered not only bank products and services but also bank production processes. evidently, the link between financial innovation and firm performance is complex, necessitating further research (jiménez-jiménez & sanz-valle 2011). the degree of complexity is further compounded by a number of studies which have attempted to link innovation to either past or future firm performance. for instance, bowen, rostami and steel (2010) argue that although there is a positive link between innovation and future performance, the link between innovation and past performance is unclear. notably, recent technological innovations have led to the emergence of new financial innovations worldwide. the implication of this development is that most of the studies in previous years, largely carried out in the developed world, have not kept pace with new financial innovations in developing countries. the dearth of research data on emerging financial innovations could partly be explained by the fact that the innovations, such as mobile money and agency banking, are not common in developed countries (ingenico 2012). we examine the link between financial innovation in the form of branchless banking models and bank financial performance in kenya’s commercial banks. the new technological developments provide an imperative for carrying out the present study. for example, the emergence of new payment systems which mainly use mobile phones to transfer funds electronically (electronic money), has significantly altered banking services in africa. the focus on kenya is motivated by several factors. firstly, the central bank of kenya (cbk) (2015) shows that mobile payments in kenya have overtaken all electronic card payments combined, in terms of the number of customers and the overall value of the payment transactions. in addition, mobile payment platforms are being employed in every aspect of human life. these aspects include utilising mobile phones to transfer money in deposit accounts held with commercial banks, withdrawing cash from bank accounts, payment of insurance premiums, payment of utility bills, air ticketing, retail outlets, and many more. the many uses of mobile financial innovations underline the importance of research in the field. importantly, the use of third parties to transact banking business, commonly referred to as agency banking, has grown substantially. this is in spite of the fact that it has been in operation in kenya since 2012. the cbk (2015) reports indicate that 90% of agency banking in kenya is controlled by three commercial banks and the individual financial reports of the three banks confirm on average that 30% of the total revenue is accounted for by agency banking. agency banking outlets are located in rural areas, mostly in locations where it would be practically impossible or unprofitable for the commercial banks to establish fully-fledged branches. secondly, kenya is a member of the east african community, comprising burundi, kenya, rwanda, tanzania and uganda. east africa is moving fast toward regional integration, with joint infrastructure projects being undertaken. the overall performance of the east african region will largely depend on developments taking place in kenya (kimenyi & kibe 2014). lastly, the mobile money services sector in kenya is the most advanced in the world (cracknell 2012). the country has a robust mobile money agent network and adequate regulatory support from the cbk. in addition, demirgüç-kunt and klapper (2012) observe that kenya is sub-saharan africa’s regional leader in mobile money. the study finds that 86% of all mobile phone users in kenya use mobile money compared to 23% in the rest of sub-saharan africa. therefore, kenya is at the focal point of financial innovations in the world. this is supported by cracknell’s (2012) work, which classifies a kenyan bank as africa’s most successful microfinance-focused bank, and a mobile phone service provider in kenya as the world’s leading provider of mobile payments. the economist intelligence unit (eiu) global microfinance survey ranks kenya at position five globally, the highest ranking in africa (eiu 2012). the study attributes kenya’s ranking to its global leadership and pioneering in mobile banking services. moreover, recent studies document kenya as the leader in terms of electronic payments, as well as bank branches and bank agents in africa (eiu 2015). the evolution of a number of branchless banking models has motivated research interest in kenya’s financial markets and a number of studies in the subject. however, most of the studies have focused on describing the existing financial innovations and the history pertaining to their introduction in kenya (see hughes & lonie 2007; jepkorir 2010; siedek 2008). all these studies have followed a consistent pattern of providing descriptive statistics on the financial innovations in kenya, but fall short of empirical analysis. this lack of empirical rigour with regard to financial innovations is observed in other studies as well (frame & white 2004, 2014). further to this, the link between financial innovations and firm performance in kenya has been documented to some extent, by a few studies (see makini 2010; mwando 2013). however, none of the studies follow a holistic approach to the study of financial innovation and its impact on firm financial performance. the studies discussed in the literature review have left knowledge gaps in the field of financial innovations, especially in kenya, which the present article seeks to address. firstly, failure or inability to assess empirically the value of financial innovations to innovating firms, has managerial implications in the sense that, in the absence of empirical evidence linking financial innovation to firm financial performance, there is no incentive to innovate. secondly, studies which have attempted to link financial innovations to firm performance have created a bypass around empirical approaches, consistent with frame and white’s (2004) findings. the implication of this state is that most of the findings are largely anecdotal, owing to the (possible) subjective nature of the responses to questionnaires. the article addresses these research gaps by examining financial innovations in two industries namely banking and telecommunications. the financial innovations in the banking industry include bank-focused and bank-led models. non-bank-led financial innovation models are found in the telecommunications industry. the results show that financial innovations are associated with a significant positive impact on the performance of banks in kenya. while controlling firm-specific and macroeconomic factors, the use of automated teller machines (atms), agency and mobile banking contribute significantly to the operating performance of banks in kenya. these results further confirm the dominance of mobile banking over the two branchless banking models (atms and agency banking). the rest of the article is structured as follows: section two reviews the literature on financial innovation, section three describes the data and methodology, section four presents the results of the study and section five concludes and provides recommendations for future research. literature review financial innovation financial innovation is defined in broad terms as ‘… the act of creating and then popularising new financial instruments as well as new financial technologies, institutions and markets …’ (tufano 2003:4). tufano argues that innovations can be categorised into process and product innovations, where product innovations are denoted by new financial instruments, while process innovations are epitomised by innovative methods of distributing the financial products, dispensing transactions or pricing them. tufano (2003) observes that although innovation fluctuates, with some periods exhibiting high levels of innovation and others low, in the long run financial innovation is a distinct part of a growing economy. these findings resonate well with the recent developments in a new generation of financial innovations in kenya, namely branchless banking models. whereas most financial innovation studies in developed countries have largely concentrated on financial products, the study of process innovations appears to have been given a wide berth, especially in developing countries. the emphasis of the present study is on the process innovations used in delivering financial products. the delivery of financial products through financial innovation should improve firm performance. the multidimensional nature of firm performance and its multiple definitions make it more challenging to measure adequately. for instance, it is argued that: ‘… the challenge of measuring companies relative performance across industries and eras, declaring the top performers and finding the common drivers of their success is so daunting that it might seem a fool’s errand to attempt.’ (kirby 2005:30) assessing the performance of firms operating in multiple industries is even more complex due to the problem of allocating balance sheet and income statement items, such as sales and asset items, among the many industries within which they operate (dess & robinson 1984). dess and robinson argue that: firstly, making accurate estimates through survey techniques is a difficult task which represents a major source of measurement error, secondly, the measurement errors emanate from the confidential nature of the data and the application of different accounting policies and procedures among firms and lastly, assessing firm performance in a single industry for privately held firms is even more difficult. innovation and firm performance a number of studies have reviewed the relationship between firm financial performance and innovation in manufacturing as well as innovation in services. for instance, rosenbusch, brinckmann and bausch’s (2011) meta-analysis of previous research on the relationship between innovation and firm performance aims at establishing the direction and strength the relationship has on the performance of small and medium enterprises. they document a positive relationship between innovation and performance and that investment in process innovation leads to higher firm performance than investment in product innovations. however, the findings are largely equivocal as to what explains the variation in returns from investment in process and product innovations. according to laforet (2013), few companies have empirically examined innovation outcomes at the firm level or the link between a firm’s innovation and that firm’s performance. on the other hand, artz et al. (2010) studied 272 firms derived from 35 industries over 19 years to establish the firms’ ability to generate benefits from their inventions and innovation as well as the effect of the innovation on firm financial performance. the study observed a negative relationship between patents and performance as measured by both return on assets (roa) and sales growth. nonetheless, the negative link between innovation and firm financial performance observed in artz et al.’s work (2010) could be as a result of the use of an inappropriate proxy for innovation, namely patents. this is because patents may not necessarily result from innovation. jiménez-jiménez and sanz-valle’s (2011) work finds a positive relationship between innovation and firm performance. the authors argue that the strength of the relationship between innovation and firm performance is higher for bigger and older firms in the manufacturing sector. the respondents to the questionnaires used in the study were asked about the evolution of their firm’s performance over the preceding 3 years. the findings of the study; however, may not be replicated in other studies in view of the subjective nature of the performance measures used. recent studies observe a link between innovation and firm performance. for instance, aduda and kingoo’s study (2012) of the relationship between electronic banking and financial performance of commercial banks in kenya finds a strong positive relationship between bank performance and e-banking innovations. using roa as proxy for bank performance and the number of atms and debit cards as proxy for e-banking, aduda and kingoo (2012) find that innovation contributes to performance of large firms as well as small and medium enterprises. additionally, rosenbusch et al. (2011) argue that innovative products enable smalland medium-sized enterprises (smes) to compete with large and established firms. according to rosenbusch et al. (2011), innovative products enable small firms to avoid price competition and also create new demands which contribute to the firm’s growth. deyoung, lang and nolle’s (2007) study of 424 community banks comprising the earliest adopters of internet banking in usa explains the implication of financial innovation adoption. the study compares the change in the banks’ 1999 – 2001 financial performance with that of 5175 community banks using branch-only banking. they find an improvement in the profitability of the early adopters of internet banking among community banks associated with internet banking. in addition, hernando and nieto (2007) provide a quantitative analysis of the impact of internet banking and the financial performance of 72 banks in spain. they find that the reduction in transaction costs leads to an expansion in the banks’ profitability. lastly, cainelli, evangelista and savona (2006) assess the impact of innovation on the service firms’ economic performance by both conceptually and empirically exploring the bi-relationship between innovation and firm-level economic performance in services. they attempt to establish the existence of a virtuous circle between innovation and firm-level economic performance and report several important findings. firstly, the study finds a strong positive relationship between innovation and a firm’s economic performance. secondly, innovating firms perform better than non-innovating firms in terms of economic growth and productivity. thirdly, a reverse or circular relationship between innovation and firm performance is evidenced by the higher propensity for better performing firms to innovate and commit their capital to innovation. the relationship between innovation and firm performance is therefore two-way, meaning there is a reverse causation between the two. importantly, innovation enables small firms to become big enough to afford large expenditures in innovation and associated research and development. the findings indicate that firms with high turnover, as evidenced by high sales growth, show above-average innovation expenditure in information and communication technology, encompassing both hardware and software. these findings are consistent with the earlier work of gopalakrishnan (2000) on the reverse causality between innovation and financial performance. it appears from the literature that most of the studies on firm performance and innovation have been carried out in developed countries. however, critical success factors for innovation may not be replicable across geographical regions and markets due to cultural differences (al-ansari, pervan & xu 2013; laforet & tann 2006). consequently, more studies are needed across geographical regions for purposes of comparison. the studies reviewed in the preceding sections provide evidence of the existence of a link between innovation and firm performance in different setups. from the reviewed studies, there is evidence linking innovation to firm financial performance for both small and large firms. product and process innovation help the firms in improving performance as well as enabling small firms to compete with large firms. on the other hand, small firms use innovation to create niche markets for their new products and to avoid price competition with large firms. we seek to establish the link between the performance of kenya’s commercial banks and their usage of financial innovations. this is in view of the reviewed studies and the kenya’s banking sector performance over the period of study. performance of kenya’s banking sector kenya’s banking sector has, over the 10-year study period, grown remarkably in terms of total assets, total deposits and other parameters. the sector performed well in spite of the post-election and global financial crisis shocks, as well as changes in political regimes over the period. the banking sector is largely concentrated in favour of six large banks, which take a lion’s share of the banking sector performance. the cbk groups banks into ‘peer groups’ based on total assets, whereby banks are classified as ‘large’ if their total assets are above 15 billion kenya shillings (ksh), ‘medium’ if their total assets are between ksh 5 billion and ksh 15 billion and as ‘small’ if total assets are less than ksh 5 billion. some banks have moved from lower classification to higher ones and vice versa over the study period. although large banks account for a bigger share of the sector performance, the banking sector has generally been on upward trajectory in terms of growth, as illustrated in figure 1. figure 1: growth in total deposits and total assets. the peer group classification led to over 50% of the banks being classified as ‘large’ in the year 2010, necessitating a revision of the grouping criteria (cbk 2010). the classification of banks into three peer groups since 2010 has been based on the weighted composite index, which comprises total assets, deposits, capital size, number of deposit accounts and loan accounts (cbk 2010). as at december 2013, six banks were classified as large, 15 as medium and 23 as small (cbk 2013). the six large banks account for 52.39% of the (weighted) market size, medium banks account for 37.95% and the 23 small banks control a paltry 9.66% of the market. consequently, these statistics provide evidence of high concentration in the banking sector, which is likely to reduce small banks to mere followers and imitators of the financial innovations developed by large banks. the dominance of large banks in terms of total assets and total deposits implies that large banks have sufficient resources to develop financial innovations. figures 2 and 3 illustrate the performance of the peer groups since the year 2006, although the composition of the individual peer groups has varied over time. the apparent decline in total assets for all peer groups in year 2010 is as a result of the change in classification criteria for the peer groups. figure 2: growth in peer groups’ total assets. figure 3: growth in peer group’s total deposits. data and methodology data sources and variables this article uses secondary data obtained from a number of sources. the commercial banks’ financial performance and banking industry performance data were obtained from cbk bank supervision annual reports and from the respective banks financial reports downloaded from bankscope1. financial innovations data was largely obtained from individual company websites, financial reports, as well as media reports. the data on listed companies were obtained from capital markets authority (kenya), while kenya’s economic performance data were extracted from kenya national bureau of statistics and the world bank development indicators. the population of the study comprises all locally and foreign-owned commercial banks in kenya which are not under statutory management. we use the data on the number of bank accounts for each bank contained in the cbk annual bank supervision reports as proxies for internet accounts. the data on the number of bank accounts are available for the period 2009–2013, that is, half of the period studied. over the period of study, the data collected from the individual commercial banks reports and websites, as well as media reports indicate that 90% of agency banking is controlled by three large banks. although atm data for the banking sector is available from the cbk reports, individual banks’ atms were harder to get and, therefore, involved a combination of multiple sources, such as annual reports and websites of individual banks and media reports. all the data on mobile payments were obtained from the cbk national payment statistics contained in the cbk website. therefore, the challenges regarding the sources of the data lead to an unbalanced data panel. the structure of the data has informed our choice of systems – generalised method of moments (gmm), as discussed in section 3.3. the sample size comprises 42 out of the 43 commercial banks. one of the sampled commercial banks was excluded, as it was under statutory management during the study period. the variables used in this article are defined in table 1. table 1: variable definition. model specification this article uses a dynamic distributed lag model to estimate the relationship between financial innovations and bank financial performance. this is because the lagged values of the dependent variable (firm performance) are included among the explanatory (financial innovation) variables (gujarati 2003). the independent variables are also lagged since it takes time before the investment in financial innovations can have a significant impact on firm performance. a number of reasons would account for the lag in the financial innovation impact on firm performance. firstly, according to griliches (1967), the decision to invest in research and development (r&d) expenditure and its ultimate payoff in terms of productivity involves not only considerable lag but also several different lags. since investment in financial innovations usually involves considerable r&d expenditure, it takes time before the investment in r&d as well as the capital cost of the information and communications technology infrastructure can be recouped. secondly, the adoption and use of electronic payments is prone to network externalities. a network effect or externality arises when the value of a product to one user depends on the number of other users of the same product (katz & shapiro 1986). according to shapiro, varian and becker (1999), technologies prone to network effects have a tendency to show a long lead time followed by rapid growth. the authors argue that as existing customers return positive feedback, the customer base grows, thus making the adoption of the product worthwhile for many more users; eventually the product achieves a critical mass and takes over the market. thirdly, individuals are naturally resistant to change, especially culture change, because of the discomfort that change offers. in most cases, customers adopt a ‘wait and see’ attitude and therefore adopt the innovations at a later date. such customers are referred to as ‘laggards’, possibly because of their lagged response to the introduction of new products and innovations. the resistance to change in favour of adoption and usage of financial innovations may also be attributed to risk factors, such as the fear of money laundering and the risk of fraud associated with the use of third parties to access personal accounts under agency banking. in view of these observations, a general distributed lag model is expressed as follows: where yi,t is the measure of firm performance (indadjroa, indadroe). when using a firm’s roe and/or roa, it is possible to find unusually high or unusually low values for either of these ratios. however, the use of industry-adjusted roe and roa can mitigate this effect (kayanga 2008). these measures give us an indication of relative performance. xi,t–k represents the lagged values of financial innovation variables (atm, ib, ab and lnmbtn). zi,t represents control variables for firm i at time t,2 and μi,t is the error term. these variables are defined in table 1. to estimate the distributed lag model, the koyck (1954) transformation distributed lag model is used. this model is expressed as follows: where, yi,t−1 represents lagged values of the independent variable. μi,t = (ut – λut−1) is a moving average of ut and ut−1. ut is time t error term while ut−1 is t−1 error term. the koyck model has been used in recent financial innovation studies (muthinja & chipeta 2017). estimation technique this article adopts a dynamic model specification for a number of reasons. firstly, past literature has observed that firm performance shows persistent effects, meaning that past performance affects present performance. secondly, firm performance is not only influenced by the present financial innovation but also past financial innovations. formally, the model is specified as shown in equation 1. a priori, the optimal lag in equation 1 is unknown. however, if we assume that the effect of past financial innovation decays gradually (over time) to zero, as argued by koyck (1954), then equation 1 can transform using koyck transformation. the resulting equation through the transformation process leads to equation 2. estimating equation 2 using ordinary least squares, fixed or random effect models gives rise to a number of econometric issues such as autocorrelation and heteroscedasticity. however, the dynamic gmm developed by arellano and bond (1991) helps address these challenges. in addition, the model has been found to be robust to measurement errors, addresses some endogeneity and is well suitable where we have small t and large n. given the structure of the panel data of this study, where t = 10 and n = 42, dynamic gmm is, therefore, the most suitable estimation technique. the dynamic koyck distributed lag model is, therefore, estimated using gmm (arellano & bond 1991; arellano & bover 1995; blundell & bond 1998). the gmm models are ideal for analysing and estimating data with small time periods, data which is replete with measurement errors and for models whose independent variables are likely to be endogenous. consequently, the implication from these studies is that dynamic panel estimation technique is the most appropriate for the present study for a number of reasons. firstly, the presence of lagged dependent variable, yi,t in our model leads to autocorrelation. secondly, most of the financial innovation variables have small time periods. for example, as at the end of the study period, agency banking innovation has been in use in kenya for only 3 years (2010 – 2013), mobile money for 7 years (2007 – 2013), and internet banking data has been available for a five-year period (2009 – 2013). thirdly, the nature of accounting data used to generate accounting returns (roe and roa) is prone to measurement errors due to variations in accounting policies across firms with regard to the treatment of a number of items in financial statements. lastly, the panel data set time dimension is short (t = 10) and has a larger country (firm) dimension (n = 42). in this article, we apply the systems gmm estimator of blundell and bond (1998), which assumes that the first differences of the instruments are not correlated with the fixed effects parameters which then increase the number of probable instruments which would be used in estimating the model parameters (arellano & bover 1995; blundell & bond 1998; fowowe & babatunde 2013). control variables the purpose of the control variables is to control any other factors which may affect the dependent variables other than the main independent variables, which enhances the robustness of the final results. the industrial/organisation theory states that firm performance variations can be explained by the structural features of the sectors in the industry in which the firm operates (kamasak 2011). this implies a direct relationship between industry performance and firm performance. the banking industry roe and roa, therefore, are included in the model as control variables. since the structure of the industry affects firm performance, the peer grouping of the kenyan banks is also factored in the model as a control variable. the banks are grouped into three peer groups, namely, large, medium and small. we further control past firm and industry financial performance by including the lag of industry-adjusted roe for each firm, while past industry performance is represented by the lag of industry roe. according to mcgahan and porter (2003), firm-driven performance persists at a slower rate compared to industry-driven factors. in their earlier work, mcgahan and porter (1999) find 76.6% – 81.8% persistence of the industry-driven performance compared to 47.9% – 65.5% persistence in firm-specific factors. the implication of these findings is that past firm and industry performance may affect present or future performance, but the past industry performance may have a bigger effect. past firm and industry performance are included in the model as control variables. a number of studies observe that foreign-owned firms perform better than locally owned firms and, therefore, foreign ownership has a positive impact on firm performance (aydin, sayim & yalama 2007). these findings are consistent with goethals and ooghe (1997), who find that foreign-owned firms perform better than the locally owned belgian firms. in view of these and other related findings, it is expected that the ownership of the firms is likely to influence the results of this study. ownership of the firms is included in the model as ownership dummies, where ‘1’ represents locally owned firms and ‘0’ represents foreign-owned firms. of the 42 commercial banks studied, 10 are listed on the nairobi securities exchange. in effect, due to the possibility that the listing may influence the results, a listing dummy is included in the regression with a listing dummy of ‘1’ for listed banks, and ‘0’ otherwise. additionally, the performance of the economy where firms operate, affects their financial performance (dollar, hallward-driemeier & taye 2005). as the economy grows, the economic environment wherein the firms operate becomes more conducive. in effect, bank loans uptake increases due to increased economic activities, coupled with reduced default on loans. to control the effect of economic performance on bank performance, gdp growth rates are used as control variables in the regression model. lastly, the context of an organisation or a firm to a large extent determines adoption and usage of innovations by the firm. the technological-organisational-environmental literature suggests that the organisational context, such as the scope, firm size and the structure of management, has implications on financial innovation (oliveira & martins 2011). a number of studies have attempted to link firm size to innovation adoption and usage. for example, rogers (1995) argues that firm size is a proxy for a number of dimensions which collectively lead to innovations namely aggregate resources, technical expertise of employees and slack resources. firm size is represented by the log of total assets. results summary statistics table 2 presents the summary statistics for all the variables used in the study. the observations range between 397 and 420, indicating that the panel is unbalanced. due to log transformations and scaling down of the variables to industry values, the standard deviations have been reduced. the table also shows that there are years with missing values, as discussed earlier. the missing values largely relate to the four financial innovations, since the innovations were introduced at different years over the study period. the industry-adjusted roe and roa have been used to mitigate the effect of outliers, consistent with kayanga’s (2008) approach. table 3 reports the correlation matrix for all the variables used in the analysis. the correlations among the independent variables are not high enough to suggest that there may be a problem of multicollinearity. as such, the variables can be included in our regressions. table 2: summary statistics for all the variables used in the study. table 3: correlational matrix for all variables used. empirical results this section discusses the regression results presented in table 4. the model tests the relationship between financial innovations and financial performance for kenyan commercial banks. financial performance has been measured by industry-adjusted roe and industry-adjusted roa. the system gmm used for the study is an instrumental variable estimation technique. specifically, it generates some internal instrument for explanatory variables, which helps to deal with the time invariant effect due to the panel structure of our data, as well as the problem of weak exogeneity. thus, except for the dummy variable, all the other explanatory variables have been instrumented by their first lag. however, we differentiate between explanatory variables in which not only their present value but also their past value affects firm performance. to this variable, we include their first lag (which in the estimation procedure has been instrumented by their second lag) and level (which has also been instrumented by their first lag). hence, even though, variables such as ab, lnmtbn and atms are reported as level, in general, system gmm makes use of their first lags. this explains the reason why some variables are lagged, while others are not. table 4: regression results for financial innovation and firm financial performance. each of the performance measures has been included as the dependent variable in the model. in each case, both the arellano-bond test for zero autocorrelation in first-difference errors (ar 2 test) and the sargan test of overidentifying restrictions are carried out. the two tests confirm no autocorrelation and that overidentifying restrictions are valid in the regression models. additionally, the wald test for joint significance of the independent variables confirms that the independent variables are jointly significant at the 1% level of significance in driving firm financial performance. therefore, the model is appropriate for testing the relationship between financial innovation and firm performance. although the results largely provide evidence that financial innovations have a significant positive impact on banks’ financial performance, we observe varying results depending on the performance measure used. with regard to industry-adjusted roe, the coefficients are statistically significant at the 5% level of significance for both atms and agency banking. the results further indicate that mobile banking significantly affects firm performance at the 1% level of significance. these results are also economically significant in view of the size of the effect that the independent variables have on the dependent variable (firm performance). the size of the effect that the independent variables have on firm performance is measured by the size of the coefficients of the independent variables. according to the results in table 4, the coefficients are significantly above zero, at 31.79, 18.72 and 0.064 for atms, agency banking and mobile banking proxies, respectively. importantly, the coefficients have positive signs as expected, providing evidence that the financial innovations significantly and positively drive banking performance, as measured by industry-adjusted roe. although the effect of internet banking on firm performance is not statistically significant at all conventional levels, the effect is positive as evidenced by a positive coefficient of 4.09. these results confirm the dominance of mobile banking (non-bank-led model) over the other two branchless banking models. this can be explained by a number of observations made in the study. firstly, the dominance of mobile payments’ customer numbers over the other electronic payments is an indication of the popularity of mobile banking in kenya. although the contribution of agency banking to firm performance is significant at the 5% level of significance, agency banking was in operation for only 3 years over the 10-year study period. the implication is that the impact of agency banking is likely to be felt more in the future, considering the fact that the impact of financial innovation on firm performance is time lagged. in addition, agency banking has been adopted by only 13 out of 42 commercial banks, thus the innovation is yet to be felt more widely. the contribution of atms to firm performance is statistically significant at the 5% level. this is in spite of the fact that a number of banks (including multinationals) in kenya have not installed their own atms. these banks have linked their customers to a shared platform referred to as kenswitch3. moreover, visa and mastercard branded atms enable the sharing of the atm network globally, implying that individual firms sharing the atm platforms may not necessarily have the incentive to install many atms in view of the huge installation cost per atm machine. nevertheless, atm usage has a significant impact on firm financial performance. the results in table 4 show that internet banking positively affects firm performance, but the contribution is insignificant. a firm’s past performance has a statistically significant positive impact at the 1% level of significance, while the industry’s impact on firm financial performance is negative and insignificant when both industry roe and roa are used. however, when only industry roa is used, the impact of the industry on firm performance is negative, but statistically significant at all conventional levels. it appears that industry performance is generally not a major driver of any individual bank’s firm performance in kenya. when industry-adjusted roa is used, size significantly and positively affects firm performance, while the coefficient on size becomes insignificant when industry-adjusted roe is used. this could be explained by the fact that total assets, used as the proxy for firm size, comprise the resources controlled by the firm, which have been found to drive firm performance. the impact of firm size on firm performance buttresses the resource-based view which holds that performance variation among firms is mainly dependent on the resources which individual firms control (galbreath & galvin 2008). however, these findings are not consistent with the industrial and/or organisation economic theory, which holds that firm performance variations can be explained by the structural features of the sectors in the industry wherein the firm operates (kamasak 2011). the ownership structure of the banks has been used as a control variable in the regression. the results show that ownership structure has a statistically significant positive impact on firm performance. the size of the coefficient on the ownership variable is economically significant (at 2.52) and is positive as expected. this shows that locally owned banks are the leaders in the usage of financial innovations. as observed in the review of the banking sector performance, locally owned banks (three commercial banks) account for more than 90% of agency banking in kenya. lastly, this study finds a significant positive relationship between performance of the economy, as measured by gdp growth, and firm financial performance. secondly, the size of the coefficient is big (at 0.34) and positive as expected. the implication of this finding is that the economic environment where commercial banks operate is critical in driving their financial performance. this is because when the economy is performing well, the uptake of development loans increases and default rates on such loans fall with positive implications on profitability. we contend that roa and roe ordinarily measure different types of performance, and the interpretation of the results from our analysis needs to take this fact into consideration. roa shows how a given bank uses its assets to generate revenue. our results, therefore, suggest that over the duration of our study, atms, agency banking and internet banking do not significantly enable banks to generate revenue. this needs to be seen in the banking sector context. in the banking sector, atms and internet banking generate revenue if bank customers use the atm and the internet to either deposit or withdraw cash as opposed to just checking account balances. considering that agency banking has been in place for a very short time (3 years), perhaps in the long term these results will change. on the other hand, roe shows profitability for the shareholders. it is the shareholders’ view of how much they are getting from the profits made by the bank. we, therefore, provide evidence that financial innovations in the form of branchless banking models produce good results for the shareholders, implying that shareholders are the primary beneficiaries of financial innovations used by commercial banks. overall, the study results presented in table 4 provide evidence that mobile banking, atms and agency banking significantly explain the variation in firm financial performance in kenya. conclusions and recommendations for future research the empirical literature review in this article covers financial innovations, firm performance and kenya’s banking sector over the study period. empirical studies on financial innovations and firm financial performance provide evidence of the link between the two. nevertheless, most of the previous studies have concentrated on financial innovations in the form of financial products in developed countries. although there are multiple meanings of ‘firm performance’, as well as diverse ways in which performance construct is operationalised in the literature, the focus of this study is on bank financial performance, as measured by the industry-adjusted roe and roa. the results show that financial innovations significantly contribute to bank financial performance, and that firm-specific factors are more important in determining the firm’s current financial performance than are industry factors. management efforts at driving financial innovation should be consistent with the recent global trends. for example, a study of 246 ceos from pricewaterhousecoopers (pwc) global ceo panel, comprising multinational companies across all sectors, company sizes from developed and emerging economies, makes important findings (pwc 2013:3). according to the study ‘… ceos are now taking personal responsibility for directing and inspiring innovation as it becomes an ever more vital element of business survival and success …’ the implication of the pwc research and the results from this article is that management should recognise that innovation in general and financial innovation in particular, generate financial value and contribute to the success of the firm. moreover, financial innovation is seen as encouraging banks to take on more risks, providing valuable credit as well as firms’ risk diversification services (beck et al. 2016). we recommend that future studies seek to establish whether financial innovation has a stronger relationship with past or future performance. secondly, we suggest that future studies focus on obtaining atm transaction data (if possible) to be able carry out a more in-depth study on the impact of atms on bank performance. lastly, we suggest that future studies focus on the link between firm performance, financial innovation and the possibility of reverse causality between the two variables. acknowledgements this work benefited from african economic research consortium funding (aerc phd fellowship 2015). competing interests the authors declare that they have no financial 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the economics of finance 1, 307–335. https://doi.org/10.1016/s1574-0102(03)01010-0 footnotes 1. licensed to the university of the witwatersrand, south africa. 2. the independent variables measure financial innovation usage and have been scaled down using industry usage of the financial innovations. frambach and schillewaert (2002) contend that the innovation process becomes successful upon its acceptance and integration into the organisation and the demonstration of commitment through continued use of the product innovation. according to rogers (1995), this commitment entails the decision to make full use of an innovation as the only best available course of action. 3. kenswitch is a shared financial switch comprising a consortium of over 20 kenyan commercial banks, established so as to create a common switch and atm network linking a number of smalland medium-sized banks in kenya (lts 2015). 34 sajems ns vol 2 (1999) no i effectiveness on the influence of marketing building long-term relationships in environment a sport f j herbst and a n schreuder department of marketing and communication management, university of pretoria abstract the providers of professional sport are influenced by the ever-changing nature of sport as a fonn of entertainment and its subsequent effect on relationship building in the new millennium. the continuous aim of building relationships of high quality in a lucrative business field can only be achieved by means of effective marketing. in order to ensure marketing effectiveness, the quality of the relationship with spectators is a crucial success factor, influenced by the length of the relationship, value for money and the propensity to leave. an empirical study was undertaken in a sporting environment which investigated the quality of the clients' (season ticket holders') current relationship with the service provider (sporting union). an exposition is also given of the methods and procedures used in the study. jel m 31 "the heart and soul of relationship marketing is marketing to the customers after they have become customers" (berry, ]994). 1 introduction research in relationship marketing to date concentrated on business-to-business (btb) marketing research and little attention was given to business-to-consumer (btc) marketing research. relationship marketing has yet to progress beyond topics for articles and speeches with little real action (pruden, 1995), this view is supported by perrien (1995) and paley (1996) who believe that the implementation of relationship marketing within organisations, including service organisations, has r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 35 yet to be tackled. there is a need for a model that conceptually incorporates the relationship factors that are unique in btc marketing. an attempt was made by morgan and hunt (1994), with their commitment-trust theory of relationship marketing, which was based on research conducted in the automobile tyre retailer industry. the kmv model focuses on the relationship commitment and trust of only one party in the relational exchange. the aim of the current study is to investigate relationship marketing in general and not to direct the study at a specific industry. the empirical research was conducted on the relationship marketing of a major sport union in south africa. there is a lack of consensus on the correct terminology with regards to sport (singular) or sports (plural) marketing. in this study the term "sport marketing" is preferred based on mullin, hardy and sutton (1993) who argue that "sports marketing" tends to characterise the industry as a mass of uncoordinated segments without commonality. the singular form is therefore preferred because all sport segments should be regarded as a homogeneous entity. 2 key concepts of the study it is essential to define and explain the two key concepts used in this study before the research design and methodology are discussed. • relationship marketing many relationship marketing definitions are provided in services marketing, industrial marketing, bank marketing, advertising and business strategy. the understanding of relationship marketing requires a clear understanding of the difference between discrete transactions and relational exchanges. morgan and hunt (1994) propose that " .... relationship marketing refers to all marketing activities directed toward establishing, developing and maintaining successful relational exchanges." r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 36 sajems ns vol 2 (1999) no 1 • relationship quality relationship quality is described by bejou, wray and ingram (1996) as an important component of relationship marketing. morgan and hunt (1994) identify five major antecedents of relationship quality. these are: (i) relationship termination costs, (ii) relationship benefits, (iii) shared values, (iv) opportunistic behaviour and (v) communication. parasuraman, zeithaml and berry (1994) describe relationship quality as the difference between perceived relational benefits and perceived relationship sacrifice, and perceived episode benefits and perceived episode sacrifice, within the parameters of 'tolerance zones. ' 3 objectives of the study the primary objective was to determine the influence of the qualitative outcomes of relationship commitment and trust on the relationship quality between a service provider and a client. the secondary objectives were: (i) to compile a client profile to enable the service provider to direct its marketing strategy and to ensure the effectiveness of a future relationship marketing strategy. oi) to identify the gaps in the current relationship marketing strategy based on the client's perception of the service provider in order to enhance the effectiveness of a future relationship marketing strategy. 4 research design and methodology the total project was divided into two distinct phases a pavilion survey (phase 1) and a mail survey (phase 2). the pavilion survey was used as a pretesting phase for the mail survey questionnaire. 4.1 questionnaire design the questionnaire included specific relationship marketing questions representing the quality ofthe relationship between the client and the service provider, value for r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 37 money, propensity to leave and recommendation of the service provider to potential clients. the main body of the questionnaire included 48 individual statements divided into eight categories. the statements were measured in terms of both importance and perception of performance. both importance and perception of performance measures were done on a five point scale. the questionnaire layout was carefully planned to accommodate the mail collection methodology used and was pretested during a pilot study before it was sent to the respondents in the sample. 4.2 data collection a probability sampling design (simple random sample) was used to draw a sample of 2000 units from the customer database (a sample frame of 3500) of the service provider. the sample units were randomly selected and thereafter the selfadministered questionnaires were distributed by mail 4.3 data processing factor analysis, cross tabulation and item reliability were executed and an analysis of variance was done by means of anov a by using css statistic a computer software. 5 research hypotheses the following hypotheses were formulated and tested: hi the relationship quality of spectators that had a long relationship with the service provider is significantly higher than the relationship quality of spectators that have recently engaged in a relationship with the service provider. h1 the relationship quality of spectators who regard their season tickets as good value for money is significantly higher than the relationship quality of spectators regarding their season tickets as less value for money. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 38 sajems ns vol 2 (1999) no i h3 the relationship quality of spectators who are willing to continue their current relationship is significantly higher than the relationship quality of spectators who are not willing to continue their current relationship with the service provider. h4 the relationship quality of spectators who are willing to recommend the service provider to potential spectators is significantly higher than the relationship quality of spectators who are not willing to recommend the service provider to potential supporters. h5 the relationship quality of spectators with a high perception of marketing effectiveness is significantly higher than the relationship quality of spectators with a low perception of marketing effectiveness. h6 the relationship quality of spectators with a strong perception of image is significantly higher than the relationship quality of spectators with a low perception of image. h7 the relationship quality of spectators with a positive perception of media relationships is significantly higher than the relationship quality of spectators with a negative perception of media relationships. 6 findings 6.1 response rate the effective response rate of the mail survey sent to spectators (season ticket holders) was 25.50%. 6.2 descriptive statistics on relationsbip quality the descriptive statistics indicate the sample size, mean, standard deviation, two-top box score in table i, the mean values in table 2. the two-top box score is an indication of the percentage of respondents who have chosen scale values 9 and 10. frequency distribution results in table 3 is based on a 5 point scale and indicate the percentages of the responses on each scale item. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no i 39 table 1: descriptive statistics ·n mean standard two-top deviation box score 484 2.28 11.60% 484 6.72 2.27 19.90% 484 6.70 2.12 18.70% 484 6.67 2.24 18.20% • n = sample size .. the range of scale from 0 10 where 0 very poor and 10 = excellent 6.3 marketing effectiveness measurement marketing effectiveness was measured on a 5-point likert scale for both importance and perception of performance. figure 1: xy plot of marketing effectiveness 4100 3.900 3100 3.500 3,300 '" c:: 3100 g q. ~ 2900 iii il. :2.100 2500 .40 .9 quadrant i quadrant iii 41 • 2._1 quadrant ii • 36 10 • .38 : 130 • 2. i" r21 • 46 16 • i 25.<ilia· • .52 .jll 23 • lj"4 so .31 • 1 ~ 5. ! 31 42 '+45+ .. : ......... ______ _ 1'0· :f:., .22 .2 .21 .43 .33 .11 •• .12 .44 .41 ,. ·3. .'3 .49 ." quadrant iv 2.80 3.90 ".00 <410 .. 20 '" 30 4.40 .. 50 .. 60 4.70 .. 60 importance r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 40 sajems ns vol 2 (1999) no 1 in order to subtract the most objective criteria for a quadrant separation, the mean value of each statement was used as the central measurement for both importance and perception of performance. with this approach it was possible to distinguish between the four distinct quadrants: quadrant i quadrant ii quadrant iii quadrant iv low importance, high perception high importance, high perception low importance, low perception high importance, low perception the mean scores for each statement on both importance and perception of performance are illustrated on the vertical and horizontal axis. specific marketing problem areas are identified by the xy plot as the horizontal axis represents the column where the spectators provided an indication of the importance of each statement on a 5 point scale. the vertical axis represents the evaluation of the spectators' experience on each of the statements regarding the service provider. the individual statements were numerically identified according to their numerical sequence in the questionnaire. both axis x and y were restricted to a variance width of the scale rating. based on the variance width for each axis, a decision was taken to restrict the scale values for importance to a maximum of 4.80 and a minimum of 3.40, whilst the perception on performance scale was restricted to a maximum of 4.10 and a minimum of 2.3. the most important problem areas are identified in quadrant iv and represents the following statements: quadrant iv .~ of the sport union's management 4.383 2.590 • 49 amount of spectators visiting matches at the 4.462 2.762 stadium 13 marketing to win and to keep the loyalty of the 4.521 2.915 spectators 39 parking in and around the stadium 4.422 3.033 18 communication to spectators (keep spectators 4.421 3.046 informed) 41 the sound system and public address system 4.426 3.168 44 placement of regular match schedules and information 4.495 3.222 on other matches in newspapers '* the range of scale from 1 • 5 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 41 quadrant ii is a more positive quadrant and represents statements with a high importance and a high perception: quadrant ii 36 neatness of the stadium 4.602 4.048 38 safety and security of the stadium 4.598 3.918 3 the strong marketing identity 4.525 3.746 i 32 spirit of the stadium spectators 4.601 3.754 4.503 3.641 ~arketing of the sport to children behaviour of the spectators on the pavilion 4.530 3.575 16 image of the players 4.622 3.566 52 iinternational exposure 4.731 3.557 37 ithe toilet facilities at the stadium 4.547 3.490 * the range of scale from i 5 table 2: mean values mean values (5 point scale) importance perception of performance marketing 4.21 3.19 image 4.63 3.09 communication 4.40 2.97 tickets 4.36 3.35 involvement 4.40 3.74 stadium 4.26 3.21 media relationships 4.35 3.15 spectators 3.60 3.21 the mean values on importance are significantly higher than the mean values on perception of performance for all the categories. this result is an indication of the importance of all the categories to the clients and the weak performance of the service provider on these categories. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 42 sajems ns vol 2 (1999) no 1 table 3: frequency distribution table 0 1 2 3 4 6 7 8 9 10 total * .. 6.4 relationship propensity to value for willingness to quality leave money recommend 1.90% 2.1% 0.20% 1.90% 1.90% 0.80% 0.60% 1.20% 3.10% 2.70% 3.30% 2.70% 6.80% 4.10% 5.00% 3.50% 6.60% 4.30% 6.20% 4.10% 17.80% 13.00% 11.20% 14.50% 14.70% 11.60% 14.60% 12.40% 17.40% 19.30% 20.70% 19.30% 18.20% 22.20% 19.50% 22.20% 3.50% 9.30% 7.70% 8.30% 8.10% 10.60% 11.00% 9.90% 100% 100% 100% 100% the frequencies are the percentage of responses on each scale item. willingness to continue the current relationship was measured as the inverse of propensity to leave. validity and reliability factor analysis was used to determine the validity of the data in the data set. eight factors were extracted by principle component analysis and a varimax rotation accounting for 62% of the variance in the importance section and 55% of the variance in the perception section. by employing the varimax rotation method a rotated factor pattern was compiled and only items with factor loadings greater than 0.4 during this rotation have been included in the relevant factors. the factor loadings are an indication of the contribution of each item to the variance in each factor. items 14,26,47 and 48 were eliminated due to them not contributing to the significance norm of 0.4. these factors explain 62% (internal consistency) of the variation in the importance section of the data set and eight factors selected are shown in table 4. the factors explain 55% (internal consistency) of the variation in the perception section of the data set and the eight factors selected are shown in table 5. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 43 table 4: factor analysis based on importance item facfacfacfacfactor facfactor facto tori tor 2 tor 3 tor 4 5 tor 6 7 8 aggresive marketing 0/ 0.704 rugby advertising in newspaper, 0.698 magazines, radio & tv the strong marketing 0.646 identity using rugby players in p.741 marketing the appearance 0/ rugby 0.759 players at promotional events marketing/introducing 0/ 0.552 newlyoung players to ~ spectators marketing 0/ season tickets 0.549 marketing o/rugby to 0.440 children marketing o/rugby to 0.401 women using sponsorships in 0.462 marketinjl the use o/rugby souveniers 0.497 (caps, jerseys, emblems, cushions) convincing non-rugby 0684 spectators and tv spectators to visit the stadium marketing to win and to 0.642 keep the loyalty 0/ the spectators the total image 0/ the team 0.783 image 0/ the players 0.772 the accessibility 0/ the 0.503 union to the public r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 44 sajems ns vol 2 (1999) no 1 table 4 continued item facfacfacfacfactor facfactor factor tor 1 tor 2 tor 3 tor 4 5 tor 6 7 8 communication to 0.501 spectators (keep spectators informed) communication with the 0.481 media (newspapers, radio. tv) the variety of ticket 0.437 packages marketed the price of a season ticket 0.603 the price of a ticket at the 0.741 gate the availibility of season i 0.765 tickets the availability of tickets in 0.756 j!enerai et= convenience to obtain a ticket :06 the involvement in club ruj!by the involvement with school 0.747 ruj!by the involvement with junior 0.743 ruj!by the involvement with rugby 0.765 clinics the curtain-raisers during 0.430 important matches spirit of the spectator 0.569 the entertainment of the 0.324 spectators to build atmosphere (music. profossional announcer) cateringfacilities at the 0.717 stadium quality of the food 0.747 neatness of the stadium 0.753 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 45 table 4 continued item facfacfacfacfactor facfa~tor ifactol tor i tor 2 tor 3 tor 4 i 5 .tor6 8 the toiletfacijities at the 0.766 stadium safoty & security of the 0.691 stadium parking in and around the 0.598 stadium the accessibility of 0.510 spectators to players after a match the sound system and public 0.508 adress system publicity in newspapers 0.530 talk shows on radio 0.667 placement of regular match 0.495 schedules and information on other matches in newspapers maintaining effective media 0.565 relationships behaviour of the spectators 0.495 on the pavilion table 5: factor analysis based on perception of performance item factori facfactor factor 2 3 tor 4 factor 5 facfactor factor 6 7 tor 8 aggresive marketing of 0.553 rub events r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 46 sajems ns vol 2 (1999) no 1 table 5 continued item facfacfacfacfactor facfactor factor tor 1 tor 2 tor 3 tor 4 5 tor 6 7 8 marketing/introducing 0/ 0.685 new/young players to spectators marketing 0/ season 0.631 tickets =+=1 marketing 0/ rugby to 0.524 children gbyto 0.606 using sponsorships in 0.555 marketing the use o/rugby 0.531 sou\leniers (caps. jerseys, emblems. cushions) convincing non-rugby 0.656 spectators and tv spectators to visit the stadium marketing to win and to 0.598 keep the loyalty o/the spectators the total image o/the 0.761 team image of the players 0.786 the accessibility 0/ the 0.333 union to the public communication to 0.426 spectators (keep spectators iriformed) communication with the 0.555 media (newspapers. radio. tv) the variety 0/ ticket 0.5 packages marketed the price 0/ a season 0.566 ticket the price 0/ a ticket at the 0.564 gale the avai/ibi/ity 0/ season 0.735 tickets r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 47 table 5 continued item facfacfacfacfactor facfactor factor tor 1 tor 2 tor 3 tor 4 5 tor 6 7 8 the availability of tickets 0.754 in general corrvenience to obtain a 0.666 ticket the irrvolvement in club 0.713 ruji!by the irrvolvement with 0.735 school rugby the irrvolvement with 0.745 junior ruji!by the involvement with 0.731 rugijy clinics the curtain-raisers during 0.411 important matches spirit of the spectator 0.436 the entertainment of the 0.535 spectators to build atmosphere (music, professional announcer) cateringfacilities at the 0.830 stadium quality of the food 0.837 neatness of the stadium 0.740 the toilet facilities at the 0.724 stadium safety & security of the 0.625 stadium parking in and around the 0.412 stadium the accessibility of 0.439 spectators to players after a match the sound system and 0.438 public adress system publicity in newspapers 0.702 talk shows on radio 0.637 placement of regular 0.652 match schedules and information on other matches in newspapers r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 48 sajems ns vol 2 (1999) no 1 table 5 continued item facfacfacfacfactor facfactor factor tor 1 tor 2 tor 3 tor 4 5 tor 6 7 8 maintaining effective 0.676 media relationships behaviour of the pavilion 0.448 spectators all the items identified in factors 1-5 and 7-8 were very consistent except for the items in factor 6 and there were no overlapping of items in factors 1-8. the following items were the major contributors to each factor in the perception of perfonnance: factor 1 marketing and introducing of new i young players to spectators (item 6). factor 2 publicity in newspapers (item 42). factor 3 the availability of tickets in general (item 24). factor 4 involvement with junior sport (item 29). factor 5 neatness of the stadium (item 36). factor 6 image of the players (item 16). factor 7 quality of food (item 35). factor 8 the entertainment of the spectators to build atmosphere (item 33). reliability was computed by means of the cronbach alpha coefficient. reliability results of these factors were computed by means of cronbach alpha based on the total data, importance and perception of perfonnance. the reliability result for the total evaluation of the data set is 95,12% and reliability for importance and perception of perfonnance are shown in table 6. table 6: reliability results based on importance and perception items reliability for reliability for importance perception on performance marketing (items i 13) 85,85% 88,96% image (items 14 16) 83,88% 76,22% communication (items 17 19) 79,81% 72,80% tickets (items 20 25) 86,41% 80,43% r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns yol2 (1999) no 1 49 table 6 continued items reliability for reliability for 1 importance perception on performance i involvement (items 26 30) 87,56% 81,00% • stadium (items 31 41) 87,21% 76,62% media relationships (items 42 45) 82,43% 80,60% spectators (items 46 48) 29,03% 27,55% the reliability results for both importance and perception of performance are relatively high, considering that a standardised measurement instrument was not used. a cronbach alpha coefficient of more than 70% was used as the norm and all items were found to be reliable except for items 46 48. the reason for the low reliability on these items can be possibly ascribed to the controversial aspect of playing sport on a sunday. 6.5 hypotheses testing two-tailed hypotheses were used in order to perform tests for significant differences based on the p-value and to provide direction (higher and lower). anoy a was used to determine the difference between categories 1 and 2 as described in table 7. subjective criteria were determined for the qualitative labels "high" and "low". on the 0-10 point scale, a qualitative label of "high" was assigned for scale values between 7-10 and the "low" label was assigned to scale values less than 7. 6.6 anova analysis of variance (anoy a) was used to examine group differences on a single dependent variable. the dependent variable of relationship quality measured the effect of the various independent variables on the spectator's perception (test units) of the service provider's perception. the anov a results for the different hypotheses are summarised in table 7. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 50 sajems ns vol 2 (1999) no i table 7: anova results variable independent i lot [category i: 1 2 years] lot [category 2: > 3 yearsl vfm [category i: 0 6] vfm [category 2: 7 10] ptl [category i: 0 6] ptl [category 2: 7 10] wtr [category 1: 0 6] wtr [category 2: 7 101 meff [category i: 1 3] meff [category 2: 4 5] image [category i: i 3] image [category 2: 4 5] comm [category 1: 1 3] comm [category 2: 4 5] >i< lot= length * ptl = propensity to leave * meff = marketin effectiveness dependent mean p-value relationship 5.32 0.0001 quality 7.21 relationship 5,17 0.0001 quality 6,95 relationship 4,89 0.0001 quality 7,03 relationship 4,92 0.0001 quality 7,08 relationship 5,66 0.0001 quality 6,56 relationship 5,49 0.0001 quality 7,10 relationship 5,77 0.0001 quality 6,92 * vfm = value money * wtr = willingness to recommend * comm = communication all hypotheses were accepted based on the differences in the mean values of the different categories and are statistically significant based on the p-value for each anov a result. 7 conclusion the findings of the empirical study can be regarded as valid and reliable based on the research results. the overall reliability for the evaluation of the data set is a reliability coefficient of 0.9512 and the scientific execution of the methodology increased the validity of the results. based on the validity and reliability results of this study, the following major conclusions are drawn: r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 51 • relationship quality is influenced by the duration a spectator is engaged in the relationship with a service provider. the longer the· relationship a spectator has with a service provider the higher the quality of the current relationship. • the quality of the relationship is influenced by the spectator's perceived value for money based on his experience of the service provided to him by the service provider. the higher the perceived value for money the higher the quality of the current relationship. • propensity of a spectator not to leave or not to terminate the current relationship with a service provider influences the relationship quality between a service provider and a client. the higher the quality of the relationship the lower the propensity to leave and to terminate a current relationship with a service provider. • willingness of a spectator to recommend his current service provider to a potential client influences the quality of the current relationship between a service provider and a spectator. the higher the quality of the current relationship the higher the willingness of a spectator will be to recommend the service provider to a potential spectator or spectators. • the quality of the current relationship between a service provider and a spectator is influenced by a spectator's perception on the marketing effectiveness of a service provider. the higher the spectator's perception of marketing effectiveness the higher the quality of the current relationship with a service provider. 8 recommendations for future research recommendations for future research are divided into recommendations based on the literature review and recommendations based on the empirical research. • recommendations based on the literature review firstly, more literature is needed on marketing and relationship marketing focusing on sport. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 52 sajems ns vol 2 (1999) no 1 secondly, more literature is needed on relationship marketing in a business-toconsumer (btc) environment. • recommendations based on the empirical research firstly, to develop a relationship quality model by applying the relqual model (ewing, 1996) specifically on rugby and on professional sport unions in general and to compare the findings across different sport unions and administrations. secondly, to develop a marketing mix specifically for rugby and professional sport unions in general. thirdly, to determine the effect of a winning team on the marketing effectiveness, on short and long term relationship quality with a sport union and to investigate the effect that a winning team has on the relationship quality of the stakeholders and spectators. fourthly, to develop a marketing orientation for management of sport unions, officials and players. references i. berry, r. (1994), "laying foundation for future sales", trusts & estates, 95(5):58. 2. bejou, d., wray, b. & ingram, t.n. (1996), "determinants of relationship quality: an artificial neural network analysis", journal of business research, 36(2):137-143. 3. gruen, t.w. (1995), "the outcome set of relationship marketing in consumer markets", international business review, 4(4):447-469. 4. morgan, r.m. and hunt, s.b. (1994), "the commitment-trust theory of relationship marketing", journal of marketing, 58:20-38. 5. mullin, bj., hardy, s. & sutton, w. (1993), sport marketing. human kinetics. 6. paley n. mar (1996), "romancing your customers", sales & marketing 7. parasuraman a., zeithaml, v. & berry, l.l. (1994), "reassessment of expectations as a comparison standard in measuring service quality: implications for future research", journal of marketing, 58:111124. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 53 8. perrien, j. & richard, l. (1995) "the meaning of relationship marketing", industrial marketing management, 24(1 ):37-43. 9. pruden, d. (1995) "retention marketing gains spotlight", brandweek. 36(6): 15. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction literature overview method conclusion: implications and applications acknowledgements references about the author(s) jean du toit research focus area for chemical resource beneficiation, faculty of natural and agricultural sciences, north-west university, potchefstroom, south africa anmar pretorius school of economic sciences, faculty of economic and management sciences, north-west university, potchefstroom, south africa henk louw school of languages, faculty of humanities, north-west university, potchefstroom, south africa magdaleen grundlingh writing centre, faculty of humanities, north-west university, potchefstroom, south africa citation du toit, j., pretorius, a., louw, h. & grundlingh, m., 2022, ‘perceptions of writing prowess in honours economic students’, south african journal of economic and management sciences 25(1), a4323. https://doi.org/10.4102/sajems.v25i1.4323 original research perceptions of writing prowess in honours economic students jean du toit, anmar pretorius, henk louw, magdaleen grundlingh received: 09 sept. 2021; accepted: 24 june 2022; published: 19 sept. 2022 copyright: © 2022. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: economists are often asked to explain or foresee the economic impact of certain events. except for theoretical and practical knowledge, clear communication of views is therefore required. however, post-graduate training in economics mostly focuses on technical modules. furthermore, students often overestimate their (writing) abilities – as described in the dunning-kruger effect. aim: this article aims to establish if, and to what extent, perceptions of writing quality differ between students, subject-specific lecturers and writing consultants. setting: honours students at a south african university wrote an argumentative essay on a specific macroeconomic policy intervention. methods: in this study qualitative samples (an evaluation rubric) were quantified for an in-depth analysis of the phenomenon, which allowed for a mixed-methods research design. the essays were evaluated by fellow students, the economics lecturer, academic literacy lecturers and writing centre consultants and then their evaluations were compared. the evaluation form contained 83 statements relating to various aspects of writing quality. results: student evaluators in the peer review were much more positive than the other evaluators – in a potential confirmation of the dunning-kruger effect. however, despite the more generous evaluations, students were still able to distinguish between varying skills levels, that is, good and bad writing. discrepancies in evaluations between the subject specialists were also observed. conclusion: more conscious effort needs to be put into teaching economics students the importance and value of effective writing, with clear identification of the requirements and qualities of what is considered to be effective writing. keywords: perceptions; writing skills; economics students; dunning-kruger effect; peer review; writing assessment introduction background: the importance of writing for economists economists are often asked for opinions about the economic consequences of certain events. examples include the potential impact of brexit on south african exports to the united kingdom (uk) and the potential impact of the us-china trade war on south african trade. to respond to such requests, economists have to analyse the situation, using subject knowledge and existing models, but they are then also required to clearly communicate their message, either in written format or through oral communication (interviews). curriculums for post-graduate studies in economics mostly include technical modules and other applied fields of economic theory and although the field of economics is quite logically associated more with numbers than with writing ability, some scholars on economics make a strong case for honing writing skills. to be an economist, is to be a writer, or in the words of mccloskey (1985): economics depends much more on the mastery of speaking and writing than on the mastery of engineering mathematics and biological statistics usually touted as the master skill of the trade. (p. 188) mccloskey (1985:188) further states that writing ‘… is the economist’s trade’. he also identifies the problem: most people who write a lot, as do economists, have an amateurish attitude towards writing’ (mccloskey 1985:187). therefore, the question: ‘how well do you think you write and how well do other people think you write?’ at the heart of this article, is a very relevant question for post-graduate students training to be economists. mccloskey is not alone in his opinion; therefore, the graduate attributes ascribed to by the faculty of economic and management sciences at the north-west university, include the following, very specific references to written communication: in addition to the general outcomes of the b.com hons degree, the content of this qualification is structured in such a manner that specific exit levels (including the critical outcomes) will enable students to demonstrate the ability to formulate, present and communicate insightful and creative academic and professional ideas and arguments effectively – verbally and in writing, using appropriate media and communication technology and suitable economics methods. (nwu 2015: 37 [emphasis added]) specific module outcomes for honours in economics also refer to the ability to analyse and disseminate information and present it in an ‘honours dissertation’ (written research report) and an oral presentation (nwu 2015). problem despite these explicit requirements regarding writing contained in outcomes, lecturers often experience that, students, when required to write longer texts in their final and honours years, illustrate a half-hearted outlook regarding the necessity of effective writing. many fail to see the relevance of effective written communication and display an apathetic attitude towards acquiring or honing these skills. this may in part be due to large class sizes at undergraduate level, which necessarily limit written assignments as options of assessment. as a result, extended writing is seldom done at undergraduate level, which sends the unintended message to students that writing as a skill is not required. in addition, writing may be considered as the educational outcome of the so-called soft sciences (humanities); and therefore not considered to be necessary for the harder, numerical sciences. dunning (2011:248) touched on this in his explanation of the dunning-kruger effect, with specific reference to economists. he states that economists have reasoned that most ignorance is rational, seeing that in many cases the effort to gain expertise on several topics would not provide a person with enough perceptible benefit to justify the expended learning effort. this seems to be aggravated by students’ unfounded beliefs that their writing abilities are of higher standard than is the actual case. when their texts are measured objectively or externally (by lecturers), the perceived quality is in reality much lower than students themselves, and by implication peers, evaluate it to be – a frustrating situation for lecturers. the current study was therefore prompted in part by perceptions on part of the lecturers who experienced that students in economics had erroneous beliefs regarding their writing abilities; the lecturers wished to dispel these mythical self-evaluations. in addition, at face value, students with overall better performance in the subject seemed to be able to communicate better in writing about the subject content. this is already a classic manifestation of the so-called dunning-kruger effect (kruger & dunning 1999). although not reported as part of the dunning-kruger effect, such a disparity between actual and perceived performance may lead to a sense of disillusionment and avoidance (munchie 2000:49) when students receive results for written assessments. numerous articles on writing pedagogy (hyland 1990; spencer 1998) report, for example, that students discard feedback due to not possessing the skill to interpret and understand the feedback they receive; failing to use it to improve future writing. it may also lead to other non-desirable consequences such as withdrawal, or a lack of trying when constructing follow-up texts. the activity reported on in this article can also be seen as an exercise in awareness raising (or ‘consciousness raising’ as in james 1997:257), which was aimed at establishing if and to what extent the perceptions of writing quality differ among students, lecturers (subject-specific and academic literacy lecturers), and also writing centre consultants. the ultimate goal with this exercise was to raise the awareness of students as to the quality of writing expected of them, with the hope that an illustration of the mismatch between peer evaluation and actual performance may stimulate greater attention to detail and metacognitive evaluation of activities when working on written texts. method preview for this exercise a written assignment was evaluated on four levels: peer to peer, subject lecturer to student, writing centre consultant to student, and academic literacy lecturer to student (the full method is explained under methodology). evaluations were done via a google forms interface, which yielded quantifiable data. the data were analysed and discussed with students to identify the most salient discrepancies in evaluation, and these discrepancies are also identified and discussed in this section. for the purposes of this article, an in-depth analysis of six of these texts is also included. findings preview although there are certain areas of agreement in evaluation, some specific areas find great discrepancies in evaluation among students, subject lecturers, academic literacy lecturers and writing consultants. these areas can be associated with the finesse of writing. preview in the rest of this article an overview of the dunning-kruger effect is first presented, then what was defined as quality writing in this specific context is discussed, whereafter the full methodology is explained, followed by a discussion of the findings and their implications for the teaching of writing to students of economics. literature overview dunning-kruger effect the dunning-kruger effect explains that a person’s perception of his/her ability is rarely accurate (kruger & dunning 1999). while it falls outside the scope of this article to provide a full overview of the dunning-kruger effect, a few key points relevant to this article will be raised. dunning and ehrlinger (2003:5) explain that a person’s views of their own abilities in general and during specific instances, usually do not correlate well with the actual quality of the performance and in some instances do not correlate whatsoever. dunning and ehrlinger (2003:5–6) then list a range of published research articles in which the findings repeatedly illustrate that actual performance rarely, if ever, matches perceptions of performance and note that people generally hold perceptions of their overall ability or specific performances that only correlate modestly with the reality of the actual output. the popular maxim of ‘believe it and you can do it’ is, simply put, false. peer evaluations, by contrast, tend to be much more accurate with regards to aspects such as leadership qualities, but as for an illustration of subject knowledge, an incompetent peer suffers from the same ‘unknown unknowns’ (dunning 2011) as the one whose work they are evaluating. this statement is also supported by the study of brindley and scoffield (1998:85) in which they state that students felt peer evaluations to be unfair due to a lack of objectivity. grammar and argumentation formed the basis of a few of the experiments central to the dunning-kruger theory and in dunning (2011:261) it is explained that the ability to judge whether you or someone else has written a sentence that is grammatically correct, relies on the same skillset required to produce a grammatically correct sentence in the first place. the same holds true for the evaluation of an argument. in order to evaluate if an argument is sound, the same know-how is needed as for constructing one. a poor performer has limitations which cause them to fail when attempting to form correct responses. those same limitations also fail them when they have to judge the accuracy and correctness of their own responses and those of others. they would be unable to know when their own responses are incorrect and will lack the ability to know when somebody else formed a better response. performance estimates are also partly driven by perceived task difficulty. if something is perceived to be easier, a person tends to overestimate their ability and if something is perceived to be hard, they underestimate their ability (dunning 2011). to complicate matters even further, the more skilled a person is in a task, the more accurate they can judge the level of difficulty, while the more unskilled a person, the less chance they have of accurately judging the difficulty of the task at hand (kruger & dunning 1999). this leads to dunning (2011) explaining that the dunning-kruger effect is not a single misjudgement, but a range of activities all dealing with perceptions and judgements of abilities and performance. probably the most well-known findings from the research done on the dunning-kruger effect, can be summarised in the quote that poor performers are: … doubly cursed: their lack of skill deprives them not only of the ability to produce correct responses, but also of the expertise necessary to surmise that they are not producing them. (dunning et al. 2003:83) this leads to incompetent students failing to estimate the level of their incompetence (those performing in the lower 25% extensively overestimate their performance [dunning 2011:264]), while those who are competent, underestimate the level of their competence. note that two estimates are applicable here: the first is judging the task difficulty and the second is judging performance. poor performers are worse in judging performance, regardless of whether it is their own performance or that of someone else – as confirmed in study three of the four kruger and dunning (1999) studies. although dunning (2011) reports that motivation plays no statistically significant role in the dunning-kruger effect, one may suspect that the perceived usefulness of the task influences the amount and level of care and conscious effort a student will spend on an activity, such as producing and evaluating a written assignment. in this context, when students consider writing to be of no importance for their academic studies, one can assume they do not see the relevance of improving it, and if they think the task of writing is easy, they will overestimate their and others’ ability to write well. previous south african studies studies on the performance of south african economics students are limited to the overall performance in specific modules like first year (edwards 2000; horn & jansen 2009; parker 2006; pretorius, prinsloo & uys 2009; smith 2009; smith & edwards 2007; van der merwe 2006; van walbeek 2004) and second year (horn, jansen & yu 2011; smith & edwards 2007). no empirical study could be found that focuses on performance in post-graduate modules in economics. broadly linked to the theme of this article, matoti and shuma (2011) assessed the writing efficacy of post-graduate students at the central university of technology. their sample included students with three post-graduate qualifications, but none of these were in economics. students were found to exhibit low levels of writing efficacy through-out the writing process – including ‘sentence construction, lack of understanding of concepts related to the discipline, problems in interpreting questions, spelling, grammar, tenses, reference techniques, punctuation, writing coherently and logically, synthesising information’. no selfor peer-evaluation was present in this study. only two studies were found investigating the dunning-kruger effect in a south african context. in dodd and snelgar (2013) students’ self-evaluation was compared to a formal assessment of learning. the findings indicate that students with lower levels of learning achievements had higher levels of self-evaluation than students with moderate learning achievements. as was to be expected, students with the highest learning achievements also demonstrated the highest levels of self-evaluation, in keeping with the international findings. the study did not, however, focus specifically on writing abilities, leaving a large gap in the research. the only other south african study that used the dunning-kruger effect, was by yani, harding and engelbrecht (2019) which attempted to explain the development of students’ perceptions regarding their academic maturity. defining quality writing while ‘quality writing’ is the topic of numerous books on its own (see mccloskey 1985; wentzel 2017), it is necessary for the purposes of this article to explain what was defined as quality writing in this specific exercise. this is of course the first place where the dunning-kruger effect manifests itself: in essence the question is if a person knows what (s)he experiences to be quality writing, or if it falls into the categories of ‘unknown unknowns’ or ‘general world knowledge’, or ‘reach-around knowledge’ (to use the terminology in dunning 2011:252). dunning (2011) explains ‘reach-around knowledge’ as something which appears to be ‘relevant and reasonable’ but is actually make-belief standards. the definition for a quality text used for the context of this article, is a few years in the making for the learners. all learners were required to take a compulsory course in academic literacy in their first year of study (about three years prior to the experiment for most learners in this study). in the academic literacy module, students were introduced to certain universally accepted qualities of effective academic writing (adrianatos et al. 2018; van der walt 2013). in their current honours year, workshops were presented to the students on elements of good writing covering topics on the structure of a dissertation (introduction, literature review, conclusion, etc), as well as general writing skills (sentences, paragraphing, logical order, linking devices, source use, etc). their written assignments were also assessed using a marking scheme (see the method section) which was created with reference to earlier work covered by the students in their first year of study and again revisited in said workshops. the marking scheme (evaluation rubric) for their written assessment was divided into five sections. the complete evaluation rubric is available as addendum, but an overview is provided below. note that it falls outside the scope of this article to provide a full academic justification for the categories and also note that the concept of ‘quality’ with regards to written texts admittedly contains many more categories than those selected for this exercise. for obvious practical reasons, some limits had to be imposed on the number of qualities attended to. the five categories of text quality used for this exercise five categories of text quality were used in the marking rubric based on expert opinion for the inclusion of standard writing elements and the specific goals for the written assignment: title, language, paragraphing, macrostructure, and academic sources, each of which is elaborated on very briefly below. the title of the text should be fit for purpose, clear and descriptive. titles like ‘assignment 1’ or ‘essay’ are of insufficient quality. the ability to write a clear concise title illustrates the ability to state the main idea of a text succinctly. the category of language refers to objective measures (correctness), as well as subjective measures of quality or standard. punctuation, spelling and grammar are in most cases objectively measured – a matter of right or wrong. sentence length and structure are more subjective categories, referring to the readers’ expectations of and experience with the sentences – overly long and complex sentences are usually more difficult to read, while an overuse of very short sentences stunt reading and fluency and may create the impression that the writer is unable to ‘string together’ larger sections of meaning, which may imply a lack of subject knowledge or a lack of linguistic control. paragraphing is a factor of writing that seldom falls into place automatically, but takes conscious editing efforts. well-structured paragraphs should focus on one main idea per paragraph and contain a clear topic sentence. support for the main idea (examples, elaboration, explanations) should be present in the paragraph and these support statements should be clearly linked to the main idea and to each other. for this reason, the use of so-called linking devices are vital (linking devices are known by a number of synonyms, like cohesive devices, discourse markers, or transition markers). the macrostructure category refers to the organisation of information in the text. for this, each section has certain characteristics which usually occur in academic texts. for example, the introduction and conclusion each has specific qualities which need to be present. these qualities could be measured objectively (are they there?), as well as subjectively (are they good?). the introduction should at the very least contain a background which leads to a thesis. it should also contain an overview of the discussion to follow, as well as an overview of findings. the conclusion should in turn present a summative review of the text with a final verdict on the question investigated. the conclusion should not present new information. the most subject-specific part of the text (still part of the macrostructure), is the text body in which the main argument is presented. for this, students were required to provide additional background, as well as an explanation of the concept under discussion. the final evaluation category is the use of academic sources, once again subject to both objective evaluation (the correctness of referencing and bibliographical formats) and subjective evaluation, which refers to how well academic sources were used to support statements in the text and the argument in general. the evaluation scheme was set up to allow the reader the ‘ease into’ the text and gradually build up to the more cognitively demanding aspects of textual evaluation. for example, while it is relatively easy to spot a typing error or identify a sentence with unclear meaning, it takes a lot more effort and subject knowledge to identify errors in the argument. in the terminology of the dunning-kruger effect, evaluation was started at supposedly ‘known-knowns’ (spelling) and moved to ‘known-unknowns’ (where a learner can see that, for example, a sentence is bothersome, but is unable to identify how to improve it) to ‘unknown-unknowns’ (a complete inability to identify an issue, which will become apparent when a student evaluates an argument as effective, while it is in fact incomplete). awareness raising occurs when known-unknowns become clearer and unknown-unknowns are taught. this systematic approach in evaluation also mirrors to an extent the study by williams, dunning and kruger (2013) who found that a systematic approach to a problem gives learners greater confidence in their performance and evaluation of own performance. method a mixed method exploratory sequential design (qualitative followed by quantitative) was used to investigate the observed trend in-depth and to measure its occurrence (creswell & clark 2017; creswell et al. 2003). a similar approach was employed by joubert and feldman (2017). a rubric, a qualitative grading method in the form of an evaluation form, was utilised to record the evaluators’ perceptions of the written assignments. the responses were then quantified for an in-depth analysis. experiment setup: data generation system students wrote a long essay of 2000 words as part of their preparation for entering the annual national budget speech competition. the essay also formed part of their assessment plan for the semester. the requirements for the essays are outlined on the competition website, but can be summarised that students should argue for or against a specific economic policy intervention; in this particular case, quantitative easing (abbreviated as qe). the completed essays were then evaluated by four different stakeholders using an evaluation form in question format on google forms. the content of the evaluation form is discussed above. the form was set up in multiple choice format, meaning that it contained a number of statements on which evaluators could respond by picking only one option (although additional comments could be added as general comments at the end of a section). this format was chosen as clearly expressed answer statements reduce marker uncertainty. additionally, a feedback letter containing the selected answers was automatically generated giving the students immediate guidance on the issues in their manuscript. in total, 83 statements had to be evaluated. figure 1 shows an extract of the evaluation form. figure 1: extract from digital evaluation form. this technique allows for focused peer review as well as having the benefit of producing a data set which is easily quantifiable. for pedagogical purposes it was also connected to a form-fill letter which provided a feedback letter of approximately three pages in length to the student, with the letter containing the chosen comments. students would therefore have been able to use this feedback to revise their work towards their second draft, but also to use the feedback form as general guidelines for future writing. the form was created by staff at the north-west university writing centre. the evaluators all submitted essays were first evaluated by writing centre consultants, which yielded 66 responses on the google form datasheet. the next evaluation was a peer review exercise using the same form. for the peer review, all students were assigned to evaluate the essays written by two peers and they received access to these files via electronic distribution. this was done with the intention of raising their awareness of the writing standard as well as the subject content in the essays of the peers. this part of the exercise provided 103 responses. students were not randomly assigned to each other’s work, but were matched according to subject field, with students from the different fields (economics, international trade, and risk management) evaluating students taking similar subject combinations. the next evaluator was a subject specialist – the lecturer for the subject. the lecturer was assigned to evaluate a selection of six essays, which were randomly selected from three bands of results – high, average and low academic achievement scores. the final evaluators were lecturers from the subject group, academic literacy who also evaluated the selection of six essays. in this instance the academic literacy lecturers and the writing centre consultants act as the writing specialists, or non-subject specialist evaluators, with the aim of focusing on writing structure and style. their evaluations therefore serve as the external standard. students were not required to do a self-evaluation on the google form, which would have provided interesting additional data. however, the expectation was that students would have utilised the form as a marking rubric before submission to evaluate their own work and, based on their self-evaluation, submitted an essay they deemed to be of good quality. ethical considerations all participating students signed the standard consent form of the writing centre which allows the university to use submissions at the writing centre in anonymised research. the consent form also informed students on confidentiality and withdrawal procedures. analysis method two sets of analyses were done on the data. in the first place, the data were observed holistically. in this instance, data for the evaluation for all 66 student essays are discussed. the data obtained for this set includes peer review and writing consultant review answers to the form questions. the second analysis is an in-depth analysis on just six student essays. these six essays were also evaluated with the same form, by the subject lecturer as well as a writing specialist. data set a: holistic analysis all students were bona fide students who had moved directly from undergraduate studies to their honours degree. for the majority, english is their second language. table 1 summarises the overall evaluations of the writing consultants and the students (peer-reviewing other students’ essays). the third column contains the specific statement that was used to evaluate the different aspects of the essays. from the total number of 83 questions only the answers that had a percentage difference of greater than 20% points between the consultants and the students were further analysed (22 answers in total). this percentage difference was selected according to the pareto principle as utilised by o’neill (2018) to identify the ‘critical few’ errors that could improve 80% of the students’ writing ability. because 22 responses (very close to 17 out of 83) had a difference of greater than 20% this percentage was therefore chosen as the cut-off for the analysis. the fourth and fifth columns indicate the percentage of cases for which the consultants and students agreed with the statement. for example, the consultants felt that 30.3% of the essays had a descriptive title, while the students in their peer review felt that 52.4% of the essays had a descriptive title. the last column of table 1 indicates the percentage point difference between the two scores. the table is organised according to the five categories of text quality which is also the order in which they appeared in the marking rubric. table 1: comparing the evaluation between writing consultants and students. for all of the statements, without exception, the students’ peer review was much more positive than the evaluation of the consultants. this is an overwhelming indication of students’ over estimation of their peer’s performance. figure 2 provides a graphical representation of the values in table 1. panel a indicates the percentage awarded by the students and consultants for each statement number, while panel b illustrates the percentage point difference for each statement (similar to the last column of table 1). the smallest difference (of 22.1) was observed for the statement relating to a descriptive title (number a1) and the largest (57.7) for statement a83 about a correct bibliography. figure 2: a graphical representation (a and b) of the evaluation between writing consultants and students (table 1). a closer look at panel b indicates that some of the largest differences are observed in the later statements (81–83) relating to the handling of resources. students have a much more skewed perception of their abilities and accuracy in handling sources. statements dealing with paragraphing received scores closest to each other (discussed later in the article). table 2 summarises the average scores for the five categories of text qualities as explained above (see five categories of text quality used for this exercise section). table 2 also ranks the scores per category for each group of evaluators. rank 5 refers to the ranking of the five main categories and rank all to the ranking of all seven categories – where macrostructure is represented by three sub-categories. paragraphing received the highest scores from both groups of evaluators, while the use of resources received the second highest scores – also from both groups of evaluators. indication of a relevant title, language ability and macrostructure received the lowest scores. table 2: comparing average scores between writing consultants and students. apart from the evident overoptimistic view of their peers’ writing ability, table 2 conveys two additional messages or underlying trends. despite the higher scores awarded by the students, the students’ overall ranking of the various categories is similar to those of the consultants. the students agreed with the consultants that paragraphing and the use of resources were the best qualities of the essays. the students thus display the ability to satisfactorily distinguish varying skill levels between the various elements of the writing exercise. the comparison in table 2 also indicates that, although not at a satisfactory level yet, the students’ ability to write coherent paragraphs received the highest score. this is a core competency and very much needed in building convincing arguments and communicating successfully (mccloskey 1985). it also serves as a solid foundation to improve on their ability to combine all the elements into a meaningful macrostructure. as could be expected from a sample of predominantly non-english first language speakers, some language and grammar skills are lacking and students are aware of it. recognising the need to improve a specific skill will hopefully encourage the students to pay attention to it in future. data set b: in-depth analysis of six student essays data set b is also analysed in two ways. the first, easiest analysis is simply to compare the accuracy of the students’ peer evaluation with all evaluators’ responses. six student documents were assessed by four different evaluators. these evaluators comprised fellow students (peer evaluation) (s), the subject specialist (the economics lecturer) (ss), a writing specialist (first-year academic writing lecturer) (ws), and a writing centre consultant (c). it must be noted, however, that the fellow student evaluator was not the same person for all six documents. this is also the case with the writing centre consultant. the documents were firstly assessed based on the number of times all evaluators agreed on the given criteria for each topic (as shown in figure 3). this agreement is irrespective of the correctness of the writing, only the question whether all evaluators have the same opinion of the criteria is investigated. figure 3: the count of cases where there is an agreement on each topic in all six student documents among the evaluators. the second analysis is an attempt at finding agreement or disagreement in evaluations based on the understanding of the topics, between two ‘camps’ – the student and subject expert in the one camp and the writing centre consultant and academic literacy lecturer on the other hand. the student’s own evaluation is compared to the evaluation of the three other evaluators. this kind of analysis will indicate where the student and subject specialist understand the definitions or concepts of writing elements differently from the writing experts. this illuminates areas of shortcoming where both the subject specialist and the student act in the area of unknown-unknowns and subsequently should be assisted by agents trained in writing, in order to attain exit level graduate attributes, but it could also indicate areas where the writing experts may need to ascertain additional clarity from subject experts in an activity like this. data set b: analysis of peer evaluation accuracy while the above discussion is drawn from a comparison between the evaluation of the students and writing centre consultants, the last part of the analysis compares the evaluations of the students, academics of the writing centre and the economics lecturer. as discussed earlier, six specific essays were chosen and the comparison includes all the statements and aspects covered in the evaluation form and not only the 22 mentioned in the analysis method section. comparing the responses of the academic literacy centre (as language/writing specialist), the economics lecturer (as subject specialist) and the students, confirms the earlier observation that students judge their fellow students’ work to be of a higher standard than the subject specialists. out of all the responses (each student essay evaluated on 35 statements by three evaluators) in 6% of the evaluations only one of the evaluators had a positive view on the specific aspect of the essay. in all these cases, the positive view came from the student evaluation. in other words, in 6% of the evaluations both the subject and language specialists felt that the specific standard was not met – while the student felt that the standard was met. there was no instance where one of the specialists was the only one to have a positive view. delving deeper into the instances in which the students provided the only positive response – ignoring the one statement on the configuration (quality of the title) – resulted in more interesting observations. from the essays written by low performers, the only positive response came from the peers in 4.4% of the questions. this increases to 8.1% for the medium performers and 6.3% for the best performers. the students, therefore, tend to be more positive in their evaluation of medium and top performers compared to low performers; that is, they are able to distinguish between poor and better work. concentrating on the different categories of text quality, the students were more positive in their evaluation than the academics regarding the use of sources (8.3% of the questions) and paragraphing (8.3%). language quality and macrostructure came in at lower levels of 6.3% and 4.6%. data set b: agreement on comprehension of elements of writing in figure 3 the cumulative count of cases where evaluators are in agreement are plotted for each topic of the eight different categories (title [t], language [l], paragraphing [p], introduction [i], background [b], specific position [s], conclusion [c], and resources [r]). the data were arranged from top to bottom in the order of highest agreement to lowest agreement for all evaluators. hundred per cent (100%) (6/6) in agreement: on only one topic, all evaluators were in agreement: identifying the background of qe in the united states. the criteria asked if it was clear if the student used qe in the us. therefore, because the subject terms were easy to identify, all the evaluators could correctly interpret the student’s explanation. this, therefore, falls in the dunning-kruger category of known-knowns. eighty three per cent (83%) (5/6) in agreement: the three topics in which a good agreement is still observed for all evaluators, are all related to clearly identifiable contextual themes: did the writer explain his/her position, did they discuss the potential impact, and did they recap the main results in the conclusion. thus, independent of subject knowledge, all evaluators can understand and identify main context elements. sixty seven per cent (67%) (4/6) in agreement: the moment the topics turned to more in-depth subject background questions, some evaluators started to disagree. interestingly, regarding the overview of the introduction the students and the subject specialist were in full agreement. on the other hand, in respect of the subject-specific knowledge in explaining qe, the students, writing specialist and consultant agreed on five of the six documents with only the subject specialist needing more information. fifty per cent (50%) (3/6) in agreement: all the topics in this section relate to a misunderstanding of what was required in terms of subject content. furthermore, the students, writing specialist and consultants were all in agreement about the quality of the background on the topic specified in the introduction. only the subject specialist wanted a more in-depth discussion of the background. thirty three per cent (33%) (2/6) in agreement: the lack of expertise of each evaluator for the other’s disciplines clearly starts to show. in the case of more in-depth subject knowledge in which students need to evaluate or integrate their knowledge, only the subject specialist along with the students could identify issues (specific policy, reason for specific policy, and contrast with alternatives). however, in the case of specific language elements (word choice and sentence length), the writing specialist and consultants require more sophisticated standards. furthermore, in the case of good source use, the students tend to agree with the writing specialist and not the subject specialist who wanted better source use. this may be due to the subject specialist exhibiting a greater awareness of the quality of subject-specific sources available. seventeen per cent (17%) (1/6) in agreement: four topics relating to referencing fall under this category: matching of sources between the in-text and the reference list, correctness of in-text referencing, the referencing style and the correctness of quoted sources. this result clearly highlights the issue of discrepancies in plagiarism prevention and the (mis-)understanding students illustrate regarding the stringent requirements of good referencing practice in academic writing. this could be labelled as a problematic unknown-unknown dunning-kruger effect. zero per cent (0%) (0/6) in agreement: the problem of identifying good grammar and spelling is a fundamental issue based on the standard of english writing proficiency of the students. both the students and writing consultants overestimate the level of the students’ language proficiency. only more experienced writers (subject specialist and writing specialist) know that a higher standard is needed. however, the problem of identifying good paragraph elements is problematic because both the students and the subject specialist are in agreement, highlighting the gap in writing expertise between writing specialists and writers more focused on content. in a typical educational situation like this, the assumption could be that the economics lecturer is the subject specialist or content expert, with some experience in writing. the student on the other hand, is a novice in writing, with limited subject knowledge, albeit more subject knowledge than the writing specialist or the writing consultant. these assumptions are not born out in the data (figure 4). there is a lack of agreement between the pair student and subject specialist (s+ss), as well as the pair writing specialist and writing consultant (ws+wc) with regards to many of the variables. in figure 4 we show the discrepancy between the agreement of the writing specialists and the subject specialists more clearly. the four blocks in figure 4 denote areas of special interest. in these blocks, the subject specialists (economic student and economic lecturer) disagree with the writing experts (writing lecturer and writing consultant). due to lack of space, all of these cannot be discussed in depth, but a few salient examples are mentioned. figure 4: the number of cases in which there is an agreement on each topic in all six student documents between the student (s) and the subject specialist (ss) (blue) where the number of all evaluators are in agreement (orange) plotted against the topics that were evaluated in the eight different categories. in blocks b and c, it is clear that the subject specialists have the same understanding of issues of grammar, spelling and punctuation, but this understanding is not shared by the writing experts. the next area is the concept of what entails good paragraphing. in paragraphing, a good paragraph has one main idea, and this idea is presented with coherently linked sentences. while both the subject specialist and student had similar evaluations regarding their perceptions of these two paragraph elements, the writing specialists differed in opinion. in table 3 we analysed if the level of the students’ writing ability influences the ease with which evaluators could identify the correctness of the writing topics. in other words, is it easier to spot problems in bad writing or good writing? the topics in the table are grouped according to the type of writing in which the evaluators disagreed the most. the type of writing is then arranged from top to bottom in the following order: all types, bad, average, good and none (no one disagreed on that/these topic[s]). the last column shows who disagreed the most about each topic as based on the analysis done in figure 4. therefore, on each topic we evaluated which type of writing was the most difficult to evaluate and who disagreed the most. thus, if for instance all evaluators differed in opinion on the correctness of the background in any type of writing, it will be listed as all. if, on the other hand, they agreed, for example, about the correctness of the grammar in good and average writing but not in bad writing, the grammar will be listed as ‘bad’. table 3: types of writing per topic where all evaluators had the most disagreements. it is, therefore, of interest to note which topics group together and why. in the case of the topics that are listed as ‘bad’ writing, we see almost all the disagreements are between the two ‘camps’: the writing specialists, and the students and the subject specialist. this trend indicates that the students and the subject specialist have the same idea or understanding of those topics and deem that in the ‘bad’ writing these topics are correct. furthermore, the topics listed for average writing illustrate the topics in which the evaluators have some knowledge but not sufficient to confidently analyse the correctness. it is interesting to note that in average to good writing all evaluators agreed on the topics in which basic level subject content could easily be identified. the disagreements in good writing came from the topics in which evaluators venture into the ‘unknown-unknown’ field, each determined by their expertise and perceived understanding of the others’ discipline. implication of in-depth analyses data thus, it seems that when elements of language, like grammar, spelling and punctuation, are to be evaluated, external (language expert) assistance will be required by both students and subject specialists alike. this is not surprising, since most universities at present require their post-graduate texts to be proofread by professional language editors and many journals nowadays refuse to accept articles without proof of professional proofreading as well. as far as effective communication (the graduate attribute mentioned earlier) is concerned, it is vital to obtain a logical flow and focus in written texts. the data illustrates that assistance from writing pedagogues may be needed to assist students in economics to refine their writing in order to meet the graduate attributes expected of them, that is, formulate, present and communicate ideas and arguments effectively. conclusion: implications and applications the overall outcome of the study confirms that students’ peer reviews of their honours essays tend to be much more positive, compared to that of the subject lecturer and writing specialists: in line with the dunning-kruger effect. on the positive side, however, despite the more generous evaluations, the students did display the ability to distinguish between varying skills levels, that is, good and bad writing. they ranked the elements of quality writing in the same order as the specialists and were more generous towards good writing compared to bad writing. based on the evaluations from all the role players, paragraphing (a required characteristic of good writing) received the highest marks. it is thus comforting to know that this specific group of students, although in the first half of their honours academic year, are deemed to be able to build an argument and write coherently – the building blocks of economic rhetoric. on the negative side, they were not deemed to be eloquent in the use of sources and, being second-language english writers, certain issues regarding language use were highlighted by all the role players – including the students themselves. non-surprising findings were that students were able to evaluate some easier aspects of writing quite accurately, whereas the areas of writing skill illustrating greater finesse, were evaluated less accurately. where the findings become troublesome as far as pedagogy is concerned, is when both the economics student and lecturer differed in their analyses from the analyses done by the analysers trained in writing and language, illustrating discrepancies in the experience or definition of what constitutes effective writing. a second area of contention is where only the subject lecturer disagreed in evaluation from the other three parties, illustrating either substandard subject knowledge and application from the students, or possible unclear expectations regarding academic requirements on the side of the lecturer. implications of this for pedagogy are quite simply that more conscious effort needs to be put into teaching economics students the importance and value of effective writing. furthermore, the skills, requirements and qualities (definitions) of what is considered to be effective writing need to be spelt out and illustrated in more elaborate detail. economics lecturers, and probably the syllabus, need to put more emphasis on the correct use of sources. this includes paraphrasing (not merely copying of other’s ideas), as well as referencing (both in text and the compilation of a reference list). this, in combination with clear academic expectations regarding subject knowledge and academic application to content and context, may assist in raising the awareness of students about what it really takes to become an effective communicator on matters relating to their chosen profession. an improvement on this study would entail a few more pre-exercise steps, such as a pre-test of students’ theoretical knowledge of concepts and an investigation into how students acted upon the information they received about the mismatches between their self-evaluations and those of others. a self-evaluation on the same form as the peer evaluation would also provide additional quantifiable data. acknowledgements competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions j.d.t. was involved in the conceptualisation, data collection, data analysis and writing of the article. a.p. was involved in the conceptualisation, data analysis, writing of the article and critical reading. h.l. was involved in the conceptualisation, writing of the article and critical reading. m.g. was involved in the conceptualisation, project administration and writing of the article. ethical considerations the data were collected anonymously and all participants provided informed consent. funding information this research received no specific grant from any funding agency in the public, commercial or not-for-profit sectors. data availability data that support the findings of this study are available from the corresponding author, a.p., upon reasonable request. disclaimer the views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of any affiliated agency of the authors. references adrianatos, k., fritz, r., jordaan, a., louw, h., meihuizen, e., motlhankane, k. et al., 2018, ‘academic 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p. 976 yani, b., harding, a. & engelbrecht, j., 2019, ‘academic maturity of students in an extended programme in mathematics’, international journal of mathematical education in science & technology 50(7), 1037–1049. https://doi.org/10.1080/0020739x.2019.1650305 microsoft word 2 black et al sajems 19(5) 2016.docx 702 sajems asset research ns 19 (2016) no 5:702-713 how to cite doi: http://dx.doi.org/10.17159/2222-3436/2016/v19n5a2 issn: 2222-3436 evaluating the cost-effectiveness of ecosystem-based adaptation: kamiesberg wetlands case study david black and jane k turpie environmental-economics policy research unit (epru), university of cape town nalini rao conservation international, united states of america accepted: july 2016 ecosystem-based adaptation (eba) is increasingly being promoted as a cost-effective means of adaptation to climate change. however, in spite of considerable international press, there is still little evidence to substantiate this claim. this study proposes a method through which the cost-effectiveness of eba strategies can be evaluated against alternative adaptation options, and contributes to south african literature on the subject. the potential cost-effectiveness of wetland restoration is assessed as a means of securing the carrying capacity of land for pastoralist communities of the kamiesberg communal area in south africa under projected future climate conditions. the conventional alternatives would be to respond to increasingly dry conditions by drilling boreholes and using supplemental feed for livestock. it was assumed that the eba interventions would occur upfront, whereas the alternatives are more likely to be implemented in reaction to droughts over a longer time period. the study found the implementation of conventional alternatives to be more cost-effective than eba as a means to sustaining livestock stocking rates, with eba being twice as costly. however, this is framed from the perspective of those directly affected (the landowners), and does not include the benefits to broader society. key words: climate change, ecosystem-based adaptation, cost-effectiveness, south africa, wetlands jel: q51, 54, 57 1 introduction with the pressing need for climate change adaptation strategies, the concept of ecosystem-based adaptation (eba) is increasingly being brought to the fore (vignola, locatelli, martine & imbach, 2009; huq, renaud & sebesvari, n.d.). ecosystems can provide a range of services that are beneficial to humans. the tenet of eba is that a community’s resilience to future climate change stress can be increased through the restoration, conservation and maintenance of supporting ecosystems (vignola et al., 2009; ainley, perez, andrianarisata, barnes & beck et al., 2010; doswald & osti, 2011; munroe, doswald, roe, reid & giuliani et al., 2011; munang, thiaw, alverson, mumba & liu et al., 2013; midgley, marais, barnett & wågsæther, 2012; secretariat of the convention on biodiversity, 2009). conventional approaches to climate change adaptation typically include artificial, engineered solutions. in contrast, eba can result in a range of additional benefits for both biodiversity and local communities (huq et al., n.d.; ainley et al., 2010; munang et al., 2013; campbell, kapos, scharlemann, bubb & chenery et al., 2009). in some instances it has also been found to be a more cost-effective approach than conventional approaches (munang et al., 2013; naumann, anzaldua, gerdes, frelih-larsen & davis et al., 2011; rao, carruthers, anderson, sivo & saxby et al., 2012; midgley et al., 2012). the evidence base to support the implementation of eba strategies is growing both internationally and within southern africa (munroe et al., 2011; midgley et al., 2012; ziervogel, new, van garderen, midgley & taylor et al., 2014), where the majority of these case studies is built around qualitative analyses for policy and strategic recommendations (doswald & osti, 2011; munroe et al., 2011; naumann et al., 2011; munroe et al., 2012; unfcc, n.d.; midgley et al., 2012; birch , newton, aquino, cantarello & echeverría et al. 2010). however, while currently abstract sajems asset research ns 19 (2016) no 5:702-713 703 limited, there is an increasing focus on quantitative scientific analyses of the cost-effectiveness of eba strategies relative to more conventional climate change adaptation options (jones, hole & zavaleta, 2012; birch et al., 2010; hoang tri, adger & kelly, 1998; batker, de la torre, costanza, swedeen & day et al., 2010; teeb, 2010; russi, ten brink, farmer, badura & coates et al., 2013). this study proposes a method through which the cost-effectiveness of eba strategies can be evaluated against alternative adaptation options. the application of this method is demonstrated through a case study of wetland rehabilitation in the kamiesberg uplands of namaqualand in the northern cape, south africa a semi-arid region which is home to pastoralist communities. south africa’s generally water-stressed environment and the magnitude of its socio-economic challenges make it particularly vulnerable to climate variability and change. different regions of the country are likely to be affected in many different ways, and impacts on people, biodiversity and the water sector are likely to be considerable, and will add additional pressure to systems already facing significant stress (bourne, donatti, holness & midgley, 2012; schulze, 2011; ziervogel et al., 2014; dea, 2013b; dea, 2013a). for the succulent karoo biome of namaqualand, the climate will become hotter and drier, with more intense storms, floods and droughts (bourne et al., 2012). for the kamiesberg region, temperature increases will most likely be moderated by altitude, where average temperatures are projected to increase by between 2° c and 3° c over the next 100 years (bourne et al., 2012; schulze, 2011). rainfall is projected to be reduced to 90-100 per cent of present by 2050, and 70-80 per cent of present by 2100 (schulze 2011). these projections are further reinforced by those of the climate systems analysis group (csag) (cip, 2014), where, on average across months, rainfall in nearby springbok (approximately 60 km to the north; and similarly vredendal, approximately 160 km to the south of the kamiesberg) is projected to decrease for the period 2030-2050, and further decrease for the period 2070-2090, relative to the historical period of 1980-2000 under the more conservative rcp (representative concentration pathway) 4.5. minimum and maximum temperatures for springbok (and similarly for vredendal) are projected to increase for the period 2030-2050, and further increase for the period 2070 2090, relative to the historical period of 1980-2000, under the rcp 4.5. given the already arid nature of namaqualand, this could have significant implications. adapting to the predicted effects of climate change is therefore an imperative. the rural villages of the leliefontein communal area are characterised by low economic activity and high unemployment (bourne et al., 2012; samuels, 2013). while communal farming is an important livelihood source in the leliefontein communal area, communities typically rely on a combination of several livelihood sources (benjaminsen, rohde, sjaastad, wisborg & lebert, 2006) including wage labour (commercial farms, schools, the working for wetlands programme, government posts or shops), remittances and government grants, where livestock farming represents a “hedge against fluctuations in other incomes” (ellis, 2013, oral communication, june 18; benjaminsen et al., 2006). due to the arid nature of the region, livestock farmers have long since adopted transhumance strategies in response to seasonal differences in grazing and the scarcity of water resources (hill, archer & webley, 1990), where the wetlands of the kamiesberg uplands are a key focus-point. the communities rely on the wetlands as a critical support system for livestock owing to their ability to continue to retain water and quality forage throughout the dry summer months of the year (samuels, 2013; kotze, malan, ellery, samuals & saul, 2010). the wetlands also provide other benefits, such as erosion control and flow regulation (kotze et al., 2010). however, over time, many of these wetlands have been severely degraded through cultivation and overgrazing. the reliance of the local communities on these degraded ecosystems, predominantly through pastoralist activities, accentuates their vulnerability to the projected pressures of climate change. based on the socio-ecological vulnerabilities of the region, the principle of eba to climate change is strongly aligned with the challenges faced by these communities. this study therefore analyses the cost-effectiveness of wetland rehabilitation in the kamiesberg uplands relative to ‘conventional alternatives’, where ‘conventional alternatives’ include the installation of boreholes 704 sajems asset research ns 19 (2016) no 5:702-713 and the importation of dry feed (maize and lucerne) into the leliefontein communal area. the study is framed by the objective of sustaining livestock stocking rates into the future, and specifically from the perspective of those directly affected (the landowners). it does not seek to quantify the benefits to broader society. 2 study area 2.1 location and extent of study area the study area has been defined as that which falls within the kamiesberg uplands (above 800 m above mean sea level (amsl)), and within the leliefontein communal area (see figure 1). the leliefontein communal area is one of six communal areas in the namaqualand region, and falls within the namakwa district municipality of the northern cape province of south africa (samuels, 2013; agricultural research council animal production institute, 2012). the communal area is approximately 192 000 hectares in size (samuels, 2013; agricultural research council animal production institute, 2012), and is divided into ten village commons. these village commons have unfenced and permeable boundaries, and vary between 12 000 and 25 000 hectares (samuels, 2013). the area above 1200 m amsl in the kamiesberg is a centre of endemism within the succulent karoo biome (helme & desmet, 2006), which mostly extends up the western flank of south africa (mucina & rutherford, 2006). the vegetation in the kamiesberg uplands have changed significantly as a result of heavy grazing and cultivation. figure 1 the location and extent of the study area (based on wetland data from job (2008)) sajems asset research ns 19 (2016) no 5:702-713 705 2.2 wetlands wetlands generally provide a number of ecosystem services that are beneficial to people, including, amongst others: flood attenuation; provision of water; provision of livestock fodder; nutrient cycling and the amelioration of pollution; erosion control; the provision of harvestable resources; and refugia (kotze et al., 2010; agricultural research council animal production institute, 2012). while these benefits can be quantified according to their direct and indirect use values, the data collection requirements are onerous, and this was outside the scope of the study. just under 1 per cent (1750 ha) of the leliefontein communal area comprises small ephemeral wetlands (calculations based on wetland data from job (2008)). these wetlands are generally located on sedimentary fill sequences situated between steeply-sloped granitic outcrops. shallow soils, combined with the steep terrain results in high run-off discharges through the upper catchments of the kamiesberg (kotze et al., 2010). according to kotze (kotze, 2013, oral communication, july 25), these wetlands act to reduce run-off velocity within their surrounding catchments, allowing water to permeate through the underlying soil. while this may not recharge the deep aquifers of the region, these wetlands are integral to the recharge of shallow sub-surface water, the presence of which is vital to the existence of springs and water levels that are accessible to livestock in dug wells. the capacity of these wetlands to provide a range of ecosystem services varies with their hydro-geomorphic type, attributes and level of functionality. hydro-geomorphic wetland types within the study area vary between valley bottom with a channel, valley bottom without a channel and hill slope seeps (kotze et al., 2010). more than 60 per cent of the wetlands in the kamiesberg uplands have been severely degraded (helme & desmet, 2006) by the removal of indigenous vegetation, over-burning, cultivation, overgrazing, roads, the over-abstraction of water and the establishment of alien tree stands (predominantly populus sp. and eucaluptus sp.). in some cases this has resulted in the severe onset of erosion, loss of ecological integrity, and changes to the wetlands’ hydrological regimes (kotze, 2013, oral communication, july 25). rehabilitation efforts have been carried out in some of these wetlands by the working for wetlands programme, where efforts include alien clearing, revegetation and the installation of gabions, concrete structures, earth works and earth structures. 3 methods a cost-effectiveness analysis was undertaken to evaluate the implementation of eba options compared to alternative measures to deal with the expected impacts of climate change. climate change is likely to exacerbate the pressures that are already faced by people living in the leliefontein communal area, through desiccation of agricultural lands, reduced grazing capacity and reduced water availability. restoration of the degraded wetlands could reduce these impacts through restoring the provision of their services, and with that improve the resilience of the socioecological system. in this instance, wetland restoration was therefore considered as a form of eba. the restoration of wetlands was compared to ‘conventional alternatives’ that would otherwise need to be implemented in the future in order to continue to sustain livestock stocking rates, where these ‘conventional alternatives’ included the installation of boreholes, and the importation of dry feed (maize and lucerne) into the leliefontein communal area. the costs associated with the conventional alternatives are outlined below. the timing of these alternative types of investments (eba vs conventional alternatives) would not be the same. while ecosystem restoration would need to occur in the near future in order to realise benefits over the medium to long term, the ‘conventional alternatives’ were expected to be implemented only once the predicted pressures of climate change became locally evident. although these ‘conventional alternatives’ might be implemented in response to severe drought periods, the probability of these drought periods occurring in any given year is essentially equal across all years. thus, annual ‘conventional alternatives’ costs were averaged out up to 2050, and 706 sajems asset research ns 19 (2016) no 5:702-713 discounted to the present using discount rates of 3 per cent, 5 per cent and 8 per cent, and subsequently summed for comparison. 3.1 wetland rehabilitation costs the ecological rehabilitation actions implemented by working for wetlands in the past (from the 2010 to the 2013 financial year) include alien clearing, revegetation, the installation of gabion structures, concrete structures, and earth structures. these rehabilitation actions have only been implemented on a few wetlands, and areas surrounding wetlands, in and just outside of the leliefontein communal area. the initial costs of these rehabilitation options were obtained from working for wetlands, and then inflated to the 2013 financial year using the south african producer price index (ppi) (see table 1). table 1 expenditure on rehabilitation of wetlands within the study area, excluding follow-up or maintenance costs* wetland ha revegetation removal of alien trees gabion structures concrete structures earth structures earth works total total per ha mideselfontein 10 1 230 75 011 76 240 7 624 suurhoek 10.6 5 540 209 678 158 263 142 152 515 632 48 645 uppereselfontein 3 17 284 31 768 49 052 16 351 groenkloof 2 3 088 1 273 553 168 588 1 445 229 722 615 skaaprivier 1.8 5 714 5 714 3 175 blokdrif 2.03 5 714 5 714 2 815 hoorngaat 3.31 20 000 20 000 6 042 xharas 2.5 19 883 206 020 1 030 277 32 099 1 288 279 515 312 leliefontein 1.6 30 355 466 562 496 917 310 573 witsand 0.2 1 385 730 21 326 1 407 056 7 035 281 total 37.04 5 309 835 143 354 source: working for wetlands (2013) *all costs converted to 2013 rands it was assumed that the initial intervention would take place in the 2013 financial year, and maintenance actions would be carried out over the following ten years, to ensure the effective rehabilitation of the wetlands, to the degree to which their provision of ecosystem services is restored. these maintenance costs were conservatively estimated at an annual average of 5 per cent of the cost of initial intervention. as the cost per unit differs across ecological rehabilitation options (cost per hectare for alien clearing and revegetation, and cost per m3 for gabion structures, concrete structures, earth works and earth structures), the costs per unit for all the rehabilitation actions were standardised to the cost per wetland area that would be rehabilitated. the type of rehabilitation required by wetlands within the study area also varies greatly from one wetland to another. it is thus impossible to determine the specific rehabilitation actions required by each wetland across such a broad area without detailed evaluation, and the average of the costs per wetland area was taken based on the average overall combination of rehabilitation actions. the area of wetlands within the kamiesberg that also falls within the leliefontein communal area, and above 800 m amsl was determined to be approximately 917 hectares using a geographic information system (gis). since at least 60 per cent of the wetlands have been severely degraded (helme & desmet, 2006), the total cost of rehabilitation was based on an estimated 65 per cent of the wetland area, which equates to the rehabilitation of 596 hectares of wetland. 3.2 conventional alternatives without intervention, it was assumed that the continued degradation of the wetlands combined with the projected pressures of climate change would result in further loss of wetland services in sajems asset research ns 19 (2016) no 5:702-713 707 the future. the implementation of ‘conventional alternatives’ included supplementary feeding of livestock as well as construction of boreholes for water supply. the amount of investment required was estimated for the climate situation projected for 2050. the implementation of these measures was projected to increase over time as climate change effects increased. as there is uncertainty surrounding both climate change projections and the way in which the communities and municipalities will react to these pressures in the future, alternative assumptions were explored as to the timing and extent of the introduction of these measures. the 2050 requirements for feed and boreholes were estimated as follows. the livestock farmed within the leliefontein communal area is predominantly made up of small stock (mainly boer goats and dorper sheep), with very few cattle (basson, 2013, oral communication, 6 september) (samuels, 2013). it was assumed that the carrying capacity of the surrounding rangeland vegetation would be the limiting factor with regards to the year-round stocking rates in the leliefontein communal area, and that supplementary feed would be required to replace the contribution that wetlands make to grazing. samuels (2013) recorded the variations in the livestock stocking rates (ssu/10 hectares) over the whole of the leliefontein communal area for the period 1999-2006. to calculate the extent to which the wetlands of the kamiesberg uplands enable farmers to sustain their livestock stocking rates through the dry summer months of the year, the differential between the summer livestock stocking rates in the wetlands of the kamiesberg uplands, and the average livestock stocking rates for the rest of the leliefontein communal area was estimated. this suggests that the wetlands of the kamiesberg uplands enable farmers to sustain an additional 0.563 ssu/10 hectares under the conditions during that period. the costs of substituting the wetland fodder with dry feed (maize and lucerne) was estimated based on the cost of supplying dry feed for the peak summer months of the year, when wetlands would normally be relied upon. the requirement under expected 2050 conditions was estimated to be 90 days of feed for 51.64 ssu (the product of the stocking rate differential and the total area covered by wetlands within the study area). based on feed requirements (le maitre et al., 2009), and current market prices for maize (r2 600 per ton) and lucerne (r3 000 per ton) (kaap agri, 2013, oral communication, 12 september), this would cost some r305 per day (table 2). for sensitivity analysis, the total feed requirement was varied by 30 per cent either way. table 1 estimated cost of feed, based on department of agriculture’s recommended dry feed diet () per 50kg ssu/day (kg) price of feed (r/t) price of feed (r/kg) price of feed (r/ssu) total (r/ssu/ day): subst. wetlands (r/day) maize 0.25 2600 2.6 0.65 5.9 304.676 lucerne 1.75 3000 3 5.25 source: le maitre et al. (2009) it was assumed that the feed requirement would increase every year in relation to increasing climate stress, eventually reaching the expected 2050 feed requirement. as it is difficult to justify a specific non-linear relation on solid ground, it was assumed that this increase would be roughly linear. livestock in the leliefontein communal area obtain drinking water from a number of different sources: dug wells in wetlands; boreholes; springs; and dams (samuels, 2013). the number of livestock drinking sources within the study area was calculated from data compiled by the agricultural research council (table 3). these wetlands play an integral role in recharging the shallow sub-surface groundwater of the kamiesberg (kotze, 2013, oral communication, july 25). therefore, if the degradation of these wetlands is allowed to continue, combined with the predicted pressures of climate change, the assumption is that the wetlands of the kamiesberg will in the future no longer be a source of water for livestock, and that the springs and dug wells will need to be substituted with the installation of boreholes a total of 46. it was assumed that boreholes are installed gradually over time as 708 sajems asset research ns 19 (2016) no 5:702-713 conditions deteriorate. although it could reasonably be argued that borehole installation is likely to be concentrated around drought events, since the timing of these drought events is unknown, the result will be equivalent if the relative probability of drought in each period is unknown and assumed to be equal. for sensitivity analysis, the total borehole requirement was varied by 30 per cent either way. table 3 livestock drinking sources within the study area livestock drinking sources type number dug wells 28 boreholes 21 springs 18 dams 2 total: 69 source: samuels (2013) borehole installation costs were obtained from mek drilling, based in vanrhynsdorp. a quote was obtained for the drilling of a borehole in the kamiesberg region specifically, to a depth of 100 m (with an assumed water availability at 50 m below the surface). the quote includes the costs associated with drilling, casing, concrete collar, and a solar pump (no fuel costs entailed) with two solar panels. the quoted total cost for installing a borehole in the kamiesberg region is r105 588 (as at 16 september 2013). according to vollgraaff (vollgraaff, 2013, oral communication, september 16), once the boreholes have been installed, no regular maintenance is required, unless under exceptional circumstances. 4 results the cost estimates of wetland restoration were extremely variable, depending on the type of work required. this resulted in markedly different lower and upper bound estimates of r4.93 million and r112.87 million, respectively, for a discount rate of 5 per cent (table 4). while it is likely that the wetlands that have been rehabilitated are those that required the most structural work, it is unlikely that no other wetlands need this kind of work. thus the actual cost is likely to lie closer to the lower bound than the upper bound value. nevertheless, the lower bound estimate is higher than all estimates of costs of the conventional alternatives. using our primary assumptions and a discount rate of 5 per cent, these are estimated to be about r2.33 million, but range from r1.13 to r4.08 million depending on assumptions and discount rate (table 5). as the choice of the appropriate discount rate is a subject of debate, three different discount rates were used (3 per cent, 5 per cent and 8 per cent) to serve as a sensitivity analysis. note that the choice of discount rate has less of an effect on the wetland rehabilitation option than on the conventional alternatives, because the former investment is mainly upfront, whereas the latter costs are spread over time up to 2050. at a low discount rate, the lower bound wetland rehabilitation cost is closer in value to the upper bound estimate for the conventional alternatives, but is still higher. table 4 upper and lower bound estimates of the costs of ecosystem-based adaptation through wetland rehabilitation net present value (r millions) discount rate 3% 5% 8% lower bound (only alien clearing required) r 5.18 r 4.93 r 4.62 upper bound (all measures required) r 118.41 r 112.87 r 105.73 sajems asset research ns 19 (2016) no 5:702-713 709 table 5 upper and lower bound estimates of the costs of conventional adaptation through feed supplements and borehole construction net present value (r millions) discount rate 3% 5% 8% lower bound r 2.19 r 1.63 r 1.13 primary estimate r 3.13 r 2.33 r 1.61 upper bound r 4.08 r 3.02 r 2.09 5 discussion internationally, the majority of eba studies are built around some form of qualitative analysis or policy recommendations. while still scarce, quantitative analyses on the cost-effectiveness of eba strategies are increasing. as a case study, rao et al. (2012) applied least-cost, benefit-cost, and net present value analyses to storm surge adaptation options for lami town, fiji. in terms of the leastcost analysis, a number of alternatives were analysed, where combinations of these alternatives would need to be implemented in order to achieve the end objective of reducing projected future flooding events associated with climate change. while lami town in fiji is very different from the northern cape, the approach to the cost-effectiveness analysis chosen by rao et al. (2012) is very similar to this study, where costs for each alternative are summed over 10 and 20 year time periods, and discounted to the present using a discount rate of 3 per cent. rao et al. (2012) found combinations of eba options to be the most cost-effective in reducing flood risk for lami town. tinch & ledoux (2006) assessed the ‘managed realignment’ of coastal regions in the uk as an eba strategy against coastal flooding relative to engineering alternatives, in which the costeffectiveness of ‘managed realignment’ was found to be site-specific. as outlined by rao et al. (2012) relative to alternative economic analyses, a cost-effectiveness analysis embodies the least amount of uncertainty. uncertainty rises with the inclusion of benefit estimation. for this reason, a cost-effectiveness analysis should be the first ‘port of call’ in assessing alternative adaptation options. a full cost-benefit estimation was not attempted in this study because of the onerous data requirements and the uncertainty surrounding the estimation of benefits associated with wetland restoration. in this study, the implementation of ‘conventional alternatives’ was found to be more costeffective than the implementation of eba in the present, as a means to sustaining livestock productivity for the local communities into the future. this represents only the benefits to those directly affected (the landowners), and not the benefits to broader society. the implementation of ‘conventional alternatives’ was assumed to increase linearly. if, however, a nonlinear relation was specified (e.g. discrete or continuous exponential), the effect on the final costs would depend on the discount period – ‘conventional’ alternatives would be favoured even further if a greater majority of these alternatives were only implemented further into the future. restoration of wetlands can be very costly, especially where structural work is required to repair damage caused by draining wetlands for cultivation. this is largely driven by the ‘engineered’ component (installation of gabions, concrete structures, earth works and earth structure) of the rehabilitation actions. such high costs are to be expected where rehabilitation strategies are implemented in somewhat ‘challenging’ wetlands, such as those in the kamiesberg (wetlands characterised by high gradients and shallow soils) (kotze, 2013, oral communication, november 08). as an indication, kotze & ellery (2008) found the cost of rehabilitating the killarney wetland in kwazulu-natal, south africa, to be r223 000 per hectare, and the cost of rehabilitating the manalana wetland in mpumalanga, south africa, to be r947 000 per hectare. in this study, the clearing of invasive alien trees was found to be the cheapest form of restoration, by orders of magnitude, yet this is still a very costly exercise. the actual restoration requirements for the kamiesberg area have not been assessed, and this presented a serious limitation for this study. it is possible that initial restoration efforts have targeted the most seriously damaged wetlands that 710 sajems asset research ns 19 (2016) no 5:702-713 require structural work, and that much of the remaining work required is alien clearing, which means that the costs would be closer to our lower bound estimate. nevertheless, these costs would still be twice as high as conventional options (r4.93 million as compared to r2.33 million). this accords with the lower-bound wetland rehabilitation cost estimate, and the primary estimate for conventional adaptation, respectively, both calculated at a discount rate of 5 per cent. however, this does not necessarily mean that wetland restoration is not a justifiable means of adaptation to climate change, as there are some other issues that also need to be considered. the first of these is who bears the costs and benefits of implementing the adaptation measures. the restoration of wetlands that has up to now taken place in the study area has been undertaken by working for wetlands, which is a government-funded poverty-relief programme that aims to provide employment while also restoring ecological integrity and ecosystem services. in this case, it can be argued that the costs associated with eba implementation can effectively be discounted. however, the conventional adaptation options described above are typically undertaken by landowners, but are unlikely to be affordable to the communities of the study area. while these options could be subsidised by the state, they are less likely to have the same reach in terms of employment benefits as the labour-intensive restoration of wetlands. these economic implications would probably be reflected elsewhere in namaqualand and across other semi-arid regions within south africa. but if the implementation of eba can be shown to make economic sense to those directly affected (the landowners), this suggests a ‘win-win’ situation. in spite of their value, these wetlands have been subject to considerable anthropogenic degradation, which has reduced their capacity to deliver ecosystem services. some of this is through direct destructive behaviour for short term gain from agriculture, and some degradation is due to the spread of invasive trees. the draining and ploughing of wetlands for agriculture is illegal and needs to be curbed if investments in wetland rehabilitation are to be successful in the longer term. indeed, based on the costs found in this study, the prevention of further degradation is likely to be less costly than the ‘cure’. the spread of invasive trees is an accident of historical ignorance and in spite of legislation mandating the clearing of listed invasive species, the authors contend that the onus is on government to clear existing infestations, especially where this requires financial resources that are well beyond those of the local communities. in analysing the cost-effectiveness of eba options relative to ‘conventional alternatives’, it is important to frame the cost-effectiveness analysis in terms of a particular end-objective. in this case, the objective was to sustain livestock stocking rates through the dry summer months of the year under projected future climate conditions. for local applicability, this objective should address the vulnerabilities of local communities to the projected effects of climate change and the need to rehabilitate critical ecosystems on which these communities rely in essence, the definition of eba. researchers need to take cognisance of the fact that, in reality, alternatives to achieving the same end-objective may not need to be implemented within the same time period. thus the choice of discount rate in the analysis has obvious importance. while the costs associated with eba options would usually need to be incurred in the present or near future, those associated with ‘conventional alternatives’ are more likely to be incurred at a much later stage, in reaction to climate changes. 6 conclusion this study presents and demonstrates through the analysis of wetland restoration in the kamiesberg uplands, south africa, a method for the cost-effectiveness analysis of eba to climate change from a landowner perspective. the analysis was framed by the objective of sustaining livestock stocking rates into the future, given the predicted pressures of climate change. the implementation of ‘conventional alternatives’ (installation of boreholes and supply of dry feed) was found to be more cost-effective than eba as a means of sustaining livestock stocking rates, where eba is likely to be twice as costly. sajems asset research ns 19 (2016) no 5:702-713 711 it is generally assumed that eba is likely to be more cost-effective than conventional options, by capitalising on the services provided by ecosystems that help to ameliorate the impacts of climate change. however, in this study, from the perspective of landowners in a poverty-stricken arid region facing the prospect of further heat and droughts, eba proved to be a more costly intervention than conventional measures. but if the implementation of eba measures is done by an organisation that simultaneously addresses poverty on a broader scale, then the costs of eba measures can effectively be discounted. the model provided by working for water and its related programmes in south africa may therefore prove to be a critical strategy in implementing eba under conditions of information scarcity and uncertainty in areas where eba would not otherwise be implemented. references agricultural research council animal 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https://unfccc.int/adaptation/nairobi_work_ programme/knowledge_resources_and_publications/items/6227.php [accessed february 2014]. vignola, r., locatelli, b., martinez, c. & imbach, p. 2009. ecosystem-based adaptation to climate change: what role for policy-makers, society and scientists? mitigation and adaptation strategies for global change, 14(8):691-696. http://link.springer.com/10.1007/s11027-009-9193-6 [accessed january 2014]. working for wetlands. 2013. kamiesberg wetland rehabilitation data. department of environmental affairs (dea), department of water and sanitation (dws), and department of agriculture, forestry and fisheries (daff). ziervogel, g., new, m., van garderen, e.a., midgley, g., taylor, a., hamann, r., stuart-hill, s., myers, j. & warburton, m. 2014. climate change impacts and adaptation in south africa. wiley interdisciplinary reviews: climate change, 5(5):605-620. http://doi.wiley.com/10.1002/wcc.295 [accessed november 2014]. sajems ns vol 1 (1998) no 3 348 prediction of the success level of entrepreneurial ventures by means of biographical and business variables in a third world setting a b bosboff, s w theron and j l schutte university of pretoria abstract a study to determine the degree to which biographical and business variables can predict entrepreneurial success is described. archival data obtained from the records of a venture capital organization were used. data were obtained for two cohorts, each of which represented individuals to whom financial assistance was provided in a given financial year. criterion data consisted of the entrepreneurs' accounts three or four years later. the total sample consisted of 569 small business owners in 435 business firms. data were captured on 14 biographical and 16 business variables. a statistical analysis strategy to limit capitalization on chance was implemented. the results indicated that the number of loans granted., nationality of entrepreneurs, security cover, education level, economic sector, number of dependants, language preference, and race appeared as predictors of success. ]elm 130 introduction "entrepreneurship as we all know is in vogue" (kaplan, as quoted by schutte, bennett, and boshoff, 1993: 2) sums up the current enchantment with entrepreneurship in the western world. this strong interest in entrepreneurship is probably partly due to findings that new business enterprises are the primary source of new employment opportunities (schutte, bennett, and boshoff, 1993: 2). with unemployment at high levels the interest in entrepreneurship as a way of creating jobs is understandable. mcclelland (1987) and harper (1991) argue that entrepreneurship has a critical role to play in economic development and that this role is even more important in the poorer nations of the world. barry (1985: 139) sees economic activity as consisting of continually exploiting price differences that exist in a necessarily imperfect world. it is a course that r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 349 satebnr vol i (1998)nr3 constitutes profit, a phenomenon which is absent from an equilibrium world. if there were no possibility of profit there would be nothing to drive the system towards equilibrium. in hayek's instructive phrase the market is a "discovery procedure" rather than an "allocative device" by which means are somehow mechanistically directed towards the production of given ends. this approach appreciates the role of individuals and what littlechijd (1986) describes as "entrepreneurship" in a generic sense as the mainspring of economic change and progress (ball, 1982: 17). under these circumstances carland, hoy, and carland (1988) strongly argue that understanding of entrepreneurship will be enhanced by studying the characteristics of entrepreneurs, and such studies, therefore seem called for in south africa too. the quarterly bulletin of the reserve bank (as quoted by lunsche, 1997) noted with concern that "a somewhat disquieting aspect of long-term employment trends in the south african economy is that the number of job opportunities created during an economic recovery is getting smaller with each successive recovery". figures confirm this trend, and, seen against the background of about 300,000 new schoolleavers entering the job market every year, this trend is nothing short of catastrophic. it makes the targets espoused in the budget gradually raising the job creating capacity of the economy to 400,00 by the year 2000 appear like wishful thinking. most economists find the answer in an inflexible labour regime. the options are to invest in technology and make existing staff work harder. the reserve bank confirms that 1996 witnessed strong productivity growth and real output per worker which had increased by 3,3% in 1995, rose further by some 3% in the first three quarters of the following year. a solution to the south african job crisis, may yet be found in entrepreneurial activity (lunsche, 1997: 22). erez (1993) argues that, if societies indeed organize themselves around the principle of free markets and free enterprise as is now the case in the ex-soviet bloc, china, and other states, and if entrepreneurship and innovation are the driving forces behind free enterprise, as many believe, then growing importance will be attached to the development and growth of entrepreneurship in the developing countries too. and, during the 1980s, a period when many large american and european firms downsized, net job creation came almost entirely from e!ltrepreneurial businesses. it is therefore essential to understand the nature of entrepreneurial orientation and activity in a developing south africa and its striving for international competitiveness. studies on the personality characteristics of successful entrepreneurs are therefore warranted, especially if south africa with its rich r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 3 350 natural and human resources is to forge ahead to a more prosperous future now that it has rid itself of the restrictive apartheid policies. south africa appears to be in short supply of bold and innovative entrepreneurs, perhaps because the political environment is not yet completely congenial to the genesis of entrepreneurial skills (financial mail, 1996). studies on these personality characteristics have not yet yielded a clear picture (boshoff, bennett, and owusu, 1992). gartner (1988: 21) summarized the situation as follows: "a startling number of traits and characteristics have been attributed to the entrepreneur and a psychological profile of the entrepreneur assembled from these studies would portray someone larger than life, full of contradictions, and conversely someone so full of traits that he/she would have to be a sort of generic everyman". studying business variables as predictors of entrepreneurial success seems to be in line with gartner's (1988) view that the entrepreneurial process should be studied in more depth. trying to predict business success seems to be a relevant research objective in the light of the high failure rate of entrepreneurial businesses (timmons, 1990), especially as venture capital is an active ingredient in many entrepreneurial endeavours (sahlman, 1994). birley and westhead (l994) link up with this argument, reflecting the increased recognition of the importance of both locational considerations in the functioning of the economy and of spational variations in both business formation and small finn survival and growth. johannesson (1990) argues that the personal network of the entrepreneur is "the strategically most important resource" of the finn. ostgaard and birley (1994: 282) are adamant that the value oft!te network is only realized through the owner-manager's positive use of resources contained within, which implies an interchange with members of the network through some form of networking activity. this is consistent with social network theory relying on two basic premises, viz. the entrepreneurial process involves gathering scarce resources from the environment and resources are usually obtained through contact with the entrepreneur's social network (ostgaard and birley, 1994). dubini and aldrich (1991: 3il) argue that "effective entrepreneurs are able to view effective networking as a crucial aspect of ensuring success of their company". according to them the use of personal networks is a concept sufficiently general to include all business dimensions considered relevant for success, e.g. understanding the business, market orientation, stress on quality, and attention to customers. variables of strategic significance which may be used to compare a finn's competitive advantages within and across industries are product i service innovation, marketing, differentiation, focus i scope, and conservative cost control (ostgaard and birley, 1994: 284). hofer and sandberg (1987) identify r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 351 saleb nr vol 1 (1998) nr 3 five business variables of particular strategic importance t9 the success of new ventures, viz. product differentiation; quality, service, and price; market and/or segment domination; innovation; and methods of growth. in the present study an attempt is made to determine whether and to which degree demographic and business variables could be used as predictors of entrepreneurial success. memod our research approach may be described as archival research, as the data were obtained from the archives of a venture capitalist operating with funding from both government and private sector sources, active in the northern province of south africa. the study may therefore be seen as being done by means of "available materials" (kerlinger, 1986: 468). the venture capitalist concerned had six different financing schemes in operation. data from only three of these schemes could be incorporated into the present study. data from the three other schemes had to be omitted due to the absence of information on biographical characteristics of the individuals to whom loans had been granted. the loans included in the study were granted between april 1, 1985 and march 31,1987. subjects the sample consisted of 569 entrepreneurs active within 435 business enterprises. of the 569 persons 433 were male and 136 female. more than two thirds, i.e. 392, preferred to communicate in afrikaans, while 177 preferred english. the majority of the respondents were south african citizens (n = 489). their average age was 39,5 years with a standard deviation of 9,9 years and a range of 18 69 years. 463 respondents were white and 106 black.. statisdeal procedure the variables included in the study can be seen as typical biographical variables, as well as related to financial and other characteristics of the business venture for which loans had been granted. a list of the variables extracted from the archives is shown in table i. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 3 352 table 1: variables extracted from the files of the venture capitalist and seale categories biograpbical variables categories race black i white language preference afrikaans i english residential area city / town / rural education years number of dependants number sex male / female 'onality south african i not south african residential status citizen / not citizen of south africa age years employment history related to present venture / not related to venture / (kg~onalremwe~~ apprenticeship! completed / not completed i none clerkship marital status single! married i divorced / widow / widower criminal record yes/no sequestration record yes/no economic sector manufacturing i retail! wholesale i services i construction / foods purpose of obtaining take-over / new business! expand e~sting finance of business! unknown number of loans number total amount borrowed numerical sum percentage own ratio of own capital: total capital of venture contribution security cover ratio ratio of amount of security: amount borrowed interest paid on loan rate of interest charged by venture capitalist legal fonn of venture sole proprietor i partnership i close corporation i company development state of existing! take-over / new venture employment (existing) number of employees employment (additional) increase in number of employees since starting risk classification low!memum/ffi~/veryhi~ status of entrepreneur in sole proprietor! partner i member / shareholder venture entrepreneur's stake in . percentage of ownership the venture r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 353 sated nr vol 1 (1998) nr 3 table 1 (coatiaued) . bieal variables categories account status bad debt / legal control/current account / paid-up loan account number as indicated by venture capitalist the status of the accounts of the entrepreneurs in the venture capitalist's financial records approximately three and four years after the loans had been granted, served as the criterion of success of the subjects' businesses. the venture capitalist classifies its' clients accounts into four levels: bad debts (do); legal control (lc); current accounts (cal; paid-up loans (pl). for the purpose of this study the first two (bad debts and legal control) are considered to indicate levels of failure while levels three and four (current accounts and paid-up loans) are seen to depict levels of business success. one-way analyses of variance with bonferooni's ranges-test specified where necessary and chi-square analyses (in the case of nominal variables) were carried out on all the biographical and business variables included in the study with account status (as described) the dependent variable. the analysis was repeated with success/failure as the dependent variable. these analyses were followed by stepwise discriminant analyses using s1epdisc of sas (1985). only variables on which, according to the analyses of variance and chi-square analyses, successful and unsuccessful entrepreneurs differed were included in the stepwise discriminant analyses. for the pwposes of these analyses the variables measured on essentially nominal scales were treated as ordinal in character. more information on how this was done can be found in schutte (1992). justification for including variables measured on scales which were not at the interval or ratio levels in discriminant analyses is found in kerlinger (1986: 402). also, using the discrim procedure of sas (1985), discriminant analyses were performed to predict success/failure and account status, using only the predictor variables that had not been rejected by the analyses described up to now. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 3 354 results the aim of the data analysis was to build predictive models (in terms of the two criteria employed in the study) by means of biographical and business variables. this process was carried out in two phases. the first phase consisted of analysis of variance and chi-square calculations. the second phase of the data analysis consisted of a stepwise discriminant analysis to determine which of the variables identified as potential predictors in the first phase of the analysis could be retained as predictors in the two models i.e. discriminating subjects into (1) account status and (2) success or failure of the subjects' business. the results of the one-way analysis of variance and the chi-square analysis with account status and success i failure as dependent variables are presented in table 2. table 2: results of the one-way analyses of variance and chi-square analysis for account status and success or failure predictor account status variable nominal variables df chi" 0 race 3 9.317 0002 language preference 3 1656 0,001 sector in economy 15 3725 0001 residential area 6 1475 0022 nationalitv 1369 0003 ordinal i interval variables f p number of loans 1-567 7,65 00001 amount 1-567 403 00075 security cover 1-567 339 00179 own contribution 1567 413 00066 education 1-567 412 00067 number of dependants 1-567 431 00051 success i failure nominal variables df chi" d race 1 10774 0,013 sector in economy 5 is,37 0,009 nationalitv 1 8690 0003 ordinal/interval variables f d education 1567 11 07 00009 interest rate 1567 430 00386 risk classification 1-567 ns ns r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 355 sateb nr vol i (1998) nr 3 according to table 2 nominal variables having a significant effect on account status are race, language preference, sector in economy, "residential area, and nationality. ordinal i interval variables significantly influencing account status are number of loans, amount, security cover, own contribution, education, and number of dependants. as regards success i failure, nominal variables having a significant effect are race, sector in the economy, and nationality while education, interest rate, and risk classification are the ordinal i interval variables significantly effecting success i failure. as regards the second phase of data analysis, the results of the stepwise discriminant analysis are presented in table 3. as is evident from table 3, eight predictor variables, viz. number of loans, language preference, economic sector, own contribution, number of dependants, nationality, security cover, and education level form a relatively weak but statistically significant prediction module to predict the account status of the subjects. four of these variables are classified as biographical variables and four as business variables (schutte, bennett, and boshoff, 1993: 8). the best discriminating predictor variable contributing to the prediction equation is the number of loans with a wliks' lambda of 0,96 at a significance level of p > f = 0,000 i. however, the discriminatory power of this predictor variable is rather weak as it only explains a relatively small amount of the variance (r2 = 0,038). therefore it may be concluded that the relatively weak wilks' lambda and canonical correlation (0,82 and 0,0661 with a p < 0,0001 respectively) point to a significant but weak model to be developed predicting account status of the subjects. table 3: results of stepwise discriminant analysis for classifying subjects into account status groupings predictor partial f p>f wilks' average variable rl lambda* canonical entered correlation * number of ,0379 7,41 ,0001 ,96 ,0126 loans language ,0295 5,70 ,0008 ,93 ,0225 i preference economic ,0256 4,918 ,0022 -')1 ,0307 sector own ,0257 4,937 ,0022 ,89 ,0389 contribution r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 3 356 table 3 (continued) number of ,0203 3,873 ,0093 ,87 ,0454 dependent nationality ,0191 3,635 ,0128 ,85 ,0516 cover ,0179 3,396 ,0177 ,84 ,0573 education level ,0144 2,703 ,0449 ,82 ,0662 *p < ,0001 the stepwise discriminant analysis was repeated with the success i failure rate of the group the dependent variable in an attempt to establish whether a prediction model could be built for this criterion. businesses of subjects were regarded as successful when their account status was given as either "paid up" or "current". failure was seen as all cases where the account status was either "under legal control" or "insolvent". the results of stepwise discriminant analysis are presented in table 4. table 4: results of stepwise discriminant analysis predicting success i failure predictor partial f p>f woks' average variable rl lambda* canodical entered correlation * educational ,0190 11,01 ,0010 ,98 ,0190 level nationality ,0136 7,80 ,0054 ,97 0324 race ,0077 4,36 ,0372 ,96 ,0398 *p < ,001 as is evident from table 4, and as could be expected in the case of a dichotomous criterion, the prediction model was less strong with only three predictor variables entering the model and the values ofwilk's lambda and the canonical correlation indicating weak and thus less strong predictions. the results of the stepwise discriminant analyses described up to this point are summarised in table 5. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 357 sateb nr vol i (1998) nr 3 table 5: summary of predictor variables with signi~eant discriminating power for the two criteria of success criteria of success variables account status success i failure total sample total sample number of • loans nationality • • education level • • economic • sector language • preference security cover • number of • dependants race • amount borrowed own • contribution interest rate • significant prediction it is evident from table 5 that variables applicable on a personal level, viz. nationality, educational level, and race influence the success i failure criterion. business variables are related to account status. to determine the strength of the prediction model which could be obtained by means of the predictor variables identified in the previous analytical phases discrimant analyses were carried out. the percentages of subjects placed in the correct groups in terms of the two criteria, viz account status and success level by the discriminant analyses are shown in table 6. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . samms ns vol 1 (1998) no 3 358 table 6: percentages of subjects in each of the four levels of account status and the two levels of success status correctly categorized by discriminant analysis for each level groups total n=s69 account status bad debts 34,57% legal control 54,55% current account 38,38% paid-up loans 52,17% success level unsuccessful 25,24% successful 86,50% to facilitate this comparison a model which is commonjy used in decision making in personnel selection (beach, 1985) was used. this model is presented in figure 1. figure 1: model of the inflnence of relationship between predictor and criterion scores on selection decisions false valid rejections acceptance valid false rejections acceptances (source: beach, 1985) this model enables an organization to compare results obtained by a selection procedure with the predicted results (results which would have been obtained if the predictors identified as significant were used in the selection procedure). the number and percentages of valid acceptances, false acceptances, valid rejections, and false rejections could be determined both in reality, i.e. as manifested in the venture capitalist's records and for the predictions, i.e. the categorization of subjects obtained by means of discriminant analysis (schutte, 1992: 99). particulars of this comparison are presented in table 7. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 359 satebnr vol i (1998)nr3 table 7: predicted success levels (percentages). using significant biographical i business variables on small business owners' success level and account status success level aeeoudt status groups udsuc% suee 0/0 unsuc % succ% successful fr va fr va 8,6 55,2 25,1 38,7 unsuccessful 9,1 27,1 19,7 16,5 vr fa vr fa fr = false rejection fa = false acceptance vr = valid rejection unsuc = unsuccessful va = valid acceptance succ = successful the contents of this table seem to indicate that the prediction (selection) models created by the analyses would improve the selection of small business owners to be granted loans, in the sense that fewer false acceptances (loans granted but the business failed) would be found. the prediction model. therefore, seems capable of successful prediction and the elimination of failures. discussion the results presented in the previous section seem to indicate that the use of biographical and business variables hold the promise of improving the selection process used to decide which small business owners should be funded by a venture capitalist. variables which appeared as potent and promising predictors of success or failure appear to be different with remarkably little overlap. number of loans granted, nationality of entrepreneurs, security cover. education level, economic sector in which business operated, number of dependants, language preference, and race appeared as potent and promising predictors of the success or failure of small business owners. the predictors which did appear seem to be quite different from what has been found in previous studies. most of the "traditional" biographical variables like age, gender, and marital status failed to survive the elimination process used in this study. in this sense the present study is seen to represent a contribution to the understanding of the entrepreneurial personality. race is usually seen as a major characteristic in the complex south african society. 'this variable did, however, not feature prominently as a predictor of success in the present study. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 3 360 this is likely to have important socio-econonuc and political implications for the development of south afiican society with regard to its great problems, e.g. unemployment among all sectors of the population. the study has some clear shortcomings. the criteria of success used are in many ways naive and simplistic due to lack of infonnation on, for instance, financial ratios (schutte, bennett, and boshoff, 1993). the study was essentially a concurrent validity study where an attempt was made to predict success as a small business owner on a selected group without taking into account that a number of applications had been rejected by the venture capitalist. data from only three loan programmes, albeit the largest three, operated by the venture capitalist was used, making the sample less representative of small business owners in the country. problems regarding the short time period over which the study was done have already been mentioned. however, it is hoped that the implication of this study may enable venture capitalists, in a modest way, to identify entrepreneurial potential at an early stage and ensure that the right person is financially supported, thus minimising the losses caused by the financing of business ventures that eventually fail. it might therefore contribute something positive to the much needed economic growth in south afiica. references 1. ball, j. (1992). the creation of wealth. in: ball, j. (ed.), the economics of wealth creation, harts, uk: edward elgar, 4 30. 2. barry, n. (1985). in defence of the invisible hand. cato journal, 5(1), 133 148. 3. beach, d.s. (1985). personnel the management of people at work. fifth edition. new york: macmillan publishing company. 4. birley, s. and westhead, p. (1994). a taxonomy of business start-up reasons and their impact on finn growth and size. journal of business venturing, 9, 7 31. 5. boshoff, a.b., bennett, h.f. and owusu, a.a. (1992). entrepreneurship research: where are we and where should we be going? development southern africa, 9(1), 47 64. 6. carland, j.w., hoy, f. and carland, j.c. (1988). "who is an entrepreneur?" is a question worth asking. american journal of small business, spring. 33 39. 7. dubini, p. and aldrich, h. (1991). personnel and extended networks are central to the entrepreneurial process. journal of business venturing, 6, 305 313. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 361 sateb nr vol 1 (1998) nr 3 8. financial mail. (1996). entrepreneurship. freedom nourishes innovative thinking. financial mail. 140(12).26 28. 9. erez. m. (1993). facilitating entrepreneurial orientation and behaviour in developing countries. research proposal, international research project. faculty of industrial engineering and management, technion city, haifa, israel 10. gartner, w.b. (1988). "who is an ent:repreneur?" is the wrong question. a.merican journal of small business, spring, 12, 11 32. 11. harper. m. (1991). enterprise development in poorer nations. entrepreneurship theory and practice, 15(4), 7 11. 12. hofer. c.w. and sandberg, w.r.. (1987). improving new venture performance: some guidelines for success. a.merican journal of small business, 12(4),41 56. 13. johannes son, b. (1990). economies of overview guiding the external growth of small firms. international small business journal, 9(1),32 44. 14. kerlinger. f.n. (1986). foundations of behavioural research. third edition. new york: holt, rinehart and winston. 15. litilechild, s.c. (1986). the fallacy of a mixed economy. london: institute of economic affairs. 16. lunsche, s. (1997). jobless wait in the queue as employed work harder. sunday times, business tunes, march 23, 1997,22. 17. mcclelland, d.c. (1987). characteristics of successful entrepreneurs. thejoumal of creative behaviour, 21(3), 219 233. 18. ostgaard, t.a. and birley, s. (1994). personal network and firm competitive strategy a strategic or coincidental match? journal of business venturing, 6, 305 313. 19. sas institute, inc. (1985). sas users guide: statistics, version 5 edition. carvy, nc: sas institute, inc. 20. sahlman, w.a. (1994). insights from the venture capital model of project governance. business economics, 29, 35 37. 21. schulte, jl. (1992). prediction of small business owners success level by means of biographical and business variables. university of natal,durban: unpublished m.com-thesis. 22. schuite, jl., bennett, rf .• and boshoff, a.b. (1993). prediction of the success level ofent:repreneurial ventures by means of biographical and business variables in a third world setting. paper delivered at international conference on entrepreneurship, vienna, austria, july 4 7, 1993. 23. timmons, j.a. (1990). new venture creation (third edition). humewood, illinois: irwin. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction literature review method ethical consideration results discussion conclusion acknowledgements references about the author(s) renier steyn graduate school of business leadership, university of south africa, south africa g.p. (deon) de bruin centre for work performance, university of johannesburg, south africa citation steyn, r. & de bruin, g.p., 2018, ‘the structural validity and measurement invariance across gender of the brief corporate entrepreneurship assessment instrument’, south african journal of economic and management sciences 21(1), a1965. https://doi.org/10.4102/sajems.v21i1.1965 original research the structural validity and measurement invariance across gender of the brief corporate entrepreneurship assessment instrument renier steyn, g.p. (deon) de bruin received: 02 june 2017; accepted: 30 mar. 2018; published: 19 june 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: corporate entrepreneurial activity and innovation are presented as essential elements of organisational success, and gender diversity is often seen as an important variable in this context. the efficient measurement of these variables is essential to the management thereof. it is within this context that the brief corporate entrepreneurship assessment instrument (bceai) was developed. shorter instruments seem to be favoured by researchers and practitioners alike. however, little is known about the psychometric properties of the bceai, particularly regarding measurement invariance. aim: this study seeks to address the structural validity and measurement invariance for the bceai applied for men and women. the objective was to establish the utility of the instrument within the south african context, with specific emphasis on cross-gender comparisons. setting: medium to large south african organisations, with more than 60 employees, were targeted for inclusion in the study. once organisations indicated their willingness to participate, 60 employees per organisation were randomly selected to participate in the study. methods: data on the bceai were captured and pairwise multi-group confirmatory factor analyses with robust maximum likelihood estimation were used to examine four levels of measurement invariance, as well as the equivalence of latent means pertaining to male and female respondents. results: data were collected from 3180 employees representing 52 south african organisations. the results support the structural validity of the bceai and demonstrate strict measurement invariance for the bceai across gender. equivalence of latent means across gender was also supported. conclusion: these results reveal that the bceai mirrors the structure of the original instrument in the south african context and that bceai yields psychometrically equivalent scores among employees of both genders. researchers and practitioners can therefore use the bceai with the knowledge that its theoretical structure is sound and can apply it with confidence when comparing male and female employees in the workplace. introduction this article addresses the important matter of the accurate assessment of the entrepreneurial environment within organisations, as perceived by employees. this topic is important as organisational success is dependent on innovation, and the accurate assessment of the entrepreneurial environment, which fosters such behaviour, is necessary should any interventions be planned. the issue is complicated by the debate about gender differences as far as innovation is concerned, and it may therefore be asked if men and women perceive the organisational environment in the same manner. this study will focus on the last-mentioned matter. the focus on gender in the assessment of the entrepreneurial environment stems from the comparisons often drawn between men and women. although numerous attempts have been made to explain differences in men’s and women’s attitudes and intentions, the extent to which these differences are due to the assessment thereof is less often considered. it may well be asked if these differences are real, or whether the measuring instruments do not function equivalently for men and women. in some cases, instruments have indeed been found to function differently for men and women (pässler, beinicke & hell 2014; wetzel et al. 2013), while in other cases no such differentiation was noted (baker, caison & meade 2007; wei et al. 2014). within the context of entrepreneurship, zampetakis et al. (2017) report that gender differences, at the item level, regarding entrepreneurial attitudes, perceived behavioural control, subjective norms and entrepreneurial intentions, are almost non-existent and negligible. however, ignoring the possibility of deferential functioning has the potential to compromise any substantive gender-based comparisons resulting from the measurement (salzberger, newton & ewing 2014). more so, the national institute of education and american psychological association standards lists differential validity and differential prediction as a major concern of test fairness (pässler et al. 2014). only once construct comparability (measurement invariance) is demonstrated does it become possible to interpret differences in test or scale scores as true representations of differences explained by group membership (wu, li & zumbo 2007). in this research, structural validity and measurement invariance across gender of the brief corporate entrepreneurship assessment instrument (bceai) was tested, using five consecutive hypotheses related to similar factor loading patterns, unstandardised loadings, intercepts, error variances and latent means. the objectives were to examine if the bceai structure could be replicated across gender groups, and to examine the level of measurement invariance attained across the groups. evidence on the bceai deferential functioning across male and female respondents is not presently available. the aim of this study was to produce such evidence, focusing on medium to large south african organisations, gathering data from random employee samples. the literature review follows, focusing primarily on the characteristics of the corporate entrepreneurship assessment instrument (ceai; hornsby, kuratko & zahra 2002). the literature review starts by explaining the importance of entrepreneurship and an entrepreneurial climate to organisational success. this is followed by a detailed discussion of the ceai’s psychometric properties, as well as some data collected on the bceai by strydom (2013). attention then shifts towards gender differences and the literature review is concluded with a discussion of the concept of measurement invariance. the method used in the study is provided, followed by a presentation of the empirical results. the obtained results are then discussed and the limitations of the research acknowledged. lastly, conclusions are drawn on the structural validity and gender-specified measurement invariance of the bceai, given this sample. literature review organisational performance is an imperative indicator of organisational success and one of the most important key variables in management research (stegerean & gavrea 2010). research indicates that organisational performance is affected by innovation (e.g. durán-vázquez, lorenzo-valdés & moreno-quezada 2012; likar, kopa & fatur 2014; nybakk & jenssen 2012; oke, walumbwa & myers 2012). it is important for organisations to undertake research on the antecedents to innovation so as to allow managers to take note of the potency of different predictors of organisational performance, as well as to manage these in an effective manner (bigliardi 2013; ndregjoni & elmazi 2012). yen (2013) also makes this link and states that the facilitation of innovation is an essential management function which is directly linked to organisational performance. an important element with regard to innovation is organisational climate (nusair 2013; panuwatwanich, stewart & mohamed 2008). some scholars (e.g. björkdahl & börjesson 2011; lin & liu 2012; zhang & begley 2011) have reported a distinct relationship between organisational climate and innovation. according to hamidianpour et al. (2015), organisational climate denotes the employee’s perceptions about the organisation’s reward system, leadership credibility, organisational policy and its formal and informal procedures – as well as, ultimately, his or her sense of belonging in and trust of the organisation. along similar lines, padmaja (2014) argues that organisational climate includes the provision of challenging jobs to employees, the provision of a good working environment, the creation of acceptable career paths and the leadership styles adopted in the organisation, including participation in decision-making. hornsby et al. (2002) are important authors with regard to the conceptualisation and measurement of organisational climate associated with innovation in the workplace. the hornsby et al. (2002) measure of entrepreneurial climate (ceai) is often both referred to and used (bhardwaj 2012; brazeal, schenkel & kumar 2014; de villiers-scheepers 2012; hajipour & mas’oomi 2011; holt, rutherford & clohessy 2007; hornsby et al. 2013; karimi et al. 2011; kuratko & audretsch 2013; marzban, seyed & ramezan 2013; nikolov & urban 2013). this instrument measures five constructs typically found in organisational climate surveys, namely the level of management support, work discretion/autonomy, rewards and reinforcement, time availability and organisational boundaries (hornsby et al. 2002). the focus of this research was on investigating the validity of the bceai, a truncated version of the ceai, proposed by strydom (2013), specifically with reference to measurement invariance across gender. the validity of cross-gender comparisons is important in assisting to address philosophical issues, such as the fundamental feminist philosophical questions, which include assertions that women are equal to men, different from men, or superior to men (mikkola 2016). another reason for investigating the invariance in cross-gender comparisons is the numerous studies that proclaim that such differences, based on group membership, exist in the workplace. authors suggest, for example, that there are significant differences between men and women with regard to how they manage and express stress and emotions (bennie & huang 2010). authors also suggest variations based on group differences with regard to health or safety risks in the workplace (mühlau 2011), differences concerning interest in communal factors (frame et al. 2010), as well as differences in work scheduling (cascio 2015; robbins & judge 2011). important within the context of this research is the role that gender plays in organisational innovation. while some researchers have found a link between gender diversity and innovation in the workplace (adams & ferreira 2009; deloitte 2013; francoeur, labelle & sinclair-desgagné 2008; jiménez, fuentes-fuentes & ruiz-arroyo 2014), research also suggests that this does not occur in all situations (mcmahon 2010; parrotta, pozzoli & pytlikova 2014). sonfield et al. (2001), as well as kvidal and ljunggren (2014), found no differences. the last mentioned report actually states that gender is a non-issue in terms of innovation. the research referred to in this paragraph affirms the use of gender as a variable in the work and innovation environment. in addition, the mixed findings point to a need for further research, including the investigations regarding methodology, measurement, and the validity of measurement – which constitutes the focus of this research. the ceai (hornsby et al. 2002) was used as a basis to develop bceai. as mentioned earlier, the ceai measures five constructs, namely the level of management support, work discretion or autonomy, rewards and reinforcement, time availability, and organisational boundaries (hornsby et al. 2002). considerable work has been published on the factor structure and reliability of the ceai. hornsby et al. (2002) reported a five factor ceai solution, which yielded cronbach’s alpha coefficients of 0.92, 0.86, 0.75, 0.77 and 0.69 for management support, discretion or autonomy, rewards and reinforcement, time availability and organisational boundaries respectively. the results did not fully support organisational boundaries as an important factor as it marginally failed to meet the set threshold of α = 0.70. kamffer (2004) reported alphas of 0.88, 0.80, 0.62, 0.71, and 0.77 for management support, discretion or autonomy, rewards and reinforcement, time availability and organisational boundaries respectively. in this study, rewards and reinforcement did not meet the 0.70 threshold. an analysis of the ceai by holt et al. (2007) demonstrated support for four factors: management support, work discretion or autonomy, rewards and reinforcement and time availability. the coefficient alphas of these factors were 0.92, 0.91, 0.82, and 0.77 respectively. again, organisational boundaries failed to meet the 0.70 threshold. the questionnaire used in this study, as proposed by strydom (2013), consisted of 20 items. the length of the ceai (i.e. 48 items) triggered the development of the bceai (strydom 2013). in a similar manner to the ceai, the bceai proposes a hierarchical structure with each of the five factors consisting of four items (see table 1). the items were selected from the original questionnaire, based on the individual item factor loadings on the particular targeted factor (strydom 2013). the four items with the highest loading per factor were retained, based on the hornsby et al. (2002) findings. the aspiration was that the bceai would yield psychologically equivalent factors to the ceai, with acceptable reliabilities. table 1: constructs and items of the brief corporate entrepreneurship assessment instrument. the ceai items are presented as statements, such as the following: ‘individual risk takers are often recognised for their willingness to champion new projects, whether eventually successful or not’. respondents respond to the statements on a standard likert scale. a high score on any particular subscale would be suggestive of a climate that is favourable to entrepreneurial activity, and a low score would suggest circumstances that impede entrepreneurial activity. an overall high score would be indicative of the existence of a positive entrepreneurial climate. the five constructs, as well as the four items representing each of the constructs, are presented in table 1. the reliability of the subscales and the total questionnaire are reported by strydom (2013) as 0.731, 0.825, 0.742, 0.689, and 0.574 for management support, discretion or autonomy, rewards and reinforcement, time availability and organisational boundaries. as in previous research, organisational boundaries failed to meet the threshold of 0.70. the reliability of the total scale was 0.810. these reliabilities appear adequate for research purposes, but results with respect to the organisational boundaries scale need to be viewed with caution, given the low cronbach’s alpha value reported. strydom (2013) reported that the covariance of these items was adequately explained by five factors. each item loaded on factors as expected and all factor loadings were higher than 0.50. no cross-loadings were observed. this would suggest that the bceai has factorial validity. in the present study, the focus will be on whether the bceai (strydom 2013) mirrors previous findings about the ceai (hornsby et al. 2002) in non-western contexts and whether scores on these factors are comparable across gender groups. some evidence with regard to the replicability of the ceai structure in a western context (holt et al. 2007; hornsby et al. 2002) is reported, while evidence in the non-western context seems mixed, with kamffer (2004) replicating the structure and van wyk and adonisi (2011) failing to do so among african participants. to date, however, no study has comprehensively examined measurement invariance of the ceai among employees across different gender groups. this is also true as far as the less-used bceai is concerned. the matter of measurement invariance is central to this research. measurement invariance relates to an observed score being reflective of an individual’s standing on a construct, independent of their group membership (mellenbergh 1989; meredith 1993; meredith & millsap 1992; wu et al. 2007). within the context of factor analysis, measurement invariance means that the same latent variables are measured on the same scale (metric) across groups, allowing for cross-group factor scores to be comparable (meredith 1993; wu et al. 2007). multi-group confirmatory factor analysis is the de facto standard for use in investigating the degree to which measures are invariant across groups (chen 2008). five consecutive hypotheses will be tested in this research. these are that men and women have: (1) similar factor loading patterns, (2) equal (unstandardised) factor loadings, (3) equal factor loadings and intercepts, (4) equal factor loadings, intercepts, as well as error variances and (5) equivalence of the latent means, when responding to bceai items. method a cross-sectional survey design was used to generate data to test the structural validity and measurement invariance of the bceai across gender. setting the target population was all employees. however, availability, accessibility, proximity and cost necessitated a focus on south african organisations. only organisations with more than 60 employees were targeted. the setting was therefore medium to large organisations, based in south africa, to which access was granted. all participants completed the bceai in english (which is the lingua franca of high school and post-school education, as well as of the business milieu, in south africa). instrument the bceai (strydom 2013), as discussed in detail above, was used in the study. procedure within organisations random sampling was therefore done. each fieldworker advised participants as to the nature of their participation. those who agreed to participate then completed a hard copy of the questionnaire and handed it back to the respective fieldworkers. most employees were willing to participate. those unwilling to participate were replaced, using the same list from which the original 60 participants were drawn. analysis following the recommendations of vandenberg and lance (2000), pairwise multi-group confirmatory factor analyses (wu et al. 2007) with robust maximum likelihood estimation were used to examine four levels of measurement invariance across men and women: (1) configural invariance (similar pattern of freely estimated and fixed factor loadings), (2) weak invariance (equal unstandardised factor loadings), (3) strong invariance (equal unstandardised factor loadings and intercepts) and (4) strict invariance (equal unstandardised factor loadings, intercepts, and error variances) (vandenberg & lance 2000). as a final step, equivalence of the latent means of men and women on the five factors was tested. ethical consideration following receipt of permission from the research ethics review committee of the graduate school of business leadership (gsbl) at the university of south africa for the data to be collected, master of business leadership (mbl) students were recruited as fieldworkers to collect data. they were requested to target relatively large organisations where they could have access to at least 60 employees who had a sufficient command of english to complete the instruments in a meaningful way – as the instruments were administered in english. the collection of organisations presented in this study was therefore the product of a convenient sample. once approval to conduct the research within the organisations was obtained, a list of staff members was obtained from each organisation’s human resource department and participants were selected randomly from the list. results the participants were 3180 employees, representing 52 south african organisations. this study examines the bceai structure across 1771 men and 1372 women employees, with 37 participants providing incomplete information. data were available across all of the companies concerned. the distribution of participants with respect to race or ethnicity was as follows: 8.3% asian people, 58.4% black people, 8.4% mixed race people, and 24.6% white people (missing data = 0.3%). participants’ ages ranged between 20 and 72 years (m = 37.80, sd = 9.11). participants’ tenure at their present companies ranged from 1 month to 42 years, with an average of 8.39 years (sd = 7.47). a preliminary analysis was performed to ensure that no violations of the assumptions of normality were committed. the skewness and kurtosis coefficients of the bceai items ranged between –1.08 and 0.45 for skewness, and –1.15 and 1.16 for kurtosis. overall, the data appeared appropriate for factor analysis with maximum likelihood estimation. analyses were performed with the lavaan package (rosseel 2012) in r (r core team 2013). in each group, a baseline independent cluster confirmatory factor analysis (ic-cfa) model was specified in accordance with the structure given in table 1. the baseline models were identified by fixing the unstandardised factor loading of one item per targeted factor to reflect unity. factor loadings of items on non-target factors were fixed to reach zero. factor loadings of the remaining items, factor covariances and error variances were freely estimated using robust maximum likelihood. the maximum likelihood chi-square (mlχ2), bayesian information criterion (bic), comparative fit index (cfi) and root mean square error of approximation (rmsea) were used to evaluate global fit. according to the mlχ2 the hypotheses of perfect fit for all models were rejected (p < 0.001). however, the cfi suggested marginally good fit across all the models and the rmsea suggested good fit. table 2 and table 3 summarise the changes in fit across successively more stringent measurement invariance models with respect to the bic, cfi and rmsea. for each comparison, very small δcfi and δrmsea values were found (≤ 0.002 for all comparisons; see table 3). the lowest rmsea and bic values were observed for the strict invariance model (i.e. equal loadings, intercepts and error terms), suggesting that this model has the best chance of being successfully replicated in future studies. table 2: chi-square test and change in chi-square statistics. table 3: fit measures and changes in fit measures. as a final step, we added the constraint of equal latent means across men and women, producing a statistically non-significant δχ2 (p = 0.094). in addition, the δcfi and δrmsea values greater than 0.001 (see table 3) indicated that the latent means of the male and female respondents could be treated as equal. against the background of the support yielded by the δcfi and δrmsea for strict measurement invariance, table 4 shows the standardised factor loadings obtained for the total group (n = 3.143). each factor was well defined and each item was a statistically significant (p < 0.001) and satisfactory indicator of its target factor. three items with standardised factor loadings less than 0.30 were observed (i.e. item 14 and item 16 on the factor time availability, and item 19 on the factor organisational boundaries). table 4: standardised factor loadings of the brief corporate entrepreneurship assessment instrument items for men and women jointly. the correlations between the factors ranged from 0.25 (work discretion and time availability) to 0.61 (management support and rewards) (see table 5). the range of the cronbach’s alpha reliability coefficients of the bceai traits across the genders was 0.670 for men and 0.685 for women on management support (4 items), 0.745 for men and also 0.745 for women on work discretion or autonomy (4 items), 0.652 for men and 0.616 for women on rewards and reinforcement (4 items), 0.573 for men and 0.606 for women on time availability (4 items) and 0.536 for men and 0.601 for women on organisational boundaries (4 items). the cronbach’s alpha reliability coefficients of the total bceai were 0.762 (20 items), with 0.762 for men and 0.755 for women respectively. the reliabilities of the five factors were uniformly similar in strength across the sexes and, given the evidence in support of strict measurement invariance, these reliabilities can be assumed to be invariant across the groups. table 5: factor and scale correlations of the brief corporate entrepreneurship assessment instrument. across the groups, weak covariance between factors was observed, which points to the independence of the different factors. discussion due to the interest in gender as a differentiating variable in the workplace, and particularly the availability of statistical technology to test gender-based differences in responding to psychological testing, this study set out to test whether the bceai structure mirrors the ceai in non-western contexts and whether scores on these factors are comparable across gender groups. the results are discussed below, with specific reference to the theoretical and practical implications, as well as to the contribution of this study to the present body of knowledge. according to the maximum likelihood chi-square test, the hypothesis of perfect fit for all the measurement models had to be rejected (see table 2). however, the cfi and rmsea values evidenced that the degree of misfit across the models was relatively small (see table 3). the δcfi values in table 3 revealed negligible deteriorations in fit across successively stringent levels of measurement invariance (note that the cfi does not take model complexity into account). the δrmsea values showed improved fit with successively stringent models. indeed, the rmsea and bic, which both take model complexity into account, showed that the strict measurement invariance model yielded the best fit (see table 3). taken together, these results suggest that a measurement model with invariant factor loadings, intercepts and error variances for men and women is likely to best replicate across different studies. the additional test of latent mean equality was also met, which supplements the notion of invariance. overall, the results of this study indicated that despite differences in gender, participants responded to the items on the bceai in a similar manner. this study contributes towards addressing limitations in the existing literature of innovation climate measurement as the results support the construct validity of the bceai elements among south african men and women. strydom (2013) showed the replication of the ceai/bceai structure in a heterogeneous (men and women combined) south african group. the results of the present study reflect additionally that strict measurement invariance is achieved, which implies that scores on the bceai can be compared across the gender groups. moreover, the results also show equivalence of latent means scores across factors. this signals that the latent mean scores of men and women do not differ significantly, implying that any critique towards strydom (2013) for neglecting gender as a moderator would be unfounded. the results portray a picture contrary to the perception of certain individuals or groups who see gender as a differentiating factor in the entrepreneurial domain (e.g. jiménez et al. 2014), but are considered to be aligned to the findings of other researchers (e.g. kvidal & ljunggren 2014), who suggest gender to be a non-issue when predicting innovation. these empirical results could have repercussions for feminist philosophers and theory regarding gender, as the study does not report any significant differences in the ways men and women perceive this aspect in the workplace. the results of this study also have implications for organisational assessment practices. since strict measurement invariance was achieved, researchers and practitioners may use scores on the bceai to compare individuals across gender groups, knowing that the responses should not be affected by gender-based response biases. lastly, the replication results also permit researchers in south africa to capitalise on existing theoretical and empirical knowledge about the ceai (hornsby et al. 2002). the hornsby et al. (2002) structure of internal environment for corporate entrepreneurship is widely followed, with more than 1000 citations, and abundant knowledge has been created around their conceptualisation of the organisational environment. the knowledge about the replication of this structure in the south african context provides a fertile base to conduct additional empirical work with south african samples. limitations as with most research endeavours, the present study has a number of limitations that need to be considered when interpreting the results. firstly, the organisations employed for the study were targeted in terms of convenience and availability, limiting generalisability to all south african organisations. although this is a limitation, it would be difficult to mitigate, as proposing any sample frame representative of a country would be contentious, and not all organisations included in the sample frame would be willing to participate in the study. the present sample presents an overrepresentation of women when considering the demographics of the south african workforce (statistics south africa 2016). this overrepresentation of women in the sample was deemed to be an effect of the present sample, and it was thus not controlled for. a further limitation is that the reliability coefficients reported in the study are low – in fact substantially lower than those reported by strydom (2013) during the development of the bceai. this places a damper on the results. the low reported reliabilities is likely to inhibit the use of the instrument. conclusion the results provide ample evidence of measurement invariance of the bceai across gender in the workplace context in south africa and also support the veracity and stability of the ceai model among job incumbents in the country. the results further suggest that it is warranted for researchers and practitioners to tap into the accumulated wealth of empirical and theoretical knowledge associated with the ceai model. after establishing measurement invariance, it will be appropriate for researchers to proceed with testing substantial hypotheses about the means and interrelations between latent constructs across groups (hirschfeld & von brachel 2014). this will advance enquiries into the evaluation of entrepreneurial climate, the prediction of innovation, as well as studies directed towards the identification of gender as a moderator in this context. acknowledgements the authors gratefully acknowledge the assistance of the mbl class of 2014 for collecting the data and the sbl-rec for allowing access to the data used in this study. the project was partly funded through the national research foundation’s incentive funding for rated researchers. competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions both authors contributed to the conceptualisation of the article with r.s. 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university of technology, south africa citation zondo, r.w.d., 2018, ‘the impact of gainsharing in the automotive parts manufacturing industry of south africa’, south african journal of economic and management sciences 21(1), a1773. https://doi.org/10.4102/sajems.v21i1.1773 note: this article is partially based on the author’s thesis of the degree of doctor of commerce in the faculty of commerce, law and public administration at the university of zululand, south africa, with promotor dr k. nel and co-promotors prof. e. contogiannis and mr i. kaseeram, november 2009, available here: http://uzspace.uzulu.ac.za/bitstream/handle/10530/542/research+(productivity+gainsharing).pdf.txt?sequence=3 original research the impact of gainsharing in the automotive parts manufacturing industry of south africa robert w.d. zondo received: 01 feb. 2017; accepted: 04 sept. 2017; published: 10 apr. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract the majority of south africans expect greater prosperity that can be accomplished through greater employment, high productivity and wage increases. increased productivity can finance higher wages without burdening the customer with higher selling prices. consequently, there should be strong co-operation between management and labour to improve productivity, thereby ensuring the survival of south african companies. to achieve this objective, organisations find themselves turning to their employees for creative suggestions and ideas on better ways of doing things. this sentiment underpins the concept of gainsharing. gainsharing is a formula-based company-wide programme that offers employees a share in the financial gains of a company as a result of its improved performance. this motivation boosts a company’s productivity and radically reduces the cost of waste, spoilage, rejects and rework. this study examined the impact of a gainsharing programme on the improvement of labour productivity in the automotive parts manufacturing sector. the study investigated the production and related experience of two automotive parts manufacturing companies (referred to as a and b in this study) that have adopted a gainsharing strategy. the two companies operate in the ethekwini district municipality in kwazulu-natal. it assessed if gainsharing is responsible for company labour productivity improvements. the investigation was achieved by collecting preand post-gainsharing quarterly data for spoilage, absenteeism, capital investment and labour productivity. gainsharing improves labour productivity and reduces spoilage and absenteeism rates. in order to maximise performance, a comprehensive performance policy must be developed, which aligns pay (and other incentives) to performance. the study uncovered the strengths and weaknesses of gainsharing for labour productivity improvement in south africa. introduction productivity has generated tremendous interest among economists. parry and lacey (2000) define productivity as management’s ability to combine resources optimally and utilise them fully in order to maximise production per unit of resource input. today, organisations are faced with the challenge of promoting competitiveness and innovative productivity improvement among employees. as a result, fourie (2008) states that organisational effectiveness depends on an appropriate reward system and that, in order to maximise performance, a comprehensive performance policy must be developed, which aligns pay (or other incentives) to performance. according to armstrong (2010), gainsharing is an incentive strategy that meets these requirements. gainsharing is a compensation system that includes employees in plans to improve performance so that they, and management, share any gains (weiss 2006). it is about improving productivity and attracting and retaining high achievers as well as creating a working environment that encourages worker participation (rondeau 2007). it also provides the opportunity for linking improved performance to improved compensation and is a means of creating the kind of workplace that attracts motivated risk-takers and work teams. consequently, gainsharing can be motivated as a tool to increase productivity as out-of-pocket expenses are generally low, because any payouts accrued by workers are linked to future unit performance, and any realised gains are distributed between employees and the company. an effective gainsharing programme involves a diverse set of factors, for instance, profitability, labour costs, material savings and, most importantly, employee participation and involvement (ritson 2008). hence, organisations in south africa (sa) are encouraged to revise their reward philosophies and develop reward strategies, policies and practices that help to achieve new business goals and support organisational and cultural change. such developments should be based on an understanding of the economic factors affecting pay, the significance of the psychological contract and the practical implications of motivation theory as these affect the provision of both financial and non-financial rewards (smith 2007). interest in performance-related pay incentives like gainsharing in various sectors of economic activity is increasing. gainsharing is a desirable alternative as it can contribute to raising the competence levels and productivity improvement of an organisation (masternak 2009). problem statement: low labour productivity level in south africa south africa showed a weakening of productivity growth to −0.4% in 2014, while total factor productivity growth declined at an even higher rate of −3.3% (conference board 2015). south african companies are faced with the challenge of promoting competition and innovation in productivity improvement among employees. their labour productivity in the manufacturing sector, is low when compared to korea, the united states of america (usa), taiwan, japan, france and the united kingdom (uk) (klein 2012). in 2014, they only achieved 36% of the usa productivity level (conference board 2015). it is against this background that the study focuses on a gainsharing programme, given the low labour productivity levels in the south african manufacturing industries (unido 2013). gainsharing increases company performance (hanlon & taylor 2005), improves labour productivity and decreases absenteeism (shonfield 2003). studies on the use of gainsharing programme in sa are lacking (grobler et al. 2006). hence, this study investigates whether gainsharing can increase labour productivity in the selected automotive parts manufacturing companies. it explores the suitability of gainsharing as an appropriate tool for labour productivity improvement. literature review this section discusses the overview of gainsharing for employee participation. it elaborates on how gainsharing as a programme supports organisational improvement strategy. overview of gainsharing for employee participation the central theme in gainsharing is employee involvement. it is a systematic tool that is carried out at all stages of implementation, including design and periodic evaluation (armstrong 2010). for gainsharing to be successful, it must link two of the most important areas in organisational behaviour, namely employee participation and positive employee involvement (masternak 2009). hence, this section presents the overview of gainsharing for employee participation. under gainsharing schemes, knowledge sharing is formalised through an employee suggestion system. workers are encouraged to participate in various ways. for instance, they write down cost-saving ideas and submit them to a committee, generally made up of employee and management representatives, who determine the viability of the suggestion (masternak 2009). these savings become part of a pool of money that is distributed to all participating employees in the form of a gainsharing bonus or reward (rahman 2011). although the financial element is a key feature of gainsharing, its strength as a process for improving performance, lies in other important features such as ownership, involvement and communication (armstrong 2010). the participation structure of gainsharing varies according to organisations and tends to grow and evolve over time (masternak 2009). initially, involvement may be as small as conducting regular communication meetings or as major as forming self-directed work teams (armstrong & stephens 2005). however, rondeau (2007) notes that team-based suggestion systems are common gainsharing participation structures. basically, employee involvement teams are formed to solicit and review performance improvement suggestions from other members of the workforce. the groups are fixed and meet on a regular basis to approve and implement ideas within their spending authority. suggestions that are approved by teams, but are beyond its spending authority, are advanced to a higher level review or steering teams. roman (2009) investigated how making changes to a team-based incentive programme affected productivity, product quality and absenteeism in three large manufacturing plants in texas (in the usa). results indicated that there were significant improvements in all of these areas. furthermore, the investigation noted that changes in organisations must be linked to changes in incentive schemes if they are to be continuously successful. irrespective of the employee involvement system the organisation chooses it is critical that all the problems or challenges are addressed, questions are answered and employee ideas are given proper consideration. hietpas (2008), in a study of gainsharing in the building industry in the usa, identified employee involvement at all stages of programme implementation as vital. he noted that meetings between mid and upper management and employees must take place frequently so that discussions about important issues are not being ignored. the aforementioned are key issues in separating gainsharing successes from gainsharing failures. gainsharing as a programme that supports organisational improvement strategy companies go through stages of growth, maintenance and decline, each of which calls for a different compensation strategy (armstrong 2010). as a result, successful plans are not introduced as isolated initiatives but in response to what other companies are doing in different stages. they are developed from clear objectives and should form part of a comprehensive management strategy that engages employees in a collective effort to achieve key business goals. management use such plans in accordance with the direction the organisation follows. they develop the right mix and levels of financial and non-financial rewards in order to support their business strategies (remmen 2003). bowey (2003) contends that companies without clearly stated objectives generally have unsuccessful compensation plans. successful companies operate their plans as part of a holistic approach involving senior management support and a wide range of team building, performance management and communication initiatives. hence, gainsharing should be viewed as a complex organisational development intervention and not simply as an incentive system (matthew & sanjiy 2005). the reasons and conditions under which gainsharing alters employee behaviour, remain to be learned about. according to wellbourne, bakin and gomez-mejia (1995), most of the existing literature indicates that employee involvement drives gainsharing results. however, the participation models are loosely specified, leading to a belief that employee involvement is a necessary precedent to behaviour. therefore, the financial reward is but one dimension of a gainsharing programme. the system has a behavioural influence with links to social psychological constructs (arnolds & boshoff 2002). heath (1999) in arnolds and boshoff (2002) indicates that the social psychology suggests that pay will affect behaviour only if employees have an internal desire for rewards and that the intrinsic rewards will influence behaviour only when something in the external environment makes that behaviour worthwhile. consequently, gainsharing programmes are not quick fixes to inherent problems but are devices that take advantage of a focused organisational strategy that combines employee participation and an incentive system. fundamentally, gainsharing rewards motivated employees and saves the company money (gardner 2011). if high productivity is required over a short period, incentives offered are better than the normal pay. employees under gainsharing reward structures are expected to engage in more co-operative behaviours, including sharing their ideas for saving costs and improving production, than employees under more competitive, individual-based compensation systems (tjosvold 2004). gainsharing offsets one of the downsides of flatter structures, namely fewer promotion opportunities. it raises the level of both intrinsic and extrinsic rewards, particularly for that portion of the workforce that is predisposed to make an extra effort. it helps motivated employees take a keener interest in organisations that do not offer promotion as an incentive (tsui 2003). therefore, it enables the organisation to recognise its employees’ creativity and intelligence in ways other than increasing their rank or formal status. the organisational perspective of gainsharing is linked to organisational behaviour that plays a pivotal role in understanding employee behaviour (wellbourne & gomez-mejia 2011). in this regard, employees must perceive that gainsharing is properly set up and that procedures are fair and objective. in the usa, brazil and parts of europe, gainsharing creates a working environment that encourages worker participation and provides opportunity for linking improved performance to better compensation (wellbourne & gomez-mejia 2011). according to leitman et al. (2009), in the private health sector in the usa, a pay-for performance programme introduced at a large private hospital between july 2006 and june 2009 resulted in a $25 million reduction in costs. the gainsharing programme proved an incentive for medical staff to reduce hospital costs while maintaining quality care. at the ford motor company (in the usa), employees at dealerships are given purchasing incentives (sachin & roble 2008). if they can buy the part below the normal purchase price, they get a share of the overall savings that are made. the aforesaid findings bring important perspectives to the impact of gainsharing in a global context. hypothesis the study is based on the following assumption: h1: the implementation of a gainsharing programme leads to labour productivity improvement in the automotive parts manufacturing companies. methodology the method for this research will be discussed under the following headings, namely companies that participated in the study, data collection, as well as measurement and data analysis. companies that participated in the study the study is exploratory in nature comparing preand post-gainsharing intervention using quantitative research tools. a convenience sample utilising two large companies that operate in the automotive parts industry situated within the e-thekwini district municipality in the province of kwazulu-natal in sa was used. the two companies that adopted gainsharing as an incentive strategy agreed to participate in the study. they are identified as companies a and b. company a had 1005 employees, while company b had 1302 employees. they both operate a three-shift system. table 1 presents a percentage breakdown of employees in terms of their level of activities for companies a and b. table 1: percentage breakdown of employees in terms of their level of activities. data collection the collection of data from the two automotive parts manufacturing companies was carried out in two phases. this involved the collection of preand post-gainsharing results for spoilage, absenteeism, capital investment and labour productivity. the pre-gainsharing results were quarterly data reflecting each company’s performance over the 3 years prior to the implementation of gainsharing. this includes data from the first quarter of 2005 to the final quarter of 2007. the post-gainsharing data reflect company performances 2 years after gainsharing was implemented. this includes data from the first quarter of 2008 to the final quarter of 2010. measurement and data analysis the company’s quarterly time series data on spoilage, absenteeism, number of workers involved in production, capital investment and labour productivity rates were used. although company a and b are relatively similar in nature, the data from two companies were collected for an optimum sample size so that statistically valid results could be obtained. the measurements were based on 22 observations per company. therefore, the results are based on a total of 44 observations. additionally, a dummy variable that assumed the value of 0 and 1 to represent the preand post-gainsharing periods, respectively, was introduced into the ordinary least squares (ols) model. the aim was to isolate the preand post-labour productivity effects. consequently, if gainsharing proved to be a useful strategy in raising labour productivity levels, this would result in a statistically significant coefficient on the dummy variable. hence, the favourable findings regarding the cointegrating tests enabled the study to engage in quantitative analysis involving ols in order to quantify the magnitude of the impact that the implementation of gainsharing has had on labour productivity. cointegration provides evidence of a long-run relationship between variables (juselius 2006). the ols model used was as follows: labour productivity = bo + b1 spoilage + b2 absenteeism + b3 number of workers involved in production + b4 investment + b5 pre and post-dummy the above model assumes that labour productivity is a function of spoilage rate, absenteeism rate, the number of workers involved in production, investment and gainsharing strategy. the investment variable is the labour productivity lagged by 1 period (i.e. 1 quarter). this variable aims to capture previous machinery input and skills obtained by workers through both skills development programmes and learning through work experience. for the study to achieve its objective, the stationarity tests (as shown in table 2) were conducted in order to determine the status of the variables. table 2: augmented dickey–fuller stationarity test results. the results for both companies’ pooled data indicate that the variables exhibit mixed orders of integration. if one ran the ols models that had non-cointegration level variables, this could have resulted in spurious regressions. as a result, the following tests in table 3 were carried out on the assumption that the cointegrating vector comprises the labour productivity, spoilage rate, absenteeism, number of workers and the exogenous policy dummy variables. table 3: johansen trace and maximum eigenvalue statistics for cointegrating vector. the above tests show that the variables of company a and b have a cointegrating relationship. as a result, there is more than one cointegrating relationship in the pooled data of company a and b (also shown as ab) in table 3. this indicates that the results of tables 5–7 consist of statistically valid data that could perhaps represent long-run relationships. study results preand post-gainsharing comparison table 4 presents the average indexes for spoilage, absenteeism and labour productivity. it shows the extent of percentage change from preto post-gainsharing periods. table 4: preand post-gainsharing comparison. table 4 shows a slight decrease of 0.32% on spoilage rates when the post-gainsharing results are compared with pre-gainsharing results. it also shows a marginal increase on absenteeism rates of 0.12%. however, labour productivity rates have a substantial increase of 3.76%. labour productivity results table 5 presents the results for labour productivity as a dependent variable to absenteeism and spoilage rates, the number of workers involved in production, as well as gainsharing. table 5: labour productivity results. results in table 5 indicate that absenteeism and spoilage rates, as well as the number of workers involved in production at t-values 0.99, −0.24 and 1.63, respectively, have no relationship to labour productivity. their results are below the critical t-value of 2.02 at the 5% level of significance, thus accepting the null hypothesis of relationship between these variables. this indicates that absenteeism and spoilage rates as well as the number of workers involved in production are independent of labour productivity. however, results also show that the gainsharing programme has a positive relationship and is statistically significant to labour productivity. this is determined by its t-value of 3.38 and is above the critical t-value of 2.02 at the 5% level of significance, thus accepting the assumption (i.e. the alternative hypothesis) of a significant relationship between the two variables. this indicates that the gainsharing programme is dependent on labour productivity. positive relationship entails that the implementation of the gainsharing programme increased labour productivity. labour productivity results with capital investment lagged by 1 quarter results in table 6 illustrate labour productivity as a dependent variable to past capital investment (lagged by 1 quarter), absenteeism and spoilage rates, the number of workers involved in production, as well as gainsharing. table 6: labour productivity results with capital investment lagged by 1 quarter. table 6 indicates that absenteeism and spoilage rates as well as the number of workers involved in production (1 quarter after the two companies have invested to capital) at 0.99, −0.24 and 1.63, respectively, have no relationship to labour productivity. their results are below the critical t-value of 2.02 at the 5% level of significance, thus accepting the null hypothesis of relationship between labour productivity and these (independent) variables. this indicates that absenteeism and spoilage rates as well as the number of workers involved in production are independent of labour productivity. however, results show that past capital investments (lagged by 1 quarter) and a gainsharing programme have a positive relationship and are statistically significant to labour productivity. this is determined by their t-values of 3.28 and 3.38 for past capital investment and a gainsharing programme, respectively. their results are above the critical t-value of 2.02 at the 5% level of significance, thus accepting the assumption of a significant relationship between labour productivity and these two (independent) variables. this indicates that past capital investments lagged by 1 quarter and a gainsharing programme are dependent on labour productivity. positive relationship entails that the implementation of a gainsharing programme as well as past capital investment lagged by 1 quarter increased labour productivity. labour productivity results with capital investment lagged by 2 quarters table 7 illustrates that results for labour productivity as a dependent variable of past capital investment lagged by 2 quarters, absenteeism and spoilage rates, the number of workers involved in production, as well as gainsharing. table 7: labour productivity results with capital investment lagged by 2 quarters. results in table 7 indicate that absenteeism and spoilage rates, the number of workers involved in production, as well as past capital investments (lagged by 2 quarters) at 1.44, −0.66, 1.90 and −0.82, respectively, have no relationship with labour productivity. their results are below the critical t-value of 2.02 at the 5% level of significance, thus accepting the null hypothesis of relationship between labour productivity and these (independent) variables. this indicates that past capital investments lagged by 2 quarters, absenteeism and spoilage rates as well as the number of workers involved in production are independent of labour productivity. however, results show that the gainsharing programme has a positive relationship and is statistically significant to labour productivity. this is determined by its t-value of 3.19. the result is above the critical t-value of 2.02 at the 5% level of significance, thus accepting the assumption of a significant relationship between labour productivity and gainsharing variable. summary of results: box plots for determining whether the normality and homogeneity of variance have been met this section analyses data using factorial designs. it incorporates the box plots to determine whether the factorial anova assumptions of normality and homogeneity of variance have been met. porkess (2005) explains that the populations represented should be normally distributed (i.e. the normality) making the mean an appropriate measure of central tendency. however, the homogeneity of variance indicates that the population from which the data are sampled should have the same variance. in this study, ‘policy 1’ is pre-dummy (i.e. the period before gainsharing was implemented), while ‘policy 2’ is post-dummy (i.e. the period after the gainsharing was implemented). the following figure 1 presents the box plots for this study. figure 1: box plots determining the normality and homogeneity of variance. figure 1 shows that the mode of change between company a (labelled as ‘company 1’) and company b (as ‘company 2’) from pre(i.e. policy 1) to post(in policy 2) gainsharing period is homogeneous. box plots indicate a similar spread of gainsharing results from both companies. statistical tests suggest that the conditions for homogeneity of variance between the preand post-gainsharing periods from the two companies have been met. this is confirmed by levene’s test of equality shown in table 8. table 8: levene’s test of equality of error variances porkess (2005) defines levene’s test of equality as an inferential statistic used to assess the equality of variance on different samples. in levene’s test of equality, the statistical procedure assumes that variances of the populations from which different samples are drawn are equal. as a result, the findings in table 8 show that the obtained similarities between the variances in the samples for companies a and b at p-value 0.008 have occurred. they are below the statistical standard value of 0.05. in addition, the interacting factors between the marginal means of preand post-gainsharing implementation periods yielded similar patterns between the d means. hence, there are mean changes between company a and company b in relation to preand post-policy periods (as shown in figure 2). figure 2: estimated marginal means of d means for companies a and b (as labelled by 1 and 2, respectively). figure 2 indicates that the implementation of gainsharing improved labour productivity. the findings are confirmed by the results in sections ‘preand post-gainsharing comparison’, ‘labour productivity results’ and ‘labour productivity results with capital investment lagged by 1 quarter’, which show that gainsharing has a positive relationship with labour productivity. discussion results from this study indicate that absenteeism and spoilage rates as well as the number of workers involved in production have no relation to labour productivity. however, it reveals the relationship between a gainsharing programme and labour productivity. the positive relationship indicates that the implementation of a gainsharing programme increases labour productivity. this is supported by fourie (2008) who states that the organisational effectiveness depends on appropriate reward systems. in addition, rondeau (2007) indicates that gainsharing is about improving productivity and attracting and retaining high achievers as well as creating a working environment that encourages worker participation. the researcher also measured the impact of a gainsharing programme on labour productivity (one or two quarters after the companies have invested in capital). similarly, the results show the positive relationship between a gainsharing programme and labour productivity. the relationship indicates that the implementation of a gainsharing programme (one or two quarters after the company has invested in capital) increases labour productivity. implications of results for policy and practice organisations in sa are encouraged to revise their reward philosophies and develop reward strategies, policies and practices that help to achieve new business goals and support organisational and cultural change. this must be based on an understanding of the economic factors affecting pay, the significance of the psychological contract and the practical implications of motivation theory as these affect the provision of both financial and non-financial rewards. however, the research has established gainsharing as a programme that facilitates employee satisfaction. besides the achievement of study objectives, the following conclusions can be made: gainsharing is a desirable alternative as it contributes to raising the competence levels and productivity improvement of an organisation. during the gainsharing implementation, the employee involvement teams should be able to solicit and review performance improvement suggestions from other members of the workforce. in order to maximise performance, a comprehensive performance policy must be developed, which aligns pay (and other incentives) to performance. study limitations the study was limited to the automotive parts manufacturing industry within the ethekwini district municipality. the investigation was conducted with two companies that have adopted gainsharing. as there are 378 registered automotive parts manufacturers in sa (sainfo 2008) and the investigation was conducted on two of these companies (representing 0.53%), the results cannot be generalised to other companies within the sector. lastly, the econometrics model used was of the ols variety, solely because of data constraints. future studies ought to use the more advanced johansen var methodology or panel data analysis, both of which rely on large data sets. conclusion gainsharing creates a working environment that encourages worker participation and provides opportunity for linking improved performance to better compensation. however, it is not a quick fix to inherent problems. it is a programme that takes advantage of a focused organisational strategy to combine employee participation and an incentive system. future research required during the course of this study, issues relating to the long-term survival of gainsharing after implementation were not intensively covered. this includes the applicability of gainsharing to a wider sector of the economic activity including the public sector. the nature of this research did not allow these areas to be covered in depth. it is recommended that future research should examine the following issues in greater depth: when to use and when not to use a gainsharing programme the applicability of gainsharing for other industrial sectors a more comprehensive investigation should be carried out using a randomised sample of the registered automotive component manufacturers that use gainsharing to see if the results can be generalised. references armstrong, m., 2010, handbook of reward management practice, kogan page, philadelphia, pa. armstrong, m. & stephens, t., 2005, a handbook of employee reward management and practice, kogan page, new york. arnolds, c.a. & boshoff, c., 2002, ‘compensation, esteem valence and job performance: an empirical assessment of alderfer’s erg theory’, international journal of human resource management 13(4), 697–719. 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special edition), viewed 20 october 2016, from http://www.humanresourcesiq.com/benefits-compensation/articles/gainsharing microsoft word 7 boshoff sajems vol 16(3) 2013.doc sajems ns 16 (2013) no 3:329-346 329 towards a listed real estate investment valuation model douw gb boshoff department of construction economics, university of pretoria accepted: march 2013 this paper presents a listed real estate investment valuation model that was developed to investigate the movement in indirect real estate investment through the consideration of the underlying assets of property loan stock companies. specific reference is given to information that is made available to shareholders by way of annual financial statements in order to determine the extent to which shareholders can make investment decisions based on this information. the study enhances the knowledge of direct vs. indirect real estate investment behaviour and provides more insight into price discovery in the property sector. key words: valuation models, indirect property, listed property, price discovery jel: g120, 170, 300 320 1 introduction stock-market-listed property investment funds bring the two different investment classes, i.e. the stocks and bond market and the property market, together as comparable entities. previous literature has shown that price discovery takes place in the listed property market, which might be an indication of market activity also in the direct property market. the objective of this paper is to develop a model that can measure the relationship between the share prices of property loan stock (pls) companies and their underlying assets, by investigating specifically the information provided to shareholders by means of annual financial statements. in order to develop such a model, the stock exchange listed pls companies in south africa are taken as case study, with the aim to formalise the listed real estate investment valuation model (lreiv model). 2 null hypothesis and alternative hypothesis in order to formalise the lreiv model, it is necessary to consider the null hypothesis, which could be stated as follows: spi x nsi ≠ β0 + β1pi + β2tai + β3dti + β4toi + β5opi + β6tci + β7idi + β8ltli + β9ei + ϵi and the alternative hypothesis as: spi x nsi = β0 + β1pi + β2tai + β3dti + β4toi + β5opi + β6tci + β7idi + β8ltli + β9ei + ϵi where: β0 = y intercept spi = average share price at observation i nsi = average no. of shares issued at observation i pi = prime interest rate at observation i tai = total assets at observation i dti = deferred tax at observation i toi = turnover at observation i opi = operating profit at observation i tci = total cost shown at observation i idi = debenture interest paid at observation i ltli = leverage due to long term debt at observation i ei = equity at observation i ϵi = random error in y for observation in i source: author if the null hypothesis could be rejected, that the mentioned variables together do not explain the movement in the market capitalisation (share price x number of shares issued), or that any of the individual variables better explains the market capitalisation, then the alternative hypothesis could be accepted abstract 330 sajems ns 16 (2013) no 3:329-346 that the movement in market capitalisation could be explained by the movement in the mentioned variables. this would imply that shareholders of pls companies have sufficient information available from financial statements in order to make investment decisions. 3 data use data on the listed property funds was obtained from mcgregor bfa, a company specialising in the capturing of financial information of companies listed on the johannesburg stock exchange in a standard format, and included: • share price performance; • financial statements; • shareholding; the data for evaluation of the pls companies comprises panel data; which is structured as a short panel with annual data over a period of 10 years (2001 to 2010) for 19 companies. the panel is balanced for most of the observations, but some of the companies under investigation do not include the whole time frame, causing the panel to be unbalanced. due to the time series component of the data, the observations were deflated by cpi before testing, in order to ensure that inflationary effect did not distort the findings of the study. for regression purposes the first difference of the company variables were taken. 4 related literature glascock, lu and so (2000:178) mention that the relationship between real estate investment trusts and unsecuritised real estate is most controversial. on the one hand, some studies suggest that these types of real estate are unrelated (see gyourko and linneman, 1988; scott, 1990; ross & zisler, 1991). newell and keng (2005:8) also found that property is only a small contributor to the performance of listed property trusts (lpts) in australia. they found that lpts correlated less with stocks over the period of 1985 to 2004 (newell & keng, 2005:4), and that lpts correlated more closely with bonds over this perio (p. 5). the study furthermore noted that unlisted property trusts and property syndicates are more likely to perform like their underlying direct property assets (p. 8). this is an indication that the structure of the vehicle in which the assets are held might have an influence on the performance and the predictability of the underlying assets. a number of other studies also document that direct and indirect real estate are linked by the same common factors (see chan, hendershott & sanders, 1990; giliberto, 1990; gyourko & keim, 1992). doppegieter and rode (2002:2) mention that also in south africa, property securitisation is still in its infancy and has not yet reached a critical mass. the literature therefore indicates that securitised real estate investment and direct real estate investment are still relatively unexplored in both their application and the available knowledge of application. booth and marcato (2004:147) state that information from the indirect real estate market could be useful in understanding the direct real estate market in two ways: • real estate indices could be developed from traded investments which are closer to a transaction-based index rather than objective valuations. • this could enable a more timely flow of information. ”unfortunately, property values cannot be determined by quick reference to the stock market, but have to be determined independently” (hager & lord, 1985:23). although this statement questions the possibilities of this research, a number of studies do find useful information in the listed property market. it is, however, a cautionary note that there are other influences on listed property that are not evident in direct property. if these are not taken into consideration, they could obscure the information on direct property that could be obtained from listed property investment vehicles. it was also mentioned earlier that the different structure of vehicles may also show different results, and therefore special care should be taken when assessing listed property for the purpose of analysing direct property behaviour. yavas and yildirim (2011) investigated the price discovery in real estate markets. as in most other literature investigated, they concentrate on the returns in reits sajems ns 16 (2013) no 3:329-346 331 against the returns in the net asset values (nav). it was found that that reits are leading, causing changes in the nav returns to follow. the same was found by barkham and geltner (1995) in american as well as british property markets, using asset value indices for both. this confirms the possibility to utilise information from the listed property market for price discovery purposes in the direct property market. various studies consider the relationships between direct and indirect property investment behaviour. it was found that listed property shares show various similarities in behaviour to direct property investment. however, listed property shares alsoshare many similarities with other investments, like index-linked gilts (hager & lord, 1985:23), the general stock market and bond returns (giliberto, 1990:259), other securities (sagalyn, 1990:209) or exchange-traded non-real estate shares (ling & naranjo, 1999:483 & 505-506). peterson and hsieh (1997:322) on the other hand, found that most of the evidence regarding reit performance shows that reits tend to either outperform or perform about the same as common shares. it is evident from these studies that, due to their structure, listed real estate shares have similarities to other types of investments, causing distinct differences to direct real estate. lizieri and satchell (1997:12) show that property shares also exhibit a strong “contemporaneous correlation” with overall equity performance. lee and stevenson (2007:551) found strong links between reits and value shares, but they state that there remain sufficient differences in their return behaviour and driving forces for the two sectors to retain a level of distinctiveness, providing portfolio optimisation opportunities for which the one is not substitutable with the other. boudry, coulson, kallberg & liu (2011: 13-14) found that although reits have characteristics of stocks and bonds, they also share characteristics with the underlying real estate and reits and real estate markets adjust to each other in the long term. there are, therefore, some clear similarities between direct and indirect real estate behaviour, as well as some distinct differences. it is assumed that listed real estate funds are influenced by factors similar to those influencing direct real estate. yet the correlation between indices of listed funds and direct property investment is questionable (giliberto, 1990:259). giliberto (1990:262) showed that stock and bond market movements heavily influence the performance of ereits, but have a relatively minor effect on direct real estate investment. however, if financial market effects are disregarded, a strong positive correlation becomes evident. this suggests the presence of a common factor, or factors, in both sets of returns. glascock et al. (2000:178179) indicated that reits and unsecuritised real estate should be co-integrated. however, co-integration between reits and stock markets may be absent when the key gains in securitised real estate come from management and risk-sharing rather than the underlying asset of real estate per se. this suggests that company structure may influence the level of co-integration between direct and indirect real estate. of particular importance in this regard is the difference between the pls structure used in south africa and the reit structure used in various other markets. further evidence that the structure of the investment vehicle that owns the direct property rights could influence the perceived real estate performance, is found by glascock et al. (2000:177-178). they indicate that as the reit market continues to develop, institutional investors are becoming more comfortable in this form of real estate investment, and institutional holdings of reit ipos have increased from less than 10 per cent before 1990 to 41,7 per cent after 1990. this increase in institutional investment in the reit market is partly facilitated by the tax reform act of 1993. the tax reform act allows more institutional investment without jeopardising the trust’s tax-favoured status. these structural changes are important to portfolio management, because they may allow reits to behave more like traditional (small-cap) shares than real estate. the evidence of tax structures influencing indirect real estate, further supports the presumption that reits and plss may perform differently, as their tax treatment is different. institutional as well as individual investors often perceive investment in listed property vehicles or real estate funds such as plss or 332 sajems ns 16 (2013) no 3:329-346 puts, as equivalent to investment in direct real estate, while retaining a degree of liquidity that is unavailable from other forms of real estate investment (giliberto, 1990:259). the studies mentioned above show that there are certain correlations between the behaviour of listed funds and direct real estate, but also indicate that real estate shares have similarities with the stock market in general. chan, leung and wang (1990:432) showed that three factors consistently drive both real estate and stock market returns: changes in the risk structures, term structures and unexpected inflation. according to gyourko and keim (1993:39), real estate shares traded on the new york and american stock exchanges reflect changes in real estate market fundamentals more timeously than a widely used appraisal-based system. they mention two findings that are of particular relevance: • there is no significant contemporaneous correlation between ereit and appraisal series returns. • ereit returns are significantly positively correlated with broader stock market returns. these findings have led many to conclude that share prices are not reliable guides to real estate values. they show, however, that the stock market provides reliable return measures for one of the most important, yet least studied and understood asset categories. they show that decisions based on movements in appraisal-based indexes rely, in large part, on out-dated information. the stock market, however, provides a reliable measure of real estate conditions. fisher, geltner and webb (1994:137-160) consider the history of commercial property values by comparing different methods of constructing commercial property value indices and return series. three types of indices were examined: 1) indices that attempt to reconstruct property market values by “unsmoothing” appraisal based indices; 2) indices that trace average ex post transaction prices of commercial properties over time; and 3) an index based on unlevering reit share prices. they found that the reit index shows more volatility than the other indeces, and leads by up to two years, indicating that market changes could be identified much quicker in the listed property sector. in the long term, however, it shows the same pattern of returns. booth and marcato (2004:147) found that the two main causes of the difference between the performance of direct real estate and real estate share indices were first the smoothing of valuation based indices and, second, the gearing ratio of property shares or reits indices. it was found that there was a close relationship between de-geared indirect market indices and unsmoothed direct market indices, and that there was a larger degree of causality running from the indirect to the direct market. booth and marcato (2004) mentioned that direct real estate indices do not measure the performance of underlying transaction prices properly because they are based on valuations, and therefore may be subject to valuation smoothing. indirect real estate indices do not properly measure the value investors put on the underlying assets of real estate companies, because real estate companies are geared. they furthermore note that the analysis of the relationship between annual returns from direct real estate and annual returns from real estate shares suggests that de-geared real estate share returns have useful information content that could help one to understand performance in the direct real estate market. it is shown that when direct real estate data is unsmoothed, measures of dependency between the direct and the de-geared indirect market strengthen considerably, and if it is assumed that unsmoothed direct real estate returns better reflect underlying transaction prices than direct real estate data, the results suggest that data from the market for real estate shares could be useful for filling the gaps in direct market series. doppegieter and rode (2002:2) explain that the dividend yields and capitalisation rates of puts, when used for valuation, are not based on the same variables, and differences should be expected. they state that put dividend yields provide a better indication of commercial property values in south africa than capitalisation rates. sajems ns 16 (2013) no 3:329-346 333 the studies mentioned so far mostly consider the relationship between direct real estate investment and investment through listed vehicles by way of the similarities in the return achieved. the factors driving the return are discussed and the effect on share prices is tested and used to construct indices to predict return behaviour rather than value. there is also evidence of similarities between real estate share behaviour and the behaviour of other shares. again, discussion is largely based on returns rather than actual share prices or value. no evidence of studies conclusively comparing the value of shares directly to the value of the underlying real estate could be found. chan et al. (1998:357) indicate that ownership structure (as well as the resulting shareholder activism) has a direct impact on the ability of shareholders to monitor management activities. in addition, this monitoring ability provided by institutional investors could affect a firm’s value. according to the authors, several studies further show that the investment strategy of institutional investors has an impact on share returns and their autocorrelation. chan et al. (1998:357-358) continue, that fewer institutional investors invest in reit shares than in the general stock market. in addition, reit shares with a higher per centage of institutional ownership perform better than other reit shares with fewer (or no) institutional investors. it therefore appears that the participation of institutional investors increases the control and monitoring ability of shareholders, and hence the value of reit shares. furthermore there are some large institutional investors who concentrate their investments in the reit stock market. consequently, the monitoring and control aspects of those reits must be improving, as institutional investors normally have the expertise and are more willing to spend resources to monitor the companies in which they invest (chan et al., 1998:372). downs and güner (1999:518) stated that problems associated with observing the value of the underlying asset in real estate securities are frequently cited by practitioners and academics. brennan (1990:727-728) refers to this as a latent-asset problem, i.e., the information acquisition problem of investors when the value of some assets is not observable. from the above it appears that securitised real estate is a good alternative to direct real estate, from an investment perspective as well as an information supply perspective, but the differences should be understood. this substitution appears to be increasing, indicating the importance of understanding the relationship between securitised and direct real estate, but also that information availability could increase over time. wilson and zurbruegg (2003:205206) indicate that, with the emergence of securitised real estate as a viable alternative for institutional investors in the late 1980s and early 1990s, the question whether the direct and indirect property markets are driven by different forces has become an integral part of the research debate. they state that a shortcoming in the literature appears to be a lack of the effective identification of those factors that have a lasting effect on moving property markets (permanent components) and those factors that do not (transitory components). identifying those factors is important because: • institutional investors have both longand short-term goals driven by their strategic and tactical asset allocation objectives. isolating the objectives would provide them with more effective information on how to adjust their portfolios; • securitised property markets have their underlying assets in the direct property sector. it is therefore reasonable to suppose that the permanent driving forces should be the same in both, although the transitory components may differ; • isolating permanent vs. transitory components will help identify the sort of controls that monetary and fiscal authorities have over domestic real estate, which again have important ramifications for institutional investors. it is apparent from the above that the behaviour of listed property share prices is influenced by the involvement of institutional investors, and also by the amount of information that is available to them when they are making investment decisions. this was also found by gillan and starks in two separate studies (gillian & starks, 1999; gillian & starks, 2000). 334 sajems ns 16 (2013) no 3:329-346 5 multiple regression of identified data the literature discussed in section 4 indicated that there is information that has similarities in the listed as well as the direct property market. this indicates that there should be similarities in the direct property market’s behaviour, as seen in the assets of the companies, as well as the share prices. the difference between direct property and the pls company is, inter alia, that the pls consists of a portfolio of properties, opposed to individual properties that are directly measurable when directly invested, and the pls company is geared through financing activities, which obscures the movement of share prices in relation to the asset holdings, which financing is not taken into consideration with direct property values. although there are other differences as well, such as the influence of stock market sentiment and irrational behaviour of investors, these do not fall under the scope of this study. the variables mentioned in the hypothesis were selected through the use of artificial intelligence techniques with the aim to achieve the following: prime interest rate influence expenses at different levels of gearing total assets provides the total value of the portfolio of assets deferred tax proxy for capital growth turnover proxy for the quality of the portfolio, i.e. total income derived operating profit proxy for effectiveness of company i.t.o. income total cost shown proxy for effectiveness of company i.t.o. expenses debenture interest paid proxy for cash return by shareholders leverage due to long term debt proxy for financing activities to explain gearing equity proxy for the value of the company to shareholders the results of the multiple regression, where the above variables were used as explanatory variables and the average market capitalisation was used as dependent variable, is shown in annexure 1. from the model summary, the adjusted r square value is indicated at 0.815. it is however necessary to test the influence of outliers on the model. by excluding all outliers outside two standard deviations, the adjusted r square change to 0.814, with the f-value reducing from 30.862 to 26.353. from the descriptive statistics the number of observations in the pooled data could be seen to vary between different variables. this is due to information availability and in line with literature on information deficiency which might have an influence on the results. the missing values could be due to the fact that they are indeed zero, or are excluded from the financial statement item due to a different accounting policy in that specific year, or omission for whatever other reason. the regressions done thus far were done by excluding missing variables on a case-by-case basis, i.e. by accepting the other variables in that observation would sufficiently explain the dependent variable. it is, however, necessary to test the effect if the regression is done by excluding an entire observation, whether it has any missing observations for any of the variables in it. of most concern in doing so, is the number of observations in the variable interest paid – debentures, which has substantially lower observations. by excluding all observations where this variable is missing, the number of observations is significantly affected. for this reason, the effect is tested by excluding ‘interest paid – debentures’ from the model, thereby having all observations of the balance of the variables available. alternatively they could be included , reducing the number of observations as mentioned. by excluding interest paid – debentures first from the model where missing values are excluded case-by-case, and outliers outside two standard deviations are excluded, the r square reduces from 0.814 to 0.804, but the f-value increases from 26.353 to 49.666. the critical f-value in this case is 5.01 at the 0.01 level of significance. by including interest paid – debentures, but excluding all observations with missing observations in any variable, the number of observations is reduced to 43, and result in an r square of 0.618 with an f-value of 7.788. the critical f-value for this is 4.25 at the 0.01 level of significance. by excluding the interest paid – debentures variable, the remaining observations for the balance of the variables with no missing data, are 84. in this sajems ns 16 (2013) no 3:329-346 335 case the r square is 0.539 with an f-value of 13.143. the critical f-value in this case is 4.99 at the 0.01 level of significance. by excluding interest paid – debenture, it could therefore be accepted that, with the information available on debenture loans of the coefficient of determination reducing slightly, the level of significance increasing substantially, the hypothesis could be accepted that this variable does not belong in the model. the model is also best described by excluding missing values on a case-by-case basis, rather than excluding the entire observation. these results are shown in annexure 2. for the purposes of the hypothesis, the null hypothesis is tested that the individual items better explain the average market capitalisation than the items combined in the multiple regression. the individual items are regressed against average market capitalisation and the hypothesis is tested based on the f-values of these individual regressions. the results are shown in table 1. one of the variables could be accepted at the 0.05 level of significance and one at the 0.01 level. the r square as well as the fvalues in relation to the respective critical fvalues suggest that the multiple regression is better at explaining the market capitalisation than the individual regressed variables. therefore, the null hypothesis that any of the individual simple regressions could equally or better explain the movement in the average market capitalisation could be rejected. the alternative hypothesis is therefore accepted that the multiple regression better explains the movement in the average market capitalisation than any of the individual regressions. t a b l e 1 comparison of simple regression to multiple regressiona variable r square f critical f 0.05 critical f 0.01 reject / accept h0 multiple regression .804 49.666 1.57 2.62 accept @ .01 total assets .598 175.384 63.1 253 accept @ .05 deferred tax .192 26.403 63.0 253 reject leverage long term % .036 5.029 63.0 253 reject equity .720 296.268 63.1 253 accept @ .01 turnover .214 32.887 63.1 253 reject operating profit .240 37.927 63.1 253 reject total cost shown .002 1.283 63.1 253 reject interest paid debentures .277 25.565 62.8 252 reject a. dependent variable: average market cap in order to confirm that the alternative hypothesis is not incorrectly accepted, the variables are also tested for multicollinearity, heteroskedasticity and serialor autocorrelation. multicollinearity is tested by first considering the correlation between the independent variables. total assets and equity stand out to be quite highly correlated, with a correlation of 0.84. the variance-inflating factors (vif) shown in annexure 1, are indicated at 6.381 and 7.002 for these two variables respectively, which, although start out on the high side, are considered not to be severe. the eigenvalues of the model have minimum and maximum figures of 0.011 and 4.578, indicating a k-value of 416 and a resultant ci-value of 20.274. all these tests indicate that a moderate to high multicollinearity is present, but it is still substantially below a severe level, where the extent to which it affects the model makes the results questionable. the levels of multicollinearity are therefore considered to be acceptable without needing any transformation. testing for heteroskedasticity was done by way of a goldfeld-quandt test, where it is tested if λ is greater than the critical f-value, in which case heteroskedasticity is present. for this purpose, two datasets were established, each with (n – c)/2 number of observations, with c chosen as 30 for the total of 126 observations (n), leaving each dataset for the test with 48 observations. λ is then determined by the equation: 336 sajems ns 16 (2013) no 3:329-346 λ = (rssh / dfh) / (rssl / dfl) this resulted in the value of λ being 2.502. the critical values of f are 1.91 at the 0.05 level of significance and 2.52 at the 0.01 level of significance. this indicates that the hypothesis of homoscedasticity is rejected at the 0.05 level of significance, but the test failed to reject the hypothesis at the 0.01 level. it is however an indication that some level of heteroskedasticity is suspected. because it is not confirmed at the 0.01 level, it is sufficed with a note of possible remedial measures, which are left for further research. the data transformation was done by way of taking the first difference for the time-series data, but growth is an exponential pattern, not a straight line. it is therefore expected that the higher difference figures in bigger companies as well as later growth periods, are causing some level of heteroskedasticity. in order to resolve this, it should be considered to take the per centage growth for analysis, rather than the first difference. the level of heteroskedasticity is however not considered to be so severe that the findings of the study are jeopardised. serial correlation is tested by way of a durbin-watson test. as indicated in annexure 2, the durbin-watson value for the model is 2.121. the significance points of the durbinwatson d statistic are dl = 1.552 and du = 1.849 at the 0.05 of significance and dl = 1.433 and du = 1.725 at the 0.01 level. this indicates the range for rejecting h0 of positive or negative autocorrelation to be between 1.849 and 2.151 at the 0.05 level and 1.725 and 2.275 at the 0.01 level. this indicates that the hypothesis of negative or positive autocorrelation to be present could be rejected at the 0.01 level and it is therefore accepted that autocorrelation is not present. in order to ensure the test is accurate, it is worth mentioning that the data ordered for the variables is in time-series order, i.e. all observations per company grouped together in date order. this is important to test the effect of autocorrelation over time; otherwise the durbin-watson d statistic could provide a false output. as mentioned in section 4, price discovery was found in the listed sector, which could provide information on the non-listed property sector. the regression done thus far proved that there are price discovery possibilities, but it needs to be determined in which direction the price discovery takes place. for this purpose a granger causality test was performed between total assets and average market capitalisation for 1, 2, 3, 4 and 5 time lags of one year each. the f-values for this is shown in table 2. t a b l e 2 granger causality between total assets and average market capitalization dependent number of lags f-value critical values 0.25 0.1 0.05 0.01 total assets 1 6.409 9.80 63.10 253.00 2 3.739 3.47 9.48 19.50 99.50 3 3.314 2.47 5.14 8.55 26.20 4 6.189 2.08 3.79 5.69 13.70 5 3.791 1.88 3.15 4.44 9.24 average market capitalization 1 137.648 9.80 63.10 253.00 2 69.043 3.47 9.48 19.50 99.50 3 32.441 2.47 5.14 8.55 26.20 4 34.640 2.08 3.79 5.69 13.70 5 20.873 1.88 3.15 4.44 9.24 the green shaded areas in table 2 show where the f-value exceeds the critical f-value for the various time lags and at different levels of significance. the f-values indicate that there is better evidence for total assets to granger cause average market capitalisation than there is for average market capitalisation to cause total assets. this suggess that price discovery may take place in the direct property market rather than in the listed property sajems ns 16 (2013) no 3:329-346 337 market. this is in contrast to the findings of both yavas and yildirim (2011) and barkham and geltner (1995) as discussed in section 4. the reason may be the data frequency used for the estimate, keeping in mind that share prices change on a daily basis, while the data used is only the annual weighted average. because the total assets of the pls companies are not revalued more frequently, the test cannot be performed on the actual valuations as performed here. it should however be considered to perform the test on index data, similar to the mentioned literature, taking into consideration more frequently observed direct property data. if the findings of yavas and yildirim (2011) and barkham and geltner (1995) are also applicable here, it would suggest that price discovery takes place in the short term in the listed sector, but over longer periods, prices are corrected by direct property behaviour. from the above it can be seen that the share prices could be predicted by the changes in different company variables, given the company structure. the value of the market capitalisation, which is the product of the share price and the number of shares, can be written in terms of the lreiv model as: spi x nsi = β0 + β1pi + β2tai + β3dti + β4toi + β5opi + β6tci + β7ltli + β8ei + ϵi where: β0 = y intercept spi = average share price at observation i nsi = average no. of shares issued at observation i ei = equity at observation i dti = deferred tax at observation i ltli = leverage due to long term debt at observation i toi = turnover at observation i opi = operating profit at observation i tci = total cost shown at observation i pi = prime interest rate at observation i ϵi = random error in y for observation in i source: author in conclusion, although the alternative hypothesis stated in section 2 could be accepted, it was shown that market capitalisation could be explained at a higher level of significance if the interest paid on debentures was excluded from the model. this is considered due largely to the limited information that is available in this variable, pointing to some information deficiency in the financial statements. 6 listed real estate investment valuation model tested in order to test the model, three transactions that took place in the period 2010/2011 will be considered: • the purchase of 50 per cent of the v&a waterfront by growthpoint for r4 858 500 000; • takeover of the attfund portfolio by hyprop properties; • listing of the investec property portfolio on the jse. these transactions provide an opportunity to test the lreiv model by comparing the influence of the transactions on the portfolio value, and on the share price movements for the period over which the transactions were concluded. a growthpoint acquisition of 50 per cent interest in v&a waterfront on 13 december 2010, growthpoint published a cautionary announcement for its shareholders trading with its shares, due to negotiations that were under way and might influence their share price. the cautionary announcement was renewed on 26 january 2011. at that stage the growthpoint share price started to decline (see figure 1), but so did the pls index. so it is difficult to say to what extent this transaction was responsible for the change in share price. growthpoint represents approx. 31 per cent of the pls index, so a change in growthpoint could influence the index as a whole, but the movement in the index seemed more severe than that caused by growthpoint. on 14 february 2011 growthpoint announced that it had entered into an agreement to acquire a 50 per cent interest in the v&a waterfront with the government employees pension fund (gepf) represented by the public investment corporation (pic), subject to certain suspensive conditions that had to be fulfilled. the information provided to shareholders included some details of the property in terms of its use, 338 sajems ns 16 (2013) no 3:329-346 size, etc. and its financing, which was said to have been done on credit to cover the equity portion of the sellers, and by preference shares to cover the debt portion of the sellers. for the present purpose, the financing is considered as debt, as both portions basically imply debt. on 9 june 2011 it was published that the transaction was finalised and all suspensive conditions had been met. f i g u r e 1 growthpoint share price vs j203 24000 26000 28000 30000 32000 34000 36000 1400 1500 1600 1700 1800 1900 2000 2100 10-aug-10 18-nov-10 26-feb-11 06-jun-11 14-sep-11 23-dec-11 01-apr-12 a ll sh ar e in d ex g ro w th p o in t sh ar e p ri ce date growthpoint growthpoint 22 day mov. ave. as as 22 day mov. ave. if the share price movement of growthpoint is compared to the all share index (j203), as shown in figure 1, it can be seen that there is a very close co-movement between growthpoint and the j203. this confirms the findings of literature in terms of co-movement in the stock market and listed property. it is however evident that there are short periods where differences could be seen more clearly in the 22 day moving averages of growthpoint’s share price and the j203. if the transaction of growthpoint is considered in terms of the lreiv model, it may be possible to explain some of the movement. growthpoint indicated that the transaction would be financed primarily by debt and preference shares, which for the purpose of this exercise is also considered as debt, indicating that there should not be a change in equity. this implies that the market capitalisation, and therefore the share price, has a priori expectation to remain constant. according to the lreiv model, the changed long term leverage ratio does however influence the situation. taking into consideration the expectations regarding the change in total assets, turnover, operating profit and total cost shown, it seems that the market capitalisation should be altered by approximately r77,6 million. this represents approximately 0.27 per cent of the total market capitalisation at the time, based on income and expenses for the property that is assumed to be similar to the average of the portfolio, which implies a turnover increase of approximately 12 per cent of the value of the property. given the size and type of property, this is considered to be unlikely, and therefore the sensitivity for lower levels of turnover and profit figures is also considered. the model shows a zero change in the market capitalisation with a yield of 11.06 per cent, while at an 8 per cent yield, the indication is that the market capitalisation would reduce by r252 million, or 0.87 per cent. the last mentioned figure is considered more likely and therefore it could be stated that a reduction in the share price is expected. sajems ns 16 (2013) no 3:329-346 339 the above could be an explanation for the underperformance of the growthpoint share price relative to the j203 during the timeframe in which the transaction took place, as indicated by the blue shaded area in figure 1. soon after completion of the transaction, new shares were issued that changed the market capitalisation due to the number of shares issued and influenced the level of leverage. the latter change and a number of subsequent share issues are also marked by negative changes in the share price. the share price either became lateral or downward moving, which was not all explained by the movement in the j203. in conclusion, although it appears that the purchase price of the property was higher than evident in the share price movement and in the individual property attributes, the details available are limited; and more accurate details would enhance the results of the model. generally share prices are determined by the perceptions of investors, which may be more or less rational. therefore, some irrationality in the behaviour of investors may also cause short term differences in the results of the model. for more information on the irrational behaviour of investors it is worthwhile to consider behavioural finance (shiller, 2003). b hyprop acquisition of attfund portfolio on 6 december 2010 hyprop announced that it had in principle reached agreement to purchase the property portfolio of attfund retail. on 21 december 2010, it issued a cautionary announcement regarding the trading of hyprop units, and provided some financial information on the proposed transaction. on 3 february 2011 the cautionary announcement was renewed. on 8 april 2011 it was announced that the competition tribunal had approved the transaction. an updated proposal for the transaction with financial effects and forecasts was issued on 13 april 2011, and on 21 april 2011 a circular was posted with full details of the updated transaction, the withdrawal of the cautionary announcement, and a notice of a general meeting for the shareholders of hyprop to approve the transaction. the transaction was approved by shareholders of hyprop on 13 may 2011. the effective date of the transaction was anticipated for either 1 june 2011, or 1 july 2011, conditional to the implementation of the attfund retail restructure. the share price movement of hyprop for the period september 2010 to 1 july 2011, which was the anticipated effective date of the transaction, is shown in figure 2. the blue shaded area highlights the period from the first announcement to the one that the transaction was finally approved. from this it seems as if the hyprop share price underperformed relative to the j203, but if it is similarly compared to the pls index (j256) as shown in figure 3, it is obvious that hyprop may have slightly outperformed the sector in this time period. after the transaction however, the share price falls back to a very similar pattern to the sector. by testing the effects of the transaction on the share price, using the lreiv model and the details as provided by hyprop in the cautionary announcements, the value of the 112 000 000 shares to be issued, is calculated at r58-00 per share or combined unit. the transaction, however, takes place at r54-00 per share. this suggests that the share price should increase after the transaction due to the positive effect of these higher valued shares. this is assuming the values given for the assets included in the transaction are accurate. c listing of the investec properties portfolio: investec property fund limited (ipf) announced on 6 april 2011 that it would list its portfolio of properties on the jse, and issued the pre-listing statement containing the financial forecasts for this transaction on the same day. 340 sajems ns 16 (2013) no 3:329-346 f i g u r e 2 hyprop share price vs all share index 24000 26000 28000 30000 32000 34000 36000 4350 4850 5350 5850 6350 10-aug-10 29-sep-10 18-nov-10 07-jan-11 26-feb-11 17-apr-11 06-jun-11 26-jul-11 14-sep-11 03-nov-11 23-dec-11 a ll sh ar e in de x h yp ro p sh ar e pr ic e date hyprop hyprop 22 day mov. ave. as as 22day mov. ave. f i g u r e 3 hyprop share price vs pls index 1250 1300 1350 1400 1450 1500 1550 4800 5000 5200 5400 5600 5800 6000 10-aug-10 29-sep-10 18-nov-10 07-jan-11 26-feb-11 17-apr-11 06-jun-11 26-jul-11 14-sep-11 03-nov-11 23-dec-11 p ls in de x h yp ro p sh ar e pr ic e date hyprop pls index ipf was listed on 14 april 2011, with no debt other than debenture loans. the 170 000 000 shares were issued at r10-00 for a combined unit, resulting in a total equity position of r1 700 000 000. the well diversified property portfolio was valued at the time of listing at r1 696 500 000 (investec: 2011). by testing the pre-listing forecast company structure and financials with the lreiv model, the share price was estimated to be sajems ns 16 (2013) no 3:329-346 341 r960. this is assuming that the property values as given by the prelisting announcement are accurate. by comparing the share price performance to the j203 for the period from listing to 1 year after listing, as shown in figure 4, it seems that ipf performed slightly better than the j203. figure 5 compares the ipf share price to the j256, where it appears that ipf slightly under-performed against the pls sector for approximately 6 months, and then started to outperform the sector from approximately october 2011. the lreiv model calculated share price of r9-60 against the ipo amount of r10-00 for the shares might explain the initial underperformance against the sector, but in order to explain the change to an outperformance trend, the history of the company was investigated. on 18 october 2011 a shareholders’ meeting was held, approving the purchase of another two properties. by testing the effect of this in the lreiv model, it was calculated that the share price should increase by approximately 27 cents. the trend over the few months after the annual meeting revealed that ipf outperformed the sector (if normalised) by approximately 30 to 40 cents. f i g u r e 4 investec property fund share price vs all share index 28000 30000 32000 34000 36000 38000 40000 900 950 1000 1050 1100 1150 1200 1250 1300 26-feb-11 17-apr-11 06-jun-11 26-jul-11 14-sep-11 03-nov-11 23-dec-11 11-feb-12 01-apr-12 21-may-12 a ll sh ar e in d ex in ve st ec s h ar e p ri ce date investec investec 22 day mov. ave. as as 22 day mov. ave. 7 conclusion, shortcomings and recommendations the paper investigated the use of financial statement items to predict the share price movement of pls companies. it was possible to show that approximately 80 per cent of the long term movement in the market capitalisation, and with the number of shares known, the share price could be explained by the variables as shown as the lreiv model. the results found however, that price discovery takes place in the direct property market when annual data is used, which is in contrast to previous research that found price discovery in the listed property market. in section 6, the lreiv model was testedon three different examples of recent market transactions. this not only provided some validity to the study, but showed the practical application of the model. 342 sajems ns 16 (2013) no 3:329-346 f i g u r e 5 investec property fund share price vs pls index 1350 1400 1450 1500 1550 1600 1000 1020 1040 1060 1080 1100 1120 1140 1160 1180 1200 26-feb-11 17-apr-11 06-jun-11 26-jul-11 14-sep-11 03-nov-11 23-dec-11 11-feb-12 01-apr-12 21-may-12 p l s in d ex in ve st ec s h ar e p ri ce date investec pls index f i g u r e 6 investec property fund lreiv model regressed vs observed values 50 000 000 100 000 000 150 000 000 200 000 000 250 000 000 300 000 000 350 000 000 1" 2" 3" 4" 5" 6" 7" 8" 9" 10" 11" 12" 13" 14" 15" 16" 17" 18" 19" 20" 21" 22" 23" 24" 25" 26" 27" 28" 29" va lu e observation number regressed values observed values the lreiv model is limited mostly by information availability. it was noted in section 5 that there is evidence of information deficiency, with specific reference to debenture interest paid and to a lesser extent to some observations of other variables. this is similarly the case with the lreiv model as tested, which is based on information available to shareholders only, in the form of annual data. although this limitation is evident for sajems ns 16 (2013) no 3:329-346 343 shareholders or other third parties, it is not necessarily the case for executives of these companies, who have inside information that could be used in the model. the model is however not tested in such an environment and this could therefore not be stated conclusively. by accepting the alternative hypothesis, the model was formalised in principal form. in order to increase the model’s accuracy and credibility it is required to increase the data available for analysis. it is therefore recommended that the model be enlarged with more data, to investigate opportunities of increasing its accuracy. the study was also limited to pls companies. it is suggested that further research be performed on the possibilities of applying the model to property unit trust funds as well as real estate investment trusts, as alternative forms of listed property investment. furthermore, the study was limited to the south african property market. it is suggested that the applicability of the research be tested on other international markets. references barkham, r. & geltner, d. 1995. price discovery in american and british property markets. real estate economics, 23(1):21-44. booth, p.m. & marcato, g. 2004. the dependency between returns from direct real estate and returns from real estate shares. journal of property investment and finance, 22(2):147-161. boudry, w.i., coulson, n.e., kallberg, j.g. & liu, c.h. 2011. on the hybrid nature of reits. the center for real estate and finance: working paper, 38 pp. brennan, m.j. 1990. latent assets. journal of finance, 45(3):709-730. chan, k.c., hendershott, p.h. & sanders, a.b. 1990. 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wealth effects of corporate governance related proposals. ssrn working paper series. gillan, s.l. & starks, l.t. 2000. corporate governance proposals and shareholder activism: the role of institutional investors. journal of financial economics, 57:275-305. glascock, j.l., lu, c. & so, r.w. 2000. further evidence on the integration of reit, bond, and stock returns. journal of real estate finance and economics, 20(2):177-194. gyourko, j. & keim, d.b. 1992. what does the stock market tell us about real estate returns?, real estate economics, 20(3):457-485. gyourko, j. & keim, d.b. 1993. risk and return in real estate: evidence from a real estate stock index. financial analysts journal, september-october:39-46. gyourko, j. & linneman, p. 1988. owner-occupied homes, income-producing properties, and reits as inflation hedges: empirical findings. journal of real estate finance and economics, 1(4):347-372. hager, d.p. & lord, d.j. 1985. the property market, property valuations and property performance measurement. conference paper, jia (112):19-60. lee, s. & stevenson, s. 2007. the substitutability of reits and value stocks. applied financial economics, 17:541-557. ling, d.c. & naranjo, a. 1999. the integration of commercial real estate markets and stock markets. real estate economics, 27(3):483-515. 344 sajems ns 16 (2013) no 3:329-346 lizieri, c. & satchell, s. 1997. interactions between property and equity markets: an investigation of linkages in the united kingdom 1972-1992. journal of real estate finance and economics, 15(1):11-26. mcgreggor bfa. 2009-2011. available at: <http://www.mcgreggor bfa.com> [accessed january 2009july 2011]. newell, g. & keng, t.y. 2005. factors influencing the performance of listed property trusts. paper delivered at the pacific rim real estate society conference 23-27 january 2005, melbourne, australia, 22 pp. peterson, j.d. & hsieh, c. 1997. do common risk factors in the returns on stocks and bonds explain returns on reits? real estate economics, 25(2):321-345. ross, s.a. & zisler, r.c. 1991. risk and return in real estate. journal of real estate finance and economics, 4(2):175-190. sagalyn, l.b. 1990. real estate risk and the business cycle: evidence form security markets. journal of real estate research, 5(2):203-219. scott, l.o. 1990. do prices reflect market fundamentals in real estate markets? journal of real estate finance and economics, 3:5-23. wilson, p.j. & zurbruegg, r. 2003. isolating important driving forces in indirect real estate markets. journal of real estate portfolio management, 9(3):205-218. yavas, a. & yildirim, y. 2011. price discovery in real estate markets: a dynamic analysis. journal of real estate finance and economics, 42:1-29. annexure 1 multiple regression of company data descriptive statistics mean std. deviation n average market cap 432980815.019 1101497612.517 126 prime 11.948 2.009 126 total assets 710665.473 1705619.146 126 deferred tax 53026.684 163529.957 117 turnover 66922.280 201819.192 124 operating profit 70615.576 417515.550 126 total cost shown 1520.867 41244.040 126 interest paid debentures 69675.607 129470.593 68 leverage long term% .515 .237 112 equity 539431.671 1426996.169 122 model summaryb model r r square adjusted r square std. error of the estimate durbin-watson 1 .918a .842 .815 473752574.775 1.998 a predictors: (constant), equity, prime, total cost shown, leverage long term%, turnover, operating profit, deferred tax, interest paid debentures, total assets b dependent variable: average market cap anovaa model sum of squares df mean square f sig. regression 62340158303708600000.000 9 6926684255967620000.000 30.862 .000b residual 11670958109519100000.000 52 224441502106136000.000 total 74011116413227700000.000 61 a dependent variable: average market cap b predictors: (constant), equity, prime, total cost shown, leverage long term%, turnover, operating profit, deferred tax, interest paid debentures, total assets sajems ns 16 (2013) no 3:329-346 345 coefficientsa model unstandardized coefficients standardized coefficients t sig. vif b std. error beta (constant) -754633141.199 425313750.940 -1.774 .082 prime 45981466.196 32107910.050 .084 1.432 .158 1.131 total assets 63.686 95.330 .099 .668 .507 7.185 deferred tax 2520.437 972.115 .374 2.593 .012 6.868 turnover 2621.867 805.903 .480 3.253 .002 7.190 operating profit 117.726 248.572 .045 .474 .638 2.927 total cost shown -1582.077 1556.735 -.059 -1.016 .314 1.120 interest paid debentures 3080.487 1193.162 .362 2.582 .013 6.486 leverage long term% 377216472.089 288827916.559 .081 1.306 .197 1.274 equity -243.110 112.149 -.315 -2.168 .035 6.961 a dependent variable: average market cap annexure 2 multiple regression of company data – debenture interest paid and outliers removed descriptive statistics mean std. deviation n average market capsd2 299416850.250 586145230.963 123 prime 11.948 2.009 126 total assetssd2 399876.080 919188.909 120 deferred taxsd2 24446.293 68211.754 109 turnoversd2 32997.394 77840.666 119 operating profitsd2 68394.276 197656.980 120 total cost shownsd2 -197.419 11472.996 121 leverage long term%sd2 0.520 0.234 111 equity sd2 312054.026 678474.277 117 model summaryb model r r square adjusted r square std. error of the estimate durbin-watson 1 . 906a .820 .804 259595336.664 2.121 a predictors: (constant), equitysd2, prime, leverage long term%sd2, total cost shownsd2, turnoversd2, operating profitsd2, deferred taxsd2, total assetssd2 b dependent variable: average market capsd2 anovaa model sum of squares df mean square f sig. regression 26775884742060500000.000 8 3346985592757560000.000 49.666 .000b residual 5862907277136060000.000 87 67389738817655800.000 total 32638792019196600000.000 95 a dependent variable: average market capsd2 b predictors: (constant), equitysd2 , prime, leverage long term%sd2, total cost shownsd2, turnoversd2, operating profitsd2, deferred taxsd2, total assetssd2 346 sajems ns 16 (2013) no 3:329-346 coefficientsa model unstandardized coefficients standardize d coefficients t sig. vif b std. error beta (constant) -427453520.992 187806016.175 -2.276 .025 prime 30947161.307 14075496.979 .106 2.199 .031 1.127 total assetssd2 -160.427 73.192 -.252 -2.192 .031 6.381 deferred taxsd2 -2896.922 611.889 -.337 -4.734 .000 2.456 turnoversd2 1149.176 462.045 .153 2.487 .015 1.824 operating profitsd2 689.365 174.508 .232 3.950 .000 1.677 total cost shownsd2 2638.330 2548.489 .052 1.035 .303 1.205 leverage long term 201149167.230 122614791.361 .080 1.640 .105 1.156 equitysd2 970.870 103.879 1.124 9.346 .000 7.002 a dependent variable: average market cap abstract introduction literature study data and methodology results and discussion conclusions and suggestions for future work acknowledgements references footnotes about the author(s) dirk visser department of risk management, school of economics, north-west university, south africa gary van vuuren department of risk management, school of economics, north-west university, south africa citation visser, d. & van vuuren, g., 2018, ‘filter selection for countercyclical capital buffers’, south african journal of economic and management sciences 21(1), a1744. https://doi.org/10.4102/sajems.v21i1.1744 original research filter selection for countercyclical capital buffers dirk visser, gary van vuuren received: 09 jan. 2017; accepted: 27 sept. 2017; published: 12 apr. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: procyclicality plays a pivotal role in finance in both thriving and crisis periods. this influence stems not only from the way market participants behave but also from risk metrics used and regulatory capital amassed and released during bust and boom periods, respectively. the introduction of the regulatory countercyclical capital buffer aims to thwart procyclicality by accumulating (releasing) capital in upswings (downswings), subsequently reducing the amplitude of the financial cycle and promoting macroprudential stability. the timing of the accumulation and release of buffer capital is critical so identifying accurate indicators is important. aim: this paper applies a kalman filter to south african data and confirms the procyclicality of the basel committee on banking supervision (bcbs) proposal. setting: for south africa, studies suggest alternatives such as residential property indices because research has demonstrated that the bcbs proposal is procyclical rather than countercyclical. methods: this paper applies a kalman filter to south african data and compares the results obtained with those filtered using the hodrick–prescott filter. results: results indicate that buffer signals are dependent upon the filter employed. conclusion: buffer signals are strongly dependent upon the filter employed to detect procyclicality. the south african reserve bank and other regulators should reconsider the use of the hodrick–prescott filter and entertain the possibility of using the kalman filter instead. introduction the procyclical nature of financial markets is well documented as are the intrinsic procyclical characteristics of regulatory capital regulations prior to basel iii. several studies including heid (2003), gordy and howells (2004) and goodhart and taylor (2006) forewarn that the procyclical nature of regulatory requirements impede macroeconomic stability as these regulations force institutions to retain more capital in low-profit, liquid divisions when they may need to continue extending credit. this institutional behaviour and the inability of risk measurements to capture this phenomenon proved to be disastrous in the 2008/2009 financial crisis. conventional measures such as value at risk (var) and its successor, expected shortfall (basel committee on banking supervision [bcbs] 2013), do not account for procyclicality as these metrics are volatility-based measures that use procyclical historical data (these have no components which indicate the financial cycle’s position). the bcbs proposed the implementation of a countercyclical capital buffer (ccb) to promote the macroprudential goal of protecting banking sectors from periods of excess aggregate credit growth (bcbs 2010a, 2010b). these periods have historically been associated with the build-up of system-wide risk and the ccb thus aims to ensure institutions are not only solvent through stress periods but also able to maintain the flow of credit. research on the ccb since its introduction has been plentiful, but the metric has several indicator components that signal the retention of a ccb buffer as well as indicators that signal the buffer’s release. determining these signals has received significant interest, because, initially, the bcbs (2010b) only mentioned a one-sided hodrick–prescott (hp) filter1 in a footnote. use of the one-sided hp filter has been questioned (edge & meisenzahl 2011; kelly, mcquinn & stuart 2013; van vuuren 2012) because of the endpoint problem associated with the metric as well its sensitivity to changes or revisions of many macroeconomic variables such as gross domestic product (gdp) and inflation. hosszú, körmendi and mérő (2015) applied several univariate and multivariate filters to decompose the credit-to-gdp ratio into trend and cyclical components. their research finds a multivariate hp filter to be most effective as its endpoint uncertainty is the least, with the result that new data do not materially affect previous estimates too much. galati et al. (2016) apply a kalman filter2 to extract cycles from financial time series data for the u.s. and the euro area. they find that series including credit, credit-to-gdp and real house prices demonstrate medium-term cyclical behaviour and that the periodicity and amplitude of these cycles vary over time and between countries. they further find that, since the mid-1980s, u.s. financial cycles have increased in duration and amplitude whereas such conclusions cannot be made for the euro area. procyclicality research in south africa includes that of akinboade and makina (2009, 2010) in which the linkage between the behaviour of bank lending and business cycles in south africa is assessed. they found new mortgage lending to be countercyclical prior to 1993 and that bank lending and interest rates moved in tandem with business cycles. fourie, botha and mears (2011) attempted to determine the role banks play with regards to the amplification of business cycles and the subsequent macroeconomic impact. these studies did not, however, focus expressly on the credit-to-gdp gap. south african research on the credit-to-gdp gap and the ccb is increasing as its implementation is currently (2017) in a staggered implementation approach. van vuuren (2012) implemented both a single and a two-sided hp filter on south african data to illustrate the possible ccb capital charges under both approaches. burra et al. (2014) discussed practical considerations for the ccb in south africa as proposed in basel iii. they found several series including credit extension, advances to the domestic private sector and house prices to be positively correlated with gdp growth. however, the credit-to-gdp gap was found to be negatively correlated with gdp growth, suggesting that buffers would accumulate in downturns, thereby fuelling procyclicality rather than countering it. they affirm that accurate build-up signals remain; however, they were significantly weaker in the buffer’s release phase. bernstein, raputsoane and schaling (2014) applied a logistic smooth transition autoregressive model to assess the credit-to-gdp as the recommended common reference for ccb implementation. the authors found that the credit-to-gdp gap decreased when the economic cycle experienced upturns and vice versa and thus caution the use of this standard as a uniform or mechanical estimate of countercyclical south african capital buffers. the kalman filter – which was originally developed to provide aeronautical navigation – offers a different, but parsimonious and accurate solution to the problem of time-dependent variable estimation. the kalman filter enjoys the advantage of real-time application. time series observations are used to forecast future observations (as in most forecast applications), but in the kalman filter case the state variables (which define the forecast framework) are ‘optimal’, being determined via minimisation of the variance between prediction and observation differences by rapidly reacting to changing conditions. this makes the kalman approach to the problem of time-dependent variable estimation extremely practical to financial practitioners (see, e.g. jain, yongvanich & zhou 2011; thomson & van vuuren 2017). the kalman filter is a recursive procedure for computing the optimal estimator of the state vector at time t+1, based on information available at time t (arnold, bertus & godbey 2008; kalman 1960), which provides a linear estimation method for equations represented in a state-space form. estimation problems are transformed into state-space by defining state vectors. the kalman filter output is governed by two equations: a measurement equation and a transition equation. the measurement equation unites unobserved data (xt where t represents the time of measurement) and observed data (yt) by the equation, yt = mxt + vt, where e[vt] = 0 and the variance of the error term, var[vt], is known (rt). the transition equation describes the evolution in time of unobserved data, such that xt+1= axt + wt, where e[wt] = 0 and the variance of the error term, var[wt], is unknown (qt). the remainder of this paper proceeds as follows: literature study section explores the literature regarding procyclicality and the ccb from an international and south african perspective, respectively. the choice and extent of the data are explained in ‘data and methodology’ section as well as the mathematics of the various filters including the kalman filter. the logic behind how filters reduce signal variance when estimating unobserved moments is also discussed here. results obtained from analysis are illustrated and discussed in the fourth section and the last section provides the conclusions. literature study procyclicality the basel iii accord, which was introduced to address shortcomings of basel ii (recall that basel iii did not replace basel ii), places significant emphasis on reducing procyclicality through the introduction of several regulatory measures. subsequent guidelines by the bcbs address implementation and measurement considerations of these measures including the ccb. the bcbs identified procyclicality as one of the most destabilising elements with regards to the amplification of financial shocks in the banking sector throughout the 2008/2009 financial crisis (bcbs 2010a). procyclicality’s ability to act as a financial accelerator in both expansions and contractions lies in information asymmetries between borrowers and lenders (borio, furfine & lowe 2001). in distressed economic environments (where collateral values decline), even profitable borrowers struggle to find access to credit as institutions are more risk adverse and must retain more capital as suggested by procyclical regulatory capital models. in benign economic conditions, where credit extensions occur with fewer restrictions, institutions chase profitable positions as capital does not have to keep liquid reserves – thereby temporarily reinforcing the cycle’s upswing. borio et al. (2001) argued that the worst excesses of financial cycles can be mitigated; however, this requires the acknowledgement of increased risk in boom periods and that the materialisation of bad loans does not necessarily imply an increase in risk. measurement difficulties and biases have also contributed to the effects of cycle excesses and procyclicality. market participants often struggle to optimally assess how correlations between credit losses across borrowers and the financial institutions change over time (drehmann, borio, tsatsaronis 2012). this, along with other measurement complications, has led to short horizons and extrapolation of current conditions further into the future than possibly deemed appropriate (borio et al. 2001). complicated risk measurement techniques, market participant behaviour and existing regulatory capital have all contributed to the phenomena of procyclicality and are all being addressed in the drive to mitigate it. borio (2012) asserts that it is critical to rediscover the role of the financial cycle and its empirical features like procyclicality in macroeconomics as it is closely related to systemic crises. the financial crisis accelerated endeavours to mitigate procyclicality (van vuuren 2012), with regulators proposing changes to accounting standards, risk measurement practices and the conduct of monetary policy. further measures included the introduction of noncyclical probability of default proxies in internal rating models and the ccb to address the phenomena. countercyclical capital buffer basel iii’s countercyclical objectives attempt to dampen the cyclical effects stemming from minimum capital requirements as well as promote forward-looking provisioning. the build-up of capital buffers to be used in stress periods at individual bank and sector level aims to achieve a macroprudential goal of guarding the banking sector against periods and aftermaths of excessive credit growth (bcbs 2010a). drehmann et al. (2010) suggest that the ultimate goals for ccb schemes are twofold. firstly, the schemes should attempt to limit risk of large-scale strains on banking systems. secondly, the schemes should attempt to limit the banking system and its participants from amplifying economic (cycle) fluctuations. to achieve these closely related goals, the authors suggest desirable characteristics off a ccb scheme which include the following: correct implementation and timing appropriate size (the buffer should not impede growth) robust to capital arbitrage and manipulation internationally enforceable rules-based low implementation cost simple and transparent. drehmann et al. (2010) suggest that achieving all these features present significant challenges as fully rules-based schemes allow for no judgement of false signals. furthermore, making these schemes simple and transparent as well as internationally enforceable limits modelling-based measures. the top-down approach is preferred by the bcbs for ccb schemes because credit-to-gdp gap data are readily available for all jurisdictions, whereas this is not the case for bottom-up data. bottom-up data also produced substantial individual components, suggesting that differences in the values of bank-adjusted factors would be large even under periods of broad financial stability (drehmann et al. 2010). measurement techniques galati et al. (2016) assert that previous investigations into financial cycles and their statistical properties focussed on three approaches. firstly, attempts to identify turning points focussed on positions of peaks and troughs. claessens, kose and terrones (2011) rely on a classical3 definition of a cycle to analyse how business and financial cycles interact and the implications thereof. their data for housing, equity and credit markets and gdp from 44 countries accounting for 90% of global output are grouped into advanced and emerging economies. similar research by boshoff (2006) analyses the cyclicality of financial markets in relation to the cyclical behaviour of the south african real economy and identifies turning points for several domestic and international variables. both boshoff (2006) and claessens et al. (2011) rely on the fundamental methodological foundations produced by burns and mitchell (1946) for business cycle turning-point analyses. secondly, galati et al. (2016) suggest that statistical frequency–based filters include the hp filter, the baxter-king filter (1999) and the christiano and fitzgerald (2003) filter. these require prespecification of the range of cycle frequencies and thus are referred to as non-parametric filters. these have been increasingly interrogated and compared since the introduction of basel iii to determine superiority under different scenarios compared to the bcbs’s one-sided hp filter. international research for these filters are plentiful as the bcbs (in its guidance for national authorities operating the ccb [bcbs 2010b]) conduct analysis for several countries using a one-side hp filter. this was followed by several studies affirming or contradicting the use of a one-sided hp filter and other frequency-based filters. these studies include drehmann et al. (2010) and aikman, haldane and nelson (2015). south african research includes that of van vuuren (2012), who estimated the credit-to-gdp gap using both a oneand two-sided hp filter to illustrate the implications of ccb charges. unresolved questions include the lack of bcbs clarification on why a one-sided hp filter has been suggested and how the jurisdiction-wide measure will influence individual bank operations. a basel iii update has since clarified on how bank-specific ccbs can be calculated using their individual credit exposures (bcbs 2010a). finally, the third approach involves unobserved component time series models, which include the kalman filter. these have several advantages compared with non-parametric filters including no requirements regarding self-imposed, ad hoc parameters and the relaxation of the requirement for predetermined frequencies required to extract cycles. kalman filters function with non-normal data, a useful attribute because financial data commonly exhibit fat tails. these models also present more accurate estimations because model-based filter diagnostics can be used to validate models and estimate their goodness of fit. international research for the kalman filter include numerous studies analysing business cycles, that is, valle azevedo, koopman and rua (2006), koopman and azevedo (2008) and creal, koopman and zivot (2010); however, few have expressly focussed on financial variables. galati et al. (2016) attempted to measure financial cycles for the united states and the euro using a kalman filter and found that financial cycles are longer than business cycles and have higher amplitudes. extracting cycles from business failure rates, real gdp and credit spreads, koopman and lucas (2005) found comparable medium-term cycles for u.s. data. south african research on financial cycles using the kalman filter has not yet been conducted. a more dynamic, forward-looking buffer variation suggested by wong (2011a, 2011b) manipulates time series data through an inflator to produce increased capital requirements for both market and credit risk. the credit version of the author’s bubble var model further attempts to combine default and spread risk under a single risk measure, arguing that this measure lies between spread risk and the principal loss of the bond (total loss). the benefit of the wong’s (2011a, 2011b) methods is that they avoid timing issues of a ccb buffer currently faced by regulators and financial institutions. south african applications of wong’s bubble var methodology (and the performance thereof) have been conducted by visser and van vuuren (2018, in press). data and methodology data the data chosen were monthly nominal gdp and credit extended by all monetary institutions to the domestic private sector since 1965. these data are prescribed by the bcbs (2010b) and obtained from the reserve bank of south africa. from these data, growth rates were determined and the credit growth-to-gdp ratio determined. south african small residential price index data obtained from the bis are also used in a similar manner as the credit growth-to-gdp data (bis data 2016). south african data from january 1966 were used to determine the credit growth-to-gdp growth ratio as well as this ratio’s long-run trend. detailed examination of these data, using standard fourier analysis, indicates that they exhibit cyclical behaviour. this result is not unexpected because they comprise several macroeconomic components (such as the economic – or business – cycle), which are inherently cyclical. a fourier frequency analysis of these data indicate that the main component has a frequency of approximately 7 years: the duration of south africa’s business cycle, found previously (botha 2004) and confirmed in later studies (e.g. thomson & van vuuren 2016). using these macroeconomic data, the credit growth-to-gdp growth ratio was constructed as well as the long-run trend using both the one-sided hp filter and the kalman filter (figure 2). methodology hodrick–prescott filter a popular method of trend extraction from data is the hp filter. the hp filter was first introduced (hodrick & prescott 1981) in the context of estimating business cycles, but the research was only published in 1997 after the filter had gained widespread popularity in macroeconomics (hodrick & prescott 1997). the bcbs also chose the hp filter to de-trend relevant macroeconomic ratio data and thus extract the information required to evaluate excessive growth in economies. figure 1: monthly nominal percentage changes in gdp (grey line) and fourier-fitted cycle. the most prominent cycle has a frequency of 28 quarters (7 years). the hp filter has been criticised for several limitations and undesirable properties (ravn & uhlig 2002). canova (1994, 1998) agreed in principle with the use of the hp filter to extract business cycles (of average duration between 4 and 6 years) from macroeconomic data, but doubted the methodology for determining key parameter inputs. spurious cycles and distorted estimates of the cyclical component when using the hp filter were obtained by harvey and jaeger (1993), who argued that this property may lead to misleading conclusions regarding the relationship between short-term movements in macroeconomic time-series data. cogley and nason (1995) also found spurious cycles (and extreme second-order properties in de-trended data) when using the hp filter on difference-stationary input data. application of the hp filter to u.s. time-series data was found to alter measures of persistence, variability and co-movement dramatically (king & rebelo 1993). many of these critiques do not provide sufficient compelling evidence to discourage use of the hp filter. as a result, it remains widely used among macroeconomists for de-trending data, which exhibit short-term fluctuations superimposed on business cycle–like trends (ravn & uhlig 2002). the idea which on which the hp filter rests is that an observable macroeconomic time series (xt) may be decomposed into its long-run, non-stationary secular trend (τt) and a stationary residual, or cyclical, component (ct): neither the long-run trend nor the cycle is directly observable so de-trending approaches generally define these elements somewhat arbitrarily. the hp filter extracts the cycle by solving eqn (2), a standard-penalty programme: where the parameter λ controls the smoothness of the adjusted trend series, τt, that is, as λ → 0, the trend approximates the actual series, xt, while as λ → ∞ the trend becomes linear and the procedure converges to a standard least squares solution (yakhim 2001). the optimisation procedure in (eqn 2) maximises the fit to the trend of the series, that is, minimise the cycle component ct by minimising changes in the gradient of the trend τt. note that both τt and ct are unobservable and because ct is a stationary process, xt may be thought of as a noisy signal for the non-stationary trend τt. hodrick and prescott (1981) originally suggested an exogenous and subjective value of 1600 for the value of λ for quarterly data, but backus, kehoe and kydland (1992) proposed adjusting λ based upon the square of the frequency of observations relative to quarterly data. the relative frequency is 3 for monthly data and 0.25 for annual data, so the corresponding λs are 14 400 and 100, respectively. despite on-going research (e.g. marcet & ravn 2003; ravn & uhlig 2002), who derived endogenous values for λ by solving [eqn 2] as a constrained minimisation problem), the λs discussed above are still in common use (mise, kim & newbold 2005). the optimal value for λ for south african business cycle data was explored by du toit (2008), who argued that the optimal smoothing constant was that value of λ that least distorts the frequency information of the time series (in this case, λ = 254 for quarterly data were used to determine the south african business cycle frequency). drehmann et al. (2010) found λ = 1600 and λ = 25 000 performed poorly on historical data while, λ = 125 000 and λ = 400 000 performed well with quarterly data. the higher value of λ = 400 000 is considered important from a policy perspective as it provides both a greater range and more time when the indicator provides strong and reliable signals. the hp filtering procedure optimises the fit to the data series, but this optimality is based on the application of the filter to an infinitely long time series. for practical purposes, the estimation of the trend and cycle components works well for a moderately long series (mise et al. 2005), but at the end points the hp filter is demonstrably suboptimal. the two-sided, symmetrical filter applies large symmetrical weights to the end points of the observed values to determine the corresponding trend value (ley 2006) disproportionately distorting the filtered values at the most recent time (apel, hansen & lindberg 1996; baxter & king 1995; st-amant & van norden 1997). kalman filter the kalman filter (kalman 1960) is a bayesian updating scheme that maximises the likelihood of correctly estimating unknown parameter values (koch 2006). the filter addresses the general problem of determining the state [x ∈ ℜn] of a time-controlled, discrete process, which is governed by the linear stochastic difference equation: with a measurement [z ∈ ℜn]: the random variables w and v, which are assumed to be independent (i.e. 0 correlation between them) and normally distributed: represent process white noise and measurement white noise, respectively. in practice, the process noise covariance q and measurement noise covariance r matrices (here variance matrices because the correlation is zero) change with each time step. in this case, they are assumed to be constant (koch 2006) – a common assumption – and these values are obtained using maximum likelihood methods (tommaso & alessandra 2012). the 2×1 (in this case) state transition matrix, f, links the state at the previous time step t−1 to the current state at step t, assuming no driving function or process noise. the 2×2 control matrix b relates the optional control input u ∈ ℜl to the state x. the 2×1 matrix h in the measurement relates the state to the measurement zk. in practice, f and h might change with each time step, but here again they are both assumed to be constant. the mechanical process to be followed is given below: predict: project state 1 time step ahead: project error covariance 1 step ahead: update: compute kalman gain: update estimate with measurement: yt update error covariance: where is the estimated state, f is the state transition matrix (i.e. transition between states), u represents the control variables, b is the control matrix (i.e. mapping control to state variables), p is the state variance matrix (i.e. error of estimation), q is the process variance matrix (i.e. error caused by the process), y represents the measurement variables, h is the measurement matrix (i.e. mapping measurements onto the state), k is the kalman gain and r is the measurement variance matrix (i.e. measurement error). subscripts represent the following: t|t: the current time period t−1|t−1: the previous time period t|t−1: intermediate steps. for this analysis, let yt denote a vector that contains the time series values at time t, for t = 1,…, n. an unobserved components model comprises a trend-cycle decomposition: where is the value of the series at time t, µt is the long-term trend and ψt is a variable representing the dynamics of the underlying cycles. the residuals εt are assumed to be normally distributed with variance σ2. all components are unobserved and the kalman filter must be used to estimate them. two important decisions must be made regarding the assembly of yt. trend smoothness: that is, how much variable fluctuation is assigned to the trend as opposed to the cycle. galati et al. (2016) defined a general form of the mth-order trend as follows: where . the trend’s smoothness depends on the differencing order m, so as m increases, the trend becomes smoother. for m = 0, yt is stationary, for m = 1, yt is a random walk process and for m = 2, yt is an integrated random walk used in most macroeconomic time series (e.g. see koopman and lucas 2005; valle azevedo et al. 2006): where cycle stochastic process: using harvey’s (1989) approach, the cycle is modelled as a second-order autoregressive process. a trigonometric process is used to specify ψt: where , the frequency, is measured in radians and bounded by 0 ≤ λ ≤ π, the period of the stochastic cycle is 2π/λ and the persistence (or damping factor) parameter, f, is bounded by 0 < f < 1, which ensures that the cycle, ψt, is a stationary stochastic process. the disturbances are assumed to be uncorrelated and normally distributed with mean 0 and variance . the state-space forms of (12) through (19) are given below: where the state vector αt encapsulates the cycle and trend and the system matrices zt and tt contain the parameters from (12) through (19). the state disturbance vector, ηt contains the disturbances of the trend and cycle equations. it is at this stage that the kalman filter is invoked to determine the estimates of the unobserved components contained in αt. maximum likelihood methods are used to estimate the unknown variances of unobserved component disturbances, the persistence parameter, j, and the frequency parameter, λ. details of these estimations may be found in schweppe (1965) and koopman and ooms (2011). results and discussion although the credit-to-gdp gap is disputed with regards its appropriateness as ccb buffer indicator for south africa, the purpose of this paper is to primarily focus on the measurement technique of a ccb and then on the indicator variables. as it is recommended as a common reference guide by the bcbs, it is used as an investigation point of departure. figure 2 illustrates south african credit-to-gdp data and the long-term trend estimated with a one-sided hp and kalman filter, respectively. figure 2: south african credit-to-gdp, hodrick–prescott-filtered (λ = 144 000) and kalman-filtered series. the gap obtained using the kalman filter is smoother (flatter) than that obtained using the hp filter during low and stable credit-to-gdp ratios. in an increasing credit-to-gdp ratio environment, the kalman filter is more reactive than the hp filter and tends to accentuate the peaks and troughs to a greater extent. this is a critical difference between the two filters, the results from which affect the magnitude and timing of the capital buffer injection and release. the kalman-filtered trend series in figure 2 presents a smoother trend to that of the hp-filtered series up until the 1995. this affects the credit-to-gdp gap materially prior to and during the housing bubble of the 1980s. the kalman filter trend does not deviate significantly from the actual credit-to-gdp ratio for the asian crisis period suggesting that capital retention would be less under a kalman filter approach compared to the hp filter approach. both filters deviate substantially from the actual ratio before the onset of the financial crisis with the kalman doing so before the hp-filtered series. gaps from both approaches drive suggested buffer levels (figure 3). figure 3: south african credit-to-gdp gaps using the hodrick–prescott (λ = 144 000) and kalman filters. positive credit-to-gdp gaps are the focus in figure 3 as ccb buffers are only accrued in these periods where the gap exceeds 2%. the kalman-filtered series in figure 3 illustrates superior gaps in both the late 80s and the most recent crisis period. the hp-filtered gap exceeds the kalman with regards to capital requirements in the period associated with the asian crises. the capital charge add-on is affected by these elevated gaps (figure 4). figure 4: historical countercyclical capital buffer capital charge using the hodrick–prescott (λ = 144 000) and kalman filters. additional capital charges in figure 4 show dominance if derived using a kalman-filtered series up until 1980. this period preceding the house price bubble collapse in the early 1980s was characterised by high inflation in developed markets as well as a lack of confidence in the u.s. dollar (luüs 2005). this led to a surge in the gold price and positive spin-off effects on the south african economy. luüs (2005) notes that, in this period, 50% of south african export revenue could be attributed to gold. furthermore, increased household wealth as a result of a combination of increased incomes and income tax cuts improved liquidity conditions and reduced mortgage lending rates. subsequently, increased local and international political tensions as well as pressure on the balance of payments led to significant increases in mortgage lending rates. this ultimately caused the market to collapse and house prices to decline by 42% in real terms (luüs 2005). in the last decade of the 20th century the hp-filtered series increases additional capital by more than 2% – although only briefly. this is because of the long-term trend derived through the hp-filtered series (figure 2) being notably lower compared to the kalman-filtered, long-term trend. additional capital charges in the late 1990s are partially because of the lack of global demand for commodities as a result of the asian crisis and the severe depreciation of the south african rand in 1998. in the 2008/2009 crisis period, the kalman-filtered credit-to-gdp gap produces an elevated capital charge compared to the hp filter and also reaches the maximum add-on of 2.5% as prescribed by the bcbs. both metrics throughout this period illustrate a similar release rate of the buffer after the crisis period. applying the kalman filter to the small residential price index allows for the estimation of a small residential gap and subsequent capital charge based on a residential series (figure 5). this draws from burra et al. (2014) where it is found that the absa house price index for all sizes of properties is positively correlated with gdp growth, suggesting that ccb buffers would build up in prosperous periods. figure 5: south african small residential price index and kalman-filtered series. the south african small residential price index and its kalman-filtered, long-run trend in figure 5 illustrate how the south african residential market benefited from the pre-crisis global housing market boom. the subsequent crisis did not impact the south african market as severely as it did other countries’ housing markets: some of this may be attributed to the national credit act (nca) of 2005. this legislation along with other measures curbed reckless lending by financial institutions, partially protecting the quality of assets on intuitions’ books. figure 6 illustrates the gap produced from the difference between the actual index and the trend in figure 5. figure 6: south african small residential price index gap and fourier-fitted series. the south african small residential price index gap in figure 6 indicates the severe shocks of both the 1980s and the latest financial crisis on the residential market. the gap falls and remains negative for more than 2 years in the 1980s. in the recent crisis, the gap recovers more rapidly, however, relapses to turn towards the biggest negative gap in the observation period. these shocks are also prevalent in the credit-to-gdp gap in figure 3; however, there timing is different, indicating that the two measures will certainly provide different capital requirements at different periods (figures 9 and 10). figure 6 imposes a fourier fit to the residential price index gap to determine whether there is a cycle component for the purposes of cyclical capital requirements. figure 7 illustrates a frequency spectrum of south african small residential price index gap. figure 7: frequency spectrum for south african small house price gap. the spectrum in figure 7 illustrates that principal component has a duration of 85 months (corresponding to a 7-year cycle). the semi-cycle found at ±43 months is encouraging as the fourier analysis also detects semi-cycles, which suggests that the 85-month cycle is correct. this 7-year cycle further aligns with the findings of van vuuren (2012) for credit-to-gdp growth and botha (2004) and thomson and van vuuren (2016) for the south african business cycle. figure 8 illustrates the additional ccb capital requirements estimated using the residential gap and the bcbs ccb implementation suggestions. figure 8: small residential gap using the kalman filter and countercyclical capital buffer capital charge add-on. countercyclical capital buffer capital requirements are at a maximum three times in the observation period with two of these being associated with the respective crises mentioned. the bursting of the 1980s housing bubble occurred in 1984, and ccb capital requirement indicators begin as early as the late 1970s. this suggests that the measure might have had the ability to impose countercyclical capital effectively in the years building up to the crisis. this is similar in the latest financial crisis with ccb capital imposed as early as the year 2000 up until mid-2007. figure 9 illustrates additional ccb capital charges calculated for both the credit-to-gdp gap and the residential gap using the kalman filter approach for trend extraction. figure 9: countercyclical capital buffer capital charge add-on for credit-to-gdp and housing index series using the kalman filter. the ccb charge requirements differ significantly for the two series analysed with the credit-to-gdp gap raising no ccb requirements for the pre-crisis period of 1980. the residential price index does, however, increase the ccb requirement to its maximum allowable threshold for almost 5 years prior to the crisis. the residential index further solely suggests a ccb between 1990 and 1995, this is because of political uncertainties and an exodus of professionals placing significant pressure on the housing market. the investigation of signals like these is of utmost importance as they may not be appropriate for ccb indications, particularly if signals are isolated to their sector and not applicable to the entire banking or financial sector. the pre-2008 crisis period shows significant ccb retentions if the measure is based on the residential price index, suggesting that it would have been countercyclical in the pre-crisis period potentially countering excessive credit growth. the ccb measure based on the credit-to-gdp gap also indicates maximum capital retention, however, in the crisis period. this aligns with research of burra et al. (2014) and bernstein et al. (2014), cautioning regarding the use of the credit-to-gdp gap as an indicator for the ccb. figure 10 focusses solely on the most recent financial crisis comparing the credit-to-gdp gap and the residential property price gap, both estimated using the kalman filter and hp filter, respectively. figure 10: countercyclical capital buffer capital charge add-on for credit-to-gdp and housing index series using the kalman and hp filters preand during the credit crisis. hp, hodrick–prescott. figure 10 illustrates that the residential price index would have suggested a ccb long before the onset of the crisis. suggesting stringent buffer requirements from the onset of the millennium might have been too severe and would potentially have hindered economic and financial market growth. the superiority of the kalman filter over the hp filter cannot be concretely established for the buffer (estimated using the residential price gap) as buffer-retention signals leading up to 2003 are similar. the buffer’s release signal under the kalman filter approach is more rapid: this should be further explored in future research. the credit-to-gdp gap buffer estimated with the kalman filter for the crisis period is more conservative compared to the buffer estimated with the hp filter. the kalman filter–estimated buffer reaches the maximum prescribed 2.5% and maintains it throughout the crisis period, eventually diminishing along with the hp-filtered buffer. the accumulation of the buffer also begins a few months prior to that of the hp-filtered approach and may have countered procyclicality and acted as a warning signal. conclusions and suggestions for future work procyclicality is not isolated to one element of a financial market or economy; it emerges because of the combination of several elements including regulatory requirements and market participant actions. the identification and isolation of a single metric which captures all relevant features of procyclicality is unlikely: regulators and financial institutions will have to identify the optimal measures and variables that describe its effects in order to attain macroeconomic stability. the ccb was introduced to limit the effects of procyclicality, but several aspects need to be considered. these include retention and release signals as well as techniques to determine these signals with appropriate variables. the information used in setting the ccb must capture upand downswings inherent in the financial cycle. the development of system-wide risks is associated with the buffer’s build-up phase while financial contractions correspond to the buffer’s release phase. doubts have been expressed about a single measure reliably capturing both the build-up phase and the release phase: robust leading-indicator properties are required for the former and a reliable contemporaneous indicator is required for the latter, as pointed out by drehmann et al. (2010). in addition, a good proxy for the build-up phase should vary considerably from its long-run trend during the build-up phase (a feature which would rule out non-performing loans – bounded at zero – e.g. and would limit the information content of credit spreads). credit spreads, however, would provide much useful information about release phase timing (chen & christensen 2010). indicators may provide more useful information in combination than in isolation. borio and drehmann (2009) showed that aggregate credit growth and real estate prices jointly contain more predictive information about future financial crises than either in isolation. if adequately implemented, the chosen metric (or metrics) has the potential to reduce the financial cycle amplitude and thereby, potentially, reduce all (or the majority of) credit risk in the financial cycle. the metric may thus lead to a reduction in credit risk regulatory capital: the relationship between the two capital requirements is yet to be fully explored. this paper applies a kalman filter to the bcbs-prescribed and other financial variables to determine the appropriate signal for the implementation of the ccb. results indicate that for different crises, results obtained from the kalman filter and the one-sided hp filter suggest substantially different signals – excluding for the most recent crisis (where the results are similar). this paper corroborates the findings of other studies which find that the credit-to-gdp gap would likely fuel procyclicality rather than dampen it (e.g. borio et al. 2001; creal et al. 2010; koopman & azevedo 2008) for south africa if employed as a sole measure. the small residential price index gap identifies countercyclical signals that would have suggested full ccb retention for substantial periods prior to historical crises. this emphasises that, although the metric used to calculate signals is important, the variable used to calculate these signals is a critical input as the incorrect one may fuel procyclicality. the south african reserve bank (sarb) suggested that it would still use the credit-to-gdp as a principal indicator for the ccb; however, it further asserted that it would use other indicators in conjunction with the credit-to-gdp gap (sarb 2015). future research opportunities include an investigation into how the kalman filter approach performs in conjunction with other variables that have been found to be more suitable for ccb buffers in south africa than the credit-to-gdp gap. work may also focus on buffer-release signals and how measures such as the kalman filter recognise these occurrences. a combination of models that avoid timing issues such as wong’s (2011a) buvar model and filter-based approach also present future research opportunities. solutions to such an approach would be of considerable value to regulators and financial institutions in resolving their current (2017) dilemma regarding ccb timing issues. in addition, we note the possibility of ultimately incorporating machine-learning into the processes described here. machine-learning and artificial intelligence (ai) are already widespread in the financial industry and pattern identification – on the skill and timeliness of which this paper is based – is ideally suited to ai applications. thus, it is probably only a matter of time before ai is used for cyclical identification and thus mitigation. it could be argued that embracing ai has thus been proposed in this paper because the kalman filter is, effectively, a bayesian variance-reduction tool, a fundamental building block of machine-learning. acknowledgements competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions d.v. is the principal author and analyst. g.v.v. is responsible for filter design and implementation references aikman, d., haldane, a.g. & nelson, b.d., 2015, 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african journal of economic and management sciences 15(3), 309–324. https://doi.org/10.4102/sajems.v15i3.235 visser, d. & van vuuren, g., 2016, ‘trading book risk metrics: a south african perspective’, south african journal of economic and management sciences 19(1), 118–138. https://doi.org/10.17159/2222-3436/2016/v19n1a8 visser, d. & van vuuren, g., in press, ‘procyclicality tradeable credit risk: consequences for south africa’, south african journal of economic and management sciences 21(1). wong, m., 2011a, ‘credit buvar: asymmetric spread var with default’, journal of risk management in financial institutions 5(1), 86–95. wong, m., 2011b, ‘market buvar: a countercyclical risk metric’, journal of risk management in financial institutions 4(4), 419–432. yakhim, y., 2001, business cycle fluctuations and the hodrick–prescott filter, viewed 23 january 2011, from http://www.bgu.ac.il/~yossiya/teaching/macro_graduate/ln1_bc_hpf.pdf footnotes 1. see data and methodology section. 2. see data and methodology section. 3. a classical methodology focuses purely on changes in the levels of economic activity and not on the fluctuations of these activities around their long-term trend. sajems ns vol 2 (1999) no 2 308 a note on the effects of public finance on the economy eui-gak hwang korea university, seoul and visiting professor, university of pretoria 1999 abstract this note attempts to measure the effects of aggregate government expenditure on gnp growth and monetary policy in a growing economy. a version of the standard st louis model is used for empirical estimation. related effects were also estimated by means of south korean data for the period 1970-1988. the findings, inter alia, support the position that government bondholding is regarded as an asset, not a future tax burden. jel e 63 introduction most developing economies experience that they are mostly on the short side of resource availability. in other words, the demand for public investment for economic development exceeds the supply of tax revenue. foreign resources and trade also play an important role in financing economic development. however, here we simply choose to set aside the functions of toreign resources and trade in order to solely look into the role of public finance in economic development. most ldcs mainly depend upon domestic resources for their development. two important domestic means of filling the savings gap are inflation tax and deficit financing. extensive studies have shown empirical evidence for some latin american and asian countries that suggested positive and significant correlation between money supply and real output growth between 1959 and 1966. it is indeed tempting for the deficit-stricken ldcs to resort to inflation as a major "tax" to finance their public expenditure to promote economic development, particularly when the tax revenue as a proportion of the gross national product is low and tax elasticity with respect to income is not always greater than unity. given certain demand-for-money assumptions, inflation can raise revenue. the practice of the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 309 sajems ns vol 2 (1999) no 2 government gaining real revenue from inflation has a long history. the normal procedure today is for the government to finance some of its spending by selling government bonds to the central bank., while the central bank pays for the bonds with newly printed currency. this procedure results in an increase in prices. a high rate of inflation tends to exert a negative influence on real income growth by distorting the efficient allocation of resources. it must also be noted that many ldcs experience significant inequalities in the distribution of income and inflationary financing, which often tends to redistribute income in favour of protits rather than wages, which may deepen existing inequalities. of course, it may be argued that even if inflation promotes more inequality, it tends to raise the profit share and thereby the saving ratio in national income, and this could have a beneficial effect on growth. it is however highly inconclusive whether a higher profit share or higher consumption, due to more equal income distribution, would have a more favourable effect on growth in the ldcs. mundell (1965) illustrated the relationship between inflation and economic growth by using the basic quantity-theory equation. subsequently, many studies on the issues of both government revenue from inflation and the welfare cost of inflation have been made (baily, 1956; friedman, 1971; barro, 1972; mckinnon, 1973). this note attempts to empirically evaluate, firstly, the effects of aggregate government spending on the economy and, secondly, of deficit financing on the welfare of the public. empirical analysis public tinance policy is closely related to the big trade-otf between efficiency and equality which became an important part of the economic lexicon with the publication of arthur okun's book, equity and efficiency, in 1975. the first question has been widely pursued in the well-known controversy between the keynesian multiplier approach and the monetarist assertion that fiscal expansion policy only ends up with crowding-out effects. all positive and normative aspects of the effects of government taxation and expenditure on the economy constitute an important topic of macroeconomic research. welfare effects of taxation as well as alternative forms of public spending need to be analyzed in an overlapping-generations model framework. however, we explore only a simple relationship between government fiscal policy and the aggregate economy in south korea using quarterly data for the period 1971-1988. the reason for choosing this observation period is that at the time korea depended most heavily upon deficit financing for her economic development. to obtain a r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol2 (1999) no 2 310 simple elasticity estimate of the effects of aggregate government spending on gnp growth, the following standard st louis model was used: • 4 .i j j y, a+l p,m,-,+l o,gt-i+ et (i) ;=0 1=0 . where y mi . g real income growth rate after seasonal adjustment growth rate of money supply (m i ) growth rate of total money supply (m 2 ) growth rate of total liquidity emj) growth rate of aggregate government spending, that consists of consumption and investment expenditure of central government et white noise the estimated results are given in table i. table 1 regression results of equation (1) with different m~ 1971 (i) -1998 (iv) ,wi ml m., 0., 0.0532 0.0324 0.0151 po 0.1646 -0.5099 -0.2487 ....... pi -0.1316 0.6599 0.1449 p, 0.3291 0.1177 0.1638 p, -0.0867 0.7050 0.3306 ii, 0.1957 -0.4796 0" 0.1348 0.1609 0.1249 0, 0.0827 0.1038 0.1130 oj 0.0277 0.0224 0.0700 d, 0.0768 0.0448 0.0966 rl 0.7242 0.718292 0.6060 rmse 0.0551 0.0556 i 0.0645 dw 0.9170 0.9640 0.6730 notes: rmse root mean square error; dw == durbin-watson statistics r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 311 sajems ns vol 2 (1999) no 2 the long-term effect of government spending on gnp growth rate is 0.322 compared with 0.3092 of money supply cu'i ) while the elasticity coetlicient tor government spending is 0.3319 compared with 0.4931 of total money supply (m:!). this shows that government spending is more effective than monetary policy when m, is considered, but less effective when m2 is taken into consideration. the drawback with the equation lies in an identification problem, because the regression relationship of income growth on both government expenditure and money supply does not explicitly explain whether it is a demand equation or a supply equation. furthermore, the equation does not take account of the negative ettects of taxes on income. therefore, an index is derived explicitly to consider the net demand effects of government fiscal policy, following the rutaro komiya and kazuo yasui (1984) model. adgx =gx -tx(i-~i) where adgx (;x tx n.') ni net demand effect of the government sector government consumption and investment expenditure direct plus indirect taxes national saving national income (2) the approximate effect of the government sector on aggregate demand can be tound from the annual percentage change rate of the index. the net demand effect of government expenditure fluctuates with each peak recorded in 1972, 1975, and 1980, and has remained on a steady slow growth path since 1983. (this can easily be seen if we calculate percentage changes of adgx over time tor the 1970-1988 period). a set of simple regressions are computed to check the causal relation between government expenditure ( gx ) and net demand effect ( adgx). the correlation coefficient of adgx on gx is estimated to be 0.65, showing that a unit change in gx results in a marginal increase of 0.65 unit of adgx. additional results were obtained for the relationships between the growth rate of government spending (gxr) and the consumer price inflation rate (cl'lil) , between the growth rate of government spending (jxr) and interest rates (jrr), and between government spending (gx) and gnp as well as exports (export): 1. adgx -226.422 + 0.65007 gx (3.812 (89.160) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajemsns vol 2 (1999) no 2 312 2. cpir= 1.7496 + 0.4418 gxr r2=o.6263 (0.756) (5.338) 3. irr 10.7583 + 0.13895 gxr r2=o.2279 (6.202) (2.240) 4. gnp = -3582.37 + 6.1686 gx r2=0.9637 (-1.324) (21.238) 5. export = -846.5196 + 2.6447 gx r2=0.9178 (-0.473) (13.773) figures in parenthesis are all t statistics. table 2 statistics used for the derivation of adgx· (billions of won) cxc cxx tx ni ns adgx 1970 263.4 141.2 280.1 2355.9 510.7 185.2 1971 344.0 153.8 251.1 2887.7 556.9 214.4 1972 425.3 151.0 362.0 3574.3 734.2 288.7 1973 451.7 162.4 428.1 4549.5 i 233.5 302.1 1974 734.3 205.1 696.8 6415.7 1565.6 412.6 1975 i 121.1 338.2 949.6 8408.7 1865.5 720.4 1976 1520.6 429.7 1317.7 11418.2 3451.3 1030.9 1977 1919.1 623.0 1634.8 14568.9 5017.1 i 470.3 1978 2501.2 921.3 2224.8 19637.9 7331.0 2028.2 1979 3059.4 1323.0 2998.4 24898.9 8928.5 2 1980 4386.6 29176.8 8702.5 3 1981 5515.0 35994.4 10627.4 4363.3 1982 6254.7 40758.7 13062.1 5 182.1 1983 6851.9 47790.2 17343.3 5841.4 1984 7262.6 54469.3 20996.1 6557.0 1985 60755.1 23037.7 7356.9 1986 70645.2 30321.6 8350.3 1987 82 113.0 39006.2 9708.3 1988 96408.0 47 132.5 11493.3 ·cxc = government consumption expenditure; cxk = government tlxed capital formation; tx direct and indirect taxes; nl = national income; ns national saving; adgx gx tx(1 ni) where gx = cxc + cxk. (sources: bank of korea, national income statistics, various issues; economic statistics yearbook, various issues.) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 313 sajems ns vol 2 (1999) no 2 lastly, the welfare (or wealth) effects of government deficit financing were explored by regressing total private consumption expenditure (pct) on sets of explanatory variables including permanent income (y), private assets value (w), social insurance assets (sw), government expenditure (g), taxes (t), and government bonds outstanding (d). the hypothesis for this analysis is based on the government budget constraint equation, that is, g-t == db+dm, where g is government expenditure and t government tax revenue. if g-t >0, then there is a government budget deficit, which must be financed either through additional bond issue (db) or a change in money supply (dm). assuming no inflationary revenue financing, that is dm=o, bond issue financing (db) mayor may not have an effect on the real sector. as briefly discussed in the beginning of this note, keynesians emphasize the short-run direct ettect of public bond financing on real income, but monetarists argue that the wealth effect of government bonds will increase the demand for money by private wealth holders, which in tum increases interest rates, thus resulting in crowdingout effects of government expenditure by a fall in private investment. how much does the amount of government bonds outstanding affect private-sector wealth? a cochrane-orcutt estimation method applied to a somewhat modified version of the blinder-solow model (1973) for korean data, produced the result that government bonds had had about a 48% wealth effect on the aggregate consumption function estimate, while it influenced 58 per cent of the wealth ettect on per capita consumption function estimation. the outcome implicitly explains that government bondholding is regarded as an asset instead of a future tax burden more vividly by each individual than by consumers as a whole. keeping such a priori net asset ettect of bonds in mind, the regression analysis of total private consumption expenditure on explanatory variables produced the following equation tor the period 1971-1988 in south korea: in c 1.648 + 0.730 in y + 0.122 in w 0.596 in sw (1.72) (6.60) (1.56) (1041) + 0.127 in g 0.125 in t + 0.346 in d (1.46) (1041) (1.31) r" = 0.990; dw = 1.60 the facts that an empirical testing of the marketability of government bonds featured about 48 per cent in the aggregate consumption function and about 58 per cent in the individual consumption function, and that the marginal consumption expenditure (c) with respect to change in government bonds r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 314 outstanding (d) showed a positive elasticity of 0.346, well explain the significant existence of the net positive relationship between the amount of government bonds outstanding and its net wealth effect in south korea. suggestion for furmer research this note has very briefly dealt with the effects of aggregate government spending on the economy as well as of deficit financing on the wealth of the public. the results give us some macro level conclusions as expected, but more micro-level studies need to be attempted. for example. it would be interesting to check the effects of both inflationary and non-inflationary deficit tinancing on economic development and growth. this can easily be done by regressing the gdp growth rate on a set of relevant explanatory variables, particularly on the deticit financing and inflation tax variables. such an attempt may well be made for south african data, too. references i. baily, m.1. (1956) "welfare cost of inflationary finance", journal of political economy, september/october. 2. barrow, r.i. (1972) "inflationary finance and the welfare cost of inflation", journal of political economy, september/october. 3. feldstein, m. (1956) "welfare cost ofintlationary finance", journal of political economy. september/october. 4. friedman, m. (1971) "government revenue from intlation", journal of political economy, julyl august. 5. hwang, e.g. (1993) the korean economies. a comparison of north and south, clarendon press oxford, 146-188. 6. mckinnon, r.1. (1973) money and capital in economic development, brookings institution, washington, d.c. 7. mundell, r. (1965) "growth, stability and inflationary finance", journal of political economy, marchi apri i. 8. komiya, r. & yasui, k. (1984) "japan's macroeconomic performance since the first oil crisis: review and appraisal", carnegierochester conference series and public policy, no 20, amsterdam. north-holland. 9. kormendi, r.c. (1983) "government debt, government spending, private sector behaviour", american economic review, 73: 994-1010. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction theoretical approach and literature review methodology data and the selection of the variables results conclusion acknowledgements references appendix 1 footnotes about the author(s) talita greyling school of economics, university of johannesburg, south africa citation greyling, t., 2018, ‘internet access and its relationship to subjective well-being in a developing region’, south african journal of economic and management sciences 21(1), a1841. https://doi.org/10.4102/sajems.v21i1.1841 original research internet access and its relationship to subjective well-being in a developing region talita greyling received: 21 mar. 2017; accepted: 22 aug. 2017; published: 28 feb. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract internet access has been shown to play an important developmental role and internet access to all people has become an international goal. this is also true for south africa where the ‘south africa connect’ policy was introduced in 2013. the question arises whether internet access goes beyond meeting developmental goals to improving the subjective well-being of people. furthermore, if the association between internet access and subjective well-being vary between different race and age groups. previous research was performed in developed countries at a national level or for specific small subsamples, like the elderly; however, this study contributes to the literature by analysing a substantial sample, at sub-national level, in a heterogeneous, unequal society, in a developing country. the benefit is that heterogeneities masked in studies at a national, macro level are highlighted in a study at a sub-national, micro level. this article investigated the relationship between subjective well-being and internet access within a developing region with a heterogeneous, unequal society. the article used a data set representative of the gauteng population, the economic centre of south africa, which was collected in 2013 by the gauteng city region observatory. to analyse the data, ordered probit, ordinary least square and instrumental variable regression techniques were used. the results show that internet access is positively related to subjective well-being and this relationship holds across all race groups and all age groups, from 18 years to over 65 years of age. in addition, it seems that the stark inequalities between race groups present in south africa are fading among younger generations. based on the results, the ‘south africa connect’ policy, which aims to give internet access to all people, including those in gauteng, the region analysed, is supported, as it not only contributes to the development of the region but also to the life satisfaction of the citizens. introduction this article examines the association between modern information and telecommunication technologies (icts), in particular the internet and subjective well-being. subjective well-being1 can be defined as a person’s cognitive and affective evaluations of his or her life (diener & ryan 2009) and is typically measured by a subjective measure of global life satisfaction or happiness (andrew & withey 1976). in recent years, ict has been shown to be an important and positive contributing factor to the development of a country (united nations 2001b; world bank 2016). the human development report of 2001 (united nations 2001b) and the recently published world development report 2016 on digital dividends (world bank 2016) note that technological advances enhance human capabilities such as a healthy life, knowledge, creativity and participation in the social, economic and political life of a community and impact on economic growth through productivity gains. based on the knowledge that ict, and specifically internet access, enhances development, many high-profile initiatives have been undertaken to increase awareness of the benefits of ict investment and to promote policy measures for the deployment of telecommunications infrastructureand the diffusion of ict. notable examples of these projects include the digital opportunities task force (dot force) (g-8 2000) of the eight industrialised countries (g-8), the world economic forum (wef) global digital divide initiative (gddi) (2002) and the world information technology forum (witfor) established by the international federation of information processing (2003), the establishment of the united nations ict task force (2001a), which to developing countries has a broader legitimisation than other initiatives. in south africa, the contribution of internet connectivity to development is also recognised, as is revealed by the electronic communications act 2005 (act no. 36 of 2005), through the implementation of south africa’s broadband policy, known as ‘south africa connect’ (republic of south africa: department of communications 2013). this policy gives expression to south africa’s vision in the national development plan (national planning commission 2012) of ‘a seamless information infrastructure by 2030’ (rsa 2011). ‘south africa connect’ aims to provide all south africans access to broadband services that have a minimum speed of 10 megabits per second by 2030. however, the question that arises, and is addressed in this article, is whether internet access, although found to be positively associated with development, also positively contributes to a person’s own evaluation of his or her well-being. research on the association between internet access and subjective well-being has been carried out; nonetheless, some limitations in these studies are evident. previous studies either considered small samples of specific individuals such as the elderly (cotten et al. 2012) or adolescents (gross, juvonen & gable 2002), or did analyses at a national level (pénard, poussing & suire 2013), which masks the heterogeneities found at sub-national levels. furthermore, previous research focused on developed countries such as luxembourg (pénard et al. 2013) and various other european countries (kavetsos & koutroumpis 2011), with limited research in developing countries. these limitations of previous research are addressed in this research paper by analysing a substantial sample of individuals at a sub-national level in a developing country across different race and age groups. the sub-national region in question is the gauteng province, the economic centre of south africa. it is one of the nine provinces of the country and hosts 22% of the population of 53 million people (statistics south africa 2015b). it is well suited for a study of this kind because of its diverse and heterogeneous population. segregated development of race groups, prior to the establishment of a democracy in 1994, led to a very unequal distribution of income2 (van der berg 2011), with the biggest proportion of black people and mixed race people in the lower income groups and white people, indian people or asian people in the higher income groups. the age distribution in the region is also skew with a disproportional number of youths under the age of 25, which creates its own challenges, such as a high youth unemployment rate3 of 40% (statistics south africa 2015a). to address the research questions, i analyse a cross-sectional survey data set collected in 2013 by the gauteng city region observatory (gcro) (2013), making use of probit-, ordinary least square (ols) and instrumental variable regression (ivr) techniques. the results of the study show that a positive and statistically significant relationship exists between the internet variables and subjective well-being. similar results are found in the analyses within different race and age groups. the only exception is for the internet home variable, which was not statistically significant for respondents over 65. the rest of the article is structured as follows: the ‘theoretical approach and literature review’ section shortly gives the theoretical underpinnings of the subjective well-being literature and reviews the literature pertinent to the current study. the ‘methodology’ section sets out the methodology. the ‘data and the selection of the variables’ section describes the data and the selection of the variables. the ‘results’ section reports the results and the last section concludes the article. theoretical approach and literature review theoretical approach according to diener et al. (1999), there are two main theoretical approaches to explain the differences in individuals’ subjective well-being. the first approach pertains to external (bottom-up) factors and is related to what wilson (1967) describes as ‘the fulfilment of needs’ theory. the second approach refers to personal or internal (top–down) processes within individuals where, for example, personality explains differences in perceived subjective well-being (diener et al. 1999). the majority of the empirical research pertains to the first theoretical approach. the results in these studies show that desirable events increase subjective well-being, whereas undesirable events decrease subjective well-being (stallings et al. 1997). it is this theoretical approach adopted in this article. from the abovementioned, it can be deduced that if the internet experience is a desirable event, it should increase subjective well-being, but if it is undesirable, a decrease in subjective well-being is expected. theoretically, there are a few plausible reasons to describe internet use as a desirable event, for example, its use to communicate with friends and family (facebook) or for leisure (to watch movies) (franzen 2003). it might be described as an undesirable event if its use leads to addiction or isolation (li & chung 2006). subjective well-being (life satisfaction) in recent years, there has been a proliferation of studies on subjective well-being focusing on the measurement and determinants of the concept (for a summary of the findings in the subjective well-being literature, see diener et al. (1999) and graham (2009) among others). on the measurement of subjective well-being, the studies conclude that subjective assessments of well-being are meaningful and valid indicators of welfare and that they provide a more holistic picture than traditional objective indicators, such as income or consumption (diener & seligman 2004; frey & stutzer 2010). to measure subjective well-being, a question, such as ‘how satisfied are you with your life as a whole?’, is asked, of which the response categories vary between very satisfied and very dissatisfied (andrew & withey 1976; diener & suh 1997). in this study, this type of question is used to assess the subjective well-being of the respondents. regarding the determinants of subjective well-being, the results of the studies reveal a number of standard variables found to explain life satisfaction and which are seldom omitted in estimation functions. these determinants hold across countries and across time. the variables include health (diener & seligman 2004), income (relative income) (easterlin 1974), marriage (diener et al. 1999), gender (verme 2009), age (blanchflower & oswald 2008), employment (verme 2009), education (witter et al. 1994) and race (fontaine & yamada 2014). in general, the results show that being healthy, having a partner or being married (clark & oswald 2002), being female, not being in your middle ages, between 35 and 50 years, having higher levels of education and being white, in the south african context (posel & casale 2011), lead to higher levels of life satisfaction (diener et al. 1999). some studies have also shown that being widowed or divorced is negatively associated with subjective well-being (graham 2009). other variables that also frequently appear to be statistically significant in explaining subjective well-being are the number of children in a household (there is no consensus on the relationship to life satisfaction), time spent with family and friends (positive), political ideology (higher levels of democracy increase life satisfaction), freedom of choice (positive), societal trust (positive) and religion (positive) (helliwell 2003; verme 2009). in this study, the standard variables found to explain subjective well-being are used as control variables to estimate the subjective well-being of the surveyed population. internet access and subjective well-being the literature on internet access and subjective well-being can broadly be divided into three groups: (1) literature that investigates the direct relationship between internet access and subjective well-being, (2) literature that investigates the indirect relationship via social media and (3) literature that looks at the relationship between the purpose and duration of use of the internet and subjective well-being. in this study, i only review the most relevant literature that pertains to group 1. (for readings on the other groups of literature, see mitchell et al. (2011), muusses et al. (2014), nie et al. (2017), sabatini and sarracino (2014) and wickramasinghe and ahmad (2013), among others.) by far the majority of the studies that investigated the direct relationship between internet access and subjective well-being found a positive association; nevertheless, the reader is reminded that these studies were mostly undertaken in developed countries and the question if this relationship holds in heterogeneous regions in developing countries is still unanswered. in the study of kavetsos and koutroumpis (2011) using pooled cross-sectional data for european countries, it was concluded that having a fixed or mobile phone, music players, personal computers and internet access at home is associated with higher levels of subjective well-being. the study of pénard et al. provides similar conclusions using luxemburgish data extracted from the european value survey. the study finds that non-users are less satisfied with their lives than internet users. moreover, their results show that the positive influence of internet use is stronger for younger users or those not satisfied with their income. cotten et al. (2012) furthermore reveal that internet access not only improves subjective well-being, but also reduces depression among older retired americans over the age of 50 years. a recent study by ganju, pavlou and banker (2016) reaffirmed the pre-mentioned results. they investigated the role of ict (number of fixed telephones, internet and mobile phones) on the subjective well-being of countries. to measure the country-level subjective well-being, they used the gallup world poll data and for ict data, they used the world bank database. the study argues that ict can improve the subjective well-being of people by developing their social capital, by achieving social equality, enabling access to health-related information and health services, providing education to disadvantaged communities and by facilitating commerce. their results reveal that the level of ict use in a country is statistically significant and positively related to subjective well-being. furthermore, they find that less developed countries increase their levels of well-being with primarily mobile phones, while more developed countries increase their levels of well-being with any of the ict systems. building on the subject of internet use and subjective well-being, pierewan and tampubolon analyse the relationship before, during and after the financial crisis in europe. they use the four waves of the european survey, from 2004 to 2010, in their analysis and a multi-level model to understand how contextual factors explain individual well-being. they find that before the financial crisis, internet use was not associated with subjective well-being, but during 2007 and thereafter a positive relationship was found. in the only study found to include countries from sub-sahara africa, graham and nikolova (2013) report, using data from the gallup world poll, that subjective well-being is higher in countries with higher levels of access to the internet and mobile banking than in countries with limited access; however, in these countries, increased levels of anger and frustration are also reported (graham & nikolova 2013). methodology the generic model estimated in this research article is as follows: where yi represents the life satisfaction of individual i, interneti refers to internet access of the same individual (i), xi is a vector of demographic and economic variables and έi is the error term capturing all variances in the dependent variable not explained by the model. as life satisfaction, the dependent variable specified in the model is ordinal of nature, the appropriate estimation technique is either an ordered probit or an ordered logit model (wooldridge 2010). as the method, ordered probit, is favoured in the subjective well-being literature (see, among others, bartram 2013; mackerron 2012; posel & casale 2011), this is the method of choice in the current study, although all models are also estimated using ols. the choice of ols is based on the findings of ferrer-i-carbonell and frijters. their findings show that the estimated coefficients, using ordered probit and ols, are often similar in signs and levels of statistical significance, with the difference that ols-estimated coefficients are directly interpretable in contrast to ordered probit’s estimated coefficients4 (ferrer-i-carbonell & frijters 2004). furthermore, as endogeneity is often an issue in the estimation of human behaviour, i also estimate the specified functions using ivrs. to find an adequate instrument for internet access, thus a variable that is exogenous, which is uncorrelated with the error term and sufficiently strongly correlated with the endogenous variable, was a challenge and the options of variables to instrument internet access were limited. i considered the possibilities and found ‘having a laptop’ the preferred choice, as it is strongly correlated to the internet access variables (rs > 0.5) and not highly correlated to the ‘life satisfaction’ variable (rs = 0.15). i ran diagnostics on all estimated regressions. data and the selection of the variables data a cross-sectional survey data set, collected by the gcro in 2013 (gcro 2013) and made available in 2014, is used in all analyses. it includes, among others, objective and subjective measures of the different dimensions of quality of life and questions referring to internet access, which makes it ideal for the current research. the sample is representative of the gauteng population aged 18 years and older and includes 27 490 respondents in the 10 municipalities of gauteng (geospace international prepared for the gcro 2014). in the current study, the secondary research question relates to analyses per race and age groups: four different race groups are defined in the data set including black people, white people, mixed race people and asian people or indian people (table 2). to divide the sample according to age groups, i recoded the age variable into four categories: under 20, younger adults from 20 to 39, which are by far the biggest group, older adults from 40 to 64 and respondents of pensionable age from 65 and older (table 1). table 1: race and age groups in gauteng. selection of variables life satisfaction to measure subjective well-being, i followed the standard practice (see andrew & withey 1976) and used the survey question related to life satisfaction. the question is: ‘how satisfied are you with your life as a whole these days?’ the respondents have five options to choose from, ranging from very satisfied to very dissatisfied. figure 1 shows the distribution of the life satisfaction variable, with the majority of the sample (69%), indicating that they are satisfied or very satisfied and only 21% of the sample showing that they are dissatisfied or very dissatisfied with life. figure 1: life satisfaction (frequency %). decomposing and comparing the life satisfaction variable for the different race groups, i find the percentage of white people reporting to be satisfied with life (89%), much higher than that reported by black people (66%) or mixed race people (76%). comparing life satisfaction among the four age categories (figure 2), the standard u-shaped relationship between life satisfaction and age, found in the literature, is observed (blanchflower & oswald 2008). however, in this data set, it seems as if the lowest levels of life satisfaction are experienced within an earlier age category of between 20 and 39 years compared to 35–50 years reported by blanchflower and oswald (2008). figure 2: life satisfaction per race and age groups (frequency %). regressors the selection of the regressors was based on the standard variables found in the literature to explain subjective well-being (‘subjective well-being’ section), but also including the internet access variables, which are the variables of interest. variables of interest – internet accessed and internet home: the survey included two questions related to the internet. the first question determines if the respondent has internet at home (internet home) and the second question enquires whether the respondent accessed the internet at any location during the 4 weeks prior to the interview (internet accessed). it is likely that the two internet variables might reflect different time spans with the internet at home variable possibly indicating a longer period of access than the variable measuring if a respondent accessed the internet in the past 4 weeks. to accommodate these time span differences, i estimate two separate functions including the different internet variables, respectively. if the results of the regressions are similar, it reflects the robustness of the findings. i report the results of the internet accessed variable in the body of the article and the results on the internet home variable in appendix 1. table 2 shows that 17% of the respondents had internet access at home and a far bigger proportion of 33% had access to the internet 4 weeks prior to the interview (gcro 2013). of those respondents who accessed the internet, they got access in the following ways: via mobile phones (45.6%), from home (24.4%), from work (16.8%), from internet cafes (7%), from schools, colleges or universities (4%) and from community centres or libraries (2%). table 2: regressors. the majority of the respondents that accessed the internet had an education level of matric or more (80.9%), were between the ages of 20 and 39 (61.3%), were male (55.2%) and were black people (61.3%) (gcro 2013). based on the aforementioned, the majority of the current internet users in gauteng can be described as young, educated, black people respondents, with little to choose among the genders. it should also be noted that, within the race groups, the majority of asian people (59.4%) and white people (64.9%) accessed the internet, compared to only 28.7% of the black people (gcro 2013). other repressors – the standard variables found to explain life satisfaction: based on the literature reviewed in the ‘subjective well-being’ section, the following standard variables were included in the life satisfaction model: gender, race, age, age2, being married or living with a partner, education, health, employment status, income and satisfaction with money. table 2 gives each variable’s name, an explanation of the variable, a description of the coding and descriptive statistics. in addition, i give information on the selection of the method used to generateand the recoding of variables. the health variable was derived from a question that asked if a person usually needs health care, assuming that if a person needs health care he or she is not healthy and vice versa. education is a discrete variable that was recoded to take a value of 1 if the respondent has no education, 2 if the respondent has grade 0, 3 if the respondent has grade 1, 4 if the respondent has grade 2, and so forth, up to a maximum of 18 representing a respondent that has a post graduate degree (in table 2 frequencies for specific grade groups are indicated). the survey included two variables related to income. the first measured the income of a household per month and the other determined the satisfaction of a respondent with the money available to him or her personally, which is a subjective measure of income; both of these measures were included in the estimated model. the household income variable was categorical and reported total household income, including income from employment, government grants and remittances. i transformed the variable to reflect individual income by making use of the average number of adults per household (2.5) (table 2). a substantial proportion (27%) of the respondents chose not to answer the income question, which made analysis based on the income variable problematic, especially seeing that the missingness was most likely not random. to address the missingness in the data, i imputed the income variable using the mode of nearby points, as this method is most likely to capture the approximate distribution of the income variable. the reported income per household varied between ‘no income’ and more than r500 000 ($34 722)5 per month, which indicates the inequality in income levels in the province. to measure social relationship, i compiled a composite index, derived from the first extracted principal component,6 which included the variables ‘satisfaction with time available for friends’, ‘for family’ and the number of community meetings attended during the year. the religion variable was derived from the question if a person attended a church or religious organisation in the past. the expected relationship between the repressors and subjective well-being is as follows: concerning gender, females generally report higher levels of life satisfaction than males (alesina, di tella & macculloch 2004), but the opposite has also been found (andrew & withey 1976). being married or living with a partner has been shown to be positively related to life satisfaction (diener et al. 1999; helliwell 2003). being unemployed has largely been found to be negatively correlated to subjective well-being (helliwell 2003). contrary to the general findings in the literature (diener & seligman 2004; helliwell 2003), studies in south africa have shown that the relationship between health and subjective well-being is statistically not significant (blaauw & pretorius 2013). furthermore, race has been shown to be statistically significant in explaining life satisfaction (fontaine & yamada 2014) and in south african literature, it has been shown that black people are often less satisfied with their lives than other race groups (greyling & tregenna 2016). the relationship between education and subjective well-being is not clear and often not statistically significant in explaining subjective well-being when controlling for health and income (blanchflower & oswald 2004). nevertheless, some studies do find a positive relationship (witter et al. 1994). literature mostly reveals a positive relationship, up to a certain point (easterlin 1974), between income and subjective well-being, the same holds for the satisfaction with money variable. it is interesting, however, to note that almost 65% of the sample indicated that they were not satisfied with the amount of money available to them, reflecting a sense of relative poverty in the region. previous literature has shown that there is a u-shaped relationship between age and life satisfaction (blanchflower & oswald 2008). based on these findings, i included an age variable and an age2 variable to control for the non-linear effects of age. social relationships have been shown to be positively related to life satisfaction (helliwell 2003) and studies on religion fairly consistently suggest that regular engagement in religious activities is positively related to subjective well-being (clark & lelkes 2005). results results for the sample as a whole all estimations were executed using the two internet variables, respectively. however, in this section, i only report the results on the internet accessed variable, whereas the results on the internet home variable are reported in appendix 1. i found the results on the two internet variables very similar and identical in signs and level of statistical significance; therefore, i deem the findings related to the internet variables robust. as was explained in the ‘methodology’ section, i used ordered probit, ols and ivr techniques to estimate the subjective well-being function. table 3 shows that the signs and levels of statistical significance of the three estimation techniques are in general similar, although the size of the estimated coefficients differs. therefore, according to ferrer-i-carbonell and frijters (2004), the olsor ivr-estimated coefficients are preferred, depending on the presence of endogeneity. table 3: estimation results for subjective well-being (whole sample). testing the hypothesis that internet accessed is exogenous, the wooldridge’s (2010) robust score test (chi2 = 42.410) and the robust regression-based test (f = 42.722) were statistically significant (p = 0.000), and therefore the null hypothesis was rejected, accepting the alternative that internet accessed is endogenous. to test the strength of the instrument, i used the cragg-donald wald f-statistic (f = 2816.289) that was greater than the stock yogo’s weak id critical value at 10%7 of 16.38. therefore, it was concluded that the instrument was strong. accepting the endogenous nature of the internet variables, i interpret the ivr estimations. i found the ivr-estimated model statistically significant with f = 304.02 (p = 0.000); furthermore, the model explained 14% (adjusted r2) of the variance in life satisfaction, which is relatively low but acceptable in the subjective well-being literature. looking at the regressors, i find internet accessed to be statistically significant and positively related to life satisfaction; this was also true if i considered the relationship between internet home (appendix 1) and life satisfaction. these findings indicate that internet access, irrespective of the time period under consideration, is positively related to life satisfaction. the results are in line with the findings of previous literature; see kavetsos and koutroumpis (2011), cotten et al. (2012) and ganju et al. (2016), among others. furthermore, as internet access is endogenous, simultaneity might be plausible, suggesting that people who are more satisfied with their lives are more likely to access the internet than those less satisfied. this finding at micro level, confirming a positive relationship between life satisfaction and internet access, is in line with the macro level perspectives, which indicates that internet access is positively related to development. accordingly, internet access is not only beneficial to the development of a country as a whole, but also to the life satisfaction of individuals. furthermore, based on the theoretical assumptions of the bottom-up approach, it seems as if internet uses for desirable events outweigh the use for undesirable events. implying that internet use is put to worthy and desirable activities in gauteng such as job searches, gives access to online banking and shopping, information (ganju et al. 2016) and increased social interaction via social media (sey et al. 2013). considering the other regressors, all the standard variables found in the literature to be associated with life satisfaction were also statistically significant in this model, with the exception of health. furthermore, the religion variable’s sign is negative contravening previous findings. the result on the health variable is unexpected, as previous literature has shown that health is positively related to life satisfaction (diener & seligman 2004). the health variable is derived from a response that indicates that a person does not usually need health care and therefore is assumed to be healthy, as the question does not directly assess the health status of a person; it is likely that the question underestimates the importance of health in explaining life satisfaction. religion is statistically significant though it has the opposite sign to what was expected, indicating that being religious is negatively related to life satisfaction. this finding differs from the study of greyling (2015) on forced migrants in gauteng where she found no statistical significance and the study of blaauw and pretorius (2013) who found a positive relationship. from these contradicting results, it seems that the relationship between religion and life satisfaction in a south african scenario is still contested. furthermore, pertaining to race, the mixed race variable is not statistically significant, showing that being mixed race compared to being a black person does not warrant higher levels of life satisfaction in gauteng. however, being a white person is statistically significant showing that a white person relative to other race groups is likely to enjoy higher levels of life satisfaction. this result reflects the inequalities between race groups in gauteng, which is likely the remains of the previous political dispensation, in which white people received certain rights and socio-economic privileges denied to other race groups. the political dispensation ended with the democratisation of south africa in 1994. results per race group the results in this section are reported per race group; therefore, the variables related to race used in the previous estimations are omitted from these models. all the models, as in the previous section, were estimated using ordered probit, ols and ivr estimation techniques. after conducting post-estimation tests, i found that the endogenous nature of the internet variables8 was also present when estimating the subjective well-being function per race group; thus, i only report and interpret the ivr estimation results (table 4). the estimated models per race group were all statistically significant and explained between 11% and 15% (r2) of the variance in the life satisfaction variable (table 4). table 4: instrumental variable regression estimation results for subjective well-being (race groups). all the estimated functions per individual race group found the internet accessed variable (table 4) statistically significant and positively related to life satisfaction. this indicates that access to the internet contributes to all race groups’ life satisfaction. therefore, from a policy point of view, all people in gauteng, irrespective of their race, should have access to the internet, as internet access can improve their well-being. the gender variable, interestingly, is only statistically significant in explaining the life satisfaction in the model pertaining to black people respondents, implying that black females are more satisfied with their lives than males. for the whiteand mixed race people estimated models, the gender variable is not statically significant, therefore showing that gender within these race groups is irrelevant in explaining life satisfaction. the socio-economic status variables (ses), namely, employment status, education and income, are statistically significant and positively related to the life satisfaction in the african estimated model, but not in the other estimated models. this is likely a reflection of the inequalities within the gauteng province, which is along racial lines, with black people often having lower levels of education, higher levels of unemployment and lower levels of income than the other race groups (statistics south africa 2015). any improvement in ses will positively contribute to the subjective well-being of black people. where the ses variables in the white people’ and mixed race’ models are not statistically significant, maybe showing that to improve the latter race group’s life satisfaction higher order needs, such as self-fulfilment, should be reached (maslow 1943). interesting to note that the subjective measure, measuring the amount of money available to an individual, is statistically significant and positively related to the life satisfaction of all the race groups, indicating that subjective measures capture different sentiments than objective measures. results per age group to estimate the life satisfaction function per age group, i grouped the sample into four age categories (table 2). i omitted the age and age2 variables from the estimated models as each age categories’ life satisfaction was estimated individually. after using probit, ols and iv regression techniques to estimate the life satisfaction models per age group, the post-estimation tests showed that the internet variables were endogenous as was found in the estimation of the sample as a whole and per race group. i therefore report and interpret the ivr estimation results (table 5). all the models estimated per age categories were statistically significant and explained between 11% and 15% (r2) of the variance in life satisfaction. table 5: instrumental variable regression estimation results for subjective well-being (age groups). the internet access variable is statistically significant and positively related to life satisfaction for each estimated model per age group (table 5). this finding also holds for internet at home, with the exception of those respondents who are 65 and older.9 thus, the ‘south africa connect’ policy to provide internet access to all people is likely to improve the subjective well-being of people across all age groups. the results on the majority of the other control variables are in line with those found for the whole sample; however, the race white, employment status and education variables’ results differ somewhat per age group (table 5). the race white variable is not statistically significant for respondents under the age of 20, although it is statistically significant for older respondents. this might indicate higher levels of equality for younger age groups who are facing similar educational and employment challenges. furthermore, one should keep in mind that this age group, in general, enjoys higher levels of life satisfaction than those in the age group between 20 and 39 years of age. the employment variable is statistically significant and positive for the younger age groups up to the age of 39. from the age of 40, the employment variable is no longer statistically significant. often, the younger people struggle to find employment, whereas respondents who are older and have more experience are likely to be employed and therefore employment is not necessarily a predictor of their life satisfaction. employment was also found not to be statistically significant for respondents aged 65 and older as they are of pensionable age and employment no longer plays a role. conclusion in this article, i investigated the relationship between subjective well-being and internet access at a sub-national level in a developing country. the research article in particular also investigated the relationship across different race and age groups. the region analysed was the gauteng province in south africa, which is known for high levels of inequalities among race and age groups in terms of income, education, employment levels and access to infrastructure. the article firstly contributes by analysing the relationship between subjective well-being and internet access at a sub-national level in a very diverse region. secondly, it investigated this relationship in a developing country, which is particularly relevant as internet access is seen as a development tool. thirdly, it used a substantial sample representative of the region, in contrast to many of the previous studies that only looked at relatively small samples of specific individuals, such as adolescents (gross et al. 2002) or the elderly (cotten et al. 2012). to the author’s knowledge, this is the first study of its kind. to analyse the research questions, i made use of a data set collected in 2013 on the quality of life of the people in gauteng (gcro 2013). all estimations were performed using ordered probit, ols and ivr estimation techniques. post-estimations tests revealed that the internet access variables were endogenous; therefore, i interpreted the ivr results. the results showed that life satisfaction and the internet access variables, namely, internet accessed and internet home, were positively related and statistically significant, implying that higher levels of access to the internet improve the subjective well-being of all people notwithstanding their race or age. the results of a positive relationship agree with studies such as kavetsos and koutroumpis (2011), cotten et al. (2012), ganju et al. (2016) and pierewan and tampubolon (2014). furthermore, these results support the ‘south africa connect’ policy implemented by the south african government, which aims to give internet access to all south africans by 2030 as it not only contributes to the development of the region but also to the life satisfaction of the citizens. when the models were estimated per race and age groups, the results confirmed the findings of the sample as a whole. interesting for the age group under 20, being a white person did not imply higher levels of life satisfaction than being a black person. this suggests a more equal society for younger respondents. as it is likely that internet access to certain groups will be prioritised, it seems that younger age groups will benefit most as it gives them access to knowledge, education and employment possibilities (pénard et al. 2013). furthermore, judging from groups experiencing lower levels of life satisfaction compared to others, like black people, measures taken to give internet access to these groups may improve their life satisfaction. in so doing, current inequalities within the gauteng province can be addressed. the current study has limitations, as the analysis is cross-sectional. a future longitudinal study could reveal more insightful results. furthermore, research on the specific use of internet access and the time spent online could be valuable for policy development in the future. acknowledgements i would like to thank the gcro for giving me access to their data set on the quality of life in gauteng. competing interests the author declares that she has no financial or personal relationships that may have inappropriately influenced her in writing this article. references alesina, a., di tella, r. & macculloch, r., 2004, ‘inequality and happiness; are europeans and americans different?’, journal of public economics 88(9–10), 2009–2042. https://doi.org/10.1016/j.jpubeco.2003.07.006 andrew, f.m. & withey, s.b., 1976, social 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econometric analysis of cross section and panel data, mit press, cambridge, ma. world bank, 2016, world development report 2016: digital dividends, 1st edn., world bank, washington dc. https://doi.org/10.1596/978-1-4648-0671-1 world economic forum, 2002, annual report on the global digital divide initiative, viewed 03 august 2015, from http://www.weforum.org/pdf/initiatives/digital_divide_report_2001_2002.pdf appendix 1 table 1-a1: estimation results for subjective well-being with ‘internet home’. footnotes 1. in this article, the term ‘subjective well-being’, ‘life satisfaction’ and quality of life are used interchangeably. 2. the gini-coefficient, which is an indication of the unequal distribution of income, is extremely high, at 0.7 for the province, and 0.63 for the country as a whole (ihs regional economic explorer 2014). 3. the strict definition of unemployment considers a person to be unemployed only if they have taken active steps to look for work or to start some form of self-employment in the 4 weeks prior to the interview. 4. probit estimated coefficients predict the probability (derived from the computed odd ratios) that the dependent variable is in a specific category. though often the interpretation of probit coefficients is not as accurate as using ols estimations. 5. sa rand, us dollar exchange rate on 25 july 2016: $1 = r14.40. 6. see the handbook on the constructing of composite indicators (oecd 2008) for a more detailed description on the construction of composite indices using principal components analysis (pca) 7. accepted level of size distortion. 8. because of space limitations, the models, including ‘internet home’ and all ordered probit and ols estimation results, are not published but available on request from the author. 9. because of space constraints, these results are not published but are available on request. abstract introduction problem background literature review theoretical framework methodology results discussion conclusion and managerial implications acknowledgements references about the author(s) patient rambe department of business support studies, central university of technology, south africa takawira m. ndofirepi department of business support studies, central university of technology, south africa citation rambe, p. & ndofirepi, t.m., 2017, ‘ethical perceptions of employees in small retailing firms: a case of indigenous-owned fast-food outlets in zimbabwe’, south african journal of economic and management sciences 20(1), a1574. https://doi.org/10.4102/sajems.v20i1.1574 original research ethical perceptions of employees in small retailing firms: a case of indigenous-owned fast-food outlets in zimbabwe patient rambe, takawira m. ndofirepi received: 11 apr. 2016; accepted: 18 apr. 2017; published: 06 july 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: although the subject of ethical business practices has a well-established tradition in large corporations where shareholder value maximisation is largely dependent on such entities’ conduct of good business ethics, its investigation in small businesses in agile, economically depressed economies such as that of zimbabwe has targeted business owners and managers but excluded their employees. given the middleman role that employees of emerging indigenous-owned retail firms play in the distribution chain from manufacturers to the consumers, the ethical perceptions of these employees are critical to the leveraging of businesses’ strategic orientations. employees are the coal face of the firm, withering intense competition from these firms’ rivals and achieving the firms’ strategic orientations (profitability, market share, business growth and survival). in order to meet stakeholder expectations simultaneously largely depends on the ethical conduct of such employees. aim: the overall aim of this study is to contribute to ethical theory and literature by demonstrating how employees’ ethical perceptions and behaviour shape the strategic orientations of the business. to achieve this aim, the study sought to: (1) establish the typical ethical dilemmas that employees of these retail firms faced in their daily tasks, (2) assess how they responded to these ethical challenges, (3) ascertain whether demographic factors such as age, level of education, gender and their position in the organisational hierarchy influence their reaction to ethical dilemmas; and (4) determine these employees’ overall perceptions of ethical issues within their organisations. setting: the study was conducted on employees of an indigenous-owned fast-food firm operating in two cities in zimbabwe. methods: a survey was conducted on 108 employees working in two cities. a structured questionnaire was developed and administered to the employees. results: the results suggested that a majority of the respondents were ethically conscious and could make ethical choices. in addition, most respondents deemed the ethical scenarios presented to them as morally wrong, suggesting that the surveyed employees wished to engage in ethical behaviour. however, while the respondents were deemed to be ethically astute in their individual capacities, they seemed to lack an in-depth knowledge of the ethical policies of their organisation. conclusion: the study concludes that owners and managers of small firms should provide interventions to cascade ethical policy to the lower ranks of the organisation to enhance the ethical perception amongst employees of these firms. the study implication is that an institutional top-down approach is critical to embedding ethical sensitivity into employees without which employees may continue to speculate about the business ethics of their organisation. introduction the business ethics of large corporations have attracted considerable attention in both developed and developing world contexts. the reasons for such interest are: these entities’ dependence on relationships of trust with their customers (institute of business ethics 2007; martínez & del bosque 2013), print and electronic media’s obsession with ethical failures and scandals of large, publicly-traded corporations (fassin 2005; fassin, van rossem & buelens 2010; huimin & ryan 2011; longenecker et al. 2006) and the concern of leaders in business and government on the moral climate of the corporate world (longenecker moore et al. 2006). although the ethical practices of large business entities have been explored extensively, the business ethics of small, micro and medium enterprises (smmes) in developing economies have received minimum attention (murillo & lozano 2006; painter-marland & spence 2009; okyere 2012; spence & rutherfoord 2003). yet, the issue of ethical behaviour and indiscretion in business is a concern for all companies, regardless of size (longenecker et al. 2006). in fact, literature acknowledges the dire need for more concerted research in various areas of small business ethics studies (dees & starr 1992; painter-marland & spence 2009; phatshwane 2013). the exploration of the ethical conduct of smmes in developing economies is critical to understanding the strategic choices of the smme managers and owners (and employees) that optimise the profitability of their businesses (fassin et al. 2010; garray & font 2012; spence & lozano 2000). business ethics are also key to smmes’ survival in volatile and highly competitive environments characteristic of developing countries. spence and lozano (2000) argue that the relevance of the small firms’ ethics to economic and social environments, especially those of emerging economies, is too significant to be disregarded, and discussions about ethics are pivotal to addressing particular ethical strains on smmes. the nascent literature on small business ethics tends to be preoccupied with managers and owners of these firms (institute of business ethics 2007; longenecker et al. 2006) and ignores employees’ perceptions of organisational ethics. perhaps the interest in smme managers and owners at the expense of employees lies in the fact that managers and/or owners normally bear the brunt of breach of trust in the event of ethical malpractices. an example of such breach of trust is when suppliers deliberately fail to meet the agreed terms and conditions of supplying products or services (institute of business ethics 2007). more so, because the small business is generally the prime source of income for small business managers and owners and consumes a majority of their resources and time (fassin et al. 2010), researchers are naturally inclined to investigate the managers’ and owners’ ethical conduct as it directly affects the successful performance and survival of the business. however, because employees tend to deal more directly with customers compared with their managers, it might mean that the intimate nature of the small business–customer relationship makes it highly susceptible to the debilitating and potentially disastrous consequences of unethical behaviour (humphreys et al. 1993). therefore, mitigating the negative consequences of unethical behaviours of employees is foundational to promoting the growth of small businesses. the few researchers that studied employee perceptions of ethics targeted employees of large public and private organisations (basran 2012), or explored their gender-based perceptions of organisational ethics in the developed world (mcdaniel, schoeps & lincourt 2001). in view of the paucity of research on employee perceptions of ethical conduct of the small organisations that employ them, especially smmes, this study explored how employees would perceive and respond to typical ethical dilemmas they could be confronted with on a daily basis. the study also explored employees’ perceptions of the business ethics of their organisation. more specifically, the study sought to: (1) establish the typical ethical dilemmas that employees faced in their daily tasks, (2) assess how they responded to these ethical challenges, (3) ascertain whether demographic factors such as age, level of education, gender and one’s position in the organisational hierarchy influenced his or her reaction to ethical dilemmas and (4) determine the extent of employees’ perceptions of ethical issues within their organisations. the rest of the article is arranged as follows: firstly, the study background is provided and relevant literature on the area of study is reviewed. this is then followed by the research methodology used in the study. the findings are then analysed and discussed. this article then concludes with the practical and theoretical implications of the research and suggestions for future research. problem background zimbabwe grappled with a hyperinflationary environment between the years 2000 and 2008. this culminated in unprecedented inflation levels of 231 million per cent by july 2008 when it was last calculated officially by the central statistical office (biti 2015). the imf team that visited zimbabwe in march 2009, however, calculated that inflation peaked at 500 billion per cent in september 2008 (biti 2015). kabote, chimutingiza and mirimi (2013) provide an illuminating account of the dollarisation process. to cushion themselves from the hyperinflationary environment, zimbabweans resorted to the use of the us dollar and south african rand, hence unofficially dollarising the economy which was considered illegal then (pre-official dollarisation stage). in november 2008, reserve bank of zimbabwe issued licences to tourism businesses to trade in foreign currency (reserve bank of zimbabwe 2008), with the rest of the economy continuing to use the zimbabwean dollar (the semi-official dollarisation phrase). zimbabwe was officially dollarised in february 2009, presenting its national budget in us dollar although other major currencies were allowed to be used for trading purposes (official dollarisation stage) (kabote et al. 2013). in the post-dollarisation stage, the zimbabwean fast-food sector experienced significant growth, with a number of new players entering the market (mkono 2012). research and markets (2011) reported on mcdonalds, the global fast-foods giant’s plans to penetrate the zimbabwean market in september 2010. this strategic move was made against a backdrop of economic conditions and the attractiveness of the zimbabwean market. initially, the multinational firm had attempted to penetrate the market in 1999 but later floundered because of perceptions of economic and political risks in the country at the time (research and markets 2011). in september 2010, the post-dollarisation phase, innscor, a leading player in the fast-food industry, projected an annual sales growth of 25% per annum by july 2011. the firm also reported sales revenue of usd 512 996 433 in december 2015 from its local operations (innscor report 2014). the generation of sales revenue by local companies and the entrance of other international firms contributed to a positive outlook of the zimbabwean fast-food sector. the positive outlook of the local fast-food market has attracted more players into the industry, with a number of international franchises also entering the fray. for example, kentucky fried chicken (kfc) returned to zimbabwe in early 2014, intensifying competition and generating discomfort amongst old players (mkono 2012). established businesses have also employed aggressive tactics against competitors to remain economically viable and reduce competition. for example, when innscor reduced prices drastically, many fast-food smmes became more vulnerable and were compelled to close their businesses because of loss of competitiveness and declining profits. the pressure to survive and to reduce business rivalry has intensified the temptation to engage in unethical practices (brizek 2014). in view of such competition from rivals, small zimbabwean fast-food firms have been compelled to impose tough performance targets on their employees. this pressure coupled with the ‘free-for-all’ economic phase the country has just emerged from served as an ideal breeding ground for employee unethical behaviour. it seems the widely condemned business scandals like the mcdonalds horse meat and chinese expired tinned meat scandals have done little to deter similar ethical transgressions in the fast-food industry in emerging economies. although larger firms often have a semblance of ethical programmes in place to guide their employees’ conduct, good ethical behaviour is not so obvious for most smmes, as rules of engagement are often informal and undocumented. the grey areas in zimbabwean smme employees’ ethical behaviour have increased the calls for ethical sensitivity and morally responsible business practices (masaka 2011; mawere 2011). yet, to our knowledge, no concerted efforts have been made to investigate the smmes’ ethical conduct, especially the ethical perceptions of their employees in the small fast-food industries in the country. literature review a case for employee perspectives on organisational ethics: an overview the under-exploration of smme employee ethics is unfortunate as ethically sensitive employees are considered to make independent decisions that are consistent with the company’s culture, objectives and values, thus improving organisational efficiency, reducing the levels of supervision required and increasing their adaptation to changing roles and responsibilities (ethic resources centre 2010). more so, an employee’s positive perceptions of an organisation’s ethical culture are associated with higher levels of engagement in the organisation (ethic resources centre 2010). limited consideration of employee’s ethical practices can be attributed to the authoritarian–paternalistic style of management of small businesses in which the main business functions (such as marketing, product development sales, finance etc.) of the organisation are monopolised by the manager or owner whose approaches to these issues are based on their personal experiences, standards and judgement (spence & lozano 2000; vivier 2013). most smmes are owner-managed and the owners are directly involved in the day-to-day activities of the company, often undertaking multiple roles and functions (vivier 2013). the centrality of the small business managers and owners in decision making processes, therefore, has made them the ideal candidates for investigation, thereby unintentionally excluding employees who actually have more direct contact with clients and other stakeholders. the paternalistic orientation of smme managers and owners lies in the sense that they, in the execution of their tasks, rely on employees with limited scope for critical decision making, but who are more often rewarded for their support for the manager’s decisions (spence & lonzano 2000). despite the immense potential of employees in advancing the economic and ethical interests of the organisation (institute of business ethics 2007; vivier 2013), their perspectives on organisational ethics have received marginal attention in business management literature (dhanesh 2012; paillé et al. 2014; ruiz-palemino, martínez-cañas & fontrodona 2013; slack, corlett & morris 2014). although concepts related to business ethics are alluded to in these two aforementioned studies, the studies focused more on corporate social responsibility (csr) and not business ethics in particular. as such, it is vital to underscore that although some complementarities and an increasing overlap have been observed between business ethics, csr and corporate governance (cornelius, van den berghe & louche 2005; fassin et al. 2010), these concepts have also evolved independently over time. this scenario clouds and complicates any attempt to categorise various researches into the issues of ethics and csr. although csr relates to ‘…the complex and multifaceted relationships between business and society, and tries to account for the economic, social and environmental impacts of business activity’ (jamali, dirani & harwood 2015:1), the subject of business ethics is confined to the morality of business activities and can be viewed at both the organisational and individual levels. this under-exploration of smme employees ignores the fact that they are often the primary stakeholders for smme managers and owners (klein & vorbohle 2010; vivier 2013) and where contractual arrangements (e.g. through employee ownership programmes) exist between the manager or owner and the employees, the latter often enjoy a mutual commitment to shared values as well as to the welfare of the group (barnett & schubert 2002; sledge & miles 2012). an overview of business ethics although the definition of ethics is heavily contested, there is some consensus that the term entails moral values and dilemmas in everyday contexts. shaw (2014) defines ethics as principles or values that guide behaviour. within the organisational settings, these values are embodied in virtues such as honesty, compassion and loyalty (velasquez 2006). because ethics deal with distinctions between right and wrong (ferrell, fraedrich & ferrel 2014), they are founded on morality, which includes moral judgement, standards and rules of conduct (parboteeah & cullen 2013). moral judgements may relate to decisions on fair, honest and competent pricing of products, while standards emphasise providing the appropriate service and product offerings of the expected quality and required quantity at the appropriate places and times. cant, wiid and kallier (2013) define business ethics as: the commonly agreed upon principles, rules, behaviour and conduct that should be followed in the business environment. it is the moral code of conduct of the business, what is right or wrong, good or bad. (p. 5776) business ethics, therefore, are a set of moral principles for arriving at a decision, which is consistent with the values of an organisation (holme 2008). ethical business values shape and inform management behaviour and can directly influence employee satisfaction and their job performance (holme 2008). the direct relationship amongst corporate ethical values, employee satisfaction and firm performance stems from the building of trust (hosmer 1994). it can be inferred that where smme employee–stakeholder relations of trust prevail, business performance and survival are more guaranteed than where relations of mistrust are bred. yet, the application of ethical values varies across contexts. for example, sustaining honest relationships with customers is critical for marketers (abratt, bendixen & drop 1999) and sensitivity to various market-related factors is a fundamental moral consideration for marketers (rao et al. 2001), while the need to trust business is non-negotiable for consumers (singhapakdi, vitell & franke 1999). more so, the impact of organisational ethics on employee behaviour is unclear. sharma, borna and stearns (2009) surveyed 400 chain furniture retail outlets in southern usa to explore such a relationship. their findings suggest that although there is a direct relationship amongst corporate ethical values and employee and customer behaviour, other variables seemed to mediate that relationship. normative ethics and small, micro and medium enterprise conduct because this study examines smme employees’ perceptions of organisational ethics, the normative ethics, standards and rules are worthy of examination. normative ethics deal with what actions one ought to or ought not to perform (morris et al. 2002). they also are concerned with whether those actions are good or bad, right or wrong, virtuous or vicious, worthy of praise or blame or worthy of a reward or punishment (smith & hasnas 1999). in an smme context, normative ethics relate to the moral standards and rules that govern smme employees’ conduct with the internal (i.e. with their managers or owners, and peers) and external world (customers, suppliers, investors and government agencies). these range from safety of employees and stakeholders in the business context, honesty and trustworthiness in the distribution chain (from sourcing of raw materials to final disposal of product), socially acceptable marketing practices and fair pricing to refraining from misrepresentation of the contents of products or constitution of services. normative ethics have two main sub-areas, namely virtue ethics and rule-based ethics. virtue ethics are about entrenching goodness in everything that one does (van hooft & van hooft 2014). therefore, ethical conduct such as patience, courtesy and humility towards customers and suppliers could be fundamental to effective smme relationships with their stakeholders, particularly in view of the intimate and personal relations between them. although the aforementioned ethical conduct can be expressed as good customer relations, desisting from ethical constraints such as bribery, theft, coercion, deception and unfair discrimination, which constrains the freedom of the business to make decisions, (botha 2012:5) is all expressions of business ethics. virtue ethics can also relate to intra-organisational relations such as employee–peer relations and immediate superior–employee relations such as fair compensation for employees, decent and human working conditions and fair and equal treatment amongst other considerations. virtue ethics seem to be more inclined to maintaining good employer–employee relations than entrenching business ethics, which should focus on customers and other stakeholders. virtue ethics need to be distinguished from ethical misconduct such as bribery, which alters the conditions under which a decision is made and results in the business allocating more recourse to options that are less favourable for the business (botha 2012; cant et al. 2013). the same is applied to coercion of customers, which results in the altering of the value and belief system of the organisation, which can result in an unhealthy work environment (davoren 2013) and loss of loyal customers. because smme managers or owners tend to consider employees as the bedrock of a company, the smme normally regards employees’ health and well-being as their sole responsibility (seeletse & ladzani 2012; vivier 2013). although employee welfare is a component of the broader regime of ethics, the importance of ethics to smmes compared with larger businesses needs to be acknowledged. cant et al. (2013) reiterate that small businesses are more prone to ethical issues because of their size, while large businesses are more equipped to deal with ethical issues and decisions. they elaborate that large businesses tend to have a corporate environment and set rules and regulations that help prevent ethical problems. this can be contracted with smes, which do not have the same resources and expertise to handle ethical problems that arise (assad 2013; cant et al. 2013). rule-based ethics are a form of normative ethics that is prescriptive in nature. they attempt to provide a guideline to ethical behaviour (carroll & buccholtz 2014). rule-based ethics are conceived as either consequentialist or deontological. consequentialism seeks to evaluate actions on the basis of their results, in particular their utilitarian consequences. based on this principle, an action is deemed to be ethical if it brings more happiness to a group than an individual (boyle 2002). people in communities guided by such consequentialism, therefore, are often prepared to surrender individual happiness for the sake of community contentment. smme employees may, therefore, prioritise availing goods to the community at the expense of profiteering. however, the challenge is that employees’ ethical decisions regarding consequentialism may remain unknown as the manager or owner tends to make such decisions at their expense. deontology examines the goodness or correctness of an action on the basis of the intrinsic goodness of the action, rather than their end result. hence, deontology simply outlines moral duties without paying attention to the subsequent compensation or penalty (boylan 2002). theoretical framework normative ethics and ethical dilemmas the current study drew on three prominent theories that underpin the examination of normative ethics in view of the nascent, fragmented literature that explores employees’ perceptions towards normative ethics within an organisation. these theories are as follows: stockholders, stakeholders and social contract theories. friedman (1999), the main proponent of stockholders theory, posits that managers (and employees) as instruments of stockholders must abide by the norms and rules of society when they conduct their business. as such, these human beings are compelled to abstain from social vices like corruption, fraud and dishonesty in their business dealings. however, the application of social norms and rules is not a simple, straightforward exercise of pairing a business motive to a particular ethical consideration because smme employees often make tight-rope decisions and choices based on limited courses of actions. employees may be under pressure to sacrifice a moral principle in pursuit of their business or self-interests when confronted with these either-or-situations. ideally, while refraining from social vices should be the norm, jackson (1996) laments that in the real business world, business operators such as smme employees are often confronted with two kinds of difficulties – namely the difficulty of identification and difficulty of compliance. employees display the difficulty of identification when they struggle to pin down what their actual duty is in a particular situation. employees are confronted with a difficulty of compliance when they fail or choose not to do their duty once they recognise it. stakeholders theory, another normative ethics theory, which has been extensively written about (clarkson 1995; donaldson & preston 1995) emphasises that management of enterprises must take cognisance of all parties affected by their business activities whenever ethical dilemmas arise and are being resolved. the business, therefore, should take concerted steps to prevent the violation of shareholders, employees, customers, suppliers and society at large in their conduct of business. an ethical perspective on stakeholders, therefore, enables firms to gauge the impact of their decisions on several groups of people within and outside the organisation (vivi & yothmontree 2002). given the diversity of stakeholders that interact with smmes, the process of reconciling smme interests with stakeholder aspirations becomes an inexorably complex exercise that straddles personal motives, business intentions and broader social demands and expectations. ethical dilemmas are bound to arise when smmes struggle to reconcile these various contenting interests in their fulfilment of their business responsibilities. dees and starr (1992) describe four main ethical dilemmas that business operations regardless of size, namely moral conflict, prudential tension, personal–social conflict and moral ambiguity. moral conflict is when personal values contradict each other. prudential tension occurs when one realises that the right action to be taken is not in sync with one’s short-term. personal–social conflict occurs when personal moral values are in conflict with the social environment in which one is operating. lastly, moral ambiguity occurs when ethical values and guidelines are not clear and there are no prior examples to emulate. donaldson (1982) propounded the social contract theory in an attempt to reconcile the economic objectives (especially profit maximisation) of the business and the broader societal goals of well-being such as promoting social development, enhancing empowerment and nurturing good will. the theory is premised on the understanding that business managers should pursue profit objectives in so far as it enhances social well-being because the society at large allows businesses to be formed and sustained. yet, balancing economic and social objectives is not a simple logic matter as smme entrepreneurs and their employees are often confronted with unique ethical dilemmas arising from various organisations such as resource constraints and environmental factors that affect the ethical standards and values of an enterprise (declerq & dakhli 2009; harris, sapienza & bowie 2009; volkman & berg 2012). payne and joyner (2006) state that entrepreneurs face ethical dilemmas involving their own values, organisational culture, employee well-being, customer satisfaction and external accountability which complicate their pursuit of ethical values and standards. the smmes’ realisation of societal demands may be constrained by relatively limited market presence, product and service demand fluctuations, forceful competitive attacks and lack of support from suppliers and distributors (bennett et al. 2012), which pressurise smmes to make ambiguous decisions that compromise their ethical practices. it is critical to demonstrate how the aforementioned issues, namely virtue ethics, deontology and consequentialism against stockholders and stakeholders theories fit together. from a theoretical perspective, the stakeholder theory is a critique of the stockholder’s minimalist perspective that puts great emphasis on the accountability of the management and board of directors to the investors of the company to the exclusion of stakeholders who are also implicated in business operations. the stockholder theory asserts that those who control and manage a company (i.e. directors, managers, the chief executive or executive directors) do so for the benefit of shareholders and are effectively accountable to them (sama-lang & njonguo 2016). the stakeholder theory challenges and extends this argument by contending that management and directors owe their duties not only to the shareholders but also to the company’s employees, customers and the community (sama-lang & njonguo 2016). as such, the stockholder theory can be conceived as a subset of the stakeholder theory as it (stockholder theory) only captures management’s relationship with one of the stakeholders (i.e. investors), while the latter is broader and encapsulates a range of stakeholders. although stockholder theory can be conceived as a subset of stakeholder theory, both theories dictate and inform normative ethics, hence normative ethics are subsumed in these theories. normative ethics comprise rule-based ethics, which define in prescriptive terms the courses of moral behaviour and conduct (often through a code of ethics), and virtue-based ethics, which generally emphasise entrenching good in society. the difference is that rule-based ethics seems to give preponderance to employees and management’s internal ethical conduct even though they do not necessarily preclude their external conduct with external stakeholders. more so, in the event of their breach by management and employees, rule-based ethics are enforceable through rewards, deterrents and sanctions drawing on the moral code. virtue-based ethics seem to focus more on the organisational workforce and management’s good will and good relations with their world (government, community environment) even though they do not ignore internal stakeholders (employees, employers, investors, financiers). however, virtue-based ethics are hard to enforce or may not be enforceable. sama-lang and njonguo (2016) distinguished these rule-based on virtue-based ethics by highlighting that although the law prohibits companies from engaging in acts of bribery and corruption (i.e. rule-based ethics), the same law will not compel a company to sponsor water projects or build schools in the locality where it operates. it is the company’s knowledge of right and wrong, good and evil, as related to its objectives and sphere of operation, that will compel it to act (virtue-based ethics) (sama-lang & njonguo 2016). the former could be aligned to stockholder theory and the latter to stakeholder theory because of its focus on the extended community. lastly, rule-based ethics can be judged on two foundations, their outcomes (a consequentialist perspective) or on their internal goodness (e.g. virtue) without any recourse to their outcomes (deontological perspective). methodology research design the study adopted a quantitative approach. the quantitative research design was considered as desirable as findings from such studies can be generalisable to the entire population, and claims based on findings from quantitative studies (e.g. surveys) are often supported by empirical data (cohen, manion & morrison 2007; saunders, lewis & thornhill 2009). apart from that, the outcome of quantitative studies can be statistically summarised and tested for its significance. research strategy the survey approach was used to gather data. a structured questionnaire characterised by close-ended questions was used in the data collection process. probability sampling was used for the selection of the sample upon which the questionnaire was administered. target population the target population for this study comprised 118 employees from the four branches of an indigenous-owned fast-food firm in zimbabwe. of this population, a sample of 108 respondents was subsequently surveyed. the surveyed employees came from various levels of the organisation, that is, from managerial, team leaders to those at the operational levels. measuring instrument the questionnaire employed lickert-scale questions to determine employee perceptions of customer-related and work-related ethical scenarios presented to them. the customer-related scenarios had 6 items, while the work-related scenarios had 11 items. the categories of ethical scenarios were adapted from abratt et al.’s (1999) research instrument. in the cited study, the scales used exhibited satisfactory reliability levels with cronbach’s alpha coefficients of above the minimum acceptable level of 0.6 (0.602 for work-related scenarios and 0.7030 for customer-related scenarios). george and mallery (2016) proposed the following guidelines for evaluating α value: > 0.9 excellent, > 0.8 good, > 0.7 acceptable, > 0.6 questionable, > 0.5 poor and ≤ 0.5 unacceptable. instead of a five-item scale, however, a three-item scale was used for the current study to prevent possible ambiguity to respondents, who were all non-native english speakers. the respondents had to choose between (1) wrong, (2) indifferent and (3) not wrong/appropriate for all ethical scenarios presented to them. it is important to note, however, that the use of a narrow scale has the effect of lowering the reliability of the measuring instrument (pallant 2013). these scenarios related to comprehensive situations related to customer care and work in the retail sector. the validity of the instrument was safeguarded because pre-validated items were used. the last component of the questionnaire on employees’ ethical perceptions was self-developed. here, the respondent chose amongst the following options: (1) yes, (2) no and (3) not sure. data collection the permission to conduct the study was sought and granted by respective branch managers of the fast-food firm. the researcher, with the assistance of branch managers and shift supervisors, distributed the questionnaires to the respondents during their different work shifts. using the pick and drop method, data were collected over a 2-week period. all the 108 distributed questionnaires were successfully completed and returned to the researchers, giving a 100% response rate. data analysis descriptive and inferential statistics were used to analyse the data. as such, frequencies of responses to each question were derived and percentages were calculated. further, the mann–whitney and kruskal–wallis tests, which are non-parametric techniques, were used to ascertain any differences in the composite mean scores for responses to work-related and customer-related ethical dilemmas on the basis of specified demographic factors. these techniques were considered because of their less stringent requirements on the dataset being analysed. this was done using statistical software, statistical package for the social sciences 19. results demographic factors table 1 shows the diverse demographic characteristics of respondents who participated in the study. table 1: demographic characteristics of respondents. a cursory examination of this data reveals that most respondents were female (80.6%), ordinary workers (77.8%), were aged 25 years or below (81.5%) and had, at most, secondary level education (94.4%). findings from the data collection process are divided into three sub-categories, that is, employee responses to work-related and customer-related ethics scenarios, differences in employee responses to ethics scenarios on the basis of demographic factors and their perceptions of organisational ethics. work-related scenarios about 30% of the respondents viewed giving a friend or relative a discount which they did not deserve as wrong; 41.7% were indifferent, while 27.8% said it was not wrong. respondents were also requested to express their feeling towards taking sales from fellow employees. a total of 30.6% indicated that this was wrong, 25% were indifferent and 44.4% said this was not wrong. the majority of respondents (61.1%) regarded falsifying 1s h worked as wrong. of the total respondents, 27.8% were indifferent, while 11.1% viewed it as not wrong. about 52.8% of the respondents indicated that keeping the last product on the shelf for oneself instead of customers was wrong, while 25% were indifferent. the remaining 22.2% said that such a practice was not wrong. the findings also suggest that the bulk of respondents (72.2%) regarded failure to report theft because of pressure from a fellow employee as wrong. however, 16.7% were indifferent, while 11.1% saw nothing wrong in the action. a majority (63.9%) of respondents considered the keeping of free samples meant for distribution to customers as wrong and 25% were indifferent. the remainder (11.1%) indicated that it was not wrong. overall, the pattern of responses demonstrates that a majority of respondents regarded the presented work-related ethical situations as morally wrong. it is only in one instance of taking sales from fellow employees that the majority of respondents felt it was not ethically wrong. customer-related scenarios respondents were asked how they felt about charging a customer full price on a sale item. the majority of respondents (55.6%) conceived this practice to be wrong, while 22.2% were indifferent. the rest (22.2%) saw nothing wrong with in action. respondents were also asked to indicate whether they approved the withholding of information on an upcoming sale on a product that a customer is about to buy. of the total respondents, 63.9% showed disapproval, while only 5.6% expressed approval. the rest (30.6%) of respondents were indifferent. findings demonstrate that the bulk of respondents (50%) viewed refusal to take back legitimate returns from customers as wrong. of the remainder, 33.3% were indifferent and 16.7% regarded it as not wrong. a majority (69.4%) of the respondents conceived unequal treatment of customers as wrong, while only 11.1% considered it as not wrong. the remainder (19.4%) were indifferent. closely related to unequal treatment of customers was the employees’ practice of attending to customers they conceived as better and ignoring those conceived to be bad customers. about 52.8% of respondents indicated their disapproval of the practice, while 27.8% saw nothing wrong with it. the remaining 19.4% were indifferent. most respondents (63.9%) regarded giving incomplete information about product features and functionality as wrong, while 16.7% said it was not wrong. the remaining 19.4% indicated that they were indifferent. about 63.9% of the respondents regarded making false promises to customers as wrong, while 11.1% indicated that it was not wrong. the remainder (25%) were indifferent. furthermore, an overwhelming majority (86.1%) of the respondents indicated that it was wrong to deliberately give wrong change to customers. only 5.6% saw nothing wrong with this practice, while 8.3% were indifferent. lastly, respondents were asked to indicate how they viewed the buying of products by sales staff before these are made available to customers. of the total respondents, 58.3% viewed this practice as wrong, while 16.7% saw nothing with it. the remainder (25%) were indifferent. from the above presentation, it is evident that a majority of the respondents viewed all the presented ethical situations as morally wrong. tests for statistical difference a kruskal–wallis rank sum test was conducted to assess if there were significant differences in the employees’ responses to workand customer-related ethics scenarios amongst the different age categories. the results are presented in detail in table 2. table 2: results of the kruskal–wallis rank sum test with age as the grouping variable. the results of the kruskal–wallis test were significant for work-related ethics scenarios (x2(3), 12.332, p = 0.006) but not significant for customer-related scenarios (x2(3), 3.751, p = 0.29). this means that the differences in the mean scores for the workers’ responses to work-related scenarios were statistically significant. in the absence of a specific post-hoc test for the kruskal–wallis rank sum test, we paired the various age groups and conducted the mann–whitney test on them. this was done so as to identify the particular pairs of age groups where the significant differences in the mean scores for work-related scenarios lay. significant differences were noted only between the ‘25 years and below’ and the ‘26 to 35 years’ (u = 71.000, -3.007, p = 0.003). however, the differences were not significant for customer-related scenarios. a mann–whitney test was also conducted to explore the impact of gender on the respondents’ perception of workand customer-related ethics scenarios. respondents were divided into two groups according to gender, which are female and male. the results are presented in detail in table 3. table 3: results of the mann–whitney u with gender as the grouping variable. on analysis, the results show that there were no significant differences on the basis of gender in the scores for work-related and customer-related ethics (u = 830, z = -0.579, p = 0.563 and u = 850.5, z = -0.494, p = 0.621, respectively). furthermore, a kruskal–wallis rank sum test was also used to determine whether there were significant differences in the perceptions of work-related and customer-related ethics scenario scores amongst members at different levels of the organisation. the results are shown in table 4. table 4: results of the kruskal–wallis rank sum test with level in the organisational structure as the grouping variable. a closer look reveals that the results of the kruskal–wallis test were significant (χ2[3] = 14.865, p < 0.002 [work-related scenarios] and χ2[3] = 9.555, p = 0.023 [customer-related scenarios]), indicating that the differences in mean ranks of work-related and customer-related scenario scores were statistically significant across categories of employee levels in the organisation. to identify where the actual differences lie, we paired the employee categories and conducted the mann–whitney test as a post-hoc test measure. significant differences in the mean scores for work-related scenarios were identified in the following pairs of employee categories: student-ordinary worker (u = 296.200, z = -2.292, p = 0.022), ordinary worker-manager (u = 2.000, z = -2.913, p = 0.004) and supervisor-manager (u = 2.000, z = -2.161, p = 0.031). apart from this, significant differences in the mean scores for customer-related scenarios were identified in the following pairs of employee categories: student-manager (u = 0.000, z = -2.714, p = 0.004) and ordinary worker-manager (u = 0.000, z = -2.972, p = 0.003). furthermore, the kruskal–wallis rank sum tests conducted on the data also revealed significant differences amongst employees with different levels of education on their responses to both work-related and customer-related ethics scenarios (χ2(2) = 14.707, p = 0.001 and χ2(2) = 17.181, p = 0.000) respectively. more details are shown in table 5. table 5: results of the kruskal–wallis rank sum test with highest level of education as the grouping variable. in addition to the preceding test, we paired the ‘highest level of education’ categories and conducted the mann–whitney test on them as a post-hoc measure. significant differences in the mean scores for work-related scenarios were identified in the following pairs of categories: secondary level-college level (u = 22.000, z = -2.546, p = 0.011) and secondary level-university level (u = 22.000, z = -2.937, p = 0.003). in addition, significant differences in the mean scores for customer-related scenarios were identified in the following pairs of categories: secondary level-college level (u = 0.000, z = -2.974, p = 0.003) and secondary level-university level (u = 0.000, z = -2.974, p = 0.003). ethical perceptions the ethical perceptions of employees who participated in the study are presented in table 6. table 6: employees’ perception of the organisational ethics environment. table 6 summarises the findings on smme employees’ perceptions of various ethical aspects within their organisation. a majority of respondents were either not aware of or responded negatively to this question on their perceptions of organisational ethics. only 2.8% of employees affirmed that ethical conduct was rewarded in their organisation, while the remainder either did not know or were non-committal. in the same vein, when quizzed on whether ethical conduct was part of the criteria for promotion, only 11.1% responded positively. it was only on the question of whether employees were inducted on the ethical conduct of the firm that a majority of respondents (72.2%) responded in the affirmative. discussion this study explored the various ethical scenarios that employees in an indigenous fast-food firm would be confronted with on a daily basis. the same study solicited these employees’ responses to situations requiring ethical judgement. the findings indicate that most respondents found workplace scenarios presented to them as morally wrong. these findings corroborate findings from extant literature on the ethical sensitivity of smme employees operating in emerging economies (abratt et al. 1999; phatshwane 2013; storsletten & jakobsen 2015) as well as the social responsibility of the organisation to the broader society as espoused in the social contract theory (donaldson 1982). as storsletten and jakobsen’s (2015) study suggests, employees are increasingly encouraged to be aware of and to question their firm’s core values, strategies and concrete actions especially in contexts where participative management and value-based leadership are considered key values for the realisation of social and environmental responsibility. this call resonates with an earlier exhortation for employees in the retail sector to be aware of the importance of ethical conduct (abratt et al. 1999). the fact that a majority of employees found most workplace scenarios presented to them as morally wrong buttresses the mainstream literature’s recognition of the value of business ethics for the survival of such organisations. another finding was that there were significant differences in employees’ reactions to work-related ethical dilemmas on the basis of age categories. however, no such differences were noted for customer-related scenarios. this possibly means that people from different age categories react similarly to customer-related ethical challenges, but react differently to work-related ethical predicaments. the preceding findings confirm wang and calvarno’s (2015) observation that the results on the relationship between respondents’ ages and their reaction to the ethical climate in their respective organisations were inconclusive. this inconclusiveness is prevalent in climates where corruption and unethical behaviour is rampant. in an environment that is rife with unethical behaviour, it becomes increasingly difficult to make ethical decisions, or to objectively assess the implications of a decision (van der walt, jonck & sobayeni 2016). the findings relating to work-related scenarios however confirm claims that individuals generally develop a moral compass as they grow older (kim et al. 2016). this finding also resonates with van der walt et al.’s (2016) findings that there were statistically significant generational differences amongst baby boomers, generation x and generation y for certain facets of work ethics such as hard work and delay of gratification. however, sweeney, arnold and pierce (2009) question the significance of the effect of age on an individual’s ethical judgement. it was also postulated that respondents of different gender categories responded differently to both customer-related and work-related dilemmas. contrary to conventional wisdom, the current study did not detect a significant difference between genders on both categories of ethical dilemmas. this may mean that when presented with the same ethical scenarios, both genders respond in similar ways to ethical challenges at the workplace. perhaps both genders are exposed to the same ethical codes and ethical awareness campaigns within their organisation. the results contradict those of some scholars whose studies revealed significant difference across genders (atakan, burnaz & topcu 2007; wang & calvarno 2015). the study also examined the influence of one’s position in the organisational hierarchy on his or her reaction to customer-related and work-related reactions to ethical dilemmas. the results confirmed significant differences across levels of organisational hierarchy for both customer-related and work-related dilemmas. this finding contradicted phatshwane’s (2013) findings on the ethical sensitivity of small and large business managers in botswana to the views of the key personnel. phatshwane (2013) found no significant differences between the two groups of managers regarding most questions that queried respondents’ ethical value statements. however, findings corroborate bobek, hageman and radtke’s (2015) idea that individuals in leadership roles respond differently to ethical challenges when compared to those in non-leadership roles. in fact, ardichvili, jondle and kowske (2012) observed that organisational members in non-leadership positions are accommodating to ethically suspect behaviour. in the context of the developing world, the results may possibly be explained by the generally poor remuneration in the workplace, which increases the attractiveness of deviant behaviour as a way of getting additional income. another question was whether there were any statistically significant differences in responses to customer-related and work-related dilemmas amongst individuals of different educational backgrounds. the results were significant for both categories of dilemmas, with those individuals with better educational qualifications reporting positive ethical perceptions compared with their counterparts. the study findings corroborate the findings on the positive influence of education on morality (honeycutt jnr et al. 2001; singhapakdi et al. 1999). a clear polarity of views emerged on employees’ perceptions of ethical values of their organisation (i.e. organisational ethics). this lack of consensus was evident on questions relating to employees’ knowledge of whether the firm had integrity as one of its core values, whether the firm had a code of ethics and whether the firm offered in-house seminars and training as part of the induction on ethical issues. as small firms are often resource constrained and may not have a written ethical code which employees are required to abide by, firm managers’ and owners’ behaviour modelling practices may be critical to employees’ increased sensitivity to ethical issues. literature highlights that individuals (e.g. employees) learn appropriate behaviour by modelling the behaviour of others whom they consider as important, for example, parents, siblings, peers, teachers, superiors and so forth (luthans & kreitner 1975; sama-lang & njonguo 2016). as such, powerful superiors in smmes such as manager and owners need to demonstrate exemplary ethical behaviour, which may wield great influence in shaping, either directly or indirectly, ethical decisions of their subordinates (sama-lang & njonguo 2016). behaviour modelling could be better than establishing ethical codes in smmes. in a study on the communication of ethics in british and spanish small firms, spence and loranzo (2000) reported on the likely ineffectiveness of formal business tools such as formal codes of ethics and social and ethical standards as ways of communicating ethical policies and generating voluntary commitment to specific rules. they attributed the absence of formal codes of practice, standards and mission statements in small uk firms to the opportunity for dialogue and management without the imposition of formal and bureaucratic controls, which often lead to the mistrust of bureaucracy and reliance on informal control mechanisms (spence & loranzo 2000). similarly, a study conducted by slack et al. (2014) on employees’ knowledge of the four strands of csr (of which ethical responsibility is a component) suggests that employees lacked a detailed knowledge of company csr policies or the four key strands. a majority of employees either had vague understanding of the csr concept. we inferred that the documentation of ethical codes and standards does not translate into wide scale rollout of and total commitment to the implementation of ethical practices at lower levels. consistent with stakeholder theory, the divergence of views on the aforementioned ethical matters could be symptomatic of the ambivalence of owners and managers with regard to consideration of all parties implicated in their business activities involving ethical issues. the fact that 44.4% of respondents affirmed that their organisation held induction training courses to new employees and in-house seminars to existing employees on ethical issues while 13.8% of employees disagreed is revelatory. it gives an impression that while there is a good sense of ethical training in the organisation, these seminars may not be held frequently. these findings resonate with cant’s (2012) claim that in the contemporary complex business environment, which is stressful for small businesses to survive, small businesses are pressured to pursue profit and survival at the expense of operating ethically. on whether ethical behaviour was rewarded or not in the organisation, 97.1% of respondents either said it was not or they were not sure of it. it can be inferred from these responses that perhaps there was no reward in the organisation expressly meant for ethical behaviour. it can be inferred that as smmes do not have a moral code governing employees’ ethical behaviour, it is an unspoken rule that employees should just behave ethically or risk being dismissed. as such, it would be unrealistic to expect employers to compensate employees for good ethical conduct as it is an unwritten component of their ethical responsibility. it is suffice to say that this finding seems to mirror cant’s (2012) view that ethical behaviour and the perception towards ethics are not formulated from the morals and beliefs of individuals on its own but rather as a result of the interaction with external factors in the business environment. when asked whether senior management at times allowed the breaking of moral rules for the firm’s benefit, a majority of respondents were either not sure or disagreed. as the percentage of those who were not sure was almost similar to that of those who agreed, it is unclear whether the overall result can be conceived as negative or positive. the clear spit of opinion further complicates the ambivalence manifested in those who were unsure about managerial practices. the ambivalence of responses could speak to the ad hoc nature in which management fulfilled their ethical responsibilities. it is not enough for an organisation to have a corporate code of ethics if the intention is to cherry-pick values and standards in the implementation process. the company must therefore enforce ethical standards particularly through managerial example (carroll & buccholtz 2014; fritz, arnett & conkel 1999). conclusion and managerial implications except for two scenarios (i.e. giving a friend or relative a discount which they did not deserve and taking sales from fellow employees) for which employees expressed polarity of views, these respondents were generally apprehensive of a majority of ethical violations presented to them. these findings suggest that employees in organisations appreciate the value of ethical conduct for business survival (ferrell, fraedrich & ferrel 2014; hartman 2011; trevino & nelson 2010). although this result is commendable, employees’ approval of the two aforementioned ethical violations demonstrates the need for increased ethical sensitivity amongst employees through reprimanding such behaviour and increasing moral guidance through ethical dialogue with employees. employees also expressed disapproval of the ethical violation embodied in the customer-related scenarios presented to them. such disapproval is indicative of the possible existence of consistent and appropriate ethical training on customer service within the organisation. given the proximity and intimacy of relations between smme employees and customers and the significance of customers to smme profitability, the employees’ disapproval of ethical violations relating to customers would be inevitable. while such ethical sensitivity is commendable, it is vital to acknowledge that this practice was far from universal. therefore, smmes should be exhorted to increase their employees’ sensitivity to ethical matters to ensure widespread acceptance of ethical conduct. senior management may need to provide best examples of good ethical conduct to apprehend simmering immoral behaviour and encourage explicit acceptance of good moral conduct. operational level employees are more likely to adopt ethical conduct if strategic people in the organisation lead by example in ensuring ethical acquiescence (antoncic & antoncic 2011; koh & boo 2004). as smmes may not have the financial resources to appoint an ethical compliance officer to drive all ethical compliance programmes, senior management should be briefed about ethical compliance and employees would be expected to take ethical responsibility. however, the extent of their ethical sensitivity is limited to the level to which they are exposed to ethical issues by their employers. therefore, few employees are aware of broader ethical issues beyond the unwritten rule about good ethical behaviour. as resource constraints may complicate the wider rollout of ethical practices through training and seminars on ethical matters at the lower levels only managers and supervisors in the fast-food industry should be trained in ethical responsibility and these individuals can then appraise employees of these issues. verschoor (2000) advocated for a value-based approach to implementing ethics within contemporary business enterprises as opposed to the traditional top-down approach. our study contradicts this view by suggesting that business ethics can be made more pervasive in small firms by training supervisors who can share their ethical knowledge with subordinates rather than developing a detailed ethical code, which could be more demanding resource-wise. employees were not aware of any rewards for ethical conduct by employees. it is plausible that this lack of compensation arose from management’s belief that ethical conduct was already a component of the good behaviour expected of employees and hence there was no need for additional benefits. given the profound connection between a company’s ethical culture and employee engagement, managers and supervisors should work actively to demonstrate a commitment to ethics (ethics resource centre 2010) by modelling exemplary ethical behaviour for employees to emulate. there was a clear polarity of views on whether the firm had integrity as one of its core values, whether the firm had a code of ethics and whether management accepted the violation of moral rules for the benefit of the organisation. the ambivalent and positive views were both well represented in employees’ responses to the three questions, suggesting that although the organisation might have had a code of ethics and had integrity as one of its core values, these could have been undocumented or were arbitrarily effected by management. this may require the clear documentation and consistent application of the code of ethics and the demonstration of integrity in business operations. as for management’s violation of moral rules, the ambivalence of responses could mean guesswork on the part of respondents since many of fast-food employees may not necessarily have higher education qualifications, which capacitate them to make moral judgements on business decisions. detienne et al. (2012) suggest that as one’s education level is often consistent with position in a firm, less educated employees are less situated to know about ethical policies and to engage with organisational authority on such matters. more so, as decisions may be handed down in authoritarian ways in smmes because of the significant role of managers and owners in various matters of the business, few employees may be appraised of such decision making. the provision of induction and on-the-job training on ethical matters would leverage employees’ sensitivity on ethical matters. acknowledgements the authors wish to acknowledge the input of the anonymous reviewers which gave shape to this article. competing interests the authors declare that they have no financial or personal relationship(s) that may have inappropriately influenced them in writing this article. authors’ contributions p.r. wrote all sections of this article. t.m.n. designed the research methodology and did the data analysis. references 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received: 08 mar. 2017; accepted: 04 oct. 2017; published: 19 apr. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: understanding and assessing fiscal sustainability is essential in ensuring financial and macro-economic stability. fiscal sustainability has emerged as an important subject for swaziland given the increasingly volatile government revenues especially those coming through the south african customs union (sacu), which threw the country into a severe fiscal crisis between 2010 and 2012, as well as the pressures on increased government spending in the post-fiscal crisis era. aim: this article primarily focuses on studying whether swaziland’s fiscal policy remains on a sustainable path or whether corrective measures would be required. setting: study focuses on swaziland, a small open economy that is vulnerable to external shocks. the country also relies heavily on south african customs union (sacu) revenues. methods: the study employs a broad approach to assessing fiscal sustainability in swaziland covering both deterministic and stochastic analysis. on the deterministic analysis, the article studies the evolution of debt given macro-economic variables and further estimates fiscal sustainability indicators such as the primary gap and tax-gap. from a stochastic analysis, the article uses the trehan and walsh methodology as well as hakkio and rush methodology. results: fiscal sustainability indicators reflected that the country is on an unsustainable path with a primary gap and tax-gap of about 7% of gross domestic product (gdp) that has to be corrected. the econometric results also portray an evidence of ‘weak-form’ sustainability in the long-run. this is because public expenditures are rising at a faster pace than revenues thereby rendering government deficits unsustainable in the medium term. the econometric results also suggest a tax-spend hypothesis in the long-run, while short-run developments point to a spend-tax hypothesis. in both instances the correction measure is cutting expenditure, mainly recurrent expenditure. conclusion: the study recommends corrective measures (mainly cuts in government expenditure) for fiscal policy to be brought back into a sustainable path without which a fiscal crisis is imminent. the recommendations are mainly based on the fiscal sustainability indicators as they are more forward looking for the short to medium term. the article suggests fiscal rules based on these indicators. introduction the prominence of fiscal policy as a tool has waxed and waned. before 1930 an approach of limited government or laissez-faire prevailed (horton & el-ganainy 2009). although there are various arguments regarding the role played by fiscal policy in ending the 1930s great depression, such as those advanced by romer (1992) and perry and vernengo (2011), the role and objective of fiscal policy gained more prominence in the aftermath of the 2007–2009 financial meltdown as governments stepped in to support financial systems, stimulate growth and mitigate impact on vulnerable groups (aizenman & jinjarak 2011; pelinescu & caraiani 2010). the second-round effects of the global financial crisis hit swaziland negatively through reduced revenues from the south african customs union (sacu), which led to fiscal imbalances and culminated in a fiscal crisis in 2010/2011 and 2011/2012. following 2 years of severe fiscal crisis a recovery in sacu revenues led to improvement in both fiscal and external balances, exerting pressure on the swaziland government to the restore growth and social spending which had been sacrificed during the crisis period. socio-economic challenges faced by the country include inter alia a persistently high poverty level of 63%,1 an unemployment rate of 28.0%,2 a high prevalence of hiv infection and aids and a continuous struggle to attract fresh direct foreign investment. the smallness and openness of the economy has resulted in the swaziland government becoming the largest player therein, with a number of state-owned and small-medium enterprises being heavily dependent on business from the government (basdevant, forrest & borislava 2013). acknowledging the pressure on the government to intervene in the economy to spearhead development initiatives and fight poverty, the finance minister in his 2013/2014 budget speech announced that the government of swaziland was focusing on a ‘big push for growth’, with the theme: ‘jump-starting economic growth: bringing prosperity to the people’ (sithole 2013:1). in the subsequent year fiscal policy remained expansionary, the budget speech theme being ‘invigorate economic growth, create employment opportunities and accelerate public sector reforms’ (dlamini 2014:5). however, this had unintended consequences, which have seen the government incur high levels of expenditure with the potential to spiral out of control if corrective measures are not taken soon. in light of heavy reliance on the government to drive economic growth there is a demand for it to continuously embark on expansionary policies, with expenditure exceeding revenue, which cumulates in increasing public debt. revenue sources have become increasingly volatile, especially from sacu. persistent increases in expenditure against shrinking, volatile revenues signal concern regarding sustainability of the fiscus. as noted by bernanke (2011), large and increasing level of government debt relative to national income or even the prospect of unsustainable deficits has a great economic cost, including rising interest rates that crowd out private investment, reduction in productivity and even increased possibility of a sudden fiscal crisis. fiscal adjustments tend to be more painful in an environment of a looming or actual crisis – hence it is very important to assess fiscal sustainability beforehand in order to implement corrective measures if current fiscal policy is deemed unsustainable. this is also important since credibility and sustainability are key in the continuous financing of public debt. the rest of this article is organised as follows. the next section provides a brief overview of swaziland’s fiscal characteristics, followed by a view of the conceptual framework for analysing fiscal sustainability. this is followed by an empirical strategy with deterministic and stochastic methods for assessing fiscal sustainability, empirical results and conclusions and policy recommendations. swaziland’s fiscal characteristics this section provides a brief review of swaziland’s fiscal characteristics in terms of historical trends and composition of fiscal variables. this provides some stylised facts on public sector developments in swaziland and sets the background for assessing fiscal sustainability in the country. government revenue and expenditure trends historical data for the past 35 years show that the highest government revenues were recorded in 2008 at 34.2% of gross domestic product (gdp), while government expenditures peaked at 32.8% of gdp in 2008 and 2009. in the past 10 years (2006–2015), government revenues retained high volatility, mainly associated with volatile sacu revenues. in general, government expenditures tend to lie above government revenues: even when revenue falls, expenditure does not fall to the same degree. the historical trend of government revenue and expenditure is shown in figure 1. figure 1: government revenue and expenditure trends. over the years sacu transfers have been a major contributor to government revenues, albeit on a declining trend, as illustrated in figure 2. from around 2005 to 2015, the share of sacu revenue declined by over 10%, from about 61% to 48% during the fiscal crisis period, and is projected to decline further to about 35% of total revenue in 2016/2017. major domestic sources of revenue are vat, income tax and corporate tax. classification of swaziland as a lower middle income country by the world bank means that grant funding has been rather low, at less than 2% of total revenue. while efforts are being made to broaden the domestic revenue base, the volatility of sacu continues to put a major financial constraint on the swazi government. figure 2: composition of (a) government revenue and (b) government expenditure. government expenditure constitutes a capital budget, recurrent budget and statutory expenditure. recurrent expenditure is broadly broken down into wages and salaries, goods and services and transfers. the capital programme largely consists of road projects, dams/irrigation, construction of buildings, agriculture, housing and amenities and manufacturing. goods and services under recurrent expenditure largely consist of travel, communication, rentals, drugs, supplies and durables, while transfers include subscriptions to international organisations and subsidies to state-owned enterprises. figure 2 summarises the composition of government revenues and expenditures over the past 10 years. wages and salaries have historically dominated government expenditure, accounting for about 40% thereof (about 10% of gdp), followed by goods and services, which on average accounted for 30% (8% of gdp) and then capital expenditure at 20% of total expenditure (6% of gdp). what can be observed is that during difficult times government responds by reducing the capital budget, as shown in figure 2 for the period 2011–2013 (which was dominated by a fiscal crisis). while estimates for 2016/2017 indicate that capital expenditure is rising, wages and salaries are also on the rise. overall recurrent expenditure accounted for approximately 25% of gdp, while capital expenditure accounted for approximately 7% of gdp over the past 10 years (2005–2015). it is clear that the bulk of government expenditure is recurrent in nature, which loosely means that government has been running recurrent deficits. public debt developments historically the swazi government’s debt has been characterised by a low domestic debt to external debt ratio, at around 19% to 81% respectively. this trend persisted from the early 1990s to the mid-2000s. in 2005 government started issuing treasury bills in a bid to develop the domestic market. as expenditure continued to increase and sacu revenue began falling, the treasury bills programme became a financing item for government. figure 3 shows the composition of public debt and its historical evolution. at the peak of the financial crisis in 2009 and 2010, domestic debt declined due to loss of confidence by the market. figure 3: composition of public debt. it was established during this period that the domestic market uses sacu revenue as a risk indicator for government securities. when sacu receipts fall, the market perceives lending to government to be a risk, hence the fall in domestic debt during the crisis period. consequently, an increase in external debt is observed in 2008–2010, not because of new financing but rather because the share of domestic debt to total public debt fell during this period. perceived risk led foreign creditors to reduce the credit they advanced to government. confidence was later regained by the market when sacu receipts picked up in the post-crisis era, with domestic debt sitting at 45.8% and external debt at 54.2% of total public debt (as at december 2015). conceptual framework on fiscal sustainability the conceptual framework covers fiscal sustainability definitions and assessment methods which could be applied in the case of swaziland. definition of fiscal sustainability the concept of fiscal sustainability refers to the ability of a government to sustain its current spending, tax and other policies in the long run without threatening government solvency or defaulting on liabilities or promised expenditures. while the concept seems easy to understand in theory, there is no consensus among economists on the operational definition. according to krejdl (2006:2), the most general definition states that ‘fiscal policy is sustainable if the present value of future primary surpluses is equal to the current level of debt’. however, this definition only covers the solvency condition. another related concept is that of liquidity: an entity is said to be illiquid if, regardless of whether it satisfies the solvency condition, its liquid assets and available financing are insufficient to meet or roll-over its maturing liabilities. in broader terms, schick (2005) argues that fiscal sustainability has four dimensions: solvency (ability of government to pay its financial obligations); growth (fiscal policy that sustains economic growth); stability (capacity of government to meet future obligations with existing tax burdens); and fairness (capacity of government to pay current obligations without shifting the cost to future generations). assessing fiscal sustainability the study on swaziland’s fiscal policy sustainability uses a number of methodologies, mainly geared towards assessing the fiscal sustainability via different indicators, and also runs policy scenarios that yield recommendations needed for correcting the fiscal policy path if results show current policies not to be sustainable in the medium to long term. as noted by chalk and hemming (2000), the starting point for analysing fiscal sustainability is to use a representative agent model where the government satisfies its intertemporal budget constraints in every period. the intertemporal budget constraint is shown by equation 1: where is the discount factor applying between periods t and t + j, dt is the stock of public debt at time t and pd is the fiscal primary deficit. from equation 1, sustainability requires that the present value of future primary surpluses must exceed the present value of future primary deficits by an amount sufficient to cover the difference between initial debt stock and the present value of the terminal debt stock. noting that the private agents cannot forever remain indebted to the government, implying that the government cannot use ponzi schemes forever3 to keep rolling its debt infinitely, then the second component of equation 1 should be zero (i.e. obey the ‘no ponzi scheme condition’), and hence a sustainable fiscal policy has to respect a present value budget constraint (pvbc) of the form thus from a pvbc standpoint the sustainability test, as suggested by chalk and hemming (2000), will be to test, using historical data, the null hypothesis on whether the transversality condition shown by equation 3 holds: this test checks whether the data-generating process for fiscal data is likely to result in the violation of pvbc. the increase in public debt in real terms should not increase indefinitely at a growth rate beyond the real interest rate. empirical strategy in assessing swaziland’s fiscal sustainability the main focus will rest on studying the evolution of the swaziland government’s debt over time, covering both deterministic debt sustainability analysis (ddsa) and stochastic debt sustainability analysis (sdsa). deterministic debt sustainability analysis for an open economy the government’s budget constraint with no seigniorage4 is given by: where ; α represents the share of foreign denominated debt to total public debt, while εt represents the rate of depreciation for the lilangeni/rand against the us dollar. dt represents the sum of both domestic and foreign debt adjusted by the nominal exchange rate, and pdt represents the primary balance (government revenues – government expenditure excluding interest payments). dividing everything in equation 4 by nominal gdp yields equation 5, which allows for analysis of evolution of the debt to gdp ratio: where dt = debt to gdp ratio and pbt is the primary balance as a percentage of gdp, r is the implicit real interest rate while g represents real gdp growth. another measure for fiscal sustainability used by cruz-rodriguez (2014) expands on equation 5, as shown . from equation 5 the interest is in testing whether j *< 1; that is, whether the implicit real interest rate is less than the real gdp growth (i.e. r* < g). if this is achieved then the debt converges; if not, then the debt will explode and fiscal policy will be deemed unsustainable. from equation 5 the study calculates the primary deficit (surplus) that will be needed to stabilise the debt in the medium term for a given long-run average real economic growth and real implicit interest rates. fiscal sustainability indicators given the real interest rate, real gdp growth and fiscal variables, the study focuses on two fiscal sustainability indicators: the ‘primary gap’ and ‘tax-gap’. according to blanchard (1990), a good indicator for fiscal sustainability should be easy to understand and interpret as well as providing the magnitude of adjustment required. given that fiscal sustainability is a forward-looking concept, it is important to study not only historical data but also whether the projected fiscal variables will obey the government’s intertemporal budget constraint. from equation 5 the primary gap for historical data is calculated as follows: where bt is the debt stock as a percentage of gdp at time t, (r − g) is the differential between real interest rate and real gdp growth also known as the ‘snowball effect’, and pdt* is the primary deficit at time t. from a forward-looking perspective a constant sustainable primary deficit (pd*) that will stabilise debt at its initial level is given by the following: however, if the intention is to achieve a debt level different from initial debt at time t, then the sustainable primary deficit is given by the following: where bt is the targeted debt to gdp ratio at period t and b0 is the initial debt stock, and r and g represent implicit real interest rate and real gdp growth. the primary gap for both equations 7 and 8 is given by subtracting the projected primary deficit (pdt) from the sustainable deficit (p*), in other words pd*–pdt. if the current/projected primary deficit is higher than the calculated sustainable primary deficit (i.e. pd*–pd < 0) then debt will increase without limit; thus current fiscal policy will be deemed unsustainable. the sustainable primary deficit can be used as a yardstick to guide government towards a sustainable deficit path. the primary gap is then computed by subtracting pdt from pd*, and measures the magnitude of adjustment needed to return fiscal balance to a sustainable level. given that the primary deficit is calculated from government primary expenditure and tax revenue, by decomposing the primary deficit to its components more fiscal indicators can be retrieved, one of which is the ‘tax-gap’. like the primary gap, one has to calculate the sustainable tax ratio then compare it with projected tax ratios as a percentage of gdp. the sustainable tax ratio that stabilises debt at its initial level is given by the following: where τ* is the sustainable tax ratio, and εj is the planned primary government expenditure. if the targeted future debt level at time t (bt) is different from the initial debt level (b0), then the sustainable tax ratio is given by: the tax-gap is then calculated by subtracting the current/projected tax ratio (τ) from the calculated sustainable one (τ*). if the tax-gap is positive (τ* > τ), that means the current level of tax revenue is not sufficient to cover future government expenditure and debt repayment. thus adjustments will be needed in fiscal policy if the target of stabilising the debt to gdp ratio at a desired level is to be achieved. according to krejdl (2006), the name of the indicator ‘tax-gap’ does not imply that the necessary changes should come through tax increases. it only suggests that the current tax ratio is not high enough to finance future government spending and service debt – thus a combination of reduced spending and/or increased taxes is necessary for fiscal sustainability. the magnitude of the tax-gap indicator is the size of adjustment required to bring fiscal policy onto a sustainable path. given the tax-gap, any delays in the adjustment process entail increased future costs, because the level of debt to gdp ratio which will have to be stabilised in future would be higher. according to monogios (2011), the cost of any given delay or postponement in filling the tax-gap (i.e. cost of postponing fiscal consolidation) is calculated as follows: stochastic debt sustainability analysis to improve results from the simplistic deterministic debt analysis carried out earlier, this article adopts two econometric methods suggested by afonso (2000), namely the trehan and walsh (1991) method and the hakkio and rush (1991) method. the trehan and walsh method seeks to test the absence of ponzi schemes using the following: where l is the lag operator and bt is the public debt stock. the point of interest is to test whether (1 – l)bt is a stationary process. using the following hypothesis h0:β0= 0, h1:β0 < 0, if the null hypothesis is rejected then debt is sustainable, but if we fail to reject the null hypothesis then that might signal sustainability problems. the hakkio and rush (1991) methodology for fiscal policy sustainability uses co-integration tests. the idea is to test the type of relationship that exists between government revenue and government expenses including interest payments. it involves testing the following co-integration regression5: if government revenues (rt) and government expenses, including interest payments (ggt), are i(1), then the point of interest is to test whether the residual series ut is stationary using unit root tests. the empirical results can be interpreted as follows: if there is no co-integration between r and gg, the fiscal deficit is not sustainable. if there is co-integration with b = 1, the deficit is sustainable. if there is co-integration, with b < 1, then government expenditure is growing faster than government revenue and the deficit may not be sustainable. co-integration tests in estimating the long-run equilibrium shown by equation 13, the study uses the dynamic ordinary least squares (dols) suggested by stock and watson (1993), which is deemed to be robust, particularly in small samples. the procedure corrects for a possible simultaneity problem among regressors by including lead and lags of the change in regressors. the johansen and juselius (jj) procedure is also used to complement the co-integration analysis, which will give the number of co-integrating vectors using both the trace statistic and maximum eigen values test. causality tests given results from co-integration tests, the causality relationship between government revenues and government expenditures is tested using the granger causality test. from the jj procedure, a vector error correction model (vecm) is used to confirm the direction of causality and estimate the speed of adjustment to the deviation from the long-run equilibrium between government revenue and government expenditure. the error correction model is based on the following two equations: where (µt-1) and (µt-1) represent the error-correction term lagged residual from the co-integration relations. the error-correction terms will capture the speed of short-run adjustments towards long-run equilibrium. models 14 and 15 also allow for long-run causality between government expenditure and revenue. negative and statistically significant values of the coefficients of the error-correction terms indicate the existence of long-run causality. the relationship between government revenue and expenditure would then be interpreted within four hypotheses: (1) the tax-and-spend hypothesis by friedman (1978), where causality is unidirectional from revenue to expenditure; (2) the spend-and-tax hypothesis by peacock and wiseman (1979), where causality is unidirectional from expenditure to revenue; (3) the fiscal synchronisation hypothesis, which means government revenues and expenditures are determined simultaneously (bi-directional causality); and (iv) the institutional separation hypothesis, when there is no causality between revenue and expenditure. data sources the study uses government sector accounts with data on the primary balance, government expenditures, revenues and interest payments – all of which are sourced from the medium-term framework (mof) as at december 2015 as well as the budget estimate book of 2016/2017. data on national accounts (gdp) was sourced from the combined sewer overflow (cso) computed after the 2011 rebasing exercise and published in 2015. complementary data were sourced from central bank quarterly and annual report bulletins. for the variables of interest, such as government revenue, expenditure and debt, annual data for the period 1980–2015 were used. e-views version 9 was used for analysis of data for the different methods highlighted in the conceptual framework. empirical analysis this section presents results of the analysis in line with what was covered in the conceptual framework, divided into two broad areas: deterministic analysis results and stochastic analysis results. deterministic debt sustainability analysis results evolution of public debt the ddsa results mainly focus on evolution of the debt to gdp ratio and the shortand medium-term sustainability indicators. figure 4 depicts the law of motion for swaziland’s total public debt, from which it can be observed that the debt to gdp ratio has historically been on a sustainable path. however, post-2015 forecasts (of implicit interest rates and real gdp growth) show that the sustainable path may have been violated. figure 4: law of motion for the debt dynamics. fiscal sustainability indicators this article analyses two fiscal sustainability indicators, namely primary gap and tax-gap, for both historical series as well as shortto medium-term projections, as discussed in the conceptual framework. primary gap indicator: the historical primary gap is calculated using equation 7. the historical series allows for comparison of ‘actual primary balance’ and the ‘debt-stabilising primary balance’; when the actual primary balance is lower than the debt-stabilising primary balance then debt is set on an unsustainable path. figure 5 shows comparison of these two primary balances. figure 5: sustainable versus actual primary balance. as noted in figure 5, prior to the 2010–2011 fiscal crises the government of swaziland ran a primary balance that was above the debt-stabilising level, which kept debt at low levels and ensured fiscal sustainability. however, after 2011 the primary balance more often fell below debt-stabilising levels, signalling sustainability problems. in the medium term, table 1 shows the different primary deficit levels required to keep debt contained, but these are above the initial level of 14.4% of gdp at the end of 2015. these levels are calculated for the 3-year period 2016–2018 using different real gdp growth rate scenarios: the higher the gdp growth, the wider the space to run primary deficits. for all scenarios the primary gap is negative, suggesting that current and projected primary deficits for 2016–2018, as recorded in the mof budget estimate book of 2016/2017, are too high to stabilise the debt and thus will lead to a violation of budget constraints. the primary gap of about 7% of gdp provides the magnitude of adjustment required to bring fiscal policy back onto its sustainable path. table 1: primary deficit to keep debt below 25% of gdp by 2018. tax-gap indicator: using blanchard’s (1990) simplistic formulae6 the tax-gap indicator can be compiled to study historical data. when the tax-gap is greater than zero, this depicts periods where actual taxes fell below sustainable levels, and vice versa (as shown in figure 6). figure 6 shows that prior to the 1990s the actual tax ratios were significantly higher than the sustainable ones, which kept debt accumulation at bay. however, after the 1990s actual taxes often fell below the sustainable ratios, with a peak of 8% of gdp during the height of the fiscal crisis in 2010–2011. figure 6: tax-gap indicator (historical). table 2 shows the sustainable tax ratio that will keep debt below 25% of gdp by 2018. the sustainable tax ratio is 30% of gdp, compared to the projected average tax revenue7 of 23.62% of gdp contained in the mof budget estimate book of 2016/2017. if the gdp growth averages 1.5% (between 2016 and 2018), as announced in the 2016/2017 budget speech, then a tax-gap of 6.8% of gdp would have to be filled in the short to medium term in order to ensure fiscal sustainability. this can be done through a combination of tax increases and cuts in government spending. given the slow growth of the economy, the gap would have to be filled from the expenditure side (by cutting expenditure), noting that some tax measures have already been implemented as proposed in the budget speech of 2016/2017. table 2: sustainable tax ratio to keep debt below 25% of gdp by 2018. from the tax-gap calculations, the cost of postponing fiscal consolidation can be calculated for the different achievable real gdp growth rates. according to table 3, postponing fiscal consolidation by another 3 years post-2018 will cause a 0.87% increase in terms of the sustainable tax ratio that would have to be achieved in order to keep debt at sustainable levels. table 3: cost of postponing fiscal consolidation. the findings of the study are in line with those of mufusire (2015), who also argued that the restoration of swaziland’s fiscal policy to a sustainable path broadly requires adjustment of fiscal variables (mainly government expenditure) in the short term while structural reforms can be done in the medium term. stochastic debt sustainability analysis results this subsection covers results from econometric analysis, primarily the trehan and walsh method and the hakkio and rush method, as described in the conceptual framework. trehan and walsh methodology through the trehan and walsh method interest is on testing for the existence or lack of ponzi schemes in the data-generating process for debt, as shown in equation 6. table 4 shows the results of the econometric estimation of equation 12 using augmented dickey fuller (adf) tests. according to the results in table 4, the historical data for swaziland reflect a ‘no ponzi scheme’ on real total debt. however, after splitting the debt into domestic and external, the hypothesis of ‘no ponzi scheme’ in the domestic debt is not rejected. this means that the solvency condition is threatened from a real domestic debt point of view. these results are consistent with what prevails in practice in domestic debt issuance where short-term article is issued to meet upcoming maturities. public external loans, on the other hand, mostly finance development because they are linked to projects. increase in short-term domestic debt can be expected to threaten total debt sustainability in the medium to long term. table 4: test results for ‘no ponzi scheme’ on real total debt hakkio and rush methodology under the hakkio and rush (1991) methodology to test fiscal sustainability, the interest is on testing for co-integration between government revenue and government expenditure. unit root test results: the study determined the degree of integration of research variables using unit root tests. the adf and philips perron (pp) tests with intercept were adopted to check whether the variable (revenue and expenditure) contained unit roots or not. the results are reported in table 5. table 5: results of unit root tests. the unit root tests show that both real government revenue and government expenditure are integrated at order 1 i(1) in level and integrated at order zero in first difference i(0). co-integration tests: given that the government revenue and expenditure (in real terms) are non-stationary in level, we then test whether the two variables are co-integrated using equation 13 and testing whether the value of b is statistically significant from 1. this equation is estimated using the dynamic ordinary least squares (dols) procedure, which produces more efficient estimators (table 6). the engle-granger and jj co-integration tests are conducted using the resulting dols estimate, and the results are presented in tables 7 and 8. table 6: dynamic ordinary least squares estimation. table 7: engle-granger co-integration test. table 8: jj co-integration tests. the engle-granger tau statistic and the normalised correlation coefficient (represented by the z statistic), which test for unit root in the residuals of the dols output, show that the null hypothesis of no co-integration between government revenue and expenditure is rejected. this is further confirmed by the jj co-integration tests. table 8 represents the results of the trace test and maximum eigen value test statistics for existence of long-run equilibrium between government revenues and expenditure. the null hypothesis of no co-integration (r = 0) based on both the trace test and the maximum eigen value test is rejected at the 1% level of significance. however, the null of r ≤ 1 could not be rejected. these tests confirm that there is only one co-integrating vector. from the dols estimated output it can thus be concluded that government revenues and expenditures are co-integrated and the co-integrating vector is [1 -0.89]. however, the question of whether or not b = 0.89 is statistically significant from 1 is of interest to this study in understanding the strength of fiscal sustainability. the wald test is used to ascertain this, and the results are presented in table 9. table 9: coefficient restriction wald test results. the results from table 9 show that the coefficient b on government expenditure is statistically significant from 1 (i.e. the null hypothesis of b = 1 is rejected) at 5% level of significance. thus it can be concluded that swaziland satisfies a ‘weak’ condition of sustainability as expenditures are rising at a faster pace than revenues. a 1% increase in government expenditure leads to 0.89 of a percentage point increase in revenues, which means fiscal deficits may become unsustainable in the near future. causality tests: given the existence of a long-term relationship between government revenue and expenditure, the next point of interest is to determine which variable causes which. this is done using the engle-granger causality test, the results of which are presented in table 10. table 10: engle-granger causality test results. the granger causality tests show unidirectional causality from government revenue to government expenditure. the null hypothesis of no causality from revenue to expenditure is rejected, while the null hypothesis that expenditure does not cause revenue is not rejected. this means that increases in revenue induce higher expenditures and not vice versa. this implies a tax-spend hypothesis in government’s resource allocation in the long run. vector error correction model the vecm is used to generate short-run dynamics. this article adopts the specification of a vecm government where revenue and expenditure are endogenous variables and national income (real gdp) is used as a control variable. as suggested by sobhee (2004), the inclusion of national income captures the effects of tax on public spending via output and vice versa. there is one lag based on the akaike information criterion (aic) and the final prediction error (fpe) criterion. the vecm results are presented in table 11. table 11: vector error correction model results. the results show that in the short run the lag of expenditure variable has a negative impact on current values of revenue. this means that a 1% increase in expenditure at time t leads to a 0.54% decrease in revenue at time t + 1, and this is statistically significant at the 5% significance level. changes in revenue have an insignificant effect on expenditure in the short run, which means that the spend-tax hypothesis is supported in the short run. the results also show that there is a strong positive association between increases in real gdp and government revenues. a 1% increase in real gdp growth leads to a 1.23% increase in government revenue. the error correction term for the expenditure equation is statistically significant at 1% level, while the error term for the revenue equation is statistically insignificant at all conventional acceptable levels. this supports the assertion that in the long run causality runs from revenue to expenditure and not vice versa, supporting the tax-spend hypothesis which, according to friedman (1978), postulates that raising taxes leads to more than proportionate increases in government spending and keeps deficits at high levels. rezaeri (2015:845) observes that according to this hypothesis the government follows a political rule which says ‘the government will spend what it receives plus as much more as it can get away with’. according to young (2009), under these circumstances fiscal sustainability can be ensured through the ‘starve the beast’ hypothesis, which basically states ‘that the most effective way to shrink the size of government is to reduce the revenue that feeds it’ (romer & romer 2009:140). according to these results it can be inferred that increases in sacu revenues (which are the main contributor to total revenues) resulted in more than proportionate increases in government expenditure, especially prior to the fiscal crisis between 2010 and 2012. conversely, during the fiscal crisis a significant drop in sacu revenues led to an average 25% decrease in revenues, which led to government expenditures being curtailed from 35% of gdp in 2009 to about 23% of gdp in 2012. the error correction coefficient for the expenditure equation shows that any deviation of government expenditure from its path of equilibrium is restored at a rate of 49.7% each year, and this is statistically significant at the 1% confidence level. for revenue any deviations from equilibrium is restored at a much slower pace of 17.3% each year; however, this figure is not significant at conventional levels of testing. the verification of short-term and long-term causality is performed using the generalised impulse response function (irf). given the dynamic structure of a vector autoregressive (var) model, the irf reveals the effects of simultaneous positive innovation shock in one variable on the current and future values of endogenous indicators. figure 7 shows the impulse responses of a one standard deviation innovation for government revenue and on real government expenditures (and vice versa). the impulse response analysis shows that a positive shock (measured as one standard deviation innovation) in real government revenue leads to a sharp increase in government expenditure within the first 2 years of positive shock, followed by a modest decrease and stabilisation at higher levels than before the initial shock. expenditure, on the other hand, has an insignificant effect on revenues. in fact, a positive shock (impulse) in government expenditures leads to a decrease in government revenues within the first 2 years of the shock and then returns to initial levels. this confirms the tax-spend hypothesis. figure 7: generalised impulse responses for one standard deviation (sd) shock for vector error correction model equations: (a) shows the response of real government expenditure following a shock from itself; (b) shows the response of real government expenditure following a positive shock in real government revenues; (c) shows the response of real government revenue following a positive shock in government expenditure; and (d) shows the response of real government revenue following a shock from itself. conclusion the main purpose of this article was to use different methodologies to assess fiscal sustainability in swaziland. the methodologies were broadly divided into two categories: deterministic and stochastic methods, the latter allowing for backward-looking assessment while the former provided futuristic assessment. historical assessment showed that historical public debt obeyed the government pvbcs, thereby satisfying the solvency conditions. however, swaziland satisfies a ‘weak-form’ of fiscal sustainability, suggesting that government expenditures are rising at a faster pace than revenues, rendering the deficit unsustainable in the medium term. vecm results showed that in the short run government was operating according to a spend-tax hypothesis, while in the long run government followed a tax-spend hypothesis. it was also noted that developments in the domestic debt market could result in violation of the transversality condition, which in turn will imply violation of the government’s budget constraints and undermine solvency. with government operating under the tax-spend hypothesis, any increases in revenue translate into more than proportionate increases in government expenditure. fiscal sustainability indicators showed that the current and planned revenues in the short to medium term are too low to finance planned expenditures and keep debt levels sustainable. a primary gap of 7.4% of gdp and a tax-gap of 6.8% would have to be filled to keep fiscal policy sustainable. with no corrective measures, the cost of postponing fiscal consolidation is estimated at 0.75% each year in terms of widening of the tax-gap. on the basis of these results, in the short run government spending has to be curtailed to ensure fiscal sustainability. the study recommends that the primary deficit has to be cut to below 3% to keep debt at sustainable levels. fiscal rules based on tax-gap analysis are also ideal for a given interest growth differential. further research has to be undertaken into improving quality, efficiency and effectiveness of government spending in order to ensure the government achieves more from her limited resources. acknowledgements the authors would like to thank the swaziland economic policy analysis and research centre (separc) who initiated the exercise of this research article through her call for paper and the 100% funding that they provided for this article. separc also facilitated the peer reviewing of the article and provided useful comments, particularly the executive director dr. thula s. dlamini. more comments were obtained from colleagues from the central bank of swaziland research department. disclaimer: welcome n. nxumalo and nomvuyo f. hlophe work as economists in the central bank of swaziland under the economic policy research and statistics department. the views expressed in this article are those of the authors and do not necessarily reflect the views or policies of the central bank of swaziland. the authors assume full responsibility of any errors and omissions. competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions the authors worked jointly throughout the execution of this project. w.n.n. made contributions to the conceptual framework and analysis. n.f.h. worked on fiscal data preparation and interpretation of results. references afonso, a., 2000, fiscal policy sustainability: some unpleasant european evidence, instituto superior de economia e gestao lisbon, portugal. aizenman, j. & jinjarak, y., 2011, the role of fiscal policy in response to the financial crisis, background paper for united nations, world economic situation and prospects 2011, viewed 10 october 2016, from http://www.un.org/en/development/desa/policy/wesp/wesp_archive/2011wesp_bg_paper_aizenmanpdf basdevant, o., forrest, e. & borislava, m., 2013, restoring sustainability in a changing global environment: options for swaziland, african department publication 13/1, international monetary fund, washington dc. bernanke, b., 2011, ‘fiscal sustainability’, in annual conference of the committee for responsible federal budget, washington dc, viewed 11 january 2016, from https://www.federalreserve.gov/newsevents/speech/bernanke20110614a.htm blanchard, o., 1990, suggestions for new set of fiscal indicators, oecd working paper no. 79, oecd publishing, paris. chalk, n. & hemming, r., 2000, assessing fiscal sustainability in theory and practice, international monetary fund working paper no. 00/81, international monetary fund, washington dc. cruz-rodriguez, a., 2014, assessing fiscal sustainability in some selected countries, mpra paper no. 54975, university library of munich, germany. dlamini, m.g., 2014, the budget speech presented to the parliament of the kingdom of swaziland, lobamba, swaziland. friedman, m., 1978, ‘the limitations of tax limitation’, policy review, summer, 7–14. hakkio, c. & rush, m., 1991, ‘is the budget deficit “too large”?’, economic inquiry 29(3), 429–445. https://doi.org/10.1111/j.1465-7295.1991.tb00837.x horton, m. & el-ganainy, a., 2009, back to basics: what is fiscal policy? finance and development pamphlet, international monetary fund, washington dc. ilzetzki, e., 2011, fiscal policy and debt dynamics in developing countries, policy research working paper, wps5666, world bank, viewed 14 november 2016, from https://openknowledge.worldbank.org/handle/10986/3429 krejdl, a., 2006, fiscal sustainability – definition, indicators and assessment of czech public finance sustainability, working paper series, czech national bank, prague, czech republic. mackinnon, j.g., haug a.a. & michelis, l., 1999, ‘numerical distribution functions of likelihood ratio tests for cointegration’, journal of applied econometrics, 14, 563–577. monogios, y., 2011, the tax-gap as an indicator of fiscal sustainability: analysis and policy proposals for the case of greece, centre of planning and economic research, athens, greece. mufusire, a., 2015, assessing swaziland fiscal sustainability and policy options, research article, african development bank, abidjan, cote d’ivoire. muzenda, a., 2014, ‘an empirical assessment for fiscal sustainability in south africa’, journal of economics and sustainable development, 5(23), 1–7, viewed 21 january 2017, from http://iiste.org/journals/index.php/jeds/article/viewfile/16751/17112 o’connell, s. & zeldes, s., 1988, ‘rational ponzi games’, international economic review, 29(3), 431–450. https://doi.org/10.2307/2526789 peacock, a. & wiseman, j., 1979, ‘approaches to the analysis of government expenditure growth’, public finance quarterly, 7, 3–23. https://doi.org/10.1177/109114217900700101 pelinescu, e. & caraiani, p., 2010, ‘fiscal policy in the context of the economic crisis’, romanian journal of fiscal policy, 1(1), 1–21. perry, n. & vernengo, m., 2011, what ended the great depression? re-evaluating the role of fiscal policy, levy economics institute working paper 678, levy economics institute of bard college, new york. rezaeri, a., 2015, ‘tax-spend, spend-tax or fiscal synchronization hypothesis: evidence from iran’, international journal of innovation and applied studies, 10(3), 844–857. romer, c.d, 1992, ‘what ended the great depression?’ the journal of economic history 52(4), 757–784 romer, c.d. & romer d.h., 2009, ‘do tax cuts starve the beast? the effect of tax changes on government spending’, brookings papers on economic activity, spring, 139–214. schick, a., 2005, ‘sustainable budget policy: concepts and approaches’, oecd journal on budgeting, 5, 107–126. https://doi.org/10.1787/budget-v5-art5-en sithole m.v., 2013, the budget speech presented to the parliament of the kingdom of swaziland, lobamba, swaziland. sobhee, s., 2004, ‘the causality between tax and spend of the public sector in mauritius: a vecm approach’, international journal of applied econometric and quantitative studies, i, 115–130. stock, j. & watson, m., 1993, ‘a simple estimator of co-integrating vectors in higher order integrated systems’, econometrica, 61(4), 783–820. https://doi.org/10.2307/2951763 swaziland government, 2010, ‘2009/10 swaziland household income and expenditure survey – poverty in a decade of slow economic growth: swaziland in the 2000s, central statistics office, mbabane. swaziland government, 2014, the swaziland integrated labour force survey 2013/14, ministry of labour and social security, mbabane. trehan, b. & walsh, c., 1991, ‘testing inter-temporal budget constraints: theory and applications to us federal budget and current account deficits’, journal of money, credit & banking, 23(2), 206–223. https://doi.org/10.2307/1992777 wigger b.u., 2007, ‘a note on public debt, tax-exempt bonds and ponzi games’, imf working paper wp07/162, international monetary fund, washington dc. young a.t., 2009, ‘tax-spend or fiscal illusion?’, cato journal, 29(3), 469–485. footnotes 1. according to the swaziland household income and expenditure survey of 2010. 2. according to the swaziland labour force survey of 2013–14. 3. literature on ponzi schemes is well documented by o’connell and zeldes (1988) and wigger (2007). 4. seigniorage is the revenue governments derive from printing money: the face value of the money minus the cost of physically making and distributing it. 5. most recent papers use vector error correction models (vecm) e.g. muzenda (2014) or vector auto regressive models (e.g. ilzetzki 2011). 6. using sustainable tax ratio τ* = primary expt–(gt–rt)bt, where g and r represent the real gdp growth rate and implicit real interest rate; b represent s government stock of debt. 7. tax revenue in this context includes both tax and non-tax revenue but excludes grants. sajems ns vol 7 (2004) no 2 387 an overview of commodity tax reform in southern africa ________________________________________________________________ z robinson department of economics, university of pretoria ________________________________________________________________ abstract various studies have emphasised the trade and/or revenue implications of free trade. the purpose of this study is to investigate future tax implications of further economic integration. additional considerations are whether tax competition can become an issue and whether it can be used to the benefit of all sadc members. an integrated approach was done of what is needed in terms of commodity taxation to reach a workable long-term solution. this article analyses experiences in the developing world with reference to lessons learned from developed regions. the first section provides a theoretical background, analysing the meaning of commodity tax. the second section emphasises the importance of fiscal decentralisation in federations and the sadc and the third investigates the character of and changes in commodity taxation that could occur in the future. jel h20 1 introduction the world bank (1991) has expressed concern about tax competition and harmonisation in developing countries. this specifically includes competitive responses from other countries to incentives (tax holidays, accelerated depreciation, tax credits, and favourable resource royalties designed to attract foreign capital) used in developing countries. unexplained phenomena relate to the effectiveness of these incentives to attract foreign capital and trade as well as the side effects of these incentives, e.g. tax discrimination, to induce or limit growth. the need for developing countries to harmonise taxes among themselves through multilateral and bilateral negotiations is therefore, again emphasised. apart from finding sensible explanations for problematic tax practices, a continuous attempt is also made to find long-term workable solutions. the emphasis falls on southern africa, that is, the southern african development community (sadc). an african renewal has been postponed for many years. with the advent of the sajems ns vol 7 (2004) no 2 388 new millennium, president mbeki of south africa referred to this renewal as an “african renaissance”. the millenium partnership for the african recovery programme (map, 2001) led by mbeki, obasanjo of nigeria and boutefilka of algeria, and the omega plan (omega, 2001) proposed by president wade of senegal, can therefore be seen as a welcome change to previous efforts. at this special summit meeting of the heads of state and government in march 2001, the need to make provision for a new streamlined structure for the sadc in order to speed up its economic integration and cope better with the crisis in the region (e.g. the war in the drc), was also recognised. some of the proposed changes sought to create legal structures that would adjudicate issues of trade and economics that would not suit the interests of individual members. the aim of the reform process is to address the fears of smaller economies and to accommodate their aspirations and interests. the world bank (2000: 34) points out that both “winners and losers (and more of the former than the latter)” should be recognised as the first step, although the persuasion of the winners to forgo some of their gains to compensate “influential losers who could otherwise stymie the process” should form part of trade and investment reform. although the sadc has gone beyond the initial stages of an fta, tax competition and coordination problems as such have not yet surfaced. the possibility of a higher degree of economic integration may yet expose these in future. at the same time the formulation of macroeconomic convergence criteria for this region has become essential and this should be dealt with within the confinements of certain tax restrictions. the emphasis in this article is not specifically on trade or the revenue implications of free trade because various studies have already been conducted in this area. the purpose here is to take the lead and investigate the future tax implications of further integration. an additional consideration is whether the current situation can be used to the benefit of all sadc members. the idea is to form an integrated approach of what is needed in terms of commodity taxation to reach a workable long-term solution in terms of macroeconomic stability. this article attempts to analyse experiences in the developing world with crossreferences to lessons that can be learned from developed regions. in this context, the first section analysis the meaning of commodity tax competition and therefore provides a theoretical background. a short background study of fiscal decentralisation is then provided and hence also the institutional character of the more “developed” federations in the developing world, namely argentina, brazil and india in comparison with the sadc. deeper integration means increased exposure to the consequences of the removal of barriers to trade and factor movements and the experiences of selected federations can provide useful lessons. argentina, however, is a unique case study, and is included because of its successes with institutional reform during the 1980s and sajems ns vol 7 (2004) no 2 389 1990s. on the downside, it is also included to show the effects of fiscal insustainability on macroeconomic stability1. the second section emphasises the importance of fiscal decentralisation in federations and the sadc. the third section emphasises the current character of and changes in commodity taxation that could occur in the future. the last section attempts to give an overview with some conclusions and recommendations. if not otherwise mentioned, data and statistical resources utilised in the article are mainly from the finance and investment sector coordinating unit (fiscu), the international monetary fund (imf), the national treasury of south africa (ntsa), pricewaterhousecoopers (pwc), and the world bank (wb). various problems arise when one tries to analyse data from developing countries. in the case of african studies, burkett, humblet and putterman (1999) state that the main problem is the unreliable nature of the available data. different variables may be recorded for the same observation in different editions of the same source. the imf (1998) warns that the results obtained by using data should be interpreted with caution. before proceeding, it is therefore important to shed some light on the international status of developing countries in terms of taxation. 2 commodity taxes against the backdrop of tax competition commodity taxation is investigated within a tax competition context by various authors. this type of analysis is especially applicable within a process of economic integration, e.g. in a common market or economic union, and a federation. different commodity tax rates across borders create distortions that in turn induce spillovers or externalities such as cross-border shopping. the most familiar types of commodity taxes are the single-stage retail or general sales tax (rst/gst) and the multi-stage or broad-based value-added tax (vat). the main difference between the two entails different methods of collection, with rst on a suspensive system and vat on a repayment system; and the tax base that is being taxed also differs. with vat the onus is always on traders to convince the tax authorities that their claims for refunds on their inputs are justified, whereas under rst there are no such claims (the tax is levied only once at the final destination or on imports). the claims for refunds or the tax liability can be computed via subtraction, addition or tax credits (invoice method). detailed records of purchases as well as sales have to be kept under a vat mechanism but not under rst. administrative difficulties may therefore occur more readily with vat, but it is also normally implemented to curb tax evasion and corruption. vat is also sajems ns vol 7 (2004) no 2 390 introduced for minimising “tax-on-tax” for which rst/gst is criticised. 2.1 mintz and tulkens (1986) mintz and tulkens (1986: 135) were the first to investigate commodity tax competition between independent fiscal authorities. a two-region economy (high-tax and low-tax) where an origin-based commodity tax2 is levied by each region, is investigated. the tax is levied on a private good to finance a local public service. the nash equilibrium of these tax rates is analysed whilst all other private goods are untaxed. a single region’s market and fiscal decisions as functions of the region’s characteristics as well as of its environment, is investigated. the analysis is extended in order to consider simultaneous decisions made by the two regions. a so-called regional market equilibrium (rme) and interregional market equilibrium (ncfe) are included in the model. in these two cases, the equilibrium is fully efficient. the main reason for this is that transport costs are so high that no cross-border shopping occurs, either in equilibrium or in response to small tax changes. in these cases, none of the interregional externalities described previously appear. wilson (1999) argues that it is difficult to describe these cases as “tax competition”, because governments are not really competing over the tax base. not all theorists on tax competition, however, share this view. there is a two-person game and the players are local governments. the strategies are local taxes and expenditure levels, and the payoffs are the regional welfare function. nash equilibrium is established in this two-person game in which there is collusion, i.e. a non-cooperative or competitive situation. this is referred to as a non-cooperative fiscal equilibrium (ncfe). a ncfe amongst two regions that choose optimal tax rates and public services production may not always exist due to a significant change in the fiscal or tax reaction functions. this means that a switch from one type of regime to another could occur. differences in the regions’ government size, as well as tax levels can therefore arise from strategic behaviour and not only from differences in tastes and endowments. in the absence of interregional public service spillovers, the inefficiency of a ncfe thus arises from two types of externalities, viz.: (a) negative private consumption effects (terms-of-trade effects) that occur when an increase in a region’s tax affects the private good purchases of the other jurisdiction’s residents; and (b) positive public consumption effects that occurs when an increase in one region’s tax, increases the tax base of the other region (see also bucovetsky 1995: 362). sajems ns vol 7 (2004) no 2 391 emphasis is placed on the fact that tax competition is inefficient under the origin (source) principle in both regions and that cooperative policy measures may become essential in improving the outcome of the ncfe, in short nash equilibrium. 2.2 kanbur and keen (1993) in kanbur and keen’s spatial model of cross-border shopping (1993: 877), it is argued that unrestricted tax competition (open borders) can take place between small and large regions (countries). the following assumptions are utilised: (a) there is a partial-equilibrium model of two countries (home and host) and a single taxed good; (b) the population is distributed uniformly in each country, but the two populations may differ in size; (c) commodity taxes are levied on a destination basis3, and there are no barriers to the entry or exit points of new stores; and (d) the individual has two decisions to make when buying a commodity, viz. to buy in the home country or to travel to the host country with transportation costs involved. a pay-off matrix can be utilised to show the results of the different game situations. in this case, the matrix (table 1) describes unrestricted tax competition as a “prisoners’ dilemma”. prisoners’ dilemma is a famous case in game theory literature. although the analysis is given in terms of commodities (cross-border shopping), the same analysis can be applied to mobile capital (hallerberg, 1996). table 1 prisoner’s dilemma facing two regions on tax policy region b region a confess (compete in taxes) deny (no tax competition) compete in taxes 3,31 6,0 no tax competition 0,6 2,2 note: 1 these values (x, y) represent pay-offs in terms of ordinal utility between a and b (the higher the values, the better the pay-offs). in table 1 it is shown that nash-equilibrium (3,3) is reached where both regions a and b both compete in taxes. when small and large regions compete in sajems ns vol 7 (2004) no 2 392 taxes, both behave in a nash manner. this means that each region chooses its own tax rate to maximise its tax revenue while assuming a fixed tax rate by the other region, bearing in mind the impact on cross-border shopping. in this equilibrium situation the small region (size relating to the number of residents) undercuts the large region because the small region’s tax rate (t) is below the large region’s tax rate (t), i.e. t<t. this point, however, is pareto-inefficient. when neither region competes in taxes, i.e. tax competition is restricted (by closed borders), joint tax revenues are reduced or minimal, with larger regions suffering a revenue loss (if the difference in size is sufficiently great) and the small regions normally gaining revenue. cnossen (1990: 476) argues that the potential revenue loss with cross-border shopping may be particularly injurious to smaller regions because these regions are normally rate-takers and not rate-setters as is the case in larger regions. smaller regions normally tend to set rates lower to increase the volume of their sales. it is therefore undesirable to set a uniform tax rate somewhere between t and t because this will always harm small regions, relative to the nashequilibrium. it will, however, be beneficial to the large country (relative to the nash equilibrium or unrestricted tax competition) if harmonisation takes place at rate t (rate-setter); but harmful if harmonisation takes place at rate t (ratetaker). setting a minimum tax rate somewhere between t and t, will lead to the small region setting the minimum rate, still undercutting the large region. in this case both regions will set their tax rates higher at point (2,2) and, therefore, revenue will increase in both the large and small regions. this point is thus pareto-efficient because there is no other strategy choice that makes both players better off. tax competition is therefore inefficient. kanbur and keen (1993: 889) offer two criteria to determine the optimality of coordination, viz. pareto-efficiency and joint product or revenue maximisation. in the latter instance it is possible to make compensating transfers between the revenuelosing and revenue-gaining regions. in the next section a short background study of fiscal decentralisation is provided and hence also the institutional character of the more “developed” federations in the developing world, namely argentina, brazil and india in comparison with the sadc. 3 fiscal decentralisation within federations and the sadc argentina and brazil, two of the largest federations and democracies in latin america, have been chosen as examples. together with sub-saharan africa (ssa), latin america has the highest number of regional groupings in the sajems ns vol 7 (2004) no 2 393 developing world, often with overlapping membership and objectives ranging from limited cooperation in specific areas to full-fledged economic integration. furthermore, latin america has had significant tax reforms since the 1980s with substantial growth in fdi inflows during the 1990s as well as macroeconomic instabilities. india, the largest democracy in the world, has a long history in federal finance and has been chosen as the representative of the asian region. south, east and south-east asia are currently attracting most of the fdi inflows to developing countries worldwide (unctad, 2000) with china at the forefront. the region becomes even more interesting if one takes the effects of the financial crisis of 1997 into account, but at the same time realising the advantages of global production networks and attracting most of the parts and components trade worldwide (see world bank, 2000: 66). africa, which is still struggling to become a major market player, can therefore learn from these and other experiences which are also unique in terms of sub-national commodity taxation in argentina, brazil and india. in the following sections, fiscal decentralisation which is prominent in the three federations, will be discussed and where possible compared with the sadc. although fiscal decentralisation is not yet relevant to the sadc which still has a long way to go before being transformed into a common market or economic union, it lays a foundation and provides a summary of what these economies could become together or individually. figure 1 provides a summary of the fiscal decentralisation features in the federations in question and those members of the sadc, which possess actual components of decentralisation. the table provides only a glimpse at the degree of fiscal decentralisation and further discussions should shed some light on the different countries’ tax and expenditure legislation. latin america has had a long tradition of centralisation, which dates back to the period of colonial administration. after the independence movement, centralised fiscal structures remained in place, partly because of colonial inheritance, and partly because of the need for countries to keep distant provinces under one power. even today, when compared with the industrialised world, the region as a whole remains highly centralised. while sub-national levels of government are responsible for over 35 per cent of total government expenditure in industrialised countries, on average, in latin america the corresponding figure is less than 15 per cent (stein, 1998). the latter, however, does not refer to the federations within latin america (fig 1). although the region remains highly centralised, the tendency towards decentralisation is quite strong. sajems ns vol 7 (2004) no 2 394 figure 1 the composition of sub-national shares in selected federations and the sadc 0 10 20 30 40 50 60 argentina brazil india botswana south africa zimbabwecountries p er ce nt ag e (% ) share of government expenditure 1990 share of government expenditure 2000 0 5 10 15 20 25 30 35 40 45 argentina brazil india botswana south africa zimbabwe countries p er ce nt ag e (% ) share of government revenues 1990 share of government revenues 2000 source: imf, 2002; see also table a.1 in latin america, revenues were traditionally decentralised before expenditure responsibilities, and national governments therefore had to maintain spending levels with a smaller resource base resulting in large deficits. for instance, argentina’s subnational governments’ share of total governments expenditure declined from 46,3 per cent in 1990 to 43,9 per cent in 2000 while the opposite happened in government revenue. the national government’s share has therefore declined even further in terms of revenues. separate tax and spending powers have allowed subnational governments to incur only a fraction of the political and financial costs of their expenditures, especially when most local resources are funded from a common national pool of tax revenues creating a commons problem. subnational governments have controlled substantial resources (e.g. the subnational vat in brazil), and in some cases have adopted revenues from these resources as their “own”. both national government and local governments levy limited forms of vat but the state vat is by far the sajems ns vol 7 (2004) no 2 395 most important of the three and it may therefore be difficult to find a solution to this problem. although brazil has gone a long way in the process of devolving revenue sources and expenditure functions to subnational governments and granting significant autonomy in policy making, local revenue mobilisation has hardly been encouraged by the country’s system of intergovernmental transfers. a significant vertical fiscal imbalance has arisen in the latin american region typically because more expenditure responsibilities have been assigned to local governments with limited own revenues. the vertical fiscal imbalance has been greater than that in industrialised countries with an average of 42 per cent for oecd members compared to 52 per cent in latin america. the vertical imbalance also seems to vary significantly between different countries in latin america, and among decentralised countries the difference between latin america and the oecd seems to be even greater. this suggests that finding a suitable tax base to assign to subnational governments is more difficult in the case of developing countries (stein 1998: 105). the high degree of vertical imbalance in decentralised countries in the region creates the possibility of a commons problem, in particular when combined with highly discretionary transfer systems, or a large degree of borrowing autonomy. for instance, central bank bailouts to state banks that are “too big to fail” have been important in some brazilian states, such as são paulo and rio de janeiro. these tendencies can also be compared with tendencies in asian economies. the fiscal systems of east asian economies have traditionally been highly centralised. in india, states have been granted substantial powers to tax and spend but these powers have not been properly implemented. central government has maintained control over substantial resources and the states have had to cope with financing large spending functions with limited resources. however, this unitary behaviour appears to be changing gradually with a process of adjustment for states with high deficits and debt. this trend can be partly observed in an increasing tendency in both expenditure and revenue shares of subnational governments. subnational shares have increased in terms of government expenditure (from 51,1 per cent in 1990 to 53,3 per cent in 2000) and with a greater but not significant amount in terms of revenues (from 33,8 per cent in 1990 to 36,1 per cent in 2000). an overall summary of fiscal decentralisation in developing and developed countries provides insightful reading. subnational expenditures comprise a small share of government expenditures (the median for developing countries is about 14 per cent), except in industrialised countries (the median is about 34 per cent) and large federations such as argentina, brazil, canada, india, mexico, the russian federation and the us (the median is approximately 45 per cent). sajems ns vol 7 (2004) no 2 396 experience in these countries suggests a few guidelines for decentralisation. firstly, in the case of developing countries, fiscal decentralisation is likely to generate imbalances at the subnational level which may lead to a deterioration of the fiscal position of the national/central government. as a result, the growth performance of these economies may be negatively affected. secondly, mature federations and eu members have nevertheless experienced higher subnational spending shares for a much longer period than most developing countries mentioned, without significant fiscal imbalances at the centre. in these countries, more stringent control of subnational fiscal positions (applicable budget constraints with explicit transfers) seem to have prevented the deterioration of national and subnational fiscal positions owing to decentralisation. returning to figure 1, most sadc members have centralised or unitary governments and are characterised in some cases by authoritarian rule and/or high military expenditures especially in war-torn countries such as the drc. several heads of state, for instance, those of namibia and uganda4 (with the most recent case in zambia) have also opted to adjust their constitutions in order to lengthen their terms of office. data are therefore not always available or nonexistent for subnational levels. furthermore, in a number of countries decentralisation has not yet resulted in relinquished control from the centre and this is partly related to the quality of governance at different levels. ghana, malawi and zambia have each created local councils, but the national government continues to direct almost all subnational spending and management decisions. similarly, the ruling national party in tanzania holds almost all subnational offices. besides uganda, south africa is regarded as one of the few african countries that is in a process of unification through decentralisation. south africa is a much larger country than, say, france, germany, the netherlands and the uk combined, and compares well with these unitary countries in terms of revenue decentralisation. the share of subnational revenues remained relatively constant from 1990 to 2000 but increased to approximately 10 per cent. in comparison, a substantial change has occurred in terms of government expenditures and according to the new constitution (1994), the provinces have received many more responsibilities regarding expenditure. south africa’s national government therefore has a relatively small share in expenditures (about 50 per cent) in comparison with the european countries mentioned. this makes sense because the larger a country is, the more local governments it is bound to have. the provinces have a share of about 40 per cent of general government expenditure but relatively little own revenue, creating the need for a large amount of downward funding (unconditional and conditional or block grants). this will probably change in the future with the sajems ns vol 7 (2004) no 2 397 south african constitution making provision for a higher degree of devolution in terms of taxes. the process and methods of implementation (either through tax surcharges or tax sharing) is, however, still uncertain and future legislation should provide clarity on this issue. from the discussions on fiscal decentralisation, it should be clear that decentralised fiscal systems offer a greater potential for improved macroeconomic governance, if managed correctly, than centralised fiscal systems. mature federations in the developed world are proof of this conclusion. decentralised fiscal systems require greater clarity in the roles of various players (centres of decision making) and transparency in rules that govern their interactions, to ensure fair play. 4 commodity taxation and some of the implications for trade although in the short and medium term, the trade effects of the establishment of a free trade area (fta) in southern africa are of particular importance for sadc members, more emphasis is placed on future issues concerning commodity taxation in the region. the liberalisation of regional trade will have definite fiscal effects with short-term loss of tax revenues, for instance those from sacu. fiscal reform and specifically tax reform in this case, should therefore be initiated so that the already vulnerable macroeconomic position of sadc members is not exacerbated. tax reform in this regard again entails the objectives of taxation. the distortionary influence of taxation on consumption (savings) and investment should be minimised (ensuring neutrality) whilst administrative costs should be kept as low as possible to ensure effectiveness. the sadc technical arm spearheading trade negotiations, the trade negotiating forum (tnf), has agreed on the various policies that are required to underpin the implementation of the trade protocol. it mainly recognises the need for harmonisation and also includes a need for macroeconomic stability. it also promotes the idea of a future common market set for after 2006. various studies have been conducted on the introduction of the sadc fta and its effects on southern africa (crefsa, 1998; evans, 1997; 1998 & 2000; akinkugbe, 2000; roberts, 2000). the conflicting effects of other bilateral agreements on the sadc are included in these studies, for instance, the likely impact of the fta between the eu and sa on the remaining member countries of the sadc which are neither party nor signatory to the agreements. at present, the other sadc-members belong to a wider regional grouping known as the african caribbean and pacific (acp) group to which south africa only holds qualified membership because it was not regarded as a typical lesssajems ns vol 7 (2004) no 2 398 developed country. south africa was therefore excluded from any agreements between the eu and the acp under the lomé convention. in march 1996, the eu mandate of offers to south africa for the fta was formally tabled and negotiations commenced for the eu-sa fta. several rounds of negotiations were completed by the end of march 1999, giving rise to the agreement on trade, development and cooperation between the european community and the republic of south africa of 1999. the agreement was finally signed on 11 october 1999 in pretoria and the effective date of implementation fixed for 1 january 2000. the salient feature of the agreement is that the eu-sa fta will be established over a transitional period, lasting on the south african side for a maximum of 12 years, and on the eu side for a maximum of 10 years from the date on which the agreements take effect. a phased elimination of duties is therefore designed in the agreements that will eventually lead to free movement of goods, services and capital between the eu and sa. the eu-sa fta could therefore change the competitive advantage that the rest of the sadc members have and south african exports could even replace part of the other sadc members’ current exports to the eu. akinkugbe (2000: 21) finds that “the implementation of the eu-sa fta is almost parallel with that of the uruguay round negotiations (wto agreements) around the world, in the sense that the competitive conditions of the sadc members vis-à-vis europe stand to be fundamentally altered in the next decade or so”. as already mentioned significant structural changes due to macroeconomic imbalances are thus necessary in those sadc economies planning to diversify the composition of their export trade. furthermore, sacu members, particularly swaziland and lesotho, may lose a sizeable proportion of their annual fiscal revenue on the full implementation of the eu-sa fta, and these countries will have to find other ways of diversifying their internal revenue bases rather relying on trade taxes. these effects are also similar to the full establishment of the sadc fta and it is therefore realistic to think with the establishment of the sadc fta with south africa as one of the members, that the eu-sa fta and the eu-acp agreements will be incorporated into further integration measures to simplify the process. 4.1 trade within southern africa observing the trade behaviour of the sadc members identifies some interesting characteristics. the sadc has successfully increased intra-regional trade over the past decade. the trade flows have increased more than tenfold since the formation of the sadcc. the sadc’s performance has clearly outweighed that of other regional groupings within africa, which reinforces the notion of the sadc being the most successful integration scheme in africa sajems ns vol 7 (2004) no 2 399 (world bank, 2002). in 1997, the world bank estimated intra-regional sadc exports to be over 11 per cent of total exports. however, many of the sadc members’ major trading partners are still outside the community and the african continent. a significant share of the region’s trade is conducted with the developed world and the eu in particular. over the past two decades, for instance, almost 40 per cent of all sadc exports were destined for western europe. there is also a strong correlation between trade patterns and their colonial ties. about 13 per cent of all sadc exports over the past two decades went to their former colonial rulers. also, as already pointed out earlier in the discussion, trade levels are low because of the composition of their exports. they often find themselves dependent on the export of one single commodity. for instance, exports from angola are predominantly oil (86 per cent) and for botswana, diamonds (88 per cent), while malawi’s exports mainly comprise tobacco (76 per cent). it is also a well known fact that high dependence percentages make economies more vulnerable to fluctuations in price and therefore market conditions. table 2 south african trade within the sadc (excl. sacu), 1998-2001 percentage of total sa exports percentage of total sa imports country 1998 2001 1998 2001 angola 6,9 7,2 0,5 0,1 drc 6,4 3 0,8 0,6 malawi 7,7 7,6 21,3 10,9 mauritius 6,6 11,7 1,4 2,4 mozambique 16,9 24,9 10 12,3 seychelles 1,1 1,1 0,4 1,9 tanzania 6,6 6,6 1,3 1,3 zambia 13,5 21,1 9,9 7,7 zimbabwe 34,4 23,3 54,5 64 sadc 11,1 11,8 11,1 11,2 source: department of trade and industry (2001) besides western europe, south africa is the largest trading partner of other sadc members. trade between south africa and the rest of the sadc countries increased dramatically during the period 1990 to 2001 (see table 2). imports from the sadc increased from less than 1 per cent of total imports in 1990 to more than 11 per cent of total imports in 2001. the increase of south africa’s exports to the region was even greater – from 5 per cent of total exports in 1990 to almost 12 per cent of total exports in 2001. south african exports sajems ns vol 7 (2004) no 2 400 are concentrated in the value-added sectors such as minerals and base metals, chemicals, machinery, transport equipment and food and beverages. the rapid increase in trade with sadc countries during the 1990s shows that south africa enjoys a relative advantage in accessing these markets, mainly by virtue of its geographical proximity and south african businesspeoples’ networks with their counterparts in the different sadc countries. the same, for instance, applies to germany which enjoys a trade advantage in the eu towards neighbouring ceecs. cross-border effects such as trade spillovers and cross-border shopping is therefore evident between south africa and the other sadc members, rather than between the sadc members themselves. south africa experienced significant trade reforms and liberalisation because of its economic isolation prior to 1994. the import tariff rate (weighted average) declined significantly from 21 per cent in 1994 to 15 per cent in 1998. textiles, electronic goods and automobiles are considered to be price elastic or sensitive and tariffs on these items will be phased out over the longer term. trade liberalisation and change will continue in line with south africa’s commitment to the wto (see ntsa, 2003). since 1999, south africa has concluded nonreciprocal bilateral trade agreements with malawi, mozambique, tanzania, zambia and zimbabwe which should increase trade even further between south africa and these countries. under the eu-sa fta, south africa has also agreed to remove barriers on 86 per cent of eu imports, while the eu will scrap 95 per cent of its tariffs on south african goods phased in over a 12-year period. at this stage, the average tariff rate in the countries of southern africa is about 12 per cent and this compares well with federations such as argentina and brazil (13,5 per cent). these rates are still uncompetitive compared with developed regions such as japan (2,3 per cent) and the us (2,8 per cent) and europe where the average is 2,7 per cent (wef, 2003). south africa has, however, established foreign trade relations but always attempts to improve on its trade performances by also improving small, micro and medium enterprises initiated though the department of trade and industry’s ntsika project. south african manufactured goods account for about 70 per cent of exports to africa, where these goods have been successful because of competitive prices, shorter supply routes and a sound understanding of the african market. south africa is, however, still largely reliant on the export of primary and intermediate commodities to developed countries despite attempts to diversify its export base. south africa’s principal exports are gold (40 per cent of total exports), platinum, diamonds, coal, food, wine and manufactured products. imports mainly comprise capital goods, raw materials, semi-manufactured goods and sajems ns vol 7 (2004) no 2 401 consumer commodities, and originate primarily from germany, japan, the uk and the us. by february 2003, the main imports together with switzerland and the blns countries, were machinery (30 per cent), chemicals (11 per cent) and minerals (8 per cent). germany, japan, the uk and the us are also major export markets for south africa. from the above-mentioned discussion, it should become clear that fiscal adjustment may not be as significant in south africa as in other sadc countries where customs and import duties are still important in comparison with other revenue sources. also, the notion that the integration among african states may be sub-optimal to the integration between african states and higherincome regions (e.g. the eu). furthermore, “regional trade agreements between sub-saharan african (ssa) countries could be of limited value and could even lead to trade diversion and a divergence of per capita income amongst member states” (naude & krugell, 2001: 502). this also means that for the sadc it would be more beneficial to integrate with the eu than with south africa, and vice versa for south africa. further integration and fiscal adjustment measures should therefore rather be implemented as a cooperative mechanism between the members to ensure that tax revenues are equally distributed on some basis such as the population size. 4.2 commodity tax coordination and reform figure 2 summarises the structure of the domestic tax systems of the federations and the sadc. for the sadc members there are still significant disparities. as already mentioned, malawi, mozambique, zambia and zimbabwe are countries that suffer the most from an fta and/or customs union (evans, 2000). in general, tax systems are known to be non-neutral, that is, they cause distortions in terms of the allocation, especially in goods and factor markets in developing regions. although estimates are unreliable, that is, the excess burden of taxation is significant in these countries various reforms have been introduced mainly to broadening the tax base with a simultaneous reduction in tax rates. in the sadc, members would either have to broaden the tax base or increase tax rates to compensate for losses incurred by the planned fta and/or customs union. some of these members have already started significant adjustments, especially in the field of commodity taxation, because capital income taxation does not allow much room to increase rates (see fig 2) or broaden the base. marginal income tax rates are already high in comparison with international standards and increases in these rates are likely to distort employment, savings and investment even more, with a likely increase in tax evasion. sajems ns vol 7 (2004) no 2 402 figure 2 commodity tax revenue, 2000 0 10 20 30 40 50 60 70 argentina brazil india (central) south africa sadc countries % o f t ot al ta xa tio n sales taxes excise taxes commodity tax capital income tax source: imf, 2002; see also table a.2 in terms of the tax base, the average share of capital income taxes already carries a significant weight (31,3 per cent) and leaves some room for adjustment compared with the eu average (41,6 per cent). the worldwide tendency has, however, been to rather keep the corporate tax burden as low as possible in order to attract more active or fixed capital and even to zero-rate some withholding taxes on foreign interest income. the belief is that capital income taxes, specifically those on interest income, are “disappearing” because the implementation of the residence principle on interest income has become ultra burdensome with cooperation between governments not always forthcoming. the sadc member governments also realise the need for the attraction of capital and this can be observed from the numerous tax incentives provided in terms of export processing zones (epz) and foreign investors. accepting that the sadc governments have already decided on the relevant balances between capital income and commodity taxation, the most significant reform measures and fiscal adjustment could occur in terms of commodity taxation in the sadc. capital income taxation, however, is not flawless and there is room for improvement. the average share of sales taxes (14,6 per cent) and excise taxes (10,1 per cent) in the sadc are still relatively low (fig 2) compared with the eu average of 27,4 per cent for vat and 18,9 per cent for excise duties. in terms of the federations, argentina’s subnational authorities’ tax revenue as a share of total revenue is about 90,8 per cent, brazil’s 77,4 per cent and india’s 83,4 per cent for 2000. sales taxes (vat) as a percentage of total taxation in argentina are 27,5 per cent, brazil 8,5 per cent and india only 0,1 per cent. the same shares sajems ns vol 7 (2004) no 2 403 in terms of excise taxation are 13,8 per cent in argentina, 7,8 per cent in brazil and 25,7 per cent in india. although india’s subnational share seems high, the central government still tends to undermine these authorities’ rights and exercise to much control over these resources. the commodity tax shares of subnational levels are also much higher than those in mature federations such as canada and the us. taxing powers have therefore been significantly devolved in argentina, brazil and india, and in some cases even to the detriment of the national governments. although this trend of decentralisation is not observable within the sadc (only in south africa), experiences from these countries can serve future prospects of sadc members as the region becomes more integrated towards a common market and possibly an economic union. the tax reform experiences of latin american countries such as argentina and brazil, which have experienced significant tax reforms since 1980, can also provide important insights for future reform in the sadc. latin american governments realised the importance of tax policy, and tax reform therefore became an integral part of wide-ranging economic reforms in the region. latin american governments found that tax policy was an instrument that was relatively easier to wield than politically difficult expenditure cuts, and its effects were more immediate, and in the short and medium term at least, it was more directly measurable than those of other economic policies. as latin american economies became more integrated with the rest of the world, tax systems could no longer be viewed in isolation. the growth of emerging financial markets and the surge in direct investment and more open trade and payments regimes gave impetus to the reform movement. tax competition became a prominent issue and governments realised that they had to reduce or eliminate taxes that raised business costs and domestic firms in positions where higher rates applied at a disadvantage in world markets. at the beginning of the 1980s, most latin american tax systems were complex and cumbersome, loaded with hundreds of revenue agencies with little revenue being collected. consumption and production suffered because of multiple rates and were weakly administered (shome, 1995). these taxes were also insufficient because of “cascading”, which taxed not only the value of production but also taxes paid at earlier stages of production since they were generally levied at the manufacturing stage (such as those now present among some of the sadc members), rather than the retail stage, they hampered competition and added to production costs. tax reform in latin america has been implemented in various ways. in argentina, for instance, tax reform led to a radical redesign of the entire system, sajems ns vol 7 (2004) no 2 404 whereas in columbia, it was carried out as a series of steps over a number of years. reform-induced countries simplified their tax systems focusing on income taxation in the early years of the reform process and, increasingly, the taxation of production and consumption in later years. as the economies of the region matured and were integrated with the rest of the world, attention was also focused on the fine-tuning of particular aspects of the tax system with international ramifications such as the exchange of information, foreign tax credits and transfer pricing. in terms of commodity taxation, vat was an important part of the reform effort between the early 1980s and 1994, and the number of countries with a vat doubled from 10 to 20. in the early 1980s, some countries either had a rudimentary vat up to the manufacturing-importing stage, or a productiontype (origin-based) vat which disallowed credit for capital goods purchases. in the second half of the decade, these countries began to reform their vats, by reducing the number of rates (bolivia, chile, columbia and mexico) and expanding the base by reducing exemptions and raising coverage, particularly of services (argentina, bolivia, chile, colombia and mexico). furthermore, some countries, notably argentina, chile, colombia and mexico converted to consumption-type (destination-based) vat and improved their tax administrations. countries that achieved a large increase in their tax-to-gdp ratios, such as argentina, bolivia and colombia often did so through vat. as vat revenue rose, countries relied less on excises, taxing only a few items such as beverages, tobacco, petroleum products and automobiles instead of a broad range of goods and services. all of the major countries in latin america have also done away with export duties and most have reformed import tariffs with the dispersion of these rates being reduced and tariff levels significantly decreased. the latin american experience is far from perfect, especially with regard to subnational commodity taxation as in brazil. fiscal or tax adjustments should therefore always directly be handled in line with economic circumstances in a particular country. as mentioned earlier, some sadc members have already started fiscal adjustments for the planned sadc free trade area (fta) and/or customs union (cu), specifically in terms of commodity taxation. in the next section, commodity taxation in the sadc is discussed, specifically in terms of adjustment and reforms that might be needed in future. 4.2.1 fiscal adjustment and tax reform table 3 gives an indication of the present commodity tax rates (column 2) against what is required in terms of the planned sadc fta and/or future cu (column 3), and also excise tax categories. namibia has experienced a sajems ns vol 7 (2004) no 2 405 significant adjustment with a switch from a gst of 8 per cent in 1997 to a standard vat of 15 per cent with an increased rate of 30 per cent in 2000 (column 2, table 3). this rate would leave ample room to compensate for any losses in terms of customs revenues. tanzania also has a vat system with a rate that changed from 10 to 20 per cent from 1997 to 2000, with the drc close on its heels with a standard vat rate of 18 per cent. although these countries did not incur significant problems in compensating for any revenue losses of tariff reform, the rate is not as important as the quality of the reform involved. keen and lighthart (1999: 18) point out that, if an underlying tariff reform improves production efficiency, replacing the tariffs with domestic consumptions taxes (specifically emphasising vat) will raise welfare in a small open economy. this should therefore also be applicable to those countries in which significant tariff reforms are necessary. countries such as malawi, mozambique, zambia and zimbabwe would lose the most in terms of the planned fta and/or customs union (column 3, table 3) and therefore require close scrutiny. malawi has a so-called sur-tax (between sales and value-added tax) of 20 per cent. crefsa (1998) estimates that this rate would have to increase by 5 percentage points to offset revenue losses. mozambique has a standard vat of 17 per cent which was introduced in 1999 and as such is already on the road to change. zambia has a standard vat of 17.5 per cent introduced in 1995. according to crefsa (1998), this rate would have to increase by 3 percentage points to offset losses. the vat in zimbabwe would have to change by 8 percentage points to 23 per cent if the present standard rate of 15 per cent on goods and services other than basic goods (0 per cent), electricity (5 per cent) and luxury goods and motor vehicles (25 per cent) is taken into account. mauritius, which has been relatively dependent on trade taxes, has a vat of 15 per cent bringing it more in line with the rest of the sadc members. besides rate increases, the mere fact of switching to vat in the sadc can already improve the buoyancy of these revenue sources and decrease the distortions associated with commodity taxation. any sales tax that does not extend through the retail sales level can cause administrative problems because if the actual sales price is used, competitive distortions are created in different channels of distribution. for instance, when manufacturers or wholesalers sell directly to ultimate consumers at retail prices, the price should presumably be reduced to the wholesale level. however, if manufacturers sell directly to retailers who assume some manufacturing or wholesaling functions, the actual sales price should be increased to equalise the situation of such sales with those made through regular channels of distribution. this type of tax has, therefore, proven to be ineffective as a revenue-raising sajems ns vol 7 (2004) no 2 406 instrument in several countries such as australia (see messere, 1993), and countries such as angola should also consider changing over to a vat system. south africa’s experience probably served as a directive to those sadc countries that switched over to vat during the 1990s and more recently. table 3 commodity tax rates and excise categories, 2003 country sales tax rates (%) vatrates (sadc fta/cu) excise categories argentina1 1 – 3.5 (rst) --wide variety (other than exports) at varying rates. brazil1 7 & 25 (icms) --federal excise tax (ipi) which is similar to a vat. india1 4 (cst) --levied on certain types of manufactured goods. angola 10 & 30 (sales tax at manufacturing level) n/a other taxes include taxes on oil production, an oil transaction tax and a surface tax. botswana 0 & 10 (sales tax at manufacturing and import level) 2 10 tobacco (15 per cent), alcohol, fuel, soft drinks and certain luxury goods with specific rates on fuel and alcohol. drc 0.25-3 (x), 3-13 (local), 18 (construction), 302 n/a luxury goods, alcohol and tobacco. lesotho 142 11 alcohol, fuel, soft drinks, matches and certain luxury goods. other taxes include sand and stone levies and a petrol levy. malawi 17.5 (sur-tax) 25 tobacco and alcohol. mauritius 152 12 tobacco, alcohol and materials (textiles). mozambique 17 2 n/a tobacco, alcohol, perfume, cosmetics and toiletries. namibia 15 & 30 (luxury goods)2 15 tobacco, alcohol, fuel, soft drinks and certain luxury goods. other taxes include a sales duty (0–25 per cent). seychelles trades tax under the trades act 1992 on all imports and locally manufactured goods and services. n/a -- sajems ns vol 7 (2004) no 2 407 table 3 continued country sales tax rates (%) vatrates (sadc fta/cu) excise categories south africa 14 2 14 tobacco, alcohol, fuel, soft drinks and certain luxury goods. other taxes include a fuel levy. swaziland 14 & 25 (luxuries) 13 imported local goods such as tobacco, alcohol and petroleum products. other taxes include a sugar cane levy, sugar export levy, entertainment tax, sports levy and fuel tax. tanzania 202 11 other taxes include a dairy industry levy, entertainment tax and motor vehicle registration tax. zambia 0 & 17.52 20 tobacco, alcohol, fuel and entertainment tax. zimbabwe 0, 5, 10, 15 & 25 23 tobacco, alcohol, fuel, soft drinks, petroleum products. other taxes include a tobacco levy and automated financial transactions. notes: 1 in argentina, a vat of 21 per cent is applicable at federal level. each of the 24 provinces imposes a quasi-rst (taxation on the gross revenue for the sale of goods and services) where most industries and exports are exempt from this tax. in india, the central government levies a vat of 16 per cent (the union excises). besides the latter, a special tax, namely the central sales tax (cst) of 4 per cent, is levied by exporting states on interstate exports (origin-basis) in all the states and the revenues also accrue to the states. brazil has a subnational vat (7-25 per cent) levied on an origin-basis. 2 all these countries have a vat system. 3 the blns countries and south africa as sacu members maintain essentially the same tax base in terms of customs and excise duties (customs and excise act with amendments, 1964; ntsa, 2001). source: pwc (2004) the south african experience, like the experience of latin american countries, can also provide useful lessons to the rest of the sadc members that are planning to switch over to a vat system. the collection of commodity taxes through a comprehensive vat (including retailers) has become standard practice worldwide. it has also become the focus of tax reform efforts in developing regions. in south africa, the margo commission (1987: 345) sajems ns vol 7 (2004) no 2 408 recommended as an alternative to reducing the gst rate and introducing a comprehensive business tax (cbt) or a value-added income tax (vait), that gst should be abolished and replaced with a vat credit or invoice-based system. consequently, vat was introduced on 30 september 1991. 4.2.2 base broadening and tax compliance in accordance with the oecd practice worldwide which is a reasonable indicator of “international best practice”, vat should be on a broad basis (including goods and services) and a credit (invoice) system, and the destination principle should hold. thus far, the administrative ideal of only a few rates has been achieved in south africa with only one standard rate and a zero rate. the rate has also been relatively low and increased from 10 to 14 per cent, which is still within the recommendation of the world bank (1991) of between 10 and 20 per cent for developing countries. in 1996, the vat base was broadened to include most fee-based financial services. however, the vat system tends to be more regressive with a few exemptions and zero-ratings still in place. the katz commission (1994: 133) recommended against the further erosion of the vat base through zero-rating or exemptions stating that targeted poverty relief and development programmes should rather receive priority instead. this currently is being done in south africa through the department of public works community-based projects. in addition, higher vat rates on luxury goods or a multiple vat rate system should be avoided. the main reason for the latter recommendation was that such a system would not reduce regressivity, would have high administration and compliance costs and would not have much additional revenue potential. in a vat credit system, multiple rates, as in the case of zero-rating (say, on exports) and exemptions, open up opportunities for fake claims and hence tax evasion, but also complicate administration for tax authorities and taxpayers alike. in the end, an optimal system of commodity taxation can be secured only if the loss of economic efficiency with vat is minimised through uniform rates or a few rates applied to the broadest possible base. if this does not happen, a compromise will have to be made between administrative costs and equity. this case is even further strengthened if a system of income and expenditure supports is already in place for the poor. a broad-base vat also means that the necessary increase in tax rates is smaller than for specific commodity taxes such as excise taxes and that the risk of distorting specific markets is correspondingly lower. the sadc region can gain from south africa’s experience of excise duties. the world bank (1991: 6) recommends setting three or four selective tax rates on luxuries and nonessentials, with the rate ascending according to the item’s role in the sajems ns vol 7 (2004) no 2 409 consumption of the rich. the katz commission (1994: 133) recommends that the present ad valorem excise duties in south africa be retained but that the possibility of introducing a progressive ad valorem duty on luxury motor vehicles should be investigated. since 1994, excise taxes on tobacco products (for health reasons) have progressively been increased to 50 per cent of the retail price. the blns countries already have a common customs (which has been phased down in line with wto regulations) and excise system applicable under south african legislation for sacu, and it will become necessary for a future sadc fta (cu) to specifically coordinate excise duties for further integration purposes. the south african government has also initiated a rewrite of the customs and excise act of 1964, primarily because its readmission to the international arena has shifted the focus from revenue collection to trade facilitation and control (ntsa, 2000: 73). at present the excise categories in the sadc largely correspond and include mainly tobacco, alcohol, fuel, soft drinks and certain luxury goods (table 3). the rates, however, still seem to differ considerably. in this regard, the eu experience can serve as an example with common customs and tariffs, and common excise duties, which have been set through minimum rates. the sadc countries should, however, be careful not to imitate developed regions’ experience in every detail because as already mentioned, the needs of developing countries’ may differ significantly from those of developed countries. another more recent experience of the zambian government could better serve the sadc region. the government undertook a comprehensive review of both the tax system and customs duties, with the intention of significantly broadening the base of taxation. a considerable number of exemptions in both taxes and customs duties were eliminated and the emphasis shifted from specific consumption taxes such as excise duties to sales taxes in the form of vat introduced during 1995. the zambian authorities achieved higher revenues (tax revenue reached 31.5 per cent of the gdp in 2000), despite significant cuts in customs duties and marginal tax rates. the ultimate objective is that other sadc governments would learn from, say, the south african and zambian experience. it is, however, questionable whether the different sadc governments cooperate with their neighbours or whether they have established links with one another5. the zambian experience reminds one of argentina’s experience with tax reform at the beginning 1990s. the government implemented radical changes in response to successive crises, and the lack of political resolve to enforce tax laws progressively eroded the tax structure and administration. revenue only reached 11 per cent of the gdp in 1989, compared with 14 per cent in 1985. sajems ns vol 7 (2004) no 2 410 the strategy was thus to improve the quality and quantity of revenue mobilisation by eliminating taxes that were easy to collect but inhibited growth such as export taxes and taxes on financial transactions, and to concentrate instead on a few major taxes such as vat and on overhauling the tax administration. the strategy was highly successful, and the ratio of tax revenue to gdp climbed to 16 per cent in 1993. argentina’s vat went from being the least revenue-productive6 in the world to being highly productive (shome, 1995). the tax base was broadened and evasion sharply cut. businesses failing to make timely or correct declarations were summarily closed for three days. in 1990, 700 taxpayers were penalised in this way. in 1992, the number rose to 12 000. this had a strong impact on vat compliance. new invoicing requirements and controls were introduced, and expanded information on vat taxpayers helped to improve the collection of other taxes by permitting tax inspectors to cross-reference tax data. since the second half of 1992, the government has focused increasingly on using the tax system to improve enterprise competitiveness. foreign trade taxes have been lowered and in an effort to improve the cost structure of the economy as a whole, the federal government has also started encouraging provincial governments to reduce or eliminate local taxes that impinge directly on enterprise costs. although the argentine vat system is not flawless, it can teach the sadc an important lesson on the topics of base broadening and tax evasion. although it would appear unnecessary with a tax revenue effort already in full swing, a broadening of the tax base in the sadc could minimise upward pressure on tax rates, and thus improve the international competitiveness of the region and avoid excessive tax-induced distortions. it could also improve the revenue productivity of commodity taxes (gst and vat), which is still relatively low measured in terms of oecd standards (crefsa, 1998). various countries also still maintain tax incentives concerning sales taxes on exports or export-processing zones (epzs). for instance, in angola, malawi, mauritius, mozambique, south africa, zambia, and zimbabwe all kinds of incentives (vat exemptions, and customs and excise duty exemptions) on materials and inputs used for exporting purposes or within an export-processing zone (epz), are still included in the gst/vat system. although these incentives apply to outward-oriented operations, they can reduce the effective vat rate and work against the objective of a broader and ultimately a coordinated base for the region as a whole. sadc governments have, however, increasingly started with concerted efforts in tax compliance, notably mozambique where an independent uk-based private agency has been appointed to operate customs revenue, and in south africa, where the south african revenue service (sars), an autonomous agency within the public sajems ns vol 7 (2004) no 2 411 service, has been established. in both cases the result has been a significant increase in revenues collected. tanzania and zambia have also established independent revenue authorities and it seems as if this type of reform appears to be gaining ground in the region with positive effects for revenue productivity. zimbabwe had the same kind of spot calls in 1997 as those in argentina in 1992. under separate operations, the department of taxes and the department of customs and excises in zimbabwe checked businesses for tax payments and gained substantial sums of money outstanding. in south africa, the sars record speaks for itself. by the end of march 2001, sars had continued its 6-year track record of surpassing tax collection targets (national treasury of south africa, 2001). most of the additional revenue was derived from income tax and it would thus appear that tax evasion has been considerably reduced. although from experience, the most attractive instrument of commodity taxation for fiscal adjustment is a broad-based gst in terms of simpler administration and compliance, sadc members generally seem to be switching over to a destination-based vat credit system. the administrative capacity of these countries seems to have a greater reliance on vat, and this could even enlarge in future. botswana, for example, has decided to introduce a destination-based vat of 10 per cent in 2002, which will make its sales tax base much wider but with fewer exemptions and zero-rated exports. lesotho, has also implemented a 14 per cent vat on 1 july 20037. the vat system is usually known for its broad basis with value being added in each production stage (multiple stages). higher rates are therefore more tolerable in terms of vat rather than a us-type gst or rst levied at one stage. the vat system normally entails more administrative costs and it is therefore important that the introduction of such a system involves careful planning and that governments already have the administrative capacity in place to maintain the system. an effective vat system, if correctly implemented, can therefore eliminate any discrepancies that might exist in terms of bookkeeping for tax purposes and also tax evasion as such. shalizi and squire (1988: 7) emphasise that if an “embryonic” or all-inclusive commodity tax is in place, the role of this taxation as a source of revenue should be expanded. in the short run, this could be achieved by means of an increase in the tax rate with a compensating reduction in tariff rates (as already pointed out in the case of the sadc). in the long run, expansion in the base will allow further reductions in rates and cause an increasing amount of revenue to be generated from the taxation of domestic activities. further measures of fiscal adjustment in the sadc to reach the objective of regional growth may therefore include a broadening of the commodity tax base past the sajems ns vol 7 (2004) no 2 412 manufacturing/wholesales level as already discussed, and the broadening of capital income tax bases with enhanced compliance and disciplined spending. 4.3 future prospects it is clear from the investigation thus far that the sadc governments will have to make some adjustments in terms of commodity taxation and that there is always room for improvement. in this section, future prospects in terms of the present system of commodity taxation that exist in the region will be explored. the possibility of the adoption of a vat system for the whole of the region in particular will be analysed, especially with a view to further integration efforts such as a common market (cm). under the present system, it would appear that most of the sadc governments will apply a destination-based vat in the future, and that the intention in the short run could be to skip the fta and immediately move to a cu where origin is irrelevant. 4.3.1 revenue sharing, revenue clearance and the destination principle the sadc might proceed with a cu because of the difficulty of compliance with origin rules in the planned fta and/or cu. in a cu, countries are normally concerned with avoiding fiscal discrimination (i.e. ensuring tax neutrality) which causes differences in competitiveness, and the importance of fiscal autonomy or sovereignty is recognised. customs duties are collected at the point of entry, irrespective of the final destination of the goods within the cu. all of the parties to the cu may therefore collect duties on imports destined for other parties. unless the customs revenues from such cross-border or trans-jurisdictional imports are more or less equal, some mechanism or formula for revenue allocation must be devised if one of the parties is not to end up subsidising the other. for instance, in terms of sacu, bnls imports from the rest of the world reach south african harbours first and south african imports alone are also much more than those of the bnls countries. a cu therefore abolishes economic but not fiscal borders, and fiscal equalisation measures (e.g. the common revenue pool of sacu) are needed to eliminate distortions due to taxation. in terms of the future sadc fta/cu, countries such as south africa may not be willing to provide compensatory mechanisms such as those applicable within sacu. the uncertainty exists about south africa’s ability or willingness to continue its compensation programme to current or any future members of an enlarged sacu (sadc) as well as the willingness of the other members to stay in sacu in the absence of such payments. as sacu continues to liberalise, the new revenue-sharing formula will become impractical but will also have a negative impact on smaller economies that have done little to diversify their sajems ns vol 7 (2004) no 2 413 revenue source. a similar problem arises in respect of other indirect taxes, especially the vat, if the destination principle is to be upheld. it is often argued that this principle is rarely supported in full by tax-incidence analysis, and that if one considers the implications of the term “vat” a tax on value added in production then its revenues should fall to the tax jurisdiction in which production (origin) takes place, rather than the one in which the final products are consumed (destination). the application of the destination principle, however, ensures that foreign sales (exports) are tax-exempt and all domestically paid taxes are reimbursed. taxation therefore takes place in the importing country, including taxes on the last exchange with compensation corresponding to the various taxes that a similar product of the importing country would have paid in the preceding phases. normally special provisions such as border tax adjustments still have to be made to enable the exporter to be rebated for vat previously paid in the importing country. the importer can then reclaim vat after retail sale in the importing country. the destination-based vat therefore guarantees a greater degree of neutrality and uniformity. for a future sadc cu/cm, revenue sharing or rebate schemes can be constructed on some general formula or on that of actual revenue clearance. whereas the former has the advantage of administrative simplicity, it also raises questions of the formula’s derivation and its adjustment over time. in the case of vat, for instance, the general formula normally fails to take into account the composition of trade. for instance, it could be that vat-exempt items constitute a larger share of zimbabwe’s exports to south africa than of imports from south africa. the formula would therefore overestimate the vat revenue on south africa’s purchases accruing to zimbabwe, thus underestimating the sum to be rebated to it from south africa. more detailed formulas, on the other hand, would require frequent updating and renegotiation. a bookkeeping approach or national accounts of revenue clearance on the basis of actual payments would make more sense for a future sadc. this will, however, require identification of the ultimate destination and that such information be readily available from a computerised customs-clearance system operated by the south african customs authorities which are now also responsible for customs and excises of sacu. in this case, it is important to add that the sadc ministers of finance signed a memorandum of understanding (mou) on cooperation in taxation in 2002. the mou will be incorporated into the sadc protocol on trade and investment that is due to be signed in 2004 (ntsa, 2003). further, in terms of vat, a credit system with invoices issued by the sellers (registered traders) to the importers will prevent double taxation. the importer normally uses this invoice to claim a rebate from his/her tax authorities for vat already paid on inputs purchased from the sajems ns vol 7 (2004) no 2 414 exporting country and thus retrieving the money from the exporter’s exchequer or revenue authorities. in the absence of economic borders, say in a future sadc common market (cm), the difficulty of levying vat on a destination basis (same as interest income on a residence basis) effectively means that the origin principle is practised. the origin principle is, however, distortive in terms of production. the destination principle (with a revenue-clearance system) will therefore make more sense in a developing context, specifically because production (exportoriented growth) and fdis are first in line as employment generators. furthermore, in a future sadc, competition could become exceptionally severe when tariffs have been eliminated among member countries in terms of a cm. here, each country could promise a wider market to foreign capital than before and consensus would have to be reached in terms of tax diversity (competition) or uniformity. the same argument applies once revenue losses in terms of the sadc fta have been recouped through, say, higher vat rates, and countries such as malawi, zambia and zimbabwe will have to re-evaluate their different situations to prevent tax competition from driving them out of the market. the experiences of other developing countries can also provide useful lessons in this context. in countries such as india and argentina, commodity tax reforms have proceeded more slowly (only started in 1992) than those in brazil, perhaps because of fear of the same difficulties. india’s sales tax system is still problematic because of its non-harmonised nature with various types of sales taxes at central and state level, including a cst levied on an origin basis at state level (table 3). most of the asian economies carry a sales tax or vat-rate of 10 per cent and as such the world economic forum (2003) classifies sales tax or vat rates in asian economies as a competitive asset whereas latin america’s sales tax or vat systems is seen as a liability. argentina, however, provides the best-case scenario in this analysis because it has already started to switch over to a destination-based subnational vat system (table 3). brazil’s problematic vat-system specifically, can therefore provide some interesting insights for the future decentralisation exercises of individual sadc members or for further integration of the sadc members (subnational level) into a common market or an economic union. brazil was the first country to introduce a fully-fledged vat in 1967. the introduction of vat in brazil and the consequent problems are directly related to the fact that it was also introduced as a subnational vat. the rate structure also changed from a single to a multiple rate system and the new tax resulted in a series of complex technical and administrative problems of how to apply different vats in the different states (the icms for each state) in addition to a federal vat (the ipi)8. sajems ns vol 7 (2004) no 2 415 at present, the origin principle applies to interstate trade in brazil. there is no meaningful concept of administrative integration between the federal and state versions of the vat. brazil therefore has the problems of dealing with crossborder trade which has been problematic even in the eu, but also excessive compliance and administrative costs, location distortion, and tax exporting and competition. despite uniform rates for the states on exports and attempts to alleviate the distortionary effect of the origin principle by imposing a standard rate of 12 per cent on interstate trade (with an exception of a lower rate of 7 per cent on shipments to the poorer state), there are still economic complications. recent recommendations in brazil made provision for the adoption of an integrated vat system with a new federal icms that would be collected together with a revised state icms on the same base as a unified vat at a uniform national rate consisting of a federal rate and a uniform state rate similar to the “harmonised” vat system in canada or the proposed “common” vat system (1996) in the european commission. after considerable debate, the state icms was substantially revised to eliminate significant elements of taxation on exports and investment in the existing system, with the federal government guaranteeing that no state would lose revenue as a result of the change. it is therefore argued that in brazil, as in the case of argentina and india, a decent vat system with subnational governments also applying independent vats will require the implementation of the destination principle at different tax rates on interstate trade and some means of compensating “losing” states for revenue losses implied by the transition. this type of system resembles the one in canada, which is also similar to the cvat option and also the tax-sharing option (specifically the so-called gewerbesteuer or local business tax) in germany. a good administrative system assisted by mutual trust and a high degree of negotiation between the different levels of government is necessary when the destination principle is applied. the theoretical case for the destination (residence principle) is strong but not absolute. the ease with which some commodities or capital goods can be moved means that a significant element of origin (source) taxation is always inescapable. however, consensus seems to exist in favour of maintaining as much of the destination principle as possible (maybe supporting it by use of restrictions on distance sales); also because of a fear of transfer pricing problems that potentially arise when vat is levied by the origin principle9. although sadc governments’ administrative capacities seem to have improved since the 1980s (shalizi & squire, 1988), a high degree of mutual trust such as the one present in the “harmonised” vat system of canada or tax-sharing options of germany, could still elude these governments10. the growing sajems ns vol 7 (2004) no 2 416 problem of direct sales through electronic commerce might still also become a problem in the sadc. the green paper on e-commerce (rsa, 2000b: 30) in south africa also recognises this problem and questions to what extent econsumption should be taxed. a consideration of alternative approaches (the cvat and vivat systems) to the destination-based vat system has therefore become necessary11. when considering alternative approaches, the importance of an overarching authority again becomes clear. keen (2000) argues that in the absence of an overarching authority, vat systems run into difficulty in securing appropriate clearing, ensuring that revenue collected on exports from one jurisdiction is available to finance credits/refunds claimed in another. this problem could be resolved by providing incentives to subnational tax administrations to provide the appropriate level of effort in terms of their wider collective interests. of course, also in terms of the eu where tax sovereignty is regarded as more important, the adoption of an overarching federal or supra-national authority becomes a natural outflow. in the sadc the harmonisation or coordination of commodity taxation could become necessary in the long term. in the short term it is important to concentrate on revenue losses and therefore rate increases for some countries, notably zambia and zimbabwe. cross-border trading has also shown significant growth with south african cross-border debtor finance worth approximately $20 million in april 200112. with enhanced cross-border trade the possibility of factor movements increases and the concept of tax competition in terms of customs and excise duties, sales taxes and vat becomes relevant. in this regard, south african authorities would have to take the future effect of the enhanced taxing powers for south african provinces into account in terms of the whole sadc region. intergovernmental relations will have to be coordinated in accordance with a strategy for the whole of the sadc. the adoption of the destination principle is therefore advisable for a future sadc, although not always administratively feasible, and could secure most of the neutrality needed in a region that is in a process of trade liberalisation. with deeper integration and in the absence of border controls, a national accounts clearance mechanism operated by sars or an agreed upon independent revenue authority, could be the sensible route to follow. even if the destination principle prevails in the sadc, governments must consider the adoption of permissible tax rate “bands” for vats although the benefits of complete harmonisation are unlikely to exceed the costs (crefsa, 1998). a degree of flexibility could drive a “healthy”, export-oriented competitive process with automatic harmonisation. sajems ns vol 7 (2004) no 2 417 faria (1995: 24) summarises the experience of the eu with vat as follows: “within the eu, it has proved easier, in relation to vat, to agree on the nature of the tax (consumption or destination type), and the base (virtually all domestic consumption goods and services except investment goods or financial services) than the tax rate structure (number and levels of rates, although the 6th directive has formalised a minimum rate level of 15 per cent)”. tax sovereignty (normally secured by the origin principle) will probably also be high on the agenda of sadc countries. although a spontaneous harmonisation is possible with the adoption of proper convergence criteria as in the case of the eu, an overarching (independent) fiscal authority (and maybe a clearing mechanism in the absence of border controls) may be necessary for administrative ease and the perfection of vat operation. this can only be achieved through a high degree of close cooperation and negotiation on the sadc governments’ part, especially through ministers of finance. in short, developing countries such as those in the sadc have to choose a tax system that promotes growth and development. another factor that should never be overlooked in the choice of the most appropriate system of taxation in a future sadc is that a balance should be maintained between commodity and capital income taxation. it could happen that one country is in favour of high commodity taxation but not capital income taxation. the opposite could be true of another country within a future sadc, with the argument that low commodity taxation compensates for high capital income taxation. in the first case, the country with the high commodity taxation would favour the destination principle (with border tax adjustments). in the second, the country with the low commodity taxation would favour the origin principle because exports already carry a high capital income (corporate) tax burden. 5 conclusion and recommendations most sadc members have centralised or unitary systems with some characterised by authoritarian rule and/or high military expenditures especially in war-torn countries such as angola and the drc. several heads of state such as those of namibia and uganda, with the most recent case in zambia, have also opted to adjust their constitutions in order to lengthen their terms of office. data are therefore not always available or nonexistent for subnational levels. in a number of countries, decentralisation has not yet resulted in a relinquished control from the centre, and is partly related to the quality of governance at different levels. besides uganda, south africa is regarded as one of the few african countries that are in a process of unification through decentralisation. the role of a democratic south africa in terms of further regional integration (and thus the process of fiscal decentralisation) in southern africa therefore has sajems ns vol 7 (2004) no 2 418 to be confirmed. most sadc members will have to take action to restore internal balance, although countries such as botswana, lesotho, mauritius, namibia, swaziland and seychelles are already showing signs that further trade liberalisation will be to their advantage. although countries such as malawi, mozambique, zambia and zimbabwe could lose in terms of revenue, broadened tax bases, improved tax compliance and rate increases of especially commodity taxes could significantly alleviate the problem. the importance of strong leadership should also be recognised, and in this regard it is advisable for the sadc to utilise south africa’s experience and resources to its advantage instead. the south african economy is, an exception especially because of its relative size in the sadc. however, this should be regarded as an advantage in the region. the south african economy already makes significant contributions in terms of exports and imports in the region. it can therefore be expected that although compensation may be needed in the shorter term, a range of benefits from an expansion of foreign trade over the longer term would make the sadc economies less dependent on south africa. a continuous process of trade liberalisation exercised with care could therefore be beneficial, although strategies such as tax competition (including profit-shifting) would have to be taken into account especially competition from other regions dominating trade in the developing world, for instance, asia. this also includes effective commodity tax competition and/or coordination in a future sadc. future studies could, therefore, model the behaviour of sadc countries in order to measure the degree of competition in terms of commodity taxation. issues emphasised and recommended include the following: (1) although not always administratively feasible, the destination principle can secure most of the neutrality needed in a region which is in a process of trade liberalisation; (2) directly linked to (1), the adoption of a national accounts clearance mechanism operated by sars or an agreed upon independent revenue authority will be advisable with further integration; (3) governments could consider the adoption of permissible tax rate “bands” for vats or minimum rates; although (d) a degree of flexibility (applied with care) could drive a “healthy” export-oriented competitive process with automatic harmonisation. endnotes 1 argentina’s foreign debt soared to $149,7 billion in 2001. sajems ns vol 7 (2004) no 2 419 2 this tax is levied at producer’s level that is, a uniform tax is collected only on the output of domestic firms regardless of where this output is ultimately consumed. exports are taxable whilst imports are zero-rated (production tax). zero-rating implies that the firm files a return but pays zero tax on sales and gets a refund in respect of vat payments made at earlier stages in the production and distribution chain. by contrast, exemption implies the firm need not file a vat return and does not levy vat but also cannot claim refunds for any vat included. 3 the commodity tax is levied at the consumer’s level and enables the region to collect a tax on all of its residents’ private good consumption. if the destination principle is adopted in both the home and host regions, imports are taxed at the same rate as domestically produced goods and exports are zero-rated. as in the case of the residence principle, the destination principle is perceived to be a more fair and equitable practice because domestic and imported goods are treated the same (exports are zero-rated but imports are taxable). administrative problems may be more likely with this system because of information difficulties in the taxation of imported goods. 4 questions were also raised about the legitimacy of the elections in 2001 in which the current president, mr museveni, was re-elected with nearly 70 per cent of the votes. 5 in the event of directing various requests for information from the different sadc members, it was interesting to find that these countries do not have information about one another’s tax systems and tax rates which indicates a lack of either cooperation or communication. 6 revenue productivity of commodity taxes such as vat/gst can be measured as follows: vat/gst as per cent of gdp: vat/gst tax rate. 7 in an electronic discussion with mr gt pasi, the commissioner of taxes from zimbabwe, it was confirmed that zimbabwe is also planning to switch over to a destination-based vat. 8 nowadays, brazil levies a vat payable on sales and transfers of goods (industry) in the form of a federal excise tax or then vat (ipi or imposto sobre productos industrializados) at various rates in accordance with the nature of the product (10 to 15 per cent and in certain cases over 300 per cent). a state sales and services tax or vat on agriculture, industry and other services (icms or imposto sobre operacoes relativas a circulacao de mercadirias e servicios) of 7 to 25 per cent is also levied. in addition, a municipal services tax, the iss (imposto sobre servicios) is levied on gross income by municipalities on a variety of industrial, commercial, and professional services levied on gross income by municipalities on a variety of industrial, commercial and professional services. 9 levying vat on an origin basis effectively means charging the value sajems ns vol 7 (2004) no 2 420 that is added to a product in different jurisdictions at the rates charged by those jurisdictions. multinational firms or firms operating in multiple jurisdictions then have an incentive to transfer price value-added into low-tax jurisdictions, say, charging high internal prices for intrafirm sales out of them. 10 in an electronic questionnaire to some of the sadc governments, one of the requests was whether they had any information about their neighbouring countries’ tax systems. the answer was conclusively negative. 11 see keen (2000) for an extensive discussion of alternative approaches to the destination-based vat system such as the cvat proposal for india and brazil where an over-arching federal government exists and the viable integrated vat or vivat proposal for the eu where no such authority exists. 12 international cross-border debtor finance was worth $500 billion in 2000. acknowledgements: the author would like to thank the anonymous referees for useful comments. sajems ns vol 7 (2004) no 2 421 appendix a statistical tables table a.1 sub-national shares of selected federations and the eu share of total government expenditure (%) share of tax revenue (%) country 1990 1997-2001 1990 1997-2001 australia1 50,4 49,7 20,7 25,1 austria1 31,9 32,2 21,7 20,7 belgium1 11,9 11,8 4,5 5,4 canada1 58,7 49,4 49,5 43,5 denmark 54,8 54,5 31,1 31,5 finland 46,5 41,2 25,9 27,6 france 18,7 18,6 9,7 10,8 germany1 40,2 37,8 28,9 28,8 greece --7,9 (1994) --3,6 (1994) ireland 27,9 30,7 2,5 2,4 italy 22,8 25,4 3,6 6,5 luxembourg 19,9 16,9 6,8 6,3 the netherlands 29,0 26,1 3,4 4,1 portugal 8,7 11,6 3,6 5,9 spain 34,3 35,0 13,3 13,8 sweden 39,8 36,2 28,2 31,4 switzerland 51,2 49,3 37,0 35,5 uk 29,0 27,0 5,9 3,6 us1 42,0 46,4 33,8 32,9 note: these countries represent federations whilst the rest are eu members (including austria, belgium & germany) source: own calculations imf (2002) sajems ns vol 7 (2004) no 2 422 table a.2 commodity tax revenue, 2002 commodity taxes as % of gdp commodity taxes as % of total taxation country a1 b1 a b total taxation as % of gdp canada (provinces) 2,7 1,6 21,2 12,5 12,5 us (states) 1,9 0,9 33,3 16,0 5,6 austria2 6,0 2,7 27,2 12,2 33,4 belgium 1,3 3,2 8,1 19,8 33,2 denmark 10,2 5,8 29,8 17,0 35,3 finland 8,6 5,4 35,4 22,2 36,0 france 7,9 3,3 37,9 16,1 40,1 germany 3,4 3,2 30,1 28,0 27,9 greece 9,4 6,6 33,7 23,5 40,3 ireland 7,0 5,2 24,8 18,3 33,0 italy 5,6 4,1 21,1 15,4 39,3 luxembourg 6,7 5,3 22,4 17,8 41,3 the netherlands 7,0 3,5 28,7 14,5 43,4 portugal 7,1 6,2 30,4 26,7 34,5 spain 4,9 2,9 28,7 16,7 41,3 sweden 7,0 4,4 29,7 18,8 33,4 uk 6,4 4,7 23,2 17,2 34,2 eu 15 average3 6,6 4,4 27,4 18,9 36,4 notes: 1 commodity taxation includes categories a and b, that is general taxes (including vat) and taxes on specific goods and services (including excise taxes) respectively as defined by the oecd. 2 starting with austria, the eu members’ commodity taxation is shown at central or national level. 3 unweighted. source: oecd (2003) sajems ns vol 7 (2004) no 2 423 references 1 bird, r.m. 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(1995) “value added tax”, in shome, p (ed.) tax policy handbook, imf: washington d.c. abstract introduction theory research method ethical consideration results and comments conclusions and recommendations acknowledgements references about the author(s) joline sturdy department of financial governance, school of applied accountancy, university of south africa, south africa christo j. cronje department of financial governance, school of applied accountancy, university of south africa, south africa citation sturdy, j. & cronje, c.j., 2017, ‘the levels of disclosure relating to mine closure obligations by platinum mining companies’, south african journal of economic and management sciences 20(1), a1556. https://doi.org/10.4102/sajems.v20i1.1556 original research the levels of disclosure relating to mine closure obligations by platinum mining companies joline sturdy, christo j. cronje received: 07 mar. 2016; accepted: 20 mar. 2017; published: 27 june 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: mine closure obligations are economically significant, and the consequences of insufficient mine closure obligations are of public interest. the incidence of acid mine drainage and the high number of ownerless and abandoned mines in south africa have brought the consequences of insufficient mine closure obligations in the mining sector into the spotlight. aim: the aim of this study is to establish the extent to which platinum mines listed on the johannesburg stock exchange (jse) comply with a recommended disclosure framework. setting: south africa is the largest producer of platinum in the world. the study covers all platinum mines listed on the jse. methods: using a framework, a census of the annual financial statements, integrated annual reports and sustainability reports or websites was conducted to determine the level of compliance of disclosure relating to mine closure obligations to the recommended disclosure framework. results: the results show disclosure relating to mine closure obligations of platinum mines listed on the jse is inconsistent and not sufficient for stakeholders to understand the scope, key assumptions, parameters or reliability of the assessment and calculation of mine closure obligations. conclusion: the assumptions used to determine mine closure obligations are specialised and multi-disciplinary. the accuracy and reliability of mine closure obligations will improve dramatically through greater transparency and access to information. it is recommended that the jse listings for mining companies should require a competent person’s report to provide disclosure on assumptions, key values and processes applied to determine the mine closure obligations. furthermore, it is recommended that the department of mineral resources implements a mechanism of independent assessment of mine closure obligations by experts on an ongoing basis. introduction there is an enormous body of research relating to corporate social responsible reporting and the reasons why companies disclose social and environmental information. companies are reluctant to inform the public of environmental and macroeconomic risks their business activities could cause (yoo & nam 2015). companies with a good image and reputation tend to disclose more environmental information (zeng, xu, yin & tam 2011). roberts’ (1992) study confirms that the levels of corporate social responsible reporting are significantly influenced by stakeholder power, strategic posture and economic performance. corporate financial profitability is a key factor that influences corporate social responsible reporting, but khlif, hussainey and achek (2015) found that national culture moderates the association between profitability and corporate social responsible reporting. de villiers and alexander (2014) found evidence that management intent or company social and environmental performances do not necessarily drive corporate social responsible reporting but is rather a reflection of global corporate social responsible reporting templates. it is also well known in literature that company size and industry influence the level of corporate social responsible reporting. however, de villiers, low and samkin (2014) found specifically that the field of corporate environmental disclosures among mining companies only listed on the johannesburg stock exchange (jse) reached a level of maturity and professionalisation causing environmental disclosures by small companies to become similar to the disclosures by large companies. there is a disparity in the amount of information presented in the corporate annual reports of mining companies with respect to mine closure obligations (deloitte 2007; wwf 2012). mine closure obligations include the provisions for decommissioning and rehabilitation. the estimation uncertainty of mine closure obligations creates an opportunity where management can plausibly withhold ‘bad news’ (deegan & rankin 1996; ferguson & walker 2011). this situation allows management to either withhold disclosure of ‘bad news’ to protect their proprietary information for economic advantage (dye 1985) or presents an opportunity to reduce the price impact on the per share value of a company by either disclosing or withholding information (verrecchia 1983). tilt and symes (1999) argue that income tax incentives relating to mine rehabilitation present an alternative explanation for disclosures relating to mining rehabilitation in australian mining companies. investors interpret the disclosure of mine closure obligations as a positive sign of the company’s ability to manage their exposure to future costs (ferguson & walker 2011). the incidence of acid mine drainage and the high number of ownerless and abandoned mines in south africa have effectively brought the consequences of insufficient rehabilitation provisions in the mining sector into the spotlight (wwf 2012). section 41 of the mineral and petroleum resources development act 28 of 2002 (mprda) is based on the ‘polluter pays’ principle (republic of south africa 2002). during 2009, the auditor-general estimated that the cost to rehabilitate 5906 abandoned mines will be at least r30 billion (auditor-general south africa 2009). it is clearly in the public interest that the level of disclosure relating to the provisions for decommissioning and rehabilitation be improved to ensure public scrutiny of the calculation of mine closure obligations. this study found that even with the introduction of the international integrated reporting framework and the global reporting initiative (gri) guidelines, crucial areas remain where mining companies fail to be transparent. there is evidence that the type of information in respect of mine closure obligations disclosed by companies listed under the platinum and precious metal sub-sector on the jse is varied and reveals little about the company’s estimations used to determine the mine closure obligations. the implications are that public scrutiny of the calculation of mine closure obligations is limited, and mining companies in south africa should engage stakeholders to determine the information they need to disclose relating to mine closure obligations. mine closure obligations are economically significant in the mining sector. various macro and sub-macro factors influence the recognition of appropriate mine closure obligations and transparent reporting of them. this leads to the research question of this study. research question and objective the research question is as follows: to what extent do platinum mines listed on the jse limited comply with a recommended disclosure framework regarding their corporate social responsibility in respect of mine closure obligations? the objective of this study is to establish the extent to which platinum mines listed on the jse comply with this recommended disclosure framework. the rest of this article is organised as follows: firstly, an outline of the various drivers determining the levels of provisions for decommissioning and rehabilitation is given, followed by a discussion of the theoretical perspectives of this study, then a description of the sample selection and research methods are provided. a presentation of the results follows, and finally, the conclusion and recommendations are presented. background and literature review although a review of the relevant literature provides insight into environmental disclosure, decisions or factors driving the level of disclosure can be complex and are still not fully understood (summerhays & de villiers 2012). various factors drive the level of decommissioning and rehabilitation provisions reported in corporate annual reports as well as in corporate sustainability reports. these factors can generally be described as macro and sub-macro factors (deloitte 2007). macro drivers group-specific and regional factors drive the level of disclosure of provisions for decommissioning and rehabilitation. these drivers include the company’s portfolio of mines, the accounting and financial reporting framework used to govern accounting practices and specific group policy relating to rehabilitation of the company’s mines. the portfolio of a company’s mining operations may include various mines in different stages of the mining process. environmental impact starts when mining commences and deteriorates rapidly when mine closure is reached (van eeden, liefferink & durand 2009). mining companies can hold mining licences over large areas of land, but the environmental impact of mining activities can be better assessed against the amount of land already disturbed and by the amount of land already rehabilitated (gri 2013). the status and mix of operational and closed mines of a mining company will influence the monetary balance of the mine closure obligations in the statement of financial position and the related disclosures (deloitte 2007). decommissioning and rehabilitation provisions are covered under ias 37, provisions, contingent liabilities and contingent assets (iasb 2014). as mining operations disturb the environment, a significant part of a mining company’s legal or constructive obligation to rehabilitate the environment arises during the construction phase, with the provision growing as the operations increase (ferguson & walker 2011). from a disclosure point of view, ias 37 requires a reconciliation of movements for each class of provision. the accounting standard against which mining companies report their mine closure obligations will influence the level of disclosure. mining companies have a visible impact on the environment and therefore come under close scrutiny from environmental groups and concerned citizens (de villiers & barnard 2000). mining companies have potentially complex relationships with the environment which indirectly influences the relationship between the affected communities and the natural environment (gri 2013). some companies go beyond the minimum requirements of local legislation and develop common standards across a group of companies in determining expectations and obligations to address the socio-economic impacts of mine closure (deloitte 2007). an example of a group policy is the ‘closure standard’ rio tinto adopted, which requires that business decisions must take into account closure considerations from the earliest stages of project development, bearing in mind that stakeholder consultation is a vital element in closure planning (rio tinto 2012). environmental disclosure policies are difficult to define because the disclosed information is often unrelated to a company’s performance (magness 2006). but, understanding the definitions and applications of group policy to mine closure obligations and how these relate to determining forecast expenditure is important to assess a company’s mine closure obligations (deloitte 2007). therefore, group policy and biodiversity strategies will influence the level of disclosure of mine closure obligations. sub-macro drivers sub-macro-level drivers refer to country and mine-specific factors influencing the level of disclosure (deloitte 2007). these drivers include the characteristics and environment of the mines and country-specific mine closure legislation. the scope and nature of closure activities depend on the ore body characteristics and the environmental setting of the mining operations (deloitte 2007). the characteristics of the ore body will influence the types of mine, which are either open cut or underground. the type of mine influences the type of rehabilitation activities. mining operations impact on biodiversity in various ways and to a degree depend on the location and sensitivity of the area (gri 2013). mining operations situated in environmentally sensitive areas are likely to have higher costs relating to rehabilitation of the environment (deloitte 2007). the level of rehabilitation required by regulatory bodies has gradually increased in recent years (ferguson & walker 2011). therefore, the age, location and type of mine influence the monetary balance of the mine closure obligations and the related disclosures. the level of environmental disclosure is furthermore influenced by the enforcement efforts of regulatory bodies (neu, warsame & pedwell 1998). south africa has various legislative frameworks for mine closure. section 41 of the mprda specifically refers to the financial provision of rehabilitation of exploration or mining sites and requires that a provision be maintained until the minister has issued a closure certificate in terms of section 43 of the mprda (republic of south africa 2002). regulations in this regard cover the quantum for the above-mentioned provision (swart 2003). the methods of above-mentioned provision include trust funds, written guarantees, financial deposits and other methods (dixon 2003). from the above, it is clear that legislation governing mine closures in south africa influences the monetary balance of the mine closure obligations and the related disclosures, to be found in the corporate annual reports and corporate social responsibility reports, also called sustainability reports. only companies with a primary listing on the jse would be bound by its listing requirements, which include complying with the king code (jse 2015). the king code stipulates that sustainability includes environmental considerations, but stops short of providing a detailed framework for environmental, social and governance disclosures (carels, maroun & padia 2013). the most widely used codes for best disclosure practice by mining companies in south africa include the gri’s g3 (currently g4) reporting guidelines, specifically the mining sector supplement and carbon disclosure project (carels et al. 2013). the gri focusses on the aspects of economic, social and environmental impact, as a reporting framework on corporate sustainability (cronjé & buys 2015). the jse listing requirements also require mining companies to comply with the south african code for reporting of exploration results, mineral resources and mineral reserves (jse 2015). the international integrated reporting framework does not prescribe specific key performance indicators relating to mine closure obligations, but is principles-based and requires disclosure of matters that are material to value creation (iirc 2013). the jse listing requirements therefore also influence the level of mine closure obligation disclosure. theory financial reporting is aimed at all users of information about the entity’s business, operations and the management’s stewardship of an entity’s resources (cronjé & moolman 2013). literature dealing with why companies disclose social and environmental information generally predicts an association between profitability and corporate social responsible reporting based on three theoretical frameworks including stakeholders, legitimacy and proprietary costs theories. stakeholder theory suggests that companies try to manage their relationships with different stakeholders to gain competitive advantage, therefore lead to better financial performance (khlif et al. 2015). in response to pressures from various stakeholders such as governments, environmental groups, employees and the public, companies increase corporate social responsible reporting. legitimacy theory suggests that companies provide additional corporate social responsible reporting in response to social pressure and to secure credibility in the society they operate (maroun 2015). proprietary costs theory suggests that companies with low economic performance are not able to bear the additional costs of additional non-financial disclosure and would rather place more emphasis on activities that influences directly the earnings of the company (cormier & magnan 2013). institutional theory suggests companies implement rules and structure, including corporate social responsible reporting patterns to legitimise themselves (de villiers & alexander 2014). this leads to disclosure of corporate social responsible reporting in a uniform way that reveals little about a company’s social responsible commitment. this study does not attempt to support or refute any of the theoretical stances discussed above. theory tells us that information reported in annual reports is not only useful to capital providers but also useful to other users as the users of annual reports are heterogeneous (cronjé 2010). the extent of the information included in annual reports is influenced more by a need of compliance with legal and financial reporting standards and becomes a disclosure checklist exercise. atkins and maroun (2015) found in their study of perspectives from south african institutional investor of integrated reporting in south africa that the most important need is to define and engage with primary and secondary stakeholders to identify relevant information needs and to avoid generic disclosures. this study attempts to point out that environmental disclosures reveal little information relating to the provisions for decommissioning and rehabilitation, even though it is in the south african public’s interest to ensure the ‘polluter pays’ principle is followed as specified in the mprda. research method as south africa is the largest producer of platinum in the world (platinum today 2015), it was decided to conduct a census of the companies listed under the platinum and precious metal sub-sector under the mining sector on the jse. there are 11 companies listed under this sub-sector. one of the companies has a suspended status, and therefore, the population of this study is the remaining 10 companies. anglo american platinum ltd (amplats) is the world’s leading primary producer of platinum and accounts for about 40% of the world’s newly mined platinum, whereas impala platinum holdings limited (implats) produces approximately 22% of the world’s supply of primary platinum. both are listed under the platinum and precious metal sub-sector on the jse (amplats 2015; implats 2015). the study specifically concentrates on the level of mine closure obligations disclosure. the 2014 annual financial statements, integrated annual reports and sustainability reports or websites of companies listed under the platinum and precious metal sub-sector under the mining sector on the jse were scrutinised. four of the ten companies listed under the platinum and precious metal sub-sector under the mining sector on the jse have primary listings elsewhere and did not produce integrated reports. a census of the annual financial statements, integrated annual reports and sustainability reports or websites was conducted with the aid of a disclosure framework. the disclosure framework was based on the recommendations concerning the disclosure of mine closure provisions suggested by deloitte (2007) and aspects relating to mine closure mentioned in the mining and metals sector disclosure of the g4 sustainability reporting guidelines (gri 2013). content analysis is regularly used to research disclosures related to corporate social responsibility, and environmental and intellectual capital in annual reports (samkin, schneider & tappin 2014). the aim of the content analysis is not to determine the quantity of mine closure obligations disclosure by counting words, headings and figures (carels et al. 2013). instead, the aim is to determine the level of compliance of mine closure obligations disclosure to the recommended disclosure framework. the recommended disclosure framework concerning the disclosure of mine closure obligations is produced in table 1. table 1: recommended disclosure framework in respect of mine closure obligations. ethical consideration secondary data that is publicly available are used. the college of accounting sciences research ethics review committee approved the research. results and comments the research findings are summarised in two sections. the first subsection summarises the findings of the six companies with primary listings under the platinum and precious metal sub-sector on the jse, and the second subsection summarises the findings of the four companies listed under the platinum and precious metal sub-sector on the jse, but with primary listings elsewhere. tables 2 to 7 indicate the number of companies that disclosed the recommended disclosure framework information. disclosure of recommended disclosure framework information in respect of mine closure obligations by companies with primary listings under the platinum and precious metal sub-sector on the jse the findings relating to the three principles of the recommended disclosure framework are summarised below. all of the companies made reference to compliance with current legislation that establishes the mine closure liability in their annual financial statements and integrated reports, and to a lesser extent in their sustainable development reports. although none of the companies provided a reconciliation showing total land disturbed and not rehabilitated with annual changes, three (50%) of the companies disclosed some information regarding either total land disturbed or disturbed land rehabilitated in either the sustainable development report or the integrated annual report. three (50%) of the companies disclosed the sites and areas that are included in the mine closure obligations in their sustainability report, whereas three (50%) of the companies described the type of decommissioning and rehabilitation works in their integrated annual report. the findings in table 2 show that the information disclosed by the six companies with primary listings under the platinum and precious metal sub-sector on the jse is not consistent and transparent enough for interested parties to be better informed as to the scope of the liabilities included in the mine closure obligation. table 2: principle 1: clear description of the scope of liabilities covered by the provision (n = 6). the findings in table 3 show that the details of the parameters and the assumptions used in determining the scope and the costs involved in rehabilitation or decommissioning is poorly described, whereas three (50%) of the companies do describe the parties involved in defining the scope and the estimated costs of rehabilitation or decommissioning in either their annual financial statements or integrated annual reports. a range of variables impact the judgements used in determining the mine closure obligation. the findings in table 3 show that the description of the process and parties involved in defining the scope and estimated costs of rehabilitation or decommissioning disclosed by the six companies with primary listings under the platinum and precious metal sub-sector on the jse is not sufficient for interested parties to understand the key assumptions, parameters or reliability of the assessment and calculation of the mine closure obligation. table 3: principle 2: outline description of the process and parties involved in defining the scope of work and estimated costs of decommissioning works (n = 6). one of the companies with a primary listing under the platinum and precious metal sub-sector on the jse was only doing exploration drilling, and rehabilitation was done on an ongoing basis at the drilling sites; therefore, the company did not disclose a mine closure obligation. the findings in table 4 show that all the companies with a mine closure obligation with a primary listing under the platinum and precious metal sub-sector on the jse disclosed the supporting information in their annual financial statements as recommended by the disclosure framework listed in table 1. the same information was rarely disclosed elsewhere. table 4: principle 3: provision of supporting information to be provided in a standardised form (n = 6). disclosure of recommended disclosure framework information in respect of mine closure obligations by companies listed under the platinum and precious metal sub-sector on the jse, but with primary listings elsewhere (n = 4) the findings relating to the three principles of the recommended disclosure framework are summarised below. the majority (75%) of the companies made reference in their sustainability development report or on their website to compliance with current legislation that establishes the mine closure liability. one of the companies disclosed a reconciliation of total land disturbed and not rehabilitated with annual changes in its sustainability development report, whereas none of the others disclosed any information relating to land disturbed or rehabilitated. two (50%) companies disclosed the sites and areas that are included in the mine closure obligations and described the type of decommissioning and rehabilitation works in their annual financial statements. the findings in table 5 show that the information disclosed by the four companies listed under the platinum and precious metal sub-sector on the jse, but with primary listings elsewhere, is inconsistent and do not provide a clear description of the scope of liabilities covered by the mine closure obligation. table 5: principle 1: clear description of the scope of liabilities covered by the provision (n = 4). the findings in table 6 show that the description of the process and parties involved in defining the scope and estimated costs of rehabilitation or decommissioning disclosed by the four companies listed under the platinum and precious metal sub-sector on the jse, but with primary listings elsewhere, is not sufficient for interested parties to understand the process and parties involved in defining the scope of work and estimated costs involved in determining the mine closure obligation. table 6: principle 2: outline description of the process and parties involved in defining the scope of work and estimated costs of decommissioning works (n = 4). the findings in table 7 show that the companies listed under the platinum and precious metal sub-sector on the jse, but with primary listings elsewhere, disclosed the supporting information relating to the mine closure obligation in the annual financial statements. only two (50%) of the companies disclosed total undiscounted estimated cash flow, expected timing of eventual cash payments and the credit-adjusted risk-free rate at which the estimated cash flows have been discounted in their annual financial statements. table 7: principle 3: provision of supporting information to be provided in a standardised form (n = 4). conclusions and recommendations with the introduction of the international integrated reporting framework and the gri guidelines, many mining companies have taken steps to be more transparent in the disclosure of material environmental factors. however, crucial areas remain where mining companies fail to be transparent. there is evidence that the type of information in respect of mine closure obligations disclosed by companies listed under the platinum and precious metal sub-sector on the jse is varied and not sufficient to allow effective scrutiny by interested parties. the majority of companies listed under the platinum and precious metal sub-sector on the jse lacks disclosure relating to the scope of liabilities, description of the process and parties involved in defining the scope of work and estimated costs of the mine closure obligations as recommended by the disclosure framework. the information recommended by the disclosure framework is disclosed in various reports. interested parties have to scrutinise various reports to find all of the information disclosed by a company relating to its mine closure obligations. mine closure obligations are economically significant, and it is of public interest that mine closure obligations are regulated. the assumptions used to determine mine closure obligations are specialised and multi-disciplinary. the accuracy and reliability of mine closure obligations will improve dramatically through greater transparency and access to information. it is recommended that the jse listings requirements for mining companies require a competent person’s report to provide disclosure on assumptions, key values and processes applied to determine the mine closure obligations. this will allow greater transparency and access to information for effective public scrutiny. furthermore, for holders of exploration or mining rights other than companies listed on the jse, it is recommended that the department of mineral resources (dmr) adopt a mine closure obligations disclosure framework to be submitted on an annual basis to the dmr for independent assessment by experts. these disclosures should be made available to ensure effective public scrutiny. this study has some limitations. the size and nature of our sample precludes generalising results, but the intention of the study was to conduct a census of the platinum mines listed on the jse to show that even with the introduction of the international integrated reporting framework and the gri guidelines, environmental disclosures reveal little information relating to the provisions for decommissioning and rehabilitation. the framework checklist is not able to entirely remove subjectivity in evaluating requirements which were measured. future research could include defining and engaging stakeholders to identify relevant information needs relating to provisions for decommissioning and rehabilitation. acknowledgements competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions both authors were involved in the analysis of the 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objectives of gear in south africa consistent or conflicting? dmahadea department of economics, university oftranskei. abstract this paper critically examines the attainability of the targets set out in the south african growth, employment and redistribution strategy (gear). the gear document envisaged an economic growth rate of 4.2% per annum, on average, with a rapid expansion of employment over the five-year period ending in 2000. however, actual performance thus far falls short of gear projections, except for defmite progress towards a reduction of the budget deficit. the current macroeconomic conditions, an over-regulated labour market, prohibitive taxation, low savings and high crime rates make it difficult to stimulate entrepreneurship and attract sufficient investment, especially of a labour absorbing nature, to meet the gear projections. the gear targets evidently need to be scaled down. jel h300 introduction after several years of recession and low or negative economic growth rates, south africa entered a recovery phase in 1994, registering a growth rate of 2.7% in that year, 3.4% in 1995, 3.2% in 1996 and 1.7% in 1997. but this economic revival has not been accompanied by the creation of new jobs. a process of jobless growth seems to prevail in south africa. the unemployment situation today, at about 30% or more, and the associated poverty are worse than three years ago. the public sector is an important employer of labour. while the public sector employment increased from 1.8 million in 1994 to 1.9 million in 1996, about 104 000 employment opportunities were lost in the private sector between 1995 and 1996 (the economist, 27/9/1997; sarb, (997). from the end of 1996 to the end 1997, aggregate employment in the formal non-agricultural sector of the economy declined by another 130 000 jobs, resulting in a situation r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 447 sateb nr vol 1 (1998) nr 3 in which the current total employment level is about the same as in 1981. in effect, total employment in the fonnal sector declined by ad annual rate 1.6% in 1997; both the public and private sectors experienced job losses in 1997. specifically, employment in the private sector declined by 2.3% and public sector employment, which expanded at an annual rate of 5.2% in 1996, declined by 0.5% in 1997 (sarb, 1998). a daunting challenge facing the new south africa is job creation with high economic growth. against the background of a steady decline in the labour absorption capacity of the formal sector and the need to transform the economy into a rapidly growing one, capable of attacking the problems of social transformation, unemployment and development, the government came up in mid-1996 with a "new" macroeconomic strategy: growth, employment, and redistribution (gear). this paper presents some economic fundamentals of gear and the prospects as well as limitations of gear to deliver on employment and growth, against the backdrop of the current south african macroeconomic situation. after the introduction, the paper consists of five parts: the first section highlights the main elements of the gear strategy, the second considers alternative development strategies for south africa. the third examines the prospects of gear delivering on growth and employment, the fourth looks at the limitations of the fiscal system in sustaining economic and employment growth, and the last section contains some concluding remarks. fundamental elements of growth, employment and redistribution: a macoeconomic strategy (gear) a central objective of the gear strategy is to "catapult the economy" (1996: 2) to higher levels of growth, development and employment in order to provide a "better life for all" south africans. the gear document is related to the previously released reconstruction and development programme (rdp). thus, the minister of finance stated in his 1997 budget speech that "the success of the rdp is dependent on the successful implementation of the gear" (1997: i), in his 1998 budget speech minister manuel further stressed that gear is one of the principal instruments for realising the policy objectives of the government within the rdp framework. "the rdp and gear are as much about addressing the needs of our peole today as they are about creating a strong country and economy" (1998: 1). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 3 448 gear is essentially an economic reform programme directed towards a competitive and fast growing economy, that would create sufficient jobs for all jobseekers, a redistribution of income and opportunities in favour of the poor, a society capable of ensuring that sound health, education and other services are available to all, and an environment in which homes are safe and places of work productive. the macroeconomic strategy aims to change the economy into a more competitive outward-oriented system, with increased emphasis on exports and investment, labour absorption, and infrastructural or service development, using labour-intensive techniques. gear rests on the following policy foundations: fiscal discipline to prevent the resurgence of inflation and to reduce the budget deficit before borrowing as a percentage of gop, i.e. to reduce government dissaving; monetary discipline and relaxation of exchange controls; trade and industrial policy reforms, i.e. lowering import tariffs, tax and supply-side incentives to promote competitiveness, exports and investment, and the development of , micro, small and medium-sized enterprises (smmes); public sector asset restructuring, i.e. privatisation; public infrastructure and human capital investment; greater flexibility in collective bargaining to support competitive production and a bigger role for economic factors in wage determination. effective policy coordination is regarded as essential for achieving the gear objectives. it is believed that the above measures "will establish a stable and competitive environment for significantly improved export and investment growth" (1996:5). the depreciation of the rand exchange rate especially since 1996, and more so in 1998, should make south african exports more price sensitive and elastic. in the medium term, growth is to be driven by exports, followed by a recovery in investment, and accompanied by credible economic policies and social stability. the resulting economic growth should hopefully reduce poverty and create opportunities for productive and remunerative employment. in terms of specific targets, gear aims to reduce the fiscal deficit in proportion to the gop from 5.1 % in 1996 to 3% in 2000; to raise the increase in real gop r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 449 sateb nr vol i (1998) nr 3 from 3.5% in 1996 to 3.8% in 1998,4.90/0 in 1999 and 6% in 2000, and an increase in employment growth from 1.3% in 1996 to 4.3% 1n 2000. in absolute tends, 400 000 new jobs are to be created by the year 2000 and a total of 1 352 000 jobs between 1996-2000. the projected objectives of gear and the conditions for achieving them are sound in principle, as they agree to a considerable extent with the modern approach to successful, sustainable longterm economic growth and development(de wet and harmse,1997:26). however, these macroeconomic targets may remain at the blueprint stage unless implemented with determination and accompanied by good governance. an important question is, then, whether the government has the capacity and ability to carry it through for several years. in the face of constraints and resistance from various quarters, as de wet and harmse (1997) put it, the government will "need nerves of steel" to implement the strategy over the next 5 to 10 years. it is therefore encouraging to note that, as stated by the deputy president mbeki in parliament in february 1998, the government remains committed to implementing gear. alternative macroeconomic strategies gear is a policy document that, if successfully implemented, may set the economy on the path to high employment and economic growth. this policy framework is broadly in line with the so-called washington set and those that the high performing south east asian pursued before their financial setback that commenced in the second half of 1997. other documents of a similar nature on south african economy have been produced in the recent past, such as the merg report (1993), the normative economic model (nem)(1993), the imf report (1992) "economic policies for a new south africa", and the world bank discussion paper (1994) entitled "south africa: economic performance and policies". the merg report was in favour of a growth through redistribution policy, and in this regard the government was to have a more interventionist role in the economy to achieve redistribution and through it a faster rate of growth. on the other hand, the nem proposed a neo-classical framework for growth, with a more prominent role to be played by the private sector. but the 1992 imf paper, edited by lachman and bercuson (1992:13), stressed that for south africa to return to an economic and employment growth path, it will need, inter alia, a substantially higher rate of domestic savings and investment than in the previous decade, to create government savings and to improve productivity, to which real wages are to be linked. however, the world bank (1994: 15) report indicated that for a higher growth, south africa should encourage a reorientation of manufacturing r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 3 450 towards exports, emphasise job creation in small £inns and agriculture, restructure government expenditure, restrict growth of recurrent spending to meet budgetary targets and maintain prudent fiscal and monetary policies. the same report further asserts that this "strategy will only be successful if there is a major revival in private investment... direct foreign investment should be encouraged, ... and to stimulate growth the single most important ingredient is investor confidence" (1994: 15-16). on the other hand, the south africa foundation (saf) asserts that the reengineering of growth in the south african economy should rest on a strategy that focuses on enhancing savings and investment in plant and people, fiscal discipline linked to a reduction in government debt and current spending, increased competition through deregulation and privatisation of state activities, outward orientation through trade iiberalisation and foreign investment, and a reform of the labour market relations that remove labour market rigidities. in short, the saf pillars of growth are guided by a solid legal framework protecting property rights and contract enforcement, a sound macroeconomic policy, financial iiberalisation, competitive markets, and an outwardly-oriented economy. broadly speaking, gear seems to follow both the saf and nem in that they also emphasise free markets and advocate the need for flexibility of wages and prices in the labour and financial markets. in 1997 the africa institute policy analysis (aipa) published its "growth with equity" framework, with an emphasis on integrating black south africans into the mainstream economy. in terms of its recommendations, the aipa does not differ radically from those of gear in that it advocates: • outward orientation; • an inflow of foreign capital, encouraged by the removal of exchange controls; • improved efficiency and competitiveness following • enhanced skills and adoption of appropriate or improved technology; • greater labour market flexibility; • trade iiberalisation accelerated by a depreciated rand; • more rapid privatisation; and • a major advance in the efficiency of social sector expenditures. looking at the above framework, one can notice that the gear document encompasses various common elements of different models. gear has been generally received in a favourable way; however it has also been subject to r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 451 sateb nr voll (1998) nr 3 criticisms. for example, pillay (1997), questions the assumptions and predictions of the model, arguing that much of gear emerges as "an exercise in hope and hardly fonns a confident basis for a strategy of growth,employment and redistribution." to edward osborne (1997), gear relies on a "cascade of improbabilities", and recent trends in capital investment and developments in financial markets make it unlikely that employment will come anywhere near the target envisaged by gear in the next few years. the trade unions, especially cosatu, are against gear. however, the government seems to be on course with the gear in general, and the framework has been described as "non-negotiable" in top policy-making circles. macroecono~ccondnnonsandgear investment according to gear projections, real private investment should increase from about 9.3% per annum in 1996 and 1997, to 13.9010 in 1999 and 17% in 2000, i.e. at an average annual rate of 11.7% over the period 1996-2000. in addition, real investment in the parastatals and the government sector would grow at the average annual rates of 7.6% and 7.1% respectively over the same period. specifically, real government investment is projected to increase from about 3% in 1996 to 11.6% in the year 2000. it is estimated that an acceleration of the private and public sector investment would increase the real gdp growth from 3.5% in 1996 through 3.8% in 1998 to 6.1% in 2000. this implies that the economy is geared to register an average annual gdp growth of 4.2% over the period 1996-2000, with the help of real growth in non-gold exports averaging 8.4% per annum, together with an expected rise in new foreign direct investment, from $155m in 1966 to s804m in the year 2000. but growth in real gross domestic fixed investment actually declined from 8% in 1996 to 3.5% in 1997 (sarb, 1997). imports, exports and balance or payments against the background of a rand depreciation in 1996, the gear strategy relies heavily on faster growth in manufactured exports to lift economic growth (from 3.5% in 1996) to 6% by the year 2000. a shift towards exports is expected to be employment enhancing as south african exports have a higher labour capital ratio than its imports (holden, 1992; holden and holden, 1980). further evidence from other countries shows conclusively that outward-oriented trade policies are conducive to rapid economic growth, as they promote r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 3 452 competition, encourage leaming-by-doing, improve access to trade opportunities, raise productivity and enhance positive externalities resulting from modem technology (dollar, 1992; edwards, 1993; world bank, 1993; world development report, 1995). manufactured merchandise exports as a proportion to gop have consistently increased from 18% in 1993/94 to 23% in 1997 (sarb,1997). while the depreciation of the rand should make south africa's manufactured exports more competitive, a significant part of this price effect might be dissipated by higher costs of imports. on the other hand, south africa's gold production declined from 619 tons in 1993 to 485 tons, resulting in a fall in employment, in the first half of 1997, owing partly to rising costs of extraction and a fall in the price of the metal. furthermore, while the inflation rate had fallen from 9% in 1994 to 5% in (april) 1998, partly thanks to the tight monetary policy of the reserve bank, the import penetration ratio (ratio of imported goods at constant prices to total real gross domestic expenditure) increased from 19'/0 in 1993 to 28.5% in the fourth quarter of 1997. despite a relatively modest growth in exports, the negative current account on the balance of payments deteriorated from rl.2 billion in 1994 to r8.8 billion in 1997 (sarb, 1998). net capital inflows remained insufficient to cover the current account deficit, thus resulting in a decline in net gold and foreign reserves. in effect in 1997, net reserves contracted from r12.7 billion in the second quarter to r2.1 billion in the third quarter (sarb, 1997). while gear envisages an economic growth rate of 6% in year 2000, it should be stressed that growth is likely to give rise to unsustainably large deficits on the current account of the balance of payments in view of the south african high propensity to import. hence, the rising deficit on the current account is likely to constrain the speed at which new investment, and hence growth and employment can be accelerated during the immediate years before 2000. fiscal discipline gear envisages that fiscal discipline will be exercised. the objective is to reduce government consumption expenditure relative to gop and to reduce the fiscal deficit from 5.1% in 1996 to 3% in 2000. large and persistent fiscal deficits crowd out the wealth-creating capacity of the private sector, and lead to inflation and balance of payments difficulties. the exercise of fiscal prudence is stressed by the need to impart credibility, stability and consistency to government policy. otherwise wrong signals would be sent to markets, which in tum harm investor confidence and adversely affect capital inflows. the gear document holds that a declining fiscal deficit will lead to falling rates of interest, that in tum would support expected rise in private investmenl if one compares the fiscal deficit of 8.6% of gop in 1992193 against the current r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 453 sateb nr vol i (1998) nr 3 deficit of about 4% in 1997/98, there is a definite trend towards reduced deficits. one might plausibly argue that this is the greatest success that gear has achieved thus far. the servicing of the public debt is an expensive component of government spending. the cost of servicing state debt in south africa increased from 5.9% of gop in 1995196 to 6.4% in 1997/98. the interest cost of debt servicing is thus a continuous drain on the country's resources; absorbing 21% of the total government expenditure in 1997/98, making it the second largest category of spending after education at about 25%. of the r201 billion budgeted expenditure for 1998199, only rl59 billion is available for spending; the rest goes to meet the cost of state debt. this suggests that future reductions of the debt burden should enable the government to augment the spending on its social ends without necessarily creating fiscal pressures. the expected reduction in budget deficit to 3.5% of gop in 1998/99 and more sharply to 3% in the following year as per gear, would adversely affect some of the services provided by the national and provincial authorities. a case in point is the current crisis in many schools and universities, resulting largely from a budget cut by the government. clearly, this would generate a generally contractionary situation, whereby the growth of some welfare or essential services may be negatively affected, let alone the adverse impact on employment in the public sector. moreover, several promises have been made to the electorate on the delivery of socio-economic services designed to improve the quality of life of the citizens. as the election year 1999 approaches, populist measures might be adopted; and in that electioneering context government expenditure might then be increased rather than reduced. overall, it seems unrealistic to believe that it will be possible to reduce the fiscal deficit to 3% by 2000, and at the same time increase real government investment expenditure by 7.1 % on average over the gear period. any significant reduction of the fiscal deficit would probably require a strong growth in state revenue. revenue from the sale of public assets might help to boost the state coffers. the progress of privatisation has thus far been rather slow, as only sun air, a domestic air line and a segment of telkom have been sold off. the 1998 budget does not make any direct reference to privatisation, but recent positive statements by the government suggest that the pace of asset sales might increase. in spite of these asset sales, the growth in government revenue actually declined from 14.2% in the first half of the fiscal year to 8.94'10 in 1997198. on the other hand, in the first half of the fiscal year 1997198 there was also a sizable disparity between government expenditure and revenue, resulting in a net deficit ofri9 billion (sarb, 1997). as a percentage of gop, this deficit came to 6.4%, which is indeed much higher than the 4% for r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 3 454 the fiscal year 1997/98 envisaged by gear. the financing of this r19 billion deficit by government borrowing contributed to an increase in the public debt from r310.6 billion to r336.1 billion over the 9-month period ending december 1997. this implies that total debt as a percentage of gop increased from 55.8% in march to 56.5% in december 1997 (sarb, 1998). monetary policy linked to fiscal policy is monetary policy, an important instrument of which is the interest rate. gear advocates a policy of high real interest rates, an average real prime rate of7.911/o and a real bank rate of 4.4% over the 1996 -2000 period. a policy of high interest rates is helpful in attracting foreign capital and to generate savings. thus, in his budget speech (1997: 3) the minister of finance stated that ''we need to compete to attract savings from elsewhere in the world", and this year he further stressed that since ''we do not generate sufficient domestic savings to finance the levels of investment we need, we must attract foreign savings" (1998: 9). gear's target is to raise private savings in relation to gop ratio from 20.5% in 1996 to 21.9% in 2000. in the classical approach, savings are directly related to interest rates and investment is inversely related to interest rates. thus, with low interest rates we expect higher investment, which via the multiplier effects, lead to higher income, output and employment. these in tum generate higher savings. high real interest rates might attract capital inflows and suppress inflation but, more damaging, they could make the cost of borrowing capital for investment purposes prohibitive. this is all the more true for the micro and small fum entrepreneurs, who are trying to create jobs for themselves and others under conditions of financial constraints. hence, what is needed for promoting investment and employment creation are lower interest rates than those during the past few years. in terms of the harrod-domar model, the real economic growth of an economy is directly related to its savings rate and inversely to the capital-output ratio. if one assumes an optimistic investment-incremental capital output ratio (investment divided by the additional gop associated with it) of 5, then south africa needs to invest 30% of its gop to achieve a real growth of 6% as set by gear (edwards, 1997). but the actual investment in 1997 at about 17% of gop is well below the desired 30%. this is clearly too low to meet the growth, employment and development needs of south africa. a prerequisite for the growth and employment objectives is the creation of an investment friendly climate. to raise capital formation in the spirit of gear, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 455 satebnr vol i (1998)nr3 the government recently introduced various supply-side and tax incentives. existing manufacturers, for example, are allowed with effect from october 1996 to depreciate new plant and equipment over 3 instead of 5 years, and to write off new buildings used in manufacturing at 10% per annum instead of 5%. an accelerated depreciation allowance and easier access to finance is offered for the formation or expansion of small, medium and large enterprises with assets of r3 million or less. the government is also encouraging various investment projects in partnership with the private sector, such as the maputo development corridor and the wild coast (east london port st johns) spatial development initiatives. exchange controls have been partially relaxed since july 1997 and were further relaxed in march 1998. while these efforts are bold and commendable, it is questionable whether it will be possible to maintain conditions conducive to attract substantial inflows of capital and to appreciably speed up investment for the creation of new jobs on a scale projected in the macroeconomic strategy. labour flesibiuty gear relies considerably on labour market flexibility for its delivery. a lack of market flexibility is a major cause of unemployment. but the government's the basic conditions of employment act, affirmative action and the payroll levy legislation will impose rigidities that will price more jobs out of the labour market. such regulation not only constrains the hiring of labour, but affects factor substitution and mobility of capital, and these run counter to the tenets of gear. savings and foreign direct investment fast economic growth cannot be imported; it must be generated mainly at home. the experiences of the east asian economies indicate that their average annual growth rates of over 8%, for almost three decades, were rooted in wise government policies and attracting large inflows of foreign direct investment. these capital inflows served to supplement their own high level of internal savings (the economist, 113/97). so it is vital for south africa, too, to attract more foreign investment to reach growth and employment targets as set in gear. now that apartheid is gone and a new democratic government is in place, south africa should. in principle, be in position to attract substantial amounts of foreign capital. but south africa has been able to attract only some 0.1% of the world's foreign direct investment (foi). according to unclad's world investment report (1997) south africa received around $330 million over the previous 3 years in foi, whereas south east asia received $81 billion in 1996. clearly. the actual amount of fdi in south africa compares poorly r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 3 456 with the average annual figure of $509 million that it is targeted to receive in terms of gear. a closer look at the experience of the east asian tigers reveals that the (pre1998) growth of these economies were driven by high savings and investment ratios as well as by high imports and exports. these were cases of growth-led exports more than cases of export-led growth. domestic savings and investment were the driving elements, with external savings and fdi providing supplementary support. the direction of the growth force was from inside outward, rather than outside-inward (bradford, 1997). this implies that south african households and firms need to channel domestic resources towards investment as the necessary trigger for international investment, rather than rely on foreign capital or foreign trade as the motor for growth. the savings record of south africa is rather low, partly on account of government dissaving and high taxation. the current low saving rate is a structural impediment to sustained, investment-driven, output and employment growth. in effect, gross domestic saving as a percentage of the country's gdp declined from 16.91'10 in 1995 to 16.5% in 1996, and to about 14.5% in the first quarter of 1998 (sarb, 1998). yet in terms of gear, the government is aiming for an annual gross private saving rate of around 20.5% of gdp. it is estimated that with a cut in government's dissaving and a boost in the level of private savings, overall savings rate would be close to 22% of gdp. even with an optimistic savings rate of 22% by the year 2000, south africa will require substantial capital inflows from abroad to fmance the shortfall in its projected investment requirements. gear assumes that foreign fmancing will be equivalent to about 4% of gdp. even though south africa has a relatively low external debt, it seems unlikely that it can attract such a scale of foreign capital for its growth and employment needs. there is an exaggerated and uncritical view of the importance of foreign capital to south africa's economic development (padayachee, 1997). excessive reliance on foreign borrowed capital could develop into unsustainable growth in foreign debt, which in turn would demand increasing servicing costs. rising debt would have intergenerational debt repayment implications, with the present generation imposing debt burdens on future generations. it should not be overlooked that in the era of globalisation and intense competition, firms invest, and jobs are created, on the prospect of returns. capital flows to regions where returns to investment are substantial and there is security of property rights, good governance and stability. corruption, robbery and crime in general are on the rise in south africa. some services in certain provincial administartions seem close to collapse, and the murder rate remains r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 457 sateb nr vol 1 (1998) nr 3 among the highest in the world; ..... today, of all the threats to south africa's stability the most serious is probably.... violent crinie" (the economist 13/12197, p. i 8). these perceptions, or realities, lead not only to a misallocation of resources, but have a detrimental effect on actual and potentail investors' willingness to invest in the country. in its bid to attract foreign and encourage domestic investment, south africa will also have to address the issue of poor work ethic, productivity and competitiveness. poor competitiveness impinges on trade and job creation. the world competitiveness yearbook ranks south africa in the 45th place, second to last amongst 46 countries, and the ranking for sa management dropped to the 43rd position in 1997 from the 40th in 1996 and 38th in 1995. these perceptions obviously do not make south africa a suitable area for long term foreign investment, with other countries vigorously competing for capital. the insufficiency of household saving limits the availability of funds for investment and consumption of durables. in the keynesian framework, saving and consumption are mainly a function of income, net of tax. as real disposable income increases, saving and consumption increase too. high interest rates may influence households to increase their saving by substituting future consumption for current consumption, in response to the higher rewards for saving. recent evidence from research by the imf and others on the intertemporal elasticity of substitution, indicates that elasticity actually falls as interest rates rise higher than 3 per cent (pill, 1997; ostry and reinhart, 1995). indeed, according to the mckinnon-shaw hypothesis (1973), repression of the domestic financial system in the form of interest ceilings, directed credit programmes and other forms of government interventions in the domestic capital markets, especially the banking system, hinder economic growth. this implies that low positive real interest rates may have a minor effect on encouraging personal saving; hence, one cannot rely on variation of interest rates as an effective measure for augmenting national saving in south africa. taxation the saving and consumption as well as investment problems in south africa may also be examined in the context of the country's overall tax system. government expenditure needs to be financed mainly out of tax revenue and by public sector borrowing. real government consumption expenditure as a percentage of the country's gdp, has increased from 20.5% in 1996 to 21 %.5 in 1997 (sarb, 1997), and to 22% in the first quarter of 1998 (sarb, 1998), thus leaving fewer resources for the private sector. in effect, such a growth in r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 3 458 consumption expenditure by the government is well in excess of the gear projected ratio of 19.5% for 1997 and 18.1 % for year 2000. it is true that owing to the legacy of apartheid, considerable backlogs have to be addressed in the provision of essential services. the government is spending about 22.5% of its 1997198 budget on basic social services, education, health care, water, and welfare, but about three fifths of the earmarked funds are spent on debt and salaries, leaving very little scope for capital investmenl social welfare is an item on which government will have to spend more money in the future. one might well ask. how far can the government reprioritise its expenditure to meet a rising welfare bill without sacrificing other expenditures. turning to the private sector,in recent years households have resorted increasingly to debt financing at high interest rates to support their average propensity to consume. as their income after tax leaves them with little prospect of maintaining accustomed living standards. this is evidenced by the rapid growth of total household debt in relation to personal disposable income, from less than 60% in 1994 to almost 69% in (june) 1997 (sarb, 1997). accordingly, the debt servicing ratio of private households has increased from less than 10% in 1994 to about 14% in 1997. this means that approximately 14% of household disposable income is spent just for the payment of interest on household debl on top of this, a high proportion of the households' hardearned income is being absorbed by prohibitive direct and indirect taxation. south africa's marginal tax rate of 45% on individual income earners of ri20 000 or more compares unfavourably with its neighbours and is regarded as being too high. the middle-income south african with an annual income of ri20000 must work for 4 months in a year just to pay his tax bill, whereas his counterpart in the u.i(. earning £25 000 a year would spend only 92 days to settle his income tax bill, and in the usa, someone earning $80 000 (equivalent to about 500 000 rands!) would give up just under 70 days' work to settle his income tax bill (sunday times, 119196). recent ,conservative estimates by n. czypionka (1998) indicate that for an individual with an annual income of ri40 000, 55% of his earnings is absorbed by direct, indirect and quasi-taxes, and for someone earning a yearly income of r75 000 the total tax burden is 45% (sunday times. 514/98). in addition, the average household has to pay a host of other taxes that impinge on its consumption. savings and investment, such as the fuel levy, various rates, security costs and municipal tax. in return, one should expect the households in south africa to enjoy certain basic services, such as security protection, adequate health care and proper education. further, south africa's corporate tax of 35% does not compare well with neighbouring countries, such as botswana, having a corporate tax rate of only 25%. and the qecd countries with a tax rate, on average, of 33% (the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 459 saleb nr vol! (1998) nr 3 economist. 20/9/1997). another heavy blow to domestic saving and consumption is the sales or value added tax. south africa's value added tax at 14% compares unfavourably with countries such as botswana (100/0), namibia (8-11 %) and swaziland (12%). the principle of taxation is understandable, as the government needs to earn revenue to finance its expenditure and meet redistributive needs. redistribution on a large scale is however possible to the extent that the economy registers high growth and the national product grows in proportion to the population. the tax burden on the average south african is already too high and the imposition of further taxes would no doubt dull incentives and may even generate less revenue. as the authors of an imf study on south africa stated, "the overall south african tax burden and its marginal tax rates cannot be judged to be low by international standards;indeed the tax burden ... appears to be relatively high even by industrial country standards. this would argue against raising tax rates in south africa and running the risk of heightening disincentive effects" (lachnman and bereuson,i992:2). taxes, even though they pay for worthwhile public goods and services, impose an inescapable economic burden, the so-called deadweight loss, and this cost rises more than proportionately as taxes go up (the economist, 2019/97). hence, the solution is clear: if the government tries to produce or offer too many things, it is likely to do so at rapidly diminishing returns. at low levels of government activity, the deadweight cost of taxes may well be outweighed by the gains that flow from essential public goods. therefore, in the domestic context, if south africa is to attain faster rate of growth in employment and output, the government should reduce spending and cut marginal tax rates at all levels of income. these tax cuts have led to an economic boom virtually everywhere they have been tried. the u.k. for example, cut its top tax rate on earned income from 83% in 1979 to 400/0 in 1986, and as a result annual economic growth in britain, which was on average only 1.2% for over 10 years, shot up to 4% between 1985 and 1989. likewise, after turkey slashed its top rate from 75% to 50%, and its minimum rate from 40010 to 25%, its average annual economic growth jumped to nearly ,./0 in 1986-1989, and to 9010 in 1990. south korea reduced the top rate from 70010 in 1981 to 55% in 1984, and the bottom tax rate from 8% in 1981 to 6% in 1982, and enjoyed an average economic growth rate of 8% between 1981 and 1989, and 7.,.10 between 1990 and 1996 (the economist, 113197). the lesson to be learnt from the growth experiences of other countries that have made an economic breakthrough, is that a major obstacle to high employment and national prosperity is heavy government intervention, through high taxes, unnecessary price controls, lavish government spending and regulation of the market, particularly the labour market. therefore, if south africa is to be put r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . samms ns vol 1 (1998) no 3 460 on a significantly higher employment and growth path, the government should have the courage to deregulate the labour market, reduce tax at all levels of income and cut unproductive public expenditure to the maximum extent possible. conclusion the growth, employment and redistribution challenges facing south africa are formidable and intricate. the legacy that the apartheid system bequeathed to the new democratic government is indeed burdensome. thus the present government inherited considerable backlogs of housing, education, employment and basic soci<reconomic needs. these backlogs cannot be redressed unless appropriate strategies are implemented in a rapidly growing economy. hence, gear aims to transform the economy into a fastgrowing one, capable of providing jobs and a better life for all south africans. although the economy has been in an upswing phase for the past four years, this has not been robust enough to meet the gear growth or employment targets. perhaps some progress has been made towards the target of the 6% growth rate by the year 2000, but the prospect of creating some 400 000 new jobs by then has become increasingly remote. progress has been particularly lacking in the area of labour market flexibility. instead of removing rigidities, new labour legislation might well encourage factor substitution and discourage firms from hiring labour. nevertheless, the budget deficit seems on a definite downward trend. inflation has also been declining, giving scope for lower interest rates and perhaps a boost to domestic investment the coming presidential summit on job creation might assist in developing policies relating to gear's vision of an increase in the labour absorption capacity of the economy. what is further required, is an institutional and fiscal mechanism to encourage savings and promote investment. of particular significance is a sensible fiscal policy with the effect of reducing unproductive public expenditure and cutting taxation. economists from the days of adam smith through schumpeter to laffer have, with reason, stressed that high taxes undermine economic growth, ultimately producing less public revenue than what the government might have collected from low taxes. reduced marginal tax rates should encourage people to venture into entrepreneurial activities and to work harder, which in turn would boost work effort and productivity. tax cuts also promote business formation and expansion, as firms would find it easier to finance their investment with internal funds. to quote a prominent economist, who also became an influential finance minister of the austrian government: "any tax on net earnings will tend to shift the balance of choice between 'to do and not to do' a given thing .... and, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 461 sateb nr vol i (1998) nr 3 therefore, taxes beyond a percentage that greatly varies as to time and place must blunt the profit motive." (schumpeter, 1934: 291-292). punitive levels of taxation reduce our capacity to save, invest and generate jobs. references i. aipa (1997):growth with equity, aipa (africa institute for policy analysis)ifrancolin publishers, cape town 2. bradford, c. i (1997): growth with equity: south africa's challenges,paper presented at aipa's international conference on growth with equity in south africa,september 17, victoria and alber hotel, cape town. 3. de wet, g. l. and harmse, c. (1997): an appraisal of the rdp and the macroeconomic strategy of the south african govemmentin terms of conditions of sustainable economic growth and development, south african journal of economic and management sciences, vol 21: 18-29 (autumn). 4. oolar. d. (1992): outward-oriented developing economies really do grow more rapidly: evidence from 95 ldcs, 1976-1985, economic development and cultural change, vol 32 (april): 523-544. 5. edwards, c. (1997): savings., investment and the development of the south african economy: how can the rate of economic growth be raised? 6. paper presented at the udwlmecury/coastal inemational conferenece, durban, april 24. 7. edwards, s. (1993): openess, trade liberalization and growth in developing countries, journal of economic literature, vol. 31(september): 1358-93. 8. fallon, p. and de silva, south africa: economic performances l. a (1994): and policies, the world bank, washington, d. c. 9. gear (1996): growth, employment and redistribution: a macroeconomic strategy, department of finance, pretoria. 10. holden, m. (1992): trade reform: finding the right road, the south african journal of economics, vol 60, no 3: 249-262. ii. holden, m. and holden, p. (1980). the employment effects of different trade regimes in south africa, the south african journal of economics, vol 44, no 3: 232-240. 12. lachman, d. and bercuson, k. (eds.) (1992). economic policies for a new south africa, washington, imf. 13. merg (1993): making democracy work.: a framework. for macroeconmic policy in south africa, macroeconomic group (merg), centre for development studies, cape town. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 3 462 14. osborn, e. (l997):fiscal and monetary policy and the gear, paper presented at the udw /mercury international conference, durban, 24 april. 15. ostry, j. and reinhart, c. (1995): saving and the real interest rate in developing countries, finance and development, (december 1995): 18. 16. pill, h. (1997). real interest rates and growth: improving on some deflating experiences, the journal of development studies, vol 34, no 1,85-110. 17. pilla y, v. (1997). the budget, gear, and the emasculation of the role of the state in the national economy, paper presented at the udwlthe mercury international conference, durban, 24-25 april. 18. saf (1996): growth for all: an economic strategy for south africa, south african foundation. johannesburg. 19. sarb (1998). south african reserve bank quarterly bulletins, no 207208., pretoria. 20. sarb (1997). south african reserve bank quarterly bulletins, no 203206, pretoria. 21. sarb (1997). annual economic report, pretoria. 22. schumpeter, a. j (1939). business cycles, vol i, mcgrawhill, ny. 23. sunday times (1996). taxed to debt, i september. 24. sunday times (1998). you are a civil servant until lunchtime, slaving for tax, 5 april. 25. the economist(1997). the asian miracle, march 1,23-25. 26. the economist (1997). a survey of the world economy, september 20,19 -21. 27. the economist (1997). south africa: the end of the miracle?, december 13,17-18,22. 28. unct ad (1997). world investment report, ny. 29. world bank.. (1993). the east asia miracle: economic growth and public policy, oup, oxford. 30. world development workers in an integrating world, report (1995). oup, oxford. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 52 sajems ns vol 1 (1998) no 1 causes of bankruptcy amongst maize and extensive beef farmers in south africa: 19701994 d s swaneplel, g f ortmann and mag darroch department of agricultural economics, university of najal. pietennaritzburg abstract the number of maize fanns and extensive beef fanns annually declared bankrupt in south africa rose sharply over the period 1970 to 1994. principal components regression confirmed a priori expectations that maize farm and extensive beef farm bankruptcies were negatively related to annual rainfall (business risk factor), but positively related to the lagged aggregate farm debt/asset ratio and lagged real interest rates (financial risk factors). maize farm bankruptcies also increased as lagged real maize and beef producer prices fell (business risk factors). beef fann bankruptcies rose with lower jagged real beef producer prices and higher lagged real stockfeed subsidies and transport rebates (business risk factors). part of the rise in maize and extensive beef fann failures between 1970 and 1994 can therefore be ascribed to changed agricultural price and macroeconomic policies introduction the number of maize fanns and extensive beef fanns annually declared bankrupt in south africa rose sharply over the period 1970 to 1994. bankrupt maize fanns increased from 16 to around 150 farms per year, while bankrupt extensive beef fanns increased from 12 to about 50 per year (van niekerk, 1995). in 1988, there were about 7 500 maize fanns and 2 500 extensive livestock farms in the summer rainfall and cattle grazing regions of south africa respectively (central statistical service. 1988a and 1988b; directorate agricultural statistics. 1996, p.iio). while the rate of bankruptcy for both fann types is relatively low. the marked rise in the number of bankrupt fanns is of concern. maize is the major field crop in r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr voll (1998) nr 1 53 south africa comprising some 40 per cent by value of all field crops, and about nine per cent of the gross value of all agricultural products in 1994/95. beef constituted approximately 37 per cent of the gross value of animal products, and approximately 11 per cent of the total gross value of agricultural production in 1994195 (directorate agricultural statistics, 1996). therefore, maize and extensive beef farm bankruptcies impose major adjustment costs on the agricultural economy and give rise to demands for government assistance to alleviate financial stress for farmers. substantial government involvement generally arises when a large number offarming operations are threatened with bankruptcy. for example, nominal subsidies on farm carry-over debt in south africa in 1992/93 totalled r2,7 billion (directorate financial assistance, 1996). given that farm debt is concentrated in the maize and extensive beef sectors (human, 1989; volkskas bank, 1988), research on the causes of farm failure can help to identify appropriate future policy and management measures to avoid having to reorganise an insolvent business or liquidate the business and pay creditors (barry et al., 1995, p. 557). shepard and collins (1982) studied aggregate united states (us) farm sector bankruptcy data over the period 1910 to 1978. prior to world war ii, the farm bankruptcy rate appeared to be linked with financial risk (leverage), while postwar bankruptcy was associated with business risk factors (variable real net farm income). agricultural suppon payments since world war ii did not induce. defer or reduce farm failures. chan and rotenberg (1988) identified financial leverage and energy-related expenses as key causes of farm loan arrears and ultimate bankruptcy in canada during 1979 to 1986. davies (1996) found that the annual rate of insolvency in agriculture in england and wales from 1%9 to 1986 was negatively related to the current price of land, but positively related to the land price two years previously. past common agricultural policy price supports, which were capitalised into higher land values that encouraged farmers to use more debt. were thus partly responsible for higher insolvency. in south africa, van zyj et ai. (1987) found that the initial farm solvency position. nominal interest rates and inflation together affected survival of 'typical' western transvaal and nonh-western transvaal bushveld farms. leslie and darroch (1993) reponed that successful farms (positive long-run real return on equity) in natal, the eastern orange free state and western transvaal in 1993 had higher rates of return to assets and equity and lower costs of debt than unsuccessful farms. rates of return to assets on successful farms exceeded costs of debt, implying positive use of leverage. de jager and swanepoel (1994) identified insolvent farmers in the nonhern springbok hats during 1990 as having higher directly allocatable costs, relatively more carry-over debt, liquidity problems, less land as collateral and lower gross farm incomes relative to long-term debt. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 54 sajems ns vol 1 (1998) no 1 given that no published study, to the authors' knowledge, has yet analysed causes of fann bankruptcy at a product sector level, this paper considers sources of business and financial risk which may have caused maize and extensive beef fann bankruptcies in south africa to rise since 1970. bankruptcy trends and possible causes are outlined in the next two sections, after which research methodology and results are reported. a concluding section considers the management and policy implications of the results. trends in bankruptcies of maize and extensive beef farmers in south africa: 1970-1994 figure 1 shows trends in annual maize and extensive beef fann bankruptcies in south africa during 1970-1994 for the areas defined by the directorate agricultural statistics (1996, p.1io) as summer rainfall and cattle grazing areas respectively. maize fann bankruptcies rose from 16 in 1970 to 206 fanns by 1986 and then fluctuated around the 150 farm level. bankrupt extensive beef farms followed a similar pattern, rising from 12 fanns in 1970 to 62 farms in 1987, fluctuating around the 50 farm level during 1988 to 1992, and then falling to 35 farms in 1994. tile absolute level of farm failures and bankruptcy rate are higher for maize farmers compared to extensive beef farmers. the fall in both maize and beef farm bankruptcies in 1993 and 1994 was probably due to a drought relief package (carry-over debt subsidy and loan guarantee scheme instalment) in 1992193 totalling some r3,o billion (directorate financial assistance, 1996). tile following section explains possible causes of the sharp rises in the level of farm bankruptcies. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr vol 1 (1998) nr 1 55 fagure 1: maize and extensive beef farm bankruptcy trends in south africa, 1970-1994 250 70 en ./\ !!:! 60 t.1 i~ 200 a.. f\~ ::l u 50 i i-!5 <ii: ; 150 m f \/ \ 40 ::ie <ii: c:: cd <ii: ~ 100 .... 30 .... j ~ w w 1.1.. m w .,......1 20 ~ n ~ 50 !2 ::ie wf~ 10 ~ x w 0 0 1970 1975 1980 1985 1990 1994 year --maize -beer source: directorate agriculrural economic trends (1995); central statistical service (1994 and 1995); van niekerk (1995). possmle causes of bankruptcy of maize and extensive beef farmers in south africa commercial maize and extensive beef farmers in south africa experience business and financial risk:. busiix'!ss risk: refers to risk: inherent in a busiix'!ss independent of the way the busiix'!ss is financed and is reflected in variability of ix'!t operating income. it arises from factors such as price variability in both output and input markets. financial risk reflects added variability of ix'!t cash flows due to fixed financial obligations associated with debt financing (gabriel & baker. 1980). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 56 sajems ns voll (1998) no 1 business risk factors product and /npw prices success or failure in fanning is closely linked to prevailing trends in output and input prices. farmers are usually debtors and this makes them vulnerable to a decline in farm product prices (fomek & robinson. 1991. p.l79; tweeten, 1985, p.78). variable product and input prices can impact on farm failure rates by producing wide fluctuations in farm income (liquidity effects). lower real net farm income is likely to increase bankruptcy rates (shepard & collins, 1982). reliable net farm income data for the maize and extensive beef sectors were not available, hence product prices were used as a proxy for net farm income. real input prices since 1970 have remained relatively stable (directorate agricultural statistics. 1996). a negative relationship between real producer prices and farm bankruptcy is thus expected. in this analysis, producer prices are adjusted to real terms using the consumer price index (cpl) (1990= 100). in south africa, an added risk dimension affecting maize farm incomes would be the fall in real maize producer prices since the 1987/88 marketing year when maize board pricing policy changed and losses on export sales were reflected in lower fixed real net maize producer prices (farninow & laubscher, 1991). the board administered a single-channel pool price maize marketing system until 1995, whereby farmers had to market maize grain via the board or its agents. the real producer price of maize set by the maize board in south africa declined from r350/ton to r290/ton between 1987/88 and 1993194. maize farmers in the sununer rainfall area derive some 30 per cent of gross farm income from beef cattle (central statistical service, 1992) which can be sold to provide liquidity in times of financial stress. a negative relationship between real beef producer price and maize farm bankruptcy is thus expected. drought drought is expected to increase bankruptcies by reducing net cash flows and creating financial stress. particularly severe drought conditions occurred in the summer rainfall and extensive beef areas in 1982, 1990, 1991 and 1992 (ccwr, 1996). annual rainfall in the summer rainfall and cattle grazing areas of south africa was used as a proxy for drought conditions. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sated nr vol 1 (1998) nr 1 57 agricultural policy government support, such as drought relief schemes, can improve farm liquidity by reducing current liabilities and hence improving the prospects of short-tenn survival (standard bank, 1994). rucker and alston (1987) found that govenunent programmes successfuuy aueviated farm financial stress in the 1930s in the us. decreased government support has possible costs; if, e.g., future farm policy is more market orientated with reduced credit programmes, then private lenders and farmers are likely to feel the effects of future farm recessions more severely (drabenstotl, 1983). stockfeed purchase subsidies paid to extensive beef farmers in south africa since 1 %5 may have promoted more intensive production in higher risk production areas. also, stockfeed transport rebates to these farmers could have caused production over time to relocate away from areas where beef had a comparative advantage in production (nieuwoudt, 1985). therefore, a positive relationship is anticipated between bankruptcy and lagged real stock feed subsidies and transport rebates. annual subsidies were adjusted to real terms using the cpi (1990=100) (directorate agricultural statistics. 1996). it is paradoxical that policies intended to make farming less risky. may lead to more risk for farmers in the iong-tenn. fmancial risk factors real/nterest rates expected real interest rates are a critical explanatory variable for invesnnent decisions as they represent the real cost of borrowing (mishkin, 1988). murdock and leistritz (1988, p.4s) identify both direct and indirect effects of high nominal and real interest rates on agriculture. the direct effects include an increase in interest payments due from indebted farmers, and a negative impact on land values. indirect effects include a higher value of the local currency, as relatively high interest rates in local markets attract capital from abroad. higher than expected real interest rates transfer wealth from debtors to creditors, placing farmers who are net debtors at a disadvantage (fweeten. 1985, p.l(0). when real interest rates are expected to be relatively high, farmers should shift from debt to retained earnings to finance expansion (drabenstotl. 1983). in these periods of tight money and high interest rates, lenders are less willing to extend loan terms and farmers are less able to afford additional credit. low interest rates assist potential bankrupts who acquire credit to see them through difficult times and prevent foreclosure. this would suggest a positive relationship r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 58 sajems ns vol 1 (1998) no 1 between real interest rates and farm bankruptcy. high real interest rates add to fann expenses and reduce real wealth by increasing the rate of discount on expected future earnings of durable farm resources resulting in declining collateral for loans. high nominal interest rates create cash flow problems but not necessarily low returns because land values appreciate with inflation that led to the high norninal interest rates for farmers (fweeten, 1985, p.loo). interest rates affect agriculture directly through cost and stock effects (devadoss, 1985; rausser, 1988, p.l50). a higher interest rate will increase the cost of production through higher financing costs which in rum will decrease farm supply (cost effect). an increase in the interest rate will raise the cost of holding stocks causing farmers to run down inventories (stock effect). this reflects the increased opportunity cost of non-farm invesonent in interest-bearing assets (hughes et ai., 1985; rausser, 1985, p.220). financial sector reform in south africa during the rnid-1980s led to the banking sector's reserve requirements being changed, and subsidised interest rates to farmers from the land bank were discontinued (vink, 1993). in response to the de kock commission's recommendation in 1983, monetary policy became more market-orientated and market-related interest rates were increasingly applied to agljculture. this subjected the farming sector to a 'double' increase in interest rates; firstly from a decline in subsidised interest rates, and secondly, due to the imposition of positive real interest rates on the economy as a whole. commercial bank overdraft interest rates adjusted to real terms using the change in cpi (1990 = 100) are used in this study as a proxy for market interest rates. annual real overdraft interest rates fell from two per cent to around -1,5 per cent from 1970 to 1975, rose to one per cent for the period 1976 to 1978 and fell to -4,5 per cent by 1980. de kock commission recommendations for more marketorientated commercial and land bank interest rates led to historically high real overdraft interest rates of between five and 10 per cent during 1983 to 1985, while positive real rates between 2,5 and 6,5 per cent have continued since 1988 (south african reserve bank, various years; standard bank, 1994). more market-related rates imply greater expected future interest rate volatility and higher financial risk. debt/asset (leverage) ratio the aggregate fann debt/asset oeverage) ratio (total farm debt as a per cent of total farm assets) shows the solvency and risk-bearing ability of farmers. farmers with substantial net worth or equity have the potential to borrow additional funds to meet shon-term needs (murdock & leistritz, 1988, p.78). higher debt burdens imply higher fixed debt service charges and greater financial risk, as debts must be repaid in high and low income years. this increases the probability that highly r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr vol 1 (1998) nr 1 59 leveraged fanners will face difficulties in servicing debt (chan & rotenberg, 1988). increasing financial leverage increases the variation of expected returns on equity and the potential for loss of equity capital, and reduces liquid credit reserves. furthennore, variations in interest rates magnify these financial risks as leverage increases (barry et ai., 1995, p.i69). leverage and bankruptcy of maize and extensive beef fanners are expected to be positively related. farm sector leverage in south africa rose from 0,06 in 1970 to a peak of 0.17 in 1985 and remained around 0,15 to 1994. these relatively 'safe' aggregate leverage levels mask the distribution of farm debt, which was concentrated in the summer rainfall and cattle grazing areas over this period (central statistical service, 1972 and 1994; human 1989; volkskas bank, 1988). favourable accelerated depreciation allowances on machinery investment, negative real interest rates in the early 1980s and drought in the early 1980s and 19908 probably encouraged use of more debt. investing in equipment and land was an attractive alternative to paying income tax. this probably encouraged borrowing from farm co-operatives and commercial banks and brought about a level of mechanisation that was economically unsustainable. higher real interest rates would reduce asset values and increase the leverage ratio, thereby reducing solvency and increasing the potential for bankruptcy. this interaction is incorporated in the models of maize and extensive beef farm bankruptcy specified later. a real return problem occurs when interest rates remain high and disinflation removes capital gains as a compensating return (tweeten. 1985. p.87). a high ratio of debt to assets becomes a low return problem when interest rates exceed total rates of return on assets for an extended period. highly leveraged farms are likely to experience cash flow problems because the rate of return to assets is less than the interest rate that must be paid (murdock & leistritz. 1988, p.78). realising this problem. local lenders now place more emphasis on fanner repayment capacity than on fanner collateral. farmers must now have the ability to cover expected production costs, fixed costs, existing commitments (capital and interest) and personal expenditures from farm and non-farm income (louw, 1995). there is likely to be a time lag between the incidence of business and financial risk factors and ultimate farm bankruptcy. for example. drought and higher interest rates in one year will affect borrowers' future ability to meet debt repayments. as they reduce present income (and possibly savings) and raise the commitments against future income (rucker & alston. 1987). lagged proxy variables for business and financial risk in the maize and extensive beef farm bankruptcy models estimated below are used to indicate that the bankruptcy process is dynamic. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 60 sajems ns vol 1 (1998) no i research methodology and results factors affecting bankruptcy of maize and extensive beef fanners during 1970 to 1994 were estimated from time series data using ordinary least squares (ols) regression and principal component analysis. regional sequestration data were obtained for the swnmer rainfall and cattle grazing areas over this period for all farms exceeding 50 hectares, excluding farm companies and close corporations (van niekerk, 1995). the number of farm sequestrations was taken as a proxy for the number of farm bankruptcies. maize farm bankruptcy model the preliminary ols model is given by equation (1): bankrm = a. + al rmp + lu wea + 3.l lev +a. rint + 3.lil + at. rbp + e, (1) where bankrm = number of annual maize farm bankruptcies; rmp = lagged real maize producer price; wea = lagged annual rainfall in summer grain areas (annual rainfall is used because of the importance of soil moisture levels for crop growth) (ccwr, 1996); lev == lagged annual farm sector leverage ratio; rint = lagged real annual commercial bank overdraft interest rate; il interaction term (rint x lev) showing how higher real interest rates reduce asset values and heoce increase leverage and potential bankruptcy; rbp = lagged real farm beef price, and e. == disturbance term. correlation coefficients reported below were used to identify the appropriate length of lag for the explanatory variables. the lev variable is a reasonable proxy for maize farm leverage as farm debt is coocentrated in the swnmer rainfall and cattle grazing areas (human, 1989; vojkskas bank, 1988). correlajion coejficiems a correlation matrix of the variables used in the analysis is presented in table i. all coefficient signs agree with a priori expectations, with bankrm negatively related to rmpi (real maize producer price in previous year), weal (annual rainfall in swnmer grain areas in previous year) and rbpt (real beef producer price in previous year). however, bankrm is positively related to rinti (real annual commercial bank interest rate two years prior), levi (farm sector leverage lagged one year) and iut (rinti x levi). multicollinearity is likely to be a problem due to statistically significant pairwise correlations between the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr vol i (1998) nr i 61 explanatory variables. for example, rinti and levi were significantly correlated with lui and rbpi, and lui respectively, at the i per cent level. table 1: correlation coefficients between variables of the maize bankruptcy model, 1970-1994 bankrmpi rint2 levi weal 1l21 rbpi rm bank 1,0000 -rm rmpi -0,4531"' 1.0000 rint2 0.6663'" -0.0906 1.0000 levi 0.8418'" -0,3688' 0,4998" 1,0000 weal -0,4011' 0,0122 -0,4704" -0.4393" 1.0000 1l21 0,6959'" -0.0896 0.9790'" 0.5474'" -0.4767" 1.0000 rbpi -0,4470" 0,4312" -0,6606'" -0.2705 0.3730' -0.5939" 1,0000 note: ***, ** and * mdlcate slgruficance at the i per cent, 5 per cent and 10 per cent levels respectively. regression model the initial maize farm bankruptcy model estimated by ols (genstat, 1993) was: bankrm = 30,427 0.202 rmpi+ 0.012 weal + 945.783levi + 2.935 rint2 + (-1,615) (0,154) (3.515)'" (0.277) 27,568il21+0,023 rbpi (0,407) (0,193) (2) where adjusted r2 = 75,87 per cent, d= 1,077, degrees of freedom = 16, tvalues are in parentheses, and *** indicates significance at the i per cent level. the durbin-watson d statistic for detecting autocorrelation falls in the iocooclusive range, but the geary test passed at the 5 per cent significance level, so the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . -----.... -~62 sajems ns voll (1998) no i hypothesis of randomness is accepted (gujarati, 1995, p.419). however, the high adjusted r2, non-significant coefficients for rmpi, weal, rlntl, lui and rbpi and wrong signs for the weal and rbpi coefficients indicate expected multicollinearity. principal compo~nts extracted from the standardised explanatory variables (zrmp1, etc.) to cope with this problem are shown in table 2. table 2: principal components extracted for the maize farm bankruptcy model,i97o-l994 principal component variable 1 pci pc2 pc3 pc4 pcs pc6 zrmpi 0,18784 -0,84989 0,01351 0,04826 0,48923 0,02333 zweal 0,35692 0,26765 0,57445 0,63961 0,24870 0,00519 zlevi -0,39584 0,21561 1-0,58040 0,45820 0,49893 -0.03269 zrintl -0,50236 -0,23602 0,28239 0,21360 -0,21157 -0,72236 ziul -0,50015 -0,24167 0,20173 0,30876 -0,29644 0,68377 zrbpi 0,42205 -0.21319 -0.46100 0,48750 -0,56323 -0,09495 eigen 3,292 1.156 0,789 0.550 0,197 0,015 value % vari54,86 19,27 13.16 9,17 3.28 0,26 ation the principal compo~nts (pcs) are used to restate equation (2) in terms of the original variables purged of multicollinearity (chatterjee & price, 1977). standardised annual maize farm bankruptcy, zbankrm, is first regressed on pc i, pc2 and pc3. these three pcs explain 87 .29 per cent of the variation in the explanatory variables (pc4, pcs and pc6 were omitted as they showed the linear relationships between the explanatory variables which led to multicollinearity and instability in the model): r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr vol 1 (1998) nr 1 63 zbankrm =0,444 pci + 0,217pc2 0,231pc3 (3) (-6,940)'" (2,010)' (-1,770)* where adjusted r2 = 70,40 per cent, d = 0,991, degrees of freedom = 19, tvalues are in parentheses, and *** and * indicate significance at the i per cent and 10 per cent levels respectively. the durbin-watson d statistic falls in the inconclusive range (1 per cent significance level), and the hypothesis of randomness is still accepted as the geary test passed at the i per cent significance level. standardised annual maize farm bankruptcy could also be estimated by ols regression of zbankrm on the standardised explanatory variables as per equation (4): zbankrm = bl zrmpi + b2 weal + b3 levi + b4 rint2 + bs il21 + ~~i ~ the b coefficients of equation (4) can be estimated from equation (3) coefficients and the pci, pc2 and pc3 loadings in table 2 as: k hi = l:mijilij . j=l (5) where ffiij = estimated loading for variable i in pcj, ilij = estimated coefficient for pcj from equation (3), and k = number of pcs retained. for example, bl = (0,18784 x -0,444) + (-0,84989 x 0,217) + (0,01351 x -0,231) = -0,271. substituting these expressions into equation (4) gives the estimated standardised maize farm bankruptcy regression model as: zbankrm= -0,271 zrmpi0,233 zweai +0,356 zlevi + 0,107 zrint2+0,123 zil21-o,127 zrbpi (6) the standardised variables are independent of the original units of measurement, and their coefficients show the relative importance of the variables. lagged r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 64 sajems ns vol 1 (1998) no 1 leverage. zlevi. is the most important explanatory variable. followed by the lagged real maize producer price. zrmpl, lagged annual rainfall, zweal, lagged real beef price, zrbpl, the interaction term, zil21, and lagged real interest rate, zrinn. standard errors and t-values of the b coefficients were estimated following gujarati (1995, p.70). the t-values are equivalent to those in original scale since scaling does not affect the correlation of the variables. finally, the regression coefficients in equation (6) were multiplied by sbankrmlsx; (standard deviation of bankrm divided by standard deviation of the relevant explanatory variable) to express the amended ols annual maize farm bankruptcy model in original scale (chatterjee & price, 1977, p.178) as per equation (7): bankrm = 244,800 0,235 rmpi 0,140 weal + 612,818 levi + (-2,921) ••• (-2.779)" (4,271)'" 1.840 rint2 + 14,265 il21 0.082 rbpi (7) (1,933)* (2,512)" (-1,816)* where adjusted r2= 70,40 per cent. t-values are shown in parentheses, and "'n . • '" and-· indicate significance at the i per cent, 5 per cent and 10 per cent levels respectively. compared to equation (2), the adjusted r2 falls slightly but the t-values increase markedly. all coefficients are now statistically significant and the wea i and rbpi coefficient signs are correct. estimation of factors affecting bankruptcy of extensive beef farms is described in the next section. extensive beef farm bankruptcy model the preliminary ols model is given by equation (8): bankrb = co+ cl rbp+ c2 rint+ c; lev+ ca wea + c5 rbs + coil + e, (8) where bankrb = annual number of bankrupt extensive beef farms; rbp = lagged real beef producer price; rint = lagged real annual commercial bank overdraft interest rate; lev = lagged farm sector leverage ratio; wea = jagged anrmai rainfall in cattle grazing area (ccwr, 1996); rbs = lagged real stockfeed subsidies and transport rebates; il = lagged interaction term (product of lagged rint and lagged lev, showing that higher real interest rates reduce asset values r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr vol 1 (1998) nr 1 65 and hence raise leverage and potential bankruptcy), and et = disturbance tenn. the lev variable is again a reasonable proxy for extensive beef farm leverage as farm debt is concentrated in the sununer rainfall and cattle grazing areas (human. 1989; volkskas bank, 1988). correlation coefficients were used to identify the most appropriate length of lag for the factors affecting bankrb. correlation coefficients a correlation matrix of the model variables is shown in table 3, where bankrb is negatively related to rbpi (at the 15 per cent significance level) and wea4. but positively related to rint3, lev3, rbs3 and il43 (the number(s) in each variable again show(s) the lag period). these coefficient signs agree with a priori expectations. multicollinearity is again likely to be a problem due to statistically significant pairwise correlations between most of the explanatory variables. table 3: ban· krb rbpi rlnt 3 lev3 wea 4 rbs3 iu3 correlation coefficients between variables of tbe extensive beef bankruptcy model, 1970-1994 bankrb i ! rint3 lev3 rbs3 1,0000 -0,3085 -0,3221 1,0000 0,9158'" -0,3626' 0,5182'" 1,0000 ..(1,6337"" 0.4038' -0.5716'" ..(1,6083'" 1.0000 0,6319'" 0,1929 0,4173" 0,5885'" -0,4473" 1,0000 0,4121' -0,0090 0,5876'" 0,5689'" -0,3649' 0,4600" 1.0000 note: ***, ** and * indicate slgruflcance at the 1 per cent, 5 per cent and 10 per cent levels respectively. the three and four year lags in the explanatory variables are expected as beef herds take from three to four years to build up (directorate agricultural statistics, 1996), a real interest rate increase. for instance, would probably take a number of years to impact on farm bankruptcy due to the liquidity effect of fanners' destocking decisions. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 66 sajems ns vol 1 (1998) no 1 regression model the initial extensive beef farm bankruptcy model estimated by ols (genst at, 1993) was: bankrb= 13,463 0,042 rbp1+ 0,513 rint3 + 318,178 lev3 0.006 wea4 (-1,855)(0,931) (4,497)'" (-0,372) + 0,095 rbs3 2,472 1l43 (9) (2,006)" (-0,678) where adjusted r2 = 86,40 per cent, d = 1,544, degrees of freedom = 14, tvalues are in parentheses, and *** and * indicate significance at the i per cent and 10 per cent levels respectively. expected multicollinearity occurs in equation (9) as the il43 coefficient is not statistically significant and has the wrong sign. the model has a high adjusted r2 but the coefficients of variables rintj and wea4 are not statistically significant. the vurbin-watson d statistic falls in the inconclusive range, but the hypothesis of randomness is accepted (the geary test passed at the 5 per cent level of significance). extracted principal components to remedy multicollinearity are shown in table 4. table 4: principal components extracted for the extensive beef bankruptcy model, 1970-1994 principal component variable i pci pc2 pc) pc4 pc~ poi zrbpi 0,20901 0,77605 0,08287 0,26251 0,16217 0,50198 zrintj ~'~~ ~,47238 0,55335 -0,57255 0,23684 zlev3 -0,48 , 0,26170 -0,57255 ~,18101 0,57431 zwea4 0,44198 0,24607 -0,37438 -0,43112 -0,64285 -0,06950 zrbs3 ~,40651 0,47060 0,43355 0,06505 ~,33541 ~,55551 zil43 -0,39492 0,33010 ~,61105 ~,32709 0,45390 -0,22062 eigenvalue 2,968 1,292 0,694 0,528 0,353 0,165 % variation 49,46 21,54 11,57 8,80 5,88 2,76 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr vol i (l998) nr i 67 standardised annual beef farm bankruptcy, zbankrb. is regressed on pcl and pc2. 1bese two pcs explain 71 per cent of the variation in the explanatory variables (the other components, as sources of the multicollinearity and model instability, were omitted), as per equation (10): zbankrb = o,s04 pc1 0,115 pe2 (10) (-7,665)'" (-1,152) where adjusted r2 = 74,40 per cent, d = 1,082, degrees of freedom = 18, tvalues are in parentheses, and *** indicates significance at the 1 per cent level. the durbin-watson d statistic falls in the inconclusive range at the 5 per cent significance level, and the hypothesis of randomness is still accepted as the geary test again passed at the 5 per cent significance level. following the same procedure outlined in equation (5), the standardised beef farm bankruptcy model was estimated as: zbankrb= 0,195 zrbpi + 0,234 zrint3 + o,2s1 zlev3 0.251 zwea4 + 0,151 zrbs3 + 0,161 zil43 (11) lagged leverage, zlev3, and lagged annual rainfall, zwea4, are the most important explanatory variables, followed by the lagged real interest rate zrint3, lagged real beef producer price zrbpl, the interaction term zil43 and lagged real subsidies zrbs3. the amended ols beef farm bankruptcy model in original scale was: bankrb= 42,269 0,036 rbpi + 1,130 rint3+ 126,473 lev3(-2,476)" (7,717)" (7,744)'" 0,035 wea4+0,os rbs3+s,367 il43 (12) (-6,603)'" (2,798)*" (3,848)*" where adjusted r2= 74,40 per cent, t-values are shown in parentheses, and *** and ** indicate significance at the 1 per cent and 5 per cent levels respectively. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 68 sajems ns vol 1 (1998) no i compared to equation (9), the adjusted r2 falls but remains relatively high, the tvalues increase markedly and all estimated coefficients are highly statistically significaru.. the regression coefficient estimates in equations (7) and (12) are biased as sotre information was lost by dropping respective pcs, but the new estimates have more precision than the ols estimators in equations (2) and (9) (chatterjee & price, 1977, p.l7s; doran, 1989, p.106). conclusions higher lagged aggregate farm leverage and lagged real interest rates (financial risk factors), and lower annual rainfall (business risk factors) increased bankruptcies of south african maize and extensive beef farmers over the period 1970 to 1994. farm bankruptcy in both sectors was also negatively related to lagged real producer prices (business risk factors). bankruptcy of extensive beef fanners was positively related to lagged real stockfeed purchase subsidies and transpon rebates (business risk factors). bankruptcies of both fann types were positively related to an interaction term between real interest rates and the aggregate leverage ratio. bankruptcy is therefore a dynamic process, with a time lag between the incidence of causal factors and ultimate farm failure. lags for the beef bankruptcy model are longer than for the maize bankruptcy model, probably due to the longer production cycle for beef and beef farmers being able to increase liquidity via stock sales. when estimated standardised coefficients for both models are compared, the aggregate farm debt/asset ratio is the most important determinant of farm bankruptcies. higher leverage probably reflects a combination of poor borrowing decisions by eventual bankrupts, past tax policy measures (e.g., accelerated depreciation allowances on machinery investments) which may have contributed to increased debt use aid fann bankruptcies, and past monetary policy (negative real interest rates) which made borrowing attractive. changes in maize board maize producer price policy from 1987/88 created another source of risk for maize farmers to manage. recent further deregulation of dotrestic maize pricing means that maize farmers must give more attention to managing price risk, possibly by forward contracting, electronic marketing or hedging a ponion of their maize crop via recently introduced futures contracts on the south african futures exchange (safex) or enterprise diversification. producer price and rainfall effects on extensive beef farmers emphasise the need to build up fodder banks to counter drought, and possibly use forward contracting and hedging a portion of their intended beef sales via new safex beef futures r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sates nr vol 1 (l998) nr 1 69 contracts 00 manage price risk:. stockfeed purchase subsidies and transpon rebates intended 00 help beef farmers led 00 more risk and potential bankruptcy for some of these farmers in the long-term as they probably encouraged beef production in unsuitable areas. macroeconomic policy changes towards more market-related real interest rates directly affected maize and extensive beef farmers by raising fmancing costs and indirectly raised leverage and potential bankruptcy. stable monetary policy over time can thus contribute to stability in the maize and extensive beef sectors. highly leveraged farmers are particularly vulnerable to higher interest rates associated with deflationary policy. farmers must closely monitor changes in agricultural price, trade and macroeconomic policies to form accurate expectations of potential bankruptcy causes and improve management of debt and business and financial risk: at farm level. specialist extension personnel, consultants and lenders need to advise clients on the relationship between net farm income, interest costs and leverage levels for successful debt management. fanners could use improved information now available from local researchers on forecasting shon-term regional weather patterns to better manage recurring droughts (e.g., reduce fenilizer input at planting if below average rainfall is expected). a vailable data limited the study to analysis of farm bankruptcies at maize and extensive beef regional level, but more research is needed on the individual characteristics of bankrupt farmers. for example, are farmers operating relatively larger farms going bankrupt? and are yowlger, more leveraged farmers, or those less able to manage business and fmancial risk, failing? highly leveraged maize and extensive beef farmers may have incurred more debt than they can realistically service in a changing agricultural and macroeconomic policy environment. therefore, the rise in maize and extensive beef farm bankruptcies in south africa during 1970 to 1994 could have been a necessary fmancial adjustment. note this research was conducted in the agricultural policy research unit, university of natal, south africa, which is finaoced by the centre for science development (csd). financial suppon from the csd is gratefully acknowledged. opinions expressed are, however, those of the authors. the authors thank colleagues at the university of natal for constructive criticism on earlier drafts of the paper. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te 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(1993). enr-epreneurs and the political economy of reform in south african agricullure, agrekon, 32(4),153-166. 40. volkskas bank (1988). economic spotlight, march 1988. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction the service encounter the role of physical features the nature of human attractiveness the impact of attractiveness the value of neuro-physiological measurement objectives hypotheses and propositions methodology empirical results the contribution of this study conclusion acknowledgements references appendix 1 about the author(s) christo boshoff department of business management, university of stellenbosch, south africa citation boshoff, c., 2017, ‘an assessment of consumers’ subconscious responses to frontline employees’ attractiveness in a service failure and recovery situation’, south african journal of economic and management sciences 20(1), a1612. https://doi.org/10.4102/sajems.v20i1.1612 original research an assessment of consumers’ subconscious responses to frontline employees’ attractiveness in a service failure and recovery situation christo boshoff received: 31 may 2016; accepted: 10 feb. 2017; published: 13 june 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: initial analyses of the impact of physical attractiveness in a business context have supported the ‘what is beautiful is good’ contention. however, in circumstances characterised by negative emotions, duress and stress, very little is known about how human beings respond at the subconscious level to the attractiveness of frontline service providers. aim: the purpose of this study was to assess whether consumers who complain to a frontline service provider about a service failure respond differently at the subconscious level when the service provider involved in the service encounter is attractive compared with one who is less attractive. method: forty respondents were exposed to a video clip of a service failure and service recovery situation. while viewing the hypothetical scenario, two neuro-physiological measurements were used to collect data at the subconscious level, namely galvanic skin response (gsr) and electroencephalography (eeg). results: the results suggest that, at the subconscious level, customers respond differently to the service recovery efforts depending on the attractiveness of the frontline service provider who attempts to rectify the service failure. conclusion: the results seem to suggest that the physical attractiveness of a frontline service provider moderates (or softens) the negative emotions that a complaining customer might experience during a service failure and complaint situation – consistent with the ‘what is beautiful is good’ contention. introduction marketers, based on the principles of environmental psychology (bechel & churchman 2002), acknowledge that the environment in which marketing interactions – such as a service encounter – take place influence all those involved in the interaction (bitner 1990, 1992). in a service delivery context, sundaram and webster (2000:380) conceptualise the service environment in a communication paradigm by referring to the verbal and non-verbal communication cues the environment transmits. their conceptual model indicates that both forms of communication (verbal and non-verbal) between a frontline service provider and a customer influence the consumer’s feelings, which then influence their evaluation of the service encounter. an important element of the non-verbal communication in the model is the physical appearance of employees (sundaram & webster 2000:380). although the scholarly interest in people’s physical appearance can be traced back to the 1920s (rumsey 2008), it was not until the 1960s that researchers such as walster et al. (1966) started systematically to investigate the role that the physical attractiveness of people plays in influencing others’ perceptions and attitudes (feingold 1992; landy & sigall 1974). before that, many psychologists found the idea that others can be judged by their appearance ‘unpalatable’ (kleinke 1974). initially, the consensus was that those who are physically attractive, particularly with very few other cues at their disposal, are more likely to be associated with favourable outcomes such as social acceptance. attractive people were rated as having better career prospects, expected to be more competent spouses and expected to have happier social and professional lives (dion, berscheid & walster 1972). the ‘what is beautiful is good’ contention was confirmed in a variety of studies (dion et al. 1972:285). these results led berscheid (1981) to conclude that physical attractiveness is an ‘extraordinarily important psychological variable’ that leads to a variety of favourable outcomes for those who possess those characteristics. however, bull and rumsey (1988) argued that berscheid (1981) had overstated the importance of physical attractiveness, and they were particularly critical of the methodologies used in many of the studies on which those conclusions were based. in the majority of these studies, undergraduate students were used as subjects, the stimuli were often limited to head-and-shoulder photographs and they expressed concern about the ecological validity of some of the experiments. closer scrutiny in later years by feingold (1992) and others suggested that these ‘positives’ associated with attractiveness are more likely to be limited to social contexts (popularity and more friends, lower social anxiety) and favourable evaluations of ‘soft skills’ such as persuasion (chaiken 1979). the impact of physical attractiveness was far less influential in situations where the attractive person was associated with cognitive skills and competencies, and ‘near zero’ for character-like traits such as integrity and concern for others (eagly et al. 1991; feingold 1992). in other words, the generalisability of the attractiveness–ability relationship was strongly questioned. although the initial thrust of this stream of research on the impact of physical attractiveness was grounded in psychology, marketers have increasingly shown an interest in the impact that the physical attractiveness of employees can have on variables of interest to them. these include the effectiveness of product endorsers (kahle & homer 1985), advertising effectiveness (baker & churchill 1977), salesperson performance (ahearne, gruen & jarvis 1999) and customer satisfaction (söderlund & julander 2009). service managers have also become interested in the influence of the physical appearance of service delivery staff. because service delivery and consumption often occur simultaneously (bitner 1990), and given that the role of frontline employees is crucial in customer perceptions of service quality and satisfaction (bitner, booms & tetreault 1990), service marketers are particularly interested in the appearance of their employees. the seminal work of bitner (1990, 1992) on the impact of physical surroundings, including the appearance of frontline staff, has shown that the physical appearance of service providers strongly influences customers’ evaluations and perceptions in a service delivery context. however, we know that consumer responses and decisions are not based entirely on so-called rational thinking only. those responses and decisions hinge on both reason and emotion, and it is estimated that up to 95% of human thinking takes place in the subconscious mind (zaltman 2003). however, humans are often not able to articulate their feelings and thinking because they occur below the perceptual level (zurawicki 2010) – yet these feelings and thinking drive their decisions and responses (kagan 2002). unfortunately, marketing researchers often do not adequately explore what consumers cannot articulate. consumers share only the logical aspects of their responses and decision-making, as these are much easier to convey than their subconscious emotions. as a result, as zaltman and zaltman (2008) point out, researchers only explore at the surface level of what consumers think, and this bias often produces invalid responses. given the fact that consumer responses and decision-making are strongly influenced by the social and physical contexts they find themselves in at the time of the decision-making (lowenstein 2001), which service encounters inevitably are, this study explored consumers’ subconscious responses in a service encounter context. no research has been done to assess whether the physical attractiveness of service providers can play a role in an emotion-laden situation such as service failure–customer complaint interaction. using neuro-physiological measurement to measure subconscious emotional responses when collecting the data overcomes many of the methodological limitations of earlier studies. against this background, the primary purpose of the study was to assess whether customers who complain to a service provider about a service failure respond differently at a subconscious level when the service provider involved in the service encounter is attractive rather than one who is less attractive. the service encounter a service encounter – including a customer complaint encounter, which is the focus of this study, can be characterised in terms of social exchange theory, as it contains all of the basic components of the theory, namely actors, access to resources, exchange structures and a process of exchange (molm 2006). consistent with social exchange theory, the actors in a dyadic service encounter act in their own self-interest to maximise the advantages of the outcome of the encounter. both the service provider and the customer have access to resources: the customer’s future patronage is of value to the service provider, while the service provider has the ability and resources to address the complaining customer’s problem or complaint. both actors, thus, depend on each other to some extent to ensure what molm (2006) refers to as ‘positive value’ from the exchange (resolution of the complaint for the customer and loyalty for the service provider) and to minimise the negative value (such as financial loss and loss of time). this mutual dependence or structure is a key component of social exchange theory. finally, a service encounter provides a process of exchange in which the benefits any party receives during the exchange are contingent on the benefits the other party receives. in a service complaint–resolution situation, a service provider will only address the complaint if he or she feels the customer will, as a result, remain in the relationship; and the complaining customer will only remain in the relationship if the problem or complaint is addressed. in other words, both parties will exchange value if there are sufficient benefits for both of them. how the service encounter is experienced is, however, not only largely determined by the behaviour of frontline employees (sergeant & frenkel 2000) but is also strongly influenced by the emotional responses of both the employees (hennig-thurau et al. 2006; slatten 2011) and the customers (harris & ogbonna 2006; mccoll-kennedy et al. 2009). those emotions can be influenced by both verbal communication and physical cues (dallimore, sparks & butcher 2007; sundaram & webster 2000). the role of physical features social psychologists are interested in consumers’ physical features (mainly their demographics) because they believe a person’s physical appearance is generally the first piece of information available to them when meeting a stranger (dion et al. 1972), and the interpretation of those features will strongly influence the subsequent assessment of the person (hogg & vaughan 2008). social categorisation theory suggests that this assessment leads to group identification (attractive people in this case) or rejection of the group in an attempt to reduce subjective uncertainty about the person. although a person’s appearance is concrete and directly observable, it is often linked to traits such as honesty and sincerity, which are often based only on inference (park 1986). these inferences influence human feelings (affect, emotions and mood) and, as a result, their decision-making process too (hogg & vaughan 2008). however, although human beings will cognitively evaluate a situation (which includes the physical appearance of a person in a dyad such as a service encounter), this evaluation is normally followed by both an affective and a physiological response. the affective component of such a response (the emotion) is largely autonomic and can be described in one of two terms: either ‘harm’ (characterised by negative emotions such as fear, resulting in avoidance behaviour) or ‘benefit’ (evoking positive emotions such as happiness, leading to approach behaviour). this emotional response influences thought, judgement and subsequent behaviour (bitner 1992; kardes & cronley 2000). in other words, what consumers actually see during an interaction will impact their responses and their subsequent evaluation of the encounter, (dis)satisfaction and behaviour (such as buying or not buying). for instance, söderlund and julander (2009) have empirically demonstrated that, when customers interact with an attractive airline stewardess, their assessment of her attractiveness influences their assessment of the employee, which spills over into a positive impact on customer satisfaction. the nature of human attractiveness attractiveness can be seen as a socially valued characteristic in the same category as intelligence, charm or athletic ability (feingold 1992). the evaluative meaning of what is regarded as attractive is based on two sources (eagly et al. 1991): direct observation in one’s social environment and exposure to cultural representations of ‘attractive’ and ‘unattractive’ people. the former is strongly influenced by how others respond to attractive people and how they are treated by their peers. these perceptions lead to a social consensus about what is regarded as beautiful or attractive (berscheid & walster 1974). in a marketing context, ahearne et al. (1999) define attractiveness as the extent to which a customer perceives an employee (such as a salesperson or, in this study, a service provider) as possessing an appealing and pleasing physical appearance. the impact of attractiveness in a marketing context, attractiveness has proved both influential and beneficial. a meta-analysis of the impact of source effects, of which physical attractiveness was one, has shown that physical attractiveness does impact the persuasiveness of interpersonal communication (wilson & sherrell 1993). attractive spokespersons, advertising models and salespeople have, compared with less attractive ones, been shown to be more persuasive, producing more positive product evaluations and better recall, and are more likely to influence purchasing intentions (chaiken 1979; deshields, kara & kaynak 1996; joseph 1982; kahle & homer 1985; reingen & kernan 1993). the attractiveness stereotype proved particularly influential in the absence of other cues such as perceived expertise (joseph 1977), especially when used ‘appropriately’. the latter refers to the role of attractiveness in the ‘right’ product categories, consistent with the so-called ‘match-up’ hypothesis (baker & churchill 1977; kamins 1990). in an advertising context, the match-up hypothesis argues that there needs to be congruence between the person (such as an endorser of a product) used in an advertisement and the product being advertised. the research on the impact of physical attractiveness in a marketing context reveals two major caveats. firstly, the impact of the gender of the person assessing physical attractiveness has not been adequately explored. this is surprising if one considers the fact that differences in how males and females process information and make decisions have been reported. for instance, male consumers are typically more independent decision-makers, and female consumers are more interdependent (meyers-levy & loken 2015). in an advertising context, it has been demonstrated that different genders respond differently, for instance, to advertisements (putrevu 2004) and to the perceived effectiveness of advertising (noble, pomering & johnson 2014). differences have also been reported at the subconscious level (spalek et al. 2015). music psychologists have demonstrated that emotions evoked by music differ between males and females: females typically have a stronger response than males towards an arousing and unpleasant musical stimulus (nater et al. 2006). the manipulation of gender in this study was also based on the contention that the attractiveness stereotype is more prevalent among females than among males (bar-tal & saxe 1976; eagly et al. 1991; reingen & kernan 1993). for instance, jackson, sullivan & rostker (1988) reported that females, compared with males, rated physical attractiveness as more important to them and that they do more to look attractive than their male counterparts. the second caveat is the fact that almost all of the empirical results related to the impact of physical attractiveness reviewed here have been based on perceptual data – respondents basing their evaluations on how ‘successful’ (depending on the context and the dependent variable under investigation) they expect the attractive target to be. the only exception was ahearne et al. (1999), who used actual sales data as the dependent variable and found a positive relationship between physical attractiveness and successful selling. however, the strength of the relationship weakens over time. although attractiveness on a cognitive level has been investigated in the psychology and sociology literatures, the emotional impact of attractiveness has not received much attention (friedman, riggio & casella 1988) since the seminal study of mehrabian and blum (1997). they reported a link between the emotions reported by their respondents and the ratings of humans’ physical attractiveness. for instance, faces that produced feelings of pleasure, arousal and submissiveness were judged as attractive, while those that elicited feelings of displeasure, low arousal and dominance over others were considered unattractive (mehrabian & blum 1997). unfortunately, they, like most others who have investigated emotional states in marketing contexts, relied on pencil-and-paper tests to ‘measure’ emotions. pencil-and-paper measures of emotional states may be problematic, as humans often try to regulate their emotions (zeelenberg et al. 2008), and as a result, when self-report tests are used to ‘measure’ emotional states, social desirability bias is often a source of concern (paulhus & john 1998). another source of concern is the fact that self-reports are often retrospective in nature and rely on the person’s post hoc, cognitive interpretation of their own mental or behavioural responses (cacioppo 2002). unfortunately, not all people have the same ability or willingness to report their emotional states effectively (mauss & robinson 2009). studies conducted on attractiveness are also, from a methodological perspective, not beyond reproach. the empirical research conducted mainly by social psychologists has collected data by one of two means: either by a self-rating of attractiveness, or by respondents (often referred to as ‘perceivers’) being asked to rate a target’s attractiveness on a perceptual scale (e.g. walster et al. 1966), and the attractiveness score is then the mean scores of multiple raters (feingold 1992), usually after exposure to a photograph or photographs. despite the clear importance of the physical appearance of frontline service delivery personnel, very few studies have addressed the role of physical attractiveness in a service encounter context, despite calls to investigate the relationship (söderlund & julander 2009). in one of the few exceptions, koernig and page (2002) investigated the match-up hypothesis in a dentist service encounter environment and found that the attractiveness of a service provider must be consistent with the image of the service if it is to be influential. söderlund and julander (2009) did investigate the role of physical attractiveness in a service encounter, but used photographs as experimental stimuli and collected perceptual data to measure satisfaction. the current study overcame many of these methodological limitations by assessing the subjects’ subconscious responses to attractiveness or unattractiveness by measuring their neuro-physiological responses. the value of neuro-physiological measurement psychologists such as uleman and bargh (1989) and zaltman (2003) have shown that a fair amount of mental processing is subconscious in nature. human beings and their decision-making are strongly influenced by emotions, they often think in an automated manner, and many motivations and behaviours are not consciously ‘controlled’. neuroscience measures consumers’ subconscious and emotional responses that are not controlled by the central nervous subsystems (which is what happens when a self-report type test is used). this ‘observation-like’ approach to data collection prevents the subjects from cognitively rationalising their decisions and largely avoids the risk of false and inaccurate self-reports (labarbera & tucciarone 1995:37). the benefits of this methodology are that researchers better understand consumer choice and decision-making (vartanian & mandel 2011). this contention is particularly true when consumers experience responses that they cannot explain themselves, are unaware of, or prefer to hide. in these circumstances, this neuro-physiological measurement methodology is able to enhance the validity of empirical results. objectives the primary purpose of the study was to assess whether customers who complain to a service provider about a service failure respond differently at a subconscious level when the service provider involved in the service encounter is attractive than when the person is less attractive. the purpose was, thus, to investigate whether the ‘what is beautiful is good’ contention also holds at the subconscious level – and more specifically, when the person complaining experiences negative emotions such as stress and anxiety, which service failures inevitable provoke (chebat & slusarczyk 2003; tronvoll 2011). a secondary objective of the study was to assess whether these subconscious responses are influenced by a gender–effect. hypotheses and propositions social exchange theory predicts that both parties in a dyadic service encounter will try to maximise their obtained benefit from the interaction. from a customer perspective, this benefit will be to maximise satisfaction with the outcomes of the encounter. but if goal attainment is threatened, a negative emotional response is the likely consequence (lazarus 1999). however, based on social categorisation theory (tajfel 1981), we know that when a customer enters a service encounter, the human brain will almost automatically classify the other party as either attractive or not attractive (gulas & mckeage 2000), which may influence how the customer will respond. the empirical results reported by söderlund and julander (2009), that the satisfaction of a customer in a service encounter is mediated by their perception of the attractiveness of the service provider, suggest that the attainment of the desired benefit could be enhanced or reduced by responses to the physical features of the service provider. these responses can be both conscious-cognitive responses and subconscious emotional responses (zaltman 2003). based on the general tone of the ‘what is beautiful is good’ literature (deshields et al. 1996; dion & stein 1978; mehrabian & blum 1997; reingen & kernan 1993), the theoretical model of sundaram and webster (2000), the empirical evidence that gender impact on how information is processed subconsciously (spalek et al. 2015) and the empirical findings specifically related to a service encounter (söderlund & julander 2009), the following hypotheses and propositions are addressed: h01: service recovery by an attractive opposite-gender service provider will not lead to negative subconscious responses among males. h02: service recovery by a less attractive opposite-gender service provider will not lead to negative subconscious responses among males. h03: service recovery by an attractive opposite-gender service provider will not lead to negative subconscious responses among females. h04: service recovery by a less attractive opposite-gender service provider will not lead to negative subconscious responses among females. p1: service recovery by an opposite-gender attractive male service provider will not produce more positive subconscious responses than a less attractive male service provider among female complainers. p2: service recovery by an opposite-gender attractive female service provider will not produce more positive subconscious responses than a less attractive female service provider among male complainers. based on the often-cited concern about social desirability bias in research (zikmund 2003:183) and the argument that neuro-physiological research overcomes this potential bias (labarbera & tucciarone 1995:37) because skin conductance changes and brain activity are not under the control of the central nervous system, a further research question was considered: do complaining customers suppress their (negative) emotional responses following a service failure when asked to express a cognitive assessment of the service failure and recovery experience? methodology stimuli the context of this study was a hypothetical airline service failure and recovery scenario. the airline industry was selected because it allows the creation of realistic hypothetical service failure and recovery situations (enhancing the external validity of the study) and has been used in several previous service failure recovery studies (harris et al. 2006; lorenzoni & lewis 2004). in this study, only facial attractiveness was investigated – primarily because it is a more influential attribute than bodily attractiveness (mehrabian & blum 1997) and also to avoid the risk that the inclusion of bodily attractiveness could have confounded the empirical results. subjects’ subconscious responses were recorded while watching a realistic service failure and recovery scenario (video) lasting about 2 min rather than the static, single photographs in association with text-based vignettes that were used in earlier research. the former adds an element of external validity absent in many previous studies. as frontline service providers can respond in a variety of ways in a service failure and customer complaint situation (e.g. angrily, denying responsibility, unhelpful), the service providers’ response to the complaint was held constant in all scenarios. following the complaint, the service provider in each hypothetical scenario offered an explanation for the service failure, accepted blame on behalf of the airline, apologised, offered a resolution (i will make sure that your luggage is delivered to your home tomorrow), offered compensation (a free airline ticket) and expressed their appreciation for the passenger’s custom with the airline. the scenario is, thus, characterised by a non-confrontational attitude from the service provider. because a person’s physical appearance and gender classification are the personal characteristics that are most obvious and accessible to others in social interaction (berscheid & walster 1974), physical attractiveness and gender were manipulated in this study. in addition, consistent with saad’s (2004) contention that assessments of physical attractiveness are influenced by an opposite-gender effect, we tested only opposite-gender responses in this study (e.g. female respondents watching video clips with only male service providers handling the complaint). in this way, we controlled for the opposite-gender effect in attractiveness assessments. neuro-physiological measurement in this study, two neuro-physiological measures were used to assess the arousal and the valence of responses when exposed to service recovery scenarios by both attractive and less attractive service providers. these measures were galvanic skin response (gsr) and electroencephalography (eeg). galvanic skin response electrodermal activity refers to changes in the electrical conductance of the skin due to changes in moisture levels (van praet 2012:22). these changes are the result of changes to the eccrine (sweat) glands in the human skin and are regulated by the autonomic nervous subsystems. changes in electrical activity are the result of physiochemical changes and are, therefore, an indication of emotional arousal. because humans have no control over their autonomic nervous systems, these electrodermal responses (as the glands dilate) are indications of activation or arousal in response to stimuli that human beings cannot control (venkatraman et al. 2015). galvanic skin response measures only arousal, it has a base level of zero, and therefore, cannot be a negative value. in other words, the higher the index, the stronger the level of arousal. electroencephalography electroencephalography measures the amplitude of cerebral waves or brain activity in response to the exposure to some form of stimulus such as viewing a product, packaging or an advertisement or, as in this study, as a customer moves through a service encounter. what makes this data collection method particularly suitable for studies of this nature is its high temporal resolution. eeg is capable of recording data in sub-millisecond intervals, while alternative methodologies, such as functional magnetic resonance imaging (fmri), have a resolution time of several seconds (ohme et al. 2010). in this study, frontal asymmetry was measured by means of eeg, and specialised procedures and algorithms were used to control individual differences in the baseline cortical activation. the eeg measurement used 32 electrodes on each subject’s scalp according to the 10–20 electrode placement system. the electrodes were placed in a bipolar fashion, as proposed by cacioppo, tassinary and berntson (2000). pre-test as the literature confirms, beauty is in the eye of the beholder. the manipulation of the attractiveness of the service provider in the service recovery scenarios thus had to be empirically confirmed. consistent with previous studies (koernig & page 2002; reingen & kernan 1993), a single-item, semantic differential scale anchored by very attractive (scored as 10) and very unattractive (scored as 1) was used by a sample of 44 respondents to rate each actor in the hypothetical service failure and recovery scenario. using the mean scores across all participants, a paired sample t-test revealed that the expected attractive male and female actors were rated significantly more attractive than the less attractive actors (males t-value = 11.66; p < 0.00 and females t-value = 14.01; p < 0.00). these results suggest that the manipulation of attractiveness was effective. data collection the research design of this study can be described as a laboratory experiment, although the data were collected by means of electronic observation. each subject was exposed to exactly the same scenarios in the form of a video clip illustrating a hypothetical service failure and recovery situation involving an airline. the only exception was the manipulation of the physical appearance of the airline agent (attractiveness and gender). the words used in the scenario (in the video clip) are provided in appendix 1. these words, expressed by the complaining customer only, were scrolled across the screen to control for the influence of tone of voice. the voices of the actors (service providers) during the service encounter were, however, their own. although the actors (service providers) were instructed to use a consistent, monotone-like tone of voice devoid of any emotion, the differences in the tone of voice could not be controlled for. similarly, the actors (service providers) were instructed to keep their facial expressions neutral and not to exhibit any expressions that might reflect an emotional response. the nature of the service provider–customer interaction can be described as an airline traveller, who has just disembarked, complaining to an agent of the airline about lost luggage after a transatlantic flight. the video clip consists of an opening scene of a commercial aeroplane landing at a national airport (shot on location), passengers disembarking, and then walking towards a rolling carousel full of luggage. this is followed by a shot of an empty carousel, and the camera then moving towards the luggage handling kiosk. the kiosk is ‘neutral’ in the sense that there is no branding or logo of any actual airline. the focus of the camera is then on the service provider while the passenger’s words of complaint are scrolled across the screen (good morning. i have just arrived on flight 221 from new york via london. my luggage is not on carousel 1 as you announced, or on any other carousel for that matter. can you please establish what happened to my luggage?). the service provider then addresses the complaint by responding in his or her own voice, as described in appendix 1. four hypothetical service failure and service recovery scenarios were created in the form of video clips lasting slightly more than 2 min each: one attractive male, one less attractive male; one attractive female, one less attractive female. each participant, however, viewed only opposite-gender scenarios. after viewing each of the two opposite-gender video scenarios, the respondents were asked one question about their satisfaction with how they were treated by the airline agent: ’if you were the passenger in this video clip, how satisfied would you be with the way the airline handled your complaint?’. the question was linked to a bipolar semantic differential scale anchored by very satisfied (5) to very dissatisfied (1). exposure to the scenarios (including distracters) was counterbalanced and presented in random order. the purpose of distractors is temporarily to occupy the cognitive processes and to ‘reboot’ the working memory of respondents. this task requires a higher cognitive load and allows respondents to focus on something other than the main purpose of the study without being exposed to emotionally loaded content. the only task expected of the subjects was to watch the stimuli presented on the screen. buffer assignments (a cognitively engaging task – e.g. fragments of the stroop test) were used. within-subject designs are common in these types of studies (hazlett & hazlett 1999), and all subjects were exposed to the stimuli individually. before being exposed to each scenario, a baseline was measured for 30 s. before the test started, the subjects were told that they had to pretend that they were the complaining customer in the scenario. the sample the group of 40 subjects consisted of 20 males and 20 females drawn on a convenience basis from a panel of volunteers. the sample size compares favourably with others that have done similar studies (boksem & smidts 2015 – 32 subjects; plassman & weber 2015 – 20 subjects). the subjects were all aged between 20 and 45 years and had travelled on a commercial airline at least once before. empirical results neuro-physiology measurement results table 1 summarises the gsr indices, which are indications of activation or arousal in response to the scenario stimuli. it shows that – regardless of the gender of the respondent and the physical features of the frontline service provider – the arousal of the respondent is significantly above the baseline in all four instances. however, it is noticeable that the female gsr indices are higher than those of the male respondents when dealing with the opposite gender. the results reported in table 1, thus, provide some evidence of a gender effect at the subconscious level. it must also be noted that the gsr responses (arousal) are higher for the less attractive service provider for both genders (1.83 in the case of females and 1.32 in the case of male respondents). it thus appears as if, at the subconscious level, there is some evidence of an attractiveness bias. unfortunately, the gsr scores do not indicate valence; and so the subconscious responses to the service recovery situations were further explored using eeg measures. table 1: galvanic skin response results. table 2 shows that all of the eeg responses are negative compared with the baseline, regardless of whether or not the service provider handling the complaint is attractive. however, only one response is statistically significantly different from the baseline, and that is when male respondents deal with the less attractive female service provider (t = −3.22; p < 0.01). h02 must, thus, be rejected (in respect of the less attractive service provider). however, h01 cannot be rejected (in respect of the attractive service provider). hypotheses h03 and h04 can both not be rejected, as the relative attractiveness of the service provider does not seem to influence the subconscious responses of the female subjects. table 2: electroencephalography results. a cursory glance at the eeg indices in table 2 does seem to suggest that male respondents are a lot harsher in their subconscious responses to the recovery efforts than females, but that they are particularly displeased with the efforts of the less attractive service provider, despite the fact that the service provider accepted responsibility, apologised and offered the customer some compensation. the results reported in table 2, thus, provide further evidence of a gender effect at the subconscious level as well as evidence supporting the attractiveness bias. it is also notable that the eeg values (in table 2) for the more attractive service providers are consistently better (less negative) than for the less attractive service provider, regardless of the gender of the respondent. in the case of female respondents, it is −0.14 for the less attractive male service provider, compared with only −0.03 for the more attractive service provider (a difference of 0.11). in the case of the male respondents, the scores are −0.49 and −0.34, respectively (a difference of 0.15). these results seem to suggest that, at the subconscious level, the attractiveness bias is influenced by gender. based on the results reported in table 2, propositions 1 and 2 must be rejected. in table 3, the eeg responses of the male respondents are analysed per individual scene (see appendix 1) during the service recovery encounter. when ‘interacting’ with the less attractive female service provider, the eeg indices of the male participants are consistently negative (right pre-frontal activation), suggesting avoidance behaviour. the eeg index deviates from the baseline to a significant extent when the less attractive service provider offers an explanation (p < 0.01), when she accepts blame for the lost luggage (p < 0.001), when offering compensation (p < 0.10) and when expressing appreciation for the traveller’s custom (p < 0.10). when the less attractive service provider apologises for the poor service delivery and offers a resolution (i will make sure that your luggage is delivered to your home tomorrow), the scores are still negative, but do not differ significantly from the baseline. table 3: male respondents: less attractive female service provider. table 4, on the other hand, shows far less severe negative responses among males to the attractive service provider. only when the attractive service provider offers compensation does the eeg index deviate from the baseline to a significant extent. in other words, males respond considerably less negatively at the subconscious level when dealing with a more attractive service provider than they do with a less attractive one. this pattern of responses adds credence to the earlier contention that proposition 2 must be rejected. table 4: male respondents: more attractive female service provider. when considering the scene-by-scene analyses (tables 3 and 4), it is clear that the compensation offered by the service provider (i will issue you with a voucher for a free ticket for local travel any time during the next year) leads to a negative subconscious response among male respondents regardless of the physical appearance of the service provider. table 5 explores female respondents’ responses to individual scenes in the service complaint scenario. table 5: female respondents: less attractive male service provider. in contrast to the male participants’ responses to the less attractive female service provider (table 3), female responses are far less severe (less negative), and the eeg responses do not differ significantly from the baseline in any of the scenes. the same applies to the scene-by-scene analyses when female respondents deal with the more attractive male service provider (table 6). however, a cursory comparison between the male responses (tables 3 and 4) and the female responses (tables 5 and 6) seems to suggest that males respond considerably more negatively than females during every scene. table 6: female respondents: more attractive male service provider. table 7 shows that when male respondents ‘interact’ with a female service provider, the eeg responses to the less attractive service provider are consistently lower (more negative responses, implying avoidance behaviour) than to the more attractive service provider (indicated by the positive scores in the differences column), except for the compensation scene (negative) and the appreciation scene (which is neutral). the positive scores in the difference columns of table 7 imply that the subconscious scores with the more attractive service provider are superior to those of the less attractive service provider. this result provides evidence in support of the ‘what is beautiful is good’ premise at the subconscious level. table 7: male respondents: a comparison of electroencephalography responses to attractiveness of female service provider. although it was not specifically addressed in this study, one can speculate that the negative difference (−0.20) between the attractive service provider and the less attractive service provider in the compensation scene seems to suggest that male respondents may experience the attractive service provider as insincere (cf. estelami & de maeyer 2002). insincerity (or the absence of authenticity) has been shown to impact negatively on how complaining customers experience a service encounter (hennig-thurau et al. 2006). another possible explanation may be that the compensation offered by the service provider may be regarded as inappropriate, given the relatively minor nature of the failure, and that may lead to feelings of guilt (cheng et al. 2015:838). smith, bolton and wagner (1999) have demonstrated that complaining customers prefer service recovery efforts that are commensurate with both the type and the magnitude of the failure. when female respondents ‘interact’ with male service providers, five of the six scenes are positive (table 8). the positive scores in the difference columns of table 7 imply that the subconscious scores for the more attractive service provider are superior to those for the less attractive service provider. this result provides evidence in support of the ‘what is beautiful is good’ premise at the subconscious level. table 8: female respondents: a comparison of electroencephalography responses to attractiveness of male service provider. the negative difference (−0.32) between the subconscious responses when the attractive service provider accepts blame for the service failure (−0.36) compared with the less attractive service provider (−0.04) again raises the question of perceived insincerity. however, when service recovery does take place (explanation, apologising, resolution, compensation and appreciation), female respondents seem to experience the service recovery actions more positively when the service provider is relatively attractive than when the service provider is less attractive. cognitive measurement to explore further the ‘attractiveness hypothesis’, an attempt was made to measure the respondents’ rating of the encounter at the conscious level. a five-point likert scale was used to measure responses to the question: ‘if you were the passenger in this video, how satisfied would you be with the way your complaint was handled?’ the mean score for the female sub-sample when rating the less attractive male service provider was 4.37; for the more attractive service provider, it was 4.27. the difference was not statistically significant (p > 0.05). when the males were asked the same question, the mean scores were 3.62 (less attractive service provider) and 3.90 (more attractive service provider). again the difference was not statistically significant (p > 0.05). thus at the conscious level, it appears as if attractiveness does not play a role in how complaining customers perceive the service recovery interaction, regardless of the gender of the respondent. at the conscious level, there is thus no support for the ‘attractiveness hypothesis’. however, at the subconscious level, it is apparent that males and females do indeed differ in their responses to more attractive and less attractive service providers in a customer complaint situation. female respondents were far less likely to respond negatively to the less attractive male service provider than the male respondents’ inclination towards the less attractive female service provider. the result of the pencil-and-paper test (conscious measurement) raises two important issues. firstly, it appears as if males suppress their negative responses to service failure in general, but their negative emotional responses to less attractive service providers in particular. the second is the question of social desirability bias in consumer responses to customer complaint and service recovery situations. the contribution of this study the study makes a theoretical contribution to our understanding of service failure and recovery in general. at a global level, almost all the measurements revealed a consistent pattern of negative neuro-physiological responses (negative eeg scores) to the service failure and complaint situations, regardless of the gender of the service provider, regardless of the attractiveness or otherwise of the service provider, and almost regardless of the actions the service provider took to address the complaint. more attractive service providers did, however, solicit lower negative responses than the less attractive ones, but they were still negative. another theoretical contribution is that there is evidence that participants suppressed their true feelings about the hypothetical service encounter when asked to evaluate cognitively their satisfaction with the service recovery outcome. their responses to the likert-type question were neutral, while their subconscious responses told a different story. the empirical results also showed a gender effect. at the subconscious level, males were considerably harsher on the less attractive service provider in the service recovery situation than they were with the prettier service provider – but they would not admit to that at the cognitive level. it must be noted that the compensation offered by the service provider (i will issue you with a voucher for a free ticket for local travel any time during the next year) led to a negative subconscious response among male respondents, regardless of the physical appearance of the service provider. this could be due to the fact that the male respondents feel that, if the service provider accepts responsibility, offers an explanation, apologises and resolves the complaint, compensation is not necessary; and so they may experience uncomfortable emotions such as guilt due to the relative minor nature of service failure and respond very negatively to the proposal. the underlying premise of this study was the contention that our understanding of consumer decision-making and consumer behaviour can be enhanced by exploring the role of information that the consumer does not consider rationally or even think about. the failure to incorporate subconscious information-processing in research has led to spectacular research failures in recent times. the so-called ‘pollsters’ were completely wrong in predicting the outcomes of both the 2016 american presidential election and britain’s referendum on leaving the european union. the pollsters measured their respondents’ cognitive evaluation only and ignored their emotional feelings when making their voting decisions. it is against this background that this study used a data collection method (neuro-physiological research) that collects data on responses that are not under the direct control of the central nervous system. the benefit of using neuro-physiological methodologies in consumer research is aptly described by telpaz, webb and levy (2015:511): ‘…. neuroscience can reveal information about consumer preferences that is unobtainable by conventional methods’. it is in this context that this study makes several contributions. one is a contribution at a methodological level. as bagozzi et al. (2000) point out, much of the reported research on emotional and subconscious consumer responses is limited because subjects are often prompted to anticipate their affective responses rather than their ‘natural’ responses. natural, unbiased responses are of importance to service managers because a fair amount of mental processing is at the subconscious level (uleman & bargh 1989). as a result, consumers often think in an automated manner, and many motivations and behaviours are not consciously ‘controlled’. due to the influence of these subconscious processes, even consumers themselves are often not aware of the reasons for some of their reactions. the most important advantage of neuro-physiological observation is that subjects do not know that their subconscious responses are being measured, and they are unable to adjust their responses at will. the methodology offers an important advantage to researchers when responses to sensitive topics are investigated, especially when those responses might be contaminated by stereotyping or social desirability bias (greenwald & banaji 1995). neuro-physiological measurement also overcomes problems such as respondents’ inability to recall past events or behaviours. conclusion in summary, both the gsr and eeg results reported in this study suggest that, at the subconscious level, there is evidence in support of the ‘what is beautiful is good’ premise in a non-confrontational service failure and recovery situation. the results also provide evidence that, at the subconscious level, males and females respond differently to the relative attractiveness of the service provider in a non-confrontational service failure and recovery situation. in other words, there appears to be support for the gender effect at the subconscious level. managerial implications the results of this study demonstrate that, in a service failure and recovery situation, consumers respond differently at the subconscious level to service providers, depending on how attractive the service provider handling the complaint is. this is so despite the fact that at the conscious level no differentiation is apparent. it is also apparent that, at the subconscious level, males respond more negatively to service failure and recovery than do females. these negative responses are particularly severe when they are interacting with a less attractive service provider. this is so despite the fact that the service provider accepts blame for the service failure, apologises and recovers the situation. this result may be problematic for managers of service organisations. on the one hand, they are under pressure from social activists such as wolf (2012) who decry what they see as unfair discrimination based on ‘lookism’. and it is not only females who suffer from this bias. more attractive male employees with an ‘above-average appearance’, in a study she cites, earn on average 5% more than their less attractive counterparts. on the other hand, managers know that dissatisfied customers do respond more favourably to those who are more attractive. one way to respond to this situation is to deflect attention away from a potential focus on the attractiveness of a service provider who handles a customer complaint. instead, service providers can tailor their own responses in a manner that nullifies the potential impact of attractiveness. examples could be the physical environment where complaints are handled. pleasing décor, soothing music and friendly (non-confrontational) employees can go a long way to overcome the negative impact of frayed emotions. however, these responses must be experienced as authentic and genuine. so-called ‘deep acting’ has been suggested as a means of conveying the authenticity of provider responses (hennig-thurau et al. 2006). there is considerable value in a managerial strategy based on the principles of contagion. however, as söderlund and julander (2009) point out, this approach will not work in an environment characterised by acrimonious interpersonal relations among co-workers, or by acrimonious interpersonal relations among employees and management. thus, for contagion to succeed, managers need to broaden their approach to ensure an organisational service climate in which employees can be authentic and genuine in their responses to complaining customers. arranging for complaining customers to interact with satisfied customers who had complained earlier, testimonials from satisfied customers, and case studies of how the airline addressed complaints in the past, may be beneficial. regardless of the facial features of individual service providers, their general appearance cannot be neglected. the physical appearance of service providers must reflect respect and consideration for their customers and that calls for proper grooming and a professional dress code that beam the message that they are ‘professional’ rather than ‘sexy’. limitations of the study a limitation of this study, common to almost all neuro-physiological studies, is the relatively small sample size that was studied. given the prohibitive costs associated with this relatively new method of exploring human responses and data collection, sample sizes tend to be relatively small, which inevitably limits the use of the statistical procedures typically associated with large samples. a further limitation is that only one broad organisational response to service recovery was investigated: the offending airline accepted blame for the service failure, apologised and offered some compensation. future research could explore an alternative service provider response such as denying responsibility or placing the blame on the customer. in addition, only opposite-gender responses were considered (males responding to female service providers and vice versa). the subconscious responses to same-gender service providers might be totally different. another limitation of the study was that assessments of the frontline service provider, such as perceived insincerity, have been ignored. a further limitation of the study was that the impact of the tone of voice of the service providers was not controlled. their tone of voice could have confounded the respondents’ subconscious responses. having said that, using a service provider’s actual, real-world voice does add a degree of external validity that would have been absent had an alternative option, such as an animated voice, been used. another theme of future research is a consideration of the legal limitations in including the physical attractiveness of applicants as a criterion in considering job applications. these limitations leave scope for future research. acknowledgements the contribution of rafal ohme and michal matukin, based at the neurohm research laboratory in warsaw, poland, to this study is gratefully acknowledged. the author would also like to thank the two anonymous reviewers whose feedback contributed significantly to the development of the 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during your connection in london. i do not understand why this happened. your luggage will only be here in 24 hours’ time. accept blame: it appears as if our airline is to blame for the problem. apologising: i want to apologise unreservedly for the inconvenience we have caused. resolution: i will make sure that your luggage is delivered to your home tomorrow. compensation: to compensate, i will issue you with a voucher for a free ticket for local travel any time during the next year. appreciation: again, please accept my humble apologies. you are a valued customer of our airline and we value your business. journal 4.p65 ������������ ��� ����� ��� �������������������� ��� �� ���������������������� �� �� ����� ����� � ����� ���� ��� ���� ��� ����������� ������ ���������������������� ����������� ���� � ����������������� ���������������� �� ��������������� ������� � �� � ��� �������� ��������� ���� ���� ������ ����� ������� ������������� ���������� ��������� �������� ������� ������ 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*�"5���#���, ���5 ��g�#(���#�d�34��$#%�23������& �$#%�23 )0��,�+����� � ���+0���� ��'��� ����7��������� ���!���"� � ���� ������ ���� *� ��!�$ �!�� �����;#�b,%���;9�#""&��3��3� )7 0g������� � �����0,������ * ������� /l �"#�d�>���2�>�����>3�2���+3 �$��4�#%�� �2�#! �#�����4#�>�&�0$���3"��34��+���===�@ �"#�d ��� ���%������5��5�6�������� ����������������� �����������!����� � ������ �� ����+�)�.�& :��9-� )� 0g�e����� ��)===��/��1�#>���3���$�����" 31�#3��?�(�" ��#3��34�%�1#��"�1�3m�%���#� �2�#% "� ��6���2�#*335�)===��3�2���� ��3%��5#�2����2�#! �#�����+3%#��d�34�� ����"#�& ,�"!3 ������ ����"#���� 2 ����89�-��)==)&�.-9 �) .= e���'���e�e����� �����.��/������"d�#��34 �$��g+�#>13���>��<���43��4���$��11"���;#�$ �1�%#4#%���4����%���3�3113�� �#�#���43��+3 �$ �4�#%�6�������� �����������������������������! ���� � ��� ��� �� ����=&�.:9:8 .� h�� '���� �������0��)==���/����#"��� <�3;�;$����$�d�;���6���� �-���!� ""� �$ "���� 7����"�3�����% &�� "">����h��$#�2�3�&��9 sajems ns vol 1 (1998) no 2 assessment of the municipalities d fourie financial resources school for public management and administration, university of pretoria abstract 268 of the challenges with which municipalities are currently faced, include the fulfilment of the expectations of many new communities to whom they must render services, while they must simultaneously improve the quality of existing services and eliminate backlogs. the sources from which local authorities generate their revenue at present do not appear to be adequate for the increased need for funds. this paper provides an overview of the issues that have led to the current state of municipal finances and the factors that influence the revenue and expenditure of municipalities. in the light of the lack of sources of income for municipalities, particular attention is given to issues which could have an effect on the improvement of administration in municipalities. introduction the restructuring of municipalities in south africa has been the cause of a variety of serious difficulties experienced by the newly formed municipalities. these difficulties include a dramatic increase in their responsibility for the rendering of services while certain sections of the community default in respect of the payment of service charges, increased administrative and personnel costs, a relative decrease in intergovernmental grants and a decline in the number of personnel who are experienced in financial matters. the short-term effects of these difficulties are that significant pressure is exerted on municipalities' cash flow and that their financial resources diminish. to date, municipalities have coped with these pressures by spending their accumulated reserves; reducing expenditure on maintenance and capital projects; deferring payments to creditors, in particular bulk service suppliers such as eskom; utilising r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 269 sateb nr vol 1 (1998) nr 2 bridging finance and extending long-term debt. municipalities in south africa are therefore facing a complex new political, social and financial environment. it is particularly the financial capability of municipalities that will determine the success of service delivery at municipal level. the primary objective of this paper is to provide background information on the development of municipalities, especially in respect of their financial viability and the current state of municipal finance. a secondary objective is to present an innovative perspective on alternatives to higher taxation. municipal developments until the 1990s, municipalities were racially segregated and directly and indirectly geared towards political control. like most state institutions, this was an object of political conflict. for the current purpose it is not necessary to record the entire constitutional history of municipalities. it is, however, necessary to identify the cardinal factors and dynamics in order to understand the financial difficulties with which municipalities are faced. whites traditionally elected municipal councillors, the elections usually being associated with fairly high-priced real estate, industrial areas and commercial centres in urban areas. this base gave the municipality an adequate source of revenue. on the other hand, the coloured and indian communities had management and local affairs committees, but these committees tended to be underfunded and rarely engendered much enthusiasm (botes et al., 1996: 212-214). in view of the guiding ideology of the government, africans were not considered to be permanent residents of "white" south africa, but rather as citizens or future citizens of "independent" homelands. nevertheless, local structures were designed to provide assistance in the management of the problems experienced in urban african communities. in order to improve local service delivery, the black local authorities act, 1982 (act 102 of 1982), was introduced. this act devolved on the black municipalities powers in respect of matters such as electrification, waste disposal, and the construction and maintenance of roads, but the minister of cooperation and development retained a large measure of control over the activities of these authorities. because they did not have commercial or industrial property from which they could obtain revenue in the form of rates, and due to service backlogs, the black municipalities began to accumulate financial deficits. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 2 270 in the 1980s, the central government attempted to manl.lge the situation by extending credit to municipalities whose financial situation was in a particularly parlous state. the legislative steps taken, were designed to provide a long-term solution to the financial and developmental problems facing the black municipalities. the regional services councils act, 1985 (act 109 of 1985), is an example of such legislation. this act provided for the joint provision of bulk services by white, coloured, indian and black municipalities as well as for the collection of levies from the commercial sector to contribute to the costs incurred by municipalities. with the introduction of reform initiatives in the early 1990s, the concept "own affairs" was abandoned by the government of the day. in march 1993 the local government negotiating forum was established for the purpose of negotiating the formation of a democratic, non-racial, non-sexist and financially viable municipal system (sairr, 1993/94:564). the process of restructuring involved the establishment of negotiating forums throughout the country in order to pair areas which were previously governed by racially defined bodies. it was intended that this measure might satisfy the requirement of non-racism and, hopefully, also improve financial viability, as inferred in the slogan "one city, one tax-base". the democratisation process at the municipal level created 835 municipal structures of which only 35 percent are viable, 35 per cent marginally viable and 28 per cent not viable. it has become apparent that many of these municipalities do not have the required financial resources to deliver services at a level acceptable to the community they serve. the needs of townships mainly occupied by people previously classified as blacks, in particular, are very real. according to kruger (1996: 3) their needs are as follows: • four million people have access to untreated water only; • eight million people have minimal sanitation only; • seventeen million people have no electricity; and • eight million people have no formal road access to residential areas. municipalities, as the sphere of government closest to the citizenry, is expected to take a leading role in addressing the above-mentioned problems. the current system of municipalities, which is regulated by the local government transition act 1993 as amended by the local government transition act, second amendment act, 1995 (act 89 of 1995), is a transitional one. the south african constitution, 1996 (act 108 of 1996), specifically includes municipalities. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 271 sateb nr vol i (1998) nr 2 constitutionally, municipalities are enjoined to carry out two main tasks: ensure the delivery of services to the communities under its jurisdiction, and promote economic development. a new system is due to be implemented in 1999. however, the current financial position of municipalities will most certainly continue into a new constitutional dispensation. me state of municipal finances one of the most important factors contributing to the present highly unsatisfactory state of municipal finances is the non-payment of municipal service charges by a substantial percentage of the communities newly incorporated into the transitional municipal structures. in addition, there is an inability, and seeming unwillingness, on the part of the central government to compensate municipalities for these losses to the extent that they were expected to do so. the minister of finance, in presenting his budget to parliament on 12 march 1997, acknowledged that there were problems in respect of municipal finances which required attention, and singled out non-payment as the most important of these. furthermore, the minister pointed out that the amount owing to municipalities at the end of october 1996 represented 25 percent of the total annual rates and service charges payable. in monetary terms the municipal debt is at least r26 billion (see table i). this amount includes loans of r964 million owing to the local authorities loans fund board which makes loans to municipalities for the financing of capital projects (budget review, 1997: 4.8). the minister stated clearly that it is unsustainable and unacceptable, and neither right nor fair, that on average only 69 percent (see table 2) of residents pay for municipal services on a regular basis, and that a democratic south africa cannot afford a culture of non-payment (budget review, 1997: 4.9). it is, however, equally important that municipalities should also manage their finances better by improved administration, including the implementation of proper credit control. see table 3 in this regard. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 2 272 table i: municipal debt type of debt rm stock issues 7070 government loans (housing and other) 2779 loans from dbsa 707 i loans from the local authorities' loans fund board 964 other annuity loans 200 overdrafts and loans from commercial banks 2714 bills issued by local authorities and held by banks 605 leases and instalment credit from banks 70 loans from insurers and pension funds 140 other loans 700 total 25949 source: budget review, 1997: 4.8 table 2: percentage of regular payers. october 1995 october 1996. i all grades 10grades 6-9 grades 0-5 provinces 15 % % % % october 1995 68 70 67 57 march 1996 69 71 • 64 59 june 1996 69 71 65 60 t1996 69 ! 69 71 60 october 1996 68 69 70 60 source: project liquidity surveys, 1997 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 273 sateb nr vol 1 (1998) nr 2 table 3: ability to render accounts to all areas. september 1995 october 1996 all grades grades 6-9 grades 0-5 provinces 10-15 % % % % september 1995 88 62 95 90 march 1996 88 76 94 90 june 1996 91 74 92 90 august 1996 90 76 95 91 october 1996 95 91 99 94 source: project liquidity surveys, 1997. although the non-payment of municipal charges has been largely politically motivated and exacerbated by socio-economic conditions, other reasons also come into play: inadequate services, inability of the municipality to effectively meter and charge for service usage, and weak internal capacity to exercise credit control and manage debt collection effectively. the levying of rates on property (real estate) is still the main source of revenue, supplemented by revenue from the sale of services (bahl & linn, 1992: 79). over the years, a number of investigations were undertaken and recommendations made in respect of additional sources of revenue for municipalities. the net result of these investigations and recommendations was the decision by government in the 1970s to pay rates on its properties to municipalities, and to subsidise services such as preventative health care and ambulance and emergency services. in the absence of an alternative source of revenue to supplement their revenue from rates in order to finance non-revenue yielding services, municipalities came to rely rather heavily on the profit they make on the sale of services. however, uncertainty has since arisen regarding this source of revenue, because the national electricity working group has decided to support a model of regional electricity distribution which will bring about the establishment of regional and subregional electricity distributors and operators, while eskom and municipalities discontinue their electricity distribution activities (argus, october 9 1996). this decision was followed by an announcement by the director-general of mineral and energy affairs on 10 february 1997 concerning a proposed rationalisation and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 2 274 restructuring programme, which would result in only 20 to 30 institutions being pennitted to distribute electricity while municipalities forfeit the right to do so. according to the director-general, consideration was also being given to the introduction of unifonn electricity tariffs, especially in respect of households. this measure could also have a detrimental effect on the finances of municipalities (die burger, february 2 1997). the "tax revolt" in sandtoo: a new culture of non-payment? the "tax-revolt" which began in 1996 in sandton, in the eastern metropolitan substructure of johannesburg, is still in progress. an increase in the property rates together with the revaluation of property resulted in rates increasing by as much as 300% (franzsen, 1997:12). the funds collected were to be incorporated into the budgets of the metropolitan council and the southern and western substructures. the gauteng's development planning and local government department argues that this approach is tantamount to taxing the rich in order to subsidise the poor. this argument may well be true and there is probably also validity in the view that the rates increase was exceptionally high and bound to elicit a reaction. the lessons to be learnt from the "tax-revolt" should be noted. the first lesson is in respect of the legal issues that were raised when ten finns based in the eastern metropolitan substructure attempted to have the increases and levy nullified. this experience was repeated in pretoria. in march 1997 the supreme court in pretoria refused the pretoria city council leave to appeal against a decision that differentiated rates de facto along racial lines were discriminatory and therefore unconstitutional. this dispute had started when a resident of "old" pretoria had refused to pay more than the "flat rate" applied in areas which were fonnerly under the control ofblas. the residents were initially ordered by a magistrate to pay the outstanding amount, but this ruling was reversed on appeal the legal arguments were based on the principle of "equitable shares" as well as the relationship between primary and secondary tiers of municipalities. the aforementioned issues should be clarified when a new, pennanent system is developed and introduced. the second lesson to be learnt from the sandton "tax revolt" is that the boycotting of rates and service payments has become a feature of south africa's culture and it cannot be considered to be merely part of the particular experience of the "struggle". it also points to the manner in which such boycotts are likely to recur in future: this time the white taxpayers in sandton, next time perhaps the black residents in another town e.g. soweto? r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 275 sateb nr vol i (1998) nr 2 tbe impact of non-payment according to kapp (1995:6), for every rim lost by a municipality as a result of the non-payment of service charges, the capital budget decreases by about r5m. this decrease is essentially due to the adverse impact that lost revenue has on the ability of a municipality to raise loans and to finance their repayment. it should be borne in mind that the capital budget is the only instrument that political leaders have to make a meaningful difference to the quality of life of their followers and fellowcitizens. if non-payment is not addressed, it will continue to create serious problems for municipalities. in the short term, it will put pressure on the liquidity of local authorities and retard the development of projects. municipalities would be unable to finance capital projects, because a greater proportion of their budget would have to be utilised for their operating expenses. the long-term implications of persistent non-payment should be regarded as speculative, since it is unclear how central, provincial and local governments would respond to it over a long period. as already mentioned, there are indications that all levels of government do not intend permitting this to continue. improving municipal finances the total municipal budgets for 1996/1997 exceeded r47 billion, or about 7y2 per cent ofgdp, including capital expenditure ofrl1,5 billion (budget review 1997: 4.7). with the aforementioned in mind, an extension of the power to impose taxes is commonly regarded as the logical solution to the problem of local finances. the simplest way to improve revenue would be to increase the percentage of revenue received from current sources. this could, however, have a negative effect, for example, some residents would be taxed out of their homes, unpaid bills would escalate, more enforcement would be required and municipalities would therefore require more officials. the extension of tax powers does, however, entail increased political responsibility which, although it may be desirable, will nevertheless not meet with approval at the central government level (evans, 1992: 298; cf. also section 229 of the constitution, act 108 of 1996). solutions related to new resources of local revenue may be easy to suggest, but it is highly unlikely that the higher levels of government would hand over many sources of revenue to local bodies. with the aforementioned in mind the question which immediately arises, is: are there other r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 2 276 sources of revenue available to municipalities? investigations into the finances of municipalities are not new; good examples in this context are the borckenhagen commission (1965 66), the browne report (1980), the croeser working group (1982) and the malan committee (1990 92). croeser (l992: 282 9) also paid attention to vertical and horizontal disparities, and suggestions were made regarding the improvement of the financial capabilities of municipalities. these suggestions include a local revenue or sales tax, a tourism tax and a road or tax, but such suggestions are regularly turned down . it should be borne in mind that the central government is unlikely to release its hold on taxation of income in order to allow municipalities to build up and strengthen their own capacities (craythorne, 1994: 361; cf. also evans, 1992: 300 302) and that central government demonstrates a tendency to centralise rather than to decentralise. furthermore, central government tends to delegate more and more functions to municipalities, often without the necessary financial powers or grants. in the budget review (1997: 4.7) it is stated that municipalities already have a substantial tax base; own resources account for over 90% of their budgets. therefore municipalities are said to have a significant capacity to support the services they provide. the inference of this statement is that a municipality must find its own way of balancing its books, because a dramatic increase in the transfers received from national government or the provinces is unlikely. in the light of the these circumstances, it is important that municipalities should take cognisance of and consider innovatively the issues discussed in the rest of the paper, in order to strengthen their financial capabilities. the masakhane campaign the masakhane campaign is part of the broad national strategy intended to create the necessary conditions for the success of the reconstruction and development programme (rop). it is aimed at mobilising all sectors of society to become actively involved in redressing the imbalances of the past and creating a society characterised by new values and norms. this aim should also include a sense of responsibility by all citizens to build and sustain democratic municipal structures (sono, 1995: 78-9). integral to this responsibility is the payment of rates and service charges. in many areas the effort has not been particularly successful, but there have also been some reasonable successes, such as the informal settlement of ivory park, midrand and areas of the north west province. it should be borne in mind that municipalities are ultimately responsible for their own financial affairs, which includes securing sources of revenue and balancing the budget. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 277 saleb nr vol i (1998)nr2 considering priorities one of the important duties of municipalities is to reconsider their priorities on a regular basis. they should ask: what are our priorities? what must we do first? and: what must be postponed because we do not have the necessary resources at present. one of the main pitfalls that a public authority should avoid is the force of habit to regard the matter currently being considered as having the highest priority. however, no one issue should be considered in isolation, but be assessed against the background of all the other issues to be considered, and thus determine its position in the order of priorities thus be determined (abernethy, 1974: 70). in this regard it is important that municipalities should do an infrastructure audit in selected areas to determine precisely what the existing needs are, and if necessary to reprioritise capital budgets so that precedence can be given to the provision of really basic, essential services. they need to develop the necessary capacity to be able to render the services with which they are charged. furthermore, it is important that the communities should be involved in the process of deciding precisely what services residents require, as well as in the provision of the required services (kruger, 1996: 5). assessing the internal capacity of the administration if a municipality is to be people-centred and people-driven, then it should address current challenges and opportunities. in order to enable the administration to do this, functions and activities that hamper the effective rendering of services and thus waste scarce financial resources, should be identified. in the process, attention could also be given to the elimination of duplication of work, identification of the areas in which officials need better administrative skills, functions that should to be restructured and the development of business plans (pallot, undated: 18 9). economic promotion areas of municipal jurisdiction are generally "open" economies, in the sense that there is constant movement of people and goods across their boundaries (browning & browning, 1994: 504). the basic economic objective is to create and maintain conditions that are conducive to the development of a city or town. it is essential for the successful promotion of local economic promotion activities that they should respond to the special conditions and needs of the local economy and are implemented in close co-operation with decision-makers in both public and private sectors. the main thrust of economic policy should be to identify the strengths, weaknesses, opportunities and pitfalls of economic development, in order r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 2 278 to work out strategies for short-tenn and long-tenn development. a co-operative policy of this nature will create a suitable climate for attracting new enterprises. attention should also be given to existing industries and their growth, in order to create new jobs and income for the population, which will in due course broaden the tax base too (honert, 1992: 118). it should be noted that economic promotion does not necessarily involve money and public expenditure. what is required, is initiative and flexibility on the part of the municipality and local entrepreneurs. a system of communication and coordination between local actors should be established, and necessary infonnation on infrastructural conditions should be timeously available. simplification of rules and regulations there is no specific legislation covering financial policy at local level. it is, however, the duty of municipalities to observe the laws and ordinances of the government and the provinces. extremely rigid legislation together with very detailed regulations and procedures which demand very high standards, could strangle the independence of municipalities. municipalities not only have to deal with the issue of funding (honert, undated: 8), but it is generally accepted that an increasing number of laws are setting excessively stringent requirements for local authorities. consequently, it is generally proposed that the large number of laws and regulations, guidelines and administrative controls should be reduced as soon as possible. discussions should be held to devise programmes for the reduction and simplification of legislation affecting local administrations in order to relieve them of some of their current burden. political responsibility with the introduction of the new municipal system, cognisance should be taken of the fact that any new system will have to be based on "existing" realities. it therefore cannot be assumed that there is a clean slate to work on. the legacies of the past will have to be acknowledged. for example, the backlog in respect of infrastructure in some municipal areas still exists and will continue to exist for some time (thornhill, 1993: i 2). a lack of funds will continue to be a limiting factor in the reconstruction process. councillors should support officials in the decisions they have to take, for example, to apply strict credit control measures (kruger, 1996: 4). furthennore, councillors should play an active role in their areas by infonning the members of the community about the implications of nonpayment for services. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 279 satebnr vol i (l998)nr2 according to craythorne (1994 : 10 i), councillors play a decisive role in financial management. furthermore, section 160(3)(b) of the constitution determines that the budget of a municipality shall be decided by a majority of all its members. therefore, if councillors are to govern effectively, they should successively comply with the task of allocating resources and determining priorities in respect of their approved budget. however, the functioning of any budgetary system is very complicated, and training in and exposure to budgetary, priority determination and decision-making would improve the skills of councillors in carrying out their responsibilities. improvement in the ability to collect and administer revenue a sustainable system of financing municipal infrastructure and services requires stable and predictable sources of revenue and, in particular, revenue which is under the direct control of municipalities. although the present sources are stable, the actual amount of revenue collected from these sources is very unpredictable, and adversely affects the ability of municipalities to access finance in capital markets. to ensure that revenue is collected, it is important that the revenue collection system is operating optimally. a municipality should, among other things, have adequate records of the households in its area of jurisdiction, the metering and billing systems should be functional, accurate accounts should be compiled, and adequate and safe payment points should be accessible within the area (kruger, 1996 : 5-6). the involvement of partners (heymans, 1993: 21) in the field of revenue collection may also be helpful, and in this regard banks, post offices and private organisations can play an important role. the services of a revenue manager, as in the ivory coast, could also be considered there, taxes are collected in the communes under the auspices of a revenue manager. the latter hands his "tickets" to local revenue collectors who in tum deposit the revenue received on a daily basis. if a revenue manager succeeds in collecting all the tax revenue within his area, he receives a bonus. the bonus system also applies to individual collectors (thornhill, 1993: 130). it should, however, be borne in mind that this system might give rise to corruption, and measures should therefore be introduced to prevent this from occurring. in attempting to improve the collection and administration of revenue, qualified and trained financial personnel should send out accounts on a regular basis and apply strict credit control measures (kruger, 1996: 4). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 2 280 training to build local capacity some of the above proposals assume increased competence on the part of municipalities to plan and manage the services for which they are responsible. clearly there is still much that needs to be done in this area. some municipalities remain woefully inadequate in terms of financial, technical and managerial capacity, and fmd it difficult to recruit and train staff of a high calibre. in expressing concern about auditing, the auditor-general reported that a month after the closing date for the submissions of their 1995/1996 annual financial statements, 184 municipalities had yet to submit their statements for the previous financial year (kluever, 1997). furthermore, the concept of pairing could also be utilised in training. this means that an experienced and capable municipality is paired with an inexperienced one in order to exchange ideas and to provide instruction, especially in respect of financial administration. privatisation or outsourcing of services with budgets being cut and the demand for more and better services increasing, privatisation or outsourcing could be considered. privatisation is based on the neoclassical hypothesis that private ownership means greater efficiency and more rapid growth, that should curb the growth of expenditure, raise money to reduce internal and external public debt, and promote individual initiative. avenues that might be explored are those that lower cost to consumers, while minimising the negative impact on the employees concerned. the benoni fire department may serve as an example in this regard (barber, 1997:4). if managed correctly, the privatisation of services has the potential to become a source of job creation and thus provide a broader revenue base for local authorities. in addition to privatisation is the possibility of partnerships between the public and private sectors, that could be utilised to develop managerial and financial skills and to provide access to private capital with a view to the improvement of service delivery. against this background, it is imperative for municipalities to take an objective and innovative look at their problems, in order to strengthen their financial capabilities. in focusing upon its internal functioning, successful management will to a large extent depend on the degree to which it exercises control over its own activities. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 281 sateb nr vol i (1998) nr 2 conclusion south africans have some very fundamental problems to address, as they seek to move their local communities through a process of transition. these problems transcend the immediate issues which typically tend to be the target area of finance. this article presents a perspective on an inherently complex problem, namely, an overview of the financial problems facing municipalities in south africa. in particular, the article attempts to show that there are no simple solutions to difficult problems. the notion of "financial problems" should not be accepted at face value, but be qualified in respect of specific cases and the economic, political and constitutional environment within which they operate. attention should be given to the system of local taxation. the purpose of local taxation is to obtain revenue to finance expenditure at municipal level. whatever the prevailing political or economic ideology of a country, its economic and social progress depends largely on its government's ability to generate sufficient revenue to finance an expanding programme of essential. non-revenue yielding services, like health, transport and other components of the socio-economic infrastructure. in order to develop an economic and social infrastructure, municipalities need funds. it is therefore essential to promote a culture of payment for services received, and to combat non-payment of rates and service charges. in this respect, municipalities should, wherever possible. take creative measures to make payment acceptable, enjoin their administration to eliminate unnecessary procedures and regulations. and take a fresh look at their own priorities. finally, in order to utilise existing sources of revenue effectively, it is important that central and provincial government should assist municipalities to determine which taxes they may levy and successfully collect, and give them the necessary authority and technical assistance to implement programmes to mobilise resources. references 1. abernetiiy, w.l. (1974). financing of urban renewal in urban renewal. college of estate management. united kingdom. 2. bahl, r.w. & linn, j.f. (1992). urban public finance in developing countries, oxford university press, new york. 3. barber, s. (1997). the privatisation of fire emergency services, paper presented at a conference on local government at the university of pretoria, pretoria, 4 june r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 2 282 4. botes, p.s., brynard, p.a., fourie, dj., & roux, n.l. (1996). public administration and management: a guide to central, regional; and municipal administration and management. pretoria. haum tertiary. second edition. 5. browning, e.k., and browning, j.m. public finance and the price system. 4th edition. new york. macmiiian publishing company. 1994. 6. craythorne, d.l. (1994). municipal administration a handbook. kenwyn, juta & co., reprinted. 7. croeser, g. (1992). inkomstedeling: die suid-afrikaanse problematiek en moontlikhede. saipa. 27 (4). december 1992. 8. evans, s. (1992). requirements for financially viable local authorities. saipa. 27 (4). 9. franz sen, r. (1997). the current status of property taxation in south africa: legislation and practice, paper presented at a conference on local government at the university of pretoria, pretoria, 24 july 1997. 10. heymans, c. (i993). local government in s.a: realities and issues from the past andfor the future. occasional papers. johannesburg. konradadenauer stiftung. october 1993. ii. honert, s. (1992). organization of economic promotion in germany on local level. economic promotion by local authorities in the philippines and in germany a reader. german foundation for international development. 1992. 12. kapp, c. (1995). financing of local government. paper presented at a seminar on local government", paper presented at a seminar on local government at the university of pretoria, pretoria, 30 may 1995. 13. kluever, h. 1997). deteriorating local government finance a cause for concern. cape town. press release. 26 march 1997. 14. kruger, r. (1996). non-payment of services: how to guard against the ruining of local authorities. institute for strategic studies. volume 5. university of pretoria. is. pal lot, j. international developments in public sector accounting and financial management. unpublished paper. office of the controller and auditor-general, new zealand. undated. 16. republic of south africa. (1996). local government transition act. second amendment act 97 of 1996. government gazette 17607, 22 november 1996. pretoria. government printer. 17. republic of south africa. (1997). 199711998 budget speech of the minister of finance. national assembly, march 14, 1997. pretoria. government printer. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 283 sateb nr voll (1998) nr 2 18. sono, t. (1995). "behind the tariffs, rent and rates boycotts" in strategic review of southern africa, may 1995. 19. south african institute of race relations, (sairr) survey, 1993/94. 20. thornhill, c (1993). an overview of local government and administration in cote d'/voire. saipa. 28 (2). june 1993. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 168 sajems ns vol 1 (1998) no 1 a framework for improving the quality of management information g ie r cidiers and h de jager school of accountancy. university of pretoria abstract computer-created infonnation is rapidly becoming too great for executives and others to absorb. the quality of infonnation must therefore be enhanced to provide business managers with appropriate infonnation to make efficient decisions. this paper presents the findings of a study to clarify the main and supponive attributes of quality infonnation and the computer tools that support the production of such infonnarlon. the study presents a framework for the evaluation of the most appropriate computer equipment and applications that would lead to the improvement of infonnation quality in a particular organisation. introduction computing in business has developed from the mechanical processing of limited sets of data some ninety years ago to a highly sophisticated electronic tool to manage business processes from the very small too the extremely large. organisations fmd themselves today in the sixth major generation of computers in forty-three years (edmunds, 1987:1(9). computers have become an integral part of success in business. in order for business to survive industry competition in the 1980's and into the 21st century the use of computers must be part of business strategy (griffiths 1986: 184). the expanded scope and diversity of infonnation systems and the infiltration of infonnation technology into every facet of business mean that infonnation management cannot be confined to the data processing arena it is a corporatewide affair. hammer. chairman of one of the largest banks in the united states, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr vol 1(1998) nr i 169 regards the corporation's three fundamental assets as people, capital, and information systems (griffiths, 1986:185). as a resource, information is wlique. unlike most resources, information is not exhausted by use, rather its value can be increased by its circulation (longley, 1982:165). tile price-perfomlance ratio of technology has also improved many times over and is still improving. the use of information warrants more attention as many more people in the wider community outside data processing deparunents began to make use of technology (griffiths. 1986:186). initially the focus of computers was on the processing of data. in the 1970's the awareness of the significance and value of information became more evident. the mere processing of data shifted to the compilation of information for management. growth in the size of organisations and an increase in the number of managers demanded a wider distribution of information within shorter periods. this caused information to expand rapidly. according to murdock, 75% of all information available was produced in the last two decades (murdock, 1980:4). users are rmding it difficult to cope with the overload of information. adams said that "computer-created information is rapidly becoming too great for executives and others to absorb" (adams, 1977:7). the apparent overload caused by the vast volumes of information demanded in turn the development of new technology to improve the capabilities of handling this information. the growth in the computer industry has been phenomenal. forty years ago there were virtually no computers, now the computer industry is the fourth largest industry in the world, with over three thousand firms (awad, 1988:55). computers offer an ever increasing variety and complexity of products, technologies and developments. the technological development emphasises the production and manipulation of ever increasing volumes of data and the presentation of acceptable information for management decision making. more recent developments include database management systems, advanced and more user-friendly programming capabilities, hypermedia, powerful processors and expert systems. a major technological trend is the convergence of computer and communication technologies. all these developments enhanced the users' ability to obtain better information for decision making. complex alternatives such as the choice between processors, software development platforms, and networking topologies are available to management to select suitable equipment, applications and the appropriate technological environment to produce acceptable results. because of the complex relationship between different alternatives and the impact it could have on the production of information, it is no simple task to produce the information required at the right r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 170 sajems ns vol i (1998) no 1 place, and at the right time. this wide variety of tools available to collect, manipulate and produce infonnation, presents a potential problem to management. selection of alternatives is often made for reasons other than the production of good quality infonnation, such as price or processing power. the contribution that specific equipment and computer applications could make to improve the quality of infonnation should be considered to help management with the appropriate selection and application of computer technology. objectives it was against this background that a study was undertaken with two main focus areas: computer tools and quality infonnation. it aimed at bringing the interrelationship of these focus areas together. the first focus area of this study was infonnation. the study of infonnation is contained in several scientific disciplines including: infonnation management, psychology and other human behavioural sciences. computer science. and business science. this study approached infonnation from a very specific angle. it focused on the attributes of infonnation in a business environment. it considered the background, nature, and features of electronic infonnation in business produced by fonnal electronic infonnation systems. the second focus area was the computer equipment, applications and technology environment which produce infonnation. computers and related technologies are very wide subjects. they are covered by computer science, electronic engineering, and management science. this study did not elaborate on all aspects of computer equipment. types of applications and technologies in the computer environment. it concentrated on those aspects that relate to the processing of data and the production of infonnation. finally, the study considered the impact that the components of computer systems have on the value of infonnation. many other factors, beside computers could affect the value of infonnation. for example, the ability of the infonnation user to deftne, interpret and react appropriately on the infonnation could greatly affect the value of infonnation. another factor determining the value of infonnation, is the source data. the quality of the source data will have a direct impact on the quality of infonnation. notwithstanding the impact that other factors might have on the value of infonnation. this study concentrated on the impact that computer equipment and applications have to produce quality infonnation. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sates nr vol 1 (1998) nr 1 171 hypothesis quality information is that information that can have a decisive impact on the decisions and actions of the decision maker. this study submitted that it is feasible to identify the attributes of quality information and clarified the main and supponive attributes of such information. computer equipment and applications, collectively known as computer tools, used and managed in an organisation contribute to enhance or impair quality information. 'this study considered these tools and the role they play to suppon the production of quality information. the hypothesis was defined as follows: using the most appropriate computer equipment and applications, and managing the optimisation of the features of these tools would lead to the improvement of information quality. research method the research method of the study unfolding the hypothesis, is illustrated in figure l. the research method included the following steps: a comprehensive literature study and synopsis of the historical development and trends of computing concluded with a sununary of the main driving forces behind computer development. the overview of the nature and characteristics of business information and the identification and compilation of the attributes of quality information isolated the main attributes and gave assurance that the attributes identified are comprehensive. the study classified the computer equipment and applications, collectively called tools, into logical groups. to ensure that a comprehensive review was done of all applicable tools that might influence the production of information, an extensive survey off computing topics was done in the literature. an assessment of the potential contribution that each group of tools identified in the step above could make to improve the attributes of quality information was then done. the characteristics of the tools and the attributes were analysed to deduce an acceptable method of assessing each tool's contribution to the production of quality information. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 172 sajems ns vol i (1998) no i figure 1 overview or research method phase 2 , . identify computer tools ~" consiof:r contribution of tools toauality of informa tion .-, phase 1 histor1cal qveri,hew of computers ii "-', ~nfoamation / , cons,der nature: of information , oefin€ attfusutes of quauty , compare i .... ... ! phase :3 cdmplle i framework information , evaluate performance ~ tools , to evaluate the significance of the attributes. the elements of information were refined into measurable components. the definition of these measurable components of information is described later in this study. a framework was then compiled to be used by managers to analyse information components and to identify areas of improvement to produce better quality information. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sated nr vol 1 (1998) nr 1 173 overview of coj\.1puter developmei\'t driving forces the literature study of the historical development and trends of computing covered computer development from the early days in the eighteenth century, to the current sixth generation of computers. the synopsis of the developments showed that a combination of key forces caused change in the computer world. research and development opened up new possibilities. the immediate needs of society at a particular point in time, consumed the ideas of the scientists and inventors to create viable products. research also created new opportunities to solve new problems. factors which increased the pressures on researchers to produce better results included changes in the scales of economy, developments in areas like communication, human behavioural research, and electronics and many other disciplines. during the last forty years, the main forces behind the direction in which computers developed can be summarised as follows: • the profit motive of a major industry in the world; • increased processing power of smaller and smaller "engines"; • the widespread use of computers in all areas of life; • the connectivity of computers throughout the world; • the storage capacity of data and information for many uses. the driving forces behind the developments in the six computer generations, with the. major benefits and shortcomings of each phase, are summarised in table 1. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . table 1 driving forces phase driving force early days natural desire to account for wealth 1800-1950 and possessions government requirements increased size of businesses creative forces to build calculating machines world war 2 demand for faster computations research first advances in processor technology generation awareness of scientific importance of 1951-1958 computers to universities pulling more power into programming systems to operate remotely second cost reduction in accounting generation applications --products & benefits replacing mundane tasks performed by humans adding machines arithmometers mass production of data building of powerful processors productive programming relation between human thinking and computer achieved bi rth of information age faster processors first digital commercial computer fortran developed commencement of multiprogramming experimentation with interactive systems and timesharing front-end processors and remote communications shortcomings limited stored programs enormous computers no communication between computers no networking limited reliability bulky and inoexible used vacuum tubes for memory required air-conditioning handled one program at a time programming performed in machine language little realisation of potential of software i -~ ci) (: rn 3: ci) 6i ~ j lr ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . table i (continued) second 1cost reduction generation applications in accounting i front-end processors and remote 1 little realisation of potential of communications software need to use data communication 1959-1964 i multi processing transistors replacing vacuum tubes magnetic core memory symbolic programming languages development of cobol edp managers move up organisation no software industry management lax in full in i utilisation of edp resources upcoming data professionals processing i ty~ical applications: payroll. accounts 1no charge back of edp costs receivable. accounts to users third generation 1965-1970 applications in all functional areas exponential demand for computer use appearance of software houses growth in size of organisations and economy payable. billing integrated circuits improvements in speed. capacity. types of input/output, storage devices lack of oexibility primarily concerned record keepi ng and data processing with management information not common high maintenance and .. .. development costs ryplcal applications: general ledger. i mini computers forecasting. budgeting. poor documentation inventory control high demand for programmers en ;j> @ ttl z ~ 9: ~ j z ... ..j iji r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . table 1 (continued) fourth 1expansion of generation production and needs information i significant improvement in design and 1little inter-organisational performance communication 1970-1980 complexity of economy and i large scale integrated circuits enterprises increased micro computers further growth in number of managers and other users database management systems emphasis on quantitative move towards centralised computing techniques in management controls and standards enforced controlled application development restructuring of application portfolios edp funds tightened surge of application software packages emphasis on user needs greater involvement of users explosion in use of communication databases and distributed computing based systems appear requirements for integrity, user base expansion availability and reliability l--~ dependence programming on user limited use of micro computers ~ ti) c: ~ ti) z ti) 9: j "l: r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . table 1 (continued fifth generation user machine interface expert systems networking distributed processing client-server technology communication wide range user support graphical developments human computer interaction sixth ,expert systems generation machine translation systems intelligent robots cross disciplinary rescarch e.g. physiology, psychology. vision world wide communication vlsi architecture parallel processing office automation explosion of information expectation gap between users and dp departments for users and i technology explosion user-friendly packages decision support systems experimental work in expert systems end user computing graphics total integration of computers comprehensive information provider interface unde'r expert systems not commonly used use of advanced technology limited pressure on capabilities intuitive reasoning associative recall creativity hearing smelling feeling tasting emotion gestures ~ ~ ~ j ~ -...) -...) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 178 sajems ns vol 1 (1998) no j the main atiributes of quality ~'fori\1ation the literature study revealed a very haphazard coverage of the attributes of quality infonnation. some 62 adjectives, used by authors to refer to the attributes of infonnation, were identified. most of the authors referred to 'relevancy', 'accuracy', and 'timeliness' being important attributes. several other aqjectives relate to these. other adjectives relate to the ability of the user to understand and work with the infonnation. although the ability to comprehend the infonnation is closely associated with 'relevancy', there is a distinct difference between the two. 'relevancy' has to do with the content of the infonnation. 'comprehension' has to do with the interface between the user and the infonnation. no single concept was defined in the literature as the dominant collective term for the attributes referring to these two aspects. for the purposes of grouping all these adjectives togellter, "comprehensibility" is used. the four main attributes identified in the study: relevancy, accuracy, timeliness and comprehensibility, and the other adjectives associated with them are summarised in table 2. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr voll (1998) nr 1 179 table 2 attributes of quality information main attribute sub-attributes relevancy sufficient detail i ability to manipulate not too much acceptable not too little accessible comprehensi ve available appropriate adaptable closeness to ease of access problem pertinence flexible meaningful suppon decisions fitness i authorised selective degree of integration complete accuracy limited noise credible i verifiable i reliable precise valid freedom from bias timeliness at the right time current not too late on schedule on priority i out of time comprehensibility readily understood ease of usc adequately output quality presented quantifiable clarity simplicity reproducible user friendly understandable i output r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . iso sajems ns vol! (1998) no ! the significance of the main attributes are discussed in the following paragraphs. relevancy information is constantly accumulating, having reference made to it and being stored. it can be a frankenstein monster if not controlled. too much in store can be self-defeating, but too little causes the decision makers and problem solvers to operate without true knowledge of what they are doing. to be kept under control, information must first be analysed and categorised to ensure useful benefit to all potential users. according to whitehouse information is knowledge; rapid and easy access to the right knowledge is intelligence (whitehouse, 1971:2). it must be available in sufficient detail to meet the needs of the user. all information progresses from new to old and will be lost if not consciously preserved. too much information gives retrieval problems, so information must not only consciously be preserved but must be consciously destroyed (whitehouse, 1971 :3). the information retained must be appropriate for the users, and sufficiently close to the problem to be pertinent. vast quantities of information are produced, more than any person can possibly need or use. a person's brain filters most of the data, and is consciously aware of it, but acts upon only a tiny fraction of it. the objective is for a management information system to be so constructed as to filter out unneeded information, and to convey only the information that supports the needs of the decision maker. the difficulty is that designers of information systems cannot know exactly what information will be relevant to an organisation. the challenge is to assess the relevancy. and to provide appropriate access to it. to be relevant. the information must apply to the action or decision to be considered. it must be close to the problem, not over-presented information but have sufficient detail and be flexible enough to provide for all the alternatives to be considered. two users facing the same decision might use completely different information to arrive at an acceptable conclusion. for example two managers face a decision to increase production volumes. the one wi1\ primarily use production statistics and sales volume information; the other will largely base his decision on market trends, the age of the plant and equipment and make his final decision because it will please his boss. appropriate relevancy is therefore primarily dependant on user preferences. only when the information is available in a required form or place, can it become relevant. non-existing information calulot be relevant. information however, can be incomplete and have a low quality. the degree of fit in a r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr vol 1 (1998) nr 1 181 particular situation is largely dependant on the process of filtering irrelevant information, and providing easy access to that which is relevant. because of the developments in information technology, there will be a marked increase in the quantity of rapidly accessible information and the ability to manipulate it (longley, 1982: 165). this will not necessarily improve the relevancy of the information. facilities must be provided to get the right information at the right time. accuracy any communication channel contains some background activity, which is called noise. information can only be recognised on the channel if it transmits signals stronger than the noise. the theory of noise in a communication channel and methods to minimise it, is well established in natural sciences. it is more difficult to detennine noise in management systems. however it does exist and because it can never be eliminated, measures to improve the clarity of the messages in a management system are worthwhile to be considered. with each message the relevant question is whether the information is a close enough approximation to reality for the intended purpose. deciding the accuracy of information depends on the nature of it. usually accuracy is associated with quantitative information. there are two types of quantitative information: counts and measurements. counts can be precise. a count of twelve stock. items is exact, in the sense that it is not twelve and a fraction. a measurement is never precise. measurements are always approximations. modem technology has made many measurements very accurate, but a margin of error always remains. most messages in a management infonnation system are measurements, rather that counts. inventory quantities may be obtained by counts, but the monetary amount of inventory is a measurement. measurements of such items as the expenses of an accounting period are likely to be a fairly rough approximation. many accounting measurements are also not precise because they are surrogates (anthony, 1980: 127). a surrogate is a substitute measure of some phenomenon that is used because it is not feasible to measure the phenomenon directly. profit, as defined according to certain rules, is often used as a general measure of a division's performance. accuracy can also be associated with non quantitative information. for example, a rejxln on the attitudes of staff in the organisation. the accuracy of the infonnation cannot be measured or counted. it could however be judged by r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 182 sajems ns vol 1 (1998) no 1 comparing it with other data, for instance, general knowledge about the staff, or the result of a comparable repon. mostly, precise measurement is not only impossible, it is also undesirable. the more precise the measuring instrument, the more it costs. there is no point in spending money to increase the precision of measurement beyond the degree of approximation that is needed to make sound decisions. for information to be accurate, it must be verifiable. to be verifiable, it should be related to other information from the same system, or to information from another system, or even to information such as verbal confirmation, prior knowledge, or 'gut feel'. although it might not necessarily be precise, it must be credible for the needs of the user. this credibility could be supponed by the process of validation, or even beliefs or perceptions. for the information to be valid the user should be able to rely on it. some inaccuracy of information is attributable to incorrect data producing unacceptable results. to improve the accuracy of the information, the source data must be improved. inaccuracy could be caused by noise in the communication channel. 'this is panicularly true when the user is biased towards an expected result and therefore judge the accuracy of the information inappropriately or incorrectly. noise in the communication channel could also result from a lack of interpretative skills, cultural background, or emotion of the user. finally information could get lost in a channel during the process of transferring information, for example, from one person to another. there is a trade-off between precision and timeliness. often it will take more time to produce more accurate information. approximate information might be more useful to the decision maker than late, accurate information. quality information must be accurate, however. the desired accuracy to form quality information is completely dependant on the user and could vary from siruation to situation and user to user. time6ness timeliness simply means that the recipient can get the information when he needs it. when information is not timely, it is usually because it is late. the same piece of information might be too late for one decision maker, and just in time for the other, depending on the priorities. information can also be received too early. receiving it too early might result in the storage of the information until it is used, or even the loss of it when it is eventually required. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr vol 1 (1998) nr 1 183 an important angle of timely information is related to the time that it takes to produce the information. preece (1990:7)quotes a study that licklider had done in 1960. with the following results: "about 85% of my 'thinking' time was spent getting into a position to think. to make a decision. to learn something i know. much more time went into finding or obtaining information than into digesting it. hours went into the plotting of graphs and other hours into instructing an assistant how to plot. when the graphs were finished, the relations were obvious at once, but the plotting had to be done in order to make them so." although this study of licklider is somewhat old. the problem is still very real. no information can be regarded to be timeless, a situation where there is no necessity for information to be available at a particular point in time. every decision has a beginning and an end. the beginning commences when the need for the decision arises, the end when the decision has been made, every piece of information used for a decision is received within a time frame, which either suits. or does not suit the time frame of the decision. the information is on schedule when it is received or available within the boundaries of the time frame of the decision. because of the difficulty of figuring out the exact timing of when the information must be available. and the different needs of users. some information providers lean towards having the information always available on request. for instance. the accumulation of large databases of information which can be queried at any time. this trend is noticeable in document imaging, cd rom and intercontinental information networks. these trends are indicative that the cost of information storage is less that the cost of not having the information available on time. information that is not on time is worthless and makes no contribution to add to the relevant knowledge of the user. for information to have any quality at all, it must be on time. the degree of on time will decide the degree of quality of the information. comprehensibility the presentation of information is vital for the actual grasping of it. it must be presented in a format that could be understood by the recipient. recipients have preferences, some prefer graphics. some tables, and other numerical data. when information is retrieved it must be presented in a way that will enhance its meaning and ensure rapid assimilation, (whitehouse. 1971:3). the presentation must be free from ambiguity, and should contain a clear picture for the actual purposes of the infonnation. the output must be r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 184 sajems ns vol i (1998) no i understandable. today much is done to make computers more user friendly. this implies that as the interaction between the computer and the user improves, the presentation of information by computer is more comprehensible. major computer development trends focus on the need for better presentation such as multimedia. graphics, high resolution screens. and windows. the information must not only be presented. but perceived and readily understood. without understanding, information would not be convened into knowledge by the user. understanding is dependant on the quality of the information and t.;e abilities of the user. despite the availability of information, or its accuracy, or even its timeliness, without comprehending the information. information will loose the benefit of all other attributes. summary of assessment of computer tools the study summarised the computer equipment and applications used to produce information into logical groups. these groups were illustrated as information system building blocks. figure 2 depicts these building blocks. figure 2 infonnation system building blocks i i design information system !~ .. ------------~;~~ i i ~; input technology ! :oatabases : controls , , appllca· :! lion l j softwari:: ; output butch infor· mation pad. cessing i cost! 1 effectn,le· ness demano the design building blocks: input, technology, databases, controls application software and output, produce the information. these computer tools were analysed and an assessment made of the contribution that they make to the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sates nr vol 1 (1998) nr i 185 production of quality information. the assessment was expressed in quantitative terms and is summarised in a comparative analysis illustrated in figure 3. figure 3 comparative analysis of assessment comparative analysis of assessment appllclltlons software 'iii databases) communications processing oata t,.,sfer o 10 15 20 25 cummulate assessment 30 ocomprehensible _timeliness ii! accurac:y _relevancy 35 these assessments represent the potential of each building block to improve the attributes of quality information. the results were deduced from an analysis of the characteristics of each group of tools, the identification of the primary objective of the tool group, and the supportive role it played to enhance the quality attributes of information. the reasoning behind each assessment rating was stated in the discussion of each tool group. it is important to stress that the purpose of the study was not to make an accurate assessment of each individual computer tool. the objective was to create a framework from which the potential contribution of tool groups could be assessed. it will highlight those tools that concentrate on the achievement of specific quality attributes. the assessment would point readers in the direction to find tools that will make the most significant contribution to a specific quality attribute. if the assessment achieves this objective, it can be regarded as a valid and successful assessment. the following general observations are made from the analysis: • all tools do not contribute equally to each attribute of quality information. • the two lowest scorers, controls and software. are both very supponive tools that do not perform primary information production roles. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 186 • • • sajems ns vol i (1998) no 1 all the tools make a good to an excellent contribution to the relevancy of infonnation. when considering quality infonnation, the model tools are by far the most significant. it is application programs that make the biggest contribution to enhance all the attributes of quality infonnation. in relation to other computer technology development, the technology that enhances the understanding and comprehension of data is relatively inunature. it is only in recent years that a major focus has been placed on this deficiency. tile analysis illustrates this immaturity and the lack of support of the tools for comprehensibility in relation to the support for other attributes. information components an infonnation component was defined in the study as the entity to be evaluated for quality attributes. an infonnation component has the following characteristics: • it is associated with a specific user, or group of users, in a specific organisation. • it has a homogeneous purpose or objective. • it demands distinguishable and homogeneous infonnation quality attributes. • it is a sub set of infonnation. • it is produced by a specific infonnation system. framework for evaluating the quality of information following the assessment of the contribution that computer tools make to produce quality infonnation, the study compiled a framework to be used by managers to analyse infonnation and identify areas of improvement to produce better quality infonnation. there are four major generic stages to perform an evaluation of the quality of infonnation and possibilities of improvement: decide what to evaluate, gather the infonnation, analyse the results and choose a plan of action. tile following steps were proposed to perform the evaluation and achieve the desired results: • select the infonnation area to be evaluated. • decide on the infonnation components to be evaluated. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sated nr vol 1 (1998) nr 1 187 • obtain responses from users of their assessment of information quality. • conven the responses into quality attribute ratings. • gather funher information if required. • match anributes to the potential computer tools. • select the tools to work on. • design improvement program. • carry out improvement program. step 1 is necessary to confine the evaluation. it is impractical and virtually impossible to perform an evaluation of all information in an organisation simultaneously. steps 2-7 will be described in funher detail in the next paragraph. steps 8 and 9 deal with the improvement actions. the study did not deal in detail with these steps. step 2: decide on the information components to be evaluated and improved using the main characteristics of an information component as identified in a previous paragraph as a guideline, the information must be reduced into information components. usually any specific repon from an information system in the organisation will comply with the information component definition. by listing these reports and results from the information system to be evaluated this step will be completed. this listing should be done by information system and should contain the following information: • • • step 3: shon description of information component. user or users of the information component. purpose or objective of information component. obtain responses from users on their assessment of the information quality once the information components have been identified, responses can be obtained from the users on their evaluation of the quality attributes for each information component. to simplify responses, a questionnaire can be prepared specifying, for each information component, the anribute and the appropriate scale for evaluation developed in the study. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 188 sajems ns vol 1 (1998) no 1 step 4: conven responses from users into quality attribute ratings for each information component when the responses have been received from the users, each questiormaire must he analysed to identify those information components and attributes in need of improvement. this can he done by putting all the returns into a small database such as dbase. tile record layout should contain the following fields: • questionnaire reference. • information component code. • attribute code. • rating. after all the questiormaires have been captured. the data must he soned by attribute, by rating and by information component. the result wiij he that all information components with incomplete information. or all information components received too early will he exposed. by analysing this information, trends can he identified. these will give rise to the type of further information to he gathered. step 5: gather junher information if required it is expected that further information will he required to explain the results of the analysis in step 4. it may he necessary to gather background knowledge of the information systems that produce the information component it will then he necessary to further investigate cenain replies by asking the users for the reasons hehind the replies. step 6: match the tools contributing 10 specific anributes the first step in homing in on the tools that can contribute the most to improve the quality of the information component, is to use table 3 to match the attributes to the tools. the result of this comparison must he added to the database questiormaire results compiled in step 4 by adding a field for the most likely computer tool to improve the quality of the information component. if more than one tool is involved, they too should he attached to the record. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr vol 1 (l998) nr 1 189 step 7: select the tools to work on the database can then be resorted to provide an analysis by tool and by information component. the result will clearly focus the anention on those tools that can potentially improve the information components the most. the tools that can make the most significant contribution in improving the quality of the information have now been identified. all that remains to be done is to implement the improvements to the tools. this is done in steps 8 and 9. by following the steps detailed in the previous paragraphs, an organisation can find out which tools to concentrate on to provide the most benefit for improving the quality of information. this will avoid focusing on incorrect areas. for example, there is a perception that the information in an organisation is inaccurate. this would give rise to developing a new information system. however, doing an analysis according to the framework could show that the information is not understood, or that the data capturing should change. addressing the actual problems can result in substantial savings for the organisation. conclusion no major focus on the inter-relationships between information quality and computer tools was evident from the literature study. the study aimed at illustrating the importance of this relationship. although the effect of computer tools was debated and illustrated, the study did not intend to field test the approach in the information management community. it did, however, add substantial benefit by illustrating the relationship between information quality and computer tools and by refining a framework for evaluating this quality. the study recognised the different contributions that individual tools within a building block can make to improve the quality of information. to ensure that the focus was not lost with attention to too much detail, the differential contributions of individual tools were ignored. the study focused only on groups of tools. further studies could focus on individual tools, and highlight those tools' effect on panicular developments in technology, which could improve quality information the most. another aspect regarding computer tools that the study steered away from, was the effect that one tool group could have on another. for instance, if processing is bad, it pulls down the effectiveness of other tool groups such as applications software. the inter-relationships between tools for producing quality information, could be another important area to study further. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 190 sajems ns vol i (1998) no 1 the attributes of quality infonnation were deduced from the study. the literature showed the lack of commonalty among some sixty-two attributes of quality that were mentioned. empirical studies could further enhance the understanding of exactly what users regard as the most important anributes of quality, and whether those attributes remain static. finally, in considering methods to improve quality infonnation, the focus of the study was on computer tools. it was mentioned that the human factor. in enhancing or reducing the quality of infonnation, would be substantial. it was not the intention of the study to focus on this factor. considering the human factor. and the interaction between computer tools and it, would offer substantial rewards to improve the ability to enhance the quality of infonnation. the hypothesis was defined as follows: "using the most appropriate computer equipment and applications, and managing the optimisation of the features of these tools would lead to the improvement of information quality. " the study considered quality infonnation and the computer tools that can improve the production of bener infonnation. after stating the objectives and research approach, it commenced with an overview of the historical development of computers. from this overview, it is apparent that the last 23 years has brought an ever-increasing focus on the development of improved computer tools to produee more efficient infonnation. the more infonnation that is being produced, the more focus there is on effective storage, manipulation, communication, processing and presentation of infonnation. the study then examined the nature and characteristics of infonnation pointing towards the decisive impact that infonnation has on the decisions and actions of decision makers. good infonnation, information that has quality, was then considered. the four main attributes of quality infonnation relevancy, accuracy, timeliness and comprehensibility were clarified. from the literature considered it was evident that a gap exists between infonnation produced by systems and the quality infonnation that users expect. this pointed to the need for improvement in quality infonnation. the process of producing infonnation from the initial stages of acquiring the data. through processing. communicating, storing, controlling, modelling and outputting the final infonnation was considered. each building block of the infonnation system, and the computer equipment used, was analysed to find out their effect on the process of producing infonnation. the computer equipment was classified into groups, called computer tools. the potential contribution that these tools can make in improving the quality of infonnation was considered and rated. a method was developed to evaluate infonnation by dividing it into smaller measurable components, performing an evaluation of the quality attributes of each r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sates nr voll (1998) nr 1 191 component, and finally identifying those tools that could make the most significant comribution towards improving the quality of information components. by presenting a process of evaluation of quality information, and ways to improve it, by means of a practical framework, the hypothesis was proven. by using this framework organisations can improve the quality of their information, make better decisions and take more appropriate action by using the appropriate computer tools. it is recommended that this framework be used in an organisation to collect and analyse the information necessary to design a plan of action to improve the quality of information in a specific area. references 1. adams, 1.m. & faux, d.d. (1977). printing technology. a mediwn 0/ visual communications. north scituate, massachusetts. duxbury press. 2. anthony, r.n. & dearden, 1. (1980). manogement control systetns. fourth edition. homewood, illinois, richard d irwin inc. 3. burch, 1.g., strater, f.r. & grudnitski, g. (1979) in/onnation systems: theory and practice. new york, john wiley & sons. second edition. 4. edmunds, r.a. (1987). the prentice-hall encyclopaedia 0/ in/onnation technology. englewood cliffs, n.j. prentice-hall inc. 5. griffiths. p.m. (1986). in/onnation management: state o/the art report. berkshire, england, pergamon infotech limited. 6. longley, d. & shain, m. (1982). dictionary 0/ in/onnation technology. london, the macmillan press ltd. 7. murdock, r.g. (1980). mis concepts and design. englewood cliffs, new jersey, prentice-hall, incorporated inc. 8. preece, 1. (1990). human-computer interaction. hertfordshire, uk, prentice hall international (uk) ltd. 9. whitehouse, f. (1971). docwnentation, how to organise and control in/onnation processing in business and industry. business books. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 207 sajems ns vol 2 (1999) no 2 on the shady side of economics ,i h van heerden and j n blignaut department of economics, university of pretoria n s groenendijk university oftwente and visiting professor, university of pretoria j 999 abstract this paper explains fraud from an economic point of view, using traditional economic tools and reasoning. it is shown how a supply-of-fraud function can be defined and estimated for individuals, and subsequenhy aggregated to derive crime rates for societies. another approach is to explain the behaviour of fraudsters as rent-seekers, a fa mode gary becker, and the problem of fraud may be seen as a case of market failure too. the paper also discusses some effects of fraud on society, and gives an empirical comparison between countries. jel k 42 you shall not have unequal weights in your bag, one heavy, the other i ight. you shall not have unequal measures in your house, one large, the other small. you shall have true and correct weights and true and correct measures ... all who commit these offences, all who deal dishonestly, are abominable to the lord. deuteronomy 25: 13-/6. introduction the above quotation stresses that fraud is an ancient sin, morally condemned in the strongest terms. today it is widely seen as a typically "economic" kind of crime, and few examples illustrate this better than the great portuguese bank note fraud of 1925 1• this was no routine forgery, but a particularly audacious swindle that caused currency circulation in portugal to increase by about 5%. the remarkable aspect of the fraud was that the notes spuriously introduced into circulation were in a sense quite genuine. for instead of producing their own counterfeit money, an international gang tricked the firm waterjow and sons of london, official suppliers to the bank of portugal, into printing a new batch of notes on their behalf from perfectly authentic plates. all the notes were of the denomination of 500 escudos (about five pounds) and displayed the image of vasco da gama, with a total value of some 300 million escudos, almost half of which was eventually put into circulation. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 208 the achilles' heel of the scheme was obviously the numbering of the notes. if they were given numbers not recorded in the books of the bank of portugal, the risk of immediate discovery was naturally very great. the fraudsters therefore instructed waterlow and sons to repeat the numbers on the last genuine consignment of notes they had sent to the bank of portugal. the gullibility of the printers in accepting such an outlandish order may seem extraordinary, but evidently this was a profession where intrigue and secrecy were considered quite normal. the enterprising criminals next established a new bank in oporto, as the vehicle for putting the notes into circulation. business boomed for about five months, betore the discovery of four notes with duplicate numbers led to the arrest of the swindlers and the closure of the bank. the bank of portugal next called in the entire vasco da gama currency issue, undertaking to exchange genuine notes for equal value with a different design. however, it was at times virtually impossible to tell the difference between the genuine and the spurious notes, especially seeing that the operation was pertormed in some haste in order to prevent complete loss of confidence in the national currency. the net result was a permanent, albeit marginal, increase in the amount of bank notes in the hands of the portugese public. the ensuing series of lawsuits between the bank of portugal and water low proved almost as sensational as the fraud itself, but unfortunately the matter cannot be discussed here. the legal and economic implications of the case even gave rise to a learned article in the prestigious economic journal by no less an authority than sir ralph hawtrey (1932: 391-8). economists are interested in crime and fraud for at least two reasons. first because like all human beings, they are led by a concern for what goes on in society. second, their interest in crime comes from a belief that the conceptual tools used in economic analysis also happen to be useful in reaching a better understanding of the origins and consequences of crime. more generally, economists think that their analytical tools are useful in the study of numerous social issues, traditionally belonging to the territory of psychologists, political scientists, sociologists, jurists and philosophers. towards the end of this century, the discipline of economics has been enriched by sub-disciplines like social choice, public choice and neo-institutionalist economics, which have in common that they do not focus on traditional market behaviour alone, but on consumer-like and producer-like behaviour in a much wider setting. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 209 sajems ns vol 2 (1999) no 2 the economic approach to the study of crime is not accepted by everybody. opponents have accused economists of academic imperialism, and the debate has centred around two related themes (fiorentini & peltzman, 1995: i). firstly, in non-traditional research areas opinions differ on the merits of modelling human behaviour as strictly rational. whereas most european economists are reluctant to use their tools outside their traditional research areas, their colleagues in north america (e.g. becker, posner, peltzman, stigler, coase) are generally less reserved. secondly, even if a rational choice model can be applied to a field like crime, what should be included in the model: economic and/or non-economic factors? economists are naturally partial to using economic variables. after defining fraud in the next section of the paper, two aspects of fraud are discussed in the following two sections: the phenomenon is first explained from an economic point of view, after which its economic implications are discussed. in the subsequent section, some statistics are given and their implications for economic analysis considered and, finally, a short conclusion is drawn in the last section. defining fraud for the purpose of this paper fraud is seen from an economist's point of view, and we therefore work with the definition of the termfraud as set out below. bastiat describes the attitude of individuals toward plunder as a means of satisfying their economic needs (o'donell, 1993). he states that men and women could work and produce what they needed by toil, but history has shown that they prefer to take what they can from others who have done the toiling. this might be done by either force or fraud. levi (1987) defines fraud as an unusual type of crime where the fraudster gets the victim to part with his property voluntarily, albeit under false pretenses. bastiat defines it as tantamount to frustrating the freedom of exchange, in order to receive a good or service without giving one in return (o'donell, 1993). fraud differs from most other forms of crime in that it involves deceit or misintormation. in the cases of crimes like robbery and assault, it is immediately clear to the victim that a crime has been committed against him or her. fraud, however, like corruption, can remain unnoticed. fraud occurs when one of the agents involved in a transaction withholds, distorts or concocts intorn'lation that is essential for the agreement by the other agent on the transaction. if a second-hand car is bought, it is essential to have correct intormation on the car. if an insurance company is making a payment for r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 210 damages suffered, it is essential that the company is accurately intormed of the damages. whether correct information is essential may, however, not always be clear, and this can be the subject of legal disputes. in most legal systems, an antiques dealer who sells a fake antique chair for, say, rio 000, is considered to commit fraud. on the other hand, a buyer who pays rio for a chair in a flea market, knowing it is worth rio 000, does not commit fraud, even though the deal would never have been agreed upon had the seller been correctly intormed of the chair's value. it is fairly straightforward to distinguish fraud from crimes like larceny (burglary, theft, robbery), sexual offences, violence against the person, damage to property, slander and libel. fraud and embezzlement are, however, hard to discern, as are fraud and forgery, and fraud and corruption. fraud differs from embezzlement in that the latter does not involve a transaction between two parties. fraud and forgery are related crimes: forgery can be used to misintorm the other party. in the case of fraud, it is best not to treat forgery as a separate crime, but as one example of fraud. fraud differs from corruption in two ways (groenendijk, 1997: 217-8). first, corruption in itself does not necessarily involve an unauthorised or illegal action by a corrupt agent. it is the authorised action (say, granting a license) in exchange for a bribe that is unauthorised. fraud always means an illicit action. moreover, corruption involves three parties: a principal, a corrupt agent and a corrupt client (that could be seen as a second principal), whereas fraud is committed by a single agent in a transaction between two other agents. however, reciprocal fraud can occur too: an agent buys a fake swiss watch from another agent and pays with counterfeit money. an economic explanation of fraud the seminal work on the economics of crime is a learned paper by becker (1968), the 1992 nobel laureate in economics. following his contribution, most of the work in this field has been targeted on the allocative choice by individual agents legal and illegal activities, in the face of different deterrence systems and opportunity costs. put simply, an individual decides to embark on a criminal act if the benefits of that act outweigh its costs. the optimal amount of illegal activity is reached where the marginal benefits are equal to the expected value of the marginal costs, made up of the probability of getting caught times the penalty involved. homo economic us or homo sociologicus? following eide (1994: 9). the debate on the merits of economic crime could be related to what elster calls one of the most persistent cleavages in the social r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 211 sajems ns vol 2 (1999) no 2 sciences, namely two opposite poles of thought conveniently associated with adam smith and emile durkheim, that is, between homo economicus and homo sociologicus. homo economicus is guided by instrumental rationality, attratced by the prospect of future, adapting to changing circumstances, always on the lookout for improvements. homo sociologic us is again driven by social norms, pushed by quasi-inertial forces, insensitive to circumstances, adhering to prescribed behaviour even if new and better options become available (elster, 1989: 99). these can be treated as two conflicting concepts, but they are also complementary. the economic approach concentrates on the importance of probabilities and the magnitudes of reward and punishment; the sociological (or criminological) approach investigates how people deal with probabilities, rewards and punishments, given their norms, values and beliefs. the concepts are blended together in what eide (1994) calls a norm-guided rational offender. figure 1, based on eide (1994: 13, 20), illustrates the role of norms for a rational actor. figure i the choice problem of a norm-guided rational offender preferences norms wants (binding or non-binding) 1 1 feasible set structure of ---. opportunity of actions the set of environment outcomes the rational choice problem here, is to choose a course of action (from a feasible set of actions), that, given the structure of the environment (or situation), will lead to a certain outcome. the feasible actions and outcomes are evaluated by the offender using preferences. the preferences of the would-be ottender consist of norms and wants. norms are moral attitudes towards actions, and wants refer to attitudes towards outcomes. norms are not always binding. if an action is likely to produce an outcome that is wanted very badly but happens to clash with a norm, then the individual might well choose to break the norm (eide, 1994: 13, 14). on the other hand, a desired outcome may be forgone if it requires an action that breaks a (binding) norm. three perspectives on fraud are given below. firstly an equation is developed with the amount of fraud on the left hand side, and the factors determining that r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 212 amount on the right hand side. strange as it may seem, this illustrates the way that many economists think. secondly, following becker (1993: 391), the idea of rent-seeking is used to explain fraud. finally, fraud is explained from the perspective of market failure and/or government failure. a supply-of-fraud function eide's model of the nonn-guided rational offender comprises a number of different factors that explain individual behaviour. using the model, it can be argued that variations in fraud at the individual level are the result of ditterences in: • feasible courses of action (opportunities); • benefits and costs of legal and illegal activities; • personal characteristics that shape norms and wants (preferences); • the environment's formation of preferences. criminological studies tend to stress the third and fourth factors, economic studies the first and second. following becker2, these factors are usually put into an individual supply-of-crime function, like: (i) which can then be used to do cross-section, time-series, or pooled studies, where c, is the number of crimes committed by person i in a given time period, pi and si are the probability and the severity of punishment, respectively; w, and w ll are the net benefits of a successful and an unsuccessful crime, respectively: and w" is exogenous income or wealth (eide, 1994: 90). ifall individuals were identical, equation (1) could also be used as an aggregate crime supply function. however, in the nonn-guided model individuals are not identical: norms, wants, the outlook for and the environment of crime are all ditterent. therefore one has to assume that there is an "average individual", with the following supply-of-crime-function: c = f(p, s, w" wu, wo) (2) where the variables are mean values of the corresponding variables in equation (i) (eide, 1994: 91). the next step then is to rewrite (2) as an equation in which the crime rate (cr) in a country is explained by different groups of variables, like: • punishment variables (pv). first of all there is the probability of punishment, for which number of variables can be used, such as the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 213 sajems ns vol 2 (1999) no 2 clear-up ratio (cleared-up crimes divided by reported crimes), the arrest ratio (arrests divided by reported crimes), the conviction!crime ratio (convictions divided by reported crimes), and the conviction! arrest ratio (convictions divided by arrests). the severity of punishment in a country can be measured by the average length of sentence that is handed down, the average length of actual imprisonment, the use of capital punishment, or the jail/fine-ratio (number of jail sentences divided by number of fine sentences). as a proxy for all these punishment variables, one could use the per capita government expenditure on police and justice; • variables representing the magnitude of material gain from crime (mv). often variables like average income, median personal or family income are used, together with variables for income distribution, or the unemployment rate; • environmental, socio-economic and demographic variables (esd), like the proportion of the male population in the age bracket 15-24 years, population density, mean period of school attendance, number of non-husband-and-wife households, and the levei of migration. the result is an equation like: cr f(pv, mg, esd) (3) that can be estimated for various individual countries. comparisons between countries can be made too, and reasons found for differences between their crime rates. the word crime above may be substituted by the word fraud. to indicate the specific form of crime discussed in this paper. economic rent and rent-seeking frank (1997: 542) has spelt out two different meanings of the word rent: in everyday usage, the term rent refers to the payment received by a landlord, a rental car company, or some other owner in return for the use of a real economic asset. in economic analysis, however, the term has taken on a slightly different definition. economic rent is the difference between the payment actually received by the owner of a factor of production and his reservation price (the minimum amount necessary to induce him to employ it in its current use). for example, a professional golfer might be willing to play in a tournament for a fee of $10 000. if he however receives $50 000, the difference is his economic r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 214 rent, namely $40 000. economic rent is often connected with a tixed factor of production, such as land. if a landlord is willing to hire out an expensive city plot for a certain monthly payment, but gets more for it, then the difference is economic rent. the two examples above have much in common. the golfer and the landlord own something that creates profit for themselves, and the profit is called economic rent. the golfer was, quite possibly, born with his talent, and the landlord either bought or perhaps inherited the land. in south africa and many other countries, land was given by government to some families in the past, and now they extract economic rent from it. similarly, the government may lease or sell to somebody the right to mine, say, diamonds or gold; a liquor license; or the right to broadcast tv programmes. the holders of these rights have an advantage over non-holders, and there exists the possibility of extracting economic rent from society by means of these privileges. it would be no more than natural for people to look for opportunities to derive economic rent, and their action to do so is then called rent-seeking. frank (1997: 635) therefore writes: gains from public choices are often large and concentrated in the hands of a few, whereas the costs, while also large, are spread among many ... the prospective beneficiaries of a public program have powerful incentives to lobby government in favour of it, while each of the prospective losers has too little at stake to bother about. the result may be that projects are approved even when their benefits do not exceed their costs. if the benetits do however exceed the costs, and there are large net gains to be had from the project, private parties are then willing to spend large sums of money to enhance their odds of being chosen as the beneficiary. pursuit of such gains goes by the name of rent-seeking. this is related to crime and fraud in the following way. becker (1993: 391) argues that criminals "spend on weapons and on the value of the time in planning and carrying out their crimes, and that such spending is socially unproductive it is what is now cailed rent-seeking because it does not create wealth, only forcibly redistributes it". he estimates the social cost of theft by the amount of money stolen (since rational criminals would be willing to spend money up to the value of their crimes), plus the resources applied by potential victims to protect themselves against crime. legal ways of rent-seeking is to buy land, make a bid for a government contract, or work on one's golf swing. if successful, the result is that you become one of a small number of owners of a scarce resource, or an opportunity that may yield r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 215 sajems ns vol 2 (1999) no 2 economic rent. the illegal way of rent-seeking is to spend time and/or money to acquire the power of extracting financial and other rewards from criminal activity. becker (1993: 390) argues that criminal behaviour is rational, and that criminals do not have radically different motivations from anyone else. rational behaviour does however not imply narrow materialism. many people are constrained by moral and ethical considerations, and they do not commit crimes even when these are profitable and there is no danger of detection. however, police and jails would be unnecessary if such attitudes always prevailed. rationality implied that some individuals become criminals because of the financial and other rewards from crime compared to legal work, taking into account of the likelihood of apprehension and conviction, and the severity of punishment (becker, 1993: 390). market failure committed advocates of the market system believe that the market can provide in any need that consumers may have. producers thus see the opportunity to make profits by providing the goods demanded. there are however also goods and services that the market fails to provide, namely public goods, such as law and order and clean air. there are also some problems that the market fails to solve, such as air pollution, which is a well-known example of a so-called externality. another example is the existence of excessive market power. the sole producer of a good or service (monopoly) might ask any price he wants, due to a lack of competition in the market. such market power usually can then come to be controlled by the government. the externality referred to above, is a negative side-effect of some economic activity that is not automatically solved by the economic system. for example: a factory pollutes the air around it, and harms everyone that lives or works close to it. the factory does not deliberately pollute the air; this is a coincidental sidediect of a regular kind of economic activity. externalities can also be positive: the factory may serve to attract other businesses to a region, thus creating new job opportunities. the reason for the factory's existence is to make protit, and in the process both positive and negative side-effects can arise. pollution is the opposite of a public good, namely a public "bad", and this has to be addressed by the government. the market and other economic systems (e.g. socialism) do not automatically take care of fraud, and then the government has a responsibility to act on behalf of the citizens to combat these problems, using tax revenue to this end. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 216 sometimes firms, especially larger ones, have fraud detection departments to fight the problem, and in this way the market does partly take care of the problem • at a cost. fraud is quite similar to some forms of market failure referred to above, and can therefore itself be considered as another market failure, since the market "does not take care of the problem". in such circumstances, a large part of the state budget goes towards the police and the legal system, which represents a heavy cost to the community as a whole. another well-known market failure is imperfect information. for perfect competition to take place, all consumers must know where the best bargain (lowest price) is to be found. if they all go to this seller, other sellers will be forced to lower their prices too if they wish to stay in business. reality is however very different, and information as a rule is only imperfectly available. fraud is also to a large extent an information problem. the ideal situation in any market transaction would be that buyers and sellers have the same amount of information. but this is often not the case: for example, if someone buys a used car, he or she has far from perfect information about it. this gives the seller in the transaction the opportunity for fraudulent behaviour. the economic implications of fraud an economic explanation of fraud should include the effects that it has on the economy. fraud is an economic issue by definition, since economic assets are deceitfully transferred from one person to another, or falsely withheld from somebody. the bigger picture of the impact of fraud on the national economy is the ultimate reason for our interest in the subject. what are the specific costs associated with fraud? seeing that fraud amounts to misinformation, these costs are mostly information costs. consider two agents: a fraudulent agent f, who has the costs of providing misinformation and concealment, and a victim v, who incurs damage and monitoring costs. these monitoring costs have to be weighed against the probability of fraud multiplied by the damage caused by fraud. from the perspective of v, the optimal amount of fraud allowed for will not be zero: at some point the costs of reducing the probability of becoming a victim of fraud exceed the expected benefits. a good example of the economic implications of fraud, is represented by insurance fraud. we consider the following four points: r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 217 sajems ns vol2 (1999) no 2 in the first place, there is the amount of money directly involved in the fraud. insurance fraud will either decrease the profits of the insurance company or, more likely, lead to an increase in insurance premiums. the economic rent that accrues to a successful fraudster, means the redistribution of funds from the insurance company to the criminal. secondly, there is an increase in compliance costs for other (honest) consumers when they file an insurance claim, on account of the higher degree of scrutiny the insurance company will apply. this is not a redistribution, but an efficiency loss. the same goes for the additional costs the insurance company incurs to reduce future fraud which will probably again lead to higher premiums. again, these costs represent an efficiency loss, even when the prevention of fraud leads to the development of an "anti-fraud industry" in which people tind employment. it would be fundamentally wrong to think of such a spin-ott as "the benefit of fraud". thirdly, although the increased premiums as such represent "only" redistribution, insurance as a service will become relatively more expensive. this change in relative prices leads to a distortion of economic behaviour, a socalled excess burden. fourthly, there are the rent-seeking costs of the fraudster, that is, his investment in crime. the three examples that involve efficiency loss (increased compliance and prevention costs, the excess burden of distorted economic behaviour due to the change in relative prices, and the rent-seeking costs of the fraudster) may be called the deadweight costs of fraud. again, when the specific "benetits" of fraud are treated as they should, namely as a redistribution form victim to fraudster, it becomes clear that fraud has social costs only, and no social benetits. that is not to deny that preventing fraud can give rise to positive externalities, such as the prevention of related crimes, like corruption and larceny. empirical analysis statistical data on fraud are notoriously incomplete. according to professor de koker of the faculty of law at the university of the free state they are also arbitrary and unreliable for the purpose of empirical analysis (personal interview). it was therefore decided not to try to estimate any rigorous economic functions in the present case. de koker argues furthermore that such statistics can hardly be compared between countries, since there are basic differences between the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 218 legal systems of countries, and hence in their definitions of what is fraud (e.g. in roman-dutch law and in english law). also, there may be no clear-cut understanding of the difference between fraud, corruption, forgery and embezzlement. moreover, data often reflect the number of convictions, not the number of offences. an indication of the latter is usually obtained by means of surveys, and are therefore estimates based on the firms or individuals interviewed. according to transparency international (an international rating institution), an index which rates countries in terms of their crime rates, is nothing but a perception index based on the impressions of international business people. statistical estimates are therefore very doubtful, thus stressing de koker's view. for example, assume that a criminal is caught for credit card fraud. if he has used the stolen card 50 times, one police officer might record 50 cases of fraud, whereas another might record just one. de koker pointed out that fraud statistics are also unreliable, because governments and firms may not admit that they have a problem, or reveal the magnitude of the problem. japan, for example, has only started to admit during the last few years that they, too, have experienced major economic crimes like fraud and organised syndicates. in the past the existence of such problems was denied, due to the population's high moral values. if fraud is successful, the injured party does not necessarily report it, and it may then not be discovered. if discovered, it might again not be reported, if this would embarrass the injured party. a company's shareholders might decide to sell their shares if the company proves to be vulnerable to fraudulent behaviour. on the other hand they may decide to buy more shares if the company is known for detecting fraud and dealing with the culprits. there are, however, at least some statistics available on the subject and these reveal certain interesting trends. for example, the united nations human development report (1996) shows that education expenditure, as a percentage of gnp, and the adult literacy rate in the economically developed countries, far surpass those in the developing countries. on the other hand, expenditure on general public services and public order in the developing countries (18.2% of total government expenditure) is more than double that of developed countries (8.6%). ceteris paribus, these statistics suggest that the more developed a country becomes, the less it spends on police and justice services, and the more on education. this would imply a re-prioritisation of government spending from less towards more productive ends, that is, from policing to education. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 219 sajems ns vol 2 (1999) no 2 however, despite the fact that the proportion of the government budget spent on public order is smaller in developed countries, the expenditure per one million of the population is much higher, due the huge difference in the size of the respective economies. in 1997, developed countries spent on average $355.5 per million of the population whereas the developing countries spend $43,6 per million of the population. it is significant that the number of fraud cases per 100 000 of the population in relative terms are generally higher for developed than the developing countries. a statistically significant relationship is found between the amount money spent on maintaining public order in a country, and its number of convictions for fraud. this relationship for a selection of countries is illustrated in figure 2. figure 2 the relationship between the number of fraud cases and the amount of money spent on public order 800 c 700 .9 ;;; ::; 600 0.. 0 0.. '500 0 0 0 0 0 400 0 ... 300 '" ~ 0.. vl • (lj vl 200 '" u "'0 ::i '" 100 ... u.. 0 0 100 • new zealand botsy.ana ~,8,9 • onan 200 300 i: ramnia, 2: elhiq1ia, 3: midag;!scar,4: cllina, 5: indjnesia, 6: carreroon, 7: miiaysia 8: g=, 9: trinidad & tobigo 400 500 gn pub. + pub. qder expeoo / million of ropulation 600 700 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 220 conclusion fraudulent practices are legion. three widespread examples (not discussed above) are money laundering, round~tripping and pyramid schemes. the first tries to conceal the origin of illegally obtained money by transfers involving legitimate businesses, often banks. the second means to take advantage. again illegally, of international market imperfections. for example, under south africa's dual exchange rate system, money was withdrawn from the country at the lower commercial-rand exchange rate, and bought back again at the higher financial-rate exchange rate. agricultural subsidies in the european union have again led to the round-tripping of surplus products and fraudulent profits. the third, pyramid (or ponzi) schemes, are "a form of fraud in which belief in the success of a non-existent enterprise is fostered by the payment of quick returns to the first investors from money invested by later investors" (node, 1998: 1441). in 1997 such schemes caused anarchy and economic contraction in albania (some of the several misfortunes to befall that country recently). like pollution, crime produces "bads" rather than goods. this, of course, means that national income statistics, which only allow for physical capital depreciation, ceteris paribus, exaggerate the welfare implications of the otlicially recorded data. but national accounting suffers from other omissions too, for example, it has never included the work of the housewife and seldom estimates the value of the goods and services produced in the so-called informal sector of the economy. while it would be over-optimistic to expect major improvements in entrenched national accounting systems in the foreseeable future, there is every reason to continue to investigate and draw attention to the (negative) welfare effects of criminal activity. endnotes 2 the authors are grateful to the managing editor of sajems for having drawn their attention to this episode. it is important to point out that the seminal work by becker (1968) does not focus on explaining individuals' criminal behaviour as such, but on the analysis of the social cost of crime. the total social loss of crime consists of the damages (the net direct damage of the offence, e.g. harm to society minus the gain to the offender), the costs of apprehension and conviction (or the social costs of obtaining a certain probability of punishment) and the costs of carrying out the punishment (the social cost of punishment to society, including that of the ottender) (becker, 1968: r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 221 sajems ns vol 2 (1999) no 2 207; eide, 1994: 49). becker's main interest was to determine the optimal amount of crime, e.g. the amount that would minimise the social costs of crime. to determine how to combat crime in an optimal fashion he developed a model that incorporated the behavioural relations behind the costs of crime (becker, 1968: 172), i.e. a model on the individual level. references becker, g.s. (1968) "crime and punishment: an economic approach", journal of political economy, 76: 169-217. 2. becker, g.s. (1993) "nobel lecture: the economic way of looking at behavior", journal of political economy, 101: 385-408. 3. de koker, l. (1999) personal interview. 4. eide, e. 1994 economics of crime. deterrence and the rational offender, amsterdam: north holland. 5. elster, 1. (1989) "social norms and economic theory", journal of economic perspectives, 3: 99-117. 6. fiorentini, g., & peltzman, s. (eds.) (1995) the economics of organised crime. cambridge: cambridge university press. 7. frank, r.h. (1997) microeconomics and behavior. new york: mcgraw-hili. 8. groenendijk, n.s. (1997) "a principal-agent model of corruption", crime. law & social change, 27: 207-29. 9. hawtrey, r.g. (1932) "the portuguese bank notes case", the economic journal, 42: 391-8, september. 10. levi, m. (1987) regulating fraud, london: tavistock publications. 11. new oxford dictionary of english (node) (1998) oxford: clarendon press. 12. o'donell, m.g. (1993) "economics as ethics: bastiat's nineteenth century interpretation", journal of business ethics, 12(1): 57-61. 13. united nations. (1996) human development report 1996, new york: oxford. 14. world bank. (1997) world development report 1997, new york: oxford. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction literature review model framework research findings conclusion and policy options ethical consideration acknowledgements references about the author(s) kore m.a. guei department of economics and economic history, nelson mandela metropolitan university, south africa gift mugano department of economics and economic history, nelson mandela metropolitan university, south africa pierre le roux department of economics and economic history, nelson mandela metropolitan university, south africa citation guei, k.m.a., mugano, g. & le roux, p., 2017, ‘revenue, welfare and trade effects of european union free trade agreement on south africa’, south african journal of economic and management sciences 20(1), a1655. https://doi.org/10.4102/sajems.v20i1.1655 original research revenue, welfare and trade effects of european union free trade agreement on south africa kore m.a. guei, gift mugano, pierre le roux received: 28 aug. 2016; accepted: 03 jul. 2017; published: 25 oct. 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: using the partial equilibrium wits-smart simulation model to assess the impact of liberalisation under the trade development and cooperation agreement (tdca) of a free trade area between the european union and south africa. the identification of the impact of such agreement allows for trade policy negotiation adjustment that can be beneficial for south africa. aim: the aim of the study is to estimate and discuss the impact of a free trade agreement (fta) with the european union and south africa. more specifically, the study intends to estimate the impact of revenue, welfare, imports, exports, trade creation and to come up with policies options for south africa that can be used in negotiations and policy formulations. setting: the study used international trade data (2012) available in the wits-smart model to assess bilateral trade agreement between the european union and south africa. methods: to identify the impact on revenue, welfare, imports, exports and trade creation, the study simulated an fta (0% tariff rate) for all goods exchanged between the european union and south africa. also, the elasticity of substitution used for the simulation model was 99%. results: the findings of the study reveal that total trade effects in south africa are likely to surge by us$ 1.036 billion with a total welfare valued at us$ 134 million. dismantling tariffs on all european union (eu) goods would be beneficial to consumers through net trade creation. total trade creation would be us$ 782 million. however, south african producers are likely to contribute a trade diversion of us$ 254 million which has a negative impact on consumer welfare. the country might also experience a revenue loss amounting to us$ 562 million because of the removal of tariffs. in trade, the country’s exports and imports to the eu are expected to increase by us$ 12.419 million and us$ 1.266 million, respectively. conclusion: the european union–south africa fta would result in both trade creation and trade expansion effects. however, trade creation and revenue loss are potential threats. in order to mitigate revenue loss, government needs to consider alternative tax such as consumption tax on certain goods and value-added tax. introduction south africa embarked on a trade development and cooperation agreement (tdca) with the european union (eu) in october 1999, which came into effect in 2004 (european commission act 2004). the tdca established preferential trade arrangements between the eu and south africa with the progressive introduction of a free trade area. this occurred because there was a general belief that lifting trade barriers would contribute to economic growth and create jobs. the european commission believed that bilateral free trade agreement (fta) with its key partners would be mutually beneficial and reinforce competitiveness. the treaty consists of three areas of agreement. it includes the fta between the eu and south africa. it includes development aid as well as several areas of cooperation such as economic and social cooperation. the agreement provides for the liberalisation of 95% of the eu’s imports from south africa within 10 years and 86% of south africa’s imports from the eu in 12 years (european commission act 2004). the south african department of trade and industry (dti) revealed that the eu is south africa’s main trading and investment partner (european commission council 2006). the free trade area aims to ensure better access to the community market for south africa and access to the south african market for the eu. this plays an important role in integrating south africa into the world economy. the agreement sets out detailed rules of origin to ensure that products benefitting from the preferential arrangement come only from south africa or the eu. it also aims to avoid misuse by firms with a dominant position in the market, thus ensuring free competition among the companies from the eu and south africa. the agreement also allows south africa and the eu to adopt safeguard measures when an imported product threatens to cause serious injury to the national industry. south africa may adopt transitional safeguard measures (e.g. by increasing customs duties). in 2016, the international monetary fund (imf) estimated gross domestic product (gdp) in south africa to be us$ 315 billion with an unemployment rate of 25.4 %. the world bank revealed that south africa’s exports of goods and services were last estimated at 30.6% of gdp in 2016. since democracy in 1994, south africa has opened up its economy, and trade quotas and tariffs have decreased considerably; however, the gains from conventional trade liberalisation for an economy like south africa are moderate at best. during the last decade, south africa has undergone several changes. the primary sector which comprises agriculture, forestry and fishing, as well as mining, has collectively maintained their share of gdp over time, amounting to 11.8%. since 1994, the share of the secondary sector has decreased continuously from 27.7% to 19 % in 2012. from 1994 to 2012, there has however been a significant expansion of the tertiary sector from 12% to 22% (industrial development corporation 2013). the rapid growth of the tertiary sector, which includes trade and transport, and other business services can be attributed to the multilateral reduction in tariffs and subsidies through the country’s world trade organization commitment (dti 2014). the tdca establishes preferential trade agreements as well as the progressive introduction of a free trade area. according to south africa’s dti, the scheduled liberalisation entered into force in may 2004 and was to be completed by 2012 (department of foreign affairs 2009). this study therefore seeks to analyse the impact of an fta between the eu and south africa, assuming full liberalisation during the year 2012. trade liberalisation presents a serious challenge to south africa as the country already expects a budget deficit of 3.4% for the year 2016/2017 (department of national treasury 2017a). the dti reveals that the eu offered to liberalise 95% of its duties on south african–originating products by 2010, and south africa, in turn, offered to liberalise 86% of its duties on products originating from the eu. this, therefore, means that in the event of an fta, only 14% of the eu products would be subject to import duty. this would have a negative effect on revenues and the competitiveness of local industries. the simple mean applied tariff rate for all products in south africa is at 4.2% (world bank 2015). an fta with the eu would affect competitiveness of south african exports as the inputs acquired outside the fta would be acquired at a higher price. trade liberalisation would therefore not only pose a threat to import revenue but could also result in the closure of local industries. notwithstanding these adverse effects of liberalisation, south africa has continued to liberalise substantially over the last decade and has played a leadership role in the current doha round of negotiations. in the light of the above discussion, a research question has emerged: has trade liberalisation led to trade creation in south africa? has trade liberalisation led to welfare gain? has trade liberalisation led to an increase in imports? has trade liberalisation led to an increase in exports? has trade liberalisation led to a loss of revenue for south africa? the purpose of this study is to estimate and discuss the impact of an fta with the eu and south africa. specifically, the study intends to: examine the revenue and welfare implications of the eu-south africa fta (eu-sa fta) on south africa examine the impact of the eu-sa fta on south africa’s imports and exports examine the impact of the eu-sa fta on trade creation in south africa to come up with policies options for south africa that can be used in negotiations and policy formulations. literature review this section reviews the literature on the different economic integration and specifically trade expansion effects, as well as the revenue implications of an fta. the assessment shall be based on both theoretical and empirical literature. economic integration economic integration is a process in which two or more states in a broadly defined geographic area reduce a range of trade barriers to advance or to protect a set of economic goals. from a political point of view, economic integration differs from the broader idea of regionalism in general. the aim of the economic integration is to reduce costs for both producers and consumers and to increase trade between the countries taking part in the agreement (burges 2007). economic integration helps to reduce and ultimately remove tariff and nontariff barriers to the free flow of goods, services, capital and labour. there are four main types of economic integration. a preferential trade agreement is a trade pact between countries that reduce tariffs for certain products and the countries who signed the agreement. the new tariffs set are not necessarily eliminated but they are lower than those countries that are not part of the agreement. preferential trade agreements offer additional benefits such as increased foreign benefit, and other positive externalities (baldwin 2011). a free trade area represents an economic bloc in which all barriers to trade are abolished among member countries, but each member maintains its own independent external trade barriers beyond the bloc. the fta as opposed to the custom union does not specify the external tariffs of all signatories contractually (mclaren 2004). the third form of economic integration is a custom union. it allows free trade among its members and adopts a common external tariff (cet) against countries outside the custom union (peters 1979). unlike the common market, it does not allow free movement of capital and labour among member countries. the economic union is the most advanced type of economic integration. it is a common market involving more than one nation based on a mutual agreement to permit the free movement of capital and labour. it also requires the coordination of various social, fiscal and monetary policies among participating nations. trade liberalisation may result in static and dynamic benefits. static and dynamic benefit of a free trade agreement in terms of static and dynamic benefits, the fta leaves future external trade policy to the discretion of each member government, thus providing a continual incentive for interest groups to try to influence the government (mclaren 2004). the impact of the eu–south africa fta is of a more dynamic nature in terms of increased imports and exports competition. secondly, tsolo (2010) in their study state that the agreement could lead to a substantial reduction in revenue as a direct outcome of tariff reductions. the reason for this would be because the cet that was applied before the agreement has been removed. trade liberalisation may also result in revenue loss and welfare gain. revenue and welfare effect of free trade agreement the free trade area is generally seen as welfare creation and revenue loss as a result of the removal of tariffs. it is important to note the revenue loss relates to import tariff revenues. the belief exists that free trade will maximise world welfare. free trade increases imports and exports through trade creation. however, as long as these countries have indirect taxes such as value-added tax (vat), the shortfall in revenue would taper off (lang 2006). aggregate welfare of a free trade area is just the sum of effects across countries. free trade area creates both trade creation and trade diversion. trade creation occurs when trade increases. however, trade diversion occurs when an fta shifts imports from a more efficient supplier to a less efficient supplier, which in itself causes a reduction in national welfare. national welfare gains occur when trade creation outweighs trade diversion. thus, a country would only enter an fta if the fta is welfare improving (suranovic 1997). this happens when trade creation outweighs trade diversion. the market with trade creation would generate national welfare gains, while the market with trade diversion would generate national welfare losses. however, it is also possible for trade diversion to outweigh trade creation. this is welfare reducing. this is quite interesting because it suggests that free trade could also reduce the national welfare of the countries involved. the only way to prevent this is to ensure that all barriers to trade against all countries are removed. this would reduce trade diversion. the european union and south africa free trade agreement when south africa became a democracy in 1994, the government applied for a membership in the lome convention in order to have access to the beneficial trade contract. the eu realised that trade with south africa was important and a free market would benefit both of them. hence, in 1996, the eu and south africa began a discussion on creating a new trade and development collaboration. the collaboration’s objective was to increase and improve the trade condition between the two parties. in 1999, they signed the ‘trade development and cooperation agreement’ (tdca). the implementation date of the agreement was set on 01 january 2000. the government of south africa viewed the tdca as a sign of further development and more integration. the tdca contracts consist of two parts. the eu-sa fta and the european program for reconstruction and development (eprd). the aim of the eu-sa fta is to gradually increase the amount of duty-free agricultural and industrial products in each market. the agreement is asymmetric in terms of time frame and commodity coverage. the eu has a period of 10 years to fully implement the agreement, while south africa has a period of 12 years. the different time frames and commodities are supposed to make the agreement fair to both parties. figure 1 describes the trends in trade between the eu and south africa from 2001 to 2014. this shows that south africa has experienced a considerable increase in its exports to the eu since 2001. after 2012, south africa’s exports to the eu is still rising even though the increase is not significant as it is shown in figure 1. this can be explained by the fact that the liberalisation process has reached its final stage. figure 1: south africa’s value of imports and exports to the eu (2001–2014). strategies to mitigate revenue loss from a free trade agreement the government of south africa will have to reduce the overall tax burden because of trade liberalisation. this requires the adoption of compensated revenue to offset any loss of trade tax revenue. this section highlights some recommendations to the government of south africa in order to reduce the revenue loss associated with a fta. in terms of fiscal implication for south africa, a first policy advice will be the shift away from trade tax towards other forms of taxation such as income and sales tax. in fact, the need to offset revenue losses from trade liberalisation by strengthening domestic taxation has been a key consideration in the adoption of vat (imf 2003). the recommendation to move away from trade tax towards domestic consumption and income tax reflects the view that trade taxes are a relatively inefficient way of raising revenue. indirect taxes, which shift the overall taxation burden from factor of production (capital and labour) to consumption, are believed to be associated with superior employment. in terms of personal income, there is the need for south africa to look for opportunities to broaden the tax base. south africa can improve its tax base by adopting the resident and ordinarily resident rules of the indian tax system. this means that residents and ordinarily residents in south africa will be taxed based on their worldwide income. south africa can also consider increasing the property taxes. this can be done by including the annual value of house property in income as it is done under indian legislation. the country can also allow certain deductions against the annual value of house property to maintain a fair tax system. exemptions and deductions remain significant in south africa, hence the government may consider disregarding the employment abroad exemption or the foreign pension exemption. furthermore, the government can allow for the deduction of interest payments on loan for higher education. these measures would help improve revenue collection and offset the losses associated with the tariff cut. in the financial sector, the government should adopt a financial activities tax (fat), which is a tax on the sum of wages and profits of financial institutions. this would provide a fair and substantial contribution of financial institution to the fiscal revenue (imf 2011). the fat will serve to counteract the vat exemption for financial services. another avenue for south africa to reduce the loss in its tariff revenue is by identifying and acting on compliance gaps. the improvement of the compliance gap would promote fairness and reduce distortion. this can be done by addressing offshore tax abuse. this measure would discourage volatile financing. empirical literature the united states international trade commission (2017) looked at the likely impact of the trans-pacific partnership (tpp) agreement on the united states. the findings suggest that the tpp has a positive impact on the united states although it is a small percentage of the overall size of the economy. the united states exports and imports will be us$ 27.2 billion (1%) and us$ 48.9 billion (1.1%) higher, respectively. the commission estimates that the tpp will harmonise regulations, increase certainty and decrease trade costs for firms that trade and invest in the tpp regions. another study in the united states by abdelmalki, sandretto and jallab (2007) assesses the fta between the us and morocco using the wits-smart simulation model. the findings showed that the fta significantly reduced moroccan tariff by more than us$ 147 million. almost 60% of this loss resulted from the elimination of duties on the imports of us cereals. cereals represented 0.5% of gdp and 4.5% of the balance of payments. cereals accounted for almost 60% of revenue shortfall. this explains why this product was treated separately during the negotiations. the findings also show that consumer surplus was mainly improved by lowering the price of industrial goods. the partial equilibrium revealed that imports from the united states to morocco increased by us$ 53.68 million. in america, villa, gomez and omar (2012) used trade data for 2010 and applied ex-ante partial equilibrium modelling to calculate the impact of the preferential trade agreement between canada and colombia. the simulations carried out showed that trade creation could be one and a half times larger than trade diversion. trade between the two countries in the first year grew by approximately 10%. use of the wits-smart model showed that though canadian tariff revenue fell by us$ 78.1 million, canadian consumer welfare improved by us$ 11.5 million. in the eu, elebehri and hertel (2004) have compared the potential impacts on morocco’s welfare, production and trade, from implementing the morocco-eu-fta. the analysis pays special attention to several key structural features of the moroccan economy. the results show that the fta with the eu generates a welfare loss for morocco as most of the manufacturing sectors contract under the fta and only few export-oriented sectors, such as clothing, expand production. hence, it appears that the main effect of fta with the eu is to lock the moroccan manufacturing sector even more firmly into its current pattern of specialisation. lang (2006) also looked at the impact of the full liberalisation of imports from the eu to the economic community of western african states (ecowas) using the partial equilibrium smart model. the result showed that trade creation by far outweighs trade diversion. total eu exports to the ecowas surged by us$ 1.8 billion, with france and united kingdom making the largest profits. however, more than us$ 365 million was diverted in favour of less efficient eu producers. tariff revenues were reduced by the agreement. for example, guinea-bissau and ghana lost approximately 19% of their budget revenues. in asia, choudhry, kalumnal and varma (2013) evaluated the impact of sri lanka’s fta using a sector-specific analysis of the textile and clothing sector. sri lanka provided reduction in tariffs – 35% in 2003, 70% in 2006 and 100% in 2008. the result of the smart analysis revealed that indian exports of textile to sri lanka increased from us$ 121 million to us$ 395 million during the period 1999–2009. trade creation effects dominate trade diversion effects. for example, when articles of apparel and clothing accessories were traded, trade creation was around us$ 555 000 and trade diversion was around us$ 248 000. turning to africa, othieno and shinyekwa (2011) in their study investigated the effects of the east african community customs union principle of asymmetry on uganda with regard to trade, welfare and revenue effect since 2005. the end of tariff reduction increased trade creation and welfare effects. this effect was reflected in consumer surplus in terms of reduced prices. tariff reduction implies government revenue loss. in addition, the diversion effect that resulted from the cet on respective products such as woven cotton fabric, soap products and paints vanished. inefficient producers within the union could equally have been displaced by building specialised capacity in the sectors. mugano, brookes and le roux (2013) conducted a study on the impact of a south african development community (sadc) customs union on zimbabwe. the wits-smart model was used for the study. the findings reported that trade expansion valued at us$ 39 million and consumer welfare at us$ 7 million. in trade, zimbabwe’s exports were expected to fall by 0.94%, while imports were expected to surge by 2.05%. however, the country lost revenue amounting to us$ 42 million. the results obtained varied from one case study to another. the implication of an fta between two countries depends on a number of factors. from the literature, it is not possible to discern the impact of an fta on imports, exports, trade creation, trade diversion and revenue and consumer surplus. the empirical review, however, does help to identify the possible outcomes of an fta. however, it does not allow one to draw a general conclusion about any fta. thus, the eu-south africa fta remains an empirical question that needs to be addressed in order to determine whether it is welfare increasing or decreasing. a recent study by kwaramba, kwenda-magejo and rankin (2015) examined the eu and south africa fta and export trade margins. their study used a different way of measuring trade margins at the product-, countryand product–country levels. their results show that tariff reductions had a constantly positive impact across products at the intensive margin. studies conducted by assarson (2005) on the impact of south africa and the eu-fta support the view that eu-sa fta stimulated both exports and imports. the analysis conducted compared the trade statistics between the years 1999 and 2004. their results indicate that south africa benefits from the agreement in terms of improved trade. tsolo (2010) looked at the south africa and eu tdca. their results indicate that the volume of exports and imports to south africa from botswana, lesotho, namibia and swaziland (blns) will increase following the agreement. this shows that the eu-sa tdca has benefitted the blns countries by boosting their exports. efforts still have to be made by both the eu and south africa for the agreement to be fully implemented. previous studies undertaken by assarson (2005) and tsolo (2010) on the implication of the eu-fta on south africa used trade statistics and time-series cross-sectional data to determine the impact of the eu-fta on south africa. these studies did not analyse the potential impact such an agreement would have on trade creation, trade diversion, and welfare and revenue effects. this study (by means of the wits-smart model) would, therefore, fill the gap by analysing the potential impact such an agreement if fully implemented in 2012 would have on south africa. the wits-smart model is a partial equilibrium model (pem) developed by the united nations conference on trade and development (unctad) during the 1980s mainly to assess the impact of the general agreement on tariffs and trade (gatt) rounds. the wits-smart model gives the possibility to approximate the consumer surplus. model framework the study used the pem to investigate the impact of the eu-south africa fta on south africa. the focus was on exports, imports, trade creation, trade diversion, welfare and tariff revenue. the figures used in the simulation were for the year 2012. the pem was chosen over the general equilibrium (ge) model because pems provide results at a more disaggregated level (hs-6 in this study). the pem enables the calculation of direct trade effects (trade creation and trade diversion effects). the wits-smart model was developed by the world bank and the unctad. it employs tariff data from the trade analysis and information systems (trains) and the world trade organization integrated database (idb-wto) and consolidated tariff schedule (cts-wto). trains has an advantage in that it uses harmonised schedule nomenclature and includes data from 1988. the cts-wto contains binding tariffs, which are useful when commenting on the negotiated tariff schedules (villa et al. 2012). pem may be sensitive to the elasticity parameters used and ignore interactions with other markets, although interaction can be modelled in pem (mkenda & hangi 2009). in this study, three different elasticity scenarios were used to compensate for these shortcomings and to gauge the effects on the simulations. milner, morrissey and mckay (2005) provide a simple analytical framework explaining the theory behind partial equilibrium modelling. despite its shortcomings, a partial equilibrium framework is more suitable as it allows the utilisation of widely available trade data at the appropriate level of detail to capture the principle of special and differential treatment in the simulation analysis. this study simulated the welfare and revenue effects resulting from the fta. the welfare effect is related to the consumer surplus. however, because government revenue tends to decline with the reduction in tariffs and rise when imports increase, the net welfare effect needs to be carefully addressed. pem is static in nature, allowing only for comparative static comparison (lang 2006). however, the focus of this study is on the static effect of the eu-south africa fta agreement on south africa. hence, the wits/smart model emerged as the best choice not only because of the static effect but also because of its strength in analysing the tariff effect of a single market on disaggregated product lines. sensitivity analysis and robustness tests for the purpose of this study, one scenario is defined to represent a magnanimous release by the south african market to eu imports. these findings would not necessarily be the exact outcome of the fta. analysing the impact of full liberalisation using the partial equilibrium framework allows one to distinguish the products and sectors where the impact is greatest. identifying the products for which the impact of liberalisation is greatest may help south africa to define their most sensitive products from which they may want to benefit by receiving a special and differentiated treatment. the sensitivity parameters analysed here are trade diversion and revenue loss. the elasticity of supply is considered infinite as much as the market partners perform as price-takers, and changes in demand are met with adjustments in quantities. the value considered for the elasticity of substitution, which determines the degree of substitution between different varieties of goods, according to the exports partner is 1.5 for each product or item. hence, this study applies a 100% tariff reduction to all products at the hs-6 level for the year 2012. the smart model can be solved either with perfectly elastic export supply, as when world prices of each variety are given, or by assuming upward-sloping export supply curves. the smart model incorporates three types of elasticity. firstly, when import substitution elasticities record the rate of substitution between two goods with different origins. the armington assumption is incorporated in the smart model, meaning that similar goods from different countries are imperfectly substitutable. in smart, the import substitution elasticity is considered to be 1.5 for each good. secondly, when the supply elasticities are deemed to be infinite (=99), which means that an increase in demand for a given good will always be matched by the producers and exporters of that good without any impact on the price of the good. this assumption is reasonably realistic when the importer (south africa) is a small market and the exporter (the eu) consists of large industrialised economies. thirdly, when import demand elasticity measures the demand response to a shift in import price. stern, francis and bruce (1976) revealed that in smart analysis, the import demand elasticity varies at the hs-6 level. the study used the elasticities in the base case scenario to evaluate the effects of the south africa eu-fta and then used the lower-, upperand worst case scenarios to evaluate the robustness of the results (table 1). table 1: elasticities used in sensitivity analysis. research findings this section presents findings from the study. the smart model simulation analyses the eu-south africa fta impact on trade creation, trade diversion, trade diversion, exports, imports, and revenue and welfare effects. table 2 shows trade creation and trade diversion effects of the eu-fta on sa. table 2: trade creation and trade diversion effects of the european union free trade agreement on south africa (us$ 000). trade creation and trade diversion in standard analysis, when countries decide to embark on an fta, trade creation occurs when the removal of tariffs changes the prices of imported goods, such that less efficient domestic production is replaced by imports from members of the free trade area whose products are now cheaper with the tariffs removal. milner et al. (2005) explain, ‘trade creation usually describes the displacement of less efficient home production by globally efficient extra-regional production’. in the case of south africa, it means that more efficient producers from the eu countries would displace the less efficient producers in south africa and consumers would therefore benefit from lower prices. trade diversion occurs after the formation of a free trade area, the elimination of tariffs leads to a substitution of goods from countries that are not part of the free trade area but are more efficient than the goods from countries that form the free trade area. milner et al. (2005) state, ‘trade diversion usually relates to diverting trade from more efficient extra-regional suppliers to less efficient intraregional suppliers’. trade diversion would be costly for south africa as revenue that would have been generated from imports from outside the eu is forgone and the products become more expensive because they would be sourced from higher-cost producers. the fta is expected to create a total trade effect of us$ 1.035 billion in south africa from the eu member states. trade creation which is 75.44% of the total trade effect is expected to outweigh trade diversion which is just 24.55% of the total trade effect. thus, the eu-south africa fta would have a positive total trade effect. this would be welfare improving for south africa because consumers of the imports whose prices fall would enjoy the goods at a lower cost. these findings are in line with the research of (abdelmalki et al. 2007) on the impact of fta between the us and morocco. in this case, the agreement led to a total welfare gain by moroccan consumers because they had access to goods at lower prices. table 3 shows the top 10 products with highest trade creation in south africa. table 3: top 10 products with highest trade creation effects on south africa (us$ 000). table 3 exhibits the products for which trade creation is the largest. because of the level of disaggregation, trade creation is rather evenly spread across tariff lines. the products that bear the largest trade creation varied, they include vehicles and parts at 85.75% of total trade creation, followed by petroleum products and textile material. the findings are similar to the research of lang (2006) on the impact of an fta with the eu on ecowas countries. the products that bore the highest trade creation in the ecowas countries included vehicles and parts, and clothes. table 4 shows the top 10 most vulnerable products to trade diversion. table 4: top 10 most vulnerable products to trade diversion (us$ 000). the most vulnerable products to trade diversion are imported products from the eu that will now come to south africa at the expense of more efficient producers outside the fta. this information is of great importance to south africa in their negotiation process. the most sensible products to trade diversion are petroleum products, vehicles and parts. most of the loss results from these products being part of the fta as south africa would be importing from a higher-cost producer within the eu. these findings are in line with the study of lang (2006) on the ecowas-eu-fta, where most trade diversion loss in ecowas was because of fuel and oil products. revenue effect the elimination of tariffs from eu’ imports is shown to harm the south african government revenue. table 5 shows the top 10 largest losses in south african products revenue after the fta with the eu. table 5: top 10 largest losses in south african products revenue after the free trade agreement with the european union (us$ 000). after the full implementation of the fta, south africa would see revenue fall by us$ 562 million. it is important to note that the revenue loss in this study relates to import tariff revenues. the south african government needs to use vat on the imported products so that the revenue shortfall described would taper off. vehicles and parts would account for most of the government revenue loss if south africa and the eu decide to embark on an fta. petroleum products also have the second most important impact on government revenue loss. this result is confirmed by the study of mugano 2013, which found that motor vehicles contributed to major loss in revenue in the zimbabwe-eu-fta. south africa would also need assistance from the eu in building a new fiscal system to replace the budget revenue loss incurred after the fta. south africa could also consider lowering the tariffs on eu imports in a gradual way so as to soften the fall in revenue. welfare implications the concepts of producer and consumer surplus help economists to make welfare (normative) judgements about different ways of producing and distributing goods. the wits model can only estimate the possible consumer surplus. the major argument in favour of free trade is that consumers benefit from lower prices. this occurs only if trade creation is greater than trade diversion. in the eu-south africa fta, trade creation is greater than trade diversion. therefore, consumers would benefit from the implementation of the fta. although this agreement would lead to government revenue loss and have a negative impact on some producers, individual households would benefit from the lower prices. individuals would be in a position to increase consumption, and therefore, welfare would also increase. table 6 shows the top 10 products with largest consumer welfare after the fta with the eu. table 6: top 10 products with largest consumer welfare after the free trade agreement with the european union (us$ 000). after full liberalisation, south african consumers would be able to purchase eu goods at cheaper prices, thus obtaining an improvement in their standard of living. total consumer surplus in south africa would be estimated at us$ 134.45 million. it is assumed that eu exporters and south african importers would pass the benefit of tariff reduction to south african consumers because if they do not do so, consumer welfare would not improve. the impact of full liberalisation on south africa would lead to consumer surplus of us$ 134.45 million. the group of products yielding the highest welfare gains are vehicles (82.82%) followed by oil (0.82%). lang (2006) also found that vehicles were the group of products that led to the highest welfare gain in the eu-ecowas fta. the impact of european union free trade agreement on south africa exports trade liberalisation provides market access beyond their boundaries to participating member states. the eu represents a ready market for south africa. has south africa been able to increase exports in the eu-fta? this is one of the research question answered in this study. using the wits-smart model, exporter’s point of view is to evaluate whether south africa has been able to increase its exports after the implementation of the eu-fta. table 7 shows the impact of the eu-fta on south africa exports. table 7: impact of the european union free trade agreement on south africa exports (us$ 1000). south africa exports are expected to increase by us$ 33.37 million after the eu-fta. however, it is important to look at the impact of exports on the individual eu countries. table 8 shows the increase in exports of individual eu countries. table 8: increase in exports of individual european union countries after free trade agreement with south africa (us$ 1000). for negotiation purposes, it is interesting to look at how the eu countries would benefit from the fta with south africa. the positive gain is not necessarily in all 28 eu countries. some countries such as the united kingdom and portugal are negatively affected. this could be explained by the fact that the liberalisation schedule has reached its final stage, and other countries such as poland and cyprus took advantage of the more open south african market. however, the 28 eu countries as a whole could gain more than us$ 12 billion in exports revenue after the fta. such information might be of interest to south africa in order to identify which eu countries could have the greatest stake in negotiating the eu-south africa fta. these eu countries would have a decisive role in the negotiation process and might be reluctant to implement full liberalisation. the total increase in exports remains very low for the eu, with only us$ 12.4 million compared with the overall exports from south africa to the eu of us$ 12.88 billion. this result is confirmed by the study of lang (2006), which found that the importance of increased exports for the eu countries remained very limited after the eu-ecowas fta. countries such as the united kingdom for instance would see exports decline by us$ 60.78 million in an fta with south africa. the impact of european union free trade agreement on south africa imports (us$ 1000) based on smart simulation, south africa is expected to record an increase of us$ 1.266 billion, which is merely of trade creation effect. table 9 shows south africa imports before the eu-fta, imports after the eu-fta and changes in imports revenue. table 9: the impact of european union free trade agreement on south africa imports (us$ 1000). using smart simulations, table 10 shows the top 10 imports from the eu-fta (us$ 1000). table 10: south africa’s top 10 imports from the european union free trade agreement (us$ 1000). as shown in table 10, petroleum products, light oils and preparations, vehicles, semi-milled or wholly milled rice, electrical machinery equipment and minerals are the top south africa imports from the eu-fta, with an import bill of us$ 15.75 billion, us$ 5.82 billion, us$ 839 million, us$ 678 million, us$ 327 million and us$ 110 million, respectively. the lion’s share of these imports comes from the united kingdom as shown in table 8. from an eu total exports perspective, the percentage increase in eu exports in south africa does not look very important (1.34%). however, it is still significant because the actual amount would be about us$ 1.22 billion. sensitivity analysis and robustness tests the smart model does not provide a built-in sensitivity analysis. also, the uncertainty of the actual values for the armington market analysis and demand elasticities require rigorous sensitivity to ensure the robustness of the main result presented in this study. the study allows changes in the parameter values (elasticities) in order to test the robustness of the results over a reasonable range as suggested by mugano (2013). initially, a base case simulation was run using elasticities from armington. the researcher had to re-run the simulation under varying assumptions. lowerand upper bound limits were established for different elasticities. table 11 shows the robustness and sensitivity analysis of the eu-south africa fta on trade creation, revenue welfare, imports and exports. table 11: robustness and sensitivity analysis of the european union–south africa free trade agreement on trade creation, revenue welfare, imports and exports (us$ 1000 and % change). reducing elasticity of substitution to 0.5 shows the change in the trade creation from the base case in south africa. the outcome shows that trade creation increases by 40% (see table 11). on the contrary, by increasing elasticity of substitution to 2 and 6 will result in the reduction of the trade creation by 99% and 98%, respectively. south africa’s total change in imports remains the same in value, although its composition changes as economic agents are substituted across various imports. reducing the trade elasticity value to 0.5 reduces revenue loss by 8.66% (see table 11). increasing trade elasticities values to 2 and 6 will respectively increase revenue losses by 4.15% and 28.13%. the resulting deviations from the middle ground are generally significant. accordingly, the middle ground estimates could be close to potential sizes. reducing the trade elasticity value to 0.5 increased welfare gains by 1.55%. by increasing the trade elasticity value to 2 and 6, welfare gains will respectively reduce by 0.78% and 7%. although the margin of error is slightly higher than 10% in the lower bound limit, the worst-case scenario is that the deviation of welfare gains from the base result is sensible and significant (see table 11). accordingly, the middle ground estimates could approximate potential sizes. reducing the trade elasticity value to 0.5 is expected to cause an increase in exports by 0.0025% from base case, (see table 11). increasing the trade elasticity value to 2 will decrease exports by 0.00016. increasing trade elasticity to 6 will increase exports by 82%. the resulting deviations from the middle ground results are generally significant. accordingly, the middle ground estimates could resemble potential sizes. reducing the trade elasticity value to 0.5 shows no change in imports from the base case (see table 11). south africa’s total change in imports remains the same in value although its composition changes as economic agents are substituted across various imports. conclusion and policy options the partial equilibrium simulation with disaggregated trade data for 2012 showed that imports from the eu to south africa would increase by approximately us$ 1.27 billion. although the intention of the eu-south africa fta was to expand trade, it did not significantly create more trade between its members. this is in line with the findings on export data that reveal a reduction of trade volumes between south africa and some european countries such as the united kingdom. the eu-south africa fta would result in both trade creation and trade expansion effects. trade creation effects represent 75.44% of the overall trade effect, largely exceeding trade diversion effects. trade creation is spread across a large variety of goods though some concentrations are on groups of products such as vehicles and parts, oil products and textile material. trade diversion effects seem relatively significant (24.56%), which is almost 25% of the whole trade effect. hence, south africa has to take these particular products into account during the eu-south africa fta negotiation. in terms of government revenue, the removal of tariff barriers would result in a government revenue loss of us$ 562.11 million and a welfare gain of us$ 134.45 million. it appears that consumer surplus would be largely improved by the lowering of the prices of cars and machines. from the study, it is clear that although the eu-south africa fta may have some negative effects on south africa’s economy, it would be welfare improving. the revenue loss and trade creation are potential threats. however, the welfare gain is significant for south africa. the following policy recommendations can be drawn from the study. in order to mitigate revenue loss, south african government may need to consider domestic consumption tax such as excises on particular goods and general sales tax such as vat. the basic argument behind this principle consists of matching each 1% point reduction in the tariff rate on some final consumption goods with a one point increase in the corresponding domestic tax in consumption on that same good. this will preserve the efficiency gain from the tariff cut because south african consumers will now pay a price that is closer to those in the world market. also, the government’s total tax revenue will go up because these revenues are now collected on all consumption. the increase in government revenue could, in turn, be used as subsidies or targeted tax incentives to support the transition of those sectors that stand to lose from trade liberalisation such as light oil and other vehicle parts. the government might seek assistance from the eu in finding a way to reduce the revenue loss. oil products, cars and parts are the main products that would create the most trade diversion. these products would generate the major revenue losses to south africa, and hence, the tariff liberalisation on these products need to be implemented in a progressive manner to soften the loss in tariff revenue. these measures would improve welfare in south africa. a limitation of pem used in this study is that it is static in nature, allowing only for a comparative static comparison of preand post-policy change, when all the other variables are held constant which is an oversimplification of the real world. thus, they ignore the second-round effects, as these models do not consider impacts of policy reforms on the wider economy, as well as intersectoral implications and exchange rate effects. dynamic linkages and market feedbacks can be captured in ge models. therefore, exploring the impact of trade liberalisation between the eu and south africa on employment and inflation using the ge model should be an important avenue for future research, and help with more precise policy prescriptions for south africa. ethical consideration the research is independent and the results are based on the model simulation. the research is therefore impartial. acknowledgements the author would like to acknowledge with gratitude the support provided by his supervisors dr g. mugano and prof. p. le roux. he would also like to include a special note to the department of economics of the nelson mandela metropolitan university for their invaluable support. the research was supported by the research capacity of development (rcd) of the nelson mandela metropolitan university. competing interests the authors declare that they have no financial or personal relationship(s) that may have inappropriately influenced them in 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remuneration in south africa mark bussin department of industrial psychology and people management, university of johannesburg chris blair school of business administration, university of cumbria, uk accepted: may 2015 in an attempt to address the growing gap between chief executive officer (ceo) remuneration and that of the general worker, reign in rising ceo remuneration, and justify the portion of long-term incentive pay that makes up the bulk of ceo remuneration, shareholders and other stakeholders are trying to find definitive factors that will link ceo remuneration to company performance. finding this link has become central to all executive remuneration issues. the results of the studies linking ceo remuneration to company performance are varied and inconclusive, particularly in south africa. the reason for this is that previous studies have not looked at whether the company performance measures chosen have definite relationships with ceo remuneration in each industry. this study investigated eleven financial indicators of company performance to determine which of them have significant and positive relationships to ceo remuneration in different industries in south africa. 254 south african listed companies, spread over 5 industries, were analysed for the period 2008 to 2012 using panel data analysis and statistical tests. the results were conclusive, finding performance metrics that had a positive and significant relationship to ceo remuneration in 4 of the 5 industries investigated, as well as over the aggregate of all the industries. key words: ceo compensation, remuneration, reward, pay-performance sensitivity, principle-agent theory, emerging markets, south africa jel: g3, 35, c10 1 introduction there is a growing perception that the remuneration of ceos has become detached from the performance of the companies they manage (bebchuk, 2009). as a result, regulators, employees, investors, the media and civil society are now closely scrutinising remuneration practices and considering the sustainability of company performance when making long-term investment decisions (baltes, 2007). excessive and often unwarranted ceo remuneration increases have contributed to placing south africa in the top 10 countries worldwide in terms of global inequality (ortiz & cummins, 2011). in order to address these issues of inequality, ceo remuneration needs to be linked to company performance. much research has been done on the relationship between the determinants and the quantum of ceo remuneration, and numerous measures and codes have been put in place to try to redress this issue. the johannesburg stock exchange (jse) developed its socially responsible investment (sri) index in 2004 which assesses companies across the triple bottom line as well as against specific governance criteria. the king iii codes on corporate governance were brought into effect in south africa in 2010 (iodsa, 2009). the core philosophy of the king iii codes revolves around leadership, sustainability and corporate citizenship. the code specifically states that: abstract sajems ns 18 (2015) no 4:534-550 535 “2.17.4. the board should ensure that the role and function of the ceo is formalised and the performance of the ceo is evaluated against the criteria specified”, and “2.25.1. companies should adopt remuneration policies aligned with the strategy of the company and linked to individual performance”. the code for responsible investing in south africa (crisa) is a “stewardship code” detailing the responsibility of institutional shareholders to look after the interests of individual investors or policy holders (iodsa, 2011). it advocates that shareholders “should give appropriate consideration to any factor which may materially affect the sustainable long-term performance of a fund’s assets, including factors of an environmental, social and governance character”. in spite of all these interventions and changing business practices, it can be argued that stakeholders have not been able to effectively measure company performance in relation to the increasing or decreasing value of the long-term portion of ceo remuneration over time. a breakdown of ceo remuneration in 2013 shows that long-term incentives (lti) pay makes up nearly half of the total ceo remuneration in south africa (21st century pay solutions group, 2013). if ceo remuneration is motivated through remuneration that is linked to the performance of the company then the ceo will act in the interests of the owners and will strive to maximise shareholder wealth (de wet, 2012). it is therefore imperative that ltis should be directly linked to long term sustainability measures of company performance (iodsa, 2011). however, many remuneration committees and boards of companies do not know which company performance measures are appropriate for their industry. thus there is a strong need to determine which particular performance indicators in different industries affect ceo remuneration, so that the relationship between the ceo remuneration and the company performance may be measured reliably and based on defensible statistics. this study determines: • whether there is a statistically significant and positive correlation between long-term portion of ceo remuneration and company performance measures for different industries, and • which financial indicators are most significant by industry for this correlation in south african companies. • the paper covers the relevant literature research around ceo remuneration and the link to performance which is then linked to the research hypothesis and presented in statistical results. the study covers six broad industries and concrete conclusions are presented for each. 2 literature review 2.1 ceo remuneration definitions ceo remuneration is made up of 3 components, namely, total guaranteed package (tgp), shortterm incentive pay (sti) and long term incentive pay (lti). • fixed pay /total guaranteed package (tgp): all guaranteed components of remuneration, including base salary and benefits that typically accrue on a monthly basis (pension, medical, and car allowance among others). fixed pay is influenced primarily by governance and company size (bussin, 2012). • variable pay (also known as incentive pay): the variable components of remuneration that accrue to an individual based on achievement of satisfactory measures of performance, consisting of: short-term incentives (stis): all cash based payments that accrue to an individual based on company performance for a 12 month period 536 sajems ns 18 (2015) no 4:534-550 long-term incentives (ltis): all cash and equity based awards that accrue to an individual based on company performance over a period longer than 12 months (21st century pay solutions group, 2012). it is widely accepted that the sti and lti components of ceo remuneration are linked to company performance (allcock, filatotchev & chahine, 2010; cale, jurow, romana, deasy, haddick & napierala, 2009; choo & francisco, 2004; the high pay commission, 2010; gates, 2001). 2.2 the link between ceo remuneration and company performance since 1969, many people have researched the relationship between ceo remuneration its determinants. cosh (1975) investigated over 1500 uk companies over a period of two years (1969 1971) to determine which factors where significant when determining ceo remuneration. he found that company size was a much greater determinant of ceo remuneration than company performance measures (such as share return, earnings per share or accounting returns). more recently however, häsä (2013) studied executive remuneration determinants across 10 countries and 6 industries, and discovered that company size, governance and company performance accounted for only a small part of share-based executive remuneration. theunissen and oberholzer (2013) formulated a model to describe ceo remuneration for company size and performance. however, this study has limitations as return on equity (roe) was used as the only measure of performance, and may not necessarily be the most appropriate measure to incentivise ceo remuneration in all these industries. zulfiqar, shah, javed and abbas (2009) proposed a model where the determinants of ceo remuneration include: audit committee independence; shareholder activism, board size and independence; institutional ownership, ownership structure; ownership concentration; company performance and company size. they excluded geographical and cultural factors which have been found to explain a large part of the ceo remuneration variances. for example, salazar and raggiunti (2013) found that lower ceo remuneration in japan (versus the usa) does not result in poorer company performance and is in fact a necessity for local cultural conditions. 2.3 industry and country-specific research on the link between ceo remuneration and company performance research results linking ceo remuneration and company performance differs across industry sectors and countries. in addition, different research findings support or refute the payperformance relationship, making a definitive conclusion hard to reach. several contrasting research studies are described below to demonstrate the varied nature of the findings. 2.3.1 positive links a chinese study in the petroleum industry showed that there is a positive relationship between executive remuneration and company performance even though share-based pay is not used extensively (hong-bo, 2013). in australia the ceo remuneration-performance relationship, based on the shareholder return measures of return on assets (roa), return on equity (roe) and earnings per share (eps), has been strengthening since 1999 (doucouliagos, haman & askary, 2007). a study of australian companies in 2004 showed that the ceo remuneration-performance link is positive, statistically significant, and in line with other international findings in usa, uk and canada (merhebi, pattenden, swan & zhou, 2006). supporting this evidence, farmer, archbold and alexandrou (2013) analysed a panel of ceos from 204 uk companies over a similar period 2003 to 2007. they found that both basic pay and sti pay had a significant relationship with the ftse 350 market performance, and that lti pay was linked to the 3-year ftse 350 industry sector performance (it must be noted that in this study they did not attempt to link each company’s performance to the remuneration of its ceo). another sajems ns 18 (2015) no 4:534-550 537 study of uk company panel data (1999-2005) showed a direct positive relationship between shareholder returns and ceo remuneration (ozkan, 2011). extensive studies undertaken in canada and the usa have also shown a positive link between ceo remuneration and performance. 1 397 companies in the usa were studied from 1999-2006 by manders (2012) who found that there was a strong and positive relationship between company performance and the percentage of equity-based ceo compensation. zhou (2010) examined 755 canadian companies (over the period 1991 to 1995), and concluded that ceo remuneration is tied to company performance. sheikh (2008) found a positive relationship between return on equity (roe) and total shareholder returns (tsr) in us companies over the period 1992-2005. studies investigating the role between ceo remuneration and company performance have also been conducted in south africa. shaw (2011) found that in the south african financial sector, company performance and ceo remuneration display a favourable, positive relationship with each other. van blerck (2012) also found a strong, positive relationship between ceo remuneration and the south african financial sector’s company performance metric, economic value added (eva). 2.3.2 negative links an industry-specific study by reiter, sandoval, brown and pink (2009) found no relationship between ceo remuneration and the three most commonly used financial measures of performance in the hospital sector unit cost, margins and current ratio. a study on listed chinese logistics companies also demonstrated no linear relationship between executive remuneration and company performance when using eps and roe as performance metrics (fang, ya-xuan & hui, 2013). a 2010 study, specific to the uk financial sector, found no positive relationship between ceo remuneration and company performance (shiwakoti, 2012). a study conducted by cooper, gulen and rau (2009) indicated that over a period of time, long-term incentive pay does not necessarily result in higher stock price. laux and laux (2009) also found that an increase in ceo remuneration does not necessarily increase earnings management for us listed companies. in brazil a study by krauter and de sousa (2013) showed that, for the period 2006 – 2007, there was not a significant relationship between executive compensation and corporate financial performance of sales growth and roe. bradley (2011) performed a study, over a period of 5 years, on the largest 40 companies on the johannesburg stock exchange and found that there was no relationship between ceo remuneration and return on equity (roe), return on assets (roa) and earnings per share (eps). it is clear that research conducted to support the link of ceo remuneration to company performance metrics is not definitive, and that the results vary depending on the country, industry sector, and the selected performance metrics. the research conducted in south africa (van blerk, 2012; shaw, 2011; bradley 2011) shows a similar trend of varied results. very few studies have focused on using an accurate and accepted methodology to value the long-term component of ceo remuneration and determine the link to company performance. in addition, most studies did not check for serial correlation, joint significance and causality in the relationship. in almost all of the studies, the measurement of ceo remuneration used actual ceo remuneration rather than the expected long term component of the ceo remuneration based on company performance. the actual payouts to executives may not coincide with the expected value, as the ceo can decide when to receive the payouts after they become payable to him/her. for example, a ceo may have shares allocated to him in 2008 that vest (payout) in 2011 to the value of $1 million. he may opt to only cash them in 2016 (five years later) and this amount would be reported as remuneration to the ceo in that year. the company performance may have been good in 2011 (when the vesting occurred) whilst it may be poor in 2016 when the payout actually occurred. this would then result in a poor pay to performance link. this confirms the conclusion 538 sajems ns 18 (2015) no 4:534-550 that the tenuous relationship between ceo remuneration and company performance is a function of how the ceo remuneration is measured rather than the relationship itself (farmer, 2008). black scholes is a sound, thorough methodology that overcomes this issue as it values the expected long-term value of a share based allocation at its future vesting or payout points. the studies that used this methodology are limited to that by essopp (2013) and lilling (2006). both these studies found a positive and significant relationship between ceo remuneration and company performance. 2.4 measures of company performance the geo global equity insights (2013) study focused on the prevalence of measures of company performance in 133 companies across 13 countries and 10 industries. the results of this study are presented in table 1 below (anderson, gohm & kramarsch, 2013). table 1 geo global equity insights 2013 company performance measures percentage prevalence performance measures total europe usa share price/tsr 26% 33% 20% profit/earnings 17% 12% 21% eps 15% 17% 13% return on capital 11% 12% 11% cash flow 9% 11% 8% sales/revenue 8% 5% 10% return on sales 3% 3% 3% economic value added 3% 3% 3% other financial measures 6% 2% 9% other non-financial measures 2% 2% 2% total 100% 100% 100% source: anderson et al. (2013) ernst & young’s (2013) survey results on remuneration governance in south africa (table 2) describe remuneration trends for the previous year. the key indicators of performance are an aggregate for all industries and are similar for both short-term and long-term incentives. this means that the link to ceo remuneration may be tenuous when aggregate indicators are used. this study identifies key indicators that have a strong relationship with ceo remuneration for a particular industry. table 2 key performance metrics for short-term and long-term incentives in south africa performance measures sti lti profit (ebit, ebitda) 26% 25% headline eps 9% 13% return on capital 11% 12% share price/tsr 4% 12% sales/revenue 11% 10% eps 6% 8% other non-financial measures 13% 7% cash flow 10% 5% economic value added 4% 5% other financial measures 6% 3% none 0% 2% total 100% 100% source: ernst & young (2013) sajems ns 18 (2015) no 4:534-550 539 3 research hypotheses the following research hypotheses were made: hypothesis 1: there is a statistically significant correlation between lti ceo remuneration and company performance measures for different industries; hypothesis 2: the financial indicators differ by industry for the statistically significant correlation between lti ceo remuneration and company performance measures. it is proposed that the validity of these hypotheses will help to describe the relationship between ceo remuneration and company performance in different south african industries. these hypotheses may imply that the principle-agent theory (agency theory) is more effective in certain industries than others. agency theory is however the most widely accepted and relevant theory to describe the ceo remuneration link to performance. agency theory currently there are eleven accepted theories explaining the determination of ceo remuneration. five of these theories are linked to company performance and rely on agency theory for justification (berle & gardiner, 1932). agency theory postulates that the separation of ownership and control leads to two distinct sets of factors in the organisation; the principle (or shareholder), and the agent (who acts as a manager for the principle – in this case, the ceo). the literature notes that agents consistently act in a manner that promotes self-interest and are said to be ‘rent seeking’, claiming greater pay while working less. clearly this arrangement will not satisfy the principle’s desire for profit maximisation (o’reilly & main, 2010). the principle-agent conflict is further exacerbated by the fact that the various actors experience differing levels of risk. it is unlikely that the ceo will ever experience the same risk as shareholders without pledging his or her own capital, and shareholders typically employ agents so that they can focus on running the business from a pragmatic perspective, free of the emotional burden that investor risk creates (o’reilly & main, 2010). the efficiency wage theory (stiglitz, 1981) states that ceos are paid premiums (incentive pay) for improved productivity which, in turn, pays for the incentives. the marginal productivity theory postulates that the ceo should receive compensation based on value-add and that monitoring of ceo performance is related asymptotically to company performance (gomez-mejia, balkin & cardy, 1995). tournament theory (lazear & rosen, 1981) describes tournament type behaviour where if the gap in pay to the next level is big enough and the employee believes that they can get promoted, they are motivated to work hard to get the promotion, and there is a resulting performance increase (kubo & saito, 2008). the pay compression hypothesis (lazear, 1989) describes the theory where the pay difference between employees may be smaller than the productivity difference thus leading to higher performance. 4 research design and objectives the research methodology used quantitative and empirical analytical research to establish the relationship of the hypotheses. a longitudinal study was used to determine the key components of each company’s ceo remuneration and performance, and measure the relationships between ceo remuneration and metrics of company performance for each full financial year for the period 20032012. the research design provided a comprehensive framework using: • the quantitative approach (using regression and ordinary least squares (ols) analysis (strathclyde university, 2014) to determine the statistically significant correlation between ceo remuneration and measures of company performance; 540 sajems ns 18 (2015) no 4:534-550 • time series analysis and panel data regression (baltagi, 2008) to determine the suitability of the performance measures for ceo’s by industry or the extent to which they are applicable; • the development of descriptive trends in the longitudinal data to identify any observations. the data set used in this analysis consisted of the entire remuneration database from all 254 jse listed companies for the period 2008 to 2012. the sample group changes from year to year but in all years, companies that were present in every year of the complete sample group were used. no sampling within this group occurred. the data was obtained from a private company called mcgregor bfa that captures statistics from all listed south african companies’ annual financial and remuneration reports. the lti portion of ceo remuneration is used as the dependent variable. essop (2013) made use of a similar methodology, using a black scholes model to calculate the value of the share options available to each executive. the chief difference in this analysis however, is that the lti is used as the focus (dependent variable) in this study whereas essop (2013) used the lti as a component of total earnings. the importance of this is that the pay-performance link should not be diluted by fixed pay. in order to calculate the company volatilities for the black scholes evaluation of the long-term portion of the ceo remuneration for the years 2008-2012, the data for the preceding 5 years was also required (2003–2007). using company volatilities distinguishes this study from previous studies that used industry volatilities (essop, 2013; lilling, 2006). the long-term portion of ceo remuneration is the ceo’s expected annualised value of the lti scheme after a specified number of years (in this case, after 3 years). this value is determined using a black scholes model, making use of the actual volatility of each company’s share price over the 5 years leading up to the year in which the long-term portion of ceo remuneration was calculated. the value of a call option (based on the original black scholes model) has been described as a function of five parameters (chriss, 1997): cb-s = f(s,δ2,x,t,rf) s = the price of the underlying asset (in this project the underlying asset is stock) δ2 = the instantaneous variance of the asset returns (share price volatility) x = the exercise price t = the time to vesting in days rf = the risk free rate the following assumptions have been used in developing valuation models for options (chriss, 1997): 1) the rate of return on the stock follows a lognormal distribution. this means that the logarithm of 1 plus the rate of return follows the normal, or bell-shaped, curve. (the assumption ensures continuous trading the stock rate of return distribution is continuous.) 2) the risk-free rate and variance of the return on the stock are constant throughout the option’s life. (the two variables are non-stochastic.) 3) there are no taxes or transaction costs. 4) the stock pays no dividends. (this assumption ensures no jumps in the stock price. it is well known that the stock price falls by approximately the amount of the dividend on the exdividend date.) 5) the calls are european, which does not allow for early exercise. lti data shows full value shares or share appreciation units with a strike price. when exploring the possible model specifications detailed in equations 1 to 3, essop’s research (2013) was used as the benchmark model, yielding an attractive result (which was also cited by bradley (2011) showing that dummy variables for industry were significant in the models and that industry had a role to play in determining executive remuneration. sajems ns 18 (2015) no 4:534-550 541 this analysis focuses only on ceos (rather than on all executives) and attempts rather to find which performance variables are most relevant in each industry. essop (2013) did not apply a time lag to the performance variables being analysed, whereas bradley (2011) included a time lag in the performance variable. intuitively, bradley’s view makes more sense, as one would expect this year’s share based incentive allocations to be based on last year’s performance. when analysing variable pay, bradley (2011) makes use of actual payout data. this type of analysis can be quite misleading if one is searching for a link between pay and performance, as these shares may have vested 10 years ago and are only now being paid out. this analysis therefore follows essop’s (2013) methodology (using a black scholes model to calculate the realisable lti value of a ceo’s shares) which is far more appropriate when researching a link between remuneration and performance. three equations were postulated, based on variables where a relationship between different performance measures and the long-term portion of ceo remuneration (lagged by one year), was found to be present in previous studies. additional variables were considered but were excluded if there was no relationship present. since each of the six industries was heterogeneous, these three equations were tested in order to allow for differences across the model specification in each industry. the three equations used were as follows: equation 1: long-term portion of ceo remunerationit = cit + performanceit(-1) + tgpit + industry_gdp_growthit + turnoverit + share_priceit equation 2: long-term portion of ceo remunerationit = cit + performanceit(-1) + industry_gdp_growthit + turnoverit + share_priceit equation 3: long-term portion of ceo remunerationit = cit + performanceit(-1) + tgpit + turnoverit + share_priceit the performance variables tested in each industry are as follows: capital employed, change in capital employed, change in fixed assets, change in turnover, dividend per share, ebitda, fixed assets, headline eps, profits after interest tax, profits after interest tax, share price change and total shareholder return. both accounting-based and market-based measures have been used in order to measure company performance in this analysis. these are the most common performance variables featured in the remuneration governance in south africa survey by ernst & young (2013). the four control variables used in the models (all of which are used in equation 1) were included to control the model for external effects. it could be questioned why the model utilises share price data, and not share return data. the shareholder will value both their return on investment and the performance of the company relative to the market. for example, share price increases of say 20 per cent in one year might appear good but if the market or industry average increase was 30 per cent, then it is clear that the ceo has actually performed poorly. in this study we have accommodated the change in share price (return) over the five year period in addition to looking at share returns (including dividend per share). we have also controlled for industry effects (relative to industry average returns) by using industry gdp growth as a control variable. once the result of each equation for each industry had been generated, each industry’s output was analysed. interpretation was made based on six specific criteria. 1) firstly, we expected that if there was a relationship between the long-term portion of ceo remuneration and company performance, that the relationship would be positive. if the 542 sajems ns 18 (2015) no 4:534-550 relationship was positive, we tested for significance at a 5 per cent level (p-value < 0.05). 2) we then tested for serial correlation (the correlation of a time series with its own past and future values) using the durbin-watson test statistic and the durbin-watson statistical tables. these tests were performed using a 5 per cent level of significance. 3) we tested whether the model variables were jointly significant in determining the dependent variable (lti portion of ceo remuneration). the f-statistic was used to determine this, with a p-value < 0.05 stating that the independent variables (company performance metrics) were jointly significant in determining the value of the lti portion of ceo remuneration. 4) having determined these positive relationships, we then tested whether a large part of the variation in the dependent variables was explained by the independent variables (company performance metrics), as well as by the four control variables tgp, turnover and share price. we did this using the adjusted r-squared value. 5) finally, we tested whether pairwise granger causality existed between the long-term portion of ceo remuneration and the performance variable. 6) the industries which were analysed have been grouped into six categories as depicted in appendix 1. social services as an industry was omitted from the study as insufficient data were available. 5 results and discussion each industry analysis contains 4 tables, each tabling a set of results for one of the equations plus the causality test. the test is stated on the y axis and the performance metric tested is stated on the x axis. the results are colour coded: • a grey background indicates a positive result – i.e., it contains information which supports the argument that there is a relationship between long-term portion of ceo remuneration and that particular performance metric. • a black background indicates an inconclusive result. • a negative result contains no shading. an inconclusive durbin-watson test statistic for an equation means that a serial correlation cannot be proved or disproved. the national industry is presented and discussed in detail whilst the other industries’ conclusive results are presented and discussed. 5.1 national industry in equations 1, 2 and 3 (tables 3, 4 and 5, respectively), profits after interest and tax and earnings before interest, tax, depreciation and amortisation (ebitda) are the only two independent variables (company performance metrics) which display a consistently positive and significant relationship with the dependent variable (lti portion of ceo remuneration). in equation 1 (table 3), these relationships are highly significant at more than a 1 per cent level. there is also joint significance of the independent variables at a national level. sajems ns 18 (2015) no 4:534-550 543 table 3 results of the national regression using equation 1 equation 1 c ap ita l e m pl oy ed c ha ng e in c ap ita l em pl oy ed c ha ng e in fi xe d as se ts c ha ng e in tu rn ov er d iv id en ds p er sh ar e e b it d a fi xe d as se ts h ea dl in e e p s p ro fit s af te r in te re st & ta x c ha ng e in s ha re pr ic e to ta l s ha re ho ld er re tu rn positive coefficient + + + + + + + significance of performance variable’s coefficient 0.557 0.862 0.936 0.746 0.011 0.000 0.244 0.36 0.001 0.529 0.5899 serial correlation no (1.977) no (1.936) no (1.943) no (1.964) no (1.928) i/c (1.737) no (1.944) no (1.965) no (1.842) no (1.928) no (1.929) jointly significant yes (0.000) yes (0.000) yes (0.000) yes (0.000) yes (0.000) yes (0.000) yes (0.000) yes (0.000) yes (0.000) yes (0.000) yes (0.000) adjusted r-square 0.35 0.37 0.37 0.35 0.37 0.35 0.34 0.36 0.35 0.37 0.37 table 4 results of the national regression using equation 2 equation 2 c ap ita l e m pl oy ed c ha ng e in c ap ita l em pl oy ed c ha ng e in fi xe d \a ss et s c ha ng e in tu rn ov er d iv id en ds p er sh ar e e b it d a fi xe d as se ts h ea dl in e e p s p ro fit s af te r in te re st & ta x c ha ng e in s ha re pr ic e to ta l s ha re ho ld er re tu rn positive coefficient + + + + + + + significance of performance variable's coefficient 0.043 0.063 0.982 0.980 0.081 0.000 0.002 0.166 0.046 0.152 0.162 serial correlation yes (1.330) yes (1.331) yes (1.336) yes (1.324) yes (1.248) yes (1.192) yes (1.269) yes (1.249) yes (1.274) yes (1.333) yes (1.333) jointly significant yes (0.000) yes (0.000) yes (0.000) yes (0.000) yes (0.000) yes (0.000) yes (0.000) yes (0.000) yes (0.000) yes (0.000) yes (0.000) adjusted r-square 0.03 0.03 0.03 0.03 0.05 0.06 0.04 0.05 0.04 0.03 0.03 table 5 results of the national regression using equation 3 equation 3 c ap ita l e m pl oy ed c ha ng e in c ap ita l em pl oy ed c ha ng e in f fx ed as se ts c ha ng e in tu rn ov er d iv id en ds p er s ha re e b it d a fi xe d as se ts h ea dl in e e p s p ro fit s af te r in te re st & ta x c ha ng e in s ha re pr ic e to ta l s ha re ho ld er re tu rn positive coefficient + + + + + + + significance of performance variable's coefficient 0.063 0.892 0.917 0.690 0.372 0.000 0.237 0.477 0.001 0.648 0.713 serial correlation no (1.989) no (1.948) no (1.954) no (1.974) no (1.944) i/c (1.740) no (1.954) no (1.973) no (1.848) no (1.942) no (1.943) jointly significant yes (0.000) yes (0.000) yes (0.000) yes (0.000) yes (0.000) yes (0.000) yes (0.000) yes (0.000) yes (0.000) yes (0.000) yes (0.000) adjusted r-square 0.35 0.37 0.37 0.35 0.37 0.35 0.34 0.36 0.35 0.37 0.37 544 sajems ns 18 (2015) no 4:534-550 table 6 the pairwise granger causality test between each performance variable and the long-term portion of ceo remuneration causality test c ap ita l e m pl oy ed c ha ng e in c ap ita l em pl oy ed c ha ng e in fi xe d as se ts c ha ng e in tu rn ov er d iv id en ds p er s ha re e b it d a fi xe d as se ts h ea dl in e e p s p ro fit s af te r in te re st & ta x c ha ng e in s ha re pr ic e to ta l s ha re ho ld er re tu rn long term incentive yes (0.03) no (0.87) no (0.84) no (0.37) no (0.99) yes (0.00) yes (0.00) yes (0.00) yes (0.00) no (0.71) no (0.76) in equation 2 (table 4), capital employed and fixed assets also have a positive and significant relationship with lti the portion of ceo remuneration. however, there is serial correlation across all performance metrics. when coupled with the low adjusted r-square values, this suggests that this is not a good model for determining the lti portion of ceo remuneration at national level. when using equation 1 (table 3), the durbin-watson test indicates that there is no serial correlation between profits after interest and tax and the lti portion of ceo remuneration. however, we cannot disprove, or prove, serial correlation between earnings before interest, tax, depreciation and amortisation (ebitda) and the lti portion of ceo remuneration when using equation 1 (table 3), as the durbin-watson test result is inconclusive. in equation 3 (table 5) there is no serial correlation between any of the independent variables (company performance metrics) and the lti portion of ceo remuneration, apart from ebitda. in this instance, the durbin-watson test was inconclusive and therefore we cannot prove or disprove the presence of serial correlation. in equations 1 and 3 (tables 3 and 5, respectively), the adjusted r-square value is within the same range (0.34 to 0.37). this result is to be expected at a national level, and explains between 34 per cent and 37 per cent of the variation in the lti portion of ceo remuneration. for the purpose of analysing ceo remuneration by industry however, a figure greater than 50 per cent is expected for a positive result as this will prove a more direct link exists. table 6 illustrates that capital employed, earnings before interest, tax, depreciation and amortisation, fixed assets, headline earnings per share and profits after interest and tax all have granger causal relationships with the lti portion of ceo remuneration. this implies that by viewing the previous year’s value of earnings before interest, tax, depreciation and amortisation and/or profits after interest and tax, one can make predictions about the lti portion of ceo remuneration. intuitively the reader may be surprised that there is no granger causality between the lti portion of ceo remuneration and the change in share price. the reason for this is as follows: 1) the majority of the shares are appreciation shares which means that if the scheme goes underwater they will not be paid out (the price is below the strike price at the time of vesting). considering how volatile share prices were since 2008 this instability could disrupt the usual link one would expect to see if the jse all share was more stable. 2) volatility is a large part of determining a black scholes value. high volatility has an upward bias in a black scholes model which could explain why the share price and lti value moved at different rates. 3) a problem may arise that the granger causality between two variables may be changed as the lag of a variable differs. this research used a one period lag on the performance metrics in each equation and therefore this has also been used in the granger causality test. in other words, the test is checking if last year’s share price has caused this year's realisable lti value of ceo remuneration. the lack of granger causality with the change in share price may be due to the structural stability of granger causality. sajems ns 18 (2015) no 4:534-550 545 this result concurs with previous studies (hall & liebman, 1997; jensen & murphy, 1990) which showed that the fortunes of ceos are strongly related to the fortunes of the companies they manage – a 1 per cent increase in the firm’s return will lead to an increase of $43 000 in ceo remuneration. the result supports agency theory that if ceo remuneration is motivated through agency costs (remuneration) with the performance of the company then the ceo will act in the interests of the owners and maximise shareholder wealth. 5.2 extractive industry fixed assets returned positive results for all tests when using equations 1, 2 and 3. this suggests that when ranking the eleven performance metrics tested, fixed assets is the most important company performance metric used to determine the lti portion of ceo remuneration in the extractive industry. this is followed by profits after interest and tax which is an important company performance metric when using equations 1 and 3, but has inconclusive serial correlation for equation 2. the extractive industry is highly capital-intensive and has large fixed assets. the combination of a profit measure and fixed assets as performance measures would deliver the return on the assets that shareholders would expect from the ceo and the business. this positive and strong correlation is supported by a study by hong-bo (2013) in the petroleum industry in china supporting agency theory 5.3 transformative industry when ranking the eleven performance metrics tested, earnings before interest, tax, depreciation and amortisation (ebitda) and profits after interest and tax are the most important company performance metrics used to determine the lti portion of ceo remuneration. however it must be noted that serial correlation is present for both of these company performance metrics when using all three equations. the transformative industry is also highly capital-intensive and has large fixed assets. ceo remuneration is linked to company performance through a combination of a profit measure and fixed assets to deliver the return on the assets that shareholders would expect. once again agency theory is supported through profit returns generated by the ceo that are linked to his/her remuneration through the long-term portion of pay (doucouliagos, haman & askary, 2007; kay, 2004) 5.4 distributive industry capital employed and profits after interest tax are the most important company performance metrics used in determining the lti portion of ceo remuneration although they display serial correlation. it is no surprise that capital employed would be a key performance measure in this industry which revolves around infrastructure and investing in infrastructure. it is interesting to note that the profit is measured after interest. these businesses are often heavily geared because of the huge startup capital required and thus would need to take the interest burden into account as a performance measure. bussin and nel (2015), who found no discernible relationship between ceo remuneration and company performance, did not investigate capital employed as a possible performance variable. the fact that the ceo has to deliver a return on capital employed by maximising profits (before and after tax) to increase his/her pay, supports the validity of using the agency theory. 5.5 producer services industry this is the only industry that has failed to produce at least one granger causal relationship. there is no clear evidence that any of the company performance metrics have a significant relationship 546 sajems ns 18 (2015) no 4:534-550 with the lti portion of ceo remuneration in the producer industry. this industry has high people costs and relatively low capital costs. a further study may look at including a ‘people’ performance measure (for example, the salary and wage cost) to test against. the most promising relationship exists between change in share price and the lti portion of ceo remuneration, supported by gomez-mejia and tosi (1994) who concluded that ceo remuneration was linked to share price but not to any other company performance indicators. agency theory is supported through the link to share price that should result in increased returns to shareholders and ceo remuneration over time. 5.6 personal services industry capital employed is the company performance metric which showed strong evidence of a robust relationship with the lti portion of ceo remuneration followed by change in share price. there are large capital costs to start up these businesses which would necessarily mean that capital employed is a good measure of performance. it is not unexpected that change in share price is an important performance measure for the ceo’s in this industry. these businesses are driven by their share price. they are high visibility end-user services, which means that their actions are constantly scrutinised by the public and their share price is continuously affected. these results are supported by other studies done by kay (2004), sheikh (2008) and sigler and carolina (2011) who found that a shareholder return measure was strongly linked to ceo remuneration in support of agency theory once again. 6 conclusion this study sought to determine whether there is a statistically significant and positive correlation between long-term portion of ceo remuneration and company performance measures for different industries and to determine which financial indicators are most significant by industry for this correlation in south african companies. the results of previous studies vary greatly, however, there appears to be consensus that there a positive relationship between ceo remuneration and company performance if shareholder return is used as a performance metric. the link between ceo remuneration and other company performance measures appears be tenuous and inconclusive, with varied results around the world, but particularly in south africa, where aggregate results have been used across all industries, and the performance metrics that have been used by industry may not be significant for that industry. this study investigated the ceo remuneration-performance link by industry. eleven performance metrics were tested across 5 industries. these metrics are reported routinely in the annual financial statements of south african companies according to international accounting standards (ias). hence this information is readily accessible, and the reporting on these company metrics is consistent and uniform. at an industry consolidated level (national level – all industries), the profit performance variable shows the most significant relationship. this tells us that ceo remuneration is driven by profit in most profit making businesses. this is not surprising as this is the core reason for the existence of profit making business and we would expect ceo remuneration to be based on this in the long term. this is in line with agency theory rather than managerial power theory and concurs with many similar studies done previously. when we use the same methodology to investigate the relationship between performance measures and ceo remuneration at an industry level, the following performance measures were found to have the most positive and significant relationship. sajems ns 18 (2015) no 4:534-550 547 table 7 performance variables by industry sector industry performance variables extractive earnings before interest, tax and depreciation fixed assets profit after tax and interest transformative earnings before interest, tax and depreciation fixed assets profit after tax and interest distributive services capital employed profit after tax and interest producer services personal services capital employed change in share price total shareholder return the results are not unexpected and support agency theory in all cases as the ceo remuneration is linked to a shareholder return measure. we have used a lag period of one year and found significant relationships. a further study could be conducted where the lag periods are altered to include greater periods e.g. 2, 3, 4, and 5 years to see whether a better fit can be found. the long-term portion of ceo remuneration may lag company performance by a longer period the lti performance measures for ceos usually run over a period of 3 to 5 years. this study assumes that the ceo remuneration is positively and significantly linked to the company’s performance in the year after the performance. in light of this, the panel data set would need to be extended to cover a period of at least 10 years. this could be a difficult task in south africa since ceo remuneration disclosure has only been required since 2010. the value of the research is that remuneration committees and boards in south africa now have empirical evidence to both measure and set ceo company performance measures against indicators that are positive and significant to a particular industry. these measures align with the criteria set by king iii currently, but could be considered to enhance the code in the 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and drinking, repair services, laundry, barber and beauty services, entertainment and leisure, media and advertising, miscellaneous personal services abstract introduction consumer information-processing social marketing types of persuasive messages emotion-based social marketing campaigns fear-appeals in advertising a theoretical perspective on consumer responses to fear text-based versus picture-based fear-appeals gender-based responses to advertising stimuli objectives methodology the neuro-physiological measurement of consumers’ subconscious responses galvanic skin response eye-tracking empirical results summary and conclusions implications of the study limitations of the study acknowledgements references about the author(s) christo boshoff department of business management, stellenbosch university, south africa lucea toerien department of business management, stellenbosch university, south africa citation boshoff, c. & toerien, l., 2017, ‘subconscious responses to fear-appeal health warnings: an exploratory study of cigarette packaging’, south african journal of economic and management sciences 20(1), a1630. https://doi.org/10.4102/sajems.v20i1.1630 original research subconscious responses to fear-appeal health warnings: an exploratory study of cigarette packaging christo boshoff, lucea toerien received: 14 july 2016; accepted: 08 feb. 2017; published: 28 apr. 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: tobacco smoking has serious health and financial implications for both smokers and non-smokers. a wide range of measures have been used over many years to combat this scourge. one of these measures is social marketing communication campaigns. whether these campaigns are effective has been the subject of some debate. some of the questions that arise are: what kind of advertising appeals (for instance, informational versus emotional) should be used? which elements should form part of such campaigns? some argue that pictures are more effective. others believe that text-based messages are more effective. regardless of how these campaigns are structured, they have very little chance of success if they are unable at least to cause arousal (activation) among the target audience. not only does emotional arousal increase engagement, enhance information-processing and render communication memorable, it also helps to increase the mental accessibility of related knowledge. aim: in this exploratory study, the ability of fear-based pictures and text messages on cigarette packaging to create emotional arousal among consumers is explored. methods: galvanic skin response and eye-tracking methodologies were used. results: the results indicate that both fear-based pictures and fear-based text messages activated arousal among consumers. conclusion: the extent of arousal is influenced (at least to some extent) by both gender and whether or not the viewer is a smoker. introduction the harmful impact of tobacco smoking on human health has been well documented. for instance, in 2000 it was estimated that tobacco smoking was responsible for a large portion of premature mortality, causing approximately 4.8 million adult deaths worldwide (saloojee 2005). this figure is expected to increase to about 10 m. by 2025 and to 7 m. in developing countries alone by 2030 (saloojee 2005). in china, india and south africa there is evidence that chronic respiratory diseases account for a higher number of deaths than they do in developed countries (groenewald et al. 2007). it is further estimated that about 2 m. deaths per year in the developed world can be directly attributed to tobacco use (saloojee 2005). this situation, as well as the resultant unnecessary health-related expenditure in particular, has a significant economic impact. in taiwan, for instance, medical expenditure attributable to smoking is estimated at $397.6 m. per year and accounts for 6.8% of total medical expenditure. per capita medical expenditure for people who smoke is $70.00 more than for those who do not smoke (yang et al. 2005). in china, the medical spending attributable to smoking and consumption spending on cigarettes is estimated to be responsible for impoverishing 30.5 m. urban and 23.7 m. rural residents (liu et al. 2006). reducing tobacco consumption thus appears to be not only a public health strategy, but also a poverty-reduction strategy. unfortunately, despite these alarming statistics, many people still grossly underestimate the health risks associated with tobacco use. the cessation and prevention of tobacco smoking can substantially reduce these risks. although fear-based social marketing campaigns (communication campaigns using marketing principles to address societal problems) have been implemented internationally to point out the dangers of smoking, their effectiveness has been questioned (manyiwa & brennan 2012; prevention first 2008; van‘t riet & ruiter 2013). one possible reason is that the impact of these campaigns on consumers’ emotional and subconscious responses has never been properly assessed. this ‘oversight’ may be an important limitation, as there is considerable evidence that suggests that consumers often make decisions at the subconscious level rather than at a cognitive level (zaltman 2003:9). in other words, consumer behaviour is often driven by subconscious thoughts and feelings rather than by conscious ones, although the latter are no less important (lindstrom 2008). understanding subconscious responses may be particularly valuable when investigating reactions towards social marketing communication campaigns that make use of the so-called ‘fear-appeals’, such as those used on cigarette packaging in australia and ireland. these fear-appeals attempt to activate the human emotion of fear and are used in the belief that emotional arousal raises consumer involvement and thus enhances consumers’ motivation to process the information (consistent with the elaboration likelihood model). fear-appeals usually take the form of either social disapproval or physical danger (shimp 2003:304). it is against this background that this study attempts to contribute to both the social marketing and the smoking cessation literatures by exploring how consumers respond at the subconscious level to fear-based appeals on cigarette packaging. fear-appeals are often at the centre of social marketing campaigns. however, how consumers process the information conveyed in these advertisements and how they respond to these fear-appeals at the subconscious level are still poorly understood (lindstrom 2008). consumer information-processing in a marketing communication context, the concepts of attitude and persuasion go hand-in-hand. persuasion is an effort by a communicator to influence the consumer’s attitude and behaviour (shimp 2003:222). the basic purpose of any social marketing communication campaign is attitude change (to refrain from smoking or to start wearing a seatbelt when driving a vehicle, for instance). persuasion is thus a key feature of these efforts. persuasion, according the elaboration likelihood model (elm) of petty and cacioppo (1986), can occur via either the so-called central route or the peripheral route. according to the elm, the level of a consumer’s motivation and ability to process a message determine the extent to which they will engage in the different routes of elaboration (lewis, watson & white 2008). should a consumer possess a high level of motivation and a high ability to process a message, the subsequent elaboration will also be high, resulting in the central route of persuasion being taken (fry 2006; lewis et al. 2008). conversely, if a consumer possesses low motivation and low ability to process a message, their elaboration will be low and the peripheral route of persuasion will be engaged (lewis et al. 2008). the peripheral route of processing is automatic, shallow, heuristic and often mindless (petty & cacioppo 1986). many believe that cognitive change can be effected by both routes of persuasion, but that the systematic (the central route) rather than heuristic processing of a message (the peripheral route) is more effective (petty & cacioppo 1986:191). more specifically, messages that are processed by way of the central route of persuasion are believed to be more persistent and more difficult to alter, and will better predict behavioural intentions than messages that are processed via the peripheral route of persuasion (vidrine, simmons & brandon 2007). it is for this reason that many marketers and advertisers believe that they should strive to create persuasive messages that draw full attention and that engage consumers in the systematic, cognitive processing of messages. others argue that by using emotional arousal (such as a fear-appeal), elaboration is high and the chances of attitude change being permanent and enduring are high (petty & cacioppo 1986:191). in the context of this study, emotion-based persuasion was operationalised as the graphic fear-appeal warnings, and the text-based fear-appeal warnings represented the message-based persuasion in a social marketing communication context. social marketing the term ‘social marketing’ was first coined in 1971 to refer to the use of commercial marketing principles in the resolution of societal problems (kotler & zaltman 1971:3; macfadyen, stead & hastings 1999). since its inception, this idea has been widely used in attempts to effect attitudinal and behavioural changes that contribute to the well-being of society (weinreich 2006) or to alter deviant behaviours that are difficult to modify (fry 2006:33). such behaviours include cigarette-smoking, unsafe road usage practices such as drinking-and-driving, traffic speeding, unsafe sex, unhealthy eating patterns and other poor lifestyle choices (sheer & chen 2008:936; thompson, barnett & pearce 2009:181). changing human behaviour, however, is not easy. as knowledge is a pre-condition of behaviour change (renner & schwarzer 2003:189), marketers who focus on social issues need both to inform and to caution at the same time. often they must convey a message whose information is both unpalatable and undesirable to a target market that is behaving dysfunctionally (cummings 2012:26). considering the sensitive and sometimes controversial nature of social marketing messages, it is important that social marketing campaigns are carefully constructed. more importantly, the type of persuasive interventions, messages and appeals used should be grounded in a sound understanding of the core contributing factors to the occurrence and re-occurrence of dysfunctional behaviour (fernandes, hatfield & job 2010:180) so that the persuasive message’s impact is optimised. types of persuasive messages the purpose of persuasive messages is to influence consumer thoughts and actions. it is by means of creative strategies that marketers translate these persuasive messages into precise communication (kotler & keller 2012:506). these creative strategies can be broadly defined as either positive or negative in nature and can further be classified as using either an informational or an emotional message appeal (brennan & binney 2010:141). informational message appeals, otherwise known as rational appeals, focus on providing meaningful facts to consumers (cutler, thomas & rao 2000:69). the purpose is cognitive engagement by the consumer via the central route of information-processing, in terms of the elm model (cacioppo & petty 1986). those marketers who favour informational appeals believe that it is by providing factual information that the consumer is cognitively engaged and ultimately persuaded towards some form of action. others believe that appeals to the emotions of consumers are more effective. in contrast to informational appeals, emotional appeals are concerned with the evocation of emotions to persuade consumers (aaker & williams 1998:243). cameron (2009:310) believes that persuasive messages should attract the receiver’s attention and peters, ruiter and kok (2014:73–74) suggest that the best way to do so is by arousing their emotions. not only does emotional arousal render communication memorable, but it further helps to increase the mental accessibility of related knowledge (hendriks, van den putte & de bruijn 2014:685; peters et al. 2014:74). emotion-based social marketing campaigns emotions can be described as internal mental states that vary in intensity and represent evaluative, valenced reactions to occurrences, agents or objects (nabi 2015:114). watson and tellegen (1985:219) suggest that emotion is a two-dimensional structure, consisting of positive (high or low) and negative (high or low) affect. they argue that the emotions a consumer will experience in a given situation will alternate, depending on the valence and urgency of the prevailing event. shaver et al. (1987:1061) identify five basic emotional categories: love, joy, anger, sadness and fear. these five basic emotions are further categorised as either a positive superordinate (i.e. love and joy) or as a negative superordinate (i.e. anger, sadness and fear) emotion. the positive emotions, otherwise known as ‘approach affect’, arise from beneficial stimuli, while the negative emotions, alternatively known as ‘avoidance affect’, result from threatening stimuli (fry 2006:26). in other words, how a consumer perceives a situation (i.e. as either beneficial or threatening) will determine which superordinate category (positive or negative) and basic emotions (love, joy, anger, sadness or fear) will be aroused. well-accepted consumer behaviour models and theories such as the affect-beliefs-conation (abc) model of attitude (tri-component models) acknowledge the influence of both cognition (beliefs) and affect (feelings and emotions) and the resultant attitudes in consumer decision-making (hawkins & mothersbaugh 2013:384–388). some researchers argue that the role of emotions in consumer decision-making may previously have been under-estimated (zaltman 2003:9). the argument is that consumers often first make decisions on a subconscious and emotional level and then justify them on a rational level (blair-broeker, ernst & myers 2003:118; heath 2007:172). as zaltman (2003:8) points out: ‘although our brains have separate structures for processing emotions and logical reasoning, the two systems communicate with each other and jointly affect our behaviour’. more importantly, emotional arousal strongly influences decision-making processes, attitudes and behaviour change, particularly in the realm of persuasion (blair-broeker et al. 2003:118; heath 2007:172; nabi 2015:115). as the objective of social marketing campaigns is to influence or persuade consumers to avoid or stop harmful behaviour, focusing on subconscious and emotional responses can be an important means to realise this objective. therefore, this study focuses on one specific emotional appeal, namely fear. fear-appeals in advertising fear-appeals in advertising attempt to evoke fear to stimulate a desired behaviour (such as not starting to smoke tobacco) or to initiate a behaviour change (such as to stop smoking tobacco) among a target audience. campaigns based on fear-appeals typically attempt to persuade the target audience to change their maladaptive behaviour patterns by recommending the adoption of more constructive, alternative behaviour (morales, wu & fitzsimons 2012). however, in a social marketing context the effectiveness of fear-based appeals has been controversial, as years of research have still not produced conclusive evidence that social marketing is effective (o’hegarty et al. 2006:467; peters et al. 2014:68). some have concluded that these campaigns have a significant effect on message recall, persuasion and behavioural responses (rayner, baxter & ilicic 2014:62). moreover, it has been demonstrated that fear is a key motivator of systematic message processing (terpstra et al. 2014:1509) as well as behaviour change (rogers 1983:155; soames job 1988:164). using fear-appeals instead of other types of emotional message has been advocated because of evidence that consumers more frequently recall messages that use fear than other appeals (chung & ahn 2013:454). similarly, fear is a primary motivator of behaviour change (rogers 1983:155; soames job 1988:164). typical themes in campaigns where fear-appeals have been used to alter undesirable behaviour include unsafe road usage (hastings, stead & webb 2004), abuse, fat consumption (grier & bryant 2005), breast cancer, rape and hiv (hastings et al. 2004; kees et al. 2010; kotler & keller 2012; witte 1992). fear is also a theme that social marketers have regularly used in anti-smoking campaigns. however, several studies have questioned the effectiveness of fear-based appeals in social marketing campaigns and have pointed out that they can lead to unintended consequences. more specifically, they have pointed out that fear-appeal messages have the potential to reinforce maladaptive behaviour patterns by encouraging some of those exposed to the fear-appeal message to become defensive (prevention first 2008; van‘t riet & ruiter 2013). more importantly, it has been suggested that defensive reactions are most likely to occur in individuals who are categorised as most at risk, based on their current behaviour (harris et al. 2007:438). defensive reactions include: (1) avoidance, which refers to the actions of escaping the threatening communication; (2) denial, otherwise known as the rejection of the message; (3) suppression, which is defined as inhibiting threatening thoughts or emotionally charged behaviour; (4) cognitive dissonance, a state of discomfort when an individual simultaneously holds two conflicting mental representations; and (5) psychological reactance, which is aroused when an individual perceives their freedom as being restricted or removed and attempts to gain back that freedom by means of behavioural defiance (kessels et al. 2014; shen 2015; van‘t riet & ruiter 2013). these defensive outcomes will diminish the effectiveness of fear-appeal messages as receivers of the communication regard the message as a psychological attack on their freedom (müller et al. 2009; shen 2015). in order to recover their freedom, defensive individuals then typically continue engaging in a maladaptive way or, as found in some studies, even partake in the behaviour to a greater extent than before exposure to the fear-appeal message (prevention first 2008; ruiter et al. 2001). a theoretical perspective on consumer responses to fear when facing a threatening situation or event, protection motivation theory suggests that how humans respond depends on four considerations: (1) how severe the threat is perceived to be; (2) how capable the person judges themselves to deal with the potential threat should it occur (self-efficacy); (3) the chance or probability of the threat actually occurring (in other words, vulnerability); and (4) how effective the methods considered for dealing with the threat are expected to be (rogers 1975). protection motivation theory has formed the basis of several studies in which persuasive communication, as well as the use of fear-appeals in particular, was a central theme (rogers 1983). these studies were conducted in the domains of health care, including hiv-related studies (van der velde & van der plight 1991), sun protection behaviour (prentice-dunn, mcmath & cramer 2009) and anti-social behaviour such as drinking-and-driving (fry 2006; witte & allen 2000), alcohol abuse (stainback & rogers 1983) and smoking (pechmann et al. 2003). in these contexts, protection motivation can be described as a mediating variable that can arouse, sustain and direct protective health care behaviour (boer & seydel 1996). text-based versus picture-based fear-appeals in many countries, the (often growing) number of deaths attributable to smoking is forcing governments to adopt a stricter stance on cigarette consumption. in some countries, legislation requires the use of picture-based cigarette warnings, ousting the use of text-based cigarette warnings (tobacco labelling resource centre 2016; tobacco tactics 2016; world health organization [who] 2013). the current text-based cigarette warning labels attempt to engage consumers in a rational thought process in the hope that they will realise the negative effects of smoking. by engaging a consumer in this cognitive thought process, marketers hope to influence their attitudes (hawkins & mothersbaugh 2013). however, when introducing fear-appeals that use picture-based warnings, the effect on consumer attitudes is believed to increase dramatically (hammond et al. 2003; o’hegarty et al. 2006; thrasher et al. 2007). this intensification is because the use of pictures makes the possibility of the threat occurring seem much more credible (cantrell et al. 2013), leaving the consumer feeling susceptible to the threat. as a result, picture-based warnings create a more believable warning that could affect consumer attitudes more effectively (cantrell et al. 2013). because of this belief, picture-based warnings (see examples under the section on stimuli below) have been used extensively (hammond et al. 2003). their effectiveness has been questioned, however, and contradictory evidence has been reported. some researchers caution against the use of graphic labels, as these gruesome images are more likely to initiate defensive reactions than to bring about the desired adaptive behaviours (harris et al. 2007:438). others claim that graphic warnings cause avoidable emotional discomfort, result in the weakened credibility of the message, cause smokers to avoid the warning message altogether and even increase smoking behaviour because of reactance (hammond et al. 2004:1442). these findings suggest that graphic warnings could initiate selective attention where smokers (and potential smokers) ignore warning messages or react in a defiant manner by continuing their maladaptive behaviours. little research exploring the potential and unintended results of graphic warnings exists, however (gallopel-morvan et al. 2011:8). more importantly, whether or not consumers respond subconsciously to these cues has never been explored. also, how gender and smoking status (smoking vs. non-smoking) subconsciously influence responses to cigarette warnings has never been investigated either. gender-based responses to advertising stimuli differences between males and females have been considered in consumer research in the past (brebner 2002; eagly et al. 2004; kempf, laczniak & smith 2006; noble, pomering & johnson 2014; putrevu 2004). these studies are particularly diverse; examples include the study of gender identity (palan 2001), the impact of gender on information-processing in an advertising context (darley & smith 1995; kempf et al. 1997) and gender differences in technology adoption and schematic processing (venkatesh, morris & ackerman 2000), to name a few. although researchers have reported that gender often explains only limited amounts of variation in a range of dependent variables (fischer & arnold 1994), gender differences have been widely reported in responses to a range of stimuli, including advertisements (covell, dion & dion 1994). several studies have explored gender differences in the context of information-processing (brunel & nelson 2003; wolin 2003), where some have specifically considered responses to advertising for low-involvement products in different information-processing conditions (papyrina 2015). no gender differences were observed when the opportunity for processing was low. in contrast, when there was an opportunity for detailed information-processing, females were more likely to use it and methodically consider the content of an advertisement, while males were more likely to disregard it and instead process an advertisement in a heuristic manner (papyrina 2015). in the past females have often been considered to be more emotional than males, and therefore they are believed to respond more strongly to advertisements with emotional content or emotional appeals (moore 2007). when studying the differences in information-processing between male and female consumers at an emotional or subconscious level, it is important to acknowledge that traditional research methods (such as survey research or observation of what is believed to be emotional responses) might not reveal underlying differences that could still influence the behaviour of the consumer, specifically with regard to information that the consumer does not consider rationally or think about. it is against this background that this study used a data collection method (neuro-physiological research) that collects data on responses that are not under the direct control of the central nervous system. the benefit of the use of neuro-physiological methodologies in consumer research is aptly described by telpaz, webb and levy (2015:511): ‘… neuroscience can reveal information about consumer preferences that is unobtainable by conventional methods’. objectives the primary objective of this study was to explore how consumers respond at the subconscious (emotional) level to the anti-smoking, fear-based appeals typically found on cigarette packaging. the secondary objectives of the study were: to compare the neuro-physiological responses to text-based versus picture-based, fear-based anti-smoking appeals typically found on cigarette packaging; to explore whether males and females differ in how they respond to the anti-smoking, fear-based appeals typically found on cigarette packaging; and to explore whether smokers and non-smokers differ in how they respond to anti-smoking, fear-based appeals typically found on cigarette packaging. methodology sample the sample size was 90 consumers in the age category of 25–50 years, as that is typically the age group of current smokers or those susceptible to becoming smokers. the sample size compares favourably with others in similar studies (boksem & smidts 2015 32 subjects; hazzlet & hazzlet 1999 49 subjects). the gender split was 50%. however, smokers were under-represented, with only 21 of the participants being smokers at the time of the data collection. as a result, the empirical results related to this sub-sample are reported using descriptive statistics only. stimuli the stimuli used in this study were four anti-smoking, fear-based appeals that are typically found on cigarette packaging and consisted of two text-only warning messages (figures 1 and 3) and two text and picture warning messages (figures 2 and 4). for each text-only warning label a pictorial warning message (still including the original text-only warning message) was also used. the combination of text and visuals on one stimulus is consistent with previous studies (kees et al. 2010:266; vardavas et al. 2009:1). when referring to results relating to picture stimuli, reference is therefore made to the combination of text and picture warning messages on the same packaging (see graphics in figures 2 and 4). figure 1: text-based warning: smoking causes peripheral vascular disease. figure 2: both text and picture-based warning: a gangrene-affected foot. figure 3: text-based warning: smoking causes mouth and throat cancer. figure 4: both text and picture-based warning: a mouth with a tooth missing, several damaged teeth and cancerous sores on the lower lip. the neuro-physiological measurement of consumers’ subconscious responses research has shown that, when exposed to marketing stimuli, consumers exhibit a variety of different emotions that influence outcome variables such as behaviour (shimp 2003). however, the literature on emotions still contains a number of caveats. the inadequacy of studies of consumers’ emotional responses to marketing stimuli has been pointed out by several authors (heath 2007; zaltman 2003). its measurement has been a particularly thorny issue (bagozzi, gopinath & nyer 1999). although attempts have been made to measure consumers’ emotional responses, they have almost always used ‘self-report’ assessments from which to draw conclusions. in these studies, consumers are asked to indicate the degree to which they feel they experienced each emotion on an ordinal response scale such as a likert or a semantic differential scale. this approach, often relying on introspection at a later stage or even memory and recall, as several authors have pointed out, is seriously flawed (mccoll-kennedy & smith 2006; zaltman 2003:38–39). even efforts to deduce emotional responses by observing customers’ eye contact, smiling and thinking behaviour (matilla & enz 2002) must be questioned because they rely on the researcher’s interpretation of physical responses and attempts to link that observation to the observed person experiencing a certain emotion. the data collection methodology used in this study overcomes many of these limitations by focusing on consumers’ subconscious responses that are not controlled by the central nervous sub-system (as would be the case if a self-report type test were used). this mechanical, ‘observation-like’ approach to data collection (galvanic skin response [gsr] measurement and eye-tracking) allows the researcher to bypass the mind’s ‘cognitive rationaliser’ and does not rely on potentially false and often inaccurate self-reports of experienced emotions from consumers (labarbera & tucciarone 1995:37). in this study, two data collection methods were used: gsr and eye-tracking. these two methodologies were selected because a change in skin conductance is a measure of arousal, and eye-tracking allows the researcher to link where a respondent looks (gaze, or eye-fixation) directly with the subsequent arousal and attention (wedel & pieters 2000). galvanic skin response gsr refers to a change in the electrical conductance of the skin, which is influenced by its moisture level (labarbera & tucciarone 1995). electrical activity is the result of the activity of the eccrine (sweat) glands in the human skin, and is regulated by the sympathetic nervous system (bridger 2015), a part of the autonomic nervous system that regulates the human body’s ‘fight or flight’ response. because it is regulated by the autonomic nervous system, a person does not have control over the response (skin conductance), which is a ‘direct measure of arousal when watching an ad’ (venkatraman et al. 2015). these electrodermal responses (as the glands dilate) are thus unbiased indications of activation or arousal in response to stimuli (labarbera & tucciarone 1995) or – in the current study’s case – to advertising material. before a subject is exposed to any stimulus, a baseline of gsr measurement is first established. the resultant stimuli-induced response score (or data) is then statistically compared with the baseline. it should be noted, however, that the arousal measured by gsr cannot indicate valence (shimp 2003:339). eye-tracking given the fact that advertising managers typically ‘place’ physical stimuli in front of potential purchasers (mostly by means of advertising), consumers’ target searches and what attracts consumer attention when exposed to the stimuli are important considerations to advertisers. as arousal (activation) will result in quicker and more accurate perception-formation during periods of eye-fixation, eye-fixation provides evidence of the extent to which sensory information has been transferred to short-term memory for further processing (kroeber-riel 1979). witt (1977) has demonstrated that the elements of an advertisement on which consumers focused more frequently were recalled more successfully. attracting and retaining consumer attention is an important issue from an advertising effectiveness perspective (pieters & wedel 2004). where consumers focus their attention when watching an advertisement is, however, an unobservable mental process (van der lans, pieters & wedel 2008). however, modern eye-tracking equipment allows analysts to track eye-movement patterns accurately and, at least to some degree, to understand the relationship between the conscious eye-fixation of consumers and their subsequent activation and attention levels. eye-tracking thus offers a rich source of data on temporal psychological processes (kroeber-riel 1979). from a marketing perspective, the study of eye-movement patterns has been linked to outcomes such as retail shelf allocation decisions (drèze, hoch & purk 1994), product choice (lohse 1997) and the ability to remember brands (wedel & pieters 2000). empirical results comparison of text-based versus picture-based warnings galvanic skin response baseline results before addressing the first objective, an attempt was first made to assess whether both the text and the pictorial warnings were able to solicit a gsr response that would differ significantly from the baseline. a ‘baseline’ in neuro-physiological research usually means that the respondent looks at a blank computer screen (no stimuli) for about 10 s and a measure (in this case gsr) is taken during this period. the respondent is then exposed to the stimuli (in this case a picture of cigarette packaging) and a new reading taken. the difference between the two (gsr) scores is then statistically compared. the gsr results reported in table 1 show that both the text and the picture warnings of gangrene and mouth cancer generated gsrs that were significantly different from the baseline. figure 2 (gangrene-affected foot) seemed to produce the highest level of arousal, followed by text message 2 that smoking causes mouth and throat cancer. table 1: galvanic skin response baseline results: text and picture. comparison of stimuli after concluding that all stimuli were able to solicit a gsr response that was statistically different from the baseline, objective 1 (to compare the neuro-physiological responses to text-based vs. picture-based, anti-smoking, fear-based appeals) could be addressed. in order to address the first objective, each text message was compared with its picture counterpart to determine whether a pictorial warning label (coupled with a textual explanation) is able to elicit a significantly higher gsr response than a text-only version. because it was expected that graphic images should result in higher responses (compared with textual stimuli), a one-tailed t-test was used. table 2 reveals that figure 2 initiated a higher difference in grs responses than did figure 1 (p = 0.06). however, the same result was not found for figures 3 and 4. in the case of the packaging highlighting mouth and throat cancer, the text stimulus initiated a higher gsr response than did the pictorial warning. therefore, figure 4 did not result in a significantly higher gsr score than did the text-only warning. table 2: galvanic skin response results: pictures versus text†. gender comparison the next step (objective 2) was to explore gender differences in the gsr responses to both the text and the pictorial warnings. table 3 explores the relationship between gender and the gsr responses to the pictures. table 3 shows that males were aroused to a significant extent (p < 0.01) by figure 2 (the gangrene-affected foot). the gsr responses of females to figure 2 were not significant, although the difference approaches statistical significances (p = 0.06). however, the responses of males to figure 2 seemed to be much stronger than those of females. table 3: galvanic skin response results: pictures. neither males’ nor females’ gsr responses to figure 4 differed statistically significantly from the baseline, although both approached significance at the 5% level. table 4 reveals that, when exposed to the text messages, both males and females returned significant responses from the baseline, except when females looked at figure 1 (‘smoking causes peripheral vascular disease’). it thus appears as if text-based messages were also able to solicit subconscious responses among the participants. table 4: galvanic skin response results: text. to address the objective of investigating the relative impact of text-based messages compared with picture-based messages on the same cigarette package, a statistical comparison (text vs. pictures; males vs. females) was conducted using independent sample t-tests. table 5 shows that the gsr comparisons for both males and females did not differ significantly, regardless of whether the text or picture warnings were compared. in other words, when comparing the two messages (picture vs. text) on the two packages that had both a picture and a text warning, no differences emerged. thus, when combining both picture and text warnings on a single package, one does not fare better than the other in soliciting a subconscious response, and this conclusion applies to both genders. table 5: galvanic skin response results: a comparison of text versus picture responses per gender. table 6 shows that males did respond more strongly than females to figures 1 and 2, but that the opposite is true for figure 3. however, these differences are not statistically significant. table 6: galvanic skin response results: gender comparison of pictures versus text. eye-tracking results as mentioned earlier, attracting and retaining consumer attention is an important consideration from an advertising effectiveness perspective, particularly for advertisements (pieters & wedel 2004:36). where consumers focus their attention when exposed to an advertisement is an unobservable mental process (van der lans et al. 2008). modern eye-tracking equipment, however, allows analysts to track eye-movement patterns accurately by means of the so-called ‘scan paths’ and, at least to some degree, to understand the relationship between the conscious vision of consumers and their subsequent attention levels (pieters & wedel 2004). it is against this background that this study explored the contact time of the participants with both the text-based and the picture-based warnings. consistent with the study’s first objective, a comparison between each text stimulus and its picture counterpart was conducted by comparing eye-fixation time (measured in seconds). by means of a one-tailed t-test, this comparison further explored whether pictorial warnings are able to generate statistically longer periods of fixation than do text-only labels. table 7 reveals that eye-fixation for figure 4 is significantly longer than for its text-only label, where the statistical difference between figure 2 and its text-only counterpart approached significance (p = 0.09). table 7: contact time results: text versus pictures. in addressing objective 2, table 8 compares the eye-fixation time spent on both text and pictures between genders. it is apparent that the eye-fixation time of males was longer than that of females in all four instances. these differences (between males and females) were, however, not statistically different. table 8: contact time results comparing genders: text and pictures. comparison of smokers with non-smokers because of the small sub-sample of smokers who participated in this study, the data related to them could not be analysed using inferential statistics. the results shown in tables 9 and 10 are thus reported as a descriptive analysis. table 9 shows the comparison of smokers with non-smokers when exposed to the warning referring to peripheral vascular disease (commonly known as ‘gangrene’) (figure 1). in terms of the text message ‘smoking causes peripheral vascular disease’, it appears as if: the eye-fixation of smokers on the text (5.56 s) was longer than that of non-smokers (5.05 s). smokers looked at the picture (5.72 s) longer than at the text-only version (5.56 s). the gsr responses (arousal) of smokers to the text (gsr 2.26) were higher than those of non-smokers (gsr 2.05). table 9: peripheral vascular (gangrene) warning: analysis of both text and pictures. table 10: mouth and throat cancer warning: analysis of both text and pictures. when exposed to the picture of a gangrene-affected foot, it appears as if: the eye-fixation of smokers on the picture was slightly shorter (5.72 s) than that of non-smokers (5.81 s). the gsr responses (arousal) of smokers (1.46) were lower than those of non-smokers (2.71). table 10 tabulates the results of the second packaging. in this case the text message reads: ‘smoking causes mouth and throat cancer’, while the associated picture shows a mouth with a tooth missing, damaged teeth and cancerous sores on the lower lip. the empirical results (table 3) are very similar to those reflected in table 10. when exposed to the warning about mouth and throat cancer, it appears as if: the eye-fixation of smokers on the text (4.72 s) was longer than that of non-smokers (3.44 s). smokers looked at the picture (5.53 s) much longer than at the text (4.72 s). the gsr responses (arousal) of smokers to the text (gsr 3.06) were higher than those of non-smokers (gsr 1.88). smokers’ contact time with the picture (5.53) was slightly shorter than that of non-smokers (5.58). the picture produced a stronger gsr (1.50) among non-smokers than among smokers (1.17). when comparing the results from tables 9 and 10 (the two different cigarette packages), the results were consistent in terms of both text and the pictures. the eye-fixation of smokers on the text was longer than that of non-smokers, and the gsr responses (arousal) of smokers to the text were higher than those of non-smokers. in terms of pictures, the eye-fixation of smokers on the pictures was slightly shorter than that of non-smokers, and the gsr responses (arousal) of smokers were lower than those of non-smokers. summary and conclusions the point of departure of this study is that behaviour modification in respect of tobacco smoking (both prevention and smoking cessation) by means of mass communication such as social marketing campaigns will not be successful unless they at least solicit some arousal among the target audience (hendriks et al. 2014:685; peters et al. 2014:74). emotional arousal (or activation) makes communication memorable, it enhances involvement with the message, it increases information-processing and it allows the mental accessibility of related knowledge (hendriks et al. 2014:685; peters et al. 2014:74). it is against this background that the ability of fear-based appeals on cigarette packaging to generate subconscious arousal among consumers was investigated. both gsr and eye-tracking data were collected as subjects were exposed to both picture-based and text-based warning labels. galvanic skin response baseline results all four stimuli (two text only warnings and two text and picture warnings) were able to solicit a subconscious response, as measured by gsr, among participants. however, the fear-based appeal in the gangrene-affected foot picture produced the highest level of arousal. gender comparison when comparing the two gender groups, both females and males responded more strongly to the very graphic depiction of a gangrene foot than to the mouth cancer picture. males’ responses to the gangrene foot picture were more than twice as strong as those of females. when exposed to the text messages, both males and females returned significant responses from the baseline gsr data, except when females looked at figure 1 (‘smoking causes peripheral vascular disease’). message stimuli when comparing the text warning to the corresponding picture warning (including the original text warning) for both messages (‘smoking causes peripheral vascular disease’ and ‘smoking causes mouth and throat cancer’), no significant differences emerged. thus, when combining both picture and text warnings on a single package, one does not fare better than text-only warnings in arousing a subconscious response. smokers versus non-smokers the descriptive analysis of smokers’ responses compared with non-smokers suggests that smokers paid more attention to the text-only message (longer eye-fixation), and they experienced higher levels of gsr arousal than did non-smokers. the picture warning produced different results: the eye-fixation of smokers on the picture was slightly shorter than that of non-smokers, and their arousal levels were lower than those of non-smokers. eye-tracking results the eye-tracking results also suggested differences. respondents looked longer at the peripheral vascular disease picture than at the text-only message. the same trend was evident for the mouth cancer picture compared with the text-only counterpart. males consistently looked longer at both the picture-based warning labels and the text-based warnings than did females, but the distinctions were not statistically different. it was also apparent that the eye-fixation of smokers on the text was longer than that of non-smokers, and the gsr responses (arousal) of smokers to the text were higher than those of non-smokers. however, the eye-fixation of smokers on the pictures was slightly shorter than that of non-smokers, and the gsr responses (arousal) of smokers were lower than those of non-smokers. in summary, the results of the study indicate that both fear-based pictures and text messages activated arousal among consumers. the study also demonstrated that the extent of arousal is influenced (at least to some extent) by gender and by whether or not the viewer is a smoker. implications of the study an exploratory study, by definition, does not attempt to provide final, conclusive results or insights. it explores a relatively new subject domain in the hope that it will provide a basis for further, future research that may attempt to offer more conclusive (even irrefutable) empirical results. typically, exploratory studies use modest sample sizes, and the interpretation of the results is not beyond question. based on the results of this exploratory study, we offer tentative conclusions, but we are not able to provide firm managerial guidelines. having said that, it appears that if social marketers want to arouse the emotions of males, graphic fear-inducing imagery should be effective (table 3). for females, however, text-based appeals are more likely to stimulate subconscious arousal (table 4), particularly when the graphics are less threatening. furthermore, if social marketers want to arouse the emotions of non-smokers in seeking to dissuade them from starting to smoke tobacco, the use of strong graphic imagery should achieve that goal. when targeting smokers, on the other hand, social marketers should take note that smokers spend longer on eye-fixation and demonstrate higher emotional arousal when viewing text-based warnings as opposed to picture-based warnings. it could be that smokers find the graphic image ‘unrealistic’ – ‘that will not happen to me!’ – and then avoid the graphic. the results could thus suggest that a defensive reaction, known as denial, follows exposure to the graphic image (müller et al. 2009; shen 2015). a theoretical contribution of the study is the insights offered by the elm. the results seem to suggest that the images that are more graphic successfully lead to emotional arousal. by contrast, the text message (targeting the central route) generated higher levels of arousal (although not statistically significant) when the picture message is less graphic. this result raises the concern that more graphic, high fear-appeal pictures may distract viewers or draw their attention away from the factual information provided by the text message. limitations of the study a limitation of most studies using neuro-physiological measures to collect data is the relatively small sample size. although the sample size in this instance was relatively large for studies of this nature, it was still limited when sub-samples were analysed. a second limitation is that too few smokers participated in the study to draw firm conclusions, or statistically to compare their subconscious responses with those of non-smokers. despite this limitation, it appears that there is evidence that smokers and non-smokers differ substantially in how they respond at the subconscious level to fear-appeal cigarette warnings. this tentative result paves the way for exciting opportunities for future research. acknowledgements the contributions of rafal ohme and michal matukin (both of whom are from the neurohme laboratory in warsaw, poland) and stephanie bührer of the department of business management at stellenbosch university in the design and execution of the study are gratefully acknowledged. the funding provided by the national research foundation is also gratefully acknowledged. competing interests the authors declare that they have no 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africa citation zondo, r.w.d., 2018, ‘assessing the financial implications of quality management system accreditation on small training providers in kwazulu-natal’, south african journal of economic and management sciences 21(1), a1728. https://doi.org/10.4102/sajems.v21i1.1728 original research assessing the financial implications of quality management system accreditation on small training providers in kwazulu-natal robert w.d. zondo received: 14 dec. 2016; accepted: 08 nov. 2017; published: 10 apr. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: a quality management system (qms) in education and training is designed in accordance with industry quality models of iso 9001. its techniques ensure quality in skills development. however, training providers incur significant costs to obtain qms accreditation. therefore, the discourse on the economic effect of qms accreditation in small training providers is crucial. aim: this paper investigates the influence of qms accreditation on the financial performance of small training providers in kwazulu-natal (kzn). setting: the south african qualification authority (saqa) is a statutory body, regulated in terms of the national qualification framework (nqf) act no. 67 of 2008 to oversee the development and implementation of the nqf. they are responsible for accrediting 21 sector-based education and training quality authorities (etqas) for the purpose of monitoring and auditing training achievements in terms of the national standards and qualifications. methods: for this study to achieve its objectives, the etqas belonging to 12 different sector education and training authorities (setas) provided the sample frame of accredited training providers in kzn. the setas are responsible for administering education and training within their industrial sectors. of the 89 small training providers, 81 participated in the study. descriptive and correlation analysis were used to test the two objectives. that is, to examine whether the management and marketing practices of qms accredited small training providers improve their financial performance. results: the study indicates that there is no statistical significant relationship between the management and marketing practices of qms accredited small training providers and their financial performances. this shows that small training providers do not incorporate financial measures during qms implementation. the accounting departments are not covered in the qms strategy. conclusion: small training providers should take advantage of qms accreditation for their business’s financial performance. they should incorporate financial indicators during qms implementation and measure qms’s economic effects on an ongoing basis. the original value of this paper is in its approach in uncovering the strengths and weaknesses of qms accreditation in the financial performances of accredited small training providers in kzn. introduction a number of studies in the manufacturing sector were carried out relating to the impact of quality management practices on organisational performance. results obtained by gupta (2000) show that iso 9001 certified companies do differ positively from non-certified ones in technological management, quality management control, causes of poor quality and quality control techniques used. romano (2000) reports statistically significant improvements after iso 9001 certification, concerning quality performance in production, the reliability of the production system and external quality performances. the majority of these studies were carried out in the manufacturing sector. fewer studies focused on the performances of quality management system (qms) accredited (or certified) small training companies that provide education and training to their defined markets. in education and training, manyaga (2008) defines qms accreditation as the quality assurance systems that ensure the provision of set qualifications and educational standards for a particular period of time. the idea of a qms in education and training has had little impact, because of the complexity of factors influencing quality in education, such as the attitudes and skills of teachers, abilities and motivation of learners, organisational backgrounds, contexts and values, and the existing structures, such as rules, regulations and legislation (seghezzi 2003). it has been suggested that quality development in education has to focus on incorporating new values, skills and attitudes into professional educators’ behaviour in order to have an impact on the teaching and learning (ehlers 2009). furthermore, ehlers (2009) explains that educational quality is the result of a co-production process in an actual learning situation. research into the relationship between qms accreditation in education and training and the performance of training provider organisations is scarce, and the results seem sometimes contradictory. peters (1999) and labaree (2000) debate the relevance of qms to education. empirical research in this area is necessary; hence, this study aims to bring clarity. therefore, this study attempts to find additional insights on the following research questions: is there an influence of management practices of qms accredited small training providers on financial performance? is there an influence of marketing practices of qms accredited small training providers on financial performance? organisations incur significant costs to obtain quality certification (or accreditation), making it worthwhile to study the process with a view to better understand the pertinent measures for certification success. qms accreditation requires a focus on performance measures, underscoring that an organisation’s management system is a valuable, non-tangible asset. the right business performance measures help focus qms to achieve desirable and required results in accordance with a qms certification standard. in one of the comprehensive examinations of the impact of quality on business performance, sousa and voss (2002) found that a strong association existed between productivity (both labour and capital) and quality, as well as between profitability and quality. lapointe and rivard (2006) found that the relationships between quality and profitability were less established because of the many other variables affecting return on investment (roi) measures. sousa and voss also found strong relationships between productivity improvement and organisational success in such factors as customer satisfaction programmes, product quality improvement, reduction in waste and strategic quality improvement. relatively little research was conducted into the economic impact of qms on the accredited small training providers in various sectors of the south african economy. hence, this paper assesses the financial impact of qms on the accredited small training providers in kwazulu-natal (kzn). problem statement: the lack of financial indicators on quality management system a financial indicator can be defined as ‘something that shows how good a company’s financial situation or the situation of a financial market is’ (cambridge dictionaries 2011). when specifically applied to organisations, this concept is used to refer to those measures that are included in the various accounting and financial reports or to any ratio calculated from them. on the one hand, there are some financial measures, such as the actual total costs and revenues, that can be obtained from the financial statements that every institution issues in accordance with external accounting rules and formats (leonardo 2014). on the same note, there are indicators, such as profit margins per unit or standard costs and revenues, that are provided by management accounting reports prepared to support internal decisions. however, there are various reasons that discourage organisations from measuring economic effects of qms implementation. according to leonardo (2011): the measurement of qms economic effect is not compulsory (that is, it is not required by the national accounting standards nor the international standards). the shortage and dispersion of qms monetary data makes the data collection very difficult and the information gathered is usually not precise. the accounting department is not covered in the qms implementation strategy, either due to the dissociation between accounting and other areas or for the reason that qms is thought to be associated with production or provision of service activities. having discussed the problem relating to the lack of incorporating financial indicators during qms implementation, the next section presents study objectives. these will be followed by the provision of a theoretical framework considered for this study. study objectives this study assesses the financial implication of qms on accredited small training providers in kzn. the following are sub-objectives: to examine if the management practices of qms accredited small training providers improve their financial performance. to establish if the marketing practices of qms accredited small training providers improve their financial performance. theoretical consideration for this study this section presents the impact of qms accreditation on business financial results, the implications of measuring economic effects of qms, the motivation for qms accreditation as well as the relationship between business practices of qms accredited organisations and financial performance. the impact of quality management system accreditation on business financial results south africa’s quality management relating to its education and training system is based on the keystones of quality of commitment, communication and capability (edutel 2011). commitment is a pledge to follow a policy or get something done. qms is the sum of the activities and information an organisation uses to enable it to deliver products and services that meet and exceed the needs and expectations of its customers and beneficiaries. traditionally, business organisations evaluate their performance in terms of quantifiable measures such as profits, turnover (for example, the sales and employee turnover) and financial ratios (psomas & pantouvakis 2015). in recent decades, there has been a growing concern that companies should also address quality-related aspects of performance in their business goals and performance measurements (zairi & alsughayir 2011). these performance aspects and their relevant measurements should be balanced between both financial and operational measures, as well as internal and external measures (alsmadi, almani & jerisat 2012). the right business performance measures can help qms implementation to be more efficient and effective (bell & omachonu 2011). qms implementation reduces the cost of poor quality (lee, to & yu 2009) and increases the organisation’s chances of gaining work in the public sector through the creation of better internal management systems and service quality improvement (mcadam & canning 2001). as a result, companies need financial indicators that measure the economic impact of qms accreditation. performance measures that demonstrate the value of an organisation’s management systems can be difficult to develop, use and interpret (bell & omachonu 2011). some organisations simply treat the cost of implementing qms as a business overhead expense often hidden inside various budgets. however, the right business performance measures can help the organisation focus the qms accreditation process on a more efficient and effective system. the cost and the benefits of implementing a quality management framework can be substantial. obtaining qms certification can take up to a year of preparation (sampaio, saraiva & guimarães 2011). given its widespread use and economic implications for industry, the qms framework must be researched to understand which aspects are most beneficial to organisations and to identify the best ways to measure the benefits derived from adopting a management system framework. various performance measures have been used to quantify the impact of accreditation on organisational performance. some of these indicators, including the return on assets (roa), sales increase, and market share, have been used most frequently. return on equity (roe) is considered as one of the four key financial ratios used to measure earnings performance. however, equity can be difficult to parse out to divisions of a large corporation and the roa is commonly used (kristy 1994, in sampaio et al. 2011). roa can be used to characterise the efficiency of an organisation and is often used as an industry standard to indicate what the organisation is capable of, given what it has to work with, and also indicates how much profit the organisation can achieve for each value of assets the company controls (sun 2000). hence, an organisation with an effective management system is expected to be more efficient with the use of its resources than the organisations without effective management systems. this research will demonstrate whether a connection exists between qms accreditation and both the roi and profit margin of various training providers. it examines whether the management practices of qms accredited small training providers improve their financial performance. furthermore, it establishes if the marketing practices of qms accredited small training providers improve their financial performance. the implications of measuring economic effects of a quality management system knowing the economic effects of implementing a qms grants certain advantages to companies because it provides additional information for decision-making. leonardo (2011) lists some of these advantages as follows: it allows organisations to become acquainted with the economic importance of qms implementation through comparing the actual outcomes achieved with those that would have been reached if this system had not been used. therefore, it provides evidence of the attainment of the quality management genuine goals, beyond the mere point of receiving a certificate. this information encourages companies to manage quality voluntarily (even if they are not required to do it) and, once implemented, pushes companies to take full advantage of the qms. it enables organisations to learn how much they could increase their profits by implementing quality management, given that this method compares actual economic outcomes to those that would have been gained if qms had not been implemented with different stringency levels. this information can serve as a decisive factor when making business decisions. for instance, it would allow a company to tell whether it is able to enhance its cost structure in the future by means of reducing quality costs. it allows companies to give proper relevance to different kinds of problems or failures that have occurred and allows them to investigate and find causes. a virtue of every common qms lies in detecting various causes of non-conforming products and in improving opportunities. additionally, a company can use this measurement tool to make it possible to assign a monetary value to each of these findings on mistakes and errors. the managers then become more challenged if they have to allocate resources in order to solve those problems. the method thus makes it possible to assign or establish a priority to quality problems using an economic consequence criterion. it provides information on cost-benefit relationship of each prevention and appraisal action that the company undertakes. ordinarily, qms gives information about the effects caused by prevention and appraisal actions but only through non-financial indicators. but, in this proposed method, these non-financial data could become valued in monetary units, which, when compared against its cost, could provide an essential element to decide the implementation of these kinds of actions. motivation for quality management system accreditation the motivations for qms accreditation can be classified according to one of two main categories: internal and external (sampaio et al. 2011). internal motivations are related to the goal of achieving organisational improvement, while external motivations are mainly related to promotional and marketing issues, customer pressures, improvement of market share, etc. there is a consensual opinion that iso 9001 benefits are related to the company certification motivations (that is, when companies become certified based on internal motivations, the derived benefits are fulfilled on a more global dimension). on the other hand, when companies implement iso 9001 based mostly on external motivations, improvements obtained are then mainly of an external nature (conca, llopis & tarí 2004; corbett, montes-sancho & kirsch 2005). companies that sought quality accreditation for ‘developmental reasons’ have experienced more internal benefits from accreditation. wiele and brown (1998) argue that companies driven by internal reasons to seek accreditation have a more positive perception about improvements achieved. the manager who sees accreditation as an opportunity to improve internal processes and systems, rather than simply wanting to get a certificate on the wall, will get broader positive results from qms accreditation. gotzamani and tsiotras (2002) state that companies seeking qms accreditation mainly based on external motivations will also achieve mostly external benefits, while those that seek accreditation based on true quality improvement will get benefits mainly in terms of internal operations improvement. conca et al. (2004) explain that companies more concerned with internal reasons are those that: obtain higher profits deriving from the implementation of a quality system reach a greater practical implementation of quality management principles are most likely to progress towards total quality management. sampaio et al. (2011) is of the view that companies maximise their benefits if they achieve qms accreditation based on internal motivations. according to sousa and voss (2002), the improvement of product and service quality will influence marketing and business performance and, from there, result in financial performance improvement. hence, this paper examines the influence of both the management and marketing practices of qms accredited small training providers on business financial performance. relationship between business practices of quality management system accredited organisation and financial performance a systematic approach to quality improvement results in two key factors that drive financial performance (george 2002). it generates greater value for customers, builds market share and revenues as well as lowers the costs, increases margins and asset usage. there are a number of studies carried out on areas relating to productivity improvement and organisational success in such factors as customer satisfaction programmes, product quality improvement, reduction in waste and strategic quality improvement. these studies have produced contradictory results on the influence of qms accreditation on financial improvement. some authors conclude that there is a positive relationship between qms accreditation and companies’ financial improvements (dimara et al. 2004) while others do not find evidence to support such a relationship (heras & arana 2006). singels, ruël and van de water (2001) have also not found a positive relationship between qms accreditation and the performance of organisations. however, sampaio et al. (2011) claim that the motivation for seeking accreditation has an influence over the organisation performance. most organisations seem to pursue qms accreditation based on external pressures, often resulting in a hollow achievement (bell & omachonu 2011). only when an organisation is internally motivated for an improvement of its organisational processes will accreditation result in a real significant improvement of its performance. regarding a better financial performance as indicated by qms accredited companies, heras, casadesús and ochoa (2001) argue that one must consider the multitude of variables that influence or can influence a company’s financial performance. it is important that the characteristics of the samples used by future studies are analysed in greater detail since the higher profitability of the accredited companies may have to do with the sectors under which the accredited firm enjoy greater profitability levels. heras et al. (2001) add that the higher profitability rates verified among qms accredited companies may be related to the most profitable companies being those that have a greater propensity to become qms accredited. methodology the method of this research will be discussed under the following headings: the target population, brief background of businesses that participated in the study, sample, data collection as well as the measurement and analysis. target population the population on which this study was conducted comprised 89 small training providers accredited by sector education and training authorities (setas). these providers operate in kzn province. while the focus of the study is on the small training providers, table 1 illustrates the schedule of size standards in south africa. table 1: schedule of size standards of small businesses in south africa. small training providers who were previously accredited but had had their accreditation withdrawn were excluded from the study. exclusions also include medium and large training providers in kzn. medium-sized businesses are entities that have between 51 and 200 full-time employees while large businesses have more than 200 full-time employees (olawale & garwe 2010). some small training providers were accredited by more than one seta. providers that had more than 50% courses under a particular seta were counted once, to avoid double counting. brief background of businesses that participated in the study only businesses registered under the three forms of incorporation (that is, close corporation, private company and non-governmental organisation) participated in the study. the ratio of business participation as per their registration was 6:3:1 with respect to close corporation at 60%, private company at 30% and non-governmental organisations at 10%. sample the education and training quality authorities belonging to 12 different setas (that is, manufacturing, engineering and related services; energy; construction; services; wholesale and retail; education, training and development; health and welfare; bank; transport; agriculture; media, information and communication; and safety and security) provided the sample frame of accredited training providers across south africa. the respondents were selected based on their business size, their location (i.e. operating within the kzn province), and their ability to access both fax facilities and electronic mails. the study only focused on small training providers whose number of full-time employees ranged between 0 and 50, as in antonites et al. (2008). the 81 training providers that participated in the study had between 2 and 23 full-time employees. recruitment of small training providers was undertaken with the aim of ensuring a representative spread of small training providers from the different sectors of the south african economy. a simple random sampling method was used and each small training provider in the kzn population (of small training providers) had an equal likelihood of being selected (welman, kruger & mitchel 2009). table 2 shows the percentage of total training providers that participated in the study as per their seta accreditation. table 2: small training providers that participated in the study (as per their sector education and training authority accreditation). the highest number of training providers per seta accreditation that participated in the study was from the media, information and communication seta at 27%, transport seta at 13% and the agricultural seta at 10%. data collection method data had to be collected from 89 owners of small training providers whose businesses were still in existence. this was achieved by mailing the questionnaires through electronic mail. similarly, the completed questionnaires were sent back to the researcher via electronic mail or fax. eighty-one questionnaires were returned, which represents a 91% response rate, considered high compared with the norm for survey responses (baruch & holtom 2008). the main reason for this high response rate was due to the invitation letter sent to the small training providers and consistently following up the questionnaires through telephone calls. measurement and analysis in line with the research framework, the study measured eight variables, using a questionnaire. on the impact of qms accreditation on financial performance, the study employed a likert scale, ranging from 1 (strongly agree) to 5 (strongly disagree). descriptive statistics were used on the impact of qms accreditation on business financial performance. a spearman’s rho correlation analysis was applied on both the effect of management practices of qms accredited small training providers on business financial performance, as well as the effect of marketing practices of qms accredited training providers on business financial performance. effect of management practices of quality management system accredited small training providers on their financial performance these variables were measured by four management practice items listed in the questionnaire and were based on the benefits for qms accreditation to business’s financial performance (feigenbaum 1999; mak 2011:119; saqa 2001). these include the management practice of qms accredited small training providers to: follow specific document procedures, create volumes of paperwork (qms being a paper-driven process), improve service to learners, and improve productivity. effect of marketing practices of quality management system accredited small training providers on their financial performance these variables were measured by two marketing items and were based on the benefits for qms accreditation to business’s financial performance (piskar & dolinsek 2006; quazi & jacobs 2004; sun & cheng 2002). the marketing benefits of qms include demonstration of quality to potential learners and reduction of learner complaints. the statistical package for the social sciences (spss) version 23.0 was used to do the data analysis. descriptive and correlation analysis were used to analyse the three objectives of the study. study results the following sections assess both the management and marketing practices of qms accredited small training providers on financial performance (that is, the roi and profit margins). effect of management practices of quality management system accredited small training providers on financial performance spearman’s rho correlation tests were used to find any significant relationship between study variables, which in any two-variable study are dependent or independent of each other, and to find the direction and strength of dependency (cooper & emory 1995). correlation can reveal the significance of correlation and, if significant, whether it is positive or negative (direction of correlation), as well as the strength of the correlation. the results of the tests for significant relationships between the variables for management practices of qms accredited small training providers are shown in table 3. the effects on financial performance are discussed in the following two sub-sections. the two financial performance variables are the roi and profit margins. these two variables were obtained from the organisations that participated in the study and are tested with management practices where qms: ensures businesses follow specific documented procedures is a paper-driven process that creates volumes of paperwork improves services to learners improves productivity. table 3: effect of management practices on both the return on investment and profit margins. management practices of quality management system accredited small training providers and the return on investment table 3 presents results on the management practice variables of qms accredited training providers with both the roi and profit margins. the management practice variables in table 3 do not statistically have a significant relationship with the roi. the p values for these variables are more than the standard value of 0.05. these include qms as a variable: for ensuring that the business follow specific documented procedures, that creates volumes of paperwork and for improving productivity. however, the management practice that ensures that qms improves service to learners and the variable for achieving the roi have a coefficient r-value of 0.373. this is a directly proportional effect but shows a low correlation between the two variables. management practices of quality management system accredited small training providers and profit margins the management practice variables in table 3 also do not statistically have a significant relationship with the profit margins. the p values for these variables are more than the standard value of 0.05. these include qms as a variable: for ensuring that business follow specific documented procedures, that creates volumes of paperwork, for improving services to learners and for improving productivity. effect of marketing practices of quality management system accredited training providers on financial performance the spearman’s rho correlation analysis in table 4 was also used to test the relationship between the marketing practices of qms accredited small training providers and financial performance. these analyses are discussed in the following two sub-sections. the two financial performance variables are the roi and profit margins. these were tested with qms as a system that: demonstrates quality to potential learners reduces customer complaints. table 4: effect of marketing practices on both the return on investment and profit margins. marketing practices of quality management system accredited small training providers and the return on investment table 4 presents results on the relationship of marketing practice variables of qms accredited training providers with both the roi and profit margins. the marketing practice variables in table 4 do not statistically have a significant relationship with roi. the p values for these variables are more than the standard value of 0.05. these include qms as a variable to demonstrate quality to potential learners and to reduce learner complaints. marketing practices of quality management system accredited small training providers and profit margins the marketing practice variables in table 4 also do not statistically have a significant relationship with the profit margins. the p values for these variables are more than the standard value of 0.05. these include qms as a variable that demonstrates quality to potential learners and reduces learner complaints. discussion the main objective of the study was to examine the financial impact of qms on accredited small training providers in kzn. the study was conducted based on various reasons that discourage organisations from measuring economic effects of qms implementation (leonardo 2011). the author indicated that the measurement of qms economic effect is not required by the national accounting standards or the international standards. the accounting department is not covered in the qms implementation strategy either due to the dissociation between accounting and other areas or for the reason that qmss are thought to be associated with production. as a result, the influence of qms accreditation on business’ financial performance is not measured. hence, this study analysed the management and marketing practices of qms accredited small training providers and their relationship with their financial performance. however, the study revealed that there is no relation between either the management or marketing practices of qms accredited small training providers and the roi and profit margins. it is crucial that small training providers determine the right business performance measures during qms implementation in order to be more efficient and effective (bell & omachonu 2011). this reduces the cost of poor quality (lee et al. 2009) and increases the organisation’s chances of gaining work in the public sector through the creation of better internal management systems and service quality improvement (mcadam & canning 2001). as a result, companies need financial indicators that measure the financial impact of qms accreditation. implications of results during the course of the study, many issues relating to the implications of qms accreditation were analysed. consequently, the management and marketing practices of qms accredited small providers do not show their relationship to financial performance. however, the following recommendations can be made: small training providers should measure the qms’s economic effects. the financial indicators should be incorporated into qms during its implementation. the accounting departments of small training providers should be covered in the qms strategy. small training providers should measure the impact of qms accreditation on an ongoing basis. limitations of the study the usefulness of the findings is constrained by the small sample size. small training providers who were previously accredited but had had their accreditation withdrawn were excluded from the study. however, the respondents were geographically dispersed within kzn and represented a wide range of industrial sectors. conclusion the majority of the variables for management and marketing practices of qms accredited small training providers have no relationship with either the roi or profit margins. however, the management practice variable that ensures that qms improves services to learners does have a relationship with the roi. on the other hand, the improvement of services to learners does not result in an increase in profit margins. therefore, small training providers should take advantage of qms accreditation for their business’s financial performance. they should incorporate financial indicators during qms implementation and measure qms’s economic effects on an ongoing basis. future research required based on the findings of this study, further research should focus on the market implications of qms accreditation on small training providers. the studies should explore the market significance of qms accreditation in south africa as a whole. acknowledgements competing interests the author declares that he has no financial or personal relationships that may have inappropriately influenced him in writing this article. references alsmadi, m., almani, a. & jerisat, r., 2012, ‘a comparative analysis of lean practices and performance in the uk manufacturing and service sector firms’, total quality 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2009, research methodology, oxford press, london. wiele, t.v.d. & brown, a., 1998, ‘venturing down the tqm path for smes’, international small business journal 16(2), 50–68. https://doi.org/10.1177/0266242698162003 zairi, m. & alsughayir, a.a., 2011, ‘the adoption of excellence models through cultural and social adaptations: an empirical study of critical success factors and a proposed model’, total quality management and business excellence 22(6), 641–654. https://doi.org/10.1080/14783363.2011.580654 abstract introduction theoretical and conceptual framework methodology results and discussion conclusions and implications acknowledgements references footnotes about the author(s) uchenna obih discipline of agricultural economics, school of agricultural, earth and environmental sciences, university of kwazulu-natal, south africa lloyd s. baiyegunhi discipline of agricultural economics, school of agricultural, earth and environmental sciences, university of kwazulu-natal, south africa citation obih, u. & baiyegunhi, l.s., 2017, ‘willingness to pay and preference for imported rice brands in nigeria: do price–quality differentials explain consumers’ inertia?’, south african journal of economic and management sciences 20(1), a1710. https://doi.org/10.4102/sajems.v20i1.1710 original research willingness to pay and preference for imported rice brands in nigeria: do price–quality differentials explain consumers’ inertia? uchenna obih, lloyd s. baiyegunhi received: 26 nov. 2016; accepted: 10 aug. 2017; published: 06 dec. 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: rice (oryza sativa) is the most consumed staple food in nigeria. consumers have persistently preferred and are willing to pay higher prices for imported rice despite improvements in the quality attributes of local rice brands in the last 5 years. nigeria’s import bill of over $6million daily on rice is not only a drain on the country’s forex reserves, but a threat to the development of the domestic rice industry. previous studies on rice consumers’ behaviours have not explained the underlying reason of how consumers with imported brands preference mind-set make purchasing decisions when faced with both local and imported rice brands with almost similar quality attributes but different market prices. aim: when making purchase decisions, consumers consider product quality in comparison to its price. this study attempts to explain how the differences in prices and quality attributes of local and imported rice brands determine consumer’s inertia against preference for imported rice brands in nigeria. setting: this study was conducted in the federal capital territory of nigeria using data sets collected from a survey of 460 rice consumer households. methods: data were collected using a structured questionnaire administered to the household heads during the face-to-face interview. two separate binary logit regression models were estimated for households’ preference and wtp for imported rice. results: the results show that price, household head’s age, household’s income and general perception are statistically significant variables explaining household’s preference and wtp for imported rice brands. consumers’ inertia against preference and wtp for imported rice persists because of the negative price–quality differential gaps between local and imported rice brands. conclusion: rice consumers in nigeria compare price and quality differentials before making a choice between local and imported rice brands. there is need for implementation of flexible and synergic import restriction and strategic marketing policies that sustain wide price differentials between local and imported rice brands, while improving the quality image of the local brands to narrow consumer’s perception of the quality differential between these two sets of brands. introduction the rice industry plays an important role in nigeria’s economy; this is because rice (oryza sativa) is the most consumed staple food both in urban and rural households. according to johnson et al. (2013), about 85% of households consume rice, spending an average of 6% of its total income on rice consumption, the highest among all staples consumed in nigeria. the per capita rice consumption is estimated at 35kg per annum, giving a total of 5.2 million metric tons of milled rice consumed in nigeria per annum (gyimah-brempong et al. 2012). the country’s domestic rice production, which is estimated at 3 million metric tons per annum, gives a consumption gap of about 2.2 million metric tons per annum, which is being filled by imports (johnson et al. 2013). nigeria is among the top five rice importing countries in the world. past governments had acknowledged that high import bills of over $6million daily (johnson et al. 2013) were not only a drain on foreign exchange earnings but also a threat to the growth of the domestic rice industry. in the last 7 years, the government has put in place some programmes and policies to discourage rice importation and encourage domestic production. these included: (1) an increased import tariff on rice from 5% to 50% in 2012 and 100% in 2013, (2) a ban on importation of rice through the land borders and (3) an establishment of commercial agricultural credit scheme (cacs) to provide cheap funds to agribusinesses, and the nigeria incentive–based risk sharing system for agricultural lending (nirsal) programme to encourage commercial banks’ lending to the agricultural sector on risk sharing basis. these policies and programmes have so far attracted many investors, leading to massive and expanded investments in paddy rice production and establishment of many modern rice-processing mills. domestic rice production has been stimulated and has been on the increase annually by more than 5% (seck et al. 2010). in the last 5 years, rice production, processing, polishing and packaging in nigeria have tremendously improved and there are many local rice brands with improved quality attributes (africarice 2012) despite improvements in the physio-chemical quality attributes of local rice, there is still a steady increase in the quantity of imported rice consumed in nigeria because of the burgeoning population, increased consumer incomes, changes in tastes and preferences, rapid urbanisation, ease of preparation that fits easily into urban lifestyle of workers and better physical attributes (erhabor & ojogho 2011). consumers still prefer imported rice brands based on their already established perception that imported rice brands possess better after-cook physical attributes such as a bright-white colour and separate, neat and even long grains. (adeyeye et al. 2010; johnson et al. 2013; lancon et al. 2003). according to erenstein et al. (2003), the fundamental cause of this preference for imported rice is the intrinsic nature and pedigree of the paddy grain found in nigeria. the visual presentation (a factor that matters the foremost in valuation of rice by the market) of rice milled from such a paddy grain does not match up to its imported kin in terms of grain shape, neatness, colour and percentage of broken rice. thus, the local consumer applies a rather heavy differential to the price of locally milled rice vis-à-vis imported rice (lançon & benz 2007). this differential can be above n2000 (about $15)1 per 50kg bag of rice (erenstein et al. 2003). the long-term negative perception against local rice has become a persistent habit that is strongly responsible for consumers’ inertia against preference and willingness to pay (wtp) higher prices for imported rice brands in order to avoid local rice (akaeze 2010). previous studies on rice consumption in nigeria have been limited to explaining quality differentials as the reason for consumers’ preference for imported rice brands (adeyeye et al. 2010; alfred & adekayode 2014; bamidele, abayomi & esther 2010; gyimah-brempong et al. 2012; johnson et al. 2013; kassali et al. 2010; propcom 2007). however, several studies have found that, when making purchase decisions, consumers do not consider product quality in isolation, but in comparison to its price (akdeniz, calantone & voorhees 2013; bornemann & homburg 2011; sahay & sharma 2010; thanasuta & metharom 2015). it therefore seems that previous studies have not adequately explained the underlying reason on how consumers with a brand preference mindset make purchasing decisions when faced with two or more brands of food products with almost similar quality attributes but different market prices. this has left a knowledge gap in consumer behaviour literature, which this study aims to fill by determining how consumers’ comparative analyses of price and quality differentials of local and imported rice brands influence their choice behaviour. this is with a view to providing some insight useful for rice marketing managers and government in designing appropriate marketing policy measures for breaking the current consumers’ inertia against preference for imported rice brands. specifically, this study seeks to: determine the factors influencing consumer’s preference for imported rice brands and provide empirical evidence of this choice behaviour assess how market price and consumers’ perceived quality differentials determine consumers’ inertia against preference for imported rice brands in nigeria theoretical and conceptual framework the choice behaviour of consumers towards food products is based on the theoretical framework of millock et al. (2002). according to this framework, a consumer’s purchase behaviour towards food product is a relationship between the consumer’s wtp premium price and the market price of the product. product price is determined by the market, while consumer’s wtp is determined by consumer’s socio-economic characteristics, consumer’s attitude and/or intention and perception of the product’s quality attributes (millock 2002). past studies such as zeng and wei (2005) and bonti-ankomah and yiridoe (2006) have adopted millock’s framework to explain consumer’s behaviour towards food products. the major limitation of this framework is that it explains consumer behaviour from the viewpoint of one product. it answers consumer’s typical question of whether a product’s quality is worth its market price. however, in real market situations, a consumer is often faced with choice decisions on which brand to buy among two or more alternative brands of similar products with almost the same quality attributes but varying market prices (chern & chang 2009; zeithaml 1988). for this study, it is assumed that, at the point of purchase, a rational consumer often makes a quick comparative analysis of the differences in the prices and quality attributes of two or more brands of a product before deciding the particular brand to buy. this comparison could be the underlying reason for the consumer’s choice behaviour. therefore, this study was built on the framework developed by millock et al. (2002). the modified millock’s framework presented in figure 1 indicates that consumer’s choice of a brand of food product from two or more alternative brands is dependent on the price–quality differentials of these alternative brands of the product. figure 1: conceptual framework for consumer’s behaviour towards local and imported rice brands in nigeria. this study also gleaned from literature that consumer’s purchasing choice decisions are based on price–quality relationships (akdeniz et al. 2013; bernués, olaizola & corcoran 2003; gerstner 1985; krutulyte et al. 2009; monroe 2003; shiraia 2015; thanasuta & metharom 2015). consumer’s perception of product’s quality has often been estimated by determining consumer’s wtp price for the product (chern & chang 2009). the value of wtp often creates a gap between consumer’s perceived quality and the market price of the product (zeithaml 1988). wtp largely reflects the product’s quality as perceived by the consumer, while market price largely reflects the product’s quality from the producer’s perspective (zeithaml 1988). previous studies have included market price as explanatory variable in determining consumer’s utility and hence wtp (chern & chang 2009; hanemann 1984). wtp is the additional price consumers pay to reflect preference for a particular brand of a product in order to avoid another brand (chern & chang 2009). therefore, comparing the differences between the market prices and consumer’s perceived qualities could provide some insights on how consumers make decisions when choosing from alternative brands of a product (hanemann 1984). for this study, it is assumed that a consumer household is faced with two brands of rice (local and imported rice brands) from which a purchasing choice decision is made by comparing the differences in the market prices of these two brands with the differences in the household’s wtp. the millock framework provides the basis for the choice of explanatory variables upon which this study estimated consumer’s preference and wtp using the basic concept of random utility modelling (rum) by greene (1974), mcfadden (1987) and haab and mcconnell (2002). random utility modelling is an econometric approach based on the utility theory, which states that, among a set of j number of alternative products, a rational consumer will prefer the alternative j that provides the highest utility uj (greene 1974; mcfadden 1987). random utility modelling allows for the parameterisation of the probability of preferring alternative j among j alternatives. the conceptual framework for rum is based on lancaster (1966), which assumes that the utility (v) a consumer derives from a product can be decomposed into two components, namely: deterministic component (u), which is observable and often associated with the product price; and random error component (ε), which represents the unobservable characteristics affecting the consumer’s choice. thus, faced with local and imported rice brands, and assuming a linear representation, the utility function of ith consumer household for alternative choice of a rice brand j can be represented as: the utility derived from any of the two alternative rice brands depends on the quality attributes (u) of such a brand (as reflected in the brand’s price), consumer household’s socio-economic characteristics and general perception of the brand’s quality affecting households’ decision. a consumer household facing two alternative rice brands chooses the brand associated with higher utility (hensher, rose & greene 2005). if vj and vk denote the utility a consumer household derives from consuming imported and local rice brands j and k, respectively, and if imported rice is associated with higher utility, then vj > vk. if yi denotes the ith consumer household’s preference for imported rice, then: the presence of the error component εij in equation 2 implies that predicting ith consumer household’s preference for imported rice cannot be made with certainty. therefore, the consumer household’s behaviour becomes one of probabilistic choices. hence, the probability that ith consumer household will choose imported rice over the local rice is whether the difference in the deterministic components of their utilities exceeds the difference in the error components (mcfadden 1980), and this can be expressed as: equation (3) implies that the distribution of the error term, εij, determines the explicit distribution of this probability. according to mcfadden (1980) and ben-akiva and lerman (1985), a typical assumption is that the error term εij is independently and identically distributed with a type i extreme value distribution specified as follows: where f denotes the cumulative distribution function and the error term εij is normally distributed with zero mean and constant variance σ2. the distribution of the error term εij as shown in equation 4 implies that the probability of ith consumer household choosing imported rice j is expressed in terms of the logistic distribution (mcfadden 1980) as follows: where equation 6 is a binary equation of ith consumer household choosing imported rice j; xi is a vector of explanatory variables that influence ith household’s purchase decisions such as price, a reflection of quality attributes (bornemann & homburg 2011), household’s socio-economic characteristics and general perception of quality attributes of imported rice brands; βi is the vector of estimated coefficients of all the explanatory variables and exp is the base of natural logarithms. the error term is assumed to follow logistic distribution; hence, equation 5 is the standard binary logit model (ben-akiva & lerman 1985; maddala 1993). this discrete choice model is estimated by maximum likelihood technique, and is useful for modelling choice behaviour. the results of the binary logit model are interpreted in terms of the odds ratios, that is, the ratios of the probability of choosing one outcome category over the reference category. these ratios are defined as: where pik is the probability of ith household choosing local rice. a positive parameter indicates that the relative probability of ith consumer household choosing imported rice over the local rice increases relative to the probability of choosing local rice over the imported rice; and otherwise for a negative parameter. following latvala (2010), if pr (yij = 1) > 0.5, there is consumer preference for imported rice brands; and otherwise if pr (yij = 1) ≤ 0.5. methodology study area and data this study was conducted in the federal capital territory (fct) located in north central nigeria (figure 2). it lies within latitudes 7 25’ and 9 25’n and longitude 5 45’ and 7 39’e. it is geographically located in the savannah vegetation and at the centre of the country with a landmass of 7315 km2. federal capital territory is characterised by alternating dry and wet seasons with a mean annual rainfall that varies from 1100 mm to 1600 mm and temperatures of between 12°c and 33°c. the fct has six area councils, namely abuja municipal area council (amac), bwari, gwagwalada, kwali, kuje and abaji. amac is the area council where the seat of federal government, its agencies and diplomatic offices are located. it has the highest infrastructural development and is residence to politicians, wealthy nigerians and diplomats. the other area councils are satellite towns with lesser infrastructural development and resident to mostly civil servants, farmers, artisans and traders. the choice of fct for this study is purposive because it has multi-class consumers of different socio-economic characteristics who have varying demand strength and consumption behaviours. virtually all imported and local rice brands can be found in the major markets in these area councils. figure 2: map of nigeria showing the federal capital territory and the six area councils surveyed. federal capital territory has a total population of about 3.5 million people (npc 2013) out of which at least 70% (2.45 million people) are rice consumers who constitute our target population of about 490 000 households (based on average of five people per household). following the method used by yamane (1967), this household population gives a sample size of 400 households which is considered adequate for interview and data collection. to cover wider geographical area of the fct-abuja, a multi-stage random sampling method was used in selecting a total of 460respondent households as follows: amac (76),2 kuje (77), gwagwalada (77), abaji (77), kwali (76) and bwari (77). sampling frames were obtained from the federal capital development authority (fcda) and abuja geographical information system (agis 2014). data were collected using a structured and validated questionnaire. jury’s method was used to test questionnaire content validity (wallace et al. 2003), while the test–retest method was used to evaluate questionnaire reliability. the questionnaire was primarily administered to the household heads during the face-to-face interview, while other household members contributed in providing answers to the questions raised during the interviews. data were collected on the consumer households’ socio-economic characteristics, level of perception of the quality attributes, market prices at which they buy and maximum prices they are willing to pay for imported rice brands. empirical framework for the study many studies have used various methods such as choice experiments and contingent (goldberg & roosen 2005), stated choice experiment (travisi & nijkamp 2004), conjoint analysis (ara 2003), survey rankings and ratings (quagrainie 2006), travel cost (gonzalez & loomis 2006), experimental auction method (yue, alfnes & jensen 2009) and discrete choice modelling (haab & mcconnell 2002) to estimate wtp as a measure of monetary value of quality attributes of food products as perceived by consumers. value perception can be defined as a judgement or a valuation by the consumer of the comparison between the benefits or utility obtained from a product, and the perceived sacrifices or costs (zeithaml 1988). the price consumers are willing to pay for each quality attribute reflects the level of utility derived and the relative importance attached (sonata & rasa 2010). the higher the level of a desirable attribute in an alternative food product, the higher the utility associated with that alternative and more likely the consumer is willing to pay a higher price for it (bennet & blamey 2001). assuming the market price pij that ith consumer pays for imported rice j rises to a new price level pimax, and if the consumer is willing to pay this price increase in order to keep deriving the same level of utility uij as previously, the linear utility functions for imported rice at the market price pij and at higher price pimax are expressed in equation 8 and 9 as follows: where pimax= (pij + wtpij) and is the maximum price that ith household can pay for imported rice. as not all of the β0js and β2js are identifiable, and equation 8 and 9 provide the household with the same level of utility, so normalisation rule was adopted such that β0js and β2js in equation 8 become equal to zero (chern & chang 2009; greene 2000). solving equation 10 for wtpij gives: taking the expected value of the wtpij, the expected wtp higher price for imported rice in order to remain at the same level of utility and avoid local rice is expressed as: where wtpij is ith household wtp for increase in the price of imported rice, xi is a vector of explanatory variables that influence ith household’s purchase decisions, β2j is the vector of estimated coefficients of all the explanatory variables and β1 is the coefficient of pimax. following the same procedure in equation 5, the probability that ith consumer household is willing to pay a higher price pimax for imported rice j in order to remain at the same level of utility uij can be expressed in terms of the logistic distribution (mcfadden 1980) as follows: where all the explanatory variables xi remain as previously defined except that the market price pij is replaced with pimax in equation 14. following latvala (2010), the deciding rule is that: if pr (wtpij = 1) > 0.5, there is consumer preference for imported rice brands; and otherwise if pr (wtpij = 1) ≤ 0.5. explanatory variables included in the model the explanatory variables hypothesised to explain consumers’ preference and wtp premium price for imported rice brands were identified based on the theoretical framework and on past empirical work on consumer behaviour towards food products (bonti-ankomah & yiridoe 2006; millock et al. 2002; zeng & wei 2005). the explanatory variables are classified into three categories: price, household socio-economic characteristics and the strength of consumer’s general perception of the quality attributes of imported rice such as neatness, duration of cooking, after-cook colour, aroma, taste, grain shape, swelling capacity, stickiness and texture. the definitions for the variables used in the analysis are presented in table 1. table 1: definitions and measure of variables included in the model. results and discussion household socio-economic characteristics the socio-economic characteristics of the respondent households are presented in table 2. about 65% of the respondents are female; this is not unexpected, because women take most purchasing and dietary decisions and generally tend to have more knowledge and bargaining power for food items as compared to men. the average age of household heads is 47 years, while the average number of years spent in formal schooling is 16 years, indicating that household heads are relatively young and educated, with an average household size of five people. younger and educated households are more likely to prefer and adopt urban lifestyles and food items that are easy to prepare (such as imported rice) than older and less-educated households. the average monthly income of a household head is ₦88 350 (about $441), indicating that households live on an average of about $10per day, which is well above the national monthly minimum wage of ₦18 000 (about $90). this is because most household heads in the study area are senior private and public employees of government, corporate organisations, international agencies, politicians and top businessmen earning higher wages and income. table 2: socio-economic characteristics of the sampled households. distribution of households according to preferences and willingness to pay for imported rice generally, consumers in nigeria classify rice as ‘local’ and ‘imported’. the distribution of households by their preference and wtp for imported rice brands in the study area is presented in table 3. table 3: percentage distribution of households by their preference and willingness to pay for imported rice. in all the six study areas, 95% of the consumer households expressed preference for imported rice as the brand of choice, while 52% of the households are willing to pay higher price for imported rice brands. preference for imported rice brands is highest (97%) in amac, kuje and gwagwalada, which are locations nearest to the city centre, abuja. while 93% and 94% of respondents in abaji and bwari, respectively, also indicated preferences for imported rice. wtp is highest among 50% of households in kuje but lowest (38%) among households in amac. the above descriptive analysis shows that people residing in urban areas with high infrastructural development, population density, income level and economic activities are more likely to express higher preference for food products they perceived to possess better quality attributes such as neatness, easy to prepare, lower cooking duration, and so on. this is also an indication that the preference and wtp for imported rice brands is higher in urban areas and cities where the consumers have the ability to pay higher prices for food items they perceive as being of superior quality. given the higher population growth in semi-urban and rural areas, it is likely that consumer inertia against preference for imported rice brands could be broken in the future when the population of consumers in cities and urban areas becomes lower than the population of consumers in semi-urban and rural areas. binary logistic regression results of determinants of household preference and willingness to pay for rice the results of the two separate binary logistic regression models estimated for consumer’s preference and wtp for imported rice brands are presented in table 4. table 4: parameter estimates and marginal effects from binary logit model of household preference and willingness to pay for imported rice. both models gave correct predictions of 80% and 96% of households’ preference and wtp for imported rice, respectively. also, in the two models estimated, the nagelkerke’s r2are 0.56 and 0.62; the hosmer and lemeshow (h-l) tests show significance values greater than 0.05, while the chi-square tests of 2 log likelihood are significant at 1%. these indicate that there is no significant difference between observed and model-predicted values, implying a moderately strong relationship between the predictors and the prediction. therefore, the two estimated binary models provide quite good fits and strong explanatory power. in this study, there is absence of multi-collinearity in the two estimated models because the variance inflation factors (vifs) for all the variables included in the two models were less than 10 (menard 1995). the coefficients of parameter estimates of the binary logit model only provide the direction of the effect of the independent variables on the dependent (response) variable and do not represent the actual magnitude of change or probabilities. therefore, the marginal effects from the binary model, which measures the expected change in probability of a choice being made with respect to a unit change in the independent variable, are reported as the exp (β ) in table 4. estimated coefficients for households’ choice of imported rice brands are compared with local rice as the base reference choice. the estimated coefficient for household head’s age is positively and statistically significant for the probability of higher household wtp prices for imported rice brands, implying that an increase in the age of household heads is more likely to influence the household to choose imported rice brands over local rice. the marginal effects suggest that a year increase in the age of the household head is likely to increase his or her choice of imported rice brands by 9.9% relative to local rice. the reason could be that the older the household head is, the more likely he or she has over the years developed stronger negative perception on poor-quality attributes of local rice, and has built his or her taste around imported rice brands. this is consistent with the findings of akaeze (2010) that consumption of imported rice brands is more of a mindset and habitual persistence. campbell et al. (2009) suggested that consumer’s negative attitude (a mindset) against local rice is stronger among older people who, in the past 1–2 decades, have had bad experience such as the presence of chaffs, impurities, uneven grains, long cooking duration and so on, in consuming local rice. the estimated coefficient for household income is positive and statistically significant for the probability of household’s wtp higher prices for imported rice brands. this implies that an increase in household income increases the probability of household’s wtp for imported rice brands. however, the marginal effect suggests that an increase in income is not likely to influence a household’s wtp for imported rice brands over the local rice. a possible explanation is that a household may prefer imported rice to local rice but may not be willing to spend additional portion of her income to pay for any increase in the price of imported rice brands. this may indicate increasing consumers’ acceptability and competitiveness of local rice in the market. this is consistent in part with a recent study by alfred and adekayode (2014) who found that a large percentage of nigerians consume local rice. some of the socio-economic variables describing the respondents, such as gender, household size, education and marital status included in the binary logistic model, were not statistically significant for influencing consumer’s preference and wtp higher prices for imported rice brands. according to enneking (2004), this non-significance of socio-economic characteristics is a typical phenomenon in studies focused on consumer choice. the estimated coefficient for price is positive and statistically significant for the probability of household’s preference and wtp for higher price for imported rice brands. this implies that an increase in the price of imported rice is likely to increase the probability of household’s preference and wtp a higher price for imported rice. this is because higher prices often lead to higher quality perceptions (raghubir & corfman 1999). the marginal effect suggests that an increase in market price increases the odds of surveyed household’s preference and wtp higher price for imported rice brands over the local rice by 0.001% and 0.05% respectively. a possible reason could be household’s belief that increased prices of imported rice brands reflect improved quality, and this belief is being reinforced by the perception that imported rice brands have always had better quality attributes than local rice brands. this supports previous finding of shiraia (2015) whose appeal leads to favourable price perceptions and purchase intentions when the product price is high. also, previous report by campbell et al. (2009) shows that consumers tend to set minimum-quality standards and are unlikely to shift from imported rice to local rice just because the price of the former has risen, instead they tend to shift to lower quality but cheaper imported rice. the estimated coefficient for consumer household’s general perception is positive and statistically significant for the probability of household’s preference and wtp for imported rice brands. this implies that an increase in the household’s general perception of quality of imported rice is likely to increase the probability of household’s preference and wtp for imported rice. the marginal effect suggests that an increase in household’s general perception from moderate to strong increases the odds of surveyed household’s preference and wtp for imported rice brands over the local rice by 188.9% and 134.5%, respectively. this indicates that consumer’s perception of the quality attributes of food product could be the highest determinant of consumer’s preference and wtp (akaeze 2010; thanasuta & metharom 2015). this could be because households’ general perception reflects the total importance attached to the quality attributes of the food product (chiliya, herbst & roberts-lombard 2009; raghubir & corfman 1999). estimating consumers’ preference and willingness to pay for imported rice brands in this study, consumers’ preferences and wtp increased prices for imported rice brands were determined by estimating their respective probabilities relative to local rice and the results across the six locations surveyed are as shown in table 5. table 5: estimated probabilities of household’s behaviour towards imported rice brands. table 5 shows that probabilities of household’s preference and wtp for imported rice brands vary across the six locations surveyed. the results show that, on average, the probability that a household prefers imported rice brands over the local rice is 95.6%, while the probability that a household does not prefer imported rice brands over the local rice is 4.6%. similarly, the probability that a household is willing to pay increased price for imported rice brands in order to avoid the local rice is 75.8%, while the probability that a household is not willing to pay increased price for imported rice brands in order to avoid the local rice is 24.2%. the overall implication is that, while many households may prefer imported rice brands over the local rice, few may actually be willing to pay increased price on imported rice brands in order to avoid local rice. this is consistent with the theory of demand in which higher price leads to lower demand. it also agrees with a recent study by alfred and adekayode (2014) whose findings show that large percentage of nigerians were indifferent in their preference of local and imported rice brands. this is an indication that consumers are beginning to accept local rice as a perfect substitute for imported rice brands. consumers’ inertia against preference and willingness to pay for imported rice brands in this study, consumers’ inertia against preference and wtp for imported rice brands is measured by the difference between price and quality differentials of local and imported rice brands as presented in table 6. the marginal willingness to pay (mwtp) is a measure of the monetary value of a household’s wtp based on its perception of the difference in the quality attributes of local and imported rice brands. table 6: estimated consumers’ inertia against preference for imported rice brands. the results in table 6 revealed that, with higher negative price–quality differential gaps, consumers’ inertia against preference and wtp for imported rice brands is stronger among households residing in the more developed locations (amac, gwagwalada and kuje) with proximity to abuja, the fct city centre. consumer households residing in locations such as bwari, kwali and abaji that are further away from the city centre and with lower economic activities seem not to see the market price differential as a true reflection of quality differential between local and imported rice brands. generally, there is negative price–quality differential gap between local and imported rice brands, and this could be a possible reason for the persistence of consumers’ inertia against preference and wtp for imported rice brands in nigeria. this differential gap of ₦396 (us$2) per 50kg bag that is lower than ₦2000 (us$15) found by erestein et al. (2003) indicates a possible growth in consumers’ acceptability and competitiveness of local rice in nigeria as earlier found by alfred and adekayode (2014). conclusions and implications the results emanating from this study have shown that age and income of household heads are important determinants of consumer preference and wtp for imported rice brands. older household heads, especially those who earn higher incomes, still perceived imported rice as superior to local rice in terms of quality. they would therefore still prefer and be willing to pay the increased price of imported rice because they can afford it. this study also confirmed that the market price and consumer’s perception of food quality play a vital role in influencing consumers’ choice of rice. consumer households perceive higher prices of imported rice brands as a reflection of better quality attributes, and this perception reinforces their preference and wtp for imported rice brands. therefore, there is a need for simultaneous implementations of import restriction policies (such as high import tariffs, levies, duties and taxes to raise the market prices of imported rice brands) and domestic marketing policies that promote a positive image of the improved quality attributes while reversing the negative perception of consumers towards local rice. this could be a crucial step towards breaking the consumers’ inertia against preference for imported rice brands. the price differential between local and imported rice brands is lower than consumers’ perceived quality differential. this negative price–quality differential gap is the reason for the persistence of consumers’ inertia against preference and wtp for imported rice brands. rice consumers in nigeria compare price and quality differentials before making a choice between local and imported rice brands. there is therefore a need for synergy between public policy makers and marketing managers in designing and implementing import restriction and strategic marketing policies. this should be carried out in a flexible and complimentary manner in order to ensure sustenance of a wide price differential between local and imported rice brands while improving the quality and image of the local brands to narrow consumer’s perception of the quality differential between these two sets of brands. economic theory assumes that consumers are rational and would always like to maximise utility. the finding of this study implies that, when a rational consumer is to make a choice between two or more brands of a product of almost similar quality attributes, preference or wtp for a particular brand is likely dependent on his or her perceived quality differential being higher than the market price differential. there is a need to integrate the role of price–quality differentials into the theoretical models of consumer behaviour for food products. this will help to provide useful insights into the understanding of consumers’ choice behaviour towards two or more brands of a food product with almost similar quality attributes but of different price regimes. acknowledgements competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions this article was conceived by u.o., who is responsible for the conception, data collection, analysis and writing up of the article, while l.b. provided technical advice and guidance at every stage. references adeyeye, j.a., navesero, e.p., ariyo, o.j. & adeyeye, s.a., 2010, ‘consumer preference for rice consumption in nigeria’, journal of humanities, social science and creativity arts 5(1), 26–36. africarice, 2012, boosting africa’s rice sector: a research for development strategy 2011–2020, africa rice research centre, cotonou, benin. agis, 2014, agis deploys high resolution satellite imagery of the fct, abuja geographic information system, viewed from http://agis.fcta.gov.ng/ 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(usd1 = ₦120 in 2003). 2. values in parentheses denote the number of households interviewed in the area council surveyed. abstract introduction revealed comparative advantage measurement latent comparative advantage estimation comparative advantages of senegal discussion: some challenges in senegalese apparel industry conclusion acknowledgements references footnotes about the author(s) jiri sejkora department of world economy, university of economics, czech republic ondrej sankot department of world economy, university of economics, czech republic corresponding author: jiri sejkora, citation sejkora, j. & sankot, o., 2017, ‘comparative advantage, economic structure and growth: the case of senegal’, south african journal of economic and management sciences 20(1), a1685. https://doi.org/10.4102/sajems.v20i1.1685 original research comparative advantage, economic structure and growth: the case of senegal jiri sejkora, ondrej sankot received: 29 oct. 2016; accepted: 21 apr. 2017; published: 26 june 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: using a concept of revealed and latent comparative advantage, this article identifies relatively productive industries and industries with great potential in the slow-growing economy of senegal. the identification of such industries allows for economic structure adjustment resulting in a higher gross domestic product (gdp) growth rate. aim: the aim of the study is to identify senegalese long-term revealed comparative advantages and to estimate senegalese latent comparative advantages. the analysis is focused solely on manufacturing industries because industrialisation serves as an engine of growth in developing countries. setting: the analysis is carried out on endowment structure and international trade data (1995–2015) of senegal and appropriate comparator economies (tanzania, cambodia, lao, vietnam and cape verde). methods: to identify revealed comparative advantages, we calculate the normalised revealed comparative advantage index. to estimate latent comparative advantages, we employ a growth identification and facilitation framework. the methodology is slightly modified because the estimation is based on long-term revealed comparative advantages comparisons (rather than export shares comparisons). results: we argue that the relatively productive manufacturing industries (with revealed comparative advantage) include chemicals and manufactured goods classified chiefly by various materials. furthermore, senegal may have unexploited potential (i.e. latent comparative advantage) in footwear and particularly in apparel production. conclusion: in order to accelerate gdp growth rate, senegal should focus on developing the above mentioned industries to align its economic structure with the comparative advantages and also to promote industrialisation. introduction many sub-saharan economies have been struggling to achieve and maintain high growth rates for a long period of time. for example, senegal, a lower-middle income economy (according to world bank [wb] criteria), grew at an annual average rate of 4.17% between 1995 and 2015. at first glance the growth rate may seem acceptable; however, taking into account the modest level of senegalese economic development and also demographics, we get a different picture. in per capita terms, the growth rate was only 1.33% (for the same period).1 such a pace of progress may be perceived as unsatisfactory – from poverty alleviation efforts to middle class development, etc. in this paper, we apply a concept of revealed and latent comparative advantage (lca) to identify productive industries and industries with great potential in the senegalese economy. identification of those industries may help to adopt a comparative advantage following approach, as lin (2012) puts it, which basically means aligning an economic structure with comparative advantages to achieve a higher gross domestic product (gdp) growth rate. we are specifically interested in manufacturing industries because industrialisation (i.e. manufacturing sector expansion) serves as an engine of growth in developing countries. indeed, kaldor’s engine of growth hypothesis claims that there exists a strong relation between the manufacturing sector output and gdp growth (kaldor 1966, 1967). the validity of the hypothesis (for developing countries) has been reinforced by many empirical studies (e.g. dong et al. 2013; ibbih & gaiya 2013; libanio & moro 2006; wells & thirlwall 2003). therefore, senegal, as well as other developing countries, could benefit from developing its productive manufacturing industries. dedicated studies analysing senegalese comparative advantages are rare. to our knowledge, there has been one dedicated study by jabara and thompson (1980) in which comparative advantages in the senegalese agricultural sector have been analysed. there are, however, several studies with broader scope – for example, world bank’s infodev (2011) discusses possible comparative advantages in senegalese horticulture and other agricultural subsectors. yeats (1998) uses the revealed comparative advantage (rca) index to calculate comparative advantages of senegal and other african countries to draw conclusions about intra-african trade. eifert et al. (2005) analyse comparative advantages of senegal and other african countries using a combination of macro and micro data. this paper, however, is mainly focused on the concept of lca, which is rather new. the author of this concept, justin y. lin, published relevant papers only a few years ago (see e.g. lin 2012; lin & monga 2011; lin & treichel 2011; lin & xu 2015), which is the reason why we lack papers on senegalese lcas. the presented analysis is carried out on official data available in unctad (2017) and other databases – penn world tables (feenstra et al. 2017) and world bank’s world development indicators (wb 2017). even though the existing data for senegal and other developing countries are poor, the analysis is primarily based on international trade data, which is generally better in quantity and also in quality. the rest of the paper is organised as follows: revealed comparative advantage measurement and latent comparative advantage estimation sections describe general theoretical background and research methodology regarding rca measurement (revealed comparative advantage measurement section) and lca estimation (latent comparative advantage estimation section). comparative advantages of the senegal section presents results of the senegalese comparative advantage analysis. discussion: some challenges in the senegalese apparel industry section briefly discusses challenges in the senegalese apparel industry, while the final section concludes. revealed comparative advantage measurement the original ricardian model (ricardo 1815) explains international trade flows as a result of different factor endowments in each particular economy. because labour productivity differs among particular economies, each economy could specialise itself on production of a good it manufactures relatively more efficiently and gains through goods exchange in an international market. ricardo used in his model just two countries and two goods, however, and so the idea that international trade could identify sector(s), where a particular economy is relatively more productive, remains to be a part of overwhelming consensus (irwin 1991). in order to identify and quantify economy’s comparative advantage, we have to determine the relation between economic conditions as a source of comparative advantage on the one side with usable and quantifiable indicators on the other side. this relation was described by balance et al. (1987) and is indicated by the following diagram (eqn 1): according to (1), economic conditions (ec) that vary across countries determine the international pattern of comparative advantage (ca), which lies under the pattern of international trade, production and consumption (tpc). the relationship between ec, ca and tpc can be understood as what the international trade theories have been trying to identify: what kind of economic conditions determine comparative advantage that makes the trade to take place, and how the trade is going to affect the economy. (sanidas & shin 2010:2). as long as we are not able to determine exact autarkic prices and autarkic production costs within an economy, we have to rely on available trade data from the past to identify rca as a second best alternative. rca describes the pattern of ca, which is based on tpc. in other words, ca determines tpc and available combinations of tpc are recorded by rca (sanidas & shin 2010; vollrath 1991). furthermore, the original theory considers only a simplified 2 × 2 situation, where merely two countries trade with one another and the whole trade volume consists of two types of goods only. because the current global economy is not that transparent and straightforward, some authors dispute the relation between ca and tpc in a multi-country and multi-commodity world (drabicki & takayama 1979). this suggests, as hillman (1980:315) notes, that the question of ‘the degree of advantage exhibited by a particular country over various goods’ or ‘the degree of advantage exhibited by various countries with respect to a particular traded good’ identified by rca, remains. to increase rca’s explanatory value, it should be supplemented with other data to distinguish whether the export volume is caused by a comparative advantage (ca) or not; government policies, especially, could alter a country’s original ca as, for example, clarida and findlay (1992) suggest. however, rca could still ‘certainly be used for the descriptive purpose of identifying in which sectors a country exports more or less than average’ (deardorff 2011:32). given that international trade conforms to cas, a country, which exports more particular goods than benchmark, produces this good more efficiently and disposes of the ca in its production. despite the fact that rca does not have to provide an accurate identification and quantification of the ca in its original terms, according to balance et al. (1987), rca as a post-trade indicator can identify much about underlying patterns of the ca. deardorff (1980), who proved that there is a negative correlation between net exports and relative autarkic prices, also shares this belief. that is why sanidas and shin (2010) also consider rca ‘to deliver proper information with respect to comparative advantage’ (sanidas & shin 2010:11). there are as many indicators as there are combinations of post-trade variables that could measure rca (balance et al. 1987). this paper focuses on normalised revealed comparative advantage index (ni), which patterns on the more common balassa’s revealed comparative advantage index (bi). for further rca indicators, see balance et al. (1987), memedovic (1994) or vollrath (1991). revealed comparative advantage: balassa index (bi) the most common formula for rca identification, described by balassa (1965), concentrates on a country’s relative export performance. bi compares a particular commodity’s export share with its share in total world exports. the following formula (eqn 2) holds: where xij stands for exports of commodity j by country i, xi stands for total export of country i, xwj stands for world’s exports of commodity j, whereas xw represents the world’s total exports: a given country is considered to have comparative advantage (disadvantage) in commodity, when the commodity’s exports market size of country in terms of its total national exports market size is greater (less) than the commodity`s world exports market size in terms of the world total exports market size, i.e. when is greater (less) than unity. (sanidas & shin 2010:12). comparative advantage neutral point is reached when bi equals to one. in this case, the country has neither ca nor disadvantage. bi is straightforward and easily applicable as export data are generally available and calculation is simple. however, the only information bi provides is whether a country enjoys a ca in a particular commodity, or not (yeats 1985). results of bi are incomparable across time and space, because of its asymmetry, as bi reaches values from one to infinity. normalised revealed comparative advantage index (ni) in an effort to overcome the aforementioned shortcomings of bi, alternative indicators have been developed. ideal alternative indicators should demonstrate four characteristics: (1) stable mean across time and space, (2) symmetry around mean or median, (3) independence of classification and (4) stable distribution across time and space (hoen & oosterhaven 2006). in fact, we still do not have such a perfect indicator and, therefore, as sanidas and shin (2010:17) note: ‘some researchers expressed rca using a hypothetical state: they used a deviation of the actual data from the value that would have been in the comparative advantage neutral (can) point’. this approach is incorporated in normalised revealed comparative advantage index (ni), calculated according to yu et al. (2009) by the following formula (eqn 3): where ni value falls in between −0.25 and 0.25, while comparative advantage neutral point (export value expected in the can state) equals to 0. because normalisation proceeds by the total amount of the world export, ni value tends to be very small. as recommended by yu et al. (2009), ni values in this paper will be scaled by 10 000. normalised revealed comparative advantage index is perfectly comparable across time and space, and mean value and ni sum remain stable. this explains well the notion of zero sum imbedded in comparative advantage: if a country gains comparative advantage in one sector, then the country loses comparative advantage in other sectors; and if one country gains comparative advantage in a sector, then other countries lose comparative advantage in the sector. (sanidas & shin 2010:18) normalised revealed comparative advantage index is capable of comparing the size of the ca in time, across sectors and also among economies. this is why ni is used in this paper. latent comparative advantage estimation the concept of lca is based on the aforementioned original ricardian theory, which is at the centre of a relatively young neoclassical theory of new structural economics (nse) (lin 2012). the term refers to the classical ca which is, however, not being exploited. therefore, lca merely represents a potentially productive industry of an economy. in addition, because lca is not being exploited, entrepreneurs, government and other subjects may not even be aware of its existence. for these reasons, it is obviously impossible to measure lca in the way presented in the rca measurement section. however, according to lin (2012), it is theoretically possible to estimate the lca of a particular economy by comparing its commodity export structure with other appropriate comparator economies. lin uses a structuralist approach to explain economic growth and development. nse is built around kuznets’ (1966) notion that structural change is needed to achieve sustained economic growth. lin (2012) argues: …the main feature of modern economic development is continuous technological innovation and structural change. the optimal industrial structure in an economy, that is, the industrial structure that will make the economy most competitive domestically and internationally at any specific time, is endogenous to its comparative advantage, which in turn is determined by the given endowment structure of the economy at that time. (pp. 98–99) the endowment structure (es) is, therefore, crucial because it determines the ca and, consequently, the optimal industrial structure (ois), as indicated by the following equation (eqn 4): equation 4 implies that two economies with similar ess should have similar cas. therefore, as was already mentioned, it is possible to estimate lca using a comparative method. the es (comprised of labour, natural resources and capital – both human and physical) and thus the ca are dynamic in time. according to lin (2012:307): ‘… the alignment of industry and/or technology with an economy’s ca is key … to accelerating the rate of economic growth and to realizing convergence’. this alignment is enabled by market forces, which represent an essential mechanism for resource allocation. it is noteworthy that the nse also stresses government’s facilitating role in the alignment process. government’s main tasks in this regard involve providing and/or upgrading soft and hard infrastructure to reduce transaction costs, compensating pioneer firms for externalities (such as information externalities) and temporarily protecting infant industries, provided that they are consistent with the economy’s cas. the obvious precondition is that the government is aware of the economy’s cas to fulfil its facilitating role effectively. growth identification and facilitation framework to estimate lca of a particular economy, it is first necessary to select several appropriate comparator economies. following the framework for growth identification and facilitation suggested by lin and monga (2011), the selection should be based on three criteria: (1) level of economic development; (2) rate of economic growth; and (3) similarity of ess. firstly, according to lin and treichel (2011), per capita gdp in purchasing power parity (ppp) of the appropriate comparator economies should be somewhere between 100% and 300% of the reference economy. this is because economic development is a gradual process. lca of the reference economy may be de facto rca of the appropriate comparator economies that are slightly more advanced (provided that the following two criteria are met). secondly, the appropriate comparator economies should maintain the highest possible gdp growth rate for a long period of time. lin and treichel (2011) recommend a yearly average gdp growth rate of at least 6% for about 20 years. fulfilling this criterion is essential because, theoretically, rapid and sustained economic growth is a result of the alignment between the industrial structure and the cas. in other words, rapid economic growth indicates that the cas are being exploited. thirdly, the ess of the appropriate comparators and of the reference economy should be relatively similar, so that the cas could also be similar. we compare the ess using three measures: capital–labour ratio, human capital index and natural capital indicator. once the appropriate comparator economies are selected, their rca can be calculated and compared with those of the reference economy.2 the comparison allows for drawing conclusions about lca in the reference economy because the most common and significant rca of the appropriate comparator economies in the last 20 years should be theoretically similar for the reference economy. if not, we can argue that the reference economy may possess lca. comparative advantages of senegal revealed comparative advantage of senegal (and also appropriate comparator economies – see below), based on the concept of normalised revealed comparative advantage index (ni), was determined as follows. for calculation of the ni index, export data from unctad (2017) have been used. because we are focusing on manufactured goods only, we incorporated solely the corresponding items, based on unctad (2016) product groupings and composition, that is, sitc groups 5–8, without group 68 (non-ferrous metals) and item 667 (pearls, precious and semi-precious stones). in order to determine long-term state (i.e. long-term rca), ni index was computed for years 1995, 2000, 2005, 2010 and 2015. as goods manufactured with long-term rca in a particular economy were considered items that were placed among the top 10, considering the highest ni value, in at least four out of five above mentioned years. top 10 senegalese rca in 2015 are depicted in table 1. bolded items represent long-term rca. table 1: top 10 senegalese revealed comparative advantage in manufacturing industries (2015). based on table 1, the majority of manufactured goods produced and exported from senegal with the ca is related to chemicals (sitc 5) and manufactured goods classified chiefly by material (sitc 6). to chemicals exported with the long-term rca belong: inorganic chemical elements (522), perfumery (553), insecticides (591) and soaps (554). manufactured goods produced and exported with the long-term rca are lime, cement and fabricated construction materials (661). obviously, senegal generally lacks the ability to export manufactured goods with high value added or technologically more sophisticated goods. nonetheless, as vlčková (2015) points out, that does not necessarily have to indicate a country’s low technological capabilities (relative to the achieved level of economic development). in order to promote industrialisation and growth, senegal should focus predominantly on the above mentioned industries, where the economy currently enjoys rca. furthermore, the identified rca can serve as a basis for lca estimation. to estimate lca, we have to select appropriate comparator economies first. the process of selection is based on the criteria mentioned in the lca estimation section. firstly, according to wb (2017), there are 36 developing economies (i.e. low-income, lower-middle income and higher-middle income economies) that have per capita gdp ranging from 100% – 300% that of senegal. secondly, there are 29 developing countries that achieved at least 6% average gdp growth rate in the 1995–2015 period (including tanzania with 5.99% average gdp growth rate). combining both indicators leaves us with 10 possible comparator economies for senegal: cambodia, cape verde, india, lao pdr, myanmar, nigeria, tanzania, uzbekistan, vietnam and west bank and gaza (see table 2). thirdly, from this set, we have to select the most appropriate comparator economies with relatively similar ess to that of senegal. the ess of the above mentioned economies are depicted in table 3. table 2: gross domestic product per capita, purchasing power parity (constant 2011 usd) in 2015 and average annual gross domestic product growth rates (1995–2015). table 3: the endowment structures in 2014; (the estimates of natural capital are for the year 2005). we have gradually removed west bank, gaza, myanmar, nigeria, uzbekistan and india from the set. regarding west bank and gaza, we lack required data. myanmar is unsuitable for ca analysis because of extremely low values of trade openness until 2012 (wb 2017). nigeria and uzbekistan are rich in natural capital (see table 3) and both are considered resource-rich economies in imf (2012) methodology (contrary to senegal). finally, india may be comparable to senegal in relative terms (see table 3), but not in absolute terms. the sheer size of the indian economy allows for lower trade openness, specific trade policy, etc. therefore, our selection of appropriate comparator economies for senegal includes: tanzania, cambodia, lao pdr, vietnam and cape verde.3 persistence of their economic growth rates in the last 20 years is displayed in figure 1. relatively high persistence, which is definitely desirable for comparator economies, is the characteristic for lao pdr, vietnam and tanzania. on the contrary, cape verde exhibits low persistence of economic growth. regarding the ess, lao pdr has an advantage of relative abundance of natural capital (see table 3), and it is also a resource-rich country (imf 2012). nevertheless, we include lao pdr as one of the comparator economies for two reasons: (1) the relative importance of natural resources in total exports has significantly increased only recently and (2) values of other es indicators are very similar for both economies (while taking into account differences in per capita gdp). the data on natural capital are not available for tanzania and cambodia. while cambodia is considered resource-poor, tanzania is among prospective natural resource-exporting economies (imf 2012). we include tanzania in the analysis because it is not nearly as dependent on natural resources exports as nigeria or uzbekistan. for example, the yearly average of total natural resources rents in tanzania accounted for 7.4% of gdp between 1995 and 2015, while nigeria registered 24.4% in this period (wb 2017). furthermore, cape verde exhibits a relatively high capital–labour ratio. however, we have to take into account almost three times higher per capita gdp compared to senegal, which mitigates the difference (see table 2). finally, we should also emphasise high levels of human capital in vietnam. even though the extent of this problem may be overestimated because of recent data corrections that have significantly changed values of the human capital index (downwards in the case of senegal and upwards in the case of vietnam), there is no doubt that senegal lags behind in this regard. an interesting comparison regarding human capital would be between the two sub-saharan countries at different levels of per capita gdp, that is, senegal and cape verde, but the required data are not available. in conclusion, the similarity of ess is by no means ideal. however, one can hardly find better comparator economies for senegal given its current stage of development and endowment structure. figure 1: persistence of gross domestic product growth in senegal and appropriate comparator economies (1995–2015; in percentage). to estimate senegalese lca in manufacturing industries, we have calculated and compared the most significant long-term rca (i.e. rca that were among top 10 in at least four out of the following five years: 1995, 2000, 2005, 2010 and 2015) of senegal and all five comparator economies. results of the comparisons are depicted in table 4. bolded items represent matches in long-term rca of at least two comparator economies. it is apparent from the comparison that four out of five comparator economies have long-term rca in men’s clothing of textile fabrics, not knitted [841], three comparator economies exhibit long-term rca in footwear [851] and articles of apparel, of textile fabrics, n. e. s. [845] and two comparator economies demonstrate long-term rca in women’s clothing [842, 844] and men’s or boy’s clothing [843]. in conclusion, except for tanzania, all other comparator economies have rca in the apparel industry. moreover, cambodia, vietnam and cape verde have also rca in the footwear industry. surprisingly though, according to the unctad (2017) database, senegalese apparel and footwear exports were virtually non-existent in the last 20 years. we therefore argue that senegal may have lca in footwear and particularly in apparel production. table 4: long-term rca of senegal and comparator economies in manufacturing industries (rca among top 10 in at least four out of following five years: 1995, 2000, 2005, 2010 and 2015). according to the theory, we can assume that there are: (1) infrastructural deficiencies and other constraints that prevent senegalese apparel and footwear industries from improving competitiveness and (2) some barriers that may restrict senegalese entrepreneurs from entering those industries (lin & monga 2011). the deficiencies, constraints and barriers must be identified and addressed by the government. but first it is necessary to conduct an additional detailed value chain analysis of the above identified industries to corroborate the findings (lin & treichel 2011). however, such analysis goes beyond the scope of this paper. nevertheless, we can enquire into the apparel industry in senegal to shed some light on the most common problems that local entrepreneurs face. discussion: some challenges in senegalese apparel industry generally, senegalese entrepreneurs are mostly engaged in the informal sector activities (khadidiatou et al. 2014). apparel industry is not an exception in this regard. golub and mbaye (2002) note: virtually all large scale apparel production in senegal ceased in the 1980s. the market now consists of a booming informal sector composed of independent tailors working on their own or in small shops. (p. 7) the existence of a large informal sector is a big problem for government. first of all, it is extremely hard to effectively collect useful data from decentralised and unorganised entrepreneurs in an informal economy. therefore, the government, for example, is not able to assess key infrastructural deficiencies and constraints that senegalese entrepreneurs in the apparel industry face. under such circumstances, it is very challenging to develop and implement effective industrial policy. existing literature offers at least some information (usually surveyor questionnaire-based) on those deficiencies and constraints in the senegalese apparel industry, which may provide basic guidelines for possible government interventions. the most frequent problems include: poor access to financing; unreliable electricity supply; high cost of electricity; and fierce competition from abroad including imports of second-hand clothing and illegal imports (acet 2014). moreover, these problems seem to be pervasive (golub & mbaye 2002). the government, thus, needs to tackle them systematically in order to facilitate the alignment process. furthermore, it should be noted that, according to available data, wages in senegalese manufacturing industries appear to be relatively high given the country’s per capita gdp (ceglowski et al. 2015). other constraints arise from contemporary characteristics of global apparel production. because global value chains (gvc) are concentrated in this industry (acet 2014), senegalese producers would need to enter them in order to take part in large scale exports. this poses yet another challenge, especially with regard to cost/quality/time requirements. the competition in a global market is tough. however, according to lin (2012), the most successful and competitive economies grow rapidly, and their ess and cas change over time. this process creates opportunities for catch-up in less developed economies. nowadays, a sizeable opportunity arises because the people’s republic of china is slowly losing its cas in labour intensive industries such as apparel and footwear (chandra et al. 2012). considering the fact that in 2015, china alone exported apparel worth 174 billion usd (37% of global apparel exports), the opportunity seems really promising (unctad 2017). actually, some footloose industrial enterprises have already been relocated, either to inland provinces or abroad. the trend will most likely continue accordingly to the so called flying geese pattern (chandra et al. 2012; ruan & zhang 2014). therefore, under certain circumstances, senegal might be able to attract some apparel manufacturers from china. there are, however, many more competitors. to the contrary, senegal possesses several country-specific advantages, such as easy access to the atlantic ocean, relative proximity of rich markets (eu and usa) or availability of key inputs for production (cotton, leather). in addition, senegalese exporters do not suffer from major trade barriers, thanks to preferential trade agreements (most notably the everything but arms initiative and african growth and opportunity act). senegal is also an economic community of west african states (ecowas) member state. nevertheless, as lin and monga (2011) argue, potential success of exploiting the identified lca depends on the government’s ability to implement policies to facilitate the alignment process. conclusion using the concept of rca and lca, the aim of this paper was to identify productive industries and industries with great potential in the senegalese economy. the analysis was focused on manufacturing industries because industrialisation serves as an engine of growth in developing countries. regarding rca (based on the concept of normalised revealed comparative advantage index), our results indicate that senegalese production and exports with the rca are mostly concentrated in industries related to chemicals (e.g. inorganic chemical elements, perfumery, etc.) and manufactured goods classified chiefly by material (e.g. lime, cement and fabricated construction materials). to estimate lca (based on the framework for growth identification and facilitation), we selected five appropriate comparator economies: tanzania, cambodia, lao pdr, vietnam and cape verde. the comparison of their long-term rca with the senegalese suggests that senegal may have lca in footwear and particularly in the apparel industry. however, the estimation should be further tested in a detailed value chain analysis of the identified industries. in conclusion, senegal could accelerate its rate of economic growth by aligning its economic structure with the identified cas. in particular, competitive apparel and footwear industries are undeveloped and may present great potential given the contemporary characteristics of the senegalese economy. finally, it should be emphasised that the government’s role in the alignment process is to facilitate it by proper interventions (e.g. by providing relevant soft and hard infrastructure). in this regard, one of the most challenging tasks for the government entails gathering relevant information about infrastructural deficiencies and other constraints that present obstacles for senegalese entrepreneurs. for example, existing information from informal apparel industry suggests that entrepreneurs are struggling because of poor access to financing; unreliable electricity supply; high cost of electricity; and fierce competition from abroad including imports of second-hand clothing and illegal imports. these challenges should be at the top of the government’s priority list. acknowledgements this article was created with the support of the iga project: the impact of growing global middle class on selected developing and developed regions, no. f2/47/2016. earlier versions of parts of this article were presented at the mac-emm 2015 multidisciplinary academic conference on economics, management and marketing in prague 2015 and at the international academic research conference on small & medium enterprises in danang city 2016, respectively. we gratefully acknowledge two anonymous reviewers for their insightful comments. competing interests the authors declare that they have no financial or personal relationship(s) that may have inappropriately influenced them in writing this article. authors’ contributions the authors, j.s. and o.s., contributed equally to the writing of this article. references acet, 2014, african transformation report: growth with depth [online.], african center for economic transformation, viewed 05 april 2017, from http://africantransformation.org/wp-content/uploads/2014/02/2014-african-transformation-report.pdf balassa, b., 1965, ‘trade liberalization and revealed comparative advantage’, the manchester school of economic and social studies, 33, 99–124. https://doi.org/10.1111/j.1467-9957.1965.tb00050.x balance, r.h., forstner, h. & murray, t., 1987, ‘consistency tests of alternative 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research group, the world bank, washington, dc. yu, r., cai, j. & leung, p., 2009, ‘the normalized revealed comparative advantage index’, the annals of regional science 43(1), 267–282. https://doi.org/10.1007/s00168-008-0213-3 footnotes 1. own calculations using wb (2017) database. 2. originally, lin (2012) suggests commodity export structures comparisons because exported commodities with large shares in total commodity exports over a long period of time represent exploited comparative advantages of the comparator economies and these should be theoretically similar for the reference economy. the giff methodology in this paper is, thus, slightly modified. 3. ideally, all the appropriate comparators should be sub-saharan economies because of regional similarities. however, given the senegalese level of economic development and endowment structure (see tables 2 and 3), it is not possible because, apart from cape verde and tanzania, there are no other appropriate comparator economies for senegal in the region. 492 sajems ns vol 2 (1999) no 3 developing a corporate image model c h van heerden department of marketing and communication management, university of pretoria abstract a survey of current literature and corporate identity manuals may create the impression that corporate identity consists solely of visual identity cues. in this paper the view is explored that corporate identity consists of both visual and behavioural cues. most corporations strive towards a positive corporate image. this can be attained only by taking into account also such aspects as customer service and employee behaviour, and not just creating attractive buildings, uniforms, logos and slogans. an analysis of selected literature and the results of four independent studies are reported to support the proposal of a corporate image model that needs further research and refinement. jel ml4 1 introduction marketing and communication managers might be under the impression that corporate identity consists solely of visual and graphical artefacts. in a previous paper (l994) this author stated that a review of south african corporate identity manuals may create the impression that a well-designed corporate livery package, consisting of a well-known name, a distinctive logo, visually appealing premises, and attractive colours, are the most important factors contributing to a desired corporate image. however, the main argument pursued here is that corporate identity cues (both visual and behavioural) create impressions or perceptions in the minds of corporate audiences to form an overall corporate image. it is thus assumed that a visual identity cue, such as a corporate logo, may serve as a cognitive "switch" to recall an image in the mind of the beholder, essentially based on behavioural cues experienced in the past. this means that though an image of the corporation may be recalled by an element of visual design, it in effect consists of the perceived behaviour of the corporation. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 493 the view that corporate identity consists of both visual elements and the way that the corporation behaves (bernstein, 1986; band, 1987; bellhouse, 1989; and croft, 1989), is the subject explored in this article. 2 literature review some theoretical constructs must be revisited before developing a model to explain the corporate image process. the establishment of a corporate image, personality, and reputation is similar to the establishment of an individual person's image, personality, and reputation. bad behaviour leads to a negative image, whether the individual is well-dressed or not. suitable clothing may create a favourable first impression but thereafter behavioural traits will either maintain or change that impression. this argument also applies to corporations. an attractive and suitable name, logo and slogan (identity) might create a good first impression, but inconsistency or decline in service or dishonest treatment, will give a corporation an unfavourable or bad image. 2.1 corporate personality determines corporate identity the corporate image process starts with the corporate personality. abratt (1989) says that the corporate personality is the sum total of the corporation's behavioural and intellectual characteristics. this personality is projected by conscious cues (corporate identity), such as customer service, products, and the company logo. these cues create impressions or perceptions in the minds of the audiences to constitute an overall corporate image. bernstein (1986: 40) defines personality "as the soul, the persona, the spirit, the culture of the organisation". it can be inferred that a corporation may like to manipulate its identity by managing a visual corporate identity programme and setting behavioural benchmarks (such as customer service levels) but it cannot readily manipulate its image, because the image is formed in the minds of target audiences. where does corporate identity then start? how does it evolve? what does it consist of? olins (1989) makes the point that purpose and belonging are the two major facets of identity. because every corporation is unique, it is essential that the corporate identity should spring from its roots, personality, strengths, and weaknesses. sternberg (1991) reasons that corporate identity is all about values corporate values, societal values, and living values. these values direct operations and the behaviour of management and employees. these values are r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 494 sajems ns vol 2 (1999) no 3 manifested through visual identity cues and emphasised or reinforced by behavioural cues. this view is supported by bellhouse (1989) who states that a corporate identity comprises two main elements corporate behaviour and visual appearance. managing the corporate identity programme therefore aims to create coherence, symbolism, and positioning, a view supported by olins (i 989). first, the corporation wants its different parts (business units, operations and product/service output) to relate to each other so that people can find their way around its divisions, corporations, and brands coherence; second, the corporation wants to symbolise its vision and mission so that everyone who works for it can share the same spirit and then positively communicate it to all other people who deal with the corporation symbolism; and third, the corporation wants to differentiate itself and its goods or services from those of its competitors in the market place positioning. 2.2 corporate identity creates corporate image bernstein (1986:39 & 40) explains that "corporate image is the net result of the interaction of all the experiences, beliefs, feelings, knowledge and impressions that people have about a corporation" and •• identity means the sum of all the ways a corporation chooses to identify itself to all its publics". the overall impression formed in the minds of audiences by certain identification cues, like logo, products, and customer service therefore constitutes a company's image. selame and selame (1988) condensed this to the effect that identity is what a corporation really is, while image means how the corporation appears to its audiences. 2.3 corporate logo the corporate logo can be described as a word, name, symbol, picture, device, or any combination of these, used by an institution to identify itself and to distinguish it from its competitors (selame & selame, 1988). a single logo is often sufficient to be repeated on all corporate livery. the logo is a recognition symbol and may be seen as a stamp of approval and promise that the corporation behind this seal can be trusted. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 495 it may therefore be said in summary that corporate personality management style, organisation policy, personnel and organisational goals, plus the corporate identity behavioural attributes, such as level of customer service and visual attributes, like the corporate logo, buildings and uniforms create the corporate image in the minds of corporate stakeholders. 2.4 marketing effects enabled by a positive corporate image a well-managed corporate identity is one of a company's most valuable marketing assets. it determines the corporate or business strategy, structure and personality, and in this way attempts to transmit it across to the public as clearly as possible. both large and small organisations wish to present themselves to their customers and employees in a harmonious and consistent manner. this can, inter alia, be done by making use of a series of graphic symbols, a certain layout, colour and letter-type on a company's products, as well as its letterheads. however, the corporate identity usually entails much more than a single logo, brand name or trademark. the logo does not only appear on an piece of paper. it is a statement on aspects like who and what the company is, what it stands for and the product or service quality that can be expected from the company. it is here that the essential difference in style, personality and uniqueness of one corporation differentiates it from another. a clear corporate identity is important because people prefer to deal with companies that are well known (harris, 1995). the corporate identity addresses different stakeholders or audiences. when an organisation's image is improved, this has without doubt a great influence on the employee as well as the customer. it changes the way people look at a corporation and also their opinion of it. an image of quality improves employee morale and motivation and makes them proud of their workplace and then would probably offer better service to internal and external customers. many people would like to work for a progressive organisation, and it is therefore easier to employ better quality people. the corporate image should be frequently evaluated. this promotes a better understanding of stakeholder opinions and needs and how to address them. it creates goodwill, support and loyalty on the part of all stakeholders the first step to relationship marketing. there is a link between image management and marketing planning. organisational marketing consists of activities to create, maintain, or change the attitudes and behaviour of target audiences towards an organisation. this calls for assessing the organisation's current image and developing a marketing plan to improve it (kotler & armstrong, 1993). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 496 sajems ns vol 2 (1999) no 3 corporate identity is of strategic marketing importance, because it is one of the key elements necessary to construct an image in people's minds (stewart, 1991). therefore, the projection of a favourable corporate image by means of a controlled, pre-planned corporate identity is a very important instrument in corporate and marketing strategy. this is how an organisation can focus its market segmentation, product and service positioning and integrated marketing communication approach. 2.5 what is the marketing value of corporate image and identity? a number of authors like katz (1988), lener (1989), ind (1990), miller (1990), cullen (1991), skinner and von essen (1991) have expressed opinions on corporate identity and image, but their real marketing value has not been clearly stated. according to gregory (1991), the marketing value of corporate image and identity as the cutting edge of corporate strategy, can be summarised as having the following aims: building public awareness of what the corporation stands for and establishing a more favourable market position in relation to suppliers, intermediaries, customers and competitors; redefining the corporation after a merger, take-over, acquisition, or name change; pre-selling communication to target markets to support product and service marketing; influencing shareholders and the financial community to increase their perception of the investment equity of the corporation; establishing the corporation's position on emerging issues in the market place; assisting management in a crisis to protect the corporate reputation; attracting and holding quality employees, and motivating them to promote a co-operative environment in their communities; indicating a shift in long-term corporate strategy; establishing the corporation in specific markets; reflecting a major change in product lines or operations; becoming more market-driven to aid differentiation, positioning and relationship building. 2.6 marketing and communication advantages of a good corporate image a solid image plan is a necessary tool to retain existing clients and generate new business (abramic, 1993). maintaining or expanding market share, keeping customer and business relations loyal, pre-empting competitive moves, and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 497 maintaining a profitable position, will depend on differentiation and a unique positioning in the minds of the corporate audiences. sunter (1993) states that the only way consumers will be able to differentiate between institutions in the future is through image and brand. the importance of having a well-defined identity is therefore necessary to all corporations, as competition increases by the crowding of businesses in certain areas. a wellconceived corporate image can lead to high awareness, loyalty, and a reputation of being well-liked. another important factor in the image-making process is customer service. the characteristics of services are defined by stanton et al. (1991) and kotler (1988), as being intangible, inseparable, heterogeneous, perishable, and having fluctuating demand. service providers should note that their services would be all but anonymous without a brand name or the endorsement represented by a strong corporate identity (thomas, 1988). because service quality is difficult to judge, corporations should take great care to keep quality as consistent as possible, and to maintain high levels of quality control so that customer expectations can be met. stanton et al. (1991) state that "quality is defmed by the consumer and not by the producer-seller of a service". based on present marketing and communication principles, trends visible in the market and current literature on the subject, the following advantages are summarised below: corporate image may be a decisive factor in the consumer choice of goods and services; • building a favourable corporate image becomes especially relevant in communities where the company is a major force. of particular importance here is the company's position on social responsibility; • a strong corporate image can improve the financial structure of a company and raise the appeal of its securities amongst potential investors and shareholders; building a favourable corporate image can be advantageous when public perceptions of a company do not reflect reality, are not clearly formed, or when vestiges of past management mistakes, plant accidents, poor earnings, environmental problems and the like may still be having a negative impact; and corporate image building is also very important when external forces like increased or new competition, breakthrough products and technologies, deregulation, or an existing competitor's new identity focus call for countermeasures. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 498 sajems ns vol 2 (1999) no 3 2.7 a corporate image process model the following model is designed to summarise the literature on this subject. the research that follows here, attempts to test its theoretical soundness and the role of visual and behavioural factors in determining the corporate image. an element of measurement is added, because the following gaps need to be measured and rectified: company promises versus actual performance; corporate identity aims versus the real image attained; and corporate personality versus the real image attained. figure 1 modelling the corporate image process corporate personality i vi,ion, ""'on, _tioo, ""'''gem'''' 4 corporate policy, ethos, history, employee nil corporate obi ectives asure consistency me be comp measure tween what the any says and does r"-""'"""-~'" ~--personality an image gaps corporate identity corporate image bebavioural cues such as the how do the different publics level of customer service and perceive the firm? employee behaviour visual cues such as the logo, the corporate image is based on exposure to buildings, www site, unifonns, corporate identity elements and trade marks i measure and analyse gap between corporate identity aims and current image marketing effects created by positive corporatei~age unique positioning differentiation from close competitors focused segmentation easier marketingplanning relationship marketing over longer term strategic marketing d r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 499 3 research methodology 3.1 introduction since 1993 various south african industries (banking institutions, fashion retailers, petrol companies and fast food outlets) have been the objects of research in an ongoing research project by the department of marketing and communication management at the university of pretoria. the research methodology has developed since 1993, from a more general study of the factors that determine the corporate image of south african banking institutions (van heerden, 1993) and fashion retailers (van den berg, 1995) to more extensive multi-faceted projects on petrol companies (beisiegel, 1996) and fast food outlets (gouverneur, 1997), students were used as respondents, because they are important customers of all these industries and, according to pitt and nel (1989), good representatives of all consumers when the research involves human-information testing. each research project had the following main objectives: to develop a semantic differential (sd) consisting of a set of bi-polar items created for each industry; to expose respondents the corporate logo of different companies while completing the sd. the reasons why the various south african companies (as research objects) and university students (as respondent groups) were chosen for this study, may be summarised as follows: banking institutions, fashion retailers, petrol stations and fast food outlets arelhave: widely used; commercially visible through their many branches or outlets near the campus; very competitive; highly visible in advertising and sponsorship; distinctive logos; targeting the respondents used in this investigation, namely students, as important markets. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 500 sajems ns vol 2 {i 999) no 3 3.2 research design the foundation of the study was to apply a semantic differential and different corporate logos as associative instruments to measure the perceptions of the respondent groups. the research process therefore consisted of: generating and refining a set of bi-polar items that defines a semantic differential scale; recalling perceptions through a specific concept or construct the corporate logo; asking a number of respondents to rate their perceptions of south african companies on the semantic scale; refining these responses through factor analysis in order to identify a smaller number of factors that determine the corporate image of the companies. 3.3 research procedure data collection: the data collection process was done at class meetings. a repeated measure design was used to gather the information needed for the studies. items included in the semantic differential: in all four studies, a different set of bi-polar items compiled, was based on semantic differentials developed by osgood et ai. (1957), appelbaum and anatol (1973), boyd et ai. (1985), weiers (1988) and cooper and emory (1995). measuring perceptions: respondents were shown a separate slide of the corporate logo of each company. while viewing each logo, the respondents had to complete the item semantic differential for that particular industry. the following wording appeared at the top of the semantic differential: study (company's name) logo briefly. please describe how you perceive (company), on the basis of the logo you see, by placing an "x" on the appropriate number at each of the scales below. an important factor in compiling semantic differentials is the space (visualised in a numerical scale) between the adjectives or set ofbi-polar items. the number of segments between these adjectives suggests a step-by-step movement in r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 501 meaning (perception) between the adjectives (boyd et al., 1985). in the sd used in these studies the following serves as an example of how the set of bi-polar items was presented: good 5 4 3 2 1 bad dirty 1 2 3 4 5 clean friendly 5 4 3 2 1 unfriendly the technique by fiedler (1985) of alternating the sets of items from positive to negative was used to reduce the chance of respondents simply marking the scale on either the left or the right hand side. the respondents: students in the marketing and communication classes at the university of pretoria were chosen as respondents for studying the corporate image of: banking institutions (second-year marketing class); petrol (secondand third -year marketing classes); fast food companies (secondand third-year marketing and secondand third-year communication classes); fashion retailers (home economic students from first to fourth and final year). no sampling was done. a wide variety of students attend the marketing and communication courses. they ranged from those who major in marketing or communication to those who major in hotel and tourism management, personnel management, business management and financial management. it was assumed that the respondents would understand the importance of giving honest answers for the sake of useful marketing research. no evidence was found in any of the studies that the respondents deliberately tried to falsify their answers. the corporate logo as cognitive stimulus: the study conducted by van heerden (1993) confrrmed that the corporate logo, as one element of the corporate identity mix, may create tangible images in the mind of the respondent because it serves as a "mental switch" or stimulus. the follow-up studies by van den berg (1995), beisiegel (1996) and gouverneur (1997) were based on this view. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 502 sajems ns vol 2 (1999) no 3 it was therefore inferred that the following view holds for all industries: the logo reminds the viewer of hislher perceptions, experiences, attitudes, expectations, desires, thoughts, and aversions relating to the corporation "behind" the logo. this view ties in with the argument by macinnes and price (1987) that information (on corporations) is not stored as images; rather, knowledge structures are activated, which recall mental images in response to certain stimuli (e.g. seeing the logo). exposing the respondents to the different corporate logos and then requiring them to complete the same semantic differential, was therefore regarded as a valid research association. the data of each of the researchers showed good reliability, and various factors were identified for each industry. this confirms the view that corporate behaviour as well as corporate visual identity contribute to the corporate image. it also confirms that a corporate logo can create tangible images in the minds of the respondents, because it serves as a "mental switch" or stimulus. factor analysis: this is a method used for assessing the interrelationships between a large set of variables for the purpose of reducing it to a smaller set of hypothetical factors (smith, 1988). the main purpose of factor analysis of the completed semantic differentials was therefore to "determine linear combinations of variables that will aid the researcher in investigating interrelationships between these variables" (zikmund, 1991). initially no distinction was made between visual and behavioural sets of bi-polar items. beisiegel (1996) did however distinguish between them and before she analysed the data, the variables/items in the sd were classified as being either a visual (v) attribute or a behavioural (g) attribute. this led to better understanding of the interpretation of factors. gouverneur (1997) also included dependent and independent variables in her factor analysis. 4 findings reliability: beisiegel (1996) used the internal consistency method to measure the reliability of the results obtained in her investigation. cronbach' s alpha coefficient method. randomly selects multiple pairs of subsets from an instrument, correlates each pair's scores, and then uses the composition correlation between all the paired r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 503 subsets as an index of the total instrument's internal consistency (smith, 1988). the other researchers did not use this method. factor analysis: a factor analysis subsequently enabled the students to summarise thousands of responses into a smaller number of factors. by summarising such a large number of responses, it was hoped that certain underlying constructs or dimensions of the corporate image would be found. two indices are especially important for interpreting factor analytical findings. first, factor loadings are coefficients that register the magnitude and direction of a relationship between variables and its underlying hypothetical factor. the closer a factor loading is to unity (1), the stronger is the variable-factor relationship, or the more "highly loaded" is the variable said to be. by employing the factor loading varimax normalised method, a related factor pattern was compiled. only items scoring more than 0,5 during this procedure were included in the relevant factors. the relevant factors identified in the various industries are shown in tables 1 to 4: table 1 factor 1 factor 2 factor 3 factor 4 factors determining corporate image of banking institutions in soutb africa (van heerden, 1993) factor attribute 0/0 of variance explained dynamism (behaviour and visual) 50,78 stability/credibility (behaviour) 4,91 client/customer (behaviour) 3,73 service visual identity (visual) 3,61 63,04% r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 504 sajems ns vol 2 (1999) no 3 table 2 factors determining tbe corporate image of soutb african fasbion retailers (van den berg, 1994) factor attribute 0/0 of variance explained factor 1 quality merchandise (visual) nla factor 2 customer service (behaviour) nla factor 3 location (visual) nla 55,2% table 3 factors determining the corporate image of petrol companies in soutb africa (beisiegel, 1996) factor attribute % of variance explained factor 1 visuallphysical (visual) 22,7 appearance factor 2 customer servicel (behaviour) 20,5 personnel factor 3 dynamism (behaviour and 14,0 visual) 572% table 4 factors determining the corporate image of fast food outlets in south africa (gouverneur, 1997) factor attribute % of variance explained factor 1 behavioural identity (behaviour) 35,24 factor 2 core product image (visual) 689 factor 3 core value image (behaviour and 5,67 visual) factor 4 visual recognition (visual) 556 53,36% these results lead to the conclusion that both visual and behavioural factors influence the corporate image and that the model set out in section 2.7 above, may be accepted as a workable explanation of the corporate image process. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 505 correlation: beisiegel (1996) also drew a correlation between the visual and behavioural attributes into a correlation matrix which is used to display coefficients for more than two variables. in her study, the correlation between the visual and behavioural attributes was 88% at a 95% significance level. a recommendations for further research needs to be stated: determine a dependent variable, such as, loyalty, repurchase, goodwill, support, etc. this will aid further statistical analysis. it would also be an interesting exercise to determine which visual and/or behavioural aspect has the strongest influence on the corporate image. 5 limit a nons the following limitations should be stated: no sampling was done; the respondents used in this investigation may not be representative of the south african population as a whole to make generalisation of the results possible; the list of bi-polar items used in the semantic differential might have been more complete, seeing that the possibility exists that certain important items were excluded; not all companies in each of the industries were included in the various studies; the factors identified as contributing to a corporate image may only be relevant to the particular companies included in these studies. these limitations do not detract from the importance of the results, which proved that corporate image is created by both visual and behavioural corporate identity cues. 6 conclusion a semantic differential was designed in these research projects to measure the corporate image of selected south african companies. a subsequent factor analysis of data identified the various factors contributing to the corporate image of these companies. the research results confmn the view that corporate behaviour and corporate visual identity both serve to create the corporate image. it is also confirmed that the corporate logo can create tangible images in the minds of respondents because it serves as a ''mental switch" or stimulus. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 506 sajems ns vol 2 (1999) no 3 the view that corporate behavioural characteristics are important in the creation of a corporate image, has some significant implications for management. it emphasises that management should spend more time on aspects such as customer service and implement appropriate management styles, than recruiting consultants to trifle with corporate colours, logos and slogans. in other words, management should apply more time, effort and attention to analysing corporate behaviour than designing corporate visual artefacts. an outline of literature and the results of four different studies reported in this article have lead to the design of a corporate image process model which is open to debate, further research and refinement. references abramic, k. (1993) "touting your talents", american printer, 212(2), november: 52-5. 2 abratt, r. (1989) "a new approach to the corporate image management process", journal of marketing management, 5(1): 63-76. 3 appelbaum, r.l., & anatol, k.w.e. (1973), "dimensions of source credibility: a test for reproducibility", speech monographs, 40: 231-7. 4 band, w.a. (1987) "build your company image to increase sales", sales & marketing in canada, 28( 11) december: 10-11. 5 bel siegel, k. (1996) an exploratory investigation into the corporate image of south african petrol companies, unpublished industry research report at the university of pretoria. 6 bellhouse, i. (1989) "corporate identity: are the sceptics justified?" industrial marketing digest (uk), 14(4), fourth quarter: 109-14. 7 bernstein, d. (1986) company image and reality a critique of corporate communication, holt, rinehart and winston: east sussex. 8 boyd, h.w., westfall, r. and stasch, s.f. (1985) marketing research, 6 ed., richard d irwin: homewood, illinois. 9 cooper, d.r. and emory, c.w. (1995), business research methods. fifth edition. irwin, us. 10 croft, m. (1989), "beyond the corporate logo", accountancy (uk), 104(1152), august: 65-6. 11 cullen, d. (1991) "good looks count", fleet owner, 86(6) june: 6871. 12 gouverneur, a. (1997) "an exploratory investigation into the corporate image of south african fast-food companies", unpublished industry research report at the university of pretoria. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 507 13 fiedler, f.e. (l985) "the leadership game: matching the man to situation", in gibson, j.w. and hodgetts, r.m. (eds.) readings and exercises in organizational communication, academic press, orlando, florida: 122-30. 14 gregory, j. (1991) marketing corporate image: the company is your number one product, ntc publishing group, usa. 15 harris, b. (1995) "corporate identity makes the difference", asian business, 31 (l 0) october: 87. 16 ind, n. (1990) the corporate image: strategies for effective identity programmes, kogan page, london. 17 katz, m. (1988) "corporate identity programs don't have to be real expensive", bank marketing, 20(4), april: 38-40. 18 kotler, p. (1988) marketing management, prentice-hall international editions, new jersey. 19 kotler, p. & armstrong, g. (1993) marketing an introduction, 3 ed. prentice-hall: englewood cliffs, new jersey. 20 lener, j. (1989) "seize tomorrow's markets: eight steps to master your entrepreneurial advantage", success, 36(8), october: 25-42. 21 macinnes, dj. & price, l.l. (1987) "the role of imagery in information processing: review & extensions", journal of consumer research, 13, march: 473-91. 22 miller, c.d. (1990) "building a corporate identity", black enterprise, 20(11), june: 295-8. 23 olins, w. (1989) corporate identity: making business strategy visible through design, thames and hudson. 24 osgood, c.e., suci, g.j. and tannenbaum, p.h. (1957) the measurement of meaning, university of illinois press, urbana. 25 pitt, l. & nel, d. (1989) "student surrogation in behavioral business research: a review and decision process model", management research news, 12(6): 13-19. 26 selame, e. & selame, 1. (1988) the company image: building your identity and influence in the market place, 10hn wiley & sons, new york. 27 skinner, c. & von essen, l. (1991) the handbook of public relations. 3 ed., southern book publishers, halfway house (sa). 28 smith, m.j. (1988) contemporary communication research method, wadsworth, belmont. 29 stanton, w.j., etzel, mj. and walker, bj. (1991) fundamentals of marketing, 9 ed., mcgraw-hili, new york. 30 sternberg, r. (1991) "making up a face to fit", asian business (hong kong), 27(4), april: 55-6. 31 stewart, k. (1991) "corporate identity; a strategic marketing issue", journal of bank marketing (uk), 9( i): 32-9. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 508 sajems ns vol 2 (1999) no 3 32 sunter, c. (1993) future scenarios for south africa, prestige lecture series no i. faculty of business economics, university of pretoria. 33 thomas, h. (1988) "design in marketing: can we see your id please?", marketing (uk), february 25: 48-51. 34 van den berg, m. (1994) an exploratory investigation into the corporate image of south african fashion retailers, unpublished industry research report at the university of pretoria. 35 van heerden, c.h. (1993) corporate identity as an element of marketing strategy, mcom dissertation. university of pretoria. 36 van heerden, c.h. (1994) "there is more corporate image than meets the eye", image & text a journa/for design, 4: 3-8. 37 weiers, r.m. (1988) marketing research, 2 ed., prentice-hall, new jersey. 38 zikmund, w.g. (1991) exploring marketing research, dryden press international edition, orlando, florida. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 93 internal service quality enhancement for external appeal: a south african perspective m fletcher department of marketing, university of pretoria abstract the main problems in service quality programmes seem to stem from methods and strategies used rather than actual service quality improvement itself. the present study is based on a questionnaire survey of organisations that had in fact implemented a service quality strategy. several organisations studied here, indicated that the implementation of these programmes without measuring results, ended up wasting resources on non-value adding uses. this can be partly attributed to the complexity of available software. another problem arises because organisations fail to understand the dynamics of change. service quality was thus seen as a quick fix, treating symptoms instead of underlying problems. this study concludes that organisations should implement such strategies not only with commitment but correct and with relevant information and knowledge. jel m31 introduction at inclement economic times, many managers have developed a spontaneous reflex to trim business activities that do not have an obvious effect on profits. service and service quality appear to be a favourite victim, as many service activities may seem immaterial and returns on spending tend to accrue only over the long term (davidow and uttal, 1989). further issues complicating service quality are the barriers in the way to service excellence, like the size of corporations, layers of bureaucracy, legal restrictions, diverse customer requirements, increased domestic and international competition, and scarcity of committed and competent service employees (bell, 1996). barriers to entry have however also decreased in many cases, for example, geographic r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 94 sajems ns vol 2 (1999) no 1 restrictions on service delivery have been reduced, there is more freedom to compete on price, and existing organisations often find themselves able to expand into new markets or new lines of business. some such changes represent relaxation of government regulation and much can still be done to strengthen customer protection laws, improve safety and public security, and protect the physical environment (lovelock, 1991). these issues are especially pertinent in the third world environment, where people may remain complacent and exploitation is sometimes the order of the day. to overcome these problems organisations are increasingly encouraged to enhance service quality. thanks to the emphasis on customer satisfaction, organisations are realising that value-added marketing is more than offering a good product, backed by professional service. it is an entire system that includes speed, convenience, follow-up and, most important, a relentless pursuit of customer satisfaction (cates, 1991). these factors can however not operate in isolation, but form part of an entire network based on service quality principles. in the course of the movement towards service quality, many large organisations have been transformed from a predominantly manufacturing to a service organisation, by including services as part of their total offering. these services or supplements are insufficient in themselves and must be further augmented by the element of interpersonal contact, i.e. the way the customer is treated (barnes and glynn, 1993). this customer treatment should be understood and applied by every employee, thus placing the importance of the message squarely on the shoulders of management. a problem identified by puth and ewing (1998) is that in the movement from a manufacturing-cum-sales culture to a service culture, managers often accept the logic behind the new way, but lack the basic know-how and skills required for the effective implementation of the change. furthermore, the list of activities that an organisation should follow in order to retain its customers, appears to be endless in an increasingly competitive and, especially, diverse market. but there does not seem to be an alternative. research methodology the research problem that prompted this study can be stated as follows: are there differences between the academic evolution of the service quality concept and the practical experience thereof in the south african market? or in other words: do south african organisations reap the benefits of service quality implementation r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no \ 95 promised by the academic protagonists of service quality? the ultimate purpose is to provide insight into managerial behaviour. the objectives of this study were the following: first, to determine whether or not service quality programmes are implemented successfully in the south african market. second, to identify the main driving forces behind the decision to implement such strategies. the third objective is of an operational nature, seeking to determine the impact of service quality programmes and to test whether the practitioners did receive the benefits held out by their academic supporters. the fourth and last objective is to determine whether the organisations under review focus on internal or external initiatives/interventions in their service quality programme. the target population (265 organisations) for this study were all the respondents in the business transformation survey done by the insight customer satisfaction consultants. from this target population, the sampling frame was identified as those respondents who listed the implementation of a service quality programme as a platform for transformation. here 140 organisations were identified and taken into the sample. this way the research was related to a population with knowledge of the subject at hand. the response rate achieved came to 44.28% or 62 organisations. although this may seem a rather small sample, it should be taken into account that very few south african companies have formally implemented service quality programmes. but using any other organisations would have resulted in less reliable information. as part of the data collection procedure, a questionnaire was designed to collect the data from the respondents (kinnear and taylor, \996). the source of the individual items used in the process were identified from relevant literature. as the objective was to determine the differences in perception between academic protagonists of service quality and business people with experience thereof, it was important to test what may be called the academic promises of service quality programmes. the questionnaire made use of a segmentation question to distinguish between longer running and shorter running programmes since academic advocates of the service quality principles argue that longer running programmes have higher payoffs (davidow and uttal, 1989). the questionnaire mainly consisted of scale questions to test expectation and perception, as well as importance and performance of service quality issues and techniques. the questions used a bipolar, seven-point likert scale which is one of the most widely used attituder ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 96 sajems ns vol 2 (1999) no 1 measurement techniques in marketing research (diamantopolous and schlegelmilch, 1997). this scale is ideal for the present research, as it can collectively measure a large number of statements that meet two criteria, namely each statement is believed to be relevant to the attitude studied, and each is believed to reflect a favourable and unfavourable position (emory and cooper, 1991). due to the length of the questions used, the questions themselves are not listed here only the comments. the questionnaire was divided into three main sections. firstly, a group of statements was designed to identify the driving force behind the organisation's decision to implement a service quality programme. this indicates whether external forces (changing market needs, international benchmarking) and/or internal problems (deteriorating profitability, declining turnover, loss of market share, productivity inefficiencies, inappropriate employee attitudes) gave rise to the decision to implement such a programme. this aspect was tested in h2 andh3 . the second group of statements was formulated to ascertain whether managers set out on a programme with a clear idea of what they expected to achieve, and to determine whether these expectations were realised. the difference between ex ante and ex post variables were either cause for concern or a source of satisfaction, depending on the algebraic sign of the gap. the aspects listed in this section were compiled from academic literature, where the authors stated that service quality would yield benefits such as market share, cost reduction, profit margins (fornell, 1992; hauser, 1993; rust and zahorik, 1993; devlin and dong, 1994; stafford, 1994; tatikonda and tatikonda, 1996, et at). this category was tested in 1--4 to hg• the last group of statements included were to test whether managers know which tools or techniques need to be emphasised in order to improve service quality in an organisation. a manager would thus indicate the importance of certain service quality interventions and then the organisation's performance in each case. statistical procedures used the reliability of the research was tested in hi (the instrument used to assess the reliability of service quality programme implementation) by using cronbach's alpha or the coefficient alpha (malhotra, 1993). this method is highly applicable to multi-item scales at the interval level of measurement (emory and cooper, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns yol2 (1999) no 1 97 1991). as the majority of questions is based on a likert scale, this method of reliability testing can be deemed effective. after reliability had been established, two statistical procedures were used to test the validity of the hypotheses. firstly, student's t-distribution was used to analyse h2 and hj . this method was used because the standard deviation was unknown and the sample size relatively small. this method is also suitable in situations where groups of factors are tested at one time (malhotra, 1996). then the analysis of variance (anoy a) was used for testing h~ to hid. anoy a works on the assumption that the means of several populations are equal. it represents a oneway analysis of variance and uses a single factor, fixed effects model to compare the effects of one factor on a continuous dependent variable (emory and cooper, 1991 ). since the hypothesis under discussion has a continuously dependent variable, anoy a was satisfactory for this measurement. it should be mentioned that one of the assumptions of anoy a is that it is used to compare two different populations. in this study the same population was used to measure a difference in perception based on a time frame difference. one measure was taken before the program was launched and another after the program had run for at least 6 months. this should bridge the problem, nevertheless one should caution against the absolute generalisation of the findings. descriptive research and general findings this section addresses the descriptive information gathered in the study. the results of each section of the questionnaire are first shown on a graph, after which conclusions and findings will be discussed. why did these organisations decide to implement a service quality programme? figure 1 shows the results pertaining to the driving forces in the organisation's decision to implement a service quality programme. to measure the importance of the various forces a bipolar, seven-point likert scale was used. the vertical scale measures the influence of each driving force i.e. causal factor on the decision to introduce a service quality programme, in ascending order. respondents were asked to rank each driving force along a scale from 1 to 7. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 98 sajems ns vol 2 (1999) no 1 the factor with the greatest influence on the decision to implement a service quality programme, is changing market needs. (this will be statistically proven in the following section.) the marketplace is dynamic and any organisation lagging behind these changes, will inevitably lose market share and fall behind other organisations. organisations should therefore invest in ongoing research to ensure the correct assessment of today's and especially tomorrow's market needs (berry, parasuraman and zeithaml, 1994; slater, 1996). figure 1: factors influencing the implementation of a service quality programme -----------. 60 ijl deteriorating profitability ! 50 • international benchmarking qi u ~ 40 • declining turnover a 1:1 :: 30 i!l loss of market share q ... 1:1 20 .b iii changing market needs &! 10 o productivity inefficiencies 0 .inappr employee attitudes causal factors other important factors driving this decision are inappropriate employee attitudes and productivity inefficiencies. both these problems are characteristic of the south african market and employee attitudes, in particular, should be researched to identify the reasons behind their unsatisfactory nature. employee research has been stressed by berry, parasurarnan and zeithaml (1994) and peak (1996) as one of the key elements in becoming a quality leader. defining employees' roles clearly, consistently and credibly is important to any organisation's efforts to improve service (zeithaml, berry and parasuraman, 1988; berry, zeitharnl and parasurarnan, 1990). another important driving force appears to be international benchmarking. as the south african market is comparatively new to the international arena, this factor is r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 99 likely to become stronger as the intensity of competition in the marketplace increases. do soutb african organisations reap the benefits of service quality programmes as promised by academic supporters? figure 2 shows the results of measuring the gap between respondents' expectations concerning the service quality programmes on the one hand, and their perceptions of the actual performance achieved on the other. a negative result indicates dissatisfaction, a zero result indicates technical satisfaction, and a positive result indicates higher levels of satisfaction. figure 2: the expectation performance gap -0.9 -0.9 ·0.9 -1.1 -0.4 -0.2 0 market share customer retention employee retention profit margin generated productivity competitive capabilities employee competency realignmnt of .corp culture participative mngnt style process improvement enhanced prodj serv qlty cost reductions return on investment in all cases, managers expected more from the service quality programme than what it actually delivered. this means that expectations are not being met, especially in such areas as enhanced product/service quality, customer retention, productivity, employee competency, corporate culture realignment, cost reduction r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 100 sajems ns vol 2 (1999) no 1 and return on investment. all these aspects can be linked in one way or another to the bottom line of the organisation. the high expected score attached to these attributes may be seen as an indication of the pressure on management to prove the accountability of service quality investments. initiativeslinterventions used in service quality programmes the results represented in figure 3 indicate the difference between the importance associated with a given initiative/intervention and its actual performance. the same principle of gap measurement was used as explained in figure 2, and again a negative result indicates a problem area while a positive result indicates successes achieved. although all interventions produced a negative gap, the following gaps indicated particularly substandard performances: information systems enhancement, service quality performance tracking, internal communication, all-round performance appraisals, service quality training, customer needs analyses, leadership development, consumer databases and logistic/supply chain management. a core problem experienced by the organisations appears to be internal customers, or employee issues and with that leadership development. it is especially interesting to note that the primary data set indicated that the least important attribute identified in this research was employee research in comparison with all the other initiatives/interventions. these issues represent the internal processes and functions within the organisations that decisively affect the level of service quality rendered by the organisation. problems often result not from employees, but rather from the system in use, for which management is responsible (babbar, 1992; bricknell, 1996 and coulson-thomas, 1996). managers should therefore design effective systems that will assist the employees in their tasks. in order to ensure a high level of service quality, both tompkins (1992) and weitzel, schwarzkopf and peach (1989) emphasise the importance of employee satisfaction, since people are the primary source of a competitive advantage in a service oriented organisation. a further problem is customer satisfaction needs analyses and customer data bases. this problem is a common third world phenomenon and can be partly attributed to the lack of relevant and timely information and of appropriate technology to assist in gathering information. these issues can only be dealt with through ongoing and improved customer research, and represents a key to success as this knowledge can provide the organisation with a competitive advantage in the marketplace. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 figure 3: performance gap of initiatives/interventions -o.s ci ====::ji employee research -0.6 1 activity-based costing -1.00 c:::=======:::ji cultural diversity mngemnt -1.00 c::::========l' call centres 101 -1.2 ci =========:::11 supplier partnership program -0.9 c::::======j competency modeling -0.2 c:::::::::::::: organisational restructuring -0.8 ci ======:j\ international benchmarking -1.3 [i ============:1'1 logistics management -0.9 [i =======:jl process efficiency analysis ·0.6 [i ====:j\ key account manager -0.9 c:::=======:j acknowledgment program -0.9 reward incentavisation c::::==========:j consumer data bases -la l...-__________ ---' all-round perf. appraisals -0.6 [i ====ji technical skills training -1.1 c::::========~ performance management .3[===========1 leadership development 1.1 c:::=======l' market trend + quantification c::::========j service quality workshop -la c::::==========~ internal commprogram c::::=========:j service stds definitions l...-____________ -j info systems enhancement -1.0 [i ========::::ji team-based action planning -1.30 [i ===========:::ji customer sat needs analyses lao 1 • service quality perf tracking -1.20 1 • team-building -1.30 1 1 service quality training ·160 ·1.40 ·1.20 -1.00 -0.80 ·0.60 -0.40 -0.20 0.00 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 102 sajems ns vol 2 (1999) no i perception of overall success achieved with the service quality programme the perception of overall success achieved was measured with the help of a tenpoint, bipolar scale where i indicated poor overall success and 10 excellent overall success. the mean indicated the average success of the programme to be 6.19, which suggests that most of the programmes are considered as relatively successful by the respondents. although almost all the gaps evaluated were found to be below expectation, respondents are not relinquishing their confidence in the success that these programmes can achieve for an organisation if implemented correctly. hypothesis testing the results of the empirical testing of the ten hypotheses are listed and discussed below. the hypotheses have been divided into four categorising subsets. category 1: hypothesis regarding the reliability of the instrument used to assess service quality implementation. hi: the instrument used to assess service quality programme implementation is reliable. the results indicated that the instrument scored high coefficient alphas (0,88; 0,88; 0,89; 0,88), which are above the customary cut-off point set at 0,6 (malhotra, 1996). the measuring instrument can therefore be deemed reliable. category 2: hypothesis regarding the driving force behind the organisation's decision to implement a service quality strategy. h 2: when studying the extent of the influence of various forces on the decision to implement a service quality strategy. the influence of external forces is significantly stronger than that of internal problems/forces. table 1: testing of hypothesis 2 in terms of external and internal drivers drivers mean std.dv t df p i internal drivers 3.877 1.322 l external drivers 4.721 1.554 -3.665 51 0.0005892 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 103 the mean scores of each of the two groups of drivers were calculated. internal problems/forces included: deteriorating profitability, declining turnover, loss of market share, productivity inefficiencies and inappropriate employee attitudes. the external drivers were identified as international benchmarking and changing market needs. the findings of the test were significant (p=0,00059), indicating that the influence of external forces on the decision to implement a service quality strategy was significantly stronger than that of internal forces/problems. table 2: h3: changing market needs have a significantly stronger influence on the decision to implement a service quality strategy than international benchmarking. testing of hypothesis 3 in terms of changing market needs and international benchmarking drivers mean std.dv t df p international benchmarking 4.291 1,997 • changing market needs 5.273 1.373 -3.447 54.000 0.001 a student t-test was used to test this hypothesis and the outcome was p=o,ooi, signifying that changing market needs have a significantly stronger influence on the decision to implement a service quality programme than international benchmarking. category 3: hypothesis regarding the impact of the implementation of a service quality strategy. table 3: h4 : the success achieved in increasing market share is significantly higher with service quality programmes implemented prior to 1995 than with programmes implemented since 1995. testing of hypothesis 4 in terms of market share r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 104 sajems ns vol 2 (1999) no 1 --------_._-_ .. _-_._---to test this hypothesis, anov a was used where the significance criteria were set at p<0,05. as the p-value was found to be 0,14862, it can be assumed that the success achieved in increasing market share was not significantly higher in longerrunning programmes. the null-hypothesis can therefore be accepted that there are no significant differences in increasing market share between longer-running programmes and shorter-running programmes, i.e. those implemented since 1995. h5: the success achieved in increasing profit margins is significantly higher with service quality programmes implemented prior to 1995 than with programmes implemented since 1995. table 4: testing of hypothesis 5 in terms of profit margins generated programmes implemented prior to 1995 showed a smaller deviation from the hypothesis than programmes implemented after 1995. the difference can however not be regarded as significant as p=0,541 when using anov a to analyse the data. hr,: the success achieved in improving competitive capabilities is significantly higher with service quality programmes implemented prior to 1995 than with programmes implemented since 1995. table 5: testing of hypothesis 6 in terms of competitive capabilities the p-value was found to be 0,824288. hypothesis 6 therefore had to be rejected as competitive capability did not improve significantly when the programmes were implemented over a longer period of time, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 105 h7: the success achieved in generating an increased return on investment is significantly higher with service quality programmes implemented prior to 1995 than with programmes implemented since 1995. table 6: testing of hypotheses 7 in terms of return on investment return on investment f ~ ·····---f-prior 1995 4.500 0.ql8 0.895 ifrom 1995 4.552 it was disturbing to note that the success achieved in return on investment did not seem to increase significantly the longer the programme ran. the anov a revealed a significance of p=0,895 on this hypothesis. hypothesis 8 was accordingly rejected. h8: the success achieved in reducing costs is significantly higher with programmes implemented prior to 1995 than with programmes implemented since 1995. table 7: testing of hypothesis 8 in terms of cost reduction there was an apparent difference in the mean scores for cost reduction between programmes implemented prior to 1995 and those implemented since 1995, yet the anov a tested the significance at p=0,085. when using 95% reliability criteria, as with the other hypotheses, this hypothesis would have to be rejected, but if it is evaluated on the basis of a 90% reliability level it could be accepted. hypothesis 7 was thus accepted on a 90% reliability level as it proved to be more significant than the other hypotheses in category 3 concerning market share, profit margins generated, competitive capabilities and return on investment. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . i 106 sajems ns vol 2 (1999) no i category 4: hypothesis regarding the initiatives/interventions used to achieve service quality. table 8: h9: the higher an organisation's perception of the importance of leadership development when implementing a service quality strategy the better the performance on the attribute (leadership development) will be. testing of hypotheses 9 regarding leadership development leadership development development and performance i f---ir----p---l ileadership development i 4.815 i 0.00 i there was a strong correlation between organisations that attached high levels of importance to leadership development and those that performed better on this attribute. it can therefore be accepted that the more organisations focus on the importance of leadership development, the better the performance in this regard will be. this is indicated by the anov a analysis where a significance level of p=0,00 1 was achieved. hypothesis 9 was accordingly accepted on a 95% confidence level. table 9: h/(): the more an organisation focuses on employee research in the implementation of a service quality strategy the better the performance in employee issues will be. testing of hypotheses 10 regarding employee research and employee issues employee issues (vs. importance of research) ~=-_--::_---,e-,,-,,-,-m..lpl.~y~e issues ___ 1 f i employee issues vs. employee research i 2.646 i p 0.049 the anqv a analysis marginally indicated that the performance in employee issues was higher in cases where the organisations focused on employee research. the result is considered as marginal as the significance level was found to be p=0,049, which falls within the criterion ofp<0,05, but if this number is rounded to two decimals it will place it just outside the set criterion. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol2 (1999) no 1 107 summary of main findings regarding the hypotheses it was established that south african organisations are moved more by external than internal factors into implementing service quality programmes. the external factor that proved to be the most significant driving force was changing market needs. the only wayan organisation can adapt to new requirements is through ongoing customer research (berry, parasuraman and zeithaml, 1994). the organisation that succeeds in becoming a learning organisation and thus establishes a knowledge-based advantage, will be the one to survive and prosper (d'aveni, 1994 and slater, 1996). this advantage will be significant, and at least to a degree sustainable, in the future market situation. the third set of hypotheses (h4 hs) tested the impact of the service quality programme on the overall success of the organisations studied. here it was found that market share, profit margins, competitive capabilities and return on investment did not significantly increase the longer the service quality programmes were running. the only factor that showed a significant impact on success was cost reduction. all these factors represent benefits claimed by the academic supporters of service quality in their support of the concept. however, this study cannot conclude that these academic supporters are either right or wrong, since the programmes implemented had various deficiencies and were not an exact replica of what the academics had proposed. one of the deficiencies derived from the fact that the organisations in question tended to focus on external issues, which may be regarded as leading to cosmetic, not real, changes. the literature stresses the importance of treating the root causes of problems, and warns against symptomatic treatment by means of externally focused strategies (akao, 1990; hunt, 1993; manganelii and klein, 1994; obeng and crainer, 1994; rust, zahorik and keiningham, 1994; beach and bums, 1995; ghobadian and terry, 1995; hammer and stanton, 1995). the findings of this study indicate that internal and structural problems were not accorded top priority in the programmes implemented resources rather allocated to external problems, and in some cases even mere window dressing confused the real service quality issue. the above-mentioned situation in h4 hs can be better understood when taking the following into account. practitioners or business people implementing a service quality programme may struggle to grasp and detennine the intangible benefits of service quality, since it is extremely difficult to detennine what part of the success achieved by an organisation is due to service quality improvement. this is illustrated by the fact that cost reductions were perceived to contribute significantly r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 108 sajems ns vol 2 (1999) no 1 to the success of the organisations studied here, since this factor is easy to measure and results are readily perceived over a relatively short period of time. however, all the other aspects (h4 h7) are less tangible and more difficult to isolate than cost reduction. the last group of hypotheses led to the interesting conclusion that these organisations can be blamed for the below-expectation performance of their leaders and employees. the hypotheses in question held that if these organisations focus more on leadership development they would achieve higher performance scores in this respect. the hypotheses also held that organisations would not experience as many employee problems if they invest in employee research. this also has a bearing on organisations' tendency to neglect internal issues, that are of the utmost importance to the achievement of service quality excellence. without internal strength, the objective of being competitive cannot be realised and the changes made will then seem to be no more than cosmetic changes resulting in less customer satisfaction. it thus seems that the organisations in this study did not focus their efforts on internal issues, but rather tried to solve service quality problems externally. many service quality programmes are implemented due to pressure in the marketplace, and organisations do often not have the knowledge to implement them in the most effective way. combination of descriptive research and hypotheses findings the research results identified problems such as inappropriate employee attitudes and productivity inefficiencies along side of leadership development problems. these results indicate that the organisations concerned underestimate the importance of leadership development and that employees are thus deprived of the support and guidance of a strong leadership corps. many an author on service quality has emphasised the importance of leadership in the success of service quality implementation (tanner, 1994; bricknell, 1996; coulson-thomas, 1996 and crosby, 1996). difficulties of internal communication may be one reason for the above-mentioned larger problems. it is important that organisations should realise that the difference between white-collar thinking and blue-collar doing has diminished, and organisar ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol2 (1999) no 1 109 tions need the ideas of each and every employee. employees that do not feel involved will also lack motivation and drive. employees should therefore be empowered, encouraged, trained and supported to solve problems and control quality. it is interesting to note that the problems identified in the research appear to have a chain effect. for example, the problems identified in inappropriate employee attitude can lead to customer retention problems, problems in corporate culture realignment and the inability to enhance the quality of the service. all of these issues emerged as problem areas in this research. another related issue consists of employee competency problems, which have increased together with problems of information systems enhancement. from the gaps identified in training, it is clear that insufficient resources are being allocated to training employees to adapt themselves to a changing working environment of ever increasing technological innovation. investing in technology and training can also alleviate the problems experienced with productivity inefficiencies, as increased productivity is one of the major benefits of technology enhancement. with the help of technology, the workload of employees can be decreased to give them more time to spend with customers (berry and parasuraman, 1991 & 1992; blumberg, 1991; lovelock, 1991). customers will then not be seen as a burden, as employees will be supported by information systems to assist them in quick and effective decision making. in the light of these findings it seems that the problems experienced with employees are never-ending, yet the finding of hypothesis 10 stated that organisations focusing on employee research will perform better on employee issues. organisations should thus determine where the main problem areas are, and then address these issues. people tend to be more loyal if they share a united, focussed cause. satisfied employees will then, most probably, lead on to satisfied customers. it is thus recommended that organisations look after staff relations and not make unfair demands, seeing that employees have a significant influence on the success of especially service organisations. as the competitive power of a service organisation lies in the competence and satisfaction of their employees, workers should be protected in order to retain customers in an increasingly competitive market. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 110 sajems ns vol 2 (1999) no 1 limitations as with all projects of this nature, the study has some obvious limitations that militate against the generalisation of the findings. • one obvious limitation is the sample size. although there were good reasons for such a small sample, it would be interesting to repeat this research in future when more south african organisations have implemented service quality programmes. • although the questionnaire was confidential, the sensitivity of the information required may have made some of the respondents reluctant to disclose confidential information. • as was mentioned in the research design, anov a was used for the testing of the hypotheses, even though one of the assumptions of anov a is that 2 different populations have to be compared. the reason for this is that although it is the same population the responses were in two different time frames one before the implementation of the program and another at least six months into the program. although this should bridge any problems, one should caution the reader against the absolute generalisation of the findings. recommendations a number of factors identified in this study may be of benefit to researchers in the future. • this kind of study should be repeated when the south african economy has been subjected to more intense competition, and more organisations have realised the benefits of investing in service quality. • simpler instruments for measuring service quality should be developed. current instruments are extremely complex and organisations often find it difficult to use them effectively. • more research should be done on change management and change models, particularly in respect of the implementation of service quality programmes. such models would be of great value in the implementation of these programmes. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no i 111 conclusion the research has clearly shown that the performance of service quality programmes has been below the expectations of south african practitioners. although a cause for concern, one should keep in mind that life can only be understood backwards, but has to be lived forwards. it is therefore important that organisations adopt the philosophy of a learning organisation, and use past experience to improve the future performance of the organisation. a focus on quality will increase the organisation's competitive advantage, if the goal of the organisation ultimately becomes quality performance, based on a knowledge of the underlying causes that lead to service quality leadership. organisations should realise that quality is ultimately the delivery of value to increasingly value-conscious customers. underlying the operations of every organisation working like a spine or cerebral cortex is its value delivery system. an organisation's performance can be regarded as the direct result of how effectively the system is structured and managed (swartz, 1994). this focus on internal issues will support external processes and equip the organisation with the ability to provide the customer with what was promised something that leads to customer retention and loyalty. in conclusion, organisations should understand that change is a continuous process. the hunters will distinguish themselves from the hunted (swartz, 1994) in the way they go beyond restructuring and mere programme implementation, to continually transform and equip themselves to maintain a strong competitive position. references !. akao, y. 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(1994), the hunters and the hunted. a non-linear solution for american industry oregon: productivity press. 37. tanner, s. (1994), "service quality as a competitive strategy'" journal for quality and participation, 17(7):58-64. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 114 sajems ns vol 2 (1999) no 1 38. tatikonda, l.u. and tatikonda, r.1. (1996), "measuring and reporting the cost of quality," production & inventory management journal. 37(2): 1-7. 39. tompkins, n.c. (1992), "employee satisfaction leads to quality service", hr magazine, 3 7( 11 ):93-95. 40. weitzel, w., schwarzkopf, a.b. and peach, e.b. (1989), "the influence of employee perceptions of customer service on retail store sales", journal 0/ retailing, 65(1):27·39. 41. zeithaml, v., berry, l.l. and parasuraman, a. (1988), "communication and control processes in the delivery of service quality", journalo/marketing, 52(2):35·48 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 3 362 the portrayal of children in magazine advertising: a post-apartheid study e north department of marketing and business management, university of pretoria abstract a content analysis is presented of the portrayal of child actors in advertisements obtained from nine consumer magazines over a three month period in 1983, 1987, and 1997. a limited number of studies have investigated the portrayal of children in magazine advertisements, but no previous study looked exclusively at the roles children depict in advertisements. the primary objective of the present study was to describe the various roles children portray in full page magazine advertisements. secondary objectives focused on the age and sex of the models and the use of children of different races in the same advertisement. the results indicate that children are portrayed in seven different roles in the advertisements. suggestions for further research are offered. jelm370 introduction south africa has been characterised by dramatic changes over the last decade. apart from a new political order, significant transformation has been taking place in the social, educational and business spheres. these changes bring with them many new marketing opportunities. the redistribution of income and rapid westernisation of black south africans is of special interest to south african marketers. like their counterparts in other countries, they are beginning to realise that the youth market is a segment that cannot be ignored. the use of children as models in advertising is believed to be a very effective method advertisers apply to communicate with parents and other children. the child actor in the advertisement is used as a substitute communicator to convey the advertising message to potential consumers. in many instances children figure as symbols in the advertisement to attract the attention of both adults and other children and to lend a specific meaning to the advertising message. it can be expected that a child will identify more easily with a child model depicted in a social situation than with an adult. this article reviews how marketers in south r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 363 sateb nr vol 1 (1998) nr 3 africa portray children in magazine advertisements in two very distinct periods in the country's history, namely before and after the new government of president nelson mandela came to power in 1994. an empirical study was conducted to detennine how frequently children appear in full page advertisements, the roles they play, the age and gender of the child model, and in particular if children of different races are depicted in the same advertisement. in order to put this topic into perspective, the following paragraphs will provide a global overview of marketing to children and how marketers address this issue. marketing to children: an ethical minefield? advertising to children has been a major focus of public debate and concern in many countries over the years. marketers face a dilemma when advertising to children. on the one hand they must be sensitive to ethical issues, on the other hand they must make full use of the opportunity to create powerful messages that will attract the attention of potential customers and this includes the very lucrative youth market. how marketers in a few major countries address this issue is worth noting. young people in china have money to spend and are very brand conscious. according to johnstone (1996) advertisers are increasingly looking to sway the minds of children in china. at saatchi and saatchi plans were under way in 1996 to set up a unit in its shanghai office aimed at developing a better understanding of how children in china respond to advertising. all advertisements in china are censored before they are aired or printed. the guidelines advocate respect for authority and filial piety, which corresponds in some sense with the african concept of ubuntu. almost universally, advertising in china shows visions of a healthy, happy family life, says johnstone. a section of the new advertising law in china applies particular restrictions to children's products. those producing pharmaceutical products cannot show children in a commercial, even if the product is for children. products such as tylenol cough medicine must be advertised by showing an adult recommending the product to a parent for use for his or her child. in the united states virtually every advertising practice comes under the jurisdiction of the federal trade commission (bovee et al., 1995). groups such as act (action for children's television) and caru (children's advertising review unit) have been particularly active in the field of advertising to children. caru was established in 1974 by the national advertising division of the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 3 364 council of better business bureaus for the purpose of: (1) monitoring children's advertising for truth and accuracy, (2) evaluating proposed children's advertising, (3) promoting research into children's advertising, and (4) disseminating information to the public (rajeev, myers & aaker, 1996). the major issues are whether television advertising to children is inherently unfair, whether it causes children to make poor product decisions, whether it increases parent-child conflict, and whether it results in undesirable socialisation of children. the broader issues, particularly associated with toys and games that involve violence, are whether advertising of such games, or the games themselves, should be disallowed. a related question is whether advertising, even though it does not contain violent material, should be sponsoring television programmes that do depict violent scenes that can be seen by children. the controversy surrounding the issue of children's advertising has not only generated an ongoing stream of research on the effects of children's advertising but has also encouraged the advertising industiy to regulate this practise carefully. caru revised its written guidelines in 1977 and again in 1983. the following are the five basic principles on which guidelines for advertising directed at children are based (wells, burnett & moriarty, 1995): • advertisers should always take into account the level of knowledge, sophistication, and maturity of the audience. • realising that children are imaginative and that make-believe play constitutes an important part of the growing up process, advertisers should exercise care not to exploit that imaginative quality of children. • recognising that advertising may play an important part in educating the child, information should be communicated in a truthful and accurate manner with full recognition by the advertiser that the child may learn practices from advertising, which can affect his or her health and well being. • advertisers are urged to capitalise on the potential of advertising to influence social behaviour by developing advertising that, wherever possible, addresses itself to social standards generally regarded as positive and beneficial, such as friendship, kindness, honesty, justice, generosity and respect for others. • although many influences affect a child's personal and social development, it remains the prime responsibility of the parents to provide guidance for children. advertisers should contribute to this parent-child relationship in a constructive manner. according to bradley (1995) advertising to children in europe is either hamstrung, as advertisers see it, or regulated, as the governments concerned view it. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 365 sa1eb nr vol i (1998) nr 3 • in finland, santa's homeland, child actors may not speak or sing the name of a product in commercia1s. when it comes to advertising sweets" they must not appear on the screen at all; children munching sweeties are also out of order in the netherlands. • in neighbouring sweden no child may be depicted playing with "war toys", and advertisements may not show the price of toys. • on swedish lv, all ads aimed at "gaining the attention" rather a difficult concept to quantity of children under the age of 12 are banned. • in turkey, children can only watch television commercials in the presence of an adult. • in france, anyone under 16 is banned from enunciating a product name in an advertisement; they cannot wear the colours, logo, brand name or initials of any product; and they can only introduce a product in a commercial when "here exist a direct link between the product and child usage when shown together with adults". • in greece advertising of all toys was banned from 1987 until 1998, however, the ban continues on television for all toy ads before ii p.m. • in italy commercial breaks are prohibited in cartoon programmes "aimed" at children. • one of many regulations in the united kingdom state that no product or service may be advertised, and no method of advertising may be used which might no:sult in harm to children (anyone aged is or under) physically, mentally or morally, and no method of advertising may be employed which takes advantage of the natural credulity and sense ofloyalty of children. in south afriea the advertising standards authority (1996) regulates the control of advertising to children. some of the regulations relating to advertising and children are the following: • no advertisement is allowed which encourages children to enter strange places or to converse with strangers in an effort to collect coupons, wrappers, labels or the like. • no advertisement is allowed which leads children to believe that if they do not own the product advertised they would be inferior in some way to other children. • to help in the fair portrayal offree gifts for children, television advertisements should, where necessary, make it easy to see the true size of a gift: by showing it in relation to some common object against which its scale can be judged. • while it is recognised that children are not the direct purchasers of many products over which they are naturally allowed to exercise preference, care should be taken that they are not encouraged to make themselves a nuisance to other people in the interests of any particular product or service. in an r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 3 366 advertisement offering a free gift, a premium or a competition for children, the main emphasis of the advertisement must be on the product with which the offer is associated. • with regard to safety, the following regulations inler alia apply: children should not appear to be unattended in street scenes unless they are obviously old enough to be responsible for their own safety; should not be shown playing in the road unless it is clearly shown to be a play area or other safe area; and should not be shown stepping carelessly off the pavement or crossing the road without due care. children should not be seen leaning dangerously out of windows or over bridges, or climbing dangerous cliffs. small children should not be shown climbing up to high shelves or reaching up to take things from a table above their heads. medicines, disinfectants, antiseptics and caustic substances must not be shown within reach of children without close parental supervision, nor should unsupervised children be shown using these products in any way. concern about social issues and other possible negative effects of advertising on children has not been such a sensitive topic in south africa compared to other countries, especially the uk. and the usa. one issue which causes some debate from time to time, is that of tobacco advertising. van niekerk. (1997) states that tobacco companies' expenditure on advertising is a direct cause of higher cigarette consumption in south africa according to research findings of the medical research council at the university of the witwatersrand, 95 out of 1350 (7010) five-year-olds in soweto and johannesburg have already smoked. almost 20% of these youngsters indicated they would smoke when they are adults. how marketers use children in advertising the way marketers use children in advertising in various countries will obviously differ. our attention will briefly focus on two of them, namely the united states and the united kingdom. in the united kingdom the use of children in advertising is a touchy subject for politicians and for the public. according to jane bainbridge (1996) the controversy surrounding this topic was boosted when an advertisement appeared in which a child was used to put across adult ideas. in a campaign for a sweet product the agency came up with a unique idea to exite children. the new sweet commercial was set in a child's brain (green, 1996). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 367 sated nr vol 1 (1998) nr 3 one of the more than 216 ready-to-eat cereal brands in the united states of america was in danger of losing market share. a campaign called the "taste you can see" portrayed children as "in the know" able to see what adults cannot. in the spots according to wells et al. (1995), children reversed roles with stereotypical adult authority figures and taught the adults why they prefer this specific brand. a study by victor viser (1997) focused on the images of children in american magazine advertising between 1940 and 1950. because of the changing economic conditions and socio-cultural perceptions of children in the post-world war 2 united states, one of the hypotheses stated that measures of general emotions will indicate a happier, more exited child model in the advertisement in the post-war period compared to the pre-war period. the results largely confirmed this hypothesis. bovee (1995) and schiffinan and kanuk (1997) state the following reasons why advertisers in the usa recognise children (especially teenagers) as a consumer group in an extremely prosperous potential market: • teenagers spend more than $60 billion of their own money; more than 65 percent of them have a savings account; and about 20 percent of teenagers have a credit card. • they also spend a good portion of their family's money. • teenagers also influence fads and fashion in many different product categories. examples are blue jeans and music. • whereas there were an estimated 29 million teenagers in 1995, it is expected that by the year 2010 (as the baby boomer's children become teenagers), the number of teens will increase to almost 35 million. • because teens are future consumers the marketers of branded products and services are increasingly trying to secure early brand awareness and preferences with teenagers. to reach this lucrative market, advertisers have gone beyond television (the medium of choice) to specialised magazines for children, and even direct mail (wells et al. 1995). unfortunately, advertisers in south africa presently have a limited choice when it comes to selecting a specialised magazine in which their advertising messages can be conveyed to children. as far as could be established, only one magazine aimed at children exist in south africa. career guide is aimed at pupils between 14 and 16 years old. the publication, which was launched recently, contains information on careers, tertiary study opportunities as well as advertisements applicable to children (nasser, 1997). advertisers can, however, choose from quite a wide range of consumer magazines in which child actors can be used in advertisements. the modus operandi of a research project which r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 3 368 was conducted to determine how· south african advertisers address this issue will now be discussed. research methodolgy the audit bureau o/circulations o/south africa limited served as basis for the sampling procedure. a non-probability sample of consumer magazines with circulation figures of 100 000 or more over two six-month periods in 1981 and 1985 provided the research instrument for the study. all the full-page advertisements of nine consumer magazines served as the sample frame for the study. a total of 5 133 advertisements were eventually included in the sample. a content analysis of the advertisements in which child actors are portrayed was conducted over three three-month periods in 1983, 1981 and 1991. during the 1981 study a content analysis of the portrayal of children in television advertisements, as well as focus groups with children and personal interviews with advertising agencies were also conducted (north 1981). the post-apartheid analysis of the magazine advertisements was executed between june and august 1991. in order to minimise the possible sources of error (dane. 1990) great care was taken to assure that the observations are reliable and valid. the same magazines were therefore studied in the three surveys. in total 63 editions of the nine magazines (three weekly, three bi-weekly and three monthly magazines) were used for the purpose of analysis. four of the magazines cater for the afrikaans community, three for the english speaking readers and two mainly for the black community. berelson (1911) and bush et al. (1983) emphasise the fact that a content analysis is as good as the exact description of the categories. in this study the way children are portrayed in the magazine advertisements constitute the categories. according to millum (1915) the illustration in a magazine advertisement consists of four elements, namely, the model, the product, the background, and the supporting elements. these elements constituted the criteria according to which the categories (or the roles children play in the advertisements) could be described. the following categories were identified: • the child acts as a social being in the advertisement (interacting, communicating, playing or being with members of hislher family or with friends or other people). • the child is depicted as a scholar in the advertisemenl • when the child is participating or wearing suitable sports clothes helshe is a panicipant in sport. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 369 sateb nr vol i (1998) nr 3 • the child also plays the role of an animal lover. • the child is portrayed as a consumer of the product. • in some cases the child appears merely as part of the background in the advertisement. • children also act as models in testimonial advertisements (being very prominent in the illustration, but not consuming the product). to record the data a coding sheet was designed on which all the relevant data was noted under the specific columns. as a quantitative content analysis was conducted in this study, the results of the survey were put down in numerical and percentage terms. the nature and extent of the data did not justify the execution of statistical analysis. inferences were therefore made on inspection from the tables. (in two instances, though, statistical analysis were undertaken to confirm certain inferences.) results as the primary objective of this article is to describe how south african advertisers use children in advertisements in the post-apartheid period compared with the two earlier studies, special emphasis is placed on how marketers portray children of different races in the same advertisement in order to put this issue into perspective, the following results will first be addressed: • the frequency of the portrayal of children in the advertisements • the age and gender of the child models • the various roles children play in the advertisements the freqaeaey of the portrayal of c:hildren in advertisements unfortunately only a limited number of magazines that target the black community is available on the market a comparison of the number of black and white models will therefore serve no purpose. details of the frequency of the portrayal of children in the illustrations are given in table 1. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 3 table 1: frequency octbe portrayal ofc:bildren in magazine advertisements 1983 1987 1997 child models in illustrations (n= 2163) (n= 1622) (n=1348) % 0/0 % advertisements portraying 11,00 10,60 16,61 children in the illustration advertisements without 88,99 89,39 83,38 chilren in the illustration n= number of advertisements studied 370 the increase in the frequency of the portrayal of children in advertisements of approximately 50 percent from the first two periods to the third period is quite remarkable. relative to the 1983 and 1987 data, the log-linear model applied to a contingency table (on a 5% level of significance) indicated that 1997 is positively associated with the portrayal of children in magazine advertisements. marketers probably realise that the portrayal of youthfulness can increase the effectiveness of the advertisement. the findings of a study by wiles et al. (1996), in which the similarities and differences between the values portrayed in magazine advertising in the u.s. and sweden were examined. indicate that advertising more often portrays youthfulness. a majority of the models in the u.s. magazines (more than 40%) appeared to be 16 to 30 years of age. almost 21 percent were 0 to 15 years of age. marketers also seem to use children in advetising because they can be regarded as consumers in own right. they have unprecedented purchasing power and also exert a great influence on household buying decisions (ward & wackman 1972). gender and age of tbe models the results of the three studies indicate that marketers do not favour one gender over the other. obviously the nature of the product (e.g. type of clothes) will determine whether a boy or a girl will be depicted in the advertisement. in almost one third of the cases it was not possible to determine the gender of the child. (this is partly due to the fact that a large number of babies appeared in the illustrations.) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 371 sateb nr vol i {i 998) nr 3 in order to detennine the age of the models three broad categories were used: a pre.school phase, younger children in the primary school, and teenagers. the results of the studies indicate that marketers prefer to use ~school and younger children as actors in the advertisements. the use of teenagers as models for the three periods was a somewhat disappointing 27% (1984), 24% (1987) and 11% (1997). further research is needed to gain information on possible reasons why teenagers do not appear in advertisements more frequently. roles portrayed by children the results of the three studies indicate that child models are portrayed as social beings in more than half of the cases. in seventy percent of these cases the child appeared with members of his/her own family. acting as consumers of the product was the second most important role in which children are portrayed. in less than one percent of the cases children act as animal lovers and partake in sporting activities. a significant observation of the study was the fact that no black children appeared in the advertisements as animal lovers. it is also not clear why marketers of sporting goods and equipment make much more use of children in these advertisements. almost all the major sporting bodies ill south africa became professional over the last few years. much is also being done to uplift sport in the disadvantaged communities and to encourage young black people to participate in sport. sponsorships and development programmes are common practices in south africa nowadays. race of models portrayed in the advertisements in his inaugural address as the new state president of south africa, president nelson mandela stunned the whole world when he quoted from an afrikaans poem by a well·known white south african poet, ingrid jonker. the title of the poem, "die kind" (the child), perhaps gives some indication of how important children are to mr. mandel a and his new government. the focus on the upliftment of especially black children is further illustrated by the foundation of the nelson mandela children's fund. marketing to this new generation and including children of all races in advertisements is therefore expected to be part of the advertising strategies of marketers in the new south africa. is this the case or not? the answer can (at least partially) be found in table 2. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 3 372 table 2: race of child models in magazine advertisements 1983 1987 1997 race of models (n=238) (n=i72) (n=224 % % % advertisements portraying 5,04 1,16 10,71 children of different races in the illustration child models of one race 94,96 98,84 89,29 in the illustration n= number of ads portraying children the tide has certainly turned! the results indicate that a dramatic increase in the portrayal of children of different races has taken place in the post-apartheid period (11 %) compared to the apartheid era (5% in 1983 and i % in 1987). the wilcoxon rank sum test (nonnal approximation) continned that there was a higher incidence of ads in 1997 portraying children of different races in the same advertisement (p=o.oool). these figures firstly confirm the fact that the south african community is in a process of radical change, and secondly they probably indicate that marketers are beginning to realise that their advertising messages should reflect the true nature of the new south africa. however, taking cognisance of the fact that black people constitute 76 percent (1996 statistics) of the total south african population, the 89 percent portrayal of white models only can be seen as a disproportionate use of white children in advertising. although the wiles study (1996) did not look exclusively at children, the results also indicate an imbalance in the representation of race in the ads. the discretionary income of black people has increased considerably over the last few years, which opens up many opportunities for marketers. not only can adults be targeted, but marketing efforts can also be directed to get the attention of the new young generation by building brand loyalty among the adult consumers of tomorrow. by using children of a variety of races in advertisements marketers can convey their advertising messages to various target markets. these kinds of illustrations can also serve to influence black consumers to adopt a western lifestyle, which would encourage the consumption of products such as typically western clothing and vehicles. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 373 sateb nr vol 1 (1998) nr 3 during the 1997 analysis of the advertisements in which children of more than one race are portrayed, the following significant observations were made: • children of different races interact socially (they laugh and play together). this was not the case in the 1983 and 1987 studies. • children of both sexes (e.g. a black girl and a white boy) are depicted in the same advertisement. • a very surprising result was the fact that while marketers increasingly use black child models in traditionally "white" consumer magazines, using white models in a "black" magazine, though, is the exception to the rule. • in a few instances marketers made use of drawings in stead of photographs. in some of these illustrations the race of the child model is difficult to determine. in these cases it is believed that the marketer's intention could have been to create a "melting pot" that will reflect the true nature of the new south africa. further research will be necessary to confirm this hypothesis. conclusions the results presented here suggest that marketing to children and using children as models in magazine advertisements have changed quite drastically in the post-apartheid south africa since 1994. advertisements in which models of more than one race appear are beginning to reflect the ideal of a "rainbow nation". children of different races not only appear together in the same advertisement, but they interact socially, and in some cases even quite intimately. the dramatic increase in the portrayal of children of different races in the same advertisement which has taken place in the post-apartheid period (ii % in 1997 compared to the apartheid era of 5% in 1983 and a mere i % in 1987) furnishes proof of the fact that the south african community is in a process of radical change. marketers are identifying and exploring the new opportunities that have opened up with the dawn of the new south africa. the results of the study also suggest that it is becoming common practice to portray children of different races and both sexes in the same advertisement. advertisements in which only black models appear in a "white" magazine or white models in a "black" magazine were also identified. the social implications of these kinds of advertisements can be far-reaching. on average south african marketers use teenagers in the advertisements in only 11 percent of the cases. they seem to prefer to use pre-school (especially babies) and younger children as actors in the advertisements. the reason why r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 3 374 they do not make more use of teenagers (for example to promote sporting goods) is unknown and is a topic for further research. children of all ages playing the role of a participant in sport occurred in less than one percent of the cases. although the results are based on an analysis of one medium only, it is believed that they are representative of other mediums of advertising, for example television advertising. it is recommended that a repeat study of the 1987 study in which the use of children in television advertising was conducted be done to test the abovementioned hypothesis. further research is also needed to investigate children's advertising on the internet. according to fitzgerald ( 1996) the debate over how advertisers can target children in cyberspace (as a group, they are known as "cybertots") is heating up in europe as well as the united states. belch and belch (1998) report that children's advocacy groups in the u.s. are very ctitical of marketer's online activities such as seeking household information from kids or using characters in advertisements to reach children. the report issued by the center for media education is entitled the "web of deception". in the south african context, future research could focus on the following: • the role (or possible influence) of culture in advertising to children; • comparing the values portrayed in advertising to children of different races; and • the "westemisation" of advertising practices when advertising to black children only. the council of better business bureaus (bovee 1995) suggests that marketers who are concerned about proceeding according to ethical guidelines when marketing to children should adhere to the following guidelines: the level of knowledge and maturity of the audience should be taken into account; positive social images, such as kindness, justice, generosity, and respect for others should be included, and, wherever possible, the advertisement should be as truthful and accurate as possible. the portrayal of children in mixed-race advertisements that reflect real-life situations can further the cause of truthfulness and accuracy in the south african advertising industry. and finally, the following guidelines are offered to marketers who wish to portray children in advertisements: be sensitive to feature children in commercials that advertise products primarily for the adult market segment; where applicable, children should be depicted in situations where positive parent/child or teacher/child relationships are enhanced; and marketers are urged to be sensitive when it comes to racial stereotyping and multicultural representation of children in advertising. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 375 sa 'leb nr yol i (1998) nr 3 references 1. bainbridge, j. 1996. controversy is child's play. marketing. june: 13. 2. belch, g & belch, m. 1998. introduction to advertising and promotion. (4th. edition). chicago: irwin 3. berelson, b. 1971. content analysis in communication research. new york: hamer publishing. 4. bovee, c. l., houston, m.j & thill, j.y. 1995. marketing, (second edition). new york: mcgraw-hill. 5. bovee, c.l .• till, j.y., dovel,g.p. & wood, m.b. 1995. advertising excellence. new york: mcgraw-hill. 6. bradley, f. 1995. marketing management. providing communicating and delivering value. englewoord cliffs, nj.: prentice-hall. 7. bush, a. j., ~ j. f. & busch, r.r. 1983. a content analysis of animation in television advertising. journal of advertising .. (4): 20-26. industrial marketing management, july: 145-149. 8. dane, f. c. 1990. research methods. california: wadsworth. 9. fitzgerald, n. 1996. kid's stuff on the global stage. world trade, (9)6: 82. 10. green, h. 1996. rowntrees ad looks to excite children. campaign london, april: 9. 11. johnstone, h. 1996. 'little emperors' call the shots. asian business, september: 67-70. 12. millum, t. 1975. images of woman. advertising in women's magazines. london: chatto & wmdus. 13. north, e. j. 1987. unpublished d. com. dissertation. university of south africa, pretoria. 14. nasser, d. 1997. the medium for school children. marketplace, april: 18. 15. rajeey, b., myers, j.g. & aaker, d.a. 1996. advertising management (fifth edition). englewood cliffs, nj.: prentice-hall. 16. schiffman, l.g. & k.anuk, l.l. 1997. consumer behavior (sixth edition). englewood cliffs, nj.: prentice-hall. 17. the advertising standards authority of south africa. 1996. regulations for the advertising industry. johannesburg: butterworths. 18. y an niekerk, m. 1997. advertensies laat glo meer rook. finansies en tegnielc:, augustus: 29. 19. viser, y. 1997. mode of address. emotion and styjistics. images of children in american magazine advertising 1940-1950. communication research .. {24)1: 83-101. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 3 376 20. ward, s. & wackman, d.b. (1972). children's purchase influence attempts and parental yielding. journal of marketing research (9)3:316-319. 21. wells, w., burneti, j. & moriarty, s. 1995. advertising. principles and practice (third edition). englewood cliffs, nj.: prenticehall. 22. wiles, c. r., wiles, j.a. & tjernland, a. 1996. the ideology of advertising: the united states and sweden. journal of advertising research (36)3:57-66. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr vol 1 (1998) nr 1 neosynthesis in economic theory* vkedik tallinn technical university, estonia abstract the large-scale transition from the system of (real) socialism to that of (mixed) capitalism was launched in central and eastern europe in 1989, followed by the erstwhile republics of the ussr two years later. these developments also served to open the previously closed book of socialist economics to objective study and research. much has been written on the subject by economists on both sides of the one-time iron curtain. but what are the impressions of an insider looking out'? it may come as a surprise that he might view the theoretical foundations of the market economy with serious misgivings. history knows many ciyil upheavals, s<kalled social earthquakes. the world has seen deadly famine, eruptions of violence, the rise and fall of regimes, collapse of monetary systems, waves of bankruptcy, massive unemployment, devastating misery and all kinds of disequilibrium. today's world is obviously confronted by numerous perils too. at the same time, however, such upheavals serve to stimulate the human mind: old ideas succumb to periodic shocks and this triggers the search for new ideas. seeing that every radical change is one man's meat and another one's poison, historical turning-points are accompanied with fierce conflicts of ideas. attack and defence are inseparable companions of progress. in the realm of theory, this means clashes between different schools of thought. however, reconciliation may also take place. furthermore, what was once *translated from esmnian by m.l. truu. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 2 sajems ns vol i (1998) no i thought antiquared, may become modem again. all these, and many more, are among the innwnerable facets of life. it is particularly those cases where seemingly incompatible standpoints prove capable of reconciliation after all, that are of interest in the context of the present topic. depending on one's point of view, (e.g. proprietorial vs. managerial), these are circumstances that give rise to various systemic components that are complementary to one another. the precondition for the neosynthesis in economic theory proposed in this article, has been the disappearance of erunity between the rival economic systems of the world. words that signify reconciliation are integration, multifonnity, compromise, symbiosis, synthesis and, in particular, system. words with the opposite connotation include eclecticism, conglomerate, alogism, ideology, scholasticism and any other term that signifies the lack of system. frequent causes of inaccuracy or error are deliberare distortion motivared by narrow-minded self-interest, the conscious suppression of unwelcome facts, substituting a half-truth for the whole truth, escape from the harshness of real life into an agreeable world of fantasy, in other words, self-deception or surrender to an illusion. it is, of course, not possible to rule out innocent mistakes due to lack of comprehension or deficient information. moreover, truth, like everything else, has the propensity to run its course and then come to an end. consider some examples of ageing and obsolescence. did confucius err when he thought that patriarchal succession was tantamount to a divine right? did homer err in his belief that wars of plunder were the mainspring of wealth? did plato and aristotle err when they classified working instruments into tools that were dumb, made sounds and could speak? did thomas aquinas err in his conviction that ecclesiastical power was superior to secular power? did quesnay err in assuming the landlords to be the foundation on which the whole economy rests? did marx err when he ascribed the same function to the proletariat? did keynes err when he thought government regulation would prove the salvation of the economy? one must evidently conclude that all these thinkers expressed the particular circumstances of their time with a great deal of accuracy. it would, however, go against nature to expect that what was considered to be true at a given time in the past, should remain so until the present day. in the field of economics, abiding truths are very rare if they exist at all. more often than not, misconceptions arise whenever an accepted truth is wrenched from its historical background and judged by present-day standards. by shaping life, time also shapes people and their beliefs. if keynes had lived today, would he stili have taken the same position as r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr vol 1 (1998) nr 1 3 during the 1930s? hardly so, for every stage of historical development gives birth to new ideas. consider now, four theoretically significant episodes in economic history, each one tantamount to a social earthquake. they are (1) the capital accumulation during the last agony of feudalism, (2) the revolutionary wave that rushed through europe in 1848, (3) the great depression and (4) the collapse of sovietism. the first of these triggered a feverish search for order (to avert chaos), the second led to a quest for harmony (to escape revolutionary upheaval), the third a renewed search for order (to prevent chaos from degenerating into ruin), the fourth a search for betterment (to avoid a hand-to-mouth existence among the wreckage of the command economy). as always, the alarms and fears produced by these upheavals too, caused ever more innovative ways of thinking to develop. the search for order in a free market led to the discovery of the "invisible hand". however, not even adam smith himself considered this to be a completely reliable or sufficient regulator per se, but preferred two-handed to onehanded regulation after all. in point of fact, he associated the role of the so-called visible hand with enforceable contracts, which in turn presupposed the rule of law within a state. at the same time, smith wamed mankind not to overestimate the self-regulating potential of the market. unfortunately the warning went unheeded, resulting in the harsh social anomalies analysed by marx later on. following the scare of 1848, an infant called microeconomics also known by the name of marginal ism came into the world in 1870. seeing that mathematics is a science with an exceptionally harmonious intemal structure, it was decided to explore the same source for an equally harmonious model that would fit the economy too. this is humanly understandable. unfortunately models of this kind are, however, confined to the frictionless world of abstract thought, where they exist in splendid isolation like the gods of antiquity. they cannot smooth over the rough parts of real life. moreover, in spite of much effort, nobody has ever invented a generally accepted scale for measuring subjective utility. yet, science is said to begin only there, where objective measurement begins. therefore, not much more could be expected from microeconomics than its analytical methods based on marginal concepts, since it exemplifies form without content, a so-called empty box. marshall, moreover. drew an explicit distinction between function and causation, arguing that economics is a bundle of such complex mutual relations that it may just not be possible to separate cause and effect. are things really so bad? descartes, in any case, taught that everything is open to question. the input which enters a system is the direct cause that determines the nature of the output r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 4 sajems ns vol i (1998) no 1 which emerges from it. feedback, in contrast, only serves to correct an input without being its primary cause in the process. systems analysis gives both these relationships a raison d'elre, at the same time helping us distinguish functionality from causality. general systems theory was stili unknown in marshall's day. we may note in passing, that the estonian encyclopedia, (ee, 1992 : 340) describes microeconomics as an inadequate theory, on account of the dogmatic capitivity with which it is associated. substantially the same verdict is returned by the finnish economists pikkarinen1 and sutela2 • they observe that, against expectations, microeconomics is dominated not by positive but by normative reasoning after all, which runs counter to the method of the exact sciences. (the marginal approach implies either a partly canonical, or largely a piously wishful, modus operandi.) in the end, there is no dynamic analysis here, despite marshall's introduction of the time factor. consequently, microeconomics failed to live up to its historic mission. its harmonic foundations were undermined by business cycles time and again. the great depression dealt the harmonious marginalist model a staggering blow. showing up the utter vulnerability of the theory in the face of rigorous trials. on both sides of the atlantic it was realised, more or less simultaneously, that without the aid of the ''visible hand" of state intervention, the economy cannot in fact be pulled out of depression. this gave birth to roosevelt's new deal programme in america and keynesian macroeconomic regulation in europe. both models reconciled proand retroactive intervention, thus laying the foundation of a comprehensive policy. the differences between the american and european models were matters of form rather than content. both models would, when the time came, prove to have their inevitable historical shortcomings in common too. in the context of a mixed economy, neoliberalism came to offer some fresh policy options, epitomised by freedman's monetary model in the united states and the eucken-erhard, ordo-liberal3 model (or the social market economy) in central europe. as always, these variants also had their strong and weak points. come what may, the future demands that a model should be adaptable to changing times. progress never ends: technological innovations give rise to chain reactions that continously spread their effects to the economy too. _ a harsh and in some ways bitter lesson was learned from the fourth social earthquake mentioned above. this once more served to expose the manifest weakness of theory. neither micronor macroeconomics is able to suggest any, at all sensible, solutions to the economies-of-transition4 today. something vital is missing. what can it be? the answer seems to be universality. it is precisely the lack of universality that obstructs the discovery of models powerful enough to fit r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr vol 1 (1998) nr 1 5 untypical siruations too. the neoclassical synthesis represented only a very slight movement in the direction of universality. life today demands a much more farreaching neosynthesis. above all, neosynthesis calls for the renouncement of the artificial and quite unnescessary antagonisms that have taken root in micro-macroeconomics, which are purely ideologically (and therefore unscientifically) motivated. recall the abovementioned contrast between functionality and causality. we may take gossen's laws as a case in point. although gossen himself expressed them in functional form, they might as well be causally interpreted. on the other hand. there is no reason to contrast franklin's law of value with the law of demand-andsupply. firstly, the two laws are easily reconciled and, secondly. it is possible to interpret both of them causally. what has been said here, applies to all known laws in general, whether subjective or objective in kind. world-wide agreement, as a criterion of truth. has for the present rejected all extreme forms of one-sided regulation as inefficient. solutions with outcomes that are efficient enough, are as a rule to be found on the so-called combined micro-macro or macro-micro wave bands. differences are limited to matters of emphasis, depending on whether the "thick end of the stick" that is macroeconomic power happens to be in the hand of the government or the banking sector. a balanced division of power is also conceivable. in transitional countries, including estonia, the call for moderation has often been ignored for typically political, selfish or ideological reasons. this is tantamount to gambling. it has meant leaping in the dark, cutting comers or trying to run before one can walk, irrespective of how long one's resources or luck may last. the result has been several misadventures. a major disservice to the estonian economy has been the singularly extremist restitution manias, which provoked the concomitant reaction of deepening apathy. much self-deception emanated from the simple fact that nobody can turn back the wheel of history . the state of public responsibility leaves much to be desired. disjointed legislation paves the way for irresponsible siruations. one of my articles in 1992 bore the tide "contract power will save estonia". nevertheless, the republic of estonia has not yet managed to pass a law of contracts. someone apparently likes fishing in troubled waters. let us, however, return to the subject of neosynthesis. instead of confrontation and exclusion. we now need to augment economic theory materially, to extend its universality. whereas great purges in the past have often thrown out the baby with the bath water , it seems worthwhile starting the quest for renewal precisely among these ejected babies. recall examples like historicism, causal r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 6 sajems ns vol i (1998) no 1 analysis, the invariable· measure of value, multiplication of services, social economics; to which may be added institutionalism, conflicting objectives, the commodity theory of money, vent for surplus, entrepreneurship and innovation, utopian socialism, and interindustry analysis the flow of trade that links all sectors of the economy. in contrast, the smithian approach restricts analysis to the flow of the final product, thus excluding analysis of intermediate product flows. say's theory of production gave rise to a series of production function models which, despite subsequent improvements, remained full of holes. although energy has come to represent an increasingly significant production factor in the world today. this has not been reflected as a major development in its own right. the human contribution, however, is reduced to the same level as those of machines, animals and land. it is impossible to call this a theory in which the human being really plays a central part. neosynthesis, on the other hand, makes it possible to view all factors, without exception, through a human-centred prism. moreover, it also allows one to draw a parallel with unified field theory, according to which the universal source of information consists of the trinity: energy, motion and mass. it appears that the economy may be analogously described as q = fle(l, k, e')n] where q is the output (quantitative, qualitative) of the ecooomy, e contribution of energy sources that serve to release human energy, l direct, creative contribution of live human labour, k indirect contribution of past labour embodied in capital, e' activating, creative contribution of entrepreneurship, n passive contribution of land and all natural resources. considering the fact that the triad (l, k, e') in a sense amounts to an internally homogeneous term that expresses the triune cause of economic movement, then its analogy with the basic idea of the unified field theory, as the triune source of knowledge, becomes almost complete. the key to neosynthesis is in fact a catholic or pervasive anthropocentrism: in the economy everything begins, and likewise ends, with man. where man does not go, neither money nor anything else at all related to the economy is to be found. the human being is the alpha and omega of ecooomic life. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr vol 1 (1998) nr 1 7 against this background, there is reason to assert that the chief impediment to the successful development of economic transition is also a human factor. known as homo postsovieticus. this phenomenon is encountered at all tiers of the social edifice, including top government level. a mentality of greed has gained ground in estonia and stubbornly refuses to retreat before creative thought, without the official codification of economic incentives. but the normalisation thereof is in turn hampered by corrupt self-interest. hedonistic machinations prevent strategic considerations from gaining ground to a suffiecient extent. incidentally, one-sided and peremptory deregulation is not compatible with general systems theory either, for any complex system is known to fail without the necessary regulation. the present is a time that requires us to take a broader view and to show a bener grasp of various acute and painful problems, than micromacroeconomic theory is capable of providing. the following is the fundamental problem that characterises the transition programmes of the countries embarked on this process: how to achieve the metamorphosis from a fortune-seeking or apathetic homo postsovieticus to a soberly calculating and creatively acting homo oeconomicus. thanks precisely to its consistently anthropocentric nature, the theory of neosynthesis may yet, at least to an extent, assist the search for solutions conducive to the discovery of such a turning-point. endnotes 2 4 jukka pikkarinen, director, labour institute for economic research, helsinki. pekka sutela, research officer, bank of finland, helsinki. in 1948 the german economist walter eucken founded the ordo yearbook, whose title refers to the word and social concept "order". i.e., economies in transition from the system of (real) socialism to that of (mixed) capitalism. the official policy since estonia regained independence in 1991, aimed at restoring to the previous owners or their descendants property confiscated by the soviet union after it had annexed the baltic states in 1940. reference eesti entsilklopeedia (ee), vol 6. (1992). tallinn: kirjastus "valgus". r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 407 measuring consumer attitudes toward money ggrousseau department of industrial psychology, university of port elizabeth djl venter institute for statistical consultation and methodology, university of port elizabeth abstract the main objective of this study is to compare attitudes toward money amongst english, afrikaans and xhosa-speaking consumers in the eastern cape. based on literature in the field, hypotheses were generated for four dimensions of a money attitude scale (mas) developed by yamauchi and templer. the scale was modified and applied to a convenience sample (n=326) of respondents in the port elizabethluitenhage area. results showed significant differences between the various groups for three of the four dimensions of the scale. results further suggest that the money attitude scale is a reliable instrument for measuring consumer attitudes toward money in south africa. implications are that more attention should be paid to educating consumers in the eastern cape on personal money management. introduction private consumption expenditure is an important element of total demand in the economy. in south africa, more than 50 per cent of the gross domestic product (gdp) is consumed by private individuals. in this way, private consumption expenditure can playa decisive role in the economic fortunes of any country. ultimately, private consumption expenditure is influenced by both the ability and willingness to spend. as far as ability to spend is concerned, real disposable income is the most important determining factor. willingness to spend or save depends to a large extent on levels of confidence or lack thereof which individuals hold of an economy (du plessis, rousseau & blem, 1995). looking at the current south african demographic situation, a trend emerges of the higher income groups ageing while the lower income groups are still relatively young. the latter, which represent the largest segment of the population, are net borrowers of money. their need for education, increased life expectations and relatively low per capita income, make their ability to save r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 408 sajems ns vol 2 (1999) no 3 minimal with most money spent on necessities. the middle income economically active segment of the population also shows a low saving pattern. due to the high inflation rates of the 1980s, consumers fell into the habit of living on credit to maintain their living standards. this lead to a drop in the savings ratio from 10.8% in 1980 to 2.6% in 1992. currently it is estimated that private household debt in relation to personal disposable income is as high as 66%. in 1992 it was only 53% and in 1987,43% (swart, 1997). the argument that people in the poor rural communities do not have surpluses available for saving, is generally untrue according to davel (1996). access to saving facilities is often the real problem. many banks will not allow savers to open accounts without proof of employment which excludes anyone with their own informal sector business. other institutions such as peoples banks place a minimum initial deposit requirement of rl 000,00 on its club accounts. the author concludes that the demand for appropriately structured saving facilities is not being met, resulting in the existence of a number of illegal banks specialising in the deposit mobilisation at the lower end of the market. this trend further inhibits confidence in saving behaviour. from the above, it seems as though there is a decreasing trend in the saving patterns and investment contributions amongst south african consumers. this has put the country's economy in a very vulnerable position as economic growth now relies heavily on foreign investments. from a consumer affairs standpoint, it is of interest to know how consumers view money, and whether different ethnic groups such as xhosa speaking, english and afrikaans speaking consumers display different attitudes towards money and saving behaviour. conceptualisation of attitudes to money many conceptualisation studies of money attitudes by economists (finn, 1992), anthropologists (crump, 1992), sociologists (baker & jimerson, 1992) and psychoanalysts (bornemann, 1977 and doyle, 1992) have despite their different approaches, concluded that understanding behaviour related to money is hardly rational; it is rather the result of powerful and often unrecognised (emotional) forces that reside deep in the psyches of individuals. william kaufman (1997) states that the symbolic meaning of money to the individual and the manner in which he uses it, are determined by his culture, religion, the attitudes of parents and teachers, his life experiences (including the impact of the media of mass communication), the example of the people he knows and by his short and longterm goals. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 409 penaloza (1994) in a study on mexican immigrants' acculturation, found that knowledge of fmandal options and terms as well as trust in financial institutions affected their use of financial services. there was much confusion between bank and retail store credit cards. immigrants were not familiar with american money; they found it strange that a little coin (a dime) could be worth more than a nickel. many mexican immigrants also associated credit with american materialism of which they disapproved. these fmdings reflect the important role of culture in people's perceptions and attitudes towards money. much of what we call emotional security is soundly backed by the proper uses of money. even part of what we call love and affection in parents stems from their ability to spend wisely for the benefit of their children. the proper use of money creates the individual a sense of well-being and emotional security. many individuals however also develop emotional and psychosomatic disorders (compulsive spending, gambling, unethical and illegal activities) as a result of their inability to cope with money problems or failure in business transactions. there seems to be a consensus among scholars that attitudes towards money are a complex multidimensional concept that elicit both positive (e.g. freedom, love, success) and negative (e.g. distrust, inadequacy, failure) feelings in people. it further seems as though the emotional and psychological value of money for many consumers, far exceeds its relative economic (rational) value (medina, saegert and gresham, 1996). empirical studies on money attitudes empirical research in the field has focused mainly on developing a suitable instrument for measuring money attitudes as well as comparing the attitudes of different cultural groups towards the construct. yamauchi and templer (1982) developed the original mas (money attitude scale) and claimed that attitudes towards money are essentially independent of a person's income. gresham and fontenot (1989) refined the money attitude scale and applied it to a group of mexican-americans and anglo-americans. medina, saegert and gresham (1996) in a follow-up study identified four factors along the money attitude scale, namely, power/prestige, retention/time, distrust/anxiety and quality. mexican americans scored lower than anglo-americans on the retention/time and quality factors. another scale termed a money ethic scale (mes) was developed by thomas tang (1992) to test the influence of demographic variables such as age and gender on the management of money. the author found a relation between age and attitude towards money. in a follow-up study (tang, 1993), differences and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 410 sajems ns vol 2 (1999) no 3 similarities were found between a sample of chinese and american workers in their attitudes to money. six factors emerged from the money ethic scale, namely, good, evil, achievement, respect, budget and freedom. tang concludes that income, work ethic, social, political and religious values have a strong influence on how people perceive money. in south africa, visser (1977) investigated possible differences between the meaning of money amongst students at the university of western cape and the university of stellenbosch. the author applied fifteen dimensions of the semantic differential attitude scale to a sample of 128 white students and 102 coloured students. no difference in the global meaning of money between the two groups were found, suggesting that both groups held closer views on the value of money than were initially expected. rousseau (1996) found price consciousness and bargain hunting to be two of five main factors influencing levels of consumer awareness amongst all population groups in south africa. the influence of certain demographic variables such as age and income however impacted on these factors. price consciousness, for example, was highest amongst respondents in the low to middle income categories and the older age brackets. they were mainly females. bargain hunting again featured prominently amongst larger households in the low-income category. from the above overview, it seems as though socio-demographical variables like culture, income, age and gender may well relate to money attitudes. the main objective of this study is to compare attitudes towards money amongst three language groups in the eastern cape province of south africa. these groups represent different cultural backgrounds which may impact on their attitudes towards money. the present study used a similar version of the money attitude scale (mas) applied by medina, saegert and gresham (1996) in their comparison of mexican and anglo american's attitudes towards money. based on previous research in the field, the following design hypothesis was set: there are significant differences between the attitudes towards money amongst the three language groups in the sample. method the item scale developed and used in previous studies (yamauchi & templer, 1982; gresham & fontenot, 1989 and medina, saegert and gresham, 1996) were modified for application in south africa. the scale was reduced from a seven point to a five point rating scale. malhotra (1996) suggest that in developing countries such as south africa, preference should be given to less r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 411 sophisticated scales like ordinal or simplified interval scales. opinion fonnation may not be weu crystauised in these countries due to a lower level of education and consumer sophistication. the questionnaire was translated from the original english version into afrikaans and xhosa to accommodate respondents from these language groups too. in order to avoid translation errors, the procedure of back-translation as suggested by malhotra, agarwal & peterson (1996) was followed. the money attitude scale is a 3d-item scale that measures attitudes towards four money dimensions, namely, power/prestige, retention/time, distrust/anxiety and quality. to detennine whether these four previously identified factors can be calculated accurately and reliably using the original 3d items, item analysis was perfonned for each of the factors individuauy. the analyses were perfonned to: (i) detennine whether any items should be excluded, which was done by means of principal component factor analysis and item versus scale minus item correlations; (ii) test the reliability offactors by means ofcronbach's coefficient alpha. one way analysis of variance and pearson t-tests were used to detennine the statistical significance of differences in factor scores between various levels of the demographic variables. analysis of variance was used to identify the demographic variables which were significantly related to factor scores. sample: a non-probability convenience sample (n=326) was drawn from the port elizabethluitenhage metropolis is. the sample though was stratified to include au the important sub-populations in the area. respondents were selected from the upper, middle and lower income groups residing in various suburban areas and townships in the region. they were also representative of the three main languages spoken in the province. procedure: fieldwork was carried out by students of the university of port elizabeth and officials of the consumer protection office in port elizabeth. au the fieldworkers were properly briefed on sample selection and interview procedures. households in various residential areas were chosen for interviewing. only one respondent per household, either husband or wife, completed the questionnaire. consumers from the selected households completed questionnaires in their home language (english, afrikaans or xhosa). in cases where respondents did not understand a question, they were allowed to r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 412 sajems ns vol 2 (1999) no 3 compare the phrasing with that of a questionnaire printed in one of the other languages. respondents were asked to rate each of the thirty items in the questionnaire on a five point likert type scale ranging from agree completely to disagree completely. field workers explained to respondents that there were no right or wrong answers to the questions in the questionnaire. the only answer that was important was the one that gave a true reflection of how the respondent felt about the question. demographic information was also obtained from respondents regarding household size, income, age, education and gender. data analysis: data analysis employed the computer programme bmdp 4m (frane, lenrich & samson, 1985) to perform factor analysis of the item sample. the method of principal component analysis was used with direct quartimin rotation. the bmdp programme 4m was also used to calculate item versus scale-minus-item pearson moment correlations. cronbach's coefficient alpha was also calculated to determine reliability of the various sub-scales. the bmdp programme id was then used to calculate mean factor scores for the various socio-demographic variables. these results are shown in table 3. programme 2v was subsequently used to perform analysis of variance (anov a) to investigate which of the socio-demographic variables are significantly related to the various factors. these results are shown in table 4. to test the statistical significance of factor score differences between the various socio-demographic groups (including language groups) one way analysis of variance (anov a program 7d) and pearson t-tests (program 3d) were performed. these results are also summarised in table 3. results table 1 shows the descriptive statistics and correlations. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 table 1 descriptive statistics and correlations correlations facmean s.d. 1 tor 1 power 2.1963 0.9620 prestill;e 2 retention 3.5758 0.9268 -0.1527** time 3 distrust 3.1322 0.7295 0.3844** anxiety 4 quality • 3.5758 0.9268 0.1707** n=326 * significant at 95% c.l. (r>=0.1090) ** significant at 99% c.l. (r>=o.1425) 2 0.1527** 0.1948** 0.1137* 413 3 4 0.3844** 0.1707** 10.1948** i 0.1137 * 0.1474** 0.1474** as can be seen from the table, moderate significant positive correlations between all factors occur except between power/prestige and retention time. a possible explanation for the negative correlation in the latter case may be the fact that respondents who regard money as a powerful prestige factor, may view saving and money retention for the future as less important. people want the material benefit of money now, therefore, they rather spend than save it for future benefit. table 2 shows the four factor analyses performed, one for each factor. direct quartimin rotation and principal component extraction was used. the analyses confirmed that all items loaded significantly on the applicable scale, the lowest factor loading being 0.317. the cronbach's alphas for factors one, two and three were all above 0.70 while for factor four, the value of 0.69 can also be regarded as acceptable. this confirms the reliability of the four scales. the percentage of total variance explained by factors one, two and four are all acceptable. for factor three, factor analysis indicated that the scale may be subdivided into two sub-scales, but for reasons of comparison with previous research, the sub-division was not affected. table 3 shows matrices of factor mean scores for demographic variables obtained from the sample and also indicates which factor score differences between the various socio-demographic categories are significant. in the table a low score indicates a negative response while a high score indicates a positive response. (the five point rating scale used in the questionnaire comprised verbal anchor points ranging from agree completely to disagree completely.) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 414 sajems ns vol 2 (1999) no 3 table 2 oblique rotated factor matrix: measures of money attitudes criterion factor 1 factor 2 factor 3 factor 4 powerl retention! distrust! quality prestige time anxiety item 1. i tend to judge people by their money 0.750 rather than their deeds 2. i behave as if money were the ultimate 0.697 symbol of success 3. i find that i seem to pay more respect 0.700 for those people who possess more money than i do 4. i own smart things in order to impress 0.788 others 5. i purchase things because i know they 0.741 will impress others 6. people that know me tell me that i 0.737 place too much emphasis on the amount of money people have, as a sign of their success 7. i enjoy telling people about the money 0.654 i make 8. i try to find out if other people make 0.706 more money than i do 9. i put money aside on a regular basis for the future 10. i do financial planning for the future ii. i save now to prepare for myoid age 12. i have money available in the event of an economic depression 13. i follow a careful financial budget 14. i am cautious with the money i spend 15. i keep track of my money 16. it bothers me when i discover i could have got something for less, elsewhere 17. i complain about the cost of things i buy 18. i show worrisome behaviour when it comes to money 19. i worry about not being financially secure 0.778 0.753 0.751 0.625 0.740 0.624 0.607 0.461 0.478 0.680 0.664 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 table 2 continued criterion 20. when i make a major purchase i have a suspicion that i've been taken advantage of 21. i show signs of anxiety when i don't have enough money 22. after buying something, i wonder if i could have got the same for less elsewhere 23. i hesitate to spend money, even on necessities 24. it is hard for me to refuse a bargain 25. i automatically say "i can't afford it" whether i can or not 26. i am willing to spend more to get the very best 27. i buy top-ofthe-line products 28. i buy national brand products 129. i pay more for some things because i . know i have to in order to get the best 30. i buy the most expensive items available percentage of total variance explained cronbach's coefficient alpha ! factor 1 factor 2 powerl retention! presti2e time 52.2% 0.87 49.0% 0.82 415 factor 3 factor 4 distrust! quality anxiety 0.629 0.573 0.631 0.526 0.317 0.483 0.643 0.790 0.618 0.705 0.591 30.8% 45.3% 0.74 0.69 sample size n=326 ______ -'-__ --'-____ '-__ --'-__ -j r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 416 table 3 language: afrikaans english xhosa household size: 1-2 3-4 5+ age: -25 yrs 26-40 41-55 56-70+ education: primaryl secondary tertiary income: lower middle upper gender: male female total sample significant differences: language sajems ns vol 2 (1999) no 3 descriptive statistics by language, household size, income, age, education and gender factor 1 factor 2 factor 3 factor 4 powerl retention! distrust! quality prestige time anxiety n mean so mean so mean so mean so 73 1.68a ! 0.76 3.54 1.01 2.88a 0.78 3.11 0.90 157 2.04b 0.91 3.57 0.95 3. lob 0.69 3.31 0.81 96 2.84c 0.84 3.60 0.82 3.37c 0.69 3.30 0.78 95 1.92d 0.92 3.58 1.06 3.05d 0.78 3.28 0.78 175 2.42e 0.96 3.52 0.86 3.0ge 0.69 3.29 0.80 55 1.94f 0.84 3.77 0.88 3.38f 0.71 3.13 0.97 93 1.91g 0.73 3.25g 0.99 3.08 0.67 3.27 0.85 129 2.44h 1.02 3.60h 0.87 3.18 0.73 3.31 0.77 83 2.16 1.00 3.78i 0.82 3.03 0.77 3.16 0.88 19 2.05 1.04 4.20j 0.85 3.34 0.70 3.31 0.81 135 2.34k 1.02 3.57 0.89 3.15 0.74 3.18 0.92 190 2.091 0.90 3.59 0.96 3.12 0.72 3.32 0.75 21 2.58m 1.08 1 3 .33 l.l7 3.65m 0.78 3.12 0.90 179 2.38n 0.95 3.44n 0.82 3.09n 0.68 3.20 0.84 125 1.850 0.85 3.810 0.99 3.090 0.76 3.38 0.78 140 2.32p 0.96 3.59 0.96 3.09 0.72 3.32 0.77 183 2.loq 0.95 3.56 0.91 3.16 0.74 3.21 0.86 326 2.20 0.96 3.58 0.93 3.13 0.93 3.26 0.82 **ab ac bc **ac; "'bc household size **deef **dfef age **gh **gi gj; "'gh ij education "'kl income "''''mono "''''no "''''mono gender **pq lower case letters indicate significant differences according to anov a scheffe tests or t-tests. ("'p < 0.05, "''''p < 0.01) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 417 from table 3 it can be seen that male xhosa speaking respondents, from a household size of three to four, in the 26 to 40 year age bracket, with a primary school education, and from the lower income group regarded money as an important power/prestige factor. with regard to factor two it seems that retention time scored highest amongst elderly respondents in the upper income group. this may imply that these people regard saving money as an important investment for the future. factor three (distrust/anxiety) represents a "worrying attitude" towards personal money matters. here it seems as though xhosa speaking respondents in the lower income bracket from large households, are most worrisome and careful about spending money. as far as money expenditure is associated with quality goods (factor four), english speaking upper income respondents with a tertiary education scored the highest on this factor. it is interesting to note though, that no significant relationships exist between factor four and the various sociodemographical variables. this indicates the homogeneity of the factor amongst the socio-demographic variables. table 4 demographic variables language household size income age education gender error analysis of variance to determine relationships between sociodemographic variables and money attitudes factor 1 factor 2 factor 3: disfactor 4 powerlprestige retentionltime trustj anxiety quality df f p f p f p f p 2 21.6 0.0000-0.1 0.8420 7.0 0.0010-3.1 0.04452 7.97 0.0004-2.4 0.886 2.2 0.1060 l.l 0.3224 i 4.26 0.01504.4 0.01203.4 0.03223.5 0.02902 1.95 0.1213 8.7 0.0000-1.7 0.1535 0.8 0.4860 3 0.89 oj457 1.9 0.1665 0.0 0.8757 oj 0.5759 i 2.51 0.1145 0.0 0.8498 0.7 0.3967 0.8 0.3546 310 *p<0.05; **p<o.oi table 4 shows which of the socio-demographic variables are significantly related to factor scores. from table 4 it can be seen that language is significantly related to power/prestige (factor one), distrust/anxiety (factor three) and quality (factor four); household size is significantly related to power/prestige (factor one); age significantly related to retention/time (factor r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 418 sajems ns vol 2 (1999) no 3 significantly related to all four factors (power/prestige, retention/time, distrust/anxiety and quality). table 3 shows significant differences between language groups, household size, age, education and income groups as well as between males and females for factor one (power/prestige). age and income categories differ significantly on factor two (retention/time) while language categories, household size and income groups differ significantly on factor three (distrust/anxiety). the differences observed in table 3 indicate the important role which money plays in consumers' perceptions and attitudes of how it may influence their life style. for example, respondents with a primary school education hold significantly different views on how the power/prestige value of money may influence their lives, in comparison to those with a tertiary education. likewise, low-income respondents regard the power/prestige and distrust/anxiety value of money as significantly different from upper income respondents. the fact that significant differences were observed between language and income groups on two of the factors (power/ prestige and anxiety/distrust) on the attitude scale, further suggests the different underlying influence of cultural and economic factors on the money construct. a comparison of the results of the present study with those of medina, saegert and gresham (1996) shows that while these authors found significant differences between anglo and mexican americans on the retention/time and quality factors, our study shows significant differences between afrikaans, english and xhosa speaking south africans on the power/prestige and distrust/anxiety factors. although it lies beyond the scope of this study to speculate about reasons for these differences, the results of both studies suggest the underlying role of cultural influences. hypothesis testing: based on the findings of the present study, the design hypothesis stating that significant differences exist between the attitudes towards money amongst the three language groups in the sample, may be partially accepted. significant differences were in fact observed on three of the four factors of the attitude scale. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vo12 (1999) no 3 419 conclusion the main objective of this study was to compare attitudes towards money among english, afrikaans and xhosa speaking consumers in the eastern cape province of south africa. the study was initiated by the observed declining saving pattern and increase in debt amongst consumers in general and more particular in the eastern cape. this trend of dissaving has made south africa's domestic economy highly dependent on foreign investment. excessive debt and lack of saving is often indicative of poor personal money management. because consumer organisations recognise the important role they have to play in educating consumers in a broad spectrum of consumer issues, including how to practice sound personal money matters, the consumer protection committee of the eastern cape spearheaded this research project. it is important to recognise that the findings of the study are pertinent only to consumers in the region and not necessarily to the larger consumer population. the study was based on similar research carried out in the united states (yamauchi & templer, 1982; medina, saegert and gresham, 1996) and used a modified version of a measuring instrument (mas) developed by these researchers. due to vast differences in the sample populations of the present study and the studies carried out abroad, only limited comparisons could be made. the results of the present study do show that the money attitude scale (mas) can be used as a reliable instrument for the measurement of attitudes towards money in south africa. all items loaded significantly on the applicable scale and the cronbach's coefficient alphas all fell within an acceptable range. furthennore, all the factors on the scale correlated moderately significantly positive with the exception of power/prestige (factor one) and retention/time (factor two), where a negative correlation was observed. three of the factors on the money attitude scale significantly relate to the three language groups, namely, power/prestige (factor one), anxiety/distrust (factor three), and quality (factor four). xhosa speaking respondents scored significantly higher than the other language groups on both power/prestige and anxiety/distrust. this finding partially supports the design hypothesis that significant differences between the language groups do occur regarding money attitudes. all the factors on the money attitude scale relate significantly to income. lower income groups scored significantly higher on power/prestige (factor one) and distrust/anxiety (factor three) than did middle and upper income groups, whilst r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 420 sajems ns vol 2 (1999) no 3 the upper income group scored significantly higher on retention/time (factor two) than the middle income group. the findings suggest the presence of an underlying influence of cultural and economic factors on attitudes towards money. this supports the notion by kaufman (1977) that the symbolic meaning of money to an individual is largely determined by his culture, religion and life experiences. our results show that xhosa speaking respondents in the low income bracket and from large households, experience more anxiety and distrust when spending money, whilst afrikaans speaking respondents in the middle to upper income bracket from small households worry least about money. it is interesting to observe that retention/time (factor two) scored the high average value of 3.58 on the five-point scale, the highest of all factors. this contradicts the statistics (swart 1997) which indicate that personal saving has declined drastically over the last decade. it either implies that respondents overestimate their fmancial planning and saving behaviour, or that they lack the income to save despite the motivation to do so. considering attempts by consumer organisations to empower consumers to become responsible citizens when consuming scarce natural and economic resources, the fmdings of this study may serve as a guideline for developing educational programmes on personal money management. the benefits of financial planning and saving for future events, need to be emphasised in particular. educators also need to be particularly sensitive to cultural differences and economic conditions when targeting specific consumer groups in this context. finally, the results and implications of the study should be seen as a first step in gaining knowledge on consumer attitudes towards money in the multi-cultural context of the new south africa. foilow-up studies with larger samples in different areas of the country need to be done to verify the tentative trends observed in this investigation. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 421 references baker, w.e., & jimerson, j.b. 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(1989) "the differing attitudes of the sexes toward money: an application of the money attitude scale", in gordon, p.j. & kellennan, b.j. (eds.) advances in marketing, southwestern marketing association. 10 kaufman, w. (1977) "some emotional uses of money", contribution 11 in bornemann, the psychoanalysis of money, urizen books, new york. 11 medina, j.f., saegert, j. and gresham, a. (1996) "comparison of mexican-american and anglo-american attitudes toward money", journal of consumer affairs: 30, 1, 124-45. 12 malhotra, n. (1996) marketing researcher: an applied orientation 2nd. ed., prentice hall, new jersey. 13 malhotra, n., agarwal, j. and peterson, m. (1996) "methodological issues in cross-cultural marketing research", international marketing review: 13,5,7-43. 14 penaloza, l. (1994) "altravesando fronteras/border crossings: a critical ethnographic exploration of the consumer acculturation of mexican immigrants", journal of consumer research, 21: 32-54. 15 rousseau, g.g. & venter, dj.l. (1996) ita comparative analysis of consumer awareness in south africa during 1992 and 1994. implications for the reconstruction and development programme (rdp}", journal of industrial psychology: 22, 2, 26-31. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 422 sajems ns vol 2 (1999) no 3 16 swart, h. (1997) "suid-afrika nou vierkantig binne skuldstrik", die burger, 10 maart: 8. 17 tang, t.l. (1992) "the meaning of money revisited", journal oj organizational behaviour, 13: 197-202. 18 tang, t.l. (1993) "the meaning of money: extension and exploration of the money ethic scale in a sample of university students in taiwan", journal ojorganizational behaviour, 14: 93-9. 19 visagie, d. (1977) 'n bedryfsielkundige ondersoek na die betekenis van geld: 'n vergelykende studie tussen blanke en kleurlingstudente, university of stellenbosch, mcom dissertation. 20 yamauchi, k.t. & templer, dj. (1982) "the development of a money attitude scale", journal oj personality assessment, 46, may: 522-8. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction classifying knowledge transfer mechanisms and tools: earlier research identifying knowledge transfer mechanisms and tools identifying knowledge transfer mechanism characteristics valuing knowledge transfer mechanism characteristics a typology of knowledge transfer mechanisms conclusion acknowledgements references appendix 1 footnote about the author(s) corro van waveren department of engineering and technology management, graduate school of technology management, university of pretoria, south africa leon oerlemans department of organization studies, faculty of social sciences, tilburg university, the netherlands tinus pretorius department of engineering and technology management, graduate school of technology management, university of pretoria, south africa citation van waveren, c., oerlemans, l. & pretorius, t., 2017, ‘refining the classification of knowledge transfer mechanisms for project-to-project knowledge sharing’, south african journal of economic and management sciences 20(1), a1642. https://doi.org/10.4102/sajems.v20i1.1642 original research refining the classification of knowledge transfer mechanisms for project-to-project knowledge sharing corro van waveren, leon oerlemans, tinus pretorius received: 04 aug. 2016; accepted: 29 may 2017; published: 05 oct. 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the complex, unique and temporary nature of projects makes project-to-project knowledge transfer challenging and has attracted attention from both practitioners and academic scholars. this challenging nature of project-to-project knowledge transfer led to the proliferation of a host of tools and instruments (so-called knowledge transfer mechanisms) in which little structure can be discovered making selection by (project) managers a difficult task. aim: this article aims to deal with this unstructured proliferation of knowledge transfer mechanisms by empirically categorising these transfer mechanisms, thereby reducing the number of mechanisms to groups that share a common characteristic. setting: the study takes stock of the wide range of knowledge transfer mechanisms available and analyses them in terms of specific characteristics (e.g. explicitness or reach). methods: a multi-method approach is used in which a multi-level latent class analysis is applied on data collected via an expert panel. results: five categories of transfer mechanisms could be empirically established where these mechanisms showed common characteristics. conclusion: the taxonomy developed will allow organisations and project managers to more efficiently select appropriate transfer mechanisms for use in project-to-project knowledge transfer. introduction an increasing number of organisations use temporary organisations, such as projects and task forces, to carry out their economic and societal activities (bakker et al. 2011; whittington et al. 1999). in instances where a major part or all of these activities of an organisation are conducted in the form of projects, these organisations are referred to as project-based organisations. this organisational form is increasingly present in a variety of industries. examples of relevant industries are engineering (winch 2014), advertising (grabher 2004), construction (eriksson 2013), shipbuilding (levering et al. 2013) and television (manning & sydow 2007). several scholars (godenhjelm, lundin & sjöblom 2015; packendorff & lindgren 2014) even argue that this emergence of a project-oriented way of organising activities is part of a broader societal trend, which they label as ‘projectification’. these authors distinguish a so-called narrow and broad definition of the concept. the narrow conception regards the development towards the use of projects for handling complex tasks and creative change in modern organisations. the broad conceptualisation of ‘projectification’ concerns cultural and societal processes whereby projects and project-like circumstances are embedded in the activities of individuals, the organising of all sorts of work and society at large. this wide proliferation of project-based working and thinking implies that the research problem addressed in and insights provided by this article not only have value for the business world, but can find a wide application outside this world. this stresses the relevance of this study. in this projectised and technological world, knowledge is a vital resource to any organisation. this is even more the case in project-based organisations (love, edum-fotwe & irani 2003) because in order for project-based organisations to deliver new products and expanding new markets, relevant parts of the knowledge and information in the source organisation and experiences of employees and team members need to be made available to subsequent projects (van donk & riezebos 2005). in a project-based organisation, ‘the knowledge, capabilities, and resources of the firm are built up through the execution of major projects’ (hobday 2000). the growing importance of knowledge for the organisational outcomes is also reflected in the academic literature by the emergence of the knowledge-based perspective of the firm (grant 1996). this perspective builds upon and extends the resource-based theory of the firm initially promoted by penrose (1959) and expanded by others (barney 2001; kraaijenbrink, spender & groen 2010). the knowledge-based perspective argues that the functions performed by tangible resources depend on how they are combined and applied, which is in turn a function of the firm’s knowledge. this knowledge is embedded in and transferred by multiple entities including organisation culture, routines and norms, systems and documents, as well as organisational teams, groups and individuals. as knowledge-based resources are usually difficult, costly to imitate and socially complex, the knowledge-based view of the firm maintains that these resources may generate long-term sustainable competitive advantage. it should be noted, however, that having knowledge at any given time is not decisive for creating or maintaining a competitive advantage, but rather the firm’s ability to effectively and efficiently use this knowledge to create new knowledge and implement it so it can create sustainable competitive advantage from its knowledge-based resources. put differently and applied to project-based organisations, the importance of knowledge and its application to create sustainable competitive advantage puts project-based learning at the centre of attention. project-based learning comprises of the creation and acquisition of knowledge within projects, and the codification and transfer of this knowledge across project boundaries, for example, to subsequent projects (bakker et al. 2011). in project-based organisations, this type of learning is regarded as a key performance driver as prior projects offer potentially valuable experiences that can be applied in similar projects in the future or generate new knowledge about the organisation’s technology and market base that could lead to new business offerings (bartsch, ebers & maurer 2013). project-based learning1 is far from being unproblematic. in fact, the literature suggests that projects experience a so-called learning paradox (bakker et al. 2011). more specifically, these authors (bakker et al. 2011) maintain that: on the one hand, through their transience and inter-disciplinary nature, project ventures are likely to be very suitable for creating knowledge in the context of its application. on the other hand, however, the temporary nature of projects by the same token seems to inhibit the sedimentation of knowledge, because when the project dissolves and participants move on, the created knowledge is likely to disperse. (p. 494) the problem caused by the learning paradox has been recognised in both the academic and the practitioner literature, and a wide variety of approaches has been developed to deal with it that can be united under the general heading of knowledge management (alavi & leidner 2001). knowledge management refers to identifying and leveraging the collective knowledge in an organisation to help the organisation compete. it is seen as a process involving various activities. at a minimum, scholars distinguish four basic processes of creating, storing and/or retrieving, transferring and applying knowledge (heisig 2009). in this article, the focus is on project-to-project knowledge transfer and the mechanisms and tools proposed to make this transfer happen. the matter is that in the literature, there has been a substantive proliferation of knowledge transfer mechanisms and tools. as a consequence, a large number of transfer mechanisms are available, but a clear, comprehensive overview is lacking. this indistinctness makes the selection of knowledge transfer mechanism difficult for project and knowledge managers. therefore, some order or structuring of transfer mechanisms might be useful. the aim of this study is, therefore, to identify a wider range of knowledge transfer mechanism clusters through which transfer mechanisms can be grouped together according to a common purpose or application. this will be accomplished by executing the following steps, which also form the outline of this article: to determine from the literature, which knowledge transfer mechanisms are available to transfer knowledge across projects; to determine from literature, a set of dimensions with which one can group the identified knowledge transfer mechanisms according to their capability in transferring knowledge with a certain characteristic; to empirically define knowledge transfer mechanism clusters that share similar characteristics. to address this variety of steps, the study opted for a so-called mixed methods approach in which qualitative and quantitative methods are used. more specifically, a sequential mixed method design (tashakkori & teddlie 1989) was chosen where a qualitative study (in our case literature reviews and expert panel) informs a quantitative study (in our case a multi-level latent class analysis). such a design is regarded appropriate if a research is (partly) exploratory. this study contributes to the literature in several ways. firstly, it generates a literature-based, state-of-the-art and up-to-date overview of knowledge transfer mechanisms and tools that can be used in across project knowledge transfer activities. secondly, it develops, on the basis of a consultation of a group of experts, a fine-grained typology or classification structure for knowledge transfer mechanisms, where these different transfer mechanisms can be used to transfer knowledge across projects. at a more general level, it answers a call for more research as specified by argote, mcevily and reagans (2003) who conclude that one of the emerging themes in the field is that knowledge management outcomes are affected by the ‘fit’ or congruence between features of knowledge, of the interacting organisational units, and the features of the intraor inter-organisational relationships between units. but before we can study the relationship between this fit and outcomes, a first step that has to be set is creating a typology of project-to-project, which is exactly what this article intends to do. classifying knowledge transfer mechanisms and tools: earlier research the problems and hurdles of across project knowledge transfer are acknowledged by many in the field and a large proliferation of transfer mechanisms or tools are identified by several studies (boh & wong 2013; jasimuddin 2007; jasimuddin & zhang 2009; ruuska & vartiainen 2005). however, with so many mechanisms available, a result is that there is little structure in grouping these tools that will allow organisations to be more efficient in the selection and use of transfer mechanisms and tools. furthermore, this lack of structure hinders scholars wanting to study the effects of the use of these mechanisms and tools. using typologies would be helpful for these purposes. over the years, researchers developed such typologies to classify objects into groups according to similar attributes or characteristics. the advantage of using typologies is their ability to focus on those specific attributes without necessarily providing an in-depth and separate analysis of each and every item that belongs to a category. using a comparative case study approach, prencipe and tell (2001) analysed the mechanisms adopted by project-based organisations to determine how firms are able to learn from and across projects, therefore identifying the processes in project-based organisations which are involved in the management of knowledge, as well as the collective mechanisms used for developing knowledge that can be reused in other activities and projects. based on the learning processes defined by zollo and winter (2002), principe and tell developed a matrix of different project-to-project learning mechanisms by combining an organisational reach dimension with elements of a knowledge life cycle dimension. from this matrix, prencipe and tell (2001) defined learning landscapes which refer to the collection or portfolio of learning mechanisms used by individual firms which reflects the multi-dimensional nature of a firm’s approach to project-to-project learning. dimensions used for categorising their learning landscapes included the learning process from experience accumulation to knowledge codification and levels of analysis from the individual level, project level to the organisation level. boh (2007) established a framework of knowledge transfer mechanisms for managing distributed knowledge and expertise in project-based organisations by identifying four quadrants. these quadrants categorise knowledge transfer mechanisms according to a personalisation (knowledge transferred from person-to-person) versus codification (knowledge transfer though documentation) knowledge transfer strategy as defined by hansen, nohria and tierney (1999) on the one axis, and a socialisation strategy in terms of individualised (informal) versus institutionalised (formal) on the other axis. from their study, companies could be given a recommendation on the type of knowledge transfer mechanism to be used for standardised tasks versus tasks that are more unique of nature, as well as mechanism to be used for organisations that are larger and geographically dispersed versus organisations that are small and collocated. in a later study, jasimuddin and zhang (2009) categorised knowledge transfer mechanisms into two groups, namely, soft and hard transfer mechanisms. soft transfer mechanisms mainly deal with tacit knowledge, low use of technology and are people focussed, while hard transfer mechanisms deal with explicit knowledge, and are technology focussed with people playing a very small role. the studies discussed in the above have some characteristics in common. firstly, they categorise knowledge transfer mechanisms and tools on the basis of two dimensions of knowledge only. for reasons of simplicity this is a feasible and understandable approach. however, knowledge transfer mechanisms and tools often are of a more complex nature. the implication is that more than two of their characteristics have to be taken into account to arrive at a more fine-grained categorisation. secondly, the validation of the categorisations developed in these studies is done by conducting a limited number of case studies in a wide variety of sectors, in which the categorisation is based on decisions by researchers. a possible disadvantage of this approach could be that they are not fully equipped to make proper inferences in all cases. thirdly, in the fast moving world of digital media, these research papers are relatively old and often not capturing the use of social media to the fullest extent, therefore not directly focussing on project-to-project knowledge transfer. the topics addressed in this section logically ask for a number of steps and different research approaches to be conducted in this research project: (1) make a state-of-the art overview of knowledge transfer mechanisms and tools (identifying knowledge transfer mechanisms and tools section); (2) distinguish additional dimensions of mechanisms and tools (identifying knowledge transfer mechanism characteristics section); (3) use experts to better qualify mechanisms and tools and maximise variation in the data (valuing knowledge transfer mechanism characteristics section). identifying knowledge transfer mechanisms and tools methodological approach for identifying knowledge mechanisms and tools to create an up-to-date and state-of-the art overview of knowledge transfer mechanisms and tools, a literature review was done using several databases, including scopus, web of science, science direct and others. as the scopus and web of science databases are seen as two of the most authoritative databases (aghaei chadegani et al. 2013), these two databases were mainly used. to gain an overview of the main concepts, several keywords and search terms were used and listed in table 1. table 1: keywords and search terms. more than 150 papers were identified and retrieved from the different databases. these papers were first briefly scanned in order to determine applicability to the topic. suitable papers were imported into the atlasti qualitative data analysis software tool. within atlasti, each paper was coded according to the conceptual attributes that could be identified from the manuscript. these codes were later grouped and analysed to obtain a list of knowledge transfer mechanisms, as well as knowledge transfer capability characteristics of the mechanisms to be used as dimensions for analysis. the next two sections address the identified transfer mechanism, as well as knowledge transfer mechanism characteristics in more detail. knowledge transfer mechanisms identified in the context of projects, knowledge transfer mechanisms can be defined as the formal and informal means of transmission for sharing, integrating, interpreting and applying know-what and know-how embedded in individuals and groups that will aid in the performance of project tasks (boh 2007; jasimuddin, connell & klein 2014). from the literature including the work of various scholars (brachos et al. 2007; duffield & whitty 2015; frank, ribeiro & echeveste 2015; jasimuddin et al. 2014; jeon, kim & koh 2011; ortega 2001; patriotta, castellano & wright 2013; prencipe & tell 2001; sáenz, aramburu & blanco 2012; vom brocke & lippe 2015; wickramasinghe & widyaratne 2012), a variety of transfer mechanisms were identified that are in principle applicable to project-to-project knowledge transfer. in the literature, some mechanisms were discussed in some detail, while others were only mentioned by name. from the selected papers, 73 mechanisms where initially identified and after carefully evaluating each mechanism’s description, those mechanisms with a highly similar description were grouped together under a common name. this reduced the number of mechanisms to a total of 59 to be included in the study. the final list of the 59 tools and mechanism, including a brief description is provided in alphabetical order in table 1-a1. the next section addresses the knowledge transfer mechanism characteristics in more detail. identifying knowledge transfer mechanism characteristics methodological approach in the previous section, a total of 59 knowledge transfer mechanisms were identified. these mechanisms need to be described by a number of dimensions (more than two), which will enable a fine-grained categorisation. the knowledge transfer mechanisms, therefore, need to have a specific ability, fitness or quality that is necessary to facilitate knowledge transfer across projects. in order to find dimensions for knowledge transfer mechanisms, the original literature review also included a search on the characteristics of knowledge flow and the capability of transfer mechanisms to transfer knowledge of a specific knowledge characteristic. the literature review was able to identify a number of characteristic elements, namely, knowledge explicitness (snider & nissen 2003), knowledge richness (boh 2007), knowledge stickiness (cummings & teng 2003), knowledge reach (nissen 2007), knowledge flow time (snider & nissen 2003) and timeliness (cummings & teng 2003), knowledge formality (boh & wong 2013; patriotta et al. 2013) and knowledge distortion (hansen 2002). as knowledge explicitness, richness and the stickiness characteristic element relate to each other these three are combined into a single element namely knowledge explicitness and together with the remaining four make up the five knowledge transfer mechanism characteristic dimension that will be used in this study and are discussed in the following sub-sections. explicitness dimension knowledge explicitness can be defined as how codified a particular piece of knowledge is if one would place this knowledge on a continuum scale. the two extremes of this continuum would be tacit knowledge on the one hand versus explicit knowledge on the other (snider & nissen 2003). according to nonaka (2007), new knowledge is often tacit and always starts within the individual. tacit knowledge is personalised knowledge and consists partly of technical skills or so-called know-how, which is hard to write down, but can also consist of mental models, beliefs and perspectives that are so engraved that they can be taken for granted (nonaka 2007). at the other end of the continuum explicit knowledge is found, which is formal and systematic and can be easily codified, communicated and shared. typical examples include product specifications, operating procedures, instructions, scientific formula and computer programmes and databases (nonaka 2007; snider & nissen 2003). hansen et al. (1999) maintained that firms can follow two knowledge management strategies, namely, a personalisation strategy (tacit knowledge closely tied to the individual that developed the knowledge) and a codification strategy (explicit knowledge codified and routinised and revolve around ict-based technologies). companies can, therefore, manage this knowledge in essentially the same way as part of either a knowledge personalisation strategy, or a knowledge codification (technology-based) strategy or even a combination thereof (ambos & ambos 2009). for the purpose of this study, the explicitness dimension is categorised into three groupings as depicted in table 2. table 2: explicitness dimension. reach dimension knowledge reach is defined as the extent to which knowledge is shared with others in and across organisation units, for example, team members, project, departments and organisations, as well as the number of people affected by the knowledge. snider and nissen (2003) and nonaka (1994) define four organisation-based aggregations of people, namely the individual, the work group, the organisation and the inter-organisation aggregation. in a more recent meta-analysis on research publications on the topic of knowledge brokering in project management, holzmann (2013) identified four organisational levels across in which knowledge can flow, namely, the team, the project, the organisational level and industry. by combining the different levels as defined by previous authors, this study defines knowledge reach on project-based organisations as aggregations of people across various types of organisational boundaries, namely the individual, the project team, organisational project teams and inter-organisational project teams. the reach dimension can be used for categorising knowledge transfer mechanisms in the sense that certain mechanisms are more suited to transfer knowledge from person-to-person, that is, coaching, while other mechanisms are more suited for transferring knowledge over larger distances and addressing more people, that is, training sessions. for this study, knowledge reach is illustrated in the following reach levels, namely the individual, the project team, organisational project teams and inter-organisational project teams as described in table 3. table 3: reach dimension. flow time dimension flow time pertains to the length of time that is required to transfer knowledge from a sender to a receiver or from one state to another, for example, tacit to explicit (nissen 2007). the flow time dimension can be seen as short (i.e. fast moving), as well as long (i.e. slow moving), for the knowledge to move between these states and can vary by several orders of magnitude. to operationalise the flow time dimension, snider and nissen (2003) divided the flow time in a corresponding scale using highly-granular temporal markers, namely hours, days, months and years. the flow time dimensions can be used for categorising knowledge transfer mechanisms in the sense that certain mechanisms are more suited for quick and in-time transfer of knowledge, that is, face-to-face discussion and email, while other mechanisms are more suited for longer term transfer, that is, post project reviews and best practices. for this study, the flow time dimensions of snider and nissen (2003) are used, namely hours, days, weeks, months and years as described in table 4. table 4: flow time dimension. synchronicity dimension the synchronicity mediation dimension pertains to networks through which knowledge flows, as well as the effect of intermediaries between the sender and receiver of knowledge flows. hansen (2002) argues that business units that interact and share knowledge with each other in a direct way, thus where the knowledge network path is short, the receiving unit obtains more knowledge and performs better than units where the network paths are longer and more indirect. according to hansen (2002), longer network paths lead to information distortion, making the search for useful information more difficult, while shorter network paths with direct interaction can more easily share knowledge but are more costly to maintain because of the effort of interaction. within project teams, time spend on interacting and sharing knowledge is less time spent on project-related activities. understanding the knowledge transfer mechanism’s mediation dimension can aid in the selection of transfer mechanisms that has less knowledge distortion but also require a larger effort to manage. for this study, the synchronous effect of each knowledge transfer mechanism will be measured according to two options, namely, direct or synchronous mediation versus indirect or asynchronous mediation between the sender and the receiver as described in table 5. table 5: mediation dimension. formalisation dimension the formalisation dimension pertains to whether the transfer mechanism is capable of transferring knowledge in a formal or informal way and whether the mechanism can ensure that the knowledge that is transferred can be institutionalised in a formal way or not. informal knowledge transfer refers to ad-hoc and unstructured knowledge transfer that is typically done in an unplanned, need-to-know and social manner and occurs naturally without external intervention, while formal knowledge transfer is designed to enable the transfer of learning and knowledge in a planned way as typically addressed through the formal structure and routines within organisations and are endorsed by these organisations (boh 2007; kitimbo & dalkir 2013; klimkeit 2013). both formal and informal transfer can take place between persons, as well as though documentation (boh & wong 2013). for this study, three dimensions are used to evaluate the extent to which a transfer mechanism is capable to transfer the knowledge in a formal way. the three dimensions are described in table 6. table 6: formalisation dimension. valuing knowledge transfer mechanism characteristics introduction to find knowledge transfer mechanism groupings, it had to be researched to what extent each of the identified transfer mechanisms scores on the five characteristic dimensions that were discerned in the previous section. the justification and value of the scores cannot solely depend on the opinion of a single person or researcher; therefore, a group of experts is required to provide a combined viewpoint to justify the association. it seems sensible to apply the delphi technique in this case. per definition, a delphi technique is a structured communication technique that relies on a panel of experts. the experts answer a questionnaire in two or more rounds. after each round, the answers, including a motivation, are summarised in an anonymous way. through a next round, the experts can review their initial answers in light of the summary of replies from the previous round’s panel members. by doing several rounds, it is believed that answers to the questions will converge towards a final answer where after the process is stopped. this full convergence is actually what was not aimed for in this case, as it would diminish variation to a large extent making our next analytical step (categorisation) virtually impossible. in other words, variation was deliberately allowed for. in the next section, we explain the approach taken in this study. methodological approach: expert group in this study, an independent expert group was used as reaching of high consensus through multiple rounds would be a highly undesirable outcome especially considering the latent clustering analysis technique for which variation in the data is a necessity. the word ‘group’ instead of ‘panel’ is used as the authors would like to stress that to avoid social pressure for consensus, the group members did not physically meet and came to their judgements individually and independently. a questionnaire was designed using survey monkey as a web-based survey tool. a supplement document was also prepared, which listed the 59 transfer mechanisms, as well as a short description of each mechanism to ensure that there would be a common understanding of each mechanism by every expert. each knowledge transfer mechanisms had to be evaluated against the five characteristic dimensions as described in the previous section. this resulted in a questionnaire comprising of five sections, one for each characteristic dimension, and 59 knowledge transfer mechanisms in each section. each member of the expert group, therefore, had to individually and independently answer 295 questions related to the knowledge transfer mechanisms and their transfer characteristics. to reduce the possible effect of lost concentration and the emergence of patterns in the answers because of the large number of questions each participant had to answer, the questions in each section of the questionnaire were randomised. stitt-gohdes and crews (2004) mention that members of an expert group should be knowledgeable about current information and perceptions regarding the topic under investigation, should have experience in it and should be working in such an environment. to meet these criteria, the members of the expert group were identified and selected based on their working knowledge and experience into the behaviour of individuals, teams and organisations and have a good understanding of project management processes including events in projects where knowledge transfer takes place. in addition, the members had to have some insight in how knowledge is transferred within and across projects, as well as knowledge and experience in the selection and use of knowledge transfer mechanisms. members of the expert group were, therefore, selected according to the following criteria: work experience: members had to have at least 5 years working experience in projects; multiple project experience: members had to be involved in multiple projects for at least a couple of years to understand knowledge transfer across projects and the mechanisms used; concurrent projects: members had to have experience of concurrent running projects; management level: member spectrum need to include people from different management levels, for example, project manager, programme manager or project portfolio manager; industries: member spectrum need to be from different industries; project role: member spectrum must include different project roles, for example, client, contractor, consultant, etc. project size: member spectrum need to include different project sizes; company size: member spectrum need to be from different company sizes. by using the above criteria, 20 experts were identified from different organisations and invited to participate in the study. the questionnaire and the supporting document were sent to each of the identified experts and followed up by email, telephone and instant messaging. from this group, 17 experts responded and individually completed the questionnaire. the demographics of the expert group are depicted in table 7. from the table, it is evident that the selection of the group did meet the criteria and provided a good representation. table 7: expert group demographics. the data collected through the questionnaire were analysed by evaluating the median score, as well as the standard deviation of every item. although reaching consensus on the individual item level was not a requirement of the research process, it nevertheless showed that on 85% of the items consensus was reached as indicated by low standard deviation values on the ordinal response data. as such this is an interesting outcome as only the capturing every expert’s viewpoint was aimed for. as experts reached consensus on individual items independently from each other, but hopefully not between the items, is a comforting result as fine-grained categorisation otherwise would become very difficult to accomplish empirically for the reason that within variation would become too large. a typology of knowledge transfer mechanisms methodological approach: latent class cluster analysis in the previous sections, a state-of-the-art overview of knowledge transfer mechanisms and tools is provided, several dimensions of these tools identified and data collected. the next step is selecting a statistical technique that is suited for multi-dimensional categorisation and gives objective measures to decide on the number of categories fitting the data well. latent class cluster analysis is the statistical technique selected (haughton, legrand & woolford 2009). a discussion of the characteristics of this technique is provided below. latent classes are unobservable (latent) subgroups or segments (magidson & vermunt 2002). ideally, variables (in this case, characteristics of knowledge transfer mechanisms and tools) within the same latent class have to be similar on certain criteria, while transfer mechanisms grouped in other different latent classes are dissimilar from each other in certain important ways (vermunt & magidson 2005). latent class analysis is a statistical analysis technique for finding subtypes of related cases (latent classes) from multivariate numeric or categorical data on the basis of maximum likelihood estimation. latent class analysis may be used to analyse combinations of dichotomous, nominal, ordinal and count variables and uses appropriate distributions for each scale type (magidson & vermunt 2004a). latent class analysis differs from more traditional approaches such as factor analysis, structural equation models and random-effects regression models as these techniques are severely limited in practice because they require all variables to be continuous, and it uses the assumption of multivariate normality to justify a linear model (magidson & vermunt 2004a). in latent class analysis, a maximum likelihood algorithm classifies cases (knowledge transfer mechanisms and tools) into clusters based on membership probabilities estimated from a parametric model. the procedure seeks to identify the smallest number of latent (unobservable) classes that is sufficient to account for the relationships among the observed variables (mechanism transfer capability dimensions). the latent variable is to explain all the relationships among the observed variables of its class. the analysis typically starts by fitting a baseline model for but one latent class. if this one-class solution does not fit the data well, the analysis incrementally adds latent classes to the model until the model fit is adequate. the model is evaluated in two ways, namely, model fit and model usefulness. model fit is determined by statistical means on the basis of a log likelihood criterion, in this case, the bayesian information criterion (bic). in short, the bic provides information about the explanatory power of a model relative to the number of parameters employed. the lower the bic, the better the fit of the model (magidson & vermunt 2004b). besides the bic, the p-value (p > 0.05, indicating adequate fit) and the number of parameters used (fewest number indicating parsimony). model usefulness is determined by substantive interpretation of the latent classes and whether they are meaningful to address the underlying questions at hand and through verifying the classification quality by use of classification tables or the use of an entropy criterion to estimate the number of clusters from a model (celeux & soromenho 1996). for this study, a multi-level latent class model prediction was done to determine the best cluster model for the provided data. the higher level in the latent class model consists of the 17 respondents from the expert group and the lower level consisted of the respondent’s responses on the different dimension of the transfer mechanisms. by using a multi-level model, the analysis corrected for differences in responses because of a lower consensus on some of the dimensional scoring of the mechanisms. clusters of knowledge transfer mechanisms and tools identified for the identification of the latent clusters, the software application latent gold 4.0 was employed (vermunt & magidson 2005). summary fit statistics of the models are depicted in table 8. by using the bic value as model selection criteria, it can be concluded that a five cluster model has the lowest bic value of 9930.4362. as there was no other cluster model with the same bic value, the lowest log likelihood (ll) value, number of parameters (npar) and classification error (class err) were not needed to as an additional verification of the best cluster fit. table 8: latent class model prediction summary. clusters of knowledge transfer mechanisms and tools profiled a profile table for the identified five cluster model is depicted in table 9. the first row of the table indicates the size of each cluster as a percentage of the respondents. in addition, the other cells in the profile table contain (marginal) conditional probabilities that show how the clusters are related to the indicators, for example, the dimensions of the knowledge transfer mechanism characteristics. for the indicators of an ordinal nature, for example, explicitness, reach, flow time and institutionalisation, the mean value of the indicator categories is also provided. the probabilities for each indicator sum up to one: (1) within each cluster. the probability value is interpreted as the respondents chance to choose that specific indicator category within that cluster. for example, respondents in cluster 1 have a 66.89% chance of responding that the knowledge transfer mechanisms grouped in this cluster transfer mainly explicit knowledge. the higher the probability value, the more the indicator category belongs to that cluster. in table 9, the dominant probabilities are shown and indicate the indicator categories belonging to each cluster. the characteristic of each knowledge transfer mechanism cluster will be defined according to these indicator categories, as well as the transfer mechanisms that belong to each identified cluster. table 9: profile table. from table 9, the prevailing characteristics of each cluster are identified by selecting the dominant probability values, as well as evaluating the mean value for every dimension in every cluster. for example, in cluster 1, the dominant probability is 0.6689 and the mean value is 2.6434 (»3) which corresponds with mainly explicit; therefore, mainly explicit knowledge is transferred by this cluster of mechanisms. the identified clusters, their characteristics as well as associated transfer mechanisms are discussed in more detail in the next section. descriptions of clusters of knowledge transfer mechanisms and tools from the multi-level latent class analysis, a frequency count of each knowledge transfer mechanisms belonging to a specific cluster was determined, where the maximum value for the frequency count equalled to 17 (the total number of participants in the expert group). by making use of a pareto criterion, where the transfer mechanisms in each cluster are sequenced in descending order from highest count to lowest count and then selecting the transfer mechanisms that make up the first 80% of the total count, the dominant knowledge transfer mechanisms for each cluster were identified with very little overlap of transfer mechanisms between the different clusters. cluster labels were given to each identified cluster according to the cluster characteristics, as well as the dominant knowledge transfer mechanisms, which form part of each cluster. these clusters labels are discussed in the next sub-sections. cluster 1: formal codification landscape of project-to-project knowledge transfer mechanisms cluster 1 is labelled the formal codification landscape cluster as it includes knowledge transfer mechanisms that deal with the formal capturing of knowledge within an organisation in a methodical and documented way (see table 10). knowledge is captured through formal project management methodologies, embedded project management processes and common practices, as well as dedicated and appointed role players. explicit knowledge is mainly captured through a codification strategy as defined by hansen et al. (1999), and the flow time of knowledge may vary from hours to months. the channel of transfer is mainly indirect and mediated between the sender and receiver of knowledge, which implies that the knowledge transfer may be limited and distorted because of the actual information that was captured, as well as the possibility of not being able to gain access to the original source of the information. for project-to-project knowledge transfer, this cluster of transfer mechanisms might be sluggish as most transfer will take place through documented systems, embedded processes and formalised methodologies. this cluster also relates to the exploiter landscape or transfer mechanisms as defined by prencipe and tell (2001) as it contains ict-based tools to support project-to-project learning where emphasis is placed on the codification and storage of knowledge during project execution phases to make the knowledge more accessible and exploitable for project members in subsequent projects. table 10: cluster 1 main characteristics and dominant knowledge transfer mechanisms. cluster 2: training and coaching landscape of project-to-project knowledge transfer mechanisms cluster 2 is labelled the training and coaching landscape cluster as it mainly includes knowledge transfer mechanisms that are directed towards a formal learning approach between projects within an organisation (see table 11). learning takes place within a knowledge push environment by either a formal teaching, education, mentorship or apprenticeship programmes or a lesser formal job-rotation, work sessions and site visits. both tacit and explicit knowledge are transferred through the mechanisms, and the transfer is direct between the sender and receiver and relatively fast. this cluster of mechanisms can be used by organisations to disseminate knowledge to individuals and project teams in order to bring them on par with current practices and need-to-knows’ or improve their content knowledge in given subject areas where the knowledge base needs to be deepened or broadened as required by the organisation’s needs. for project-to-project knowledge transfer, this cluster of transfer mechanisms will focus on learning of one project and through a formal learning, mentoring and educational programme transfer this knowledge to members of a receiving project. such a transfer will be planned and executed in a more formal way. table 11: cluster 2 main characteristics and dominant knowledge transfer mechanisms. cluster 3: informal person-to-person landscape of project-to-project knowledge transfer mechanisms cluster 3 is labelled the person-to-person landscape cluster and mainly includes knowledge transfer mechanisms that are directed towards people embedded knowledge and the transfer thereof through people-to-people and team-based communications as typically experienced in new product development and research activities that are exploratory of nature (see table 12). in these types of activities, there is high ambiguity and uncertainty of the knowledge to be transferred, hence the use of face-to-face discussions, brainstorming sessions and informal chatting and document exchange (cummings & teng 2003). the transfer mechanisms transfer mainly tacit knowledge in a very fast way. the transfer is direct between sender and receiver. because of the characteristic nature of this cluster, knowledge that is transferred is mainly imbedded in the individual team members and makes the capturing of this knowledge very difficult and informal. this cluster can also be linked to the knowledge personalisation strategy as defined by hansen et al. (1999), as well as the explorer landscape as defined by prencipe and tell (2001) where knowledge is embedded in individuals and mainly transferred through person-to-person interactions. for project-to-project knowledge transfer, this cluster of transfer mechanisms focusses on direct contact and interaction between team members working on different projects. table 12: cluster 3 main characteristics and dominant knowledge transfer mechanisms. cluster 4: inter-organisational networking landscape of project-to-project knowledge transfer mechanisms cluster 4 is labelled the inter-organisational networking landscape cluster as it mainly includes knowledge transfer mechanisms that are directed towards networking and communication between teams within, as well as across a wider range of organisations (see table 13). mechanisms in this cluster transfer mainly explicit knowledge in both direct (email and networking) and indirect (internet, intranet and wikis) ways. these mechanisms might also be organised to promote knowledge transfer, for example, conferences, seminars and news groups. for project-to-project knowledge transfer, this cluster of transfer mechanisms embraces knowledge sharing and networking between project team members across organisational boundaries through arranged interventions like seminars, conferences, newsgroups and the internet. table 13: cluster 4 main characteristics and dominant knowledge transfer mechanisms. cluster 5: intra-organisational communal landscape of project-to-project knowledge transfer mechanisms cluster 5 is labelled the intra-communal landscape cluster and is the weakest cluster as it contains transfer mechanism that do, to a small extent, overlap with other clusters. the cluster includes knowledge transfer mechanisms that are directed towards informal or semi-formal observations or reading, social connection, interaction and discussions within an organisation (see table 14). knowledge transferred by these mechanism is a combination of tacit and explicit and is transferred reasonable fast through mainly indirect ways. because of its informal nature, the capturing of knowledge for future use may be limited. for project-to-project knowledge transfer, this cluster of transfer mechanisms builds on the social connectivity between team members working on different projects through informal document exchange, social networking, observation of practices, audio and teleconferencing, etc. table 14: cluster 5 main characteristics and dominant knowledge transfer mechanisms. conclusion this research originated from the notion that in a projectised world, there is a growing importance of knowledge for project-based organisations to deliver new products and services in competitive markets. the need for project-based learning in these organisations requires the efficient codification and transfer of knowledge across project boundaries. considering the wide range of knowledge transfer mechanisms available for project-to-project knowledge transfer, the research aimed to refine the classification of available knowledge transfer mechanisms through the identification of a typology consisting of a smaller number of knowledge mechanism groups that would help practitioners choose the right knowledge transfer mechanisms for their projects. the research process followed three definitive steps: (1) to determine from literature the current available knowledge transfer mechanisms and tools, (2) to identify from literature appropriate dimensions to group mechanisms together and (3) empirically derive knowledge transfer clusters according to their similar characteristics. in answering the research questions, the main findings are as follows: firstly, through a systematic overview of recent literature in the field, a current list of available knowledge transfer mechanisms were identified, as well as a set of five dimensions that could be used to classify the knowledge transfer mechanisms. secondly, using latent class analysis on the inputs from an expert group, the authors could successfully identify five clusters of knowledge transfer mechanisms that could be used by project practitioners to choose between the wide spectrum of mechanisms, each cluster with its specific characteristics. in summary, the clusters are characterised as: (1) the formal codification landscape – dealing with the formal capturing of knowledge in in a methodological way, (2) the training and coaching landscape – with knowledge mechanisms directed towards a formal learning approach between projects, (3) the person-to-person landscape – that is, people-to-people and team-based communication, (4) the inter-organisational networking landscape – networks of communications between teams within and across a range of organisations and (5) the intra-organisational communal landscape – informal/semi-formal reading, social connection, interaction and discussion within an organisation. the findings from the research make a clear contribution to the field of project-to-project knowledge transfer. firstly, an updated overview of available knowledge transfer mechanisms used by project-based organisations was produced and is available to both researchers and practitioners for further use. secondly, a structured set of dimensions whereby knowledge transfer mechanisms can be classified in specific groups were added to the literature. the key contribution of this research to the field of project-to-project knowledge transfer is a newly defined typology of knowledge transfer mechanisms and tools, each element of the typology exhibiting a number of specific common characteristics that identifies a group of mechanisms and tools as unique and appropriate for specific project knowledge transfer conditions. from a theoretical point of view, the study acknowledges that knowledge transfer mechanisms are complex (social) phenomena for which multiple dimensions should be distinguished if one choses to study them. furthermore, an important strength of this study concerns its use of a multi-method approach, in which a systematic literature review is combined with the use of expert interviews and latent class analysis. this approach provides a more holistic understanding of phenomenon under study. nevertheless, it is important to consider any possible uncertainties pertaining to the research, namely the sample size of the expert group and the coupled way the expert group was consulted. although the sample size of project experts seems to be relatively small, two aspects should be considered. firstly, it could be argued that more participants in the expert group would be advantageous. this is not always desirable as in the case of this research it aimed for variability in expert opinion, and the authors were, therefore, satisfied that the level of variability in the responses already delivered the required results. secondly, the authors acknowledge that future studies could consider larger sample sizes. what are the implications of the newly identified typology for project practitioners? we already pointed out that project managers face a very wide range of project-to-project knowledge transfer mechanisms from which to select the appropriate set of mechanisms for optimum project performance. based on the needs of the specific type or class of project under consideration, a project manager can select appropriate mechanisms by comparing the project needs with the characteristics exhibited by the five clusters. this will reduce the effort and risk of wrong transfer mechanisms selection substantially. the more experienced project manager will probably find the task of selection easier than the lesser experienced project managers. efficient and successful across project knowledge transfer can be considered as a combination of the characteristics and the type of knowledge being transferred and the transfer mechanisms and tools used. future research could try to sort out which combinations of knowledge types and knowledge transfer mechanisms lead to satisfactory transfer results and could investigate the appropriate matching of specific clusters and their characteristics to the needs of specific types or classes of projects. acknowledgements the authors wish to thank prof. jeroen k. vermunt from the department of methods and statistics at tilburg university in the netherlands, for providing advice and help in the performing of the multi-level latent class analysis. they also thank the associate editor and two anonymous reviewers for their constructive feedback. competing interests the authors declare that they have no financial or personal relationship(s) that may have inappropriately influenced them in writing this article. authors’ contributions c.v.w. contributed to most of the writing. l.o. contributed to statistical analyses and co-writing. t.p. contributed to co-writing. references aghaei chadegani, a., salehi, h., md yunus, m.m., farhadi, h., fooladi, m., farhadi, m. 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of academics. it may be seen as the executive summary of a rather voluminous report for internal use in the department of finance on fiscal federalism, one of the large economic issues facing the new south africa. debate on the subject continues. jel h 70 1 introduction south africa operates as a unitary in contrast with a federal state, however, with certain federal characteristics. alternatively put, south africa bas a co· operative form of governance, brought about by its particular circumstances and development. like many other countries, government in south africa typically functions at three tiers (or levels) of authority: central (or national), provincial and local (or municipal). this paper is explicitly addressed to the fiscal relationship between the central and provincial authorities; in particular, the division of the power to tax between them. the direct reason for investigating this relationship derives from section 228( i) of the south african constitution of 1996, to the following effect: a provincial legislature may impose (a) taxes, levies and duties other than income tax, value-added tax, general sales tax, rates on property or customs duties; and (b) flat-rate surcharges on the tax bases of any tax, levy or duty that is imposed by national legislation, other than the tax bases of corporate income tax, value-added tax, rates on property or customs duties. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 60 sajems ns vol 3 (2000) no 1 whereas section 288(1} above refers to potentially new sources of provincial revenue, section 288(2} below states the constraints to which the concomitant power to tax is subject, namely, the following: the power of a provincial legislature to impose taxes, levies, duties and surcharges (a) may not be exercised in a way that materially and unreasonably prejudices economic policies, economic activities across provincial boundaries, or the national mobility of goods, services, capital or labour; and (b) must be regulated in terms of an act of parliament, which may be enacted only after any recommendations of the financial and fiscal commission have been considered. it would appear that a (provincial) surcharge on the (national) personal income tax base is potentially the most important source of provincial revenue. the surcharge has however become a contested issue in authoritative circles, and it also represents a pivotal concept in this paper. two different approaches to the matter are taken by the financial and fiscal commission (ffc) on the one hand, and in the seventh interim report of the commission of inquiry into certain aspects of the tax structure of south africa (katz commission) on the other. the ffc makes the assumption that "the [provinces'] capacity to raise more own source revenues, is justified on the grounds of promoting democratic and fiscally accountable government in the provinces". it then proceeds to conclude and recommend that the provincial authorities should be empowered to impose a flat-rate (proportional) surcharge on the national base of personal income tax (pit). in contrast, the katz commission's "preferred choice ... at this point in time would be not to adopt the pit surcharge option" (1998: 6). of all the alternatives considered, the katz commission "is of the opinion that the most favourable would be the assignment of [a] fuel levy to the provinces in the medium term (1998: 8}it. this option has again been dismissed by the ffc (kc, 1998: 7). 2 theoretical backgrollnd the scientific literature on public finance (or public economics) is vast. yet, there is no unique theory or model that may be deemed to have captured the best possible (or optimal) distribution of fiscal targets (functions) and instruments (mainly taxes) between different tiers of government. in general, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 61 the value of every individual target is determined by the values of all the available instruments: where xi refers to target i; i=l, ... n, and tj refers to instrumentj; j=l, ... , m. likewise, the value of anyone instrument is generally determined by all the existing targets: this matrix of interdependence makes it particularly difficult to predict the economic consequences when targets and/or instruments are redistributed between different tiers of government. the degree of affinity between individual targets and instruments is, however, variable in practice. for example, a specific instrument, tk, may be closely related to a particular target, say xb, which at the same time depends on other oxb(/, .. j m ) instruments only to a limited degree. in this case the value of a will it axb(/,··jm) be large, while a will be smaller for j;tk. t j in the event, the above-mentioned target-and-instrument combination may be assigned to a separate institution, in the present case, a specific tier of fiscal authority. the norwegian economist leif johansen has expressed the essence of the matter in the following concise statement (1971: 16): as a rough principle we could say, then, that instruments affecting many targets ought to be employed centrally, while instruments affecting only one or a small number of targets can to a larger extent be decentralised. it therefore follows that the inferences to be drawn from the theory of public finance are more in the nature of guiding principles than fixed conclusions. this in fact amounts to a particularly useful blend of theory and practice, not always found in economic analysis. to use adam smith's famous expression, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 62 sajems ns vol 3 (2000) no i economic enquiry has produced certain canons of taxation (e.g. certainty, clarity, convenience) that separate good and bad fiscal policies. 3 fiscal decentralisation fiscal decentralisation (or devolution) and the related issue of tax assignment (or sharing) are likely subjects of discussion wherever a system of multi-level government and public finance is found. as already mentioned, this paper is concerned with the financial relationship between the national and provincial authorities in south africa. matters of local finance are practically excluded, mentioned only in passing. fiscal decentralisation is also widely known as fiscal federalism. in a theoretical context, this subject is a branch of public finance, including elements of the theories of public choice, taxation, regional economics and more. it is the meeting ground of economics and politics, to be related to states with a federal constitution in the literal sense, for example, the united states, germany and australia. however, the term fiscal federalism is used in a less formal and comprehensive meaning too, and may then be applied to any state with more than one level of political authority, which are legion, including south africa. here the national government is, in terms of expenditure, chiefly responsible for economic services (finance, trade and industry, labour), protection services (defence, police, prisons, justice), housing and general administration. the main functions of the provinces are primary and secondary education, health and welfare services, provincial roads, regional development, and again housing. based on existing intergovernmental arrangements, the national government raises almost all fiscal revenue in the country, but exercises control over only approximately 40 per cent of total non-interest budgetary expenditure. in contrast, the nine provincial authorities control about 60 per cent of total noninterest expenditure, and raise less than 5 per cent (3.6 per cent in 1998/99) towards defraying their aggregate budgetary spending. central government funds the huge shortfalls that all the provinces have, by means of unconditional grants (or transfers). the roots of this dispensation reach down to the foundation of the union of south africa in 1910. ever since then, the fiscal relationship between the national and provincial governments has been a perennial cause of friction, and in the process the provinces grew increasingly dependent on the fiscal grants of the central government. however, it is determined in the south african constitution of 1996 that this long-standing trend must henceforth change. this means that the principle of fiscal decentralisaion and the associated redistribution (assignment or devolution) of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 63 tax. revenue from the national to the provincial authorities have become official policy in south africa. this summary article has been induced by the impending application of the new policy. however, a fundamental question that calls for detailed discussion and unambiguous clarification is to what extent "decentralization will mean ... the substitution of two or more autonomous policy-makers for a single one, and not merely the execution by a larger number of agencies of a centrally-designed policy" (tinbergen, 1967: 172). 4 fiscal and financial commission the leading role in drawing up the agenda for fiscal decentralisation in south africa has been taken by the fiscal and financial commission (ffc). the ffc is an independent body established by the constitution to make recommendations to parliament and provincial legislatures about financial issues affecting all three tiers of government in south africa. the position taken by the ffc is summarised below. (the numbers in parentheses in this section refer to page numbers of appendix d in m grote's internal report to the department of finance.) 4.1 surcharge on personal income tax the ffc considers a surcharge on the base of national personal income tax. (pit) to be "the only viable source for provincial revenue" (227). it asserts that "the fact that own source revenues make up only a small proportion of total provincial revenue is not in itself sufficient reason to advocate increased revenue-raising powers for provinces", adding the following (228): a much more compelling reason is that relating to the promotion of democratic and accountable government in the provinces. with provinces currently accounting for less than 5 per cent of their revenues there is little or no incentive for provincial governments to be fiscally accountable to their electorates ... provinces thus spend a large proportion of tax revenue but are not accountable to their electorates for it. one possible implication of such a situation is that provinces which are largely dependent on transfers from the national revenue pool can be fiscally irresponsible. this was certainly the case during the apartheid era particularly in the so-called self-governing territories, which were not required to account democratically to their electorates for it. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 64 sajems ns vol 3 (2000) no 1 the ffc interprets section 228 of the constitution (see the introduction above) to mean that provinces already have the right to impose a flat surcharge on the pit base: "a province does not require authorisation from national government to do so, but it does require national legislation to regulate this activity" (229). the ffc recommends that a surcharge up to 7 percentage points of the pit base be phased in over a period of 6 years, by means of the tax room method set out below. 4.2 tax burden and tax room national government in south africa has committed itself to limit the total national tax burden on taxpayers to approximately 25 per cent of the gross domestic product. the precondition for the proposed pit surcharge is thus the creation of enough tax room to prevent the national tax burden from rising. this requires that the national government reduces its overall tax share and makes the decrease available to the provinces as own revenue. if the central government's aggregate grant to the provinces is reduced by the amount of tax room thus created and the provinces levy new taxes to fill up the tax room, then the total funds available to the provinces would remain unchanged. the ffc gives the following numerical example to elucidate the abovementioned policy shift, which it supports (230): (i) suppose that the national average rate for pit is 25%. at the present time all of pit is collected at the national level. (ii) assume the provinces impose a surcharge of 5 percentage points on the pit yield (or 5% on the pit base). (iii) if no tax room were created and all provinces imposed the surcharge, the national tax burden for pit would rise by an average of 5 percentage points. (iv) however, if the national government agreed to the creation of tax room equivalent to 5 percentage points, the overall tax burden for pit would remain the same. (v) twenty percentage points would then accrue at the national level and five to the provinces. although the total revenue received by the provinces from the introduction of the surcharge and an equivalent cut in the central government grant would remain constant, each province would receive additional own revenue after the event. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 65 4.3 tax administration the cost of tax administration is an extremely important consideration in an overall tax reform process. a core characteristic of tax-sharing arrangements between national and sub-national levels of government, is generally that a single revenue collection agency is responsible for the tax administration. the ffc accepts this position and draws the following optimistic conclusion (234): the ffc is confident, that the tax collection capacity exists in south africa for the successful implementation of the surcharge. it is envisaged that the south african revenue service (sars) will collect the provincial surcharge on behalf of the provinces, as provided for in the sars bill. the creation of provincial revenue services should be avoided. (we return to this point under 5.3 and 6.2 below.) 5 the katz commission in july 1998, the seventh interim report of the commission of inquiry into certain aspects of the tax structure of south africa (katz commission) was published under the title synthesis of policy recommendations with regard to provincial taxation. as mentioned in our introduction, the commission expressed misgivings about the pit surcharge proposed by the ffc, and made an alternative recommendation how tax devolution might be initiated. the key passages of the report in the present context are briefly quoted below. 5.1 constitutional flaw the katz committee took the view (1998: 5) that the proposed surcharge ... contravenes the provisions of section 228( i) of the constitution in that it effectively constitutes a flat rate surcharge on national tax rates as opposed to the constitutional requirement of the tax base (le. taxable income). the ffc subsequently conceded this point. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 66 sajems ns vol 3 (2000) no 1 s.l tax room the katz commission pointed out (1998: 5) the following ambiguity of the tax room method of fiscal devolution put forward by the ffc: it needs to be remembered that all nationally collected revenue, including pit, is shared between the national and provincial governments. moreover ... the creation of tax room of say 5 percentage points at the national level, will not lead to a fall in revenues accruing to the national level unless provinces do not fully occupy the tax room, in which event there will be a fall in revenues. if, however, provinces raise surcharges higher than the reduction in the national rate, then there will in fact be an increase in revenue. the recommendations of the ffc would permit the occurrence of either of these possibilities. the redistribution of tax revenue between the national and provincial levels of government depends, at least partly, on whether or not a province is able to recoup the grant revenue it loses from the tax surcharge revenue it gains. 5.3 tax administration while a surcharge on the pit base is often found in industrially advanced countries, it has not yet been adopted in a developing economy. this is apparently due to the inadequate tax administration systems in the lastmentioned countries. in the katz commission's view, this problem at least partly exists in south africa too at present (1998: 4): without detracting from the important efforts sars is currently undertaking in its restructuring with a view, inter alia, to the inhancement of its capacity, it is correct to state that at present sars is still experiencing problems with regard to its capacity. accordingly, for the same reason that other developing countries have not burdened their tax administrations by the imposition of a surcharge on the pit base, the commission has serious concerns about doing so in south africa. to do so in the short term could give rise to risk. this concern is supported by the evidence received from sars as presented to the commission. (see also appendix c to grote's internal report: 224-5.) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . samms ns vol 3 (2000) no 1 67 5.4 surcharge on fuel levy the katz commission's recommended alternative to the pit surcharge is a provincial surcharge on the national fuel levy. this option would allow the provincial authorities more freedom of choice with regard to their revenues than at present, and thus be a workable first move in the direction of greater fiscal autonomy at the sub~national level. the commission calculated that the tax revenue from the fuel levy surcharge would represent 15.9 per cent of the provinces' total revenue from grants, and further estimated that the total revenue from the proposed fuel levy would be approximately the same as a 5 per cent pit surcharge, and the commission comments; "hence, over the short term concerns about possible revenue yield inadequacies should not disqualify the fuel levy for assignment purposes" (1998: 7). from the perspective of administrative capacity, "the commission is comfortable that the fuel levy can probably be implemented with a minimum of enforcement and compliance costs on the part ofsars" (1998: 7). in conclusion, the katz commission's report gives a list of the legislative issues to be addressed, if the fuel levy option were to be accepted. 6 other taxes it should be stressed that every one of the tax instruments outlined below would have to be thoroughly researched before drawing any definite conclusions. however, based on experience of tax policy and international practice, the following points might be noted: 6.1 excise taxes on commodities in view of the pursuit of a single or common market and to minimise revenue collection costs and policing efforts, the imposition of a provincial surcharge on national excise taxes, or their wholesale transfer to the provinces, should be carefully investigated. 6.2 mineral severance and/or production taxes although the findings of the sub-committee tasked to investigate mmmg taxation should not be pre~empted, it is pertinent to note that there is principally a strong case to be made out for assigning severance taxes based on the benefit principle (or the polluter pays principle) to provincial governments. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 68 sajems ns vol 3 (2000) no 1 6.3 excises on services the concept of excise taxes on services can be developed further with regard to the so-called bed-taxes in the tourism industry, airport departure taxes, etc. the respective tax bases are relatively immobile, highly visible and most attractive because these levies are being paid by non-residents of the tax-imposing jurisdiction. tax exporting is therefore the most likely outcome and, hence, these tax instruments should become the subject matter of thorough national control as they could have wider ramifications, particularly in respect of the national government's tourism promotion policies. 6.4 financial services due to administrative problems foreseen with the devolution of charges or imposts on the financial service sector, this source of taxation should not be considered. 6.5 marketable securities tax (mst) in view of the international tendency to abolish mst and the increased competition on international capital markets, consideration should be given to the phasing out of this kind of tax. therefore, its devolution should not be an option. 6.6 betterment taxes, valorisation taxes and/or special assessments despite the shortcomings of the betterment tax instrument, it should not be rejected ab initio but be reviewed with regard to its potential of enabling cooperative and participatory government at lower levels. massive backlogs exist in rural areas where second-tier governments are responsible for infrastructure such as housing, roads, water supply, etc. hence, the possible imposition of the betterment tax should be seriously considered and further investigated. 6.7 presumptive taxes experience with presumptive taxation suggests that it effectively reduces audit time and cost. but in this connection, it is important to sound the caveat that tax enforcement without adequate safeguards is a threat to taxpayers' basic rights. thus the use of discretion by tax officials must be minimised and the protection of taxpayer rights must be accorded the highest priority, should the national government find the presumptive tax concept attractive. against this background, only the central government could guarantee the most conscientious compliance with the preconditions for the presumptive tax r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 69 instrument. thus, the maximum tax level of presumptive tax instruments per business category (e.g. manufacturing vs service industry) has to be regulated by national framework legislation, after sars has laid down certain average income norms per business category. 6.8 business licence fees the introduction of an annual business licence fee as a minimum tax at provincial and local level may be seriously considered. by defining it as a minimum tax, deductible against the nationally collected corporate income tax, tax room would automatically be created and the administration will not need any highly skilled staff, as firms would have to clearly display their business licence token at the entrance to their premises. as the appearance of the licence could be changed from year to year, the policing effort and cost of administration may be minimised, and the compliance gap of corporate income tax could be significantly narrowed with this additional measure. 6.9 user charges and fees maximising the utilisation of user charges, licence fees or benefit taxes at subnational level, could fund a large portion of the costs of sub-national spheres of government. furthermore, they give rise to enhanced transparency in the funding of public service provision and, hence, promote a greater degree of accountability. also, they reduce the risk of tax exporting and usually do not create problems of vertical and horizontal inequity. thus, the employment of user charges and benefit taxes ought to be maximised as the first step in the incremental process towards efficient effective fiscal decentralisation. 6.10 environmental taxes environmental taxes designed to achieve pro-environment and pro-employment outcomes imply an exclusive national responsibility, as this will have farreaching macroeconomic stabilisation impact. seeing that this approach is internationally used, the possibility of its implementation in south africa should be investigated. other energy taxes, taxes on liquid fuels and road congestion levies could be the responsibility of all spheres of government. however, effluent charges and charges on air pollution (e.g. on pollutants released by coal-fired power stations) that seek to address interprovincial pollution, should also be an exclusive national responsibility. thus, on the basis of technical advice by the department of environmental affairs as to the most appropriate level of the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 70 sajems ns vol 3 (2000) no 1 charges to internalise negative externalities, energy taxes and effluent charges should be introduced and administered only by the national government. charges or levies on inter-municipal pollution and environmental degradation caused, for example, by natural resource use or extraction activities, could become a provincial responsibility. if the charges were raised on the polluter pays principle, then they would be a true user charge which should be assigned to the respective provincial governments. national framework legislation should, however, provide for a monitoring and approval procedure by the national departments of finance and environmental affairs concerning the appropriate level of the user charge, in order to prevent it from becoming subnational tax instruments in disguise. likewise, intra-municipal pollution (e.g. noise) should remain solely a local government responsibility. it is therefore suggested that penalties on explicitly local air pollution transgressions, noise pollution, charges on solid and poisonous waste removal, parking fees to influence inter-modal transport reforms, traffic congestion charges, etc., should remain the prerogative of local governments 7 economic analysis the analysis in this section is predicated throughout on economic efficiency in south africa and the welfare of its population. the conclusions that follow are of a qualitative rather than quantitative nature. in other words, we seek to discover the probable directions, not estimate the expected magnitude, of the fiscal policy changes adumbrated above. comprehensive statistical analysis of the issues discussed here will no doubt prove necessary sooner or later, but it seems only sensible to trace out their logical consequences first. 7.1 comparative advantage in tax assignment the modest attempt in section 2 above to relate various targets and instruments in public finance, on the one hand, to different levels of fiscal authority, on the other, produced the following rough guideline: instruments that affect several targets should be employed at the higher, and those that affect only a few targets, at the lower level of authority. in other words, the former should be centralised and the latter decentralised. essentially the same argument may also be stated somewhat differently. for example, available fiscal instruments form a vertical continuum whose opposite ends are the benefit of service principle at the bottom, and the ability to pay r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 71 principle at the top. more particularly, user charges for specific (i.e. excludable) services identify the lowest and general taxes to defray the cost of pure public services (i.e. externalities) the uppermost points of the continuum. it is not far-fetched to view the virtually ubiquitous municipal property rate (tax) as a user charge. nor should it be controversial to assert that the cost of national security or law and order should be met by means of progressive income tax. (after all, the rich have more to lose than the poor!) as always, the ranking of intermediate variables is far from clear-cut, and there is no really "scientific" (or obvious) way of assigning most kinds of tax to either the national or the provincial authorities. rather, tax assignment depends more on practical circumstances than theoretical principles. however, though it would be simplistic to demand that "a given fiscal authority should employ only those taxes it can best manage and no others" (netzer, 1974: 186), something akin to the principle of comparative advantage in international trade seems to be working in the field of fiscal assignment too. thus, in the present case, central government in south africa no doubt manages both income tax and the fuel levy more efficiently than the provincial governments would do. but it also seems most probable that the central government's advantage is comparatively greater in the case of income tax. by the same token, the provincial governments' disadvantage is comparatively smaller in the case of the fuel levy. therefore, a surcharge on the fuel levy rather than the personal income tax base seems the more efficient instrument of fiscal devolution in south africa. 7.2 tax administration there is general agreement in official and knowledgeable circles, that the cause of tax devolution would be best served if tax administration remains centralised in the south african revenue service (sars). only sars has prospective economies of scale or, conversely, reasonably low cost of administering the country's tax system. views differ, however, on whether sars has the capacity at present to accommodate the pit surcharge proposed by the ffc. the latter itself sees no serious problem on this count (section 4.3 above). the katz commission, however, disagrees (section 5.3), at the same time saying that sars would in fact be able to manage its own fuel surcharge proposal economically (section 5.4). surely it should be possible to settle the validity of these opposing claims by factual examination. in its 1999 budget review, the department of finance outlined various administrative improvements taking place at sars, including such productive inputs as enhanced audit capacity and new computer-based r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 72 sajems ns vol 3 (2000) no i audit systems. in its submission to the katz commission, dated 3 september 1997, sars itself pointed out several administrative problems and made the following conclusion (ap c: 225): should it be decided that ... a surcharge be levied on personal income tax, sars will not be in a position to introduce such a system before the tax year commencing on i march 1999. more recent information would seem necessary to reach a meaningful verdict on the economic relationship between tax devolution and tax administration in south africa. . 7.3 non-economic: arguments both parties to the pit-fuel levy surcharge controversy use arguments either not based on economic reasoning at all, or not sufficiently supported by the economic facts of life. this makes objective assessment of some of their policy proposals difficult, to say the least. the ffc's assertion that greater provincial tax powers would promote "democratic and fiscally accountable government" is an assumption that cannot be proved either right or wrong at present (section 1 above). it is a noble sentiment uttered in all good faith but no more. on the other hand, it is difficult to understand the katz commission's refusal to consider the assignment of excise taxes on commodities to the provinces (l998: 9). the ostensible reasons for it "(not] international best practice" and "the limited geographical size of south africa's nine provinces" are unconvincing from an economic point of view. at least the second "reason" could be used to argue against the commission's own recommended provincial surcharge on the fuel levy too even with greater force than in the case of the excise taxes on, say, tobacco and alcohol. all three products have a price-inelastic demand, which makes them outstanding candidates for any kind of fiscal impost. the matter evidently merits further study. however, a more serious problem is a general lack of objective information about several matters relevant to the tax devolution issue as a whole, aside from the question of tax administration briefly discussed in the previous sub-section. 7.4 research agenda in this sub-section we no more than highlight some topics that appear to call for further research. thus, finding answers to questions like the following should help to clarify the complex process of fiscal decentralisation on which south africa has embarked. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 73 • is there a net (negative) effect on income when a given provincial grant is replaced by an equal amount of own revenue, similar to the balanced budget multiplier? • how many social versus private benefits would be affected by the abovementioned operation? • what are the possible effects of fiscal devolution on the supply of pure public goods? • how much "tax migration" (le. tax avoidance) and other spillover effects is interprovincial tax competition likely to cause? • what are the expected interprovincial consequences of horizontal and vertical redistribution of resources, when the former do and the latter do not contain an "equitable share" component? • what would be the economic effects of transferring commodity excise taxes (e.g. on tobacco and alcohol) from the national to the provincial authorities? • if provincial expenditure targets are given, how much freedom of choice is new provincial own revenue likely to represent? • a particularly important research undertaking would be to investigate how fiscal decentralisation would affect the issues highlighted in section 288(2) of the constitution, namely, economic policies, activities across provincial borders, and the national mobility of goods, services, capital and labour. as the process of fiscal devolution grows, new topics are bound to be added to the research agenda. 8 conclusion the specific question around which much of this paper (especially sections 4 and 5) is structured, whether a surcharge on the personal income tax base or the fuel levy should be the first step in the direction of fiscal decentralisation in south africa, has already been answered in section 7.1. on the principle of comparative advantage in tax assignment, we found in favour of the fuel levy surcharge. our most important general conclusion is that the tax devolution process, in its early stages is, likely to be a learning process that should not be artificially hurried. at least some provinces initially experienced problems of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 74 sajems ns vol 3 (2000) no i overspending, but these have by now improved under the guidance of the national government (br: 92). at present again, some provinces have difficulty in spending their total budget allocations on account of capacity limitations. a similar process of tutelage is likely to be required for fiscal decentralisation too. it is to be hoped that this process of "learning by doing" would be accompanied by ongoing research into issues of fiscal devolution in south african conditions. in this context, it would be most useful if the ends-means relations that characterise fiscal decentralisation could be successfully conveyed to the participants in this endeavour. above all, provincial governments should grasp the fact that increased own revenue is not an economic end in itself, but the means of both regional and national efficiency and welfare. references i grote, m. (1999) internal report to the department of finance. 2 johansen, l. (1971) public economics. amsterdam: north-holland. 3 katz commission (kc) (1998), seventh interim report: synthesis of policy recommendations with regard to provincial taxation. 4 netzer, d. (1974) "state-local finance and intergovernmental fiscal relations", the economics of public finance, washington, dc: the brookings institution. 5 republic of south africa (1999) department of finance budget review (br) 1999. 6 tinbergen, 1. (1967) economic policy: principles and design, amsterdam: north-holland. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction aspects of business ethics significance of business ethics to small and medium-sized enterprises ethical dilemmas and challenges of small and medium-sized enterprises methodology conclusion acknowledgements references about the author(s) peter k. turyakira department of marketing and management, school of business, makerere university, uganda citation turyakira, p.k., 2018, ‘ethical practices of small and medium-sized enterprises in developing countries: literature analysis’, south african journal of economic and management sciences 21(1), a1756. https://doi.org/10.4102/sajems.v21i1.1756 original research ethical practices of small and medium-sized enterprises in developing countries: literature analysis peter k. turyakira received: 20 jan. 2017; accepted: 23 oct. 2017; published: 05 apr. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: there is increasing pressure on business organisations to behave ethically, in addition to running their operations in the most economical, efficient and effective manner possible to increase performance. customers have also become increasingly mindful of the reputation of the businesses they patronise. small and medium-sized enterprises (smes) have become the worst affected since they lack the funds, strategic information and relevant alliances to implement ethical practices. aim: this article aims at evaluating the aspects of business ethics, significance of business ethics to smes, ethical dilemmas and challenges of smes, particularly in developing countries, and suggests strategies to address ethical dilemmas and challenges. methods: the background literature review on ethical practices in smes in the context of developing countries was conducted on several journal articles. peer-reviewed articles in recent journals were analysed to identify the aspects of business ethics, significance of business ethics to smes, ethical dilemmas and challenges of smes and the proposed strategies to address ethical dilemmas and challenges thereof. results and conclusion: it is clear that business enterprises can no longer afford to disregard business ethics. there are continuous business failures as a result of unethical practices, especially those associated with employees and top executives. this article has added to the body of existing literature on ethical practices of smes in developing countries. as such, sme owners and managers can use the findings of this article to design ethical policy frameworks and guidelines to improve their reputations and competitiveness. introduction there is currently increasing pressure on business organisations to be ethical, in addition to running their operations in the most economical, efficient and effective manner possible to increase performance (khomba & vermaak 2012). due to continually changing competitive environments, businesses must also find new ways of meeting competition other than the traditional ways of offering better products, or lower prices (mcmurrian & matulich 2006). it is important to note that modern businesses employ people with diverse backgrounds in terms of nationality, culture, religion, age, education and socioeconomic status. each of these persons comes into the workplace with different values, goals and perceptions of acceptable behaviour. this diverse background creates ethical challenges for individuals as well as managers (abiodun & oyeniyi 2014). businesses have realised that ethical misconduct can be very costly not only for the organisation but also to society as a whole (abiodun & oyeniyi 2014). furthermore, today’s customers have become increasingly mindful of the reputation of the businesses they patronise. consequently, small and medium-sized enterprises (smes) have become the worst affected since they lack the funds, strategic information and relevant alliances (ononogbo, joel & edeja 2016) to implement ethical practices. regardless of their size, business enterprises can no longer afford to disregard business ethics (sraboni & sharmistha 2011). smes, and not small, medium and micro enterprises (smmes), are chosen for this study because they are more formal compared to smmes. it is notable that smes, which have been playing a leading role in the business domain in the last few decades, have remained outside the floodlights of review regarding the issue of business ethics (werner & spence 2004). there are also continuous business failures as a result of unethical practices especially those associated with employees (sraboni & sharmistha 2011). this in turn has adversely affected smes’ reputations (ononogbo et al. 2016). with the expanding role of smes globally, an ethical approach towards business is imperative for them (sraboni & sharmistha 2011). hence, business organisations and managers need to behave ethically and protect their own business interests (abiodun & oyeniyi 2014) if they are to survive and remain competitive. there is also increasing awareness of ethics, leading societies to disapprove of businesses that are found to be ethically ill (ahmad, amran & halim 2012). however, the study of the role and function of ethics in business organisations has unfortunately focused primarily on larger enterprises, even though smes exert a strong influence on the economies of all countries, particularly in the fast-changing and increasingly competitive global market (naidoo, perumal & moodley 2009). while many large companies have gained their reputation by applying ethical standards, smes in developed countries are progressively becoming more alert to the significance of trustworthy dealings with employees, clients, suppliers and society. however, smes in developing countries still require more understanding and awareness of the implication of business ethics and its benefits. they may be unable to recognise such gains due to lack of a long-term vision (mahmood 2008). the unique opportunities and challenges that smes encounter often tempt them to diverge from ethical practices when interacting with their stakeholders, especially the employees (sraboni & sharmistha 2011). hence, the study of business ethics has become imperative in today’s competitive business environment. this article attempts to evaluate the aspects of business ethics, significance of business ethics to smes, ethical dilemmas and challenges of smes, particularly in developing countries, and to suggest strategies to address ethical dilemmas and challenges. this article focuses on smes in developing countries because of their role in economic growth and poverty reduction. smes also contribute to economic development by creating employment for the rural and urban population. in developing countries, smes employ more than 70% of the labour force (mahmood 2008). for example, in thailand, smes account for more than 90% of the total number of establishments, 65% of employment and 47% of manufacturing value added, while in philippines, smes comprise 99% of the total manufacturing establishments and contribute 45% of employment and 18% of value added in the manufacturing sector (mahmood 2008). in africa, smes account for more than 90% of businesses and contribute about 50% of gross national product (gdp) (kamunge, njeru & tirimba 2014). for instance, in kenya, smes contribute 40% of the gdp, over 50% of new jobs and account for 80% of the workforce (mwarari & ngugi 2013). in uganda, smes constitute over 90% of businesses operating in the private sector; they contribute to 75% of gdp and employ approximately 2.5 million people (hatega 2007; uganda ministry of finance, planning and economic development 2011). this article will inform sme stakeholders, especially sme owners and managers in developing countries, to create and promote an environment that nurtures and facilitates the sme sector and enables it to realise its true potential. the article will also add to a body of knowledge with regard to sme ethical practices in developing countries. aspects of business ethics ethics refers to a system of moral principles or rules of behaviour which involves doing the right thing in the right manner (okafor 2011). according to mujtaba (2005), ethics is the branch of philosophy that theoretically, rationally and reasonably determines right from wrong, good from bad, moral from immoral, and fair from unfair actions and behaviour. behaving ethically implies doing what is morally right (okafor 2011; riley 2012). according to abiodun and oyeniyi (2014), ethics is based on broad principles of integrity, transparency, accountability, responsibility and fairness, and focuses on internal stakeholder issues such as product quality, customer satisfaction, employee wages and benefits, and local community and environmental responsibilities. ethics is also viewed as the moral values and principles that guide action and behaviour (emerson 2009). it is the discipline that deals with what is good and bad and with moral duty and obligations. ethical rules of conduct generally attempt to provide guidelines of human behaviour that will preserve a society and its individual members. bucholz (2003) views ethics as guiding values, principles and standards that help people determine how things ought to be done. similarly, spence and van heekeren (2005) regard ethics as a set of prescriptive rules, virtues, values and principles that inform and guide conduct. hence, ethics means moral principles that govern the action of an individual or a group (abiodun & oyeniyi 2014). most scholars generally agree that ethics is a set of principles, rules, morals and values that inform and guide the conduct of individuals and groups in society or a business organisation. business ethics is basically the study of morality and standards of business conduct. according to twomey and jennings (2011), business ethics denotes the application of ethics to business practices. it is simply the application of general ethical rules to business behaviour (hodgelts & luthans 2003). according to elbert and griffin (2003), business ethics refers to ethical or unethical behaviour by a manager or employee of an organisation and varies from person to person, from situation to situation, and from culture to culture. velentzas and broni (2010) view business ethics as the set of moral principles and values that take control over the behaviour of the organisation with reference to what is regarded as right and wrong. as such, business ethics can be seen as what is regarded as right and wrong or good and bad human behaviour in a business setting. hence, what is regarded as right or wrong can obviously be influenced by various factors such as the type of staff and their cultural background, and will vary from business to business (wiid, cant & van niekerk 2013). business ethics involves how a business integrates core values such as honesty, trust, respect and fairness into its policies, practices and decision-making (hellriegel et al. 2008). rossouw (2004) asserts that business ethics is about identifying and implementing standards of conduct that will ensure that a business does not detrimentally affect the interests of its stakeholders. for businesses to be profitable today, they must conduct their activities in such a way that they can be seen as ethical. therefore, ethics point towards the application of morality, while morality is derived from ethics (borade 2012). it should be noted that an individual’s moral sense guides moral behaviour (krebs 2011). this is in line with borade (2012) who asserts that while business ethics signifies the abstract moral code accepted and obeyed by members of the business, morality is the judgements, values and guidelines of good conduct in the workplace. as such, morality is what guides people towards acceptable behaviour, with respect to basic values (mujtaba 2005). according to borade (2012), morality refers to an adopted code of conduct within an environment and a set of agreed-upon rules for what is right and wrong. on the other hand, krebs (2011) asserts that morality is the equilibrium of individuals, which implies that interaction takes place according to a set of rules that balances the benefits and burdens of cooperation. ethical practices are the conscious compliance with the standard of morality that guides an individual and business to follow certain norms of conduct when dealing with people within and outside the organisation (ononogbo et al. 2016). as such, unethical business practices usually reflect the values, attitudes, beliefs and behaviour patterns of the organisational culture. according to abiodun and oyeniyi (2014), business decisions and behaviour may be judged ethical or unethical, depending on whether the decisions and actions promote or threaten the values and standards of individuals and the societies in which a business operates. however, ethical standards are not static ideals but dynamic patterns of human conduct. ethical standards, therefore, reflect the end product of a process of defining and clarifying the nature and content of human interaction. when identifying the business’s core values, it may help to think of some values as business values and others as ethical values, although the distinction can be insignificant, and business and ethical values are often interrelated. some common values of smes are shown in table 1 below. in smes, these values will inevitably be influenced by the personal and professional values and principles of the owners or managers. table 1: ethical and business values. significance of business ethics to small and medium-sized enterprises it is important to note that in the 21st century, power in the market has shifted from producers and sellers to buyers and consumers (weinstein 2012). where stakeholders have control over markets and can affect business performance, ethical practices are critical success factors when it comes to business (twomey & jennings 2011). as such, business owners and employees must exercise good faith in the practices they engage in if they are to continuously make profits. businesses that operate without regard for ethical values are likely to run into problems with the law, customers, employees and business partners. consequently, business reputation will suffer and the loss of business from unethical behaviour could be significant and difficult to erase. customers value ethical businesses and once a business has lost trust by being unethical, customers will seek alternatives and much will be lost to competitors, or in the process of defending against lawsuits (donovan 2013). however, smes must be especially cautious to balance the goals of profits with the values of individuals and society by practising good business ethics (twomey & jennings 2011). hence, businesses need good ethical values to survive. ethical and socially responsible practices benefit entrepreneurs financially in the long run. this means that behaviour associated with maintaining honesty and integrity, being trustworthy, engaging in fair commercial practices, taking responsibility and being accountable for one’s own actions are very important for smes in the long run (ahmad 2009). according to goll and rasheed (2004), in fast-changing and unpredictable environments, ethical and socially responsible behaviour helps businesses to gain support from different external stakeholder groups. such behaviour provide them with some protection from the unpredictability they face. as such, a business’s image and reputation may be influenced by the good practices it exhibits to its customers and to the general public (jones 2000). the benefits of ethical practices enable competitive advantage to be attained as a business distinguishes itself from its competitors (ahmad 2009). in fact, businesses with high ethical codes of conduct and a commitment to enhancing integrity are not only profitable but more likely to succeed in a commercially competitive world (hasnah, ishak & sobei 2015). although some managers consider ethics programmes in their organisations to be very expensive activities that are only societally rewarding (mcmurrian & matulich 2006), businesses that are viewed as ethical by their key stakeholders (i.e. customers, employees, suppliers and public) do enjoy several competitive advantages such as higher levels of efficiency in operations, higher levels of commitment and loyalty from employees, higher levels of perceived product quality, higher levels of customer loyalty and retention, and better financial performance (ferrell 2004). hence, high standards of organisational ethics can contribute to profitability by reducing the cost of business transactions and building a foundation of trust with important stakeholders (mcmurrian & matulich 2006). business activities require the maintenance of basic ethical standards, such as honesty, reliability and cooperation. businesses cannot survive if their directors never tell the truth, if buyers and sellers never trust each other or if the employees refuse to provide support to each other and to customers (branko, drago & zoran 2015). good ethics in terms of being fair, honest, responsible and upright helps to build credibility and trust for businesses. customers and other stakeholders want to engage businesses and business owners whom they can fully trust with their happiness, needs and wants, their money and their safety, health and well-being (donovan 2013). therefore, sme owners must see business investment, growth and sales as stemming from a circle of trust (twomey & jennings 2011). there is indeed a link between a business’s commitment to values and its financial performance (chun et al. 2011; twomey & jennings 2011). while not conclusive, research (webley & more 2013) has shown that the relationship between good financial performance and other indicators of corporate responsibility is positive. hence, businesses have something to gain financially from being ethical. after all, being ethical should naturally create a solid and better reputation that leads to recognition by stakeholders, especially customers who, in turn, increase their loyalty and are willing to purchase with more confidence and make referrals. as such, smes must develop their ethical presence and reputation in order to remain strong in the eyes of customers (donovan 2013). furthermore, when a business has a good reputation, it benefits from a good name and its good deeds are noticed by the public. having an ethical conscience and being ethically conscientious is the best approach to building a good reputation. this requires smes to be fair, honest, carry out decisions and operations with integrity and consideration, be trustworthy, and respond to stakeholders’ needs for action and community engagement (donovan 2013). building a good reputation can pay off in the long run as the business becomes well-endorsed by business stakeholders and creates new customers. hence, good reputation can build lifetime customer value as it leads to stronger customer relationships (peppers & rogers 2004; weinstein 2012). smes that ethically conduct their businesses are likely to have a positive effect on sales and profits, experience a lower incidence of staff turnover, as well as increased productivity, as employees prefer to work at an ethical organisation, easily attract potential employees wanting to work for the organisation, thereby reducing recruitment costs and helping the company get the right skills, and protect the business from a possible hostile takeover by attracting investors (wiid et al. 2013). hence, smes need to develop ethical policies and adhere to them in their day-to-day operations. the lack of general ethics among sme owners affects the growth opportunities of business by negatively impacting customer loyalty, brand building and deterring investment partners (kalyar, rafi & kalyar 2013). this also creates a stereotype and perceptions of a general lack of credibility and reputation among smes, thereby affecting their ability to compete with larger businesses and to obtain funding for development. hence, it is imperative for smes to appreciate the nature and importance of business ethics in order to develop strategies and solutions to effectively address existing challenges and minimise business failure, increase opportunities for growth, competitiveness and performance, and improve their general reputation in industry and community (donovan 2013). indeed, the importance of business ethics cannot be overemphasised (mahmood 2008). the advantages of adopting business ethics include: investors use business practices and values as primary considerations in their decision-making. as customers are becoming increasingly aware of their rights, they value ethical practices. hence, adopting ethics can help to build reputation of businesses. promoting reputation can help in building customer loyalty and increase revenue. attract a talented workforce and employees thus improving business performance and productivity of employees. comply with regulations such as labour laws and environment. collaboration with other firms both domestically and internationally. according to sraboni and sharmistha (2011), a satisfied and motivated workforce is the primary step towards long-term success in business. ethical practices towards the employees can warrant job satisfaction and enhanced motivation levels of employees, which eventually leads to better business profitability. essentially, ethical hiring practices, the implementation of a rational performance appraisal system, a formal procedure for employee replacement, a proactive approach towards handling employee grievances, workplace safety and voluntary investments for employee welfare are all instrumental towards creating an ethical work climate. furthermore, encouraging employees to participate in decision-making, attending to the training and development needs of employees, without discrimination, and presence of a formal code of ethics in the organisation are also ethical issues that motivate employees (sraboni & sharmistha 2011). ethical dilemmas and challenges of small and medium-sized enterprises the practice of providing benefits to someone in business or government to obtain an inappropriate market, workplace or economic advantage is widely judged as an unethical practice. this is due mainly to the evil effects of corruption, bribery and fraud. this practice is widespread in most developing countries especially african nations. in fact, it is so institutionalised in a number of africa nations such as nigeria and somalia that it is the only effective way of doing business (abiodun & oyeniyi 2014). in many cases, bribery in african nations transcends the level of being referred to as unethical to being a common practice (unruh & arreola 2009). there is evidence to suggest that these vices of corruption, bribery and fraud hinder the creation of an acceptable legal system, encourage red tape and bureaucracy, thus eroding public confidence and trust, and blocking the development of the infrastructure on which business organisations depend (unruh & arreola 2009). relatedly, piracy and counterfeiting practices have become more prevalent in many developing countries. piracy and counterfeiting adversely affect society and businesses (abiodun & oyeniyi 2014). unethical behaviour has indeed become prevalent in businesses of all sizes today, and they pose significant risks to business organisations and their stakeholders (wiid et al. 2013). smes are in a more vulnerable position today with regard to corruption, fraud and other unethical practices. this is attributed to the fact that they need to survive and as they tend to be small in size, they experience more difficulties. smes are especially vulnerable to the practice and consequences of unethical business behaviour (medlin & green 2003) due to their size, limited finances and funding sources, their dependence on word-of-mouth strategies to market products, dependence on sometimes overpowering customers, difficulty in building a reputation and their tendency to take shortcuts when doing business. however, smes in the developing countries lack awareness and understanding of the importance of business ethics and its advantages. smes lack long-term vision and focus more on survival in the short term. due to lack of financial resources to build a formal ethical culture, smes in some countries like pakistan embrace unethical practices in order to remain afloat. for example, they seek unethical schemes to access low-quality goods at lower prices and evade taxation so that they have the upper hand over their competitors (mahmood 2008; tarus & nganga 2013). others accept contracts at lower prices than they should because there are no rules governing their operation. furthermore, lack of information, credit, scale economies, quality and reputation make most smes very uncompetitive (tarus & nganga 2013). on the other hand, smes are aware of the large scale of unethical practices taking place in large companies and government departments, which they see as standard or acceptable practice. therefore, this may influence their behaviour and perceptions, and even make them more open to dishonest behaviour (wiid et al. 2013). in some instances, smes see these unethical actions as necessary for survival. their size ultimately limits their resources and capabilities to avoid corruption and fraud in the business sector. consequently, many, particularly in developing countries accept corruption and fraud as normal, acceptable practices and utilise these as a means of getting something done quicker, even when they know that it is illegal and unethical (rune 2011). developing entrepreneurial culture and ethical business environment are critical challenges for smes (mahmood 2008). it should be noted that smes are primarily driven by the personal beliefs and values of their owners and also face significant resource pressure. this may lead smes towards more individualist ethical postures such as non-repayment of credit (hopkins 2005). the common unethical practices in businesses include padding expense accounts, seeking reimbursement for questionable or non-existent business expenses, taking business property or materials for personal use, soliciting or offering kickbacks and price fixing (ononogbo et al. 2016). this is in line with botha (2012) who states that the most common ethical concerns about misconduct in the business environment include bribery, coercion or bullying, theft, discrimination, fraud, harassment, dishonesty, cover-ups and pornography. similarly, collins (2012) observes that the most common forms of ethical misconduct experienced by many businesses are abuse of a company’s resources, abusive behaviour towards employees, lying to employees, internet abuse, conflict of interest, discrimination, lying to stakeholders, employee benefit abuse, employee privacy violation and falsifying expenses. however, it should be noted that these actions of misconduct are not limited to large organisations, but equally apply to smes in all sectors. for instance, in a survey conducted by collins of sme professionals, the major concerns identified regarding ethical behaviour were kickbacks paid to employees, honesty in contracts and internal communications, and the granting of pay raises. by nature of their limited size, smes may also be more prone to bullying from a large unethical customer or supplier (collins 2012). on the basis of the current economic climate and the realities faced by smes, moral concerns are widespread as there are various conflicting standards and interests due to rare resources, high uncertainty and risk, vague roles, and continuous competitive strain. the most challenging moral issue that businesses encounter is to decide between upholding normative business ethics and following their own selfishness for their own interest (bryant 2009). it is obvious that employees and managers are ill equipped to cope with ethical challenges due to a number of reasons (bryant 2009) and, therefore, they may not even perceive ethical issues in the working environment. from a normative perspective, a lack of moral awareness is likely to increase the risk of a person behaving immorally and an increase in business ethics misconduct (bryant 2009). hence, moral awareness is the backbone to an individual’s sense of moral behaviour and ethical decision-making (wiid et al. 2013). a summary of the ethical dilemmas and challenges of smes in indicated in table 2: table 2: summary of ethical dilemmas and challenges of small and medium-sized enterprises. methodology in this article, the background literature review on ethical practices in smes in the context of developing countries has been conducted on several journal articles. peer-reviewed articles from journals between 2004 and 2016 were analysed. this helped identify the aspects of business ethics, significance of business ethics to smes, ethical dilemmas and challenges of smes and the proposed strategies to address ethical dilemmas and challenges thereof. the key words used for the literature search are ethics, business ethics, ethical practices and smes. proposed strategies to address ethical dilemmas and challenges dealing with ethical issues requires the input of all stakeholders, a multidisciplinary and multidimensional approach. therefore, consideration of employability skills such as honesty, ability to work cooperatively, respect for others, pride in one’s work, willingness to learn, dependability, responsibility for one’s actions, integrity and loyalty is very critical (abiodun & oyeniyi 2014). it has been noted that ethics is based on a set of moral and ethical values. such values must be taken seriously to override any human rationalisation, weakness, ego, or personal faults (putnam 2016). these values include honesty, integrity, responsibility, quality, trust, respect, teamwork and leadership. good ethics should be most noticeable at the top, and every employee must be accountable to the same rules. therefore, everyone’s common goal should be to build a strong, profitable business that will last. training must be provided to get everyone on the same page (putnam 2016). the training should focus on business ethics and how smes can introduce the concept in their structure. hence, sme owners and their employees need to become more educated and more aware of the need for ethics in business. they need to understand what ethics means and how to apply the stakeholder model in making ethical decisions (donovan 2013). business ethics and corporate social responsibility are very important to the success of smes (the institute of business ethics 2007). there is the need for smes to maintain good, trusting relationships with key stakeholders such as customers, employees, suppliers and the community. it is recommended that sme owners should design a code of ethics as a key tool for implementing business ethics in their businesses. such code of ethics should translate core values into specific commitments and expected behaviour in relation to the organisation’s stakeholders. the code of ethics should also clearly show how the business will address environmental responsibility and how the firm will relate to competitors (fatoki & chiliya 2012). business ethics should be introduced as a major module in the universities and in institutions of higher learning in developing countries to educate likely entrepreneurs about the importance of ethics. smes need to collaborate with each other and the best way to do this is to form strategic alliances. this will help them to learn about challenges and best practices. working through associations will also help in promoting fair business practices. additionally, smes should be provided orientation towards developing a long-term vision as opposed to short-term objectives and how these two are interlinked for business growth as well as benefit of the community (mahmood 2008). sme owners practise good faith as the foundation of business engagement with stakeholders. this requires a business to act honestly, and sincerely endeavor to behave in accordance with one’s own agreements, ethical standards in the industry and the law itself (emerson 2009). sme owners must desist from taking unfair advantage of their employees, customers, and other stakeholders. hence, smes must appreciate that doing business requires exercising good faith and honouring their promises and carrying out their responsibilities towards customers and stakeholders with goodwill and good intention. with regard to contracts and other agreements, sme owners must accurately represent their products and services, be honest in transactions and honour their promises. conclusion business enterprises can no longer afford to disregard business ethics. there are continuous business failures as a result of unethical practices especially those associated with employees and top executives. this in turn has adversely affected smes’ reputations and survival, particularly in developing countries. business organisations and managers need to behave ethically and protect their own business interests if they are to remain competitive. sme owners and their employees need to become more educated and more aware of the need for ethics in business. they need to understand what ethics means and design a code of ethics as a key tool for implementing business ethics in their businesses. such a code of ethics should translate core values into specific commitments and expected behaviour in relation to the organisation’s stakeholders. this article has added to the body of existing literature on ethical practices of smes in developing countries. as such, sme owners and managers, as well as the industry, can use the findings of this article to design ethical policy frameworks and guidelines to improve their reputations and competitiveness. limitations of the article and directions for future research this article mainly focused on the literature review of business ethical practices of smes particularly in developing countries. as such, it does not give the current state of ethical practices of smes and large companies. hence, future scholars and researchers should conduct empirical qualitative and quantitative studies covering both smes and large companies globally with regard to ethical business practices and 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weinstein, a., 2012, superior customer value: strategies for winning and retaining customers, 3rd edn., crc press, coral springs, fl. werner, a. & spence, l.j., 2004, ‘literature review: social capital and smes’, in l.j. spence, a. habisch & r. schimidpeter (eds.), responsibility and social capital: the world of small and medium sized enterprises, pp. 7–24, palgrave macmillan, new york, ny. wiid, j.k., cant, m.c. & van niekerk, c., 2013, ‘moral behaviour and ethical misconduct in nigerian small businesses’, international business & economics research journal 12(9), 1087–1100. https://doi.org/10.19030/iber.v12i9.8054 abstract introduction literature review problem statement purpose and objectives of the research research design ethical consideration results conclusions acknowledgements references about the author(s) joseph a. feldman graduate school of business leadership, university of south africa, south africa citation feldman, j.a., 2018, ‘an archival review of preferred methods for theory building in follower research’, south african journal of economic and management sciences 21(1), a1582. https://doi.org/10.4102/sajems.v21i1.1582 original research an archival review of preferred methods for theory building in follower research joseph a. feldman received: 30 apr. 2016; accepted: 01 mar. 2018; published: 11 june 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract aim: the purpose of this research was to delineate methodological trends in articles published both internationally and locally that will reveal the extent of new theory building. setting: the research strategy and methodology examined trends in theory building over a 52-year period (1962–2014). method: an archival review of the published literature was conducted and each article was examined to identify the general research method employed. the chi-square test was used to determine whether there is a significant difference between the expected frequencies and the observed frequencies in one or more of four categories. results: the archival data indicate that articles published over the past 52 years in major international and south african journals are skewed towards quantitative and conceptual research. this implies that researchers in leadership studies employed qualitative and mixed methodologies in their work less often than quantitative and conceptual methodologies. conclusion: this trend has implications for the development of leadership-followership research. research methods should be used with mindfulness, with qualitative methods being used to observe social and human problems, followed by quantitative methods to test inductively formulated followership theories. it is particularly important, in the context of diverse cultures, to note that local attempts to formulate authentic theory development will remain difficult and unsuccessful until endogenous management systems are established and institutionalised. this is very important for scholars who believe that an affinity for qualitative methodology affords the opportunity for emic research rather than merely for testing theories and constructs that may not capture local followership phenomena. introduction an informal preliminary literature review by the author of this research revealed that the concept of followership has, until now, received very little attention in leadership studies. in most leadership studies, very little or no reference is made to followership or to its role in leadership-followership dynamics. a need has now emerged to build followership theory that reflects the unique reality of different cultures and contexts in the global and south african leadership-followership environment as they relate to one another, that is, building follower capacity that is understood by leaders. kelley (1992) states that, in general, the views of leadership in various leadership studies are more developed and advanced compared with the views on followership. vecchio (2002:659) states that ‘a number of models exist that detail dimensions of leadership, whereas there are no formal models that detail styles or dimensions of followership’. as a result of the conclusions reached by researchers such as vecchio, research with a follower-centred approach has been receiving increased attention. evidence by eden and leviathan (1975:740) is enlightening: ‘it is evident from the results of the study that the leadership factors are in the mind of the respondent’ (being the follower). this means that the chance to emerge as, and remain, an effective leader does not depend solely on the leader’s own behaviour, but also on followers’ accessing of information to make attributions about the leader. such approaches indicate that the evaluation and acceptance of a leader in a specific situation is determined by followers’ mindsets, which consist of assumptions, beliefs and expectations regarding the causes, nature and the consequences of leadership, or, in other words, their implicit leadership theories, which, in fact, can be thought of as their follower theories. literature review the awareness of the lack of sustained research of followership to complement leadership research, prompted by vecchio, eden and leviathan above, was also felt by joubert and feldman (2017). their research findings achieved a deeper appreciation of followers’ epistemological and ontological views, within a specified context, and were supported by a common need to achieve organisational safety objectives. a practical managerial benefit was found in the insights presented by followers of leadership, one which might also possibly bolster leadership development and training needs, along with the training and advancement of followers. harms and spain (2014) reflect on an alternative, yet relevant, view. they direct attention towards the perceptual biases held by followers as a potentially fruitful topic for future research in the field of leadership-followership dynamics. leaders become effective or ineffective because of how followers – however idiosyncratically – perceive them. perceptual biases can lead to negative or positive views of leader behaviour. followers view leaders differently, depending on positive (prototypical) or negative (anti-prototypical) leader behaviour. against the background of the literature above, petros malakian completes the rationale for follower research in his 2014 article. its essence is conveyed below. malakian (2014) refers to thirteen leadership approaches and points out how each of the studies omits the follower dynamic in its thesis: the trait approach, the earliest systematic study of leadership (bass 1981; lord, de vader & alliger 1986), does not address followership. gardner et al. (2005) goes on to state that one of the evidences of this omission is the complementary list of leadership traits with no follower traits developed from 1948 to 2004, with the exception of authentic leadership, where the leader and follower development is considered. the skills approach, which aims to solve complex problems in organisational leadership (katz 1974; mumford et al. 2000), omits the leader-follower dynamic as a subject of study. the style approach, which defines leadership as relational and task-oriented behaviour (ohio state and michigan state studies) – and which also embraces the managerial or leadership grid (blake & mouton 1985) in order to explain the importance of concern for people and concern for productivity – is also a leader-centred approach. the situational approach, with its four leadership styles (hersey, blanchard & johnson 2012), is also a leader-oriented study because follower-styles, and how they may affect the leader’s behaviour, have not been identified. the contingency theory, being a leader-match theory (fiedler 1964, 1967; fiedler & garcia 1987), assumes that leadership effectiveness is contingent on leadership style and leadership situation. it thus offers no discussion on follower style and its impact on leadership effectiveness. the path-goal theory is concerned with the motivation of subordinates towards the goal set forth by the leader of the organisation (evans 1970; house 1971; house & dessler 1974). the goals of the organisation are not necessarily discussed and mutually agreed upon by the leader and the follower. leader-member exchange theory (lmx theory), which puts sole emphasis on leader-follower interactions as a dyadic relationship within a three-phase developmental process (stranger, acquaintance and partner) (danserieu. graen & haga 1975; graen & uhl-bien 1995), seems to segregate followers into two types of groups: in-groups and out-groups. the lmx theory can thus be accused of favouritism and unfairness. phillips and bedeian (1994) commented on leader-follower attribution exchanges that have been conducted. attitudinal similarity and introversion or extroversion measures were inferred to be more positively related to leader-member exchange level than follower growth, need strength and locus of control. other predictors are also employed as part of lmx theory, along with diverse samples and measurement procedures intended to lead to a complete understanding of the leader-member exchange model. transformational leadership is also concerned with the leader’s behaviours and can be viewed as elitist and anti-democratic (avolio & gibbons 1988). team leadership allows for functional flexibility among team members in that they choose their own teammates from among the members of the entire team (fisher 1985; hackman 2002; kinlaw 1998). this approach tends to focus more on the leader’s decision-making towards team effectiveness through internal or external leadership interventions. servant leadership. the focus here seems to remain on the one who becomes a leader through his or her service. it still does not show how one can be a servant follower. leadership ethics approach. here, the leader is at the centre of the research attention, which raises the question of how the followers’ ethical behaviour can be discounted (hollander 1995). authentic leadership. in this theory, followership is fully present in research and the followers’ emotional reaction to the leader’s inauthentic behaviour has been studied alongside leadership (eagly 2005; gardener et al. 2005; george & sims 2007). most scholars, however, still ascribe leadership and followership to two separate human identities. thus, the theory seems to hold a static view of the leader and the follower. followership does serve as the subject or study-matter in the following research: singh and bodhania (2013) conducted their research from a south african point of view and state that, while leadership and leaders are an important part of organisational life, they cannot exist without followers. they also express their surprise that such a great disparity exists between the volume of existing leadership and followership literature, with the volume of leadership literature far outweighing that of followership. scholars have challenged the assumption that management (by implication leadership-followership) theories formulated in one country are applicable universally. research in one country cannot be generalised directly to other countries. greyvenstein and celliers (2012) used qualitative descriptive research, titled: ‘followership’s experiences in organizational leadership’. this approach presupposes that leaders are more effective in their roles when they understand their own psychological world, as well as that of their subordinates, and that the emotional responses and habitual patterns of behaviour of both leaders and followers are the result of strong influences from past experiences. the follower does not necessarily seem to be the subject of study in relation to the leader. they found that six themes manifested, namely a negative leadership view, idealisation of the past and blaming the present, obsession with race and gender, constantly changing identity, unfinished business and the future, and ‘cope and hope’. from a followership in leadership studies view, this research can be credited with at least posting the following practical managerial implications: leadership seems to focus more on business than on followership issues and this leads to followers feeling disregarded and de-authorised. as a result, followers withhold authorisation from leadership which, in turn, may be instrumental in leadership’s difficulties in managing change and transformation effectively. leadership development needs to incorporate the self-authorisation of leaders as well as the invitation of authorisation by leaders. conclusion: there is a gap in the existing research on the leadership-followership continuum. research on followers is in its beginning stages and is outweighed by research on leadership. in addition, no knowledge exists on the prevalence of research paradigms and methods in followership. problem statement the literature study, which reflects the gaps in archival studies of followership research in international and south african literature, presents the opportunity to address the problems, which may be presented as: the very limited prevalence of followership research and knowledge of the preferred methods used in the research. purpose and objectives of the research against the background of the need to address the problem statement above, the purpose of this study is to determine, firstly, the extent to which theory-building trends are occurring in the field of followership in organisations. more specifically, the objective is to delineate methodological trends in articles published in international as well as south african leadership-followership research as an indicator of new theory development. secondly, the other objective of this study is to review a sample of studies as the most likely sources from which theorists would publish theory-building research. this research strategy and methodology examines trends in theory building in followership over a 52-year period (1962–2014). research design method the study reviewed research published from 1962 to 2014 in journals that were selected on the basis of the following keywords: followership; follower attributes; follower perceptions of leadership; follower attributions of leadership; leader attributes; leadership behaviours; leadership attributions about followers. an archival review of the published literature was conducted and each article listed in table 1 was examined to identify the general research method employed. the categories used to assist in the classification of the articles published were: ‘conceptual’, ‘quantitative’, ‘qualitative’ and ‘mixed’. articles were defined as ‘conceptual’ if they were reviews of literature, essays or systematic attempts to explain the explicit and implicit use of concepts. these articles did not involve the collection of empirical data. table 1: frequencies on measures used. ‘quantitative’ research relates to a nomothetic or etic science, based on probabilities derived from the study of large numbers of randomly selected cases (cresswell 2003). ‘qualitative’ research was used if data collection occurred through means such as case studies, interviews, narrative studies, ethnography, archival retrieval, participant observation and a variety of other qualitative methods. a ‘mixed’ research method, also known as triangulation, is used if a study employed both ‘quantitative’ and ‘qualitative’ design techniques (opperman 2000). to continue with analysis of prevalence of categories, the interrater reliability was found to be 95%. interrater reliability addresses the consistency among researchers in assigning each article, based on consensus, to the four different types of research. it does not assess the validity, which would be concerned with the classification system itself. however, a minimum content validity was achieved by using well-established definitions of each type of research article. analyses on completion of categorisation, a statistical analysis was performed to ascertain whether there were significant differences in the research methods utilised. a chi-square analysis was performed, which allows for a test of differences in cell frequencies of each of the different types of methods (gravetter & wallnau 2000). the chi-square test is used to determine whether there is a significant difference between the expected frequencies and the observed frequencies in one or more categories, that is, the chi-square goodness of fit test allows us to test whether the observed proportions for a categorical variable differ from hypothesised proportions; if the four categories above are postulated to be in equal proportions, then the hypothesised proportion is 25%, for instance. for this research, the null hypothesis is that the proportion of conceptual studies, the proportion of quantitative studies, the proportion of qualitative studies and the proportion of joint or mixed studies are equal, as opposed to the alternative, which is that at least two types will differ in their proportions. the decision rule was to reject the null hypothesis if the p-value (of the chi-square statistic) is less than the level of significance, which is 0.05. alternatively, the null hypothesis will be accepted if the test statistic (chi-square) is greater than the critical value. ethical consideration the study was cleared ethically by university of south africa (unisa) school of business leadership. results based on the analysis in the table, the frequencies of the theory-building research methods in follower research are found to be: conceptual: 27% quantitative: 59% qualitative: 7% mixed: 7% the chi-square value 300, which is very high (thus, reject the null hypothesis) and that is highly significant, meaning reject the null hypothesis and conclude there is evidence to show that the proportions are not the same or there is association between type and proportion. table 2: type * proportion cross-tabulation. table 3: chi-square tests. table 4: symmetric measures. conclusions the archival data indicate that articles published over the past 52 years in major international journals are skewed towards ‘quantitative’ and ‘conceptual’ research. this implies that researchers in leadership studies employed ‘qualitative’ and ‘mixed’ methodologies in their work less often than ‘quantitative’ and ‘conceptual’ methodologies. this trend has implications for the maturation of leadership-follower research. figure 1: bar chart of trends in research method based on a sample of 25 articles published between 1962 and 2014. there is a need to close the gap between qualitative and quantitative research methods and to integrate their use rather than separate them (carlie & christensen 2004). research methods should be used with mindfulness – with qualitative methods being used to observe social and human problems, followed by quantitative methods to test inductively formulated followership theories. international trends in leadership-followership research should be assessed to examine the relative use of qualitative and quantitative research methods in the extant literature. the question can now be asked: ‘so what?’ researchers can use any method they want to, as long as it is done in scholarly ways. this researcher encourages the reader to think again. as mentioned in paragraph 1 of this conclusion, this trend has implications for the maturation of leadership-followership research. we want our research to respond to the needs of the populations who benefit from it. the aim of any method is to impart the greatest possible relevant meaning it is particularly important in the context of diverse cultures that local attempts to formulate authentic theory development will remain both difficult and unsuccessful until endogenous management systems are established and institutionalised. this is very important in the case of south african followership scholars who may well believe that an affinity for qualitative methodology affords the opportunity for meaningful emic research rather than merely testing theories and constructs that may not capture local followership phenomena. the question now is that, if ‘qualitative’ and ‘joint’ research are so important in theory building, why are so few researchers employing these methodologies? a number of authors suggest that quantitative research is more likely to find acceptance in academic journals because statistical methods are viewed as more rigorous and reliable while qualitative methodologies appear more open to bias and subjectivity (argyris 1980). both qualitative research and mixed research require good group and interpersonal facilitation skills. in addition, both preclude the gathering of aggregate data and demand long-term commitment from researchers. qualitative research often requires in-depth study of the history, culture and language of the people one is investigating (triandis & gelfand 1998). lee (1995) states that interviewing via focus groups and structured interviews can be very difficult to perform and be emotionally draining (harari & beaty 1990). researchers are encouraged to be mindful when selecting research paradigms and methods, and this researcher pleads that we take cognisance of peshkin (1993) who states that: qualitative research studies typically serve one or more of the following purposes: description: they can reveal the multifaceted nature of certain situations, settings, processes, relationships systems and people. interpretation: they enable a researcher to (1) gain new insights about a particular phenomenon, and (2) develop new concepts or theoretical perspectives about the phenomenon, and/or (3) discover problems that exist within the phenomenon. verification: they allow the researcher to test the validity of certain assumptions, claims, theories, or generalisations within real-world contexts. evaluation: they provide a means through which a researcher can judge the effectiveness of particular policies, practices, or innovations. recommendations research on followership is relatively unexplored and is, to some extent, ignored because of the overwhelming focus on leadership. it is evident from table 1 and the conclusions and implications therein that: a pilot study making use of qualitative and mixed method research could be launched in south africa to test follower experiences of leader behaviour in a setting where follower-leader dynamics are critical. a study could be initiated using the same data as the foregoing archival study to produce a meta-analysis of the relevance of the keywords as possible 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https://doi.org/10.1108/01437729710169373 54 sajems ns vol 2 (1999) no 1 size efficiency of sugarcane farms in kwazulunatali s mbowa, w l nieuwoudt department 0/ agricultural economics, university o/natal, pietermaritzburg pm despins department 0/ agricultural economics, university o/wisconsin-madison abstract the analysis is based on survey data collected from small and large sugarcane farms during 1995 in the north coast region of kwazulu-natal. a non-parametric research procedure to analyse farm efficiency was employed. results indicate that farms smaller than eight hectares exhibit substantial economies of size; such economies tend to decline with size of enterprise; and fanns larger than 10 hectares appear to have near constant returns to scale. this implies that efficiency of very small scale sugarcane farms can be enhanced by land consolidation while giving small scale farmers larger than 10 hectares access to the large scale commercial sector, may not lead to a loss in efficiency. results are relevant as south africa is embarking on settling small scale farmers on former large scale commercial farm land. jel 12 introduction with government policies focusing on issues of equity and efficiency, the relationship between farm size and fann efficiency is of interest to south african (sa) agricultural policy makers (van zyl, i 994). land reform has been accorded high priority by the national government and is expected to alter the distribution of farm sizes appreciably over a short period of time (department of land affairs, 1996, pp. 4). as a vehicle to uplift living standards of people in rural areas in kwazulu-natal, the south african cane growers' association (sacga), is directing resources to develop small sugarcane growers (chadwick and sokhela, 1992). sugarcane production is viewed as having the potential to support smallr ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 55 scale commercial agriculture, and the capacity to absorb a substantial amount of labour (small grower financial aid fund-f af, may 1992). this is compatible with recent policy shifts in south african agriculture where policy makers including the world bank, believe small farmers can and should playa key role in developing rural areas in south africa (sa). in the sugarcane industry, productivity differences are evident between small and large sugarcane farms, as average yield on small farms is 40 tons per hectare, compared to 55 tons per hectare on large scale farms (sacga, 1994). there is a possible efficiency loss to the industry if emphasis is placed on small farm operations although some argue that efficiency of large scale farms results from policies which favour large farms over small-scale family type farms (van zyl, 1994; binswanger, 1994). in this study some information is provided on the trade-off between equity and efficiency if large sugarcane farms are subdivided into smaller units under the land redistribution programme. the critical question therefore discussed is the viability of very small farms, and what might be the effects on economic efficiency of the sugarcane industry if farm size structure were to change. reasons for focusing on sugarcane farming include; the long history of small farms operating alongside large-scale farms, and the importance of the crop in the agricultural economy of kwazulu-natal, accounting for about 41 % gross value of agricultural products in the province (erskine, 1982). the main purpose of this paper is to examine how efficiency of resource use varies with size of a farm business, and implications which variations in performance might hold for the reallocation of resources between size-groups in pursuit of land redistribution. efficiency differences in resource utilisation on farms were studied using data collected from a sample of 160 small and large sugarcane units in the north coast region of the kwazulu-natal sugarcane belt. the presence of both small and large-scale farm units in the region enabled the collection of information showing resource use on a wide range of farm sizes, operating in relatively homogeneous agro-climatic conditions, and under a similar land tenure regime (private ownership). studies on farm size efficiency relationships in sa show mixed evidence for the existence of scale efficiencies (van zyl, 1995). empirical studies showing inverse relationship between farm size and efficiency have a tendency to overlook the fact that the adoption and use of any technology involves fixed transaction and information costs (lyne, 1996). likewise many studies are based on information collected from "medium" and "large" commercial farms (van zyl, 1995), thereby r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 56 sajems ns vol 2 (1999) no 1 drawing conclusions in isolation of information from the very small farms. in this study farms studied range from one to six hundred hectares, small farms are defined as farms of twenty hectares and below under sugarcane, as defined by the south african cane growers' association (sacga). the sample is stratified to maximize the variation of the farm size variable in order to study the effect of this variable on efficiency. 2 analysis of farm size efficiency, options and considerations 2.1 meaning of efficiency conventional definitions of efficiency are in terms of the optimality conditions associated with the perfectly competitive norm, that is, "the marginal rates of substitution between any two commodities or factors must be the same in all their different uses" (pasour, 1981). this implies a comparison of the observed situation with a defined efficiency norm. the 'perfect market' norm is often used in agriculture as agricultural producers are almost always price-takers. however, this norm has three important assumptions; (a) perfect communication, (b) instantaneous equilibrium, and (c) costless transactions. decision makers are thus assumed to have perfect knowledge about all relevant variables, including future occurrences (pasour, 1981). pasour (1981) argues that real world decision makers will always appear inefficient when measured against the perfect market norm which assumes away uncertainty and information costs. to be meaningful, efficiency measures must be based on the costs and returns which face the individual decision maker. therefore many economists (friedman, 1962; pasour, 1981), contend that it is difficult to measure efficiency, because individual decision makers have different cost functions as they value opportunity costs differently and display different attitudes towards risk. individual farmers therefore each have an optimum farm size and there is no single optimum farm size for all farmers. the existence of specialized factors of production (friedman, 1962, pp. 141) introduces an additional reason why firms should differ in size. in any industry where resources used cannot be regarded as unspecialized, there will tend to be firms of different sizes, hence one could speak of an "optimum distribution of firm size" rather than "optimum" size of a firm (friedman, 1962, pp. 142). in a market r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 57 economy an optimum distribution of farm size may occur, and a study of optimum size is thus superfluous. however in south africa, where government is encouraging small farm development, the issue of efficiency and equity becomes relevant. in this study the term 'efficient farm' refers to a farm utilizing less resources than other farms to generate a given quantity of output. alternatively, for a given quantity of resources they generate a greater output. this superior performance is manifested in higher efficiency ratios (output per unit of input), and a lower cost per unit of production. therefore, agricultural efficiency is attained when the greatest possible product is achieved from a given stock of resources, or conversely, when a minimum input of resources is used to produce a given level of output. 2.2 sources of efficiency (economics of size or scale) experience in agriculture as well as manufacturing industries has frequently confirmed that average costs per unit produced (or sold) decline as fixed costs are spread over a greater output, so that the small farm or firm with limited output and/as well as certain unavoidable costs finds itself at a disadvantage (britton and hill, 1975, pp. 7). fixed costs such as management, supervision, information and machinery can be used over more units of output (krause and kyle, 1970), resulting in reductions in cost per unit of output (increasing returns to scale or size). lower operating costs per unit of capacity are often given as a major source of economies of size in the use of fixed capital (britton and hill, 1975, pp. 121). tractors and harvest machines reach their lowest cost of operation per unit at a much larger area, so optimum operational family farm sizes will increase with mechanization (hall and leveen, 1978; binswanger et ai, 1992, pp. 24). but rao (in binswanger and elgin, 1988) argues that, economies of scale for machines do increase minimum efficient farm sizes but by less than expected, because of rental markets for machines. the renting of machinery involves fixed transaction costs which introduces size economies that favour large farm operations (lyne, 1996). rental markets for machines, can circumvent the economies of scale inherent in machines only partly, because rental markets often are feasible not for time-bound operations, such as seeding in dry climate or harvesting where climatic risks are high (binswanger and elgin, 1988; binswanger et al, 1992, pp. 21). binswanger, et at (1992, pp. 21), argue that in plantation crops like sugarcane, economies of scale arise from processing or marketing stage rather than in farm r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 58 sajems ns vol2 (1999) no 1 operation. economies of scale in processing are transmitted to the farm because processing must occur within hours from harvesting" (binswanger and elgin, 1988). binswanger et al (1992, pp. 22), further explain that where little coordination between harvesting and processing is required, markets (local and national) are supplied by family farms even in economies dominated by plantations3 • this explanation, however disregards fixed transaction and information costs incurred in the use of technology at farm level. deininger and binswanger (1992) believe that there is considerable empirical evidence to indicate that large-scale unmechunised agriculture is less efficient than small-scale farming based on the effort of labour. family labour is thought to cost less than hired labour as there are no search and hiring costs (i.e. transaction costs are zero), and transaction and supervision costs may indeed be lower for family labour. however, in a situation where an active and diversified off-farm labour market prevails, such as in kwazulu-natal (lyne and ortmann, 1996), people with different skills command difterent wages. the opportunity cost of a family member used on the farm is therefore likely to approximate his or her expected wage rate (adjusted by the probability of employment). in this study family labour shadow price is imputed by costing operations performed by family labour based on what is paid to similar factors of production in similar occupations as suggested by britton and hill (1975, pp. 50). management costs were imputed considering what a farm operator could earn in his/her best paid alternative employment (opportunity cost). the adoption and use of any technology invoh'es tixed transaction and information costs (lyne, 1996). information costs are tixed and therefore introduce size economies (huffman, 1974; welch, 1978, pp. 259). therefore average cost curves vary among managers. with better managers having lower cost curves, due to lower information costs (huffman, 1974), [n this study, information costs were computed based on mean annual cash costs of farm information from private sources compiled in a study by bullock (1994, pp. 58) on small and large commercial vegetable fanners in kwazulu-natal. using ranked scores accorded by a respondent to reflect the extent of use of each of the i isted information source as weights, average information costs for each individual j~lrmer were computed. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol2 (1999) no 1 59 2.2.1 costs of borrowing economies of size that stem from borrowing capital remain less documented (britton and hill, 1975, pp. 110). variability of production and 'informational imperfections' restrict the amount of credit available to small farmers as lenders seldom have enough information to determine which of the small farms are relatively productive and low risk borrowers (carter, 1988). the cost of information required to determine the credit-worthiness may exceed the benefits to be gained from the relatively small loan amount. transaction costs associated with many small loans act as a disincentive for lenders and the cost of credit to small farmers is likely to increase (carter, 1988). in the presence of fixed transaction costs, the cost of borrowing in the formal credit market is therefore a declining function of the amount of owned land (binswanger et ai, 1992, pp. 26). experiences from lending agencies in sa (e.g kwazulu finance corporation-kfc and small cane growers financial aid fund-faf) regarding small farmers, is that costs of lending to small farmers are substantially higher for small farmers than large farmers (bates, 1996). in the south african sugarcane industry, the actual cost of small loans during the survey was 14.5 % which is highly subsidized. interest rates (reflecting administration and transactions costs) on loans to small farmers are expected to range between 30 % to 48 % if there were no subsidy. mortgage bond rates paid by large farmers ranged between 15 % to 18.5 % during the respective period, while small farmers were charged 12.5 % in ) 993/94 season (bates, 1996). in this study a shadow price of 30% on average, is used to cost funds lent to small borrowers. 3 conceptual framework 3.1 the measurement of farm efficiency the study of efficiency falls into two broad categories; parametric and nonparametric. the parametric approach relies on a parametric specification of the production function, cost function, or profit function (forsund et al. 1980; bauer, 1990). alternatively, production efficiency analysis relies on non parametric methods (seiford and thrall, 1990). the nonparametric procedure of analysing efficiency is adopted in this paper. this section relies substantially on chavas and aliber (1993) and contains a summary of description of efficiency. the analysis of farm efficiency has typically centred on the technical, allocative and scale r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 60 sajems ns vol 2 (1999) no 1 efficiency of production decisions (farrell, 1957; fare et ai, 1994; chavas and cox, 1996). in this paper more emphasis is placed on scale efficiency because of the importance of the farm size variable in the analytics of this study. 3.1.1 scale efficiency a firm is producing optimally at a given output y has been analysed through the measurement of returns to scale s, expressed as s(y, x, tv). according to chavas and aliber (1993), returns to scale can be characterised from the production function tn as well as the cost function c(r, y, tv). returns to scale can be expressed from the cost function in terms of the ray average cost (rac): rac (k, r, y,t,) ~ c(r, ky,t,)/k, (1) where; r is an (m xl) input price vector r = (ri, r2, ... , rm)'e9t m+ denoting prices for inputs x represented by an (m xl) input vector x = (xl, x2, ... , xm)'e9t m+ in the production of an (n x 1) output vector y = (yi, y2, ... , yn)'e9t n+, and y * o. 9t n+ denotes n-dimensional space of a specified technology. the set of all technologically feasible production plans (firm's production possibilities sety) is a subset of9tn+ (varian, 1992, pp. 2). the underlying technology is characterised by the production possibilities set tv, where (y x) e tv is a non-empty, closed, convex, and negative monotonic set that represents a general technology under variable return to scale (vrts). k e~rt and measures the proportion by which output changes given a change in inputs. assuming differentiability, let the elasticity of the ray average cost function with respect to k (evaluated at k = i) be denoted by e=8in(rac)/8in(k). then under competition, the function s(y,x,tv) evaluated at the cost minimizing solution x· (baumol, et ai, 1982:55) can be expressed as: s (y, x', t,.) ~ 1/(1 + e) (2) given the above definition of returns to scale in terms of s, it follows that returns to scale at the point yare increasing, constant, or decreasing whenever the elasticity of e is negative, zero, or positive, respectively. this implies that, when returns to scale are increasing, then the ray average cost rac(k,r,y,tv) is a decreasing function of k (where a proportional increase in output leads to a less than proportional increase in cost). similarly, when returns to scale are decreasing, then the ray average cost rac(k, r, y, tv) is an increasing function of k (where a r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 61 proportional increase in output leads to a more than proportional increase in cost). in the case where the rac function has a u-shape, then constant returns to scale are attained at the minimum of the rac with respect to k. this suggests the following index of scale efficiency: se(r, y, t,) ac (r, y, t, )/c(r, y, t,). (3a) where ac(r, y, t,) = inf. denotes the minimal ray average cost function with respect to k. clearly, o<se:::;i. values of the vector y that satisfy se(r, y, tv) 1 identify an efficient scale of operation corresponding to the smallest ray average cost. alternatively, finding se(r, y, tv)< i implies that the value of the vector is not an efficient scale of operation. in this case (l-se) can be interpreted as the maximal relative decrease in the ray average cost that can be achieved by proportionally rescaling all outputs toward an efficient scale of operation (where the output vector y exhibits locally constant return to scale). seer, y, tv) rises (declines) with a proportional augmentation in y under increasing (decreasing) return to scale. according to chavas and aliber, (1993), ac(r,y,tv} can alternatively be expressed as: a( '(1' y, t,) = c(i', y, t,). therefore scale etliciency index se(r,y,tv} can be alternatively written as se(r,y,t,) c(r,y,lj/c(r,y,t,.) (3b) 3.3 the nonparametric approach consider a sample of n observations on tinns in a given competitive industry. let y' and x' be the output vector and input vector, respectively, chosen by the ith firm, i i, 2, ... , n. denote the production possibility set of each firm in the industry by l with (y', x') f: l 1 = i, .. . ,11, where t is a non-empty, closed, convex, and negative monotonic set. the question then is: how to use the production data, (y', x')l= i, ... , n, to provide a representation of the set 1. following (afriat, 1972; hire, et ai, 1985), consider the following nonparametric representation oft r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 62 sajems ns vol 2 (1999) no 1 11 11 ii t, ((y,-x)ysia,y,x~i,l)('.i;l 1,)"ell,vi) (4) i i the set tv in (4) is closed, convex, and negative monotonic, under variable returns to scale, it is the smallest convex set that satisfies the monotonicity property and includes all the observations (yi, x\ ii, .. " n, as such, it corresponds to the inner bound of the underlying production possibility set ! (banker and maindiratta, 1988). using !, in (4) as a representation of technology, the measurement of the farrell technical efficiency index te for the ith firm is obtained form the following linear programming problem: n te( y',x',t,)= mint k, y' s i)~j, k,x xl, i), = l')~1 e \ii ,v j} (5) i i i j where r is the price vector for x, then, based on t,., in (4), the measurement of the farrell allocative efficiency index ae for the ith firm is obtained from the cost function c(r, yl, tv) being calculated from the following linear programming problem: err,y', t,) min{r'x y' s fa, y' ,x~ i>, x', fai = i, a1 e iji , v j} (6) ~ ), ! i i i i i alternatively, under constant return to scale (crts), consider the following nonparametric representation of!: t,={(y,-x).ys a,y'.x~fa,x"ait:91, vi} (7) i i comparing (4) and (7), note that te <;;; t", in (7) is closed, convex, negative monotonic and exhibits crts (afriat, 1972; fare, et ai, (1985), it is the smallest cone that satisfies the monotonicity property and includes all the observations (yi , xl ), i = i, . . " n. as such, it corresponds to the crts inner bound of the underlying production possibility set t. based on tc in (7) as a representation of the crts technology, consider calculating c(r, /, te) from the following linear programming problem: r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 63 c ,t,) = min ( r' x .' y' :5 (8) >,a then, the scale efficiency index se for the ith finn can be obtained from (7b), where c(r, y', tv) and c(r, y', tc) are given in (6) and (8). this analysis of production efficiency is conducted using data from kwazulu-natal sugarcane fanners. 4 anal ytical method 4.1 data sources fann input/output data used in the analysis were collected from a sample of 160 small and large scale sugarcane operations in the north-coast region of the kwazulu-natal sugarcane belt during marchi april 1995. data were collected on costs and returns for fanns in different size classes. data include reported sugarcane output and inputs such as: (a) hired and family labour; (b) management; (c) fertilizers; (d) herbicides, seeds, and other chemicals; (e) operating and machinery maintenance costs; (f) miscellaneous (rent, supplies and utilities); (g) cost of borrowed capital; (h) infonnation cost (i) machinery (intennediate-run assets); and u) land and buildings (long-run assets). the measurement of the effect of size on overall economic efficiency requires valuing all inputs so that the relative proximity of each fann to the cost frontier can be detennined (hall and leveen, 1978). all inputs were therefore valued at their opportunity cost. this included the imputed value of family and fann operator labour (management)4, and the opportunity cost for land and capital. quantity measurements are annual flow variables. a 6% interest rate was used to transfonn machinery and tools5 (intermediate-run capital inputs) to service flows. the six percent per annum is the average interest on machinery investment in sa (ortmann, 1985, pp. 72). after adjusting fann size for differences in land quality within regions by using land values to nonnalize area, a 5% interest rate on the value of land was used as a measure of the flow resource of land. the rental rate of return for land in sa agriculture is about five percent (nieuwoudt, 1987). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 64 sajems ns vol 2 (1999) no 1 4.2 descriptive statistics tests of the difference in means on major factor costs, which could be sources of economies of size in sugarcane farming on the sample farms, are presented in table 1. the data indicate significant differences in per ton average cost of labour, operator labour services and information costs on small and large farm units studied, with small farms recording higher costs than large farms. table 1: mean differences in economic characteristics of sugarcane farms in kwazulu-natal, 1993/94 season i small large t-value i area under cane (ha) mean 8.3 197 6.81'" sd 5.75 218 n (95) (62) labour costs/ton (rand) mean 78.7 33.3 -3.37'" sd 121.6 21.6 n (87) (51) management costs/ton mean 250 22.8 -6.10'" (rand) sd 359.6 24.2 n (93) (59) information costs/ton (rand) mean 2.20 1.07 -2.29" sd 4.10 1.42 n (85) (32) interest on borrowed capital mean 23 15 -13.22*** (%) sd 3 3 n (85) (32) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 65 table 1 continued small large t-value input costs/ton (rand) mean 32.9 20.6 -2.61 ." sd 38.6 16.9 n (93) (56) sales/ha (rand) mean 4761 5463 1.95' sd 2212 2010 n (88) (55) yield (tons/ha) mean 48 55 1.91' sd 22 20 n (88) (55) machinery investment/ton mean 166.9 41.4 -2.65'" (rand) sd 350 49.4 n (56) (43) significant at: ... 1 per cent, .. 5 per cent and ' 10 per cent level. figures in parentheses represent valid sample cases. all inputs presented in this table are valued at their opportunity cost. the combined expenditure reported for fertilizers and herbicides shows that large farms have a significantly lower average costs for these items. this supports the contention by hall and leveen (1978) that the combined factors of pecuniary economies of size may account for at least as much of the cost advantages of large units as do technical economies of size. however, it cannot be determined from the data collected if cost savings derive from lower input prices or from more efficient use of the inputs. yields are higher for large farms, suggesting the possibility that resources are better utilized (as a result of better management on these farms). per ton investment in machinery is about 303% greater on small r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 66 sajems ns vol 2 (1999) no i farms than on large farms, while per ton investment of labour is 136% higher on small farms. 4.3 economies of size for each farm, the optimal objective function for (5), (6), and (8) (refer to section 3.1) was calculated from the linear programming problems using the gams computer program. the long-run (lr) estimate of the farrell technical efficiency index te is given by (5), where all inputs are rescaled toward the frontier isoquant6• the lr estimate of the farrell allocative efficiency (ae) index is given by (2) and (6). treating all inputs as variable, the scale efficiency (se) indexes were obtained from (7b). the indexes; ae and se estimated for each farm range between zero and one, with 100% efficiency indicated by a score of one. a summary of the results is presented in table 2. the 0.71 mean technical efficiency te within the small-scale farm group, and 0.81 for the large farms (table 2) shows that, while the average technical efficiency score of the small farms is lower than the average score of large farms, gains from improving lr technical efficiency do prevail, but tend to be of limited magnitude for large farms compared to small farms. this is also reflected by the difference in percentages of technically efficient farms (with te= 1) between the small and large farms. the mean allocative efficiency of 0.52 and 0.60 for both small and large farms respectively, suggests that price or allocative inefficiency is more important than technical inefficiency in causing farms to fall short of achieving the lr economic efficiency (te ae). the low percentage of price efficient farms (with ae=i) 2.4% among the small farms and the 9.4% for large farms, indicates that improving allocative efficiency can help to reduce production costs on both large and small farms. the mean scale efficiency se index of 0.46 and 0.88 for the small and large farms respectively, suggests that while there are inefficiencies (technical and allocative) for small scale farms, they are not as large as inefficiencies which are related to size. however, the percentage of scale efficient farms (with se= i) tends to be low even among large scale farmers (see table 2 and figure 1). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 67 table 2: long-run efficiency indexes of sample sugar cane farmers in kwazulu-natal index small-scale large-scale (n=85) (n=32) technical efficiency (te) mean 0.71 0.81 sd 0.28 0.24 %1'5 35.3 46.9 allocative efficiency a1ean 0.52 0.60 (ae) sd 0.18 0.20 %1'5 2.4 9.4 economic efficiency a1ean 0.37 0.49 (teae) sd 0.21 0.24 % ]'5 1.2 9.4 scale efficiency (se) 114ean 0.46 0.88 sd 0.25 0.13 % ]'5 0 3.1 note: significant at ••• i per cent," 5 per cent and • 1 0 per cent level. the inverse of scale efficiency index (lise) is plotted against output in figure 2. following the discussion in section 3.1.3, this inverse measure can be interpreted in a similar way to an average cost function (chavas and aliber, 1993). lise is a declining function of output/farm size under increasing returns to scale, and an increasing function of farm size under decreasing returns to scale. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 68 sajems ns vol 2 (1999) no 1 figure 1: distribution of scale efficiency among sampled small and large sugarcane farms 1 a small scale fanns 35 30 <il 25 e r-ro 20 ll '0 15 qj r-r-.0 e 10 :::l ;--r-f--z :::r. 5 '" 0 i-r-r-r-hi 0-19.9 20-39.9 40-59.9 60-79.9 80-99.9 scale efficiency % i b large scale farms 80 70 <j) 60 e (ij 50 u. 15 iii 40 .0 e 30 :::> z ;j!. 20 10 0 ii i i r---1 100 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 figure 2: economies of size in sugar cane production ..... 20 18 16 14 12 ~ 10 ..... 8 6 4 2 o 20 18 16 14 12 ~ 10 8 6 4 2 o o o 2 500 1000 2a 468 ql,!tput (t onj __ ttliousonds ) 2b 10 12 ~ 3000 3500 4000 1500 2000 2500 output (tons) '--____________ '---'--_-'-___ ~_ ... ____ . __ .. .j note: in figure 2, graph (2b) gives details of graph (2a) 69 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 70 sajems ns vol 2 (1999) no 1 figure 2, shows that the cost structure of sugarcane farms studied is "l"shaped, indicating substantial economies of scale on very small scale farms. diseconomies do not set in, thus the average cost remains relatively flat as typically found in previous research (hall and leveen, 1978; chavas and aliber, 1993). implications are that farms operating at the declining portion of the average cost curve (farms with gross income less than r 40000) employ extra resources in the production process. in terms of area, these are farms of approximately 8 hectares and below. farms larger than 10 hectares appear to have near constant returns to scale7, which is in range with the 14 hectares estimated by lyne and ortmann ( 1996), as the size of a minimum sugarcane farm. 4.4 further interpretations nonphysical inputs, for example; farming experience, information, and supervision tend to influence the ability of a producer to use the available technology efficiently (parikh, et ai, 1995). in this study, variation in scale efficiency recorded among farms prompted a further investigation of factors associated with differences in efficiency levels. a vailable data provided an opportunity to examine possible linkages between farm characteristics and farm efficiency by estimating an econometric model whereby scale efficiency indexes were regressed on a set of explanatory variables. with the largest possible value of se indexes being 1, this generates the following tobit model (mcdonald and moffitt, 1980; chavas and aliber, 1993; gujarati, 1995, pp. 572). se, x, b+ e, ifx,b +e,</ (9) dllll!r""o'i.<f:. where is the scale efficiency index of ith farm, x; is a vector of explanatory variables, ~ is a parameter to be estimated, and e; is an error term -n(o,b 2). explanatory variables in the tobit model were selected on the theoretical basis that; the level of education or farm operator improves efficiency performance of output as well as inputs in a production process (kumbhakar and bhattacharya, 1992). likewise increased education and extension services improve allocative efficiency of farmers (ram, 1980; huffman, 1977; parikh et ai, 1995). however, age of household head has negative effects on efficiency (parikh et ai, 1995), because older farmers are constrained in resource utilization to attain scale efficiency. the explanatory variables in final estimated tobit model were; (a) an index (principal component) capturing farmers' formal education level and agricultural training, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 71 infonnation use, and institutional extension supportive infrastructure (pc i ); (b) fann size in hectares (fmsze); (c) age of fann operator (age); and a variable measuring fanner managerial proficiency (adopt)7. the results are presented in table 3 below. table 3: tobit estimates explanatory variable dependent variable (se) coefficient std. error t-stat intercept 0.5921 0.0876 6.761*** pc i 0.572 0.0275 2.076*** age -0.0032 0.0013 -2.348*** adopt 0.1461 0.0013 2.544** fmsze 0.0004 0.0002 2.544** ...... --~ .. ~----....... --~------.... ... -n = 117 log-likelihood function = 2.395 significant at: ". 1 percent and •• 5 percent tobit coefficients are estimated by the method of maximum likelihood (breslaw, 1993, pp. 159). the value of a tobit coefficient does not represent the expected change in the dependent variable given a one unit change in an explanatory variable (norris and batie, 1987). rather, the tobit model estimates a vector of nonnalized coefficients which can be transfonned into the vector of first derivatives. nonetheless, where such a decomposition is not relevant, beta coefficients are directly usable (mcdonald and moffitt, 1980) as in this study. all coefficients of variables (pci> fmsze, adopt, age) have a priori expected signs and are statistically significant. the positive relationship between se and coefficients of variables pcl. fmsze, and adopt respectively, imply that high levels of knowledge attained by a fanner are associated with scale efficiency on a sugarcane fann. large fanns are more scale efficient, and fann operators demonstrating higher managerial abilities attain high level of scale efficiency on their fanns. the negative sign on age implies that older fanners are constrained r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 72 sajems ns vol 2 (1999) no 1 in resource utilization to attain scale efficiency. human resource factors thus influence efficiency in farm resource use, supporting the results of britton and hill (1975, pp. 8). 5 conclusions a non parametric approach of estimating technical, allocative and scale efficiencies was employed on a selected sample of 160 small and large sugarcane farms in the north coast region of kwazulu-natal sugar belt. the method is flexible in the sense that it does not require imposing functional restrictions on technology as is typically done using a parametric approach. the procedure provides firm-specific information on sources, and magnitude of production efficiency by solving appropriately formulated linear programming models. lack of statistical inferences associated with the estimates ofthe efficiency indexes is the major weakness of the method. farm-specific indexes for technical, allocative and scale efficiencies are estimated. technical inefficiencies are rather limited among small and large sugarcane farms, with these farms attaining on average 71 % and 81 % level oftechnical efficiency, respectively. this indicates that economic losses are more generated by allocative inefficiencies, implying that most farms can find ways of reducing production costs. small farms exhibited relatively high scale inefficiencies attaining on average 46% scale efficiency level, compared to 88% among large farms. size of an operation therefore appears to affect the level of efficiency attainable in a sugarcane farm operation. results show evidence of important economies of size in sugarcane production, with strong economies of size on farms less than eight hectares. this implies that smaller farms require relatively more resources to produce a rand's worth of output than large farms. if commercial farms are subdivided in the land resettlement programme, some significant efficiency loss may occur if resettled farms are less than eight hectares of planted sugarcane. efficiency loss falls if resettled farms are larger than 10 hectares of cane. an econometric analysis of efficiency indexes indicates significant linkages between scale efficiency and farmer characteristics, institutional factors and size of farm holdings. this suggests that the shape of the agricultural structure may not entirely be responsible for differences in efficiency but rather also a whole range of factors (for example, level of education, age and managerial proficiency) which are associated in different degrees with small and large farms. this implies that r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no i 73 efficiency of very small scale sugarcane farms (less than 10 hectares) can be enhanced by land consolidation, farm operators' education, training and extension services for expansion and propagation of modem techniques of cane production, and by promoting the use of farm information. on the other hand, giving small scale farmers (farms larger than 10 hectares) access to the large scale commercial sector may not lead to a loss in efficiency, provided that land is individually owned. this require the repeal of act 70 of 1970 which forbids the subdivision of agricultural land into 'non viable' farms. endnotes the financial assistance of the centre for science development (hsrc, south africa) is hereby acknowledged. opinions expressed and conclusions arrived at are those of the authors and are not necessarily attributable to the centre for science development. sugarcane harvesting and processing must be well co-ordinated, for if cane is left unprocessed for more than 12 hours the sugar is lost to fermentation (binswanger, et a11992, pp. 22). in central america unrefined fomls of sugar such as muscovado, where processing did not involve economies of scale, were produced by family farms (binswanger, et ai1992, pp. 22). the procedure is based on an assumption that the operators' main work activity even on the smallest farms is that of management and supervision. machinery.and tools were valued at market prices to account for cost of depreciation. technology employed in sugarcane production on farms studies does not differ (i.e., both small and large farms are mechanised in most farm operations, sugarcane in the region studied is rain-fed, and both farm groups make considerable use of herbicides and fertilizers). therefore the assumption of a single production frontier was made for both small and large in the analysis. the conversion into hectares was done based on r 100 per ton of cane in crop season 1993/94, and average yield of 50 tons/ha recorded between small and large farms (see table 1). the variable adopt is computed as an average score recorded by a farmer on the implementation of appropriate farm practices (i.e., soil testing and use of certified seedcane) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 74 sajems ns vol 2 (1999) no 1 references l afriat, s.n, (1972), "efficiency estimation of production functions", international economic review, 13: 568-598. 2. banker, r.d., and maindlratta, a. (1988), "nonparametric analysis of technical and allocative efficiencies in production", econometrica, 56: 1315-1332. 3. bates, r.f. (1996), the financing of small scale sugar cane growers in south africa. department of agricultural economics, university of natal. 4. baumol, w.j., panzar, j.c. and willig, r.d. (1982), contestable markets and the theory of industry structure. new york: harcourt, brace, and jovanovich, incorporation. 5. baurer, p.w. (1990), "recent developments in econometric estimation of frontiers", journal of econometrics, 46: 39-56. 6. binswanger, h.p. and elgin, m. (1988), "what are the prospects for land reform?", agriculture and governments in an interdependent world, proceedings of the twentieth international conference of agricultural economists, 739-751. 7. binswanger, h.p., deininger, k. and feder g. (1992), "power, distortions and reform in agricultural land markets", prepared for handbook of development economics, vol. iii, jere berman and t.n. srinivasan, editors. 8. breslaw, j. (1993), gaussxtm econotron software. version 3.2, montreal. 9. britton, o.k. and hill, b. (1975), size efficiency in farming. saxon house and lexington books. 10. bullock, w.i., ortmann, g.f. and lyne, m.e. (1995), "use of information and computers by commercial vegetable farmers in kwazulunatal", south african journal of agricultural extension, 24: i-ii. 11. carter, e.n. (1988), "equilibrium credit rationing of small farm agriculture", journal of development economics, 28 (i): 83-103. 12. chadwick, j.b and sokhela, m p. (1992), "the small grower development trust: a vehicle for rural upliftment through a farmer support programme approach", paper presented at south african society for agricultural extension, cape town. 13. chavas, j.p. and aliber, m. (1993), "an analysis of economic efficiency in agriculture: a nonparametric approach", journal of agricultural and resource economics, 18: 1-16. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no i 75 --------------------------... --~ 14. cha vas, j.p. and cox, tl (1996), a generalized distance function and the analysis of production efficiency. department of agricultural economics, university of wisconsin, madison. 15. deininger, k. and bins wanger, h.p. (1992), "are large farms more efficient than small ones?", government intervention, large scale agriculture, and resettlement in kenya. south africa, and zimbabwe. unpublished world bank policy paper. 16. department of land affairs. (1996), our land: green paper on south african land policy. department of land affairs, pretoria. 17. erskine, j.m. (1982), agriculture in natallkwazulu: development potential. institute of natural resources, university of natal, monograph i. 18. fare, r., grosskopf, s. and lovell, cak. (1985), the measurement of efficiency of production. boston: kluwer niljhoff publishers. 19. fare, r., grosskopf, s. and lovell, cak. (1994), production frontiers. cambridge university press, cambridge. 20. farrell, m.j. (1957), "the measurement of productive efficiency", journal of royal statistical society, series a, 120: 253-90. 21. forsund, f.r., lovell, cak. and schmidt, p. (1980), "a survey of frontier production functions and their relationships to efficiency measurement", journal of econometrics, vol 13: 5-25. 22. friedman, m. (1962), price theory. provisional text. university of chicago, aldine publishing company 64, east van buren street chicago 5, illinois. 23. gujarati, d.n. (1995), basic econometrics. third edition, mcgraw-hill, international editions, economic series. 24, hall, rf., and leveen, e.p. (1978), "farm size and economic efficiency: the case of california", american journal of agricultural economics, 60:589-600, 25, huffman, w.e. (1974), "decision making: the role of education", american journal of agricultural economics, 56: 85-97. 26. huffman, w. (1977), "allocative efficiency: the role of human capital", quarterly journal economics, 91: 59-79. 27. krause, k.r. and kyle, l.r. (1970), "economic factors underlying the incidence of large farming units: the current situation and probable trends", american journal of agricultural economics, 2: 748-760. 28. kumbhakar, s.c. and bhattacharya, a. (1992), "price distortion and resource use efficiency in indian agriculture: a restricted profit function approach", review of economics and statistics, 77: 143-152. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 76 sajems ns vol 2 (1999) no 1 29. l yne, m.e. (1996), "land redistribution does our policy help small fanners?", agricultural faculty forum, university of nata!. 30. l yne, m.c., and ortmann, g.f. (1996), estimating the potential for creating additional livelihoods on commercial farmland in kwazulunatal. department of agricultural economics, university of nata!' 31. mcdonald, j.f. and moffiit, r.a. (1980), "the uses of tobit analysis", the review of economics and statistics, 62: 318-321. 32. nieuwoudt, wl (1987), "taxing agricultural land", agrekon, 26:10-14. 33. norris, p.e., and batie, s.s. (1987), "virginia fanners' soil conservation decisions: an application of tobit analysis", southern journal of agricultural economics, 19: 79-90. 34. ortmann, g,f. (1985), the economic feasibility of producing ethanol from sugarcane in south africa. phd dissertation. university of natal, pietennaritzburg. 35. parikh, a., ali, f. and shah, m.k. (1995), "measurement of economic efficiency in pakistani agriculture", american journal of agricultural economics, 77:675-685. 36. pasour, e.e. (1981), "a further note on the measurement of efficiency and economies of size", journal of agricultural economics, 20:160-178. 37. ram, r. (1980), "role of education in production: a slightly new approach", quarterly journal of economics, 95 :365-3 73. 38. seiford, l.m. and thrall, r.m. (1990). "recent developments in dea: the mathematical programming approach to frontier analysis", journal of econometrics, 46:7-38. 39. south african cane growers' association (sacga). (1994), statistical division. 40. south african sugar association small cane growers financial aid fund. (1992), kwazulu cane growers' support programme report, f af 36/92 41. v an zyl, 1. (1994), "fann size efficiency, food security and market assisted rural land refonn in south africa", agrekon, 33, no.4: 156-164. 42. van zyl, j. (1995), "the fann size-efficiency relationship in south african commercial agriculture", agrekon, 34 (4) : 127-137. 43. varian, h.l. (1992), microeconomic analysis. third edition., w.w. norton & company, inc., new york. 44. welch, f. (1978), the role of investment in human capital in agriculture. distortions of agricultural incentive, (editor) shultz t w. bloomington, indiana university press. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr voll (1998) nr 1 portability of the job involvement and job satisfaction constructs between the united states of america and south africa a b boshoff and c hoole graduate school of management, university of pretoria abstract 73 the notion of portability of constructs measured by psychometric instruments is introduced. psychometric investigations by means of principal components analyses, item analyses and calculation of cronbach alpha on the items of two generally used instruments are described. the results indicate that the constructs measured by the kanungo job involvement questionnaire and the minnesota satisfaction questionnaire as well as the instruments themselves seem to be robust as far as portability between the unites states of america and south afiica is concerned. introduction the notion of portability of constructs used in a psychometric measure is mentioned in several publications (stimpson, robinson, waronusuntikule & zheng, 1990: stimpson, huefner, narayanan & shanthalearnar, 1992). the problem seems to be that instruments developed in one country to measure specific constructs are sometimes psychometrically unacceptable when used in a different country on people of a different culture. this makes comparison of levels of a construct in different countries very difficult. relationships among constructs e.g. attitudes and success as an entrepreneur (robinson, stimpson, huefner & hunt (1991) can often not be cross validated across countries due to the non-availability of measuring instruments which have been proved to be valid and reliable when used on samples from different countries. essentially the problem seems to be that r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 74 sajems ns vol 1 (1998) no 1 the interpretations given to especially questiormaire items tend to differ in different cultures, even among individuals speaking the same language. whether portability existed with regard to two measures widely used in research on and in organizations is the question investigated in the present study. the rationale was that if non-portability was a problem in entrepreneurship research it could also confound research findings in other fields. kerlinger (1986) states that confusion about the contents of a construct is one of the most fundamental problems in social research. some more clarity on whether the constructs embodied in the job involvement inventory (kanungo, 1982) and the minnesota satisfaction questionnaire (weiss, dawis, england & lofquist, 1967), both widely used instruments, would be stable when used on a south african rather than united states of american sample was therefore sought.. the purpose of the present paper is therefore to examine the portability of the constructs, measured by two instruments developed in the united states of america, to the south african situation. this meant that some psychometric investigation of these measuring instruments had to be undertaken. the aim is not to give final answers about the factor structures and contents of the constructs embodied in the instruments but rather to provide some clarity on how well the constructs stood up to psychometric evaluation when used in south africa in contrast to the united states of america. method measuring instruments the first instrument which was included in the present study is the job involvement questionnaire developed by kanungo (1982). this instrument was developed as an improvement on the up to then extensively used job involvement measure of lodahl and kejner (1965). the scale is supposed to measure job involvement unidimensionally as psychological identification with one's work. kanungo (1982) reported the reliability of the instrument as alpha=o.83. the instrument consists of 10 items to which respondents have to react on a 10-point scale. the second instnunent which was subjected to investigation is the minnesota satisfaction q'jestionnaire (weiss. davis, england & lofquist, 1967). it was completed by the same respondents who completed the kanungo job involvement questionnaire. the msq is supposed to measure job satisfaction in terms of two dimensions i.e. intrinsic and extrinsic job satisfaction, each measured r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr vol i (1998) nr 1 75 by means of 10 items. responses are given on a five point liken-type scale. job satisfaction is seen as the result of a psychological comparison process involving the appraisal of current job experiences against personal standards of comparison, with the implication that both negative and positive discrepancies may arise, resulting in various degrees of job satisfaction (or dissatisfaction). procedure data on the two instruments were gathered during a research project of which the main aims were different from that of this paper. the job involvement questionnaire and the minnesota satisfaction questionnaire were administered during a study in which information on the career orientations, job satisfaction, job involvement and biographic and work situation backgrounds of professional people and the relationships among these variables were gathered. the data was gathered by means of a mail survey of randomly selected samples of the south african members of 14 professions. more information on the procedures followed and the composition of the samples can be found in boshoff, bennett and kellerman (1994). results the responses of 1 791 professional individuals engaged in 14 different professions on the two instruments i".e. kanungo job involvement inventory and the minnesota satisfaction questionnaire were analyzed in the present study. a preliminary analysis was also reponed by boshoff, kaplan, schutte & kellerman (1989). in the case of the kanungo instrument the responses of the sample (n = i 791) were firstly analyzed for principal components. a one-factor solution was firstly specified and the prornax rotation technique was used. eigenvalues between 4.06 and .40 were obtained, with two eigenvalues (4.06 and 1.14) being > 1. all ten items loaded > .30 on the one factor with loadings varying between .34 and .76. eight of the 10 items loaded > .50 on this factor. item analysis (calculation of corrected ru-values of the items) was then carried out. this analysis indicated that, with the exception of one item, the r,,values exceeded .30. this item had a r,,-value of .28 and it was felt that it should probably not be included in the measure if a one-factor solution was to be accepted. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 76 sajems ns vol i (1998) no i cronbach's ceefficient alpha was used as a measure of internal consistency and resulted in a alpha value of .83. the cronbach alpha results confirmed the item analyses results by indicating that the removal of the same item i.e. item 7 in the job involvement questionnaire, would maximize the value of cronbach's alpha. the suspicious item was left out of further analysis and the three sets of analyses were repeated on the remaining 9 items. factor analysis now produced eigenvalues between 3.97 and .40, with one eigenvalue (3.97) > 1. the one factor explained 44.1 % of the total variance. all nine items loaded> .30 on this factor with loadings varying between .45 and .77. eight of the 9 items loaded> .50 on this factor. the factor loadings are shown in table i table 1 factor loadings of items in kanungo's job involvement questionnaire in one factor solution job involvement items ~umbers a<l in jiq) 8 9 4 5 i 10 6 3 2 i factor loadings 0.773 0.764 0.741 0.741 0.663 0.651 0.561 0.559 0.447 item analyses resulted in all the items having a rll-value > .30, as shown in table 2. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sates nr vol i (1998) nr 1 77 table 2 corrected item weights of items in kanungo's job involvement questionnaire job involvement items rtt-values (numbers a<i in jiq) i 9 ! 0.663 ! 8 0.662 5 0.623 4 0.627 1 0.552 io 0.530 3 0.448 6 0.452 2 0.347 cronbach's coefficient alpha was calculated on the items in the unidimensional instrument and resulted in a value of .83. confirmatory factor analysis was then carried out on the one-factor solution. the results are shown in table 3. the results of the analyses carried out on the responses to the job involvement questionnaire seem to indicate that the measure is a robust, probably unidimensional scale. the confirmatory factor analysis results seem to show that a one-factor solution provides quite a good fit. the construct seems to be quite portable between the usa and south africa. the job involvement questionnaire can probably be used with a great deal of confidence in south africa. the sample of 1 791 professional people also completed the minnesota job satisfaction questionnaire. the responses were analyzed in a similar fashion to that of the liq. the principal components analysis with prornax rotation yielded three eigenvalues> 1.00 (respectively 7.25; 1.62 and ll7). this again raised the possibility that the instrument could be unidimensio!l'll. a one-factor solution was therefore firstly specified. this yielded a factor on which all of the 20 items loaded> .30. the loadings varied between .40 and .74. item analysis yielded corrected fit-values ranging between .36 and .67. it therefore seemed as if the items could all belong to one scale, of which the cronbach alpha coefficient was .90. this factor contained 36.3 % of the total variance. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . ----_ ...... _78 sajems ns vol i (1998) no i table 3 indkes obtained from confirmatory factor analysis on one factor solution (kanungo's job involvement inventory) fit indices value goodness of fit index (gfl) .9685 gfl adjusted for df (agfi) .9455 root mean square residual .0359 chi-square df=26 p= .0001 227.8937 null-model chi-square df=36 4648.8185 diff chi-square (df= 10) 4420.9248 ak:aike's information criterion 178.14 bozdogan's (1987) calc 7.5792 bentler & bonnett's (1980) non-normed index .9394 bemler & bonnett's (1980) nfl .9510 relative non-centrality index (rni) .9562 bollen (1986) normed index rhol .9322 bollen (1988) non-nonned index delta2 .9563 a three factor solution with promax rotation was also specified in the light of three eigenvalues being > 1.00, in this solution eight items had their highest loadings on factor one. six items had their highest loadings on, respectively. factors two and three. all these loadings were above .40. a three factor solution yielded factors which were quite highly intercorrelated with each other (between .38 and .49). factor two correlated with respectively factors one and three .49 and .46. factors one and three correlated .38 with each other after the promax rotation. cross loadings were evident in the factor pattern. all the items with highest loadings on a factor also had at least one loading> .30 on another factor. item analyses were subsequently carried out on the items with their highest loadings on each factor. all the items included in each of the three factors (according to the principal components analysis) had corrected rn-values of > .30, varying between .37 and .73. after promax rotation the three factors respectively explained 36.3 % .8.1 % and 5.9 % of the total variance. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr vol 1 (1998) nr 1 79 specifying a two-factor solution with promax rotation yielded two factors which after rotarion correlated .54 with each other and respectively explained 52.8 % and 47.2 % of the common variance. twelve items had their highest loadings on factor one. these loadings varied between .39 and .78. the eight items loading highest on factor two had loadings on this factor of between .64 and .78. item analyses yielded rn-values of between .34 and .68. cronbach's alpha for factor one was .87 and for factor two .84. factor one explained 36.3% and factor two 8.1 % of the total variance. the two factors together explained 44.4% of the total variance. after promax rotation all the items had loadings of at least .30 on both factors. to determine which of the solutions provided the best 'fit', confirmatory factor analysis were carried out on the factor patterns for one, two and three factor solutions. the indices are compared in table 4. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 80 sajems ns vol i (1998) no i table 4 results of confirmatory factor analysis on one, two and threefactor solutions of responses in msq fit indices one two three factor factors factors goodness of fit index (gfi) .8260 .8799 .8918 gfi adjusted for df (agfi) .7838 .8799 .8639 root mean square residual .0652 .0529 .0514 chi-square (df) 3167.845 2276.384 2055.436 (169) (168) (167) null model chi-square df = 190 13430.16 13430.16 13430.16 (190) (190) (190) diff chi-square (df) 12062.32 11153.78 11374.73 (21) (22) (33) bentler's comparative fit index .7735 .8408 .8574 akaike . s information criterion 2829.845 1940.384 1721.436 bozdogan's (1987) calc 1735.8006 852.8138 640.3393 bentler & bonnett' s (1980) non.7454 .8199 .8377 normed index bentler & bonnett's (1980) nfl .7641 .8305 .8470 relative non-centrality index (rni) .7735 .8408 .8574 bollen (1986) normed index rhol .7348 ,8083 .8259 bollen (1988) non-normed index .7734 .8410 .8576 deita2 the twoand three-factor solutions both seemed to provide a better fit than the one factor solution. but also had highly intercorrelated factors as explained before. the second factor (in a two factor solution) and the second and third factors (in the three factor solution) explained relatively small percentages of the total variance. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sa teb nr vol 1 (1998) nr 1 81 the one-factor solution on the other hand yielded a relatively good fit with most of the indices reaching acceptable levels. to use the instrument as a unidimensional measure will probably be acceptable. the factor loadings and the item weights (correcled rn-values) are shown in table 5. table 5 factor loadings and corrected ru values of items in msq (one factor solution) item (no in msq) f ador loading col'1'ected rn value 1 .553 .491 2 .536 .469 3 .604 .536 4 .610 .549 5 .578 .529 6 .593 .546 7 .559 .498 8 .403 .361 9 .503 .442 10 .474 .422 11 .698 .630 12 .659 .608 13 .504 .458 14 .651 .599 15 .738 .672 16 .718 .648 17 .653 .602 18 .500 .450 19 i .647 .593 20 .717 i .653 from table 5 it can be seen that all the items had acceptable ilem weights and factor loadings, making for a robust scale. the one factor solution on the msq responses was investigaled further. bagozzi & heatherton (1994) stale that the "fir" indicated by the indices yielded by r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 82 sajems ns vol i (1998) no i confinnatory factor analysis can be an underestimation of the quality of the fit when the scales included in the analysis consists of several items. 1be same is true when large samples are used. in the present study quite a large sample (n = 1791) was involved and the one-factor solution on the items of the msq contained 20 items. a procedure advocated by bagozzi & heatherton (1994) was therefore carried out. this consisted of fonning aggregate "items" by combining groups of items in the msq with each other. in this way the following aggregates were formed: items 1-4; 5-8; 9-12; 13-36 and 17-20. 1be aggregates were then used as variables in a second order principal components analysis. 1be factor pattern obtained from a principal components analysis with one factor specified indicated factor loadings for the different aggregates of .84, .84, .83 •. 80 and .79. a confinnatory factor analysis yielded the indices as shown in table 6. table 6 results of cf a on msq factor pattern (secondary analysis) goodness of fit index (g.f.i.) .9836 gfi adjusted for degrees of freedom .9384 (agfi) root mean square residual (rmr) .0217 relative non-centrality index (rni) .9836 bentler's comparative fit index .9836 akaike's information criterion 65.1881 bozdogan's (1987) calc 39.2935 bentler & bonnett's (1980) non-normed .9590 index bentler & bonnett's (1990) nfl .9827 bollen (1986) normed index rho 1 .9567 bollen (1988) non-normed index deita2 .9836 chi-square df=4 p=.oool 73.1881 null model chi-square df:::: 10 4225.2171 diff chi-square df=6 p= .0001 4152.0290 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr vol 1 (1998) nr 1 83 from table 6 it can be seen that elimination of error variance resulted in a very good fit being obtained. a one-factor structure can therefore probably be accepted as representing the variance measured by the msq. discussion the results of the analyses of the characteristics of the liq seem to indicate that the construct is 'ponable' to the south african situation, at least as represented by the samples on which the results reported in this paper were obtained. the msq proved to be probably essentially one-dimensional. the scale seems to be robust when used on a sample from the south african population instead of that of the united states. it should be clearly remembered that the respondents on whose responses the analyses presented in this paper were carried out were predominantly white, middle class and upper middle class south africans. these samples probably did not differ much from the validation samples used by the authors of the two instruments. the question therefore remains: will these results stand up to crossvalidation on black, asian and south african mixed race samples? put differently the question is: are the constructs job satisfaction and job involvement the same for different ethnic/cultural and different socio-economic groups? it seems as if a rich possibility for further research exists in this regard. references i. bagozzi, r.p. & heatherton, t.f. (1994). a general approach to representing mullifaceted personality constructs: application to self-esteem. structural equation modelling, i, 35-67. 2. boshoff, a.b., bennett, h.f. & kellerman, a.m. (1994). prediction of job involvement of professionals by means of career orientations scores. journal of industrial psychology, 20(2), 8 13. 3. boshoff, a.b., kaplan, r.a.l., schutte, j.l. & kellerman, a.m. (1989). job satisfaction, job involvement and career anchors of professionals in a third world / first world country. proceedings of the second international conference on comparative management. kaohsiung, taiwan, 80 112. 4. kanungo, r.n. (1982). measurement of job and work involvement. journal of applied psychology, 67(3), 341 349. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . -----~ .......... -84 sajems ns voll (1998) no 1 5. kerlinger, f.n. (1986). foundarions of behavioral research. new york, holt, rinehart & winston. 6. lodahl, t.m. & kelner, m. (1965). the definition and measurement ojjob involvement. journal o(applied psychology, 49(1), 24 33. 7. robinson, p.b., stimpson, d.v., huepner, j.c. & hunt, h.k. (1991). an attitude approach to the prediction of entrepreneurship. entrepreneurship theory and practice, 15(4) 13 30. 8. stimpson, d.v., robinson, p.b., waronusuntikule, s. & zheng, r. (1990). attitudinal characteristics of entrepreneurs in the united states, korea, thailand and the peoples republic of china. entrepreneurship and regional development, 2,49 55. 9. stimpson, d.v., huepner, j.c., narayanan, s. & shanthakumar, d. (1992). attitudinal characteristics of male and female entrepreneurs in the united states and india. paper read at 2nd conference on internationalizing entrepreneurship research, education and training. dorunund, june. 10. weiss. d.j., dawis, r.v., england, g.w. & lofquist, l.h. (1967). manual for the minnesota satis/action questionnaire. mirmeapolis, university of minnesota. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns 7 (2004) no 2 299 trade openness and economic growth in nigeria: further evidence on the causality issue ________________________________________________________________ saibu muibi olufemi department of economics, obafemi awolowo university ________________________________________________________________ abstract the study specifically investigated the causality between the openness variable and economic growth, using data from the nigerian economy. previous studies in nigeria have interpreted the regression results of output variables on the export trade variable as providing support for trade liberalization as engine for growth with less emphasis on other measures like import. such an interpretation is questionable, since these regressions provided no means for determining the direction of causality. this paper performed causality tests with various forms of openness measures and economic growth. the results indicated a unidirectional relationship between openness and growth. this shows that an increasing level of openness will be beneficial, depending on the level of economic development in nigeria. the result is robust across different measures of openness and analytical techniques. jel f14, 43 1 introduction the idea that trade openness affects economic growth is not new again. however, the nature of the effect is being seriously debated in the literature. some empirical studies have identified a positive linkage between a country’s rate of economic growth and its openness to international trade, while others have failed to demonstrate such linkage, (jin, 2002; sinha & sinha, 1996). the crux of the differences in these results has been the differences in methodology as well as the way the openness variables were defined (baldwin, 2002 and ajayi, 2003). most striking fact about the existing volume of studies is that despite the fact that both exports and imports are equally important in promoting economic growth, most researchers have focused attention on the former (sinha & sinha 2003, jonsson & subramanian, 2001). a developing country like nigeria is sajems ns 7 (2004) no 2 300 import dependent, therefore, its import effects on the growth process should not be ignored or assumed away without any empirical basis. also, nigeria has experimented with different exchange rate regimes, which might have implications for the trade-growth nexus. more importantly, with exception of odusola and akinlo (1995), no other studies on the nigerian economy examined the causal relationship between trade (openness) variables and economic growth. the neglect of the causality nexus has implication on the correct modeling of the trade-growth equation. a causality test could provide insight on whether a single or simultaneous equation model is appropriate for trade-growth relationship. the fact that trade volume and economic growth are in tandem revealed nothing about the causal direction. therefore, the issues of causality between trade and economic growth need to be investigated. this paper essentially contributes to existing studies in three ways: first, the paper included new time series from 1993 to 2000, which were excluded in the earlier studies on the nigerian economy. the period of 1993 to 2000 coincided with the period when the external trade and exchange rate were extensively liberalized (see figures1 & 2) and thus could have implication on the empirical results. second, rather than using the common narrow definition of openness, this paper used a variety of measures of trade openness and this helped to check the robustness of the causality results. third, both vecm and standard granger causality tests were used. this was done to check whether omission of the error correction channel of influence in the granger causality test has any implication on the results. therefore, this paper not only extended the existing literature but also improved the quality of the evidence. the structure of the paper is as follows. section 2 examined the trend of trade openness and economic growth over the years. section 3 provided a review of the existing studies. section 4 presented the methodology while section 5 analyzed the empirical results. section 6 concluded the paper with policy implications of the findings. 2 trade openness and economic growth in nigeria the analysis of the growth of exports and imports gives an indication as to the extent of the openness of an economy. however, trade flow analysis provides the basis of robust empirical investigation of the openness of an economy. empirically, openness can be measured by the share of trade (import plus export) in total output, measured by the gross domestic product (gdp). this is a broad concept of openness; in the narrow context, the ratio of imports or exports to gdp can represent the degree of openness of an economy. sajems ns 7 (2004) no 2 301 a cursory look at figure 1 shows that the nigerian economy has been relatively more open since 1986, as a result of policy measures applied under the structural adjustment programme. the broad measure of openness, total trade to gdp (tt/gdp) increased from 0.21 in 1986 to 0.64 in 1987 as a result of the consistent implementation of adjustment measure. in 1990, there was an upward trend in openness when the index reached 1.72. the situation further improved from 1995 when the index rose to about 17.0 because of a policy of deregulation that was re-introduced. the most important factor responsible for the upsurge in the trade volume and the phenomenal increase in the openness index was the final removal of other restrictions on trade as a final measure of the nigerian government in becoming a member of the world trade organisation (wto) in 1995. this led to increased trade relations with other countries. at the end of 1999, the index of openness reached a remarkable level of 17.6 from 1.1 in 1989. figure 1 aggregate output growth and trade openness in nigeria, 19702000 -10 -5 0 5 10 15 20 25 19 70 19 72 19 74 19 76 19 78 19 80 19 82 19 84 19 86 19 88 19 90 19 92 19 94 19 96 19 98 20 00 year gdpgr tt/gdp sajems ns 7 (2004) no 2 302 while the economy has recorded remarkable progress in improving trade relations with other countries as reflected by the increasing rate of total trade to gdp, the rate of economic growth has remained sluggish. the low correlation depicted by the graph between the openness of the economy and the growth rate of the economy showed that openness has not contributed much to economic growth in nigeria. in other words, nigeria has not benefited as expected from the liberalization of the economy. though, the above trend analysis is informative and indicative of the inverse relationship between economy growth and external trade in nigeria, definite statements cannot be made without any empirical basis. the subsequent sections examined the empirical relationship between economic growth and openness in nigeria. 3 review of related studies the relationship between openness and economic growth in developing economies has been fully analyzed by a large number of empirical papers. primary attention has been given to the role of exports in economic performance with little attention paid to other growth promoting openness variables. in their paper, cuadros, orts and alguacl (2001) employed a var model to examine the causal relationship between output level, inward foreign direct investment (fdi) and trade in argentina, brazil and mexico. they found that though fdi had significant impacts on growth, their results failed to find evidence in support of export led growth. they concluded that the fragility of their result may stem from the omission of other relevant mechanism through which openness can promote growth. similarly, goldberg and klein (1999) had also opined that if capital flow is significant, focusing only on export as proxy for openness may be misleading. using data from some asian countries, sinha and sinha (2001) also reiterated that omitting import from trade openness measure creates a missing variable bias. using data from imports and exports to capture openness, they found positive effects of openness on economic growth for some asian countries. apart from export, other trade measures have gained prominence in the literature in recent times. for example, chanda (2001) used an index of capital account openness to show that more developing countries have suffered from opening their economies than not, while rodrik (1998) as well as alesina et al. (1994) found no effects of capital account openness on economic growth. with respect to fdi, there is evidence of a positive growth-effect in countries that are sufficiently rich (blomstriom et al., 1992, zhang, 2002; alfaro & chanda, 2001) and a negative one in low-income countries (garrett, 2001). also, carkovic and levine (2002) did not find a robust influence of fdi on growth. studies examining the effects of fdi on countries growth rates, summarized by sajems ns 7 (2004) no 2 303 durham (2000), were not unanimous in their findings. similarly, edison et al. (2002) detailed analysis of the impact of several indicators of financial openness on growth, showed that no robust relationship exists. however, dreher (2002) using different measures of openness to capture economic globalization found that globalization promote growth but not to the extent that it can reduce poverty. studies carried out on nigeria using time series data, has been scanty. egwaikhide (1994) examined the link between the trade variable (export) and economic growth in nigeria between 1959 and 1989, using cointegration and error correction methods. this approach is appealing as it could eliminate the problem of spurious estimates, which previous studies ignored. ekpo (1995) also examined the openness and performance of the nigerian economy for the period 1970 to 1992 using broad measures of openness. using the aggregate production model, his analysis showed that capital stock and labour contributed positively to output growth during the period. however an increase in trade share measured by the black market premium rate and trade/gdp respectively, reduced output. oladipo (1998) extended the ekpo and egwaikhide (1994) model. he measured the degree of openness as the ratio of total trade (export + import) to gdp and as the ratio of export to gdp. based on a sample period of 27 years (1970 to 1996), nigerian quarterly data, the results showed that when the export/gdp ratio was used as a measure of openness it correlated positively with gdp growth. but, the conventional broad measure (import plus export) to gdp indicated a negative relationship. olomola (1998) used the endogenous growth model to explore the long-run relationship between openness and economic growth. he adopted dickey-fuller and augmented dickey-fuller test to examine the stationarity properties of the variables. openness was proxied by export/gpd and total trade/gdp for sample period of 1960 to 1998, he found that total trade/gdp, has no significant relationship with long run growth in nigeria. in recent studies, akinlo (2003a,b) examined the effects of fdi on economic growth in sub-saharan africa. he found out that fdi had a positive impact on sub saharan african economic growth. in addition, both export and stock market development had positive effects. though, this result is indicative of the possible role openness in the form of inward flows of capital goods could play in a developing sub-saharan african country, the fact that the analysis was based on panel data makes country specific policy inferences difficult from the evidence. it is possible that individual country result may differ if time series data are employed. apart from this shortcoming, one other important shortcoming of these studies is that they ignored the causal relationship between sajems ns 7 (2004) no 2 304 trade openness and growth. their outcomes were monumental but the neglect of the nature and direction of influence between the trade variable and growth, made their results tentative. some studies have attempted addressing the issue of causality between the trade variable (especially export) and economic growth. jung and marshall (1985) used time series data to perform granger (1969) causality tests between export and growth for 37 developing countries. the results provided evidence in favour of export led growth in only four instances. the result showed that the export promotion hypothesis is weaker than what previous statistical studies have indicated. kunst and mario (1989) also investigated the causality between productivity and exports using quarterly data for the period between 1965 and 1985. the result indicated no causal link from export to productivity. muhammed and sampath (1999) also empirically examined the causality between exports (as a measure of trade openness) and economic growth for 97 countries using data for the period 1960 to 1992. while determining the stationarity of the two variables and their order of cointegration, they found that gdp and exports are integrated of different orders for 36 countries. among the other 61 countries, for 17 countries, there were no long-run relationship between the two variables, 35 countries showed causality at least in one direction. uni-directional causality from gdp to exports was reported for 10 countries, from export to gdp for 5 countries and bi-directional causality for 20 countries. nine (9) countries did not show any causality between gdp and exports at all. one important issue of relevance to this study, is that nigeria was among the 9 countries without causal relationship between exports and economic growth. the findings were contracted from existing studies. anoruo and ahmad (1999) used johansen’s (1991) cointegration technique instead of the granger (1969) causality test to examine the causal link between trade openness and economic growth. in the five (5) asian countries, selected covering 1960 to 1998, they found that both openness variables and economic growth are cointegrated and that there was a bi-directional causality between trade openness and economic growth. our perusal of literature on nigeria has not indicated any detailed effort at investigating the causal link between trade variables and economic growth. the only exception was odusola and akinlo (1995). they used the traditional granger (1969) causality test to examine the causal relationship between openness and gdp growth. the set of trade variables considered were export, import, and terms of trade and factor inputs, proxied by gross capital formation and labour force, using nigerian data over 32 years from 1960 to 1992. the causality analysis using the granger (1969) test indicated bi-directional causal effects between export and growth, there was a unidirectional relation between sajems ns 7 (2004) no 2 305 terms of trade and exports while imports had causal effects on capital formation only. this result contradicted the muhammed and sampath (1999) result on nigeria despite using the same causality test. however, odusola and akinlo's (1995) traditional granger causality test suffered from two methodological deficiencies. first, the standard test adopted did not examine the basic cointegration properties of the variables. if the variables were cointegrated, their model which incorporated the difference variables, is mis-specified since the lagged error correction term is not included (granger, 1988). second, the noninclusion of the error correction term from the cointegration equation eliminated the long-run information embodied in the original form of the variables. the exclusion of the error correction term also foreclosed the detection of an additional channel of granger causality through the lagged error correction terms. in view of this, odusola and akinlo’s (1995) result could not be regarded as final and conclusive. it would, therefore, be interesting to reexamine the causality between trade openness and economic growth through the yet to be explored (error correction term) channel using data from nigeria. the fact that none of the existing studies was categorical about the nature and direction of the relationship between trade openness and economic growth makes further analysis imperative. most importantly, the methodology adopted in these studies cannot capture the complex interrelationship between trade and economic growth. it cannot show the likely long run (feedback) effects that exist among trade variables and economic growth. this paper therefore addressed this empirical issue by employing johansen (1991) cointegration and vecm procedure (in addition to the standard granger causality test) with time series data for nigeria and a larger set of trade variables. this method has been found to perform better than the granger (1969, 1980) causality approach (anorou & ahmed, 1999). 4 data and methodology this study used annual data on gross domestic product (tgdp), industrial output (indgdp) and openness measured by a set of trade openness variables for nigeria. the data cover the period 1970 through 2000. the openness variable was proxied by a set of five (5) variables: export (expt), import (impt), and export plus import (ttrade), exchanges rate premium (exrt) and net capital inflow (nfci). indeed, we are aware of the criticism of using trade volume instead of trade policy as measures of openness (rodriquez and rodrik, 1999; rodrik, 1999 and jonsson & subramanian, 2001). as rodrik also observed, most of the trade policy measures in developing countries, like sajems ns 7 (2004) no 2 306 nigeria, are of low quality and unreliable. also jonsson and subramanian (2001) had argued that trade openness has two forms, namely trade outcomes and trade liberalization. in view of the inadequate and unreliable consistent time series data in nigeria trade outcomes measures become more appropriate. therefore, this paper utilizes the trade outcome to measure openness. all the data are collected from statistical bulletin and annual report and statement of account published by central bank of nigeria (cbn, 2001). cointegration procedure requires time series in the system to be non-stationary in their level. similarly, it is imperative that all time series in the cointegrating equation have the same order of integration. consequently, the study first ascertained the time series properties of all the variables. we employed the augmented dickey-fuller test for stationarity; the equation estimated for the augmented dickey-fuller test is as follows: ∆ ∆x x t xt t t i i n t t= + + + +− = −∑α β ∂ θ1 1 1 1 1l ... where, ∆ is the first-difference operator; t is the time trend, and l t is the stationary random error, n is maximum lag length. xt is total output (tgdp), industrial output (indgdp), and export (expt), import (impt), exchange rate premium (exrt), net capital inflow (nfci) and sum of import and export (ttrade),. to ascertain the long run relationship between economic growth and openness, the johansen cointegration procedure is utilized (johansen, 1991) and johnsen and juselius (1990). the procedure involves the estimation of a vector errorcorrection model (vecm) in order to obtain the likelihood-ratios (lr). the vecm used in the study is as follows: ∆ ∆y y yt i m i t i t k t= + + + = − −∑θ θ α β0 1 2' .l .. where, ∆ is the difference operator, ∆y is total output (gdpt), industrial output (indgdp), and export (expt), import (impt), exchange rate premium (exrt), net capital inflow (nfci) and sum of import and export (ttrade)], θ0 represents the intercept, and l t represents the vector of white noise process. the matrix ∃ consists of r (r<n – i) co-integrating vectors. similarly, the matrix ∀ contains the error correction parameters. in equation (2), the null hypothesis is that the matrix (β = ∀∃') has a reduced rank of r< n – i. the alternative hypothesis, is that the matrix (β = ∀∃') has full rank. johansen procedure of cointegration provides two statistics. these include the value of the lr test based on the sajems ns 7 (2004) no 2 307 maximum eigenvalue of the stochastic matrix and the value of the lr test based on the trace of the stochastic matrix. the causal relationship between economic growth-openness is examined with the help of granger-causality procedure based on vecm. this procedure is particularly attractive over the standard var because it permits temporary causality to emerge from (1) the sum of the lagged coefficients of the explanatory differenced variable and (2) the coefficient of the error correction term. in addition, the vecm allows causality to emerge even if the coefficients of lagged differences of the explanatory variable are not jointly significant (anoruo & ahmad, 1999). it must be pointed out that the standard grangercausality test used in earlier studies (e.g. odusola & akinlo, 1995) omitted the additional channel of influence (zt-1). in this study, the error correction model is based on: ∆ ∆ ∆ ∆ ∆ gdp z gdp trd trd z trd gdp t t i j i a t j j i b t t t t i j c t j j d t t = + + + = + + + − = − = − − = − = − ∑ ∑ ∑ ∑ α β θ µ ϑ θ λ 1 1 1 1 1 1 1 1 3 4 ...... .......l where zt-1 represents the error correction term lagged by one period, gdpt represents tgdp and indgdp, the growth variables, and trdt stands for the openness variables (i.e. expt; impt; ttrade; nfci and exrt). a, b, c, and d represent the optimal lag lengths obtained from the final prediction error (fpe). all the variables are logarithmic and enter the co-integration analysis in levels. in equation (3), the rejection of the null hypothesis that openness does not granger cause economic growth, requires that (i) the θ j be conjointly statistically significant and/or (ii) the error-correction term (zt-1) be statistically significant. similarly, in equation (4) the null hypothesis that economic growth does not granger cause openness is rejected on the condition(s) that the λ j s are jointly significant and/or the error correction term (zt-1) is significant. 5 empirical results following the steps discussed in section 4, the result of the augmented dickeyfuller (adf) unit root tests are presented in table 5.1. the non-hypothesis of non-stationarity of economic growth and trade openness variables is tested against the alternative hypothesis of stationarity. the results indicated that sajems ns 7 (2004) no 2 308 except for industrial output that was stationary at level, all the other series were not stationary in their levels. however, at first difference, the null hypothesis of no unit roots is not rejected as 5 per cent significance level. in all, the results indicated one order of integration for both economic growth and trade openness variables. table 5.1 adf unit root test results unit root tests for stationarity with constant only: 1970-2000 variables levels first difference ltgdp -2.286 -6.211 lindgdp -6.926 -9612 lexpt 0.003 -4.244 limpt -0.085 -3.246 lexrt 0.668 -3.198 lnfci -0.997 -9.235 lttrade 0.7169 -5.402 the critical values at 5 per cent for levels and first difference are 2.967 and -2.971 respectively. the series are; ltgdp = aggregate gross domestic output; lindgdp=industrial output; lexpt=exports; limpt=imports; lttrade=sum of export and import; lexrt=exchange rate premium; lnfci= net capital inflow. all the variables are in log forms. having determined the stationarity of time series the next step of our study involved the application of johansen procedure to ascertain whether trade openness variable are co-integrated with the economic growth variables for nigerian data. in the bivariate system, consisting of economic growth and trade openness variables, the maximum number of co-integrating vectors is one so the null hypothesis is that there is no co-integrating vector and the alternative is that, there is one co-integrating vector the results of the procedure are presented in table 5.2. the null hypothesis of no co-integration between economic growth variables and trade openness (i.e. r=0) is rejected at the 5 percent significant level in all the cases. however, the null hypothesis that there is at most one cointegrating vector (r < 1) could not be rejected for the all the cases. the fact that the economic growth and openness variable are co-integrated for nigerian economy suggests that (i) there is a long run equilibrium relationship between the time series and (ii) the existence of causality in at least one direction. given the results of the co-integration tests, the next step is the estimation of the vecm of equation 3 & 4 to determine the direction of causality between economic growth and trade openness variables. the results from the bivariate sajems ns 7 (2004) no 2 309 causality tests from the estimates of the vecm were presented in panel a(i-ii) and b(i-v) of table 5.3. panel a(i) and a(ii) contain the estimates of growth equation 3 for aggregate output (tgdp) and industrial output (indpgdp) respectively. the estimates of openness for each openness measure, lexpt; impt; lexrt; lttrade; and lnfci, accordingly, were presented in panel b(i-v). table 5.2 results of johansen co-integration test maximum eigen values trace statistics series ho: r=0 ho: r<1 ho: r=0 ho: r<1 lgdp & lexpt lgdp &limpt lgdp & lexrt lgdp & lttrade lgdp & lnfci 0.747 0.756 0.175 0.752 0.856 0.001 0.003 0.016 0.0001 0.062 39.840* 41.026* 43.664* 40.462* 49.894* 0.017 0.082 0.462 0.003 1.597 lindgdp & lexpt lindgdp &limpt lindgdp & lexrt lindgdp & lttrade lindgdp & lnfci 0.001 0.687 0.697 0.680 0.712 0.001 0.001 0.015 0.014 0.045 36.685* 33.255* 35.088* 33.480* 32.274* 0.023 0.042 0.431 0.396 1.151 rejection of the null hypothesis at 5 per cent significance level. the critical values for the hypothesis r=0 at 5% (1%) are 15.41 (20.04). the critical values for the null hypothesis r=1 at 5% (1%) are 3.76(6.65). table 5.3 f-statistics for the bivariate causality test based on vecm series joint coefficients ecm tvalues panel a(i) growth equation (3) for ∆lgdp: σ∆lexpt σ∆limpt σ∆lexrt σ∆lttrade σ∆lnfci panel a(ii) growth equation (3) for ∆lindgdp: σ∆lexpt σ∆limpt σ∆lexrt σ∆lttrade σ∆lnfci -0.107 -0.038 -0.289 -0.081 -0.018 0.047 -0.175 0.006 0.005 -0.064 -3.290* -3.183* -3.638* -3.232* -1.285 -10913* -11.071* -9.913* -10.134* -10.974* sajems ns 7 (2004) no 2 310 table 5.3 continued series joint coefficients ecm tvalues panel a(i) openness equation (4) for ∆lexpt: σ∆lgdp σ∆lindgdp panel a(ii) openness equation (4) for ∆limpt: σ∆lgdp σ∆lindgdp panel a(iii) openness equation (4) for ∆lexrt: σ∆lgdp σ∆lindgdp panel b(iv) openness equation (4) for ∆lttradf: σ∆lgdp σ∆lindgdp panel b(v) openness equation (4) for ∆lnfci σ∆lgdp σ∆lindgdp 0.845 -0.219 0.327 -0.348 -0.217 0.136 0.516 -0.212 -1.87 0.180 -1.462 0.095 0.039 0.905 -0.484 -0.325 0.402 -0.500 1.07 0.562 * represents rejection of hypothesis at 5 per cent of significance. the joint significance of the coefficient is ascertained by the standard f-test. the level of significance for the error correction terms is determined by standard tstatistics. as could be observed from the table 5.3, causality is only present in panel a that is from openness to economic growth, not the other way round. this is evident from the significance of the error correction terms (ecms) in panel a and the insignificance of all the ecms in panel b. however, there was no causation through the statistical significance of the explanatory variables. as far as the joint significance test applied to the sum of the coefficients of each explanatory variable is concerned, there is no support for causality between trade openness and economic growth. therefore, the principal source of causality is through the error correction terms, which validated the existence of a long-run equilibrium relationship between economic growth and openness. this result suggested that there is only uni-directional causality from trade openness to economic growth. sajems ns 7 (2004) no 2 311 to check the robustness of the results and the implication of excluding ecm terms in modeling variables that were cointegrated, the standard granger causality test was conducted. as shown in table 5.4, except for the total trade measure of trade openness, which indicates bi-directional causality, there was no causality from economic growth to other openness variables. unidirectional causality was indicated from trade measures to aggregate output but no causality was indicated between industrial output and the trade variables. the result from the standard granger causality test suggested that the causal effects of economic growth on trade is weak in nigeria, as reported by the vecm method. thus, the estimates were robust and hence the omission of the ecm term might have resulted in specification bias, if the causality was presented only in the error correction term as observed in this paper. table 5.4 bivariate granger causality test the null hypothesis f-statistics p-values expt does not cause gdp gdp does not cause expt impt does not cause gdp gdp does not cause impt exrt does not cause gdp gdp does not cause exrt ttrade does not cause gdp gdp does not cause ttrade nfci does not cause gdp gdp does not cause nfci expt does not cause indgdp indgdp does not cause expt impt does not cause indgdp indgdp does not cause impt exrt does not cause indgdp indgdp does not cause exrt ttrade does not cause indgdp indgdp does not cause ttrade nfci does not cause indgdp indgdp does not cause nfci 4.029* 0.094 3.805* 0.413 2.321 0.569 4.087* 7.323* 2.670 0.629 1.400 1.187 1.595 0.189 2.022 0.066 12.811* 8.072* 1.868 0.283 0.031 0.910 0.021 0.666 0.776 0.607 0.030 0.033 0.938 0.544 0.267 0.322 0.224 0.829 0.154 0.936 0.0001 0.002 0.181 0.757 sajems ns 7 (2004) no 2 312 * represents rejection of hypothesis at 5 per cent level of significance. p-value means the probability that the null hypothesis could not be true. critical value of 2.89 at 5 per cent level of significance has been used for the rejection of no causality. it is interesting to observe also that, the signs on the sum of the coefficients in most of the variables were negative. this implies (table 5.3) that there is an inverse relationship between the openness variables and economic growth. this also seems contradictory to the generally held view that openness should not only cause but also promote economic growth. the significant negative causal effects of increasing openness on real output growth is consistent with the argument of aiken and harrison (1999) and jin (2002), that increased international competition due to openness may cause domestic investment to decline, and its decrease would be greater than an increase in capital inflows from abroad. if this net investment falls, aggregate demand will follow. the results indicated further that trade openness or liberalization depressed the growth process in the nigerian economy. the results are not surprising giving the nature of nigerian external trade. most often, the export volume is dominated by crude oil whose price and quantity is determined in the international market and has little or no relation with economic reality in the nigerian economy. in the case of imports, the volume is skewed towards semiprocessed goods deceitfully packed as raw materials when being imported; this hindered the development of the local industries. there is a high incidence of exchange rate round tripping, a situation where some scrupulous people buy foreign currency at official rate in order to sell it on the black market. as a result, the productive sector was deprived access to foreign currency to procure locally unavailable raw materials. the premium therefore do not reflect the reality in the economy. this consequently depressed the production capacity of the economy rather than promoting it. in fact, the non-causal linkage from economic growth to trade openness indicated that the growth in nigeria's total trade has nothing to do with nigerian economic reality. this result thus suggested that increased trade openness might have contributed to the low economic growth in nigeria in recent times. 6 summary and conclusion for the past decade, the relationship between economic growth and openness has been a topic of sustained interest and controversy in economic development literature. this study improved on previous studies done on the nigerian economy by suggesting a reasonable approach to re-investigating the economic growth openness nexus. specifically, the study employed the johansen sajems ns 7 (2004) no 2 313 cointegration technique for the long-run relationship between openness and economic growth. finally, vecm was estimated to capture the permanent and transient movement between the variables contained in the co-integration equations. the paper found that economic growth and openness were cointegrated for the nigerian economy, thus there was a long-run relationship between them. only unidirectional causality from economic growth to trade openness was present. this was corroborated by a standard granger causality test. alfaro and chanda (2002) also argued that openness measured by fdi played an ambiguous role in contributing to economic growth. countries with a well-developed financial market, benefit from openness while countries like nigeria with a lessdeveloped financial market, lose more with increasing openness. the trade sector, therefore, could not be excused from the blame for overall low economic performance in nigeria. in fact, the extensive liberalization of nigerian external trade without taking cognizance of the economic reality in nigeria, could have engineered the economic recession experienced in the country in recent times. the import dependent (industrial) sector, which is vulnerable to adverse development in the trade sector, seemed weak to absorb the shocks from disturbances from the international market. the policy implication that emerged from this study is that, the trade-growth relationship could be model led in a single equation, as no interactive (feedback) nexus exist between trade and growth variables considered in this paper. the nigerian government also needs to moderate its trade liberalization policy as the economy seems too weak to absorb the negative shocks from external trade. most importantly, adequate fiscal and monetary policies should be put in place to offset the likely negative effects of exposing the economy to external influences. references 1 ajayi, s.i. 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(2001) “openness, investment and economic growth in asia”, indian economic journal, 49(4): 90-95. 33 zhang, s. (2002) “a panel study of the openness growth linkage”, department of economics, syracuse university mimeo. abstract introduction current income tax treatment of trusts in south africa benefits and costs of establishing a trust clarification of the taxation of trust reform proposals trust reform proposals versus amendments summary, conclusion and recommendations acknowledgements references about the author(s) sophia m. brink school of accountancy, university of stellenbosch, south africa citation brink, s.m., 2017, ‘an investigation into the future of discretionary trusts in south africa: an income tax perspective: part 2’, south african journal of economic and management sciences 20(1), a1789. https://doi.org/10.4102/sajems.v20i1.1789 note: this article follows ‘part 1’, namely: brink, s.m. & willemse, l., 2014, ‘an investigation into the future of discretionary trusts in south africa – an income tax perspective’, journal of economic and financial sciences 7(3), 795–816, available here: http://journals.co.za/content/jefs/7/3/ejc164675#abstract_content. original research an investigation into the future of discretionary trusts in south africa: an income tax perspective: part 2 sophia m. brink received: 16 feb. 2017; accepted: 20 mar. 2017; published: 31 july 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: trusts have long been used as an estate planning mechanism, including the avoidance of estate duty and donations tax. in the 2016 national budget the minister of finance indicated that government was proposing several legislative measures during 2016/2017 to prevent individuals from using a trust to avoid estate duty (and donations tax to a certain extent). unexpectedly, the 2016 draft taxation laws amendment bill and the final amendment bill did not give effect to any of these proposals, but introduced other less drastic measures to control the abuse of trusts for tax purposes, albeit with the same stated purpose. aim: the main aim of the study was to clarify the reform proposals (albeit unclear and consequently based on certain assumptions) and to compare the reform proposals with the final amendments. this comparison will shed some light on the fairness and appropriateness of the final amendments and, more importantly, on the possibility that the reform proposals published by national treasury in february 2016 not included in the final amendments will be enacted in the future. this investigation will assist tax practitioners and taxpayers in effective tax and estate planning, given that the reform proposals and final amendments have a possible impact on the future of discretionary trusts in south africa. setting: this article examines existing literature in a south african income tax environment. methods: in order to meet this objective a qualitative approach based on a literature study of pure theoretical aspects was used. results and conclusion: it was found that should the reform proposals become law, many trusts would become ineffective from a tax-planning perspective and these changes might erode other benefits trusts offer, jeopardising the future of discretionary trusts in south africa. introduction background and formulation of the study trusts have long been associated with elaborate tax avoidance schemes, and there exists a perception that trusts are misused by wealthy south africans (bdo 2013). for tax purposes trusts are being used as an estate planning mechanism, including the avoidance of estate duty and donations tax. the founder of a trust would typically transfer assets to the trust by selling these assets to the trust and granting an interest-free (or low-interest bearing) loan. the founder of the trust will not be liable for donations tax because the assets are sold to the trust, and the assets so transferred will not be included in the founder’s estate at death (mazansky et al. 2016; treasury 2016a:49). an interest-free loan is also not regarded as a donation for donations tax purposes (strydom 2008). according to cecil morden, the chief director of economic tax analysis at national treasury, the avoidance of tax is further exacerbated by the founder not receiving interest – on which tax is payable – and the value of the loan being eroded by the time value of money (du preez 2016). in terms of the ‘conduit principle’, income or capital that is realised inside a trust can ‘flow-through’, or be distributed to the beneficiaries of the trust, while retaining the nature of the income, resulting in the income or capital being taxed in the hands of the beneficiary and not in the trust (stiglingh et al. 2016:845). the consequent tax advantage is that the natural person beneficiary qualifies for the limited interest exemption in terms of section 10(1)(i) of the income tax act no. 58 of 1962 (act) and the annual capital gains tax exclusion. the topic of trust reform first featured in the 2012 national budget [south african institute of tax practitioners (sait) 2013]. the south african revenue service (sars) strategic plan (2012/13–2016/17) states that an analysis shows that a significant number of high-net-worth individuals (hnwis) are under-declaring their income (sars 2013:19) and that trusts are used as a means of avoiding tax (sars 2013:33), resulting in significant revenue losses (sars 2013:19). it also stated that under-declaration of income by persons in the hnwi category was wide-spread with ‘only a fraction’ actually declaring their income to the sars. the strategic plan announced that trust reform would be prioritised. no further detail was given at that stage of what the reform proposals might entail. during the 2013 national budget the minister of finance indicated that government was proposing several legislative measures during 2013/2014 regarding trusts to control abuse. the minister of finance also stated that ‘various measures [will be] proposed to protect the tax base and limit the scope for tax leakage and avoidance’. one such measure was that ‘the taxation of trusts will come under review to control abuse’ (gordhan 2013:21). the national budget review document (chapter 4) shed some light on what these proposals entail and include the following: discretionary trusts should no longer act as flow-through vehicles. taxable income and losses (including capital gains and losses) should be fully calculated at trust level with distributions acting as deductible payments to the extent of current taxable income. beneficiaries will be eligible to receive tax-free distributions, except where they give rise to deductible payments (which will be included as ordinary revenue). (treasury 2013:54) the implication of the above proposal can be summarised as follows: the conduit pipe principle is under review as the proposals state that trusts should no longer act as a flow-through vehicle, meaning that the amounts distributed to the beneficiaries will no longer retain their original identity (bdo 2013) and that a trust should be taxed as a separate and distinct entity (croome 2013). the proposals suggest that taxable income or losses and capital gains or losses will be taxed in the trust, with distributions acting as deductible payments to the extent that there is current taxable income. a trust will therefore only be able to distribute ‘taxable income’. if the trustees of a discretionary trust exercise their discretion to distribute amounts to beneficiaries in the same year of assessment in which the amounts are received or accrued, a normal income tax calculation for the trust needs to be carried out. the taxable income of a trust must be calculated by including all receipts and accruals (certain of these receipts and accruals may be exempt from tax, for example local dividends), claiming certain expenses as deductions and including any taxable capital gain. the result of this calculation should be the theoretical taxable income of the trust if no distributions were to be made and none of the receipts and accruals vested in any beneficiaries during that same year of assessment. after calculating the taxable income of the trust, the trustees can make distributions to the beneficiaries. once the amount of taxable income has been distributed out of the trust, the amount will be subject to tax in the hands of the beneficiary and not in the trust. any distributions to beneficiaries would therefore be treated as a deductible payment by the trust and the beneficiary would then be taxed thereon as having received ordinary income (the effect of the income not retaining its original identity). the proposed amendments therefore directly disqualify the beneficiary from making use of both the basic interest exemption and the capital gains tax concessions available to a natural person. it was expected that the trust reform proposals would be included in the 2013 draft taxation laws amendment bill and tax administration laws amendment bill (issued in july 2013) as the draft legislation usually gives effect to tax proposals announced during the budget review. the draft legislation however did not include any trust reform information or specifics, which resulted in national treasury indicating that the trust reform proposals required more consultation and would be dealt with later in 2013 or as part of 2014’s process (treasury 2013). after the issue of the bills the minister of finance mandated the davis tax committee (dtc) ‘to assess our tax policy framework and its role in supporting the objects of inclusive growth, employment, development and fiscal sustainability’ (citadel wealth management 2016). the 2014/2015 and 2015/2016 national budget did not include any reference to the above-mentioned proposals. the only change to the taxation of trusts was the increase in the income tax rate from 40% to 41% for years of assessment beginning on or after 1 march 2015. the first mention of trust reform proposals after the 2013 national budget was found in the dtc’s first interim report on estate duty (january 2015). in this report the dtc made certain recommendations in order to address many deficiencies of the current estate duty system, including the following (dtc 2015): the deeming provisions of section 7 and 25b of the act should be repealed, insofar as they apply to republic of south africa (rsa) resident trust arrangements and trusts should be taxed as separate taxpayers. the dtc explained that the provisions of sections 7 and 25b of the act allow the trustees of a trust to cause the trust income to vest and be taxed in the hands of a beneficiary. this is known as the ‘attribution principle’. the attribution rules in section 7 were originally intended as an anti-avoidance measure aimed at preventing a trust from being used as an income splitting device. however, today the attribution rules are employed to avoid tax, thereby subverting the very purpose for which they were introduced. in order to avoid the donations tax implications of implementing an inter vivos trust arrangement, many assets are transferred into trusts, allowing the transfer consideration to remain outstanding by way of an interest-free loan account. in december 2015, the citadel fiduciary team attended a sait webinar on the first interim report on estate duty of the dtc, presented by judge davis. the judge indicated that there had been some changes in the dtc’s views because it received responses to the first interim report. judge davis stated that trusts were not dealt with correctly in the first interim report and that the conduit principle would probably remain in respect of distributions from local trusts made in the year of assessment. this is consistent with the industry feedback on the initial recommendations (citadel wealth management 2016). trust reform proposals were again a topic during the 2016 national budget. the national budget review document (chapter 4) provides the following detail regarding the rationale behind the proposals: an important role of the tax system is to reduce inequality. some taxpayers use trusts to avoid paying estate duty and donations tax. for example, if the founder of a trust sells his or her assets to the trust, and grants the trust an interest-free loan as payment, donations tax is not triggered and the assets are not included in his or her estate at death. to limit taxpayers’ ability to transfer wealth without being taxed, government proposes to ensure that the assets transferred through a loan to a trust are included in the estate of the founder at death, and to categorise interest-free loans to trusts as donations. further measures to limit the use of discretionary trusts for income-splitting and other tax benefits will also be considered. (treasury 2016a:49) the 2016 draft taxation laws amendment bill and the final amendment bill (‘amendment bill’) did little to include any of the above-mentioned proposals, but shifted focus to introduce rules on interest-free loans or loans with interest below market rates to limit taxpayers’ ability to transfer wealth to a trust without being subject to tax (treasury 2016d). the following rate changes were also included in the 2016/2017 national budget speech: the inclusion rate for capital gains will increase from 66.6% to 80%, resulting in an increase in effective rate from 27.3% to 32.8% (effective for years of assessment beginning on or after 1 march 2016). on 24 august 2016, the dtc released its second interim report on estate duty. the following recommendations were made based on the dtc’s investigations and observations (davis tax committee 2016): the conduit pipe principle should be retained for vested trusts and for discretionary trusts only insofar as the trust deed confers upon its beneficiaries an indisputable and irrevocable vested right to both the capital and income of a trust. the flat rate of taxation of trusts (currently 41%) should be retained and be subject to adjustments in line with changes to the maximum personal income tax rate. trust arrangements should also be examined by the sars on registration of the trust and upon transfer of assets into trusts so as to, inter alia, reduce aggressive tax-planning. donors and beneficiaries of all vested trusts should be subject to stricter disclosure requirements and enforcement measures. the dtc also recommends extending the provisions of section 3(3)(d) of the estate duty act no. 45 of 1955 (estate duty act) by expanding the meaning of ‘deemed control’. the dtc suggests that section 3(3)(d) will apply in the following scenario: where a loan account exists between a trust and a ‘connected person(s)’, the loan is not subject to interest, or is subject to interest at below the official rate of interest, the holder of the loan can demand repayment within a specified period, and the holder of the loan will be deemed to be in effective control of the trust. the holder of the loan account would then be subject to annual taxation on interest paid on the loan account (at least the official rate of interest) and the trust arrangement would be devoid of any estate duty advantage owing to the application of section 3(3)(d). literature review brink and willemse (2014:795–816) investigated the future of discretionary trusts in south africa given the 2013 national budget trust reform proposals. the research problem was derived from the fact that the proposals, at that stage, were vague and confusing and that no effect was given to the proposals in the amendment bills, leaving taxpayers, tax practitioners and the general public uncertain and confused as to what exactly the proposals are and what the future of trusts in south africa might be (brink & willemse 2014:796). the main objective of their research was to clarify the 2013 proposed changes to the taxation of trusts, to investigate the potential impact(s) of these proposals (albeit unclear and consequently based on certain assumptions), and to assess whether discretionary trusts still have a future in south africa given these proposals (brink & willemse 2014:797). from the literature review brink and willemse (2014:803) identified two possible interpretations of the reform proposals mentioned in the 2013 national budget speech: the scrapping of the conduit pipe principle would mean that the amounts distributed to the beneficiaries will no longer retain their original identity and those amounts will be income in nature in the hands of the beneficiary. the beneficiary therefore does not qualify for the basic interest exemption and the capital gains tax concessions available to a natural person. any distributions to beneficiaries would be treated as a deductible payment by the trust to the extent that there is current taxable income. a trust should be taxed as a separate and distinct entity meaning that a trust would be liable to pay tax in its own right without the possibility of passing income and capital gains through to beneficiaries. therefore, irrespective of whether the trustees exercise their discretion or not, amounts received by the trust will be taxed in the trust’s hands and distributions made to beneficiaries would be tax-free in their hands (brink & willemse 2014:812). the article also made use of practical examples (a trust receiving interest, dividends and proceeds from the disposal of a capital asset) to illustrate the impact of the proposals. brink and willemse (2014:804–808) compared the current tax position with the proposed tax position, for both the trust and the beneficiary, for interpretation 1 and interpretation 2. the tax effect of the proposed amendments in a scenario where the trustees decide to distribute all of the receipts and accruals (the interest, dividends and capital gain) in the trust to the beneficiary is an alarming increase of almost 200% for interpretation 1 and 320% for interpretation 2 in the overall income tax liability (for the given example illustrated in the article). the current and proposed tax position is the same in a scenario where the trustees decide not to distribute any of the receipts and accruals in the trust to the beneficiary (for interpretation 1 and interpretation 2) (brink & willemse 2014:804–808). brink and willemse (2014:811) state that the current legislation regarding the taxation of discretionary trusts in south africa is sufficient and that a more effective application of current anti-avoidance rules and mechanisms by the sars would discourage taxpayers from abusing trusts. to punish discretionary trusts in the manner proposed therefore seems exaggerated and unnecessary given the current legislation and the structures available to the revenue authority at present (brink & willemse 2014:811–812). the article referred to above highlights that should the radical proposed amendments be applied the use of a discretionary trust might become extremely unfavourable. the article subsequently explains the procedure that should be followed to terminate a trust as well as the possible tax effect should a trust be terminated (brink & willemse 2014:812). brink and willemse (2014:813–814) recommend that national treasury should scrap these proposed amendments in order to ensure and promote equitability and that the sars should rather apply current anti-avoidance rules more efficiently and strictly. research problem the dynamic of discretionary trusts has changed drastically since 2012, when trust reform first became a topic, and there is uncertainty regarding whether or not a discretionary trust is still an effective vehicle to use for minimising overall tax liability. research objective and methodology ‘an investigation into the future of discretionary trusts in south africa – an income tax perspective [part 1]’ investigated whether discretionary trusts have a future in south africa, given the 2013 national budget reform proposals. part 2, this article, is based on research that investigated whether discretionary trusts have a future in south africa, given the new developments since 2013. the trust reforms as announced in the 2016 national budget speech as well as the amendments will possibly have an impact on the future of discretionary trusts in south africa. therefore, the research aimed firstly to clarify what exactly the taxation of trusts reforms as announced in the 2016 national budget speech are and secondly what the potential effect or impact of these proposals could be. the possible impacts are based on the assumptions applied in the clarification process found in the section clarification of the taxation of trust reform proposals of this article. these proposals can then be compared with the amendments, contained in the amendment bill, to determine the fairness and appropriateness of the amendments and – more importantly – the possibility that the proposals not included in the amendments might still be enacted in the future. in order to meet the main objective, the research considered how the dynamic of trusts has changed and compares the position of trusts, without the tax benefits currently in jeopardy under reform proposals, with other benefits a trust offers. in summary, the potential problems associated with the taxation of trusts reforms are highlighted and the result of the investigation could assist tax practitioners and taxpayers in effective tax and estate planning. relevant issues for future consideration are therefore identified to potentially assist the taxpayer in deciding whether a discretionary trust is appropriate for his or her objectives and needs. the research made use of a qualitative approach based on a literature study of pure theoretical aspects. a documentary analysis was used as the research method. hutchinson and duncan (2012:101) describe the research strategy followed (which is doctrinal in nature) as research which provides a systematic exposition of the rules governing a particular legal category, analyses the relationships between rules, explains areas of difficulty and, perhaps, predicts future developments. the problem-based doctrinal research methodology applied in the research included the following steps (hutchinson & duncan 2012:106): gathering of all relevant and applicable facts identification of the specific requirements analysis of the issues from a legislative perspective studying of sources such as academic text books, journal articles as background the identification of primary sources including case law and legislation synthesising of all the relevant issues within the correct context the drawing of an effective and sensible conclusion. bearing in mind the above-mentioned steps, the article is structured as follows: literature review of the topic at hand a concise discussion on the current income tax treatment of trusts in south africa a discussion of the benefits and costs of establishing a trust clarification of the taxation of trusts amendment proposals practical example of the potential implications of the proposed taxation on trusts amendments a comparison of the amendments contained in the amendment bill with the national budget reform proposals summary, conclusion and recommendations. scope and limitations of the study the research on which this article is based focused exclusively on the potential impacts of the reform proposals and final amendments in respect of a discretionary trust. furthermore, in the study, consideration was given only to ordinary trusts. special trusts are therefore excluded from the scope of this article. current income tax treatment of trusts in south africa as stated in the scope and limitations section above, the income tax treatment of special trusts is not discussed in this article. the article therefore focuses on an ordinary trust that, by default, is a trust which is not a special trust as defined in the act. special trusts are taxed at the rates applicable to individuals. the tax rate for an ordinary trust is fixed at 41% (treasury 2016b) of taxable income – representing the highest rate of tax. a trust is also taxed at the highest rate for capital gains purposes. with effect from 1 march 2016 an inclusion rate of 80% is applied to a net capital gain of a trust, causing a taxable capital gain in the trust, which will be subject to tax at 41%, resulting in an effective rate of capital gains tax of 32.8%. according to haupt (2016:893), there are two types of ordinary trusts, namely a testamentary trust (this is a trust created in terms of a will) and an inter vivos trust (this is a trust created by contract during the lifetime of the creator). in each of these trusts there are two types of rights a beneficiary can have: a vested right – which means that either the income or the capital of the trust must be paid to the particular beneficiary. the trustees therefore merely administer the capital or income for the beneficiary a contingent right – which means that no particular beneficiary is entitled to any income or capital unless the trustees decide to make a distribution to the beneficiary. in this case there is a chance that the beneficiary will never receive any portion of the income or capital in the trust (haupt 2016:893). in the first-mentioned instance (a vested right), the trustees administer the capital and income for the beneficiaries as a group with no certainty as to which beneficiaries will ultimately benefit from the funds in the trust, and to what extent (haupt 2016:893). section 25b provides that (subject to section 7) the income of the trust is taxed either in the trust or in the hands of the beneficiaries if that beneficiary has a vested right to the amount (for example in terms of the trust deed) (haupt 2016:811; stiglingh et al. 2016:848). with regard to a discretionary trust, section 25b(2) states that the exercise of the trustees’ discretion qualifies as a vesting event. this means that if a person did not have a vested right in terms of the trust deed, vesting will occur when the trustees decide to make a discretionary distribution to a specific beneficiary (stiglingh et al. 2016:848). the same result is achieved for capital gains tax purposes by applying paragraph 80(2) of the eighth schedule to the act. paragraph 80(2) is applicable when a beneficiary acquires a vested interest in a capital gain (as a result of the trustees exercising their discretion to distribute the gain) made by the trust on the disposal of an asset. paragraph 80(2) states that (subject to paragraphs 68, 69, 71 and 72) in this scenario the capital gain vesting in the beneficiary must be disregarded in the trust but taxed in the hands of the beneficiary in whose hands the gain vests. section 7(1) applies where the beneficiary has a vested right to the income retained in the trust. in other words, the beneficiary is certain to receive the income at some time in the future; only his enjoyment of it has been postponed. if he dies before the income is paid to him, it will go to his estate. therefore, as the income is effectively the beneficiary’s, he will be taxed on it (haupt 2016:817). benefits and costs of establishing a trust when an individual considers whether or not to make use of a discretionary trust, the benefits a trust offer will typically be compared with the costs associated with the establishment and management thereof. in answering the question whether discretionary trusts have a future in south africa, a distinction must be made between the benefits currently in jeopardy under reform proposals and amendments and other benefits a trust offers. each individual’s objectives and needs will differ, and these objectives and needs will determine whether or not an individual deems a discretionary trust to still be cost-effective and whether or not an individual will still make use of a discretionary trust given the reform proposals and suggested amendments. benefits trusts offer individuals current tax benefits trusts offer currently in jeopardy under reform proposals according to hill (2012), trusts are commonly used to ‘freeze’ the value of assets where a natural person does not want the assets to form part of his deceased estate. the founder of a trust will usually sell his assets to the trust at market value on an unsecured, interest-free loan (mazansky et al. 2016). the loan will be included in the founder’s estate at death, but the further growth in the value of the assets will accrue to the trust. the effect is to reduce the dutiable estate of the seller over time (by not including any further growth in the value of the assets) and effectively the estate duty (levied at 20% on the net value of an individual’s estate) arising upon his death as well. this ultimately results in the heirs receiving a larger inheritance (hill 2012). the founder can also reduce the loan by annually donating to the trust the maximum amount of r100 000 that a natural person can donate, under the general exemption (section 56(2)(b) of the act), without triggering donations tax. by the time the founder dies, the loan that should be included in the founder’s estate is either greatly reduced or written off (du preez 2016). another reason for accumulating assets in a trust is the deceased’s potential liability for capital gains tax. for capital gains tax purposes a deceased person is deemed to have disposed of his assets to his deceased estate for proceeds equal to its market value at the date of his death (paragraph 40 of the eighth schedule to the act or section 9ha(1) for persons who die on or after 01 march 2016). the founder would have been liable for capital gains tax on the initial disposal of the asset to the trust at the date of the disposal, but the further growth in the value of the assets will accrue to the trust and will therefore not be subject to capital gains tax at the date of the founder’s death. the deceased founder will also not be liable for capital gains tax on the deemed disposal of the loan because the base cost of the loan should not be less than the market value of the loan (warneke 2016a). when considering donations tax on the transaction the following is applicable: the founder will not be liable for donations tax, at a flat rate of 20%, because the assets are sold (given that they are sold at market value) to the trust (treasury 2016a:49). the conduit pipe principle, as codified in section 25b of the income tax act, applied to trusts offers a further advantage with regard to potential tax savings. in armstrong v cir (1938) it was determined that income of a trust retains its identity until it reaches the parties (beneficiaries) in whose hands it is taxable. a trust is therefore a mere conduit pipe through which the income flows, meaning that if income accrues to a trust and the trustees distribute it to one or more beneficiaries in the same year, the income retains its nature in the hands of the beneficiary (holdstock 2013). the trust law therefore provides for income splitting opportunities (holdstock 2013) – this provides the main reason why trusts can be used efficiently for income tax purposes. based on the conduit or flow-through principle when the accrual of the income is to a beneficiary, any exemption from tax provided in the act applying to the income will be available to that beneficiary. for example, if the beneficiary receives local dividends as a distribution from the trust, the section 10(1)(k) exemption will be available to the beneficiary. if the beneficiary receives interest as a distribution from the trust, the beneficiary will be entitled to the section 10(1)(i) exemption (currently r23 800 for taxpayers under 65 and r34 500 for taxpayers 65 and above for the 2017 year of assessment) (treasury 2016b). if a beneficiary receives a distribution of capital gain, the income will not be treated as ordinary income but will retain its identity as a capital gain (applying paragraph 80(2) of the eight schedule to the act). the capital gain will be included at the inclusion rate of 80% in the beneficiary’s taxable income after deducting the annual capital gains tax exclusion of r40 000 (for the 2017 year of assessment) (treasury 2016b). natural persons can therefore benefit from the tax exemptions related to the income derived from a specific asset class, while housing the said assets in a trust. a trust can therefore be used to avoid tax. it is important to distinguish between tax avoidance and tax evasion, the latter referring to illegal activities deliberately undertaken by a taxpayer to free himself from a tax burden. tax avoidance, by contrast, is where the taxpayer has arranged his affairs in a perfectly legal manner, resulting in a reduced tax liability (stiglingh et al. 2016:811). tax avoidance does therefore not constitute tax evasion and it is a trite rule of tax law that taxpayers are allowed to order their tax affairs in the manner that gives them the best advantage (cir v conhage [pty] ltd. [1999]). the act contains various provisions that are designed either to prevent or to counter specific schemes or operations aimed at the avoidance of tax. a discussion of specific anti-avoidance provisions contained in the act that are applicable to the misuse of trusts follows. section 7(2) to 7(8) of the act and paragraphs 68 to 72 of the eighth schedule to the act are anti-avoidance provisions aimed at taxing, in the hands of the donor, any income and capital gains which have resulted from a donation, settlement or other disposition, even though a beneficiary has a vested right to an amount or has actually received it (stiglingh et al. 2016:849, 942). it is important to note that these provisions are not concerned with who formed or created the trust but rather with the person who transferred assets into the trust. these provisions effectively seek to tax the person who introduced the assets into the trust on the income or capital gain generated by those assets (haupt 2016:812). section 7(2) to 7(8) and paragraphs 68 to 72 of the eighth schedule to the act may only be invoked if a ‘donation, settlement or other disposition’ has taken place (stiglingh et al. 2016:850, 943). in ovenstone v sir (1980) it was held that the expression ‘donation, settlement or other disposition’ should be read as ‘donation, settlement or other similar disposition’. the word ‘disposition’ was interpreted to mean any disposal of property made wholly or to an appreciable extent gratuitously out of the liberality or generosity of the disposer. an interest-free loan, being a gratuitous disposal, can therefore be seen as a ‘donation, settlement or other disposition’ for purposes of section 7(2) to 7(8) (stiglingh et al. 2016:850). the deemed interest, calculated by using a market-related interest rate, indicates the maximum amount that may be attributed to the donor should income accrue that is subject to section 7(2) to 7(8) (stiglingh et al. 2016:855). paragraph 73 of the eighth schedule to the act further limits the total amount of the section 7 income that is deemed to accrue to the donor plus the capital gain attributed to him in terms of the attribution rules of the eighth schedule to the act. therefore, in the scenario described above the income or capital gains derived from the assets transferred to the trust through an interest-free loan can also be distributed to beneficiaries (excluding scenarios as described in section 7(2) to (8) and paragraphs 68 to 72) resulting in the income or capital gains being taxed in the hands of the beneficiaries and not in the hands of the donor or the trust. section 3(3) of the estate duty act provides for certain property to be deemed property of the deceased estate. section 3(3)(d) of the estate duty act determines that property that the deceased was competent to dispose of for his own benefit or for the benefit of his estate immediately prior to his death is deemed to be property in his estate. section 3(5)(b) explains the meaning of ‘competent to dispose of any property’ for purposes of section 3(3)(d) as that the deceased had the power that would enable him to dispose of such property. stiglingh et al. (2016:1008) give the following example to explain the meaning of section 3(3)(d) in the context of a trust: if the deceased was the sole trustee and a beneficiary of a trust, he could be considered to have had the power to dispose of the property of the trust for his own benefit. because he had the right to dispose of the property for his own benefit, the property of the trust would be deemed property in his estate, even if he did not exercise that right. an interest-free loan can be seen as a ‘donation, settlement or other disposition’ for purposes of section 7(2) to 7(8) and paragraphs 68 to 72 of the eighth schedule to the act but not necessarily a donation for the application of donations tax (stiglingh et al. 2016:850). section 54 of the act determines that donations tax is payable on the value of any property disposed of by a south african resident in terms of a donation. the definition of ‘property’ includes any right in or to property (section 55(1) of the act). for purposes of determining whether an interest-free loan constitutes a donation for donation tax purposes, it has to be established whether the lender had any ‘right’ to interest, which is gratuitously waived. the loan agreement will determine whether a right to interest exists. if the loan agreement provides for interest and the lender waives that right stipulated in that agreement, a gratuitous waiver would result and would therefore be regarded as a donation. however, if no provision is made for interest in the agreement, no inherent right to interest arises, and there can be no waiver of any right to interest and no donation will arise (stiglingh et al. 2016:827). strydom (2008) also states that it is not the practice of the sars to treat an interest-free loan as a donation for donations tax purposes. the only other way that donations tax will be triggered is if the granting of the loan led to a deemed donation in terms of section 58, which stipulates that if property is disposed of for a consideration which is inadequate, it may be deemed to be a donation. other benefits hill (2012) states that there are seven main reasons for establishing a trust: trusts offer protection against other types of tax. should the deeming provisions in section 7 of the act not apply, tax savings might be available. for example, income and capital gains can be distributed to trust beneficiaries who might fall under a lower tax bracket than the original owner of the assets. furthermore, if the trustees do not wish that beneficiaries use the cash immediately (for various reasons), income and gains can be vested in such beneficiaries and physical payment made later, for example, at a time when they reach an age of understanding, or the monies are needed to fund education. trusts can reduce the costs of winding up a deceased estate. executor’s fees and other winding up costs can reduce the available cash balance in an estate. trusts do not die and would therefore not incur such costs. trusts offer protection against the uncertainties of life. trusts offer protection against claims arising against a personal owner of assets during his lifetime. at death, compensation in the form of life assurance proceeds is usually available, but during life, a large claim against one’s estate, possibly leading to personal sequestration, results in no assurance compensation. a trust is consequently a useful risk management tool. trusts offer protection against the uncertainties of death. trustees who are skilled in financial planning and wealth management can materially enhance the long-term financial well-being of current and future generations. trusts can buy time. the winding up process of an estate could be a lengthy process which can take 6–8 months or even longer. during this time, a business owned personally by the deceased, or a company of which he was the sole director, is at risk. in such circumstances, normal commercial decision-making is suspended, which can lead to customer shrinkage and a potential drop in the value of business assets. should the deceased’s business have been placed in a trust beforehand, no such time constraints are applicable. it also makes more sense to reduce one’s personal assets and liabilities to manageable portions, while building up trust assets which the trustees can continue to manage after a person’s death, unconstrained by legislated timetables. trusts can mitigate or avoid the common shortfalls in cash in a deceased estate. most estates require the executor to sell assets to generate sufficient funds to discharge debt. the timing of the sale is not a luxury available to the executor and so, quite often, valuable assets realise far less on a forced sale than they would under normal circumstances. this means that even more assets have to be sold (again at lower prices) to make up any shortfalls. trusts permit one owner, many users. management, registration, accounting, expense and financial records can be centralised, thus saving costs, while trust beneficiaries can enjoy the advantages of ownership on an equitable basis. costs related to the establishment and management of a trust the cost for the establishment of a trust is currently in the vicinity of r7500 (rall-willemse 2016). a trustee is not automatically entitled to compensation, but trustees are often lawyers or other professionals who cannot afford to work for free. therefore, a trust deed usually makes provision that trustees are entitled to reasonable payment for their work (sebenza 2013). trustees’ fees could therefore vary from trust to trust. depending on the nature and extent of the activities of the trust, additional costs such as administration or management fees, accounting fees and legal fees might also be incurred. finally, a trust (other than a special trust) is taxed at a flat rate of 41% and its inclusion rate for purposes of capital gains tax is 80% (for the 2017 year of assessment). clarification of the taxation of trust reform proposals the 2016 reform proposals can be summarised as follows: assets transferred through a loan to a trust will be included in the estate of the founder at death, interest-free loans to trusts will be categorised as donations and further measures to limit income splitting and other tax benefits will also be considered. these reform proposals are cryptically worded (warneke 2016a) and very unclear (du preez 2016); therefore, the following section of the article aims to clarify these vague proposals. the interpretation of the proposals can then be compared with the amendments included in the final amendment bill. this might shed some light on the thought process behind the amendments included and provide some insight on whether or not the proposals not included in the amendments might become law in the future. warneke, tax partner at bdo sa, is of the opinion that there was an error in the wording of the first proposal in that it meant to say that it is the disposer (seller) of the assets who would be taxed, rather than the founder of the trust (warneke 2016a). assuming that this is the case the following is applicable: the total value of the assets transferred through a loan to a trust will be included in the estate of the disposer at death. cecil morden, the chief director of economic tax analysis at national treasury, explains that the disposal of an asset to a trust on a loan account will not be deemed a disposal for estate duty purposes, meaning that the total value of the asset (including the growth in the value of the asset) will be taxable in the deceased estate (du preez 2016). it is important to note that the proposal states that the value of the assets will be included in the estate of the disposer and not that the value of the assets will form part of the disposer’s assets at date of death. the effect is that the disposer will not be deemed to have disposed of these assets at market value to the deceased estate (paragraph 40 of the eighth schedule to the act or section 9ha(1) for persons who die on or after 1 march 2016) for purposes of capital gains tax. section 5 of the estate duty act will then determine the value of the assets included in the estate for estate duty purposes. also note that the first proposal refers to a loan, meaning any loan, be it interest-free or interest bearing. treasury is also considering including the interest-free loan in the estate of the person who grants the loan (du preez 2016). treasury says this is ‘another option’ seeing that it suggests that the disposer will be taxed twice on the amount transferred to the trust (du preez 2016). warneke (2016a) is of the opinion that only the growth in the asset from the date of initial transfer into the trust will form ‘deemed property’ in the estate of the deceased for purposes of estate duty. this interpretation means that the value of the asset’s growth together with the outstanding balance of the loan at the date of death of the disposer will form part of the dutiable estate of the disposer for estate duty purposes. warneke (2016a) believes an alternative to the above interpretation is that the full market value of the asset will be included in the dutiable estate of the deceased and that the loan will be disregarded as an asset in the hands of the disposer. morden interprets the categorising of the interest-free loan as a donation to mean that the lender will pay donations tax at 20% (after the donations tax exemption of r100 000) of the value of the asset moved to the trust. it is important to note that this proposal specifically refers to an interest-free loan, meaning that as long as the trust pays interest on the loan, donations tax will not be triggered. it is not necessary for the interest that accrues on the loan to be paid in cash; an alternative is to capitalise the interest against the loan account, which then grows accordingly in the estate of the lender (du preez 2016). morden argues that an alternative proposal to making the interest-free loan a once-off donation is to deem the income the lender has received on the loan, had interest been charged, to be an ongoing donation, to which donations tax and, potentially, income tax will apply. this alternative proposal is in line with harbour and associates’ (2016) opinion that the proposal will probably be modified to state that only the deemed interest is treated as a donation rather than the initial loan itself. a similar amendment was made with regard to loans made by companies to directors and their original treatment as dividends. this amendment was subsequently amended to treat only the deemed interest as a dividend (harbour and associates 2016). warneke (2016a) is also of the opinion that it is the non-charging of interest that would be regarded as a donation rather than the entire capital amount of the loan. to regard capital lent as a donation is inconsistent with the meaning of the word ‘donation’, as it is an amount that has to be repaid. warneke (2016a) states that the proposal may be formulated in such a way that, regardless of the terms of the loan, the non-charging of interest will be regarded as a donation for purposes of donations tax. one possibility is that donations tax will be levied annually at the rate of 20% on a market-related interest rate applied to the outstanding balance on the loan (warneke 2016a). it appears that treating the loan as a donation subject to donations tax and also including the trust’s assets as assets of the founder’s estate at death for estate duty purposes would amount to double counting (mazansky et al. 2016). in order to avoid double taxation, either the asset or loan or the donations tax on the asset or loan will be taken into account in determining the estate duty due on the asset (du preez 2016). there is uncertainty whether or not these proposals, to the extent that they are not given effect to in the draft amendment bill, will be applied retrospectively (harbour and associates 2016) and if not, what steps will be taken to avoid retroactivity (mazansky et al. 2016). warneke (2016a) emphasises that the timing of the effective date of the proposed legislation will be very important to monitor and will answer the question of retroactivity. if the proposal becomes effective for assets disposed of to a trust on or after a given future date then it will not have retrospective effect. however, if the proposal applies to trusts on or after a given future date then it will have retrospective effect in that it will apply so as to tax unrealised gains in assets already held in trusts. the constitutionality of such a proposal may well be challenged (warneke 2016a). the 2016 reform proposals once again refer to ‘further measures to limit income splitting’, indicating that the review of the conduit pipe principle is still on the table. this proposal was discussed in detail in ‘an investigation into the future of discretionary trusts in south africa – an income tax perspective [part 1]’ and therefore excluded from ‘part 2’ of the article. the reform proposals are unclear and from the above-mentioned literature four potential interpretations can be attributed to it, namely: interpretation 1 the disposer’s deceased estate will be liable for estate duty on the full market value of the assets transferred through a loan to a trust. the disposer’s deceased estate will be liable for estate duty on the outstanding value of the loan. the disposer will be liable for annual donations tax on a market-related interest rate applied to the outstanding balance of the interest-free loan and/or, the disposer will be liable for annual income tax on a market-related interest rate applied to the outstanding balance of the interest-free loan. interpretation 2 the disposer’s deceased estate will be liable for estate duty on the growth in the asset from the date of initial transfer into the trust till the date of death of the disposer. the disposer’s deceased estate will be liable for estate duty on the outstanding value of the loan. the disposer will be liable for annual donations tax on a market-related interest rate applied to the outstanding balance of the interest-free loan and/or, the disposer will be liable for annual income tax on a market-related interest rate applied to the outstanding balance of the interest-free loan. interpretation 3 the disposer’s deceased estate will be liable for estate duty on the full market value of the assets transferred through a loan to a trust. the disposer’s deceased estate will not be liable for estate duty on the outstanding value of the loan (the outstanding loan is disregarded as an asset in the disposer’s deceased estate). the disposer will be liable for annual donations tax on a market-related interest rate applied to the outstanding balance of the interest-free loan and/or, the disposer will be liable for annual income tax on a market-related interest rate applied to the outstanding balance of the interest-free loan. interpretation 4 the disposer will be liable for donations tax on the value of the asset transferred through an interest-free loan to the trust. the following section makes use of a practical example illustrating the probable tax implications of all four interpretations of the reform proposals. the current income tax treatment and the proposed income tax treatment for the scenario are investigated and compared. tax rates, concessions and exemption thresholds applicable to the 2017 year of assessment are used for the purpose of the example. practical examples of the probable implications of the reform proposals to illustrate the practical impact of the reform proposals the following scenario is considered: abc trust is a discretionary trust. on 1 march 2016 the disposer (a natural person under 65) transferred an asset, with a market value of r1 000 000 and a base cost of r500 000, to the trust by selling the asset (at market value) to the trust and granting an unsecured loan. the loan agreement provides for no repayment conditions or interest payable. on 28 february 2026 the disposer dies. on 28 february 2026 the market value of the asset transferred to the trust amounts to r2 000 000 and the total value of the loan is outstanding. assume a market-related interest rate of 10% for the entire period under consideration. further assume that section 7(2) to 7(8) of the act and paragraphs 68 to 72 of the eighth schedule to the act are not applicable in this scenario. table 1 illustrates the current tax effect and proposed tax effect per tax type on the disposer’s tax calculation per transaction for the given scenario. table 1: tax effect of the scenario on the disposer’s tax calculation: illustrating the current tax effect and proposed tax effect per tax type on the disposer’s tax calculation per transaction for the given scenario. table 2 illustrates current tax effect and proposed tax effect per tax type on the disposer’s deceased estate’s tax calculation per transaction for the given scenario. table 2: tax effect of the scenario on the disposer’s deceased estate’s tax calculation: illustrating current tax effect and proposed tax effect per tax type on the disposer’s deceased estate’s tax calculation per transaction for the given scenario. in this scenario where no loan repayments were made, interpretations 2 and 3 of the reform proposals have the same effect on the disposer’s deceased estate’s tax calculation. interpretation 2 includes the outstanding loan and only the growth in the value of the asset in the disposer’s deceased estate and interpretation 3 disregards the outstanding loan but includes the full market value of the asset in the disposer’s deceased estate. ultimately the same value, that is, r2 000 000, is included in the disposer’s deceased estate. this same result will only occur when no loan repayments have been made. the above interpretations of the reform proposals can now be compared with the amendments contained in the amendment bill. this comparison will determine the fairness and appropriateness of the amendments and more importantly shed some light on the possibility that the proposals not included in the amendments might still be enacted in the future. trust reform proposals versus amendments final amendments in order to limit taxpayers’ ability to transfer wealth without being subject to tax, the new section 7c of the act was promulgated in respect of years of assessment commencing on or after 1 march 2017 (treasury 2016d). this section applies if a natural person, or a company in relation to which that natural person is a connected person, makes an interest-free loan or a loan with interest below market rates to a trust. section 7c determines that interest foregone in respect of low-interest loans or interest-free loans that are made to a trust will be treated as an ongoing and annual donation made by the natural person to the trust on the last day of the year of assessment of that trust. the deemed interest will be calculated as an amount equal to the difference between interest that would arise as determined with reference to the official rate of interest (as determined in terms of the seventh schedule to the act) and the applicable actual rate of the loan below market rates made to a trust. section 7c also provides that no tax deduction, allowance or loss would be allowed to be claimed by the lender on the waiver or cancellation of an interest-free loan or a loan with interest below market rate (treasury 2016d). the following tax effect for the lender will be the result of applying section 7c to the same example used above (refer to the section practical examples of the probable implications of the reform proposals): donations tax will be levied annually for each year of assessment under review on the deemed interest of r100 000 (r1 000 000 × 10% = r100 000). donations tax will be calculated, after deducting the r100 000 general exemption, at a rate of 20% of the taxable amount. comparing the trust reform proposals with the final amendments the first trust reform proposal is aimed at stopping the avoidance of estate duty by transferring assets to a trust. the amendment bill makes no reference to the proposal of including the assets transferred through a loan to a trust in the estate of the disposer at death. the only amendment contained in the amendment bill aiming at countering the avoidance of estate duty is that no deduction is allowed in the case of the cancellation or waiver of an interest-free or low-interest loan. moving on to the second reform proposal, namely to categorise interest-free loans as donations, the following will be applicable: the explanatory memorandum on the taxation laws amendment bill rules out the proposal of categorising the interest-free loans to trusts as donations (interpretation 4) by stating that donations tax will not be triggered on an asset when an asset is sold at market value to a trust, because there is no gratuitous disposal as required for donations tax purposes (treasury 2016c:8). to address the avoidance of donations tax section 7c only levies donations tax on the deemed interest (treasury 2016d). this rules out the interpretation of also levying income tax on the deemed interest. when comparing the amendments with the interpretations of the reform proposals it is clear that less drastic measures were taken and that trusts got off lightly. given that trust reform has been a topic since 2012, without any of the previous proposals enacted, these less drastic or minor amendments were unexpected and should set off warning lights. therefore, there is a possibility that reform proposals not included in the amendments and not specifically ruled out might become law in the future and will therefore have an impact on the future of discretionary trusts in south africa. accordingly, the focus now shifts to trust reform proposals not included in the suggested amendments that might be enacted in the future. trust reform proposals not included in the amendments the following reform proposals not included in the amendments and not specifically ruled out might be enacted in the future: including the full market value of the assets transferred through a loan to a trust in the disposer’s deceased estate or only including the growth in the asset from the date of initial transfer into the trust till the date of death of the disposer in the disposer’s deceased estate, and including the outstanding loan in the disposer’s deceased estate or disregarding the outstanding loan as an asset in the disposer’s deceased estate. it is unlikely that income tax will also be levied on the deemed interest as interpreted from the reform proposals seeing that the amendments provide for donations tax on this amount. measures to limit income splitting and other tax benefits are also still a possibility for the future. summary, conclusion and recommendations trusts offer various tax and other benefits. many of the tax benefits trusts offer are currently in jeopardy under reform proposals and amendments to taxation laws. each individual’s objectives and needs will determine whether or not an individual deems a discretionary trust to still be cost-effective and whether or not an individual will still make use of a discretionary trust given the reform proposals and amendments. in order to assist tax practitioners and taxpayers in effective tax and estate planning, research was conducted on the reform proposals and amendments, given that both have a possible impact on the future of discretionary trusts in south africa. in the 2016 national budget the minister of finance indicated that government was proposing several legislative measures during 2016/2017 regarding trusts to control abuse. the proposals can be summarised as follows: assets transferred through a loan to a trust will be included in the estate of the founder at death, interest-free loans to trusts will be categorised as donations and further measures to limit income splitting and other tax benefits will also be considered. the 2016/2017 trust reform proposals are cryptically worded, unclear and vague; therefore, an attempt has been made in this article to clarify the proposed changes to the taxation of trusts. the amendment bill did not give effect to these proposals, but introduced other less drastic measures to control the abuse of trusts for tax purposes. these measures can be summarised as follows: donations tax will be levied on the deemed interest of an interest-free loan or a loan with interest below market rates to a trust (treasury 2016d). given that trusts have long been associated with elaborate tax avoidance schemes and that trust reform has been a topic for the past 8 years, these less drastic or minor amendments were unexpected and possibly indicate that proposals not included in the amendments and not specifically ruled out might become law in the future. in all likelihood there will be a waiting period to determine the efficiency of the new section 7c before any new legislation is passed, but based on dtc’s second interim report it is clear that trust reform is far from over. the proposals that might be enacted in the future are the following: including the full market value of the assets transferred through a loan to a trust in the disposer’s deceased estate (this will be achieved by expanding section 3(3)(d) of the estate duty act as recommended by the dtc’s second interim report) or only including the growth in the asset from the date of initial transfer into the trust till the date of death of the disposer in the disposer’s deceased estate including the outstanding loan in the disposer’s deceased estate or disregarding the outstanding loan as an asset in the disposer’s deceased estate measures to limit income splitting and other tax benefits referring back to the 2013/2014 reform proposal of scrapping the conduit pipe principle, meaning that the amounts distributed to the beneficiaries will no longer retain their original identity and those amounts will be income in nature in the hands of the beneficiary. even though the above reform proposals were not included in the amendment bill it is clear from the dtc’s second interim report that treasury is planning to control the abuse of trusts in one way or another in the near future. if and when the reform proposals are enacted many trusts would become ineffective and these changes might erode other benefits trusts offer. a natural person that is making use of a trust or that is planning to make use of a trust should consider the possible impact of the amendments and reform proposals and, based on their own needs and requirements, determine whether or not it is cost-effective to use a trust. should one decide that the use of a trust is no longer cost-effective, it is important to note that a trust cannot simply be terminated owing to a change in tax legislation. ‘an investigation into the future of discretionary trusts in south africa – an income tax perspective [part 1]’ discussed the procedure to follow to terminate a trust and also explains the possible tax effect should a trust be terminated (brink & willemse 2014:812). against the background of the summary and conclusion above, the following recommendations are made with regard to the amendments and reform proposals: should the reform proposals be enacted into south african income tax legislation treasury must consider and clear up the following current uncertainties derived from the reform proposals: should the full market value of the assets transferred through a loan to a trust be included in the disposer’s deceased estate or only the growth in the asset from the date of initial transfer into the trust till the date of death of the disposer? should the outstanding loan be included as an asset in the disposer’s deceased estate or should the outstanding loan be disregarded? should these proposals be applied retrospectively? alternatively, treasury should scrap the reform proposals, and to deter taxpayers from abusing discretionary trusts with regard to tax avoidance, the sars should apply the following current anti-avoidance rules more efficiently and strictly: section 7(2) to 7(8) of the act and paragraphs 68 to 72 of the eighth schedule to the act, and sections 3 (3)(d) read together with section 3(5) of the estate duty act. the sars should monitor trusts more closely by implementing structures to enforce the registration of existing and new trusts with the master’s office, by monitoring the submission and accuracy of income tax returns of trusts. the sars might also consider levying penalties for the non-submission of annual income returns for trusts (peacock 2016). although at this stage there is no finality with regard to the reform proposals, this article could serve as a potential problem or risk indicator for future use. taxpayers and tax experts alike could use this article as a guideline and additional source to take into consideration when one has to decide whether to make use of a discretionary trust in south africa. acknowledgements competing interests the author declares that she has no financial or personal relationships that may have inappropriately influenced her in writing this article. references armstrong v cir, 1938, 10 satc 1, ad 343. bdo, 2013, the continued attack on the trust structure, viewed 16 july 2013, from http://www.bdo.co.za/resources/showitemarticle.asp?resourcesectionid=4&resourcesectionname=publications&resourceid=7&resourcename=tax%20flash&issueid=401&contentpageid=4&archive=&articleid=399 brink, s.m. & willemse, l., 2014, ‘an investigation into the future of discretionary trusts in south africa – an income tax perspective’, journal of economic and financial sciences 7(3), 795–816. cir v conhage (pty) ltd., 1999, zasca 64. citadel wealth management, 2016, why the review of trust taxation? viewed 26 may 2016, from 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silke: south african income tax 2016, lexisnexis, durban. strydom, s., 2008, ‘good-bye interest-free loans?’, blue chip journal: journal for financial planning and management wealth, viewed 27 may 2016, from http://www.bluechipjournal.co.za/index.php?option=com_content&task=view&id=27&itemld=30&ed=1 treasury, 2013, national budget review 2013 chapter 4, viewed 26 may 2016, from http://www.treasury.gov.za/documents/national%20budget/2013/review/chapter%204.pdf treasury, 2016a, national budget review 2016 chapter 4, viewed 26 may 2016, from http://www.treasury.gov.za/documents/national%20budget/2016/review/chapter%204.pdf treasury, 2016b, tax pocket guide 2016, viewed 27 may 2016, from http://www.treasury.gov.za/documents/national%20budget/2016/sars/budget%20pocketguide%202016-17.pdf treasury, 2016c, 2016 draft explanatory memorandum on the taxation laws amendment bill, viewed 18 july 2016, from http://www.treasury.gov.za/public%20comments/tlab%20and%20talab%202016%20draft/2016%20draft%20explanatory%20memorandum%20on%20the%202016%20draft%20taxation%20laws%20amendment%20bill.pdf treasury, 2016d, 2016 taxation laws amendment bill, viewed 18 january 2017, from http://www.treasury.gov.za/legislation/bills/2016/taxation%20laws%20amendment%20bill%2017b%20of%202016.pdf warneke, d., 2016a, ‘uncertainty about tax proposals regarding trusts’, fin24, viewed 10 june 2016, from http://www.fin24.com/money/wills-and-trusts/uncertainty-about-tax-proposals-regarding-trusts-20160308 abstract background and context introduction to mine mechanisation in the south african context state of knowledge global context – key learnings and approaches lessons for the south african context critique of the current thinking research approach, sample selection and data collection analysis of findings ethical consideration discussion of results results limitations conclusions acknowledgements references appendix 1 about the author(s) hlangabeza gumede faculty of engineering and the built environment, university of witwatersrand, south africa citation gumede, h., 2018, ‘the socio-economic effects of mechanising and/or modernising hard rock mines in south africa’, south african journal of economic and management sciences 21(1), a1848. https://doi.org/10.4102/sajems.v21i1.1848 original research the socio-economic effects of mechanising and/or modernising hard rock mines in south africa hlangabeza gumede received: 28 mar. 2017; accepted: 26 feb. 2018; published: 16 may 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background and aim: this article aims to explore stakeholders’ views on the potential effects of modernising hard rock mines in south africa. methods: this objective was achieved through eliciting and bringing together the views of different stakeholders. different stakeholders were interviewed using qualitative research methodologies. the sample demographics were fairly representative and ranged from operators to executives and from employee to employer representatives. the main form of data collection was one-on-one face-to-face interviews. results: one of the major findings of this research is that stakeholders have different levels of understanding of mechanisation and modernisation. the levels of understanding were found to be proportional to the levels of education. conclusion: there seems to be general support for mechanisation and modernisation among the participants. the identified socio-economic challenges and benefits were relatively similar and aligned among participants. the main difference, however, pertained to the depth and scope of the problem or opportunity as perceived by different participants. interviewees were also unanimous in identifying the social-economic benefits of mechanisation; these were in line with those identified in the literature, namely benefits in occupational health and safety issues, efficiency, costs and improved life of mines. furthermore, participants viewed mechanisation and modernisation as an opportunity to reskill themselves and to improve operations and quality of life. more importantly, stakeholders seemed to share a common vision and interest of the future; as such, they were able to see beyond their constituencies and interests. background and context the mining industry is an important contributor to the current and future economy of the republic of south africa (rsa). the estimated economic value of the mineral reserves in the country is about $2.5 trillion (mining weekly 2016). the country has about 90% of known platinum group metals (pgms) reserves in the world and has supplied over 10% of all the gold in the world (department of minerals and energy 2009). the mining industry directly contributes about 8% of the country’s gross domestic product (gdp) and this contribution can be as high as 17% if indirect and induced effects are added. the gold and pgm mining companies (hard rock mines) contribute about 30% of the total mining contribution to the gdp. furthermore, the industry directly employs about 462 000 people (chamber of mines 2014), and an additional 800 000 people are employed indirectly by the industry, namely mining-dependent subsector industries (chamber of mines 2014). a study in 2008 estimated that every mine worker employed in the mines has 10 other people who are financially dependent on their employment (chamber of mines 2009). all these facts indicate that the mining industry plays a significant role in both the economic status and socio-economic status of the country. however, there is a general perception that the current conventional method of hard rock mining in rsa is unsustainable. the current conventional mining methodology is deemed unsustainable due to rising labour costs, weak metal prices, occupational health and safety concerns and low productivity levels. modernisation of mines in the form of mechanisation has the potential to improve the competitiveness, health and safety and profitability issues within the mining industry in rsa. most mining companies in rsa are already implementing their mechanisation plans and most mines will be mechanised in the next decade. the improvements that come with mechanisation will have varying impacts on different stakeholders. on a short-term basis, mechanisation generally has a negative effect on the labour complement and on the communities in which these mining companies operate (hattingh, sheer & du plessis 2010). however, the net effect of not mechanising can also be worse on a mediumto long-term basis. it is therefore important to explore how different stakeholders are impacted by such an initiative and to explore the views of stakeholders regarding the potential effects of modernising rsa’s hard rock mines. identifying and analysing stakeholders’ concerns and mitigating the negative effects of mechanisation (modernisation) may potentially lead to a win-win scenario for all stakeholders. for instance, critical stakeholders such as labour unions traditionally oppose the mechanising of mines; however, kaupp, makarenko & durrant-whyte (2010) have shown that mechanisation may not necessarily lead to job losses but to different employment demographics such as the employment of more skilled people and to the upskilling of the current workforce. introduction to mine mechanisation in the south african context in simple terms, mechanisation involves the substitution of manual tasks carried out by people or animals with machinery. the machinery becomes the interface between the humans and the task. automation is the next phase of mechanisation, where the interaction between humans and tasks is further reduced through modern information and control systems. in the south african gold and pgm mines, such classification is ingrained within the mining methods classification and characteristics. for instance, it is generally accepted that conventional hard rock mining is manual (egerton 2004; musingwini & minnitt 2008; nong 2010). however, conventional mining uses handheld drilling machines for the drilling task while scraper winches and mechanical loaders are used for the subsequent cleaning task. mechanised mining methods are normally carried out in a board pillar environment using trackless mechanised mining equipment for most mining activities and tasks. the hybrid mining method is a combination of the manual and mechanised methodologies (nong 2010). it is imperative to get the proper classification framework as this might empower stakeholders to understand better what exactly is meant by mechanisation (or modernising) of hard rock mines. in an australian environment, modernising mines will largely be understood to mean automation. lynas and horberry (2011) classify different levels of automation into three broad categories, namely: lower level automation: this is where the human being (operator in particular) is in full control of the system and technology only assists with warnings, for instance proximity detection systems. midlevel automation: this level involves having an operator control the equipment from a nearby location. the operator is in control at most times, but some functions are controlled by the system. full automation: in this category, the operator is in a remote location and controls the equipment using computers, joysticks and other controls. based on the above classification by lynas and horberry (2011), one can conclude that south african mines are in different stages of automation. moving from one level of automation to another can have a different socio-economic effect (including comprehension and understating) for different stakeholders. state of knowledge there is a consensus in literature that modernising (mechanising or automating) mines is driven by the desire to improve safety and productivity in mines. lynas and horberry (2011) identify the following drivers for mechanising mines: efficiency and reliability: machines are generally cheaper and more efficient than humans. safety: there is increased responsibility on the mining leadership and stakeholders to operate safe mines and this has led to the increased drive towards mechanisation. costs and productivity: machines are generally thought to be more productive and free humans to perform other important tasks such as planning and other decision-related tasks. increased orebody access: mechanisation can improve the access to orebodies that were previously hazardous and unprofitable if mined through conventional means. consistence and stability of operations: machines are thought to provide process consistency and reliable data and information. most of the literature (botha 2015a; boudreau-trudel et al. 2014; fisher & schnittger 2012; hattingh et al. 2010; horberry, burgess-limerick & steiner 2010; kaupp et al. 2010; mcnab et al. 2013; nong 2010; parasuraman, sheridan & wickens 1997) agree with the paraphrased summary from lynas and horberry (2011). there have been modernisation initiatives such as proximity detection systems that have reduced vehicle-to-vehicle (and vehicle-to-person) accidents. some council for scientific and industrial research (csir) initiatives like goafwarn and fogwarn have undoubtedly contributed better management of excavation stability. in addition to the above summarised benefits of mechanisation, hattingh et al. (2010) add another rsa specific dynamic which relates to the achievement of legislative requirements of gender transformation in the mining industry. they postulate that mechanisation results in less labour-intensive requirements from humans and, as such, women and occupationally challenged workers can still be accommodated by the industry. other socio-economic effects that were suggested by kaupp et al. (2010) are that skilled professionals and operators might be located in areas remote from the actual mining site. the location of some mining personnel (usually skilled and with more disposable income) would have an impact on the micro-economic development of mining communities. there is also increased scepticism on the validity and shared vision of the above benefits of mechanisation. regarding the shared vision behind mechanisation, lynas and horberry (2011) suggest that mechanisation is driven from four major areas, namely: companies with particular interest in profitability, costs, efficiency and safety issues. original equipment manufacturers (oem) and suppliers with an interest in product differentiation to increase their market share. workers with an interest in improving their specific local challenges. technology researchers and developers with a particular interest in improving their specific local challenges. boudreau-trudel et al. (2014) measured the impact of new equipment and innovations in 10 mining projects based in north america. the analysis of each machinery lasted over a year, and the results showed that the introduction of new equipment did not necessarily improve productivity and efficiency. in fact, in most cases the productivity was reduced. major reasons for this rejection of the innovations by the operator were skills shortages, different machine functions and standards. musingwini and minnitt (2008) used analytic hierarchy process methodologies to compare different efficiencies of different mining methods in rsa platinum. although the study was not comparing mechanisation stages or equipment, it did show that the conventional method (largely manual based) was more efficient than both the mechanised and hybrid mining methodologies. lynas and horberry (2011) seem to concur with these findings as they argue that humans provide flexibility and creativity to operations; machines cannot provide these. this is often underestimated by proponents of mechanisation, especially the ability by humans to adapt to unplanned scenarios and conditions. also, in most cases, automation does not replace the human being but tends to introduce a new set of tasks and increased workloads, thus leading to distrust between the management and operators. some of the recorded socio-economic effects of mechanising mines are: elimination of some jobs: this was recorded as early as the 1960s by authors such as rico (1966). although rico (1966)’s study focused on the automation of the manufacturing sector, it suggested that the overall net effect of job losses was not significant because new jobs were created. mcnab and garcia-vasquez (2011) estimate that about 30% – 40% of the workforce from the mining community lost their jobs due to mechanisation of an open pit mine. however, in some open pit mines the job losses were estimated to be as high as 75% (bellamy & pravica 2010). they further posit that there would be reduced populations in mining towns as most work would be carried out remotely. the skills profile would also change as there would be a decrease in lower skilled labour and an increase in higher skilled people, but based in remotely controlled centres. the effect of job losses seems to be the major reason that some stakeholders (labour unions) are against mechanisation. a review of stakeholder opinions regarding the mines of the future in australia by lynas and horberry (2011) indicates that most stakeholders were concerned with technological implications, skills implications, maintenance and organisational issues of the modernised mines. the same authors further note that there were different opinions among different stakeholders. for instance, senior mine managers were more worried about productivity benefits while end users (mostly lower level employees) were concerned about how technology would impact their job roles. lynas and horberry (2011) identify five factors that are critical for an effective modernisation process, namely operator acceptance, skilling, user technology interface design, human system integration and trust in technology. mcnab et al. (2013) further note that most employees from local mining communities work entry level (and operator level) type of jobs with relatively less education. it is this type of workforce level that would be affected the most by the modernisation of mines. the net effect would be extended to the actual mining communities as they lose out on some businesses, such as accommodation and access to workers’ disposable incomes. all these factors are human factors, but the mining industry has traditionally been perceived as not embracing a human-centred (stakeholder view) approach to modernising mines. creation of new jobs and roles: mechanisation has the potential to create jobs for people with skills in other areas. for instance, botha (2015a) and hattingh et al. (2010) allude to the fact that mechanising south african mines would create jobs for engineers, information technology and maintenance artisans. dudley, mcaree & lever (2010) estimate that 190 skilled automation support staff would be required each year to fill a total of 1500 positions in the next 15 years to sustain the implementation of automation in australian mining. the potential for modernisation to create other forms of jobs and trades is also concurred by mcnab and garcia-vasquez (2011) and mcnab et al. (2013). however, all these examples are from a context that is slightly different from a first world country like australia where the literacy rates are higher than south africa, and this can have an effect on the ability to reskill operators. global context – key learnings and approaches most of the work on the socio-economic effects of modernising the mining industry has been carried out by australia and north america. england also used to contribute a lot in the research before the collapse of their coal mining industry. the australians are approaching the socio-economic effects of mechanisation from an automation angle with more urgency than their rsa counterparts. for instance, they established a programme called the mineral futures collaboration cluster that brought together researchers from the university of queensland, curtin university of technology, university of technology sydney, australian national university, cq university, monash university and their csiro to research these challenges. there has not been such large-scale collaboration on this subject in the rsa mining industry. also, the mineral futures collaboration cluster had a budget of about r100 million over 3 years; this is a large amount compared to the budget for an almost similar organisation in rsa (centre for mechanised mining systems – cmms). cmms had a total budget of r5 million over the last 3 years. this has an effect on the capacity and capability (internal and contracting) of institutions. for instance, the mineral futures collaboration cluster has already published almost 30 referred articles on this subject while there have been a handful of publications from the rsa side. this is paradoxical because the socio-economic effects would be felt more in the rsa than in australia. in all these, the australians still feel that they are not doing enough (mcnab et al. 2013). the current lack of research capacity in rsa is also noted by porter (2014). in the same article, porter (2014) highlights that most of rsa’s research focus has been on the mechanistic issues that are related to modernisation, such as costs and efficiencies. in conclusion, the socio-economic effects of mechanisation can easily result in serious socio-economic conflicts, as demonstrated by how luddites in england attacked cities, torching factories and machinery in the early 1900s. also, research from other industries shows that mechanisation and automation improves productivity and that job losses are at times not as dire as would have been anticipated. other industries have shown that mechanisation and automation may (at times) come with human-related issues such as boredom, complacency and deskilling, which can reverse the potential gains of mechanisation and automation. lessons for the south african context mechanisation and automation in some south african mining sectors is already at a world class stage, such as in most coal mines. gold and some pgms have generally lagged behind the coal mines because of the nature of the deposits. hard rock mines can adopt ways that coal mines have successfully used to automate. however, there does not seem to be much referred material that explicitly explains how the coal industry caters for socio-economic issues. one possible reason would be that coal mines mechanised during the apartheid era when socio-economic issues of all mine workers were not important. south african research on mechanisation has largely focused on the efficiency or productivity (including occupational health and safety) benefits (harrison 2006; menasce & de jager 2006; nong 2010; willis et al. 2004). an article by willis et al. (2004) on the framework for mechanising mines explicitly states the importance of consulting different stakeholders. however, there seems to be a perception that companies who own internal change management programmes cover these socio-economic issues. most of the referred publications on rsa’s context are from the cmms. south african mining companies are also not an exception in being slow to embrace the human-centred approach to modernisation, as is also implied by hattingh et al. (2010). the mining industry around the world generally neglects the socio-economic effects of some of these initiatives. the other factor that slows research in south african mining is the tripartite arrangement of managing research, that is, most research initiatives and projects must be approved by all stakeholders (companies, labour unions and government). while this works in normal engagements, it becomes a serious hindrance when it comes to research approvals and focus areas as there may be capacity and capability limitations among stakeholders. vogt and hattingh (2016) correctly suggest that the south african mining industry must also adopt principles of human and organisational behaviour, trial sites, simulations and promote applied research to fully benefit from mechanisation. critique of the current thinking most of the current thinking around the socio-economic effects of modernising the mining industry is informed by the australian influence, mainly because australia has well-funded and dedicated initiatives such as mineral futures collaboration cluster. however, the context and conditions in australia are different from rsa. firstly, australia is a developed nation while rsa is developing, with lower literacy levels. further, most australian mines are open pits while most rsa hard rock mines are underground mines. this presents completely different challenges especially in the size and skills of people that would be affected by mechanisation. for instance, the total workforce in the australian mining industry can be compared to the current workforce in rsa platinum mines only. thus, the socio-economic effects would be more dire in rsa than in australia and any conversation on the subject tends to be emotional and political in rsa. also, because of the stage of automation in australian mines, the discussions are more focused on the ergonomic effects of mechanisation as opposed to rsa where the discussion is still at a conceptual stage. literature also fails to acknowledge that mining is a primary industry and, as such, there are some forms of emotions that seem to be attached to these types of industries. all over the world mining invokes the same emotions that are invoked when discussing land (farming) or forestry. it would greatly assist the understanding of this subject if these socio-economic effects are not viewed with the same lens as those used to view socio-economic effects of automating a pilot cabin or banks. lastly, most literature focuses more towards mine workers and tends to neglect mining communities. as such, not much in-depth study has been carried out on communities surrounding mines. rsa also brings in another dimension in this category in the form of remote labour-sending communities. these specific areas, villages, provinces and tribes are historically known to groom and send their people to work in mines. in developed countries like australia, labour-sending areas are normally big, well-established cities that do not explicitly depend on these migrant workers. in rsa, some of these villages largely depend on these migrant workers. most workers from these labour-sending areas perform manual labour and are likely to be affected by mechanisation; therefore, the net effect of mechanisation would also be felt in these areas. research approach, sample selection and data collection the specific data collection methodology chosen for this research was semi-structured individual interviews. the interviews were mainly face-to-face but there were some that were carried out remotely. a total of 21 stakeholders were interviewed, ranging from operators, executives, academics, union leaders and consultants. most of the sampled population were operators, and the sample distribution in the sampled population was fairly representative of the rsa hard rock mines. the overall qualifying criteria for this sample selection included anyone working in rsa hard rock mines, any stakeholder who is affected by mechanising of hard rock mines and with knowledge of, or experience in, the socio-economic effects of mechanisation. furthermore, some union leadership representatives who participated in the study provided their official organisational position on the questions asked and, as such, they were comfortable with their views being provided to the public. the primary method of data collection was in the form of open-ended, one-on-one, semi-structured interviews. interviews with most operators and supervisors were conducted in underground working spaces because most operators work there and do not have time on surface. analysis of findings understanding of mechanisation and modernisation participants were asked to describe what they understood about mechanisation and modernisation. seventeen (17) of the 21 interviewees (81%) had a basic understanding of the subject, while the other 4 participants (19%) had no knowledge of the subject and the interviewer had to explain to them. the different levels of understanding are illustrated in table 1 below. table 1: levels of understanding mechanisation and modernisation. there seems to be a direct relationship between the understanding of mechanisation and levels of education. most participants in the sampled population had a basic understanding of mechanisation. participants who had no prior knowledge of mechanisation were operators with no formal education qualifications. senior principals from both employer and employee representatives showed extensive knowledge of mechanisation and modernisation and all perceived it as an opportunity to improve value for all stakeholders. views mechanisation and/or modernisation based on their understanding of mechanisation, participants were asked to explain their views on mechanisation and modernisation. all participants unanimously supported and easily identified the benefit of mechanisation. this includes the participants (19% of the population) who previously did not have a prior understanding of mechanisation. participants’ answers had common themes, but the foci differed depending on the level of understanding of the subject. common themes for level 1, level 2 and level 3 are that mechanisation or modernisation would: improve occupational health and safety improve production and productivity reduce the need for manual labour. one view that was exclusively from a level 3 category was that mechanisation should follow an extensive change management process and more people should be educated on the initiative. level 4 themes were related to level 1, level 2 and level 3 themes but with a broader focus. some of the themes identified are: achieve the zero harm vision (every employee should return home unharmed every day): this relates to the common theme of improving occupational health and safety identified by level 1, level 2 and level 3. all participants in this category acknowledged that rsa mines are becoming too deep and dangerous to mine safely using the current methods; thus, sending machines and automating would make them safer and reduce mining-related fatalities. improve life of mine: this theme was also unanimous among level 4 participants. the participants were unambiguous in explaining that the vast mineral reserves are at depths that are expensive to mine using the current methods but may be feasible when mined by machines. improve the industry’s competitiveness and attraction of investors: this theme was common for all labour unions. the participants acknowledged that current mining industry challenges of labour unrest, high costs and productivity issues are not attractive to investors. on further probing, they acknowledged that the challenges are not personality based but more on the need for the mining industry to holistically reinvent itself and be attractive to all stakeholders (investors, workers and communities). leverage on new technologies and invention: this was articulated by mining professionals in level 4 category, including the professor from cmms. on probing the basis of this point, participants were concerned that the industry is slow in leveraging on the current innovations and improvements in technology when compared to other industries. one mining professional identified mechanisation as a critical strategy to save cost and cushion the mines from commodity price fluctuations. save jobs in the long term: due to the expected increased life of a mine. their rationale here was that if mining continued in its current form, it would soon be unsustainable, and most deposits would not be mineable. as such, most people would lose their jobs. however, if they mechanised now, fewer people would lose their jobs in the short term but more would gain in the long term. both employers and employees in the level 4 category agreed on this. however, one union (solidarity) emphasised that the mining industry had to try by all means to retain as many jobs as possible and at all levels. they further wanted equitable beneficiation of retrenched workers and communities, including the upskilling and reskilling of retrenched workers so that they could participate in other downstream and upstream mining processes. stakeholders affected by mechanisation and modernisation participants were asked to identify potential stakeholders who were likely to be affected by mechanisation; this was normally followed by the probing question of how these stakeholders would be affected. this question was at times reposed at the end of some interviews because some participants (level 1 and level 2) initially gave too broad answers such as ‘everyone’. the following stakeholders were identified by the participants as the potential people to be affected by mechanisation: employees: 50% of the participants were of the view that mechanisation would lead to job losses because machines would substitute manual labour. most participants (82%) who identified this effect were of the level 1 and level 2 participants while the other 18% were employee representatives classified as level 4 participants. furthermore, 18% of the sampled population were explicit that job losses would mostly affect the old and less educated employees. this sample population represents about 36% of participants who had initially identified the negative ramification and all of them were level 1 and level 2 participants. mine owners, shareholders and management: about 24% of the participants identified mine owners and management as being critical stakeholders of mechanisation. these were mostly level 3 and level 4 participants but there was one supervisor (from level 2) who concurred with them. the main cause of this was the huge capital requirements needed for mechanisation and modernisation; thus, the short-term effects would be negative but with positive long-term effects. mining communities (including labour-sending areas): this was identified by 19% of the sampled population, all of which were level 4 participants. stakeholders in this category (representing about 68% of level 4 participants) clearly viewed communities as people who would be affected both positively and negatively by modernisation. the positive impact would be from improved reduction in mining-related environmental hazards due to safe mining methods (precision) from machinery. the other positive effect would be improved income from increased life of mines and increased profitability. these benefits would be limited to communities around the mining operations. labour-sending communities would be affected negatively as there would be loss of income; this might come with negative social ills such as crime or political instability. the profile of the migrant worker would also change as they would likely be specialists and from major cities and not from the current remote areas. labour unions and worker profile: this was also raised by 19% of the participants, all of whom were level 4 participants. the main issue here is that mechanisation would largely change worker profile and demographics as there would be more skilled and educated workers. this would also change the nature and level of engagements between workers and employers. issues such as the long drawn-out and violent strikes of 2013/2014 might no longer happen due to the long-term focus of discussions among stakeholders and less diversity of socio-economic needs among workers. original equipment manufacturers (oem) and suppliers: this was raised by level 4 participants from different constituencies. it is envisaged that the current oems and suppliers would have to reinvent themselves and supply equipment that would be required by the mines of the future. there would also be opportunities for new entrants. training institutions: the emphasis is that training institutions might have to relook at their offering and adjust to the needs of a mechanised industry. how mechanisation and modernisation individually affects participants participants were then asked to describe how mechanisation and modernisation individually affected them. the identified effects on an individual level are summarised in table 2. in table 2, the opportunity column refers to participants who saw personal opportunities in this initiative, while the calamity column refers to participants who foresee serious personal challenges with this mechanisation initiative. of the participants, 38% were scared that machines would substitute them, thus leading to loss of their jobs. these participants were all level 1 and level 2 participants (about 53% of this category). a significant number of level 1 and level 2 participants (33% of this category and 24% of the population) also saw potential opportunities in mechanisation. these opportunities include reskilling, learning new mining methods and changes in profession. of level 3 and level 4 participants, 83% saw the opportunity in having focused engagements with labour due to the reduced diversity of socio-economic needs among stakeholders. mining executives (10% of the population) saw a potential opportunity to implement business process changes and productivity improvement initiatives that would make shafts sustainable. the two level 2 participants aged above 50 years (10% of the population) were confident that mechanisation would not personally affect them as they would have retired by the time it was implemented. table 2: effects of mechanisation and modernisation at an individual level. as part of probing, some interviewees were also asked to estimate the times they were likely to feel the effects of modernisation and estimates varied from now to 10 years’ time. further, a total of five level 4 participants (83% of this category) were asked whether the stakeholders were doing enough to prepare for the new world. everyone was unanimous on the fact that stakeholders were not doing enough even though some engagements had begun as part of government’s mining phakisa project and ccmi initiatives. however, most critical stakeholders such as labour had limited knowledge and participation in these initiatives. ethical consideration the project has been subject to ethical review in accordance with the procedures specified by the university of reading research ethics committee and has been given a favourable ethical opinion for conduct. discussion of results one of the major findings of this research is that stakeholders have different levels of understanding of mechanisation and modernisation. the levels of understanding were found to be proportional to the levels of education and not related to classifications such as gender, race, commodity mined and type of jobs. it seems that the different levels of understanding of mechanisation and modernisation have a limited influence on how participants viewed the impact of socio-economic effects because the effects identified by different participants at different levels were largely related. most participants in the sampled population had a basic understanding of mechanisation and modernisation. reviewed literature seems to indicate that researchers do not initially establish the participants’ levels of understanding of this subject and generally move straight ahead to explore the views of stakeholders. this is probably so because most of the literature on this subject is from developed countries such as australia who have high literacy rates. nevertheless, this initial probe was invaluable in this instance as it demonstrated that stakeholders’ perception of socio-economic challenges is not limited to their constituency or needs but more to their comprehension of the challenge. for instance, there are a couple of examples in the previous section where labour unions raised issues that were of interest to shareholders, investors, country competitiveness and communities and level 1 and level 2 participants (workers) who raised concerns of capital requirements that accompany mechanisation. there seems to be general support for mechanisation and modernisation among the participants. the identified benefits and challenges were relatively similar and aligned among participants. the main difference, however, was in the depth and scope of the problem or opportunity as perceived by participants. for instance, while mining executives mentioned issues like achieving the zero harm vision, lower level employees would mention safe working place. the more educated participants naturally had a more holistic view of the socio-economic effects and could logically relate them to causes when probed, while the less educated participants struggled with this. literature by lynas and horberry (2011) suggests that different stakeholders have different opinions on the socio-economic effects of mechanisation and studies acknowledge this observation. however, this research has shown that this difference in opinions is probably driven more by different levels of understanding as opposed to different interests. participants expect mechanisation and modernisation to affect the following stakeholders: employees (i.e. job losses) – this was identified by most participants and is in line with observations in literature by authors such as bellamy and pravica (2010) and mcnab and garcia-vasquez (2011). the participants are justified to be wary of this factor because literature has cases where the job losses were as high as 40% (and 75% at some sites). however, literature also acknowledges that job losses might not be that big because there would be employment opportunities in upstream processes, as demonstrated by authors such as botha (2015a), hattingh et al. (2010) and dudley et al. (2010). job losses are likely to be felt by lower level employees currently doing operator type of jobs; this would be more severe for older employees (above 45 years). mining owners and shareholders – mechanisation and modernisation as a capital-intensive initiative would likely cause short-term losses for the companies, albeit with longer-term benefits. it is generally not explicitly clear whether this would be an industry initiative in rsa, because if companies could leverage on the economies of scale then envisaged losses would be minimum. mining communities (operations) – none of the participants was a mining community representative; nonetheless, they were identified as critical stakeholders who would be affected by modernisation of mines. there would likely be long-term benefits for the communities where the actual mining operations are located due to perceived improvement on mine profitability and the life of mines, which would in turn increase the local royalties. mining communities (labour-sending areas) – there would be a loss of income in the current labour-sending areas. literature does not seem to focus much on this fact because in developed countries, labour-sending areas are normally big cities and communities are not directly dependent on migrant labour. however, in rsa some of these villages depend heavily on the income from these migrant workers. workers that are likely to lose their jobs are from these labour-sending areas. it is also worth noting that in mines that are close to full automation, the origins of labour-sending areas tend to be cities as opposed to remote areas. this fact was also observed in literature by kaupp et al. (2010). labour union and employee profile – in line with what mcnab and garcia-vasquez (2011) and mcnab et al. (2013) suggested, participants foresaw a change in the employee profile due to mechanisation. the interviewees foresaw a more literate employee, which might reduce diversity of socio-economic needs among stakeholders. this would in turn make stakeholder engagements more focused. this came out strongly and seems to frustrate participating unions, senior management and mining professionals. other stakeholders (department of mineral resources, oems, suppliers and training institutions) – even though these stakeholders were not represented in the study, different participants at different levels identified mechanisation as having an impact on them and the way they offer and deliver services to the industry. interviewees were also unanimous in identifying the social-economic benefits of mechanisation. the identified benefits included occupational health and safety issues, efficiency, costs and improved life of mines. all these are in line with the benefits identified in literature by boudreau-trudel et al. (2014), botha (2015a), fisher & schnittger (2012), hattingh et al. (2010), horberry et al. (2010), kaupp et al. (2010), lynas and horberry (2011), mcnab et al. 2013; nong 2010; parasuraman et al. 1997). on a personal level, most participants (irrespective of education levels) viewed mechanisation and modernisation as an opportunity to reskill themselves, improve operations and improve quality of life. the potential job losses seemed to be secondary when asked at a personal level. this was also contrary to common perception and was probably influenced by an increase in access to information and technology, which might be making people accept technological changes as part of life. overall, participants (irrespective of their educational levels) seemed mature enough to look beyond their constituencies and interests when exploring the socio-economic impacts of mechanisation and modernisation. the only notable hindrance was the level of education, which in turn influenced the depth and comprehension of issues, but this did not influence the principles. results limitations some of the limitations of this study are: not all labour union principals were represented – the two unions’ leadership whose members are most likely to be affected by job losses were not represented in the study despite repeated efforts to engage them. one of these unions blatantly refused (in writing) to participate in the study. the other had capacity issues and was always busy with other challenges such as wage negotiations. however, it is important to mention that most of the interviewees (over 60%) were from these two unions so some of their members were represented. no representation from communities – the interviews did not manage to obtain the views of communities because it was difficult to find legitimate representatives within the limits of the planned timelines. need for quantitative research – most of the issues identified by stakeholders and literature are backed with adequate quantitative numbers. for instance, one is not sure of the approximate number of people likely to lose jobs, and if (for instance) the industry fully mechanises in 10 years’ time, workers who are above 50 years old may not be involved in the analysis and scenario planning exercise. this research was cross-sectional and collected data during the wage negotiation year; it would add more value if a more detailed research were carried out in a longitudinal manner. conclusions the following conclusions can be drawn from the study results: stakeholders seem to be able to see beyond their interests for the benefit of the mining industry. also, the stakeholders’ interests are reasonably aligned and largely common. stakeholders do support mechanisation and modernisation efforts. however, the leadership of different stakeholders must engage with one another and with their members to measure and categorise different stakeholder needs and apply them as part of the implementation plan for mechanisation and modernisation. mechanisation and modernisation efforts require a multi-stakeholder approach that should be accompanied by thorough research to scientifically quantify the probable effects on stakeholders. mechanisation and modernisation should follow both quantitative and qualitative research methodologies. there is room for other stakeholders, especially government institutions like the department of mineral resources and the mine health and safety council to take a more visible role in this initiative. there are apparently few published, documented and referred articles on the socio-economic impact of modernising rsa mines. the results presented in this article are believed to be the first such data and will contribute to the discussion. recommendations the following recommendations can be drawn from this research: there is need for a comprehensive approach to the socio-economic impact of mechanisation on the south african mining sector; that way, mines may gain more by being uniformly integrated and aligned in a manner that would reflect the industry’s initiative as opposed to it appearing as an individual company’s initiative. further, such a move would allow for easy sharing of resources and experience. in seeking to mitigate the socio-economic impact of mechanisation, companies need to gradually incorporate these changes into their change management programmes. there is still need for much more in-depth research (both qualitative and quantitative) on the socio-economic impact of mechanisation on the mining industry, with specific focus on the variegated communities – both labour-sending communities and those in close proximity to the location of the different mining companies. there is a need for the government to work in consultation with other stakeholders in establishing a permanent unit which would be responsible for coordinating this industry initiative and providing some form of project management office services. this is necessitated by the clear lack of ownership of such a policy initiative by both captains of industry and government. managerial contributions this is probably the first research of this kind on the subject in rsa and in the hard rock mining environment. the research will contribute to the elimination of the current perception that operators and ordinary workers are opposed to and do not comprehend the value of mechanising and automating the rsa hard rock mines. lastly, this report further emphasises the importance of extensive stakeholder consultation when carrying out these types of initiatives. theoretical contributions this research has provided a base framework for classifying different levels of the understanding of mechanisation and automation in rsa mining. these different levels will need different interventions when conducting change management initiatives. acknowledgements the research described in this article was carried out by the author for a dissertation at university of reading (and henley business school). the research and studies were funded through oceana business re-engineering, ayanda mbanga communications and letaba elihle investments. the assistance by all interviewees is appreciated. competing interests the authors declare that they have no financial or personal relationship(s) that may have inappropriately influenced them in writing this article. references bellamy, d. & pravica, l., 2010, ‘assessing the impact of driverless haul trucks in australian surface mining’, resources policy 36(2), 149–158. https://doi.org/10.1016/j.resourpol.2010.09.002 botha, d., 2015a, global trends and development in mechanisation and automation with specific reference to hsec and social dimensions, internal nosa report, chamber of mines south africa, johannesburg. boudreau-trudel, b., zaras, s., nadeau, s. & deschamps, i., 2014, ‘introduction of innovative equipment in mining: impact on productivity’, american journal of industrial and business management 4(1), 31–39. https://doi.org/10.4236/ajibm.2014.41006 chamber of mines of south africa, 2009, south african yearbook 2008/2009, 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ieee transactions on systems, man and cybernetics 30(3), 286–297. https://doi.org/10.1109/3468.844354 porter, j.l., 2014, ‘are efforts to mechanize sa mines too focused on machinery rather than technology?’, journal of the south african institute of mining and metallurgy 114(9), 681–692. rico, l., 1966, ‘automation and manufacturing employment: a reappraisal’, human resource management journal 5(1), 1–10. https://doi.org/10.1002/hrm.3930050102 vogt, d. & hattingh, t., 2016, ‘the importance of people in the process of converting a narrow tabular hard-rock mine to mechanization’, journal of the south african institute of mining and metallurgy 116(3), 265–274. https://doi.org/10.17159/2411-9717/2016/v116n3a8 willis, r.p.h., dixon, j.r., cox, j.a. & pooley, a.d. 2004, ‘a framework for the introduction of mechanized mining’, international platinum conference on ‘platinum adding value’, the south african institute of mining and metallurgy, johannesburg, viewed n.d., from http://www.saimm.co.za/conferences/pt2004/117_willis.pdf appendix 1 questionnaire and information sheet and consent form for face-to-face interviews title of research project: the socio-economic effects of mechanising and/or modernising hard rock mines in south africa the research forms part of my academic qualification at henley business school at the university of reading. part of the research involves interviewing people who are involved in, affected by and have knowledge/experience regarding the socio-economic effects of modernising the hard rock mines in south africa. for this reason, i would like to invite you to take part. if you agree, you will be asked to participate in a telephone/video interview of about 60 min. during the interview i will ask you questions such as: what do you understand about modernisation? what is your view on modernisation? who will be affected by modernisation? how will modernisation personally affect you? how will modernisation affect other stakeholders? your participation is entirely voluntary. you can choose not to answer any particular questions and you are free to withdraw from the study at any time. with your permission, i would like to record the interview/take notes for later analysis. the data will be kept securely and destroyed after the completion of the project. your identity will remain confidential throughout all stages of the research. your name and identifying information will not be included in the final report. the identity of your organisation will not be included in the final report. a copy of the completed project/summary of the project/summary of findings will be available on request. the project has been subject to ethical review in accordance with the procedures specified by the university of reading research ethics committee and has been given a favourable ethical opinion for conduct. sajems ns vol 3 (2000) no 2 165 the casualization of black female labour in south africa ti fenyes and p lalthapersad department of economics, vista university, mamelodi and east rand abstract black women workers in south africa are highly marginalized in that their work has been undervalued and underpaid due to disadvantage and discrimination. they were severely curtailed by legislation that aimed to keep them away from urban areas and the formal job market. this paper reports the results of an empirical study of the work done by black women in the manufacturing and retail industries. the purpose of the study was to determine the kind of work black women do and the nature of the job processes. the article examines the main [mdings of the study. jel j 16 introduction gender oppression occurs in all societies and its form rests on the socio-political forces located in the society. in south africa, women's oppression was mainly shaped by two socio-political factors: • the ideology of apartheid and racial exclusivity which fostered white supremacy and black inferiority; and • the development of the capitalist sector (gwagwa, 1989). thus in south africa, the oppression of black women was tightly bound to national oppression. the state viewed black women as the most inferior of all racial groups and capital regarded them as the cheapest source of labour. they had often no legal rights, could not own property, were given the least skilled jobs and were forced to eke out an existence in the tribal homelands. poor access to education and training, lack of housing, the skewed provision of fringe benefits and the wider socio-political dynamics enmeshed to lock black women into a web of hardship, poverty, control and marginality. black women were entrapped in a state of triple bondage in that they were oppressed as a race, a class and as women. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 166 sajems ns vol 3 (2000) no 2 black women endured the cumulative burden of low wages for themselves and their spouses, male migration, live·in domestic jobs, poverty, customary law, traditionalism and state regulation. the state exerted rigid control over the lives of black families. laws governed the physical movement of black people, access to the cities, the right to housing and above an access to the job market (berger, 1992: 13). once in the urban areas, black women had to contend with the threat of deportation back to the tribal homelands and arrest if they lacked legal documentation. the pass laws specifically denied black women access to the urban areas and the job market, a factor that polarized ~e position of women of different races. black women could not refuse jobs seeing that they were confronted with a limited range of work. their dire economic circumstances meant that they could not afford a break in their working lives due to childbearing or marriage. the experience of black women in south africa is unique compared to that of working women of other racial groups within the country and of women in other countries. whilst these women could rely on male earnings and were privileged in that they could retreat to the household if so desired. black women had little choice as they were household heads with families to support. the geographic distribution of black labour exuded a sexual dimension, that is, black men in the town and black women in the rural areas. of all groups in south africa, black women were the last ones to be proletarianized (bozzoli, 1983: iso). when women entered the urban areas, they had to contend with low paying and unskilled work. the racilil stratification of society underpinned occupational mobility in the job market. the feminization of occupations assumed a racial character. this was especially evident in the manufacturing sector where white women used the entry of black women into the industry to segregate jobs racially. white women moved into the cleaner, lighter, clerical and administrative positions and left black women to tackle the heavy menial jobs in factories (walker, 1990: 163). thus black women created occupational mobility for white women. racism rigidified the occupational structure with white women occupying the· skilled jobs and black women doing menial and unskilled work. black women dominate the essentially female.oriented economic sectors such as sales and service work where they are employed as cleaners, tealadies, messengers and cooks (kraak, 1993: 84). in 1996 the occupational structure in sa showed the following trends: • black women comprise a minor part (26%) of the managerial and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 167 administrative staff; • black women dominate the service and farming occupations (84% and 81% respectively); • over 40% of the occupations of black women are classified as "unspecified"; and: • black women comprise a small portion of artisans and apprentices (statistic south africa, 1998). the south african labour market segmentation and stratification of the labour market has splintered workers into distinct groups, each with its unique characteristics. the south african labour market is mainly split along racial and gender lines. black women comprise a "peripheral" rather than a "core" workforce in the sense that they perfonn mostly unskilled, menial jobs that are secondary or subsidiary to the production process. black women, still are, disadvantaged in terms of employment, work status, occupational and sectoral segregation, income levels and lack of worker representation (standing et al. 1996: 389-414). black women dominate the segments of the labour market where income, training, promotion prospects and working conditions are poor. in addition, they are afforded little protection against dangerous and exploitative conditions. there are very few black women in management, technical and supervisory positions. black women are also more likely to be employed in part-time and casual jobs. they are prone to employment insecurity (likely to be arbitrarily dismissed due to the nature of their employment); job insecurity (denied the means to develop a career); work insecurity (likely to work in dangerous and unsafe conditions) and income insecurity (earn extremely low wages and have little chance of improving their income levels) (standing et al. 1996: 396-7). the nature of jobs that black women do is prone to downsizing and redundancies. the empirical study the survey on which this paper is based, was conducted in 1998 and fonned part of the research for a doctoral thesis. the lack of suitable and recent infonnation on labour force participation in the south african labour market made such an investigation both urgent and worthwhile. the authors themselves designed the survey questionnaire. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 168 samms ns vol 3 (2000) no 2 the study thus took the fonn of a questionnaire survey in the manufacturing and retail industries l • whilst manufacturing falls under the secondary sector, retail trade is part of the service or tertiary sector. the aim of the survey was to determine the following: • the jobs black women perfonn; • the nature of the work itself; • the skills levels of black women; • the extent of flexibility in tenns of part-time, full-time, shift and overtime work; and • the possibility of sustaining injuries in the course of work. the questionnaire was exploratory in nature, designed to capture the type of infonnation that census data does not reflect, namely, the conditions and nature of work itself. census data are inadequate in that occupational categories are so broad that many different jobs are compressed together. this precludes any infonnation on the different incomes and working conditions that the jobs entail. the questionnaire looked at employment practices, that is, the issue of flexibility, and the use of non-regular employment was also addressed. parttime work is a fonn of numerical or external flexibility. this section aimed to verify the growing trend favouring the use of non-regular employment rather than pennanent full-time workers. the type of work that black women do fonned a large proportion of the questionnaire. under type of work, three aspects were touched on : • the distribution of women according to departments or sections at a factory level; • the functional tasks of black women; and • the main products and materials handled by black women. analysing the distribution of black women according to departments or sections at a factory or shop level, is reflective of the demographics of the workplace. regarding the tasks that black women may undertake, a comprehensive list of thirty-three possible tasks was provided. although many of the tasks overlapped, it was hoped that the response would provide greater clarity on the nature of the work perfonned by black women. the list of materials and products complies with the standard classification usep, by statistics south africa (ssa). the type of materials and products handled can serve as an indicator as to whether certain industries are inclined to hire a certain gender. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 169 the questionnaire also dealt with the working conditions and hazards that black women encounter, that is, whether they are exposed to grease, dust or dangerous fumes. such information exposes the nature of work black women do, whether they have to contend with dangerous, exploitative working conditions, the health and safety of workers and their place in the job hierarchy. the questionnaire also looked at the likelihood of sustaining injury in the execution of one's job. such information can be used to gauge the potential riskiness of jobs performed by black women. another aspect of the questionnaire dealt with the physical effort required by the job. specifically, the following matters were examined: • the postures that black women adopt in performing their jobs; • the kind of weight black women pick up or handle; • the importance of special skills for job performance; and • whether the work that black women do requires ordinary, definite, considerable or great physical strength. a further aspect of the questionnaire dealt with the skills and educational levels of black women. four broad categories defined by ssa were provided, and firms were asked to categorize workers according to these definitions. the skills and educational levels of workers are crucial in segmenting the labour market and determining the workers' place in the hierarchy. survey method two industries, namely, manufacturing and retailing were chosen because they have historically employed large numbers of black women. only the gauteng region was considered. the industrial register at the bureau of market research (bmr) of the university of south africa served as basis for choosing the sample. in the manufacturing industry, only firms with a staff complement of more than a hundred workers were considered. in retailing, only firms with over thirty workers were included. firms were randomly selected and a total of 300 questionnaires were sent by mail. a total of 265 questionnaires were returned (139 from manufacturing and 126 from retailing firms). this gives a total response rate of 88%. the categorical nature of biographic and organizational questions made it appropriate to work with frequency distributions, and in the cross tabulation of two variables to calculate the chi-square statistic as a test of the null hypothesis of independence (hays, 1963: 558-9). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 170 sajems ns vol 3 (2000) no 2 the questionnaire required the respondent to respond on a 4 or 5 point likert type scale. since such questions give information on an interval scale, it is important to calculate mean scores for subgroups. in the present study, the mean scores obtained for different groups were compared using the so-called ttest for differences between means of independent groups (hays, 1963: 280). conventionally, the levels of 0.05 and 0.01 are used as levels of significance performed to control the so-called type-i error rate, that is, to limit the risk of incorrectly rejecting the null hypothesis or concluding a significant result (hays, 1963: 281). in the social sciences, we are mainly concerned about missing a significant result (type-ll error). winer (1971: 14-15) points out that when both types of errors (type-i and type-ii) are equally important, levels such as 0.20 (and possibly 0.30) are more appropriate than the conventionally used 0.05 and 0.01 levels. in this study, it was decided to use statistics mostly on an item level. this resulted in more than 100 tests being performed. in order to achieve reasonable protection against type-i error, the authors decided to use a level of 0.005 for anyone particular test. this choice remains arbitrary to a large extent firms in manufacturing were subdivided into two industrial types based on the kind of output they produce, namely light and heavy industries. light industries are comprised of: • food, beverages and tobacco products; • textiles, clothing, leather products and substitutes, footwear; and • pottery, china, glass products and other non-metallic products. heavy industries are comprised of: • wood and cork products, furniture and fixtures; • paper and paper products, printing and publishing; • industrial chemicals, petroleum and coal products, rubber and plastic products; • iron and steel industries and non-ferrous basic metal industries; and • fabricated metal products, machinery, motor vehicles and transport equipment. survey findings in this section, the main findings of the. empirical study and its implications for the future utilization of black female labour are discussed. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 171 classification of job criteria question 8 in the questionnaire (see endnote) required firms to rate the extent to which they utilize the criteria in table i to classify jobs. table 1 criteria used to classify jobs in manufacturing and retail industries classification manufacturing retail pcriteria mean std mean std value education 3.36 0.967 3.07 0.964 0.129 mental effort 3.47 0.885 3.30 0.981 0.145 skills 3.69 0.905 3.40 1.085 0.017 physical effort 2.80 0.953 2.81 i 1.080 0.917 responsibility 3.67 0.889 3.35 1.076 0.010 working conditions 3.48 0.947 3.23 i 1.005 0.038 according to the criteria used to classify jobs, it appears that all five factors except "physical effort" are deemed important (mean score greater than 3) in classifying jobs (table i). however, "skills" (mean score of 3.67) and "responsibility" (mean score of 3.69) are the most relevant factors. firms consider "physical effort" least relevant, possibly because it is not seen as warranting special attention and is accepted as a given. . overtime, full-time and shift work questions i, 2, 16, 17 and 18 called for information on the use of full-time workers, part-time workers, shift work and overtime work. figure 1 shows the results obtained. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 172 sajems ns vol 3 (2000) no 2 figure 1 overtime, shift and full-time work in the retauing and manufacturing industries % black women in shift wort company shift wort % black women in overtime company oven.ime ful1~lime work od retail trade !!ii manufacturing for all finns, 98% of the workforce were employed on a full-time basis, respectively 87.8% in retail trade and 94.7% in manufacturing. only 12.2% of workers in retail trade and 5.35% in manufacturing were part-time workers. it is apparent that part-time work is not very widespread, a deviation from the international trend and an indication of low labour market flexibility. however, the greater occurrence of part-time work in retailing, is due to the fact that the service sector tends to employ large numbers of women in jobs that are labourintensive in nature. both industries make substantial use of overtime, that is, over 80%. however, for all firms, only 34% of black women workers were involved in overtime work. the number of black women involved in overtime is higher in retail trade (45.4%) compared to manufacturing (23.7%). higher overtime rates in retailing could be attributed to the fact that many black women are employed as salesworkers and work extended hours over weekends. shift work existed only at 44.5% of all firms and only 11 % of black women employees worked shifts. overall, the use of shift work is very low in the retail sector (16.8%) but substantially higher in the manufacturing industry (69%). this could be due to the production processes used in manufacturing. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 173 the survey also showed that black women did less shift work compared to the general workforce (namely, 4.5% in retailing and 16.4% in manufacturing). a possible reason for this is that black women are not so much doing technical jobs but jobs that are peripheral to the production process, like packing. potential risk of injury question 3 of the questionnaire asked firms to assess the likelihood of black women sustaining certain injuries in .their job environment. the results are shown in figure 2. figure 2 risk of injuries to black women in retail and manufacturing industries 0..1 j..i 2.5 lid retail trade 1111 manufacturing the retail and manufacturing industries are quite similar in terms of exposure to injury. "possibility of accidents" occurring is lower in retail trade (69.8%) compared to manufacturing (75.5%). "burns" have the lowest occurrence in both retailing (20.5%) and manufacturing (51.6%) but are relatively higher in manufacturing. "bruises" are the second highest category of injury likely to occur, namely, 79.2% in retail trade and 73.5% in manufacturing. "cuts" are the most common injury, that is, 84% in retail trade and 82.5 % in manufacturing industries. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 174 sajems ns vol 3 (2000) no 2 these statistics indicate that the work environment of black women is not particularly safe as the likelihood of sustaining injury exists to quite a substantial extent. in comparing heavy and light industries, it is noticeable that the occurrence of injuries such as accidents, cuts, burns and bruises is higher in heavy industries. this is because jobs in heavy industries are more physically demanding. also the type of output differs between the two industries. exposure to hazards question 14 of the questionnaire requested fmns to rate the extent to which black women are exposed to certain hazards in the work environment. the results are shown in table 2. table z exposure to hazards in manufacturing and retall industries type or hazard manufacturing retall trade p-value mean std mean std explosives 1.06 0.344 1.03 0.250 0.3709 height 1.09 0.338 1.64 0.874 0.0001 fire 1.40 0.940 1.93 1.078 0.0001 radiation 1.02 0.168 1.00 0 0.0451 atmosphere 1.37 0.827 1.09 0.344 0.0004 chemicals 1.33 0.736 1.07 0.325 0.0003 electrical 1.76 0.921 1.38 0.534 0.0001 mechanical 2.00 1.073 1.14 0.394 0.0001 self safety 3.17 1.398 2.07 1.146 0.0001 other safety 2.74 1.315 l81 0.906 0.0001 black women employees were rated as being exposed to hazards "to a fair extent". a pertinent result of the survey is that black women in both manufacturing and retail industries are "responsible for their own safety", a factor that is significantly more important in manufacturing industry. also in manufacturing industry black women are "responsible for the safety of others". generally, it appears that black women in the manufacturing industries are more exposed to hazards than in the retail trade, with the exceptions of "fire" (p value of 0.0001) and "height" (p value of 0.0001) where the reverse is true. "mechanical" and "electrical" hazards (both with a p value of 0.0001) are substantially bigger in manufacturing. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 175 relativt:1y greater exposure to hazards in the manufacturing industry is consistent with mechanized job processes. it can be deduced that the work environment of black women does not appear to be particularly dangerous in terms of health risks. exposure to harmful conditions question 9 of the questionnaire requested firms to rate the extent to which black women were exposed to various harmful conditions in industry. table 3 shows the scores obtained. table 3 exposure to harmful conditions in manufacturing and retail industries conditions manufacturin2 retail trade p-value mean std mean std grease 1.58 0.784 1.11 0.342 0.000 coolants 1.72 0.891 1.10 0.306 0.000 general noise 2.35 1.119 1.49 0.745 0.000 fumes 1.47 0.735 1.09 0.294 0.000 dust 2.14 0.996 1.93 1.063 0.104 dirt 2.18 0.990 1.87 0.937 0.010 asbestos 1.05 ·0.277 i 1.07 0.271 0.392 black women are relatively unexposed to harmful conditions or irritants in the work environment. exposure to "asbestos" is non-existent (mean scale score close to 1) in both the retail and manufacturitig industries. a relatively higher amount of exposure to "noise" (mean score of 2.35), "dirt" (mean score of 2.18) and "dust" (mean score of2.14) is experienced in manufacturing industries. this could be due to three factors: • the type of materials and goods handled; • the size of the enterprise; and • the level of technology. in the retail industry, only "dust" (1.93) and "dirt" (1.87) are relatively important negative factors in the activity of packing. postures of work and physical demands question 10 of the questionnaire requested the respondent to rate the extent to which black women adopt certain postures when performing their jobs. table 4 displays the scores obtained. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 176 sajems ns vol 3 (2000) no 2 table 4 postures of work in manufacturing and retau industries posture manufacturine retail trade p·value mean std mean std climbing 1.46 0.911 1.50 0.766 0.701 crawling 1.03 0.223 1.00 0.091 0.180 sitting 3.14 1.540 1.84 1.248 0.000 walking 2.50 1.175 3.32 1.441 0.000 stan,ding 2.87 1.554 3.92 1.293 0.000 bending 1.52 0.872 1.83 1.052 0.012 crouching 1.24 0.626 1.35 0.558 0.128 kneeling 1.11 0.472 1.21 • 0.576 0.134 stooping 1.27 0.651 1.28 0.645 0.915 regarding the posture that black women adopt in executing their jobs, it is apparent that none of the physical positions are especially typical of black women workers. the exceptions are "standing" and "walking" in the retail trade with a mean score of3.92 and 3.32 respectively or ("quite a bit") and "sitting" in the manufacturing industries (mean score of 3.14). these postures are consonant with saleswork, packing and operating light machinery. the "crawling" position is especially uncharacteristic (mean scale score close to 1) in both the retail and manufacturing industries. another aspect impinging on the physical demands on black women entailed determining the extent to which their jobs involved physical lifting. the majority of fums (62%) reported that black women did perform jobs that involved physical lifting. furthermore, 51.3% of firms indicated that there were physical demands in the work environment of black women. jobs involving physical lifting are more prevalent in the retail industry (69.3%) compared to manufacturing (55%). black women are also more involved in jobs requiring physical lifting in the light (65.1%) than heavy industries (55%). this might be due to the large amount of packing that occurs in these industries. for all firms, the average weight that black women lift in their jobs is 9.5 kg. it appears that the average weight lifted is heavier in retailing (l0.7kg) than in manufacturing (8.5kg). likewise, the average weight lifted is heavier in light compared to heavy industries (14.8kg and 8kg respectively). it is probable that in retailing and light industries, black women are responsible for a wide range of related tasks (like packing and arranging goods) apart from their specific job description. . r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vo13 (2000) no 2 177 functionsl tasks question 11 of the questionnaire requested the respondent to rate the extent to which the list of functional tasks in table 5 describes the work of black women. table 5 functional tasks of black women in manufacturing and retail industries functional tasks manufacturing retail trade p-value mean std mean std packing 2.97 1.609 3.69 1.341 0.0001 material handler 2.94 1.640 2.41 1.492 0.0064 machine handler 2.46 1.552 1.15 0.620 0.0001 stacking 2.10 1.519 1.07 0.348 0.0001 placing things on 2.00 1.454 1.12 0.551 0.0001 conveyor belt counting 1.94 1.402 1.09 0.463 0.0001 doing things 2.00 1.496 1.09 0.445 0.0001 machine operator 2.44 1.629 1.28 0.847 0.0001 machine minder/ 2.31 1.493 1.11 0.430 0.0001 watching general operator 2.51 1.571 1.29 0.709 0.0001 production worker 2.81 1.679 1.23 0.801 0.0001 cleaner/tea lady/ 3.51 1.495 3.43 1.483 0.6712 messenger wordprocessor 2.26 1.427 1.89 1.216 0.0238 operator typing 2.17 1.418 1.90 1.124 0.0872 secretarial 2.20 1.378 1.95 1.192 0.1285 personnel clerk 2.29 1.415 1.92 1.271 0.0292 administrative 2.43 1.414 2.61 1.362 0.3137 assistant bookkeeper 1.76 1.002 1.58 1.075 0.1428 computer operator 2.20 1.345 2.44 1.472 0.1681 administrative 2.23 1.380 2.07 1.276 0.3112 official telephonist 2.47 1.529 2.42 1.449 0.7819 sales worker 1.51 0.866 4.18 1.427 0.0001 technical 1.49 0.958 1.34 0.826 0.1753 accounts 2.07 1.288 1.91 1.285 0.3381 ironer 1.21 0.746 1.37 0.944 0.1365 presser 1.13 0.608 1.12 0.593 0.8747 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 178 sajems ns vol 3 (2000) no 2 table 5 continued functional tasks manufacturine retail trade p-value mean std mean std launderer 1.18 0.762 1.07 0.338 0.1009 dry cleaning 1.08 0.521 1.07 0.371 0.8822 lift operator 1.02 0.189 1.10 0.454 0.0620 credit control 1.83 1.253 1.91 1.436 0.6381 meter reader 1.03 0.223 1.15 0.480 0.0097 licence inspector 1.01 0.119 1.07 0.314 0.0580 client canvasser 1.46 1.059 0.0002 the task of "cleaner, tealady, messenger" is high in both industries with a mean score exceeding 3. in retail industry, most black women are employed as "salesworker" (mean score dose to 4). other jobs that are frequently done in retailing industry are those of: • packing (mean score of 3.69); • material handler (2.41); • administrative as::.i::.t.mt (2.61); • computer operator (2.44); and • telephonist (2.42). in manufacturing industry, the main task of black women are "cleaner, tealady, messenger" with a mean score of 3.51. other jobs that are commonly done in the . manufacturing are those of: • packing (2.97); • material handler (2.94); • production worker (2.81); • general operator (2.51); and • telephonist (2.47). "packing" is significantly higher in retail industry than manufacturing (p value of 0.0001). the following tasks are especially unrepresentative (mean scale score close to 1) of both the retail and manufacturing industries, namely those of "licence inspector", "lift inspector", "meter reader", "dry cleaner", "launderer", "ironer", "presser" and "cli~nt canvasser". black women a:ce crowded into certain jobs which ultimately causes low wages. jobs such as packing, cleaning, serving tea, delivering messages are elementary and unskilled in natare. they are also gender-stereotyped. the type of jobs that black women do belong to that part of the labour market, where jobs entail simple technology, is menial and repetitive in nature. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 179 the three jobs most frequently done in both light and heavy industries are as follows: • cleaner, tea lady, messenger with a mean score of 3.54 in heavy and 3.37 in light industries; • packing with a mean score of 2.71 in heavy and 3.62 in light industries; and • material handler with a mean score of 2.75 in heavy and 3.20 in light industries. jobs such as "machine handler", "machine minder" and "machine operator" are higher in light industries compared to heavy industries. "packing" is significantly greater in light than in heavy industry. the greater number of machine handlers and general operators in light compared to heavy industry point to the fact that these industries produce mainly cheap semi and non-durable goods. in manufacturing, the jobs women do have been deskilled in that they are menial and do not require much responsibility. the ghettoization of jobs is quite evident in that black women mostly do low-paying, auxiliary jobs like packing and cleaning. the number of black women employed in the technical field is very small. the impression gained is that men dominate technology and technical skills. the small number of black female technical workers could be a consequence of the unequal education system in the past which restricted blacks access to subjects such as science and mathematics (themba, 1986: 73-97). white-collar jobs such as word "processing", "typing", "secretarial" and "personnel" are higher in the manufacturing industry than in retail trade. these occupations are fairly "new" in that they have only recently been opened to black women. the number of black women in accounting and bookkeeping is also very low, a consequence of a tainted educational system that offered a limited range of subjects. general administration work, for example, "administrative assistant and official" are quite important in the both industries. they can also be categorized as "new occupations" as they only recently admitted black women. jobs such as "stacking or placing things on the conveyor belt" are relatively more frequent in light than in heavy industries. on the other hand, "counting items on the conveyor belt" is higher heavy than in light industries. in relation to other jobs, these jobs are typically unrepresentative, perhaps because conveyor belt technology is utilized to a limited extent in industry. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 180 sajems ns vol 3 (2000) no 2 types of job question is of the questionnaire requested flill1s to rate the extent to which black women perform certain types of job. the scores are shown in table 6. table 6 type of jobs black women perform in manufacturing and retail industries job manufacturing retail trade p-value mean i std mean std sitting in one position 2.17 1.006 1.53 0.909 0.0001 lengthy operation 2.20 1.204 1.24 0.643 0.0001 operating long hours 2.29 1.136 1.18 0.605 0.0001 liaising with people 1.81 0.979 3.19 1.101 0.0001 sedentary in office 2.13 1.084 1.78 0.926 0.0049 operate switchboard 2.05 1.152 2.38 1.192 0.0236 record keeping 1.86 1.015 • 1.99 1.103 0.3269 • attention to detail 2.09 1.122 1.73 0.862 0.0038 physical effort 1.57 1.014 1.15 0.463 0.0001 lifting etc up/down stairs 1.50 1.002 iai 0.723 oa073 bending or stooping 1.66 1.060 1.70 0.770 0.6945 pushin~heavyloads 1.52 1.033 1.39 0.719 0.2214 in this section, a broad summary of job types was provided to ascertain the physical demands of the various jobs. none of the job types are especially performed by black women, that is, having a mean scale score of 2 or "moderately". the exception is possibly "liaising with people" in the retail trade with a mean scale score of just over 3. other jobs most frequently done in retailing are "operating the switchboard, keyboard, photocopier or cash register". the "liaison" aspect of jobs is an offshoot of saleswork that is consistent with the fmding established earlier that sales and rudimentary administrative jobs are popular in retailing. in manufacturing, the jobs most frequently performed are as follows: • operating machines, tools and equipment for long periods of time; • lengthy operation of machines or tools that require skill and dexterity; and • sitting in one position. in manufacturing, work requires more physical effort and is more strenuous. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vo13 (2000) no 2 181 jobs involving "lifting and carrying loads up and down stairs", "bending and stooping" and "pushing heavy loads" are relatively insignificant in both retail trade and manufacturing. in heavy industries, the jobs most frequently done are: • operating machines, tools and equipment for long periods; • paying attention to detail, functional operation and standing for long periods; • liaising with people; and • lengthy operation of machines or tools that require skill and dexterity. in light industries, the main jobs performed are: • operating machinery, tools or equipment for long periods; • sitting continuously in one position; • lengthy operation of machines or tools that require skill and dexterity; and • work requires excessive physical effort. the jobs that black women do in the light industries require considerable physical effort. this seems be due to the fact that more women are involved in operating machinery in these industries. the concentration of black women in some jobs could be due to employer discrimination or perception. although work in the retail sector does not require much physical effort, in manufacturing it requires medium physical strength. work that requires great physical strength is done to a limited extent in light industries, due mainly to the greater number of women who are machine operators. materials bandied question 12 of the questionnaire requested respondents to indicate the extent to which black women handle various materials or products. the results are shown in table 7. black women do not handle any materials often in either industry. in retail trade, footwear, textiles, leather products and wearing apparel are frequently handled. relatively important in retail trade are also paper products, nonmetallic products, plastic products, food., soaps and pottery. in manufacturing, paper products, food and beverages are mostly handled. women do not handle materials such as motor vehicles and accessories, scientific equipment, metal products, electrical equipment, fertilizers, edible oils and furniture to any significant level. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 182 sajems ns vol 3 (2000) no 2 table 7 materials handled in manufacturing and retail trade materials handled manufacturing retail trade p-value mean std mean std motor 1.12 0.550 1.12 0.489 0.975 paper 1.70 1.189 1.83 1.029 0.366 chemicals 1.46 1.000 1.21 0.664 0.015 metal products 1.43 0.951 1.37 0.730 0.569 scientific equipment 1.44 1.001 1.06 0.275 0.000 electrical 1.29 0.779 1.32 0.690 0.773 plastic products 1.40 0.940 1.93 1.078 0.000 nonmetallic 1.30 0.845 1.68 0.913 0.000 products fertilizers 1.05 0.378 1.10 0.375 0.337 edible oils 1.16 0.596 1.28 0.791 0.145 beverages 1.59 1.088 1.56 1.042 0.812 food 1.76 1.220 1.62 1.115 0.333 furniture 1.22 0.675 1.49 0.927 0.008 soaps 1.39 0.910 1.78 1.077 0.001 textiles 1.38 0.967 2.52 1.329 0.000 pottery 1.23 0.778 1.68 0.985 0.000 candles 1.07 0.431 1.53 0.935 0.000 wearing apparel 1.34 '0.902 2.23 1.431 0.000 leather products 1.29 0.787 2.60 1.452 0.000 footwear 1.26 0.824 2.63 1.460 0.000 black women mostly handle non-durable goods (beverages and food) and semidurable goods (clothing and footwear) rather than durable goods (cars and furniture). also, the market value of the output they handle is low which would have a direct bearing on wage levels and conditions of employment. the type of products and materials handled by black women indicates that they are concentrated in the traditional female industries of manufacturing, such as textile, food and beverages. even in retail trade, black women are responsible for output that does not have high monetary value. importance of special skills question 14 of the questionnaire required the respondent to indicate the importance of certain skills for job performance; see figure 3. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . samms ns vol 3 (2000) no 2 183 figure 3 importance of special skills for job performance in manufacturing and retail industries pbysi<a1 ,kill, co-«diaation manual dexterity 0.5 2.\ lid retail trade ill! manufacturing this. section attempted to detennine whether black women workers required any special skills to do their jobs. the skills concerned are: manual dexterity, coordination and physical skills. none of the skills seem to be especially needed in the retail industry. eye-hand co-ordination and manual dexterity skills are significantly more important in manufacturing. physical skills (means score of 1.8) are deemed unnecessary in both industries. comparing light and heavy industries, all three skills are relatively more important in light compared to heavy industries due to the greater number of women machine operators. the overall impression gained is that job-specific skills are unnecessary and that workers are interchangeable between jobs. representation in different skill categories question 21 of the questionnaire aimed to determine the skill levels of workers. figure 4 displays the scores obtained. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 184 sajems ns vol 3 (2000) no 2 figure 4 skills levels of black women in manufacturing and retail trade hishly skilled (mallie" 2 yb aainins) skilled (sid 7 or 8 " rew months trainins) semi-skilled (primary education" few months traininj) unskilled (only introductory course) 10 is 20 dii retail trade 42.69 25 30 35 40 45 iii manufacturing for all finns, 40% of black women workers were skilled and 24% semi-skilled. in both retail trade (42.69%) and manufacturing (37.84%) industries, the majority or workers were classified as skilled that is, they had a standard 7 or standard 8 education. the second highest group was semi-skilled workers, 22.7% in retailing and 25.89% in manufacturing. the percentage of highly skilled was comparatively low, 20.59% in retail and 15.13% in manufacturing. the number of unskilled black women workers was much higher in manufacturing (21.12%) compared to retail (14%). even though one-fifth of the black women in retailing and more than 10% of those in manufacturing were highly skilled, they did not perform work: commensurate with their skill levels. two possible explanations are plausible. on the one hand, it could be that their skills were undervalued. on the other hand, maybe these women accepted any job owing to the limited number of job vacancies. the number of highly skilled black women is likely to increase in future, given the greater accessibility to education and training opportunities. representation in different departments in question 19, the percentage of black women in the different departments was asked for. table 8 shows the results obtained. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 185 tables percentage black women per department in manufacturing and retail industries representation of black manufacturing retail trade p-value women in the different mean std mean std factory 27.16 31.919 0.800 4.134 0.0001 production 12.30 24.407 0.360 1.815 0.0001 administration 11.29 15.652 14.984 15.544 0.0579 sales 3.99 10.953 51.192 29.174 0.0001 clerical 8.88 13.811 6.384 11.989 0.1189 accounts 5.20 11.166 3.648 7.835 0.1911 supervisory 2.94 5.922 2.824 7.458 0.8826 cleaning & maintenance 18.66 28.238 14.600 19.609 0.1761 technical 2.02 6.714 0.360 1.272 0.0052 labourer & unskilled 7.50 16.876 4.848 13.130 0.1563 in both industries, black women dominated the following four departments or sections: • sales (26%); • cleaning and maintenance (17%); • factory work (15%); and • administration (13%). a mere 1 % of black women were employed in technical jobs and only 2% in supervisory positions. the number in production and clerical work is approximately 7% to 8%. in manufacturing, black women were found in the following departments: • factory (27.16%); • production (12.30%); • administration (11.29%); and • cleaning and maintenance (18.66%). in retail trade, the number of black women worked mainly in the following sections: • administration (14.98%); • sales (51.19%); and • cleaning and maintenance (i4.6oelo). the number of skilled black women is higher in manufacturing than retail trade. but in both industries, the number of black women in supervisory positions is low (3%). also, the number of women in the technical field is low (2%). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 186 sajems ns vol 3 (2000) no 2 in light industry more black women were found in the factory and in heavy industry, in the cleaning and maintenance departments. in heavy industry, factory, production and administration are rated high. the number of black unskilled workers was higher in light industries compared to heavy industries. the above analysis points to the fact that black women performed mostly secondary kind jobs in most industries. black women were also concentrated in a limited range of jobs. furthermore, these jobs are stereotyped and an extension of the household care that women provide at home. conclusion the questionnaire generated information on a number of important issues. the results of the survey confirm the hypothesis that black women are doing work that is rudimentary, quite dangerous, physically demanding and repetitive in nature. in other words, they do mainly semi-skilled work. most importantly, they work in secondary jobs under both unpleasant and dangerous working conditions (e.g. exposure to dirt, noise, and a high risk of incurring cuts). black women also perform basic administrative jobs (telephonist, clerk) and genderstereotyped jobs (salesworker, cleaner, serving tea). the jobs of black women are often physically quite demanding as the work involves standing and walking about, lifting goods that weigh an average of 9.5kgs, and doing a large amount of packing in both retail and manufacturing industries. the number black women doing the preferred or primary kind of jobs, such as the technical and supervisory work, is negligible. even the number of black women doing more challenging jobs, such as bookkeeping and accounts, is low. the labour market thus appears to be segmented along racial and gender lines. the distribution of black women workers is such that they are found mainly in the factory (15%), administration (13%), sales (26%) and cleaning and maintenance (17%). the number of back women in supervisory and technical positions is negligible, namely, 2% and 3% respectively. the nature of jobs that black women perform implies that they constitute a peripheral rather than a core workforce and their activities are subsidiary to the production process. the type of work black women do is prone to rationalization, thereby making women more expendable in the event of downsizing. it is only in the traditional female industries, for example, the textile and food industry, that black women function as machine and general operators and can be viewed as directly responsible for production. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 187 deskilling makes workers more interchangeable and expendable. typically "women's jobs" are more prone to deskilling and displacement from technological change. microelectronic technology can replace clerical work and repetitive tasks in manufacturing like assembly-line work and packing. women in manual work are under-represented in all skilled work, with the exception of machine operators in the light industries, whilst they are again over-represented in jobs like packing~ in non-manual work, they are overrepresented in clerical, sales and service jobs. black women have been only able to secure employment in almost only low status, menial and low-paying jobs, seeing that racism, classicism and sexism are locked together to limit their employability in the formal labour market. black women experienced much hardship in their personal and working lives as a result of apartheid. their marginality in the labour market is evident in the kind of jobs they undertake. given the transformation of south african society, a growing economy and greater access to education and training, it is hoped that black women workers will rise to the upper levels of the occupational hierarchy. thus a higher overall material well-being could be attained endnote a copy of the questionnaire may be obtained from the authors on request. references bozzoli, b. (1983) "marxism, feminism and south african studies", journal of southern african studies, 9(2): 139-71. 2 budlender, d. (1991) women and the economy, case offices: johannesburg. 3 berger, 1. (1992) threads of solidarity women in south african industry 1900 1980, indiana university press: indianapolis. 4 gwagwa, n.n. (1989) "the family and woman's emancipation in south africa", unpublished paper, malibongwe conference: amsterdam. 5 hays, w.l. (1963) statistics, holt, rinehart and winston: new york. 6 k.raak, g. (1993) breaking the chains labour in south africa in the 1970s and 1980s, pluto press: london. 7 standing, g.; sender, j. and weeks, j. (1996) restructuring the south african labour market the south african challenge, international labour office: geneva. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 188 sajems ns vol 3 (2000) no 2 8 statistics south africa (1998) census in brief, report no. 1:03:01:11. pretoria. 9 themba, a. (1986) "educational obstacles to black advancement", in blackadvancement, smollan, r. (ed.) macmillan press: johannesburg. to walker, c. (1990) women and gender in southern africa to 1945, david philip: cape town. 11 winer, b.j. (1971) statistical principles in experimental design, mcgraw-hill publishers: tokyo. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 2 192 maintaining financial stability' e a j george governor of the bank of england monetary stability gerhard (de kock) took a close interest in our experiments (at the bank of england) with intermediate monetary targets in the late 1970s and first half of the 1980s. in the event, unpredictable changes in the velocity of circulation at a time of financial deregulation and intensifying competition meant that monetary growth proved to be an unreliable short-term guide to monetary policy, though we still pay very careful attention to underlying trends in the growth of money and credit. the focus of monetary policy now in the uk is an explicit target for retail price inflation, not simply as an end in itself, but as a means to the end of sustainable growth. inflation is in effect regarded as a measure of the balance between aggregate demand, which we can influence through monetary policy, and the underlying, supply-side, capacity of the economy determined essentially by its structural characteristics to meet that demand. so what we are, in fact, doing, in seeking to achieve our inflation target, is to keep demand growing more or less continuously in line with the growth in capacity thereby avoiding the exaggerated inflationary booms, and inevitable, consequential busts that we experienced all too often in the past. we cannot contribute much directly through monetary policy to underlying, supply-side, capacity growth. but if we are successful in maintaining monetary stability in this broad sense, that will provide the context for more rational and longer-term economic industrial, commercial and financial decision-making and so contribute indirectly to the underlying growth of potential output. gerhard de kock would, i think, have approved of what we are trying to do in the uk. the basic underlying philosophy of macroeconomic, monetary, stability and • gerhard de kock memonal lecture. university of pretoria in co-operation with the south african reserve bank, pretoria, delivered on 10 february 1998. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 193 sateb nr vol 1 (1998) nr:; supply-side refonn is, as i understand it, essentially the same as that which underlies your own gear strategy to promote sustainable growth here too in south africa. he would have approved too, of the fact that the bank of england has now been made operationally independent. financial stability in my conversations with gerhard we did not much discuss the other essential purpose of central banks everywhere maintaining the stability of the financial system. as if to make up for that, i should like to take financial stability as the subject of my lecture this evening. of course the two core central banking purposes monetary and financial stability are inextricably bound up with each other. failure to maintain monetary stability provides a very uncertain operating environment for financial intennediaries, which is largely outside their control. but this causality may sometimes run the other way. just as monetary instability can undennine the stability of financial institutions, so too the emergence of weakness in the financial system can disrupt monetary stability. you cannot easily maintain a stable monetary policy if the banking system in particular is collapsing about your ears! financial intennediaries are in the business of taking and managing financial risk that is their economic function, for which they are paid. banks, of course, classically take on the particular risk of maturity transfonnation. their liabilities represent "money" because they are typically immediately available on demand to make payments or to be turned into an obligation of the central bank. on the asset side, banks are still the overwhelming providers of, mostly non-marketable, loans to the economy, which involves them not just in credit risk but also liquidity risk, because most loans cannot in practice be called on demand. this service converting immediately liquid liabilities into less liquid loans is still in fact what distinguishes banking from other fonns offinancial intennediation. in the nonnal course of events a bank will maintain a sufficient proportion of its assets available, to meet withdrawals of deposits, in the fonn of liquid assets which may be realised in the money market or which are acceptable to the central bank in the conduct of its regular money market operations, as well as sufficient capital to act as a cushion against loan losses. but driven by competition which is vitally important for the efficiency of the system a bank may overextend itself and be r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 2 194 faced with failure. in principle the potential failure may be a result either of illiquidity or of insolvency but in practice initial illiquidity may well lead on to insolvency if the bank in question has to realise illiquid assets at a loss. individual bank failures are not necessarily serious in themselves at least from a systemic or macroeconomic standpoint. the possibility of failure is an intrinsic feature of a market economy and indeed an essential part of market discipline. but in the case of bank failures there is a danger that the initial failure will bring down other otherwise healthy banks. the reasons are plain. banks typically have substantial direct exposures to each other, as a result of their involvement in payments and settlements systems, on their own account or on behalf of customers and they have direct exposures to each other through interbank credit lines. but even where there is no direct exposure to the failing bank, other banks particularly those with a similar business profile may be affected by a loss of confidence on the part of their depositors or other creditors, and a drain on their liquidity. so bank failures can be contagious, and once contagion starts it can be difficult to stop. now none of this is new. in fact maintaining the stability of the financial system was increasingly recognised as a key responsibility of the bank of england, following a series of systemic disturbances during the 19th century; and it has since become a core function of central banks everywhere. what has changed is the financial environment. new technology, increased competition, and financial deregulation have progressively transformed the financial services industry over the past twenty years or more. the result has been a blurring of traditional boundaries between different types of financial intermediaries, the emergence of complex financial groupings, and the development of new financial markets, new instruments and new techniques. these changes have brought huge benefits to consumers of financial services, which translate into benefits to the macroeconomy. they provide new opportunities, too, to the financial intermediaries themselvesif they choose to take advantage of them to diversify their risks and to manage them more effectively. but they equally provide new opportunities for financial intermediaries to take on additional risk. if such additional risk is mismanaged, it can add to the danger of financial instability and increase the risk of its spreading through the banking system, which remains especially vulnerable to contagion. so the task of preserving systemic financial stability has become a good deal more complex. it goes without saying that a key condition is macroeconomic, monetary stability. but, beyond that, it breaks down essentially between accident prevention and damage limitation which i will discuss briefly in tum. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 195 sa teb nr vol 1 (1998) nr :2 accident prevention (i) infrastructure new technology can, of course, be turned to advantage in the task of maintaining systemic stability, and applied to accident prevention, most obviously by reducing interbank risks in payments and settlements systems. until quite recently in the uk and we were by no means uniqueour core sterling payments system involved end of day net settlement, in which the settlement banks did not even know the size of their intra-day exposure to each other. now sterling interbank payments are made, definitively, in real time, on a gross basis across accounts at the bank of england, so that interbank payments exposures have effectively been eliminated. from next year similar national real time gross settlement systems for payments in the new euro currency will be linked together through a system, called target, allowing euro payments to be made in real time throughout the whole of the european union. in principle rtgs payments systems can be linked with securities settlements systems, or with foreign currency payments in settlement of foreign exchange transactions, to provide simultaneous delivery against payment. with sufficient application, nationally and internationally, payment and settlement risk could eventually become a thing of the past as a potential cause of systemic instability though we do need to sort out the millenium bug first! (ii) supervision and regulation helpful though it is, improving the payments and settlements infrastructure addresses only a part of the risk of systemic instability. our main defense against accidents will, of course, remain supervision and regulation of individual financial intermediaries. financial regulation in fact has a dual purpose. it evolved originally, in the uk at least, in the context of the bank of england's concern for systemic stability, which led us to exercise informal and non-statutory surveillance over key elements of the banking system. but the purpose, and scope, of financial regulation has over the past twenty years or so been extended to include a degree of consumer protection, against financial loss in the event of the failure of financial intermediaries, and also against business misconduct. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 2 196 for the most part these conceptually distinct purposes of financial regulation sit reasonably comfortably alongside each other. the prudential supervision or regulation is essentially the same and there are practical advantages in conducting the regulatory oversight for both purposes as a single operation. the important thing is that the twin purposes be kept in balance. systemic stability does not mean that the aim of prodential regulation should be to prevent the failure of each individual financial intermediary. indeed it would overconstrain the capacity of the financial system to perform its essential risk-taking function, and weaken market disciplines, if that were to become the aim. the protection of individual consumers, on the other hand, does point more in that direction, but it would similarly create "moral hazard" and undermine market discipline if authorisation of a financial intermediary came to be regarded as an implicit guarantee against failure. limited protection schemes for depositors or investors can help to square the circle. they recognise that many smaller, often financially less sophisticated, depositors cannot realistically know enough about their reliability. but such schemes in the uk are deliberately and in my view wisely limited. if users of financial services were relieved of all responsibility, their money would simply flow to the highest bidder, regardless of risk, which would distort competition and actually encourage systemic fragility. the message of limited protection is unmistakable. financial intermediaries can fail and consumers can lose at least a part of their money. the underlying question is just how much risk we wish to tolerate in the financial system. there can be no definitive, precise, answer. it emerges in practice out of the decisions of the regulator, and as a result of public and political reactions to particular events. but there is little doubt, it seems to me, that rising public expectations, in the context of the rapid evolution of financial markets, are causing the tide to run in favour of greater protection. these same developments the pace of financial change, including particularly the blurring of traditional boundaries between different types of financial intermediary, and increased emphasis on protection raise major questions about the appropriate structure of financial regulation. they explain the recent decision in the uk to consolidate all the various separate financial regulators, of particular types of intermediary or activity, under the single umbrella of the new financial services authority. the fsa is in the process of taking on responsibility for the regulation of all forms of financial activity in the uk banks, building societies, securities businesses, insurance and so on including both the prudential r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 197 sateb nr vol i (1998) nr 2 supervision of individual intermediaries and regulation of their business behaviour. this includes responsibility for banking supervision which has up to now been with the bank of england although the bank remains responsible for the overall stability of the financial system as a whole. there are compelling reasons in the british context for making this change. it will in particular facilitate the effective, consolidated, oversight of multi-functional financial businesses including banking businesses. and it provides clearer lines of responsibility, both for the regulated intermediaries themselves and for the consuming public. we will in fact have a one-stop regulatory shop. from the bank of england's perspective it relieves us and it is a relief of a growing involvement in consumer protection, which is not our natural habitat. it allows us to focus more single-mindedly on systemic stability. for that purpose, of course, we will need to maintain a very close and continuous working relationship with the fsa as we certainly will. whatever the regulatory structure, the pace of financial change has major implications, too, for supervisory techniques. just as some i'm tempted to say many financial intermediaries themselves are having to struggle to keep up with changes in the market place in terms of risk management and controls, so too are the supervisors. the setting and monitoring of minimum standards for capital, liquidity and concentration of risk to ensure that intermediaries have a cushion against emerging pressures giving them time to respond is still at the heart of it. but their financial condition can now change so rapidly that supervisors too are having to focus increasingly on systems and processes rather than on balance sheets. it is a trend that i expect to continue. damage limitation prudential supervision of individual financial institutions is a powerful defense against systemic instability and can be used pro-actively to encourage them to prepare by strengthening their liquidity. for example, or scaling down their business ahead of an approaching storm. but accidents will inevitably happen. the central bank's concern then is to ensure that it does not spread to other parts of the financial system. this may involve providing liquidity on penal terms, outside the central bank's normal money market operations, against high quality assets to a particular institution. that does not want to appear in the market because it is under a cloud. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 2 198 or it may mean standing between an intermediary and the market place, to facilitate payments or settlements which might not otherwise be completed, which could then cause gridlock. such involvement would not normally involve the central bank in significant financial risk. but in more difficult and mercifully rare situations, where the failure of one institution could bring down other otherwise viable institutions, the central bank may need to consider acting in the role of "lender of last resort" to the failing institution, against poorer quality, less liquid, assets which might expose the central bank to financial loss. the key phrase here, of course, is "where its failure could bring down other otherwise viable institutions". the central bank safety net is not there to protect individual institutions from failure. it is there to protect the stability of the financial system as a whole. in the absence of a serious systemic threat, the right course would be to allow the institution to fail. if any institution felt that it could rely on being bailed out if it ran into real difficulty, that, too, would introduce "moral hazard", encouraging excessive risk-taking and financial fragility in the system as a whole. there can be nothing automatic about "lender of last resort" assistance and, when it is provided, it should always be on the most onerous terms that the borrower can bear: it is not provided to protect the shareholders who should be looked to first. nor is it there to protect the management. "lender of last resort" assistance involves the commitment of public money taxpayers' money and it needs therefore to be justified in terms of the damage that would otherwise result to the financial system and to the wider economy. for this reason we at the bank of england would always seek the chancellor of the exchequer's explicit prior approval wherever circumstances allowed, or at least his tacit prior approval, in emergency situations and where the risks were manageable in relation to the size of our capital. global financial stability so far i have discussed financial stability implicitly in a national context. but there is of course a read-across to international financial stability, to which i now turn. financial change has become increasingly global in scope. information technology knows no national boundaries, and competition including the provision of financial services abroad has been as much a cause as an effect of deregulation and increasingly free international movement of capital. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 199 satebnr vol i (1998)nr2 all this has brought huge economic benefits, not just to the emerging countries of latin america and asia, or the transition economies of eastern europe, through faster growth of the world economy as a whole. at the same time it has also brought greater risks of global instability, as we have seen most recently in asia. these recent crises are unusual. typically in the past international payments problems have had their origins in some evident macroeconomic policy failure. at least in hindsight there are usually clear tell-tale signs of expanding fiscal deficits and/or lax monetary policies, accompanied by evidence of imbalance in the form of accelerating inflation or a rapid deterioration in the external current account. there were such signs in some of the asian countries involved in the recent crises; but they were not, for the most part, particularly pronounced. in fact through the earlier part of the 1990s, and in some cases for very much longer, the countries in question were remarkably successful, so much so that they attracted, by their very success, huge inflows of capital from the rest of the world, in search of higher returns than were available in the more mature industrialised countries. with the benefit of hindsight the increasing scale of the capital inflow, and particularly the form that it took, became an important part of the problem. it was not all effectively employed. there was overinvestment in some production sectors; much of it went into ambitious property development; and much went into financial rather than real assets. again, with the benefit of hindsight, one can identify a number of structural weaknesses in the financial structures of the recipient countries which contributed to this misallocation of capital. there was, for example, a general lack of reliable financial information, and a lack of transparency in relation to the financial position of both the public and private sectors. financial markets were not well developed, leaving the system heavily dependent upon the banks. there was inadequate regulatory oversight especially over the banking system. and there was widespread government influence over the allocation of finance which contributed to a perception that much of the borrowing was effectively underwritten. a key part of the problem was the seemingly unrecognised build-up of unhedged, increasingly short-term, foreign currency debt as an apparently cheap alternative to domestic currency borrowing. the borrowers variously the local banks and non-banks were obviously convinced that exchange rate pegs against the dollar would be maintained even when the dollar strengthened as they had been earlier during the period of dollar weakness. the result was that the asian economies were extraordinarily vulnerable to a change in sentiment and a withdrawal of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no:2 200 foreign currency credit lines. there was little that the national authorities could do once this started. they can in principle create their domestic currency through the national central bank if they choose to do so, even if it may lead to inflation; but they cannot simply create foreign currencies out of thin air in the same way. so, once the run started, it was violent and contagious. accident prevention clearly in this international context, too, accident prevention is infinitely better than damage limitation. that certainly means continuing emphasis on disciplined national macroeconomic policies and on international macroeconomic policy surveillance through the imf. but the particular lessons of asia are that we must pay far more attention to international capital flows, the forms they take and the uses to which they are put. that means greater emphasis on the structure and efficiency of the financial system, including the development of more transparent and open capital markets. it means more effective financial regulation, including regulation of the banking system in line with the "core principles" developed by the bis. and it means, crucially in my view, collecting and monitoring, and preferably publishing through the imf, more comprehensive data on the foreign currency assets and liabilities, both on and off balance sheet, and their maturity structure, of both the public sector and the banking system. the imf and world bank have a key role in bringing about these changes. meanwhile, from the creditor side, it was clear, well before the asian cnsis, financial globalisation means we must be able to exercise more comprehensive umbrella or consolidated oversight over multinational financial firms. that might ultimately involve changes to the international structure of regulation. it certainly means greater international regulatory co-operation between regulators and financial market authorities both multilaterally, through the relevant international institutions, but also through the expanding network of bilateral relationships. it is a huge agenda given added urgency by recent events. damage limitation immediate attention in the asian crisis has nevertheless necessarily focused on damage· i imitation. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 201 sateb nr vol 1 (1998) nr 2 essentially there are two broad options for dealing with the sort of crisis that suddenly broke over asia. one is simply to allow financial markets exchange rates, interest rates and stock and bond prices to take the strain, and to seek to restore confidence, and moderate the impact of market movements, by restrictive macroeconomic policy adjustment. the second is to limit the financial market impact and the extent of the associated macroeconomic adjustment by providing or arranging alternative external financing. in practice these options are not, of course, mutually exclusive and the real question is the appropriate balance between them. where a country has transparently been pursuing an undisciplined and unsustainable macro-economic policy, most people find it easy to accept that that country should bear the burden and adjust, painful though that may be. many people find that harder to accept where, as in the present case, conventional macroeconomic policies had, for the most part, been relatively responsible and the immediate severity of the problem arose largely from weak financial structures and, immediately, from a lack of foreign currency liquidity. there were certainly adjustments to macroeconomic policy that needed to be made. and, once the capital outflow had started, macroeconomic retrenchment needed to be more abrupt than might otherwise have been necessary, in order to shore up confidence. but there are real dangers in extreme market movements or in excessively severe macroeconomic adjustment to contain them. that could cause a vicious circle of domestic default and aggravate systemic financial weakness. and it would have seriously adverse implications in terms of both financial and economic knockon-effects for the global economy. that, essentially, is why it was in the self-interest of the international community to attempt to mitigate the market and macroeconomic adjustment pressures in asia by providing official financial support. it is why the international community acting effectively as international lender of last resort promptly offered very large amounts of official assistance $17 bn in the case of thailand, $43 bn for indonesia and $57 bn for south korea. but, as in the domestic context, official last resort assistance cannot be unlimited and it cannot be provided without strings. it, too, has real dangers. if it were too readily forthcoming it could encourage "moral hazard", especially by encouraging commercial lenders particularly foreign currency creditors in the belief that they will be bailed out if things go wrong. that would be likely to add to the problem of potentially volatile capital inflows next time around. not surprisingly, too, there is strong political resistance in many countries, including notably the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 2 202 united states, to the idea that public taxpayers' money should be used to bail out private creditors, especially foreign creditors, without clear demonstration that it is in their own national as well as the international interest. alternative external financing need not come solely from the public sector. private finance would, in principle, serve the same purpose, and in many situations moderate market price adjustments may be sufficient to attract back private inflows. but given the extent of the loss of confidence in asia it would have been optimistic to think that other private lenders would volunteer to stand in place of those that are rushing for the exit. in practice in the present situation private support meant persuading existing creditors that their assets would be better protected if they were prepared to leave them in place, especially if other major creditors agreed to do the same, and if official support were being made available in parallel. but in this case, too, difficult judgments have to be made. there are powerful arguments for somehow or other making the provision of exceptional official support in a foreign currency liquidity crisis, dependent upon forbearance on the part of private foreign currency creditors as a matter of course. but that is not the situation we are currently in. in the absence of such arrangements, there is a danger that, if private creditors have in effect to be coerced into staying put, they will immediately cut their positions elsewhere, before they become locked in there too, adding to the international contagion. achieving a reasonable balance between market and macroeconomic policy adjustment and official and private financing was never going to be easy. it depended upon the good sense and judgement of key players all around the world the governments and central banks as well as major market participants in both the major creditor and the debtor countries, as well as the international organisations. my impression is that after the initial shocks, in which market adjustments have been massively overdone, the key players are now co-operating more effectively to bring about stabilisation. within the constraints imposed upon it, the imf in particular is playing a very positive leading role. i especially welcome the constructive part which the major commercial banks, from all the main creditor countries, are now playing in extending the maturity of their loans to korean banks and in finding workable solutions to the debt problems of indonesian corporations. this has already helped to stabilise the situation in the region more widely and, i believe, now provides the basis for convalescence. there will nevertheless be a very significant price to pay in terms of slower world economic activity for some time to come particularly, but not only, in asia. in that light we clearly need to review international arrangements for handling such crises in the future to see if there are ways in which the economic costs could be reduced. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 203 sateb nr voll (1998) nr 2 conclusion there is something of an irony in the fact that financial stability nationally and internationally should come to the top of the agenda, as a result of the rapid changes in the financial services industry and deregulation of domestic and external capital flows, at a time when we are making relatively good progress towards sustained monetary stability. it means i think that central banks and financial regulators will continue to find plenty of work to do. it is a challenge which gerhard de kock would have relished. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction and background problem statement research objective, research methodology, scope and value of research the literal (ordinary) meaning of the term ‘income’ interpretation of words used by the legislature understanding the meaning of ‘income’ in sections 7(2) to 7(8) of the act conclusion and recommendations acknowledgements references about the author(s) danielle van wyk school of accountancy, university of stellenbosch, south africa mareli dippenaar school of accountancy, university of stellenbosch, south africa citation van wyk, d. & dippenaar, m., 2017, ‘a critical analysis of the meaning of the term ‘income’ in sections 7(2) to 7(8) of the income tax act no. 58 of 1962, south african journal of economic and management sciences 20(1), a1560. https://doi.org/10.4102/sajems.v20i1.1560 original research a critical analysis of the meaning of the term ‘income’ in sections 7(2) to 7(8) of the income tax act no. 58 of 1962 danielle van wyk, mareli dippenaar received: 10 mar. 2016; accepted: 29 aug. 2016; published: 26 apr. 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: section 7 of the income tax act 58 of 1962 (the act) was introduced as an anti-avoidance measure to prevent tax avoidance by means of a donation, settlement or other disposition in various types of schemes. in terms of this section, in certain circumstances, ‘income’ is deemed to be income received by or accrued to a taxpayer. despite the fact that the term ‘income’ has been used in section 7 from the time that it was first introduced into the act and the fact that it is defined in section 1 of the act, there still remains uncertainty regarding the intention of the legislature and the actual meaning of the term in terms of section 7. aim: the objective of the study is to understand whether the term ‘income’, as used in sections 7(2) to 7(8) of the act, is used in its defined sense or if it should be ascribed a different meaning. setting: this article examines existing literature in a south african income tax environment. method: a non-empirical study of existing literature was conducted by performing a historical analysis within a south african context. a doctrinal research approach was followed. results: possible interpretations determined include ‘income’ as defined in section 1 of the act, namely ‘gross income’ (also defined) less exempt income, ‘gross income’, profits and gains or ‘taxable income’ (i.e. ‘income’ less allowable expenditure, deductions and losses) and ‘gross income’ less related deductible expenses and losses. conclusion: it was found that the meaning of ‘income’, for purposes of sections 7(2) to 7(8), remains an uncertainty, and it is recommended that the wording of section 7 be amended to reflect the intended meaning thereof. introduction and background sections 7(2) to 7(8) of the income tax act 58 of 1962 (the act) were introduced into the legislation as an anti-avoidance measure to prevent tax avoidance by means of a donation, settlement or other disposition by a taxpayer, to or in favour of another, in various types of schemes. in terms of these provisions, a person other than the person who is entitled to the income or who receives the income is deemed to be taxable on certain ‘income’. although the income tax act 28 of 1914 (1914 act) contained a section that is equivalent to the current section 7(1) deemed accrual provision and a section that is the predecessor of the current section 7(2), the equivalent of the current sections 7(3) to 7(8) was only added much later: as the years went by, more tax avoidance schemes were designed by taxpayers and the legislature attempted to close the loopholes by introducing further anti-avoidance measures. the predecessor of section 7(3) was added to income tax act 40 of 1925, although no reference was yet made to a donation, settlement or other disposition (those words were only added by income tax act 28 of 1932, resulting in the section closely reflecting the current version of section 7[3]). provisions similar to the provisions of the current sections 7(4) to 7(6) have been part of the south african income tax legislation since 1941 (republic of south africa 1941). section 7(7) was only added in 1983 to counter tax avoidance schemes whereby taxpayers attempted to transfer certain of their income to others, without necessarily surrendering control over the income or over the investments that generate the income (republic of south africa 1983). section 7(8) was only introduced in 2000 (republic of south africa 2000), although its provisions were previously covered by the scope of section 9d of the act. the provisions of section 9d used to provide for the taxation of investment income of controlled foreign entities (presently known as controlled foreign companies) and investment income arising from donations, settlements or other dispositions. however, it was proposed in 2000 that section 9d only deal with the income of controlled foreign entities and that the anti-avoidance provisions relating to donations, settlements or other dispositions be included in section 7, which deals with similar anti-avoidance issues (republic of south africa 2000). various other changes were made to section 7 over the years to either cover additional loopholes, to clarify the provisions or to simply make consequential amendments where other legislation, definitions and terminology changed. section 7(2) was amended numerous times to clarify which persons and what income are covered by its provisions. the section initially only deemed the income of a married woman to be the income of her husband, but this was subsequently amended to deem the income of either spouse (husband or wife) to be the income of the other spouse, in certain circumstances (republic of south africa 1991). other notable amendments to section 7 include: the addition of sections 7(2b) and 7(8)(b) to allow any deduction or allowance relating to the income, in the hands of the spouse (or resident, in the case of section 7[8]) that is being taxed on the deemed income (republic of south africa 1992, 2005a) and the amendment of section 7(8) to refer to ‘any amount…which would have constituted income’ instead of to ‘income’ (republic of south africa 2004a). throughout the current section 7, with the exception of section 7(8), the term ‘income’ is used in the deemed income provisions of this section. section 7(8) also used to refer to ‘income’, until it was amended in 2004, as pointed out above. the term ‘income’ has, in fact, been used in section 7 from the time it was first introduced into the act. in addition, the term ‘income’ is defined in section 1 of the act and has had the same meaning, namely ‘the amount remaining of the gross income…after deducting therefrom any amounts exempt from normal tax…’, since 1925 (republic of south africa 1925, 1941, 1962). the 1914 act, which contains the predecessors of the current section 7(1) and 7(2), also referred to ‘income’ in those sections, although ‘income’ had an entirely different meaning back then. there was no distinction between ‘gross income’ and ‘income’ in 1914 and ‘income’ was defined as ‘any gains or profits derived by, or accrued to or in favour of…from any source within the union…’. however, although the term used in section 7 and its definition in section 1 have remained unchanged from 1925, there still remains uncertainty regarding the intention of the legislature and the actual meaning of the term in terms of section 7. problem statement the term ‘income’ is defined in section 1 of the act as ‘the amount remaining of the gross income… after deducting therefrom any amounts exempt from normal tax under part i of chapter ii’. the term ‘income’ is, however, used in some provisions of the act, where the meaning thereof could be interpreted to be different to the definition in section 1 of the act, such as in the anti-avoidance measures of section 7. if these sections of the act are interpreted incorrectly, it can have far-reaching consequences, which might lead to either a loss to the fiscus or unfair tax consequences for the taxpayer. various academic writers have identified the lack of guidance from the south african government regarding the meaning of the term ‘income’, as used in sections 7(2) to 7(8). these writers have different opinions regarding whether the term means ‘income’ in the literal (ordinary) sense of the word or if it should be ascribed a different meaning in the context that it is used (clegg & stretch 2007; davis, olivier & urquhart 1999; de koker & williams 2001; de swardt et al. 2015; meyerowitz 2008; meyerowitz & spiro 1995; olivier 1989). research objective, research methodology, scope and value of research the objective of the study is to understand whether the term ‘income’, as used in sections 7(2) to 7(8) of the act, is used in its defined sense, namely the amount remaining of the ‘gross income’ after the deduction of allowable exemptions, or if it should be ascribed a different meaning. a non-empirical study of existing literature was conducted by performing a historical analysis within a south african context. a doctrinal research approach was followed by applying the following steps to solve the specific research problem, as suggested by hutchinson and duncan (2012): gathering the relevant facts identifying the relevant legal issue at hand analysing the issue from a legal perspective studying relevant background material such as dictionaries, textbooks and journal articles, inter alia analysing primary research sources such as case law and legislation combining all issues within the context reaching a preliminary conclusion. the research objective was achieved by investigating the following: the meaning of the term ‘income’ as used in sections 7(2) to 7(8) of the act, by exploring the ordinary definition thereof as well as obtaining an understanding of the different interpretations suggested by various academic writers, as there is no specific guidance available in this regard the impact of the different possible interpretations of the term ‘income’ in sections 7(2) to 7(8) of the act on a taxpayer’s ‘taxable income’. the study can potentially highlight areas for improvement or, at the very least, for a consideration by the south african department of national treasury to clarify the meaning of the term ‘income’ in sections 7(2) to 7(8). the study can potentially also assist taxpayers to understand this intended meaning, to correctly apply the provisions thereof in their tax returns. this could prevent possible unfair tax consequences to either taxpayers or the fiscus. the study commences with a brief summary of all the possible literal (ordinary) meanings of the term ‘income’ and a discussion of the possible approaches to the interpretation of legislation. this is followed by a discussion of the possible interpretations of the term ‘income’, as suggested by various academic writers, for each of the sections 7(2) to 7(8), a practical illustration of the impact of each possible interpretation on a taxpayer’s taxable income and a conclusion regarding the most likely interpretation intended by the legislature, based on the literature study performed. the study concludes with recommendations for the amendment of the existing wording in section 7 in order to clarify the legislature’s intention regarding the amounts that are deemed to have accrued to a specific person. the literal (ordinary) meaning of the term ‘income’ the term ‘income’ can have different meanings, depending on the context in which it is used. the possible literal (ordinary) meaning of the term ‘income’ is assessed in terms of dictionaries, as well as from an accounting, general business and tax perspective. the oxford english dictionary (2015) defines ‘income’, inter alia, as profit and proceeds, while the collins english dictionary (2015) defines it as ‘the amount of monetary or other returns, either earned or unearned, accruing over a given period of time’ or ‘receipts or revenue’. the penguin english dictionary (2015) has a similar definition as the collins english dictionary, namely ‘money received from work, property, or investment, regularly or over a specified time’. the chambers dictionary (2015), on the other hand, defines ‘income’ as profit or interest from anything, as well as revenue. it therefore seems as if dictionaries define income as representing both a gross and net amount (in other words, after deducting expenditure). the international financial reporting standards (ifrs foundation 2015) define ‘income’ as: increases in economic benefits during an accounting period in the form of inflows or enhancements of assets or decreases of liabilities which result in an increase in equity, other than those relating to contributions from equity participants. (appendix a) this clearly refers to gross amounts, as opposed to net amounts after deductions. from a business perspective, income is generally accepted to represent total receipts, revenue or earnings, in other words, also a gross amount. the act, on the other hand, defines the term ‘income’ in section 1 as ‘gross income’ less the exempted income, but before any deductions. according to clegg and stretch (2015), ‘unless the context otherwise indicates’, the meaning attributed to specific words must be those given in the definition sections of the act. section 1 of the act, which defines ‘income’, contains the words ‘unless the context otherwise indicates’. this stipulates that the defined meaning provided will not necessarily apply in all circumstances. clegg and stretch (2015) further note that, in establishing whether or not the context indicates otherwise, the whole of the act must be considered, as other parts of the act can shed light upon the legislature’s intention. for purposes of this study, the literal (ordinary) meaning of the term ‘income’ will be interpreted as the defined meaning in section 1 of the act, unless the context otherwise indicates. interpretation of words used by the legislature in this section of the article, the interpretation of words used by the legislature is briefly discussed, to form the basis for the interpretation of the term ‘income’ as used in sections 7(2) to 7(8). clegg and stretch (2015) note that the interpretation of statutes is frequently a tough task and the rules of interpretation are not applied consistently. they further state that income tax is, in principle, a creature of statute, and the principles of interpretation which apply to statutes, also apply to the interpretation of tax statutes. according to de koker and williams (2015), the meaning of the words used by the legislature is often unclear because of the nature of the language. reference is made to case law in this regard for guidance on interpretation. two main approaches of interpretation are applied by the courts when interpreting the law: the literal (textual) approach and the purposive (contextual) approach (de swardt et al. 2015). in terms of the literal approach, the interpreter pays attention to the plain language of the provisions of the act (de koker & williams 2015). the literal approach to the interpretation was described in the judgement of cape brandy syndicate v inland revenue commissioners k.b. (swarbrick 2015), as follows: …[i]n a taxing act one has to look merely at what is clearly said…there is no equity about a tax. there is no presumption as to a tax. nothing is to be read in, nothing to be implied. one can only look fairly at the language used. (p. 71) according to van der zwan (2015), the literal approach was, however, altered slightly in the case of r koster & son (pty) ltd & another v commissioner for inland revenue 47 satc 23. in circumstances where the literal approach gives rise to absurdity, inconsistency, hardship or anomaly, the courts may depart from the ordinary meaning of the word, to the extent that is required to eliminate the absurdity, inconsistency, hardship or anomaly and to give effect to the intention of the legislature by interpreting the word in its context (de koker & williams 2015). if the ordinary wording does not indicate the intention of the legislature, the contra fiscum rule must apply, which means that the text must be given the interpretation that is in favour of the taxpayer (de koker & williams 2015). the purposive approach determines the purpose of the legislation by taking all the adjacent circumstances and resources into account (de swardt et al. 2015). in order to give meaning to the fundamental purpose of the statute, the interpreter takes numerous factors into account, including the context and political context in which the legislation was approved, the evil which the legislation is intended to forbid and punish and the good which the legislation is intended to indorse (mota 2012). according to van der zwan (2015), the purposive approach essentially entails legislation to be interpreted holistically. he further remarks that wording with several interpretations, and where the purpose of the legislation may not be reflected by some of them, should be seen as preconditions for this interpretation approach and not necessarily ambiguous wording. ambiguity or uncertainty arises where the meaning of the words used is unclear and can either be regarding individual words or an entire phrase (clegg & stretch 2015). sections 39(1) and (2) of the constitution of the republic of south africa, act 108 of 1996 (the constitution) state the following: when interpreting the bill of rights, a court, tribunal or forum: (a) must promote the values that underlie an open and democratic society based on human dignity, equality and freedom (b) must consider international law (c) may consider foreign law. when interpreting any legislation, and when developing the common law or customary law, every court, tribunal or forum must promote the spirit, purport and objects of the bill of rights. sections 39(1) and (2) of the constitution, therefore, indicate that it is vital that the purposive approach be followed when interpreting legislation (de swardt et al. 2015). mdumbe (2004) states that the starting point when interpreting legislation remains to read the text. the courts should, nevertheless, also consider the broader context and not limit themselves to the wording of the text. in 2008, goldswain performed a study to examine the way that the interpretation of fiscal legislation is approached by our judiciary. the study concluded that the promulgation of the constitution has been a catalyst for a change in interpretation approaches, from literal to purposive (goldswain 2008). following the aforementioned, the ordinary (literal) meaning of the term ‘income’ will be referred to, unless it is in conflict with the intention of the legislature and the bill of rights. however, seen that section 1 of the act, which defines ‘income’, contains the words ‘unless the context otherwise indicates’, the defined meaning will not necessarily apply in all circumstances. all circumstances and resources, therefore, need to be considered, to determine the meaning of the term in context of its overall purpose and in context of the act as a whole. it is therefore submitted that a purposive approach is followed in interpreting the meaning of the term ‘income’ in sections 7(2) to 7(8). in the next section, the article aims to outline the working of sections 7(2) to 7(8) by investigating the possible meanings of the term ‘income’ as envisaged in each of these provisions. understanding the meaning of ‘income’ in sections 7(2) to 7(8) of the act section 7(2) of the act section 7(2)(a) of the act (republic of south africa 1962) reads as follows: any income received by or accrued to any person married in or out of community of property (hereinafter referred to as the recipient) shall be deemed for the purposes of this act to be income accrued to such person’s spouse (hereinafter referred to as the donor) if: (a) such income was derived by the recipient in consequence of a donation, settlement or other disposition made by the donor on or after 20 march 1991 or of a transaction, operation or scheme entered into or carried out by the donor on or after that date, and the sole or main purpose of such donation, settlement or other disposition or of such transaction, operation or scheme was the reduction, postponement or avoidance of the donor’s liability for any tax, levy or duty which, but for such donation, settlement, other disposition, transaction, operation or scheme, would have become payable by the donor under this act or any other act administered by the commissioner; or (b) income was received by or accrued to the recipient: (i) from any trade carried on by the recipient in partnership or association with the donor or which is in any way connected with any trade carried on by the donor; or (ii) from the donor or any partnership of which the donor was at the time of such receipt or accrual a member or any private company of which the donor was at such time the sole or main holder of shares or one of the principal holder of shares, and such income represents the whole or any portion of the total income so received by or accrued to the recipient which exceeds the amount of income to which the recipient would reasonably be entitled having regard to the nature of the relevant trade, the extent of the recipient’s participation therein, the services rendered by the recipient or any other relevant factor. section 7(2a) of the act (republic of south africa 1962) reads as follows: in the case of spouses who are married in community of property: (a) any income (other than income derived from the letting of fixed property) which has been derived from the carrying on of any trade shall, if such trade is carried on: (i) by only one of the spouses, be deemed to have accrued to that spouse; or (ii) jointly by both spouses, be deemed, subject to the provisions of subsection (2)(b), to have accrued to both spouses in the proportions determined by them in terms of the agreement that regulates their joint trade or, if there is no such agreement, in the proportion to which each spouse would reasonably be entitled having regard to the nature of the relevant trade, the extent of each spouse’s participation therein, the services rendered by each spouse or any other relevant factor; and (b) any income derived from the letting of fixed property and any income derived otherwise than from the carrying on of any trade shall be deemed to have accrued in equal shares to both spouses: provided that any such income which does not fall into the joint estate of the spouses shall be deemed to be income accrued to the spouse who is entitled thereto. in order to determine the meaning of ‘income’ in sections 7(2) and 7(2a), reference is made to commissioner for inland revenue v simpson 4 all sa 460 (a) (the simpson case), which dealt with the predecessor of the current section 7(2). in the simpson case, judge watermeyer noted that it was the object of act 31 of 1941 (1941 act) to tax a person’s profits or gains, in other words, after deducting allowable expenditure incurred in making those profits or gains, and not ‘income’ as defined in the 1941 act (which is similar to the current definition of ‘income’, namely ‘gross income’ less exempt income). he was of the opinion that it was reasonable to accept that the legislature’s intention was that a husband (later ‘donor spouse’) should pay tax on his wife’s (later ‘recipient spouse’) profits or gains after deducting allowable expenditure (in other words ‘taxable income’) and not on her ‘income’ as defined. based on the rule laid down in halsbury, laws of england, the court found that to use the literal (defined) meaning of ‘income’ would undermine the purpose of the section, since then the donor spouse would not be authorised to deduct expenditure incurred by the recipient spouse. judge watermeyer reasoned that, in practice, the donor spouse would surely be entitled to all the deductions which the recipient spouse would have been entitled to, had she been the taxpayer. meyerowitz and spiro (1995) agree with the view of the simpson case, namely that ‘income’ in section 7(2) refers to profits or gains, after deducting expenditure. de koker and williams (2015) also agree that ‘income’ in the context of section 7(2) should not be interpreted as ‘income’ as defined in the act. interestingly, section 7(2b) of the act, which addresses the issue of the expenditure, was only inserted in the act by income tax act 141 of 1992, and reads as follows: so much of any deduction or allowance which may be made under the provisions of this act in the determination of the taxable income derived from any income referred to in subsections (2) and (2a) as relates to any portion of such income which is under the provisions of that subsection deemed to be income accrued to a spouse shall be deemed to be a deduction or allowance which may be made in the determination of the taxable income of such spouse. (p. 9–10) the authors of this article are of the opinion that it must have been the legislature’s intention that sections 7(2) and 7(2a) referred to ‘income’ as defined, or to ‘gross income’, otherwise section 7(2b) would not have been added to specifically allow for the deduction of expenditure. consequently, it is held that the interpretation of ‘income’ in the 1949 simpson case, namely that section 7(2) refers to ‘taxable income’, cannot be applied. davis et al. (1999) also agree that it appears then that the simpson case does not hold for sections 7(2) and 7(2a). the predecessor of section 7(2) arose in the 1914 act and also referred to ‘income’, but the 1914 definition of ‘income’ was very different to the current definition. there was no distinction between ‘income’ and ‘gross income’ in 1914 and ‘income’ was defined as ‘any gains or profits derived by, or accrued to or in favour of…’. examples given in the 1914 definition included, inter alia, profit, gains, rents, interest and salaries, which seem to refer to gross amounts (in other words, before exemptions and deductions). based on such an interpretation, it then makes sense that the legislature specifically added a provision to allow for the deduction of expenditure in 1992, and therefore, the authors of this article tend to lean towards an interpretation as ‘gross income’. interestingly, these profits and gains mentioned in the 1914 definition of ‘income’ were interpreted in the simpson case as referring to net amounts, in other words, after exemptions and deductions. such an interpretation, however, does not make sense to the authors of this article in the light of the fact that the legislature subsequently felt the need to add section 7(2b) to specifically deal with the deduction of expenditure. section 7(3) of the act section 7(3) of the act (republic of south africa 1962) reads as follows: income shall be deemed to have been received by the parent of any minor child or stepchild, if by reason of any donation, settlement or other disposition made by that parent of that child: (a) it has been received by or has accrued to or in favour of that child or has been expended for the maintenance, education or benefit of that child; or (b) it has been accumulated for the benefit of that child. de swardt et al. (2015) are of the opinion that the term ‘income’ used in sections 7(2) to 7(7) should be interpreted as ‘taxable income’ (based on the judgement in the simpson case) and that a provision similar to section 7(8)(b) (which deals with the deduction of expenditure, as discussed under section 7[8]) is therefore not necessary in these sections. meyerowitz (2008) also considers ‘income’ in the context of section 7(3), as well as in the context of all the other deeming provisions of section 7, to mean ‘taxable income’, as it is unbelievable that the income is deemed to be that of the parent and the expenditure attached to the income, is left not to be deductible. the purposive interpretation approach considers, inter alia, the evil which the legislature is intended to forbid and punish (mota 2012). according to olivier (1989), the purpose of sections 7(3) to 7(6) is not to punish a taxpayer but to prevent tax avoidance. any interpretation which will place the taxpayer in a worst position than what he would have been normally, therefore, seems to be contrary to the legislature’s intention. so for instance, in this case, it would not make sense to be taxed on deemed income but not to be able to benefit from possible exemptions or deductions. therefore, where no specific deductions provision exist in a section, it seems reasonable that the ‘income’ referred to in the section, should be interpreted as ‘taxable income’. alternatively, one can argue that no deductions are allowed, as no specific provision is made for it and therefore that ‘income’ cannot imply ‘taxable income’. de koker and williams (2015) are of the opinion that, although no authority exists for it, for purposes of this section and sections 7(4) to 7(7), ‘income’ should be interpreted as ‘gross income’ less related deductible expenses and losses. according to them, it would be unfair if the term ‘income’ is interpreted as defined, as a deduction for expenses incurred, will not be allowed. the authors of this article, therefore, agree that an interpretation that is more favourable to the taxpayer, namely ‘taxable income’, should be considered in the light of the contra fiscum rule. however, in the light of the fact that both sections 7(2b) and 7(8)(b) specifically allow the deduction of expenses, it seems reasonable to the authors of this article to assume that such deductions are not allowed in the other subsections of section 7. therefore, it is submitted that the interpretation of ‘income’ as ‘taxable income’ in this context was not the legislature’s intended meaning. if the term ‘income’ in the context of section 7(3) is indeed interpreted in line with the view of de koker and williams (2015), namely as ‘gross income’ less related deductible expenses and losses, the question arises as to whether exempt income is simply ignored? in section 7(7), the benefit of exempt income is specifically withheld from the taxpayer that is taxed on the deemed income; therefore, it is submitted by the authors of this article that one must assume that in the other subsections the taxpayer is entitled to that benefit. otherwise, the legislature would have made specific mention of exempt income in all the other subsections and not merely in section 7(7). if, however, no exempt income is applicable in a scenario and ‘deductible’ has the same meaning as ‘allowable’ deductions in terms of the act, then the meaning of ‘income’ according to these authors, is similar to meyerowitz and de swardt et al.’s ‘taxable income’. however, davis et al. (1999) argued that, as the legislature provided specifically for net income (after deductions) to be attributed only under subsection (8), ‘gross income’ has to be attributed under the other subsections, which include section 7(3). according to meyerowitz (2008), interpreting ‘income’ as ‘taxable income’ in section 7 is also the view accepted by the south african revenue service (sars). however, if that is the case, why is it not indicated as such in the act or through guidance issued by the sars and were provisions allowing the deduction of expenditure only added to sections 7(2) and 7(8)? therefore, the authors of this article do not agree with such an interpretation and are of the opinion that the meaning of ‘income’ in this subsection is intended to be ‘income’ as defined in section 1 of the act. it is clearly evident that, based on the above-mentioned proposed interpretations, uncertainty exists with regard to the meaning of the term ‘income’ in this context, and different authors have different views. similarly, uncertainty exists with regard to the meaning of the term ‘income’ throughout sections 7(4) to 7(8), as illustrated below. section 7(4) of the act section 7(4) of the act (republic of south africa 1962) reads as follows: any income received by or accrued to or in favour of any minor child or stepchild of any person, by reason of any donation, settlement or other disposition made by any other person, shall be deemed to be the income of the parent of that child, if such parent or his or her spouse has made a donation, settlement or other disposition or given some other consideration in favour directly or indirectly of the said other person or his or her family. (republic of south africa, 1962:42) the various authors ascribe a similar meaning to the term ‘income’ in section 7(4) to that of section 7(3) discussed above. these interpretations include ‘taxable income’, ‘gross income’ less related expenses and losses and ‘gross income’, while the authors of this article believe that it should be interpreted as ‘income’ as defined in section 1 of the act, as nothing indicates the contrary with reference to the interpretations discussed under section 7(3). section 7(5) of the act section 7(5) of the act (republic of south africa 1962) reads as follows: if any person has made any donation, settlement or other disposition which is subject to a stipulation or condition, whether made or imposed by such person or anybody else, to the effect that the beneficiaries thereof or some of them shall not receive the income or some portion of the income thereunder until the happening of some event, whether fixed or contingent, so much of any income as would, but for such stipulation or condition, in consequence of the donation, settlement or other disposition be received by or accrue to or in favour of the beneficiaries, shall, until the happening of that event or the death of that person, whichever first takes place, be deemed to be the income of that person. (republic of south africa, 1962:42–43) the various authors’ possible interpretations of the term ‘income’ discussed in section 7(3), which also apply in the context of section 7(5), include ‘taxable income’, ‘gross income’ less related expenses and losses and ‘gross income’. they all seem to agree that ‘income’ in section 7(5) is not meant to be interpreted as ‘income’ as defined. according to clegg and stretch (2015), problems can arise where, for example, a south african resident trust has been funded by a non-resident and the nature of the funding was gratuitous, when ‘income’ is interpreted as ‘income’ as defined. for instance, it is questionable, according to the author, whether the deemed ‘income’ amounts of the non-resident funder can nevertheless be exempt from tax, if they comply with the provisions of section 10 that are applicable to non-residents. these authors further state that, for an interpretation of ‘income’ as ‘taxable income’ to hold (in other words, allowing non-resident exemptions), section 7(5) should be interpreted as deeming the income to accrue to the non-resident. however, if ‘income’ is rather seen as having its defined meaning, then the assumption needs to be that the income, which essentially accrues to a resident, would be ‘income’ (in other words, after section 10 exemptions applicable to residents) of the resident and henceforth must be deemed ‘income’ of the non-resident. clegg and stretch (2015) submit all in all, although the matter cannot be beyond doubt, that the latter interpretation, namely ‘income’ as defined in the act, is better, as that is also what they understand the view of the sars to be. for the same reasons mentioned in the context of section 7(3), the authors of this article also believe that the term ‘income’ in section 7(4) should be interpreted as ‘income’ as defined in the act. section 7(6) of the act section 7(6) of the act (republic of south africa 1962) reads as follows: if any deed of donation, settlement or other disposition contains any stipulation that the right to receive any income thereby conferred may, under powers retained by the person by whom that right is conferred, be revoked or conferred upon another, so much of any income as in consequence of the donation, settlement or other disposition is received by or accrues to or in favour of the person on whom that right is conferred, shall be deemed to be the income of the person by whom it is conferred, so long as he retains those powers. (republic of south africa, 1962:43) interpretations of the term ‘income’ in section 7(6) are similar to those discussed for section 7(3). these interpretations include ‘gross income’ less related deductible expenses and losses, and ‘taxable income’, while davis et al. (1999), however, interpret it as ‘gross income’. the authors of this article agree that a gross amount, before deductions and exemptions, is implied in this context, based on the phrase ‘the right to receive any income’. this leads the authors of this article to believe that a taxpayer is in fact entitled to income exemptions in the other subsections of section 7 in which the wording does not specifically refer to gross amounts, such as here. section 7(7) of the act section 7(7) of the act (republic of south africa 1962) reads as follows: if by reason of any donation, settlement or other disposition made, whether before or after the commencement of this act, by any person (hereinafter referred to as the donor): (a) the donor’s right to receive or have paid to him or for his benefit any amount by way of rent, dividend, foreign dividend, interest, royalty or similar income in respect of any movable or immovable property (including without limiting the foregoing any lease, company share, marketable security, deposit, loan, copyright, design or trade mark) or in respect of the use of, or the granting of permission to use, such property, is ceded or otherwise made over to any other person or to a third party for that other person’s benefit in such manner that the donor remains the owner of or retains an interest in the said property or if the said property or interest is transferred, delivered or made over to the said other person or to a third party for the said other person’s benefit, in such manner that the donor is or will at a fixed or determinable time be entitled to regain ownership of or the interest in the said property; or (b) the donor’s right to receive or have paid to him or for his benefit any income that is or may become due to him by any other person acting in a fiduciary capacity is ceded or otherwise made over to any other person or to a third party for that other person’s benefit in such manner that the donor is or will at a determinable time be entitled to regain the said right, any such rent, dividend, foreign dividend, interest, royalty or income (including any amount which, but for this subsection, would have been exempt from tax in the hands of the said other person) as is received by or accrues to or for the benefit of the said other person on or after 1 july 1983 and which would otherwise, but for the said donation, settlement or other disposition, have been received by or have accrued to or for the benefit of the donor, shall be deemed to have been received by or to have accrued to the donor. the various interpretations of the term ‘income’ that were already discussed for section 7(3) apply similarly to section 7(7) and include those of de koker and williams (2015), namely ‘gross income’ less related deductible expenses and losses, in contrast with meyerowitz’s (2008) and de swardt et al.’s (2015) opinion that ‘income’ should rather be interpreted as ‘taxable income’. the authors of this article, however, agree with davis et al. (1999) that the meaning of ‘income’ in this context can be interpreted as ‘gross income’. this is deduced from the wording in the last sentence of section 7(7), which includes otherwise exempt income in the ‘income’ that the taxpayer is deemed to have received. once again this leads the authors of this article to believe that a taxpayer is entitled to income exemptions in the subsections of section 7 where the wording does not specifically disregard exemptions as in section 7(7). section 7(8) of the act section 7(8) of the act (republic of south africa 1962) reads as follows: (a) where by reason of or in consequence of any donation, settlement or other disposition (other than a donation, settlement or other disposition to an entity which is not a resident and which is similar to a public benefit organisation contemplated in section 30) made by any resident, any amount is received by or accrued to any person who is not a resident (other than a controlled foreign company in relation to such resident), which would have constituted income had that person been a resident, there shall be included in the income of that resident so much of that amount as is attributable to that donation, settlement or other disposition. (b) so much of any expenditure, allowance or loss incurred by the person contemplated in paragraph: (a) as does not exceed the amount included in the income of the resident in terms of that paragraph and which would be allowable as a deduction under this act in the determination of the taxable income derived from that amount had that person been a resident, is deemed to be an expenditure, allowance or loss incurred by that resident for purposes of the determination of the taxable income of that resident from that amount. what makes this subsection different from subsections 7(3) to 7(7) is the existence of section 7(8)(b), included in 2005, which specifically allows the deduction of certain expenditure, allowances or losses relating to the deemed income (republic of south africa 2005a). this is similar to section 7(2b). clegg and stretch (2015) state that ‘income’ in the context of section 7(8) should be interpreted as ‘income’ as defined in the act. however, when interpreting the meaning in the context of section 7(8), one should consider the amendment of section 7(8) to refer to ‘any amount’ instead of to ‘income’ (republic of south africa 2004a). the reason for the amendment was that it might have been argued that the term ‘income’ in the previous version of section 7(8), only referred to income from a south african source and that foreign-sourced income of a non-resident technically fell outside the ambit of section 7(8) (republic of south africa 2004b). the amendment therefore ensures that all the receipts and accruals of a non-resident are deemed to be income of the resident, if they would have constituted income had they been received by or accrued to a resident (republic of south africa 2005b). once section 7(8)(b) was subsequently added, the resident is now allowed to deduct allowable expenses too. according to clegg and stretch (2015), until this amendment, it was considered that ‘income’ in this context should have been interpreted as a net amount, calculated in a similar manner as ‘taxable income’, based on only income from a south african source. meyerowitz’s (2008) interpretation of ‘income’ as ‘taxable income’ agrees to some extent to that of clegg and stretch, although he does not address the effect of the amendment on his interpretation. de swardt et al. (2015) and de koker and williams (2015) are of the opinion that ‘income’ in this context should be interpreted as ‘income’ as defined. the authors of this article believe that the legislature intended for ‘income’ in the context of section 7(8) to be interpreted either as ‘gross income’ or ‘income’ as defined, otherwise they would not have specifically provided for the deductibility of expenditure. in section 7(7) the benefit of exempt income is specifically withheld from the taxpayer that is taxed on the deemed income, and in section 7(6) the wording specifically refers to gross amounts being taxable as deemed income. therefore, it is submitted by the authors of this article that one must assume that in the other subsections where the wording is silent regarding exemptions, the taxpayer is entitled to potential income exemptions. consequently, the authors of this article agree with de swardt et al. (2015) and de koker and williams (2015) that ‘income’ in the context of section 7(8) should be interpreted as ‘income’ as defined. basic illustration of effect of different interpretations on a taxpayer’s taxable income an example of the impact of each possible interpretation, as discussed in the section ‘understanding the meaning of “income” in sections 7(2) to 7(8) of the act’ of this article, is now provided to illustrate the effect of possible incorrect interpretations of the term ‘income’ in sections 7(2) to 7(8) of the act. assume that taxpayer x is deemed, by any one of sections 7(2) to 7(8), to be taxable on certain ‘income’ received by or accrued to person a. a breakdown of amounts received by or accrued to person a by reason of a donation, settlement or other disposition by taxpayer x, together with related expenditure incurred by person a, is as in table 1 (in rand). table 1: receipts or accruals and related expenditure. table 2 illustrates the amounts that would be included in taxpayer x’s income in his income tax return, based on each of the possible interpretations of ‘income’ in section 7. table 2: possible amounts to be included in taxpayer’s tax return. this example clearly illustrates the significant impact that the interpretation of the term ‘income’ in sections 7(2) to 7(8) can have on a taxpayer’s ‘taxable income’ and for which a suitable solution is required to ensure consistency. conclusion and recommendations in terms of the literal approach of interpretation, unless the context otherwise indicates, the term ‘income’ in sections 7(2) to 7(8) of the act should be ascribed its ordinary meaning, as defined in section 1 of the act. based on the study performed, however, the context of sections 7(2) to 7(8) of the act sometimes indicates a different meaning. the purposive approach was therefore followed to determine the meaning of the term ‘income’ that is used in sections 7(2) to 7(8) of the act. interestingly, it was established that different authors interpret the meaning of the term ‘income’ differently, and the interpretations also differ among the various subsections of section 7. the authors of this article believe that the legislature’s intention, albeit possibly unfair in terms of not allowing deductions or exemptions throughout section 7, was for the term ‘income’ to be interpreted as ‘gross income’ in sections 7(2), 7(6) and 7(7) and as ‘income’ in sections 7(3), 7(4), 7(5) and 7(8). the meaning of the term ‘income’ for purposes of sections 7(2) to 7(8) of the act can be widely argued and remains an uncertainty. it is therefore imperative that application guidance is issued or that the wording in sections 7(2) to 7(8) be amended to reflect the intended meaning of the legislature, where it is not meant to be ‘income’ as defined in section 1 of the act. acknowledgements competing interests the authors declare that they have no financial or personal relationship(s) that may have inappropriately influenced them in 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amendment act 32 of 2004, government printer, pretoria. republic of south africa, 2004b, explanatory memorandum on the revenue laws amendment bill 2004, government printer, pretoria. republic of south africa, 2005a, revenue laws amendment act 31 of 2005, government printer, pretoria. republic of south africa, 2005b, explanatory memorandum on the revenue laws amendment bill 2005, government printer, pretoria. the chambers dictionary, 2015, viewed 14 january 2016, from http://www.credoreference.com/ the collins english dictionary, 2015, viewed 14 january 2016, from http://www.credoreference.com the oxford english dictionary, 2015, viewed 14 january 2016, from http://www.oed.com/ the penguin english dictionary, 2015, viewed 14 january 2016, from http://www.credoreference.com van der zwan, p., 2015, ‘interpretation of tax law’, accountancy sa 22–23. 315 sajems ns vol 2 (1999) no 2 correlates of type a behaviour among professionals r van wyk and a b &shoff department of business management, university of pretoria c l bester department of psychology, university of the orange free state abstract a review of the relevant literature indicates that a study of the relationships between type a behaviour and personal as well as organizational variables is necessary. information was gathered from 375 professionals on a number of demographic and personality variables, as well as type a behaviour. manova, product-moment correlation, and multiple regression were used to determine the relationships between type a behaviour and other variables. total type a scores could be predicted reasonably well by means of personality variables. demographic variables were less closely related to type a scores. jel j 20 introduction high demands are currently placed on members of the working population in western society. such demands may lead to high strain in persons who are involved in commercial and in professional activities (byrne, 1987). type a behaviour may be a causal factor as well as an outcome of such a situation. the term type a behaviour pattern was coined by two cardiology researchers, friedman and rosenman (1959), who identified a typical behaviour pattern presented by many of their cardiology patients. rosenman ( 1991 ) later defines type a behaviour as comprising: • specific characteristics such as ambitiousness, aggressiveness, competitiveness and impatience, • specific muscle tense behaviour, such as alertness, rapid and emphatic vocal styl istics, • an accelerated pace of activities, and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 316 • emotional responses characterized by irritation, hostility and increased potential for anger. type a behaviour has been extensively studied. it seems as if the interest in this field at first centered around the effects of type a behaviour on the health of individuals (friedman & rosenman, 1959; friedman & rosenman, 1974; jenkins, zyzanski and rosenman 1979; adler & matthews, 1994). in later work the relationship between type a behaviour and a large number of other variables was examined. among them were demographic variables like age (friedman & rosenman, 1974; blumenthal & herman, 1985; helman, 1987; byrne & reinhart, 1990; jamal & baba, 1991), gender (burke, 1983; cox, 1983; forshaw, 1984; hicks, olsen & smith-robison, 1986; moss, dielman, campanelli, leech. van harrison and horvath, 1986; sorenson, jacobs, pirie, folsom, luepker and gillum, 1987; hartell & chambless, 1989; wiegele & oots, 1990; bedeian, mossholder and touliatos, 1990; thorenson & low, 1991; greenglass, 1991; jamal & baba, 1991; gamble & matteson, 1992; greenglass, 1993; byrne & reinhart, 1995), marital status (jamal & baba, 1991; byrne & reinhart, 1995), home language (cox, 1983; swanepoel, 1984; jamal & baba, 1991; striimpfer, 1993), occupation (jamal & baba, 1991; byrne & reinhart, 1995; striimpfer, 1995), employment situation (striimpfer, 1993; begley, 1995), number of years worked (chusmir & hood, 1988), urban/rural background (jamal, 1985). the relationship between type a behaviour and other variables that can be of importance in the work situation attracted the attention of a number of researchers. one such variable is locus of control (wolf, hunter, webber and berenson, 1981; furnham, 1983; feather & volkmer, 1988; spector & o'connel, 1994; begley, 1995; norden, 1995; gomez, 1997; morrison, 1997). the relationships that were found in these studies are generally weak. it seems as if the strongest relationship was found to be between internal locus of control and the achievement dimension of type a behaviour. another variable that was related to type a behaviour is schein's (1978) notion of career anchors or career orientations. burke (1983) found low but significant correlation between several of the career orientations identified by schein (1978) and scores on the jenkins activity survey developed by jenkins, zyzanski and rosenman (1979). in the same study differences were also found between the strength of the relationships for men and for women. in a further study burke (1985) measured four career orientations. significant correlation was found between these orientations and type a behaviour. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 317 sajems ns vol 2 (1999) no 2 job involvement is another variable which attracted attention with regard to its relationship with type a behaviour, with significant correlation found between job involvement and measures of type a behaviour (chusmir & hood, 1986; chusmir & hood, 1988). job satisfaction, being widely studied and regarded as an important organizational variable (mccormick & ligen, 1985), was also correlated with type a behaviour. negative correlations were found between job satisfaction and type a behaviour scores by chismur and hood (1988), byrne and reinhart (1990), gamble and matteson (1992) and by byrne and reinhart (1994). significant positive relationships were, however, found between job satisfaction and type a behaviour by bedeian, mossholder and toujiotos (1991), day and bedeian (1991), kushnir and vickers (1991) and by norden (1995). robertson, cooper and williams (1990) point out that the relationship between job satisfaction and type a behaviour is probably more complex than assumed in the studies quoted. robertson et al. (1990) found in their study of 105 management consultants that the best prediction of job satisfaction was provided by the interaction between job pressure and type a behaviour. mugdil, muhar and bhatia (1992) also differentiate between low job satisfied and high job satisfied individuals who display high levels of type a behaviour. according to mugdij et al. (1992) individuals who are not satisfied with their jobs tend to display high levels of type a behaviour as part of such individuals' chronic struggle to achieve goals that are poorly defined. this will not happen when individuals are satisfied with their jobs. anastasi (1990) states that research about the self-concept has been focused on the cumulative effect that self-evaluations have on cognitive and affective traits, which directly or indirectly influence the performance of the individual. wolf, hunter, webber and berenson (1981) and lobel (1988) therefore studied the relationship between the self-concept and type a behaviour. the relationship appeared to be negative higher levels of type a behaviour tend to be associated with negative rather than positive self-concept scores. entrepreneurs and entrepreneurship attract considerable attention at present. professionals have an important role to play in rendering service to society (schein & kommers, 1972). the relationship between type a behaviour and entrepreneurship has, as far as could be ascertained, not yet been studied at least not in a sample of protessionals. this however seems to be an important area for investigation (van wyk, 1998). the studies that were reviewed suffered from several problems. in many cases only small samples were used. in almost all cases samples of convenience were employed. under these circumstances the representativeness of the samples on r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 318 which the studies were carried out must be in doubt. taking into account the present state of statistical analysis of data. the analyses carried out in most of the studies cited were not very sophisticated. it also seems as if researchers in this field did not try to minimize error variance in the measuring instruments which they used. the results from different studies are often contradictory. the vast majority of the studies were done on samples from the north american culture. under the circumstances it seemed necessary to conduct a more comprehensive study in order to determine the relationships of different variables with type a behaviour more precisely. as professional people form a very important group in society (schein & kommers, 1972; gamble & matteson, 1992) it was decided to do the study on members of two professional groups. method sample the sample consisted of 221 men with a mean age of 45.72 years (so 12.79, range = 22 to 84) and 154 women with a mean age of35.70 years (so 9.52, range 22 to 72). the total sample (n 375) had a mean age of 41.6 years (so = 12a6, range = 22 to 84). the total group could also be divided into pharmacists (n = 200, mean age = 39.46, sd = 12.70, range = 22 to 84) and accountants (n 175, mean age 44.05, sd 11.95, range = 24 to 82 years). of the total sample (n = 375) 98.4% had either afrikaans (n = 158 or 42.1 %) or english (n 211 or 56.3%) as home language. the home language of one participant was unknown. one, two and two paiticipants had respectively venda, zulu and north sotho as their home language. of the total sample 201 participants (53.6%) saw themselves working as employees in organizations while 169 (45.1%) were working as private practitioners. five participants did not indicate whether they were working as private practitioners or as employees. the number of jobs held by participants prior to the study varied between one and eight. ninety-three percent of the participants had held five or fewer jobs during their career prior to the s.tudy. the number of years worked up to the time of the study varied between one and sixty. the mean number of years worked was 18.7 (so = 12.56). members of the sample had worked for an average of 2.83 (sd = 1.56) organizations before participating in the present study. the majority of the participants i.e. 295 or 78.7 percent, were married with, respectively 62 (16.5 percent), 10, 6 and 2 indicating that they were divorced, widowed or cohabiting. the majority of the participants (77.6%) grew up in an urban environment. the majority (56.8%) of the participants grew up in the gauteng province of south africa with a more or less even spread over the other eight provinces. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 319 sajems ns vol2 (1999) no 2 procedure systematic sampling was done from the professional registers of pharmacists and accountants. only members of these occupational groups residing in the main areas of economic activity in south africa, i.e. the western cape and gauteng, were included in the sample. in total 1210 questionnaires were distributed, 1110 in gauteng and 100 in the western cape. a total of 418 completed questionnaires were received back. of this number 375 were used in the analysis. completed questionnaires, in which one or more items in any of the psychometric instruments had not been responded to, were left out of further analysis. the study was carried out as a postal survey. the various measuring instruments and the questions about demographic variables were combined into one questionnaire, and mailed to the individuals who had been selected to be part of the sample. a reminder letter was sent out one week after the questionnaire had been mailed. a second reminder letter was sent one month after the tirst mailing. the responses to the different measuring instruments were, where applicable, subjected to psychometric investigation in order to determine the construct validity of each instrument when applied to members of the present sample. this was done as an attempt to eliminate error variance due to measurement error as far as possible. exploratory factor analysis in the form of principal factor analysis with direct quartimin rotation was used for this purpose. the final factor structures were in all cases subjected to confirmatory factor analysis in order to determine the fit between the data and the factor structure. more intormation on how these procedures were carried out is given in van wyk (1998). measuring instruments the primary purpose of the study was to determine whether type a behaviour was related to the demographic and personality variables identified in the introduction. the demographic information that participants were asked to provide were: gender, occupation, home language, employment, marital status, area of birth, province of birth, age, number of jobs held, number of years worked, and number of organizations to which the individual had been attached. locus of control was the first personality characteristic that was assessed and related to type a behaviour. this variable was measured by means of a r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 320 questionnaire developed by schepers (1995), based on the responses of firstyear university students. this instrument measures, according to schepers (1995), three factors, namely belief in internal locus of control, belief in external locus of control and thirdly autonomy. schepers found cronbach alpha coefficients of .83, .84 and.87 for, respectively, the internal, external and autonomy scajes. in the present study 23 of the items in the questionnaire were excluded due to the findings of the exploratory factor analysis. a three-factor solution was finally accepted. the three factors respectively contained 38, 14 and five items and had cronbach alphas of .91, .78 and .84. the factors were identified as internal locus of control, external locus of control and vicissitudes of life. the second personality characteristic measured was career orientation, a notion developed by schein (1978). career orientation was measured by means of the career orientations inventory (schein, 1995). this instrument is supposed to measure eight orientations, namely managerial competence, technicalfunctional competence, entrepreneurship, security, lifestyle integration, pure challenge, service dedication and autonomylindependence. recent internal reliability information was not available for the version of the instrument used in the present study. the exploratory factor analysis carried out on the responses of the present sample indicated the presence of only four identifiable factors. these factors were labeled service dedication (ii items), job security (five items), entrepreneurship (five items) and lifestyle integration (three items). the cronbach alpha coefficients for the four factors were, respectively, .86, .81, .80 and .72. the third characteristic that was measured was job involvement. kanungo's job involvement inventory (1982) was used to measure this variable. this instrument measures, according to kanungo (1982), job involvement as a unidimensional factor with a cronbach alpha coefficient of .81. exploratory factor analysis carried out on the responses of the participants in the present study indicated that a one-factor solution with all the items loading >.35 could be accepted. the single factor had a cronbach alpha coefficient of .88. the minnesota satisfaction questionnaire (weiss, davis, england and lotquist, 1967) was used to assess the job satisfaction levels of participants. this short form of the original questionnaire consists of 20 items, measuring two factors, namely intrinsic and extrinsic satisfaction. according to the authors the intrinsic scale has a cronbach alpha coefficient of .86. the corresponding figure for the extrinsic scale is .80. the scale has been evaluated for use on south african samples (boshoff & hoole, 1998; kamfer, venter & boshoff, 1998). the exploratory factor analysis carried out on the responses in the present sample yielded three factors, identified as general job satisfaction, intrinsic job r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 321 sajems ns vol 2 (1999) no 2 satisfaction and satisfaction with supervision. the three scales consisted of, respectively, six, six and two items. the cronbach alpha coefficients were, respectively, .82, .82 and .85. self-concept was measured by means of the six-factor self-concept scale developed by stake (1994). the scale measures, according to stake (1994), six factors, labelled as power, morality, likeability, task accomplishment, vulnerability and giftedness. test-retest reliabilities varied between .74 and .88. in the present study four of the 36 items as developed by the author of the instrument were eliminated during the exploratory factor analysis, yielding a three-factor solution. the factors were identified as power, task accomplishment and likeability. the three factors had cronbach alpha coefficients of, respectively, .85, .84 and .84. factor one contained 14 items, factor 2 contained 12 items and factor three six items. to measure entrepreneurial orientation, the entrepreneurial attitude orientation scale developed by robinson, stimpson, huefner and hunt (1991) was used. the scale measures, according to the authors, four constructs or entrepreneurial attitudes to business, i.e. towards achievement, self-esteem, personal control and economic innovation. according to the authors the sub-scales had test-retest reliabilities of, respectively, .76, .76, .71 and .85. the cronbach alpha values were .84, .73, .70 and .90, respectively. after exploratory factor analysis carried out on the responses of the participants in the present study, a threefactor solution was accepted. the three factors (with their respective alpha coefficients) were identified as attitude towards economic innovation (.90), achievement/personal control (.80) and self-esteem (.77), and respectively contained 29, 21 and 12 items. thirteen of the items in the original questionnaire did not load satisfactorily on any of the newly defined factors. type a behaviour was assessed by means of a shortened form of the jenkins activity survey developed by spence, helmreich and pred (1987). according to the authors, two factors are measured by means of this form of the instrument. the tactors (and their cronbach alphas) are achievement striving (.79) and, impatience-irritability (.65). exploratory factor analysis on the responses of the participants in the present study yielded three factors consisting of five, four and three items respectively. the three factors were named achievement, hard driving/competitive, and speed/impatience. possibly due to the shortness of the sub-scales, the alpha coefficients of the three scales were only .65, .52 and .49. confirmatory factor analysis was carried out on the three-factor structure. the indices showed a satisfactory fit between the measurement model and the data. the goodness of fit index was .93. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 322 after the psychometric investigation of the scales, statistical analyses were done to determine whether relationships existed between the type a scores and the responses to the variables included in the study. results to determine whether relationships existed between the scores of the participants on the three sub-scales measuring type a behaviour and the demographic variables, which were measured on categorical scales, manov a was used to assess whether different biographic groups differed in terms of their scores on the type a sub-scales. groupings that were too small to be subjected to the relevant statistical procedures were left out of the analyses. this happened, for instance, in the case of home language groups other than the afrikaans and english. significant overall differences were found among the scores of gender (f(3;371) = 7.49, p = .0001), occupation (f(3;371) 5.66, p = .0008), language (f(3;367) = 3.50, p .002), employment (f(3;366) = 4.14, p = .0066) and marital status (f(3;371) = 3.72,p .01) groups. the unidimensional analyses that formed part of the manov as carried out, yielded a significant difference (f(i;367) = 6.55, p = .01) between the scores of respondents with afrikaans and english as home languages on the type a subscale achievement. afrikaans speakers had higher scores than english speakers. demographic groups formed in terms of gender (fi ;373) = 16.06, p .000 i), occupation (f( i ;373) 14.15, p = .0002), employment situation (f( i ;368) = 1l.l5, p .0009) and marital status (f(l;373) = 4.05, p = .05), dittered significantly from each other on the type a sub-scale measuring hard-driving competitive behaviour. males had higher scores than females, accountants higher scores than pharmacists, self-employed individuals higher scores than respondents working as employees in organizations and married persons higher scores than individuals who were unmarried. on the third sub-scale measuring type a behaviour, i.e. speed/impatience, accountants had higher scores than pharmacists (f(i; 373) = 4.21, p = .04), english speakers higher scores than afrikaans speakers f(1; 367) 7.26 (p = .007) and married respondents higher scores than those who were unmarried (f(1; 373) 8.00, p = .005). on the total type a score significant differences were found between occupational groups (f( i ;373) = 6.94, p = .009), with the scores of accountants higher than those of pharmacists. married respondents also had a significantly higher score than unmarried persons on the total type a scale (f(1; 373) = 6.30, p = .0 i). the relationships found up to this stage of the analysis were, even when significant, not very strong. the value of r-squared in no case exceeded 4.5%. to determine whether the findings could be interpreted as conceptually r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 323 sajems ns vol 2 (1999) no 2 important, discriminant analyses were carried out. this was done in two phases. a discriminant model was built by means of the stepdisc procedure in sas using type a sub-scale scores as discriminants. this model was then used, by means of proc discrim in sas, to categorize respondents into demographic subgroups. the results indicated that the discriminations achieved were generally poor. the model developed to predict membership of gender subgroups included the achievement and hard driving/competitive sub-scales of type a behaviour. only 58.4% of male respondents and 52.6% of female respondents were placed correctly by the model. the afrikaans/english division was predicted by means of a model in which the achievement and speed/impatience sub-scales were included. only 57.3% of respondents with english and 59.5% of those with afrikaans as home language were placed correctly. of the accountants in the sample 57.1% were placed correctly using a model in which only the hard driving/competitive sub-scale could be included. the corresponding figure for pharmacists was 53.0%. private practitioners were placed correctly at the level of 58.6%, while 54.7% of respondents working as employees were categorized correctly by means of a model containing only the hard driving/competitive sub-scale. of unmarried respondents, 71.8% could be correctly categorized by means of a model in which only speed/impatience was included. for married respondents, however, the figure was 43.8%. calculating product-moment correlation coefficients tested the relationships between biographical variables measured on continuous scales and scores on the jenkins scale and sub-scales. a significant correlation (.11) was obtained in the case of the relationship between age and the speed/impatience sub-scale. the number of jobs held correlated .14 with both the hard driving/competitive subscale of the jenkins activity scale, and with the jenkins total score. the relationship between age and the scores on the jenkins scale and sub-scales was investigated further, as it was thought that the relationships could possibly be non-linear with older respondents scoring lower on type a behaviour than younger ones. for this purpose two age groups, including respondents up to the age of 40 years and those over the age of 40, respectively were formed. oneway analysis of variance was used to determine whether the scores of the two age groups differed on the jenkins scale and sub-scales. only one significant ditference was found, namely that between the scores of the two groups on the hard driving/competitive sub-scale (f(3; 371) = 5.91, p .0006). the older age group had a significantly lower score than the younger group. this result must be interpreted with caution, as the analysis of variance procedure is not robust against large numbers in the comparison groups. the relationships between type a behaviour and the variables that were measured on psychometric scales, were first investigated by calculating pearson product moment correlation coefficients between the scores on the type a r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 324 behaviour scale and sub-scales, and the scores on the different variables as identified through factor analysis described earlier. of the 17 correlation coefficients calculated between scale and sub-scale scores and the jenkins subscale measuring achievement, ii were significant at the 95% confidence level. the scale and sub-scales that yielded significant correlation with the achievement sub-scale were (with the values of r in brackets): internal locus of control (.34), service dedication (.36), job security (.15), job involvement (.27), general job satisfaction (.16), intrinsic job satisfaction (.15), power (.31), task accomplishment (.29), economic innovation (.34), achievement/personal control (.29), and self-esteem (-.11). fourteen of the correlation coefficients between sub-scale scores and the hard-driving/competitive type a behaviour sub-scale were significant at the 95% confidence level. these coefficients were: internal locus of control (.40), external locus of control (-.21), service dedication (.23), job security (-.18), the entrepreneurship career orientation (.20), job involvement (.19), general job satisfaction (.24), intrinsic job satistaction (.15), power (.48), task accomplishment (.12), likeability (.16), economic innovation (.35), achievement/personal control (.21), and selfesteem (-.32). at the 95% confidence level five of the 17 correlations between sub-scale scores and the type a sub-scale measuring speed/impatience were signiticant. the significant coefficients were: internal locus of control (.11), vicissitudes of life (.13), entrepreneurship (.18), supervision (-.12), power (.13). the total type a score correlated significantly with: internal locus of control (.47), service dedication (.38), the entrepreneurship career orientation (.20), job involvement (.29), general job satisfaction (.25), intrinsic job satisfaction (.19), power (.49), task accomplishment (.26), economic innovation (.44), achievement/personal control (.31) and self-esteem (-.23). to further investigate the relationships, multiple regression analysis was used. the scores on the different sub-scales in the psychometric instruments were used as the predictor variables, and the type a sub-scales and the total type a score as the dependent variables. the prediction model contained eleven independent variables (dedication to service, task accomplishment, likeability, power, job security, economic innovation, internal locus of control, external locus of control, general job satisfaction, and entrepreneurship (career orientation) in the case of the dependent variable type a achievement. the common variance amounted to 36.05%. the model to predict the sub-scale hard driving/competitive contained the power, general job satisfaction, internal locus of control, and the job security variables. the common variance amounted to 27.15%. the third type a sub-scale (speedllmpatience) scores were predicted by a model containing the variables entrepreneurship career orientation and the vicissitudes of life sub-scale. the common variance in this case was only 4.56%. the total type a score was predicted by a model containing the variables power, internal locus of control, likeabil ity, external locus of control, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 325 sajems ns vol 2 (1999) no 2 achievement/personal control, general satisfaction, task accomplishment and, finally, job involvement. the common variance in this case was 40.30%. discussion in order to place the results obtained in perspective, the tindings of the present study are compared to those of previous research. the results regarding the relationships between type a behaviour and biographical variables are discussed first. in the present study, it was found that older respondents had lower scores on the hard driving/competitive sub-scale of the jenkins activity survey. similar results were obtained by friedman and rosenman (1974), blumenthal and herman (1985), helman (1987), striimpfer (1988) and by dielman et al. (1990). jamal and baba (1992) obtained the opposite result in their study of the level of type a behaviour in nurses. the possibility that the occupation of respondents might be a confounding factor as far as the relationship is concerned must be considered in interpreting these results, but the present evidence suggests that type a behaviour tends to decrease with age. an overall difference between the type a score profiles of men and women was found in the present study. the uni-dimensional analysis revealed a significant difference between the scores of men and women on the hard driving competitive sub-scale of the jenkins activity survey, with men scoring higher than women. a similar finding was made by bedeian et ai. (1990). the opposite result was obtained in several other studies (burke, 1983; sorenson et al., 1987; wiegele and dots, 1990; greenglass, 1993; byrne and reinhart, 1995). the possibility of confounding variables, like differences in the composition of samples, influencing the results of studies must be considered in coming to a conclusion in this regard. it seems as if the conflicting results warrant further research. the finding that accountants scored higher than pharmacists on type a behaviour seems to confirm a finding in this regard by strlimpfer (1993). studying respondents from different language groups striimpfer (1993) found that afrikaans speakers scored significantly higher than english speakers on a measure of type a behaviour. in the present study it was found that afrikaans speakers scored higher than english speakers on the achievement sub-scale. the opposite was true for the speed and impatience sub-scale. the relationship between home language and type a behaviour therefore does not seem to be a straightforward one. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 326 in the present study it was found that respondents who were self-employed scored higher than those who worked for somebody else. this result may point to the existence of a self-selection process with hard driving and competitive individuals entering private practice rather than to be employed by others. type a behaviour can, as van wyk (1998) pointed out, be a behaviour pattern that may be useful in the business world. significant relationships were also obtained between the number of jobs held and the number of working years on the one hand and type a behaviour on the other. these were, however, very weak relationships with the common variance not exceeding 3%. married respondents tended to have higher scores on the type a measure. this is in accordance with the findings of byrne and reinhart (1995). the findings that scores on the achievement sub-scale of the jenkins activity survey and the internal locus of control sub-scale correlated positively (r = .40) with each other, and that both the variables internal and external locus of control entered into the multiple regression model in which achievement was the dependent variable, are in accordance with findings by furnham (1983), volkmer and feather (1991) and by spector and o'connel (1994). these relationships therefore now seem to be well established. the hard driving/competitive sub-scale of the jenkins activity survey showed a statistically significant positive relationship with internal locus of control (r = -.40) and a significant negative correlation (r = -.2 i) with external locus of control. internal locus of control also entered into the multiple regression model with the hard driving/competitive type a sub-scale as dependent variable. the speedlimpatience sub-scale of the jenkins scale showed statistically significant positive relationships with internal locus of control and with vicissitudes of life. these were, however, weak relationships, containing only 1.2% and 1.7% common variance. volkmer and feather (199 i) found the opposite a weak negative relationship between speed /impatience and internal locus of control. the different results and the low strength of the relationships that were found probably indicate that the results should be seen as inconclusive. the jenkins total score showed a statistically significant relationship only with internal locus of control (r = .47). both the internal and external locus of control sub-scales were included in the multiple regression model predicting jenkins total score. these findings are in agreement with those of volkmer and feather (1991) and morrison (1997). gomez however found the opposite r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 327 sajems ns vol 2 (1999) no 2 (1997). the results cited seem to indicate that locus of control is probably related to type a behaviour. in a previous study (burke, 1983), the managerial career orientation correlated with the job involvement and hard driving sub-scales as well as with the total score on the jenkins activity survey. this result is difficult to compare with those obtained in the present study, as the factorial structure of the instrument used for measuring career orientations differed considerably from that used in previous studies. (this indicates how difficult it is to do rigorous quantitative intercultural research when the available measuring instruments have only been standardised in one country.) in the present study it was found that significant positive relationships existed between the achievement sub-scale of the jenkins activity survey and the dedication to service and job security career orientations. the job security/achievement relationship was not strong as only 2% common variance was found to exist. the multiple regression model for the prediction of scores on the achievement sub-scale contained the career orientations service, job security and entrepreneurial. the scores on the service, job security and entrepreneurial orientations correlated significantly with scores on the hard driving/competitive jenkins sub-scale. these were weak correlations, the common variance being, respectively, 4.8%, 3.2% and 3.6%. job security was included in the multiple regression model for the prediction of hard driving/competitive scores. the entrepreneurial career orientation scores correlated significantly with the speed and impatience subscale scores. the relationship was not strong as the common variance amounted to only 2.9%. the same orientation was included in the multiple regression model developed for the prediction of speed and impatience scores. the total score on the jenkins scale correlated .38 with the service career orientation and .20 with the entrepreneurial orientation. none of the career orientations was included in the model built to predict the total type a scores. in the present study, job involvement scores related statistically significantly with the scores on the achievement sub-scale, the hard driving/competitive sub-scale and with the total type a score, with the common variances being only 7.3, 3.6 and 7.8% respectively. job involvement also entered into the multiple regression model predicting the total type a score. chusmir and hood (1986) and (1988) obtained similar results. it seems as if a rather weak but statistically significant relationship exists between job involvement and some aspects of type a behaviour. the relationship between job satisfaction and type a behaviour has been investigated in several studies. the results were contradictory. chursmir and hood (1988), byrne and reinhart (1990), gamble and matteson (1992) as well as byrne and reinhart (1994), found negative relationships between at least r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 328 some facets of type a behaviour and job satisfaction, the opposite i.e. a positive relationship, was found by bedeian, et al. (1990), day and bedeian (1991), kushnir and melamed (1991) and norden (1995). in the present study low but significantly positive relationships between some type a facet scores and some of the sub-scales of job satisfaction were found. a low but significantly negative relationship was observed between the supervision subscale of the msq as identified in the present study and the speed/impatience type a sub-scale. a final conclusion on the relationship between job satisfaction and type a behaviour can therefore not be drawn at this stage. the relationships found in different studies were not strong and appear to be rather contradictory. in the present study, four dimensions of the self-concept scale used were identified. scores on these factors were related to the scores on the type a subscales and the totaj type a score. it was found that scores on the achievement sub-scale of the jenkins activity survey correlated significantly positive with the scores on the self-concept factor identified as power and with the task accomplishmentimorality self-concept factor. the common variances amounted to 9.7 and 8.4% respectively. with achievement as dependent variable the task accomplishment and likeability factors were included in the multiple regression model. the hard driving/competitive sub-scale correlated statistically significantly with al three of the self-concept sub-scales. the percentages of common variance were, respectively, 22.1% (power), 1.7% (task accomplishmentimorality) and 2.6% (likeability). only the power sub-scale entered into the multiple regression model with hard driving/competitive as dependent variable. it seems as if only the relationship between power and the hard driving/competitive relationship is of real significance. the power subscale also correlated statistically significantly with the speedjimpatience type a sub-scale. the common variance at 1.7% was also low. the total score of the jenkins activity survey showed two significant relationships with self-concept factors i.e. with power (24% common variance) and with task accomplishmentimorality (6.8% common variance). when the jenkins activity survey total score was used as the dependent variable in the multiple regression analysis, the task accomplishmentimorality and the likeability sub-scales were included in the model. the findings with regard to the relationship between dimensions of the self-concept and type a behaviour seem to contradict the results of previous studies in which it was found that type a behaviour was associated with lower rather than higher self-esteem (wolf et al., 1981; lobel, 1988). the opposite tendency was found in the present study, i.e. a positive relationship between type a behaviour and self-concept scores. the interpretation of this result is at present not unclear. it might be speculated that respondents higher in type a behaviour may be more successful in their occupations and in life generally and therefore have a more positive self-concept r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 329 sajems ns vol 2 (1999) no 2 than those lower in type a behaviour. this presupposes a relationship between type a behaviour and success, which has not been proved yet. in the present study, the possible relationship between type a behaviour and entrepreneurial attitudes was also investigated. significant but relatively weak correlations were obtained between the achievement sub-scale of the type a measure and attitude to economic innovation (11.6% common variance); attitude to achievement/personal control (8.4% common variance); and attitude to self-esteem (negative relationship, 1.2% common variance). attitude towards economic innovation was included in the multiple regression model with the type a achievement sub-scale as dependent variable. the hard driving/competitive type a sub-scale also related significantly to all the subscales of the entrepreneurial attitude orientation scale (eaos). the common variances were: economic innovation, 12.3%; achievement/personal control, 4.4%; self esteem, 9.6%. the relationship between self-esteem and hard driving/competitive was found to be negative (r = -.32). the total scale score on the jenkins activity survey showed significant relationships with economic innovation (19.4% common variance), achievement/personal control (9.6% common variance) and self-esteem (5.3% common variance). the relationship between attitude towards self-esteem and the total type a score was negative. these findings cannot be related to those of previous studies, as no such studies could be found. it does seem as if the finding with regard to the relationship between self-esteem and type a behaviour, which was found in the present study, is in accordance with earlier findings as stated earlier. the multiple regression models built to predict the scores on the sub-scales and the total score of the jenkins activity survey, represented a first attempt of this nature. the results were encouraging. it could be shown that scores on the jenkins sub-scale achievement could be predicted quite well by means of scores on the sub-scales of the psychometric instruments used in the present study. common variance of 40.30% between the scores on this scale and predictors included in the multiple regression model, seems to indicate that a definite relationship was established between type a behaviour and the variables included in the model. the primary contribution of the present study seems to be the determination of the relationships among a number of variables in the work situation, in this case of professional people. although limited, the sample was carefully defined and seemed to represent a clear statistical set. the results indicate that a substantial proportion of the variance in type a behaviour can be explained by means of the variables measured in this study. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 330 the present study seems to have broadened the view of the relationships of different variables with type a behaviour in the work environment. the multiple regression analyses showed type a behaviour to be related to various self-concept constructs, e.g. locus of control, self-esteem as measured by the self-concept scale and the individual's career self-concept as measured by means of the career orientations inventory. self-perception therefore seems to be involved in the development and maintenance of type a behaviour. the relationship between type a behaviour and entrepreneurial attitude has, as far as could be determined, been investigated for the first time. the analyses indicated that entrepreneurial orientations seem to be related to type a behaviour to a significant extent. this study carefully investigated of the measurement qualities ofthe instruments by the revalidation of each of the measuring instruments used. it could be shown that several of the instruments did not stand up well to revalidation on a south african sample. the importance of scepticism about the validity and reliability of instruments developed in one culture, and used on members of another culture is emphasized by these results. the study also seems to represent a contribution to our knowledge of the correlates of type a behaviour in a culture different from the north american one, where the majority of such studies has until now been done. the study has clear limitations. the results must be interpreted with caution due to the low values of the cronbach alpha coefficients of the sub-scales of the type a measurement. the study was done on individuals in only two professional categories and the findings can therefore not be generalized to other occupational groups too. it seems advisable to use a longer version of the jenkins activity survey in future studies, and to carefully revalidate the instrument before utilizing it as a criterion measure. more information on the psychometric qualities of measuring instruments when used in cultures different from those in which they were developed, seems essential in future research of this nature. future studies should be aimed at professionals other than accountants and pharmacists. considerable further analysis of the data gathered in this study is possible, and is also currently being undertaken. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 331 sajems ns vol 2 (1999) no 2 references i. adler, n. & ma1thews, k. 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(1981) "self-concept, locus of control, goal blockage, and coronaryprone behavior pattern in children and adolescents: bogalusa heart study", the journal of general psychology, 105: 13-26. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol2 (1999) no 1 115 customers' perception of bank service quality: the importance of employee service quality k kgovender department of economics, university of transkei abstract in financial services marketing, especially among banks, there is limited opportunity to impress the customer because services are becoming more automated. this paper reports the findings of a mail survey using selfadministered questionnaires, conducted among a random sample of 1050 bank customers. from a usable sample of 190 respondents, it was found that the customers' perception of the overall service quality [squal] is positively associated with their perception of the bank employees' service quality [equal]. this implies that service firm managers need to understand what kind of employee behaviour most effectively serves to satisfy customers, and also discover ways to foster such behaviour by their customer contact employees. an agenda for future research is proposed. jel m 21 introduction according to bettencourt and brown (1997: 39), in many services contact employees are the source of differentiation and competitive advantage. customer satisfaction, service quality perception, and decisions either to remain loyal or to change service providers are significantly influenced by the attitude and behaviour of these company representatives. mohr and bitner (1995: 240) assert that contact employees contribute to service excellence by delivering on the promises of the firm, creating a favourable image for the firm, and going beyond the call of duty for the customers. despite their importance, these employees continue to be treated by many organizations as disposable resources (bettencourt and brown, 1997: 40). in view of this, the present research attempts to discover whether the customers' perception of employee service quality [equal] is associated with their perception of the overall service quality [squall. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 116 sajems ns vol 2 (1999) no 1 brief theoretical review and hypothesis lulian and ramaseshan (1994: 29) assert that because of the labour intensity of many services, quality can vary from one firm (branch) to another and from one situation to the next within the same firm. furthermore, too much emphasis on short-term profitability in a service tirm may be reflected in lower service quality assessments by the customer. for example, a short-run view can lead to many cost-reducing moves and their consequences, such as reducing the number of bank tellers and lengthening the lines at the teller windows. high employee turnover, according to berry, bennett and brown (1989: 10), can cause poor service, and service problems can in turn lead to high employee turnover. mohr and bitner (1995: 239) assert that since services are intangible, in many cases the only tangible evidence (or cue) available to compare quality and performance in a service transaction is the contact person with whom they interact. by referring to the service employees as "part-time" marketers, gummesson (1991:68) argues that during the product/service delivery process, the service providers, have a unique chance of influencing the customers' present and future purchases as they are in direct contact with the customers. thus natural points of marketing occur which can be used to the advantage of the service provider. some researchers such as larkin and larkin (1996: 213-227) argue that information technology has made it possible to provide service that is personal, personalized and convenient. information transmitted instantaneously throughout an organization can empower either the consumer or the service provider and in some cases both. thus front-line employees are granted real authority that allows them better to help their customers at the point of initial customer contact. while an industrialization approach to services, as suggested by some researchers (chase, 1978: 137-142; lovelock and young, 1979: 168-178), may initially seem appealing, the service marketer is in danger of losing the customer orientation which is so vital during the interactive employee-customer service encounter. moreover, advocates of the "technological" approach to the management of service performance may have ignored an important factor, namely, the level of sophistication achieved by the customer or target market. for example, if a bank operates in an area in which the majority of customers are illiterate or have only a low level of education, there is need for more personal interaction between bank r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (l999) no 1 117 employees and customers to conclude most transactions. serving a semi-literate population segment is bound to result in many queries emanating from a lack of knowledge about or incorrect use of atms. by interacting with customers and responding to queries, bank employees are provided with "opportunities" to impress these customers. schneider and bowen (l995: 7) proposed that service organizations should be viewed as comprising three tiers: the customer tier, the boundary tier, and the coordination tier. this way of thinking about the service organization has some unique features, in that management's task is not to "control" or "lead" employees to service excellence but to put together a system that actually makes it possible to deliver quality service. it is apparent from the brief literature review above, that the in the service sector the contact person is often the main cue for the customer regarding the service being sold; for example, an insurance agent influences the consumer's perception of the insurance agency, as well as the insurance being sold. although many top managers who are seeking to improve company competitiveness are now producing plans calling for a stronger organizational commitment to high-quality customer service, less attention has been given to the effective implementation of these plans by customer-contact employees. far removed from the strategic planning table and lacking much practical guidance, customer-contact managers and employees must translate top management service goals into action. all too often ambitious strategies for better service break down at the point of delivery, jeopardizing the organization's strategic plans and its very survival. in the light of foregoing, it is hypothesized that: hl: the bank customers' perception of the overall service quality [squal] is positively associated with their perception of the employee service quality [equal]. ho: the bank customers' perception of the overall service quality [squal] is not associated with their perception of the employee service quality [equal]. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 118 sajems ns vol 2 (1999) no i methodology sample, research setting and response using convenience and judgmental sampling techniques, a sample of 21 0 front-line employees of three major commercial banks in south africa were selected to participate in this survey. the commercial banks were selected by means of simple random sampling. the managers of three eastern cape branches were personally briefed about the research and they assisted by distributing questionnaires to customers through their front-line employees. each bank employee (70 per bank) was requested to hand five questionnaires (a sample of 1050 customers) together with postage paid envelopes to every third customer with whom they interacted for at least ten minutes. the rationale for choosing every third customer was to introduce a "sense of randomness" into the customer sample, a method which has been used in previous researchers such as danaher and mattsson (1993: 8) and naumann and giel (1995: 207-209). by providing customers with stamped, self-addressed envelopes, it was hoped that this procedure might contribute to the bank customers responding freely and honestly to all questions. anonymity was assured as no respondent was required to supply his or her name or bank account number. after a three month period, only 190 usable questionnaires were returned. the unfavourable overall response rate (of 18.1 per cent) was to be expected, considering that customers could not be compelled to complete and return (post) the questionnaires. furthermore, banks could not identify customers to whom questionnaires were given since this was done randomly. however, notices to remind customers to complete and return the questionnaires were posted in the various banks. table i reflects the frequency distribution of the respondents. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 ( 1999) no i 119 table 1: distribution of respondents banks i employees i employee i customers customer % i selected ! participation i surveved response r ii_ ••••• ~ ~-~ ----~---! a 70 50 350 79 -,~ .., ..... ':".! .... --i b 70 26 ! 350 63 is.0 : c 70 30 350 48 13.7 total 210 i 106 : 1050 r190 i 18.1 i ! i i research instruments the customers' perception of the overall sen-ice quality (squal) was measured using an adapted servqual instrument, due to research (buttle, 1996: s-32: nel pitt and berthon, 1997: 113which identified deficiencies in the servqual instrument. in this study the instrument used was based on the 22 items of the servqual instrument; however, it combined expectations and perceptions into one measure by asking customers whether certain aspects of service quality exceeded or fell short of expectations. customers were asked to rate each of the 22 items on a scale from 1 (worse than expected) to 5 (better than expected). the overall squal score was a summed average score. this approach is supported by researchers such as cronin and taylor (1992: 55-6s) and parasuraman et al. (1994: 210-230). in order to measure the customers' perception of the employee service quality (equal) an instrument [see appendix a] was developed, based on the universal servqual instrument. customers were required to think about their interaction with the bank employee and indicate their agreement to each of 16 items (eq i to eq 16) on a five point scale where i = strongly disagree and 5 = strongly agree. a high score would indicate that the respondent perceived the employee service quality as being high. measurement reliability and validity since a common procedure for assessing reliability via the internal consistency method is cronbach's (1951) alpha (steffens, 1995: 10), the computer programme sas proc .corr (sas institute, 1990) was used to determine cronbach's coefficient alpha of the measuring instruments. the squal scale returned a cronbach's coefficient alpha of 0.961 and the equal scale 0.946. which implied ~i r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 120 sajems ns vol 2 (1999) no 1 that these latent variables were measured with acceptable levels of reliability (bless and higson-smith, 1995: 135). as an initial step to address the question of validity, the measure development paradigms recommended by researchers such as churchill (1995: 534-539) and parasuraman (1991: 442-443) were closely followed during the development of the scales. thereafter, exploratory factor analysis (willie 1996) was performed to ascertain the discriminant and construct validity of the measuring instruments. in each step of the exploratory factor analysis (ef a), individual items were deleted from the respective measuring instruments if the factor loadings were below oa (rummel, 1967). this process was repeated until all the (remaining) measuring instruments possessed acceptable levels of discriminant and construct validity. in each step of the analysis, bmdp4m (frane, jennrich & sampson 1993) was used to perform a maximum likelihood factor analysis with a direct quartimin rotation (jennrich & sampson, 1966: 313-323) of the unrotated factor matrix. due to the fact that the latent variables squal and equal had too many measurements, it was decided to reduce the number of individual measurements by averaging individual measurements to generate adapted measurements. the final squal instrument which comprised 16 items was refined as follows: sqi (sq6+ sq7+sq8+sq9)/4; sq 2 (sqii+sqi2+sqi3+sqi4)/4; sq3 (sqi5+sqi6+sq17 +sqi8)/4; sq 4 (sqi9+sq20+sq21+sq22)/4. the equal instrument which was also refined as follows: eq 2 (eq5+eq6+eq7)/3; eq 3 (eq8+eq9+eqio+eqii)/4; eq 4 (eqi2+eqi3+eqi4+eqi5)/4 consisted of 11 items. table 2 reflects that the measuring instruments possess acceptable levels of discriminant and construct validity since they load with loadings above 0,4 (rummel, 1967) only on one factor. table 2: rotated factor loadings item i factor 1 factor 2 overall service quality employee servicequality squall -0.033 0.841 * squal 2 i 0.013 0.924* squal 3 i 0.068 0.847* ~ squal 4 -0.001 0.944* i r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 121 table 2 continued item factor 1 factor 2 overall service quality employee servicequality equal 2 0.810* -0.046 equal 3 0.972* -0.000 equal 4 0.842* 0.026 data analysis exploratory data analysis was conducted using the sas (sas institute, 1990) computer programme. more specifically, the univariate, general linear model and correlation procedures were performed. to further empirically evaluate the hypothesized relationship depicted in figure i, the computer programme ramona (brown and mels 1990) was used. figure 1: hypothesized model empirical findings + \ ________ ~ overall service quality the initial descriptive results using the sas (sas institute, 1990) computer programme and the proc. univarlate procedure are summarized in table 3. the favourable overall squal (4.1047) and equal (4.116) scores implied that the banks concerned were offering quality service to its customers. however, the low response rate, the large kurtosis values (greater than 0) and the skewness implied that non parametric tests had to be used to analyze the data. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 122 sajems ns vol 2 (1999) no 1 table 3: univariate data analysis squal equal i n 190 190 mean 4.1048 4.1164 std. dev. 0.7946 0.8278 skewness -0.9819 -2.2713 kurtosis 0.9409 8.7428 variance 0.6314 0.6853 pr> iti 0.0001 0.0001 the proc glm. procedure, with squal as the dependent variable and equal as the independent variable produced a r2 of 0.2655, a cv of 16.63339 and a rmse of 0.6828 , f value of 67.98 and apr> f of 0.0001. the proc corr. procedure produced a pearson correlation coefficient of 0.5153, and a spearman's correlation coefficient of 0.6045, both of which implied that there is a positive association between overall service quality and employee service quality. furthermore, the covariance matrix of 0.3390 suggested a need to conduct further analysis so as to ascertain the determinant in the model. the hypothesized model (figure i) was also fitted to the observed data, using the computer programme ramona (browne and mels, 1990) by specifying an analysis based on sample correlation matrix with maximum likelihood estimation. the resulting maximum likelihood estimate with the associated significance information in terms of p values is shown in figure 2. it is evident from figure 2 that the overall service quality (as measured by spe) is signiticantly influenced by the employee service quality (0.552; p < 0.01). this implies that the service quality delivered by the banks' employees to their customers is a very important determinant of the overall service quality delivered by the banks. thus the hypothesis in this study is supported and the null hypothesis is obviously rejected. the hypothesized model (figure 1) provided a reasonable fit to the data as was evident by the root mean square error of approximation of 0.068. this result was further supported by the fact that the expected cross validation index for the model (3.046) was less that that for the saturated model (3.345). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . n figure 2: empirical evaluation of hypothesized model ~ ,--.. 0\ 0\ 0\ n ~ izl z izl ~ w ....., < izl 0552 p..:::; ~ .. s01 = (sog + s07 + sos + s09)/4 ; s02 = (sou + s012 + s013 + 8014) 14 : s03 = (so 1 5 + s016 + s017 + s018)/4 : s04 = (s019 + s020 + s021 + s022)/4 e02 = (e05 + e06 + e07) 13; e03;; (eob + e09 + e010 + e011)/4 eq4 = (e012 + e013 + eq14 + e015) 14 overall service quality r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 124 sajems ns vol 2 (1999) no 1 discussion and managerial implications it emerged that when evaluating service quality, the consumer considers the service delivery process as well as the service outcome. with reference to the delivery process, the importance of the service delivery personnel has been highlighted. this finding has been supported by previous research undertaken by gronroos (1984: 36-44). this researcher maintained that in service businesses, the consumer is not only interested in "what" he receives as an outcome of the production process, but in the process itself. "how" he gets the technical outcome or technical quality is also important to him, and his view of the service he has received. gronroos' view has also received empirical support from researchers such as ennew, reed and martin (1993: 59) and cronin and taylor (1994: 125). since service employees are both physically and psychologically close to the customers they serve, they play at least two important roles, namely, impression managers and gatekeepers of information. for many customers, the service employee is the organization. this means that the "boundary" employees' behaviour, and the experiences their behaviour creates for the customers, are service quality in the eyes of the customer. moreover, boundary employees, being in constant contact with customers, are an endlessly useful source of insights into customer attitudes, information on competitor strategies and ideas about how to enhance service quality. moreover, schneider and bowen (1995: 4) argue that the "make-it-or-break-it" role service employees play is that of linking customers to the organization. seeing that services marketing in the 21 sl century is likely to be characterized by "high touch" through "high tech" strategies, organizations need to understand what employee behaviours most effectively serve to satisfy customers and also find ways to foster these behaviours in their customer contact employees. limit a tions of this study and future research although this exploratory study highlighted the importance of the service employee in customer evaluation of the overall service quality, much remains to be explained in terms of employee behaviour. the ongoing debate about the empowerment of service workers; why, how, when, and to what effect, should be addressed through future research. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 125 in order to improve the response rate, customers could be interviewed in the bank immediately after their interaction with the service employee. furthermore, to increase its generalizability, this study should be replicated in different research settings (service and non-service), and among a larger sample. references l. berry, l.l., benneit, d.r. & brown, c.w. (1989), service quality: a profit strategy for financial institutions. homewood, ill: dow jones. 2. beitencourt l.a. & brown, s.w. (1997), "contact employees: relationships among workplace fairness, job satisfaction and pro-social behaviours", journal of retailing, 73( 1): 10-17. 3. bless, c. & higson-smith, c. (i 995), fundamentals of social research methods: an african perspective. 2nd ed. kenwyn, cape town: juta. 4. browne, m.w. & mels, g. (1990), ramona pc user's guide. unpublished report. pretoria: human sciences research council. 5. buitle, f. (1996), "is there a role of expectations in servqual?" working paper no. 305. uk: manchester business school. 6. chase, r.b. (1978), "where does the customer fit in the service operation?" harvard business review, 56: 137-142. 7. churchill, g.a., jr. (1995), marketing research: methodological foundations. 6th ed. florida: dryden. 8. cronbach, l.j. (1951), "coefficient alpha and the internal structure of tests", psychometrika, 16(3): 297-334. 9. cronin, j.j., jr. & taylor, s.a. (1992), "measuring service quality: a re-examination and extension", journal of marketing, 56: 55-68. 10. cronin, j.j., jr. & taylor, d.a. (1994), "servperf versus servqual: reconciling performance based and perceptions-minus expectations measurement of service quality", journal of marketing, 58: 125-131. 11. danaher, pj. & maitson, j. (1994), "customer satisfaction during the service delivery process", european journal of marketing, 28(5): 5-16. 12. ennew, c.t., reed. g.v & binks, m.r. (1993), "importanceperformance analysis and the measurement of service quality", european journal of marketing, 27(2): 59-70. 13. frane, j., jenrich, r.l & sampson, p.f. (1990), "4m-factor analysis". in dixon, w.j. et al. (eds.). bdmp statistical software manual, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 126 sajems ns vol 2 (1999) no 1 vol. 1. berkeley: university of california. 14. gronroos, c. (1984), "a service quality model and its marketing implications", european journal of marketing, 18(4): 36-44. 15. gummesson, e. (1991), "marketing orientation revisited: the crucial role of the part-time marketer", european journal of marketing, 25(2): 1121. 16. jenrich, r.i. & sampson, p.f. (1966), "rotation of simple loadings", psychometrika, 31: 313-323. 17. julian, c.c. & ramaseshan, b. (1994), "the role of customercontact personnel in the marketing of a retail bank's services". international journal of retail and distribution management, 22(5): 15-28. 18. larkin, t.j. & larkin, s. (1996), "reaching and changing front-line employees", harvard business review, 105: 95-104. 19. lovelock, c.h., & and young, r.f. (1979), "look to customers to improve productivity", harvard business review, 57: 168-178. 20. mohr, la & bitner, m.j. (1995), "the role of employee effort in satisfaction with service transactions", journal of business research, 32(3): 239-252. 21. nauman, e. & giel, k. (1995), customer satisfaction measurement and management: using the voice of the customer. cincinnati, ohio: thompson. 22. nel, d., pitt, l.f. & berthon, p.r. (1997), "the servqual instrument: reliability and validity in south africa", south african journal of business management, 28(3): 113-122. 23. parasuraman, a. (1991), marketing research. 2nd.ed. massachusetts: addison-wesley. 24. parasuraman, a., zeithaml, va & berry, l.l. (1994), "a reassessment of expectations as a comparative standard in measuring service quality: implications for future research", journal of marketing, 58: 111-124. 25. rummel, r.j. (1967), "understanding factor analysis", journal of conflict resolution, 11: 444-480. 26. sas institute inc. (1990), user's guide, release 6.03, cary, n.c.: sas institute inc. 27. schneider, b.& bowen, d.e. (1995), winning the service game. boston: harvard business school press. 28. steffens, f.e. (1995), initial data analysis. pretoria: centre for statistics. human sciences research council. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vo12 (1999) no 1 127 29. wille a.s., 1996, a stepwise procedure for the empirical assessment of latent variable models. unpublished m.sc. dissertation, port elizabeth: university of port elizabeth. appendlxa with regard to the bank. employee who served you, please indicate the degree of your agreement or disagreement with the following: i = strongl y disagree; 2 disagree; 3 neutral; 4 = agree; 5 = strongl y agree. the bank employee: eqi was neatly attired 1 2 3 4 5 eq2 understood your needs 1 2 3 4 5 eq3 was wiiiing to help 1 2 3 4 5 eq4 was courteous i 2 3 4 5 eq5 was prompt i 2 3 4 5 eq6 gave you personal attention 1 2 3 4 5 eq7 treated your transaction confidentially 1 2 3 4 5 eq8 was able to answer queries ~ 2 3 4 5 eq9 delivered on promises 2 3 4 5 eqio had your best interest at heart 2 3 4 5 eq11 was sincere in solving your problem/s i 2 3 4 5 eqi2 performed the service right the first time 1 2 3 4 5 eq13 was never too busy to respond to your 1 2 3 4 5 requests eqi4 told you exactly when the service will be i 2 3 4 5 performed. eq15 made you feel safe in conducting your 1 2 3 4 5 transaction eq16 used language which you could understand 1 2 3 4 5 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 509 an econometric analysis of the impact of the rdp on the demand for construction materials in south africa charles c okeahalam donald gordon professor, graduate school of business, university of the witwatersrand abstract the reconstruction and development programme (rdp) is an attempt by the south african government to redress the imbalances of apartheid. it has many facets. one of these involves the provision and distribution of infrastructure to citizens who hitherto have been neglected. this calls for significant construction effort particularly for housing, water, roads and other social construction. this will require efficient production, and allocation of resources to ensure that there is adequate supply of materials to meet the likely increase in demand. this paper examines the expected demand for construction materials, assesses the supply capacity of south african suppliers of construction materials, and develops an econometric model which can be used to evaluate the impact that growth of the internal construction activity will have on construction industry suppliers. jel 011 1 introduction the role of construction as part of keynesian economic policy has been debated, by for example coates and hillard (1987) and fishlow (1995). some, such as easterley and vierra da cunha (1994) and tanzi (1996), see specific industrial sector focus, unwarranted by potential for positive expected financial returns, to be a distortion of incentives and thus a form of fiscal laxity. accordingly, they consider pump-priming (greater expenditure by government on public works on construction as a method of stimulating economic growth) to be inefficient; indeed detrimental, to long term growth. different conditions face each of the southern african countries in terms of resources, population, economic and technological levels. the objective of this paper is to provide an analysis of recent trends and patterns within the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 510 sajems ns vol 2 (1999) no 3 construction industry of the southern africa region and then develop a framework to conduct an econometric analysis of the south africa construction material demand-supply position. section 2 provides an analysis and evaluation of salient trends, in section 3 we estimate an econometric model to test the data, in section 4 we present the findings of the econometric exercise, section 5 gives some methodological points with which to validate the results, section 6 contains conclusions and section 7 provides recommendations, managerial implications and areas for future research. 2 review of trends in the southern africa construction sector in what follows here, we discuss the main trends in the data to provide an overview to the reader and to describe the data used in the econometric model which follows in section 3. the data set used is based on information for the four-year inclusive period of 1991 to 1994 and is derived primarily from desk top and library search from a variety of publications, including the business construction review (1992, 1993 and 1994) and publications of the southern african research strategy consulting unit (sarscu) notably, the market for building materials (1996). as noted in gouden, merrifield, amod and nkosi (1996) it is inevitable that effects of war damage and insufficient delivery of transport infrastructure will influence the rate of inflation in the regional construction industry and this varies greatly, as can be seen in table i below. furthermore, table 2 shows the different annual rates of change in planned residential investment in the southern africa region. this shows that botswana which has experienced significant annual rates of economic growth has the highest rate (110.5%) while tanzania has the lowest (6.9%). in table 3, again it can be seen that, with regard to the non-residential sector, namibia has the highest (39.5%) and mozambique the lowest rate (6%). the size and growth of the construction industry of countries in the southern africa region thus differ and the extent to which they have penetrated each others' construction markets and industries will also differ. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 511 table 1 average construction industry inflation rate (%) in southern african (sadc) countries country 1991 1992 1993 1994 mean angola 1185.4 1011.9 1617.1 1738 1388.1 botswana 12.0 11.6 il.l 10.9 11.4 lesotho 15.2 15.5 15.1 15.6 15.4 malawi 28.8 25.1 24.6 19.8 24.6 mozambique 497.9 454.5 404.3 343.6 425 namibia 12.1 9.2 8.6 8.9 9.6 south africa 14.4 14.6 14.5 14.7 14.6 swaziland 14.7 15.0 14.9 15.1 14.9 tanzania 25.9 25.2 24.4 22.0 24.4 zambia 29.1 27.6 27.9 28.7 28.3 zimbabwe 19.0 18.7 18.4 17.2 18.3 sources:statistical year book, united nations, 1994 construction industry study, botswana technology centre, 1992 southern african research centre, harare, zimbabwe. economic research bureau, university of dar es salaam, 1991; central statistical office, mbabane, swaziland; the economic intelligence unit ltd, 1994; business and construction review, june 1993; the central bank of swaziland, 1993; bank of tanzania annual report, 1992. table 2 southern african construction industry indicators, annual rate (%) of change for residential buildings approved plan/investment country 1991 1992 1993 1994 mean angola 2.3 2.6 4.5 4.8 3.5 botswana 50.7 30.1 20.8 8.9 27.6 lesotho 3.4 4.3 4.4 3.6 4.0 malawi 2.1 3.6 3.3 2.9 2.9 mozambique 1.8 2.7 2.2 2.9 2.4 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 512 sajems ns vol 2 (1999) no 3 table 2 continued country 1992 1993 mean namibia 9.8 8.7 7.1 8.4 south africa 4.5 10.3 14.7 21.2 12.7 swaziland 4.5 6.1 5.2 tanzania 2.0 1.0 1.7 zambia 2.3 2.6 2.0 1.8 2.2 zimbabwe 13.2 13.8 13.1 12.9 13.1 sources; csir pretoria, personal communication division of information services (infortek) construction industry study, botswana technology center, 1992; bureau of economic research, university of stellenboscb, building and construction business and construction review, 1996; development and cooperation, 1990; central bank of swaziland, 1993. table 3 southern african construction industry indicators, annual rate of change for nonresidential buildings approved plan! investment country i 1991 1992 1993 1994 mean angola 3.7 4.1 2.1 4.2 3.5 botswana 8.2 7.8 7.6 7.2 7.7 lesotho 24.1 2.6 3.7 3.0 8.4 malawi 2.9 1.6 2.7 1.7 2.2 mozambique i 1.6 1.4 2.0 1.0 1.5 namibia i 9.6 6.4 12.3 11.2 9.9 south africa 10 15 20 23 17.0 swaziland 5.2 3.6 5.0 4.5 4.6 tanzania 4.9 3.5 2.6 2.1 3.3 zambia 3.7 4.9 3.3 2.6 3.6 zimbabwe 6.9 7.8 6.3 5.0 6.5 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 513 sources: business and construction review, 1992-93ministry of works, transport and communications, botswana quarterly economic and statistical review, zimbabwe. although not shown here, the data set makes it possible to observe that the demand for south africa bricks is highest in south africa itself. we can also observe that the largest regional importer of bricks which are manufactured in south africa is botswana. the data moreover suggests that botswana as the major importer of bricks is followed by namibia, swaziland and lesotho. we suggest that the prime reason for this is geographical proximity. there also appears to be a significant amount of horizontal and vertical integration between south african construction companies and construction materia] manufacturers in namibia, lesotho, and swaziland. table 4 percentage of gdp allocated to the construction in sadc countries in 1994 country percentage angola 12.1 botswana 33.8 lesotho 6.5 malawi 4.8 mozambique 10.6 namibia 7.1 south africa 30.2 swaziland 6.9 tanzania 5.2 zambia 5.0 zimbabwe 5.1 sources: southern african research centre, harare, zimbabwe construction industry study, botswana technology centre, 1992 building research strategy consulting uniq ply), ltd. 'the market for materials 1990-95' quarterly economic and statistical review, zimbabwe, 1992 world bank report, 1994. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 514 sajems ns vol 2 (1999) no 3 table 4 indicates the role which the construction industry plays in the gdp of southern africa countries. it would also appear that countries which until recently were involved in war and conflict, notably angola and mozambique, are currently allocating a high proportion of their gdp to construction. however, the actual size of this growth for angola and mozambique is still lower in monetary terms than that of botswana, and of course south africa. the latter in particular, has socio-economic and political reasons for allocating a high proportion of its gdp to this industry sector. the data trends suggest that given the peaceful conditions which now prevail in most of the region, economic growth is likely to be more buoyant and the region-wide demand for south africa materials should increase accordingly. this is primarily because of the significant technological advantages which it would appear south africa has over its regional neighbours. now, given the construction sector demand-impact which will be generated by the reconstruction and development programme (rdp), i neighbouring countries may experience either supply backlogs in quantity and time, and/or, they may experience price inflation depending on the extent to which the sector becomes overheated. 3 methodology specification and test of an econometric model to validate the above view, in this section we use econometric methods to test the demand for south african construction materials, and the impact that the growth of internal (sa based) construction activity will have on this demand. the demand for construction materials is a derived demand, arising from the commissioning of construction projects projects which will use materials as part of the construction process. here we develop an econometric framework in which the derived demand level for construction materials is made conditional on demand for construction projects. the largest catalyst of the demand for construction projects and therefore materials, is likely to be the rdp .. it is clear that the actual demand/supply structure of materials will vary as we near finite levels, however the principal economic trends, even if different in impact, applies to different types of materials. accordingly we proceed in a generic framework to establish likelihood relationships which in principle should be applicable to all materials. the model is: r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 515 y jil = r. ucmc jlx p + gdpjtx l+rdpjt x jp+ etlj,x 4+8 + eil where (i) lji' = is the dependent variable and the total demand for construction materials} in period t for construction project i; ucm0uxt = unit construction material consumption of material} in period t by construction project i; a vector of parameters associated with ucmcjit xi; gdp jg = country average gop growth rate; d· rdp xj a binary dummy variable2 for a vector of rdp independent jj eil construction project commission rate variables; = vector of parameters associated with rdpx3 , = economic trade link variables3; = vector of parameters4 of economic trade links which are correlated with neighbouring country demand for sa country materials; = error term for construction project i in period t. the term rdp jg accounts for the range of possible types of construction projects, housing, roads, bridges, dams. for our pwpose the distribution of the ucmcu associated with these specific projects is of less interest than the aggregate level. a pure conditional-demand approach approximates the terms ucmcit via variables related to the type of construction project under consideration. specification can take a linear form and be simplified by using the financial value of the construction project as a proxy for the use of construction materials; linearly the higher the value of the project the more material is used. however, there is a problem with this specification in that different projects use materials at a different rate and accordingly, the demand for construction materials is not fully correlated nor monotonic in functional form. an engineering·econometric approach would condition a ucmc specific type of project and the underlying technology to be used. thus the structure of the estimated equation would be best emphasised by including all the relevant construction engineering data available. using this latter approach, to apply the model empirically it would be necessary to focus on the specific end uses of construction materials at the rate that they differ for different types of construction. this would elicit cross·sectional as well as regional/country variations. however, in the case of roads for example, if a regional road construction plan exists it would be possible to enter calibrations based on this plan into the model. for housing we could, given the rdp, subtract the term from the left hand side of the equation. if the values are measured with error, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 516 sajems ns vol 2 (1999) no 3 this approach may reduce the parameter estimates of pi but should not bias the estimates, if the measurement errors are uncorrelated with the right hand side variables. the estimation of the model has to take cognisance of the cross-sectional and time-series properties of the data and attempt, in particular, to exploit the ucmc j response rates over time. we also have to assume homoscedasticity of disturbances for the construction period of every i. given differences in each i, the paucity of the time-series data available and the increase in empty cells that arise from cross-sectional disaggregation, this would be a reasonable assumption.6 even if we assume that the cross-section and time series construction material demand data are independent for each i, it is still possible to assess individual project construction material demand over time. to do this we need to assume that the disturbances in each project material demand behaviour structure are equi-correlated over time and given the current vintage of technology are time-invariant. such a situation may arise from unobservable but universally applicable or acceptable standard construction project characteristics such as, for roads, the number of metres per tonne of bitumen, or in the case of house construction, the number of cement bags required to produce bricks. the calculus then simply becomes arithmetic, as demand is then a function of scale. alternatively, given the rdp, we can argue with some persuasion that disturbances have an auto-regressive structure in which e( eft e is) = pt., . s 4 findings results of the model estimates. table 5 model estimates l~txl estimate standard error (se) 0.714 (0.023) gdpx 2 0.391 (0.011) d-rdpx3 drdpx3-0 0.54 (0.017) d rdpx3-1 0.23 (0.004 etl~ 0.29 (0.316) i , ion: 0 log-likelihood (0) l*(o)= -512242 dfl *(0) =183.7 log-likelihood (p) l *(p)= -366125 dfl* (p)= 141.4 -1 _ 0.322 p r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 517 to gain further information in support of the data in the tables, we have calibrated, estimated, and validated the above model. there are some empirical problems which we should briefly touch on before the provision of results. given that we wish to understand what the impact that sa demand will have on the sa construction material supply-demand position, we have disaggregated the data and removed all non-sa demand. we have also divided each annual entry into quarterly entries to be able to have sufficient data points to fit the number of explanatory variable parameters. while this diverges from reality in that the level of demand for construction material is unlikely to be uniform for each quarter of the year, it allows for a better fit of the model and does not distort the aggregate numbers since the quarterly entries are obviously a function ofthe yearly entries. we estimated the above model equation using the maximum-likelihood technique. 7 as would be expected the estimated coefficient for ucmyit is extremely significant. this is to be expected, given the way this explanatory variable is specified and the strong correlation this variable has relative to ljil' although the parameter estimate is significant, the relationship is not univariate. the gdpx1 is also significant, suggesting that the level of gdp in the years for which we have time-series data has a positive influence on the demand for construction materials. the coefficient for d-rdpxro is significant, suggesting that the rdp will have an impact even if the trend in construction demand is constant at the underlying rate. the estimate for d-rdpxrl is smaller than that for 0 but significant, suggesting that the 6% stimulus of the rdp will also have an impact on the demand for construction materials. finally, we tried to test the hypothesis that the level of economic trade links that exist between sa and each of her neighbours, measured by data from the current account trade balance tables, would have some discernable impact on the demand for construction materials. however, while the coefficient value supports this view, it is not statistically significant and as such is a null hypothesis.s r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 518 sajems ns vol 2 (1999) no 3 5 validation and other methodological issues data has been collected from a variety of sources which are listed in the references. the methodology has involved evaluation of data count, such that with the observed data we are fairly sure that we have not double counted and that the variety of sources used does not bias the overall results. this is the usual methodology that is used with some form of asymptotic estimator to validate combined cross-section and time-series (panel) data. this is particularly so with regard to some construction materials where, as we disaggregated further, the number of empty cells increased. i do feel that for further investigation and as the analysis becomes more detailed. there is a need to employ some form of simple random sampling, stratified sampling or exhaustive sampling to validate the overall statistical consistency. to gain further statistical confidence information on the significance of rsa firm demand of sa materials, a two-step estimation process would then isolate the significant variables of equation i, and this could then be re-estimated by using xl and xj in a reduced-form equation. we however have insufficient data on sa firm involvement and are therefore unable to estimate the reduced form. however this should be pursued in later work. 6 conclusions it is quite clear that the rsa construction sector is the major determinant of the derived-demand level for rsa construction materials. we also see that a very high proportion of rsa gdp is geared to construction and allied sectors. we believe that while the rdp is undoubtedly going to stimulate the level of internal demand for construction materials, given macroeconomic limitations, of its own accord, it is not going to be capable of creating the level of demand pull, to present supply capacity problems and industrial construction material inflation.9 the regional impact of rsa construction material supply sector is most readily felt in botswana, namibia and latently in mozambique. however, the building boom that drove the botswana demand is over. furthermore it is clear that the further we move from rsa, the less significant is its role as a supplier of construction materials to southern africa. there is significant scope for development in this regard. the corollary is also worthwhile noting. in that there has been little or no inroad into the rsa market by her regional neighbours. the econometric analysis suggests that there is a fairly strong relationship between the unit material consumption rate for construction projects, that the rsa economic growth rate is positively related to domestic demand for r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 519 construction materials, and that the rdp, whether measured at the underlying rate or a multiplier of 1.06/1 also has a positive impact on internal demand for construction materials. 7 recommendations, managerial implications, and future research an interesting managerial implication of this is that sadc governments need to find ways in which regional construction business suppliers can enter the .expanding sa construction supply market, and effectively manage strategic partnerships in the vertical or horizontal supply chain which develops. see forrest (1992) and fellows and langford (1993). the primary strategic managerial implication is that managers in the southern africa construction material supplies industries need to closely examine the possibility of joint ventures to share market revenues. the joint ventures need to be designed in such a way that while they are profitable, in that they yield adequate returns on the capital employed, they do not lead to political discord and trade protectionism, as charges are made of attempting to dominate local, national or regional markets. accordingly, assessing the long term impact which such joint ventures may have on demand and supply patterns is an area of research, which in the future, should be further developed. endnotes the rdp is the blue print for economic and social development which was developed by the african national congress (anc) led majority government in 1994. there is a level of construction activity which would exist without the impact of the rdp. accordingly we need to ascertain the level of pre-rdp construction activity level and subtract this from the rdp construction activity level. we envisage the rdp to be a major catalyst of the 'growth of the internal construction activity' that is referred to in brief and accordingly i devote attention to its role the econometric model developed herein. 2 this dummy variable takes the value 0 for non-rdp related growth in the demand for construction materials, i.e. the underlying pre-rdp growth rate and 1 for a factor of(+ 6%) which is added to the underlying rate and is determined by the rdp induced growth in demand for construction materials. this factor is equivalent to rdp construction sector rate minus non-rdp underlying construction sector growth rate. we have calibrated this aspect of the model with 6%. it is based on the government's bluer ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 520 sajems ns vol 2 (1999) no 3 print macroeconomic annual growth forecast of 1996, which has unfortunately proved ambitious, but was the best information available at the time. 3 this variable can be established by examining the degree of openness which each country has with the rsa via protocols, agreements and tariffs apart from the general sadc positions on such issues. it can also be calibrated as the actual observed level of trade between the two countries, and is the method we use when we introduce this model in the estimation process later on. 4 these parameters include the state of intra-country construction manufacturing vintage of technology, geographical proximity to rsa, availability or lack of skilled construction sector manpower. there is likely to be some form simultaneity bias which is difficult to decipher exactly. 5 thus the disturbances for this model take the following form where e, = (ejt.e;t •.....• en') is the vector of disturbances for project i; i =1,2, ... ,n) in period 1. the covariance for two different construction project periods can be given as e( e,e!) o'ul n t.s = /,2, .... t. note that e( eii~) is the covariance of each project i over time while e( ell ejs) is the cross-sectional covariance which we assume to be zero. 6 usually a robust test of the goodness of fit of the model would be to evaluate it empirically via a simulation exercise, i.e. use ii ex-post trends to carry out 41 ex-ante analysis. alternatively it is possible to statistically validate an econometric model which has been estimated via maximum likelihood via the following procedure. the validation of the model herein followed the procedure in which the log-likelihood was evaluated at l*(o)= 512242 with 183 degrees of freedom and fell to -366125 with the log-likelihood evaluation as l*(,o) with 141 degrees of freedom. the overall statistical validity of the model is fairly robust particularly given that the p2 value is 0.322 which falls within the acceptable range which johnston (1984) has shown to be a good fit for model of this type. see johnston j., econometric methods, mcgraw hill, 1984 for more on this. this validation procedure was used because firstly there are no previous empirical results and secondly there is no sufficiently clean data to test this model via simulation. 7 a good way of basically explaining the maximum-likelihood estimation method used herein is to assume a bounded random variable p with a parameter with an unknown value since it is drawn from a random sample with data values of yl =1, y2 =1 and y3= o. 'the maximum-likelihood technique will choose the value of the unknown parameter p that maximises the probability (likelihood) of randomly drawing the sample r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 521 that was actually obtained.' judge hill, griffiths, lutkepohl, and lee (1988), page 63. since it is probabilistic the model is multiplicative. 8 in the tests for t value significance one sided alternative hypothesis is used by using the critical value of t (since it is usual to test at the 95% level of confidence). the t(oo) value cutting off 5% of the highest values in this data distribution is 1.645 and that cutting off the lowest values is -1.645. 9 the current economic growth rate suggests that excess supply capacity exists in rsa industry (not just in the construction sector but through out the economy) which can easily be geared up to meet the demand pull impact of the rdp. furthermore, stagflation (inflation and recession) is more likely than inflation on its own. references coates d. & hillard j. (1987) the economic revival of modern britain the debate between left and right, edward elgar publishers. 2 easterley w. & p. vierra da cunha (1994) "financing the storm: macroeconomic crises in russia", economics of transition 2,4, 443-465. 3 fellows r. & langford d. (1993) marketing and the construction client, chartered institute of building publication, london. 4 fishlow a. (1995) "inequality, poverty and growth: where do we stand?" proceedings of the annual world bank conference on development economics. world bank publications: 25-39. 5 forrest j. (1992) "management aspects of strategic partnerships", journal of general management. 17(4): 25-40. 6 gouden s., merrifield a., amod s., and nkosi j. (1996) "regionalising the rdp creating a common economic community for the construction and allied industries in southern africa", rsa public works department publication. 7 johnston. (1984) econometric methods, mcgraw-hili publishers. 8 judge g.e., carter hill r., griffiths w. lutkepohl h., and lee t -c. introduction to the theory and practice of econometrics, john wiley publishers, 2nd ed. 9 okeahalam c.c. (1996) "an analysis of the expected total demand and supply capacity of south african suppliers of construction materials", report submitted to the rsa public works department as part of the enabling environment initiative project. 10 public works department, republic of south africa (1997) "creating an enabling environment for reconstruction, growth and development in the construction industry". r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 522 sajems ns vol 2 {i 999) no 3 11 southern african research strategy consulting unit (sarcsc u)(1995) the marketfor building materials. 12 tanzi v. (i996) "fiscal federalism and decentralization: a review of some efficiency and macroeconomic aspects", in proceedings of the lih annual world bank conference on development economics bruno m and pleskovic b, ed., world bank publication. acknowledgements some of the ideas for this paper originated from work which was carried out for the ministry of public works of the republic of south africa in preparation for a green paper. i wish to acknowledge the comments of sam amod. the usual disclaimer applies. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . ������������ ��� ����� � � ������������� ����� � � ��������� ����� � � ��� ���� � �������������� �� ������������ ����� � ��� �� ����� ���������� � ��� ����� ��� � ��������� � ����������� ���������� � ���� ��� �������� �������������� ������� � � ������ ���� ��� ��� �������������� ����� ��������� ��������� ��� �� � � ������������������������ ���������������� ����� � 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��������������?#��$&$$� microsoft word 8 kamala sajems 19(4) 2016.docx sajems ns 19 (2016) no 4:579-591 579 how to cite doi: http://dx.doi.org/10.17159/2222-3436/2016/v19n4a8 issn: 2222-3436 users’ corporate environmental information needs pieter nasiema kamala, christa wingard & christo cronjé college of accounting sciences, university of south africa accepted: july 2016 most listed south african companies appear to have embarked on environmental reporting without enquiring what the users’ needs are. if users’ needs are not determined prior to reporting, it is unlikely that the resulting reports will meet those needs. using a questionnaire, this study investigated the environmental information needs of south african users of environmental reports. the study was deemed necessary to unveil users’ preferences which, if incorporated in reports, could enhance their perceived decisionusefulness, thus increasing readership. the results of the survey revealed that users need balanced environmental information that identifies and describes key, relevant issues and that is both specific and accurate. in addition, users need future-oriented information that identifies and addresses key stakeholders’ concerns, and which demonstrates the integration of environmental issues into core business processes. furthermore the information should be summarised in an integrated annual report and posted on a company’s website. based on its findings, this study recommends that standard setters and regulators should recognise that both financial and non-financial users need decision-useful environmental reports. disclosure standards and regulations should therefore be amended to accommodate this reality. key words: environmental reports, users, relevance, reliability, verifiability, comparability, understandability, timeliness, conceptual framework jel: m4 1 introduction in response to the mounting public pressure for companies to account for their environmental performance, growing numbers have increased the volume and scope of their environmental reports (jira & toffel, 2013; marquis & toffel, 2014). however the number of environmental reports produced appears to have increased without regard to users’ needs (laud & schepers, 2009). given the widespread lack of meaningful stakeholder engagement by companies, most appear to have embarked on environmental reporting without enquiring what the users require (de villiers & van staden, 2008). accordingly, the stakeholders have not influenced the content presented in the reports to suit their needs, an approach that has undermined the perceived relevance of the reports (marquis & toffel, 2014). despite the advancements in information technology that can enable a company to tailor their environmental reports to suit the unique needs of stakeholders, most companies have failed to exploit their online capabilities to serve this purpose (kpmg, 2011; radley, yeldar & gri, 2011). notwithstanding the emergence of assurance standards and the growing uptake of independent third party assurance of environmental reports, the assurance statements in environmental reports have varied significantly with regard to their titles, objectives, scope of assignment, amount of description of the nature, timing and extent of procedures employed, as well as the wording of their conclusions (furmann, ott, looks & gunther, 2013). company stakeholders have also been sidelined from the assurance process, a situation that has made them dismissive of the assurance practices of companies (furmann et al., 2013). indeed, the assurance engagements are typically determined by and undertaken for the companies' management, an approach that has undermined the perceived independence of the assurance providers (acca, 2009). in addition, most companies’ environmental performance measurement systems are inept and error prone, given abstract 580 sajems ns 19 (2016) no 4:579-591 their reliance on manual or simple spreadsheet software that cannot guarantee the accuracy of the reports produced (ernst & young, & greenbiz, 2013). furthermore, the users have lamented the apparent disconnection between the environmental reporting practice and the actual environmental performance given that companies with a poor environmental track record appear to report more comprehensively than their counterparts with a good track record for legitimisation purposes (leavoy, 2010). despite the widespread uptake of the internet as a medium of environmental reporting and the resulting proliferation of environmental information reported, no efforts have been made to standardise online reporting practices (laud & schepers, 2009). in addition, numerous environmental reporting guidelines and frameworks have emerged that do not harmonise with one another (kpmg, cfcgia, gri & unep, 2013). the foregoing has impaired the ease with which environmental reports may be compared (menselsohn, hjartarson & pearce, 2010). besides, most companies have proliferated their environmental reports in different formats and types, using a varying range of media including paper and electronic which has not only led to multiplication of data but has also further made it more difficult for readers to compare the reports (laud & schepers, 2009). by purporting to cater for diverse stakeholder groups, many companies have expanded their reports by simply ‘dumping’ verbose, un-prioritised and unintelligible information into them, an approach that has impaired the clarity of the reports (business & society, morris & chapman, 2010). although technological advancements have made more frequent reporting at a low cost possible, most companies have not leveraged their online capabilities to produce more timely reports using hypertext markup language (html) format files (kpmg, 2011). instead, they have increasingly relied on pdf files that take longer to upload, and that are aligned to the annual reports, thus missing an opportunity to produce more timely environmental reports (radley, yeldar & gri, 2011). environmental reporting, like any other form of accounting, is aimed at providing information that is useful to a wide range of users for making decisions (gri, 2013). however, the concerns raised above cast serious doubt on the ability of the current environmental reporting practices to meet users’ decision-making needs. consequently, it is debatable whether the environmental information provided by companies meets users’ needs or whether these needs are even known (hwang, khoo & wong, 2013; said, sulaiman, ahmad & senik, 2013). in the south african context, the lack of knowledge of users’ needs is exacerbated by a lack of research on environmental information needs of users (kamala, 2015). this research article aims to fill this gap in the literature by investigating the environmental information needs of both financial and non-financial users of environmental reports. the rest of the paper proceeds as follows: section 2 reviews the relevant prior literature; section 3 provides the theoretical perspective adopted in this paper as well as the expectations developed for interpreting the results; section 4 presents the methodology; section 5 presents results and discussion; and finally, section 6 provides the summary and conclusion. 2 literature review although extensive research has been conducted on environmental disclosure patterns (ernst & young, 2007; trucost & environmental agency, 2009; kpmg, 2011; kpmg, 2013), only a few studies have asked the users of such information what they need (de villiers & van staden, 2010b). even fewer have investigated the extent to which users actually read environmental reports, how they read the reports, the reasons for not reading the reports, and where environmental information should be reported (solomon & solomon, 2006; kpmg & sustainability, 2008; european commission, 2011; miller, 2012). from the limited studies that employ questionnaires to determine users’ needs, it is apparent that financial stakeholders do not read or even need environmental reports, given their narrative nature (de villiers & van staden, 2010b; european commission, 2011). however, studies that sajems ns 19 (2016) no 4:579-591 581 employ experimental methodology have revealed that financial stakeholders do use environmental information for making investment decisions when the information is provided, confirmation that they actually do need such information (chan & milne, 1999; rikhardsson & holm, 2005). unlike questionnaires, experiments only require participants to make an investment decision, therefore they do not explore other possible reasons users may want environmental information (de villiers & van staden, 2010b). in the south african context, surveys that investigate users’ needs are few and far between (kamala, 2015). in one rare such study, de villiers and van staden (2010b) investigated the preferences of individual shareholders and found that 97 per cent of the sampled respondents wanted companies to provide a description of their major environmental risks and impacts, 94 per cent wanted the disclosure of a company’s environmental policy, while 81 per cent wanted a disclosure of actual performance against environmental targets. in addition, 80 per cent wanted disclosure of environmental costs by category, 78 per cent wanted a disclosure of measurable targets based on environmental policy, while 75 per cent wanted an independent audit of environmental disclosures. with regard to where the environmental information should be disclosed, de villiers and van staden’s (2010b) survey revealed that that 90 per cent of the individual shareholders preferred that environmental information be disclosed in a company’s annual report; 82 per cent wanted the information to be disclosed on a company’s website; while 62 per cent wanted the information to be disclosed in a company’s separate environmental report. however, de villiers and van staden’s (2010b) study focused only on individual shareholders, thus neglecting the needs of the voiceless non-financial stakeholders. in addition, de villiers and van staden’s (2010b) study did not interrogate whether shareholders actually read environmental reports, how they read the reports, and for those that did not read them, the reasons for not doing so. in another south african study that focused only on the environmental information needs of non-financial users, mitchell and hill (2010) found that non-financial stakeholders were generally dissatisfied with the corporate social responsibility (csr) disclosures as issues perceived to be important were poorly or inadequately reported on and even omitted from the reports. however, mitchell and hill’s (2010) study did not focus on environmental reports nor did it investigate whether users had actually read environmental reports, how they read the reports, and for those that did not read the reports, the reasons for not doing so. from the foregoing, it is apparent that at present, little is known about users’ environmental information needs. specifically, there may be a gap in knowledge of whether users read environmental reports; how they read the reports; reasons for not reading the reports; their preferences as to what an environmental report should contain; how the information should be reported; and where. the main objective of accounting, and environmental reporting is no exception, is to provide information that is useful to users for making decisions (fasb, 2010; iasb, 2010; gri, 2013). providing environmental information without enquiring about the users’ needs from the users themselves casts doubt on the usefulness of that information, particularly where research on users’ needs may be lacking, as is the case in the south african context. given the high monetary costs that are incurred in producing environmental reports, it seems imperative that those costs be justified by ensuring that environmental reports meet users’ needs and are widely used. accordingly, research from a south african viewpoint to investigate users’ needs seems necessary. in an attempt to fill in the gaps in the literature produced to date, this study, being arguably the first south african study, according to the authors’ best knowledge, to investigate the environmental information needs of both financial and non-financial users (including impartial users, namely academics) in the post-king iii report era, aims to: • determine whether users read environmental reports and if they do, to determine how they read the reports; • determine the reasons why potential users may not read environmental reports; and 582 sajems ns 19 (2016) no 4:579-591 • elicit users’ preferences as to which information should be contained in environmental reports and how that information should be reported. 3 theoretical perspectives and development of expectations this survey aims to investigate the information needs of both financial and non-financial users of environmental reports, therefore some of the theories that are typically employed in social and environmental reporting research such as legitimacy, stakeholder and accountability theories are inappropriate because they explain only why companies undertake environmental reporting and therefore do not take users’ perspectives into account (de villiers & van staden, 2010b). likewise, the agency theory is deemed inappropriate as it focuses only on the needs of shareholders as the principals and on managers as the agents, and thus ignores the needs of nonfinancial stakeholders. suitably, the decision-usefulness theory is adopted in this survey. this theory is premised on the view that the primary purpose of accounting, including environmental reporting, is to provide information to permit informed judgements and decisions by users of the information (fasb, 2010). the decision-usefulness theory, unlike legitimacy, stakeholder and accountability theories, takes a users’ perspective and not that of reporting entities, and does not focus exclusively on the needs of financial stakeholders as is the case with the agency theory, but rather also recognises the information needs of non-financial stakeholders (iasb, 1989; fasb, 2010). according to the decision-usefulness theory, accounting reports are only useful if they are perceived to be relevant and reliable (the two fundamental qualitative characteristics that decisionuseful information must possess) (fasb, 2008; iasb, 2008; fasb, 2010). if accounting information is perceived to be completely lacking in either of these two characteristics, it will be neither useful nor read (fasb, 2008; iasb, 2008). it is therefore expected that those who do not perceive accounting reports to be either relevant or reliable will not read the reports (expectation 1). the decision-usefulness theory also posits that understandability, comparability, timeliness, and verifiability are the qualitative characteristics that enhance the decision-usefulness of accounting information (iasb, 2008; fasb, 2010; iasb, 2010). however, the enhancing qualitative characteristics, either individually or collectively, cannot make information useful if the information is irrelevant or unreliable (fasb, 2010). therefore users are expected to prefer information that has more fundamental qualitative characteristics than enhancing qualitative characteristics (expectation 2). also posited by the decision-usefulness theory is the notion that users’ perceptions of decisionuseful accounting information are limited by the cost constraint, according to which the information can be useful and yet too costly to access (fasb, 2008; iasb, 2008; fasb, 2010; iasb, 2010). the cost in accessing accounting information does not necessarily refer to monetary expense, but may take the form of the time required as well as the inconvenience faced when accessing the information (fasb, 2008). accordingly, users are expected to prefer accessing accounting information in a fast and convenient way (expectation 3). 4 methodology a questionnaire was employed to collect the data, which was analysed using both descriptive and inferential statistics. the following sub-sections further elaborate on this. 4.1 questionnaire design the questionnaire comprised 10 primarily closed-ended questions meant to maximise the response rate. only one question was open-ended to capture the full richness and complexity of the perspectives held by the respondents (o’dwyer, unerman & hession, 2005). sajems ns 19 (2016) no 4:579-591 583 the questionnaire was divided into three sections. the first section requested data concerning demographic characteristics such as gender, age, highest educational qualification and occupation. this information was deemed relevant to ascertain the suitability of the respondents to participate in this survey. the second section dealt with questions pertaining to whether environmental reports are read, how they are read, and reasons why potential users may not have read these reports. the third section focused on users’ preferences as to how and where environmental information should be reported. prior to disseminating the questionnaire, it was completed and critically evaluated by ten selected experienced researchers to ensure that the questions were clear, unambiguous, and understandable. the questionnaire was revised according to the recommendations made by the researchers and tested on ten full-time fourth-year accounting students (acting as surrogates for users) who found it to be clear, concise, and understandable. 4.2 population and sample selection the population comprised users of environmental reports produced by companies listed on the johannesburg securities exchange (jse). given that the population of users as defined in the accounting conceptual framework could foreseeably include the entire south african population (gri, 2008; iasb, 2008; fasb, 2010), this study focused only on user groups actively involved in 1) ethical investment, 2) environmental protection and 3) environmental reporting research. accordingly, the study focused only on ethical investment funds, environmental ngos, and environmental reporting researchers. in view of the fact that there appears to be no comprehensive public listing of all ethical investment funds, environmental ngos and environmental reporting researchers in south africa, a compilation of a population frame list was done through a thorough internet search that yielded 100 users comprising 30 ethical investment funds, 30 environmental ngos and 40 accounting researchers. consistent with prior studies, a census of the identified users was conducted considering that the population was relatively small (tilt, 1994; danastas & gadenne, 2004). 4.3 questionnaire distribution the 100 identified users were contacted telephonically in order to obtain their co-operation. the author explained the purpose of the study, and the reason why the user had been selected. an email link was sent to the users who had consented to participate. attached to the e-mail link was a detailed covering letter that explained the purpose of the study and invited the respondents to participate in the survey by clicking on the uniform resource locator (url) link provided. a click on the url link re-directed respondents to a web-based questionnaire which they were required to complete anonymously. this implies that only respondents who had e-mail addresses were included in this survey. the e-mail was sent out on the 1st of july 2013 with a deadline of the 31st of august 2013 for the completion of the questionnaire. 5 results and discussion the analysis and discussion of the results of this study are presented in the following sub-sections. 5.1 response rate and test for non-response bias from the 100 respondents, 54 usable questionnaires were returned, resulting in a response rate of 54 per cent. this rate was higher than that achieved by tilt (1994) (46.8 per cent), and o’dwyer et al. (2005) (52.8 per cent), and conforms to fowler’s (1988) recommendation that a response rate should be at least 20 per cent to provide credible statistics about a population. of the respondents, 55.56 per cent were male whereas 44.44 per cent were female. all the respondents were above 26 years old and had a minimum of a post matric certificate/diploma. most of the respondents were accounting researchers (39.62 per cent), followed by other professionals (32.08 per cent), 584 sajems ns 19 (2016) no 4:579-591 representatives of environmental groups (22.64 per cent), followed by representatives of environmental groups (22.64 per cent). the respondents thus represented a broad cross-section of users, which did not only increase the likelihood that respondents of different persuasions had answered the questionnaire (de villiers & van staden, 2010a), but was also consistent with the broad definition of users in the accounting conceptual framework (fasb, 2010; iasb, 2010). to further test for non-response bias, the responses of early respondents (the first 27) were compared to those of late respondents (last 27). early respondents were taken to represent individuals who were favourably disposed towards the subject of the questionnaire, whereas the late respondents were taken to represent those who were less in favour, as well as those who chose not to complete the questionnaires (de villiers & van staden, 2010a). for each of the three main likert-scale questions, a series of t-tests was conducted. there were no significant differences in the questionnaire answers between those who responded early compared to those who responded late. accordingly, there was no evidence of non-response bias in this test. although this kind of test is not conclusive in ruling out a non-response bias, given the relatively high and acceptable response rate, different user groups’ opinions and similarity of early and late responders' responses, it is unlikely that non-response bias influenced the results significantly (de villiers & van staden, 2010b). 5.2 whether users read environmental reports users were asked by the way of a yes/no question whether they had read an environmental report in the past 12 months. the responses to this question are reported in table 1. as shown in the table, 83.33 per cent of the users indicated that they had read an environmental report in the past 12 months, whereas only 16.67 per cent indicated that they had not done so. table 1 extent to which users read environmental reports in the past 12 months total number of users number responding to the question percentage responding “yes” percentage responding “no” binomial exact sig. (2 tailed) 54 54 83.33% 16.67% 0.000* *statistically significant difference (p<0.05) at 95% confidence level a binomial test (2-tailed) was conducted to determine whether there was a significant difference between the total number of users who read the environmental report, and those who did not. a significant difference was found between the proportion of the users who had read the environmental reports (83.33 per cent), and the proportion of those who had not read them (16.67 per cent) (p<0.05). the fact that an overwhelming majority of the sampled users (83.33 per cent) had read an environmental report in the past 12 months confirms that an appropriate sample of users had been selected as it is only those who have read an environmental report that can really articulate their environmental information needs. 5.3 how users read environmental reports to determine how users read environmental reports, the respondents were asked to indicate how often they employed five reading techniques, namely: scanning (to locate specific information); skimming (rapid reading of headings, topic sentence to get the main idea); exploratory reading (to get a fairly accurate picture of the entire report); study reading (to maximise understanding of the main ideas); and critical reading (questioning, analysing, and evaluating the text). a five-point likert scale was used with weightings of one for ‘never’, two for ‘rarely’, three for ‘sometimes’, four for ‘often’, and five for ‘almost always’. therefore the closer the mean was to five, the more often a reading technique was used by the users. for the sake of clarity and brevity, the percentages of those who indicated that they had used the five reading techniques either ‘often’ or ‘almost always’ were added up together, and reported as “percentage that used the technique sajems ns 19 (2016) no 4:579-591 585 often” in the third column of table 2. in essence therefore, those who indicated that they had used a reading technique ‘sometimes’ or ‘rarely’ are conservatively reported as never having used the technique, as the words “sometimes” and “rarely” suggest infrequent to almost non-usage of a technique. this approach is justified because it ensures that only those who frequently use a reading technique are reported as such, and it has also been used in prior studies (see de villiers & van staden, 2010b). table 2 how often various reading techniques were employed number reading technique percentage that used the technique often users standard deviation n=48 mean 1 scanning (to locate specific pieces of information) 77.15% 4.06 0.873 2 skimming (rapid reading of headings, topic sentence to get the main idea) 74.29% 3.89 0.796 3 exploratory reading (to get a fairly accurate picture of the entire report) 64.70% 3.68 0.638 4 critical reading (questioning, analysing and evaluating the text) 42.86% 3.34 1.027 5 study reading (to get a maximum understanding of the main ideas ) 34.28% 3.37 0.731 scale: 1=never; 5=almost always as table 2 shows, most users (77.15 per cent) indicated that they used the scanning reading technique, followed by skimming (74.29 per cent), then exploratory reading (64.70 per cent). the least often used reading technique was study reading (34.28 per cent), followed by critical reading (42.86 per cent). with the exception of the critical reading technique, the above results reveal an agreement in the responses of the users in view of the fact that the standard deviations of the responses are below one. the users’ preference of scanning, skimming and exploratory reading as opposed to critical reading and study reading suggests users’ inclination to quick, convenient reading which suggests a need of summarised information of the kind that is contained in executive summaries, fact sheets of key indicators, tables, charts, graphs, scorecards, gri index tables, dashboards and pictures. these findings are consistent with the decision-usefulness theory’s cost constraint, and confirm the third expectation (expectation 3), that users are expected to prefer accessing environmental information as fast and as conveniently as possible, as opposed to time-consuming and even inconvenient ways of doing so. 5.4 reasons why some potential users do not read environmental reports the potential users who had not read any environmental report in the past 12 months (hereafter referred to as non-readers) were asked to rank the various statements that could explain why they did not read any environmental report during the above-mentioned period. a scale of seven ranks was provided, with one being the most important statement, two being the second most important statement and seven being the least important statement. a rank was to be allocated once only to each statement. the mean rank for each statement was computed. the closer the mean of the statement was to one, the more important the statement was in explaining why environmental reports were not read. the ranking of means of the responses to this question is tabulated in table 3. as table 3 shows, the most important statement that could explain why non-readers did not read environmental reports was that the reports were not perceived to be reliable. the second most important reason was that the reports were not perceived to be verifiable. the least important statement that could explain why environmental reports were not read was that they were not perceived to be comparable. the non-readers’ views varied widely on all the statements except the last one (environmental reports were not comparable), as indicated by standard deviations above 586 sajems ns 19 (2016) no 4:579-591 one. the above findings are consistent with expectation 1 that those who did not perceive accounting reports to be either relevant or reliable will not read them. table 3 reasons why environmental reports were not read in the past 12 months reason for not reading users (non-readers) rank standard deviation n=6 mean environmental reports are not reliable 2.83 1 1.941 environmental reports are not verifiable 3.33 2 1.751 environmental reports are not understandable 3.67 3 2.338 environmental reports are not timely 4.00 4 1.265 other 4.33 5 3.011 environmental reports are not relevant 4.83 6 2.401 environmental reports are not comparable 5.00 7 0.632 scale: 1=most important; 7=least important 5.5 users’ environmental information needs companies can only meet users’ needs if they know what those needs are in the first place. this section was meant to explore users’ needs by eliciting their views on what environmental information should be reported, how it should be presented, and where. 5.5.1 the information that an environmental report should contain and how it should be presented bearing in mind that the users that have read an environmental report are in the best position to articulate their needs, the respondents who had read an environmental report in the past 12 months were asked to rate the importance of 28 statements about what a company's environmental reports should do or should be. a five-point likert scale was used with weightings of one for ‘not important at all’, two for ‘slightly important’, three for ‘fairly important’, four for ‘very important’, and five, for ‘extremely important’. therefore the closer the mean was to five the more important the statement was to the users. for the sake of brevity, the percentages of those who perceived each of the 28 statements as either very important or extremely important were added up together, and reported as “percentage that perceive statement to be important” in the fourth column of table 4. therefore, those who perceived the statements to be fairly important were reported as perceiving the statements not to be important, as the words “fairly important” suggest neutrality in perception of the importance of the statements. this approach is justified to ensure that only those who perceived the statements to be important with certainty were reported as such, and it has also been used in prior studies (de villiers & van staden, 2010b). as can be seen from table 4, the top six statements perceived by most respondents to be either ‘very important’ or ‘extremely important’ relate to the fundamental (primary) qualitative characteristics of decision-useful information, namely relevance or reliability. in fact, out of the top ten statements ranked according to the percentage of respondents that perceived them either as ‘very important’ or ‘extremely important’, only two statements relate to the qualitative characteristics that enhance the decision-usefulness of environmental information, whereas eight statements relate to the fundamental (primary) qualitative characteristics. five out of the top ten statements relate to reliability and three relate to relevance. each of the remaining two statements was either related to comparability or to understandability. another interesting observation that can be made from table 4 is that four out of five bottomranked statements relate to the qualitative characteristics that enhance the decision-usefulness of environmental information, whereas only one statement relates to the fundamental qualitative characteristics. the above results are consistent with the decision-usefulness theory’s assertion contained in the accounting conceptual framework that relevance and reliability are the two sajems ns 19 (2016) no 4:579-591 587 fundamental (primary) qualities that make accounting information useful for decision-making (fasb, 2010; fasb, 2008; iasb, 2010; iasb, 2008). the results thus confirm expectation 2, that users are expected to prefer the environmental information that has more fundamental qualitative characteristics than enhancing qualitative characteristics. table 4 users’ perceptions of what a company's environmental report should do/should be number statement related qualitative characteristic percentage that perceive statement to be important rank users standard deviation n=48 mean 1 disclose both negative and positive aspects in a balanced manner reliability 100.00% 1 4.67 0.478 2 identify and describe key relevant issues (significant aspects) relevance 91.67% 2 4.61 0.728 3 be specific and contain accurate information reliability 91.67% 2 4.47 0.810 4 provide future oriented information relevance 91.67% 2 4.42 0.732 5 identify and address key stakeholders and their concerns relevance 88.89% 5 4.33 0.756 6 demonstrate integration of environmental issues into core business processes reliability 88.89% 5 4.33 0.756 7 compare quantitative outputs/ impacts against best practice /industry standards comparability 88.88% 7 4.33 0.676 8 adhere to well-established international guidelines reliability 86.11% 8 4.36 0.798 9 demonstrate top management commitment to environmental issues reliability 86.11% 8 4.33 0.793 10 be readily accessible via multiple media (printed hard copies and soft copies via internet) understandability 86.11% 8 4.31 0.786 11 provide targets comparability 83.34% 11 4.36 0.762 12 allow for quick reading (executive summary, and fact sheet of key indicators) understandability 83.33% 12 4.28 0.741 13 provide quantitative/ monetary disclosure of significant impacts comparability 80.56% 13 4.17 0.811 14 include interpretation and benchmarks to provide context understandability 80.56% 13 4.17 0.811 15 show trends (performance over time) comparability 77.78% 15 4.19 0.786 16 be produced annually timeliness 70.59% 16 3.74 1.109 17 enhance readability using multiple languages, pictures, charts, explanations understandability 69.45% 17 3.86 1.046 18 include an assurance statement from an independent third party reliability 69.44% 18 3.94 1.013 19 the reports should provide contacts for feedback relevance 66.67% 19 3.78 1.045 20 indicate whether internal auditing coverage is extended to environmental systems/procedures verifiability 66.67% 19 3.78 1.017 21 describe the management system verifiability 65.71% 21 3.74 0.95 22 indicate whether environmental management systems have been certified reliability 61.12% 22 3.75 1.105 23 describe an organisation's structures that deal with environmental matters reliability 61.11% 23 3.83 1.082 24 enhance accessibility of information using navigation tools understandability 50.00% 24 3.50 0.878 25 be produced on a real time basis timeliness 50.00% 24 3.06 1.393 26 include stakeholder voices reliability 47.23% 26 3.42 1.052 27 be produced quarterly or bi-annually timeliness 28.57% 27 2.77 1.109 28 be interactive understandability 27.77% 28 2.97 1.108 scale: 1=not important at all; 5=extremely important 588 sajems ns 19 (2016) no 4:579-591 5.5.2 where environmental information should be reported to determine which medium was preferred by the respondents, they were asked to indicate how often they read environmental reports from two types of media, namely print media and company websites. with regard to the print media, the users were required to specify how often they read environmental reports from integrated annual reports or sustainability reports. likewise, with regard to the company websites, the users were required to specify how often they read environmental reports in integrated annual reports, or stand-alone sustainability reports, and the format of the reports that they often read html format or portable document format (pdf)). a five-point likert scale was used with weightings of one for ‘never’, two for ‘rarely’, three for ‘sometimes’, four for ‘often’, and five for ‘almost always’. therefore, the closer the mean was to five the more often environmental reports were read from a given medium. table 5 how often users read environmental reports from different media number medium percentage of users that read from the medium often users standard deviation n=48 mean 1 pdf integrated annual reports on companies' websites 51.43% 3.46 1.170 2 pdf stand-alone sustainability reports on companies' websites 45.72% 3.43 0.770 3 html format stand-alone sustainability reports on companies' websites 42.86% 3.29 1.172 4 html format integrated annual reports on companies' websites 38.23% 3.32 0.976 5 print medium integrated annual reports 34.29% 2.83 1.014 6 print medium stand-alone sustainability reports 26.47% 2.74 0.963 scale: 1=never; 5=almost always for the sake of clarity and conciseness, the percentages of those who indicated that they had read environmental reports from the various media, either ‘often’ or ‘almost always’, were added up together, and reported as “percentage of users that read from the medium often” in the third column of table 5. in essence therefore, those who indicated that they had read from a given medium ‘sometimes’ or ‘rarely’ are conservatively reported as never having read from a given medium, as the words “sometimes” and “rarely” suggest infrequent reading of the reports. this approach was used to ensure that only those who frequently read environmental reports from a specific medium were reported as such. besides, the approach has also been used in prior studies, such as that undertaken by de villiers & van staden (2010b). as summarised in table 5, most users read environmental reports from companies' websites as opposed to the print medium. of the users, 51.43 per cent often read environmental reports in pdf integrated annual reports posted on companies' websites; 45.72 per cent of users often read environmental reports in pdf format stand-alone sustainability reports posted on companies' websites; while 42.86 per cent of users often read environmental reports in html format standalone sustainability reports posted on companies' websites. by contrast, only 34.29 per cent of users often read environmental reports in print medium integrated annual reports. likewise, only 26.47 per cent of users often read environmental reports from print medium stand-alone sustainability reports. the users' opinions were mixed as the standard deviation of their responses for the three media were above one whereas for the other three it was below one. the preceding results highlight the emergence of companies' websites as the medium of choice for users as this medium made environmental reports easily accessible, readily searchable and portable, convenient and time-saving as opposed to print medium reports (mlarvizhi & yadav, 2008). the preference of websites by users is consistent with the accounting conceptual frameworks' assertion that users incur costs, in terms of time and inconvenience to obtain information (fasb, 2008; iasb, 2008). hence users are bound to prefer a medium that minimises these costs such as a company’s website which, unlike the printed media, minimises the inconvenience and time spent in searching and accessing the desired information. the above sajems ns 19 (2016) no 4:579-591 589 results thus confirm expectation 3 that users can be expected to prefer accessing environmental information as fast and as conveniently as possible. 6 summary and conclusion the purpose of this paper was to investigate the environmental information needs of both financial and non-financial users of environmental reports. to this end, three expectations based on decision-usefulness theory were developed and a survey conducted to determine users’ needs. the results of the survey revealed that a majority (83.33 per cent) of the sampled users had read an environmental report in the last 12 months while only 16.67 per cent had not. as far as how environmental reports were read was concerned, the results revealed that the most preferred reading techniques were scanning, skimming and exploratory reading, as opposed to study reading and critical reading. the preference of these quick and convenient reading techniques suggested that the users needed summarised information presented in the manner of executive summaries, fact sheets of key indicators, tables, charts, graphs, scorecards, gri index tables, dashboards and pictures. this result confirmed expectation 3 that, given the resource/ cost constraint, users could be expected to prefer accessing environmental information as fast and conveniently as possible, as opposed to time-consuming and even inconvenient ways of accessing the information. concerning the reasons why some potential users had not read any environmental reports in the past 12 months, the results of this survey revealed that the most important reason was the perception that the environmental reports were not reliable. considering that reliability is one of the fundamental characteristics that decision-useful information must possess, this result confirmed expectation 1 that those who do not perceive accounting reports to be either relevant or reliable will not read the reports. in respect of users’ preferences as to which information should be contained in environmental reports and how that information should be reported, the results of this survey revealed that the top six most popular environmental information attributes were all related to the two fundamental qualitative characteristics of decision-useful information. likewise, four out of five of the least popular attributes were related to the enhancing qualitative characteristics of decision-useful information. the preceding results confirm expectation 2 that users are expected to prefer the environmental information that has more fundamental qualitative characteristics of decision-useful information than the enhancing qualitative characteristics. the above results show that ethical investors, accounting researchers and environmental groups as a collective need environmental information that contains both negative and positive aspects in a balanced manner, identifies and describes key relevant issues and provides specific, accurate information. in addition, the above users need future-oriented information that identifies and addresses key stakeholders and their concerns, and that demonstrates the integration of environmental issues into core business processes. furthermore, the results show that users prefer summarised environmental information included in an integrated annual report that is posted on a company’s website. this finding has not been reported in any other prior study. among the most popular improvements in environmental reports that users wanted to see was an improvement in reliability of the reports, most notably the independent verification of the reports. other improvements were mostly centred on the relevance of the reports, particularly relating to the deployment of an effective stakeholder engagement approach. in conclusion, bearing in mind that relevance and reliability are the two fundamental qualitative characteristics that decision-useful accounting information must possess, and considering that users overwhelmingly need information that has these two characteristics, it can be concluded that users need decision-useful environmental information provided in a convenient, and readily accessible manner. the above results have implications for the standard setters and regulators who need to recognise that both financial and non-financial users need decision-useful environmental reports, and therefore they may consider changing the disclosure standards and regulations to make the required information obligatory. 590 sajems ns 19 (2016) no 4:579-591 among the limitations of this study is that it focused only on the needs of three user groups, namely the ethical investors, accounting researchers and environmental groups, so its findings may not be generalisable to all the user groups of environmental reports. further research could investigate the environmental information needs of other user groups such as environmental regulators, company employees, local communities, and green consumers. this study also did not examine the specific type of environmental information needed by specific user groups. future studies could usefully explore these aspects. references 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have established currency board arrangements in recent years. argentina, djibouti, estonia and lithuania at present maintain such a monetary system, and bosnia-herzegovina is about to establish one. imf staff have discussed the introduction of currency board arrangements with postconflict somalia and liberia. in some cases a currency board arrangement has been a major element in a stabilization programme (currency board arrangements 1997:54). in the opinion of researchers and politicians in several countries, a stable currency based on a currency board arrangement is a cornerstone of the success of estonian economic reform. for example, during his visit to the country in may 1994, g. soros stated that estonia's success is based on a stable and convertible monetary unit. the kroon (kalda 1994:25). currency boards are not a new phenomenon is economics. the currency board principle was established in the bank charter act of 1844, where the issue department of the bank of england acted as a currency board. for this reason, many of the british colonies in africa, asia and the caribbean used currency boards on introduction of their own currencies. more than 70 such boards operated at one time. among the best known examples of territories which still have a currency board of some kind are hong kong and singapore. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 3 464 the orthodox currency board is not subordinate to a central bank but only backs bank notes with foreign assets, therefore, some observers do not consider present-day currency board arrangements to be real currency boards (hanke, jonung, schuler 1993:12). however, as the main characteristic of a currency board is that it is always willing to exchange domestic currency for a foreign reserve currency at a fixed rate, it may be concluded that estonia does have currency board arrangement which conforms to present-day developments in money and central banking, as did the orthodox currency board in its own time. the liberation of the central and east european countries (ceec) from the socialist political and economic regime previously forced on them, gave birth to financial and economic problems analogous to those caused by the liberation from colonial subjection. it was therefore natural for the idea of the currency board to be reborn in the 1990s. the aim of a currency board system is to achieve currency convertibility and a fixed exchange rate, and thereby help to stabilize the economy, bring about structural change and integrate the country into the world economy as quickly as possible. estonia has 6 years of positive experience in applying a currency board system, which permits some generalizations about its positive and negative impact on the development of estonia's economic reforms. given the spread of the currency board arrangement, the time seems right for trying to draw some conclusions about its performance today. this paper attempts this by drawing on the estonian case. necessity of a currency reform in august 1991 the three baltic states regained their independence from the ussr, and estonia was the first to introduce its own currency the estonian kroon (eek) in june 1992. the idea that estonia should have its own currency dates from september 1987, when four estonian social scientists put forward a proposal for estonian economic autonomy. the supporters of the idea of a national monetary system hoped to achieve three objectives: (1) eliminate inflationary influences from the east, (2) establish approximate macroeconomic balance of supply and demand, and (3) conquer persistent cash crises (kallas, sorg 1995:53). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 465 satebnr vol 1 (1998)nr3 hyperinflation had broken out due to the liberalization of prices and the disruption of estonia's eastern trade at the beginning of i992. the consumer price index rose by 87% in january 1992, 74% in february and 30% in march in comparison with the previous month. this caused sharp cash crises and threatened to paralyze monetary circulation completely. the bank of estonia and the estonian savings bank issued cheque books (a major innovation) to alleviate the shortage of cash but the population used them rather reluctantly. the public sector was instructed to pay wages four times a month, instead of twice as previously, and a ceiling on cash payments was fixed at 1000 roubles. permission was given to use foreign currency alongside the rouble in buying and selling goods and services. various means of payment started to emerge spontaneously in enterprises, which were used for shopping there, and on march 25 1992 the board of the bank of estonia gave pennission for the introduction of temporary money in tartu so-called tartu currency to alleviate the shortage of cash (kallas, sorg 1995:57). confidence in the inflationary rouble, also called the "occupation rouble", was lost completely. this was stressed by a higher dollarization ratio than elsewhere in the baltic states. before estonia's currency refonn (second quarter 1992) the dollarization ratio peaked around 60 percent in estonia, 50 percent in lithuania (first quarter 1993), and 35 percent in latvia (first quarter 1993) (sahay, vegh 1995:37). for the estonian authorities such a situation set up two conditions for a successful currency refonn: (1) the currency refonn must be carried out as quickly as possible before multiple wage and inflation shocks would cause a social explosion and economic collapse, and (2) the new currency had to inspire confidence, though introduced under circumstances of deep economic crisis and lack of experience by the central bank in carrying out monetary policy. an early goal of monetary refonn was to control inflation. however, during the first month after the currency refonn, prices rose quite sharply (table 1), which can be interpreted as a temporary effect of the currency refonn. the rise in prices was mostly the effect of merging two goods markets (foreign currency and rouble shops) and eliminating the cash shortage experienced by the population. hence, during the first month after the currency refonn, the cash in circulation doubled. another reason was higher tax rates in order to balance the central government budget (vat rose from 10 to 18%). those who carry out a currency refonn must take into account a temporary acceleration of inflation. having eliminated the shortage of cash, it is necessary to create confidence in the new currency. this may be done by means of a currency board arrangement where the value of the new currency is fixed in terms of a major reserve currency. in estonia the exchange rate between the kroon (eek) and the deutsche mark (oem) was based on the prevailing market r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 3 466 exchange rate between the soviet rouble (sur) and the oem, i.e. approximately 80 sur = idem. roubles were thus exchanged for kroons at the rate 10 sur = 1 eek., and the estonian exchange rate was fixed at 8 eek = 1 dem. seeing that this rate took into account the gloomy future of the rouble, the kroon was undervalued by 4 to 5 times. according to un data, the price level in estonia in 1993 was four times lower than in austria if the official exchange rate between eek and the austrian schilling is taken as a basis (kaasik 1996:35). the undervaluation was obviously too big and caused inflationary pressure on consumer prices. however. the inflation rate in estonia declined continuously (table 2) and in 1997 the cpi increase had reached a level lower than 10%. table 1: changes in tbe consumer price index in 1992, compared with tbe previous month ('yo) general food manufacservices index tured eoods january 87.0 iis.5 40.5 58.6 february 74.0 72.1 64.1 135.7 march 30.0 14.5 52.8 88.s april 10.6 4.4 25.4 5.8 may 5.2 -0.3 7.6 25.8 june 11.4 7.9 16.3 12.6 july 24.3 25.2 16.3 40.8 august 17.6 12.8 32.4 8.4 september 6.6 3.1 5.1 18.4 october 7.7 1.1 14.0 11.3 november 9.5 20.6 0.1 8.6 december 3.3 5.2 1.2 3.1 (source: sorg 1994: 180) a moderate inflation rate (up to 10-20%) is useful to a transition economy for several reasons. for example: (i) it is easier to adjust the wage and price structure derived from the old socialist system and unsuitable for a market economy upward, instead of correcting the components equally upward and downward by subtracting from the one and adding to the other; (2) it is impossible to enforce sufficiently high tax rates given the weakness of public authorities and the low living standard of the population, and inflation tax helps to balance the state budget less painfully; and (3) inflation causes the real value (purchasing power) of bank deposits to decline continuously. and money is redistributed among its more active users. this causes primary capital ! r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 467 sa teb nr vol 1 (1998) nr 3 accumulation to take place and facilitates the rapid development of a new type of entrepreneurship. . table 2: ladation against the previous year (%) 1992 1993 1994 1995 1996 1997 increase in consumer 1076.5 89.8 47.7 29.0 23.1 11.2 . prices open sector 991.6 84.9 33.9 17.5 18.6 7.8 sheltered sector 1702.7 149.3 89.2 52.1 30.5 15.8 increase in producer ... 99.9 36.8 25.6 14.9 8.9 prices increase in export ... ... ... 15.1 11.3 7.5 prices (source: bank of estonia) the advantages of a fixed exchange rate in a transnnoneconomy in 1991-92 the estonian political elite had already come to the decision that a liberal economic policy would be the best for the country. the then prime minister of estonia, mart laar, stressed the following in his address at a colloquium of the german foreign policy association in june 1993 : "a vital factor in estonia's economic success has been the openness of the estonian economy" (laar 1993). estonia's liberal economic policy means to interfere with the activities of the market as little as possible. besides the smallness of the estonian market there are other reasons for this too: (1) the long-term experience of the overregulated socialist command economy had been strongly unfavourable and thus gave rise to a generally negative attitude towards state regulation; (2) regulation demands financial resources, but in a transition economy there is a lack of money even for the most urgent social and other government expenditures; and (3) the weakness of public authorities with respect to both political and economic sense. for a long time the population had regarded the state as the instrument of a foreign power and passive resistance to government structures was widespread. if the authorities in the restored estonian republic had tried to impose significantly higher tax rates than before and tighter regulation, the reaction to these measures would have been hostile and more. events in other post-socialist countries have also shown that r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 3 468 the more liberal the economic policy of a country is, the faster will the improvements caused by reforms work to stop the decline of economy. in order to prevent the development of pressures that might be conducive to a return to the former system, the first stage of transition (economic decline) must be passed as quickly as possible. the market economy has proved a flexible and robust system of organizing production in a modem society. for a market economy to function efficiently, at least three things must be in place: private ownership, free competition and exchange of goods, and a uhard" budget constraint which permits bankruptcy and thus creates the conditions necessary for economic renewal and growth (isachen, hamilton, gulfason 1994:127). it follows from these principles that the market economy also needs a currency in which people would have confidence. while the estonian economy, reorienting itself to a new economic system and new markets, was passing through a deep crisis, it was difficult to forecast the behaviour of the market and the central bank lacked experience how to manage the money supply. there was not even a theory of economic transition, and the only method how to establish a currency that inspired confidence was to introduce a fixed exchange rate. this had been clear long before the currency reform itself. in 1991 the then president of the bank of estonia, siim kallas, wrote in unitas (a finnish monthly journal): "we have passed a resolution with regard to our currency that we shall try to create a real currency that would have both confidence and convertibility" (1991:22). the ideas of a stable currency and free convertibility have indeed been reflected in the estonian monetary system and monetary policy. the estonian monetary system is considered particularly liberal because the kroon's purchasing power and currency flows are entirely determined by market forces. no restrictions are imposed on the flows of currency and capital to and from estonia. it is also possible in estonia to freely convert foreign currency into estonian kroons and vice versa, and to hold one's savings either in foreign currency or the kroon. no maximum or minimum rates of interests on deposits and loans have been imposed. in addition, the right of people to hold and use their money is secured by the fact that its stability is guaranteed by pegging the estonian kroon to the deutsche mark at the fixed exchange rate 8 to i, and the currency in circulation is (at least) 100% backed by foreign reserves. estonian banks are liquid and there are enough currency exchange offices more than 500 for a population of 1.5 million. in addition, banks use electronic credit cards and electronic payment systems. all these attributes secure the operational use of money. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 469 sateb nr vol i (1998) nr 3 liberal monetaiy policy goes together well with the main objective of estonia's reform policy, i.e. developing a free and open economy. the positive influence of liberal monetaiy policy on economic reform in estonia becomes significant when it is realized that an illiberal monetary policy would, at least to an extent, have sustained the old structures and customs and thus hindered the birth of market forces. the major reason why a strict monetaiy policy might have failed in estonia or not have been introduced in the first place, was the weakness of state power and the habit of civil servants and the population to ignore laws and regulations. if measures to enforce control had been taken, this would only have deepened the rift between the introduction and application of state economic policy (including the monetaiy policy). this is, for example, illustrated by the accusation that the bank of estonia (boe) robbed pensioners of their "funeral money" in the 1992 monetaiy reform, which can still be heard, although all rouble bank deposits were exchanged at the same exchange rate that applied to prices and pensions. thus, the currency reform only made it clear to the depositors that due to inflation, their savings had lost most of their value (purchasing power). another reason for adopting liberal monetary policy was the absence of the necessary conditions and means to manage the monetary demand and supply. at the end of 1990 the equity capital of the boe was only 10 million roubles and it had to borrow 6 million roubles from the estonian insurance agency. in 1991, when domestic currency had to be printed abroad, the boe postponed issuing a letter of credit to the printers because it had not received the necessary hard currency ($ 2 min.) from the government. the amount of reserve currency necessary to back the kroon issue during the 1992 currency reform was uso 120 million, which was also not achieved on time. on july 16 1992, nearly a month after the currency reform, the boe published its first balance sheet which showed foreign exchange reserves of eek 1165 million ($ 98 min.). in the draft of the 1992 annual report, the boe gold and foreign currency reserves were, on june 30 1992, said to be only eek 718 million ($ 57.9 min.). introducing a fixed exchange rate regime during the period of transition, first of all allowed the central bank to reduce the wrong decisions that it might have made due to the lack of theory, information, skill and experience. the estonian statistics system was, still is, in a process of evolution. gathering initial data is very complicated and in the circumstances of economic transition, it is not possible to determine and assess long term trends. preliminary data are unreliable and often late. for example, the statistical office published exact gop data for 1993 only at the beginning of february 1995. according to r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 3 470 presently available sources, estonia's gdp decreased between 8.5% and 9.0% in 1993. in may 1994, however, the statistical office recorded a 7.8% decline. the imf again showed a 3% decline. the bank of estonia in turn published the most optimistic figures, showing a 3% positive gnp growth in 1993 (lainela, sutela 1994:21). if the last-mentioned estimate had been accepted, then the wrong (discretionary) monetary policy might easily have been followed. from the above example it is clear that the central authorities cannot manage the economy efficiently until there are reliable theories about the influence of monetary policy in a transition economy. consequently, until then, the market should be allowed to fmd the right path. the risk of bad decisions is aggravated by a high level of corruption and the influence of corporate personalities on public authorities in transition economies. the author is of the opinion now, that when there is a need for estonian exporters to raise their competitiveness, something which domestic inflation forces these finns to do all the time, they strive to improve quality, reduce costs and look for new markets and products. here the fixed exchange rate remains the most impartial judge in the market. fluctuations in the kroon's exchange rate would create undeserved advantages for some and equally undeserved disadvantages for others (e.g. the users of imported raw materials). the share of intermediate goods sent to estonia to be processed has grown rapidly. while they accounted for 14% of overall export turnover in 1994, in 1997 the respective figure was almost 27%. in 1997, the exports of processed goods formed 71 % of total machinery exports, while the relative share of clothing was 46% of manufacturing exports. it may be noted that foreign investors are very careful in placing their money in countries with an economy-in-transition. moreover, in 1992-94 international stock market dealings had not yet materialized in estonia. a fixed exchange rate coupled with a liberal monetary policy were therefore no less than essential preconditions for foreign investors to risk putting their capital in estonia. at frrst, foreign capital came in small amounts, but by 1994 estonia was wellknown enough and outstripped the other transitional ceec in respect of foreign investment per capita (table 3). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 471 sateb nr vol i (1998) nr 3 table 3: foreign investment in central and eastern european (usd millions) country 1992 1993 1994 per capita per capita in 1989in 1994 1994 517 850 289 83 160 253 295 158 2339 1146 671 iii 51 155 92 57 61 60 16 580 542 14 400 1000 7 156 187 35 estonian monetary system: main characteristics in may 1992 the estonian parliament (riigikogu) passed three laws: the currency law, the law of backing the estonian kroon and the foreign currency law. they also were, however, not applied at once but from the moment when the monetary reform came into force. these laws lay down the principles of estonia's currency and monetary system. they make the operation of the estonian currency board the task of the central bank, which also retains the option of pursuing certain monetary policies. in order to allow the currency board to operate efficiently, it was deemed necessary to safeguard the independence of the bank of estonia to a large extent, while regulating its detailed functions as a currency board. the independence of the bank of estonia is guaranteed by the following stipulations: it is not allowed to extend credit to the government, its assets are kept separate from the state budget and its managerial staff is appointed by estonia's president and parliament. the bank of estonia has been instructed that the exchange rate of the kroon is fixed (or pegged) nominally to the deutsche mark (idem = 8eek). only parliament can change this nominal anchor, though the bank of estonia may permit fluctuations of the pegged rate within margins of 3 per cent. the decree of the estonian currency reform committee "on the performance of currency reform", dated june 17 1992, provided the main features of the currency reform. the decree established the estonian kroon as the sole legal tender in the republic of estonia with effect from 4 am on june 20 1992. it also r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 3 472 detennined that every resident whose name was on an approved list could exchange up to 1500 roubles, one-off, between june 20 and 22 at the rate 10 roubles = 1 kroon. roubles exceeding this sum could be converted into kroons in unlimited quantities at the exchange rate 50: 1, until july 1 1992. in addition to the 1500 roubles in cash. residents could exchange cash cheques, demand and time deposits with the banks as well as deposit certificates of the boe at the exchange rate 10:1. a total of 768.4 million roubles in cash deposited with banks was removed from circulation by the currency refonn, and 1567.5 million roubles were accepted from residents at cash exchange offices. a total of eek 157 million in cash was thus supplied to 1.1 million residents by means of currency exchange, and rouble deposits were converted into kroons to the extent ofeek 207 million. thus every resident exchanged the equivalent sum ofdem 28 on the average (kallas, slirg 1995:59). seeing that the currency law allowed only the kroon as quid pro quo in the exchange process, the demand for kroon notes in circulation increased. the supply of bank money also increased, due to the fact that there was no need for barter transactions any more, and also because of the high inflation rate at the time. this can be seen from table 4. table 4: key monetary data after the currency reform in estonia (million kroons at the end of a month) cash issued aceountsof gold and purchasing power by doe commercial foreign ofkroon in banks held reserves of domestic market with doe doe 06/92 = 1.000 06/92 365.5 245.5 1165.2 1.000 07/92 677.7 317.9 1541.2 0.816 08/92 781.5 420.2 1635.6 0.677 09/92 874.2 309.6 1607.0 0.635 10/92 973.5 517.6 2023.1 0.590 11192 1084.6 556.6 2213.3 0.538 12192 1228.6 580.5 2370.4 0.521 (source: bank of estonia) as the currency board principle detennined the kroons in circulation to be fully covered by gold and foreign reserves, then the main way of buying cash kroons was to sell foreign currency to the bank of estonia. this was the reason why the foreign exchange in circulation and held by the banks began to flow to the bank of estonia. it is evident from table 5 that immediately after the currency refonn, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 473 saleb nr vol 1 (1998) nr 3 the gold and foreign currency reserves of the boe were significantly less than those of the commercial banks, but by the end of 1993 the foreign currency reserves of the boe exceeded those of the commercial banks more than 18 times. obviously a decrease in the population's hard currency holdings contributed to this development. table 5: dyaamics of relocatioa of moaetary resources ia estoaia (million kroons) juae30, dec. 31, dec. 31, dec. 31, 1992 1992 1993 1997 gold and foreign 718 2502 5237 10902 currency reserves of theboe cash in circulation 366 1229 2730 5352 reserves of 370 581 1147 2514 commercial banks withtheboe total assets of 6256 4788 6396 38755 commercial banks convertible 1911 874 280 16521 currency accounts of commercial banks (source: bank ofestoma) after the currency reform the population's cash in hard currencies was replaced by estonian kroons. by july i 1992, kroons were 18.5% of total cash in circulation (m2d), and by august i it had risen to 29.6%. at first the relative share of cash in the total money supply (in kroons) was 30010. the increment of cash has slowed down over time. thus, table 6 shows that the monthly increase in cash was highest in 1992, after which it has been decreasing from year to year. as the estonian kroon received a warm welcome by the population and business enterprises alike, the foreign currency law was of no use any more. this jaw had come into force with the currency reform and provided that foreign currency may be used only in clearing accounts with foreign countries, and that the bank rendering this service must have the necessary license from the central bank. to concentrate foreign currency reserves at the central bank and thus increase the kroon's reserve assets, legal persons were required to sell their assets in foreign currency within two month through an intermediary bank to the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 3 474 boe. government bodies and institutions had to do so within 7 days. in order not to disturb external economic activity, importers could buy foreign exchange without restriction. it was enacted that individuals and legal persons could not have foreign currency accounts in estonia, and all foreign currency paid to them had to be converted into kroons. as it soon became evident that foreign currencies would not drive the estonian kroon out of circulation, and in order to simplify business, the board of the boe on july 8 1992 permitted that largescale enterprises with a high share of foreign trade may have foreign currency accounts abroad. as the estonian kroon repeatedly proved its vitality, the restrictions in the foreign currency law were gradually reduced and in march 1994 parliament annulled the law completely. table 6: additiodally issued cash (millions kroons) year peraddum permodth (averaee) 1992 (june 20 dec. 31) 862.7 136.9 1993 1501.6 125.1 1994 769.3 64.1 1995 824.8 68.7 1996 649.6 54.1 1997 541.8 45.2 (source: bank ofestorua) the openness of the estonian monetary system is guaranteed by the free inflow and outflow of foreign currency. the exchange of the formerly inconvertible currencies of the (ex-soviet) cis countries is now also allowed. the bank of estonia daily fixes the exchange rates between the kroon and major foreign currencies. for a long time the rate was determined as a ratio to the currencies of 20 industrial countries, but in february 1997, 13 soft and minor currencies (those of kazakhstan, greece, lithuania, latvia, moldova, portugal, czech republic, ukraine, hungary, uzbekistan, new zealand, belarus, russia) were added to the list. at the end of 1997 the assets and liabilities of banks in foreign currencies were 44.0 and 42.6% of their respective totals. the major currencies concerned are the dem and usd, and at the end of 1996 they formed 80% of the banks' total foreign currency assets and liabilities. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 475 sateb nr vol 1 (1998) nr 3 impaci' of the monetary system on the economy before the currency reform. shops in estonia had been practically emptied and basic consumer goods were subject to rationing cards. a major achievement of the currency reform was to end this shortage economy. this had many causes, but the most important was undoubtedly the restoration of the propensity to save. despite negative real interest rates, the savings of the population steadily increased during the post-reform period. the increase in time deposits was especially rapid. at the end of june 1992 time deposits formed 4.1 % of total kroon deposits; at the end of october 1992 the figure was already 10.6%. the incentive to produce and to import western goods was also highly motivated by the stable currency relation. the impact was significantly expressed by the growth of both export and import capacities (table 7). table 7: estonian foreign trade after the currency reform in 1992 (million !croons) exports to imports from trade balance total west total west may 340 198 308 210 32 june 381 244 359 227 22 july 698 376 587 380 111 august 568 322 513 309 55 september 601 343 594 326 7 october 573 339 633 405 -60 november 546 353 536 286 10 december 655 433 588 361 67 (source: bank of estonia) due to the fact that consumer prices in estonia's limited internal market have been rising in comparison with the prices of its western business partners, western imports have become more and more profitable and attractive, and since 1993 estonia's trade balance has continuously been negative. the major part of the deficit derives from western trade. in 1997 imports into estonia amounted to 45530 million !croons (in 1992 it was eek 5128 min.) while exports were 29060 million kroons (eek 5549 min. in 1992). thus the volume of foreign trade grew about eight times within a year and exceeds estonia's nominal gdp to a significant extent. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 3 476 the currency law ended the (soviet-type) system of hard currency shops, and all goods are now sold for estonian kroons. thus, imported goods became available to everybody but, contrary to expectations, the sales of imported goods declined considerably in the first post-reform weeks because of the great difference between the prices of imported and domestic goods. as a consequence, the prices of domestic goods rose and those of imported goods fell. the reaction was sharp: while a gallup poll in the ftrst half of 1992 revealed unsatisfied net consumer demand, a similar poll in the third quarter of the same year showed that 19% of shop assistants thought they could now meet the demand (kallas, sorg 1995 :66). the big success of the currency board system has been to abate inflation. the rate of inflation had dropped somewhat just before the currency reform, but after the reform there was a great jump upward again. the original price rise was caused by an increase in taxes ensuing from the currency reform and further price liberalization. in the foreseeable future, an inflation rate of about 100/0 will probably be normal despite the peg of the kroon to the deutsche mark. the reason is the lag of the domestic price and especially wage level vis-a.-vis the european levels. the average monthly wage in estonia was 3571 kroons (oem 446, taxes included) in 1997. yet in estonia the rise in prices has been less than in the other post-socialist countries. the liberalization of prices in 1992 increased the kroon's real exchange rate index in relation to estonia's eastern trading partners more than 2.3 times, but at the end of april 1998 the index had dropped to 0.856 (table 8). table 8: estonian real excbange rate index, june 1992-1 index western trading eastern trading partners partners 10/92 1.991 1.830 2.320 10/93 1.900 2.778 0.957 10/94 2.430 3.770 1.097 10/95 2.658 4.776 0.899 10/96 2.891 5.391 0.900 10/97 3.015 5.923 0.837 04/98 3.176 6.329 0.856 (source: bank of estoma) research by the imf has shown that countries with a currency peg have comparatively low inflation. for example, in a sample of countries, those with pegged exchange rates had an average annual inflation rate of 8 per cent, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 477 saleb nr vol 1 (1998) nr 3 compared with 14 per cent for intermediate and 16 ~ cent for floating exchange rate systems (ghosh. guelde, ostry, wolf 1996:4). it has been theoretically argued that exchange rate volatility adds to business cost and risk (langmore 1995:189). in estonia, from time to time, there are rumours about an impending devaluation or revaluation of the kroon. banks have increasingly begun to write into loan contracts clauses that would insure them against losses caused by a change in the kroon exchange rate; also, the number of derivative contracts is rising. this shows that there are enough persons who are against the fixed exchange rate. however, it is only due to the currency board system and a liberal monetary policy that foreign investors have agreed to place their money in estonia. this applies particularly to long-term investments. for example, in 1997 more than 6()oa, of the foreign investments in estonia were made in industry and transport, storage and communications (table 9). table 9: foreign direct investments made into estonia by kind of activity in 1997 spheres of activity eekmln 0/. industry 1293 35.6 transport, storage and communications 902 24.9 wholesale and retail trade 325 9.0 finance 575 15.9 real estate, leasing and business activities 170 4.7 hotels and restaurants 45 1.2 other 317 8.7 total 3627 100 (source: bank ofestorua) on june 3 1996, the tallinn stock exchange was inaugurated as an electronic share market. transactions are carried out via the estonian central depository for securities ltd., founded in february 1994. the opening of the stock exchange brought about a rapid growth in market liquidity and the rate of portfolio investment. in 1996 the capacity of the capital market in estonia increased approximately 4 times and by the end of the year had reached 13.2 billion kroons, which forms 28% of gross domestic product. this is said to exceed comparative figures in all the states of the ceec, except the czech republic. in march, 1997 the tallinn exchange exceeded the daily turnovers of the riga and lithuanian stock exchanges on average by 5 to 6 times. by the end of 1996 the volume index of the tallinn central depository for securities (t alse) had increased about 5 times within a year-and-a-half. the growing r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 3 478 interest of foreign investors in the estonian capital market has been of great advantage in this context (table 10). table 10: structure oftbe estonian capital market (%) 1995 1996 groups/features issuers investors issuers investors private persons n.a. 8.0 n.a. 8.8 institutional investors 94.0 63.0 96.0 56.1 • incl. companies 74.6 63.0 86.7 55.4 • public sector 19.4 9.3 non-residents 6.0 29.0 4.0 35.1 market capitalization 3.2 13.2 (bin. kroons) capitalizationidgp 7.7 26.4 turnover/capitalization 2.9 12.5 (source: bank of estoma, partial estimates) the author completely agrees with stanley fischer that the currency board system is the strongest form of commitment to a fixed exchange rate, though its gold standard-type monetary policy rules may put severe strain on the banking system. a currency board can work well if fiscal policy is highly responsible or becomes so as a result of the currency board and if the commercial banks operate on an international scale (fischer 1996:37;1998:21). estonia's balance of payments has in fact been sufficiently balanced, because the current accowlt deficit is compensated by the inflow of foreign capital due to a favourable investment climate. a currency board does not only demand the internationalization of commercial banks, but creates favourable conditions for it by the low exchange rate risk. at the end of 1997, 43% of the stock of estonian commercial banks was held by foreign owners, and the shares of the two major banks are quoted on the frankfurt and helsinki exchanges. estonian banks have acquired or, are about to acquire, banks in the other baltic states and the republics of the cis. also, the number of international bank cards and their use are growing rapidly (table ii). the major advantages of currency boards are briefly stated: (1) they issue a medium of exchange to facilitate trade and other transactions; (2) the local currency they issue also provides a satisfactory wlit of accowlt; (3) the currency issued by the boards promotes the financial confidence necessary for the growth of the economy (ghatak 1995:73). in the case of estonia these advantages have paved the way for the success ofits economic reforms. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 479 sateb nr vol 1 (1998) nr 3 table 11: number of bank ards and terminal centres'in estonia (end of year; unit) 1994 1995 1996 1997 domestic bank cards 5000 108200 381300 406200 international debit cards 9000 42700 186300 international credit cards 2300 9300 14900 bank cards total 5000 119500 433300 607400 automatic teller machines 5 140 230 427 point of sale accepting banks 20 250 1200 2153 ards (source: bank of estonia) the experience of currency boards in post-colonial africa points to the weaknesses of the system. the chief criticisms of currency boards can be summarized as follows: (1) since the volume of currency is linked to the state of the balance of payments, the supply of money is reduced whenever the balance of payment is in the red. in other words, the economy has to deflate at the time of a deficit on the balance of payments. contrariwise, with a surplus on the balance of payments, the money supply expands; (2) domestic finance is thus really governed by the vagaries of foreign trade and such a situation may be considered undesirable; (3) the financial system will fail to promote the growth of poor regions since it is not designed to perform this function; (4) the existence of a currency board deprives a country of monetary sovereignty, which would be needed to pursue independent economic policies; (5) currency boards have also been criticized because of the cost of the foreign reserves necessary to back the local currency (ghatak 1995:73-74). in the estonian case these problems are not acute because the negative trade balance has been offset by capital inflow; estonian monetary sovereignty has not been compromised; and the reserve backing allows the central bank to earn revenue by investing such assets in foreign countries. this covers the expense of the currency issue and the bank's upkeep costs, and may provide financial aid to problem banks and dividends to the state budget it should be stressed that a currency board needs sound and liberal monetary policy support, an open economy and free international financial and trade relations. at the end of 1997 the foreign loan liability of estonia's central government and municipalities was only 7i'ai of gop, and overall surplus of the estonian consolidated budget was 2.4% of gop. on the other hand, it is possible that after some time the real exchange rate may become overvalued and force devaluation, undermine monetary confidence and cause the economy to become uncompetitive (dale r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 3 480 1997:35}. there are always people who complain that the foreign exchange rate is the reason for e1::onomic failure. the most dangerous sentiment to a currency board system is one that casts doubt on its security. steps in the direction of devaluation or abandonment of the currency board are likely to bring about inflation, and convert efforts designed to cut costs and improve the competitiveness into arguments for devaluation. in 1994 the bank of estonia introduced forward contracts at the official exchange rate (8 eek = 1 dem) with a duration up to 7 years, in order to dispel doubts about the continued existence of the currency board. by december 1994, the total amount of these contracts was worth 1428 million kroons (dem 178.5 min.), which formed about 18% of the kroon's cover by the bank of estonia. 1'bis author is of the opinion that a currency board by itself acts as a very effective check on inflation. if there are substantial amounts of foreign money in circulation, fixed exchange rates provide an even stronger nominal anchor (calvo, vegh 1993:36). sound monetary policy raises the possibility of borrowing the necessary resources to start a currency board. the later profit from the currency board system will allow to pay back the loans with big returns. finally i would like to recommend to those with doubts about the stability and duration of fixed exchange rates, to examine the austrian experience. for the past two decades, austria's monetary policy has been successfully geared to keeping the schilling's nominal exchange rate stable vis-a-vis other "hard" european currencies, by pegging it to an anti-inflationary central currency, the deutsche mark (see austrian exchange rate policy, 1995). conclusions at the time of writing this paper, nearly six years had elapsed since the estonian currency reform. the estonian economy had reached the upturn stage, the balance of payments showed a modest surplus, estonia's external debt was minimal, the inflation rate declining, the unemployment rate comparatively low and real income growing. it seems reasonable to conclude that this success is positively related to the country's currency board system, supported by liberal monetary and economic policy. after the restoration of national independence in 1991, it was natural for estonia to choose a currency board system. the economic stability, resources and experience necessary to introduce a flexible exchange rate regime did not exist at the time. instead, a monetary system that met the actual economic and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 481 sateb nr vol 1 (1998) nr 3 financial situation in estonia, suitable to its banking and management skills, was opted for. the currency board endowed the estonian kroon with confidence, which helped to attract foreign capital to support the country's reforms and supply the resources necessary to back its currency. another key to the success of the currency board is the extremely liberal monetary policy followed at the same time. this created a favourable environment for developing the financial infrastructure necessary for the progress of reform, and the rapid integration of estonia's monetary system and economy with the international economy. in the author's opinion there are no serious arguments that would compel estonia to give up the currency board system and its liberal monetary policy. on the contrary, these principles amount to an important mechanism which allows estonia's economy to develop consistently, and retain and improve its competitiveness in the world market. a small country has no better road to social welfare. this view is shared by the board of the bank of estonia and the government and opposition in parliament. endnotes 2 statistics published after this article was written. do not materially affect its analytical contents. the author would like to thank professor m. l. truu for helpful comments on an earlier draft of the paper. references 1. austrian exchange rate policy and european monetary integration. (1995). oesterreichische nationalbank wp no 19, p.71. 2. calvo ga. and yegh c.a. (1993) currency substitution in high inflation countries. finance & development, march, pp. 34-37. 3. camard w. (1996) lessons from the currency board arrangement in lithuania.imfppaaj96/1 4. currency board arrangement more widely used. (1997). imf survey, february 24, pp. 54-57. 5. dale r. (1997) currency boards. review of economics in transition. bank offiniand, no 3, pp. 23-36. 6. fischer s. (1996) maintaining price stability. finance & development, december, pp. 34-37. 7. ghatak s. (1995) monetary &onomics in developing countries 2nd ed. st. martin's press, p. 226. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 3 482 8. ghosh a.a., guide a.-m., osuy j.d., wolf h. (1996) does the exchange rate regime matter for inflation and growth? imp economic issues, september, p. 13. 9. hanke s.h., jonung l. and schuler k. (1993). estonia: it's not a currency board system. transition, no i, p. 12. 10. isachsen a.j., hamilton c.b., gulfason t. (1994) basic economics: from plan marlret to marlret. stragest ltd., tallinn 1994, p. 372. 11. kaasik a. (1996) ida-euroopa riikide ostujou pariteedid. eesn panga bal/etddn 1996 no.3 (26), p. 34-35. 12. kalda t. (1994) george soros: "establishing a stable and convertible currency is the basis for estonia's success". &tonian kroon no 4, pp. 24-25. 13. kallas s. (1991) kauan odotettu tapahtuikin odottamattomasti. unitas, no 4, p. 22-23. 14. kallas s. and sorg m. (l995) currency reform transforming the &tonian economy. ed. o. lugus and g.a. hachey, jr. international center for economic growth, tallinn, pp. 71-91. 15. laar m. (1993) &tonian policy priorities and perspectives. address at a colloquy of the german foreign policy association, bonn 1993, june 28, p. 5. 16. lainela s., sufela p. (1994) the baltic economies in transition. bank of finland 1994, p. 138. 17. langmore j. (1995) restructuring economic and financial power. the potential role of a foreign exchange transaction levy. futures, vol 27, no.2, pp. 189-194. 18. sahay r. and vegh c. (1995) dollarization in transition economies. finance & development, pp. 36-39. 19. sorg m. (1994) estonian strategies in the reconstruction of its monetary system. the competitiveness of financial institutions and centres in europe. ed. d.e. fair and r.j. raymond. kluwer academic publishers, pp.171-182. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction context and focus: medical scheme expenditure on private hospitals results discussion: other drivers of medical scheme expenditure on private hospitals conclusion acknowledgements references footnotes about the author(s) marine erasmus econex, stellenbosch, south africa department of economics, stellenbosch university, south africa helen kean econex, stellenbosch, south africa citation erasmus, m. & kean, h., 2018, ‘private hospital expenditure and relation to utilisation: observations from the data’, south african journal of economic and management sciences 21(1), a1658. https://doi.org/10.4102/sajems.v21i1.1658 original research private hospital expenditure and relation to utilisation: observations from the data marine erasmus, helen kean received: 02 sept. 2016; accepted: 16 sept. 2017; published: 29 mar. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: this study contributes to the detailed understanding of the drivers of medical scheme expenditure on private hospitals in south africa over 2006–2014. this is important in the context of various regulatory reforms that are being considered at present. aim: the aim is to provide an updated analysis and description of the drivers of medical scheme expenditure on private hospitals in south africa. setting: private hospital market, south africa. methods: data from the three largest private hospital groups – which account for approximately 70% of the south african private hospital market share – are collected, aggregated and analysed. this study uses targeted descriptive and exploratory analyses, relying on a residual approach to hospital expenditure. results: it is found that over time medical scheme beneficiaries, on average, are being admitted to private hospitals more frequently, as well as staying in hospital for longer during each admission. the data also indicate that over time older people are being admitted to hospital more often. conclusion: this study’s findings contradict previous assertions that it is only prices driving increased medical scheme expenditure on private hospitals. introduction this study starts by showing that medical schemes in south africa spend the largest portion of health funds on private hospitalisation. this is in line with expectations given the specific regulatory environment and benefit design. however, expenditure on private hospital care has exhibited a steep increase over the last decade and a half. this article critically analyses the drivers of the increase in medical scheme expenditure on private hospitals. in earlier years, these expenditure increases were, without due consideration, attributed to pricing increases in hospital services. more recently, the facts have been better informed by research into detailed utilisation trends that are representative of the medical scheme population. the literature review shows that these studies found utilisation increases, rather than hospital price and/or tariff increases, to drive the largest part of the increase in expenditure above consumer price inflation (cpi). this study contributes by collecting and aggregating extensive and detailed confidential admission data from the three largest south african private hospital groups (netcare, mediclinic and life healthcare, with the data referred to as ‘private hospital data’) – which account for approximately 70% of the private hospital (bed) market share (econex 2014a) – and analysing admission and expenditure trends over 2006–2014.1 the aim is to contribute to the existing research by providing an updated analysis of private hospital utilisation2 trends and their impact on expenditure. in order to do so, expenditure on private hospitals is firstly decomposed to account for the relevant medical scheme beneficiary growth as well as headline inflation. having accounted for these factors, the residual increase in expenditure is the focus of this study. this is analysed alongside utilisation trends at the three private hospital groups – including admission rates and patient days; both at aggregated, and age levels. the main aim of the study is therefore to critically analyse the drivers of medical scheme expenditure on private hospitals by analysing how these expenditure increases adjust after accounting for factors that are evident in the data. the section ‘context and focus: medical scheme expenditure on private hospitals’ provides brief context regarding medical scheme expenditure on private hospitals by discussing the relevant literature or data. the specific research aims and approaches are also included therein. the analysis is then divided into two sections: first presenting the results for aggregate utilisation trends (‘utilisation rates in aggregate’ section) and then by age band (‘utilisation rates by age group’ section). in the section ‘discussion: other drivers of medical scheme expenditure on private hospitals’, other drivers of medical scheme expenditure on private hospitals are discussed, before concluding the study in the last section. context and focus: medical scheme expenditure on private hospitals this section considers the trends in medical scheme expenditure on private hospitals from 2000 to 2014. the source of the data analysed in this section is the council for medical schemes (cms) annual reports, which record various categories on which medical schemes spend their funds. it is important to note that these expenditure increases are often reported (even in the popular press) and that the conclusion that automatically follows is that this is driven by private hospital price inflation. this section therefore commences with these data and increases, before unpacking these trends into their constituent parts, in order to understand the real drivers of this expenditure. nominal expenditure trends in nominal and aggregated terms, medical scheme expenditure on private hospitals is high and increasing. in order to better understand the absolute and relative increases over time, these nominal values are indexed to 2006 in figure 1.3 the green trend line shows total medical scheme expenditure over time, the red line indicates the amount thereof spent on private hospitals and the underlying bars show the latter as a function of the prior. expenditure on private hospitals has accounted for between 28% and 37% of total annual medical scheme expenditure over the time period analysed. figure 1: indexed (to 2006) nominal (rands) total medical scheme expenditure and the portion spent on private hospitals, 2000–2014. figure 1 indicates that in 2014, medical scheme, expenditure on private hospitals (r 46.4 billion), in nominal and aggregate terms, had increased significantly from its 2000 value (r 8.1 billion) and more than doubled from 2006 (r 17.7 billion) to 2014. similarly, total nominal medical scheme expenditure increased from r 27.2 billion in 2000, to r 51.3 billion in 2006 and r 124.1 billion in 2014. the gradient (year-on-year increases or growth) in expenditure on private hospitals was closely related to the gradient for total medical scheme expenditure over the entire period, but particularly so between 2006 and 2014. therefore, this figure indicates that while expenditure on private hospitals has increased as a portion of total medical scheme expenditure (from 30% in 2000 to 35% in 2006 and 37% in 2014), the trend between 2006 and 2014 has been in line with increases in total medical scheme expenditure. the longer term landscape is relevant, but the explanatory data in this study are restricted to the period from 2006 onwards. real hospital expenditure to further analyse increasing medical scheme expenditure on private hospitals – specifically its relation to price and volume of care – the data are decomposed to account for the growth in medical scheme beneficiaries, as well as headline inflation. beneficiary numbers have grown by almost 2 million over the period 2000–2014, from approximately 7 million to more than 8.81 million. careful consideration of the data indicates that beneficiary growth was flat in the earlier years with growth significantly increasing after 2006. this is mainly because of the introduction of the government employees medical scheme in 2006, as well as growth in formal employment. growth in more recent years is positive, but exhibiting a declining rate, in line with macroeconomic realities and specifically low growth in formal employment. in addition to adjusting the expenditure of medical schemes on private hospitals to account for the increase in beneficiary numbers (i.e. to show the values per average beneficiary per annum [pabpa]), the data must also be adjusted by headline inflation (cpi). it must be highlighted that this adjustment – here and throughout the report – is made for headline inflation and not hospital price inflation (as measured and reported on by statssa), notwithstanding the well-documented drivers of hospital price inflation ahead of general inflation. (higher hospital price inflation is driven by the fact that the price of hospital input items, for example, nurse wages, increase at rates higher than the headline cpi basket. this may be because of macroand microeconomic factors, for example, skills shortage, unionised labour, power supply constraints, basic services, exchange rates, etc.). information that is of interest to the study may, however, be removed by accounting for hospital price inflation at the outset. in other terms, although the existence of some degree of hospital price inflation is recognised, no control for this is made at the outset so that it can be investigated in the residual of expenditure. it is therefore important to note that the use of headline inflation might exaggerate the role played by price increases, but this conservative approach is preferred. figure 2 shows the real pabpa expenditure on private hospitals by medical schemes. this shows that there are higher increases in the earlier years (2002–2004), with single-digit growth for the remainder of the period. although some years exhibit a negative growth rate, the overall trend is a positive increase in real pabpa medical scheme expenditure on private hospitals. it is therefore true that expenditure by medical schemes on private hospitals is increasing, also on a ‘per beneficiary’ level. in our view, the year-on-year growth rates in the earlier (2001–2004) years may be related to institutional and macroeconomic factors, including the introduction of open enrolment, community rating and prescribed minimum benefits (pmbs)4 packages, as well as hospital input costs at the time and as reflected in exchange rates. similarly, the year-on-year increase in 2009 may be related to the macroeconomic environment existent at the time and following the global financial crisis (as reflected in exchange rate depreciation). after acknowledging these potential influences, a general upward trend is observed. it is therefore relevant to question what known factors contribute to this. figure 2: real (rands, 2006 = 100) per average beneficiary per annum medical scheme expenditure on private hospitals, 2000–2014. literature review while this research is one of the first contributions (in south africa) to the academic literature on the phenomenon pointed out above, it has been investigated by a number of stakeholders locally. in 2016, the hospital group netcare stated that, ‘the principle industry role players all appear to be in agreement that inflation and increases in utilisation are some of the primary reasons for the increase in private healthcare expenditure’ (netcare 2016:46). one of these role players is the medical scheme administrator discovery health, which analysed the increase in discovery health medical scheme (dhms) claims for the period 2008–2013. from this, claims expenditure per life per month were found to increase by an average of 11.3% per annum, of which 6.7% could be attributed to headline inflation. the remaining 4.6% was found to be attributed to increased consumption of all healthcare goods and services (4.2%), and tariffs and prices exceeding inflation (0.4%). forming part of these claims were the hospital admissions of members, which experienced an increased rate, from 23.9% in 2009 to 24.8% in 2013. this was found to be higher than the 24.55% predicted by demographic factors (discovery health 2014:22, 51). the hospital association of south africa (hasa 2008) also analysed the increase in total private hospital expenditure that can be attributed to utilisation. for the period 2002–2006, they found evidence of higher levels of utilisation in terms of increased volume: the total number of admissions to the same hospitals owned by the three largest hospital groups in south africa (life healthcare, netcare and mediclinic) showed an increase of approximately 13% over this period. this was equivalent to an increase of slightly over 3% per annum (hasa 2008:20). econex (2012) examined a later period and found similar results for inpatient admissions and total number of patient days. the total number of inpatient admissions per 1000 medical scheme beneficiaries to those three hospital groups (with the data adjusted to reflect their share of beds in the market) increased from 244 per 1000 beneficiaries in 2006 to 256 per 1000 beneficiaries in 2010. this amounted to a cumulative increase of 6.2% in the admission rate over the period. patient days, or beneficiary days in hospital, refer to the cumulative number of days that medical scheme beneficiaries spend in hospitals. econex’s (2012) calculations showed that this increased from 753 per 1000 beneficiaries in 2006 to 847 beneficiaries in 2010, or by 12.5% cumulatively. from this, the average length of stay (alos) was calculated, revealing that beneficiaries spent 3.09 days in hospital in 2006 compared to (the 5.9% higher) 3.27 days in 2010. globally, increased healthcare costs and their drivers have been analysed under various different frameworks dependent on the context of healthcare in question. a commonly cited framework specific to expenditure on private hospitals is provided by the american hospital association and the lewin group (2005). this framework attributes a role to utilisation, with this utilisation being driven by inter alia, ageing and burden of disease. alongside these types of frameworks, various detailed breakdowns of healthcare expenditure, both hospital and other, by private insurers have been documented. certainly, the most complex and extensive disaggregation of healthcare spending, including that for hospitalisation, is included in the 2016 study by dieleman et al. this study comprehensively disaggregates us healthcare spending according to condition, age, gender and type of care, thereby eliciting what the main drivers are. in this, utilisation is found as the primary driver of cost, consequently driven by factors most prominently including an increasing burden of disease. more specific to the south african context, with medical scheme expenditure on private hospitals in question, a gap in the academic literature exists. despite this, and as mentioned above, various factors have been suggested by industry stakeholders, in line with international frameworks and studies. the growing medical scheme population, increased burden of disease (especially the higher prevalence of beneficiaries with chronic diseases) and the related ageing of the medical scheme population have been argued to worsen the case mix. new and improved technologies have been discussed to lead to an increase in the number of procedures performed in hospitals. the introduction of pmbs and open enrolment to medical schemes with community rating has been shown to increase utilisation by beneficiaries, and the fee-for-service structure is said to incentivise higher utilisation because of its direct relationship between earnings and volume of services (cms 200838; hasa 2008:21; life healthcare 2016:18; mcintyre & thiede 2007:42). supplier-induced demand has also been suggested as a reason for increased hospital utilisation. while there is not as yet a robust study on this phenomenon in the context of south african private hospitals, the literature highlights the technical and context-specific considerations one should have in studying this. econex (2016) provides a review of this literature. similarly, moral hazard by those insured is expected to drive up utilisation and consequent expenditure rates. the existence of the latter within healthcare is well established, with the most cited references of this deriving from the rand health insurance experiment that elicited the phenomenon of increased claims as a result of coverage (vera-hernandez 2003). despite these reasoning, there exists a gap in the academic literature with regard to the drivers of medical scheme spending on private hospitals in south africa. this study aims to make a first contribution to this gap, with subsequent studies deepening this contribution. research aims and approach the analysis thus far indicates that after adjusting the medical scheme data for volume growth (beneficiary numbers) and inflation, expenditure growth has still been positive overall. this study contributes by further unpacking the data in order to examine which other factors have contributed to these growth rates in medical scheme expenditure on private hospitals. factors such as ageing, burden of disease, advances in medical technology and institutional factors are expected to play a role and may interdependently impact on utilisation and expenditure. against this background, the aim of this study is to provide an updated review of some of these factors at private hospitals in south africa and their impact on expenditure. in other terms, the aim of the study is to critically analyse the drivers of medical scheme expenditure on private hospitals, by analysing these expenditure increases after accounting for factors that are evident in the data. more specifically, the questions of the study are the following: has private hospital utilisation per 1000 beneficiaries increased, and how does this relate to expenditure? has private hospital utilisation per 1000 beneficiaries, per age band increased, and how does this relate to expenditure? how do technological and other factors influence utilisation and expenditure? in addition to these research questions, this study mentions our further preliminary investigation of the private hospital data for individual disease classifications per age band. this will be the focus of a forthcoming analysis. data and methodology having illustrated the overall trends of medical scheme expenditure on private hospitals, the remainder of the study aims to answer the specific research questions (stated above) by looking at private hospital admission data from netcare, mediclinic and life healthcare. these are the three largest private hospital groups in south africa and represent approximately 70% of private hospital beds in south africa over the period 2006 to present. the admission data will be referred to throughout the report as ‘private hospital data’. private hospital data were chosen for two reasons mainly. firstly, the hospital data provided more detailed and granular information, for example, admission indicators by age and diagnosis levels, as opposed to utilisation data published by the cms. this was crucial to the study as the aim was to move beyond previous aggregate analysis. secondly, independently collecting and collating the data from the three largest private hospital groups ensured consistent variable definitions, which was also crucial to the accuracy of the study. the private hospital data collected cover the period of 2006–2014, as, at the time of writing, 2014, were the latest year for which cms beneficiary data were published.5 the data are assessed at face value and cover all admissions in the time specified, aggregated by year, age band and select ranges of icd10 codes.6 each aggregate entry then includes number of admissions, total patient days and total expenditure – where the following definitions are noted: admissions – occupation of a bed in a hospital (all hospitals considered); excludes outpatients patient days – calendar patient days and not bed patient days; [discharge date – admission date + 1] expenditure – billed revenue in nominal rands, including value-added tax (vat). all data were cleaned and organised for the purpose of the study, and reasonability checks carried out. this study uses targeted descriptive and exploratory analyses, relying on a residual approach to hospital expenditure, in order to analyse the data for the purpose of answering the research questions. the residual approach, pioneered by feldstein (1971) and fuchs (1972), subtracts the impact of known variables from hospital expenditure, leaving a residual, which may be an approximate representation of expenditure attributable to a variable of interest. such an equation is usually analysed in growth rates rather than absolute terms. the study analyses the expenditure-utilisation link from various angles, in aggregate and per age band. where necessary and appropriate, the data are adjusted for the share of total private hospital beds accounted for by the three listed hospital groups, and for self-paying patients.7 results utilisation rates in aggregate the first step in the utilisation analysis is to examine the aggregate trends (all diagnoses, all ages, etc.). this has limitations as, in aggregate, relevant trends may be hidden and even reversed.8 however, this is a valuable starting point to indicate overall trends before moving to the next step that is decomposing the data by age group. when considering the aggregated admissions of netcare, mediclinic and life healthcare, it is found that utilisation per 1000 beneficiaries at these three groups has, over the period of analysis, increased. this is indicated in the left-hand frame of figure 3 where it is shown that admissions per 1000 beneficiaries have increased by a cumulative 3.5% over 2006–2014, from approximately 242 admissions per 1000 beneficiaries in 2006 to 250 admissions per 1000 beneficiaries in 2014. figure 3: aggregate admissions (a) and patient days (b) at three hospital groups per 1000 beneficiaries; 2006–2013. similarly, patient days per 1000 beneficiaries at these three groups have also increased by a cumulative 13.2% over the 2006–2014 period as shown in the right-hand frame, from approximately 877 patient days per 1000 beneficiaries in 2006 to approximately 992 patient days per 1000 beneficiaries in 2014. the underlying lengths of stay in this variable may be driven by supply (e.g. extent of care) and/or demand (e.g. acuity) factors. this study does not analyse the split, but the impact of acuity is analysed in terms of age in this study, and in terms of diagnoses in the forthcoming study. these increasing utilisation trends are relevant insofar as they impact expenditure increases and therefore inform related perceptions. figure 4 illustrates that when viewing expenditure per 1000 beneficiaries, the real cumulative increase over 2006–2014 is approximately 21% (upper line). however, if viewing real expenditure increases in terms of admissions and/or patient days, these cumulative increases are lower, exhibiting cumulative increases of 17% (middle line, approximately 2% p.a.) and 7% (lower line, approximately 1% p.a.), respectively (2006–2014). such expenditure increase residuals correlate closely to hospital price inflation, with the latter averaging 0.8% points above headline inflation over 2003–2013 (econex 2014). the fact that the increase in real expenditure per 1000 beneficiaries trends above the increase in real expenditure per admission and patient day is therefore a first indication that increased utilisation is a significant contributor to increased expenditure, and that inflation trends are in line with overall price increases in the economy. in other words, simply ascribing private hospital expenditure increases to hospital price increases is incorrect. the below subsection expands on this by further unpacking the aggregate data by age band. figure 4: cumulative indexed increase in real expenditure at three hospital groups per 1000 beneficiaries, per admission and per day; 2006–2014 (2006 = 1). utilisation rates by age group population ageing is expected to have an influence on healthcare expenditure as older beneficiaries are generally expected to require more care relative to younger individuals. this is because of higher prevalence of various acute and chronic health conditions in older age groups – a global phenomenon. as such, ageing within the medical scheme population is relevant to this study’s context. previous researchers have often looked at the average age of beneficiaries (rather than patients) and concluded that this is relatively stable, and therefore they do not delve deeper into other drivers such as utilisation and cost (cms 2008; van den heever 2013:65). this is, however, not sufficient as it is a simplistic measure of central tendency and may be balanced by the underlying distribution, such that information regarding the latter is lost. this is also the view taken by discovery health, dhms and insight actuaries, as, respectively, referred to here: while the average age is a good summary measure for comparing age trends and their claims impact over time, this summary measure also hides changes in the distribution of age groups over time. (discovery health 2014:34) average age calculations tend to hide the negative impact of changes in the distribution of age groups on the health profile of the medical scheme membership base. while dhms has maintained a relatively stable average age, it now has a) a higher proportion of lives at the older ages, as well as more younger children, who are higher claimers; and b) fewer older children and young adults, who are relatively low claimers. (discovery health medical scheme 2014:86–87) the average age is not a good indicator of the demographic profile of medical scheme beneficiaries as increases in the proportion of older members can simultaneously be masked by similar increases at lower ages. (insight actuaries and consultants 2014:36) understanding changes in the underlying beneficiary age distribution is therefore imperative, but it is not sufficient when analysing its related influence on private hospital utilisation and expenditure. this study therefore considers patient (rather than general beneficiary) ageing by analysing actual admission and expenditure data per age band from the above-mentioned three hospital groups. this concentrates the analysis on the age distribution and its direct relation to expenditure, using the same age bands as are analysed by the cms. the trends both within and between age bands, and both in levels and growth rates, are of interest. in addition to controlling for the number of beneficiaries per age band and the change in this over time, the data are also adjusted to the share of total private hospital beds accounted for by the three listed hospital groups, and for self-paying patients. the data presented here provide ample indication of the ageing-utilisation-expenditure link. figure 5 shows admissions per 1000 beneficiaries per age band in 2006 and 2014. the trend lines relate to the left axis and show the level of admissions per 1000 beneficiaries in these two time periods. the bars relate to the right axis and show the growth in admissions per 1000 beneficiaries between these two time periods. most relevant to note from this figure is that levels of admissions per 1000 beneficiaries are the highest for the 65+ age band. considering that it is shown that there are around 600 admissions for every 1000 beneficiaries in this upper age band, it can be said that of every 10 beneficiaries aged 65+, six of them are admitted to hospital per year. this is in contrast to the younger age bands for which between one and four of every 10 beneficiaries are admitted to hospital per year. in terms of the growth in admissions, this is also highest for the 65+ age band. between 2006 and 2014, admissions per 1000 beneficiaries increased by 6% for that age band, that is, indicating that utilisation increased at a greater rate than its beneficiary base for this age band. such positive figures are also indicated for other age bands, but to a lesser degree. figure 5: admissions per age group, per 1000 beneficiaries; 2006 and 2014. interestingly, it appears that admissions per 1000 beneficiaries decreased in the very young age bands, implying that in this period, admissions grew at a lesser rate than beneficiaries in these age bands. this is because of a number of factors and will be the focus of future research. preliminary investigation indicates that it is partially driven by significant beneficiary growth (66%) for this age band from 2006 to 2014, making the overall fraction of calculation (admissions per 1000 beneficiaries) negative. it may also be influenced by the fact that in south africa, healthy newborn babies are not counted as separate admissions. hence, the newborns that are included in this figure are those that have complications and so are admitted in their own right. high growth in beneficiaries (44%) for those aged 1–4 also partly explains the negative fraction in this age band. other factors such as medical scheme option choice or benefits and demographic factors of new beneficiaries being added to the medical scheme population may also influence these trends. this study’s data do not, however, allow analysis of these factors. in summary, it is clear that ageing has a strong and increasing influence on admissions at private hospitals both in terms of admission levels and growth rates per 1000 beneficiaries as shown in figure 5. figure 6 shows a similar trend for patient days as for admissions; illustrating that when jointly considering the levels of patient days per 1000 beneficiaries and the growth thereof over the past 9 years, these appear to be most significant in the case of the 65+ age band. at just over 3000 patient days per 1000 beneficiaries for this age band in 2014, it can be said that, on average, there are three patient days spent per year for every beneficiary in that age band, and that this is increasing significantly over time. the negative trends for <1 s and 1–4 s are similar to those observed in figure 5 and have been discussed above; suffice to note that it remains an interesting phenomenon that will be researched further in the future. figure 6: patient days per age group, per 1000 beneficiaries, 2006 and 2014. these utilisation trends are relevant for many reasons but most importantly insofar as they impact on expenditure. if utilisation is increasing at a more rapid rate than beneficiaries are increasing, it may be expected that the expenditure per average beneficiary is also increasing. considering the impact of utilisation increases on expenditure is particularly important because of the higher average expenditure in the older age bands, which are also the age bands with the largest utilisation increases. figure 7 shows the expenditure per admission (left-hand side frame) and per patient day (right-hand side frame) per age band, indexed to the average across all age bands. the left frame shows that the expenditure per admission for patients under the age of 1 and above the age of 65 is the highest – the average expenditure for treating patients in these age bands is roughly 50% (1.47 indexed value) higher than the average spent on all admissions. the expenditure per admission for a patient aged 55–64 is also significantly above the average – close to 30% (1.27 indexed value) above the average. in slight contrast to the left frame, the right frame shows that patient days are progressively more costly for older age bands. these trends confirm that older individuals, on average, and when hospitalised, generally require more care and may also stay in hospital for longer periods. taking these trends into account, it is clear that the increasing utilisation trends for older age bands, as shown in figures 5 and 6, are significant cost drivers for private hospitals and therefore also medical scheme expenditure. while the average cost of treating an individual aged <1 is also costly, this is overshadowed by the fact that the admission and patient days for this age band have been decreasing. however, this does not ‘cancel out’ the increase in expenditure related to the increase in admissions and patient days for those in the older age bands as there are many more beneficiaries in the older age bands, relative to beneficiaries in the youngest two age bands. figure 7: indexed (a) average expenditure of admissions and (b) patient days, 2014. the section below proceeds to examine the change in average expenditure per age band over time, while controlling for beneficiary growth and inflation. as expected from the evidence presented in the preceding three figures, figure 8 illustrates that real expenditure per 1000 beneficiaries has cumulatively increased over the period 2006–2014. expenditure has therefore increased at a more rapid rate than beneficiaries in this period. the largest portion of expenditure is attributed to the 65+ age band as shown (by the lines), and this age band also relates to the most rapidly increasing expenditure as indicated (by the bars). note that expenditure per 1000 beneficiaries for <1 s is positive, in contrast to utilisation in this age band (as earlier shown). this study has, however, discussed that this is because of the fact that those patients admitted in this age band are those who have complications (healthy babies remain on their mother’s admission file). in these cases, they usually require significantly more care. figure 8: cumulative real expenditure (rands) growth per age group, per 1000 beneficiaries; 2006 and 2014. to be certain that the above analyses do not mask changes that are occurring in the interim periods, figure 9 additionally shows average annual growth rates for admissions, patient days and real expenditure, with each being per thousand beneficiaries (as in the above figures). this indicates the same trends as evident in figures 6–8, specifically that utilisation of hospital services by older medical scheme beneficiaries, and consequently related expenditure, is increasing over time. figure 9: average annual increase in admissions, patient days and real expenditure per 1000 beneficiaries and per age band from 2006 to 2014. the above analyses and discussions have indicated that utilisation, in terms of admissions and patient days, plays a strong role in medical scheme expenditure on private hospital services. this is particularly pronounced for patients in older age bands, confirming that there is an evident link between ageing, utilisation and expenditure. it may, however, be relevant to more explicitly question what the expenditure increases are once this utilisation has been accounted for. figure 10 shows these increases over 2006–2014 in expenditure per admission and per patient day. figure 10: cumulative real expenditure (rands) growth per admission and patient day, per age group; for netcare, mediclinic and life healthcare; 2006 and 2014. the results show that, after accounting for utilisation in terms of admissions and patient days, real expenditure has increased minimally. in terms of patient days, for instance, the data show an average (unweighted) cumulative increase across all age bands over the 9-year period of 7.4%, translating into an increase in expenditure per patient day of less than 1% per annum. this may be related to benign hospital price inflation, technological advances that may cost slightly more, and so on, but, in general, negates the fact that price is the main driving factor in expenditure increases. in the case of the younger age bands, the higher expenditure increases noted are most likely derived from technological advances in neonatal and general childcare over the last decade, as well as general acuity in these age bands. as discussed above, the case of <1’s is particularly unique. in this age band, the data indicate decreased admissions and patient days per 1000 beneficiaries, alongside increased expenditure per 1000 beneficiaries. it has been mentioned that beneficiaries in this age band have been increasing rapidly, while admissions in this age band are mostly for those babies who present highly acute conditions and require a significant amount of care. this is hence not expected to be a function of increasing prices, but rather more intensive treatments. nevertheless, utilisation trends in these younger age bands remain interesting and different from the other age bands – this will be the focus of future research. in summary, the analyses in this section show a strong and increasing influence of ageing on utilisation and this, in turn, has a significant influence on expenditure on hospital services. the fact that older individuals are in general likely to be admitted to hospital more often, and when admitted also require more care, is not the main issue. the issue to be highlighted is rather the problem that utilisation by these age bands appears to be increasing rapidly over time. this implies that ageing is not only a strong influence on expenditure, but also one that is playing an increasingly important role. looking at expenditure in terms of utilisation confirms that utilisation is a strong driver of expenditure. it is found that the residual of expenditure increases per patient day over time, after adjusting for utilisation increases, is below 1% per annum. in addition to and in conjunction with medical scheme ageing effects on utilisation and expenditure at private hospitals, the disease burden of beneficiaries is expected to impact on utilisation and expenditure. there is a growing body of research that supports that there is an increasing burden of disease evident in the south african medical scheme population, with the majority of research focussing on chronic diseases. research by the cms (2015) indicates that the upward trend in prevalence rates of chronic diseases in the south african medical scheme population had, over 2008–2013, continued to increase at rates more rapid than the medical scheme population growth. in addition, it is found that concurrent disease prevalence is becoming an increasing phenomenon. in this regard, the following was stated by the cms (2015): the number of medical scheme beneficiaries who were diagnosed and treated for multiple chronic conditions increased by more than 25% between 2012 and 2013, whilst the number of beneficiaries with four or more chronic conditions increased over the same period by 78%. (p. 9) other stakeholders have also provided insights into the growing chronic disease burden. for example, discovery health (2014) reports that: over a 5 year period, age and plan mix adjusted chronic disease prevalence in dhms has increase by 27.3%, or 4.9% per annum. this increase in chronic disease prevalence leads to an expected increase in claims costs of approximately 1.4% per annum, before any other inflation related factors. (pp. 35–37) the above indicates that chronic disease prevalence does impact on overall healthcare expenditure and it is also expected to be the case specifically for medical scheme expenditure on private hospitals. this is because of the medical schemes regulatory environment mandating chronic diseases and other conditions that are specified as included in pmbs to be covered in full by medical schemes, particularly in the case that a designated service provider (dsp) is utilised and the correct protocols are followed for treatment.9 in addition to chronic diseases, it is also well documented that south africa in general is facing a complex, quadruple burden of disease. as stated by the competition commission of south africa in their initial terms of reference to the ongoing inquiry into the private healthcare sector: south africans are facing what is referred to as a ‘quadruple burden of disease’: the first burden is the hiv/aids pandemic; the second is that of injury, both accidental and non-accidental; the third consists of infectious diseases such as tuberculosis, diarrhoea and pneumonia, and the fourth is the growing prevalence of lifestyle disease related to relative affluence. (south african competition commission 2013:77) in this context, it is important to understand the profile of diseases that the private healthcare sector of south africa is exposed to. a preliminary investigation of the private hospital data for individual disease classifications per age band seem to confirm and further explain the results presented earlier in this study: disease related utilisation by beneficiaries in the older age bands appears to be increasing rapidly over time. it also looks to be the case that younger individuals are progressively exposed to such diseases. a complete analysis of changes in the disease burden per age band should prove very interesting and aid in the better understanding of utilisation increases, as well as its interaction with ageing and expenditure. this will be the focus of a forthcoming analysis. discussion: other drivers of medical scheme expenditure on private hospitals it was explained in earlier sections that the expenditure residual can be attributed to many factors. the sections above have accounted for beneficiary growth, headline inflation and utilisation adjustments. having adjusted the expenditure data for these factors, the analysis showed that the price residual is similar to general price increases in the economy (and highly correlated to hospital price inflation). this section provides some qualitative discussion on the other factors that are known to contribute to healthcare expenditure here and in other countries. technology in addition to an increase in the volume of private hospital services being demanded, the last decade has also witnessed a shift in the type of services being demanded and supplied. this is driven by the ageing and disease trends that have been discussed, but concurrently also by the development of new medical technologies over the last decade. these technologies facilitate new or improved treatments, and are therefore expected to interdependently influence utilisation and expenditure by medical scheme beneficiaries at private hospitals. the relevant international literature provides a significant amount of discussion and empirical work on the portion of healthcare cost and expenditure increases that is driven by new technology. there are also numerous international literature reviews available on this topic (see, e.g., sorensen, drummond & kahn 2013). new medical technologies include products that are both substitutes and complements to existing products (and thus those that may result in substitutive or complementary procedures), as well as those that are entirely new products and may therefore result in entirely new procedures. they therefore include diagnostics, medicines, surgicals, prostheses and equipment, as well as knowledge and support systems. where these technologies have been linked to improved health outcomes, they are expected to influence both demand for and supply of private hospital services, and also to influence expenditure on private hospitals through both price and utilisation (with the direction of influence for each being specific to that technology). institutional factors although this study has analysed increases in medical scheme expenditure on private hospitals mainly over 2006–2014, institutional changes in the preceding period should also be noted insofar as they are expected to relate to private hospital utilisation and expenditure. specifically: in 2000, the medical schemes act10 was promulgated in south africa. this introduced various important pillars of the private healthcare system that are in existence today. importantly, it introduced open enrolment – removing any option to decline membership of an open scheme to any prospective member. additionally, community rating was introduced – removing any option to differentiate members’ contributions based on the health or similar risk profile of that person. with the introduction of the medical schemes act also came pmbs.11 these are benefits that are mandatory for medical schemes to cover in full, irrespective of the members’ medical scheme benefit option. all medical schemes at present are specifically obliged to cover the full costs related to the diagnosis, treatment and care of any life-threatening emergency condition, a defined set of 270 diagnoses and 25 chronic conditions. this must be sought at a dsp in order to be covered in full, except in the case of emergencies. the next section explains how these two broad institutional factors are expected to influence utilisation and expenditure by medical scheme beneficiaries at private hospitals. anti-selection and moral hazard as the medical scheme environment in south africa is characterised by open enrolment and community rating, but not mandatory membership, it can be expected that some degree of anti-selection is exercised by medical scheme beneficiaries. the existence and degree of anti-selection in the medical scheme population impacts the private hospital admission rate. the general concept of anti(or adverse) selection is well understood by healthcare funders, for example, as explained by discovery health (2014): adverse selection describes a process whereby low risk individuals drop out of (or fail to join) the insurance pool, leaving proportionally more high-risk individuals in the pool – resulting in unsustainable insurance markets. an insurer has to base the premium on a risk pool that includes both healthy and sick individuals, as the principle is that everyone pays less because the costs of only a proportion of those members who become sick are spread across everyone. but individuals purchasing insurance have better information regarding their risk status than does the insurer. therefore, low risk individuals (who know they are low risk) are less inclined to purchase insurance (or to remain members) because the premium does not reflect their risk status, whilst high risk individuals are more inclined to buy insurance (or to remain members), resulting in premium revenue over time being insufficient to cover expected losses. an increasing age and increasing chronic prevalence and disease burdens … are manifestations of the broader problem of adverse selection. (p. 40) there is a growing body of research to support the existence of adverse or anti-selection in the south africa medical scheme population. this is evident in studies that consider the age distribution of the medical scheme population relative to the age distribution of the south african population as a whole (e.g. mcleod & grobler 2009). these studies find that there is, in fact, a significant difference, with the medical scheme population showing peaks around maternity years and again around more disease prevalent, older years. studies regarding the inflation of contribution trends between open and closed medical schemes (e.g. oxera 2012) also offer support for the existence of adverse and anti-selection. these find that inflation is significantly higher for open schemes, indicating the fact that these schemes are more widely exposed to risk-seeking individuals. while this study does not estimate a counterfactual or precisely quantify to what extent utilisation and expenditure trends are affected by the institutional changes, the data analysed in the preceding sections have illustrated that anti-selection is a plausible characteristic of the current private healthcare system in south africa. this is deduced from the fact that the private hospital utilisation data are indicative of a progressively ageing distribution. in addition to adverse selection, it is also expected that moral hazard within the private healthcare sector influences increases in utilisation and hence increases in medical scheme expenditure on private hospitals. moral hazard is a common phenomenon within healthcare markets and, in south africa specifically, is a function of the community rating principle, whereby medical schemes cannot charge different amounts for the same level of coverage. therefore, this coverage turns unpredictable health expenditures into predictable coverage payments, and consequently may encourage beneficiaries to simply utilise (or act in such a way so as to be more likely to utilise) more care because of the fact that they are covered. as with anti-selection, the data in this study do not allow inference about the degree of moral hazard existent within the private healthcare sector, but this is acknowledged to be an additional and relevant driver of cost. any further study of this phenomenon would need to carefully distinguish this from anti-selection as it is expected that these two phenomena would exhibit joint effects. prescribed minimum benefits prescribed minimum benefits also influence utilisation of and expenditure by medical scheme beneficiaries at private hospitals. pmbs, defined at the start of this section, were introduced with the intention of providing a minimum healthcare package for all those who contributed to a medical scheme. however, because of the hospital-centric nature of many pmbs, these do significantly impact medical scheme expenditure on private hospitals by expanding medical scheme beneficiaries’ access to private hospitals and increasing utilisation of private hospital services by these beneficiaries. there is evidently greater incentive for patients to seek out these benefits in hospital and potentially also for service providers to provide care in these instances (as this is not a direct financial cost to their patient). again, this study does not estimate a counterfactual and precisely quantify to what extent utilisation and expenditure trends are affected by the pmbs regulation. the forthcoming research on disease diagnoses provides more detail on this. in summary, there are many interdependent factors that may impact on private hospital utilisation and expenditure. amongst these are technological factors and institutional factors. this study discussed the mechanisms through which these factors may impact on expenditure, and the data analysed in this report support the fact that these factors do play a role in determining utilisation and expenditure. they must therefore be taken into account by the relevant stakeholders and policymakers when considering expenditure increases. conclusion this study was motivated by the high and rising medical scheme expenditure on private hospitals that has often been referred to in the ongoing debate around what drives these expenditure increases. in previous years, this was, without due consideration, attributed mainly to hospital price increases. in recent years, however, more detailed research has contributed to a better understanding of the expenditure trends and its relationship to utilisation and associated underlying trends such as ageing, disease, technology, anti-selection and so forth. this study contributes to this progressively growing body of research by providing important insights into how utilisation is a driving force in explaining medical scheme expenditure on private hospitals. in order to do so, this study analysed the detailed admission data of netcare, mediclinic and life healthcare – the three largest private hospital groups in south africa, accounting for more or less 70% of the total private hospital beds. the level of detail allowed us to answer specific research questions by analysing the data at a granular and aggregate level (e.g. age level). the analysis shows that year-on-year increases in real expenditure pabpa by medical schemes on private hospitals over the last decade present low single-digit growth rates. specifically, the data show year-on-year increases in real pabpa expenditure of less than 5% over 2010–2014. notwithstanding this, it is found that utilisation of private hospitals has, in fact, increased, with the results indicating that admissions and patient days per 1000 beneficiaries have cumulatively increased by 3.5% and 13.2% over 2006–2014, respectively. the analyses indicate that in aggregate, these utilisation adjustments explain a significant portion of the real expenditure increases and after accounting for these increases, there is a residual of 2% p.a. per average admission and 1% p.a. per average patient day over those 9 years. these residuals can be decomposed further and are shown to correlate closely to hospital price inflation, with the latter averaging 0.8% points above headline inflation over 2003–2013 (econex 2014). most notably, the study finds that the cumulative expenditure increase residual, after accounting for utilisation, is in most cases relatively benign. the residual may be because of hospital price inflation, acuity and/or technology. for this purpose, a discussion on the impact of technology and institutional factors on the admission rates faced by private hospitals is included. the evidence analysed, therefore, clearly shows that utilisation trends significantly contribute to the medical scheme expenditure increases that are observed for private hospitals. in addition, utilisation is inter alia driven by ageing and disease trends, the first of which is analysed in detail in this study and the latter in a forthcoming study. in summary, the detailed analysis in this study showed that utilisation at private hospitals is indeed on the rise, and that this is inter alia driven by the ageing trends of the medical scheme population. this strongly contradicts certain stakeholder’s assertions that such factors do not play a role in explaining utilisation and expenditure trends. the data also indicate – after controlling for beneficiary growth and headline inflation – that hospital price increases during the latter years examined in this study (2006–2014) have been in line with general price increases in the economy. it would therefore be incorrect to attribute expenditure increases to price increases, as the analyses clearly show that there are many factors contributing to increased expenditure, with price increases being fairly benign over the period. these trends should also carefully be interpreted in the context of a continually evolving private healthcare sector with consistent improvements in care and concurrent incentives for individuals to self-select into the private sector. taken together, the evidence in this study shows that utilisation and underlying trends explain most of the medical scheme expenditure increases that are observed for private hospitals. this is an important finding and relevant for informing the direction of future health policy. acknowledgements this work has been commissioned and paid for by the hospital association of south africa (hasa). competing interests the authors declare that they have no financial or personal relationship(s) that may have inappropriately influenced them in writing this article. authors’ contributions m.e. was responsible for research and writing the report and interpretation of results. h.k. did statistical and technical analysis and wrote the report. references american hospital association and the lewin group, 2005, the cost of caring: sources of growth in spending for hospital care, viewed from http://www.aha.org/content/00-10/costcaring.pdf besesar, s. & van eck, h., 2009, hospital admission rates for the medical scheme population in sa: is there a supplier induced demand problem? in private hospital review, commissioned by hasa, viewed 26 march 2016, from http://www.compcom.co.za/wp-content/uploads/2015/05/mediclinic-annexure-14-hasa-publication_-private-hospital-review-2009.pdf cms, 2008, evaluation of medical schemes’ cost increases: findings and recommendations, cms research brief, viewed 30 march 2016, from https://www.medicalschemes.com/files/research%20briefs/report_on_cost_inc.pdf cms, 2015, prevalence of chronic diseases in the population covered by medical schemes in south africa, research and monitoring unit of the cms, viewed 30 march 2016, from http://www.medicalschemes.com/files/research%20briefs/rbprevcd20150128.pdf dieleman, j.l., baral, r., birger, m., bui, a.l., bulchis, a., chapin, a. et al., 2016, ‘us spending on personal health care and public health, 1996–2013’, jama 316(24), 2627–2646. https://doi.org/10.1001/jama.2016.16885 discovery health, 2014, submission to the competition commission market inquiry into the private health sector, viewed 14 april 2016, from http://www.healthinquiry.net/lists/submissions%20from%20public/allitems.aspx econex, 2012, medical scheme expenditure on private hospitals, viewed 14 april 2016, from http://econex.co.za/publication/occasional-note-august-2012/ econex, 2014a, market concentration trends in private healthcare. research note and underlying analysis, viewed 14 april 2016, from http://econex.co.za/publication/occasional-notes-march-2014/ econex, 2014b, rising prices in the healthcare sector: unpacking health inflation, econex research note, viewed 14 april 2016, from http://econex.co.za/publication/research-note-36/ econex, 2016, supply-induced demand in the private healthcare sector: theoretical considerations, viewed 24 july 2017, from https://econex.co.za/publication/research-note-40/ feldstein, m., 1971, the rising costs of hospital care, information resources press, washington, dc. fuchs, v.r., 1972, essays in the economics of health and medical care, national bureau of economic research, new york. hasa, 2008, private hospital review 2008: examination of factors impacting on private hospitals, viewed 06 december 2015, from http://www.mediclinic.co.za/about/documents/htg%20private%20hospital%20review%202008.pdf insight actuaries and consultants, 2014, international benchmarking of hospital utilisation, commissioned by hasa, viewed 15 may 2016, from http://www.compcom.co.za/wp-content/uploads/2016/03/hasa-intl-utilisation-benchmarking-final-20141123.pdf life healthcare, 2016, presentation for health market inquiry public hearing – set 1, viewed 14 april 2016, from http://www.compcom.co.za/week-3-public-hearings-2/ mcintyre, d.i. & thiede, m., 2007, ‘health care financing and expenditure’, south african health review 2007, 35–46. mcleod, h. & grobler, p., 2009, ‘the role of risk equalisation in moving from health voluntary private insurance to mandatory coverage: the experience in south africa’, advances in health economics and health services research 2009(21), 159–196. netcare, 2016, presentation to healthcare market inquiry, viewed 14 april 2016, from http://www.compcom.co.za/week-3-public-hearings-2/ oxera, 2012, private healthcare market in south africa, p. 20, viewed 02 march 2016, from http://www.healthinquiry.net/public%20submissions/mcsa%20annexure%205.10%20-%20oxera%20report%20entitled,%20private%20healthcare%20market%20in%20soutth%20africa,%20dated%2014%20december.pdf sorensen, c., drummond, m. & kahn., b.b., 2013, ‘medical technology as a key driver of rising health expenditure: disentangling the relationship’, clinicoeconomics and outcomes research 2013(5), 223–234. south african competition commission, 2013, terms of reference for market inquiry into the private healthcare sector, government gazette, 29 november 2013, notice 1166 of 2013: 77. van den heever, a., 2013, review of competition in the south african health system, produced for the competition commission, p. 65, viewed 09 june 2016, from http://www.compcom.co.za/wp-content/uploads/2014/09/review-of-competition-in-the-south-african-health-system.pdf vera-hernandez, m., 2003, ‘structural estimation of a principal-agent model: moral hazards in medical insurance’, rand journal of economics 34(4), 670–693. https://doi.org/10.2307/1593783 footnotes 1. this period is selected because of data availability. 2. for the purpose of this report, utilisation is used as a collective term to describe changes in volume and case mix. 3. this year (2006) was chosen as the analysis of utilisation data focused on the period between 2006 and 2014. prior to 2006, differences in clinical coding make it difficult to aggregate data across hospital groups. while this issue still needs to be overcome with data after that point, it is less of an issue and data seem to be more comparable. 4. prescribed minimum benefits as a policy instrument were introduced in the medical schemes act, 131 of 1998. these are benefits that are mandatory for medical schemes to cover in full, irrespective of the members’ medical scheme benefit option. regulations made in terms of the act were promulgated in 1999 and came into force in 2000. significant clarity was added to the pmbs regulation in 2002 (published in the government gazette volume 449, no. 24007, november 2002). this is discussed further in the section ‘institutional factors’. 5. the private hospital data were not collected for the period preceding 2006 because of coding inconsistencies and problems related to the cross-mapping of clinical codes between the various hospital groups. 6. international classification of diseases and related health problems, 10th version. 7. the methodology is as used by (1) econex (2012), (2) insight actuaries and consultants (2014) and (3) besesar and van eck (2009). this assumes an equal occupancy to bed ratio between groups. 8. this is usually referred to in statistics and probability theory as simpson’s paradox. 9. this may impact on the care seeking behaviour of medical scheme beneficiaries and those in particular using private hospitals, further exacerbating the indication of disease patterns. this regulatory environment and relation to expenditure is discussed further in the ‘institutional factors’ section. 10. no. 131 of 1998. regulations made in terms of the act were promulgated in 1999 and came into force in 2000. 11. please refer to section 29 (1) of the medical schemes act, as well as regulation 8. sajems ns vol 2 (1999) no 2 financial accounting and reporting in developing countries: a south african perspective johan oberhokter school of accountancy, university of pretoria abstract 222 south africa is currently going through major changes in political, social and other arenas. it is therefore appropriate to consider the effect of these developments on financial reporting in a changing environment. this paper explores the origins of the current south african accounting system, given its status as a developing country, and endeavours to show that financial reporting needs to be amended to retlect the changing face of the south africa's social fabric, its status as a developing country, as well as the emergence of new users of financial statements. certain recommendations are made to address these issues. jel m 41 introduction south africa moved into an entirely new dispensation when a new democratically elected government came into power on 27 april 1994. up to that date, a disproportionate share of the country's resources was directed towards serving a small, generally well-educated, section of the south african population of european origin (booysen, 1993: 1). if one takes into account that blackcontrolled firms still owned less than 3% of the market capitalisation on the johannesburg stock exchange (jse) in july 1997, it is sate to say that this eurocentric section of the population has in the recent past controlled the bulk of the economic and financial power in the country (ramaphosa, 1997: ii; singh, 1997: i). given this state of affairs it follows that the communication of accounting information also evolved to serve and address the needs of this firstworld western component of south african society. as the economy of the country is being restructured to achieve a more even distribution of the economic power, and as a larger portion of that power moves to the previously disadvantaged and less educated sections of the population, it is inevitable that these people will become more important users of tinancial r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 223 sajems ns vol 2 (1999) no 2 intormation. this situation, together with the growing importance of employees as stakeholders in business enterprises (mostly unschooled workers via trade unions) as illustrated by booysen (1993: i), raises the question of the suitability of the current format and disclosure provided by the financial statements of enterprises. this article sets out to investigate the origins of the accounting systems used by most developing countries, and seeks to determine whether the accounting systems of the developed countries and the financial reports thus generated, are suitable for use in the developing countries too. these issues are then related to the south african situation. finally some recommendations to correct the situation are made. south africa as a developing country according to wallace (1990: 3), a developing country can in broad terms be defined as a country seeking to advance to a higher state of economic well-being. this term would therefore include a wide range of countries mostly found in africa, asia and latin america. apart from the quest tor economic development, most of these countries received their independence from the colonial powers from the late 19508 onwards, and share the common characteristic of the presence of poverty, while experiencing wide disparities in their development levels (todaro, 1994: 34; wallace, 1990: 3). in general, the following problems are associated with developing countries: poverty; rapid population growth; high levels of unemployment; unequal income and wealth distribution; regional imbalances; insufficient domestic savings; large foreign debt; low levels of technology; and a need to improve education (samuels, 1990: 69; nafziger, 1997: 73-83; todaro, 1994: 28). against this background and based on numerous reports in the news media and scientific literature, it can be argued that south africa, too, largely meets these criteria and thus falls within the group of countries classified as developing (strachan, 1997: 28). however, it is also true that certain parts of the south african economy may show characteristics typical of a developed country. south africa's status as a developing country is however confirmed by its classification as an upper middle income country in the world development report according to 1995 data (1997: 215, 223). south africa may however since then have slipped r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 224 from an upper-middle income to a lower-middle income country, especially if one takes into account the severe depreciation of the rand during 1996 and 1998 (bethlehem, 1996: 16; schoombee, 1996: 9; wood, 1996: 7; de lange, 1998: 7; muller, 1998: 12). the origins of accounting systems in (most) developing countries wallace and briston (1993: 215) point out that the international transter of accounting technology has occurred for many years in a non-formalised manner by way of the following methods: (a) previous colonial legacies; (b) the importation of accounting qualifications from developed countries; (c) the activities of transnational enterprises in these countries; (d) the role of international organisations like the world bank and regional development agencies like the african development bank; (e) etforts by the developed countries' aid institutions; (t) the role of the international federation of accountants and the international accounting standards committee, and regional groups such as the african accounting council and the association of accounting bodies of west africa; (g) the fact that english is the first or second language in many of these countries, has led to the use of british, american or australian textbooks for accountancy training, as local text books are rarely available. the etlect of the above transfer methods on south africa is next considered. case (a), the british colonial legacy, has been of major importance (samkin, 1996: 70). south africa, which became a republic on 31 may 1961 after approximately 150 years of a formal british link in one form or another, is a perfect example of the entrenchment of the british accounting system in a former colony of the united kingdom. this fact is supported by researchers who have tried to classify the practices embodied in national accounting systems in countries around the world. mueller (1966: 91-103) suggested ten such national groupings and included south africa in the british commonwealth group. mueller's findings were supported by those of da costa, bourgeois, and lawson (1978: 79) who also classified south africa as a part of the british sphere of influence. frank (1979: 596), once again, classified south africa as falling under the british sphere of influence. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 225 sajems ns vol 2 (1999) no 2 briston (1990: 200) states that many countries around the world which were once part of the british empire, found themselves on independence with a professional accounting body and company law based on the british model. given its entrenched nature, most of these countries found it very difficult to move away from the british system. hinton (1968: 11) points out that the south african disclosure requirements at least up to 1968, were based on the eighth schedule of the companies act of 1926, which was in tum based on the recommendations of the english institute of chartered accountants. consequently the south african reporting requirements up to that stage were virtually identical with those of england. according to chaderton and taylor (1993: 51), several authors like engleman and hove have also argued that colonisation has been the most important vehicle for the transfer of accounting systems to developing countries. the importation of formal accounting qualifications from developed countries to south africa, mentioned in (b) above, appears to have been adversely affected by the political dispensation under the previous south african government. this point is argued by referring to the history and activities of the chartered institute of management accountants (cima) and the association of chartered certified accountants (acca) in south africa. acca, which featured in the south african accounting environment up to the 1950s, closed its south african branch in 1956 and was only relaunched here in 1993, as south africa's period of political isolation drew to a close. the relaunch followed an investigation by acca, after the association of black accountants in south atrica (abasa) had approached acca with a view to establishing its international qualification function in south africa once more (kamukwamba, 1997: 14,15). apropos cima, little written evidence in this regard is available. a telephone conversation with craig durant, the administration officer at the south african divisional head office of cima, on 24 july 1997, confirmed that cima first opened a branch in south africa in 1950 and that its membership grew to approximately i 900 persons during the forty years until 1989. during this tortyyear period, the cima international head office in london merely funded a small contingent of administrative staff and did not actively promote clma in south africa. in 1990, however, with the changing in the political situation in south africa, a divisional director was appointed in south africa for the first time, after which clma operations in south africa expanded rapidly. for example, according to a telephone conversation on 25 january 1999 with samantha louis, the divisional director of the south african division ofcima, membership of the body increased from approximately 1 900 to 2 800 persons during the period 1989 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 226 to 1998. it would therefore appear that cima kept a low profile in south africa during the previous political dispensation, and only became active from 1990 when political change was in the offing. another reason for the recent popularity of the cima qualification, could be the fact that it is promoted and regarded as an internationally accepted professional qualification, while the political situation in south africa has induced especially white people to acquire this qualitication to enhance their future marketability and job security abroad. transnational enterprises, mentioned in (c) above, have definitely contributed to the transfer of accounting technology to south africa, given the scale of operations oftirms like ibm and pepsico in the country. but sanctions forced several of them to withdraw from south africa during the 1970s and 1980s after which their intluence waned. with the return of these business enterprises, the position may well become reversed. the methods of transfer mentioned in (d) and (e) above, have only been reintroduced in south africa recently, after an absence of several decades. this was mainly due to the fact that south africa was isolated from the rest of the world for most of the last three decades through sanctions. of the professional bodies mentioned in (f) above, only the international accounting standards committee (iasc) has recently played a major part in the development of accounting in south africa, up to the 1994 election. this role can be attributed to the fact that south africa remained an active member of the iasc throughout its years of isolation, and therefore kept abreast of the accounting issues addressed by this body (hepworth, 1979: 472; mockler, 1993: 3). with the launch of the harmonisation and improvement project of the south african institute of chartered accountants in 1993, the iasc once again emerged as a major influence, seeing that the bulk of the revised south african accounting standards are closely aligned to those of the iasc (mockler, 1993: 3; blumberg, 1995: 3). as regards (g), the fact that the english language has dominated the business world tor so long, contributed to the use of english textbooks which further entrenched the british accounting system in south africa (victor, 1992: 36). the subsequent emergence of accounting textbooks in afrikaans in the early 1970s, contributed little to changing the entrenched british position, tor at that stage the south african accounting system had already developed along british lines and the new afrikaans textbooks merely reflected the status quo. in recent times wallace (1993: 123) has also supported the majority of the abovementioned points in the international context, by stating that betore 1960, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 227 sajems ns vol 2 (1999) no 2 accounting regulations and practices moved from the one-time imperial powers to the now independent ex-colonies. he added that countries once incorporated with the british empire, operate accounting systems based on the belief "that economic resource allocation can be achieved by the invisible (or visible) hands of the free market system." moreover, as the united kingdom is a leading economically developed country according to the world development report (1997: 215,223), and as south atrica and other former british colonies have based their accounting systems on that of the united kingdom, it follows that the accounting systems of several developing countries (including south africa) have been greatly influenced by the united kingdom model. problems associated with the transfer of the accounting systems of developed to developing countries as shown in the previous section, the accounting systems of most developing countries were imported from developed countries. the next logical step would there tore be to determine whether the accounting systems of the developed countries are in fact suited to the environments, circumstances and needs of the developing countries. problem areas are now individually discussed. different environments and needs according to scott (1970: 7), the environments in which the accounting systems of developed countries operate, differ to a large extent trom those of developing countries. as a consequence, it is unlikely that these systems will produce infonnation which is relevant to developing countries struggling with completely ditferent problems. wallace (1990: 43) has stated that the developing countries are not homogeneous, and according to samuels (1990; 69) neither are their problems which include poverty, unequal wealth distribution, regional economic imbalances, insut1icient domestic savings, large foreign debt, low levels of technology and the need to improve education. briston (1990: 215) concurs with the view that each country is different and has different needs. as a result, accounting is also likely to be influenced by the diflerent political, economic, social and religious environments in which it operates. he (1990: 201) adds that it should be borne in mind that a specific system of accounting (such as the united kingdom system) evolved in a particular r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 228 environment, and may need considerable adaptation to meet the needs of another country. considering these points, the financial statements produced in a developing country like south africa, which are based on accounting standards designed for developed countries, may not address really relevant issues. for example, to what extent are business enterprises involved in alleviating typical problems associated with developing countries? when this is not the case, reason for the omission may be due to the fact that developed countries do not normally experience these problems. different users oni (1986: 26) states that the difference between the objectives of financial reporting in developed as opposed to developing countries, lies in the fact that the most important user groups in developing countries are different from the most important user groups in developed countries. briston (1984: 12-26) is also of the opinion that the accounting objectives of developed countries are different from those of developing countries, and that conventional accounting statements are investor-driven and therefore of little relevance to countries with few private investors, no stock exchange and very strong government involvement in the economy. he (1990: 201) also argues that the united kingdom system presupposes that the bulk of economic activity is carried out by companies financed by private shareholders, whose shares are listed on a stock exchange. although all of the above scenarios may not apply here, south africa is in a situation where private and institutional investors mainly consist of the eurocentic component of south african society, with the afrocentic majority very much in the background. this problem can mainly be attributed to the fact that the african section of the population was not economically empowered under the previous government (ramaphosa, 1997: ii). however, moves are afoot to correct this situation, as can be seen in the changing share ownership on the jse. black firms owned only r4,6 billion of the total market capitalisation on the jse in 1995, while this had risen to r65,6 billion (or 7%) by mid-november 1998 (dasnois and de kock, 1999: 9). as was pointed out in previous paragraphs, the financial statements and accounting systems in developed countries are designed primarily for the use of investors, although they are used by other people as well. these tinancial statements would however not necessarily address the problems typical of the developing countries. to do so, changes to financial statements produced by r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 229 sajems ns vol 2 (1999) no 2 investor-driven accounting systems should include additional disclosures by firms indicating how they assist in alleviating problems like poverty, correct regional imbalances, and contribute to the education of workers. such disclosures apply specifically to south africa, and could also be extended to include details on the affirmative action programmes implemented by enterprises. market forces in developing countries according to samuels (1990: 70), the conventional system of accounting in the developed world is designed for a situation where most of the crucial decisions regarding the allocation of resources are made according to market forces, while this is not necessarily the case in developing countries. measurement and reporting practices implicit in the accounting standards of developed countries, are designed to meet their own circumstances and would therefore be inappropriate in the case of developing countries where the market forces are affected by government intervention. the impact of government on free market forces can be illustrated in the south african context, amongst others, by reference to the involvement of the department of health in regulating the prices of pharmaceutical products and medicines (sapa, 1997: 1). the allocation of resources in south africa therefore also appears to be affected by government intervention. acceptance of international accounting standards although most national accounting systems initially used by developing countries were designed and became entrenched in colonial days, subsequent developments have mainly been derived from international trends dictated by developed countries such as the united kingdom and united states. this is confirmed by the tact that several developing countries, including south africa, have for various reasons chosen to adopt the international accounting standards (lass) issued by the international accounting standards committee (lasc) with only minor changes, for implementation in these countries (mockler, 1993: 3). wallace (1993: 133), however, argues that the international accounting standards do not normally address the topics particularly relevant to developing countries, seeing that to developed countries "development" means industrialisation and the improvement of ancillary stock and capital market operations. this view of development might explain why the lase has neglected the regulation of mining and agricultural businesses which are the potential engines of many developing countries. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 230 samuels (1993: 20) continues by saying that several research papers have come to the same conclusion, namely that the accounting standards a country adopts, should reflect the local situation. this appears to be confinned by the south african experience with the acceptance of lass. so tar the "easy" lass have passed through the hannonisation and improvement project, and already some problems have surfaced (blumberg, 1995(b): 3). consequently, if the problems associated with the status of south africa as a developing country are taken into account, the acceptance of the lass without any attempt at making these more acceptable to unschooled users, could create even bigger problems. uses of financial statements in developing countries peasnell (1993: 10, ii) points out that the purpose of accounting infonnation systems should always be kept in mind. the economic and social policies pursued by many third-world countries are different from the developed market economies and call for different kinds of accounting infonnation. he further argues that modem anglo-american accounting thought is based on the assumption that accounting reports are intended to facilitate decision-making and should therefore be judged in those tenns. according to samuels (1990: 71), for accounting to be useful in developing countries, is should be relevant to their economy and social climate, and also move towards a more complete infonnation system. samuels (1990: 75) adds that the accounting demands of a nation go beyond those required for making economic decisions about business operations and, when properly structured, these should enable a nation to decide on the efficient allocation of its scarce resources. briston (1978: 105-20) again states that the accounting standards of the united kingdom are concerned only with the issues of corporate reporting of annual financial statements, while the intonnation needs of other users are not seen as the concern of the accountant. therefore, should financial statements in south africa be adapted to disclose, in addition to the infonnation required for decision-making in business affairs, also other infonnation associated with the solving of national problems, this could lead to an improved understanding of business and greater loyalty by users with a poor financial background. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 231 sajems ns vol 2 (1999) no 2 one system of accounting for all developing nations already some two decades ago, briston (1978: 109) argued that western (mainly united states and united kingdom) accounting systems, particularly in the public sector, did not keep pace even with environmental changes and principles. systems appropriate to developed countries are therefore most unlikely to be appropriate to the entirely different social and economic environment of the developing world. peasnell (1993: 2) concurs with briston in pointing out that part of the problem is that the accounting needs of the third world differ greatly from country to country. developing countries include states like singapore, korea and taiwan which are industrialising rapidly and have a promising future. some other countries are again rich in natural resources, such as nigeria and indonesia, and their relative lack of development has much to do with a colonial legacy, the birth pains of nationhood, and difficulties in establishing good government (peasnell, 1993: 2). samuels (1990: 79) argues that the diversity of economic and social systems in third-world countries, would necessitate evolutionary rather than revolutionary changes in existing accounting systems. relevant existing information which is available to an enterprise, but which is not disclosed currently, should be presented in the financial statements of enterprises in developing countries. such disclosures would facilitate a better understanding of financial statements. wallace (1990: 4) also states that developing countries are not a homogeneous group and that each country differs from the other as regards: gross national product; population; political system; culture; economic system; and the degree of literacy. these factors will invariably impact on the nature and extent of financial reporting. in the light of the above considerations, the accounting systems, the financial reports generated by these systems, as well as the accounting standards of developing countries should be adapted to the circumstances of a particular developing nation. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 232 the south african situation the accounting system opemtional in south africa at present, has been imported from the united kingdom and the reports generated by it are not necessarily appropriate to overall south african circumstances. furthermore, at this stage the financial statements genemted by the system merely meet the requirements of the first-world component of the south african corporate sector, and the acceptance of lass will not change the situation. the fact that south africa is a developing country is ignored, and this is not an ideal situation seeing that a large part of the south african population, including the workers who are becoming a force to be reckoned with, do not understand or accept it as their own. summary and conclusion in the light of the above considerations, it can safely be stated that the accounting systems of most developing countries, originate from previous colonial powers like the united kingdom, and others too. subsequent developments in the accounting systems, and the financial reports genemted by them for the developing countries, appear to be derived mostly from accepting the guidance of the iasc and other international accounting bodies. however, the iasc for example, is dominated by the economically developed world, and international accounting standards do not specifically cater for the different environments, users and needs of the developing nations. these standards also do not take into account the fact that market forces in developing countries are usually affected by government intervention, more than in the economically developed nations. consequently, the acceptance of lass by developing countries without any adaptation, fails to accommodate the problems that are unique to them. furthermore, the heterogeneous nature of the developing countries does not allow for the development of a single system of accounting and reporting for these countries as a group. recommendations bac:kground in the south african context. it is therefore suggested that the lass which are accepted in terms of the harmonisation and improvement project, be adapted to reflect the circumstances unique to south africa as a developing country. this process of adaptation should, seeing that the majority of the south african population and employees are of african origin, amongst other things permit the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 233 sajems ns vol 2 (1999) no 2 accommodation of african culture in financial statements by way of additional disclosures. this would lead to greater understanding and possession of financial infonnation by a much larger body of economic stakeholders (blumberg, 1996: 10). the line of thought above does not propose that the main body of international accounting standards be south africanised, as this would defeat the object of the harmonisation and improvement project, which is to make south african corporate reporting more useful to international investors. this would in the long run not contribute to the well-being of south africa as a whole. it is however suggested, that the existing standard-setting process be amended, one way or another, to ensure that the majority of the south african population also contribute to the accounting standards developed for south african use. given the fact that the main body of south african accounting standards should not largely differ from international accounting standards, it proposed that certain additional disclosures in financial reports be required in south african accounting statements, over and above what is required by the international accounting standards. these disclosures should take into account the status of south africa as a developing country, as well as the cultural background of the majority of the south african population. to detennine exactly what should be disclosed, is a subject for future research. this article addresses only the underlying reason why our current accounting statements fail to meet the needs of our current circumstances. the existing standard-setting process at present, the setting of accounting standards in south africa is the responsibility of the south african institute of chartered accountants, the body that represents the chartered accountants of the country (samkin, 1996: 74). this body is there tore ultimately responsible for the generally accepted accounting practices currently applied in south africa. in order to ensure that the necessary (abovementioned) disclosures are in fact made, it is recommended that the composition of the bodies involved in the standard-setting process in south-africa be investigated and revised, to ensure that the majority of the south african population also contribute to the accounting standards prepared for south african use. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 234 the current composition of bodies involved in the standard-setting process in south africa at present two bodies are involved in the local standard-setting process, namely, the accounting practices board and the accounting practices committee (samkin, 1996: 73). the control, development and publication of statements pertaining to generally accepted accounting practice in south africa, rests with the accounting practices board, which is composed as follows: banking associations joint apb committee; chamber of mines of south africa; die afrikaanse handelsinstituut; institute of municipal treasurers and accountants; investment analysts society of southern africa; public accountants' and auditors' board; southern african accounting association; the chartered institute of management accountants; the johannesburg stock exchange; the south african chamber of business; the south african institute of chartered accountants; the south african institute of chartered secretaries and administrators; and the steel and engineering industries federation of south africa. (source: south african institute of chartered accountants, 1991: acioo.03.) moreover, the accounting practices board was formed by the national council of chartered accountants (sa) (currently the south african institute of chartered accountants) (vorster, et al., 1997: 5). to ensure that the accounting standards developed commanded the widest possible acceptance, the national council of chartered accountants decided to form a body sufficiently representative of the business community to provide leadership in the setting of accounting standards (samkin, 1996: 74). the accounting practices board members are appointed by their constituent bodies as follows: the south african institute of chartered accountants appoints five members, the johannesburg stock exchange appoints two members and all the other bodies appoint a single member. each member has a single vote; the chairman is non-voting and does not represent a constituent body (blumberg, 1995(a): i). the accounting practices committee is a committee of the south african institute of chartered accountants, and is responsible for the development of statements of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 235 sajems ns vol 2 (1999) no 2 generally accepted accounting practice. once these statements have been developed, they are submitted to the accounting practices board for approval (samkin, 1996: 75). according to blumberg (l995(a): 2), the composition of the accounting practices committee is as follows: 1 chairperson; 4 auditors; 3 preparers; 2 users; 1 academic; and 2 international accounting standards committee representatives (as observers). blumberg (1 995(a): 2) adds that the members of the accounting practices committee are appointed by the council of the south african institute of chartered accountants on the principle of the "best person for the job". during their tenn of three years, members present their own view and not that of their finn or company. problems associated with the current composition of standard-setting bodies in view of the composition of the two bodies involved in the current standardsetting process, and the well-known fact that the majority of leadership positions in the south african business world are held by chartered accountants, the standardsetting process for accounting standards is clearly dominated by the south african institute of chartered accountants. according to mabena (1997: 5), less than 10% of the chartered accountants in south africa are black (i.e. coloured, indian and african) and of that 10% only very few are african (aitken, 1995: 21). consequently, it is evident that the representation by the african section of the population in the standard-setting process is very limited, therefore, their influence on the standard-setting process is also bound to be limited. apart from the fact that their numbers are small, it should be kept in mind that african chartered accountants are highly skilled individuals who probably subscribe to western culture to a large extent. for these reasons, merely enlarging the accounting practices board or the accounting practices committee by appointing an african chartered accountant, is unlikely to serve the african cause, or the cause of employees as stakeholders in enterprises. from the perspective of the developing world, there is also a lack of representation in the current system of standard-setting. individuals endowed with this kind of knowledge are not likely to be represented amongst the members currently listed r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 236 under either the accounting practices board or the accounting practices committee. final reeommendations to solve the problems identified above, it is recommended that the composition of the accounting practices board and the accounting practices committee be amended as follows: to serve the cause of employees as users of fmancial information and the african perspective, representation on these bodies should be extended by appointing members of the major trade union groupings in south africa and the national economic development labour council (nedlac). examples of trade unions would be the congress of south african trade unions (casa tu) and the national council of trade unions (nactu). to amend financial reports to disclose the way in which enterprises have addressed the problems associated with developing countries, development economists and representatives from appropriate government departments dealing with specific development issues, may be appointed to the above-mentioned two bodies. in fairness to the south african institute of chartered accountants, it should be mentioned that a new accounting standard-setting process has in tact been proposed, where casas and nedlac are represented on the nomination board (south african institute of chartered accountants, 1995: 28). to date, however, the old system still functions and as the proposed new system would only allow four representatives from each nomination group and representation for african culture is not guaranteed, it is doubtful whether the proposed new standard-setting process will satisfactorily address the problems discussed above, or main issues pertaining to the economically developing countries. references i. aitken, c. 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(1993) "improving the accounting infrastructure in developing countries", in: wallace, r.s.o., sameuls j.m. and briston kj.(ed.), research in third world accountancy, vol 2, london: jai press ltd. 43. wood, s. (1996) "rand's slim chances", finance week, 25 april: 7. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction literature methodology data estimation and results conclusion acknowledgements references footnotes about the author(s) willem h. boshoff department of economics, stellenbosch university, south africa lewis mclean department of economics, stellenbosch university, south africa citation boshoff, w.h. & mclean, l., 2018, ‘what do deviation cycles measure? an analysis of the informational content of filter-based business cycles’, south african journal of economic and management sciences 21(1), a1689. https://doi.org/10.4102/sajems.v21i1.1689 original research what do deviation cycles measure? an analysis of the informational content of filter-based business cycles willem h. boshoff, lewis mclean received: 02 nov. 2016; accepted: 25 may 2018; published: 30 aug. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: empirical business cycle research typically commences with the extraction of a so-called deviation cycle using a time-series smoothing filter. this methodology is appealing for its pragmatism; it is easy to implement, and the output it produces is conveniently interpreted as percentage deviations from the natural level of output. however, recent literature offers staunch criticism of deviation cycle analysis, especially with regards to the assumption implicitly underlying it – that business cycle fluctuations are restricted to distinct intervals on the frequency domain. aim: despite its lack of a basis in theory, the analysis of deviation cycles over particular frequency ranges may still yield useful stylised business cycle facts. this, however, hinges on whether the information that a frequency filter captures consistently aligns with relevant theory-based business cycle concepts. whether this is the case is an empirical matter, and herein lies the rationale for our research. setting: we investigate the informational content of south africa’s output deviation cycles. methods: we extract deviation cycles at standard highand medium-frequency ranges (denoted as shortand medium-term deviation cycles respectively) and analyse their informational overlap with the components of an alternative theory-based estimate of the business cycle, decomposed into demand, supply, domestic and foreign sources of business cycle dynamics. results: our findings suggest that the contents of deviation cycles extracted over a high-frequency range do not neatly correspond to the transitory ‘demand-driven’ business cycle, while cycles extracted over a medium-frequency range correspond closely to the combined path of permanent output shocks. conclusion: one should thus be cautious of drawing strong conclusions about the nature of business cycles from filter-based deviation cycle estimates, particularly if the objective of the study relies on assuming that high-frequency deviation cycles correspond to transitory demand shocks. introduction empirical business cycle research typically commences with the extraction of a so-called deviation cycle using a time-series smoothing filter. this methodology is appealing for its pragmatism; it is easy to implement, and the output it produces is conveniently interpreted as percentage deviations from the natural level of output. however, recent literature offers staunch criticism of deviation cycle analysis, especially with regard to the assumption implicitly underlying it: that business cycle fluctuations are restricted to distinct intervals on the frequency domain. if permanent shocks are a significant driver of the business cycle (as real business cycle theory suggests), business cycle dynamics may be inextricably linked to the low-frequency permanent component of output, presenting challenges for the core assumption underlying frequency-based business cycle analysis (canova 1998; harding & pagan 2002). in short, the core assumption underlying deviation cycle analysis of business cycles may be at odds with economic theory, causing us to doubt its usefulness as a means of studying business cycles. despite the lack of a neat alignment between method and theory, the analysis of deviation cycles over particular frequency ranges may still yield useful stylised business cycle facts. this however hinges on whether the information that a frequency filter captures, consistently aligns with relevant theory-based business cycle concepts. whether this is the case is an empirical matter, and herein lies the rationale for our research. we investigate the informational content of south africa’s output deviation cycles extracted at standard highand medium-frequency ranges (denoted as shortand medium-term deviation cycles respectively) by comparing them with the components of an alternative theory-based estimate of the business cycle, decomposed into demand, supply, domestic and foreign sources of business cycle dynamics. our theory-consistent estimate of the business cycle consists of structural shocks to real output, which we estimate via an open-economy structural vector autoregressive (svar) model and identify by imposing long-run restrictions in the style of blanchard and quah (1989). in addition to its strong theoretical coherence, we selected the blanchard-quah identification strategy on account of its decomposability, which allows us to isolate the source of business cycle dynamics. using one such decomposition allows us to differentiate permanent and transitory fluctuations in real output, what real business cycle theorists regard as demand and supply shocks (plosser 1989). isolating these sources of fluctuations in real output allows us to test whether shortand medium-term deviation cycles correspond neatly to transitory or permanent components of real output. similarly, we also use the blanchard-quah identification strategy in conjunction with the open-economy specification of our svar to decompose real output into domestic and foreign shocks and assess whether either of these aligns more closely with deviation cycles extracted at different frequencies. subsequent to obtaining our estimates of the business cycle, the bulk of our analysis centres on simple pearson correlations between our statistically identified components of the business cycle and our shortand medium-term deviation cycles estimates. while rudimentary, we deem this approach appropriate and sufficiently robust, given that we are comparing information extracted from the same time series. however, we supplement our analysis of the informational content of deviation cycles extracted over medium-range frequencies by testing for cointegration with the decompositions of our benchmark svar business cycle estimate. we thereby take advantage of the apparent nonstationarity of our medium-term deviation cycles estimate to determine what information is sufficient to render this time series stationary. given that cointegration in a univariate setting implies that the two series contain the same underlying stochastic trend (engle & granger 1987), we regard cointegration between these series as an indication of extensive informational overlap. literature harding and pagan (2005) develop a taxonomy of business cycle concepts that are typical in the applied literature of business cycle analysis, distinguishing between classical, deviation and growth rate cycles. classical cycles, the original business cycle concept used by burns and mitchell (1946), as well as central banks and research institutes such as the nber, refers to cycles in the level of the output series. deviation cycle analysis involves identifying and removing a so-called ‘permanent component’ from the output series; the remainder is then a set of serially correlated deviations called deviation cycles.1 growth rate cycles, that is, cycles in growth rates, capture periods of accelerating and decelerating growth. these are a special type of deviation cycle, wherein the previous value of output is regarded as the permanent component. economies experiencing sustained growth do not often exhibit classical cycles (see mintz 1969) and mainstream business cycle research consequently departs predominantly from the analysis of deviation cycles. for a more thorough discussion of different business cycle concepts see harding and pagan (2005) or see du plessis (2006) for a concise summary. deviation cycle analysis is based on the decomposition of a time series into a growth component and a cyclical component. when applying this decomposition to real output data, the cyclical component is regarded as a measurement of the business cycle, and the permanent component is often interpreted as a measure of lucas’s (1977) concept of potential output. these applications are common in the literature of applied macroeconomics, forming the basis of numerous papers in the south african and international literature. for example, boshoff and fourie (2010) incorporate an analysis of deviation cycles in south african real output as part of their assessment of the relationship between economic activity and trade in the early cape colony, where they find evidence that deviation cycles in productivity and trade are positively related. kabundi and loots (2007) depart from the extraction of deviation cycles and subsequent estimation of dynamic correlation coefficients in their analysis of co-movement between south african real output and those of the other 13 southern african development community countries, and similar research has been conducted for south africa and germany (kabundi & loots 2010) and south africa and the united states of america (u)s (kabundi 2009). in the international literature, deviation cycles have served as a point of departure for establishing stylised facts about business cycles in developed and developing countries.2 the widespread usage of the deviation cycle method makes due consideration of its weaknesses a worthy concern. in this regard, harding and pagan (2002) have raised staunch criticisms of filter-based business cycle analysis. firstly, they argue that the practice of shifting all information beyond the short-term into a permanent component may be associated with significant loss of information relevant for business cycle research. their position departs from real business cycle theory, which implies that business cycles should not necessarily be regarded as transitory disturbances to a smooth long-run growth path (blanchard 1997; krugman 1998; sargent 1999; solow 2000). from this theoretical point of departure, it is arguable that the removal of permanent shocks from real output is at odds with business cycle research, particularly if the aim of that research is to obtain a plausible overall representation of business cycles. however, harding and pagan (2002) also note that removing a filter-estimated trend from real output data does not necessarily remove the permanent shocks to the time series. thus, even if the researcher’s aim is to isolate transitory shocks to real output, frequency filters do not necessarily deliver the desired result. in sum, it might be said that the core contention that underlies harding and pagan’s (2002) critique is that deviation cycle analysis unduly circumvents the statistical identification problem that is fundamental to business cycle research, providing convenient estimates of quantities that may not correspond to any theoretical notion of the business cycle. despite this identification deficit, deviation cycles may still yield useful stylised facts and insights into business cycle dynamics. frequency filters are advantageously flexible, allowing researchers to check the robustness of their results by isolating and analysing cyclical variation in real output at various frequency ranges, and recent research based on deviation cycle analysis has used this flexibility to conduct business cycle research that investigates and accounts for the impact of frequency range choices on stylised business cycle facts. for example, comin and gertler (2006) show that the high-frequency characterisation of business cycles provides limited insight into their nature given that economies also exhibit medium-term fluctuations. comin et al. (2012) use the same concepts to show that short-term business cycles tend to have large and persistent effects in developing countries, and thus propagate into medium-term fluctuations. this research seems to indicate that an analysis of medium-term deviation cycles may be an appropriate point of departure to understanding of business cycle dynamics and propagation. however, regardless of frequency range choices, research on the dynamics of deviation cycles still departs from an atheoretical basis and thus remains exposed to the harding and pagan (2002) critique: given the purely statistical basis of this methodology, the researcher simply cannot know precisely what information is captured at any choice of frequency ranges. it is on account of this problem that we provide this evaluation of the informational content of deviation cycles in south african real output. we extract deviation cycles over frequencies conventionally used to capture shortand medium-term business cycle movements and compare them with business cycle estimates obtained from a structural econometric model. as discussed below, our svar estimate of the business cycle can be decomposed into transitory and permanent shocks (loosely interpreted as demand and supply shocks) and into domestic and foreign shocks. comparison with these decompositions of the business cycle allows us to observe the extent to which deviation cycles, extracted at different frequencies correspond to these sources of business cycle fluctuations in south african real output. methodology we use the christiano and fitzgerald (2003) (cf) filter to extract deviation cycles for domestic output. our choice of filters was informed by research that suggests that the cf filter outperforms others when considering longer-term fluctuations (zarnowitz & ozyildirim 2006). we define the high-frequency (i.e. short-term) deviation cycle as the component of output corresponding to a frequency range of 6–32 quarters. this is the business cycle frequency range used by king and watson (1995), king and rebelo (1999) and guay and st-amant (2005). medium-term deviation cycles are extracted for a frequency range of 6–200 quarters. the medium-term deviation cycles thus contain both highand medium-frequency components, where the medium-frequency component ranges from 32 to 200 quarters. as noted previously, filters are statistical instruments with no basis in economic theory. however, an alternative approach to estimating business cycles that grapples directly with the identification problem is the svar identification strategy developed by blanchard and quah (1989). in their influential paper, blanchard and quah (1989) show that it is possible to recover permanent and transitory structural shocks to real output from a two-variable reduced-form var by restricting the long-run response of real output to transitory shocks to zero. consistent with real business cycle theory, one can then represent the contribution of transitory shocks and permanent shocks to the evolution of real output. following this work, various authors investigate the sources of business cycles using var estimation and the blanchard-quah identification strategy, and some have subsequently extended the framework to a greater number of variables, thus increasing the number of distinct structural shocks that may be estimated. for instance, karras (1993) estimates such a model for the us, ahmed and park (1994) for a sample of small open economies, karras (1994) for various european economies, west (1992) for japan and du plessis, smit and sturzenegger (2008) for south africa. in all instances, these authors use the blanchard-quah identification strategy to recover permanent and transitory shocks to real output, which they often interpret as aggregate demand shocks (transitory shocks to real output) and supply shocks (permanent shock to real output). they then cumulate the demand or supply shocks to derive a demandor supply-based estimate of the business cycle. this is precisely the approach we take to obtain a structural estimate of the components driving fluctuations in real output for south africa. the study by du plessis et al. (2008) provides the basis for our svar-based estimate of the factors underlying the south african business cycle. their study departs from a three variable svar, wherein government expenditure as a percentage of gdp and the real interest rate are used to identify demand shocks to output. we extend the du plessis et al. (2008) study along two dimensions. firstly, we incorporate data following the sample period set out in their study (2007q1 – 2015q3), which allows us to observe how output has evolved since the recent financial crisis and subsequent european debt crisis. secondly, we add two variables to the model that allow us to explicitly model the evolution of south african output in response to global shocks. given that the blanchard-quah decomposition is standard in the literature we provide a cursory description of the identification procedure. see du plessis et al. (2008) or clarida and gali (1994) for a more extensive overview of this procedure for vars of three or more variables; also see enders (2010) for an introduction to vars, svars and the blanchard-quah identification strategy for the case of a two-variable var. variable selection is the first step to achieving identification via the blanchard-quah methodology. following clarida and gali (1994) and du plessis et al. (2008), the domestic components of our model consist of real gdp (yt) along with two sources of demand shocks, namely government expenditure as a percentage of gdp (gt) and the real interest rate (rt). tests for unit roots in these variables were performed and the results are excluded for brevity (results are available upon request). we find a unit root in all series except for the real interest rate. the model estimated by du plessis et al. (2008) does not explicitly account for the impact of global shocks and their dynamics in relation to the other (domestic) variables. given south africa’s small open-economy status, taking into account the effect that global shocks have on the economy seems appropriate. to this end, we augment the model proposed by du plessis et al. (2008). following balcilar and tuna (2009), we add two additional variables chosen to identify global shocks to the economy: a trade weighted proxy for world output and the rand-denominated real oil price . augmented dickey-fuller (adf) tests confirm that these variables are difference stationary. variable section is important for obtaining a well-specified var, but it should be noted that our interest lies in the evolution of the structural shocks underlying these variables and the extent to which they determine the evolution of real output in particular. we are not interested in the causal parameters of these variables as determinants of real output. additional variables that may constitute further sources of transitory and permanent shocks abound, but we have chosen to limit our specification to these five variables on account of data availability, the precedent set by du plessis et al. (2008), in the case of domestic variables, and that of balcilar and tuna (2009), in the case of external variables. the next step in following blanchard and quah (1989) is to ensure that our data are stationary. thus we first-difference and , and we find that they are difference stationary – we denote these as and . while adf tests indicates that gt is difference stationary, we hold the argument maintained by du plessis et al. (2008), that the ratio of government expenditure to gdp cannot possibly be the product of a unit root process.3 tests of the stability of the var did not indicate that including gt in levels destabilises the system. our system of equations can be represented as a vector moving-average process of the form yt = c(l)εt, where is our vector of dependent variables, our vector of structural shocks. c(l) is an infinite order lag polynomial matrix defined as c(l) = c0 + c1l + c2l2 + c3l3 … in the lag operator l, where each cn for n = 0,1,2, is a 5×5 matrix containing the contemporaneous impact of εt−n on yt. the matrix c(l) thus represents the cumulative impact of all preceding structural shocks on the system of variables yt. each of the five structural shocks contained in the vector εt are assumed to be independently, identically distributed and serially uncorrelated. we will refer to these, from left to right, as the oil price shock , global output shock , domestic output shock , government expenditure shock and real interest rate shock . despite our naming convention, it is important to note that variation due to these five shocks do not correspond uniquely to any one of these five variables. as discussed in enders (2010), this representation assumes that the system of variables is endogenous to five distinct structural shocks. this is made clear by the unrestricted matrix c(l), which allows each shock contained in εt to impact yt to an arbitrary extent. consequently, given the current state of the matrix c(l) it is not possible to differentiate these shocks from one another, that is, the system yt = c(l)εt is an unidentified var. however, we can identify the structural shocks in εt by placing a sufficient number of restrictions on c(l), the required number of restrictions being 10 in this instance (see enders 2010). this is precisely the crux of the blanchard-quah identification strategy, that we can recover structural shocks underlying the progression of a set of endogenous variables yt via imposing theory-based restrictions on the long-run impact of the shocks εt on the variables yt. in addition to standard normalisation assumptions on εt, the remaining assumptions required to achieve identification are a set of restrictions on c(l) however, because we have assumed that the shocks in εt are independent and serially uncorrelated, we can identify εt by imposing restrictions on the matrix: this we obtained by setting l = 1. the matrix c(1) represents the cumulative impulse response of the vector yt to a single pulse of all five elements of εt. in its current state, the matrix c(1) would allow for any of our five structural shocks to have a permanent effect on any one of the five variables in our var. however, if we are willing to assume that our unobserved structural shocks do not permanently affect a sufficient number of variables in our model (i.e. if we assume that a sufficient number of elements in c[1] are in fact zero) then we can recover each of the distinct shocks in εt. following balcilar and tuna (2009), we thus achieve identification by imposing the following 10 restrictions on the matrix c(1). firstly, we assume that permanent shocks to world output do not affect the real price of oil in the long run. this implies that c12 = 0. next, the assumption that south africa is a small open-economy implies that domestic shocks to domestic variables have no long-run impact on foreign variables, and as such that c13 = c14 = c15 = c23 = c24 = c25 = 0. lastly, we assume that monetary shocks do not have a long-run impact on government expenditure and domestic output, and that shocks to government expenditure do not have a long-run effect on domestic output, implying that c34 = c35 = c45 = 0. incorporating the above on the matrix c(1) gives the identified long-run impact of the shocks on the endogenous variables: from these assumptions we have a sufficient number of restrictions to estimate the matrix c(1) and hence to identify the shocks in εt. for the sake of brevity, we do not discuss the process of obtaining εt in detail here, as the process of moving from restrictions on c(1) to estimates of εt is a matter of mere computation now that we have restricted c(1) to a lower-triangle matrix. (clarida and gali, 1994, provide a step-by-step guide to this process.) however, for completeness sake we note succinctly that as under our 10 identifying assumptions the matrix c(1) may be obtained as the lower-triangle cholesky decomposition c(1) c(1)’ = r(1) σr(1)’, where σ and r(1) are respectively the variance-covariance matrix and cumulative impulse response matrix of an unidentified var of the form yt = r(l)ut, and where ut is its vector of reduced-form disturbances. once we have estimated yt = r(l)ut, we can write , thus identifying εt (clarida and gali 1994). with εt identified we can assess the informational content of deviation cycles extracted at different frequency ranges. we compare the content of deviation cycles with a range of combinations of structural shocks, with particular emphasis on the path of transitory shocks, that is, the demand-based business cycle as defined in du plessis et al. (2008) ( and ), the path of aggregate supply disturbances, which we define as the combination of all permanent shocks to yt ( and ), the combined path of domestic shocks, both transitory and permanent ( and ), and the path of global shocks to output and . as a final note on our methodology, we acknowledge that the results of our analysis rest on whether or not the blanchard-quah identifying assumptions hold for our five variable var. with respect to the assumptions of spherical and serially uncorrelated error terms, we can (and do) test this, but we unfortunately cannot test whether our restrictions on the long-run impact matrix are valid. our analysis also relies on the general efficacy of the blanchard-quah identification strategy. lippi and reichlin (1993) show, for instance, that several nonstandard moving-average representations produce results quite different from those obtained by blanchard and quah (1989) in their original application of the strategy. even so, it must be remembered that the business cycle is an unobserved theoretical construct, and hence quantifying it necessarily requires some assumptions about the process underlying it. in the case of frequency filters, the implicit identifying assumption seems to be that the business cycle is in all instances restricted to a subset of the frequency domain, and this is clearly far removed from explicit economic reasoning. in contrast, the blanchard-quah identification strategy provides a set of explicit and economically sensible assumptions that produce an estimate of the business cycle. notwithstanding the inevitability that the blanchard-quah identifying assumptions may not hold, the business cycle estimates it produces follow from a sensible application of economic theory. hence, we propose that in the absence of any objective alternative measure of the business cycle, our method of assessing the informational content of filter-based deviation cycles provides an important step in the direction of becoming critically aware of the limitations of deviation cycle analysis and filter-based business cycle estimation broadly. data we estimate deviation cycles and svar-based structural shocks to real output on a sample period from 1961q2 until 2015q3, chosen on the basis of data availability. we define real output, our variable of interest, as real gdp measured at a quarterly frequency. quarterly data for south african real output and government expenditure and monthly data for the repo rate were obtained from the south african reserve bank (sarb 2016). quarterly real output for the us, the united kingdom (uk), australia and japan (all obtained from the international monetary fund’s international financial statistics database, 2016) and europe (obtained from the organisation for economic co-operation and development’s oecd.stat database, 2016) were averaged to construct a proxy for global output. this selection was informed by the variables used by boshoff (2010), updated to include japan on account of its importance as major trading partner to south africa. note that china was initially considered as an additional economy to be included in our measure of global output but was omitted due to the limited availability of data detailing real output in china prior to the mid-1970s. monthly and quarterly south african consumer price index (cpi) and the quarterly series of the west texas intermediate (wti) spot oil price and the rand-dollar exchange rate (used to convert the spot oil price to rand) were obtained from quantec’s easydata database. we calculate the quarterly real interest rate from monthly data using the ‘within-quarter’ formula from du plessis, smit and sturzenegger (2007). the wti spot oil price was first converted to nominal rand, then to real rand using the quarterly cpi. all data are seasonally adjusted with 2010 as the base year. in the final specification of our svar, the real rand-denominated oil price, our proxy for global output and domestic real output, are specified in log-differences; the ratio of government expenditure to gdp and the real interest rate are included in levels. estimation and results we apply the cf filter to the log of south african real gdp data. the results are reported in figure 1, which shows both the highand medium-frequency deviation cycles along with the medium-term component. recall that our high-frequency deviation cycles are the variations in real output within the frequency range of 6–32 quarters, and that the medium-term deviation cycle encompasses both the high-frequency and medium-frequency component, that is, it encompasses the frequency range of 6–200 quarters. as such, the difference between the medium-term cycles and the medium-frequency component (i.e. the variation in real output in the frequency range from 32 to 200 quarters) gives the high-frequency deviation cycles. values are expressed as a percentage of the low-frequency component. the shaded area indicates the period following the financial crisis. figure 1: shortand medium-term deviation cycles. several features of figure 1 are worth noting. the medium-frequency component is clearly characterised by a larger amplitude across the entire sample period. following giannone and reichlin (2005), we interpret this as an indication that shortand medium-frequency components of south africa’s business cycle contain distinct information. historically, the medium-term deviation cycle reaches a local minimum during the time that south africa underwent its democratic transition and started to recover thereafter. this feature is consistent with boshoff (2010), who finds that the medium-term deviation cycle starts declining relative to the low-frequency component in the early 1980s and falls below the low-frequency component in the late 1980s. boshoff (2010) attributes this marked decline to the political unrest, economic sanctions and subsequent debt standstill that characterised south africa in the 1980s. note that the cycle only moved above its permanent component recently, since 2005. similar to boshoff (2010), we find that since about 2002 the short-term deviation cycle is smaller in comparison with the medium-frequency component, a finding which he ascertains implies that ‘strong output growth since 2003 could be ascribed to a longer-term momentum, rather than short-term spikes’. however, since the onset of the crisis, the short-term deviation cycle again increases relative to the medium-frequency component, in line with the recent sluggish and volatile output growth discussed previously. for our theoretical benchmark, we estimate the svar described above at six lags. we conducted standard specification tests for normality and autocorrelation on the unrestricted var (the results have been omitted for brevity and are available upon request). tests for autocorrelation were deemed passable, but it should also be noted that the unrestricted var did not pass tests for the joint normality of the residuals. this result seemed to follow primarily from world output, whose residual series is platykurtic on account of the great recession. adding additional lags did not correct this misspecification. we do not attempt to correct for this finding by including outlier dummy variables, as this would unduly reduce the information contained in the residual series (and hence in our estimates of the vector of structural shocks). furthermore, we maintain that non-normality is not so problematic in this context. while the assumption that the residuals are uncorrelated is necessary for the structural decomposition of the estimated residuals into structural shocks (clarida & gali 1994), the assumption of spherical residuals is only necessary for statistical inference with ordinary least squares. we thus proceed, noting that inference on the coefficients of our model is biased. table 1 provides a first look at the extent of the informational overlap between combinations of structural shocks to output and deviation cycles at different frequency ranges. we also check for correlation between the medium-term deviation cycle and structural shocks in differences, on account of the apparent nonstationarity of these series. of course, filtered data is mean-reverting by design, but we investigate the extent of the relationship between changes in these series so as to check the robustness of our result in levels. correlation between cycles and structural shocks is positive for all but the shock to the real interest rate, . the positive contemporaneous correlation with the shock real price of crude oil, found for all three series, is a counterintuitive result. however, as was mentioned in our discussion of the blanchard-quah methodology, it must be remembered that cannot strictly be interpreted as oil price shocks; is the series of shocks that has a permanent effect on the price of oil after factoring out the systematic relationship between the oil price and the other variables included in our svar model. presumably, this series will contain shocks underlying variations in commodity prices more generally, where we might anticipate that positive shocks to commodity prices will be positively related to domestic real output. all other positive correlations are consistent with our intuition. table 1: pearson correlation coefficients for shocks and deviation cycles. with reference to short-term deviation cycles, we find that there is substantial correlation with the negative demand shocks that correspond to the real interest rate . the pure demand shock underlying government expenditure exhibits a positive correlation with the short-term cycles but is the least correlated with short-term cycles of all of the pure shocks (the correlation coefficient is also statistically insignificant). interestingly, the combined path of these transitory shocks produces the smallest correlation coefficient of all the combinations we consider, seemingly indicative of some degree of countercyclicality between these demand shocks. this result can also be observed in figure 2a, which shows that the combined path of transitory shocks is characterised by low variance relative to that of the short-term deviation cycles. figure 2: structural shocks and short-term deviation cycles: (a) medium-term deviation cycles and transitory shocks; (b) medium-term deviation cycles and permanent shocks; (c) medium-term deviation cycles and domestic shocks; (d) medium-term deviation cycles and external shocks. in contrast with these results, it is interesting to note the correlation coefficient corresponding to . while the other permanent shocks ( and ) show no significant correlation with the short-term deviation cycle, the oil price shock is the pure shock with the single highest correlation with the series of short-term deviation cycles. the correlation coefficient on of 0.214 even exceeds the correlation associated with the combination of all permanent shocks ( and ) as well as the correlation with all five shocks. only the correlation coefficient of 0.222 associated with the combination of external shocks ( and ) exceeds the coefficient associated with (a result that in any case appears to be primarily driven by the correlation with ). observing the patterns in figures 2b and 2d, it is apparent that the series of permanent and external shocks appear to align closely with the short-term deviation cycle turning points. in contrast, the combined path of domestic shocks (figure 2c) exhibits cycles that occur over longer periods than those of the short-term deviation cycles. in sum, the two factors most strongly related to short-term deviation cycles are transitory shocks associated with the real interest rate and permanent shocks associated with real oil prices. short-term deviation cycles, frequently interpreted as transitory demand shocks, do not appear to be strongly related with the combined path of (domestic) transitory shocks. we regard these findings as cursory evidence corroborating the critique of harding and pagan (2002), illustrating that high-frequency deviation cycles in south african output do not neatly correspond to transitory shocks. turning now to observations regarding medium-term cycles, permanent shocks (with a correlation of 0.7244) account for a far greater proportion of deviation cycle variation at this frequency than do transitory shocks (0.166). the varying extents of overlap between medium-term cycles and transitory and permanent shocks is evident in figures 3a and 3b. note that while the combined path of all five structural shocks exhibits the highest overall correlation (0.7672) with the medium-term cycles, it is only marginally more correlated than the combined path of all permanent structural shocks (which shows a correlation coefficient of 0.7244). figure 3: structural shocks and medium-term deviation cycles: (a) ; (b) ; (c) ; (d) it is particularly interesting to note that the combination of transitory shocks is more strongly correlated with medium-term cycles than with short-term cycles. in fact, barring the correlation reported for the real interest rate, it seems that the cycles and shocks are more strongly related in the medium term for all of the reported combinations of structural shocks – this observation is robust, holding for the correlations reported for both the levels and differences of these series. tentatively, we regard the finding that the combined path of transitory shocks is more strongly correlated with medium-term cycles than with short-term as a corroboration of the notion that medium-term deviation cycles are less prone to discarding relevant business cycle information. considered along the domestic-external dichotomy, we find that the combined path of domestic shocks to output has a reportedly higher correlation with medium-term cycles than do external shocks – these series are depicted in figures 3c and 3d. referring again to table 1, these findings contrasts with what we observe for short-term cycles, which are reportedly more strongly correlated with external shocks than with domestic shocks. this result appears to be primarily driven by correlation with the permanent domestic shock . this is an intuitive result, indicating that what would often be interpreted as domestic supply (permanent) shocks account for the majority of the medium-term variation in domestic output. in order to further investigate the overlap between medium-term cycles and different combinations of structural shocks, we test for cointegration between these series. we test the stationarity of the medium-term cycles and find them to be difference stationary. thus, if a regression of these cycles on a series of structural shocks yields stationary residuals, this might be regarded as an indication that the cycles capture the same stochastic trend as the shocks. for these tests, we capture the medium-term component of the business cycle by simply removing the long-term component – that is, we use the information captured in the frequency range 1–200 quarters. this leads to better behaved specification tests than for results obtained using medium-term cycles as defined earlier but does not change the conclusions we draw from our tests for cointegration. table 2 presents specification tests and tests for cointegration for the medium-term cycles and 10 different combinations of structural shocks to domestic output. following the johansen (1988) procedure, we first test for stationarity among the combinations of structural shocks; we find that none of these series is stationary at any traditional level of significance. we then estimate an unrestricted var for the cycles and each one of the combinations of structural shocks in levels. each var was run with a lag length selected by the akaike information criterion (aic). specification tests reported in table 2 indicate that the only var that passes the jarque-bera (j-b) test for joint normality at the 5% level is the var containing the combined path of permanent shocks to real output. however, even the combined path of permanent shocks to output fails the joint test for normality with regard to kurtosis at the 5% level. for completeness sake, in table 2 we show that four of the vars that fail the j-b test at the 1% level yield johansen test results indicative of cointegration at the 5% level, and that the johansen tests on the vars estimated on the combined path of permanent shocks and on the combined path of all shocks indicate the presence of a cointegrating vector at the 1% level of significance. however, the j-b test results cast doubt on one of the key assumptions necessary for the validity of the maximum-likelihood-based johansen test. table 2: pretests and test for cointegration. on account of the non-robustness of the johansen procedure under non-normally distributed errors, we opt to test for cointegration via the engle and granger (1987) procedure. the engle-granger test for cointegration does not require the strong assumption of normally distributed errors for validity, reducing our risk of a type one error. table 2 reports adf tests of the residuals obtained from ols regressions of the cycles on each of the shocks and of the shocks on each of the cycles. we find that none of the residuals of the shocks regressed on the cycles test as stationary at the 5% or even the 10% level; it is worth noting, however, that the combined path of permanent shocks to output is associated with a p-value of 0.114, and that the combined path of all five shocks tests as stationary at the 10% level of significance. reversing our specification, adf tests indicate that a regression of the cycles on either the combined path of permanent shocks or the combined path of all shocks produces residuals that test as stationary at the 5% level. no other set of cycle residuals tests as stationary at any traditional level of significance. in sum, our tests for cointegration yield an interesting refinement to the findings reported in table 1. as discussed above, the results reported in table 1 indicate that all of the structural shocks (barring the real interest rate shock) are more strongly correlated with medium-term deviation cycles than with short-term deviation cycles. here we find that the combined path of permanent shocks and the combined path of all five shocks – the two series of structural shocks that were found to have the highest correlation with the medium-term deviation cycles – also appear to be cointegrated with medium-term deviation cycles. our engle-granger tests show that in addition to being highly correlated with medium-term deviation cycles, the combined path of permanent shocks and of all five shocks contain sufficient informational overlap with these cycles to render them stationary. thus, interpreting our tests for cointegration as tests for a common underlying stochastic trend (engle & granger 1987), these test results are indicative of a strong degree of informational overlap between these series. conclusion our comparison of deviation cycles with business cycles identified by an open-economy svar model produced several tentative, but interesting, conclusions. we did not find evidence that the high-frequency deviation cycle neatly corresponds to the purely transitory demand-based business cycle as measured by the open-economy svar. rather, permanent shocks to output (often interpreted as supply shocks) seem to constitute an important source of variation in the high-frequency deviation cycle. medium-term cycles were more strongly related with all shocks and combinations thereof, except shocks to the real interest rate. however, it seems that medium-term deviation cycles primarily capture business cycle information driven by permanent shocks to output, as suggested by our tests for cointegration. our findings suggest that deviation cycle analysis should be interpreted with caution. the medium-term deviation cycle seems to provide a good approximation of the south african business cycle, if one is interested in studying cycles derived from both transitory and permanent shocks, that is, demandand supply-side variation in output. however, we did not find that short-term deviation cycles capture distinctly transitory, demand-driven information, as has been assumed in some applications. one should thus be cautious of drawing strong conclusions about the nature of business cycles from filter-based deviation cycle estimates, particularly if the objective of the study relies on assuming that high-frequency deviation cycles correspond to transitory demand shocks. acknowledgements willem boshoff would like to acknowledge financial support from economic research southern africa (ersa) for an earlier version of the paper, which appeared as a working paper: ersa working paper 200. willem boshoff would like to thank laurie binge for research assistance on an earlier revision and would like to thank adrian pagan 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(2008) for an extended discussion. 377 satebnr vol i (1998)nr3 die evaluering van 'n opleidingsprogram ten opsigte van interpersoonlike doeltreffendheid * l i jorgensen en s rothmann departement bedryfen personeelsielkunde. potchefttroomse universiteit vir eho abstract the south african police service (saps) is increasingly moving towards community policing. this movement makes great demands on the interpersonal efficiency of police officers and their trainers. it seems, however, that trainers in the saps seldom have sufficient knowledge and/or skills to manage interpersonal contact effectively. a two-group design was used to evaluate a training programme regarding interpersonal efficiency for instructors within the saps training college. it transpired that interpersonal skills improved significantly after completion of the training programme. as far as qualitative impressions are concerned, it was found that certain organisational factors might inhibit the development of interpersonal efficiency of trainers jelj 400 opsomming die suid-afrlkaanse polisiediens (sapd) beweeg toenemend na gemeenskapspolisiering. laasgenoemde stel groot eise aan die interpersoonlike doe 1treffendheid van polisiebeamptes en hul opleiers. dit wil voorkom asof opjeiers binne die sapd seide oor genoegsame kennis en/of vaardighede beskik om interpersoonlike kontak effektief te hanker. 'n tweegroepontwerp is gebruik om 'n opleidingsprogram t.o.v. interpersoonlike doeltreffendheid by instrukteurs binne die sapd-opleidingskollege te evalueer. die metodiek van die kursus behels 'n individuele groeistimuleringsgesprek, 'n groeigroep en interpersoonlike vaardigheidsopleiding. die opleidingsprogram het daartoe bygedra dat opleiers na afloop daarvan meer geneig was om vanuit die self te reageer en hulself te aanvaar. hul interpersoonlike vaardighede het ook beduidend verbeter na afloop van die opjeidingsprogram. wat die kwalitatiewe indrukke betref, blyk dit sekere faktore struikelblokke kan wees in die weg van die ontwikkeling van • the evaluation of a training programme with respect to interpersonal efficiency r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 3 378 interpersoonlike doeltreffendheid die suid-afrikaanse polisiediens (sapd) beweeg toenemend na gemeenskapspolisiering en 'n groter openheid vir die gemeenskap. ten spyte hiervan word k1agtes van die publiek ontvang dat polisiebeamptes belangeloos, ongevoelig, vyandigheid en aggressief teenoor die gemeenskap optree (du preez, 1990). de kock. schutte en ehlers (1995) bevind dat een van die oorsake van misdaad die verwydering tussen die gemeenskap en die polisie is. dit lei tot swak verhoudinge tussen die gemeenskap en polisie en 'n swak vloei van inligting. de kock en schutte (1994) meen die polisie moet opgelei word in vakke wat hul verhouding met die gemeenskap sal fasiliteer. vakke soos tale, kommunikasie, sosiologie en sielkunde moet aan die studente geleer word volgens kriek (1995) meen sekere lede van die sapd meen dat hulle niles aan die gemeenskap verskuldig is nie. hierdie houding manifesteer in negatiewe optrede teenoor die publiek. goeie gemeenskapsverhoudinge is egter 'n voorvereiste vir gemeenskapspolisiering. verandering wat op hootkantoor beplan word, sal slegs met sukses getmplementeer word indien dit op grondvlak by elke lid van die sapd suksesvol inslag vind volgens midgley en wood (1995) behels gemeenskapspolisiering dat 'n k1ientgeorienteerde benadering ten opsigte van polisiering in die sapd aanvaar word. die fokus op gemeenskapspolisiering en groter openheid vir die gemeenskap wat hierdeur van polisiebeamptes verwag word, stel groot eise aan die interpersoonlike doeltreffendheid van die polisiebeamptes en veral aan hul opleiers. alhoewel die meganika van kommunikasie by die kurrikulum van die opleidingsbeamptes van die sapd ingesluit is, word min aandag geskenk aan dinamiese aspekte van interpersoonlike doeltreffendheid. interpersoonlike doeltreffendheid is noodsaaklik om die rolie van konsultant, aanbieder enlof fasiliteerder in opleiding te vertolk (gibb, 1982; jones & wood· cock. 1985; lidstone, 1988; stuart, 1988). dit wi! egter voorkom asof opleiers dikwels nie oor genoegsame agtergrond enlof vaardighede beskik om die inter· persoonlike kontak en intrapsigiese gebeure wat vereis word ten opsigte van die rolle van fasiliteerder en opleier effektieftoe te pas nie (harrold, maxon & berry, 1988; lefton. 1988; leventhal, 1984). op grond van die persoongesentreerde teorie (rogers, 1983) kan die afleiding gemaak word dat dit noodsaaklik is dat die opleier oor hoe vlakke van die kemdimensies van sensitiewe verhoudingvorming sal beskik ten einde interpersoonlik doeltreffend te funksioneer. hierdie kemdimensies is respek. empatie, egtheid en konkreetheid (cilliers & wissing, 1993; rogers, 1983). senr ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 379 sateb nr vol i (1998) nr 3 sitiewe verhoudingvonning verwys na die vonning van fasiliterende interpersoonlike prosesse, of die skep van 'n verhoudingsklilnaat wat opbouende prosesse tussen die opleier en die deelnemer/groeplid stimuleer (cilliers & wissing, 1983). aanwesigheid van hoc! vlakke van die kemdimensies van sensitiewe verhoudingvonning by die opleier lei tot groeifasiliterende verandering by die deelnemer. 'n belangrike resultaat wat uit die navorsing van carkhuff (1969) voortvloei, is dat 'n hoc! vlak van psigologiese optimaliteit (selfontwikkeling) by die opleier groeistimulerend kan inwerk op deelnemers. 'n lae vlak van psigologiese optimaliteit kan die deelnemer laat agteruitgaan. daarom behoort die opleiding van opleiers onder andere te berus op die fasilitering van psigologiese optimaliteit (cilliers, 1988). volgens cilliers en wissing (1993) moet die opleier oor die intrapersoonlike kenmerke van psigologiese optimaliteit beskik om interpersoonlik doeltreffend te kan funksioneer. verskeie interpersoonlike vaardigheidsopleidingmodelle het veral vanuit die psigodinamiese, hwnanisties-eksistensiele en die behavioristiese benaderings gegroei (ivey & authier, 1978; marshall & kurtz, 1982). uit die evaluering van die verskillende opleidingsprograrnme ten opsigte van interpersoonlike doeltreffendheid wat in die literatuur opgespoor kon word (bv. anderson, 1982; arbess & hubbell, 1973; berry, 1993; cilliers, 1988; harrold et al., 1988; jacobs, brown & randolph, 1974; mcwhirter, 1974; russell & easton, 1979; stokes & tail, 1980), blyk dit dat verskeie van hierdie kursusse nie voorsiening maak vir die opleiding van opleiers in organisasies nie, en/of dat hierdie kursusse nie op multikulturele groepe toegepas is nie. verskeie opleidingsprogramme om interpersoonlike doeltreffendheid, soos gekonseptualiseer op grond van die persoongesentreerde teorie (rogers, 1983) en die menslike potensiaalontwikkelingsmodel (carkhuff, 1987), te bevorder, is in suid-afrika ontwikkel. cilliers (1988; 1995) en cilliers en wissing (1993) bevind dat hierdie opleidingsprogramme bydra tot die stimulering van interpersoonlike doeltreffendheid (gekonkretiseer as die intraen interpersoonlike kenmerke van psigologiese optimaliteit) van bestuurders, personeelbeamptes en opleidingsbeamptes. rothmann (1996) bevind dat 'n opleidingsprogram in fasilitering (wat interpersoonlike doeltreffendheid insluit) vir opleidingsbeamptes in die sapd opleidingskollege te pretoria tot 'n beduidende verbetering van interpersoonlike vaardighede aanleiding gee, maar dat die intrapersoonlike kenmerke van psigologiese optimaliteit nie beduidend verbeter het na afloop van die kursus nie. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 3 380 omskrywing en kenmerke van psigologiese optimaliteit psigologiese optimaliteit word gedefinieer as die proses van konstante innerlike groei tot die volle uitlewing van die menslike potensialiteite, gekenmerk deur 'n strewe na konstruktiewe interaksie met die omgewing, die verwerwing van 'n innerlike lokus van evaluering en buigsaamheid ten opsigte van die toepassing van waardes (cilliers & wissing, 1993). dit blyk uit die humanistiese persoonlikheidsteoriee dat die psigologies optimaal-funksionerende persoon oor spesifieke intrapersoonlike kenmerke beskik (lowenstein, 1993; rogers, 1980). hy/sy is geintegreerd en selfgenoegsaam, leef in die hede, het vaste waardes, is sensitief vir sy/haar emosies en openbaar dit op 'n spontane wyse sonder om kompulsief of impulsief te wees (raskin & rogers, 1989; schultz, 1977). sy/haar selfbeeld word gekenmerk deur selfaanvaarding en positiewe selfagting (raskin & rogers, 1989). hy/sy aanvaar verantwoorde1ikheid vir wat hy doen, vir keuses wat hy/sy uitoefen en houdings wat hy/sy inneem (frankl, 1978; raskin & rogers, 1989). hierdie kenmerke dien as voorvereiste vir interpersoonlike effektiwiteit (cilliers, 1995; cilliers & wissing, 1993). interpersoonlik word die psigologies optimaal-funksionerende persoon gekenmerk deur hoe vlakke van respek., empatie, egtheid en konkreetheid (cilliers & wissing, 1993). interpersoonlike doeltreffendheid is noodsaaklik ten einde psigologiese groei by 'n individu en groep te bewerkstellig (berry, 1993; corey & corey, 1992). interpersoonlike doeltreffendheid word in hierdie konteks gekonseptuaiiseer as kemdimensies van sensitiewe verhoudingvorming (respek., empatie, egtheid en konkreetheid) (ciuiers & wissing, 1993) en as spesifieke mikro-vaardighede bestaande uit aandaggewing, luister en waameming, respondering, vraagstelling, minimaie aanmoediging, parafta-sering, opheldering, samevatting, konfrontasie, interpretasie en refiektering van gevoel) en duidelike kommunikasie (dickson & mullan, 1990; gallagher, 1993; ivey, 1988). volgens ivey (1988) bestaan daar 'n verband tussen hierdie interpersoonlike vaardighede en die kemdimensies van sensitiewe verhoudingvorming. opleiding in die genoemde kemdimensies kan aan die hand van die menslike potensiaalontwikkelingsmodel van carkhuff (1987) geskied, terwyl opleiding in spesifieke interpersoonlike vaardighede aan die hand van die mikroopleidingsmodel van ivey (1988) kan plaasvind. die doelsteuing van hierdie navorsing is om die effek van 'n opleidingsprogram ten opsigte van interpersoonlike doeltreffendheid binne die sapo opleidingskollege te hammanskraal te bepaai. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 381 satebnr vo11 (1998)nr3 metode navorsingjontwerp 'n tweegroepontwerp met 'n voor-, nameting is gebruik. oit is die voonnetingnameting-kontrolegroepontwerp (kerlinger, 1986). samestelling van die interpersoonlike doeltreffendheidsprogram die inhoud en metodiek van die opleidingsprogram ten opsigte van interpersoonlike doeltreffendheid behels die volgende aspekte: stimulering van die intrapersoonlike kenmerke van psigologiese optimaliteit deur middel van 'n individuele groeistimuleringsonderhoud en 'n groeigroepervaring, wat bestaan uit 'n kombinasie van 'n t-groep (wheelan, 1990) en 'n ontmoetingsgroep (rogers, 1970). iniigting ten opsigte van die kenmerke van psigologiese optimaliteit en die stimuleringsproses ciaarvoor, is in die interpersoonlike doeltreffendheidsopleidingsprogram ingesluit. aanleer van die kerndimensies van sensitiewe verboudingvorming (empatie, respek, egtheid en konkreetbeid) soos gekonkretiseer deur 'n kombinasie van die menslike potensiaalontwikkelingsmodel van carkhuff (1987) en die mikroopleidingsmodel van ivey (1988) deur middel van interpersoonlike vaardigheidsopleiding (instruksie, gedragsmodellering en rolspel) en gestruktureerde oefeninge. wat die tydsverdeling van die kursus betret: is vier ure (30 minute per persoon) aan individuele groeistimulering bestee, 14 uur aan 'n groeigroep en 14,5 uur aan vaardigheidsopleiding. ondersoekgroep die ondersoekgroep is uit instrukteurs by die opleidingskollege van die sapo in hammansk:raal (n=42) gekies. 'n ewekansige steekproefvan 24 (12 per groep) is uit die totale populasie van instrukteurs by die opleidingskollege getrek. 'n klein groep is gebruik as gevolg van die intensiteit van die opleidingsmetodes wat gebruik is (rogers, 1974:14) en omdat dit prakties onmoontlik was om meer as 24 persone vir ses dae (opleiding en evaluering) uit die werksituasie te onttrek. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 3 382 die metingsbattery die meting van die intrapersoonlike kenmerke van psigologiese optimaliteit by instruk:teurs is met behulp van die persoonlike orientasievraelys (poi) (knapp, 1976; shostrom, 1976) gedoen. die betroubaarheid van die poi wissel tossen 0,41 (mensbeskouing) en 0,82 (ondersteuningsratio) (schulz, 1994). die poi beskik oor konstrukgeldigheid en onderskei duidelik tossen selfgeaktualiseerde en nie.selfgeaktualiseerde persone (leitschuh & rawlins, 1991; schulz, 1994; shostrom & knapp, 1966). volgens knapp (1976:187-202) kan die poi gebruik word om die effek van groeigroepe op selfaktualisering te bepaal. veral die ondersteuningsratio, spontaneiteit, eksistensialiteit, aanvaarding van aggressie, kapaslteit vir intieme kontak, selfaktualiseringswaarde en selfaanvaarding is vatbaar vir verandering as gevolg van groeigroepe. cilliers (1984) vind 'n beduidende positiewe verandering in elf van die twaalf skate van die poi na die aanbieding van 'n opleidingsprogram in sensitiewe relasievonning. cilliers (1988) bevind dat 'n selfontwikkelingsprogram die volgende kenmerke van psigologiese optimaliteit (soos gemeet deur die poi) by deelnemers verhoog: rea1iteitskontak, buigsaamheid in die toepassing van waardes, emosionele volwassenheid en 'n interne lokus van kontrole. die meting van interpersoonlike vaardigbede is met behulp van die carkhuffskale (carkhuff, 1967) gedoen. elke proefpersoon het 'n rolgesprek van tien minute met 'n klient gevoer. die onderhoud is op videoband opgeneem, waarna die vlakke van die kemdimensies van sensitiewe verhoudingvonning deur twee geregistreerde sielkundiges beoordeel is. interbeoordelaar-betroubaarheid was groter as 0,95 vir al vier die skate. statistiese verwerkings data is met behulp van die sas-pakket (sas institute, 1985) statisties verwerk. gepaarde t-toetse is gebruik om die beduidendheid van verskille tossen die gemiddeldes van vooren nameting by die eksperimentele en kontrolegroep te bepaal, en om te vas te stel of daar 'n beduidende verskil tossen die veranderinge in hierdie groepe was (christensen & stoup, 1991). resultate word as beduidend beskou indien die p-waardes kleiner as 0,05 is. die verkree p-waardes (tweekantige toets) is omgeskakel na 'n eenkantige toets (plug et al., 1988). 'n bonferroni-aanpassing (miller, 1981) is ten opsigte van hierdie p-waarde gemaak deur dit met twee te vermenigvuldig (aangesien daar twee stelle vergelykings was). indien die finale p-waarde statisties beduidend is (~ 0,05), word die praktiese betekenisvolheid van resultate (d) bepaal. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 383 sateb nr vol i (1998) nr 3 die praktiese betekenisvolheid (d) ten opsigte van die vergelyking van die eksperimentele en kontrolegroep word gegee deur (stat kons., 1990: i 0-1 0): waar x e = die rekenkundige gemiddelde van die verskil tussen die metings van die eksperimentele groep, xk = die rekenkundige gemiddelde van die verskil tussen die metings van die kontrolegroep, en smaks = die maksimwn-standaardafwyking tussen die eksperimentele en kontrolegroep. volgens cohen (1977:20-27) geld die volgende afsnypunte ten opsigte van praktiese betekenisvolheid: d ~ 0,2 klein eft'ek d ~ 0,5 mediwneft'ek d ~ 0,8 groot eft'ek resultate psigologiese optimaliteit die verskille tussen die vooren nameting van die eksperimentele en kontrolegroep ten opsigte van die poi word in tabel 1 uiteengesit: wat die psigologiese optimaliteit betref, blyk dit dat die opleidingsprogram daartoe bygedra het dat die eksperimentele groep se vlak van psigologiese optimaliteit (soos gemeet deur die poi) beduidend verhoog het betreft'ende die ondersteuningsratio en selfaanvaarding. lede van die eksperimentele groep was dus na afloop van die opleidingsprogram meer geneig om op 'n onathanklike en outonome wyse vanuit geinternaliseerde beginsels en motivering vir hulself te kan besluit hulle is ook meer geneig om hulself te aanvaar ten spyte van swakhede oftekortkominge r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 3 384 tabell: die venlul tossen die vooren nameting volgens die poi van die eksperimentele groep (eg) en kontrolegroep (kg) item eg kg gem. s.a. gem. s.a. tydratio (tc) 0.83 3.21 0.25 2.14 ondersteuningsratio (i) 3.50 4.29 -1.33 6.18 selfaktualiseringswaarde -0.58 2.23 0.33 2.31 (sav) eksistensialiteit (ex) -0.08 2.43 0.25 3.67 gevoelsrefleksie (fr) 1.33 2.15 0.25 1.86 spontaneiteit (s) 0.33 1.78 0.5 1.68 selfagting (sr) 0.00 1.04 8.33 1.44 selfaanvaarding (sa) 1.17 2.17 -1.5 2.24 mensbeskouing (nc) 0.33 2.19 0.25 2.8 sinergie(sy) -0.33 0.98 0.25 1.48 aanvaarding van aggressie 0.58 1~3 1.44 (a) kapasiteit vir intieme 0.92 25 2.87 kontak (c) • verskil is statisties beduidend: p :s; 0.05 # verskil is prakties betekenisvol: d ~ 0.50 (mediumeffek) + verskil is prakties betekenisvol: d ~ 0.80 (groot effek) p d 0.60 0.03· 0.78, 0.33 0.79 0.20 0.81 0.87 0.01· 1.19+ 0.93 0.26 0.13 0.26 die verskille tussen die vooi'en nameting van die eksperimentele en kontrolegroep ten opsigte van die carkhuffskale word in tabel 2 uiteengesit: tabel2: die venlu. tossen die vooren nameting ten opsigte van die carkhuff-skale van die eksperimentele groep (eg) en kontrolegroep (kg) item eg kg p d r.g. s.a. r.g. s.a. 1.63 0.23 0.19 0.01· 8.94+ 1.60 0.31 0.19 0.01· 8.21+ 1.72 0.33 0.18 0.01· 10.22+ re 1.91 0.28 0.19 0.01· 10.22+ • verskil is statisties beduidend: p:s; 0.05 + verskil is prakties betekenisvol: d ~ 0.80 (groot effek) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 385 sateb nr vol i (1998) nr 3 die eksperimentele groep het na afloop van die opleidingsprogram 'n beduidende hoar telling ten opsigte van die vier carkhuffskale behaal as met die voonneting. wat interpersoonlike doeltreffendheid betret: is daar gevind dat die opleidingsprogram tot interpersoonlike vaardighede bygedra het. die eksperimentele groep se empatie, egtheid, respek en konkreetheid het beduidend verbeter (in vergelyking met die kontrolegroep). wat empatie betret: is deelnemers in staat om akkurate begrip ten opsigte van die oppervlakgevoelens van kliente te toon, hoewel dieperliggende gevoelens soms nog wanvertolk word. ten opsigte van respek is deelnemers in staat om 'n positiewe agting en omgee vir die gevoelens, ervaringe en potensialiteite van kliente te openbaar. wat egtheidbetref, gee deelnemers gepaste response wat nie vals voorkom nie. ten opsigte van /wn/rreetheid is die deelnemers in staat tot spesifiekheid of feitlikheid ten opsigte van uitdrukking met betrekking tot persoonlike of doe1matige tersaak:like inligting, in teenstelling met vae of oorveralgemeende uitdrukkings. bespreking die opleidingsprogram is suksesvol in die verandering van interpersoonlike doeltreffendheid (psigologies optimale fimksionering en interpersoonlike vaardighede) direk na afloop daarvan. wat psigologiese optimaliteit betref, blyk dit dat die opleidingsprogram daartoe gelei het dat eksperimentele groep se aanvaarding van selfverantwoordelik:heid (interne lokus van evaluering) en selfaanvaarding beduidend veritoog het. hierdie bevinding stem ooreen met die van cilliers en wissing (1993) en cilliers (1995:96-103). die feit dat die ander skale van die poi nie beduidend verhoog het nie, ondersteun die bevindings van rothmann (1996:296). die outokratiese kultuur waarbinne die deelnemers werk asook weerstand teen gevoelsuitdrukking kan moontlik beperkend inwerk op hut psigologiese optimaliteit en derhalwe die oorsaak wees dat minder skale in vergelyking met cilliers (1994) 'n beduidende toename na afloop van die opleidingsprogram getoon bet. tweedens is daar gevind dat die opleidingsprogram interpersoonlike vaardighede (soos gemeet deur die carkhuffskale) verbeter bet. die eksperimentele groep se empatie, egtheid, respek en konkreetheid het beduidend verbeter. hierdie resuitate stem ooreen met die van cilliers (1994:96-103) en rothmann (1996:296). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 3 386 tenslo'ite interpersoonlike doeltreffendheid behoort neerslag te vind in die kurrikulum van opleidingsbeamptes by die sapd-opleidingskoliege aangesien daar bevind is dat die opleidingsprogram daartoe bydra dat die interpersoonlike doeltreffendheid verbeter. opleiding in interpersooniike doeltreffendheid van polisiebeamptes moet aangebied word om hulle toe te rus vir hul rol in die verandering na gemeenskapspolisiering. navorsing rakende die langtermynstimulering van psigologiese optimaliteit as voorvereiste vir interpersooniike doeltreffendheid binne die suid-afrikaanse polisiediens-opleidingskollege moet ondemeem word. die navorsers se subjektiewe indrukke tydens die groeigroep, individuele onderhoude en aanbieding van die program was dat outoriteit, onderdrukking van gevoelens, wantroue in senior range en onsekerheid gereeld na vore gekom het. in aansluiting by rothmann en sieberhagen (1997) kan gestel word dat die organisasie se gedrag en die interpersoonlike doeltreffendheid van sy opleiers in die toekorns moontlik vanuit 'n psigodinamiese benadering (byvoorbeeld die tavistock-benadering) (cilliers & koortzen, 1996) nagevors en gestimuleer word verwysings l. allport, g.w. 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(1990). facilitating training groups: a guide to leadership and verbal intervention skills. new york: praeger. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction research questions literature review research design empirical results and discussion limitations of this study and areas for further research conclusion acknowledgements references about the author(s) mark h.r. bussin gordon institute of business science, university of pretoria, south africa marvin ncube gordon institute of business science, university of pretoria, south africa citation bussin, m.h.r. & ncube, m., 2017, ‘chief executive officer and chief financial officer compensation relationship to company performance in state-owned entities’, south african journal of economic and management sciences 20(1), a1644. https://doi.org/10.4102/sajems.v20i1.1644 original research chief executive officer and chief financial officer compensation relationship to company performance in state-owned entities mark h.r. bussin, marvin ncube received: 06 aug. 2016; accepted: 14 july 2017; published: 30 oct. 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: optimal contracting continues to dominate boardroom and dinner discussions worldwide in light of the 2008 global financial crisis and especially in south africa, due to the growing income gap. increased scrutiny is being placed on south african state-owned entities (soes), as a result of the seemingly poor performance of soes. some of the soes are reported to have received financial bailouts from taxpayers’ money, while executives are raking in millions of rands in remuneration, provoking some concerns on the alignment of executive pay to company performance in soes. aim: the study will assist remuneration committees and policymakers in the structuring of executive pay in soes to ensure alignment to company performance. setting: the study sought to assess, based on empirical evidence, if there is a positive relationship between chief executive officer (ceo) and chief financial officer (cfo) remuneration and company performance in south african soes in the period between 2010 and 2014. all 21 schedule 2 soes were included in the study. methods: the research was a quantitative archival research methodology. correlation and multiple regression analysis were the main statistical techniques used in this study. results: contrary to popular media, a positive relationship between ceo and cfo remuneration (fixed pay and short-term incentives) and company performance in soes was observed. company size appears to be the key determiner of fixed pay in soes. the positive relationship was mainly noted on absolute profitability measurements like ebitda (earnings before interest and tax and depreciation and amortisation) and net profit. conclusion: soe remuneration committees and policymakers should maintain the positive relationship; however, more emphasis should be placed on financial efficiency measurements so as to enhance efficiencies in soes. introduction the executive remuneration of south african state-owned entities (soes) has come under increasing scrutiny because of their perceived poor performance and as a result of being in a country with one of the worst economic inequalities in the world (naidoo 2012). the increasing income gap in south africa between rich and poor split along racial lines has resulted in numerous questions being raised about the seemingly excessive top management remuneration. naidoo (2012) cites a 2012 price waterhouse coopers report stating that executive directors of large-capital companies earn on average r10m/year (r4m/year guaranteed package, r2m performance bonus and r4m in share plan benefits). in contrast, sa’s lowest-paid workers earn around r3500 per month or r42 000 per year. this equates to a pay gap of 250–300 times. it is no different in soes. the average pay gap ratio between eskom’s top management and workers is 93:9 (naidoo 2012). globally, the executive remuneration debate has intensified following the 2008 global financial crisis as bankers were seen to have given themselves excessive remuneration, despite the poor performance of the institutions (choe, tian & yin 2014). equally, soes have not been immune to this debate. for example, the spanish government in 2012 announced that it was cutting executive pay by up to 35% for companies supported by taxpayers’ money in order for the executives to share in the pain of austerity measures (tremlett 2012). furthermore, the chinese government announced it would be cutting the salaries of the top executives in banks and soes in order to reduce inequality (wright 2015). the state-owned assets supervision commission of china recently called for all soe salaries to be strictly linked to business performance, it emphasised that salary increases should be in line with the increases in company profits (juan 2015). some authors have questioned whether the exponential growth in executive compensation in the past two decades is consistent with shareholder interests (bebchuk & fried 2004; jensen & murphy 1990). chief executive officer (ceo) compensation is crucial in mitigating the potential conflict of interest between executives and shareholders, as it is used as an instrument of aligning shareholders’ and executives’ interests (ozkan 2011). prior studies by murphy (1999); core, guay and larcker (2003); jensen, murphy and wruck (2004) and devers et al. (2007) conducted on mostly listed companies, have not been consistent on the impact of executive compensation on company performance. the studies have raised doubt on the ability of executive compensation to align with shareholder and executive interests. the debates on executive compensation have essentially been split into two seemingly competing views. the first view contends that executive compensation is a result of efficient bargaining between executives and shareholders to mitigate the agency–principal problem, commonly referred to as the optimal contracting approach. the competing view contends that executive compensation is a result of ‘greedy’ powerful executives who essentially extract rents from companies and thus set their own pay, commonly referred to as the managerial power approach. these seemingly contrasting views have resulted in the ongoing debate on whether executive pay is linked to organisational performance, in line with the optimal contracting approach. the concept of pay for performance has largely been led by jensen and murphy (1990). in south africa, there is growing discontent regarding executive compensation in soes, in light of the seemingly poor performance by the soes. some of the soes, like the south african broadcasting corporation limited (sabc) and south african airways (pty) limited (saa), have been reported in the media to be receiving or have received government bailouts, yet the company executives are said to be raking in millions in salaries and bonuses (business tech 2014). most of the literature reviewed has focused primarily on the relationship between executive pay and company performance in listed companies. academic literature relating to pay for performance relationships in soes is scarce. most of the executive pay studies in soes have been done on listed chinese soes and these studies have generally been inconclusive. it is therefore crucial to understand how south african soes set compensation packages and how they are linked to company performance, considering the critical developmental role that these organisations play in the economy and the importance of these entities to remain sustainable. research questions based on popular media reports and current debates between policymakers and academics, there appears to be a disconnection between executive remuneration and soe performance. the aim of this study is to contribute to the literature relating to executive pay for performance in soes, especially unlisted soes in developing countries, where policymakers, academics and the general public have been debating the link between ceo pay to company performance. the following are the research questions: research question one is there a positive relationship between ceo and chief financial officer (cfo) fixed pay and company performance over the period 2010–2014 in south african schedule 2 soes? research question two is there a positive relationship between ceo and cfo short-term incentive payout and company performance over the period 2010–2014 in south african schedule 2 soes? research question three which individual company performance measure is the best predictor of the ceo and cfo fixed pay component of compensation over the period 2010–2014 in south african schedule 2 soes? research question four which individual company performance measure is the best predictor of the ceo and cfo short-term incentive component of compensation over the period 2010–2014 in south african schedule 2 soes? literature review chief executive officer and chief financial officer responsibilities according to shaw (2012), the ceo’s main responsibility is to manage company resources within the context of a dynamic external environment in order to create value for the shareholders. friedman (2014) states that the cfo’s responsibility is to oversee and manage information and reporting systems. the author also notes that, while the cfo has a fiduciary duty to the shareholders and the board, he also reports to the ceo. the sox act requires that the cfo and ceo certify the financial reports of companies listed in united states. in south africa, the companies act of 2008, which came into effect on the 1 may 2011 requires that both the ceo and cfo certify the financial statements (republic of south africa 2011). moreover, the ceo and cfo are the two executives who are generally the members of the company board in south african soes. this fact elevates the power and importance of cfos beyond that of other executives. according to hambrick and quigley (2014), executives play a critical role in a company as they substantially shape the fate of companies. the ceo and cfo can be viewed as shareholder agents; thus, their primary role is to protect and grow shareholder value. company performance measurement bussin (2015) notes that there are three different measurements of company performance, that is, absolute financial performance measures (verified measures of performance within a specific year), financial performance ratios derived from absolute financial performance measures and market performance measures, assessed through the share price performance of the company. various agency theorists argue that multiple performance measurements can be used by principals in an optimal contract, for the principals to be able to fully understand the effort put in by the agent in achieving shareholder value. conyon and he (2014) posit that once principals have a full understanding of the performance measurements that best reflect the agent’s effort, more sensible and precise measures can be consistently used in the optimal contract as an indication of the agent’s effort. goergen and renneboog (2011) and bussin (2015) argue that accounting-based performance measurements measure past performance and are subject to manipulation and thus might not be appropriate in determining executive past performance as rent-seeking ceos are prone to manipulating the accounting measurements in order to achieve higher bonuses, evidenced by accounting scandals at enron and worldcom. according to goergen and renneboog (2011) and wang and xiao (2011), the most common accounting measures used to assess company performance are revenue, operating income or profit and earnings per share (eps). however, based on literature reviewed, there appears to be no consensus on measuring company performance as various authors have used various measures of absolute financial performance to assess company performance in the pay to performance studies. shaw (2012) used profit after tax, earnings before interest and tax and depreciation and amortisation (ebitda), return on equity (roe) and headline earnings per share (heps) in order to assess company performance, while bussin and nel (2013) used roe, asset turnover, profit margin and leverage in order to assess company performance. van blerck (2013) used economic value added (eva), share price performance and roe. theku (2014) used roe, return on assets (roa), asset turnover, revenue, heps, change in share price and market capitalisation as measurements of company performance. bussin and modau (2015) used market value added, eva, roe and eps. state-owned entities there is no comprehensive legislative definition of national or provincial soes in the south african statues (bronstein & olivier 2015). the starting point for defining national or provincial soes is the pfma act 1 of 1999, which lists public entities in schedules 2 and 3. major public entities like eskom, transnet and telkom are listed in schedule 2. according to ‘introduction’ section of the pfma act 1 of 1999, national public entities are defined as government business enterprises or an entity that is substantially funded from tax revenues or levies or other statutory funds. thus, government business enterprises are more self-sufficient and commercial than the remainder of the ordinary entities. most of the entities that are substantially funded from tax revenues are classified under schedule 3 entities, while major government business enterprises are classified as schedule 2 enterprises. most of the schedule 2 soes have come under scrutiny in recent years in the media because of the seemingly excessive executive salaries in spite of the poor performance of the soes. according to thomas (2012), soes primarily drive a developmental agenda in developing countries through the provision of basic services such as water and electricity, and thus profit maximisation is not their main goal. however, thomas (2012) notes that the funding model prevalent at most of the major soes is generally profit driven, which is at odds with the provision of basic resources at the lowest cost possible to the populace. it is this conflict between social objective versus the profit motive that raises debates on executive remuneration in soes, that is, whether the executive compensation should be based on company performance measured through accounting measurements or the company achieving its social objectives. however, it is apparent that for the soes to remain financially sustainable, a closer alignment of pay for performance is necessary. pay for performance relationship agency theory suggests that a high pay–performance relationship motivates top executives to enhance their input and improve corporate performance (amzaleg et al. 2014). numerous studies relating to the relationship between ceo pay and company performance have been done in south africa. a study by shaw (2012) on executive pay to performance relationship in the south african financial industry over a 6-year period (2005–2010) noted a moderate to strong relationship between ceo remuneration and company performance. however, the study noted that the moderate to strong relationship noted was in decline during periods of economic downturn, and thus, ceos tended to use managerial power in uncertain economic periods to draw high pay than for their pay to be in accordance with the company performance. moreover, shaw (2012) observed a shift from variable pay to fixed pay in the remuneration structure of ceos as a result of the declining company performance. the restructuring of the ceo remuneration results in a lower pay to performance relationship as most of the variable pay is linked to company performance. in a study by bussin and nel (2015) on the pay to performance sensitivity in the south african retail and consumer goods industry over a 6-year period (2006–2011), the authors observed a weak relationship between ceo pay and company performance, based on du pont analysis measurements. a negative relationship was noted between ceo guaranteed pay versus roe. thus, bussin and nel (2015) note that there is no alignment between ceo compensation and company performance in this industry. a study by van blerck (2013) supported the findings by shaw (2012) as van blerck (2013) noted in the study of the relationship between executive remuneration and company performance based on eva over a 10-year period (2002–2011) that, unlike united states, south african banks showed a strong positive relationship between executive pay and company performance and this could serve to explain why south african banks survived the 2008 financial crisis. theku (2014) also supported the findings by shaw (2012), van blerck (2013) in the study of 30 south african mining companies listed on the johannesburg stock exchange (jse) over a period of 5 years (2009–2013). in the study, the author noted that in most of the mining companies there was a moderate to strong relationship between ceo remuneration and company performance. furthermore, bussin and modau (2015) supported the observations by shaw (2012), van blerck (2013) and theku (2014), in the study of executive remuneration relationship to company performance in 26 firms listed on the jse over a 7-year period (2006–2012). in the study, bussin and modau (2015) noted that there was a positive relationship between ceo pay and company performance based on roe. however, similar to observations by shaw (2012), bussin and modau (2015) observed that during periods of economic uncertainty, such as after the 2008 financial crisis, there has been a restructuring of ceo remuneration among firms. post 2008, most of the variable pay linked to company performance has been restructured to be fixed, thus resulting in a declining correlation between ceo pay and company performance. approaches and theories corporate governance corporate governance is defined as a collection of rules and policies, which affect how a company is controlled or monitored (donaldson 2012). corporate governance serves to ensure that executives are working mainly for the benefit of shareholders by trying to increase the economic value of the firm (chalevas 2011). conyon and he (2011) also support the above view, as they note that, according to various studies by hölmstrom (1979), holmstrom and milgrom (1991) and core and guay (1999), agency theory predicts that incentive remuneration and monitoring are substitute mechanisms that together mitigate agency problems. conyon and he (2011) note in their study that the relationship between executive pay and firm performance is driven by the strength of internal corporate governance mechanisms, mainly being the monitoring by shareholders and boards of directors. in addition, dicks (2012) notes in his study that governance mitigates agency costs, by allowing firms to reduce incentive compensation and thus pay executives in line with company performance, limiting rent extraction by powerful ceos. in south africa, according to the institute of directors southern africa (2017), the code that drives governance of executive compensation is king iv. according to bussin (2015), a critical requirement by the code is the requirement that ceo remuneration be linked to company performance. even though the code is not legally enforceable as it is a code of practice, it appears to have a significant impact on how south african companies, including soes, set their executive remuneration (bussin 2015). the code also recommends that every company should ideally have a minimum of two executive directors as part of its board of directors, being the ceo and cfo. composition of chief executive officer compensation according to goergen and renneboog (2011), the amount and composition of the compensation package is important for motivating and aligning executives with shareholders’ interests. compensation packages normally consist of the following: base salary, pension, insurance, bonus, severance package and long-term benefits like shares or share options (goergen & renneboog 2011). goergen and renneboog (2011) posit that the following is considered with regards to the following compensation components: base salary – in setting the base salary, the authors note that the compensation committee takes into account some of the factors such as the experience, seniority and firm size of the company. according to bussin (2015), base salary is viewed as a risk-free monthly payment as this is normally not linked to company performance. in addition, bussin (2011) notes that the base salary includes allowances such as travelling, entertainment and telephone and it also includes company benefits, such as pension and the guaranteed annual bonuses, commonly referred in south africa as the 13th cheque. bonus – this represents the annual bonus that is mainly based on the company performance of the previous financial year. based on previous studies, company performance is mainly based on financial performance (accounting and market). the bonus is normally referred to as a short-term incentive as this is based on annual performance. long-term benefits – this normally includes share options, shares and long-term bonuses, which are based on company performance over more than a year. severance and retirement package – companies award this to executives, so as to encourage shareholder wealth maximisation without any job loss concerns by the executives. among the major south african soes, only telkom is listed, thus most of the executive remuneration in soes exclude the long-term benefits, such as shares and share options. research design a quantitative deductive research methodology was used in this study. the study was longitudinal, covering the period 2010–2014 financial years and followed an archival research strategy. the financial data used were obtained from published financial statements of the soes. all the soes have a common financial year-end that is 31st of march. thus, no adjustments had to be done to the financial information to ensure comparability and analysis. the quantitative deductive research methodology approach enables the testing of the relationship between ceo and cfo remuneration with company performance. population and sample this study focused on entities listed in schedule 2 of the pfma act as these entities are more commercially oriented and thus have a profit objective. the executive compensation of schedule 2 soes is expected to be aligned to company financial performance. the list shown in table 1 is a list of the schedule 2 entities. all the entities, including the subsidiary companies are included in the study. table 1: list of schedule 2 entities. unit of analysis the ceo and cfo total remuneration includes the fixed and variable portion of remuneration. bussin (2011) notes that fixed pay includes basic salary and employee benefits, for example, all allowances, guaranteed annual bonuses (13th cheque) and car and housing benefits and employer contributions, while variable pay includes short-term incentives such as performance bonuses. fewer than five companies were noted to be paying long-term bonuses; thus, long-term bonuses were excluded for the purposes of this study. company performance according to theku (2014), two key performance measures are commonly used to assess company performance. these are market-related performance measurements, for example, change in share price and accounting-related performance measurements, and for example, change in net profits. because soes are not listed companies, only accounting measures of performance can be used to assess the company performance. the company information that was used to assess company performance, measured through 10 accounting performance metrics based on prior pay for performance relationship studies, was roe, roa, liquidity, revenue growth, ebitda margin, net profit margin, revenue amount, ebitda amount, net profit amount and total assets. data collection and analysis the source of the data used in this study was the published annual reports of the schedule 2 soes. once the financial statements were obtained, the company financial information as stated above, that is, the remuneration of the ceo and cfo and the relevant financial performance information, was captured onto an excel spreadsheet. some of the descriptive statistics were done using excel functionalities and the rest of the descriptive statistics, for example, calculating mean, minimum and maximum were done using the statistical package for social sciences (spss 2012) software package. in addition, spss (2012) was also used to perform correlation statistical analysis in order to test the strength of the relationship between remuneration and company performance measured as per the accounting measures mentioned above for the ceo and cfo. because of the statistical analysis required to be performed on the data, the data were tested for normal distribution using the shapiro–wilks test as the sample size was small. based on the shapiro–wilks test, the data were observed not to be normally distributed. as a result, non-parametric testing was performed to test for differences between the financial years for all the variables (company performance measures and remuneration components). according to pallant (2013), the kruskal–wallis test allows comparison of scores on a continuous variable for three or more groups. the kruskal–wallis test was performed to test for differences between the financial years. following the test for normality and the comparison test, the data were observed to be positively auto-correlated and thus in order to test which company performance measurement is the best predictor of the ceo and cfo fixed pay and short-term incentive, a multiple regression analysis using the cochrane–orcutt estimation method was performed. empirical results and discussion descriptive statistics the study included all the soes listed as schedule 2 entities. there are 21 schedule 2 entities. because of the small number of schedule 2 entities, all schedule 2 entities were included in the sample. only schedule 2 entities were included in the sample as these are the major soes and these soes are expected to be self-sustainable, thus remuneration is expected to be linked to company performance. of the 21 soes, only 4 soes had no change in ceo over the study period (2010–2014) and only 6 soes had no change in cfo over the study period (2010–2014). thus, the bulk of the soes had more than one ceo or cfo over the study period. in a case where a ceo or cfo was in the position for few months of the financial year, the few months fixed pay was extrapolated for 12 months. no extrapolation was, however, done on short-term incentives as this was expected to be aligned to company performance. the total number of cases included in the study was 104, being 21 soes over a period of 5 years (2010–2014). at the time of the study, sa express had not published the 2014 financial year results, thus only 2010–2013 results for sa express were included in the study. table 2 shows a summary of the descriptive statistics relating to the sample included in the study. table 2: descriptive statistics. as shown in table 2, they were six missing data points relating to cfo fixed pay and cfo sti relating to two soes (alexkor (soc) limited and cef (soc) limited). the information relating to the above two soes was not disclosed in the relevant financial years and, as a result, was excluded from this study. each variable in table 2 is discussed below under the company performance measures and remuneration measures. research question 1 this research question sought to assess if there is a positive relationship between fixed pay for the ceo, cfo and company performance measures. the positive relationship between fixed pay and company performance was tested using spss (2012) correlation analysis. it was observed in the correlation analysis results that with the exception of the roa measure, the company performance measures that had a relationship with ceo fixed pay and cfo fixed pay were similar. thus, ceo and cfo fixed pay determination appears to be based on similar company performance measures. the following is a discussion of the relationship of each company measures to the fixed pay of the ceo and cfo based on the correlation analysis results presented in tables 3 and 4. table 3: correlation analysis – ceo fixed pay and company performance variables. table 4: correlation analysis – cfo fixed pay and company performance variables. chief executive officer fixed pay it was observed that 7 out of the 10 performance measures showed a statistically significant relationship with ceo fixed pay. among the seven performance measures that displayed a statistically significant relationship with ceo fixed pay, three had a strong positive relationship with ceo fixed pay, which includes revenue, ebitda and total assets. three displayed a weak relationship between ceo fixed pay and company performance (liquidity ratio, roa and ebitda margin), while net profit showed a moderate to strong relationship with fixed pay. the company performance measures that displayed a moderate or strong relationship with fixed pay are closely related to the company profitability measurements (ebitda and net profit) and size of the company measurements (revenue and total assets); thus, it appears that ceo fixed pay in soes has a positive relationship with company performance, mainly being profitability measurements. in addition, it was observed that ceo fixed pay has a strong positive relationship with company size. chief financial officer fixed pay six out of the 10 performance measures showed a statistically significant relationship between cfo fixed pay and the company performance measures. revenue and ebitda showed a strong relationship with cfo fixed pay. net profit and total assets showed a moderate to strong positive relationship with cfo fixed pay. ebitda margin showed a weak positive relationship, similar to what was observed for the ceo fixed pay. however, it was observed that there was a weak to moderate negative relationship with the liquidity ratio. this was not expected, however, because of the fact that the relationship was noted to be weak, and no further investigation was conducted. similar to the ceo fixed pay relationship with the company performance measures, most of the company performance measurements with a moderate or strong positive relationship were related to company profitability and company size; thus, it can be reasonably assumed that cfo fixed pay in soes has a positive relationship with company performance, mainly being company profitability measurements and a strong positive relationship with company size. the strong positive relationship observed between ceo and cfo fixed pay and company size is in line with studies by tosi et al. (2000), gabaix, landier and sauvagnat (2014), yusuf and abubakar (2014) and theku (2014). research question 2 this research question seeks to understand if there is a positive relationship between short-term incentive payout for ceo, cfo and company performance measures. a correlation analysis was performed between the short-term incentive payout and each of the company performance measures. similar to the observations made in research question 1, it was noted that the ceo and cfo had similar statistically significant company performance measures that had an impact on their short-term incentive amount, and inversely, company performance that did not have any statistically significant impact on short-term incentive. the results of research question 2 are summarised in table 5. table 5: chief executive officer (ceo) and chief financial officer (cfo) short-term incentive relationship with company performance. as per table 5, it was observed that 4 of the 10 company performance measures that were tested for correlation with ceo and cfo short-term incentive payout had a statistically significant relationship. of the four company performance measures, only ebitda had a moderate relationship with a short-term incentive payout for the ceo. the rest of the measures, that is revenue, net profit and total assets had a weak positive relationship for the ceo. the weak positive relationship for company size measurements that is revenue and total assets indicates that company size does not appear to be a key consideration for the purposes of determining ceo short-term incentives. with regard to the cfo, three of the 10 company performance measurements had a moderate relationship with cfo short-term incentive payout, that is, revenue, ebitda and total assets, while net profit had a weak relationship. of the three company performance measurement with a moderate relationship, it was observed that ebitda had the strongest correlation. thus, it appears that company size does not appear to be a key consideration with regards to short-term incentives. based on the correlation analysis results, it appears that there is positive relationship between ceo and cfo short-term incentives and company performance measure, mainly being the absolute company profitability measurement (ebitda). this finding is line with the findings by firth, fung and rui, (2006) and conyon and he (2011), who observed a positive relationship between ceo pay and company performance in state-controlled companies in china, even though the relationship was weaker than privately controlled companies. the moderate positive relationship between company ebitda and ceo and cfo short-term incentives might be an indication that other factors other than the financial performance of the company have an influence on the ceo and cfo short-term incentive payout. this could be an indication that ceos and cfos use managerial power in determining the short-term incentives as envisaged by bebchuk and fried (2004). moreover, this might be explained by the dichotomy of objectives as indicated by thomas (2012) that soes drive a developmental agenda, yet their funding model is profit driven; thus, ceos and cfos performance rating for the purposes of short-term incentives might be more biased towards social development key performance indicators (kpis) than financial performance kpis. research question 3 this research question seeks to understand which company performance measure is the best predictor of ceo and cfo fixed pay. a standard multiple regression analysis was performed. however, prior to performing the regression analysis, a multicollinearity test relating to the independent company performance measures that have a correlation was performed. this test is performed to ensure that independent variables that display a high correlation are removed from the regression analysis. based on the latter, with regards to ceo and cfo fixed pay, total assets and ebitda company performance measures were removed from the regression analysis model. total assets and ebitda had the highest correlation as evidenced by the multicollinearity test results in (ceo fixed pay) and (cfo fixed pay). revenue was observed to have a low correlation with the rest of the company performance measures after removing total assets and ebitda, evidenced by the multicollinearity test results. furthermore, because of the positive auto-correlation that was observed, the cochrane–orcutt estimation method was used to perform the regression model analysis. the results for the ceo and cfo fixed pay are discussed below separately. to determine which individual company performance measure is the best predictor of fixed pay for the ceo and cfo in soes, a regression analysis using the cochrane–orcutt estimation method was performed. the results for both the ceo and cfo indicate that revenue, which is a proxy for company size, is the best predictor of the fixed pay for the ceo and cfo. this finding thus supports similar studies by tosi et al. (2000), gabaix, landier and sauvagnat (2014), yusuf and abubakar (2014), theku (2014) and bussin and nel (2015), who indicated in their studies that firm size was the key determiner of ceo pay. research question 4 this research question sought to observe which individual company performance measure is the best predictor of ceo and cfo short-term incentive payout in soes. similar to research question 3, a standard multiple regression analysis was performed. prior to performing the multiple regression analysis, multicollinearity tests were performed. the multicollinearity tests were performed as the inputs to the multiple regression analysis. in testing which performance measures had a high correlation, that is, through the multicollinearity test, total assets were observed to have a high correlation with the other company performance measures and thus was excluded for both the ceo and cfo short-term incentive test. as a result of the positive auto-correlation that was noted, based on the durbin–watson score that was observed, the cochrane–orcutt estimation method was used to perform the regression model analysis. the following is a discussion of the results for the ceo and cfo short-term incentive regression analysis. the regression analysis based on the cochrane–orcutt estimation method shows that ebitda is the best predictor for both the ceo and cfo short-term incentive payout. this finding is contrary to the sentiments expressed in popular media that executive remuneration in soes is not linked to company performance. however, the extent of influence of ebitda on short-term incentive for the ceo and cfo appears to be small, evidenced by the r2 result of 17.3% for the ceo and 12.3% for the cfo. the r2 result shown in table 6 (ceo short-term incentive) and table 7 (cfo short-term incentive) is an indication of the variation in the short-term incentive payout that is explained by changes in revenue, ebitda, net profit and the constant. ebitda is the most significant predictor of the short-term incentive payout as a result of having the highest standardised co-efficient beta for both the ceo and cfo short-term incentive payout. table 6: model fit summary – chief executive officer short-term incentive regression. table 7: model fit summary – chief financial officer short-term incentive regression. limitations of this study and areas for further research as a result of time and the nature of the study, the following limitations were noted: the study does not show a causal relationship between ceo and cfo remuneration and company performance; thus, no additional information about the casual factors influencing ceo and cfo remuneration and company performance has been provided as the study only describes the relationship between ceo and cfo and company performance, measured through accounting measurements. the study is limited to schedule 2 entities, and thus, the findings from the research may not be applicable for other non–schedule 2 soes or soes in other countries because of other dynamics coming into play, for example, culture and the business environment in which the soe operates. the study focused on accounting company performance measures and thus other critical performance measures, for example, achieving of shareholders compact was considered outside the scope of this study. the meeting of the shareholders compact might be a good indicator of company performance for south african soes because the mandate of soes is different from listed or privately held companies. furthermore, as a result of the high ceo and cfo turnover noted in the soes, the impact of the high turnover on the financial performance of the soe can be considered for future research. while the appointment of south african soes ceo and cfo is made by the board, the decision requires to be ratified by the minister of the responsible government department and south african executive cabinet. the latter opens up space for political appointments. further studies could consider comparing the performance of south african soes with highly connected executives or board members to soes with low political connections. moreover, further studies could be done to assess what effect the political connections have on the pay to performance relationship. conclusion executive remuneration remains a hot topic, especially in the south african context where the income gap continues to increase. thus, it is important that the policy makers ensure that an appropriate balance is achieved between executive pay and company performance in order to ensure that executives are appropriately rewarded to achieve company objectives, while ensuring that soe employees or customers are not alienated in the process as a result of the rising income gap. contrary to popular media reports, it appears that the fixed pay and short-term incentives of ceos and cfos have a positive relationship with company performance. however, the positive relationship was mainly observed on absolute profitability measurements, like ebitda and net profit. company size appears to be a key consideration in the determination of ceo and cfo fixed pay. more emphasis needs to be placed on efficiency-related company performance measures, to ensure that the soe executives continue to drive efficiencies in their operations and in so doing secure the financial sustainability of the soe and reduce reliance on market dominance as the competitive advantage. moreover, it is important that remuneration committees of the soes reconsider the balance of financial performance measures versus non-financial performance measures in the determination of the ceo and cfo short-term incentive payout as evidenced by the moderate positive relationship and the low level of influence ebitda seems to have on the short-term incentive payout, in order to ensure that the financial sustainability of the soes remains a top priority for the executives. this will reduce the reliance of some of the soes on south african taxpayers as some of the soes have been reported to having received financial bailouts from the south african government in the past financial years. lastly, it is important that soes remuneration committees continue to manage fixed pay for soe executives to ensure that company size is not used as the main reason for high fixed pay, by rent-seeking executives. however, at the same time, in order to attract the appropriate talent at these soes, it is important that short-term incentives take into account company size. acknowledgements competing interests the authors declare that they have no financial or personal relationship(s) which may have inappropriately influenced them in writing this article. authors’ contributions the study was conducted by m.n. 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abstract introduction literature review case sites: ivory park and tembisa research methods and analysis results conclusion: potential for growth? acknowledgements references footnotes about the author(s) andrew charman sustainable livelihoods foundation, cape town, south africa citation charman, a., 2017, ‘micro-enterprise predicament in township economic development: evidence from ivory park and tembisa’, south african journal of economic and management sciences 20(1), a1617. https://doi.org/10.4102/sajems.v20i1.1617 original research micro-enterprise predicament in township economic development: evidence from ivory park and tembisa andrew charman received: 07 june 2016; accepted: 27 oct. 2016; published: 18 may 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: in south africa, the idea that the township economy needs to be ‘revitalised’ has begun to gain significant political traction. the gauteng provincial government has responded to this challenge by setting out a strategy that promises to channel resources and create opportunities for micro-enterprises. the paper responds to development interventions such as this through interrogating the nature of the challenges facing micro-enterprises that need to be overcome in south african townships. aim: in response to the developmental need to stimulate micro-enterprise growth in south african townships, the paper poses the question: what approaches are most likely to have a positive impact on township businesses, given current micro-enterprise dynamics? setting: primary research was undertaken in two neighbouring townships in gauteng province, in ivory park and tembisa. methods: the data comprises a geospatial census of enterprise activities, a survey of select firms and qualitative interviews with business owners. the research utilised a small-area census approach to obtain data on business activities within an area of approximately 2km2 in each site. the census enumerated 2509 micro-enterprises in ivory park and 1722 micro-enterprises in tembisa. firm interviews were conducted with business owners in four sectors: grocery retail, liquor retail, hair care and early childhood development centres. results: the business census identifies a strong similarity in the structure of the townships’ informal micro-entrepreneurship despite the considerable differences in the socio-economic status of the respective case sites. the enterprise survey highlights the resource constraints of township businesses and thinness of local markets. interviews with entrepreneurs reveal four main pathways through which individuals enter into self-employment with the most dynamic enterprises established by inward investing entrepreneurs. spatial considerations exert an influence on the position of enterprise sectors, whilst access to land and business infrastructure are notable constraints. conclusion: reflecting on the evidence, the paper concludes with making a call for a more low-geared development approach, focusing on lessening the legal, institutional and regulatory obstacles to enterprise growth as a first step. municipalities have an important role in liberalising the spaces and places where township informal enterprises can and should be permitted to trade as well as creating a more favourable business environment. the challenges of crime and finance demand more purposeful action from the national government. introduction in south africa, the idea that the township economy needs to be ‘revitalised’ has begun to gain significant political traction. for a while it had seemed as though the informal economy1 and micro-enterprises2 had fallen off the developmental radar, with the national development plan (ndp) focusing on job creation in the formal economy. fourie (2015:14) argues that the ndp provides inadequate attention to the ‘unique obstacles faced by micro-enterprises in the margins of the economy’. that current policy blind spot is not only specific to south africa but is also noted in low-income sub-saharan african development strategies in general, where informal micro-enterprises have much potential for job creation (fox & sohnese 2012; ligthelm 2006; mead & liedholm 1988). whereas the national government may have an ambivalent approach to the informal economy and micro-enterprises, the gauteng provincial government has positioned itself squarely in support of reviving the economic margins. its objectives in this respect are set out in a strategy document ‘revitalisation of the township economy’ (2015). the strategy details a plan of action through which the government seeks to channel resources and create opportunities to foster an inclusive economy based on the promotion of manufacturing, support for cooperatives, and the growth of opportunities in retail and financial services. but what precisely are the challenges for micro-enterprises that need to be overcome in south african townships? this paper seeks to encourage reflection on the kinds of enterprise development interventions that might be possible, or indeed feasible, in urban townships. to explore such possibilities and practicalities, the aim is to examine actual informal micro-enterprise activities, their scope and scale, and the reported challenges of doing business in two specific township contexts in gauteng, namely in the settlements of ivory park and tembisa. the paper seeks to address questions about what business activities occur, where people conduct business, how entrepreneurs enter into the township informal economy, what challenges they face and how they respond to these issues. the emphasis in this paper is on the geographical context of the township, rather than on the size of the businesses operating therein – although most of the businesses in this study are ‘micro’ in size vis-à-vis assets and employment criteria – or the position of the enterprise relative to institutional processes of regulation. our perspective includes micro-enterprises that are partially or fully legal and those that are illegal, and engaged in both licit and illicit activities. literature review there is a wide literature on informal micro-enterprises, and considerable research has focused on the south african context. macro studies, drawing on nationally and regionally representative data sets, such as the statistics south africa quarterly labour force survey (qlfs), or independent surveys such as the one undertaken by the finmark trust (finscope 2010), provide a generalised indication of the sectors in which the self-employed participate and some indication of informal micro-enterprise dynamics. the literature raises two main concerns. first is a concern that the level of participation in micro-enterprise activities (including informal employment) is low, in relative and absolute terms (wills 2009; yu 2012). the developmental implication is that unemployed persons are reluctant or unable to pursue self-employed businesses. in seeking to understand motivational factors, research has examined sociocultural considerations such as perceived barriers towards self-employment amongst the unemployed (cichello et al. 2011). the cichello study identified crime, the high costs of capital, transport costs, fear of failure and jealousy as obstacles that hinder a more widespread embracing of self-employment. the second concern is that the structure of the township economy is dominated by small-scale trade in food and/or consumables, serving ‘thin’ localised markets with ‘weak effective demand’ (mahajan 2014), whilst the retail sector in general has come under increasing competition from supermarkets and large retailers, thus reducing opportunities (charman, petersen & piper 2012; ligthelm 2008; piper & yu 2016). the finscope survey (2010), which prides itself on being the ‘first study being able to provide a credible sense of the size and dynamics of the south african small business sector’ (2010:7), found that 78.7% of small businesses are retail oriented (21.3% service-oriented), though in gauteng province service businesses increased proportionally to 34%. sector-specific studies, using qualitative and/or quantitative methods, have sought to examine entrepreneurial and firm dynamics (including resource allocation) and motivational considerations amongst township entrepreneurs. these include writings on grocery retail outlets (spaza shops) (ligthelm 2005; charman & piper 2013), liquor retailers (charman, herrick & petersen 2014; rogerson & beavon 1982), traditional healers (petersen et al. 2014) and township tourism enterprises (nemasetoni & rogerson 2005) to list four examples. research on street traders, in contrast, has predominately investigated urban inner-city informal markets and central business district localities (see benit-gbaffou 2015; skinner 2008). sector studies permit a more nuanced understanding of entrepreneurship. for example, writers have highlighted the considerable differences between large (more sustainable and entrepreneurial) and small (though nevertheless resilient) enterprises. the concern with differentiated enterprise size has helped bring about the idea of ‘survival’ or ‘survivalist’ businesses: micro-enterprises that are not deemed to derive from entrepreneurial motivation (for one of the original uses of the survival concept, see mead & liedholm 1988). the projection of the analytic lens on ‘survival’ has also drawn our attention to the structural weaknesses of informal township enterprises as a result of under-capitalisation and resource constraints (rolfe et al. 2010). counter to the concern with slow or little growth amongst survivalists, neves and du toit (2012) have indicated that township enterprise activities are embedded in a social context where relationships of mutual support and reciprocity can be as important as profit motives, whilst economic participation itself serves a social function and reinforces peoples’ sense of belonging, place in community and self-identity. this argument aligns with institutional theory’s tenet that enterprise decisions are influenced by both formal institutions (laws, regulations etc.) and informal institutions (consensual agreements, moral practices etc.). in consequence, webb et al. (2013:601–602) argue that the ‘incongruence’ between formal and informal institutions’ conception of social acceptability enables ‘opportunity recognition’ for informal entrepreneurs, a process which in the township environment explains the widespread illicit sale of both licit (such as beer and pharmaceuticals) and illicit products (such as drugs, traditional medicines and grey market goods). area studies have sought to understand the influence of the specific socio-political and urban context on enterprise activities (or absence thereof). these include the world bank–funded study of the diepsloot township economy (mahajan 2014; mengistae 2014) and the business census studies in five cape town townships (charman & petersen 2014). the area approach allows researchers to interrogate notions about the kinds of enterprises that operate within a geographical environment and their business dynamics. mengistae (2014:192), for instance, found that despite the constraints on business growth, 40% of the surveyed enterprises reported to operate on a larger scale than when starting out and concluded that even survival businesses have growth potential. the finding that ‘time helps’ is consistent with research elsewhere on the african continent (gulyani & talukdar 2010; mcphersen 1996; mead & liedholm 1998). yet the comparative literature offers caveats. gulyani and talukdar (2010:1711, 1722) emphasise that ‘living conditions matter’, bearing an influence on the formation of the enterprise as well as its performance. of relevance to the south african situation is their finding from nairobi slums that those informal enterprises that sell their goods (or a portion thereof) outside the settlement are less likely to be poor. it is also important to note mcphersen’s (1996:274) finding that human capital has a significant bearing on enterprise growth, such that those entrepreneurs with experience, education and training are better able to grow their businesses than persons with less such capital. south african researchers have devoted little attention to understanding the impact of the institutional context on township business development. research in the global north recognises the polycentricism of policy approaches (especially differences between national and local levels) with respect to the institutional process of business regulation and divergences in enforcement in stimulating informal entrepreneurship (webb et al. 2013). in this respect, the township informal economy has enabled certain kinds of entrepreneurs (both local residents and outsiders) to take advantage of the ‘ambiguities’ around jurisdiction to operate businesses, which, outside the township, would confront more onerous state control. some of the examples in the literature are ‘large’ informal retailers (liedeman 2012), traditional healers and unregistered health services (petersen et al. 2014), and gambling rings (scott & barr 2013). additionally, the institutional barriers that confront township entrepreneurs are inadequately understood, apart from those sectors where regulation a priori determines formalisation. understanding these obstacles is important if facilitation towards formalisation is to be embraced as a policy strategy, an approach that is currently not part of the discussion on township economy development. a developmental approach to business regulation is considered to be the most viable option given the recognised limitations inherent in the ‘do nothing’ and ‘eradication’ policy strategies (for a review, see williams & nadin 2014, 2012). the paper now turns to the two case sites to examine entrepreneurial constraints facing township micro-enterprises. the paper is structured into four further sections. firstly, the paper introduces the case sites, providing an overview of their contrasting histories and demographic profiles. secondly, we detail the methods utilised to gather data through an enterprise census and qualitative firm survey. thirdly, the article examines the results. we first highlight the surprising similarities between the two case sites in the range of enterprises and their distribution. we then distinguish the different pathways that entrepreneurs have taken to establish their business. then we describe the main obstacles that micro-enterprises confront. fourthly and finally, the paper takes a sober reflection on the question posed at the outset: what developments are achievable given the business dynamics identified? the paper concludes with making a call for a more low-geared approach to township economic development, focusing on lessening the legal, institutional and regulatory obstacles to enterprise growth as a first step. case sites: ivory park and tembisa the case sites are portions of two adjoining townships: ivory park, which falls into the city of johannesburg, and tembisa, which falls into the city of ekurhuleni. our focus is on the sub-place areas of section 2 and section 5 in ivory park and the neighbourhoods of entshonalanga, umnonjaneni, moedi, khatamping, endayini, umfuyaneni and umthambeka in tembisa. in both cases, the research sites measure approximately 1.6 km2. the two townships are situated in gauteng province. in topographical terms, the sites are divided by a small stream, though share a common spatial geography in relation to the broader metropolitan area. in their settlement histories, layout and demographic profiles, ivory park and tembisa differ significantly. in the spatial segments under examination, there are no formally established markets. instead, businesses have silently ‘encroached’ (bayat 1977) and now operate from ‘public space’, homes, utility servitudes and streets. ivory park is a post-apartheid township. it was established in 1996 on a site at which an informal settlement had emerged (mahon 2010). the new settlement accommodated residents from overcrowded townships including alexandra. as a result of informal settlement, the urban planning process had to align with land claims and settlement patterns. the street layout is haphazard apart from the ‘high streets’ that bisect the settlement and provide transport corridors linking ivory park to tembisa and the major north-south freeway arteries. under the government reconstruction and development programme, the first generation of settlers obtained brick and mortar housings. the settlement has also benefited from a modicum of social infrastructure, including schools, a taxi rank, a police station and a clinic. today, all land within the township (apart from a few parcels reserved for commercial activities) is occupied with settlement. tembisa was established in 1957 (saha n.d.). the settlement, in spatial terms, epitomises apartheid modernist planning, the streets laid out in a grid pattern, social infrastructure clustered in the centre of each segment, positioned on the hill ridges, and a green fringe preserved on the perimeter. the population is ethnically heterogeneous with the largest group, isizulu, accounting for one-third of the total. over time, the settlement has changed in size and composition, with neighbourhoods becoming less ethnically segregated and notable investments in home improvements. in the neighbourhoods under consideration, one neighbourhood has informal dwellings within this neighbourhood less than 4% of the households reside informally. despite their dissimilarities (historical, spatial, demographic and structural), the two settlements share similar characteristics in socio-economic profiles. unemployment is high (31.4% in ivory park and 34.5% in tembisa, narrow definition) and spatially distributed across both sites. in terms of income distribution (using the 2011 statisticssa census data, categorised in quintiles), about one-fifth of households report ‘no-income’, 34% – 40% earn between r9600 and r38 000 per annum, and a further 24% – 34% earn between r38 001 and r153 800 per annum (see table 1). the latter cohort approximate to full-time salaried workers. in both settlements the ‘middle class’ comprises less than 5% of the population. the proportional income distribution across quintiles suggests that households in tembisa have marginally higher income than those in ivory park. it is possible that the official census data under-report informal income streams from business activities, accommodation rental, welfare transfers and private transfers. table 1: ivory park and tembisa, comparative socio-economic indicators. ivory park accommodates a substantial community of migrants and immigrants. the census data indicate that 29% of the population gave their home language as xitsonga, isindebele and other, thus potentially including mozambicans and zimbabweans. some of the new settlers reside in shack settlements, which accommodate 13% of the population in ivory park, although most migrants and/or immigrants are accommodated in single dwelling ‘backyard’ structures built by the house owners who have thus acquired a highly profitable and reliable income stream. research methods and analysis field research was undertaken over the period may 2012 – august 2012. the research formed part of a project to study the township informal economy in various localities.3 the research methods comprised two main components: a census of business activities and a business survey. the research utilised a mixture of qualitative and quantitative methods in a small-area census approach, described in charman et al. (2015). the data collection process entailed traversing every street, pathway and passage within a specific area, recording the spatial position and activity of each identified business, undertaking a survey of specific businesses, and gathering data from conversations, collecting artefacts (such as flyers, posters) and taking photographs of business activities and contexts. the survey component was not applied universally but targeted to particular sectors and within sectors to businesses with specific characteristics. the focus was on sectors considered to be most significant (numerically and in terms of their potential for business growth). these were grocery shops (known as spaza shops), taverns (and shebeens, an unlicensed liquor retail outlet), hair salons and businesses providing child care (known as educares). in addition, the research protocol restricted the interviews to enterprises that met the following criteria: businesses had to have dedicated infrastructure (however modest, including a room in a house), have a commercial identity (a name or signage) and trade on a regular basis. in most cases, the targeted businesses were micro in size, evident in the modesty of assets and sole proprietorship, with employment uncommon and restricted to part-time workers and occasional family assistance. all enterprises traded solely in cash. the data from the census were extracted from the geographic information system (gis) devices and compiled into a data set. based on preliminary enterprise categorisation, field notes and photographs, each entry was classified into one of 34 categories of business activities (reflecting the goods and services provided; not industrial classifications which are inappropriate in their aggregation; see wills 2009) and ordered according to the primary, secondary or subsidiary business activity. the classification of businesses on their spatial location, such as the street, was avoided where their activity, such as selling fruit and vegetables, could be more accurately reflected within a sector categorisation. the survey data were recorded on paper questionnaires and were subsequently transferred to a database and categorised to enable comparative analysis (following suggestions on data organisation in creswell 2014). the qualitative responses were examined to identify core themes and substantiate the analysis with human voices. where first names are given, these are the actual names of the business owners, though their identities remain otherwise anonymous. the reference refers to a unique identification number in the data set. the research also draws on personal observations and/or field notes from having criss-crossed both settlements and engaged in dozens of conversations. results similarities in scope and scale the results of the enterprise census are summarised in table 2. the census identified 2509 enterprise activities in ivory park and 1722 in tembisa. this equates to 55.1 enterprises per 1000 people for ivory park and 38.4 for tembisa and 13.1 per 100 households in ivory park against 9 per 100 households in tembisa. the level of entrepreneurship is substantially higher in ivory park and comparatively higher than other township sites we have studied in the western cape where we identified an average of 30 enterprises per 1000 people or 9.7 per 100 households (charman & petersen 2014). the heightened level of business activity in ivory park is probably attributable to a combination of factors, though two influences are notable. firstly, immigrant entrepreneurs have responded to their economic situation through creating new opportunities (or ‘make work jobs’, mukhopadhyay 2011); secondly, entrepreneurship benefits as a result of the broader scope for informalisation within ivory park, such as the spatial opportunities to conduct business in the street environment, utility servitudes and private households and so forth. table 2: summary of enterprise census results. though there are more micro-enterprises in ivory park than in tembisa, the structure of the neighbourhood economies is not substantially different. this is a surprising result given the differences between the two settlements. figures 1 and 2 show the distribution of micro-enterprise activities per 1000 people in ivory park and tembisa, respectively, across the 34 business categories. in ivory park, the top five ranking (in terms of percentage) are house shops (17.1%), street trade (12.5%), taverns and/or shebeens (9%), grocery retail (7.2%) and green grocer and takeaways tied (5.7%), whereas tembisa’s top five are house shops (25%), grocery retail (8.9%), taverns and/or shebeens (8.5%), street trade (6.9%) and green grocers (5.7%). in both townships, hair care services occupy the next place with 5.6% of all identified activities. the sale of food (groceries, fresh produce, meat and poultry), beverages (cold drinks and alcohol) and prepared foods (street food, takeaways and restaurants) equates to over 50% of all business activities in both sites (53.1% ivory park; 56.7% tembisa), a finding that is similar to the results found in diepsloot (mengistae 2014). service-related enterprises, including hair care, health services, building services (construction), business services, repair services, mechanical services, religious services, educational services and transport services, comprise 18.7% in ivory park and 23% in tembisa. micro-manufacturing, which includes activities related to the production of arts and crafts, furniture, cobbling and clothes making, comprises 5.1% of activities in ivory park and 4.1% in tembisa. figure 1: ivory park, enterprise activities per 1000 people. figure 2: tembisa, enterprise activities per 1000 people. the small-scale of micro-manufacturing, relative to all activities, might be anticipated, though the significance of the sector should not be overstated. most of the businesses were artisanal producers, making items such as burglar bars and gates, cupboards, prefabricated ‘zozo’ huts, beds and mattresses made with recycled springs, dresses and shoes (particularly in ‘ethnic’ styles). there were examples of collaborative production (in bed making), though limited evidence of employment and downstream value chain links. in most cases, manufactured wares were sold at the point of production which was usually on the street or an open piece of land. amongst the artisanal crafts persons, some have advanced skills though many exhibit rudimentary skills. the use of hand tools predominates. these craft persons tend to work alone (though immigrant furniture makers work in small groups), replenishing materials once products are sold and trade at the point of production. core business strategies of these entrepreneurs are, one, to produce goods of ‘cultural’ value, two, to provide customised items for home renovations (gates and burglar bars), three, to sell products that are cheaper (in many cases because the product is knowingly inferior) and four, to target persons unable to purchase from formal stores (because they cannot access credit and/or acquire furniture on hire purchase). enterprise characteristics spatial influences business activities are conducted in different spatial localities. the home, or residential context, is especially important for retailers operating within a house or shack selling groceries, snacks, cold drinks, liquor and fast food such as ‘kota’ (bread and filling) outlets. education services, such as crèches and educares, are usually home-based, as are businesses that collect scrap materials and need the storage space of a yard. the street hosts a different range of businesses. these include green grocers, street fast food outlets (such as braai stands), hair care businesses and ambulatory hawkers selling anything from clothes to homeware (brooms, dish towels, dusters, etc.). across the range of street environments, the ‘high street’ (major roads and transit routes) is particularly significant for certain kinds of business activity. in ivory park, 32% of all businesses’ activities are situated on the high street; the corresponding figure for tembisa is 34%. this finding shows a higher percentage of business activity on the high street than the 23% recorded in the western cape sites (see charman & petersen 2014). the kind of businesses situated on the high streets does vary, as shown in figures 3 and 4. service-oriented businesses along with specialist services and micro-manufacturing tend to occupy high street locations. although 20% – 30% of grocery stores occupy high street positions, most are residentially situated, serving localised niche markets whose geographical scope typically falls within a radius of between 50 m and 100 m. a similar spatial-economic logic accounts for the position of venues for liquor consumption and recreation with fewer than 15% of shebeens (unlicensed) situated on the high street. figure 3: ivory park, percentage of enterprise category situated on the high street. figure 4: tembisa, percentage of enterprise category situated on the high street. spatial logics not only determine where enterprises are situated but also influence the nature of the business infrastructure itself. on the high street, notably in places with high pedestrian density such as close to transport nodes, residential properties have been converted into business units that in turn sustain an infrastructure of signage, public entrances and veranda that encroach (and appropriate) public space. permanent structures include containers, shacks, and kiosks, whilst semi-permanent stands include gazebos, tarpaulin and post, rudimentary trading counter and umbrella stands. some traders use open land (for car repair and manufacturing activities) or display their goods on the ground. there are also a range of mobile businesses and entrepreneurs whose minimal space requirements enable them to position their trade in sites of high pedestrian density. in contrast, home-based businesses such as spaza shops tend to occupy a single room or outbuilding, such as a shack the entrepreneurs the characteristics of entrepreneurship vary from sector to sector. the data below (tables 3, 4 and 5) refer to four sectors: grocery retail (spaza shops), taverns and shebeens, hair care and educare4 businesses. in comparing the results from the two sites, broad contours of entrepreneurship can be identified. table 3: business ownership and/or gender (% of enterprise category). table 4: business ownership and/or county of nationality (% of enterprise category). table 5: business ownership and/or age (% of enterprise category). spaza shops are predominately male-run businesses, a finding that might seem surprising given that spaza shops were historically thought of as business enterprises run equally by men and women (indeed, as family run entities). the result reflects the fact that nowadays merely 33% of shops in ivory park and 37% of shops in tembisa are run by south africans. roughly 70% of all spaza shops are operated from rented premises with the landlords earning r1200 per month (median value). this suggests that the monthly return on labour did not justify the efforts of former shopkeepers in an environment which has become highly price competitive (piper & yu 2016). overall, the majority of shops are run by (male) immigrant entrepreneurs and their workers, with bangladeshis and mozambicans in ivory park and ethiopians and bangladeshis in tembisa having a strong presence in the sector. taverns (inclusive of shebeens) and hair care businesses are equally run by men and women (liquor retail sees a particularly even gender-split), though the entrepreneurs derive from very different age segments. hair entrepreneurs are generally persons of younger age; roughly half of all business owners are under 30 years of age. in contrast, fewer young people operate taverns, with 71% of tavern owners in ivory park and 75% in tembisa older than 30 years. most liquor retailers are survivalist businesses, run merely to supplement household income. in terms of the volume of beer sold, 44% in ivory park and 49% of liquor sellers in tembisa reported selling five or fewer crates (12 ml × 750 ml) of beer per week, thus earning potentially less than r100 in profit. yet these individuals are willing to run the risk of police raids, arrest and prosecution such is their desperate need to supplement income. the data on the educational background of the business owners are patchy, apart from the hair care sector where this information is most reliable. the data set comprises 133 responses. only one individual had obtained a post-tertiary qualification. at the other end of the spectrum, a handful of individuals have no schooling. most of the salon owners have either obtained matric (24% in ivory park; 27% in tembisa) or completed some level of high school education. as a sector characterised by young entrepreneurs, it appears that many of the persons owning and working in salons have dropped out of school. it is possible that salon work has acquired a reputation as ‘work for drop-outs’, therefore lessening the attractiveness of the sector for persons interested in pursuing post-school training in the field of hair care. as in the spaza sector, south african hair salon entrepreneurs are a minority, comprising 32% of businesses in both ivory park and tembisa. in contrast, over 60% of the salons in both sites are operated by nationals from mozambique and zimbabwe. the renowned franco and west african barber shops, ubiquitous in some townships and settlements (weller 2011), are largely absent apart from four ghanaian barbers. most hair salons are run by the owners (73% in ivory park and 88% in tembisa). spaza shops and tavern and/or shebeens are categories in which employment is frequently observed, see table 6. the data on spaza shops show that around one-third of shops (36% in ivory park and 26% in tembisa) are owner-operated. approximately half of all shops employ one person (in addition to the owner) (48% in ivory park and 53% in tembisa) and 19% of shops in tembisa employ two persons (the comparative figure for ivory park is 12%). most of the south african–run spaza shops are single-worker enterprises. taverns have a potentially high demand for labour, though much work is performed by part-time workers and family members. this is a sector that is largely dominated by south african entrepreneurs, self-employed men and women, apart from a minority of mozambican and zimbabweans businesses (28 in total; 8% of category) in ivory park. there were 62 licensed liquor outlets in tembisa (37% of category) and 39 (11% of category) in ivory park. the capacity of unlicensed shebeen owners (the majority of outlets) to operate on-consumption venues is influenced by the generalised state of informality (e.g. there are more shebeens in informal settlements) and localised risk factors relating to police action from raids and tribute extraction. for this reason, merely 40% of liquor traders in tembisa have on-consumption venues and only 30% in ivory park; in both sites most liquor retailers sell for off-consumption. off-consumption venues have a lower labour requirement. only 13% of taverns and/or shebeens in tembisa provide employment for one additional person; this finding indicates that obtaining a liquor licence does not, in itself, foster employment growth. the corresponding figure in ivory park is 35%. in the 2 sites, the research identified 17 venues in ivory park (13% of category) that provided employment to 2 or more persons and 19 such venues (12% of category) in tembisa. the results on employment in the liquor retail sector should be interpreted with caution because informants might under-report the role of family labour as well as casual services. the researcher encountered numerous young men working as freight handlers, transporting liquor using trollies, wheelbarrows and wheelie bins to move stock between supplier and retailer. table 6: employment (% within enterprise category). the educare sector is an outlier in the provision of employment. all bar one of the businesses we surveyed were run by south africans, who as mentioned above are mostly women, whilst 88% of educares are owner-operated. most educares had been running for several years (9 years median in ivory park; 4 year median in tembisa), and it seems that rarely does business ownership transfer from one entrepreneur to another (partly because of the infrastructure requirement). as can be expected, educares have a relatively high labour requirement. less than 12% of the educares in ivory park and 17% in tembisa are single-person operations. the employment profile differs between the sites with about 48% of educares in tembisa employing three or more persons, though in ivory park over 80% of educares employ three or more persons. the registration of educares with the department of social welfare and development impacts the characteristics of the enterprise. sector registration enables the enterprise to gain access to pupil subsidies, and the regulatory criteria compel the businesses to invest in facilities and adopt minimum standards. the registered businesses employ more workers. yet only half the educares in the survey were registered. informants report that the obstacles to registration include land-use zoning, the lack of space within homes and insufficient resources to meet all the compliance criteria. pathways into business the interviews with the owners indicate that there are four main pathways by which people establish businesses. the first relates to what is referred to as ‘make work jobs’: these usually start out as livelihood strategies through which persons that are unemployed seek to make ‘ends meet’ utilising whatever assets and resources are accessible and affordable. the business then unfolds, developing a scale that was unimaginable at the outset, confirming that survivalist businesses can grow beyond initial projections. steve (informant 1698), to provide one example, runs a spaza shop in ivory park. he started the shop 13 years ago with r700 after he lost his job. he set up the business in a portion of his mother’s house and after a while the business did sufficiently well to enable him to buy out his mother’s house. the second pathway is based on the acquisition of skills, on-the-job experience and access to the market or customers through working. young entrepreneurs in the entertainment sector, such as disk jockeys, acquire their skills through their hobby of making and/or playing music which, in turn, can process into a business as their craft gains reputation. on-the-job skills acquisition is an important pathway for employees to acquire entrepreneurial skills. this route to entrepreneurship in the hair care sector is common, as in the case of monica’s (2594) business. a mozambican national, she started plaiting hair in a salon where she acquired her skills and then when she had accumulated enough money she set up in business on her own, taking some of the customers with her. she has one employee and makes about r2500 per month. the third pathway is through a strategic investment to establish the business. in many cases the investor is not involved in the running of the business; either they have a job which provides the source of investment capital or they own other businesses. many of the immigrant run spaza shops have been established by investors, either through setting up new shops or buying out struggling businesses. spaza shops are now often bought and sold. in response to a question about whether the business could be purchased and the possible sales price, the research learnt that well-stocked spaza shops in ivory park and tembisa sell for between r60 000 and r85 000 on average. but the spaza scenario in which entrepreneurs purchase established businesses with the objective of selling them at a profit is not evident in other sectors. usually, the investment sums are smaller and the business is started from scratch. martin (2697), for example, purchased his salon (excluding building) from an individual for r2000 after seeing an advertisement posted in the street. upon acquiring the business, he maintained the lease agreement with the property owner, paying r200 per month for rent, water and electricity. successful township entrepreneurs often diversify their investments in a range of sectors or acquire multiple outlets. shifting investment away from the core business is done to minimise risks (theft, state regulation and jealously, to mention some of the explanations provided). it is not uncommon for successful entrepreneurs to own minibus taxis, provide school transport services and operate a tavern, spaza shop or butchery. in the survey of tavern owners, for example, 9% had other business interests, most commonly a spaza shop, then meat and food scales (take away), recycling and rental income. a fourth pathway is where the businesses are passed on within the extended family, such as from parents to children. there are fewer cases of this pathway within the data set. where a business requires a licence or operates from a permanent structure or has accumulated business assets, there is a greater rationale for maintaining the business within the family as an ongoing concern. obstacles what do the entrepreneurs regard as their main obstacles in growing their enterprise and what are their strategies to overcome these challenges? firstly, it should be recognised that some owners passively accede to the lowly state of their business and have no intention to pursue growth. this is not uncommon in the informal economy where markets are established on a confluence of commercial and social rationales (see neves & du toit 2012). jane (2399 has run an educare for 4 years and has grown the business from looking after 5 children to 32 children, enabling her to make a profit of r4000 per month. she has no intention of further expansion. like joyce, several of the educare owners saw their business in an altruistic light, offering a service to the community ‘so parents could go job hunting’ (2400). the great majority of the business endeavours in the food–drink range constitute livelihood strategies and to speak of a micro-enterprise misrepresents the state of these activities. these are survivalist businesses: individuals trade so long as they make some income (however small), though would abandon the business to pursue better opportunities (such as employment) when and where the opportunity arises. a few will see their business grow. but is there a ceiling to this growth? the answer to this question is probably ‘yes’, though of course outliers can transcend the obstacles. there are many examples where a survivalist entrepreneur grows the business from point zero to the point of deriving a stable income. but it would seem that rarely can these entrepreneurs take the business to the next level, acquiring property, fixed assets, employing permanent staff and formalising their business. the research invested perceived obstacles to enterprise growth; see table 7. the researcher employed a mixed method approach, recording qualitative responses (open ended) and enumerating barriers where specifically named. the data were subsequently recoded under the heading listed in the table; the data indicate the percentage of responses by category and site. across the four categories, shortage of finance is the most common listed. this obstacle refers to both investment capital and working capital. in the educare sector, the result potentially relates to the aim of entrepreneurs to access state subsidies. it should be noted that the provision of credit is central to the working of the township economy. businesses have poor access to finance, but trade in a market with high credit demand. the research encountered credit provided at spaza shops, taverns and/or shebeen, by street traders (including hawkers, though excluding food service businesses) and clothing shops. all payments are settled in cash. across both sites, the researcher found no business with electronic payment services. access to finance in the hair care sector impacts the capacity of the entrepreneur to invest in products, equipment and facilities, and (importantly) change the location from which the business operates. table 7: perceived obstacles to enterprise growth (% responses and/or categories). regulatory barriers affect educares, tavern and/or shebeens and spaza shops, especially those that trade (illicitly) in liquor. in the case of liquor traders, more informants identified police harassment as a barrier than licensing or other laws. the twin obstacles of licensing and police harassment were more commonly cited by liquor traders in ivory park, where (as previously noted) merely 11% of micro-enterprises have liquor licences. small survivalist liquor-selling businesses were less affected by crime, though larger businesses had to deal with armed robbery (28 businesses) and other kinds of theft. a particular challenge for unlicensed shebeen operators is posed by conmen who offer to assist the business owners acquire liquor licences. crime impacts heavily spaza shops, with tembisa spaza traders more commonly affected by crime than their counterparts in ivory park (33% of responses vs. 10%). in the spaza sector, with respect to a separate question, 82 shopkeepers (23% of the category) recalled incidents of robbery and/or theft over the past 5 years, with incidents of crime affecting all nationalities equally on both sites. other reports of crime (across all sectors) included the use of counterfeit notes, non-payment of debts, social and political harassment and extortion from petty thugs (for cigarettes from spaza shops). complaints about police raids, fines and stock confiscation are surprisingly common in the spaza sector, especially amongst those businesses selling beer. yet immigrant shopkeepers (who do not sell beer) also complained about police raids which are undertaken in the name of searching for illegal (grey market) cigarettes (sold widely in most shops). an obstacle listed across all four sectors are the challenges presented by the business location (disadvantages of the place at which the enterprise operates) and/or the inadequacy of the infrastructure out of which the business trades. the comparatively greater number of responses to this variable amongst ivory park entrepreneurs (37% vs 13% in educare; 20% vs. 15% in hair care) is due, in part, to the insecurity of business tenure as a result of the informality in land-use and ownership. many hair care businesses operate on the street verge. in hair care and educare sectors, lack of physical space to extend the business infrastructure was commonly identified as an obstacle to growth. these entrepreneurs would want to expand their premise but cannot access land. another challenge is that high street salons are not connected to the municipal water and sewerage lines; most of them use buckets to access water. several of the educare owners spoke of the absence of space for children to play, inadequacy of the toilets and crammed conditions in classrooms. space constraints sorely affect the possibilities of taverns to provide adequate seating, recreational facilities and storage. liquor products are thus stored in the house, and thresholds between public and private space overlap and compete for space. in the spaza sector, it is not uncommon for the shopkeeper(s) (especially immigrants who rent the shop building) to sleep within the store. the challenge of business competition was persistently reported by south african spaza shop keepers (12% in ivory park; 24% in tembisa) as well as entrepreneurs running educares (data omitted in quantitative survey) and hair salons (14% ivory park; 15% tembisa). at the time this research was undertaken, a number of south africans spaza shops had closed because of competition. for those continuing in business, such as zandile (informant 1877), she responded to increasing competition through lowering her prices, providing credit and selling alcohol. an often cited strategy for addressing competition is to shift to a new locality. it is noteworthy that many respondents gave enterprise specific responses to the question of growth obstacles. these are recorded under ‘other’. the factors mentioned ranged from issues of a sociocultural–psychological dimension (such as jealously, witchcraft and bad luck), to external shocks on the household (resulting from death and disability), to relationships problems issues within the family. other issues were high transport costs, tenancy disputes and electricity supply issues. immigrants specifically complained of their inability to acquire bank accounts. there is minimal evidence that people work cooperatively, for example, to enhance purchasing power. this was cited as a cause of poor competitiveness amongst some south african informants. eddie (informant 1531), for example, once ran a spaza, which he now rents out to ethiopian shopkeepers. he endeavoured to create a ‘collective association’ to enable bulk purchasing. but no one was willing to join him. he explained ‘people refused because of a lack of trust, a lack of education, they did not understand how much more profitable the business of spaza shops could be’. in contrast, the research came across several cases of stokvel groups working effectively to mobilise finance and enhance business opportunities. these self-selecting groups are highly effective in enforcing compliance with the stokvel rules. conclusion: potential for growth? the paper has sought to outline the state of the township economy in two different localities. the overall situation is cause for concern, even though there is considerable evidence of livelihood resilience and entrepreneurship. although we cannot extrapolate our results across other township settlements, the data on the two case sites are rigorous (based on a census approach), insightful in qualitative terms and provide a compelling perspective on what business activities occur, where people conduct business, how they get into business, what constraints the entrepreneurs have to confront and, finally, reflect on the common business strategies that have been pursued to achieve growth. the research found a surprising consistency between ivory park and tembisa in the scale, scope and spatial distribution of micro-enterprises, despite their socio-demographic, spatial and historical differences. the results are also not dissimilar to the state of entrepreneurship in five townships in the western cape that were studied using the same methodological approach (charman & petersen 2014) or indeed the findings from diepsloot (mahajan 2014; mengistae 2014). based on this insight into township micro-entrepreneurship, we return to the question posed at the outset, namely what should government do to stimulate the township economy? a simple answer is to keep strategies low-geared, focusing on achievable results. ambitious plans to change the structure of the economy towards manufacturing and non-food and/or drink retail are likely to disappoint and will not benefit the majority of existing businesses. throughout the paper the issue of space is mentioned. there is a need to make land available for business expansion. people need title deeds to formalise market transitions and invest in property assets. the current land-use zoning approach is illogical. townships are mixed business area and should be recognised as such. the street environment is central to businesses, and trading in particular should be legitimised and respected, whilst municipal authorities should seek to maximise the use of the street including verges and unutilised land for business activities without overly prescribing the manner in which the space is utilised. mobility is crucial to most businesses. municipal authorities should be accommodating towards diverse forms of transport including trollies, push-carts and the like. street lighting can lengthen the business day, allowing traders to target markets at times when they are busiest: early in the morning and evening. infrastructure for business would also help, especially in places of dense trading, but as infrastructure needs to be inclusive of a range of spatial requirements it should not comprise homogenous units, laid in geometric order. instead, infrastructure should permit the flexible and fluid use of facilities, reflecting business needs and spatial requirements, organised and managed through participatory processes. in sectors where regulation is deemed necessary, the requirements should be positioned at the capacity of the micro-enterprise and the capability of the entrepreneurs, recognising that township entrepreneurs are disadvantaged vis-à-vis formal businesses. a process of ‘facilitating formalisation’ (williams & nadin 2012, 2014) must have a developmental approach. compliance processes need to be simple with benchmarks set out to enable the business to achieve full regulatory compliance through a growth-oriented process. this will give the enterprise time to grow, reinvest resources in the businesses and, most importantly, to respond to failure. adherence to regulation needs to be monitored, but not by authorities who have the power to extract tribute but rather it should be undertaken by technical specialists who can simultaneously advise on corrective action. the police should not be afforded a front-line role in managing the ‘where’, ‘when’ and ‘how’ business is conducted but mobilised only when non-compliance is persistent or public safety materially threatened. training, whether in business or technical skills, is not a panacea. none of the study informants bemoaned ‘skills shortage’. government resources would be better spent funding young people who desire to attend college to acquire skill; they may one day return to open up a business in the township. micro-credit is obviously needed, though credit is notoriously difficult to target the right people who will use the money in the manner intended. those organisations that work closest to the micro-entrepreneurs are probably best placed to deliver a service that meaningfully benefits the business though such a developmental service comes with high overhead costs. a different approach may be to channel lending through established stokvels, enabling the group to lend resources to its members on terms that the group can contractually uphold. previous approaches in this respect have had promising results (sebstad 1992). the role of immigrant entrepreneurs needs to be accepted and where justifiable (in the case of larger businesses) compelled to formalise. a simple first step would be enabling immigrant entrepreneurs to establish bank accounts. national government has the core responsibility to tackle crime. yet the role of the police needs to be carefully strategised, especially in enforcement of regulatory compliance where opportunities for bribery and the abuse of power are difficult to prevent. finally, government should be encouraged to refocus its attention on markets that have greater potential for productivity enhancement of township residents. this requires rethinking the spatial implications of township revitalisation. township entrepreneurs may achieve greater success selling goods and services outside the geographical confines of the township, in inner-city or suburban neighbourhoods. these markets are more lucrative and sustain demand for a greater diversity of goods and services. yet municipal policies have a determining impact on where, when and how micro-enterprises may operate, usually with the intention to either control or exclude. the institutional incongruence between national, provincial and municipal objectives should be redressed. thinking differently entails not only liberating new market places and spaces outside the township but also ensuring that the township poor have the priority to operate businesses in these contexts. acknowledgements the research was commissioned by the sustainable livelihoods foundation. the author thus acknowledges them for making available the data on which this article is based. the research findings and conclusions are those of the author alone and the foundation had no influence on either the interpretation of the data or on the author’s decision to publish the findings. the author acknowledges the rockefeller foundation’s bellagio residency programme during which time the article was written. the author acknowledges the research support of colleagues leif petersen, rory liedeman and caitlin tonkin. the author benefited from the comments of the south african journal of economic and management sciences editors and two anonymous reviewers. competing 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united states. yu, d., 2012, ‘defining and measuring informal employment in south africa’, development southern africa 29(1), 157–175. https://doi.org/10.1080/0376835x.2012.645649 footnotes 1. the informal economy is understood to consist of partially or completely unregistered and unregulated businesses, and includes unregistered employees. 2. a ‘microenterprise’ refers to a small business that is usually not registered for business tax and which typically employs fewer than five employees, engaged to work on an informal basis. 3. the research was commissioned by the sustainable livelihoods foundation. the author led the research process and data collection. 4. educares are home-based microenterprises that provide out-of-home care and educational services for children between the ages of 0 and 6. educares range in their size and business offering. although some educares are formally recognised by local municipalities and departments of social welfare, others are largely informal. those that are recognised are commonly eligible for subsidies per child. although it is a requirement (at municipal and provincial levels of government) for these businesses to be registered with the municipality and/or provincial department for social welfare and development (dswd), registration is seldom enforced. sajems ns vol 2 (1999) no 3 423 a theory for industrial make-buy decisions? d rsnaddon school of mechanical engineering, university of the witwatersrand d rprobert department of engineering, cambridge university abstract after an introduction, the authors derive some common industrial make-buy situations. six prominent economic theories of the firm are then outlined, before setting criteria to select the most appropriate economic theory for deciding when to make and when to buy. an augmented transactions cost theory may we1l be the most secure basis for a manager, in an industrial setting, to decide what to make within, and what to buy outside, the firm. jel d23 1 introduction managers often decide whether to make or buy a part or process. they can use rules of thumb such as installing parts that are cheaper to make than buy, are new, are within the competence of the firm, or avoid problems dealing with sellers. consider the rule to make new parts and processes. when a part has never been made before it may be easierl to make it than to describe it for someone else to make. similar situations can be constructed for the other rules leading to the conclusion that a1l these rules of thumb may be credible in different situations. while credible, these rules may contradict each other. for example in a particular situation it may be cheaper to buy a new part meaning that the first two rules cannot be met simultaneously. this implies some fundamental theories from which approaches and rules arise. such a theory can provide a basis to help the manager to answer the question should this part or process be sourced in-house or bought from a suppjier?2 the process of finding the theory consists of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 424 sajems ns vol 2 (1999) no 3 describing the situation, • outlining the fundamental make-buy theories, setting criteria for selection, and then making a selection. z derivation of situation managers within competitive industry take make-buy decisions involving conventional parts and processes. the make-buy decisions considered are resolutions taken over the longer term involving investments in capital, labour and processes. such decisions include raw materials and parts procurement as well as production processes. trivial purchases are excluded, as are unconventional transactions. conventional parts and processes are restricted to those that allow the decision to change after locating the plant (e.g. we exclude situations like buying coal for coal-fired electrical generating plants, etc.); • exclude ulterior motives like taking over the supplier; occur frequently (unlike large capital items purchased as "one-offs", e.g. a dam); and are not epochal changes in technology (like changing from electronic valves to transistors). restrictions are not onerous and allow for many industrial make-buy decisions. examples include financial and other information technologies, product development, scrap disposal, and utility supplies. to this must be added all components and raw materials for manufacturing. managers, taking conventional make-buy decisions, focus on particular factors they regard as important. if managers act in the interests of the frrm, such factors indicate importance and help to distinguish between theories. to determine important factors in make-buy decisions two sources are used below. first, secondary data were drawn from articles by practitioners. second, data from a previously unpublished survey of south african pump and valve manufacturing managers are reported. table 1 practitioners' factors for making and buying buy-; make-; make or buy decision factors total frequency ~ .. (a) cost or price 6 (b) other factors not specified elsewhere 6 (c) volume or demand 4 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 425 table t continued buy-; make-; make or buy decision factors total frequency (d) speed 4 (e) competence, strategy or strategic 3 (f) inadequate resources 3 (g) trust, security and theft 2 a limited set of practitioners' articles were read and words associated with subcontracting, outsourcing or buying on the one hand or making on the other hand were captured. words were then transferred and counted (see appendix i). table i is a summary of these results. in this figure "cost" is most frequent with "volume" and "speed" second, etc. ("other factors" is a general category.) to augment these views, a previously unpublished market research of south african pumpand valve-manufacturing managers' reasons for subcontracting, where one of the authors was involved, are disclosed. views are analysed from the open-ended question, "for what reason does your business use subcontractors for any part of the production process (including) product and process development?" (newell, 1996: 99). table 2 shows the results given by forty-five managers (newell, 1996: 78). table 2 0 skill, facilities and capital {expenditure avoidance demand cost minimisin labour reasons for buying (subcontracting) for sa pump and valve manufacturers 23 2 ii 3 6 4 4 5 4 3 non-core, focus 2 product ran e 1 total iii 8 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 426 sajems ns vol 2 (1999) no 3 the three most frequent subcontracting reasons in table 2 account for threequarters of the responses for subcontracting. these reasons are "skill, facilities and capital", "demand" and "cost minimising". the first category "skill, facilities and capital" refers to situations where resources are not available at the time when the subcontracting decision is made, but after the work has been accepted. it may be that the machines cannot make to the required tolerances, and this is thus a short-term decision in the economic sense. "demand" refers to circumstances where demand exceeds a resource constraint, for example, not enough machining capacity, not enough labour. in other cases this refers to work that disturbs high volume production. (one response refers to such work as "nuisance work".) "demand" refers to those responses that attempt to allow the firm to operate within a given capacity range. it is a physical measure of volume. compare results in table 2 and table 1. in table 2 "skill, facilities and capital" indicate "inadequate resources" for making. "demand" in table 2 is a "volume" effect similar to that in table 1. similarly, practitioners advocating "cost minimising" in table 2, see "cost" as an important factor in table i. when sources are combined from tables i and 2, then the top replicated factors, in order of combined rank for making and buying, are shown in table 3. the order is "cost", then "inadequate resources" and "volume" (or demand). core tasks or strategy may also be important. many other factors could also make a difference. table 3 practitioners' factors in make-buy deeisions by combined rank category in literature category in market combined table 1 ranking table 2 research rank rankin! column 1 column 2 column 3 column 4 col. 2 + col. 4 cost i cost minimising 3 4 volume 3 demand 2 5 inadequate 5 skill, facilities i 6 resources speed, rapid, 3 delivery 5 8 fast, save time strategic, core 5 non-core, focus 7 12 reliability 8 breakdown 5 13 = both combining ranks and the representative nature of the market research for all conventional industrial situations may be queried. combined ranks in table 3 (that are renumbered in table 4) are therefore indicative rather than highly accurate. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 427 table 4 ranking of important factors in make-buy decisions by practitioners factors rank cost or cost minimising 1 volume or demand 2 inadequate resources or skill, facilities 3 speed, rapid, fast, save time or delivery 4 strategic, core or non-core, focus 5 reliability or breakdown 6 managers, in competitive manufacturing, making make-buy decisions involving conventional parts and processes, seem to rank cost as most important, followed by volume considerations. other important factors include inadequate resources and speed. 3 economic theories for make-buy various theories for make-buy decisions are found in the supply chain, purchasing, marketing and strategic management literature. managers take decisions in firms and firms exist to produce and sell goods and services. if managers decide to make, then their firm makes. if managers decide to buy, then another firm makes. managers faced with the make-buy decision, therefore decide who makes. if managers always decide to make, then their firm grows to make all parts and processes. it vertically integrates expanding towards mining raw materials and retailing to customers. if managers always decide to buy, the firm contracts until all parts and processes are bought from other firms. the fmal stage is buying (or subcontracting) the managers' work. after this the firm ceases to be a productive system, economically changing inputs into outputs. so the economic reason for a firm ceases. the size and existence of the firm depend upon make-buy decisions. so the reasons for the firm and make-buy decisions are closely intertwined. theories of the firm are therefore likely to be closely related to make-buy theories. a starting point for economic make-buy decisions is then the economic theories ofthe firm. the manager deciding whether to make or buy, using economic theories of the firm, still has a wide choice. as machlup (1967: 26) says, "i am sure that there are at least 21 concepts of the firm employed in the literature of business and economics." restricting the choice to longer-term make-buy choices, corresponds to limiting economic theories of the firm to those with a strategic r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 428 sajems ns vol 2 (1999) no 3 management orientation. we follow conner's (1991) classification approaches which focuses on strategic managemene, namely neo--classical, • bain-type industrial organisation, schumpeter. chicago, coase-williamson, and resource-based theory4 . 4 criteria for selecting a theory of six a theory chosen for the make-buy decision must allow the question of make or buy to be asked and answered, lead to patent factors, and should accord with factors cited by practitioners as important. the theory: must allow the question oj make or buy to be asked and answered we link the make-buy decision to theories of firms. hence each theory presented should allow the make-buy decision to be asked and answered. if the theory does not allow the decision to be made, then either the theory should be rejected or expanded to include the make-buy decision. theories can be judged by the questions that can be asked and answered by means of them (loasby, 1976: 212). must lead to patent jactors when investigating theories, care must be exercised. while theorists point to specific factors, they assume that other factors will remain the same (the ceteris paribus condition). as such, each theory is useful for factors patently noted in the theory. (empiricists trying to validate one theory, often include factors that may be construed as giving credence to another theory, and so we limit the discussion to patent factors and not ceteris paribus conditions). should accord with jactors cited by practitioners as important a theory should be congruent with the situation described including some factors in table 4. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 429 5 selection of a theory for the given situation and explanation of the selected theory we follow conner's (1991) classification but combine neo-classical competition theory with the chicago tradition, and discuss the coase-williamson approach after resource-based theory. neo-classical and chicago approach to make-buy conner (1991) only deals with neo-classical perfect competition theory. this theory allows managers to combine inputs making outputs. the firm buys inputs that it combines and makes into an end product. we remove some of the restrictive conditions of perfect competition (e.g. that each firm exactly replicates other competing firms that survive) and allow managers in the firm some latitude in determining make-buy decisions which, in turn, may imply some monopoly power. must allow the question of make or buy to be asked and answered. neo-classical competition analysis sees managers in firms combining inputs, and deciding what to make and buy, especially if the firm is either a monopolist or monopsonist. as the firm becomes more competitive, decisions become prescribed. the chicago school (especially stigler) extends neo-classical analysis to distribution efficiencies in the supply chain. the neo-classical and chicago approaches to the firm lead to comparing the costs of making and buying. these theories give rise to models like break-even analysis, abc costing, etc., which allow the make-buy question to be asked and answered. must lead to patent factors. and these theories patently consider: cost differences and volume effects should accord with factors cited by practitioners as important. cost differences and volume effects are the first two factors in table 4. this theory is acceptable and forms a standard which other theories can improve bain bain's emphasis is that managers restrain market outputs, doing this collusively with managers in other firms. managers raise and lower barriers to those wishing to enter and leave the industry. this leads to the structure-conductperformance (scp) model (e.g. hay and morris, 1991, part 2). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 430 sajems ns vol 2 (1999) no 3 must allow the question of make or buy to be asked and answered bain's approach identifies useful elements and linkages that operate in industry in the scp model. analyses consider make-buy decisions at industry level measuring the concentration of firms supplying to, or demanding from, markets. such theory is useful for buying and selling frrms (mergers and takeovers). must lead to patent factors, and there are many patent factors in this model. they include the number of buyers and sellers in the market; barriers to entry such as differentiating the product directly or through advertising; degree of spare capacity available; and vertical integration practised. these factors can influence the make-buy decision. the number of buyers and sellers in a market point to the degree of monopoly there, which has already received comment. product differentiation can be accomplished by making or buying extra enhancement and promotion. a frrm's spare capacity can be used to change volume quickly (by changing the make-buy decision), and increased vertical integration increases the length of the supply chain on which make-buy decisions can be made. should accord with factors cited by practitioners as important while the approach is general, complexity of the scp model makes it difficult to test and also makes predictions weak. (see e.g. peltzman's review (1991, especially p.213». in addition, it focuses mainly upon industry rather than specific firms. a proponent of the scp model, porter, asks how much the specific industry matters in determining profitability, as opposed to other variables. he estimates that industry type accounts for 19% of profit variation, while business-specific matters account for 32%, and 43% is unexplained (mcgahan and porter, 1997). this indicates that less than a fifth of profitability is explained by this rather general approach. if this is true for the theory of the firm, we do not see that it could explain more in the case of the make-buy decision. consider the patent factors above and those in figure 4. spare capacity may explain the interest in speed, but note that that this is rather speed by any producer rather than speed by the manager making the decision. the factors do not highlight the contents of the figure directly. the scp model rather finds application in buying and selling firms (mergers and takeovers). such activity is regarded as an ulterior motive, that is unlikely to happen often for the situation under consideration. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vo12 (1999) no 3 431 as the scp model is overly complex and has weak predictive power for the manager in the given situation, it is excluded here schum peter this approach links the finn to innovation. the firm tries to innovate making rival products obsolete and is based upon the notion of "creative destruction". must allow the question of make or buy to be asked and answered, schumpeter's theory of creative destruction deals with epochchanging products where making and buying are subsidiary to innovating. consider innovating relative to the factors in table 4. a link exists between innovating and provision for inadequate resources, enhancing the core of the business, or services like speed or reliability. however, when seen in terms of prosaic make-buy decisions, the link is of a longer term than that faced by the manager. must lead to patent factors, and the patent factor is innovation which is not in table 4. should accord with factors cited by practitioners as important. with regard to the factors in table 4, empirical work on schumpeter's theory mainly links firms with investment in innovation rather than its fruits. even at this level conner (1991: 128) says that "empirical investigations are beset by measurement and data problems and offer inconclusive results". links are not seen as being strong, although this is an empirical question in the context, seeing that innovation proxies all factors. with, at best, indirect links to the make-buy decision and little empirical support, we exclude this theory. resource-based theory for our pwpose, this theory may also be called capabilities or competence theory. resource-based theory sees firms as having costly-to-copy attributes from which managers extract economic gain. managers may choose only to make costly-to-copy attributes focusing on core competencies. resource-based theory has promise as, coming from penrose's (1959) approach, it focuses on managerial decisions. these managers may be similar to the managers that we envisage. however, there may be questions whether this theory enlarges, or conflicts with, neo-classical theorys. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 432 sajems ns vol 2 (1999) no 3 • must allow the question of make or buy to be asked and answered as each finn is a unique set of resources and relationships, the choice of making or buying is a large issue in resource-based theory. an important point is that of distinguishing core competencies. • must lead to patent factors, and consider core and non-core competencies for making and buying. drtina (1994) advocates outsourcing (buying) non-essential services when this offers advantages in respect of cost. flexibility, and access to the latest tecbnology. quinn and hilmer (1994) agree, adding that the manager should "concentrate the finn's own resources on a set of 'core competencies' where it can achieve definable pre-eminence and provide unique value for customers ... strategically outsource other activities including many traditionally considered integral to any company for which the fum has neither a critical strategic need, nor special capabilities." this stance of outsourcing non-core activities is however not universally advocated. chesborough and teece (1996: 73) would restrict buying to specific types of innovation. prahalad and hamel caution on outsourcing as follows: "outsourcing can provide a shortcut to a more competitive product, but it typically contributes little to building the peopleembodied skills that are needed to sustain product leadership" (1990: 84). they neither advocate nor reject buying in the case of non-core activities6 so the theory is clear on make for core resources, but not clear on make-buy of non-core resources. the theory needs empirical testing on certain points. preliminary attempts to test resource-based theory empirically (e.g. maijoor & van witteloosuuin, 1996) do not concern the factors essential to our purpose. argyres (1996: 129) explains the state of the theory, saying "unlike transaction cost logic, the capabilities approach as yet cannot generate empirical predictions, only ex post explanations." as the theory is as yet undeveloped in its treatment of non-core activities, its recommendations are not yet clear. should accord with factors cited by practitioners as important resource-based theory specifically has merit in that practitioners base the makebuy decision heavily on inadequate resources such as lack of skil1 and facilities. in addition, practitioners specifically use the theory's tenns core, non-core and focus. this makes resource-based theory attractive. resource-based theory has much to offer. it includes factors that some practitioners cite as important, and clearly favours making where core competency exists. yet there may be difficulties with the theory for the makebuy decision. questions are raised whether resource-based theory is consistent r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 433 with the emphasis on cost and volume in the neo-classical approach, and how to deal with non-core resources. so, in spite of factors from this approach being cited in table 4, this approach is not used. however, it is a strong contender and it is worth remembering that the manager may prefer to make core parts and processes. coase-williamson or transaction cost economics (tce) the coase-wiuiamson approach, also called transaction costs economics, extends neo-classical analysis of firms making, to avoid costs of buying in markets. (the terminology used is obscure but preserved in the explanation that follows.) must allow the question of make or buy to be asked and answered. making and buying are examples of transacting. the approach sees firms making to avoid costs of buying in markets. costs include, but go beyond, those found in the noo-classical approach. for example, they include deception. williamson's costs include those arising from a person's "bounded rationality" with simultaneous "opportunism". "bounded rationality" means taking judicious decisions (as is done in neo-classical economics), but with limited personal capacity to process information. an "opportunistic" person is self-seeking with guile. such a person can mislead with information that is difficult to ascertain. the cost of dealing with such people cannot be easily determined, and there may be differences between prior expectations and actual behaviour. even with credible commitments from, and frequent transactions with, such a person, it may be cheaper to employ than to buy from the person. employment means making while buying means market transactions. must lead to patent factors, and in deciding what to make and what to buy, williamson says that frequency of transactions, investment characteristics and uncertainty are important while uncertainty and frequency of transactions have standard meanings, investment characteristics need some elaboration. investment characteristics are specific stakes of parties to a transaction. put another way, investment characteristics measure the amount put into a particular deal. williamson gives four investment characteristics, also called specificities. these are site-specific, physical asset-specific, human asset-specific and dedicated assets. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 434 sajems ns vol 2 {i 999) no 3 site-specific is where location, once undertaken, is costly to change, for example locating a coal-frred electricity generating station near a particular coal-mine. physical asset-specific is where special equipment has to be made for the process alone. human asset-specific is where people have special skills not easily transferred. dedicated asset is where a facility is made in response to a specific customer, for example, a supplier building a plant to smelt ore for an aluminium buyer. for the situation given in section 2, the manager is not concerned with decisions that occur infrequently and do not allow reviewing the decision after locating the plant, so we eliminate site-specificity and dedicated assets. the manager, in the situation using the coase-williamson approach, would have the following as important factors: from neo-classical analysis: costs, volume effects, and from tce: physical asset-specificity, human asset-specificity, and uncertainty this approach advocates that the manager, undertaking frequent transactions, should follow the prescriptions ofneo-classical theory and: buy with ordinary contracts when investment characteristics are nonspecific, make when investment characteristics are unique and build relationships7, and make when there are high levels of uncertainty. should accord with/actors cited by practitioners as important consider the factors relative to those in table 4. cost and volume effects are repeated. resource skills and facilities are found in human and physical assetspecificities, respectively. uncertainty may be reflected in reliability. thus factors outlined mirror the practitioners' most highly ranked reasons for the make-buy decision. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 435 given both the evidence from practitioners and the theories outlined above, the coase-williamson theory (williamson, 1985) or transactions cost economics (tce) is currently the most attractive make-buy theory for the given situations. 6 conclusion we advocate that the manger, in the situation described, uses the coasewilliamson theory. it allows the make-buy question to be asked and answered, leads to patent factors and accords with the factors cited by practitioners as important. augmenting neo-classical economics, it forms a secure basis for the make-buy decision described. in addition, the manager may wish to enhance this by the resource-based theory prescription to make parts and processes at the core of the firm and monitor further developments in this area. appendixl practitioners' views of making and buying some published literature shows that practitioners advocate either making or buying. current articles were selected to cover both service and product elements. these studies are summarised in table ai, showing sources and reasons for making or buying. as far as possible, authors' original terms have been retained. in table ai, columns are arranged as follows: the sources ofthe study comprising the names of the author(s), task considered for making and/or buying, and where the study is undertaken, are in the first column. the second column has factors important in coming to the decision whether to make or buy. words are interspersed with letters from (a) to (i) corresponding to factors. these are transferred to the last nine columns a to i. the rows in table al are divided into factors which managers control, called endogenous, and factors where managerial control is tenuous (e.g. legislation), called exogenous. total frequencies for each column a to i give an idea of the importance of a factor in this sample for the make-buy decision. by total frequencies, practitioners cite cost, volume, speed and then competence as important in make-buy decisions. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . table al practitioners' factors for making and buying sources of study reasons given for making or buying author; task (group); area buy-; make-; make or buy decision factors factors (see ke below) endogenous service abc d e f g h i smith (1996: 40); buycost (a) effective and rapidly i i i developing integrated implemented (d) financial accounting makethe company has the more systems; canada understanding of problemsinefficiencies, inadequacies and loss of competitive edge (b) anthes (1997: 75); internet buya fast start-up is important (d), skills are i i i i i i i functions; us companies lacking internally (f), an outsourcer has better security arrangements (g), and high reliability and round-the-clock coverage is needed (h) (that cannot be provided in-house). makeservices are of strategic importance (e) and the company demands maximum control, services are ill-defined (b), the company demands, and can provide in-house, rapid change to design and content (d), and the company can do it more cost-effectively (a). malloy (1997: 88); is makesecurity fears (g), equipment and i managers; training investments and lack of trust (g) in keep is holding on to remote access. (other deterrents include investment already in equipment and employee training). """ i.>j 0'1 ~ en z en £ n --\0 \0 ~ ~ i.>j r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . table al continued sources of study reasons given for making or buyina author; task (group); area }juy-; make-; make or buy decision factors factors (see ke below) kiely, (1997: 11-12); buyescalating number of service providers i i business processes that it allows buyers to bargain on price (a), and many supports, e.g. billing and service providers are able to handle bigger, logistics management; more complex work (c). endogenous product "make or buy? research buydomestic suppliers cannot meet all the i findings", (1996: 28); competitive needs of consumers (volume) (c) ciotlli!tgind~try; uk johnson and leenders, decision to make or buy-volume is dominant i (1997: 20-6); ferrous scrap (c) gain (1997: sio-s16); buyto reduce costs (a) and increase the speed i i pharmaceutical and of delivery of new products to market (d) ~ticide' us_ moore (1996: 28-31); decision to make or buy. buy special-purpose i i i making bar code labels; labels special services, volumes (c) are low us companies and/or orders intermittent, cost (a), and performance (b). haner (1997: 80, 78); buyexpanding capacity in the corporate i 1 1 i i appliance industry product environment such as a lack of specialised development; us. experience (f), the inherent nature of the corporate structure and culture (i) makefirm is more competitive. managers focus their firm's resources on core competencies (e) and can save costs (a), time _ (d), and other resources (f) cil ~ ~ cil z cil e: n ,-, ~ ~ w .jl. w -...) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . table at continued sources or study reasonse:iven ror making or buying author; task (group); area f-exogenous buy-; make-; make or buy decision factors johnson and leenders decision to make or buygovernment (1997: 20-26); ferrous regulations, competitive pressures, and public scrap; us plants opillion (b) ferguson (1996: 34-36); decision to make or buychanging from electrical undertakings; regulated to unregulated (b) us. exogenous & endogenous kurokawa (1997: 124decision to make or buynumber of rivals 134); r&d; japan and us expected to develop a similar product (b) and high tech industries needed technology is less related to a firm's core technology (endogenous) (e) total frequency column key factors (a) is cost including price (b) is other factors not specified elsewhere (c) is volume including demand (d) is speed (f) is inadequate resources (0) is trust, security and theft (h) is reliability (i) is corporate structure and culture (e) is competence, strategy or strategic factors (see ke below} 1 1 1 1 6 6 4 4 3 3 2 1 1 e 00 ; cil z cil g: t-..:.i ....... -~ $ ~ 1..1.) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 439 endnotes 1 it may ensure that the part or process is not stolen! 2 this is part of the industrial make vs buy decisions (research grant number grll63013) being conducted at cambridge university. 3 there are alternate classifications, e.g. teece et al. (1997: 527) 4 the dynamic capabilities model by teece et af. (1997) has not had time to be empirically tested and is excluded. 5 penrose's theory is a growth dynamic theory whilst neo-classical theory is a static profit maximisation theory. 6 venkatesan's (1992) well-cited case of whether to make or not, maintains the status quo. 7 williamson advocates forming alliances when investment characteristics are at a mixed stage. 8 tce or the coase-williamson theory, has roots in neo-classical economics therefore, no clash is expected when including neo-classical theory factors. references anthes, g.h. (1997). "ousourcing pros and cons". computerworld, 31(14): 75. 2 chesborough, h.w. and teece, dj. (1996) "when is virtual virtuous, organizing for innovation". harvard business review, 74(1): 65-73. 3 conner, k.r., (1991) "a historical comparison of resource-based theory and the five schools of thought within industrial organization economics: do we have a new theory of the firm?" journal of management, 17(1): 121-54. 4 drtina, p.e., (1994) "the outsourcing decision". management accounting (us), 75(9): 52-62. 5 fergusson j.s., (1996) "transmission or distribution? reengineering cost-of-service studies for the emerging competitive market", public utilities fortnightly, 134(3). 6 gain, b., (1997) "custom manufacturing takes off', chemical week, custom manufacturing profiles supplement, may 14: sio-s16. 7 haner, r. (1997) "smart outsourcing: product development". appliance manufacturer, 45(4): 80 & 78. 8 hay, d.a. and morris, d.k. (1991) industrial economics and organization theory and evidence, oxford university press, oxford. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 440 sajems ns vol 2 (1999) no 3 9 johnson, p.f. and leenders, m.r. (1997) "make-or-huy alternatives in plant disposition strategies", international journal of purchasing and materials management, vol. 33: 20-6. 10 klel y, t. (1997) "business processes: consider outsourcing", harvard business review, vol. 75(3): 11-12. ii kuroka w a, s. (1997) "make-or-buy decisions in r&d: small technology based firms in the united states and japan", ieee transactions on engineering management 44 (2)": 124-34. 12 loasby, b.s., (1976) choice, complexity and ignorance, c.u.p., cambridge. 13 machlup, f. (1967) ''theories of the firm: marginalist, behavioral, managerial", the american economic review, 57(1): 1-33. 14 maijoor, s. and van witteloostjuin, a. (1996) "an empirical test of the resource based theory: strategic regulation in the dutch audit industry" strategic management journal, 17(7): 549-69. 15 "make or buy? research findings" (1996) logistics focus, 4(2). 16 malloy, a. (1997) ''the outsourcing option", computerworld, 31(8): 88. 17 mcgahan, a.m. & porter, m.e. (1997) "how much does industry matter really?", strategic management journal, 18(special issue): 15-30. 18 moore, b. (1996) "bar code labels: make or buy?", automatic ld. news, 12(3): 28-31. 19 newell, a. (1996). "selected environmental uncertainties, manufacturing flexibility and subcontracting" msc(eng) research report, faculty of engineering, university of the witwatersrand, johannesburg, unpublished. 20 peltzman, s. (1991) ''the handbook of industrial organization: a review article",journal of political economy, 99( 1): 201-17. 21 penrose, e. (1959) the theory of the growth of the firm, o.u.p., oxford. 22 prahalad, c.k. & hamel, g. (1990) ''the core competence of the corporation". harvard business review, 68(3): 79-91. 23 quinn, j.b. & hilmer, f.g. (1994) "strategic outsourcing", sloan management review, 35(4): 43-55. 24 smith, g. (1996) ''the make-or-buy dilemma", computing canada 22(17): 40. 25 teece, dj., pisano, g. and shuen, a. (1997) "dynamic capabilities and strategic management", strategic management journal, 18(7): 509-53 26 venkatesan, r. (1992) "strategic sourcing to make or not to make", harvard business review, 70(6): 98-107. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 441 27 williamson, o.e. (1979) "transaction cost economics: the governance of contractual relations", journal of law and economics, 22(2): 233-61. 28 williamson, o.e. (1985) the economic institutions of capitalism, the free press, new york. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction methodology framework data and analysis results conclusions and discussion acknowledgements references appendix 1 appendix 2 about the author(s) paul mokilane council for scientific and industrial research, pretoria, south africa school of statistics and actuarial science, university of the witwatersrand, south africa jacky galpin school of statistics and actuarial science, university of the witwatersrand, south africa v.s. sarma yadavalli department of industrial and systems engineering, school of engineering, university of pretoria, south africa provesh debba council for scientific and industrial research, pretoria, south africa school of statistics and actuarial science, university of the witwatersrand, south africa renee koen council for scientific and industrial research, pretoria, south africa siphamandla sibiya council for scientific and industrial research, pretoria, south africa citation mokilane, p., galpin, j., yadavalli, v.s.s., debba, p., koen, r., sibiya, s., 2018, ‘density forecasting for long-term electricity demand in south africa using quantile regression’, south african journal of economic and management sciences 21(1), a1757. https://doi.org/10.4102/sajems.v21i1.1757 original research density forecasting for long-term electricity demand in south africa using quantile regression paul mokilane, jacky galpin, v.s. sarma yadavalli, provesh debba, renee koen, siphamandla sibiya received: 20 jan. 2017; accepted: 14 sept. 2017; published: 27 mar. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: this study involves forecasting electricity demand for long-term planning purposes. long-term forecasts for hourly electricity demands from 2006 to 2023 are done with in-sample forecasts from 2006 to 2012 and out-of-sample forecasts from 2013 to 2023. quantile regression (qr) is used to forecast hourly electricity demand at various percentiles. three contributions of this study are (1) that qr is used to generate long-term forecasts of the full distribution per hour of electricity demand in south africa; (2) variabilities in the forecasts are evaluated and uncertainties around the forecasts can be assessed as the full demand distribution is forecasted and (3) probabilities of exceedance can be calculated, such as the probability of future peak demand exceeding certain levels of demand. a case study, in which forecasted electricity demands over the long-term horizon were developed using south african electricity demand data, is discussed. aim: the aim of the study was: (1) to apply a quantile regression (qr) model to forecast hourly distribution of electricity demand in south africa; (2) to investigate variabilities in the forecasts and evaluate uncertainties around point forecasts and (3) to determine whether the future peak electricity demands are likely to increase or decrease. setting: the study explored the probabilistic forecasting of electricity demand in south africa. methods: the future hourly electricity demands were forecasted at 0.01, 0.02, 0.03, … , 0.99 quantiles of the distribution using qr, hence each hour of the day would have 99 forecasted future hourly demands, instead of forecasting just a single overall hourly demand as in the case of ols. results: the findings are that the future distributions of hourly demands and peak daily demands would be more likely to shift towards lower demands over the years until 2023 and that qr gives accurate long-term point forecasts with the peak demands well forecasted. conclusion: qr gives forecasts at all percentiles of the distribution, allowing the potential variabilities in the forecasts to be evaluated by comparing the 50th percentile forecasts with the forecasts at other percentiles. additional planning information, such as expected pattern shifts and probable peak values, could also be obtained from the forecasts produced by the qr model, while such information would not easily be obtained from other forecasting approaches. the forecasted electricity demand distribution closely matched the actual demand distribution between 2012 and 2015. therefore, the forecasted demand distribution is expected to continue representing the actual demand distribution until 2023. using a qr approach to obtain long-term forecasts of hourly load profile patterns is, therefore, recommended. introduction electricity load is the amount of electricity that balances the amount generated with that drawn from the grid. in the absence of black-outs, load-shedding and the availability of electricity generated from renewable electricity sources, the electricity load is equivalent to the electricity demand. therefore, in this study, the hourly electricity demand is defined as the amount of electricity (load) in kw sent out every hour by eskom to meet consumers’ demand. the 1996 census showed that only 57.6% of the south african households had access to electricity for lighting (statistics south africa 1998). the 2001 census showed that this percentage went up to 70.2% (lehohla 2005). the 2007 community survey indicated that 80.1% of the south african households had access to electricity for lighting (statistics south africa 2008). the 2011 census showed that this percentage went up to 84.7% (statistics south africa 2011). these censuses and surveys indicate that the high percentages of new households that were connected to the electricity grid between 1996 and 2007 would imply that residential electricity demand would be expected to have increased during the same period. the percentage of new households connected to the grid stabilised between 2007 and 2011 and, therefore, residential electricity demand would be expected to have stabilised during this period. the shrinking south african economic growth between 2007 and 2015 could have contributed to a decline in electricity demand: south africa experienced an average growth rate of approximately 5% in real terms between 2004 and 2007. however, the period 2008 to 2012 only recorded average growth of just above 2%. (statistics south africa n.d.) the penetration of other sources of electricity such as renewables for example solar and wind, could also have contributed to a decline in electricity demand from eskom. in addition, because of the lack of capacity in the generation of electricity experienced by eskom in 2007 (inglesi & pouris 2010), some companies and households had to find other sources of electricity, which would have resulted in a decline in electricity demand from eskom. unfortunately, the actual size of the electricity demand market is still unknown because of the unavailability of certain types of data, such as renewable energy and other forms of electricity generation. the combined effect of all these changes in the demography, economy and usage patterns can be investigated using historical patterns, but contribute to uncertainties when trying to forecast future electricity demand. uncertainties occur in estimation, prediction or in forecasting. when statisticians develop predictions (forecasts) for an uncertain future, they need to quantify the uncertainties around these for those that have to make decisions in the face of those uncertainties. sigauke (2014) indicates that uncertainties in future electricity demand could emanate from increased technologies making use of electricity, population growth, general randomness in individual usage of electricity, seasonal effects, prevailing economic patterns, change in weather conditions, escalating costs, use of power saving electrical appliances and the growing sources of renewable energies. the inherent uncertainties in predictions imply that forecasts should ideally be probabilistic; in other words, they should take the form of probability distributions over future quantities or events (gneiting & katzfuss 2014). probabilistic forecasts could take the form of quantiles, prediction intervals or density forecasts to quantify uncertainties in predictions. they are an essential ingredient of optimal decision-making (gneiting & katzfuss 2014). it is important to quantify the uncertainties around the demand forecasts for planning purposes, to avoid building unnecessary infrastructure and to ensure that future electricity demand is met. tay and wallis (2000) define density forecasts of the realisation of a random variable at some future time as estimates of the probability distribution of the possible future values of that variable. hong, wilson and xie (2014) argue that forecasting is by nature a stochastic problem, but that most of the utilities are still developing and using point forecasts. they state that it would be better to use probabilistic forecasts that provide estimates of the full distribution of the possible future values as a way of quantifying the uncertainties in the forecasts. in the late 1880s, when lighting was the sole end use of electricity, the forecasting of electricity demand was straightforward (hong & shahidehpour 2015). power generating companies would count the number of light bulbs they installed and planned to install and they would then roughly estimate the level of demand in the evening. as electric appliances such as electric irons, radios, television sets, geysers, stoves and washing machines were invented and commonly used in many households, the complexity of forecasting electricity demand grew. the penetration of air conditioners into homes and offices to regulate temperature within comfort zones, and industrial uses of electricity became important drivers of electricity demand. these drivers of electricity demand add complexity in electricity demand forecasting and create uncertainties around the forecasts. electricity forecasting methods have evolved from counting light bulbs and engineering approaches which were based on the use of charts and tables, to manually forecasting future demand, to sophisticated forecasting techniques. the availability of powerful computers and statistical software today enables forecasters to produce more accurate forecasts through sophisticated forecasting methods. electricity demand forecasts can be developed for short, mediumor long-term horizons, and they could be provided as point forecasts, which give one value at each time interval, or as probabilistic forecasts which give a full distribution of future values and therefore allow the assessment of uncertainties around the forecasts. quantification of uncertainties around forecasts is even more important for long-term forecasts, because, as sigauke and chikobvu (2011) indicated, long-term decision-making in the electricity sector involves planning under substantial uncertainty. in the literature to date, short-term electricity demand forecasting has attracted substantial attention because of its importance for power system control, unit commitment and electricity markets. mediumand long-term forecasting have not received much attention, despite their value for system planning and budget allocation (hyndman & fan 2010). international literature on probabilistic load forecasting is very limited, and for load forecasting it is still dominated by short-term point forecasting. there are some literature available on long-term forecasting of annual electricity demand as well as peak electricity demand in south africa (inglesi-lotz 2011; koen, magadla & mokilane 2014; rasuba, khuluse & elphinstone 2010; sigauke 2014; sigauke & chikobvu 2011; ziramba 2008). the models used to forecast electricity demand in south africa do not forecast the full distribution of demand and most of them are for short-term electricity demand (sigauke 2014 among others). the objectives of the study were (1) to apply a quantile regression (qr) model to forecast hourly distribution of electricity demand in south africa; (2) to investigate variabilities in the forecasts and evaluate uncertainties around point forecasts and (3) to determine whether the future peak electricity demands are likely to increase or decrease. methodology framework weron and misiorek (2004) indicate that forecasting models could be classified into two broad streams: those that use statistical methods (e.g., multiple regression, autoregressive (ar), autoregressive integrated moving average [arima], autoregressive generalised autoregressive conditional heteroscedasticity [ar-garch], jump diffusion, factor models, regime switching models, multilevel models, mixed models and semi-parametric models) and those that use computational intelligence techniques (such as fuzzy techniques, support vector machines and, in particular, artificial neural networks [anns]). statistical methods differ from ann in that the former forecast the current value of a variable by using mathematical combination of the previous values of that variable and sometimes the previous values of exogenous factors (weron & misiorek 2004). weron and misiorek (2004) pointed out that the reviewers of ann-based forecasting systems have concluded that much work still needs to be conducted before they are accepted as established forecasting techniques. ann is considered a black-box modelling approach. in electricity demand forecasting, statistical models are attractive because physical interpretation may be attached to their components, and hence allow forecasters to understand behaviour (weron & misiorek 2004). suganthi and samuel (2012) give a comprehensive review of demand forecasting models which are commonly used in the energy sector. electricity demand data consist of a sequence of observations collected over equally spaced time periods (hourly) with no missing data. the observations are serially correlated. statistical modelling approaches for forecasting electricity demand can be divided into three main groups. firstly, there are approaches which consider demand as a univariate time series, that is, a load forecasting process which results in one forecasted value at each step, or point forecasts. secondly, there are approaches which take each intraday period as a separate parametric regression and estimate each model’s parameters separately, ignoring the intraday correlation in the process. thirdly, there are approaches which consider each intraday period as a separate parametric regression model and estimate model parameters together in a way that takes the intraday correlations into consideration. within the univariate time series framework, the stochastic nature of electricity demand as a function of time has frequently been modelled with seasonal autoregressive integrated moving average (sarima) and state space models (taylor, de menezes & mcsharry 2006). mostly, electricity data exhibit not only non-constant mean and variance, but also multiple seasonalities corresponding to daily, weekly, monthly and yearly periodicity. the assumption of homoscedasticity in sarima models is also inappropriate for the forecasting of electricity demand. furthermore, sarima models are used for point forecasting and cannot forecast the full demand distribution. sarima models could be extended to a sarima-garch model to account for the possibility of heteroscedasticity. a garch modelling approach could be used to capture potential conditional heteroscedasticity in electricity data (byström 2005; taylor 2006). however, this modelling approach does not accommodate exogenous drivers of electricity demand, and is used for point forecasting. seasonal autoregressive integrated moving average with exogenous variables (sarimax) models, also known as regression-sarima, have been used in load forecasting in order to incorporate important drivers of demand such as calendar variables and temperature (bunn 1982; suganthi & samuel 2012; weron 2007). this method uses an ordinary least squares regression (ols) model which may be affected by outliers and could underestimate the peaks as it models the mean of the distribution. structural time series (sts) models have also been successfully used in demand forecasting. sts modelling was developed by harvey (1990) and it involves the decomposition of a time series into trend, seasonality, cycle and irregular (noise) components. this modelling approach can accommodate drivers of electricity demand like temperature, but is also used for point forecasting. hyndman and fan (2010) propose a semi-parametric additive model in the regression framework, but which includes nonlinear relationships and serially correlated errors. the proposed models allow for nonlinear and non-parametric terms using the framework of additive models. the authors applied this method to develop long-term probabilistic load forecasts. ols regression models model the relationship between covariates x and the conditional mean of a response variable y given x = x. koenker and bassett (1978) argue that what the regression curve does, is to give a summary for the averages of the distributions corresponding to the set of xs. one could go further and compute several different regression curves corresponding to the various percentage points of the distribution and thus get a more complete picture of the set (koenker & bassett 1978). ordinarily this is not done, and so regression often gives a rather incomplete picture. in forecasting electricity demand, least squares regression models the mean of the electricity demand as the dependent variable. ols regression determines coefficients α0 and αi which minimise . to apply an ols regression model, the data must meet stringent assumptions, such as that the residuals should be normally distributed, the observations should be independent and the variance of the residuals should be homoscedastic. as we are dealing with time series data the observations are not independent, and for electricity demand data, the variance is heteroscedastic. therefore, some assumptions of ols are violated in the time series data used in this study. in this article, qr is proposed for developing long-term probabilistic forecasts. qr was developed as an extension of ols regression for estimating rates of change in all parts of the distribution of the response variable (cade & noon 2003). qr offers a comprehensive strategy for completing the regression picture and it has been applied in ecology (cade & noon 2003). qr has been widely used in financial economics where the data are volatile and extremes are important to study. gibbons and faruqui (2014) applied qr methodology for forecasting the annual peak electricity demand. cornec (2014) proposes qr as a way of estimating the distribution of forecasts, and uses the dispersion of the estimated quantiles for calculating an uncertainty index. qr imposes no normality assumption, allowing, for example, for fat-tailed distributions, which is useful for forecasting extreme events. in electricity demand forecasting, qr can be used to model the median, the 1st, 5th, 10th, 90th, 95th and 99th percentiles or all quantiles to describe the full distribution of forecasted electricity demand at each hour. qr attempts to find the coefficients a0 and ai which minimises . qr does not require any distribution assumptions regarding the population and can estimate the parameters non-parametrically (koenker & bassett 1982). a linear model for the τth quantile is given by: where is the transposed (indicated by t) design matrix (matrix of covariates), β is the regression coefficients and the τth quantile of ϵi is assumed to be zero. the standard qr model is given by: where is the conditional τth quantile of the response (yi) given the covariate (xi) and qτ(y|x) is non-decreasing function of τ for any given x. β is the vector of parameters and is the marginal change in the quantile because of the marginal change in xi in estimating the qr model for a given quantile, we follow the ideas of koenker (2005) and yue and rue (2011) who used the standard approach of koenker and bassett (1978) to estimate their qr model. qr minimises the tilted absolute function ρτ(.), which they called the check-function (maistre, lavergne & patilea 2017), which asymmetrically weights residuals from the model to a degree that depends upon τ. ρτ(ϵ) is a continuous piecewise linear function and non-differentiable at ϵ = 0 but differentiable everywhere else (has directional derivative in all directions) (yue & rue 2011). this check-function ensures that all ρτ are positive and the scale is based on the probability τ. a linear model is estimated by solving: this concept is extendable to any quantile, such as the 75th, 90th and 99th percentile. the qr estimator for β at quantile τ minimises the objective function: this is a non-differentiable function and there is no closed-form solution for ; instead these parameters can be found using a linear programming algorithm (gibbons & faruqui 2014). the minimisation is done for each subsection defined by ρτ, where the estimate of the τth quantile function is achieved with the parametric function . features that characterise qr and differentiate it from other regression methods are: qr computes several different regression curves corresponding to the various percentile points of the distribution and thus provides a more complete picture of the relationship between the response variable and the covariates. heteroscedasticity can be detected and, if the data are heteroscedastic, median regression estimators can be used instead of mean regression estimators. median regression is more robust to outliers than other regression methods that use mean estimators, and it is semi-parametric, therefore, avoiding assumptions about the parametric distribution of the error process. qr is, therefore, considered to be more suitable than other methods, given the type of data used, as well as its ability to provide the full distribution of forecasted electricity demand. data and analysis the hourly electricity demand data for south africa for the period 1997–2015 was provided by eskom. for developing the long-term forecasting model, a transformed series was developed using a logarithmic transformation. the logarithmic transformation is convenient for turning a highly skewed variable into one that is more approximately normal (benoit 2011). hourly demands were forecasted from 2006 to 2023. the data from 2013 to 2015 were withheld in order to validate the model. the forecasts from 2006 to 2012 were then used as in-sample forecasts, whereas the forecasts from 2013 to 2023 were out of sample forecasts. various time-related variables were used as covariates, namely day, public holidays, months, weekends, december break and seasons (see table 1 for details). lagged demand variables were included in the model to test whether suspected lagged demand effects from the high degree of diurnal activity in electricity usage were significant, that is, whether the south african consumers of electricity typically exhibit consistent daily patterns of usage (as in farland 2013). for example, in the afternoon when people return from work, around 19:00, they start cooking, watch tv and take bath and at this time the household electricity demand could go up. fourier series or harmonic terms were used, where applicable, to capture the cycles inherent in the demand data. table 1: variables used in the quantile regression. the future hourly electricity demands were forecasted at 0.01, 0.02, 0.03, … , 0.99 quantiles of the distribution using qr, hence each hour of the day would have 99 forecasted future hourly demands, instead of forecasting just a single overall hourly demand as in the case of ols. to avoid graphs that are too busy and difficult to read, only the 1st, 50th and the 99th percentile graphs are shown and discussed. the uncertainties in the forecasts are captured by the interval between the 1st and 99th percentiles of the demand distribution, as this is the interval into which 98% of the possible future hourly demands are expected to fall. the wider the interval, the more uncertain we are about the forecasted hourly demand as the variability between the forecasts would be very high. the forecasts at the 50th percentile (median) are important because they could be used as point forecasts, namely, our best guess of demand at that certain hour. the density functions give the full distribution of the hourly electricity demand. the probability of the hourly demand between the two demand points say, ‘a’ and ‘b’, is the area under the demand density function between the two points. the area could be calculated by integrating the density function between the two points. the probability of exceedance relates to the probability of electricity demand exceeding the specified hourly demand and this could also be calculated by integrating the density function from the specified demand and upwards. the forecasted density demand functions between 2013 and 2023 are compared. if the density curves shift towards the higher demands over time, then an increase in future hourly demand is expected. if the shift is towards smaller demands over time, then the decrease in future hourly demand is expected. the south african electricity demand has two daily peaks, especially noticeable in winter, namely a morning demand peak at around 08:00 and an afternoon demand peak at around 19:00. as the winter peak represents the highest annual demand, this is important for planning electricity generation. therefore, it is important to examine the demand densities of both morning and afternoon peak forecasts over the years. the morning peak density demand is generated from all possible demand forecasts at 07:00, 08:00 and 09:00, whereas the afternoon peak density demand is generated from all possible demand forecasts at 18:00, 19:00 and 20:00. the probability of the future peak electricity demand exceeding a certain value was then calculated by integrating the density functions. the performance of the qr model is evaluated by comparing the predicted demand density functions with the actual demand density functions. the predicted demand density is generated from all demand forecasts from 1st to 99th percentile of the demand distribution. if the forecasted demand density function closely tracks the actual demand density, then it shows that the model is forecasting well and it is, therefore, reliable. the model is also evaluated by observing the closeness of the actual demand distribution to the predicted lower and upper 99% interval. if the interval is narrow, then the predictions exhibit sharpness. the mean absolute percentage error (mape) is used to compare the forecasts at the 50th percentile with the actual demands; this is mainly to determine how far the point forecasts are from the actual demands. figures 1 and 2 depict the time series of the actual and logarithmic hourly demands, respectively, for the hourly electricity demand over the 1997–2015 period. during this period the highest demand reached was 36 826 kw in 2011, whereas the minimum was 13 533 kw in 1998. figure 1: electricity demand between 1997 and 2015 in south africa. figure 2: adjusted electricity demand between 1997 and 2015 in south africa. the historical demand data from 1997 to 2015 indicate that the demand for electricity increased steadily between 1997 and 2007 (figure 1). during this period, south africa experienced accelerated economic growth and a large number of new households were connected to the grid as government wanted to make electricity accessible to all south africans. the electricity demand from eskom stabilised between 2007 and 2012 and started declining in the latest 4 years until 2015 (see figure 1). the decline in electricity demand from eskom could partly be attributed to the shrinking economic growth between 2007 and 2015 and the growth of renewable sources of electricity. table 1 provides a summary of all the variables considered in the modelling of hourly demand. the demand data have periods 6, 12, 18 and 24 as shown in figure 1-a2. the fourier series terms were formed using these periods. results model assessment for each hour, the demand at the 1st to 99th percentiles was forecasted from 2006 to 2023, which translated into the full demand distribution being forecasted. the actual and predicted demand densities between 2012 and 2015 illustrated in figure 3 were used to assess the model fit. if the predicted demand distribution is close to the actual demand distribution, then the forecasts are considered to be reliable. the closer the 1st and the 99th percentile points are to the actual demand, the better it is and this indicates the sharpness of the forecasts (figures 4–6). the sharpness of the forecasts refers to how tightly the predicted distribution covers the actual distribution. figure 3: comparison of actual and forecasted demand distributions: (a) 2012; (b) 2013; (c) 2014 and (d) 2015. figure 4: distribution of forecasted daily electricity demand: (a) 22 june 2013, (b) 23 june 2013, (c) 24 june 2013, (d) 25 june 2013. figure 5: distribution of forecasted daily electricity demand: (a) 22 june 2014, (b) 23 june 2014, (c) 24 june 2014, (d) 25 june 2014. figure 6: distribution of forecasted daily electricity demand: (a) 22 june 2015, (b) 23 june 2015, (c) 24 june 2015, (d) 25 june 2015. the mape between the hourly demand forecasts at the 50th percentile and the actual hourly demand over the period of 4 years were below 5% and the overall mape was 2.77%, as shown in table 2-a1. lewis (1982) indicates that a mape of less than 10% can be classified as a highly accurate forecast. the qr model therefore provides very good demand forecasts at the 50th percentile. further confirmation of the suitability of fit of the qr model is obtained by comparing the actual values to the full range of quantile predictions. model estimates for illustration purposes, estimates for only three of the qr models (at 0.01, 0.5 and 0.99 quantile levels) are given in table 1-a1. at the 5% level of significance, some variables in table 1-a1 are significant at the certain percentile of the demand distribution, but insignificant at others. for example, at the 5% level of significance, the variable ‘month1’ is significant at the 1st percentile, but not significant at the 99th percentile of the distribution. probabilistic forecasts of the daily profiles over the years for illustration purposes, 4 days in june (22–25 june) were selected and their results from 2013 to 2015 were discussed. (note that june falls in the high-demand winter period of the year.) the different panels in figure 4 give the hourly electricity demand of each of the 4 days in 2013. for each day, the green circles represents hourly demands at the 1st percentile level of the distribution; these are the points below which 1% of all possible future hourly demands are expected to fall. the grey line represents future hourly demands at the 99th percentile of the demand distribution; these are the points above which 1% of the future hourly demands would fall and below which 99% of all possible future hourly demands are expected to fall. the blue circles represent the forecasted hourly demands at the 50th percentile and the red circles represent the actual hourly demands. figures 5 and 6 give the hourly demand forecasts for the same 3 days in 2014 and 2015, respectively. figures 4–6 confirm that the demand forecasts at the 50th percentile are close to the actual hourly electricity demand in winter. in addition to just using the 50th percentile as a ‘best guess’ or point forecast, information contained in the other quantile forecasts produce probabilistic information which may also be useful in the planning process. it can be seen from figures 4–6 that the interval between the 1st and the 99th quantiles was in fact fairly narrow, and therefore the uncertainties around the point forecasts were not too large. using probabilistic forecasts of hourly demand distributions for comparing demand over the years the hourly electricity demand distribution in south africa is bimodal as shown in figure 7. by comparing the demand density functions over the years, insight into expected shifts in patterns can be obtained. the forecasted demand distributions obtained from the qr models for the period investigated suggest that the hourly electricity demand from eskom is more likely to shift towards lower demands over the years until 2023 (figure 7). the apparent year to year decline in electricity demand from eskom between 2012 and 2015, among others, could be attributed to the increase in the number of households and companies generating their own electricity through renewable energies, the shrinking economic growth and the increase in electricity prices. the renewable electricity market in south africa is growing. figure 7: distribution of forecasted hourly demand between 2013 and 2023. in addition, the forecasted hourly density demands (in figures 7–9) could be used to calculate the probabilities of exceedance, for example, the probability of hourly demand exceeding 32 860 kw (exp[10.4]). this probability of exceedance can be calculated from the area under the density curve comprising all demands ranging from 32 860 kw and above, and the area can be computed by integrating the density functions in figure 7. the probability of demand exceeding 32 860 kw is less likely in 2023 than it is in any previous year while 2015 had the highest probability of demand exceeding 32 860 kw in the period between 2013 and 2023 as shown in figure 7. figure 8: the morning peak demand distributions. figure 9: the afternoon peak demand distributions. finally, the forecasts obtained from qr can be used to investigate the expected future peak demands and their probability of exceedance over the years. the annual peak demands are very important for planning purposes, as these represent the maximum that would need to be supplied in an hour and if the power generating company could meet the daily peak hourly demand, it could meet any hourly demand. figures 8 and 9 suggest that the morning and afternoon peak demand distributions are more likely to shift towards lower demands over the years until 2023. conclusions and discussion the daily electricity demand in south africa generally has two peaks, more noticeable during winter than summer seasons. the morning demand peak occurs at around 08:00 and the afternoon demand peak at around 19:00. ols would most likely underestimate the peaks as it models the mean of the demand distribution while qr models demand at all percentiles of the demand distribution and therefore can provide better peak forecasts. in addition, as qr gives the full hourly demand distribution, the uncertainties around the forecasts are quantifiable. while the best guess of the future hourly electricity demand can be obtained from forecasted demands at the 50th percentile, qr gives forecasts at all percentiles of the distribution, allowing the potential variabilities in the forecasts to be evaluated by comparing the 50th percentile forecasts with the forecasts at other percentiles. additional planning information, such as expected pattern shifts and probable peak values, could also be obtained from the forecasts produced by the qr model, while such information would not easily be obtained from other forecasting approaches. the first important finding presented in this article is that the demand forecasts at the 50th percentile from the qr model closely estimate the actual hourly demands (see the red and blue circles in figure 4–6 and the mape values in table 2-a1 in appendix 1). the second important finding is that the distributions of hourly demand and the peak daily demand in south africa are shifting towards lower demands over the years until 2023 as shown in figures 7–9. the third finding is that qr allows the assessment of uncertainties around point forecasts. this was illustrated by calculating the probability of forecasted hourly density demands (in figures 7–9) exceeding 32 860 kw. the probability of demand exceeding 32 860 kw was found to be less likely in 2023 than in any previous year. the forecasted electricity demand distribution closely matched the actual demand distribution between 2012 and 2015 as shown in figure 3. therefore, the forecasted demand distribution is expected to continue representing the actual demand distribution until 2023. using a qr approach to obtain long-term forecasts of hourly load profile patterns is, therefore, recommended. acknowledgements the research was conducted during a contract research project funded by eskom. the researchers would therefore like to thank eskom for funding the research, and we would also like to thank the following eskom staff members for the supply of data: moonlight mbata and ntokozo sigwebela. i would also like to thank the following csir staff members for their technical support: nontembeko dudeni-tlhone and nosizo sebake. competing interests the authors declare that they have no financial or personal relationship(s) that may have inappropriately influenced them in writing this article. authors’ contributions p.m. was the project leader. did the analysis and wrote the paper. p.d, j.g. and v.s.s. were supervisors for p.m.’s phd and gave guidance and critically read the paper. all authors edited the article. r.k. gave guidance, assisted in the writing of conclusions, proofread and did the final editing of the paper. s.s. helped with 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weron, r. & misiorek, a., 2004, ‘modeling and forecasting electricity loads: a comparison’, international conference eem-04 proceedings, september 20–22, 2004, poland, pp. 135–142. yue, y.r. & rue, h., 2011, ‘bayesian inference for additive mixed quantile regression models’, computational statistics & data analysis 55(1), 84–96. https://doi.org/10.1016/j.csda.2010.05.006 ziramba, e., 2008, ‘the demand for residential electricity in south africa’, energy policy 36(9), 3460–3466. https://doi.org/10.1016/j.enpol.2008.05.026 appendix 1 table 1-a1: selected quantile regression models. table 2-a1: mean absolute percentage error – forecasts at the 50th percentile. appendix 2 figure 1-a2: the autocorrelation plot: correlation of hourly electricity demand data. abstract introduction research questions literature survey research design research results discussion conclusions acknowledgements references appendix 1 about the author(s) haydn du plessis postgraduate school of engineering management, faculty of engineering and the built environment, university of johannesburg, south africa annlize l. marnewick postgraduate school of engineering management, faculty of engineering and the built environment, university of johannesburg, south africa citation du plessis, h. & marnewick, a.l., 2017, ‘a roadmap for smart city services to address challenges faced by small businesses in south africa’, south african journal of economic and management sciences 20(1), a1631. https://doi.org/10.4102/sajems.v20i1.1631 original research a roadmap for smart city services to address challenges faced by small businesses in south africa haydn du plessis, annlize l. marnewick received: 18 july 2016; accepted: 09 june 2017; published: 29 sept. 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: small businesses are an important part of the south african economy, yet they have high rates of failure. several contributing factors have previously been identified through literature, including regulatory compliance, skills shortages and lack of government support. globally, there has been an increased interest in smart cities and the variety of services they offer. these technologies were investigated to establish what role, if any, they could play in alleviating the challenges that small businesses face. aim: identify the relative impact of each of these challenges on the small-business and the relative value of each of the smart city services in order to determine which services would have the largest impact in addressing the challenges. method: this research used these factors and identified which challenges had the largest time and financial impact on small businesses and investigated ways in which a variety of smart city services could be leveraged to address these challenges. using a multi-criteria decision analysis technique, 44 small-business owners participated in the research. weighted results for the impact of each of the challenges and the value of each of the services were obtained. results: through the subsequent analysis of the results, it was found that small businesses face many challenges because of lack of government and entrepreneurial support, as well as widespread corruption. similarly, the small-business owners identified that educational material, small-business support portals and egovernment systems would be the most valuable services that a smart city could offer them. various sources of literature were used to identify these smart city services and link them to the business challenges that they may be able to mitigate. the infrastructural prerequisites for each of the services were also investigated to identify dependencies and potential problems in their deployment. conclusion: the various aspects of this study were integrated, and a smart city roadmap for small-business support was subsequently developed. this roadmap will assist cities in planning their smart city deployment, so that they may better support small businesses in the role that they play in the country’s economy. introduction in south africa, sbp (2014) and olawale and garwe (2010) found that small businesses are responsible for 56% – 60% of the country’s employment, which leaves considerable ground to be covered in order to meet the national development plan’s target of 90% set by the national planning commission (2010). by contrast, in new zealand, which is considered the easiest country in which to start a business (world bank group 2014), the new zealand government (2015) found that 97% of their population is employed by small and medium enterprises (smes). businesses face a variety of challenges which could prevent them from reaching their full potential; one such challenge is maintaining regulatory compliance, which sbp (2014) has identified as the most critical challenge facing south african smes. sbp (2004) has determined that on average it takes eight working days per annum to maintain regulatory compliance, largely because of overlapping, conflicting and ever-changing regulations, lack of information access, as well as inefficiencies within the various municipalities themselves. groepe (2012) emphasises that small businesses have a crucial role to play within the economy, and as such, steps should be taken to alleviate the challenges they face, so that they may become more effective contributors to the economy. herrington, kew and kew (2014) note that this can be accomplished through an increased focus on education and skills and by creating a more enabling entrepreneurial environment. for example, online web portals can be utilised to reduce regulatory red tape, making it easier to start a new business. the usage of online portals and egovernment services is one of the core services in the emergence of smart cities, as found by albino, berardi and dangelico (2015), calzada and cobo (2015) and lövehagen and bondesson (2013). according to the united nations (2014), this improved accessibility can make it easier for small businesses to conduct their daily operations by removing the physical barriers associated with typical municipal interactions and by allowing them to operate in a more autonomous and self-sufficient manner. businesses face several challenges on an ongoing basis, and the types of challenges are expected to vary depending on the nature of the business. to identify which smart city services should be prioritised, the objective of this research was first to determine which challenges have the greatest impact on small businesses. literature was then used to select smart city services that have the potential to address these challenges. a total of 44 small-business owners from various sectors participated in this research by completing an online survey. a multi-criteria decision-making framework was then used to rank the challenges faced in terms of their impact on the business. similarly, the potential smart city services were ranked in terms of the value that they could offer the businesses. once the prioritised challenges and services had been determined, the infrastructural and technological prerequisites of each of the proposed smart city services were investigated. this allowed dependencies to be identified so that a logical service deployment could be achieved. these results were subsequently integrated into a technology roadmap that can assist cities in planning for their own smart city rollouts. research questions the purpose of this research was to explore the challenges that south african small businesses face so that suitable smart city services can be identified to alleviate these challenges. these services will have several infrastructural prerequisites that must be met before they can be deployed, and recommendations are made on how these services should be developed. to achieve this, the following research questions were formulated: what challenges are south african small businesses faced with? which smart city services would offer the most value to these small businesses? what development roadmap should be followed to ensure that these services are implemented successfully? when planning any smart city deployment, there are many stakeholders that need to be considered, including businesses, communities and schools. this research was limited to assessing value from the perspective of small businesses only. literature survey definitions there are numerous definitions of a smart city, as discussed by albino et al. (2015). for the purposes of this research, the definition by caragliu, del bo and nijkamp (2011) was adopted: a city is considered to be smart when investments in human and social capital and traditional (transport) and modern (ict) communication infrastructure fuel sustainable economic growth and a high quality of life, with a wise management of natural resources, through participatory governance. (p. 70) this research dealt with the challenges that small businesses face as well as smart cities and the services they offer. for brevity, some aspects are grouped into generic terms, with the full definitions being available in appendix 1. small-business challenges worldwide, small businesses employ an average of 77% of the population, yet this is not the case in south africa. research by sbp (2014) has shown this figure to be closer to 60%. additionally, small businesses have high failure rates, with zulu (2015) claiming that as few as 9% of businesses remain operational after 10 years. these businesses face various challenges on a regular basis which, if addressed, could pave the way for them to become more significant contributors to the economy. examining the literature reveals that many prominent challenges facing businesses have been identified, such as maintaining regulatory compliance, dealing with corruption, skills shortages and infrastructure issues. these challenges have been grouped in table 1, as per the definitions in appendix 1. for each item in table 1, various sources of literature were used to establish each challenge as being a viable threat to small businesses. table 1: issues facing south african small businesses. one of the most commonly recurring challenges is the lack of entrepreneurial training and education, which was identified by each of the sources in table 1. typically, this includes general aspects of business operations and management, but worku (2016) found that this demand exists even at school level and suggests that governments consider offering entrepreneurial training to interested candidates immediately after leaving school. access to finance is the largest obstacle to small-business growth, as identified by olawale and garwe (2010), with worku (2016) finding that businesses need over r50 000 on average in initial capital in order to become viable. although the government has made various funding bodies available to small businesses, peters and naicker (2013) maintain that many businesses are not even aware of all the avenues of funding available to them and that a significant number do not pursue these sources of funding because of the amount of bureaucracy and red tape involved. however, red tape is not only an issue in terms of inhibiting access to funding – red tape associated with maintaining regulatory compliance costs businesses an average of eight working days per year (sbp 2014). other sources of red tape include dealing with the south african revenue service, labour issues and black economic empowerment compliance (sbp 2014). this is further burdened by frequent changes in the regulatory environment, lack of access to information and various administrative inefficiencies. these issues were also identified by the world economic forum and the world bank group (schwab 2014; the world bank 2011), with the world bank group (2014) further finding that the use of electronic resources may be able to alleviate these issues. the literature identifies corruption as being in the top 11% of the most problematic factors for doing business (schwab 2014). corruption is particularly prevalent when there is a lack of transparency and accountability, but andersen (2009) asserts that the usage of online government systems reduces corruption because of its ability to reduce or remove contact between corrupt officials. although infrastructural and workforce issues are generally not considered to be as critical as the other challenges addressed here, they were identified by seda (2016) as key impediments because of the significant costs they add to doing business. having access to efficient utilities and transport systems, along with access to affordable communication services and property, is instrumental in supporting new businesses (herrington et al. 2014). subsequently, the literature reveals that many, if not all, of these issues could be alleviated through using various smart city services. this was explored further to identify which services hold the most potential to address these challenges, as well as identify any crucial prerequisites and interdependencies. smart city services with the growing ubiquity of wireless networks, trends in connected services have begun to emerge, with the concept of smart cities also gaining interest. as discussed by albino et al. (2015), lövehagen and bondesson (2013) and calzada and cobo (2015), a critical theme throughout smart city literature is the notion of leveraging digital systems and communications networks to improve efficiency, promote development and encourage sustainability. however, these systems alone are not enough to make a city smart. chourabi et al. (2012), lee, hancock and hu (2014) and woods and goldstein (2014) describe the physical aspects of this infrastructure, the servers, storage and processing power that are required. these cities rely heavily on large volumes of data (stratigea, papadopoulou & panagiotopoulou 2015; woods & goldstein 2014) in order to provide real-time insight into the cities’ operations, thereby allowing them to improve efficiencies and identify emerging trends (albino et al. 2015; chourabi et al. 2012; stratigea et al. 2015). there are several such services that a city could deploy, and cities must work to ensure alignment between the stakeholders’ expectations and what is offered. proper adoption of these services may also require behavioural change within the various stakeholder groups (branchi, fernández-valdivielso & matias 2014; calzada & cobo 2015) and can be accomplished through the increased awareness of the benefits that the smart city has to offer. deploying wi-fi at city-wide level is a concept that is gaining in popularity and is often seen as a first step for a city to become smarter. walravens (2015) explores how this can be used as the founding infrastructure for other initiatives but states that it is typically focused in more densely populated areas, which limits its usefulness. however, lee et al. (2014) caution that being able to offer this service requires a significant investment in backhaul network connectivity, as well as the equipment required to operate the wireless network. additionally, this is a time-consuming process and can be somewhat disruptive because of the construction that needs to take place. smart cities typically incorporate aspects of egovernment and open data policies to provide a variety of services to stakeholders. in doing so, they can provide skills training, financial support as well as general information to interested parties. sbp (2014) and the united nations (2014) describe how online access to smart portals can help combat governmental inefficiencies by removing the physical barriers associated with a business’s interactions with the city. although egovernment does not require the vast physical infrastructure that a wi-fi rollout does, it still relies heavily on interconnectivity between departments, municipalities and third-party services. to ensure effective egovernment implementation, the hong kong government (2016) and ryan (2014) suggest that the network topology be carefully planned, while ensuring that security and access control are implemented through a combination of firewalls, encryption schemes and authentication systems. part of any smart city adoption is ensuring the use of the various services through the ongoing education of the communities; stratigea et al. (2015) and lövehagen and bondesson (2013) caution that the failure to properly educate the stakeholders could lead to the lack of service adoption. however, apart from just imparting basic knowledge, smart cities have the potential to provide access to a variety of skills and educational training, such as finance and management – two areas which could prove valuable to business owners. availability of educational content has additional benefits, as dirks and keeling (2009) and letaifa (2015) have found. increased educational levels are a major motivating factor for potential citizens, with educated workforces experiencing faster growth and subsequently being able to attract more graduates to the city, which in turn drives an increase in knowledge and innovation. because of the interaction that any potential smart city services will have with each other, it is crucial to plan their development so that efficient integration is ensured. this typically requires that services start off at a basic level and then slowly evolve to include more functionality and deeper integration with other aspects of the city, a process described by kumar (2015). by adopting a more agile development approach, cities can constantly align their service offerings with the expectations of the stakeholders. figure 1 shows a potential approach that was adapted from birmingham’s own smart city deployment (kakderi 2014). this process allows incremental developments to be tested and guided by a small group of early adopters, before making that functionality available to the general population. figure 1: a potential smart city development process. at the time of writing, the city of johannesburg was in the process of rolling out some of its own smart city initiatives. this included the deployment of a widespread broadband fibre network throughout the city, with further plans to offer wi-fi connectivity in some areas (templeton 2015). the city has also begun the process of making it possible to submit some regulatory documents online, in addition to partnering with educational institutions to provide access to selected online courses (shezi 2015). to encourage collaboration between municipalities throughout the country, the city has made its smart city portal available to other municipalities (burger 2015). mapping challenges to services having established the major challenges that small businesses face, the literature was used to link each challenge to a variety of smart city services that could potentially address the challenge. the sources for each of the statements below, along with a summary of this mapping, are provided in table 2; it was found that focusing on a small selection of smart city services would result in an improvement across each of the identified challenges. table 2: mapping of small-business challenges to smart city services. the value that egovernment offers very quickly becomes clear, as the literature has shown that it is able to address each of the challenges to various extents. furthermore, egovernment is the only service capable of addressing workforce issues – a crucial consideration for south africa’s economy. by combining egovernment with other web-based services, such as online portals and educational material, a city would be able to offer significant value from a centralised system. these three services, when combined and integrated, would form the foundation from which the other services could be monitored and managed. additionally, because of the nature of centralised systems, cities would be able to constantly expand their service offerings, further increasing the value of these smart city services over time. the remaining three services (city-wide wi-fi, smart traffic management and smart power) are all decentralised services, and they would predominantly contribute to addressing the infrastructural issues that pose a challenge to small businesses. however, because of their reliance on physical infrastructure, these services could be logistically more challenging to deploy. finally, only egovernment and smart security services would able to address the issue of corruption that businesses face – an important factor to mitigate because of the impact that it has on small businesses. in concluding the literature review, it has been shown that small businesses face a variety of challenges that inhibit them from reaching their full potential. furthermore, it was shown that certain smart city initiatives make it possible to alleviate, or even eliminate, these challenges that continue to plague small businesses in the country. research design to answer the research questions, the relative impact and potential of small-business challenges and smart city services had to be determined. however, different businesses face differing challenges, and therefore, a single business case could not be used. an expert in the field of small-business challenges could be utilised to determine the relative importance of the issues faced. however, research by castillo (2013) has shown that judgements made by a group of non-experts are typically far more accurate than the judgement of a single expert. as such, this research sought to include the responses and feedback from a group of small-business owners. the analytical hierarchy process analytical hierarchy process (ahp) was chosen as the decision-making framework because of its effectiveness as a collaborative group decision-making tool. when compared to other multi-criteria decision-making techniques, ahp was found by peniwati (2007) to offer the most valid indication of a group decision and is most capable of resolving conflicts within a group decision. as described by saaty (1990), the tool’s inventor, ahp is a hierarchical decision-making framework that is capable of incorporating both tangible and intangible aspects in the evaluation. this is accomplished by ranking the various alternatives, based on how well they meet a series of criteria that define the decision goal. the tool also includes the ability to perform consistency checking to identify any potential issues within the results, while still being able to account for some degree of inconsistency because of differences in human judgement. as described by saaty (1987, 2008), group decisions can be made by allowing individuals to complete their own decision matrices, and then calculating the geometric mean to yield the group decision matrix. ahp is well documented within the literature, but the process can be briefly summarised from vaidya and kumar (2006) as follows: identify the objective develop the hierarchical decision structure incorporating the goal, the criteria and the alternatives utilise pairwise comparisons to rank the alternatives perform consistency checks and reject inconsistent responses calculate the relative weightings of each of the criteria. brunelli (2015) found ahp to be an effective tool for city evaluation and planning and discusses how it can be used to determine which features and services consumers value most when purchasing smartphones and electronic devices. further research by vaidya and kumar (2006) confirms that ahp is suitable for a wide variety of decision-making problems, largely as a result of its inherent flexibility and adaptability, making it a suitable framework to use when evaluating the challenges that small businesses face and how various smart city services could be used to alleviate them. research methodology having established a theoretical basis for this research through the literature and having identified ahp as a suitable decision-making framework, it was then necessary to develop the hierarchical decision structure required by ahp. this was accomplished through a series of informal interviews to validate the literature and provide additional context. two executives from the gauteng department of economic development were interviewed to establish gauteng’s involvement in and plans for their own smart city deployment, with the intention being that this research could further supplement their own. several informal interviews were conducted with small businesses in the johannesburg region, with the focus being on the challenges they face as well as how they believed these challenges could best be addressed. in most cases, these solutions were in line with the identified smart city services. for example, the businesses expressed a strong interest in being able to complete regulatory paperwork online or gain access to educational content – two factors that fall within the scope of the smart city services discussed in the literature. although informal, these discussions provided a good basis for the subsequent research by validating the challenges faced, as well as the potential solutions to these challenges. this also ensured that the challenges being faced by small businesses have remained relevant in the country’s ever-changing political and regulatory environment. the development of the ahp decision structure is discussed further in the section ‘applying the analytical hierarchy process structure’. to conduct this research, a standardised questionnaire was developed to allow participants to rank both the challenges they faced as well as the smart city services identified. by deriving the questionnaire from the ahp decision structure described in the section ‘applying the analytical hierarchy process structure’, it would be possible to gain insight into the relative impact of each challenge or service. at this point, the questionnaire was tested with the ahp process to ensure that it could achieve the desired objective based on the required decision structure. the questionnaire was then tested by two small-business owners to gather their feedback, thereby checking that the participants could understand the questionnaire and verifying that it took an acceptable amount of time to complete. once the revisions were incorporated, the questionnaire was used to collect and subsequently analyse the data. figure 2 summarises the research process that was described in this section, and then followed when developing the research tool and conducting the research. figure 2: the research process. applying the analytical hierarchy process structure to develop the ahp decision structure, it is first necessary to identify the objectives, as described by the process outlined in section: ‘the analytical hierarchy process’. for this research, there were two ahp objectives: determine the impact of the small-business challenges identified determine the value of the smart city services identified. next, it is necessary to identify the criteria to use when solving for the objective. as discussed by sbp (2014), the challenges that small businesses face impact them in two primary ways – time lost and cost incurred. similarly, the value of the smart city services can be assessed in terms of the value they offer – both in time and costs saved as well as their importance in a smart city. based on table 1 and the definitions in appendix 1, the alternatives for the small-business challenges were identified as regulatory compliance, government support, infrastructural issues, entrepreneurial support, workforce issues and corruption. the resulting decision structure for determining the impact of the challenges that small-business face is shown in figure 3. figure 3: analytical hierarchy process diagram for small-business challenges. similarly, based on table 2 and the definitions in appendix 1, the alternatives for the smart city services were identified as city-wide wi-fi; egovernment and open data policies; small-business support portal; smart meters, grid and lighting; smart security, transport and traffic management and educational tools and training material. the resulting decision structure for determining the value of smart city services is shown in figure 4. figure 4: analytical hierarchy process diagram of smart city services. by developing two distinct decision structures, it was possible to verify the selected smart city services both through literature (from table 2), as well as through the participants’ own responses, thereby increasing the confidence that the correct services were identified. data collection and analysis using the derived ahp structure, an online survey was used to conduct the research. to complete the decision matrices, participants were guided through a series of multiple-choice questions to establish the relative importance of each alternative. for the sampled participants to be representative of the small-business population, participation in the research was limited to individuals who owned or were involved in the management of small businesses that operated within south africa. these businesses could operate within any industry sector and were considered small if they employed fewer than 50 people. this ensured that the research data were collected from participants who were qualified to provide insight into the challenges that small businesses face and which smart city services may be able to add value for them. because the entire population of south african small businesses was not known, the following businesses and people were contacted directly, with snowball sampling being used subsequently to solicit additional responses: various consultants who regularly worked with small businesses (approximately 30 people) the recipients of the radio 702 small-business awards from 2009 to 2015 (approximately 250 people) some businesses that had worked with the ministry of small-business development (approximately 20 people). the research was carried out using standardised, pretested and pre-validated questionnaires distributed through an online survey system to gather data from the sample of the small-business sector. scales were utilised as the primary principle of measurement, making it possible to incorporate both the objective and subjective aspects of the decision-making process. by conducting the research in this way, it was possible to conduct a detailed analysis that would ensure that the most important challenges and services were identified. the questionnaire consisted of four sections. the first section gathered demographic data to ensure that the participants fit the profile of a small-business. this section included questions relating to revenue, location, number of employees, business sector and other factors. the second section required participants to indicate the time and financial cost incurred in overcoming each of the challenges identified in table 1. the final two sections required the participants to rank, using the ahp comparisons, the relative impact of each of the challenges and smart city services. of the approximately 300 people who were invited to participate, a total of 82 responses were recorded. however, 38 respondents started the survey but did not reach completion, and their results were subsequently discarded. this then left 44 valid responses. the survey system was hosted on a private server in a south african data centre. once the responses were collected, they were exported in comma-separated values (csv) format, which was then used by matlab to perform the required data conversions and calculations. matlab does not have built-in functionality for performing ahp analyses, and as such, custom code was developed. this functionality was tested against known data sets to ensure the validity of the results obtained through the custom toolkit. limitations of analytical hierarchy process consistency although saaty (1990) provides a method for checking consistency of the results, this technique has been criticised by alonso and lamata (2006) as too restrictive when dealing with a large number of alternatives, or when combining decision matrices from a number of participants. based on the generation of 500 000 random matrices, alonso and lamata (2006) propose a method of checking for consistency that does not utilise saaty’s technique, but instead uses λmax and defines a general consistency condition, given by (equation 1): using this method, n is the number of alternatives and is the factor that defines the level of inconsistency that is tolerated (with 0 < α ≤ 1). for this research, it was found that λmax ≤ 0.2 provided a good trade-off between consistency and the inclusion of sufficient decision matrices in the combined group decision. with these constraints, the final group decision could be determined by calculating the geometric mean of the individual matrices to obtain the group decision matrix. once this had been calculated, the final results could be determined through a series of simple matrix calculations. having defined the research process, it was then executed to collect and analyse the data, with the results being presented in the next section. research results participants’ demographic profile along with the ranking comparisons that each participant made, they were also asked to answer a series of demographic questions to establish an understanding of the small businesses that took part in the research. of the 44 responses that were received, the majority (58%) were from businesses that operated with 1–5 employees, as shown in figure 5, and only 11% of the businesses employed more than 20 people. additionally, the data revealed that a quarter of the businesses operated entirely online, with the remainder relying on physical storefronts and office spaces (figure 6). in all, 82% of respondents were from the johannesburg area, which highlights the relevance of this research to the city of johannesburg. a total of 68% of the participants operated within the engineering, consulting and construction sectors, while finance, insurance, real estate and education accounted for only 7% of the responses. figure 5: participants by number of employees. figure 6: participants by operational sector. time and cost impact of small-business challenges to investigate the extent of triangulation, participants were required to answer several questions independently of the ahp comparisons. this was also used to confirm the findings in literature in respect of time lost and cost incurred when dealing with these challenges. figure 7 shows a frequency distribution of the amount of time, in days, that each participant required to address each of the identified challenges on an annual basis. when considering the number of businesses that spent more than 20 days in dealing with any of the challenges, it becomes clear that these issues represent a significant amount of lost time to the businesses, with regulatory compliance being the biggest offender in this regard. figure 7: time impact of the challenges faced on an annual basis. figure 8 shows a frequency distribution of the amount of money, in rand, that each participant spent on each of the identified challenges on an annual basis. of the 44 respondents, 10 indicated that infrastructure and workforce issues cost them over r100 000 per year, representing a serious cost that must be absorbed regularly. although corruption was generally considered to not have much of an impact in terms of time, a quarter of the respondents reported that it cost them over r50 000 per year. figure 8: annual cost impact because of challenges faced. calculation of weighted rankings following the process outlined by saaty (2008), the pairwise comparisons from the questionnaire were converted to a total of seven group decision matrices by calculating the geometric mean of the individual participant matrices. these seven matrices consist of: challenge time – the challenges faced with regard to the time impact on the business challenge cost – the challenges faced with regard to the cost impact on the business cost priority – the relative priorities of the criteria ‘save time’ and ‘save money’ service time – the smart city services with regard to the impact of time saved service cost – the smart city services in respect of the impact of cost saved service value – the smart city services in respect of the value and importance within a modern city service priority – the relative priorities of the criteria ‘save time’, ‘save money’ and ‘importance in a modern city’. to demonstrate, the matrix for the time impact of small-business challenges was found to be (equation 2): the custom-developed matlab code was then used to determine the relative weightings of each challenge, as well as to perform consistency checking (equation 3): this process was repeated for each of the six remaining matrices, and the priorities of each alternative were overlaid on figures 2 and 3 to yield figures 9 and 10, respectively. these two figures show how the group decision was distributed across the various challenges and services. within each block, the priority value indicates the relative importance of that item, with the sum of each group always being equal to 1. figure 9: relative impact of small-business challenges. figure 10: relative value of smart city services. with these results, it is now possible to calculate the final priorities using matrix multiplication, in the form of , where r is the vector of final normalised priorities, m is the matrix of priorities of the various alternatives with regard to each criterion and p is the vector of priorities for the criteria themselves. the calculation of these results is shown in eqn 4 and eqn 5. similarly, the final normalised priorities for smart city services can be calculated (equation 5): the results of the matrix multiplications in equations 4 and 5 have been ordered by weighting and are presented in table 3. table 3: weighted rankings of small-business challenges and smart city services. impact of small-business challenges and smart city services at this stage of the analysis, the results in figure 9 show the clear preference of participants for saving money over saving time (77% vs. 23%), which highlights just how cash-sensitive small businesses are. furthermore, figure 9 shows that government support is the single largest factor and accounts for over a quarter of both the time and the cost impact, with entrepreneurial support being the second largest contributor in both time and cost impact. participants indicated that city-wide wi-fi deployment would have the lowest impact on their cost savings. this is surprising, as the cost of telecommunications was identified by herrington et al. (2014) as one of the key factors that the south african government should work to reduce, and in doing so, alleviate some of the strain on small businesses. while the participants did find it valuable if a smart city service was able to result in time and cost savings, the research revealed that the businesses placed strong emphasis (57%) on a potential service’s importance in a modern city, perhaps demonstrating the inherent interest that small businesses have in future developments. in this light, both educational tools and small-business portals were considered the most important aspects of a modern city, each accounting for over 22% of the weighting. across the remaining two criteria, these two services were also the highest ranked. smart security and traffic management were generally regarded as unimportant (< 12%) across each of the three criteria, with slightly lower levels of disinterest (< 14%) being shown for services involving smart meters and power management. while the impact of these challenges and services across the individual criteria does yield interesting perspectives, the true impact of these factors can be assessed when considering the final ahp-weighted priorities, as calculated previously using matrix multiplication. ethical consideration the data collected have been kept confidential and only the aggregated and anonymised findings from the collected data were included in the publication. discussion when considering the final weighted results, it becomes clear that government support dominates the challenges that are faced by small businesses, whereas educational tools and training material are deemed to be the most valuable. combined with the results presented in table 2, the research shows a strong link between the services that were selected by the participants and the services that were identified through literature as being able to address these challenges. from the literature, it was also shown that the top three ranked services are, to some extent, capable of addressing each of the challenges that were identified. it is therefore imperative for any city to place a strong emphasis on these services to meet the needs of small businesses effectively. these results confirm what was previously indicated by the literature – that the lack of government support constitutes the single greatest impact on the small businesses. this is followed closely by a lack of entrepreneurial support, corruption and infrastructural issues. the results further show a clear preference for educational tools and training material – an aspect that was shown by simpson, tuck and bellamy (2004) and kangasharju and pekkala (2001) as having a significant impact on the success of a business. in an ongoing effort to minimise costs and time wasted, especially because of the relatively small number of employees, it is understandable that small businesses wish to learn and explore on their own, a fact which is further supported by their interest in a small-business support portal and egovernment and open data policies. the analysis of the results has determined the extent to which the issues impact small businesses, but it will be the city’s responsibility to subsequently implement the services. to ensure that this is successful, several prerequisites and dependencies must be considered during the smart city’s development. roadmap development having identified the issues that need to be addressed, along with their relative importance, the infrastructural requirements can now be used to develop a smart city roadmap, shown in figure 11, for the deployment of smart city services tailored towards supporting small businesses. along the top of the roadmap, in green, are the challenges that businesses face, ordered by importance. beneath that, in blue, is the ordered list of smart city services capable of addressing the challenges. these relationships were listed in table 2 and are illustrated with a series of interconnecting lines. the x-axis shows the increasing integration that is required, and the y-axis shows the increasing levels of development. the relationships between the challenges and the services are also shown. figure 11: proposed smart city roadmap for supporting small businesses. the deployed services would be heavily dependent on the use of ict, and as such, care should be taken to ensure the stability, availability and resilience of the underlying infrastructure. arana (2014) suggests that this could be accomplished through the use of an integration and monitoring layer, which would monitor the various systems in order to minimise the impact of subsystem failure. to protect the data, arana (2014) further proposes that security and access control systems be implemented across the services. with the basic infrastructure having been defined, the specific services can now be explored. educational tools and training material were identified as being the most valuable, and the implementation of these services would provide support for entrepreneurs in multiple ways. at its simplest, this would require collaboration with educational institutions to make the relevant training available online. because of the limited resources that small businesses have, being able to leverage self-service systems was found to be highly valuable. creating a central information repository and integrating it with other government departments would provide businesses with access to any required information and allow them to submit various documents electronically. the small-business support portal would form the basis of a more complex egovernment system, which would be expanded to include further integration with other departments and third parties, thereby facilitating access to a variety of services in an effective and coherent manner. however, being able to offer these services would require increasing levels of development and integration, which can be a costly endeavour. thus far, all planned systems have relied on a centralised architecture. before offering widespread wi-fi coverage, it is necessary to deploy infrastructure on a much wider scale. the deployment of city-wide fibre infrastructure will require extensive earthworks and construction and will be a time-consuming process. it is therefore recommended that this phase be started in parallel with the initial smart city rollout. with this infrastructure in place, wi-fi hotspots can be deployed for use by stakeholders, as well as by connected sensor systems which provide data to the city. the remaining services can be implemented through varying combinations of decentralised sensors and real-time monitoring systems to allow the city to optimise its efficiency and usage of resources. if followed, the proposed roadmap will allow a city to implement the services that were found to be the most valuable to small businesses, in an order that would address their greatest challenges first. this infrastructure would then be used as a basis on which any number of additional services could be built. limitations of this study and areas for further research smart city development will affect many stakeholders within the city, and as such, it is crucial to ensure that all the stakeholders are considered before beginning the deployment process. this research covered a smart city’s development from the perspective of small businesses, but other stakeholders, such as schools, communities, large businesses and even the government itself, would need to be considered. it was also discovered that some individual decision matrices needed to be discarded as they failed to meet the consistency restrictions set during the research design. to alleviate this, it is suggested that future survey methods incorporate real-time feedback to the participants, so that they can correct inconsistent responses, thereby ensuring that all the decision matrices can be used to form the group decision. seda (2016) found that there are 667 433 formal smes in south africa, meaning that this research was conducted with a very small sample size. although this research could provide initial insight into the challenges faced, it is recommended that further research with a larger sample be carried out in future. these results cannot be generalised to all small businesses within south africa, as they were obtained from a limited subset of the target research population. however, because of the shortage of research linking smart cities and small businesses, the results of this research can be used as a basis for planning future research. conclusions this research set out to identify the challenges faced by small businesses and then explored which smart city services, if any, would be able to address these challenges. an initial literature survey was used to identify potential challenges and services, with this knowledge being used to guide the design of the research instrument. the ahp was identified as a suitable methodology because of its ability to make group decisions based on both subjective and objective judgements to obtain a single, coherent decision. this approach yielded a final set of ranked priorities, showing the relative importance of each alternative. this research sought to identify which challenges had the greatest impact on small businesses. the lack of government support was found to be the most detrimental. similarly, the research sought to identify which smart city services offered the most value, and it was found that educational tools and training material would assist the most in addressing the challenges that are constantly faced. the literature was used to derive a link between the services and the challenges they could potentially address. these findings were supported by the research participants by identifying which services they found to be the most valuable. in terms of time lost and cost incurred, both the literature and the research demonstrated that these challenges have a substantial impact on small businesses, with businesses spending weeks of time and hundreds of thousands of rand to address the challenges. by developing solutions and systems to minimise the impact of these challenges, cities would be able to provide direct value to the businesses, allowing them to save both time and money and thereby increasing their chances of success. finally, this research intended to use these findings to develop a smart city roadmap focused on alleviating the challenges faced by small businesses. cities following the roadmap’s recommendations would be able to quickly and effectively deploy the required infrastructure and integrations needed to start offering these services. this would allow small businesses to waste less of their resources in dealing with these challenges, and instead focus on what they do best – driving employment and contributing to the economy. acknowledgements competing interests the authors declare that they have no financial or personal 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http://www.iol.co.za/business/opinion/importance-of-smmes-is-big-business-for-country-1.1768670?noredirect#.vgehwi-qpbc appendix 1 table 1-a1 lists the definitions of terms used throughout this research. these definitions were also supplied to the research participants when completing questionnaires. table 1-a1: definitions of terms used throughout the article. sajems ns vol 1 (1998) no 2 284 south africa: political economy. or virtual economics? mltruu department of economics, university of pretoria abstract in 1994 south africa was politically transfonned from an oligarchy into a democracy. how has this momentous change affected the framework of economic policy? this paper approaches the question via the virulent unemployment that is south africa's most serious economic problem today. the apparent answer gives great cause for concern: south africa's policy-makers seem about to leave the real world of political economy to enter the illusory world of virtual economics instead. " ... a little fact will sustain a lot of illusion ... the lie stands most securely on a pin-point of truth." eric ambler, judgment on deltchev (1951). introduction as in the past, the expression "political economy" has several shades of meaning today. it is, for example, much used in the context of the large-scale transition from (real) socialism to (mixed) capitalism, particularly in central and eastern europe, where it usually refers to a more or less systematic interaction of political and economic variables. thus, the abolition of communism-socialism was a political sea change that is totally reshaping basic economic institutions like property rights, money and prices. south africa, too, experienced a decisive political break with the past in april 1994, when it changed from an oligarchic to a democratic fonn of government. it would be most naive to think that such political transfonnation would have no major economic consequences. this means that there is a good reason to approach the political economy of south africa today as a "unified subject", as professor avinash dixit (te, sept. 20 1997: 8) has expressed it. the problem at the core of economic policy in present-day south africa has r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 285 satebnr vol i {l998)nr2 been concisely put by the american development economist r. stephen brent (foreign affairs, marchi april 1996 : 117) in the following words: the challenge for the government is to keep the focus on long-tenn growth but provide enough benefits to the majority population along the way that political consensus can be maintained and moral commitments protected. it would be difficult for anyone to disagree with this general diagnosis. the tenn "virtual economics" which also appears in the title of this paper, has just been invented by the author. this does, however, not represent a claim to originality, for the wording is obviously a variation on the name "virtual reality", which may be defined as follows : "virtual reality ... creates the illusion of being immersed in an artificial world, or being present in a remote location in the physical world" (mondo 2000, 1993 :252). the device is by no means new to economics. its all-time champion was the french socialist charles fourier (17721837), who abhorred industrialism and advocated a return to the land. the hub of his envisaged rural economy was the phalanstere, where a worker "would be employed almost exclusively in looking after his garden, just like adam was before the fall and candide after his misfortunes" (gide & rist, 1917 : 242). this did not amount to a purely abstract notion; the phalanstere was actually tried out in the united states and proved to be a complete failure. karl marx contemptuously dismissed this kind of socialism as unscientific and utopian, compared to his own doctrine of "scientific socialism". how do these rival approaches (political economy vs virtual economics) relate to the above-mentioned problem at the core of south african economic policy? faced with a comparably thorny issue, joan robinson (1962 : i) recalled the counsel of the great boyg in ibsen's peer gynt: "backward or foreward, it's just as far. out or in, the way's as narrow ... go round about, go round about." so shall we, though remaining in the broad field of labour economics. the great majority of economics students during the 1950s and 1960s were no doubt told by their instructors that the problem of unemployment had been solved for good by keynesian fiscal policy. during approximately the first two decades after the second world war, the objective of full employment did in fact enjoy top priority in the market related economies. this, however, also meant an uninterrupted period of rising prices, as a result of which inflation came to be seen as the typical condition of the economy. in other words, the public lost its sense of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 2 286 money illusion, or faith in price stability, and came to expect that the past experience of inflation would continue in the future as well. return of unemployment in terms of the traditional philips curve model, it had been possible to "buy" more employment at the cost of more inflation, both in the short and the long term. with the establishment of inflationary expectations, however, this trade-off disappeared in the long term, and stubborn policy attempts to stimulate more employment would only cause more intlation without raising employment and output. the main reason for this is that government spending designed to increase economic activity, came to be neutralised by policy clashes and trade union action to maintain (or increase) real wages. as a result of inflationary expectations, unemployment once more became a serious problem during the 1970s. this, inter alia, led to a redefinition of the concept labour market equilibrium. the latter no longer signified an optimal situation, implying a state of full employment. instead, equilibrium in the labour market was said to exist when trade union determined wage rates were equal to the rates that business firms considered economically feasible, which would then coexist with the economy's natural rate of unemployment (stiglitz, 1977:4). to make the point that this should not be taken to mean a normal or desirable state of affairs, economists replaced the last-mentioned term by the rather cumbersome phrase "nonaccelerating-inflation rate of unemployment" (nairu). this is the rate of unemployment, other things being equal, to which the economy tends to return in the long run. nairu increased world-wide during the 1970s and the first half of the 1980s, when the opec cartel practically held the oil importing nations to ransom. this ill-considered policy eventually caused an oil glut on the world market, and thus boomeranged on its author when the price of oil was more than halved in 1985-86. as a result, both the actual and the expected rate of inflation fell, which served to reverse the rising trend ofnairu in the economically developed countries. south africa, however, did not share in this positive turn of events. although the international oil price expressed in us dollars fell precipitately, the dollar value of the rand fell even more at the time. consequently the price of oil in terms of the rand actually rose in south africa, and inflationary expectations continued as before. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 287 sateb nr vol 1 (1998) nr 2 against the background of rapid technological progress, particularly the information revolution, nairu has again recently declined in the united states (gordon, 1997 : 29-30), though not in europe (blanchard & katz, 1997 : 66-7). unemployment in south africa has by now become the country's most serious economic problem. according to available estimates, the long-term increase in unemployment relative to the labour force, has been alarming to say the least : 8% in 1960, 12% in 1980, 19% in 1991 and 29% in 1995 (fm, july 4 1997 : 35). whatever the actual size of south africa's nairu may be, it has certainly grown a great deal over the years. from time to time, someone makes the point that "keynes taught us how to conquer unemployment" (in excess of its so-called frictional level of, say, 2 or 3 per cent). this would mean a deliberate policy of deficit spending by the government. in present-day conditions, however, such a policy option is a nonstarter (kapstein, krugman & lawrence, 1996 : 16-37, 164-73). keynesian-type deficit spending was originally designed to eliminate cyclical unemployment caused by deficient aggregate demand. but this is not at all the same thing as the structural (or supply side) unemployment that has entrenched itself today. far from reducing unemployment, large budget deficits would serve to rekindle inflation where it has been extinguished, or cause inflation to accelerate in countries where it has slowed down (e.g. south africa). the essential nature of unemployment today is shown in figure 1, which depicts an imaginary labour market (where frictional unemployment is not taken into account). figure 1: the labour market wj wk wf o d -----l r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 2 288 there is only one demand curve for labour, dd, but two supply curves marked sn and sa, where the former represents the notional (or potential) and the latter the actual (or effective) supply of labour. the split in labour supply means that some workers are adequately qualified for the jobs available in the market, others not. alternatively put, the composition of labour demand and labour supply are not perfectly matched. notional equilibrium with full employment would be at point f (wage rate wf, employment lf), but actual equilibrium occurs at point k, where the demand for labour is equal to its actual or effective supply. thus, at wage rate wk the number of workers employed (those with the right skills) are represented by lk. this would then amount to equilibrium of a sort in the labour market, coexisting with structural unemployment (where demand and supply fail to mesh) equal to lklf. unemployment may be aggravated by trade union behaviour. assume that a trade union demands, and gets, a wage rate equal to wj. employers would then respond by reducing their labour input to lj. provided that the trade union members keep their jobs, a new state of equilibrium would then coexist at point j with ljlf unemployment, due partly to job-worker mismatch and partly to trade union pressure. the economy's natural rate of unemployment (nairu) would then be equal to ljlf/olf per cent. this imaginary labour market example is in fact not far removed from what is happening in the formal sector of the south african economy today. this discussion has important macroeconomic implications, both theoretical and practical. the natural rate of unemployment is common to both the labour market and modern phillips curve analysis. given inflationary expectations, there is no permanent trade-off between inflation and unemployment: the long-term phillips curve is vertical at nairu level. the phillips curve is not a special case, separate from the rest of macroeconomics. it is in fact directly related to the aggregate demand aggregate supply (ad-as) model, where the long-term as-schedule is also vertical (truu & contagiannis, 1996 : 221-25). the position of the long-term phillips curve is determined by nairu, that of the as-schedule by its reciprocal: the total labour force minus natural unemployment. policies to train (or retrain) workers and curb trade union power, would therefore at the same time serve to increase effective labour supply, the economy's productive capacity and aggregate supply of final output. appropriate training would make more workers employable in an increasingly sophisticated economy, and less trade union militancy would be generally 1997 conducive to more labour-intensive production methods. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 289 satebnr vol i (j998)nr2 long-term economic growth the classic method how productive capacity expands over time, is by means of economic growth. samuelson and nordhaus boldly state in their best-selling textbook : "economic growth is the single most important factor in the economic success of nations in the long run." (samuelson & nordhaus, 1992:546). although aggregate demand and aggregate supply jointly determine the economic growth rate, aggregate supply is the greater force behind the growth process. expressed in the most general terms, the economy's output of final goods and services (le. its real income) results from both quantitative and qualitative causes, namely, the physical inputs of labour and capital as well as their productivity. with regard to the labour force, long-term economic growth holds the promise of more jobs and rising per capita output, real wages and living standards. the world bank affirms tout court: "economic growth is good for workers." (wdr. 1995:3). the respective weights of the three above-mentioned growth factors do vary according to time and place, but a steady improvement in productivity (or technological innovation) is the crucial determinant of economic growth in the long term (bacon & eltis, 1978:35). both the meaning and measurement of productivity tend to be poorly understood, but here it is possible to note only two popular misconceptions, more or less midway between a half-truth and complete error. first, productivity is measured by expressing output as a ratio to a selected input, e.g., labour productivity is equal to output divided by labour input. it is frequently asserted that if a given reduction in labour input causes final output to fall less than proportionately, then labour productivity would have risen. this arithmetical truism is, however, not economically meaningful. in economics, productivity is deemed to increase if a given quantity of input(s) produces more output than before. thus labour productivity would be raised by more capital per worker, enhanced labour skills and improved production technology in general. a particularly hardy fiction is represented by the claim that higher productivity (or technological innovation) destroys jobs and perpetuates unemployment. paul krugman has called its current version the doctrine of global glut, or "the view that capitalism is too productive for its own good" and "there simply is not enough work to go around ... as productivity rises" (krugman, 1997 : 79,82). while it is true that technological innovation destroys old jobs, it also serves to create new jobs. the process is in fact known as "creative destruction", today generally represented by the transformation of secondary (manufacturing) into tertiary (service) jobs. however, the fact remains that some societies (e.g. usa) are r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 2 290 managing the transfonnation rather better than others (e.g. western europe). while the debate continues, the reason most frequently given' for their disparate perfonnance, is that european labour markets are less flexible than their american counterparts. an important development has been the new growth theory pioneered by paul romer (romer, 1986 : 1002-37). according to this approach, knowledge is classified as a source of economic growth, just like raw labour and physical capital. the growth of knowledge results from investment in human capital, based on the same logic and incentives that motivate investment in physical capital assets. the new growth theory has, inter alia, toppled the old platitude that less affluent countries typically have too little physical capital, instead, the main problem is that they invest too little in human capital. romer's theory has been followed by a remarkable upsurge of empirical research, that overwhelmingly confinns the positive relation between human capital and real income growth. the locus classicus of these studies is a paper by robert barro (1991 : 408-43), based on cross-section data for 98 countries (including south africa) over the period 1960-85, which yielded the following conclusion: ... the growth rate of real per capita gop is positively related to initial human capital...countries with higher human capital also have lower fertility rates and higher ratios of physical investment to gop. growth is inversely related to the share of government consumption in gop, but insignificantly related to the share of public investment. growth rates are positively related to measures of political stability and inversely related to a proxy for market distortions. potentially significant causes of economic growth have therefore come to encompass several factors other than quantitative labour and capital inputs, lumping the rest together under the "residual". moreover, never before has the non-specialist press shown so much interest in scientific growth studies as during the past half-dozen years, or so (see e.g. the economist (london) : jan. 4 1992, pp. 17-20; jan. ii 1992, pp. 19-21; may 25 1996, pp. 23-29; june 291996, pp. 23-25; june 14 1997, pp. 19-24). we may also note the gist of a major research project by jeffrey sachs and associates at harvard university (sachs, 1997 : 19-24). international patterns of economic growth during the research period (1965-90) were found to depend crucially on four sets of factors: initial conditions, population trends, physical r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 291 sateb nr vol i (1998) nr 2 geography and government policy. the initial conditions include per capita output and human capital endowment, the first-mentioned varying inversely and the lastmentioned directly with the per capita economic growth rate. more gradual population growth (ideally the difference between declining fertility and low mortality) would reduce economic dependency and raise the average income level. geographical properties likely to impede growth, are adverse climate, poor soil and landlocked location. such disadvantage may, however, be offset by favourable official policy, for example, consistent market orientation and liberalisation, openness to foreign trade and investment, private instead of state ownership, protection of private property rights, low tax rates, fiscal saving, rule of law and honest administration. not surprisingly, sachs arrives at the following conclusion: "global capitalism is surely the most promising institutional arrangement for world-wide prosperity that history has ever seen." this seems the essence of what the term globalisation means today. the combination of globalisation and information technology has in tum been given the name of "the new economy" so far restricted to the usa (bw, nov. 17 1997: 48-50). increased productivity induces new investment in human and physical capital, and thus promotes economic growth. in a study that covered 133 countries (including south africa), hall and jones (1996 : 33) found that the level of a country's productivity depends on the following factors, in descending order of importance : institutions that favour production over "diversion" (e.g. theft, corruption, expropriation, high taxes), openness to international trade, private ownership, knowledge of an international language (e.g. arabic, chinese, english), and a temperate climate. the causes of productivity are therefore quite similar to the causes of growth. labour conditions in south africa seeing that high unemployment and deficient job opportunities reside at the core of south africa's labour problems, despite recently positive economic growth, the following comment on labour conditions in europe (siebert, 1997:53) may serve as a starting point for south africa too: the institutional phenomena described in this paper have led to a dual labor market in most european countries. there is a sizable section of the labor force for which the labour market does not function anymore. the combination of intensified competition in a global economy and of labor-saving technical progress requires flexibility in wages, but r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 2 this flexibility is prevented by institutional conditions. once created, unemployment is reinforced by ratchet effects; it becomes more and more difficult to find employment again when one has been out of employment for a while. the unemployed lose qualifications relative to the employed; in severe cases, they may lose their social competence altogether. unemployment can easily become persistent, and to overcome rising unemployment in a self-enforcing trap, it takes a comprehensive push of institutional change. indeed, the specter of unemployment that is haunting europe will not be exorcised unless governments are prepared to undertake major reforms of the institutional set-up of the labor market. 292 examples of institutional labour market disincentives in europe are said to include: attractive welfare, social security and unemployment payments; high levels of minimum wages; powerful trade unions; extensive regulations governing hours of work, business zones arid leave conditions; payroll taxes; job protection laws; difficult and costly dismissal procedures, and so on. the term "euro-sclerosis" has been invented to describe such an inefficient labour market. shortage of investment capital may aggravate the predicament. apart from less generous welfare benefits, all these disincentives, and more, have an even much greater negative effect on labour conditions in south africa today. the policy of affirmative action is a particularly strong barrier to job creation in south africa. the expression "jobless growth" has been coined for this disconsolate situation (te, sept. 27 1997:52). deep-seated labour problems have been present throughout south africa's economic history. the major problem areas during the twentieth century have been an abundance of unskilled and a relative shortage of skilled workers, the migratory labour system, the economic colour bar and complex industrial relations (wilson, 1972:1). the descent into mass unemployment was, amongst others, foreshadowed by professor hobart houghton when he wrote in the 1960s: if south africa is to expand manufacturing industries, it is essential to adopt the most modem processes. attempts to compete with automated industry by using labour-intensive processes seem doomed to failure ... moreover in a labour force lacking a high degree of manual dexterity and craftsmanship, automation has been found to improve quality and reduce cost ... automation in industry, however, renders most unskilled labour redundant (1967: 165). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 293 sateb nr vol 1 (1998) nr 2 having failed to meet the (above) challenge once raised by automation, the south african economy is today again powerless in reconciling the sectoral shift from manufacturing to services with growing job opportunities. the fact that south africa's labour force has proved unable to meet the needs of a progressively more sophisticated economy, is no less than a national failure. it is also the underlying, long-tenn cause of today's unemployment debacle, the essence of which is captured by the index numbers (1990 = 100) below. year 1990 1991 1992 1993 1994 1995 1996 q 100.0 99.0 96.8 98.1 100.8 104.1 107.4 l 100.0 note: source: 98.3 96.3 94.3 93.7 94.4 93.3 q = real gdp, l = non-agricultural employment. * jan. sept. sarb, quarterly bulletin (various issues). 1997 109.2 91.9* not only has economic growth been erratic and thus an unreliable source of employment during the 1990s so far, but even when growth was positive, employment ras still fallen largely on account of "unemployable" labour. employment growth has also been held back by a long-tenn process of capital deepening, for example, the capital-output ratio in the south african economy rose from 2.22 in 1960-64 to 3.32 in 1993-97. this has been associated with sharp increases in wages and other labour costs, like those caused by strikes, stayaways and the so-called institutional disincentives mentioned at the beginning of this section (ceas, 1993 :42-3). briefly put, labour problems have caused business finns to adopt excessively capital-intensive, and hence economically wasteful, production methods. the topic of trade union activity inevitably takes one into the realm of so-called political economy, in other words, the economic consequences of political behaviour. the political power enjoyed by cosatu, south africa's largest and most influential trade union federation, is comparable only to the solidarity movement in poland. cosatu is much more than a conventional trade union entity, together with the african national congress and the south african communist party it actually governs the country. cosatu is therefore not really constrained by collective bargaining in the labour market or the country's economic state of health. if need be, its demands are simply enforced by government, in other words, cosatu's will r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 2 294 then becomes the law of the land. one example of this is the soon to-be-passed basic conditions of employment act, with a potentially '(disastrous effect on growth and job creation" and "the triumph of politics over economic reality" (stbt, nov. 9 1997). other examples of recent labour legislation already passed or awaiting ratification have a similarly negative effect on employment in south africa. cosatu's political lineage is of the revolutionary marxist-leninist kind (truu, 1997:47), moreover, "the government is still clinging to its belief that ideology did not entirely succumb to market forces with the collapse of the soviet union" (fts, sept. 19 1997:xxv). to vilify the business sector, left-wing spokesmen even trot out what is probably the biggest marxian fallacy of all, the tired old base-superstructure theory that in pre-1994 south africa too, government was the servant of capital (pn, nov. 13 1997; bd, nov. 14 1997:1, 15). bombarding private enterprise with threats and abuse, government and trade union representatives seemingly overlook the fact that such poisonous atmosphere is least of all conducive to investment and job creation. also, given south africa's high incidence of serious crime and its "burgeoning corruption in the government" (teiu, south africa, 3rd quarter 1997:7), only the less risk-averse entrepreneurs seem prepared to invest their capital in the country. as if this were not enough, ordinary (white) households have also been stridently berated at top government level. even the foreign press was moved to describe such rhetoric as "paranoid" and "dated marxist theology" (pn, dec. 19 1997:8). although south africa's inadequate stock of human capital was called a national failure above, this does not mean complete failure in the sense of being incapable of future progress. even people who live in a generally adverse socioeconomic environment, show positive evidence of meaningful development potential. for example, some 17 per cent of the south african labour force is occupied in so-called informal economic activity, instead of being literally unemployed. it would be difficult, perhaps impossible, to find a more urgent economic challenge to south africa than the empowerment of its labour force. the same thought was expressed by the president of the world bank james wolfensohn, when he said that too many people have been excluded from gainful employment, choosing the title the challenge of inclusion for his 1997 annual address to the bank's governors. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 295 sateb nr vol 1 (1998) nr 2 international opinion sense from bretton woods at the beginning of 1992 when the new political dispensation was already in the offing, the international monetary fund (imf) published an occasional paper with the title economic policy for a new south africa, edited by desmond lachman and kenneth bercuson. this slender volume is noted for its common sense and unvarnished realism. for example: the main conclusion to be drawn is that poverty in south africa is so severe that redistribution policies, which alone will not be adequate to counter it, must be supported by policies designed to place the economy on a higher growth path. only then should the economy be expected to generate the resources necessary to satisfy the needs of the least privileged sectors on a sustained basis (p. 1). this is, of course, the tested distribution-through-growth formula, which south africa's policy-makers ignore at the peril of the national economy. although economic growth and income redistribution are quite compatible in the long term, it is vital to get the sequence of events right in the short term. if initial priority is given to rapid growth, then greater equity has usually followed in due course. in contrast, research findings also show that if the priorities are reversed, then neither growth nor equity, but decline and poverty are more than likely to follow (truu, 1992:291). the imf study goes on to say that a significantly improved growth performance is, in tum, conditional on the achievement of higher rates of domestic saving and investment, the reversal of declining productivity, a government budget surplus and moderate real wage growth to alleviate unemployment. the authors of the international labour office publication discussed in the next section quite seriously claim that south africans are manifestly under-taxed (their emphasis). on the other hand, the authors of the imf study point out that the truth is more or less the opposite: ... the overall south african tax burden and its marginal rates cannot be judged to be low by international standards; indeed the tax burden on the white community appears to be relatively high even by industrial country standards. this would argue against raising tax r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 2 296 rates in south africa and running the risk of heightening disincentive effects (p.2). . this conclusion is still valid for south africa today, though it would be only realistic to substitute for the expression "white community" the words "middleincome group". for it is government policy to tax all middle-class incomes and savings "till the pips squeak". the imf philosophy has, however, not met with total rejection in south africa. the government's growth, employment and redistribution (gear) strategy is precisely meant to "catapult the economy to the higher levels of growth, development and employment needed to provide a better life for all south afric"ll1s (gear, 1996:2)." although the matter cannot be discussed here, the gear policy obviously calls for fiscal and monetary discipline, something which has not surprisingly been badly received by cosatu and in other leftist circles. the second bretton woods organisation, the world bank, has also taken an interest in the south african economy, particularly its labour market and employment conditions. three discussion papers on the subject have been written by peter fallon (1992), fallon and de silva (1994) and fallon and lucas (1997). the lastmentioned monograph bears the title south african labour markets : adjustment and inequalities, and restates the familiar employment-distribution relationship as follows: there are two major policy aims: to reduce unemployment, and lessen labor market inequalities. neither aim can be achieved by labor market policies alone. sensible macroeconomic policies are needed to encourage labour-demanding growth, while the skills of much of the labor force must be improved considerably to support growth and lessen inequality. a competitive economic environment will also help, as discrimination tends to wither under such circumstances (p. 28). the world bank diagnosis of labour's role in the south african economy rests on deductive reasoning and statistical analysis, rather than preconceived notions and political correctness. for example: "rising real product wages have a substantial dampening effect on the demand for black workers" (p. 10) and "union activity depresses formal employment" (p. 18). if such findings are a rock of offence to left-wingers, those on the right may well be irked by the statement that "even after standardizing (for education and skills), wage differentials are still heavily r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 297 sateb nr vol i (1998) nr 2 detennined by differences associated with labor market discrimination by race and gender" (p.14). however, most of the world bank's conclusions are (or should be) uncontroversial, for example: markets clear for skilled but not for unskilled work (p. ii); not just trade union detennined wages, but excessively capital-intensive production methods, inadequate working skills and insufficient private investment serve to cause unemployment (p. 9); and "the probability of being unemployed is much lower for well-educated workers irrespective ofracial group" (p. 13). the authors are no doubt right in suggesting that job creation would be promoted by the following policy approaches: more investment in human capital, more competitive markets (to avoid excessive wage increases), no policy intervention to raise wages, encouragement of the positive aspects of trade union activity, more labourintensive infrastructure and tripartite (state labour business) agreement on key issues (pp. 29-33). it is, however, most doubtful whether land refonn in subsistence agriculture would be an effective way of creating jobs (pp. 3, 20, 28) in the by third world standards relatively sophisticated south african economy. small and medium-sized business development seems a rather more likely bulwark against worklessness. however, the kind of political economy discussed above cannot be taken for granted. if the relation between economics and politics is to be successful, then its main components must positively interact with each other over time, filling the roles of cause and effect by turns. the creation of employment opportunities, greater equality of income and wealth, and increased supply of social services are often said to be important policy objectives in south africa. such objectives can only be met consecutively, not all at once, and it is vital that the process should be started the right way by an acceleration of economic growth. the combination of rapid growth and rising income would not only promote distributional equity but establish the budgetary base for increased social spending. insofar as this is channeled into human capital fonnation (e.g. health care, education), the productivity of labour rises and the scope for employment growth is sustained. but south africa's policy-makers refuse to learn from experience. attempts in the 1970s to reduce the then existing wage gap autonomously, mainly caused inflation to accelerate (ar, 1977:15). in the new south africa too, priority has been given to redistribution at the wrong time. fiscal policy so far has been to fleece middleincome taxpayers, perhaps because this is seen to incur little electoral risk. neither has it benefited anyone economically, as the imf warned. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 2 298 nonsense from geneva the international labour office (ilo) in geneva is noted for its social comment rather than economic analysis. in 1996 it published a country review by guy standing, john sender and john weeks with the title restructuring the labour market,' the south african challenge. this ilo review was conceived and (partly) sponsored by the south african department of labour, and the responsible minister, tito mboweni, has contributed a foreword to it. the authors make the unassailable point that "a higher rate of economic growth is required to generate more employment and to reduce unemployment" (p. 38), but from the outset take leave of the real world to enter that of virtual economics instead. this is an illusory world where income redistribution and budget deficits cause the economy's productive capacity to grow (pp. 2, 31), where inflation is self-eliminating (p. 34) and macroeconomic stabilisation unnecessary (pp. 42-3), where state regulation is tantamount to market flexibility (p. 16), and where there are no unskilled workers, just unskilled jobs (p. 449), and high wages do not really have a dampening effect on employment (p. 204). the theoretical underpinnings of the system are almost equally bizarre. the authors generally favour a keynesian-type approach, but when discussing economic growth they make use of a cobb-douglas production function where raw labour and physical capital provide the only input services. technical progress is dismissed as "manna from heaven" (p. 199), while "endogenous" growth theory and "human capital" (arguably the most significant developments in modem growth analysis) are not only written between quotation marks but qualified by the (presumably derogatory) adjective so-called (p. 55) after which they disappear from the scene. or maybe not, for the 500-page review has no index. this is a major disservice to readers, likely to be in for a long search should they wish to know the authors' perception (if any) of, say, the relation between population growth and labour supply or comparative informal sector employment elsewhere in africa. the authors say that their hypotheses are supported by "considerable international evidence" (p. 2), but it would be easy to name several authoritative studies that refute every one of their "heterodox" (p. 50) claims. however, as this would be rather tedious, only one example of such false premises is given here. the authors hold up the economies of south east asia (the asean countries) in the review as a financial role model for south africa, where monetary and fiscal discipline is r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 299 sateb nr vol i (1998) nr 2 seen to slow down economic growth unnecessarily (pp. 26, 51). seldom has blind faith (or prejudice) been dealt a harder blow. the economic collapse that most asean mem,bers suffered during 1997 was triggered precisely by their lax monetary and to an extent fiscal policies, against a background of pegged and overvalued exchange rates. in contrast, speculation against the rand was thwarted by "the fundamentally healthier state of macroeconomic management in south africa" (qb, dec. 1997: 18). the authors keep building their virtual economy untrammeled by rules of logic: "just because ... more of the non-poor have wage income than the poor, does not mean that increasing the number of low-wage jobs would reduce poverty and income inequality, although they may do so" (p. 225). this type of statement does not rule out any conceivable event from happening, thus, if low-wage jobs were in fact increased, then poverty (and income inequality) may in consequence increase, decrease or remain constant: obviously true, but useless knowledge. policy questions raised by the authors themselves, are again dismissed for falling "outside our terms of reference" (p. 40). if so, why raise them in the first place? the authors also tend to flounder whenever the conceptual difference between the short and long-term time periods comes up for discussion. in the event, their stock reaction seems to be that any short-term effects of relative prices are likely to be dominated by the long-term effects of economic growth (pp. 228-35). incidentally, this might be a cryptic way of saying that neo-keynesian economics is better than neo-c1assical economics. or are these perhaps deeper waters? on the subject of labour market discrimination and disadvantage, the authors conclude: "the phenomena are systemic, the response must be systemic" (p.414). now, this is a slogan that marx might have coined, which could even lead one to suspect it freudian slip when the reconstruction and development programme is called the reconstruction and development plan instead (p. 469). but that would be going too far; the ilo review does have a leftist bias, however, without being cryptocommunist. the authors have, instead, produced what is today known as a politically correct document, likely to match the strongly dirigiste also left-wing bent of the south african government. in his foreword, mr mboweni mentions two items that in a sense capture the essence of the book. first, thanks to informal economic activity, south africa's effective rate of unemployment, though still alarmingly high, is less than often supposed approximately 20 instead of 30 or even 50 per cent. (this might represent the pin-point of fact on which a large superstructure of fiction stands.) the second item is the recommended introduction of so-called employment and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 2 300 development accords, which the authors proffer in place of conventional labour market arrangements. this is, of courste, the epitome of virtual economics, and the kind of scenario bound to appeal to both the department of labour and its undisguisedly revolutionary alter ego cosatu. but there is no comfort in this hocus-pocus for employment and growth in south africa. conclusion to summarise, unemployment in south africa has two major causes: lack of appropriate working skills and a hostile market environment. the former is a historical question that has today become south africa's most serious economic problem. the latter is of a more recent date, the combined product of trade union militancy and ill-judged labour legislation. from whatever angle the unemployment problem is approached, any serious enquiry is bound to arrive at these causal factors : unskilled labour and inflexible markets. such is not only the finding of this particular study, but one supported by many independent conclusions and research projects. for example, the economist (december 13 1997:17) wrote the following on the subject of unemployment in south africa: part of the problem is the heavy state-imposed cost to employers of hiring and firing, which has risen under the government's new labour laws. in addition the labour market is made sticky by an illiterate and unskilled workforce, which pushes up the cost of scarce skilled labour. taking a second example, a survey by the south african institute of race relations (sairr) found two sets of major hindrances to the employment of less skilled labour in gauteng province the economic heartland of the country. first: in one context the characteristics of the labour market are completely dominant as a consideration; the difficulties and impediments in hiring more less-skilled labour. virtually every [survey] respondent, black and white, identified problems in the field of labour relations, labour laws, trade union activity or the [poor] cost effectiveness of unskilled and semi-skilled labour (schlemmer & levitz, 1998 : 49). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 301 satebnr vol i (l998)nr2 these may be called impediments of a market-related nature. to them the sairr survey adds a second set of environmentor culture-related impediments, namely, low skills, high wages, high costs, low productivity and low motivation. seen through rose-tinted spectacles, the south african government's economic policy has been described as "fairly free-market economics" (te, dec. 7 1996 : 47). the macroeconomic strategy known as gear is often taken as sufficient proof of the government's commitment to a market-based economic system, no matter what the rest of its economic policy might be. if this is the essence of the south african economy today, what is the nature of its political counterpart? the question calls for a somewhat circuitous answer. before the final collapse of the ussr in 1991, the politics of the south african government-in-waiting (the anc-sacp-cosatu-alliance) closely resembled the moscow version of communism, whose economic parallel was the system of planned (or "real") socialism. on the disintegration of the soviet union, however, the alliance became a political orphan. if the fall of sovietism caused the plan to be replaced by the market, does the metamorphosis of a commissar into a democrat logically follow? not necessarily, for in today's world it is by no means uncommon to be an autocrat and a democrat at the same time. this topic has been eloquently discussed by fareed zakaria (lithe rise of llliberal democracy") in the american journal foreign affairs (nov.ldec. 1997 : i, 22-43» from which the following precis has been taken : around the world, democratically elected regimes are routinely ignoring limits on their power and depriving citizens of basic freedoms ... [thus] we see the rise of a disturbing phenomenon : illiberal democracy. it has been difficult to recognize because for the last century in the west, democracy free and fair elections has gone hand in hand with constitutional liberalism the rule of law and basic human rights. but in the rest of the world, these two concepts are growing apart. democracy without constitutional liberalism is producing centralized regimes, the erosion of liberty, ethnic competition, conflict and war. this description fits the south african polity today almost perfectly. moreover, it represents a political attitude that is very likely to beget a strongly authoritarian economic outlook too, thus resulting in an irrational and unstable political economy relation ("the interaction of political and economic variables"). the epitome of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 2 302 such a system, at the same time imperious and inefficient, was national socialism in germany (1933-45), which has also been described as an "economy without economics" (neumann, 1963:211). although hitler never claimed to be a democrat, by today's standards he might plausibly have done so, for almost 90 per cent of the german and no less than 99.75 per cent of the austrian electorate endorsed his most radical political measures (kershaw, 1991:212,214). the nazi economic system rested on control rather than nationalisation, coupled with the rejection of economic liberty and free markets. south africa seems to be moving in the same direction. the dismantling of civil liberties by the country's democratically elected government has been competently set out by tony leon in a paper called "the death of the rainbow nation" (internet http://dp.org.za). the counterpart of a schizoid polity ("illiberal democracy") is a dirigiste economy, as recently discussed in this journal (vol. 21, 1997). common to the loss of both political and economic freedom, is the government's guiding principle of "comparativeness" or "representativity", briefly put, the fallacy that the racial composition of the total population should also be reflected in most (or all?) conceivable subdivisions of society (e.g. tertiary education, national sports teams, public and private employment). the main economic disadvantage of comparativism is that it contradicts the principle of specialisation, on which all forms of productive activity are founded. still in the economic context, the policy-induced distortions in the labour market, called "affirmative action", perversely aggravate the currently high unemployment in south africa that was identified as the core problem of economic policy in this paper. as leon points out, affirmative action is not associated with equality of opportunity but with equality of outcome, an impossible fiction not taken seriously anywhere in the world except in south africa today. ironically enough, the racial bias of the employment equity act resembles the previous government's labour legislation turned upside down, for example, the equally misguided physical planning act of 1967 required business firms to maintain a ratio of black to white employees of 2 : i (tomlinson & addleson, 1987 : 38). given its past deep-rooted commitment to planned socialism, the present south african government has in fact had the market economy pretty well foisted on it by a major accident of history. this may have contributed to the misconception that it is somehow possible to retain the positive attributes of rival economic systems, while discarding their negative ones. but the institutions (e.g. property rights, decision-taking, incentives) that make up a particular economic system, are essentially of a complementary nature and, hence, basically indivisible. nor is it possible to enjoy the advantages of the output markets, at the same time r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 303 sateb nr vol i (1998) nr 2 manipulating the input markets, particularly the labour market, according to the dictates of affirmative action. (the attempt to create such a spurious hybrid by force, eventually led to the destruction of the yugoslav state.) furthermore, complete disregard or ignorance of liberal values at times gives rise to breathtakingly outlandish policy proposals. for example, not since the days of hitler and stalin have innocent people been sentenced to forced labour as a matter of public policy. yet the south african government under the leadership of the minister of health, seems bent on doing precisely that to university graduates. in the dark days of statutory racial segregation the american journal business week (sept. 23 1985: 50) wrote: "the economy is one of the few aspects of life in south africa that transcend apartheid." shocking as the thought may be, is a system that passes for democracy now undermining the south african economy as never before, and subjecting the nation to unknown internecine strife? finally, to answer the question put in the introduction (political economy or virtual economics?), south africa's policy-makers seem about to leave the real world of . political economy to enter the illusory world of virtual economics instead, where a gigantic lie stands on a pin-point of truth. how can such an aberration happen? undying fidelity to an extinct politico-economic system (communism-socialism) is more than likely a big part of the explanation. thus revolution is now called transformation (phase two), class struggle has become affirmative action and the classless society will be a politically correct one. none of this makes economic sense, as not only the breakdown of communism-socialism but south africa's persistent unemployment rate show. economics, like nature, does not proceed by leaps and bounds. natura non facit saltum was the motto that alfred marshall chose for the title-page of his celebrated principles of economics, first published in 1890 and still widely read today. references 1. bacon, r. & eltis, w. 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(1995): workers in an integrating world. new york: oxford university press, p.3. abbreviations: ar south african reserve bank annual report, bw business week, ceas central economic advisory service, fm financial mail, fts financial times survey, gear growth, employment and redistribution, a macro-economic growth strategy, pn pretoria news, qb south african reserve bank quarterly bulletin, stbt sunday times business times, te the economist, teiu the economist intelligence unit, wdr world bank world development report. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . microsoft word 2 dachapalli & parumasur sajems 15(3) 2012.doc sajems ns 15 (2012) no 3 253 the prevalence and magnitude of job insecurity leigh-anne paul dachapalli department of human resource management, unisa sanjana brijball parumasur school of management studies, university of kwazulu-natal accepted: junie 2012 this study investigates the prevalence and magnitude of job insecurity experienced by employees in an organisation undergoing major transformation, while taking cognisance of intercorrelations among its subdimensions. the research adopted a formal, hypothesis-testing approach whereby quantitative data was collected using a cross-sectional survey method from a sample of 1620 employees. the findings indicate that threats to salient job features/total job and feelings of powerlessness trigger the potential for job insecurity. this study identifies conditions that increase the potential for job insecurity. recommendations are presented for reducing the prevalence and magnitude of job insecurity. key words: job insecurity, job threats, powerfulness, powerlessness, importance of job features, total job jel: j280, 630 1 introduction south africa is undergoing tremendous changes in the political, economic, legal, social and educational environments. working life has been subjected to dramatic change over the past decades as a result of economic recessions, new information, technology, industrial restruc turing and accelerated global competition (hartley, jacobson, klandermans & van vuuren, 1991; hellgren, sverke & isaksson, 1999). as a consequence, organisations have been forced to engage in various adaptive strategies in order to address new demands and remain vigorous in this unpredictable environment. organisations have two options if they wish to become more profitable; they can either increase their gains or decrease their costs, often by reducing the number of employees (burke & cooper, 2000; burke & nelson, 1998; tetrick & quick, 2003). these organisational options often surface in actions like outsourcing and privatization, often in combination with personnel reductions through layoffs, offers of early retirement and increased use of sub-contracted workers (burke & cooper, 2000; burke & nelson, 1998; tetrick & quick, 2003). the changes in south africa have impacted tremendously on organisational structures and have created a continuous need for organisational changes in terms of retrenchments, rightsizing, mergers and acquisitions and downsizing. as a result of these organisational changes, job insecurity has emerged as one of the most important issues in working life and has brought the issue of insecure working conditions into the forefront (sverke, hellgren & näswall, 2002). organisational restructuring/downsizing has had a tremendous effect on employees’ health. bohle, quinlan and mayhew (2001) concluded that 88 per cent of studies undertaken investigating the impact of organizational restructuring found a measurable negative effect on health in at least one of a range of measures, such as the increased risk of work-related injury, occupational violence, cardiovascular disease and psychological distress or mental illness. in addition, mohren, swaen, van amelsvoort, borm & galama, 2003) found a relationship between job insecurity and common infections and health problems. furthermore, studies deduce that the characteristic effects of downsizing, that is, job strain and job insecurity, have resulted in abstract 254 sajems ns 15 (2012) no 3 higher levels of mental and physical health problems (kim, 2003; kivimaki, vahtera, pentti, thomson, griffiths & cox, 2001; mauno, kinnunen, makikangas & natti, 2005; pepper, messinger, weinberg & campbell, 2003; strazdins, d’souza, lim, broom & rodgers, 2004). repeated rounds of downsizing/ restructuring (quinlan, 2007) and job insecurity have been found to result in negative and longterm symptoms of distress (isaksson, hellgren & pettersson, 2000) and work/family conflict and burnout, including crossover burnout (westman, etzion & danon, 2001). evidently, restructuring/downsizing creates volatility in the job market and is a threat to both stable and long-term relationships between employers and employees, as well as to their well-being. hence, this study aims to: • investigate the prevalence and magnitude of job insecurity on the part of employees in an organisation undergoing major transformation; and • assess whether significant intercorrelations exist among the sub-dimensions of job insecurity (the importance of job features, the existence of job features, perceived threats to job features, the importance of the total job, perceived threats to the total job and feelings of power/powerlessness). in other words, the study aims to determine the strength and direction of the relationships among the sub-dimensions of job insecurity. 2 literature review 2.1 the definition and nature of job insecurity job insecurity is situated between employment and unemployment because it refers to employed people who feel threatened by unemployment (hartley et al., 1991). job insecurity has been conceptualised from two points of view, that is, as a global or as a multidimensional concept. greenhalgh and rosenblatt (1984) define job insecurity as a feeling of powerlessness to maintain desired continuity in a job situation that is under threat. job insecurity has been defined according to a global viewpoint, signifying the threat of job loss and job discontinuity (caplan, cobb, french, van harrison & pinneau, 1980; de witte, 1999). hence, job insecurity is said to be both an individual’s negative expectations about continuity in their job situation (davy, kinicki & scheck, 1997) and their perception of a potential threat to continuity in their current job (heaney, israel & house, 1994). this definition has been applied in the context of organisational crisis or change in which job insecurity is considered as a first phase of the process of job loss (ferrie, 1997). researchers adopting a multi-dimensional definition of job insecurity argue that the term refers not only to the degree of uncertainty felt or experienced by the employee, but also to the components of job insecurity: • the severity of the threat concerning job continuity or aspects of the job. • the importance of the job features to the individual. • the perceived threat of a totally negative effect on the job situation. • the total importance of the organisational changes. • the powerlessness and inability of the individual to control the above components. likewise, hellgren et al. (1999) differentiated between two different forms of job insecurity: quantitative job insecurity, which is worrying about losing the job itself, and qualitative job insecurity, which is worrying about losing important job features. while quantitative job insecurity is related to the general comprehensive operationalisation of the construct, qualitative job insecurity refers to feelings about potential loss of quality relating to the organisational position, such as the deterioration of working conditions, the lack of career opportunities and decreasing salary development (sverke & hellgren, 2002). the underlying theme contained in the various definitions is that job insecurity is a subjective phenomenon, meaning that it is based on the individual’s perceptions and interpretations of the immediate work environment (hartley et al., 1991). job insecurity refers to the anticipation of this stressful event in such a way that the nature and continued existence of one’s job are perceived to be at risk, the implication being that the feeling of job insecurity occurs only in sajems ns 15 (2012) no 3 255 the case of involuntary job loss. two main themes identified in job insecurity are differentiated by borg & elizur (1992) as being: • cognitive job insecurity, which refers to the likelihood of job loss. • affective job insecurity, which refers to the fear of job loss. 2.2 the occurrence and degree of job insecurity in this study, the main aim is to investigate the prevalence and magnitude of job insecurity experienced by employees in an organisation undergoing major transformation. the prevalence and magnitude of job insecurity will be assessed in terms of the multi-dimensional definition of job insecurity. researchers, like greenhalgh and rosenblatt (1984), who hold this view, believe not only that job insecurity is more than the perceived threat of job loss but also that it includes thoughts about losing valued job features, such as pay, status, opportunity for promotion and access to resources. hence, in this study, job insecurity represents the interaction of three factors: (1) the threat to job features; (2) the threat to the entire job; and (3) the degree to which individuals perceive themselves to be powerless in counteracting threats to job features and the entire job or the work situation. these individuals further see the threats to the entire job as more severe than the threats to the job features, because one can lose one’s job features but still maintain organisational membership. however, the loss of the entire job entails potential loss of career advancement (greenhalgh & rosenblatt, 1984). threats to the entire job and threats to job features correspond to what hellgren et al. (1999) refer to as quantitative job insecurity and qualitative job insecurity respectively. 2.3 the dimensions of job insecurity in this study, it is maintained that in order for qualitative job insecurity to take place, individuals must attach importance to the job features and must regard the existing job features as salient. in this study, the dimensions of job insecurity therefore include: • the importance of job features: this determines the salience of job features such as pay, status, opportunity for promotion, access to resources, career opportunities, and position within the organisation; • the existence of job features: this refers to the extent to which the salient job features exist in the organisation; • perceived threats to job features: this refers to the estimated likelihood of losing salient job features and feelings that important job features are being threatened; • importance of the total job: this determines how salient the total job is to the individual; • perceived threats to total job: this refers to either the estimated likelihood of the job itself being at risk or to perceptions of losing the job; • feelings of power/powerlessness: for example, during a process of transformation individuals do not know how to protect themselves and the sense of powerlessness or being unable to secure their future intensifies the insecurity they experience. 2.3.1 perceptions of job features hellgren et al. (1999) found that the importance of job features significantly related to the features’ actual existence. greenhalgh and rosenblatt (1984) indicated that job features are as important as the total job because loss of the former represents aspects of job insecurity but their loss would be less severe than losing the total job. yousef (1998) concluded a significant and inverse correlation between the importance of job features and perceived threats to them. brun and milczarek (2007), like chovwen and ivensor (2009), found a significant relationship between the existence of job features and perceived threats to job features, such as position within an organisation or career opportunities. this reveals that, although the job features do exist, individuals perceive threats to these job features as a result of the restructuring that is taking place in the organisation. chovwen and ivensor (2009) and ito and brotheridge (2007), unlike ugboro and obeng (2001), found a significant relationship between power/ powerlessness and perceived threats to them. 2.3.2 perceptions of total job ugboro and obeng (2001) found that the relationship between perceived threats to job 256 sajems ns 15 (2012) no 3 features and perceived threats to the total job were directly significant. this indicates that as threats to job features increase so do the threats to the total job; however, the threats to job features and to total job were not related to power. 2.3.3 the consequences of job insecurity since job insecurity involves the experience of a threat, and implies a great deal of uncertainty as to whether individuals keep their jobs in the future, it has been described as a stressor (barling & kelloway, 1996; de witte, 1999). like other work-related stressors, job insecurity is associated with a number of detrimental consequences for both the individual and the organisation. the perception of job insecurity is frequently linked to reduced organisational commitment (borg & elizur, 1992; forbes, 1985), job satisfaction (lord & hartley, 1998), job involvement (sverke et al., 2002), job performance and productivity (dunlap, 1994), work effort (brockner, grover, reed & de witte, 1992) and to lack of trust in management (ashford, lee, bobko, 1989; forbes, 1985; romzek, 1985) and intentions to leave the organisation (ashford et al., 1989; davy et al., 1997; greenhalgh & rosenblatt, 1984). job insecurity is also associated with decreased safety, motivation (borg & elizur, 1992; greenhalgh & rosenblatt, 1984) and compliance, increasing the risks of workplace injuries and accidents (probst & brubaker, 2001). evidently, job insecurity is consistently associated with lower levels of relevant job attitudes and behaviours. furthermore, job insecurity is also associated with higher levels of burnout, anxiety and depression and psychosomatic complaints (hartley et al., 1991). the component of uncertainty inherent in job insecurity makes it a potent work stressor (mauno & kinnunen, 1999). the lack of predictability or knowledge of what is to come with reference to the present job would give rise to distress for the individual. several research studies have suggested that job insecurity should be related to different negative attitudinal, health-related and behavioural outcomes (ashford et al., 1989; dekker & schaufeli, 1995; heaney et al., 1994; hellgren et al., 1999; probst, 2003; sverke et al., 2002; sverke & hellgren, 2002). in terms of attitudinal outcomes, for example, de witte (1999) states that job insecurity has a significant negative influence on the emotional well-being of the individual. it reduces the level of job satisfaction and leads to healthrelated outcomes such as psychosomatic complaints. prolonged job insecurity is more detrimental and acts as a chronic stressor which has the potential to result in more potent negative effects as time progresses and may lead to behavioural outcomes like absenteeism (dekker & schaufeli, 1995), thereby emphasizing the importance of the early identification of its occurrence. undoubtedly, the increasing antecedents and the detrimental consequences (individual and organisational) of job insecurity necessitate the study of the prevalence and magnitude of job insecurity in an organisation undergoing major transformation so as to attempt to reduce its occurrence and/or negative effects in the future. 3 research design 3.1 participants the target population for this study consisted of 8341 employees from a telecommunication company, selected because it was undergoing major transformation. it was therefore expected that job insecurity would prevail. the population was made up of employees from the gauteng and kwazulu-natal provinces. a sample of 1620 employees was drawn from both regions, using a probability sampling technique, simple random sampling, whereby subjects were extracted using a random number selection process. according to sekaran (2003), the corresponding minimum sample size for a population size of 8341 is 367, confirming that the sample size of 1620 is more than adequate for the study. the adequacy of the sample for conducting factor analyses was further determined using the kaiser-meyer-olkin measure of sampling adequacy for the measurement of job insecurity (0.914) and bartlett’s test of spherecity (66210.340; p = 0.000), which respectively indicated suitability/ adequacy and significance. the results indicate that the normality and homoscedasticity preconditions have been satisfied. sajems ns 15 (2012) no 3 257 3.2 measuring instruments data was collected using an adapted version of ashford, lee & bobko’s (1989) measuring instrument to assess the level of job insecurity. the questionnaire consisted of two sections. section 1, which aimed to obtain a profile of the respondents, included biographical data relating to age, tenure, race, number of years in the current position, educational level, gender and region, and was measured on a nominal scale. section 2 assessed the level of job insecurity. section 2 consisted of structured questions using closed-ended questions relating to six sub-dimensions (2a to 2f) of job insecurity: • the importance for the individual of job features relating to opportunities for promotion, freedom to schedule one’s own work and current pay (section 2a, 17 items); • the existence of job features that encompass perceptions of the extent to which the individual believes that the salient job features exist in his/her job (section 2b,17 items); • perceived threats to job features that relate to the individual’s fear that his/her job features will be under threat in the process of change (section 2c, 17 items). the greater the extent to which the individual perceives job features to be threatened, the greater the job insecurity; • importance of the total job in terms of the individual’s current job (section 2d, 10 items); • perceived threats to the total job which encompass the individual’s fear that his/her job will be under threat in the process of change (section 2e, 10 items); and • power/powerlessness encompasses an individual’s ability/inability to counteract the threats (section 2f, 3 items). those who are high in power or low in powerlessness should not experience much job insecurity. these sub-dimensions were measured on a 1 to 5-point itemised scale ranging from very unimportant (1) to very important (5) and a 1 to 5 point likert scale ranging from strongly disagree (1) to strongly agree (5). 3.3 procedure in-house pretesting was adopted by distributing the designed questionnaire to colleagues and experts in the field to comment on the items, structure and layout of the measuring instrument. in addition, pilot testing was used to detect whether weaknesses in the design, measurement and layout of the questionnaire existed, using the same protocols and procedures as that designated for the actual data collection process. fifteen questionnaires were distributed to various categories of employees, reflecting the demographics of those included in the main study. the pilot subjects confirmed that they understood the instructions, wording of the items and how to use the scale, and that the questionnaire was appropriate in terms of the language-level used. 3.4 statistical analyses of the psychometric properties of the questionnaire the validity of the questionnaire was statistically analysed using factor analysis (table 1). the principal component analysis was adopted using the varimax rotation method and 6 factors with latent roots >1 were generated. only items with loadings >0.5 were regarded as significant and, when an item was significant on two or more factors, the one with the greatest loading was considered. table 1 indicates that sixteen items load significantly onto factor 1 and account for 11.84 per cent of the total variance in determining job insecurity. since all sixteen items relate to perceived threats to job features, factor 1 may be labeled likewise. furthermore, table 1 indicates that fifteen items load significantly onto factor 2 and account for 9.39 per cent of the total variance in determining job insecurity. since all fifteen items relate to the importance of job features, factor 2 may be labeled likewise. table 1 also reflects that fourteen items load significantly onto factor 3 and account for 9.34 per cent of the total variance. since all fourteen items relate to the existence of job features, factor 3 may be labeled as existence of job features. from table 1 it can be noted that eight items load significantly onto factor 4 and account for 7.35 per cent of the total variance in determining job insecurity. since all the items relate to the importance of total job, factor 4 may be labeled likewise. it is evident from table 1 that eight items load significantly onto 258 sajems ns 15 (2012) no 3 factor 5 and account for 6.52 per cent of the total variance. since all eight items relate to perceived threats to total job, factor 5 may be labeled likewise. table 1 reflects that five items load significantly onto factor 6 and account for 4.17 per cent of the total variance in determining job insecurity. two items relate to perceived threats to total job and three items relate to power/powerlessness. since more items relate to power/powerlessness, factor 6 may be labeled such, since the three items had moderate to high item loadings. t a b l e 1 factor analysis: dimensions of job insecurity item component item component item component item component item component item component 1 perceived threats to job features 2 importance of job features 3 existence of job features 4 importance of total job 5 perceived threats to total job 6 power/power lessness c2 0.521 a2 0.540 b2 0.552 d1 0.757 e1 0.707 e4 0.741 c3 0.570 a4 0.670 b3 0.508 d2 0.570 e2 0.662 e5 0.727 c4 0.657 a5 0.562 b4 0.581 d3 0.679 e3 0.665 f1 0.601 c5 0.677 a6 0.663 b5 0.681 d6 0.828 e6 0.819 f2 0.613 c6 0.757 a7 0.694 b6 0.701 d7 0.832 e7 0.826 f3 0.600 c7 0.794 a8 0.756 b7 0.734 d8 0.800 e8 0.715 c8 0.765 a9 0.705 b8 0.683 d9 0.798 e9 0.708 c9 0.779 a10 0.675 b9 0.663 d10 0.739 e10 0.758 c10 0.744 a11 0.597 b10 0.676 c11 0.693 a12 0.644 b11 0.677 c12 0.689 a13 0.514 b14 0.584 c13 0.685 a14 0.653 b15 0.613 c14 0.800 a15 0.651 b16 0.567 c15 0.798 a16 0.669 b17 0.703 c16 0.802 a17 0.684 c17 0.812 eigenvalue 8.761 6.949 6.913 5.435 4.826 3.024 % of total variance 11.84 9.39 9.34 7.35 6.52 4.17 the reliability of the questionnaire was statistically assessed using cronbach’s coefficient alpha and indicated a very high level of internal consistency of the items (alpha = 0.901), with item reliabilities ranging from 0.899 to 0.902 (table 2) and thus reflecting a very high degree of reliability. t a b l e 2 cronbach’s coefficient alpha if item deleted: dimensions of job insecurity item cronbach’s coefficient alpha if item deleted item cronbach’s coefficient alpha if item deleted item cronbach’s coefficient alpha if item deleted a1 0.902 b9 0.900 c17 0.899 a2 0.902 b10 0.899 d1 0.900 a3 0.901 b11 0.899 d2 0.900 a4 0.901 b12 0.900 d3 0.900 a5 0.900 b13 0.901 d4 0.901 a6 0.900 b14 0.900 d5 0.901 a7 0.900 b15 0.900 d6 0.900 a8 0.900 b16 0.900 d7 0.900 a9 0.900 b17 0.900 d8 0.900 a10 0.900 c1 0.901 d9 0.901 sajems ns 15 (2012) no 3 259 a11 0.900 c2 0.900 d10 0.900 a12 0.900 c3 0.900 e1 0.901 a13 0.901 c4 0.900 e2 0.901 a14 0.900 c5 0.899 e3 0.901 a15 0.900 c6 0.899 e4 0.901 a16 0.900 c7 0.899 e5 0.901 a17 0.900 c8 0.899 e6 0.900 b1 0.900 c9 0.899 e7 0.901 b2 0.900 c10 0.899 e8 0.901 b3 0.900 c11 0.899 e9 0.901 b4 0.900 c12 0.899 e10 0.901 b5 0.900 c13 0.899 f1 0.902 b6 0.900 c14 0.899 f2 0.902 b7 0.900 c15 0.899 f3 0.902 b8 0.900 c16 0.899 descriptive statistics (frequency analyses, mean analyses and standard deviations) and inferential statistics (correlations, anova, post-hoc scheffe’s test, t-test) were used to analyse the results of the study. 4 results of the study 4.1 composition of the sample when categorized on the basis of region, the majority of the respondents (63.8 per cent) were from gauteng while 36.2 per cent were from kwazulu-natal. in addition to region, the sample may be classified on the basis of biographical data, that is, age, tenure, race, number of years in current position, educational level and gender. in terms of age, the highest percentage of respondents (42.1 per cent) fell into the age group 30-39 years, followed by 40-49 years (36.5 per cent), 50 years and above (12.5 per cent) and 20-29 years (8.8 per cent) respectively. the majority of the respondents were in the age group 30-49 years (78.6 per cent). in terms of tenure, 54.5 per cent of the respondents in the company were 16 years of age and above, 28.1 per cent were between 6-10 years of age, 9.3 per cent were between the 0-5 years and 8.1 per cent had been working for the organisation for 11 to 15 years. further, the majority of respondents were whites (45.1 per cent), followed by blacks (28.1 per cent), indians (19.2 per cent) and then coloureds (7.6 per cent). when distinguished on the basis of the number of years in their current position, it is evident that 53.8 per cent of the respondents had been in their current position for ten years or more, 23.7 per cent between 7-9 years, 11.9 per cent from 0-3 years and 10.6 per cent for between 4-6 years. in terms of educational qualification, a significant proportion of the respondents had a certificate (33.7 per cent), while 27.4 per cent had matriculation and 24 per cent had a high school qualification. the sample was comprised of 74.3 per cent male respondents and 25.7 per cent female. 4.2 descriptive statistics table 3 indicates the descriptive statistics (means, variance, standard deviations, critical values) for each of the sub-dimensions of job insecurity. the greater the mean score value, the greater the extent to which the subdimension existed. however, in the power/ powerlessness sub-dimension of job insecurity, the greater the score value, the greater the extent of power and the less the degree of powerlessness displayed. table 3 shows that employees strongly agreed that the job features were very important to them (mean = 4.28). however, while they believed that these job features existed in their jobs (mean = 3.54), it is evident that they perceived a high level of threat to these valued features (mean = 3.25). likewise, table 3 reflects that employees felt strongly that their total job was important to them (mean = 3.88). however, they perceived that it was under threat (mean = 2.88). 260 sajems ns 15 (2012) no 3 t a b l e 3 descriptive statistics: sub-dimensions of job insecurity sub-dimension of job insecurity mean standard deviation 95% confidence interval for mean lower bound upper bound the importance of job features 4.28 0.666 4.25 4.32 existence of job features 3.54 0.725 3.50 3.57 perceived threats of job features 3.25 0.851 3.20 3.29 importance of total job 3.88 0.993 3.83 3.93 perceived threats of total job 2.88 0.816 2.84 2.92 power/powerlessness 2.75 1.112 2.69 2.80 in order to assess exactly where employees reflected job importance, perceived threats and experienced feelings of power/powerlessness, frequency analyses were conducted (table 4): t a b l e 4 frequency analyses: sub-dimensions of job insecurity dimension and related statements rating importance of job features important (%) very important (%) a job in which one can tell how well one is doing. 36.8 54.3 maintaining opportunities to receive periodic pay increases. 19.6 75.2 maintaining my current level of pay. 31.1 55.3 existence of job features agree strongly agree i experience a sense of community in working with good co-workers. 51.8 15.6 i receive feedback from my supervisor regarding my job performance. 49.3 18 the opportunity to do a variety of tasks exists in my job. 53.4 21.9 existence of job features disagree strongly disagree i have promotion opportunities in my current job. 23.2 36.4 maintaining opportunities to receive periodic pay increases exists in my job. 14.6 12 the status that comes with the position in the organisation exists. 22.3 11.2 my job places physical demands on me. 51.5 22 i have freedom to schedule my own work. 16.7 9.9 perceived threats of job features agree strongly agree negative change is likely to affect my potential to attain pay increases. 27.2 22.5 negative change is likely to affect my potential to maintain my current pay. 31.5 19 perceived threats of job features disagree strongly disagree negative change is likely to affect my potential to get ahead in the organisation. 21.7 11.8 negative change is likely to affect me in doing an entire piece of work from start to finish. 24.3 6.6 negative change will affect the variety of the tasks that i perform. 23.5 5.5 negative change is likely to affect my current freedom to perform the work in a manner that i see fit. 24 6.2 importance of total job agree strongly agree not to be laid off from my job even for a short period of time is important to me. 9 12.3 not losing my job and not being moved to a lower level within the organisation is important to me. 22.8 42.8 being moved to a different job at a higher position in the current location is important to me. 32.2 44.4 being moved to a different job at a higher position in another geographical location is important to me. 34.8 35.1 the uncertainty of my department or division’s future is important to me. 23.5 45.6 being laid off permanently is important to me. 6.5 14.9 being pressured to accept early retirement is important to me. 7.1 11.4 sajems ns 15 (2012) no 3 261 perceived threats to total job agree strongly agree a fluctuation in the number of hours worked from day to day is likely to occur. 32.2 11.5 losing my job and being moved to another job at the same level within the organisation is likely to occur. 32 12.8 my department or division’s future is likely to be uncertain. 26.4 13.2 losing my job and being laid off permanently is likely to occur. 21.2 10.6 perceived threats to total job disagree strongly disagree being moved to a higher position in another geographic location is likely to occur. 25.1 24.3 losing my job and being moved to a lower level within the organisation is likely to occur. 23 18.6 being moved to a higher position within the current location is likely to occur. 24.1 27.7 losing their job by being fired is likely to occur. 25.4 32 power/powerlessness agree strongly agree i understand the organisation well to control things that affect me. 32 9.9 disagree strongly disagree i have the power in the organisation to control events that affect my job. 29.8 32.2 from the results, it is evident that while the employees experienced a high level of perceived threats to their job features (mean = 3.25) and a high level of perceived threats to the total job (mean = 2.88) (figure 1 and figure 2), they also reflected a moderate level of powerfulness/powerlessness, which showed their potential for experiencing job insecurity. f i g u r e 1 importance of, existence of and perceived threats to, job features figure 1 shows that the trend line for the existence of job features is lower than that of the importance of job features, thereby reflecting the potential for unhappiness among employees. further, the trend line for perceived threats is negligibly lower than that for the existence of job features, thus reflecting the potential for job insecurity. in other words, even the job features that exist are perceived to be under threat, thereby creating the potential for job insecurity. figure 2 shows that the trend line for the importance of the total job is rather high. considering that employees attached a high level of importance to their total job, an abovemoderate level of threat to the total job could 0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5 1 2 3 4 5 6 7 8 9 10 11 job features mean importance of job features existence of job features perceived threats to job features 262 sajems ns 15 (2012) no 3 trigger a high level of job insecurity. added to this, with the moderate level of power (mean = 2.75) or the moderate level of powerlessness (mean = 2.25) experienced, a high proportion of employees felt that they did not hold sufficient power in their organisation to control events that might affect their jobs (mean = 2.71). this was followed by those who felt that they could not prevent negative things from affecting their work situation in the organisation (mean = 2.09). finally, there were those who felt that they did not understand the organisation well enough to be able to control things that affected them (mean = 1.94). this could result in a group of disillusioned employees whose sense of job threat was potentially heightened. f i g u r e 2 importance of, and threats to, total job 4.3 inferential statistics correlation was used to generate the results of the study and make decisions on the hypotheses. hypothesis 1 the items relating to the importance of job features (a) significantly correlate with the existence of these job features (b) and perceived threats to them (c) respectively (table 5). column 3 in table 5 indicates that the majority of the items relating to the importance of job features correlate significantly with the items relating to the existence of job features at the 1 per cent level of significance. hence, hypothesis 1 may be partially accepted in terms of the relationships between the items of importance and the existence of job features. the items where the importance and the existence of job features do not correlate include: • a2b2, where the mean of a2 is 4.34 and the mean of b2 is 2.41, thereby indicating that the importance attached to having promotion opportunities far exceeds the existence of promotion opportunities. • a4b4, where the mean of a4 is 4.64 and the mean of b4 is 3.33, thereby indicating that the importance attached to receiving periodic pay increases exceeds the existence of such opportunities. column 6 of table 5 indicates that the majority of items relating to importance of job features correlate significantly with the items relating to perceived threats to job features at the 1 per cent level of significance. hence, hypothesis 1 may be partially accepted in 0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 1 2 3 4 5 6 7 8 9 1 0 total job m ea n importance of total job threats to total job sajems ns 15 (2012) no 3 263 terms of the relationships between the items relating to the importance of, and threats to, job features. the items for which the importance and the perceived threats of job features do not correlate include: • a2c2, where the mean for a2 is 4.34 and the mean for c2 is 3.16, indicating that while employees attached great importance to promotion opportunities, they felt that these opportunities for advancement were greatly threatened in the organisation. • a4c4, where the mean for a4 is 4.64 and the mean for c4 is 3.36, reflecting that, while employees attached a very high level of importance to pay increases, they felt that salary increases were, to a great extent, threatened in the organisation. • a14c14, where the mean for a14 is 4.27 and the mean for c14 is 3.17, indicating that, while employees attached a high level of importance to doing a variety of tasks, these faced a high level of threat. • a16c16, where the mean for a16 is 4.29 and the mean for c16 is 3.28, reflecting that, while employees attached a high level of importance to having a job that made a significant impact on others, the significance of their jobs was threatened. t a b l e 5 correlation (r) and significance (p) between importance of job features (a), existence of job features (b) and perceived threats to job features (c) correlate r p correlate r p correlate r p a1b1 0.143 0.000* a1c1 0.139 0.000* b1c1 0.245 0.000* a2b2 -0.043 0.080 a2c2 -0.035 0.156 b2c2 0.136 0.000* a3b3 0.205 0.000* a3c3 0.058 0.020** b3c3 0.076 0.002* a4b4 0.026 0.303 a4c4 0.018 0.462 b4c4 0.091 0.000* a5b5 0.174 0.000* a5c5 0.144 0.000* b5c5 0.149 0.000* a6b6 0.088 0.000* a6c6 0.086 0.000* b6c6 0.223 0.000* a7b7 0.066 0.008* a7c7 0.076 0.002* b7c7 0.212 0.000* a8b8 0.064 0.010* a8c8 0.053 0.034** b8c8 0.143 0.000* a9b9 0.222 0.000* a9c9 0.081 0.001* b9c9 0.149 0.000* a10b10 0.232 0.000* a10c10 0.097 0.000* b10c10 0.175 0.000* a11b11 0.281 0.000* a11c11 0.142 0.000* b11c11 0.170 0.000* a12b12 0.336 0.000* a12c12 0.138 0.000* b12c12 0.173 0.000* a13b13 0.431 0.000* a13c13 0.131 0.000* b13c13 0.156 0.000* a14b14 0.141 0.000* a14c14 0.025 0.306 b14c14 0.123 0.000* a15b15 0.197 0.000* a15c15 0.069 0.005* b15c15 0.134 0.000* a16b16 0.289 0.000* a16c16 0.044 0.078 b16c16 0.069 0.005* a17b17 0.189 0.000* a17c17 0.082 0.001* b17c17 0.107 0.000* column 1 2 3 4 5 6 7 8 9 * p ≤ 0.01 in these four sets of items, the importance of job features supersedes the perceived threats of job features only negligibly. in such cases, when employees strongly valued job features which faced such a high level of threat, they were more likely to experience job insecurity. column 9 in table 5 indicates that all the items relating to the existence of job features significantly correlated with the items relating to perceived threats to job features, indicating that employees believed that as far as the job features existed, they were equally under threat, signifying the potential for job insecurity. hence, hypothesis 1 may be accepted in terms of the relationships between the items relating to the existence of, and perceived threats to, job features. hypothesis 2 the items relating to the importance of the total job (d) correlate significantly with the perceived threats to the total job (e) (table 6). 264 sajems ns 15 (2012) no 3 t a b l e 6 correlation (r) and significance (p) between importance of total job (d) and perceived threats to total job (e) correlate r p d1e1 0.313 0.000* d2e2 0.231 0.000* d3e3 0.291 0.000* d4e4 0.118 0.000* d5e5 0.203 0.000* d6e6 0.286 0.000* d7e7 0.325 0.000* d8e8 0.343 0.000* d9e9 0.178 0.000* d10e10 0.320 0.000* columns 2 and 3 in table 6 indicate that all the items relating to the importance of the total job directly (positive sign of r values in column 2) and significantly correlate with the items relating to perceived threats to the total job. hence, hypothesis 2 may be accepted. the implication is that the more important the total job, the greater the perceived threat to it, thereby increasing the potential for employee job insecurity. 5 discussion 5.1 the occurrence and degree of job insecurity this study aims first to evaluate the prevalence and magnitude of job insecurity, which was assessed in terms of the perceptions of job features and the total job. 5.2 perceptions of job features in this study, it is found that the importance of job features (mean = 4.28) is greater than their actual existence (mean = 3.54), which is greater than perceived threats to job features (mean = 3.25), which is greater than power (mean = 2.75). it is therefore, evident that the existence of job features is lower than their importance, thereby reflecting the potential for unhappiness among employees. furthermore, perceived threats to job features are only negligibly lower than the existence of the job features, thus reflecting the potential for job insecurity. this result correlates with the literature overview (de witte, 2005), which indicated that, for individuals in the organisation, the existence of job features was very low in comparison with the importance they attached to the feature, which left employees feeling dissatisfied. however, certain individuals in the organisation experienced threats to certain job features, some of which did exist, resulting in job insecurity among only those individuals. 5.3 perceptions of total job in this study, it was found that the importance of the total job (mean = 3.88) is greater than perceived threats to the total job (mean = 2.88), which is greater than power/ powerlessness (mean = 2.75). it is evident that the importance of the total job is rather high. considering that employees attached a high level of importance to their total job, an abovemoderate level of threats to the total job could trigger a high level of job insecurity among those employees. in addition, there was a moderate level of power (mean = 2.75) or powerlessness (mean = 2.25) experienced, whereby a high proportion of employees felt that: • they did not have enough power in their organisation to control events that might affect their jobs (mean = 2.71); • they could not prevent negative things from affecting their work situation in the organisation (mean = 2.09); and • they did not understand the organisation well enough to be able to control things that affected them (mean = 1.911). sajems ns 15 (2012) no 3 265 these factors could result in a group of disillusioned employees whose job threat was potentially heightened. 5.4 relationships between the dimensions of job features and those of the total job this study aims, secondly, to assess the relationships between the sub-dimensions of job features and those of the total job. there is an indication of a significant relationship between the importance of the job features and the existence of the job features and the importance of the total job respectively. the employees believed that the job features that were important to them did exist. the study found that job features were just as important to the employees as the total job. this finding correlates with the literature (greenhalgh & rosenblatt, 1984), which indicated that job features were as important as the total job, because the loss of valued job features represented aspects of job insecurity, but this would be less severe than losing the total job itself. it was also found that the importance of job features correlated significantly and directly with perceived threats to the job features. the positive sign for the ‘r’ value in each of these correlations indicates that as the importance of job features increases so do the perceived threats to them. the study further reflects that the more important the job features are, the greater the degree of perceived threats to the features, creating the potential for job insecurity. this finding correlates with the literature (boya, demiral, ergör, akvardar & de witte, 2008), which reflected that the importance of job features was significantly related to anxiety and depression, indicating higher levels of job insecurity and a greater degree of perceived threats to the job features. a significant relationship was found between the existence of job features and perceived threats to them. the study further reflects that, although the desired job features did exist, they faced an equal degree of perceived threats, which in turn reflected the potential for job insecurity. these findings correlate with the literature overview (brun & milczarek, 2007; cambell, carruth, dickerson & green, 2007; chovwen & ivensor, 2009;). this reveals that, although the job features did exist, individuals perceived threats to them as a result of organisational restructuring, seeing that these important job features could change or be lost in the new environment. in this study, as in that by ugboro and obeng (2001), it was found that there is no significant relationship between power/ powerlessness and perceived threats to job features. this study indicates that there is a significant and direct relationship between perceived threats to job features and perceived threats to the total job. the positive sign for the ‘r’ value in each of these correlations indicates that, as threats to job features increase, so do the threats to the total job and vice-versa. this study found further that there was a significant and direct relationship between the importance of the total job and perceived threats to total job. this indicates that the greater the importance of total job, the greater the perceived threats to it, which increases the potential for intensified job insecurity. similar findings were obtained in the literature overview (ugboro & obeng, 2001). this study also found that there was a significant but inverse relationship between power/powerlessness and perceived threats to the total job. this indicates that the greater the perceived threats to total job, the less the feeling of power (the greater the feeling of powerlessness), thereby increasing the level of employee job insecurity experienced. 5.5 implications for job insecurity from the results of the study, it is evident that: • when an increase in the importance attached to job features corresponds to an increase in existence of job features (that is, a significant and direct relationship exists), the potential for job insecurity is reduced. • when an increase in the importance attached to job features corresponds to an increase in the perceptions of threats to these job features (that is, a significant and direct relationship exists), the potential for job insecurity increases. • when an increase in the perceived existence of job features corresponds to an increase in perceptions of threats to job 266 sajems ns 15 (2012) no 3 features (that is, a significant and direct relationship exists), the potential for job insecurity increases. • when an increase in the importance of the total job corresponds to an increase in the perceptions of threats to the total job (that is, a significant and direct relationship exists), the potential for job insecurity increases. 6 conclusions and recommendations the high level of importance of job features and the importance of the total job displayed reflects that employees do not carry out a job simply for the sake of doing so. employees attach value to the job features and to their total job. it is therefore important for organisations to ensure the existence of these job features and to minimise or reduce threats to these and to the total job. after all, organisations have the potential to reduce any feelings of job insecurity. when employees attach a high level of importance to their job features, perceiving threats to them, as well as experiencing feelings of powerlessness, they become susceptible to job insecurity. specifically, in an organisation undergoing major restructuring, it is imperative for change managers to: ü close the gap between the importance of job features and perceived threats to job features by: • providing regular feedback on performance. • ensuring sustainable pay progression. • encouraging social association. • providing task variety. • creating more training opportunities. • creating more promotion opportunities. • implementing the strategy of empowerment by, for example, allowing employees the freedom to schedule their own work. • being sensitive to issues of redeployment. • providing regular and precise information regarding the process of transformation. • ensuring effective, open and transparent communication before, during and after the process of transformation. ü they could close the gap between the importance of the total job and perceived threats to it by: • providing promotion opportunities in the organisation and in other geographical regions of the organization. • constantly updating employees on changes in the organization. • being cautious about issues of retrenchment and dismissal. • finding alternatives to employee retrenchment, for example, by making use of early retirement options. • maintaining consistency in working hours/ shifts. • considering employees’ perceptions. • ensuring the effective management of conflict, negotiation, perceived fairness and job design. • encouraging creativity. • providing clear direction, vision and mission of the organisation, in the process focusing on individual role clarity and how each employee will contribute to the vision and mission. • develop strategies to reduce feelings of powerlessness and enhance feelings of power. • encourage employee participation, especially when it comes to issues of work scheduling and work methods. • ensure open channels of communication. • provide employees with opportunities for decision-making and problem-solving. delimitations and suggestions for future research due to the lengthy duration of any major restructuring process, it would be valuable in future studies relating to job insecurity in any organisation undergoing transformation to assess the prevalence and magnitude of job insecurity by using a longitudinal time frame rather than the cross-sectional one used in this study. in this way, comparisons could be made before, during and after the process of transformation. such an approach would enable the researcher to assess whether differences in the magnitude of job insecurity during a period of major change existed and when it was at its peak. sajems ns 15 (2012) no 3 267 acknowledgement the authors are grateful to the reviewers for constructive comments and motivation. references ashford, s.j., lee, 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accepted: 10 nov. 2017; published: 23 apr. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: although attention has been given to the importance of positivity in the workplace, it has only recently been proposed as a new way in which to focus on organisational behaviour. the psychological resources which meet the criteria for positive organisational behaviour best are hope, self-efficacy, optimism and resilience. aim: the purpose of this study was to investigate the construct validity of the psychological capital questionnaire (pcq), with specific reference to its psychometric properties. setting: the sample included a total of 1749 respondents, 60 each from 30 organisations in south africa. methods: a multi-factorial model was statistically explored and confirmed (with exploratory factor analysis and confirmatory factor analysis, respectively). results: the results support the original conceptualisation and empirically-confirmed factorial composition of psychological capital (psycap) by four elements, namely hope, optimism, resilience and self-efficacy. however, the study yielded a three-factor solution, with hope and optimism as a combined factor and resilience and self-efficacy made up of a reconfigured set of substantively justifiable items (three of the original 24 items were found not to be suitable). the three reconfigured factors showed good psychometric properties, good fit (in support of construct validity) and acceptable levels of convergent and discriminant validity. recommendations were made for further studies. conclusion: based on the results obtained, it seems that the pcq is a suitable (valid and reliable) instrument for measuring psycap. this study could thus serve as a reference for the accurate measurement of psycap. introduction human resources play a crucial role in the success of organisations and help them to achieve a sustainable competitive advantage. a number of studies have been conducted seeking to find effective ways to attract and manage talented employees (or human capital) and the part played by compensation, job design, work-life balance and growth opportunities, among others, have been examined (barnett & hall 2001; johnson 2004; olson 2003). however, nowadays, stimulated through positive psychology movements, there is a need to search beyond the human capital and to move the focus to positive psychological capital (psycap) (luthans & youssef 2004; luthans, youssef & avolio 2007). psycap focuses not only on human capital (‘who you are’) but also on developing the ‘who you want to become’ or ‘your best self’ senses (luthans et al. 2010). according to luthans (2002), the positive psychology resources for psycap are self-efficacy, optimism, hope and resilience. to date, researchers support these four components of psycap (dawkins et al. 2013; du plessis & barkhuizen 2012; görgens-ekermans & herbert 2013). the purpose of this study is to build on work previously done by luthans et al. (2007) through an examination of the instrument (psychometric) properties of the psychological capital questionnaire (pcq). dawkins et al. (2013) found 29 studies (in english) concerning the pcq in 2013. the studies reported by dawkins et al. (2013) ranged in sample size from 80 to 1526 and took place mostly in homogeneous settings. these studies included sample populations such as employees in a specific organisation, students, marching band members, financial advisors and managers. dawkins et al. (2013) suggested that, as part of this meta-study on previous research on the pcq, further research should be conducted (outside of the founding psycap research team) and in more diverse settings. the authors could retrieve only three south african studies on pcq (outside of those by the founding psycap research team). however, all three of these studies involved a homogeneous setting and had small sample sizes. the south african studies were conducted by du plessis and barkhuizen (2012), who reported on the properties of pcqs using a sample of 131 human resource practitioners; görgens-ekermans and herbert (2013), using a sample consisting of 209 employees drawn from a mid-sized construction company and consisting of a race and gender distribution which is not representative of the south african population and workforce; and pillay, buitendach and kanengoni (2014), sampling 11 call centre employees. this study is intended to contribute by establishing a valid measure of psycap. such a measure has been set by luthans (2002), as well as luthans et al. (2007). in contrast with the initial developmental work and studies on the pcq (both locally and internationally) – which was based on relatively homogeneous samples – this study made use of a representative sample of the south african work force, with the sample including employees in both the private and public sectors. the objectives of this study were, first, to determine the construct (factorial) validity of the original factorial composition of the psycap (luthans et al. 2007) and second, if necessary, to develop a reconfigured factor structure should the original configuration yield unsatisfactory results. finally, it was also the intention to support the notion of factorial validity through the application of discriminant and convergent validity. literature review meaning of psychological capital: background although attention has been given to the importance of positivity in the workplace, it has only recently been proposed as a new way in which to focus on organisational behaviour (cameron, dutton & quinn 2003; luthans & youssef 2007). motivated by the new positive psychological movement, positive organisational behaviour can be defined as the application and study of positively-oriented human resource psychological capacities and strengths that can be developed, managed and measured for improved performance in the workplace (luthans 2002). this newly-emerging, positive organisational behaviour recognises early history such as herzberg’s (1966) two-factor theory of job satisfaction, maslow’s (1954) hierarchy of needs and mcgregor’s (1960) theories x and y, as well as other contemporary research and theories which are positively-oriented. these include, among others, organisational commitment, job satisfaction, positive affectivity, organisational citizenship, core self-evaluations, organisational justice, intrinsic motivation, self-determination and humour (luthans, avolio et al. 2007). the psychological resources which meet the criteria for positive organisational behaviour best are hope, self-efficacy, optimism and resilience (luthans 2002; luthans et al. 2007; luthans, avey & patera 2008). researchers such as luthans and youssef (2004, 2007) and luthans et al. (2007) developed the term ‘psychological capital’. according to these authors, psychological capital (or psycap) is a term used for positive organisational behaviour and can be defined as an individual’s positive psychological state of development which is characterised by optimism (making positive attributions), self-efficacy (having confidence), resilience (to attaining success) and hope (redirecting paths to goals) (luthans et al. 2007). according to dawkins (2014), psycap can be defined as an individual’s state of psychological development comprising resources such as optimism, self-efficacy, resilience and hope. according to sapyaprapa, tuicomepee and watakakosol (2013), psycap has been developed to attain a supporting unity between the organisation and its employees and to put the organisation at a competitive advantage. dimensions of psychological capital authors such as luthans and youssef (2004), luthans et al. (2007), sapyaprapa et al. (2013), dawkins (2014) and pillay et al. (2014) agree that psychological capital has four dimensions, namely optimism, self-efficacy, resilience and hope, as reflected in figure 1 below: figure 1: the individual psycap components. optimism can be conceptualised in two dimensional constructs, namely (1) the degree of permanence (i.e. when positive events are seen as permanent and negative events are seen as temporary), and (2) pervasiveness (when positive causes are perceived as applicable to all events and negative causes are seen as applicable to some events) (dawkins 2014). this means that optimistic people incorporate a positive explanatory style linking positive events directly to pervasive, internal and permanent causes, and negative events are linked to situation-specific, temporary and external factors (seligman 2002). self-efficacy within the psycap context refers to an individual’s confidence with regard to his/her ability to activate cognitive resources, establish a course of action and to find the motivation needed to successfully implement certain tasks in a given context (stajkovic & luthans 1998). in other words, when an individual’s self-efficacy is high, he or she is more willing and able to face challenges and to extend his or her effort and motivation to successfully achieve goals (dawkins 2014). according to luthans et al. (2007), an individual with high self-efficacy cherishes five characteristics, namely: (1) setting high goals; (2) embracing challenges and then flourishing; (3) being self-motivated; (4) putting in effort to accomplish goals; and (5) persevering to overcome obstacles. resilience as a dimension of psycap is described by luthans et al. (2007) as the ability to bounce back in order to attain success when affected by difficulty and problems. in the workplace, resilience assets are seen as protective factors used to reduce risk within an individual and his/her environment. resilience assets may include temperament, spirituality, cognitive ability, a sense of humour, a positive outlook on life, initiative and emotional stability. dawkins (2014) continues by saying that, on the other hand, resilience risk factors predict poor adjustment or negative outcomes and could include burnout and stress, lack of training and knowledge and unemployment (dawkins 2014). hope as a psycap dimension can be defined as the willpower (to have positive expectations and goals) and the waypower (having alternative pathways in place to cope with these expectations should they not happen in the way they were supposed to) that employees have towards a certain goal (luthans, vogelgesang & lester 2006). psycap measurement luthans et al. (2007) developed the pcq to measure psycap. the psycap questionnaire was developed by using published and pre-existing measures on the four psycap concepts (optimism, self-efficacy, resilience and hope). the measures varied in the number of items as well as likert scale points and the degree to which these concepts were relevant and state-like to the workplace. therefore, some the items were either eliminated or modified so that they fit into the pcq (dawkins et al. 2013). this questionnaire consists of 24 items and has four subscales which measures the four factors, namely, hope, self-efficacy, resilience and optimism. each factor consists of six items. examples of the items in the pcq are ‘i feel confident helping to set targets/goals in my work area’ (self-efficacy): ‘if i should find myself in a jam at work, i could think of many ways to get out of it’ [hope]; ‘i usually take stressful things at work in stride’ [resilience]; and ‘when things are uncertain for me at work i usually expect the best’ [optimism]. (p 1) the pcq follows a six-point likert scale ranging from 1 to 6, (1 = strongly disagree and 6 = strongly agree). respondents have to provide responses based on how they think about themselves right now. dawkins et al. (2013) reported that the internal reliability of the pcq was found to be relatively consistent across the 29 studies included in the meta-analysis. they further reported that optimism and resilience showed generally lower cronbach alpha coefficients than the other two factors. this might be attributed to the inclusion of three negatively-worded or reversed items. however, the pcq has also been criticised, despite the fact that this questionnaire is endorsed in the literature. little, gooty and nelson (2007) criticised the pca as they were of the view that the questionnaire is only conducted in a non-organisational setting. dawkins et al. (2013) continued by suggesting that further research should be conducted (outside of the founding psycap research team) and in more diverse settings. this study is intended to contribute by establishing a valid measure of psycap. du plessis and barkhuizen (2012) have identified a three-factor structure for the pcq through an exploratory factor analysis (efa) with hopeful-confidence, optimism and resilience as factors, with cronbach alpha coefficients of 0.86, 0.77 and 0.81 respectively. görgens-ekermans and herbert (2013) on the other hand, after confirming the theoretical four-factor structure, reported acceptable cronbach alpha coefficients for hope and self-efficacy. similar to the findings of dawkins et al. (2013), the görgens-ekermans and herbert (2013) study reported optimism and resilience cronbach alpha values of 0.67 and 0.69, respectively, which is regarded to be marginally acceptable, considering that α > 0.70 is regarded as acceptable according to nunnally and bernstein (1994). pillay et al. (2014), on the other hand, employed a principal component analysis on the pcq, resulting in a one-factor solution, in other words, the subscales hope, optimism, resilience and self-efficacy all loaded on one factor with a cronbach alpha value of 0.87. construct validity an important scientific concept to evaluate the validity of a measure is construct validity. construct validity is the extent to which a test measures the concept or construct that it is intended to measure. construct validity is usually tested by measuring the correlation in assessments obtained from several scales purported to measure the same construct. there is no cut-off that defines construct validity. it is important to recognise that two measures may share more than construct similarity. specifically, similarities in the way that constructs are measured may account for some covariation in scores, independent of construct similarity (devellis 2003). benson (1998) described three necessary components to developing a strong case for construct validity: (1) a substantive component, (2) a structural component, and (3) an external component. all three are fundamental in creating a case for construct validity. the substantive component of construct validity involves theoretical and empirical definition of the domain of interest so that potential variables, or observables, of a construct are adequately represented in measurable ways. in the case of this study, the overall conceptualisation of the composite construct psycap (and its four components, optimism, self-efficacy, resilience and hope) would be accepted and would not be contested on a theoretical level, except if the results were to indicate a serious defect in this conceptualisation. the first objective of this study was to examine the structural component, construct validity, that involves the inspection of the internal relationships among items or subscales representing a particular measure, using such statistical analyses as correlations, exploratory and confirmatory factor analyses, and reliability analyses. the external component entails establishing a nomological net, or examining the relationships between the construct of interest and related constructs. this external investigation of construct validity entails both convergent and discriminant validity. researchers emphasise that this third step is particularly critical in establishing necessary validity evidence for a scale (benson 1998; benson & hagtvet 1996) and, consequently, such a step was conducted as part of this study and in support of various other correlational studies between previous psycap and positive organisational behaviour constructs such as larson and luthans (2006), pillay et al. (2014) (organisational commitment), shaik and buitendach (2015) (locus of control), cheung, tang and tang (2010), hansen, buitendach and kanengoni (2015) and larson and luthans (2016) (job satisfaction), avey, luthens and youssef (2010) (intention to quit), avey, wernsing and luthans (2008) (engagement), avey, luthens et al. (2010), avey et al. (2008), gooty et al. (2009), norman et al. (2010) (organisational citizenship behaviour), luthans et al. (2007), as well as luthans et al. (2010) (performance). research design research approach this study employed a typical empirical paradigm using a cross-sectional design and quantitative analysis. surveys were used as a data generation technique. leedy and ormrod (2014) highlighted the fact that a cross-sectional design involves sampling and comparing people from several different demographic groups. this approach enables the researcher to collect the required data at the same time. research participants the population (n) of the study is the employees of 30 organisations, with the sample being 60 employees per organisation selected randomly by the participating co-researchers. the characteristics of the participants in terms of the three relevant demographical variables, namely sector, race and gender, are reported in table 1 (only the valid responses are reported). table 1: sample characteristics – frequencies of demographical variables, race, gender and the sector in which employed. the total sample consisted of 1749 participants. in terms of the racial distribution, the majority of the participants were african (61%), followed by white (20.8%), mixed race (9.7%) and indian (7.7%). the representation of the gender groups was slightly higher for men at 52.8% compared to 46.7% for women. the racial and gender distribution of the sample seems to be relatively representative of the south african workforce in general, taking into consideration that the distribution of the workforce as indicated in statistics south africa (2015) was 73.4% african, 12.7% whites, 3.2% indians and 10.7% mixed race. according to the same source, the proportion of men in employment is 56.3% while the proportion for women stands at 43.7%. the characteristics of the participants in terms of the mean age as well as mean tenure, both expressed in years, are reported in table 2. table 2: age and tenure statistics of the sample (n = 1749). the mean age of the respondents was 38.44 years (sd = 9.53), and the mean tenure in the specific organisation was 8.83 years (sd = 7.67). statistical analysis the statistical analysis was conducted with the use of statistical package for the social sciences (spss), version 23. the statistical analysis was performed by using spss 23, supported by spss amos (analysis of moment structures). the dataset was first cleaned up by means of case screening, followed by variable screening in order to explain why there was variation in the data. it was deemed necessary to follow this process to ensure that there were no missing values in the dataset and also to get a feel for the dataset. the dataset was further inspected for unengaged responses by running a standard deviation on inspected cases with sd < 0.50. the variables were further screened by means of kurtosis and the central limit theorem, in order to gather information about the distribution of the data. this information was used in parametric statistic techniques applied in this study. from the data cleaning process it was deduced that the missing values were very sparse and therefore they were not considered a main contributor to any bias. no cases were therefore removed. the first step of the factor analysis was to evaluate the appropriateness of the sample size. the item to respondent ratio is ±1:73, which is acceptable according to meyers, gamst and guarino (2013) and tabachnick and fidell (2007). second, the inter-correlations between items were inspected using bartlett’s test of sphericity (hair et al. 2010). with this test, the statistic generated should be significant (p < 0.05) for an efa to be considered an appropriate technique (hair et al. 2010). finally, the kaiser-meyer-olkin (kmo) measure was used to quantify whether the items correlated sufficiently in order to determine whether a factor analysis could be performed. the minimum level set for this statistic is 0.60 (tabachnick & fidell 2007). to aid in the interpretation of the initial results, oblique rotation and specifically the promax rotation was used, as it is assumed (based on the relevant literature) that the factors are correlated (tabachnick & fiddell 2007). the decision regarding the number of variables (factors) to be retained was based on the guttman-kaiser eigenvalue greater-than-one rule (k1 rule), together with the scree plot (with specific reference to the shape of the curve) and, lastly, the monte carlo pca for parallel analysis. meyers et al. (2013) indicate that a guide for variance accounted for by the factors needs to meet the lower limit of 50%.the cronbach alpha coefficient was determined for factors of the instrument, taking into consideration that the general rule according to nunnally and bernstein (1994) is α > 0.70. to operationalise this construct definition, a higher order, multidimensional model of the psycap construct was conducted by means of a confirmatory factor analysis (cfa). cfa is generally intended to examine whether a second-order ethical risk factor exists and whether it explains the relationships among the five lower-order factors (as identified by the exploratory factor analysis) with analysis of moment structures maximum likelihood procedure (byrne 2010). to assess the model fit, several fit indices were used, including the comparative fit index (cfi), the root mean square error of approximation (rmsea), chi-square (χ2), and the ratio of the differences in chi-square to the differences in degrees of freedom (χ2/df). given that there is no one acceptable cut-off value of what constitutes adequate fit, it was elected to evaluate each model and to recommend the model closest to the cfi value of 0.90, an rmsea value of 0.05 and χ2/df, a ratio of less than 5.00 or lower (byrne 2010). the first model was a one-factor solution (unidimensional) in which all the items identified through the exploratory factor analysis were indicative of one larger psycap factor. the second was a first-order factor model in which items were allowed to load onto their respective factors. the third was a second-order factor model in which items were loaded onto their respective factors and the factors loaded on a second-order latent psycap factor. the validity of the pcq was also established, according to the various definitions and types of validity provided. cohen, swerdlik and sturman (2013) are of the opinion that validity is, in short, an estimation of how well a test measures what it is intended to measure. for the purposes of this study, the main focus will be on construct validity, which is an estimate of how the construct (which is intended to be measured) behaves in relation to other constructs and related measures (devellis 2003). thus, ‘to evaluate the construct validity of a test, we must amass a variety of evidence from numerous sources’ (gregory 2011:119). an additional rigorous test of construct validity is the so-called factorial validity, which is based on the results of factor analysis, with the primary purpose of defining the underlying structure among the variables included in the analysis (hair et al. 2010). when the instrument displays the expected structure internally, this could be indicative of construct validity (moerdyk 2009) and, specifically, factorial validity. the strategy adopted for model cross-validation was to use a combination of the likelihood ratio test (differences in χ2 or chi-square difference between the models), the difference in tucker–lewis index (tli) which should be less than or equal to 0.05 and lastly the comparison of the expected cross-validation index (ecvi) point estimates. if the model cross-validates well, there should be little, if any, difference between the chi-squares and ecvi point estimates for the calibration and validation samples. information on convergent validity was created by calculating the correlation between the pcq (and its components/factors) and several other measures. it was hypothesised, supported by previous studies and literature, that psychological capital would correlate significantly with (developers indicated, with the cronbach alpha coefficients (α) as determined in this overall study): passion for work, including the sub-factors harmonious passion (α = 0.87) and obsessive passion (α = 0.89) (vallerand & houlfort 2003); person-organisational fit, including supplementary fit or indirect fit (organisation fit as values congruence) (α = 0.91) and complementary fit or direct fit (needs–supplies fit and demand) (α = 0.87) (cable & derue 2002; grobler 2016); and lastly, organisational energy, which comprises an affective (α = 0.96), behavioural (α = 0.84) and cognitive (α = 0.86) dimension (cole, bruch & vogel 2012). a correlation of 0.4 is an indication of convergence with 0.50 and higher – a clear sign of convergence (cohen et al. 2013; gregory 2011) – and is often referred to as the heterotrait-mono method coefficient. this entails correlations between measures of different traits that are furnished by the same method of measurement, with the opposite being heterotrait-hetero method coefficients (correlations between measures of different traits that are obtained using different measurement methods). multiple regression was used to assess the discriminant validity of the factors. the pcq factors will be used as independent (or predictor) variables in a multiple regression, with the hypothesised related constructs mentioned above as dependant variables. the rationale is to inspect the beta values, and to determine whether discriminant validity exists through the unique contribution of the pcq factors when the beta values are inspected. ethical consideration ethical clearance was obtained from the unisa graduate school of business leadership’s research ethical committee before the field work was conducted. the ethical clearance application included all the standard items such as: consent of participants (with an explanation of the study); permission to conduct the study in the respective organisations; inclusion criteria and the methodology to be used (pencil and paper). the research ethics clearance certificate is dated 16 february 2016, with reference number 2016_sbl_002_ca. results an initial analysis of the pcq was done through the assessment of the cronbach alpha coefficient of the original factors and the results, together with the descriptive statistics of the four factors, are reported in table 3. table 3: descriptive statistics, cronbach’s alpha coefficient of the original pcq factors. the cronbach alpha coefficients (α) of the factors were acceptable for self-efficacy (0.90), hope (0.86) and, to some extent, resilience with 0.67, when the guideline of α > 0.7 (tabachnick & fidell 2007) is applied. optimism reported a low cronbach alpha value with 0.55, which is probably due to the negative or reversed items (20 and 23). the results are consistent with previous studies reported in dawkins et al. (2013), although the α of 0.55 for optimism is even lower than the 0.65 reported by avey, patera and west (2006), and 0.63 by roberts, scherer and bowyer (2011). the total psychological capital reported a 0.90 cronbach alpha coefficient. the structural validity of the original psycap factor structure was further analysed by means of a cfa. missing values in the dataset, related to the pcq constructs, were deleted case-wise as the total dataset consisted of enough cases to accommodate this measure (the deletion was less than 5% which is considered to be the limit). a test for normality was performed. the results of the three models tested are reported in table 4 in terms of the respective fit indexes (comparative fit index, root mean square error of approximation, chi-square and the ratio of the differences in chi-square to the differences in degrees of freedom). the results of the assessment of the a priori pcq factor structure (original factor structure) of luthans et al. (2007) as used in south african studies by görgens-ekermans and herbert (2013), pillay et al. (2014), shaik and buitendach (2015) and hansen et al. (2015), are reported in table 4. table 4: comparison of a priori psychological capital questionnaire factor structure (original factor structure). the first-order factor model, with self-efficacy, hope, resilience and optimism as factors, reported slightly better fit results (cfi = 0.90, rmsea = 0.068) compared to the second-order model (with the sub-factors leading to a super factor, namely psychological capital (cfi = 0.90, rmsea = 0.069). it was further decided to assess the goodness of fit of the factor structure as determined by du plessis and barkhuizen (2012), testing it against the sample of this study. they have identified a three-factor structure for the pcq with hopeful-confidence (items 24, 20, 17, 15, 5, 21, 14, 16, 6, 10, 9 and 7), optimism (items 12, 11, 13, 19, 18, 8 and 1) and resilience (items 2, 23, 22, 3 and 4) as factors. the first-order model, with all 24 items loading onto the three factors, yielded the best (although not acceptable) goodness of fit results, with cfi and rmsea values of 0.82 and 0.091, respectively. due to the relatively poor psychometric properties reported in table 3, and the relatively poor fit statistics of the original factor structure as well as the structure determined by du plessis and barkhuizen (2012) within the south african context, it was decided to conduct an efa. in order to determine the suitability and appropriateness of a factor analysis on the existing instrument with 24 items, bartlett’s test of sphericity and the kmo were performed. the bartlett’s test of sphericity c2(276) = 19 157.12, p < 0.001, indicated that correlations between the items were sufficiently large for an efa. the kmo value was 0.94, which is higher than the critical value of 0.60; in other words, both these criteria meet the criteria to perform an efa. the k1 rule was used in conjunction with the scree plot to determine the number of factors. the kaiser’s criterion focusing on eigenvalues >1 was performed and is reported in table 5. table 5: eigenvalues >1 and explanation of variance. five factors reported eigenvalues >1, with the first factor explaining 36.12% of the variance in the construct psychological capital, followed by 7.77%, 7.08%, 5.58% and 4.49% of factors two to five, respectively. the total variance explained by the five factors is 61.03%. in order to determine the number of factors to retain in the factor structure, the cattell’s scree test was performed and the results are reported in figure 2. figure 2: cattell’s scree plot. due to the fact that the interpretation of the scree plot does not yield a clear answer in terms of the number of factors to retain, the monte carlo parallel analysis simulation technique was utilised. the eigenvalues obtained from the actual data are compared to the eigenvalues obtained from the random data. if the actual eigenvalues from the principal component analysis from the actual data are greater than the eigenvalues from the random data, then the factor is retained. the results are reported in table 6. table 6: results of the monte carlo parallel analysis. the results of the monte carlo parallel analysis yielded a four-factor model. the four factors accounted for 56.55% of the total variance (see table 5). the results of the correlational analysis (pearson correlation) are reported in table 7. table 7: pearson correlations between extracted factors (n = 1749). the correlations between the f1, f2 and f3 factors were relatively high, ranging between 0.59 and 0.65. f4, however, reported low (although statistically significant) correlations with the other three factors. the fact that factors are strongly related overall suggests the appropriateness of an oblique factor rotation method and, consequently, promax rotation was used. the results of each of the four factors are summarised in tables 8 to 11. these tables include the factor loadings, commonalities, percentage variation of the first-order factor withdrawal and promax rotation of the four respective factors, including the descriptive statistics and psychometric properties. table 8: factor 1 – self-efficacy. table 9: factor 2 – hope & optimism. table 10: factor 3 – resilience. table 11: factor 4 – buoyancy. the factor loadings also ranged between 0.43 and 0.93 for the four factors. the criteria of a factor loading cut-off point of 0.40 for inclusion in the interpretation of a factor (hair et al. 2010; meyers et al. 2013) resulted in all 24 items being included in the instrument, with significant factor loadings on two. f1: self-efficacy, which is a composite dimension of the original instrument by luthans et al. (2007), has seven items, with six items from the original self-efficacy factor (psc1–6) and one item (psc7) from the original hope factor. f2: hope & optimism has eight items and is also a composite factor (in terms of the original factor structure), with four items each (eight in total) from the original hope factor (psc8,10,11,12) and the original optimism factor (psc19,21,22,24). f3: resilience (total five items) also consists of items from two of the original factors of luthans et al. (2007), with four from the original resilience factor (psc14–17) and one from the hope factor (psc7). the last factor is the only factor not in the luthans et al. (2007) factor structure, called for the purpose of this study, buoyancy. the obvious factor name would have been pessimism (as also alluded to by dawkins et al. 2013), but due to the fact that psycap falls within the domain of positive organisational behaviour, it was decided to name it positively. it consists of one item from the original resilience factor (psc13) and two from the original optimism factor (psc20,23). the commonalities (h2) of the items are relatively high (> 0.30). the items as well as the factors were tested for multivariate normality. all the items, as well as the factors reporting skewness and kurtosis values for both factors, do not exceed the critical values of 2 and 7, respectively (west, finch & curran 1995), which means that the normality assumption was met for this sample and no data transformations would be required. the cronbach alpha coefficients (α) of self-efficacy, hope & optimism and resilience were acceptable (0.90, 0.85 and 0.79, respectively) when the guideline of α > 0.70 (tabachnick & fidell 2007) was applied. the fourth factor, buoyancy, reported a below-acceptable cronbach alpha value with α = 0.60, although such a value could be tolerated under exploratory circumstances (clark & watson 1995; nunnally & bernstein 1994). a possible cause of this low cronbach alpha value is the relatively few items (three) that loaded onto this factor. field (2009) is of the opinion that it is difficult to achieve high coefficients when a scale consists of only a few items. this is also the factor with the only negative or reversed items, which are known to impact negatively on the cronbach alpha coefficient (distefano & motl 2006; jackson barnette 2000). a similar process, as described in table 5, was followed to validate the adapted pcq factor structure by means of a cfa. the results of the three models tested are reported in table 12 in terms of the respective fit indices. table 12: comparison of a priori psychological capital questionnaire four-factor structure (adapted factor structure). assessment of the best-fitting model within the three models was conducted through the application of cfa. the one-factor model (all 24 items) was identified as the worst-fitting model (cfi = 0.72, rmsea = 0.110). by analysing the chi-square test values, it further appears that the first-order factor model is slightly better than the second-order factor model. the difference in chi-square between the second-order factor and first-order factor models is 2 (i.e., 3743–3741), which is distributed as chi-square with 222–224 = 2 degrees of freedom. the best-fitting model is thus the first-order model (modelb) in which all 24 items loaded directly on their respective factors (i.e. self-efficacy, hope & optimism, resilience and buoyancy). the convergent validity of the pcq was investigated by comparing it to a range of instruments which were also used in the broader study. these instruments and constructs are within the domain of positive organisational behaviour and were selected because of their hypothesised relationship with the psycap construct. the instruments/constructs used are: passion for work, including the sub-factors harmonious passion and obsessive passion; person-organisational fit, including supplementary fit and complementary fit; and lastly, organisational energy, which comprises affective, cognitive and behavioural dimensions. the results are reported in table 13. table 13: convergent validity of the adapted (reconfigured) psychological capital questionnaire factors by means of correlations (pearson) with other related measures. from table 13, it can be read that self-efficacy as well as hope and optimism reported relatively high correlations with the related constructs (ranging from r = 0.21 to r = 50, p ≤ 0.001). especially high correlations were reported with passion for work: harmonious passion (r = 0.43 and r = 0.49, respectively, with p ≤ 0.001) and person-organisational fit (r = 0.43 and 0.44, respectively), and on all the organisational energy factors, including the total organisational energy with r = 0.50 and r = 0.41 for self-efficacy as well as hope & optimism, respectively (p ≤ 0.001). resilience reported small to moderate correlations with all the related constructs (ranging from r = 0.15 to r = 0.29, p ≤ 0.001), except for the organisational energy: affective dimension (r = 0.08, p ≤ 0.001). the buoyancy factor reported only two small, significant (p < 0.05) correlations, with passion for work: obsessive passion and passion for work: total with r = 0.21 and r = 0.11, respectively. the correlation coefficients reported for self-efficacy as well as hope & optimism and to some extent resilience, may be seen as an indication that convergent validity exists. very little evidence of convergent validity is, however, found for buoyancy. in order to determine discriminant validity, multiple regressions were performed with passion for work, person-organisational fit, and organisational energy (each with its respective factors) as dependent variables (each one separately) and self-efficacy, hope & optimism, resilience, and buoyancy as independent or predictor variables. the rationale for this procedure is to determine the uniqueness of the contribution (and therefore discriminant validity) of the respective psycap factors to the explanation of the variance in the dependent variables. the results are reported in table 14, with the large differences in betas (ß) marked in bold to indicate discriminant validity. table 14: discriminant validity of the adapted (reconfigured) psychological capital questionnaire factors. all the multiple regression results, as reported in table 14, are statistically significant (p ≤ 0.001). the beta (ß) values reported indicate the uniqueness of the four factors in terms of their contribution in explaining the variance in the related constructs. this is an indication of discriminant validity, but, consistent with the convergent validity, buoyancy’s contribution, although unique, is relatively limited with only two beta (ß) values that are statistically significant (p < 0.05), on passion for work: obsessive passion and passion for work: total. due to the relatively poor psychometric properties, and convergent as well as discriminant validity results, a cfa was conducted with the exclusion of the buoyancy factor. the results are reported in table 15. table 15: comparison of a priori psychological capital questionnaire three-factor structure (adapted factor structure). the best-fitting model, after the assessment of the three cfa models, is thus the second-order model (modelc) in which the reduced number of items (21 of the original 24) loading on self-efficacy, hope & optimism and resilience, and these factors contribute to a secondary factor, namely psychological capital (χ2/df (141) = 6.93, cfi = 0.95, rmsea = 0.058). this specific model has the best-fitting indices reported for the four-factor (see table 13) and the three-factor structures (reported in table 15). the purpose of this study was not to determine invariance between demographic groups, but it was deemed necessary to conduct an elementary cross-validation assessment of the preferred, second-order factor structure as reported in table 15. the sample was split into gender groups, with 568 men (58%) and 410 women (42%). the results reported for the two sample groups were χ2/df (162) = 4.65, cfi = 0.94, tli = 0.92, rmsea = 0.063 and χ2/df (162) = 5.04, cfi = 0.92, tli = 0.89, rmsea = 0.070 for the male and female group respectively. the degree of invariance in terms of the likelihood ratio test is 0.39 (5.04 – 4.65). a further indicator of invariance is the difference between the tli values (0.92 – 0.89 = 0.03), which is lower that the norm of 0.05. the ecvi values reported by the male and female sample groups are 1.01 and 1.22, respectively (difference = 0.21), which is marginal. the results of this assessment in terms of the comparisons between the two sample groups lend support to the accuracy of the cross-validation results. discussion of results the purpose of this study is to examine the instrument properties of the pcq which (unlike other positive organisational constructs) have not been studied intensively, especially in the south african/african context. validity of any measurement is regarded as paramount and is even included in the criteria for any construct to be regarded a positive organisational construct. the objectives of this study are twofold: first, to determine the construct (factorial), and second, to determine the discriminant and convergent validity of the pcq. the substantive component of construct validity, although not directly an objective of this study, would be addressed where deviations from the original constructs (and items) of luthans et al. (2007) are reported. construct validity – also referred to as factorial validity and based on the results of both an efa and a cfa – was conducted with the primary purpose of defining the underlying structure among the 24 items of the pcq. the first step was to examine the psychometric properties of the original factors of psycap as proposed by luthans et al. (2007), and used in various studies in south africa, by, for instance, görgens-ekermans and herbert (2013), pillay et al. (2014), shaik and buitendach (2015), and hansen et al. (2015). acceptable cronbach alpha coefficients were reported for self-efficacy (0.90) and hope (0.86), marginal for resilience (0.67) and unacceptable for optimism (0.55). this original factor structure was also examined by means of cfa, which found little difference between the first and secondary models (χ2/df (224) = 9.11, cfi = 0.90, rmsea = 0.068 and χ2/df (226) = 9.31, cfi = 0.90, rmsea = 0.069 respectively). the first-order model consists of the items loading on their respective factors; with the secondary model, in addition, the factors contribute to a higher order or secondary factor (in this case, psychological capital). the three-factor model determined by du plessis and barkhuizen (2012) was also assessed, but yielded poor goodness of fit results (the first-order model was the best-fitting model with cfi = 0.82, rmsea = 0.091. based on these relatively poor psychometric results, it was decided to conduct an efa, a decision supported by the results of the bartlett’s test of sphericity and the kmo. the efa with promax rotation, as well as the monte carlo parallel analysis simulation, yielded a four-factor solution, explaining close to 57% of the variance. the four factors extracted by means of the efa reported reasonable psychometric properties, with cronbach alpha coefficients of 0.90 and 0.60 (the lowest for f4 which is a factor with only three items, all of which are negatively-worded). the factors were named in accordance with their original theoretical and pcq names, with the self-efficacy (seven items – six items from the original self-efficacy factor and one item from the original hope factor), hope & optimism (eight items – four items from the original hope factor and four from the original optimism factor), resilience (five items – four from the original resilience factor and one from the hope factor) and lastly, buoyancy (three items, a new factor with all items phrased negatively, with one item from the original resilience factor and two from the original optimism factor). in order to satisfy the substantive element of construct validity (although not the aim of this study), and with full acceptance of the luthans et al. (2007) conceptualisation of psycap, one has to determine possible causes for this reconfiguration. the self-efficacy factor stayed very similar, with the addition of psc7 ‘if i should find myself in a jam at work, i could think of many ways to get out of it’. this item includes an element of positive belief in the individual’s abilities to execute a specific task successfully which, according to stajkovic and luthans (1998), is an attribute of self-efficacy. the structural positioning of this original hope item with self-efficacy can therefore be justified substantively, without changing the original definition of self-efficacy by luthans et al. (2007), luthans and youssef (2004) and dawkins (2014), as ‘having assurance to put in and take on the essential effort to successful overcome challenges, and to obtain specific outcomes’. the second factor is a composite factor which includes items of the original hope and optimism factors. both these elements of the reconfigured hope & optimism factor have state-like properties (luthans et al. 2007) which are not totally stable and are open to change and development. this factor is further based on the successful interaction between the agency (goal directed energy) and pathways (planning to meet goals). if one uses the dawkins (2014) depiction of psycap, it is clear that hope and optimism are part of focusing on the future. luthans et al. (2007) also indicate that hope and optimism are similar constructs as this factor entails the utilisation of goal-based cognitive processes that would be employed if the individual perceives the outcome as having substantial value. based on this explanation, it is not unfamiliar to have items from the original hope and optimism factors loading on this composite factor and it would therefore be prudent to merely combine (or merge) the definitions of the original factors by luthans et al. (2007) to describe this reconfigured factor. the factor could thus be described as: having the explanatory style that attributes positive events to internal and pervasive causes, and further having the willpower to succeed now and in the future, even if this requires a change of paths in order to succeed. (p. 1) the third factor, resilience, is very closely comparable to the original factor with the same name, with only the addition of psc9 from the original hope factor. the item reads ‘there are lots of ways around any problem’ and could be related to the adapted description by dawkins (2014:9) that what resilience entails is ‘bouncing back when affected by problems and difficulty and sustaining and going beyond this towards achieving goals’. this item fits into this definition as it is about recovery from unfavourable stressors and events in maintaining the status quo, providing practical substantiation as to why it is added to the original resilience factor. all the elements of the original conceptualisation of psycap have been included so far, with the only deviation being that of the composite factor hope & optimism. the efa has, however, yielded a four-factor model with the last factor comprising three items (all negatively phrased) with psc13 ‘when i have a setback at work, i have trouble recovering from it, moving on’ from the original resilience factor and two from the original optimism factor, namely psc20 ‘if something can go wrong for me work-wise, it will’ and psc23 ‘in this job, things never work out the way i want them to’. due to the fact that psycap is considered to be a positive organisational behaviour construct, and that one of the criteria for it to be classified as such is that it should have a positive impact on work-related behaviour (according to luthans 2002), it was decided to name it positively, hence buoyancy. based on the content of the three items, it can be defined as ‘a positive work attitude by anticipating that things would go according to plan, with confidence in coping with setbacks occur and when things don’t go according to plan’. cfa was further conducted on this factor structure, as determined by the efa. the results explain that the best-fitting model is the second-order factor model, which is a confirmation of the efa results. this second-order factor model consists of psycap as a super factor and equal contributions of the four factors (self-efficacy, hope & optimism, resilience, and buoyancy) included in the second-order model. the respective indexes are χ2/df (224) = 9.11, cfi = 0.92, rmsea = 0.063. the adjusted (reconfigured) factor structure was exposed to a rigorous investigation for construct validity, which also included convergent validity. this was based on the hypothesised relationship that psycap (specifically the newly-configured factors) has related work attitudinal and positive organisational behaviour constructs. the constructs chosen are passion for work, person-organisational fit; and organisational energy, as well as their respective sub-factors. convergent validity was confirmed through the reporting of many high correlations between self-efficacy, hope & optimism, resilience and the related measures. this is an indication of convergent validity. buoyancy, however, reported very few strong and significant correlations with the related constructs, raising some validity questions. the third construct validity measure performed was that of discriminant validity. this was done through a basic multiple regression with all the work attitudinal and positive organisational behaviour constructs as dependent variables, and the newly-configured factors of the pcq as independent or predictor variables. the results are consistent with the findings in the convergent validity analysis with self-efficacy, hope & optimism, and resilience reporting a large degree of uniqueness in terms of their contribution in the accounting and explanation of the variance in the dependent variables. this is supportive of the notion of discriminant validity. due to the fact that buoyancy reported a poor cronbach alpha coefficient (α = 0.60) and the relatively low convergent and discriminant validity compared to that of the other three factors, it was decided to exclude it and to repeat the cfa, but with only the self-efficacy, hope & optimism and resilience factors. the remaining three factors explain 51% of the variance in psc, as determined with the efa. the best-fitting model (also when compared to the cfa results discussed earlier) is the second-order model, with self-efficacy, hope & optimism and resilience contributing (with even weights) to the secondary factor, namely psychological capital (χ2/df (141) = 6.93, cfi = 0.95, rmsea = 0.058). this supports the notion of dawkins et al. (2013) that the overall psychological capital has a synergistic effect where the whole may be greater than the sum of its parts. the instrument in its adapted (reconfigured) structural configuration was thus found to be valid on the substantive (theoretical / conceptual), structural (factorial) and external (discriminant / convergent) levels. it has also been found to be reliable, all adding up to overall evidence that it is a suitable instrument to accurately measure psycap. the results of the cross-validation assessment support the notion of configural invariance; that is, participants belonging to different groups (in this instance, the gender groups) conceptualise the constructs in the same way. it is thus an indication that data collected from each group decompose into the same number of factors, with the same items associated with each factor. conclusion, limitations and recommendations psycap is considered to be an important positive organisational behaviour construct in developing individuals in the workplace to become the best that they can become. as clearly indicated in the criteria of categorisation as a positive organisational behaviour construct, there must be an accurate measurement to enable the individual (as well as the organisation) to design and implement directed developmental interventions to enhance it. the value of this study lies in the fact that the original conceptualisation of psycap – consisting of hope, optimism, resilience and self-efficacy elements – has been confirmed. the measurement of psycap (by means of the pcq) has been adapted through a reconfiguration of items and factors, ending up with a three-factor solution (that includes all four psycap elements), and the elimination of three problematic items. based on the results obtained, it seems that the pcq is a suitable (valid and reliable) instrument for measuring psycap. this study could thus serve as a reference for the accurate measurement of psycap. this research does have certain limitations, however, mainly in terms of the methodology. the pcq is based on self-reporting – a method which may lead to method bias, and this may still be a reality, even with the assurance provided to participants during the briefing regarding anonymity as well as confidentiality. social desirability and subsequent response bias will always remain a concern and a limitation in studies such as this one, while self-reporting may be seen as a one-sided report from the respondents’ side. an additional possible limitation is that the wording of the initial scale was used ‘as is’, without adapting it to the south african (multilingual) context. a further limitation of this study is the drawback of a cross-sectional design which might have increased the relationship between the four components artificially. a recommendation for further studies is to investigate the relationship between the four components (and related measures) over a period of time through a longitudinal study. another recommendation is to analyse results further with the possible addition of the effect of membership of specific demographic groups (e.g., generational differences) and the determination of the antecedents and consequences of psycap on work attitudes and organisational behaviour. psycap profiling could also be considered in future research to determine how different organisational cultures, climates and leadership styles impact on the employees’ psycap. acknowledgements competing interests the authors declare that they have no financial or personal relationship(s) that may have inappropriately influenced them in writing this article. authors’ contributions both authors, a.g. and y.t.j., contributed equally to the writing of this article. references avey, j.b., luthans, f. & youssef, c.m., 2010, ‘the additive value of positive psychological capital in predicting work attitudes and behaviors’, journal of management 36(2), 430–452. avey, j.b., patera, j.l. & west, b.j., 2006, ‘the implications of positive psychological capital on employee absenteeism’, journal of leadership and organizational studies 13(2), 42–60. https://doi.org/10.1177/10717919070130020401 avey, j.b., wernsing, t.s. & luthans, f., 2008, ‘can positive employees help positive organizational change? 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(ed.), structural equation modelling: concepts, issues, and applications, pp. 159–176, sage, thousand oaks, ca. abstract introduction most frequently cited articles analysis of recent accounting publications most prolific authors conclusion acknowledgements references appendix 1 footnote about the author(s) charl j. de villiers graduate school of management, faculty of business and economics, the university of auckland, new zealand department of accounting, university of pretoria, south africa pei-chi k. hsiao graduate school of management, faculty of business and economics, the university of auckland, new zealand citation de villiers, c.j. & hsiao, p-c.k., 2017, ‘a review of accounting research in internationalising journals in the south african region’, south african journal of economic and management sciences 20(1), a1729. https://doi.org/10.4102/sajems.v20i1.1729 original research a review of accounting research in internationalising journals in the south african region charl j. de villiers, pei-chi k. hsiao received: 14 dec. 2016; accepted: 19 july 2017; published: 07 dec. 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: this study analyses the accounting research articles published by south african journals. aim and setting: a review of accounting research in internationalising journals in the south african region that publish accounting research. methods: the characteristics of accounting articles were analysed. five journals were analysed, including the four internationalising journals, investment analysts journal, meditari accountancy research, south african journal of business management, and south african journal of economic and management sciences and one local journal, south african journal of accounting research (sajar). results: the findings of this study will be of interest to journal editors, authors who would like their research to make an impact and be cited, as well as university research administrators and government higher education policy-makers. conclusion: the analyses show that many of the highly cited articles have been published recently, boding well for the citation statistics of these journals in future and indicating some success in their efforts to internationalise. the citations of sajar lag behind the citations of the internationalising journals. each journal publishes articles that cover different subject area(s). within accounting research, accounting education and social and environmental accounting are popular areas of research, whereas taxation; the public sector; and management accounting are not well represented among published articles during 2015–2016 in these five journals. about half of all accounting articles claim their insights will contribute to the accounting literature, with much smaller percentages claiming to contribute to management, policy-making and practice. the most prolific authors and most prominent universities to some extent follow the most popular subject areas, with a social and environmental researcher, warren maroun, featuring strongly, and his university, the university of the witwatersrand, being prominent. large proportions of authors of 2015–2016 articles are from outside of africa, speaking to the success of the internationalisation efforts of the internationalising journals, whereas sajar mostly publishes articles by african authors. introduction the accounting academic community in south africa is characterised by a teaching focus rather than a research focus (samkin & schneider 2014b; venter & de villiers 2013), which has hindered efforts to link with the international research community. south african accounting academics tend to publish in south african journals. however, universities are increasingly expecting accounting academics to fulfil their research obligations and publish in international journals, which are seen to be better quality compared to local journals (samkin & schneider 2014a). a number of south african journals have started to internationalise their journals by, for instance, aspiring to be included in international journal lists, such as scopus. this review reflects upon the state of accounting research as exemplified by articles published by internationalising south african journals, contrasted with the premier local accounting journal. this study assesses south african journals (defined in this study as scientific journals on the south african department of higher education and training journal list) which publish accounting research (defined in this study as journals that have published at least four accounting articles in 2015 and 2016). while the focus is placed on internationalising journals (defined in this study as being on scopus), the premier local accounting journal is analysed for a more comprehensive assessment of accounting research and to provide a point of comparison. the four international journals to be identified by following the assessment criteria were investment analysts journal (iaj), meditari accountancy research (medar), south african journal of business management (sajbm) and south african journal of economic and management sciences (sajems). the local accounting journal, south african journal of accounting research (sajar), is assessed because of its status as the premier south african accounting journal among south african accounting academics. an overview of the journals is provided in appendix 1, which includes the year of first issue, editor, 2015 scopus citation statistics, overall and 2012 to present h-index,1 2016 abcd rating and current statement of ‘aims and scope’. it should be noted that, although the focus is on accounting research, these journals publish papers from diverse management fields. medar and sajar primarily focus on accounting research, iaj focuses on finance and investments, with sajbm and sajems having a broader, general business, remit. these differences are also evident from the types of articles published in each journal, which will be discussed in the findings section. an inspection of the journals’ h-indexes in appendix 1 provides an early indication that articles published in the internationalising journals are cited more than articles published in sajar. this study is based on a similar study of accounting research in asia-pacific journals (benson et al. 2015). following benson et al. (2015), modified where appropriate, this paper analyses the most cited papers in each of the five journals, as measured by total citations and by citations per year (total citations divided by the number of years since publication). in addition to the characteristics examined by benson et al. (2015), this study provides an overview of the non-accounting publications, details of what is published in the journals, summarises the relevance to practice of the articles, provides more detail on the research methods applied and summarises the universities that feature prominently in published articles in these journals. the findings of this study should be of interest to universities in their efforts to manage the research output of their accounting academics, and may also hold policy implications related to government efforts to promote research at universities. in addition, journal editors and authors who are interested in maximising the impact of their research and being cited, will be interested in the findings. most frequently cited articles google scholar data and the abdc journal rankings were used to measure the impact of accounting articles; this is consistent with studies such as benson et al. (2015) and rosenstreich and wooliscroft (2009). google scholar includes all citations in scientific sources, such as journals, books, theses, etc. by contrast, other sources of citation statistics, such as scopus and web of science, limit their citations statistics to references made in the journals on their lists. google scholar provides the most comprehensive coverage of scientific publications and is therefore considered appropriate for the purpose of this study. citation counts were drawn from google scholar on 7 july 2017, using the software program harzing’s publish or perish. citations per year for each article are calculated as the total number of citations for the paper divided by (2017 less the year of publication). table 1, panel a, lists the 10 most frequently cited articles, measured by total citations, published in each journal over its history. this is followed by panel b listing the most frequently cited articles measured by citations per year, measured as total citations divided by number of years since publication. in situations where there is no clear cut-off, all papers with the same number of citations, or citations per year, are included. table 1: most frequently cited articles in each journal. table 1-a1(continues…): most frequently cited articles in each journal. table 1-a1(continues…): most frequently cited articles in each journal. table 1-a1(continues…): most frequently cited articles in each journal. sajbm has the highest mean total citation for their top 10 cited articles, followed by medar, sajems and iaj. note that sajbm on 148.80 is far ahead of the three journals in the middle, which are bunched together between 46 and 61, with sajar lagging behind on 23 medar has the highest mean citations per year for their top 10 cited articles, followed by sajbm, sajems, iaj and finally sajar. however, it should be noted that the difference between the internationalising journals’ averages are relatively small, with sajar lagging behind. note that many of the most cited papers per year were published in 2015 or later. this may be because these journals are internationalising and therefore their articles are being noticed and cited more frequently of late. if this trend continues, these journals’ citation statistics should benefit in future. this is also true for sajar, but apart from raemaekers et al. (2016), none of the other papers would have made it onto the list if it was published in one of the other journals. table 2 lists the 10 most frequently cited articles published during 2015–2016 for each journal, measured by total number of citations. where fewer articles are listed for a journal, this is because fewer than ten articles have been cited. where more than 10 articles are listed for a journal, this is because more than one article has been cited the same number of times around the cut-off of 10 articles. table 2: most frequently cited articles published in each journal during 2015–2016. medar has the highest number of citations for articles published during 2015–2016, with the other journals lagging far behind. as mentioned before, a high level of citations for recent articles bodes well for future citations. it is worth noting that articles published in the journals that do not have ‘south african’ in their names are cited more often. journal names may be indicative of their strategic stance towards integration with the international research community and internationalisation strategies may be increasing the attention of the international research community on articles published in journals with an internationalisation strategy. analysis of recent accounting publications relative role of accounting research all papers published during 2015–2016, within the five journals were classified into a management field. multidisciplinary studies were categorised according to their dominant focus, which results in papers being classified under a single category. the classification is based on the keywords listed by the author(s), the stated purpose of the paper, the references cited and the academic department of the author(s). table 3 shows the subject area of articles published in each journal during 2015–2016. table 3: management field of articles published during the period 2015–2016. among these five journals, the main sources of accounting research are medar and sajar. each journal has a unique focus in terms of subject area(s), based on articles published during 2015–2016, with iaj being finance oriented, medar and sajar accounting, sajbm management and sajems being economics and management oriented. medar and sajar are most focused on accounting, as can be expected from the inclusion of the word ‘accounting/accountancy’ in these journals’ titles and the emphasis on accounting research in their stated objectives. table 4 shows the accounting research (2015–2016) classified according to scholarone manuscript submission categories. table 4: article classifications of accounting articles 2015–2016. as can be expected for refereed journals, research paper is the most common classification. research areas in accounting table 5 documents the major topic areas covered within the accounting research published in the five journals during 2015–2016. the topic categories follow benson et al. (2015) in using the 10 european accounting association (eaa) topic areas: auditing (au), accounting education (ed), financial analysis (fa), financial reporting (fr), governance (gv), accounting and information systems (is), management accounting (ma), public sector accounting (ps), social and environmental (se), taxation (tx), and an additional category, other, for studies not captured in the eaa categories. table 5: articles by eaa categories: 2015–2016 articles. au includes any article related to auditing and assurance, for example, auditors, audit reports, and audit fees. ed covers any educational aspects of accounting, for example, universities, accounting students, and accounting curriculum. fa relates to users and analysis of financial accounting information, e.g. analyst forecast, value relevance of voluntary disclosure, and firm valuation. fr relates to preparers of financial information, e.g. accounting standards and risk-related disclosures. gv includes e.g. internal audit, directors, and shareholder oversight. is relates to, for example, information systems, accounting software, and xbrl. ma covers, e.g. management accounting, control systems, and organisational learning and change. ps includes anything related to accounting in the public and voluntary sectors, inclusive of not-for-profit sectors and local governments. se covers all aspects of social and environmental accounting, e.g. carbon accounting, and voluntary environmental and social disclosures. tx includes, for example, tax regimes and tax aggressiveness. other captures, for example, accounting literature and theories, accounting history and accounting research. none of the journals cover all eaa categories, with no research on the public sector in any of the journals. the top categories, ignoring other, were in order from the top: accounting education, social and environmental, and financial analysis. the coverage of these accounting research areas, to a large extent, follow the focus of medar, being the journal that published the most accounting research. a brief overview of the articles published follows. accounting and information systems (is): esterhuyse and wingard (2016) assess the extent companies listed on the jse comply with international best practice guidelines for investor relations practices based on analysis of corporate website contents. accounting education (ed): there is a focus on enhancing the learning experience of accounting students and implementing methods of teaching to better prepare accounting students for their professional career. sugahara et al. (2016) investigate the impact of a new interactive form of teaching on the learning motivation and performance on accounting undergraduate students in japan. stainbank and gurr (2016) study whether accounting students in south africa find social networking sites useful for their learning. viviers, fouché and reitsma (2016) evaluate the usefulness of an educational game to develop soft skills. van oordt and mulder (2016) describe the consequences of implementing basic e-learning tools in an undergraduate taxation curriculum. kirstein and kunz (2015) report on the development and implementation of two student-centred approaches, suggesting active student participation in large classes are possible and develops professional skills. barac et al. (2016) describe factors that influence students’ learning approaches in auditing. from a teaching perspective, kirstein and kunz (2016) examine whether learning style flexibility has been incorporated into accounting courses, keevy (2016) examines educators’ views on whether case studies can be used to transfer soft skills to students, and samkin and stainbank (2016) discuss the challenges faced by accounting teachers. other topics include investigating the quality of accounting doctorates in south africa (de jager & frick 2016), gender and performance of accounting students (callaghan & papageorgiou 2015). auditing (au): soni et al. (2015) applies organisational justice theory in examining variations in the tendency for trainee auditors in south africa to whistle blow on a leader’s internal misconduct. hay (2015) reviews literature to identify current issues in auditing research. financial analysis (fa): studies have investigated the relation between csr reporting or activities on market competition, stock returns, and financial performance (marcia et al. 2015; ruiz-palomino, pozo-rubio & martínez-cañas 2015; ryu et al. 2016), and the potential impact of the marikana incident on stock prices of mining companies listed on the jse (hill & maroun 2015). huang, su and wang (2015) examine market reactions to seasoned equity offerings. da silva (2016) assesses the effect of earnings announcement on credit default swaps markets. lin, lai and tang (2016) examine how liquidity and price discovery are affected by the incremental transparency provided by the limit-order book in taiwan. badenhorst (2016) investigates whether investors price the future growth of acquisitions and the subsequent materialisation accurately. oberholster, koornhof and vorster (2015) examine whether the financial information contained in interim reports is understood by individual shareholders. atkins and maroun (2015) explore the initial reactions of south african institutional investors on integrated reporting. financial reporting (fr): vivian and hutcheson (2015) use principles by adam smith to develop a framework for annual financial statements applicable to property-casualty insurers. scott, wingard and van biljon (2016) discuss the challenges public entities encounter with the application of generally recognised accounting practice 101. badenhorst (2015) compares actual and stated fair value measurement policies to investigate the use and potential consequences of exchange-traded funds’ equity investments. governance (gv): studies have investigated into the relation between diversity, gender or racial, and financial performance (taljaard et al. 2015; willows & van der linde 2016). islam, sathye and hu (2015) develop a corporate governance index and applied it in examining the relationship between corporate governance and bank performance. mey and de klerk (2015) examine whether having a chartered accountants south africa as chief executive officers is associated with accruals quality. management accounting (ma): morris (2015) investigates the movement in human capital efficiency of the workers of south african listed companies over time. alkaraan (2016) focuses on strategic management accounting and examines the strategic investment decision-making processes of a case company. social and environmental (se): the process of developing environmental and social disclosures, or assessment of such reports, is a common focus. del sordo et al. (2016) analyse the contents disclosed in the social reports of italian state universities’ and discusses their motivations and difficulties faced. massa et al. (2015) discusses the mechanisms and consequences involved in developing a sustainability report for a small to medium enterprise. leung and gray (2016) explore the relevance of social responsibility and social and environmental reporting to controversial industries. borghei, leung and guthrie (2016) explore voluntary greenhouse gas disclosures after the introduction of the national greenhouse and energy reporting act 2007 and before the introduction of the australian ets. stent and dowler (2015) assess the gap between current corporate reporting and integrated reporting principles. other topics include investigating the role of moral philosophy and ethics in csr activities and disclosure (ackers 2015), whether buddhism is informing the sustainability practices of corporations in sri lanka (abeydeera, tregidga & kearins 2016), the moderating effect of cultural dimensions on the relation between environmental and social disclosures and profitability (khlif et al. 2015), and emergence of integrated private reporting (atkins et al. 2015). yoo and nam (2015) proposed an accounting framework to provide information on both financial information of a focal firm and stakeholder relationships. rao and tilt (2016) examine the relationship between board diversity and csr reporting. maroun (2015a) discusses key limitations to meta-analyses that assess the correlation between corporate social environmental disclosures and financial measures. taxation (tx): maroun (2015b) assesses section 24jb of the income tax act no. 58 of 1962 and the international financial reporting standards 9, suggesting potential for dysfunctional consequences following adoption of a fair value taxation regime for financial instruments. junpath, kharwa and stainbank (2016) surveyed taxpayers regarding their attitudes towards tax amnesties and tax compliance. other: researchers have investigated into accounting for the bitcoin (ram, maroun & garnett 2016), frameworks used to examine fraud (free 2015), power exerted by accountants on small enterprises (stone 2015), earnings management (liu 2016; pududu & de villiers 2016), gender in accounting (broadbent 2016; galizzi & siboni 2016; siboni et al. 2016; zhao & lord 2016), analysis of performance or publications of academic journals (murphy & maguire 2015; ngulube & ngulube 2015), central banks with private shareholders (rossouw 2016), accounting historiography (parker 2015), theory of autopoiesis and its association with sustainability (khan & gray 2016), the legitimacy of the international financial reporting standards (wingard, bosman & amisi 2016) and review of the use of hofstede’s cultural dimensions in accounting research (khlif 2016). relevance to practice table 6 shows the stated contributions of the 2015–2016 articles. papers may have specified multiple contributions. if so, the papers are coded in multiple categories. table 6: stated contribution by articles – 2015–2016. a common contribution stated by studies is extending the current literature by improving research methodology, such as considering analysis of additional variables for a particular research topic or extended time periods or databases (marcia et al. 2015; taljaard et al. 2015; ryu et al. 2016). studies also express addressing knowledge gaps in current literature (barac et al. 2016; huang et al. 2015; leung & gray 2016), and develop theories (ram et al. 2016). suggestions for future research are also common (free 2015; siboni et al. 2016). a few studies are targeted at practitioners. research that may be relevant to the accounting profession includes those that investigated into whistle-blowing in the audit profession (soni et al. 2015), relationship between accountants and small businesses (stone 2015), and suggested the need to develop education regarding non-financial performance and assurance (ackers 2015). for investors, there have been suggestions for improvements in investment analysis methods (liu 2016), and indication of factors to consider for in the appointment of a ceo (mey & de klerk 2015). studies relevant to managers are those, for instance, related to identifying aspects or factors to consider to improve corporate disclosures (atkins & maroun 2015), corporate policies (khlif et al. 2015), and corporate governance (willows & van der linde 2016). for educators, studies have suggested the use of technology and social media as beneficial for student learning (stainbank & gurr 2016, van oordt & mulder 2016) and implementation of innovative and student-focused teaching styles (kirstein & kunz 2015, viviers et al. 2016). articles targeted at contributing to policy or standard development includes zhao and lord (2016) who calls for enforcement of employment laws to support equal opportunity rights for women accountants in china, stent and dowler (2015) who developed an integrated reporting checklist and systems thinking proposal which could be used in assessing the potential and the additional requirements integrated reporting will impose on corporate reporting, and lin et al. (2016) assessed the impact of introducing the limit-order book change event which may be considered by similar markets to taiwan. articles classified under other are those that did not specifically state their contribution or are difficult to group into the other categories; for instance, wingard et al. (2016) question the legitimacy of the international financial reporting standard, broadbent (2016) argues for reform towards a broader diversity agenda in the accounting profession, and murphy and maguire (2015) evaluate the future potential of medar. research methods table 7 shows the research approach applied by the researchers; this only applies to articles classified as research papers or case studies. table 7: research approaches. the literature reviews and general reviews are classified under ‘not applicable’ (maroun 2015a; siboni et al. 2016). mixed methods are generally characterised by a combination of questionnaires and focus groups or interviews (stone 2015; viviers et al. 2016). qualitative methods involve action research (kirstein & kunz 2015), case studies (kirstein & kunz 2016), focus group discussions (barac et al. 2016), and interviews (atkins & maroun 2015). quantitative methods include survey and questionnaires (oberholster et al. 2015; del sordo et al. 2016), regression analysis (ryu et al. 2016; willows & van der linde 2016) or other descriptive statistics and graphical descriptions (de jager & frick 2016; pududu & de villiers 2016). content analysis could be either employed qualitatively by interpreting the text (abeydeera et al. 2016), or quantitatively by quantifying the text to data for statistical analysis (borghei et al. 2016). most prolific authors the most prolific authors and institutions cover all individuals who published in the five journals and are not limited to those that published accounting articles. for each paper, all individual authors and institutions were counted to have one publication even when papers may involve multiple authors and institutions. table 8 lists the authors who published more than three articles during 2015–2016 and shows the number of articles in total and the number of these articles that were classified in each of the subject areas. the most prolific accounting author, by far, was warren maroun. table 8: most prolific authors (number of articles 2015–2016). table 9 lists universities with more than five papers published in the five journals during 2015–2016. the university of pretoria and the university of the witwatersrand feature prominently in terms of accounting articles. most of the universities listed are south african, except the university of bologna (italy). table 9: top universities (number of articles during 2015–2016). table 10 lists the geographical regions the author(s) were associated with at the time of publication. table 10: geographical regions of published authors. south africa authors account for 159 of the 164 authors from africa, the rest are spread through nigeria, tanzania, tunisia and zambia. from asia, the greatest contributors are from south korea (10/42), china (8/42), taiwan (7/42) and the remainder by individuals in hong kong, india, iran, japan, malaysia, pakistan and saudi arabia. from australasia, 13/24 is based in australia, while 11/24 is from new zealand. for europe, the highest contribution is from united kingdom (13/42), with the remainder from austria, belgium, italy, netherland, poland, portugal, serbia, spain, sweden, switzerland and turkey. for north america, 6/10 is from canada, 3/10 from the united states and 1/10 from mexico. the one south american author was from brazil. iaj and medar have the lowest percentages of published authors from africa, reflecting a greater level of internationalisation than the other two internationalising journals, sajbm and sajems. sajar appears to be very parochial, mostly publishing articles by african authors. these latter journals declare themselves as south african in their titles and this may have a bearing on the efforts of sajbm and sajems to internationalise, whereas sajar may not be interested in the international research community at all. conclusion this study identifies four south african journals that publish accounting research articles, journals that are also internationalising, as shown by their inclusion in scopus. the four journals are iaj, medar, sajbm and sajems. these journals are contrasted with the premier south african accounting journal, sajar. the study’s analyses show that many of the highly cited articles have been published during or since 2015. this may be indicative of the international community starting to notice and cite work from these journals and if this trend continues, future citation statistics will benefit. thus, these journals show signs of success in their efforts to internationalise. the citations of sajar lag behind those of the four internationalising journals, providing evidence that reliance on a largely south african support base, without tapping into the international accounting research community, leads to the maintenance of a stagnant position, whereas internationalising journals are moving ahead. the fact that sajar’s board appears to be dominated by non-academics and non-researchers (e.g. the editor in chief) can be taken as a signal that the journal has no interest in integrating with the international research community. each journal publishes articles that cover different subject area(s), with iaj publishing mostly finance, medar and sajar publishing mostly accounting, sajbm mostly management, and sajems mostly economics and management. when considering accounting research only, accounting education and social and environmental accounting are popular focus areas. by contrast, taxation, the public sector, and management accounting are not well represented among published articles during 2015–2016 in these five journals. accounting articles claim to contribute in different ways, with about half claiming to contribute to the accounting literature, and much smaller percentages claiming to contribute to management, policy-making, and practice. the most prolific authors and most prominent universities make for interesting reading and, to some extent, follow the most popular subject areas. for example, warren maroun, who does social and environmental research, is the most prolific accounting author, and his university, the university of the witwatersrand, features strongly. large proportions of authors of 2015–2016 articles are from outside of africa, which can again be taken as evidence of success in the internationalisation efforts of the four internationalising journals. overall, the evidence points towards iaj and medar being more successful in their internationalisation efforts and reaping the benefits of more articles by non-african authors and increased citations for published papers. having ‘south african’ in the name of a journal appears to work against efforts to internationalise, or otherwise it may be reflective of an underlying editorial philosophy to remain true to the initial target audience of the journal and not to aggressively pursue a strategy to internationalise. journal editors and authors who would like their research to make an impact and be 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table 1-a1: journal overview for five south african accounting journals footnote 1. a journal’s h-index reflects the number of articles published in the journal (h), which has been cited at least h number of times. therefore, a higher h-index reflects higher overall citations. sajems ns vol 3 (2000) no i factors affecting the use of management tools by large maize producers in south africa a brown, g f ortmann and mag darroch 75 . price risk commercial school of agricultural sciences & agribusiness, university· of natal, pietermaritzburg abstract ordinary least squares regression was used to examine what characteristics affect the use of maize price risk management tools by a sample of large commercial south african maize producers in 1998. the use of maize storage facilities, off-farm employment, formal crop insurance, length of formal education of operators and the proportion of farm turnover from maize, all positively influence producers' use of these tools. crop insurance thus appeared to be a complementary method of risk management. in contrast to previous united states studies, operators' self-rated score of marketing management ability was negatively related to the use of price risk management tools. maize marketing seminars and other sources of information on managing price risk would reduce adoption costs and encourage broader producer participation. jel q 12 introduction maize was the second largest contributor (r4.4 billion), after poultry, to south africa's gross value of agricultural production (r42.4 billion) in 1997/98. south african maize production is concentrated in the north-west province, free state and mpumalanga which, respectively, accounted for 32, 33 and 21 percent of maize production in the five years since 1993/94 (directorate: statistical information, 1999). maize marketing in south africa was highly regulated from the 1930s until the mid 1990s, with maize being sold through a single-channel system administered by the maize board, which also set producer prices. the maize board was eventually disbanded in april 1997 after the passing. of the marketing of agricultural products act of 1996 (mieliesimaize, 1997). the deregulation of maize marketing has placed the responsibility for the marketing of this r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 76 sajems ns vol 3 (2000) no 1 important agricultural commodity in the hands of producers, and will probably expose them to greater price risk. several new maize marketing alternatives have consequently evolved in recent years and the channels which farmers employ to market their crop are changing. flexible, sequential marketing strategies allow farmers to spread sales over time and thereby manage price risk (musser et a/., 1996:66). three main markets have emerged for maize in south africa: the cash (spot) market, forward contracting and the derivatives market. producers may now sell maize to whoever they please for whatever price they can get in the cash (spot) market, or forward contract their crop to assure prices prior to harvest (van der merwe, 1998). the derivatives market involves the trading of futures and options contracts, usually through the south african futures exchange (safex). physical delivery of maize is generally avoided, but acceptable price levels are "fixed-in" prior to delivery (futures contracts), or minimum prices are guaranteed, with potential left for gains from positive price movements (options contracts) (frank, 1992). since many price risk management tools may be effectively substituted for each other and farmers are expected to use a portfolio of price risk management tools, it would be simplistic to consider the use of any single tool in isolation. previous studies in the united states (us) have considered the adoption of single marketing alternatives (goodwin & schroeder, 1994; makus et a/., 1990; shapiro & brorsen, 1988), such as futures hedging, but no studies were found which considered farmers' use of a full range of substitutable price risk management tools. this study should, therefore, make a useful contribution to the scarce south african literature on the topic of price risk management in maize marketing. the objective of this study is to examine the recent marketing behaviour of south african commercial maize producers, and estimate by regression analysis what business and personal characteristics affect their use of price risk management tools. the data presented were elicited in a postal survey of a sampje of national maize producers' organisation (nampo) members in the three major maize growing regions of south africa, namely the north-west province, mpumalanga and the free state in 1998. the sample cannot be considered representative of all south african maize farmers and is biased towards larger specialised maize producers. the questionnaire used was developed to measure respondents' business, personal and marketing characteristics. the paper first describes the postal survey and characteristics of the respondents. it then explains how an index of the use of price risk management tools was developed for each sample farmer. the following section describes the rationale for selecting relevant variables which may r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 77 explain variation in the index, and presents regression model results. the concluding section discusses the information and management implications of the results. the survey and characteristics of respondents the postal survey a postal survey was conducted in 1998 amongst a sample of maize farmers in the three study regions (the north-west province, free state and mpumalanga), based on the nampo mailing list of its over 7 000 members nationwide. this membership list is divided into magisterial districts, and members are assigned to magisterial districts according to their postal addresses. average annual maize production has exceeded 100 000 tons in each of the top 24 magisterial districts. these districts accounted for an average of 61 percent of total south african commercial maize production over the previous ten years. an index score was created to quantify average tonnage of maize produced per nampo member in each magisterial district. the ten magisterial districts with the highest indices were drawn from this list and farmers were sampled randomly, according to the districts' average contribution to maize production over the previous ten years. the resulting sample comprised some 301 farmers from the north-west province, 272 from mpumalanga and 227 from the free state. of the 800 questionnaires sent out in june 1998, a total of 107 were returned, yielding an overall response rate of 13.4 percent. response rates were similar between the regions, ranging from 12.1 percent in mpumalanga to 15.9 percent in the free state. some 26 returned questionnaires were initially unusable because important marketing responses were incomplete. the relevant questions in 20 of these incomplete questionnaires were mailed back to respondents who had given their addresses, in an effort to increase the number of useable responses. ten of these were returned, leaving the total number of unusable responses at 16. thus, 91 responses in total were useable for evaluating the maize marketing statistics, giving an 11.4 percent useable response rate, although a 13.4 percent useable response rate (all 107 respondents) was recorded for certain business and farmer characteristics. survey data, such as these, which rely on voluntary provision of information are subject to many sources of error. error may arise due to failure to properly recall events, deliberate distortion of the facts or refusal to participate in the study (norusis, 1993: 167). in addition, if certain respondents refuse to participate or answer certain questions, further bias will arise. since the focus of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 78 sajems ns vol 3 (2000) no 1 this study is on the use of maize price risk management alternatives, and the sample is drawn from the main maize-producing regions of south africa, the sample is probably biased towards large, specialist maize producers. general characteristics of sample respondents respondents had an average of 24 years farming experience, 14 years formal education, and a mean age of 47 years. sample farmers also cultivated an average of918 ha of maize annually, whilst average annual turnover per farm was r2 862 000, of which 68 percent was derived from maize. the mean value of respondents' assets was r5.6 million, whilst debt averaged r1.5 million. respondents' debt: asset ratios averaged 0.30, and ranged from 0 to 0.89 with a mode of 0.25. seventy-two percent of respondents reported owning a personal computer for use in the farm business, and of these, 38 percent had internet access. the internet was most commonly used for personal .e-mail correspondence and access to maize price and management information. roughly 57 percent of sample farmers considered south african maize marketing to be free and fair, while 43 percent disagreed with this statement. respondents rated maize yield variability as the most important source of risk they faced. maize price variability was rated only the joint fourth most important source of risk along with changes in labour legislation and interest rate variability, after exchange rate variability and changes in input costs. respondents spent an average of 3.2 hours per week reviewing marketing information. weekly agricultural magazines (e.g. farmer's weekly) were rated the most important sources of maize price information, followed by subscription-based information providers (e.g. agrimark trends) and safex. when producers were asked to identify their needs for additional information and services to better manage their maize marketing, the most commonly requested services were for information on price and production trends in international markets. producers generally rated their skills in marketing management lowest compared to production, financial and general management. a trend of decreasing levels of understanding of forward pricing tools was observed among respondents, from the more familiar concept of forward contracting to the more complex concept of options trading. an index of price risk management few observations of futures hedging were recorded (nine percent of cases), whilst only 17 percent of respondents utilised cash (spot) marketing exclusively, implying that the remainder used a portfolio of marketing alternatives. previous studies have focused purely on the forward-pricing aspects of price risk r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 79 management and ignored farmers' use of flexible and sequential marketing strategies. due to the low number of observations of both hedging and exclusive cash (spot) marketing activities and a wish to measure other aspects of price risk management behaviour, a continuous index of price risk management was composed. this contrasts with previous us studies where discrete adoption of derivatives, and proportion of crops hedged (shapiro & brorsen, 1988; goodwin & schroeder, 1994; makus et al., 1990) were used as dependent variables. an index was thus created to measure the degree to which respondents used price risk management tools, and serves as the dependent variable in the regression model specified in the next section (lyne, 1998). the index (ii) was calculated by formula (1): where: zaj m nf ii (lza;xzdo)x(lz/l;xzd/)xzu; (1) k:/ /=/ the standardised proportions of the i-th farmer's crop marketed through cash (spot) market channels, plus a constant term (5). zp; the standardised proportions of the i-th farmer's crop protected by forward, futures and options contracting mechanisms, plus a constant term (5). ns+nf = n = the total number of cash (spot) (ns) and forward-pricing (nf) marketing channels used by the i-th farmer. zd the standardised value of a dummy variable scoring 0 for cash market and 1 otherwise, plus a constant term (5). zui the standardised value of the total number of marketing channels used by the i-th farmer, plus a constant term (5). the computed values of this index were then standardised so that the final index (ji) was derived as follows by equation (2): (2) the variable ji is an index of price risk management for the ith farmer. it takes into account three aspects of price risk management behaviour exhibited by sample farmers: the use of forward pricing mechanisms (using a dummy variable), the number of different marketing channels used, and the relative proportions of the producer's crop passing through these channels. higher index scores imply greater use of price risk management tools, such as forward r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 80 sajems ns vol 3 (2000) no i pricing and sequential marketing. due to the standardisation procedure, the scale effects of the different units of measurement of the index components on the resultant index are eliminated. the constant added to each standardised variable (5) simply ensures that all values used in the construction of the index are positive. the index accounts for three aspects of price risk management behaviour, without applying subjective weights to the different components. computed values of ji for the 1998/99 marketing season lie in the range 1.2 i to 3.56 and had a mean value of 0.00. thirty-two of the 80 respondents recorded index values above the mean and were classified as "higher-level users of price risk management too)s", while 48 respondents had index scores below the mean ("lower-level users of price risk management tools"). the regression model ordinary least squares (ols) regression was used to examine relationships between relevant explanatory variables and the index of price risk management score (dependent variable). probit and tobit models were used by goodwin and schroeder (1994), makus et al. (1990) and shapiro and brorsen (1988), who au examined us grain farmers' use of forward pricing, treating it as a technology adoption decision using dummies and proportions of crop hedged as dependent variables. edelman et al. (1990) used logistic regression to model the discrete (0/1/2) adoption of cash marketing, forward contract marketing, futures hedging and options hedging by us grain producers. the ols method is preferred for the analysis of local price risk management tools because the ji index score is continuous. variables hypothesised to affect respondents' use of price risk management tools adapting economic theory on technology adoption, and the us studies previously outlined, the following factors are postulated to affect the sample south african maize farmers' adoption and degree of use of price risk management tools: • farm size is expected to be positively related to the use of both forward contracting and derivatives. the scale-dependent potential gains of price risk management tools increase, and fixed (information and transaction) costs associated with their use can be spread over a larger volume of output, as farm size increases. the "lumpy" nature of some marketing contracts due to specified unit contract and order volumes, also favours larger producers .. the size of the maize enterprise is particularly r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vo13 (2000) no 1 81 important, and various measures of farm size were considered, including turnover (rand) and area (hectare) indicators. • education is expected to have a positive effect on the adoption of price risk management tools. more educated farmers would probably have lower transaction costs associated with adopting the "new technology" of more complicated marketing tools. it should take less time and effort for more educated individuals to better understand and use such tools. education was measured by the respondents' number of years of formal education (e.g. 12 years represents matric level, and 15 years a three-year degree or diploma). • financially stressed farmers would more likely use price risk management tools due to their being relatively less able to bear risk. hedging can be a source of liquidity and lenders are expected to favour those who "lock-in" forward prices (turvey, 1989). relative indebtedness among respondents was proxied by comparing sample farmers' debt:asset ratios. • fanning experience is expected to have a negative effect on the adoption of price risk management tools. more experienced farmers, who were used to the previous regulated marketing environment, may be slower to adopt novel marketing techniques such as hedging. previous studies in the us (goodwin & schroeder, 1994; shapiro & brorsen, 1988) found that experience was negatively related to commercial grain farmers' use of derivatives. the experience variable is likely to be positively correlated to farmers' age and can be used as a proxy for it. experience was measured as the number of years of employment on a farm since the age of 18. • risk aversion should positively influence the use of price risk management tools, ceteris paribus. in reality, all other things are however not equal. economic theory recognises two forms of risk facing farmers: financial risk incurred due to the fixed, contractual obligations associated with debt financing, and business risk incurred independently of the way the business is financed and caused by factors like price and yield variability (barry et al., 1995). forward pricing tools can be used to manage price risk which is an important source of business risk. however, there are many other business and financial risks that comprise the total risk facing the farmer. there are a variety of alternative methods which may substitute for, or complement, forward pricing tools in risk management. measurement of risk aversion per se is difficult, because farmers' use of alternative risk management measures will affect their exposure to risk and thus their attitude towards it. consequently, few studies have found any measure of risk aversion to be significantly related to forward pricing use (edelman et ai., 1990; shapiro & brorsen, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 82 sajems ns vol 3 (2000) no 1 1988; makus et al., 1990; turner et al., 1983). goodwin and shroeder (1994:943) report, contrary to their expectations, that "respondents with a stated preference for risk were more likely to adopt forward pricing than risk averse producers". this suggested that commercial us grain farmers viewed forward pricing as riskier than other marketing techniques. the findings of optimal hedging literature that optimal hedging ratios are less than one, implies that "forward pricing reduces income risk at low levels, but increases risk as the proportion forward priced increases" (musser et al., 1996:66). this evidence, and the popularity of sequential and flexible marketing strategies with producers (patrick et al., 1980; king & lybecker, 1983) which implies that a combination of cash and forward pricing reduces income risk led musser et al. (1996) to conclude that the effect of the full range of forward pricing methods on risk reduction is unclear. a self-rating of risk aversion relative to other farmers in the region was included in an attempt to measure risk aversion in this study. the alternative risk management tools discussed below were analysed as separate explanatory variables: • enterprise diversification should be negatively related to the use of price risk management tools as it is a means to reduce risk, and so may be a substitute for price risk management. diversification was measured by an index composed of the sum of the squared proportional contributions of each individual enterprise on the farm to total income. this index ranged in value from 0 (highly diversified) to 1 (completely specialised in one enterprise), so that a positive sign on this variable would indicate a risk management substitution effect. • the proportion of total income derived from maize is expected to be positively related to sample farmers' use of price risk management tools. the more reliant the farm business is on maize for its income, the more likely it will be for any risk averse producer to use maize price risk management tools. • crop insurance. the use of crop insurance implies that the respondent is averse to yield risk and should thus be more likely to use price risk management tools to insure his income. crop insurance is complementary to the use of many price risk management tools which require the physical delivery of maize. • maize storage facilities, either on-farm or at a cooperative/elevator company, allow producers to store crops to take advantage of seasonal price movements. producers using these alternatives would be more exposed to price risk and thus more likely to use price risk management tools. respondents' use of maize storage facilities, either on or off-farm, was measured by a dummy variable r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no i 83 (i = use, 0 = no use). • the proportion of farm land rented reflects arrangements that may incur fixed annual rental charges which must be met regardless of yields and prices (except for share-cropping arrangements). producers who incur these costs may be more likely to use price risk management tools to guard against price risk which may reduce their ability to meet these fixed charges. • marketing management rating is expected to negatively influence use of price risk management tools. respondents who lack confidence in their own marketing skills may be more likely to utilise brokers and marketing agents. these agents and brokers may be more likely to use forward pricing tools to ensure prices prior to delivery. a self-rating of management skills relative to other farmers was included to measure the respondents' level of confidence in various areas of management. • producers' perceptions of the usefulness of price risk management tools will probably affect the degree to which they adopt these tools. the following measures of producer attitudes were considered in the model as dummy variables (i agree, 0 = otherwise): • expected income effects producers who believe their expected income will be increased by forward-pricing (1) are more likely to hedge and forward contract. • price stability effects producers who perceive that forwardpricing will stabilise prices (1) are more likely to use forward pricing tools. • free market preferences producers in favour of the freer marketing of agricultural produce (i) are expected to be more likely to use more novel marketing channels. • bad experiences farmers who have had, or know someone who has had, a bad experience (1) with a particular marketing alternative may be less likely to use that alternative. • off-farm income (i) may have a positive or negative effect on the use of price risk management tools. the higher the level of offfarm income, the less dependent the farmer will be on farm income. price risk might thus not concern him as much as it would a farmer without off-farm income. conversely, a farmer with significant off-farm income might be more acquainted with business and financial matters and be more likely to use price risk management tools. • time spent reading publications of an agricultural or financial nature is expected to positively influence use of price risk management tools. producers who spend relatively more time reading these sources may be more likely to be "early-adopters" due to the additional insight and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 84 sajems ns vol 3 (2000) no 1 knowledge gained. the average number of hours spent reading agricultural and financial publications was used as the proxy for this variable. • communication infrastructure would directly influence the ability to use certain marketing channels. farmers with access to reliable communications media are more able to monitor and manage price risk management tools. an inverse index of communications infrastructure was created to measure this variable. this index was created in a similar manner to the enterprise diversification index mentioned earlier. • market information. the importance which producers attach to market information, and how they source this information, are expected to influence their use of price risk management tools. those who use subscription-based information sources are expected to be more concerned with price risk and more able to make informed decisions. sample farmers' ratings of various information sources were considered in the model. • regional effects on the use of price risk management were considered by using two dummy variables to define the three study regions. regression model results table 1 shows the model coefficients (b's) and other statistics estimated after the elimination of variables with statistically insignificant t statistics. the r2 statistic of the model was 35.7 percent, while the adjusted r2 was 29.6 percent. this implies that 35.7 percent of the variation in the price risk management index score was accounted for by the explanatory variables included in the model. the adjusted r2 statistic takes account of distortions in the data which can be caused by the loss of degrees of freedom accompanying the addition of more explanatory variables, and is considered more reliable than r2 (mirer, 1983). goodness of fit the f statistic of the regression model was highly significant (sig. f = 0.0001) and all t-statistics were significant at least at the 10 percent level of probability. the adjusted r2 statistic of 29.6 percent is relatively low, but as gujarati (1995:211) notes, "it does not mean the model is necessarily bad". measures of goodness of fit must be viewed in the context of previous us studies. goodwin and schroeder (1994) achieved a 72 percent correct classification of users in their probit model of adoption of forward pricing methods. shapiro and brorsen (1988) achieved an equivalent r2 statistic of 84 percent in their tobit model of futures hedging adoption, whilst makus et al. (1990) correctly predicted 71.8 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . samms ns vol 3 (2000) no 1 85 percent of cases in their probit model. goodness of fit, as measured by percentage correct classification, is not directly comparable to r2 measures, and logit models with correct classification percentages as high as 92 percent may have r2 equivalents as low as 24.2 percent (stockil, 1997). this model correctly classified 72 percent of "higher-level users" of price risk management tools (farmers with marketing index scores above the sample mean) and 69 percent of "lower-level users". overall, 70 percent of cases were correctly classified. edelman et al. (1990) achieved model r statistics (analogous to rj in ols) ranging from 18.9 percent to a maximum of 26.4 percent in four logistic regression models of discrete adoption of cash, forward contract, futures-hedged and options-hedged marketing alternatives for iowa grain farmers. one reason for the low adjusted k statistic in the south african study may be that there was little variation in the data since the sample was biased towards large, specialist maize farmers who face similar price situations and marketing decisions. the index may also understate the use of risk price management tools because of the major marketing role played by cooperatives to whom farmers may seli maize knowing that prices are guaranteed by the cooperative's use of price risk management tools. the marketing of maize in south africa has only recently been liberalised, whereas many of the price risk management tools measured in the index have been available to us farmers for over a century. this may have contributed to a large random component in the adoption of price risk management tools, due to the actions of local sample producers still experimenting with the new marketing alternatives available to them. the relatively small sample size (n=84) may have further enhanced this random component. similar low measures of goodness of fit were obtained by makus et al. (1990) for a tobit model of adoption of forward pricing for com and soya beans in a sample of large-scale midwestern us farmers. this was attributed to "a large random component (effect) on forward pricing, or some non-economic explanation" (makus et al., 1990:76). a referee of that study suggested that an alternative non-economic explanation may be that "some farmers use forward pricing because it makes them feel good". specification error may also have played a role in reducing the r2 in the south african model. although all those variables included in previously discussed models were considered in this model, some variables particularly relevant to south african maize marketing may have been excluded. the dominant role still being played by cooperatives (and former cooperatives now operating as public companies) in local maize marketing may be masking direct producer use of price risk management tools. the lack of a reliable explicit measure of risk aversion, and the risk-balancing behaviour that producers are expected to employ, may also have created specification error. these aspects could be considered in future research work related to this topic. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 86 sajems ns vol3 (2000) no i table 1 summary of ols regression results variable variable definition b se(b) name storage respondent uses maize 0.762 0.258 storage facilities (1) or not (0) ofemp gndent has off-farm 1.113 0.379 oyment (1) or not (0) insure respondent covered by formal 0.632 0.225 crop insurance (i) or not (0) educa respondent's number of years 0.132 0.049 of formal education lnmaize natural logarithm of the pro0.778 0.301 portion of annual turnover arising from maize (both yellow and white) mktgm self-rating of marketing ma-0.220 0.124 nagement ability (on lickerttype scale of i (low)-5(high» con-0.457 1.600 stant if statistic adjusted r2 statistic standard error 0.357 0.296 0.870 f statistic significance of f variables included in the model t 2.957 2.938 2.802 2.690 2.585 -1.779 -0.285 5.831 0.0001 sig t 0.004 0.005 0.007 0.009 0.012 0.080 0.776 some inferences drawn from the theory outlined earlier linking the variables given in the estimated regression model in table 1 to the use of price risk management tools are considered below. storage storage is a dummy variable indicating whether or not the respondent used maize storage facilities, either on-farm or at commercial silos. the positive regression coefficient implies that the use of some price risk management tools, such as forward contracting and sequential marketing, is complementary to storage activities. farmers who are both physically and financially able to utilise maize storage facilities both on or off the farm, may have a longer planning horizon for maize marketing. they may be aiming to benefit from seasonal trends in the maize price associated with a one-off supply shock and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol3 (2000) no 1 87 steady spread of demand over time that characterise the south african maize market. storing maize for any length of time exposes the maize inventory to increased price risk and is thus likely to increase the need to use price risk management tools. if the storer is aiming to benefit from anticipated positive price movements, hedging on futures markets would obviously not be appropriate since prices will be more or less "locked-in" apart from unexpected changes in the basis. however, sequential marketing strategies and options hedging may be used as they can capture potential benefits from positive price movements, and it is likely that these are the components of the index of price risk management affected by storage activities. ofemp a priori expectations as to the effect of off-farm employment on farmers' use of maize marketing alternatives were unclear. on the one hand, employment off the farm provides an additional, often reliable source of income to respondents, reducing the seriousness of the effects of price risk on farmers, and reducing use of price risk management tools. on the other hand, farmers with off-farm employment may be more acquainted with business and financial matters and be more likely to use these tools. access to such tools may also be easier for farmers with off-farm employment. given that the sample is biased towards larger, specialist maize farms, the income provided by off-farm employment was probably small compared to the possible variation in income brought about by variations in the maize price. the second effect would thus outweigh the first, which is borne out by the positive sign on the regression coefficient. insure the positive coefficient of insure, a dummy variable indicating respondents' use (or otherwise) of crop insurance, was statistically significant at the 1 percent level of probability. the use of crop insurance mainly in the form of hail insurance could indicate risk averse behaviour with regard to income risk, which comprises both production and price risk. respondents may then be considered more likely to use price risk management tools. crop insurance could theoretically substitute for price risk management tools, resulting in a negative relationship between crop insurance and the use of these tools. however, the use of forward pricing tools often requires that physical delivery be ensured (to some degree) and crop insurance would then complement the use of price risk management tools. educa respondents' number of years of formal education (educa) was positively related to use of price risk management tools. this supports a priori expectations and previous studies in the us (goodwin & schroeder, 1994; shapiro & brorsen, 1988; makus et al., 1990).more educated farmers probably r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 88 sajems ns vol 3 (2000) no i have lower transaction costs associated with the adoption of relatively complicated forward pricing strategies. the educa variable may also capture respondents' age, as younger farmers would be expected to have relatively more years of formal education. age was expected to be negatively related to respondents' use of price risk management tools and so the age component of educa would enhance its positive effect on the use of price risk management tools. younger, less experienced, more educated respondents who tend to make more use of these tools, may also tend to be less established farmers who are more susceptible to price risk and thus have more need to manage price risk. various transformations (exponential, cubic and quadratic) of educa were tested in the study as it was thought that use of price risk management tools should increase with the respondents' number of years of formal education at an increasing rate the best fit, however, was linear. lnmaize the natural logarithm of the percentage contribution of maize to gross income, lnmaize, was positively related to the use of price risk management tools. specialised maize farmers are more prone to maize price risk than farmers with a more diversified enterprise mix and would be more likely to utilise, and devote more time to, maize price risk management tools. the lnmaize measure may capture aspects of farm size as well; the focus of the sample is biased towards large, specialised maize farms, thus specialist maize producers in the sample regions are more likely to have larger farm sizes. both the scaledependent benefits and fixed transaction costs associated with the use of certain price risk management tools, may be spread over a larger amount of output as the volume of maize marketed increases. the "lumpy" nature of contracts (minimum volume specifications) associated with futures and options hedging excludes farmers who market only small volumes of maize. the larger the proportional contribution of maize to gross income, the larger is the volume of maize likely to be marketed by the producer and the more likely that he will use price risk management tools. the logarithmic transformation implies that the use of maize price risk management tools increases at a decreasing rate as the maize share of gross income increases. decreasing returns to size may be experienced by larger-volume maize producers or marketing management time may be limited for very large producers. mktgm mktgm represents respondents' self-rating of marketing management ability relative to other farmers in their district, measured on a lickert-type scale ranging from 1 (low) to 5 (high). this variable was negatively related to jh and the estimated coefficient was statistically significant at the 10 percent level of probability. a priori expectations were that mktgm would measure respondents' level of confidence in the use of price risk management tools and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 89 would thus be positively related to ji. however, respondents who rated their marketing management skills highly were less likely to use price risk management tools. the explanation may be that those rating their marketing skills highly have less need for futures trading, as they are inherently better able to manage spot price risk via other marketing methods. in addition, such farmers may be using price risk management tools indirectly via intermediaries such as cooperatives, which may guarantee spot prices to farmers by using price risk management tools such as hedging. respondents generally rated their skills in marketing management lowest compared to other aspects of management such as production and financial management, indicating concern about their inadequate marketing skills. comparison of results with previous studies table 2 compares the results of this study with those of previous us studies. although the focus of and the statistical methods employed in this study differed from those of previous studies, the models share many similar variables. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . table 2 comparison of results of this study with previous studies partithis study shapiro and goodwin and culars (1998, n=84 brorsen schroeder (1988, n=41) (1994, n = 509) focus factors influencing factors influencing factors affecting producers' use of price producers' participaproducers' adoption risk management tools tion in future markets of forward pricing methods target sa commercial maize indiana maize and kansas corn, wheat, populaproducers soyabean producers soyabean, cattle and tion pork producers statistical ordinary least squares tobit regression tobit regression methocds regression (ols) employee! market et al. (1990, n=595) factors influencing producers' use of futures and options contracts participants of a pilot program covering 22 us states probit regression i i \0 o ell i ell z ell ~ t...j t::3 ~ ~ r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . table 2 continued particulars this study shapiro and (1998, n=84 brorsen (1988, n=41) definition of off-fann + off-fann income + variables with employment statistically use of maize + self-rating of + significant storage facilities marketing macoefficients nagement ability and direction self-rating of producers' debt of effect marketing maposition (+ or-): nagement ability crop insurance + years of farcover ming experience proportion of + area fanned + annual turnover arising from maize years offonnal + years of fonnal + education education perception as to + the ability of futures to stabilise income goodwin and schroeder (1994, n = 509) years of fanning experience %ofiand + cropped debt/asset ratio + input intensity + marketing semi+ narattendance market el til. (1990, n=595) previous use of + forward marketing club + membership higher + education turnover (fann + size) siting of fann + (region) u'l ~ 3:: u'l z u'l <: g. w '""' n o g '-' t \0 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 92 sajems ns vol 3 (2000) no 1 measures of enterprise size were included in all four models. this study used the proportion of turnover arising from maize, which is related to size (correlation coefficient between proportion of turnover arising from maize and gross income = 0.277). shapiro and brorsen (1988) used area farmed, goodwin and schroeder (1994) used percentage of land cropped, and makus et al. (1990) used gross income as size measures. in all cases, size was positively related to the dependent variable. this study and the shapiro and brorsen (1988) study both found that off-farm employment/income had a positive effect on farmers' use of price risk management tools/futures hedging. the two studies, however, differed in their estimation of the effect of self-rated marketing management ability on the respective dependent variables. shapiro and brorsen (1988) found a positive relationship and interpreted the rating as one of self-confidence in management ability. this study found a negative relationship, with the rating interpreted as an inverse measure of ability to handle price risk. these differences in the interpretation of this variable may be justified for the reason that south african maize producers have only carried full responsibility for the marketing of their crop since 1997, whilst us producers have long had access to price risk management tools. in common with shapiro and brorsen (1988), this study found that use of price risk management tools/futures hedging was positively related to producers' level of education. the negative relationship between the dependent variable and years offarming experience was supported by shapiro and brorsen (1988) and by makus et al. (1990). both the education and experience variables are expected to be influenced by operators' age (all three variables were highly correlated). the primary objective of using forward pricing methods is to reduce price risk. previous studies reviewed did not explicitly account for risk aversion although some aspects of risk aversion are incorporated in other variables (shapiro & brorsen , 1988; goodwin & schroeder, 1994). one measure of risk aversion incorporated in this model was the presence or absence of formal crop insurance. it was difficult to isolate absolute price risk aversion due to the riskbalancing behaviour of producers. the insure measure may be considered a rather poor measure of risk aversion and future studies should carefully consider ways to objectively measure price risk aversion and account for risk-balancing effects. certain factors that significantly influenced adoption of various forward pricing tools in previous studies, did not significantly influence the use of price risk management tools in this model. shapiro and brorsen (1988) reported that r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no i 93 positive perceptions of the effectiveness of hedging had a positive influence on the adoption of hedging. goodwin and schroeder (1994) identified marketing seminar attendance and input intensiveness as further factors positively related to use of forward pricing. makus et al. (1990) found siting of the farm with respect to region, marketing club membership and previous use of forward contracts to further influence hedging activity in addition to farm size and operator's education. use of maize storage facilities was the only variable in the local model that did not occur in any of the previous us models. this again emphasises the strong role still played by elevators (cooperatives and former cooperatives) in south african maize marketing. conclusion the use of maize storage facilities, off-farm employment, use of formal crop insurance, operators' number of years of formal education and the proportion of farm turnover arising from maize all had a positive effect on sample maize farmers' use of price risk management tools. operators self-rated score of marketing management ability was negatively related to their use of these tools. farmers who are able, both physically and financially, to utilise maize storage facilities are more likely to be able to use several marketing channels over time in a sequential marketing strategy. maize storage activities incur price risk and are thus positively related to the use of price risk management tools such as hedging. most respondents (70 percent) stored at least a portion of their maize (either on-farm or with elevators), implying that storage can be a profitable activity. off-farm employment often provides farmers with greater exposure and access to price risk management tools. crop insurance cover implies aversion to income risk, and producers with this insurance are thus also likely to be concerned about price risk. crop insurance is also complementary to the use of forward-pricing tools which require that the physical delivery of maize be guaranteed. producers considering using forward-pricing tools should note that these tools may increase their exposure to yield risk if applied to too high a percentage of the crop. use of price risk management tools is expected to increase with operators' education since their transaction costs of adoption will be lower. more specialised maize producers may allocate a greater amount of time to, and reap greater benefits from price risk management. opportunities for providers of price risk management services lie in the marketing education of farmers. maize marketing seminars explaining the full range of price risk management tools r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 94 sajems ns vol 3 (2000) no 1 available to maize producers would reduce the adoption costs and encourage broader producer participation. opportunities for private sector consultants and the various institutions involved in south african maize marketing (e.g. safex, nampo) lie in the provision of these seminars. given the impact of farm size on adoption of price risk management tools, these seminars may have the greatest potential payoff if directed at owners of larger maize farms. the print media are already being used by various organisations to inform farmers about price risk management tools. weekly agricultural magazines (e.g. farmers' weekly) were the most highly rated sources of marketing information in this study and may well be the most effective medium of producer education. sample respondents generally rated marketing management as the weakest facet of their management further evidence of their concern over their ability to manage price risk, and a need for producer education. the estimated model had a low adjusted rl statistic, but this was comparable to some previous studies in this field. goodness of fit as measured by percentage correct classification of cases using more price risk management than the average (82 percent), compared favourably with many previous studies which used tobit and probit models. as maize marketing in south africa develops and matures· further, more research into producers' use of price risk management tools will be needed. future studies should carefully consider how to objectively measure price risk aversion and account for risk-balancing effects. endnote the authors gratefully acknowledge the guidance given by dr kit le clus of the national maize producers' organisation (nampo) and the financial assistance provided by nampo and the centre for science development (csd). opinions expressed in this paper, and conclusions arrived at, are those of the authors and are not necessarily to be attributed to nampo or the csd. references barry, p.j., ellinger, p.n., baker, c.b. & hopkin, j.a. (1995) financial management in agriculture, fifth ed., interstate publishers, inc. danville illinois, usa. 2 directorate: statistical information (1999) abstract of agricultural statistics, national department of agriculture, pretoria. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 95 3 edelman, m.a., schmiesing, rh. & olsen, d.r. (1990) "use of selected marketing alternatives by iowa farmers", agribusiness: an international journal, 6(2): 121-32. 4 frank, dr (1992) "agricultural commodity futures markets in south africa", agrekon, 31(4): 313-20. 5 goodwin, b.k. & schroeder, t.c. (1994) "human capital, producer education programs, and the adoption of forward-pricing methods", american journal of agricultural economics, 76(4): 936-947. 6 gujara ti, d.n. (1995) basic econometrics, third ed., mcgraw-hill, new york, usa. 7 king, r. & l ybecker, d. (1983) :flexible, risk-oriented marketing strategies for pinto bean producers", western journal of agricultural economics, 8(2): 124-33. 8 l yne, m.c. (1998) "personal communication", department of agricultural economics, university of natal, pietermaritzburg. 9 makus, l.d., lin, b.h., carlson, j. & krebil-pra ther, r. (1990) "factors influencing farm level use of futures and options in commodity marketing", agribusiness: an international journal, 6(6): 621-30. 10 mieliesimaize. (1997) information as the key to price determination, july 1997:5. 11 mirer, t.w. (1983) economic statistics and econometrics, first ed., macmillan publishing company, new york, usa. 12 musser, w.n., patrick, g.f. & eckman, d.t. (1996) "risk and grain marketing behavior of large-scale farmers", review of agricultural economics, 18( 1): 65-77. 13 norusis, m. j. (1993) spss" for windows: base system user's guide, release 6.0, copyright© 1993 by spss inc. 14 patrick, g.f., whitaker, w.n., & blake, b.f. (1980) "farmers' goals and risk aversion: some preliminary analyses", risk analysis in agriculture: research and educational developments, department of agricultural economics, university of illinois, usa. 15 shapiro, bj. & brorsen, b.w. (1988) "factors affecting farmers' hedging decisions", north central journal of agricultural economics, 10(2): 145-53. 16 stockil, r.c. (1997) "risk and market deregulation: attitudes of commercial farmers in kwazulu-natal", unpublished magricmgt thesis, department of agricultural economics, university of natal, pietermaritzburg. 17 turner, s.c., epperson, j.e. & fletcher, s.m. (1983) "producer attitudes toward multicommodity electronic marketing", american journal of agricultural economics, 65(4): 818-22. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 96 samms ns vol 3 (2000) no 1 18 turvey, c.g. (1989) "the relationship between hedging with futures and the financing function of farm management", canadian journal of agricultural economics, 37(4); 629-38. 19 van der merwe, c. (1998) "the contractual commitment between the grain producer and the grain buyer", paper presented at the agekon academy internet conference on maize trading at http: ilwww.agekon.com. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr vol 1 (1998) nr 1 85 the portability of american job involvement and job satisfaction scales to non-english speaking south africans l kamfer and d venter university of pon elizabeth a b boshott university of pretoria abstract the scales discussed in boshoff and hoole (above) were applied to a sample of non-english mother tongue speakers in south africa to test their "portability" between america and south africa. where more than one possible structure was obtained, they were compared by means of confirmatory factor analysis. to reduce error variance and improve goodness of fit indices, items were aggregated by taking the mean of random item clusters, and the confirmatory factor analyses repeated. the best fit solution for each of the scales was identified and discussed. indications are that both the minnesota satisfaction questionnaire and the kanungo job involvement scale can be used with confidence in south africa, even on respondents who are not home language english speakers. introduction it is not uncommon for a researcher to use a scale developed in one country to gather data in another, on the assumption that the scale would be measuring the same construct in its new area of application. edwards & leger (1995) list various studies in which this has been done by researchers in africa. the term "portability" has been applied to this aspect of construct validity, and was introduced into the south african literature by boshoff. julyan and botes r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 86 sajems ns vol i (1998) no i (1996) in their study of the kanungo job involvement questionnaire and the minnesota satisfaction questionnaire (msq) from this perspective. however, concerns have been expressed as to whether instruments developed in one cultural sening would be appropriate when used in another (anastasi, 1982; berry, pooninga, segall & dasen, 1992; bhagat & mcquaid, 1982; bhagat, kedia, crawford & kaplan, 1990; retief, 1988; taylor, 1987; triandis, 1972). retief (1988) suggests a three-part framework (comparability and equivalence, translation of meaning, and bias) to describe the pitfalls that exist when applying tests across cultures. in an attempt to address these concerns, the international test commission (1994) has developed guidelines to be followed when using psychological instruments in cross-cuitural studies. at least two studies performed in this country, albeit involving different scales, have shown that different psychometric patterns sometimes occur when scales developed for one language group are applied to another (edwards & riordan, 1994; edwards & leger, 1995). a major problem in the cross-cultural use of psychometric instruments appears to lie in the systems used to attribute meaning to events in different cultures (poortinga, 1983; relief, 1992). berry & triandis (1980) and berry & lonner (1986) state that for scale scores obtained from different cultures to be comparable, the instrument used must show three types of equivalence: junctional, ie the behaviour referred to should have a similar function in each culture; conceptual, an item should have the same meaning to members of both cultures, and metric, the scale used should have the same psychometric propenies in both the cultural groups concerned. this paper investigates the metric equivalence of the two scales being studied. in a study which also focuses on the metric equivalence of these same two scales, boshoff et a!. (1996) used exploratory and confirmatory factor analyses to examine the structures produced for the scales on a south african sample which consisted of white collar professionals. they found the nine items which they retained from the kanungo scale to measure one confirmed factor which accounted for 44.1 % of the variance. the scale had an alpha of .83. they also found the msq to be essentially unidimensional. one factor explained 36.3% of the variance and the scale alpha was .90. they concluded that both scales were robust as far as ponability between the united states and south africa is concerned. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr vol i (1998) nr i 87 in this study, the portability of these two instruments was again examined, on a south african sample that differed in an important way from that used in the study of boshoff and his colleagues: scales were applied to respondents who did not have english as their mother tongue method instruments the instruments used in this study were again the two scales used in the previous study, ie the msq and kanungo's job involvement scale. msq median reliabilities of .90 have been reported for the short, 20 item form of the minnesota satisfaction questionnaire (weiss, dawis, england and lofquist, 1967). the msq measures job satisfaction in two dimensions, extrinsic and intrinsic, with 10 items for each dimension. a total satisfaction score is also provided by the responses to all 20 items. all items are positively worded. kanungo's job involvement scale the kanungo (1982) job involvement scale contains 10 items and has developed as an improvement on the previously widely used measure of lodahl and kejner (1965), measuring job involvement as a unidimensional construct (boshoff, bennett & kellerman, 1994). kanungo reported an alpha coefficient of .83 for the scale. two items are negatively phrased and have to be reverse scored. sample the sample for this study was obtained from a south african government organization, the department of correctional services. the sample frame was 540 employees to whom english was a second language. the two scales used were combined into one questionnaire which was applied by the human resources staff of the client organization. completed questionnaires were received from 237 respondents (43.9%). non-response was mainly the result of unavailability of respondents on the day that the data gathering had been scheduled. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 88 sajems ns vol 1 (1998) no 1 four of the respondents were indian, 97 coloured, and 136 black. all were matriculated (had twelve years of schooling). males numbered 213 (90%) while 24 (10%) were female. mean length of service for the sample was 10.01 years, so = 7.29. mean age for the indian respondents was 32.5 years, so = 10.5; for the coloured respondents, 37.0, so = 10.3 and for the black respondents 3l5 years, so = 10.3. the men had an average age of 30.5, so = ill and the women 33.5, so 0= 12.3. average age for the sample frame was 33 years, so = 13.7, and age range was 20 to 59 years. analyses performed program 4m of the bmop (1990) statistical package was used to factor analyze the data. the extraction method was principal component factor analysis with direct quartamin oblique factor rotation to allow for intercorrelation between factors. factor loadings greater or equal to .30 were regarded as significant. both kaiser's rule, ie factors with eigenvalues greater than one, and scree tests were used to aid in decisions on the optimal number of factors to retain. items with maximum factor loadings less man .30 were omined as well as items that loaded significantly on more than one factor. items were inverted where necessary to ensure that all were scored in the same direction. cronbach's alpha was used to determine internal consistency. confirmatory factor analysis, using the eqs computer package (bentler, 1996) was performed for one-, twoand three-factor solutions for both scales. first for models consisting of the original items. and thereafter for models with aggregated scores. the following fit indices were inspected to determine which model provided the best fit: r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sated nr vol i (1998) nr 1 89 (a) independence model chi-square; (b) model chi-square; (c) akaike's information criterion (aic); (d) bozdogan's consistent version of the aic (calc); (e) bentler-bonnet normed fit index (bnfi); (f) bentler-bonnet nonnormed fit index (bnnfi); (g) comparative fit index (cfi); (h) residual normed index (rni); (0 robust comparative fit index (rcfi); (j) bollen fit index (lfi); (k) mcdonald fit index (mfi); (i) lisrel fit index (gfi); (m) lisrel fit index (agfi); (n) root mean square residual (rmr): (0) root mean square error of approximation (rmsea); according to bentler (1996), chi-square values are inversely related to model fit. the rmr and rmsea are also inversely related to model fit. the model that produces the minimum aic or calc may be considered, in the absence of other substantive criteria, to be a potentially useful model. regarding the fit indices. values greater than .90 are desirable. results msq the indices obtained from the various confirmatory factor analyses conducted on the outcomes of the exploratory factor analyses for the msq are shown in table 1. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . t: -_._.btained fl _ .. _n f: indepenakaike's model denee information chimodel criterion square chi-square (aic) ~c three203.58 850.97 75.58 factor d/f = 78 solution two410.90 1574.11 72.90 factor d/f=169, d/f = 190 solution 2<·00 one503.73 1574.11 163.73 factor d/f=170. d/f = 190 solution ~<.oo msq bozdogan's bentlerbentlerconsistentve bonnett bonnett rsion of tile normed nonnormed aic fit index fit index (calc) (bnfi) (bnnfi) -209.01 .76 .78 -678.60 .74 .80 -592.22 .68 .73 comparatlve fit index (cfi) .82 .83 .76 residual normed index (rni) .82 .82 .76 • ~ ii) ~ m ~ ~ ~ ~ ~ r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . table i (continued) robust bollen mcdonald lisrel (rcfi) (ifi) (mfi) (gfi) three.83 .82 .74 .89 factor solution two.85 .83 .59 .85 factor solution one.78 .76 .49 .81 factor solution root mean usrel ( square residual agfi) (rmr) .85 .21 .81 .09 .76 .10 root mean square error of approxiation (rmsea) .10 .08 .09 --til ~ ~ g: ~ j ~ 10 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 92 sajems ns vol 1 (1998) no 1 msq from table 1 it can be seen that the three-factor solution is best on four of the indices reponed. bnfi, mfi. gfi and agfi. the two-factor solution has the best score on eight indices, aic. calc, cft bnnfi, rcfi, ifi, rmr and rmsea. the one-factor has no bests. the two-factor solution is shown in table 2. in table 2 (and later in table 6) the factor loading matrix has been rearranged so that the columns appear in decreasing order of variance explained by factors. the rows have been rearranged so that for each successive factor. loadings greater than .30 appear first. for ease of reading, loadings less than .30 have been omitted. the two-factor solution is preferred because it performs best on more of the goodness of fit indices produced by the confinnatory factor analysis than either of the other two solutions, although the three-factor solution also does well. also in favour of the two-factor solution is the fact that it retains all of the original 20 items (compared with the ii retained in the three-factor solution). it also has higher cronbach's alphas, .87 and .75 compared to the .79, .66 and .80 of the three-factor solution. its configuration also closely resembles the extrinsicintrinsic aspect of the msq in its original form. the two factors explain 40.62 % of the total variance. factor 1 contains 11 items, being all eight of the original "extrinsic" items, plus three "intrinsic" items. this factor explains 31.51 % of total and 77.57% of common variance. factor 2 contains 9 items, all "intrinsic". it explains 9.11 % of total and 22.43% of common variance. the two factors correlate .41 with each other. in their analysis of the msq, boshoff et ai. (1996) also retained all 20 items. they preferred a one-factor solution which had an alpha of .90, the one factor explaining 36.3% of total variance. their confinnatory factor analysis fit indices were acceptable and better than the ones portrayed in table i, which are not very good. in an attempt to improve the fit indices by reducing the error variance (bagozzi & heatherton, 1994), the items in the msq were aggregated into subscales. this was done by taking the mean of random item clusters. the three-factor structure was represented by the following msq items (factors in square brackets and clusters in parantheses) [(15, 19, 18), (16, 20)]; [(9, 7, 3), (4, 2, 8),]; [6, 5]; two-factor structure was [(19, 6, 5, 16), (14, 13, 12, 17), (15, 18,20)]; [(10, 1,9), (7, 3, 2), (8, li, 4)]. the one-factor structure contained all 20 items clustered as follows: [(13,3,7, 10), (8, 15,4,5), (2, l, 14, 19), (12.6, 17,9), (16, 11,20, 18)]. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sated nr vol 1(1998) nr i tablel soned rotated factor loadings for best fit. exploratory factor analysis on msq msq item ~ wo,kio, oood;,"', 19 the praise) get for doing a good job 13 18 12 6 16 is 5 14 20 9 4 8 3 \0 11 2 7 i my pay and the amount of work 1 do the way my co-workers get along with each other the way company policies are put into practice the competence of my supervisor in making decisions the chance to try my own methods of doing the job the freedom to use my own judgement the way my boss handles his workers the chances for advancement on this job the feeling of accomplishment) get from the job the chance to do things for other people the chance to be "somebody" in the community the way my job provides for steady employment the chance to do different things from time to time the chance to tell people what to do the chance to do something that makes use of my abilities the chance to work alone on the job being able to do things that don't go against my conscience being able to keep busy all the time % common variance % total variance % total variance explained e .. item measures extnnslc job satisfaction item measures intrinsic job satisfaction 93 twofactor solution after fac9 tor 1 (e) .77 (e) .72 i (e) .71 (e) .67 (e) .63 (e) .63 (i) .61 (i) .59 (e) .58 (e) .50 (i) .42 (i) .78 (i) .61 (i) .60 (i) .58 (i) .57 (l) .54 (i) .42 (i) .41 (i) .37 77.57 22.43 31.51 9.11 40.62 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 94 sajems ns vall (1998) no i confirmatory factor analyses were then performed to compare the degrees of fit produced for these aggregated structures. results appear in table 3. table 3 shows that the three-factor solution can be discarded as it performs significantly worse than the oneand two-factor solutions. its model chi-square is significant. all its fit indices are unacceptably low, well below those of the other solutions. the two-factor solution appears to be better than the one-factor solution: it does better on the model chi-square, aic and calc whilst all the other fit indices are identical to those for the one-factor solution. for both twoand one-factor solutions model chi-square probabilities are not significant, which indicates a non-significant deviation from the postulated factor model. in the two-factor solution, the two factors explain 71.58% of total variance. factor 1 explaining 55.72% and factor 2, 15.86%. factor i explains 77.84% of common variance, and factor 222.16%. the factors correlate .55. cronbach's alpha for factor 1 is .86, and for factor 2 •. 73. to summarize: the two-factor solution for the msq is preferred in both the non-aggregated and the aggregated analyses. in the non-aggregated analysis, the two factors explain 40.62% of total variance. factor 1 accounts for 31.51 % of total and 77.57% of common variance. factor 2 explains 9.11 % of total and 22.43% of common variance. the cronbach's alphas are .87 for factor 1 and .75 for factor 2. the correlation between the factors is.41. in the aggregated analysis, the two factors explain 71.58% of total variance, factor 1 accounting for 55.72% and factor 2 for 15.86%. factor 1 explains 77.84% and factor 2, 22.16% of common variance. the factors correlate .55. cronbach's alphas are .86 for factor i and .73 for factor 2. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . ._--------,---_._.fi n . f: indepenakaike's model dence infonnation chimodel criterion square chisquare (aic) three-factor 84.40 525.55 68.40 solution d/f=8 d/f 15 1'< .00 two-factor 5.96 559.95 -10.04 solution d/f=8 d/f 15 1'=.65 one-factor 4.36 624.15 -5.64 solution d/f = 5 d/f = 10 p =.50 .-.... _., .. _ .. _fmsq bozdogan's bentlerbentlerconsistentve bonnett bonnett rsion of the nonncd nonnonned aic fit index fit index (calc) (bnfi) (bnnfi) 32.82 .84 .72 -45.62 .99 1.00 -27.87 .99 1.00 comparath'e fit index (cfi) .85 1.00 1.00 residual nonned index (rni) .85 1.00 1.00 ~ z ~ ~ '"' j ~ ::5: r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . table 3 (continued) robust bollen mc donald lisrel (refi) (lfi) (mfi) (gfi) three-factor .87 .85 .85 .91 solution two-factor 1.00 1.00 1.00 .99 solution one-factor 1.00 1.00 1.00 .99 solution root mean lisrel ( square residual agfi) (rmr) .75 .25 .98 .01 .98 .01 root mean square error of approxiatlon (rmsea) .20 .00 .00 i i i ~ en c: ttl ~ en z en 2: ~ z o r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sates nr vol 1 (1998) nr 1 97 kanungo's job involvement scale exploratory factor analyses were performed on kanungo's job involvement scale producing three-, twoand one-factor solutions. confirmatory factor analysis was conducted to determine the goodness of fit of the three solutions. results appear in table 4. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . table 4 indices obtained from confirmatory factor analyses on kanungo bozdogan's bentlerbentlerakalke's consistent v bonnett bonnett indepenersion or nonned nonnonne dence inronnatio the aic fit index d fit model ncriterion chlmodel index square chi(calc) (bnfi) square (aic) (bnnfi) three35.76 316.83 19.76 -15.81 .89 .83 factor d/f=8 solution p<oo d/f == is two69.48 619.66 17.48 -98.14 .89 .90 factor d/f = 26 solution p<~ d/f == 36 one63.89 616.79 23.89 -65.05 .90 .90 factor d/f=20 d/f::, 28 solution p<oo comparatlve fit index (cfi) .91 .93 .93 residual nonned index (rni) .91 .92 .92 i ~ ~ ttl ~, ~ ~ j a: r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . table 4 (continued) robust bollen me donald l1srel (refn (lfi) (mfi) (gfi) --!----three.94 .91 .94 .95 factor solution two.95 .93 .91 .93 factor solution one.95 .93 .91 .93 factor solution root mean lisrel ( square residual agfi) (rmr) .88 .15 .88 .07 .87 .06 root mean square error of appro xiation (rmsea) .12 .09 .10 ~ z :oc ~ ~ ~ ~ ~ r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 100 sajems ns vol i (1998) no 1 indices obtained from confll'lll8tory factor analyses on kanungo table 4 shows that the three-factor solution has the best score on two of the indices produced by the confirmatory factor analysis (mfi and gfd. the twofactor solution has three bests, aic. calc. and rmsea. the one-factor solution has two bests (bnfl and rmr). compared with the two-factor solution. it does bener on two indices. poorer on four. and equal on seven. its alpha of .86 is better than those of the two-factor scale which are .84 and .59. it explains 47.95% of variance. model chi-squares are all significant, which indicate poor model fit. in order to improve the model fit and to reduce the error variance. the scales were aggregated randomly and confirmatory factor analyses performed for the twoand one-factor solutions. the three-factor solution could not be aggregated due to too few items per factor. the two-factor configuration consisted of the following clusters: [(8, 5. 9. 6). (4. 1. 10)]; [7, 2]. and the one factor configuration [(5. 9) (3. 6) (10, 8) (4, 1)], results appear in table 5. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . table 5 indices obtained from con6rmatory factor analyses on aggregated scales of kanungo bozdogan's bentlerbentlercompaakaike's consisten.v bonnett bonnett rative indepenersion of nomled nonnonlle fit deflce inronnatlo the aic fit index d fit model ncriterion index chimodel index square chi(calc) (bnfi) square (aic) (bnnfi) (cfi) three35.76 19.76 19.76 -15.81 .89 .83 .91 factor d/f=8 solution p<oo dlf = 15 two69.48 17.48 17.48 -98.14 .89 .90 .93 factor dlf = 26 solution p<oo dlf = 36 one63.89 23.89 23.89 -65.05 .90 .90 .93 factor d/f=20 solution p<oo dlf = 28 residual nonned index (rni) .91 .92 .92 ~ ~ < eo i ~ .... o .... r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . table 5 (continued) robust bollen me donald lisrel (ref!) (if!) (mf!) (gfi) three.94 .91 .94 .95 factor solution two.95 .93 .91 .93 factor solution one.95 .93 .91 .93 factor solution root mean lisrel ( square residual agfi) (rmr) .88 .15 .88 .07 .87 .06 root mean square error of approxlat ion (rmsea) .12 .09 .\0 § vl c: m 3:: vl 6i 2: j z o r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sates nr vol! (1998) nr i 103 the one-factor solution for kanungo produces the best results, having the highest scores on 12 of the confirmatory factor analysis indices. the one factor accounts for 70.01 % of total variance , and has an alpha of .86 compared to .87 and.59 for the two-factor, and .80, .59, and undefined for the three-factor solution. the one-factor solution retains eight of the original 10 items, only losing both the negatively phrased ones. the one-factor solution is shown in table 6 table 6 sorted rotated factor loadings for best fit, one-factor solution after exploratory factor analysis on kanungo's jiq kanungo item factor 1 5 most of my interests are centered around my job .78 4 i live, eat and breathe my job .76 6 i have very strong ties with my present job which .73 could be very difficult to break 9 i consider my job to be very central to my existence .72 10 i like to be absorbed in my job most of the time .72 8 most of my personal life goals are job-orientated .69 3 i am very much involved personally in my job .56 1 the most imp.onant things that happen to me .53 involve my present job % total variance explained 47.95 in sum, in its non-aggregated form, the one-factor solution of the kanungo scale retained eight items, explaining 47.95% of variance and having an alpha of .84. when aggregated into scales, the aggregated one-factor solution accounts for 70.01 % of variance with an alpha of .86. the confirmatory factor analysis indices for the aggregated solution are all better than those for the non-aggregated solution. the non-significant model chi-square statistic is further indication of good model fit. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 104 sajems ns vol 1 (1998) no 1 in the boshoff et al. (1996) study, one of the two negatively phrased items was dropped. the remaining nine items (one more than was retained in this analysis) fonned a one-factor solution which had an alpha of .83 and explained 44.1 % of total variance, which is slightly less than our result. their confirmatory factor analysis (on non-aggregated scale) produced fit indices that were good, being in the mid to high nineties, which were even better than those found in this study for the non-aggregated scale. conclusion the two scales tested on this sample both retained their structure to a large degree. the msq retained all 20 of its items (in the context of the comment made in the second last paragraph below it is significant to note that all were positively worded originally) in a two-factor configuration that closely replicated the original extrinsic and intrinsic dimensions. internal consistency was satisfactory. this solution differed from that obtained by boshoff, el ai. (1996), who preferred a one-factor solution. while the fit indices produced by the confirmatory factor analysis on the non-aggregated msq in this sample were not very good, those obtained from the analysis on aggregated items were high. kanungo's job involvement scale retained eight of the original 10 items, losing only the two negatively phrased items. the single factor solution had good internal consistency. boshoff et ai. (1996) also found a one-factor solution, retaining nine items, again with good internal consistency. boshoff et af. (1996) commented on the possible effect of the nature of the foreign sample in the interpretation of (their) portability results. the sample in their study (white, middle and upper middle class professionals) did materially differ from the one used as raison d'etre for this study, who were all non-english mother tongue speakers with a high-school education. despite this difference, the results obtained for the kanungo job involvement scale were very similar to those of boshoff et al. they retained one more item, and their fit indices were higher. the structure obtained for the msq in this study was different, and the fit indices were again lower proving their point to some degree. it is interesting that the two negatively phrased items in the kanungo scale did not perform well in the item analysis and both were discarded. in the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr voll (1998) nr 1 105 boshoff et al. (1996) study, one negative item was discarded. this may not be strong evidence, but the comment by schmitt and stults (1985) (quoted by tetrick & farkas, 1988) reporting a concern about the use of negatively worded items to reduce response tendency does spring to mind. despite the fact that the sample on which the msq and kanungo's job involvement scale were applied in this study differed from the one used by boshoff et al. (1996), the conclusion can be made that both scales again performed at least reasonably well and could be considered for further use on non-english speaking groups in south africa. the msq held up very well and could be used with confidence virtually as is. the eight positively worded items of kanungo's scale would provide a good scale for measuring job involvement. this study concentrated mainly on the aspect of metric equivalence (berry & triandis, 1980; berry & lonner, 1986). poortinga (1983) warns that psychometric analysis is in itself a limited way of investigating equivalence. bhagat & mcquaid (1982) have questioned whether job satisfaction, the focal area of one of the scales examined in this paper, would hold the same connotation for workers in other countries that it holds in the united states. these aspects have not been adequately dealt with in this paper. the fact that the two scales stood up well psychometrically may in itself suggest that there were no great conceptual differences involved. however. the fact that the patterns obtained did differ to a degree. and that, where used, the reverse scored items had to be discarded does indicate that there may be some differences. therefore, whether these two scales also have functional and conceptual equivalenc~ still has to be shown. note the financial assistance of the centre for science development, human sciences research council, which enabled the first-mentioned author to present a version of this paper at an overseas conference, is gratefully acknowledged. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 106 sajems ns vol i (1998) no i references 1. anastasi, a. 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(1996). ponability of the job involvement and job satisfaction constructs between the united states of america and south africa. journal of industrial psychology, in press. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr vol i (1998) nr i 107 13. cook, j.d., hepworth, sj., wall, t.d., & warr, p.b. (1981). the experience of work: a compendiwn and revue of 249 measures and their use. london, academic press. 14. edwards, d., & riordan, s. (1994). learned resourcefulness in black and white south african university students. journal of social psychology, 134(5),665-675. 15. edwards, d., & leger, p. (1995). psychometric propenies of the right wing authoritarianism scale in black and white south african students. international journal of psychology, 30(1), 47-68. 16. international test commission. (1994). guidelines for adapting educational and psychological instruments and establishing score equivalence. draft distributed at the congress of the international association of applied psychology. madrid, july 17-22. 17. poortinga, y.h. (1983). psychometric approaches to intergroup comparison: the problem of equivalence. in s.h. irvine & j. w. berry, (eds), human assessment and cultural factors. new york, plenum. 18. retief, a. (1988). method and theory in cross-cultural psychological assessment. pretoria, human sciences research council. 19. schmitt, n., & stults, d.m. (1985). factors defined ijy negatively keyed items: the result of careless respondents? applied behavioural measurement, 9, 367-373. 20. taylor, t.r. (1987). test bias: the roles and responsibilities of test user and test publisher. nipr special repon pers-424. pretoria: human sciences research council. 21. tetrick, l. e .. & farkas. a. j. (1988). a longitudinal examination of the dimensionality and stability of the organizational commitment questionnaire (ocq). educational and psychological measurement, 48, 723-735. 22. triandls, h.c. (1972). the analysis of subjective culture. new york: wiley. weiss. dj., dawis, r.v .• england, g.w., & lofquist, l.h. 1967. manual for the minnesota satisfaction questionnaire. minnesota studies in social rehabilitation. 22. minneapolis, university of minnesota. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction previous research on the topic theoretical principles provincial growth performance constructing a net fixed provincial government capital stock series for the province provincial fixed capital stock and provincial economic performance summary and conclusions acknowledgements references about the author(s) clive e. coetzee school of economics, north-west university, south africa ewert p.j. kleynhans school of economics, north-west university, south africa citation coetzee, c.e. & kleynhans, e.p.j., 2017, ‘the contribution of public capital towards economic growth: a kwazulu-natal case study’, south african journal of economic and management sciences 20(1), a1591. https://doi.org/10.4102/sajems.v20i1.1591 original research the contribution of public capital towards economic growth: a kwazulu-natal case study clive e. coetzee, ewert p.j. kleynhans received: 04 may 2016; accepted: 13 oct. 2016; published: 28 apr. 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the adequate supply of infrastructure is essential to ensure increasing productivity and economic growth. research found this relationship to be significantly positive. the external effects that spending on public capital has on the production function of private firms stimulates economic growth overall. this implies that public capital inputs should be incorporated into the production function. aim: the way provincial or regional growth depends on infrastructure is investigated in this article and it is applied to data from kwazulu-natal province, as an illustration. setting: this study investigates the extent to which infrastructure in kwazulu-natal province in south africa leads towards economic growth of the province. methods: from a theoretical framework, this article develops an endogenous growth model, which investigates the association between provincial public capital stock expenditure and economic growth. data series for public capital formation are first developed to apply in this study and others to follow. econometric techniques are then employed, using quarterly data between 2001 and 2015, to assess the set hypothesis that growth in expenditure on public capital leads to national economic growth. results: the empirical results support the argument of a positive relationship between provincial capital stock and economic growth in the long-term. the findings also suggests that the long-term causality or effect fades over time, albeit slowly. conclusion: the nature and statistical significance of the long-term equilibrium relationship seems to be ambiguous at best. some evidence of an equilibrium relationship in the short-term was, however, also observed. in conclusion, there also seems to be some causality between provincial capital stock and provincial gross domestic product in the short-run. introduction this article investigates the extent to which the economic growth of a region is stimulated through the expenditure on public capital by the authorities. the extent to which regional growth and economic performance were influenced by infrastructure had been researched quite extensively in the united states, and it is now being recognised that the decline in public expenditure on infrastructure in the united states was a major contributor to the extensive decline in national productivity growth in the 1970s and 1980s (holtz-eakin & schwartz 1994). this led to much research on the relationship between public capital, national productivity and growth. the fact that higher investments lead to higher output in future is accepted intuitively by most (king & levine 1994). the concept of capital fundamentalism was built on this assumption, which can then be extended to assume that higher levels of national capital stocks lead to higher national economic growth as it raises national production. research, especially in poorer counties, provided much evidence in this regard. correspondingly, capital fundamentalists emphasise the importance of increasing a county’s capital stock in order to generate faster economic growth and development. capital fundamentalism saw this as a solution to many countries’ growth problems. to enhance economic development in a country, the most important aspect of policy design should therefore be focused on obtaining a higher stock of physical capital. this article aims to develop a new data time series of provincial public capital stock for the kwazulu-natal province of south africa, and then apply it to investigate the extent to which physical capital stock can promote economic growth in this province. the data series on capital stock will be constructed using the perpetual inventory method (pim) and adjusted for depreciation, which is a unique contribution of this study. in the next section, attention will be given to a literature study on previous research related to the role of infrastructure and public capital in the promotion of economic prosperity, followed by an exposition of the theoretical principles on which this article is based. previous research on the topic in previous research, a positive relationship was established between infrastructure and economic growth. in a 1994 report, the world bank stated that a 1% rise in infrastructure increase across all countries’ gross domestic product by 1%. researchers in south africa also found similar relationships (see, e.g., bogetic & fedderke 2006; fedderke & garlick 2008; fedderke, perkins & luiz, 2006; volkwyn & kleynhans 2014; visser et al. 2015). nannan and jianing (2012) initiated the debate stressing the importance of infrastructure for private entrepreneurship, living quality, prosperity and the environment. aschauer (1989) also focused on the way infrastructure leads to economic development. he also refers to other researchers that found similar relations between capital stock and production income, which occur not only in single economies but also across countries. a relationship between growing private returns on capital and more public capital is also noted but theory and practice also indicate that higher public expenditure can crowd out private sector investments (munnell 1990). using production functions for the timespan between 1965 and 1983, aschauer found that public productivity rises significantly with core infrastructure. it was, however, found that the marginal product of public capital was much higher than that of private capital. much research was conducted on the relation between public capital and productivity (gupta et al. 2011). several estimated production functions add public capital stock as another factor of production. others estimated profit and cost functions, which included public capital, and some followed a vector auto regression (var) approach, which enables researchers to have very little restrictions. literature in this regard generally reports on macro-economic production functions that includes public capital. capital stock is either included as a factor of production or affects those factors through its effect on multifactor productivity. most researches have, however, included both these effects and had problems to distinguish between these direct and indirect effects (de haan, romp & sturm 2007). zainah (2009) stated that government expenditure on capital enhances capital accumulation in the private sector, leading to economic prosperity. public expenditure saves the private sector costs on infrastructure, and this leads to higher returns on private capital and higher productivity. there exists complementarity between public and private investments. the productivity of the factors of production increases everywhere and adjustments lead to cost savings. most economists and politicians agree that expenditure on public infrastructure is essential when designing competition policy for a region. decreasing cost structures that lead to better capital stock attracts investments, private capital and resources, leading to higher output and income in the region (egger & falkinger 2003; haughwout 2002). public capital is often regarded as an input factor of production of private firms. in this way, it has an external effect that lowers production costs and improves production and income of private enterprises (fedderke & garlick 2008:12; kalaitzidakis & tzouvelekas 2007). this was investigated by barro (1990) who incorporated total public expenditure into his production functions or turnovsky (1997) who modelled it as part of the total public stock. canning and pedroni (2004) estimated a large panel data study, considering the information of many countries between 1950 and 1992, to ascertain their relationship between public capital and economic growth in the long-term. the study also examined the role of innovations. instead of investment figures, they considered physical aspects such as the size of a country’s power plants, and the number of telephones and the kilometre of roads in the region of study. several researchers, including canning and pedroni (2004), lee, pesaran and smith (1997) and cheung and lai (2000), found unit roots existed in the data on public capital, as well as the per capita gross domestic output. the co-integration that were found between this data enabled the researchers to design a model that could distinguish between the shortand long-term effects; and also extended the research to cross-country averages. the study found bi-directional causality in the short and long-term. they found that shocks in infrastructure have a very strong impact on national income and that infrastructure also has a long-term effect on income. the study also found that the public capital stock of many countries was in excess of the optimal required amount. this over-supply was also found by the research of ghali (1998) and devarajan, swaroop and zou (1996). in order to achieve regional development and growth, public investment in infrastructure is essential (márquez, ramajo & hewings 2010). as the long-term effect was already indicated above, permanent increases of infrastructure should exist to support private sector development. ‘new growth theory’ (ngt) and ‘new economic geography’ (neg) models emphasise the importance of capital expenditure by the authorities in order to ensure economic development. applying the research findings of others in meta-regression analysis, it was found that the output elasticity of infrastructure is significantly positive (bom & litghart 2010). the output elasticity of public capital was on average estimated to be 0.5, and their benchmark for conditional elasticity was 0.17. this elasticity ranged between 28.8% and 32.6% in 2001 for the united states. much variation in primary estimates was found and across countries much heterogeneity was also found. onakoya and somoye (2013) investigated the disaggregated effect of infrastructure on the income of the various sectors of nigeria. they used a three-stage least squares (3-sls) regression and simultaneous equations to model the country’s economy. as the case in other research, they also established a positive relation between the expenditure on public infrastructure and economic growth. they did, however, also find indications of ‘dutch disease’, as spending on infrastructure led to higher oil production, while the agriculture and manufacturing sectors are neglected and their growth rates declined. their results did suggest that higher public expenditure on capital leads to an increase in private investments, but that the effect on the service sectors is insignificant. research that studied the relationship between public capital investment and economic progress in china by nannan and jianing (2012) also indicated a positive relationship, justifying their large expenditure aimed to minimise the impact of the global financial crisis. china’s strategy to invest in public infrastructure to enhance economic growth can in this situation be regarded as a success. they studied chinese data over the period 1988–2007 and estimated output elasticities using cobb–douglas production functions, which they developed into a gross productive equation. sava and zugravu (2010) studied the correlation coefficients between infrastructure and national income for romania using regression analysis over the period 2006–2009, and found a similar positive relationship, although not very strong. higher government expenditure on capital thus also led to economic development in romania. a study on mauritius found that expenditure on public capital led to significant increases in economic growth. zainah (2009) also found indirect effects on private investments and the accumulation of private capital. the study estimated production functions based on solow’s growth model and also applied a vector error correction model (vecm), which is able to consider feedback effects. on the contrary, not all studies agree. several studies found that infrastructure expenditure by the authorities may also have a negative impact on the private sector and long-term national economic growth. gregoriou and ghosh (2009) studied 15 industrialised nations and obtained mixed results. they found the relationship to be negative for thailand and brazil in the long-term, but current spending to be positive. on the contrary, zimbabwe and sudan enjoyed no benefit from any of these kinds of public expenditure. a study on belgium indicated a negative relationship between the rate of employment and expenditure on public capital (everaert & heylin 2004). an increase of 1% in this kind of public expenditure led to an increase in private sector unemployment of 0.32% (sava & zugravu 2010). in these cases, a relationship between public expenditure on capital and economic growth was found, but it was negative probably because of a crowding-out effect of private investments. the following section explains the basic theoretical basis of the current research. theoretical principles this study is based on production functions to determine to what extent expenditure on public capital by the provincial authorities leads towards the economic growth of the province. public capital is regarded as an input factor of production into the provincial production function. this expenditure does, however, reduce other kinds of investments (barro 1990). the production function is specified as: where yt is the total real provincial production and income (gross domestic product), t is the time period, kt is the aggregate total national capital stock (general government and private) in the province (excluding aggregate provincial public capital stock), gt is the aggregate provincial public capital stock, while st represents the skill adjusted aggregate provincial labour supply. rather than using raw labour (gupta et al. 2011), this study constructs and uses skill adjusted labour incorporating data on the average literacy rate. the level of technology is represented by ‘a’, as in other cobb–douglas production functions, and α, β and γ are normal distributed parameters. the empirical analysis adopted by this approach specifies the aggregate input–output production relationship as: where a0 indicates the level of technology at the start of the research period (2001). the assumption is that year-specific intercepts λt may represent external technology shocks. taking logarithms yields: the estimation of such a relationship and determination to what extent the stock of provincial capital stock affects growth of the provincial economy requires the researchers to construct a dataset of provincial capital goods, which first takes depreciation into account. this is one of the major contributions of this study. the following section studies the growth in kwazulu-natal, followed by the design of the database for public capital. provincial growth performance in 2015, kwazulu-natal’s gross domestic product was estimated to be approximately r480 billion (2010 prices). provincial output increased from r79 billion during the third quarter of 2001 to r121 billion during the third quarter of 2015 (2010 prices). economic activity picked up robustly from 2000 to 2008 (with 4.42% average annual growth), and thereafter grew moderately and ultimately decreased (−1.78%) in 2009 because of the global financial crisis. positive growth resumed during 2010, albeit at a very modest pace with the provincial economy recording 3.43%, 3.54% and 2.55% of growth during 2010, 2011 and 2012, respectively (figure 1). between 2010 (first quarter) and 2015 (third quarter), the provincial growth has steadily declined, mostly because of domestic risk factors, including growing labour unrest, electricity shortages and political uncertainties, as well as the downturn in the commodities and chinese economic cycles (2.10% during 2013 and 1.82% in 2014). figure 1: provincial and seasonal adjusted gross domestic product (r billion, constant 2010 prices). for non-stationarity, the seasonal adjusted provincial gross domestic product per skill adjusted labour supply (figure 2) in log form is tested. to perform the unit root test on an autoregressive model (ar)(p), the regression was determined as: figure 2: provincial seasonal adjusted gross domestic product per skill adjusted labour supply (r billion, 2010 prices). the test statistics suggest that the variable is stationary in the first difference form and is integrated to the order of 1 or i(1). the stationary variable (first difference of the log of the provincial seasonal adjusted gross domestic product per skill adjusted labour supply in 2010 prices) is displayed in figure 3. figure 3: log of first difference of the provincial seasonal adjusted gross domestic product per skill adjusted labour supply (2010 prices). the following section describes the way the provincial capital base was constructed and estimated. constructing a net fixed provincial government capital stock series for the province in economic theory, capital goods, such as computers, buildings, vehicles and machines, are always regarded as an important production factor (berlemann & wesselhöft 2012). data on such capital stock is required to determine its impact on total output and income. data on the development of the capital stock have, however, been unavailable for most countries for a considerable time and this also applies to the province of kwazulu-natal. the development of datasets on large provincial capital stock is mostly unavailable and this necessitated the development of a dataset, especially for this research. statistical offices that did develop such datasets in the past all used the pim. examples include griliches (1980), nehru and dhareswhar (1993), fuente and domenech (2000), kamps (2006) and derbyshire, gardiner and waights (2010). investment in capital goods implies an increase in capital goods. the principle pim method, therefore, also regards public expenditure on infrastructure as an inventory item and capital formation as investments. after an investment, the owner enjoys utility from that capital good acquired and the quality thereof declines as time expires. in principle, capital goods will always have some use, indicating some perpetual value, but with time the capital goods will deteriorate and its value will also depreciate. the value of public capital goods after depreciation can then be estimated as: where kt is the capital stock during time t, gfkt is gross fixed capital formation (gfcf) and δ is the rate of depreciation (assumed constant over time). the way that researchers estimated the initial levels of capital stock differs between researchers. the approaches most frequently used in the literature are the steady state, disequilibrium and synthetic time series methods. this article does not employ any of the above approaches but rather a national disaggregation approach (predicting times series by related series) to estimate initial provincial government capital stock. such an approach allows for the transition from aggregate indicators to disaggregate indicators. more specifically, an attempt was made to estimate the value of public capital of kwazulu-natal provincial, with analogous indicators that are available at the national and provincial level. vidoli and mazziotta (2010) stated that chow-lin’s approach allows for the reconstruction in an appreciably precise way of the infrastructural index at the disaggregate level on the basis of the corresponding indicator at the superior territorial level. polasek (2009) demonstrated how regional data can be developed from national data. chow and lin (1971) disaggregated national data for their regional spatial analysis, when only the total country-wide figures were available. the national disaggregation approach estimates are derived from three basic components: an indicator that measures the desired characteristics reliably at the national level auxiliary information that provides provincially detailed data models to relate the indicator estimates to the auxiliary information. since reliable provincial government gross capital formation is only available from 2001, the total provincial government capital stock from 2001 has to be estimated. this is done using the total national government gross capital stock data (national indicator), published by the south african reserve bank (sarb), which was then disaggregated on a provincial level (equitable share data). calculation of the total provincial government capital stock is based on the following steps: step 1: the total fixed capital stock (general government) based on the sarb statistics was r1.4 trillion during 2001 (constant 2010 prices). step 2: national government distributes on average approximately 32% of its resources to the nine provinces through the equitable share system and therefore it is estimated that the total fixed capital stock (provincial government) was r450 billion in 2001 (constant 2010 prices). step 3: of this 32%, kwazulu-natal receives approximately 21% and therefore the estimated total fixed capital stock (kwazulu-natal) was r94 billion in 2001(constant 2010 prices). the rate of depreciation is assumed at 1% since the majority of total fixed provincial government capital stock consists of long service life capital. the organisation for economic cooperation and development and eurostat (2017) defines gfcf: as the acquisition, less disposals, of fixed assets plus major improvements to, and transfer costs on, land and other non-produced assets. the assets acquired may be new or they may be used assets that are traded on second-hand markets. the assets disposed of may be sold for continued use by another economic unit, they may be simply abandoned by the owner or they may be sold as scrap and be broken down into reusable components, recoverable materials, or waste products. (oecd 2009:126) the oecd (2001) states that gfcf: is measured by the total value of a producer’s acquisitions, less disposals, of fixed assets during the accounting period plus certain additions to the value of non-produced assets realised by the productive activity of institutional units. (p. 1) gfcf is a ‘gross’ value as the figures are neither adjusted in any way nor adapted for depreciation or consumption of fixed capital. it also excludes land sales and purchases. figure 4 displays the provincial government gfcf in both nominal and real terms. in an effort to determine the real provincial government gfcf, the gross domestic product deflator was applied. figure 5 displays the real provincial gfcf after seasonal and non-seasonal adjustments. figure 4: nominal and real provincial government total capital formation (r’000). figure 5: real provincial government and real seasonal adjusted provincial government total capital formation (r’000). figure 6 displays the real seasonal adjusted fixed provincial government capital stock applying the pim where: figure 6: seasonal adjusted fixed provincial government capital stock (2010 prices). the log of the seasonal adjusted fixed provincial government capital stock per skill adjusted labour supply (r’ 2010 prices) is tested for non-stationarity against the alternative that the variable is trend stationary (figure 7). the test statistics suggest that first difference stationary exists and is therefore integrated to the order of 1 or i(1). the stationary variable (first difference of the log) of the seasonal adjusted fixed provincial government capital stock per skill adjusted labour supply is displayed in figure 8. figure 7: seasonal adjusted fixed provincial government capital stock per skill adjusted labour supply (r’ 2010 prices). figure 8: log of first difference of the seasonal adjusted fixed provincial government capital stock per provincial skill adjusted labour supply. this constructed capital database was then applied to determine the contribution of public infrastructure towards provincial economic growth. provincial fixed capital stock and provincial economic performance the behaviour of the provincial gross domestic product per skill adjusted labour supply and total fixed capital stock per skill adjusted labour supply over the period 2001 (third quarter) to 2015 (third quarter) are displayed in figure 9. some correlation between the two variables seems to be present. figure 9: co-movement of seasonal adjusted provincial gross domestic product per skill adjusted labour supply and seasonal adjusted fixed provincial government capital stock per skill adjusted labour supply (rand). a regression function for the variables displayed in figure 9 can be estimated. it shows provincial gross domestic product per skill adjusted labour supply and total fixed capital stock per skill adjusted labour supply in first difference log format using the following equation: where: yt = provincial gross domestic product per skill adjusted labour supply in first difference log format, that is, gt = seasonal adjusted fixed provincial government capital stock per skill adjusted labour supply in first difference log format, that is, εt = error term the coefficients (α and β) were estimated using ordinary least squares (ols) and regressions; using time series data from 2001 (third quarter) to 2015 (first quarter). table 1 shows the empirical results of the regression. the t-statistics and adjusted r2 (0.57) indicates that the α (-0.001) and β (0.84) coefficients and the regression functions are statistically significant. table 1: output of the regression equation. to test the hypothesis that the coefficient of the seasonal adjusted fixed provincial government capital stock per skill adjusted labour supply is equal to 0.79, a wald test was performed. the results suggest that the null hypothesis (β = 0) can be rejected. forecasting the seasonal adjusted provincial gross domestic product per skill adjusted labour supply using the above equation suggests that an average annual 6% increase in the seasonal adjusted real fixed provincial government capital stock per skill adjusted labour supply will cause an average annual 4.7% increase in the seasonal adjusted real provincial gross domestic product per skill adjusted labour supply, ceteris paribus. the single-equation regression model that was used in this study (similar to aschauer 1989) may sometimes entail problems of endogeneity, misspecification of the production function and causality with regard to the relation between infrastructure and productivity. to determine the effect of unexpected shocks in public capital expenditure, vars model was estimated. this model can indicate the dynamic effects, such as the effect on regional production, with very little restrictions. var can also address the problems of endogeneity and causality mentioned above. aschauer (1997) employs a cobb–douglas type of production function, expressed in terms per labourer, as: where: y is output, k is a broad measure of private capital (inclusive of tangible and human capital) kg is public infrastructure capital. constant returns to scale of private and public capital exist, while raw labour and capital yields increasing returns. depreciation, population growth and technological developments are, however, not considered in this model. this study estimated a var model similar to aschauer’s cobb–douglas production function. the time path of (yt) may be influenced through the (kt, st and gt) sequence, while it can also be the other way round. the estimated var (in i(1) format) system is as follows: where: yt = provincial seasonal adjusted gross domestic product per skill adjusted labour supply in first difference format, that is, kt = seasonal adjusted fixed provincial government capital stock per skill adjusted labour supply in first difference format, that is, gt = total national capital stock (general government and private) per national skill adjusted labour supply in the province in first difference format, that is, it is assumed that yt, and kt are stationary; e1t, and e2t are white noise disturbances with standard deviations of σy and σk, respectively; gt is assumed to be an exogenous variable, and the error terms are uncorrelated. as the lag length equals one, a first-order var was estimated. additional lags could, however, be included if deemed necessary. as yt and kt may affect each other, there is also some feedback build into the system. the model was estimated using eviews and employed quarterly data, ranging from (third quarter) 2001 to (third quarter) 2015. four lags are included in the model. no exogenous variables, except the constant (and gt), have been included. several tests were performed on the model suggesting that (1) the estimated var is stationary (stable) in that modulus of all roots is less than unity and is inside the unit circle, (2) the granger causality test (p = 0.07) suggests stationarity of the model and no spurious granger causality problems exist, (3) the lag length criteria supported the use of four lags, (4) the residual portmanteau test for autocorrelations suggested no residual autocorrelations (p at lag 5 = 0.001), (5) at the lag order of 6 there exists no serial correlation according to the residual serial correlation lagrange multiplier (lm) test and (6) the white heteroscedasticity test indicates the joint significance of the repressors (p = 0.25). the results of the diagnostic statistics in general support the appropriateness of the estimated var model. forecasting the provincial gross domestic product per skill adjusted labour supply using the var suggests that an average annual increase of 6% in the real provincial total fixed capital stock per skill adjusted labour supply will cause an average annual increase of 0.6% in the real provincial gross domestic product per skill adjusted labour supply, ceteris paribus. most studies employ co-integration and an error correction process to assess where public capital relates to economic progress, both short and long-term. this approach enables to determine the effects of capital stock innovations, as well as departures from a steady state, at the same time. this study tested this relationship using the engle–granger co-integration and error correction procedure. the assumed co-integrated relationship can be expressed as: where: yt = log of provincial gross domestic product per skill adjusted labour supply, that is, kt = log seasonal adjusted fixed provincial government capital stock per provincial skill adjusted labour supply, that is, gt = log total national capital stock (general government and private) per national skill adjusted labour supply in the province in first difference format, that is, εt = error term to test whether the assumed co-integrated relationship indeed exists, it is important to integrate all the variables to the same order and ensure that error terms are stationary. consider that the two variables yt and xt are both i(d), which implies long-term compatibility. although any linear combination of yt and xt will also be i(d), if there exists a vector (1, β)’, such that the linear relation εt = yt α βxt is i(d b), and d ≥ b > 0, then following engle and granger (1987) yt and xt are co-integrated in the order (d, b). the augmented dickey–fuller test (adf) statistics shows the variables to be indeed i(1) and therefore they are indeed integrated to the same order. the results of the regression suggest that the β and λ consumption is statistically significant (t > 2). the adjusted r statistic is fairly high (0.23), but the durban watson statistic (of 0.83) is a cause of concern. however, the biggest surprise is the negative sign of the λ coefficient. the co-integrating equation can be expressed as: the results of the adf test (using the engle granger critical value at 10% = 3.04) suggest that the residuals are indeed stationary and there exists a co-integration relationship between these variables at a 1% level of significance (p = 0.023). after the long-term relationship between the variables is established, it was possible to construct a vecm that can simulate the short-term association between the variables. an error correction model was specified as: where: δyt = log of provincial gross domestic product per provincial skill adjusted labour supply, that is, δgt = log total national capital stock (general government and private) per national skill adjusted labour supply in the province in first difference format, that is, δkt = log provincial total fixed capital stock per provincial skill adjusted labour supply in first difference format, that is, β and λ = co-integrating coefficient ؏ = coefficient on the lagged gap or known as equilibrium error term of one period lag vt = white noise innovation in this form, β2 and λ2 are called the long-term parameters and ؏ is termed as the short-term parameter. the residuals that have been calculated using the co-integration equation, and that have been tested for stationarity, are incorporated in an error correction equation to derive the error correction model. this proposed model seems statistically significant intuitively because the lagged residual coefficient is significant negative (؏ = −0.18 with a t = −2.54). a possible alternative approach may be to develop a vecm similar to a cobb–douglas type of production function, using the johansen co-integration test. the four variables are then integrated to the same order of 1: where yt is the real total provincial production and income (gross domestic product) at period t, gt is the total national stock of capital (general government and private) in the province (excluding aggregate provincial public capital stock), kt is the total provincial public capital stock and st is the skill adjusted total provincial labour force. εt is the stationary error term. log transformed variables were used in the model. the results of the test procedures suggest that at the 0.05 level there are indeed four co-integrating equations. the long-term co-integration (lag = 2) is displayed in table 2. there does seem to be a statistically significant long-term relationship between provincial economic growth and provincial capital (maxeigen statistic at none p = 0.00). however, it is an inverse relationship, as suggested by the negative sign. table 2: normalised co-integrating coefficients (standard error in parentheses). co-integrating equation is as follows: the results of the vector error correction estimates (two lags included) yield a coefficient of -0.014 and -0.013 for the first difference of the log provincial total fixed capital stock (yt-1) and first difference of the log provincial total fixed capital stock two lags (yt-2), respectively. estimating the system using ols indicates that the γt-1 and yt-2 coefficients are statistically significant. testing for the joint significance (using the wald test statistics) of γt-1 and γt-2 coefficients indicates that they are jointly significant (p = 0.014). this indicates that there seems to be short-term causality between the provincial capital stock and the provincial gross domestic product. testing the above model for statistical errors indicates that the r2 is fairly high at 0.83, the f statistic (joint significance) is statistically significant at 30, the breusch–godfrey serial correlation lm test shows no serial correlation with p = 0.35, the heteroscedasticity test: breusch-pagan-godfrey indicates that the model does not have heteroscedasticity (p = 0.08) and the residuals are normally distributed (p = 0.67). forecasting the real aggregate level of provincial output using the vecm suggests that an average annual increase of 6% in the real provincial total fixed capital stock, ceteris paribus, will cause an average annual increase of 2.78% in the real provincial gross domestic product. summary and conclusions this article assessed the extent to which provincial expenditure on fixed capital stock (infrastructure) may promote provincial economic growth using time series data of kwazulu-natal province, south africa. the article introduced provincial infrastructure into a neo-classical production function model, and investigated the empirical results. this article first reported on the construction of a new dataset for total provincial public capital stock since national accounts do not report a data time series for it. a provincial capital stock data series was designed using the perpetual inventory method (pim). this study found that long-term causality or effect fades over slowly. however, the nature and statistical significance of the long-term equilibrium relationship is ambiguous at best. to the contrary, some short-term equilibrium relationship was observed. therefore, there seems to be some causality between provincial capital stock and provincial gross domestic product in the short run. this is not unsurprising given that provincial public investment projects take some years to complete. research by various authors studied the role of infrastructure in the economy. a number of economists argue that increased investment in public infrastructure improves growth and prosperity. david aschauer seemingly triggered a long overdue dialogue among economists and political leaders on public capital investment in the united states. he stated that public investments enhance the quality of people’s lives, raise economic progress as well as the return on private sector investments. the major contribution of this article is that it studied the relationship between provincial public stock and provincial economic growth. it presents models that analyse the link between provincial public stock and provincial growth within a spatial economic context. literature on spatial economic analysis within provincial context is fairly scarce in south africa and therefore this article contributes to the spatial economic research effort. this study also developed a time series of fixed capital stock formation for the kwazulu-natal province, which did not exist and may now also be applied by other researchers in their investigations. literature suggests that there is indeed some sort of optimal level public capital above which more expenditure would be wasteful and alternative expenditure would be more profitable. unfortunately, given the reliability and inconstancy issues encountered with the models, it was not possible to venture into this particular topic. however, this topic should be high on the agenda for future research. the application of growth models to guide expenditure on public capital seems to be a worthwhile endeavour and should be continued in further research. this article studied the role of provincial government capital accumulation and its advantages but did not model municipal infrastructure accumulation nor differentiate between private and national government capital accumulation. it would be important in future to estimate private, national, provincial and municipal capital accumulation within the context of a well-specified model. acknowledgements competing interests the authors declare that they have no financial or personal relationship(s) 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viewed 08 april 2017, from http://www.satnt.ac.za/index.php/satnt/article/viewfile/430/2597 world bank, 1994, world development report 1994: infrastructure for development, oxford university press, new york, viewed 08 april 2017, from https://openknowledge.worldbank.org/handle/10986/5977 zainah, p., 2009, the role of public investment in promoting economic growth: a case study of mauritius, service sector development and impact on poverty, thematic working paper, tips project, trade & industrial policy strategies, pretoria. abstract introduction literature review research methods and design results discussion and conclusion acknowledgements references about the author(s) elda du toit department of financial management, university of pretoria, south africa karabo lekoloane department of financial management, university of pretoria, south africa citation du toit, e. & lekoloane, k., 2018, ‘corporate social responsibility and financial performance: evidence from the johannesburg stock exchange, south africa’, south african journal of economic and management sciences 21(1), a1799. https://doi.org/10.4102/sajems.v21i1.1799 original research corporate social responsibility and financial performance: evidence from the johannesburg stock exchange, south africa elda du toit, karabo lekoloane received: 21 feb. 2017; accepted: 20 july 2018; published: 18 oct. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: stakeholders are increasingly concerned whether the companies they are involved with act in a socially responsible way. however, stakeholders like employees and shareholders also have a direct financial interest in those companies and need to be assured that company actions bring forth some financial benefit. aim: the research investigated one of the main questions surrounding the concept of corporate socially responsibility, namely whether a company’s investment in and effort towards corporate social responsibility results in improved financial performance. the purpose of this study was to narrow the gap in the body of knowledge in relation to corporate social responsibility and its relationship to financial performance. setting: this research investigated whether there was a relationship between being listed on the johannesburg stock exchange (jse) socially responsible investment (sri) index and financial performance. the unit of study comprises 885 company-years of companies listed on the jse over the period 2009–2014. methods: logistic regression was used to find evidence of a relationship between a listing on the jse sri index and financial performance. results: it is evident that there was no real relationship between inclusion on the jse sri index and financial performance, but there was a direct relationship between the size of a company and having a listing on the jse sri index. conclusion: a listing on the jse sri index does not have a clear and direct impact on financial performance, but it appeared that larger companies are perhaps better able to invest in corporate social activities and are, as a result, more likely to be listed on the jse sri index. introduction the issue of corporate social responsibility remains increasingly relevant. society is continuously bombarded with not only news about natural disasters all over the world but also the related reports of humanity’s negative impact on the earth in terms of climate change, dwindling natural resources and the effect of waste and pollution on the environment. stakeholders show an increasing interest in whether the companies they interact with, act in a socially and environmentally ethical way (lins, servaes & tamayo 2017; liu & zhang 2017; margolis & walsh 2003; orlitzky, schmidt & rynes 2003; qiu, shaukat & tharyan 2016; soobaroyen & sheik-ellahi 2008). however, many stakeholders have a direct financial interest in companies and need to be assured that the companies’ actions also bring some financial benefit. this paper investigates the relationship between corporate social responsibility practices and financial performance. according to vaughn and ryan (2006), good corporate governance practices are of particular importance in emerging economies such as the brazil, russia, india, china and south africa (brics) countries, where foreign investment is needed for economic growth. one reason these authors, together with baskin (2006), cite for south africa’s economic success as part of the african continent is its leadership in corporate governance reforms. investors would pay almost 30% more for an investment in a company with ‘good’ corporate governance (abdo & fisher 2007; braga-alves & shastri 2011). it is evident that companies in south africa understand what good corporate governance and corporate social responsibility are, as well as the benefits they bring. compliance with the king code of corporate governance, as set out in king iv (iodsa 2016), and implemented as a listing requirement of the johannesburg stock exchange (jse) (johannesburg stock exchange [jse] 2013), promotes the highest standard of corporate governance and corporate social responsibility. there is a direct link between corporate governance and corporate social responsibility. corporate governance is about the responsibility with which a company is run, through accountability, transparency and compliance to benefit all stakeholders (muralidharan, 2016). social responsibility refers to ‘softer issues’, that is, company actions that support social objectives considered to be sought after by investors (rosen, sandler & shani 1991). social investors are not only concerned about the financial performance of a company but also the non-financial dimensions of corporate performance, such as the impact on the environment, social relations and corporate governance and thus the interests of all stakeholders as per stakeholder theory (galema, plantinga & scholtens 2008). improvements in a company’s corporate governance and social responsibility practices have the potential to result in improved financial performance as a result of enhanced reputation (preston & o’bannon 1997; ruf et al. 2001). however, companies that are financially unstable may find it difficult to invest in corporate social performance activities, while those that have a better financial standing have the resources to spend in ways that may enhance long-term strategic impacts (alexander & buchholz 1978; waddock & graves 1997). in south africa, viviers (2007) and gladysek and chipeta (2012) found that socially responsible investment funds significantly outperformed their benchmark indices, which implies a positive relationship between corporate social responsibility and financial performance. however, despite numerous studies conducted worldwide to establish the relationship between corporate social responsibility and financial performance, there has not been any clear consensus on the existence of or direction of such a relationship. even though research on the relationship between corporate social responsibility and financial performance was conducted with data from as early as 1970 (alexander & buchholz 1978), the findings are contradictory and published research on this relationship for south african companies is scarce. this study sets out to fill this gap by investigating whether a listing on the jse socially responsible investment (sri) index can predict whether a company has better financial performance than a company not listed on the index. the results ought to enable investors and other stakeholders with a financial interest in a company to better predict whether a company’s shares are a potentially profitable investment. even though the findings of this research are of interest to investors, business managers, company boards, regulators and academics, investors ought to derive the most benefit from the findings for purposes of investment decision-making. the article next provides a detailed literature review to establish the theoretical foundation of the article, as well as giving account of what has been published in previous research in the field of corporate social responsibility and financial performance. this is followed by the research design and method, the quantitative data analysis, empirical findings and a summary and conclusions. literature review theoretical foundation a company does not conduct its business activities in isolation. engagements with and contributions by stakeholders (customers, suppliers, investors, the community and employees) need to be taken into account. this research is conducted from the viewpoint of stakeholder theory. the most well-known definition of a stakeholder is by freeman (1984), stating that stakeholders are all the individuals or organisations that affect the achievement of a company’s goals, or are affected by the activities of a company in achieving its objectives. there are numerous variations of this definition, but all point in the same direction. evan and freeman (1993) penned the most commonly used definition for stakeholder theory, namely that ‘the real purpose of a company is to serve as a vehicle to coordinate the interests of stakeholders’. stakeholder theory thus challenges the assumptions that underlie agency theory and argues that a company should be managed in the interests of all its stakeholders. in terms of corporate governance, corporate social responsibility and socially responsible investments, the company’s responsibility towards stakeholders comes to the fore as per stakeholder theory (boaventura, da silva & bandeira-de-mello 2012; margolis & walsh 2003; orlitzky et al. 2003; preston & o’bannon 1997; ruf et al. 2001). this reflects on a company in two ways, firstly as an indicator whether a company has the means to invest in socially responsible activities and, secondly, as an indicator of the benefits investors and society can derive from socially responsible practices. by implication, stakeholder theory also involves legitimisation theory, where companies attempt to achieve legitimacy for their actions before their stakeholders (callan & thomas 2009). corporate social responsibility and socially responsible investments the basis of corporate governance dates back many years to when the separation of ownership and management of a business first occurred (abdo & fisher 2007). the market is deeply involved in the business operations and performances of companies. therefore, one of the means that could expedite transformation in market governance is that of socially responsible investments (herringer, firer & viviers 2009). after the apartheid regime in south africa, along with the political reform thereafter, foreign investors felt it safe and strategic to reignite investments in south africa for a couple of decades (abdo & fisher 2007). this subsequently created a platform for increased scrutiny into the conduct of business, which included governance structures and practices. overall, from a world bank survey of government and civil society representatives, corruption unfortunately was deemed a major obstacle to economic growth (world bank – civil society engagement 2013). however, corporate governance and corporate social responsibility practices can reduce unethical behaviour and ensure that society faces no harm from the activities of a company. abdo and fisher (2007) commented that effective corporate governance decreases the ‘control rights’ of managers over shareholders and can be beneficial but only if management has the best interests of the business, the company and its stakeholders at heart, as per stakeholder theory. other than that, an agency problem could arise, which could unearth the corporate governance matters that could potentially run the business down. when applied effectively, together with the mitigation of any detrimental risks, corporate governance has the potential to serve as a tool to attract investors and influence the price they pay for company stock, as well as improve non-financial results (abdo & fisher 2007; soobaroyen & sheik-ellahi 2008). the king committee highlights seven prime features of good corporate governance. these are discipline, transparency, independence, accountability, responsibility, fairness and social responsibility (abdo & fisher 2007; iodsa 2009). the adoption of corporate governance principles in the business or corporate culture is aimed at improving internal activities, increasing accountability and transparency, and encouraging communal credibility, which can potentially migrate towards better managerial and operational performance and company value. chen, feldmann and tang (2015) claim that it is commonly expected for profitable organisations to have stronger incentives than others, to reveal information on social performance to enhance their public relations and reputation. however, there is the shortcoming of increased cost during the process as a result of corporate social responsibility activities (alexander & buchholz 1978; michelon, boesso & kumar 2013; pava & krausz 1996). from an optimistic perspective, investors would rather pay a premium for the shares of companies with a corporate governance reputation against those companies with the same level of financial performance but with a poor reputation for bad corporate governance (abdo & fisher 2007). socially responsible investment index there is a direct link between the concepts of corporate governance, corporate social responsibility and socially responsible investments. socially responsible investment is broadly described as an investment strategy that creates a balance between financial and social objectives (herringer, et al. 2009; statman 2006). heightened concerns regarding climate change and its associated risk to portfolios have escalated the interest in socially responsible investment among managers and stakeholders at large. various sri indices have been established around the world to allow investors to trade the shares of companies that are considered to be socially responsible. examples include the ftse4good, jse sri, domini-400 index and the dow jones sustainability group index (gladysek & chipeta 2012; statman 2006). these indices give assurance to investors and fund managers that the constituent companies have been screened, monitored and assessed according to objective environmental, social and governance criteria. the jse first implemented an sri index in may 2004. the main objectives were to distinguish companies that make an effort to deliver on the triple bottom line (economic, social and governance reporting), to provide a benchmark to compare socially responsible and non-socially responsible companies (gladysek & chipeta 2012) and to serve as an enabling conduit for responsible investment to those investors who wish to include non-financial risk variables in their investment decisions (jse limited 2014). for a jse-listed company to qualify for inclusion on the jse sri index, the company had to meet the criteria of the required number of indicators as set out in each individual area of measurement. the indicators are divided into the categories ‘core’, which is the bare minimum a company should adhere to, and ‘desirable’, which are more aspirational. the general criteria themes referred to in the index are environmental, societal and governance (esg) and related sustainability concerns. the criteria of the jse sri index have been influential to conventionalise sustainability for top south african companies across different sectors that have their own sector-specific challenges (profile’s stock exchange handbook, 2015). corporate social responsibility and financial performance the relationship between corporate governance and/or corporate social responsibility and financial performance has been extensively investigated in the past. researchers have also conducted meta-analyses on prior research to establish the general trend of previous findings (allouche & laroche 2005; boaventura et al. 2012; margolis & walsh 2003; orlitzky et al. 2003; pava & krausz 1996; revelli & viviani 2015; van beurden & gössling 2008). the main findings from the meta-analyses of over four decades’ research reveal a mostly positive relationship between corporate social responsibility and financial performance, with a lagged effect in financial performance, with a few exceptions. this is in line with stakeholder theory, claiming that all stakeholders should benefit socially and financially from corporate actions. a company has responsibilities towards many stakeholders, and shareholders represent one of the most important ones (ruf et al. 2001). to establish the tone of prior research on corporate governance or corporate social responsibility and financial performance, this study investigated a sample of more recent studies (since 2000) on the topic (see table 1). this gives the researcher an idea of the general direction regarding the relationship between corporate social responsibility and financial performance, as well as establishing the extent of research conducted in south africa specifically. note that this summary is by no means exhaustive. table 1: a summary of a selection of prior studies investigating the link between corporate social responsibility and financial performance (ordered chronologically). as table 1 shows, it appears that most previous studies were conducted in the united states of america (us), with only very few conducted in emerging economies. many studies investigated individual aspects of corporate governance or corporate social responsibility, with similar findings (bebchuk, cohen & ferrell 2008; bhagat & bolton 2008). the aim of this study is simply to investigate whether a jse sri index listing is a sufficient predictor of a company’s market and financial performance. research methods and design this study was developed to understand the practices of business operations, their management and the financial performance outcomes of companies. the focus is concentrated towards an investigation and comparison of the financial results of the companies included on the jse sri index against counterparts that are not included in the index. study design and data collection the intention of the study was to analyse and assess jse-listed companies over a period of five years from 2009 to 2014. the main reason for using 2009 as a base year was because the jse, through its listing requirements, made it compulsory for all listed companies to comply with king iii in 2009 (iodsa 2009). another reason for using 2009 as a base year is that it is subsequent to the 2008 global financial crisis. therefore, it is reasonable to expect that companies had started their recovery and would no longer fully reflect the negative consequences of the financial crisis. the ftse/jse responsible investment index series replaced the jse sri index in october 2015, reflecting an ongoing commitment to progress in corporate sustainability practices. the ftse/jse responsible investment index series considers a different set of requirements for companies to become a member; thus, it is not sensible to include data from 2015 onwards in this particular study. the sample was not restricted to any specific industry. the industries represented in the sample are widespread within the south african jse main board listings. therefore, companies that delisted at any given point in time during the period 2009–2014 were not included in the sample, as they are not representative of the criteria needed to be a constituent in the jse sri index. the dominant industries represented in the sample include basic materials, consumer goods, consumer services, financials, healthcare, industrials and telecommunications. previous researchers applied a variety of research approaches to find a relationship between corporate social responsibility or corporate governance performance and corporate financial performance. firstly, good corporate social responsibility or corporate governance practice must be defined. in this paper, it is considered that if a company is one of the constituents of the jse sri index, it can be deemed to have good corporate governance or corporate social responsibility practices, as these companies had to fulfil certain criteria in order to be included in the list for the year under review (nkomani 2013). these criteria cut across the triple bottom line: the environment, society and the economy, and governance. the unit of study comprises a total of 885 company-years, specifically 378 company-years categorised as constituents of the jse sri index from 2009 to 2014 and 506 non-sri-listed company-years for the same period. the original dataset was reduced by removing companies for which no information was available as a result of starting in a year after 2009 or delisting before 2015. in addition, to ensure comparability between the jse sri and non-sri-listed companies, all non-sri-listed companies with a market capitalisation of less than r1.3 billion were removed and all jse sri–listed companies with a market capitalisation of more than r7.0 trillion were removed. the sample was divided into two categories, namely sri-coded companies and non-sri-coded companies (respectively coded as 1 and 0 in the dataset). the dominant industries represented in the sample include basic materials, consumer goods, consumer services, financials, healthcare, industrials and telecommunications. the sample contains more non-sri-coded companies than sri-coded companies, which could add bias to the sample; however, all the non-sri-coded companies are representative of each of the industries of the jse, south africa. financial information for the selected companies was collected from the iress financial database. iress is a distinguished provider of fundamental stock market research data feeds and analysis tools covering market and corporate news for both the financial sector, as well as the market in general. for financial performance, data was collected for the accounting return on equity, the market-based stock returns and the accounting or market-based price-earnings ratio. meta-analysis of similar studies have indicated that these were ratios often used (allouche & laroche 2005; boaventura et al. 2012; margolis & walsh 2003; orlitzky et al. 2003; pava & krausz 1996; revelli & viviani 2015; van beurden & gössling 2008). in addition, these financial performance measures were selected firstly on the basis of how easy they are to understand and secondly for how easy investors or other interested parties can obtain them. tobin’s q is, for example, often used in similar studies but is unfamiliar to many investors and not easy to find in published financial information. market capitalisation was added as a control variable for size. table 2 presents the descriptive analysis of the values for the selected variables. table 2: descriptive statistics for the data set (n = 885). for purposes of the analysis, a log transformation was performed for the market capitalisation values (presented here in south african rand). in its currency format, the values are excessively large and will impact the model fit unfavourably. data analysis logistic regression does not make assumptions regarding the distribution of the scores of predictor variables, as is the case with multiple regression (pallant 2016). however, results can be sensitive to sample size, multicollinearity, the presence of outliers and lack of linearity of the logit for continuous variables (field 2013). to lessen the problem of sample size, the predictor variables in this study were limited to one accounting-based measure, one market-based measure, one accountingand market-based measure and one control variable for size. the dataset was tested for multicollinearity and the variance inflation factor and tolerance were found to be acceptable for all variables. linearity tests also showed that all variables were linearly related to the log of the outcome variable. as is normally the case with financial data, there were outliers for all the variables. therefore winsorising of 5% was applied to reduce the extreme values to lesser values (richardson et al. 2005). after these tests, binary logistic regression with bootstrapping, based on 1000 samples, was performed at a 95% confidence interval to examine whether there is a relationship between the financial performance of a company and its place on the jse sri index. to test whether a place on the jse sri index predicts better financial performance for a company, the logistic regression model was structured as follows: where πi is the probability that the dependent variable takes on a value of 1, xi represents the variables included in the regression, β represents the coefficients of the variables, β0 is an intercept parameter, roe represents the return on equity, pe represents the price–earnings ratio, stock_ret represents the stock returns and market_cap represents the market capitalisation of each company. results the aim of this research was to ascertain if there exist a relationship between the socially responsible investment practices and financial performance of south african companies, with particular reference to the companies listed on the jse. worldwide trends towards social, environmental and economic sustainability initiatives are on the increase. there are benefits and disadvantages to the implementation of socially responsible investments in a company, and one of the main concerns connects with the cost of implementation and its impact on the company’s financials. however, studies have indicated that those companies with higher corporate social responsibility scores enjoy a considerably lower cost of equity capital (el ghoul et al. 2011). in hindsight, it is of benefit to ascertain whether investment in socially responsible activities results in financial gains for a business. in this field of study, the greatest hindrance is to establish the most suitable internationally recognised measurement criteria. logistic regression was performed to assess the impact of accounting and market-based factors on the likelihood that a company would be listed on the jse sri index. the model contained four independent variables (return on equity, price–earnings ratio, stock return and market capitalisation). the full model containing all predictors was statistically significant, χ(4) = 201.39, p < 0.05, indicating that the model was able to distinguish between companies listed on the jse sri index and those that are not. the model as a whole explained between 27.3% (cox and snell r-squared) and 36.7% (nagelkerke r-squared) of the variance. an inspection of the individual predictors (as shown in table 2) revealed that only two of the variables made a significant contribution to the model, namely the stock return (beta = 0.994, p < 0.05) and market capitalisation (beta = 2.711, p < 0.05). the strongest predictor of a listing on the jse sri index was market capitalisation, with an odds ratio of 2.71. a comparatively larger company thus has a 2.71 better chance of being on the jse sri index than a smaller company. the odds ratio for stock return is close to 1, indicating that stock returns for both companies listed on the jse sri index and those not listed are nearly the same. the final logistic regression model correctly classified 75% of cases. the overall model is presented in table 3. table 3: coefficients of the model predicting the relationship between company financial performance and being listed on the johannesburg stock exchange socially responsible investment index. note than an analysis using market capitalisation without log transformation resulted in the same conclusion. the results reveal that size is the most likely predictor for a company to be considered for a listing on the jse sri index. from the studies considered in table 1, this finding only corresponds to the study by charlo et al. (2015), which was conducted in spain. the explanation for these results may be as simple as that smaller, financially unstable companies may find it difficult to invest in traditional corporate social responsibility activities, while larger companies in better financial standing have the economies of scale and resources to spend in ways that may have long-term strategic impacts. this highlights an issue of cost and cost structure and its impact on the extent of focusing on corporate societal matters. however, the results may also indicate a more far-reaching effect of corporate social responsibility on a company’s profile and thus its investment prospects. discussion and conclusion this study sought to investigate the relationship between the financial performance of jse-listed companies included in the sri index over the period 2009–2014, as compared to those companies that were not included as jse sri constituents. the study analysed the return on equity, price–earnings ratio and stock returns to reflect the companies’ financial performance and internal efficiency. the market capitalisation of each company is included for each year to account for any size effect. the findings of the study points to a definitive relationship between company size and a listing on the jse sri index, but no clear relationship between a listing on the jse sri index and accountingor market-related financial performance. the jse sri index criteria have been influential in a process to conventionalise sustainability for top south african companies across different sectors. in conclusion, the financial performance of a jse-listed company does not make a significant contribution towards determining its likelihood of being included in the jse sri index as a constituent in any financial year. this knowledge is of value to investors, business leaders, market analysts and company management, as it indicates how socially responsible investment and financial performance interact. according to the definition of stakeholder theory as per evan and freeman (1993), that ‘the real purpose of a company is to serve as a vehicle to coordinate the interests of [all] stakeholders’, it stands to reason that companies are perhaps not investing in socially responsible activities for the benefit of the wider society but rather because they have the financial means to do so (as a result of size) and can use it as a legitimisation strategy to improve their companies’ reputation. limitations and future research boaventura et al. (2012) highlight the fact that theoretical empirical studies on the affiliations between corporate financial performance and corporate social performance have encouraged an increasing trend over the years, which emphasises the need for continuous research in this field. the performance of companies has been at the forefront of interest areas among researchers (shah, haldar & nageswara rao 2015). future research in this area has the potential to bring advancements in a number of ways. there is still a significant gap in the literature surrounding socially responsible investment, the value it adds and creates, as well as the importance of its content and context, more specifically with reference to socially responsible investment. it is recommended that future studies focus on those aspects. it will also be to the benefit of investors and other interested parties to know whether good financial performance results in good corporate social responsibility practices or vice versa. the reliability and sustainability of socially responsible investment on the financial performance of jse-listed companies could also be researched and investigated. this recommendation has an impact on all stakeholders, with the emphasis on investors and business leaders, together with academics and novice researchers. the research was conducted on south african jse-listed companies. there are thus certain limitations in terms of the environment of the study. the environment conforms to the regulations of the country, which includes the performance of the economic market of south africa in relation to the rest of the world. expansion of the study to cover a larger period or conducting the study for individual periods and/or over various countries may deliver interesting results. a few further delimitations for the study, which can translate into future research areas, are as follows: there are other operational factors that may have an effect on a company’s corporate financial performance, regardless of corporate social responsibility, but these fall outside the scope of this investigation. some of the companies listed on the jse may have dual listings and may be linked to multinational companies. this could be an added advantage for those companies in terms of economic exposure and, therefore, financial performance. the base years fall into the period of recovery from the global financial crisis (2007–2010). therefore, comparison of financial performance has a lower base year and could misrepresent the magnitude of improvement in financial performance. the ratios used in the study have their own limitations and constraints. they could hamper the findings of the overall study if looked at in isolation. the study did not focus on the position of the industry life cycle, although other scholars indicated that extrinsic factors such as the growth of an industry positively regulate correlations between environmental and economic performance (surroca, tribó & waddock 2010). acknowledgements the authors would like to thank dr véronique blum and two anonymous reviewers for their invaluable input in improving this article. competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions e.d.t. was the project leader, made contributions to the literature review and conducted the statistical analyses. k.l. was responsible for the majority of the literature review and collection of data for analysis. references abdallah, a.a.-n. & ismail, a.k., 2017, ‘corporate governance practices, ownership structure, and corporate performance in the gcc countries’, journal of international financial markets, institutions and money 46(2017), 98–115. https://doi.org/10.1016/j.intfin.2016.08.004 abdo, a. & fisher, g., 2007, ‘the impact of reported corporate governance disclosure on the financial performance of companies listed on the jse’, 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measured by calculating nine sufficiency and efficiency ratios. these ratios were calculated for each institution in the industry; weighted averages were also calculated for each industry. the results were compared with the norms developed for american institutions. all the listed south african companies in the industries concerned were included in the study. jel m 41 1 introduction this study was undertaken to establish whether the cash flow statement succeeds in increasing the usefulness of financial information to decision-makers interested in the results of specific companies and other types of institutions. ratios are used in the analysis of financial statements. with the addition of the cash flow statement to other financial statements, a need arose for calculating ratios which would serve to evaluate the results indicated by the cash flow statement. at present there is no complete series of ratios with which to evaluate cash flow statements. the primary goal of financial reporting, according to ac 000 (opperman, 1994), is to establish useful financial information for economic decision-making. according to ac 101 (cilliers, 1995:535), one purpose of the cash flow statement is to supply r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 129 information on the cash flow of an institution. this information would be helpful to the users of financial statement as a basis upon which to form an opinion on the institution's ability to generate cash and cash equivalents, as well as the cash flow needs of the institution. economic decisions taken by users of financial statements require an evaluation of the ability of an enterprise to generate cash and cash equivalents, the timing thereof and the probability that it will in fact be generated (cilliers, 1995:535). an advantage of the cash flow statement, when used together with the rest of the financial statements, is that it supplies information which enables users to evaluate the cash effect of changes in the net assets of an institution, as well as its financial structure (including liquidity and solvency). the cash flow statement also enables users to evaluate the institution's ability to influence the amount and timing of the cash flow, in order to adapt to changing circumstances and opportunities. the cash flow information enables users to develop models to assess and compare the current value of the future cash flows of different institutions. it also facilitates the comparison of sectoral performance, since it eliminates the effect of different accounting conventions on the same transactions and events. historical cash flow information is also used to indicate the amount, timing and certainty of future cash flow. it is moreover useful for checking the accuracy of previous calculations, the relationship between profitability and net cash flow, and the effect of changing prices (cilliers, 1995:536). independent performance ratios are of limited use. however, when the ratios of one institution are compared with those of others over a number of years, then they become more meaningful (giacomino & mielke, 1988:56). one of the goals of this study is to determine whether the potential exists for developing ratios for industries, in terms of which the relative performance of institutions may be measured. an empirical study was made of institutions in the chemicals and oils, food and electronic industries, from 1994 to 1996. nine ratios for assessing relative performance were calculated for each institution in the industry, which could be compared with a set of norms developed for this purpose. all the institutions in the particular industry were included in an empirical study to evaluate relative performance. (table 2 sets out the number of institutions used for the calculation of performance ratios.) relative performance evaluation is one of the uses of cash flow ratios, which evaluate the sufficiency and efficiency of the cash flow. sufficiency means the ability of an institution to provide for its requirements of cash, and efficiency r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 130 sajems ns vol 2 (1999) no i means the extent to which cash is generated over time and relative to other institutions (giacomino & mielke, 1988:55) 2 the use of ratios analysts use ratios, inter alia, to evaluate the cash effects of changes in the net assets, financial structure (including liquidity and solvency), and relative performance of an institution. relative performance evaluation proceeds from the assumption that with the comparison of an institution's performance to a norm, general uncertainties are eliminated and only specific performance with regard to the institution remains. the performance of other institutions then provides information regarding a specific institution's performance (giacornino & mielke, 1993:55). 3 cash flow ratios in the cash flow statement, the cash flow from operating activities is a summary of the transactions and events involved in the determination of net income. operating activities are the primary activities of an institution. cash flow from operating activities is a component of each ratio used to evaluate relative performance. in this study norms were calculated for each ratio based on the cash flow. this was done by expressing the industry ratios as weighted averages over the three year period 1994-1996. the components and interpretation of the ratios are summarised in table 1. table 1: summary of ratios name of ratio components of ratios interpretation of ratios sufficiency ratios cash flow cash from operating evaluates an institutions sufficiency activitiesl ( long-term debt ability to generate sufficient repayments + purchasing cash to meet primary of assets + dividends paid) obligations long-term debt long-term debt repayment evaluates the sufficiency of repayment i cash from operating cash flow to settle long-term activities debt r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 131 table 1 continued name of ratio components of ratios interpretation of ratios sufficiency ratios dividend pay-out dividends paid / cash evaluates the sufficiency of from operating activities cash flow to pay dividends reinvestment purchasing of assets / cash evaluates the sufficiency of from operating activities cash flow for reinvestment and maintaining the asset structure debt cover total debt / cash from estimates the number of operating activities years to repay debt at the current level of cash flow impact of (depreciation + amounts evaluates the percentage depreciation written off) / cash from cash from operating write-offs operating activities activities due to adjustments and amounts written off efficiency ratios cash flow to cash from operating indicates the percentage of sales activities / sales each one rand-sale from operating activities which is realised as cash flow operating index cash from operating compares cash flow from activities / income from operating activities with continued activities income from continued activities cash flow on cash flow from operating evaluates the cash flow from assets activities / total assets assets utilised the sufficiency and efficiency ratios in table 1 are examples of the kind of information which is available from the cash flow statement to the users of financial statements. in table 1 cash from operating activities is measured before dividends. for the purchase of assets, the gross acquisition of assets is used in the calculation of the ratio. depreciation and other sums written off include losses on the sale of assets and other sums written off on assets r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 132 sajems ns vol 2 (1999) no 1 table 2: numver ofinstitutions in industry year chemicals and oils food electronic 1996 11 27 34 1995 10 25 31 1994 8 23 27 according to table 2, the companies in the industries which were analysed differed from year to year. the reason for this is that some excising companies were delisted while new companies came to be listed on the johannesburg stock exchange. the weighed averages over three years were taken as the norms for the ratios of an industrial sector. 4 empirical results the chemicals and oils, food and electronic industries were used in the present study, since these are the same as the industries used by giacornino and mielke (1993:55-8) in a study in the usa. in table 3, the 3-year weighted average (used as the norm) is set out for each industry. table 3 gives the norms for the ratios of the industries concerned. the ratios of individual institutions based on their respective norms may be used, to evaluate their respective performances. table 3: norms for ratios per industry ratio three-year averages 1994· 1996 chemicals food electronics and oils sufficiency ratios cash flow sufficiency 1,85 1,49 1,94 long-term debt repayment 0,88 0,60 0,24 dividend pay-outs 0,09 0,14 0,16 reinvestment 0,51 0,50 0,42 debt cover 2,52 3,27 3,18 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol2 (1999) no 1 133 table 3 continued ratio ~ th ..... y •• r .mag" 1994 19% micals food i electronics oils sufficiency ratios impact of depreciation 0,22 0,23 i 0,18 write-offs efficiency ratios cash flow to sales 0,17 ! 0,09 i 0,08 operating index 0,95 0,89 u,o..) cash flow on assets v,21 0,17 i 0,18 5 data analysis an analysis was made of the data obtained from the bureau for financial analysis (bf a) at the university of pretoria. each ratio was analysed over three years, to determine whether there had been an increase and/or a decrease from year to year. individual institutions in an industry were evaluated by comparing their performance with the norm for each ratio. an institution cannot be evaluated by only looking at isolated ratios. a comparison with other institutions, the averages of the industry concerned, institutions from other industries and the relevant norms are however more informative (giacomino & mielke, 1988:56). relative performance evaluation proceeds from the assumption that when an institution's performance is compared with that of an industry or a norm, this eliminates the effect of general uncertainties in performance and only leaves specific performance of the institution (giacomino& mielke, 1993:55). the results are discussed next. 5.1 cash flow sufficiency ratio the cash flow sufficiency ratio indicates the adequacy of an institution's cash flow from operating activities to cover its long-term payments, purchase of assets and payments of dividends. giacomino and mielke (1993, 56) consider a ratio of one as a reasonable target. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 134 sajems ns vol 2 (1999) no 1 an analysis of the cash flow sufficiency nonns in table 3 indicates that the industries had indeed generated enough cash to cover their primary cash requirements. in all cases the nonn for the industries is more than one. after the analysis of the cash flow sufficiency ratios of individual institutions, the following conclusion was derived: in the chemicals and oils industry, four institutions in 1996, one in 1995 and two in 1994 did not have sufficient cash flow from operating activities to cover primary cash flow obligations. likewise in the food industry seven institutions in 1996, ten in 1995 and nine in 1994 did not have sufficient cash flow. in the electronics industry ten institutions in 1996 and 1995 and four in 1994 did not meet this requirement. in 1996 four institutions in the chemicals and oils industry, fourteen in the food industry and fifteen in the electronics industry had a cash flow ratio higher that that of the industry for three years. the average over three years for chemicals and oils, food and electronics, was 1,85; 1,49 and 1,94 respectively. if these figures are taken as the nonn, analysts may measure an individual institution's perfonnance on the basis of the nonns of the industry in question, and also those of other industries. causes of significant differences may have to be sought. in the event, the long-tenn debt repayment, dividend pay-out and reinvestment ratios may possibly be used. the latter ratios are components of the cash flow sufficiency ratio, and may thus indicate the causes of the observed differences. 5.2 other ratios which relate to cash flow sufficiency in table 3, an analysis of the long-tenn debt repayment, dividend pay-out and reinvestment ratios per industry indicates, with one exception, that there were hot more pay-outs than the cash flow from operating activities. the average of the chemicals and oils industry in 1994, indicates that the repayment of long-tenn debt was more than the cash flow from operating activities. the long-tenn debt repayment, dividend pay-out and reinvestment ratios, each represent a component of the denominator in the cash flow sufficiency ratio. the ratios per industry (table 3) are discussed in paragraphs 5.2.1 to 5.2.3. a summary is given in paragraph 5.2.4. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 135 5.2.1 industry: chemicals and oils in the chemicals and oils industry, the average of the three ratios decreased over the three years. there was a decrease of23,5% in long-term repayment of debt, 66,7% decrease in the payment of dividends and 33,8% decrease in reinvestment, in relation to cash flow from operating activities. in 1996 there were two institutions, and in 1995 and 1994 one institution, that repaid more long-term debt than what the cash flow from operating activities had been. no institution paid more dividends than their cash flow from operating activities. two institutions in 1996 and 1994 and one in 1995, reinvested more than their cash flow. these appeared to be the same institutions as those which repaid their long-term debt. the ratios of the individual institutions in 1996 indicate that three institutions' repayment of long-term debt, and six institutions' dividend pay-out and reinvestment ratio were higher than the corresponding norms. 5.2.2 industry: foad the food industry appears to show the same tendency as chemicals and oils, although the percentage decreases were less for the three years. the decrease in repayment of long-term debt was 9,6%, dividend pay-out 29% and reinvestment 21,7%. six institutions in 1996, six in 1995 and five in 1994, had more repayments of long-term debt than their cash flow from operations. in other words, these institutions had a negative cash flow. six institutions in 1995, four in 1996, and three in 1994 reinvested more than the cash flow from operating activities a comparison of the institutions in 1996 with the norm of the industry in table 3, indicates that seven institutions' repayment of long-term debt, and thirteen institutions' payments of dividends and reinvestment were higher either than or equivalent to the norm . 5.2.3 industry: electronics in the electronics industry there appears to have been a decrease in the repayment of long-term debt and payments of dividends of 9,6% and 29% respectively. reinvestment increased by 70% in 1995 and decreased by 19,6% in 1996, where the global increase was 36,7%. three institutions in 1996, four in 1995 and one in r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 136 sajems ns vol 2 (1999) no 1 1994 had more repayments of long-term debt than cash flow from operating activities. of these institutions, one had been present for three years. the same three institutions were present in 1996 and 1995, of which one institution had existed for only two years. three institutions had made more dividend payments than their cash flow over the three-year period. two of the institutions had a negative cash flow and one institution had existed for only one year. five institutions in 1996 and four in 1995 had increased their reinvestment in assets. two of the companies had a negative cash flow. the long-term repayment of debt, dividend pay-out and reinvestment ratios of the various institutions in the three industries, were compared with the respective norms in table 3. the comparison indicated that eight firms in chemicals and oils, seventeen in food and ten in electronics had specific ratios higher than or equal to the industry norms. 5.2.4 evaluation of the industries an analysis of the industrial average used as the norm (table 3), shows that chemicals and oils, and food spent the greatest portion of their cash flow from operating activities on the repayment of long-term debt. electronics spent most of its cash flow on reinvestment. in all three industries, the smallest portion was paid out in dividends. it appears that over the three-year period, a total of five institutions made more dividend payments than their cash flow from operating activities. in 1996, one institution had existed for only one year, and four institutions had a negative cash flow. the norm for dividend payments of varies from 9% to 16% for the three industries. a possible conclusion with regard to the decrease in dividend payments may be that institutions tend to distribute less profits. this appears to be the case in all three industries. enlightened conclusions may be drawn from the three ratios. if norms are established for industries, the performance of institutions may be assessed on the basis thereof. a specific ratio for an institution may be compared with the average for the industry in a given year, or with the averages of other institutions in the industry for one, two or three years. the long-term debt repayment, dividend pay-out and reinvestment ratios provide insight into the individual significance of these three items. the three ratios may r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no i 137 be expressed as percentages and added together. this indicates the percentage cash flow from operating activities which is available for discretionary use. if the analysis is done on the basis of the norms in table 3, only the electronics industry has any remaining cash flow from operating activities for discretionary use. this may also serve as a norm to which institutions in the industries may be compared. 5.3 long term debt repayment ratio although an institution may generate cash from investment and financing activities to repay debt, cash flow from operating activities is the main source of long-term funds. the repayment of debt ratios for the three industries in table 3 were reasonably constant over time. an increase in the repayment of debt ratio may indicate a decrease in the repayment of long-term debt and an increase in debt. both food and electronics experienced a decrease in repayments of long-term debt. a comparison of the institutions in the industry with the norm, indicated that the ratios of six institutions from chemicals and oils and food, and fifteen from electronics were below the norm. the denominators of three institutions were negative, indicating that they had negative debt, and were not included in this calculation. 5.4 impact of depreciation write-off ratio the impact of the depreciation write-off ratio indicates the percentage of cash flow from operating activities which arises from the adding back of depreciation, adjustments and other write-offs. the three-year average ratios in table 3 were in fact relatively constant. this may indicate that the industries have the capacity to maintain asset structures. over the period 1994-1996 there was only one institution from the food industry and three from electronics, where the impact of the depreciation write-off ratio was more than the cash flow from operating activities. a comparison of the institutions in 1996 with the norm in table 3, indicates that the ratio of six institutions in the chemicals and oils, eight institutions in the food and fourteen institutions in the electronic industry was greater than or equivalent to the norm. three institutions had a negative denominator and were excluded from the calculation. the reinvestment ratio may be used to determine whether reinvestment occurs at a higher or lower level than the writing-offldepreciation of assets (giacomino & r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 138 sajems ns vol 2 (1999) no 1 mielke, 1993:57). a comparison of the impact of the write-off ratio on the reinvestment ratio provides insight into the sufficiency of an institution's reinvestment and the maintenance of its asset structure. over a number of years the reinvestment ratio should exceed the impact of the depreciation/write-off ratio. this would ensure that there is adequate replacement of assets at current increased costs. in the three industries, it does in fact appear from table 3 that the asset structure has been either maintained or increased. the ratio may also be used to evaluate efficiency. an institution would be considered the more efficient if its write-off ratio has a relatively low impact on the cash flow from operating activities. 5.5 cash flow to sales ratio the cash flow to sales ratio is an efficiency ratio. it indicates the percentage of each rand's worth of sales which has been realised as cash flow from operating activity. over a period, the ratio should indicate an institution's return on sales (giacomino & mielke, 1993:56). when the norms of cash flow to sales ratio of the industries are compared with each other, some meaningful conclusions may be drawn. according to giacomino and mielke (1993: 58) the food industry had a lower earnings on sales than chemicals and oils, and electronics. if the food industry is compared with chemicals and oils, in table 3, this is in fact the case. when comparing the food and electronics industry, it does not appear to be the case. the electronics industry, on the other hand, shows a lower cash flow to sales than food, and chemicals and oils. the industry's norm was used to evaluate the individual institutions. in 1996 it appears that the cash flow to sales of four institutions in chemicals and oils, sixteen in the food and nineteen in the electronics industry, was better than the norm for the different industries. 5.6 operating index ratio the operating index ratio compares the cash flow from operating activities with the income from continued operations. the ratio measures the capacity to generate cash from continued operating activities. the ratio is also useful when it is compared with income from continued operations. it shows the extent to which non-cash transactions are involved in the calculation of operating income. over a number of years it may be expected that cash flow from continued operating r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 139 activities should be more or less equal to income from continued operations. the operating index ratio makes such comparison possible (giacomino & mielke, 1993:58). when the institutions comprising an industry are measured against the industrial norm in table 3, there are to be only 18 cases over 3 years where the cash flow from operating activities was equal to or more than the norm for income from continued operations. if the figures for 1993 are also taken into account, the two variables over an average of four years are still not equal to each other. according to table 3, the norm for chemicals and oils (0,95) is the highest, compared to food (0,89) and electronics (0,85). it appears that the ratio for all the industries has declined during 1994-1996. only electronics showed an increase in 1995. individual institutions may also be compared with the norm, as well as the industry trend. the trend appears to be decreasing over the three years. as in the previous discussions, individual institutions may be measured against the industrial norm. 5.7 cash flow on assets ratio the cash flow on assets ratio measures the return on the assets used. it is used to compare institutions in terms of the cash generated from assets (as against the income produced) (giacomino & mielke, 1993:56). when cash flow from operating activities is compared with total assets, it appears that there was a reasonably constant return on assets per industry over the three years. according to table 3, there was an increase in the norm of 0,01 in chemicals and oils in 1995. food decreased in 1996 by 0,01. electronics increased by 0,01 in 1995 and decreased by 0,03 in 1996. this 3% decrease might be ascribed to the increase in reinvestment in 1995 (giacomino & mielke, 1993:58) when a comparison is made of institutions with the industrial norm in 1996, it appears that six institutions in chemicals and oils, sixteen in food and twenty in electronics had a cash flow return on assets equal to or more than the industrial norm. 6 comments no specific institution was analysed in this study; analysis was done in general. firstly the norms of the industries were compared with each other to determine r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 140 sajems ns vol 2 (1999) no 1 evident tendencies. for example: it appears that the dividend payment norm relative to cash flow may be low in all the industries. it also appears that repayment of long-term debt was significantly higher in the chemicals and oils industry than in the electronic industry. the debt cover ratio in food appears to be the highest of the three industries. electronics again appears to be the only industry which had any cash flow left for discretionary use. in the efficiency ratios there are remarkable differences in cash flow to sales. it is significantly higher in chemicals and oils than food and electronics, for all three years. the next step was to compare the institutions in an industry with the norm. the question of how many institutions fared better, the same or worse than the norm, was also considered. to evaluate performance, an institution should not just be evaluated against one norm, but against a series of norms (for ratios) and also other institutions. if the cash flow sufficiency ratio of one institution is higher than the norm of other institutions, it does not necessary follow that the first-mentioned institution's financial performance has been the best. a reason for this might be that long-term repayment and reinvestment was comparatively low. a low reinvestment ratio could indicate that an institution does not replace or increase assets. if an institution has to maintain or increase an assets structure, the reinvestment ratio must exceed the depreciation write-off ratio for some years. the cash flow return on the assets of an institution, on the other hand, may be lower than the norm and that of other institutions. a possible cause of this may be that reinvestment has increased. giacomino and mielke (1993:58) suggest that in cases where norms of industries differ significantly, cut-off values for industries should be established. for all other ratios, it is suggested that inter-industry averages be developed. conclusions in this study, nine ratios based on cash flows were used to evaluate relative performance on the basis of sufficiency and efficiency ratios. these ratios furnish additional information (over and above the traditional financial ratios) about the ratio between cash flow from operating activities and other significant industrial variables. the ratios become more useful in the determination of averages and tendencies when they are calculated over a period of years, and particularly when they are compared with industrial norms. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no i 141 several comparisons were made in this study. ratios for the institutions in an industry were compared with the norm for the industry. the users of financial statements may supplement the data obtained from traditional analysis of these statements, by using information derived from the cash flow statement. cash flow ratios may, inter alia, be used to evaluate the financial performance of institutions in terms of financial strength and profitability. sufficiency ratios measure the ability of an institution to comply with its obligations. efficiency ratios for a given year, may be used to determine whether an institution has generated enough cash in relation to other years and to other institutions. the ratios in this study were calculated from operating activities. this is the primary activity of an institution, and in difficult economic times it is cash flow in particular, rather than operating profit, that determines the viability of an institution. up to now very little has been done to develop an extensive set of ratios which measures financial performance. it has been suggested, inter alia, by giacomino and mielke (1993), that cash flow ratios should serve as a starting point for the development of ratios which are based on cash flow and furnish a basis for general analysis. currently there is little agreement on precisely which ratios represent the most applicable measures. time and experimentation with several alternatives should determine which ratios give the best quality of information in the cash flow statement. this study used the same industries in south africa as the analysis by giacomino en mielke (1993) in the united states of america. based on the evaluation of the food industry in the last-mentioned study, luchau and ross (1994) made a comparative study of the australian food industry. a south african industry might also come to form part of a similar analysis. the present study supplies information on the potential value of ratios based on cash flow. seemingly unlimited scope exists for further research, such as: • the development of a framework for financial analysis by ratios, which identifies the usefulness/suitability of individual ratios and selects applicable ratios for economic decision-making; • the development of an extensive series of cash flow ratios which evaluates financial strength and profitability in conjunction with traditional ratios; • the development of norms for industries, in terms of which the institutions in an industry may be compared; r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 142 sajems ns vol 2 (1999) no 1 • the development of cut-off values for industries where norms significantly differ between the industries; and • the development of inter-industry averages where the norms of the industries are relatively similar. although the cash flow statement focuses mainly on the capacity of an institution to generate positive cash flow from normal operations, it does not provide a complete assessment of the liquidity and viability of an institution. this must be supplemented by other aspects in the financial statements, to furnish a more complete assessment of the ability of a company to generate and use cash. endnote based on an mcom (accounting sciences) dissertation completed at the university of pretoria. information from the data bank of the bureau for financial analysis was extensively used for this study. references 1. opperman, h.r.b. et al. (1994), rekeningkundige standpunte en riglyne. kenwyn: juta. 2. cilliers, h.s. et al. (1995), maatskappy finansiele state in konteks. durban: butterworths. 3. giacomino, d.e. and mielke, d.e. (1988), "using the statement of cash flows to analyse corporate performance", management accounting, pp. 5457. 4. giacomino, d.e. and mielke, d.e. (1993), "cash flows: another approach to ratio analysis", journal of accountancy, march, pp. 55-58. 5. juchau, r. and ross, p. (1994), "putting cash into ratios", australian accountant, november, pp. 29-31. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems vol 7 no 2 (2004) 221 business plans in bank decision-making when financing new ventures in south africa ________________________________________________________________ marius pretorius and gordon shaw chair in entrepreneurship, university of pretoria ________________________________________________________________ abstract this article focuses on the position that south african commercial banks adopt when evaluating an application for finance of new business ventures. the role and importance of the business plan in the decision-making process is highlighted and investigated. this article begins to qualitatively describe the decision-making processes, criteria and processes instituted by the four major south african commercial banks that between them serve 96 per cent of the banking services for small business. it then questions the barriers placed on applicants applying for finance and recommends how these barriers can be removed. the article concludes that banks finance business ventures with poor potential for success if the applicant is creditworthy or has the necessary security rather than assist applicants with good plans and ventures with potential, but lacking sufficient security. jel g21 1 introduction pretorius and van vuuren (2003) state that in south africa, as in many other countries, the national strategy for the development and promotion of small business identifies small business development and the empowerment of entrepreneurs as the most important avenue for economic growth. gorman, hanlon and king (1997: 56) confirm that there is widespread recognition that entrepreneurship is the engine that drives the economy of most nations. timmons (1999: 4) also refers to entrepreneurship as america’s secret weapon and argues its value as the main contributor to the superior position that the usa holds as part of the global economy. he suggests entrepreneurship to be the fundamental difference in the american culture where 37 per cent of the population is somehow involved in their own ventures apart from their regular jobs. sajems vol 7 no 2 (2004) 222 in south africa, however, each year brings with it a rush of school and university graduates wanting to enter the job market. this in itself would not pose a problem in a first world country, but in south africa with its high unemployment figure of over 5.525 million people (representing approximately 29.5 per cent of the labour market), it only adds queues at the employment offices (statssa, 2001). the problem is highlighted when the numbers entering the job market are estimated to be in excess of 462,000 potential entrants per annum (department of education, 2002). the roughly estimated figure of more than 100 000 jobs being lost annually does not improve the situation at all. when one considers the options open to these unemployed people, entrepreneurship will not only offer employment but will create much needed downstream jobs. the south african government recognised the dilemma of financing small ventures and as such has implemented a strategy for the development and promotion of smmes (small, medium and micro enterprises) in south africa in february 1995 under the umbrella of the department of trade and industry. from the national small business act 102 of 1996 it appears that the government is clear in its intention of creating small ventures and thereby assisting with the creation of jobs (bsa, 1996). the thinking is that the only way more jobs can be created is by establishing new businesses and this is where the problem links to financing. finance is needed in the establishment of new businesses, and the entrepreneur or business owner finds difficulty in obtaining the necessary finance. in many cases, lack of finance is cited as a reason for business failure and non start-up. in south africa, lack of financial support is the second most reported contributor to startup failure, after education and training (orford, wood, fisher, herrington & segal, 2003: 17). nieuwenhuizen (1999: ii) reports in a comprehensive study the criteria to be used for financing of small industrialists. these include seven success factors associated with the personal characteristics of the individual (perseverance, commitment to and involvement in the enterprise, willingness to take risk, sound human relations, creativity and innovation, and a positive attitude and approach) and ten factors that relate to functional management skills (planning of the enterprise, knowledge and skills relating to the enterprise, the use of experts, client service, knowledge of competitors, market orientation, concern for high quality work, bookkeeping for own benefit, financial insight and financial management). of these 17 success factors financiers use only eight for sajems vol 7 no 2 (2004) 223 evaluation in general. it may rightly be asked why financiers use so few of these key success factors? when talking to entrepreneurs, much debate occurs about credit applications accompanied by business plans that are submitted to banks and financial institutions for financing. few, however, are perceived as successful. the question can rightly be asked …why? it is therefore the intention of this article to explore the reasons why and determine the problems experienced by applicants when applying for finance with commercial banks. 2 purpose of the article obtaining finance for the start-up of new ventures has proved to be crucial for smme growth and is therefore the prime concern of this article. lack of finance is also generally accepted as the key stumbling block for business startups. this article specifically investigates the role of the business plan as a means to obtain finance from the commercial banks. foxcroft, wood, kew, herrington and segal (2002: 41) state that banks are less likely to grant loans than to offer credit via credit cards or overdraft. only one quarter of applications for bank loans were reported successful in south africa. shaw (2002: 1) confirms this by reporting that the deputy minister of trade and industry (dti), in his 2002 annual report, asked two very important questions: what steps can be taken to fill the gap caused by the aversion of the formal banking sector to lending in the smme sector? related to this, what can be done to change the attitude of banks in south africa? these questions highlight the ongoing debate relevant to the financing of smme’s. development, small business growth, elimination of unemployment etc. are all relevant issues when smme financing is discussed. this article investigates the importance of producing a business plan when applying for finance from commercial banks as suggested by berry, von blottnitz, cassim, kesper, rajaratnam and van seventer (2002). it is propositioned that banks as financiers look at several different aspects before awarding the finance. the intention is mainly to determine what these aspects are and whether there is a difference between the requirements of the different banking institutions within south africa. sajems vol 7 no 2 (2004) 224 all banks require a business plan to accompany applications. when evaluating a business plan, the investor or banking institution will always consider risk as a prime factor, together with management skills and expertise relating to the type of business or venture before committing any funds (shaw, 2002: 36). the main contribution of the article is the identification of what really determines the success of the applicants when applying for bank funding. limited empirical research findings are available on the subject, as it is fairly specific to south africa. a secondary benefit is that the findings clarify the role of the business plan in the decision-making criteria of commercial banks. the reason for this is that the banks are accused of discrimination against small businesses and disadvantaged entrepreneurs (foxcroft et al., 2002: 40). another contribution of the findings is that it gives guidance to applicants when they submit business plans, especially about the information critical to the decision-making process of the banks and thereby enhancing the success rate of applications. additionally the findings could lead to: time saving – by correctly completing the bank’s application documents in detail and having supporting documentation on hand when requested. improved communication and understanding of the full requirements of the bank when applying for finance. more applications – the banks would spend less time requesting additional information and therefore have more time to source more deals. 3 literature 3.1 business plans – basic notes throughout the business and academic world, a successful business plan is perceived as the most essential document to be prepared by the entrepreneur or small venture owner when setting up a business. although many will regard a business plan as a waste of time and money, one must take cognisance of the fact that many of the top 500 united states companies have business plans. hisrich and peters (1998: 227) encourage entrepreneurs and small business owners to draw up such a document, as it describes all the relevant external and internal elements involved in starting-up a new business. while a business plan is often obsolete as soon as it is printed, it is an important tool for the entrepreneur as well as the potential financier (timmons, 1999: 368). sajems vol 7 no 2 (2004) 225 entrepreneurs and small business owners are encouraged to prepare a business plan for presentation to banks, financial institutions and venture capitalists to stand a chance of obtaining financial support. timmons (1999: 368) states the importance of the plan to prospective investors and how they can use it to begin their due diligence. timmons further postulates that even when negotiations are in an advanced stage, collisions between entrepreneurs and banks occur. the business plan is then used as the guideline for action. the business plan is an essential document to be used in setting codes and business relationships between the parties. hisrich and peters (1998: 225) refer to the business plan as the single most important document when applying for finance at the start-up stage. this article only identifies the most suitable elements of a business plan and describes the relevant elements as required by the banks before granting finance. for this article, only the basic issues relevant to business plans are listed, as it is not the article’s main focus. the literature on business plans show that the main headings to be included in a business plan should cover at least the following: executive summary, a business description, a marketing plan, a management plan, a financial plan, a manufacturing and operating plan, critical risks description and a future growth and contingency plan (shaw, 2003: 5). 3.2 south african financial institutions driver, wood, segal, and herrington (2001) report that south african financial institutions have a history of dealing mainly with large corporations that undertake large projects. their management skills in handling small businesses were not properly developed as they focused on large businesses with sufficient resources. they also state “fund managers have to show a good return on capital invested” and therefore focus on their own goals rather than that of the entrepreneur. there’s a lot of pressure because of that, especially as they are employees of large organisations and they get remunerated as employees. there is often not enough incentive for them to take the risk with a potentially high upside, because at the same time there could be a personal cost for them if they make the wrong investment decision. as a result, the situation moves the financier/investor to be more concerned with the downside risk while entrepreneurs tend to focus more on the upside risk (potential), and at that point the entrepreneurs and financiers miss each other. driver et al. (2001) further postulates that banks don’t support ventures through a process and would rather lend r200 million to one customer than lend r50 000 to 25 000 customers because it is messy, costly and involves too much paperwork for the banks. sajems vol 7 no 2 (2004) 226 khula (as a dti extension) has initiated, since its establishment in 1996, a number of loan schemes to increase access to finance for smmes through retail financial intermediaries (rfis), which are also smme departments of commercial banks or accredited non government organisations (ngos). rfi’s apply their own minimum lending criteria (the most basic is the provision of a business plan). 3.3 the south african commercial banking sector according to okeahalam (2001: 9), the four larger banks govern 96 per cent of the small business market segment. the market share distribution of banks in the small business sector is shown in table 1. table 1 banking services for small business market shares of major banks (okeahalam, 2001) bank absa standard bank first national bank nedcor other banks market share (%) 27 33 19 17 4 it is hypothesised that the practices of the four major banks will determine the practices for the whole sector and therefore the research is focused on their requirements. 4 problem statement and propositions entrepreneurs and small business owners who apply for funding are expressing reservations about the availability of finance. the views of the financial institutions are that funds are available but no viable business projects are forthcoming. initial exploratory investigation, however, indicated that access to finance (start-up and expansion) is the most cited reason for business non startup and failure. what causes concern is the apparent lack of common perception between the parties. initial pre-investigation discussions (informal) with financial institutions and entrepreneurs indicated that financiers are not willing to take any risk, however minimal, in funding small business and this triggered the investigation. the findings of driver et al. (2001: 44) confirm that financial institutions are not able to interact effectively with entrepreneurs, thus supporting this statement. this statement also underlines the importance of the investigation. sajems vol 7 no 2 (2004) 227 the problem is therefore to establish the extent of the discrepancy between the financier and the entrepreneurial view on access to finance and the role of the business plan in accessing such finance from banks. this article is limited to the four major banks, their procedures and how it could affect potential decisionmaking. 4.1 propositions to lead the thinking process to investigate the problem as stated above the following propositions were set to govern the thinking during the investigation: p 1 banks have clear guidelines for evaluating an application. if the banks have proper guidelines in place, it is important to understand whether their procedures are not inhibiting successful application and therefore the second proposition is set as: p 2 bank application procedures for financing of business ventures are simple to comply with. whether the procedures laid down by the banks are simple to comply with or not, it is important to understand the role of the business venture’s potential (as described in the business plan) in their assessment and therefore the third proposition is set as: p 3 the guidelines for selection of a venture for financing are dominated by its potential as described in the business plan. if the business potential is not dominant in the assessment, it is important to understand the role of other factors such as creditworthiness in the success of the application and therefore the fourth proposition is set as: p 4 creditworthiness is the dominant factor in the decision of financing a business. 5 research methodology a cross sectional, in-depth qualitative investigation was applied to the four major banks (one investigation per bank at head office). with the recent centralisation within the banks, the investigations were done at the different head offices where credit-granting decisions are mostly taken with a standardised process. a structured questionnaire as described by shaw (2002: 45) was designed to investigate the salient points during interviews with senior and junior credit managers (at least two per bank) of the four major banks. it was based on the literature on business plan elements to guide the interviewer to sajems vol 7 no 2 (2004) 228 note the different perceptions, priorities and importance attached to the different issues. after completion of the investigation and based on the different responses, the interviewees were personally questioned (with open ended questions) to gain indepth knowledge of their perceptions about the relevant issues within their specific bank policies. secondly, all applications for finance documents (also those for internal use by the individual banks only) were collected from them and scrutinised and evaluated for length, focus and the degree of difficulty to complete these forms. finally, the researcher observed and noted certain reactions of the officials during the interview and has made reference to these potential issues in the findings. observations included anything not obvious, variations and contradictions in answers, personal opinions and salient issues underlying the statements of the interviewees. the collected information was categorised firstly for objective versus subjective rating of the criteria used by the bank. criteria that could be measured (ratios and values) were rated as objective and those where opinion or judgment was the main contribution to the decision was rated as subjective (see also table 3). secondly each criterion was rated for its focus on either creditworthiness or potential as shown by the business plan. each criterion was further rated based on the apparent importance granted to it by the interviewee namely: mentioned as playing a role (m), focused on strictly by the specific bank (f) or assumed as playing a role too (a). 6 findings the banks investigated were nedbank, absa, standard bank and first national bank, but are referred to as a, b, c, and d (no order) in this article, as confidentiality was promised prior to the investigation to get the different bank personnel to agree to the interviews and investigation. this was done in the hope that more honest opinions would be given. confidentiality was important firstly to “hear the real truth” and secondly because respondents felt that their “competitive advantage” may be eroded if their specific information is exposed. the focal points examined in the document analysis are shown in table 2. while the original investigation was concerned with the differences between banks, this is not necessarily the case for this article because the broader sajems vol 7 no 2 (2004) 229 economic issue of inability to find financial support surfaced more strongly during the research. table 2 evaluation of bank application documents bank a b c d length 11 pages first six pages cover personal and banking details, following 3 pages of business details last 2 pages relate to description of security 11 pages first three cover personal and banking details, following eight cover business and description of security no formal documents to be completed. copies of the following documents to be handed to bank; business plan, cash flow projection for 12 months, members cv’s in detail, confirmation of capital deposit no application documents available for scrutiny, but there are internal documents considered confidential between client and bank. business plan, cash flow for 12 months, personal balance sheet, members cv’s, confirmation of capital deposit focus primary banking and credit card accounts, current obligations, statement of assets and liabilities, mortgage bonds, shares and other investments, life policies, sureties and contingent liability leases personal details, current obligations, statement of assets and liabilities, fixed property, other movable assets, overdrafts/loans, income and expenditure statement, insurance policies, sureties and contingent liability leases business plan 12 month cash flow projections members cv’s confirmation of cash deposit business plan 12 month cash flow projection personal balance sheets members cv’s confirmation of cash deposit difficulty to complete due to the preciseness of the information, it is advisable to engage the services of an accountant or attorney to assist with the completion of the documents full assistance is provided by the client services of the bank full assistance is provided by the client services of the bank the process and procedures for application and documentation of each bank follows similar routes with the difference mainly found in the checking (control) of the documents. two of the banks allow their branches to check for creditworthiness and security prior to sending final documents to head office. the other two banks do all the relevant checks at head office. sajems vol 7 no 2 (2004) 230 6.1 application processes and evaluation criteria once the applicant has completed the documentation, the departments within the bank handle the documents as shown in figure 1. it shows clearly that the application documents for finance are generally received by a smme consultant at branch level, which in the case of two of the banks are then sent to the branch credit department for credit approval while the other two banks conduct the necessary credit checks at head office. if approved, this approved application, together with the business plan, is forwarded to khula for the issuing of the government program guarantees. khula plays a role mostly when the application is weak, while the banks will fund stronger applications without the khula guarantee. applications not passing credit approval are returned to the smme consultant for additional information and any other detail that may improve the credit status of the application. alternatively the application is rejected. table 3 describes the criteria evaluated by each bank and shows the different focuses as well as the similarities between them. figure 1 generic route followed by application documentation through the various banks (compilation based on responses) application for finance received at bank regional offices by smme consultant two banks do credit checks at regional office credit department. successful applications sent to head office for final processing. the two other banks check credit references at head office (highly centralised decision-making). after final approval, all documents are sent to khula for finance guarantee if it has potential and needs a guarantee unsuccessful application re-worked by consultant in conjunction with applicant and returned to credit department khula – alternative guarantee scheme for weaker applications sajems vol 7 no 2 (2004) 231 table 3 summary of the comparison of the different criteria used for selection for financing by different banks banks bank criteria scrutinised objectively/ subjectively measured primary focus a b c d a all application for finance documents to be completed in great detail. s f a creditworthiness of owner, obtained by completion of a detailed credit application form, listing assets and liabilities. o credit f a asset values, properties registered in owner’s name, stock, vehicles, shares and unlisted shares receive high priority. o credit f f a owner’s uninhibited cash contribution (funds not allocated for other purposes). o credit f a cash flow projection and financial plan, including the following: turnover, cost of sales, gross profit (turnover minus cost of sales), royalty payments, bank repayments, and net profit after loan repayment. o credit f f a marketing plan, place, promotion, price and competition. s/o potential of plan f m a “what-if” proposal, or contingency plan. the ability to keep the business on track whatever happens. s/o potential of plan f a when all criteria are finally analysed, the approval is dependent on the owner’s creditworthiness, assets value (collateral) and the availability of uninhibited funds to be used as deposit. o credit f b business plan must be well constructed and workable. s m f b cash flow projection must be well prepared and must contain the following; overdraft at beginning of month, cash sales, collections from debtors, draws on loans, discounts, fixed overheads, variable expenses, payments to suppliers, loan repayments, purchases of fixed assets, tax payments, surplus/shortfall and overdraft at end of month. s/o potential of plan f f b marketing plan must be realistic, prepared for 1, 3 and 5 years, must include price, promotion, place and competition s potential of plan f sajems vol 7 no 2 (2004) 232 table 3 continued banks bank criteria scrutinised objectively/ subjectively measured primary focus a b competent management structure, skills, training, previous management positions, where and position held. s potential of plan f b securities and guarantees are checked, to ensure guarantees are uninhibited. o credit f f c check failure rate of businesses in the area, the bank has in the past experienced problems pertaining to certain types of businesses in different areas. s/o potential of plan f c understanding that the applicant is “au fait” with the contents of the document. s potential of plan f c ensure that the project is feasible: banks have received many projects that are feasible in the minds of the applicant but, due to demographics and competition, are not deemed to be feasible to the bank. s/o potential of plan f c check cash flow projections: ensure that the projections will allow for a monthly/ annual breakeven. s/o credit and potential of plan f f f c check demographics, location, access, transport and security. s potential of plan f c personal visit to area by bank management team, the area is a place on the map. only by personal visits by the bank personnel can they make an accurate assessment of the prevailing situation. s potential of plan f d owner investment: it is considered extremely important to have the applicant invest personal funds into the business. o credit a a a f d management: a successful business is managed and lead by a successful management team, necessary to ensure the past experiences of the team, by reference checking and ensuring certificates, diplomas and degrees are authentic s potential of plan m f d collateral offered in the owner’s name: must be in the name of the owner and must be uninhibited. o credit f sajems vol 7 no 2 (2004) 233 table 3 continued banks bank criteria scrutinised objectively/ subjectively measured primary focus a b c d d business plan must be read and understood by the applicant from a macro perspective, referring to the type and nature of business being undertaken and if all facets of the plan have been implemented. s potential of plan f f all proper research into all aspects of the business has been thoroughly done by applicant and that the numbers add up. s/o potential of plan a a a f all realistic projections and that all eventualities have been taken into account s/o potential of plan a a a f summary for all banks elements subjectively evaluated 36 (%) elements objectively evaluated 32 (%) elements in both categories 32 (%) creditworthiness focus 34.7 (%) potential of the plan focus 60.8 (%) both 4.3 (%) m = mentioned as playing a role, f = focused on strictly by bank, a = assumed as playing a role too. s = subjectively measured, o = objective measured with criteria, credit = focus on creditworthiness and payback potential, p = focus on the business potential as described in the business plan. table 4 case and percentage comparison of the creditworthiness vs potential of the business focus and subjective and objective measurement thereof (base data from table 3) measurement focus objective both subjective total creditworthiness focus 8 0 0 8 (34.4%) credit and potential focus 0 1 0 1 (4.3%) potential of the plan focus 0 7 7 14 (60.8%) total 8 (34.7%) 8 (34.7%) 7 (30.4%) 23 sajems vol 7 no 2 (2004) 234 table 4 shows a grid that indicates that all objective measurements were focused on creditworthiness while most subjective measurements had to do with the potential of the plan (although not statistically proven). there seems to be an attempt to use objective measurements for the evaluation of the business potential but it seems overweight on the subjective side instead. 6.2 interesting issues mentioned during interviews an interesting comment made by the senior credit manager of one of the banks was about the importance of the funds needed to start the business. a recurring problem for the bank was that applicants were budgeting too low in the initial stages and had to keep re-applying for additional funds. another bank suggested that they “find more reasons to say yes rather than no to clients”, a commendable but potential marketing focused statement. the banks further mentioned that applicants were paying consultants to write a business plan on their behalf, while not participating in its content. this is obvious as seen in the similarities in business plans submitted over a period of time. this practice is unwarranted and weighs negatively on the application. underestimation of the financial needs comes up frequently as a problem as mentioned before. this seems to be a shortcoming in terms of applying for finance and should be addressed during the initial interview with the consultants. 6.3 evaluation of relevant issues that should be included in the business plan after completion of the interviews at the various banks, comparisons were made relating to each individual question. the findings considering the potential of the venture are discussed in an abridged form highlighting the prominent features. support research (of which the detail is not reported for lack of space) further indicated that each of the banks rated location, market research and the financial plan as being extremely important. the management team and the marketing plan are high on the list of priorities as confirmed by table 3, while the executive summary receives a lessor priority despite being the most read part of the plan. this may be important information for potential applicants when writing a business plan for obtaining finance from banking institutions and should definitely be included. the industries that were rated as preferential by respondents were manufacturing, wholesale, retail, service industry, transport sector and the it sajems vol 7 no 2 (2004) 235 industry. it is interesting to note the apparent preference that the banks place on the service and it industries, although there are no definite/clear preferences. different elements that support the business plan by adding value to it was issues such as: signed contracts, license agreements, franchise agreements, patents and copyright. while everyone is calling for job creation, it is surprising to note that this item is not near the top of the priorities when consideration is made for finance. the banks do not indicate a preference when it comes to rural or urban locations for positioning a business, although one bank investigates the failure of businesses in the specific area as part of their decision-making. they also considered a formal address as important by reasoning that it is needed before granting any funds. from the list of business sites namely business hives, industrial areas, metropolitan areas, office blocks or suburban shopping centres/malls, the preferred locations indicated by the banks were suburban shopping malls because of the number of feet (traffic) entering such malls. surprisingly metropolitan areas received a low preference rating, which could be ascribed to the perceived higher rate of crime associated with these areas. all four banks concur that applicants tend to underestimate the funds needed at the start-up of a business. access to markets as well as lack of skilled labour and weak management skills tend to be important for all banks. asked how important environmental issues, technical advantages, policy and regulatory issues and business / product life cycle are in the granting of funds the banks were all in agreement that the political environment played the most important role despite it being stable and currently not considered a problem. the banks do not rate the business and product life cycles as important. 6.4 evaluation of findings the aim of the research was to gain understanding of how the banks in south africa evaluate business plans that are offered to them when potential small business entrepreneurs apply for finance to fund their ventures. revisiting the propositions guides the thinking and evaluation of the findings. based on the aggregate responses of the four major south african banks, the following propositions were supported or not: from the findings it seems that a business plan is claimed to be an essential requirement by the major banks. each individual bank does, however, place sajems vol 7 no 2 (2004) 236 certain (and sometimes different) priorities on different sections of the business plan. overall the financial and management structures of individual institutions play a significant role in the final decision-making. added to the business plan are the extensive application forms that must be completed and therefore the first proposition can be supported that the banks do have clear guidelines for evaluation of applications. each bank, however, seems to have its own focuses when granting the finance. table 3 shows the diversity that exists between banks for documents and the focuses of each. what should be considered is that many of the criteria are subjective in nature; especially criteria used to evaluate the potential of the business are mostly subjective compared to the objective criteria that are used to evaluate issues of creditworthiness and financial projections. therefore the next proposition becomes relevant. considering all the complicated documentation (see table 2) and financial requirements requested by the banks, together with the unencumbered assets and cash required as deposit, makes the procedures lengthy and at times not linked to the business plan. the second proposition is therefore not supported and it is stated that the application procedures for financing are not simple to comply with. the question can now rightly be asked whether this serves as a purposeful deterrent for applications and if so, what is the magnitude thereof? despite this, some applications proceed through the process leading to the next proposition. the research has shown that in essence, the acceptance for financing of the business comes overwhelmingly down to creditworthiness and how much the applicants are able to finance from own sources. no matter how good the venture looks on paper, what really counts is how much capital the applicant can put down in cash, so as to limit the financial risk to the bank. the third proposition is therefore not supported, based on the evidence of this research and it is accepted that the guidelines for selection are not dominated by the business potential as described in the business plan. it should be stated that the business plan plays a secondary role when and if the creditworthiness requirement test is passed. tables 3 and 4 indicate that despite the evaluation for potential of the venture, the criteria for success is mostly subjective except for those related to financial issues that are objectively evaluated. therefore, it is much easier to use the standards as set by ratios such as financial contribution and a debt:equity ratio, for example, to discriminate with rather than evaluating the potential of the venture. potential is hard to determine due to the many elements to be sajems vol 7 no 2 (2004) 237 considered. it is also easier for unqualified people to rate an application based on predetermined ratios while evaluating business potential required experience and knowledge beyond the average found in bank employees. the fourth proposition, that creditworthiness is the dominant factor, then becomes even more relevant. these results have shown that the banks in general appeared to take cognisance of business plans, all calling for relatively similar criteria. their decisions were, however, firstly based on the same standard, namely if you have the creditworthiness and collateral, they will extend a loan. based on this evidence, the fourth proposition that creditworthiness is the dominant factor in the financing decision is supported. it seems that despite khula being the risk underwriters to the banks and while banks consult with khula to find a way to make finance easier for applicants, at present, banks are still extremely stringent in the checking of credit requirements, assets and liabilities and creditworthiness before forwarding an application to khula for the granting of credit. it appears that they are still overly risk averse and the reasons for this appears to be twofold: the time delay in receiving khula’s guarantee of funds, should the business go insolvent the difficulty to obtain the guarantee from khula paid to the bank in case of default (these are explored in a follow-up paper). 7 discussion and recommendations khula (the sa government retail funding body) state that they have a mandate to ensure that the people of the country, especially the less privileged and previously disadvantaged, have ready access to the tools and resources that will allow them to create wealth for themselves by forming smmes. khula has an expectation about the contribution of the banks to this goal. tati (2002: 9) reflects on the banks that are experiencing as he puts it “a torrid and disruptive period”. he refers to recent problems such as saambou’s demise; the problems at boe bank and the rejection of the proposed take-over of standard bank by nedcor by the minister of finance. these issues were taking preference over the financial needs of applicants applying for finance. he suggests that these factors had a disruptive influence and have impacted on the relationship with the banks, in so far as the progress made with the small business units in the banks have suffered as a result of these events, and that sajems vol 7 no 2 (2004) 238 these units being highly vulnerable, were the first to be shut down. he further believes that the small group of skilled and knowledgeable people in the field of small business lending are now also lost to the finance industry and will find employment in other fields (tati, 2002: 9). after all is said, the government who is a key role player is calling for more businesses to be created resulting in more jobs. the rejection of a business plan because of the non-availability of the required deposit could and should be overcome in instances of potentially good business ventures with growth possibilities. given the politically based history of south african banks the issue is also contentious. the results have shown that in essence the business plan forms the foundation of turning a good business idea into an opportunity. the banks, however, are reluctant to pass any deal on the strength of a business plan without having sufficient collateral and knowing the applicant is creditworthy. the findings for each bank were reported individually but there were many similarities when a comparison was made. while the overall evaluation procedures and criteria observed between the banks were not too far apart, the understanding is that assets and owner creditworthiness were of utmost importance to each of the institutions. this article focuses on the entrepreneur / small businessperson applying for a loan and it is, therefore, important to understand that the applicant often is someone with limited business and entrepreneurial skills or one that is probably going into business for the first time and mostly is in need of finance for the start-up. this is especially the case for micro level business ventures. one fairly shocking confirmation from the informal comments of interviewees was that it appears that several feasible applications have been rejected because the applicants did not have the necessary deposits, irrespective of the business potential. the question that now arises is how many poor potential ventures with creditworthy applicants failed? in the end the entrepreneurs lost everything but the banks got their investment back because they did not take any risk. proposed in figure 2 is a simple model to underscore the differences between the perspectives of banks and entrepreneurs that may underlie the problem. typically, if the intersection can be increased, there will be more space for success. at the point that this study was completed, however, there appears to be a gap between the banks and the entrepreneurs despite certain measures such sajems vol 7 no 2 (2004) 239 as khula’s guarantee scheme implemented by the government. it is clear that there appears to be little within the intersection between the two sides. given the importance of this issue, banks should perhaps seek more alternatives to move closer to the entrepreneur. other measures such as the creation of an additional fund (deposit assistance) that can finance the required deposit of good business plans could be investigated. it seems that the individual banks will always control the decision when vetting each individual business plan and would therefore only recommend poorer business plans they do not deem viable for funding to khula for guarantees. additionally, trained and competent staff at khula, who can arrange the finance with an approved and participating bank, should evaluate the application for finance and the business plan. there is also a need to investigate and streamline the process used by the banks to obtain refunds from khula, in the case of defaulters or bankruptcy. currently this process is rated as taking too long. this may be an important reason for banks still being stringent on credit rather than considering alternative merits. as business plans are vital to the start-up of a business, it is important to ensure they are correctly compiled and contain all the relevant information that will encourage the banks to retain interest in the business, and assist in bringing the business to fruition, as far as possible. to alleviate the problem of banks hiring additional staff, khula could assist in having suitably qualified consultants present during the initial encounter with the entrepreneur/businessperson and the banks. further it must be ensured that business plans are correctly compiled. this might in the first place help to expedite the application process and encourage more applicants to apply for finance, which will in turn produce more small businesses and in so doing, produce the much-needed increase in job numbers. further investigation is needed to find methods and ways to ensure that the banks, with or without khula assistance, assist the entrepreneur in drawing up a business plan that contains the necessary business ingredients needed for being successful. the findings seem to be in line with driver et al. (2001: 45) in their finding about the banking institutions in south africa when they state “twenty years ago bank managers in small towns had their own independence. now everything in terms of credit control is centralised, and the last thing a computer thinks of is character. it is all done on assets, if you don’t have assets you don’t get credit”. the findings reported in this article are in support of this statement. sajems vol 7 no 2 (2004) 240 based on the findings, it can be concluded that although the banks all ask for a business plan to be submitted when applying for credit, the final decision comes down to the creditworthiness of the business owner and the extent of his/her guarantees. creditworthiness or own contribution / guarantees are further used as a basic screening tool long before the business plan is relevant. the business plan therefore becomes relevant only if the above “minimum requirements” are satisfied. figure 2 difference in the perception of needs for banks and entrepreneurial applicants when applying for funding b a n k p e r s p e c tiv e e n tr e p r e n e u r p e r s p e c tiv e r is k a v o id a n c e s e c u r ity f a ilu r e a v o id a n c e s h o r t te r m r e tu r n f in a n c ia l r e tu r n s e e s le s s r is k l o n g te r m p a y b a c k n o s e c u r ity – r e a s o n f o r a p p lic a tio n l e a r n b y f a ilu r e b u ild in g a b u s in e s s the final question that arises concerns the ability of those who evaluate the business plans to determine potential and their ability to do so. nieuwenhuizen (1999: 2) asked this question before. generally, this ability is not easily found and therefore the banks have mostly centralised their vetting capacity. is it focused on measurable credit parameters because the banks do not have the capacity to evaluate business potential meaningfully? this warrants further investigation. references 1 berry, a., von blottnitz, m., cassim, r., kesper, a., rajaratnam, b. & van seventer, d.e. (2002) “the economics of smme’s in south africa”, www.tips.org.za (accessed on16/09/02). 2 department of education (2002) “improvements in the senior certificate examination”, http://education.pwv.gov.za accessed 4/01/03. sajems vol 7 no 2 (2004) 241 3 driver, a., wood, e., segal, n. & herrington, m. (2001) global entrepreneurship monitor, graduate school of business. cape town. www.gemconsortium.org. 4 foxcroft, m., wood, e., kew, j., herrington, m. & segal, n. (2002) global entrepreneurship monitor, south african executive report. graduate school of business. cape town. www.gemconsortium.org. 5 gorman, g., hanlon, d. & king, w. (1997) “some research perspectives on entrepreneurship education, enterprise education and education for small business management”, international small business journal, 15(3) 56-77. 6 hisrich, r.d. & peters, m.p. (1998) entrepreneurship, (4th ed.) mcgraw-hill: boston. 7 nieuwenhuizen, c. (1999) “kriteria vir die finansiering van kleinnyweraars”, phd thesis. potchefstroom university for cho. 8 okeahalam, c.c. (2001) “structure and conduct in the commercial banking sector of south africa”, paper presented at the tips 2001 annual forum. 9 orford, j., wood, e., fisher, c. herrington, m. & segal, n. (2003) global entrepreneurship monitor. uct graduate school of business. www.gsb.uct.ac.za/cie. 10 pretorius, m & van vuuren, j.j. (2003) “the contribution of support and incentive programs to entrepreneurial orientation and start-up culture in south africa”, south african journal of management sciences 6(3): 521-35. 11 shaw, g.k. (2002) “decision-making processes of commercial banks in financing new ventures: the role of the business plan” m phil dissertation, university of pretoria: pretoria. 12 south africa. national small business act (1996) no. 102. government printer: cape town. 13 statssa (statistics south africa) (2002) labour force survey: pretoria www.statssa.gov.za (accessed on16/9/2002). 14 tati, s. (2002) khula enterprise finance ltd-annual report 20012002, http://www.khula.org.za/divisions_credit_individual.html (accessed on 29/09/2002). 15 timmons, j.a. (1999) new venture creation, (5th ed.) mcgraw-hill: boston. 308 sajems ns vol 3 (2000) no 2 a south african perspective on the existence of an interest tax shield ajpienaar accounting training corporation of south africa. johannesburg mshotter school of accountancy. university of pretoria abstract this paper investigates whether the use of debt in the capital structure of a company is beneficial to its shareholders. it finds that, in the south african context, gearing has no effect on the value of a company. the use of debt can increase the value of a company in a country where capital profits and interest are taxed equally. this is the result of an interest tax shield, which is directly related to the tax deductibility of interest paid. however, when capital growth and dividends are exempt in the bands of investors, as is the case in south africa. the interest tax shield does not exist, and thete appears to be no benefit in increasing debt. jelm41 1 introducflon in 1958 modigliani and miller wrote an article to the affect that capital structure was not relevant to company value. they argued that the value of a company was determined by the capacity of its assets to earn income, and not by the way these assets were financed (modigliani & miller, 1958: 261-97). five years later, however, modigliani and miller amended their previous article (1963: 433-43). they demonstrated that due to the existence of company taxation, there was indeed an advantage attached to debt financing, which may be referred to as the interest tax shield. modigliani and miller (1963: 436) formulated the value of a company with financial gearing as follows: where vg = the market value of a company with financial gearing; r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 vu "" the value of a similar company without financial gearing; tc = the company tax rate; dg the market value of the debt in the geared company; and the interest.rate. 309 the interest tax shield (tcdg) can be defined as the tax saving due to (taxdeductible) interest paid on the debt, capitalized at the pre-taxation interest rate. the modigliani-miller propositions have subsequently become an integral part of modem capital structure theory, referred to in most conventional textbooks on financial management examples of these are samuels, wilkes and brayshaw (1995: 649-53), brigham and gapenski (1996: 364-70), brealey and myers (1996: 449-56) and van home (1992: 272-3) . • research conducted by cooley and heck (1981: 23-33) amongst financial experts from different sectors of the fmancial and academic world in the usa, indicated that the modigliani and miller 1958 article should be regarded as the most significant contribution ever to fmance literature: 85% of 296 respondents included this article as one of the ten most significant contributions to finance literature. this percentage was higher than for any other such contribution to fmance. 2 problem statement and approach to the investigation the questions regarding optimal capital structure and the validity of the modiglia.l1i-miller propositions are complicated when approached from a south african perspective. the reason for this is that the majority of the existing literature that deals with the subject originated in the usa and the united kingdom. there are significant differences between the taxation systems in these countries (especially at the time when modigliani and miller produced their work) and south africa, which impact on the validity of the modigliani-miller propositions in the south african taxation context. the current situation in south africa is that the modigliani-miller theories are taught at tertiary institutions without adapting the material due to differences in the taxation systems. south african finance literature on capital structure theory corresponds exactly to overseas literature. this may be illustrated by two examples: financial management (1993: 589) by correia, flynn, uliana and wormald, and the first south african edition of fundamentals of corporate finance (1996: 432-3) by ross, westerfield, jordan and firer. both these textbooks have south african authors or co-authors and are specifically directed r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 310 sajems ns vol 3 (2000) no 2 at the south african market. this article investigates the benefit obtained from the use of debt in the capital structure of a company, focusing specifically on the existence of an interest tax shield under south african tax legislation. it questions the validity of the interest shield where capital profits (capital growth and dividends) are exempt in the bands of the investor. the approach of the examination is to firstly compare the distribution of earnings of a company under two different tax systems in order to illustrate that an interest tax shield does not exist where capital profits are exempt in the hands of the investor. the second part of the paper consists of a review of related but independent empirical research to detennine whether the results of these studies support the finding of this paper. since the four empirical studies were carried out autonomously, they were not designed to specifically test the existence of an interest tax shield. in all four cases though, the studies investigate whether the use of debt in the capital structure is beneficial to the company. 3 the validity of the interest tax shield under south african taxation legislation when examining the validity of the interest tax shield, a distinction should be made between a taxation system where capital profits are taxed in the hands of the receiver thereof, for example the usa, and a system where these two items are not included in taxable income, such as south africa. the theory of the existence of an interest tax shield was developed in a system where capital profits and dividends were taxed in the same manner as normal company profits and interest received (brealey & myers, 1996). several adjustments were subsequently made to account for differences between personal and company tax rates and the effect of unrealised capital profits (miller, 1977; brealey & myers, 1996: 479·84). nonetheless, the modigliani and miller theory regarding the effect of debt in a company's capital structure, in a world with taxes, simply requires that income from debt and equity be taxed at the same rate (brealey & myers, 1996: 480). in terms of the us taxation system, the rate at which interest and dividends received are taxed in the hands of investors, is the same (brealey & myers, 1996: 475), the us system effectively levies double taxation on company net profit (miller, 1988: 11), first on corporate and then on personal level. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 311 however, while interest paid by the company is tax-deductible, dividends paid are not. the us tax system thus results in a saving for the providers of equity capital at the expense of the receiver of revenue when debt is included in the capital structure (brealey & myers, 1996: 476; samuels, wilkes & brayshaw, 1995: 653). in terms of south african tax legislation, dividends received by investors are currently not taxable. net profit is taxed only once at corporate level, and consequently there is no saving for the investor when a company uses debt. the above can best be illustrated by means of a comparison of how $ or r i million of earnings before interest and tax of a geared and an ungeared company will be distributed amongst debt holders, equity holders and the receiver of revenue, under the two tax systems. the first is a system where capital earnings are taxed (as in the usa), whilst in terms of the second dispensation capital earnings are exempt (as in south africa). the illustration assumes that debt ofri million is included in the capital structure of both geared companies at an interest rate of 10%. it also accepts that all after tax income is declared as dividends, and that both the corporate and personal taxation rates are 35%. secondary tax on companies is ignored. table 1 a comparison of a distribution of earnings in two tax systems capital earnings taxed capjtal earnings tax exempt (usa) (soutb mriea) ungeared geared uogeared geared $ $ r r ebit 1000000 1000000 1000000 1000000 interest @ 10% (100000) (100000) ebt 1000000 900000 1000000 900000 corporate tax @ 35% (350000) (315000) (350000) (315000) 650000 585000 650000 585000 equity holders dividends received 650000 585000 650000 585000 taxation @ 35% (227500) (204 750) net 422500 380250 650000 585000 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 312 sajems ns vol 3 (2000) no 2 table 1 continued capital earnings taxed capital earnings tax exempt (usa) (soutb africa) ungeared geared ungeared geared $ $ r r debt bolders interest received 100 000 100000 taxation @ 35% (35000) (35000) 65000 65000 summary receiver of revenue 577 500 554750 350000 350000 equity holders 422500 380250 650000 585000 debt holders 65000 65000 1000000 1000000 1000000 1000000 source: plenaar, 1999: 56. it is clear that the receiver of revenue receives a smaller share of the income in the case of a geared company under the us tax system. the difference ($22 750) capitalized at the cost of debt before tax, is the present value of the interest tax shield ($22750/0,1 $227 500). the theory of the tax shield therefore appears to be correct. there is ultimately a saving for the providers of capital when a company uses gearing, and this saving must revert to the equity holders. however, this only appears to apply in a taxation system where dividends and interest received are taxed equally. we can see from table 1 that under south aftican taxation legislation, the debt and equity holders receive no benefit due to gearing. the receiver of revenue does not subsidize any of the interest paid. the fact that interest is tax-deductible merely makes it a cheaper form of coiporate finance than it would have been if it had not been tax-deductible. from the above comparison it can be deduced that under south aftican tax legislation, the same principles as described in a modigliani and miller world without taxes still apply: gearing has no effect on the value of a company. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 313 4 empirical research results in south africa 4.1 introduction the following four studies have directly or indirectly investigated the effect of the use of debt on the value of south african companies. davidson and rapp (1995) inter alia examined the effect of gearing on return on equity and fasol and firer (1995) studied the reasons why very few companies were prepared to take up additional debt in an attempt to lower their cost of capital. whilst uliana (1993) considered the effect of the debt-equity ratio on the growth of share prices, shotter, btiimmer, dennis and boshoff (1998) investigated the correlation between shareholders' wealth and capital structure. these studies are reviewed to assess whether the results of independent empirical investigations are consistent with the deduction made in this study. 4.2 davidson and rapp davidson and rapp (1995: 90) made an inquiry into the use of debt amongst south african companies. the research population consisted of the finance week 200 group of listed companies and the period investigated was from 1989 to 1991. they identified two possible reasons for the use of debt: (i) as a method of obtaining finance, and (2) as a technique for regulating the shareholdermanagement relationship. the latter is accomplished when management is forced to pay interest on a regular basis. this prevents them from investing large amounts of cash at their own discretion, which may be detrimental to shareholders (davidson & rapp, 1995: 91). davidson and rapp (1995: 94) found that financial risk did not affect return on equity. they argued that one of the reasons for this was that there was hardly any tax advantage to the use of debt. they used the formula developed by miller (1977: 267), d x {i [(1 te)(1 tps)/(1 tpd)]), where d represents the market value of debt, te the corporate taxation rate, ips the personal taxation rate on equity income, and tpd the personal taxation rate on interest received, and showed that the advantage of using debt was minimal. in 1991 ie was 50%, ips was nil, and the marginal taxation rate on interest received (ipd) was 45%. if these values are substituted in the formula, it appears that the tax advantage of debt was minimald x 0,0909. in the case where a company's effective taxation rate is lower than the personal taxation rate, the factor with which the debt component is multiplied, becomes negative, with the result that the use of debt is to the company's detriment. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 314 sajems ns vol 3 (2000) no 2 the research conducted by davidson and rapp confinns that, due to the absence of an interest tax shield, there appears little advantage in the use of debt. 4.3 fasol and firer fasol and firer's research (1995: 75) included a sample of 222 listed south african companies. although 62% of the respondents indicated that they had spare capacity for additional gearing, very few were prepared to take up additional debt in an attempt to lower the company's cost of capital. the main reasons for this were (1) to maintain a strong cash flow, (2) a lack of good investment opportunities, (3) the negative impact on fmancial ratios, and (4) the perception that additional debt would not decrease, but rather increase, the company's cost of capital. the last aspect supports the view that the use of debt in a capital structure is not beneficial to shareholders in south africa, which might be ascribed to the fact that an interest tax shield does not exist. 4.4 uliada uliana (1993: 61-8) examined 135 companies listed on the johannesburg stock exchange, to determine the effect of the return on assets and the debt-equity ratio on the growth of each company's share price. the research covered the period 1987 to 1992, and growth was determined by comparing the share price at the beginning of the period to the value at the end of the period the average prime bank rate during the period of the research was 17,96%, which was lower than the return on assets (uliana, 1993: 66). uliana refers to zakon's formula (in uliana, 1993: 61) to determine sustainable growth: sgr = die [p" i(i tc)jrp + parp where: sgr sustainable growth d = debt e equity p" == return on assets interest rate te company taxation rate rp = rate of retention of profits after tax. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 315 according to this formula it is expected that companies with a higher return on assets (pa) would show higher sustainable growth than companies with a lower return on assets. similarly, it is anticipated that companies with a high debt.equity ratio would experience higher sustainable growth than companies with a low debt·equity ratio, especially where the return on assets is higher than the interest rate. the investigation revealed that companies with a higher return on assets (pa) experienced a significantly higher sustainable growth. this is in accordance with zakon's formula for sustainable growth. however, with regard to the debt·equity ratio, companies with a lower debt·equity ratio experienced more growth than companies with a higher debt.equity ratio. this is contradictory to zakon's formula (uliana, 1993: 65). uliana (1993: 66) divided the total sample into two groups, namely the lower debt-equity ratio companies in one group, and the higher debt-equity ratio companies in the other. the results of the research pertaining to the debt.equity analysis can be summarized as follows: table 2 tbe results oftbe debt-equity analysis lower die higher die average growth 3,25 1,77 number of observations 68 67 average return on assets 19,41% 18,56% average retention ratio 61,64% 6596% table 2 shows that neither the return on assets nor the average retention ratio of the two groups differed significantly. yet the group with the lower debt-equity ratio experienced substantially more growth (3,25 times) than the group with the higher debt-equity ratio (1,77 times). uliana's (l993: 66) interpretation of this phenomenon is that sustainable value can only be achieved through fundamental operations such as operational efficiency, and not necessarily through the use of debt. these findings support the absence of an interest tax shield within the south afiican tax enviromncnt 4.5 sbotter, brimmer, dennis and boshoff shotter, briimmer, dennis and boshoff (1998: 301-17) conducted empirical r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 316 sajems ns vol 3 (2000) no 2 research to investigate the correlation between shareholders' wealth and eva (economic value added) as well as other traditional indicators of shareholders' wealth. ev a is the residual income after subtracting the cost of all capital, including equity, that has been employed to generate the operating profit. they identified mv a (market value added) as the measure of shareholders' wealth. mv a is defmed as market capitalization plus the market value of preference shares and total debt less the carrying value of total debt and equity. market capitalization is based on the equivalent number of fully paid-up ordinary shares at the end of the company fmancial year times the average price of shares traded during the month of the company financial year-end. total debt is described as total long-term loans, short-term loans and bank overdrafts (shotter et ai., 1998: 303). the research examined the relation between mv a and the following traditional indicators of shareholders' wealth: cash flow per share, earnings per share, headline earnings per share, dividend per share, return on equity, capital structure, and eva. the population included all companies listed on the johannesburg stock exchange during the period 1987 to 1996, with the exception of financial institutions, mining companies, shell, pyramids and property holding companies. a total of 135 companies were examined. a pearson correlation coefficient analysis was performed with market value added as the dependent variable and the other indicators as independent variables. the analysis was carried out at a 1 % level of significance. table 3 the correlation between mv a and other indicators total period si2l1ificance eva 0,155 0,0001 cash flow per share 0,048 0,0822 earnings per share 0,102 0,0002 headline earnings per share 0,068 0,0146 dividend per share 0,079 0,0044 return on equity 0,061 0,0289 capital structure 0,001 0,9800 on the basis of the above data it appears that the strongest correlation over the period as a whole was between mv a and ev a, followed by earnings per share and dividend per share. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 317 the weakest correlation was between mv a and capital structure, namely 0,001. during four of the ten years the correlation was negative. this is inconsistent with modigliani and miller's (1963) amended view, that an increase in debt increases shareholders' value. these results again support the deduction made in this paper, namely that there is little if any advantage to debt within the south african taxation context. 5 conclusion there appears to be no benefit to shareholders if the proportion of debt in the capital structure is increased, under south african circumstances. the proposed increase in shareholders' value as suggested by modigliani and miller (1963) depends on the existence of an interest tax shield. however, such a shield only arises where capital income and interest are taxed equally, as is the case in the united states of america. in south africa, dividends and capital growth are exempt in the hands of investors, meaning that an interest tax shield does not exist these fmdings have implications for financial management theory and practice in south africa. whenever modem capital structure theory is taught or explained in textbooks, the limiting assumptions that accompany these theories should be stressed. if the theory in respect of the existence of the interest tax shield could be modeled on south african circumstances, it would be evident that gearing holds no benefit to shareholders. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 318 sajems ns vol 3 (2000) no 2 appendix a list of symbols dg = d e ebit = ebt = eva = i = mva= pa rp = sgr = ie ipd ips vg vii the market value of the debt in the geared company; and debt equity earnings before interest and tax earnings before tax economic value added interest rate market valued added return on assets rate of retention of profits after tax sustainable growth the company taxation rate; the personal taxation rate on interest received the personal taxation rate on equity income the market value of a company with financial gearing; the value of a similar company without financial gearing; r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . samms ns vol 3 (2000) no 2 319 references brealey, r.a. and myers, s.c. (1996) principles of corporate finance (5th ed) mcgraw-hiu, new york. 2 brigham, e.f. and gapenski, l.co (1996) intermediate financial management (5th ed.) the dryden press, fort worth. 3 cooley, p.l. and heck., j.l. (1981) "significant contributions to finance literature", financial management, tenth anniversary issue, 1981: 23-33. 4 correia, c., flynn, d., uuana, e. and wormald, m. (1993) financial management (300 ed) juta & co, ltd, cape town. 5 davidson, s. and rapp, l. (1995) "the corporate uses of debt", south african journalfor business management, 26(3). 6 f asol, r. and firer, c. (1995) "00 south african managers focus on the creation of shareholder value?" south african journal for business management, 26(2). 7 marsh, p. (1982) ''the choice between equity and debt: an empirical study", journal of finance, march 1982. 8 miller, m.h. (1977) "debt and taxes", journal of finance, 32: 261-76. 9 miller, m.h. (1988) "the modigliani-miller propositions after thirty years", journal of applied corporate finance, 1988. 10 modigliani, f. and miller, m.h. (1958) "the cost of capital, corporation finance and the theory of investment", american economic review, 48: 261-97 (june 1958). 11 modigliani, f. and miller, m;h. (1963) "corporate income taxes and the cost of capital: a correction, american economic review", 53: 433-43 (june 1963). 12 pienaar, a.1. (1999) 'n suid-afrikaanse perspektief op die toorie van optimale kapitaalstruktuur, unpublished masters thesis, university of pretoria 13 samuels, 1.m., wilkes, f.m. and brayshaw, r.e. (1995) management of company finance (6th ed.) chapman & hall, london. 14 shotter, m., brommer, l., dennis co and boshoff a. (1998) "creation of shareholder value: a comparison of economic value added (eva) with traditional performance measures", meditari, 6: 301-17. 15 uliana, e. (1993) "the attainment of growth through debt", meditari, 1: 61-8. 16 van horne, j.c. (1992) financial management and policy (9 th ed.) prentice-hall, inc. englewood cliffs, new jersey. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . journal 3.p65 ������������ ��� ����� �� ������������� �� �� ��� ������ � ������ ������������ ������� �������� ������ ��� ����� �� ���������� � � � ������ � �� � ��� � ������ ��� � ���� ��� �������� ���������� � ������� ����� � �� ��������� ���� ������� ��������������� ����� �� ��� �������� ����������� ����� ������������� ������������� �������������� ��������� ������������ ��� ������ ����������� ����������������������� ���� ��� ��� ���� ��������� ������ ����������� ��� ���������� ������ ������������� ��������������� ����������������� ���� ������������� ���������� ������ � �� ������� ������ ����������������� ��� ���� ��������� ������ ����������� �� ��� ���������������������� �������� �!""#$�%"""������� ������������ ���� ����� ��� � ������� � �� ��� ���� ����� � ����� � ���� � � 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�.�0�/��� ����1� ��!��������!� !2 � � ���!+����!� !2 �!�� �2"�+�� �������� ��"3��!"�'( ��3���!� �4 �!3��*�" ���1( 1 ��5������ ������������6� ��� ��75���.��8������6� ������ �7��#� �! � � ����"%"�����!� ��# �%%��+���!� !2 � � ��� 9���:���� ����#�"# 2!" � � +!�������; ��;����"��; ��#���"�'4 ����4 6��$���4 �)��$�"���#( < 6�=4 �( ������ �������� ����"��+� 2!" +!���"�+��!� %"!2����!����: "���# !" 2!�>' ��3�� 6��;#!� ��# ��� +!�������+�: ���;�%!"�( ? &.����74 =(6( ����?� �������� ����;����� �� �!�� �2"�+�� �"+ ���+��"�� %"�+��+��'4 .�%�*��� �# &�+ �="!@�+� &���;������ �"������4 .��3�"���� !2 ="��!"��4 ="��!"��4 �!�� �2"�+�( a ��b&��4 c( ����<� &��*�"� �% ��+"���"�4 �����( d ��.� � ����� ����������� � ����.6���7 ��7������ ����<� ��#3��!"� �!��: ��%��������; ��# ����������; � e������ ����;����� ������' )))(���+�(+!($�-�&��( �� f ��.� � ����� �.�6��/ ������.��( ����1� ��� ���"!#�+��!� �! e������' )))(��e�(+!($�-��68���,8a( �� 9 ��������� ��.� � ���� ������ �������� ����;����� ������� g "�e��"������' �!�� �2"�+�� ����!��� ����#�"#( ���� 9���:����: ="��!"��( �� � � ��.� � ����� �.���. � ��������� ������ �������� ����;����� ������� g 2��#�������� ��# 3!+�*���"�'4 �!�� �2"�+�� ����#�"#( ���� ��� 9���( �!#� !2 ="�+��+�: ="��!"��( sajems ns vol 1 (1998) no 2 204 stages of growth in the south african economy: the role of agriculture r f townsend and j van zyl department of agricultural economics, university of pretoria abstract this paper identifies the stages of growth in the south african economy with particular reference to agriculture. simple a-matrix causality tests are used to determine the direction of causality between the gross sectoral products of the economy and the gross agricultural product. the percentage share of the agricultural industry in the south african economy is relatively small and continues to decline as the economy grows. however, there has been a greater integration of agriculture within the economy during the 1990s as a result of the liberalisation of many aspects of the economy. agriculture may have played a passive role in the economy, but has provided foreign exchange revenue from net exports to facilitate growth in other sectors of the economy. in a more decontrolled environment, the agricultural sector will become increasingly susceptible to the changes in the macroeconomy, particularly the exchange rate. introduction a persistent tendency in economic thought is to systemise the process of economic growth within a framework of sequential stages. several attempts to divide economic history into discrete segments are testimony to this trend. the early work on this subject was conducted by friedrich list and karl marx during the nineteenth century, each with his particular version of the sequential 'stages of growth' theory. list proposed five stages, namely savage, pastoral, agricultural, agricultural-manufacturing and commercial. his model posited increased in industrial development and export demand as prerequisites for agricultural progress, thus advocating policies that would promote of industrialisation. in contrast, marx's stages were primitive communism, ancient slavery, medieval feudalism. industrial capitalism and socialism. he stressed the importance of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 205 sateb nr vol i (1998)nr2 technical change in shaping economic institutions and considered agricultural productivity as a 'precondition' to the emergence of industrial capitalism. there have been a number of developments since the time of these early proponents. list's approach was modified by clark (1940) to cover three stages, i.e. primary, secondary and tertiary. his formulation of the transformation required the intersectoral transfer of labour to sectors of higher productivity, suggesting that labour would move to industry from agriculture. the 1960s saw the emergence of rostow's (1964) 'leading sector' stages of growth approach, focusing on how society moved from one stage to another. he introduced the concept of a sequence of leading sectors, which succeed each other as the basic generators of growth. following this view, the 'dual economy' models developed out of an attempt to understand the relationship between a lagged traditional sector and a growing modem sector (lewis, 1954, 1955; kaldor, 1966; fei and ranis, 1964) many authors had a rather limiting view of agriculture, the reasons for this being twofold. first, the income elasticity of demand for unprocessed food is less than unity and declines with higher incomes. hence, the demand for raw agricultural products grows more slowly than consumption in general second, increased labour productivity in agriculture means that the same farm output can be produced with fewer workers, implying a transfer of labour to other sectors of the economy (eicher and staatz, 1990; timmer, 1990). as agriculture's share of the economy was perceived to be declining, the need to invest in agriculture in the short run was played down. even within the agricultural sector, four evolving stages have been proposed (timmer, 1990). the earliest phase of development is concerned with 'getting agriculture moving' (mosher, 1966). this includes investment in the prime movers of agriculture, which are identified by rukuni and anandajayasekerarn (1994) as new technology, human capital, infrastructure, effective institutions and a favourable political and economic environment. as the early investments payoff, the agricultural sector evolves into the next phase where it becomes a key contributor to the overall growth process, as outlined by johnston and mellor (1961). this development includes increase in the supply of food for domestic consumption, the release of labour for industrial development, thus enlarging the size of the market for industrial output, increasing the supply of domestic savings and earning foreign exchange. the third phase is the integration of agriculture with the rest of the economy, through the development of more effective labour and credit markets that link the urban and rural economies. the idea is that this will 'speed up the process of extracting labour and capital from these uses in agriculture r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 2 206 with low returns for those in industry or services with high productivity' (timmer, 1990). the fourth phase can be seen in the treatment of agriculture in industrial economies, i.e. the usa and europe. commodity support policies, particularly in respect of prices, become the primary vehicle for supporting farm incomes. these subsidies have major effects on resource allocation. the rest of the paper will attempt to clarify the situation in south africa with regard to its various stages of growth. the next section supplies a view of the perceived stages of growth in the south african economy. section three then analyses trends in sectoral output growth, while causality tests are performed in the subsequent section to determine whether agriculture has been a leading or passive sector in the economy. the final section gives a summary of the findings. stages of growth in the south african economy a number of authors have contributed to the literature on the stages of growth within the south african context, for example lumby (1995), jones (1991), wickens, (1989) and minnaar (1989). these authors highlight some of the forces that initiate change in economic growth. in a recent article van der berg (1993) has summarised the stages of growth in south africa according to five phases. the first stage is the agricultural phase up to 1868, when the country was dominated by subsistence agriculture due to the limited scope for exports, together with small and fragmented domestic markets and scarce inputs. the environment was not conducive to economic growth, owing to poor demand, supply and institutional factors. substantial developments in industry resulted form the mineral discoveries in the middle to late 1800s. the second phase was the agricultural/mining phase from 1868 to 1924. in the early stages of this phase agriculture and mining were the dominant driving forces in the economy. diamond and gold discoveries induced large labour, capital and entrepreneurial transfers to south africa. this in turn spurred domestic industry and agriculture but most consumer goods were imported due to limited domestic supply. the first world war fuelled the process of import substitution in manufactured goods, this process being carried further by the adoption of a policy of tariff protection from 1925 onwards (lumby, 1990). table 1 shows increases of the sectoral shares, over the period 1911-23, for manufacturing, construction and electricity of 5.71 %, 8.43% and 2.38% per annum. in 1911 local manufacturing consisted mainly of sheltered industries dependent on gold mines for their r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 207 sateb nr vol 1 (1998) nr 2 continued existence, with little general expansion of secondary industry (lumby 1990). this was the result of a widely dispersed population, expensive transport facilities and a lack of cheap energy (lack of markets). south african industry experienced considerable expansion during the second half of the 1920s. this start was however restrained by the great depression of 1929-32. the third phase from 1924 to 1933, saw the laying of the foundations of industrial policy. this was a period of consolidation and restructuring. the sectoral share of manufacturing continued to increase together with electricity at the rates of 2.89% and 8.58% per annum receptively. this growth was predominantly at the expense of agriculture. the government therefore attempted to stimulate agriculture, address the 'poor white' problem and reduce dependency on mining, a wasting resource. the policy initiatives during this period included: the organisation of agricultural marketing; labour legislation excluding blacks from certain jobs and reducing their ability to compete with whites; and the protection of domestic industry through tariffs to promote import-substituting industries. the fourth phase from 1933 to 1974, was a period of diversifying industrialisation. the industrial growth in the early thirties was partly the result of south africa's decision to abandon the gold standard and devalue the currency in december 1932 (lumby, 1995). the increased price of gold (due to the devaluation) and the multiplier effects which flowed from the subsequent gold mining boom of the 1930s, were felt chiefly in the construction industry and local manufacturing (lumby, 1995). table 1 shows that there was tremendous economic growth at the beginning of this stage (j 933-39), with significant growth in all sectors of the economy. real gdp per capita for the economy as a whole grew at the rate of 5% per annum, with the per capita growth of agriculture, mining, manufacturing, construction and electricity being 4,9%, 2.34%, 8.42%, 15.53% and 6.16% respectively. the fourth phase was characterised by several demand surges, largely due to: another devaluation of the south african currency; industrial expansion to support world war ii; the international minerals boom of the 1960s; and the gold price rise following the first oil price shock of 1970s. these demand-led booms laid the foundations for sustained high economic growth, and the increased sophistication and diversification of industrial activity. the 1960s saw rapid growth which was closely correlated with developments in manufacturing. the growth of construction in the 1 960s was substantial, but since the 1 970s the performance has declined, this may be the result of the high interest-high inflation economy which was a feature of the 1970s and 1980s (jones, 1991). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 2 208 table 1: sectoral gdp shares and growth rates of at factor cost (r miliions)1 period years i total agr men eae con ele i tra. ww i and its 1911 100 i 21.5 27.3 4.15 0.7 1.03 10.03 35.3 aftermath 1923 100 120.1 17.1 7.9 1.9 l3 11.0 40.6 semnd stage of share ns -5.26 5.71 8.43 2.38 ns ~! growth rsp ns ns -5.68 5.29 8.00 1.96 ns rsppc ·1.99 ns ·7.25 3.72 6.44 ns ns consolidation 1924 100 21.0 16.6 7.8 1.8 1.2 10.8 and restruc· 1933 100 13.3 21.4 10.1 1.1 2.5 10.8 48.7 turing third stage of share · -6.20 ns 2.89 -5.27 8.58 ns ns growth rsp ns -4.83 ns 4.26 ns 9.95 2.00 2.15 rsppc t! -6.97 ns 2.11 -6.10 7.79 ns ns pre ww ii 1933 13.3 21.5 10.1 ill 2.5 10.8 40.6 growth 1939 13.2 18.8 12.4 12.2 ~~m stage four share ns 1 10.53 rsp 6.90 6.80 1 17.42 8.05 rsppc 5.00 4.90 2.34 8.42 15.53 6.16 ww ii and its 1940 100 12.6 19.4 12.8 1.9 2.4 9.7 i. aftermath 1947 100 15.3 10.5 17.6 2.7 1.9 10.1 stage four share · ns -8.64 5.01 ns ·2.81 ns ns rsp 3.90 5.50 -4.74 8.91 8.08 ns 4.69 4.32 rsppc 2.16 3.76 -6.48 7.17 6.34 ns 2.95 2.59 diversifying 1948 100 16.4 10.3 18.1 3.4 1.8 9.9 41.9 industriali1974 100 9.4 12.2 21.4 5.3 2.3 8.9 40.1 sation :::. stage four share -3.02 0.75 1.63 1.53 ns 0.48 rsp 5.09 2.12 5.89 6.77 6.67 5.09 5.62 rsppc 3.22 ns 2.42 • 3.97 4.85 4.75 3.17 3.70 secular 1975 100 8.34 11.2 23.4 5.2 12.6 9.2 40.3 stagnation 1993 100 4.3 8.3 22.3 0.7 3.8 7.7 50.1 stage five share · -2.86 -2.64 ins -2.20 1.11 -1.56 1.38 rsp 1.94 ns ns 1 2.27 ns 4.04 0.57 3.52 rsppc ns -3.07 -2.48 ins -2.41 1.70 ·1.77 1.18 total period 1911 100 21.5 27.3 4.2 0.7 1.0 10.0 35.3 1993 100 4.3 8.3 22.3 3.1 3.8 7.7 50.6 share !~~r i tt2 1.94 1.74 1.53 -0.27 0.07 rsp 4.51 .59 6.45 6.25 6.04 4.24 4.58 rsppc 2.56 .63 4.50 4.29 4.09 2.29 2.62 note: growth rates are calculated as x=e llt where il is the owth rate, x is the variable of gr interest and t is a time trend. source: sectoral gdp shares were derived from various issues of south african statistics. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 209 sateb nr vol i (1998) nr 2 stimulated by the gold mines, electricity also experienced rapid grovv1h. this grovv1h continued in the 1970s with the establishment of large power stations in the former eastern transvaal (jones, 1991). in 1965, the share of manufacturing in gdp exceeded the combined contribution of the agricultural and mining sectors for the first time. this signalled a significant broadening of the industrial base away from the pre-war concentration on primary products and the production of consumer goods, towards a wide range of intermediate goods (lumby, 1995). in contrast, agriculture experienced moderate grovv1h in the 1960s which even slowed down in the 1970s. despite the grovv1h and diversification of south african industry during the decades following the second world war, the manufacturing sector continued to remain reliant upon the export earnings of the primary sector. the fifth stage from 1975 until the present has been a period of secular stagnation. this is reflected in the low and non-significant grovv1h of output in of most sectors of the economy and the decline in the corresponding per capita figures. the factors causing these low grovv1h rates were: international recession; an overvalued exchange rate of the rand in the 1970s; and economic sanctions that served to limit south african exports. import substitution offered no further scope for grovv1h, and domestic demand was stagnant. moreover, there was an unattractive environment for economic grovv1h. this can be attributed to social and political conflict in south africa; regional wars and destabilisation policies by the south african government to counter what it termed a 'total onslaught'; deteriorating international relations, culminating in sanctions and disinvestment pressures from abroad; labour conflict and the visible collapse of the apartheid paradigm's legitimacy and ability to be maintained without coercion (van der berg, 1993). the three decades after 1960 the transformation of the economy has been characterised by grovv1h of the secondary sector followed by mining and agriculture. over the sample period, agriculture in south africa has played a diminishing role in its contribution to gdp (21.5% in 1911 compared to 5.1% in 1990), with its share declining at the rate of 1.78% per annum (see table 1). this decline has been interpreted by some as the normal pattern of economic development, by others as being exacerbated by distorted policy incentives (world bank, 1994). the fastest growing economic sectors have been manufacturing, construction and electricity, which experienced annual grovv1h rates of sectoral shares between 1.5% and 2.0% over the entire period 1911-93. south africa's gdp increased from r289 million in 1911 to r258 348 million in 1990, at the annual grovv1h rate in real gdp of 4.51 %. even though the share of agriculture's contribution to total gdp declined between 1911 and 1990, the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 2 210 growth rate of agriculture's real gdp contribution increased at 2.73% per year, which was about the same rate as the population growth rate (2.8%) over the same period. manufacturing was the fastest growing sector with the average annual growth rate of 6.45% per year, while construction and electricity expanded at 6.25% and 6.04% respectively. mining had a lower growth rate of 3.59%, and transportation a growth rate of 4.24%. these results obviously suggest that emphasis has shifted from agriculture and mining to manufacturing. increases in per capita gdp did not depend directly on increases in food production. however, even though agriculture's direct contribution to gdp is low, its indirect effects, in other words market relationships, are relatively high (brand, 1969; townsend, 1997). food supply expanded to meet the growing demand that accompanied economic development, thus avoiding the use of scarce foreign exchange to finance imports. even though agriculture has not played a leading role in the economic growth of south africa during the past decades, foreign exchange earnings by agricultural exports have helped finance inputs imported for other sectors, mainly manufacturing. (brand, 1969). it would appear that the most important market contributions of agriculture to economic development in south africa has been to facilitate growth in other sectors of the economy, particularly industry. in order to separate the different stages of gro\.\1h, tests for long-run relationships and causality between these sectors were performed. this provided some information as to whether agriculture has been a leading or passive sector in the economy. the next section provides the analysis. testing for long-run relationships and causality methodology a common approach used to test for long run relationships between variables is co integration and recent literature has proposed many alternative methodologies to test for cointegration between variables. the johansen approach (1988) is used in this analysis: this has superseded some of the other tests, such as the more common augmented dickey-fuller (adf) test (1981). the present approach allows the estimation of all cointegrating relationships and constructs a range of statistical tests to test hypotheses about how many cointegrating vectors there are and how they work in a system. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 211 sateb nr vol i (1998) nr 2 johansen (1988) proposed a general framework for considering the possibility of multiple cointegrating vectors, and this framework also allows questions of causality and general hypothesis tests to be carried out in a more satisfactory way. the procedure begins by defining a v ar of a set of variables x t = j, ... ,t (1) if there are four variables in the model, then this becomes a four-dimensional k-th order vector autoregression model with gaussian errors. x; is a vector of all relevant variables and k is large enough to make the error term white noise. the length of the lag can be determined by the akaike information criteria (alc) or the schwarz criteria (sc). in this form, the model is based on minimal behavioural assumptions on the economic phenomenon of interest. this then allows for a maximum likelihood analysis if we assume gaussian errors. the v ar model can be reparameterised in error correction form (cuthbertson el a11993) as; k-l &1 = ll&,-i+tixt k+ef. t = 1, ... ,t ;=1 where r = [(i + m),(i + m + 1l'2), ... ,(i + m + .. + m)] n =i-m-fcz... -m (2) i is the identity matrix. the johansen testing procedure is a multivariate likelihood ratio test for an autoregressive process with independent gaussian errors. the procedure involves the identification of rank of the matrix n. the heart of the johansen procedure is simply to decompose n into two matrices, a and ~, such that: n == afj' (3) the rows of ~ may be defined as the r distinct cointegrating vectors, i.e, the cointegrating relationships between the four non-stationary variables, and the rows of a show how these cointegrating vectors are loaded into each equation in the system. the loading matrix, therefore, effectively determines the causality in the system; i.e. it allows us to test the direction in which causality flows. johansen (1988) gives a maximum likelihood estimation technique for estimating both matrices and outlines suitable tests to find the number of distinct cointegrating vectors that exist, as well as to test hypotheses about the matrices. locating a unique cointegrating vector implies that the variables are integrated of order one, since the reduced rank condition of n r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 2 212 can be viewed as a multivariate analogue of the adf test for a wlit root (dickey, 1990). testing restrictions on 13 in equation (3), allows testing parameter restrictions on the long-run properties of the data. by testing restrictions on the a-matrix, the direction of causality within the model can be tested. this causality test has superseded those introduced by granger (1969). mosconi and giannini (1992), and hall and wickens (1993), developed similar estimation and testing procedures for causality within systems of integrated variables which exhibit cointegration. hall and wickens use a more restrictive definition of causality than mosconi and giannini, involving only 10ng-fw1 conditions. they suggest that a sufficient, but not necessary, condition for weak (long-run) causality is given by a simple restriction on the johansen loading matrix, a in n=apt. if the a-matrix has a complete column of zeros, then no co integrating vector will appear in a particular block of the model, thus indicating no causal relationship. using this approach for the bi-variate case of agriculture and another sector in the economy, this can be represented as an expansion of equation 3, namely: [ lua] = [ra,] [lua, -,] + [ala a.~o roi . luo, , a2a alo].[f3la a2o_ f32a f31o] [xa, -,] /3.20 xoi i (4) where x" is the agricultural sector's real product and xv is the real product of another sector in the south african economy, i.e. mining, manufacturing, transportation, construction, electricity and 'other' in this particular analysis. each of these sectors was used in sequence, i.e. causality was tested between agriculture and mining, then between agriculture and manufacturing, etc. a weather variable was iqcluded in each of these equations to accowlt for variations in climate. if ala~o, alo=o, a2a=o and a2o=0, then causality runs from the relevant sector '0' to agriculture and there is no feedback in the system from agriculture to the relevant sector. bi-directional causality requires al.~o, alo~, a2a~o, and a2o~0, while no causal relationship requires ala=o, alo=o, a2a=0, and a2o=0. results the a -matrix tests described above were performed, while the wald test of the restrictions were used to test the significance of the loading weight (hall and milne 1994, caporale and pirtis, 1995). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 213 sateb nr vol 1 (1998) nr:2 table 2: unit root tests on sectoral real product series dp variable ar dickeyi crdw johansen process fuller! augmented test" test dickev-fuller test agriculture, forestry -1.09 and fisbe ': levels first difference -5.72 1.87 5123 mining and quarrying: -oai 0.02 0.17 levels first differences -7.21 1.59 3 -1.86 0.01 -4.82 1.l6 transportation: levels 2 -0.61 0,01 first differences -5,89 la8 construction: levels -1.59 0.01 2.57 first differences -5.96 1.05 30.33 electricity: levels -0.44 0.03 first differences -6.74 1.41 others: levels -0.17 0.01 first differences -5.72 1.15 weather: levels -7.50 1.64 critical values -2.9 0.58 note: ·crdw is the cointegrating regression durbin watson test proposed by sargan and bhargava (1983) a rolling regression with a window size of 30 years was used in the analysis in an attempt to capture the variation in causality over time, i.e. causality was determined between the variables for the time period 1911-1940, then from 1912 to 1941. etc. to the end of the period. additional tests (dickey-fuller, 1981) for determining the order of integration of the individual variables were also performed (table 2). all the variables are integrated of the order one [i(l)]. the causality tests are presented in table 3, 1940 represents the 30 year sample (1911-1940). due to the extensive number of regressions tested, only a summary of the results is presented in the table. bivariate causality tests were then performed between all sector real products between 1911 and 1993 to determine whether agriculture was causally prior, which would suggest that growth in agriculture affects the growth of other economic r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 2 214 sectors. as the strength of the relationship is likely to vary over time, corresponding to different 'stages of development', a time-varying approach was used in the analysis. table 3: causality between real product of agriculture and other sectors causal period of uni-directional causality period ofbirelationship of no causal directional agriculture relationship causality with: period direction manufacturing 1940-1956 1957-1987 manufacturing to 1988-1993 agriculture t ransportati on 1940-1974 1975-1987 transport to 1987-1993 i agriculture construction 1940-1961 1962-1988 construction to 1989-1993 agriculture electricity 1940-1968 1969-1990 electricity to 1991-1993 agriculture other intermittent 1979-1988 other to agriculture 1952-1~ until 1951 1989-19 the causality results suggest no causal relationship between the sector gdps and agriculture from 1911 to about the late 1950s. this is contrary to a priori expectations. causality would be expected to exist between some sectors. a possible explanation is that most of the strong sector linkages occurred before 1911. agriculture dominated the economy until 1868 prior to the discovery of diamonds with economic growth remaining minimal (van der berg, 1993). the subsequent discovery of diamonds and gold stimulated the initial boom in infrastructural investment, which in the larger part of south africa took place during the last quarter of the nineteenth century. this is evidenced by the fact that the open railway mileage in south africa increased from 160 in 1875 in the cape colony to some 4167 around the tum of the century (brand 1969). the discovery of diamonds and gold also served to increase the rural population considerably. this larger market caused a surge in farming throughout south africa. where the market had mainly been wool, grain, hides and skins, there was now a market for fresh produce and meat. in consequence, there was a rapid change from a selfsufficient economy to intensive production methods (joubert and groenewald 1974). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 215 sateb nr vol 1 (1998) nr 2 the absence of a causal relationship between agriculture and manufacturing between 1940-56 and between agriculture and transport is somewhat surprising. however, as mentioned in an earlier section, the main driving force behind manufacturing in the early 1 940s was industrial expansion to support the war effort. while the major impact on agriculture was from agricultural policies on agricultural production, i.e.: the effects of the agricultural marketing boards. the mining sector was primarily responsible for the growth of the transport system. the direction of causality within the system becomes significant after the 1970s, with the predominant direction of causality being from manufacturing, transportation, construction and electricity to agriculture. however, from the late 1980s there is significant bi-directional causality, reflecting the greater integration of agriculture into the economy. this corresponds to the deregulation and liberalisation of many aspects of the agricultural sector, which made it more responsive to the market conditions faced by other sectors of the economy. to the extent that the sector has become more integrated, it has also become more vulnerable to changes in the economic environment in which it operates. changes in the operation of industries from which it buys inputs or sells output to, will impact more significantly on agriculture itself. this suggests that agriculture is currently at the initial stages of phase three of timmer's (1990) evolution of agriculture model discussed above, while it also shows some characteristics of stage four. agriculture in south africa can be separated into two distinct sectors, namely a large-scale commercial sector producing both food and industrial crops for sale by means of sophisticated production practices and a high level of purchased inputs, and a small-scale, basically subsistence sector using few inputs and producing primarily for its own needs. these different sectors are obviously at different stages of growth, with the small-scale sector positioned at the beginning of the first stage, and the large-scale sector positioned at the beginning of the third stage. conclusion this paper has attempted to identify the stages of grov.th in the south african economy with particular focus on agriculture. simple a-matrix causality tests were used to determine the direction of causality between sectors of the economy. the percentage share of the agricultural industry in the south african economy is relatively small and continues to decline as the economy grows. however, there has been a greater integration of agriculture within the economy in the 1990s as a result of the liberalisation of many aspects of the economy. thus, the agricultural sector will be increasingly subject to the changing economic environment and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 2 216 changes in the operation of industries from which it buys inputs and to which it sells output. the present stage of agriculture's development corresponds to the initial stages of phase three of timmer's (1990) proposed scheme where agriculture becomes a significant contributor to the overall growth process. in order to improving these contributions, a number of strategies are relevant for south africa. market expansion, investment in research and development, land reform and the reduction of small-scale biases will all help in enhancing performance to ensure increased efficiency, export earnings and employment opportunities (townsend, 1997). 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(1994). south african agriculture: structure, perfonnance and options for the future. discussion paper 6, infonnal discussion papers on aspects of the economy of south africa. southern african department, world bank, washington, d.c. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . journal 3.p65 ������������ ��� ����� �� �������������� ������ �������� ��� �� ���������� �� ����� �� ������� � � ����� � ���� �� ��������� ������� ���� � ���� ������� ������� ��� ������ � ����� ����������� ��� ���� ���� ����� �� �� ���������� ����� ��������� ������ ����������� ��� ���� ���� ����� �� �������� ������������ ��� ������� ��� ���������������� ������������� ���������� ����� ��������������� �� ������������� �� � �������� ��� �� ���� ������ � ����� ��� ��� ����!"!������ �� #���������� �������� �$%������ �� �� �� ����� ��� ���������� #��� �� ������ ������������������������ # ������&���� ����� ���������������� ��� ���� �������� �� ���������� �� ���������������'� �� � �������� � ��&� ��������������������� ��� ����������������� ��&� �&���� ��� ��� ���� ������� �� � ��� ������������� ��&� #������� �� � �� ����������������� �� � �� ���������������������� � ( ���������� ������������� �� �������������������� ����� �������������������)���������������� ����������� ����� ��������� ����� ������ ������������������ ������������������������� ��� ����� �� ��� ���������� ��� ���� ��� ������������ �������������������� �� ������ �������������� ���������� �� � � ���� ��&����� #������ ���� �� �� ����� � ���� ��� � ������� � �������� � ���� �� ���� �� �������� �� ���� � ���� �� � ���� ��� ����� ����� �� �� � ����� �� � � ���� ���� ���� � � ��� ��������� ��� ��� ���� �� � ��������� � ������� ��� ��� ���� ����� ��������� ����!��� ��������� � � ������������� �� ����� ������ �!!�� ���� ���� �� � �� ���� ����� ����� ��� ���� �� ���� ��!� �� � �� ����� "�� � � � !� ���� ���� � ������!������� ���� ��������� ���� ��!� �� ����� � �� ��� � �� ������� � ��� ������������ �#$�����%�&���� '(()* � "��� � ����� � �� � �� ����� � � ������ �� ��!���!��� �� ��� ����! 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���� ,) �-��%9 � b�79�0"0%-079 �7��0��079��6)../8�c0�� � � ������� ����12 #���� �������"�����d��-�� ������ �������� ��� ��&&������������� ��%������ ��� 2�3���& *������-��#��!������ �-��������� ��-��� ,( �0""0%����#�:�m0"mb9�� �:��%��#b""����: -%"�%% �� ��@��%���%0"�����6(+++8���� ��� ��� ����� �� ��� * ,-� ��� ��� �� ��� �� ���#� � ���!������� ���� ������� � %��� ��� �� ����%����� ��������������� � ���������0���� ����� � ����� ������ ����1� ,, �9%0 ���6)...8�/�� � �� ������� ���� * ,-� ��# �����$��&� +���� ���� �������"��� ������%0 ����1� sajems ns vol 2 (1999) no 3 523 financial management education: is there a gap between academics and practitioners? h p wolmarans graduate school of management, university of pretoria abstract from previous studies it seems that financial management may be regarded an important managerial skill. this study investigates the importance of different topics in finance. the ranking of these topics according to their importance, as perceived by academics versus practitioners, is compared here. it was found that some topics are indeed regarded as more important than others. there were significant differences in the rankings of topics by the two groups of respondents. areas which practitioners believe need more research to enhance the value of finance for south african managers are indicated. finally, conclusions are drawn about the implications of this study for the volatile management environment in south africa, and possible areas for further research are indicated. jelg30 introduction most experts would agree that financial management as a discipline can be regarded as one of the most valuable skills in the proverbial kitbag of a typical business manager. in a follow-up study of the career experiences of mba graduates at least 5 years after graduation, a number of mba alumni of a wellknown south african business school were requested to rank management disciplines in the order of importance perceived by them, in the light of the present as well as expected future business situation in south africa (jonker, 1997: 125). in both rankings the discipline of financial management was placed first. seeing that respondents were employed in diverse industries, these findings may well be representative of the general experience of mba graduates some years after completing their degree. in a related but independent study, the employers of these mba graduates were asked the same question, namely to rank a number of management disciplines in order of importance in the current as well as the expected future business situation in south africa (otto, 1997). once again, financial management was rated as the most important subject. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 524 sajems ns vol 2 (1999) no 3 other similar surveys have produced essentially the same results (bosch, radder, tait & venter, 1994; olivier, 1998). one possible explanation for such high ratings could perhaps be that a large number of managers may have rated financial management as second most important, after his/her own area of specialisation had been ranked. if this happened often enough across a number of management fields, it would not be surprising that financial management took the overall first place. firer (1990:21) has suggested that finance may well emerge as the key subject in the mba curriculum. ellis and williams (1993:4) have argued, that to judge a company's strategic position and probable direction requires a synthesis of both real (e.g. quality of management, products, markets) and financial factors (e.g. profitability, cash flow, debt levels) in order to fully assess the company and its likely future stock market performance. on the basis of these considerations, one concludes that if finance is not the most important business discipline, then it should be very close to the top. questions to be answered if financial management can be generally regarded as an important discipline in a manager's repertoire, what is the relative importance of different topics in the field of finance? also, what are the possible differences between academics and practitioners with regard to these topics? to put it more formally, answers to the following questions are needed: are there some topics in finance that might be regarded as more important than others for a general manager? are there differences in the way that academics and practitioners rate various topics in finance? which topics in finance do practitioners regard more important than others, and how does this compare with the topics that academics regard as more important? which topics in finance do practitioners regard less important than others, and how does this compare with the topics that academics regard as less important? are there areas in finance that practitioners believe should deserve more attention than others in the education of future south african managers? are there areas in finance that practitioners would like researchers to focus on, to enhance the value of the discipline to south african managers? r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 525 the aim of this paper is to fmd answers to these questions, that could be of value to a wide spectrum of role players. anyone who has even a superficial interest in finance, would be interested to know which topics in finance have been found most useful until now. if there are significant differences in the ratings of the various topics in finance by academics and practitioners respectively, this could be of interest to both these groups. academics need to keep in mind future training needs, and practitioners need to know where inputs should be made if future academic training is to get to grips with the problems that they experience. an evaluation of the areas in finance that both academics and practitioners regard as most important for a general manager, as well as those that are regarded of lesser importance, may be important to those who design the courses by means of which managers are trained in finance. it may also be important to the designers of specialised courses for future financial managers. in addition, designers of courses need to know of possible areas that practitioners believe deserve more attention than others in the education of future managers. finally, if practitioners believe that some areas in finance deserve more attention by academic researchers, this is likely to affect the nature of future research. empirical study at a conference of saf a (the south african finance association), participants were requested to rate different topics in finance in order of their importance to a general manager in south africa. the general structure of the topics set out by gitman (1997) was followed. respondents were asked to complete a twopage questionnaire, rating each topic according to importance on a 7-point scale. although no questions were asked to determine whether all south african tertiary educational institutions were represented at the conference, the 30 responses obtained in this study may be regarded as representative of the south african academic community in the field of finance. in a second survey, a number of financial directors of companies listed on the johannesburg stock exchange (jse) were requested to complete the same questionnaire, with two additional questions. the first of these asked which single aspect of finance, in the experience of these financial directors, needs more attention than others in the education of future managers, taking into account the changes in the new south africa. the second question asked respondents to state which aspect(s) of finance they believed academic researchers should focus on to enhance the value of finance as a discipline to r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 526 sajems ns vol 2 (1999) no 3 south african managers. respondents were also offered a summary of the research findings, when completed, if they were interested. the top 200 companies (in terms of market capitalisation on 31 december 1998) identified by the bureau of financial analysis at the university of pretoria and published by finansies & tegniek (26 march 1999), were regarded, for the purpose of the study, as the companies which represented the greatest value in the south african private sector. an attempt was made to establish telephonic contact with the financial directors of all of these companies in order to seek their co-operation. a questionnaire was faxed to 134 of these financial directors. of the questionnaires, 66 were returned, representing a 49% response rate, which could be regarded as sufficient, taking into account the nature of respondents' work and the claims on their time. results in table 1, the results of the surveys of the two groups of respondents are given, in the form of means and standard deviations of how the various topics were rated. table 1 means and standard deviations of topic ran kings by academics and financial directors i questopic academics financial signifition directors canee mean s.d. mean s.d. 01 the role of finance in the firm 5.50 1.96 6.39 0.80 0.002 *** q2 the income statement 4.90 1.40 5.95 1.00 0.001 *** 03 the balance sheet 4.90 1.42 5.61 1.04 0.007 *** 104 the cash flow statement 5.77 1.04 5.76 1.40 0.975 i q5 understanding fmancial ratios 5.20 1.45 5.05 1.28 0.601 ! 06 time value of money 5.43 1.72 5.31 1.39 0.728 q7 risk and return 5.63 .82 1.08 0.506 q8 valuation of securities 4.43 1.85 3.92 1.33 0.129 q9 cash flow and capital 6.03 1.03 5.65 1.27 0.153 budgeting qlo capital budgeting techniques 5.30 1.26 4.30 1.42 0.001 *** 011 the cost of capital 5.50 1.22 5.18 1.25 0.248 012 leverage and capital structure 4.87 1.48 4.76 1.48 0.738 q13 long-term debt 4.47 1.36 4.48 1.27 0.949 014 equity and stock markets 4.17 1.29 4.21 1.34 0.877 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 527 table 1 continued . questopic . academics financial signifiition directors cance 1 mean s.d. mean s.d. ,q15 efficient markets 3.40 1.65 3.80 1.17 0.173 qi6 dividend policy 4.03 1.43 4.03 1.11 0.991 iqi7 pref shares, convertibles, 2.93 1.60 1 3.30 1.32 0.238 i warrants qi8 shortand medium-term i 5.1o 0.99 4.55 1.38 0.051 * i financing iqi9 cash and marketable securities 4.47 1.57 3.89 1.18 0.049 ** i q20 accounts receivable and 5.17 1.26 5.20 1.47 0.922 inventory iq21 1 mergers and acquisitions 3.70 1.70 4.33 1.41 0.059 * iq22 international finance 14.27 1.78 4.00 1.55 0.458 iq23 futures, options, derivatives 13.73 2.00 3.74 1.66 0.981 q24 relationship with other 4.40 1.85 4.77 1.40 0.279 disciplines q25 foreign exchange risk 4.10 1.67 5.29 1.21 0.002 *** i management iq26 value-based management 5.14 1.38 4.92 1.37 0.487 levels of significance: *** 1 %; ** 5%; * 10% a multivariate analysis of variance (manova) was performed in sas (statistical analysis systems) on the mainframe at the university of pretoria to determine whether any elements of the two vectors of means are significantly different, taking into account the variance and the dependency of response (sas institute, 1985). seeing that provision was made for possible correlation between questions, this procedure is more appropriate than the 26 t -tests that might have been performed on the data. (if the t -tests had been performed, this would have capitalised on the level of significance, which would have increased the possibility of a type ii-error.) from table 1 it is evident that the mean ratings of different topics (each on a 7point scale) are variable, ranging between 2.93 and 6.03 for academics (see also table 2) and between 3.3 and 6.39 for financial directors (see also table 3). from this it seems that both groups of respondents regard at least some topics in finance more important than others. this would answer the first question posed above, but more evaluation is needed to determine whether these differences are significant. i 1 i r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 528 sajems ns vol 2 (1999) no 3 a proc glm procedure was also perfonned in sas on both datasets individually, to detennine whether, on average, respondents had rated questions i to 26 in a similar manner or not. the most appropriate test here was the waller-duncan k-ratio t-test, perfonned on all main-effect means (sas institute, 1985:118,487). the results are set out in tables 2 and 3, where means with the same letter under "grouping" are not significantly different at p=o.05. this indicates that some topics in finance are regarded as significantly more important than others, in the opinion of both groups of respondents. discussion from table i it is evident that the mean ratings differ significantly for eight of the 26 topics. topics that financial directors regarded as significantly more important than academics did, are the role of finance in the finn, the income statement, the balance sheet, mergers and acquisitions, and foreign exchange risk management. this could imply that these topics should be given more weight in academic courses than is the case at present. perhaps surprisingly, many topics were rated rather similarly by the two groups of respondents. these include the cash flow statement, long-tenn debt, equity and stock markets, dividend policy, accounts receivable and inventory, and futures, options and derivatives. the fact that these ratings are numerically almost the same, also indicates that the one group of respondents did not consistently rate some topics higher than the other group. (if such differences in ratings had occurred, the need for a scale transformation might have arisen, where only the relative ratings of the two groups could be compared. fortunately, this was not the case.) academics rated the following topics as significantly more important than did financial directors: capital budgeting techniques, shortand medium-tenn financing, and cash and marketable securities. this could mean that these topics are, at present, receiving more attention in academic courses than practitioners believe to be necessary. in fact, there seem to be at least some significant differences in the perceived importance of the various topics in finance, as seen by financial directors on the one hand and academics on the other. this answers the second question posed above. tables 2 and 3 give the relative rankings of financial topics by academics and financial directors respectively, indicated by the average score on a seven-point scale. if a topic was rated as more important, it had a high score; a relatively less important topic would again have a low score. the waller grouping indicates that topics with the same letter are not rated significantly differently. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 529 this means, in table 2, that cash flow and capital budgeting (q9) are regarded as significantly more important than capital budgeting techniques (qlo), but not significantly more important than the time value of money (q6). table 2 ranking of topics by academics mean grouping a b c a b d c a b d c a b d c b d c b d c 9 b d c 10 5.14 b d c 11 5.10 e d c fmancin 4.90 e f 4.90 e f d 4.87 e f d 4.47 e f g 4.47 e f g 4.43 f g 4.40 f g 19 4.27 h f g 20 4.17 g 21 4.10 h g 4.03 h i 3.73 h i 3.70 h i 3.40 j i pref shares, convertibles, 2.93 j warrants r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 530 sajems ns vol 2 (1999) no 3 when the topics ranked in the first five places of tables 2 and 3 are compared, it is interesting to note that four of these five topics were seen to be important enough by both academics and financial directors to occupy one of the top five places. thus both groups of respondents agreed that the role of finance in the firm (ql), risk and return (q7), the cash flow statement (q4) and cash flow and capital budgeting (q9) are among the five most important topics in the ranking. this confirms the importance of a holistic view of the place of finance, the important variables risk and return, as well as cash flow and its application. table 3 ranking of topics by financial directors ranquestopic mean grouping king tion 1 01 the role of finance in the firm 6.39 a 2 02 the income statement 5.95 b 3 q7 risk and return 5.82 b 4 04 the cash flow statement 5.76 b 5 09 cash flow and capital budgeting 5.65 b c 6 03 the balance sheet 5.61 b c d 7 q6 time value of money 5.31 e c d 8 025 foreign exchange risk management 5.29 e d 9 020 accounts receivable and inventory 5.20 e f 10 oil the cost of capital 5.18 e f 11 q5 understanding financial ratios 5.05 e f g 12 q26 value-based management 4.92 f g 13 024 relationship with other disciplines 4.77 h g 14 q12 leverage and capital structure 4.76 h g 15 018 short"'a.55 h i 16 q13 long-term debt 4.48 h i 17 q21~ 4.33 j i 18 qio j i 19 q 14 i equity and stock markets 4.21 j i 20 q16 dividend policy 4.03 j l 21 q22 international finance 4.00 j l k 22 08 valuation of securities 3.92 l k 23 q19 cash and marketable securities 3.89 l k 24 015 efficient markets 3.80 l 25 q23 futures, options, derivatives 3.74 l 26 q17 pref shares, convertibles, warrants 3.30 m r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 531 if the first ten places are compared, more topics are added to this list, namely, the time value of money (q6), accounts receivable and inventory (q20) and the cost of capital (qil). notably absent from the first ten places ranked by academics, are the income statement (q2), the balance sheet (q3) and foreign exchange risk management (q25), which confirms the results set out in table l. the third question posed above as to which topics are regarded more important by both groups, has now been answered. when one compares the topics ranked in the last five places in tables 2 and 3, it is clear that the topics futures, options and derivatives (q23), efficient markets (q15) and preference shares, convertibles and warrants (qi7) were regarded by both groups of respondents as among the least important to them. both groups seemed to agree that these topics could be regarded as rather specialised and therefore not quite as important to someone who needs a general knowledge of finance. if one compares the last ten positions as ranked by both groups, more topics are added to the "less important" list. these include valuation of securities (q8), equity and stock markets (qi4), dividend policy (qi6), mergers and acquisitions (q21) and international finance (q22). this does not mean that these are totally unimportant topics, but rather they are considered less important, at least for a general manager. from the waller grouping in tables 2 and 3, one can also see that some of these topics were rated as significantly less important than many other topics. the fourth question posed above, as to which topics are regarded as less important by both groups, has now also been answered. table 4 ,question 01 q2 03 q4 05 q6 q7 08 topics in need of more attention in training future managers, and topics in need of more research, as perceived by practitioners topic more i~:s attention arch frequency 0/0 frequency 0/0 the role of finance in the firm 4 17 2 5 the income statement 0 0 0 0 the balance sheet 0 0 0 0 the cash flow statement 4 17 5 12 understanding financial ratios 4 17 8 20 time value of money 0 0 3 7 risk and return 3 13 4 10 valuation of securities 1 4 0 0 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 532 sajems ns vol 2 (1999) no 3 table 4 continued questopic more needs tion attention research frequencv 0/0 frequency 0/0 q9 cash flow and capital 2 8 i 2 budgeting qio capital budgeting techniques 0 0 2 5 oil the cost of capital 0 0 i 2 qi2 leverage and capital structure i 4 0 0 q13 long-tenn debt 0 0 0 0 qi4 equity and stock markets 0 0 0 0 ~effident m.,kets 0 0 0 * i dividend policy 0 0 0 qi pref shares, convertibles, 0 0 0 warrants qi8 shortand medium-tenn 0 0 0 0 financing qi9 cash and marketable securities 0 0 0 0 q20 accounts receivable and 0 0 0 0 inventory q21 mergers and acquisitions 0 0 i 2 022 international finance i 4 0 0 023 futures options derivatives 0 0 2 5 q24 relationship with other 0 0 i 2 disciplines q25 foreign exchange risk 0 0 0 0 management q26 value-based management 4 17 ii 27 total 24 100 41 100 in two of the questions above, financial directors were given the opportunity to share some of their perceptions of future developments. the responses to these questions were roughly classified in the structure of the original questionnaire, to identify the principles involved here. if a respondent indicated, for example, that "valuation of a company" needed more emphasis during training, it was reasoned that the same principles apply as those in the case of "valuation of securities". the results of the responses to these questions, set out in table 4 should thus be regarded as an attempt to interpret the principles indicated by respondents. the fifth question posed above relates to areas in finance that practitioners believe deserve more attention in the education of future south african r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 533 managers, taking into account the changes in the new south africa. only 24 respondents answered this question. prominent topics here (each receiving 17% of the response) are: the role of finance in the firm, the cash flow statement, understanding fmancial ratios, and value-based management. the sixth question in the study asked whether there are areas in finance that practitioners would like researchers to focus on, to enhance the value of the discipline to south african managers. only 41 respondents answered this question. notable topics here are: value-based management (27% of response), understanding fmancial ratios (20%), the cash flow statement (12%), and risk and return (10%). thus it seems that there is a real need for research that would give south african managers a better understanding of financial statements, and ways of using the important topic of value-based management to their benefit. conclusion from this study, it follows that some topics in finance are indeed regarded more important than others by both academics and practitioners. these include the role of finance in the firm, risk and return, the cash flow statement, and cash flow and capital budgeting. topics generally regarded as least important (or so specialised that they are not part of general skills), include efficient markets, futures, options and derivatives, and preference shares, convertibles and warrants. topics that practitioners rated as significantly more important than the academics did, include the role of finance in the firm, the income statement, the balance sheet, mergers and acquisitions, and foreign exchange management. topics that academics again rated as significantly more important than the practitioners, include: capital budgeting techniques; shortand medium-term financing; and cash and marketable securities. although the focus here was on the relative importance of various topics in finance to a typical general manager, the possibility cannot be excluded that the findings might also apply to any financial manager/director. this would then mean that the results of this study could be of interest to a fairly large circle of business leaders in south africa. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 534 sajems ns vol 2 (1999) no 3 areas for further research areas for further research include the ways in which financial management as a discipline can be made more valuable to management as a whole. this could be done, for example, by means of a survey in which practitioners would have the opportunity to disclose ways of presenting financial knowledge that they have found to be most helpful in the past. the extent to which different kinds of information technology, including simulation games, are used in educating financial as well as general managers could also be investigated. is it true that there is a vast potential for the use of simulation games in a subject seen by managers as useful in their day-to-day work? this study concerned the experience of financial practitioners in private companies. a similar study could be done on the experience of practitioners employed by government or semi-government institutions. whereas the emphasis in this study fell on financial management, institutions that train future managers might also be interested in the relative importance of topics in other managerial disciplines. finally, researchers should not ignore the topics that practitioners have identified as useful in raising the value of financial management to south african managers. the important topic of value-based management is one of these. another is the ways of using financial ratios in the better management of an enterprise. much has changed over the past few years, but for any enterprise, the bottom line is still that the bottom line is important. references bosch, j.k., radder, l., tait, m. and venter, dj.l. (1994) "empiriese bevindinge met betrekking tot onderrigbehoeftes in bedryfsekonomie", management dynamics, 3(2): 17-38. 2 ellis, j. & williams, d. (1993) corporate strategy and financial management, pitman, london. 3 finansies & tegniek (1999) 26 march 1999, appendix: top 200 companies 1999. 4 firer, c. (1990) "should mba students study the theory of finance?", investment analysts journal, summer: 16-23. 5 gitman, l.j. (1997) principles of managerial finance, addisonwesley, new york. 8ed. 6 jonker, w.o. (1997) a follow up study on the educational experience of mba graduates, unpublished mba dissertation. university of pretoria, pretoria. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 535 7 olivier. g.j. (1998) die onderrig en opleiding van laevlakbestuurders, unpublished phd dissertation. vista university, pretoria. 8 otto, p.p. (1997) a comparison of the perceptions regarding mba studies of different stakeholders, unpublished mba dissertation. university of pretoria, pretoria 9 sas institute (1985) sas user's guide, 5ed., cary, north carolina r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 8 sajems ns vol 1 (1998) no 1 a view on the treatment of collusive and restrictive practices in competition policy wdreekie e p bradlow professor, department of business economics, unil'ersity of the witwatersrand abstract south african competition policy is in a state of flux. while professing to serve so-called national interest, legislation has tended to overlook the principles of economic efficiency and conswner welfare. 'the south african national drug policy is a case in point. the best defence against collusion and restrictive practices in business is competition, but the department of health favours blanket rules like uniform pricing and a fixed fee-for-service. thus supermarkets may not employ dispertsing pharmacists, and uniform price legislation would make it illegal to negotiate discounts on prescription medicines with retailers. as a rule cortsumers are the losers. many fallacies are contained in the debate on the "right" competition policy for south africa. for example, a firm may appear big simply because the domestic market is small. introduction this paper begins with a brief overview of south african competition policy since 1979. in particular, the approach of the competition board to restrictive practices and collusive behaviour, rather than towards monopoly or merger activity, is detailed. four main manifestations of what is sometimes regarded as evidence of restrictive practices are then discussed. 'these are the presence of parallel pricing, the favouring of associated firms, predation, and price discrimination. 'the board has recently decided against the cement producers cartel. some writers (e.g. leach, 1994) have argued that the decision was inappropriate given both the guidelines of the act and the theory of cartels. conversely. this paper shows how the board has consistently refused to pronounce agairtst another long standing cartel, the retail pharmacists. again appropriate appeal to the act and use of economic theory could have been used to suggest that this stance also is in error. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sates nr vol i (1998) nr i 9 in this section of the. paper reference is made in particular to competition board report, no 52, 1996. the paper concludes with some general thoughts on the future direction of competition policy legislation. current sol'th african policy a brief review the maintenance and promotion of competition act of 1979 enables the competition board to examine three main aspects of business, namely monopoly situations, acquisitions and restrictive practices. its definition of a monopoly situation is broad: ... a situation where any person, or two or more persons with a substantial economic connection, control in the republic or any part thereof, wholly or to a large extent, the class of business in which he or they are engaged in respect of any commodity. so too is its definition of acquisition: ... the acquisition by the holder of a controlling interest in any business or " undertaking involved in the production, manufacture, supply or distribution of any commodity, of such an interest (a) in any other business or undertaking so involved; or (b) in any asset which is or may be utilised for or in connection with the production, manufacture, supply or distribution of any such commodity, provided such acquisition has or is likely to have the effect of restricting competition directly or indirectly. however, the "acquisition" definition is more precise in that it relates to ''restricting competition". the definition of "restrictive practice" is also helpful, and again the criterion required for implicit condemnation is the restriction of competition. restrictive practice means: any agreement, arrangement or understanding, whether legally enforceable or not, between two or more persons; or any business practice or method of trading, including any method of fixing prices, whether by the supplier of any commodity or otherwise; or any act or omission on the part of any person, whether acting independently or in concert with any other person; or any situation arising out of the activities of any person or class or group or persons, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 10 sajems ns voll (1998) no 1 which restricts competition directly or indirectly by having or being likely to have the effect of restricting the production or distribution of any commodity; or limiting the facilities available for the production or distribution of any commodity; or enhancing or maintaining the price or any other consideration for any commodity; or preventing the production or distribution of any commodity by the most efficient and economical means; or preventing or retarding the development or introduction of technical improvements or the expansion of existing markets or the opening up of new markets; or preventing or restricting the entry of new producers or distributors into any branch of trade or industry; or preventing or retarding the adjustment of any profession or branch of trade or ir;dustry to changing circumstances. it took three years (as demonstrated by the board's annual repons) for the board to tilt its interpretation of its definition of monopoly to the structural rather than a behavioural one. the same period saw the "public interest" concept added in such a way that consumer welfare ceased to be the ultimate yardstick of whether or not a monopoly situation was to be condenmed. the first annual repon of the competition board (1980, para ii) highlighted points regarded as crucial. the minister of economic affairs was quoted thus: . .. preservation of the free market system ... is the cornerstone of our ". economic life [and] , .. the preservation of healthy competition .. , [is] an imponant condition ... [for] economic development. to achieve these ends the board was established to help implement the 1979 maintenance and promotion of competition act to: ... provide for the maintenance and promotion of-competition; .. , [prevent] or control restrictive practices; ... [prevent or control] the acquisition of controlling interests in businesses and undenakings; [and] ... [control] matters connected therewith (para 12). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr vol i (1998) nr i 11 in short, market concenrration (smallness of fum numbers and largeness of fum size) was not included in the board's terms of reference. within a year, this constructive approach to competition and sober approach to big business had altered. the second annual report (para 9) said: oligopolies ... [can cause} prices to congeal at unduly high levels, while conglomerates can distort competition by ensuring market support for their members at the cost of more efficient outside fums. clearly, these oligopolies and conglomerates should be under constant scrutiny so that possible abuses can be detected and, where necessary, corrected in the public interest. the board's third (1982) and fourth (1983) annual reports took similar positions (paras 16-17 and 12-13 respectively) and the latter (para 14) explained why: market conduct is never unrelated to market structure ... [so] both are of the utmost imponance for the efficient implementation of competition policy. thus south african competition policy in its very early years was designed to take account primarily of the newer thinking in industrial economics, which downplayed the importance of structure as a criterion. however. after 1982. structure, in conrrast to the more permissive policy abroad, emerged as a key criterion for investigation. moreover, although not detailed in the original act, the board came to view the "public interest" rather than the consumers' interest as the "final criterion" in judging a monopoly or a merger. it has proved difficult for the board, however, to agree on what the public interest is. this makes its judgements unpredictable and creates uncenainty for consumers and producers alike. one chairman of the board (dr 0 mouton, in 1982) defined it as "the interest of consumers, producers and traders as well as the broad national interest". the national interest in turn was defmed as achieving ... economic growth, the efficient utilization of resources, an acceptable pattern of income distribution, a desirable general price level, and equilibrium in the balance of payments. in practice, when the board has tried to apply this criterion its verdicts have not been consistent. this is not surprising since the definitions embrace groups whose interests do not necessarily coincide. and economic goals which may be mutually exclusive. not only are the board's reports sometimes inconsistent in how they interpret the public interest, but even in the same report members of the board may express disagreements in minority reports. the mechanistic structuralist approach towards monopoly did not survive long. the second chairman, dr s naude, argued for a less structurally r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 12 sajems ns vol i (1998) no 1 constrained approach, though he also emphasised the "public interest" as a cntenon. he stressed that effective competition was independent of market structure: "it could include both the extremes of atomistic competition ... and the oligopolistic market structure with a few large dominant firms." he went on to define effective or workable competition as "a market situation that (a) holds the essential benefits of competition such as freedom of entry ... a choice for buyers and the inability of sellers to impose terms (including prices) on buyers; (b) is practical, i.e. workable; and (c) can be reconciled with the public interest"'. in 1986, dr naude noted the counter-revolution that had taken place recently in us policy and ascribed it to, inter alia, the increased influence of economic analysis. he quoted a leading us anti-trust jurist, judge robert bork. who expressed the "hope that the process will continue until this body of the law becomes completely economically rational". at present in the 1990s, however, it appears as if the economic analysis which is applied is based on both approaches, which have quite different policy implications. the competition board still has some way to go in applying consistent criteria in its decisions and recommendations. this policy ambivalence was highlighted by the approach adopted towards restrictive practices. also in 1986. per se prohibitions of certain agreements were introduced as additions to the 1979 act (including resale price maintenance. horizontal price collusion and collusion on conditions of supply). exemptions could be granted if it could be shown that the agreements were in the public interest, whereas generic restrictive practices in the original act were "restrictive" only if they restricted competition as defined, not simply because they existed per st. restrictions against the interest of consumers can certainly occur the point is, either they do not persist or else they arise because they are, in fact. means of lowering costs and therefore prices to consumers. per se prohibition denies consumers the opportunity to discover if this is ttue. now, in the late 1990s, a major review of south african policy is contemplated, prompted by political. structural and populist concerns. if economic and consumer-interest criteria were regarded as the only relevant considerations. such a root-and-branch examination would not be necessary. before concluding with out own recommendations for reform, we examine some of the concerns already detailed from the second annual report. (namely prices which are held at "congealed" levels and "market support" for conglomerate members by use of discriminatory practices.) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr vol 1 (1998) nr 1 13 parallel and uniform prices to some theoreticians unifonn prices are a result of collusion and are to be expected because of concentrated industrial structures. this theory does not stand up to examination. "parallel pricing" is the practice by which two or more sellers set their prices at or about the same level and change them at or about the same time and by the same amount or proportion. the important matters that need to be established are whether this fonn of behaviour is competitive and/or if it can be expected to have consequences which may be detrimental to the public interest as measured by consumer welfare. areas in the 1990s where this has been of concern to the competition board include cement prices. bank interest rates, retail pharmacy seiling prices and cellular phone rates. in the perfect competition of elementary theory no individual seller is able to influence the market price. market price is determined impersonally by the interaction of the total supply of the product and the total demand. the individual seller is a "price taker" in that he or she cannot influence the price hy his own actions. it is in this sense that these markets are customarily described as perfectly competitive. sufficient conditions are a large number of sellers (and indeed of buyers), all of substantially similar size, standardisation of different sellers' products. and a high degree of knowledge of market prices among sellers and buyers. these conditions prevail in various commodity and financial markets. in such markets the price charged by all sellers will be uniform. no individual seller will be able to charge more than the market price or will wish to charge less than that price, whatever his own costs. changes in demand conditions in the market. or in the costs of all or a significant number of sellers, will result in prompt change in the market price since all sellers will fmd it to their advantage to charge the price at which total supply and total demand are balanced in the new condition. the fact that sellers' prices change at or about the same time and by the same amount in these circumstances would be evidence of a highly competitive situation. moreover, with the further condition that entry of new sellers into such markets is easy, there would be no reason to expect the rate of profit to deviate for long from the minimum necessary to attract investible funds. given the risks involved. we can call this rate of profit the "competitive" or "normal" profit. observed profit rates in such markets may display fluctuations and may not correspond to the normal rate at anyone time. but there can be no long-run tendency for profit rates to remain above the competitive level. in a situation of economic not legal monopoly (a single seller), there will also be a unifonn price since there will be only one price and one product. the decision-taker in such a situation has a more difficult job in setting prices than the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 14 sajems ns vol 1 (1998) no i "price-taker" of perfect competition. he or she cannot accept the market price (since there isn't one) but must choose by more or less infonned trial and error what is believed to be the wealth-maximising price. selection of a price above or below that level will result in a wealth loss. furthermore, there can be no presumption that the wealth gained by selling at the (unknown) optimal price will be at a level above "normal profit". provided others can readily enter the industry (provided it is a "contestable" market), the monopolist's wealth-maximising prices will be constrained and his capital will earn only the competitive rate of return. contestability requires not large numbers of firms, but only easy and low-cost entry and exit. an incumbent monopolist cannot charge a high price and succeed in earning returns above the competitive norm in a contestable situation. he will instead be subject to competition from a new entrant, so destroying the monopoly. alternatively, the threat of such entry, or the effect of actual hit-and-run entry, will be such as to bring price and returns down to the competitive level, leaving the economic monopoly intact. concern about monopoly arises when entry is barred in some way say by govenunent regulation. the incumbent can then charge a higher price, earn higher returns, and provide consumers (because of the higher price) with lower volumes of the commodity than they would otherwise purchase at more competitive levels. in addition, any spur to higher efficiency or innovation may be blunted. uniform or parallel prices can thus be regarded as the competitive norm whether a diffuse or a single-seller structure is considered. similarly, returns or profits can be regarded as appropriate in either situation (with the added requirement of contestability in monopoly). it is when we turn to markets which are not characterised by a large number of sellers that we may encounter a practice which gives rise to concern, that is, collusive parallel pricing. industries with relatively few sellers, or in which a few sellers dominate the market, are generally termed oligopolistic. in modem economies a considerable number of markets are oligopolistic. the distinctive feature of oligopolies is that a major decision by one seller will have a significant effect upon the other sellers and that the reactions of those sellers will in turn affect him. recognition of these interdependencies may deter the individual seller from self-interested price changes which must be made at the expense of competitors. instead, pricing policies may be co-ordinated with the aim of balancing the interests of all the sellers as a group. price changes may then be initiated only when there is good reason to expect that all sellers will benefit, whether the change is upwards or downwards. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr vol 1 (1998) nr 1 15 in short, the sellers may try to act in collusion, tacitly or explicitly, as if they were an economic monopoly. this is often termed collusive or cartel behaviour. decisions are taken with group welfare in mind. rather than being prompted by a rivalrous desire to get one step ahead of the competitors. the belief is that pro rata shares of profits resulting from group wealth-maximising behaviour will be greater than would accrue if individualistic, but self-defeating, motivations dominated. the social costs of noncontestable monopoly would therefore accrue. in fact, as opposed to belief. firms will collude only if the expected benefits are greater than the expected costs. the costs of collusion may prevent any attempt to collude. an attempt to collude may fail and, indeed, typically will fail as discussed in the following paragraphs. moreover, even a successful collusion will be far from perfect and so the colluding frrrns will still fail to act as if they were a monopoly. these assertions are now examined more closely. george stigler's view of cartels was that they are either tacit or explicit agreements which. because of rivalry. seldom last. 'they are gentlemen's agreements: where they seldom are or long do.' collusive parallel pricing is understandable but it will not persist (see stigler, 1966. ch 13). there are several strands to the argument. individual firms will always have an incentive to chisel or cheat on any explicit or implicit price agreement. such cheating will quickly be noticed and responded to by competing price reductions (leading to non-collusive uniform prices providing nonnal returns). to guard against chiselling firms may set up monitoring mechanisms (of each other) or allocate shares of market or territories for exclusive use. this is costly and/or agreement may be difficult. the less likely outcome is agreement (e.g. efficient firms do not like feather-bedding inefficient ones, each likes a "fair" share of profits and ''fairness'' is difficult to define) the more likely outcome is cartel breakdown. cartel breakdown by chiselling (price rivalry) is also more likely the higher is the ratio of fixed to total costs in an industry. given a relatively high burden of fixed costs, a "voluntary" diminution of the flow of cash revenues (by "agreeing" to high uniform prices and claiming to forgo chiselling) may create financial difficulties. this is particularly true in times of market depression or its supply-side corollary. capital outlay growth. further, cartel breakdown through cheating (price rivalry) is also likelier in a rapidly growing industry. if demand is rising fast, other things equal, the likelihood of being instantaneously spotted cutting price will appear to be less. the impact on rivals' current outputs need not now be negative -you r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 16 sajems ns vol! (1998) no! may merely slow their rate of growth. rivals, of course, each reason in the same way, and the collusion crumbles. if existing firms do not cheat and pull prices down to lower (but still unifonn) levels, then as in contestable monopoly, new firms will enter and achieve the same result. indeed even the threat of their entry can have this result. (again, as in monopoly, the situation must be contestable, and entry easy to activate.) as with perfect competition and contestable monopoly, unifonn parallel prices and the profits derived therefrom simply represent convergence on the competitive norms. this analysis can be applied to most if not all so-called collusive areas of industrial practice. collusion may be an instinctive behaviour pattern for many businessmen but competitive forces rob them of their ability to indulge it. a ward government protection, however, and new forms of competitive behaviour, new rivals, new entrants, and "cheating" by existing competitors can be ruled out by law. consumers need reflect only on the cartels protected by government to see how easily they could be better off. (medicines and petrol prices are only two examples of the results of outmoded distribution channels protected by government; clicks may not employ dispensing pharmacists and pick 'n pay may not cut petrol prices.) favouring associated firms the charge that large pyramidal or conglomerate firms selectively favour associated companies for monopolistic reasons is very unlikely in theory. judge bork in his analysis of anti-trust in the usa points out that "it is impossible for a finn acrually to sell to itself for less than it sells to outside finns because the real cost of any transfer ... includes the return that could have been made on a sale to an outsider. no matter what the bookkeeper writes down as the transfer price, the real cost is the opportunity foregone." (if r am a dressmaker buying in fabric at r50, selling completed dresses at rloo, and i give a new dress to my wife, my cost is r100, not r50, no matter what figure i put in my books.) subsidising associated firms, if it occurred, would be self-deception, involving sacrifice of returns, and merely providing encouragement to the associate to operate at an uneconomical rate. (see bork, 1993, p.228.) cross-subsidisation cannot increase existing returns, nor can it enhance any above-normal or monopolistic returns. as judge bork points out (p.229), above-normal returns can be abstracted only once from the value chain and as we have already seen, firms cannot, unless protected r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr voll (1998) nr 1 17 by goverrunent in one way or another, act as if they were monopolists in any event. bork (p.229) demonstrates this by looking at an integrated manufacturer and retailer. if each tries to maximise profit by restricting output, the result will be a price higher and an output smaller than the monopoly point. (my own text, managerial economics, 1995, contains several pages of rules managers can apply in their own interests to avoid this unhappy outcome.) the rationale starts by looking at a monopoly manufacturer selling to competitive retailers. the manufacturer will set output and price so that consumers will be charged the monopoly price after retailers have added their costs, including a normal return. the manufacturer will not want retailers to earn more (since that would be foregone profit), nor will he want them to earn less, since then retail investment and so throughput would ultimately decline to the manufacturer's detriment. similarly, if retailers earned more and so expanded, the manufacturer would be paying for unwanted retail services. if the manufacturer takes over the retail sector, the demand he faces and costs he would incur will be unchanged. his profit-maximising output decision will thus also be unchanged. there is only one monopoly profit. predation the only other reason for fear of monopolistic abuse by cross-subsidisation is predation: that is, the intent to drive independent firms out of business either by a direct price war or by selling inputs to associated ftrms at such low prices that the associates can indulge in a price war. after a successful price war prices can be raised to monopolistic levels. if this is the case, of course, it immediately suggests that firms so accused cannot be currently abusing their market positions (monopoly returns can be abstracted only once in the value chain). once achieved, any subsequent vertical relationship could be examined for abuse in due course. ex posl analysis, however, is not very helpful for policy makers before the event. again, appeal must be made to both theory and precedent. the idea of future abuse (predation) as the intent is very unlikely. to succeed, predation requires losses by both victim and predator today so that the predator can maintain higher prices tomorrow, earning above normal profits for long enough to recover both of these losses. entry by new rivals or chiselling by existing ftrms is then even more attractive and would easily defeat the project. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 18 sajems ns vol 1 (1998) no 1 restrictive practices and price discrimination in both the usa and the uk restrictive practices, collusion and "anti-competirive" devices were either deemed illegal from the days of the original sherman act (1890) or, in the case of the monopolies and restrictive practices act (1948) at the very least, subject to investigation. the uk legislation was strengthened by the restrictive trade practices act 1956 which deemed that all agreements between finns (not just the "legal" monopolies which held 33 percent [later 25 percent] of the relevant market) had to be registered officially and were presumed to be against the public interest unless the non-criminal restrictive practices court deemed them to be acceptable against a list of prescribed criteria (which included a final, 'catch-all' public-interest yardstick). the two main additional pieces of us legislation are the robinson-patman act 1936 and the federal trade commission act's ban on false and misleading advertising which resulted in major (but indecisive) investigations in the i 970s. the robinson-patman act was passed because of perceived weaknesses in the clayton act 1914 which prohibited price discrimination which 'substantially' lessened competition or tended 'to create a monopoly'. the clayton act excludes from this prohibition discrimination owing to differences in grade, quality or quantity of the good sold; discrimination which makes 'due allowance' for differences in cost; and third, discrimination 'carried out in good faith' to meet a competitor's price. small traders were not protected since the quantity clause provides an easy escape; moreover the courts refused to apply the law when the discrimination resulted from the pressures of large traders on their suppliers. these issues became increasingly apparent with the advent of large-scale retailing during the 1920s and 1930s. the depression coincided and the problems of smalland medium-sized buyers were compounded by the tendency of manufacturers to shade prices and give less than overt rebates in the face of declining demand. the trend towards government approval of cartelization at that juncture of history was embodied in the national recovery administration in the usa and the robinsonpatman act was passed against that background. its main purpose was to prevent powerful retailing groups from obtaining 'undue' favours from their suppliers relative to smalland medium-sized traders. it prohibits the charging of different prices to different purchasers of 'goods of like grade and quality' if the effect 'may be substantially to lessen competition or tend to create a monopoly ... or to injure ... competition'. another section renders it illegal for a buyer 'knowingly to induce or receive a discrimination in price'. the refunds allowed relate to perishability, obsolescence. 'due allowance for differences in the cost ... resulting from the differing methods or quantities' specific to the transaction in question. and/or that it was done 'in good faith to r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr vol i (1998) nr i 19 meet an equally low price of a competitor'. neale (1960, pp.252-3) summarizes the case law history of the act's application as follows: [itj will be met with frank unbelief. the idea that a manufacturer may break the law by granting a wholesaler's discount to a wholesaler who also runs retail shops, or by selling goods direct to retailers at a price higher than one of his wholesalers may be charging, or by beating an offer made to an important customer by a rival manufacturer or even by matching the offer unless he is satisfied that his rival can justify his low price by cost savings ... may simply seem incredible. but incredible or not, that is the us law. the muddle is inevitable given the conflicting objectives of the act. it is attempting to protect small business against price disadvantages on the one hand, while simultaneously attempting to combat price discrimination as anti-competitive. the difficulty industry has with the law is illustrated by the 'good-faith' pricematching defence. to succeed, the seller must show that the matched price is itself lawful. this necessitates knowledge of the competitor's own price and cost structure but in a classic catch·22 if he shows he has such knowledge he may be prosecuted for conspiring to restrain trade under the shennan act. further confusion is caused by the phrase 'price differences' which is used in the legislation, not 'price discrimination', which is a technical term indicating disproportionality of price : marginal cost ratios. thus identical prices with different costs (uniform price discrimination) cannot be touched by the legislation. in 1980 the us department of justice recommended repeal of robinsonpatman, as well as the section of the clayton act which it had amended. but to date this has not happened. in the interim it has fallen into disuse but prior to 1980 it certainly had anti-competitive effects by deterring firms from engaging in selective price-cutting (which is one main reason why economists argue cartels cannot survive absent government regulatory support). essentially the act is concerned more with protecting particular competitors, rather than competition. a case study: pharmaceutical pricing in south africa in a 1994 study entitled uniform pharmaceutical pricing, ernst r bendt, concluded (p.20) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 20 sajems ns vol 1 (1998) no 1 unifonn pricing provisions should be recognised for what they are: anti-competitive policies designed to protect a diminishing segment of the increasingly price-sensitive retail marketplace. public policy should ... {be) encouraging more price flexibility, not less. the south african government's national drug policy (deparnneru of health. 1996, p.8) takes the opposite view. it argues for a "single exit price" (jargon for a unifonn manufacturer price) for apparently "equivalent transactions" and favours a "transparent" pricing structure for private sector purchasers in south africa. recently the deparnnent of health announced that it wishes in addition to see the conventional mark-up of a fixed percentage on retailer purchasing price (plus a nominal dispensing fee) replaced by a fixed fee for professional services. unifonn price legislation would go far beyond current competition policy in that first, it would be directed at particular market practices, not at abuse of particular practices. the abuse criterion in the competition act would examine current or proposed market practices in the light of their ultimate impact on consumer welfare. for example, does the current of proposed practice strengthen and improve the efficiency of the existing retail sector? does the practice encourage innovation in the existing distribution chain which would be to the benefit of the consumer (in terms of lower final prices or a better service)? does the practice facilitate or hinder the development of more efficient means of purchasing and paying for products by the consumer or others acting on the patient's behalf, such as the managed care arms of medical schemes? does the practice facilitate or hinder the widest possible distribution of the product in areas of the economy where conventional outlets are scarce or conventional medical scheme cover is unavailable or hard to come by? does the practice facilitate or discourage innovative methods of monitoring phannaceutical consumption such as total disease management, phannaceutical benefit management or drug utilisation reviews either preor post-consumption by patients? does the practice facilitate or discourage innovative distribution methods such as direct mail, health maintenance organisations, preferred providers of medicines. or entry by large-scale retailers in either cbds or hospitals? clearly if a blanket rule (such as unifonn pricing or a fixed fee-for-service) is applied it can have deleterious or beneficial effects on consumer welfare depending on circumstances. tile legislation will then be either difficult to apply. complicated to draft or produce many and often unpredictable distonions. "abuse" legislation is then more appropriate; and abuses can be dealt with on a case-byr ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr vol! (1998) nt 1 21 case basis and with. a proper definition and understanding of competition consistently borne in mind. uniform price legislation would make it illegal to negotiate discounts on prescription medicines with retailers who can offer services to manufacturers that justify discounts. uniform prices should be opposed as a form of price controls. they are inconsistent with the goal of strengthening competition in the private health-care sector and would curtail company pricing flexibility a flexibility which has been important in causing reductions in ex-factory price levels in recent years (see reejtie, 1996), and which in tum, despite many artificial rigidities in the distribution chain, has resulted in lower prices paid by patients to many previously unavailable forms of medicine distribution systems. retail pharmacies, leading proponents of uniform pricing. are among the many businesses that now find it essential to offer discounts to their customers. the national drug policy also argues for transparent pricing structures. but transparency per se is neither desirable nor undesirable in the public interest. for example, high (but transparent) price levels are undesirable. fixed transparent mark-ups in pharmacy have been deemed to be anticompetitive (by the market place as discounts have eroded them over the last decade see competition board repon 52). transparent fixed-fee-for-service has also been deemed undesirable in other areas of health-care provision (the medical schemes amendment act 1989 removed the legal requirement). appropriate or competitive transparency is where buyers, whether patients, medical schemes, pharmaceutical benefit managers. managed care groups or others, can easily obtain information on alternative services of lower price suppliers. this results' in lower prices and better services as higher cost, less satisfactory suppliers are forced to cut prices to gain or retain business. inappropriate or anticompetitive transparency, such as collusively determined and legally guaranteed margins or fees, discourages this rivalry and preserves and conserves existing high prices and distribution modes. the competition board (repon 4. p.61) writes: ... codes of conduct, 'fair trade' rules and 'open trading' systems, or whatever they may be called, tend to maintain prices at overly high and rigid levels (and) ... (it) is an intriguing fact that the powerful manufacturer and the weak trader both champion these systems. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 22 sajems ns vall (1998) no i the preference of some traders for anticompetitive transparency to avoid rivalry has been discussed. why would manufacturers prefer a uniform price? the competition board (report 4, pp.lo and 62) notes that price discrimination by manufacturers (the converse of a uniform price for equivalent transactions) "is indispensable in the public interest". the preference of large manufacturers for an anticompetitive transparent pricing structure is understandable. marketing, product design and sales efforts are easier to use in the guaranteed absence of price rivalry. they are less easily countered, less readily noticed when used and discourage the promotion or market entry of generics on a pure price basis. "secret" rebates do not remain secret for long and any rebate is soon matched. this is how competition avoids prices congealing at high levels. the need to avoid price uniformity and not to regulate against price discrimination is therefore indeed "indispensable". but the attractiveness of avoiding price competition is only one reason the competition authorities saw price discrimination in this light (report 4). other arguments against an anticompetitive, transparent, uniform price include the desirability of providing cross-subsidisation to different sectors of the market which vary in their ability to pay. this equity argument partly explains the low price charged to public-sector buyers of medicines, and to dispensing doctors servicing patients for a single, allinclusive (and low) consultation fee. total industry output is therefore increased and total consumer welfare raised. of course the phrase "price discrimination". like the phrase "perfect competition" is emotive. it also misleads. the issue is consumer welfare. the most common theoretical charge of abuse in any monopoly situation is that firms can reduce output and so raise price. however as joan robinson (1933) demonstrated, price discrimination is one business practice where it can be shown, in general, that the ability to practise it either simply enables the same output to be reallocated to different market segments (an equity or iilcorne distribution issue) or that it can permit firms to increase their output. pure theoreticians, therefore, would concur with the competition board that price discrimination is, if not indispensable, at least benign. enforced uniform pricing, on the other hand, would at best have no impact on quantity (but a negative one on equity) and at worst would be malign in its impact on quantity. the national drug policy (ndp) wishes to enforce an anticompetitive transparent, uniform price, for "equivalent transactions". that wording was used first by the minister for public enterprises in government notice no. 1136 on 24th june 1993, in terms of the competition act. the intention of the notice was the same as that of the ndp, namely to make it r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr vol 1 (1998) nr 1 23 unlawful ... to sell ... medicines '" in a manner which ... discriminates between buyers ... by applying dissimilar prices ... to equivalent transactions. the ndp (as proposed government policy) is thus in broad agreement with the then proposed policy of the government before the 1994 election. notice 1136 was intended to apply under existing competition policy legislation. it was appealed against by some but not all manufacturers. the appeal has currently lapsed. would the appeal stand under existing or proposed competition policy legislation? to answer that question is difficult, but three factors make it likely that the appeal should succeed if put before the board. these are: the definition (appropriately) is similar to the formal theorists' definition of price discrimination. that is, to cite stigler (1966) it is: the sale of technically similar products at prices which are not proponional to their marginal costs. we have already seen how price discrimination is approved of theoretically as indispensable, how in practice it has encouraged competition, how it results in competitively transparent price reductions and in competitively transparent shifts in buyer behaviour as they exen preferences by shifting from one distribution channel to another. both definitions (stigler's and that of the notice) show also that price discrimination is identified by examining ratios (price: cost), not by examining price alone. thus identical prices can be discriminatory if costs differ. this is why the phrase "equivalent transaction" is necessary. ii the notice emphasised that differences in price are "justifiable" if they are required "to provide for the cost or probable cost in the manufacture and/or distribution of the medicine". the policy problem here, as both economists and the drafters of the notice understand, is that costs are subjective. when the manager of a firm takes a decision only he/she knows the benefit he/she is foregoing the cost of the decision. hence the use of the adjective "probable". to illustrate one difficulty with uniform prices for equivalent transactions, ask "what is equivalent?" a manufacturer may wish to raise his share of the market. should he price at the same level today to two different distribution channels if he anticipates one channel has a much higher growth potential tomorrow? if he believes the one channel has a more efficient (lower cost) method of reaching the patient and can expand r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 24 sajems ns vol 1 (1998) no 1 more rapidly romorrow than the other charmel, how can he encourage that for his own (but also the final patient's) benefit? the answer is to price ahead of demand by lowering price to the channel with high potential a common business practice with prima facie evidence of tmjustifiable price discrimination. yet closer inspection, taking accotmt of probable costs, would render any price differences "justifiable". implementation of the notice on appeal would, therefore, be difficult since (1) it is attempting to ban a practice the board accepts in principle as "indispensable" and (2) it would be difficult to ascertain in practice if any price differences (or unifonnities) tmcovered represent or do not represent price discrimination as defined both by theoreticians and the minister in the notice. iii the third reason, paradoxically, is due to the current state of flux of competition policy. it is uncertain whether the redrafted policy will follow an "american" or "european" pattern, or alternatively retain the existing south african mode, at least on specific issues. as far as price discrimination is concerned, however, the three bodies of competition policy or law adopt a similar approach: usa: the 1936 robinson-patman act prohibits the sale of goods at different prices to customers iruending to sell onwards to final conswners, with limited exceptions (see above). this precedent would appear to be a paradigm for the uniform price proposed in the ndp. however, as we have seen the act has proved tmworkable, tmenforceable and impossible to interpret. the us department of justice has recommended its repeal on these grotmds and on the grotmds that if enforced, it would be detrimental to competition. its repeal is continually opposed by lobbies of small-scale retailers but de facto the act has simply withered away. the consensus of legal and economic opinion is that next to the act's repeal, benign neglect is the optimal approach from the viewpoint of the public interest and of the conswner. there is little in american precedent to encourage south african proponents of uniform pricing for equivalent transactions. uk: the united kingdom monopolies commission in 1971 produced a multi-industry repon entitled parauel pricing. this too provides no suppon for proponents of uniform pricing, indeed the reverse. firms, it argues (para 9), often prefer to compete in ways other than price "because the cards of non-price competition are less easy to trump". that, of course, mayor may not be in the conswner interest. but (para 67) each case should be examined to ascertain, for r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sates nr vol i (1998) nr 1 25 example. if coordinated pricing policies (to say nothing of mandated ones such as those proposed in the notice and by the ndp) inhibit expansion of market shares by sellers of products or modes of distribution preferred by consumers; or if departures from published prices by way of discounts etc. (para 74) weaken anti-competitive. collusive or conservative behaviour; or whether differences in cost levels. managerial aspirations. market shares. expectation of future growth or management styles impact more heavily on price coordination patterns than does a desire to restrict output or lead a quiet life. if price competition is minimised. the report continues. excessive costs can be built into given prices. the incentive to satisfy the final consumer and gain hislher patronage by lowering price may be weakened. and inflationary pressures may be strengthened due to an ability to pass on cost increases in a coordinated fashion (particularly if only one price controller or watchdog has to be convinced rather than a multitude of consumers or their agents with an ability to switch custom -the latter is an impossible argument for firms to counter after it has been acted upon). sa: in south africa price discrimination falls under section i (b) of act no. % of 1979. that is. it could be deemed to be a restrictive practice operating against the public interest. if so. it can legitimately be banned by the minister. if not. it is then regarded as a legitimate business practice or method of trading. taken seriatim. the seven criteria laid down by the act to determine whether or not a practice is restrictive and against the public interest are: does it restrict production or distribution? does it limit facilities available for the same? does it enhance or maintain the price? does it prevent production or distribution by the most economical means? . does it prevent or retard technical improvements or the expansion or opening up of markets? does it prevent or restrict entry into any branch of trade? does it prevent or retard the adjustment of any profession or trade to changing circumstances? in each case the answer in pharmaceutical distribution is negative: in theory, price discrimination expands or maintains output. it does not restrict it. in practice it has been used to gain access to additional r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . --..... -~-26 sajems ns vol i (1998) no i and novel disrribution channels health maintenance organisations. dispensing doctors, direct mail distribution. preferred provider pharmacies etc -and these expansion modes have probably been used to a greater extent than they would have been had conventional community pharmacists not be prohibited from expanding through normal corporate means because of the regulatory ban on corporate ownership. price discrimination has done the reverse of limiting facilities for production and distribution (in the face of the ban on pharmacy corporate ownership which has limited retailing facilities to conventional small-scale retailers only). price discrimination has resulted in the newer modes of distribution demanding discounts, and both the new and the older modes of distribution passing discounts on to reimbursers. it has not maintained or increased price. ex-factory prices indeed tend to have declined (reekie. 19(6), while conventional retail markups and wholesale margins result in south african factory exit prices being among the lowest in the world when calculated as a proponion of the final price paid by patients. price discrimination has not resulted in distribution through uneconomical modes. rather it has encouraged sellers to seek out alternative and less costly modes to the outdated retailing pattern of small-scale, individually owned community pharmacies which are banned by law from operating under an ownership other than that of a pharmacist. price discrimination has encouraged innovation in pharmaceutical distribution, not retarded it dispensing doctors. mail-order pharmacists, and preferred provider organisations promoted by innovative groups such as mediscor are just a few examples. price discrimination has not resrricted entry into any trade. rather the reverse is true. doctors qualified by competence, if not function, to dispense have done so, and pharmacists have entered into agreements as preferred providers, and also moved into direct mail dispensing as a consequence. price discrimination has encouraged, not retarded, the adjustment of the retail pharmacy profession to changing circumstances. in shon, by all criteria price discrimination fails to meet the yardstick of a business practice operating against the conswners' interest. of course, the competitive pressures observed could well have been differently and still more efficiently r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sates nr vol 1 (1998) nr 1 27 expressed had they not been legally compelled to "get around" rather than being prevented from competing head-on with conventional retailers. furthermore, competition policy authorities must not forget adam smith's dictum. while people of the same trade are motivated to meet together to raise prices, smith emphasises that the state should do nothing to facilitate such assemblies 'much less to render them necessary'. yet an insistence on publicly posted uniform prices for the pharmaceutical industry's sales into the private sector of the health care market, and the use of the sealed bid tender system for pricing in the government sector both encourage collusive behaviour. in the former overt collusion is made easier and cheating is simpler to detect and to punish. in the latter collusion is encouraged because the costs of not colluding, le. loss of an allor-nothing contract, are much greater than they are in a more normal sales relationship. a fmal question remains. has the evolution of pharmacy distribution in the last decade been optimal from the viewpoint of the consumers' interest? the answer is no not because of price discrimination, however, that has generated price and cost reducing developments but because of the ban on corporate ownership imposed by the 1974 pharmacy act, which has retarded such developments. a more detailed description of the conventional retail pharmacy market is provided in the attached table. the retail pharmacy cartel: the conflict between official reports and govenunent support, "1962-1996 snyman 1962 commission of inquiry into high cost of medical services and medicines pharmacy act 1974 findings and comments 'the crux of the problem is that from the economic point of view, there are too many chemist shops ... a lower price to the public and a better living standard for the pharmacist could be attained ... by decreasing the number ... ., (p.912). only pharmacists, not corporate personae allowed to own retail pharmacists. a "grandfather" clause pennitted existing corporate owners (both in conventional shopping areas and in private hospitals) to remain, as it also did medical benefit scheme owrership, but not medical aid scheme owrership. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 28 sajems ns vol i (1998) no i the retail pharmacy canel : the conflict between official reports and govenunent support. 1962-1996 steenkarnp 1978 report of the commission of inquiry into the pharmaceutical industry browne 1985 interim report on pharmaceutical services " ... the pharmacist is not at present being used to his full capacity" (para 525). in earlier paragraphs steenkamp pondered how (given modem manufacturing technology) phannacists could "practicably" cooperate with doctors at least outside of the hospital setting . ..... involvement of the pharmacist in the prescription of the right medicines became all the more difficult. if at all possible" (para 523). ''the problem is rather the limited volume of prescriptions mainly as a result of over-concentration of retail pharmacies in certain urban areas ... " (p 9). indeed many pharmacists (some ten per cent) had too small a turnover "to produce a profit" (p 81). the consequence was that pharmacists wished protection from medical benefit schemes (who could own pharmacies) and from the encroachment of dispensing doctors (p 9). browne (p.9, para 6.10) queried whether such protection was required. "although pharmacists emphasise the value of pharmacist's advice about prescription medicines, the patient seems to have very little interest in obtaining (it). usually only a commercial transaction takes place. " "the committee found that .in the usa. the (sic)! restrictive pharmacy ownership increased the consumers' medicine cost by approximately 10%. therefore, the committee recommends (that) a pharmacist, whilst preserving his professional authority. should be allowed to contract his services, for his own gain, to nonpharmacists ... " (p.341 para 1l2). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr vol 1 (1998) nr 1 29 the retail pharmacy canel : the conflict between official reports and government support, 1962-1996 phannacy act 1974, no. 53 amendment biji 1993. melamet 1994 conunission of inquiry into the manner of providing for medical expenses broomberg-shisano 1996 restructuring the national health system for universal primary health care this act, if passed, would have pennitted corporate ownership, and allowed medical schemes to own and operate pharmacies. it was withdrawn by president de klerk and acting health minister, adriaan vlok, during the hospitalisation of health minister rina venter. the report reads as follows (pp.38-40) ''the largest item of expendirure by medical schemes is medicines ... one infonned witness, referring to the withdrawoli of the ... amendment biji ... argued that "the interests of 2 800 or so retail phannacists are being put before the 7,5 million members and dependents of medical schemes ... " ''the view that monopolistic mark-ups exist in the private sector, reinforced by regulatory protection of existing distribution technologies, is further underscored by the advent of new fonns of distribution which have escaped the regulatory net. whereas in the early 1980s nearly all private sector sales passed through retail .phannacists, by 1993 this had fallen to 41.33% by value, with 42.89% being paid out to dispensing doctors." 'this is evidence that high mark-ups have attracted new fonns of distribution into pharmacy and that competitive forces are at work. the medical schemes amendment act would have enabled medical schemes also to enter retail phannacy readily had the pharmacy act amendment biji not been withdrawn. " recommended (p.57) that "phannacies may be owred by any legal persona". r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 30 competition board report 52, 1996 investigation to detennine whether any restrictive practices .. . exist .. . in the supply and distribution of medicine sajems ns vol i (1998) no i page 2 of the report notes that in south africa there are 91 phannacies per 100 000 people while in the uk the equivalent figure is 12. this overtrading has resulted in high costs and gross margins of up to 74.5%. however, substantial deregulation has occurred leading to these margins falling to 29%. in particular price competition is no longer frowned upon since i. advertising of price is now allowed ii. preferred provider organisations (ppos) can be set up an activity this report could curtail . iii. dispensing practitioners exist iv. mail order dispensing has arisen. on p.7 the board acknowledges that medicine costs in the private sector are proportionately very high by world standards. on p.23 the board notes that the regulatory regime militates against competition and that the pharmacy profession ''remains unmoved on the key issue of retail pharmacy ownership". but the ownership regulations are preventing income maintenance by retailers. income maintenance can only be achieved by concentration of outlets and growth of the survivors. on pp. 11-14. a listing of complaints received from retailers is given. they include establishment of ppos, mail order dispensing and other distribution charmel innovations. the board defines a ppo (preferred provider organisation) network as operating in two ways i. open membership to all pharmacies who request to join and qualify on certain criteria, and 2. restricted membership where in addition a quantitative restriction on the number of pharmacies applies. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr vol 1 (1998) nr 1 31 most complaints revolved around the latter, in para 64 (p.17) the board expresses concern at the impact on competitors (retailers not included in the , ppo) , it does not mention the impact on patient costs, i rather "the effect of this restriction (mediscor's ppo) may be '" that the number of retail pharmacies could be reduced", on p.22 the board notes that thanks to ppos and other distribution innovations coupled with deregulation. drug costs have declined. the drug spending may have fallen from 33 % of medical scheme expenditures to 25 % and is possibly on track to 15 % . on p.31 this positive result is ignored and the board notes only. and with implicit approval, that mediscor may have now ceased to regard the operation of a ppo as a main focus of its business. rather it may intend to use its network simply for claims processing on which it will earn commission income. on p.32 the board concedes that the needs of cost containment have to be weighed against the harm to retailers. but despite the evidence the board "is satisfied that a closed panel (ppo) is not a prerequisite for cost containment", r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 32 sajems ns vol i (1998) no i concluding thoughts competition policy in south africa is in a slare of flux. in 1996 new legislation was drafted and withdrawn. the existing legislation (essentially the 1979 act) remains in place, and although further new legislation was promised by the end of 1996, it is likely to be implemented only in mid-i997. public opinion about what competition policy is or should be is also in a stare of flux. influential opinion-formers range from those who are simply anti-big business to those who would take a pragmatic srance, issue by issue. to those who adopt a panglossian approach that wharever is, must be optimal. some argue that existing policy is sensibly flexible. others believe the allegedly "rigorous" american antitrust laws should be translated to south africa, while still others would have south africa model itself on the more "behaviourally" oriented approach of some european legislators. there are many fallacious and inrernal inconsisrencies in the arguments being put forward in the debare. for example, the anti-big business lobby overlooks the fact that a "big" firm in south africa may simply appear big because the market is so small. a smaller firm in that context may simply be inefficient. those who argue for the "rigorous" american antitrust system are referring to the rigours of forced divestiture or trust-busting, but judgements of that sort have not been made in american courts for some 70 years, and the last attempred case of that kind, ibm, was rejecred in 1981 after 13 years oflitigation. in fact, in the last quarter of the century the usa has indeed proved to be "rigorous" in its application of its laws, but its "rigours" have not been in the stiffness or harshness of judgements and sentences, but rather in the rigorousness with which it has applied economic analysis in its procedures and arguments prior to arriving at conclusions. (former us solicitor general judge robert bork, in the 1993 edition of his 1978 book surveying 100 years of us legislation, provides case-by-case support for the thesis that economic reasoning has pervasively and surely become the yardstick by which the antitrust laws are applied.) however, rigorousness in the use of economic analysis is not what many south african commentators mean when they use the word "rigour". by and large they mean tough attitudes to break-up, and an "incipiency" approach to merger, as illustrated by the working paper on future south african competition policy by fourie, lewis and pretorius (1995, p.22). they wrore: r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr vol 1 (1998) nr 1 one option would be to judge dominant enterprises on the basis of their structure alone, without reference to their conduct. (this is the approach followed in the us.) 33 although this approach (misleadingly labelled american) is still popular in some quarters, fourie et al (p.23) proposed instead the "abuse approach". abuse could be defined as "exploitative", "exclusionary" and "structural". the abuse would be one of "dominance", and "presumptions" would be required in any new legislation to define "dominance" or the market-share level at which investigation would be triggered. some commentators have called that the european approach. certainly "presumptions" of legal monopoly exist in the uk (for investigative purposes) when market share hits 25 per cent (originally 33 per cent). however. the "presumptions" implying definitions of abuse would be mechanistic. fourie et al (p.23) argue that a "clearer definition of abusive behaviour" would enable "enterprises to organise their conduct accordingly". it is of course possible to provide clear definitions. yet the essence of competition is that entrepreneurs do the unpredictable in order optimally to meet consumer requirements. presumptions and definitions may simply exclude surprise, they may simply inhibit ex ante certain types of behaviour which, ex post would be interpreted as competitive. alternatively, a code of presumptions of dominance or abuse might, in the long run, be simply ignored (as is robinsonpatman) although in the shon run it will have significantly damaged competition. similarly, under restrictive practice legislation venical restraints and price discrimination would probably be banned per se. but we have already seen that to practise venical restraints is usually irrational for a profit-maximising businessman, whilst price discrimination tends to be neutral or expansive in terms of output. the draft bill based on the fourie et al working paper was rejected by the minister of trade and industry in late 1995. work was begun on the second redraft in 1996. in the meantime, it was announced in july 1996 that the task force formulating the new legislation had recommenced its work for a third time. their most recent working document highlights the dichotomy the policy-makers face. it argues that government must take a political decision as to whether the legislation should have "an exclusive economic focus or should serve political and social goals". this is the dilemma. early us antitrust judgements were whimsical and unpredictable, varying with the dominant politically appropriate view. later us judgements have been tackled from an economic point of view. this newer south african document veers towards that approach and states that competition law should promote r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . --..... -~~34 sajems ns vol) (1998) no ) ... consumer welfare and economic efficiency by preserving the freedom of economic action of market panicipants. one will need to consider whether it is necessary to target excessive conglomeration and/or enterprises ... in a monopoly siruation, what factors are relevant in deciding whether a merger restricts competition to a substantial extent, and under what circumstances mergers that restrict competition ... or result in market dominance ought to be condoned. if this stance is indeed ultimately adopted, then the 1979 act will be little amended in intent, albeit physically it may be substantially rewritten. if the political decision swings the other way then the current concern will continue. what is required is not the impossible (and undesirable) -namely that all aspects of monopoly control should be expressed in universally applicable laws and regulations. rather the aim should be confmed to promoting competition. a sustained effon to building up a coherent body of decisions and of guidelines for them should be made. this will give assurance of as much consistency founded on economic analysis and experience as can be made. in effect little amendment of the original 1979 act is required. even the board's view of concepts such as the "public interest" occur seldom in the existing legislation but have rather accumulated over the years in annual repons. if these views are correct they will stand, if not they will depreciate in the face of later economic arguments. some earlier repons of the board may not have received the attention they deserve (e.g. repon 4). as a consequence inconsistent judgements have been given. inconsistency, however, can be corrected. inappropriate drafting of inflexible presumptions cannot. that south african competition policy is imperfect is not questioned. that the overall objective of the act maintenance and promotion of competition requires rejection is unacceptable. rather, what is required is a regular and more consistent application of economic principles. cross-referencing and frequent consultation of existing precedents and works of analysis by the board should be expected. this wiii result in more predictable and more appropriate board verdicts, whilst previous errors will be corrected in the light of better understanding. government (and business) resources can then be put to better use examining anti-i:ompetitive structures and practices in state-protected industrial or professional environments (including the nationalised industries and parastatals as well as protected cartels like the pharmacists). and per se illegalities in business behaviour which have been declared in minor amendments to the 1979 act can be questioned as to their appropriateness and consistency with the overall objective of promoting competition in the principal act. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr voll (1998) nr 1 35 as judge bork emphasised (p.422) , a competition policy that opts for openness of markets reflects the ideal of equality of opponunity. those who argue for a structuralist approach to antitrust and for per se declaration of behavioural illegalities are more concerned with the small and less efficient, i.e. they have a preference for equality of outcome. economic rigour demands that policy concern itself with the smallest economic unit of all, the individual consumer and his or her welfare. references 1. bendt. er (1994). uniform pharmaceutical pricing. american enterprise institute. 2. bork, rm (2nd ed.) (1993). the antitrust paradox. free press. 3. fourie. fcvn; lewis. d and pretorius. wj (1995). towards competition policy reform in south africa (mimeographed). 4. leach, df (1994). the south african cement cartel: a critique of fourie and smith. south african journal of economics. 5. national drug policy (1996). department of health. 6. naude, sj (1986). south african competition policy: challenges and pitfalls. modem business law, july. 7. neale, ad (1960). the antitrust laws of the us. colchester, utrecht. 8. reekie. wd and crooke, in (1995). managerial economics (4th ed). prentice hall, hemel hempstead. 9. reekie, wd (1996). medicine prices and innovations: an international survey. institute of economic affairs, london. 10. robinson, j (1933). the economics of impelject competition. cambridge university press, cambridge. 11. stigler gj (1966). the theory of price (jrd ed). macmillan. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 483 sateb nr vol 1 (1998) nr 3 'n minimum loon vir huishulpe: antwoorde vir beleidmakers * l j bothma en c j jordaad departement elwnomie, universiteit van die oranje-vrystaat departement bemarldng, technilwn vrystaat abstract this study, which was conducted in a bloemfontein residential area, revealed that a considerable number of domestic workers may lose their jobs if a minimum wage is implemented. in order to keep job losses to the minimum, a minimum wage should not be too far above the current market wage level. this article sets out how labour market theory and empirical research can assist policymakers to detennine market and minimum wage levels for domestic workers. the main conclusion of the research is that a minimum wage for domestic workers should be regressive higher for part-time than full-time workers. jell 490 inleiding met die nuwe wet op arbeidsverhoudinge wat in 1996 in werking getree het, en die wet op basiese diensvoorwaardes wat onlangs deur die parlement gevoer is, het minimum lone vir huishulpe2 in suid-afrika nou 'n moontlikheid geword. beskou teen die agtergrond van suid-afrika se besonder hoe werkloosheidskoers, is dit noodsaaldik dat besin moet word oor die impak wat so 'n stap op die in diensnamevlakke van hierdie groep werkers kan he. moet daar 'n minimum loon vir huishulpe wees, en indien wei, op watter vlak moet dit vasgestel word? die doel van hierdie artikel is om moontlike riglyne vir beleidmakers daar te stel. omdat huiswerk 'n beroep met 'n lae status is, is 'n mens geneig om te dink dat die huishulpmark ongekompliseerd is. dit is 'n gevaarlike vergissing, want die mark is ingewikkelder as wat dit op die oog af wil voorkom. daar is byvoorbeeld voltydse sowel as deeltydse huishulpe. wat die situasie verder • a minimum wage for domestic workers: answers for pojicymakers r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 3 484 kompliseer, is dat baie deeltydses by meer as een huishouding werk. almai verrig ook nie dieselfde take nie en die werkplek kan of 'n huis, of 'n meenthuis of 'n woonstel wees. verder bestaan die unieke situasie dat die meeste werkgewers in hierdie mark weer in diens van ander werkgewers is. anders as in ander arbeidsmarkte is daar in hierdie gevai nie 'n direkte verbruiker aan wie loonverhogings deurgegee kan word nie. vergoeding bestaan ook nie net uit kontantlone nie, maar ook uit vergoeding in natura, en hoer lone kan benewens afdankings ook korter werkstyd enlof die inkorting van take tot gevolg he. teen hierdie agtergrond beskou kan 'n minimum loon vir huishulpe 'n ingewikkelder kwessie wees as wat sekere rolspelers wil glo. 'n empiriese ondersoek wat in 1997 in die bloemfonteinse woonbuurt langenhovenpark gedoen is, het insiggewende resultate opgelewer waarvan beleidmakers kennis behoort te neem. metode van ondersoek steekproef langenhovenpark is 'n relatief nuwe, maar tradisioneel blanke woonbuurt aan die westekant van bloemfontein. oor die algemeen beskou is dit 'n middelldas woonbuurt met besonder baie meenthuise 'n kenmerk van hedendaagse stedelike woonbuurte. volgens die bloemfonteinse stadsraad was daar aan die einde van 1996 onderskeidelik i 129 (41,3%) huise, i 580 (57,9%) meenthuise en 22 (0,8%) woonsteleenhede in langenhovenpark. in totaaj kom dit neer op 2 731 huishoudings. nie aile huishoudings het egrer 'n huishulp in diens nie. volgens die 1991populasie sensus van die sentraje statistiekdiens (sso), maak gemiddeld tweederdes van aile blanke huishoudings van die dienste van 'n huishulp gebruik. derhaiwe is die aantal wooneenhede in die woonbuurt waar daar huishulpe in diens is op 1 802 geskat, waarop 'n proporsioneel ewekansige steekproef van 10,4% (187) volgens 'n formule wat deur stoker (1981: 13) aan die hand gedoen word, getrek is. omdat wooneenhede waar daar nie huishulpe in diens is nie noodwendig ook in die steekproef sou vai, en voorsien is dat daar ook werkgewers sou wees wat nie aan die ondersoek sou wou deelneem nie, is die aantal besoekpunte uitgebrei tot 290. die aantal woonsteleenhede wat binne die steekproef gevai het was te min om enige betroubare resultate op te lewer en is weggelaat. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 485 satebnr vol i (1998)nr3 vraelys 'n gerekenariseerde vraelys is in afrikaans en engels opgestel, en verskillende vrae is san onderskeidelik werkgewers en huishulpe gevra om sodoende die vraagsowel as die sanbodkant van die mark te ondersoek. opgeleide veldwerkers het gedurende die periode 17 februarie tot 10 maart 1997 onderhoude met huishulpe en hulle werkgewers in laasgenoemde se wonings gevoer. in totaal is 177 bruikbare vraelyste wat 94,6% van die steekproeftotaal verteenwoordig voltooi. by die ander 113 wooneenhede wat besoek is wou werkgewers 6f nie deelneem san die ondersoek nie, 6f was daar nie huishulpe in diens nie. om 'n profiel van die huishulpe te kry is hulle ouderdomme gevra, hulle huwelikstatus, boeveel skoolopleiding bulle gehad het, en hoeveel afhanklikes hulle het. ten einde 'n idee van arbeidsomset in die mark te kry moes huisbulpe se hoeveel keer en om watter rede(s) hulle die afgelope vyfjaar van werkgewer verwissel het. hulle moes ook sandui by hoeveel verskillende werkgewers hulle gedurende die week werk. om vas te stel in watter mate die arbeidsmag georganiseer is, is san huishulpe gevra of hulle san 'n vakbond behoort of nie. omdat 'n minimum loon nie net afdankings nie, maar ook die inkorting van take tot gevolg kan he, moes huishulpe se watter take hulle alles moet verrig. huishulpe se take en die omvang daarvan kan egter verband hou met faktore soos die grootte van die werkoppervlakte en die aanta! mense wat in 'n wooneenheid bly. derhalwe is onderskei tussen huise en meenthuise, en moes werkgewers se hoeveel mense saam met hulle woon. vir sover dit minimum lone vir huishulpe aanbetref moet daar noodwendig tussen voltydse en deeltydse werkers onderskei word, en moes werkgewers aandui hoeveel dae per week hulle 'n huishulp in diens het, wat hulle haar betaal, en ofhulle 'n dienskontrak met haar gesluit het. aangesien huishulpe se vergoeding nie slegs uit kontantlone bestaan nie, maar ook vergoeding in natura insluit, wat moeilik is om te bereken, is aan werkgewers gevra om sodanige vergoeding te spesifiseer en self die geldwaarde daarvan te skat. hierdie metode word ook deur die ssd in sy jaarlikse survey of dwellings and domestic workers gebruik. dataversameling en -verwerking anders as die ssd wat huiswerkers op grond van ure gewerk per week in drie groepe, naamlik voltydses (meer as 35 ure per week), deeltydses (meer as 20 maar minder as 30 ure per week) en loswerkers (minder as 20 ure per week) re pr od uc ed b y sa bi ne t g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 3 486 indeel (ssd; may 1994: 4), is huishulpe in hierdie studie volgens dae gewerk per week gekategoriseer. huishulpe word in die praktyk nie vir 'n sekere aantal ure per week gehuur nie, maar vir 'n sekere aantal dae per week. hulle het elke dag sekere take om te verrig, en wanneer dit klaar is, is hulle gewoonlik vry. op grond hiervan is deeltydse huishulpe in drie groepe ingedeel, naamlik die wat een; of twee; of drie dae per week by 'n spesifieke werkgewer in diens is. die wat vier en meer dae per week deur 'n bepaalde werkgewer gehuur word, is as voltydse huishulpe beskou. daar is voorts gepoog om vas te stel wat huishulpe in elke kategorie se kontantvergoeding per dag is. dit het probleme opgelewer, want sommige werkgewers betaal hulle huishulpe weekliks en ander maandeliks. waar huishulpe weekliks betaal word, is die weeklikse loon gedeel deur die aantal dae wat die huishulp per week werk. in die geval van maandelikse vergoeding is die aantal dae gewerk per week met vier vermenigvuldig en deur die maandelikse loon gedeel. 'n verdere probleem is dat sommige werkgewers hulle huishulpe bo en behalwe 'n kontantloon ook 'n kontantbedrag gee vir reiskoste. in hierdie gevalle is die ssd nagevolg en is geld vir reiskoste as deel van kontantvergoeding geag (survey of dwellings and domestic workers,may 1994: 4). om 'n idee te kry wat die impak van 'n rrummum loon op die in diensnamevlakke van huishulpe kan wees, moet die vlak waarop die ampteiike minimum loon vasgestel gaan word bekend wees. hieroor is nog geen besluit geneem nie. 'n woordvoerder van 'n vakbond vir huishulpe het in 1996 aan die arbeidsmarkkommissie gese (voltydse) huishulpe eis 'n minimum loon van r600 per maand (report of the commission to investigate the development of a comprehensive labour market policy, par. 197). oit kom neer op r30 per dag vir 'n maand met 20 werksdae. die navorsers het hierdie bedrag as riglyn geneem en die kontantlone van voltydse huishulpe in langenbovenpark hiermee vergelyk. oaarna is vergoeding in natura by kontantlone getel om sodoende ook voltydse huishulpe se totale vergoeding aan die minimum loon van r600 per maand i r30 per dag te toets. ondersoekresultate die resultate van die ondersoek word uiteengesit en bespreek onder die volgende hoofde: huishulpe, huishoudings, indiensname, arbeidsomset en dienskontrakte, aard van take en vergoeding. daarna word voltydse huishulpe se vergoeding aan die minimum loon getoets. huisbulpe r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 487 sateb nr vol i (1998) nr 3 die gemiddelde ouderdom van huishujpe wat in die woonbuurt werk is 39,2 jaar. waama twee-derdes tussen 30 en 45 jaar oud is. byna die helfte (47,2%) het aangedui dat hulle getroud is, terwyl 16,5% gese het hulle is ongetroud. oit is opmerklik dat 21 % van die huishulpe geskei of van hulle eggenoot vervreemd is, terwyl 8,5% weduwees en 6,8% saamblyers is. die feit clat die huishulpe wat by die ondersoek betrek is gemiddeld 2,9 afhanklikes het, beteken clat afdankings in hierdie mark 'n groot getal mense kan raak. sowat 'n kwart (47) van die 177 huishulpe het boonop geen formele skoolopleiding gehad nie, en van die 130 wat wei op skool was, het 'n derde (44) nie laerskool voltooi nie. oit beteken dat diegene wat hulle werk verloor min vooruitsigte op 'n hoi!r besoldigde pos het. slegs 19 huishulpe het aangedui dat hulle inslaap, wat verband hou met 'n munisipale regu1asie wat nog tot onlangs bediendekamers in die woonbuurt verbied het. derbalwe is die oorgrote meerderheid (158) pendelaars waarvan meer as die helfte (88) in botshabelo woon. hulle moet in totaal ongeveer 130 km per dag aile om by die werkplek en terug te kom. die res van die huishulpe woon op hoewes en in die ttadisioneel nie-blanke woonbuurte rondom bloemfontein, wat beteken dat afstande na die werkplek en derhalwe ook reiskostes baie verskil. slegs drie van die respondente het aangedui clat hulle aan een of ander vakbond behoort, wat daarop mag dui dat die huishulparbeidsmag in bloemfontein nog ongeorganiseerd is. buisboudings hoewel daar minder huise as meenthuise by die ondersoek betrek is, is ongeveer twee-derdes (64,4%) van die vraelyste by huise en 'n derde (35,6%) by meenthuise voltooi. oit volg omclat 'n groter persentasie meenthuisbewoners as huisbewoners wat in die steekproef ingesluit is, of nie wou deelneem aan die ondersoek nie, of aangedui het dat hulle nie 'n huishulp in diens het nie. oaar is nie aan hierdie huishoudiags gevra hoekom hulle nie 'n huisbulp huur nie, maar dit is opvallend dat die buise wat by die ondersoek betrek is gemiddeld 3,5 bewoners per eenheid het, teenoor 2, i bewoners in die geval van meenthuise. huisbewoners het ook 'n hoer gemiddelde bruto inkomste per maand as meenthuisbewoners r6 811 teenoor rs 085. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 3 488 indiensname, arbeidsomset en dienskontrakte uit die ondersoek blyk dit dat net 45 (25,4%) van die huishoudings 'n huishulp op 'n voltydse basis in diens het, terwyl 52 (29,4%) een dag per week, (50) 28,2% twee dae per week, en 30 (17%) drie dae per week 'n huishulp huur. soos verwag kan word is meenthuisbewoners meer geneig as huisbewoners om deeltydse huishulpe te huur. so is gevind dat 61,3% van die meenthuisbewoners in die steekproef net een dag van die week 'n huishulp in diens het, teenoor 10,6% in die geval van die huisbewoners. wat voltydse huishulpe aanbetref is die prentjie net mooi omgekeerd, want 34,5% van aile huisbewoners het voltydse huishulpe, teenoor slegs 9,7% van meenthuis-bewoners. hoewel 'n huishulp miskien net een dag per week by 'n spesifieke huishouding werk, kan sy egter die ander dae van die week ook by ander huishoudings werk. so is gevind dat twee-derdes (67,7%) van aile huishulpe net by een huis of meenthuis per week in diens is, 17% by twee, 8,5% by drie en 6,8% by vier en meer. hieruit blyk dit dat daar meer werkgewers as werkers in die huishulpmark is. ironies genoeg beteken dit nie dat die vraag na huishuipe die aanbod oorskry nie, maar dat 'n aantal huishulpe as gevolg van die relatief klein aantal voltydse poste, hulle inkome probeer vergroot deur meer as een deeltydse pos op te neem. slegs 29,8% van die huishulpe het aangedui dat hulle nie gedurende die afgelope vyf jaar van werkgewer verwissel het nie, terwyl onderskeidelik 27,4%, 24,2% en 13,7% gese het dat hulle gedurende dieselfde periode een, twee of drie keer van werkgewer verwissel het. die res (4,90/0) het meer as drie keer van werkgewer verander. voltydse huishulpe verander egter nie so baie van werkgewer soos deeltydses nie. aitesaam 38,5% van die voltydses het aangedui dat hulle nie die afgelope vyf jaar van werkgewer verwissel het nie, teenoor 26,1% van die deeltydses. die algemeenste rede waarom van werkplek verwissel is, en deur 43,2% van die huishulpe genoem is, was omdat die werkgewer verhuis het. dit is insiggewend dat slegs 13,5% swak betaling as rede aangevoer het. wat ontstellend is, is dat net 17,5% van die werkgewers aangedui het dat hulle 'n skriftelike dienskontrak met hulle werknemer gesluit het. aard van take huishulpe verrig 'n verskeidenheid take soos huisskoonmaak, wasgoed was en stryk, koskook, en die versorging van kinders en bejaardes (tabel 1). die vernaamste taak is egter huisskoonmaak. aile huishulpe het aangedui dat hulle r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 489 sateb nr vol 1 (1998) nr 3 hierdie taak moet verrig, hoewel was en stryk ook baie prominente take is. koskook en kinderen bejaardesorg is minder prominente take, en waar dit gedoen moet word. is dit meestaj dee1 van voltydse huishulpe se pligte. so byvoorbeeld moet 42% van die voltydse huishulpe koskook, terwyl net 'n paar van die deeltydses daarmee belas is. tabell: huishulpe se take take idag 2dae 3dae voltyds n=52 n=50 n=30 n=45 huisskoon1000/0 100% 100% 100% maak wasgoedwas 88% 96% 97% 96% enlof st:rvk koskook 2% 4% 11% 42% kinder-en 00/0 6% 8% 38% beiaardesonl hierdie resultate stem baie ooreen met die van 'n studie van davidson en grossett (1995:95) wat in die gauteng-provinsie gedoen is. hulle het bevind dat 97,8% van aile huishulpe moet huisskoonmaak, 96,4% moet wasgoed was enlof stryk, 36,1 % moet koskook en 12,1 % moet kinders versorg. vergoedinl huishulpe in elke kategorie se kontantlone per dag word aan die hand van histogramme voorgestel (figure 1 tot 4). kontantlone in elke kategorie is in interval ie van rs opgedeel en die persentasie huishu1pe word per interval voorgestel. so byvoorbeeld verdien 32,5% van aile huishulpe wat een dag per week by 'n spesifieke werkgewer in diens is tussen r30 en r34 per dag. huishulpe in elke kategorie se gemiddelde kontantvergoeding per dag is soos volg: een dag per week r34,50; twee dae per week r29,27; drie dae per week r27,15; en voltydses r21,27. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 3 490 figuur 1: kontantloon per dag een dag per week figuur 2: kontantloon per dag twee dae per week r10-14 r15-19 r20-24 r25-29 r30-34 1<35-39 r40-44 r45-49 r50-54 r55-59 ~ r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 491 sater nr vol 1 (1998) nr 3 fipur 3: kontantloon per dag drie dae per week r1o.1 .. r15-19 r20·2.. r25·29 r30-3 .. r35·39 r .. o ...... fipur 4: kontantloon per dag voltyds % r10-14 r15-19 r20-24 r25-29 r30-34 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 3 492 so en behalwe 'n kontantloon kry huishulpe ook sekere vergoeding natura soos blyplek, maaltye, uniforms, mediese hulp, 'n pensioenenlof 'n spaarplanvoordeel. syna aile huishulpe kry gratis maaltye, maar wat elke vorm van vergoeding in natura aanbetref is daar is 'n groter persentasie voltydse as deeltydse huishulpe wat sodanige vergoeding ontvang (tabel 2). tabel2: huisbulpe se vergoeding in natura vergoeding in voltyds deeltyds natura n=45 n=132 blyplek 42% ()o/o maaltye 98% 94% uniform 70% 56% pensioenlspaarplan 12% 2% medies 38% 10% vergoeding gemeet aan die minimum loon vit figuur 4 blyk dit dat met die uitsondering van 'n klein persentasie (2,2%), aile voltydse huishulpe se kontantlone laer as die voorgestelde minimum loon van r600 per maand / r30 per dag is. word vergoeding in natura egter by kontantlone getel en voltydse huishulpe se totale vergoeding aan die minumum loon gemeet, verbeter die prentjie aansienlik. net 20,3% van aile voltydse huishulpe se totale vergoeding is laer as die minimum loon van r600 per maand / r30 per dag (figuur 5). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 493 sateb nr vol 1 (1998) nr 3 figuur 5: totale vergoedidg per dag voltyds moontlike antwoorde vir beleidmakers? in zimbabwe word werkgewers vir doeleindes van minimum lone nie toegelaat om huishulpe se vergoeding in natura by kontantlone te tel nie (van der walt, 1993:813). uit die bostaande resultate blyk dit dat onder sulke omstandighede, 'n aansienlike persentasie van die huishulpe wat by hierdie ondersoek betrek is, gevaar loop om hulle werk te verloor. 'n mens moet egter versigtig wees om nie te wil aflei dat in gevalle soos hierdie, waar feitlik alle voltydse huishulpe se kontantlone minder as die minimum loon is, almal afgedank gaan word nie. sekere werkgewers plaas so 'n hoe premie op 'n huishulp sodat hulle beslis die minimum loon sal betaal (net soos wat hulle nie afgeskrik sal word om motor te ry as die brandstofprys styg nie). ander weer sal miskien nie hulle huishulp afdank nie, maar haar minder dae per week laat werk en/of haar take inkort. dit sal tot 'n toename in die aantal deeltydse huishulpe aanleiding gee. dat 'n aansienlike persentasie voltydse huishulpe hulle werk kan verloor, is egter nie uitgeshut nie. op die vraag wat hulle sal doen as hulle 'n minimum loon van r600 per maand moet betaal, het 23,2% van die werkgewers wat voltydse huishulpe in diens het gese r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 3 494 hulle gaan hulle huishulp afdank. byna die helfte (45,2%) het gese hulle sal haar nog steeds huur, terwyl 31,6% aangedui het dat hulle onseker is. hoeveel werkgeleenthede in gedrang kan kom hang uiteindelik af van die vlak waarop die minimum loon vasgestel gaan word. hoe hoer die minimum loon bokant die vryemackvlak is, hoe meer afdankings kan volg. in hierdie verband kan acbeidsmackteorie 'n nuttige riglyn vir beleidmakers wees. omdat die huishulpmack 'n mack met baie kopers (huishoudings) en verkopers (huishulpe) is, is daac rede om te glo dat dit 'n volmaak mededingende arbeidsmack is. in so 'n mark is alle werkgewers loonnemers, wat beteken dat almal dieselfde, met ander woorde die markloon betaal. in teorie impliseer dit 'n volmaak elastiese acbeidsaanbodkurwe (mcconnell en brue, 1995: 155-6). in die huishulpmack is daac egter faktore wat daactoe lei dat arbeiders en huishoudings nie heeltemal homogeen is, soos wat die teorie van volmaakte mededinging dit wil he nie. werkplekke en take verskil, en reiskoste (wat in hierdie geval by geldlone ingesluit is) wissel na gelang van afstand vanaf die werkplek. die gevolg is dat in stede daacvan dat alle werkgewers dieselfde loon betaal, lone in 'n band rondom die gemiddeld versprei is met 'n boonste (w u) en 'n onderste (wd limiet (figuur 6). binne hierdie band is daac vir die individuele werkgewer ruimte om loonvlakke te bepaal (kaufinan, 1994:24153). figour 6: loon band wu we loonband wl vraagkurwe lu le ll indiensnamevlak r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 495 satebnr vol i (l998)nr3 die loonbande vir huishulpe in elke kategorie lean baie duidelik op figure i tot 4 gesien word. in die geval van werkgewers wat net een dag per week 'n huishulp huur (figuur i ), is die boonste en onderste limiete van die loonband onderskeidelik rs9 en r15. as daar na die loonverspreiding van voltydse huishulpe gekyk word (figuur 4), dan is dit opvallend dat die minimum loon van r600 per maand i rjo per dag in die interval naaste aan die boonste limiet van die loonband (r34) val. die frekwensie van die vorige interval (r25-29) is trouens ook relatief laag, en vanaf hierdie vlak tot by die boonste limiet van die loonband, is die area waar die vraag na arbeid baie elasties raak. oit verklaar waarom so 'n groat persentasie van die werkgewers aangedui het dat hulle hulle huishulpe gaan afdank as hulle 'n minimum loon van rjo per dag moet betaal. as dit as rigtingwyser gebruik word, dan behoort die minimum loon vir voltydse huishulpe die hoor as rsoo per maand i r25 per dag te wees nie. oit sal nie net die gevaar van afdankings verminder die, maar ook die kanse dat werkgewers vergoeding in natura sal inkort. word bogenoemde maatstaf ook gebruik om te bepaal wat die minimum loon vir deeltydse huishulpe moet wees, iyk die prentjie min of meer s6: r40 (of miskien r35) per dag in die geval van 1 dag per week, r35 vir 2 dae per week en rjo ofmiskien rj5 per dag vir drie dae per week. hieruit wit dit voorkom asof 'n minimum loon vir huishulpe regressief behoort te wees hoer vir deeltydses as vir voltydses (figuur 7). figuur 7: 'n regressiewe minimum loon vir huishulpe mininum loon per <lag r40 r35 i---+-_~ r30 1---+_--1 __ r25 2 3 voltyds daeperweek r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 3 496 behalwe clat die loonverspreidings en boonste grense van die onderskeie loonbande dit so wil he, is claar ook ander redes waarom deeltydse huishulpe 'n hoer minimum loon per clag as voltydses betaal kan word. soos in tabel i gesien kan word, moet bykans alle deeltydse huishulpe net soos die voltydses huisskoonmaak sowel as was en/of stryk, maar eersgenoemdes het minder dae vir dieselfde take. ook moet verreken word clat 'n werkgewer wat 'n deeltydse huishulp huur, relatief makliker 'n hoer loon (per clag) kan bekostig as een wat 'n voltydse huishulp in diens het. 'n regressiewe minimum loon behoort derhalwe ook die gevaar van afdanlcings te verminder, mits loonvlakke nie te hoog vasgestel word nie en die regte balans tussen die onderskeie kategoriee gevind kan word. dit moet ook nie uit die oog verloor word nie clat 'n minimum loon oor die lang termyn 'n groter impak op indiensnamevlakke gaan he as oor die korttermyn. daar is verskeie redes daarvoor. so byvoorbeeld neem die aantal meenthuise in verhouding tot huise voortdurend toe. soos uit hierdie navorsing blyk, impliseer dit meer deeltydse in plaas van voltydse werk. 'n nuwe tendens wat skynbaar vinnig posvat, is om nie meer self 'n huishulp te huur nie, maar om soos in die geval van tuindienste 'n kontl'akteur te betaal om die diens te lewer. beleidmakers moet dit in oorweging neem clat hierdie mark, net soos enige ander arbeidsmark, ook by die res van die ekonomie ingeskakel is en voortdurend verander. daar moet ook voor oe gehou word clat hoewel hierdie navorsing nuttig mag wees, dit nie te se is dieselfde geld vir huishulpe in ander woonbuurte en op ander plekke nie. eindnota ander kategoriee "huiswerkers" soos tuinwerkers en chauffeurs is nie by hierdie ondersoek betrek nie. bronnelys i. backer, l & olivier, m. (1996). gids tot die wet op arbeidsverhoudinge. pretoria: bactas personeelkonsultante. 2. department of labour. (1996). report of the presidential commission to investigate the development of a comprehensive labour market policy. pretoria: staatsdrukker. 3. department of labour. (1997). proposed basic conditions of employment bill. pretoria: directorate minimum standards. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 497 sateb nr vol 1 (1998) nr 3 4. departement stedelike beplanning en behuising (1996). fourth metropolitan transportation plan 0/ bloemfontein. die stad bloemfontein: munisipaliteit. 5. davidson, s. &. grosseti, m. (1995). "the economic consequences of legislation governing working conditions of domestic workers". suid-afrikaanse tydskrif vir elconomiese en bestuurswetens/coppe, vo1.l5: 91-103. 6. kaufman, b.e. (1994). the economics of labor markets. orlando: the dryden press. 7. mcconnell, c.r. &. brue, s.l. (1995). contemporary labor economics. singapore: mcgraw-hill. 8. senfrale statistiekdiens. (1991). populasie sensus 1991, opsommende result ate no aanpassings vir onderskatting. pretoria: staatsdrukker. 9. senfrale statistiekdiens. (1996). survey of dwellings and domestic workers, mei 1994. pretoria: staatsdrukker. 10. stoker, 0.1. (1981). steekproefneming in die praktylc. universiteit van pretoria: reeks nr. 178-1981. 11. van der walt, l.m. (1993). "minimum wage fixing for domestic labour"'. industrial law journal. 14(4): 811-20. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . microsoft word 2 urban sajems 15(4) 2012 .doc 352 sajems ns 15 (2012) no 4 tracking the venture creation phases in terms of entrepreneurial self-efficacy: links to competitiveness of south african ventures boris urban wits business school accepted: may 2012 examining entrepreneurial self-efficacy across venture creation phases is important as research indicates that behaviours to which self-efficacy corresponds are largely concerned with new-venture formation processes and as such are required of entrepreneurs well beyond the point of founding. hypotheses are formulated, which take into account the sequential nature of entrepreneurial tasks in the venture process. a multidimensional instrument is used to collect data from medium businesses (n = 199). correlational and regression analysis are performed where empirical evidence supports that entrepreneurial self-efficacy during searching, planning, marshalling resources and implementing people phases of venturing are significantly associated with the competitiveness of the venture. implications of this study can be advanced to the policy domain where it needs to be stressed that government initiatives will affect venture sustainability only if these policies are conceived in a way that influences entrepreneurial self-efficacy. key words: venture creation phases, entrepreneurial self-efficacy, competitiveness, skills, entrepreneurial tasks, south africa jel: d8, j24, l26, m13 1 introduction extant literature demonstrates that new firm formation is a specific, identifiable organisational process that has been subjected to previous empirical research (de clercq & arenius, 2006; kickul, gundry, barbosa & whitcanack, 2009; mueller & goic, 2003; newbert, 2005). of particular research interest has been the identification of factors, characteristics, and conditions which foster entrepreneurial processes, new venture creation and contributing successes factors (mcgee, peterson, mueller & sequeira, 2009). by positioning the new firm formation process as a dynamic capability (newbert, 2005), a common set of gestation activities emerge for successful entrepreneurship, where entrepreneurs typically emphasise different venture creation steps to outperform the competition (goel, gonzalez-moreno & saez-martines, 2003). new venture creation is typically concepttualised in terms of broad stages or as entrepreneurial tasks within a venture creation phases model (clouse, 1991; farrington, venter, eybers & boshoff, 2011; mcgee et al., 2009; stevenson & jarillo, 1990; timmons, 2002; vesper, 1996). the transition of individuals from one stage of an entrepreneurial process to another is often the result of a combination of various motivational and cognition components where environmental conditions and opportunities also play a role (luiz & mariotti, 2011; shane, locke & collins, 2003). however, environmental factors being held constant, researchers argue (shane et al., 2003; urban, 2010) that human motivation plays a critical role in the entrepreneurial process. being motivated is not only considered an integral aspect of the entrepreneurial process but must be supplemented with the requisite skills and competencies (bandura, 1986; 1997; 2001). unless individuals perceive themselves as capable and willing to be entrepreneurial, their venture will remain uncompetitive and underperforming. recent research finds that although motivation is implied, or assumed, in abstract sajems ns 15 (2012) no 4 353 papers on intentions, scripts, and cognitive maps to entrepreneurial behaviours, it remains largely under researched despite its critical importance to predicting and explaining entrepreneurial behaviours (carsrud & brannback, 2011). this paper responds to calls for research (poon, ainuddin & junit, 2006) in this direction by investigating entrepreneurial self-efficacy (ese) across the venture creation phases and attempts to establish links with the competitiveness of medium-sized firms. research finds those with higher entrepreneurial self-efficacy as perceiving their environment as more opportunistic rather than fraught with risks, and they tend to believe in their ability to influence the achievement of goals (chen, greene & crick, 1998; de noble, jung & ehrlich, 1999). since ese refers to cognitive evaluations of personal capabilities with reference to specific tasks of entrepreneurship, it achieves the entrepreneurial distinctiveness that is well suited to tracking the venture creation phases (chen et al., 1998; de noble et al., 1999; mcgee et al., 2009). many individuals in emerging economies may have the desire to pursue entrepreneurial ventures but are not engaging because they are lacking in self-belief and requisite entrepreneurial skills (luthans, stajkovic & ibrayeva, 2000). research confirms this lack of “can-do” attitude is prevalent in south africa, where not only is there a sense of entitlement and an expectation that big business, government and others should create jobs, rather than one creating one’s own employment, but aspiring entrepreneurs have low levels of self-belief, experience, inadequate education, and lack of access to finance and business-orientated networks (herrington, kew & kew, 2010; urban, 2006). while it is widely recognised that new ventures are pivotal to the growth and development of the south african economy, and inextricably linked to economic empowerment, job creation, and employment within disadvantaged communities (gauteng provincial government, 2008), most entrepreneurs are restricted by their scarcity of skills, business knowledge and resources in their ability to grow and create competitive ventures (urban, van vuuren & barreira, 2008). although substantial research exists interrogating links between start-up motivations and entrepreneurial intentions (edelman, brush, manolova & greene, 2010; hmieleski & corbett, 2006) there is still limited understanding of ese’s role in the new venture’s performance after start-up. examining ese across venture creation phases is pertinent as research indicates that once small businesses begin to be sustainable their reported management challenges converge (chan, bhargava & street, 2006). ese can influence how well existing entrepreneurs discharge their responsibilities during each of the venture creation phases. the behaviours to which ese corresponds are largely concerned with newventure formation and as such are required of entrepreneurs well beyond the point of founding (forbes, 2005). not only does the literature suggest that higher levels of ese influence the likelihood of successfully launching a new business, but there have been calls for future research to apply ese effectively so as to understand casual directions and see how ese can be related to venture performance (mcgee et al., 2009). equally important, it remains unclear if certain underlying dimensions of ese are more important than others after a new business is launched. for instance experienced entrepreneurs might be more aware of the role of luck and favourable timing in their achievements, and therefore more humble about their own ability to control the destinies of their ventures. this effect might be more marked for those entrepreneurs pursuing highgrowth ventures (mcgee et al., 2009; urban, 2009). given the recognised need for data-based and integrative process studies of the venture creation phases, this paper makes a contribution to the field of entrepreneurship by empirically investigating ese across the different venture creation phases and providing links to the competitiveness of enterprises. the paper proceeds by first accessing a relevant theoretical base to support the hypotheses which are formulated on existing findings from a range of disciplines. next the research approach and measurement issues related to the constructs are discussed. this is followed by specific analytic methods best suited to test the hypotheses. results and implications follow, and the study’s limitations are 354 sajems ns 15 (2012) no 4 addressed and future research directions are suggested. 2 theoretical overview 2.1 competitiveness of ventures competitiveness is a concept often related to long-term performance of firms and economies. many governments believe that new ventures can contribute towards the promotion of more equitable development, as well as the enhancement of the competitiveness of local industries within a global economy (bygrave & minniti, 2000; preece, miles & baetz, 1998; wright, hmieleski, siegel & ensley, 2007). at the firm level, existing studies suggest that a sustainable competitive advantage is derived from how a firm approaches strategy formulation (dess, lumpkin & mcgee, 1999). strategic management in entrepreneurial firms has gained prominence in recent years as organisations compete in volatile environments. the venture creation environment is characterised by complexity and dynamism, with ventures having to anticipate future scenarios and develop proactive strategies in an ambiguous and unstructured surrounding (allen & stearns, 2004). competitiveness, with a focus on small and medium enterprises (smes) (ventures and smes are used interchangeably in this paper), has shown how the interaction of the scope for action or growth in the business environment, together with the degree of access to capital resources and the intrinsic ability of the firm, are all necessary factors required to improve the performance of the firm (chan, bhargava & street, 2006; ireland, covin & kuratko, 2009). for any venture, consequences primarily concern the degree to which results lead to acceptable (or better) current performance and to the possibility of acceptable (or better) future performance. literature has emphasised several organisational-level outcomes of entrepreneurship, where two principal types of such outcomes are: (1) capability development, and (2) strategic repositioning (ireland, covin & kuratko, 2009). competitiveness is the capacity of ventures to create and sustain economically viable industry positions (nelson, 1991; teece, pisano & shuen, 1997). competitive development is created as ventures use entrepreneurial initiatives to explore new technologies or product-market domains or exploit existing ones. enhanced competitiveness, in particular, is often the result of exploitation of entrepreneurial opportunities. in terms of strategic repositioning, entrepreneurial behaviours can (1) place the venture, or portions thereof, in a new position within its pre-existing productmarket domain(s), (2) alter the attributes of that domain(s), and/or (3) position the venture within a new product-market domain(s) (ireland, covin & kuratko, 2009). rather than rely on typical performance measures such as sales and profit growth, assessing the competitiveness of smes is important, particularly as differences in growth measures have led to different relationships among constructs, with a reduction in the appropriateness of accumulating knowledge across studies (shepherd & wiklund, 2009). building in this direction of competitiveness the focus of this study is on the organisational outcomes resulting from entrepreneurial action during the venture creation phases. 2.2 entrepreneurial self-efficacy in the venture creation phases self-efficacy is an important motivational construct that influences individual choices, goals, emotional reactions, effort, coping and persistence. it refers to individuals’ convictions about their abilities, and consequently an important set of cognitions is self-efficacy or beliefs about one's capacity to perform at designated levels (bandura, 1986; 1997; 2001; bird, 1989; boyd & vozikis, 1994; stajkovic & luthans, 1998). self-efficacy is based on tenants of social cognitive theory (sct) which favours the concept of interaction where behaviour, personal factors, and environmental influences all operate interactively as determinants of each other. previous studies on entrepreneurial motivation have focused on basic concepts such as achievement need, risk taking, tolerance of ambiguity, and locus of control, all of which have yielded mixed results. however, findings have been more consistent for the self-efficacy construct when applied to entrepreneurial behaviour (bradley sajems ns 15 (2012) no 4 355 & roberts, 2004; forbes, 2005), and through its effect on entrepreneurial orientation (poon et al., 2006). unlike personality traits selfefficacy can be developed through training and modelling. efficacy judgments are task specific and regulate behaviour by determining task choices, effort and persistence (earley, 1994; gist & mitchell, 1992; stevens & gist, 1997; vesper & mcmullan, 1997). the self-efficacy construct has application to entrepreneurship and the entrepreneurial self-efficacy (ese) construct has been proposed to predict the likelihood of the individual being an entrepreneur, that is entrepreneurial selfefficacy refers to the strengths of a person’s belief that he/she is capable of successfully performing the various roles and tasks of an entrepreneur (boyd & vozikis, 1994; chen et al., 1998; de noble et al., 1999; krueger & brazeal, 1994). researching ese is important, since it can affect individuals’ willingness to engage in entrepreneurship as well as the behaviour of those who already are entrepreneurs (urban, 2009). previous research on ese has been related to the pursuit of entrepreneurial activity in various ways, for instance, where general self-efficacy (gse) is related to perseverance in difficult fields and greater personal effectiveness (chen, gully & eden, 2001; markman, balkin & baron, 2002), and where ese is influenced by the way in which entrepreneurs make strategic decisions (forbes, 2005). the value of understanding ese to help predict how well entrepreneurs perform the tasks associated with the venture creation phases cannot be underestimated (mcgee et al., 2009; poon et al., 2006). since self-efficacy beliefs are domain specific, it is important to consider what is being measured and how. some measures of ese, while multi-dimensional, are based on general management tasks such as marketing, strategic planning, and business decisionmaking. these more generalised measures of ese however do not assess confidence in performing specific tasks associated with planning, launching, and growing a new venture. another way of measuring selfefficacy of a broader domain, such as entrepreneurship, as chen et al. (1998) did with ese, is to develop a conceptual framework of task requirements on the basis of which self-efficacy of a domain is aggregated from self-efficacy of various constituent subdomains. many studies have conceptualised self-efficacy as a task specific or state like construct (sse). de noble et al. (1999) developed a measure of ese consisting of six sub-scales tailored specifically to the venture creation phases. despite these efforts there is inconsistency in the manner in which researchers attempt to capture the dimensionality of the ese construct which impedes further development and effective application of the construct. indeed much of the preceding empirical research has relied on ‘total ese’ scales and the results of such research have shed little light on how the underlying dimensions of ese influence entrepreneurship and which ones, if any, are most important for strengthening ese. while most theorists argue that ese is best conceptualised as a multidimensional construct, much of the empirical research has relied on limited-dimensional or even one-dimensional measures of ese (arenius & minniti, 2005; baum & locke, 2004). while the ese construct holds promise, it remains empirically underdeveloped and many scholars have called for further refinement of the construct (for example, forbes, 2005; lee & bobko, 1994; kolvereid & isaksen, 2006). in a recent study mcgee et al. (2009) demonstrate the multi-dimensional nature of the ese measure by testing it within a fourphase venture creation framework. this framework builds in the direction of new venture creation being conceptualised in terms of broad stages or as entrepreneurial tasks within a venture creation model (stevenson & jarillo, 1990; timmons, 2002). these stages are labelled (1) searching, (2) planning, (3) marshalling, and (4) implementing (kickul et al., 2009; mueller & goic, 2003; mcgee et al., 2009). 1) the searching phase involves opportunity identification and development. lumpkin, hills and shrader (2004) argue that the creation of successful businesses follows successful opportunity development and also involves the entrepreneur’s creative work. 356 sajems ns 15 (2012) no 4 2) the planning phase consists of activities by which the entrepreneur converts the idea into a feasible business plan. here the idea or business concept is evaluated in terms of various market and profitability criteria. 3) the marshalling phase involves assembling resources to bring the venture into existence. to bring the business into existence, the entrepreneur gathers (marshals) necessary resources such as capital, labour, customers, and suppliers without which the venture cannot exist or sustain itself. 4) the implementing phase requires that the entrepreneur grow the business and ensure the sustainability of the venture. to this end, the successful entrepreneur applies management skills and principles, particularly in implementing people management and financial management. on the basis of above theory and in line with empirical evidence, by recognising the multidimensional nature of ese within a four-phase venture creation framework, six hypotheses are formulated which allow for specific explanations to emerge based on expected relationships with venture competiveness. h1: there will be a strong positive relationship between ese concerning the searching venture phase and competitiveness. h2: there will be a strong positive relationship between ese concerning the planning venture phase and competitiveness. h3: there will be a strong positive relationship between ese concerning the marshalling venture phase and competitiveness. h4: there will be a strong positive relation ship between ese concerning the implementing people venture phase and competitiveness. h5: there will be a strong positive relationship between ese concerning the financial management venture phase and competitiveness. h6: there will be a strong positive relationship between attitude toward venturing and competitiveness. following mcgee et al. (2009) the hypotheses take into account the multidimensional and sequential nature of entrepreneurial tasks. the theoretically grounded four-dimensional structure of ese, includes the modification that the dimension of ‘implementing’ has two sub dimensions (one representing the ‘people aspects of implementation’ and the other representing the ‘financial aspects of implementing’). attitude toward venturing is included in the set of hypotheses, as the theory of planned behaviour (tpb) (ajzen, 1991) identifies attitudinal antecedents of intentions, which reflect the perceived desirability and the perceived feasibility of intentions and is thus related to perceptions of self-efficacy. furthermore path analysis confirms that the correlation between attitudes and behaviour is explained by attitude – intentions behaviour links (kim & hunter, 1993; krueger, reilly & carsrud, 2000). although venture performance is influenced by a host of factors including the sector in which the firm operates, firm age and size, as well as cultural and environmental contexts (luiz & mariotti, 2011), it is specifically argued for purposes of this paper that the competitiveness of the sme is influenced by the ese of individuals as conceptualised through the different venture creation phases. 3 methodology 3.1 sampling and data collection much of the existing empirical research on ese has relied on data collected exclusively from samples of university students. this lack of diversity in those populations sampled and tested has proved an obstacle in the development of an appropriate ese construct. the sampling frame was identified from the sme toolkit sa which is affiliated with the world bank and business partners locally (sme toolkit, 2011), and the johannesburg chamber of commerce and industry (jcci), which collectively represent a population of approximately 4400 businesses. the sampling frame for this study was based on businesses operating in the greater johannesburg area. johannesburg is situated in the gauteng province, the economic hub of south africa, which has the highest number of businesses in the country (gauteng provincial government, sajems ns 15 (2012) no 4 357 2008; south african business guidebook, 2005/6). in line with the objectives of the study the focus was on ventures that have navigated the different venture phases and performed tasks required beyond start-up activities. addressing ese within this venture phase framework at the firm level corresponds to similar studies’ sample characteristics (kreiser, marion & weaver, 2002). as ese refers to an owner’s self-perception of a firm’s strategic orientation, their self-perception will be closely related to the behaviour of the venture. consequently ese measures the owners’ self-perception and accordingly serves as a relevant proxy for measuring the entrepreneurial tasks within the venture creation phases. considering that smes in south africa can employ up to 200 people (econometrix, 2002; south africa survey, 2006/2007), and in line with the global entrepreneurship monitor (gem) studies’ operational definitions (bosma & levie, 2009), mediumsized ventures were targeted represented by new business owner-managers who currently own and manage a new business that has paid salaries for more than three months but not more than 42 months. sample parameters, which served as control variables, included: (a) gender, (b) age, (c) education level, (d) ethnic group, (e) work experience, (f) business sector, and (g) firm employment size class set as medium ventures. these ventures operated in a variety of business sectors including manufacturing, financial services, and retail and wholesale. based on the eligibility criteria 677 potential respondents were surveyed. the survey was solicited physically with periodic reminder telephone calls. based on eligibility criteria, 199 usable responses (an effective 29 per cent response rate) was generated as the final sample. to test for non-response bias archival sources were used where firm size and age were compared with non-responding firms by using secondary data. results of t-tests comparing these firms with the current study sample’s mean scores on select ese variables revealed no differences (p >.10), suggesting that the sample appears to be representative of the population from which it is based (cooper & emory, 1995). 3.2 measures 3.2.1 predictor variables ese during venture phases: instruments utilised in previous studies were scrutinised for construct validity and reliability. in previous studies the items for the ese factors produced values for cronbach’s alphas above 0.80, indicating high reliability (chen et al., 1998; de noble et al., 1999; mcgee et al., 2009; urban, 2006). similarly in previous studies, the factor structure of the ese items was tested using a confirmatory factor analysis approach and using covariance analysis. the factor analysis model provided evidence of convergent validity (the items included in the model share a relatively high degree of the variance of their respective underlying constructs, as indicated by the factor loadings being statistically significant at p = .05) (mcgee et al., 2009). given the evidence supporting the application of these scales confirms that their further use is justified. based on the a priori inclusion of compelling theory, as well as evidence for discriminant and convergent validity of these measures, the present study retests the internal consistency of items measuring ese within the four-phase new venture creation phases, for this study’s sample. five ese dimensions are used which were previously conceptualised in the hypotheses section, and are labelled as: (1) searching, (2) planning, (3) marshalling, (4) implementingpeople, and (5) implementing-financial (mcgee et al., 2009). in the original study, to test the discriminant validity of these five ese dimensions and to better understand the nomological validity of the ese dimensions, items representing attitude toward venturing were included and are subsequently also used in this present study. to measure ese across the venture phases, three items were used to measure the ese search dimension, four for ese planning, three for ese marshalling, six for ese people, and three for ese financial, and three items for attitude toward venturing. all items were measured on a 5-point likert scale where respondents were asked to indicate their confidence on their ability to perform ese dimensions (1 = very little to 5 = very 358 sajems ns 15 (2012) no 4 much). cronbach’s alphas were calculated indicating relatively high reliability (nunnally, 1978) across dimensions: (1) searching α = 0.77, (2) planning α = 0.71, (3) marshalling α = 0.65, (4) implementing-people α = 0.81, (5) implementing-financial α = 0.88 and (6) attitude toward venturing α = 0.85. 3.2.2 dependant variables competitiveness was measured in terms of two venture outcomes: (1) capability development, and (2) strategic repositioning. seven items in total were used to measure these two indicators of competitiveness, where respondents were asked to what extent they agree or disagree (1 = strongly disagree to 5 = strongly agree), with statements indicating levels of attaining capability and positioning. the following items measured competitiveness (ireland et al., 2009), and are reported as a consolidated score in further analysis: • ability of venture to develop capabilities in order to exploit entrepreneurial opportunities; • venture capacity to create and sustain an economically viable industry position; • venture use of entrepreneurial initiatives to explore new technologies or productmarket domains; • venture use of entrepreneurial initiatives to exploit existing technologies or productmarket domains; • strategic positioning of the venture within its pre-existing product-market domains; • strategic positioning of the venture to alter the attributes of their product-market domains; • the ability of venture to assume a new strategic position in relation to its competitors. an overall cronbach’s alpha of 0.83 was obtained for these two combined sets of measures representing overall competitiveness. 3.2.3 control variables variables measuring gender, education, ethnic group affiliation, work experience, and a question pertaining to relatives or friends who either are or have been entrepreneurs were surveyed. these variables provided a fuller picture of the sample characteristics. there is a prior theoretical basis for expecting these variables to have a systematic relationship with either the dependant or independent variable, or both (minniti & bygrave, 2003), where for instance chen et al. (1998) showed that prior education and gender were related to ese, and drnovsek & glas (2002) showed that prior entrepreneurial experience was related to ese. however, as the focal point of this study was the influence of ese on competiveness, not on the of the potential influence of other individual level variables, only firm size was included as a control variable which coincided with sampling parameters. this restriction ensured that a manageable number of variables were used in the correlation and regression analysis. 3.3 data analysis descriptive statistics were first calculated, followed by correlational and regression analysis. common method response bias was controlled for by safeguarding respondent anonymity, as well as ensuring that the questions relating to the dependent variables were located away from the independent and control variables in the instrument. furthermore, all items relating to independent, dependent and control variables were explored in a single principal component analysis (pca), using harman’s one-factor test (podsakoff et al., 2003) to check if one component accounted for most of the variance. six components with eigenvalues greater than 1.0 were detected, which accounted for 63 per cent of the variance. the largest component accounted for only 15 per cent. consequently no evidence of common method bias was identified. 4 results 4.1 sample characteristics the profile which emerges from the sampling procedure is that the typical respondent is predominantly male, 41 years old, university/ college graduate, with more than six years work experience. the dispersion of respondents in terms of ethnic groups (indian = 14 per cent; black = 66 per cent; white = 19 per cent; coloured = 4 per cent), reflects south africa’s sajems ns 15 (2012) no 4 359 multiracial society. additionally several respondents indicated they had parents (51 per cent), friends (85 per cent) or relatives (75 per cent) who are or had been entrepreneurs. 4.2 correlation and multiple regression mean scores, standard deviations and correlation coefficients are displayed in table 1. descriptive statistics indicate that mean scores are leaning towards the ‘mostly agree’ end of the scale. these high average scores across all the dimensions, suggest that individuals have high levels of confidence in performing tasks through the different venture stages. in terms of competitiveness the mean score is 3.786 suggesting a well-positioned and competitively capable venture. for the correlation matrix, refer to table 1, the pearson correlation coefficients are reported with levels of significance denoted. the interpretation of these correlations and the corresponding levels of significance allowed for acceptance or rejection of the hypotheses, as follows: • ese concerning the searching phase was positively and significantly correlated with competitiveness (r = 0.45, p < .01), providing support for hypothesis 1. • ese concerning the planning was positively and significantly correlated with competitiveness (r = 0.37, p < .01), providing support for hypothesis 2. • ese concerning the marshalling phase was positively and significantly correlated with competitiveness (r = 0.35, p < .01), providing support for hypothesis 3. • ese concerning the implementing people phase was positively and significantly correlated with competitiveness (r = 0.20, p < .05), providing support for hypothesis 4. • ese concerning the implementing finance phase was not significantly correlated with competitiveness (r = 0.28), not providing support for hypothesis 5. • attitude toward venturing was positively and significantly correlated with competitiveness (r = 0.19, p < .05), providing support for hypothesis 6. • the control variable of firm size was not significantly correlated with competitiveness or any of the ese venture phases. t a b l e 1 descriptives and correlations for venture creation phases and competitiveness mean sd 1 2 3 4 5 6 7 1 searching 4.186 0.651 1 .489** .505** .408** .142* .276** .457** 2 planning 3.981 0.600 .485** 1 .527** .489** .334** .277** .373** 3 marshaling resources 4.085 0.597 .508** .520** 1 .523** .162* .365** .354** 4 implementing people 4.334 0.505 .404** .483** .521** 1 .317** .408* .202* 5 implementing financial 3.991 0.842 .142* .332* .161* .315** 1 .192* .025 6 attitude to venturing 4.534 0.544 .272** .277** .368** .402** .195* 1 .191* 7 competitiveness 3.786 0.651 .458** .376** .354** .208* .286 .194* 1 * p ˂ .05; ** p ˂ .01, two-tailed. to further evaluate the relationship between the ese dimensions and competitiveness, multiple regression analysis was conducted. refer to table 2 for the full set of results. multiple regression analyses, using ordinary least squares regression, were performed to determine the predicted relationship between the specified variables. firm size as the control variable was included in the regression analyses by means of an appropriate dummy variable. a significance level of 5 per cent was considered appropriate for this research and all statistical tests were carried out at this level. table 2 represents the independent variables regressed on the various dependent variables. the use of multiple regressions allows for the partitioning of variance with correlated predictors, thereby reducing the likelihood of making a type 1 error (cohen & holliday, 1998). it is worth noting that although the coefficient of determination (r-squared) does not exceed 30 per cent, the relationships determined through the regression analysis, while they may be weak, are nevertheless 360 sajems ns 15 (2012) no 4 statistically significant. model 1 has an r square of 0.221, which is interpreted as the predictors (ese dimensions in the venture phases) explaining 22 per cent of variance in the dependant variable (competitiveness). in the anova section (not shown) an f-value of 5.991 is highly statistically significant (0.000). referring to table 2, the constant coefficient provides a t-value of 3.908, significant at the 0.05 level (p < 0.001). the highest beta weight (0.305) and only significant t-value (4.320, p < 0.001) is for the ese search phase dimension. the second highest beta was for the ese planning phase dimension, with a borderline level of significance (p = 0.012). since other coefficients are not significant, the predictive and explanatory power of this model is reduced. to try and determine if the predictive power of the regression could be improved by only entering the significant coefficients another model was tested where ese search and ese planning were entered together with the dependant variable. the adjusted r-square was 0.228 in this instance suggesting a very small improvement where the two ese dimensions explain only a marginally greater variance in competitiveness. t a b l e 2 regression results for ese venture phases on venture competitiveness β std. error t-value h0: β (i) =0 sig. reject h0 at 5% step 1 ͣ constant 1.623 0.415 3.908 0.000 yes searching 0.305 0.071 4.320 0.000 yes planning 0.208 0.082 2.538 0.012 yes marshalling 0.112 0.084 1.323 0.187 no implement people -0.091 0.095 -0.960 0.338 no implement finance -0.064 0.048 -1.334 0.184 no attitude towards venture 0.061 0.077 0.789 0.431 no firm size (medium) 0.096 0.131 0.738 0.461 no ͣvariable(s) introduced in step 1include: ese search, plan, marshal, people, finance, attitude, firm size. examinations of the collinearity diagnostics reveal relatively low variance proportions for the ese dimensions. these diagnostics when read in conjunction with collinearity statistics, not shown due to space limitations, indicate variable inflation factor (vif) values between 0.274 and -0.022. these figures are well below critical values and deemed as acceptable, indicating no incidence of multicollinearity. when the values are 10.0 or more the regression coefficients can fluctuate widely from sample to sample, making it risky to interpret the coefficients as indicators of the predictors (cooper & emory, 1995). apart from the above analysis, to try and make further sense of the results differences in ese across venture phases were tested between groupings of gender, education and work experience. initially the descriptives were interrogated in terms of lower bound and upper bound values, followed by test for homogeneity of variances. the levene statistic was significant and greater than 0.05 across all ese dimensions for all variables. a one-way analysis of variance (anova) was used to compare ese mean scores on first gender and education and then work experience. anova results were interpreted as follows (not shown): for the ese search dimension there is a 0.288 probability of obtaining an f-value of 1.488 or higher if there are no differences among group means in the population. since this probability exceeds 0.05 one can conclude that for this ese dimension as well as for all the other dimensions there are no significant differences among the ese mean scores across these variables. further post-hoc robust tests of equality of means were calculated and the brown-forsythe statistic indicates that there were no significant differences on ese mean scores across gender and education. the same procedure in terms of anova and post-hoc comparisons were conducted for work experience, with no significant results detected. sajems ns 15 (2012) no 4 361 5 discussion the purpose of this study was to build on research incorporating ese as conceptualised through the four phases of the venture creation process and to establish possible links to venture competitiveness. specifically it was hypothesised that each of the venture creation phases will be significantly associated with the competitiveness of the ventures. the study demonstrates that ese influences how entrepreneurs discharge their responsibilities during the venture creation phases and that these behaviours to which ese corresponds are largely concerned with tasks that are required of entrepreneurs well beyond the point of founding. the empirical evidence ensuing from this study supports five out of the six propositions, where ese in searching, planning, marshalling resources, and implementing people, as well as attitudes toward venturing were significantly associated with the competitiveness of the venture. these findings translate into the following entrepreneurial actions that are desirable during the venture creation phases in order to ensure competitiveness: (1) searching in terms of opportunity identification and development; (2) planning and evaluating the business concept in terms of various market and profitability criteria; (3) gathering (marshalling) necessary resources such as capital, labour, customers, and suppliers without which the venture cannot exist or sustain itself; (4) growing the business and ensuring the sustainability of the venture through implementing people management practices. the results also resonate with the suggestion that attitudes toward venturing may have important implications for the competitiveness of a venture after the founding event (forbes, 2005). the only non-significant result in this study, in relation to venture competitiveness was for the ese implementing financial management phase of the venture process. this means that based on the study sample the respondents lack the necessary beliefs in implementing financial management activities. this is perhaps indicative of the high rate of financial illiteracy which has been ranked as the most important factor inhibiting entrepreneurial activity in south africa (orford et al., 2003). based on the regression results the different ese dimensions in the venture creation phases explain a modest, albeit significant amount of variance in the competitiveness of the sme. competitiveness was conceptualised as firm outcomes resulting from entrepreneurial action during the venture creation phases and measured in terms of competitive development and strategic positioning, as a consolidated score. competitive development has been recognised as important as ventures using entrepreneurial initiatives to explore or exploit new technologies or product-market domains, particularly by exploiting entrepreneurial opportunities. the same importance is often attached to strategic repositioning, where entrepreneurial behaviours during the venture creation phases can place the venture in a new position within its pre-existing product-market domain(s). interlinking the empirical results of this paper with established literature allows for additional insights to emerge. while individuals are thought to identify opportunities (aligned with the searching phase) because they possess uniquely different forms of knowledge or human capital (venkataraman, 1997), this study confirms that ese as a task specific activity plays an important role at the start of this process. this finding is consistent with the view that during the venture process phases, competent functioning requires both skills and self-beliefs of efficacy. operative efficacy calls for continuously improving multiple subskills to manage ever-changing circumstances, as typified in entrepreneurial environments, most of which contain ambiguous, unpredictable and often stressful elements (chandler & jansen, 1992). moreover as entrepreneurial opportunities encompass a social learning process whereby new knowledge continuously emerges to resolve uncertainty inherent to each stage of the venture creation phases, the relevance of ese in the searching, planning, marshalling, and implementing phases is confirmed. this would suggest that a major factor influencing the process of opportunity recognition and development which leads to venture sustainability includes maintaining high levels of ese throughout the venture creation process. the success of any venture, 362 sajems ns 15 (2012) no 4 particularly in terms of competitiveness is more probable when an individual has the ese required to structure (accumulate and strategically divest), bundle (successfully combine), and leverage (mobilise and deploy) its resources (sirmon, hitt & ireland, 2007). not surprisingly the relationship between selfefficacy and performance has been found to be mediated by strategy use and vice versa (forbes, 2005), which reflects the generative capability of self-efficacy where cognitive, social, and behaviour sub-skills are organised into integrated courses of action. such action requires perseverant effort and self-doubters are quick to abort this generative process if initial efforts are deficient (bandura, 1997). in a broader framework, research on entrepreneurship, in an emerging market context as a whole, may be considered valuable as very few empirical studies have previously been conducted which focus on ese and competitiveness. examining ese in an emerging market context is pivotal to understanding entrepreneurship, since little evidence exists that self-efficacy is salient to entrepreneurs from non-western cultures (vecchio, 2003). investigating how different individuals under different socioeconomic circumstances, display ese is important as ese may be context specific, and one can expect patterns of ese to vary depending on an individual’s situational context (urban, 2010). this is important as emerging economies are unique environments that offer the ability to obtain fresh insights to expand theory and our understanding of it by incorporating more contextualised considerations (bruton, ahlstrom & obloj, 2008). by contextualising this study in the current south african socio-economic milieu, it becomes clear that in order to successfully navigate the venture creation phases, entrepreneurs need high levels of ese. unless entrepreneurs perceive themselves as capable and willing to be entrepreneurial, their venture will remain uncompetitive and underperforming. being motivated is not only considered an integral aspect of entrepreneurship but must be supplemented with education and training, since start-ups without possessing the requisite skills, knowledge and attitudes nullifies the formula for more entrepreneurship. moreover by acknowledging the legacy of apartheid it becomes apparent that damage was very likely to have occurred to the self-esteem, motivation, and creativity of specific ethnic groups in south africa (ahwireng-obeng, 2006). disadvantaged communities often suffer from deficits in self-efficacy, where victims of poverty visibly reflect the symptoms of learned helplessness (rabow, barkman & kessler, 1983). based on the present study’s sample characteristics – mostly university educated and with some work experience, it is apparent that the results of the study are more in line with opportunity-driven entrepreneurship. it is more likely that opportunity-driven rather than necessity-driven individuals, with higher levels of human capital would have higher levels of ese which serves to organise what opportunities they recognise and exploit marshal resources and implement strategies in order to promote the competitiveness of their ventures. this line of thinking resonates with amartya sen‘s (2000) ‘capability approach’, who assesses people’s welfare in terms of their functioning and capabilities. in terms of an individual’s current and future activities and states of being respectively, the ‘capability approach’ is useful in understanding the concept of the conversion factor which measures the individual‘s ability to convert existing opportunities into activities and achievement. 5.1 implications the practical implications of this study are that entrepreneurs need to develop ese throughout the venture creation phases to ensure the competitiveness of the venture. the specific tasks required for this begin with the recognition of an entrepreneurial opportunity which is followed by the development of an idea for how to pursue that opportunity, and this leads to the evaluation of the feasibility of the opportunity, then to the development of the product or service that will be provided to customers, and requires an assembly of human and financial resources (reynolds, 2011). this means that ese is integral during each of the venture creation phases, and may be linked from one stage of the entrepreneurial process to another in terms of overall competitiveness. in fact, it is quite plausible that ese influences one part of the process which has effects at that sajems ns 15 (2012) no 4 363 stage in the process and possibly affects the later stages of the venture creation phases, meaning that an ese is required continuously to ensure the venture is competitively capable. further implications of this study can be advanced to the policy domain where it needs to be stressed that government initiatives will affect venture creation only if these policies are perceived in a way that influences selfefficacy (krueger et al., 2000). it has been suggested that the emergence of entrepreneurs in transitional economies depends on the entrepreneurial potential of the society which is, in turn, largely a function of systematic efforts of developing entrepreneurs with a high ese. instead of hoping for a massive capital infusion to improve business prospects, transitional economies may well be advised to implement formal self-efficacy programs to foster individual initiative for entrepreneurial development (luthans, stajkovic & ibrayeva, 2000). the practical implications of this study can also be advanced to the classroom setting, where consideration of self-beliefs in the design of curriculum and teaching methodologies can enhance learning and propel ese. improving the skills base and fostering positive ese across the venture creation phases is critical for ensuring sustainable ventures. 5.2 limitations and future research this study has typical survey design limitations in that data was obtained from a selfadministered questionnaire, where self-serving bias may have influenced the responses. secondly, since study was cross-sectional in design, results should be interpreted with caution and links between ese and competitiveness cannot be confirmed unambiguously. moreover the entrepreneurial process can only be understood as a constellation of personality features of which self-efficacy is only part of. future studies could be extended to include specific contextual factors to help explain the venture formation process, and also identify variables which may moderate levels of ese and venture competitiveness. 5.3 conclusion this study has contributed to the broader framework of existing theory and research on ese, consequently enlarging scholarship in terms of the venture creation phases. recognising the importance of self-belief issues in entrepreneurship, it seems that ese is required continuously throughout the venture creation phases to ensure competiveness. to continually improve multiple sub-skills required to manage ever-changing venture phases, requires 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accepted: 27 sept. 2017; published: 29 mar. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: enron was considered a strong corporate social performer when their infamous accounting scandal emerged in 2000. literature suggests that companies use corporate social responsibility (csr) to disguise corporate misconduct. aim and setting: this study examines one type of corporate misconduct, namely, earnings management (em). prior studies have found significant associations between csr performance and em; however, none of these studies controlled for csr disclosure. this study unbundles the effects of csr performance and csr disclosure on em. to examine the relationship between csr performance and csr disclosures and em of listed south african companies. methods: a company included on the socially responsible investment (sri)1 index is used as an indicator of csr performance. four measures of csr disclosure are used. results and conclusion: the study tests both csr performance and csr disclosure against both real earnings management (rem) and accrual-based earnings management (aem). csr performance and earnings management: companies with better csr performance were more likely to engage in em through income increasing discretionary accruals. this suggests that managers who inflate earnings may engage in csr activities to avoid unwanted scrutiny from stakeholders. companies with better csr performance were less likely to engage in rem, suggesting that managers with better csr performance regard the management of earnings through accruals that reverse in the next period less incriminating than managing earnings through actual company resources. csr disclosure and earnings management: companies that integrated their csr disclosures more into their annual report engaged less in income decreasing discretionary accruals, suggesting that managers with incentives to make more csr disclosures to reduce information asymmetry will also be less inclined to manage earnings. introduction management may engage in corporate social responsibility (csr) to disguise corporate misconduct (hemingway & maclagan 2004). one form of corporate misconduct, earnings management (em), is defined as management’s use of judgement in financial reporting in order to mislead stakeholders about the underlying financial performance of the company (healy & wahlen 1999). this study investigated whether companies use csr to disguise earnings management. firstly, the study investigated the association between the csr performance and earnings management of south african companies. the proxy for csr performance is an indicator of whether the company is included in the socially responsible investment (sri) index1 or not. to be included in the sri index, companies are independently assessed from public information, only, on whether they meet the environmental performance, social and economic sustainability, corporate governance and commitment to climate change criteria. assessments are overseen by experts from the investment community, non-governmental organisations (ngos), unions and academia, which increase their credibility. companies cannot voluntarily decide to be assessed, and all companies listed on the all share index are automatically included. the study measured earnings management through both discretionary accruals and real earnings management (rem) as managers may manage earnings through either accruals or actual cash flows (cohen, dey & lys 2008; zang 2012). managers use real earnings and accrual-based earnings management (aem) as substitutes for each other; thus, examining either type in isolation cannot lead to definitive conclusions (zang 2012). this study makes some advances on the prior literature. firstly, it is the first study to ascertain whether companies classified by the johannesburg stock exchange (jse) as sris are, indeed, also ‘socially responsible’ when it comes to the transparency of their earnings. secondly, prior studies that tested the relationship between csr performance and earnings management (gargouri, shabou & francoeur 2010; kim, park & wier 2012; lassaad & khamoussi 2012) did not control for the effect of csr disclosure in their analyses. csr disclosure has been shown to be significantly correlated with earnings management (martínez-ferrero, garcia-sachez & cuadrado-ballesteros 2013; suteja, gunardi & mirawati 2016; yip, van staden & cahan 2011). by adding an additional variable, namely, csr disclosure, when testing the relationship between csr performance and earnings management, this study unbundles the effects of csr disclosure and csr performance on earnings management. thirdly, this study tested the association between csr disclosure and earnings management of large, listed south african companies, using a rigorous research design. previous studies have used simple measures of csr disclosure such as word count, sentence count or page count (pinto, de villiers & samkin 2014), disregarding the actual content of the disclosure. this study improves on these prior studies by firstly using four different measures of csr disclosure, including a composite disclosure measure, which analyses the content of the csr disclosure and not just the amount of disclosure. all data used in the measures of csr disclosure were independently collected by a reputable audit firm (kpmg inc.), which increases its credibility. fourthly, prior studies that tested the association between earnings management and csr disclosure did not control for csr performance in their analyses. as discussed, several studies have found significant associations between csr performance and earnings management; however, none of these studies controlled for this in their analyses. in terms of practical implications, the results of this study will be useful for investors in their decision-making as they may give insights into the expected transparency of earnings reported by entities classified by the jse as sris. the jse, and possibly the financial times stock exchange (ftse), may also find the results insightful as they might consider adding additional criteria regarding the transparency of earnings when assessing their sris. in addition, auditors (both financial and csr auditors) may consider the findings of this study when determining audit risk, as well as regulators when determining further regulations with respect to csr disclosures. the remainder of this paper is set out as follows: the ‘related literature and formulation of hypotheses’ section discusses relevant literature and the theoretical framework used in the study and formulates the research hypotheses. ‘method’ section describes the research design. ‘results’ section presents the results of the study and the ‘conclusion’ section contains concluding remarks. related literature and formulation of hypotheses corporate social responsibility performance and earnings management it has been suggested that, when acting as agents for shareholders, managers are motivated by self-interest in their decision-making (healy & palepu 2001; jensen & meckling 1976; mcwilliams, siegel & wright 2006). bergstresser and philippon (2005) find that chief executive officers (ceos) engage in earnings management for personal gains. on the csr side, hemingway and maclagan (2004) suggest that csr performance is driven by the personal values of managers. lawrence et al. (2013) also found that social and environmental practices are driven by the values and beliefs of senior management. managers may have an incentive to act ethically or have an incentive to act opportunistically. in line with this theory, prior studies used two main hypotheses to explain the relationship between csr performance and earnings management: ethical hypothesis and opportunistic hypothesis (kim et al. 2012). ethical hypothesis the ethical hypothesis states that managers have an incentive to be ethical, honest and transparent in their financial reporting and to be socially and environmentally responsible in their activities. if stakeholders believed that earnings were being managed or that a company was not being socially responsible, the company concerned may lose value in the market. turyakira, venter and smith (2014) found a positive relationship between society-related csr activities and competitiveness of small and medium-sized enterprise (smes). martínez-ferrero, banerjee and garcía-sánchez (2016) found that csr increases corporate reputation and reduces cost of capital, while earnings management reduces corporate reputation and increases cost of capital. a tarnished corporate reputation, decreased competitiveness and increased cost of capital would have dire consequences for managers (job loss, reduction in salary, etc.). thus, it is these dire consequences that may motivate managers to act ethically. such ‘ethical’ managers would then be less inclined to manipulate earnings, and they would endeavour to ensure that the company’s reputation was not compromised by inappropriate social and environmental activities. kim et al. (2012) found support for this hypothesis in their investigation of a sample of companies in the united states. they found that companies with higher csr performance scores delivered more transparent financial information to investors. in a study of malaysian companies, it was found that companies supplying islamic products (and therefore assumed to be complying with the principle of preserving the interests of society, and not only the interests of the manager) were not engaging in csr to cover up earnings management (ibrahim et al. 2015). in addition, south korean firms engaging in csr (measured as donations expenditure) were also less likely to engage in earnings management through discretionary accruals (pyo & lee 2013). bozzolan et al. (2015), in an international study of 24 countries, found that csr activities act as a constraint for rem but not aem. rem negatively affects the future financial performance of a company which csr-orientated companies seek to avoid. this also suggests some support for the ethical hypothesis as csr-orientated companies were found to be less likely to engage in rem, which may negatively affect a company’s future financial performance. interestingly, rem seems to be even more constrained by csr activities in countries with strong legal enforcement (bozzolan et al. 2015). these results suggest that countrywide institutional factors (e.g. societal values and legal enforcement) may curb a manager’s unwanted behaviour and therefore play a moderating role in the relationship between csr performance and earnings management. garcía-sánchez and garcía-meca (2017) also found that socially responsible banks in strict regulatory environments have less earnings management. these results suggest that managers in strong regularity environments have more incentive to be socially responsible in their activities and transparent in their financial reporting than those in weaker regularity environments. prior studies have shown that, countrywide, institutional factors influence the relationship between csr activities (performance) and earnings management. in this study, in order to reduce the ‘noise’ of institutional factors, we focus solely on south african companies. in doing this, we add to the scant research on the relationship between csr and earnings management in emerging economies, and to our knowledge, the first to test the relationship in an african country (namely, south africa). accordingly, the first hypothesis may be stated as follows: h1a: companies with better csr performance are less likely to manage earnings. opportunistic hypothesis it is also possible that managers may have an incentive to act opportunistically in their decisions on whether or not to be socially and environmentally responsible. prior research has obtained support for the opportunistic hypothesis (prior, surroca & tribό 2008), with hemingway and maclagan (2004) stating that companies may adopt a policy of csr to cover up corporate misconduct, thereby obtaining the support of stakeholders by diverting their attention. grougiou et al. (2014) found that earnings management in us banks drives csr, suggesting that bank managers engaging in questionable financial reporting practises are also likely to be engaging in csr to deflect unwanted attention. martínez-ferrero et al. (2016), in a study of companies in 26 countries, found that as expected csr had a positive effect on a company’s cost of capital. interestingly, the favourable effect was greater in companies where earnings management was detected. this indicates that stakeholders are unable to identify when csr is being used to ‘greenwash’ earning management. once again, it was found that countrywide institutional factors, specifically the legal environment in which a company operates, play a moderating role with investors less likely to fall for managers’ greenwashing antics in common law countries (when compared to civil law countries). this is largely because of increased investor protection in common law countries (martínez-ferrero et al. 2016). while most of the related research has studied developed economies, the research in emerging economies is scant (muttakin, khan & azim 2015). in one emerging economy, bangladesh, a civil law country with a poor legal and monitoring environment, it was found that managers use csr to hide earnings management (muttakin et al. 2015). companies in nigeria, an emerging economy in a poor monitoring environment in africa, were found to manage earnings less when the board of directors was larger and more independent (fodio, ibikunle & oba 2013). this suggests that good corporate governance may curb managers from managing earnings when the monitoring environment is weak. in a recent study of earnings management in south african companies, pududu and de villiers (2016) found no evidence of south african managers managing earning to avoid small losses or small decreases in earnings. they, however, mention that this may be because of investors and analysts rather being interested in other reported figures such as headline earnings per share (which may or may not be managed). thus, if managers are managing earnings opportunistically and engaging in csr activities in an attempt to ‘greenwash’ the misstated financial results, it is feasible to expect a positive relation between csr performance and earnings management. the hypothesis may, thus, be stated as a competing hypothesis to h1a: h1b: companies with better csr performance are more likely to manage earnings. corporate social responsibility disclosure and earnings management managers may be driven by self-interest (jensen & meckling 1976) in deciding what disclosures to make to shareholders with voluntary csr disclosures being associated with positive economic outcomes (healy & palepu 2001) such as higher share prices (de klerk & de villiers 2012; de klerk, de villiers & van staden 2015; de villiers & marques 2016). csr disclosures are still primarily voluntary with managers having discretion over what and how much is disclosed (del sordo et al. 2016; de villiers 1998, 1999, 2003; massa, farneti & scappini 2015; rao & tilt 2016). these decisions are often driven by environmental factors (amoako, lord & dixon 2017; borghei, leung & guthrie 2016; green, taylor & wu 2017; khan & gray 2016; leung & gray 2016; welbeck 2017). individual shareholders (de villiers & van staden 2010a, 2011) and institutional investors (solomon & solomon 2006) require corporate environmental disclosure, use it in their investment decision-making (radley yeldar limited 2012) and hold companies accountable for their environmental impacts (de villiers & van staden 2010b). atkins and maroun (2015) interviewed institutional investors and found that they thought that reporting on environmental and social issues was an important source of legitimacy in the south african capital markets. fund managers are also beginning to use these traditional ‘soft issues’ in their formal analyses (atkins et al. 2015). ethical hypothesis prior studies have found csr disclosures to be associated with earnings management. martínez-ferrero et al. (2013) found a positive relationship between conservative accounting practices and the extent to which managers disclosed their csr information in line with the global reporting initiative (gri)2 guidelines for csr reporting. they argue that managers who have incentives to reduce information asymmetry will minimise earnings management and disclose more csr information to shareholders. in line with this, chen, srinidhi, tsang and yu (2016) found that companies committed to better financial reporting, proxied by their audit fee expense, are more likely to issue stand-alone csr reports. if this is the case, it is feasible to expect a negative relationship between csr disclosures and earnings management. thus, the next hypothesis is stated as follows: h2a: companies that make more csr disclosures are less likely to manage earnings. opportunistic hypothesis managers with an incentive to manage earnings opportunistically may disclose more csr information in order to satisfy stakeholders and prevent unwanted scrutiny. yip et al. (2011) concluded that managers in industries under intense public scrutiny tend to manage earnings less and disclose more csr information as compared to managers in industries under less public scrutiny. these results suggest that managers who may get away with opportunistic behaviour are more likely to engage in such behaviour. patten and trompeter (2003) found that companies with lower levels of csr disclosures manage earnings downwards during periods of intense political scrutiny, thus also suggesting that managers use csr disclosures as a tool with which to avoid unwanted scrutiny. stakeholders may be less likely to scrutinise managers with more csr disclosures. this will enable managers to hide irregularities (earnings management) behind a curtain of csr disclosure. if managers with an incentive to manage earnings disclose more csr information in order to avoid unwanted scrutiny from stakeholders, it is feasible to expect a positive relation between csr disclosures and earnings management. accordingly, the final hypothesis may be stated as a competing hypothesis to h2a: h2b: companies that make more csr disclosures are more likely to manage earnings. method sample the researcher identified all the south african companies for which csr disclosure data had been collected for the purposes of kpmg’s published 2008, 2011 and 2013 reports on csr reporting practices (kpmg 2008, 2011, 2013). kpmg did not collect csr disclosure data for the other years. csr disclosure data for 100 companies for each of the 3 years were collected by kpmg, resulting in an initial sample of 300 company-years. financial data to compute the earnings management measures for the companies were obtained from the iress database. following prior research, financial companies were eliminated from the final sample because of their differing financial ratios (zang 2012). the final sample consisted of 214 company-years (72 for 2008, 78 for 2011 and 64 for 2013). table 1 presents the breakdown of company-year observations per industry. table 1: sample companies classified by industry. corporate social responsibility performance measure during 2004, the jse launched the jse sri index (jse 2014a). eligibility for inclusion in the sri index is based primarily on a company’s environmental performance, social and economic sustainability, corporate governance and commitment to climate change (jse 2014b). all companies in the all share index are automatically rated against these criteria and a list of companies that meet these criteria is issued annually by the jse (jse 2014a, 2014b). the companies cannot voluntarily decide to be rated. only publicly available information is assessed and no information is accepted directly from the companies. ftse international limited (ftse) calculates the ratings on behalf of the jse. an independent committee comprising experts from the investment community, ngos, unions and academia reviews all ratings. this increases the credibility and transparency of the information obtained. the proxy for csr performance used for the purposes of this study is an indicator variable equal to 1 if the company is included in the sri index and 0 if not. corporate social responsibility disclosure measures kpmg international analysed the csr reporting practices of the largest 100 companies, in terms of revenue, in different countries during 2008, 2011 and 2013. regional kpmg offices collected the data by analysing the csr disclosures in annual financial reports and stand-alone reports and on company websites, using a questionnaire-based design. the analyses were based on publicly available information only and not on information submitted by companies to kpmg member companies. the data were coded, the questionnaires were compared, and the following four measures of csr disclosure were developed, used in this study to proxy for csr disclosure: int3: this measures the level of integration (int) of the csr disclosures in the annual report. gri: this indicates whether the company used the gri guidelines when disclosing csr information. comp_dis: this is a composite measure of disclosure combining the level of integration of the csr disclosures in the annual report (int) and whether the company issues a stand-alone csr report and/or csr information is available on the company’s website. comp_all: this is a composite, all-inclusive measure which combines the level of integration of the csr disclosures in the annual report (int); an indicator if the company uses the gri guidelines when disclosing csr information (gri); an indicator if the company issues a stand-alone csr report and/or csr information is available on the company’s website; an indicator if a company addresses supply chain issues in its csr disclosure; an indicator if the csr disclosures have been assured by a third party; a measure of the scope of any assurance provided on the csr disclosures (e.g. whether the whole csr report or only certain chapters and/or indicators were assured); and, finally, a measure of the level of assurance (e.g. positive assurance or limited assurance) provided by the assurance provider. earnings management measures in line with the suggestions of kim et al. (2012) and zang (2012), this study used two measures of earnings management, one that measured discretionary accruals and one that measured rem. the reason for using both measures of earnings management is that managers may manage earnings through accruals and/or actual cash flows (cohen et al. 2008). managers use real earnings and aem as substitutes for each other; thus, examining either type in isolation cannot lead to definitive conclusions (zang 2012). the more managers manage earnings (through discretionary accruals and/or rem), the less useful the reported financial figures are to stakeholders and the lower the accounting quality of such reported financial figures. discretionary accruals several prior studies used discretionary accruals as a proxy for earnings management (cohen & zarowin 2010; kim et al. 2012; zang 2012). similarly, this study used discretionary accruals as the first proxy for earnings management as accruals may be used by managers to manage earnings either upwards or downwards. the study used a modified jones’ (1991) model as specified by dechow, sloan and sweeney (1995) and controlled for the book-to-market value of equity (growth) as well as current year cash flows before extraordinary items and discontinued operations (performance) as specified by larcker, richardson and tuna (2007). using data from the iress database, the study estimated discretionary accruals (ε) for all the companies in the sample per industry for each of the sample-years 2008, 2011 and 2013 (cross-sectional). in accordance with the literature, this study used the absolute value of discretionary accruals rather than the signed value as all accruals reverse in future periods. in other words, an income decreasing accrual in one period will reverse and increase income in the next period. in an additional analysis, the signed discretionary accruals were split between positive and negative discretionary accruals in order to evaluate whether csr performance or csr disclosure (or both) was associated with either positive or negative discretionary accruals (i.e. are these companies using income increasing or income decreasing accruals to manage their earnings?). all accrual estimates were scaled by lagged assets to ensure comparability, as larger firms would naturally have larger accruals than smaller firms. real earnings management roychowdhury (2006) defines rem as management actions that are not in line with normal business practices and with the main objective of meeting certain earnings thresholds. roychowdhury found that companies use rem in order to avoid losses and either to meet or to beat analysts’ forecasts. he found that managers increase sales by offering price discounts and lenient credit terms and reduce the cost of inventories sold (cogs) through the overproduction of inventory, which lowers the amount of fixed production costs allocated to each item of inventory (zang 2012). roychowdhury (2006) and zang (2012) also found that managers reduce discretionary expenses such as advertising and research and development expenditure in order to increase profits. real earnings management is not desirable to stakeholders as it may reduce a company’s value in future periods as customers may demand the reduced selling price in the future. lenient credit sales may increase doubtful debts and increase opportunity costs as debtors need to be financed, while excessive inventory on hand carries additional holding costs, as well as the risks of potential write-downs if the net realisable value falls below the cost price of such inventory. reducing advertising and research and development costs may reduce future sales, as well as potentially cause companies to lose their competitive advantages. in line with kim et al.’s (2012) study, this study estimates the abnormal cash flows, abnormal production costs (ab_prod), abnormal discretionary expenses (ab_exp) as well as a combined measure using the models below. abnormal levels of operating cash flows: lower cash flows than the industry norm in relation to lagged assets (ε) when regressed on sales may indicate earnings management, as cash flows may be lower as a result of managers offering price discounts, etc., to drive sales upwards. in addition, offering more lenient credit terms may also result in sales that are never realised in cash. thus, lower abnormal cash flows may indicate more rem, through attempts to drive up sales that may not realise in cash, and lower accounting quality. abnormal production costs: higher production costs than the industry norm (ε) when regressed on sales may indicate earnings management by the overproduction of inventories. the overproduction of inventories reduces the cost of goods sold as the fixed production costs are spread over a larger number of items (assuming that the ‘saving’ from fixed production costs being allocated to more individual inventory items is greater than the variable costs incurred to produce one additional item). thus, higher ab_prod may indicate more rem, through the overproduction of inventory and lower accounting quality. abnormal discretionary expenses: if discretionary expenses (e.g. research and development costs) are being reduced in order to meet short-term earnings targets, it is expected that the discretionary expenses regressed on lagged sales will be lower than the industry norm. thus, lower ab_exp may indicate more earnings management and lower accounting quality. combined real earnings management: the main proxy of rem in this study is calculated by aggregating the three residuals from models 2.1, 2.2 and 2.3. if managers engage in more rem, it is feasible to expect abnormal levels of operating cash flows (ab_cfo) to be lower, ab_exp to be lower and ab_prod to be higher. the ab_prod were deducted when calculating combined real earnings management (combined_rem) so that positive ab_prod reduced the combined_rem. lower combined_rem indicates higher earnings management and lower accounting quality. regression models to test hypotheses the regression model is based on kim et al.’s (2012) study. however, it has been extended to include an additional variable of interest, a measure of csr disclosure in order to ‘unbundle’ the effects of csr disclosures and csr performance on earnings management. csr performance has been shown to be significantly correlated with earnings management (gargouri et al. 2010; kim et al. 2012; lassaad & khamoussi 2012); however, none of these studies controlled for the effect of csr disclosures. the main models used in this study to test the association between csr and earnings management are given below. model a: β1 is the first coefficient of interest that tests the association between earnings management through discretionary accruals and csr disclosure. β2 is the second coefficient of interest that tests the association between earnings management through discretionary accruals and csr performance. csr_disclosure is the measure of csr disclosure. the measures are detailed in the ‘corporate social responsibility disclosure measures’ section of this article. sri is the measure of csr performance and is an indicator of whether the company is listed on the jse sri index. da (abs, pos, neg) is the measure of earnings management through discretionary accruals computed as the residual of model 1 in appendix 1. combined_rem is the measure of earnings management through rem computed by model 2.4 in appendix 1. size is the natural logarithm of the market value of equity (mve). mb proxies for growth calculated as market-to-book equity ratio, measured as mve divided by book value of equity. roa proxies for performance calculated as profit before extraordinary items, scaled by lagged total assets. lev is long-term debt scaled by total assets. shares_issued is the number of shares issued in the following year. rd_in is research and development expenditure scaled by total revenue. company_age is the logarithm of 1 + number of years since incorporation of the company. model b: β1 is the first coefficient of interest that tests the association between earnings management through rem and csr disclosure. β2 is the second coefficient of interest that tests the association between earnings management through rem and csr performance. all other variables are discussed under model a. additional tests, controlling for both year and industry, were conducted. the untabulated results are discussed in the ‘additional regressions controlling for years and industry’ section. results descriptive statistics table 2 presents the descriptive statistics for the sample. the absolute discretionary accruals (abs_da) had a mean of 0.044 of lagged assets, while rem (combined_rem) had a mean of 0.011 of lagged assets. this suggests that, on average, the companies in the sample managed earnings more through discretionary accruals (4.4% of lagged assets) than through rem (1.1% of lagged assets). the sample was split between companies with positive discretionary accruals (pos_da) (101 companies) and those with negative discretionary accruals (neg_da) (113 companies). the average pos_da was 4.9% of lagged assets, and the average neg_da was 3.9% of lagged assets. prior research (bergstresser & phillippon 2006; larcker et al. 2007) supports this notion that discretionary accruals, rather than rem, are primarily used for earnings manipulation. zang (2012) also hypothesises that managers find rem more costly as it represents a departure from optimal operating decisions. of the sample companies, 51.9% were listed as sris by the jse. the majority (66.6%) of the companies in the sample disclosed csr information in terms of the gri guidelines. the median integration level (int) was 2 out of 3, which means that the majority of companies in the sample were disclosing csr information in a separate section of the annual report only. the median composite disclosure score was 2 out of 4, and the median all-inclusive csr score was 4 out of 10. table 2: descriptive statistics on selected variables. table 3 depicts the descriptive statistics of the companies that the jse had classified as sris (hereinafter sri companies) as compared to those companies that had not been classified as such. the average abs_da were higher for sri companies (0.051) than for non-sri companies (0.036). this difference is statistically significant (p < 0.05), suggesting that sri companies may engage in more earnings management through discretionary accruals than non-sri companies. the sri companies had a higher mean of positive discretionary accruals (0.628) as compared to the non-sri companies (0.325). this may suggest that the sri companies were managing earnings through income increasing discretionary accruals more than non-sri companies (p < 0.01). table 3: descriptive statistics by socially responsible investment versus non-socially responsible investment companies. the sri companies had a higher combined_rem, suggesting less rem than the non-sri companies (p < 0.05). the rem appears to be driven mainly by ab_prod, with the non-sri companies managing earnings through the overproduction of inventory more than their sri counterparts. as expected, sri companies were more likely to report using the gri guidelines (p < 0.01) and had higher levels of csr disclosure (p < 0.01). the sri companies were smaller (based on the mve) with higher growth (based on the market-to-book value of equity). this may show that the smaller companies were trying to gain a competitive advantage over their established competitors, gaining stakeholder support by getting classified as sris. the study tested the control variables for multicollinearity and found that the control variables were not significantly correlated (variance inflation factors (vif) ranged between 1.026 and 2.017 for both sets of models). thus, multicollinearity between variables is not a concern in the research design. regression results corporate social responsibility performance and earnings management through discretionary accruals the results depicted in table 4 suggest that there is no overall association between earnings management through discretionary accruals (abs_da) and csr performance (sri). when abs_da were split between pos_da and neg_da, there was a significant positive relation between pos_da and sri (p < 0.05), suggesting that companies with better csr performance are more likely to engage in earnings management through income increasing discretionary accruals. this may suggest that companies that are managing their earnings upwards are engaging in more csr activities, possibly to divert the attention of investors away from their misconduct. gargouri et al. (2010) found a positive correlation between csr performance and earnings management, and suggest that the cost of csr activities reduce financial performance and subsequently give management an incentive to manage the earnings. this notion finds some support for hypothesis h1b (the opportunistic hypothesis). these results hold true, after controlling for the effects of csr disclosure on earnings management (see ‘corporate social responsibility disclosure and earnings management through discretionary accruals’ section). suteja et al. (2016) found that companies use csr activities to cover up earnings management and not out of social responsibility and caring. in line with kim et al.’s (2012) study, the results also suggest that larger companies are less likely to engage in income reducing discretionary accruals as compared to smaller companies (p < 0.01). turning to the control variables, companies with a higher debt ratio leverage (lev) are more likely to have more positive discretionary accruals and less negative accruals. this is consistent with managers attempting to increase earnings to avoid violating debt agreements (kim et al. 2012; yip et al. 2011). table 4: accrual-based earnings management on corporate social responsibility performance. corporate social responsibility performance and real earnings management the results depicted in table 5 suggest that combined_rem is positively and significantly (p < 0.05) associated with sri, thereby indicating that companies with better csr performance are less likely to engage in rem (higher combined_rem indicates lower levels of earnings management). bozzolan et al. (2015) also found that csr activities act as a constraint for rem (rem) but not aem. real earnings management negatively affects the future financial performance of a company, which csr-orientated companies seek to avoid. this also suggests some support for the ethical hypothesis as csr-orientated companies were found to be less likely to engage in rem, which may negatively affect a company’s future financial performance. interestingly, rem seems to be even more constrained by csr activities in countries with strong legal enforcement (bozzolan et al. 2015). table 5: real earnings management on corporate social responsibility performance. in the untabulated results, consistent with our descriptive statistics, the measure of combined_rem is primarily driven by the overproduction of inventory (ab_prod) in order to reduce the fixed cost allocated per item and, ultimately, to reduce the cost of sales. thus, companies with better csr performance are less likely to engage in rem, specifically relating to the overproduction of inventory. this notion finds some support for hypothesis h1a (the ethical hypothesis). these results hold true after controlling for the effects of csr disclosure on earnings management (see ‘corporate social responsibility disclosure and real earnings management’ section). managers use rem and aem as substitutes for one another, based on their relative costliness (bozzolan et al. 2015; zang 2012). real earnings management potentially imposes a greater future cost on the company than aem (roychowdhury 2006) and is less likely to be detected (zang 2012), which may explain why these ‘ethical’ managers find it less incriminating to increase profits through discretionary accruals (that will reverse in future periods) than to engage in rem with actual company resources. kim et al. (2012) found that csr activities were associated with less rem, finding support for the ethical hypothesis. turning to the control variables, companies with better financial performance (roa) (kim et al. 2012), as well as those that employ more financial resources in research and development, are less likely to engage in rem. corporate social responsibility disclosure and earnings management through discretionary accruals the results depicted in table 6 suggest that there is no overall association between earnings management through discretionary accruals (abs_da) and csr disclosure (comp_all). however, when splitting the discretionary accruals between pos_da and neg_da there was a significant positive relationship between neg_da and int (p < 0.05), suggesting companies that integrate their csr disclosures in their annual report engage in less earnings management through income reducing discretionary accruals. thus, in line with the above, some support is found for hypothesis h2a (the ethical hypothesis). prior research testing the association between csr disclosure and earnings management has found support for the ethical hypothesis (chen et al. 2016; martínez-ferrero et al. 2013). chen et al. (2016) argue that managers with a high degree of integrity and commitment towards financial stakeholders are most likely going to exert the same effort to all stakeholders, hence the issuance of a stand-alone csr report. table 6: accrual-based earnings management on corporate social responsibility disclosure. after controlling for the effects of csr disclosure, companies listed as sri were still more likely to engage in income increasing discretionary accruals (pos_da) as compared to those not listed as such (p < 0.05). turning to the control variables, once again, indebted companies with higher lev were found to manage earnings upwards (positive pos_da) and positive (less negative) neg_da, and bigger companies were found to be managing earnings downwards. corporate social responsibility disclosure and real earnings management the results depicted in table 7 suggest that there is no overall association between rem and csr disclosure. once again, after controlling for the effects of csr disclosure, the results revealed that combined_rem is positively and significantly (p < 0.05) associated with sri, again suggesting that companies with better csr performance are less likely to engage in rem (higher combined_rem indicates lower levels of earnings management). table 7: real earnings management on corporate social responsibility disclosure. additional regressions controlling for years and industry corporate social responsibility performance and earnings management yip et al. (2011) found that industry is an important driver of the relationships between earnings management and csr disclosures. once again, the untabulated results showed no significant association between abs_da and sri, suggesting that there is no overall association between earnings management through discretionary accruals and csr performance. however, the study found a positive significant relationship (p < 0.05) between csr performance and earnings management through positive discretionary accruals after controlling for year and industry effects on earnings management. in addition, the study found that companies with better csr performance are less likely to manage earnings downwards through discretionary accruals (neg_da) (p < 0.05). once again, the study found that combined_rem is positively and significantly (p < 0.05) associated with sri, indicating that companies with better csr performance are less likely to engage in rem. on the other hand, the study did not find any significant differences in combined_rem between any of the industries or years. conclusion this study tested the relationship between both csr performance and csr disclosure and earnings management of listed south african companies. the study unbundled the effects of csr disclosure and csr performance on earnings management using a rigorous research design. corporate social responsibility performance and earnings management the jse annually assesses listed companies’ csr performance and issues a sri index. a company included on this index is seen to be a better csr performer and, as such, is used in this study as an indicator of csr performance. the overall results found no association between csr performance and either aem or rem when controlling for csr disclosure. however, it was found that companies with better csr performance are more likely to engage in earnings management through income increasing discretionary accruals. prior studies have suggested that managers act in self-interest and inflating earnings may result in better job security, earnings potential, etc., for managers. the results suggest that managers who are inflating earnings may engage in csr activities in an attempt to ‘greenwash’ their misstated earnings to avoid unwanted scrutiny from stakeholders. prior studies have shown that countrywide institutional factors influence the relationship between csr activities (performance) and earnings management. in this study, in order to reduce the ‘noise’ of institutional factors, we focused solely on south african companies. in doing this, we add to the scant research on the relationship between csr and earnings management in emerging economies, and to our knowledge, the first to test the relationship in an african country (namely, south africa). it was also found that south african companies with better csr performance are less likely to engage in rem. this may suggest that managers with better csr performance regard the management of earnings through accruals that reverse in the next period to be less incriminating than managing earnings through actual company resources. corporate social responsibility disclosure and earnings management the study also evaluated the relationship between the earnings management and four measures of csr disclosure of large south african companies, while controlling for csr performance. the overall results found no association between csr disclosure and either aem or rem. however, it was found that companies that integrated their csr disclosures more into their annual report engaged less in income decreasing discretionary accruals. prior studies have suggested that managers act in self-interest and, if stakeholders believed that earnings were being managed or that a company was being socially or environmentally unethical, it may result in salary cuts or job losses for managers. the results may suggest that managers with incentives to make more csr disclosures to reduce information asymmetry avoid unwanted attention from lobby groups and tax authorities or gain stakeholder support, will also be less inclined to manage earnings. this study makes some advances on the prior literature. firstly, it is the first study to ascertain whether companies classified by the jse as sris are, indeed, also ‘socially responsible’ when it comes to the transparency of their earnings. secondly, prior studies that tested the relationship between csr performance and earnings management did not control for the effect of csr disclosure in their analyses. csr disclosure has been shown to be significantly correlated with earnings management. by adding an additional variable, namely csr disclosure, when testing the relationship between csr performance and earnings management, this study unbundles the effect of csr disclosure and csr performance on earnings management. thirdly, this study tested the association between csr disclosure and earnings management of large, listed south african companies by using a rigorous research design. previous studies have used simple measures of csr disclosure such as word count, sentence count or page count, disregarding the actual content of the disclosure. this study improves on these prior studies by firstly using four different measures of csr disclosure, including a composite disclosure measure that analyses the content of the csr disclosure and not just the amount of disclosure. all data used in the measures of csr disclosure were independently collected by a reputable audit firm (kpmg), which increases its credibility. in addition, prior studies which tested the association between earnings management and csr disclosure did not control for csr performance in their analyses. in terms of practical implications, the results of this study will be useful for investors in their decision-making as it may give insights into the expected transparency of earnings reported by entities classified as sris. the jse may also find the results insightful, as they might consider adding additional criteria regarding the management of earnings when assessing their sris. future research may test the association between csr and earnings management over a broader time frame, using a larger sample that incorporates smaller as well as unlisted companies in order to increase the generalisability of the conclusions reached. acknowledgements competing interests the authors declare that they have no financial or personal relationship(s) that may have inappropriately influenced them in writing this article. authors’s contributions l.a.j. (university of south africa) was responsible for generating the idea, gathering the data, performing the analyses, concluding and writing the article. m.d.k. (university of pretoria) and c.j.d.v. 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and financial issues 6(4), 1360–1365. turyakira, p., venter, e. & smith, e., 2014, ‘the impact of corporate social responsibility on the competitiveness of small and medium-sized entities’, south african journal of economic and management sciences 17(2), 157–172. https://doi.org/10.4102/sajems.v17i2.443 welbeck, e.e., 2017, ‘the influence of institutional environment on corporate responsibility disclosures in ghana’, meditari accountancy research 25(2), 216–240. yip, e., van staden, c. & cahan, s., 2011, ‘corporate social responsibility reporting and earnings management: the role of political costs’, australasian accounting business & finance journal 5(3), 17–34. zang, a., 2012, ‘evidence on the trade-off between real activities manipulation and accrual-based earnings management’, the accounting review 87(2), 675–703. https://doi.org/10.2308/accr-10196 appendix 1 model 1: discretionary accruals (abs_da, pos_da, neg_da) abs_da is the absolute value of discretionary accruals pos_da is positive (income increasing) discretionary accruals neg_da is negative (income decreasing) discretionary accruals where discretionary accruals is computed as the residual(ɛ). ta is profitless cash flows from operations. ∆rev is the change in revenue from prior to current year. ∆rec is the change in trade receivables from prior to current year. ppe is the book value of property, plant and equipment at year end. bm is the book-to-market value of ordinary shares at year end. cfo is cash flows from operations. model 2: real earnings management abnormal levels of operating cash flows (ab_cfo) where abnormal cash flows is computed as the residual(ɛ). cef is the cash flow from operations. a is total lagged assets. s is sales for the year. ∆s is change in sales from prior to current year. abnormal production costs (ab_prod) where abnormal production costs is computed as the residual(ɛ). prod is cost of sales + the change in inventory from prior to current year. a is total lagged assets. s is sales for the year. ∆s is change in sales from prior to current year. abnormal discretionary expenses (ab_exp) where abnormal discretionary expenses is computed as the residual(ɛ). disc_exp is the sum of research and development and advertising expenditure. a is total lagged assets. s is sales for the year. combined real earnings management (combined_rem) footnotes 1. during 2004, the johannesburg stock exchange (jse) launched the jse socially responsible investment (sri) index (jse 2014a). eligibility for inclusion in the sri index is based primarily on a company’s environmental performance, social and economic sustainability, corporate governance and commitment to climate change (jse 2014b). all companies in the all share index are automatically rated against these criteria and a list of companies that meet these criteria is issued annually by the jse (jse 2014a, 2014b). 2. the global reporting initiative (gri) developed a comprehensive, sustainability reporting framework that provides guidelines, metrics and methods for measuring and reporting sustainability-related impacts and performance. the use of these guidelines is almost universal, with 78% of global companies reporting on their csr by referring to such guidelines (kpmg 2011). this study used an indicator variable equal to 1 if the company used the gri guidelines when disclosing csr information and 0 if not. 3. if csr disclosures are made in the directors’ report and in a separate section in the annual report, a score of 3 is awarded. if csr disclosures are made in a separate section of the annual report only, a score of 2 is awarded. if csr disclosures are made in the directors’ report only, a score of 1 is awarded. if csr disclosures are not made in the annual report, a score of 0 is awarded. the higher the int score, the more integrated the csr disclosure is in the annual report. sajems ns vol 2 (1999) no 3 335 an empirical capital market rate function for an emerging market economy in international financial crisis chris harmse and charlotte du toit department of economics, university of pretoria abstract after the first democratic election in south africa in april 1994, south africa's financial markets became more exposed and vulnerable to international developments, vide the financial crisis of 1998. this vulnerability raises some important questions. has its greater degree of openness led to a structural change in the south african economy? are long-term interest rates now primarily determined by international sentiment regardless of domestic economic and political conditions, during periods of international financial market volatility? and, in the event, what is the consequent effect on monetary policy in south africa? the aim of this paper is to investigate these questions by using a cointegration approach to estimate a long-run interest or bond rate function for south africa. jel f 40 1 introduction prior to the democratic election of 1994, the south african capital market was known as a captive market. domestic private and government institutions dominated transactions on financial markets. monetary policy was conducted in an isolated environment, where monetary targets and the fixing of short-term interest rates were used as the main policy instruments in the attempt to achieve price and exchange rate stability. after the election, the abolition of sanctions and the end of disinvestment in south africa, together with the scrapping of exchange controls applicable to foreigners, south africa's financial markets became more exposed to world financial market movements. the east asian and russian crises of 1998 exposed the new-found vulnerability of south african financial markets. this vulnerability raises the following important questions: has its greater degree of openness led to a structural change in the south african economy? are longterm interest rates now primarily determined by international sentiment, regardless of domestic economic and political conditions, during periods of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 336 sajems ns vol 2 (1999) no 3 international financial volatility? and, if so, what is the consequent effect on monetary policy in south africa? the aim of this paper is to investigate these questions. the sample period covers a twelve-month time span, the year 1998, during which south africa experienced severe turmoil in domestic financial markets. the aim of the research was to determine the longer-run trend in capital market rates at internationally volatile times, rather than to develop a tool for analyzing day-to-day trading. a market-related approach was followed, where the effects of changes in money, foreign exchange and foreign financial markets on the south african capital market were modelled. these results are not necessarily applicable during times of stability in international financial market sentiment, and need to be addressed in further research. a co integration approach was used to estimate a long-run interest or bond rate function for south africa. the estimation consists of a long-run equilibrium function, representing the long-run equilibrium growth path of long-term interest rates and an error correction model (ecm), representing the short-run dynamic adjustment process to longrun equilibrium. apart from analyzing the univariate characteristics of the data and determining the long-run cointegration and short-run dynamic relationships, the estimated function is subjected to rigorous diagnostic and stability testing. 2 changes in south african financial markets since 1994 the changeover of the south african political system to a democratic dispensation with the country's first non-racial election on 27 april 1994 removed the political barriers that had prevented successful economic adjustment during the 1980s. the dropping of sanctions and disinvestment actions against south africa opened up its markets to foreign goods, services and financial flows. during 1995 alone, more than r21 billion worth of foreign capital flowed into the economy (qb, june 1996). the initial political stability, a decreasing rate of inflation, record harvests, high real interest rates and a stable exchange rate, all served to attract foreign capital, although mainly of volatile, indirect and speculative nature. the real economic growth rate increased from 1.3 per cent in 1993 to 2.75 per cent in 1994, 3.3 per cent in 1995 and was 3.2 per cent in 1996 (qb, june 1998: s41). however, uncertain political events combined with persistently high crime levels and unrest since the beginning of 1996, again led to quick withdrawal of foreign capital. the result was a serious depreciation of the rand, together with uncertainty and instability in capital and equity (share) markets. capital market rates r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 337 increased rapidly by more than 300 basis points, from the middle of february to the middle of april 1996 (www.sharenet.co.za). monetary policy aimed at curbing inflation and easing the balance of payments constraint, tax reform and fiscal discipline, all came suddenly under pressure after the middle of 1997, as attempts were made to open the economy to international competition and secure access to new markets. foreign market sentiment towards south africa started to influence daily movements on the financial markets, and was reflected in movements on the equity, capital and foreign exchange markets. these movements, especially since the middle of 1997, were in conflict with the improved macroeconomic fundamentals of the south african economy: "south africa where macroeconomic stability is not in doubt and the financial system is fundamentally sound could not escape the spillover effects of the asian crisis" (qs, december 1998: 1). whereas capital market rates had been determined mostly by domestic demand and supply of shares and bonds prior to the 1994 election, global financial markets and international market sentiment started to dominate movements in capital market rates after 1994. the yield curve turned negative as capital market rates started to lead interest rate movements, rather than following short-run money market rates. the vulnerability and instability thus generated were especially conspicuous over the 1998 sample period, when heavy speculative selling against the rand of fixed-interest securities to the value of $4 billion between april and august 1998 by non-resident portfolio investors, caused a sharp rise in bank lending rates by 725 basis points. the volatility was heightened by the dramatic recovery of the market from the end of august to october during the same year (qs, december 1998: 1). 3 the south african capital market the capital market in south africa represents the long-term part of the financial system. the market acts as a source of funds with maturity dates longer than three years (fourie, falkena and kok, 1992: 130). the market is a complex entity, which consists of institutions and mechanisms through which funds are pooled and made available to the private and the public sectors ofthe economy. the secondary market, where previously issued securities (fixed-interest and equities) are traded, makes up the largest part of the market, about 96 per cent (qs, june 1998). the primary market, which makes up the rest of the market, is where first issues are offered to the public. the fixed-interest securities market, where mainly government bonds are traded, forms the largest part of the secondary market. sond transactions to the value of $4 268.822 billion on the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 338 sajems ns vol 2 (1999) no 3 johannesburg bond exchange took place in 1997. this was 99 per cent of the turnover in the market as a whole during 1997 (qb, march 1999: s30). government stocks are sold by means of a tap issue, or on tender basis. in the case of a tap issue the reserve bank (central bank) buys the stock from the treasury at a rate at which the bank can sell a fairly large volume in the market. by selling the biggest volume at the highest price (lowest interest rate) the reserve bank aims to find a balance between demand and supply. new stock is issued by means of an announcement to the market on the general terms of the issue, which includes the coupon, maturity date and maximum stock to be issued. the yield rate is determined by negotiations between buyers and the issuer (fourie, falkena and kok, 1992: 133). the leading bond on the south african capital market is the r150, 12 per cent 2005 government bond. daily buying and selling determine the yield rate of the bond, which can be higher or lower than its 12 per cent value, payable on the date of redemption. the rl50 yield rate can be considered the most important capital market rate, and it influences all other bond rates. therefore, an empirical function has been estimated for the r150 yield rate. 4 the empirical model: r150 the model is estimated on a daily (5 days per week) basis over the period 05/0111998 to 1111211998. the sample period is of great significance since south africa experienced a large degree of volatility (prosperity and economic crisis) in the capital market during 1998 (figure 1). data have been obtained from various sources i and consist of the daily closing figures for the relevant variables. although numerous explanatory variables were tested for their significance in explaining the volatile behavior of the r150, the following variables were ultimately included in the model: the rand/dollar exchange rate; the overall share price index on the johannesburg stock exchange; the dow jones stock exchange industrial index; the rand/pound exchange rate; the us thirty-year bond rate, which is considered to be the leading international capital market rate; net purchases of south african bonds by foreigners; the repo rate as a short-run interest rate and cost of financial assistance to the money market. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 figure 1 r1s0 yield rate, 1998 22000,---------------------------------, 1/05 3116 5/25 8/03 horizontal scale: time (month/day) vertical scale: yield rate (points) 10112 339 in order to avoid bias in estimation by ignoring some significant events in the south african economy, a number of dummy variables were created and tested to describe the short-run effects of the following events: international (exogenous) economic and political events (e.g. the east asian and russian crises) and the announcement of domestic macroeconomic data such as monthly merchandise export/import trade, monthly level of foreign reserves, monthly consumer and production price indices and monthly m3 and credit figures. the dummies were created by activating the days on which the announcements took place. however, the whole issue is far more complex since the market usually responds in two ways. first, prior to the release of economic data the market discounts the expected values, whether negative or positive. second, the market responds to deviations between the expected and actual values of the monthly merchandise export/import trade, monthly level of foreign reserves, monthly consumer and production price indices and monthly m3 and credit figures. if there is no deviation the market usually does not respond. the estimated model has certain constraints with regard to expectations. the first is the lack of a historically and scientifically reliable time series of the expected values, usually released by reuters. second, also due to the lack of data on expected values, the effect of deviations in the explanatory variables could not be tested. for these reasons, certain a priori economically significant variables turned out to be statistically insignificant and had to be dropped from the model (e.g. the cpi and ppi figures). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 340 sajems ns vol 2 (1999) no 3 in analyzing the univariate characteristics of the data, the dickey-fuller (df) and augmented dickey-fuller (adf) tests were used to establish the order of integration of the data series. a list of the variables is given in appendix i. results (tables al and a2) together with a description of the testing procedure are given in appendix 2. in addition, graphing the data series in levels as well as their first and second differences, looking at correlograms or autocorrelation functions and spectrum analysis, proved to be helpful when adf-test results were inconclusive. 4.1 estimation results the estimation technique used was the engle and y 00 (1989) three-step procedure, which is an extension of the engle-granger (1987) two-step procedure. this approach consists of a simple test for the presence of co integration between variables, indicating whether a particular set of variables represents a combination that is consistent with a long-run equilibrium relationship. (see appendix 2.) at the second stage an ecm was constructed in order to estimate the short-run or dynamic adjustment process to long-run equilibrium. the ecm indicates the dynamic relationship between variables, i.e. fluctuations in the· dependent variable around its long-run trend are explained by fluctuations in the explanatory variables around their long-term trends. "the idea is simply that a proportion of the disequilibrium from one period is corrected in the next" (engle and granger, 1987: 254). long-term effects are accounted for by the inclusion of the error term (e) of the long-term co integration relationship in the ecm (harris, 1995: 24). all the variables in an ecm were transformed (differenced) into stationary variables. a regression of the stationary form of the dependent variable on the other stationary variables and the first lag of the error term of the cointegrating regression was run. other variables besides those included in the cointegrating regression can be considered for inclusion in the ecm. examples of such variables are those which were discarded from the cointegrating regression, stationary variables (in levels) and variables. which theoretically will only influence the short-run trend of the dependent variable and were therefore also not considered for inclusion in the cointegrating regression. since all the variables in the ecm are stationary. the assumptions of classical regression analysis are fulfilled. therefore, standard diagnostic tests can be used to determine which variables should be included in the final specification of the ecm (harris, 1995: 24). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 341 the third step is applied to adjust the coefficients and t-statistics so that they are closer to their true values. this ensures that the variables included in the longrun regression can be evaluated statistically. engle and yoo (1989) have proposed a "third step" in addition to the engle and granger two-step estimation technique which is computationally tractable and overcomes two of the disadvantages of the two-step procedure. this step provides a correction to the parameter estimates of the first stage, static regression that makes them asymptotically equivalent to fiml and provides a set of standard errors, which allows the valid calculation of standard t-tests. the third step simply consists of a further regression of the conditioning variable from the static regression multiplied by minus the error correction parameter, regressed on the errors from the second-stage error correction model. the coefficients from this model are the corrections to the parameter estimates while their standard errors are the relevant standard errors for inference. the three steps are then: first estimate a standard co integrating regression of the form: y, = a l x, + z, where zi is the ols (ordinary least square) residual to give firststage estimates of d . then estimate a second-stage dynamic model (ecm) using the residuals from the co integrating regression to impose the long-run constraint: /l y, = i1j(l )/ly,_1 + o(l )m, + 02'_1 + ii, the third stage then consists of the regression: ii, = &( -jx, ) + v, the correction for the flrst-stage estimates is then simply: a 1 = a l + & and the correct standard errors for d are given by the standard errors for ii (se,) in the third-stage regression. the t-values for d are given by: t = se. the estimation results obtained for the r150 are reported below. the long-run relationship the cointegration equation is listed first, followed by the ecm together with the results from diagnostic tests performed on the ecm. the cointegration correction is finally shown for the long-run cointegration relationship. figure 2 gives a graphical representation of the goodness-of-fit of the estimated ri50-function. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 342 sajems ns vol 2 (1999) no 3 long-run interest (yield) rate: rls02 table 1 cointegration equation: dependent variable: in(rlsot ) in( rand _ doll art) in(jseovert) constant e-g cointegration3 coefficient s.e. t-ratio 0.905596 0.019766 45.81651 -0.332431 0.011913 -27.90526 2.642065 0.285303 9.260568 -3.188 table 2 ecm: dependent variable: mn(rlsot ) coefficient s.e. t-ratio residt.l -0.134124 0.025577 -5.243858 ll1n(jseovert) -0.221417 0.035425 -6.250355 llln(jseovert+ 1) -0.121188 0.034265 -3.536764 llln( rand_do liar,) 0.514554 0.050723 10.14439 llln( dowt.l) 0.114825 0.045944 2.499229 llln(dowd 0.100531 0.044457 2.261312 llln(poundt. l) 0.093540 0.037900 2.468081 llln(ustbond30,.i) 0.162747 0.063504 2.562800 dumjoreign, 0.007938 0.001628 4.875458 dum_trade _ fig'.2 -0.007275 0.002591 -2.807205 dum_trade _ figt•5 -0.005650 0.002707 -2.087466 dum _reserv _ figt• 3 0.006981 0.002761 2.528208 llln(ri50t+3) -0.105799 0.041692 -2.537626 llln(r 150'.3) -0.142182 0.044427 -3.200321 foreign_eft. -2.33e-06 9.91e-07 -2.351186 llln( repot.]) 0.068055 0.024328 2.797391 llln(repot.3} 0.096777 0.024203 3.998562 llln( mon _ assist+2) 0.007786 0.003861 2.016721 sample period: 05/01/1998 -15/12/1998 included observations: 226 after adjusting endpoints r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 343 r2 0.687176 tj i (2) 13.67068 [0.001075] fp 0.661609 tj2 (1) 0.043494 [0.834798] f(18,208) 26.87712 tj3 (32) 61.68 [0.001244] s.e. 0.007921 tj4 (2) 0.043651 [0.957296] tjs (36) 34.392 [0.545000] tj6 (2) 1.771553 [0.412394] tji denotes the jarque-bera test for the normality assumption; tj2 and tj3 denote the arch lm and the white tests respectively for the homoscedasticity assumption; tj4 and tjs denote test statistics of the assumption of serial correlation the breusch-godfrey lm test and the lung box q test; while tj6 denotes the ramsey reset test statistic for misspecification. all tji (d.f.) are in -l form, with figures in round brackets denoting degrees of freedom. the figures in square brackets denote the probability values. table 3 cointegration correction: dependent variable: in(r150t ) in(rand_dollart) ingseovert) constant coefficient 0.895262 -0.320155 2.642065 s.e. 0.014471 0.017992 0.285303 figure 2 r150 yield rate, aetual and predicted, 1998 t-ratio 61.86594 -17.79430 9.260568 22000~------------~---------------~---~ 20000 18000 16000 14000 1/05 3/16 actual 5/25 ----predicted scales: same as figure 1 8/03 10112 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 344 sajems ns vol 2 (1999) no 3 4.2 dynamic simulation: response characteristics of the model an initial dynamic simulation (without applying any shocks) was carried out as an indication of the goodness of fit of the model. the response characteristics of the model were evaluated by subsequently subjecting the model to sensitivity testing by changing (shocking) a1l explanatory variables (one at a time). this was done by increasing them by 10 per cent. for a model to be stable and robust, shocks applied to it should result in consistent long-run multiplier effects. a consistent long-run multiplier effect means that the difference between the shocked simulated value and the simulated value without a shock must ideally result in approximately 10 per cent of the original coefficient of the shocked variable (le. the multiplier effect). a shock in short-term explanatory variables should cause an initial movement away from the long-run equilibrium growth path, but eventually the model should converge on the original equilibrium growth path. all explanatory variables were shocked by 10 per cent. in all cases the dependent variable converged on a new equilibrium at a higher level, equal to 10 per cent of the estimated coefficient of the shocked long-run explanatory variable, or it converged on the original equilibrium growth path in the case of shocked short-run explanatory variables. results of the adjustment process towards either a new long-run equilibrium (in accordance with the elasticities of the respective cointegration relationships) or the baseline equilibrium (in the case of short-run explanatory variables) are shown in figures 2 and 3. vertical axes measure the difference between the outcome of baseline estimation and the estimation subjected to the exogenous shock, as a percentage of the level of the dependent variable. the speed of adjustment in the respective cases is apparent from the graphs. in all instances the adjustment process is completed within the sample range. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 figure 3 response characteristics of the error correction model (time scales same as figures 1 & 2) 3 (a) percentage difference between the estimated and shocked r150 0.001"""t"---------------. -0.02 -0.04 -0.06 ~ -0.08 convergence on 0.08 -0.10j"""."""",,,,,,,,,,,,,,,,,=,,,,,,,,,,,,,,,,,,,,,,,,,,,,""";'..,,..,.,,,,,,,,,,,,,,,,,,,,,,",,,..,,.,,.l rand-dollar shock 3 (b) percentage difference between the estimated and shocked r150 0.04,-----------------, 0.03 v 0.02 0.01 0.00 .i",i".~"""""""""""'".,.".,.-.,..",.c;;.;0;,;.n;;.,ve;,;.rg~e;;;,n;;;;ce;;..0;;.;n;,,;0;,;..0;;.;3;.,.,.,j jse overall shock index 5 economic evaluation of results 345 from the long-run equilibrium relationship it appears that changes in the rand/dollar exchange rate and the johannesburg stock exchange (jse) share price index dominate long-run movements in the rl50-bond rate. speculation against the rand and selling of equities on the jse by foreigners led to a sharp increase by almost 800 points in capital market rates during the east asian and russian crises (figure i). the consequent transmission effect on short-term r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 346 sajems ns vol 2 (1999) no 3 interest rates caused the banks to increase their prime rate by more than 7.0 per cent to 25 per cent during the third quarter of 1998 (qb, december 1998: s-28). the significant high value of the intercept (constant) of 2.64 could reflect the movements in market sentiment, the risk to invest in south africa given the current economic structure. the dynamic results of the ecm-model indicate that foreign market movements were mostly attributed to the volatile short-run changes in capital market rates. changes in the dow jones share index, the rand/pound exchange rate and the us long bond rate movements on a daily basis, contributed to the erratic changes in south african bond rates. the net purchases/sales of stock by foreigners were also a significant cause of short-run fluctuations in the r150rate. changes in international sentiment towards emerging market economies in general, were reflected in the negative movements of these indicators. the rand/dollar exchange rate depreciated by more than 23 per cent, as foreigners sold rl50 bonds to the value of more than $2 billion during the third quarter of 1998 (www.sharenet.co.za. appendix 3). the announced key indicators of the south african economy on a monthly basis served as dummy variables. portfolio managers reacted to these data before and after their announcement. foreign trade figures had the biggest effect on the rl50-rate with a two-day and a five-day lag. negative trade figures were interpreted by portfolio managers as a weakening of the current account on the balance of payments, which would lead to an expected further depreciation of the currency. as a result, bonds were sold two to five days after the announcement. the same reaction, lagging three days, also occurred after the announcement of south africa's foreign reserve figures. international economic and political events, as a dummy variable, also showed a significant effect on the dynamic movement in the ri50-rate. news of east asian and russian financial market uncertainty immediately affected the south african bond market negatively. during such periods, net selling of bonds by foreigners and the accelerated depreciation of the rand exchange rate were common phenomena. a significant relationship between daily money market movements and the r i 50-rate was found. periods of a liquidity shortage in the money market led to an increase in the banks' daily demand for cash assistance from the reserve bank (the money market shortage). the result was an increase in the reserve bank's repo rate (assistance rate). this upward pressure on short-term interest rates also led to domestic and foreign selling of bonds on the capital market. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 347 lastly, the market makers also played a significant role in the erratic movements of bond rates. buyers and sellers acted on the market according to the t+ 3 day method of settling accounts. buyers and sellers thus cleared their positions within three days of each transaction. these speculative reactions influenced the movements in bond rates significantly. 6 the effect on monetary policy the results of the long-run equilibrium growth path of long-term interest rates and the error correction model, show that capital market rates in south africa reacted mostly to exchange rate changes, foreign market sentiment and foreignrelated economic indicators (trade and reserve figures) during international financial turmoil short-term interest rates followed rather than led long-term interest rates in the long run. however, in the short run, changes in money market rates affected the dynamic behavior of the ri50-rate. in this regard, the challenge to monetary policy in an emerging country like south africa, is to stabilize the exchange rate. exchange rate stability seems to have become the primary objective of monetary and interest rate policy in south africa, with domestic price stability taking second place. evidence for south africa shows that a lower inflation rate during 1998 was not reached due to lower growth of the m3 money supply or the extension of less credit to the public by the monetary banking sector. both these aggregates recorded average growth of more than 15 per cent during 1998 (qb, june 1998: s22-23). rather, the lower inflation rate (which fell from 9.9 per cent in february to 5.5 per cent in july) was due to the stable exchange rate and subsequent decrease in import prices and interest rates. during the east asian crisis from april to october, the rand depreciated from r5.96/$ to r6.70/$ (www.sharenet.co.za). the accompanying sharp increase in both long-run and short-run interest rates led to a sharp increase of the inflation rate to 9.4 per cent in 1998 (qb, june 1998: si48). the evidence therefore shows that price stability follows exchange rate stability, not the other way around. 7 conclusion this paper attempted to determine a long-run capital market rate function for south africa during a period of international financial uncertainty. the model first used a long-run co integration technique, applying the engle and y 00 threestep procedure, with an extension of the engle-granger two-step procedure. at the second stage, an error correction model (ecm) was constructed to estimate the short-run dynamic adjustment process to long-run equilibrium. all variables r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 348 sajems ns vol 2 (1999) no 3 in the ecm were stationary, according to the assumptions of classical regression analysis. the coefficients and t-statistics were adjusted to be closer to their true values, after which a correction was made to the parameter estimates of the first stage static regression was made. the third stage consisted of a further regression of the conditioning variable from the static regression, multiplied by minus the error correction parameter, regressed on the errors from the secondstage error correction model. the estimation results for the rl50-bond were listed in terms of the long-run relationship the cointegration equation followed by the ecm together with results from diagnostic tests performed on the ecm. from this a dynamic simulation was done by shocking the explanatory variables by 10 per cent. in all cases the dependant variable converged on a new equilibrium at a higher level, equal to 10 per cent of the estimated coefficient of the shocked long-run explanatory variable. this means that the dependent variable converged on the original equilibrium growth path in cases where short-run explanatory variables were shocked. evaluation of the results shows that the rand/dollar exchange rate and the johannesburg stock exchange all share index movements, were responsible for more than 90 per cent of the long-run movement in the ri50 bond rate. the short-run dynamics of the model indicate that foreign market sentiment, foreign buying and selling of bonds, movements in the dow jones all share index and us long bond rate changes determined the erratic movements of rl50 around the long-run growth equilibrium path. the monthly key economic indicator announcements like trade and foreign reserve figures and growth in the money supply (and credit extension to the public), also played a significant role in the short-run dynamic movement of capital market rates. lastly, money market indicators, namely the repo rate and daily cash assistance to the banks by the reserve bank, also influenced the short-run movement of the rl50 bond rate. it therefore follows, that whereas capital market rates were mostly determined by domestic demand and supply for shares and bonds prior to the 1994 election, global financial markets and intemational market sentiment started to dominate movements of the south african capital market rates after 1994. this structural change has important consequences for economic policy in general, and south african monetary policy in particular. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 appendix 1 list of variables series r150t rand dollart --'--....... .. dow! jseovert mon assist c-........ poundt rcpot ustbond30t foreign_eft; dum joreignt dum_trade_figt dum jeserv _ figt de~crij:)tion ...... --~~ r150 yield rate rand/dollar exchange rate dow jones stock exchange index : overall index (us) johannesburg stock exchange : overall index (south africa) cash assistance towards to t4e money market rand/pound exchange rate repo rate (south african short-run interest rate) us 30 year bond rat~ net purchase of south african r150 bonds by foreigners dummy: international economic and political events dummy: announcement of monthly merchandise trade figures dummy: announcement of monthly level of foreign reserves 349 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 350 appendix 2 order of integration sajems ns vol 2 (1999) no 3 the augmented dickey-fuller test was employed in order to test whether the data series are stationary. the testing strategy followed is as suggested by dolado et al. (1990), and as applied also by strum and de haan (1995). dickey and fuller (1981) consider the problem of testing the null hypothesis on non-stationarity versus stationarity, suggesting ordinary least squares estimation of 8 yi == t70 + '71 trend + 712 yi1 + ~:'72+i yi..; + &1 ... (l) where y1 is the series being j=1 tested, m is the number of lags in the testing equation and ei is the residual. the test is implemented through the usual t-statistic of ;'2, denoted as t •. under the null hypothesis t. will not follow the standard t-distribution; adjusted values as computed by mckinnon (1990) are used for evaluation. if t. is significant, the null of non-stationarity is rejected and the series are stationary. in that case there is no need to go futher. however, if t, is insignificant, the joint null hypothesis that 0 1=02=0 using the f-statistic denoted as <1>3 is tested. the relevant critical values from dickey and fuller are used. if <1>3 is significant, test again for a unit root, now using the critical values of the standard t-distribution. if the trend is not significant in the maintained model, the next step would be to estimate equation (i) without a trend (1']1 0). again test for the unit root, now denoting the t-statistic of ~2 as tjl. and using the relevant critical values from mckinnon. if the null hypotheses is rejected, again there is no need to go further. if it is not rejected, the joint null hypothesis 1'jo=lj2=o with use of the f-statistic, denoted as <1>1. is tested, employing the critical values reported by dickey and fuller. again, if it is significant, test for a unit root using the standardised normal distribution. if not, remove the constant from the testing equation as well (1'jo=1'j2=o)' the new statistic is called t. again mckinnon reports relevant critical values for this t-statistic. the last step is to examine whether the null hypotheses is rejected or not, i.e. whether the series are stationary or not. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 351 the number of lags used in the estimated equations were determined in a similar way as perron (1989). perron suggested starting with eight lags. if the last lag is insignificant at a 10 per cent level (using the standard normal distribution), then it is omitted. now seven lags are included. again it is tested whether the last lag is significant (or there are no lags left, in which case the test is called the dickey-fuller (df) test). this large significance level is taken because, as perron (1989: 1384) pointed out, " . .including too many regressors of lagged first-differences does not affect the size of the test but only decreases its power. including too few lags may have a substantial effect on the size of the test". furthermore, molinas (1986) noticed that " ... a rather large number of lags has to be taken in the adf test in order to capture the essential dynamics of the residuals". tables al and a2 report the outcomes of the adf tests for all relevant data series employed in the estimations. the series tested are given in the first column. the second column reports whether a trend and a constant (trend), only a constant (constant), or neither (none) is included. in the third column, the number of lags recorded are reported. the next column shows the adf tstatistic. called "c t when a trend and constant are included, "ci' when only a constant is included, and "c when neither occurs. the last column reports the fstatistic, <1>3 (<1>1)' testing whether the trend (constant) is significant under the null hypothesis of no unit root. according to table al there are 5 variables that seem to be stationary in levels. however, the test results are not conclusive for 4 of the variables and much doubt exits whether these variables are indeed stationary in their levels. by simply looking at data plots of of the natural logarithm forms of the variables in_dow. in..jseover. in_mon_assis and in_ustbond30, it is obvious that these series cannot be stationary in levels. table a2 indicates that all variables, except joreign_ejj, are indeed integrated of order 1. due to the nature of construction of the dummy variables, they are all integrated of order 0 and are therefore all stationary in levels. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 352 sajems ns vol 2 (1999) no 3 table al augmented dickey-fuller tests for non-stationarity, levels, 05/01/98 -11/12/98 series model lags 't'to 't'u. 't ~,«lil 1--.. in_dollar jandt i trend i 5 i -1.46 2.58 • constant 5 -1.16 2.87 none 5 i 0.78 in_dowt trend 7 -2.27 1.83'" constant 7 -2.35 i 2.07 ...... none 7 0.53 i lnjseover{ trend 1 -1.76 7.34'" • constant 1 -0.67 8.63 i none 1 -0.75 in _ mon _assist trend 7 i -3.13 3.82 ...... constant i 7 -3.15'" 4.32 ...... none i injjoundt trend 7 -1.01 3.62 constant 7 -1.09 4.07 none 7 0.97 in_r150t trend 3 -1.24 3.40 constant i 3 -0.59 3.94 none 6 0.65 injepot trend 5 -1.23 15.53 constant 5 -1.11 18.12 none 5 0.46 in _ ustbond30t trend 4 -2.63 3.21 ...... i constant 4 -0.25 2.11 none 4 -1.09 foreign _ eff trend 8 -3.87'" 17.71 ...... constant none *(**) slgmficant at a 5( i) per cent level. a at a 5(1) 'per cent significance level the mckinnon critical values are 3.43(-3.99) when a trend and a constant are included ('tt), and 2.88(-3.46) when only a constant is included (-r,,), and -1.95(-2.58) when neither is included ('r). the standard normal critical value is -1.645(2.33). b at a 5(1) per cent significance level the dickey-fuller critical values (for 250 observations) are 6.34(8.43) when a trend and a constant are included (<113), and 4.63(6.52) when only a constant is included (<11). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 353 table a2 augmented dickey-fuller tests for non-stationarity, first differenced, 05/01/98 -11/12/98 series model lags 'tn 't • 't cd3• cdl b.ln _do har jandt trend 4 -5.29** 31.72** constant none b.ln_dowt trend 6 -5.16** 24.23** constant none b.lnjseovert trend 0 -11.33** 64.15** constant none b.ln _ mon _assist trend 6 -4.62** 43.32** constant none b.ln "'pound, trend 6 -6.12** 32.77** constant none b.ln_ri50t trend 5 -5.76** 19.85** constant none b.lnjepot trend 4 -5.50** 48.50** constant none b.ln _ ustbond30t trend 8 -4.89** 21.67** constant none *(**) slgmficant at a 5(1) per cent level a at a 5( i) per cent significance level the mckinnon critical values are 3.43(-3.99) when a trend and a constant are included ('tt), and -2.88(-3.46) when only a constant is included ('t), and -1.95(-2.58) when neither is included ('t). the standard normal critical value is -1.645(2.33). b at a 5(1) per cent significance level the dickey-fuller critical values (for 250 observations) are 6.34(8.43) when a trend and a constant are included (cd), and 4.63(6.52) when only a constant is included (cd i ). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 354 sajems ns vol 2 (1999) no 3 appendix 3 graphical representation of data 70000~--------------------------------~ 65000 60000 55000 50000 w'r'~ _____ rand/dollar exchange rate 2000~--------------------------------~ 1000 o ·1000 ·2000 ·3000~~~~~~~~~~~~~~~~~~ for e ig n pur c has e 0 f r 150 bon 0 s 950000 .,.-----------------------------------, 900000 850000 800000 dow jones overall in dex r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 9000,-------------------------------------~ booo 7000 booo 5000 4000~~~~~~~~~~~~~~~~~~~~ jse overall index 110000~----------------------~--------~ 100000 90000 aoooojj'",",,_ran dip 0 uno ex c han g era t e 2dooo~----------------------------------~ 1 5000 12000 8000 4000 o~~~ __ ~~~~~~~~t_~~~~~~ m 0 net a r y ass is tan c e 26,-----------------------------------------, 24 22 20 18 1 6 ..,--------, 14~~~~~~~~~~~~~~~~~~~~~~ repo rate 355 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 356 sajems ns vol 2 (1999) no 3 endnotes south african reserve bank database safex database www.resbank.co.za www.safex.co.za statistics south africa database www.statssa.gov.za south african department of finance www.finance.gov.za south african excise and duties www.sas.gov.za sharenet database www.sharenet.co.za reuters database 2 see appendix 1 for variable list. 3 this test consists of a unit root test on the residuals of the cointegration equation. it is also referred to as the (cointegration regression) augmented dickey-fuller tests. to make a clear distinction between this test and the augmented dickey-fuller test on stationarity, davidson and mckinnon (1993) are followed in naming this test the augmented engle-granger test. the difference between these tests result from the critical values which are used. critical values for the relevant response surfaces can be found in mckinnon (1991). the response surface for any number of regressors, excluding any constant and trend component, 1~:::; 6, can be calculated as c(p) = \p",+ \pi r-i + \p2r-2the 10 per cent critical value in this case, with n = 2 and p (sample size) = 237 is -3.063. references banerjee, a., dolado, j., galbraith, j.w. and hendry, d.f. (1996) co-integration, error-correction, and the econometric analysis of non-stationary data, oxford university press. 2 charemza, w.w. & deadman, d.f. (1997) new directions in econometric practice, edward elgar. 3 engle, r.f. and granger, c.w.j. (1987) "co-integration and error corrections representation, estimation and testing", econometrica, 55: 987-1007. 4 engle, r.f. and yoo, s. (1989) a survey of cointegration, mimeo, university of california, san diego. 5 fourle, l.j., falkena, h.b. and kok, w.j. (1992) fundamentals of the south african financial system, southern book publishers. 6 harrls,r.i.d. (1995) using co-integration in econometric modelling, prentice hall. 7 mckinnon, ig. (1990) critical values for cointegration tests, department of economics discussion paper no 90-4, university of california, san diego. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 357 8 mckinnon, j.g. (1991) "critical values for co-integration tests", in r.f. engle and c.w.j. granger (eds.) long-run economic relationships, oxford university press: 267-76. 9 qb: south african reserve bank quarterly bulletin, various issues. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction conceptualisation research design ethical consideration results and discussion conclusion and recommendation acknowledgements references appendix 1 appendix 2 appendix 3 about the author(s) juan-pierre bruwer school of accounting sciences, cape peninsula university of technology, south africa philna coetzee college of accounting sciences, university of south africa, south africa jacolize meiring college of accounting sciences, university of south africa, south africa citation bruwer, j-p., coetzee, p. & meiring, j., 2017, ‘the empirical relationship between the managerial conduct and internal control activities in south african small, medium and micro enterprises’, south african journal of economic and management sciences 20(1), a1569. https://doi.org/10.4102/sajems.v20i1.1569 original research the empirical relationship between the managerial conduct and internal control activities in south african small, medium and micro enterprises juan-pierre bruwer, philna coetzee, jacolize meiring received: 28 mar. 2016; accepted: 18 apr. 2017; published: 07 july 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: although south african small, medium and micro enterprises (smmes) play an imperative role in the stimulation of the national economy, previous research studies show that these business entities have severe sustainability problems as approximately 75% of them fail after being in operation for only 3 years. the latter dispensation is pinned on the belief that south african smmes make use of inadequate and ineffective internal control systems. aim: since a system of internal control comprises five inter-related elements, while also taking into consideration that management is ultimately responsible for the internal control in their respective business entities, which is greatly influenced by their managerial conduct, this research study placed focus on determining the relationship which exist between the managerial conduct and the internal control activities evident in south african smmes. setting: this study was conducted in the cape metropole, south africa by obtaining responses from 240 stakeholders of smmes: 120 members of management and 120 employees. methods: in order to achieve the latter, quantitative data were collected through a questionnaire and analysed accordingly through both descriptive statistics and inferential statistics. results: from the results, a very weak negative statistically significant relationship was identified between the managerial conduct and the internal control activities evident in south african smmes. conclusion: essentially, management and employees should revisit the internal control activities evident in their respective smmes through placing emphasis on those internal control activities which can be built on their control environment. introduction since the early 1980s, small, medium and micro enterprises (smmes) have been regarded as the driving forces of many economies around the globe (hill 2001; park 2001; wren & storey 2002). more often than not smmes need to attain socio-economic objectives, as devised by relevant governments to, inter alia, eradicate poverty, to provide employment opportunities and to boost the national gross domestic product (gdp) (bruwer 2016). unfortunately, previous research (herath 2014; wagner 2013) shows that approximately 80% of these business entities, worldwide, fail within their first 3 years of existence. in a south african context, smmes are believed to provide employment opportunities to at least 61% of the national workforce while also contributing up to 57% towards the national gdp (dti 2013; swart 2011). however, these business entities are believed to have one of the worst sustainability rates in the world with an estimated 75% of south african smmes failing after being in operation for only 3 years (cant & wiid 2013; moloi 2013). over the years, prior research confirmed that the high failure rate of these business entities is strongly associated with the inharmonious south african economic environment which is characterised by inter alia high unemployment rates, high inflation rates, high interest rates and high taxation rates (brink, cant & ligthelm 2003; cant & wiid 2013). both the economic environment and relevant economic factors need to be properly managed by business entities in order to make ends meet. one approach is to make use of a sound internal control system (coso 2013; teittinen, pellinen & järvenpää 2013) – a structured system comprising five inter-related elements, which helps provide reasonable assurance to management that applicable organisational objectives will be achieved in the foreseeable future (spira & page 2003). these elements include (coso 2013) the control environment (the overall attitude of management towards internal control), risk management (the manner in which risks are approached by management), internal control activities (the activities which help prevent and detect risks), information and communication (the actual sharing of information through applicable communication lines to help an organisation achieve its objectives) and monitoring (the ensuring of the soundness of the entire system of internal control). siwangaza (2013) indicates that south african smmes’ systems can often be deemed as inadequate and ineffective. since the onus rests on management to implement sound internal control systems (honoré, munari & van pottelsberghe de la potterie 2015) it can be assumed that the soundness of an internal control system is influenced by the managerial conduct (a core component of the control environment), which consists of managerial philosophy and managerial operating style (greco, ferramosca, & allegrini 2014; mayle 2006). previous studies (mellor 2014; nkulu 2012) indicate that the managerial conduct in south african smmes is both flexible and customised, providing possible reasons as to why these business entities’ internal control systems are regarded as inadequate and/or ineffective, as a flexible managerial conduct is synonymous with an unstable foundation for a sound internal control system (dmitrieva 2014). despite the above however, this relationship has not been tested, which leads to the main objective of this study, namely to explore the relationship that exists between the managerial conduct and the implemented internal control activities evident in south african smmes. this could lead to insight as to how management in south african smmes could enhance their managerial conduct to, in turn, improve the internal control activities evident in their business entities. conceptualisation an internal control system is a structured process that is implemented by management and designed to provide reasonable assurance regarding the attainment of relevant organisational objectives in the foreseeable future (coso 2013). this is achieved particularly through means of maintaining and/or enhancing the economy, efficiency and effectiveness of operations, the reliability and integrity of financial information and non-financial information, and compliance with applicable policies, procedures, laws and regulations (buhr & gray 2012; wallace 2008). the five inter-related elements of an internal control system constitute control environment, risk management, control activities, information and communication, and monitoring (coso 2013). despite the fact that all these elements are necessary for the implementation of a sound internal control system, this study predominantly placed emphasis on the elements of ‘control environment’ and ‘internal control activities’, being seen as two of the most important elements of a simple internal control system (conserve & kociolek 2015). managerial conduct as part of the control environment the control environment serves as the foundation of an internal control system (d’aquila 1998). it comprises a collection of expected norms, qualities and actions which management need to adhere to, which, in turn, leads to the promotion of sound internal control in an organisation (ntongo 2012; wathowan 2010). moeller (2007) argues that a sound control environment is evident in an organisation when, inter alia, an appropriate managerial philosophy is followed and an appropriate operating style is used by management, justifying that an appropriate managerial conduct makes up a substantial part of the control environment in an organisation. the term ‘managerial philosophy’ can be regarded as the manner in which management makes business decisions based on their personal beliefs (kirkeby 2000), while the term ‘operating style’ can be viewed as the methods which management use to plan, organise, lead and control their respective organisations which, in turn, are directly influenced by their personal preferences (jamian, sidhu & aperapar 2013). managerial conduct (including managerial philosophy and operating style) will always be directly influenced by the personal beliefs and/or personal preferences of management (aicher, paule-koba & newland 2016; davis 2009; moeller 2009) – rendering it a subjective phenomenon. this observation is placed in perspective by previous research studies where the concept of managerial conduct are described as an indication of management’s appreciation of the influence of ethics on the execution of respective responsibilities (beer 2010), the manner in which management executes their relevant responsibilities (hoque 2006), the manner in which management performs their relevant responsibilities to achieve relevant organisational objectives (tomasic, bottomley & mcqueen 2002), and the behaviour of management in relation to circumstances in and around an organisation (tsukamoto 2007), and can be measured in terms of their communication skills, management practices, industry-specific knowledge, personal governance (i.e. their promotion of accountability, responsibility, ethics, sound values and transparency) and their ability to solve problems (gill 2008; müller et al. 2016). therefore, based on the above, the managerial conduct was conceptualised within the ambit of this research study as follows: ‘the manner in which management behaves when discharging their applicable responsibilities; being directly influenced by their personal primary values and their personal ethical standards’. because of the subjective nature of the concept, management needs to adopt an appropriate managerial conduct as it directly impacts on, inter alia, organisational decisions that are made, the effectiveness and efficiency of organisational operations, the productivity of employees and the morale levels of relevant organisational stakeholders (lee 2013; wright, szeto & cheng 2002). an appropriate managerial conduct is strongly associated with the characteristics of good corporate governance (berry & junkus 2013; heracleous 2001; palliam & ankli 2015), which includes discipline, transparency, independence, accountability, responsibility and fairness. with regard to managerial conduct in smmes, previous studies (mccartan-quinn & carson 2003; tresca 2013) show that it is flexible and/or customised, mainly because of the fact that these business entities have to reasonably satisfy their customer needs, supplier wants, and expectations of investors. on the one hand, a flexible and/or customised managerial conduct in smmes may have a positive influence on the operations of these business entities, for example, maintaining and/or fortifying relationships with relevant stakeholders (christ, sedatole & towry 2010). on the other hand, it may have a negative influence on the overall sustainability of a business, for example, unstable foundation for an internal control system (mellor 2014; nkulu 2012). it is important that management has sufficient insight into the business to ensure a balance between these two aspects. internal control activities one of the elements in an internal control system which will be influenced by managerial conduct is that of internal control activities. internal control activities are those actions that are implemented by management, as based on policies and procedures, across all hierarchal levels in an organisation, which assists with the attainment of organisational objectives through the appropriate mitigation of risks (coso 2013). this is performed through means of deploying mainly preventive and detective controls (coso 2013; halonen 2014; koranteng 2011). internal control activities are strongly relative to the safeguarding of assets, independent checks, proper authorisation activities, the segregation of duties, and adequate document usage and design (martin, sanders & scalan 2014). bruwer and van den berg (2015) investigated the control environment of south african smmes and conclude that the control environment of these business entities appears to be flexible and that their internal control activities are customised. although a flexible control environment and customised internal control activities are not guaranteed to provide reasonable assurance surrounding the attainment of organisational objectives in the foreseeable future, christ et al. (2010, 2012) argue that the latter does, however, add customised value in relation to the fortification of internal control in an organisation, by placing emphasis on corporate culture, corporate values and trust. furthermore, siwangaza (2013) concludes that south african smmes make use of ineffective and/or inadequate internal control systems as they do not provide reasonable assurance surrounding the attainment of organisational objectives in the foreseeable future. however, the question remains whether the way management conduct themselves will have an effect on the adequacy and/or effectiveness of internal control activities. this leads to the following hypothesis: h1: there is a statistically positive significant relationship between the managerial conduct in south african smmes and their implemented internal control activities. research design this research study was empirical in nature and fell predominantly in the positivistic research paradigm as survey research was used to glean data from respondents (refer to appendix 1 for the questionnaire). surveys were disseminated to a total of 120 members of management and 120 employees of south african smmes by an independent data collection organisation over the course of 3 weeks. both members of management and employees had to be based in the same smmes where possible. the approach followed by the independent data collection company was to first convert the questionnaire to be compatible with its electronic tablets, where after five qualified fieldworkers were identified and temporarily recruited by relevant company and briefed by a fieldwork supervisor on the content of the questionnaire and the expectations of the client (the researchers). after the briefing, all five qualified fieldworkers commenced with the collection of data from respondents through means of face-to-face interviews. all responses were directly captured via electronic tablets, automatically uploaded and saved on a single, stable cloud storage device secured through encryption software and protected by a firewall. each uploaded response was validated (100%) by the fieldwork supervisor. all targeted respondents had to be based in non-franchised smmes, based in the fast-moving consumer goods industry, while also operating in the cape metropole. the rationale behind this decision was first that both the industry and geographical location are regarded among the largest industries and contributing provinces in south africa, respectively (statistics south africa 2014) and secondly, because of saving costs to conduct the research. valid responses were received from 119 members of management (99.17% response rate) and from 78 employees of (65% response rate). respondents were sampled through means of non-probability sampling methods, mainly through a mixture of purposive sampling and convenience sampling since all respondents had to adhere to strict delineation criteria. to determine whether a relationship exist between the managerial conduct and the internal control activities, spearman rank correlation was performed – indicating both the strength of the correlation and the direction (positive or negative) thereof. to test the possible bias perceptions of management, a mann-whitney u test was performed to identify significant differences between the views of employees and those of management and the relationships they perceived to exist between the two aspects. the validity of the questionnaire was also tested by taking face validity, content validity and construct validity into account (leedy & ormrod 2010), with the first two supported by extensively piloting the questionnaire tool. to test the construct validity of the questionnaire statistically, relevant hierarchical cluster analyses, on a variable level, were performed. although, it is also important to take reliability of the data into account, as most of the questions were of likert-scale type (80.83%) and with the data being classified as ordinal, such data cannot be fairly tested for reliability, as it will provide biased results (bonanomi, ruscone & osmetti 2013). hence, no reliability tests were performed on the data that were collected. ethical consideration all respondents were safeguarded from physical harm, all information provided by respondents were treated with confidentiality, all respondents were assured anonymity and all respondents voluntarily participated in the study. in addition, respondents could withdraw from the study, for any reason, at any time, without being discriminated against. results and discussion to place the results in context, a brief summary of the demographical and other relevant information of respondents are provided. thereafter, the perceived correlation between managerial conduct and the internal control activities are provided. information of sampled south african small, medium and micro enterprises and respondents based on the results, 67.68% of sampled south african smmes were sole traders, 14.4% were partnerships, 11.62% were close corporations and 6.57% were private companies – 45% of these business entities were in operation for 5 years or less (x = 8.33 years). in addition, 76.26% of sampled smmes had only one outlet; with a total of 58.59% of these business entities being responsible for employing maximum five employees, 27.78% between 6 and 10 employees and 13.64% between 11 and 50 employees. moreover, 23.23% of sampled smmes were described as ‘retail stores’, 17.68% as ‘taverns’, 13.13% as ‘spaza shops’ and 10.61% as ‘convenience stores’. as most employed maximum five employees, only a minority of individuals were responsible for executing the day-to-day tasks; meaning that these business entities most probably did not have a need for formal internal control activities. respondents that were classified as members of management mostly (62.15%) indicated that they had less than 5 years’ managerial experience. the highest qualification of 48.74% of respondents was ‘grade 12’ (successfully completed their secondary education), while only 32.77% of respondents had a tertiary qualification (qualification achieved at a university or equivalent). as members of management need to take the lead in their respective business entities, one would expect respondents to have a sound practical understanding of business and management sciences (measured in years of experience), and a sound theoretical understanding of the same sciences (measured in qualifications), the results are concerning. however, business intelligence should not be measured by formal qualifications (schroeder 1993), especially when taking cognisance of the fact that many entrepreneurs have become successful over the years without a tertiary qualification (smale 2015). interestingly, the majority of respondents have a secondary qualification or lower, which could be because of the economic environment of south africa, particularly the high unemployment rate (trading economics 2014). this could have led to their inability to secure a job, with the only manner in which respondents could make a living was by starting their own businesses – becoming necessity entrepreneurs. respondents that were classified as employees were represented by 83.54% full-time employees and 16.46% part-time employees; with 81% of all respondents having less than 5 years’ experience as employees. the highest qualification of 45.57% of respondents was ‘grade 12’, while 41.77% of respondents had only partial secondary education. the results are concerning as not only did 87.34% of employees have a highest qualification of grade 12 or lower but overall, employees were only marginally less qualified (in terms of their highest qualifications) than members of management. it is highly probable that responding members of management did not want to employ staff more educated than they were; or responding members of management could not afford to employ staff that had a highest qualification greater than grade 12, or because of the high unemployment rate in south africa, responding employees could not secure a job at a larger (and more established) organisation in order to make a living – their only immediate option was to be employed by smmes. perceptions of respondents on the managerial conduct and internal control activities based on the questions (refer to appendix 1) asked on managerial philosophy, results indicated that respondents are of the opinion that it was strongly associated with three of the core characteristics of good corporate governance, namely transparency (mean score of 4.01), accountability (mean score of 4.08) and responsibility (mean score of 4.41). as these characteristics are often influenced by the values of members of management, the assumption can be made that the values of management were also relative to the core characteristics of good corporate governance. to test this perception, respondents were asked to rate the values of members of management, including discipline (mean score of 4.27), transparency (mean score of 3.91), independence (mean score of 4.05), accountability (mean score of 4.15), responsibility (mean score of 4.31) and fairness (mean score of 4.16). respondents were also asked about the managerial operating style of management, with members of management making use of a flexible operating style; consisting of a mixture of a paternal operating style (mean score of 4.09), a chaotic operating style (mean score of 2.99), a persuasive operating style (mean score of 3.38), a democratic operating style (mean score of 3.64), a laissez-faire operating style (mean score of 2.85) and an autocratic operating style (mean score of 3.36). the deduction was made that the managerial conduct in sampled smmes was flexible. hence, justification was provided for the inference made that these business entities made use of informal (customised) control systems and internal control activities. the literature supports that south african smmes make use of customised internal control activities, mostly being informal. in order to test this inference, respondents were asked to describe their internal control systems. respondents indicated that the ‘detection of risks’, the ‘attainment of reporting objectives’ and the ‘attainment of compliance objectives’ were not integral parts of their current implemented internal control systems. in addition, they indicated than an array of internal control frameworks (e.g. coso internal control framework, coco framework and cobit framework) was used as foundation to develop their currently implemented internal control systems – serving as additional evidence that these business entities made use of information internal control systems. respondents were asked to provide insight on the internal control activities evident in their respective smme. results indicated that source documents were not extensively used (52.7%); limited proof of transactions existed (52.7%), authorisation activities were neither proper nor improper (49.7%), assets were predominantly safeguarded through means of preventive controls (56.9%), limited detective controls exists (44.1%), operational tasks were not segregated (54.1%), one person performed more than one operational task at a time (45.9%) and an average amount of independent checks were used for control purposes (59.8%). clear tangent planes emerge as to why these inferences are imminent. the solvency, liquidity and profitability of these business entities made it difficult to implement a wide range of formal internal control activities. as 58.59% of these business entities employed between zero and five employees, it is not feasible to make use of too formal internal control activities. hence, additional justification is provided as to why the managerial conduct was regarded as flexible. respondents were asked to describe the characteristics of their implemented internal control activities in their respective smmes. results indicated that the implemented internal control activities in sampled smmes added value to these business entities. this view is specifically supported by the above average mean scores of characteristics – implemented internal control activities were adaptable to changes in the immediate business environment (4.07), assisted management with the execution of their responsibilities (4.06), were robust (4.01), were suitable for the industry in which these business entities operated (4.06), supportive of policies and procedures (4.08) and were supportive of risk management strategies (3.92). although it appears that the internal control activities evident in sampled smmes were both adequate and effective, it should, however, be noted that very few internal control activities had an average presence in sampled smmes, and the financial performance and financial position of these business entities were only slightly above average. correlation between perceptions on managerial conduct and internal control activities when analysing the correlation between the managerial conduct and the internal control activities evident in sampled smmes, a very weak negative statistically significant relationship existed (refer to appendix 2 for all results). of the 451 tested correlations, only 66 (14.63%) were statistically significant at a 99% level of confidence (shaded in grey in appendix 2) and 51 (11.31%) at a 95% level of confidence (also shaded in grey appendix 2), 35 (29.91%) were identified as positive, whereas 82 (70.09%) were negative. in turn, when focus is shifted to the strength of all statistically significant correlations, only one (0.85%) was found to be moderate, whereas 50 (42.74%) were weak and 66 (56.41%) very weak. a summary of all statistically significant correlations is shown in table 1. table 1: summary of significant correlations between the managerial conduct and internal control activities. of all 451 tested correlations, 154 (34.15%) related to independent checks, 121 (26.83%) to document utilisation and design, 110 (24.39%) to the safeguarding of assets, 33 (7.32%) to authorisation activities, and 33 (7.32%) to the segregation of duties. when referring to the number of employees of these business entities, there appears to be a limited need for sampled smmes to make use of internal control activities pertaining to authorisation activities and the segregation of duties with internal control related to segregation of duties having a below-average presence and those pertaining to authorisation activities were not deemed appropriate. with regard to all tested correlations, only 35 of the 451 tested correlations were significant and positive, with those pertaining to the segregation of duties (15.15%) and independent checks (10.39%) obtaining the highest percentages. of these, 35 correlations linked to the managerial conduct indicated that the members of management are on par with the latest trends in the industry in which their respective smmes operate (17 = 48.57%), have industry-specific knowledge (12 = 34.29%), have leadership skills (4 = 11.42%), promotes ethics (1 = 2.86%) and promotes accountability (1 = 2.86%). also, pertaining to the remaining 416 correlations, characteristics of the managerial conduct either had a negative significant correlation or no significant correlation with internal control activities – communicate well (41 = 9.86%), have effective management practices (41 = 9.86%), have industry-specific knowledge (29 = 6.97%), have leadership skills (37 = 8.89%), are on par with the latest trends in the industry (24 = 5.77%), promotes accountability (40 = 9.62%), promotes ethics (40 = 9.62%), promotes proper values (41 = 9.86%), promotes responsibility (41 = 9.86%), promote transparency (41 = 9.86%), and solves problems (41 = 9.86%). although a very weak negative statistically significant relationship was found to exist between the managerial conduct of sampled smmes and the internal control activities evident in these business entities (resulting in the rejection of h1), it should be noted that the views of both members of management and employees were taken into account. to minimise respondent bias, the statistical significance between the views of management and those of employees were tested. the results are presented in appendix 3. although some statistically significant differences exist between the views of these two parties on the internal control activities (39.02%) and the characteristics of the managerial conduct (9.09%), it is disconcerting to note that members of management and employees mostly had different views. the only variable pertaining to the managerial conduct, where a statistically significant difference was identified, was the ‘promotion of responsibility’. this dispensation can be pinned on the nature of the positions of respondents – members of management had to be more open-minded than employees owing to their business decision-making responsibilities. however, it is expected that both members of management and employees have a similar understanding of the internal control activities evident in these business entities as well as the managerial conduct of their respective members of management. this test conducted serves as confirmation that members of management most probably are biased in evaluating their own managerial conduct as well as the internal control activities implemented (and used) in their respective smmes. to further test the significant correlations between the views of respondents on the relationship they believed to exist between the managerial conduct in sampled smmes and the internal control activities evident in these business entities, separate spearman rank correlations were conducted for members of management and employees. the calculated results were compared to determine whether members of management and employees had similar views on the relationship between the managerial conduct and the internal control activities in sampled smmes. stemming from the results, of 451 tested correlations for each group, it was found that members of management had 147 (32.59%) statistically significant correlations, while employees had only 31 (6.87%) statistically significant correlations, serving as an indication that members of management believed that their managerial conduct had a greater influence on the internal control activities evident in their business entities when compared with the beliefs of employees. when the direction of these statistically significant correlations were tested, 119 (80.95%) significant correlations of the members of management were negative and 28 (19.05%) were positive, while 9 (29.03%) significant correlations of employees were negative and 22 (70.97%) were positive. in terms of the strength of the statistically significant correlations, 8 (5.44%) significant correlations of members of management were moderate and 107 (72.79%) were weak, while 32 (21.77%) significant correlations of members of management were very weak and 31 (100%) were weak. with this in mind, the significant correlations of members of management were compared with the significant correlations of employees to determine how similar the views of respondents were. after comparing the 147 statistically significant correlations of members of management and the 31 statistically significant correlations of employees, it was found that only eight (4.49%) of all statistically significant correlations of respondents were similar for both respondent groups. a summary of the similarities is shown in table 2, with positive significant correlations shaded in grey. table 2: summary of similar significant correlations between members of management and employees. the views of members of management and employees, on the relationship they believed to exist between the managerial conduct in sampled smmes and the internal control activities evident in these business entities, were not significantly similar to one another. in core, from a total of 451 correlations, only four positive statistically significant correlations were found to be similar in relation to the views of both members of management and employees. as employees had only 31 statistically significant correlations on the relationship they believed to exist between the managerial conduct and the internal control activities, members of management should be concerned that their managerial conduct does not influence the views (and also presumably the actions and attitudes) of employees on internal control activities. conclusion and recommendation in this research study, emphasis was placed on the relationship which exists between the managerial conduct in south african smmes and the internal control activities in these business entities. the results show that there exists a very weak negative significant relationship between the managerial conduct and the internal control activities. in particular that internal control activities implemented by these business entities were positively associated with the popularity and/or proven feasibility of these activities in the industry in which they operate, and negatively influenced by the appropriateness of the managerial conduct. previous research studies explain that the managerial conduct, as a major part of the control environment, should have an influence on the internal control activities in these business entities. the results are also troubling as only 17.14% significant positive correlations pertaining to the managerial conduct were relevant to the characteristics of good corporate governance. therefore, enough evidence was obtained to reject h1. this study also concludes that virtually no statistically significant relationship exists between the views of members of management and those of employees, on the relationship they believe to exist between the managerial conduct and the internal control activities evident in sampled smmes. this comparison thus serves as confirmation that the views of members of management are most probably biased in respect of the support that their managerial conduct has on the internal control activities in these business entities. this is an avenue for further research. from the research conducted, although h1 was rejected, it does not mean that this dispensation should remain the status quo. it is recommended that members of management and employees collaborate with one another in order to find the ‘best way forward’ in terms of managerial conduct. the more appropriate managerial conduct in south african smmes, the better their control environments should become. the internal control activities of south african smmes should also be revisited by members of management and employees. in particular, emphasis should be placed on internal control activities as built on the control environment of south african smmes which, in turn, should help provide reasonable assurance surrounding the attainment of relevant organisational objectives in the foreseeable future. these internal control activities should make provision for: (1) the mandatory utilisation of source documents, (2) proper authorisation activities as supported by written policies and procedures, (3) proper detective controls in relation to the safeguarding of assets (e.g. alarms, cctv cameras, etc.), (4) the segregation of duties as supported by written policies and procedures and (5) the introduction of mandatory independent checks (daily banking of cash, staff supervision, etc.). to improve the sustainability rate of smmes, the government bodies associated with the strengthening of smmes in south africa should provide these business entities with guidance on how to improve their managerial conduct and internal control activities. acknowledgements competing interests the authors declare that they have no financial or personal relationship(s) that may have inappropriately influenced them in 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perspective’, international journal of human resource management 13(1), 156–182. https://doi.org/10.1080/09585190110083839 appendix 1 research questionnaire section a: business demographics a1) how would you classify the business? (tick the most appropriate box below) sole trader [ ] partnership [ ] close corporation [ ] private company [ ] a2) how would you describe the products sold by the business? (tick as many appropriate boxes below) frequently sold by the business [ ] frequently consumed by customers [ ] necessity products [ ] non-necessity products [ ] fast-moving consumer goods [ ] a3) how would you describe the geographical nature of the customers of the business? (tick as many appropriate boxes below) based in cape town only [ ] based in the greater western cape [ ] based in the greater south africa [ ] based beyond south africa [ ] a4) how would you describe the selling policy of the business relating to products sold? (tick the most appropriate box below) cash sales only [ ] credit sales only [ ] cash and credit sales [ ] a5) how would you describe the reach of the business apart from this outlet? (tick as many appropriate boxes below) this is the only outlet [ ] another outlet(s) in cape town [ ] another outlet(s) in the greater western cape [ ] another outlet(s) in the greater south africa [ ] another outlet(s) worldwide [ ] a6) what type of business is this? (tick as many appropriate boxes below) retail store [ ] wholesale store [ ] caterer [ ] restaurant [ ] convenience store [ ] café [ ] spaza shop [ ] tuck shop [ ] other: _________________________ a7) what is the business’ modus operandi? (tick as many appropriate boxes below) buy products to sell to customers [ ] buy products to sell to businesses [ ] a8) is this business a franchised business or a non-franchised business? (tick the most appropriate box below) franchised [ ] non-franchised [ ] a9) how many employees does the business employ? (tick the most appropriate box below) 0 – 5 employees [ ] 6 – 10 employees [ ] 11 – 50 employees [ ] 51 – 100 employees [ ] 101+ employees [ ] a10) how long has the business been in existence? (please enter a number) ____________ years section b: position in the business b1) what is your position in the business? (tick the most appropriate box below) managerial position (owner/manager) [ ] non-managerial (employee) [ ] if you are in a managerial position, please continue to section c if you are in a non-managerial position, please continue to section d section c: management demographics c1) what is your exact position in the business? (tick the most appropriate box below) owner [ ] manager [ ] owner and manager [ ] c2) how long have you been in this position? (please write in a number) ____________ years c3) are you a south african citizen? (tick the most appropriate box below) yes [ ] no [ ] c4) what is your highest qualification? (tick the most appropriate box below) lower than grade 12 [ ] grade 12/senior certificate/matric [ ] national higher certificate/higher certificate/national certificate [ ] higher diploma/diploma/national diploma [ ] bachelor’s degree/advanced degree [ ] honours degree/postgraduate diploma [ ] master’s degree [ ] doctoral degree [ ] c5) do you have decision-making power in the business? (tick the most appropriate box below) yes [ ] no [ ] if ‘yes’, please continue to section e if ‘no’, please continue to section c(a) section c(a): management demographics (additional) c6) based on c5, you indicated that you do not have decision-making power in the business. why is this the case? (please write a short sentence) ________________________________________________________________________________________________________________ ________________________________________________________________________________________________________________ ________________________________________________________________________________________________________________ ________________________________________________________________________________________________________________ ______________________________________________ c7) based on your answer in c5, would you rather say that you regard yourself as an employee of the business? (tick the most appropriate box below) yes [ ] no [ ] section d: employee demographics d1) what is your exact position in the business? (tick the most appropriate box below) employee [ ] other: __________________________ d2) how long have you been in this position? (please write in a number) ____________ years d3) what is your employment status? (tick the most appropriate box below) full-time employee (permanent) [ ] part-time employee [ ] d4) are you a south african citizen? (tick the most appropriate box below) yes [ ] no [ ] d5) what is your highest qualification? (tick the most appropriate box below) lower than grade 12 [ ] grade 12/senior certificate/matric [ ] national higher certificate/higher certificate/national certificate [ ] higher diploma/diploma/national diploma [ ] bachelor’s degree/advanced degree [ ] honours degree/postgraduate diploma [ ] master’s degree [ ] doctoral degree [ ] d6) do you have decision-making power in the business? (tick the most appropriate box below) yes [ ] no [ ] if ‘yes’, please continue to section d(a) if ‘no’, please continue to section e section d(a): employee demographics (additional) d7) based on d6, you indicated that you do have decision-making power in the business. why is this the case? (please write a short sentence) ________________________________________________________________________________________________________________ ________________________________________________________________________________________________________________ ________________________________________________________________________________________________________________ section e: economic sustainability of the business e1) for each statement below, indicate your level of agreement. the base sentence reads: the business … (tick the most appropriate box(es) below). statement strongly disagree disagree neutral agree strongly agree has more income than expenses has more assets than liabilities has sufficient cash on hand has a good reputation among customers has a good reputation among competitors has a good reputation among its suppliers will remain in operation for the foreseeable future e2) based on your answers in e1, how would you describe the overall economic sustainability of the business? (tick the most appropriate box below) it is very good [ ] it is good [ ] it is neutral [ ] it is bad [ ] it is very bad [ ] section f: internal control system f1) does the business have a system of internal control? (tick the most appropriate box below) yes [ ] no [ ] f2) how would you describe the business’ system of internal control? (tick as many appropriate boxes below) a process [ ] realised/implemented by management [ ] formal [ ] informal [ ] helps prevent risks from realising [ ] helps detect risks as they realise (loss events) [ ] corrects loss events [ ] helps the business to achieve operational objectives [ ] helps the business to achieve compliance objectives [ ] helps the business to achieve reporting objectives [ ] n/a, the business has no system of internal control [ ] f3) for each statement, indicate ‘yes’ or ‘no’. the base sentence reads: the business’ system of internal control is … (tick the most appropriate box(es) below). statement yes no based on the coso framework based on the coco framework based on the cobit framework based on another framework not based on any particular framework f4) the term ‘adequacy’ relates to whether something is ‘good enough’. how would you rate the adequacy of the business’ internal control system based on your answer(s) in f2? (tick the most appropriate box below): it is very adequate [ ] it is adequate [ ] it is neutral [ ] it is inadequate [ ] it is very inadequate [ ] n/a, the business has no internal control system [ ] f5) the term ‘effectiveness’ relates to whether something is ‘working as intended’. how would you rate the effectiveness of the business’ internal control system based on your answer(s) in f2? (tick the most appropriate box below) it is very effective [ ] it is effective [ ] it is neutral [ ] it is ineffective [ ] it is very ineffective [ ] n/a, the business has no internal control system [ ] section g: internal control activities g1) for each statement below, indicate your level of agreement. the base sentence reads ‘in the business …’ (tick the most appropriate box(es) below) statement strongly disagree disagree neutral agree strongly agree source documents are used when goods are bought source documents are used when goods are received source documents are used when goods are sold source documents are used when payments are made source documents are used when money is received copies of all relevant source documents used are kept all relevant source documents used are pre-numbered unused source documents are kept safe all relevant source documents used have spaces for the date of transaction all relevant source documents used have spaces for signatures all relevant source documents used are simple to complete only management may authorise transactions employees may authorise transactions based on formal policies and/or procedures employees may authorise transactions with management approval only access controls are evident at entrances to the premises access controls are evident at all doors access controls are evident at tills and/or safes access controls are evident at storage points alarm systems are used cctv (surveillance) cameras are used security guards are used inventory is located and/or stored in a safe location staff are protected on premises (bars, security guards, etc.) backup and disaster-recovery measures are in place staff are supervised staff are monitored (e.g. behaviour changes) staff-performance reviews are conducted periodically quality checks are performed on goods received quality checks are performed on goods before they are sold surprise cash checks are performed (at tills) surprise cash checks are performed (petty cash) inventory is periodically counted cash is banked daily independent audits are performed periodically internal audits are performed periodically the bank account is regularly reconciled by an independent person the debtors’ control account is regularly reconciled by an independent person the creditors’ control account is regularly reconciled by an independent person the person authorising transactions does not record or execute them / (e.g. the authorising of a delivery) the person recording the transactions does not authorise or execute them (e.g. the recording of delivery of goods) the person executing transactions does not authorise or record them (e.g. the actual delivery of goods) g2) for each statement below, indicate your level of agreement. the base sentence reads the control activities above are … (tick the most appropriate box(es) below) statement strongly disagree disagree neutral agree strongly agree adaptable to changes in the immediate business environment assist management with the execution of their responsibilities robust suitable for the industry of operation supportive of policies and procedures supportive of risk management strategies g3) the term ‘adequacy’ relates to whether something is ‘good enough’. how would you rate the adequacy of the business’ internal control activities based on your answer(s) in g1 and g2? (tick the most appropriate box below): it is very adequate [ ] it is adequate [ ] it is neutral [ ] it is inadequate [ ] it is very inadequate [ ] n/a, the business has no internal control activities [ ] g4) the term ‘effectiveness’ relates to whether something is ‘working as intended’. how would you rate the effectiveness of the business’ internal control activities based on your answer(s) in g1 and g2? (tick the most appropriate box below): it is very effective [ ] it is effective [ ] it is neutral [ ] it is ineffective [ ] it is very ineffective [ ] n/a, the business has no internal control activities [ ] section h: managerial conduct h1) for each statement, indicate your level of agreement. the base sentence reads: ‘the business’ management …’ (tick the most appropriate box(es) below). statement strongly disagree disagree neutral agree strongly agree communicates well has effective management practices has industry-specific knowledge has leadership skills is on par with the latest trends in the industry promotes accountability promotes ethics promotes proper values promotes responsibility promotes transparency solves problems h2) for each statement, indicate your level of agreement. the base sentence reads: i associate the business’ management with the following values … (tick the most appropriate box(es) below). statement strongly disagree disagree neutral agree strongly agree accountability adaptability ambition analytical cautiousness commitment communicative compassion competitiveness consistency courageous creativity curiosity dependable discipline diversity enthusiastic ethical fairness futuristic generous humble inclusiveness independence innovation logical loyalty optimiser optimist organised realistic responsibility strategic transparency trustworthiness h3) for each statement, indicate your level of agreement. the base sentence reads: ‘the business’ management’s operating style is best described by … ’ (tick the most appropriate box(es) below): statement strongly disagree disagree neutral agree strongly agree employees are given full control of taking action (chaotic) employees are persuaded to management’s view before taking action (persuasive) employees’ inputs are asked before taking action (democratic) management gets input from some employees before taking action (semi-autocratic) management has the final say before taking action (paternal) management lets employees take action at their own pace (laissez-faire) management only takes own views into account before taking action (autocratic) h4) taking into account the nature of the business (size thereof, the industry in which it operates, etc.) how appropriate is the managerial conduct? (tick the most appropriate box below) it is very appropriate [ ] it is appropriate [ ] it is neutral [ ] it is inappropriate [ ] it is very inappropriate [ ] h5) for each statement, indicate your level of agreement. the base sentence reads: the managerial conduct of the business’ management has a direct influence on the … (tick the most appropriate box(es) below): statement strongly disagree disagree neutral agree strongly agree adequacy of the business’ internal control activities (e.g. proper document design, proper authorisation, etc. – refer to section g) adequacy of the business’ internal control system (e.g. helps prevent risks, detect risks and achieve business objectives – refer to section f) business decisions that are made economic sustainability of the business effectiveness of the business’ internal control activities (e.g. proper document design, proper authorisation, etc. – refer to section g) effectiveness of the business’ internal control system (e.g. helps prevent risks, detect risks and achieve business objectives – refer to section f) efficiency and effectiveness of business operations going-concern status of the business morale levels inside the business productivity of employees appendix 2 table 1-a2: all correlation between the managerial conduct and internal control activities. table 1-a2 (continues…): all correlation between the managerial conduct and internal control activities. appendix 3 table 1-a3: significant differences between the views of members of management and employees. sajems ns vol 1 (1998) no 3 390 die strategiese bestuur van regstellende aksie in plaaslike regering in suid afrika * p brydard en e vad rooyed skool vir openbare bestuur en administrasie, universiteit van pretoria abstract the south african government regards affinnative action as an important method to rectify the discriminatory career practices followed against blacks, coloureds, indians and women under the previous political dispensation. legislation and policy that provide for affirmative action in institutions have been formulated and are considered in this paper. after normative and empirical research, it is concluded that it is possible to develop strategic affinnative action programmes in local government institutions and that affirmative action can be managed in terms of a strategic process in local government. it is further concluded that managers in local governments playa key role in the successful implementation of strategic affirmative action programmes. jeld630 inleiding ten spyte van die afskaffmg van apartheid en die uiteindelike daarstel van 'n demokraties verkose regering in suid afrika. word die land se sosio-ekonomiese bedeling steeds gekenmerk deur rasse-, geslag-, religieuseen k1asseongelykheid. die suid afrikaanse regering het gevolglik die herstrukturering van die suid afrikaanse openbare sektor as een van sy primm oogmerke gestel. herstrukturering, beskou teen die agtergrond van die herophou en ontwikkelingsprogram (hop), verwys onder andere na regstellende aksie (reconstruction and development programme, 1994: 9). volgens die heropbou en ontwikkelingsprogram word die ontwikkeling van menslike hulpbronne in suid afrika met behulp van regstellende aksie gesien as 'n sleutelprogram vir die heropbou en ontwikkeling van die gemeenskap (reconstruction and development programme, 1994:9) . • the strategic management of affinnative action in local government in south africa r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 391 sated nr vol i (1998) nr 3 w&eldwyd word programme geloods met die oog op die uitwissing van verskeie soorte ongelykbede. regstellende aksie is so 'n program . en word verskillend getipeer; terme saos regstellende maat:reels, positiewe diskriminasie. spesiale regte, standardisasie, seuns-van-die-grond-voorkeurreg en voorkeurbehandeling, is terme wat gereeld in literatuur aangetref word (working paper of the constitutional development service, 1993). voorbeelde hiervan word ook in plaaslike regerings aangetref. die stadsraad van pretoria besig byvoorbeeld benewens regstellende abie, ook nie-amptelik die term instaatstellingsaksie om hierdie instelling se regstellende abieprogram te beskryf. volgens die stadsklerk voan die stadsraad van pretoria (1996). is 'n altematiewe beslaywing van die inhoud en oogmerk van die regstellende abieprogram wat deur die stadsraad geloods word, instaatstellingsaksie. die groter johannesburg metropolitaanse oorgangsraad besig byvoorbeeld die terme regstellende abie en gelyke geleenthede om hulle ~fonnasieprogram te beskryf (regstellende aksieadviseur: groter johannesburg metropolitaanse oorgangsraad, 1996). in hierdie artikel word die konsep regstellende abie verldaar en 'n model voorgehou vir die strategiese bestuur daarvan in plaaslike regering. regstellende aksie in die verenigde state van amerika die verenigde state van amerika se program van aktiewe regstellende abie is een van die bekendste en oudstes ter w&eld (development and democracy, september 1993). regstellende abieprogramme het 'n wesentlike invloed op die openbare personeeladministrasie in die verenigde state van amerika gehad. hofgedinge oar vermeende onbillike arbeidspraktyke kom gereeld voor. getuienis daarvan word gevind in die vele hofsake wat die afgelope dertig jaar oar die onderwerp plaasgevind het (andrews, 1992: 34). gedurende die sestigerjare het die verenigde state van amerika geeksperimenteer met regstellende abieprogramme en het innoverende denke oar die onderwerp posgevat. die gevolg is dat verskeie sosiale gelykbeidsprogramme met in mindere of in meerdere mate van sukses geimplementeer is. debatte is ondermeer gevoer oor die aanpassing van indiensnemingstandaarde, die wenslikheid van kwotastelsels en of indiensnemingsdoelwitte noodsaaklik is. regstellende aksie as 'n eietydse sum afrikaanse verskynsel regstellende abie blyk nie in totaal nuwe idee in die suid afrikaanse milieu te wees nie. gedurende die dertiger jare van die twintigste eeu is die blanke afrikaner ook met behulp van 'n ekonomiese en sosiale bemagtigingsprogram r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 3 392 opgehef (adams ed 1993). in die sewentiger jare het verskeie suid afiikaanse maatskappye byvoorbeeld in terme van die sullivan-kode regstellende aksie toegepas (madi, 1993: 5). suid afiikaanse instellings put egter tans heelwat idees en lesse oor regstellende aksie uit die amerikaanse ondervinding. kenners oor regstellende aksie en akademici vanuit die verenigide state van amerika, tree gereeld tydens suid afiikaanse seminare op. sowel die openbareas die privaatsektor mask van diegene se kundigheid op 'n konsultasiebasis gebruik ten einde hulle instellings te herstruktureer. die agtergrond waarteen suid afrikaanse instellings regstellende aksieprogramme implementeer, is uniek en pionierswerk word deurlopend in hierdie opsig verrig (wingrove, i 993:vi). een van die belangrikste verskille tussen suid afrika en die verenigde state van amerika se regstellende aksiebehoefte, handel oor wie die regstellende aksieteikengroep in die onderskeie twee lande is. in die verenigde state van amerika maak die regstellende aksieteikengroep 'n minderheids-bevolkingsgroep uit en in suid afrika maak die regstellende aksieteikengroep 'n meerderheidsbevolkingsgroep uit. diegene wat hoofsaaklik deur in regstellende aksieprogram in suid afrika sal baat is swartes, bruinmense, indii!rs, vroue en gestremde persone. tydens die ontwikkeling van geskikte regstellende aksieprogramme vir die bogenoemde groepe behoort in aanmerking geneem te word dat hulle op verskillende vlakke van en oor 'n verskeidenheid vaardighede, kwalifikasies en ondervinding beskik (whitepaper on the transfonnation of the public service, 1995:13). fonneel geskoolde en kundige lede van die voorheen benadeelde groepe, behoort oor die algemeen nie verdere opleiding anders as orienteringsen induksieprogramme te deurloop nie. diegene wat egter potensiaal toon, maar nie oor die nodige vaardighede, kwalifikasies en ondervinding in bepaalde rigtings beskik nie, behoort aan intensiewe en versnelde programme onderwerp te word. die president, mnr nelson mandela, huldig die volgende standpunt oor regstellende aksie: "the primary aims of affirmative action must be to redress the imbalances created by apartheid ... it must be based on patently just, and whenever possible, universally agreed, criteria of entitlement and redress, and be implemented according to widely acceptable and clearly equitable procedures ... the goal of affirmative action will be truly to achieve equal chances for all, and amount neither to a vengeful turning of the tables of oppression, or the creaming of the country by a small new class of exploiters" (mandela, 1991). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 393 satebnr vol i (1998)nr3 oogmerke met regstellende aksie regstellende aksie behoort dus rue 'n hek.sejag of voortgesette diskriminasie te behels rue. maar eerder 'n program wat op gelyke geleenthede en die bemagtiging van 'n bepaalde groep ingestel is. wmgrove (1993:5) beweer dat regstellende aksie onder meer die volgende oogmerke het: (a) die fokus val op die ontwikkeling en die bevordering van 'n benadeelde groep persone; (b) wetgewing, 'n kwotastelsel en die stel van tydskale vir die implementering van regstellende aksie kan daargestel word; ( c) bepaalde posisies en be1rekkings wat voorheen buite die bereik van die benadeelde groep was, word geidentifiseer en indiensstellingsprosedures. opleidingsen ontwikkelingsprogramme word gejoods; regstellende aksie is dus 'n metode waarmee gepoog word om bepaalde personeelgroepe. waarteen in die verlede gediskrimineer is. 'n geleentheid te bied om werksgeleenthede en loopbaanontwikkelingsgeleenthede in instellings te bekom. die aard van die diskriminasie teenoor die bepaalde personeelgroepe is wydlopend. diskriminasie kan die vorm aanneem van inter alia indiensnemingsbeleid, wat daarop ingestel is om eerder aan 'n bepaalde rassegroep of geslag. voorkeur te verleen tydens 'n werwingen keurmgsproses, of dit kan daarop afgespits wees om ontwikkelingsgeleenthede en loopbaanbevorderingsgeleenthede aan slegs 'n uitgesoekte groep personeellede te bied. met die inwer:kingstelling van die grondwet van die republiek van suid afrika, 1993 (wet 200 van 1993) en later die grondwet van die republiek van suid afrika, 1996 (wet 108 van 1996) is die diskriminerende praktyke van die verlede statuter verbied. die grondwet van die republiek van suid afrika, 1996 (wet 108 van 1996) stipuleer in die handves van menseregte (hoofstuk 2) dat ras, geslag en geloof kriteria is in terme waarvan rue teenoor persone gediskrimineer mag word rue. artikel 9(2) van die grondwet van die republiek van suid afrika, 1996 (wet 108 van 1996) stipuleer egter dat die bereiking van gelykheid met behulp van byvoorbeeld wetgewende maatreels, bewerksteuig kan word. sodanige wetgewing kan daargestel word vir die beskerming en ontwikkeling van persone of kategorie! persone wat in die verlede deur diskriminerende maatreels benadeel is. die regering het in terme hiervan 'n beleid van regstellende aksie van stapel gestuur. die implikasie hiervan is dat bepaalde persone of kategorie! r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 3 394 persone voortaan daarop geregtig sou wees om aanspraak te maak op voorkeurgeleenthede. in soverre dit werksgeleenthede en loopbaanontwikkeling en loopbaanvordering aanbetref. die wet op arbeidsverhoudinge. 1995 (wet 66 van 1995) bepaal byvoorbeeld dat werkgewers diensbeleid en praktyke mag handhaaf wat daarop afgespits is om personeellede of personeelgroepe waarteen in die verlede gediskrimineer is, te beskerm en te bevoordeel ten einde uiteindelike gelykbeid te bewerkstellig. die doel hiermee is om benadeelde persone sosiaal-ekonomies te bemagtig en op te hef sodat hulle na afioop van die regstellende aksietermyn as gelykes kan meeding om loopbaangeleenthede. regstellende aksie befuvloed ester plaaslike regerings in terme van hulle hulpbronaanwending, funksie-uitvoering en bestuur. die afieiding kan gevolglik gemaak word dat bestuurders in plaaslike regerings in suid afrika voor die uitdaging staan om regstellende aksieprogramme te implementeer met inbegrip van die finansiele beperkioge op hulle onderskeie instellings en volgehoue doeltreffende dienslewering aan die gemeenskap. regstellende aksie is daarop afgespits om bepaalde veranderinge in die personeelstruktuur van plaaslike regerings te bewerkstellig en behoort gevolglik doeltreffend bestuur te word ten einde die sukses daarvan te verseker. normatiewe en empiriese navorsing is gevolglik ondemeem deur dwingende maatreels wat deur die regering ingestel is om gelyke werksen vorderingsgeleenthede vir voorheen benadeelde persone en kategoriee persone te verseker, te ondersoek. die nasionale arbeidsverhoudingeforum vir plaaslike regering se gids vir die praktiese implementering van die ooreenkoms oor gelyke jndiensnemingspraktyke en regstellende aksie in plaaslike regering, die organisatoriese transformasie-dokument van die instituut vir munisipale bestuur in suider afrika en regstellende aksiebeleidsdokumente van die groter johannesburg metropolitaanse oorgangsraad en die stadsraad van pretoria , is ondermeer tydens hierdie navorsing geraadpleeg. die gevolgtrekking waartoe geraak word, is dat 'n bree riglynmodel ontwikkel kan word vir die strategiese implementering van regstellende aksie in plaaslike regering. die strategiese regstellende aksiemodel mag vir bestuurders en besluitnemers in plaaslike regering in suid afrika nuttig wees tydens die beplanning en implementering van hulle onderskeie regstellende aksieprogramme. regstellende aksie as 'n strategiese bestuursprogram strategiese bestuur behels die aktiwiteite betrokke by die formulering en implementering van strategiee om 'n instelling se doelwitte te bereik (thompson en strickland, 1989: 4). regstellende aksie word tans deur verskeie insteuings r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 395 sated nr vol 1 (1998) nr 3 geimplementeer as 'n veranderingsproses waartydens 'n personeelkorps daargestel behoort te word wat verteenwoordigend van die bevolkingsame-stelling van die land is, (reddy ed., 1996: 99). strategiese bestuur bestaan volgens thompson en strickland (1989: 12) uit die volgende santa! opeenvolgende stappe: die eerate stap is om as deel van die beplanningsfase 'n visie en 'n missie in die betrokke instelling te ontwikkel. die tweede stap bebels dat langen korttennyndoelwitte in die instelling gestel word. die derde stap behels die ontwikkeling van die strategie in die instel1ing. tydens die vierde stap word die strategie geimplementeer en tydens die vyfde stap word die proses herevalueer en word indien nodig, veranderings san die missie, doelwitte en strategie gemaak (thompson en strickland, 1989: 12). strategiese bestuur en die eiesoortigbeid van plaaslike regeringsinstellings strategiese bestuur, soos dit in die privaatsektor en die openbare sektor toepassing vind, verskil van mekaar. die verskille in die strategiese bestuursprosesse is as gevolg van die onderlinge eiesoortigheid van die privaatsektor en die openbare sektor. privaatsektororganisasies is op winsbejag ingestel en doelwitte in hierdie verband is gevolglik maklik kwantifiseerbaar. openbare sektorinstellings, daarenteen, is op gemeenskapsdienslewering ingestel en kan me in aile gevalle die diensleweringsmotief geredelik kwantifiseer me. 'n vername aspek wat die openbare sektorinstellings eiesoortig maak, is dat hulle in 'n politieke omgewiog fimksioneer en dat hulle deur belastinggeld van die gemeenskap befonds word (reddy ed., 1996:96). verskeie teoretiese en praktiese strategiese bestuursmodelle word tans in plaaslike regeringsinstellings toegepas. 'n vername vertrekpunt by die strategiese bestuur van regstel1ende aksie is dat die besondere omstandighede en behoeftes wat heersend in 'n bepaalde plaaslike regeringsinstelling is, die soort strategiese benadering wat gevolg word, behoort te bepaal. die strategiese regstellende aksie bestuursmodel en die inhoud daarvan, word dus met inbegrip van die unieke omstandighede in die onderskeie plaaslike regeringsinstellings bepaal. die unieke omstandighede van die onderskeie plaaslike regerings-instellings, word vasgestel tydens die beplanning van die regstellende aksieproses deur inter alia met die bejangegroepe te onderhandel, die regstellende aksie-oudit te onderneem en om 'n korporatiewe klimaatsondersoek oor die heersende korporatiewe kultuur, uit te voer (regstellende aksie-adviseur, stadsraad van pretoria, 1996). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 3 396 plaaslike regerings wat strategiese bestuursprogramme toepas, stel hulle bestuurders in staat om die omgewing waarin die instelling funksioneer, se toekoms te antisipeer, te vertolk en te vorm. tydens die strategiese beplanningsproses word bepaalde sterkpunte en swakpunte van die betrokke instelling geldentifiseer en word geantisipeerde geleenthede en bedreigings in die omgewing (en omgewingskragte), wat op die instelling inwerk, vertolk (staal, 1994: 147). 'n visie en missie word opgestel ten einde aan die plaaslike regeringsinsteuing tn toekomsstrewe te verskaf. die sterkpunte, swakpunte, geleenthede en die bedreigings van 'n betrokke plaaslike regeringsinstelling behoort ook bepalend te wees van die aard en inhoud van die gekose strategiese bestuursprogram. die strategie word gevolglik rondom die visie en missiestelling ontwikkel, om sodoende sinvolheid en rigring aan die strategiese proses te verleen. die rol van bestuurders in plaaslike regering tydens die implementering van regstellende aksie strategiese beplanning en bestuur van regstellende aksie in plaaslike regering vereis dat bestuurders oor bepaalde noodsaaklike vaardighede behoort te beskik. bestuurders behoort te begryp dat die gemeenskapsbehoeftes wat plaaslike regerings behoort te dien, en die tekort aan hulpbronne. veroorsaak dat buitengewone eise aan personeellede gestel word wanneer regstellende aksie in plaaslike regeringsinstellings toegepas word (regstellende aksie-adviseur, groter johannesburg metropolitaanse oorgangsraad: 1996). plaaslike regerings wat strategiese regstellende aksieprogramme impiementeer, behoort dus buitengewone ondersteuning aan bestuurders en personeellede te bied 'n vername rol van bestuurders tydens die suksesvolle implementering van regstellende aksie is dat hulle onomwonde steun aan die regstellende aksieprogram behoort te betuig (human, 1993: 54 en 56). personeellede behoort daarvan bewus te wees dat hulle bestuurders en gevolglik diegene wat aan hulle leiding verskaf, die regstellende aksieproses openlik ondersteun. 'n positiewe korporatiewe klimaat ten aansien van regstellende aksie is dus bevorderlik vir die sukses daarvan. regstellende aksie bring mee dat bestuurders toenemend bevel behoort te voer oor 'n heterogene personeelkrops. die diversiteit van personeellede en groepe, elk met 'n besondere agtergrond en verwysingsraamwerk. bring mee dat bestuurders in gedagte behoort te neem dat hulle kommunikasie en bestuurstyle dienooreenkomstig behoort aan te pas. beide empiriese en normatiewe navorsing het getoon dat bestuurders in 'n regstellende aksiemilieu, personeel behoort te kan motiveer, hulle behoort effektief te kan kommunikeer en hulle behoort oor die kennis en vermoe te beskik om teenstand teen verandering te kan hanteer. die r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 397 sateb nr vol 1 (1998) nr 3 ideaal is dat aile bestuurders leiers behoort te wees. tydens die onsekerbeid wat in instelling met die implementering van in regsteuende 'aksieprogram beers. behoort bestuurders as voorbeeld te dien en hulle ondergeskikte personeellede te kan motiveer. in vemame bestuursaspek wat deurentyd na yore tree, is dat bestuurders in plaaslike regeringsinstellings in deelnemende bestuursbenadering behoort te volg. die rede hiervoor is dat die veranderingsproses teo eerste gelegitiroiseer behoort te word deur middel van die ondersteuning van aile personeellede. die personeel se ondersteuning van die veranderingsproses kan slegs vekry word indien hulle deel het in die beplanning en bestuur van die verandering. teo tweede word die personeel deur middel van die deelnemende bestuursproses van noodsaaldike inligting rakende die veranderingsproses voorsien, wat deursigtigheid in die fimksionering van die betrokke instellings bevorder (regsteuende aksie-adviseur. stadsraad van pretoria: 1996). personeeuede wat dus deeglik oor die regstellende aksieproses ingelig is, behoort minder vrese en bekommemisse oor hulle loopbaanvooruitsigte te he. in deelnemende bestuursbenadering in plaaslike regeringsinstellings behoort teenstand teen verandering te verminder en gevolglik die regsteuende aksieproses te bevorder. die bestuurders in plaaslike regeringsinstellings speel dus in sleutelrol in die suksesvolle implementering van strategiese regstellende aksie programme. die strategiese bestuur van regstellende aksie in plaaslike regering: '0 model die klem behoort tydens die ontwikkeling van in strategiese regstellende aksieprogram geplaas te word op die eiesoortige omstandighede en behoeftes wat heersend in die onderskeie plaaslike regerings is. in strategiese bestuursproses behoort nie as in teoretiese proses gesien te word wat noodwendig volgens 'n bepaalde aantal opeenvolgende stappe verloop nie. plaaslike regerings se unieke omstandighede en behoeftes behoort tydens die ontwerp van 'n strategiese regstellende aksiebestuursprogram in gedagte geneem te word. die riglynmodel vir die strategiese bestuur van regsteuende aksie in die plaaslike regerings word in figuur 1 geniustreer. die regstellende aksieprogram word telkens as 'n strategie getipeer ten einde die klem te plaas op die strategiese bestuursaard daarvan. verwikkelinge op die politieke, ekonomiese, sosiale en tegnologiese terreine in die omgewing, lei daartoe dat plaaslike regerings hulle daarby behoort aan te pas. die rede hiervoor is dat plaaslike regerings instellings is wat uitsluitlik daarop ingestel behoort te wees om gemeenskapsbehoeftes te bevredig. plaaslike regerings behoort dus sensitief te wees ten opsigte van enige verandering wat r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 3 398 voorkom, in die omgewing waarin hulle funksioneer. indien plaaslike regerings rue by die omgewingskragte skik rue, mag die gevolg wees dat hulle rue aan hulle diensideaal teenoor die gemeenskap getrou bly rue. na afloop van die verkiesings op nasionale en provinsiale regeringsvlak in 1994 en die plaaslike regeringsverkiesing in 1995, het bepaalde politieke, sosiale en ekonomiese omgewingskragte regstellende aksie op plaaslike regeringsvlak genoodsaak. die regering het as gevolg hiervan bepaalde regstellende aksiewetgewing geformuleer en verskeie beleidsdokumente en 'n arbeidsforumooreenkoms vir regstellende aksie in plaaslike regerings is ontwikkel. in terme van hierdie dokumente kan 'n regstellende aksieprogram, gebaseer op 'n strategiese bestuursproses, vir plaaslike regering ontwikkel word. die stappe in die model, soos in figuur 1 supra aangetoon, kan soos volg verklaar word: stap 1: ontwikkel 'n visie en 'n missie vir regstellende aksie die eerste stap van die strategiese bestuursproses vir regstellende aksie in plaaslike regerings behels die voorlopige ontwikkeling van 'n visie en 'n missie vir regstellende aksie. plaaslike regerings behoort as deel van strategiese beplanning oor 'n visie en 'n missie vir regstellende aksie te beskik. hierdie fase word as die beplanningsfase vir die implementering van die regstellende aksieproses getipeer. 'n v oorlopige regstellende aksie-ondersoekspan, bestaande uit plaaslike raadslede, bestuurders en personeellede van 'n bepaalde plaaslike regering word aangestel om 'n voorlopige ondersoek te loods, wat as 'n regstellende aksieterreinverkenningsproses beskou kan word. die strategiese regstellende aksiebestuursproses behoort in deurlopende konsultasie met georganiseerde plaaslike regering, die instituut vir munisipale bestuur in suider afrika, konsultante, academici en ander plaaslike regerings plaas te vind. die rede vir die deurlopende konsultasie is om te put uit die ondervinding en kennis van spesialiste op die gebied van strategiese bestuur en regstellende aksie. voortvloeiend uit die voorlopige regstellende aksie-ondersoekspan se aktiwiteite, behoort 'n konsultatiewe forum geskep te word om onderhandelinge met bepaalde belanghebbendes oor die implementering van die regstellende aksie te voer. die konsultasieforum se werksaamhede kan die vorm aanneem van werkswinkels en seminare om sodoende aile belangstellende persone of groepe persone by die regstellende aksieproses te betrek. 'n vername funksie van die konsultatiewe forum is om aile belanghebbendes wat 'n legitieme belang by die regstellende aksieproses in 'n bepaalde plaaslike regering het, te identifiseer. die regstellende r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . i 399 sateb nr vol i (1998) nr 3 aksieproses sal die suksesvol deurgevoer lean word, alvorens aimal wat daarin 'n belang het, die deel van die proses gemaak word die. . figuur 1: 'n model vir die strategiese bestuur van regstellende aksie in plaulike regeringj stapl ontwikkel 'n vlsie en 'n missie vir regstellendeaksie stap2 stel korten langtermyn doelwi'ite vir regstellende aksie r "' deurlopende stapj evaluering ontwikkel 'n regstelenlndlen lende aksiestrategie nodig, aanpassing stap4 aandie implementeer die strategie regstellende \.. .j aksiestrategie sta.p5 ev aluering en moontlike aanpassing v an die regstellende aksiestrategie die konsu1tatiewe forum vir regstellende aksie behoort voorts die aanstelling van 'n regstellende aksiekomitee te fasiliteer. die regstellende aksiekomitee behoort te bestaan uit verteenwoordigers van aile belangegroepe by die regstellende aksieproses. insluitend politieke ampsbekleers. bestuurders en personeellede in 'n bepaalde plaaslike regering. die regstellende aksiekomitee moet 'n regstellende aksie-adviseur aanstel wat daarvoor verantwoordelik sal wees om die regstellende aksieproses in die bepaalde plaaslike regering te lei. die regstellende aksieadviseur sal in bekwame persoon wees wat verkieslik kennis dra van regstellende aksie, strategiese bestuur en plaaslike regering. aangesien die regstellende aksieadviseur 'n sleutelrol in die suksesvolle implementering en deurvoering van die r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 3 400 regstellende aksieproses speel. is dit noodsaaklik dat die persoon die volle ondersteuning van die regstellende aksiekomitee geniet. die regstellende aksie-adviseur is verantwoording aan die regstellende aksiekomitee verskuldig en behoort direk aan die hoofuitvoerende beampte van die betrokke plaaslike regering te rapporteer. aangesien regstellende aksie so 'n vemame proses in plaaslike regering is, moet die keuse op tn regstellende aksieadviseur ook die volle ondersteuning van die plaaslike mad te geniet. die regstellende aksiekomitee, waarvan die hoofuitvoerende beampte en die regstellende aksie-adviseur lid is, kan verskeie altematiewe metodes en benaderings ondersoek met behulp waarvan die veranderingsproses in die betrokke plaaslike regering kan plaasvind. hierdie ondersoek kan met behulp van georganiseerde plaaslike regeringsinstellings, die instituut vir munisipale bestuur in suider afrika, konsultante, akademici en ander plaaslike regerings plaasvind, ten einde voldoende inligting oor die veranderingsproses in plaaslike regering te bekom. tn regstellende aksie-oudit sal deur 'n konsultant uitgevoer word wat deur die regstellende aksiekomitee aangestel is. die regstellende aksie-oudit is 'n kritiese ondersoek na die heersende personeelbeleid en -prosedures in 'n betrokke plaaslike regeringsinstelling. die doel van die regstellende aksie-oudit, is om enige diskriminerende praktyke wat in 'n plaaslike regeringsinstelling mag voorkom te identitiseer. 'n personeelprotiel word opgestel om aan te dui hoe verteenwoordigend 'n plaaslike regeringsinstelling van die gemeenskap wat bedien word, is en welke regstellende aksiemaalreels dus nodig is. 'n korporatiewe klimaatsondersoek word ter gelyke tyd uitgevoer om die beskouinge van die personeel oor regstellende aksie te toets. die inligting wat tydens die regstellende aksie-oudit ingesamel word, is noodsaaklik vir die beplanning van die regstellende aksieproses. indien die korporatiewe klimaatsondersoek daarop dui dat die heersende korporatiewe kultuur van 'n plaaslike regeringsinstelling oorwegend negatief teenoor regstellende aksie is, kan die nodige intervensies geloods word om die personeel beter op die verandering voor te berei en hulle beskouinge te verander. onderwyl die beplanning vir regstellende aksie onderweg is, behoort plaaslike regeringsinstellings steeds daarop bedag te wees om hulle hoofsaaklike funksie, naamlik kwaiiteit dienslewering aan die gemeenskap, uit te voer. regdeur die implementering van die regstellende aksieproses behoort dienslewering telkens voorrang bo ander plaaslike regeringsaktiwiteite te geniet. die ideaal is om die standaard van dienslewering aan die gemeenskap met behulp van die regstellende aksiemaatreels te verbeter. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 401 sateb nr vol 1 (1998) nr 3 stap 2 en 3: stel langen korttermyndoelwitte en ontwikkel 'n regstellende aksiestrategie tesame met die ontwikk.eling van 'n visie en 'n missie vir regstellende aksie in piaaslike regerings, behoort langen korttermyndoelwitte ontwikk.el te word sodat konkrete mylpale vir regstellende aksie vasgestel kan word. hierdie langen korttermyndoelwitte behoort duidelik gestel te word en haalbaar te wees. aile belanghebbendes in die ondersk.eie piaaslike regeringsinstellings behoort tydens die s1l'ategiese bestuursproses deurlopend van inligting voorsien te word oor vordering wat met doelwitbereiking gemaak word. die doelwitstellingsproses behoort 'n konsultatiewe proses te wees en onderhandelinge behoort met alle interne en eksterne belanghebbendes van die onderskeie plaaslike regeringsinstellings gevoer te word. indien aile belangegroepe die by die doelwitstellingsproses betrek word die, mag die gevolg wees dat onrealistiese doelwitte gestel word, wat die regstellende aksieproses sal benadeel. die onderhandelinge wat met die belangegroepe in plaaslike regering oor doelwitte gevoer word, kan met behulp van die dinkskrumtegniek ondersteun word. die dinkskrumtegniek behels dat diegene wat as sleutelpersone tydens die beplanning van die regstellende aksieproses beskou word, op 'n gelee tyd en plek afgesonder word en 'n dinkskrum vorm om met voorstelle vorendag te kom. hierdie voorstelle word dan aan die regstellende aksiekomitee voorgele vir evaluering. die dinkskrumspan behoort met behulp van inligting wat tydens die regstellende aksie-oudit en die korporatiewe klimaatsondersoek bekom is, bepaalde voorstelle rakende die s1l'ategiese proses, die finale visie en missie en moontlike regstellende aksieteikens en kwotas te maak. die gevolg van die korten langtermyn doelwitstellingsproses behoort te wees dat 'n onderhandelde ooreenkoms oor regstellende aksie bereik word. 'n regstellende aksiebeleid word geformuleer wat vervat behoort te word in 'n regstellende aksiebeleidsverklaring. die doel met die regstellende aksiebeleidsverklaring is om aan aile belanghebbendes 'n dokument te bied waarin hulle detailinligting k:an bekom oor regsteuende aksie in 'n bepaalde plaaslike regering en die verloop van die betrokke regstellende aksieproses. die regstellende aksiebeleidsverklaring neem die vorm aan van 'n kontraktuele ooreenkoms tussen die onderhandelingsvennote en is gevolglik 'n dokument met regstatus. deurlopende konsultasie behoort regdeur die langen korttermyn doelwitstellingsproses met kundige persone gevoer te word sodat verseker k:an word dat die regstellende aksieproses wat ontwikkel word aan aile wetlike vereistes voldoen en dat geput k:an word uit andere se ervaring. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 3 402 stap 4: implementeer die regstellende aksiestrategie die regstellende aksieprogram kan na atloop van die beplanningsfase geimplementeer word. die implementering van die strategiese regstellende program behoort te voldoen aan alle voorskrifte wat in wetgewing, arbeidsforumooreenkomste en die regstellende aksie-ooreenkoms van die bepaalde plaaslike regeringsinstelling, gestel word plaaslike regeringsinstellings behoort daarop bedag te wees dat die normale plaaslike regeringsfunksies steeds tydens die implementering van die strategiese regstellende aksieproses behoort voort te gaan. volgehoue kwaliteit dienslewering aan die gemeenskap behoort steeds die hoofdoelwit van die instelling te wees. die hulpbronne wat vir die implementering van regstellende aksie gea110keer word. behoort steeds doeltreffend aangewend te word. deurlopende konsultasie behoort steeds met kundige persone plaas te vind aangesien die implementering van die regstellende aksieprogram 'n kritieke deel van die regstellende aksieproses is. intervensies word tydens hierdie fase in die funksionele aktiwiteite van die plaaslike regeringsinsteuings geloods. strukture, personeelstelsels, prosesse en bestuurstegnieke, is aspekte wat ondenneer deur die intervensies beinvloed word bestuurders in plaaslike regeringsinstellings vervul 'n vername rol gedurende die implementering van die regstellende aksieprogram. die bestuurders is diegene wat in die werksplek die veranderingsproses behoort te bestuur, behulpsaam behoort te wees om die korporatiewe kultuur te verander en daarvoor verantwoordelik is om konflik tussen die personeel te hanteer. stap s: evalueer die regsteuende aksiestrategie 'n strategiese bestuursproses behoort sodanig te funksioneer dat daar tydens enige stap van die proses, 'n verandering aan die strategiese doelwitte gemaak: kan word sonder dat die hele proses benadeel word. tydens die strategiese bestuursproses word 'n deurlopende evaluering gedoen oor doelwitbereiking en of die onderskeie stappe suksesvol deurgevoer is. die finale stap in die strategiese proses behels egter 'n evalueringsproses om vas te stel hoe suksesvol die totale strategiese regstellende aksieprogram was. die geleentheid word gebied om die hele proses in herotmskou te neem en, indien nodig, veranderings aan te bring. bestuurders behoort tydens hierdie stap vas te stel of die strategie uiteindelik identifiseerbaar was in tenne van die verandering wat in die prosesse, korporatiewe kultuur en dienslewering van die instelling meegebring het 'n suksesvolje strategie behoort ook gemeet te word aan die mate waartoe dit voldoen aan die kriteria wat die omgewingskragte dikteer. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 403 sateb nr vol 1 (1998) nr 3 die evalueringsproses word uitgevoer met behulp van 'n verdere regstellende aksie-oudit en periodieke korporatiewe klimaatsondersoeke. 'n vemame komponent van die evalueringsproses is om terugvoer san die belanghebbendes te verskaf ten opsigte van doelwitbereiking. terugvoer is veral noodsaaklik vir bestuurders en personeellede aangesien hulle 'n sanduiding behoort te k:ry oor hulle werkverrigting in tenne van die strategiese regstellende aksiedoelwitte wat vir hulle gestel is. die uiteindelike gevolg van die strategiese regstellende aksieproses behoort te wees om 'n personeelkorps te bekom wat verteenwoordigend is van die bevolkingsamestelling van die bepaalde gebied en om die werkplek te verdemokratiseer. dienslewering san die gemeenskap behoort uiteindelik verbeter te word indien die voomoemde bree doelwitte met behulp van die strategiese regstellende aksiebestuursproses bereik is. gevolgtrekking die suid afrikaanse regering beskou regstellende aksie as 'n vemame metode waardeur diskriminerende loopbaanpraktyke wat deur die vorige politieke dispensasie teenoor swartes, bruinmense, indisrs, vroue en gestremdes gevolg is, reg te stet. wetgewing en regstellende aksiebeleidsdokumente wat vir regstellende aksie in instellings voorsiening maak, is gefonnuleer. plaaslike regerings behoort gevolglik ook regstellende aksie te implementeer. regstellende aksie plaas egter addisionele druk op hulpbronne en bestuurders in instellings behoort te verseker dat sodanige programme doeltreffend bestuur word. na atloop van nonnatiewe en empiriese navorsing is bevind dat dit moontlik is om regsteuende aksie in plaaslike regering in tenne van 'n strategiese proses te bestuur. in hierdie artikel is 'n riglynmodel ontwikkel in tenne waarvan strategiese regstellende aksieprogramme suksesvol bestuur kan word. verwysings i. adams, c. ed. 1993. affirmative action in a democratic south africa. kenwyn: juta & co, ltd. 2. andrews, y. 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(1993). dolrument. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 403 sajems ns vol 3 (2000) no 3 external shocks, financial markets and the real economy policy options in south africa ra stuart department of economics, rhodes university, east london p a black south africa foundation and university of stell en bosch abstract the paper considers the transmission of an external shock through the bond, equity, money and foreign exchange markets and, depending on the nature and duration of the shock, the attendant effects on various sectors of the south african economy. while it is acknowledged that the ability of the reserve bank to intervene in the foreign exchange markets is limited, it is argued that the current policy may not be appropriate in the face of a sustained speculative attack. instead, a policy of selective intervention aimed at the relative degrees of change in foreign exchange and interest rates may be used to affect the distribution of costs between various sectors ofthe economy. jel g 10 1 introduction it is 8 o'clock in the morning on friday 28th of april, 2000. members of a top asset management company meet in their office in frankfurt to discuss the news that an important southern african country is experiencing a destabilizing internal political crisis. because of its close trade and financial links with south africa, the effects of this crisis are expected to rapidly spread to south african markets. a heavy speculative attack against the rand is expected, and consensus is reached that a dramatic depreciation of the current r/$ exchange rate from its present value ofr6.701$ to around r7.201$ is imminent an expected rise far in excess of that which is indicated by the current forward exchange rate of r6.851$. having formed this new expectation of the future exchange rate, our frankfurt team naturally expects the dollar value of their south african bond and equity holdings to fall; and so too do many other portfolio managers across the world. suppose they respond by putting their south african short-term bonds up for sale r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 404 in the local bond market the increased supply would, since additional foreign demand is unlikely to be forthcoming, drive bond prices down and short-term yields up. how will these actions impact on local financial markets and the real economy? what, if anything, should the monetary authorities do to cushion or even counter the impact? the financial impact discussed in section 2 below can be broken up into three "transmission channels", referred to as the substitution, leads-and-lags and speculative effects, as well as the accommodation response. the real effects are briefly considered in section 3, the broad policy implications in section 4, and a brief conclusion is provided in section 5. 2 financial impact information about increased activity in the bond market will be readily available and quickly spread among local dealers and other relevant parties, including commercial banks, insurance companies, importers and exporters, and the reserve bank itself all of whom will adjust their expectations of the future spot exchange rate. substitution effect the substitution effect would work through two channels portfolio adjustments and the switching of trade and other financing from foreign to domestic markets. once bond prices have been driven down far enough, banks and other financial institutions will enter the bond market and t>uy the cheaper short-term bonds on offer. their oecision would be a perfectly rational one substituting cheaper assets for relatively more expensive ones in their respective asset portfolios. these portfolio adjustments by both foreign and domestic fund managers would have a direct impact on the long-term bond market, the equity market, the foreign exchange market and the money market. bond and equity markets. the funding necessary for the purchase of the short term bonds could be arranged through the sale of long-term bonds and/or equities. the effect in the bond market would be a fall in the price and higher long yields, and in the equities market a decrease in share prices. foreign exchange market. in order to repatriate the proceeds of the short-term bond sales, foreign fund managers would offer the rand proceeds in exchange for foreign currency (say dollars) in the foreign exchange market. the increased demand for dollars would put upward pressure on the current rj$ spot exchange r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 405 sajems ns vol 3 (2000) no 3 money market. the effect on domestic interest rates through these portfolio adjustments is somewhat uncertain. upward pressure would arise to the extent that the funding for the purchase of short-term bonds was supplemented by borrowing in the money market, but this would be countered to a greater or lesser extent by the additional supply of rands arising from dollar purchases in the foreign exchange market. increases in the r/$ forward exchange rate (explained below) will raise the cost of covered foreign borrowing, leading to trade and other financing being shifted onshore. pressure on domestic liquidity and interest rates would result and, as noted by crefsa (1998: 28), would have a marked impact on bank credit extension to the private sector. switching between foreign and domestic financing would also lead to a decreased supply of dollars to the foreign exchange market and thus an increase in the pressure on the spot exchange rate. leads-and-iags effect a second channel of transmission is felt through "leading and lagging" by domestic importers and exporters. importers, expecting a dramatic depreciation of the exchange rate in future, would gain by leading their dollar payments, profiting through obtaining the dollar at a more favourable (lower) current spot rate. this may well require local borrowing of rands in order to finance the purchase of spot dollars sooner rather than later. exporters, on the other hand, would profit by delaying the conversion of their dollar receipts into rands and exchanging them at a more favourable (higher) future rate; this may again require local borrowing in order to meet some of their current expenses. the actions of both importers and exporters would thus result in direct pressure for an increase in short-term interest rates, and further pressure on the current spot ex~hange rate. indeed, crefsa (1998: 24) argue that these trade-related outflows were mainly responsible for the large outflow of short-term capital and the substantial depreciation of the rand in 1996. importers and exporters may also use the forward exchange market to cover themselves against the expected currency depreciation. if the expected spot exchange rate exceeds the current forward rate as we have assumed above importers would buy dollars forward at the current forward rate; exporters, on the other hand, would withdraw from the forward market or cancel forward sales previously contracted. the effect of these transactions will, as explained below, increase the pressure on short-term interest rates and the spot exchange rate. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 406 speculative effect spot market speculators also expecting a dramatic rand depreciation would gain by borrowing rands in order to buy dollars which they invest abroad at the prevailing world interest rate. at the appropriate time, they will convert their dollar proceeds back into rands at a more favourable rate in order to repay the original loan, profiting by the difference between the rate at which the dollars were originally bought and the (higher) rate at which they are sold. such speculative transactions will continue as long as the gain from the expected currency depreciation exceeds the loss incurred from the difference between the domestic and world interest rates. the initial act of borrowing will once again put upward pressure on short-term interest rates, whilst the initial buying of dollars will likewise raise the spot exchange rate. speculators are likely also to enter the fonvard market if they believe the future spot exchange rate to be higher than the current forward rate. dollars would be bought forward at the current forward rate and, when the contract matures, speculative profits taken by selling these dollars against rands at the higher future spot rate. the additional demand for forward dollars would tend to push the forward rate up, leading to a wider margin between the spot and forward rates than that suggested by the interest rate differential, and making profitable risk-free arbitrage possible. arbitrageurs would borrow rands, buy dollars spot (for investment offshore) and simultaneously sell the dollars forward. the loss arising from the fact that domestic interest rates are higher than world rates is more than offset by the gain from the forward sale of the dollars at a relatively higher rate. once again, pressure on interest rates and the spot exchange rate would be intensified. the pressure on the money and foreign exchange markets arising from these forward transactions would be aggravated through spot covering by the commercial banks. we can trace this effect through the actual forward transactions undertaken with the banks. outright forward purchases of dollars from the commercial banks would, as explained above, be undertaken by both pure forward speculators and by importers leading their payments through the forward market. these additional purchases of forward dollars, taken together with reduced sales of forward dollars as exporters withdraw from the forward market, would create a net excess demand for forward dollars. the effect would be that the commercial banks would be left with a net oversold forward position which, to the extent that this was not met through forward sales by arbitrageurs, would expose the banks to foreign exchange risk. spot dollars would be needed for delivery on maturity of the forward contracts and, if the spot rate ruling at the time were higher than the contracted forward rate, the banks would incur a loss on r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 407 sajems ns vol 3 (2000) no 3 each dollar purchased (given by the difference between the two prices). these potential losses can be avoided by the banks covering their residual net forward sales in the spot market; the bank would borrow rands in order to buy dollars spot immediately, and invest these dollars offshore at the current world interest rate. on maturity of the forward contract say three months later the bank would withdraw its foreign investment to supply the requisite amount of dollars to the speculator or importer. the additional domestic borrowing and spot purchases of dollars would increase the pressure on both interest rates and exchange rates. accommodation response the increased borrowing pressure in the money market, as outlined above, means that the commercial banks would probably have to approach the reserve bank for additional liquidity at the daily tender, and the repo rate can thus be expected to increase along with other short-term interest rates. increased pressure on the current spot exchange rate, again for the reasons outlined above, may raise inflationary expectations in the economy. to the extent that the automatic increase in interest rates is not sufficient to counter these expectations, the reserve bank may respond by adopting a less accommodating stance and limiting the amount of liquidity provided. banks with unsatisfied liquidity needs would have to make use of a marginal lending facility at a penal rate, so that a sudden capital outflow and the associated drain in liquidity would be rapidly met by sharp increases in short-term interest rates. 3 real impact whether or not the speculative attack is transmitted to the real economy, and the extent of any effects felt, will depend on the nature and duration of the shock itself and the recovery afterwards. specifically, this will depend on the time taken for foreign confidence in the south african economy to be restored and the outflows of international capital to be reversed. if the crisis is short and quickly reversed, the real effects will be limited as the capital account recovers and the pressure on both interest rates and the spot exchange rate are relieved. however, periodic repeats of such external shocks would lead to increased volatility in financial markets. volatility in the exchange rate and interest rates could cause a great deal of uncertainty, possibly discouraging both trade and new investment projects and leading to a reduction in long-term growth prospects. the cost to the south african economy of participating in the global economy would thus be significantly increased. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 408 if the external shock and its aftennath are more prolonged, as was the case with the east asian crisis (botha, 1999; saf, 1998), the effect on the real economy can be devastating. the combination of a falling rand and rising interest rates wi\l boost production costs and inflation; higher interest rates will discourage consumption and investment spending, precipitating closures and bankruptcies and thus destroying jobs; the induced fall in tax revenue will limit the state's ability to provide social services and infrastructure; declining expenditure on infrastructure will in tum further reduce real investment and hann long-tenn growth prospects. it is often argued that a depreciating exchange rate can encourage exports and curb imports, but this will depend to some extent on the potential for growth in our major export markets as well as on the price elasticity of demand for our imports. growth in manufactured exports tends to be slow, and could be inhibited by any uncertainty regarding future exchange rates. furthennore, the majority of south africa's imports are of a capital or intennediate nature. these goods have a relatively low price elasticity of demand, and import volumes are unlikely to decline significantly in the face of higher prices. indeed, the resulting higher production costs may well offset the positive effect of the depreciation on the increased international competitiveness of our exports. 4 policy response how should the monetary authorities respond to the crisis? should they take action in an attempt to minimize the effects of the crisis, or should they simply ride out the stonn? the sa reserve bank does have several options (or combinations thereof) available to it (saf, 1998). the first option is not to respond at all, and to accept the interest rate hikes and currency depreciation that are well-nigh unavoidable in the wake of a major external shock. secondly, the bank can intervene in the money market by accommodating the increased borrowing pressure and thus avoiding or reducing the pressure on interest rates; this will shift the burden of adjustment onto the exchange rate. thirdly, the bank can intervene in the spot and/or forward exchange markets and shift the burden of adjustment onto interest rates. given south africa's current state of economic development, the "hands off' approach is probably not appropriate. while positive economic signals are emerging and international investment ratings are being upgraded, standard and poor (cited in citadel, 2000) have expressed some concern regarding factors such as low savings and investment rates, labour market rigidities and hiv. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 409 sajems ns vol 3 (2000) no 3 possibly more importantly, the fact that the south africa's reserves cover only around 50% of annual external financing requirements, and that these consist predominantly of short-term portfolio capital, makes the country vulnerable to volatile capital flows and means that a high degree of potential volatility in foreign exchange and interest rates exists. south africa may thus be viewed as a candidate for contagion2, with the real costs to the economy of a neutral stance by the bank being both unpredictable and potentially severe. the previous governor of the reserve bank, chris stals (1999) has argued that in the face of heavy speculative pressure, a contraction in domestic liquidity, higher domestic interest rates and a depreciation of the rand are unavoidable. from a practical point of view, however, it may be argued that some form of intervention should be considered, and the question that needs to be addressed concerns the extent of intervention in the money and foreign exchange markets that should be undertaken in an attempt to affect the relative magnitudes of changes in short term interest rates and the exchange rate. this will in turn depend, at least in part, on the current state of the economy, the government's macroeconomic objectives and the costs and benefits associated with the intervention policy. the extent of the intervention contemplated is also constrained to some extent by the ability of the bank to intervene. the bank may ultimately have to make a judgment call: either to reduce inflationary pressure by protecting the currency, or prevent a severe downturn in the domestic economy by means of an accommodating monetary policy. both options carry high risks, as we show below. firstly, if inflation is an overriding concern (vis-a-vis growth and employment), then the reserve bank could intervene in the spot and forward markets to protect the rand and limit the cost-raising effects of depreciation, thus shifting the burden of adjustment to short-term interest rates. the effectiveness of this intervention will, however, depend on a number of factors: spot market intervention. the ability of the bank to intervene in the spot exchange market is limited by the amount of foreign exchange it has at its disposal and any international borrowing facilities it has available. depending on these limitations and on the strength of the expectations concerning the future exchange rate, foreign fund managers and speculators may well believe that the intervention will ultimately have to be abandoned, and the speculative pressure will be maintained. forward market intervention. intervention in the forward market, while it can relieve pressure on both interest rates and the exchange rate, is limited by the state of the "official forward book". selling dollars forward in order to prevent an increase in the forward margin, as explained above, will mean that the net r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol3 (2000) no 3 410 oversold position on the reserve bank's forward book will increase. the current state of the forward book, although being reduced, is a matter of both domestic and international concern, and it will once again be believed that the intervention will ultimately have to be abandoned. intervention in the foreign exchange markets in order to limit the extent of the depreciation will, as indicated above, shift the burden of adjustment onto domestic interest rates. while higher interest rates are generally regarded as being necessary to contain inflationary pressures, they could have the perverse effect of boosting production costs and causing a once-offincrease in inflation. higher interest rates are also bound to have a greater immediate negative impact on a much broader segment of the population than an equivalent currency depreciation. with relatively high levels of household debt as well as a small business sector that is heavily reliant on borrowed capital, these two sectors would bear the brunt of the increased interest rates. secondly, the bank could use accommodation policy to limit the extent to which short-term interest rates increase. in this case the burden of adjustment would be borne mainly by the exchange rate, and the currency would depreciate by a relatively bigger margin than would otherwise be the case. the depreciation would reduce the difference between the expected and current spot exchange rates, as well as bring the forward margin into line with the difference between domestic and foreign interest rates. this policy is similar in many respects to the "hands off' position described above, but with a higher degree of depreciation. although it has been used with some success in certain foreign countries, it has been argued that the current structure of the south african economy, particularly with regard to its external sector, would make this policy very risky. the major concern surrounding a depreciating currency is the ensuing impact on domestic inflation. it can be argued that the inflationary effects of a depreciation may in any case be limited as a result of lower dollar-denominated world prices and increased global competition, restricting the ability of local producers to pass on cost increases. nonetheless, a large-scale and prolonged depreciation would surely raise the domestic prices of imported capital and intermediate goods, cutting profits among domestic producers and forcing them to retrench workers and postpone new capital investments goldstein et al. (1992) also warn that, if speculative pressures are allowed to be absorbed solely by the exchange rate, this may simply help to feed the speculation. they argue that the notion that exchange markets are inefficient in r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 411 sajems ns vol 3 (2000) no 3 the sense of being driven partly by bandwagon effects and speculative bubbles has gained increasing empirical support. a perception that the authorities are unwilling to defend the currency through interest rate adjustments could thus lead to an intensification of speculative pressure and increased volatility, as well as threatening the credibility of exchange rate management policy. 5 conclusion participation in the global economy, while accepted as a necessary condition for sustained economic growth, also exposes emerging countries to the volatility of international capital flows. these flows can disrupt financial markets and, depending on both their duration and repetition, have damaging real effects on the economy. given the predominance of short-term capital in total capital flows, south africa remains vulnerable to external shocks. asian contagion had a pronounced impact on this country in 1997 and 1998, while the year 2000 ushered in new shocks in the form of a strengthening dollar and political upheaval in neighbouring countries. following the massive losses experienced by the reserve bank during the east asian crisis, which in part limited its ability to intervene subsequently, the south african reserve bank has indicated that it has no intention of intervening in the foreign exchange markets to defend the rand against speculative attacks, especially when they are of a transitory and reversible nature. but it can be questioned whether such a "hands-off' approach would be appropriate in the case of a more sustained speculative attack. under such a ~<::enario it may become necessary for the bank to provide liquidity to the foreign exchange market, at least from time to time. while the bank is clearly unable to resist sustained attacks on the currency, the absence of support for the market could mean that the exchange rate and interest rates are set to become more volatile in future. we have argued that a sustained attack on the currency will inevitably raise both the level and the degree of volatility of both the exchange rate and short-term interest rates in the domestic economy. the attendant real costs are therefore unavoidable. whether a policy of selective intervention aimed at affecting the relative degree of change in the two critical prices can alleviate these costs is open to debate. but it will at least change the extent to which external crises impact on different sectors and groups in the economy. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 412 endnotes based in part on a paper entitled speculative attacks, exchange rates and interest rates a view of monetary and exchange rate policy presented at the biennial conference of the economic society of south africa, university of pretoria, 6-7 september, 1999. thanks are due to rudolph gouws of rand merchant bank for discussion on this point. references botha, d.h. (1999) "emerging markets, short term capital movements and international regulation (review article)", south african journal of economics vol 67(2) : 226-56. 2 citadel (2000) "market review: s & p investment upgrade", available: i1ttp;llwww.ciradel.co.zaimarketsiinvestment.asp (25 february 2000). 3 crefsa (1998) "capital flows and macroeconomic policy in south africa", quarterly review, /998(1), centre for research into economics and finance in south africa, london school of economics. 4 goldstein, m.; isard, p.; masson, p.r. and taylor, m.p. (1992) "policy issues in the evolving monetary system", occasional paper no 96, international monetary fund, washington dc, june 1992. 5 south africa foundation (saf) (1998) "global financial turmoil & the south african economy", occasional paper no 4198. 6 st als, c.l. (1999) "the challenges to monetary policy in increasingly volatile international markets", paper presented at a conference on the south african economy in a world (\f volatile financial markets, johannesburg, 25 may 1999. 7 stuart, ra and black, pa (1999) "speculative attacks, exchange rates and interest rates a view of monetary and exchange rate policy", paper presented at the biennial conference of the economic society of south africa. university of pretoria. 6-7 september, 1999. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction life cycle versus balanced funds research method empirical results discussion conclusion acknowledgements references about the author(s) elbie louw department of financial management, university of pretoria, south africa cornelis h. van schalkwyk department of financial management, university of pretoria, south africa michelle reyers department of financial management, university of pretoria, south africa citation louw, e., van schalkwyk, c.h. & reyers, m., 2017, ‘life cycle versus balanced funds: an emerging market perspective’, south african journal of economic and management sciences 20(1), a1695. https://doi.org/10.4102/sajems.v20i1.1695 original research life cycle versus balanced funds: an emerging market perspective elbie louw, cornelis h. van schalkwyk, michelle reyers received: 14 nov. 2016; accepted: 26 apr. 2017; published: 25 aug. 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: inadequate retirement savings is an international challenge. additionally, individuals are not cognisant of how asset allocation choices ultimately impact retirement savings. life cycle and balanced funds are popular asset allocation strategies to save towards retirement. however, recent research is questioning the efficacy of life cycle funds that switch to lower risk asset classes as retirement approaches. aim: the purpose of this study is to compare the performance of life cycle funds with balanced funds to determine whether either dominates the other. the study compares balanced and life cycle funds with similar starting asset allocations as well as those where the starting asset allocations differ. setting: the study has a south african focus and constructs funds using historical data for the main local asset classes; that is, equity, fixed income and cash, as well as a proxy for foreign equity covering the period 1986–2013. method: the study makes use of monte carlo simulations and bootstrap with replacement, and compares the simulated outcomes using stochastic dominance as decision-making criteria. results: the results indicate that life cycle funds fail to dominate balanced funds by first-order or almost stochastic dominance when funds have a similar starting asset allocation. it is noteworthy that there are instances where the opposite is true, that is, balanced funds dominate life cycle funds. these results highlight that while the life cycle funds provide more downside protection, they significantly supress the upside potential compared to balanced funds. when the starting asset allocations of the balanced and life cycle funds differ, the stochastic dominance results are inconsistent as to the efficacy of the life cycle fund strategies considered. conclusion: the study shows that whether one fund is likely to dominate the other is strongly dependent on the underlying asset allocation strategies of the funds. additionally, the length of the glide path and the risk and return characteristics of the investable universe are also likely to influence the findings. introduction the potential inadequacy of accumulated retirement wealth is a global dilemma. the national institute on retirement savings (2013) estimates that, should one consider formal retirement savings of households only, 92% of american households will fall short of their retirement targets while the department for work and pensions (2012) estimates that 38% of the united kingdom’s workforce will not be adequately prepared for retirement. despite 5 143 retirement funds registered in south africa which covers approximately 16 million members in 2015, it is estimated that only 6% to 10% of south africans are saving sufficiently for retirement (financial services board 2015a; jones 2011; old mutual in kemp 2005). similar to other countries, the retirement funds in south africa are predominantly defined contribution pension funds, which have significant implications for members who must participate in the investment decision-making process and who ultimately end up bearing the investment risks related to these decisions (financial services board 2015a, 2015b; levitan and merton 2015). in a defined contribution retirement fund, the retirement benefit received by a participant upon retirement is not guaranteed and depends on the performance of financial markets. the individual bears the investment risk of the fund, and the plan often shifts a significant number of decisions such as the asset mix as well as how much to invest from the plan sponsor to the participant as is the case in a member-directed plan (thaler and benartzi 2007). in contrast, a defined benefit retirement fund refers to a fund for which the retirement benefit received by an individual upon retirement is guaranteed, irrespective of how financial markets perform, and determined by a formula which usually considers an individual’s ending salary and years of service (bodie, marcus & merton 1988). as this study focuses on asset allocation strategies, it is only applicable to defined contribution plans. in terms of the allowable range of asset mixes, regulation 28 of the pension funds act dictates maximum exposures that a south african retirement fund may have to particular investable asset classes and, in certain instances, the acceptable selections within a particular asset class (national treasury of south africa 2011). importantly, the higher return, higher risk equity asset class is restricted to a maximum of 75% of the overall asset allocation with the allocation to foreign asset classes limited to 25% (national treasury of south africa 2011). however, within the limits provided by regulation 28 there are a wide variety of different asset mixes and asset allocation strategies, which members of defined contribution plans need to choose between which impact on their accumulated retirement wealth. many individuals are not cognisant of how the asset allocation of their chosen retirement savings vehicle and the consequential risk and return characteristics can influence the likelihood of reaching an accumulated retirement wealth target to sustain their post-retirement years or how different asset allocation strategies compare to one another. the importance of the asset allocation choice is further highlighted by brinson, hood and beebower (1986) in that 93.6% of the variation of portfolio performance over time can be explained by the asset allocation. to help participants of defined contribution funds with some of the choices they have to make, plan sponsors often offer default options within the retirement fund to add some assistance to individuals with regard to appropriate investment choices (levitan and merton 2015). to this end, much research, using us data, has been devoted to comparing life cycle and balanced funds to determine, which approach provides a superior outcome (basu, byrne & drew 2011; estrada 2014; lewis 2008a, 2008b, 2008c; spitzer and singh 2011). there has been limited research regarding retirement savings decisions in south africa and research that has been carried out has focused on understanding retirement adequacy goals and behavioural influences on retirement savings decisions (reyers et al. 2015; van zyl and van zyl 2016). only a limited number of studies have considered asset allocation strategies in a south african context with the focus varying from evaluating the impact of including foreign investments, comparing post-retirement investment choices, a comparison of default choices offered by retirement funds and the impact on portfolio optimisation based on an efficient frontier (de villiers-strydom and krige 2014; levitan and merton 2015; mjebeza 2016; van heerden and koegelenberg 2013). although valuable, none of these studies address the life cycle versus balanced fund question or apply the decision-making criteria stochastic dominance (sd). the objective of this study is to make use of the sd decision-making criteria to provide additional insights into the debate concerning life cycle versus balanced funds. in addition, the study adds to the literature by providing a developing world perspective by using south african data. life cycle versus balanced funds while balanced or target risk funds maintain a constant asset allocation strategy throughout the investment horizon, basu et al. (2011) describe life cycle or target date funds as funds where the assets are moved from higher risk to lower risk asset classes as the individual advances towards retirement in an attempt to preserve retirement ending wealth and offer downside protection (also see branch and qiu 2011; lewis 2008b, 2008c; spitzer and singh 2011). both mutual funds with a life cycle structure and pension fund life cycle funds have, therefore, become popular in the retirement fund offering because the individual does not have to make the asset allocation and switching decisions (with the intent to preserve capital) as the fund does so automatically – his or her only decision is choosing the appropriate life cycle fund given his or her expected retirement date (basu and drew 2009; basu et al. 2011; estrada 2014; lewis 2008a, 2008b, 2008c; spitzer and singh 2008, 2011). much of the body of knowledge is devoted to consider how different balanced fund asset allocation strategies and life cycle fund asset allocation strategies fair as well as to critically compare the efficacy of traditional life cycle versus balanced funds. importantly, estrada (2014) highlights that the debates on the most optimal asset allocation strategy may be nestled in how risk is defined. some may view a low-risk fund as a stable investment with little adverse shocks while an alternative view may be that a low-risk fund is the fund, which provides the highest mean accumulated ending wealth (lewis 2008c; shiller 2006). should ‘risk’ be interpreted as a greater range exhibited by the outcomes, the balanced funds would be a riskier choice. research specifically related to life cycle funds carried out by lewis (2008b) focuses on the replacement ratio that can be achieved by different life cycle strategies namely a conservative, moderate and aggressive strategy and includes the interquartile range as an indication of the risk of each strategy. the median replacement ratio for each strategy is 0.38, 0.36 and 0.33, respectively; however, the interquartile range of the replacement ratio for each portfolio offers valuable insights. for the aggressive portfolio, the range is 0.30 to 0.52, for the moderate portfolio 0.29 to 0.46 and for the conservative portfolio 0.27 to 0.41. the results highlight the issue of how an individual views retirement wealth risk; if shortfall risk during retirement is perceived as being a greater risk, more aggressive strategies with higher allocations to equity might be preferable where the shortfall refers to accumulating less wealth than what was required at retirement. in lewis (2008a), the focus shifts to shortfall risk in determining the efficacy of life cycle fund strategies. he acknowledges that the intent of life cycle funds is to lower the likelihood of potential losses by decreasing the allocation to risky assets as retirement approaches. the three life cycle funds modelled exhibit a 34.7% (aggressive), 43.8% (moderate) and 58.6% (conservative) probability of shortfall for an income replacement ratio of 0 to 0.5. hence an individual who invests in the aggressive portfolio and pursues an income replacement ratio of 0.5 has a 34.7% probability of shortfall. based on this approach, a higher allocation to low-risk asset classes may not be optimal despite the lower short-term volatility of the portfolio. the research of schleef and eisinger (2007) compares different life cycle and balanced fund strategies and the chances of meeting a retirement target. the researchers conclude that strategies weighted towards equities still have a better chance of achieving the retirement target and that for all the simulated portfolios (life cycle and balance funds) there is more than a 50% chance of failing to meet the retirement target. balanced funds with an asset allocation to equities of 70% or more are superior to all other portfolios, including an aggressive life cycle portfolio, in achieving the retirement target; the 100% equity portfolio has only a 39% chance of not meeting the target (schleef and eisinger 2007). byrne et al. (2006) follow suit by comparing how a balanced fund (60% equity, 40% bonds) and a life cycle fund (100% equity minus the individual’s age over the investment horizon) impact accumulated retirement ending wealth. the life cycle fund offers a higher mean replacement ratio irrespective of the investment horizon. in contrast, the results of spitzer and singh (2011) indicated that neither of the life cycle portfolios modelled outperformed a balanced portfolio with an allocation to equities of equal to or greater than 80%, and all the models exhibited right-skewness (the mean exceeding the median) similar to the findings of pfau (2010). importantly, spitzer and singh (2011) focus on achieving the highest mean ending wealth and do not consider the range of possible outcomes or the risk exhibited by each strategy. the studies highlight that the beginning and ending equity allocations over the investment horizon along with how aggressive the glide path is, are important factors which determine the success of a life cycle strategy. a valuable conclusion drawn by basu and drew (2009) is that life cycle strategies that commence with a glide path early in the investment horizon are better at protecting downside risk. there also seems to be a diminishing risk reduction benefit for life cycle strategies that defer switching to more conservative asset classes. lewis (2008c) also compared balanced funds with life cycle funds [similar to spitzer and singh (2011)] using similar life cycle strategies as in his previous research. focusing on the proportion of final salary that could be obtained from the accumulated retirement wealth, the aggressive portfolio exhibits the highest standard deviation and widest range of proportion of final salary with the conservative portfolio exhibiting the lowest risk (standard deviation and range). lewis (2008c) subsequently infers the average asset allocation to equity within each life cycle portfolio and simulates three comparable balanced funds. the results reveal the following: the average percentage of retirement salary which could be achieved by each of the resulting three portfolios is consistently higher for the balanced funds (lewis 2008c). furthermore, the kurtosis of the life cycle funds is consistently slightly higher than that of the comparable balanced funds (lewis 2008c). pfau (2010) also makes a strong case in support of life cycle funds by focusing on the risk-return trade-off between more aggressive balanced funds and the protection offered by life cycle funds. his research introduces a utility function that captures the risk aversion of the individual and how this may alter one’s interpretation of which strategy is optimal. without considering investor utility, the life cycle strategies modelled by pfau (2010) slightly underperform the balanced fund strategies with a similar average equity exposure. basu et al. (2011) introduced an innovative alternative to the traditional life cycle fund; the dynamic approach proposed considers the retirement target and the asset class returns achieved to date and only switches to lower risk asset classes on the condition that the retirement target may realistically be achieved based on the accumulated wealth at every stage of switching, therefore, considering the impact of past market performance and future return expectations. basu et al. (2011) contend that although the traditional life cycle strategy may be appropriate to protect the downside risk of the portfolio closer to retirement, it may fail to realise the retirement wealth target. the results of basu et al. (2011) indicate that the dynamic life cycle strategies seem superior to traditional life cycle funds, irrespective of how long the glide path is. it also offers better downside protection and mean accumulated wealth compared with a balanced fund. likewise, the higher the allocation to equities in a balanced fund, the better the mean wealth accumulation. the riskiness of the strategy as measured by range, distribution and standard deviation increases with the equity allocation. the literature presents life cycle funds that start and end with varying exposures to equity and diverse periods over which the glide path is implemented. these factors make it difficult to generalise about the performance of these funds. however, the majority of literature indicates that, generally, a balanced fund with an average asset allocation over the investment horizon, which is similar to that of a life cycle counterpart, offers a higher mean retirement accumulation and wider range, distribution and standard deviation (lewis 2008c). this general finding has been challenged by pang and warshawsky (2011), who acknowledged that balanced funds exhibited a wider range, distribution and standard deviation but indicated that, in their research, the mean accumulated ending wealth for balanced and life cycle funds was quite similar. research method life cycle and balanced fund models four balanced funds (bf) and life cycle funds (lc) each are considered. the four balanced funds (bf1 to bf4) each have a unique asset allocation strategy as detailed in table 1. in the case of the life cycle funds, two contrasting starting asset allocations are considered (lc1 vs. lc2), as well as different glide paths over 10 and 5 years, respectively (contrast lc1 (10) with lc1 (5)). in all instances, the funds modelled comply with the requirements of regulation 28 of the pension fund act. the asset allocations and glide paths (where applicable) for all funds modelled are shown in table 1. table 1: balanced and life cycle funds modelled. in comparing traditional lc funds with bf, the research considers a south african resident that saves for retirement from age 25 to 65 (a 40-year investment horizon) and earns a starting salary of r673 101 (south african rand). the individual’s salary annually increases at a rate of inflation of 4.5%. throughout the pre-retirement investment horizon, the individual contributes 15% of the annual salary to a retirement fund while the contributions are made at the end of each month. this implies that the individual makes 480 monthly contributions. furthermore, the individual is assumed to be in the workforce for the full 40-year investment horizon. all the funds modelled are rebalanced annually similar to other studies (basu and drew 2009; lewis 2008c; pfau 2011; schleef and eisinger 2007; spitzer and singh 2011) either to the original static asset allocation in the case of bf or, in the case of lc funds, the static asset allocation in the earlier years and then, during the glide path, in the manner necessary to ensure a linear reduction in the higher risk asset classes over the glide path period at the beginning of the year that it applies to. simulating accumulated retirement ending wealth values to simulate the accumulated retirement ending wealth values, the study uses sas statistical software to programme each model based on the general and model-specific assumptions highlighted in the previous section. by means of monte carlo simulation and bootstrap with replacement, the simulation trial of each model is iterated 10 000 times resulting in 10 000 nominal accumulated retirement ending wealth values for each model. secondary historical financial market data from reputable data providers and peer-reviewed research studies are used for the simulations. monte carlo simulation is favoured for the analysis because of the intrinsic statistical independence it exhibits when compared to other estimation models (ervin, faulk & smolira 2009).with regard to bootstrapping with replacement, the method follows a random draw with replacement from the empirical distribution of asset class returns. the historical monthly return data for every asset class are randomly resampled with replacement to create asset class return vectors for each period (i.e. each month). because the resampling is done with replacement, a particular data point from the original data set can appear multiple times in a given bootstrap sample (basu et al. 2011). the bootstrapping results in vectors of asset class returns from the same time period, which maintains the correlation between the different asset class returns (branch and qiu 2011). it is assumed that the returns of individual asset classes are independently distributed over time (basu and drew 2009). historical data the study uses monthly data from the period january 1986 to december 2013, that is, 336 historical monthly data points for each asset class. from january 1986 to december 2000, the local asset class data were provided by staunton (2013) as per firer and mcleod (1999) and firer and staunton (2002). data from 2001 to 2013 were constructed by applying the return calculation method used by firer and staunton (2002) and using the alexander forbes short-term fixed interest index (stefi) for the money market asset class, ftse/jse all bond index (albi) for the fixed income asset class and ftse/jse all share index (alsi) for the equity asset class. the firer and staunton (2002) database does not include a foreign equity asset class and so the msci world index is used as a proxy for the foreign equity asset class from january 1986 to december 2013. the total return descriptive statistics for each asset class are shown in table 2. it is acknowledged that historical data are not necessarily reflective of future expected returns and that the data period and data set used may influence the results. table 2: descriptive statistics of nominal total monthly returns of local and foreign asset classes (1986–2013). stochastic dominance decision-making criteria similar to basu et al. (2011), the study uses the cumulative distribution function of the accumulated retirement ending wealth and the principle of sd to compare lc and bf. sd is the most general approach to decision-making under uncertain circumstances (levy 2009). additionally, sd can be employed irrespective of whether the distributions of the choices under consideration are normally distributed or not (basu et al. 2011; levy 2009). first-degree stochastic dominance (fsd) assumes that the utility function of the decision-maker u(x) increases with x, u’(x)>0. therefore, the decision-maker prefers more of x rather than less (graves and ringuest 2009), with x being the metric that the decision is related to whether return or wealth. assuming two portfolios, namely a and b, an individual would prefer portfolio a over b under fsd if: for all values of x. with: fb(x) = cumulative probability distribution of b fa(x) = cumulative probability distribution of a this implies that a will dominate b if the cumulative probability distribution of b is always below or to the right of that of a (graves and ringuest 2009). almost stochastic dominance (asd) relaxes this strict assumption because it does not require that the cumulative probability distribution of b always must be below that of a to dominate by asd. however, the relaxation of this assumption is conditional: the area of violation (i.e. the area where the cumulative probability distribution of b is above that of a) must be very small compared with the total area of the two distributions (basu et al. 2011; levy 2009, 2012). the sd decision-making criteria consider both risk and potential outcomes with the cumulative distribution function. additionally, if the cumulative distribution function of a model is steeper relative to another, the strategy is generally considered to result in less volatile outcomes (basu et al. 2011). where there is no clear indication of fsd for one model against the other, the study applies a similar conservative rule that if ε, the area of violation, is between 0 and 0.01, one can accept dominance by asd. this implies that one of three outcomes is possible: a may dominate b, neither a nor b may dominate, or b may dominate a by asd. empirical results the distribution functions of all the model simulated outcomes are positively skewed (i.e. exhibit right-skewness) with means higher than the median and skewness values above 0. all the models exhibit leptokurtic distributions as the kurtosis values are positive. funds with similar starting asset allocations to consider the potential sd of life cycle funds versus balanced funds with similar starting asset allocations, the ε values of models lc1(10) and lc1(5) versus model bf3 as well as models lc2(10) and lc2(5) versus model bf4 were determined. the comparative cumulative distribution functions (log scale, with a base of 10) are shown in figures 1 and 2 with the asd results shown in table 3. figure 1: cumulative distribution functions of accumulated retirement ending wealth for models lc1(10) and lc1(5) against model bf3. figure 2: cumulative distribution functions of accumulated retirement ending wealth for models lc2(10) and lc2(5) against model bf4. table 3: asd results of life cycle funds against balanced funds – similar starting asset allocation. in figure 1, the cumulative distribution functions of model lc1(10) and lc1(5) cross that of model bf3, violating the strict fsd principles. the cumulative distribution functions of lc1(10) cross bf3 at an accumulated ending wealth value of approximately r113.7 million. to the left of r113.7 million, the cumulative distribution function of lc1(10) is below or to the right of bf3, therefore for an accumulated retirement ending wealth value below r113.7 million, an individual should prefer lc1(10) as this model is likely to achieve a higher accumulated retirement ending wealth for each cumulative probability versus bf3. however, an individual with a retirement target of more than r113.7 million should prefer bf3 as, in these instances the cumulative distribution function of bf3 is below or to the right of lc1(10). however, because the area enclosed by the cumulative distribution functions which is to the right of r113.7 is much larger than the area enclosed to the left, the cumulative distribution functions indicate that bf3 is more likely to dominate lc1(10) by asd if the ε value is between 0 and 0.01. also in figure 1, the cumulative distribution functions of lc1(5) cross bf3 at an accumulated ending wealth value of approximately r111.9 million. to the left of r111.9 million, the cumulative distribution function of lc1(5) is below or to the right of bf3, therefore for an accumulated retirement ending wealth value below r111.9 million, an individual should prefer lc1(5) as this model is likely to achieve a higher accumulated retirement ending wealth for each cumulative probability versus bf3. however, an individual with a retirement target of more than r111.9 million should prefer bf3 as, in these instances the cumulative distribution function of bf3 is below or to the right of lc1(5). however, because the area enclosed by the cumulative distribution functions which is to the right of r111.9 million is much larger than the area enclosed to the left, the cumulative distribution functions indicate that bf3 is more likely to dominate lc1(5) by asd if the ε value is between 0 and 0.01. similarly, in figure 2, the cumulative distribution functions of the life cycle models, lc2(10) and lc2(5), cross that of the balanced fund model bf4, also violating the strict fsd principles. similar to the case with lc1(10) and lc1(5) versus bf3, there is only a small area where lc2(10) and lc2(5), respectively, versus bf4 seems optimal which suggest that the life cycle funds are unlikely to dominate the balanced fund by asd. table 3 shows the ε values for models lc1(10), lc1(5), lc2(10) and lc2(5) against the applicable balanced fund models (bf3 and bf4, respectively). in all instances, the ε values to test for asd of the lc funds against the bf are much higher than the threshold value of 0.01, that is, in no instances the lc funds dominate the bf. as this is the case, the table also indicates the instances where the balanced funds dominate the life cycle funds by fsd or asd with the symbol ‘§’ (bf3 dominates both lc1(10) and lc1(5) by asd and bf4 dominates lc2(5)). the test for dominance of the bf over the lc funds requires a comparison of the inverse ε values shown in the table to the threshold value of 0.01. as rounding could affect the outcome of test for dominance of the balance funds over the lc funds, it was deemed prudent to, similarly to basu et al. (2011), round all ε values to four decimal places. a further analysis of the result shows that the long glide path of lc1(10) and lc2(10) is an important factor in the inability of the life cycle fund models to dominate the balanced fund models. although the longer glide path provides greater downside risk protection, the upside potential is, however, significantly limited. the results indicate that the longer the glide path, the lower the area of sd violation relative to non-violation, all other factors held constant. another matter to consider is the impact of the risk and return characteristics of the asset classes invested on the possibility of whether a lc fund is likely to dominate a balanced fund with similar starting asset allocation by fsd or asd as the volatility of the asset classes will influence the range of potential accumulated retirement ending wealth values. funds with dissimilar starting asset allocations to consider the potential sd of life cycle funds versus balanced funds with dissimilar starting asset allocations, life cycle fund models lc1(10) and lc1(5) are compared against balanced fund models bf1, bf2 and bf4, respectively and life cycle fund models lc2(10) and lc2(5) are compared against bf1, bf2 and bf3, respectively. the comparative cumulative distribution functions are shown in figures 3 and 4 with the asd results shown in table 4. figure 3: cumulative distribution functions of accumulated retirement ending wealth for models lc1(10) and lc1(5) against models bf1, bf2 and bf4. figure 4: cumulative distribution functions of accumulated retirement ending wealth for models lc2(10) and lc2(5) against models bf1, bf2 and bf3. table 4: asd results of life cycle funds against balanced funds – dissimilar starting asset allocation. in figure 3, the cumulative distribution functions of life cycle fund models lc1(10) and lc1(5) are compared against balanced fund models bf1, bf2 and bf4 while figure 4 shows the cumulative distribution functions of life cycle fund models lc2(10) and lc2(5) compared against balanced fund models bf1, bf2 and bf3 with the fsd and asd results presented in table 4. table 4 shows the ε values to test for dominance of the lc funds over the bf. the table also indicates the instances where bf dominate lc funds by fsd or asd with the symbol ‘¶’. models lc1(10) and lc1(5) successfully dominate all the balanced fund models which have a dissimilar starting asset allocation (bf1, bf2 and bf4). for life cycle fund model lc1(5) against models bf2 and bf4 there is no sd violation area, resulting in model lc1(5) and lc1(10) dominating models bf2 and bf4 by fsd. this indicates that the lower risk and return characteristics of the bf significantly change the cumulative distribution functions of the bf to such an extent that the particular lc fund successfully dominates the bf by asd. life cycle fund model lc2(10) does not dominate any of the balanced fund models by fsd or asd (bf1, bf2 and bf3). rather, there are instances where the opposite is true, namely a balanced fund dominating the life cycle fund by fsd or asd (bf3 dominating lc2(10)). as the asd results indicate, life cycle fund model lc2(5) also fails to dominate any of the bf by fsd or asd. similarly, there is an instance where a balanced fund (bf3) dominates life cycle fund model lc2(5). the results indicate that the nature of the different starting asset allocations of a lc fund compared with a balanced fund is an important characteristic, which influences whether a particular fund could dominate the other by fsd or asd. additionally, the risk and return characteristics of the asset classes invested in play an important role in whether a particular fund is likely to dominate another as it influences the range of potential accumulated retirement ending wealth values. discussion dominance of life cycle funds over balanced funds: similar starting asset allocations irrespective of the glide path, the lc funds fail to dominate their balanced fund counterparts. had basu et al. (2011) also considered this case, it would have been valuable to compare their results with that of this study. however, the focus was on comparing the dynamic lc fund strategy with the traditional lc and balanced fund strategies and not the latter two with each other. in all instances, the cumulative distribution functions of the lc funds are, for the most part, above or to the left of the bf and the ε values fail to be below the threshold value of 0.01. importantly, there are some instances where the opposite is true, namely the bf dominate the lc funds by fsd or asd. although the studies of lewis (2008a, 2008b, 2008c); spitzer and singh (2011); as well as estrada (2014) use different methods, they all conclude that the bf lead to superior results versus the lc funds. based on the fsd and asd criteria, lc funds do not dominate bf with more persistent higher equity allocations based on the dominance decision-making criteria. yet, this does not consider the unique characteristics that people may have such as a particular retirement target, which may change the individual preference of one fund over the other. where a retirement target rather than asd is considered, the individual would not be concerned with the entire cumulative distribution function but only with the cumulative distribution function below the retirement target which could change which model or fund would be appropriate for the individual. when comparing lc funds with bf that have similar starting asset allocations, it is likely that because of the lower risk characteristics of lc funds, the lc fund could be appropriate for an individual if they have a very low retirement target. however, if the retirement target becomes quite high and meeting the target is more important than the overall risk of the fund chosen, a balanced fund could be chosen. however, important is the fact that reaching the retirement target becomes the primary driving force. however, the asd decision-making criteria, which consider the total cumulative distribution function and not a retirement target, are conclusive that when comparing bf and lc funds with a similar starting asset allocation, the lc funds fail to dominate the bf. there are some instances where the balanced fund dominates the lc fund though, and in these instances, most individuals would prefer the balanced fund over the lc fund. similar studies regarding the lc versus balanced fund question consider predominantly lc funds that start with a 100% equity allocation, which does not provide comparative results to this study. it is important to acknowledge that the risk and return characteristics of the asset classes invested in play an important role in whether a balanced fund or lc fund is likely to dominate the other. similar to basu et al. (2011), equities have the highest standard deviation and range of historical returns, followed by fixed income and the money market. in this study, the impact of including some exposure to the lower risk and return foreign equity asset class instead of a greater allocation to local equities (which have a higher risk and return than foreign equities) influenced the results. hence, the results are very sensitive not only to the asset classes invested in but also to the historical data used, what the assumed local asset classes are and the risk and return characteristics of the asset classes used in the study. additionally, the simulations for each balanced fund exhibit much lower and higher accumulated retirement ending wealth values compared to the lc funds, resulting in a much wider range of potential outcomes compared to other studies (see basu et al. 2011; estrada 2014; spitzer and singh 2011). dominance of life cycle funds over balanced funds: dissimilar starting asset allocations the findings indicate that a generalisation regarding dominance of bf and lc funds with dissimilar asset allocation strategies is not possible and mirrors the findings of spitzer and singh (2011). in this study, however, life cycle fund models lc1(10) and lc1(5), which have no foreign equity exposure, dominate by asd or fsd in most instances, while life cycle fund models lc2(10) and lc2(5), which have some foreign equity exposure, in all instances fail to dominate the bf. the findings seem to indicate that the results are very sensitive to the following characteristics of the models: starting asset allocation, length of the lc glide path and risk and return characteristics of asset classes. as to the starting asset allocation, all other factors held constant, the greater the exposure of a lc fund to the higher risk and return equity asset classes compared with the balanced fund, the more likely the lc fund could dominate by fsd or asd. generalisations with regard to the impact of the glide path are not meaningful as the results are mixed. lastly, the risk and return characteristics of the asset classes invested in play an important role in whether a balanced fund or lc fund is likely to dominate the other. in this study, the impact of including some exposure to the lower risk and return foreign equity asset class instead of a greater allocation to local equities (which have higher risk and return than foreign equities) influenced the results; although it can be argued that inclusion of foreign equity adds diversification benefits as mjebeza (2016) suggests, this study showed that the inclusion thereof did not create a more favourable accumulated retirement ending wealth distribution for the applicable models compared to those funds that excluded the foreign equity asset class. impact of the glide path a glide path for a lc fund seems to play a significant role in the inability of lc funds to dominate the bf when they have similar starting asset allocations similar to the findings of basu et al. (2011). the longer the glide path, the greater the downside risk protection provided by a lc fund. however, because of the cumulative nature of the accumulated retirement ending wealth problem, the upside potential is significantly capped, which has a noticeable impact, especially for the longer investment horizons. risk and return characteristics of asset classes the risk and return characteristics of the asset classes invested in play an important role in whether a balanced fund or lc fund is likely to dominate the other. while the balanced fund represented by balanced fund model bf4, which has a foreign equity allocation, could not dominate the lc fund models with a similar starting asset allocation by fsd or asd, this was not the case for the life cycle versus balanced pairs that had no allocation to foreign equity and similar starting asset allocations. the impact of the asset class characteristics was even more obvious with regard to the findings pertaining to lc and bf with dissimilar starting asset allocations where the extent of foreign equity exposure in the models had a significant impact on whether a lc fund could dominate the other by fsd or asd. none of the current works of literature demonstrate this finding as it only considers us asset classes (basu et al. 2011; pfau 2010; spitzer and singh 2011). this finding also indicates that sd results for comparative studies regarding lc funds as opposed to bf are most likely to yield very different results depending on the historical data used, what the assumed local asset classes are and the risk and return characteristics of those asset classes. conclusion saving for retirement is a south african and global challenge; however, research in south africa on the impact of asset class decisions is limited. in addition, a research contribution that focuses on how to protect retirement funds while facilitating sufficient accumulated retirement ending wealth is valued by the industry and individuals alike. the study shows how the risk-reducing attributes of lc strategies impact the accumulated retirement ending wealth compared with balanced funds and which choice would be appropriate for most individuals. because lc funds are a fast-growing portion of the retirement fund market and becoming more popular as default options in retirement funds, this study contributes by statistically contrasting lc funds with balanced funds and by showing that the choice of which fund is optimal is driven by the different characteristics of the funds such as investment horizon, starting and ending asset allocations as well as the length of the glide path. retirement fund trustees, investment committees and sponsors must take great care regarding the default funds (life cycle and balanced) that are offered to individuals and, while considering that some individuals may have very specific needs, be careful not to create default options that are sub-optimal. in this study, life cycle funds were shown, in many instances, to fail to represent a better choice for most individuals. additionally, investor education on the characteristics of different investment choices as well as the implications on accumulated retirement ending wealth will be beneficial in facilitating individual decision-making. further research in this area that model dynamic life cycle strategies and use expected returns will be valuable. acknowledgements the authors would like to thank mr sollie millard from the department of statistics, university of pretoria, south africa. competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions e.l. was responsible for the analysis and results. all three authors contributed to the literature review and the interpretation of the results. references basu, a.k., byrne, a. & drew, m.e., 2011, ‘dynamic lifecycle strategies for target date retirement funds’, 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asset allocation strategies for south african pension funds’, studies in economics and econometrics 37, 29–54. van zyl, n. & van zyl, d., 2016, ‘the impact of behavioural economics and finance on retirement provision’, south african actuarial journal 16, 91–125. https://doi.org/10.4314/saaj.v16i1.4 212 sajems ns vol 3 (2000) no 2 the labour supply conditions for the transformation of peasant agriculture in africa: lessons from a malawian experience pacharo h simukonda department of public and development administration, university of venda for science and technology abstraci' in implementing rural development projects, african states expect that the otherwise poor peasantry would respond positively by maximising use of the productivity-enhancing technologies available to them, in order to improve their income status. the basic requirement is that the producer must supply significantly higher levels of productive labour-time, mainly from subsistence production and other traditional activities. the malawi experience suggests that this process revolves around the critical role of both the physical and psychological dimensions of labour-time application. therefore, the transformation of peasant commodity-surplus producers is unlikely to be effectively achieved, unless attainable commodity income is sufficient to at least support both customary production and subjectively defined socio-economic goals. jel013 introduction labour is an essential factor of production, whether perceived in a quantitative or qualitative sense. this paper attempts to show that in peasant agricultural production, labour supply is a critical issue in achieving a commodity surplus level. to the peasant household, surplus-level production is obviously necessary, as it is in this way that the household can attain the cash income it would need to improve its socio-economic status above meeting subsistence requirements. at the outset, two questions may be asked: how can the desired commodity surplus be achieved, and why is it that the peasantry is often not able to achieve it? r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 213 generally, it can be argued that peasants face a host of constraints, of an environmental, technical and economic nature, that together limit their ability to achieve a level of production which could improve their physical and economic status. but the authorities often perceive an additional production constraint. this is contained in the traditional set-up, which limits the development of perceptions of rational production behaviour towards higher surplus production. thus, african states have implemented rural development projects with the aim of breaking the vicious circle of low production and low income among the peasantry. these projects have focused on three major elements of the transformation of peasant agriculture: improvement of knowledge of production, improvement of access to higher yielding agricultural inputs, and improvement of production behaviour. the last implies that if the needs of commodity production are to be effectively met, there must be a significant change in the structure and level of supply of productive labour-time, away from the traditional pattern of life and production. this is the focus of analysis in this paper. the point of departure for the transformation of the peasantry into commoditysurplus producers is the idea that both the state and the producers must meet on a common ground. the state on its part, must provide the range of production facilities that would help to effectively remove the technical constraints the peasants face in achieving the desired production levels. the peasantry, on their part, must be able to perceive the benefits of maximising the available inputs to achieve the desired level of production. this consists of supplying the required quantity and quality of labour. what remains, therefore, is the significance of the specific dynamics of interaction of the two situations, as they occur in a specific context of production, shown in the form of particular producer responses. in analysing the dynamics of these processes in the context of a malawian project, the paper seeks to demonstrate how, in practice, the potential benefits of the project are unlikely to be maximised by both parties the peasant producer and the state. this is simply because as the state is often more likely to pass a greater part of an increase in the cost of production onto the producer, the latter is likely to respond by withdrawing from production. the paper attempts to show both how the context of peasant production decisions have been defined and how producers have exercised their relative production freedom in commodity production. ~sofruraldevelopmentprogrammes for a newly independent country in africa, rural development has been considered the most realistic and feasible basis for simultaneously effecting the desired rapid rate of national economic progress and the most immediate r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 214 sajems ns vol 3 (2000) no 2 improvement in rural socio-economic welfare. it is simple to understand this. for most of these poor and not yet industrialised countries, agriculture is the natural economic activity of the mainly rural-based, subsistence population. furthermore, improvement in peasant agriculture is probably much less demanding of the national financial and human resources than is the case with industrialisation efforts. this means, therefore, that during the initial stages of an economic development endeavour, much of the national production would have to come from the efforts of the rural subsistence population. malawi exemplifies this situation very well. at independence in 1964, the government was faced with the stark reality of having to rely not only on agriculture generally, but particularly on peasant agriculture. the country did not have known mineral development potential, and the share of private commercial agriculture had shrunk from 16 per cent of the total land area in 1900 to just below 3 per cent (pachai, 1978, quoted in simukonda, 1986: 54, 55), while about 95 per cent of the population was still rural, subsistence-based, and contributing significantly both to the marketed output and export earnings. agricultural products contributed over 90 per cent to such production (mg, economic report: 1964 to 1971). nevertheless, there were significant constraints faced by peasant agriculture, but which. inter alia, implied that it had significant potential for improvement. within the above context, government immediately embarked on a conscious policy of developing peasant agriculture, by providing more agricultural extension services and reorganising production. this was done in the context of rural development projects (rdps) and specific crop schemes. the latter were administered either separately or as part of the rdps. although general agricultural extension services had been provided since the colonial period, particularly since the 1940s, the concept of an area-bound development scheme involving intensified agricultural services was adopted in 1966. but this soon (1967) came to be (partly) replaced by a programme of integrated rural development projects (irdps). there were four regional projects under the latter concept, implemented between 1968 and 197i. this approach had the advantage of both covering a much larger geographic area and involving development of basic infrastructure related to comprehensive regional development. nevertheless, the four projects were still limited in relation to the national peasant population. accordingly, in 1977, government decided to extend the benefits of their relative success to the rest of the rural population, this time under the concept of the national rural development programme (nrdp). the nrdp concept involved reorganising two or more integrated rural development projects under an agricultural development division (mg, 1978: 29). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 215 official perceptions about the production behaviour of peasants by its "rural development approach" the malawi government apparently viewed mete intensity of agricultural extension as providing an insufficient basis for effecting the desired improvement in peasant production. it also saw a change in peasant production behaviour as necessary for achieving the desired improvement in production. such change would facilitate rational provision by the state of a host of necessary agricultural services. as the government also considered its intervention in peasant agriculture a form of primary development investment. a production franiework that ensured peasant producers' compliance with official goals would provide a better basis for ensuring that such investment in the technical, financial and material aspects of production achieved the desired maximum results. such a framework centred round the basic idea that along with improving the technical aspects of production, producers needed to be effectively controlled with respect to their production behaviour. implementation of integrated rurai development projects (lrdps) involved several service components pertaining to a more comprehensive scope of regional development. it commenced with land survey and development (including irrigation works in some cases), and land demarcation and allocation to producers. the production process involved provision of agricultural extension, yield augmenting inputs (seeds, fertilisers and pesticides) as well as (in selected aspects) farm implements. to ensure that all producers had access to these inputs, an official agricultural credit facility was provided. associated services included construction of access roads, provision of produce markets, and health facilities (clinics and preventive services). furthermore, there were two distinctive features. one was new land tenure arrangements. the other was the setting up of a specific institution to manage the programme, on a semiautonomous basis. it is, therefore, clear from this rather complex institutional arrangement that implementation of the lrdps involved considerable (public investment) costs, which gave rise to measures aimed at controlling the peasants' production behaviour in the attempt to ensure that the programme would achieve planned production targets. the land tenure issue seems to have been central to official perceptions about production relations. peasant agriculture is in essence customarily land-based. as such, the relatively low productivity and production characteristics of peasant agriculture are usually perceived to emanate from the rather poor and uneconomic land use practices, in tum derived from the type of land holding system (see e.g. gershenberg, 1971: 54). thus, a major aim of malawi's lrdps was to remove perceived poor peasant performance, arising from rather "careless, uneconomic and wasteful" practices. according to the views held by officials (at least during the earlier stages of the country's development), such r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 216 sajems ns vol 3 (2000) no 2 negative agricultural practices mainly derive from the widespread traditional perception that "land belongs to no one in particular", but is "held in common". at least this is what state president kamuzu banda said when introducing the malawi land bill of 1965 (hansard, 12 april 1965) and the customary land (development) bill of 1967 (hansard, 4 april 1967). therefore, rdps must have been seen as offering the most effective framework for controlling the peasantry in their agricultural labour supply and application decisions. this could be accomplished through a combination ofland tenure change, away from the traditional system, and strict supervision of production. within this context, it appears that state intentions of controlling peasant producers derive from at least two other closely related ideas. one is the perception that much higher levels of labour-time are indeed required for the new style of production, which is directed at achieving surplus levels of production. the other is the fear that the peasant producer would normally be reluctant to meet these higher labourtime requirements. this is particularly so in the short-term period, when the producer may not yet fully appreciate the need to radically transform into an economic producer, given certain production .conditions. an example of such labour-intensive new style of farming system is the karonga rural development project the rural development project context: the karonga model the karonga rural development project (krdp) represents a context in which the new farming system is introduced in a geographically defmed region. krdp was launched in 1972, as the last of the four regional projects under the initial integrated rural development programme. it involved implementation of a series of crop development schemes, scattered across the defmed region. each agricultural scheme either focused on a single crop, or involved two or more crops, depending on the specific soil conditions to which they were suited. only four crops (rice, maize, groundnuts and cotton) were officially chosen for the project, on account of their commercial value. they were grown in rain-fed conditions, except rice which was grown under irrigation. it is significant to note that the peasantry were already cultivating all these crops to commodity levels in this lakeshore region of extremely high agricultural potential (see e.g. mg, 1970: 1). what was new, however, and had significant implications for social change, were both the introduction of new hybrid strains of these crops and the method of organising production. before krdp, agricultural production was undertaken on traditional land holdings. by virtue of the krdp programme, the production of the selected crops came to be undertaken in almost purely commercial terms. and in order to support the achievement of the project's aims, production was organised within the framework of a cultivation scheme, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . samms ns vol 3 (2000) no 2 217 which consisted of three main categories. one was double-cropped irrigated rice in three subschemes2• the second was single-cropped rice production on inundated/rain-fed land. the third was cotton, groundnuts and maize production on drier land. by the completion of the development phase, the total amount of land under such schemes was some 23 840 acres, in the respective proportions of 10.5, 43.1 and 46.4 per cent. (krdp, 1978; wb, 1978: summarised in simukonda, 1986: table 4.1: 188). there are four main issues of the karonga model which bad significant implications for commodity labour supply. first, the "scheme approach" implied an intensification of labour-time and externally induced differentiation of the peasant population of the region. secondly, the different scheme types were associated with different degrees of labour-time demand as well as differences in cash earning potential, arising from a combination of productivity and producer price. thirdly, the schemes were simply contiguous pieces of land, normally no more than 560 acres, carved out of village agricultural land, and comprising demarcated family allotments ranging from two to four acres. these pieces of land were officially declared "special areas" under state control, distinguished from traditional land, and were meant for the cultivation of selected cash crops. lastly, in terms of both overall size and the number of demarcated holdings in each village scheme, such schemes could accommodate only a portion of the village population. both the scheme farmers and the rest of the peasant population continued to' hold their traditional village holdings for subsistence and other cash production purposes. the karonga model is, however, not so typical of malawi's rural development approach outside the irrigated schemes. the common approach is one where there is no separation between cash crop and subsistence production, in terms of the legal status of the land held and used. instead, use is made of some form of crop rotation, on demarcated rectangular family allotments. perhaps the government saw the karonga model as an alternative experiment to achieve the highest possible desired results. presumably this was perceived to be arising from stressing cash crop production, attempting to match crop types to soil properties, and ensuring that only the most suitable (i.e. able and willing) producers were involved by careful selection. it might also have been an attempt at providing a clearer basis for measuring and evaluating the programme's success. the idea of farmer selection has at least two further implications. on the one hand, it is possible that officials feared that the expected higher commodity labour-time demands might fail to generate the required sustained higher levels of labour supply response from the producers. therefore, only by having a farming framework in which the farmers could be compelled to comply with the standards of production, would the desired response be forthcoming. on the ~ther hand, the officials appeared less concerned with the objective of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 218 samms ns vol 3 (2000) no 2 directly improving the income welfare of the region's peasant population as a whole, than with ensuring that the programme did achieve the perceived level of production success. such success was calculated on the basis of individual performance (simukonda, 1994: 293-6). farmer status differences by scheme types two main issues defined the differences amongst the scheme types with respect to their commodity labour-time demands. one was the absolute labour-time required for the production of a particular crop type. the other was the degree to which scheme officials enforced production standards. the latter was apparently necessitated by the capital (investment) ratio or internal rate of return on capital. that is, the amount that the state expended on the development and maintenance of the scheme, relative to the value of the crop produced by the farmers. the other was the relative sensitivity of enforcing production targets, through strict adherence to standard procedures. in this case, the doublecropped rice irrigation scheme required the highest level of enforcement of farmer production behaviour. this is simply because it required more strict adherence to the production calendar and agricultural input use, in a relatively higher technical context. on the one hand, farmers had to strictly fonow the planned production calendar in order to meet the requirements of two croppings in a year. on the other, the highly technical nature of double-cropped irrigated production required a large presence of technical and extension personnel, to supervise the operations and promptly deal with any problem of water supply to irrigation canals. such official presence, together with the high cost of the development of the irrigation works, implies higher administrative cost, that must be made good by the resultant value of the crop. in addition, as the doublecropping system involved continuous year-round cropping activity, officials might perceive that farmers decided to relax or take "unauthorised leave". this would have a serious negative effect both on performance by the neighbouring plot-holders and the scheme's overall ability to achieve its planned production targets. the effect of this was that the state had almost complete authority in assessing the performance of peasant households for the purpose of deciding their eligibility for membership of the farming scheme. in contrast, production in the other two scheme types involved significantly lower technical and administrative costs. as they were rain-dependent and involved single-cropping, their physical development and production management were largely left to the farmers themselves, who were also organised into land allocation committees for that purpose. as such, the scheme came to be viewed as virtually traditional land, with respect to landholding status. all this was even more so in the case of the dryland crops scheme type. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . samms ns vol 3 (2000) no 2 219 commodity labour-time implications generally, what appears to be most significant about the application of labourtime is the degree of independent decision-making enjoyed by the scheme fanners. the starting point of analysis is that the peasant household needs to carry out commodity production in order to meet its defined income needs. in order to do so, it needs adequate external (state) agricultural support services, which are of three basic categories. these comprise land on which to carry out the production, such agricultural inputs as seeds, fertilisers, chemicals and farming tools, for which a credit facility may be necessary, and extension services for proper knowledge of production. in this context, the maximum level of independent decision-making is defmed by a situation where the producer simply responds by achieving the highest level of production consistent with the defined income needs and the technical limitation of production facilities. the opposite of this is where state agents have to put in place, and strictly enforce, production standards to ensure that the producer does indeed follow them. enforcement of production standards arises because of the complex realities of the production system itself. it suggests that there is a need to match the state aims of production with the producers' own needs, desires, behaviour and production capacity. the experience with the hara irrigated rice scheme might shed light on the matter. the hara rice scheme the malawi government launched the hara irrigation scheme 1967, with the aim of radically increasing rice production above what had so far been achievable under traditional methods of production. with irrigation, both productivity and overall production were to be sharply increased through the use of hybrid, quick-maturing seed varieties, which allowed double-cropping in a calendar year. in addition, the 560-acre land that was developed, was much larger than what had previously been cultivated for rice production. this permitted bringing in additional producers from more distant areas, including from outside the natural catchment area3• it is significant to note, from a labour supply viewpoint, that rice, along with groundnuts, was produced mainly as a cash crop. otherwise, cassava was the staple crop, and there were also a number of minor crops grown primarily for food or for sale. these included maize which together with rice supplemented the staple crop, millet cultivated on the hilly parts of the hara flood valley, pulses, sugar cane, bananas and other fruits and vegetables. cattle were the main part of livestock fanning, and fishing on nearby lake malawi was the main protein source. finally, agricultural activity was mainly seasonal: it was r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 220 sajems ns vol 3 (2000) no 2 largely confined to the seven-months rainy season (summer), while during the dry season (winter) time was largely spent on leisure and social responsibilities. when the hara scheme was introduced, the idea was that it would be the major source of agricultural incomes, due to its sheer income-yielding superiority. but whether or not it was also intended to supplant other cash-based agricultural activities (e.g. rain-fed rice and groundnuts production) is not clear. nevertheless, at least from the point of view of practical realities, it was not expected that those engaged there would need to have the time to cultivate other crops as well. based on planning statistics, the gross annual income from a double-cropped two-acre allotment in the scheme was to be significantly higher than the average amount derived from the same amount. of land within the traditional sector. compared to rain-fed rice, groundnuts, maize and cotton, the maximwn irrigated rice income was to be as much as 2.6, 8.6, 8.4 and 6.8 times, respectively. such a significant possible income improvement was enough to attract the peasantry into enlisting for the commodity scheme. however, this was to be at the cost of much higher levels of labour-time. for instance, the fanner shifting from rain-fed rice, groundnuts or cotton would expect to increase labour-time by as much as, respectively, 2.6, 2.3, 3.9 and 2.3 times (krdp, 1978: 57-60; simukonda, 1986: table 4.4: 190t, more significant is the fact that the scheme allotments were additional, rather than alternative, to the land held under traditional cultivation. the reasoning was simply that scheme households would still find it necessary to continue with customary production. at least, it is in this way that they would meet their subsistence requirements. how far this simultaneous production arrangement could serve the interests of scheme commodity production is not obvious. on the one hand, it could help reduce the pressure to retain part of the scheme rice output for conswnption purposes. on the other hand, the greatly increased pressure on the supply of household productive labour-time could seriously undermine the efforts to meet the full labour-time requirements on the scheme allotment. the question then arises: just where would this required additional labour-time come from? looking at the traditional pattern of life, the main productive activities outside agricultural production included fishing and livestock (for men and male children), house construction and repair, and a host of food procurement and processing activities. then there are activities of a social nature, such as attending funerals and to attend to the sick and visitors, or visiting relatives and friends. the rest of the time may be spent on leisure pursuits and resting (mg, 1972: 5). how dispensable some of these activities may be considered, compared to the labour-time required for scheme rice production, depends on the extent to which they are held as a cherished norm or social obligation, or for reasons of personal preference. in the context of socioeconomic development, however, officials may take the view that many of these r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 221 activities are pursued simply because there is time available to do so, and that this is so because there is no more profitable alternative to substitute for them. such a view remains to be tested against experience, and experience with commodity production in the hara area provides the necessary basis. labour-time allocation in the hara scheme the scheme commenced in 1968 with an "experimental" group of about 80 household farmers, that included those who had been cultivating rice on the land taken over for the scheme. a year later, the government extended an invitation to the rest of the population to participate in the scheme. there was an expected rush for scheme plots, enthusiasm having been generated by an intensive official publicity about the income superiority of the scheme's operations. consequently, by 1970 (the second year of operation), the planned 500-acre scheme was oversubscribed by about 64 holdings. this was made possible simply by permitting the extra farmers to develop plots on their own initiative. it would take place under official supervision on land adjacent to the scheme, in the hope that the farmers would receive scheme canal water supply. in effect, the area of the scheme was officially expanded to accommodate them. initial r~ponse the apparent enthusiasm by farmers to participate in the commodity scheme was, however, severely restrained by the sheer physical drudgery involved in developing the land into plots. the plots had to be sufficiently level to hold water evenly, and the farmers had to construct water canals leading to their plots. the first result was that most farmers were not able to complete development work on their allotments in time for the planting stage, as determined by the production calendar. in some cases, floods damaged allotments which had been prepared or planted, and work had to be redone. within the above context, farmers soon realised that they were spending so much time on their scheme operations, that they had neither the time nor the energy left for anything else, to meet their subsistence production and other: domestic requirements. this was a serious dilemma if they were to secure their scheme membership, they had to continue attending to their scheme allotments to a satisfactory extents. while this would assure the eventual realisation of their income objective as per official plan targets, it also seriously detracted from their ability to meet the full requirements of domestic production and other necessary activities. in other words, scheme rules were such as to seriously limit the producers' freedom to decide on a desirable and necessary balance in the allocation of labour-time between the two categories of production. although r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 222 sajems ns vol 3 (2000) no 2 scheme officials allowed households to retain part of their rice harvest for their own food requirements, this was considered inadequate compensation for the loss of staple crop production. and scheme commodity production was certainly no substitute for livestock production, for instance, as the latter was to a significant extent socially determined. within this context, scheme farmers found it necessary to split the household, having some members attend to domestic requirements, allocating chores on the basis of gender and age. thus, adult male members did most of the land preparation and fertilisation work in both sectors, while women and children did most of the planting, and male children attended to the livestock. but as this tended to slow down progress on the scheme allotment, the next solution was to hire the required additional labour-power, for both sectors of production. however, employing hired labour required the farmer earn some commodity income first. fortldlately most labourers accepted payment at harvest time. as a result, during the first two years, about 90 per cent of the scheme farmers employed hired labour, on a more or less permanent basis. many also hired work oxen for tilling and levelling the allotment. hired labour contributed, on average, about 23 per cent of all the labour-time spent on work of a clearly productive kind (e.g. crop production, livestock, and construction and repair work). the major part of this was applied to non-scheme operations. for instance, 47 per cent of it was spent on cassava production, as against 27 per cent on scheme rice production (mg, 1972: tables 11-12). the above situation did not necessarily mean that scheme farmers were able to fully utilise their allotments. by the end of the scheme development phase in 1970, only about 76 per cent of the scheme's capacity was adequately utilised. but the farmers themselves were able to utilise, on average, only about 55 per cent of their allotments (67 per cent for the summer and 45 per cent for the winter crop). about 20 per cent of the rest was attributed to plot-borrowers (mg, 1972: 6). what explains the above allotment utilisation situation is a combination of several factors. first, plot-borrowers were those members of the immediate community who either had failed to gain scheme membership, or who did not wish to be permanently committed to its commodity requirements through such membership. plot-borrowing, therefore, gave them an intermediate chance of benefiting from the scheme's superior crop productivity, in order to realise the rice needed for consumption. the scheme farmers, on their part, may have felt a moral obligation to assist relatives or friends who were not so fortunate as to gain scheme membership, by sharing the privilege to an extent. nevertheless, the more compelling reason is that they actually needed extra labour-time in order to utilise the allotment at a higher level, and thus to avoid official disciplinary action against them. finally, such private social arrangements tended to serve the interests of the scheme authorities very well. they needed to r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 223 see that the scheme's utilisation was maintained at a high level, to achieve a justifiable level of performance. furthermore, it would not be in their interest to have to evict farmers for failing to achieve and maintain an acceptable level of production performance. thus, plot-lending was seen in the context of ''mutual assistanc,:", which was in the end beneficial to everyone concerned. differential seasonal performance suggests the existence of a significant behavioural phenomenon. this is simply that expected performance would have been higher in winter than in summer. winter is when agricultural activities within the traditional sector are at a minimum. therefore, there is a strong possibility that scheme farmers found it difficult to adjust to the new pattern of labour-time allocation demanded by double-cropping. it suggests that scheme farmers sought to continue to pursue the traditional pattern of social and domestic activities, as well as to enjoy leisure-time and rest, which are more permissible during the dry (winter) season. thus, it was at this time that they needed and encouraged plot-borrowing labour-time more. they knew that this extra labour-time was more forthcoming during this period, which was outside the necessary agricultural production activity. rather unfortunately, however, scheme farmers tended to overestimate their ability to mobilise such labourtime, as they themselves sought to allocate too much labour-time to domestic and social activities. longer-term responses soon after 1970, the respective summer/winter performances were however reversed, almost pennanently. but overall average performance on the allotment did not improve. in fact, it gradually declined. the average allotment fell from 2.3 to 123 acres between 1970 and 1984, while the planted portion at these levels declined from 66.4 to 55 per cent by 1983 (krdp, 1983: table 2; 1978: appendix 5). this performance is inclusive of the plot-borrowers' contribution. the pertinent question is: why did overall performance fall when it ought to have improved with successful adjustment to the new labour-time allocation pattern and the employment ofhired labour-time? the starting point was that scheme farmers began to use less and less hired labour-time and to replace it with household labour-time. but apparently they were not quite successful in the latter case. at the same time, they gradually reduced household labour-time, and in extreme cases, some completely withdrew from the scheme, whether by voluntary or official disciplinary action. in the latter context, the scheme lost members every year, averaging 22 members (or 6.3 per cent of existing members) between 1970 and 1983. meanwhile, scheme membership grew, and by 1984 it had grown by almost 75 per cent to 457 farmers. such growth in membership was a result of the scheme r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 224 sajems ns vol 3 (2000) no 2 authorities admitting more farmers than required to simply replace those who had left. some of these came to take up portions of allotments given up by existing farmers, either by choice or official disciplinary action. available statistics also suggest that farmers grew increasingly reluctant to directly prepare their allotments for planting themselves (by hand-hoe), in preference to labour saving devices (work oxen and mechanical tillers). for instance, between 1979 and 1980 work prepared by hand-hoe only averaged 14 per cent. the rest was prepared by means of work oxen, which were often hired. when mechanical tillersllevellers were introduced in 1981, work prepared by hand fell to 6 per cent, then to 5 per cent in 1982. at the same time, the proportion of the work prepared by work-oxen fell from 68 to 58 per cent (krdp, 1983: table i). it is possible, therefore, that if there had been sufficient work-oxen and mechanical tiller capacity, all the land preparation work would have been done by such means. the above levels and developments in labour-time allocation suggest the following situations. first, farmers were unable to meet the labour requirements of scheme production because they could not mobilise enough labour-time from within the household itself. this was partly because they needed to carry out subsistence and other domestic operations at the same time, and partly because they found it difficult to give up completely some of the less indispensable activities they had been accustomed to. secondly, farmers felt compelled to employ hired labour and, later, mechanical devices too. not only was this help needed to supplement household labour-time, but it also helped to save human energy and time, which increased efficiency. however, the farmers were unable or unwilling to employ these to the extent that would have allowed them to achieve full-level production on the scheme allotment. and finally, in spite of both this and the apparently adequate adjustment to the new seasonal pattern of labour allocation, farmers grew increasingly averse to the physically demanding work of scheme commodity production. this is gauged from the continuous withdrawal of farmers from scheme commodity relations, either by leaving the scheme or by reducing allotment utilisation levels. what would explain this phenomenon? analysis of commodity-related responses at the outset, the labour-time supply problem seems to be rooted in two major phenomena: the level of income, and the drudgery of work whether perceived in a physical or psychological context. to these could be added the absolute scarcity of labour-time. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 225 the income factor an analysis of the peasant commodity responses, as related to hired labour-time, may be built on two main interrelated premises. on the one hand, hired labour can only be supported on the income proceeds from the crop which it helps to produce. and from a qualitative (psychological) viewpoint, on the other hand, the idea is that the farmer will want to remain in the scheme only if he is able to realise a "satisfactory" level of income. in tenns of simple calculation, therefore, the commodity farmer would see himself as justified to maintain hired labour if the commodity value of the hired labour's contribution were higher than what the farmer has to pay for it the exception appears to be where a greater value is placed on the simple ability to maintain commodity operations. this could be defined either in the social context or in the context of longer-tenn objectives relating to future production plans. the above conceptual framework suggests, in the flist instance, that hiring labour-power within the peasant economy is very sensitive to the income level. in other words, the peasant farmer would normally not resort to the use of hired labour, unless it is really helpful or absolutely necessary to do so. the purpose . might be to raise the net income level, or to help secure the privilege of remaining in the production system. in the event, trends in the use of hired labour-time in the hara scheme are consistent with this hypothetical framework, particularly as they relate to trends in expected income levels. during the initial stages, when almost all scheme farmers hired labour-time on a more or less full-time basis, this happened in mainly two ways. first, as plot development work was quite demanding in labour effort, farmers felt compelled to complete the work in time for the fixed planting stage in order to immediately start realising their income. secondly, farmers most probably wished to demonstrate (to the scheme authorities) that they were indeed capable of accomplishing the work expected of them at selection time. this necessity was also brought about by the farmers' inability (if not simply unwillingness) to sufficiently adjust to the new labour-time allocation pattern demanded by irrigation production. however, the hiring of labour was also made possible by the fact that at the prevailing producer price input cost level, the farmer was able to realise a satisfactory income margin. but then, why did farmers (on average) not employ more hired labour to maximise income from a fuller allotment utilisation at this early stage? the most likely explanation is that the farmers must have perceived the possibility of being able to mobilise sufficient additional labour-time from within the household. if so, they could maximise income by avoiding the "luxury" of having costly hired labour work for them. some simple calculations r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 226 samms ns vol 3 (2000) no 2 may demonstrate this. at 1970 prices, the fanner could expect to achieve a maximum rice output value of 1060 (malawi kwacha)., based on the standard allotment size of 2 acres, double-cropped, at the planned maximum yield level. after the compulsory input package (10 per cent of gross value) and the wages paid to one labourer (23 per cent), net earnings would be k241 (or 67 per cent of gross output valuet. since evidence shows that with one labourer the fanner was unable to utilise the whole allotment, he would probably need to employ at least two labourers. in that case, his net earnings would be reduced to only 44% of the value of the crop. it appears that for the peasant commodity producer, it might not be necessary to accept so large a reduction in the income earned, particularly as the fanner would be paying for hired labour-time more than he would retain (i.e. ki66 in wages as against ki58 retained), just for the "luxury" of continuing to enjoy some leisure that he was accustomed to. from available evidence (mg, 1972: table 10), the actual situation was that a scheme household spent about 38 per cent of the total available labour-hours (about 4 170 hours) "doing nothing" of productive nature. meanwhile, hired labour contributed about 22.6 per cent (1 507 hours) of the total productive labour-time. if the household were to convert the unproductive labour-time in productive work. all it needed to fully utilise the scheme allotment was about 2 200 labour-hours. this could have been drawn either from hiring an additional labourer or, preferably in this context, from time spent on less indispensable domestic activities. the consequences of what happened in reality were, however, quite significant. by operating at about only 56 per cent of plot capacity, the household was able to realise a maximum income margin (after input and labour costs) of only about k97 or 27 per cent of the possible gross earnings. at this level, the labour cost alone was about 41 per cent of gross earnings, almost equal to the income that the household was able to retain for itself. the above possible and actual performance point to two or more alternative requirements for improving the household's income. the basic requirement was the need to increase household labour-time (from time spent on leisure). this could be done either together with retaining or even increasing hired labourtime, or by reducing the latter, so that the household could be seen as paying itself rather than the hired labourer. the actual situation was that the household opted for the lauer, presumably because it could no longer tolerate the falling net income level. as the income/input cost structure began to change, towards a gradual reduction in real net income, the idea by the commodity producers of reducing and replacing hired labour-time became increasingly urgent. the process of . reducing hired labour did indeed continue, and by the 1980s hardly any fanner r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 227 employed a hired labourer on full-time basis. only the few who still held more than 2 acres, particularly women farmers, retained a labourer. even so, labourers were almost exclusively employed on a piece-work basis, mainly for land preparation work. this phenomenon probably also explains the increasing popularity of the work-oxen and mechanical tillerlleveller methods of land preparation. it is understandable why this labour substitution might have been felt as the necessary thing to do. by 1983, farmers were able to plant an average of only 1.23 acres. if their realised output had been at the planned maximum rice yield level (assuming they had not let out any part of their allotment), the possible gross income would be k402 and the net income k294. if they had employed a full-time labourer, at k209, their retained income would be only about k85, just 41 per cent of the labourer's income (simukonda, 1986: 303-6). thus, the simple reasoning behind reducing (or eschewing) hired labourer services is that it does not seem rational if one's employee earns more than what you are able to earn from your own operation. but then, what explains the gradual fall in the allotment size that seems to have compelled scheme farmers to place themselves under such production limitations? tbe drudgery factor equally important in the context of performance, appears to be the drudgery phenomenon, often perceived more in psychological than physical terms. a theoretical comparison between the initial and subsequent periods might shed light on this. it is obvious that agricultural (crop cultivation) work entails a great deal of physical effort. rice production, particularly according to the irrigation method, is particularly demanding of such effort. it saps one's energy so much that there is little time and effort available to do anything else. thus, during the initial period, hara farmers realised that their necessary non-scheme operations would significantly suffer unless hired labour were employed. that situation applied less after the initial period, when the farmers had sufficiently adjusted to the new pattern of labour-time allocation, especially with respect to work stages beyond the rather strenuous land development work. therefore, when farmers decided to increase the amount of household labour-time instead of hired labour-time, this was done mainly for two reasons. on the one hand, it was because they placed a higher value on the expected income, relative to the associated rise in the physical burden of work. on the other hand, it was because they perceived the benefit of the marginal income to be higher than the cost of non-scheme production and the leisure-time that they would forgo in the process. in reality, however, their commodity production performance gradually fell at the same time as the real producer income was falling too. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 228 samms ns vol 3 (2000) no 2 the plausible explanation for this commodity-related behaviour, therefore, appears to be that the farmers were becoming increasingly unable to accommodate the negative change in their income status. this situation, which can be translated into the concept of drudgery7 as a human feeling or perception, is defined by two main dimensions. one applies in a psychological sense. it focuses on the individual satisfaction from attainable commodity income, relative to the benefits of non-scheme activities, both of a productive and a socialj1eisure type. in other words, scheme farmers were becoming increasingly dissatisfied with their inability to achieve non-scheme production and to pursue their customary pattern of life, simply because the value of attainable commodity income failed to compensate for this loss. as a result, commodity operations became increasingly burdensome. farmers consequently, responded by gradually withdrawing household labour-time, at each stage to a level of commodity operations which reflected the best compromise between the value of the income and its opportunity cost, in the form of customary production forgone. this conceptualisation places commodity relations in a dynamic context, in the sense that it explains the continual decline of the average performance level in the commodity scheme, consistent with the continual fall in commodity income. another dimension applies to the sense of physical drudgery. this is simply that farmers had to supply more productive labour-hours than normally necessary to meet subsistence production needs in the traditional sector. it has been stated that at the very beginning, farmers had to stretch themselves to the limit of their ability and/or endurance, just in order to be able to participate in the commodity scheme in pursuit of superior income prospects. it has also been stated that in order to meet the official minimum commodity requirements, to retain membership of the scheme, farmers had to hire additional labour-time. therefore, when the rate of income began to fall, their initial response was to proportionately substitute household labour-time for hired labour-time. this was done simply to maintain the level of income earned, or at least to keep the reduction to a minimum level. this means the farmers had to endure the increasing physical burden of simultaneously carrying out commodity and domestic/traditional production. in physical terms, however, there is a scale of operation at which further labour application becomes impossible, particularly when the labour substitution process is complete. at this level, the decision to begin scaling down the commodity operations, assuming the commodity income rate remains constant, is explained by the significant part played by the phenomenon offatigue. in practice, both the above dimensions apply simultaneously in varying degrees, depending on individual circumstances. thus, the above conceptualisation provides the context and basis of the various types of individual commodityr ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 229 related behaviour responses, applying to withdrawal of household labour-time. some fanners withdrew from the scheme completely, while others remained, albeit at reduced operational levels. this differential response, in time and scale, suggests a lack of commonality within the peasant society with respect to perceptions of a satisfactory level of income. such differences apply to particular or individual circumstances and perceptions among the peasantry, relating to the defined pwpose of commodity income. a study carried out among the hara scheme fanners (simukonda, 1986: 253-5) revealed the significance, in this context of the socio-economic andlor demographic backgrounds of households. for example, some people had been operating village retail shops and therefore sought commodity income to support their business operations. this was typical of the scheme farmers. their basic reason for joining the commodity scheme was the expectation that commodityderived income was far superior to any other income-generating activity they had been engaged in. within this context, their withdrawal from the commodity scheme was generally based on disappointment with the reality of expected commodity benefits. thus, some left the scheme to seek employment in distant places, apparently after raising enough funds to support the move. others felt that the original pressure to join the commodity scheme no longer existed (e.g. the need to raise funds for supporting their children's secondary school education). however, the majority withdrew, partially or wholly, to return to their previous mode of social and economic life. they were those who felt that the cost of commodity output, relative to its income benefits, was not worth the sacrifice of the freedom to pursue their traditional pattern of production and social activity. they therefore decided to exercise their basic freedom to rid themselves of the entrapment of commodity relations, which could no longer be justified by their original income claims. such producers included those who returned to their rain-fed rice scheme operations on traditional land. therefore, those who remained consisted of the "semi-captured peasantry", who would normally grow rice for cash, with or without the irrigation scheme. the main difference between the two categories of farmers is that those who withdrew for alternative cash-related production in the traditional sector, felt that the loss of production decision-making in the commodity scheme was more than compensated for by the higher production! income opportunities it offered. therefore, they came to be "effectively" entrapped in the supposedly marginal production/income benefits of the commodity schemes. for some, the commodity scheme provided the necessary additional cultivable land, for meeting the total subsistence requirement while also yielding some income. but in the case of all farmers, it offered the only official access to superior agricultural technology (e.g. high yielding seed and agricultural tools) on credit, as well as continued agricultural training. after all, their labour burden and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 230 samms ns vol 3 (2000) no 2 domestic opportunity cost were significantly reduced by having the limited discretion to reduce their operations to one acre of land. this had become the minimum officially acceptable allotment size, down from the original standard two acres. nevertheless, by 1984, most farmers had reduced themselves to operating at a level which was almost the same as in average traditional land operations. the conclusion derived from this, therefore, consists of two main dimensions applying to the status of the peasantry in relation to commodity production. on the one hand, there is no doubt that commodity production, as demonstrated by the ham rice irrigation scheme, offers households the opportunity to increase their income for improved socio-economic life. this opportunity is provided not only by the superior agricultural technology used, but also the ready access to such technology through the official credit facilities. yet, this opportunity comes at significant cost. participation in commodity production compels households to work at minimum levels of labour-time, which greatly increases labour-time application beyond the amount necessary to meet subsistence requirements. this has further effects on the need and desire to meet subsistence and other domestic production requirements, as well as on the freedom to decide on the allocation of labour-time. the other dimension relates to the value of achievable commodity income. experience so far suggests that the state is unlikely to pass the economic gains of commodity production onto the peasant producers at the maximum level. instead, it is likely to pass on to them any structural cost increase. therefore, given this principle, as the peasantry become economically worse off, they respond by withdrawing their labour-time. the overall consequence is that while the state may continue to enjoy maximum benefits through the overall commodity output achieved, the peasantry become reduced to almost their original low income and, therefore, socio-economic status. this is at least what the ham experience suggests, although in other cases, such negative consequences may apply to both parties, or even more so to the state (see e.g. simukonda, 1994: 298). further analysis generally, therefore, it appears that commodity income and drudgery exist for the peasantry, in inverse proportions, from the point of view of supplying the necessary productive labour-time. within the context of its application to income, the significance of drudgery for the peasant is defined more in psychological than physical terms. thus, the greater the value placed on attaining a particular level of income, the lower is the level of drudgery perceived. therefore, it is arguable that once the desired or needed level is r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vo13 (2000) no 2 231 reached, the perception of drudgery begins to increase dramatically. this may apply to a given level of commodity operation. or more seriously, to any increase in the operational level. against the background of the above analysis, the question may be asked: what would be the response if there were a change in the rate of commodity income? there may be two possible types of producer response. one is based on the idea of a possible ''target income". it appears that when there is a negative change in the rate of income, producers would increase the level and quality of production, just to ensure that the desired/needed income is maintained. this suggests that from the point of view of the interests of the state, it would not be wise to permit a gradual increase in the rate of achievable net income. the alternative response is when the producer's income goals are almost insatiable. if so, the state would be wise to implement a policy that allows for a positive change in the rate of achievable income. this would encourage producers to aim at increasing the scale of production, and, within the limitations imposed by the size of allotment and technological levels, to improve the standlp'ds of production. furthermore, it would encourage farmers to remain in commodity production, and to seek to maximise the cash disposal of the crop. this would serve the interests of both the state and the producers very well. the state would maximise the amount of the crop output. in addition, retaining the same, motivated individuals in scheme membership means that the cost of the commodity scheme could be falling, as it would require less and less resources to be spent on the training and supervision of farmers. the producers, on their part, would increase their household income levels, and enjoy a higher standard of living. conclusion the hara experience suggests several alternative social responses to commodity relations among the peasantry. first, it suggests that commodity production is significantly sensitive to labour supply. the supply of productive labour-time is determined as much in absolute (physical) terms as in relative (psychological) terms. these aspects converge on the level of commodity-derived income that could be earned. the value of such income is perceived in relation to the extent to which it permits households to enjoy higher consumption levels, while minimising loss of production and other activities within the traditional or subsistence sector. the latter include: necessary subsistence production and domestic activities, desired social and leisure activities and physical rest, as well as other social obligations. secondly, it suggests that the peasantry are amenable to change consistent with the defined goals of commodity-derived income, so long as this kind of income more than compensates for loss of alternative, traditional sources of income. lastly, it suggests that a process of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 232 sajems ns vol 3 (2000) no 2 socio-economic differentiation is possible within the peasant economy, at least in sociological terms. this is reflected in the respective behaviour of both parties in commodity production. the state on its part, prefers a system of selecting farmers for commodity production scheme membership. the peasantry on their part, seek to employ hired labour either to boost the total amount of the required labour-time for higher income levels, or to substitute household labourtime for reaching a more comfortable level of life. in this context, it is likely that the transformation of the peasant economy is likely to suffer on the account of serious practical realities, based on the interaction of the interests of the state and the peasantry. typically, in its commodity programmes, the state tends to pass on to the peasant producer a greater part of any increase in cost of production. this tends to have a negative impact on the producer's enthusiasm to provide the required higher levels of productive commodity labour-time. therefore, the producer utilises any available method to withdraw from commodity relations. the ham experience suggests that such withdrawal could be in the form of resigning from membership of the commodity scheme or simply reducing the level of production. and where there is an improvement in the cost-price structure, the . state is often reluctant or slow to adjust input and producer prices in favour of the fanner. it is arguable, therefore, that such a process tends to reinforce the condition of "peasantness". and this may be viewed as failure of state commodity programmes to effectively transform the peasantry into real commodity producers, whether in a sociological or a materialist sense. it is possible that such experience is of wider application in sub-saharan africa, and perhaps elsewhere, albeit based on varying forms of production dynamics. endnotes 2 the four irdps were allocated on the basis of political region. since malawi has three regions (northern, central and southern) two projects were allocated to the central region. but a project only covered the area of one to two administrative districts. actually, only one of the irrigation subschemes (lufila) was initiated by krdp and financed by the world bank. krdp came to inherit the other two (ham and wovwe) which had been established earlier by the malawi government. they were the only ones with fanner settlement facilities, which accommodated farmers from more distant places. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 233 4 6 7 despite this, the hara scheme was officially viewed as a regional facility, as it allowed settlement of a few farmers from the rest of malawi, mostly from northern region. both the income. and labour-time figures for inigated rice are calculated on the basis of the two-acre standard allotment, double-cropped. those for the other crop types are based on two acres according to the single (rain-fed) cropping pattern. all irrigation schemes had clearly stipulated guidelines as to the criteria for the selection of farmers. they included demonstrated (or presumed) ability to cany out the expected high-level operations based on the area of cultivated traditional land, or previous training received in farming. for maintaining scheme membership, farmers had to comply with defined production procedures and good interpersonal farming behaviour. such conditions were stipulated in the world bank loan agreement (world bank, 1972). all calculations are based on official statistics, applying to: input and crop prices, krdp's standard input packages generally per acre, and recorded rice farm output and scheme allotment utilisation rates in the hara inigation scheme. see a v chayanov (1966), for a detailed analysis of the concept and context of drudgery. see, for example, bernstein (1982: 165-6) on what he calls "the simple reproduction 'squeeze"'. references bernstein, h. (1982) "notes on capital and peasantry", in rural development: theories of peasant economy and agrarian change, (ed.) j. harriss, london: hutchinson university library: 160-77. 2 cra y anov, a.v. (1966) the theory of peasant economy (ed.) daniel thorner, et ai., homewood, iii: richard d. irwin. 3 gershenberg, 1. (1972) "customary land tenure as a constraint on agricultural development: a re-evaluation", east african journal of rural development. 4 karonga rural development project (krdp) (1983) settlement aspects report: hara irrigation scheme, karonga: karongachitipa agricultural development division. 5 karonga rural development project (krdp) (1978) the implementation and effects of karonga rural development project phase i, karonga: karonga rural development project. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 234 sajems ns vol 3 (2000) no 2 6 mala wi government (mg) (1977) national rural development programme (nrdp): policies, strategy and general features, lilongwe: ministry of agriculture and national resources. 7 malawi government (mg) (1972) "hara: a fann management survey of rice growers in the ham irrigation scheme in karonga district, malawi", agro-economic survey report 8 (by t w bieze), lilongwe: ministry of agriculture and natural resources. 8 malawi government (mg) (1970) karonga development project: project proposal, zomba: ministry of agriculture and natural resources. 9 malawi government (mg) economic report, zomballilongwe: department of economic planning and development, (various years). 10 pachal, b. (1978) land and politics in malawi 1875 • 1975. kingston: limestone press. 11 simukonda, p.h. (1994) "integrated rural development in malawi and socio-economic change: the karonga project", development southern a/rica.ll(3): 283-300. 12 simukonda, p.h. (1992) "land tenure change on customary land as a strategy for agricultural and rural development: a malawi case", journal of rural development. 11(4): 377·9l. 13 simukonda, p.h. (1986) rural transformation and smallholder agriculture in malawi, phd thesis, swansea, uk: university of wales. 14 world bank (wb) (1978) malawi: karonga rural development project phase 1 (project completion report). washington: world bank. 15 world bank (wb) (1972) development credit agreement (karonga rural development project) between the malawi government and the international development association, washington, dc: the world bank. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no i 97 the impact of organisational restructuring on organisation climate and employee attitudes h e brand and j wilson department of human resources management. university of pretoria abstract this study investigated the impact of an organisational restructuring intervention on the climate of an organisation and the attitudes of its employees. an organisation climate and employee attitude questionnaire were used as measuring instruments. a convenience sample was used, comprising all personnel of the specific organisation. results show that the restructuring did in fact influence the organisation climate and affected employee attitudes. recommendations based on the results of and experiences gained from the study, are that effective communication should be seen as having a direct influence on successful organisation restructuring and that an effective performance management system is essential in providing employees with opportunities to measure own performance against organisation performance standards during a period of restructuring and change. jelm 12 background business process re-engineering has become an important instrument of organisation development, with the objective of making organisations more competitive by streamlining work processes, re-defining jobs within the organisation and redesigning the overall organisational structure (donaldson, 1994). these strategies and changes have a profound impact on organisation climate and employee attitudes (kochan & useem, 1992). organisational climate, according to veldsman (1995), refers to the psychological structures of organisations and their sub-units, and can also be described as the personality or character of the organisation's internal environment. the internal environment is influenced by various forces and in tum influences aspects such as employee achievement, behaviour, attitudes and job satisfaction (ve\dsman, 1995). organisation climate is determined by both external and internal factors, for example economic conditions, leadership styles, and organisation policies and procedures (robbins, 1996). while the characteristics of organisation climate may r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 98 sajems ns vol 3 (2000) no 1 vary from one organisation to another, there are also common elements of climate across different organisations (moran & volkwein, 1992). milton (1981) draws the following conclusions from extensive investigations into organisation climate: organisations may have multiple climates which can be affected differently by various organisational interventions, for example organisational restructuring. climate is often perceived differently by top, middle and lower levels of management, indicating that changes in climate can also be differently perceived and experienced by these management levels. evidence suggests that organisations have climates that differ from one another, meaning that climate changes will impact differently on the various organisations. organisation studies have clearly indicated that climate variables influence the predictability of such aspects as employee performance, job satisfaction and motivation. changes in climate variables can thus also affect these aspects. attitudes are the result of the feelings and beliefs that one has about one's self, as well as about other people and situations (lamberton & minor, 1995). attitudes also directly influence one's behaviour. according to kochan & useem (1992), it is almost impossible to implement organisational change or restructuring without affecting the prevailing employee attitudes within the organisation. various theories have been postulated trying to explain the process of change which occurs in employees' attitudes when some form of organisational change is implemented, for example, the group dynamic approach and the yale attitude change approach (zimbardo & leippe, 1991). although present attitudes relate to past experience, the problem in organisation management is the future tense of attitudes. the individual, the people surrounding the individual and the environment are in a constant state of change. this means that attitudes supporting the individual's personal development in the present need to be changed, if they are to perform the same or a different function in the future. according to kochan & useem (1992), attitude change can be classified in two ways, namely: the congruent change: this change is classified as a change, in intensity, but not in the direction of an existing attitude. if employees, for example, have a negative attitude towards their job, this attitude can be intensified by a bad experience or a bad working environment. the result is that the employee can form an even more unfavourable attitude towards work. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 99 the incongruent change: this refers to changes in direction of the individual's attitude. it simply implies, for example, that an employee's unfavourable or negative attitude towards work can be changed to a favourable way of thinking. it is widely accepted that an intervention such as organisation restructuring or change, can significantly contribute towards attitude changes among employees, which in turn affects employee loyalty, productivity and motivation either positively or negatively, depending on the nature and direction of the attitude changes (donaldson, 1994; heyrnans, 1997; robbins, 1996). misstudy within the framework of the above-mentioned corporate properties, the organisation in which this study was done in fact embarked on a process of extensive organisation restructuring, and identified, among others, the need to determine the impact of the restructuring process on the organisation's climate and its employees' attitudes, which are the joint objective of this study. the study aimed at determining whether climate and employee attitude were in fact influenced by the restructuring process, as well as the direction of change. the following two pairs of hypotheses were formulated and tested: ho: the organisation climate of the organisation involved is affected by the restructuring process. hi: the organisation climate of the organisation involved is not affected by the restructuring process. ho: employee attitudes are affected by the organisation restructuring process. hi: employee attitudes are not affected by the organisation restructuring process. research method the research method followed in this study, is discussed under the headings of research strategy, research group, sample, response rate and data analysis. research strategy the survey method in this study, to determine the impact of organisation restructuring on organisation climate and employee attitudes, was to use two questionnaires as measuring instruments. the organisational climate questionnaire was applied to all the employees of the specific organisation before the onset of the restructuring process, and again six months after the completion of the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 100 samms ns vol 3 (2000) no 1 process. the attitude questionnaire was applied to all employees six months after completion of the restructuring process. the questionnaires were distributed together with an information brochure, indicating the motivation for and characteristics of the study, as well as the relevant instructions. it was also clearly stated that the study was conducted with the approval and support of the organisation's top management. the following are the particulars of the two questionnaires: litwin and stinger's organisational climate survey questionnaire: this 40item questionnaire, grouped into nine elements of organisational climate, was used to measure the employees' perception of the organisation climate. this instrument was also adapted in 1972 for use in south africa. this version of the questionnaire is commonly used in south africa and in previous studies obtained a cronbach's alpha of between 0.80 and 0.83 (heymans,1997; otterman,i991; veldsman, 1995). the nine elements evaluated in this questionnaire are the following: structure responsibility warmth support standards conflict identity recognition risk the likert-scale is used for the evaluation of the items in the following manner: 1 agree strongly 2 agree slightly 3 unsure 4 disagree slightly 5 disagree strongly employee attitude questionnaire: a 16-item questionnaire was used to determine the employees' general "feel" or perceptions of the organisational restructuring process that was implemented. the 16 items included here in the form of statements to which employees expressed their opinions, are the following: changes that have taken place had no influence on the organisation. i do not react to the changes that have taken place. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . samms ns vo13 (2000) no 1 the changes do not influence me directly. management did not discuss any changes with me. 101 i feel that the changes pose a threat to my career within the organisation. i feel that the changes which already have taken place were unnecessary. if i would receive an employment offer from another organisation with the same remuneration package, i will definitely consider resigning. during the last couple of months, i have experienced more conflict with managementjco\leagues than usual. i make it a point to know what changes are taking place and how this will affect me personally. the impact of these changes on my career have been discussed with my manager. i feel that the changing environment brings about new challenges and opportunities for me personally. i would like to rapidly develop myself to be able to meet the set requirements of change. i feel positive that these changes provide an opportunity for greater success of the organisation. the changes that have taken place have influenced the cooperation and team spirit in the organisation. i am fully informed of the newly defined action plans of the organisation. in changing times, i see myself as a supporter of the process. the likert-scale is also used for the evaluation of the items in the same format as with the organisation climate survey questionnaire (from 1: agree strongly to 5: disagree strongly). research group the research group consists of all the employees of a national organisation operating in the property development market, numbering a total of 80 people. sample a convenience sample was utilised, including all employees of the organisation. response rate a response rate of 100% was obtained for the sample. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 102 sajems ns vol 3 (2000) no i data analysis the above-mentioned questionnaires were completed by the respondents, after which the data were captured in order to obtain statistical information for analysis and interpretation. the data derived from these questionnaires were analysed by means of the descriptive statistics of the spss-windows computer programme. the arithmetic means and standard deviations of the various elements and items were used to determine any significant differences in the results of the prerestructuring and post-restructuring testing. results of the study organisation climate evaluation: the results of the evaluated elements of organisation climate, prior to and after the organisation restructuring intervention, are shown in table i. table 1 organisation climate evaluation element item pre-restruc. post-restruc. (mean) (mean) structure i 3,250 2,00 9 2,533 2,533 18 2,562 1,937 27 3,250 3,500 40 3,000 1,937 arithmetic mean 2,919 2,381 responsibility 2 2,625 2,312 10 3,067 2,200 19 2,937 2,267 28 3,062 2,187 arithmetic mean 2,923 2,241 warmth 4 3,125 2,062 23 3,937 2,625 30 2,250 2,187 35 3,000 1,812 arithmetic mean 3,078 2,687 support 5 2,667 2,200 ii 3,250 2,125 14 3,625 2,875 31 2,750 2,067 36 2,750 1,750 38 3,000 3,437 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vo13 (2000) no 1 103 table 1 continued element item pre-restruc. post-restruc. (mean) (mean) arithmetic mean 3,007 2,409 standards 6 3,467 2,067 15 3,533 2,437 22 2,875 2,500 24 3,000 2,375 37 2,625 2,812 39 2,875 2,125 arithmetic mean 3,063 2,386 conflict 7 2,312 2,875 16 2,937 3,437 25 3,500 2,187 32 3,062 2,062 arithmetic mean 2,953 2.640 identity 8 2,875 1 812 17 2,812 1,812 26 3,250 2,187 arithmetic mean 2,979 1,937 recognition 3 3,125 2,187 12 3,125 2,000 20 3,000 2,267 21 3,000 2,067 33 3,250 2,250 arithmetic mean i ! 3,100 2,153 risk 13 3,500 2,125 29 2,812 1,750 34 2,562 2,687 arithmetic me 2,958 2,817 according to table 1, all nine elements have seemingly been affected by the organisation restructuring process. in the employees' perceptions, the direction of change was positive in all nine cases (according to the likert-scale used for each item). in order of priority (most affected to least affected), determined by the width of the mean differences, the elements appear in the following order: identity recognition responsibility standards support r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 104 structure wannth conflict risk sajems ns vol 3 (2000) no 1 thus the null hypothesis relating to this part of the study is supported and the alternative hypothesis rejected. employee attitude evaluation: the results obtained from the attitude study (16 attitude variables) are shown in figure 1. figure 1 s ,0 4,s " 4,0 ~ ),s ,. ),0 " 2,5 b 2.0 ::;: 1,s 1.0 0,5 0,0 1 -1 11 -~ -i employee attitude evaluation: arithmetic means (questions 1-16) .. .... :m iii ••• i 2 1 4 5 6 7 8 9 10 ii 12 13 14 15 16 questions _responses figure 1 shows that the employees of the organisation seemingly disagreed with the statements related to items i to 8 in the attitude questionnaire, indicating that the organisation restructuring process and its accompanying changes affected the employees' respective attitudes in a positive manner (according to the likert-scale used with each item). figure 1 also shows that the employees seemingly agreed with the statements related to items 9 to 16 of the questionnaire, again indicating that the restructuring process and its changes had positively affected employee attitudes (according to the likert-scale used). thus the null hypothesis relating to this part of the study is supported and the alternative hypothesis rejected. conclusions and recommendations the results of the study show that the organisation climate and the attitudes of employees of the specific organisation had both been affected by the organisation r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 105 restructuring process, and that the direction of change of the employees' perceptions of these dimensions was positive. these findings support those of donaldson (1994) that organisation restructuring, as a fonn of "global" change of the organisation, have definite implications for changes in culture, climate, and employee attitudes and perceptions regarding their jobs and the broader working/organisation environment.the results of the study also support the findings of zimbardo and leippe (1991) that organisation restructuring is often tantamount to radical organisation climate or culture changes, with accompanying employee feelings of insecurity, resulting in attitude shifts and changed perceptions of jobs and work. conclusions with regard to the dimension of organisation climate are the following: identity: employee identification with the organisation showed a marked improvement after restructuring. more emphasis was placed on pride of belonging to the organisation, and employees were better able to align personal objectives with those of the organisation. recognition: this element changed after restructuring, in that employees felt more certain that management would recognise their efforts and achievements. possible reasons for this could be that the consultants and management responsible for implementing the restructuring interventions, carefully considered the needs and wishes of all stakeholders in the organisation. thus promoting a sense of personal recognition amongst employees. responsibility: after the restructuring • employees felt more confident that they were able to use greater initiative. as well as to take more responsibility in their work. roles and responsibilities were more clearly defined, in tum suggesting more organisational loyalty, greater flexibility and higher achievement, both on an individual level and in group context. standards: the organisation restructuring process addressed issues such as work standards and perfonnance. after the restructuring, it seems that greater emphasis was placed on continual improvement of organisational standards, especially in tenns of higher work/job standards. standards are influenced by employees' perceptions of the goals and work standards set by the organisation. support: support refers to the extent to which employees perceive the organisation as one in which they will be able to obtain infonnation freely, as well as whether other members and management are seen to act in a helpful and encouraging manner. after restructuring, employees felt more confident about the support they would receive from management and peers. this would indicate a r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 106 sajems ns vol 3 (2000) no 1 higher level of trust within the organisation, as well as an environment where greater sharing of information takes place. structure: the study shows that employees experienced a more effective working environment within the organisation after the restructuring process. employees had greater clarity about the nature of the organisation and management structures. warmth: after the restructuring, employees found that greater emphasis was placed on a friendly and warm organisational atmosphere. conflict: after restructuring, employees felt more at ease about conflict and the way it was handled, as fear of reprisal was minimised. there seemed to be a move towards a more open style of conflict management. this may mean that management is not afraid of opposing views amongst employees, and that there is an emphasis on immediate settlement of differences. risk: although the general level of risk-taking remained almost constant after the organisational restructuring, this study indicates a tendency on the part of the company and its employees to take more calculated risks. conclusions regarding the impact of the organisational restructuring process on employee attitudes are the following: employees felt that the changes that were implemented in the organisation had far reaching effects. employees were affected directly both personally and professionally by the changes that were implemented. the implemented changes were effectively communicated to employees prior to being implemented. employees felt that the changes made to the organisation's structure do not hold a current threat to their job security. employees are convinced that the changes implemented were in fact necessary for the survival of the organisation. employees identified strongly with the organisation after the restructuring process and did not seek alternative employment. the level of conflict amongst organisation members decreased after the organisational restructuring. employees took a personal interest in the changes that were being implemented. changes are seen to be positive in that they bring about new challenges, as well as opportunities for success to employees. cooperation and team spirit were increased after the restructuring process. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 107 stakeholders within the organisation supported the change process. with the experiences and results gained from this study, the following recommendations are suggested: communication: the quality of communication has a direct influence on the success of a widespread structural intervention. it is therefore of utmost importance that a comprehensive plan be drawn up and made known to all stakeholders prior to the implementation of such a change project. information about inputs, processes, methodologies and desired outcomes should effectively and timeously be made available to employees. effective communication also plays a significant role in overcoming resistance to change, as fears can be addressed by management and other agents of change. performance management systems: performance management systems provide employees with opportunities to effectively measure own performance against those that the organisation has set. clearly defined goals are established by management and communicated to employees. employees are able to comment and make amendments during these feedback sessions. this also provides an opportunity for improved communication between different levels of the organisation hierarchy, in terms of both top-down and bottom-up communication. climate study: it is suggested that the organisation conduct a climate study approximately two years after the restructuring process, in order to re-evaluate the various elements used in this study, as well as to re-align organisation goals and communicate these goals to employees. organisational change, a seemingly painful process, can be implemented with success, as illustrated by this study. certain fundamentals, such as effective communication, should however be upheld. various successful methodologies are already in existence and utilised by management and other agents of change. these processes should however be adapted to suit the needs of each individual organisation. references donaldson, g. (1 994} corporate restructuring: managing the change process from within, harvard business school press, first ed., 658.16120/s. 2 heymans, k. (1997) "culture versus climate", unpublished mba dissertation, university of south africa, pretoria. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 108 sajems ns vol 3 (2000) no i 3 kochan, t.a. & useem, m. (l992) transforming organisations. first ed., oxford university press. 4 lamberton, l.h. & minor, l. (1995) human relations: strategies for success. first ed., irwin mirror press. 5 litwin, g.h. & stringer, r.a. (1968) motivation and organisational climate. first ed., division of research, graduate school of business administration, harvard university. 6 milton, c.m. (1981) human behaviour in organisations: three levels of behaviour, first ed., prentice hall, inc. 7 moran, e.t. & volkwein, j.f. (i992) "the cultural approach to the formation of organisational climate", human relations, 45 (i). 8 otterman, c.l. (1991) "die belewing van organisasieklimaat en stres by bestuurders van 'n nasionale diensorganisasie", unpublished m com (human resource management) thesis, university of pretoria, pretoria. 9 robbins, s.p. (1996) organisational behaviour: concepts. controversies. applications. 7th ed., prentice hall international editions. 10 veldsman, f.h.j. (1995) "die invloed van enke\e biografiese veranderlikes op die werknemer se persepsie van organisasieklimaat en organisasieverbondenheid", unpublished m com (human resource management) thesis. university of pretoria, pretoria. ii zimbardo, p.g. & leippe, m.r. (1991) the psychology of attitude change and social influence, first ed., mcgraw-hill, inc. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction relevant literature empirical methodology data empirical results conclusion and policy implications acknowledgements references appendix 1 footnotes about the author(s) emmanuel owusu-sekyere africa institute of south africa, human science research council, south africa citation owusu-sekyere, e., 2017, ‘the impact of monetary policy on household consumption in south africa: evidence from vector autoregressive techniques’, south african journal of economic and management sciences 20(1), a1660. https://doi.org/10.4102/sajems.v20i1.1660 note: this article is partially based on the author’s economic research southern africa (ersa) working paper 598, ‘the impact of monetary policy on household consumption in south africa: evidence from vector autoregressive techniques’, 18 april 2016, available here: https://econrsa.org/system/files/publications/working_papers/working_paper_598.pdf original research the impact of monetary policy on household consumption in south africa: evidence from vector autoregressive techniques emmanuel owusu-sekyere received: 06 sept. 2016; accepted: 29 mar. 2017; published: 27 july 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: this article adds to scarce sub-saharan african and south african literature on monetary policy transmission mechanisms by looking into: (1) the keynesian interest rate channel of monetary policy transmission in south africa, focussing on the behaviour of household credit and household consumption; (2) using the time-varying parameter vector autoregressive (var) techniques with stochastic volatility to capture the time-varying nature of the underlying structure of the south african economy to see whether it performs better than the constant parameter var in so doing and (3) policy implications emerging from the findings of the study. aim: in testing the hypotheses of the interest rate channel of monetary policy transmission, the aim is to see how household credit and ultimately household consumption have evolved in south africa: (1) before inflation targeting (1994–1999), (2) after inflation targeting (2000–2007) and (3) during the global financial crisis (2007–2012) in response to different monetary policy positioning. setting: we focus on three periods: post transition from apartheid, during inflation targeting and during the global financial crisis, periods which saw changes in the monetary policy stance in south africa. methods: quarterly data from 1994q1 to 2012q4, constant parameter var and time-varying parameter vector autoregressive (tvp-var) techniques are used in this study. the use of the tvp-var is to capture the time-varying nature of the underlying structure of the south african economy and also to investigate whether it performs better than the constant parameter var in so doing. results: the results show that household credit and consumption declined and stayed negative post transition and after inflation targeting – periods of monetary tightening in south africa but increased during the global financial crisis, which saw expansionary monetary policy measures aimed at mitigating the negative output gap in south africa. conclusion: these changes in household credit and consumption across the different time periods show evidence of the cost of credit effect of monetary policy on household consumption in south africa. they further reflect the impact of different structural changes and exogenous shocks on monetary policy conduct in south africa and its pass through effect on household consumption in south africa. we further conclude that the time tvp-var with stochastic volatility performs better than the constant parameter var in capturing the time-varying nature of the underlying structure of the south african economy. introduction the transmission mechanism of monetary policy has received enormous theoretical and empirical attention in macroeconomic literature. the aim has been to establish how a shock to a key monetary policy tool impacts on interest rates, exchange rates, inflation, output and other macroeconomic variables. monetary policy is transmitted via a number of channels through the macroeconomy. the transmission mechanisms of monetary policy include the interest rate channel, exchange rate channel, asset price effects and the credit channel (mishkin 1995). interest rates play a key role in most of the channels of monetary policy transmission. the interest rate channel of monetary policy transmission basically states that, keeping all else unchanged, a change in monetary policy, whether contractionary or expansionary, impacts on real short-term interest rates which in turn affects the cost of capital, investment spending, aggregate demand and ultimately the level of output. thus, a contractionary monetary policy, for instance, would mean an increase in the policy tool [repurchase rate (repo) in south africa], leading to a rise in short-term real interest rates, raising the cost of capital which results in a fall in investment spending. aggregate demand falls and output falls. on the contrary, expansionary monetary policy would mean a reduction in the repo rate leading to a fall in real short-term interest rates, lower cost of capital, a boost to investment spending, aggregate demand and ultimately the level of output (mishkin 1995). the hypothesis this article seeks to test is the traditional keynesian interest rate channel of monetary policy transmission in south africa, for a number of reasons. the monetary policy committee of south africa’s reserve bank (sarb) has had to increase the repo rate on three consecutive occasions in less than a year, between july 2015 and march 2016. the aim is to reign in inflationary pressures generated by 13% depreciation of the south african rand since january 2015. core inflation is forecast to hit 5.5% in 2016 and 5.4% in 2017 if the current prevailing macroeconomic circumstances pertain (sarb 2015). adverse climate change effects on food production have also led to south africa to import staple food to subsidise the shortages in domestic food production. coupled with the weak rand, this is likely to further fuel import induced inflation and also worsen the current account balance. on the demand side, household consumption expenditure is expected to remain muted as higher personal income taxes, the effect of the rand’s depreciation and higher interest rates, kick in. the stalling household consumption expenditure is further reflected in credit to households because consumption in south africa is highly driven by credit. growth in credit extension to households in q1 2015 was 10.6% below credit to firms. the interest rate hikes by the sarb imply that the cost of servicing existing debt increases coupled with a higher cost of acquiring new debt by households. against this background of a depreciating rand, increasing inflation and interest rate hikes, this article seeks to investigate the interest rate channel of monetary policy transmission in south africa. we focus on three periods: post political transition, after inflation targeting and during the global financial crisis. these three periods each saw a distinctly different monetary policy stance. in the process, we focus on how household credit and household consumption behaved during these three different periods. although the original keynesian theory on the cost of credit focussed on business investment spending, later research has shown that consumption of durables goods and household residential expenditure are equally investment decisions (mishkin 1995). wilcox (1990) also found that nominal interest rates are relevant in explaining both durable and non-durable household consumption. the rest of this article is structured as ‘relevant literature’, ‘empirical methodology’, ‘data’, ‘empirical results’ and ‘conclusion’. relevant literature studies on the transmission mechanism of monetary policy mostly employ the canonical vector autoregressive approach proposed by sims (1980). notable among these are bernanke and gertler (1995) who looked at the credit channel of monetary policy transmission in the united states; mishkin (1995) examined various channels of monetary transmission mechanisms; kim and roubini (2000) for the g7 countries, and christiano, eichenbaum and evans (1999) for the united states. the vector autoregressive framework by sims (1980) used in these studies assumes time-varying coefficients but constant volatility of the disturbances. hence it has been found to fail to capture structural changes underlying the macroeconomy. consequently, recent research (franta, horvath & rusnak 2011 on the czech republic; nakajima 2011 on japan) has seen the use of the time-varying parameter vector autoregressive (tvp-var) with stochastic volatility proposed by primiceri (2005) to capture the time-varying nature of the underlying structure of economies. to control for the structural changes underlying the data generating process, it is assumed that the parameters in the tvp-var specification follow a first-order random walk. this allows for the capture of both temporary and permanent changes in the parameters. the concept of stochastic volatility was initially proposed by black (1976) and later used in macroeconomic research (cogley & sargent 2001; primiceri 2005; uhlig 1997) as well as in financial economic research (ghysels, harvey & renault 2002; shephard 2005). the tvp-var algorithm is well suited to this study for a number of reasons. firstly, the monetary policy framework in south africa has been through various institutional changes. as expected, these institutional changes would have different effects over time on economic outcomes in south africa1. secondly, there have been several structural shocks and global financial developments over the sample period. three periods within the sample period are considered; after the political transition from 1994 to 1999, the inception of inflation targeting from 2000 onwards and during the global financial crisis from 2007 onwards. the period after the political transition posed significant challenges to monetary policy conduct in south africa. there was first a massive capital flight out of south africa prior to the political transition. post transition, south africa’s capital markets were liberalised, increasing the level of integration with global financial markets. exchange controls were relaxed, and the financial sector deepened as financial service providers began to extend financial access to previously excluded households who were in the majority (smal and de jager 2001). these new economic developments led to high inflation and interest rates (smal and de jager 2001). south africa then adopted inflation targeting in 2000, after which the rate of inflation was largely kept within the target range of 3% – 6% as a result of a macroprudential and more forward looking approach to monetary policy. the period of the global financial crisis saw low global inflation and low demand for exports from resource endowed and commodity exporting countries like south africa. this led to softening commodity prices, declining export revenues and a sharp depreciation of the currencies of such countries. south africa’s current account balance as a ratio to gross domestic product (gdp) worsened from a deficit of −2.7% of gdp in 2009 to −5.4% of gdp at the end of 2014 (sarb 2014). on the domestic front, labour stoppages in key sectors of south africa’s economy and demand for above inflation wages led to falls in productivity, increases in per unit cost of labour and declines in export volumes. the rate of inflation in south africa was forecasted to push close to the upper range of the inflation target (6%) in 2014 and 2015. this further led to corresponding increases in lending rates of banks (sarb 2012). figure a1 illustrates these trends in gdp growth, rate of inflation, lending rate and the current account deficit as percentage of gdp as discussed above. these diverse structural and external shocks across the sample period make it clear that macroeconomic shocks can be generated from different sources, exogenous and endogenous, at different times and simultaneously. this confirms the time-varying nature of the underlying structure of the south african economy. consequently, the varying volatility of shocks and their attendant varying size effects is the motivation for using the tvp-var model which is known to be more suitable compared to constant parameter var estimation under such circumstances (nakajima 2011) furthermore, the focus of existing literature on monetary transmission mechanisms has mainly been on developed countries and, to a much lesser extent, low-income countries or sub-saharan africa to be specific. in some of these sub-saharan african studies using vector autoregressive approaches with both recursive and structural identification, it has been difficult to establish evidence of monetary policy transmission mechanisms or any impact of monetary policy innovations on aggregate demand or output. mishra and montiel (2012) reviewed a number of such publications to assess the effectiveness of monetary policy transmission mechanisms in low-income countries. in sub-saharan african countries, a weak and unreliable monetary transmission dominated by the banking or credit channel was found. saxegaard (2006) compared the effects of monetary policy innovations in nigeria, uganda and cemac2 countries under two monetary policy scenarios; one with banks holding excess reserves and the other in which banks held no excess reserves. for nigeria and uganda, saxegaard (2006) found weak effects of monetary policy on output and inflation in the scenario in which banks held excess reserves. monetary policy innovations had a stronger impact on inflation and output under the scenario in which banks had no excess reserves. for cemac countries, monetary policy innovations had weak effects on aggregate demand indicators under both scenarios. on the contrary, cheng (2006) found a statistically significant effect of monetary policy innovations on the level of prices but no effect on output in kenya. in ghana, abradu-otoo, amoah and bawumiah (2003), using generalised impulse responses, could not find any effects of monetary policy shocks on aggregate demand or output. these findings for some sub-saharan african countries have largely been attributed to underdeveloped financial sectors and poor institutional environment, which restrict lending activity or mute the impact of monetary policy innovations on economic stabilisation. unlike most sub-saharan african countries, south africa has a well-developed financial sector. consequently, it is expected that monetary policy innovations would have the anticipated effect on aggregate demand indicators and output. aron and muellbauer (2002) used a multistep forecasting technique to predict output growth in south africa, taking into consideration several factors including monetary policy regime shifts in the 1980s in south africa. they found that real interest rates impact on output in south africa with the effects persisting for 3 years. gumata, kabundi and ndou (2013) used a large bayesian vector autoregressive model to investigate the relevance of different monetary policy transmission channels in south africa from 2001 to 2012. they found that for the interest rate channel, there was evidence of changes in the repo rate impacting on short-term interest rates, the cost of capital and therefore investment spending by corporates and households, and consequently the level of output. a more recent study on south africa is by du plessis, smit and steinbach (2014), which compared the efficacy of dynamic stochastic general equilibrium models (dgse) as a potential forecasting tool for consumer price index (cpi) and growth to other private sector consensus approaches. du plessis et al. (2014) found that the dynamic stochastic general equilibrium (dsge) models outperform the private sector models especially over longer horizons, whereas the private sector models outperformed the dsge model in the near term as forecasting tools for cpi inflation and growth. these studies on sub-saharan africa and more specifically south africa have looked mainly at the channels of monetary transmission or the impact of a monetary policy shock on inflation, interest rates, exchange rates and aggregate level of output. the response of a specific component of aggregate demand to a monetary policy shock has not been given adequate attention in the sub-saharan african literature. bernanke and gertler (1995), looking at the credit channel of monetary policy transmission in the united states, found that inconsistencies with theory emerge when output or aggregate demand is decomposed into its interest sensitive components. there were differences in the magnitude, timing and composition of spending effects. long lived assets, such as residential investment and consumption of durables which should respond to real long-term rates, equally responded to monetary policy shocks, which ideally impacts on short-term rates (bernanke and gertler 1995). again, in the monetary policy literature on sub-saharan africa, there is very little evidence of the use of tvp-var. one such study is mwabutwa, bittencourt and viegi (2013) on malawi (unpublished). other papers that have used tvp-var looked at other issues such as the impact of house and stock prices on consumption (peretti, gupta & inglesi-lotz 2012) and the impact of house prices on interest rates (aye, gupta & modise 2013). this article, therefore, adds to scarce sub-saharan african literature by looking into: (1) the keynesian interest rate channel of monetary policy transmission in south africa, focussing on the behaviour of household credit and household consumption; (2) using the tvp-var with stochastic volatility by primiceri (2005) to capture the time-varying nature of the underlying structure of the south african economy and whether it performs better than the constant parameter var in so doing; and (3) policy implications emerging from the findings of the study. in testing the hypotheses of the interest rate channel of monetary policy transmission, the aim is to see how household credit and ultimately household consumption have evolved in south africa: (1) before inflation targeting (1994–1999), (2) after inflation targeting (2000–2007) and (3) during the global financial crisis (2007–2012) in response to different monetary policy positioning. empirical methodology the tvp-var model evolves from a basic structural var model specified as: where yt is a k × 1 vector of observed variables, and a, π1t,…,πst are k × k matrices of coefficients. the disturbance term μt is a k × 1 structural shock assumed to be μt ~ n (0, σ), where: the simultaneous relations of the structural shock are specified by recursive identification, assuming that a is a lower triangular matrix with diagonal elements equal to one: equation 1 is re-specified as a reduced from var model defined as follows: where bi = a−1πi, for i = 1,…s. stacking the elements in the rows of the bi’s to form β(k2sx1) vector and defining xt = ik⊗(y′t−1,…..y′t−s) where ⊗ denotes the kronecker product. we can re-write equation 2 as: all the parameters in equation 3, β, a and σ are time-invariant. to extend this to a tvp-var, the parameters must be allowed to change over time. following nakajima (2011) and primiceri (2005), equation 3 can be re-defined in a tvp-var specification as follows: where the coefficients βt, at and σt are all time-varying. following primiceri (2005), to model the process for these tvps, let αt = (α21, α31, α41,……αk,k−1)′ be a stacked vector of lower triangular elements in at; and ht = (h1t,…,hkt), where , for j = 1 …,k, t = s + 1,…n. it is assumed that the tvps in equation 4 follow a first-order random walk process, where βt+1 = βt + μβt, αt+1 = αt + μαt, ht+1 = ht + μht: for t = s + 1,…,n, where: allowing all parameters to vary over time causes an over-identification problem and makes the likelihood function intractable and the model difficult to estimate (nakajima 2011; peretti et al. 2012). stochastic volatility also raises the possibility of overparameterisation, which impedes precise estimation of the parameters and impulse responses (koop and korobilis 2010). consequently, the tvp-var is estimated using the markov chain monte carlo (mcmc) methods. the mcmc algorithm avoids the issue of dimensionality and helps to mitigate over-identification or parameter explosion and nonlinearities in the relationships between economic variables emanating from the assumption that all the parameters in the tvp-var follow a first–order random walk process (banerjee and malik 2012). furthermore, the essence of the mcmc method is to assess the joint posterior distributions of the parameters of interest based on set prior probability densities within a bayesian inference. flat priors are set for the initial stage of the tvp-var such that μβ0 = μα0 = μh0 = 0 and σβ0 = σα0 = σh0 = 10 × i. flat priors are set based on the assumption that we have no prior information about the south african economy. unlike in nakajima (2011) which follows primiceri (2005), we do not set our priors based on the estimates of the constant parameter var. the two estimation approaches are kept mutually exclusive of each other. the essence is to test whether the tvp-var performs better compared to the unrestricted constant parameter var with a few exogenous control variables in capturing the underlying structural changes in the fundamentals of the south african economy. in the estimation, m = 10 000 samples are drawn discarding the initial 1000 samples. the geweke (1992)3 convergence diagnostics (cd) and inefficiency factors are used to establish whether the posterior means converge to the posterior distribution. if the cd statistic is less than 1 and the inefficiency factors are less than 100, we fail to reject the null of convergence to the posterior distribution. this is done at 95% credible intervals4 and 5% level of significance. in this case, the estimated posterior prior mean will be close to the true value of the parameter and will be included in the 95% credible interval. data the variables selected for estimation in this article are based on the keynesian interest rate channel of monetary policy transmission. quarterly data are used in this article from 1994q1 to 2012q4. all variables are from the sarb and international financial statistics of the imf detailed in appendix 15. these are the south african reserve bank repurchase rate (repo), real lending rate (rrate), domestic private credit to households (hhcr), and real aggregate household consumption of final goods and services (hc). as detailed in table a2, the variables are i(1) as per results of the augmented dickey–fuller (1981) adf test and phillips–perron (1988) both with a h0: non-stationarity, and the kwiatkowski, phillips, schmidt–shin (kpss) (1992) test which has a h0: stationarity. the mean, maximum and minimum levels of the repo rate and real lending rate are highest post transition and during inflation targeting and lowest during the global financial crisis. this shows higher levels of monetary tightening post transition and during inflation targeting, than during the crisis. consequently, the mean, maximum and minimum levels of household credit and household consumption are lowest post transition, during inflation targeting and highest during the period of the crisis (see table a3). using the standard deviation as a basic measure of volatility, the inception of inflation targeting (2000–2007) shows the lowest levels of volatility in the repo rate, real lending rate and household credit. volatility for household consumption is lowest post transition from apartheid and highest post inflation targeting, declining marginally during the global financial crisis. cross-correlation analysis across the different time periods also shows significant differences (see table a4a–a4c). the period post transition shows positive correlation between the repo rate, lending rate and household credit and household consumption. this period was mainly characterised by measures to extend financial access to previously excluded households who were in the majority (smal and de jager 2001). thus, other systemic changes that enhanced financial access must have overshadowed the impact of the cost of credit to households and on household consumption. the period post inflation targeting shows evidence of the cost of credit to households as depicted by strong negative correlations between repo and lending rates on one hand and household credit and household consumption on the other hand. there is also a strong positive correlation between household credit and household consumption emphasising the extensive role of credit in household consumption in south africa. the period during the global financial crisis shows much stronger evidence of the cost of credit to households, evidenced by the negative correlation between the repo rate, real lending rate and household consumption. there is also a lower positive correlation between household credit and household consumption as compared to the preceding period. this could probably be explained by the fact that household incomes were over leveraged by this time as well as the credit crunch that characterised the period of the global financial crisis. empirical results a var(2) model is estimated that examines the impact of the repo rate (repo) on the real lending rate (rrate), private domestic credit to households (hhcr) and aggregate household consumption of final goods and services. we consider the timing, direction and duration of the response of household credit and household consumption to a shock to the repo rate. although the variables are i(1), the estimation of the constant parameter var is done with the data in levels as recommended by sims (1980) and further evidenced by disyatat and vongsinsirikul (2003), eichenbaum (1992). the variables are ordered recursively under the assumption that variables ordered early affect subsequent variables contemporaneously with no feedback effect. the recursive ordering is determined by economic theory, using the traditional keynesian theory on the interest rate channel of monetary transmission in mishkin (1995). the repo rate is the monetary policy tool that determines other short-term interest rates at which households borrow for consumption expenditure. duca (1995) found a strong positive relationship between the availability of consumer instalment loans by banks and various indicators of monetary policy. cholesky decomposition is then used to factorise the covariance matrix of the var model. thus, the relationship between the reduced form errors and the disturbances become lower triangular. as in cheng (2006), a non-fuel world commodity price index (comm) and a world fuel price index (oil) are used as exogenous variables to control for external shocks in the constant parameter var estimation. a wage index (wages) is also used to capture the impact of externally driven supply side factors that have driven structural breaks in south africa over the sample period. although wage agitations are domestic in nature, factors driving the reasons for above inflation wage demands are largely external, such as the upside risks posed by prevailing global economic trends to the rate of inflation and depreciation of the south african rand. thus, the use of a wage index here as an exogenous factor is not the ideal, it is simply a proxy to ‘capture the impact of’ externally driven supply side factors driving wage agitations in south africa. this is purely an improvisation solely for the purpose of this article. an optimal length of two lags determined by the standard lag order selection criteria applied to a constant parameter var is used in the estimation (see table a5 for results of lag order selection results and table a6 for var stability tests). three out of the five criteria selected 5 lags, while two criteria selected 2 lags as the optimal lag length. although both 5 lags and 2 lags meet the var stability condition (all roots lie within the unit circle) two lags are preferred to 5 lags in the estimation. this is because in the tvp-var estimation 2 lags are used. hence, to ensure consistency with the constant parameter var estimation, 2 lags are used for both estimations. the tvp-var results in table 1 give the estimates for the posterior means, standard deviations, 95% credible intervals, the cd of geweke (1992) and inefficiency factors computed using the mcmc sample. table 1: estimated results of the selected parameters in the time-varying parameter vector autoregressive model. the cd statistics are less than unity, and the inefficiency factors are less than 100. thus, we fail to reject the null hypothesis of convergence to the posterior distribution at 5% level of significance. the low inefficiency factors show that the mcmc algorithm efficiently produces posterior draws. additionally, the estimated posterior mean for each parameter falls within their respective 95% credible intervals. thus, the estimated posterior means are close to the true value of the parameters. figure 1 plots the posterior draws for each data series (top panel) and posterior mean estimates for stochastic volatility of the structural shock (bottom panel). the results show that repo rate volatility peaked sharply in 1998, early 2000s and 2009. these volatility peaks in the repo rate have been attributed to increase in interest rates by the sarb aimed at mitigating capital flow reversals from south africa emanating from the spill over effect of the asian crisis in 1997, the global economic aftermath of the 9/11 usa attack and the global financial crisis, respectively. figure 1 also depicts periods of downward trends in repo rate volatility. repo rate volatility trends downward from 1998 towards the year 2000 as a result of south africa adopting inflation targeting and the resumption of capital flows back towards emerging markets because of a strong global recovery from the asian crisis (sarb 1999), from 2004 to 2007 thereabouts because of stronger global economic growth, higher level of domestic output per worker, higher economic growth and declining rate of inflation (sarb 2004). repo rate volatility then declines from 2009 onwards, staying very low thereafter because of an expansionary monetary policy stance aimed at stimulating economic activity to address the large output gap in south africa (sarb 2009). figure 1: posterior draws (a-j) for each data series and posterior mean estimates for stochastic volatility of the structural shock. the lending rate volatility closely tracks trends in repo rate volatility, peaking and declining in the same periods as the repo rate before inflation targeting, after inflation targeting and during the global financial crisis for the same reasons as explained above. household credit volatility peaks sharply post transition towards 1998. adequate banking sector liquidity and a declining repo rate led to cheaper cost of credit and an extension of credit (sarb 1998). household credit volatility after 1998 stays flat and close to zero throughout the inflation targeting period and during the global financial crisis. among other possible factors, this could be attributed to improvements in the ease of acquiring credit in diverse forms beside direct bank loans for consumption by previously excluded households (smal and de jager 2001). household consumption volatility first reflects the volatility in household credit post transition towards 1998, after which it trends with the volatility patterns in the repo rate and lending rate. the sturdy pace of increase in household consumption post transition was attributable to an increase in all aspects of domestic expenditure post transition despite weak growth, peaking sharply in 1998. specifically, household consumption of non-durable goods and services was accountable for this upward trend in household consumption, as compared to durable goods and semi durable goods consumption, which declined during this period (sarb 1998). household consumption volatility again peaks slightly in the early 2000s. despite the weak global growth, domestic growth in south africa remained robust. there was an increase in non-agriculture sector employment, increases in salaries and wages and therefore household disposable income (sarb 2002). from 2004 onwards, household consumption volatility moderately trends downwards, staying close to zero after 2010 because of the availability of other forms of credit, increased ease of acquiring debt-financed consumption and consequently overleveraged household disposable income. this is confirmed by the high household debt to disposable income ratio in south africa (76%) (sarb 2013). the increase in diverse forms of credit in 1998 is captured to some extent by trends in household credit over the sample period. this is because in numerous literature on financial inclusion credit to households or the private sector is used as a measure of financial inclusion or access to finance although financial inclusion itself is much broader than just credit extension. overleveraged household incomes could be measured by household debt to disposable income ratio and unemployment by unemployment rate. we do not control for this in the model directly; however, the extent to which one could acquire credit for consumption is captured by household credit and household consumption, both of which are not possible if one’s income is overleveraged, and also require that one is employed in order to be able to acquire credit for debt finance consumption. thus, these other variables are to some extent indirectly controlled for in the model. the sample autocorrelation function, the sample paths and posterior densities for the selected parameters are shown in figure 2. figure 2: estimates of the moments and posterior distributions of the model: with (a) sample autocorrelations (b), sample paths and (c) posterior densities. after discarding the initial (1000) samples in the burn-in period the sample paths look stable and the sample autocorrelations drop smoothly. this indicates that the sampling method efficiently produces samples with low autocorrelation (nakajima 2011). figure 3 plots impulse responses of the time-invariant var and tvp-var models. figure 3a–f illustrates the constant parameter var impulse response functions. figure 3a–f shows how real lending rate, household credit and household consumption respond to shocks in the repo rate and how the repo rate responds to shocks in itself. figure 3a–f further shows the response of household consumption to shocks in household credit and conversely the response of household credit to shocks in household consumption. figure 3g–j details impulse response functions of the tvp-var estimation. the time-invariant var averages the impulse responses at all points in time over the sample period. on the contrary, the impulse responses from the time-varying var model show the magnitude of the responses of the tvps for each selected period – one quarter, two quarters, 1 year and 2 years. as can be observed from figure 3a–f, the response of the repo rate to shocks in itself is positively significant till the eighth quarter, after which it dissipates. the real lending rate impulse response follows a trend similar to that of the repo rate. real lending rate responds contemporaneously to a shock in the repo rate spiking in the first quarter in response to the shock. it then stays significantly positive for the first six quarters after the shock. figure 3: impulse response functions of (a–f) constant parameter var model and (g-j) time-varying impulse responses (tvp-var) models (repo, rrate, hhcr, hc) to a one standard deviation change in the repo rate. figure 3 (continues…): impulse response functions of (a–f) constant parameter var model and (g-j) time-varying impulse responses (tvp-var) models (repo, rrate, hhcr, hc) to a one standard deviation change in the repo rate. household credit declines steeply one quarter after a repo rate shock, becoming negatively and statistically significant in the second quarter after which it dissipates. household consumption responds more moderately to a shock in the repo rate with a lag, becomes negative and statistically significant in the third quarter after the shock and declines steadily thereafter. both household credit and household consumption respond contemporaneously to a shock in each other, staying positive and statistically significant for most part of the sample period. it implies that although household consumption is credit driven, household credit is also demand driven by household consumption in south africa. figure 3g–j depicts the impulse responses of the tvp-var model at different horizons of one quarter, two quarters, four quarters and eight quarters at each point of the sample. the tvp-var impulse responses vary more significantly over time as compared to the constant parameter var impulse responses. the tvp-var impulse response of household credit to a repo rate shock shows a steep decline and greater variability, especially in the short-term, than in the constant parameter var impulse responses. the decline in household credit is, however, milder over longer horizons as depicted by the two, four and eight quarters ahead trajectories. household credit, however, remains largely negative and on a downward trend after the political transition post 1994 to 2000, and after the adoption of inflation targeting in south africa in 2000. this trend can be observed across all horizons, but is more pronounced in the short-term than over longer horizons. the steep decline in household credit post transition as explained is in reaction to monetary tightening by monetary authorities in south africa aimed at mitigating the impact of the asian crisis and the capital flight from south africa during this period. the further decline in household credit post inflation targeting is also attributable to the contractionary monetary policy implemented at the time to stem the vast depreciation of the rand because of unprecedented capital outflows and dip in portfolio flows to south africa. we observe a positive response of household credit to a repo rate shock between 2006 and 2008. this is because despite a steady increase in the repo rate from 7% in 2006q1 to 12% in 2008q3, there was an expansion in household income during this period leading a steady increase in household credit, although households incurred more debt in the process (sarb 2012). this explains the positive response of household credit to the repo shock between 2006 and 2008. the repo rate then declined sharply from 12% in 2008q3 to 5% in 2012q4, during which household credit stays positive but trends downwards in response to overleveraged household disposable income (sarb 2014). the tvp-var impulse response of household consumption also shows greater variability in the short-term than over longer horizons. similar to trends in the impulse response of household credit, household consumption stays negative post transition and after inflation targeting, becoming positive after the global financial crisis. it, however, trends downwards approaching zero after 2009. this depicts a close comovement between household credit and household consumption as depicted by the cross-correlation analysis. additional factors driving the downward trend in household consumption post 2010 were job losses, labour stoppages and falls in household disposable income. conclusion and policy implications this study set out to investigate the keynesian interest rate channel of monetary policy transmission in south africa, focussing on the behaviour of household credit and household consumption. the study focussed on three periods: (1) before inflation targeting (1994–1999), (2) after inflation targeting (2000–2007) and (3) during the global financial crisis (2007–2012) during which different monetary policy stances existed. constant parameter var estimation techniques by sims (1980) and tvp-var with stochastic volatility by primiceri (2005) were used in this study. testing the hypotheses of the traditional keynesian interest rate channel of monetary transmission, the results show that household credit and consumption declined during periods of monetary contraction – post transition, and post inflation targeting, and increased during periods of monetary expansion – during the global financial crisis. basically, the hike in the repo rates leads to hikes in short-term interest rates, ceteris paribus, increasing the cost of borrowing for households and worsening existing levels of household debt. the increased cost of borrowing reduces household demand for credit, as households’ debt position would also have worsened. this serves as evidence of the cost of credit effect of monetary policy on household consumption in south africa. the tvp-var impulse responses show more detail and greater variability over time in the response of household credit and consumption to a repo rate shock than the constant parameter var impulse responses. this variability better captures the impact of structural changes in south africa and exogenous shocks on monetary policy conduct and its pass through effect on household credit and consumption in south africa. contrary to the moderate and lagged response of household consumption to a repo rate shock as depicted by the constant parameter var, the tvp-var impulse responses show an immediate steep decline in response to a repo rate shock, especially in the short-term. longer horizons in the tvp-var show milder declines in household credit and consumption to a repo rate shock. this indicates that household credit and household consumption decline more steeply in the short run in response to a monetary tightening in south africa and decline mildly over longer horizons. the mild decline over longer horizons could be attributed to households adjusting their spending portfolios to the budget constraints generated by the monetary tightening. this study, therefore, concludes that there is a cost of credit effect of monetary policy on household credit and consumption in south africa strongest in the immediate short-term, one to three quarters after the shock and milder over longer time periods. however, we also see a period of contractionary monetary policy between 2006 and 2008 that still saw a positive relationship between repo rate and household credit and household consumption in south africa. this is attributable to an increase in household incomes during this period. again although household credit and household consumption increase during the global financial crisis because of an expansionary monetary policy stance, they increase in a decreasing manner as a result of overleveraged household disposable income. finally, the tvp-var algorithm is superior to the constant parameter var in capturing the impact of structural breaks and external shocks on the conduct of monetary policy in south africa and its pass through effect on household credit and consequently household consumption in south africa. in terms of policy implications, the findings of this article show that there are microeconomic effects of changes in macroeconomic policy. monetary tightening affects households’ ability to borrow affordably and further worsens existing household debt, especially as household consumption in south africa is largely driven by debt. for existing debt portfolios, household debt to disposable income ratio would be worsened by the monetary tightening. in the case of new credit, the declining impact of the monetary tightening on household credit would be strongest in the short-term as depicted by the 1q and 2q ahead trajectories in the tvp-var irfs. this would further worsen already muted household consumption expenditure. there is, therefore, the need to take into consideration the microeconomic effects of macroeconomic policy changes. on the brighter side, households without overleveraged incomes should be encouraged to save in financial products with attractive yields thereby taking advantage of the higher interest rates to earn higher yields on their investment portfolios. this could help to mitigate household liquidity constraints over time created by the unfavourable macroeconomic outlook expected to pertain in the short to medium term going forward. in terms of policy implications, the findings of this article show that there are microeconomic effects of changes in macroeconomic policy. monetary tightening affects households’ ability to borrow affordably and further worsens existing household debt, especially as household consumption in south africa is largely driven by debt. for existing debt portfolios, household debt to disposable income ratio would be worsened by the monetary tightening. in the case of new credit, the declining impact of the monetary tightening on household credit would be strongest in the short-term as depicted by the 1q and 2q ahead trajectories in the tvp-var impulse response functions. this would further worsen already muted household consumption expenditure. there is, therefore, the need to take into consideration the microeconomic effects of macroeconomic policy changes. on the brighter side, households without overleveraged incomes should be encouraged to save in financial products with attractive yields thereby taking advantage of the higher interest rates to earn higher yields on their investment portfolios. this could help to mitigate household liquidity 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bank (sarb), 2013, quarterly bulletin, south african reserve bank, pretoria, south africa. south african reserve bank (sarb), 2014, quarterly bulletin, south african reserve bank, pretoria, south africa. south african reserve bank (sarb), 2015, quarterly bulletin, south african reserve bank, pretoria, south africa. the international monetary fund, n.d., international financial statistics of the international monetary fund, viewed 12 may 2016, from http://www.imf.org/external/ uhlig, h., 1997, ‘bayesian vector autoregressions with stochastic volatility’, econometrica 65(1), 59–73. https://doi.org/10.2307/2171813 wilcox, j., 1990, ‘nominal interest rate effects on real consumer expenditure’, business economics 25(4), 31–37. appendix 1 table 1-a1: sources and definitions of variables. table 2-a1: order of integration of the variables. table 3-a1: data properties. table 4-a1: correlation matrix (1994q1–1999q4). table 5-a1: correlation matrix (2000q1–2006q4). table 6-a1: correlation matrix (2007q1–2012q4). table 7-a1: lag order selection criteria. table 8-a1: autoregressive root test for stability of the vector autoregressive (2) model. figure 1-a1: trends in selected south african macroeconomic indicators. footnotes 1. see smal and de jager (2001) for details on the different regimes of monetary policy in south africa. 2. cemac means central african economic and monetary community. it consists of six member countries, namely: gabon, cameroon, the central african republic (car), chad, the republic of the congo and equatorial guinea. 3. in geweke (1992), a comparison is made between the first n0 draws and the last n1 draws. the middle draws are dropped to check for convergence in the markov chain. the cd statistic is given by where with x(i) being the i-th draw, is the standard error of respectively for j=0, 1. the sequence of the mcmc sampling converges to a standard normal distribution if it is stationary. we set m0=1, n0=1000, m1=5001 and n1=5000. is computed using a prazen window with bandwidth (bm) =500. the efficiency factor is defined as ρs, where ρs is the sample autocorrelation at lag s, which is computed to measure how well the mcmc chain mixes. 4. bayesian inference uses credible intervals instead of confidence intervals to describe the uncertainty of the parameter. in mcmc analysis, 97.5% or 2.5% quartiles of posterior draws are usually reported. 5. see appendix 1 for details of variables, unit root tests, and descriptive statistics and correlation matrices. abstract introduction contextualising and defining systemic risk measuring systemic risk data and results summary and conclusions acknowledgements references footnotes about the author(s) gregory m. foggitt department of risk management, school of economics, north-west university, south africa andre heymans department of risk management, school of economics, north-west university, south africa gary w. van vuuren department of risk management, school of economics, north-west university, south africa anmar pretorius department of risk management, school of economics, north-west university, south africa citation foggitt, g.m., heymans, a., van vuuren, g.w. & pretorius, a., 2017, ‘measuring the systemic risk in the south african banking sector’, south african journal of economic and management sciences 20(1), a1619. https://doi.org/10.4102/sajems.v20i1.1619 original research measuring the systemic risk in the south african banking sector gregory m. foggitt, andre heymans, gary w. van vuuren, anmar pretorius received: 08 june 2016; accepted: 18 may 2017; published: 24 oct. 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: in the aftermath of the sub-prime crisis, systemic risk has become a greater priority for regulators, with the national treasury (2011) stating that regulators should proactively monitor changes in systemic risk. aim: the aim is to quantify systemic risk as the capital shortfall an institution is likely to experience, conditional to the entire financial sector being undercapitalised. setting: we measure the systemic risk index (srisk) of the south african (sa) banking sector between 2001 and 2013. methods: systemic risk is measured with the srisk. results: although the results indicated only moderate systemic risk in the sa financial sector over this period, there were significant spikes in the levels of systemic risk during periods of financial turmoil in other countries. especially the stock market crash in 2002 and the sub-prime crisis in 2008. based on our results, the largest contributor to systemic risk during quiet periods was investec, the bank in our sample which had the lowest market capitalisation. however, during periods of financial turmoil, the contributions of other larger banks increased markedly. conclusion: the implication of these spikes is that systemic risk levels may also be highly dependent on external economic factors, in addition to internal banking characteristics. the results indicate that the economic fundamentals of sa itself seem to have little effect on the amount of systemic risk present in the financial sector. a more significant relationship seems to exist with the stability of the financial sectors in foreign countries. the implication therefore is that complying with individual banking regulations, such as basel, and corporate governance regulations promoting ethical behaviour, such as king iii, may not be adequate. it is therefore proposed that banks should always have sufficient capital reserves in order to mitigate the effects of a financial crisis in a foreign country. the use of worst-case scenario analyses (such as those in this study) could aid in determining exactly how much capital banks could need in order to be considered sufficiently capitalised during a financial crisis, and therefore safe from systemic risk. introduction one of the key elements to understanding the propagation of financial crises lies in the understanding of the nature of systemic risk (allen, babus & carletti 2010:1). as the sophistication of the world financial system has evolved, so has the understanding of systemic risk. systemic risk can be an externality of bank distress on the real economy or the financial system as a whole (bernanke 2009). these externalities can be split into three broad categories. firstly, externalities associated with excessive or correlated risk taking; secondly, externalities related to fire sales; lastly, externalities related to interconnectedness (de nicoló, favara & ratnovski 2012:5). systemic risk can also be categorised in both a broad and narrow sense (de bandt, hartmann & peydró 2009:636). the narrow sense concerns contagion effects on the interbank market while the broad sense refers to a common shock to many institutions or markets. in essence, systemic risk is the risk of a disruption to financial services that is caused by an impairment of all or parts of the financial system and has the potential to have significant negative consequences for the real economy (imf, bis & fstb 2009:2). this disruption to financial services was especially prominent during the sub-prime crisis of 2007/2008. the collapse of american international group and lehman brothers in particular illustrated how single, large financial institutions can cause a contagion effect in the financial sector that later spills over to the entire economy (georg 2011:4). the us economy was plunged into recession, declining from 3% growth in gross domestic product (gdp) in 2005 to −3% in 2009 (world bank 2015). given the substantial impact of this event on the world economy, the prevention of such a contagious event must be prioritised, something that is only possible if the systemic risk posed by such financial institutions can be addressed. considering the complexity of systemic risk, it would follow that systemic risk is difficult to measure. given that the national treasury (2011) stated that regulators should proactively monitor changes in systemic risk, it would follow that the accurate measurement of systemic risk is important because regulations should be based on this measurement. furthermore, because systemic risk is such a broad concept, finding a measure that sufficiently encompasses the entire risk and all its complexities is an additional challenge. the research question that follows is therefore whether systemic risk could potentially be overlooked or underreported in south africa (sa) because the correct measurements have either not yet been discovered or are not being used? furthermore, are regulators aware of the levels of systemic risk of the entire financial sector, and the specific banks that are contributing to this risk? in order to address this problem in the sa financial sector, we propose a new way of estimating systemic risk. this is done by applying a marginal expected shortfall (mes) measure using a new technique to calculate the tail distribution component, based on extreme value theory and the hill estimator. these techniques are ideal for modelling unlikely yet large losses and therefore provide distributions more suited to extreme events. additionally, to provide a measure for a longer period and a worst-case scenario simulation, the long-run marginal expected shortfall (lrmes) is calculated. to accomplish this, a monte carlo simulation procedure and cholesky decomposition are used to simulate returns that preserve the sub-prime crisis period volatilities and correlations. this is considered the worst-case scenario because it takes into account the volatility and correlation over the sub-prime crisis period of 1 july 2007 to 31 december 2008 and therefore inflates the tail dependence of the banks. the reason for this is that it represents the period of greatest market volatility and is therefore likely to present a scenario of a very low probability. this provides an interesting comparison because it illustrates the systemic risk index (srisk) values of banks over the sample period, given that they had the volatility and tail dependence shown during the sub-prime crisis. a previous article by lópez-espinosa et al. (2012) measured the systemic risk contribution of standard bank to a sample of international banks but considering that this was the only sa bank used, no meaningful comparison can be made. another measurement approach was undertaken by bartram, brown and hund (2007), but only two banks were considered for sa and no explicit results were reported. the contribution of this article is therefore to measure the level of systemic risk in the sa financial sector and to identify which banks are the largest contributors to the overall level. in doing so, we also make a novel contribution to the field through the development of a new technique for measuring systemic risk. the rest of the article is structured as follows. the next section contextualises the concept of systemic risk and provides an overview of the literature pertaining to it. the ‘measuring systemic risk’ section then presents the methodology used to measure systemic risk, before the ‘data and results’ section describes the data used and subsequently reports on the findings. finally, the ‘summary and conclusions’ section presents a summary of the results and concludes the article. contextualising and defining systemic risk the sub-prime crisis affected not only the us economy but also financial markets across the world (bis 2009:16). this was mainly because of the advancement of information technology and computer systems, which facilitates a greater degree of linkage among global financial markets (kim & ryu 2015:20). an investor seeking higher yields as well as portfolio diversification may invest in any market that offers a greater return on investment. however, these linkages can also lead to increased risk of contagion and informational spillovers (kim & ryu 2015:21). these are two of the three broad elements of systemic risk, with common shocks being the third. contagion refers to the direct linkages that take place between financial institutions such as those in the interbank market. informational spillovers are similar to contagion, but in a more indirect sense, whereby ‘bad news’ concerning a large bank in a given country could result in a negative perception regarding all banks in that particular country’s financial sector. common shocks on the other hand refer to indirect linkages between banks that may occur when they hold similar or identical assets. such correlation between portfolios may lead to fire sales and result in considerably large losses (georg 2011:8). these elements of interconnectedness therefore ensure that an adverse shock in one financial sector has the potential to negatively affect the entire global financial sector and economy. the effect on emerging market economies, however, differed from developed economies in the sense that their systemic risk could largely be attributed to a slowdown or reversal in capital flows that are intermediated through the domestic banking sector (claessens & ghosh 2013:107). challenges that are unique to emerging markets include the following: how to supervise and regulate the shadow banking sector and foreign banks; increasing cross-sectional risks such as contagion and the development of systemically important financial institutions; and the driving of economic outcomes in correlation with domestic financial cycles and subsequent credit booms (claessens & ghosh 2013:115). in order to respond to these challenges, certain policies could be implemented. because the challenges were different, it would follow that the policy responses would also differ for developed, emerging and developing economies. the exact difference between emerging and developing economies is not entirely clear in the literature. the imf world economic outlook database classifies countries according to their gross national income, export diversification, and level of integration into the global financial system (imf 2015). it can therefore be stated that emerging markets are developing economies in the middle-income group that exhibit characteristics of both a developed economy as well as a developing economy. emerging markets essentially fall into a broad grey area between the two main categories. compared to developed economies, developing economies and emerging markets use monetary and fiscal policy less extensively. in particular, fiscal outlays associated with financial sector interventions – such as bank recapitalisation with public funds – are greater in emerging markets (laeven & valencia 2013:226). as an emerging market, sa demonstrates a large degree of global financial integration, and therefore has a greater susceptibility to possible contagion. this contagion could include greater international risk sharing, as well as the risk of transferring negative financial shocks across country borders, and subsequently, increasing the overall level of systemic risk. this interconnectedness magnifies cross-border spillovers early on through channels such as liquidity pressures, global equity sell-offs and a depletion of bank capital (claessens et al. 2010:8). although the sa economy was not unaffected, it generally had a strong financial regulatory framework and macroeconomic fundamentals, both of which allowed the financial system to remain relatively stable during the sub-prime crisis (national treasury 2011:4). the sub-prime crisis may therefore not be the most useful example for examining systemic risk in sa. however, a banking crisis that occurred in the sa financial sector during 2014 provides a more appropriate example. the collapse of african bank limited (african bank) in sa during 2014 was a significant event. the failure of african bank was brought about by a combination of issuing many loans and credit cards (mostly at a high interest rate to low-income consumers) while accepting few deposits. additionally, a large portion of the loans they granted were to consumers who were not creditworthy, leading to the subsequent failure by consumers to repay these loans. this translated into losses of approximately zar6.4 billion. in order to recoup these losses, african bank attempted to raise zar8.5 billion through an unsuccessful second-rights offer, finally culminating in the need for a zar17 billion bailout by the south african reserve bank (sarb). these events may illustrate that the financial sector in sa is possibly not as well-regulated as previously believed. however, the swift action of the sarb was decisive in preventing contagion (imf 2014:7). the fact that the sarb had to intervene to prevent contagion could legitimise the case for a re-examination of the financial sector, its various institutions, their activities and the actual level of systemic risk in the sa financial sector. such a re-examination of the financial sector should distinguish between the two dimensions of systemic risk, namely the cross-sectional dimension and the time dimension. the cross-sectional dimension refers to the structure of the financial system and how it influences, responds to and has the potential to amplify shocks (caruana 2010:2). it follows then that cross-sectional systemic risk refers to the systemic risk at a particular point in time across all institutions (borio & drehmann 2009:3). the cross-sectional dimension of systemic risk therefore focuses on the common exposures and interconnections in the financial system and the potential of a specific shock to propagate throughout the system because of either interconnected balance sheets or direct common exposures. in contrast, the time dimension of systemic risk refers to the build-up of risk that occurs over time with the macroeconomic cycle and the subsequent pro-cyclicality of the financial system (caruana 2010:3). an expansionary economic period is typically characterised by periods of financial innovation where institutions and individuals may undertake more risk, make use of untested financial instruments, while credit may grow quickly and result in higher asset prices. the pro-cyclicality of systemic risk is therefore the underlying build-up of risk over time in areas that may be hidden or underpriced, the result being that during economic contractions, these risks appear and amplify the retrenchment that is already occurring. viewing the build-up of systemic risks as an endogenous cycle illustrates that it occurs during both expansions and contractions and suggests that risk taking should be restrained during an expansionary phase (borio & drehmann 2009:3). this implies that a countercyclical prudential approach may be best for regulating systemic risk. the time dimension therefore focuses on the pro-cyclicality of the business and financial cycles and how they reinforce each other, creating a progressive build-up of risk and increasing financial instability – with the financial sector endogenously creating systemic risk (caruana 2010:3). a number of measures exist for systemic risk, addressing various aspects related to it – such as its macroeconomic measures, granular foundations and cross-sectional measures – and the possible channels through which it can cause financial distress. a more restrictive definition would allow for an accurate assessment of whether an institution’s failure was because of systemic risk and would subsequently ensure that bailouts only occur for institutions whose failure are truly as a result of systemic risk (taylor 2010:33). in general, measures of systemic risk are based on market data, but in order to capture the propagation of shocks through a financial network, the optimal measure should consider the losses a bank would experience, conditional on a market decline (engle, jondeau & rockinger 2015:2). srisk therefore provides a unique approach by including accounting data as an extension to the mes measure, in order to accurately quantify the exact amount of systemic risk an institution possesses. measuring systemic risk the ambition of the dodd-frank act and other measures undertaken in europe, in response to the sub-prime crisis, led to a large number of research groups attempting to produce a measurement for systemic risk (hansen 2012:3). in order to adequately regulate systemic risk, an accurate measurement is needed. the srisk reflects the propensity of an institution to be undercapitalised when the entire financial sector is undercapitalised and is therefore currently the most appropriate measurement for systemic risk (v-lab 2015). this chapter describes the research methodology we follow, namely the calculation of all the inputs required for srisk and then the estimation of srisk itself. two different equations can be used to calculate srisk. the first is set out in equation 1 (brownlees & engle 2015:7): with lvgi,t representing the leverage ratio (di,t+wi,t)/wi,t, k the prudential capital ratio and lrmes the long-run marginal expected shortfall. the lvg measure represents a combination of market and balance sheet data. (di,t+wi,t) is the quasi-market value of the bank’s assets, defined as the sum of the book value of its debt (di,t) and the market capitalisation of the bank (wi,t). the lrmes measure is calculated using either an approximation equation or a simulation procedure. in addition to equation 1, an alternative srisk equation is also specified, which uses mes instead of lrmes as the input. this is presented in equation 2: in equation 2, srisk is calculated by taking into account the prudential capital ratio (k), the bank’s total liabilities (d), the market capitalisation of the bank (e) and the one-day mes at a certain threshold value (in this case −2%). the key differences between the two measures are therefore the choice of mes or lrmes. the sriski,t index across all institutions is then used to construct a financial distress index that is system wide, with the total amount of systemic risk in the entire financial sector being measured as: with (x)+ representing max (x,0). the total amount of capital that the government would need to provide in order to bailout the financial system, conditional on the occurrence of a systemic event is therefore represented by aggregate sriskt. the contribution of negative capital shortfalls (capital surpluses) is ignored because surplus capital is unlikely to be mobilised easily during a crisis through mergers or loans – therefore providing no support to failing institutions. the srisk measure can also be illustrated in percentage form, indicating the systemic risk share an institution possesses, as follows: if sriskki,t ≤ 0, then the srisk%i,t = 0. in order to calculate the srisk for both the bank and the market, the dynamic time-varying volatilities will need to be calculated, followed by the dynamic conditional correlations (dccs) and finally the tail expectations will also need to be captured. these three components will then be used to produce the mes for a threshold value of −2%,1 i.e., the daily equity return of the firm, given that the market as a whole has fallen below the −2% threshold level. the lrmes can then be obtained by using the following approximation equation (acharya, engle & richardson 2012:60): an alternative to equation 5 is a dynamic simulation procedure, which takes into account the conditional volatilities and correlations of returns (brownlees & engle 2015:7). the first component of mes is the conditional volatility. this is calculated using a modified threshold-generalised autoregressive conditional heteroskedasticity (tgarch) known as a glosten–jagannathan–runkle (gjr) garch model (glosten, jagannathan & runkle 1993:1787). the tgarch model used by rabemananjara and zakoian (1993) is an extension of the standard tgarch model but includes the lagged conditional standard deviations and variances as a regressor. the tgarch model equations for the dynamics of volatility are as follows: with the volatility is therefore calculated by maximising the log likelihood function for both the bank and market’s data series. the returns are then adjusted by dividing with these volatilities in order to produce standardised returns. the second component of mes is the dcc. a mean-reverting correlation model allows the correlations to revert to the average long-run correlation ρij=e(zi,tzj,t). in the equations that follow, the correlation dynamics are driven by the variable qij, which gets updated by the cross-product of the volatility-adjusted returns. by using correlation targeting and setting the initial unconditional correlation seed point , a specification in the form of a garch (1,1) model can be illustrated as: the conditional correlations for the two entities are then obtained by normalising qij,t+1 as: where: the same quasi-maximum likelihood method used for the volatilities is then used to find the persistence parameters α and β with the dynamics initialised by setting q11,0=1, q22=1 and . the quasi-maximum likelihood method provides constant, inefficient estimates but remains the best choice in order to avoid numerical optimisation in high dimensions (christoffersen 2011:164). the log likelihood equation that will be maximised is illustrated using the bivariate normal distribution function for z1,t and z2,t as: an important feature to note about this model is that the persistence parameters will be constant among the two entities. the implication of this is that the level of correlation will change over time, but the persistence will not. the persistence in correlation is also different to the persistence in volatility. the dcc model can be written in matrix notation as: where qt+1 is a positive semi-definite matrix because it is a weighted average of positive definite and positive semi-definite matrices, which will cause the correlation matrix and covariance matrix to also be semi-definite. in summary, the dcc model estimation occurs as follows. firstly, the volatilities are calculated using the gjr-garch model, then the returns are adjusted using these volatilities, allowing the calculation of the unconditional correlation matrix. finally, the correlation persistence parameters α and β are estimated in order to obtain the dccs. the final component involves the estimation of tail expectations. this study contributes a new parametric approach based on extreme value theory to model the tail expectations. extreme value theory can be viewed as a way of smoothing and extrapolating the tails of an empirical distribution (hull 2015:290). extreme value theory therefore shifts the focus from modelling the entire distribution to modelling the tail behaviour alone and as a result requires fewer degrees of freedom (skoglund & chen 2015:104). asset returns approach a normal distribution over a long time horizon; therefore extreme value theory is only useful over short time horizons, such as daily periods. however, this gives rise to a potential problem relating to the assumption that all returns are independent and identically distributed (i.i.d.). as a result of the time-varying variance patterns that take place over short time periods, the i.i.d. assumption does not hold, and the variance dynamics have to be removed before applying extreme value theory (christoffersen 2011:18). conveniently, the volatility-adjusted returns we constructed earlier can be defined as: because the assumption of i.i.d. can be made regarding the volatility-adjusted returns, extreme value theory can be applied to them. extreme value theory in this situation is concerned with modelling the tail distribution of returns, with the tail defined by the user (christoffersen 2011:138). in this case, the threshold value (u) is selected as −2% for the market. one of the key points in extreme value theory is that any observations (y) that go beyond the threshold value (u) will converge to the generalised pareto distribution (gpd): where β > 0 and y ≥ u. the tail-index parameter ξ is responsible for the shape of the distribution and the speed with which it approaches zero as y approaches infinity. we make the assumption that the tail-index parameter is positive, therefore allowing the use of the hill estimator to approximate the gpd. because this study is concerned with extreme losses as opposed to extreme gains, the methodology will only be applied to the negative of returns. using the hill estimator, the expected shortfall can then be calculated as: where: equation 16 therefore calculates the daily expected shortfall, given that the returns are below the threshold value of −2% (christoffersen 2011:143). this is known as the tail distribution of the market. considering that the volatilities, correlations, and tail expectations have been estimated, the final step is to now use the three calculated components to obtain the mes. because we changed the technique for measuring the tail expectations for the bank and market, it follows that the original mes equation (see brownlees & engle 2012:10) will need adjustment. mes is adjusted to: where represents the expected shortfall of the market beyond the threshold value of −2%, while represents the expected shortfall of the bank on the number of occasions when the market breached its threshold value. in addition to the mes values, we also use a simulation procedure to construct hypothetical values of mes over a longer time period, which take into account the historical volatilities and correlations. the process we follow in this study is a new contribution that uses the monte carlo simulation procedure and cholesky decomposition to simulate returns that preserve the volatilities and correlations of returns over a specific time period. because we are simulating returns for a crisis period, the sub-prime crisis provides the appropriate sample period. the exact time period used will be 1 july 2007 to 31 december 2008. a crisis scenario where the market return falls below −40% is rare, with only three such falls ever to have taken place. these are the crash in 1929 (black tuesday), the dotcom bubble in 2000 and the sub-prime crisis in 2008. in order to account for this scarcity, 50 000 draws will be made. the average of these draws, which return a result, will then be calculated, giving the final lrmes as: the final lrmes is then used as an input into the alternative srisk equation. the lrmes may provide an advantage in that it provides a prediction over a longer, hypothetical crisis period. it is therefore more likely to represent more of a ‘worst-case scenario’ for banks. the lrmes value will also be constant for the entire period 2001 to 2013. the reason for keeping the lrmes constant is because this will allow the estimation of srisk values using the balance sheet data for the current period while investigating the effect that sub-prime crisis volatilities and tail dependence would have had in that period. data and results all balance sheet data were acquired from fitch ratings agency in the united kingdom. the data cover the period 2001–2013. fitch data are reported in usd; therefore in the case of sa banks, the values are converted using the exchange rate at the end of the reporting period of that particular year to arrive at the zar value. the equity returns and market capitalisation data for sa are acquired from the inet bfa data set. us equity returns and market capitalisation data are retrieved from the bloomberg database. daily stock market returns data are used for the period 2001–2013. considering that the equity returns data are an integral part of the study, the entity selected for participation in the study will be conditional on its listing on a stock market. for the sa financial sector, the ftse/jse all-share index (alsi) is used and five banks are studied. although it may be argued that the other sa banks are relevant to this study, data availability was a limiting factor. financial data are only available for the five largest banks, and nevertheless, these banks account for 90.5% of banking assets in sa. considering that bank size is a significant input for the srisk measure, it may be argued that even if data were available, the results for these banks would be insignificant by comparison because they are unlikely to contribute substantially to the undercapitalisation of the financial sector. when a bank has more than the required amount of capital during a crisis scenario, the srisk values would be negative, thereby indicating a capital surplus. in particular, srisk measures the amount of capital that would be needed during a crisis to maintain a capital to asset ratio of 8%.2 the srisk (%) contribution measures the bank’s percentage of total financial sector capital shortfall. it follows then that banks with the highest percentage of srisk are the most vulnerable during a crisis, but are also the most responsible for causing the crisis. total srisk in the entire sa financial sector is presented in figure 1. figure 1: systemic risk index of the south african financial sector. from figure 1, it is clear that using the daily mes value resulted in the smallest srisk value. the simulated lrmes measure takes into account the historic volatility and correlation of the sample period, which includes the sub-prime crisis period of 1 july 2007 to 31 december 2008 and therefore inflates the tail dependence of the banks. the reason for this is that the sub-prime crisis represented a period of larger than normal market volatility and therefore results in inflated lrmes, and subsequently srisk values. henceforth, to represent more moderate scenarios, only the srisk measure using the approximated lrmes as in input measure will be reported. figure 2 presents the amounts of srisk each individual bank was responsible for producing. figure 2 illustrates some interesting characteristics. firstrand bank displayed large capital surpluses (negative srisk values), which offset much of the srisk that the rest of the financial sector was responsible for producing. all the banks showed increased srisk measures over the period 2002 to 2003 when the stock market crash took place, as well as during the sub-prime crisis. following that, the levels of srisk have generally decreased with the exception of investec, which displayed a steady upward trend. standard bank contributed a large amount of srisk during the sub-prime crisis period but was only responsible for small contributions during the rest of the period. in general, sa banks seem to have increased srisk levels during and following crisis scenarios. considering the manifestation of systemic risk in emerging markets and the role that volatile capital inflows play, this event may be evidence of a link between the two factors. a spike of this nature may raise questions about the role of capital flows in contributing to systemic risk in sa and emerging markets in general. that is, a build-up of foreign capital may have taken place, then once a crisis occurred, the capital was withdrawn and left the bank undercapitalised. figure 2: systemic risk index of each south african bank. another conclusion that can be made is that the sa financial sector as a whole generally displays low levels of systemic risk, with many banks in fact displaying large capital surpluses. the only years in which the sector as a whole had a positive amount of srisk were 2002 to 2003 and 2008. however, during a crisis scenario, capital surpluses may be misleading. brownlees and engle (2015:8) argued that surplus capital held by other banks during a financial crisis is unlikely to be easily mobilised and used to bail out partnering banks. therefore, assuming low market liquidity, srisk is reported as: the percentage contribution of each bank to the total srisk of the sa financial sector is presented in table 1 and figure 3. figure 3: systemic risk index contribution (%) of each south african bank. table 1: systemic risk index contribution (%) of each south african bank. in figure 3, the effect of crisis periods on sa banks can be seen. practically, a 0% contribution indicates that those specific banks contributed no systemic risk. during both crisis periods, the srisk contribution of investec dropped rapidly as other banks increased their contribution. during 2002, nedbank took over as the leading contributor while during the sub-prime crisis, standard bank contributed the most. this may be indicative that systemic risk in the sa financial sector is not an inherent characteristic but largely determined by external factors. firstrand was clearly the least systemically risky, with no contributions ever above zero. investec could be classified as the most systemically risky because it was responsible for 100% of the systemic risk at most points during the sample period. the spikes displayed by other banks as soon as a crisis takes place in another economy may make a ranking based on srisk contentious. investec was the smallest of the big five banks, yet it contributed the most systemic risk. however, when financial crises or turmoil occurred in foreign countries, the systemic risk levels of the sector increased. this may lead to an argument regarding the success of regulatory measures in mitigating systemic risk. based on the results, sa’s regulatory approach was successfully mitigating systemic risk, but came under more pressure when crises occurred in foreign countries. it is therefore likely that a future financial crisis in areas such as china or europe could have a similar or even larger effect. it is also worrisome that no prediction could be made as to which bank would be the most affected prior to a crash or crisis. interestingly, standard bank was the most risky during the sub-prime crisis, and nedbank was the most risky following the stock market crash. given the absence of crises, however, investec was clearly the most systemically risky bank in sa over the rest of the sample period. the reasons for investec’s large contribution of systemic risk can be explained by looking at some of the components used in the srisk equation, namely the leverage ratio (table 2) and lrmes (table 3): table 2: leverage of each south african bank. table 3: long-run marginal expected shortfall of each south african bank. based on the components, it is clear that investec has significantly higher leverage ratios and in many cases more than double that of the other banks. additionally, the lrmes is also higher, indicating it has a higher tail dependence. the implication of this is that when the alsi declines, investec shares are more affected by this than the other banks. firstrand bank by comparison has the lowest levels of srisk in the sa financial sector. an investigation of the components shows that it has low leverage ratios and lrmes values, indicating that even though it has the highest market capitalisation of all the banks, its lower amounts of liabilities offset the potential effects of this. its lrmes values also show that firstrand had less tail dependence and was therefore not as significantly affected by an alsi decline. although investec contributes the most systemic risk, the actual amount of systemic risk in the sector is not uncontrollably high because most other banks display capital surpluses. however, in a crisis scenario when liquidity dries up, there may be systemic implications, and this is before taking into account factors related to interconnectedness. additionally, the change in srisk contributions during the period following the stock market crash and sub-prime crisis period may be indicative of vulnerabilities in the economies following upswing periods (claessens, ghosh & mihet 2013:157). this further strengthens the argument of a different manifestation of systemic risk in sa, whereby the systemic risk lies in the amount of capital inflows in the economy and potentially the regional source of these capital flows. the argument may be made that the total financial sector srisk will always increase as the size of the financial sector increases. that is, as banks undertake more liabilities, it will follow that the amount of srisk increases. increases in market capitalisation will, however, not offset these increases because the market may malfunction during a crisis. external factors such as the stability of financial sectors in foreign countries will then also need to be taken into account. a final conclusion is that all financial sectors are not the same when it comes to systemic risk and the determinants may differ for various countries. similarly, individual banks may also produce srisk as a result of different activities. the causes of srisk for the united states are largely inherent (see laeven, ratnovski & tong 2014:15), i.e., they are within the us financial sector. in contrast, the sa sector may be affected by factors outside of its own financial sector and the economic fundamentals of the country may be largely irrelevant. summary and conclusions the sub-prime crisis sparked a renewed interest in systemic risk. this is arguably one of the most important, yet least understood risks. it may therefore be perplexing that a single definition for systemic risk cannot be agreed upon yet. at present, a broad definition refers to the risk of a financial system collapse. however, part of the problem with identifying systemic risk may relate to its manifestation within different economies and countries, something which a broad definition does not capture. the sub-prime crisis showed that systemic risk in developed economies such as the united states occurred as a result of large, highly leveraged banks undertaking complex activities that left them undercapitalised. emerging markets by comparison were affected both differently and belatedly through third-party effects. interestingly, none of the economic fundamentals of emerging markets such as sa changed, yet they were still affected by the crisis emanating from the united states. this illustrates the global impact that a large enough level of systemic risk could have. this article measured the level of systemic risk in sa, and subsequently identified which banks were the largest contributors to this level of systemic risk. in doing so, we also contributed a new technique for measuring systemic risk. the level of systemic risk for sa provides an interesting analysis. the largest contributor to systemic risk throughout most of the sample period was the smallest bank in the sample. however, when the stock market crash took place in 2002, systemic risk contributions from the other banks increased. a similar, more dramatic situation occurred during the sub-prime crisis. during both these periods, the total financial sector systemic risk also increased markedly. the implication is that systemic risk levels within sa seem to be largely dependent on external factors, regardless of the economic fundamentals of the country itself. whether regulatory measures adequately consider these factors for financial stability is arguable. the implications of these findings are that in addition to complying with individual banking regulations such as those laid out by basel, banks should ensure that they always have sufficient capital reserves in order to mitigate the effects of a period of financial turmoil in a foreign country. these levels of capital can be determined through worst-case scenario analyses – such as those performed here – to ensure that banks are sufficiently capitalised during a financial crisis and therefore protected from systemic risk. considering the increased levels of systemic risk in sa following crisis periods in foreign countries, and the different way in which systemic risk manifests in emerging markets, it may be worth investigating which particular events have the largest impact on systemic risk in sa. further studies could also take a more granular approach, with the objective of determining which bank-specific characteristics result in that particular bank having a larger amount of systemic risk. if banks and regulators are more informed of the sources of systemic risk, they may be able to pre-empt the risk and ensure that sufficient capital is available. acknowledgements we gratefully acknowledge the support of the north-west university school of economics and the reviewers for their valuable feedback. competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions all authors made significant contributions to the study. references acharya, v.v., engle, r. & richardson, m.p., 2012, ‘capital shortfall: a new approach to ranking and regulating systemic risks’, the american economic review 102(3), 59–64. https://doi.org/10.1257/aer.102.3.59 allen, f., babus, a. & carletti, e., 2010, financial connections and systemic risk, working paper no. 16177, national bureau of economic research, cambridge, ma. bank for international 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document, pretoria. taylor, j.b., 2010a, ‘defining systemic risk operationally’, in g. shultz, k. scott, j. taylor (eds.), ending government bailouts as we know them, pp. 33–58, hoover institution press, stanford, ca. world bank, 2015, world development indicators, viewed 20 march 2016, from http://data.worldbank.org/data-catalog/world-development-indicators footnotes 1. we follow the work of brownlees and engle (2012:10) and specify a market drop as a decline of −2% in the market index. 2. eight per cent is the minimum fraction of capital (as a ratio of total assets) that the basel committee requires each bank to hold. sajems ns vol 2 (1999) no 2 240 geological occurrence and economic feasibility in closing decisions by gold mines stefano mainardi! department of economics. university of natal. pietermaritzburg abstract with successful exploration of deposits often lagging behind mineral extraction, and the international price of gold showing no signs of recovery, mining companies are under pressure to reassess their strategies. the decision whether or not to close a mining activity is the outcome of a process of adapting expectations to a changing economic and geological environment. part of the literature emphasizes the role ofthe mineral price and operating costs. however, the extent, pace and intertemporal allocation of metal recovery is in practice determined by a complex interaction of both these with other factors. following a review of theoretical interpretations, and a reformulation of associated hypotheses, binary-response models are applied to a sample of gold mines in mainly three major southern hemisphere producers (australia, south africa and chile). jel q32 introduction gold production around the world may be facing a stagnating tendency by the end of the 1990s. among major gold producers, south africa and australia are expected to have to deal with relatively more severe problems of potential closure of mines. whereas in australia this might be partly offset by the opening of new mines, many gold mining companies in both countries seem to increasingly rely on the opening and expansion of new mining operations outside their countries (roskill, t 995: 109; gooding, 1996). in south africa, restructuring efforts by mining houses and technological innovations, along with enduring stable performance in the rand gold price, have so far prevented a continuous increase in the number of marginal gold mines. the decision to shut down a mine may be either temporary or permanent. except for particularly disruptive events which can almost permanently shorten the life of a mine, the latter case tends to occur when production is no longer r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 241 sajems ns vol 2 (1999) no 2 economically attractive, in terms of price-cost relationship. in several cases, this process of depletion of the deposit does not coincide with a near-complete physical exhaustion, since the remaining ore does not justify additional investment, or the replacement of old investment capacity (vogely, 1982: 251). however, this interpretation of the closing decision by mines should be refined in terms of different definitions of economic feasibility and geological availability of a mineral contained in a deposit. these definitions may include aspects such as market uncertainty, demand and price expectations, and technological improvements allowing a conversion of adjacent potentially exploitable mineral ores into reserves. this study relies on recent information on open and closed mines located in major gold producer countries, particularly australia, chile and south africa. the aim is an assessment of the role of economic and geological factors which may influence decisions to permanently or temporarily close down a mining operation. without seeking to provide a comprehensive survey, the following section examines contributions to the theory of mine depletion, providing thereafter, a possible analytical framework of mine behaviour. partly drawing on the theoretical background provided earlier, this analytical framework is tested with binary-choice (linear probability and logit) models. this is followed by concluding remarks in the last section. reserves, resources and mine profitability a distinction among different concepts of geological availability is a necessary preliminary step to an analysis of the optimal development of a mine. in terms of categorisations such as those by mckelvey, govett and fettweis (vogely, 1985; govett-govett, 1976: 18; siebert, 1983: 33), reserves are defined as geologically identified, economically exploitable resources, i.e. that part of resources which (i) is known following sutlicient geological evidence, and (ii) can economically be exploited for the extraction of a mineral commodity, at the time of determination, namely at present and in the near future. according to a decreasing degree of geological assurance, one usually distinguishes among proven, probable and possible reserves (especially for petroleum), or, following a more recent terminology for most minerals, among measured, indicated and interred reserves. the respective margins of errors for ore grade and tonnage of a mine deposit range from 10-20% for measured reserves, to possibly more than 30% (or 50% for some authors) for inferred reserves. in practice, reserve estimates reported by mining companies refer to 'demonstrated', i.e. measured and indicated, reserves, excluding inferred reserves. moreover, in some cases only the recoverable share of these reserves is r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 242 accounted for, to allow for material lost with extraction2• another reason for some underreporting by mining companies may be due to tax purposes, with the indication of a 'minimum quantity' of remaining ore which would still ensure investors about a sufficient time horizon and justify exploration outlays. a broader concept of mineral availability is represented by resources, which include currently (reserves) and potentially exploitable mineral ores. nonreserve resources represent a target for future evaluation. they can be below current levels of economic feasibility (sub-economic, thus implying the need for future mineral price increases or equivalent technological advances), and/or geologically known with less confidence (hypothetical and speculative). in the early theoretical contributions on the choice of the rate of extraction by a mine, non-reserve resources are ignored, and the analysis assumes all reserves as known. hotelling's seminal article hypothesises certainty of information and ricardian conditions of increasing extraction costs, with cumulative deterioration in terms of grade and quality of the ore. uncertainty is marginally treated, with reference to exploration activity and the associated need for public intervention (hotelling, 1931; devarajan-fischer, 1981: 69-70). later authors have built upon hotelling's model by formulating more articulated hypotheses. ore characteristics such as ground solidity, extent of impurities, mineral composition and hardness, which contribute to define the quality of the ore, or aspects affecting the workability of the ore (such as the thickness of the seam) may otfset the percent metal content (ore grade), or may themselves have contradictory effects. furthermore, adjustments to lower grades of the ore, eventually coupled with higher rates of output, often tend to lag behind price rises to a greater extent than in the reverse adjustment process (to price declines) (carlisle, 1954: 602-3; 616; herfindahl, 1967; scott, 1967; brobst, 1993). therefore, the relationships between grade and quality of the ore, cost of recovery and mineral price are more complex than what initially hypothesised. carlisle (1954) considers both the rate of recovery, i.e. the number of tonnes mined per unit of time, and the level of recovery, i.e. the selection of a final target percentage amount of mineral extracted from the soil (table 1: cases i and 2). for deposits characterised by wide veins of uniform quality, or in the presence of reasonable knowledge of the geological occurrence, the cut-off gradel can be established at the beginning of the mining operation. the planning decision will then only concern the rate of recovery (case 1), such as to allow a maximisation of profits over the entire life time of the mine, corresponding to the minimum average total unit cost. an intermediate situation, closer to standard microeconomic profit maximisation, i.e. with equilibrium somewhere between this point and maximum annual profit, would arise when high r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 243 sajems ns vol 2 (1999) no 2 discounting is used. in the latter case, economies of speed (or, analogously, long-term market risks) and economies of scale are particularly relevant, with a consequent reduction of the mine life. if the level of recovery is allowed to change while keeping the rate constant, to some extent the opposite framework can be envisaged. a low cut-off grade would lead to high levels of recovery, with annual production fixed at maximum annual profit equilibrium. high discounting will favour a solution closer to the least-cost level, with selective mining and a likely further shortening of the life of the mine (case 2: a). the more negative the market expectations, the more the mining company will be tempted to recover only the rich ore, thus ultimately depriving itself of the scope for greater exploration and development of the deposit. equilibrium is found in a series of static solutions, with the build up of capacity at lower levels than in the case of optimistic expectations. a joint solution is in practice likely to be based on comparing alternative levels of recovery each at its optimum rate, in view of the uncertainty surrounding the ore body (as opposed to, e.g., estimated costs for specific sections of the deposit) (carlisle, 1954: 607). in the short run, physical and financial restrictions may cause downward adjustments in the rate of extraction to higher levels of recovery (as reflected by declining ore grades). this entails a possible reverse relationship ~etween levels and rates, although this is not necessarily the case in the long run (case 2: b). this interpretation rests on the hypothesis that the level of recovery is an inverse function of the cut-off grade, unless the 'homogeneous grade' conditions are present. in the latter case, typical of fluid reserves such as oil fields, the quantity of recoverable mineral would be a function of increasing (pumping) costs, but at a constant average ore grade (scott, 1967: 27-8). this theoretical framework has more recently been refined in various respects. firstly, 'lasky's rule' of an inverse relationship between average ore grades and cumulative ore tonnages (produced in the past and estimated reserves) does not seem to hold for all types of deposits and minerals. for scarce elements, such as gold and silver, a bimodal (or multi modal) distribution has been suggested, with the mineralogical threshold4 possibly lying between the humps of the bimodal curve (scott, 1967: 25; brobst, 1993: 593-4). this implies possible discontinuities or kinks along the downward-sloping curve relating the average ore grade to the quantity of recoverable mineral. secondly, factors other than the ore grade and the discount rate influence the choice of the rate of recovery. these factors, which favour a tilt in the production sequence skewed towards the early periods of a mine life, include cumulative deterioration of mining conditions and negative expectations on demand-supply conditions5 (scott, 1967). regarding the former, even in the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 244 presence of a homogeneous grade, deposit, eventually subsequent to an initial development phase an increasing distance of the ores from the shaft and mill tends to raise average costs of extraction. this also inevitably slows down the process of depletion. with no a priori geological knowledge of the deposit, the effects on the life of the mine are uncertain (table i: case 3). on the one hand, some reserves may be later found not to be ore, or reconverted to sub-economic resources due to, e.g., substantial energy cost increases. on the other hand, the mine life could be lengthened by the extraction of ores previously thought to be too remote or low-grade. thirdly, if ores of different grade and quality are highly intermixed, with little scope for selective mining, optimum rates and levels of recovery can be difficult to establish. net effects will lie somewhere between conditions of uniformity and occurrences with relatively easier selection of seams of different grade/quality (table i: case 4). the blending of ores of different grades may be favoured by economies of mine and mill operation, due to the contiguity of the respective sites. this and the above points should ideally be incorporated in a model on closing decisions by mines. while some of the issues can be assessed only with a detailed analysis focused on individual mines, a cross-mine study can still provide some insights. hypotheses and econometric estimates optimum extraction paths and shutdown decisions the brief review in the preceding section has highlighted determinants of mine planning in an increasingly complex and uncertain geological environment. in order to account for possible future extensions of the life of a mine, compared to its initially anticipated geological and economic constraints, an optimum path of extraction can be illustrated by the following constrained maximisation conditions: max [max r (p(t)s(t) c(s(t),t, r»d(t)dt , max e ( f' (p(t)s(t) c(t»d(t)dt i 50< jo jll f's(t)dt ::; st )], jo subject to r s(t)dt::; so . the mine maximises the discounted profit per tonne extracted (d(t) is the discount factor). the mineral price (p) and the rate of extraction (s) are both a function of time. besides also being dependent on time, the extraction cost per unit of time (c) can be assumed to be an increasing function of the recovery rate r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 245 sajems ns vol 2 (1999) no 2 and the cumulative deterioration of the mine, le. strictly convex in sand r, respectively. abstracting from initial economies of speed, this assumption can be made if there is complete prior knowledge of the geological features of the deposit, and if one excludes case 4 (table i). the solution would then be exclusively based on the first option in the objective function. this option foresees an exhaustion of the deposit by time t, with no possibility of enlargement of initially estimated recoverable reserves (so). the difference between price and marginal cost at time t would represent the opportunity cost of using the limited resource at that time rather than at an alternative time (scott 1967: 35-6; sweeney 1993: 192-3). an alternative solution is represented by the right-hand side of the objective function. if by time t the reserves have been increased (s1') compared to the initial estimate (possibly by even including high-grade or high-quality ore sites), the depletion of the mine can theoretically be postponed to an indefinite period, with no unique solution in terms of an 'optimal' extraction path (unless a priori information on the probability distribution of the stochastic elements is assumed, with the possible application of bayesian or other stochastic programming techniques) (rao 1984: ch. 11; sengupta 1982: 24-34). the optimisation problem would therefore involve a maximisation of the discounted unit protit for known reserves, or of the expected value of its conditional term, given a future expected expansion of the orebody, whichever is the higher. related to this framework, the following hypotheses can be formulated: a) at levels of profitability below optimum, or even more so in cases of economic loss, the mining company may still prefer to continue operations for some time, instead of closing down, if anticipated conditions are favourable. in economic and geological terms, this is likely to occur whenever (i) the life expectancy of the mine's demonstrated reserves, given current and projected growth rates of annual mineral production, is not approaching economic exhaustion, and (ii) there is a relatively large scope for a progressive expansion of demonstrated reserves (due to, e.g., expected technological advances or mineral price developments). b) at similar conditions of economic feasibility and geological occurrence, which would eventually justify a temporary shutdown of a mine, underground mines will be less 'flexible' than open-pit mining operations. this would be revealed by either attempts to prolong the life of the mine, or the opposite decision to permanently close the mine. following a temporary closing, changed economic circumstances may allow resumption of operations provided that the costs of rehabilitating the mine r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 246 are amortised. this can be especially difficult for underground mines (brobst. 1993: 583). sample and empirical results to test the above hypotheses. dichotomous choice models are here applied to a cross-section sample of 153 gold-producing mines. this sample, which includes operating and recently closed mines, was obtained from the rmg computerised database of mines world-wide (raw materials data, june 1997 update, compiled by raw materials group-stockholm). the criteria for the construction of the sample were the availability and coherence of intormation tor the variables detined belowb• three relevant producing countries in the southern hemisphere, namely australia, chile and south africa, are well represented. the number of their mines with sufficient information is substantial and covers almost the entire sample (138). in 1996, these economies represented respectively 12.3%,2.4%, and 2] % of world gold production, thus occupying the third, tenth, and first position among gold producing countries. the remaining 15 mines of the sample are selected cases of mines located in other major producing countries. for three of these countries, only few mines provide the needed information (namibia, papua new guinea -henceforth png-, the philippines), while for other two (canada and the united states) a thorough coverage would have required additional data collection efforts, and would have biased results towards another world region (with greater risk of including pollution-related 'premature' shutdowns of mines: sal ant, 1995: 97). relative to the three countries examined here with greater attention. part of the geological information on the mines can be compared with estimates for mine projects at an early stage, also provided by the rmg database. resources and, to a lesser extent, their estimated average ore grades appear to be asymmetrically distributed across mines, especially for those under construction, with tew large mines pulling average figures above the corresponding median values (table 2). recent exploration efforts seem to have identified new deposits (currently under feasibility study) which are potentially less endowed than older ones, according to the extension and percent metal content of resources. an apparent high variation among resource estimates of recently or torthcoming closed mines is indicated by a relatively higher coefficient of variation (320.2, for sixteen mines). however, this is spuriously due to the influence of two far outliers, represented by a south african and an australian mine which have been closed (in a provisory and permanent way, respectively), despite substantial resources (but see note 7 for one of these mines), this leads to a gap r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 247 sajems ns vol 2 (1999) no 2 between an average of 13.2 mt and a median of 0.8 mt, for this sub-sample. if these mines are excluded from the sub-sample, a clear drop in the average value of resources is registered, although with no remarkable differences from open mines in terms of the ore grade (table 2). measures of level and spread of the cross-mine distribution are not substantially altered for open mines if the whole sample is considered. once again, the presence of another far outlier, represented by the large abandoned bougainville gold-copper mine in png, further widens the gap between average and median values as far as resources of all closed mines of the sample are concerned. binary choice models have been applied to dummies identifying mines which are temporarily (variable status l) or permanently (status2) closed. the latter group includes also a few mines for which, in the survey information year ( 1994-96, depending on the mine), permanent closure is anticipated by the year 1999 at the latest7 • to capture the features expressed by the hypothesis a above, the ratio of annual ore production to demonstrated reserves and the ratio of the latter variable to total estimated resources of the mine deposit are used, reflecting points (i) and (ij) under a (section 3.1), respectively (oreqrprat and rprrat: table 3). these ratios are calculated by first multiplying the gross ores (in mt, estimated, for reserves and resources, or milled for output) by the respective ore grades (grams per tonne), thus obtaining figures for these variables in t~ousands oftonnes of fine goldb• independently from the economic profitability, one can expect that the coexistence of very high values in these ratios (close or equal to one for rprrat, and above, say, 0.5 for oreqprrat)9 will indicate the proximity of physical exhaustion for a mine deposit. economic profitability is in turn proxied by the ratio ofthe lme gold price to the average operating cost per troy oz of fine gold produced (gpcorat: table 3). since both variables were originally given in us dollars or local currency relative to the information year, the period average exchange rates of the australian dollar and the south african rand were used for conversion purposes when needed (imf 1997). finally, dummies are introduced in the models to account for the hypothesis b above (variables type] and type2, since some mines are partly underground, partly open-pit: table 3), and the possible 'buffering' influence of co-product metal output extracted from polymetallic deposits (such as gold-silver-copper, or other basic metals) (categ: table 3). regressions for temporary shutdowns (status i) yield statistically insignitlcant results in terms of overall explanatory power and individual parameters (except, to a limited extent, for the ratio of ore production to demonstrated reserves, which exercises a similar influence as for permanently closed mines). relative to the variable status2, ols and maximum likelihood estimates, for the linear r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 248 probability and the logit models respectively, are reported in table 3. due to several missing values (especially relative to operating costs of the mines). regressions are based on 90 or 47 observations, depending on whether the proxy for economic profitability is included. the presence of one of the outliers mentioned above, namely an australian mine (the other two cases do not enter the regressions, since no full information is available), only marginally affects the stability of individual parameters in the linear regression. by contrast, logit results differ to a greater extent if this case is excluded from the relatively larger sub-sample (table 3: litj and lit4; see note 7). as usually found for these models, the logit model appears to be superior in terms of goodness of fit, if the nagelkerke r-square is used as an indicator approximately comparable to the r-square in standard ols regressions (nagelkerke, 1991; norusis, 1997: 48; maddala, 1986: 39-40 and cox-snell, 1987: 209). the relatively large proportion of unexplained variation in /pi (table 3) is not reduced by accounting for possible non-iinearities: terms in the square of non-categorical variables, eventually added to the regression equation, turn out to have statistically insignificant parameters. for the logit estimation, the hosmer and lemeshow goodness-of-fit test fails to reject the null hypothesis of no difference between observed and predicted values for equations lit 1. iit3 and 1it4 (!it2 is likely to have too few observations for this test: hosmerlemeshow, 1989: 140-5). this indirectly indicates a satisfactory matching of observed and predicted frequencies. however, in terms of predictions on individual observations, and based on a 0.5 cut value, the logit model appears to be better suited to predict the choice of remaining open (above 95%), than the alternative of closing down (50% of correct prediction for uti, nearly 67% for !it2 -also without dummies-, and 56% for lit3 and ut4)lo. limited to the three percentage variables. estimated parameters in both models have the expected signs. among these variables. however, gpcorat is not statistically significant, contrary to expectations. as far as categorical variables are concerned. contradictory results are given by the two models about the possible role of co-product metals. only equations fiti. lit3 and lit4 show the expected sign in the estimated parameter, implying a reduced probability of closing. an absence of unequivocal indications and statistical significance is similarly present for the dummies on the type of deposit. a likelihood-ratio test would give preference to a restricted version of the model. without these dummies (table 3: lit4; mukherjee et al., 1998: 325)". this result may at least partly be explained by the opposite effects hypothesised in the previous section. ceteris paribus, underground mines may have a wider variety of responses to changing geological and economic circumstances than other mines. this is supported by a scatter plot oftypej versus logit residuals in equation lit3 12. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 249 sajems ns vol 2 (1999) no 2 particularly relevant appears to be the influence of the share of annual production in proven and probable reserves. according to the linear probability model (equations ip] and lp2), a 10% increase in this share would bring about on average 0.045 added probability of a closing decision (with certainty equal to i). following both models, the scope for increased potential geological availability, as proxied by rprrat, is found to have a relatively lesser impact on postponing closing decisions. a limited comparison of logit parameter estimates with those of the linear probability model is possible for noncategorical explanatory variables, through a suitable transformation 13. in the logit model the change in probability is a function of the probability itself. moreover, as supposed to be often realistic, the model presupposes a higher sensitivity of the dependent variable to changing conditions in the middle range of the distribution (pindyck-rubinfeld, 1986: 287-300). in the above example, relative to results of equation lit], the added probability of a closing decision to a 10% increase in oreqprrat would range from 0.09 at pi equal to 0.5, to 0.03 towards the 'wings' (pi = 0.1 or 0.9). whereas the dynamic impact, that is relative to probability changes, is to some extent comparable between the two models, the static effects vary substantially. if one considers, for instance, equations ip / and lit f, the probabil ities of permanently closing for underground mines characterised by (i) gold as an individual product, (ii) no sub-economic or inferred/undiscovered resources (rprrat = i), and (iii) latest annual output of tine gold amounting to 50% or 90% of reserves, would be 0.28 and 0.46 for the linear probability model (with oreqrprat = 0.5 and 0.9, respectively). conversely, the logit parameters would approximately double these probabilities (0.61 and 0.87). for the parsimonious regression equation lit4, which does not distinguish between underground and open-pit mining (while apparently having the same predictive power as lit3), the respective probabilities would be even higher (0.7 and 0.93). the linear probability model, also if the outlier is accounted for, appears to systematically under-predict probabilities of permanent closure 14. conclusion decisions concerning the rate and level of recovery, and ultimately the time of abandonment or temporary interruption of mining operations, are associated with indicators of economic health and geological features of a deposit. early theoretical contributions have tended to emphasise the price-cost relationship. they assume prior knowledge of geological and economic conditions and a smooth negative schedule relating the average ore grade to the quantity of recoverable mineral. other authors have proposed a more articulated framework, which accounts for various geological environments and degrees of information. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 250 in this study, the choice of the optimum extraction path for a mine is hypothesised to have no unique solution, and to depend on the possibility of later recovery of a mineral out of initially sub-economic, undiscovered or inferred resources. the empirical analysis has focused on gold mines, with particular attention to those located in australia, south africa and chile. permanent closures of these mines are found to be strongly influenced by their 'life expectancy' and the scope for expansion of existing reserves. the current economic protitability and type of deposit seem to be less relevant factors. the analysis could be deepened into aspects of geological availability and economic teasibility other than those considered here. this would require a study focused on individual mines, with information on, among others, spatial distribution of the deposit, taxation treatment, capital outlays, and market expectations. the situation is particularly delicate for south african mines. they are much older 's and generally reaching high depth levels underground, in contrast with a prevalence of open-pit mining elsewhere. opinions on medium-term prospects of the south african gold mining industry vary from warnings of near inevitable downsizing and closing of loss-making mines to arguments stressing a renewed protitability and ore grade flexibility. one should hope that, besides the euphoria on new mining ventures in emerging producer countries, such as in west africa. efforts are undertaken to contain the social costs of this restructuring. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . table 1 mine development and exhaustion under different conditions: literature hypotheses characteristics of the deposit i unifonn quality and accessibility, and/or prior knowledge of geological occurrence 2 declining grade and ---quality and/or workability of the ore 3 remoteness of the ore from shaft/mill, with • prior knowledge • uncertainty ,;nfitermix"ed ores of different grades/sites q. optimum rate of recovery ~py td~q i b. optimum level of ~ effects on life i i recovery i of the mine'" i underlying factors ! grade) i .j, diseconomies of scale i tonst~nt (no a' cut-off 11 economies of speed vs. i ___ ~-__ ~ ____ __ r~ ii market uncertainty ---+---=-------------a. constant i nq td~ mq"py b. decreasing i increasing i 't -decreasing and tilted t constant (homogeneous grade) , ! ? ? ** (with limit to attainment of economies of scale) diminishing returns -----i --------1 cumulative deterioration 1?(for-:2f ? (lor ? (with geological uncertainty) ---------·llecono~ies ormine-and milli operation * ** relative to conditions outlined in the first row (maximum level of recovery: nq) selective mining n,m mine life q maximum profit per period ~py maximum discounted profit per tonne extracted (d = discount factor) n til r.n )'ttl ~ r.n z r.n ~ n \0 \0 ::b z o n r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 252 table 2 resources: descriptive statistics for gold mines at different stages (australia, chile, south africa; information years: 199 .... 96) stage feasibility (28) construction (31) operating (101 *) closed (14") variable resources grade resources grade resources grade resources grade average 9.0 3.1 41.3 4.5 28.2 4.1 0.9 4.4 median 1.8 2.1 2.3 3.1 7.8 3.0 0.7 3.1 lower quartile 0.6 1.6 0.2 1.9 2.7 1.8 0.2 2.0 upper quartile 4.0 3.6 32.0 5.8 26.2 5.3 l.l 6.3 coefficient of variation 250.0 83.3 205.8 93.0 197.8 87.6 99.7 68.2 in parentheses: number of mines (* including navachab mine, namibia; a permanently or temporarily closed, and excluding an australian and a south african mine: see text); resources in mt of ore; grade in grams/tonne of ore; coefficient of variation: (s.d./mean). [00 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . table 3 closing decisions by gold mines: linear probability and logit estimates linear probability model logitmodel -----------=--------r ---r-----coeff:-[ tstat. -dependent: coeff_ i t stat. wald i coett. wald coeff. wald statlls~mm i (ip i) i (lp2) i (iit3) (iit4) constant -0}4j-3.13 -0.01 0.01" 3.58 4.19 -4.30 7.91 rprrat 0.17 1.91 0.28 3.63 ! ---,39a 2.42 2.06" 2.9\ 3.02' oreqrprat 0.45 7.11 0.45 4:77 ,-3.83 4_34 8.77 4.44 9.90 ---j.ll -1.50; 0.43" 0.15 -t66'o~69 7.46 ;-0:--004" -2.32 t75 -2.28 ~ 0.09 j.l2" -0.03 -4.83 to:ofl -7.36 0.04" -i -0.06 -0.84" -0.04 7.~7 j __ 0.02" 7.16 0.04" 0~:f7 0.50 i 0.70 0.63 0.60 11.6 8.69 i 21.8 (6) i 31.8(5) 30.3(3) 1.5(2)" 17.9 (7) i 3.8" (8) 5.7"(8) ---90 r--4'7 --47 i -~-89 ---i 89 1\ less than 90% confidence interval; , 90% confidence interval (in all other cases: 95% confidence interval or more; for wald statistic, see note 11); n: sample size (in iit3 and lim, outlier excluded: see text and note 7); r2(n): nagelkerke r2; ./: chi-square test on exclusion restrictions for parameters other than the constant term (in the second column, for lit4: lr chi-square test for parameters of type 1 and type2; df in parentheses); 'i(hl): hosmerlemeshow chi-square test (df in parentheses) status2 (i if mine is permanently closed, or expected to be so by 1998-99; 0 otherwise); rprrat (demonstrated reserves/resources, in kt of fine gold); oreqrprat (ore production for last or latest year/demonstrated reserves, in kt of fine gold); gpcorat (gold price/average operating costs, in usd or local currency/troy oz, for last or latest year); categ (1 if polymetallic mine deposit, 0 otherwise); type] (l if underground mine, 0 otherwise); type2 (1 if underground and 'mixed', 0 if open-pit) iv v\ ....., (j) ~ ~ (j) z (j) ~ iv .... 1,0 ~ "-" ~ iv r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 254 endnotes 4 8 9 10 useful discussions with j. apaloo, and financial support from the university of natavurf, are gratefully acknowledged. the usual caveat applies. the recovery ratio, i.e. the percentage share of recoverable over total reserves, is estimated to amount to up to 90010 for several metals. cut-off grade is defined as the lowest grade possible for some defined time period, so as to extract a mineral economically from a deposit (e.g., 0.1% copper from porphyry ore, or 0.01% for by-product cobalt), when blended with higher grade ore (brobst, 1993: 587). the mineralogical threshold mayor may not coincide with the economic threshold represented by the cut-off grade, depending on mineral and time reference. it refers to the minimum natural conditions allowing the formation of separate particles of minerals, which, if sufficiently abundant, could be commercially exploited (brobst, 1993: 588). unlike carlisle, negative market expectations both reduce, and tilt towards the present the rates of extraction over a mine project life (scott, 1967: 46-50). since some of the variables used in the regressions have missing values for a large number of observations, the econometric estimates concern only parts of this sample (table 3). an australian mine, which was temporarily shut down after being flooded by a cyclone, and reopened in april 1996 (the information year for that mine), is classified as operating. for temporary closures, the definition in the rmg database is strictly adhered to, with temporary mines being only those which are registered as such at the time in which the information is provided (1994-1996). it should be noticed that the australian outlier case (tables 2 and 3) is represented by an officially permanently closed mine according to rmg 1995 information. however, this mine has actually been reactivated, along with other two adjacent mines, under a new name (i wish to thank a. riganti and b. groenewald of the geological service of western australia for this note). the use of gross ores would have biased the results, since for most mines there are substantial disparities among average ore grades of the three variables (resources, demonstrated reserves, and production). a value higher than 1 is not to be excluded for the variable oreqprrat (in fact it turns out to be the case for six mines). abstracting from the slowdown effects of cumulative deterioration in mining, this would theoretically point at a potential remaining life expectancy for a mine of less than one year. the incorrectly predicted cases tend to be not explainable by the model, given the general clustering of estimated probabilities at both ends of the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 255 ii 12 13 14 15 sajems ns vol 2 (1999) no 2 frequency histograms. this problem is alleviated, but not removed, if the outlier case is not included in the regressions. however, in reality all such cases, identified by large standardised estimated residuals, can be considered atypical. for the outlier, see note 7. the remaining observations concern a few mines which are foreseen to close by 1999, while not actually being permanently closed in the information year. in this case, the respective wald statistics may already be indicative. however, one should bear in mind that the wald statistic tends to be biased against the rejection of the zero null hypothesis when regression coefficients have large absolute values (norusis, 1997: 5 and hauckdonner, 1977). although in logit regression the dependent variable is the logarithm of the odds of an event's occurring, the residuals, as in the linear probability model, are the difference between the observed and predicted probabilities of the events, with the latter based on the model the logit residuals are the residuals transformed in logit scale, that is divided by estimates of their variances (pi (l-pj). indicating with pi a probability and ~j a logit parameter for a continuous variable, the change in probability can be approximated as: ~ pi ::; i3j (pi (i-pi» (pindyck-rubinteld, 1986: 299). moreover, in the presence heteroscedasticity, as intrinsic to the linear probability model, estimated coefficients are inefficient, although unbiased. however. the weighted least-squares procedure does not yield efficient estimates for small samples and is sensitive to errors of specification (pindyk-rubinfeld. 1986: 276). in the sample, the average life of mines which are closed or for which a specific year of closure is foreseen (including the expected life of mines anticipated to close before the year 2020). is 54 years in south africa. by contrast, the respective average figure barely exceeds 6 years in australia, chile and the other countries of the sample. references i. brobst, d.a. (1993) "fundamental concepts for the analysis of resource availability", in g. heal (ed.), the economics of exhaustible resources, e. elgar, aldershot: 575-611. 2. carlisle, d. (1954) "the economics of a fund resource with particular reference to mining", the american economic review, 44: 595-616. 3. cox, d.r. & snell, e.j. (1987) analysis of binary data, chapman and hall, london. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vo12 (1999) no 2 256 4. devarajan, s. & fisher, a.c. (1981) "hotelling's 'economics of exhautible resources': fifty years later", journal of economic literature, 19(1): 65-73. 5. gooding, k. (1996) "declining capacity to hit gold production", sunday times (business times), may 19: 2. 6. govett, gj.s. & govett, m.h. (eds.) (1976) world mineral supply. assessment and perspective, elsevier, amsterdam. 7. international monetary fund (imf) (1997) international financial statistics yearbook 1997, washington dc. 8. hauck, w.w. & donner, a. (1977) "wald test as applied to hypotheses in logit analysis", journal of the american statistical association, 72(360): 851-3. 9. herfindahl, o.c. (1967) "depletion and economic theory", in m. godfrey (ed.), extractive resources and taxation, university of wisconsin press. madison: 63-89. 10. hosmer, d. w. & lemeshow, s. (1989) applied logistic regression, j. wiley & sons, new york. ii. hotelling, h. (1931) "the economics of exhaustible resources", journal of political economy, 39(2): 137-75. 12. maddala, g.s. (1986) limited dependent and qualitative variables in econometrics, cambridge university press. 13. mukherjee, c., white, h. and wuyts, m. (1998) econometrics and data analysis for developing countries, routledge, london. 14. nagelkerke, nj.d. (1991) "a note on a general definition of the coefficient of determination" ,biometrika, 78(3): 691-2. 15. norusis, mj. (1997) spss professional statistics 7.5, spss inc., chicago. 16. pindyck, r.s. & rubinfeld, d.l. (1986) econometric models and economic forecasts, mcgraw-hill, singapore. 17. rao, s.s. (1984) optimization theory and applications, wiley eastern ltd., new delhi. 18. roskill raw materials group (1995) gold. market update, analysis and outlook, roskill information services, london. 19. rudawsky, o. (1986) mineral economics. development and management of natural resources, elsevier, amsterdam. 20. salant, s.w. (1995) "the economics of natural resource extraction: a primer for development economists", the world bank research observer, 1 o( i): 93-111. 21. scott, a.t. (1967) "the theory of the mine under conditions of certainty", in m. godfrey (ed.), extractive resources and taxation, university of wisconsin press, madison: 25-62. 22. sengupta, j.k. (1982) decisions models in stochastic programming, north holland, amsterdam. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 257 sajems ns vol 2 (1999) no 2 23. siebert, h. (1983) okonomische theorie natiirlicher ressourcen, mohr verlag, tiibingen. 24. sweeney, j.l. (1993) "economics of depletable resources: market forces and intertemporal bias", in g. heal {ed.}, the economics of exhaustible resources, e. elgar, aldershot: 191-207. 25. vogel y, w.a. (1982) "issues in mineral supply modeling", in r. amit and m. avriel (eds.), perspectives on resource policy modeling: energy and minerals, ballinger, cambridge mass: 249-76. 26. vogely, w.a. (ed.) (1985) economics of the mineral industries, s.w. mudd series, american institute of mining, metallurgical and petroleum engineers, new york. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction literature review data and methodology results conclusion acknowledgements references appendix 1 appendix 2 appendix 3 appendix 4 appendix 5 footnotes about the author(s) elizabeth l. nanziri southern africa labour and development research unit, school of economics, university of cape town, south africa murray leibbrandt southern africa labour and development research unit, school of economics, university of cape town, south africa citation nanziri, e.l., & leibbrandt, m., 2018, ‘measuring and profiling financial literacy in south africa’, south african journal of economic and management sciences 21(1), a1645. https://doi.org/10.4102/sajems.v21i1.1645 note: this article is partially based on the authors’ working paper: series number 171, ‘measuring and profiling financial literacy in south africa’ at southern africa labour and development research unit, university of cape town, south africa, by elizabeth l. nanziri and murray leibbrandt, available here: http://opensaldru.uct.ac.za/bitstream/handle/11090/820/2016_171_saldruwp.pdf original research measuring and profiling financial literacy in south africa elizabeth l. nanziri, murray leibbrandt received: 06 aug. 2016; accepted: 26 feb. 2018; published: 28 may 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: microeconomic theories of financial behaviour tend to assume that consumers possess financial skills necessary to undertake related financial decisions. aim and setting: we investigated this assumption by exploring the distribution of financial literacy among south africans. method: in the absence of a standard measure, a financial literacy index was constructed for the country using data collected on attitudes (towards), access to and use of financial services over the period 2005–2009. in a multivariate regression analysis, we used the index to examine the extent to which differences in financial literacy correlate with demographic and economic characteristics. results: the index revealed substantial variation in financial literacy by age, education, province and race. overall, demographic characteristics contributed up to 10% of the financial literacy differences among individuals in south africa. conclusion: these results can be used to guide policy makers where to place more emphasis in terms of financial education for south africans. introduction there is increasing focus on making formal financial services accessible to all members of society.1 at the same time, the financial sector is becoming innovative with products that might be considered complex and sophisticated for potential consumers. these developments place substantial demand on the individual in terms of financial decision making and management. in microeconomics, the consumption-saving trade-off assumes a rational and well-informed consumer who is capable of accumulating savings in times of high income and spending savings when income is low. this is in the framework of the life-cycle hypothesis advanced by friedman (1957) and modigliani and brumberg (1954). this consumption smoothing over periods, whether two-period or in a dynamic multi-period life cycle, assumes that the individuals have perfect foresight. that is, that they are able to predict the economic environment and subsequently undertake complex calculations on interest rates and discount rates in order to invest (lusardi & mitchell 2014). if such a model is extended to incorporate concerns such as credit constraints, and the risk of death of economic agents, then the financial skills requirement becomes even more demanding (see for instance gorbachev & luengo-prado 2016). rational behaviour is questionable, however, from the behavioural finance perspective.2 moreover, external factors, such as the economic environment and availability of social welfare systems, plus risk preferences of individuals have implications for the acquisition of financial skills necessary for financial decision making. the theoretical underpinnings of financial literacy are mixed. development psychology theories (psychoanalysis, psychosocial and cognitive psychology) posit that financial literacy is not learned but is shaped by one’s upbringing (which shapes one’s personality), emotions and interactions in life (erikson 1980; king & levine 1993). the exchange theory, on the other hand, argues that the level of financial literacy will depend on the level of knowledge exchange and interactions among individuals. knowledge diffusion is therefore more likely in high-density population areas (see robson & labner 2006). implicit in this is the learning process, either from colleagues or on the job, while engaging in day-to-day financial activities. in the spirit of the learning theory (see goldhaber 2000; pavlov 1960), financial literacy is linked to habit formation, whereby reinforcement or punishment determines continuity of action. an individual can therefore learn and master financial skills if he is positively rewarded. all these arguments can be summed up in the capability theory advanced by nussbaum and sen (1993), that an individual’s capability is a combination of personal capabilities (e.g. cognitive ability, personality traits) and external factors. the absence of external support can inhibit individuals’ financial performance even when they possess the relevant skills. empirical work guided by these theories and summarised in lusardi and mitchell (2014) shows that few individuals possess the necessary financial skills required to make decisions to save or invest and consume between periods. however, the definition of what constitutes financial skills, often referred to as financial literacy, is not standardised, leading to varied measurement of the same concept. huston (2010) describes financial literacy as a form of literacy that relates to one’s proficiency in making financial decisions. so, how proficient are individuals to draw up saving and spending plans? how is this proficiency distributed in a population? to answer these questions, we constructed a financial literacy index for south africa for the period 2005–2009. defining financial literacy as a composite of two domains, financial knowledge and financial capability, questions that fall in each of those domains were identified. these questions were selected from the finscope3 surveys conducted on attitudes towards, and use of, financial services. we then used the principle component approach to combine responses to these questions to obtain a score for each individual. this score was then used to investigate financial literacy differences across categories of the population and across regions. the index revealed substantial variation in the financial literacy of south africans. the national average is 48.4 on a scale that ranges between 0 and 100. below average financial literacy is found among black south africans, women, the young, individuals with less than high school education, with a low income, and those living in the eastern cape province. overall, demographic characteristics account for up to 10% variation in financial literacy while geographical location only explains an additional 0.7% of the variation. this implies that provincial differences in financial literacy are a result of demographic and economic differences between provinces. literature review the pioneering work of lusardi and mitchell (2007:36) suggests a simple definition of financial literacy as ‘the knowledge of a few but fundamental financial concepts’. in a series of studies conducted in 14 countries,4 the term is defined explicitly as ‘the possession of financial knowledge on interest rates, inflation, and risk diversifications, and numeracy skills’ (xu & zia 2012:4). in subsequent studies, and borrowing from capability theory, financial literacy has been defined more comprehensively to include both possession of knowledge and actions that accompany that knowledge as summarised in appendix a1. in the wake of the global financial crisis of 2008, the organisation for economic cooperation and development (oecd) suggested that the concept should be broadened to constitute: … consumers’ or investors’ understanding of financial facts and concepts, and their ability to appreciate financial risks and opportunities to make informed choices, to know where to go for help and to take other effective actions to improve their financial well-being. (miller et al., 2009:2) following from the above definitions, measures have included setting numeric questions and either counting the proportion of the population that gives correct responses or weighting the responses to form a financial literacy index.5 such an index is then used to investigate the distribution of the scores in a particular country as being synonymous with the level of financial literacy. some patterns have emerged. using the proportion of correct answers to a set of three questions, lusardi and mitchell (2007) found that in the usa financial literacy is low among women, the young and the old. they also found that financial literacy is positively associated with income and education attainment. however, in germany, bucher-koenen and lusardi (2011) found no significant difference between the financial literacy levels of men and women using the same measure. they report, however, a stark difference between the financial literacy of individuals in the eastern and western regions of the country. a similar regional finding is reported by fornero and monticone (2011) between the northern and southern regions of italy, and in the northern half of the usa compared to states located in the eastern and southern parts (bumcrot, lin & lusardi 2011). in the usa, the regional differences are reported to be correlated with a state’s poverty level. klapper and panos (2011) attribute the higher financial literacy levels exhibited by urban dwellers in russia compared to their rural counterparts to the high number of interactions and hence knowledge diffusion in areas of high population density. racial differences are also evident. for example, crossan, feslier and hurnard (2011) found that the maori group in new zealand have low levels of financial literacy, as do hispanics in the usa (lusardi & mitchell 2011b). both these racial groups are part of the minority groups in these countries. in the context of middleto-low income economies, financial literacy is defined in terms of financial outcomes and linked to holding a bank account (see xu and zia 2012). this follows arguments by researchers like dragan (2011) and cole, sampson and zia (2011) that individuals will only demand financial services and products if they have enough knowledge about them. indeed, the finscope surveys reported that one of the reasons why respondents in malawi and tanzania did not have bank accounts is that they had never heard of a savings account or that they did not know how to open one. lack of understanding of insurance products leading to low take-up has also been reported in countries like guatemala (cohen & young 2007), rural india (gine et al. 2010) and vietnam (tran & yun 2004). but an outcome-based measure might lead to either an upward or a downward bias owing to selection into participating in the formal financial sector or owing to capturing the extent of financial access. indeed, in the wake of broad-based financial access, it is highly likely that individuals will hold products without necessarily understanding their functionality. it is important to note that the lack of standardisation in the definition of financial literacy, and the subsequently different measurement of the concept, make comparisons across countries problematic. hence the need for more country-specific studies. south africa presents an interesting case study, in part owing to the fact that no rigorous empirical work has been undertaken following financial sector transformation towards broad-based financial access in the country in the early 1990s. secondly, the country exhibits both high-income and low-income country characteristics, which poses the challenge of which measure of financial proficiency to adopt. in the section that follows, the methodological approach to addressing this research gap is outlined. data and methodology we adopted a combination of the definitions of financial literacy of atkinson et al. (2007) and the oecd (2009) to align it to south africa’s financial sector characteristics. there are two financial literacy domains: financial knowledge and financial capability. questions aligned to these domains were identified, the individual responses computed and the average scores cross-tabulated with demographic characteristics of the population. principal component analysis (pca) was then used to construct a composite index from the two domains as advocated by the oecd (2009). this allows for the profiling of the population using the average score of the index. finally, regression analysis was used to investigate the determinants of financial literacy. regarding financial knowledge, the emphasis is on the understanding of financial concepts, financial institutions and financial regulations. in the south african context, such data have been collected in the nationally representative finscope surveys that have been conducted regularly since 2002.6 these data are collected using face-to-face interviews with individuals. we made use of the data collected on attitudes (towards), access to and use of financial services over the period 2005–2009. in the finscope surveys, respondents were asked about their knowledge and understanding of words or phrases in each of the above subcategories (financial concepts, institutions and regulations). responses were then coded as: 3 = heard of the word/phrase and know what it means; 2 = heard of the word/phrase but do not know what it means; 1 = never heard of this word/phrase. since this domain tests whether one understands the terms and concepts presented, individuals who had heard of but did not understand these concepts were considered to be in the same category as those who had never heard of them. following this argument, variables were re-coded to equal to one if a respondent had heard of and understood a particular financial term/phrase, and zero otherwise. in other questions, respondents were instead asked which financial areas they needed financial education on. this was considered to be a self-reported financial knowledge gap which was coded as a binary variable with 1 = yes (if a respondent chose a particular financial term/concept/phrase) and zero otherwise. subsequently, the coding of such questions was reversed for consistency. the following phrases from the surveys were considered: knowledge and understanding of bad debt knowledge and understanding of the national credit act (nca) knowledge and understanding of credit bureaus knowledge of compounding interest (saving small amounts and investing overtime) gap variables: use of financial services and products – combining questions that related to selecting savings and investment products, insuring household contents and how to draw up and manage a budget (deals with day-to-day financial discipline) knowledge of life insurance knowledge of how to find out about one’s credit worthiness how interest rates work and are calculated trust in banks – this question was frequently phrased as ‘you do not trust banks’ according to kempson and moore (2005), knowledge of financial terms, regulations and institutions is necessary but not sufficient to measure the financial literacy levels of individuals, hence the financial capability domain. financial capability is said to incorporate knowledge, skills and behaviour in five areas. these include: making ends meet; planning ahead; choosing financial products and services; staying informed; and keeping track of one’s finances. as is evident, the knowledge areas feed directly into this domain. the dataset used provides a range of questions corresponding to these areas. respondents were presented with a range of statements and their responses were recorded as ‘agree’ (coded as 1), ‘disagree’ (coded as 0) or ‘do not know’ (also coded as 0). selecting only questions that were consistent across surveys resulted in the following seven statements to be considered for our study: you try to save regularly. you are saving for something specific. you are worried you will not have enough for retirement. you go without basics so as to save. you love spending even if you have to borrow to do so. you read the financial pages of newspapers and magazines. when it comes to finances you prefer to speak to friends or family for advice. in our approach, we do not incorporate the holding of any product as a variable in the capability domain. product holding can be a consequence of literacy or a reflection of financial access policy. the latter is a plausible argument, given that post-apartheid south african government undertook financial sector transformations in the form of broad-based financial access. responses to questions in the two domains of financial knowledge and financial capability were combined to construct a composite financial literacy index from the pooled surveys (2005–2009). the composite financial literacy index was thus constructed according to the expression below: where flxi is the financial literacy score for individual i, qij is the score in domain j for individual i, qj− is the sample mean, sj is the sample standard deviation and fj is the eigenvector of the first principal component weights. the scores were re-scaled through a linear transformation for ease of interpretation. analogous to socio-economic status indices, the higher the score, the higher the implied financial literacy level of the individual (see vyas & kumaranayake 2006). for example, on a 0–100 index, an individual scoring zero has a financial literacy of zero (financially illiterate) while a score of 100 is equivalent to a financial literacy level of 100 (financially sophisticated). thus the financial literacy profile of south africans is obtained by comparing the mean financial literacy scores across the socio-economic and demographic characteristics of individuals in the sample, and weighting the data for national representativeness. summary of the data the weighted descriptive statistics are provided in table 1. the pooled data showed a slightly higher proportion of women (52%) compared to men (48%). black people made up almost 80% while the rest of the population groups made up the remaining 20%. the majority of the sample had some high school education (40%) and was 18–29 years old, while the oldest respondent was 92 years old. more respondents were interviewed in urban areas (57%), with a regional distribution in favour of gauteng, kwazulu-natal, the eastern cape and the western cape. twenty-seven per cent of the respondents were formally employed, followed by pensioners and the self-employed. about 60% of the sample earned a personal monthly income of less than r1000, with 16.5% grant recipients, and in some cases individuals held more than one job. the average household size was four. the data were weighted using the statistics south africa weights as benchmarks. this sample is therefore nationally representative of the major population groups of the country and is balanced in terms of gender and region. table 1: summary statistics for the data (2005–2009). table 2 shows the proportion of affirmative responses to the domain questions. panel a shows that about 44% of the respondents reported knowledge of ‘bad debt’, 11% knew about credit bureaus, and only 2% knew about the national credit act (nca) even though these terms are closely related.7 knowledge of budgeting and interest rates was low, and respondents admitted to not trusting banks. about 24% claimed knowledge of how to use savings, insurance and investment products. on average, respondents scored five out of nine points (see the sample average shown in appendix 2), while almost one-third scored between zero and four points. table 2: positive responses for financial literacy domain questions. the mean score varies across the sample. as reported in appendix 2, it is higher for men than for women, and the white subpopulation scored the highest among the population groups (7 points), followed by the indian subgroup (6.4 points), the mixed race subgroup (5.7 points) and the black subgroup (4.7 points). there is a slow but steady rise in score with increasing age, tapering off after 59 years. individuals with less than matric scored below average while those with matric level of education and above scored above average; however, students scored far lower than those in other occupation categories. grant recipients answered up to four questions correctly, while scores increased with increasing personal income. as expected, urban dwellers scored above average and higher than their rural counterparts, while individuals who were participating in the financial sector (currently banking) scored better than those who had never banked over the period. in the capability domain, 47% of our sample claimed to save regularly (table 2 [panel b]), yet only 19% alluded to spending wisely, and 21% said that they were not worried about having enough for retirement. the majority of the respondents scored between two and three points, with just about 1% scoring all or no points. overall, the average score for the sample is three out of seven points. decomposing the mean score by socio-economic and demographic characteristics, a pattern similar to the one in the knowledge domain emerges. that is, scores are lower than average for black south africans, for women, for individuals with less than matric level of education and for rural dwellers. (these results are reported in appendix 3.) a key element in this domain is the source of financial information used by consumers.8 the majority of the respondents reported using ‘friends and family’ as a source of financial information, while ‘financial pages’ are rarely used (table 2 [panel c]). notice that if only one domain was to be considered as a measure of financial literacy (see hung, parker & yoong 2009, for example), south africans would be more financially literate using the knowledge domain than using the capability domain, going by the average score in each of these domains. similarly, using the ‘big three’ as in several studies (see xu & zia 2012) would make the picture even worse, since only 1.8% of the sample reported knowledge of the interest rate concept while 23.9% reported knowledge of saving and investment (table 2), which is akin to the concept of a compounding interest rate. results profile of financial literacy the constructed financial literacy index combines the domains into a score that ranges between 0 and 100, with a mean of 48.4 (figure 1). overall, the index follows a normal distribution, with the majority of south africans around the country’s mean. but the densities become flatter and fatter for any shift to the right of the national mean, implying that there are few financially literate individuals, and that those who are literate had very high scores. appendix 4 shows the density plots for within in-group differences in financial literacy by various categories.9 there is no visible difference in the distribution of financial literacy scores by gender, age group and geo-area. there are, however, substantial differences in the distribution by education, marital status, personal income and race. higher income and education levels are associated with a shift to the right of the country’s mean, reflecting above average financial literacy. the distribution for white and asian people is also skewed to the right, while distribution for black and mixed race people is skewed to the left. figure 1: financial literacy by age, education, gender and race. to obtain a clearer view of the distribution, the with-in categories mean scores are provided in figure 1. lower than average levels of financial literacy are evident among women, black south africans, those with less than matric (high school), and those in the age group 18–29 years. this pattern is similar to those reported in studies for upper-middle income economies such as the usa, europe, japan and new zealand, as well as for low-middle income countries such as india, indonesia, west bank and gaza (see xu & zia 2012 for a summary). lusardi, mitchell and curto (2009) and johnson and sherraden (2006) found similarly low levels of financial literacy among youths in the usa. financial literacy is high at higher levels of education and for individuals older than 30 years of age, tapering off slightly at 60 years. this finding follows the inverted u-shape reported by lusardi and mitchell (2011a), xu and zia (2012) and jappelli and padula (2011). according to jappelli and padula (2011), this is evidence of a decline in cognitive ability in the latter years of an individual’s life. the index values are disaggregated further by economic variables such as major sources of money, occupation and income categories (figure 2). on average, the formally employed, self-employed and pensioners have above average financial literacy, while students and the unemployed score the lowest in the occupation category. lower levels of financial literacy among students have also been reported by beal and delpachitra (2003) among australian university students, markow and bagnaschi (2005), mandell (1997), lusardi et al. (2009), and chen and volpe (2002) among college students and young adults. individuals receiving money from formal sources have higher scores while recipients of grants and income from informal sources have below average scores. this difference could be owing to the requirement by formal employers that employees use formal financial mechanisms to receive salaries and other employment benefits, which in turn requires financial proficiency. it is worth noting that social grants in south africa are targeted at the poor and are means tested.10 this highlights the low financial literacy pattern observed among grant recipients. this is problematic as grant recipients are often offered many financial products.11 finally, financial literacy scores increase as income levels increase, a result similar to that found in most studies conducted elsewhere, reflecting either the increase in demand for financial products and services that require financial proficiency, or an increase in affordability of investment in acquiring financial literacy. figure 2: financial literacy by occupation, income, and source of money. in terms of regional distribution, the western cape (52.4), gauteng (52.5) and kwa-zulu natal (48.9) have above average scores while the eastern cape (43.1), north west (45.6) and northern cape (45.6) lag (see figure 3 and table 3). provinces with higher levels of financial literacy are also associated with lower levels of poverty (p0/p1 = 5.74/0.013, 4.87/0.014 and 22.12/0.068 respectively) while those with the lowest literacy levels also rank among the poorest (p0/p1 = 34.02/0.111, 26.13/0.072 and 42.17/0.145 respectively).12 these regional results also mimic the racial distribution in the country. for instance, white people, who have the highest scores, are concentrated in the western cape and gauteng, while indian/asian people, who follow closely, are concentrated in kwazulu-natal. on the other hand, the eastern cape has predominantly black people, while northern cape has predominantly mixed race people. these two population groups had the lowest financial literacy scores. in terms of economic activity, gauteng and kwa-zulu natal also happen to be the financial and business hubs of the country. rural dwellers on average had lower financial literacy scores (46.24) than their urban counterparts (50.07). this finding is in line with those reported in almost all empirical studies on this subject. the difference is attributed partly to the high level of interaction in densely populated areas such as urban areas, which allows for the diffusion of knowledge (klapper & panos 2011). figure 3: provincial financial literacy relative to the national average. table 3: provincial ranking of financial literacy in south africa. the multivariate correlates of financial literacy the descriptive statistics show a positive association between financial literacy and several economic, demographic and geographic characteristics. however, there is a possible correlation between some of these characteristics themselves, for instance, province with race, and province with the rural dummy. to tease out the effect of each of these variables holding others constant, we conducted multivariate regression analysis. the dependent variable was the index of financial literacy, which was a continuous variable. model 1 (table 4) reports the estimated coefficients for a specification that includes all possible controls, as used in similar studies such as that by lusardi and mitchell (2014). models 2 and 3 are specified to tease out the correlation between provinces and the rural–urban effect. results reveal that compared to black people, the levels of financial literacy of white and asian people are higher in all specifications and that this difference is statistically significant. similarly, education levels above high school level (matric), income levels above r6000, as well as being divorced, married or widowed are positively correlated with higher financial literacy scores. significant racial influences have been reported by bumcrot et al. (2011) in the usa, crossan et al. (2011) in new zealand, alessie, van rooij and lusardi (2011) in the netherlands, dragan (2011) in bosnia and herzegovina, and xu and zia (2012) globally. the effect of marital status might in part reflect the nature of marriage contracts in the country or, as hsu (2011) argues, strategic acquisition of financial literacy following separation from or the death of a life partner.13 a similar effect of education and income has been reported by behrman et al. (2010). the argument is that individuals in higher income brackets can afford the cost of acquiring financial literacy and thus seek more financial knowledge to better manage their financial wealth. table 4: multivariate correlates of financial literacy in south africa. table 4 (continues...): multivariate correlates of financial literacy in south africa. although men were found to have higher levels of financial literacy than women, this variable is not statistically significant. this result can be compared to a similar finding reported by bucher-koenen and lusardi (2011) for east germany, where gender was not significant in relation to an individual’s financial literacy level. furthermore, despite evidence of the inverted u-shape pattern often seen in the relationship between age and financial literacy, the estimation results show no statistical significance of the age variable. this result suggests that either age does not influence financial literacy in a south african setting, or that financial literacy related challenges cut across age groups. compared to the western cape, residing in the eastern cape, mpumalanga, north west or northern cape has a significantly negative influence on the financial literacy score. however, rural or urban dwelling has no significant effect. this result does not change even when we exclude provinces (model 2, table 4). excluding the rural-urban dummy while retaining provinces increases the effect of provinces slightly though. this rural-urban result is rather unusual when compared to other studies; however, we believe that the effect is probably captured at the provincial level. indeed, bumcrot et al. (2011) controlled for residence at state level in the usa and found significant results. this interesting rural-urban result shows the importance of the multivariate analysis. these regression results generally confirm some of the correlations revealed in the descriptive statistics and they are generally similar to global patterns (see lusardi & mitchell 2014; xu & zia 2012). in particular, they point to the significance of characteristics such as race, education and region (province). yet, several studies have found geographical location to statistically influence financial literacy more than economic and demographic characteristics. to isolate these effects, we followed raudenbush and bryk (2002) and estimated a hierarchical linear model. in this approach, the interest is in the incremental explained variance between groups of variables. thus, financial literacy scores were regressed first on demographic characteristics and then geographical location was added at the second level. the demographic variables considered were education, gender, income, marital status and race, as these turned out to be statistically significant in the basic ordinary least squares, while the geographical characteristics included all provinces. except for gender, which is a binary variable, all other regressors were categorical variables for which dummy variables were created.14 table 5 reports the variation in financial literacy accounted for by the two subgroups of variables. demographic variables accounts for 10% of the variation, while the inclusion of province contributes only 0.7% additional predictive power. the implication of these results is that the significance of the provincial variable, at least for three of the nine provinces, is likely to be driven by the demographic and socio-economic differences between the provinces. thus, any attempt to address the provincial financial literacy gap would only be effective if it is complemented by initiatives that address the demographic differences across provinces. table 5: demographic versus geographic variation in financial literacy. what is evident in this study is that there are significant differences in the financial literacy levels of south africans between and within demographic and social economic categories. the patterns observed resonate with global findings both in developed and in developing economies. this provides reassurance that the measure we have constructed captures the duality of the country. conclusion in this article, we provide a benchmark profile of financial literacy in south africa following financial sector transformation in the country and increasing innovation in the financial sector. in the absence of a standard definition and measure of financial literacy, we use observational data and a quantitative approach to construct a financial literacy measure in the form of a financial literacy index. the variables used in the construction of the financial literacy measure are in line with the microeconomic framework of the financial behaviour and consumption-saving decision-making process of an individual. our approach differs from approaches like the ‘big three’ and the subsequent ‘big five’ used in earlier studies, which focus on knowledge of interest rates, inflation and risk diversification as being synonymous to financial literacy. we also differ from studies that use the outcome-based approach especially in developing countries, where the possession of a formal financial product is considered to be a measure of financial proficiency. we argue that such an outcome-based approach might instead capture the extent of financial access, which in the south african context is plausible given the financial sector transformation process of the early 2000s. the results presented in this article reveal a national average financial literacy score of 48.4, and dramatic differences in financial literacy by key characteristics, using pooled data for the period 2005–2009. below average financial literacy is common among women, young adults (including students), and individuals with less than matric (high school) education, black people, the unemployed, and rural dwellers. while urban dwellers exhibit above average financial literacy, this variable is not statistically significant in the case of south africa. similarly, even though there is evidence of an inverted u-shape in the association between age and financial literacy, age is not a statistically significant correlate. education, income, geographical location, marital status and race are the significant contributors to the financial literacy of south africans. however, the significance of geographical location is outweighed by the demographic characteristics. this implies that provincial variation in financial literacy can change in line with changes in these characteristics, resulting from provincial migrations and changes in economic activities, for example. in examining what drives the financial literacy levels observed in this study, we find that the scores are higher in the financial knowledge domain than in the financial capability domain. in other words, financial concepts or terms are well engrained in the minds of south africans, but positive financial behaviour is lacking. according to the capability theory of nussbaum and sen (1993) and hilgert, hogarth and beverly (2003), this behaviour can be attributed to a potentially unsupportive external economic environment within which the individual has to convert knowledge into practice. in a south african environment, an example might be the lack of transparency of financial institutions in terms of bank fees and charges, which deters potential users of financial products. additionally, the existence of credit facilities can have the unintended consequence of not saving regularly. another possible explanation, borrowed from behavioural economics, pertains to psychological biases that underlie differences in financial capabilities over and above financial knowledge. de meza, irlenbusch and reyniers (2008) identify procrastination, aversion to loss and regret, status quo bias and mental accounting as some of the biases. however, we could not identify any of these behavioural variables in our data and many of them might be caused by socio-economic circumstances. for example, risk aversion might be induced by poverty. thus, notwithstanding these biases, these results provide a baseline for financial education programmes. indeed, positive behavioural aspects can be weaved into such programmes. the novelty of these results lies in appropriately defining financial literacy within the context of south africa and using existing surveys to construct a country-specific measure. given the prohibitive cost of financial literacy tailored surveys and experiments, this study provides an alternative and cost-effective approach for countries where such surveys exist. furthermore, as most studies tend to be focused on a particular financial product (for instance credit, investment or insurance), our approach provides a generic measure that can be tested across financial product categories. this is not far-fetched considering that cross-product holding is common practice for consumers of financial products and services. acknowledgements e.l.n. acknowledges participants at the african econometrics society conference in 2014 for their insightful comments, and funding from the carnegie foundation and the national research foundation. m.l. acknowledges the research chairs initiative of the department of science and technology and the national research foundation for funding his work as the nrf/dst research chair in poverty and inequality. e.l.n.’s phd was funded by scholarships from carnegie and the sarchi: poverty and inequality research. competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this 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(eds.), 1993, the quality of life, clarendon press, oxford. organisation for economic co-operation and development (oecd), 2005, ‘improving financial literacy: analysis of issues and policies’, financial market trends, (11)2, 111–123. http://dx.doi.org/10.1787/fmt-v2005-art11-en pavlov, i., 1960, conditioned reflexes: an investigation of the physiological activity of the cerebral cortex, trans, dover publications, new york, ny. raudenbush, s.w. & bryk, a.s., 2002, hierarchical linear models: applications and data analysis methods, 2nd edn., sage, thousand oaks, ca. robson, j. & ladner, s., 2006, asset-based approaches to settlement services in canada, discussion paper, system for electronic disclosures by insiders (sedi), toronto. tran, n. & yun, t.s., 2004, ‘tym’s mutual assistance fund: vietnam good and bad practices in micro insurance case studies’, cgap working group on micro insurance, cgap, washington, dc. vyas, s. & kumaranayake, l., 2006, ‘constructing socio-economic status indices: how to use principal components analysis’, health policy and planning 21(6), 459–468. https://doi.org/10.1093/heapol/czl029 woolard, i. & leibbrandt, m., 2009, measuring poverty in south africa, development policy research unit, university of cape town, cape town. xu, l. & zia, b., 2012, financial literacy around the world: an overview of the evidence with practical suggestions for the way forward, policy research working paper 6107, world bank, washington, dc. appendix 1 table 1-a1: conceptual definitions of financial literacy. appendix 2 table 1-a2: average scores in the financial knowledge domain (pooled data). appendix 3 table 1-a3: average scores in the financial capability domain (pooled data). appendix 4 figure 1-a4: the distribution of financial literacy scores in south africa by the individual’s characteristics (pooled sample): (a) financial literacy by gender, (b) age group, (c) race, (d) education level, (e) income level, (f) occupation, (g) marital status, (h) province, (i) geo-area and (j) banking history. figure 1-a4 (continues...): the distribution of financial literacy scores in south africa by the individual’s characteristics (pooled sample): (a) financial literacy by gender, (b) age group, (c) race, (d) education level, (e) income level, (f) occupation, (g) marital status, (h) province, (i) geo-area and (j) banking history. appendix 5 table 1-a5: decomposition of average scores of financial literacy. footnotes 1. see for instance, the world bank initiative on universal financial access (ufa), financial inclusion 2020 (fi2020) and alliance for financial inclusion, http://www.afi.org 2. see for instance muradoglu and harvey (2012), garcia (2013). 3. finscope financial access surveys, http://www.finmark.org.za 4. azerbaijan, chile, germany, india, indonesia, italy, japan, netherlands, new zealand, romania, russia, sweden, usa, and west bank and gaza. 5. see hung et al. (2009) for a summary of the measures. 6. for more detail on these surveys, see finscope financial access surveys: https://www.finmark.org.za/finscope/ 7. the nca regulates formal credit transactions and it requires lenders to be registered, but knowledge of ‘bad debt’ could imply a bad experience with credit either from formal or from informal sources. 8. for example, lusardi et al. (2009) found a significant correlation between peers and communities as a source of information and higher levels of financial literacy among youths. 9. all data are weighted by weights benchmarked against statistics south africa weights to make the statistics nationally representative. see appendix 5 for the full set of decomposition results. 10. grants include child support, foster care support, care dependency, old age support, disability, war veteran, social relief of distress, and grant-in-aid. there are as many as 8 million grant recipients on average per year (www.sassa.gov.za). 11. for instance, social welfare recipients in south africa are paid through a bank account (see http://newsroom.mastercard.com/press-releases/ten-million-sassa-mastercard-cards-issued-to-south-africansocial-grant/), while this same group is targeted by moneylenders (see http://www.kayafm.co.za/moneylender-targets-social-grant-beneficiaries/). 12. p0 is the head count poverty and p1 is the poverty gap. see woolard and leibbrandt (2009) on these and other provincial poverty measures. 13. in south africa, those married in community of property share equally in the wealth of the partnership. this includes financial obligations such as debt and investments. thus married individuals are more motivated to learn about finances or to fall victim to the financial mistakes of their spouses – but only if they are married under this regime. 14. this approach was used by bumcrot et al. (2011) to isolate the effect of the demographic variables from the geographical variations in financial literacy in the usa. abstract introduction literature review research question, purpose, hypotheses and conceptual framework research methodology results discussion, implications, limitations and future study acknowledgements references about the author(s) shingirai gomera department of business management, university of fort hare, south africa willie t. chinyamurindi department of business management, university of fort hare, south africa syden mishi govan mbeki research and development centre, department of economics, university of fort hare, south africa citation gomera, s., chinyamurindi, w.t. & mishi, s., 2018, ‘relationship between strategic planning and financial performance: the case of small, microand medium-scale businesses in the buffalo city metropolitan’, south african journal of economic and management sciences 21(1), a1634. https://doi.org/10.4102/sajems.v21i1.1634 original research relationship between strategic planning and financial performance: the case of small, microand medium-scale businesses in the buffalo city metropolitan shingirai gomera, willie t. chinyamurindi, syden mishi received: 24 july 2016; accepted: 19 dec. 2017; published: 09 may 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: arguments are made for strategic planning as an important organisational capability used to realise a firm’s goals and objectives. despite this, conflicting views appear to emerge from the extant literature over the link between strategic planning and financial performance. notably, within a south african context, a few studies have been conducted ascertaining this relationship especially within small, medium and micro-enterprises (smmes). aim and setting: the study aimed to determine this relationship using survey responses from a sample of 225 respondents classified as owners or managers of smmes operating within the buffalo city metropolitan in the eastern cape province of south africa. method: data were analysed through regression and correlation analysis. results: findings reveal strategic planning to have a positive relationship with the financial performance of the smmes. furthermore, aspects of strategic planning (formulation, implementation, evaluation and control) were also found to have a positive relationship with financial performance. conclusion: suggestions for theory and practice are made based on these findings, including how the adoption and usage of strategic planning cannot only be an important organisational capability but also a basis for attaining a competitive advantage within the smme. introduction south africa is witnessing a growth in the number of entrepreneurial start-ups (chinyamurindi 2016). such start-ups, including the development of entrepreneurial spirit, are encouraged and believed to have ramifications for national growth including economic and social development (harris, sapienza & bowie 2009). further, small, medium and micro-enterprises (smmes) perform a critical part in developing communities as they comprise a huge workforce and are considered pioneers in implementing fresh concepts (kuratko 2016). although smmes have been widely acknowledged for their economic and social contribution, the majority of smmes perform poorly and, at times, fail in their early stages (arafat el-mobayed 2006; mahembe 2011; murimbika 2011). however, the key to effectively addressing the problems of poor performance and failure in smmes is argued to be the strategic planning process (arafat el-mobayed 2006; odame 2007; pangarkar 2015). this process is defined as a measured and balanced procedure responsible for giving an organisation an unmistakably distinct drive or aim through a purposefully selected route (mintzberg 1990). within the extant literature, calls exist for more investigations into the concept of strategic planning on outcomes such as organisational performance (chinyamurindi 2016). sondari (2014) argues for the need of such research especially within a context of entrepreneurship. given the global recognition of smmes as a driver of growth (jackson 2015) there is need to continually investigate how strategic planning can contribute to the performance of organisations (aldehayyat & khattab 2013). the purpose of this study is to investigate this relationship within a south african smme context argued as a potential driver in alleviating poverty and an enabler of economic prosperity (garwe & fatoki 2012; mahembe 2011). all this despite the risk and high failure rate that characterises it (pangarkar 2015). brewer (2010) highlights that more than three-quarters of business operations in south africa come from smmes, and they also contribute marginally to the gross domestic product (gdp). as a means of moving away from the post-apartheid economic system where the economy was dominated by a few parastatals and multinational corporations (finn, leibbrandt & oosthuizen 2014), priority is placed on smmes in south africa (garwe & fatoki 2012; mahembe 2011). the support of the south african government to the growth of smmes is evident in the creation of a small business development ministry whose main objective is to govern and provide support to smmes (rustomjee 2015). literature review theoretical underpinning porter’s five forces framework porter’s five forces examine what distinguishes the competitive environment of an organisation (grant 2014). porter’s framework is argued to be a possible explanation of how a firm can operate within an industry (grant & jordan 2015). for the organisation, this idea is rather important since the organisation is capable of directing its improvements regarding the selection of tactics and investments (andersen & nielsen 2009). the five forces described by porter comprise: the threat of new entrants, threat of substitute products, bargaining power of suppliers, bargaining power of customers and competitive rivalry within the industry (grant 2014). the literature explains that all these five forces are interconnected, and the first four forces all build up to competitive rivalry within the industry (andalya 2013). for this investigation, competitive rivalry within the industry is a factor that addresses the majority of the research objectives. the rivalry between organisations controls the desirability of a segment (grant 2014). establishments are struggling to uphold their supremacy; therefore, they make strategies to keep them on top (grant 2014). rivalry is a game in which, ordinarily, one participant fails at the cost of the other by formulating and implementing better strategies (andersen & nielsen 2009). a move on the part of a participant could result in the other participant creating counter-changes or starting efforts to safeguard themselves from the danger posed by the initial move, hence strategic control and analysis (grant & jordan 2015). in this way, organisations within the same trade are equally dependent, and the manner in which they strategise is shaped by the uncertainty in the environment (grant 2014). situations in an industry keep changing based on the actions and reactions of the constituent firms (gruber et al. 2010). response to such changes within an industry can mean the difference between success and failure. this places importance on the strategic planning process and its role in making, as argued by porter (2008), an organisation understand itself within a context and map out a position that is more profitable and less vulnerable to attack. the activities within porter’s framework consist of the traditional strategic management process especially those of environmental scanning, strategy formulation, implementation and evaluation (porter 2004; ricks & woods 1996). resources-based view of the firm further to porter’s framework, this research also embraced the resource-based view (rbv) of the firm (barney 1991) as a theoretical lens. the rbv links notions from firm economics and strategic management (grant & jordan 2015). in the rbv, the competitive advantage and greater performance of a firm are described by the uniqueness of its abilities (andersen & nielsen 2009). the fundamental suggestion of the resource-based model is that organisations are diverse with regard to the strategic possessions they have and regulate (grant & jordan 2015). resources make up the major element of investigation for the rbv and can be described as those possessions that are secured partially permanently to the organisation. traditional foundations of competitive advantage such as monetary and natural resources, equipment and economies of scale can be used to craft value (gruber et al. 2010). capabilities, in contrast, state an organisation’s ability to organise and manage diverse resources, commonly in groups, thus making use of a firm’s procedures to influence an anticipated goal (grant & jordan 2015). resources are information-grounded, intrinsically imperceptible procedures that are organisation prescribed and are established over time through multifaceted connections amid the organisation’s resources (grant 2014). hence, through the definition given on resources and capabilities, the rbv and porter’s framework are not only deemed applicable but linked to this study. resource contribution rests on the capacity of the human resources to formulate sound strategies (gruber et al. 2010). more so, the part of dynamic capability factors in the ability of the firm to allocate resources to each section of the strategic planning process. in essence, the rbv, using the seminal contribution of mahoney and pandian (1992) seeks to make a link between processes within strategic planning and see how these can be utilised as a basis for competitive advantage. this warrants its use as a theoretical underpinning in this study. strategic planning strategic planning can be defined as the procedure of creating and upholding consistency between the establishment’s goals and possessions and its shifting prospects (grant 2014). the strategic planning process, in general, comprises business objectives, a vision, and a clear design to accomplish the idea and achieve the objectives (dole 2013; mintzberg 1994). the strategic planning process also entails a scan of the environment (saunders 2015) and this helps the organisation prepare a suitable action based on this information (guerras-martína, madhokb & montoro-sánchezc 2014). the key constituents of strategic planning practices involve probing questions on where the establishment intends to go, the current situation of the organisation, how the organisation will get there and what alterations or fluctuations will occur in the establishment’s environment (grant & jordan 2015; guerras-martina et al. 2014). hutzschenreuter and kleindienst (2006) view strategic management as a discipline where strategic planning is housed. hence, it can be possible to conclude that research that has supported either the presence of a positive or negative relationship with strategic management implies the same for the strategic planning process (wijetunga 2013). for this study, strategic planning is considered to consist of: (1) formulation, (2) implementation and (3) strategy control and evaluation. using the work of louw and venter (2006), strategy formulation consists of those steps taken to set the direction of the organisation through analysing the internal and external environment. conversely, strategic implementation consists of those actions of putting into practice the actions set out as part of strategy formulation. finally, strategy evaluation and control is a means of making sure that the desired strategy remains on course as per the previous steps. one of the most important managerial purposes is to measure organisational performance (sandada, pooe & manilall 2014). assessing performance, revising variations in the surrounding environment and making alterations are customary and essential parts of the strategic management practice (guerras-martina et al. 2014). the means of measuring organisational performance remain an argumentative theme to business consultants and the research fraternity alike (harris et al. 2009; sandada et al. 2014). however, some researchers suggest that organisations may use objective measures in contrast to subjective measures to evaluate organisational performance (mcllquham-schmidt 2010; sandada et al. 2014). financial records comprising an actual return, gross revenue, return on asset, return on capital invested and gross inventory revenue constitute objective measures of financial performance (mcllquham-schmidt 2010). on the other hand, subjective measures tend to depend on a manager’s or owner’s view of organisational performance (dubilihla & sandada 2014). strategic planning and financial performance a lot of research that looks into the relationship between strategic planning and organisation performance in smmes has been conducted over the past decades (chavunduka, chimunhu, & sifile 2015; dubilihla & sandada 2014; hakimpoor 2014; langat & auka 2015; monday et al. 2015; pangarkar 2015). study findings by hakimpoor (2014) suggested that organisations that conducted a strategic planning process performed better than those that had no strategy formulation procedures. dubilihla and sandada (2014) revealed that there was a positive relationship between strategic planning and the performance of small business in south africa. further, the key to success for small businesses in south africa was grounded in their ability to practise strategic planning (dubilihla & sandada 2014). arasa and k’obonyo (2012) noted that there is a positive relationship between strategic planning and organisational performance. the two authors further stress that the success and good performance of organisations are centred on how implementation and control and evaluation of the strategic planning process is conducted. chavunduka et al. (2015) found that there was a positive relationship between strategic planning and organisational performance measures such as net income, return on investment and market share, among others. monday et al. (2015) acknowledge that organisations with excellent strategy implementation processes had much sounder organisational performance compared to those with a poor or fair strategy implementation process. strategy formulation, implementation and evaluation and financial performance concerning the link between aspects of the strategic planning process (such as formulation, implementation and evaluation) and financial performance, mixed results appear to exist. a stream of work appears to suggest that these aspects of the strategic planning process are linked to performance metrics within an organisational setting (e.g. arabzad et al. 2015). within a turkish context, efendioglu and karabulut (2010) found a positive correlation to exist between strategic planning (the presence of mission and involvement of top managers) and financial performance. on the other hand, some studies have found a negative relationship to exist between aspects of the strategic planning process and financial performance (gibson, cassar & wingham 2001). for example, french, kelly and harrison’s (2004) study on small service businesses revealed that there was also no relationship between these aspects of strategic planning and financial performance. this had been earlier supported within various contexts such as an smme context (o’gorman & doran 1999) and the service industries such as hospitals in lebanon (saleh et al. 2013). these conflicting findings in literature form the basis of this study, hence the hypotheses and research question presented in the following section. research question, purpose, hypotheses and conceptual framework based on the extant literature highlighted, there are inconclusive and conflicting results on the relationship between strategic planning and a financial measure of organisational performance. based on the presented literature review, the following hypotheses are set: h1: there is a significant positive correlation relationship between the strategic planning process and an organisation’s financial performance in smmes. h2: there is a significant positive correlation between the strategy formulation and an organisation’s financial performance in smmes. h3: there is a significant positive correlation between the strategy implementation and an organisation’s financial performance in smmes. h4: there is a significant positive correlation between the strategy evaluation and control and evaluation and an organisation’s financial performance in smmes. for this research, strategic planning was considered in the context of the strategic planning process. the primary objective of this study was to determine the relationship between the strategic planning process and financial measures of organisational performance. the secondary objectives investigated the relationship between the three arms of the strategic planning process (formulation, implementation and control and evaluation) and financial measures of organisational performance. further, the hypothesised relationships are described graphically in figure 1. the research sought to answer the following question: what is the relationship between strategic planning and financial performance among a sample of smmes operating within the buffalo city metropolitan municipality? figure 1: conceptual framework: hypothesised model of the relationship between strategic planning and financial performance. research methodology research design the study adopted a positivist paradigm using the quantitative research approach to collect data (creswell 2014). the aim here was to investigate ‘cause and effect’ (creswell 2014:23–24) and in the case of the research, the relationship between the independent and dependent variables. further, the survey research technique using a self-administered questionnaire was used and, borrowing from creswell (2014:13), this technique and instrument allowed for the opportunity to understand ‘trends, attitudes or opinions’ within a subset of a population. given the research study, questionnaires were also cost-effective, thus allowing for a wider reach (jack & clarke 1998). questionnaire design before the questionnaire was administered to the participating smmes, a pilot test was conducted to test the questionnaire using a sample of 50 non-participating smmes. the purpose of the pilot test was to test the techniques from data collection to analysis that were to be conducted in the main research study. this helped prepare the researchers to prepare for any eventualities that might happen using the pilot study. the research instrument was divided into three sections. the first section consisted of questions about the smme’s background and these included: (1) the industry category, (2) age of the firm, (3) the firm capital size in rand value, (4) the characteristics of the person or team responsible for strategic planning and (5) questions about the nature of strategic planning. the second section consisted of questions about how strategic planning occurs and was adapted from previous studies (arafat el-mobayed 2006) and measured on a 5-point likert scale (strongly disagree to strongly agree). this section consisted of scales measuring (1) the organisation’s mission (4 items), (2) the organisation’s objectives (4 items), (3) strategy formulation (12 items), (4) strategy implementation (2 items) and, finally, (5) strategy control (7 items). the third section of the questionnaire measured financial performance and was also adopted from previous studies (green & medlin 2003). each of the performance-related items asked the owner, manager or ceo to highlight their organisation’s performance in comparison to the industry average on a 5-point likert scale anchored between ‘weaker’ (1) and ‘stronger’ (5) (green & mediln 2003). population and sample data collection the total number of registered smmes operating within the buffalo city metropolitan municipality central district was 515 based on information supplied by the eastern cape development corporation (ecdc). from this and using the raosoft sample size calculator (raosoft inc 2017), a total of 221 smmes were recommended as a sample. using a convenience sampling approach, a total of 225 smmes took part in the study based on issues such as accessibility (wiid & diggines 2015). given that the smmes were within the vicinity of the buffalo city metropolitan municipality, a self-administered questionnaire was dropped off at the relevant companies for the attention of the owner, manager or ceo of the smme. after a week, a follow-up visit, email inquiry or telephone call was made to arrange for collection of the questionnaire. based on the analysis, the participating smmes were split as follows: (1) manufacturing (n = 44, 20%), (2) construction (n = 34, 15%), (3) wholesale (n = 40, 18%), (4) agriculture (n = 20, 9%), (5) service (n = 52, 23%) and, finally, (6) other (n = 35, 16%). data analysis the statistical package of the social sciences program (spss) version 22.0 was used to analyse the data collected in this study. cronbach’s alpha coefficients (α) were used to assess the internal consistency of the measuring instruments (clark & watson 1995). further, statistical analysis also involved generating a descriptive picture concerning the phenomena under study. inferential statistics helped determine the association between the dependent and the independent variables (wiid & diggines 2015). inferential statistics further help to come to conclusions based on observations on the population of the study (babbie & mouton 2002). in achieving the aims of this study, correlation and regression analyses were used (wiid & diggines 2015). assessing the internal reliability of a research instrument is very important to ensure the reliability of information gathered by the researcher (cooper & schindler 2006). the cronbach’s alpha coefficients of the dependent and independent variables were computed using spss. the evidence from table 1 indicates that all the scales used in this study met the set standard of 0.70, as guided by the literature (nunnally 1978). thus, the entire questionnaire with its scales had an acceptable level of reliability. the results of the analysis are tabulated in table 1. table 1: cronbach’s alpha coefficients. results descriptive statistics results this section provides an overview of the results on the background information section of the questionnaire. the respondents were asked questions about the history of their organisations. table 2 summarises the findings of the descriptive results. based on this analysis, the majority of smmes had been operating for 1–3 years with a frequency of 27.2%, followed by those entities with over 10 years of operation with a frequency of 26.3%. concerning strategic plans, the majority of smmes (76%) used strategic plans with only 24% citing having no strategic plans. finally, concerning the duration of strategic plans, 32% of the smmes cited having plans that span 1–3 years and 28% indicated their plans cover less than a year. from this analysis, 16% of smmes cited having plans that cover a duration of more than 4 years and 24% did not respond to the question. table 2: descriptive results (n = 225). correlation analysis between variables the results in table 3 indicate that there is a correlation between the variables under study. the researcher made use of correlation as a statistical measure since correlation best describes the strength and direction of a linear relationship between two variables (graham 2009). moreover, the correlation coefficient is a statistical measure of the strength of a monotonic relationship between paired data (pallant 2010). strategy formulation and financial performance were found to have the highest correlation and significance at 0.629. the second highest correlation and significance occurs between strategy implementation and financial performance which is at 0.615. strategy control and evaluation recorded the lowest correlation and significance with a result of 0.608. therefore, due to the results obtained in the correlation analysis, the study found a correlation to exist between strategic planning (consisting of formulation, implementation, as well as control and evaluation) and the dependent variable (financial performance). table 3: correlation results. regression analysis tests the results of the regression analyses are summarised in table 4a and 4b. the researcher made use of regression analysis as a statistical test since regression describes the strength and direction of the relationship between two variables, and it goes further by providing many refined examinations of the inter-relationships among groups of variables (graham 2009). this technique is most suitable when investigating the relationship between one independent variable and a number of dependent variables (neuman 2003). the r-squared value of 0.632 (63%) explains the model concerning the relationship between strategic planning and financial performance. furthermore, the analysis of variance certifies the applicability of the model and that it can be recognised as statistically significant. table 4a: regression analysis results: model summary. table 4b: regression analysis results: analysis of variance table 4a and 4b illustrate how the factors in the regression model presented in table 3 influence the prediction of organisational, financial performance. four of the ten factors in this regression analysis model can be regarded as statistically significant predictors to the model equation. the results from the model show that the question of whether or not an organisation has a written strategic plan has the largest beta coefficient value of 0.633, thus making it the largest predictor of financial performance. the period covered by the organisation’s strategic plan is shown as the second highest predictor with a beta coefficient of 0.306, thus indicating that the greater the number of years covered by the strategy, the greater the organisation’s financial performance. the third contributing factor to the prediction of financial performance was the organisational mission which had a beta coefficient of 0.225. lastly, the firm’s capital size was the fourth predictor contributing to financial performance with a beta coefficient of –0.157. the negative beta coefficient obtained from a firm’s capital size indicates that the factor influenced financial performance negatively. thus, the larger the capital size, the worse the organisation performs financially. discussion, implications, limitations and future study discussion the main purpose of the study was to establish the relationship between the strategic planning process and organisational performance in smmes in the buffalo city municipality. the results of the study on the relationship between strategic planning processes and financial performance in smmes indicated a positive relationship to exist among the smmes sampled. the findings on the relationship between strategic planning and organisational performance are consistent with the work of dubilihla and sandada (2014). further, the findings of this work that showed that the strategic planning process has a positive effect on financial performance are also similar to findings reported in a study conducted by monday et al. (2015). the findings of this current study revealed that there was a positive relationship between strategy formulation and organisational, financial performance in smmes. the results of this study are similar to some previous investigations available in the literature (e.g. andalya 2013; chavunduka et al. 2014; monday et al. 2015; wijetunga 2013). furthermore, the results of this study support findings of wijetunga (2013) and andalya (2013) which showed that there was a positive relationship between strategy formulation and the performance of manufacturing smmes and commercial banks, respectively. furthermore, this study was set to answer the question on the relationship between strategy implementation and financial performance in smmes in the buffalo city municipality. strategy implementation was found to have a positive relationship with organisational, financial performance among the sampled smmes in the buffalo city municipality. the results of this study are similar to some previous investigations available in the literature (e.g. andalya 2013; langat & auka 2015; monday et al. 2015; pangarkar 2015; wijetunga 2013). langat and auka’s (2015) study produced results that showed a positive relationship between strategy implementation and corporate performance. these findings were also similar to previous research (e.g. pangarkar 2015). lastly, based on the evidence provided by this current study, strategy control and evaluation was found to have a positive relationship with organisational performance among the sampled smmes in the buffalo city municipality. the results of this study are similar to some previous investigations available in the literature (e.g. chavunduka et al. 2014; dubilihla & sandada 2014; langat & auka 2015; monday et al. 2015; pangarkar 2015). the current study’s findings are in line with those of hakimpoor (2014) who established that organisations that used the strategy control and evaluation had a better chance of performing well than those that did not use strategy control and evaluation. similar findings were also reported in a study done by monday et al. (2015) that put forward that there is a positive relationship between strategy control and evaluation and organisational, financial performance in manufacturing companies in nigeria. based on the evidence provided in this study and a thorough review of literature (e.g. chavunduka et al. 2014; dubilihla & sandada 2014; hakimpoor 2014; langat & auka 2015; monday et al. 2015; pangarkar 2015), the study comes to the conclusion that the strategic planning process (strategy formulation, strategy implementation, strategy control and evaluation) is of great importance to how organisations perform. moreover, the evidence provides an answer to the gap that the researcher identified in the literature on the relationship of the four factors (strategic planning process, strategy formulation, strategy implementation, strategy control and evaluation) against financial performance. implications the most important contribution of this study is that it helps to extend knowledge and understanding on the issues of the relationship between the strategic planning process and organisational performance in smmes (chavunduka et al. 2014; dubilihla & sandada 2014; hakimpoor 2014; monday et al. 2015). the research magnified the frame of information in the area of strategic planning about performance of smmes. it makes available more literature that looks into these two variables (strategic planning process and financial performance in smmes) in an african context. this work advances an understanding of phenomena that are not often researched outside the western and asian contexts. this study is one of the few that have been conducted in sub-saharan africa that look into the relationship between the strategic planning process and organisational performance in smmes (chavunduka et al. 2014; dubilihla & sandada 2014). the current research showed that there was evidence that the strategic planning process has a positive effect on organisational performance in smmes. methodologically, the quantitative approach offered an opportunity for a valuable examination of the study’s variables grounded on the information gathered, along with respondents answering questions posed to them in answering the objectives of the study (creswell 2014). the objective of the research was to be able to generalise about a specific population based on the results of a representative sample of that population. further, the quantitative research approach provided a platform for understanding the phenomena better. based on the results of this study, the researcher concludes that the strategic planning process has a positive impact on organisational performance in smmes. since the impact of the strategic planning process is positive, it is a good predictor of organisational performance. therefore, this study contributes to shedding light on how important the strategic planning process is and how much attention has to be committed by those responsible for strategic planning in smme organisations. there is a need for smme organisations to provide their employees with training programmes that would develop their abilities and skills to understand and make use of the plans provided by top management. training programmes should not only be provided to subordinates but also to the owners and managers to improve their ability to come up with sound and fruitful strategic plans. furthermore, smmes need to integrate with organisations of higher learning in providing quality training and guidance on the use and importance of strategic planning in business organisations. it is advisable for smme managers and owners to employ strategic planning experts or create a department responsible for the strategic planning in the organisational structure to improve and advance the strategic planning process. having a strategic planning manager or department will allow diverse integration of ideas between members of the strategic planning department or managers with the owner of the smme. technology has greatly advanced in the past decade, and this has brought great improvement in how people and organisations perform their day-to-day business. therefore, the use of new technology and computerised software may also improve how smme organisations strategically plan. use of specialised computer software in strategic planning aids in simplification and enabling this process, which may result in sound strategic planning and good organisational performance. limitations the major limitation of this research is that the researcher only focused on data collection in one region. restricting data collection to buffalo city metropolitan municipality in the eastern cape province of south africa limits the generalisation of the findings of this study. hence, having considered data collection from different regions would have made the findings more generalisable. secondly, the research only considered a single respondent in an organisation in the form of the smme owner or manager, thus ignoring other members of the organisation. having considered more respondents from an organisation would have provided better clarity on the information about the organisations. moreover, there are high chances of respondents responding to the questions in the questionnaire in a socially desirable way. thus, respondents may acknowledge the presence of strategic planning only because it is socially expected of them to do so, thus making the data collected unreliable. future research repeated investigations can help deliver comparative interpretations of measures in a variety of settings in an industrial, national and international context. the current study had its sample drawn from one centralised location, in the buffalo city metropolitan municipality in the eastern cape province of south africa. therefore it is advised that studies are conducted with respondents drawn from different provinces in south africa and other regions on the african continent. this may be a possible platform in advancing understanding on the role of strategic planning in organisations. apart from exclusively being grounded on the objective or performance approach, future investigations could be grounded on other various hypothetical approaches such as stakeholders, competitive value and environmental turbulence to offer an all-inclusive viewpoint of how these variables help smmes plan for their performance, success and successions. this study only considered the strategic planning process (formulation, implementation and evaluation and control) as the independent variable and financial performance as the dependent variable. there is need to conduct studies that will widen the range of independent variables and integrate factors such as gender and level of education of owners or managers, location and size of the smmes into the investigation. furthermore, there is need to integrate the non-financial measures of performance into such a study. acknowledgements the research was funded by the 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jayewardenepura, sri lanka. 36 sajems ns vol i (1998) no i a note on an alternative approach to affirmative action mgering kpmg managemenl consulting, johannesburg abstract counting in the fonn of statistical data is almost always a good indicator of past and present discrimination; counting as an action plan in the fonn of a quota is usually not. lbis article examines the issue of affirmative action from the perspective of an analytical approach developed and published in the context of higher education between 1983 and 1986. it is shown how these ideas are being extended as a proactive tool in the context of changing management projects. introduction despite the fact that the majority of their work force is black. many south african companies have filled their top and middle management positions predominantly with white managers. the inequality has a historical cause and the political pressure to redress balance is mounting. this is compounded by the apartheid heritage in which talented black managers often lack the training and experience of equivalent managers in other countries. the inequality has an economic as well as a political aspect. the white corrununity is a limited talent pool further depleted as professionals with ability take up opporrunities elsewhere. in addition a homogeneous white management team does not reflect south africa's rich cultural diversity and risks loosing touch with its customer base. affirmative action is being seen by top managers and politicians as a key issue for many south african companies. this article examines a framework for identifying and supporting talented black managers based on research published in the context of higher education. in a series of publications we were able to show that the appropriate method of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr vol 1 (1998) nr 1 37 identifying gifted but disadvanraged students has quantifiable advanrages, among them ease of implemenration, self regulation and increased student motivation. the direct approach to affir.:'\1ative action the direct approach to affirmative action places affinnative action candidates directly into positions freed up either passively or through active intervention. some companies attempting to use direct affirmative action programs are finding the direct approach problematic. a direct affirmative action program is typically built around a quora concept. top and middle positions are identified, often with a high level skills inventory. next a rarget is agreed and key perfonnance indicators are identified. one such system measures the opportunities to place affirmative action candidates, the availability of internally trained candidates and the affu1l1ative action climate. these indicators are monitored and individual targets are set. further rargets are developed, monitoring the progress of affinnative action candidates in the organisation. high level indicators are placed on the business dashboard. such system must overcome three hurdles. the first hurdle is to provide adequate suppon for the affirmative action candidate. a manager who is promoted because of skin colour may find himself out of his depth. this is panicularly true in a climate of prejudice or resentment. secondly there are a limited number of positions with which to experiment. only once a position is free is it possible to move a manager to a new level of responsibility. with the progressive flattening of organisational structures even these positions are not always being filled. finally it proves difficult to provide the systematic safety net needed since not everyone is suirable for a management position. a manager promoted too far above hislher competence may find that he can neither cope nor learn; the new manager might as well retire into the new position. affirmative action and the dual selection system in both higher education and management, we have had success by setting up a simple, flexible parallel structure. in higher education we asked ourselves how to identify students who are at the same time gifted but disadvanraged (gering and zietsman. 1983). studies had ' shown (van wyk and crawford. 1984) that the matric rating was the by far the best predictor of university success. this is not surprising since the matric r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 38 sajems ns vol 1 (1998) no 1 examination has the advantage that it measures what urriversity measures, including academic skill, the ability to perfonn under pressure and the character to remain motivated over an extended period. on the other hand rnatric rating is strongly biased to current perfonnance. the solution was to recognise that the school leaving class is a statistically significant control group. a student who performs at top of a poorly performing class is academically gifted but disadvantaged. that he is disadvantaged academically is witnessed by the academic perfonnance of his peer group. that he is gifted academically is witnessed by his perfonnance at the top of his peer group. by labelling the student as disadvantaged, we were able to tailor remedial programs to his or her needs. but by labelling him as gifted, the negative stigrna of the disadvantaged could be removed (zietsman and gering, 1985). we tested this hypothesis on a sample of over 1200 students from all racial groups over a three year period. given two students with identical rnatric ratings. the student from the disadvantaged background will begin to improve and will show in one year an average improvement of ten percent over the advantaged student. results were published international journal higher education (gering and zietsman, 1986a) and the full results presented at a conference in heidelberg, germany (gering and zietsman, 1986b). the student therefore has two routes to urriversity admission, the nonnal route where he competes against the national average and the alternative route where he competes against his peer group. the selection criteria has the advantage of being racially neutral and self regulating. the statistical sample showed that, although clearly black students were more likely than white students to have suffered academic disadvantage, the improvement effect of the gifted but disadvantaged student was not a racial effect per se. affirmative action in management while the model for affmnative action in management is not the same as that for education two key principles carry over. the first principle is testing by doing. the second principle is that there are often alternative routes to demonstrate competence, be it managerial or academic. the management context differs from higher education in that smaller numbers are selected, in a more stringent process and with the intention of long tenn retention. moreover the early part of the management career is both a learning and a selection system for later management responsibilities. it is in this context that alternative structures are needed to develop rnanagers who would otherwise not have been given the opporturllty to develop. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sa teb nr vol 1 (1998) nr 1 39 such structures do exist in industry. in the past they were found typically in staff type roles, for example the role of the young finance recruits in conglomerates such as m or general electric. the equivalent structure in the age of delegation and empowerment is that of project team. an international consulting company has a wide experience of using full time joint team members in large scale change projects. a change project with ten consultants could involve fifteen full time joint team members, up to fifty part time team members and have a duration of eighteen months. the consultants panicipate in the selection of the joint team and then formally induce, coach and outplace team members. the managers face challenging situations. some rise to the occasion and use the project as a platform for their next career jump. this is true irrespective of management level or of country . companies in south africa increasingly use the project structure as a deliberate opponunity to test black managers in a demanding role. together with the consultant they select promising candidates. the consultant is then charged with delivering the project but at the same time working closely with the joint team members, coaching them in their unfamiliar role. some candidates exceed all expectations. these candidates are snapped up by the organisation and move on to a leadership role that they have unreservedly earned and for which they are indisputably ready. not all candidates meet the mark. candidates who do not meet the mark are moved tactfully back into the organisation. this may occur either at the end of the project as a rotation d.uring the project. the candidate has been given a chance without compromising either the aspirations of other candidates or the functioning of the organisation. the advantages and prerequisites of such a structure using a project structure as a testing ground for fast track managers offers three advantages. firstly the system has a safety net. the manager who is struggling has the direct suppon and coaching of a consultant experienced both at solving business problems and at supponing managers in a sink or swim role. the manager who even then cannot cope, goes back into the organisation taking his experience with him, and is not left in a role in which he cannot succeed. secondly there is a chance to test many managers. a change project involves up to ten percent of an organisation in pan time roles. the opponunity to identify candidates and place them in stretch roles is maximised. managers in new r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 40 sajems ns vol i (1998) no i roles, panicularly in previously rigid organisations do have the propensity to surprise. and finally the candidate earns his later top management role. affirmative action in this model is not aimed at redressing past discrimination. in this model affinnative action is the opponunity of tapping the wider talent pool as a source of competitive advantage. there are however three important prerequisites, three critical success factors which we have seen threaten such projects. firstly the role must be a real role in a real project. for example business process reengineering project is ideal. it involves detailed understanding of core business processes and exposes the candidate to interesting interpersonal situations across departments. business process reengineering projects fail when top management fails to take an active, high profile suppon role. top management involvement and a high corporate profile are characteristics of real projects with real roles. secondly the project must constitute a learning situation. again large scale change constitutes a sink or swim situation involving business skills and people skills equivalent to a protracted business school case study. the pr~ject is replacing the postgraduate training that privileged managers in other countries might be afforded. finally the program needs tough decisions. a change program which is being used to test potential high fliers needs the involvement of the human resource director and a deliberate planning of later career steps. many, perhaps most candidates won't make it and the human resource director has a role in facilitating the outplacement and helping the team let go. conclusion counting in the form of statistical data is almost always a good indicator of past and present discrimination; counting as an action plan in the form of a quota is usually not. a quota system is a method of last reson; it is the tool of very high level management or of external activists: it is the tool of people determined to use blunt force to overcome resistance. alternative approaches are being used, even in organisations undergoing systematic delayering. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr vol 1 (1998) nt 1 41 references 1. gering, m.z.1. and zietsman, a.1. (1983). university elurance in an academically non-homogeneous society, south african journal of education, 3,181-184. 2. ziefsman, a.1. and gering, m.z.i. (1985). academic aptitude and background as factors in university admission policies. south african journal of education, 5, 184-187. 3. gering, m.z.1. and ziefsman, a.1. (1986a). admission to university in an academically non-homogeneous society. higher education, 15.25-35. 4. gering, m. z. i. and ziefsman, a. i. (l986b). quality and access: a dual criterion admission system for higher education institutions, twelfth international conference on improving university teaching (heidelberg 1986). 500-509. 5. van wyk. 1.a. and era wford, ll. (1984). correlation between majric symbols and marks obtained in a first-year ancillary physics course aj the university o/the witwajersrand. south african journal of science, 80, 8-9. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction literature review methodology results discussion recommendations limitations of the study conclusion acknowledgements references about the author(s) herring shava department of business management, university of fort hare, south africa citation shava, h., 2018, ‘impact of gender on small and medium-sized entities’ access to venture capital in south africa’, south african journal of economic and management sciences 21(1), a1738. https://doi.org/10.4102/sajems.v21i1.1738 original research impact of gender on small and medium-sized entities’ access to venture capital in south africa herring shava received: 04 jan. 2017; accepted: 12 oct. 2017; published: 24 apr. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the debate on the influence of gender on small and medium-sized entities’ (smes) access to finance from a demand-side perspective is still ongoing. this study seeks to contribute to the debate from an emerging economy (south africa) perspective. aim: the study investigated whether there is a gender gap in sme access to venture capital, a distinct source of finance. setting: smes play a significant role in south africa’s economy. despite the importance of smes, access to finance is one of the major constraints affecting their success rate. globally, to enhance the probability of sme survival, small business practitioners and governments are in search of relevant support measures. one of those measures could be adequate access to venture capital. however, it is sad to note that smes seldom use this distinct source of finance. methods: the study made use of the quantitative method of research and is descriptive by design. self-administered questionnaires were emailed to respondents for the purposes of gathering primary data. the t-test was used to statistically analyse primary data. results: the results reveal that there is a statistically significant difference in the accessibility of venture capital between maleand female-owned smes. conclusion: the article concludes that a gender gap in access to venture capital exists owing to differences in business approach between female entrepreneurs and their male counterparts. female entrepreneurs are cautious about the level of risk they are willing to take and the amount of control they wish to exercise in firm ownership. introduction in contrast to previous years, policymakers in developing nations are currently stepping up efforts to promote economic expansion activities of female-owned enterprises (klapper & parker 2011). the role played by female-owned business entities in reducing unemployment and the inequality gap in societies cannot be overlooked (noguera, alvarez, merigó & urbano 2015). the establishment of financial institutions such as the grameen bank in bangladesh, characterised by microfinance schemes that specialise in lending small loans to impoverished female enterprise owners regardless of collateral, testifies to the pivotal role female-owned enterprises play in societies (kumar, hossain & gope 2015). despite the importance of female entrepreneurship across the globe, female-owned firms are more likely to terminate operating activities within 5 years of operation owing to limited access to financial resources, such as venture capital (cant & wiid 2013; fatoki & smit 2011; flowers et al. 2013). according to korteweg and nagel (2016), investments by venture capitalists are a crucial source of funding that has proven to be valuable in supporting young firms and ensuring their success in the economy. this article considers a distinct source of funds in the form of venture capital, which plays a crucial role in small and medium-sized entity (sme) start-ups and growth (lucey 2010). besides the provision of equity (venture capital) to fast-growing privately owned firms, venture capital fund managers have advanced expertise in contract negotiations, and hence they function as financial intermediaries, managers, and often as directors (kortum & lerner 2000). research reveals that in some countries, for example the united states of america (usa), venture capital is the major contributor to growth and success of smes in sectors such as biotechnology and information communication technology (gompers & lerner 2001; jeng & wells 2000). memba, gakurwe and karanga (2012), in their study conducted in kenya, concluded that venture capitalists’ investment in smes facilitated wealth creation in ways that improved people’s livelihoods. memba et al. (2012) further argued that venture capital is the best source of business finance, although it is seldom used. in addition, their findings revealed that venture capital has a positive impact on sme growth. conversely, brush, carter, gatewood, greene and hart (2004) indicated that male-owned firms access formal and informal venture capital better than female-owned firms do. thus, to a certain degree, research suggests that gender is an influencing factor regarding the above-mentioned differences. empirical evidence focusing on the influence of gender on sme access to venture capital is limited. scholars such as derera, chitakunye and o’neill (2014) indicated that studies focusing on women entrepreneurial activities are needed, particularly in developing nations such as south africa. this article is a response to this call by adopting a different dimension and investigating whether or not maleand female-owned smes have a significant differential access to venture capital. the empirical study contributes significantly to the literature and unveils imbalances in practice and adoption of the entrepreneurship concept within societies. the remaining part of the article is structured as follows: literature review, research methodology, results and discussion, recommendations, and finally the conclusion to the study. literature review venture capitalists rely more on the concept of asymmetric information as it gives preference to issues of ‘selection and governance’ which are key to their success. osnabrugge (2000) pointed out that in a normal business environment, asymmetric information leads to agency problems, which prove to be an adverse selection and moral hazard. this study, however, gives preference to moral hazard as it is well associated with the concept of gender in the sense that both male and female sme owners are somehow affected by how they can best align their own interest in the firm, versus the interests of venture capitalists. in undertaking investment decisions, venture capitalists seriously take into account the firm owner’s interest and future goals, such as growth. the owner’s interest in firm growth is a key indicator in assessing the firm’s risk. thus, venture capitalists undertake and implement nearly all possible risk mitigation measures available to them in order to reduce the uncertainty of the investment outcome. this literature review section provides a detailed discussion on the nature of venture capital and the current outlook of venture capital in south africa. literature focusing on gender differences and access to venture capital is reviewed. thereafter, literature focusing on the relationship between gender, business risk, and access to finance is reviewed. the nature of venture capital venture capital refers to investments made by venture capitalists at budding or start-up stages of business (correia, flynn, uliana & wormald 2011). venture capital is managed by venture capital fund managers who are individuals who provide value-added resources to entrepreneurs in the form of strategic advice, managerial expertise, technical expertise, and financial, administrative, and marketing support activities depending on the needs of the investee (dorsey 1979; fatoki 2012). venture capital fund managers also go a step further to link entrepreneurial firms to business networks of accountants, lawyers, investment bankers, and other business organisations operating in the same sector as the investee (cumming & johan 2013). venture capital is different from private equity in the sense that the latter is broader in scope as it can be used for various purposes such as investment at a later stage of business (after start-up), or for buyout purposes and as investment to change the scope of business in the form of turnaround investments (cumming & johan 2013). table 1 indicates different financing stages where venture capital is applicable and where it has been utilised the most. table 1: venture capital financing stages. venture capital in south africa venture capitalists in south africa are formal firms owned by individuals who excelled in different endeavours in the past. they constantly monitor enterprises in which they have invested and they are very conservative (small enterprise development agency [seda] 2016). they are conservative in the sense that they take a different approach from the european and usa venture capitalists when making investments. the trend overseas is that out of 10 recipients of venture capital funding, 6 stand to fail and 3 stand a chance to break even with only 1 entity likely to make a substantial amount of money for both the owner and venture capitalists (seda 2016). venture capitalists in south africa shy away from such huge risks and they are very sceptical about investing in smes, an approach that has seen them being successful and losing very little. similar to other venture capital firms worldwide, south african venture capital firms have clearly defined exit strategies outlined in the contracts they negotiate with the sme owners (gitman et al. 2010). the organisation of south african venture capital investors is outlined in table 2. table 2: organisation of institutional venture capital investors in south africa. generally, venture capital investments are concluded through a legal contract that allocates responsibilities and ownership interests between existing owners and the venture capital fund or limited partnership, also taking into consideration the firm’s development stage (gitman et al. 2010). according to the south african venture capital association (savca 2013), a private equity industry survey reported that the south african local private equity industry added 10.4% to its total funds under management accumulating to r126.4 billion as of december 2012. this increase reportedly surpassed the previous 4 years’ combined cumulative growth of 4.6%. factors behind the observed 10.4% growth include the renewed interest of global investors to invest in the south african market. according to savca (2013), investors in developed markets, such as in the usa and europe, are in search of growth assets that are not apparent in their domestic markets. resultantly, the south african private equity managers present an attractive, sophisticated and low risk opportunity to such investors (savca 2013). furthermore, another factor that led to the increased activity in the private equity sector in 2012 was the announcement by the south african government employees pension fund (gepf) that it intended to deploy up to r60 billion into private equity over the forthcoming years (savca 2013). funds that savca raised in the year 2012 amounted to r14.4 billion, rising from r10.7 billion in 2011, a figure lower than the record level of r15.4 billion realised in the year 2007. in the year 2012, investments of r10.6 billion were made; however, this was a low figure compared to investments realised in the year 2011. significant investment activities were to be undertaken in the final quarter of the year 2013 which were expected to continue into the year 2014, given that at that time the association had availed approximately r35.3 billion in undrawn commitments (savca 2013). the value or estimate of the management advice (value addition) provided by venture capital fund managers to the various firms in south africa is not clear. however, it is probable that the skill improvement effect of venture capital is a significant additional benefit. although venture capital makes a limited contribution to the equity gap in south africa, it should be noted that the funds, and managerial and technical support, they provide remain limited compared to the needs of the sme sector (savca 2013). as of today, the south african private equity sector is one of the most developed, with r29 billion under management at the end of the year 2015. this figure is a significant increase of 145% when compared to r11 billion raised in the year 2014 (savca 2015). approximately r22 billion of the r29 billion came from south african investors dominated by fund managers who oversee investments of third parties. investments concluded in the year 2015 were as follows: r4.4 billion on follow-up investments, and r6.1 billion on new investments. a total of 534 deals were concluded in the year 2015, with the most notable as follows: 15.9% of the deals were concluded with entrepreneurs through banks, financial services, and insurance; 15.7% of the deals were concluded with entrepreneurs in the retail sector, 14.2% were deals concluded with entrepreneurs in the infrastructure sector, and 11.8% of the deals were concluded with entrepreneurs operating in the manufacturing sector (savca 2016). gender differences and access to venture capital carter, shaw, wilson & lam (2006) observed that women business entity owners may be disadvantaged in their access to various entrepreneurial resources, given their personal backgrounds and employment experience, as well as the socioeconomic and cultural context in which their businesses operate. evidence from various studies indicate that women’s access to formal finance is lower than that of men (ellis, cutura, dione, gillison, manuel & thongori 2007; global entrepreneurship monitor [gem] & international finance corporation [ifc] 2005; faisel 2004; richardson, howarth & finnegan 2004). naidoo, hilton and natalie (2006) revealed that female entrepreneurs in south africa face various challenges in accessing formal finance. for example, after 2 years of operations, the black economic empowerment (bee) equity fund only had a total of 5% female clients. research by klapper and parker (2011) pointed out that established financial houses grant finance to male applicants at a more affordable rate than they do to female applicants. however, muravyev, schafer and talavera (2009) took a different dimension to this debate and argued that even if women succeed in acquiring finance, it will be associated with high finance costs compared to men. however, greene, brush, hart & saparito (2001) revealed alarming statistics when focusing on equity investments in the usa during 1998. with regard to venture capital, a low figure of 4.1% was channelled to female-owned firms. surprisingly, 40% of firms were female-owned in the same year, yet they received less than 5% of venture capitalists’ funds. this suggests that gender significantly influences the decisions of venture capitalists (brush, carter, greene, hart & gatewood 2002). in support of the above notion, from a sample of 235 female-owned firms in the usa, 40 firms (representing 17%) were able to secure funding from formal finance houses (carter, brush, greene, gatewood & hart 2003). according to industry canada (2005), consistent findings with regard to poor venture capital investments in female-led businesses compared to male-led firms have been reported in several countries across the globe. the study by orser, riding and manley (2006) advanced a different perspective with regard to fund seeking by gender. orser et al. concluded that male business owners were actively involved in fund seeking compared to female business owners. according to correia et al. (2011), venture capital markets are characterised by high transaction costs, and the number of buyers and sellers is very small. therefore, venture capital markets are less efficient than public markets. when the observations by correia et al. and those of orser et al. are critically examined, they somehow suggest that a gender gap could exist in the access of venture capital. in their study, changanti, decarolis and deeds (1995), however, argued that gender plays an insignificant role in estimating small firms’ capital structure owing to female entrepreneurs’ preference for utilising internal as opposed to external equity. research by bennet and dann (2000), as well as haynes and haynes (1999) further confirmed female entrepreneurs’ preference for internal sources of finance compared to male entrepreneurs. orser et al. (2006) commented that although the findings of the above-mentioned studies lack in providing clear statistics on the application rates for different equity sources between male and female entrepreneurs (for comparative purposes), they do suggest that women may be less likely to obtain, let alone seek, external equity from a venture capital firm. orser et al. noted that empirical studies further prove that an insignificant number of female-owned enterprises have received equity funding in the form of venture capital compared to their male counterparts. they concluded by proposing that further research is needed to establish possible causes of this discrepancy. richardson et al. (2004) established that in sub-saharan africa, female entrepreneurs are more likely to rely on internal and informal financing than are male entrepreneurs. the study by fu, ke and huang (2002) reported the existence of a positive relationship with venture profitability when equity finance is used. in smolarski and kut (2011), indications were made to suggest the existence of a significant relationship between financing and environmental instabilities. smolarski and kut focused on entities that pursued growth in local and international markets. for venture capitalists to invest in any given firm, large or small, risk of that firm plays a significant role. the concept of asymmetric information plays a pivotal role in explaining the risks emanating from funding entrepreneurial ventures regardless of the owner’s or manager’s gender. gender, business risk, and access to finance research has pointed out that risk aversion is one of the major reasons leading to entities’ poor access to finance (carter & shaw 2006; marlow & carter 2006). in that regard, studies by manning and swaffield (2008), as well as cronson and gneezy (2009), revealed evidence that female entrepreneurs noticeably display high risk aversion and low self-esteem, among other traits. manning and swaffield lamented that the above-mentioned traits, combined with other psychological factors, largely compromise female entrepreneurs’ financial negotiation capabilities, evidenced by poor access to finance (venture capital included). the consequences of risk aversion in women are manifest in various areas; for example, women tend to lose confidence in their abilities, compromising the growth and success rate of their business entities. resultantly, female entrepreneurs turn out to be reluctant in pursuing risky activities such as firm expansion and fund seeking, which are practices mainly carried out by profitable firms dominated by male entrepreneurs (kwong, jones-evans & thompson 2011). furthermore, cliff (1998) found female entrepreneurs to be more anxious about the risks linked to speedy growth compared to their male counterparts. consequently, female entrepreneurs deliberately adopt a slow and steady firm expansion rate. in addition, cliff reported that for female entrepreneurs, personal considerations appeared to override economic considerations in relation to growing a business. venture capitalists are investors whose primary concern is to grow businesses in order to buy them out within 5 years. the comments by cliff emphasised that smaller firms, characterised by slower growth rate, appear to be women entrepreneurs’ deliberate choices, and that venture capitalists may shy away from investing in female-owned business ventures, thereby creating a gender gap in access to venture capital. empirical evidence comparing femaleand male-owned firms’ access to formal and informal credit by country is limited. available empirical evidence in this regard is readily available for developed countries such as the uk, usa, canada, and new zealand (bruhn 2009; demirgüç-kunt, klapper & singer 2013), whereas evidence from emerging countries is limited. in an attempt to compare access to formal and informal credit by gender, the study relies on evidence provided by demirgüç-kunt and klapper (2012); the comparison was made relying on regions. the respondents surveyed revealed their 1-year borrowing history in relation to formal and informal credit. south africa is economically classified as a developing country. thus, from table 3, around 7% of south africa’s women are likely to receive formal credit compared to 9% of men. also, 22% of women would have access to informal credit compared to 26% of men. from table 3, women in developing countries (including south africa) have better access to formal credit when compared to countries in sub-saharan africa, middle east and north africa respectively. however, access to formal credit is still a challenge for women in developing countries when compared to women in developed countries. the trend is however different in relation to access to informal credit. although men still have better access when compared to women by region, developing countries outperform high-income countries in the use of informal credit. table 3: men and women’s access to formal and informal credit by region. the following hypothesis was formulated: h0: there is no significant difference in the access of venture capital between maleand female-owned smes. methodology the study was undertaken within a positivist paradigm where the focus is on facts and phenomena are reduced to their simplest elements. positivism is a paradigm outlining that we can only see and observe things. also, positivism emphasises that there is objective truth out there that waits to be discovered (okeke 2015). in addition, it includes the formulation and testing of a hypothesis (o’gorman & macintosh 2015). the study relied on quantitative data and it is descriptive by design. data collection was carried out by means of a survey. to gather data relevant to this empirical study, the researchers concentrated on single-owned smes and quota sampling was used. this is a sampling method in which the researcher selects units on the basis of pre-specified characteristics. in south africa, the rates at which male and female individuals participate in self-employment stand at 51.5% and 48.5% respectively (gem & ifc 2005). a total of 109 questionnaires completed by 53 female and 56 male sme owners were returned with sufficient data to answer the research problem at hand. respondents were initially drawn from the eastern cape province. however, the respondents were later drawn from all nine of south africa’s provinces as a measure to overcome the poor response rate. small and medium-sized entities (smes) that participated in this study were identified through a random search on the internet. contact addresses were recorded and phone calls were placed to invite the entrepreneurs to participate in the study. upon consent, each sme owner was asked to provide a valid email address to which the researcher then emailed the survey instrument. reliability and validity of measurements the questionnaire consisted of items dealing with access to money and funds from venture capitalists, access to managerial expertise or training from venture capitalists, and access to technical expertise from venture capitalists as measures of access to venture capital. respondents were questioned about accessibility of any of the above-mentioned indicators on a five-point likert scale. the cronbach’s alpha coefficient was calculated to assess the internal reliability of items in the questionnaire and a coefficient value of 0.73 was obtained. to ensure that the study was valid, logical validity, which is a form of content validity, was applied. according to phelan and wren (2005), validity is a measure of quality in research. thus validity is concerned with whether or not the study has successfully measured what it intended to measure. to ensure that the study took into account the required ranges as manifested by the variables under study (content validity), a thorough literature review was undertaken on the research problem. in addition, three experienced researchers in the field of entrepreneurship and finance were consulted (expert review) and their feedback was taken on board in designing the final research instrument (mukwambo, ngcoza & chikunda 2015). data analysis data analysis was carried out through the use of the social science statistical package (spss). the distribution scores of the study were reasonably normal and hence the parametric t-test and descriptive statistics were the statistical tools applied in the analysis and summarisation of data collected. the independent samples t-test was used to statistically analyse whether or not a significant difference existed between access to venture capital by gender. ‘the independent samples t-test is used to find a difference between means of two independent samples for example, separate groups of subjects’, (nunez 2013:149). in this study the two groups are male and females sme owners. thus, making use of the t-test, the researcher sought to establish whether the means of male and female sme owners were sufficiently different to conclude that they in fact are drawn from two distinct populations, namely the population with better access to venture capital and the population with poor access to venture capital, or whether the scores predicted that both samples were drawn from a single population (nunez 2013:142). in addition, the effect size was also calculated to examine the effect of gender on access to venture capital indicator. according to pallant (2010), to calculate the effect size for an independent sample test, two main methods are normally used, namely the eta squared and cohen’s d. in this article, the eta squared method was used because it has the smallest sampling variability, that is to say, it has the greatest precision (keselman 1975; skidmore & thompson 2013). results this section outlines the results of the study. descriptive results are presented and interpreted first. thereafter, inferential results are presented. descriptive statistics an independent samples t-test was conducted to compare access to venture capital indicator scores for men and women. regarding access to money and funds from venture capitalists, results reveal that there is a statistically significant difference in the access to money from venture capitalists evidenced by a mean score for men (m = 3.79, standard deviation [sd] = 1.25) and women (m = 2.78, sd = 1.5; t(66.831) = 3.07, p = 0.003, two-tailed). the magnitude of the difference in the means is above moderate to large (eta squared = 0.12). results also reveal that there is a statistically significant difference in the access to managerial expertise from venture capitalists as shown by mean scores for men (m = 3.88, sd = 1.25) and women (m = 2.8, sd = 1.5; t(66.953) = 3.18, p = 0.002, two-tailed). similarly, the magnitude of the difference in the means is above moderate to large (eta squared = 0.13). in addition, results reveal that there is a statistically significant difference in accessing technical expertise from venture capitalists, supported by mean scores for men (m = 3.88, sd = 1.32) and women (m = 2.97, sd = 1.59; t(66.882) = 2.607, p = 0.011, two-tailed). furthermore, the magnitude of the difference in the means is above moderate to large (eta squared = 0.09). inferential statistics the study’s hypothesis, stating that there is no significant difference in the access of venture capital between male and female sme owners, was tested. results from the independent samples t-test conducted to compare access to venture capital mean scores for men and women reveal that there is a statistically significant difference in mean scores for men (m = 3.85, sd = 1.25) and women (m = 2.86, sd = 1.51; t(66.802) = 3.005, p = 0.004, two-tailed). the magnitude of the differences in the means was above moderate to large (eta squared = 0.12). discussion the descriptive statistics suggest that gender has an influence on smes’ access to venture capital. thus, male entrepreneurs have better access to venture capital when all indicators (access to funding, access to managerial expertise, and access to technical expertise) are compared between genders. in addition, these results add evidence to literature that argues that a gender gap exists in accessing of venture capital by smes. the findings from inferential statistics confirm the suggestion made from an analysis of descriptive statistics. the results reveal that gender has a significant influence on the access of venture capital by smes, thus leading to this study rejecting the null hypothesis. these results are consistent with findings by klapper and parker (2011) who revealed that female-led smes are less likely to access finance from formal venture capital providers. brush et al. (2004) also concluded that female-owned smes generally raise less formal and informal venture capital than male-owned smes. however, watson, newby and mahuka (2009) pointed out that the finance gap from the demand side could be a result of many factors that women entrepreneurs consider crucial when they are making decisions related to the capital structure of the firm. these issues include risk-taking propensity and the desire to retain full ownership of the entity. women entrepreneurs’ approach to business differs significantly from that of men, including the amount of risk they wish to take. female entrepreneurs generally prefer less risk as is evidenced by their dominance in the retail sector characterised by low growth as opposed to the service sector characterised by high growth and high risk. the risk-averse nature of female entrepreneurs and the desire to retain full entity ownership discourage female entrepreneurs from seeking external equity, leading to a gender gap in access to venture capital. the study’s findings also point to the reluctance of female entrepreneurs to seek external equity in the form of venture capital compared to male entrepreneurs, as is evident in the large differences between male and female access to venture capital mean scores (access to funds = 1.01, access to managerial expertise = 1.08, access to technical expertise = 0.97). recommendations although there is no evidence to suggest that south african female entrepreneurs’ business concepts or ideas are evaluated differently from those of male entrepreneurs by venture capital fund managers, for the purposes of funding, in many instances, societies benefit overall from venture capital firms with women partners (brush, carter, gatewood, greene & hart 2006). in a global community with at least half of the working population being self-employed, there is a high probability that venture capital firms with women partners are more likely to fund women-founded smes (brush et al. 2006; cho, robalino & watson 2016). this is likely to be the case given that in different societies women are among the vulnerable (cho et al. 2016; vidovic, peric & jozanc 2015). in an attempt to empower female entrepreneurs, it is logical for female venture capitalists to play a leading role. therefore, it is crucial for the established south african female business community to support budding female entrepreneurial activities through committing various resources in the venture capital sector. in addition, it might further help women business owners to enhance strategic connections through business networks essential for business success, such as consistent access to accountants, lawyers, and investment bankers. the concerned stakeholders, such as the south african government, private players within the business community, and non-governmental organisations, can increase female-owned smes’ access to venture capital by educating venture capitalists on issues affecting the capital structure decisions of female-owned smes. venture capitalists, to a certain degree, have little experience in concluding business transactions with women business owners because their focus is mainly on entities with the capacity of listing on the public stock exchange. the aforementioned stakeholders should design and implement programmes that create an environment where a business owner’s risk-taking propensity level is easily learned and assessed. according to vidovic et al. (2015), evidence exists suggesting that women entrepreneurs generate viable business ideas and exploit entrepreneurial opportunities at the same rate as men. when evaluating business concepts for eligibility of funding, it is important for venture capitalists to take into consideration women entrepreneurs’ business goals, approach to business, and risk-taking propensity as these significantly differ when compared to their male counterparts (watson et al. 2009). this will in turn promote venture capital lending to women, as perceptions about women’s abilities are proved to be incorrect. there is a need for non-financial support to women entrepreneurs to enhance their managerial and technical competencies. female business owners should also form networks that will assist them to link with other successful female entrepreneurs as a way of boosting their confidence. in addition, there is a need to have support programmes that provide women entrepreneurs with proper information with regard to the advantages of utilising venture capital as a source of finance. limitations of the study this study focused on access to venture capital from the demand side and ignored the supply side. further studies can be carried out to assess the influence of gender on access to venture capital focusing on both the demand side and the supply side. conclusion this article has highlighted that dissimilar access to venture capital between genders can be found in south africa. the article concludes that a gender gap in access to venture capital exists owing to differences in business approach between female entrepreneurs and their male counterparts. female entrepreneurs are cautious about the level of risk they are willing to take and the amount of control they wish to exercise in firm ownership. acknowledgements competing interests the author declares that he has no financial or personal relationships that may have inappropriately influenced him in writing this article. references bennet, r. 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of customer satisfaction and commitment in promoting customer citizenship behaviours estelle van tonder, leon t. de beer received: 11 apr. 2017; accepted: 28 sept. 2017; published: 28 mar. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: it is widely accepted that the relationship quality dimensions of customer satisfaction and commitment may impact on customer citizenship behaviour. the positive effect of customer satisfaction on customer commitment is also undisputed within the relationship marketing literature. aim: it was the aim of this study to examine the extent to which customer commitment mediates and strengthens the relationship between customers’ perceived satisfaction and their citizenship behaviour. in the context of internet banking, the study aimed to examine the extent to which customer’s commitment towards the service provider (the bank) strengthens the relationship between satisfaction with the service provided (internet banking) and customer citizenship behaviour (consumer advocacy and the helping of other customers). setting: the study was conducted in the south african internet banking environment, which could benefit from a model of factors contributing to customer citizenship behaviour, specifically the sub-dimensions of consumer advocacy and helping behaviour. methods: a descriptive and quantitative research design was followed and the survey responses obtained from 491 existing users of internet banking services were used in the analysis. results: following the structural equation model results, the direct relationships between all constructs were confirmed. customer commitment, however, has only a partial mediating effect on the relationships between customer satisfaction and the sub-dimensions of consumer advocacy and helping behaviour. conclusions: from a theoretical perspective, the research findings provide more insight into the role of customer satisfaction and commitment in contributing to customer citizenship behaviour and the extent to which both relationship quality factors are needed in order to do so. from a practical perspective, banks should adapt their marketing strategies to facilitate greater relationships with customers responsible for citizenship behaviours. customers promoting the benefits of the service to other customers and helping them to use the service may ultimately contribute to greater adoption and use of internet banking services. introduction the notion that customers act as ‘partial employees’ of a firm and through their discretionary voluntary behaviours contribute to its competitive position is receiving growing attention in marketing literature (balaji 2014; chiu, kwag & bae 2015:627; fowler 2014; jung & yoo 2016; tung, chen & schuckert 2017; wu et al. 2017). this behaviour is generally referred to as customer citizenship behaviour and has been formally defined as ‘helpful constructive gestures exhibited by customers that are valued or appreciated by the firm, but not related directly to enforceable or explicit requirements of the individual’s role’ (gruen 1995:461). hence, in addition to the in-role behaviours normally expected of customers (patterson, razzaque & terry 2003), such as paying for the service delivered, customers may perform extra-role behaviours that are not expected of them, for instance, having conversations with employees of the firm to provide feedback to them or recommending the service to other customers (yi & gong 2008:969). customers, however, do not receive remuneration for these citizenship actions that ultimately may enhance the firm’s service experience. it further appears that relationship quality may impact on customer citizenship behaviour. specifically, the relationship quality dimensions of customer satisfaction and commitment (vesel & zabkar 2010:1336) have often been examined as antecedents of customer citizenship behaviour (chiu et al. 2015; curth, uhrich & benkenstein 2014; paillé, grima & dufour 2015; patterson et al. 2003; ponnusamy & ho 2015). the predictive effect of these two factors on the citizenship behaviour of customers is explained by social exchange theory (blau 1964). it is believed that customers who are satisfied with the service received and who have become attached to the firm may want to reciprocate and give back to the firm by displaying customer citizenship behaviour (anaza & zhao 2013:133; yi & gong 2008:967). a further interesting observation, however, is that within the relationship marketing domain, customer commitment is also viewed as an outcome of customer satisfaction (hennig-thurau 2004:465) and is perceived as fundamental in all relational exchanges (morgan & hunt 1994:23). hence, considering previously established relationships between commitment and the variables customer satisfaction and customer citizenship behaviour, it is plausible that customer commitment could also serve as a mediating variable to strengthen the relationship between customers’ perceived satisfaction and their citizenship behaviours. however, greater clarity is required on this matter, which has been overlooked in academic research and that could ultimately make a valuable contribution to marketing theory and practice. specifically, from a theoretical perspective, the investigation may provide insight not only on the role of customer satisfaction and commitment in contributing to customer citizenship behaviour but also on the extent to which both relationship quality factors are needed in fostering such behaviour. from a practical perspective, an understanding of the relationships between customer satisfaction, commitment and customer citizenship behaviour may be particularly beneficial to the internet banking environment. it appears that despite the growth in the digital industry, there are still sceptical consumers believing that in-branch banking services are safer and that electronic banking platforms must be avoided (news24 2015). customer citizenship behaviour in the form of consumer advocacy and helping behaviour specifically (yi & gong 2013) may present a solution to this problem. existing users of internet banking services, through advocating the benefits to other potential users and helping them to use the service correctly, may foster the greater adoption and use of these services. managing these assisting behaviours successfully, however, requires knowing how customer satisfaction and commitment contribute to the advocacy and helping sub-dimensions of customer citizenship behaviour; this would enable the banks to manage their consumer value-adding strategies more appropriately. accordingly, to contribute further to research on relationship quality and customer citizenship behaviour, this study aimed to address the stated research gap and examine the extent to which customer commitment may act as a mediating variable in the relationship between customer satisfaction and customer citizenship behaviour. specifically, the study was interested in exploring whether customers’ commitment towards the service provider (the bank) would strengthen the relationship between satisfaction with the service provided (internet banking) and customer citizenship behaviour (consumer advocacy and the helping of other customers). the remaining sections of this article present the findings of this study. firstly, an overview is provided of the south african banking industry, the research constructs of this study and the relationships proposed in the conceptual model. next, the research methodology is outlined, followed by a discussion of the research findings and their theoretical and managerial implications. in the final part of the article, study limitations are noted and directions for further research are provided. theoretical framework overview of the south african banking industry the south african banking industry is strictly regulated by the south african reserve bank and has a well-developed banking system. there are five major role players in the field, namely absa, standard bank, nedbank, firstrand and capitec bank, which in the midst of economic challenges in the macroeconomic environment are delivering good financial results. taking into account the number of customers per bank, firstrand has the largest market share (11.1 million), followed by standard bank (9.2 million), absa (7.3 million), nedbank (7.1 million) and capitec bank (6.2 million) (petzer, de meyer-heydenrych & svensson 2017:243–244). furthermore, while each major bank focuses on its own unique strategies best suited to its areas of strength, collectively the banks appear to have certain overlapping goals. common objectives include diversification and enhancement of earnings profile across africa, growth of transactional banking franchises and enhancements in electronic platform capabilities. considering the digital objective in particular, the banks seem to be aware of important developments in the financial technology (fintech) environment and the need to focus on strategic partnerships to deliver the digital service. great investments are being made in the banks’ information technology systems to meet customer needs for smooth transactional banking and digital solutions. overall, however, the fintech industry has not yet reached its full potential. constraints hindering progress include long development cycles, legacy issues and the composition of the organisation (pwc 2016:7, 23). another problem that appears to hinder the growth and adoption of digital platforms within the banking industry is perceptions of sceptical consumers that in-branch banking services are safer and that electronic banking platforms must be avoided. this problem seems to be important in the south african banking context as almost half (43%) of all south africans are still of the opinion that traditional over-the-counter transactions are safer than conducting business over the internet (news24 2015). the citizenship behaviour performed by existing users of internet banking services may present a solution to this problem. as positioned in the introduction to this article, customer citizenship behaviour involving customers advocating the benefits of the service to other customers and helping them to use the service safely and correctly may be of great assistance in convincing the sceptical portion of the bank’s target market to convert to electronic banking services. the interrelationships among relationship quality factors contributing to these citizenship behaviours, however, have not been fully explored and require further investigation. relationship marketing and relationship quality factors relationship marketing has become a major school of thought in marketing literature over the years (sheth 2017:4). one of the most widely accepted definitions is that of berry (1983:25), who defines relationship marketing as ‘attracting, maintaining, and – in multi-service organisations – enhancing customer relationships’. according to sheth (2017:6), poor economic conditions in the early 1980s, which resulted in a period of stagnated economic growth and rising inflation (stagflation), served as a major driving force in the development of the relationship marketing domain, because it became more important to develop relationships with customers to generate business. the advancement of relationship marketing is also believed to be closely associated with the evolution of the service sector, which aims to build long-term relationships with customers. (grönroos 1983; gummerus, von koskull & kowalkowski 2017). the expectation is that service firms, to benefit over the long term, must focus on the core service and customise relationships according to the needs of the individual customer (berry 1983). therefore, to satisfy customers and to maintain them, firms must concentrate on relational exchanges instead of transactional exchanges (gummerus et al. 2017). ultimately, it is believed that the relationships established with customers will contribute to a sustainable competitive advantage (jones et al. 2015:188). it is therefore imperative for firms to establish quality relationships with their customers. relationship quality reflects the strength of the relationship between the firm and its customers (garbarino & johnson 1999; izogo 2017) and provides an indication of the closeness or intensity of the relationship (hajli 2014:19; vesel & zabkar 2010:1336). as mentioned in the introduction to this article, customer satisfaction and commitment are regarded as key indicators of relationship quality (vesel & zabkar 2010:1336) and as such are further explored in this study. customer satisfaction a number of key definitions have been formulated to explain the concept of customer satisfaction. for example, as cited by kundu and datta (2015:23) as well as yuksel and yuksel (2001:52), customer satisfaction has been described as ‘the buyer’s cognitive state of being adequately or inadequately rewarded in a buying situation for the sacrifice he has undergone’ (howard & sheth 1969), ‘the consumer’s evaluation of the extent to which the product or service fulfills the complete set of wants and needs’ (czepiel, rosenberg & akerele 1974), ‘the summary psychological state resulting when the emotion surrounding disconfirmed expectation is coupled with the consumer’s prior feeling about the consumption experience’ (oliver 1981) and ‘a person’s feeling of the pleasure or disappointment arising from comparing products’ perceived performance in relation to expectation’. from these descriptions, it seems that the central tenet of customer satisfaction is that it concerns expectations prior to purchasing and opinions formed about the performance after the purchase has been made (kundu & datta 2015:23). this behaviour is commonly referred to as the expectancy-disconfirmation paradigm, professing that customers tend to relate the actual performance of a product or service to the set of expectations they held about the performance before the encounter. customers will be satisfied if expectations are met or surpassed, and dissatisfied if the product or service has failed to meet their expectations (caruana 2002:815; narteh 2015:363; pizam & ellis 1999:28; yuksel & yuksel 2001:58). perceptions pertaining to expectations and actual performance may further include both cognitive and affective responses (narteh 2015:363; oliver 1989:1; spreng & mackoy 1996:202). the cognitive response refers to a psychological interpretation of the difference between the product or service expected and that received, whereas the affective response concerns a customer’s feelings both during and after the consumption process (narteh 2015:363). measuring customer satisfaction based on customer expectations and performance perceptions, though, is not a practice accepted by all researchers. some scholars argue that the customer satisfaction concept is very similar to that of service quality (yuksel & yuksel 2001:54), as the definitions for both allude to comparisons between customer expectations and the actual performance of a product offering (iacobucci, ostrom & grayson 1995:278). oliver (1993) sheds more light on the matter by stating that, unlike service quality, non-quality issues may also have an impact on satisfaction judgements, that perceptions of satisfaction necessitate experience with the service provider and that a greater range of factors may contribute to customer satisfaction. this view is also supported by researchers who believe that perceived service quality is an attitude, whereas satisfaction is perceived to be related to a business transaction (bitner 1990; bolton & drew 1991; cronin & taylor 1994; parasuraman, zeithaml & berry 1988; yuksel & yuksel 2001:55). for the purpose of this study, the view by oliver (1993) was adopted and customer satisfaction was assessed considering both the cognitive and affective dimensions of the concept. accordingly, customer satisfaction was regarded as customers’ cognitive beliefs concerning the service expected and experienced as well as the feelings they associate with this event. customer commitment the construct commitment was originally explored within the organisational science literature, and it concerns the level of commitment demonstrated by employees towards their firms (allen & meyer 1990). over time, the construct has also been adopted into the marketing literature (shukla, banerjee & singh 2016:324) and is considered an important dimension of the relationship marketing theory. principally, commitment concerns a willingness between partners to forfeit short-term benefits in order to profit from the relationship over the long term (anderson & weitz 1992; shukla et al. 2016:324). customer commitment then relates to a ‘lasting or enduring intention to build and maintain an ongoing relationship [with the firm]’ (izogo 2017:22; morgan & hunt 1994). it is further believed that customer commitment comprises three sub-dimensions, namely affective, normative and calculative commitment, which provides more insight into the reasons why customers would want to remain committed to the firm. affective commitment relates to the customer’s emotional attachment to the firm and a feeling that the customer belongs with the firm. normative commitment refers to the obligation a person may feel to continue the relationship with the firm and to customer perceptions that it would not be right to defect to another provider even if the opportunity was provided. calculative commitment concerns a person’s intention to remain in a relationship because the sacrifice of ending the relationship would be too great (allen & meyer 1990; jones et al. 2010:17; shukla et al. 2016:328). the social exchange theory and customer citizenship behaviour dimensions the concept of customer citizenship behaviour is grounded in the social exchange theory. according to this theory, people participate in a series of interdependent interactions that lead to obligations among the exchange parties. people who have benefited to some extent by the actions of a party may feel obligated to return the favour (blau 1964; emerson 1976; gilde et al. 2011:620; homans 1958; mitchell, cropanzano & quisenberry 2012:99). applying the theory to the service business environment may in effect mean that customers experiencing a positive encounter would, for example, want to return the favour, at no extra cost, by displaying customer citizenship behaviour. thus far, bove et al. (2009) have proposed the most comprehensive measure of customer citizenship behaviour in the services marketing context (gilde et al. 2011:620). according to bove, robertson and pervan (2003:332) and bove et al. (2009), customer citizenship behaviour includes action such as positive word-of-mouth behaviour (favourable informal communication about aspects of the organisation), relationship affiliation (using tangible displays or personal items to communicate a relationship with the organisation), suggestions for service improvements (not related to specific instances of consumption), customer policing (ensuring appropriate behaviour), voicing behaviour (communicating service failure to the organisation for improvement), being flexible (willingness to adapt to situations), benevolent acts of service (charitable acts), facilitation and taking part in the activities of the organisation (such as research or other sponsored activities). yi and gong (2013:1279), in another comprehensive study of the subject, later developed and validated a customer co-creation scale and identified the following as important dimensions of customer citizenship: feedback to the firm, advocating the benefits of the service to other customers, helping other customers with the service and being tolerant with levels of service delivery. from the various dimensions identified, it is evident that customer citizenship behaviour relates to the positive extra-role behaviour customers display that will contribute to the organisation’s being more successful (gilde et al. 2011:620). examining all the dimensions of customer citizenship behaviour, however, falls beyond the scope of this study. instead, it is the aim of this article to explore only the advocacy and helping behaviour dimensions of this concept. these two dimensions were selected because they may represent relevant forms of customer citizenship behaviour within an internet banking environment and may assist in addressing the slow adoption problem experienced in the electronic banking industry (news24 2015). as mentioned earlier, customer citizenship behaviour involving customers advocating the benefits of the service to other customers and helping them to use the service safely and correctly may be of great assistance in convincing the sceptical portion of the bank’s target market to convert to electronic banking services. consumer advocacy behaviour consumer advocacy is related to consumer helping behaviour but is still a construct in its own right (chelminski & coulter 2011:362). advocacy concerns having conversations with friends and family in which the service firm is endorsed and may include positive remarks about the firm, recommendation of its service and encouragement to use it (balaji 2014:224; yi & gong 2013:1280–1281). usually, customers who are at ease in their relationships with the service firm can be expected to display advocacy behaviour (fullerton 2003:335) and to promote the firm’s interest. this voluntary behaviour displayed through positive word-of-mouth may result in a number of benefits for the firm, including a positive image and an expanded customer base (yi & gong 2013:1280–1281). helping behaviour consumer helping behaviour is an area that to a large extent has been overlooked in marketing research (bendapudi, singh & bendapudi 1996). it appears that some consumers are of opinion that it is their responsibility to help other consumers (chelminski & coulter 2011:362). there are also perceptions that people help one another for altruistic reasons or because it is rewarding in nature (hibbert, hogg & quinn 2002). thus, some consumers enjoy being actively involved in assisting consumers and sharing their own shopping information with them. consumers may help other consumers to allow them to have positive experiences in the consumer marketplace (chelminski & coulter 2011:362). generally, consumers may receive assistance from fellow consumers in finding products, fixing them, or using them properly (johnson, massiah & allan 2013:122). consumer helping behaviour is not restricted to the non-durable and durable goods market, but may also be present within a services context (price, feick & guskey 1995:255). firms benefit by these voluntary behaviours as customers’ helping of others may contribute to business success (johnson et al. 2013:122). theoretical model the proposed theoretical model comprises several relationships, as detailed below. the link between customer satisfaction and commitment it is believed that customer satisfaction may lead to commitment. for example, hennig-thurau (2004:465) writes: ‘a high level of satisfaction provides the customers with a repeated positive reinforcement, thus creating commitment-inducing emotional bonds’. satisfaction relates to the fulfilment of social needs. the repeated occurrence of this behaviour may contribute to emotional bonds that could also result in commitment (hennig-thurau, gwinner & gremler 2002:237; hennig-thurau & klee 1997). empirical evidence of the relationships between customer satisfaction and commitment have been found in studies relating to the luxury motor vehicle environment (van tonder, petzer & van zyl 2017); the retailing, entertainment, banking and transportation services environment (dimitriades 2006); and the entertainment environment involving customers of an off broadway theatre company (johnson, sivadas & garbarino 2008). in the present study the research context is the internet banking environment, and it examines the extent to which customers are satisfied with the internet banking service provided. considering the previously established relationships between the satisfaction and commitment constructs, it is argued in this study that customers’ satisfaction with their internet banking services may affect their levels of commitment towards the bank (the service provider). customers who are satisfied with the service received from the bank may want to continue their business relationship with it. the plausibility of this relationship is further emphasised by the work of gruca and rego (2005:115), noting that customer satisfaction may elicit desirable behaviours, such as consumers being more inclined to engage in cross-selling opportunities from the same provider. satisfied customers who purchase more products from the same provider will remain committed to the firm and continue their relationship with it. the first hypothesis of this study consequently states that: h1: customer satisfaction with internet banking services has a positive and significant effect on customer commitment towards the bank. customer satisfaction and commitment as antecedents of customer citizenship behaviour several scholars are of the opinion that customer satisfaction may impact customer citizenship behaviour (anaza & zhao 2013:133; chen, chen & farn 2010; groth 2005:13). the link between customer satisfaction and the resulting citizenship behaviour can be explained by the social exchange theory. customers who are satisfied with the firm tend to believe that the firm has fulfilled its contractual obligation of providing excellent service. accordingly, customers may want to reciprocate the favour by engaging in voluntary citizenship behaviour (anaza & zhao 2013:133; yi & gong 2008:966–967). positive relationships between customer satisfaction and customer citizenship behaviour, involving customer recommendations and helping behaviour, have also been noted in academic literature (anaza 2014:255; anaza & zhao 2013:133). furthermore, the potential impact of commitment on the voluntary behaviours of consumers, including advocacy and helping behaviour, has also previously been documented (jones et al. 2010:16, 17, 22). it appears that all three dimensions of customer commitment may have an impact on customer citizenship behaviour. specifically, the effect of affective commitment on customer citizenship behaviour can be explained by the emotional attachment felt by highly committed consumers towards a firm, and the extent to which they identify with the firm’s objectives and values. customers having these feelings of emotional attachment and identification tend to be concerned about the firm’s well-being and would be willing to reciprocate its efforts by displaying customer citizenship behaviour (yi & gong 2008:967). additionally, it has been stated that normatively committed customers may have a felt obligation to display discretionary behaviours. a positive relationship between customers displaying calculative or continuance commitment and making voluntary discretionary investments has also been empirically confirmed (jones et al. 2010:18, 22). accordingly, it is further hypothesised in this study that: h2: customer satisfaction with internet banking services has a positive and significant effect on advocacy behaviour. h3: customer satisfaction with internet banking services has a positive and significant effect on helping behaviour. h4: customer commitment towards the bank has a positive and significant effect on advocacy behaviour. h5: customer commitment towards the bank has a positive and significant effect on helping behaviour. considering the proposed relationships noted in the first four hypotheses, two additional hypotheses were formulated to assess the potential mediating effect of customer commitment on the relationships between customer satisfaction and the customer citizenship dimensions of consumer advocacy and helping behaviour: h6: customer commitment towards the bank mediates the relationship between customer satisfaction with internet banking services and advocacy behaviour. h7: customer commitment towards the bank mediates the relationship between customer satisfaction with internet banking services and helping behaviour. figure 1 provides a summary of the research hypotheses that were formulated in this section. figure 1: conceptual model. research methodology design, target population and sample the conceptual model was empirically tested with data from a cross-sectional survey. the research design was quantitative and descriptive in nature, and the target population was respondents in south africa who use internet banking services. as a comprehensive list of the target population was not available, a non-probability convenience sampling method was used to select the respondents for the study. [according to the protection of personal information act 4 of 2013, retail banks in south africa are not permitted to disclose any information regarding their clients (south africa 2013)]. a total of 250 male and 250 female respondents were targeted to fill gender quotas and ensure that feedback obtained would be equally representative of both genders. male and female respondents forming part of the target population were approached by a fieldworker in public places and were invited to participate in the study. if the respondent refused, the next available respondent forming part of the target population was approached. questionnaire a self-administered questionnaire was designed that included a screening question to ensure that only respondents making use of internet banking services would be permitted to take part in the study. the first section of the questionnaire obtained more detail on the demographic profiles of the respondents. the subsequent sections focused on respondent perceptions pertaining to customer satisfaction with internet banking services, customer commitment towards the bank and the extent to which the respondents had engaged in advocacy and helping behaviour towards other consumers. measurement items from well-established scales that had previously proved to be valid and reliable were selected for the purpose of this study. the measurement items chosen were representative of the core facets of each construct, as discussed in the literature review. the concept of customer satisfaction was measured using the scale of dagger and o’brien (2010:1551), with six measurement items, and included both cognitive and affective responses. advocacy and helping behaviour were measured using the scales provided by yi and gong (2013:1281), with three and four measurement items, respectively. customer commitment towards the banking institution was assessed using the scale of smith (1998:92), with four measurement items, and it assessed commitment from an overall perspective. all scales were adapted to ensure alignment to the context of this study. table 2 provides a summary of the measurement items that were included in the survey. the respondents were requested to rate each statement on a 5-point likert-type scale. the scores ranged from 1 signifying ‘strongly disagree’ to 5, representing ‘strongly agree’. prior to completing the survey, the respondents were ensured that taking part in the study was completely voluntary and anonymous and that their responses would be kept confidential. data analysis the edited and cleaned data were entered into the spss 24.0 statistical package, and frequency statistics, descriptive statistics and cronbach’s alphas were calculated to determine the demographic profile of the respondents and the mean values of each construct and to assess construct reliability. mplus 7.4 was used to conduct a confirmatory factor analysis (cfa) of the measurement model with the maximum likelihood estimation procedure. the cfa was applied within the structural equation model (sem) framework (brown 2015). model fit was assessed by studying the comparative fit index (cfi; acceptable values between 0.90 and 0.99), the tucker–lewis index (tli; acceptable values between 0.90 and 0.99), the root mean square error of approximation (rmsea; acceptable values of < 0.08) (van de schoot, lugtig & hox 2012), and the standardised root mean residual (srmr; acceptable values of < 0.05) (byrne 1998). the guidelines of cohen (1992) were used to determine the cut-off points for correlation coefficients. correlations between 0.30 and 0.49 therefore were considered to have a medium practical effect, and correlations equal to and greater than 0.50 were perceived to have a large practical effect. validity was assessed using the results obtained from the cfa analysis. structural regression paths were then added to the measurement model (cfa), in accordance with the research hypotheses formulated (muthén & muthén 2016) and to ascertain the various relationships within the structural model. moreover, bootstrapping was also implemented to determine the potential indirect relationships (mediation) with 5000 draws from the data, and considering the 95% confidence intervals (cis) of the estimates (preacher & hayes 2008). statistical significance for all model parameters assessing the indirect effects was set at the 95% level (p < 0.05). ethical consideration a low risk study was conducted that complied with the ethical guidelines of north-west university. results and findings demographic profile in the end a total of 491 surveys were obtained from the field and were deemed adequate for further statistical analysis, resulting in a response rate of 98%. although the researchers endeavoured to obtain feedback from an equal number of male and female respondents, 53.4% male and 46.6% female respondents participated in the study. all the respondents were making use of internet banking. respondents from various racial groups completed the survey: most of them were white respondents (57.5%), followed by black respondents (18.8%), mixed race respondents (13.7%), indian respondents (5.7%) and asian respondents (4.3%). the respondents were further requested to select the bank where most of their personal banking transactions are normally conducted. absa was selected most often (27.3%), followed by firstrand (20.8%), capitec bank (20.4%), standard bank (14.3%), nedbank (13.2%) and other banks (4.1%). although these findings do not correspond with the market share of the five major south african banks, as discussed in the literature review, the statistics still provide evidence that the current data set reflects the perceptions of customers from all five major banks. measurement model sampling adequacy was first assessed. it was determined that the overall kaiser–meyer–olkin test statistic is greater than the general cut-off value of 0.6 (0.873), and bartlett’s test of sphericity presented significant results (p < 0.05). hence, the data were considered suitable for further analysis. the subsequent cfa, with all of the latent variables specified and with all of the respective corresponding items, provided the following model fit output: cfi (0.93), tli (0.91), rmsea (0.10) and srmr (0.05). upon inspection of the factor loadings, it was shown that the first and last items of customer satisfaction had loadings below 0.70 (hair et al. 2010) and were removed from the model. the respecified cfa executed successfully and provided superior fit indices: cfi (0.96), tli (0.95), rmsea (0.07) and srmr (0.04). additionally, the chi-square (365.704)/degrees of freedom (84) ratio was less than 5 (4.35). hence, it was considered acceptable to continue interpreting the correlations of these latent variables. table 1 presents the correlation matrix for the latent variables generated from the cfa, as well as the corresponding average variance extracted (ave) values and mean values obtained for each construct. table 1: correlation matrix for the latent variables with average variance extracted on the diagonal and mean values. from table 1, it is evident that customer satisfaction had a positive relationship with customer commitment (r = 0.27; small effect), bordering a medium effect size. customer satisfaction also had positive relationships with advocacy (r = 0.61; large effect) and helping (r = 0.48; medium effect). furthermore, customer commitment had a positive relationship with advocacy (r = 0.38; medium effect) and helping (r = 0.24; small effect). helping and advocacy also had a positive relationship (r = 0.58; large effect). supportive evidence was also found for discriminant validity between the constructs, as all of the ave values were above the squared correlation coefficients between the variables (fornell & larcker 1981; hair et al. 2010). for example, the squared correlation for the relationship between customer satisfaction and advocacy was 0.37, but the ave values in customer satisfaction (0.72) and advocacy (0.75) were well above that value, indicating that more variance is explained in the constructs than shared variance between them. furthermore, the mean scores for the constructs were relatively positive: customer satisfaction (m = 4.10; sd = 0.57), customer commitment (m = 3.61; sd = 0.73), advocacy (m = 3.84; sd = 0.73) and helping (m = 3.74; sd = 0.75). this indicates that participants were more likely to lean towards the positive end of the 5-point scale, which was scored from ‘strongly disagree’ to ‘strongly agree’. table 2 provides more insight into the standardised factor loadings of the individual measurement items as well as the construct reliabilities and cronbach’s alpha values that were obtained for each construct. table 2: measurement model: standardised factor loadings, construct reliability and cronbach’s alpha values. as shown in table 2, all factors loaded significantly onto their individual constructs (p < 0.001). the lowest loading was for item one of advocacy (‘i have said positive things about this internet banking service i use to other people, such as my friends, relatives or co-workers’) but close to the ideal 0.70 cut-off value as suggested by hair et al. (2010) and adopted in this study. all ave values also exceeded 0.5 (table 1), and the composite reliability value for each latent variable is greater than the cut-off value of 0.7 (table 2). therefore, from these findings it can be concluded that the latent variables of customer satisfaction, commitment, advocacy and helping behaviour show reliability and convergent validity. additionally, table 2 indicates that the cronbach’s alpha values for each factor are above the cut-off value of 0.7 (devellis 2012; tabachnick & fidell 2001), providing further evidence of internal consistency of the research constructs. structural model analysis the results of the structural model are presented in table 3. table 3: regression results for the structural model. as can be seen from table 3, all the regressions were significant and positive. specifically, customer satisfaction had a significant regression to customer commitment (β = 0.27; se = 0.05; p < 0.001; h1 supported), advocacy (β = 0.54; se = 0.04; p < 0.001; h2 supported) and helping (β = 0.45; se = 0.05; p < 0.001; h3 supported). customer commitment in turn had significant regressions to both advocacy (β = 0.24; se = 0.04; p < 0.001; h4 supported) and helping (β = 0.12; se = 0.05; p = 0.007; h5 supported). lastly, the bootstrapping of the indirect effects revealed that customer satisfaction had an indirect relationship with advocacy [0.06; p < 0.001; 95% ci (0.04, 0.10)] and helping [0.03; p = 0.02; 95% ci (0.01, 0.06)] through customer commitment. therefore, supportive evidence was found for customer commitment as a complementary (partial) mediator in these two relationships – as the direct relationships were also significant (zhao, lynch & chen 2010:201). research hypotheses h6 and h7 were therefore supported. figure 2 provides a summary of the structural model results. figure 2: structural model. research implications, limitations and directions for further research theoretical implications several theoretical implications could be derived from this study’s findings. firstly, considering the acceptance of the first research hypothesis, the findings of this study offer further confirmation of the impact of customer satisfaction on customer commitment (hennig-thurau 2004:465). the research findings of the current study, however, shed more light on the matter by indicating that customer satisfaction with the service received may contribute towards commitment towards the service provider. marketing scholars generally tend to measure customer satisfaction and commitment within an online context by making reference only to the website used (see, for example hamadi 2011). the findings from this study offer evidence that satisfaction with an online service received may also lead to commitment towards the firm providing the service. secondly, support is found of the relationship between customer satisfaction and customer citizenship behaviour and that between customer commitment and customer citizenship behaviour, as has been pointed out by previous scholars (anaza & zhao 2013:133; chen et al. 2010; chiu et al. 2015; curth et al. 2014; groth 2005:13; jones et al. 2010:16, 17, 22; paillé et al. 2015; patterson et al. 2003; ponnusamy & ho 2015; yi & gong 2008:967). the importance of relationship quality in impacting on customer citizenship behaviour is further verified by this study. additionally, the acceptance of research hypotheses two to five indicates the effect of customer satisfaction and commitment on the advocacy and helping sub-dimensions of customer citizenship behaviour. the combination of these relationships has not been extensively investigated before. one article was found that confirmed these relationships within the context of fitness centres (chiu et al. 2015), and the findings of the current study offer further confirmation. thirdly, while the potential impact of various forms of customer commitment on customer citizenship behaviour has been noted in the hypotheses section of this article, previous studies have concentrated largely on the direct effect between affective commitment and customer citizenship behaviour (curth et al. 2014; liu & mattila 2015). in the context of this study, customer commitment was measured from an overall perspective and consequently provides more insight into the matter. the established overall connection between customer commitment and the customer citizenship behaviour dimensions of this study offers evidence that the extra-role voluntary behaviour of customers may not depend solely on their degree of emotional attachment to the firm. other dimensions of commitment may also be important and should be included in the investigation. finally, the acceptance of research hypotheses six and seven provides confirmation of the mediating effect of customer commitment on the relationship between customer satisfaction and the customer citizenship behaviour dimensions of advocacy and helping behaviour. it is interesting, however, that only a partial mediating effect could be found and that while the indirect effect is significant, it is relatively small compared to the direct effects of customer satisfaction with helping and advocacy behaviour. hence, it appears that while both customer satisfaction and commitment may be required in fostering customer citizenship behaviour, the mediating effect of customer commitment is not very important in the model. instead, it seems more essential to focus on the direct relationships of customer satisfaction and customer commitment with customer citizenship behaviour. managerial implications from a practical perspective, the measurement model indicates that banks should focus on both customer satisfaction and commitment in facilitating customer citizenship advocacy and helping behaviour. the direct effect of customer satisfaction with customer citizenship behaviour, however, is greater than the direct effect of customer commitment and customer citizenship. hence, it may be more important for banks to ensure that their customers are satisfied with the online service provided than to engage in strategies to gain customer commitment. to foster customer satisfaction with online services, banks could, for example, take measures to ensure that their systems are operational at all times, the internet banking interface is easy to use and aligned to customer needs, and assistance is available to address customer queries promptly. these behaviours may lead to customer citizenship behaviour and could assist in making customers more committed towards the bank. considering that customer satisfaction and commitment are key dimensions of relationship quality, the findings of the measurement model highlight the importance of relationship marketing practices in the internet banking environment and support the view that relationship marketing practices are still relevant in the modern marketing milieu (brodie 2017; gummerus et al. 2017; gummesson 2017; payne & frow 2017; sheth 2017). finally, banks should acknowledge that the established customer citizenship behaviours in this study offer confirmation that customers are taking over the traditional marketing role and becoming responsible for promoting the service and teaching other customers to use the service. the role of the marketer is consequently changing, and marketing strategies should be formulated accordingly to facilitate greater relationships with customers responsible for citizenship behaviour. limitations and directions for further research this study has some limitations that could be addressed in further studies. the study had to rely on a non-probability sampling approach and provided valuable insight into the research problem. further research, however, is required to verify the extent to which the research findings can be generalised to the larger population and in other service contexts. furthermore, the current model focuses only on the consumer advocacy and helping dimensions of customer citizenship behaviour. future studies could expand the model by including other dimensions of customer citizenship behaviour. a list of additional customer citizenship behaviours is provided in the literature review of this article. other relationship quality factors could also be explored, such as the impact of trust on customer citizenship behaviour. additionally, it is possible that the social desirability of the respondents may have influenced some of their responses concerning customer citizenship behaviour. it is therefore recommended that the same study be repeated on a broader scale, involving a more representative sample and with additional measurement items to verify the findings of this study. qualitative research could also be conducted to obtain more insight into the role of customer citizenship behaviour and its relevant antecedents within an online environment. acknowledgements competing interests the authors declare that they 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concluded that, notwithstanding difficulties experienced, the economic integration process represents the ec's greatest achievement. an example of this is the completion of the ec internal market through the european economic community (eec) customs union and the ec-92 programme. secondly, the investigation focuses on the political success of ec integration. the evaluation shows that political powerplay endangered and inhibited the process of economic integration in the ec. introduction much has been written on economic and political integration in general, and on ecieu integration in panicular. different aspects and stages of ec integration have been placed under the spotlight. this study attempts to highlight a wider angle with the focus on mainly two aspects. the first aspect refers to the launching of successful and unsuccessful integration initiatives. the second aspect is to ascertain why some initiatives were successful, and others not. the study will seek r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sates nr vol 1 (1998) nr 1 109 to answer these questions by comparing economic reasons for ec integration with political ones. the relative successes and failures will also be highlighted. however, to put the analysis into context, the concept of economic integration and the ec as an example thereof, will firstly be defined. thereafter the rationale for western european integration following the second world war will be discussed. this will set the scene for an inquiry into the economic and political merits of ec integration. definition of economic i!io.'tegration balassa (1%1 :1) viewed economic integration inter alia as a process. this process comprises both a "negative" and a "positive" integration stage. "negative" integration implies the removal of existing crade barriers between countries (finbergen, 1954:122), while "positive" integration means the establishment and co-ordination of regulatory frameworks and economic measures into a common policy (mayer, 1990:79). these two stages have the combined effect of drawing national economies closer together. against this background, five different forms of economic integration may be distinguished. these include a free trade area. customs union. common market, an economic union and a monetary union (matthews, 1987:60(61), in general these forms involve varying degrees of complexity. free trade areas focus only on "negative" integration, as tariffs and quotas between counrries are eliminated. a customs union adds a common external tariff on imports from nonmembers to the free trade area characteristics. in addition, a common market provides for the free movement of goods and factors of production between members states. together with the above, an economic union also facilitates common policy formulation in certain fields of economic activity (matthews, 1987:61). a monetary union extends the concept of an economic union to common policy formulation in all fields of economic activity, as well as the use of the same currency by all member countries. where the same currency is not used, the respective currencies are totally and irreversibly convertible, while their exchange rates are irrevocably fixed to each other. in agdition, capital movements are completely free in fully integrated financial markets (anon, 1993:209,219). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 110 sajems ns vol i (1998) no 1 tile ec as an example of economic integration the eec treaty of 1957 provided for the creation of a customs union among its six signatories. in july 1968 all tariffs belween the six eee members were abolished and a common external tariff came into operation (european communities, 1971 :32). this completed the customs union stage. in tenns of article 2 of the eec treaty the customs union was to develop into at least a common market, and preferably into an economic union (vaughan, 1976:75). due to ec policy development in reaction to the economic circumstances at the time, the realisation of the common market ideal was somewhat lost during the 1970s and early 1980s (robinson, 1992:68). the ec-92 initiative (on completion of the internal market) was therefore required to put new life into the effort. overtures towards an ec economic union were made in due course. eventually an even closer integrated ec was proposed with the signing of the treaty on european union, or maastricht treaty. in tenns of this treaty the european union (eu) now strives towards closer economic, monetary, military and political integration (hunnings & hill, 1993:725-726). it is therefore evident that the ec started out as a customs union (one of the simplest fonns of integration), and is at present developing into at least a monetary union (one of the more complex fonns of integration). further prospects of development towards a european (political) union are also raised. to speculate on the possible success of such an endeavour, three issues must be considered, namely, the rationale for european economic integration, the success of the economic motivation the ee integration, and the success of the political motivation for ec integration. two-tier rationale for economic integration contemporary integration efforts in western europe after the second world war were mainly motivated on political and economic grounds. the political motive is evident from winston churchill's post-war call for franco-german reconciliation in "a kind of united states of europe" (walsh & paxton, 1972:14). by this he once again voiced the idea of the pan-european movement originating in napoleonic times about economic co-operation throughout europe. moreover europe rapidly divided into distinct ideological r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr vol 1 (1998) nr 1 111 blocs after the second world war (van de meerssche, 1971:71). interest in economic co-operation was therefore also designed to counteract the spread of communism (swanepoel, 1959:5). the economic motive for integration originated in the need [0 rebuild the western european economies after the war (ligthelm, 1963:41). europe, as a result of its damaged national economies, had lost its competitive position in world trade (swanepoel, 1959:5). by breaking down intra-european economic barriers. economies of scale were realised in agriculture and industry. economic integration was therefore seen as the means of restoring economic prosperity to the region, as well as puning an end to possible future conflict and fragmentation between european nations (european communities, 1971 :3). given the political and economic motives for ec integration, various efforts were initiated in this direction. these efforts are analysed and evaluated below. economic success efforts at realizing the post-second world war political and economic objectives mainly resulted in the formation of the european coal and steel community (ecsc) in 1951 and the european economic commwlity (eec) and european atomic energy community (euratom) in 1957 (european communities, 1971 :3). the ecsc after a variety of integration initiatives that were launched after the marshall plan of 1947, the ecsc was formed by belgium, france, italy, luxembourg, the netherlands and west germany (european communication, 1971, p.3). ecsc aims included conornic growth, expanded employment and a higher stabdard of living in its member states, by integrating coal and steel production and consumption. the ecsc treaty provided for a stable supply of coal and steel, and their derivatives to the commwlity market (vaughan, 1976:62). this was to be accomplished by facilitating equal access to production sources in the commwlity, establishing a framework to secure the lowest possible prices for products controlled within the community, sening conditions to encourage enterprises expand production with a commitment to exploit national resources optimally. in addition, guidelines were set to promote general growth of international trade and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 112 sajems ns vol i (1998) no i suitable export prices, modernisation and expansion of production capabilities, improvement in the quality of products and better working conditions and standards of living for workers in the industries falling under the community. all of these objectives, save the last one, relate to economic conditions. the ecsc can therefore be seen as an initiative towards western european economic integration. the establislunent of improved working conditions and standards of living, however. represented a social dimension of the ecsc. the ecsc initiative was significant on three accounts. firstly, ecsc integration minimised the possibility of future war between former western european adversaries (wegs, 1984:147). secondly, through an experiment of sectoral economic integration, the ecsc provided the first realistic method of progressively integrating western europe. by providing for a common import tariff on coal and steel to be phased in over a five year period. visions were created for a future integration effort (ligthelm, 1963:44). lastly, the ecsc prepared europeans to "think european". with the free movement of labour in integrated industries, social side-effects like for example the provision of housing and social security, moved into the supra-national sphere (lane. 1985:226). this promoted progress in future integration efforts. it follows therefore that the ecsc as an economic initiative of western european integration did not exist in a vacuwn. it necessarily introduced social side-effects as well as political and military realities. theeec the eec and euratom treaties of 1957 were concluded between the same countries as the ecsc treaty. the eec treaty aimed at creating a common market between the signatories, as well as the progressive approximation of their respective economic policies (vaughan, 1976:75). . to succeed. a range of prospects were set up. these included the elimination of customs duties and quantitative trade restrictions, as well as all other restrictions with the effect of impeding trade between members. and the removal of obstacles to the free movement of products, persons. services and capital among members. provision was made for measures to co-ordinate national policies. and to align national laws of member countries in order to facilitate proper functioning of the common market. calls were made for the establishment of a common customs tariff, commercial policy towards non-members, agricultural policy and transport policy. procedures to ensure fair competition in the common market, and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr vol 1 (1998) nr 1 113 to correct any imbalance of payments were created. the european social fund and european investment bank were established to promote the standard of living of workers, to improve employment opportunities in the community and to allow for economic expansion. lastly, the economic and social development of overseas countries (former colonies) and member territories was encouraged. these prospects mainly focused on aspects of economic integration. however, the co-ordination of national policies, the creation of the social fund and the facilitation of economic and social development of colonies and territories added a supra-national dimension to the proposed common market. the social fund also conferred a social dimension on the eec while the responsibility towards the economic and social development of former colonies provided a framework for a common foreign policy. with these development the ec surely moved into the ambit of an economic union. the initial success of the eec can be illustrated by the economic performance of its members from 1958 to 1962. industrial output in france rose by 30 percent, and in west-germany by 39 percent. in the netherlands the figure amounted to 44 percent, and in italy to 73 percent. by 1962 trade among eec members picked up by 130 percent on the 1958 level and the gross domestic product (gdp) of the eec also increased by 25 percent for the four year period (smith, 1985:448). the netherlands and west germany suffered because of a shortage of labour. however, due to the mobility of labour caused by the community, migratory workers were able to aileviate this problem, while simultaneously reducing the level of unemployment in the south, e.g. italy (smith, 1985:448). euratom the euratom treaty provided for the co-ordination. augmentation and qualified control of nuclear policies in prescribed fields of members' nuclear activities. these prescribed fields of activity included nuclear research, nuclear industrial activities, nuclear security control and international atomic affairs (polach, 1964:71-72). euratom progressed weil. when by 1969 the draft 1970 to 1974 euratom programme was submitted, it contained a request to authorize the extension of its activities to non-nuclear scientific research. the request was granted, and euratom was allowed to conduct nuclear research under contract and to undertake projects in conjunction with non-ec european states (european communities, 1971 :3132). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 114 sajems ns vol 1 (1998) no 1 economic difficulties of the 1970s and early 1980s it is therefore evident that initial economic integration as represented by the ecsc, eec and euratom had succeeded. difficulties were, however, encountered during the 1970s and early 198os. the ec economic decline during this period can be largely attributed to ec reaction to the economic circumstances of the era. these circumstances are related to a variety of events. the failed bretton woods system of fixed exchange rates led to monetary instability and a negative influence on world trade, let alone the ec (matthews, 1987:47). the oil shocks of 1973 and 1979 created inflationary pressure as well as deficits in ec balances of payments (seers, 1982:5). the detrimental effect was compounded by the fact that by 1973 imported oil represented 64 percent of ec energy consumption (kerr, 1977:122). traditional ec shipbuilding, steel, textile and clothing industries were increasingly exposed to competition from japan and the newly industrialized countries (seers, 1982:5). local ec markets in new industries like electronics. were dominated by multi-national organizations from japan and the us, as ec productivity improvements decreased. this depressed ec producers' market share in the industries concerned. in addition, demand for ec products decreased as import-substituting industrialisation increased in the developing world (seers, 1982:5). ec unemployment increased from 2,9 percent in 1975 to 10,7 percent in 1986 as a result of deflationary measures taken to counteract inflation (goodman, 1992:101). the ec economy was also over-regulated to protect it from extra-ec competition. integration in fields such as the environment, foreign, regional and social policy were widened (steyn, 1994:84-123). ec economic performance by the mid-198os was therefore disappointing. the use of non-tariff barriers (over-regulation) resulted in the fragmentation of the ec internal market a:1d the forfeiting of benefits from economies of scale. the most efficient procedures were prevented from being implemented, instability in currency markets inhibited intra-ec trade and specialization, technological progress, levels of investment and ultimately, economic growth, lagged behind (featherstone, 1990:3). ec economic performance fell behind in gdp growth and productivity to that of the usa and especially japan (goodman, 1992:95101). ec unemployme'lt levels also exceeded those of the usa and japan. a case of "eurosclerosis" was therefore diagnosed with the ec. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sa teb nr vol 1 (1998) nr 1 115 the most imponant measure taken to rectify this situation was the formulation of the ec-92 programme in completion of the ec common market. ec-92 and the maastricht treaty the ec-92 programme was designed to complete the common market envisaged by the eec treaty of 1957. thereby relaunching the communities after the economic malaise of the 19705 and early 1980s. the ec-92 programme was an effort to remove non-tariff trade barriers (i.e. physical. tecl:u1ical and fiscal) between ec members. in order to integrate the individual markets of member states into a growing and expanding single market of 320 million people. in addition, the expanding market was to be facilitated by ensuring the free movement of goods, labour, services and capital within the area of greatest economic advantage (commission of european communities, 1985:45). the maastricht treaty was inter alia designed to carry forward the vision of the eec treaty by progressively approximating the economic policies of ec members. two of its basic principles were to secure ec economic and monetary union and to aspire towards ec economic cohesion (anon, 1992:8-13). evaluation it is therefore clear that, notwithstanding the difficulties experienced. economic integration represents the ec's greatest success. economic integration carried western europe from its post-second world war position of destruction and despair to one of the three main hubs of global economic development and trade. this fact can be illustrated by comparing population and gdp statistics. by 1990 the ec countries represented 6,2 percent of the global population. but produced 26,96 percent of global output. the world gdp per capita income was $4 221, while for the ec it was $18 369 (anon, 1994:3). political success? one of the motives for ec integration was political. as integration involves a political will to effectuate successful co-operation between countries. politics has, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 116 sajems ns vol i (1998) no 1 through the years, played an important role in ec integration. this can be illustrated by evaluating political initiatives aimed at enhancing economic integration. the councu of europe in may 1948 the council of europe was created with the idea of establishing formal measures for political and economic integration in western europe (van de meersche. 1971: 103-105). continental members were of the opinion that a european federation with supra-national institutions governing and administrating europe, was the way to structure the council's activities. tile uk held a contrary point of view, namely that because of her special relationship with the commonwealth and the usa. she was not able to cede any sovereignty to supra-national european institutions (van de meerssche. 1971: 107-114). a compromise decision accommodated both points of view. the council consisted of two bodies. namely a committee of ministers comprising the foreign ministers of member countries (the british viewpoint). and a consultative assembly of representatives or european assembly constituted from members of parliament of member states (the continental viewpoint) (walsh & paxton, 1972:8). as scandinavian members of the council supported the uk's vision of european co-operation rather than political integration in a federation, the council only discussed european political integration, but was not able to take any concrete steps in that direction. this political initiative therefore did not contribute towards meaningful western european integration. the european defence community and european political community another example of a failed political integration initiative in western europe followed the success of the ecsc initiative in 1952. after the outbreak of the korean war in june 1950, the usa campaigned for west german reannament to withstand a possible soviet attack on western europe (hughes, 1981 :463). to prevent west germany from abusing her reinstated military capabilities merely five years after the end of the second world war, the french proposed a european army for the common defence of western europe (vaughan, 1976:56). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr vol i (1998) nr 1 117 this would have facilitated west german rearmament under supra-national european control. on 27 may 1952. a treaty setting up the european defence community (edc) was signed in paris (van de meerssche, 1971 :135). the existence of a european army without a european political control mechanism contained potential problems. as the same six countries were members of both the ecsc and the edc. a proposal was accepted for the integration of the ecsc and edc into a european political community (epc) (van de meerssche, 1971:138). however, due to a number of national and international reasons (steyn, 1994:28-30) the edc treaty was never ratified by the national parliaments of the contracting countries. the edc and epc initiatives at political integration in western europe thus both failed, while the ecsc's attempt at economic integration survived. this experience illustrated the failure of political integration to keep up with the pace set by the economic success of the ecsc. the bad godesberg agreement during the latter part of 1960 the french president, charles de gaulle, launched a drive towards political integration of the eec countries on the basis of a political confederation of eec states. de gaulle stressed that co-operation between countries could be accomplished on political, economic, cultural and even military levels through discussions between national governments. specialist organizations like the ecsc or euratom, were to assist national governments in planning and discussions, but these organizations were to stay subordinate to the governments (van de meerssche, 1971:205-206). during february 1961 a summit of eec leaders convened in paris to discuss the formation of a political union. after a second round of negotiations in july 1961, a declaration (the bad godesberg agreement) was issued. this declaration called for the proposed political integration to take on definite form by means of a treaty on political union (van de meerssche, 1971 :208-211). opposition to the bad godesberg agreement was voiced as the netherlands proposed the uk's inclusion in the initiative. the uk, however. did not suppon political integration due to her convictions concerning national sovereignty. by april 1962 opposition to the bad godesberg agreement mounted. the finalization of a treaty on political union was impossible. political integration therefore failed once again. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 118 saiems ns vol 1 (1998) no 1 de gaulle's response to the failure of his integration initiative resulted in the blocking of uk membership of the eec in 1963 and 1967 (steyn. 1994:57 & 67). it was not before 1972. after de gaulle's departure from ec politics. that the uk, together with derunark and ireland, was able to join the communities. political sensitiveness therefore delayed a widening of eec membership for at least ten years. the french boycott of eec activities the french also boycotted eec activities between july 1965 and january 1966. this was because de gaulle perceived eec common agricultural policy and institutional reforms as threatening to the national sovereignty of member slates (steyn, 1994:63). something perceived to be of political nature thus effectively suspended progress in economic integration for six months. without a resolution of differences (which cost walter hallstein his position as chairman of the european commission). the action could have terminated the existence of eec integration as it was then known. the single european act (sea) and maastricht treaty a final example in this regard is to be found in developments surrounding the sea and the maastricht treaty. the maastricht treaty can be seen as a continuation of the sea of 1985. the sea revised institutional provisions of the three constituting treaties of the ec (i.e. the ecsc, eec and euratom treaties) to facilitate ec political co-operation. the maastricht treaty carried these aspirations forward by inter alia relying on principles relating to the amendment of ec treaties to allow for further institutional reform, the formulation of a common foreign and security policy (fsp) , co-operation in the spheres of justice and home affairs, an economic and monetary union (emu) and the introduction of conceprs like economic and social cohesion and the establishment of european citizenship (hunnings & hill, 1993:719-720). it is too early to c;)nunent on the success of the maastricht treaty. but observations can be made about the difficulties experienced in ratifying the treaty in order to implement its provisions. in the french referendum of september 1992 only a slight majority in :avour of ratification of the treaty was registered (walsh, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr voll (1998) nr 1 119 1992:22-23). denmark required two referendwns to pass a "yes" in favour of the treaty (zagorin, 1992:32-34). it follows that integration progress was once again hampered by factors perceived to be of political narure. emu may sound to be of economic relevance, but the accompanying political perception about the importance of national sovereignty relating to central bank: independence, a national currency and monetary policy formulation is threatening smooth progress towards integration in this field. evaluation ec political integration initiatives were in general not as successful as the economic ones. they mainly served to delay ec integration, rather than to promote it. this resulted from a variety of reasons. strucrural clumsiness defeated the council of europe. changing national and international political realities left the edc and epc stillborn. convictions surrounding national sovereignity sunk the bad godesberg agreement. political wilfulness resulted in the french veto of uk membership as well as boycott of eec activities. reluctance to cede national symbols hampered ratification of the maastricht treaty. conclusion this study defined the concept of economic integration and gave the ec (today eu) as an example thereof. the rationale for western european (economic) integration following the second world war was also discussed. in an attempt to answer the two initial questions posed, a concise exposition of the economic success and political failure of ec integration was set out. generally the conclusion can be drawn that integration initiatives strucrured along economic lines of activity were more successful than were the political ones. this results largely from the jealousy with which the vestiges of national sovereignty were guarded. the unfortunate error must, however, not be made to discard all political efforts towards integration. successful economic integration will not be possible without the political will to achieve it. contemporary ec political will originated with the desire to avoid any future destruction like that caused by the second world war. this is still prevalent today, flowing from the economic advantages successful integration has offered. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 120 sajems ns vol i (1998) no i political influences have, however, to be tempered. integration is not to become a goal in itself, but should complement economic initiatives aimed at realizing the related economic advantages. references 1. anon. 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(1981) contempory europe: a history. new yersey: prentice hall. 11. hunnings, n.m. & hill, j.m. (1993) the treaty of rome consolidated and :ae treaty of maastricht. london: sweet & maxwell. 12. lane. p. (1985) europe since 1945. an introduction. london: batsford academic and educational. 13. lichtileim, g. (1963) the new europe. today and tomorrow, new york: praeger. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sates nr vol i (1998) nr i 121 14. matthews, j. (1987) international economic relations for south african students, johannesburg: southern. 15. ma yer. d.g. (1990) the external implications of closer european integration. nationallnstiluje economic review. 134:73-85, nov. 16. polach, j.g. (1964) euratom. it's background, issues and economic implications. new york: oceana. 17. robinson. j. (1992) the european challenge. 1992. the benefits of a single market. aldershot: wildwood house. 18. seers. d. (1982) the second enlargement in historical perspective. in seers, d. & vaitsos, c. (eds). the second enlargement of the eec. the integration of unequal partners. new york: st martins press: 1-21. 19. smith, k.w. (1985) the emergence of superpowers and the period of uneasy peace, 1945-1964. in van wyk, t. & boucher, m. (eds). europe 1848-1980. pretoria: academica: 413-451. 20. steyn, t.f.j. (1994) the development of economic integration in the european communities (ec): 1945-1992, potchefstroom. 21. swanepoel, j. (1959) europese ekonomiese samewerking seden die tweede wereldoorlog, pretoria: university of south africa. 22. tinbergen, j. (1954) international economic integration. amsterdam: elsevier. 23. van de meerssche, p. (1971) de europese integratie: 1945-1970. antwerpen: standaard wetenschaplijke uitgeverij. 24. vaughan, r. (1976) post-war integration in europe, london: edward arnold. 25. walsh. 1. (1992) and now vox, populi. time magazine, 5/10/95:22-23. 26. walsh, a.e. & paxton, j. (1972) into europe. the structure and development of the common market. london: hutchinson. 27. wegs, j.r. (1984) europe since 1945. a concise history. london: macmillan. 28. zagorin, a. 91992) a sea of troubles. time magazine, 15/6/92:32-34. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction literature review methods an application to efficiency estimates of commercial banks in ghana results conclusion acknowledgements references about the author(s) zhixiang zhou school of economics, hefei university of technology, china nelson amowine school of business, hohai university, ghana dechun huang department of economics and international trade school of business, hohai university, china citation zhou, z., amowine, n. & huang, d., 2018, ‘quantitative efficiency assessment based on the dynamic slack-based network data envelopment analysis for commercial banks in ghana’, south african journal of economic and management sciences 21(1), a1717. https://doi.org/10.4102/sajems.v21i1.1717 original research quantitative efficiency assessment based on the dynamic slack-based network data envelopment analysis for commercial banks in ghana zhixiang zhou, nelson amowine, dechun huang received: 30 nov. 2016; accepted: 17 aug. 2017; published: 09 apr. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: gains in bank efficiency improvement have widely been regarded as one of the most effective and efficient means of ensuring sustainability of a financial system. aim: this article proposes a relative dynamic two-stage network data envelopment analysis model for measurement of bank efficiency based on the slack-based measure. setting: twenty-seven banks in ghana during the period of 2009–2014. methods: by considering simultaneous processes within the framework of two-stage data envelopment analysis, the slack-based measure approach identifies the sources of inefficiency in the banks. results: in the empirical analysis, non-performing loans are an undesirable output in one production process, which should also be treated as a carry-over factor; that is to say, some non-performing loans from the preceding year can be collected in the current year. the carry-over factors should be used to indicate the presence of performance gaps that exist in the banks. the proposed model was used to measure the efficiency of the 27 banks in ghana during the period of 2009–2014. we also present useful suggestions for improvement in bank efficiency based on the empirical results. conclusion: the 27 main commercial banks in ghana are far from efficient. for all banks, the efficiency score in the second stage is much higher than that of the first stage. that means more attention should be paid to the first stage of production in order to increase the banks’ efficiency. introduction the banking sector has a significant impact on the development of economies worldwide. specifically, financial intermediation activities of the banking sector constitute a key element for implementation of development projects. accordingly, the balanced development of commercial banks is needed to ensure macroeconomic stability along with economic growth. in this context, amado, santos and marques (2012) emphasised that efficiency measures play a vital role in attaining sustainable development within a competitive system. data envelopment analysis (dea), as proposed by charnes, cooper and rhodes (1978), has widely been applied for analysis of banking efficiency in ghana (alhassan & ohene-asare 2016; alhassan, tetteh & brobbey 2016; saka, aboagye & gemegah 2012). the technique can easily accommodate multiple input–multiple output frameworks (paradi, rouatt & zhu 2011; paradi & zhu 2013) and is superior to partial analysis (e.g. ratio analysis), which lacks both comprehensibility and theoretical background. there is a plethora of literature available on banking efficiency. the first group of studies applies or extends traditional dea models to evaluate the efficiency of banks, such as multidimensional efficiency of banks (asmild & matthews 2012), technical and economies of scale (paradi & zhu 2013), cost and profitability efficiency of banks in china (ariff & luc 2008), as well as the impact of the environment on bank efficiency (yao, han & feng 2008a). in these studies, banks are treated as a ‘black box’, without explicitly modelling the impacts of either intermediate or carry-over factors. another group of studies attempted to describe the banking processes in a more detailed manner and defined different stages of operation. seiford and zhu (1999) proposed the two-stage dea model and applied it in their evaluation of commercial bank efficiency, with profitability marketability stages taken into consideration. cook and hababou (2001) estimated the impact of sales performance on bank branches’ efficiency, using the multicomponent dea approach. the effect of the performance of information technology on retail banking activities was analysed by means of a two-stage dea model by meepadung, tang and khang (2009). a novel slack-based measure (sbm) two-stage model for measuring serial production performance of banks was proposed by fukuyama and weber (2010). wang et al. (2014) introduced an additive two-stage dea model to explore the efficiency of commercial banks in china. the latter approach assumed two serial stages in the banking activities. during the measurement of bank performance, some scholars proposed dynamic dea models for calculating the effect of variables over a number of years (multiple time period approach). kao and liu (2014) measured the performance of commercial banks in taiwan, in which the overall efficiency was obtained by using the weighted mean of the efficiency in each period. akther, fukuyama and weber (2013) adopted the sbm and directional technology function to study bank inefficiency, emphasising the effect of intermediate outputs (security investments and loans) under the multiple time period approach. the aforementioned studies analyse the efficiency of banks by only considering internal complex structures (i.e., multiple components and two serial stages) or dynamic efficiency by treating the banks as ‘black box’. none of them calculate bank efficiency by considering the positive influence of non-performing loans (npls), by using the carried-over factors in the dynamic two-stage dea structure. hence, the present literature on banks’ efficiency naturally ignores consecutive time periods of the carry-over factors in the two-stage process, and this novel approach is used in evaluating banks in ghana for the first time. alhassan, kyereboah-coleman and andoh (2014) believe the npls account for a very high proportion of ghanaian banking industry assets and should be a significant determinant of banks’ asset quality. therefore, a more appropriate approach is required to deal with the efficiency evaluation of banks in ghana with two internal stages during multiple time periods. this current study, therefore, considers the internal processes of banks in the measurement of their relative efficiencies. the multiple-period dynamic concept is used in the computation of efficiency, where the carry-over factor of npls and loans of the previous years are used in addition to the current year variable to get the efficiency score for each bank. recently, the ghanaian economy has witnessed a massive phenomenal transformation and expansion of the banking industry. this important development can be attributed to the systemic implementation of the financial sector adjustment programme in 1986 and the gradual execution of the financial sector strategic plan in 2003 (bawumia 2010). to improve the operational efficiency of the banks in ghana, it is necessary to develop an appropriate model encompassing their operational processes. generally, a commercial bank collects deposits from the public and then provides loans or makes financial investments to fund the development of various businesses to obtain interest revenue. in order to reflect the bank operational process in a more detailed and systematic manner, it can be subdivided into the production and profitability stages. the two-stage dea framework can be applied to model the bank operational process in terms of sub-processes, or stages (yang & liu 2012). the first stage involves the use of bank resources, namely interest and operating costs, to attract deposits from the customers. the second stage, referred to as the profitability stage, defines the generation of operating and interest income. the deposit thus appears as output in stage 1 and then as input in stage 2. furthermore, npls can be treated as a dynamic factor. within a certain time period, npls can be an undesirable output in the profitability stage. in the subsequent time period, it can also be treated as an undesirable output in stage 2. in the practice of the ghanaian banking system, npls are generated in the profitability stage when the loan issued by the bank cannot be paid back during the given time period. banking activities are affected by this problem in two ways: first, by the loss of the income – banks with higher volumes of npls are eventually treated as being less efficient by using npls as an undesirable output at the profitability stage (färe & grosskopf 2004); and second, as pointed out by akther et al. (2013) and fukuyama and weber (2010), npls can be treated as a carry-over factor – npls resulting in a certain period can be carried over to the succeeding period, and the model is thus entered as a desirable input. in the latter period, either the npl can be offset by the income generated in the profit-earning stage, or the volume of npls can further be increased. as assumed by akther et al. (2013), tone and tsutsui (2014) and zha et al. (2016), npls should be modelled as an undesirable or bad output for banks. in order to address both theoretical and empirical circumstances discussed above, this article treats the npls and loans as undesirable and desirable carry-over variables, respectively, in the profitability stage in ghanaian banks. by doing so, we acknowledge that npls can influence the performance in the profitability stage during both the present and previous periods, and this may be reflected by alterations in the level of efficiency. this article aims to estimate efficiency of the ghanaian banks with respect to dynamics in the npl and loans as carry-over variables, as well as their inter-temporal impacts. reasonable evaluation of the operational efficiencies of the banks in ghana is proposed by means of a dynamic two-stage sbm dea model. the proposed model encompasses two internal processes and allows both npls and loans to be carried over the time periods. this study contributes to the present literature in that it integrates the two-stage dea and dynamic dea for analysis of the banking operations. specifically, two stages of banking operations are defined for each time period, and the time periods are linked by virtue of the carry-over factors, namely, loans and npls. we contribute by conducting an empirical study on efficiency of the ghanaian banking industry by use of bank-level data. finally, bank-specific efficiency improvements are discussed based on the proposed model. the rest of the article is organised as follows: the literature review presents useful literature on applications of the two-stage network dea to the banking sector; and the novel sbm dea model for analysis of the banking efficiency is introduced in the ‘methods’ section. the application of the proposed model to analyse the performance of commercial banks in ghana is then discussed, followed by conclusions and recommendations. literature review techniques employed in the analysis of bank performance include stochastic frontier analysis, financial ratio analysis and dea, among others. dea is regarded as an appealing method for evaluation of bank efficiency in that it can model multiple-output–multiple-input technology without assumptions regarding the functional form of representation of the underlying technology. cook and seiford (2009), sherman and gold (1985), ruggiero (2007) and avkiran and zhu (2016) showed that stochastic frontier analysis method did not generate superior results if contrasted with dea. applications of dea for analysis of bank efficiency cover the following strands: total factor productivity change (sanyal & shankar 2011), economies of scale and scope (berger & humphrey 1991; mcallister & mcmanus 1993), performance of bank branches (camanho & dyson 1999; yeh 1996) and analysis of the impact of reforms (assaf, matousek & tsionas 2013; fujii, managi & matousek 2014; hsiao et al. 2010; tsang et al. 2014; wang et al. 2014). again, both the traditional and two-stage network dea models have been applied in the analysis of banking efficiency. initially, the concept of dea was put forward by charnes et al. (1978) and banker, charnes and cooper (1984) on the basis of the pioneering work by farrell (1957). also, many studies have employed the dea technique in measuring the performance of various organisations and industries (hsu & hsueh 2009; liu et al. 2013). however, the traditional dea model used in measuring the operational efficiency only allows for a single-stage process. in order to properly model activities of banks, one can define more than a single-stage in the production process (fukuyama & matousek 2011; fukuyama & weber 2010). wang, gopal and zionts (1997) applied the two-stage dea concept to evaluate the impact of information technologies on bank efficiency. zhu (2000) advanced the three-stage dea model in his evaluation of 500 companies. the results demonstrated that the companies with the maximum revenue did not essentially have the top-ranked performance with regard to profitability and marketability. the analysis of 55 banks operating in the usa was performed by seiford and zhu (1999) in the confines of a two-stage dea approach. the underlying technology was further subdivided into profitability and marketability sub-processes. luo (2003) argued that bank efficiency should be analysed in terms of both profitability efficiency and marketability efficiency. the existing literature on the two-stage dea modelling methodology takes account of the efficiency of the entire banking processes (kao & hwang 2011). lo and lu (2009) measured the performance of financial holding companies by adopting the slack-based super efficiency dea methodology. a novel, two-stage network technology technique was put forward by fukuyama and matousek (2011) for estimating cost efficiency in turkey banks. they juxtaposed the traditional and two-stage dea models. premachandra et al. (2012) analysed efficiency of mutual funds in the usa by employing the two-stage dea methodology. their approach was not only applicable to the constant return to scale and variable return to scale settings, but also allowed the introduction of new intermediate input or output measure in the profitability stage. fukuyama and weber (2010) established slack-based, two-stage dea models to estimate the efficiency of banks with serial operations processes. wang et al. (2014) presented a novel, two-stage additive dea model for the measurement of bank efficiency in china, encompassing deposit transformation and profit-earning stages. indeed, two-stage network dea has become omnipresent in the banking sector. it is important to note that some two-stage dea studies do not include undesirable variables in their models (fukuyama & matousek 2011; premachandra et al. 2012), while others do; for example, two-stage network dea with directional distance function was applied by asmild and matthews (2012). indeed, one might arrive at biased efficiencies if undesirable variables related to the risk dimension remain ignored (chen 2012). there are other studies that have focused on evaluating the efficiency of ghanaian banks. first, alhassan et al. (2014) examined the bank-level factors to explain the performance of the ghanaian bank loan portfolio, based on the research of aboagye et al. (2008). next, the malmquist productivity index (alhassan & biekpe 2015) and stochastic frontier analysis (aboagye 2012), together with dea (saka et al. 2012), were utilised to measure the efficiency of ghanaian banks. additionally, alhassan et al. (2016) combined dea approach with the herfindahl index and concentration ratio to evaluate the relationship between efficiency and profitability of 26 ghanaian banks from 2003 to 2011. alhassan and ohene-asare (2016) employed the two-stage dea models to measure the technical and cost efficiencies of 26 ghanaian banks from 2004 to 2011, and provided the paths for inefficient banks to ‘catch-up’ with efficient banks. alhassan and tetteh (2017) constructed a two-stage dea bootstrapping approach to examine the effect of the inclusion of non-interest income on the efficiency and economics of scale of ghanaian banks. in order to account for the internal processes of banking, we adopt the two-stage network dea methodology in this article. methods we assume that there are n banks in ghana to be analysed systematically. for the j-th bank, j=1,…,n, in a particular time period t (t=1,2,…,t), stage 1 consumes m inputs to produce k intermediate products its stage 2 generates s desirable outputs and h undesirable outputs by utilising the intermediate products and h undesirable inputs produced in the previous time period t-1. note that are the links between the two stages, and are the carry-over factors, which are taken from period t-1 and the inputs for period t. we construct a new network structure for commercial banks, as shown in figure 1. figure 1: the dynamic network structure of banking technology in period t. following the prior works of chen et al. (2009) and kao (2009), as well as the dynamic dea network approaches of some researchers (kao 2009; tone & tsutsui 2010, 2014), tone and tsutsui (2010) report that dynamic dea network correlation variables can be classified into three types, namely fixed, free desirable and undesirable variables within the multiple-stage system. the above-mentioned studies give us a useful framework for the formulation and construction of our model for estimating the efficiency of the commercial banks in ghana. production possibility set we regarded bank operations in ghana as a network structure, for simplicity of the analysis, where bank deposits generated in the production stage are utilised in the profitability stage in a time period (t) to boost the bank returns. the carried-over factors (npls and loans) generated in the previous year (t-1) can be counterbalanced during the current production year (t) to reduce each bank assets’ risk significantly. these important assumptions for the deposit and carried-over factors (npls and loans) are both established for each bank, in which the connection between different stages and periods is constant. following the prior works of tone and tsutsui (2014) and zha et al. (2016), we define our production possibility sets as : in model 1, are the vectors to the two stages in time period t. the proposed model to properly estimate banks’ efficiency, the radial and non-radial efficiency measures are the two measures mostly adopted in recent studies. as stated by tone and tsutsui (2014), the non-radial sbm technique can deal with the phenomenon of both ‘the input excess’ and ‘output shortfall’. it can also help in assigning each decision-making unit to a ‘furthest’ point on the frontier, in that the optimal function can be minimised by evaluating the maximum slacks. in this regard, sbm is an efficient tool for determining the sources of the inefficient banks within the structure of network dea. we therefore applied the same concept in constructing our two-stage sbm model to estimate the performance of commercial banks in ghana empirically. as stated before, the productivity stage is characterised by banks trying to maximise their desirable outputs for a given input and simultaneously optimising both the inputs and outputs. in the profitability stage, however, banks try to boost their profits and decrease their npls to the minimum level. it is essential to consider the evaluation of banks by taking these two stages into consideration. however, the previous year’s (t-1) npls of a given bank can be collectible in the current year (t), resulting in additional revenue for the banks. based on this multiplicity of time period technology, the overall efficiency can be obtained by: therefore, are slack parameters or variables of the model representing the shortfalls: input excess, intermediate measure shortfall, undesirable carried-over factor excess, and output. β1 and β2 are the corresponding weights of the productivity and profitability stages, respectively, of the network dea model. in order to measure bank efficiency broadly over multiple time periods, stage 1 (productivity stage) and stage 2 (profitability stage) efficiency can be attained simultaneously. the overall efficiency programme can be computed as: the productivity and profitability stages’ efficiency can be defined as , respectively: in models (4) and (5) above, all the variables on the right side measure the optimal values of overall efficiency. the overall efficiency can be obtained by model (3). the productivity stage denoted by and profitability stage represented by can be obtained by models (4) and (5), respectively. in model (4), has an interval ranging from (0, 1). when (meaning all slacks are 0), the estimated bank is overall efficient; the opposite implies the bank is inefficient. likewise, when the evaluated bank can be considered as efficient in the overall, for both stages 1 and 2. an application to efficiency estimates of commercial banks in ghana data used in recent times, the ghanaian banking system has undergone significant transformations. more specifically, a lot of foreign banks emerged in ghana. this study covers a total of 27 main commercial banks in ghana during the period of 2009–2014, all of which are rather similar in terms of the services they provide. the dataset is based on the data from the bank of ghana, the unique annual financial reports of the individual banks and the annual ghana banking survey. the choice of variables is a focal issue for any dea model. this is because, in practice, a bank uses a lot of multiple inputs to generate income in the form of profits. for analysis of banking efficiency, ariff and luc (2008) and chang et al. (2012) used labour and physical capital as inputs, whereas other earning assets (i.e., investments) and total loans were used as outputs. the other earning assets can be disaggregated into shortand long-term investments (luo & yao 2010). non-interest income and interest income can also be included as outputs (fung & leung 2008; yao, han & feng 2008b). following earlier literature and data availability in ghana, we define the following variable for the dynamic network dea model. in the production stage, personnel and interest expenses should be used as the inputs, while deposits are the only output. in the profitability stage, we treat bank deposits from the production stage as input, and loans, interest and non-interest incomes are the desirable outputs, while npls are utilised as undesirable outputs. additionally, loans and npls are used as carry-over factors in two time series production periods. in this article, we argue that some of the npls produced in the profitable stage of the previous year can be collectible in the current year to increase the bank’s assets. the selections of these inputs or outputs are based on the profit orientation approach, with the cost elements (interest and personnel expenses) as inputs and the revenue elements, such as interest and non-interest income, as output. this selection has been used extensively in bank efficiency studies in the literature (see ataullah & le 2006; drake, hall & simper 2006; pasiouras 2008; zha et al. 2016). deposit is always adopted as a linkage factor between the two stages in banking efficiency studies (fukuyama & weber 2013) (table 1). table 1: descriptive statistics of inputs and outputs variable. the average numbers of personnel expenses have kept increasing for all banks throughout the entire study period. as one can note, an average npl is a great challenge for commercial banks in ghana. however, deposits and other variables varied with time. results first, we computed the slack-based (global) overall efficiency q* for each bank according to equation (3) and decomposed it into stage 1 efficiency for productivity and stage 2 efficiency for profitability, as defined by equations (4) and (5), respectively. the results for the overall efficiency and its corresponding decompositions are presented in tables 2–4: the mean efficiency scores of each of the overall efficiencies e0 and the sub-stage efficiency scores. the key message here is that the average efficiency remained rather stable for the whole research period. as these scores are relative to the contemporaneous frontiers, one can conclude that banks remained similarly heterogeneous in terms of their performance (efficiency). the average efficiency for the profitability stage showed an increasing trend and exceeded that for the deposit generation stage . this finding suggests that there is a significant gap between productivity and profitability stages in the ghanaian banking system. using the bank-specific results, we identified banks that are either highly or fully efficient in stage 2. this can help to identify and spread best practices within the ghanaian banking sector. the decline in bank efficiency in stage 1 can mainly be attributed to dynamics in interest rates in ghana, which is one of the most important determinants of efficiency. table 2: the slack-based overall efficiency of banks in ghana. table 3: stage 1 efficiencies. table 4: stage 2 efficiencies. overall efficiency estimates in table 2, we can observe that for the financial year 2009–2010, only two banks (bank 7 and bank 8) were estimated to be efficient, and the rest of the banks were rated inefficient. however, during the same year under investigation, the following banks performed slightly better: bank 1 (0.614); bank 3 (0.623); bank 6 (0.846); bank 20 (0.625); and bank 26 (0.755). only a single bank (bank 19) was computed to be efficient during the financial year 2010–2011, performance of bank 7 (0.983) was relatively encouraging, and many banks were essentially computed as inefficient. the mean efficiency of all the banks year by year showed a fluctuation phenomenon during the entire study period: in 2010, the average yearly efficiency for the banks was 0.480, followed by 0.398 for 2011, 0.484 for 2012, 0.470 for 2013, and 0.487 for 2014. the average efficiency of the ghanaian banking industry during 2010–2014 does not show an observable change of trend like that in alhassan et al.’s study (2016). we calculate the overall efficiency together with the efficiency of each sub-stage for 27 commercial banks in ghana by using our newly-presented two-stage dynamic dea model. stage 1 efficiency estimates from the results shown in table 3, bank 7 and bank 8 were estimated to be efficient in 2010; in 2011, only bank 19 was efficient; in 2012, bank 7 was measured efficient; bank 26 was efficient in 2013; and bank 17 and bank 19 were rated efficient in 2014. in the terms of mean efficiency scores across the entire study, one can see the fluctuation in the performance values over the years: in 2010, all of the banks had an efficiency value of 0.266, and this value fluctuated to 0.173 but then slightly increased to 0.254 in 2012; there was also an increase from 0.251 in 2013 to 0.263 in 2014. for the rank test, bank 7 was ranked as the most efficient bank, followed by bank 19 in second place. in this productivity stage, most banks (if not all) performed very poorly, and this has contributed significantly to the overall performance of banks in ghana. we therefore suggest that bank efficiency improvement policy should be geared towards this sub-stage. stage 2 efficiency estimates table 4 shows that mean efficiency of this stage realised more satisfactory results for banks operating in ghana. in 2010, the efficiency score was 0.873, but decreased to 0.773 in 2011. however, this increased to 0.860 in 2012, dropped to 0.788 in 2013, and then increased marginally to 0.822 in 2014. we can observe most banks’ overall improvement in the efficiency scores. in 2010, only six banks were inefficient in this stage, but the rest were efficient. in 2011, 13 banks (more than double the previous year) were inefficient. nine banks were inefficient in 2012, and 11 in both 2013 and 2014. in general, this stage’s efficiency values are much higher than the stage 1 efficiency values. relationship between the overall and stage 1 and stage 2 efficiency estimates we computed the yearly averages of all the banks under study, as well as the individual banks’ means for the whole study period. figure 2 gives an illustration of the efficiency difference of the models used in this study. figure 2: average slack-based efficiency of two-stage model across the study period. from figure 2, we can see that most banks had a lower efficiency value in the productivity stage (stage 1) than in the profitability stage (stage 2). this has greatly affected the overall efficiency values of each bank. in order for us to investigate the relationship between the overall value and that of stages 1 and 2, we paid attention to the ranks of the mean efficiency values for each bank. it can be said that most banks have similar ranks in the three types of efficiency discussed above. the two-paired-sample non-parametric wilcoxon signed-rank test was performed to ascertain whether the differences in efficiency gaps between stage 1 and stage 2 are significant (table 5) the results (z = −2.02, p = 0.043) confirmed that the commercial banks in ghana have more potential in the generation of profits. the correlation coefficients for the overall and the two-stage efficiency are 0.7112 and 0.9072, respectively. this implies that the overall performance of these banks largely depends on the systematic performance of the two stages. in detail, the mean efficiencies of the overall and the two stages for each bank are shown in figure 3, and this can greatly help in measuring the real causes of banks’ inefficiency in ghana. in figure 3, the mean efficiency for stage 1 is much lower than the overall, and the stage 2 values are comparatively higher. we can therefore conclude that the inefficiency of banks currently operating in ghana is mainly caused by the performance of the production stage (stage 1) efficiencies. our proposed model has very important implications for bank managers, in that it can help managers to be able to determine the sources of inefficiencies within the banking industry in ghana. in addition, managers can improve the overall performance of the industry by targeting improvement strategies towards the two sub-processes; in this case, stage 1 is of particular interest. figure 3: mean slack-based of the overall, stage 1 and stage 2 of banks in 2009–2014. table 5: results of wilcoxon signed-rank test. conclusion in this article, we have developed a novel two-stage dea model for the effective measurement of bank efficiency on the basis of dynamic sbm network dea, by modelling the bank efficiency in ghana, taking into account both desirable and undesirable outputs. different from the existing dea approaches, this proposed approach allows for the evaluation of bank efficiency in a time period of multiple years in which the npls produced in previous years can be collectible in the current year (t), resulting in additional revenue for the banks. by using this newly-presented model, we find that the 27 main commercial banks in ghana are far from efficient. further, we compute the efficiency of two production stages, in order to provide more information for the inefficient banks to improve their performance. we find that, for all the banks, the efficiency score in the second stage is much higher than that of the first stage. that means more attention should be paid to the first stage of production in order to increase the banks’ efficiency. in order to mitigate the efficiency gap between the productivity and profitability sub-stages, both bank managers and policymakers must take strategic and innovative measures to improve both stages in order to ensure bank efficiency in ghana. both adjustments on inputs and outputs are important for ghanaian banks: train bank staff to decrease the human input per output; improve deposit generation to increase desirable outputs; and decrease npls via strengthened internal control of loan provision and improved loan quality to decrease undesirable outputs. in a further study, we will explore the details more deeply, to find out the difference between the contribution of npls and loans to the next time period. based on the analysis, we should use the weights given to them for measuring the efficiency of each bank in order to illustrate the difference between npls and loans. with a longer time period, one could measure the effect of npls and loans for more than two years. acknowledgements this research is financially supported by the national natural science foundation of china (no. 71701059, 71771126, 71301080). competing 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2016.docx 232 sajems ns 19 (2016) no 2:232-248 how to cite doi: http://dx.doi.org/10.17159/2222-3436/2016/v19n2a5 issn: 2222-3436 the expected well-being of urban refugees and asylum-seekers in johannesburg talita greyling department of economics and econometrics, university of johannesburg accepted: january 2016 the influx of asylum-seekers and refugees from across africa into democratic south africa has increased significantly. the aim of this paper is to determine the factors that influences the expect well-being of this unique group. expected well-being is an important determinant of both the decision to migrate and the choice of a country of destination. knowledge about this determinant therefore informs refugee policies. the results show that only a few of the factors found in the literature explaining the expected well-being of voluntary migrants also explain the expected well-being of forced migrants. however, a number of factors found in the literature that explain the subjective well-being and well-being in general of refugees and asylum-seekers also went towards explaining the expected well-being of this group. these factors include: government assistance, culture, the time spent in south africa, economic factors, crime, refugee status, reasons for leaving the home countries and the number of people staying in a house in the receiving country. the findings of this study emphasise the differences between forced and voluntary migrants and highlight the factors that influence the expected well-being of forced migrants. these in turn shed light on migration decisions and the choice of destination countries. key words: expected well-being, johannesburg, forced migrants, refugees, asylum-seekers, south africa, well-being jel: d6, f23, j11, o15 1 introduction since south africa’s transition to democracy, the influx into the country of asylum-seekers from across africa has increased almost tenfold. the country has also become the largest recipient of individual applications for asylum in the world, with more than 207 000 applications out of a total of 839 000 globally (united nations high commissioner for refugees, 2011). the majority of the refugees and asylum-seekers who move to south africa find refuge in the bigger cities like johannesburg. the influx of refugees and asylum-seekers into the cities has brought about new socio-economic challenges with the concomitant need for the development of policy measures to address them. one of the major determinants of refugees’ and asylum-seekers’ migration decision and choice of destination country, insofar as they have a choice, is that of expected well-being (massey, arango, hugo, kouaouci, pellegrino & taylor, 1993; czaika, 2014; spinks, 2013). expected wellbeing can be defined as the anticipated level of a person’s well-being and is related to the level of well-being s/he aspires to achieve (czaika & vothknecht, 2012). hence an understanding of the factors that influence expected well-being will not only contribute to a better understanding of the well-being of refugees and asylum-seekers, but will also lead to a better understanding of their decision to migrate as well as their choice of a destination country and region. research into the well-being of refugees and asylum-seekers has been limited and, to the best of the author’s knowledge, no previous research on the determinants of the expected well-being of this group of people has been conducted internationally. however, studies on the factors and related matters that influence the expected well-being of voluntary migrants have been carried out (valentina, berg & vaaler, 2010; czaika & vothknecht, 2012). there have also been studies on the determinants of well-being and subjective well-being1 of refugees and asylum-seekers that exclude any consideration of the ‘expected’ dimension of well-being. in this research we therefore abstract sajems ns 19 (2016) no 2:232-248 233 address this gap in the literature by estimating the factors that influence the expected well-being of refugees and asylum-seekers residing in johannesburg’s inner city. for the purposes of this study, a data set collected by the forced migration studies programme (fmsp) (2006) on the inner city of johannnesburg, which forms part of a larger project, the african city project, is used. the study focuses on johannesburg, as it has the highest concentration of foreign-born inner-city residents in south africa. according to the census 2001 data (statistics south africa (statssa), 2003), almost a quarter of the inner-city residents in johannesburg were born outside south-africa, compared to 10 per cent in pretoria, 6 per cent in durban and 4 per cent in cape town. this research contributes to the refugee and asylum-seeker literature, as it adds to the knowledge on the factors that influence expected well-being, in turn shedding light on the decision to migrate and the choice of a destination country. a better understanding of these factors could contribute to informed policy responses. the results of this study on the factors that have been found to influence the expected wellbeing of refugees and asylum-seekers show that only a few of them correspond to those found in the literature (see section 2) to explain the expected well-being of voluntary migrants. however, according to the literature reviewed here, there are a number of explanations for the well-being and subjective well-being1 of refugees and asylum-seekers that coincide with what is found in the study to explain the expected well-being of forced migrants. these factors relate mostly to the refugee status of the forced migrants, which gives them more certainty about their future, their living conditions and the support they will receive from government. these findings emphasise the differences between forced and voluntary migrants and also the differences between the factors that explain their expected well-being, which in turn influence their decision to migrate and their choice of a destination country. in this paper, the definitions of refugees and asylum-seekers are adopted from the 1951 convention relating to the status of refugees and its 1967 protocol. the convention defines a refugee as: ‘any person who, owing to a well-founded fear of being persecuted for reasons of race, religion, nationality, membership of a particular social group or political opinion, is outside the country of his/her nationality and is unable, or owing to such fear, is unwilling to avail himself/herself of the protection of that country. an asylum seeker is a person who is seeking protection as a refugee and is still waiting to have his/her claim assessed’. refugees and asylumseekers are also referred to as ‘forced migrants’, as often they have no choice but to leave their home country to ensure their safety. the remainder of this paper is structured as follows: section 2 contains a brief review of the literature on the determinants of expected well-being of voluntary migrants and the well-being in general of refugees and asylum-seekers. in section 3, there is a discussion on the data used in the analyses. section 4 describes the methodology used, including the statistical techniques, the specification of the model and the selection of the variables. section 5 contains a report on the results of the empirical analysis and the conclusions are drawn in section 6. 2 literature on the determinants of well-being in the introduction, it was pointed out that no previous research has been carried out internationally on the determinants of the expected well-being of refugees and asylum-seekers, therefore research related to the topic of the current study is reviewed. i divide the literature reviewed in two sections: in the first section, literature related to factors that influence the expected well-being of voluntary migrants is discussed. the second section explores the findings of the literature that investigates the general and subjective well-being of refugees and asylumseekers internationally and in studies relating to south africa. 2.1 factors that influence the expected well-being of voluntary migrants the study by czaika and vothknecht (2012) is one of the only studies investigating the factors that influence the expected well-being of migrants. however, the study focuses on voluntary migrants 234 sajems ns 19 (2016) no 2:232-248 rather than forced migrants, who are the focus of the current research paper. in the study by czaika and vothknecht (2012), they used a longitudinal data set from the indonesian family life survey. the authors estimated an expected well-being function and included the following determinants: age, being male, level of education, hours worked, monthly income, community participation, being married, the age of the household head, household expenditure, households with farm income, households with non-farm income, female-headed households, number of adults in the household, number of children in the household, households with a tv set, household being rural, household’s asset value and ethnic fractionalisation. they found that being over the age of 40, being the household head and having more adults in the household to be statistically significant and negatively related to expected well-being. on the other hand, being married and having an education higher than junior high school was statistically significant and positively related to expected well-being. the other variables were found not to be statistically significant. in the current study, the author follows the example of czaika & vothknecht (2012) and includes variables similar to those they included in their study on the estimated model (depending on the availability of data). czaika and vothknecht (2012) omit to consider a fact that has been shown to be closely associated with the expected well-being of migrants, which is the region in which they live (jurjevich & schrock, 2012; faggian, olfert & partridge, 2012). the expectations of future regional well-being is also a main consideration for the migrants in their choice of a destination country (faggian et al., 2012). in the model estimated in this paper, the regional element of expected well-being is therefore incorporated into the model. a further study which is related to the expected well-being of migrants, but which does not investigate the determinants of expected well-being, compares the distress levels and negative expectations of both voluntary and forced migrants residing in norway (valentina et al., 2010). the study is qualitative and includes 48 voluntary migrants and 45 forced migrants. the data was collected from 2005 to 2008. they found that forced migrants seem to incur greater distress and higher levels of negative expectations for the future than do voluntary migrants. this study reaffirms that it is likely that the expected well-being of forced migrants and voluntary migrants might differ. 2.2 factors influencing the general and subjective well-being of refugees and asylum-seekers turning to international studies on the general well-being of refugees and asylum-seekers, the following emerged in studies undertaken in developed countries, including the usa, (meredith, 1984; tran & wright, 1986) and australia (colic-peisker, 2009). the study by meredith (1984) considered the subjective well-being of lao hmong refugees and asylum-seekers in nebraska, while the study by tran and wright (1986) investigated the subjective well-being of vietnamese refugees in the usa. colic-peisker (2009) investigated the subjective well-being of refugees from bosnia and herzegovina who had resettled in australia. all the pre-mentioned studies showed that refugees and asylum-seekers were happier if they remained in contact with their families and attempted to reunite with them if they were able to speak the local language. furthermore, a positive attitude from the people in the receiving country contributed to the refugees’ and asylum-seekers’ well-being (colicpeisker, 2009; meredith, 1984; tran & wright, 1986). acculturation and adaptation to the new environment, as well as social support, job satisfaction and financial satisfaction were all found to be significant contributors to refugees’ well-being (colic-peisker, 2009). in other international studies, further factors that influence the well-being of forced migrants are revealed. correa-velez, gifford and barnett (2010) studying refugees in melbourne, australia found that discrimination and social exclusion were some of the factors that impacted negatively on refugees’ well-being. in a study in the netherlands on iranian refugees, werkuyten and nekuee (1999) found a positive relationship between the time spent in the host country and subjective well-being, implying that the longer refugees and asylum-seekers resided in a country, the higher their level of subjective well-being. in a study considering refugees from across the world, including africa, the balkans, siberia, the middle east and southeast asia, krippner and mcintyre sajems ns 19 (2016) no 2:232-248 235 (2003) showed that refugees and asylum-seekers who leave their home countries because of persecution or civil war experience severe negative effects on their psychological well-being, which could lead to depression, anxiety and post-traumatic stress. lastly, the positive effects of religion on subjective well-being were shown in the study by connor and koenig (2013), which considered data from the usa, canada and europe. in this study they found that, in areas like the usa, the attendance at religious meetings is positively related to occupational attainment, especially for second generation migrants (connor & koenig, 2013). in this study, depending on the availability of data, these factors are built into the model to explain the expected well-being of forced migrants in johannesburg. to summarise, the factors found in the international literature that influence the subjective wellbeing of refugees and asylum-seekers are: maintaining contact with their families; speaking the receiving country’s language; being received positively by the people in the receiving country; adaptation and acculturating to the new environment and the time spent in the host country. in south africa, no studies have been undertaken on the factors that influence the subjective well-being of refugees and asylum-seekers, although there have been studies related to the subject. the related studies include those on livelihood strategies, the rights and protection of refugees and asylum-seekers and xenophobia (see. among others, landau, 2006; jacobson, 2006; crush & dodson, 2007; neocosmos, 2008). in considering livelihood strategies, jacobson (2006) found that many of the refugees and asylum-seekers’ livelihood strategies in south africa were based on their economic, cultural and religious affiliations. moreover, for refugees and asylum-seekers to enjoy a good quality of life, they needed access to protection, economic opportunities and social rights (jacobson, 2006). in this study these factors are considered in the estimation of the expected well-being model. on studies relating to xenophobia in south africa, neocosmos (2008) and crush and dodson (2007) found that south africans had a negative attitude to foreigners and that such an attitude negatively affected the well-being of forced migrants. according to the research, the animosity originated in the belief that migrants took advantage of job opportunities and contributed to the increased crime rates in the country (neocosmos, 2008; crush & dodson, 2007). factors that have been found in south africa to influence the well-being of refugees and asylum-seekers were economic, cultural and religious affiliations, crime and the ability to access protection, and economic and social rights. in summary, the literature showed that the factors found to influence the expected well-being of migrants were age, education, relative income and marriage. in addition, the factors found internationally to influence the well-being and subjective well-being of refugees and asylumseekers were: maintaining contact with their families; speaking the receiving country’s language; being received positively by the people in the receiving country; adaptation and acculturating to the new environment and the time spent in the host country. factors that have been found in south africa to influence the well-being of refugees and asylum-seekers were economic, cultural and religious affiliations, crime and the ability to access protection, and economic and social rights. in this paper, both the factors found to influence the expected well-being of voluntary migrants and those found to influence the well-being and subjective well-being of refugees and asylum-seekers, according to the literature, are included in the model to test the extent to which these factors explain the expected well-being of refugees and asylum-seekers in the inner city of johannesburg. 3 data in the analysis, the researcher uses a data set collected by the fmsp in 2006, the ‘migration and the new african city’ data set (fmsp, 2006). the survey was initially undertaken within the framework of the african cities project (acp), the purpose of which was to collect comparative and longitudinal data on the migration patterns and the integration of migrants into their reception towns in southern, central and east africa. the cities to be surveyed were selected on account of the high concentration of migrants in their inner cities. the cities included were: johannesburg, 236 sajems ns 19 (2016) no 2:232-248 maputo, nairobi and lubumbashi. however, the project as a whole was never completed. the survey conducted in the inner city of johannesburg contains information on the demographic profile of the migrant, the conditions prevailing in the sending country before migration and the living conditions of the migrants after their arrival in south africa. the data set is not a representative sample of all the migrants in south africa or even of the migrants in johannesburg, as only the inner city of johannesburg, with its high concentration of migrants, was surveyed. however, the data provide an insight into the socio-economic circumstances of often difficult-to-reach populations. an area cluster sampling technique was used for collecting the data. in preliminary consultative work, the suburbs in which the migrants reside were identified. the following suburbs in johannesburg were included: rosettenville, mayfair, fordsburg, yeoville, berea and bertrams. the survey aimed to collect data from fixed quotas of migrant groups, divided among 600 nonnationals (somali, congolese and mozambican) and a control group of 200 south africans. the main characteristics of the respondents in the sample are shown in table 1. table 1 socio-economic and demographic characteristics (percentage of selected group, except if specified otherwise) forced migrants voluntary migrants south africans characteristics number of respondents 406 242 199 sex male 70 53 48 female 30 47 52 age 18-25 years old 20 22 35 26-30 years old 28 30 18 31-35 years old 27 18 12 36-40 years old 16 15 11 40+ years old 9 15 24 marital status married/lived together 54 44 41 single 46 56 59 level of education completed secondary school 45 50 61 completed tertiary training 28 10 14 master’s degree or more 3 2 1 employment unemployed 36 13 43 employed full-time 26 40 25 employed part-time 11 7 7 casual employment 20 16 15 self-employed 2 .4 1 voluntary worker 2 1 1 total employed 61 64.4 49 income mean annual income (rand 2006) 24 319 25 717 37 711 source: author’s calculations of the migration in the new african city survey (forced migration study programme, 2006) among the total number of 847 respondents in the original sample, 406 were forced migrants, 242 were voluntary migrants and 199 were south africans. the migrants in the sample were mainly men (63), while the male percentage among the forced migrants was even higher at 70 of the total sajems ns 19 (2016) no 2:232-248 237 forced migrant sample. literature has shown that men are more likely to migrate than women are (crush & dodson, 2007). this also applies to migrants in south africa. one of the likely reasons that more men than women migrate to south africa is the job opportunities offered to men, especially in the mining sector. the majority of the migrants, including voluntary and forced migrants, are of working age, between the ages of 26 and 40 years. this underlines the notion that many migrants enter south africa to find employment. the south african respondents included in the sample were slightly younger on average than the migrants, the majority aged between 18 and 25. more than half of the forced migrants (54 per cent) were married, although their spouses were not necessarily residing in south africa. the proportion of married voluntary migrants to south africans was slightly lower, at just over 40 per cent. this might be explained by the lower age of the previously mentioned groups. a lower proportion of migrants (between 45 per cent and 50 per cent) compared to south africans (61 per cent) indicated that they had completed secondary school. however, more than double the percentage of forced migrants had had tertiary training (28 per cent) compared to both voluntary migrants (10 per cent) and south africans (14 per cent). a large proportion of the forced migrants could speak english (73 per cent) and 97 per cent could speak another south african language. approximately the same percentage of forced migrants (37 per cent) and south africans (32 per cent) reported that they were employed in either the formal or the informal sector, compared to a much higher proportion of voluntary migrants (47 per cent) working in either of these sectors. this could possibly be explained by the fact that voluntary migrants probably secured employment before migrating to a receiving country. in a study by mbatha and roodt (2014) on migrants in south africa, they showed that many of the migrants are entrepreneurs, who employ south african citizens. a fifth (20 per cent) of all the forced migrants indicated that they were in casual employment compared to 15 per cent of the south africans and 16 per cent of the voluntary migrants. considering the total percentage of employed respondents across the board in any type of employment, 61 per cent of all the refugees and asylum-seekers were employed compared to 64, 4 per cent of voluntary migrants and 49 per cent of the south african citizens. the average income per capita per annum measured in rands (for the year 2006) for the south africans was much higher (r37 711) than the average income per capita per annum reported by either the forced migrants (r24 319) or the voluntary migrants (r25 717). the difference in income levels could be explained by the different types of employment (higher-skilled compared to lower-skilled) in the different groups. furthermore, the higher income for south africans could possibly also be ascribed to their receiving different types of social grants, which are added to their total income. the majority of international migrants do not receive these grants (jacobson, 2006). most of the forced migrants (45 per cent) in the sample were residing in apartments, which they shared with more than one family, compared to voluntary migrants and south africans, who mostly lived in apartments occupied by single families. approximately 20 per cent of the forced migrants in the sample had been in south africa for less than one year, 40 per cent between one and four years (entering south africa after 2002), and only 5 per cent in south africa for a time period of longer than 10 years. the significantly higher proportion of migrants in the sample, who had entered south africa since 2002 can be explained by, inter alia, the unstable conditions which prevailed in the drc and somalia. as the focus of this paper is on forced migrants, the researcher selected only the respondents who were either asylum-seekers or refugees for inclusion in the empirical analysis. after adjustment for missing data, the sample size was 279 adult respondents. 4 methodology in this section both the model specification and the estimation techniques are described. further, the method of construction of the dependent variable, that is, expected well-being, and the selection of the explanatory variables used in the analysis are discussed. 238 sajems ns 19 (2016) no 2:232-248 4.1 model specification and estimation techniques the specifications of the expected well-being model were based on previous studies conducted on both the expected well-being (czaika & vothknecht, 2012) and the well-being literature (see, for example posel & casale, 2011; knight & gunatilaka, 2010). the specification of the expected well-being function is as follows: ewi = β0+ βm xmi + ui where ewi represents expected well-being, β0 is the constant, βm provides the coefficients that indicate the relative importance of different contributors to expected well-being, xmi is a vector of m explanatory socio-economic variables of i (i=1….n) respondents, and ui is an error term including all the factors that were not captured in the well-being equation. in most of the well-being literature, especially the subjective well-being studies, ordinary least squares (ols) and ordered probit are used as estimation techniques (see posel & casale, 2011; mackerron, 2012; bartram, 2013; blaauw & pretorius, 2013). ordered probit is an estimation technique appropriate for estimations using categorical data in which the distribution of the variables are, in all likelihood, not normal. however, in research by ferrer-i-carbonell and frijters (2004) and stevenson and wolfers (2009), it was shown that negligible differences existed between the results obtained from the aforementioned methods and that the signs and significance of the estimated coefficients in these studies were similar. furthermore, although the results of the different regression methodologies in larger samples were found to be comparable, in their analyses of cross-sectional data and smaller samples (mcfadden, 1994) with the absence of panel data, researchers found that ols regressions were more reliable than ordered probit estimates. an advantage of ols estimations as opposed to ordered probit estimations is the directness of the interpretation of the estimated coefficients (see mackerron, 2012; bartram, 2013; blaauw & pretorius, 2013). however, the ols estimation technique has certain limitations when it comes to estimating models that suffer from endogeneity, as the error term and the explanatory variables become correlated and result in potentially biased estimated regression coefficients. to determine whether endogeneity is present in the estimated model, the researcher made use of instrumental variables regressions (ivr), which control for unobserved heterogeneity. following this, post estimation endogeneity tests are conducted to confirm or deny the presence of endogeneity in the estimated model. to estimate the ivr, the two stage least square estimation technique is used. in this research, depending on the outcome of the post estimation tests of endogeneity, the researcher follows the customary methods used by earlier researchers in the well-being literature (czaika & vothknecht, 2012; mackerron, 2012; bartram, 2013; blaauw & pretorius, 2013) and uses ols (or in the event of endogeneity, ivr) and ordered probit estimation techniques. all the diagnostic tests are performed on the estimated regressions to determine whether the regressions fulfil the set assumptions of the specific estimation technique. 4.2 the derived expected well-being variable in the migration in the new african city survey (fmsp, 2006), two questions were identified, which were then used to derive an expected well-being variable. the two questions were: ‘generally speaking, do you think your life will be better or worse than your parents’ lives?’ and ‘where do you expect to be living two years from now?’ the first question captures expected individual well-being, whereas the second question refers to the preference for a specific region, thus regional well-being, which is an important dimension of the total expected well-being (dasgupta, 2004; lora & powell, 2011; faggian. olfert & partridge, 2012). the derived variable gives an all-encompassing measure of expected well-being, which informs both the migration decision and the choice of destination country. to derive the expected well-being variable, the researcher allocated scores to the responses to the two identified questions. the first question had three response categories. these were: ‘my life will be better than my parents’ lives’, ‘it will be the same as my parents’ lives’, or ‘it will be sajems ns 19 (2016) no 2:232-248 239 worse than my parents’ lives’. scores between three (‘my life will be better’) and one (‘my life will be worse’) were allocated to each response. the second question was recoded so that it had two response categories. the allocation of the scores was informed by the findings by cernea and mcdowell (2000) and faggian et al. (2012). these findings showed that, if the refugees and asylum-seekers preferred to stay in the host country, this reflected expected ‘regional well-being’ (faggian et al., 2012). however, if they wished to move to a third country, this reflected negative expectations of the region, thus affecting regional wellbeing negatively. therefore, responses to the second question indicating that the refugees and asylum-seekers would expect to live in the city where they were, or another place in south africa, scored three (the maximum score). the score of three was allocated to the question so that the two questions included in the derived expected well-being variable had equal weighting. if the respondent indicated that s/he expected to move to a third country, it was assumed that the resettlement was not successful and negatively affected the person’s expected well-being; half of the maximum score (a score of 1.5) was allocated to this response. the expected well-being variable was derived by summing the scores of the responses of the two questions of each respondent in a way similar to the methods used in the social sciences to sum the items of a scale (pallant, 2007). for example, if a refugee or asylum-seeker felt that his/her life would be worse than the parents’ lives (a score of one) and s/he would prefer to leave south africa (a score of 1.5), the summed score would be 2.5 (see table 2). a score of six was achieved if a refugee or asylum seeker thought that his/her life would be better than the parents’ lives and they would prefer to stay in south africa. the scores reflect a certain order of expected well-being, with 2.5 being the lowest and 6 the highest. these scores were recoded from one to six, to reflect the order of expected well-being (see table 2), the ordered variable was used in further analyses. table 2 shows the frequencies and percentages of the expected well-being variable. table 2 the frequencies of the expected well-being variable score code frequency percentage cumulative percentage 2.5 1 11 3.3 3.4 3.5 2 3 0.9 4.2 4.0 3 16 4.8 9.1 4.5 4 105 31.8 40.9 5.0 5 14 4.2 45.2 6.0 6 181 54.8 100.0 source: author’s calculations of the migration in the new african city survey (forced migration study programme, 2006) the majority of the refugees and asylum-seekers’ expected well-being was at a level of either four (31.8 per cent) or six (54.8 per cent). a level four indicates that the respondent felt that his/her life would be better than their parents’ lives, though they would prefer not to stay in south africa. a level six indicated that the migrant expected that his/her life would be better than the parents’ lives, and s/he would prefer to stay in south africa. judging from these results, most of the refugees and asylum-seekers in this sample were positive about their expected well-being and the majority (63.8 per cent) would most likely, if circumstances permitted, settle in south africa (fmsp, 2006). this finding concurs with the findings by valentina et al. (2010), showing that refugees and asylum-seekers generally have positive expectations about their future well-being. furthermore, myroniuk and vearey (2014), in their research specific to johannesburg, found that foreign-born migrants’ livelihood outcomes compared well to those of south african citizens. 4.3 the proposed explanatory variables the selection of the explanatory variables to describe the expected well-being function of refugees and asylum-seekers was based on the availability of data and the reviewed literature on the 240 sajems ns 19 (2016) no 2:232-248 expected well-being of migrants, as well as the well-being and subjective well-being of refugees and asylum-seekers (see section 2). factors such as ‘refugee status’, which were hypothesised as possibly influencing the ‘expected well-being’ of refugees and asylum-seekers, were also included. the researcher recoded all the nominal variables to dummy variables so that the variables took a value of either 1 or 0. the selected variables, with explanations about the coding and descriptive statistics, are shown in table 3. the selected variables are: ‘age’, ‘victim of crime’, ‘education’, ‘gender’, ‘type of housing’, ‘married’, ‘religion’, ‘relative income’, ‘employment’, ‘income’, ‘government assistance’, ‘culture’, ‘religion’, ‘time in south africa’, ‘number of people in the house’, ‘reason for leaving country’, ‘refugee status’ and an interaction variable ‘education x employment’. the interaction variable was included as an independent variable, as the researcher wanted to investigate whether employment has different effects on expected well-being depending on the level of education of the forced migrants. research has shown that education and employment are closely related (teichler & kehm, 1995). however, in studies on forced refugees, it has been found that they are often under-employed, which might have a different effect on expected wellbeing than being employed, according to specific skills levels (cornwell & inder, 2004). table 3 explanatory variables included in the model variable categories/ description type of variable coding min max mean gender male female dummy 1 0 0 1 .695 type of housing house/apartment hostel dormitory/informal dummy 1 0 0 1 .037 married married single dummy 1 0 0 1 .537 religion with a religion no religion dummy 1 0 0 1 .985 crime has been a victim of crime has not been a victim of crime dummy 1 0 0 1 .590 relative income poorer than others in area where you live about the same or better off than others in the area where you live 0 1 0 1 0.69 employment employed unemployed dummy 1 0 0 1 .563 government assistance helps never helps dummy 1 0 0 1 refugee status yes no dummy 1 0 0 1 .478 reason for leaving country escape war and persecution economic, education and other dummy 1 0 0 1 .573 culture better for society if immigrants maintain their customs better for society if immigrants adopt the customs of the host country dummy 1 0 0 1 .836 education years of education continuous 0 18 11.26 age age in year continuous 22 63 31.51 time in rsa number of months residing in south africa continuous 1 15 8.042 number of people in the house number of people living in a single structure continuous 0 30 6.462 income average income per week continuous 0 2500 523.65 employment x education interaction variable continuous 0 18 10.12 source: author’s calculations of the migration in the new african city survey (forced migration study programme, 2006) the results of the estimated model are discussed in the next section. sajems ns 19 (2016) no 2:232-248 241 5 results in the results section, the researcher discusses the findings on possible endogeneity in the estimated model, which is followed by a discussion of the results of the ols and the ordered probit models. 5.1 results on the tests of endogeneity as endogeneity is often a challenge in the social sciences, when people’s behaviour is estimated. the researcher first uses ivr to test whether endogeneity is present in the current estimated model. potential endogeneity is likely to spread from the variable ‘time spent in south africa’, as this variable might include an unobservable element of experiences by refugees and migrants while staying in the country. although these experiences are unobserved, they might potentially have an influence on the expected well-being of forced migrants. the data set has limited capability for providing instrumental variables. however, ‘how often refugees and asylum-seekers change residence’ was identified as a potential instrument for the variable indicating the time forced migrants spent in south africa (‘time in south africa’), which might be endogenous. the suggested instrument is correlated with the ‘time in south africa’ variable (r= .547). after running the ivr using two-stage least squares and conducting the post-estimations tests for endogeneity, the following was found: the durbin score = 2.772 (p = 0.096) and the wu-hausman score = 2.651 (p = 0.1044). based on these results the researcher could not reject the null hypothesis stating that the variables are exogenous. thus in the absence of endogeneity ols was used together with ordered probit to estimate the model set out in section 4.1. the results are shown in table 4. 5.2 results on the estimated ols and ordered probit models the estimated model showed that the f-statistic (ols estimation) and the wald chi-squared statistic (ordered probit estimation) were statistically significant, indicating that the explanatory variables were jointly significant in explaining the variation in the expected well-being variable. the ols model’s r squared value (0.132) and the ordered probit model pseudo r squared value (0.190) were consistent with the results obtained in similar cross-sectional well-being studies (powdthavee, 2003; ebrahim, botha and snowball, 2013). table 4 results on the determinants of expected well-being ols ordered probit explanatory variables age 0.032 (0.065)* 0.043 (0.096)* crime -0.093 (0.166)* -0.185 (0.247)* education 0.368 (0.161) 0.508 (0239) gender 0.243 (0.203) 0.391 (0.299) type of housing 0.177 (0.243) 0.612 (0.377) married 0.509 (0.173) 0.760 (0.258) religion 0.681 (0.589) 1.085 (0.898) relative income 0.245 (0.132)* 0.354 (0.195)* employment 1.677 (0.681)** 2.134 (1.015)** income 0.055 (0.053) 0.044 (0.082) government assistance 0.177 (0.128)* 0.335 (0.194)* employment x education -0.489 (0.204)** -0.666 (0.305)*** refugee status 0.006 (0.194)** 0.082 (0.287)** culture 0.134 (0.214)*** 0.246 (0.314)** number of people in the house -0.030 (0.018)* -0.042 (0.026)* continued/ 242 sajems ns 19 (2016) no 2:232-248 ols ordered probit explanatory variables time in south africa -0.034 (0.029)** -0.070 (0.043)** reason for leaving country -0.575 (0.169)* -0.877 (0.257)** n 271 271 adjusted r2 / pseudo r2 0.132 0.190 f-statistic / wald chi-square 3.406*** 1641.80*** source: author’s calculations of the migration in the new african city survey (forced migration study programme, 2006) notes: (1) dependant variable = expected well-being. (2) standard errors are in parentheses. *** significant at the 1 percent level ** significant at the 5 percent level * significant at the 10 percent level. the results for the signs and the significance of the estimated coefficients of the two estimation techniques (ols and ordered probit) were similar, in line with the findings by ferrer-i-carbonell and frijters (2004) and stevenson and wolfers (2009). the only differences noted were in the level of the statistical significance in the variables ‘employment x education’ and ‘culture’, which varied between 5 per cent and 10 per cent in the models. as explained in the methodological section, the researcher interpreted the ols estimated coefficients owing to the advantage of direct interpretability of ols estimations over probit estimations (blaauw & pretorius, 2013). the results of the model showed the majority of the included explanatory variables to be statistically significant, although not all of these revealed the expected signs. the initial discussion will be on those variables included in the model estimation based on the variables that were found in the literature to explain the expected well-being of voluntary migrants: ‘age‘, ‘relative income’, ‘education’ and ‘marriage’ and thereafter the remaining variables. the ‘age’ variable was found to be statistically significant and was positively related to the expected well-being of the refugees and asylum-seekers. the positive relationship shows that, as the age of refugees and asylum-seekers increases, their expected well-being also increases. it is likely that, as refugees and asylum-seekers grow older, and keeping in mind that the respondents are aged between 22 and 63 years, their job opportunities and housing circumstances also improve, and this positively influences their expected well-being. the study by czaika and vothknecht (2012) on the relationship between age and the expected well-being of voluntary migrants revealed similar results. the ‘relative income’ variable was statistically significant and was positively related to the expected well-being variable. however, the ‘income’ variable was not statistically significant. this finding supports the arguments by alpizar, carlsson and johansson-stenman (2002) and frey and stutzer (2002) in the subjective well-being literature, that people’s relative income position in society is a better measure of well-being than absolute income levels. therefore, it can be argued that, if refugees and asylum-seekers believe that their relative income is the same or better than their neighbours’ income, it positively influences their expected well-being. ‘education’ was found not to be statistically significant in explaining the expected well-being of refugees and asylum-seekers, although the sign was positive. a likely reason for this result is that higher levels of education among refugees and asylum-seekers do not necessarily lead to improved well-being. this result partly accords with the findings of czaika and vothknecht (2012). their results showed that lower levels of education do not explain the expected well-being of voluntary migrants, although higher levels of education are statistically significant in explaining the expected well-being of forced migrants in the usa, which is a developed country. ‘married’ was found not to be statistically significant. this finding does not match that of czaika and vothknecht (2012) on the expected well-being of voluntary migrants, or the studies by diener and seligman (2004), blanchflower and oswald (2003) and mahadea (2013) on subjective well-being. according to these studies, marriage suggests companionship and the sharing of burdens and, for this reason, it increases both expected well-being and well-being. a possible explanation for the marriage variable not being statistically significant is that marriage might sajems ns 19 (2016) no 2:232-248 243 increase the spouses’ burdens, as they have to take responsibility not only for themselves, but also for their spouse. furthermore, if a spouse remains in the original country, the partner in the host country would probably be concerned about the well-being of the one left behind in the original country, which negatively affects their psychological well-being. such factors seem to outweigh any positive effects of marriage on the expected well-being of refugees and asylum-seekers. secondly, the researcher considered the variables included in the model based on those variables found to explain the well-being or subjective well-being of refugees and asylum-seekers. the majority of these variables were found to be statistically significant, including: ‘victim of crime’, ‘gender’, ‘type of housing’ , ‘employment’, ‘government assistance’, ‘time in south africa’, ‘reason for leaving the country’, ‘culture’ and ‘number of people in the house’. the variables found not to be statistically significant, and which were included in the model based on the factors that explained the well-being of forced migrants, were ‘gender’, ‘type of housing’ and ‘religion’. the ‘victim of crime’ variable was found to be negatively related to expected well-being, and was statistically significant, indicating that higher levels of crime negatively influenced the expected well-being of the sample group. the study by partridge (2013) on internal migrants in south africa supports this finding. the study found that, post-migration, the migrants reported being exposed more frequently to a variety of crime-related factors influencing their levels of wellbeing negatively. being male was related positively to expected well-being, although the ‘gender’ variable was not statistically significant. this finding corresponds to the finding by czaika and vothknecht (2012) on migrants and the study by hinks and gruen (2007) on the well-being of south africans, showing that gender does not affect expected well-being. the ‘type of housing’, which was shown to influence the positive attitude on the part of migrants in the research by silveira and ebrahim (1998), was found not to be statistically significant in explaining the expected well-being of refugees and asylum-seekers, indicating that residing in houses, apartments, hostels or informal dwellings does not influence their expected well-being. it is likely that the type of housing is not statistically significant, as housing for refugees and asylum-seekers in south africa is often of only of a temporary nature and the possibility of moving to a better type of housing in the future plays a greater role in determining expected well-being than their current type of housing. the research on forced migrants in south africa shows that refugees and asylum-seekers have limited rights and protection in south africa. when they arrive in the country, and in cities such as johannesburg, they often stay in derelict buildings, where they seek shelter in overcrowded conditions, often sharing their accommodation with other families (peberdy & majodina, 2000; jacobson, 2006). the literature on refugees and asylum-seekers showed that religious affiliation contributes to their livelihood strategies (jacobson, 2006). it has also been shown that religion predicts people’s subjective well-being. however, in this study the variable ‘religion’ indicates only whether an individual follows a religion or not, but it does not reflect the type of religion with which a respondent is affiliated. ‘religion’ in this study was found to be statistically not significant, although it was positively related to the expected well-being variable. this finding of statistically not significant might reflect the different nuances of subjective well-being and expected well-being. subjective well-being reflects life satisfaction, whereas expected well-being is related to the level of well-being a person aspires to achieving (czaika & vothknecht, 2012). it is possible that forced migrants do not view the fact that they are religious as predictive of the level of well-being they anticipate in the future. if future studies control for the type of religion, this result might be different, especially if the type of religion either corresponds to (possibly a positive effect) or differs from (possible a negative effect) that of the local population. when the variable was excluded, the explanatory power of the model decreased, showing that religion does have an impact on the specification of the model; for this reason the researcher decided to retain the variable. ‘employment’ was found to be statistically significant. the estimated coefficient of the employment variable is relatively large and, if the other coefficients of the explanatory variables are kept constant, then being employed as opposed to not being employed, leads to an 244 sajems ns 19 (2016) no 2:232-248 improvement of the well-being variable of 1.67 units. this emphasises the importance of being employed in predicting the expected well-being of forced migrants. being employed is a means of economic survival for refugees and asylum-seekers, who have very little additional resources on which to rely, or government assistance to carry them through difficult times (peberdy, crush & msibi, 2004). a large proportion (61 per cent) of the refugees and asylum-seekers in the sample found employment in either the formal or informal sector or as casual workers, even though research by porter, hampshire, mashiri, dube & maponya (2010) showed that migrants are exposed to economic and political exclusion. this reflects their urgency and need to find employment. the finding of urgency for migrants to find jobs was confirmed in the studies by cornwell and inder (2004), which showed that, despite the theory suggesting that migrants should have higher unemployment rates than non-migrants, the opposite is true, owing to the migrants’ motivation and drive to find jobs. the interaction variable ‘employment x education’ was statistically significant and negatively related to the expected well-being variable. if a person was unemployed, the interaction variable had a value of zero and if they were employed the interaction variable had a value equal to the respondent’s years of education. it was found that the employment of people with more years of education was negatively related to the expected well-being variable. this finding is counterintuitive, although it agrees with findings by witte and kalleberg (1995), which show that people are often employed outside their field of training. in this study, the negative relationship could possibly be explained by refugees and asylum-seekers often being severely under-employed; for example, a medical doctor is employed as a security guard. a similar finding of underemployment was found in a study by blaauw, pretorius, schoeman and schenk (2012) relating to zimbabwean day-labourers in south africa. they showed that zimbabwean migrants, although they had relatively high levels of schooling and spoke and understood english well, often entered the job market at lower skills levels in positions such as day labourers. the same results were shown in the study by cornwell and inder (2004) regarding the under-employment of migrants in south africa. this situation might contribute to frustration on the part of refugees and asylumseekers, which could contribute to lower levels of expected well-being. as expected, the variable ‘number of people in the house’ was statistically significant in terms of a negative relationship with expected well-being. since ‘the number of people in the house’ might be an indication of forced migrants’ living conditions, as well as possibly reflecting the dependency ratio, it is likely that a higher number of people staying in a specific house would negatively influence expected well-being. previous studies found that integration, referring to both maintaining one’s own ethnic culture and adopting characteristics of the host country’s culture, had the best psychological outcomes for refugees (werkuyten & nekuee, 1999). in this research, the survey question, whether the respondents thought it was better for a society of migrants to maintain their customs and cultures than to adopt the customs and cultures of the host country, was statistically significant and positively related to the expected well-being variable. this finding concurs partly with that by werkuyten and nekuee (1999), who found that it contributed to the well-being of forced migrants if they maintained their own customs and cultures, although the survey question did not require the respondents’ opinion on adopting the host country’s customs and cultures. the research by werkuyten and nekuee (1999) on iranian refugees in the netherlands established a positive relationship between the time spent in a host country and well-being. the researchers found the variable to be statistically significant, although negatively related to the expected well-being variable. this implied that the longer the time period refugees and asylumseekers spent in south africa, the lower their level of expected well-being would be. a possible explanation is that, when refugees and asylum-seekers arrive in south africa, they initially have relatively high expectations, but they are disappointed when their expectations are not realised. although almost a third of the forced migrants reported finding employment in south africa (see table 1), the type of employment is often low-income employment and not what they expected. furthermore, they receive limited government support and are often exposed to hostile behaviour sajems ns 19 (2016) no 2:232-248 245 from south africans. the variable ‘government assistance’, which is the support received from government, contributed positively to expected well-being. any support for refugees and asylum-seekers in fulfilling their basic needs contributed positively to their expected well-being, while lack of government support, especially on their arrival, contributed to their suffering (jacobson, 2006). the variable ‘reason for leaving country’ was found to be statistically significant and negatively related to expected well-being. in a study by krippner and mcintyre (2003), they found that refugees and asylum-seekers leaving their home countries as a result of persecution or civil war could have severe negative effects on their psychological well-being and could lead to depression, anxiety and post-traumatic stress. the psychological effects of forced migration can also have future implications for psychological well-being and influence expected well-being negatively. lastly, the variable ‘refugee status’, indicating having been accepted as a refugee, was statistically significant and positively related to expected well-being. this positive relationship can be explained by the fact that forced migrants with refugee status have more certainty about their future in the host country. ‘refugee status’ also gives the group some protection and certain additional rights. to conclude, very few of the variables found in the literature to explain the expected well-being of voluntary migrants also explained the expected well-being of refugees and asylum-seekers. the variables that coincided were ‘age’ and ‘relative income’. however, a number of factors found in the literature to explain the subjective well-being or well-being of forced migrants also explained their expectations (expected well-being) regarding their future well-being in south africa. included in these are: factors related to government assistance, culture, the time spent in south africa, economic factors, crime, refugee status, and the reasons for leaving their home countries and the number of people in the house. the results of this study show that there are differences between the factors that influence the expected well-being of voluntary migrants, as revealed in the reviewed literature (see section 2), and the factors that influence the expected well-being of forced migrants. thus, when analysing the migration decisions of forced migrants based on their expected well-being, different factors should be considered from those used in the analyses of voluntary migrants. 6 conclusion the number of refugees and asylum-seekers migrating to johannesburg, the economic centre of africa, is increasing substantially from year to year. knowledge of the migration decision and choice of destination country by forced migrants is therefore essential. information on these topics can be gained by investigating an important determinant of these decisions, expected well-being. at an empirical level it is valuable to investigate the determinants of expected the well-being of refugees and asylum-seekers, as this informs policy and guides future developments. this paper examined the factors explaining the expected well-being of refugees and asylumseekers. as no previous research has been carried out on this topic, the explanatory variables included in the model were based on results found in research on the expected well-being of voluntary migrants and on the factors found to influence the subjective well-being and well-being of refugees and asylum-seekers. for the purposes of the study a data set on the migration in the new african cities (fmsp, 2006) was used. the researcher derived the dependent variable expected well-being by equally weighting and summing two variables representing expected well-being and expected regional well-being, representing an all-encompassing variable. it was found that very few of the variables explaining the expected well-being of voluntary migrants, as shown in the literature, also explained the expected well-being of forced migrants, as revealed in this study. the explanatory variables that voluntary migrants and forced migrants had in common were: ‘age’ and ‘relative income’. however, many of the variables that explained the subjective well-being and well-being of forced migrants, as shown in the literature, were also 246 sajems ns 19 (2016) no 2:232-248 found in this study to explain the expected well-being of this group. the variables found to explain the expected well-being of forced migrants include: ‘government assistance’, ‘refugee status’, ‘time in south africa’, ‘the interaction variable ‘employment x education’, ‘reason/s for leaving their country’, ‘culture’ (the opinion that it is better for society for migrants to retain their own culture), and the ‘number of people in the house’. the findings of this study emphasise the uniqueness of forced migrants as a group of people. when analysing the migration decisions of forced migrants based on their expected well-being, the factors found to explain the concept in this study should be considered. knowledge of these factors also contributes to understanding of the choice of destination country of forced migrants. the choice of the destination country is of importance to all policy makers. south africa has been the main destination country for refugees and asylum-seekers in africa for the last two decades. policy-makers ought to recognise this and adapt policy measures accordingly. the rights of refugees and asylum-seekers should be protected, and better housing should be made available to forced migrants. policy-makers should take cognisance of the important contribution forced migrants could make to the skills base in south africa. furthermore, based on the increasing number of xenophobic attacks in south africa, government should have stricter control over the inflow of forced migrants as well as their movements on entering and settling in the country; both to control illegal inflows and protect forced migrants from bodily harm future research based on longitudinal data is needed to enhance knowledge on the migration decisions of forced migrants. endnote: 1 subjective well-being refers to the subjective measurement of well-being, using a question such as ‘are you satisfied with your life?’ 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journal of psychiatric intensive care, 6(1):23-30. werkuyten, m. & nekuee, s. 1999. subjective well-being, discrimination and cultural conflict: iranians living in the netherlands. social indicators research, 47(3):281-306. witte, j.c. & kalleberg, a.l. 1995. matching training and jobs: the fit between vocational education and employment in the german labour market. european sociological review, 11(3):293-317. 320 sajems ns vol 3 (2000) no 2 the organisational culture types of south african firms f w strawig and e e smith department of business management, vista university, port elizabeth abstract this article sets out to examine the organisational culture types of south african finns. a literature study revealed four common organisational culture types, namely a power, role, task and person culture. an empirical study of 3000 south african fums by means of a self-administered questionnaire, investigated which of the four organisational culture types the firms exhibit. it appears that most of the respondent fums have a task culture. this culture is one that can adapt quickly, and where influence is based on expertise rather than personal authority. this in tum indicates that most south african finns do have an organisational culture that is compatible with a changing and competitive environment. jel ml4 1 introduction fischer (1992: 2) maintains that an understanding of the organisational culture of a fum is important to ensure its success in a rapidly changing environment lankford and mintu-wimsatt (1999) conclude that the organisational culture has a significant impact on a firm's long-term economic performance and productivity, that determine the success or failure of finns. although schneider (1990: 21) has stated that the organisational culture concept is relatively young on which few reviews and critiques have been written, weeks (1988: 69) maintains that managers are increasingly realising the importance of organisational culture. yet, managers often tend to have only a vague knowledge of the concept itself. martins (1993: 1) agrees that despite the increasing awareness and importance of organisational culture, there is confusion on what exactly it means. silvester and anderson (1999) also indicate that it is often difficult to define organisational culture precisely, as it includes various concepts. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 321 this article sets out to examine the organisational culture types of south african firms. the first aspect to be highlighted is to defme the concept organisational culture and to discuss its importance. then a brief exposition of the research methodology follows. last, the most important results of our particular survey and their managerial implications are discussed. 2 a theoretical overview of organisational culture 2.1 derming organisational culture defining the concept "organisational culture" is a difficult task, one that many writers avoid, assuming that the reader understands the concept (weeks, 1988: 42). williams, dobson and walters (1990: 9) indicate that most people agree that organisational culture exists, but few agree on what it is. various definitions have been given of the concept organisational culture in the context of anthropology, organisational psychology and management theory. by 1952, one hundred and sixty-four definitions of organisational culture had already been identified (fischer, 1992: 2). from the literature (see for example fey & claes 1999: 9; johnson 1992: 31; montanari, morgan & bracker, 1990: 230 and schein, 1990: 111) emerges that organisational culture includes the dominant beliefs, values and norms of the members of the group that forms the organisation. from a business perspective, organisational culture will therefore include the dominant values, beliefs and norms of the members (both employees and employers) of a fli1ll. 2.2 importance of organisational culture montanari el al. (1990: 233) assert that a strategy is most likely to succeed when there is cultural alignment. south african researchers (see e.g. de klerk:, 1989 and weeks, 1988) contend that organisational culture should be part of the strategic management process. organisational culture is therefore important to any fum that wants to implement strategic management successfully. montanari et al. (1990: 232) further point out that strong organisational cultures have been cited as a reason for continued excellence, superior financial performance and the ability tc adapt and innovate. schein (1986: 84) gives various reasons why organisational culture plays an important role in a fli1ll. the failure of mergers, acquisitions and diversifications may be ascribed to a "cultural mismatch" (maron· & van bremen, 1999). failure to integrate new technologies in a fli1ll can be seen as a culture change problem. if groups in a fum get into conflict with each other, reducing the conflict is often difficult, because a group needs to maintain its identity and one of the best ways r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 322 sajems ns vol 3 (2000) no 2 of doing so is to compare and contrast it with other groups. the conflict helps to build and maintain intragroup culture. ineffective meetings and communication breakdowns can be productively analysed from a cultural perspective. the organisational culture'also plays an important role in the socialisation process of "fitting people into a structure". productivity is a cultural phenomenon at a given work group level and at the level of the total organisation too. organisational culture also leads to consensus on the core mission, primary tasks and latent functions of the firm. the organisational culture of a particular firm will have a critical influence when determining the mission of a firm, its raison d'etre. consensus on remedial and repair strategies also influences the culture of a firm. responses to crises provide opportunities for culture building and reveal aspects of the culture that have already been built. organisational culture indicates group boundaries and criteria for inclusion. consensus on criteria for membership is always a means of determining whether a culture unit exists in any group. specific rewards and punishments, and the way in which these are administered, constitute one of the most important cultural characteristics of a firm. robbins (1992: 256) points out that organisational culture performs a number of functions within a fmn. .firsdy, it has a boundary defming role by creating distinctions between fmns. secondly, it conveys a means of identity to the members of the fmn. thirdly, organisational culture facilitates the generation of commitment to something larger than one's individual self-interest. fourthly, it leads to stability of a social system and organisational culture is the glue that holds a fmn together. finally, organisational culture serves as a sense-making and control mechanism whi.:h guides and shapes the attitudes and behaviour of group members. 2.3 characteristics of organisational culture thompson and strickland (1992: 253) maintain that every fmn has a unique organisational culture. an or;;anisation's culture can be weak and fragmented in the sense that most members do not have a deeply felt sense of the firm. on the other hand, a firm's organisational culture can be strong and cohesive when most people in the firm understand and relate to its objectives and strategy. although handy (1985: 196) agrees that organisational culture cannot be defined precisely, for it is something perceived and felt, it should however be clear that organisational culture reveals certain properties that make it possible to identify or characterise the organisational culture of a firm. handy's view (1985: 196) is shared by trice and beyer (1993: 5) who have described organisational culture as something symbolic, emotional, pervasive and vague. organisational culture is not something clearly perceptible but difficult to characterise or identify. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 323 hampden-turner (1990: 12), in turn, characterises organisational culture in terms of the advantages or value that it has for the individual or group member. characteristics such as rewards for excellence, a set of affirmations, provisions of continuity and identity and a state of balance between reciprocal values, emphasise the meaning of organisational culture to an individual or group member. the characteristics proffered by rue and holland (1986: 440), such as individual autonomy, identification and perfonnance reward, closely correlate with the hampden-turner characteristics (1990: 12) as an indication of the value thereof to a group member. fischer (1992: 6) however emphasises the general characteristics of organisational culture, in tenns of the role that it plays in a firm to satisfy the specific needs of a firm. 2.4 types of organisational culture although f ombrum (1983: 139) asserts that the culture of each finn is unique in scope and content, some researchers (see e.g. deshpande & parasuraman, 1986; kono, 1990; rue & holland, 1986 and silvester & anderson, 1999) divide organisational cultures into various types. figure i shows the organisational culture types identified by various authors. in analysing the organisational culture types in figure 1, it is possible to identify four major classifications of these types. figure 2 shows the classification of organisational culture types. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 324 sajems ns vol 3 (2000) no 2 figure 1 types of organisational culture according to handy • power • role • task • person according to kono • vitalised • follow the leader • bureaucratic • stagnant and follow the leader i according to trice and beyer • type a • typej • typez • apathetic • caring • charismatic • exacting • integrative • paranoid • avoidant • bureaucratic • sensation-thinking • intuition-thinking • intuition-feeling • sensatlon-feelm according to deal and kennedy • tough guy/macho • work hardiplay • bet your company • process culture according to ham den-turner • need to adapt • need to integrate • need for change • need for key continuities figure 2 classification of organisational culture types 4 power e task person trice & beyer type a type a typej typez sensationsensationintuitionintuitionthinking thinking thinking feeling apathetic apathetic exacting caring paranoid bureaucratic avoidant charismatic r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 325 f" 19ure 2 oed continu author type! type 2 type 3 type 4 handy power role task person . kono ! stagnant and bureaucratic follow the vitalised ! • follow the leader and stagnant leader vitalised i deal & tough guy/ bet your workhardl process . kennedy macho company play hard hampdenneed for key need for . need for i ~eed to turner continuities periodic i change mtegrate change ! considering this classification scheme, the four organisational types discussed by handy (which correspond to the classifications of the other authors) are used for the purpose of this study. this typology of organisational culture assists in understanding the ideological conflicts that arise within firms. deep-seated beliefs exist about the way that work should be done. this fourfold classification is next discussed. • power culture this culture depends on a central power source, with rays of power and influence spreading out from a central figure. there are few rules and procedures in this type of culture control is exercised largely by the central figures. the power culture, sometimes also called the club culture (thompson, 1990: 74), is a proud and strong culture. another characteristic of power cultures is that much faith is put in the individual and little in committees or teamwork. • role culture the role culture is often stereotyped as bureaucracy. organisational culture is built around defmed jobs, rules and procedures. this culture operates according to logic and rationality and its strength lies in its functions or specialists. top management is characterised by a small span of management. the firm tends to operate within a stable external environment where creative or innovative behaviour is discouraged as a rule. this culture type is slow to perceive the need for change and slow to change even if the need is seen. role cultures offer security and predictability to the individual. employees who are orderly, punctual and detail orientated are well suited to a role-cultural environment. ! r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 326 sajems ns vol 3 (2000) no 2 • task eulture the task culture is job or project~orientated and extremely adaptable. for a particular problem situation people and other resources can be drawn from various parts of the ftrdl on a temporary basis. the matrix organisation is one structural form of the task culture. influence within the firm is based on expertise rather than personal authority. • person eulture the individual is the central point in the person culture. the ftrdl exists to help the individual rather than the other way round. groups of professional people, such as doctors, dentists and architects are examples of a person culture. this fourfold classification of organisational culture types is used in the empirical survey to investigate the organisational culture types of south african firms. this is in line with the dimensions determined by the cross cultural research of hostede (1980). 3 research memodology for this study, the target population was chosen from south african firms. private and public companies and close corporations employing more than 100 employees were included in the population. the sample was drawn randomly by matrix marketing. clear instructions were given on how the sample should be drawn. for this study it was decided to include ftrdls from the following categories/activities in the sample frame: manufacturing, electricity, construction, trade, transport and other activities not listed. due to factors such as cost, time and low response rates, a sample of 3000 firms was chosen and it was decided not to do a follow~up study. a proportional stratified random sample was drawn. table i shows the forms of enterprise included in the sample and those of the respondents. table 1 forms of enterprise of sample and respondents forms of number of % of total %retum enterprise firms in sample sample firms respondents public companies 490 16 4 private 2212 74 27 companies close 298 10 63 corporations total 3000 100 94 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 327 from table i it can be seen that the majority of the respondent firms were close corporations, although close corporations were not the majority in the sampling frame. section a of the questionnaire, which investigates the organisational culture types of south african firms, consisted of 15 closed-ended questions with forced ranking options. respondents were asked to rank four options, reflecting the four culture types, in order of importance/preference. a nominal scale was used for section b of the questionnaire (biographical data of the respondents). once a questionnaire was received from a respondent, it was inspected to determine its acceptability. a total of 188 usable questionnaires was received and included in the analysis of the data (effective response rate of6.27%). 4 survey results 4.1 descriptive statistics to analyse the results of the responses investigating the culture types of south african firms, the following procedure was used. there were 15 aspects that each contained four statements, reflecting the four cultural types: power culture (first statement); role culture (second statement); task culture (third statement) and person culture (fourth statement). the sum value of each statement reflects the overall ranking of the statement. individual statements were then ranked. statements with the lowest sum value are regarded as the most important (ranked first). table 2 indicates the total sum value and therefore the manifestation of organisational culture types of south african organisations. table 2 a summary of results on manifestation of different organisational culture types overau ranking culture type • total sum value number of statement 1 task 4931 3 2 role i 6597 2 3 pow c 7755 i 4 person 8217 4 the survey results in table 2 show that the task culture appears to be the most dominant culture type and was therefore ranked overall first (lowest sum value). the role culture was ranked overall by respondents as the second most dominant culture type in south african firms. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 328 samms ns vol 3 (2000) no 2 the frequency distribution of the results in section b of the questionnaire (classification data) indicates that the (admittedly slender) majority of the respondents (51%) were employed in finns whose main activity is manufacturing. the majority of the respondents (63%) were employed in firms that are private companies and had, on average, a workforce that varied between 100 and 199 employees. seventy-nine per cent of participative firms had an annual gross revenue of more than rio million. just more than half (51 %) of participative firms described their environment as characterised by moderate changes/innovation. sixty-three per cent of the respondents who completed the questionnaires can be classified as part of top management. table 3 highlights the descriptive statistics in section a of the questionnaire (organisational culture). table 3 a summary of tbe descriptive statistics for the different organisational culture types statistic power role culture task culture culture mean 2,750 2,339 1749 mode 3,200 2333 1533 median 2,867 2,333 1667 standard deviation 0,613 0361 0,432 0432 standard error 0,045 0026 0032 0,032 analysing the mean scores for the four culture types, it appears to correlate with the overall ranking order (preference) of the culture types. the standard deviation scores are low which shows that there are low variances in dispersion of scores. 4.2 the relationship between the different variables the manov a procedure, which uses wilks's lambda multivariate test of significance, was used to investigate whether differences occur among the variables. the univariate analysis of variance using the univariate f-test, was used to detennine where the differences occur. in these tests the independent variables were the biographical data of the respondents, and the dependent variables were . the questions relating to organisational culture types. the 60 variables in section a of the questionnaire are ordinal data variables, using a forced-ranking scale. the variables in section b of the questionnaire are on a nominal scale. the results of the manov a procedures to investigate the differences between r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 329 variables are given in table 4. table 4 the results of tbe mandv a procedure to investigate the relationships between tbe variables independent i dependent variable variable i ! main activity of all culture types the firm forms of i all culture types enterprise workforce size i all culture types annual gross ! all culture types revenue [ i i typeoftbe i all culture types environment oftbe firm * significance level ofo,05 ** significance level ofo,oi i wilks's lambda. univariate f-test f -test of i of significance ' significance pi p-value value 0,721 i 0,110 0,141 0,007 power: 0,010* role : 0,192 task : 0,001 ** person = 0,911 0,013 power = 0,040* role = 0,116 task = 0,079 person = 0,201 from table 4, it can be concluded that manufacturing firms do not differ significantly from firms with other main activities, regarding the type of organisational culture. the p-value of 0,721 of the wilks's lambda f-test of significance indicates that there is no relationship between the main activity of a firm and its organisational culture. there is no significant relationship (wilks's lambda p = 0, it 0) between the forms of enterprise and the organisational culture type. finns with different fonns of enterprise are not significantly different with regard to the type of organisational culture exhibited. the survey results also indicated that there is no significant relationship (wilks's lambda p > 0,05) between the workforce size of a firm and its organisational culture type. there is a highly significant relationship between the annual turnover and the organisational culture type of a ftrnl. the univariate f-test of significance, indicates a significant difference for power culture (p value < 0,05) and also a highly significant difference for task culture (p value < 0,01). according to wilks's lambda f-test of significance, there is also a significant relationship (p value < 0,05) between the type of environment in which a firm operates and the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 330 sajems ns vol 3 (2000) no 2 organisational culture type. in analysing the results of the univariate f-test of significance, it appears that on1y the power culture shows a significant relationship (p value < 0,05) with the environment in which the finn operates. 5 conclusion having a clear understanding of the organisational culture concept is important for managers today, as management needs to understand the. basic process involved in the fonnation :md preservation of organisational culture. although every finn has its own unique culture, certain common characteristics of organisational culture were identified in our research. when a broad approach to the concept of organisational culture is taken, the real importance of organisational culture is often underestimated. the organisational culture in a firm plays an important role in its daily administration and perfonnance. to assess the culture of a firm is no easy task. our empirical results sho\\ that a task culture was the most dominant type of organisational culture implemented by the respondents, that is, a task culture was ranked first overall. of all the surveyed finns, it appears that a person culture is the least dominant type of culture, and it was ranked last. managers should understand the nature and characteristics of their respective organisational cultures. the most important characteristics of a task culture are the following: • job or task orientated • extremely adaptable/flexible • team culture • whole emphasis is on getting the job done • works quickly (each group has decision-making power) • appraisal by result • operates in competitive markets • integration, sensitivity and creativity more important than depth of specialisation • individual freedom • the end product is all-important from the above, it can be seen that a task organisational culture is flexible and can adapt to changes. it therefore seems that the south african finns, in general, do have organisational cultures that are conducive to change management, and that they can probably compete internationally. statistical analysis was used to describe the relationships between the type of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 331 organisational culture and other characteristics of the finn. the results indicate that the main activity of a firm seems to play no role in determining its type of organisational culture. management should note that the form of enterprise (whether private or pablic company or close corporation) bears no direct relationship to the organisational culture of that fum. as there is no clear relationship between the workforce size of a finn and organisational culture type, the number of people employed by a finn will therefore not determine its culture type. it is however important to note that there is a highly significant relationship between the annual gross revenue of a firm and its organisational culture type. the organisational cultures of those fums that have power and task cultures in particular, tend to show a significant relationship with the annual gross revenue. if the firm exhibits a power or task culture, it may be inferred that the annual gross revenue of the fum will playa role in the determination of those cultures (power and task). after analysis and identification of a firm that has a power culture, management should realise that the environment plays an important role in the determination of a power culture. the present study has certain shortcomings that need to be kept in mind. thus, the low response rate is a limitation. although various measures were taken to seek a higber response rate, the result was still unsatisfactory. the number of usable questionnaires was however satisfactory for statistical analysis and to draw useful conclusions. this study was restricted to the manufacturing sector oftbe economy, and a similar study including the primary and service sectors is proposed. other areas for future research include the influence of trade unions in shaping the culture of organisations, culture diversity in the workplace and its effect on organisational culture, and the influence of a firm's organisational culture on the implementation of affumative action. references de klerk, a. (l989) in ondersoek na aspekte van korporatiewe kultuur by eskom, unpublished m.comm thesis, university of south africa, pretoria. 2 deshpande, r. and parasuraman, a. (1986) "linking corporate culture to strategic planning", business horizons, 29, may-june: 28-37. 3 fey, c.f. and claes, n. (1999) "organisational cultures in russia: the secret of success", business horizons, 42(6): 47-56. 4 fischer, e. (l992) "organisasiekultuur as fokuspunt in die bepaling van bestuursprioriteite en hantering van eietydse vraagstukke", paper r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 332 sajems ns vol 3 (2000) no 2 delivered at 4th annual conference of the south african institute for business scientists, bloemfontein: 22 june 1992. 5 fombrum, c.j. (1983) "corporate culture, environment, and strategy", human resource management, 22(1): 138-52. 6 handy, c.b. (1985) understanding organizations, penguin books ltd., england. 7 hampden-turner, c. (1990) corporate culture, hutchinson, london. 8 hofstede, g. (1980) culture's consequences, sage, newbury park, ca. 9 johnson, g. (1992) "managing strategic change strategy, culture and action", long range planning, 25(1): 28-37. 10 kono, t. (1990) "corporate culture and long-range planning", long rangeplanning, 23(4): 9-19. 11 lankford, wand mintu-wimsatt, a. (1999) "derme america's organisational culture." women in management review, 14(6): 5-7. 12 maron, r.m. and van bremen, l. (1999) "the influence of organisational culture on strategic alliances," association management, 51(4): 86-92. 13 martins, n. (1993) "die waarde van organisasiediagnose vir die suidafrikaanse onderneming", paper delivered at ebm research conference. bloemfontein: 29-30 november 1993. 14 montanari, j.r., morgan, c.p. and bracker, j.s. (1990) strategic management a choice approach, the dryden press, chicago. 15 robbins, s.p. (1992) essentials o/organisational behaviour, prenticehall, inc., new jersey. 16 rue, l.w. and holland, p.g. (1986) strategic management, mcgraw-hill, inc., new york. 17 schein, e.h. (1986) "are you corporate cultured?", personnel journal, november: 83-96. 18 schein, e.h. (1990) organisational culture, (2nd ed.) jossey-bass publishers, san francisco. 19 schneider, b. (1990) organisational culture and climate, josseybass publishers, san francisco. 20 silvester, j. and anderson, n.r. (1999) "organisational culture change: an intergroup attributional analysis", journalo/occupational & organisational psychology, 72(1): 1-24. 21 thompson, j.l. (1990) strategic management, chapman & hall, london. 22 thompson, a.a. and strickland, a.j. (1992) strategy formulation and implementation: tasks 0/ the general manager, richard d. irwin, inc., boston. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 333 23 trice, h.m. & beyer, j.m. (1993) cultures of work organizations, prentice-hall, inc., new jersey. 24 weeks, r. v. (1988) the interactive role of organizational strategy and culture: a strategic management approach, unpublished m.com thesis, rau, johannesburg. 25 williams, a., dobson, p. and walters, m. (1990) changing culture: new organizational approaches, london: institute of personnel management, london. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . journal 6.indd 76 sajems ns 13 (2010) no 1 making sense of the disclosure of latent defects in financial statements and company acquisition contracts cornelius kilian former interim researcher at the european academy (eurac) centre for financial planning law, university of the free state accepted july 2009 abstract this paper analyses the statement made by the south african appeal court judge holmes in the phame v paizes (1973) case and, using economic and unique south african legal principles, it examines the true legal nature of a contract to regulate company acquisitions.1 two solutions are offered for financial managers in south africa: (1) the contract to regulate company acquisitions is a forward contract and (2) the difficulty in identifying latent defects should not be grounds for reducing the price paid for a company or enterprise in the south african legal system. jel g34, k20 1 focus of the study the main focus area of this paper is the term ‘latent defect’, generally known as a ‘defect’. in the south african legal system, a defect is defined as an ‘imperfection’ or a ‘shortcoming’. in order to rectify the imperfection or shortcoming, the aggrieved person employs actions or remedies (hiemstra & gonin, 2000). depending on the severity of the defect, the aggrieved person uses either the actio redhibitoria (action or remedy to cancel a sale transaction) or actio quanti minoris (action for the reduction of the purchase price paid for something) (van zyl, 1977). the initial development of these ideas came from phame v paizes (1973), and propounds the criterion that there should be no legal difference between tangible or intangible things. the focus of this paper is on quanti minoris defects relevant to company acquisitions (intangible things), and it is argued that the quanti minoris defects should be avoided from an economic perspective. 2 research methodology within the framework established by the phame v paizes (1973) (that is, assuming there is no legal difference between defects relevant to tangible and intangible things), reference will be made to financial statements (balance statement and income statement) to illustrate the problem of how to record value within an accounting perspective relevant to company acquisitions. finally, there will be a brief mention of new disclosure initiatives to rectify the shortcomings of financial statements. the disclosure of the shortcomings is currently known as nonfinancial indicators. 3 introduction the contractual or legal nature of company acquisitions has until recently not attracted much legal or economic interest in south africa, nor has it been the subject of any deep controversy, because company acquisitions are generally regulated by the securities regulation code on sajems ns 13 (2010) no 1 77 take-overs and mergers (‘the code’). the code has the force of law, which means, for example, that any company or enterprise must comply with the code in the event of an acquisition. however, the code does not acknowledge the use of economic terminology associated with future uncertainties as to company acquisitions (kilian, 2009). the reason for this is the unwillingness of the courts or judges to develop or to establish the relevance of economic terminologies in the legal system because the use of economics to solve legal problems has been characterised as ‘unsystematic’, and ‘confusing’ (bouckaert & de geest, 2001). in this paper, a new approach to company acquisitions will be viewed as an attempt to reformulate and systematise the traditional roman law principles to make them applicable to contemporary company acquisitions. many first attempts to deal with latent defects will be considered. examples of such attempts include the contractual nature of company acquisitions and how to disclose additional information in financial statements. 4 traditional legal approach to defects researchers have identified the traditional approach to defects as having originated in 367 bce in the roman law as aedilitian actions. the actions were named after the public officials who invented them, namely the aedilis curulis. the word aedilis derives from the word aedes, which means a building (develop) and curulis means legal authority (van zyl, 1977). in its simplest translation, aedilis curulis means ‘the authority to develop the law’. the aedilis curulis regulated the selling of defective objects or things in the commercial world through the constant development of the aedilitian actions (daube, 1959). in roman law, the buyer who had been prejudiced by a defect could not claim a reduction in the purchase price under all circumstances. in classical law, this action was intended to cover situations in which defective animals or slaves were acquired in a public market. in the post-classical period, or under justinian law, the usefulness of these actions developed to other defective things (mostert, joubert & viljoen, 1972). in its south african development, the court of appeal had to consider whether the value or quality of a fixed asset differed from a share. it is all too clear that a fixed asset is a tangible thing, whereas a share or a company is an intangible thing and exists largely in electronic format. appeal court judge holmes stated the following in phame v paizes (1973): to preserve the mercantile usefulness of the actions, i do not consider that the word should be given a restricted meaning. when one speaks of company shares of good quality, a relevant consideration is the percentage return after deducting expenses from income. if one speaks of buying 9 per cent shares, i consider that it can be said to relate to their quality. if the latter is observed, then actions are considered a major premise in resolving disputes about what amounts to value for tangible or intangible things. it is clear from the above statement that intangibles may be awarded value in two general ways: income less expenses or buying 9 per cent shares. to disprove this technical statement, which i argue is inaccurate, it is necessary to analyse what features, if any, constitute the good or bad qualities of intangible things in an economic reality. 5 tangible and intangible things in an economic reality not surprisingly, if a contract of sale is of true legal nature when buying or selling a house or a share, then the actions are relevant to solving any disputes regarding the true value or quality of the thing purchased. for example, a house with defects is of far less value than a similar house without any defects (daube, 1959). all that is required in terms of actions to claim a reduction on the price paid for a defective house should be that such a defect was undetectable by the purchaser or seller at the time the purchase was made (hiemstra & gonin, 2000). the same principle applies to shares. a listed share, for example, exists largely in electronic form. despite the apparent conclusion on 78 sajems ns 13 (2010) no 1 the impossibility of identifying a defect, it is intriguing that an aggrieved buyer of a share can make use of the aedilitian actions. the appeal court judge holmes indicated that the value or quality of a share in a legal reality depends on income less expenses, or when buying 9 per cent shares. the economic reality is that a share has value in terms of the financial statements expressed in an appropriate ratio (walsh, 1996).2 to illustrate the difficulty in earnings per share as a ratio, the following example is relevant. enterprise a owns a fixed asset of r200 000. this asset is located in a high-crime area which negatively affects the turnover of the enterprise. enterprise b possesses a fixed asset in a low-crime area, valued at r450 000. let us say that enterprise a swaps its fixed asset with that of enterprise b because b prefers to conduct business in a high-crime area. on the balance sheet of a, the fixed asset would be indicated as r200 000, because a is the owner of the fixed asset, even if a is not making use of the asset to produce turnover or net profits, as indicated in table 1 (anthony, 2004:47, 49). by making use of a financial ratio (earnings per share) the comparison between turnover and the fixed asset (r200 000) could convince any purchaser to enter into a contract with the seller to purchase shares in the enterprise. table 1 extract from income statement after asset swap asset swap turnover r100 000 net profit r20 000 issued shares 2000 earnings per share r10 extract from balance statement after asset swap fixed asset r200 000 table 2 extract from income statement before asset swap no asset swap turnover r50 000 net profit r10 000 issued shares 2000 earnings per share r5 extract from balance statement before asset fixed asset r200 000 the tangible thing (fixed asset) for a and b is r200 000 and r450 000, but, because a is the owner of the fixed asset valued at r200 000, it is the only value that can be disclosed in the financial statements (ernst & young, 2006). this is owing to relevant accounting principles to record fixed assets in the balance sheet (anthony, 2004). if company or enterprise a is sold as a result of its impressive net profitability or a share is sold as a result of its impressive earnings per share ratio, the new owner of the enterprise or purchaser of the share may find himself in a serious situation, as indicated in table 2. indeed the new owner of the enterprise must use similar business acumen (i.e. asset swap), to maintain similar net profitability in the future and the same rationale applies to earnings per share (vintcent, 1999). is it possible to claim a reduction in the purchase price paid for the enterprise or share based on sajems ns 13 (2010) no 1 79 the aedilitian actions, owing to the fact that, in many ways, undisclosed business acumen had an impact on the future profitability of the enterprise (black, wright & davies, 2001). it is obvious that enterprise a is not able to produce the same earnings per share or profitability after the acquisition. holmes’s statement is thus relevant to reducing the price paid for the enterprise or share. the question arises whether business acumen counts among actions owing to the difficulty or even impossibility of viewing undisclosed asset swap as a shortcoming. 6 complexity of intangible things in a legal reality a listed share, for example, exists largely in electronic form. despite the apparent conclusion on the impossibility of identifying a defect, it is again intriguing that the aggrieved buyer of a share can make use of the aedilitian actions. the reason for the latter is that in recent years advocates have begun replacing defect with praises (kerr 2002). in table 1 and 2, the earning per share is r10 and r5, and it is obvious that the value of the share depends on asset swap. regardless of whether the seller praises the shares (r10 per share) deliberately or innocently, he is nevertheless bound to make good what he has negotiated (visser et al., 1997). for example, in the phame v paizes (1973) an agent misrepresented the annual municipal rates as r4 646 instead of r14 736 per annum, the difference being r10 090. the praise in that case was to negotiate income less r4 646, instead of income less r14 736. the agent therefore had to make good what he had praised, which was to repay r10 090 to the purchaser, as originally negotiated. how does this apply to our example of an asset swap? cilliers et al. (2000) emphasise that, although the result of profitability depends on the financial statements, such statements have a downside to their effectiveness because they make use of generic terminology, e.g., ‘fixed asset’. under south african law, undisclosed generic terms for details or those that are presented vaguely may possibly be interpreted as innocent misrepresentation or praises (mostert, joubert & viljoen, 1972). consequently, several recent key projects have been undertaken to address these shortcomings in financial statements. these will be discussed later in this paper. 7 roman law in contemporary times it seems that the conclusion in phame v paizes (1973) is correct, owing to the difficulty in discerning any shortcomings in the financial statements (daube, 1959). however, roman law jurists (lawyers) indicated that there are certain things in the commercial world which do not possess true value, that is, things whose quality or value constantly fluctuates because of future uncertainties. with respect to the latter, pomponius, a lawyer in ancient times, wrote the following (in mommsen & kruger, 1954): sometimes, indeed, there is held to be a sale even without a thing, as where what is bought is, as it was (sic), a chance. this is the case with the purchase of a catch of birds or fish or of largesse showered down. the contract is valid even if nothing results, because it is a purchase of a hope. and kerr (1996), explaining the relevance of pomponius’s statement to modern times, observes …generations of [law]3 students have learnt that one can buy hope…and have wondered about the relevance of their newly acquired knowledge because no-one nowadays hears of anyone throwing largesse or buying the hope of a fisherman’s or fowler’s catch… . to understand pomponius’s explanation in a contemporary context, one should rather ask whether largesse or a fowler’s catch can be the main business of a company. the answer is in the affirmative. also, if you buy hope, can it still be a contract of sale? kilian (2005) explains that the word ‘sell’ is synonymous with the word ‘buy’ as far as the elements of a contract of sale are concerned, but ‘buy’ is also applicable to different kinds of contract. considering that generations of students have wondered about the relevance of pomponius’s 80 sajems ns 13 (2010) no 1 statement, for a financial or economic analyst this extract contains the characteristics of a forward contract. this is a contract to pay a current price for a future thing, where the future value of the thing may be higher or lower than the current price (arnold, 2005). the economic viewpoint is that company value is determined by future uncertainties rather than historic profit or earnings per share calculations. table 2 illustrates hope without any asset swap, rendering the company lower in value when compared to table 1. to avoid the application of undisclosed asset swap as a defect, the following paragraph is also relevant. 8 other important factors in determining the future value of a company steiner (1998) and vintcent (1999) have pointed out that the degree of future uncertainty as to whether a company is able to produce future profits is an element not to be ignored by the purchaser. a company that is able to produce future value is far more expensive than a company that is incapable of producing such value. different methods (formulae) may be applied to calculate the future value of a company or enterprise (black, wright & davies, 2001), one of which (i.e. shareholder value added) allows for an opportunity whereby the parties may agree on certain economic elements necessary to forecast the future value of the company over its economic life or case law may limit the economic elements necessary to calculate future value. in salisbury portland cement co ltd v edwards timber & lime industries (private) ltd (1962), the court held that, if an arbitrator sets a current price for a company, this must be calculated on the principles of fairness and reasonableness. this decision, with respect, is vague because economic formulae deal with future uncertainties and do not constitute an exact science, making reasonableness or fairness as confusing as alice in wonderland (vigario, 2007; kilian & du plessis, 2005). an apposite example is to be found in steyn v davies (1927), where the parties used the following simple formula to determine the value of the dairy enterprise, as indicated in table 3. table 3 24 cows and a bull £850 6 calves £30 utensils etc. £60 goodwill £160 total (current price) £1100 during the negotiations the seller did not disclose the fact that four cows were in the process of calving. this meant that for some time to come the purchaser would not be able to sell the quantity of milk that had been negotiated. on this basis, the buyer used the aedilitian actions to claim a price reduction in the purchase price on the grounds that four calving cows were currently unable to give milk. the court held that the plaintiff or purchaser did not consider the future profitability of the company and therefore the aedilitian actions were relevant to this legal difficulty. with all due respect, the future or added profitability was, in fact, negotiated and paid for – goodwill £160. the rationale behind any economic formula (even one as simple as that in steyn v davies (1927)) is whether the enterprise/company has the ability to create future goodwill within a fixed future period, for which the purchaser is willing to pay, and should not be seen as a defect when the company is unable to equal the future goodwill. the reason for the latter is simply that in the future there would be four additional cows to give milk, and the calving, or reduced milk production, was temporary in the economic life-cycle of the dairy. 8.1 future value relates to economic life in order to explain more clearly the relationship between future value and the economic life of a company in a financial context, walsh (1996) uses the following example. a computer has a practical life of 25 years, but only five years of economic life. today, a computer probably has an economic life of 24 months, 12 months or three months. if the value depended on 24 months, obviously the computer would have more value than if it had three months. similarly, sajems ns 13 (2010) no 1 81 in steyn v davies (1927), the aggrieved party did not consider the economic life of the dairy, which is possibly doing business today, fulfilling the bargain of goodwill acquired in 1927. the underlying principle in the previous paragraph is not difficult to reconcile with the phame v paizes (1973) either. with respect, this court did not consider the concept of the economic life of the company acquired in the transaction, and the firm might still be doing business 30 years later. the main business being conducted in phame v paizes (1973) was the rental of fixed assets. rent to be paid is not dependent on the value of the fixed assets: it can be either lower or higher than the market value of the fixed assets, depending on the relevant economic circumstances. in view of the uncertainty attached to company value and to avoid confusion over terminology, a forward contract should be used to describe company acquisition contracts (kilian, 2005; hurter, 1988). it is a less drastic judicial solution to conceptualise the value of future hope. however, this approach cannot be followed for fixed assets or tangible things. the value of fixed assets or tangible things is not as volatile as that of shares or company profits. a fixed asset seldom decreases in future value. however, a defective asset is always less expensive and the aggrieved purchaser should be allowed aedilitian relief. 8.2 a suitable method to disclose, inter alia, an asset swap or future profits transparent financial reporting or voluntary financial disclosure is a widely debated topic in accounting and academic circles (havenga, 1997; du plessis, mcconvill, & bagaric, 2005; ernst & young, 2006). these leaders recognise that the current financial reporting methods focus primarily on historical financial transactions (balance, income and cash flow statements), and that these methods provide limited guidance on the future value of a company (bloomfield, 2000). as a result, several recent key projects have been undertaken to address these shortcomings. 8.2.1 recent key projects the global reporting initiative (gri) (2009) represents an international effort to create a common framework for voluntary reporting on non-financial issues. this framework includes, but is not limited to, the economic, environmental and social impact of organisational activities. the gri, in partnership with the united nations environment program (unep) and the coalition for environmentally responsible economies (ceres), is attempting to evaluate the sustainability of company reporting. the gri also incorporates the active participation of hundreds of diverse stakeholders (inter alia, company people, human rights activists, accountants, labour lawyers, governmental organisations) worldwide in designing a common framework for sustainable company reporting. this framework is also referred to as the ‘sustainability reporting guidelines’, and is used by more than 50 international companies in shaping their disclosure practices. the inspired task force (itf) (2009) comprises the security exchange commission and examines current company disclosures in order to assess economic value. itf also investigates governmental and company organisations and makes suggestions for improving on company disclosures. since value is driven by a company’s expected future profits and cash flow, investors are looking for information that will help them to project both (such as operating performance measures, company model descriptions and forward-looking data). itf believes that this ‘business model’ should become mandatory over time, as more and more companies seek credibility and uniformity in the business world. extensible company reporting language (xbrl) (2009) is a computer software program that automates the mechanical aspects of reporting and analysis as an information supply chain in order to exchange relevant financial information (such as financial statements, general ledger information, and audit schedules). xbrl is licensed free and facilitates the automatic exchange of financial information which is compatible with various other software applications in the world. the world business council for sustainable development (wbcsd) (2009) consists of 200 international companies and is complementary to the gri. while the gri defines key non82 sajems ns 13 (2010) no 1 financial performance indicators, the wbcsd designs a process for disclosing these key indicators. the aim of the wbcsd is to develop a guide on how to report publicly on sustainable development and how to decide which key non-financial indicators should be disclosed in the financial statements of companies, such as political changes or environmental abuse. 8.3 an example of political changes in south africa as shortcomings what would be a suitable south african model for disclosing non-financial information, taking into account apartheid and the period beyond? the transition from an apartheid to a postapartheid state has created various democratic and social rights for all south african citizens, which are characterised by, but not limited to, trade union power as opposed to employer power. as an example, bmw south africa is disclosing political changes in their financial statements, as a way of explaining why the company suffers fewer industrial actions. 8.3.1 performance delivery agreement bmw south africa concluded a performance delivery agreement with a bmw trade union, which stated the following (in webster & van holdt, 2005): in an ever-changing environment of cost pressures, fluctuating requirements for global production capacity, as well as increased competition locally and internationally, as well as the inherent disadvantage of our plant’s location in relation to our markets, all associates need to contribute to make a positive contribution in ensuring an ongoing future for the company bmw, south africa. thus, bmw avoids the conflict that can be created by a trade union, for example, strikes, by identifying a common goal for both of them – to be equal company partners. the term ‘company partner’ represents an attempt to change the identity and subjectivity of the employees so that they identify themselves with the company by shaping their attitude and behaviour to work with commitment. it is therefore highly unlikely that the trade union would order strikes or participation in an industrial action to impose economic pressure (i.e. demands for higher salaries) on bmw. this agreement is a public document and is available to any interested person as a non-financial indicator. 8.3.2 working hours south africa (1995) stipulates a maximum working week of 45 hours. bmw has developed a bank hour account whereby their company partner can bank overtime as the global demand for bmws increases or the company partner withdraws his or her banked hours when global demand for bmws decreases. webster and van holdt (2005) indicate that, in their 2000 annual report, bmw disclosed this business model voluntarily to the outside world as a non-financial indicator. this model allows for greater transparency concerning the causes of an increased operating profit because the company did not pay overtime remuneration. 8.4 an example of market volatility as a shortcoming to illustrate the importance of voluntary disclosure from a financial perspective more clearly, the following example is relevant, as illustrated by table 4. table 4 extract from income statement 2001 2000 1999 1998 top line 2 193 2 319 2 292 1 016 operating profit 250 195 296 –56 sajems ns 13 (2010) no 1 83 share price statistics end 2001 r4.00 per share end 1998 r18.00 per share extract from balance statement 2001 2000 1999 1998 total assets 710 679 552 187 debt to equity 0.25 0.29 0.54 0.51 source: mcgregor’s (2002) it is sometimes difficult to understand why a particular company enjoys a very high share price when its operating profit is very low, as indicated in table 4. in our income statement it can be seen that operating profit is at its lowest when the share price is at its highest. surely a poor operating profit would influence the supply and demand side of shares (vintcent, 1999)? many financial analysts analyse the share price movements in relation to profitability or operating profit to form an economic opinion of the economic environment in which the company operates, so as to justify the share price movements. instead, shareholders or stakeholders appreciate more the opinion of the company on why it experienced the share price movements, owing to the correct identification of non-financial indicators, that is, the company explains its current company strategy (steiner, 1998; vigario, 2007). 8.5 other methods of avoiding quanti minoris defects if the parties are unable to reach consensus on an appropriate method of calculating future value for a company or enterprise, the seller could provide a written guarantee that the enterprise would be able to produce future value within a specific economic period. it is interesting that financial analysts consider a written guarantee to be an absolute forward contract (correia et al., 2007). the positive aspect of a guarantee is that the seller would possibly disclose the kernel of his business acumen (an asset swap, as discussed earlier) so that the purchaser could attain at least the same economic results in the future. 9 conclusion this overview of the law and economic literature on intangible defects was fortunately not a selective selection. as far as the question of whether quanti minoris defects should be similar for tangible or intangible things in the law is concerned, an article by hurter (1988) came nearly 15 years after the phame v paizes (1973) judgment, in support of which this contribution has analysed defects from the economic and legal perspectives (mommsen & kruger, 1954). this required the study of economic textbooks in which authors referred to forward contracts (correia et al., 2007). such contracts indicate that an intangible thing cannot have true value because the value of intangible things depends on future uncertainties. in addition an asset swap or the future production of milk as a future uncertainty is used to illustrate how the value of a company fluctuates, rendering the quanti minoris defects inappropriate for reducing the price paid for a company. one point of further research is the possibility of integrating future uncertainties into financial statements through the development of new disclosure policies. one of those policies is the world company council for sustainable development, which could be used as a guideline on how to report voluntarily on nonfinancial indicators (future uncertainties). endnotes 1 i am grateful to dr. david levey and two anonymous referees for useful and helpful comments on an earlier draft of this contribution. 84 sajems ns 13 (2010) no 1 2 the quality of a company is observed by means of reliable financial methods or ratios which are capable of being compared with those of other companies in the same economic sphere. bloomfield (2000) states that these methods or ratios must be universally acclaimed, otherwise good company qualities become just another synonym for hoodwink. steiner (1998) indicates that these methods usually make use of profitability to calculate investment attractiveness. 3 my inclusion. references anthony, d. 2004. rethinking the rules of financial accounting. new york. arnold, g. 2005. the handbook of corporate finance. london: prentice hall. black, a., wright, p. & davies, j. 2001. in search of shareholder value (2nd ed.) london: 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(hitting about wbcsd).[online]. available at http://www.wbcsd.org/ templates/templatewbcsd5/layout.asp?type=p& menuid=nja&doopen=1&clickmenu=leftmenu [accessed 18 march 2009]. abstract introduction literature review towards a spatial perspective data methodological extensions and applications caveats, conclusions and avenues for future research acknowledgements references footnotes about the author(s) stephanie rossouw school of economics, faculty of business, economics and law, auckland university of technology, new zealand citation rossouw, s., 2017, ‘measuring the vulnerability of sub-national regions: integrating relative location’, south african journal of economic and management sciences 20(1), a1766. https://doi.org/10.4102/sajems.v20i1.1766 note: this article is based on the working paper titled ‘sub-national vulnerability and relative location: a case study of south africa’. this working paper was published in the auckland university of technology working paper series, available at: http://www.aut.ac.nz/__data/assets/pdf_file/0007/257497/economics-wp-2012-01.pdf original research measuring the vulnerability of sub-national regions: integrating relative location stephanie rossouw received: 26 jan. 2017; accepted: 24 may 2017; published: 05 oct. 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the authors of this article ‘measuring the vulnerability of sub-national regions in south africa’ (naudé, mcgillivray and rossouw 2009b) present an exploration into economic vulnerability from a sub-national perspective. it is an important contribution because it recognises the heterogeneous nature of vulnerability across areas within a country, but its analysis is aspatial because it does not explicitly account for the relative location of or the potential for spillovers between areas. aim: this article aims to provide a purely methodological contribution towards the debate surrounding the measurement of multidimensional vulnerability by: (1) augmenting naudé et al. (2009b)’s model to take account of spatial contiguity, (2) comparing spatial and aspatial local vulnerability indices estimates to illustrate the presence and importance of spatial spillovers between contiguous areas and (3) extending their methodology on the vulnerability intervention index to present results which highlight areas that are performing better and worse than expected. methods: principal components analysis, queen-contiguity weight matrix and local indication of spatial association (lisa) maps were utilised. results: application of the methodological extensions to south african magisterial district data illustrates the presence and importance of spatial spillovers in shaping local vulnerability. conclusions: our results illustrate a clear urban–rural vulnerability divide and the need for appropriate policy. it is argued that account of spatial spillovers is an important issue if full and accurate vulnerability indices are to be identified. introduction economic vulnerability is a multidimensional, multi-faceted concept. its (re-)definition and (re-)measurement are not new areas of academic interest, but recently there has been a shift in thinking about economic vulnerability associated with the belief that the alleviation of poverty is a prerequisite for the achievement of development goals. naudé, mcgillivray and rossouw (2009b) highlighted that most previous measures of vulnerability are potentially biased because they exclude environmental and/or geographical factors. moreover, they recognised that the growing vulnerability literature has a focus at either the national or household level, which led them to emphasise the need for a characterisation and measurement of vulnerability at the sub-national area level. they attempted to fill these gaps in the literature by: advocating a method of sub-national vulnerability measurement through the construction of a local vulnerability index (lvi) that includes environmental and geographical factors as integral components and conditioning their lvi on income per capita to yield a vulnerability intervention index (vii). though the augmentation of models to include standardised variables pertaining to environmental and geographical factors is significant, a crucial aspect that was not integrated into their analysis is the potential influence on vulnerability of spillovers between areas. anything that is observed to have a spatial dimension also has the potential to encounter spatial spillovers. tobler’s (1970) first law of geography is that ‘everything is related to everything else, but near things are more related than distant things’, and most geographers are aware that many if not most socio-economic variables have a spatial component. spatial spillovers are features whereby the attributes of an area are influenced by the attributes in nearby or contiguous areas. the relative location of an area may be important when considering vulnerability because the population and policy-makers of that area may compare it to other areas that they are most familiar with, and these areas are often ones that are contiguous or close by. an individual’s perception of being in poverty, and the importance and selection of alleviating policy, may be a relative concept. this article provides a purely methodological contribution to the existing literature regarding measurement and analysis of regional multidimensional vulnerability through augmenting the methodology of naudé et al. (2009b). this will be achieved through: (1) expanding their principal components model to take account of spatial contiguity, that is, the physical contact of an area’s geographical boundary by another area, (2) comparing spatial and aspatial local vulnerability indices to illustrate the importance of spatial spillovers between areas, and (3) extending their vii method and subsequently presenting results which highlight areas that are performing better and worse than expected. application of these augmented economic vulnerability indices to the same data used by naudé et al. (2009b) (south african magisterial district level data) provides us with a critically important platform by which we can compare our results to those generated by naude et al. (2009b) and draw conclusions which suggest that the inclusion of a spatial dimension is crucial in ascertaining location-specific economic vulnerability. not appreciating the impacts of spatial spillovers will potentially bias results and lead to incorrect policy recommendations. the contribution of this article is thus vitally important for future empirical studies investigating regional vulnerability as the spatial dimension can no longer be disregarded. this article is structured as follows: the next section reviews the literature on vulnerability and critically reviews the content and approach of naudé et al. (2009b). the ‘towards a spatial perspective’ section argues that a sub-national perspective on vulnerability should take explicit account of relative location. the ‘data’ section describes the data. the ‘methodological extensions and applications’ section details augmentations and new results of naude et al. (2009b)’s model that incorporate spatial and aspatial local vulnerability and vulnerability intervention indices. the ‘caveats, conclusions and avenues for future research’ section addresses the caveats of this study and provides conclusions as well as avenues for future research. literature review vulnerability origins and the spatial scale of analysis the origins of vulnerability transcend the geographical, economic and political. primary concerns associated with negative events are their impacts on productivity growth, development potential and the extent to which they alter vulnerability (guillaumont 2004).1 however, before vulnerability can be accurately measured, attention needs to be focused on where potential shocks may arise. three basic channels of origin can be identified: (1) environmental or natural shocks, such as natural disasters; (2) other external shocks (trade and exchange related), such as slumps in external demand, and (3) other (non-environmental) internal shocks, such as political instability (guillaumont 2004). once the origins of vulnerability have been identified, the next stage in any vulnerability empirical analysis is to decide on the appropriate spatial scale. literature pertaining to the study of vulnerability has focused on three levels of analysis: household, regional and national. a large majority of this literature is devoted to measuring the relative vulnerability of a country.2 turvey (2007) advocates the need for place-specific vulnerability indices and constructed a composite vulnerability index for 100 developing countries out of four sub-indices: a coastal index, a peripherality index, an urbanisation index and a vulnerability to natural disasters index. she argued that if the measurement of vulnerability excludes a geographical component, then the construction of vulnerability profiles might be useless for framing development policy and evaluating developing countries.3 although the majority of analysis has focused on the country-level spatial scale, there are a growing number of articles that examine vulnerability at the household level. for instance, bird and prowse (2008) investigated the vulnerability of households in zimbabwe and found that if official donors did not intervene then the poor and very poor were likely to be driven into long-term chronic poverty and such chronic poverty would be extremely difficult if not impossible to reverse. gaiha and imai (2008) also argued that idiosyncratic shocks (e.g. unemployment or illness) were the primary cause of indian rural households’ vulnerability, although poverty and aggregate risks (weather and crops) were also important contributory factors; the last of these is clearly a geographical issue.4 not a lot of attention has been given to the vulnerability of regions within a country. hulme, moore and shepherd (2001) linked poverty to the vulnerability of specific regions, and kanbur and venables (2005) showed that not only is spatial inequality between regions on the increase but it will ultimately cause an overall increase in the inequality of specific countries. similarly, ivaschenko and mete (2008) presented evidence of poverty traps and argued that higher levels of poverty in a region appear to reduce radically the chance of a household emerging out of poverty and that living in a region with a slow economic growth weakens the odds of a household exiting poverty and increases its risk of slipping into poverty.5 as regards to south africa, vulnerability as currently understood in this and the naudé et al. (2009b) paper has not been high on the priority list. there are studies which comes close in nature to this article but focuses either on quality of life (see greyling & rossouw 2016; naudé, krugell & rossouw 2009a; rossouw & naudé 2008) or ex post poverty outcomes (see alderman et al. 2000; klasen 2000; mattes, bratton & davids 2003; noble et al. 2006). this reiterates the importance of increasing the literature base available as regards to incorporating spatial contiguity as regards to vulnerability measures. naudé, mcgillivray and rossouw (2009b)’s contribution much development literature still relies on income per capita measures as an indication of development and vulnerability. naude et al. (2009b) underscore the shortcomings of focusing only on incomes when assessing vulnerability by stating that ‘equal incomes do not translate into equal outcomes for all … (and) different people are faced with different environments for translating income gains into non-income wellbeing gains’ (p. 4). an important, though not new, contribution of their study was to emphasise that vulnerability is a multidimensional phenomenon that requires and deserves a multidimensional analysis. it is uplifting to see this underlying multidimensional theoretical perspective being adopted empirically in their subsequent analysis. they constructed a composite index of local vulnerability using principal component analysis (pca).6 the execution of pca7 is thought to reveal the internal structure of the data with each component being ranked in accordance with its importance to the multidimensional phenomena and with the first component known to capture most of the data’s variability. in line with theoretically driven multidimensional considerations, naudé et al. (2009b) proposed the construction of an lvi based on 10 different and distinct domains,8 which are constructed from sub-domains stated in brackets: size of local economy [gross domestic product (gdp), population size, population density, urbanisation rate]: it is argued by liou and ding (2004) that larger economies are prone to being less vulnerable. international trade capacity (ratio of exports and imports to local gdp, export diversification): as was stated by briguglio (1995) and matthee and naudé (2007), the wider the range of goods being exported and the more open a region is to trade, the less vulnerable the region will be. development (human development index [hdi], percentage age of local population in poverty, unemployment rate): the relationship between a region’s vulnerability and its level of development is inverse, and therefore, it can be argued that the higher the level of development, the lower the vulnerability of said region. demography and health (incidence of hiv and/or aids, population growth rate): the region’s resilience in terms of negating internal or external shocks may be dependent of the stress placed on its health services because of a higher hiv incidence or above average population growth rate. environment (percentage degraded land, proportion of forest-covered land and waterbodies, wetlands and rainfall): the quality of the environment influences household incomes and their perceived quality of life. financial system (number of people per bank branch, ratio of the percentage age share of the country’s financial sector in a particular area): this domain is essential when dealing with financial shocks. the less access people have to formal financial services, the more vulnerable they are seen to be. structure of the local economy (share of primary production in total production): the less diversified a specific region is in regard to their production of goods and services, the more vulnerable they are likely to be. peripherality (distance from the market): it was argued by turvey (2007) and briguglio (1995) that the longer the distance to the nearest market hub of activity, the more vulnerable a place will be. income volatility (standard deviation of gdp growth): according to liou and ding (2004), a region’s income volatility reflects an area’s income ‘riskiness’. governance (per capita capital budget expenditure): in this domain, the article attempts to capture the ability of local governments to endorse pro-poor policies. although this is not the perfect proxy to measure ‘good governance’, it can be argued that regions experiencing low per capita capital budget expenditures could also face higher future vulnerability as they lack the necessary resources for long-term development. it should be emphasised that naudé et al. (2009b) include both geographical and environmental indicators, which they strongly and correctly suggest are important for economic vulnerability measurement. they applied the following structured method to a data set detailed in the ‘data’ section. initially, pcas were run on each of the individual domains that had more than one sub-domain (i.e. domains 1–6). although it would be possible to appoint different weights to each subsequent component, this would require an appropriate selection of weights. instead, the principal components of each of the individual domains pca’s results were selected and pooled into a data set that already contained the non-multidimensional individual domains (i.e. domains 7–10). then, a second pca was estimated on these data and the principal component again chosen for subsequent interpretation; the result is a single principal component used to represent their multidimensional lvi from which district ranks and area comparisons can be made. note that each of naudé et al. (2009b)’s domains are aspatial by construction: each area’s estimate does not explicitly consider what is happening in an area’s neighbouring areas. naudé et al. (2009b) also propose the construction of a vii that is designed to reflect the vulnerability associated with per capita income, such that: where where α is an intercept, β is a slope coefficient, y is the per capita income of magisterial district i and µ is the well-behaved error term. if β is equal to one, then any change in the lvi is a proportional response to the corresponding change in income per capita. assuming that there are no scale returns disparity issues across areas, estimation of equation: (1) leads to a vector of residuals, one for each area, where each individual residual represents the deviation between the actual and the predicted lvi based on per capita income. naudé et al. (2009b) examined the absolute values of these residuals to identify areas which deviate strongly from the average and found that although the lvi was highly correlated with per capita income (with greater income per capita being associated with lower vulnerability) it was far from being equal to unity; this led them to believe that there were reasons other than achieved incomes that drive vulnerability levels.9 as far as policy formation is concerned, this belief is in line with the suggestion that any policies aimed at reducing area level vulnerability should not rely solely on increasing incomes. towards a spatial perspective as each of naudé et al. (2009b)’s domains are aspatial by construction, their lvi and vii measures are also aspatial: using the above methods implicitly assumes that relative location is not important. however, the literature emphasises that of crucial importance for vulnerability assessments is the relative location of an area. for instance, chauvet and collier (2005) stressed the importance of spatial spillover effects from fragile neighbouring countries and calculated that the negative effects of having fragile neighbours average 1.6% of gdp per annum. tondl and vuksic (2003) emphasised the importance of contiguity and spatial dependence at the regional scale by showing that a region’s growth is significantly more likely to be higher if it is a neighbour of another high growth region. they estimated that about a fifth of a region’s growth is determined by that of surrounding regions. similarly, florax and van der vlist (2003) suggested that it is necessary to include ‘neighbourhood’ effects in explaining the spatial distribution of indicators related to wages, crime, health and schooling. empirical investigations into vulnerability issues will be inefficient if account has not been taken of spatial spillovers. spatial autocorrelation, that is, the degree of dependency among observations in a geographic space, will be an important consideration in any modelling procedure if there are processes operating across space, as exemplified when adjacent observations are not independent of each other. naudé et al. (2009b) are not alone in the lack of recognition of the importance of relative location and spatial autocorrelation. for instance, although bird, mckay and shinyelawa (2007) emphasise that a location’s attributes have a significant influence on poverty traps, it is not simply the attributes of the location in isolation that are important but also the attributes of an area’s relative location. a better understanding of how area specific attributes contribute to the creation and sustainability of place-specific vulnerability is prudent, but it may be superior to improve contemporaneously our understanding of how one area contributes to another area’s vulnerability. one of the clearest expositions of the reasons why spatial autocorrelation in socio-economic variables can occur has been provided by voss et al. (2006) who emphasised the importance of, among other things, feedback, grouping forces and grouping responses. these can be positive or negative and could result in some areas being vulnerability black-spots. there is the potential for feedback forces to influence individuals and households’ preferences and activities, willingness to accept greater vulnerability and activities to reduce vulnerability. ceteris paribus, the smaller the spatial scale of analysis, the higher the likelihood and frequency of contact between individuals and the greater the potential feedback between individuals and between policy-makers, and often between individuals and policy-makers. greater similarity in socio-economic measures and conditions will mean less justification for individuals to perceive that they are relatively more vulnerable. for reasons related to the adoption/diffusion theory (rodgers 1962) and the agent interaction theory (irwin & bockstael 2004), we should expect there to be the potential for spatial spillovers in underlying vulnerability dimensions with a positive correlation in dimensions between contiguous areas. for instance, unemployment rates tend to have some degree of imitation across areas correlated with, for example, similarities in the cultural acceptance of being unemployed. individuals might incorrectly associate unemployment benefits or social grants received for children with more leisure time or freedom from not working and therefore follow suit. this could ultimately increase the vulnerability of the area or group of areas. geographically proximate districts with similar socio-economic attributes and vulnerability dimensions are more conducive to grouping forces, such as the formulation of parallel policy initiatives. the clustering of underlying vulnerability dimensions across space might be because of a number of reasons including policy that has been applied to groups of areas or socio-economic issues that lead to spatial clustering (e.g. high house prices force low-income people into other areas and seaports attract international trading activities). in south africa, as in various developing countries, there is a serious problem with informal (slum) settlements. informal settlements are the illegal and unauthorised occupation of private or government owned land and consist of dwellings usually made out of corrugated metal. typically, these informal settlements found on the periphery of large urban areas are established by unemployed, impoverished, illiterate, homeless or illegal migrants who may respond in similar ways to policies because of their socio-economic circumstances. alternatively, grouping responses can occur where the application of policy is reacted to in similar ways, often because of the spatial clustering of similar socio-economically characterised individuals. as the people occupying informal settlements share the same plight, they tend to assemble and demand ownership of the occupied land as well as the installation of water and refuge systems. if they do not receive what they demand, then protests can be organised which may cause damage not only to the reputation of the area but also to public property such as schools, libraries and so on. such demonstrations could greatly increase the vulnerability of a specific area and its neighbours. sub-indices used for the construction of vulnerability indices are particularly likely to possess a spatial dimension. for instance, the size of the local economy domain is based on gdp, population size, population density and urbanisation rate, factors which are likely to have high (low) values in areas that are contiguous to areas also with high (low) values. as a result, two important considerations arise: firstly, if the spatial evolution of socio-economic attributes is by accident, fate or otherwise, then recognition of such spatial patterns when formulating policy could improve the effectiveness of the policy; secondly, application of policy designed to alleviate vulnerability should not be focused on one area without contemporaneously and explicitly considering similarities across neighbouring areas. this perspective is supported by chauvet, collier and hoeffler (2007) who argue that because failing regions impose a large cost on their neighbours it is not only required but also justified to have cross-region intervention in decision-making processes. policy directed towards reducing vulnerability needs to have a spatial dimension and can be articulated into two simple groups. firstly, areas may suffer higher levels of vulnerability because they are distinctly different from other areas, including those areas which are contiguous. in this case the policy would need to be area specific and designed to improve the vulnerability of the area in isolation. secondly, areas may suffer higher levels of vulnerability because they are influenced by spatial spillovers. in this case, the appropriate policy would need to be targeted towards not simply the specific area but also the group of contiguous areas.10 in summary, a lack of appreciation of the spatial autocorrelation that is present in sub-domains may result in the under-specification of a model and inefficient vulnerability estimates. modelling under-specifications and inefficient vulnerability estimates can result in sub-optimal and inappropriate policy formation. data naudé et al. (2009b) applied their methodology to south african data. to illustrate the strengths and important methodological contribution of this article, we apply our extension of naudé et al. (2009b)’s methodology to the same data set, which was acquired for all of south africa’s magisterial districts over the period 1996 to 2006. south africa is classified as an upper–middle-income country, with a net national income11 per capita of approximately us$ 10 892, an overall gdp of us$ 692 billion and an estimated population of 54 million. she experienced exceptionally high inflows of foreign capital and foreign direct investment since 2003 which assisted in speeding up the process of employment creation; for instance, during the year ending 2014/2015, just over a million jobs were created. in saying this, unemployment remains severe in spite of a considerable drive for further job creation and poverty reduction. although south africa is not classified as a vulnerable state in the traditional sense, the international community recognises the role its strong institutions have played in bringing about these improvements. in the absence of these institutions, south africa could be rendered vulnerable as it is plagued by unrelenting high unemployment, widening inequality, poverty, aids-related deaths and a rapid increase in the crime rate. demombynes and özler (2005) argued that a direct link exists between this crime rate and the degree of local inequality thereby reinforcing the general consensus of institutions responsibility for implementing policies to eradicate poverty and inequality.12 the national development plan (ndp) was formally launched in 2013 to help the south african government eliminate poverty and reduce inequality by 2030 (npc 2013). the ndp concluded that in order to achieve these social objectives south africa would need to keep growing at a rate of 5.7% per annum until 2030, and there should be a concurrent reduction of deficiencies in state organisations, capacity and leadership. this target is said to be achievable by focusing on two key variables: the rate of economic growth and the employment intensity of that growth.13 to conduct the empirical analysis, data were compiled from various sources, as shown in table 1. the spatial scale of our analysis is the same as naudé et al. (2009b) and is based on the analysis of 354 magisterial districts. it should however be pointed out that the demarcation of south africa’s municipality boundaries were changed by the municipal demarcation board of south africa (mdb 2016) three times since and including the years 2000, 2006 and 2011. this would naturally provide problems when analysing municipal data over time. fortunately, a unique feature of the utilised ihs’s regional economic focus’ (ref) (see http://www.ihsglobalinsight.co.za/) regional explorer (rex) database is the inclusion of these changes in the demarcation of municipalities and its ability to adjust the data accordingly. this study uses a data set that has been adjusted for the 2006 demarcation boundary changes, thereby ensuring data for different years are directly comparable on a geographical basis. table 1: data description. socio-economic variables have a spatial dimension. one way of examining spatial patterns is to exploit the spatial nature of a data set by constructing maps and estimating moran’s i statistics. consider figure 1 that shows a map of rates of poverty expressed as standard deviations away from the sample mean.14 it illustrates that poverty rates in south africa have a spatial dimension. there is an east–west split with western (eastern) parts having relatively low (high) rates of poverty. poverty rates are relatively low throughout the western and northern capes and are relatively high in the north west and in the free state. generalisations are more difficult for limpopo, kwazulu-natal, mpumalanga and the eastern cape because of their relatively large variation in poverty rates. urban areas appear to have relatively low rates of poverty, specifically johannesburg, durban, cape town, east london, port shepstone and richard’s bay. visual inspection suggests that areas with high (low) rates of poverty are more likely to be contiguous to areas that also have high (low) rates of poverty, at least at this spatial scale. figure 1: poverty map. moran’s i values are produced to test statistically for spatial clustering, that is, similar values of a variable being present across areas that are located relatively close to each other. typically, a moran’s i value is obtained via the moran scatter plot, which in this case plots poverty rates on the horizontal axis and its (queen-contiguity) spatial lag on the vertical axis, as shown in figure 2.15 the upper right quadrant of the moran’s i scatter plot shows those areas with above average poverty values which share boundaries with neighbouring areas that also have above average poverty values (high–high). the bottom left quadrant highlights areas with below average poverty which have neighbouring areas that also have below average poverty values (low–low). the bottom right quadrant displays areas with above average poverty surrounded by areas that have below average poverty (high–low) and the upper left quadrant shows the opposite (low–high). the slope of the line through these points expresses the global moran’s i value (anselin 1996). the moran’s i value of 0.641, which is statistically significant at the 1% level, leads us to reject the null hypothesis that there is no spatial clustering. hence, the visual interpretations of figure 1 are supported with the quantitative results of figure 2 and leads us to believe that spatial autocorrelation in socio-economic variables may be important in the construction of vulnerability indices. figure 2: moran’s i of poverty methodological extensions and applications this section will illustrate the methodological contribution of this article to future empirical studies regarding the measurement and analysis of regional multidimensional vulnerability. two major augmentations of naudé et al. (2009b)’s methodology will be presented which are based on the following underlying concerns. firstly, although their lvi includes both environmental and geographical indicators, it is aspatial in nature as each area’s estimate does not explicitly consider what is happening in it neighbouring areas. hence, they do not take into account explicitly the possible effects of spatial spillovers, and they treat all areas as though they were unconnected islands; this is extremely unlikely if there are important spillovers from one area on to its surroundings. secondly, they categorise districts into nine groups and subsequently convert them into a nine-point index, where members of group 1 have a value of 1, group 2 have a value of 2 and so on. categorisation into groups can be problematic and misleading if gaps between groups are arbitrary; for instance, an area with a very low value that is part of group 4 might actually be closer to a high value member in group 5 than a high value member in group 4. this is similar to the criticism made by baliamoune-lutz and mcgillivray (2008) on the world bank’s cpia. in other words, we extend the work of naudé et al. (2009b) by addressing these two areas. firstly, we construct a spatial lvi through the inclusion of queen-contiguity spatially weighted sub-domains, and secondly by retaining the final principal component value as determined by the lvi for each area in order to sustain a quantitative indicator of disparity between district i and j that is not affected by group categorisation. augmentations of the local vulnerability index and vulnerability intervention index in contrast to naudé et al. (2009b), we apply the following structured method: begin with exactly the same original data and standardised variables as naudé et al. (2009b). this is so as to ensure comparability of the various results obtained by the different studies. replicate the estimates of naudé et al. (2009b). this will generate a set of aspatial results that are not categorised using the nine-point index. append original data to each area within a magisterial districts shapefile. construct a spatial weight matrix that will permit the formation of new variables to capture spatial spillovers. this part of the process can use weights selected purely on theory, purely on statistical strength or on a combination of these two extremes. we commenced this process by weighting data for area i by the corresponding values of the same variable in areas that are contiguous to area i – these are called queen-contiguous weights. we constructed a series of other spatial weights, including rook, second-order queen and various distance weight matrices and then compared the results. we identified no qualitative differences across the final sets of empirical results and so decided to retain the queen-contiguity weight matrix throughout. estimate pcas for each of the individual domains listed 1–10 in section ‘literature review’. note that all individual domains will have double their original number of variables: the original standardised variables and their queen-contiguous spatially weighted equivalents. retain and pool all individual domain pca’s principal components. estimate a second pca across these individual domain principal components and retain the principal component for interpretation. we retain the final principal component raw values for each managerial district in order to sustain a clear quantitative indicator of disparity between area i and j. this is contrary to naudé et al. (2009b) who instead categorised districts into nine groups. the result is two principal components: one that will represent the multidimensional lvi from naudé et al. (2009b)’s aspatial perspective and one that will represent the multidimensional lvi from a spatial perspective, which we denote by spatial local vulnerability index (slvi): reconstruct naudé et al. (2009b)’s vii to reflect vulnerability associated with per capita income. estimating lvii = α + βyi + μi(i = 1,…,354) to replicate naudé et al. (2009b)’s results and estimate slvii = α + βyi + μi to capture the spatial equivalent set. save the vectors of residuals which represent the deviations between the actual and the predicted values for lvi and slvi, respectively. interpret the absolute values of these sets of residuals and identify which areas deviate strongly from predicted. it is emphasising that this retention and subsequent analysis of the residuals is a clear extension of the methodology employed by naudé et al. (2009b), as they take the absolute residual values as an indication of the level of vulnerability of an area. collating absolute values will muddle areas into a vii irrespective of whether they were performing much better (a good form of vulnerability) or much worse (a bad form of vulnerability) than expected under the fitted model. good (and bad) forms of vulnerability may be the result of appropriate (and inappropriate) policy; for instance, some areas may have been influenced by beneficial policy or naturally occurring economic phenomena (such as urbanisation and localisation economies) that make areas perform better than would be expected otherwise, while the absence of appropriate policy (or the application of inappropriate policy) may result in the deterioration of other areas. results of local vulnerability index and spatial local vulnerability index estimations figures 3 and 4 present local indication of spatial association (lisa) maps based on the results of lvi and slvi estimations. lisa maps are special choropleth maps that highlight those locations with a significant local moran statistic classified by type of spatial correlation (anselin 1995). they highlight areas with high (low) vulnerability that are surrounded by areas with relatively high (low) vulnerability; lisa maps can also highlight areas with high (low) vulnerability that are surrounded by areas with relatively low (high) vulnerability. through visual inspection, it becomes clear that an appreciation of the influence of contiguity effects will affect lvi estimates. figure 3: local indication of spatial association map of local vulnerability index estimates. figure 4: local indication of spatial association map of spatially weighted local vulnerability index estimates. several observations obtainable from comparing figures 3 and 4 are worth highlighting. firstly, magisterial districts within and surrounding cape town, durban and johannesburg are least locally vulnerable. this emphasises a large urban–rural disparity vulnerability effect. the same pattern is not identifiable for other urban areas, with the only exception being umtata. taken together, the results suggest that umtata is an area that is doing relatively well in comparison to its hinterland (see figure 3), but it is at risk because its hinterland is performing relatively poorly and spatial spillovers might deteriorate the extent of vulnerability within this conurbation (see figure 4). umtata’s extent of vulnerability could be the result of policies that have been directed at this large conurbation without concern for its surrounding hinterland. secondly, figure 4 suggests that the greater hinterland of the three main urban areas of cape town, durban and johannesburg are much less vulnerable than those indicated in figure 3. this is illustrated by the significant spillovers between contiguous districts which, in these cases, appear to diminish vulnerability. such a contagion issue will be related to either spatial feedback, grouping or response forces. of particular interest are the magisterial districts of heidelberg and bronkhorstspruit which are low–highs according to figure 3 and high–highs according to figure 4; these differences are because of the spatial spillovers between contiguous districts, and without these spatial spillovers, it is likely that these two districts would be much more vulnerable. an alternative perspective is that individuals are being marginalised in and around johannesburg and are being forced out of relatively affluent areas and clustered into these two relatively poorly performing districts. thus, policy geared towards diminishing the vulnerability of people in heidelberg and bronkhorstspruit should be both district specific (as highlighted in figure 3) and take account of spatial spillovers (as highlighted in figure 4).16 thirdly, there are also important differences between figures 3 and 4, which reflect differences in estimates obtained that result from the inclusion of spatially weighted sub-domains. the results presented in figure 3 suggest that there are magisterial districts that suffer high levels of vulnerability, but the results presented in figure 4 illustrate that this is not an attribute that stops at areas’ borders. instead, the most vulnerable areas are clustered and contiguous in several areas. of most concern is: (1) magisterial districts occupying the area to the south of swaziland and which continues, mainly inland, down to ladysmith, (2) much of the eastern part of the eastern cape to the south of lesotho, and (3) a large, central part of the northern cape. the extent of vulnerability is not fully emphasised in figure 3; the reason why this spatial perspective is so important is because any attempts by policy-makers to alleviate vulnerability in these areas need to take a larger spatial perspective and explicitly consider large swathes of districts in their policy formations rather than simply considering the circumstances within specific districts in isolation. when account of spatial spillovers in vulnerability sub-domains is explicitly considered in the estimation process, the rankings of districts can differ substantially from estimates where account of spatial spillovers is excluded. table 2 presents the slvi estimates of the top and bottom 20 magisterial districts and each of these districts’ ranks that have been replicated using the (non-spatial) lvi. although there are some districts where the rank is unaffected, such as nelspruit (rank = 1) and soweto (rank = 354), the estimates of the ranks of many other districts do alter substantially; for instance, rustenburg’s rank improves from 228th to 18th after taking into account spatial spillovers, while simonstown’s rank falls from 62nd to 350th.17 table 2: local vulnerability index top and bottom 20 areas. results of vulnerability intervention index and spatially weighted vulnerability intervention index estimations residual estimates are presented for the top and bottom 20 districts in table 3, and figures 5 and 6 provide visual support. table 3 highlights the importance of accounting for spatial spillovers in vii estimates; although the top three districts (johannesburg, soweto and durban) only switch places when the vii and svii estimates are compared, many of the ranks of the other districts detailed do change rank substantially. figure 5: local indication of spatial association map of vulnerability intervention index estimates. figure 6: local indication of spatial association map of spatially weighted vulnerability intervention index estimates. table 3: vulnerability intervention index top and bottom 20 areas. several observations can be made when interpreting table 3 together with figures 5 and 6. firstly, the association of urbanisation and vulnerability alleviation, perhaps associated with agglomeration economies, around johannesburg, cape town, durban, richard’s bay and hluhluwe is much clearer from the visual examination of figure 6, where the residuals are the result of an equation that explicitly considered spatial spillovers. many economic geographers would expect this result. secondly, although figures 5 and 6 highlight large areas of central south africa in white, therefore suggesting that the areas are not performing substantially different than expected given their gdp per capita level, and the northern and western capes have much worse vulnerability rates than we would expect given their gdp per capital levels, the area of greatest disparity between the vii and svii estimates are in the province of limpopo. the svii perspective suggests that limpopo is an area that deserves much more policy focus as spatial spillovers are resulting in much deeper vulnerability than one would otherwise expect. policy directed towards individual magisterial districts in isolation within limpopo will probably be relatively inefficient as the province requires a more holistic policy approach which explicitly accounts for spatial spillovers thirdly, the values of the vii shown in table 3 do not have a large spread: the value for the 15th highest spatially ranked district (bloemfontein) is equal to 1.88, whereas the value for the bottom spatially ranked district (pelgrimsrus) is equal to −1.34. this is in contrast to the top 14 spatially ranked districts, which vary between 6.47 (johannesburg, 1st) and 2.05 (cape town, 14th). further examination of this data is carried out using the multivariate moran scatterplot, as show in figure 7, which presents the svii estimates on the horizontal axis and the slvi on the vertical axis. initial execution of this technique reveals a strong, statistically significant moran’s i value of 0.616, but the exclusion of these top 14 ranked areas reveals a much shallower moran’s i value of 0.104. although this latter value is still statistically significant, it becomes clear that a substantial part of the spatial correlation between svii and slvi is because of a large conurbation effect. figure 7: multivariate moran scatterplot. the large conurbation effect reflects the fact that those areas that are wealthier also have better vulnerability values. such attributes could be because of the benefits of agglomeration, typically associated with urbanisation and location economies, but may also be because of national policies that are geared towards improving the lives of urban dwellers rather than their rural counterparts. this is in line with friedmann (1963), alonso (1968) and yang (1999) who found that regional policies are biased in that they are likely to reflect the development of the urban areas as they are seem to have the most potential for development but ultimately cause greater spatial inequality. little (2009) found that government policy needs to change in order to rectify the geographical imbalances in both recorded and hidden unemployment in urban and rural areas. etherington and jones (2009) argued that the policies implemented for city-regions emphasise and have the potential to increase, rather than resolve, uneven development and socio-spatial inequalities. spatial lag and spatial error models there is an alternative method of generating estimates of svii using spatial econometrics. the first stage is to estimate a standard ordinary least squares (ols) estimate of lvii = α + βyi + μi (i = 1,…,354) and to incorporate a spatial weights matrix to permit the diagnosis of spatial dependence. this can be carried out using the geoda freeware, as employed above to generate spatial weights. application of the ols procedure yields results presented in table 4. table 4: spatial econometrics (n = 354). several values presented in table 4 are worth emphasising. firstly, the gdp value is greater than unity, suggesting that a one unity increase in gdp will result in a larger than one-unit increase in the lvi. this would lead to the conclusion that, on average, gdp has a stronger than proportional effect on the lvi thereby emphasising that gdp is vital to the alleviation of vulnerability. that gdp is important for the lvi is not surprising, but this very strongly emphasises the importance of policies designed to stimulate the economy of south africa so that they can ‘grow out of vulnerability’. although this result is based on the multidimensional pca estimation of the lvi, the result does not support a multidimensional policy alleviation perspective. secondly, the moran’s i statistic indicates that there is strong spatial autocorrelation in the errors. this implies that an area’s lvi value is very strongly and positively associated with its contiguous areas’ lvi values and that policies to reduce vulnerability should not target areas in isolation; policy-makers should examine the cause and consequences of spatial spillovers that contribute to an area’s vulnerability. thirdly, the lagrange multiplier and robust lagrange multiplier statistics indicate that the preferred spatial econometric model is the spatial error model, although this is by no means definite. if there were strong theoretical reasoning to believe that the errors of an ols regression would be spatially autocorrelated, then the appropriate technique is to estimate a spatial error model, which in our case is specified as follows: where in which ρ represents the spatial error parameter to be estimated, w represents our spatial queen-weights matrix such that wu captures the spatial lags of the model’s disturbance term, u, and ε represents the independently distributed error term. under this specification, spatial autocorrelation of the lvi is the result of exogenous influences captured in the error term and not directly from the gdp explanatory variable. selection of the spatial error model tends to be because of the list of explanatory variables excluding a variable that may have otherwise captured the spatial autocorrelation of the lvi. the results of the spatial error model are also presented table 4. the spatial error results are noticeably different from the ols results in the following ways. firstly, lambda is positive and strongly statistically significant. this indicates that the spatial component in the error term is capturing some positive spatial autocorrelation, again suggesting spatial spillovers between contiguous areas are important in influencing an area’s economic vulnerability. secondly, inclusion of lambda strongly affects the coefficient of gdp. interpretations of this effect can be numerous. one option is that the ols coefficient for gdp included both the effects of gdp on lvi and the spatial spillover component and that entering the spatial spillover effect separately reveals the effect of gdp on lvi once we hold the spatial spillover effect constant. contrary to the ols results, the magnitude of the gdp coefficient is now less than unity, suggesting that a one-unit increase in gdp will result in a smaller than one-unit increase in the lvi. now this leads to the conclusion that, on average, gdp has a smaller than proportional effect on the lvi, thereby emphasising that although gdp is important in the alleviation of vulnerability, the economy needs to grow substantially more to achieve a measured reduction in vulnerability than was suggested in the ols results. thirdly, although the proportion of the variation of the lvi that is now explained by the model has increased substantially from 0.36 to over 0.7, there is still evidence of spatial dependence as indicated by the likelihood ratio test. as the lagrange multiplier tests were not conclusive about whether the model should be estimated with either a spatial error or a spatial lag, it is worth complementing the spatial error results with the spatial lag results. the spatial lag model captures spatial autocorrelation as an explanatory variable, which in our case will take the following form: in our formulation, wlvi is the queen-contiguous spatially weighted average of the dependent variable for area i and λ is the spatial lag parameter to be estimated. although the results of the spatial error and spatial lag models originate from different theoretical concerns for the origins of spatial spillovers, our results for the spatial lag and spatial error models effectively corroborate each other: the magnitude of the impact of gdp on the lvi is positive and around 0.8, and therefore, gdp does not have a more than proportional effect on lvi. therefore, there may be important roles in vulnerability alleviation associated with factors other than stimulating gdp. the residuals of the three models whose results are presented in table 4 were retained, as before, to identify the top and bottom ranked areas and are presented in tables 5 and 6. a number of important issues that corroborate our previous results can be made. table 5: top ranks by model. table 6: bottom ranks by model. firstly, the most consistent set of results are identifiable for the top seven regions. all three model estimates suggest that cape town is the least vulnerable. all three models suggest that the next six areas are consistently in the top 15 area for low amounts of vulnerability. these results hold when the spatial and aspatial perspectives are accounted for, but this time using the spatial error and spatial lag models. also of note is how the magnitudes of the residual values are relatively stable, large and positive for these seven areas. secondly, there is substantial rank switching at the bottom end between the aspatial and spatial models. for instance, out of the bottom 20 in the ols, only six remain in the bottom 20 using either of the spatial models. also noticeable is that there is substantial rank switching at the top end between the aspatial and spatial models. for instance, ignoring the top seven, out of the next 13 in the ols results, only two remain in the top 20 using either of the spatial models. taken together, these results indicate that the method of analysis is important when identifying the relative vulnerability position of areas. thirdly, when the magnitude of the difference in the residual values are observed, it appears that the gaps in vulnerability are much smaller between areas that do not make up the top seven, which are areas that are very urban. this highlights the importance of the urban–rural divide in vulnerability terms and that the beneficial effects of urbanisation on vulnerability does not reach far into rural areas to alleviate vulnerability. caveats, conclusions and avenues for future research this article aimed to provide a purely methodological contribution to the existing literature regarding measurement and analysis of regional vulnerability through extending the methodology introduced by naudé et al. (2009b). through augmenting and expanding on their index methods, emphasis was placed on the need for recognition of the spillovers in economic vulnerability that may be present within a country at a sub-national level. vulnerability indicators therefore must take into account spatial spillovers if they are economically significant. application of the extensions to south african magisterial district data illustrates the presence and importance of spatial spillovers in shaping local vulnerability. it is argued that account of spatial spillovers is an important issue if full and accurate vulnerability indices are to be identified. our results illustrate a clear urban–rural vulnerability divide and the need for appropriate policy. if policies are going to be focused on improving vulnerability, then policy-makers must decide whether to invest in urban areas, where economic growth and development are typically at their greatest and where a vast majority of a country’s population resides, or across whole swathes of countryside, and achieves a more holistic reduction in vulnerability. governments should be aware that if they choose the wrong policy, then they may accentuate the problem and it would appear that their policies have failed. although this article does make a methodological contribution and will influence future regional vulnerability studies, it is not without its caveats. the lack of addressing institutional quality, which is highly uneven across magisterial districts and is evident from the rise in violent protests against lack of service delivery, is unfortunately a domain this article cannot capture with the present available regional data set. avenues for future research should be aimed at reproducing this article with the most recent data available in order to determine possible changes in vulnerability patterns which could be because of possible changes in south africa’s economic landscape. with the fourth wave of national income dynamics study (nids) 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in-depth discussion on the empirical and conceptual viewpoints of economic vulnerability, see briguglio (1995) briguglio and galea (2003) and atkins, mazzi and easter (2000). guillaumont (2009) suspects that there has been an upsurge in interest concerning macro vulnerability because of the unsustainability of growth episodes and contemporaneous increase in poverty rates in africa, the asian crisis’ unveiling of emerging markets’ vulnerability and the debate surrounding the construction of an appropriate vulnerability measure that can be applied for specific country groups. 2. baliamoune-lutz and mcgillivray (2008) identify that the world bank’s country policy and institutional assessment (cpia), under which a country is classified as being more or less vulnerable, has some severe flaws that can result in the incorrect classification of countries located close to classification boundaries. unfortunately, this has significant policy implications as cpia ratings are used in deciding how international development association (ida) assistance is allocated. 3. for further studies on country-specific vulnerability, see birkmann (2007), easter (1998), marchante and ortega (2006), mansuri and healy (2001) and mcgillivray, naudé and santos-paulino (2008). 4. other household level vulnerability studies include glewwe and hall (1998), chaudhuri, jyotsna and suryahadi (2002) and kühl (2003). 5. the direction of causation should remain a moot point, although it is not explicitly addressed here. greater income per capita should permit development that reduces vulnerability, but lower vulnerability should permit more efficient allocations of resources that should stimulate greater income per capita. 6. advantages of the pca technique include that: (1) it does not require the assumptions of correlation between variables that are due to a set of underlying latent factors (as would need to be the case when applying factor analysis); and (2) the application of pca should permit in-depth comparison of results with naudé et al. (2009b) and permit methodological development. 7. other approaches followed include: glaeser et al. (2000) which standardised responses to various survey questions and then simply adding them together in order to derive an index of trust; and mauro (1995) uses the average of indices – such as political and labour stability, corruption and terrorism – and then uses this average as a regressor in models of growth and investment across countries and to determine institutional efficiency and corruption. he deems his strategy as correct because many of these indices measure the same fundamental trend. lubotsky and wittenberg (2006) proposed that a regression with multiple proxies might provide better results than that of principal components. 8. the choice of using ten domains and its associated variables comes from indices compiled by the cpia, cifp (2006), usaid (2006), anderson (2007), liou and ding (2004), briguglio (1997) and turvey (2007). however, the range of variables used differs across these studies and number from 70 to 3. 9. the direction of causation should remain a moot point, although it is not explicitly addressed here. greater income per capita should permit development that reduces vulnerability, but lower vulnerability should permit more efficient allocations of resources that should stimulate greater income per capita. 10. friedmann (1963) argues that a country could be divided into the following development areas: (1) metropolitan development, (2) transitional-upward, (3) frontier regions and (4) transitional-downward areas. although each area has its own local development opportunities, they do form a spatial system, and a country’s rate of growth would be constrained if it ignores the problems of the less developed and more vulnerable transitional-downward areas. thus, any policy decisions should explicitly consider surrounding areas. ward and brown (2009) argue that regional policy should be directed towards low developing regions but they warn that a ‘one-size-fits-all’ policy is not the way to go and that policy should be changed according to the area-specific problems. 11. net national income (nni) is gross domestic product plus net receipts of wages, salaries and property income from abroad, minus the depreciation of fixed capital assets (dwellings, buildings, machinery, transport equipment and physical infrastructure) through wear and tear and obsolescence (oecd 2015). 12. the spreading of hiv and aids is also a big concern for south africa and mcdonald and roberts (2006) argued that the marginal impact on income per capita of a 1% increase in the prevalence rate is minus 0.59%. 13. when comparing south africa to other countries, it is interesting to note that she has a vulnerability index score placing her alongside france and poland (briguglio & galea 2003). however, naudé et al. (2009b) argued that there is exceptional variation in the degree of vulnerability across her regions with large spatial variations in economic activities and institutional qualities contributing to uneven social and economic conditions. 14. to undertake these tasks, we employed the geoda open source software. this is free software and was developed at the spatial analysis lab at the university of illinois. it can be downloaded from: https://www.geoda.uiuc.edu/. 15. that is any area that shares a common boundary with area i. throughout this article, a queen-contiguity spatial-weights matrix is employed, and statistical significance of moran’s i statistics is based on the randomisation approach with 999 permutations. 16. of particular note is that the results of calvo (2008) suggest that the urban–rural vulnerability divide in peru was not significantly increasing over time; our results, which use annual data between 1996 and 2006, indicate that this vulnerability divide is increasing in south africa at a time when, and explicitly after 2000, policies are focused on achieving millennium development goals. 17. one much highlighted issue concerning rankings is that they are highly sensitive to gaps in the underlying parameter. for instance, although the lvi estimate varies by a substantial margin of over 4 between the bottom 20 districts, the lvi value between the 20th and the 335th is only 2.5. 469 sajems ns vol 3 (2000) no 3 formal rural financial markets in nigeria: an attractive or deceptive development alternative? gabriel s umoh department of agricultural economics/extension, university of uyo, nigeria abstract this paper uses the outreach paradigm to examine the role of two formal rural financial institutions (nigerian agricultural cooperative bank and people's bank of nigeria) in development financing in nigeria. findings show that the two institutions have fared relatively well in the outreach to their target clientele, except women. the paper also suggests that for wider outreach, effective linkage with rural self-help is necessary. 1 introduction during the last part of the 20th century, concerted efforts were made around the world to accelerate the pace of economic development. the rural areas received increased attention, particularly in the developing countries, during the period. this attention arose from the realization that almost everywhere, a firm foundation of rural development had be ;ome an es.;ential precursor of industrial growth and urban employment. different approaches were adopted to find a solution to the problems of underdevelopment of the rural areas. much of the earlier work centred on transfer of technology from developed to developing countries. capital intensive technology was felt to be the answer to quick development. the results were however less desirable; as abasiekong (1982) reported, hospitals were built but there were few doctors; skilled labour was not available to run machines. there was also lack of local funds to pay recurrent costs, labour was displaced without alternatives for the unemployed and tractors were idle because spare parts were not available. providing affordable credit to the rural population has also been a prime component of the development strategy. advisers from rich western countries have observed the underdeveloped state of capital markets in the developing countries, and pushed for the monetarization of these states through the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 470 expansion of financial institutions. the first and "traditional" approach was to establish more private and state banks in the hinterland. this approach was adopted because it was perceived that the informal rural financial sector could not effectively meet the financial needs of rural entrepreneurs, in any meaningful economic activities which could ensure sustainable development of the rural areas. in nigeria, the rural financial market has witnessed massive government intervention. the problem was seen as a shortage of capital in rural areas, a lack of modem technology in agriculture, limited savings capacity and the predominance of informal financial service providers as the sole source of capital. the subsidized state development banks such as the nigerian agricultural and cooperative bank ltd and the peoples bank of nigeria, were employed as mechanisms to distribute funds which were to give impetus to productivity in agriculture. other credit enhancing schemes, and enabling interventions to aid the development of the rural sector, included mandatory lending to the agricultural sector by the commercial and merchant banks, the rural banking scheme of the central bank of nigeria, the nigerian agricultural credit guarantee scheme, the nigerian agricultural insurance scheme and, to some extent, the family economic advancement programme. however, starting from the mid-1980s when nigeria adopted the structural adjustment programme (sap), the macroeconomic policy thrust changed from that of intervention to liberalization which emphasises less and less government involvement in economic activities that can be handled by the private sector. this change in economic policy (which has swept across the developing world), brought with it a new approach to financial markets. this stresses setting up financial institutions with a wide outreach which fulfil an intermediary fimction and, in addition to demand-oriented credit services, also offer savings services. this system-based approach takes into consideration the entire set of financial institutions, financial markets and their legal, economic and institutional framework (mbz sector concept, 1994). both theoretical and empirical literature affirm that credit is necessary for the development of an economy. two ways of looking at achieving the development objective of a microcredit scheme/institution, would be to examine its impact on the economy or its capability to meet expected functions and objectives. this approach embodies such indices as sustainability and outreach. given the various rural credit schemes/institutions in nigeria and their potential roles in rural development, the question arises: are these schemeslinstitutions sustainable? and: do they meet the needs of all intended targets/clients? the formal rural financial markets would seem attractive development alternatives if r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 471 sajems ns vol 3 (2000) no 3 the financial institutions/schemes that make up the market are self-sustainable and have high levels of outreach. they would however be considered deceptive development alternative if they do not possess these characteristics. this is so because they cannot be relied upon to usher in the desired development of the rural economy, and ultimately the entire economy. the use of the sustainability and outreach indices to measure the performance of formal financial institutions have been suggested by many scholars (yaron, 1992; aryeetey, 1996; schrieder et al., 1999; soyibo et al., 1999; febig, 1999). self-sustainability is the ability of a financial institution to generate enough income to cover at least the opportunity cost of all employed factors of production and its own assets, also being able to honour all its liability as when due (yaron, 1992; chaves and gonzalves-vega, 1993). service delivery is an important component of outreach and sustainability. a well packaged and delivered service would attract customers, thus savings would increase and the loans and investments of the institution also improve (soyibo et al., 1999). this would ultimately enhance the development of the national economy. this paper analyses, within the limit of available data, the performance of two selected formal rural financial institutions/schemes (the nigerian agricultural and cooperative bank ltd and the peoples bank of nigeria) using the sustainability paradigm. the paper is structured into six sections. section 2 that follows this introduction, contains the conceptual framework and a literature review. in order to place the discussion in its proper perspective, an overview of the evolution of formal rural financial markets in nigeria is presented in section 3, while the performance of the selected formal rural financial markets is given in section 4. the missing link and the way forward in rural financial markets development and a conclusion follow in sections 5 and 6 respectively. 2 conceptual framework and literature review frequent reference is made in this paper to the following terminology: rural financial markets (rfms) or rural financial institutions (rfls), which embrace both formal rural financial markets (frfms) or institutions (frfls), and informal rural financial markets (lrfms) or institutions (irfis). on one hand, the operations of informal financial markets cover all financial transactions that take place outside the functional scope of banking and other financial sector regulations. these include the activities of the savings and credit associations, money lenders, traders, friends and relations, etibe (lbibio) and daily collectors (mobile bankers), and cooperative societies. formal rural financial markets, on the other hand, are mainly owned by the public sector and donor agency supported, unlike the informal rural financial markets. their operations are r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 472 usually documented with tenns agreement clearly specified (soyibo et al., 1999). in the same vein, fiebig (1999) has said the fonnal financial institutions are subject to the provisions of the banking laws and other specific regulations governing the financial sector. his definition includes the central bank, public and private sector banks, specialized financial institutions such as savings banks and credit cooperatives, as well as the capital markets. the infonnal rural financial institutions (lrfis) operate outside this legal framework; instead of legally protected contracts, social control mechanisms and nonns dominate. the evolution of the fonnal rural financial markets (frfms) have been explained by using a number of paradigms. the first explains the existence of an frfm based on the monopoly tendency of the supplier of credit in the infonnal rural financial markets. according to this view, interest rates charged and paid in the irfms are unnecessarily high. this is expected to affect the economic development of the rural areas negatively and the raison d'etre of frfms is to provide "cheap" alternative financial facilities to the rural population and thus promote the development of this group. the second view is embedded in classical theory. this perceives the observed high interest rates of the frims as reflecting perfect credit markets incorporating a high risk of default in the rural areas (stigler, 1967). the third paradigm explains rural financial markets in the context of imperfect infonnation and contracts. this view has it that the activities of rural financial markets centre on providing solutions to the three main problems of screening, incentives and enforcement. scholars have been critical of all the above paradigms, particularly the coexistence of both fonnal and infonnal financial institutions (stiglitz, 1990; soyibo, 1997). for instance, the monopoly view sees the infonnal financial institutions as being an inferior source of finance to rural areas, and fonnal rural financial institutions are then expected to attract patronage away from the irfis due to the assumed lower interest rate in the frfis. however, the irfms have in fact tended to flourish in the presence of "cheap" alternative rural finance. available evidence thus shows that the activities of irfms have increased with policy refonns in the sub-saharan african countries (aryeetey, 1996a, 1996b). soyibo et al. (1999) assisted in solving the problem when they summed up that there is no single paradigm that fully explains the workings of the rural financial market. rather, they all provide some insight into the understanding of the market, and the knowledge so gained would be useful in a meaningful design of fonnal rural financial institutions. this points to a very important issue in financial intennediation. that is: in countries where frfis are already in place, are they perfonning in a way that their ultimate aims of establishment will be r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 473 sajems ns vol 3 (2000) no 3 attained? for instance, would the theoretical expectation that the availability of credit would translate into development be achieved? an attempt to answer these important questions, has been the basis for assessing the performance of formal rural financial institutions. in the forefront of the evaluation of the rfls are scholars like yaron (1992, 1994) and gargand et al. (1996). they based their evaluation on the concept of outreach and sustainability, arguing that the traditional quantifiable measures of success profit figures and other such criteria are not helpful in evaluating the formal rural financial institutions. yaron argued that two objectives are paramount if a rural finance institution is to be successful: financial selfsustainability and outreach to the target rural population. financial selfsustainability is achieved when the return on equity, net of any subsidy received, equals or exceeds the opportunity cost of funds. the inverse of selfsustainability is dependence on subsidies. it is therefore desirable that the frfi depend less and less on the government or donor agencies to become selfsustainable. yaron gave the following criteria for measuring the selfsustainability ofa formal rural financial institution: positive on-lending that is high enough to cover non-subsidized financial as well as administrative costs, to maintain the value of equity in real terms. high rate of loan collection. deposit rates that are high enough to ensure that savings become increasingly significant in financing loan portfolios. administrative costs must be contained through efficient procedures for assessing investment plans, screening borrowers, processing loans, collecting repayment, and mobilizing and servicing savings to ensure that lending rates do not become prohibitive. these criteria were used to develop a subsidy dependence index (sdl) given as: sdi = s/(lpn) where s := annual subsidy received, lp = average annual outstanding loan portfolio, n = average on-lending interest rate of the rural financial institution. the subsidy dependence index measures the percentage increase in the average on-lending interest rate required to compensate for eliminating subsidies, including the subsidy a formal rural financial institution receives through paying interest below the market rate on its borrowed funds. an sdi of zero means that and frfi is fully self-sustainable. an sdi of 100% indicates that a doubling of the fris average on-lending rate is required if subsidies are to be eliminated. a negative sdi indicates that the frfi not only has achieved self-sustainability, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 474 but that its annual profit, minus imputed return on capital as calculated by applying the appropriate market interest rate, exceeds the total annual value of subsidies or that the frfi does not receive any subsidies, and the return on equity exceeds the cost of imputed capital. a negative sm also implies that the frfi could have lowered its average on-lending rate while eliminating any subsidies received in the same year. a fair amount of empirical research has been done in this context. yaron (1994 used the sm to asses whether the following four institutions were making progress toward self-sustainability: badan kredit kecamatan (bkk) and bank rakayat indonesia unit desa (bud) in indonesia; the bank for agriculture and agricultural cooperatives (baac) in thailand and gremaen bank (gb) in bangladesh. the data indicated that the four rfis differed substandially in their level of dependence on subsidies. a subsidy dependence index applied to the krep programme by kiiru et al. (1995) again revealed a high level of dependence on subsidies. a recent report by bomda (1999) on the operation of four mutuelle communaltaire de croissance (mc2) rural microbanks in cameroun, showed that the mc2 were gradually reducing their level of dependency on subsidies. it also showed a correlation between the level of sm and the age of the mc2. women's participation was found to be increasing, representing around 20% of active members in 1998, more than 60% of whom live in rural areas. women's participation as a component of outreach is another relevant rural finance institution perfonnance index. given the objective of a given rural finance institution, it is expected to cover many borrowers who were hitherto not served. yaron (1994) submitted that outreach can be measured by: the value and number of loans extended, • the value and number of savings accounts, the types of financial services offered by the rural financial institution, • the number of branches and village posts/units, • the age distribution of total rural population served, • the real growth of rfi assets over recent years, and • women's participation. several scholars have employed these outreach measures to assess the perfonnance of microfinance institutions. such assessments by christen et al. (1995) and webster and fidler (1996), revealed that the number of borrowers reached by micro finance programmes in africa is lower than those reached by successful institutions in asia and latin america. they found that the largest microfinance institutions in africa reached only as many people as some of the smallest institutions in asia and latin america. the west african microfinance r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 475 sajems ns vol 3 (2000) no 3 programme studies by webster and fidler was only marginally larger, with most institutions having fewer than 10 000 borrowers. 3 evolution of formal rural financial markets in nigeria in most countries, government intervention or involvement in financial intermediation is often an attempt to provide safety nets for vulnerable groups such as the poor and women. the development of formal rural financial institutions in nigeria arose from the dearth of banking services in the rural areas. to ensure that farmers were not discriminated against in credit allocation, several rural credit institutions/schemes were put in place. to give our discussion a proper perspective, we group events into the pre-1970 period, the period 1970-1980, and 1981 to present date. 3.1 pre-1970 period in the pre-1970 period, there was virtually no national government involvement in the credit programmes for the rural areas. most activities were coordinated by the regions. for instance, in the western region, there was the agricultural credit corporation which made significantly different types of loans to cocoa, rice, maize and other crop producers and marketers. there were individual as well as group loans. individual loans to farmers were disbursed to the groups to be "on-loaned" to individuals. the groups were charged 7~% interest by the credit corporation and the funds were "on-loaned" to individuals at 15% interest to defray administrative costs (miller, 1974). 3.2 the period 1970·1980 the 1970-80 period could be described as the real period of growth of the rural financial market in nigeria. the period witnessed multiple policies, programmes/schemes and emergence of institutions, all aimed at injecting more funds into the rural areas. the nigerial agricultural and cooperative bank ltd, the rural banking scheme, and the agricultural credit guarantee scheme were established during this period. the nigerian agricultural and cooperative bank (nacb) ltd: the nacb was established as the institution at the apex of agricultural development finance. its specific objectives include granting loans and advances for agricultural production, assisting entrepreneurs in agriculture and agro-based enterprises, and rendering consultancy and other technical and professional services to commercial, industrial and individual establishments. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 476 the nacb has several schemes including on-lending; direct lending, a smallholder direct loan scheme, a special smallholder loan scheme, workers schemes and marketing loans. the smallholder direct loan scheme was designed to reach farmers directly. it includes loans activities with a ceiling not in excess ofn25 000. specific programmes operated here include: a) special projects, for example, nacb/ilo/fmh revolving loan, artisanal fisheries project and ecowas fund artisanal fisheries loan. b) smallholder project, which is exclusively funded by nacb. c) the second livestock development project. in 1992, the bank instituted a revolving loan fund specifically for rural women's income generating activities. the rural banking scheme: the rural banking scheme was introduced in nigeria in 1977. the scheme came about as a result of the overconcentration of banks in the urban areas to the neglect of the rural areas. to assist in the development of rural areas by making funds available for investment, commercial banks were required to open branches in the rural areas and extend as credit to the rural dwellers about 45% of the savings mobilized within a rural area. in 1992, the minimum share of total deposits generated by rural banks which must be given as loans and advances in rural localities was raised above 50%. the scheme was implemented in phases. in june 1991, which was the end of the third phase, total deposits had increased to n8.3 billion 2!1d total loans to n5.1 billion, with 765 banking branches. the number of branches reduced to 763 during 1994, while deposits and loans in the same year were n8 807.1 million and n8 659.3 million, respectively (cbn, 1996). generally, the level of branches established in the rural areas was rated by lyare et al. (1991) to be 100%,96.6% and 38.6% for phase one, two and three, respectively. agricultural credit guarantee scheme (acgs): the acgs was established in 1977 by act 20 of the federal government of nigeria. the purpose of the scheme is to encourage by minimizing risk bank lending to all potential or actual participants in meaningful agriculture (as defined in the scheme's guidelines). the scheme provides guarantees in respect of loans granted by banks to agriculture, for both crop production and livestock rearing. there is provision for a fund of n i 00 million, contributed by the federal government (60%) and the central bank of nigeria (40%). under the scheme, the central bank of nigeria guarantees up to 75% of the value of the principal and interest on loans granted to farmers by a commercial bank. a maximum of n50 000 was to be granted to individuals and n 1 million for loans to cooperative and corporate bodies. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 477 sajems ns vol 3 (2000) no 3 in addition to the guarantee provision of the fund, the government also extends graduated tax free allowance to commercial banks on interest earned from agricultural loans depending on their duration. loans of less than 2 years have no tax exemption on interest earned, while loans of 2 to 4 years have a period of grace of at least 1 year and 40% tax free interest. longer term loans of over 7 years are 100% tax free with a period of grace of at least 2 years. 3.3 1981 to present date the midi 980s until the present time has been a period of adoption and implementation of structural adjustment programme (sap) policies in nigeria. to cushion the adverse effects of the policies on the poorest segment of society, there are some transfer institutions and programmes, including the people's bank of nigeria (pbn) and encouragement to set up community banks and the family economic advancement programme (feap) of the federal government. the people's bank of nigeria (pbn): the people's bank of nigeria (pbn) was established in 1989 as a specialized development bank for the provision of financial services to the less privileged members of nigerian society. the pbn is 100% owned by the federal government of nigeria and about 99.9% of its loanable funds derive from the three tiers of government. with its policy of providing banking services to the remote areas of the country, the bank draws its customers primarily from the informal sector. the pbn had 745 branches and ~2 834.6m deposits as at 1995. the community bank (cb): in 1990 the babangida administration encouraged communities to set up a community bank in their localities. ownership of the cb is strongly community-based. the design of the nigerian version was to correct the anomalies of the specialized banks/financial institutions which tended to ignore the rural/grass root communities. the cb system commenced operation with the opening of the first community bank in kaduna in december 1990. the bank has as its objectives the promotion of rural development through the provision of financial and banking services, inculcating the habit of banking in rural people, fostering the spirit of community ownership, and generation of credit from within the communities. the banks provide credit, deposit banking and financial services to its members, largely on the basis of self-recognition and personal creditworthiness. the also perform some non-banking services. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 478 the family economic advancement programme (feap): the family economic advancement programme (feap) was established principajiy as a poverty reduction programme by the decree ii of august 12, 1997. its aim was to be achieved through the provision of capital by loans directly to people at ward level, to enable them to set up and run cottage enterprises. the federal government provided the funds for the commencement of the programme to the participating banks, under the supervision of an feap board through the feap secretariat. subsequent funding was to involve the participation of states, local governments the private sector, international agencies and organizations, as well as ploughed back income earned by the feap. these formal rural financial institutions/schemes are at various stages of implementation. the assessment of the performance of two of them is given in the next section. 4 performance of two selected formal rural financial institutions (nacb and pbn) in order to establish whether the formal rural financial institutions are an attractive development alternative, the extent to which they perform their functions reaching out to target population was investigated. ascertaining the self-sustainability of selected institutions was not possible, as a sustainability dependence index (sol) could not be computed due to data limitations. for this reason, only outreach measures are used here. outreach is assessed on the basis of the type of clientele served and the variety of financial services offered, including: value and number of loans extended, • the value and number of savings accounts, the percentage of total rural population served, and the participation of women as clients. 4.1 outreach performance indicators of outreach (tables 1-3) need to be considered in the context of the stated objectives of each institution, which define the target clientele. the information in table 1 shows that the nacb has as its objective the provision of finance to the rural population, particularly farmers. this is done by means of credit delivery, monitoring and evaluation. the people's bank of nigeria, founded in 1989, is also engaged in development financing. its clientele extends beyond farmers to other rural entrepreneurs as well. however, its activities are similar to those of the nacb. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 479 sajems ns vol 3 (2000) no 3 in tenns of loans and advances, the perfonnance of the nacb has not been impressive. table 2 shows that the amount lent and advanced ranged from ~ 104.2 million in 1994 to ~43.9 million in 1998. the smallest amount of loans/advances was made in 1996 ~10.5 million}. the percentage change in loans/advances was -93.2, -l.l, 19.7 and -9.6 in 1995 to 1998 in that order. for the pbn, loans/advances have been on the increase, thus the percentage changes have also remained positive. the results here therefore seem to show that the people's bank is improving in its loans/advances outreach compared to the nigerian agricultural and cooperative bank. if this is viewed from the angle of the age of these institutions, (nacb was established in 1973, pbn 1989), it may be concluded that the younger institutions are doing better than the older ones. however, given the target clientele of the two institutions, the pbn would be expected to lend more, given its clientele which comprises all small-scale entrepreneurs including fanners, while the latter happen to be the only clientele ofthenacb. 4.2 staff performance and outreach the staff perfonnance and outreach indicators in table 3 show that both the nacb and pbn have been able to reach a wide spectrum of clientele by their lending activities. the number of activities financed were 14 689 and 7 107 for the two banks, respectively. average loan sizes were wi2 475238 for nacb and wi4 845 for pbn. the nacb and pbn achieved 21.04% and 16.53% loan collection, respectively, in 1994. however, the percentage of population served and women as a percentage of total clients are quite low. this means that the women credit programme of the nacb started in 1992, is yet to have reasonable impact on the target group. again, this suggests that these institutions have to do more in tenns of react,ing out to more clients, particularly women. the value of loans per staff indicate that the nacb did better than pbn in 1994. with 1.59 and 107.63 as number of loans per staff, worth w249 805 and wi77 636.7 for the nacb and pbn respectively, clearly pbn lends more per staff than nacb. the pbn seems more prudent in tenns of administrative expenses in relation to average loan volume. it is instructive that the nacb has to reduce its administrative expenses, if it is to depend less on subvention from government to carry out its operations. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 480 table 1 general information and outreach of nigerian agricultural and cooperative bank and people's bank of nigeria (1994) nigerian agricultural and people's bank of nigeria cooperative bank year established 1973 1989 objectives development of rural finance development financing types of development finance development finance institution institution institution ownership ~ .................. federal government federal government region the whole country the whole country clientele • farmers small scale entrepreneur activities • credit delivering, monitoring credit delivery, monitoring and evaluation and evaluation table 2 loans and advances (nom) of nigerian agricultural and cooperative bank and people's bank of nigeria (1994-1998) 1994 1995 1996 1997 1998 nacb 6104.2 415.2 410.5 491.3 443.9 i loans/advances percentage change over pre-93.2 -1.1 19.7 -9.6 cl: ear pbn 178.2 340.0 350.0 360.1 400.5 loans/advances ~ ..... 90.8 2.9 2.9 11.2 percentage change over preceding year ~. source: central bank of nigeria, annual report and statement of accounts, various issues. table 3 outreach: loans and savings (no), 1994 i nigerian agricultural people's bank and cooperative bank of nieeria average loan size (n) 12475238 14845 ~<lgf!4~posit (n) na 63587 loan outstandirtg {n} 2483705 13974998 annual loan collection (%) 21.04 26.53 number of activities financed 14689 7107 loan approved (n) 3820945 na loanrepayment(n) 2013945 2178443 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 481 sajems ns vol 3 (2000) no 3 table 3 continued er staff average nigerian agricultural and cooperative bank 4 249805 28.7 6286 13.2 1.73 people's bank ofni eria na 108 na 177 637 7.7 source: soyibo et al. (1999), assessment of the performance of nigeria's rural financial institutions. 5 the missing link and the way forward generally, the various outreach indicators tend to point to the fact that the nigerian agricultural and cooperative bank and the people's bank of nigeria have made commendable efforts towards their objective of making credit available to the rural population. however, the two institutions have continued to depend on government for subvention. for the banks to be self-reliant so that they can sustainably assist in rural development, they should be able to efficiently manage the resources available to them. this would mean that they have to reach out to a large number of clients, offer new and acceptable products to them, effectively mobilize savings and collect debts. one way of achieving all or most of these goals, is for these formal financial institutions to link up effectively with the informal rural financial institutions. soyibo (1996) found the linkage between the informal financial sector and the banks in nigeria to be rather weak, narrow and shallow. therefore, a stronger link between these institutions is desirable if the rfls are to be an attractive development alternative. we are aware that the pbn is reaching out to individuals in the rural areas through its mobile banking arrangements. but links with informal associations such as etibe, self-help groups (not necessarily the co-operative societies) and "family meetings or groups" are also necessary. umoh and ibanga (1997) found that family groups are a realistic platform for development purposes. such a linkage can ensure a two-way flow of funds. first, within the rural economy and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 482 second, between rural and urban economies. such a model can then be used to develop interfamily financial assistance as is, for example, the case with exchange labour and interchurch financial assistance, popularly called "combined service". 6 conclusion our analysis shows that the nigerian agricultural and cooperative bank (nacb) and the people's bank of nigeria (pbn) are making efforts in financial intermediation for the sustainable development of the rural economy. however, there is need for improvement in their operations if they are to serve as an "attractive development alternative". particularly, these institutions and indeed the entire nigerian economy stand to gain if the existing social units in the rural areas, such as family and self.help groups, are properly linked with one another in the effective harnessing of rural financial resources. references abasiekong, e.m. (1982) integrated rural development in the third world: its concept. problems and prospects, exposition press, smith town, new york. 2 areetey, e. (1996a) "informal financial markets in africa", in: forging links: economic research and policy making in sub·saharan africa, paper presented at the 1995 senior policy seminar. 3 areetey, e. (1996b) "rural finance in africa: institutional developments and access for the poor", annual world bank conference on development economics, the world bank, washingtoll dc. 4 bomda, j. (1999) "the mc2 network as an example for private initiative", a case study from cameroun, agriculture and rural development, 6(2):48·50, cbn, lagos. 5 central bank of nigeria (cbn) (various issues) annual report and statement of accounts, cbn, lagos. 6 chaves, r.a. and gonzalez-vega, c. (1993) "the design of successful rural financial intermediaries: evidence from indonesia", economic and sociology occasional paper no 2059, rural finance programme, department of agricultural economics and rural sociology, ohio state university. 7 christen, r.p.; rhyme, e. and vogel, r.c. (1994) "maximizing the outreach of micro-enterprises finance: the emerging lessons of successful programmes", consulting assistance for economic reform paper, imcc, washington dc. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 483 sajems ns vol 3 (2000) no 3 8 fiebig, m. (1999) "fonnal and infonnal financial services providers in rural financial markets", agriculture and rural development, 6(3): 3340. 9 gurgand, m.; penderson, g. and yaron, 1. (1996) "rural finance institutions in sub-saharan africa: their outreach and sustainability", savings and development, xx(2). 10 kiiru, w.k.; pederson, g.d. and nzioka, c. (1995) "kenya rural enterprise programme: a case study of sustainable microfinance scheme", environmentally sustainable development, world bank, washington dc. 11 miller, l.f. (1974) "using group loans to extend production credit to small fanners in nigeria", technical report, department of agricultural economics and extension, university of ibadan. 12 schrieder, g.; hannig, a.; kloppinger-todd, r. and marpmann, h. (1999) "the role of the central bank in setting up effective rural finance system: the case study of uganda", agriculture and rural development, 6(2): 41-43. 13 soyibo, a. (1996) "financial linkage and development in sub-saharan africa: the infonnal financial sector in nigeria", overseas development institute working paper 90, om, london. 14 soyibo, a.; edu, a.o.; ogunkola, e.o. and ajiboye, a. (1999) "assessment of the perfonnance of nigeria's rural financial institutions" final report submitted to the central bank of nigeria and the world bank. 15 stiglitz, j.e. (1990) "peer monitoring and credit markets", the world bank economic review, 4(3): 351-66. 16 umoh, g.s. and ibanga, 1.0. (1997) "an alternative microcredit delivery model for poverty alleviation in nigeria", it'): poverty alleviation in nigeria, nigeria economic society: 521-32. 17 webster, l. and fidler, p. (eds.) (1996) the informal sector and microfinance institutions in west africa: a regional and sectoral study, the world bank, washington dc. 18 yaron, j (1992) "successful rural finance institution", world bank discussion paper no iso, the world bank, washington dc. 19 y aron, j. (1994) "what makes rural finance institutions successful?", the world bank research observer 9(1): 49-70. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 143 petroleum and its consequences for prices, employment and wages in nigeria 1 richard llorab department of economics, university of the north abstract the availability of oil resources in nigeria has had a profound impact on the economy, particularly the economy's sectoral structure. although the oil sector itself never did put pressure on the other sectors directly, since its labour requirements were negligible, the policy response by the authorities towards the oil revenue inflicted adverse effects on the agricultural sector. exchange rates appreciated both in nominal and real terms, the latter considered to be a spending effect of the oil boom. consequently, labour costs increased in terms of the exogenously determined agricultural product prices. the oil resource, undoubtedly, contributed to nigerian agricultural deterioration. jel 33 the nigerian government had, before the 1970s, relied heavily on agricultural exports for its foreign exchange. such agricultural products included cocoa, palm produce (palm oil and palm kernel), groundnuts, rubber and cotton, all of which accounted for over 50% of the government total export earnings. these primary exports were produced by peasant farmers who then sold the crops to the government, through the commodity marketing boards (cmb), at prices below the world market prices. the cmb set the domestic prices of the products in such a way that farmers received prices that were below the world market prices. the difference between the world market prices and those paid to farmers were considered as taxes, comprising commodity taxes, export duties and produce purchase taxes, all of which became government revenue. during the 19705, following the oil boom in the country, the commodity taxes on the agricultural exports were greatly reduced. in many cases, they were substituted by subsidy payments to farmers. during the same period, export duties and produce purchase taxes on these exports disappeared. the oil price boom and the taxes on r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 144 sajems ns vol 2 (1999) no i oil eliminated the need to finance government development projects through the taxation of agriculture. the reduction of taxes might be expected to have increased profitability in agriculture and incomes of farmers. but that was not the case. the powerful indirect transmission mechanism from the oil boom served to offset an improvement for agriculture. this paper focuses on the effects increased revenue from oil exports had on relative prices, sectoral structure of production, and wages. the period under study here does not exceed the second half of the 1980s for two reasons: firstly, the effect of the oil boom was mostly felt in the 1970s and the early 1980s; secondly, strange as it may seem, data availability in nigeria has deteriorated drastically in recent years. loll boom and agriculture: theory the theoretical part of this paper relies on the "dutch disease" literature that was developed in the 1970s and modified in the 1980s, for the study of the effects of resource booms2• let us briefly summarize the results from this literature for an economy with three sectors: the booming (oil) sector, the lagging (agricultural! manufacturing) sector, and the non-tradeable (services) sector. the booming and the lagging sectors produce tradeable goods facing given world market prices, whereas the prices of the non-tradeable goods are determined domestically. the analysis relies on jones (1971) and snape (1977), assuming only one domestically mobile production factor, traditionally considered to be labour (corden and neary, 1982), moving between all three sectors so as to equalize its wage in all three employments (corden, 1984). other factors are assumed to be sector-specific. the initial effect of a boom in the oil sector, due to an exogenous oil price increase in the world market, is to raise aggregate incomes of the factors initially employed there. if some part of the extra income is spent, either directly by factor owners or indirectly by the government through being collected in taxes, and provided the income elasticity of demand for non-tradeable goods is positive, the price of nontradeable goods relative to the price of tradeable goods must rise. this is real exchange rate appreciation. it is the spending effect of the boom. resources will be drawn out of the tradeable goods sector into the non-tradeable goods sector. in addition, there will be a rise in the marginal value product oflabour in the booming oil sector so that, at constant wages in terms of tradeable goods, the demand for labour in the booming sector rises, inducing labour movement out of the lagging and service sectors. this is a resource movement effecf. apparently, both the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 145 spending effect and the resource movement effect tend to draw labour from the lagging sector. any further development with regard to factor-based income distribution will depend on how the authorities dispose of the oil boom revenues (neary and van wijnbergen, 1984; corden, 1984; edwards, 1986), and on how the country's labour market functions (kaldor, 1976; corden, 1984; forsyth, 1986). an oil price boom could lead to accumulation of foreign reserves, causing a high rate of domestic money growth and excess money supply in the resource exporting country. the resulting spending effect will increase the nominal price of non-tradeable goods and further cause the real exchange rate to appreciate (edwards, 1986). there will be a further shift of labour from tradeable goods sector to non-tradeable goods sector and wages in both sectors will increase. the wage increase in the nontradeable goods sector is based on the assumption that factor rewards are related to output prices (warr, 1986), whereas the wage increase in the tradeable goods sector is induced by that in the non-tradeable goods sector. wages relative to prices will rise in the tradeable goods sector and fall in the non-tradeable goods sector (corden, 1984; warr,1986). the higher wages will raise the cost of the tradeable goods (lagging) sector and hence affect profits in that sector adversely, decreasing employment and output (corden, 1985b:283; forsyth, 1986). the adverse cost effects could be avoided through exchange rate protection that avoids appreciation, and keeps the current account balance unchanged, the exogenous capital inflow being matched by an increase in official reserves,4 or by (private) capital outflow induced by monetary policy (fall in the interest rate) (corden, 1985b:275). there would then be no rise in nominal wages. alternatively, the higher income of the booming oil sector may be siphoned off by taxes,5 while government expenditure is held constant. finally, the authorities could devalue the domestic currency, combined with expenditure reduction (reducing the public sector borrowing requirements). the result would be to generate a current account surplus (corden, 1981b, 1987:17-19). 2 oil boom and agriculture: evidence in this section, we relate the general prediction of the "dutch disease" to the nigerian experience. of particular concern in our exercise are the developments of: relative prices (real exchange rates), sectoral structure of production (output and employment), and the real wage. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 146 sajems ns vol 2 (1999) no 1 2.1 tbe effed on relative prices the dutch disease predicts a decrease in the ratio of tradeable goods to nontradeable goods prices. in nigeria, the tradeable goods are agricultural (primary) crops and manufactures, whereas the non-tradeable goods are services. manufactures comprise of imports and locally produced goods. some of the imports are rationed via import restrictions so that their domestic prices are not determined by world market prices, but rather by domestic demand and supply conditions. the locally produced goods are often close but not perfect substitutes for imports. often they contain both a tradeable and non-tradeable goods element. these factors constitute a serious problem in getting a clear picture of relative price developments in nigeria. therefore we shall rely on primary crops prices and urban formal wages as proxies for tradeable goods and non-tradeable goods prices, respectively. figure 1 shows the ratio offormal wage to aggregate price of primary crops. the figure shows that relative prices have remained in favour of non-tradeable goods and against agriculture, even with the commodity tax reductions and subsidy payments to farmers in the 1970s. the main factors responsible for that development were the macroeconomic and exchange rate policies pursued by the authorities, that remained biased against agriculture. based on the 1970 level, oyejide (1986) noted a real exchange rate appreciation of 62 percent between 1973 and 1980,6 while the world bank noted a real appreciation of 30 percent between 1974 and 1978, based on the 1970172 level. 7 (we return to discussing the diagram further at a later stage.) devaluation of the nominal exchange rate should have been one of the best policy options for the nigerian authorities during the period.s to the extent that devaluation has the effect of improving the domestic prices of tradeable goods relative to non-tradeable goods prices, this device can achieve, albeit temporarily, protection of the agricultural exports. but the nigerian authorities resisted any devaluation of the nominal exchange rate.9 they rather adopted a strategy of gradual nominal appreciation of the local currency, the naira, against the us dollar and british sterling. the primary argument by the authorities was to produce naira exchange rates that would adequately reflect the country's balance of payments position. 10 between 1973 and 1980, when the oil-related capital inflows were particularly significant, the nominal exchange rate appreciated by about 17 percent (oyejide, 1986:27). the nominal exchange rate policy adopted by the authorities strengthened the tendency of capital inflows to cause the real exchange rate to appreciate. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . !; o z ,....., 000-..... '-' n "0 > tfl z tfl ~ tfl figure 1: index of real wage* in nigeria (1948=100) (per cent) 900 tj-------------------------------------------------------------------------, 800 700 600 .. 01 j! ~ 500 ! 1ii 01 ~ 400 : 0: 300 200 100 0 ., ;;; :1. .... ~ ~ ~ :\l ~ ~ ~ year ~ ~ ~ ~ ~ '" .... '" ., en ! ~ * the real wage is the nominal wage deflated by the index of aggregate producer prices of the main primary crops. sources: annual reports of the commodity marketing boards (various issues); united nations statistics year book (various issues); helleiner (1966: 444·7); fos, economics and social statistics bulletin (various issues), r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 148 sajems ns vol 2 (1999) no 1 it was in an attempt to compensate the agricultural sector, which seemed to be carrying not only the burden already created by emb taxes but also a great deal of the burden of the appreciated exchange rate, that the authorities cut siown the taxes on export crops and intensified the payment of subsidies to primary crops producers. the tax remissions and subsidy payments could, in fact, be interpreted as political decisions to mitigate the negative effects on farmers' incomes by both the commodity taxes and the appreciating naira. 2.2 the effect on sectoral structure of production (output and employment) the dutch disease stresses the changes in sectoral shares in the domestic economic activity caused by a resource boom. the problem is that such changes in nigeria that are directly related to the oil boom are not altogether clear-cut. this is partly because the oil boom descended on an economy already undergoing gradual sectoral changes, and partly because the oil sector itself is highly capital intensive,11 as well as an export enclave,'l with spending effects but only modest resource movement effects. table 1 shows changes in the sectoral contribution to total nonoil gop (total gdp minus the oil sector's contribution) and total non-oil employment, for selected years during the period 1960-80. section (a) of the table shows that agriculture's shares in total non-oil gop followed a steady decrease throughout the sample period. the decrease was, however, more pronounced during the 1970s (24.7 percent and 25.8 percent for the periods 1970-1975 and 1975-1980, respectively) compared with the decrease during the 1960s (12.6 percent and 6.1 percent for the periods 1960-1965 and 19651970, respectively). agriculture also experienced the same pattern of development in its share of total non-oil employment. (see section (b) of the table). it appears that agriculture lost more of its labour share during the 1970s compared with its falling share in the 1960s. generally, the development in the agricultural sector is consistent with the dutch disease approach. it is important though to note that the changes in agricultural structures might have taken place even without the oil boom, though one may conclude that the boom obviously reinforced the changes (declines) in that sector. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no i 149 table 1: changes in sectorial contribution to non-oil gdp and employment, 1960-1980 (per cent) (a) shares in non-oil gdp at current factor cost sector 1960 1965 1970 1975 1980 agriculture 65.1 57.0 53.5 40.3 29.9 manufacturing 4.9 7.3 8.1 11.7 7.4 serivces 30.0 35.7 48.4 48.0 62.7 (b) shares in non-oil employment agriculture 80.1 78.1 75.2 64.2 60.2 manufacturing 11.9 13.1 15.0 16.9 17.1 services 8.0 8.8 9.8 18.9 22.7 sources: federal office of statistics (fos), national accounts of nigeria; fos, economics and social statistics bulletin, january 1985; oyejide (1986: 37) the pattern of development of the services sector's share in both non-oil gdp and employment, also shown in the table, are also consistent with the predictions of the dutch disease. its shares in both gdp and employment increased steadily during the entire sample period, with the increases in the 1970s surpassing those during the 1960s. compare the growth rates of the sector's employment shares, 92.2 percent and 20.1 percent for the periods 1970-1975 and 1975-1980, respectively, with the growth rates of 10 percent and 11.4 percent for the periods 1960-1965 and 1965-1970, respectively. according to the analysis of the dutch disease, an increase in spending on non-tradeables (services in nigeria) and a consequent real exchange rate appreciation results in an increase in the non-tradeables sector's output and employment. nigerian government expenditure in the 1970s was spectacular by any standards. see figure 2 for a summary of government budget balance. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . ~ figure 2: --60 ~ 0'1 -......., n 50 '0 :> c;i.) 40 z c;i.) ~ 30 ~ c;i.) is ~ 20 ; j 10 0 ·10 ·20 ·30 sources: 0 '" summary of government budget balance measured in terms of gdp, 1970-1985 (per cent) , , -.. .., .. " .. revenue ---e~nd'ture -balance . -. //\ ,../ \ i ........ -1971 1972 1973 1974 \ 1975 1976 1977 1976 \ -....... -....... -.... '\ year 1979 \ \ v i i 1980 i / i 1981 198r -;~83 imf international financial statistics (various issues); cbn, annual report and statement of accounts (various issues). 1964 hil5 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 151 the government expenditure in terms of gdp increased successively from 19.8 percent in 1970 to 40 percent and 58.9 percent in 1975 and 1979 respectively. the increases in expenditure moved more or less in line with the services sector's expansion. this sector included government administration, defence and internal security, transport, construction and education. a great deal of expenditure also went for the creation of states. 13 the financial appropriation to the state governments and their numerous ministries grew successively from 3.7 percent of gdp in 1971 to 4.8 percent and 13.3 percent of gdp in 1972 and 1979, respectiveiy.14 the manufacturing sector's shares in total non-oil gdp and employment are also shown in table l. the share of the manufacturing employment was on the increase throughout the sample period, while its share in gdp showed a similar development but for 1980. on the whole, developments in the manufacturing sector are not consistent with the prediction of the dutch disease. this inconsistency, particularly in the increasing share of manufacturing employment, is obviously a reflection of the government import-substitution policies which have traditionally protected local manufacturing industries by imposing relatively high import duties on finished products, and very low or no import duties on industrial raw materials and intermediate capital inputs. 2.3 the effect on wages recall figure 1 for the development of the nigerian real wage (nominal wage deflated by the index of aggregate producer price of the main primary crops) during the period 1948-1985. certain points are especially remarkable. first, there is a general trend of a rising real wage during the period. secondly, the trend had few disruptions which occurred during certain historical periods in the country. for example, until the country's political independence in 1960, the rise in the real wage was gradual, reflecting a certain degree of closeness in the growth of nominal wages and producer prices, even though the former grew faster. in nearly half a decade after independence, just before the political crises in the country during the middle of the 1960s, the growth gap between the two variables widened. this wider gap reflected partly the increased commodity taxes on agricultural exports during the period to support several financial commitments of the local political parties,15 and partly the upward adjustment of wages by the ruling parties to court the support of workers (waterman, 1976). at the very peak of the political crises, 1966-69, the real wage hardly grew at all. at the end of the crises (civil war) in 1970, it was revived again showing remarkable growth until 1971. this growth r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 152 sajems ns vol 2 (1999) no 1 period reflected the government general review of wages and salaries known as the adebo award (imf, 1975:317-318). the main purpose of the wages and salaries review was, undoubtedly, to compensate workers for the post-war inflation. the adjustment provided for wage increases between 12 percent and 30 percent (imp, 1975:318). during this period, primary crops producers continued to bear the heavy burden of commodity export taxes. the oil boom of 1973 and practically during much of the i 970s, generating massive inflows of capital into the country. as the oil money flooded in, the authorities embarked on several projects that entailed massive expenditures. since a great part of this spending was on services, adjustments to the newly demand/supply conditions became inflationary. the inflation rate was estimated at about 16.2 percent annually between 1973 and 1980 (cbn, annual reports, various issues). with the accumulation of international reserves,16 the nominal exchange rate appreciated, and this tendency strengthened real exchange rate appreciation too. it was to compensate workers for the domestic inflation that the authorities resorted to upward adjustments of wages. the most significant during the oil boomdominated period was the udoji award in 1975176 (imp, 1975:319). this award granted workers wage increases between 30 percent and 131 percent (imp, 1975:319). to compensate primary crops producers for the effects of the appreciated exchange rate, as well as for the commodity export taxes, the authorities reformed the agricultural policies in 1973, introducing tax remissions, and awarding frequent subsidies to farmers. (recall figure i and note the sharp fall in real wage in 1973.) the improvement in primary crops producer prices as a result of the reform policies could however not match the increases in wages. between 1973 and 1980, wages increased over 230 percent, whereas aggregate producer prices increased about 110 percent. the real wage increase continued into the 1980s. this was partly accounted for by the increasing inflation, aggravated by successive naira devaluations and the simultaneous attempt by the authorities to compensate workers,17 and also by political forces seeking for the support of workers. 18 the cost situation was simply not favourable for the agricultural sector, particularly since the rural/agricultural labour aspired to higher wages in line with those paid in the urban/non-agricultural sector. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 153 3 concluding remarks the availability of the oil resource has undoubtedly had a profound impact on the nigerian economy as a whole, particularly the economy's sectoral structure. although the oil sector itself never did put pressure on the other sectors directly, since its labour requirements were negligible, the policy response by the authorities towards the oil revenue generated adverse effects on the agricultural sector. exchange rates appreciated both in nominal and real terms, the latter considered as a spending effect of the oil boom. consequently, labour costs increased in terms of the exogenously determined agricultural product prices. generally, the deterioration of agriculture was very much the result of a long-drawn process that originated before the oil boom. however, the boom aggravated the problem and in that way reinforced the deterioration. endnotes 2 6 7 paper presented at the ebm research conference, port elizabeth, 1996. it took its name from the effects of a boom in natural gas on the economy of the netherlands. contributions to the literature include gregory (1976), corden and neary (1982), edwards (1986), neary and van wijnbergen (1986), and oyejide (1986). some economists have analysed a special case in which the booming (oil) sector is considered as an "enclave" and participates very marginally, if at all, in domestic factor markets. in that case, there will be no resource movement effect, but only a spending effect, with the key mechanism of resource allocation being real exchange rate appreciation. see neary and van wijnbergen (1986). for a discussion on the cost of accumulating excess foreign financial assets, see corden (1981 b). it is likely that private expenditure reduction induced by lower disposable income would involve a substantial reduction in spending on non-tradeable goods (corden, 1981b). oyejide (i 986:27). ibrd (1986:72). there are sound practical arguments for the possible superiority of that form of exchange rate protection over alternative forms such as tariff, quotas, and subsidies. see warr (1986:298-300), corden (1987:18-19). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 154 9 10 ii 12 13 14 15 16 17 18 sajems ns vol 2 (1999) no 1 in a comparison of nigeria with indonesia (another oil producing and exporting country that also experienced a boom), the world bank noted that although both countries experienced almost identical real exchange rate appreciation during the period 1970-72 and 1974-78, indonesia was able to correct the development of its exchange rates by tightening the country's monetary and fiscal policies, and between november 1978 and march 1983 devalued its currency, the rupiah, by over 50 percent against the us dollar. nigeria, on the other hand, apart from resisting any devaluation of its currency, the naira, borrowed heavily on the basis of future oil earnings. see mrd (1986:72). the first remarkable devaluation of the naira (by about 16 percent against the us dollar) occurred in 1981, to be followed successively by several devaluations of various magnitudes in the following years. see central bank of nigeria (cbn), annual reports (various issues). see oyejide (1986:27). all through the period 1970-1982, the share of the mining (oil) sector in total employment was only between 0.2 percent and 0.4 percent (oyejide, 1986:37). the national account of nigeria, 1973-1975 (1981: 139). the regions/states increased successively from 3 and 4 regions in 1954/55-62 and 1963-66, respectively, to 12, 19, and 21 states in 1967-75, 1976-86, and 1987-, respectively. for the politics surrounding the creation of states nigeria, see nigerian hand book (1985:50-53). calculations are based on the data from imf international fmancial statistics (various issues); fos, economics and social statistics bulletin (various issues); central bank of nigeria (cbn), annual reports (various issues). on the issues of the political effects on export crops in nigeria, see nixon (1970). the peaks were attained in 1979 and 1980 when they represented about 25.5 percent and 31.2 percent of gdp, respectively. see cbn, annual reports (various issues). in the period 1981-85, the nigerian currency, the naira, was devalued at an average annual rate of about 11.26 percent against the us dollar. see cbn, annual reports(various issues). political influence on wage setting in nigeria has been discussed by warren (1966). for comments, see berg (1969), and for counter argmnent, see weeks (1971). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 155 references 1. berg, e. (1969), urban real wages and the nigerian trade union movement, 1939-60: a comment, economic development and cultural change, vol. 17, no.4. 2. corden, w.m. (1981), "exchange rate protection", in cooper, r n. et al. (ed), the international monetary system under flexible exchange rates: global, regional, and national, ballinger publishing co., cambridge, mass. 3. corden, w.m. and j. p. neary (1982), "booming sector and deindustriaiization in a small open economy", economic journal, vol. 92. pp. 825-848. 4. corden, w.m. (1984), "booming sector and dutch disease economics: a survey and consolidation", oxford economic papers, 36, pp. 359-380. 5. corden, w.m. (1985), protection, growth, and trade: essays in international economics. basil blackwell, oxford. 6. corden, w.m. (1987), "protection and liberalization: a review of analytical issues", imp occasional papers, no.54. washington d.c. 7. edwards, s. (1986), a commodity export boom and the real exchange rate: the money-inflation link, in neary p.j. and s. van wijnbergen (eds), natural resources and the macroeconomy. basil blackwell, oxford. 8. forsyth, pj. (1986), "booming sectors and structural change in australia and britain: a comparison", in neary, p. j. and s. van wijnbergen (eds), natural resources and macroeconomy. basil blackwell, oxford. 9. gregory, r.g. (1976), "some implications of the growth of the mineral sector", the australian journal of agricultural economics, vol. 20. no.2. 10. helleiner, g.k. (1966), peasant agriculture, government, and economic growth in nigeria. richard d. irwin inc., homewood, illinois. 11. ibrd (1986), 'trade and pricing policies in world agriculture", world development report (part ii). the johns hopkins press, baltimore. 12. imf, international financial statistics (various issues). 13. imf report (1975), survey of african economies: nigeria. vol. 6. washington d.c. 14. jones, r.w. (1971), "a three-factor model in theory, trade and history", in bhagwati, j. n. et al. (eds), trade, balance of payments and growth: essays in honor of p. c. kindleberger. north-holland, amsterdam. 15. kaldor n. (1976), "inflation and recession in the world economy", the economic journal, 86, pp. 703-714. 16. neary, j p. and s. van wijn.bergen (1984), "can an oil discovery lead to a recession?: a comment on eastwood and venables", economic journal, 94, pp. 390-395. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 156 sajems ns vol 2 (1999) no i 17. neary, j.p. and s. van wijnbergen (1986), "natural resources and the macroeconomy: a theoretical framework", in neary, j. p. and s. van wijnbergen (eds), natural resources and the macroeconomy. basil blackwell, oxford. 18. nixon, c.r. (1970), "the role of the marketing boards in the political evolution of nigeria", in eicher, c. k. and c. liedholm (eds), growth and development of the nigerian economy. michigan state university press, east lansing, michigan. 19. oyejide, t.a. (1986), "the effects of trade and exchange rate policies on agriculture in nigeria", ifpr research report, 55, international food policy research institute. 20. snape, r.h. (1977), "effects of mineral development on the economy", australian journal of agricultural economics, vol. 21. pp. 147-156. 21. united nations statistics year book (various issues). 22. w arr, p.g. (1986), "indonesia's other dutch disease: economic effects of the petroleum boom", in neary, p. j. and s. van wijnbergen (eds), natural resources and macroeconomy. basil blackwell, oxford. 23. warren, w.m. (1966), "urban real wages and the nigerian trade union movement, 1939-60", economic development and cultural change, vol. 15, no.1, pp. 22-36. 24. waterman, p. (1976), "conservatism amongst nigerian workers", in williams, g. (ed), nigeria: economy and society. rex collins, london. 25. weeks, j.f. (1971), "the impact of economic conditions and industrial forces on urban wages in nigeria", the nigerian journal of economics and social studies, vou3, no.3, pp.313-341. official nigerian publications annual report of the commodity marketing boards (various issues). central bank of nigeria (cbn), annual report and statement of accounts (various issues). federal office of statistics (fos), national accounts of nigeria, lagos (various issues). fos, economics and social statistics bulletin, lagos, 1985. national accounts of nigeria, 1973-1975, (federal ministry of national planning), lagos, 1981. the nigeria hand book, 1985. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns 12 (2009) no 1 11 financial development and economic growth: literature survey and empirical evidence from sub-saharan african countries1 songul kakilli acaravci faculty of economics and administrative sciences, mustafa kemal university, turkey, ilhan ozturk faculty of economics and administrative sciences, cag university, turkey ali acaravci faculty of economics and administrative sciences, mustafa kemal university, turkey abstract in this paper we review the literature on the finance-growth nexus and investigate the causality between financial development and economic growth in sub-saharan africa for the period 19752005. using panel co-integration and panel gmm estimation for causality, the results of the panel co-integration analysis provide evidence of no long-run relationship between financial development and economic growth. the empirical findings in the paper show a bi-directional causal relationship between the growth of real gdp per capita and the domestic credit provided by the banking sector for the panels of 24 sub-saharan african countries. the findings imply that african countries can accelerate their economic growth by improving their financial systems and vice versa. key words: financial development, growth, panel causality, sub-saharan africa jel c33, o11, o16, o55 1 introduction academic research on the finance-growth nexus dates back at least to schumpeter (1911) who emphasised the positive role of financial development on economic growth. the relationship between financial development and economic growth has been a subject of great interest and debate among economists for many years. the debate has traditionally revolved around two issues. the first relates to whether development in the financial system results in a faster economic growth, and the second relates to how financial development affects economic growth. a large body of literature has emerged, both at the theoretical and empirical level, attempting to answer the above questions. although many empirical studies have investigated the relationship between financial depth, defined as the level of development of financial markets and economic growth, the results are ambiguous (see pagano, 1993; and levine, 1997, 2003 for a survey of the literature). the theoretical relationships between financial development and economic growth have been analysed extensively in the literature and may be summarised under four hypotheses (chuah & thai, 2004). first, the conventional view of the supply-leading hypothesis postulates that the direction of causality flows from financial development to economic growth. in a world without frictions caused by transaction, information and monitoring costs, no financial intermediaries are needed. if those costs are sufficiently high, no exchanges among economic agents will take place. the need to reduce those costs for exchanges to take place has led to the emergence of financial 12 sajems ns 12 (2009) no 1 institutions and markets constituting the financial sector. a well-developed financial sector provides critical services to reduce those costs and thus to increase the efficiency of intermediation. it mobilises savings, identifies and funds good business projects, monitors the performance of managers, facilitates trading and the diversification of risks, and fosters exchange of goods and services. these services result in a more efficient allocation of resources, a more rapid accumulation of physical and human capital, and faster technological innovation, thus inducing faster long-term economic growth2. second, the demand-following hypothesis postulates that economic growth leads to financial development. the development of the real economy induces increased demand for financial services, which in turn, generate the introduction of new financial institutions and markets to satisfy that increased demand for financial services (robinson, 1952; patrick, 1966; and demetriades & hussein, 1996). third, the bi-directional causality hypothesis is a combination of the supply-leading and demandfollowing hypotheses. it postulates that financial deepening and economic growth are mutually or bi-directionally causal (greenwood & jovanovic, 1990; saint-paul, 1992; berthelemy & varoudakis, 1996; demetriades & hussein, 1996; greenwood & smith, 1997; blackburn & hung, 1998; and harrison, sussman & zeira, 1999). financial deepening gradually induces economic growth and this, in turn, causes feedback and induces further financial deepening. fourth, the independent hypothesis postulates that financial deepening and economic growth are causally independent. lucas (1988) argues that, at best, financial deepening plays a very minor role in economic growth; stern (1989) ignores the role of financial development in the growth process. the growing body of empirical research, using different statistical procedures and data sets, produces remarkably consistent results. first, countries with better-developed financial systems tend to grow faster – specifically, those with (i) large, privately owned banks that funnel credit to private enterprises and (ii) liquid stock exchanges. the levels of banking development and stock market liquidity each exert a positive influence on economic growth. second, simultaneity bias does not seem to be the cause of this result. third, better-functioning financial systems ease the external financing constraints that impede firm and industrial expansion. thus, access to external capital is one channel through which financial development matters for growth because it allows financially constrained firms to expand (levine, 2003). the objective of this paper is to review the literature on the finance-growth nexus and investigate the causality between financial development and economic growth for 24 subsaharan african countries over the period 19752005. the paper contributes to the literature in exploring the growth-financial development nexus in the african context and provides some empirical evidence. our findings indicate that there is no long-run relationship between financial development and economic growth. further, there is a bidirectional causal relationship between the growth of real gross domestic product (gdp) per capita and the domestic credit provided by the banking sector for the panel data of 24 subsaharan african countries. we conclude that policies aimed at improving financial markets (economic growth) will have a significant effect on economic growth (financial development). the rest of the paper is organised as follows: section 2 presents a literature review. the model specification and data are presented in section 3. the methodology and data are given in section 4. the empirical results are discussed in section 5. the paper concludes with a summary and policy implications. 2 empirical literature review in this section the empirical and theoretical background of the finance-growth nexus will be discussed in general and for the sub-saharan africa region separately. 2.1 empirical literature investigation on the finance-growth nexus an extensive number of empirical investigations has been conducted, aimed at testing the sajems ns 12 (2009) no 1 13 conflicting theoretical developments using d i f f e r e n t t e c h n i q u e s . t h e s e e m p i r i c a l investigations can be classified into two major groups. the first group consists of those studies that used cross-country growth regression methods in which the average growth rate of per capita output over some period is regressed on some measure of financial development and a set of control variables (see king & levine, 1993a, b; levine & zervos, 1998; de gregorio & guidotti, 1995; ndikumana, 2000, among others). the second group consists of those studies that used the time series data of individual countries to investigate the causal relationship between the two variables. the problems with the pure cross-country studies are well documented in the literature. in particular, the method fails to explicitly address the potential biases induced by the endogeneity of the explanatory variables and the existence of cross-country heterogeneity. these problems may lead to inconsistent and misleading estimates (see quah, 1993; casselli, esquivel & lefort, 1996). in the light of these problems recent empirical studies have used dynamic panel data methods, such as the first differenced generalised methods of moments (gmm), as a way to control for the potential sources of biased coefficient estimates in cross-country regressions (see levine, loayza & beck, 2000; benhabib & spiegel, 2000). the results of these studies provide evidence of a strong connection between the exogenous component of financial development and long-run economic growth. this is more or less consistent with the classical view on the relationship between growth and financial development. the analysis of the causal relationship between banking sector development and economic growth was subjected to a more advanced econometric treatment in a paper by levine et al (2000). they examined the role of financial development in a pooled cross-section setup using averaged data spanning the period 1960-1995. using a gmm estimator, the authors show that the exogenous component of financial development is positive, significant and robust in the standard growth regressions. moreover, levine et al explain that unobserved country specific effects can be controlled for in a panel data setting and that panel data models offer a way to control for the potential endogeneity bias in all the explanatory variables by using “internal instruments” (i.e., lagged values of the explanatory variables). the dynamic panel estimations of levine et al confirm that the weakly exogenous components of financial intermediary development exert a statistically significant and positive influence on economic growth. moreover, the results pass both specification and sensitivity checks. the authors therefore conclude that “the data suggest a strong, positive link between financial intermediary development and economic growth” (levine et al, 2000, p. 54). principal among existing econometric studies is the seminal paper by king and levine (1993a), which is in the tradition of cross-country empirical studies of economic growth. king and levine constructed four different financial development indicators3, and based on data for 77 different countries covering the period 19601989, they found that “higher levels of financial development are significantly and robustly correlated with faster current and future rates of economic growth, physical capital accumulation, and economic efficiency improvements” (king & levine, 1993a, p. 718-9). in addition, king and levine conclude that the link between economic growth and financial development is not just a contemporaneous correlation. instead, “finance seems importantly to lead economic growth” (king & levine, 1993a, p. 730). the cross-country study started by goldsmith (1969), which shows a graphically positive association between finance and growth, has subsequently been followed by several crosscountry studies. these added more countries and more variables for financial development and economic growth that were observed over longer periods. studies with disaggregated data across industry and firm levels were also conducted. all these studies, while finding a positive association between finance and growth, do not conclude on whether finance causes growth. levine and zervos (1998), using data for 42 countries over the period 1976-1993, found a positive relationship between stock market development and growth, capital accumulation and productivity growth. 14 sajems ns 12 (2009) no 1 l evine (1991) demonstrates that stock markets help individuals manage liquidity and productivity risk and, as a result, stock markets accelerate growth. according to levine, in the absence of financial markets, firm-specific productivity shocks may discourage risk-averse investors from investing in firms. the more resources allocated to firms, the more rapid will be economic growth. saint-paul (1992) relates the relationship between the financial sector and economic growth by emphasising the complementary role between financial markets and technology. according to saint-paul, an economy that possesses highly developed financial markets, that allow the spreading of risk through financial diversification among the economic agents, will be able to achieve a higher level of development than an economy in which the financial markets are not well developed. khan and senhadji (2000), in a cross-country and panel study, using data for 159 countries over the period 1960-1999, found that the effect of financial development on growth was positive, but the size of the effect varied with the different indicators of financial development, the estimation method, the data frequency and the functional form of the relationship. they did not deal formally with the causality issue. financial development was measured by credit to the private sector, stock market capitalisation and bond market capitalisation as a share of gdp. christopoulos and tsionas (2004) used panel co-integration analysis to examine whether a long-run relationship between financial development and economic growth existed for 10 developing countries over the period 1970-2000. their findings support a unique co-integrating vector between growth, financial development, investment share and inflation, and uni-directional causality from financial depth to growth. however, this study limited its attention to only a few developing countries and employed only one measure of financial deepening. levine (1998), using a sample of 44 developed and less developed countries during the period 1975-1993, examined the links between banking development and long-run economic growth. the usual gmm estimation procedure was used to account for the simultaneity bias. the degree to which the legal codes emphasised the rights of the creditor and the efficiency of the legal system in enforcing laws and contracts were considered as instruments. the empirical evidence is supportive of a strong positive relationship between the exogenous component of banking development with output growth, physical accumulation and productivity growth. demirguc-kunt and maksimovic (1998) estimated a financial planning model and found that financial development facilitates the firm’s growth. in this context an active stock market and a well-developed legal system are crucial for the further development of firms. beck, levine and loyaza (2000) investigated not only the relationship between financial development and economic growth but also the relationship between financial development and the sources of growth in terms of private saving rates, physical capital accumulation and total factor productivity. once again, gmm and instrumental variable estimators were used to correct for possible simultaneity biases. the authors conclude that higher levels of financial development lead to higher rates of economic growth, and total factor productivity. for the remaining variables, they could not document any relationship with financial development. the influence of the structure of the financial sector – bank-based (such as in germany and japan) and market-based (such as in the united kingdom and the united states of america (usa)) financial systems – on economic growth has also been investigated. several crosscountry studies show that the rates of growth of countries, industries or firms are not affected by the nature of the financial systems4. demirguc-kunt and levine (2001) found that as countries become richer the financial sector becomes more market-based. levine (1997) concludes that those two systems are complementary in providing financial services to the economy as both have positive associations with economic growth. a number of studies suggest that it is more important to establish a credible environment to protect the rights of investors than being concerned with which system to develop5. the above cross-country studies found positive effects of financial sajems ns 12 (2009) no 1 15 development on growth for a “representative” country. from a policy viewpoint, those findings may not directly apply to specific countries (luintel & khan, 1999). the time series approach addresses this issue by conducting the causality test for each country, thereby allowing individual countries to exhibit their own patterns of causality. numerous studies have adopted this approach but the findings on the direction of causality are mixed, depending upon the country and the proxies used to measure financial development and economic growth. jung (1986) used more standard indicators of output and financial development and conducted causality tests using level vectorautoregressions (var) for 56 developed and developing countries. he found uni-directional causality from financial development to growth for the developing countries and the reverse causality from growth to finance in developed countries. however, the inference in a level var framework is problematic, because the variables have not been tested for stationarity and co-integration (see sims, stock and watson, 1990). demetriades and hussein (1996) and thornton (1996) are among the few studies that have tested the financial-led hypothesis on several asian countries. using annual data from 1965 to 1992, demetriades and hussein found that among the asian countries covered by the study, only in the case of sri lanka did the evidence support the financial-led growth hypothesis. for pakistan, their result indicates that economic growth causes financial development. further, demetriades and hussein’s study suggests that bi-directional causal relationships are evident for india, south korea and thailand. thornton (1996) provides some empirical evidence on the supply-leading hypothesis in several asian countries. using annual data as far back as the 1950s and up to 1990, thornton found that the financial-led hypothesis was supported by the monetary data of nepal, malaysia, the philippines and thailand. the demand-following hypothesis was supported by myanmar’s and korea’s monetary data. however, a bi-directional relationship between the monetisation variable and economic growth was evident for malaysia. for a sample of six asian countries, luintel and khan (1999) examined the long-run causality between financial development and economic growth employing a multivariate var framework. they found bi-directional causality between financial development and economic growth in all six countries, namely: india, korea, malaysia, the philippines, sri lanka and thailand. in another study on asian economies, al-yousif (2002) found that the philippines and korea supported the financialled hypothesis, sri lanka and pakistan supported the demand-following hypothesis, malaysia and singapore showed a two-way causal effect between financial development and growth, and the result for thailand suggests finance was irrelevant for growth. habibullah’s (1999) study on seven developing asian countries suggests that only the philippines supports the financialled growth hypothesis. the demand-following growth hypothesis is supported by the data from malaysia, myanmar and nepal. a bi-directional causality between growth and finance is evident for indonesia, sri lanka and thailand. habibullah and eng (2006) examined the causal relationship between the financial development and economic growth of the developing asian countries from a panel data perspective, they used the system gmm technique and conducted causality testing analysis. the panel data sets involved 13 developing asian countries: bangladesh, india, indonesia, south korea, lao pdr, malaysia, myanmar, nepal, pakistan, the philippines, singapore, sri lanka and thailand for the period 1990-1998. the result of their study is that financial development promotes growth, thus supporting the old schumpeterian hypothesis and patrick’s “supply-leading” hypothesis. further evidence on the financial-led hypothesis is documented by fase and abma (2003). using pooled data from bangladesh, india, malaysia, pakistan, the philippines, singapore, south korea, sri lanka and thailand, they conclude that financial development matters for economic growth and that causality runs from the level of financial intermediation and sophistication to growth. al-zubi, al-rjoub and abu-mhareb (2006) applied a model developed by levine in 1997 16 sajems ns 12 (2009) no 1 using panel data for 11 arab countries during the period 1980-2001. the results show that all the financial indicators are insignificant and do not affect economic growth. the modified model shows that only the public credit to domestic credit indicator has a significant and positive effect on economic growth, indicating the dominance of the public sector in economic activities and that the financial sectors are still under-developed and need to expend more effort towards fulfilling their functions effectively in the arab countries. pinero et al (2005) tested the hypothesis of a positive impact of democratisation on growth, economic development and changes in wellbeing. they constructed an empirical model to explain the impact of political institutions (democracy), economic institutions, financial market efficiency, scientific achievements and “financial or fdi” geography on growth. the empirical work, based on a wide database including several indicators assessed by the authors, supports the hypothesis of the decisive role of democratic political and efficient economic institutions in stimulating economic growth for over 80 countries. the main results also highlight the importance of the effective allocation of financial resources. the supply-leading hypothesis is also supported by more recent studies by calderon and liu (2003) on 109 developing and developed countries, and christopoulos and tsionas (2004) on 10 developing countries. both studies conclude that the supply-leading hypothesis is the dominant force behind the relationship between finance and the sources of growth, in particular, financial depth contributes more to the causal relationship in developing countries. atje and jovanovic (1993) examined the effect of stock markets on development and conclude that there is a positive effect on the level of development as well as on growth. they could not, however, establish a significant relationship between bank liabilities and growth. levine and zervos (1996) used various measures of stock market development, and conclude that there is a significant relationship. when they included banking depth variables in their regressions, the variables turned out to be non-significant. they emphasise that their results are indicative of partial correlation only, and that more research is needed in the area. arestis and demetriades (1997) used time series analysis and johansen co-integration analysis for the usa and germany. for germany, they found an effect of banking development on growth. in the usa, there was insufficient evidence to claim a growth effect of financial development, and the data point to the direction that real gdp contributes to both the banking system and stock market development. apergis, filippidis and economidou (2007) examined whether a long-run relationship between financial development and economic growth exists employing panel integration and co-integration techniques for a dynamic heterogeneous panel of 15 organisation for economic co-operation and development (oecd) and 50 non-oecd countries over the period 1975-2000. three different measures of financial deepening were used to capture the variety of different channels through which financial development can affect growth. their findings support the existence of a single longrun equilibrium relationship between financial deepening, economic growth and a set of control variables. further, the evidence points to a bi-directional causality between financial deepening and growth. chuah and thai (2004) investigated the causal relationship between financial development and economic growth in the six countries of the gulf cooperation council (gcc). using error correction model (ecm) and var models for causality testing, they found evidence of bidirectional causality in five countries and finance leading growth in the last one. the results are very much country-specific and dependent on the proxies chosen for financial development or economic growth. these results indicate that gcc countries should continue to promote financial development while pursuing the needed reforms to develop the real sector. some more recent studies focused on the finance-growth causality nexus in the middle east. darrat (1999) performed causality tests on three countries (saudi arabia, turkey and the united arab emirates (uae)). the study sajems ns 12 (2009) no 1 17 finds finance leads growth in turkey, growth causes finance in the uae, and bi-directionality in saudi arabia. he concludes that financial deepening causes economic growth, although the results are country-specific and vary across the proxies used to measure financial deepening or economic growth. boulila and trabelsi (2002) found that financial reforms in tunisia changed the pattern of causality from growth to finance in the pre-reform period to bi-directional causality in the post-reform period. using annual data from 1975-2005 for turkey, ozturk (2008) found that there was no long-run relationship between financial development and economic growth and the results show a one-way causality running from economic growth to financial development. several theoretical and empirical studies have suggested that the role of financial development in the economy may vary across countries because of differences in institutional and economic structures (see laporta et al, 1997; and bell & rousseau, 2001, among others). on the one hand there are those who argue that, in a given economy, it is the sector with high economies of scale that benefits more from financial development (kletzer & pardhan, 1987; beck, 2002), implying that financial development is much more effective in promoting economic growth in more industrialised economies than in less industrialised or agricultural economies. on the other hand, there are those who contend that countries in the early stages of their development benefit more from financial development (see mckinnon, 1973; fry, 1995). moreover, it is argued that the effectiveness of financial intermediaries and markets in promoting economic growth depends on the institutions set up to implement financial transactions. for example, laporta et al (1997) found that the legal system plays a crucial role in determining financial development and growth relationships. they argue that secure property and contract rights are crucial to banks and financial institutions working properly, while weak contract enforcement creates incentives for default by debtors and decreases willingness to lend. in addition, they point out that corruption in the banking system or political interference may divert credit to unproductive or even wasteful activities, again implying that economies with developed institutions are likely to benefit more from financial development. 2.2 empirical literature survey on sub-saharan africa odedokun’s (1996) study determined and analysed the effects of financial intermediation on the growth of real gdp in least developed countries (ldcs) by employing annual data for 71 countries over varying periods that generally span the 1960s and 1980s. his findings are as follows: (a) financial intermediation promotes economic growth in about 85 per cent of the countries; (b) compared with factors that have often been emphasised in the literature (viz. export expansion, capital formation ratio and labour force growth) as important growth promoters, financial intermediation is practically on par with export expansion and capital formation ratio, and superior to labour force growth, as a partner to promoting economic growth; (c) the growth-promoting effects of financial intermediation are more predominant in low-income than in high-income ldcs; and (d) the growth-promoting effects of financial intermediation are practically invariant across the various regions of the globe. akinboade (1998) examined the relationship between financial development and economic growth in botswana. two indicators were used to examine granger causality between real per capita income and financial development. an error-correction method was adopted following the tests for unit roots and co-integration. the study suggests that per capita income in botswana and the financial development indicators cause one another, supporting the view that economic growth causes and is caused by financial development in botswana. agbetsiafa (2003) found that each of the financial development indicators and economic growth are integrated at the first order. the co-integration test results show that financial development and economic growth are linked in the long run in seven of the eight countries in the sample. causality tests indicate a preponderance of uni-directional causality from finance to growth in six of the countries. 18 sajems ns 12 (2009) no 1 ghirmay (2004) examined the causal link between the level of financial development and economic growth in 13 sub-saharan african countries. the results of the co-integration analysis provide evidence of the existence of a long-run relationship between financial development and economic growth in almost all (12 out of 13) of the countries. with respect to the direction of long-term causality, the results show that financial development plays a causal role on economic growth, again in eight of the countries. at the same time, evidence of bi-directional causal relationships is found in six countries. the findings imply that african countries can accelerate their economic growth by improving their financial systems. odhiambo (2005) investigated empirically the role of financial development on economic growth in tanzania. the study used three proxies of financial development against real gdp per capita (a proxy for economic growth). using the johansen-juselius co-integration method and a vector ecm, the empirical results of this study, taken together, reveal a bi-directional causality between financial development and economic growth in tanzania – although a supply-leading response tends to predominate. atindehou, gueyie and amenounve (2005) used causality tests to empirically examine the relationship between finance and economic growth, in the context of west african country members of the economic community of west african states. in all but a few countries, the results indicate a weak causal relationship between finance and economic development on one side, and between economic development and finance on the other side. these results imply, ceteris paribus, that leaders of west african countries should focus their economic and monetary policies on the development of financial intermediation, which in turn will favour economic growth. adjasi and biekpe (2006) studied the effect of stock market development on economic growth in 14 african countries in a dynamic panel data modelling setting. results largely show a positive relationship between stock market development and economic growth. the results reveal that the positive influence of stock market development on economic growth is significant for countries classified as upper middle income economies. on the basis of market capitalisation groupings, stock market developments play a significant role in growth only for moderately capitalised markets. the general trend in results shows that low income african countries and less developed stock markets need to grow more and develop their markets to elicit economic gains from stock markets. odhiambo (2007) investigated empirically the direction of causality between financial development and economic growth in three sub-saharan african countries – kenya, south africa and tanzania. using three proxies of financial development against real gdp per capita (a proxy for economic growth), the study finds that the direction of causality between financial development and economic growth is sensitive to the choice of measurement for financial development. in addition, the strength and clarity of the causality evidence varies from country to country and over time. on balance, a demand-following response is found to be stronger in kenya and south africa, whilst in tanzania a supply-leading response is found to be dominant. quartey and prah (2008) conducted a study to find out whether financial development in ghana conformed to either the supplyleading, demand-following or patrick’s stages of development hypotheses. whereas there is some evidence in support of the demandfollowing hypothesis when the growth of broad money to gdp ratio is used as a measure of financial development, there is no significant evidence to support either the supply-leading or demand-following hypothesis when the growth in domestic credit to gdp ratio, private credit to gdp ratio, and private credit to domestic credit ratio are used as proxies for financial development. odhiambo (2008) attempted to examine the dynamic causal relationship between financial depth and economic growth in kenya by including savings as an intermitting variable – thereby creating a simple tri-variate causality model. using the co-integration and errorcorrection techniques, the empirical results of this study reveal that there is a distinct unidirectional causal flow from economic growth sajems ns 12 (2009) no 1 19 to financial development. the results also reveal that economic growth causes savings, while savings drive the development of the financial sector in kenya. the study, therefore, warns that any argument that financial development unambiguously leads to economic growth should be treated with extreme caution. enisan and olufisayo (2008) examined the long-run and causal relationships between stock market development and economic growth for seven countries in sub-saharan africa. using the autoregressive distributed lag bounds test, the study finds that stock market development is cointegrated with economic growth in egypt and south africa. moreover, this test suggests that stock market development has a significant positive long-run impact on economic growth. the granger causality test based on a vector ecm further shows that stock market development causes economic growth in egypt and south africa. however, the granger causality in the context of var shows evidence of a bi-directional relationship between stock market development and economic growth for cote d’ivoire, kenya, morocco and zimbabwe. in nigeria, there is weak evidence of growth-led finance using market size as the indicator of stock market development. in summary, the picture that emerges from the different econometric studies is blurred. in cross-section studies there is a positive correlation between financial development and growth, but in the poorest countries the correlation is negative. in individual-country studies, different causal patterns between financial development and economic growth are characteristic. in some countries, finance seems to lead growth, while there is reverse causality or no clear causal link elsewhere. moreover, conclusions are very sensitive to the type of estimator used and slight changes in nuisance parameters often change the results (andersan and tarp, 2003). 3 model specification and data in the finance-growth nexus literature there are interesting and controversial views about the appropriate measure of financial development. many researchers used the liquid liabilities of the financial system as financial depth (see goldsmith, 1969; mckinnon, 1973; and king & levine, 1993a, 1993b). a higher financial depth implies a larger financial sector and, therefore, greater financial intermediary development. but levine and zervos (1998) argue that m3/gdp measures only financial depth and there is no theoretical relationship between this ratio and economic growth. they propose that bank credit is useful in measuring financial development. therefore, the credit given to the private sector represents an accurate indicator of the functioning of financial development because it is a measure of the quantity and quality of investment (see de gregorio & guidotti, 1995; demetriades & hussein, 1996; levine & zervos, 1998; levine et al, 2000). ndikumana (2000) employed the following financial development indicators: credit to the private sector, total liquid liabilities of the financial system, credit provided by banks, and an index combining these three indicators. ndikuma indicates that it is private investment that is most dependent on financial development in sub-saharan africa. in addition, ghirmay (2004) also emphasises that most of the financial developments have occurred within the banking system in african countries. to investigate the causality between financial development and economic development in subsaharan africa, we employ panel co-integration and panel causality methods. such a model may be specified as: gdp it = a fdi i it it+ +b f (1) where gdp it is the natural logarithm of real gdp per capita, ppp (constant 2000 international $); fd it is the measure of financial development, and  it is the error term. following the literature, we use real gdp per capita as a measure for economic development (see king and levine, 1993a, 1993b; levine and zervos, 1998; de gregorio and guidotti, 1995; ndikumana, 2000, among others. see also odedokun, 1996; akinboade, 1998; and odhiambo, 2005, 2007, 2008, among others for the sub-saharan african countries) and three financial indicators measures, which are commonly adopted in the literature: i) bank credit (bc) is defined as the 20 sajems ns 12 (2009) no 1 domestic credit provided by the banking sector (percentage of gdp); ii) private sector credit (pc) equals the domestic credit to the private sector (percentage of gdp), the indicator pc includes non-bank credit to the private sector; and iii) the liquid liabilities of the financial system (ll) are broad money (m3) (percentage of gdp). liquid liability is defined as currency plus demand and the interest bearing liabilities of bank and non-bank financial intermediaries divided by the gdp. the last is the broadest measure of financial depth used, since it includes all types of financial institutions (central bank, deposit money banks and other financial institutions). the annual time series data are taken from the world development indicators (wdi) online for the period 1975-2005 in the form of balanced panel data. the sample includes 24 sub-saharan african countries: benin, burkina faso, burundi, the central african republic, chad, congo republic, cote d’ivoire, gabon, gambia, ghana, kenya, madagascar, malawi, mali, niger, nigeria, rwanda, senegal, the seychelles, sierra leone, south africa, sudan, swaziland and togo. these countries are selected according to data availability from among 48 sub-saharan african countries. 4 methodology examining the relationship between financial development and economic growth will be performed in two steps. first, we define the order of integration in series and explore the long-run relationships between the variables by using heterogeneous panel unit root tests and a heterogeneous co-integration test, respectively. second, we test causality using the panel gmm estimator. 4.1 panel integration analysis recent literature emphasises that panel unit root tests are more accurate than univariate unit root tests. for the sub-saharan african countries, heterogeneity arises because of the differences in the economic conditions and the degree of development in each country. therefore, we employ two recently developed heterogeneous panel unit root tests to check whether the variables in our model are stationary or non-stationary. these tests are the fisher augmented dickey–fuller (choi, 2001) and the im, pesaran and shin (ips, 2003) that take heterogeneity into account using individual effects and individual linear trends. choi (2001) considers the model: y it = d it + x it (i=1,…,n; t=1,…,t i ) (2) where d it = ... ti i im m0 1 i i+ + +b b b , xit = x ( )i i t 1a + u it and u it is integrated of order zero. choi allows each time series, y it , to have a different sample size and a different specification of nonstochastic and stochastic components depending on i. the null hypothesis is that all the individual series in the panel are non-stationary (h 0 :  i = 1 for all i), the alternative hypothesis is that some of the time series are stationary (h 0 : ia < 1 for some i’s). choi proposed a fisher-type test: z = ( ) n p1 i n 1 1 u -! (2) where u is the standard normal cumulative distribution function and p0 1i# # , u-1(pi) is a n(0,1) random variable and t i   for all i, z  n(0,1). im et al (2003) using the ips test also developed a unit root test for dynamic heterogeneous panels based on the mean of the individual unit root statistics. im et al propose a standardised t-bar test based on the adf statistics averaged across the groups. the stochastic process, y it , is generated by the first-order autoregressive process: y it = ( )– y1 ,i i i i t it1+ +z n z f i=1,...n; t=1,...t (3) where the initial values, y i0 , are given. in the testing, the null hypothesis of the unit roots, 1i =z for all i. equation (3) can be expressed: y y ,it i i i t it1= + +a b fd , (4) the null hypothesis is that each individual series in the panel has a unit root; the alternative hypothesis allows for  i to differ across the groups: h 0 :  i = 0 for all i (5) sajems ns 12 (2009) no 1 21 h 1 ,  i < 0, i = 1,2,...,n 1 ,  i = 0, i = n 1 + 1, n 1 + 2, ..., n (6) the modified standardised t ips statistic below is distributed as n(0,1) when t   followed by n   sequentially: t ips = [ ]) [ ]) n var t n t – n e t 1 0 1 0 i n it i it i i n 1 1 = = b b = = c m ! ! (7) 4.2 panel co-integration analysis pedroni (1997, 1999) developed a residual-based panel co-integration method that also allows a lot of heterogeneity through individual effects, slope coefficients and individual linear trends across countries. pedroni (2004) considered the following type of regression: y it = t xi i i it it+ + +a d b f (8) for a time series panel of observables y it and x it for members i=1,...,n over time periods t=1,... t. the variables y it and x it are assumed to be integrated of order one, denoted i(1). the parameters  i and  i allow for the possibility of individual effects and individual linear trends, respectively. the slope coefficient  i is also permitted to vary from individual to individual, so, in general, the co-integrating vectors may be heteregenous across the members of the panel. pedroni (1999) derived the asymptotic distributions and explored the small sample performances of seven different statistics to test panel data co-integration. his tests can be classified into two categories: the first four test statistics are based on pooling along what is often referred to as the “within” dimension (called “panel” hereafter). these tests are the panel-v, panel-rho, panelnon-parametric (pp) and panel-parametric (adf) statistics. the last three test statistics are based on the “between” dimension (called “group” hereafter). these tests are group-rho, group-pp and group-adf statistics. the null hypothesis is h 0 : â i = 1 (i.e., no co-integration) for all tests and the alternative hypotheses are h 1 : â i = â < 1 = h 1 : â < 1 and for the first four tests and the last three tests, respectively. the small sample size properties for the seven statistics have also been re-investigated by pedroni (2004) via monte carlo simulations. in terms of power, for smaller samples (n=20) the group-rho statistic is the most powerful, followed by the panel-rho and panel-adf statistics. the calculated test statistics must be smaller than the tabulated critical value to accept the null hypothesis of absence of co-integration. 4.3 panel causality analysis the panel co-integration method tests for the existence or absence of long-run relationships between financial development and economic growth. the test does not indicate the direction of causality. but one can estimate causality using the panel gmm estimator as developed by holtz-eakin, newey and rosen (1988, 1989), and arellano and bond (1991). to test for panel causality, the most widely used method in the literature is that proposed by holtz-eakin, newey and rosen, (1988, 1989). their timestationary var model is of the form: gdp it = gdp fdj it j j m j it j j m 0 1 1 a a b+ += = ! ! i itn f+ + (9) fd it = gdp fdj it j j m j it j j m 0 1 1 + +d d c= = ! ! vi it+ +h (10) where  it and v it are error terms, and  i and  i are individual fixed effects. the test of whether financial development (fd) causes gdp is simply a test of the joint hypothesis that is  1 =  2 = ... =  m = 0. nickell (1981) shows that including the fixed effects and the lagged dependent variables correlated with the error terms leads to biased estimation. anderson and hsiao (1981) recommend using the first difference operator to eliminate the individual fixed effects. δ indicates the first difference operator, the resulting model becomes: δgdp it = gdp fdj it j j m j it j j m 1 1 a d b d+= = ! ! uitd+ (11) δfd it = gdp fdj it j j m j it j j m 1 1 d c+d d= = ! ! vitd+ (12) if the errors move by an average of the order k in the model at all levels, they will move by an average of the order k+1 at the first difference and, therefore, anderson and hsiao (1981) 22 sajems ns 12 (2009) no 1 suggest using some instrumental variables to get a consistent estimation of the parameters. the panel gmm estimator combines the level equations (9 and 10) and the differenced equations (11 and 12) in a system. this estimator uses the lagged levels as an instrument in the difference regressions and the most recent difference as an instrument in the level regressions. the panel gmm estimator is based on the assumption of no second-order autocorrelation in the firstdifferenced residuals. 5 empirical results 5.1 panel integration and co-integration results table 1 presents the results derived from the two heterogeneous panel unit root tests for the order of panel integration. the maximum lags are based on schwarz information criterion (sic) for these tests that assume the null hypothesis of each individual series is nonstationary. both the panel unit root tests have the same results: the null hypothesis of the unit roots cannot be rejected for gdp and pc series at all the levels but it is strongly rejected at the 1 per cent significance level at their first difference. the bc and ll series are stationary at the 5 per cent and 1 per cent significance levels, respectively. so we conclude that the real gdp per capita and the domestic credit to private sector (percentage of gdp) series are i(1), while the domestic credit provided by the banking sector (percentage of gdp) and m3 broad money (percentage of gdp) series are i(0). table 1 panel unit root tests variables fisher adf ips levels differences levels differences gdp 0.3470 (6) –14.4122 (5)*** –0.0277 (6) –16.7907(5)*** bc –1.7783(6)** –2.1601(6)** pc –1.2807 (5) –14.6338(2)*** –1.2691 (5) –17.3955(2)*** ll –2.5656(3)*** –2.8317(3)*** note: maximum lags in ( ). *** and ** indicate significance at the 1% and 5% levels, respectively. we can apply the pedroni panel co-integration test for only the real gdp per capita and the domestic credit to the private sector (percentage of gdp) in order to determine if there is a long-run relationship between the two variables. table 2 presents the heterogeneous panel cointegration test results. all tests accept the null hypothesis of no co-integration against the alternative of co-integration. this means that there is no long-run relationship between the gdp and pc series. all results from the panel integration and co-integration suggest that the panel causality relationship can be examined within a timestationary var framework, instead of an error correction var framework. therefore, we apply the first difference operator for the gdp and pc series to get time-stationary var models for panel causality. the new series become the growth of real gdp per capita (dgdp) and the change of domestic credit to the private sector (percentage of gdp) (dpc). sajems ns 12 (2009) no 1 23 table 2 pedroni panel co-integration test gdp – pc panel statistics panel v-stat panel rho-stat panel pp-stat panel adf-stat 0.4687 0.3494 –0.5119 –0.6314 group statistics group rho-stat group pp-stat group adf-stat 1.5652 0.3223 –0.2937 note: number of countries (n) =24 and periods (t)=31 maximum lag on schwarz information criterion (sic) is three. 5.2 panel causality results holtz-eakin et al (1988) suggest that the lag length should be less than one-third of the total time period to avoid the over-identification problem. the sargan test is a test of the validity of instrumental variables. it is a test of the overidentifying restrictions. the hypothesis being tested with the sargan test is that the instrumental variables are uncorrelated to some set of residuals, and therefore they are acceptable, healthy, instruments. the arellano– bond test is a test for the first and second order serial correlation in the first-differenced residuals under the null hypothesis of no serial correlation. full details on these tests and the estimation procedure may be found in arellano and bond (1991). we use two wald test statistics that follow a chi-squared distribution with (k-m) degrees of freedom. the wald1 test is a test for the significance of the overall regression model under the null hypothesis that is  j =  j = 0 and  j = y j = 0 for j = 1, ..., 9 equations (11) and (12), respectively. the wald2 test is for the null of no causality under the null hypothesis that is  j = 0 and  j = 0 for j = 1, ..., 9 for equations (11) and (12), respectively. table 3 presents the results of the panel causality from the gmm estimators. we set the maximum lag length as nine years, that is, less than one-third of the total time period, and test its validity by using the sargan test. the sargan test does not reject the validity of this set of instruments in all the equations (except for all bc-dgdp equations from one lag to nine lags). the arellano-bond test also accepts the null hypothesis of no serial correlation. all the estimated models are significant at the 1 per cent level. these results show that the models are well specified, and the assumptions for the panel gmm estimator are satisfied at nine lags. table 3 panel gmm estimation for causality variables dgdp-bc bc-dgdp dgdp-dpc dpc-dgdp dgdp-ll ll-dgdp lags 9 9 9 9 9 9 wald1 test (18) 196.63 [0.0000] 9379.13 [0.0000] 181.15 [0.0000] 1074.26 [0.0000] 361.84 [0.0000] 1610.65 [0.0000] wald2 test (9) 22.18 [0.0083] 37.29 [0.0000] 5.37 [0.8011] 29.31 [0.0006] 17.73 [0.0385] 12.89 [0.1678] 24 sajems ns 12 (2009) no 1 arellano-bond test 0.18 [0.8567] 0.47 [0.6371] 0.43 [0.6649] –0.66 [0.5072] 0.30 [0.7675] –0.38 [0.7011] sargan test 366.84 [0.5219] 346.09 [0.0000] 360.29 [0.6174] 390.17 [0.2150] 359.35 [0.6307] 385.29 [0.2691] notes: the wald1 test and wald2 test are for the significance of the overall model and the causality. the degrees of freedom and p-values are in ( ) and [ ], respectively. standard errors and test statistics are asymptotically robust to heteroskedasticity. the results for the causality between the financial development indicators and economic growth are as follows: there is a bi-directional causal relationship between the growth of real gdp per capita and the domestic credit provided by the banking sector; there is a one-way causal relationship between domestic credit to the private sector and the growth of real gdp per capita; and the growth of real gdp per capita causes a higher level of financial depth. higher liquid liabilities lead to higher future per capita gdps in sub-saharan african economies. our empirical result is in line with earlier studies suggesting that credit ratios capture changes in economic growth better than the financial depth variable does. many researchers suggest that credit to the private sector represents an accurate indicator of the functioning of financial development. therefore, most of the financial developments have occurred within the banking systems in african countries (see ghirmay 2004), any expansion of the domestic credit provided by the banking sector or the domestic credit to the private sector will promote economic growth per capita in sub-saharan african countries. because the financial sectors in sub-saharan africa are not well developed, deeper and more efficient financial markets are needed to improve their levels of economic development. our empirical results suggest that the financial sector affects economic growth mainly through an increase in the efficiency of investment. in order to support faster economic growth, sub-saharan african countries should expand and improve their credit systems through appropriate regulatory and policy reforms. 6 conclusion and policy implications this paper investigates the causal links between financial development and economic growth in a sample of 24 sub-saharan african countries over the period 1975-2005. the paper contributes to the literature by exploring the growth-financial development nexus in the african context and provides some empirical evidence. the empirical methodology is based on the pedroni panel cointegration test and panel gmm estimation for causality. the three main findings of the study can be summarised as follows: i) the results of the panel co-integration analysis provide evidence of no long-run relationship between financial development and economic growth. ii) the credit ratios capture changes in economic growth better than the financial depth variable in the short-run. any expansion of the domestic credit provided by the banking sector (bc) or the domestic credit to the private sector will promote economic growth per capita in sub-saharan african countries. because of a positive interaction between the domestic credit provided by the banking sector and economic development, countries should liberalise the economy while liberalising the banking sector. iii) the growth of real gdp per capita also causes financial deepening. the paper suggests that countries should promote economic growth in order to encourage and thus benefit from financial development. we conclude that sub-saharan african countries should expand and improve their credit systems through appropriate regulatory and policy reforms in order to support higher economic growth. sajems ns 12 (2009) no 1 25 endnotes 1 acknowledgement: the authors are very grateful for the comments of the two anonymous referees, which have significantly improved the depth of analysis of the paper. we also thank the editor of the journal for his encouragement. the usual disclaimer applies and views are solely those of the authors. 2 for the supply-leading hypothesis, see, for example, schumpeter (1911), mckinnon (1973), shaw (1973), gupta (1984), fry (1988), greenwood and jovanovich (1990), bencivenga and smith (1991), king and levine (1993 a,b), greenwood and smith (1997), khan and senhadji (2000), calderon and liu (2003), and christopoulos and tsionas (2004). 3 the four financial development indicators are: (i) the ratio of liquid liabilities to nominal gdp; (ii) the ratio of deposit money bank domestic assets to deposit money bank domestic assets plus central bank domestic assets; (iii) the ratio of credit to the non-financial private sector to total domestic credit (excluding credit to money banks); and (iv) the ratio of credit to the non-financial sector to nominal gdp. 4 for some other studies of the relationship between 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(1998) no 2 220 the debates in cairo once again awakened the "catastrophist" and "alarmist" vision of global apocalypse. neglect of population matters and ecological concerns is fraught with danger for the world community. but overstating and exaggerating the state of the environment and global overcrowding is certainly as dangerous, if not more so. the use of scare tactics often serves as an instrument of social control. alarmist predictions and embellished descriptions of current conditions often lead to policies of improper force and coercion. consequently, less attention is given to the policies which promote equity and democracy (bahr, chadwick, and thomas, 1972: 6; bailey, 1993: 168-178; hartmann, 1995: 39,389). in response to the doomsday philosophy displayed at icpd cairo, this paper explores four themes. first, the arrangement of social institutions, not nature, is the primary determinant in underdevelopment and poverty. second, an expansion of human rights, especially the empowerment of women, may serve as partial remedy to the three problems of population, development, and the environment.2 third, ceremonial encapsulation of technology is a major obstacle in improving the human condition. and fourth, democracy and a more equitable distribution of world produce are better remedies than draconian measures. the united nations conferences on population the united nations international conference on population and development (icpd) in cairo was the third meeting of its kind. the first meeting congregated in bucharest in 1974 where a clear split developed between the more developed countries (the north) and the less developed countries (the south). j the north took a neo-malthusian approach in suggesting the growing population was a major threat not only to development in the south, but also threatened the future of the north. in a surprise offensive, voices from the south suggested that the developed countries (particularly the united states) used the population issue as a means of avoiding the major issues which address the root cause of poverty. the south advocated a more equitable distribution of resources, a better balance of global political power, and more attention to the needs of the poorer countries. noting that population growth rates fall as economies develop, they claimed rising economic development would become the "best contraceptive." the second icpd meeting was held in mexico city in 1984. the countries of the north were much better armed the second time around. they took a position which acknowledged the impact of development on population growth; yet, they charged that the more important path of causation is from population to development. the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 221 sateb nr vol 1 (l998)nr2 return to malthusianism was awkwardly coupled with a strong anti-abortion stance. the influence of the american anti-abortionist lobby led ronald reagan to withdraw american support for any population program that involved abortion (directly or indirectly) as a means of birth control (correa and reichmann, 1994: 1-7; hartmann, 1995: 128-148; camp, 1990: 126-127). the third meeting (in cairo) returned to the theme of development as the most important factor in population growth. it integrated the major issues of population, development, and the environment with the "advances of women through education, health and nutrition." (united nations, 1995: 6) according to the un report, there are four requirements for any program of population and development: (l) gender equality and e~uity, (2) empowerment of women, (3) the elimination of violence against women and (4) the ability of women to control their own fertility: advancing gender equality and equity and the empowerment of women, and the elimination of all kinds of violence against women, and ensuring women's ability to control their own fertility, are cornerstones of population and development-related programmes. the human rights of women and the girl child are an inalienable, integral and indivisible part of universal human rights. the full and equal participation of women in civil, cultural, economic, and political life, at the national, regional and international levels, and the eradication of all forms of discrimination on grounds of sex, are priority objectives of the international community (united nations, 1995: 449). the issue of equality between the sexes (including sexual freedoms and birth control) created a major schism between some of the moslem nations and the feminists. saudi arabia led a boycott of the meeting and was joined by sudan, lebanon, and nauru. the vatican also registered its distress with the feminist position on reproductive rights. sonia correa and rebecca reichmann (1994: 3-4) question how much of the resistance to changes in gender roles and reproductive rights is due to religion and how much is due to patriarchal dominance. they maintain "fundamentalism is not religious" but is rather a "political phenomenon" with strong policy implications at the national and international level. homa hoodfar (1994: 11) contends that the controversy has more to do with "the political and economic realities of a given society" than with religion. in this context, birth control/sexual freedom is more of a matter of social control than one of religion. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 2 222 the issue of population control crosses more than religious and cultural boundaries. the question arises as to whose population is to be controlled and who is to make the choice. paul ehrlich (1968: 1990) believes some countries are so far behind in the "food-population game" that there is no hope any amount of aid could ever help them. other countries which are not as far behind in the "game" could only be saved through involuntary and coercive birth control policies. a danger exists that coercive population control could become "a government of the developing countries by the developed ones." (feenberg: 1996: 277) charles maynes (1995: 44) warns of a trend toward viewing "disease-ridden, violent, and proliferating colored people" as the main culprit in a perceived population explosion.s the population question: explosion or expansion? for almost two centuries, the population debate has centered around the work of thomas robert malthus. his bleak prognosis for humankind in the first edition of essays on the principle of population was based on the idea that population grows at a geometric rate while food and the necessities of life grow at an arithmetic rate. higher yields of crops per acre and the decline in the growth rate of population that accompanies economic development have severely challenged malthusian theory. nonetheless, the rhetoric of the "dismal" social scientist (and part-time parson) left the world with a two-hundred year hangover and has manifested itself in the contemporary population question. malthus viewed the plight of the poor as being the result of their inability to practice self-discipline and moral restraint. 6 any attempts to help the poor would only make their problem worse. nonetheless, birth control was the "improper means to hide the consequences of an irregular connection" and malthus claimed to have opposed it on moral grounds. his opposition to birth control had more to do with his resistance to sexual freedoms for the poor than moral considerations. malthus further concluded that there was a natural reason why "a breach of chastity" is far more disgraceful on the part of a woman than a man. the natural reason springs from the notion that women cannot be expected to "have resources enough to support their own children." these arguments for social control are masked as "natural" outcomes based on "moral" principles. in fact, there is no reason in nature or in moral theory which explains the poverty of women. discretionary policy, not nature, denies the access of women to sufficient income to raise children and to enjoy the basic social goods of society. gender inequality, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 223 satebnr vol i (l998)nr2 as well as all other forms of inequality, is a basic reason for overpopulation and underdevelopment. as seen at the icpd cairo, the neo-malthusian approach to population and poverty relies heavily upon "scare tactics" similar to those of the original dismal philosopher. it is true that world population now stands at 5.7 billion with some 100 million being added each year. the united nations population fund predicts world population to be 8.5 billion by the year 2025. these numbers are staggering when viewed through the eyes of population alarmists. 7 the can for alarm notwithstanding, these numbers can be less threatening when analyzed from a different standpoint. in apocalypse not, ben bolch and harold lyons (1993: 26) divided the current world population by the land area of texas. they found that every person in the world could be placed in the state of texas in a house with a floor plan of 1400 square feet. the bolch and lyons analysis is admittedly simplistic but no more so than predictions of the population control establishment. wallace kaufman best puts overcrowding in perspective when he said: fortunately population growth is likely to level out between 12 and 15 billion midway through the next century. for a little perspective, we should note that all of these people could fit in an area twice the size of rhode island. that would be shoulder to shoulder, but the rest of the world would be empty. more rationally we could fit in a futuristic megacity or "arcology", the size of texas, with the rest of the world empty. i would not want to live there, but i offer the picture to point out that even 15 billion people would not populate the world as densely as ants in an anthill (1994: 176). contrary to the claims of the population establishment, persistent famine is not the result of overpopulation. it is invariably the failure of major social institutions and the result of civil wars, wars, or ineffective public policy. nor is hunger the result of a lack of resources. japan has virtually no natural resources, little arable land, and a very larfe ratio of population to land space but faces no problem in feeding its population. distribution of democratic rights and global entitlements are much more important determinants than population (hartmann, 1995: 17,292). thus, the issues of survival and the quality of life have more to do with ideology than with natural barriers to progress and development. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 2 224 barriers to development: mental or physical? a recurring theme in the issue of economic development is centered around the notion of resources. the view of resources as being finite (and thus fixed in nature) engenders fears and doubts about the possibilities of future economic development. a growing population puts pressure on a dwindling resource base in this scenario.9 a world of finite resources translates into a call for population control, zero economic growth, and austere economic policies derived from an elite group who decides what is to be done. the functional view of resources presents a markedly different scenario. resources are not fixed by nature; they are a function of technology. in other words, resources spring from a state of mind rather than from a state of nature. human ingenuity is unlimited and historically has ensured the availability of a continuous resource base. resources become obsolete before they are exhausted (degregori, 1985; 1987; zimmermann, 1951). warnings of resource depletion have haunted humankind for hundreds of years. stanley jevons (1865) predicted the depletion of coal in england over a century ago. at about the same time, the united states department ofinterior predicted the exhaustion of timber (bailey, 1993: 66-67). jeremy rifkin (1980) predicted the exhaustion of petroleum by 1990. what each of these "catastrophists" overlooked was the role of technology. (homer, 1989) technological change brought about a larger, not smaller, supply of coal in the century following jevons' forecast. the same was true for petroleum. supplies of oil and natural gas glutted world markets within a decade of rifkin's declaration that the age of the fossil fuel economy was over. tales of doom continue to arise in spite of the miscalculations of prophets of worldly demise (ehrlich, 1968;1990; meadows and meadows, 1972). "carrying capacity", "sustainable development", and "population explosions" are just a few of the notions presented at the icpd in cairo which recommence the idea that the exhaustion of finite resources will lead to ultimate chaos and doom. the focus is misplaced. as thomas degregori notes: technology, resource creation and emergent evolution engender not a world of an unknown future but of emerging possibilities. our destiny is not in being but in becoming .... those who would tum us aside out of some fictitious fear of resource exhaustion would protect us from the dangers of the unknown but would also deny us its possibilities. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 225 sateb nr vol 1 (1998) nr 2 the liberating idea of technology and resource creation is the human potential that is there, if we are aware of it and if we frame our policies accordingly. we will exhaust resources if we exhaust creative imagination (1987: 1260). any discussion of economic development cannot be divorced from environmental concerns. women have an important role to play in this discussion given their unique relationship with the environment. environmental concerns: technology and the role of women there is a recurrent notion that economic progress always brings with it an increase in environmental degradation. environmental degradation and economic progress are not necessarily complementary outcomes. there exists a romantic notion that living conditions were better in the "old days" before the onslaught of the automobile and the modem corporation. degregori describes the "horse economy" of the cities at the tum of the century: the horse was rightly seen as a health problem that some thought the automobile would cure. each horse discharged gallons of urine and nearly twenty pounds of fecal matter on the streets daily. the manure piles drew flies, gave off a foul odor, and formed a breeding ground for diseases. streets were cesspools when it rained and pulverized dung blew into pieces in dry weather [and] ... powder irritated respiratory organs (1985: 182). the average life expectancy has risen during this century despite an increase in the use of chemicals, the advent of automobile pollutants, and the dangers of carcinogens. many cities and countries with slow growth rates suffer pollution far beyond what is seen in the more industrialized countries. most confusion and fear concerning environmental degradation is due to a misunderstanding about technology and its problem solving capacity; consequently, the contemporary attack on modem technology is frequently misguided. technology is not a "thing." nor is it a piece of equipment. technology is "our ways of knowing.,,10 new technology certainly creates new environmental problems. but if the problems created by new technology are less severe than the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vall (j998) no 2 226 ones it replaces, progress is said to have taken place. women can play an important part in this progress, if allowed to participate. ariel salleh (1994: 106-107) sees women as having certain knowledge and experiences which give them particularly important insight on the environment. their experiences may arise from female body organs in the "interplay of birthing and suckling labor" or they may arise from their historic positions of providing "caring and maintenance" functions which serve as a "bridge" between men and nature. other knowledge may arise from the traditional manual labor of women such as weaving, farming, and pottery. two examples illustrate this view. the introduction of chemical pesticides and high-yield fertilizers in the philippines caused the eradication of inexpensive domestic foods such as snails, frogs, and fish. the chemicals also resulted in spontaneous abortions, vision problems, and severe skin irritations. after these chemical substances were banned, filipino women employed native technology which was older but much more effective. they planted certain indigenous plants, which are natural pesticides, between various vegetable crops. the women now wash clothes with a coconut based soap, a natural pesticide for some plants, and use the water for crop irrigation. their compost baskets serve the function of increasing the fertility of the soil and thus replace chemical fertilizers (ayupan and oliveros, 1994: 113-120). during the 1970s, businesses in northern india quarried and processed chalk that was to be used in the manufacture of cosmetics. upper income women were the primary buyers of the cosmetics. severe deforestation and water pollution from chalk run-offs ensued. as a result, a direct conflict developed between the wants of wealthy women (make-up) and the needs of working class women and their families (food and sustenance). the narrow paths used by men to bring the chalk out of the foothills of the himalayas on burros were the same paths being used by the local women farmers to haul produce and water. the female farmers often had to wait hours for the mule teams to pass. in response, the women altered the paths so that the pack trains experienced difficulty in passing and the powder business became unprofitable for that locale. women now move freely on the paths. trees stand again where once deforestation marked the points of excavation (stone, 1989: 175-176). such success stories are rare but not because of the lack of skills or knowledge of women. rather, it is because of the impediments placed in the way of women (and all disenfranchised groups). most obstacles to effective policy toward population, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 227 sateb nr vol i (1998) nr 2 development, and the environment are due to the "ceremonial encapsulation" of technology. impediments to the empowerment to women: ceremonial encapsulation paul dale bush (1986; 1987) recognizes the strategy to capture and control new technology. the "ceremonial encapsulation" of problem-solving technology protects vested interests as new technology is absorbed by the economic system only to the extent that it fits in with the ideology of the existing power structure. ceremonial encapsulation prevents the community from enjoying the full potential of problem-solving processes. (homer, 1991) by maintaining control over technological innovations, vested interests effectively control the future of the community. bush's theory has important implications for the empowerment of women. the "son preference" practiced in india (and other countries) is a prime example of ceremonial encapsulation. sonia correa and rebecca reichmann note that the amount of medical technology available is not always the main determinant in the status of women's health. gender status, class. and race are sometimes more important factors. for example, the process known as "amniocentesis" was developed as a method to diagnose fetal genetic defects as well as the sex of the fetus. the technique has the propensity to add to the life-process and improve the quality of life. however, the ceremonial encapsulation of amniocentesis resulted in the use of the process as a means of gender selection in india during the 1980s. at the discretion of the father and not the mother, an abortion would be performed if the procedure indicated that the child was a female. the forum against sex determination and sex pre-selection (1994: 78-87) argues that this type of process reinforces and legitimates orthodox prejudices which are an integral part of the oppression and discrimination against women. the language of the icpd in cairo is specific. the "son preference" in many countries is "curtailing the access of food, education and health care" (united nations, 1995: 56). the process of ceremonial encapsulation grips the environmental and population movements. contraception technology has been encapsulated by those who are more motivated by "population control, prestige, and profit" than by the needs of those in the poor nations (hartmann, 1995: 173-187). non governmental r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 2 228 organizations (ngo's) have played a major role in population control efforts. hartmann fears that these organizations are dominated by middle and upper class whites who have little understanding of the developing world. she cites their confusion between defending the rights of population control with defending reproductive rights. many ngo's and local elites have pressured governments and communities to use particular birth control methods such as implants (norplant), inner-uterine devices (iud), and injectable hormones (depro-provera). these methods reflect the values of the countries which developed them where frequent and regular monitoring is commonplace. using these methods in the poor countries poses greater health risks as most women are not able to have regular visits with physicians; nor are these women as well informed about the dangers of using the techniques. ii hartmann (1995: 139-143) also warns of problems in the environmental movement. many in the population establishment and environmental groups treat women as an "undifferentiated mass." recognition of the differences between them (rich vs. poor, rural or urban, black or white) is essential for the empowerment of all women, not just the affiuent. the same is true for the differences between men: how many poor women of color, for example, support the position of the many rich white environmentalists that high fertility is the main cause of the environmental crisis? there is no consensus here, even by the wildest stretch of the imagination ... in the population consensus poor men's oppression, while scarcely mentioned, is also not linked in any way to rich men. in a new twist on male bonding, the corporate executive and the landless laborer are both just "men", in the same way that imelda marcos and a poor filipino plantation worker are just "women" (op cit: 136). technological innovations and better education have the propensity to add to the life process and improve the human condition for women. new knowledge is permitted to the extent that it does not disrupt the existing value structure. the ceremonial encapsulation of technological innovations in the industrial arts denies the community, especially women, the full extent of problem solving knowledge. new technology is captured by a patriarchal system enabling males to take over tasks which had been traditionally performed by women at home. the displacement of women locks them into the secondary labor market (the informal sector) where there is little upward mobility. any mobility tends to be from one low payingjob to another (op cit: 1995: 45-47). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 229 sateb nr vol 1(1998) nr 2 the mechanization of agriculture has been ceremonially encapsulated in some cases. technological innovations have the potential to narrow the biological physical differences between men and women. patriarchal systems have captured the innovations and distributed most of the gains to men. instead of allowing women to work in agricultural jobs which, heretofore, would have been beyond their physical capabilities, the work is given to men and more women are displaced (op cit: 1995: 44). conclusion the growth in population over the last half-century is not solely the result of rising fertility rates. it is better explained by longer life expectancies and the decrease in infant mortality. population growth decreases as a result of economic development; the direction of causation is not the other way around. the world is not running out of resources. history has shown that technology, price effects, and substitution effects have rendered resources obsolete before they were exhausted. living within limits set by a belief in finite resources is the path to extinction and not the path to perpetuation of life. environmental degradation plagues the earth today but the same was true in bygone years. ecological improvements come not from containing technology, but from preventing the ceremonial encapsulation of technology by vested interests; that is, those who protect the elite at the expense of the less fortunate. policymakers must choose between democratic reform and draconian measures. the empowerment of women is more ethical than the draconian measures forwarded by the population establishment and the iimits-to-growth advocates. establishing entitlements of all people to food and medical care is more likely to bring about better conditions than a slow-growth or no-growth policy. the extension of political and economic rights for women will bring about more effective decisions concerning the environment than will coercive economic and social policy. more education and better health for women provide more of a chance for economic progress, than does compulsory population control. many well-intentioned and concerned people attending the icpd in cairo were involved in a genuine quest to find the correct balance with respect to population, development and the environment. few of them will be among those involved in ultimate decision making and policy implementation. the decision makers are more likely to come from the ranks of local elites, the environmental aristocracy, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 2 230 and the population establishment. their tools of persuasion will be tales of environmental ruination, massive overcrowding, and ultimate" demise. they will not be as concerned with the empowerment of women and other disenfranchised groups as they will be with maintaining status and power. a moral and ethical approach to global problems is based on democracy and in optimism. sustainable economic progress commands an equal partnership between the north and the south, men and women, and the rich and poor. solutions to contemporary challenges thrive in the waters of freedom, mutual respect and love, but die in a flood of xenophobia, racism, and chauvinism. the success of modern technology and economic growth deserves as much attention as the failure. optimism does not draw as much attention in the short run as does tales of doom and catastrophe. but neither does it pose the almost certain long-run hardship of pessimism. perhaps wallace kaufman expresses the spirit of this paper when he says: we have unleashed dangerous forces in the world. we created them and we understand them a lot better than primitive people understood the weather or the waxing and waning of the animal populations they hunted. we are in no worse position than humans ever were. we have lost some things and gained much. we may regret the loss of glen canyon or the darkened midwestern sky. but we don't regret the passing of yellow fever, malaria, or bubonic plague. few people really want a simpler life. we may tum down the thermostat five degrees, but we don't take out the heat pump. we all want more, for ourselves and for the rest of the world, because we know that it is the way to peace. and we know it is possible. now that we know the freedom of the human mind is more important than any natural resource, no insurmountable obstacle exists to continued improvement in the quality of our lives and the way in which we manage the natural world (1994: 181). endnotes 'betsy hartmann (1995: 134) believes that "poor men need to be empowered too, but not in the traditional, patriarchal sense." women can be empowered only to the extent that they enjoy equal rights with men at home and in the community at large. 2the icpd report cites three factors necessary for the empowerment of women: (1) mechanisms are to be established for equal participation and representation at r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 231 sateb nr vol i (1998) nr.2 all levels of the political process and public life (2) promotion of women's education, employment and skills and (3) elimination of all discriminatory rractices. the term "north" is synonymous with "developed nations" and "western nations." the term "south" is synonymous with "developing nations" and the "third world." 4there was a special emphasis in cairo on the discrimination toward girl children. included in this emphasis is the equal access to health for all children. the report also admonished all countries to stop the sexual mutilation of female infants (united nations, 1995: 56). 5 as to whose population is to be controlled, there is a wide range of candidates: baby girls in the preference for male babies; ethnic groups within a society that are outside the "norm"; or the poor in developing countries. some in the developing world ask if there should be the same limits on the number of american babies who will grow up to consume a disproportionate amount of the world's resources. 6malthusian theory serves as more of a call for social control than one of population control. malthus was reacting to the french revolution where the landed aristocracy was overthrown. neo-malthusian theory is primarily an invidious attack on the poor masked as concern for the south. 7 at the beginning of the period known as the first industrial revolution, birth rates were high as was the mortality rate. the final stages of the revolution witnessed declining birth rates as well as declining mortality rates. population growth is not necessarily mutually exclusive with long-run economic developmen 8 amartya sen (1981) contends the food supply has little to do with famine and r.0verty. he notes that a major famine has never persisted in democratic societies. to paraphrase julian simon, accepting this view requires the world to carefully budget its time and natural resources over the next few million years in order to prolong the inevitable depletion of resources (simon, 1993: 446). i opaul krugman (1994: 66) credits "increases in knowledge" as the main forces behind the growth of the pacific rim countries in recent times as well as communist countries during the 1950's and 1960's. i i many population control programs are viewed as culturally biased by women in the developing nations. the emphasis on western individualism may overlook the role of culture. choice must be viewed in terms of context. the "individual choice" of women in some societies may actually be the choice of the existing framework of power (correa and reichmann, 1994: 77). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 2 232 references i. a yup an, l.b. and oliveros, t.g. (1994). filipino peasant in defense of life in close to home, ed. vandana shiva (philadelphia pa: new society publishers), 111-120. 2. bahr, h.m. and chadwick, b.a. and darwin l.t. (1972). are proposals for population control premature? in population, resources, and the future. ed. bahr, h.m. chadwick, b.a. and thomas, d.l. provo ut: brigham young university press, 1-12. 3. bailey, r. (1993). eco-scam. new york: st. martin's press. 4. bloch, b. and lyons, h. (1993). apocalypse not washington dc: cato press. 5. bush, p.d. 1986. "on the concept of ceremonial encapsulation" the review of institutianal thought. 3 december: 25-48. 6. ___ . (1987). theory of institutional change. journal of economic issues 21 (september): 1075-1116. 7. camp, s.l. (1990). population: the critical debate. foreign policy 90. spring: 126-144. 8. correa, s and reichmann, r. (1994). population and reproductive rights. london: zed books. 9. degregori, t. 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(1994). devises and desires: population policy and gender roles in the islamic republic. middle east report 24. septemberoctober: 11-17. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 233 sateb nr vol i (1998) nr 2 17. horner, j. (1991). "the case ofdat technology" journal of economic issues 25 (june): 449-458. 18. __ . (1989). the role of technology. 23 journal of economic issues 23 june: 579-586. 19. jevons, w. stanley. (1865). the coal question. new york: a.m. kelley, reprinted in 1965. 20. kaufman, w. (1994). no turning back. new york: basic books. 21. krugman, p. (1994). the myth of asia's miracle. foreign affairs 73 novemberldecember : 62-78. 22. mal hrns, t.r. (1803). on the principle of population ii (london: j.m. dent, reprinted in 1914). 23. maynes, c.w. (1995). the new pessimism. foreign policy 100. fall :33-49. 24. meadows, d.h et al. (1972). the limits to growth. new york: universe books. 25. rifkin, j. (1980). entropy: a new world view. new york, bantam books. 26. salleh, a. (1994). nature, woman. capital. labor: living the deepest contradiction in is capitalism sustainable? ed. martin o'connor. new york: guilford press, 106-124. 27. sen. a. (1981). poverty and famines. oxford: clarendon press. 28. simon, j. (1993). population matters. london: transaction publishers. 29. stone, b.w. (1989). celebrating embodied care: women and economic justice. in reformed faith and economics ed. r. stivers. new york: university press of america, 171-182. 30. united nations. (1995). the advancement of women: /945-1995. new york: united nation office of public information. 31. zimmermann, erich w. (1951). world resources and industry. new york: harper and brothers. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 413 sajems ns vol 3 (2000) no 3 the role of marketing and advertising in the legal profession a breytenbach department of marketing. pretoria technikon e j north department of marketing and communication management. university of pretoria abstract the majority of south african attorneys do not enjoy the benefits that may be derived from the marketing and advertising of their services. they seem to be unaware or do not make use of marketing and advertising opportunities to promote their firms and the services they render. the lack of marketing knowledge. ignorance of the value of advertising, as weil as the perception that advertising will cause unnecessary costs, are reasons why many legal firms are not marketing oriented. this paper reports the results of an empirical study done to determine the role of marketing and advertising in the legal profession in south africa. jelm37 introduction in today's competitive business environment, legal practitioners can no longer ... count on their reputation and country club contacts to obtain a steady stream ofciients (bloom 1984: 102). in the marketing of both products and services, many factors such as technological innovation, globalisation, improved quality and customer service, and ever changing consumer needs, require that organisations become more marketing oriented. service professions such as lawyers, doctors, auditors, architects, and engineers are discovering that the adoption and implementation of a marketing philosophy is a vital factor for business and organisational success. an increasing interest in marketing is being witnessed worldwide by professional practitioners. according to bradley (1995: xxviii) marketing ..... is a concern for all people and organisations at all times". in order to deliver value r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 414 to clients, it is suggested that even attorneys apply marketing principles in their firms, and be more customer focused rather than cost driven. the need for attorneys to become more marketing oriented was further stimulated by the worldwide lifting of restrictions and rules on the advertising and promotion of legal services. the adoption of a marketing philosophy and implementation of marketing strategies have become almost inevitable for attorneys and others in the legal field. according to coetzee (1992: 34), the abolishment of regulations on the advertising of legal services and the publicity surrounding this issue, have sparked an interest by attorneys to advertise and market their services. the question is however: how marketing oriented are south african attorneys, and to what extent do they apply marketing principles and strategies in their firms? problem statement although attorneys now have much more freedom to promote their business activities, the effect of this has not yet been investigated in south africa. an empirical research project was therefore conducted primarily to determine: • what impact the abolishment of marketing regulations has had on the marketing and advertising activities of attorneys; and • how attorneys use advertising as a marketing tool. secondary objectives of the study were inter alia to look into the following matters: • the level of marketing knowledge and expertise in firms of attorneys; • the relationshir between the age, size and geographic location of the firm and its marketing activities; • the media in which they prefer to advertise; • the reasons why some of them do not advertise; • the perceptions of attorneys regarding the possible advantages and disadvantages of advertising; and • whether advertising has an influence on fees. literature review profession as professional people, attorneys render services to the community. traditionally there is a perception that the legal profession should not adopt commercial methods and tactics to promote their services (wilson 1984: 19). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 415 sajems ns vol 3 (2000) no 3 many argue, for example, that it is wrong (unethical) to advertise. sinclair (1987: 129) and attanasio (1984: 500) state the following reasons why it is unprofessional for legal practitioners to advertise their services: • it harms the image of the firm. • advertising increases fees. • advertising leads to competition and eventually to price wars. • it is unnecessary to advertise because there will always be a demand for this kind of service. • clients should be protected against unfair competition. • advertising makes it difficult for firms to maintain objectivity and integrity. the concise oxford dictionary (1979) defines a profession as follows: "vocation or calling, especially one that involves some branch of advanced learning or science". some characteristics or "trademarks" of the legal profession are the following (bennion in wilson 1972: 4): • thorough academic training and assessment. • advisory role. • main aim is to render professional services. • representative bodies to support members and set standards. • code of ethical conduct laid down by professional institute. the legal profession demands a very high standard of integrity and know-how of its members. unfortunately, there is a perception among many people that the legal profession is characterised by self-enrichment and unrealistic profit seeking. does this then imply that advertising is taboo? in a well-known american case (bales lis slale bar of arizona. 433 u.s. 30, 1977) as discussed by elliot (1986: 23), it was found that factually correct information in advertisements informing the public about routine legal services are ?';ceptable. this led to the lifting of restrictions on the advertising of legal services in the united states, england (1984) and eventually in south africa (1990). marketing according to bradley (1995: 45), marketing entails providing, communicating and delivering value to customers. the identification of customer value and communication of the benefits of the services rendered by attorneys (wilson 1984: 2), therefore fit in well with the traditional viewpoint of the marketing concept. the competitive advantage that can be gained by adopting a marketing philosophy for the firm is neatly summarised by bloom (i 984: 106): "professional service firms can emphasise three attributes or personality features to set themselves apart: 'grey hair' (more experience, specialisation, credibility and contact), 'more brains' (better solutions to problems), and 'superior procedures "'. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol3 (2000) no 3 416 however, for many professionals in the legal field, marketing is a new concept. the implementation of marketing principles and strategies also pose problems for these professionals. wannop (i998: 3) argues that some legal professionals see marketing only as advertising. selling and research. more misconceptions listed by wannop are the following: • marketing is in essence an unprofessional activity. • the activities of marketers are "unworthy". • the marketing endeavour becomes too commercialised. • the costs involved in the marketing of services are too high. marketing of services there is a growing agreement among academics and practitioners that the socalled four traditional p's in marketing (product, price, place, and promotion) are not sufficient to take care for the marketing of services. according to booms & bitner (kotler, 1997: 472), and bradley (1995: 89) three more p's must be added to the mix, namely participants, physical evidence and processes. the participants refer to the training of personnel, interpersonal behaviour, and negotiations with customers. environmental aspects such as the furnishings, colour, layout of the buildings, and other tangible clues are included in physical evidence. the processes refer to the flow of activities, policies, and general procedures in the organisation. churchill and peter (1998: 288) summarise the nature and importance of services marketing as follows: " ... service marketers have an on-going personal relationship with their customers, the success of a service organisation often depends on its ability to retain, not just attract, customers". in the legal profession, therefore, the functional quality of services rendered is of utmost importance. advertising advertising involves an important marketing communications activity. companies do not only advertise their products and services, but also promote themselves in a very competitive way. the marketing guide for attorneys (association of attorneys 1990: 9) defines advertising on three levels: • advertising: " ... a paid fonn of non-personal communications by means of tv, radio and publications" • institutional advertising: " ... advertising on behalf of a profession at a national level to increase awareness of and promote the image of the profession" r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 417 sajems ns vol 3 (2000) no 3 • individual advertising: ..... advertising by individual practices to increase awareness of the practitioners' activities and promote the image of the practice". advertising by attorneys takes place on three levels, namely at national level, at provincial level and individually. findings of an informal study by the national productivity institute (npi) in 1990 indicate that there is a need for advertising by professional people in the legal field. two main problems were however identified, namely: • the public generally has a faulty (and sometimes negative) perception of the services rendered by lawyers; and • a negative perception exists in relation to fees, use of language, relationships with customers and the physical appearance of offices and buildings. unfortunately, many of these perceptions rely on hearsay and are not based on first-hand experiences. negative publicity in the mass media may also contribute to the negative perception. the above-mentioned problems and other factors that hamper the positive communication of legal services (such as a lack of marketing knowledge, and the strict professional code of the profession) emphasise the need for legal firms to engage in sound and effective marketing practices. the modus operandi of a research project, which was conducted to determine how legal practitioners in south african approach and apply marketing strategies in their firms, will now be discussed. method an exploratory investigation was conducted to determine the role of marketing and advertising in the legal profession. a self-administered questionnaire was used as the data collection instrument. sample size and data collection procedure all the practising attorney firms in south africa represented the population for this study. an address list of these firms was obtained from the butterworths legal diary (1997) according to which 4497 firms were registered in south africa in 1997. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 418 a probability sample of 11.11 % of the population drawn from all the provinces in south africa resulted in the dissemination of 500 questionnaires. a response rate of 20% was envisaged. the reasons why a mail questionnaire was used to obtain the information needed are as follows: • the sample had to be representative; • the geographic location of the firms necessitated this method of data collection; and • the quality of response should be more satisfactory if firms had enough time to complete the questionnaire. respondents were requested to complete the questionnaire by way of closed responses on a five-point likert scale. the questionnaire was also pretested to eliminate possible errors. data capture and analysis the excel spreadsheet was used for data capture on the computer. questionnaires were coded by assigning numerical values to the various responses. the css statistica package was used for analysis of the data. frequency tables provided the basis for descriptive analysis of the data. cross tabulations and tests of significance were also executed. results one hundred and seventy four (34.8%) of the possible 500 respondents returned their questionnaires. this is considered to be a satisfactory response rate for a mail survey. size, location and age of firms the majority of the firms in the sample (65.5%) were classified as "older" firms, that is, in business for more than 11 years. no evidence could be found that older firms advertise more than younger firms. older firms, however, seem to advertise mostly in newspapers. as could be expected, most of the firms (89.1 %) operate in urban areas. firms in urban areas are more inclined to advertise than those in rural areas. this tendency is supported by the findings of a previous study (van rensburg 1992: 72). most of the firms (83%) who use the internet as a medium are located in urban areas. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 419 sajems ns vol 3 (2000) no 3 no relation exist between the size of a firm and the advertising activities they engage in. larger firms, however, use a greater variety of media for advertising. marketing knowledge almost one half (49.4%) of the respondents indicated that they do not have any marketing expertise or knowledge in the firm. those firms who do have marketing knowledge (12.7%) gained it throughformal training. figure 1 shows the relationship between marketing knowledge and use of advertising. for example, almost 18% of the firms who gained marketing knowledge through self-study make use of advertising. more than one-third (37%) of the firms who have no marketing knowledge do not advertise at all. figure 1 relationship between marketing knowledge and use of advertising 40 35 ~ 30 : 25 i 20 t 15 c. 10 5 o formal training self study no knowledge marketing kno.vledge i ~yes ~no advertising media according to the information in table 1, 75% of the respondents make use of print media advertising. most of these respondents use newspapers as a medium. almost 14% of the firms use the internet as a medium to advertise their services. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 420 tabje 1 preferred advertising media used by firms medium frequency percentaee ~mmercial publications 14 16 newspapers 49 56 _ .... financial publications 3 3.5 ~. internet 12 13.5 other 10 ii totaj i 88 100 respondents gave two main reasons why they do not make more use of advertising in the various media, namely, the lack of marketing knowledge and the high cost of advertising. attitudes towards marketing and advertising answers by respondents relating to their attitudes and possible future marketing activities, showed the following: • almost 63% are of the opinion that they must advertise, even though they do not necessarily want to recruit new clients. • marketing in general can be advantageous (79%). • almost 70% believe that advertising does not exploit the public. • word-of-mouth advertising must be supplemented with other forms of advertising (70%). • seventy per cent of the respondents are of the opinion that marketing and advertising can raise the demand for legal services. conclusion and recommendations the results of this study indicate that many attorneys do not utilise the benefits that can be derived from the marketing and advertising of their services. they seem to be unaware of, or do not make use of the marketing and advertising opportunities to promote their firms and the services they render. many, however, also indicated that they would make more use of advertising in the future. the lack of marketing knowledge and ignorance regarding the value of advertising, as well as the perception that advertising will cause unnecessary cost, are reasons why many legal firms are not marketing oriented. some r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 421 sajems ns vol 3 (2000) no 3 probably may also believe that advertising is not necessary because their services are of a high quality. firms in urban areas advertise more than those in rural areas, probably due to the fact that they face competition. a large number of firms also believe that attorneys in general do not reflect a positive image to the broad public. the need to compile and implement a corporate communication strategy, in order to build and improve positive long. term relationships with various publics, seems to be a matter that needs urgent attention. future research can inter alia focus on the following: • qualitative research (e.g. focus groups) should be undertaken to determine, for example, the reasons why legal firms are inert in adopting marketing strategies. • the possibility to include marketing as a module in the curriculum for the training of attorneys must be investigated. • in-service-training courses on marketing for attorneys could be developed. • the role of culture in the marketing of legal services in south africa should be investigated. • research must form the basis for addressing ethical issues in advertising by attorneys. references association of attorneys (1990) marketing guide for attorneys, johannesburg. 2 attasanio, j.b. (1984) "lawyer advertising in england and the united states", ilp ·32amj compl. 32. 3 bloom, p.n. (1984) "effective marketing for professional services", harvard business review. september october. 4 bradley, f. (1995) marketing management: providing, communicating and delivering value, prentice hall, london. 5 butterworths law diary & directory (1997) butter· worths, durban. 6 coetzee, j. (1992) "prokureurs stel bemarkers aan", finansies en tegniek, februarie. 7 elliot, r.g. (1986) "trolling for clients under the first amendment: it's hard to keep a good solicitor down", ipl 60 conn. b.j.,60. 8 kotler, p. (1997) marketing management. analysis, planning, implementation and control, 9th ed., prentice hall, new jersey r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 422 9 sinclair, r. (1991) "marketing freedom: the pressures for change", de rebus, july. 10 the concise oxford dictionary (1979) oxford university press. 11 van rensburg, la. (1993) "die rol van advertensie in die prokureursprofessie van transvaal", navorsingsverslag. nagraadse skool vir bedryfsleiding, unisa. 12 wannop, d.c. (1989) marketing legal services, carswell, toronto. 13 wilson, a. (1972) the marketing of professional services. mcgrawhill, london. 14 wilson, a. (1984) practice development for professional firms. mcgraw-hill, london. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 358 sajems ns vol 2 (1999) no 3 risk relievers in mail-order catalogue retailing: the case of the high-frequency purchaser of low-involvement products n s terblanche department of business management, university of stellenbosch c boshoff department of business management, university of port elizabeth e vdmsmit graduate school of business, university of stellenbosch abstract this article reports on the identification of how various risk relievers, available to consumers and mail-order catalogue organisations, influence general risk perception. consumers who have purchased low-involvement products on a number of occasions by mail-order constitute the sample. the findings are that two of the major risk relievers significantly reduce, whilst another one increases, the general risk perceptions of mail-order customers when buying lowinvolvement goods. these findings are important to mail-order catalogue managers because they confirm that a variety of risk relievers need to be offered to ensure that perceived risks are properly addressed. jelm 31 introduction three reasons are put forward as to why shops traditionally served as primary distributors of retail products (rosenberg & hirschman, 1980), namely: customers were accustomed to purchasing at shops; few acceptable alternatives existed and the value of consumers' money exceeded the value of the time used for shopping. retailers overcome a number of discrepancies for consumers. typical of these are time, spatial, assortment and information gaps. recent years have however witnessed a large increase in the volume of retailing transactions done at r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 359 shopping fonnats other than the conventional retail shops that overcome the above-mentioned discrepancies. the past two decades there has been an increase in the use of multiple channels for the distribution of products by manufacturers and intennediaries. mcnair and may (1978) mention the role of technology in this context and argue that new fonns and applications of technology make mailcatalogue buying an acceptable shopping fonnat for an increasing number of consumers. various previous studies have found that in-shop shopping is perceived as having less risks than non-shop or in-home shopping (spence, engel and blackwell, 1970; festervand, snyder and tsalikis, 1986; hawes & lumpkin, 1986; mccorkle, t 990). a risk reliever can be defined as a device or action that is initiated by a buyer or a seller, which is used to carry out a risk reduction strategy. a number of risk relievers such as infonnation seeking, store image and major brand image that are freely available to in-shop consumers, are however not available to mail-catalogue consumers. a consumer might use a specific risk reliever as a way to get a higher probability of purchase success or rely on another as a means of minimising the loss incurred in case of product failure. this article deals with how consumers who have purchased lowinvolvement products, perceive various risk relievers available to them. objectives the primary objective of this study was to identify which risk relievers, that are available to consumers and mail-catalogue organisations, actually reduce observed general risk perceptions of consumers who have purchased lowinvolvement products in the past by mail-order. insight into the impact of such risk relievers is useful to the design of product offerings and mail-order catalogue design and should, hopefully, enhance the sales volumes of direct marketers who can convert these findings into a lower risk associated with buying a product by mail-order. theoretical considerations before discussing the risk relievers that are available to consumers and mailcatalogue organisations, it is necessary to consider the market in which maijcatalogue marketing takes place. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 360 sajems ns vol 2 (1999) no 3 the market for mail-catalogues rapp and collins (1990) identified the following trends in and characteristics of the marketplace that favour direct-order retailing : target markets that change continually because of changing demographics and lifestyles; demands on personal time; overcrowding by too many new products, services and stores; weakening of the impact of television advertising; decline in brand and store loyalty; and clutter, overkill and waste of advertising. the net effect of these trends is that it has become increasingly difficult to capture and keep the attention of the consumer. one way in which retailers succeed in achieving this, is to contact the consumer directly. shopping in retail outlets will undoubtedly remain a vital social as well as a functional activity for a long time to come. there are, however, certain social and economic forces that make shopping at home attractive. some of these forces are: the annoyance and wastefulness of having to contend with traffic and shopping crowds; the widely noted deterioration in the quality of service in many retail shops; an increase in the number of career and professional women; a greater emphasis on standardisation and branding of products (which reduces the risk involved in shopping at home); and the growing use of credit cards (rapp & collins, 1990; darian, 1987). the value of the consumer's time has also increased tremendously over the past decade and any means that can give a consumer more shopping time flexibility is viewed as positive by consumers. direct mail-order retailing thus offers consumers flexible shopping hours. rosenberg and hirschman (1980) also identified the willingness of consumers to change, and their acceptance of technology used to market products directly, as further reasons that will make shopping in the home attractive. risk relievers in mail-order catalogue retailing various perceived risks are attached to mail-order catalogue retailing, and the consumer selects whichever risk reliever appears best suited to the type of risk that is involved. akaah and korgaonkar (1988) undertook a conjoint analysis to investigate consumer preferences for risk relievers in direct order retailing. they found that a money-back guarantee ranked as the most important risk reliever. this was followed by the name of the manufacturer, the cost of the product, the reputation of the distributor, free sample/trial, endorsement by a trusted person, experience of the brand and the novelty of the product, respectively. it was also found that the lower the relative cost of an offering is, the greater will be the incentive to shop for it by means of direct-order retailing. it was reported by hawes and lumpkin (1986) that price/quality perception, personal experience, as well as r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 361 money-back guarantees are the most important risk reduction techniques used by in-home shopping respondents. festervand, snyder and tsalikis (1986) and jasper and ouelette (1994) found that catalogue buyers with prior satisfactory purchase experience, perceived significantly less risk than catalogue buyers with prior unsatisfactory purchasing experience. the risk relievers available to consumers in direct order retailing are (roselius, 1971; hoover, green and saegert, 1978; derbaix, 1983; hawes & lumpkin, 1986; shimp & bearden, 1986; akaah & korgaonkar, 1988; mccorkle, 1990; jasper & ouelette, 1994): money-back or other guarantees typically a refund if the customer is not satisfied or replacement if the product does not function properly; endorsement by an expert or a public figure designed to create confidence; samples a free miniature version of the product or a part of it is given to the customer; testing by an independent private institution the fact that a product was tested and found suitable by a respected laboratory or other institution serves to relieve risks; testing by a government institution similar to the above except that the testing institution is now part of or owned by government, for example the sabs or the csir; purchasing a well-known brand name here the consumer relies on the known reputation of the brand to serve as a guide; information search the process by which a consumer consults family, friends or colleagues to gather information to make an informed decision; brand loyalty a consumer buys only a specific brand (trade mark) that has proved satisfactory in the past; purchasing the most expensive model this reliever works on the price/quality relationship to the effect that the more expensive a product is, the higher its quality should be and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 362 sajems ns vol 2 (1999) no 3 dealing only with big and reputable business finns in the absence of other infonnation, the consumer relies on organisations known for their dependable image. the first six risk relievers above are initiated by the direct mail retailer, whilst the other four would be customer-initiated. all the above-mentioned risk relievers are included in this study as exogenous latent variables. it can be expected that an increase in or presence of risk relievers, would establish a positive relationship between the risk reliever and direct-order purchasing. in other words, the more effectively the risk relievers are used, the less the general risk perceptions of mail-order customers would be. sample and data collection the population of the study was 57 823 customers of a south african mail-order organisation who had bought more than twice from the organisation in the 18 months preceding the study. a sample of2 500 respondents were drawn from the population. the figure of 2 500 respondents was based on an expected response rate of 20%. a response rate of 20% would have resulted in the return of 500 questionnaires. this was based on a preferred ratio of 15 respondents per item as a nonn which would have required 495 completed questionnaires to be returned to meet the desired cutoff point. it must, however, be pointed out that a 5 to i ratio is regarded as the minimum whilst a ratio of 10 to 1 is the more acceptable (hair, anderson, tatham and black, 1998: 98-9). the questionnaires were mailed to the respondents and a total of 422 questionnaires were returned, giving a response rate of 16,88%. because of the relatively low response rate, it was necessary to estimate for non-response bias. because the data were captured in the same sequence in which the questionnaires were received, it was possible to use the method called time trends extrapolation as suggested by atmstrong and overton (1977), to estimate for non-response bias. the assumption underlying this method is that the fourth quartile is the same as the nonrespondents. it was therefore necessary to detennine whether the demographic characteristics of the fourth quartile differ from those of the first quartile. if no differences are found, quartiles one and four as well as the non-response are regarded as similar. the demographic characteristics of the first and fourth quartile were analysed to test for significant differences. a chi-square goodness of fit test did not reveal any significant differences between the demographic variables of the first and the fourth quartiles. table 1 contains the comparison of the first and fourth quartiles of the sample. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 363 table 1 comparison of first and fourtb quartiles of tbe sample with regard to demographic characteristics by using a chi-square test demographic critical x2 df value conclusion variable (001 level) household size 2,62 4 13,28 no signific:ant difference ~respondent 3,81 4 13,28 no significant difference hold income 6,59 5 1509 no significant difference cars in household 625 4 13,28 no significant difference time spent on occupation/profession 0,45 3 11,36 no significant difference education level 2,32 4 13,28 no significant difference proximity of shops 0,93 1 6,64 no significant difference physical disability 034 i 6,64 no significant difference children 1,99 1 6,64 no significant difference pre-school children 126 2 9,21 nosignificant difference r------time spent on community/ welfare activities 3,04 4 13,28 no significant difference shift work 264 1 664 no significant difference time spent on fitness/sport 0,32 4 13,28 no significant difference table i shows that when the first and fourth quartiles of the realised sample are compared in demographic terms, the two groups do not significantly differ from each other in any respect. as armstrong and overton (1977) argue that nonrespondents are similar to the respondents of the fourth quartile, it may therefore be concluded that non-response in this study has minimal impact on the representativeness of the sample. the mail-catalogue organisation does not specialise in any particular merchandise, but offers a wide variety of products in 22 product categories, all of which may be characterised as low-involvement products. the lowinvolvement products referred to here have the usual characteristics of low price, little social concern and requiring very limited buying decision making. typical products offered in the catalogue are cordless headphone sets for television, bathroom scales, sonic pest repellents and a range of apparatuses for exercising at home. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 364 sajems ns vol 2 (1999) no 3 the measuring instrument a self-administered questionnaire was used as measuring instrument. thirty (30) items were self-generated to represent the ten (l0) risk relievers available to respondents that purchase via mail-order catalogue. each of the ten risk relievers was thus measured by three items. general risk perceptions were also measured by three items. all the items used were subjected to an experience survey as suggested by churchill (1995: 152-3). two professors of consumer behaviour and five other individuals were asked for their opinions in respect of the suitability of the items to measure the risk relievers studied. each of the items had to be evaluated on a six-point likert-type scale ranging from "agree completely" to "disagree completely". scale purification the scale purification process consisted of three distinct phases: an assessment of the underlying dimensionality (and thus also discriminant validity) using exploratory factor analysis, an assessment of reliability by calculating cronbach alpha coefficients and, fmally, the theoretical model was subjected to empirical assessment by means of structural equation modelling. dimensionality the first step was to assess whether the data do indeed contain 10 dimensions as suggested in the literature study. for this purpose, a maximum likelihood exploratory factor analysis was conducted specifying a direct quartinum oblique rotation of the original factor matrix (jennrich & sampson, 1966). the programme bmdp4m was used for the analysis. an oblique rotation was specified because the factors are correlated. as several of the 30 items did not load a significant extent (0,40) in several solutions or did not demonstrate sufficient discriminant validity by loading on more than one factor, these items were deleted as suggested by churchill (1995). several factor solutions had been considered and the most interpretable one to emerge was the eight-factor solution shown in table 2. the factor analysis results suggest that the proposed instrument demonstrates a considerable degree of discriminant validity. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 365 table 2 rotated factor loadings for the eight factor solution factor factor factor factor factor factor factor factor 1 2 3 4 5 6 7 8 expen govt ptest samp advice loyal expert source item expenl 0,848 expen2 0,810 expen3 0,716 govtl 0,817 govt2 0,757 govt3 0713 ptestl 0,777 ptest2 0,734 : ptest3 0,730 sampl 0794 samp2 0690 samp3 0,608 advice 1 0,810 advice2 0,536 advice3 10,499 brandl 0782 brand2 0,684 expertl 0,737 expert2 0,675 expertj 0,447 source 1 0,893 source2 0,575 eigen1,943 1,860 1,728 1,601 1,340 1,336 1,278 1,244 values according to table 2 twenty-three of the original thirty items loaded to a significant extent on one of eight clearly identifiable factors. these factors were termed: 1) expen purchasing of the most expensive model 2) govt testing of a product by a government testing institution 3) ptest testing of a product by a private testing institution 4) samp availability of samples for inspection 5) advice advice from family, friends and colleagues 6) brand well-known brands 7) expert endorsement by an expert r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 366 sajems ns vol 2 (1999) no 3 8) source reliable source reuability the remaining twenty three items were then, as suggested by churchill (1995), subjected to a reliability analysis using the computer programme sas proc corr (sas institute, 1988). cronbach alpha values reported in table 3 show that all the underlying dimensions of the construct "risk relievers in mail-order catalogue retailing" are measured by an instrument with sufficient reliability (a> 0,7) and that the cronbach alpha of the entire instrument is 0,88. this figure exceeds the minimum ofo,7 suggested by peterson (1994) and nunnally (1978) and confirms the reliability ofthe instrument. table 3 internal reliability results dimensions a most expensive product 0,84 government testing 088 private testing 085 samples 0,84 advice from family/friends/colleagues 0,74 brand loyalty 0,81 expert endorsement 0,82 reliable source 0,81 overall 0,88 path analysis the proposed instrument to measure the influence of risk relievers on general risk perception (table 4) was then subjected to a path factor analysis (structural equation modeling). the results, set out in table 5, suggest that the 8-factor model in figure 1 represents a reasonable fit to the data (hair, anderson, tatham and black, 1998: 656). all the indices reported in table 5 meet or exceed the minimum acceptable standards suggested by hair, et al. (1998). the path analysis also provides some evidence of the construct validity of the proposed instrument (tull & hawkins, 1993: 318). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns v.ol2 (1999) n.o 3 367 table 4 items to measure the influence of risk relievers on general risk perception most expensive model expeni expen2 expen3 ordering the m.ost expensive m.odel .of a pr.oduct reduces the risk .of .ordering by mail-.order. it is safer t.o buy the m.ost expensive m.odel by mail-.order catal.ogue .of a pr.oduct .offered. a c.onsumer reduces the risks related t.o mail-.order by .ordering the m.ost expensive m.odel .of any product. government testing govtl govt2 govt3 if a mail-.order catal.ogue c.ontains the end.orsement .of a testing instituti.on, like the sabs .or csir, in respect .of a product, then it makes the buying .ofthat pr.oduct safer. p.ositive results and/.or rec.ommendati.on by a testing instituti.on, such as the sabs .or csir, in respect .of a pr.oduct .offered by mail.order catal.ogue make it safer t.o buy by mail-.order catal.ogue. it is better t.o buy a pr.oduct by mail-.order catal.ogue if it has been tested and approved by a testing instituti.on like the sabs .of csir. private testing ptesti ptest2 ptest3 samples sampi samp2 samp3 p.ositive results and/.or rec.ommendati.ons by a private testing instituti.on in respect .of a product .offered by mail-.order catal.ogue make it safer t.o buy by mail-.order catal.ogue. if a mail-.order catal.ogue c.ontains the end.orsement .of a product by a private instituti.on, then it makes buying that pr.oduct safer. it is better t.o buy a product by mail-.order catal.ogue if it has been tested and appr.oved by a private testing instituti.on. a sample reduces the risk when buying by mail-.order catal.ogue. the availability .of samples is likely t.o increase the buying .of a pr.oduct by mail-.order catal.ogue. a c.onsumer is m.ore likely t.o buy a pr.oduct fr.om a catal.ogue if a sample .of the product is available bef.ore taking the buying decisi.on. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 368 sajems ns vol 2 (1999) no 3 advice from family/friends/colleagues advice i buying by mail-order catalogue is safer if one seeks advice from family, friends or colleagues before buying. advice2 it is important to obtain advice from other people who have bought by mail-order before buying oneself by mail-order catalogue. advice3 advice from family, friends or colleagues makes buying products by mail-order catalogue less risky. known brands brand i a consumer can reduce risk when buying products by mail-order catalogue if he/she buys only products with well-known brand names. brand2 when buying products by mail-order catalogue, it is safer to buy only products with brand names with which one has been satisfied in the past. expert endorsement expert i it is safer to buy a product by mail-order catalogue if it contains an endorsement by an expert. expert2 an endorsement by an expert in respect of a product in a mailorder catalogue reduces risk. expert3 it is more likely that a consumer will buy a product by mail-order catalogue if it contains a testimonial by an expert on the product. reliable source source i it is less risky when one deals with an established and well-known mail-order organisation. source2 when a mail-order organisation is big and well known, then it makes transactions with such an organisation easier. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 369 figure 1 empirical model : risk relievers all path coefficients are significant at p<o,o 1 unless indicated otherwise r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 370 sajems ns vol 2 (1999) no 3 tables measures of fit of tbe model rmsea 0.062 modified aic 1 '\59 lisrelgfi 0,890 lisrel adiusted gfi 0,850 bentler-bonnett non-fonned fit index 0,909 tucker-lewis index 0,909 rmr 0,048 conclusion and empirical results in conclusion it can be stated that the instrument developed has demonstrated sufficient reliability (cronbach alpha values), discriminant validity (exploratory factor analysis) and construct validity (path analysis). this study has produced evidence that only certain risk relievers, as identified in the literature survey, that are used in mail-order catalogue retailing, are also of importance to consumers that frequently purchase low-involvement products certain risk relievers did not impact on general risk perception and can therefore be regarded unsuitable in the case of low-involvement goods. for lowinvolvement goods providing samples and offering only well known brand names will reduce risk perceptions. well-known brands are the most important risk reliever for low-involvement goods. endorsement by an expert actually increases risk perceptions. this finding is contrary to that reported in the literature. possible reasons that might explain this are : • respondents may not have a clear idea of what is meant by "an expert"; the respondents could also have experienced source credibility, in the sense that they did not believe what the particular experts said and they could have also regarded the use of an expert for low-involvement goods as a "cover-up" of poor quality. when one considers the respondents studied, it is not very surprising that some of the risk relievers did not feature. for instance, the respondents' familiarity with purchasing by mail-order catalogue offers some explanation for the little r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 371 importance of guarantees. because these consumers have purchased a number of times by mail-order, they are at ease with the arrangements offered by mailorder organisations. this is especially applicable to customers who have not yet had any negative encounters with a mail-order organisation, or those whose problems were addressed and solved in a manner acceptable to them. managerial implications as far as the managerial implications of the above findings are concerned, managers of mail-order catalogues could consider the following: direct marketers should determine which brands of the low-involvement products are the most important to customers. if research can identify these brands, mail-order organisations would be more effective in their marketing efforts if they only focus on such brands; the use of samples could be extended, especially with regard to the brands referred to above. the opportunity to know a product before purchasing it, has a major risk reduction propensity. it is however difficult, even impossible, to provide samples of certain products and resources allocated to risk relievers, other than those found to be effective in this study, should be scaled down. this is particularly relevant to the cost incurred in respect of expert endorsements. what is, however, important from the perspective of mail-order catalogue managers, is that a variety of risk relievers need to be offered to ensure that different kinds of perceived risk are properly addressed. the findings indicate that mail-order catalogue organisations must endeavour to make both of the risk relievers mentioned, namely samples and well-known brand names, available as far as possible. this research has provided additional insight into the risk relievers that are important to low-involvement products. future research should aim to determine the relationship between particular demographic variables and the risk relievers identified in this study. such information can be valuable in the design of marketing offers. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 372 sajems ns vol 2 (1999) no 3 references akaah, i.p. & korgaonkar, p.k. 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(1998) multivariate data analysis, 5th ed., prentice hall, upper saddle river. 8 hawes, j.m. & lumpkin, lr. (1986) "perceived risk and the selection of a retail patronage mode", journal of the academy of marketing science, 14, winter: 37-42. 9 hoover, r.j., green, r.t. and saegert, j. (1978) "a crossnational study of perceived risk", journal of marketing, 42, july: 102-8. 10 jasper, c.r. & ouelette, sj. (1994) "consumers' perception of risk and the purchase of apparel from catalogs", journal of direct marketing, 8, spring: 23-6. ii jennrich, r.i. & sampson, p.f. (1966) rotation for sample loadings, psychometrika, 31: 313-23. 12 mccorkle, d.e. (1990) "the role of perceived risk in mail order catalog shopping", journal of direct marketing, 4, autumn: 26-35. 13 mcnair, m.p. & may, e.g. (1978) "the next revolution of the retailing wheel", harvard business review, 56, september-october: 81-91. 14 mitchell, v-w. & mcgoldrick, pj. (1996) "consumers' riskreduction strategies: a review and synthesis", the international review of retail, distribution and consumer research, 6(1): 1-33. 15 nunnally, j. (1978) psychometric theory, 2nd ed., mcgraw-hill, new york. 16 peterson, r.a. (1994) "a meta-analysis of cronbach's coefficient alpha", journal of consumer research, 21(3): 381-91. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 373 17 rapp, s. & collins, t. (1990) the great marketing turnaround. englewood cliffs: prentice-hall. 18 roselius, t. (1971) "consumer rankings of risk reduction methods", journal of marketing, 35, january: 56-61. 19 rosenberg, l.j. & hirschman, e.c. (1980) "retailing without stores", harvard business review, 58, july-august: 103-12. 20 sas institute inc. (1988) sas procedures (release 6.03 edition). cary, n.c.: author. 21 shimp, t.a. & bearden, w.o. (1982) "warranty and other extrinsic cue effects on consumers' risk perceptions", journal of consumer research, 9, june: 38-46. 22 spence, h.e., engel, j.f. and blackwell, r.d. (1970) "perceived risk in mail-order and retail store buying", journal of marketing research, 7, august: 364-9. 23 tull, d.s. & ha wklns, oj. (1993) marketing research: measurement & method, 6th ed., macmillan publishing, new york. 24 van den poel, d. & leunis, j. (1996) "perceived risk and risk reduction strategies in mail-order versus retail store buying", the international review of retail, distribution and consumer research, 6(4): 351-71. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 3 498 komparatiewe voordeel in die landbou· e kjeynbans skool vir ekonomie, gelden bankwese. potchefstroomse universiteit vir cho absjract the object of this paper is to demonstrate the use of an alternative method to measure and quantify international competitiveness. the south african agricultural sector is taken as a case study. the paper builds on bela balassa's method (1989) of measuring comparative advantage by means of historically revealed advantage. in practice this method is easy to use, readily applicable and the necessary data are usually available. the results of this measuring excercise are interesting and support the hypotheses that a low level of labour productivity contributes significantly to the low international competitiveness of south african agriculture. jelo 170 inleiding met die aanvaarding van die algemene ooreenkoms op tariewe en handel en die toenemende liberalisering van wereldmarkte, raak dit al hoe belangriker vir lande om te bepaal waar hul komparatiewe voordeel gelee is. die uitfasering van beskermende tariewe lei noodwendig tot spesialisasie in die bedrywe waarin lande die mededingendste is. die patroon van 'n land se internasionale handel en die aiiokasie van hulpbronne behoort gevolgiik vol gens komparatiewe voordeel gerig te word. ten einde mededingend te bly is lande nou genoodsaak om koste effektiewe uitvoer moontlikhede te soek en beter produkte teen laer pryse te iewer. dit impliseer groter doeltreffendheid van die markmeganisme wat uiteindelik tot die ekonomiese ontwikkeling en welvaart van almal behoort by te dra die oogmerk van die artikel is om 'n alternatiewe metode van meting en kwantifisering van intemasionale mededingendheid voor te stel. die praktiese toepassing van die tradisionele teoriee word aansienlik bemoeilik deur werklike data en ander probleme. om dit te oorkom word daar in hierdie artikel voortgebou op balassa (1989) se voorstel dat komparatiewe voordeel aan die • comparative advantage in agriculture r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 499 sateb nr vol 1 (1998) nr 3 hand van histories geopenbaarde voordeel gemeet lean word. balassa metode wordas superieur bo tradisionele metodes, soos die van heckscher-ohlin beskou, omdat dit prakties maklik uitvoerbaar, meer gepas en die data is meer geredelik beskikbaar is. die resultate van die meting is interessant en bevestig die hipotese dat die kontinue lae vlak van arbeidsproduktiwiteit in suid-afiika 'n sterk bydraende faktor tot die lae intemasionale mededingendheid van die land is. die suid-afrikaanse landbousektor is as 'n gevalle studie gebruik. as ontwikkelende land dra die primere sektor steeds baie tot die bruto binnelandse produksie by (14% in 1996), waarvan landbouprodukte 'n groot deel uitmaak (39.6% in 1996). aangesien 'n aansienlike hoeveelheid landbouprodukte uitgevoer word, is die bepaling van komparatiewe voordeel belangrik. dit is vera! noodsaaklik aangesien tariefen invoerbeskerming tans uitgefaseer word en nywerbeidsontwikkeling en dienste se aandeel tot die bruto binnelandse produk:. relatief tot primere produkte, toeneem wanneer ekonomiese ontwikkeling in 'n landstreek plaasvind. volgens die wet van komparatiewe voordeel sal lande baat by internasionale spesialisasie en vryhandel. intemasionale spesialisasie in landbou hou talle probleme en gevare vir 'n land in. sikliese prysskommelinge, tegnologiese vervanging van produksie en biologiese vemietiging maak dit dikwels moeilik om buiteiandse betaalmiddele te verlcry en te behou. sikliese opswaai in primere kommoditeitspryse bring groot opbrengste vir 'n land, maar die ekonomie moet genoegsame diversiteit besit sodat dit die sikliese afswaaifases van sekere produkte lean oorieef(mellor, 1966a: 109-110). die bydra wat die landbousektor tot suid-afiika se produksie en uitvoer maak, asook die skakeleffekte wat claar bestaan (sien van rooyen, 1990; 6) maak die korrekte keuse en ontwikkeling van bedrywe, waarin komparatiewe voordeel bestaan noodsaaklik. dit besit die potensiaal om aansienlik tot ekonomiese groei in suid-afiika by te dra. teoretiese beginsels volgens die beginsel van komparatiewe voordeel behoort lande in produkte te spesialiseer waarin hul internasionaal relatief meer doebnatig is. produkte waarvan die produksie minder doelmatig is, behoort eerder ingevoer te word. die beginsels van komparatiewe voordeel word ten beste begryp indien dit as reaksie teen die merleantilisme gesien word. volgens die merleantilisme sal 'n r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 3 500 land ryk en welvarend word, wanneer dit meer uitvoer as invoer. die surplus word dan vereffen deur die invloei van goud en waardevolle metale vanaf ander lande. 'n land kan dan slegs ten koste van 'n ander bevoordeel word, aangesien aile lande nie gelyktydig 'n uitvoersurplus kon handhaaf nie. die merkantilisme het gevolglik sterk owerheidsbeheer oor ekonomiese aktiwiteite voorgestaan (lindert, 1996: 29). adam smith wys daarop dat lande wedersydse voordeel kan behaal uit intemasionale handel omdat dit lei tot spesialisasie. waar een land 'n produk meer doelmatig as 'n ander kan produseer, beskik dit oor absolute voordeel. produseer die land 'n ander produk minder doelmatig, sal dit vir albei lande voordelig wees om te spesialiseer in die produksie van die kommoditeit waarin dit 'n absolute voordeel het. deur wedersydse handel sal hulpbronne dan mees doelmatige benut word en sal die produksie van beide kommoditeite styg (lindert, 1996: 28). deelname in intemasionale handel is tot voordeel van aile lande, selfs as 'n land absolute nadeel in alle kommoditeite besit. david ricardo het daarop gewys dat indien so land sou spesialiseer in die kommoditeite waarin die absolute nadeel die kleinste is, relatief tot ander lande, en produkte invoer waarin sy absolute nadeel relatief die grootste is, sal aile lande se hulpbronne mees doelmatig aangewend word en die produksie van aile produkte toeneem. deur die grootte van 'n land se absolute nadeel met die van ander lande te vergelyk, kan 'n land vasstel watter produkte dit die mees doelmatigste produseer. in die produksie van sodanige kommoditeite besit 'n land dan komparatiewe voordeel. ricardo se idee is verder ontwikkel deur ander ekonome, maar die beginsel bly dieselfde (krugman, 1991: 11-15). die heckscher-ohlinteorie gaan verder en poog om die oorsake vir die verskille in komparatiewe voordele tussen lande en kommoditeite te verklaar. dit toon aan dat die produksiefaktore waaroor lande beskik verskil en dat die produksie van verskillende kommoditeite, verskillende kombinasies van hulpbron insette vereis. intemasionale verskille in produksiefaktore wat lande besit en die produksie tegnologie wat dit benodigde, lei tot verskille in relatiewe pryse en komparatiewe voordele in intemasionale handel. die teorie stel dat 'n land kommoditeite wat met die relatief volopste produksiefaktore vervaardig word, sal uitvoer. kommoditeite waarvan die produksie relatiewe skaars insette benodig, sal eerder ingevoer word. indien land a byvoorbeeld oor relatief baie arbeid (l) beskik en land b baie kapitaalgoedere (k), is die prys van 'n eenheid arbeid relatieftot die prys van 'n eenheid kapitaal, laer in land a as in land b; sodat r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 501 sateb nr vol 1 (1998) nr 3 waar p die pryse van die insette is (du plessis, 1994: 47 -48). die volopste produksiefaktore van 'n land kan ook bepaal word deur dit met die wereldtotale te vergelyk. indien land a se vojopste produksiefaktor arbeid is, sal: waar t alle produk:te en w die res van die wereld voorstel. kommoditeit j is dan land a se arbeidsintensiewe produk: as: laj/kai > lw'/k..,t. . aangesien kommoditeit j die intensiewe gebruik: van land a se relatiewe volop produksiefaktore benodig, ie land a se komparatiewe voordeel in produk: j. probleme van vorige studies die heckscher-ohlinteorie vereis internasionaal vergelykbare data en wanneer die werldike aantal produksiefaktore in ag geneem word, raak die berekeninge te gekompliseerd om van praktiese waarde te wees. intemasionale produksiedata wat tegelykertyd in elke land met identiese navorsingsmetodes bepaai is enlof vergelykbare intemasionale produktiwiteitstydreekse vir elke produk:, is ook nie beskikbaar nie (lindert, 1996: 64-67). faktore soos die verskil in smaak, gehalte en dienslewering bemvloed intemasionaie handelspatrone nog verder. in 'n volmaakte wereld met volmaakte mededinging, wat uit slegs twee lande en twee produksiefaktore bestaan, kan die heckscher-ohlinteorie kompara-tiewe voordeel maklik en akkuraat bereken word. in werklikheid is claar baie meer lande, bedrywe en produksiefaktore wat nie homogeen is nie en talle onvolmaakte markte. berekeninge van intemasionale komparatiewe voordeel, op grond van die heckscher-ohlinteorie, kan gevolglik nie 'n betroubare gids weesnie. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 3 502 mededingendheid word omskryf as die vermoe van 'n land om 'n markaandeel te bekom (ortmann, 1988: 17). verwante studies oor die landbou het meestal slegs na items soos kostes en wisselkoerse gekyk, soos die van nieuwoudt (1986), terwyl ander net enkele bedrywe bestudeer het, soos byvoorbeeld die van }ooste & van schalkwyk (1996). daar was gevolglik nie bepaal watter landbouprodukte as intemasionale wenners 'n mark aandeel kan bekom rue. die doel met hulle navorsing het egter met die van die huidige artikel verskil. daar bestaan ook probleme indien daar gepoog word om die tradisionele teoretiese beginsels, wat hierbo bespreek is, in die praktyk toe te pas. balassa se metode om die meting van mededingendheid te verbeter en te vergemaklik stel balassa (1989: 44-61) 'n berekeningsmetode voor wat hy geopenbaarde komporatiewe voordeel noem. individuele lande se komparatiewe voordeel word aangetoon deur hul handelsprestasies. die patroon van handel in kommoditeite, openbaar al die faktore wat komparatiewe voordeel beinvloed. die bestaande handelspatrone openbaar gevolglik reeds die komparatiewe voordele van 'n land. ontleding van 'n land se intemasionale handel verskaf sodoende aklrurate inligting en rigiyne vir die berekening van mededingende voordeel en vir die bepaling van beleid (du plessis, 1993: 158-160). ten einde komparatiewe voordele te bepaal, moet 'n land se handelsprestasies bestudeer word, om vas te stel wat 'n land se relatiewe aandeel in die werelduitvoer van individuele kommoditeite is; en hoe dit oor tyd verander. die data word eerstens genormaliseer sodat dit vergelyk kan word. die verhouding tussen 'n land se relatiewe aandeel in die werelduitvoer, van 'n bepaalde produk, en die land se aandeel in die totale werelduitvoer word dan as 'n indeks uitgedruk. ariovich (1979: 198) beskou balassa se metode as meer toepaslik in die berekening van komparatiewe voordeel, aangesien daar aangeneem kan word dat die relatiewe uitvoeraandeel minder deur tariewe en ander beperkings versteur word, as in die geval van kostestrukture. die uitvoeraandeel word net soos 'n markaandeel bereken, wat 'n algemeen aanvaarde kriterium vir bemarkingsprestasie is. prakties is die metode maklik berekenbaar, die nodige data is beskikbaar en dit besit verklaringsen vooruitskattingswaarde. waar die tradisionele teoriee en vorige studies komparatiewe voordeel probeer bereken deur eers te bepaal watter faktore alma! 'n invloed op die mededingendheid het, veronderstel balassa dat die bestaande patrone en rigting van handel reeds die komparatiewe voordeel van 'n land openbaar. die r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 503 sa teb nr volt (1998) nr 3 ontleding van 'n land se intemasionale handel kan gevolglik akkurate inligting vir beleidsdoeleindes verskaf en oor tyd aantoon indien stlukturele verandering in mededingendheid begin ontwikkel. die bepaiing van die komparatiewe voordeel van begin met 'n ontleding van 'n land se bestaande handelsprestasies. eerstens word die relatiewe aandeel (x) van, byvoorbeeld land a se uitvoer, in verhouding tot die werelduitvoer (x), van byvoorbeeld produk j in die eerste periode bereken as: .... (1 ) waar (i) die gemiddeld vir die eerste periode is, t aile kommoditeite en w die wereldtotaal is. tweedens word die relatiewe aandeel van land a se uitvoer in die werelduitvoer van produk j in die twee periode (ii) bereken as: .... (2) en derdens word die verhouding tussen die relatiewe aandeel in die tweede periode tot die relatiewe aandeel in die eerste periode bepaai as: .... (3) in die eerste twee stappe is aanwysers vir komparatiewe voordeel in twee periodes bereken en in die derde stap is om die verandering in relatiewe voordeel bepaai. dit word dan gekombineer om 'n enkele indeks vir komparatiewe voordeel te bepaai. die voortsetting van tendense kan geprojekteer word as die produk van vergelyking (2) en (3) en voorgestel word as: .... (4) die aanname is bier gemaak dat veranderinge in lande se relatiewe aandeel geometries groei en dan bloot geekstrapoleer kan word. balassa (1989: 46) stel voor dat die aanname met 'n kompromie gedeeltelik vermy kan word, indien die gemiddeld van vergelykings (2) en (4) geneem word as: kortweg: (balassa, 1989: 53). ~ [(~ii i xaii ) + (xajii i xaii i i (xaji i xai)] • • ••• (5) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 3 504 die aanname van die kompromie-oplossing is dat daar steeds verwag word dat vorige tendense sal voortduur, maar teen 'n dalende koers. vergelyking (5) word nou gebruik om indekse vir elke kommoditeit te bereken wat as maatstaf kan dien in die bepaling van komparatiewe voordeel. deur middel van 'n eenvoudige toetsmodel is aangetoon dat 'n produk met indekssyfer groter as een komparatiewe voordeel geniet, terwyl indekssyfers kleiner as een 'n komparatiewe nadeel verteenwoordig. 'n kommoditeit wat geen komparatiewe voordeel of nadeel besit nie is as toetsmodel gekies. 'n indekssyfer gelyk aan een vonn die afsnypunt. indien dit gelyk aan een is, ie die absolute waarde, van die produk se aandeel in internasionale uitvoere, op die kritieke grens omdat die produk se aandeel in die land se uitvoer, gelyk is aan sy aandeel in werelduitvoer. daar vind dan geen markindringing of -verlies plaas nie, aangesien die kommoditeit se relatiewe aandeel nie tussen die twee opeenvolgende peri odes verander nie. komparatiewe voordeel in die suid-mrikaan5e landbou balassa se metode is van besondere praktiese waarde. a wentzel, ekonoom by die departement van landbou, het balassa se metode toegepas in 'n studie van die komparatiewe voordeel van die suid-afrikaanse landbou en verwante bedrywe (1994). met die metode is onder andere aangetoon dat die landbou se grootste komparatiewe voordeel in onverwerkte wol gesetel is. daarna volg, in volgorde, chemiese houtpulp, druken skryfpapier, vrugte, huide en velie en heel mielies met 'n geringe voordeel. enkele van die produkte word in tabel 1 getoon. die indeks toon internasionale komparatiewe voordeel indien dit groter as een is, en komparatiewe nadeel as die indeks kleiner as een is. balassa se konsep van geopenbaarde komparatiewe voordeel is op die suidafrikaanse landbou, vir die periode van 1981 tot 1987, toegepas deur van gestandariseerde intemasionale handelsdata van die united nations intemasional trade statistics yearbook gebruik te maak (wentzel, 1994: 10). in die jaarboek word afsonderlike lande se invoeren uitvoersyfers van. elke kommoditeit gegee. die kommoditeite word in syfergroepe geklassifiseer, wat 'n bree klassifikasie is en wat weer onderverdeel is in twee tot vyf groepe. die data was gekies aangesien dit die enigste beskikbare gestandardiseerde handelsdata is wat beskikbaar was. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 505 sateb nr vol 1 (1998) nr 3 komparatiewe v oordeel van suid-afrikaanse landbouprodukte: 1981 -1987 ranaorde kommoditeit iddeks 1 wol (ontghries en rue-gekam) 38,17 2 chemiese houtpulp 18,58 3 druk.en sk:rytpapier 16,69 4 lemoene (vars en gedroog) 8,70 5 vars appels 8,06 6 natrium kalsium fosfate 7,24 7 wol (met ghries, skeersel gewas) 6,82 8 huide, velie (roll, pels uitgesluit) 5,46 9 druiwe (vars en gedroog) 4,23 10 suiker en heuning 3,99 11 ingemaakte vrugte 3,35 12 mielies (ongemaalde pitte) 3,01 13 rou beet en rietsuiker 2,04 14 sintetiese vesel 1,32 15 koerantpapier 1,31 16 wol (verwerk) 1,13 17 veevoer 0,57 18 vleis (vars, verkoel en gevries) 0,35 sleutel: indeks > 1 toon komparatiewe voordeel. indeks <i toon komparatiewe nadeel. bron: wentzel, 1994: 11-12. daar bestaan 'n groot intemasionale komparatiewe voordeel in vars en gedroogde vrugte, asook ingemaakte vrugte met onderskeidelik indekse van 3,49 en 3,35, asook die wolbedryf wat 'n algemene indeks van 6,11 het. oit is opvallend dat verwerkte wol slegs 'n indeks van 1,13 het. ru-kunsmis besit die grootste individuele voordeel van 6,18, terwyi die suikerbedryf 'n matige voordeel van 3,99 het, en mielies 3,01. papieren veipa1dcing toon gemengde resultate met indekse van 4,13 en 1,67 onderskeidelik. anders as wat verwag sou word besit die vleisbedryf, van die grootste komparatiewe nadele in die suid-afrikaanse ekonomie (0,35), maar in dierevelle het die land een van die grootste komparatiewe voordele met 'n indeks van 5,46. veevoer besit 'n komparatiewe nadeel van 0,59, terwyl die komparatiewe nadeel in koring so groot is dat dit rue r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 3 506 eens genoem word nie. suid-afrika het natuurlik 'n absolute voordeel in die produksie van rooibostee omdat die land die enigste produsent is. breedweg stem die resultate ooreen met sommige bevindings van ariovich (1979), alhoewel sy studie nie slegs op die landbousektor gefokus het nie. in die lig van veranderde toestande in die wereld kan claar verwag word dat die indeks in die toekoms baie sal verander en volgehoue navorsing in die verband is nodig, so gou as wat nuwe data beskikbaar word. met minder beskerming mag mielies byvoorbeeld swakker vaar, aangesien dit oorsee hoofsaaklik as veevoer gebruik word. lndien die subsidiering van landbouproduksie in die verenigde state en die europese gemeenskap werklik uitfaseer gaan word, kan dit moontlik weer die suid-afrikaanse landbou uitvoer bevoordeel. lndien tariewe verlaag mag die invoer van wol vanaf australie meer winsgewend raak, maar indien dieselfde situasie in alle markle geld mag suid-afrikaanse wol dieselfde voorregte smaak. die algemene gevoel is dat die uitvoering van die aotiiooreenkoms die uitvoer van suid-afrikaanse rooivleis na westerse lande gaan bevoordeel, maar dieselfde geld vir die uitvoer van australiese, amerikaanse en europese vleisuitvoere. daar kan gevolglik nie vooraf bepaal word in watter opsig intemasionale mededingendheid deur die veranderende wereld toestande geraak gaan word nie. mertertyd sal die volgehoue berekening van indekse wei bepaalde tendense aandui. 'n tekortkoming van balassa se metode is dat kommoditeite waarvoor claar nie handelsdata bestaan nie, en kommoditeite wat nie uitgevoer word nie, geignoreer word. suid-afrika het byvoorbeeld 'n absolute voordeel in rooibostee, maar dit word nie by die ontleding ingesluit nie weens 'n gebrek aan intemasionale data. in talle lande is die data vir die berekening van komparatiewe voordele egter uiters ontoereikend. vanwee die hoe vlakke van beskerming en owerheidsondersteuning wat handelspatrone versteur, veral in die verenigde state en die europese unie, is 'n ontleding van komparatiewe voordele in die landbou nie altyd baie betroubaar nie. verdere en venvante navorsing hierdie ondersoek was 'n eerste stap in die ontleding van die intemasionale mededingendheid van die suid-afrikaanse landbousektor, waarin balassa se metode toegepas is. ten einde 'n beter aanduiding van die komparatiewe voordeel in bepaalde produkte in die sektor te verlay, behoort soortgelyke indekse, van die land se belangrikste mededingers, ook bereken te word. dit kan ook aantoon waar moontlikhede vir ekonorniese integrasie bestaan en wat die effek daarvan sal wees. ook in die bree suider-afrikaanse ontwikkelingskonteks sal die berekening van sodanige indekse kan aantoon waar ekonorniese integrasie r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 507 sateb nr vol i (1998) nr 3 tussen sadc-lande die voordeligste sal wees. soortgejyke studies behoort ook vir ander sektore, soos byvoorbeejd vervaardiging, uitgevoer te word, (sien byvoorbeeld ariovich (1979 & '80). indien die heckscher-ohlinteorie gebruik wil word om komparatiewe voordeel te bereken ten einde die resultate van die balassa-metode te bevestig, sal meer data ingesamel moet word. hier in besonder is inligting rakende die totale voorraad produksiefaktore wat benodig word per kommoditeit, beide op 'n provinsiale en nasionale vlak, nodig. die data wat in hierdie artikel gebruik was om die mededingendheid van suid-afrikaanse landbou te illustreer is natuurlik onvoldoende, maar by 'n gebrek aan plaaslike data was data van die verenigde nasies gebruik. vir verdere ontledings sal data van die vn ook op gedateer moet word. vir vergelykende studies sal dit egter beter wees om van dieselfde metodes gebruik te maak. in die verband kan die huidige studie byvoorbeeld met die van ariovich (1979) vergelyk word wat ook balassa se metode, vir die periodes 1973 tot 1975, gebruik het. oit gaan vera! in die toekoms van nut wees om te monitor in watter mate kommoditeite se mededingendheid gaan verander soos wat die aoth besluite in werking tree en tariewe en invoerbeheermaatreels gaandeweg afgeskaal word. ondersoeke na verdere periodes en eksperimente rakende die lengte van die peri odes van ondersoek, mag van waarde wees om kennis en begrip van die mededingende situasie te vergroot. oit sal van waarde wees indien die studie vir die tydperk na 1987 ook uitgevoer kan word, sodra die nodige data beskikbaar is, sodat vergelykings moontlik kan wees. daar kan dan bepaal word watter veranderinge in mededingendheid aan die ontwikkel is in die verskillende kommoditeite. vera! waar tariewe en invoerbeheer nou afgeskaal word. dit sal interessant wees om indekse van jare waar tydens daar 'n groot mate van proteksionisme aanwesig was, soos in die jare sewentig, te vergelyk met periodes na die inwerkingstelling van die aothooreenkomste. indien die ontwikkeling in die jare wat voorle noukeurig gemonitor word, kan daar vroegtydig tendense bepaal word en opgetree word om skokke te vermy. te kort periodes mag moontlik te min inligting verskaf en in dieselfde rigting dui weens ewekansige gebeure, soos droogtes, die uitvoersituasie in uitvoerlande in die korttermyn en skommeling in kostes en pryse. te lang periodes sal weer hul eie nadele he. die studie kan ook na meer peri odes uitgebrei word, sodat tendense wat moontlik op sigself belangrik mag wees, ondersoek kan word. verdere navorsing wat kan aandui wat sommige kommoditeite meer mededingend as ander maak, kan uit hierdie studies voortspruit. die moontlikheid om produkte, wat reeds komparatiewe voordeel geniet, se mededingendheid verder te verstek kan ondersoek word. navorsing rakende r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajemsns vol i (l998) no 3 508 sodanige kommoditeite, mag santoon op watter wyse ander produkte ook meer mededingend kan word. produkte wat nie komparatiewe voordeel geniet rue, behoort ondersoek te word om vas te stel wat vir hul verlies san mededingendheid verantwoordelik is en hoe sodanige produkte, waar moontlik, meer mededingend gemm kan word. kommoditeite waarvan die komparatiewe voordele rue verbeter kan word nie, behoort vermy of ontmoedig te word. oit mag egter rue plaasvind alvorens die ekonomiese en sosiale kostes, wat 'n staking of verlaging in produksie daarvan sal meebring, bereken is rue, vera! omdat landbou kommoditeite soveel skakeleffekte met die res van die ekonomie het. die resultate van studies behoort san intensiewe ondersoeke onderwerp te word. so byvoorbeeld sal daar na aanleiding van die studie oor die landbou, intensief gekyk moet word na die vrugte-, wolen vleisbedryf. hierdie studie stem saam met studies rakende ander suid-afrikaanse bedrywe, soos byvoorbeeld die motorbedryf (van zyl: 1995: 8), in die opsig dat suidafrikaanse arbeid rue intemasionaal mededingend is rue. suid-afrika het byvoorbeeld 'n komparatiewe voordeel in vuil onverwerkte wol, maar sodra arbeid bygevoeg word, om dit byvoorbeeld te was of te kam, verloor die land sy mededingende voordeel. oit kom daarop neer dat arbeid rue produktief genoeg is rue en produsente nie waarde vir hulle geld ontvang, wanneer arbeidsintensiewe tegnologie geimplementeer word nie. in die verband het ariovich (1979: 192) ook gevind clat komparatiewe voordeel in suid-afrika gelee is in produkte wat kapitaalintensief is. met so groot werkloosheidsyfer sou dit vir die land beter gewees het indien mededingende voordele in arbeidsintensiewe produksie behaal kon word. kritiek teen die voorgestelde metode van balassa is dat dit die bestaande handelspatrone weerspieih en om dit getrou te kan weergee moet handelspatrone goed ontwikkel wees, produksiekostes nie versteur wees en en moet die vrye markmeganisme behoorlik funksioneer. indien dit nie die geval is nie, soos wat tans nog die geval is met distorsies en handelsbeperkinge, is die "competitive advantage" benadering van porter meer gepas. 'n ontleding gebaseer op die "policy analysis matix" (pam) sou waarskynlik ook meer sin gemm het. met die vele beperkinge en subsidies tot onlangs in die suidafiikaanse landboumark, toon balassa se metode nie werklik die potensiaal van die sektore nie en eerder slegs hoe die situasie in die wereldekonomie was, te midde van subsidies, sanksies, kwotas en ander beskermingsmaatreels. oit is juis ook weens die beginsel van geopenbaarde voordeel, instaat om ekonomiese ontwikkeling aan te toon. waar die bepalings van die aom tans inwerking tree en intemasionale handeisliberalisasie al meer veld wen, kan balassa se metode juis van waarde wees om die groeiende potensiaal van r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 509 satebnr vol 1 (1998)nr3 sommige produk:te en sektore aan te toad, terwyl sommige voonnalige wenners aan die kwyn is. die voordeel van balassa se metode ie' egter daarin dat dit maklik, vinnig en ekonomies is om te bereken. samevati1ng die doel van die artikel is om 'n alternatiewe metode van meting en kwantifisering van internasionale mededingendheid voor te stel. die bepaling van komparatiewe mededingendheid is belangrik omdat die patroon van internasionale handel en die allokasie van hulpbronne daarvan afhang. die praktiese toepassing van die tradisionele teorie! word aansienlik bemoeilik deur werklike data en ander probleme. om dit te oorkom word daar in hierdie artikel voortgebou op balassa (1989) se voorstel dat komparatiewe voordeel aan die hand van histories geopenbaarde voordeel gemeet kan word. die suid-afrikaan.se landbousektor is as 'n gevalle stodie gebruik vanwe! die groot aandeel wat die landbousektor tot die land se bruto binnelandse produk lewer, die feit dat landbou is '0 goeie verdiener van buitelandse betaalmiddele is en groot skakeleffekte wat bestaan. gedurende die laaste tien jaar het landbouuitvoer ongeveer agt persent van die land se uitvoer uitgemaak. selfs in die swakste jare en tydens die sanksie-era was die landbou '0 netto uitvoerder. met die toenemende neiging tot internasionale handelsliberalisering is dit noodsaaklik dat daar bepaal word op watter terreine die suid-afrikaanse landbou komparatiewe voordele besit weens die sosiale en strategiese belangrikheid van die landbousektor vir die suid-afrikaanse ekonomie behoort enige verandering in die produksie en mededingendheid van 'n kommoditeit aan deeglike kostevoordeel analise onderwerp te word. in hierdie stodie is indekse volgens balassa se metode bepaal wat aantoon in watter produkte die suid-afrikaanse landbou komparatiewe voordeel het. 'n indeks groter as een dui op komparatiewe voordeel. die grootste mededingende voordeel is in onverwerkte wol, houtpulp, druken skryfpapier en vrugte. opvallend is dat die komparatiewe voordeel op koerantpapier, verwerkte wolprodukte en suiker taamlik lass is. wat onverwags was, is die land se komparatiewe nadeel in vleisproduksie. hierdie stodie stem saam met stodies rakende ander suid-afrikaanse bedrywe, soos byvoorbeeld die motorbedryf(van zyl: 1995: 8), dat suid-afrikaanse arbeid nie internasionaal mededingend is nie. in die verband stem ariovich (1979: 192) saam dat suid-afrika slegs komparatiewe voordeel geniet in kommoditeite wat kapitaalintensiewe produksie tegnieke benut suid-afrika het byvoorbeeld 'n r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 3 510 komparatiewe voordeel in vuit onverwerkte wol, maar wanneer arbeid bygevoeg word, om dit byvoorbeeld te was, verloor die land sy mededingendheid. oit kom daarop neer dat arbeid nie produktief genoeg is nie en produsente nie waarde vir hulle geld kry, wanneer arbeidsintensiewe tegnologie geimplementeer word nie. met die groot werkloosheidsyfer is dit van kardinale belang dat die land se arbeidsproduktiwiteit en werksetiek daadwerklik. deur middel van opleiding en opvoeding, verhoog sal word. balassa se berekeningsmetode vir komparatiewe voordeel is relatief eenvoudig, benut beskikbare data en word as meer geskik beskou (ariovich, 1979: 189). oit lean met vrug benut word in ander sektore soos byvoorbeeld in aspekte van nywerheidsontwikkeling en lean ook 'n nuttige doel dien by die beplanning van streeksintegrasie binne die suid-afrikaanse ontwilckelingsgemeenskap. uit die studie behoort baie navorsing te spruit, wat van groot waarde vir die landbou en die suid-afrikaanse ekonomie as geheel sal wees. eindnota prof. sj van der merwe van die potchefstroomse universiteit vir christel ike hoer onderwys word bedank vir sy insette by die skryf van hierdie artikel. verwysings 1. anderson, k. & tyers, r. 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(1990). agricultural restructuring in southern africa: the contribution of the developing agricutural sector. agrikon. 29 (1). 28. van z'yl. g. & kleynhans, e.p.j. (1995). "a cobb-douglas estimation of labour productivity in the south african motor vehicle industry". journal a/industrial psychology. 21(1): 6-9. 29. wentzel, a. (1994). komparatiewe voordeel van die suid-afrikaanse landbou en verwante bedrywe. pretoria: departement van landbou: direktoraat landbou-ekonomiese tendense. 17p. 90 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . call for papers biennial conference of the economic society of south africa international capital flows, emerging markets and south africa the society will hold its biennial conference at pretoria university on 6 and 7 september 1999. papers will be read around the conference theme of international capital flows, emerging markets and south africa. contributions are invited from economists working in this field. papers may be submitted on other topics too; these will be presented in parallel sessions. a preliminary draft of the proposed paper, not more than 250 words, must reach the programme committee by 31 march 1999 at: essa programme committee, department of economics, university of pretoria, pretoria 0002, south africa. uitnodiging vir referate twee)aarlikse konferensie van die ekonomiese vereniging van suid-afrika internasionale kapitaalvloeie, ontluikende marlcte en suidafrika die vereniging se tweejaarlikse konferensie sal gehou word by die universiteit van pretoria op 6 en 7 september 1999. referate sal gelewer word rondom die kongrestema van internasionale kapitaalvloeie. ontluikende markte en suid·afrika. ekonome wat op hierdie gebied werk, word genooi om bydraes te lewer. referate oor ander onderwerpe, wat in gelyktydige sessies aangebied sal word. is ook aanvaarbaar. 'n voorlopige konsep van die voorgestelde referaat van itoogstens 250 woorde moet die evsa programkomitee bereik voor 31 maart 1 999 by die departement • ekonomie, universiteit van pretoria, pretoria 0002. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . microsoft word 1 jibao et al sajems 15(2) 2012.doc 112 sajems ns 15 (2012) no 2 fiscal regime changes and the sustainability of fiscal imbalance in south africa: a smooth transition error-correction approach samuel s jibao, niek j schoeman and ruthira naraidoo department of economics, university of pretoria accepted: october 2011 in addition to the conventional linear cointegration test, this paper tests the asymmetry relationship between fiscal revenue and expenditure, by making a distinction between the adjustment of positive (budget surplus) and negative (budget deficit) deviations from equilibrium. the analysis uses quarterly data for south africa. the paper reveals that government authorities in south africa are more likely to react more quickly when the budget is in deficit than when in surplus, and that the stabilisation measures used by government are fairly neutral at low deficit levels; that is, at deficit levels of 4 per cent of gdp and below. we conclude that the assumption that adjustment towards equilibrium is always present and of the same strength under all circumstances, is not valid in the case of fiscal data on south africa; and that that fiscal sustainability in south africa has been attained at the expense of a reduction in the ratio of expenditure to gdp on education, and a relatively constant ratio of expenditure to gdp on health. the paper noted that a priori one would expect that such a decline in the allocations to sectors which could stimulate growth and which in turn could generate future revenue, may pose a threat to the accumulated fiscal space. in south africa the main fiscal challenge, therefore, is to find ways through which the recent gains in fiscal solvency can be consolidated. key words: smooth transition error correction model; nonlinearity; government inter-temporal budget constraint; and fiscal sustainability jel: c22, 51, h62 1 introduction developments which followed the sub-prime crisis have led to renewed debate on fiscal sustainability: the massive degree of fiscal intervention, with corresponding increases in deficits and debt, are a concern. from a fiscal perspective, maintaining a stable long-term relation between expenditures and revenues is one of the key requirements for a stable macroeconomic environment and a sustainable economy. sustainability, in general, concerns current and expected policies. if economic agents do not expect current and future policies to operate within the inter-temporal budget constraint, then the fiscal process would be unsustainable and government insolvency possible. several of the empirical studies on fiscal sustainability, however, focus on the time series behaviour of tax revenues and expenditures, as well as debt series, to investigate whether the behaviour of these series is consistent with the inter-temporal budget balance. the empirical results of these studies vary depending on the sample period and the methodology used. in the united states, cunado, gil-alana, and perez de gracia (2004), hamilton and flavin (1986), and trehan and walsh (1988) failed to reject the inter-temporal budget balance, whilst hakkio and rush (1991), wilcox (1989) and others rejected it. empirical investigations into government's inter-temporal fiscal solvency constraints in east asia have also been documented (see for example, baharumshah & lau 2007). based on time series analysis and quarterly data over three decades, baharumshah and lau (2007) found evidence of sustainable fiscal finances in thailand and south korea, whilst the philippines and malaysia demonstrated only ‘weak sustainability’. baharumshah and abstract sajems ns 15 (2012) no 2 113 lau (2007) showed that in singapore, revenue was growing at a faster rate than government spending. in south africa, issues of fiscal sustainability received greater attention in the 1980s and 1990s following a growing public debt/gdp ratio. in the early 1980s, the south african economy became a closed economy following the economic sanctions by the international community. as a way of alleviating the effect of the sanctions, the said economy became highly subsidised by the government. the government introduced the industrial decentralisation programme which amounted to direct and indirect subsidies for the establishment of large industrial companies. in addition, because the government was involved in proxy wars in and around south africa, government expenditure increased significantly during the same period (caner & schoeman, 2006). increased government expenditures and debt service forced the government to increase taxation to finance future expenditure. the period beginning in the early 1980s and ending with the transition to a new constitutional and political environment was therefore marked by increasing government expenditures and taxation, with fiscal deficit increasing to 6.8 per cent in 1993. in the earlier and mid-1990s, therefore, several researchers argued that fiscal policy was unsustainable in south africa (roux, 1993; van der merwe, 1994; schoeman, 1994; cronje, 1995). roux (1993) argued that the south african government would be able to finance higher social expenditure only if economic growth improved; otherwise, debtfinanced increases in social expenditure would cause an increase in the public debt/gdp ratio. van der merwe (1994) argued that fiscal policy in south africa is unsustainable due to the large gap between real interest rates and real economic growth as well as the relatively large size of the deficit. schoeman (1994) also warned that as long as government runs a large deficit in the face of a real interest rate that exceeds the real economic growth, the public debt/gdp ratio would tend to explode. consistent with the findings of the various researchers in south africa, the south african economy has embarked on broadly three phases of fiscal reform since 1994. from 1994 to 1996, following a period of recession and a rapid rise in the budget deficit, government’s reconstruction and development programme was phased into departmental plans and budgets, and a comprehensive reprioritization of public expenditure was undertaken (manuel, 2004). the average budget deficit stood at 4.3 per cent of gdp and government debt was approaching 50 per cent of gdp by 1994. a period of fiscal consolidation from 1997 to 2000 saw the introduction of medium term expenditure planning, substantial investment in tax reform and revenue administration capacity, and efficient coordination of fiscal and monetary policy. the budget deficit declined to 3.0 per cent of gdp, public debt relative to gdp declined from 49.7 per cent in 1994 to 44.4 per cent in 2000 and average borrowing costs decreased sharply, providing room for government to spend more on social services and infrastructure. from 2001 to 2008, the government of south africa adopted a more prudent fiscal stance. the fiscal deficit as a percentage of gdp declined from an average of 4.6 per cent from 1992 to 19991 to an average of 1.3 per cent from 2001 to 2005, and thereafter recorded a budget surplus in 2006 and 2007 of 0.3 per cent and 0.7 per cent of gdp respectively2. although government had achieved a substantial reduction in its budget deficit target, from 6.8 per cent of gdp in 1993 to 0.6 per cent in 2008, the scenario has meanwhile changed again (see budget review, 2010), mainly due to the slowdown in the world economy, which also affected the revenue base of the south african economy. however, the policy of fiscal prudence during the period 2003 to 2008 resulted in a substantial decline in real debt service cost, while the real growth rate of the economy increased considerably. nevertheless, there still exist a gap between the real debt service cost and the real growth rate since the former exceeds the latter.3 furthermore, it appears that public debt and budget deficit reductions have been achieved at the expense of a relative reduction in service delivery expenditure, as is evident in the reduction in the ratio of education expenditure to gdp from an average of 6.21 per cent during the period 1990 to 1999, to an average of 5.6 per cent during the period 2000 to 2008; and a reduction in health expenditure relative 114 sajems ns 15 (2012) no 2 to gdp to an average of 2.84 percent between 2000 to 2008 from 1990 to 1999 average of 2.93 per cent.4 in most of the studies recorded in the literature on fiscal measures to address the solvency condition, researchers have either tested for linear stationarity in the total government deficit series or tested for linear cointegration between total government spending and total tax revenues. to the best of our understanding, few researchers have used non-linear techniques to quantify the adjustment process of fiscal and other macroeconomic variables towards the long-run equilibrium (van dijk & franses, 1997; hansen & kim, 1996; kunst, 1992 & 1995; dwyer, 1996; swanson, 1996; cipollini, 2001). in south africa in particular, no study has tested whether the error-correction process used in the respective studies is linear. instead, previous studies have assumed that the adjustment process driving the variables toward equilibrium is linear; i.e. adjustment towards equilibrium is always present and of the same strength under all circumstances. in this study the authors want to point out that there are situations in which the validity of this assumption might be questioned (van dijk & franses, 1997). the authors therefore apply an extension of the linear inter-temporal budget constraint rule of fiscal sustainability to a regime-switching framework, where the transition from one regime to the other occurs in a smooth way. the switching between regimes is controlled by the state of the fiscal balance. this feature of the smooth transition model allows us to test the ability of high against low budget deficits or surpluses to best describe the non-linear dynamics of fiscal policy in south africa. following the introduction, section ii presents sustainability criteria as obtained from the literature. section iii provides the estimation procedures, with both linear and non-linear specifications; section vi presents the results from the estimations and the last section summarises and concludes. 2 sustainability criteria the most straightforward way to assess the fiscal sustainability position is to start from a government’s inter-temporal budget constraint. the budget constraint looks at the long-run relationship between government revenue and expenditure (that covers the total government spending on goods and services, transfer payments and interest on debts). for simplicity, assume that budget deficits are financed using bonds with a maturity of one period. this implies that the government faces the budget constraint as shown in equation one: tg +(1+ tr ) t−1b = tr + tb (1) where g is government expenditure, r is the one-period real rate of interest, r is government revenue and b is the stock of debt. iterating equation (1) forward yields the government’s inter-temporal budget constraint: tb = (1+ tr −1 ) i=1 s ∏s=0 ∞ ∑ ( t+sr − t+sg )+ s→∞ lim (1+ t+1r −1 ) i=1 ∞ ∏ t+sb (2) we assume that the real interest rate is stationary with unconditional mean given by r and also that the growth rate of the real supply of bonds, on average, is equal to or lower than the average rate of interest (hamilton & flavin, 1986; haug, 1995). with these assumptions, we can have the following expression: s→∞ lim(1+ r) −s t+sb = 0 (3) the above equation (3) states that the debt stock, when measured in present value terms, vanishes in the limit. by definition, it excludes ponzi financing; that is, the government is not ‘bubble’-financing its expenditure by issuing new debt to finance the deficit. this is equivalent to saying that the deficit is sustainable if and only if the stock of debt held by the public is expected to grow no faster than the mean real rate of interest, which is viewed as a proxy for the growth rate of the economy (baharumshah & lau, 2007). following equation (3), the inter-temporal budget constraint, equation (2), can be rewritten as: tg − tr = (1+ r) −s+1 s=0 ∞ ∑ (δ t+sr − δ tg + rδ t+s−1b ) (4) the inter-temporal budget constraint, under the no-ponzi scheme rule, imposes restrictions on the time series properties of government expenditure and revenue given by the right hand side of equation 4. this will be stationary, as long as government expenditure, revenue and the stock of debt are all stationary sajems ns 15 (2012) no 2 115 in first differences. specifically, if gt are rt i(1), they will be cointegrated, implying that there exists an error-correction mechanism pushing government finances towards the levels required by the inter-temporal budget constraint (baharumshah & lau, 2007). assuming that the transversality condition for the budget constraint holds and the limit term in equation (3) is zero, we arrive at the following cointegrating relationship as shown in equation 5 (hakkio & rush, 1991); tr =α + β tg + tε (5) following martin (2000), the deficit is ‘strongly’ sustainable (strong solvency) if and only if the i(1) process of r and g are cointegrated and β=1. the deficit is only ‘weakly’ sustainable if r and g are cointegrated and 0<β<1 (see trehan & walsh, 1988; quintos, 1995). the linear model estimated in this paper, after eliminating insignificant lags, is specified as: tdlrev = 0α + 1α −1dlrev + 2α −2dlrev + 3α −4dlrev + 4α −5dlrev + 5α −8dlrev + 6α tdlexp + 7α −2dlexp + 8α −4dlexp + 9α −5dlexp + 10α −8dlexp + 11α −1ecm (6) where ‘dlev’t and ‘dlexp’t are the differenced revenuetogdp and expenditure-togdp variables in the current period. a priori, we expect a positive and significant relationship between government expenditure-to-gdp and its revenue-to-gdp. to choose the lag lengths, we follow the suggestions of teräsvirta (1994) by considering a number of test statistics on the error correction model (vecm) specifications; and cipollini (2001) by using the likelihood ratio sequential tests on the residuals. using the information criteria, the schwarz information criterion and the hannan-quinn information criterion (hq) suggest lag length of 3, whilst the akaike information criterion (aic) and the final prediction error (fpe) suggest lag length 5. however, like cipollini (2001) we chose lag 8 as the optimal lag length since this lag order gives evidence of homoscedastic and serially independent residuals. 3 specification and estimation techniques in this paper, our empirical estimation involves the following steps: (i) testing for stationarity of the variables; (ii) testing for cointegration and estimation of the cointegrating relation; (iii) testing for non-linearity of the adjustment process; and (iv) estimating and evaluating of the smooth transition error correction model. 3.1 linear estimation techniques we carry out three different tests for the order of integration which are: the augmented dickey-fuller (1981), the kwiatkowski, phillips, schmidt and shin (1992) and the phillips perron (1988) tests. the dickey-fuller and phillips-perron tests have as their null hypothesis that the dynamics of the respective series are characterised by a unit root. the kwiatkowski, phillips, schmidt and shin test, on the other hand, is based on the null of stationarity. the use of three tests is justified since phillips and perron (1988) and zivot and andrews (1992) have demonstrated that the augmented dickey-fuller test has low power in the presence of a structural break. we consider those cointegration tests that are most popular among researchers: the residual-based test suggested by engle and granger (1987) and the likelihood ratio test introduced by johansen (1991). given a bivariate case (for simplicity) with no deterministic regressors, the residual-based test for cointegration is performed via the two-step procedure of engle and granger (1987). that is, we first estimate the cointegration regression as specified in equation (7) using ordinary least square (ols) and second, test for the presence of a unit root in the regression residuals. uxy ttt +−= β (7) johansen (1991) advocates a test for cointegration by testing the rank r of π by applying likelihood ratio tests to test the significance of the squared partial canonical correlations between ytδ and yt 1− denoted λλ ˆˆ 21and which can be obtained by solving a generalised eigenvalue problem. the authors use trace tests to test rh r 00 : = against the alternative hypothesis rh r 101: +≥ for r0 = 0,1. this paper considers both non-parametric and parametric tests for linearity. the non116 sajems ns 15 (2012) no 2 parametric test follows brock-dechertscheinkman (1987). it tests the null hypothesis of independence and identically distributed variables against an unspecified alternative. the brock-dechert-scheinkman (1987) test cannot test chaos directly, but only nonlinearity, provided that any linear dependence has been removed from the data (e.g. using traditional arima-type models or using first differences). the brock-dechert-scheinkman (1987) statistics are, therefore, different from other non-parametric test statistics since these focuses mainly on either the secondor thirdorder properties of   x2. the basic idea of the brock-dechert-scheinkman (1987) test is to make use of a ‘correlation integral’ popular in chaotic time series analysis. given a k dimensional time series and observations } 1 { tk ttx = , define the correlation integral as: 5 )( )1( 2 )( lim xxittc jji ikktkk ∑<→∞ − = δ δ (8a) where ),( vuiδ is an indicator variable that equals one if ||u-v||<δ, and zero otherwise, and where ||·|| is sup norm. the null hypothesis of the bds test is that the series is linear and the alternative hypothesis is that the time series is non-linear after removing any linear dependence from the data, either by using arima-type models or taking the first difference of the series. this test statistic has a standard normal limiting distribution. the parametric test for linearity follows teräsvirta (1994) who suggests a method of approximating the transition function by a taylor expansion about the null of linearity γ = 0. the linearity test involves estimating an auxiliary regression by ols: εφφφφ tdttdttdtttt zwzwzwwy ++++ʹ′=δ −−− ʹ′ʹ′ʹ′ 3 3 2 2 2 1 ˆˆˆ (8b) where ),,...............,.........,1( 1 ʹ′δδδ= −−−− zxyyw dtptpttt   ),.......,.........................( 11ˆ zxxyyw dtpttpttt −−−−− δδδδ= the original null hypothesis of linearity, h0: γ = 0 is equivalent to the hypothesis that all coefficients of the auxiliary regressors zw j dtt −ˆ , j = 1,2,3 are zero i.e. 0: 3210 ===ʹ′ φφφh . for details on the lm-type test for this hypothesis, see van dijk et al. (1997). to select the most appropriate lag of zt to use as transition variable, the test should be carried out for a number of different values of d, say d = 1 …d. if the linearity is rejected for several values of d, the one with the smallest p-value is selected as the transition variable; see van dijk et al. (1997). 3.2 non-linear estimation technique if the linearity hypothesis is rejected, we can estimate a non-linear model using non-linear least squares (nls). in this paper, we apply the smooth-transition threshold models (granger & teräsvirta, 1993; teräsvirta, 1994; teräsvirta, (1998) which allow for smooth transition between regimes of behaviour and thus generalise the threshold autoregressive model (tar). the other strength of the smooth transition model is that it is theoretically more appealing than the simple tar models that impose an abrupt switch in parameter values. an abrupt switch only happens if all agents act simultaneously. additionally, the str model allows different types of market behaviour depending on the nature of the transition function. in particular, the logistics function allows differing behaviour depending on whether deviations from equilibrium are positive or negative, whilst the exponential function allows differing behaviour to occur for large and small deviations regardless of sign (see mcmillan, 2004). following mcmillan, the str model is given by equation 9 below: ερθθρδ tttit p i iitit p i t uuxuxx f ++δ+++δ+=δ −−− = −− = ∑∑ )()( 112 1 11 1 0 (9) where )(u dtf − is the transition function and u dt−   the transition variable. the logistic function is given as follows, with the full model thus referred to as a logistic str (or lstr) model: } 1 11 )](exp[1{)( − −− −−+= τγ uu ttf γ > 0 (10) which allows a smooth transition between the differing dynamics of positive and negative deviations, where γ is the smoothing parameter and τ the transition parameter. this function allows the parameters to change monotonically with ut-1. as γ → ∞, f(ut-1) becomes a heaviside function, ττ ≥=≤= −−−− )(,1)(,)(,0)( 1111 uuuu tttt ff and equation 9 reduces to a tar model. as γ → 0, equation 9 becomes a linear model of order p. sajems ns 15 (2012) no 2 117 the second type of asymmetry, which distinguishes between small and large equilibrium errors, is obtained when )(u dtf − is taken to be the exponential, with the resulting model referred to as the exponential str (or estr) model and estecm for a bivariate model: ) 2 11 (exp[1)( τγ −−−= −− uu ttf (11) equation 9 results in gradual changing strength of adjustment for larger (both positive and negative) deviations from equilibrium. it implies that the dynamics of the middle ground differ from those of the larger deviations. this model is therefore only able to capture nonlinear symmetric adjustment. a possible drawback of this choice for the transition function is that both if γ → 0 or γ →∞ , the model becomes linear. this can be avoided by using the ‘quadratic logistic function’ as proposed by jansen and teräsvirta (1996). ) 1 21111 )})((exp{1()( − −−− −−−+= ττγ uuu tttf (12) in this case, if γ→ 0, the model becomes linear, whilst if γ→∞, the function f(.) is equal to 1 for cut 11 <− and cut 21 >− . the str model is estimated using the nonlinear least squares; however, in the lstr model, a large γ results in a steep slope of the transition function at τ, thus a large number of observations is required to estimate γ accurately. furthermore, convergence of γ may be slow, with relatively large changes in γ having only a minor effect upon the shape of the transition function. to get around this problem, granger and teräsvirta (1993) and teräsvirta (1994) proffer scaling the smoothing parameter γ by the standard deviation of the transition variable, and by the variance of the transition variable in the case of estr (see mcmillan, 2004). 4 data discussion the data used to estimate the model suggested in this paper consists of the south african national government receipts and expenditures, expressed as ratios of gdp. the data, obtained from the quarterly bulletin published by the south african reserve bank, are quarterly, and seasonally adjusted, from 1960:1 to 2008:4 (see figures 1a and b). all variables have been expressed as a percentage of gdp and converted into their natural logarithmic form. we use revenue and expenditure ratios to gdp since government authorities are mainly concerned with the dynamics of the different budget items relative to the overall size of the economy (see hakkio & rush, 1991; cipollini, 2001). the cointegrating relationship between the two variables is also shown in figure 1c. f i g u r e 1 a expenditure-to-gdp .12 .16 .20 .24 .28 .32 60 65 70 75 80 85 90 95 00 05 e x p g d p s a 118 sajems ns 15 (2012) no 2 -0.15 -0.10 -0.05 0.00 0.05 0.10 60 65 70 75 80 85 90 95 00 05 year f i g u r e 1 b revenue-to-gdp f i g u r e 1 c cointegrating relationship between series 5 empirical results the augmented dickey-fuller (1981) and phillips-perron (1988) unit root tests as well as the kwiatkowski-phillips-schmidt-shin (1992) stationarity tests for both series are reported in table 1. we note that the null of a unit root cannot be rejected on the basis of augmented dickey-fuller (1981) and phillips-perron (1988) for both series. this result is supported by the kwiatkowski-phillips-schmidt-shin (1992) test as this test rejects the null of stationarity for both series. there is no ambiguity in the order of integration; therefore we use the first differences of the series in our study. the granger causality test (see table 2) gives an indication of a unidirectional causality from   .10 .15 .20 .25 .30 60 65 70 75 80 85 90 95 00 05 r e v g d p s a sajems ns 15 (2012) no 2 119 expenditure to taxes, i.e. supports the expenditure dominance hypothesis, implying that in south africa budget developments are mainly determined by government spending.6 a residual-based test of cointegration as suggested by engle and granger (1987) and the likelihood ratio test introduced by johansen (1991) show evidence of a long-run relation between the two variables of interest (fig.1c). we test the hypothesis that the co-integrating vector is (1, -1). since the ρ-value is not significant at the conventional levels we cannot reject the null hypothesis that the restrictions are binding (see table 3), implying that during the sample period, fiscal policy in south africa, consistent with the intertemporal condition of sustainability, was sustainable. t a b l e 1 unit roots tests panel a: in levels adf pp kpss revenue-gdp 1.62 [0.975] -0.598 [0.493] 1.599*** expenditure-gdp 0.83[0.889] -0.300 [0.576] 1.307*** panel b: first difference δrevenue-gdp -9.665***[0.00] -9.998**[0.001] 0.095 δexpenditure-gdp -10.132***[0.00] -7.528***[0.001] 0.092 note *(**)(***) denotes significance at 10, 5, and 1 per cent levels respectively. [ ] are probability values. t a b l e 2 granger causality test null hypothesis observation f-statistic prob. dlrevgdp does not granger cause dlexpgd 188 1.34 0.25 dlexpgdp does not granger cause dlrevgdp 2.17 0.054 t a b l e 3 binding restrictions b(1,1)=1, b(1,2) =-1 hypothesied no. of cointegration restricted likelihood lr statistics degree of freedom probability value 1 452.0105 0.219771 1 0.639215 the fitted linear conditional error-correction model for revenue to gdp is shown in table 6, column 1. the linear model seems quite satisfactory, with the post-estimation residual tests indicating normality but with evidence of heteroscedasticity. the lm-tests reject the null of no serial correlation. it may be that these significant test values are caused by neglected non-linearity (van dijk et al., 2002). 5.1 linearity testing and model selection we carry out the brock-dechert-scheinkman (1987) test on a series of estimated residuals to check whether the residuals are independent and identically distributed; i.e. whether the residuals from our linear model has any nonlinear dependence in the series after the linear model has been fitted. table 4 indicates that all the test statistics are significantly greater than the critical values. thus, we should reject the null hypothesis of independent and identically distributed series/variables. the results strongly suggest that the time series in our model are non-linearly dependent, which is one of the indications of chaotic behaviour. we also consider a parametric test, the escribano and jorda (ej hereafter) (2001) linearity lm test. the null hypothesis in this test, h0, is that the series follows a stationary linear process. the computation of the test is carried out using the fversion, which is an asymptotic wald test. computing the lm-type test statistics, and 120 sajems ns 15 (2012) no 2 setting delay variable (d) equal to 1 through 8, it is seen that linearity is rejected for d =1, 2, 6 and 8 at the 5 per cent level of significance. but given that d = 6 has the smallest ρ-value, we select it as the delay variable (see table 5). this implies that in south africa it takes 6 quarters or one and a half years for fiscal policy changes to be effective. t a b l e 4 bds test ε/σ embedding dimensions(m) bds statistics 2 2 0.014***(0.0045) 2 3 0.024***(0.0071) 2 4 0.040***(0.0085) 2 5 0.046***(0.0087) 2 6 0.046***(0.0085) note: *(**)(***) denotes significance at 10, 5 and 1 per cent respectively t a b l e 5 lm-type for non-linearity and model selection transition variable lm h01 h02 h03 ecm-1 0.018 0.018 0.043 0.025 ecm-2 0.706 0.706 0.240 0.558 ecm-3 0.448 0.448 0.140 0.680 ecm-4 0.113 0.113 0.205 0.446 ecm-5 0.144 0.144 0.068 0.090 ecm-6 0.000 0.000 0.001 0.0012 ecm-7 0.421 0.421 0.507 0.957 ecm-8 0.001 0.0011 0.0010 0.124 note: ρ-values of f variants of the lm-type tests used in the specification procedure of escribano and jorda (2001). in-sample estimates of linear and nonlinear models ) )(1( 11181059 4827685544322 110111810594827 685544322110 expexp expexpexpexp expexpexpexp exp ecm revrevdlrev revecm revdlrevrevrevrevrev dldl dldldldldldldl dlfdldldldldl dldldldldldldl t tt −−− −−−−−− −−−−−− −−−−− ++ ++++++ +−+++++ ++++++= βββ βββββββ βββαααα ααααααα this is not uncommon, as fiscal policy issues require legislature procedures, which take time. deciding between the transition functions can be done by a short sequence of tests nested within h0. this testing is motivated by the observation that if a logistics alternative is appropriate, the second-order derivative in the taylor expansion (8b) is zero (see van dijk & franses, 1997). the null hypothesis to be tested is as follows: 00:;00:;0: 231013202303 ====== φφφφφφ hhh   granger and teräsvirta (1993) suggest carrying out all three tests, independent of rejection or acceptance of the first or second test, and using the outcomes to select the appropriate transition function. the decision rule is to select an exponential str function only if the p-value corresponding to h02 is the smallest, and select the logistic function in all other cases. table 5 shows that at d = 6, the logistic representation of the data is the most preferred. 5.2 lstecm estimation having established a non-linear relationship we now estimate the parameters of the lstecm by using the non-linear least squares (nls) technique. two lstecm models are fitted, one is general and the other is fitted after parameter reduction (see table 6, columns 3 and 4); this is obtained by removing the insignificant coefficients. the model estimated is specified as: sajems ns 15 (2012) no 2 121 ) )(1( 11181059 4827685544322 110111810594827 685544322110 expexp expexpexpexp expexpexpexp exp ecm revrevdlrev revecm revdlrevrevrevrevrev dldl dldldldldldldl dlfdldldldldl dldldldldldldl t tt −−− −−−−−− −−−−−− −−−−− ++ ++++++ +−+++++ ++++++= βββ βββββββ βββαααα ααααααα                         (13) where the weight f is modelled as follows: } 1 )](exp[1{),;()( − −−− −−+=≡ τγγ ecmecmecm dtdtdt cff γ >0 the parameter γ which determines the smoothness of the transition regime is set at 10; and the threshold is computed to be at 0.04. as stated earlier, the delay variable (d) is computed to be at 6 quarters, i.e. one and a half years. we also follow granger and teräsvirta (1993) and teräsvirta (1994) in making γ dimension-free by dividing it by the standard deviation of σ ecmt-d. as the surplus grows larger, ecm dt− → ∞, f → 1. as the budget deficit grows increasingly larger, ecm dt− → -∞, f → 0. when f →0 implying (1f) = 1, i.e. a budget deficit, the relevant parameters are a summation over α and β. the results from estimating model equation (13) are presented in table 6. table 6 columns 3 and 4 report the non-linear least square estimates of our models. tests of the residuals show no residual autocorrelation, no serial correlation, no non-normality of residuals and, finally, no heteroscedasticity. the akaike information criterion shows that the non-linear model (i.e. model 3) is a better fit than the linear model. the error-correction terms are of the expected signs and statistically significant and show that the adjustment process to equilibrium is faster when the government budget is in deficit than in surplus. in short, government authorities are likely to react more quickly when the budget deficit exceeds 4 per cent of gdp, since it will create concern for the achievement of fiscal sustainability. the one-and-a-half-year reaction delay (i.e. d = 6) combined with a relatively smooth switch from one regime to the other γ =10, can be explained in terms of the political-institutional processes (see cipollini, 2001). fiscal laws and regulations are drafted, through a budget document, and tabled to parliament for approval before implementation, a process that could be time consuming. the empirical result shows that a 1 per cent increase in the government budget deficit (the transition variable) implies variation in the transition function that is larger (i.e. a stronger policy maker reaction) than the corresponding 1 per cent increase in a budget surplus,7 showing that in this phase the south african government becomes more concerned about solvency or fiscal sustainability. however, it appears that fiscal sustainability in south africa has been attained at the expense of a reduction in the ratio of expenditure to gdp on education, and a relatively constant ratio of expenditure to gdp on health, during the deficit and surplus fiscal regimes (see figures 2 and 4). whilst the ratio of expenditure to f i g u r e 2 expenditure on growth enhancing sectors during deficit regime -4 -2 0 2 4 6 8 84 86 88 90 92 94 96 98 00 02 04 06 08 deficit regime health expenditure gdp education expenditure gdp figure 2: expenditure on growth enhancing sectors during deficit regime 122 sajems ns 15 (2012) no 2 gdp on these sectors were declining both during the budget deficit and surplus regimes, expenditure to gdp on social protection and public order and safety increased in both regimes (see figures 3 and 5). this result is supported by the negative correlation between the thresholds (i.e. budget deficit and surplus regimes) and the trend of education and health expenditure to gdp (see tables 7a and b). a priori one would expect that such a decline in the allocations to sectors which could stimulate growth and which in turn could generate future revenue, may pose a threat to the accumulated fiscal space.8 f i g u r e 3 deficit vs some non-productive sectors -4 -2 0 2 4 6 84 86 88 90 92 94 96 98 00 02 04 06 08 deficit regime defence social protection expenditure public order and safety f igure 3: deficit vs some non-productive sectors f i g u r e 4 surplus regime vs growth enhancing sectors -2 0 2 4 6 8 84 86 88 90 92 94 96 98 00 02 04 06 08 surplus regime health education f igure 4: surplus regime vs growth enhancing sectors sajems ns 15 (2012) no 2 123 -3 -2 -1 0 1 2 3 60 65 70 75 80 85 90 95 00 05 -0.10 -0.05 0.00 0.05 0.10 60 65 70 75 80 85 90 95 00 05 f i g u r e 5 surplus regime vs non productive sectors -2 -1 0 1 2 3 4 5 84 86 88 90 92 94 96 98 00 02 04 06 08 surplus regime social protection expenditure public order and safety defence figure 5: surplus regime vs non productive sectors f i g u r e 6 time varying parameter, budget deficit regime f i g u r e 7 time varying parameters, surplus regime year year 124 sajems ns 15 (2012) no 2 t a b l e 6 model estimates, 1960: q12008: q4 parameter linear model non-linear (general) non-linear (specific) α0 0.002 (0.005) 0.009 (0.008) 0.005 (0.008) α1 -0.28*** (0.081) -0.424*** (0.109) -0.469*** (0.081) α2 0.102** (0.047) 0.100* (0.058) α3 0.478***(0.068) 0.507*** (0.088) 0.510*** (0.069) α4 0.227***(0.062) 0.334*** (0.089) 0.284*** (0.067) α5 0.199** (0.060) 0.154** (0.075) 0.173 *** (0.059) α6 0.153** (0.059) 0.136* (0.078) 0.093** (0.046) α7 -0.082** (0.041) -0.132** (0.056) -0.108** (0.054) α8 -0.145** (0.070) -0.1534* (0.087) α9 -0.213***(0.054) -0.253*** (0.079) -0.127* (0.066) α10 0.008 (0.054) 0.023 (0.075) α11 -0.214***(0.061) -0.165** (0.077) -0.121* (0.072) β 0   -0.058*** (0.021) -0.058*** (0.019) β 1   0.399** (0.171) 0.326*** (0.019) β 2   -0.085 (0.106) β 3   -0.073 (0.151) β 4   -0.111 (0.142) β 5   0.126 (0.131) β 6   0.103 (0.135) β 7   0.148* (0.089) 0.138* (0.078) β 8   -0.184 (0.160) -0.220** (0.094) β 9   -0.131 (0.144) -0.269** (0.125) β 10   0.018 (0.112) β 11   -0.342 ** (0.144) -0.332*** (0.124) βα 66 +   0.239*** (0.012) βα 1111+   -0.507*** (0.0147) -0.453*** (0.011) τ   -0.04 -0.04 γ   10 10 adjusted r 2 0.90 0.91 0.92 t 184 184 184 aic -2.35 -2.34 -2.37 arch [0.0066] [0.52] [0.30] lm [0.001] [0.108] [0.402] dw 2.10 2.09 2.06 note: *(**)(***) denotes significance at 10, 5 and 1 per cent respectively; tno. of observations, archautoregressive conditional heteroscedasticity, aic-akaike info criterion ,dwdurbin watson stat. [ ] are probability values. the delta method is used to calculate the standard errors of )66( βα + and )1111( βα + sajems ns 15 (2012) no 2 125 t a b l e 7 a correlation between expenditure items gdp and deficit regime deficit defence education health social protection public order & safety housing deficit 1.0000 defence -0.1398 1.0000 education -0.475 -0.5009 1.0000 health -0.237 -0.5387 0.7637 1.0000 social protection 0.1149 -0.9051 -0.4592 0.5580 1.0000 public order & safety -0.0564 -0.9047 0.6585 0.6582 0.8987 1.0000 housing -0.242 0.7138 -0.3971 -0.20092 -0.5650 -0.5861 1.0000 t a b l e 7 b correlation between expenditure items gdp and surplus regime surplus defence education health social protection public order & safety housing surplus 1.0000 defence -0.4803 1.0000 education -0.2655 -0.5009 1.0000 health -0.0099 -0.5387 0.7634 1.0000 social protection 0.4964 -0.9051 -0.4592 0.5580 1.0000 public order &safety 0.43030 -0.9047 0.658 0.6582 0.8987 1.0000 housing -0.1847 0.7138 -0.3971 -0.2009 -0.5650 -0.5861 1.0000 6 summary and conclusion this paper has tested the asymmetry relationship between revenue and expenditure, by making a distinction between adjustment of positive (budget surplus) and negative (budget deficit) deviations from equilibrium. it uses quarterly data on south africa. our findings suggest that fiscal policy over the sampled period has been sustainable, since the historical processes in south africa are consistent with the inter-temporal government budget constraint. of more importance, our findings show that the assumption that adjustment towards equilibrium is always present and of the same strength under all circumstances, is not valid in the case of fiscal data on south africa. results from the study also reveal that government authorities are likely to react more quickly when the budget is in deficit than when in surplus, implying that the south african government becomes more concerned about solvency or fiscal sustainability in the case of the former. this adjustment could be prone to social shock, as trend expenditure on education and health to gdp has been on a decline over this period of fiscal solvency. we note, however, that what the paper has presented is to flag some important concern that may require further investigation. the authors have the intention to investigate in detail, in one of the follow-up papers, the effect of government expenditure changes and even tax policy changes that have brought about fiscal sustainability, on the economy’s performance. we intend using a dynamic general equilibrium model (dsge) to investigate the impact of spending cuts on important issues such as education and health and also to assess the impact of tax cuts on the economy. endnotes 1 fiscal balance as a percentage of gdp recorded 6.8 per cent in 1993. 2 averages are calculated by the authors using data from the reserve bank of south africa online historical data. 3 see burger and fourier, 2004. 4 although in nominal terms allocations have increased in the case of social services, like health and education. 5 see tsay (2005). 126 sajems ns 15 (2012) no 2 6 the authors recognise that granger causality is different from a test for exogeneity (enders, 2004). whilst exogeneity of one variable, say, expenditure, means that it is not affected by contemporaneous values of the remaining variables (taxes, debt, etc), granger causality refers only to the effects of past values of those variables on the current value of expenditure. our causality result reported only gives an indication of the relationship which is not firmed, because it is not the focus of the paper. studies have shown that causality amongst variables is highly sensitive to the methodologies used, choice of variables, the frequency of the data, and the sample period (see ndahiriwe & gupta, 2007). 7 figures 6 and 7 shows the state dependent speed of adjustment over time. 8 this hypothesis, however, requires further investigation. references 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occasional paper no.6, johannesburg: economic policy group study. wilcox, d.w. 1989. the sustainability of government deficits: implications of the present value borrowing constraint. journal of money, credit and banking, 21(3):291-306. zivot, d. & andrews, k. 1992. further evidence on the great crash: the oil price shocks, and the unit root hypothesis. journal of business and economic statistics,10(10):251-70. appendix 1: description of the variables and sources variables description revenue national government revenue as a percentage of gross domestic product expenditure national government expenditure as a percentage of gross domestic product education national government expenditure on education as a percentage of gross domestic product health national government expenditure on health as a percentage of gross domestic product socialprotection national government expenditure on social protection as percentage of gross domestic product public order and safety national government expenditure on public order and safety as a percentage of gross product product housing national government expenditure on housing as a percentage of gross domestic product deficit expenditure greater than revenue as a percentage of gross domestic product source: south african reserve bank (http://www.reservebank.co.za) sajems ns vol 2 (1999) no 2 258 the evaluation of client service provided by the human resource division of a national service organisation h e brand and n joubert department of human resource management. university of pretoria jel m 12 abstract the aim of this study is to evaluate the quality of internal client service of the human resource division of a national service organisation. two studies were in fact conducted, one involving 388 clients of the relevant division, and the other 99 human resource practitioners in the same division. separate questionnaires were completed in the two samples. results show that communication with clients, service provision and quality and competency of the human resource personnel are important problems to be addressed by management. the implementation of an achievement acknowledgement system, the re-evaluation of the divisional structure and functioning, and upgrading service provision skills could also assist the division in improving its client service competency. south african business organisations today increasingly experience the pressure of national and international competition, as well as the extremely important role of effective and outstanding client service in this process. these realities force organisations again to realise the basic fact that the difference between success and failure largely depends on the quality of client service provided by employees and management (band, 1991). client service excellence forms an integral part of the rapidly changing and quality conscious competing markets (cottle, 1990). it is also realised that quality service depends not only on modern technology, but especially on the attitudes and abilities of people. perceptions of service are the result of certain expectations and experiences of the service provided (friedmann, 1998). clients' expectations influence their evaluation of service quality, which implies that the services rendered should adequately meet client requisites (brennan, 1997). employees and the various sectors of an organisation are also increasingly becoming dependent on internal service providers for delivering their own services efficiently and reaching their objectives. research by schneider of the university r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 259 sajems ns vol 2 (1999) no 2 of maryland in the early 1980s already showed an important relation between the external and internal client satisfaction of different departments in various organisations, indicating that the quality of internal client service can clearly promote or damage the external client service of an organisation (hoffman, 1997). according to chang, kelly and irvine (i994), it appears that the internal and external clients of organisations have comparable experiences with service providers. internal clients, however, do not often have much of a choice in utilising alternative services and products, and are largely dependent on the services of internal service providers. this situation is, however changing rapidly, as organisations are increasingly beginning to outsource the traditional services of internal service providers, such as information technology, marketing, communication management and human resources. thus the pressure is on all service and support sectors in the corporate environment to effectively assess the value and quality of their services to their internal clients, utilising the results of such investigations to promote outstanding client service, comparable to the services rendered to external clients of the company. the quality of internal client service today often determine the difference between keeping or outsourcing internal service functions in business organisations. within the framework of the above-mentioned corporate realities, the human resource division of the specific national service organisation discussed here. also had to urgently evaluate its quality of internal client service, which lead to the planning and execution of this study. the primary objective of the study was to evaluate the internal client service provided by this division. other objectives were to evaluate the satisfaction of the division's personnel with their service provision, as well as to determine the obstacles in the way of effective service provision. the philosophy of this division regarding its own objective in the organisation may be best described by the foljowing statement by band (1991: 272) : " .... viewing employees as internal customers, viewing jobs as internal products, and then endeavouring to offer internal products and services to satisfy the needs and wants of these internal customers while addressing the objectives of the organisation ". in the present study, the following three pairs of hypotheses were formulated and tested: ho: the client service rendered by the human resource division of the organisation is perceived as wlsatisfactory by its internal clients. hi: the client service rendered by the human resource division of the organisation is perceived as satisfactory by its internal clients. hu : the practitioners employed in the hwnan resource division of the organisation do not perceive their client service as satisfactory. h2: the practitioners employed in the human resource division of the organisation perceive their client service as satisfactory. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 ( 1999) no 2 260 ht,: the practitioners employed in the human resource division of the organisation did not identify any obstacles to ettective client service provided by the division. h3: the practitioners employed in the human resource division of the organisation did identify obstacles to effective client service provided by the division. research method the research method followed in this study are discussed under the headings of research strategy, research group, sample, response rate and data analysis. research strategy the survey method in this study to detennine the factors influencing the provision of internal client service of the human resource division, was to use two questionnaires as measuring instruments. one of these questionnaires was applied to internal clients of the division in the organisation (referred to as the client study), while the other questionnaire, consisting of two sections, was applied to human resource practitioners employed in the human resource division (referred to as the practitioner study). the questionnaires were distributed together with an information brochure indicating the motivation and characteristics of the study, as well as the relevant instructions. it was also clearly indicated that the study was conducted with the approval and support of the top management of the organ isation. the following are the particulars of the two questionnaires: the client study: a 32-item questionnaire was used in this part of the study. the critical dimensions of the client service model of piorier & houser (1993) was used in the construction of the instrument. the questionnaire was tested for reliability, obtaining a cronbach's alpha of 0,70. the seven dimensions evaluated by the model are the following: accessibility (of division personnel) technical skills/competencies (of the personnel) attitude and climate (of personnel and the division respectively) communication credibility (of the personnel) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 261 sajems ns vol 2 (1999) no 2 quality of services and structure efficiency (of personnel and the division) speed of service provision the practitioner study: a 75-item questionnaire, consisting of two sections, a and 8, was constructed by utilising two questionnaires, namely: section a : the "self test on the service capabilities package" of whiteley (1991), for the evaluation of the satisfaction level ofthe human resource division personnel. the seven evaluation dimensions contained in this questionnaire are the following: vision, commitment and climate (of the division) focus on client needs readiness to anticipate and solve client problems use and communication of client information reaching out to clients capability and capacity continuous improvement of products and services section b: the "team review survey" of francis & young (1992) was used for the evaluation of obstacles of effective service provision to internal clients of the division. the twelve evaluation dimensions here are : insufficient leadership unqualified leadership insufficient group involvement non constructive climate low goal achievement orientation under-cieveloped corporative role ineffective work methods insufficient role clarity ineffective handling of criticism insufficient individual development lack of creative capacity negative inter group relations as regards reliability, the questionnaire of whiteley (1991), indicated a cronbach's coefficient alpha of 0,71, while the questionnaire of francis & young (1992) had a reported alpha coefficient of 0,85. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 262 research group the research group was divided into two parts. one consisted out of all the internal clients of the human resource division in the particular service organisation, numbering a total of 2277 subjects. the other comprised all human resource practitioners employed in the human resource division, a total of 99 subjects. sample for the client study, 719 internal clients were selected on a stratified, randomised basis from the total target population of 2277 subjects. the stratitication was done according to place of work/geographical area and job grading (according to the paterson grading system). for the practitioner study, a convenience sample was utilised, including all practitioners employed in the human resource division. response rate a response rate of 54 % (n= 388) was obtained for the internal client sample, while a rate of66 % (n= 66) was obtained for the practitioner sample. data analysis the data derived from these questionnaires were analysed by means of the descriptive statistics of the spss-windows computer programme. the arithmetic mean of the various dimensions was used together with the various industrial norms of the questionnaires to determine the problematic dimensions in the process of internal client service by the human resource division of the organisation. results of the study the client study: as mentioned above, this section of the study focused on all internal clients of the human resource division, for example, corporative sections such as finance, marketing, engineering, commerce and information. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 263 sajems ns vol 2 (1999) no 2 the results obtained from the client study are shown in table 1. table 1: results of the internal client study dimension mean norm(n) & jdeal(j) accessibility 60,71 n:68% 1:77 competency 63,91 n:72% 1:77 attitude and climate 70,90 n:68% 1:77 communication 57,69 n:59% 1:77 credibility 62,92 n:67% 1:77 • services and structure 61,35 n:68% 1:77 • service provision speed 59,49 n:59% 1:77 according to table i, the following six dimensions, in order of priority, seemingly do not measure up to the expectations of internal clients of the human resource division: communication with clients availability of personnel of the human resource division structure effectivity and service function of the division credibility of personnel competency of personnel attitude of personnel and general service provision climate only the dimension attitude and climate proved to be somewhat above the industrial norm, but still far below the ideal norm. thus the null hypothesis relating to this part of the study is supported and the alternative hypothesis rejected. the practitioner study: as indicated above, this section of the study consists out of two sections, namely: section a: evaluation of the perceptions by personnel of the human resource division concerning their service provision to internal clients. section b: the identification of obstacles to effective service provision by personnel of the division. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 264 the results obtained for section a are shown in table 2. table 2: section a : evaluation of client service of division personnel by tbe personnel tbemselves dimension mean industrial ideal norm i vision, connectedness 64,50 62·68 75 + and climate focus on client needs 57,27 62·68 75 + readiness to anticipate 43,18 62 68 75+ and solve client problems use and 46,54 62·68 75 + communication of cl ient information reaching out to clients 72,35 62 68 75+ capability and 35,71 62 68 75+ capacity ! continuous 41,67 62 -68 75+ improvement of products and services table 2 indicates that the personnel of the human resource division evaluate the following important client service dimensions, in order of importance, as unsatisfactory: the capability and capacity to provide for the needs of internal clients the continuous improvement of products and services readiness to anticipate and solve client problems the division's perception of its client service indicated only two of seven dimensions of service quality to be above the industrial norm, namely reaching out to clients and the vision, commitment and climate of the division. no dimension indicated a performance higher than or even near to the ideal (75%) of an outstanding service division. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 265 sajems ns vol2 (1999) no 2 thus the null hypothesis relating to this part of the study is supported and the alternative hypothesis rejected. the results obtained for section b are shown in table 3. table 3 : section b : evaluation of obstacles to effedive service provision by the human resource division dimension mean industrial ideal norm insuft1cient leadership 25,76 45 49 20 unqualified leadership 23,11 45 49 20 • insuft1cient group 19,32 45 49 20 involvement non-constructive 42,05 45 -49 20 climate low goal achievement 20,46 4s 49 20 orientation under-developed 21,59 45 49 20 corporative role inetfective work 29,54 45 49 20 methods insuft1cient role clarity 28,03 45 49 20 inettective handling of 31,06 45 49 20 criticism insuft1cient individual 25,00 45 49 20 development lack of creative 18,56 45 49 20 capacity negative inter-group 21,21 45 49 20 relations table 3 indicates that the personnel employed in the human resource division apparently identified, in order of importance, the following serious obstacles to effective client service provision by the division: r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 a non-constructive climate in the division ineffective handling of criticism ineffective work methods 266 thus the null hypothesis relating to this part of the study is supported and the alternative hypothesis rejected. when comparing the important negative results of section a (selftest) and section b (obstacles), the following tendencies, set out in table 4, are evident: table 4: comparison of dimensions in section a (selftest) and section b (obstacles) section a : self test section b : obstacles i. capability and capacity to meet a. non-constructive division the needs of clients climate (connection with a & 3) (connection with i & 3) 2. continuous improvement of b. ineffective handling of criticism products and services (connection with 1 ,2,3,a & c) (connection with c & 3) c. ineffective work methods 3. readiness to anticipate and (connection with a,b,2 & 3) solve client problems (connection with c & 1) according to table 4, the various negatively evaluated dimensions in sections a and b indicate an inter-dependent pattern. this tendency should be seriously taken into consideration when planning interventions or steps to improve these aspects of client service provision. conclusions and recommendations the results of the study indicate that internal clients' evaluation of the client service provided by the human resource division of the relevant national service organisation, identified some important problems that should be addressed. these were communication with clients, availability, credibility, competency and attitude of personnel in the human resource division, the structure effectivity and service function of the division, as well as the general service provision climate. these findings support those of friedmann (1998) that client service is strongly influenced by the attitudes and abilities of service providers, and that perceptions of service relate to expectations and experiences of service provision. this also r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 267 sajems ns vol 2 (1999) no 2 relates to the findings of brennan (1997) that client expectations influence their experience of client service. personnel of the human resource division also identified some internal aspects that should receive attention in order to improve client service. the following perceptions emerged as being unsatisfactory : capability and capacity to provide effective service, lack of improvement of goods and services, and inability to anticipate and solve client problems. the human resource practitioners further identified a non~constructive climate in the division, ineffective handling of criticism and poor work methods as major hindrances. the problematic dimensions identified in the various sections of the study (internal clients, division self~test and division obstacles) also show a high degree of concurrence. this tendency will probably make it easier to focus on the improvement of the dimensions which require urgent attention. the following recommendations for improving the client service of the human resource division are suggested: a thorough management presentation of the results of the study to the personnel of the division. all personnel should participate in the process of discussion and deliberation of the results, as well as in any decision-making relating to client service improvement strategies. results of the study should be presented to all internal clients of the division, accompanied with information on all actions and interventions to improve service provision. the primary focus should be on the solution of service provision problems in the division itself, as indicated by the results of the practitioner study. an effective communication strategy for internal clients is very important in order to promote the division and its goods and services. an evaluation of the structure and functioning of the division. special emphasis should be placed on the availability of efficient personnel to effectively cater for the diverse needs and expectations of internal clients. the implementation of an achievement acknowledgement system for personnel of the division should be considered, through which internal clients, for example, can also recommend division personnel for acknowledgement of noteworthy achievements. the technical and other skills and capabilities of personnel with regard to the provision of client service excellence should be evaluated and promoted. the credibility of the division and its functions should be confirmed and expanded. for this purpose the professional and ethical standards of the division should be determined and put into effect. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 268 references 1. band, a.w. (1991) creating value for customers: designing and implementing a total corporate strategy, new york: j. whitley & sons. 2. brennan, c.d. (1997) proactive customer service: transforming your customer service department into a profit centre, new york: amacom. 3. chang, r.y., kelly, pk & irvine, c.a. (! 994) satisfying internal customers first, irvine & chang associates. 4. cotile, d.w. (1990) client centred service: how to keep them coming backfor more, new york: wiley. 5. francis, d. & young, d. (1992) improving work groups: a practical manual for team building, amsterdam: pheiffer & company. 6. friedmann, n. (1998) customer service nightmares: /00 tales of the worst experiences, los altos, california: crisp publications. 7. hoffman, k.d. (1997) essentials of service marketing, new york: harcourt brace college publishers. 8. piorier, j. & houser, d. (1993) business partnering for continuous improvement, san diego: pheiffer & company. 9. whitely, r.c. (1991) the customer driven company, boston: addison company. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction literature study methodology and data results and discussion conclusion acknowledgements references footnotes about the author(s) francois liebenberg department of risk management, school of economics, north-west university, south africa gary van vuuren department of risk management, school of economics, north-west university, south africa andre heymans department of risk management, school of economics, north-west university, south africa citation liebenberg, f., van vuuren, g. & heymans a., 2017, ‘contingent convertible bonds as countercyclical capital measures’, south african journal of economic and management sciences 20(1), a1600. https://doi.org/10.4102/sajems.v20i1.1600 original research contingent convertible bonds as countercyclical capital measures francois liebenberg, gary van vuuren, andre heymans received: 18 may 2016; accepted: 13 jan. 2017; published: 15 june 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the procyclical nature of capital models under the basel ii accord has been widely criticised for exacerbating lending in economic expansions and restricting lending during economic contractions. these criticisms have led regulators to employ countercyclical measures in subsequent basel accords. one of these measures, the countercyclical capital buffer (ccb), has been proposed as an effective countercyclical measure in expansionary periods as a deterrent to excessive lending through increased bank capital requirements. aim: the effectiveness of the ccb during contractions is not obvious. contingent convertible (coco) bonds – which are bond-like until triggered by a deterioration of a prescribed capital metric, at which point they convert into a form of equity – are explored as a supplementary countercyclical capital measure for such periods to establish whether or not they function effectively. setting: the analysis is undertaken using global bank coco data, and then applied to south african banks. methods: the hodrick prescott filter was applied to empirical historical data. results: the ccb functions as a good countercyclical capital measure in times of economic expansion by absorbing losses and stabilising the capital base through equity issuance. conclusion: the issuance of coco bonds – if their trigger mechanisms are designed correctly – may prove helpful to banks and the broader financial sector in times of economic contraction through the countercyclical capital properties that manifest through coco bonds under these economic conditions. introduction the credit crisis which disrupted the global economy in the latter part of 2007 had its roots nested in complex financial instruments (particularly derivative instruments), which inflated asset prices to levels that were far higher than their historic trends. these instruments behaved in complex ways and were riskier than believed at the time (baily, litan & johnson 2008). the risk mitigation techniques that were consequently employed were ineffective, leading to the large-scale collapse of the global financial system once these hidden risks materialised (g20 2009). the first internationally recognised company to fall victim to the crisis was the american bank lehman brothers which filed for a chapter 11 bankruptcy on 15 september 2008 (de haas & van horen 2012). the systemic contagion precipitated by lehman’s collapse became manifest in a conservative view of lending, including the widespread avoidance of securitised products and the severe reduction of credit (both consumer and commercial). these effects were largely because of the procyclical nature of capital requirements at the time (nikolov 2010). if an economic indicator thus increases when the economy exhibits economic growth, it is deemed a procyclical indicator and is used as a metric to measure procyclicality. credit losses suffered by banks during the credit crisis were higher than those experienced during economic expansions, evidence that the inherent procyclical nature of risk management models may amplify losses during economic downturns (bcbs 2010b; van vuuren 2012). heid (2003) described the exacerbation of bank losses in economic downturns as diminished lending capacities accompanied by increases in risk-weighted assets (rwas), a combination that significantly reduces a bank’s capital ratios.1 this effectively portrays the inherent procyclicality of capital measures under basel ii (bcbs 2010b). the effect of the procyclicality in the broader economic environment meant that the majority of banks also suffered under the economic environment that the reaction created, especially in terms of lending, and this placed pressure on the other parts of economies globally as bank lending dried up in the economic downturn (de haas & van horen 2012). following on the heels of the credit crisis, the european sovereign solvency crisis occurred in 2010. the european union initiated fiscal relief (a sovereign bailout for greece) indicating that capital levels were insufficient (sorkin 2010). south africa absorbed the effects of the crisis relatively well compared with other developing economy peers, due in large part to prudent risk management (maredza & ikhide 2013). the robustness of the south african economy is evident in the fact that all south african banks survived the crisis while many global banks required sovereign bailouts (national treasury 2011). despite these prudent risk management policies, the country still slid into the first recession in 17 years in 2009 (sarb 2011a). in response to the credit crisis and the liquidity crisis that ensued because of diminished capital, the bank for international settlements (bis) implemented a number of amendments to the then-existing basel ii accord with an updated set of regulations, called basel iii (bcbs 2011). the phased implementation of the new basel iii regulation began in 2013 and is at this stage (2016) expected to be fully implemented by 2019. the principal aim of basel iii is for better quality, consistency and transparency of tier 1 capital (bcbs 2010a), but it also introduces measures that increase the robustness of banking legislation including a reconstitution of the composition of acceptable regulatory capital, enhanced capital levels for aspects of the trading book and the introduction of new concepts such as the leverage ratio and a number of capital buffers, which increase the capital ratio from 8.0% to 10.5% (and, under certain specified conditions, to 13%) (bcbs 2011). a specific inclusion of basel iii – the countercyclical capital buffer (ccb) – is the proposed countercyclical capital measure, which can increase the capital ratio to 13.0%. the ccb works principally at the peak of an economic cycle – that is, it is effective at reducing excessive credit extension, but it is yet to be tested in real-world scenarios and as such it may not be as effective at releasing capital back into the economy (i.e. it may not effectively encourage lending in economic cycle troughs), hence the potential need for additional countercyclical measures. one such countercyclical measure is contingent convertible (coco) bonds, which converts into common equity in severely stressed economic conditions.2 cocos are thus effective loss-absorbing financial instruments that function as a mechanism for bank recapitalisation in times of economic stress (de spiegeleer & schoutens 2011) and have been proposed for use in banks (pennacchi, vermaelen & wolff 2011) as loss-absorbing instruments. despite these useful characteristics, these bonds have been overlooked as a source of countercyclical capital, and as such cocos are the main focus of this paper. the paper proceeds as follows: the ‘literature study’ section ‘interrogates the literature regarding economic procyclicality, its origins and implications on a global scale as well as in the south african market’. the bcbs’s choice of procyclical measure, the ccb, is further explored as a countercyclical capital measure in times of economic expansion. cocos are also discussed as a countercyclical capital measure with a particular focus on the behaviour of cocos upon conversion in economic contractions. coco properties (such as trigger mechanisms and conversion details) are discussed as well as specific examples currently (2016) in issue. the ‘methodology and data’ section introduces and discusses the hodrick–prescott (hp) filter, assesses its relevance and applicability to financial data and points out the pros and cons of its use and also explores the equity derivative pricing model of cocos. the hp filter is then applied to historical south african data to identify economic downturns and establish capital levels required had the ccb been implemented at those times. a simulation of coco triggers in the 2007 financial crisis is produced along with the resulted increase in common equity tier 1 (cet1) capital of the four main south african banks because of the conversions. the results of the calculations are analysed and presented in the ‘results and discussion’ section. the last section is the ‘conclusions’. literature study procyclicality the complex nature of financial market securities resulted in a severe test for risk managers as well as the basel ii accord during the 2007 credit crisis (merrouche & nier 2010). a leading catalyst of the credit crisis was the chapter 11 bankruptcy filing of lehman brothers. the procyclical nature of capital requirements at the time resulted in the considerable reduction of bank lending. the associated capital reduction and contagion effects left banks without the means to raise additional capital, and governments, regulators, central banks and quantitative models at the core of risk management were blamed for the crisis (us financial crisis inquiry commission 2010). south african banks proved to be resilient in the financial crisis largely because of two factors. firstly, the credit crisis erupted as a result of the securitisation of sub-prime mortgages (peicuti 2013). these securities were sold to investors with the assurance of accurate ratings from global credit rating agencies. banks in south africa were not able to purchase these grouped loans because of tight banking regulations, and the implementation of the national credit act no. 34 of 2005 (nca) (maredza & ikhide 2013). the nca introduced prudent financial legislation shortly before the crisis (gauteng provincial treasury 2012). south africa has, as a result, not yet experienced a full financial crisis, but rather periods of financial distress. secondly, the resilience of south african banks is linked directly to sound profitability, low leverage ratios, limited exposure to foreign assets and foreign funding as well as adequate levels of capital in times of crisis (maredza & ikhide 2013). in a period where many banks were declared bankrupt globally, all south african banks survived. this earned the south african banking system the reputation for being well developed, well-regulated and sophisticated and therefore ranked among those of first-world economies despite the fact that south africa is viewed as a developing economy (national treasury 2011). in response to the financial crisis, south africa also employed various monetary policies including an increase in government expenditure of r127bn and a r34bn decrease in tax revenue. this, along unprofitable public companies like eskom, led to the government funding needs increasing to r285bn in 2009, from r89bn in 2008. because of the recession, the government saw its budget balance fall from a 0.7% surplus in 2007 to a 5% deficit by 2009. economic growth recovered to 3.1% in 2010 and prudent fiscal management reduced the government deficit to 4.8% (gauteng provincial treasury 2012). despite this resilience though, the industry-wide recognition of the impact of procyclicality prompted a call for measures to change the procyclical nature prevalent in risk models (financial service authority 2009). this in turn highlighted the danger of procyclicality and demands a reformed risk measure to be engineered, which is inherently countercyclical, thus providing a thicker capital buffer during good times that could be drawn down during crises. heid (2003) argues that in economic downturns as maximum lending capacities decrease alongside a rise in rwas, a shortage in capital arises. two outputs from risk management models cause this. if assets are perceived to become riskier and this is correlated with business cycles, capital charges suffer large swings, consequently leading to increased volatility in not only the asset prices but also the linked interest rates. consequently, this increase in financial sector volatility would naturally spill over into the rest of the economy. perceived increases in credit risk trigger an increase in banks’ credit risk capital, leading to increased cost of money in the economy, which is positively correlated with a decrease in investment ultimately causing a further systemic stunt to economic expansion. these combined effects explain the inherent procyclicality of capital measures under basel ii and highlight the need for countercyclical capital measures in the regulatory environment. the procyclicality in the economic environment during the 2007 financial crisis meant that most banks struggled to obtain liquid funds for their lending purposes, and this placed pressure on the other parts of economies globally (de haas & van horen 2012). the procyclical nature inherent to the internal ratings–based methodology prescribed in basel ii may potentially be alleviated by using a through-the-cycle (ttc) rating system in financial models. this rating system may decrease the reaction of a lending party’s probabilities of default (pds) to macroeconomic conditions and as such dampen the effect that this has in the calculation of rwas in the capital ratio of a bank (catarineu-rabell, jackson & tsomocos 2003). the study by catarineu-rabell et al. (2003) found that the ttc method would not reduce procyclicality, and as such, their conclusion was that basel ii regulation is ineffective at combating the procyclical nature of lending in times of financial distress. repullo and suarez (2008) and repullo and saurina (2011) employed an ‘endogenous, dynamic capital-structure model under the assumption that banks have limited access to capital markets in stressed periods’, as was the case in the 2007 credit crisis. they found that basel ii encouraged capital buffers to be procyclical in nature. the results from the study also showed that the buffers suggested in times of economic growth would be unable to mitigate the heightened requirements during economic contractions. these effects would in turn also cause a vast reduction in the supply of credit leading to knock-on effects resulting in systemic failure of capital markets as capital dries up. various counteractive measures were subsequently employed by the bis as an addition to, but not replacement of, basel ii rules to supplement existing risk management regulation and address its procyclical flaws. these measures were introduced by the basel iii accord as part of their principal aim of better quality, consistency and transparency of tier 1 capital (bcbs 2010a; sundaresan & wang 2011). the ccb, introduced by basel iii, aims to reduce bank capital procyclicality by increasing capital requirements in favourable economic conditions (bcbs 2010b). ccbs were thus proposed as a measure that would assist in protecting the financial system from systemic risk because of periods of increased credit growth (bis 2009). the ccb is not a regulatory minimum capital requirement under traditional regulation, but ‘rather unencumbered capital more than the normal minimum requirement of the regulation’. this is to ensure ‘that this capital will be available to absorb losses in times of economic contraction’. building up this buffer capital is thus a countercyclical measure designed to strengthen the individual bank’s treasury, and cumulatively the banks of the entire financial system. it is specifically designed to combat risks that accumulate during economic expansions and is only imposed when the economy is perceived to be ‘overheating’ (bcbs 2010b). the countercyclical capital buffer the initial (2013) minimum capital requirement for banks under the basel iii regulation was 8% of the total rwas of the bank of which 4.5% must be cet1 high-quality capital. basel iii also requires that banks maintain a ccb of 2.5% of rwa above the 8% regulatory minimum capital requirement, which must comprise entirely of cet1 capital. this additional capital brings the total required capital amount to 10.5% and implies a confidence level of 99.97%, instead of the 99.90% employed by the previous total minimum requirement of 8% as shown in figure 1 (bcbs 2011). should a bank fail to sustain this level of capital (10.5%), it will be penalised by the regulator. the distribution of bank earnings will thus be reined in to ensure that buffers accumulate before profits are redistributed, causing negative sentiment among shareholders. lastly, a ccb of up to 2.5% of rwa is imposed, also consisting solely of cet1 capital, should national authorities detect an increase in system-wide risk associated with a specific metric measuring normalised excess aggregate credit growth. this is done to further bolster the banks during economically good times to assist in the rainy days when the economy turns for the worse (bcbs 2010b). figure 1: the strengthening of the banking sector because of the capital conservation buffer. the ccb is designed to be deployed on an infrequent basis as the trigger is correlated with aggregate credit growth. consider table 1 as an indication of the minimum capital conservation ratios (ccrs) that would be enforced upon banks for respective levels of cet1 capital ratios. to explain these ratios, consider a bank with a cet1 capital ratio of between 5.750% and 6.375%. this bank would be required to conserve at least 60% of its earnings in the next financial year (i.e. pay out no more than 40% in terms of share buybacks, dividends and discretionary bonus payments) to the detriment of current shareholders and investors. furthermore, should the bank’s cet1 ratio fall below 5.125%, no dividend distribution would be permitted. conversely, if the bank maintained a cet1 ratio of > 7%, there would be no impediments on dividend distribution. the ccrs, which a bank is required to keep under the conditional failure to meet the minimum cet1 ratios, is illustrated in table 2 and figure 2. figure 2: proposed basel iii countercyclical rules. table 1: proposed basel iii countercyclical rules implemented in south africa in 2014. table 2: proposed basel iii countercyclical rules. figure 3: the basel iii procyclical capital rules for various credit growth/gdp gap levels. for regulators to impose the ccb, the economic cycle of a market must first be expressed using an accurate metric that measures the financial cycle. potential measures of aggregate output and credit growth were explored and found to be the best fit when measuring the state of the financial cycle (saurina & trucharte 2007).3 the herding behaviour exhibited by the collective banking sector has a substantial influence on aggregate macro-indicators, depending on the sectoral market share of the banks in the economy. thus, individual banks will need to bolster their capital if the ccb measures are imposed even though they may not be directly responsible for the excessive credit in the market. this does offer the advantage that the ccb metric is to some extent resilient to external manipulation by individual banks (saurina & trucharte 2007). the measure proposed by basel iii regulation is the deviation from: the long-run trend of the aggregate credit-to-real gross domestic product (gdp) growth ratio (further referred to in this document as the ‘credit-to-gdp ratio’ and the difference between this ratio and the long-run trend referred to as the ‘credit-to-gdp gap’. (bcbs 2010b:9) the hp filter is used to fit the long-run trend. table 2 summarises the proposed basel iii countercyclicality capital rules. the bcbs are proponents of this measure as a mechanism that could solve the problem of an economy expanding in an uncontrolled fashion and has also substantiated these claims through empirical application to financial metrics in developed economies such as the united states and united kingdom (bcbs 2010b). this is as yet inconclusive because historic analysis is not a guarantee of future accuracy and also when regulations are applied to smaller, less developed economies (such as south africa), the model and data face considerably different assumptions and reactions (van vuuren 2012). in terms of the ccb, south africa’s banks are in the process of migrating to basel iii compliance and are geared to implement proposed solutions that basel ii offers to combat procyclicality (bis 2013; pwc 2015). procyclicality does not affect an economy solely in times of economic expansion, but also in times of economic distress via the dearth of capital in the banking system. the effects of procyclicality, however, need to be dealt with in times of crisis, that is, when the economy is contracting and as such banks may need another measure in addition to the ccb. coco bonds have been proposed as a loss-absorbing capital instrument for use as tier 1 capital by banks. we propose that cocos may prove to be useful as countercyclical capital measures in times of economic distress. contingent convertible bonds contingent convertibles are securities consisting of both an underlying equity and also a fixed-income component. these bonds are known to absorb losses by converting into common equity when certain conditions – usually heightened systemic risk – become prevalent (bcbs 2010a). cocos and convertible bonds share many traits, with a few fundamental differences. as an example, a callable and convertible bond may be called upon to convert into a predefined number of the common shares of the issuing bank at the bondholder’s decision. this bond is also callable by the issuer, that is, the bondholder may be required to surrender the bond to the issuing entity for a predetermined price if the issuer exercises their call option (huang 2009). thus, both the bondholder and/or the issuer of the security can determine when the contractual agreement of the bond will cease. convertible bonds offer higher yields than standard non-convertible bonds because of the uncertainty associated with the bond’s conversion attribute. income-only investors may also have mandates to invest solely in financial instruments that generate interest or coupon payments. convertible bonds have the property of potentially converting to equity and, in most cases, this risk will prevent such income-only investors from investing in convertible bonds, when the yields offered are greater than that of standard bonds (huang 2009). contingent convertibles had a discreet launch into the financial world when the lloyds banking group offered the holders of some of its hybrid debt a swap where their bonds will be traded for coco bonds, which had a possible conversion clause to convert into shares in november 2009 (de spiegeleer & schoutens 2011). credit suisse soon followed, raising $2bn in new capital using this new asset class. the coco market today, however, paints a totally different picture with usd98bn in cocos in circulation until the end of 2015 as illustrated in figure 4. cocos in issuance paid an average coupon of 6.6% at the start of 2016, roughly double the interest payment on senior bank bonds making them attractive to investors (bloomberg 2016). figure 4: total global contingent convertibles issuance (to end 2015). contingent convertibles have an array of appealing properties from the point of the investor and the issuing bank. firstly, cocos have loss-absorbing properties, bolstering a bank’s capital when the bank suffers under economically stressed conditions and it is hard for the bank to issue new equity affording cocos a countercyclical property in times of economic distress. by automatically restructuring the capital of a bank, cocos reduce the ‘debt overhang’ problem, that is, the failure of a bank to timeously acquire funds to finance additional loans because a portion of their return accrues to existing debt holders (chen et al. 2013).4 it is this property of cocos that would have rescued many banks during the financial crisis when they were required to issue new equity (atik 2010; prescott 2012). second, cocos automatically restructure the capital of a bank before bankruptcy, while the bank is still viewed as being a ‘going concern’ as opposed to a ‘gone concern’, thereby mitigating the probability of the bank suffering bankruptcy. the lehman brothers case provides a concrete example of the impact of perception in guiding the financial market decisions: knowledge of pre-bankruptcy reorganisation of financial institutions (especially a systemically important one) is valuable. lastly, if a coco bond is properly structured, regulators, both the issuing banks and the bondholders can potentially benefit from a coco conversion scenario, as opposed to a single entity taking a loss as the bank may receive additional capital, the existing shareholders making a profit and the bond holder receiving a repayment on the par value of the bond (goodhart & taylor 2006; pennacchi et al. 2011:16). contingent convertibles also have a variety of conversion mechanisms in addition to equity including cash, or in some instances, a write-down on the bond (either partially or completely) may occur. investor should take care when assuming that returns from a callable convertible bond and a coco are comparable. the potential for profit of a coco may be limited when compared to a standard convertible bond, depending on the underlying terms, and the full downside may come into play for an investor once the bond is converted to shares (de spiegeleer & schoutens 2011:8). one of the main differences between the bonds is the composition of the trigger mechanism inherent in the coco, an event that must occur in order for the coco bond to be converted into the loss absorption mechanism. the trigger is specified in the prospectus of the coco and defines the scenario where banks will most likely suffer under financial pressure (de spiegeleer & schoutens 2011). initial studies by flannery (2005) suggest that a single-trigger mechanism be used. later studies, however, have suggested the use of more triggers, with cocos becoming an increasingly important topic after the financial crisis (see flannery 2005; huertas 2009; albul, jaffee & tchistyi 2010; mcdonald 2011; pennacchi 2011; pennacchi et al. 2011; plosser 2010). in the case of a coco with more than one trigger, the loss conversion to equity (or write-down) will occur when any or a combination of triggers are breached. triggers are either modelled on a mechanical rule or on the authority that may be executed by regulators. in the former case, also known as book value triggers or accounting-value triggers, the trigger mechanism is typically set contractually as the ratio of cet1 to rwas, the cet1/rwa ratio. the loss absorption mechanism is activated should the cet1/rwa ratio of the issuing bank fall below a level which was predefined with the coco issuance. in order for a bank to remain a going concern, the trigger mechanism of a coco must come into effect before the bank is in trouble regarding its capital.5 the lloyds banking group issued a coco in 2009, which illustrates this very nicely.6 the coco referred to has a 15% semi-annual coupon rate tied to the bond, with a conversion price of £0.59 per share, should the cet1 ratio of the bank fall below 5%. under basel iii, the minimum cet1/rwa ratio for a coco to qualify as additional tier 1 capital (capital which is tier 1, but not cet1 capital) is 5.125%. since 2011, issuing banks have set their trigger at that level or at 7% as is illustrated in table 3. this is most likely because of the phasing-in of capital rules by the regulators in the various markets with the triggers set at ‘current’ or ‘fully loaded’ levels (bcbs 2012). table 3: contingent convertibles in issuance in europe and asia with additional information pertaining to their trigger mechanisms and yields. the overwhelming majority of cocos currently in issuance rely on book value triggers. however, this mechanism has received criticism for being a reactive measure of capital issues and depends on the frequency that banks publish their financial results, thereby raising questions as to internal risk model comparisons (culp 2009; flannery 2005). the reporting delay may cause book value triggers to be activated slower than the rate at which capital is required. the trigger mechanism is also difficult for investors to model as the fundamental information comprising the capital calculation differs widely between banks. history has proven this concern as prominent global banks reported regulatory capital well above the minimum level of 8% when they went bankrupt in the financial crisis (de spiegeleer & schoutens 2011). figure 5 illustrates the cet1 capital levels and the corresponding yields of banks who have issued cocos with the trend generally showing that investors are rewarded with a higher yield as the cet1 capital levels decrease. figure 5: contingent convertible common equity tier 1 ratios and associated additional tier 1 yield. the ideal trigger to use may thus be market-value triggers as these triggers address the shortcoming of inconsistent accounting valuations (calomiris & herring 2012; pennacchi et al. 2011; sundaresen & wang 2011). if these trigger-types are priced and composed correctly, the coco will convert to the triggered asset class at a given ratio of the bank’s stock market capitalisation and/or credit default swap spread to its assets (flannery 2005). such a composition reduces the risk of balance sheet manipulation and may also (hopefully) prevent regulatory forbearance (avdjiev, kartasheva & bogdanova 2013). market-value triggers, however, may prove to be difficult to price, could suffer from stock price manipulation and have the potential to exhibit multiple equilibria problems (pennacchi et al. 2011; sundaresen & wang 2011). the last trigger type, discretionary triggers (also referred to as point of non-viability, point of non-viability [ponv] triggers), will activate when regulators deem that it is appropriate to do so (albul et al. 2010). these cocos will allow a predefined regulator (usually a central bank) the power to trigger the conversion mechanism of the said coco if and when they view the action as necessary to save the bank. ponv triggers may offer a solution to the time-lag factor of book value triggers. the problem with a regulator causing a trigger is that the market could perceive this to be a blow to the financial stability of the issuing institution. methodology and data hodrick–prescott filter the long-run trend of the gdp is used to determine the credit-to-gdp gap of an economy. the best method to derive this trend is the hp filter (cogley & nason 1995; ley 2006). the hp filter dates to 1980 (hodrick & prescott 1980) as ‘a metric to measure business cycles’; however, the academic research was only published in 1997 long after the filter was used globally by practitioners of macroeconomics (hodrick & prescott 1997). thus, the hp filter was the logical choice for the bcbs to detrend relevant macroeconomic ratio data to produce ‘the information required to assess excessive growth in economies’ (van vuuren 2012). the hp filter ‘has been criticised academically for various limitations and inadequate properties’ (yakhim 2001; ravn & uhlig 2002; van vuuren 2012). canova (1994, 1998) was a proponent of using the hp filter in estimating business cycles from macroeconomic data where the duration of the trend was between 4 and 6 years, and also had many concerns around the methodology’s capability of determining certain key parameter inputs. a series of spurious cycles and distorted estimates of the cyclical component were found by harvey and jaeger (1993) when using the hp filter. the authors argued that this property may lead to misleading conclusions specifically pertaining to the relationship between short-term movements in macroeconomic time series data. the measures of persistence, variability and co-movement were found to be changed dramatically when the hp filter was applied to us time series data (king & rebelo 1993). economists have continued to use the hp filter to detrend data, which indicate short-term fluctuations when they are superimposed on business cycle-like trends (ravn & uhlig 2002). ‘the premise on which the hp filter based is that an observable macroeconomic time series (xt) may be decomposed into its long-run, non-stationary secular trend (τt) and a stationary residual, or cyclical, component (ct)’ (van vuuren 2012): both the long-run trend and the cycle are impossible to observe directly so these elements are defined somewhat arbitrarily in detrending approaches. equation 2 indicates how the hp filter extracts the cycle through a standard-penalty programme: where the parameter λ controls the smoothness of the adjusted trend series τt, that is, as λ → 0, the trend estimates the actual series, xt, while as λ → ∞ the trend becomes linear and the procedure converges to a standard least squares solution. the optimisation procedure in equation 1 maximises the fit to the trend of the series, that is, minimise the cycle component ct by minimising changes in the gradient of the trend τt. both τt and ct are unobservable and because ct is a stationary process, xt is a noisy signal for the non-stationary trend τt. in determining the ideal value for λ, hodrick and prescott (1980) used an exogenous and subjective value of 1 for quarterly data. however, backus and kehoe (1992) performed more research on the topic and found that adjusting λ based upon the square of the frequency of observations relative to quarterly data yields better results. the relative frequency is 3 for monthly data and 0.25 for annual data, so the corresponding λ values are 14 400 and 100, respectively. further research (e.g. marcet & ravn 2003; ravn & uhlig 2002) who derived λ through solving equation 1 as a constrained minimisation problem) confirm ‘that the values for λ discussed above are still in common use’ (van vuuren 2012). du toit (2008) did a study to determine the optimal value for λ for south african business cycle. the study found that the ‘optimal smoothing constant was that value of λ that least distorts the frequency information of the time series’ (in this case, λ = 524 for quarterly data used to evaluate a business cycle with a frequency of ~7 years). the hp filter has been used to explore south african business cycles and estimate long-run output levels (see burger & marinkov 2006; fedderke & schaling 2005; kaseeram, nichola & mainardi 2004; woglom 2003). drehmann et al. (2010) found that λ = 1600 and λ = 25 000 performed poorly on historical data while λ = 125 000 and λ = 400 000 performed well with quarterly data. the higher value of λ = 400 000 is ‘considered important from a policy perspective as it provides both a greater range and more time when the indicator provides strong and reliable signals’ (van vuuren 2012). the solution to equation 2 has been shown by danthine and girardin (1989) to be: where x = [x1, … xt]′ (i.e. the observed time series), τ = [τ1, … τt]′ i is a t × t identity matrix and k = [kij] is a (t – 2) matrix with elements: the hp filter works to optimise the fit to the data series, but the effectiveness of the filter is dependent on the application on an infinitely long time series. for practical purposes, though, a moderately long series works just as well (mise, kim & newbold 2005), however ‘at the end points the hp filter is demonstrably suboptimal’ (van vuuren 2012). kaiser and maravall (1999) applied autoregressive integrated moving average (arima) forecasts and backcasts when investigating the end-point problem and found that this considerably improved the performance of the filter. the two-sided, symmetrical hp filter works through applying large ‘symmetrical weights to the end points of the observed values7 to estimate the corresponding trend value (ley 2006) disproportionately distorting the filtered values at the most recent time period’ (apel, hansen & lindberg 1996; baxter & king 1995; st-amant & van norden 1997; van vuuren 2012). problems linked to the two-sided filter ‘are mitigated by implementing a single-sided filter, a technique which uses the standard two-sided hp filter incrementally when constructing the long-term trend’ (van vuuren 2012). the long-term trend is estimated by employing only information that is available at the time the calculation was made (drehmann et al. 2010) and is carried out by running a loop over time and keeping the last value derived from the standard hp-filtered output at each point in time (mehra 2006). the bcbs’s proposed countercyclical buffer ratio employs the cycle and trend data produced by a one-sided hp filter, which may differ vastly from two-sided filtered data. the bcbs could have been clearer in their choice between the oneand two-sided hp filters, as in the main document detailing the implementation of the measure, only a footnote discusses this important distinction. this distinction is important, however, as it was conclusively shown ‘to affect the difference between the credit/gdp ratio and its long-run mean (and hence capital charges) significantly’ (van vuuren 2012). the pricing of coco bonds (as a countercyclical capital measure) is explored in the next section. equity derivatives approach contingent convertible pricing model contingent convertible pricing is closely related to the field of equity derivative pricing and may be divided broadly into three model types, structural models (albul et al. 2010; pennacchi 2011), credit derivative models (de spiegeleer & scoutens 2011; serjantov 2011) and equity derivative models (de spiegeleer & schoutens 2011). the hybrid instrument nature of cocos, somewhere between pure equity and pure debt, causes a challenge when choosing a suitable pricing model. various ways to price cocos have been explored. the black–scholes model is a suitable method for pricing cocos, because of the derivative nature of the constructs of the instruments. the black–scholes assumptions have, however, been found to be empirically unsound for pricing cocos as the implied market trigger of a coco is time dependent and volatile (jung 2012). structural pricing models view cocos as being deleveraging tools, focussing on estimating the trigger event. on the other hand, credit derivative models assume that cocos exhibit inherent credit risk, paying coupons until either maturity or conversion. lastly, equity derivative models rely on the market share price as a measure of the underlying financial position of the bank and use this as an estimate of the value to be transferred at conversion. there is an overwhelming favour among academic papers for the use of equity derivative models when pricing cocos, as these models seem to come very close in reflecting the fair value of current cocos in the market (de spiegeleer & schoutens 2011; wilkens & bethke 2014). this method has thus been chosen for use in this paper. variations of coco trigger mechanisms exist, as discussed in the ‘literature study’ section. market triggers (such as the bank’s share price) are popular. the way in which a market trigger s* is associated with an accounting trigger is illustrated in figure 6, assuming an accounting trigger of 7% core tier 1 capital with a corresponding trigger share price of 159. figure 6: accounting trigger with the projected market trigger s*. the nominal amount of cocos of a bank in issuance is an important factor in estimating the increase in the cet1 capital because of the coco conversion. beginning with the cet1 ratio: when a coco converts into equity, there is an increase in cet1 capital, which increases the bank’s cet1 ratio (if rwa remains constant). consider the change in the cet1 ratio because of the increase in cet1 capital because of the trigger of a coco: where coco is the amount of cet1 capital resulting from a coco conversion and cet1 is cet1 capital as a percentage of rwa. for an x% increase in the cet1 ratio, then, the total number of shares issued because of cocos at conversion must be equal to x% of cet1 capital. consider, as an example, a bank that has cet1 capital of zar 100 and total rwa of zar 1000. the cet1 ratio is 10% (zar 100/zar 1000). if the bank has coco bonds that convert to zar 30 of shares (30% of cet1 capital [zar 30/zar 100]), this will also result in a relative increase to the cet1 ratio of 30% (from 10% to 13%) as the total cet1 capital will be zar 130 after conversion (capital ratio = zar 130/zar 1000). results and discussion the hodrick–prescott filter applied to south african data the data chosen ‘were nominal gdp (monthly) and the credit extended by all south african monetary institutions to the domestic private sector, since 1965’. these data are ‘prescribed by the bcbs’ (bcbs 2010b) and were downloaded from the reserve bank of south africa. growth rates as well as the credit growth/gdp ratio were determined from these data. data from january 1966 were used to calculate the credit growth/gdp growth ratio and its long-run trend and is illustrated in the first graph of figure 7. the rules listed in table 2 and figure 2 were then applied to the south african credit/gdp data to determine what the capital charges would have been had the new countercyclical rules been in place historically. the results are shown in the final two graphs in figure 7 for the capital charges using a one-sided hp filter and using the prescribed λ of 14 400. the shaded area in figure 11 indicates the transition period between an economic expansion and the resultant contraction. figure 7: (a) credit/gdp and (b) credit/gdp gap for the south african economy and capital charges associated with the countercyclical capital buffer charge. in the instance when basel iii rules come into force, capital charges will ‘increase to the 2.5% maximum of extra capital required’, and this would have been applicable during the period leading up to and also during the financial crisis. even without ‘the punitive capital charges in place’ – the ratio returns to ‘levels at which the difference between it and its long-run trend would have resulted in a 0% capital add-on within a few years’ (two, in this case). it is unclear whether the reduction in credit extended was a direct result of the lack of capital in the banking sector or the flight to safety. figure 7 demonstrates that the ccb charge will function well as a countercyclical capital measure in times of economic expansion, but it may be an ineffective measure during a crisis because it does not actively encourage lending during or after a crisis. furthermore, the ccb does not discourage lending through a capital charge in economic downturns as is shown from 2010 onward. however, the lack of a disincentive does not imply the presence of an incentive, and without an incentive to extend credit, banks may prolong the liquidity shortfall procyclically as demonstrated in the 2007 financial crisis. the results from the hp filter indicate how the ccb will function in times of economic expansion. to establish the effectiveness of cocos in economic contractions, consider the following section, which explores the possible influence of coco conversions on the cet1 equity of south african banks. contingent convertible pricing and common equity tier 1 ratio of south african banks to calculate the coco prices for south african banks, the historic share prices, annual market volatility, dividend yield and interest rates are required. data pertaining to the cet1 ratios of each bank were obtained from their annual financial statements or their annual integrated reports. johannesburg interbank agreement rates (jibar) were obtained from the sarb (sarb 2011b). historic share prices of the four largest south african banks, as well as the cet1 capital ratios, are given in figures 8 and 9. to illustrate the effectiveness of a coco upon trigger in times of economic contraction, a potential share value trigger for each bank is also illustrated in figures 8 and 9, derived through the same method as illustrated in figure 5 by linking the lowest share price during the financial crisis with the cet1 capital ratio at that point. it is worth noting though that although the lowest share price attained would have not have been known at the time, some reasonable constraint could have been applied with equal validity, such as a share price absolute decrease of 50%, for example. assuming the amount of the coco in issuance by each bank is equal to 2% of the rwa of each bank, the resultant conversions of cocos into cet1 of each bank would cause a 2% increase in the cet1 capital ratio of the respective banks as shown by the projected cet1 capital ratio. the assumption was made that the coco conversion to equity is instantaneous for illustrative purposes; however, in practice this may not be plausible, practical or desirable. similarly, the trend in the projected capital ratio was assumed to remain the same as the underlying capital ratio for the period following the addition to the capital ratio; however, this may not be the case. table 4 summarises the various trigger levels illustrated in figures 8 and 9 together with other market-related information used in the equity derivatives approach coco pricing model. the interest rate used was the jibar as at the trigger event date for each share. a maturity of 5 years was chosen as this is the most common maturity among previously issued cocos (see table 3). figure 8: share price of first national bank (a) and amalgamated banks of south africa (absa) (b) with common equity tier 1 capital ratios (c) prior to and(d) after contingent convertible conversions. figure 9: share prices of nedbank (a) and standard bank (b) with common equity tier 1 ratios (c) prior toand (d) after contingent convertible conversions. table 4: trigger share prices derived from figures 7 and 8 with market-related pricing model inputs. figure 10 provides the yields derived through the equity derivatives coco pricing model for the coco of each bank if the issuers composed the cocos according to the input parameters in table 4. figure 10: contingent convertible yields for various south african bank share prices. from figure 10 it is clear that the ccb requires banks to keep more capital in times of economic expansion. total credit extended may take considerable time to diminish, however, and if the increase in the ccb is accompanied by a downturn in the economy (as in the 2007 financial crisis), banks may be required to sustain a higher capital ratio while being under pressure to supply the capital in the ordinary course of business. figure 11 further illustrates the countercyclical capital nature of cocos: bank’s capital ratios would have been increased through the conversion of cocos at precisely the time when banks needed an increase in capital. this may offer an internal solution to a capital shortage in situations where banks have traditionally sought after external, often sovereign, bailouts. the shaded area in figure 11 indicates the transition period between an economic expansion and the resultant contraction and shows how the coco conversion happens at a point when the economy was in a financial crisis. figure 11: the conversion of proposed contingent convertible instruments of south african banks (a-f) during an economic contraction. conclusion the bcbs have clearly understood that the procyclical nature of capital models in global banks have caused an overextension of credit in bull markets as well as a dire requirement for capital in bull markets and ‘deliberately structured a gradual phase-in of the basel iii rules for banks’ as a result. to avoid running out of capital, the bcbs has increased the amount as well as the quality of capital that banks are required to keep under normal economic conditions with new regulation that include, among other improvements, the ccb. the addition of the ccb to the regulation is an attempt to further increase the required capital of banks in times when the economy is overheating, saving for a rainy day. the ccb remains, however, a purely theoretical exercise as the regulatory implementation of this buffer has not been completed and not a single bank up to date has had to increase their capital under the ccb rules. furthermore, the clear majority of academic research conducted on the ccb was done on developed economies, although some (burra et al. 2014; van vuuren 2012) indicate that the ccb holds various implications for developing economies, such as south africa, as well. a historical analysis on the ccb indicates that the buffer will come into effect in times of economic expansion such as the build-up to the 2007 financial crisis. it does also, however, indicate that once the ccb requirements come into force there is a significant time-lag that must be considered before the requirements are relaxed. history has also shown that markets are self-adjusting and may regulate back to their long-run trend after a period of excessive growth which poses interesting challenges for banks which will be required to keep the additional capital required by the ccb while operating in a market where capital becomes increasingly more expensive and increasing in scarcity. contingent convertibles are designed to absorb losses in severe economic conditions. the inherent mechanism which allows for a bank to cease paying the coupon on the bond in economic contractions affords the banks the opportunity to use the additional cash flow to service growing liquidity requirements. furthermore, in a situation where the conversion trigger mechanism is triggered with the coco either suffering a write-down and/or converting into equity, the capital ratio of a bank is immediately boosted. results from this study indicate that south african banks may have benefited from the increased liquidity and capital boosts if they had cocos in issuance prior to the 2007 credit crisis. the ccb thus seems to function as a good countercyclical capital measure in times of economic expansion; however, the absence of the disincentive to increase the capital of a bank in economic contractions does not necessarily imply that the banks will be incentivised to use the extra capital to extend credit into the market, especially as the rwa and pd of the banks will rise under these conditions. the issuance of coco bonds, if their trigger mechanisms are designed correctly, may prove helpful to banks and the broader financial sector in times of economic contraction through the countercyclical capital properties that manifest through coco bonds under these economic conditions. in addition to the countercyclical capital nature of cocos, further studies need to investigate the time-lapse between a coco conversion and the resultant increase in the cet1 capital ratio as the mismatch in timing could see the increase in capital coming at a stage when the bank is a gone concern as opposed to a going concern. an investigation into the trigger mechanism which results in a bank only stopping coupon payments (as opposed to converting the coco into equity) on cocos will also prove useful as currently there are no fixed rules regarding trigger mechanisms to be used for such an addition to cocos. acknowledgements competing interests the authors declare that they have no financial or personal relationship(s) that may have inappropriately influenced them in writing this article. authors’ contributions f.l. was the 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africa’, south african journal of economic and management sciences 15(3), 309–323. wilkens, s. & bethke, n., 2014, ‘contingent convertible (“coco”) bonds: a first empirical assessment of selected pricing models’, financial analysts journal 70(2), 59–77. woglom, g., 2003, ‘how has inflation targeting affected monetary policy in south africa?’, south african journal of economics 71(2), 380–406. https://doi.org/10.1111/j.1813-6982.2003.tb01314.x yakhim, y., 2001, business cycle fluctuations and the hodrick-prescott filter, viewed 12 february 2011, from http://www.bgu.ac.il/~yossiya/teaching/macro_graduate/ln1_bc_hpf.pdf footnotes 1. the capital ratio of a bank is obtained via the quotient of the common equity tier 1 (cet1 capital and the bank’s total rwas. the cet1 capital ratio diminishes when the denominator (rwa) rises, largely because of a rise in the default probability of outstanding loans (a deterministic of the rwa). 2. these bonds can potentially also suffer a partial of full write-down on the par value. 3. asset prices were ‘also considered to be useful aggregate indicators as they tend to rise strongly ahead of systemic banking crises, but these were eventually abandoned’. 4. although the conversion of debt to equity raises the book value of equity, it fails to raise new cash for the bank like a new issuance of equity would (prescott 2012). 5. the results explore the need for coco triggers to be set at a level that activates when the bank is a going concern with proposals for the african market. 6. specifically, coco isin xs0459089255. 7. that is, the ‘2-sided hp filter uses past and future data to estimate the components of equation 1, so cycle data generated using it could be biased’. abstract introduction literature review design of research and methodology results and analysis discussion and proposed framework conclusion acknowledgements references about the author(s) raveen rathilall department of operations and quality management, faculty of management sciences, durban university of technology, south africa shalini singh department of operations and quality management, faculty of management sciences, durban university of technology, south africa citation rathilall, r. & singh, s., 2018, ‘a lean six sigma framework to enhance the competitiveness in selected automotive component manufacturing organisations’, south african journal of economic and management sciences 21(1), a1852. https://doi.org/10.4102/sajems.v21i1.1852 note: this article is partially based on the author’s dissertation for the degree of doctor of technology: quality at the faculty of management sciences, durban university of technology, south africa, with promotors dr s. singh and mr r. naidoo, september 2014, available from https://ir.dut.ac.za/bitstream/10321/1175/1/rathilal_2014.pdf original research a lean six sigma framework to enhance the competitiveness in selected automotive component manufacturing organisations raveen rathilall, shalini singh received: 30 mar. 2017; accepted: 23 jan. 2018; published: 17 apr. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: currently, globalisation, economic uncertainty and fluctuating market demands prompt leaders all over the world to improve their operations and to enhance innovations in processes, products and services in a very reactive manner. literature shows that the adoption of an integrated lean six sigma tool can assist them to compete with the rest of the world in a manner where productivity, quality and operational costs reduction are crucial for economic success. aim: this article investigates the integration of lean and six sigma tools as a unified approach to continuous improvement and develops a lean six sigma framework for selected automotive component manufacturing organisations in kwazulu-natal (kzn), south africa. method: the quantitative methods of research were adopted. the target population (42) was organisations within the durban automotive cluster of which five were used for the pilot work. an empirical study was conducted using a survey questionnaire in measurable format to gather practical information from the sample organisations on the status of their existing business improvement programmes and quality practices. results: the results of the study demonstrated that the organisations had a very low success rate of lean and six sigma adoption as standalone systems, as they found it difficult to maintain the transition from theory to practice. conclusion: hence the adoption of an integrated lean six sigma approach was absent and it can be concluded that the proposed lean six sigma framework affords the kzn automotive sector a unique opportunity to integrate and operate with both tools of quality that complement its management style and industry demands. introduction south africa appears to be 20% more expensive than western europe and is 30% – 40% more expensive than china and india as an automotive manufacturing base. the main contributing factors that accounted for these challenges are the development and retention of a skilled workforce, insufficient knowledge of competitors and operational inefficiencies attributed to internal process problems (naude & badenhorst-weiss 2011:96; strauss & du toit 2010:304). brand pretorius, former president of national association of automotive component and allied manufacturers (naamsa), reported at the 2011 car conference that the automotive sector in south africa is a centre of excellence and a strategic asset for the country and should therefore consider adopting a more robust business model to adapt to the changing environment (national association of automotive component and allied manufacturers [naacam] 2011:4). this is supported by ndaita, gachie and kiveu (2015:683) and nunes (2015:896) who suggest that globalisation and volatile market dynamics in the new millennium prompt organisations from every industry to adopt specific business improvement techniques to strategically enhance their operational excellence and management philosophies in order to gain competitive advantage and to maintain a share in the market. literature shows that one such initiative that can assist organisations in eradicating the competitive challenges in the global and changing environment is the integrated lean six sigma tool which has recently been recognised as the most effective business improvement technique that provides the experience, concepts and methods to lead change and sustain global competitiveness (albliwi, antony & halim lim 2015:665; byrne, lubowe & blitz 2007:5; snee 2010:12). it is a technique that originates from synthesising standalone lean and six sigma systems into a unified approach to increase process performance. organisations that attempt to deploy lean six sigma effectively can generate substantial savings annually, as experienced in a wide range of leading industries that include chemical, automotive, finance, electronics, and health care (bhat, gijo & jnanesh 2014:614; byrne et al. 2007:5; laureani & antony 2015:406; snee 2010:12; zhang et al. 2012:602–604). the automotive sector, which purports to be at the forefront of best industry manufacturing practices in south africa, is certainly lacking in this area. it appears that business leaders in south africa adopt various improvement techniques through consultants, government funding, industry sectors or support from global sister organisations, the latest being either lean or six sigma techniques which are adopted mainly as standalone and used in isolation. on a closer examination of south african academic journals, relevant books, periodicals, newspaper articles, websites and consultation with various automotive manufacturers, there appears to be no indication to suggest that the automotive component manufacturing organisations in kwazulu-natal (kzn), south africa, are considering the integrated lean six sigma technique as an optimum business improvement strategy. this is confirmed by zhang et al. (2012:604) who identified that the integrated lean six sigma technique has only been executed in the education sector in south africa. therefore, an investigation is needed for the automotive sector in kzn to consider the application of the lean six sigma tool to achieve better business results conceptually and operationally. the aim of this article is to determine how automotive component manufacturing organisations in kzn can improve their existing processes through the integrated lean six sigma technique. to achieve this, the article will establish the consequence of integrating lean and six sigma to complement and reinforce each other and develop a conceptual framework that integrates lean and six sigma for automotive component manufacturing organisations in kzn, south africa. in the next section, a brief literature review is provided on lean and six sigma as standalone systems and then the rationale for combining lean and six sigma as an integrated tool is presented. thereafter, the research design and methodology section discusses how this study was executed. the results section provides an analysis of the empirical study and the key findings. the discussion section explains the operation of the proposed lean six sigma framework. the article concludes with recommendations and also highlights some of the limitations and proposes future research. literature review the lean technique as a standalone system the purpose of the lean technique is to eliminate waste from every possible process in an organisation. typically, the different types of waste include overproduction of work-in-progress inventory, excess warehouse inventory, transportation of components, waiting for preceding processes, motion of unnecessary operations, inadequate processing steps, defects requiring rework, and unused employee creativity (liker 2004:28–29; pepper & spedding 2010:139). the theory guiding the lean technique is based on five principles which are as follows: defining value from a customer’s perspective, identifying non-value-added activities in the value stream, creating continuous flow in all processes, establishing pull systems, and pursuing perfection (andersson, eriksson & tortenson 2006:288; morgan & brenig-jones 2009:15; su, chiang & chang 2006:3). these principles are used in conjunction with specific lean tools and methods to maximise the value-adding components in an organisation by using less human effort, space, and time to produce high-quality products as efficiently and economically as possible, while being highly responsive to customer demand. the six sigma technique as a standalone system the intention of the six sigma technique is to remove variation from processes and strive to manufacture defect-free products. it is associated with the acronym dmaic which stands for define, measure, analyse, improve, and control. this serves as the foundation and systematic five-step problem-solving methodology that is followed to find causes of variation in system processes. the dmaic cycle serves to define a process to improve, measure the baseline and target performance of the process, analyse the process data to determine the key process inputs that affect the outputs, improve the process to optimise the outputs, and, finally, to control the improved process for sustaining the improvement (andersson et al. 2006:287; foster 2010:429; su et al. 2006:4). the six sigma team members apply sophisticated root-cause analysis techniques and statistical tools at each step of the dmaic cycle to achieve continuous and breakthrough improvements towards solving a problem. the lean six sigma technique as an integrated tool at the forefront as standalone business improvement techniques, lean and six sigma have different performance measures but are popular in assisting organisations that strive for operational excellence to compete globally. they are proven techniques that have a common goal towards continuous improvement but differ in their approach to meet these objectives. although there are many success stories of performance improvements related to lean and six sigma as standalone systems, there are also inherent weaknesses that have been identified for each technique over the years. table 1 summarises the strengths and weaknesses associated with lean and six sigma as standalone systems and suggests how each technique on its own does not incorporate all the performance measures that are required to lead an organisation to perfection. table 1: lean and six sigma strengths and weaknesses. from table 1 the most significant weakness associated with lean is that it does not incorporate the tools to reduce variation. conversely, the most noticeable weakness of six sigma is that it does not attempt to develop a link between quality and speed as lean does (andersson et al. 2006:290–294; su et al. 2006:2). this rationale highlighted to the business world that conventional processes had limited aspects of both lean and six sigma improvements and proposed the need for integrating these techniques to create a unified improvement approach with minimum weaknesses (bhuiyan & baghel 2005:765; cabrita, domingues & requeijo 2015:223; laureani & antony 2015:406; ndaita et al. 2015:686; pepper & spedding 2010:147; salah, rahim & carretero 2010:251–252; svensson et al. 2015:953). the logic of the integration was to capitalise on the strengths of both techniques and to account for the weaknesses of each technique as a standalone. the justification of the lean six sigma integration is represented in figure 1 to highlight the summary and nature of improvements that would be gained by combining the two techniques. figure 1: nature of competitive advantage the lower line in figure 1 represents lean management only and the higher line represents six sigma only. it is evident that when a state of equilibrium is reached, the integrated lean and six sigma approach will not risk the possibility of the organisation becoming too lean or concentrating too much on reducing variation. in order to capitalise on the strengths of both lean and six sigma, pepper and spedding (2010:147) anticipate that the ultimate balance lies in creating sufficient value from the customers’ perspective and reducing variation to acceptable levels. combining the efficiency approach to problem-solving through lean with the innovative approach to problem-solving through six sigma enables an organisation to gain advantages from both types of improvement (hoerl & gardner 2010:31; karthi, devadasam & murugesh 2011:310). therefore, the concept of integrating lean and six sigma was favoured over the years within organisations that chose lean and six sigma to work in unity rather than independently. this is supported by ndaita et al. (2015:686), nunes (2015:891) and snee (2010:10) and thus leads to the following hypothesis: h0: a relationship exists between the integration of lean and six sigma and an increase in process performance. h1: a relationship does not exist between the integration of lean and six sigma and an increase in process performance. design of research and methodology the action-based research strategy in this article was accompanied by an empirical study. sekaran (2006:36) suggests that action research is generally undertaken to substantiate change processes within organisations which, in this instance, was aligned with the objective of developing a lean six sigma framework in the kzn context. the study incorporated quantitative techniques as the methodology to validate the research objectives. the initial step was to systematically investigate what unique performance measures lean and six sigma offered the business world when adopted independently. thereafter, the article examined the strengths and weaknesses between lean and six sigma as standalone systems in order to validate the impetus for combining them into an integrated business improvement tool. this part of the article was exploratory in nature and concluded that although lean and six sigma had unique strengths as standalone systems, their weaknesses on the other hand complemented each other to increase process performance. the next phase of the study performed the field work to collect primary data. this part of the study incorporated a self-developed survey questionnaire in measurable format to gather practical information from the sample organisations on the status of their existing business improvement programmes and quality practices. the survey method was deemed appropriate for gathering primary research data due to its flexibility in being custom designed to meet the objectives of any research project (sekaran 2006:236). lastly, explanatory analysis was applied during the construction of the lean six sigma framework as suggested by terre blanche, durrheim and painter (2006:44). the results of this study are applicable to organisations within the dac and may not be generalised to all organisations in south africa; however, the findings may be useful to organisations that have implemented or are implementing lean, six sigma or lean six sigma. survey instrument design the questionnaire was derived from literature that were closely linked with survey type questions developed by other researchers such as pulakanam and voges (2010: 158–161), zu, fredendall and douglas (2008:645–648) and shah and ward (2007:803). the choice of these studies showed that the developed scales and questions had an accurate measure of validity and reliability and highlighted key variables that were required for lean and six sigma techniques which were deemed to be justifiable in this study. douglas, douglas and ochieng (2015:775) used a similar approach in their study in various service and manufacturing organisations in east africa. the structure of the questionnaire was based on the following categories: organisations that practise the lean technique as a standalone system, organisations that practise the six sigma technique as a standalone system, lean six sigma critical success factors, and usage of different tools and techniques. the study adopted both open-ended and close-ended questions in the questionnaire design. the closed-ended questions were designed on a five-point likert scale ranging from ‘do not agree at all’ (1) to ‘agree fully’ (5). target population and sample size since this survey assessed practical experience and knowledge instead of general perceptions, the target participants included operations managers, quality managers, production system managers, six sigma experts and lean specialists who were knowledgeable and familiar with the terminology and their processes. census sampling was adopted as it involved all organisations in the dac and because the population size was smaller than 50 as suggested by saunders, lewis and thornhill (2009:243). according to the sample size determinator from the stat graphics statistical package software, a 95% level of confidence indicates an appropriate sample size of 30 (singh 2011:1622). it is also highlighted in literature that statistical analysis usually requires a minimum sample size of 30 elements for investigation (saunders et al. 2009:243). there were 42 organisations within the dac at the time of conducting the survey; however, only 32 (75%) participants completed the questionnaires. this was sufficient to adopt certain statistical analysis techniques and validate conclusions from the findings. method of data analysis the statistical package for social sciences (spss) version 20.0 was used to process and analyse the data obtained from the questionnaires. each quantitative question was analysed individually in terms of reliability, content, and the frequency of responses. internal, external, construct, and content validity checks were performed to verify the measuring instrument while the cronbach’s alpha test confirmed the reliability. frequencies and means were used to describe the data by investigating the distribution of the scores of each variable and by determining whether the scores on the different variables are related to each other as suggested by terre blanche et al. (2006:558). the mean scores are independent for lean and six sigma organisations. in an attempt to understand the variation in responses, the percentages of the three categories of results are presented as follows: organisations that practise neither technique, organisations that practise lean only and organisations that practise lean and six sigma as standalone systems. the levels of disagreement (negative statements) were collapsed to show a single category of disagreement. a similar procedure was followed for the levels of agreement (positive statements) to show a single category of agreement. in this manner, only three categories of results in percentage form are presented as ‘disagree’ (d), ‘neutral’ (n) and ‘agree’ (a). this is allowed due to the acceptable levels of reliability and consistency in the factor analysis. gap analysis was used to evaluate the difference between the desired operating levels versus the existing operating level of the critical success factors of lean six sigma in the sample organisations (foster 2010:163). the gap values represented the difference between the actual mean score and the hypothesised perfect score of 5. this implies that mean scores above 3 indicate that the questions were positively answered. reason for this dichotomy would enhance the results. the communality for a given variable, according to kinnear and gray (2009:568), can be interpreted as the total proportion of its variation that is accounted for by the extracted factors. in the case of this study, the questionnaire model is acceptable as it explains approximately 70% of the variation for the 54 variables in the lean six sigma critical success factors section. the pearson’s chi-squared test was performed to determine whether there were statistically significant relationships between the variables in this study. as suggested by kinnear and gray (2009:409) a p-value is generated from a test statistic with a significant result indicated by ‘p < 0.05’. the null hypothesis is used for testing and it is a proposition that states a definitive and exact relationship exists between two variables. the alternative hypothesis is the logical opposite of the null hypothesis and is a statement expressing a relationship between two variables or indicating differences between groups (sekaran 2006:105). the p-values in the main study indicated that there are differences (that are not due to chance) between each statement and the respective category. results and analysis organisations using the lean technique as a standalone system the positive feedback from the participants indicated that the lean technique as a standalone system included simple tools such as 5s and standardisation which is easy to understand and apply by the operators. the results engage with gupta (2005:426) that lean promotes better housekeeping, more organised workspace, higher inventory turnover, and motivated employees. however, some of the common limitations extracted from the participants revealed that more focus was required in reducing defects and customer complaints, creating a structured problem-solving approach and maintaining stable processes. this gives an indication that lean as a standalone technique has limitations in improving an organisation’s performance. these limitations are the key focus areas that the six sigma technique can improve, which is also highlighted in the literature (arnheiter & maleyeff 2005:17; thomas, barton & chuke-okafor 2009:114). this suggests that an organisation that operates with the lean technique as a standalone system does not necessarily consider the importance of reducing process variation. therefore, it can be regarded as the opportunity or building block for embracing a possible integrated lean six sigma technique. organisations using lean and six sigma techniques as standalone systems there were no organisations that practised six sigma ‘only’ as a standalone system. it appears that these organisations either practised some form of lean initially and then selected six sigma techniques into their operations later for additional improvement, or practised six sigma initially and then included lean techniques for further improvements. however, in terms of the responses towards six sigma as a standalone system, several of the participants indicated that it is a high-level process for advanced problem-solving. they claimed that the statistical and mathematical tools make it difficult for the average employee on the shop floor to utilise. another common theme that arose among the participants is that six sigma is a good systematic problem-solving tool that is similar to the plan do check act (pdca) cycle. other responses included that six sigma as a standalone system does not focus on reducing inventory, ‘on time’ delivery performance, identifying non-value-added activities, and reducing cycle times. it can be inferred from these comments that there is acceptance from organisations that there is an existing gap of meeting other organisational performance measures after they implemented six sigma as a standalone system. this is possibly the reason for their introduction of lean to their organisations. the results of the analysis mean that six sigma as a standalone system has limitations which can favourably be addressed by the lean technique; this therefore corresponds with thomas et al. (2009:114) and arnheiter and maleyeff (2005:17–18) that in order to increase process performance, lean may be needed to work in conjunction with six sigma. lean six sigma critical success factors organisational infrastructure the results for organisational infrastructure are presented in table 2. table 2: results pertaining to organisational infrastructure. it can be noted from table 2 that questions 1.1, 1.2, and 1.5 showed smaller mean values (less than 3). for question 1.1, the striking observation is that the majority of organisations that practise neither technique ‘disagreed’ with the statement which contests what liker (2004:152) argue: that clearly defined processes and procedures allow employees to understand their roles and responsibilities within predefined limits and are the strategic link between the organisation’s vision and day-to-day operations. this could possibly imply that organisations that have undefined processes and procedures will have insufficient control mechanisms in place to manage their daily operations. the high level of ‘agreement’ for question 1.2 is within organisations that practised the six sigma technique and is congruent with banuelas et al. (2006:514) that the six sigma technique increases an organisation’s focus towards its strategic objectives to sustain a competitive advantage in the business world. this means that organisations that strategically manage the business are able to increase their operational effectiveness by increasing sales, profits and efficiency. for question 1.5, there is a consistent trend of ‘agreement’ within organisations that have improvement systems in place; this corroborates the findings of shah, chandrasekaran and linderman (2008:6683) who espouse that the lean and six sigma techniques consciously engage employees to continuously improve their processes on an ongoing basis. management commitment and leadership the results for management commitment and leadership are presented in table 3. table 3: results pertaining to management commitment and leadership. with the exception of question 2.2 in table 3, all other questions have significant gaps in this section. the substantial level of ‘disagreement’ for question 2.1 could possibly be reflecting personal feelings of the participants who are probably not motivated by management, which correlates with the findings of sim and rogers (2009:37–46) who found that shop floor employees (referred to as operators) do not believe that the organisation views them as the most important asset and believes that they require constant motivation. organisations that have improvement systems in place positively ‘agreed’ with question 2.3, which indicates that management sees the benefit of frequently making their way to the production environment, which coincides with salah et al. (2010:270) that managers continuously visiting the workplace allows them to identify opportunities for improvement on an ongoing basis. for question 2.4, the largest portion of ‘agreement’ stems from organisations that practise the six sigma technique. this concurs with the views of savolainen and haikonen (2007:9) that six sigma requires the development of a hierarchy of process improvement specialists who are equipped with the tools and knowledge to make significant improvements in the business. since question 2.5 relates to improving employees’ morale and reducing their confusion in terms of expectations and current performance, the general trend of ‘agreement’ can be related to the work of de koning et al. (2008:41) who found that consistent feedback assists employees to enhance their performance and prevent repetition of errors. commitment to quality the results for commitment to quality are depicted in table 4. table 4: results pertaining to commitment to quality. it is evident from table 4 that questions 3.1, 3.3 and 3.5 have large gaps in this section. the negative responses for question 3.1 could mean that top management relies on their subordinates to assume the responsibility of quality performance which is consistent with lee and peccei (2008:5) who articulate that the traditional organisational perspective required specialists to solve quality problems. the positive results for question 3.3 could be reflecting responses that are related to training of employees on basic quality principles, while the negative and neutral responses on the other hand could be referring to organisations that do not use statistical techniques or do not see the potential benefits of statistical tools as also suggested by thomas et al. (2009:116–117). since organisations that practise neither technique reveal a high level of ‘disagreement’ and ‘uncertainty’ for question 3.5, it would appear that they may not have formal quality systems in place to manage quality. this contradicts the findings of zu et al. (2008:636) who maintain that quality data is essential to provide accurate and timely information for product quality and process performance. production control the results for production control are demonstrated in table 5. table 5: results pertaining to production control. it is observed that the focal gaps in table 5 were identified for questions 4.1, 4.2, 4.3, 4.4, 4.5, and 4.6. since the pull system is a lean tool, it is understandable that organisations that practise neither technique will have a high level of ‘disagreement’ for question 4.1. the positive results from organisations that practise the lean technique indicate that they require minimum stock levels throughout the supply chain, which is aligned with the suggestion that the pull system was created to prevent an organisation from manufacturing products in advance and storing unnecessary stock (andersson et al. 2006:288). question 4.2 indicates a high level of ‘agreement’ within organisations that practise the lean technique, which is aligned with liker (2004:23) that the just-in-time (jit) production system enables an organisation to manufacture and deliver products in smaller quantities and at reduced lead times to meet specific customer requirements. organisations that ‘disagreed’ with this statement could possibly manufacture products in excessive amounts and store unnecessarily. as expected, the extent of ‘disagreement’ depicted in question 4.3 for kanban application is similar to that of the pull system and they mirror each other closely. this makes sense, since a kanban system is the classical signalling device for pull production as highlighted by bhasin and burcher (2006:57). for question 4.4, the high sentiment of ‘agreement’ within organisations that practise the lean technique aligns with bhasin and burcher (2006:57) that manufacturing ‘cells’ group selected employees, machines, and operational processes into an independent operational unit to manufacture a complete product from start to finish in a single process flow. the organisations that ‘disagreed’ with question 4.5 imply that they probably find it difficult to accurately forecast customer demands. this is supported by liker (2004:116–117) who documents that since customers do not purchase products in a sequence, it is difficult to predict their requirements and manufacture products accordingly. since there are no restrictions for implementing the smed technique, the findings of ‘disagreement’ for question 4.6 contradicts the view of santos, wysk and torres (2006:140–145) who claim that it is possible to achieve effective machine changeover without costly investments since the smed technique seeks to eliminate the use of screws and nuts as the fixing elements. process improvement the results for process improvement are illustrated in table 6. table 6: results pertaining to process improvement. it is noted in table 6 that questions 5.1, 5.3, 5.4, 5.5, 5.8 and 5.9 have significant gaps in this section. for question 5.1, the high level of ‘disagreement’ stems from organisations that practise neither technique. it can be interpreted that these organisations do not understand the application of ‘poka yoke’ devices, which is deduced from the readings of chase, jacobs and aquilano (2006:333). since the sophisticated tools of six sigma cannot be embraced by the average employee on the shop floor, it can be interpreted from the general trend of ‘disagreement’ for question 5.3 that many organisations do not pursue the implementation of statistical process control in the context of six sigma. the positive results (lean and six sigma organisations) for question 5.4 show alignment with the thinking that six sigma improvement projects are evaluated from a financial perspective using measures such as cost savings or increased revenue and non-financial benefits such as the impact the project has on customers (evans & lindsay 2005:66–69). the majority of ‘disagreement’ (organisations that do not practise the six sigma technique) for question 5.5 could mean that these organisations undertake problem-solving intuitively and do not believe that improvement projects should be structured and undertaken systematically. for question 5.8, the high level of ‘agreement’ (lean organisations) is aligned with schroeder (2007:409) and chase et al. (2006:473) that the value stream investigation represents material and information flow for improvement opportunities. the positive responses for question 5.9 (lean organisations) seem to be in line with the findings from literature that the central focus of lean is to create more value for customers by eliminating activities that do not add value to a product or service (karthi et al. 2011:310; pepper & spedding 2010:139). employee involvement the results for employee involvement are summarised in table 7. table 7: results pertaining to employee involvement. given the emphasis on people issues in literature, the negative responses to questions 6.1, 6.2, 6.4, 6.6, 6.7, 6.8, 6.9, and 6.10 in table 7 supplement the scoring pattern. for question 6.1, the high level of ‘disagreement’ could possibly be attributed to shop floor employees not having the technical knowledge of working with complex problems. in such circumstances, it can be suggested that shop floor employees be exposed to problem-solving techniques that are directly related to their processes. the high content of ‘disagreement’ (organisations that practise neither technique) for question 6.2 reveals that the shop floor employees within these organisations do not believe that they are responsible for identifying defects, which verifies the views of santos et al. (2006:78) who are firm in their belief that operators are able to make unintentional errors during inspection and, therefore, would not like to be held responsible for performing quality checks. for question 6.4, the positive responses (lean organisations) can be related to the work of schroeder (2007:403) who advises that multifunctional teams in lean organisations do not assume productive tasks only but also indirect functions such as quality control and general maintenance of equipment. the consequence of suggestions not being implemented could validate the high sentiment of ‘disagreement’ for question 6.6; this contradicts the views of bhuiyan and baghel (2005:766) who contend that employees should be given explanations for suggestions that are rejected. the high level of ‘disagreement’ for question 6.7 contradicts the views of comm and mathaisel (2005:136) who suggest that when employees are given permission and tools to make changes in processes, they should also be appropriately recognised for their initiatives towards quality improvement. the negative responses to question 6.8 could imply that the employees do not perform work tasks outside the traditional boundaries of their original training and this results in limited workforce flexibility in these organisations. since the objective of training is to enhance the employee’s skills, the results for question 6.9 indicate that 50% of the organisations have a high level of skilled employees who are adequately trained to perform their functions. this correlates with comm and mathaisel (2005:136) who articulate that as long as organisations provide proper training it allows employees to understand their process as well as the processes before and after in the product flow. the positive responses for question 6.10 could mean that the participants view teamwork as an important competitive strategy; this correlates with evans and lindsay (2005:15) that teamwork focuses attention on building customer and supplier relationships and encourages the involvement of the total workforce. customer focus the results for customer focus are reflected in table 8. table 8: results pertaining to customer focus. it is noticeable in table 8 that questions 7.2 and 7.5 have significant focal gaps in this section. the majority of the positive responses (lean and six sigma organisations) to question 7.2 concurs with delgado, ferreira and branco (2010:518) that the voice of the customer (voc) describes what customers require and their perceptions of how well the products or services meet their needs. for question 7.5, the positive responses are consistent with morgan and brenig-jones (2009:23–24) that the customers’ critical to quality (ctq) characteristics provide the basis for the organisation to determine which process measures are critical. on the other hand, the portion of ‘disagreement’ could imply that if the customers ctqs are not investigated immediately, the relationship may become strained and they would be attracted to the competition. section e – analysis of the tools and techniques used in the sample organisations the participants’ feedback in this section revealed that problem-solving and lean tools are commonly used among the organisations as compared to statistical tools. the results strengthen the findings of antony et al. (2007:301) who identified similar trends in uk organisations. this is also supported by albliwi et al. (2015:679–686) who in addition identified that most organisations in uk and europe prefer lean tools while the six sigma tools are more popular in the american manufacturing sector. it is reasonable to conclude that since problem-solving and lean tools offer visual representation of problems and are easier to use, they appeal more to the organisations than the sophisticated and complex statistical tools of six sigma. a similar trend was established in east african organisations (douglas et al. 2015:777). discussion and proposed framework the empirical evidence of this study showed proof from a kzn perspective that lean and six sigma have limitations as standalone systems and thus justified the need for uniting these techniques. therefore, the null hypothesis is accepted that a relationship does exist between the integration of lean and six sigma to increase process performance. the hypothesis is supported from the results of the chi-squared p-values and gap scores which indicated that the weaknesses of each technique are complemented by the strengths of the other technique. the above conclusions are consistent with the authors that have tested the effectiveness of the integrated approach on many occasions, which is evident from cited literature and case studies (delgado et al. 2010:518; douglas et al. 2015:779; ndaita et al. 2015:689; svensson et al. 2015:967; thomas et al. 2009:125–127). the proposed framework in figure 2 depicts how organisations should initially develop their strategic decisions and then translate them into suitable projects that will facilitate continuous improvement. the selected projects need to be fully supported by the organisations’ leadership and management commitment to ensure success. douglas et al. (2015:778–779) demonstrated breakthrough results of lean six sigma deployment in east africa through effective leadership and management commitment. similar results were established in kenya (ndaita et al. 2015:689), india (bhat et al. 2014:637), south-eastern europe (psychogios, atanasovski & tsironis 2012:129) and portugal (delgado et al. 2010:521). figure 2: lean six sigma framework. when the projects are handed over to the operational level, it is followed through with the dmaic cycle. cabrita et al. (2015:224) state that the dmaic cycle is a robust methodology that can prevent the creation of hasty conclusions and provide an adequate investigation of alternate solutions to a given project. this part of the framework is tactical as it aligns supplier commitment and customer satisfaction directly to the operational activities. the operational activities include the infrastructure and selection of the correct tools for each step of the dmaic cycle as represented in table 9. table 9: lean six sigma problem-solving tools. from table 9 it can be surmised that the adoption of the 5s tool and standardisation at the define phase will ensure that the processes are clean and standardised before investigating the process or product for improvement opportunities. thereafter, value stream mapping will identify value-added and non-value-added activities throughout the value stream. the investigation of cycle time and process yield in the measure phase will ensure that the efficiency of the process is analysed. the adoption of constraints measurement, production levelling and takt time evaluation at the analyse phase will produce better cause and effect relationships between process and product characteristics. for example, the investigation of long cycle times and waiting times will ensure that maximum operating conditions are generated from each process. this will establish better flow conditions between processes without interruptions. for the improve stage, the addition of future state value stream maps, continuous flow, jit, kanban and pull systems will establish more efficient process flow with capable processes. it should be noted that the interaction between the current and future state value stream maps can provide an opportunity to effectively monitor the progress of the measure, analyse and improve phases of the dmaic cycle. lastly, the adoption of smed, tpm, cell manufacturing, visual controls and ‘poka yoke’ devices at the control phase will maintain a highly efficient and effective workplace and sustained customer focus. the wide range of tools associated with the proposed framework allows employees the opportunity to select the best suited tool for each step of the improvement process as also established by douglas et al. (2015:779) in east africa and svensson et al. (2015:959) in saudi arabia. in terms of cultural changes, the kzn business climate consists of complex and diverse employees; this diversity makes it difficult to capitalise on the human dimensions that are required for lean six sigma application and effectiveness. this can be overcome with an appropriate organisational infrastructure and a quality-driven culture that are required to change from passive support to proactive participation and learning. therefore, it is recommended that management develop an open, honest and transparent quality-driven culture among employees as a means of ensuring the system works effectively. this was also demonstrated in portugal (cabrita et al. 2015:229), east africa (douglas et al. 2015:778), kenya (ndaita et al. 2015:689), india (bhat et al. 2014:638) and south-eastern europe (psychogios et al. 2012:134–136). the completion of each project is determined by the results achieved to establish if the initial strategic decisions have been satisfied. svensson et al. (2015:967) suggest that management set up structured performance evaluators and follow-up procedures to continually monitor the progress of lean six sigma projects to ensure sustainability of the system. the integrated and step-based implementation methodology of the framework provides leverage for organisations to capture a coherent and holistic approach towards continuous improvement. conclusion the study concluded that there are performance gaps evident in the processes with regard to some of the essential lean and six sigma tools and techniques that are practised on the shop floor compared to the theoretical requirements in the organisations investigated. these tools and techniques are directly linked to the critical success factors of the lean six sigma approach and can thus have an adverse effect on the implementation of the proposed lean six sigma framework if it is not managed effectively. therefore, it is suggested that organisations pay closer attention to the improvement opportunities for each of the seven critical success factors as represented in table 10. this could represent the checklist to improve the current manufacturing processes within the organisations under study. table 10: improvement areas for lean six sigma operations. the specific improvements in table 10 are supported by shah et al. (2008:6696) who suggest that organisations need to carefully assess their current manufacturing processes and capabilities before implementing another technique, and achieving success. in this regard, if an organisation wants continual improvement, it needs to recognise that there are significant interactions between their management system and the improvement technique. when the organisations understand the characteristics of the environment in which they operate, it will ensure that they configure appropriate follow-up processes to sustain their management systems. the critical success factors highlighted in table 10 are applicable to all organisations and can therefore be integrated into any management system to achieve better performance measures. it also provides kzn managers with a checklist for monitoring and measuring the current improvement processes on the shop floor so that it leads to predictable results. it is anticipated that once effective corrective actions are taken for the problem areas identified, it will make it easier to implement the proposed lean six sigma framework from an application perspective. although this study enriches the literature by providing in-depth information on the reasons for combining the lean and six sigma techniques, some concerns and limitations have been identified through the research process. the limitations of this study were as follows: only organisations in the kzn automotive sector were used in the investigation, there was minimum usage of the lean six sigma technique in south africa, no organisations practised the six sigma technique as a standalone system, and the proposed lean six sigma framework could not be tested. these limitations, however, provide inspiration for potential future research activities such as extending the research into the entire geographical diversity of the south african automotive sector to learn more about other organisations that claim to practise six sigma independently and rank their existing state, and testing the validity of the proposed lean six sigma framework in a real case application to ensure that the critical outcomes are adequately ingrained to increase process performance. it should be noted that even if an organisation claims to have improvement systems in place, there are always opportunities to further improve its performance. therefore the proposed lean six sigma framework in this study affords the kzn automotive sector a unique opportunity to create its own brand of quality that complements its management style and industry demands. it forms a powerful business strategy that can assist the kzn automotive industry to become the very best in confronting local and global challenges. acknowledgements competing interests the authors declare that they have no financial or personal relationship(s) that may have inappropriately influenced them in writing this article. author’s contributions r.r. contributed to the literature review, methodology 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six sigma: a literature review’, interdisciplinary journal of contemporary research in business 3(10), 599–605. zu, x., fredendall, l.d. & douglas, t.j., 2008, ‘the evolving theory of quality management: the role of six sigma’, journal of operations management 26, 630–650. https://doi.org/10.1016/j.jom.2008.02.001 microsoft word 8 fourie et al sajems 16(1) 2013.docx sajems ns 16 (2013) no 1 83 the role and value of water in natural capital restoration on the agulhas plain1 helanya fourie western cape department of agriculture, programme: agricultural economics martin p de wit school of public leadership, stellenbosch university; asset research a van der merwe department of economics, stellenbosch university accepted: august 2012 the agulhas plain is a low-lying coastal area within the cape floristic region. it is heavily invaded by alien vegetation that infringes upon the sustainable supply of ecosystem goods and services provided by the native fynbos vegetation. alien clearing and natural capital restoration is expected to recover these ecosystem goods and services and in particular to increase water availability. the study conducts costbenefit analyses to assess whether alien clearing and natural capital restoration would add value to the agulhas plain through sufficiently increasing the supply of marketable ecosystem goods and services. the results indicate that the costs of alien clearing and restoration cannot be justified in the absence of water as a valued commodity. other ecosystem goods and services included have a negligible impact on justifying costs. key words: invasive vegetation, water and cost-benefit analysis jel: q56, 57 1 introduction by reducing the resilience of indigenous biodiversity and ecosystems, invasive vegetation threatens the sustainable supply of ecosystem goods and services. the extent of the damage caused by invasive vegetation is illustrated in a report prepared for the global invasive species programme which found that invasive species impact on 33 per cent of threatened birds, 16 per cent of threatened mammals, and 28 per cent of threatened amphibians (butchart, chanson & hoffmann, 2009). climate change is expected to further worsen these impacts (perrings, mooney & williamson, 2010). invasive vegetation is as much an economic as an ecological phenomenon: it occurs as a result of economic activity and economic incentives can contribute towards its control. valuing the impact of invasive species requires an interdisciplinary approach that draws from an understanding of the ecological and hydrological processes that drive and are in turn influenced by invasive vegetation. the economic impact of invasive species is determined by the ecosystem in question and the related ecosystem goods and services (perrings et al., 2010). valuation studies of ecosystem goods and services have become routine (van wilgen, cowling & burgers, 1996; loomis, kent, strange, fraser & covich, 2000; ricketts, daily, ehrlich & michener, 2004) with some studies focussing specifically on the costs inflicted by invasive species in south africa (de wit, crookes & van wilgen, 2001; marais & wannenburgh, 2008). estimating the value of these impacts allows decision-makers to evaluate project investments aimed at clearing invasive species and restoring natural vegetation. the economic return of such projects is determined by the direct project costs and the value of the affected ecosystem goods and services. abstract 84 sajems ns 16 (2013) no 1 this study tests the hypothesis that through its impact on ecosystem goods and services, invasive vegetation leads to a reduction in the economic value of natural capital at a micro level. it further argues that by investing in the clearing of invasive species and the restoration of indigenous vegetation, value can be restored to an area through increasing the supply of marketable ecosystem goods and services. the study employs cost-benefit analyses to assess the change in marketable ecosystem goods and services brought about by clearing invasive species and restoring natural capital. it places a specific focus on water as a determinant of the economic efficiency of clearing and restoration projects in the agulhas plain. to this end the study is arranged as follows: section 2 provides an overview of the literature on natural capital, the occurrence and management of invasive vegetation, economic complexities and markets for ecosystem goods and services. section 3 introduces the agulhas plain. section 4 describes the model, while section 5 provides a discussion of the results. section 6 concludes with some policy recommendations. 2 natural capital, invasive vegetation and associated economics ecosystem goods and services are particular features of natural capital on which humans rely for survival. daly (1994) defines natural capital as ‘the stock which produces the flux of natural resources: the population of fishes in the ocean generating the flux of fish going to the market; the forest gathering timber; the oil reserves whose exploitation provide petrol’. daly is correct in regarding natural capital as those features of the environment that support human life, but his definition can be augmented to include ecological systems such as photosynthesis processes, the atmosphere and water cycles (chiesura & groot, 2003; blignaut & de wit, 2004) without which the stocks to which he refers cannot be maintained. ecosystem goods and services are often characterised by open access and lack of property rights, rendering individuals reluctant to invest in goods or services from which other users cannot be barred. this results in an absence of markets and prices that are below the actual value of the good or service. commercial exploitation adds to the pressure, with deforestation as an apt example: as the demand for timber and fuel wood rises, carbon sequestration as one of the ecosystem services provided by trees is affected with detrimental effects to the climate of the planet. in addition to the unsustainable consumption of ecosystem goods and services, invasive vegetation further threatens their production by damaging the resilience of indigenous ecosystems. initial research on the subject was driven by the impact that invasive vegetation has on agriculture, but loss in biodiversity and the disturbance of ecosystem services, water supply in particular, has also attracted the attention of researchers (le maitre, van wilgen, chapman & mckelly, 1996; le maitre, versveld & chapman, 2000; mooney & cleland, 2001; carey, 2007; wilcove, rothstein, dubow, phillips & losos, 1998). biological invasion results from the deliberate introduction of alien species or their unintentional displacement as a consequence of cross-border activity (perrings, williamson, barbier, delfino, silvana, shogren, simmons & watkinson, 2002). global trade has been closely linked to the increase in the occurrence of invasive vegetation (turpie, 2004; levine & d’antonio, 2003), and bright (1999) has gone so far as to label invasive vegetation as a disease caused by globalisation. controlling the spread of invasive species requires ‘[limiting] the number of plant propagules in the long term to a level [that is] tolerable to human activities’ (groves, 1989), allowing the supply of natural capital to be maintained and to continue to provide a sustainable supply of ecosystem goods and services. the impact of invasive vegetation can be mitigated through passively or actively restoring eroded natural capital. passive restoration refers to the removal of invasive species and leaving the veld to fend for itself, while active restoration entails direct participation in the recovery of the area. successful restoration often requires active participation, especially in landscapes where indigenous species are unable to compete with re-sprouting alien plants, or where indigenous vegetation needs to be reintroduced to the area. evaluating whether the removal of invasive sajems ns 16 (2013) no 1 85 vegetation and the active restoration of natural capital is a value adding endeavour at a systems level depends on the direct and indirect costs and benefits incurred. this requires a valuation of the ecosystem goods and services affected by alien vegetation, described as an attempt to determine the relationship between the underlying ecosystem and the overarching economy (aylward & barbier, 1992). the lack of efficient prices whereby changes in the quantity or quality of an ecosystem good or service can be valued often calls for using shadow prices or other proxies to estimate the value of ecosystem goods and services (blignaut & lumby, 2004). a shadow price can be defined as ‘the opportunity cost of products and services when the market price … does not reflect these costs in full’ (mullins, mosaka, green, downing & mapekula, 2007). on occasion when a market for ecosystem goods and services does exist but the mechanism responsible for setting the price is influenced by distortive taxes, subsidies, quotas or tariffs, the price will not reflect the efficient price and will need to be adjusted for these distortions. 3 study area: the agulhas plain, cape floristic region the cape floristic region (cfr) spans 94000 km2 at the southern tip of the african continent. it is home to such a variety of fynbos species that it has been classified as ‘one of the hottest’ global biodiversity hotspots (myers, 1990). of the approximately 8 500 fynbos species, 68.2 per cent are endemic, causing cape flora to be acclaimed as one of the six plant kingdoms of the world (higgens, turpie, costanza, cowling, le maitre, marais & midgley, 1997). the fynbos biome supplies a large array of ecosystem goods and services, including fynbos flowers and other fynbos products, ecotourism, and water cycling from mountain catchments. turpie, heydenrych and lamberth (2003) estimate that the use (marketed and nonmarketed) and existence value of the terrestrial and coastal marine biodiversity of the cape floristic region amount to r10 000 million per annum, equivalent to 10 per cent of the gross geographic product of the western cape. the agulhas plain is a low-lying coastal region that comprises 2160 km2 within the cfr, as illustrated in figure 1. it is home to fynbos and renosterveld vegetation, both fireprone shrubland vegetation types that thrive in the mediterranean climate of the area (cowling & holmes, 1992; rouget, 2003). the agulhas plain hosts four inland towns: stanford, napier and bredasdorp and elim, as well as five coastal towns: gansbaai, pearly beach, agulhas, struisbaai and arniston. most of the land on the agulhas plain is under private ownership and used for commercial agriculture, of which livestock grazing covers close to 50 per cent and fynbos farms account for a further 28 per cent (heydenrych, 1999). nine percent of the area is under conservation in nature reserves such as the agulhas national park, quine point nature reserve and de mond nature reserve. the majority of the remaining portion of land is dryland pastures dedicated to wheat and barley production (conradie, 2010). the agulhas plain is covered by five fynbos vegetation types: mountain fynbos, strandveld fynbos, grassy fynbos, elim fynbos, and limestone fynbos (low & rebelo, 1996). the fynbos ecosystem of the agulhas plain produces a number of products that are traded in both the formal and the informal sector, of which the flower market is the most prominent. the production systems of flower farms on the agulhas plain vary between farms that rely on harvesting flowers from the wild, farms that focus on flower cultivation, and a small group of farms on which a combination of the two methods are employed. the increase in demand for fynbos flowers has led to an increase in flower cultivation (conradie & knoesen, 2009). the fynbos ecosystem also produces other marketable products, such as honeybush tea, thatching reed and sour figs, and supports the beekeeping and honey production industry by providing foraging for bees. honeybush tea is made from species of cyclopia (heydenrych, 1999) and is mostly harvested from mountain fynbos, while thatching reed (thamnochortus insignis) is harvested from limestone fynbos. non-landowners in particular draw benefit from strandveld fynbos from which they harvest sour figs used for making sour fig jam. 86 sajems ns 16 (2013) no 1 f i g u r e 1 location of the agulhas plain, western cape (nowell, 2010) invasive species constrain the production of ecosystem goods and services provided by fynbos vegetation by restricting its growth or by causing changes in the cycles and intensity of fires. this study considers the three most dominant invasive tree species on the agulhas plain: acacia, eucalyptus and pinus. acacia cyclops trees (commonly known as rooikrans) were initially introduced as dune stabilisers and to provide protection (see figure 2), while eucalyptus species were introduced in the 1940s with the purpose of providing timber. pinus species became established through plantations and were also planted to provide tree cover in shrublands (richardson, 1998). today, invasive species still provide benefits: many rural households rely on acacia cyclops invasions in strandveld and lime fynbos as a source of fuel for heating and cooking (turpie, heydenrych & lamberth, 2003), while eucalyptus trees provide a valuable source of pollination for bees. f i g u r e 2 insert from the agricultural journal (bencke, 1908) the fynbos biome is the most heavily invaded biome in south africa (richardson, macdonald, hoffman & henderson, 1997; henderson, 2007). cole, lombard, cowling, euston-brown, richardson and heijnis (2000) estimated that 14 per cent of agulhas plain was invaded with a density of above 50 per cent. in more recent work, nowell (2010) found that this figure had increased to 31 per cent. the high degree of plant endemism, limited water supply and the agulhas  plain   western  cape  province   sajems ns 16 (2013) no 1 87 prevalence of invasive species render the agulhas plain a priority area for restoration. 4 method and approach cost-benefit analysis provides an instrument that can be used to assess the efficiency of projects dedicated to the clearing of invasive species and restoring natural capital under varying assumptions. an efficient outcome of a clearing and restoration project requires that the value of ecosystem goods and services replaced by restoration at least equals the direct project costs. the project adopts a time frame of twenty years, based on the assumption that this is a sufficient period for changes within the ecosystem to occur, while simultaneously providing a realistic timeframe under which landowners can plan and be held accountable for land-use decisions. this study assumes post restoration land-use activities that will ensure a stable supply of ecosystem goods and services. following marais and wannenburgh (2008) and currie, milton and steenekamp (2009), the study tests the impact of a range of low yet positive discount rates in the results of the project. ecosystem goods and services included in the model are selected according to the expected impact of alien removal and fynbos restoration on their supply, the accuracy with which changes in their supply can be valued, and whether they can be captured in a market. the model includes wildflowers and fynbos products, water supply, beekeeping, and fuel wood in the analysis, with 2010 prices used throughout. figure 3 provides a schematic representation of the most prominent marketable ecosystem goods and services affected by alien removal and restoration. f i g u r e 3 ecosystem goods and services affected by clearing invasive vegetation and restoring fynbos on the agulhas plain (adapted from blignaut & lumby, 2004) 88 sajems ns 16 (2013) no 1 changes in biodiversity (often valued through ecotourism) are not included in the model due to the supposition that additional fynbos vegetation will have a negligible impact on the number of visitors to the area. the net impact of alien removal and fynbos restoration on carbon sequestration is also disregarded owing to the assumption that the change in the amount of carbon sequestered will be insufficient to allow for cost-effective carbon trading. the water released is assumed to be of adequate quality for consumption. non-use existence values were not included in the model due to the focus on using marketable ecosystem goods and services to justify clearing and restoration costs. 4.1 model description the value of alien removal and fynbos restoration at a systems level (𝑉!) for year 𝑡 is a function of the annual change in income from fynbos products (𝐼!), water supply (𝑊!), beekeeping (𝐵!), the supply of woody biomass 𝑀! , and clearing and restoration costs 𝐶! . 𝑉! = 𝑓 𝐼!,𝑊!,𝐵!,𝑀!,𝐶! (1) the direct benefits that the fynbos ecosystem generates through focal proteacea flowers and cones, foliage and greens used in flower arrangements, and other fynbos products such as thatching reed and honeybush is captured using net income at farm gate for each fynbos vegetation type (turpie, heydenrych & hassan, 2002). farmers in south africa are not supported by formal subsidies, suggesting that this value estimate can be regarded as an efficient price. the study distinguishes between invaded land that has been transformed by agriculture and development, and invaded natural veld. as expected, invasive vegetation has occupied natural veld to a greater extent than veld under alternative land use. it assumes that wildflowers, foliage and greens, thatching reed and honeybush will be harvested from invaded marginal agricultural land from which farmers receive no direct income, and not from invaded veld. this accommodates for the fact that the latter may be classified as protected or public areas from which no harvesting is allowed. different types of fynbos vegetation types yield varying supplies of wildflowers and fynbos products. it is assumed that the appropriate species are sown during the restoration process to allow wildflowers, honeybush and thatching reed to be harvested from restored areas. to estimate the annual change in net income from wildflowers, a veld age productivity factor that changes as the plants mature is used (bailey, euston-brown & privett, 2007). honeybush harvests are assumed to start in the second year after restoration at an annual net income of r19.20 per hectare (turpie et al., 2002; agricultural research council, 2012). thatching reed generates a net income of r39.67 per hectare (turpie et al., 2002), with harvesting assumed to start four years after restoration (jamieson, 2001; linder, 1990). sour fig harvesting often takes place without the consent of landowners, but as a marketable product provided by the fynbos ecosystem it is included as a benefit in this study. annual net income derived from sour fig harvesting is estimated as r17.90 per hectare (heydenrych, 1999). the study assumes that sour fig harvesting could take place from all restored strandveld fynbos and as a fast grower is available for harvesting one year after restoration (malan & notten, 2006). condensed hectares of different fynbos vegetation types are used to estimate the change in net income at a systems level. direct project costs incurred by alien clearing and fynbos restoration is composed of the cost of initial clearing, the cost of restoration, and the cost of five follow-up clearings. restoration costs include seed collection, seed preparation and sowing. it is assumed that initial clearing and restoration treatments are completed during the first year, and that follow-up clearings are completed consecutively during the next five years. the model uses cost estimates of clearing high density invasion to estimate the cost of clearing the number of condensed invaded hectares on the agulhas plain (marais & wannenburgh, 2008). a hypothetical cost per hectare is calculated based on the proportion of total invasion of each of the invasive species included in the study. the financial net present value (𝑁𝑃𝑉!) estimates whether it is profitable for landowners to clear and restore their land, derived from the change in net income from wildflowers and other fynbos products (equation 2). sour figs sajems ns 16 (2013) no 1 89 are excluded from this estimation since income from sour fig harvesting is not incurred by landowners. the discount rate is r. 𝑁𝑃𝑉! = 𝐶! +   !!!!! !!! ! !" !!! (2) the economic net present value incorporates into the equation the change in the supply of sour figs, the beekeeping industry, the supply of fuel wood and water. fynbos vegetation holds foraging value for bees, while eucalyptus forests provide pollination services that will be foregone if the trees are removed. the change in the value of honey production is based on the difference between net income at farm gate per fynbos vegetation type and the total value of pollination services provided by eucalyptus forests on the agulhas plain, as estimated by heydenrych (1999). if 𝐵! > 0, clearing and restoration will add value to the beekeeping and honey production industry, but if 𝐵! < 0, an opportunity cost is implied. bees do not restrict their behaviour to farm boundaries and estimates are based on the total number of condensed invaded hectares on the plain. the removal of invasive trees on the agulhas plain implies an opportunity cost to many of the rural households. the study assumes that landowners receive no rent from invaded land, leaving the opportunity cost of fuel wood to be estimated as the average net income per hectare that rural households derive from harvesting fuel wood from densely invaded vegetation (turpie et al., 2003). this value is extrapolated across condensed hectares of acacia cyclops invasion in strandveld and lime fynbos. invasive vegetation interferes with aquifers by making demands on groundwater and decreasing the amount of rainwater available to replenish the water table (le maitre et al., 1999). in the western cape, alien species account for using 15.82 per cent of the mean annual water runoff (le maitre et al., 2000). a lower incidence of invasive vegetation will lead to a decrease in evapotranspiration and ultimately to an increase in the supply of groundwater and surface water available. alien clearing and restoration on the agulhas plain will release an estimated 82 264 050 kl of water into the hydrological system (nowell, 2010). the fraction of the total water released by alien clearing that will be made available as runoff and that can be collected for consumption is unclear. in addition, no studies specific to the agulhas plain provide estimates of the average value of water for different industries. this study opts to estimate the average value of water (𝑝!) required to justify alien clearing and restoration at a systems level under different runoff scenarios (𝑦!) (equation 3). the use of average value instead of the marginal value of water is based on the assumption of constant returns to scale and price-taking by consumers. 𝑝! =   !!! !!!!!!!!!!! !!! ! !" !!! !"  !"#  !"! !! !!! ! !" !!!   (3) 5 results 5.1 ecosystem goods and services the change in annual net income from wildflowers and other fynbos products harvested from the restored areas on the agulhas plain will range from r0.4 million to r1.3 million. figure 4 illustrates that proteacea flowers and cones from mountain fynbos, and sour fig harvests from strandveld fynbos hold the greatest potential for generating income. total clearing and restoration costs amount to r176 million, of which the restoration component comprises 21 per cent. the costs incurred during the first year account for 72 per cent of total direct costs. as an indirect cost, the pollination services that eucalyptus forests provide for beekeeping outweighs the foraging value of indigenous fynbos. this suggests that an annual opportunity cost of r1.37 million to the beekeeping industry will occur if all eucalyptus forests are removed from the plain. the additional opportunity cost of fuel wood due to the removal of acacia cyclops will amount to r4.31 million. table 1 lists the range of different direct and indirect cost and benefit components. 90 sajems ns 16 (2013) no 1 f i g u r e 4 direct net income from fynbos products at a system level t a b l e 1 direct and indirect costs and benefits; million rand benefit/cost components annual average over 20 years net present value 3% 8% 12% direct costs and benefits income from wildflowers and other fynbos products r 0.92 r 13.48 r 8.48 r 6.13 clearing and restoration costs -r 9.86 -r 194.67 -r 190.83 -r 188.14 indirect costs fuel wood -r 4.31 -r 64.05 -r 42.27 -r 32.16 beekeeping and honey production -r 1.37 -r 20.33 -r 13.41 -r 10.21 5.2 cost-benefit analyses the financial net present value of clearing invasive vegetation and restoring natural capital on the agulhas plain ranges between -r183.5 million and -r184.5 million at the system level, depending on the discount rate assumed. this indicates that an investment to clear the entire agulhas plain of invasive species and restore natural fynbos vegetation will not be offset by the additional direct income that can be generated from harvesting fynbos flowers and other fynbos products. when the impact on beekeeping, honey production and the opportunity cost of fuel wood is added, the economic net present value yields a negative return of between r224 million and r265 million. the results suggest that the water released through clearing and restoration needs to be an economically valued commodity in order to ensure a cost-effective outcome. the availability and cost of alternative water sources determines whether the cost at which water can be made available through alien clearing and restoration is low enough to justify investment. figure 5 summarises the outcome of equation 3 by illustrating the average value of water that will justify clearing and restoration under different discount rates in relation to runoff, and compares these values to existing costs of water on the agulhas plain. sajems ns 16 (2013) no 1 91 f i g u r e 5 average water value that will justify clearing and restoration costs under hypothetical runoff scenarios the cape agulhas municipality (cam), in which the agulhas plain is primarily located, abstracts more than half of its water from production boreholes. an estimated 1 896 437 kl of water was supplied to towns on the agulhas plain during 2007/08, equivalent to 2.3 per cent of the total amount of water that is projected to be released through alien clearing. the cam calculates the unit cost of water (water supply divided by operating costs) at r5.75 per kilolitre. this estimate includes personnel expenses, repair and maintenance costs and capital expenditure and is not an accurate reflection of the value of water in the area, but it does provide an average upper estimate of what the municipality is willing to pay for water supply. at this upper estimate of water value, 3-6 per cent of water released by alien clearing and restoration will have to be provided as consumable runoff in order for such a project to be efficient. in 2001/02, the municipality had a budget of r0.35 million for the development of water resources in struisbaai. potential boreholes in the area were estimated at being able to yield an additional 208 050 kl per annum (overberg district municipality, 2003). this amounts to a cost of r2.46 per kilolitre, and suggests that alien clearing and restoration could provide a lower cost alternative if more than 10-14 per cent of water released is made available as runoff in the area. a similar approach for water resource development in bredasdorp provides a cost estimate of r1.25 per kilolitre (cape agulhas municipality, 2009), where 15-28 per cent of water released will have to be made available to ensure an efficient outcome. in accordance with turpie et al. (2003), a comparable value for the cost of water supply is provided by the average capital and operational costs of future water supply schemes in the western cape. burgers, marais and bekker (1995) estimate this to be r1.78 per kilolitre. our results suggest that at consumable runoff of more than 13-20 per cent of water released through alien clearing, the latter will provide a lower-cost alternative for augmenting water supply. dry land crop production accounts for a large proportion of land use on the agulhas plain. in south africa the national water accounts are increasingly regarded as one of the more accurate estimates of the average value of water per land use type (turpie, 2004). the accounts do not disaggregate water use by local municipality, but estimate that in the breede water management area (wma) – in which the agulhas plain is located – r0.89 worth of dryland crops is produced per kilolitre of water used in dryland agriculture (statistics 92 sajems ns 16 (2013) no 1 south africa, 2009). assuming that dryland production practices on the agulhas plain are similar to the rest of the breede wma, at least 23-40 per cent of water released through alien clearing and restoration will have to be made available for dryland crops on the plain in order to justify the investment. past water scarcity on the agulhas plain was addressed by building dams or drilling boreholes (cape agulhas municipality, 2009). this study suggests that, depending on the value of water in the agulhas plain, alien clearing and restoration can provide a positive return if 3-40 per cent of the water released is made available for consumption (illustrated in figure 5). as climate change progresses and the area becomes even more water scarce, clearing and restoration will become costeffective at lower quantities of runoff. 6 conclusions and recommendations growing human societies and impending climate change is threatening the sustainable supply of ecosystem goods and services. invasive vegeta tion poses an additional threat to the goods and services supplied by indigenous ecosystems. this study tests the hypothesis that alien removal and natural capital restoration may add value to invaded areas through recovering the ecosystem goods and services supplied by indigenous vegetation. it draws from ecological, hydrological and economic observations to assess the net impact that alien removal and restoration could have in the agulhas plain. the results unequivocally show that the cost of clearing the entire agulhas plain of invasive vegetation and restoring indigenous fynbos to invaded areas cannot be justified solely based on direct financial benefits. the results further illustrate that in the absence of water as an economically valued commodity, other indirect economic impacts are unable to justify investment. preliminary appraisals of the value of water under different runoff scenarios suggest that water at a systems level is sufficiently valued to provide an efficient outcome for clearing and restoration projects on the agulhas plain. however, it is important to note that runoff and water values are industry and area specific. while the results indicate that alien clearing and restoration could be justified at a systems level, investment decisions should be preceded by an investigation into area specific runoff and water demand. payments for ecosystem services can be used as an instrument to encourage alien clearing and restoration activities. local municipalities on the agulhas plain could offer landowners payments to clear and restore their land in exchange for a proportion of the water made available. in this way farming income can be augmented to the extent that it renders alien clearing and restoration financially feasible for landowners, while at the same time providing municipalities with a lower cost alternative of water supply. alternatively, municipalities can decide to undertake clearing activities themselves in return for a proportion of the water made available, leaving landowners responsible to restore cleared land. irrespective of the strategy adopted, payments must be designed in a way that ensures that landowners will continue to keep their land free of invasive alien vegetation. payments would have to compensate the gap between direct project costs and improved land use. with the rising economic value of water induced by climate change and growing demand, it is expected that alien clearing and restoration will increasingly become an economically viable land and ecosystems management strategy, and payments for ecosystem goods and services an efficient instrument with which such activities can be encouraged. endnote 1 study coordinated by asset research and funded by the water research commission (project k5/1803). acknowledgements we are grateful to the water research commission (wrc) – key strategic area, water utilisation in agriculture (ksa4) who commissioned and funded this study. the work forms 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(ed.) biological invasions: a global perspective. john wiley & sons ltd. henderson, l. 2007. invasive, naturalized and casual alien plants in southern africa: a summary based on the southern african plant invaders atlas (sapia). bothalia, 37:215-248. 94 sajems ns 16 (2013) no 1 heydenrych, b.j. 1999. historical background of land use on the agulhas plain. `1 flower valley farm (ed.). higgens, s.i., turpie, j.k., costanza, r., cowling, r.m., le maitre, d.c., marais, c. & midgley, g.f. 1997. an ecological economic simulation model of mountain fynbos ecosystems: dynamics, valuation and management. ecological economics, 22:155-169. jamieson, h. 2001. thamnochortus insignis (mast.). available at: http://www.plantzafrica.com/planttuv/ thamnocortinsig.htm [accessed 2012-06-04]. le maitre, d.c., scott, d.f. & colvin, c. 1999. a review of interaction between vegetation and groundwater. water sa, 25:137-152. le maitre, d.c., van wilgen, b.w., chapman, r.a. & mckelly, d.h. 1996. invasive plants and water resources in the western cape province: modelling the consequences of a lack of management. journal of applied ecology, 33:161-172. le maitre, d.c., versfeld, d.b. & chapman, r.a. 2000. the impact of alien plants on surface water resources in south africa: a preliminary assessment. water sa, 26:397-408. levine, j.m. & d’antonio, c.m. 2003. forecasting biological invasions with increasing international trade. conservation biology, 17:322-326. linder, h. p. 1990. the thatching reed of albertinia. veld and flora, september:86-89. loomis, j., kent, p., strange, l., fraser, k. & covich, a. 2000. measuring the total economics value of restoring ecosystem services in an impaired river basin: results from a contingent valuation survey. ecological economics, 33:103-117. low, a.b. & rebelo, a.g. 1996. vegetation of south africa, lesotho and swaziland. pretoria, department of environmental affairs and tourism. malan, c. & notten, a. 2006. carpobrotus edulis. available at: http://www.plantzafrica.com/ plantcd/carpobed.htm [accessed 2012-06-04]. marais, c. & wannenburgh, a.m. 2008. restoration of water resources (natural capital) through the clearing of invasive alien plants from riparian areas in south africa: costs and water benefits. south african journal of botany, 74:526-537. mooney, h.a. & cleland, e.e. 2001. the evolutionary impact of invasive species. pnas, 98:54465451. mullins, d., mosaka, d.d., green, a.b., downing, r. & mapekula, p.g. 2007. a manual for cost benefit analysis in south africa with specific reference to water resource development. water research commission report, 305/07. myers, n. 1990. the biodiversity challenge: expended hotspot analysis. the environmentalist, 10:243-255. nowell, m. 2010. determining the hydrological benefits of clearing invasive alien plants on the agulhas plain. msc, university of stellenbosch. overberg district municipality 2003. water services development plan: cape agulhas municipality. draft 1, volume 1:1-98. perrings, c., mooney, h.a. & williamson, m.h. 2010. the problem of biological invasion in: perrings, c., mooney, h. a. & williamson, m. h. (eds.) bioinvasions and globalization: ecology, economics, management and policy. new york: oxford university press. perrings, c., williamson, m., barbier, e.b., delfino, d., silvana, d., shogren, j., simmons, p. & watkinson, a. 2002. biological invasion risks and the public good: an economic perspective. conservation ecology, 6. richardson, d.m. 1998. ecology and biogeography of pinus. cambridge: cambridge university press. richardson, d.m., macdonald, i.a.w., hoffman, j.h. & henderson, l. 1997. alien plant invasions. in: cowling, r. m., richardson, d. m. & pearce, s. m. (eds.) vegetation of southern africa. cambridge: cambridge university press. ricketts, t.h., daily, g.c., ehrlich, p.r. & michener, c.d. 2004. economic value of tropical forest to coffee production. pnas, 101:12579-12582. rouget, m. 2003. measuring conservation value at fine and broad scales: implications for a diverse and fragmented region, the agulhas plain. biological conservation, 112:217-232. sajems ns 16 (2013) no 1 95 statistics south africa. 2009. national accounts: water accounts for south africa. discussion document. pretoria. turpie, j. 2004. the role of resource economics in the control of invasive alien plants in south africa. south african journal of science, 100:87-93. turpie, j., heydenrych, b.j. & hassan, r. 2002. fynbos: a preliminary assessment of its status and economic value. in: hassan, r. (ed.) accounting for stock and flow values of woody land resources. turpie, j., heydenrych, b.j. & lamberth, s.j. 2003. economic value of terrestrial and marine biodiversity in the cape floristic region. biological conservation, 112:233-251. van wilgen, b.w., cowling, r.m. & burgers, c.j. 1996. valuation of ecosystem services. bioscience, 46:184-189. wilcove, d.s., rothstein, d., dubow, d., phillips, a. & losos, e. 1998. quantifying threats to imperiled species in the united states. bioscience, 48:607-615. samms ns vol 3 (2000) no 2 235 foreign direct investment flows and fiscal discipline in south africa n j scboeman, z clausen robinson and t j de wet department of economies. university of pretoria abstract this paper investigates the impact of fiscal policy on foreign direct investment (pdi) in south afiica during the past 30 years. casual empirical analysis reveals a definite linkage between fdi flows and variables such as the deficit/gdp ratio, representing fiscal discipline, and the tax burden on foreign investors. this relationship is substantiated by econometric analysis. given the economy's large degree of dependence on foreign capital, the government may contribute to an investor-friendly environment by adjusting fiscal policy. some inroads have been made in this regard with the government's medium-term expenditure framework (mtef), which projects a policy of strict fiscal discipline in years to come. however, the tax burden is still relatively high and, due to its impact on foreign direct capital flows, requires urgent attention. jel e62, f21 1 introduction the growing rate of global economic integration has a profound impact on economic policy especially fiscal policy. of particular importance in this regard, is the increase in trans-national capital mobility. according to pure economic theory, free capital flows improve global resource allocation and transfer of technology. however, it could also result in speculative runs on currencies, destabilising the macroeconomic framework and imposing adjustments on the fiscus, with detrimental consequences for the socio-economic environment. the events in mexico (1994), south afiica (1996 and 1998), thailand (1997) and malaysia (1997), are illustrative of the excessive foreignexchange volatility that can arise from free international capital flows (abedian. 1998: 21). the iiberalisation of international capital movements was precipitated by a major change in the perception of the role and scope of government in the economy during the last two decades (guitiim, 1999: 26). government evolved r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 236 sajems ns vol 3 (2000) no 2 from predominant participant in economic activity towards a situation in which government activity was designed mainly to provide an appropriate setting for private economic activity, which became the dominant force in resource allocation. thus, strong markets developed in the international economy as a result of deliberate policy initiatives to liberalise capital movements. these in turn, tightened the links between national economies, with additional effects on fiscal and other policies. 2 theories explaining capital flows the objective of this study is not so much to explain the theory behind capital flows, but to indicate how capital flows could be affected by fiscal policy. therefore, a brief summary of existing theory on capital flows will suffice to illustrate this interrelationship. according to van der walt (1994: 107), the debate on the detenninants of foreign direct investment (foi) in south africa is characterised by misconceptions. most of the arguments address only the factors that encourage or discourage foi flows, instead of establishing a general framework for explaining fdi behaviour. exchange controls, for example, frequently carne under attack and it was claimed that foi will increase when exchange controls are lifted. others argued that a lack of political stability was the major deterrent for fdi for many years and that in the new, stable political dispensation, fdi will increase. other arguments refer to the costly, unskilled and militant labour, relatively high domestic production costs, low productivity, protectionist industrial and trade policies, and the smallness of south africa's domestic market compared to other emerging markets. another argument, however, deserves special attention and forms the basis for this investigation. this argument concerns the impact of economic policies and, specifically fiscal policy, on fdi. numerous studies of the emerging economies have identified fiscal discipline and a restricted, but efficient and unswerving economic role for government, as essential conditions for their economic success (harmse, 1994: 38). amirahmadi (1994: 183) emphasises the importance of fiscal incentives to attract fdi. such incentives include tax breaks and tax holidays, favourable utility usage fees" reduced custom duties and foreign exchange restrictions, relaxed ownership controls and streamlined administrative procedures. these are provided to foreign investors by host governments in an attempt to improve profitability and relax the strict control on the repatriation of profits. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 237 the newly industrialised countries (nics) are typical of those countries whose host governments have utilised liberal and attractive incentives to sustain high levels of foi inflows. many countries also set up policy enclaves such as export processing zones and special economic zones, to promote foreign investment and export industries. proven successes in this regard include the three zones in taiwan and china's zones, which utilise close to 12 per cent of total fdi at the national level (ibid: 183). however, amirachmadi also cautions that the effectiveness of enclave zones as well as fiscal incentives in attracting foi is limited. multinationals (mncs) invest according to their global strategy. if the investment climate in a developing country is generally unfavourable, the inducement offered by these zones is most unlikely to encourage mncs to change their global development strategies. conventional economic theory has relied on a model of portfolio investment to explain the international movement of capital. this theory postulates interest rate differences among countries as the cause of international capital flows (root, 1984: 456). capital will flow from country a to country b when the long-term interest rate (return on capital) is higher in country b than in country a, reflecting the comparative abundance of capital in the latter. capital will continue to flow from one country to the other until both interest rates and the marginal product of capital in the two countries are the same. however, in south africa, the data do not support the hypothesis that interest differentials explain the net flows of capital this is also the case with fdi which, according to theory, will flow in when rates of return on foi exceed the rates of return on home investment (ibid: 456). this does not apply in south africa, which foreign investors apparently still perceive as a high risk country. in fact, the majority of capital market transactions among residents of different countries, also in the south african case, could be identified as largely offsetting swaps of assets at market prices, i.e. portfolio arbitrage. the remainder of these gross flows constitutes real capital movements, i.e. trade of assets against goods. a second hypothesis, namely that multinational enterprises expect to earn a higher income than local competitors, appears to offer a better explanation. the higher cost due to distance, time, information gaps, differences in nationality and culture, etc., must be off-set by incomes exceeding those earned by local competitors. the multinational enterprise earns a higher income through the advantages it gains over local competitors due to incentives, superior technology, entrepreneurial skills, etc., provided by the host country's government. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 238 samms ns vol 3 (2000) no 2 it follows then, that the trends in foreign direct investment may be explained by departures from perfect competition (market imperfections). three different forms of market imperfections are important in this regard, namely monopolistic practices, government induced externalities and country specific factors that influence the flow of foreign investment. in the latter case, fiscal policy and expectations regarding future fiscal policies, seem to be of fundamental importance. not only has the ability of governments to tax capital diminished, tax competition has also led to a global reduction of profit taxes (abedian, 1998: 24). tanzi (1996: 20) argues that globalisation increases the scope for tax competition i, because it provides countries with an opportunity to export part of their tax burden to other countries. this opportunity clearly creates the possibility of abuse by some countries. tax competition could, however, be advocated in order to counter the over-expansion of the public sector, which may result from other tax externalities and the pursuit of self-interest of bureaucrats and politicians. the lowering of tax rates, i.e. capital income tax competition, void of harmful tax practices (oecd, 1998), could therefore be one of the disciplinary tools for future south african governments, assuming general financial stability (ceteris paribus). the government's administration of public debt has become the focus point of fiscal policy evaluation by foreign as well as domestic investors. countries with relatively high levels of deficit/gop ratios are under great pressure to undergo fiscal adjustment policies. in view of the uncertainty regarding capital flows caused by the above·mentioned externalities, it is believed that fiscal surpluses serve as a buffer to minimise disruption in the delivery of public goods and services (ibid: 25). 3 tax sensitivity of foreign direct investment for countries where the degree of fdi penetration is high, the revenue raised from taxing fdi can represent a significant portion of total tax revenues. however, should the volume of fdi respond negatively to taxation, the host country must trade off the revenue gains (if any) of increased taxation against the economic cost of discouraging fdi. in a study by shah and slemrod (1990: 2), it was found that in the case of mexico, fdi was very sensitive to changes in domestic tax rates relative to those of investing countries. however, the authors also pointed out that, in addition to taxation, the regulatory framework and overall economic and political climate in mexico have a substantial impact on fdi transfers and reinvestments. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 239 modern literature has, for the most part, concluded that the demand for fdi is primarily an issue of industrial organisation (shah, 1990: 15). the effective tax rate on corporate income from fdi is a complex function of the statutory tax rate on corporate income, the extent of tax credits granted and the definition of the tax base, including the system of depreciation and how gross income and deductions are allocated between countries. according to shah (ibid: 16), there are two approaches to measure the impact of the effective tax rate on new investment according to the analytical approach, the level of pre-tax return required for a stylised investment to yield a given return after tax, is calculated. the magnitude of the difference between the pretax rate of return and the after tax rate is a measure of the tax-related disincentive to invest. the other approach would be to calculate the ratio of taxes paid in a given year, by means of some measure of income that is independent of the definition of taxable income. this approach may capture some of the features of the tax law and other factors (such as inflation), which are not accommodated by the analytical approach. another factor that would impact on the effective tax rate, is whether the tax is . levied according to the territorial or world-wide system. under a territorial system, the home country levies no tax of its own on the foreign source income. under the world-wide system, the multinationals' home country asserts the right to tax its income regardless of where· it is generated. in order to avoid two tiers of taxation, these countries offer their multinationals a limited credit against domestic tax liability for certain taxes paid to foreign governments. in most cases the tax liability (and credit) attendant to subsidiaries' foreign-source income is deferred until dividends are repatriated to the parent company. 4 capital flows to and from south africa an empirical analysis the south african economy is characterised by a severely sub-optimal performance (sarb: s-147). due to the low level of average growth, unemployment is a major problem. furthermore, the data also indicate so-called jobless growth. this low level of growth impacts negatively on savings, which in turn impede growth as a result of a lack of foreign capital to fmance the required level of investment that would cure the unemployment problem. figure 1 shows that net capital flows to south africa became very volatile since the mid-seventies, after political incidents such as the sharpeville uprising in 1976. the volatility (and negative tendency in net capital flows) became even more evi~ent after 1984, which will be remembered for the so-called "rubicon" r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 240 sajems ns vol 3 (2000) no 2 speech of the then prime minister, mr p w botha. this had a very negative impact on investment and, therefore, economic growth and job creation in south africa, especially in view of the very low savings propensity of south africans. government savings in particular, but also personal savings perfonned very poorly. the saving/gdp ratio reached a maximum of 35 per cent in 1981, whereafter it declined to below 15 per cent in 1998 (sarb: s-130). during the same period, the investment/gdp ratio declined from 33 per cent to approximately 16 per cent. thus, the country is to a large extent dependent on foreign capital, not only to bridge the current gap between savings and investment, but also to expand investment to more acceptable levels. table 1 also shows that most of the foreign capital that is being invested in south africa, is in the fonn of portfolio investment that could be withdrawn in the very short run. a large amount of investment in south african equities also seems to be from index traders, investors who purchase a basket of equities of different countries, according to their share in the international finance corporation (ifc) emerging market index. south africa's ability to attract fdi is, therefore, tested continuously. figure 1 net capital flow and fdi 7ixxl 3oxj() 1m) 2s<m 5(xx) 20xxl 4000 15(xx) rm3qx) itrol 21m 5(xx) 1000 (i (i -1000 -5(xx) -21m -itrol n3~~~~~mm~a~~~.~~~~~~ years 1-fdi -netcap flow r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . samms ns vol 3 (2000) no 2 241 table 1: direct and portfolio investment in south africa r---' year direct investment portfolio investment 1991 111 666 1992 -5514 4950 1993 941 2417 1994 -3040 10008 1995 -4557 9020 1996 -970 9576 1997 6756 30580 1998 -6471 20375 source: s a reserve bank, december 1999 next, the changes in tax policy that could impact on tendencies in fdi had to be analysed. various tax law amendments are proof of government's commitment to fiscal refonn. since 1994, non-resident shareholders' tax has been abolished, the corporate tax rate has been lowered to 35 per cent in 1990, and to 30 per cent in 1999. further amendments included the extension of the source provisions to tax residents on their passive income from a foreign source, as well as the incorporation of transfer pricing and the capitalisation provisions in the income tax act (katz, 1994 and 1995). apart from this, the south african government introduced various supply side measures as part of its macroeconomic strategy for growth, redistribution and employment (gear). major elements of this policy include: (a) an accelerated depreciation allowance for income tax purposes on plant and equipment and on buildings intended for manufacturing activities, as from 1 july 1996; and (b) a tax holiday of up to 6 years for new projects with assets in excess of r3 million. 5 the model the discussion thus far suggests that a general empirical model explaining the impact offiscal discipline on fdi could have the following fonn: fdis = f(y, r,(tu t), x,d) where x is the deficit/gop ratio which represents the state of fiscal discipline. r is a risk index for investing countries. the risk index consists of three components, each with a weight of 33 per cent. these components consist of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 242 samms ns vol 3 (2000) no 2 the foreign debt/gop ratio, interest payments! export earnings; and the extent of import cover. the parameter d represents a dummy variable to correct the impact of sanctions, and y represents a yield-interest differential. the parameter t represents the effective rate of taxation on new investment by the recipient country and tu is the tax rate of the home country. the data used in the estimation were obtained from the south african reserve bank, the international financial statistics, government statistics and the world bank. the time series covers the period 1970 to the end of 1998. to determine the influence of the tax rate on foreign direct investment in south africa, the absolute value of corporate tax in south africa and the united kingdom is expressed as a ratio to the respective countries' gop, with a series consisting of the differential between the two ratios. in both cases, taxes as well as gop values are expressed in terms of united states dollars. in order to capture the effect of the yield (return) on investment in south africa, the net operating surplus is expressed as a percentage of total fixed investment in south africa. for investment to be profitable, the yield on investment should exceed its opportunity cost. therefore, the real interest rate in south africa was deducted from the yield on investment. the equation was estimated using the engel and y 00 three step approach. the long-run equilibrium equation was followed by the estimation of an error correction model (ecm) to capture the short run effects. the last step in the engel and y 00 approach uses the ecm to estimate the final long-run equilibrium equation. the functions are based on similar work done by shah and slemrod, 1990: 20). the long-run results are reported below. estimation of the engel and yoo long-run equation the estimated long-run model and the calculated t-values are summarised in table 2. the results in the above table represent the fmaiiong-run cointegration equation for foreign direct investment in south africa. economic evaluation of this relationship indicates that all the variables have the expected sign. in addition, all the variables are statistically significant at the 5 per cent level of significance. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 243 table 2: engle and yoo long-run equation dependent variable: foreign direct investment/gop explanatory variable: coefficient standard error t-ratio south african -137395.93 34476.10 -3.98* government oeficit/gop corporate tax differential -74.89 37.78927 -1.98* yield-interest differential 0.000917 3.15e-05 2.66* risk index -0.000138 2.8se-05 -4.85* sanctionsdummv -0.005832 0.001666 -3.51 * significant at the 5 per cent level of significance. the significance of the results in table 2 is that both the fiscal policy variables have an effect on foreign direct investment. more specifically, an increase in the difference between the south african corporate tax level (expressed as a ratio to the south african gop), and the united kingdom corporate tax level (also as a ratio to the united kingdom gop), reduces foreign direct investment relative to the gop in south africa. the effect of changes in the budget deficit before borrowing relative to the gop, bas an even greater negative impact on foreign direct investment relative to the south african gop. furthermore, an increase in the difference between the return on investment and the interest rate also proved to be significant for fdi flows. the risk index and the effect of sanctions also proved to be statistically significant. 6 conclusion fiscal policy is gaining in importance in growth-oriented adjustment programs supported by the necessary inflow of capital. not only should it contribute to increased domestic saving to finance the required level of investment, but due account should also be taken of the way in which fiscal policy influences the net flow of foreign direct investment. for south africa, to successfully address its development problems, substantially more foi has to be attracted. the empirical results from this study show that a lot will have to be done to transform the south african economy into an investor friendly environment. apart from pure economic reasons based on market principles, government policy (especially also fiscal policy), plays a major role in this regard. of special importance are the deficit before borrowing and the relative tax burden on prospective investors in south africa. the increase in both the tax burden and the deficit/gop ratios during the eighties and beginning of the nineties, have impacted negatively on fdi and, therefore, on economic growth in the country. serious attention should be paid r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 244 sajems ns vol 3 (2000) no 2 to the relationship between the structure of taxation and its impact on foreign direct investment. in south africa, a heavy dependence on a few tax instruments, applied at high rates to a limited number of taxpayers, has resulted in severe distortions in relative prices, providing incorrect signals to investors. the l tef (long term expenditure framework) of the government, has made some progress towards solving this problem. endnote various measures can be taken by governments (national as well as subnational level), to adjust (lower) their tax rates in order to attract mobile factors of production (capital is seen as the most mobile factor of production) from other regions. tax competition can, therefore, also be regarded as an inter-jurisdictional externality and can lead to an inadequate supply of public services. references abedian, i. and biggs, m. (1998) economic globalisation and fiscal policy, oxford university press, cape town. 2 amirachmadi, h. and wu, w. (1994) "foreign direct investment in developing countries", journal of developing areas, 28, part 2. 3 department of finance (1999) budget review. 4 heller. p .s. (1997) "fiscal policy management in an open capital regime", imf working papers, wp 97/20. 5 imf research department staff (1997) "capital flow sustainability and speculative currency attacks", finance and development, december. 6 mahler, w. (1990) "the growth of the korean capital market", finance and development, june. 7 razin, a. and yuen, c. (1996) "capital income taxation and longrun growth: new perspectives", journal of public economics, 59. 8 root, f.r. (1984) international trade and investment (5th ed.) southwestern publishing co, university of pennsylvania. 9 shah, a. and slemrod, j. (1990) "tax sensitivity of foreign direct investment: an empirical assessment", policy research and external affairs, working papers, world bank. 10 south african reserve bank, quarterly bulletin of the reserve bank, various issues. 11 van der walt, j. and de wet, g.l. (1994) "the prospects for foreign investment in south africa", strategic review for southern africa, vol. 16(2). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no i overcoming the development problem of the nation-state in africa through regionalism skbasante legon. ghana; formerly uneca. addis ababa abstract regionalism, of which the european union is a successful example, has also been adopted by several african countries. the economic problems to be overcome here, more often than not include a sparse population, small internal markets, deficient infrastructure and economies vulnerable to fluctuating world prices. a further rationale for regionalism is more explicitly political in nature. meeting the challenges of african development through a strategy of regionalism has been an enormous task in the past, and while there may be grounds for pessimism, this paper views the future with guarded optimism. jeloss i introduction regionalism, which has heen adopted by a large number of african countries as a strategy for meeting the development challenges of the nation-state, has become such a world-wide phenomenon that the post-world war period has been to some extent described as an "era of regional integration" or, as scholars like haberler would have it, "the age of integration". so much is this the case that nowhere in the world today, do the policy makers and economists tackle any problem of economic development without first taking into consideration theories and trends of economic integration both at home and abroad. for economists and social scientists today, regionalism is an essential aspect of the dynamics of modem society in its continuous process of transformation. moreover, it is acknowledged as an important factor of economic development in the developing countries and of more rapid growth in the industrial ones. linking the concept of regionalism with development has become so important that scholars like john sloan would prefer to substitute the term "developmental regionalism" for that of regional economic integration, because the latter, they contend, is imprecise, static, and irrelevant to the development issue (sloan, 1971: 142). in recent economic literature, the terms "integration" or "common r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 2 sajems ns vol 3 (2000) no 1 market" have tended to become nearly synonymous with "rapid economic growth", "acceleration of economic development" or "big push". regardless of the tenninology used, there can be no doubt that the process of regional integration is now inextricably linked to that of economic development. it is against this background and, particularly, following the success of experience of the european union, that the strategy of regionalism has been regarded by policy makers in africa to be a highly desirable objective. it is considered to be highly crucial in attaining economic development, .promoting regional stability and guaranteeing african influence in international negotiations. regional aspirations as shared by african leaders and thinkers, academic theoreticians and pragmatic activists alike, reflect a general desire to break the confmes of the nation-state, and a denial of all that divides the regions of the continent, including the multiple barriers to the free movement of goods and services, people and capital among countries, and differences in legal, governmental, and educational structures. these regional aspirations also constitute a response to the manifest incapacity of the state to generate development. they thus include a search for solutions extending beyond what existing nation-states appear capable of providing, including better regional infrastructure, better management of the region's resources, increased intraregional trade and promotion of autonomous regional industrialization. the strategy of regionalism was given a new lease of life with the adoption, in april 1980, of the lagos plan of action (lpa) and the final act of lagos (fal), which is a historic document that constitutes the fli'st comprehensive continentwide fonnulation and articulation of africa's preferred long-tenn development objectives. the plan is a response to the elusiveness of postcolonial development in africa, to the shattering of "the african dream", and to the dismal development prospects for africa in the 19808. it is in the lagos plan, described as africa's economic magna carta, that african leaders committed themselves to the "creation, at the national, subregional and regional levels, of a dynamic and independent african economy" and thereby pave the way for the essential establishment of the african common market leading to an african economics community (oau, 1981). regionalism, which is discussed in virtually every chapter of the plan, constitutes an integral condition for its implementation. ironically, however, experience has made many students of the history of regionalism in africa pessimists or even cynics. for by 1980, when the lagos plan was adopted, almost all the regional economic cooperation and integration schemes optimistically launched in the 1960s had become largely moribund. besides, those groupings established in the 1970s and 1980s have not made r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no i 3 much progress. thus the first phase of regionalism, which was boosted by the creation of the european community, did not flourish in africa. the striking contradiction between general emphasis on the need for regionalism and the scanty evidence of practical success has raised some crucial questions and provoked debates and exchanges on the concept of regionalism in africa. why is there so little progress and such faltering steps in the process of regionalism in africa? is it because the african states have failed to see the advantages of regionalism or collective self-reliance? or, are there some undercurrents which rock the very foundation of regionalism in africa? what has, in short, gone wrong? despite the setbacks in the past and clear indications of current uncertainties the idea of regionalism continues to be popular, while enthusiasm for it is high and actually appears to be rising. many still believe that the establishment of larger political and economic units in africa would enhance development and that regionalism is inevitable for the long-term, sustainable and self-reliant development of the continent. it is not surprising therefore, that following the second wave of regionalism in the early i 990s, the question of economic integration is once again at the top of the policy agenda in almost al\ the subregions of africa. this is partly in line with recent worldwide trends towards increasing globalization and liberalization of the world economy and the formation of new, powerful economic and trading blocs such as the single market of the european union (eu), the us-canadamexico north american free trade agreement (naft a) and the increased momentum of cooperation efforts within the association of south east asian nations (a sean). regionalism in africa is being looked at again as a way to overcome the marginalisation of the continent in the world economy, to minimise the costs of african market fragmentation, to achieve faster, more diversified and sustainable economic growth that would enable africa to effectively respond to the challenges of the emerging world of trading blocs, rapid changes in technology, liberalization of the world trade and the globalization of world production. will the regionalism of the 1990s prove more durable than the regionalism of the 1 960s, or will it run the risk of becoming "the latest international fad"? to what extent has regionalism in africa become an effective instrument of economic decolonization? or, how has it contributed to the reduction of the age old dependence of the nation-states in africa on the outside world and created conditions that will make selfsustained autonomous development possible? this paper does not pretend to provide exhaustive answers to these questions. neither does it attempt to provide solution to all aspects of the african r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 4 sajems ns vol 3 (2000) no i development problem through regionalism. particularly is this the case, as "development" is a loaded, complex and imprecise term which, as david apter argues, "means many different things to many different people" (apter, 1987: 7). regionalism should not be regarded as a single, all-inclusive means of meeting the development challenges of the nation-state in africa, for there are limits, very great limits, to what it can contribute or accomplish. economic integration, it has been stressed, is not a panacea for the complex problems of the african subregions. a number of bottlenecks to development cannot be direcdy affected by regionalism. accordingly, this paper seeks to examine the extent to which regionalism, as one of the political, security and monetary challenges of the nation-state in africa. following this introduction, section ii seeks to focus attention on the rationale for regionalism in africa. section iii provides a critical assessment of the failure of the regional integration schemes. in section iv, policy measures towards the twenty-first century are provided. section v concludes the paper with a brief summary of the chances of survival of the new regionalism in africa. ii the rationale for regionalism in africa let us begin by clarifying some conceptual ambiguities to enable us better appreciate the differences between four major concepts: those of regionalism, regional integration, regional cooperation and economic integration, which have been used almost interchangeably in this paper. regionalism is taken to represent simply a regional approach to problem solving, including regional integration, regional cooperation or both. the terms "regional integration" and "regional cooperation" have in common the involvement of neighbouring countries in collaborative ventures. on the other hand, the term "economic integration" is used more restrictively to refer to increased trade and factor flows between neighbouring countries, as a result of trade liberalisation or the coordination of economic activities. the concept of regionalism takes on a predominantly economic slant in the literature, to the point of confusion with that of "economic integration". however, it should not be viewed exclusively in such terms. for regionalism is a multidimensional process which includes not only coordination of economic policies but also political, social, regional security and natural resource management. simply put, therefore, regionalism is a package rather than a single policy, as hettne has recently highlighted (hettne, 1998: 1999-220). it has been aptly said that in africa regionalism must be sufficiently elastic to accommodate political aspirations and that it is important to marry economic propositions with political dogma (asante, 1997: 27-8). why has regionalism been adopted as the strategy for meeting the challenges of african r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no i 5 development? what is the nature of the development challenges that are to be overcome through regionalism? the case for regionalism in africa is indisputable and has long been recognised. since the massive movement towards independence in the late 1950s and early 1960s, there was immediate recognition that, while independence has been the primary goal, african countries were largely artificial by-products of the colonial scramble of the era of the 1984·85 berlin conference. the present fragmentation and small african markets emanate from the specific political and economic conditions in which the continent found itself at independence. africa has the most of the world's mini-states: 9 countries with a population of less than one million and 35 with a population of less than ten million. only 5 african countries ethiopia, egypt, nigeria, democratic republic of the congo and south africa have a population of more than 30 million. as ruth morgenthau stated a few years ago, "the typical developing african nation has a sparse population, small intemal market, limited infrastructure, new and fragile borders, and economies vulnerable to fluctuating world prices" (morgenthau, 1977: 87). domestic production for such small markets will be at extremely high cost if economies of scale are of any importance. without access to the larger market area that could be created by measures of economic integration, it is impossible to see how the economies of these small countries could be developed and diversified. without access to a larger market for new productive activities, these countries will remain tied to the world economy as producers of primary commodities and importers of manufactures. development requires the organization of social and economic activity on a much larger scale than is evident in the african situation. increased scale brings with it opportunities for a wide range of benefits associated with lower unit costs of production, increased specialisation and competition, access to a wider range of technology, and greater sharing of ideas and experience in all areas of endeavour. thus the political balkanization of the continent into arbitrary nation-states elicits from africa the understandable impulse to restructure the fragmented region into a more coherent and stronger economic and political entity. it should be stressed, however, that country size, as lavergne rightly argues, is "not the sole consideration". a large country that is weakly integrated internally due to poor infrastructure, ethnic rivalries, or socio-political factors may provide fewer opportunities for development than a small country that is well integrated (lavergne, 1997: vii). a further rationale behind the adoption of the strategy of regionalism has been more strictly political in nature. it involves the bargaining power of african states vis-a.-vis the rest of the world. african states have long recognised that acting together in economic groupings enhances their bargaining power with r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 6 sajems ns vol 3 (2000) no 1 foreign governments, international institutions, and transnational corporations. together, they have more to offer or to deny others in terms of size, economic potential, and political weight alone, their small size, narrow range of exports, poverty, and reliance on external financing combine to make them weak and vulnerable to the pressures from external powers. julius nyerere, former president of tanzania, brings this home when he counselled in 1970: together, or even in groups, we are much less weak. we have the capability to help each other in many ways, each gaining in the process. as a combined group we can meet the wealthy nations on very different terms, for though they may not need anyone of us for their economic health, they cannot cut themselves off from all of us (nyerere, 1970: 12). nyerere re-echoed this important statement in his speech in accra at the 1997 celebrations marking 40 years of ghana's independence: together, we the peoples of africa will be incomparably stronger internationally than we are now with our multiplicity of unviable states. the needs of our separate countries can be, and are being, ignored by the rich and powerful. the result is that africa is marginalised... unity will not make us rich, but it can make it difficult for africa and the african peoples to be disregarded and humiliated ... (anyaoku, 1997). given this background, it is not surprising that regionalism has been seen as a means of helping the nation-states in africa to overcome the disadvantages of small size, low per capita incomes, small populations and narrow resources bases, and of making possible a higher rate of economic growth and development. it has also been seen as a means of consolidating the political independence of african countries and thereby strengthening their overall position vis-a-vis that of the developed countries, especially the former metropolitan powers. in brief, therefore, regionalism in general is not only desirable, it is necessary if africa is to industria lise, develop intra-african trade, develop the capacity to participate effectively in the evolving global linkages and interdependence, reduce her vulnerability to .fluctuating overseas markets, mobilise and maximise scarce resources of capital and skills, and finally forge the way to effective african unity, both political and economic. it is no wonder therefore that african countries continue to adopt resolutions and declarations on regionalism, as reflected i)ot only in the lagos plan of action but also in virtually all recent internal or external action programmes or guidelines for subsaharan africa, such as africa's priority programme for economic recovery (apper) 1985, the united nations programme of action for african economic r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no i 7 recovery and development (un-paaerd) 1986, the united nations new agenda for the development of africa in the 1990s (un-nadaf) adopted in 1991 and the cairo agenda for action (1995). by 1990, 49 african states, with a total population of 465 million, had already regrouped themselves in broader subregional economic communities (asante, 1997: 34-44), such as the economic community of west african states (ecow as) 1975 (asante, 1986); southern african development community (sadc) 1980; preferential trade area of eastern and southern africa (pta) 1981; economic community of central african states (eccas) 1983; and the arab maghreb union (amu) 1989. at present, africa accounts for about half of the 30 or so subregional and regional cooperation and economic integration arrangements existing among developing countries. how have these regional groupings performed? to what extent have they achieved their objectives of meeting the challenges of african development? iii an assessment of the experience of the economic integration schemes a critical appraisal of the achievements of the existing economic cooperation arrangements should focus attention on the extent to which they have contributed towards meeting the development challenges of the nation-states in africa. at the purely economic level, the key objective of the economic integration schemes is to expand the opportunities for investment that will profit the african peoples and that will contribute to the mobilization of their underdeveloped resources. to this end, the primary goal should be to reduce the dependence of the african states on the outside world and to create conditions that will make self-sustained, autonomous development possible. in the african setting, such development can only come about through the transformation of productive structures. have the subregional groupings such as ecow as contributed to this type of change? to what extent have they played a vital role in the socio-economic transformation of the african economies and helped alleviate mass poverty through sustained recovery and growth? why has the success of african economic groupings so far been rather limited, with little or no impact on the economic growth of the co-operating countries? several issue-areas emerge as particularly relevant to an understanding of the limited progress of regionalism in meeting the challenges of african development. the first issue-area relates to the approach to regionalism adopted in the majority of the regional integration schemes. the focus of these schemes has been on market integration or, specifically, trade liberalisation, which is r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 8 sajems ns vol 3 (2000) no 1 modelled on the classical european union prototype designed for developed countries, and whose underlying assumptions are far from relevant in the african context. emphasis is placed on trade integration without addressing adequately the infrastructure and institutional framework which is necessary to facilitate the trade integration process. since all the african states have primary products to offer with no complementarity between them and since there are no manufacturing or processing industries in africa to absorb the raw materials, will the mere formation of a payments union or a common market necessarily enhance the flow of trade in africa? evidently the traditional or european model of economic integration with its emphasis on integration of markets rather than physical infrastructure and production is inappropriate because of a virtually non-existent industrial base in africa. it is like "putting the cart before the horse". the extent of commitment of african governments to the concept of regionalism constitutes a second important issue-area. for economic integration in africa to succeed in its role as an instrument for fostering the development of the partner states, requires that these countries have a clear sense of their own development objectives and strategies and are fully committed to the pursuit of these goals. in the case of regionalism, the most crucial factor is strong and sustained political commitment to keep to the agreed regional agenda. this makes the african political leaders key figures in cooperation and integration. it is their decisions and commitment to succeed which determine the role of the regional organisations and institutions, as well as that of the private sector and the response of the international community. since the establishment of ecow as, pta or sadc, how many member states have drawn up national development plans, strategies or programmes with regional considerations or the regional market as their point of reference? what measures have been introduced by governments as incentives for their business communities to venture into cross-border investments and transactions, and what encouragement are ordinary people offered to think in west, east or southern african regional terms? evidently, an integration culture is "not yet conspicuous" in africa nor is integration accorded the high priority it deserves on national economic agendas (bundu, 1997: 38). cooperation agreements have not been internalised in national administrations and development plans. in most african countries, cooperation does not go far beyond signing of treaties and protocols. the objectives of the treaties are not integrated in national development plans or in the sectoral programmes of appropriate substantive ministries. besides, no african state has the essential well-structured or viable institutions and managerial skills at the national level for the implementation of the large r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 9· and increasingly diverse number of conclusions and recommendations fonnulated within regional cooperation and integration schemes. nor is there relevant institutional machinery in place to enable the people, civil societies, employers associations, trade unions, the business community, professional associations, the private sector or agents of socio-economic activity and their organized associations, like the chambers of commerce and industry to find appropriate and adequate channels of participation in economic development activities at the subregional and regional levels. the institutional deficiencies of the economic communities such as ecow as to fonnulate and carry out policy making functions effectively constitute another disturbing issue-area. the list is impressive. it includes overlapping and often conflicting integration scheme memberships; lack of regional-level monitoring of the implementation of decisions; inadequate resources for independent, practical cooperation and integration activities; poor choice of personnel of the secretariats of the communities with professional positions usually filled on political and geographical representation grounds rather than on experience, technical and administrative competence; poor preparation before meetings, often participation by the wrong people, and little internal consultation between officials and ministers on decisions taken at the regional meetings; and, finally, the lack of follow-up by sector ministries on decisions taken at the summits by heads of state and government. what progress, then, can be expected in this context of weak and ineffective policy instruments and institutions? even with the necessary political commitment the results of regional cooperation efforts will remain poor if the institutional machinery is not in place. to be sure, unless these issues are addressed, the frequently asserted objective of closer regional cooperation and integration to effectively meet the challenges of development will remain exactly that an assertion without implementation. the colonial heritage that continues to influence national institutions and attitudes in political as well as in other fields constitutes yet another important issue-area. the colonial legacy has left many african countries dependent on their fonner metropolitan countries which tends to work against viable regional groupings as well as maintenance of regional unity. commercial and political links with europe, as evidenced, for example, in the european union africa, caribbean and pacific (acp) lome convention continue to be more important than links within africa. such preferential arrangements undennine the. commitment of african countries to integration, as individual countries pursue their more immediate interests through the perpetuation of export-import relations with their fonner colonial masters (asante, 1986: 183-22 i; asante, 1981). the lome factor, which constitutes one of the most important r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 10 sajems ns vol 3 (2000) no i constraints, at least in the long run, on the degree of economic cooperation schemes attainable in africa had been seen by president kwame nkrumah long before the emergence of the lome regime in 1975. nkrumah had as early as july 1961 described the common market as: a european scheme designed to attach african countries to european imperialism, to prevent the african countries from pursuing an independent neutral policy, to prevent the establishment of mutually beneficial economic ties among these countries, and to keep the african countries in a position of suppliers of raw materials for imperialist powers (asante, 1986: 10). on close analysis, nkrumah's prophetic statement is not far off the mark. for the linkages of the lome convention have to some extent impeded the realization of the self-reliant objectives of the african economic communities and their goal to function as independent autonomous units to overcome the probmlem of development. there is the difficulty, among other things, in promoting collective self-reliance while the lome regime is critically geared towards institutionalisation of north-bound vertical orientation of the african economy or euro-africanism, symbolising the continuity of an unequal division oflabour between europe and africa (asantei997: 128). on the whole, except perhaps the modest achievements in the integration of physical infrastructures in the case of ecowas and sadc respectively, regional peace and security provided by ecowas during the liberian civil war and the subsequent crisis in sierra leone, and the political benefits derived from annual meetings of the political leadership of the various communities which offered opportunities to deal with regional issues of importance that could not easily be dealt with in the much larger annual meetings of the organization of african unity or at the bilateral level, it is safe to say that the regional integration arrangements established in the first three decades of independence have not been particularly successful. they have been unable to effectively meet the challenges of development confronting the nation~states in africa in the area of intra~regional trade expansion through trade liberalisation; cooperation in agricultural and industrial development through harmonisation of sectoral policies; and monetary and financial integration through the establishment of viable clearing houses. despite the little progress in promoting regional integration, the emergence of trading blocs in europe, the americas and asia since the early 1990s have created a renewed interest within africa in revitalising and resuscitating regional groupings. hence was established the all~important african economic community (sadc) in 1992; the revision of the 1975 ecowas treaty in r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 11 1993 to enable the community to adjust itself to the rapidly changing economic landscape in different parts of the world; the transformation of the pta into the common market for eastern and southern africa (comesa) in 1994; the creation of the french-speaking west african economic and monetary union (uemoa) and a similar union for central africa (cemac) in 1994; and finally, the establishment of the east african cooperation in 1996. what is required are necessary policy measures that would enable these regional groupings to move towards a new direction in order to effectively meet the interlocking development challenges of the brave new world of the twenty-first century. iv policy measures for the 21 st century to meet the challenge posed by the changing international trading environment of the twenty-first century and to become an active partner in the world economic system, africa has to move fast towards pursuit of subregional, regional or continental constituency as the best guarantee of its survival in the increasingly competitive world. to this end, new initiatives to speed up the process of regionalism that would enable africa to participate in the global trends that are going to shape the future of international economic relations, would be required. policy responses to the emerging regional age as one of the "best responses" to the growing regionalism in the world, and the increasing iiberalisation and globalisation, there is great need for africa to consolidate and strengthen its programmes for regional cooperation and integration. with a large number of mini-states which collectively account for only a very tiny proportion of world trade, a proportion which has declined even further in the past two decades, there is little doubt that africa needs regionalism more than other regions. this explains why the strengthening of the integration mechanisms occupies a central position in the cairo agenda for action adopted by the african leaders in march 1995 to relaunch africa's economic and social development (oau, 1995: xvii). the rationalization and strengthening of the integration organs in the subregions wiil enhance the capacity of the african countries to respond to the global changes, and arrest the current trend towards their marginalization in the world economy. new initiatives in the process of regionalism should involve, among other things, first, speeding up the liberalization provisions of the subregional economic communities as well as those of the african economic community, so that the objectives of complete liberalization of intra-african trade can be r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 12 sajems ns vol 3 (2000) no 1 achieved much sooner than the year 2000 targeted in the abuja treaty establishing the african economic community; and second, promoting new efforts to achieve the harmonisation of macro-economic policies at the subregional level. these responses to the emerging regional age should be buttressed by the removal of internal deficiencies facing the african economic groupings in the broad areas of approach and institutional arrangements and emphasising objectives, policies and instruments as highlighted below. measures towards removal of internal deficiencies of regional groupings i new approach to regionalism as the market integration approach has proved to be inappropriate in the present african setting, a new approach that would place emphasis on infrastructural integration and integration of production structures rather than on markets would be required. the low levels of development and the limited possibilities for profitable intra-subregional exchange simply do not provide the basis for market integration. there is little purpose in liberalizing trade when the parties have nothing to exchange: regional cooperation, inter alia, must create the basis for trade. otherwise, market integration in africa will merely be for promoting non-african goods and services. ii greater role for the private sector of particular significance is the greater role which enterprises or the private sector should play in the integration process in africa. with a view to promoting and increasing a more active participation of the business community in the integration process, particularly in trade and industrial cooperation, mechanism should be established in all the economic communities to encourage the participation of the private sector in the design and implementation of regional trade production programmes and products. the experience of latin american integration association and the association of south-east asian nations in involving the regional business community in trade cooperation activities, could be of benefit to economic groupings in africa. it is encouraging to observe that such new post 1990 economic communities as comesa, sadc and the revised ecow as have established mechanisms for this purpose. iii the need for action at the national level however important the role of the private sector, there can be no effective regionalism without effective national participation. for the economic schemes to be effective, regional economic relations must be given a central role in the activities of governments, which must adopt an administrative structure that gives to those responsible for pursuing integration the weight and power they must have if they are to succeed. thus if regional economic schemes are to r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 13 yield the expected results, regional cooperation must become an integral part of the national policy making and planning processes. the importance of regional integration requires that a key ministry be established in each country to act as a focal point. it should be mandated to assume the coordination of all forms of regional integration and cooperation and should ensure that national development policies and decisions are cast in a regional perspective. regionalism, integration and cooperation, whatever it is called, will not succeed if it is seen as a matter of secondary importance, secondary, say, to the important concerns of relationships with the us, with britain, with france, with the european union and, particularly in recent years, with the world bank or the international monetary fund. iv the need for strengthening the institutional capacity at the regional level a) ratjonahzatjon of the institutional framework the first step to strengthening the economic communities appears to lie in the genuine rationalization of the present institutional framework, with a view to harmonizing the activities of the different subregional groupings and intergovernmental organizations (loos). this would not only prevent costly duplication, but also establish certainty and a better investment climate. b) importance of community-owned resources a second crucial step is to ensure that the institutions of the regional economic communities have enough autonomy and owd resources to undertake the tasks assigned to them. an organization to promote integration should have a certain independence from the participating governments so that it can effectively pursue "community" interest rather than the sum of national interests. this indepence requires a claim to owd resources to carry out the community tasks. "own" or autonomous resources may take different forms: either a percentage of duties levied on goods traded within the subregion, or a specific tax for economic integration purposes, or a portion of duties levied on goods orginating from outside the subregion. c) trainjna in the technoloi:,y of reaional inteluidjon training in the technology of regional integration or human resources development constitutes the third crucial step towards enhancing the capacity of the community institutions. training of government officials and technocrats at both the national level and the level of secretariats charged with implementing regional policies as well as finding ways to motivate them, are key factors that may help to achieve the objective of regionalism ofthe new century. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 14 sajems ns vol 3 (2000) no 1 d) hamessjoa infonnatjon for reaionalism information management constitutes the fourth crucial step towards strengthening the institutions of the economic communities. there is an acute lack of awareness of what other african countries can offer to substitute the products presently being imported from developed countries. institutionalised access to and quick transmission of information on rules and regulations implemented in partner countries and on bureaucratic procedures, publications of standardised statistical data and so on are needed to lay the groundwork for effective regionalism. v conclusion: towards survival of developmental regionalism to enable africa to move towards sustainable developmental regionalism so as to effectively meet some of the crucial challenges to development, policy measures should be initiated towards the strengthening of the popular base of the process of regionalism. for beyond actions on policy, infrastructure, and institutions lies a more fundamental need: to mobilise the media and educational and cultural institutions to promote the concept that cooperation within africa is likely to enhance the progress of all african societies. strong nongovernmental participation is a key factor in achieving the goals of regionalism. successful regional cooperation or integration schemes in europe and elsewhere have not been the work of governments alone, as laporte has recently stressed in an illuminating study (laporte, 1993: 72). they have all benefited from active participation by a wide variety of groups such as trade unions, employers' organisations, and private entrepreneurs, and these groups have ensured that issues of regionalism remain at the top of the political and economic agendas. to this end, there should be deliberate efforts on the part of the african economic communities to create active, supporting integration constituencies among, in particular, socia-economic groups in the population, chambers of commerce, professional associations, academic bodies, women's and peasant organisations. of special importance is the instrumental role which the media and the press should play in the popularization of the schemes of regionalism to increase the level of awareness of the largest section of the population about the contribution which regionalism can make to african economic and social developments. given the requisite enabling environment, the media and the press should inculcate into all segments of the population what one may term an "integration ideology" to stimulate responses from the industrial, commercial, agricultural, labour elite and student leaders. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 15 trade unions and employers' associations, which are the fundamental social partners in development and democracy must be given adequate recognition in integration matters at national, subregional and regional levels. their support will be dictated by the fact that it is through common economic effort at the community level that the standards of living may be raised and full employment secured. above all, the economic communities in africa must encourage and devote some of their resources to the foundation of integration journals and promotion of research and seminars in the field of regionalism. such an undertaking would in no small measure contribute to the broadening of outlook of socioeconomic groups in the subregions as well as the enlargement of their regional understanding, all of which would help to create a favourable nationwide climate for the development of integration movement. as a corollary of this, in order to infuse among the youngter generation of africans a tradition of integrative spirit and thinking, a course on regionalism should be taught as an independent branch of study in all research institutes, schools, colleges, and higher institutions in africa. and to facilitate communication between the various cultural and linguistic groups, the study of french and english, and possibly portuguese, should be made compulsory in all high schools and colleges. all this would help to create a long-lasting intellectual foundation for the movement towards african economic community. there are indications that the new regional initiatives should succeed where previous attempts failed. the regionalism of the 1990s had several advantages over the previous one. indeed, the most obvious advantage is that policy makers today have the benefit of hindsight. many of the new regional initiatives aim to be more outward-oriented and pragmatic. they also appear to be more sensitive to the context in which implementation must take place. a case in point is the provision of a west african parliament in the 1993 revised ecowas treaty and the establishment of the sadc parliamentary forum in 1994 to promote grassroots involvement and popular participation in the integration process. this democratic element is essential for the health and survival of the communities, by preventing them from degenerating into mere technocratic and almost bureaucratic construction. this is an important step forward since, to date, issues of regionalism have been left to governments. the second most obvious advantage of the new regionalism is that both the national and international contents are more conducive to success. at the national level, the widening influence of democracy has created new possiblities for african populations to take more active part in shaping the economic and political landscape. the rise of constitutionalism since the early 1990s, the flourishing civil society and the emergence of parliaments, after years of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 16 sajems ns vol 3 (2000) no 1 marginalization, as key institutions in african governance have provided the much-needed enabling environment for the progress of regionalism in africa. recent liberalization measures are lowering the profile of government in the economy ad encouraging its adoption of a more positive and supportive role in its dealings with the private sector. this should have a positive effect on the regional integration process, through the reduction of administrative barriers and restrictions to international trade, investment, and migration. more democratic rule should bring about a more stable and congenial political atmosphere, which is a sine qua non for regionalism. the establishment of liberal democracy in africa would also enhance free enterprise, freedom of association, and the free flow of information and ideas, all of which are fundamental to the viability of the economic communities. on the international level, there is now a more supportive environment for regional endeavours. the first wave of regionalism in the 1960s, 1970s and 1980s basically went against the prevailing mood and was generally considered to be inimical to the philosophy of the general agreement on tariffs and trade (gatt). today, even traditional sceptics of regionalism are beginning to seriously consider its merits as an instrument for advancing the cause of multilateralism. another decisive element stems from the intensification of regional links in other parts of the world, which has reinforced the conviction of african leaders that they must unite in order to enable the continent to participate more fully in the new international relationships and to achieve its development objectives. it should be stressed, however, that regional efforts alone will not be sufficient to meet the development challenges of africa and to improve its economic prospects. they can certainly not be considered to be a substitute for national economic adjustment, good governance and the strengthening of the human resources. it is, however, clear from the analysis of experiences in africa and elsewhere that regional efforts can, under certain conditions, yield significant benefits. it is also clear that many development issues not only transcend national development efforts but also induce positive reactions at national level, particularly by creating a more favourable trade and investment climate, and can thus be an important part of the solution to the african development problematics. meeting the challenges of african development through regionalism has been an enormous task, and while there may be grounds for pessimism we prefer to view the future with guarded optimism. we would like to conclude that africa's present efforts at regionalism will succeed, but instead we choose to say that they must succeed. to achieve this objective, the people of africa will have to prove to an increasingly sceptical and cynical world: r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 ... that we have the grit, the will and detennination to tum africa from being a dark continent into a beacon of light; from an economically backward and vulnerable continent into a self-reliant, self-sustaining and prosperous one; and from being the citadel of political instability and social conflict and unrest into one of stability, democracy, social cohesion, national unity and regional integration (adedeji, 1991: 211). 17 this constitutes a historic challenge that all of us face. it is a sacred duty that we owe to mother africa. references adedeji, a. (1987) "africa and the africans and their historic challenge", convocation lecture of the eighth convocation ceremony of the university of calabar, nigeria, cited in asante, s.k.b. african development: adebayo adedeji's alternative strategies: 211, london: hans zen publishers. 2 any aoku, chief e. (1997) "democracy in africa" africa at 40 conference, london. 3 apter, d.e. (1987) rethinking development: modernisation. dependency, and post-modern politics: 7, london et. al: sage publications. 4 asante, s.k.b. (1981) "africa and europe: collective dependence or interdependence?", in sesay, a. (ed.), africa and europe: from partition to interdependence or dependence?: 183-221, london et. al: croom helm. s as ante, s.k.b. (1981) "the lome convention: towards perpetuation of dependency or promotion of inter-dependence?", third world quarterly, 3. 6 asante, s.k.b. (1986) "whither africa? euro-african integration or african regional cooperation?", development and cooperation, 5: 10. 7 asante, s.k.b. (1986) the political economy of regionalism in africa: a decade of the economic community of west african states (ecowas), new york: praeger. 8 asante, s.k.b. (1997) regionalism and africa's development: expectations, reality and challenges: 27-8, london: macmillan press and new york: st martin's press, inc. 9 bundu, a. (1997) "ecow as and the future of regional integration in west africa", 10 hetfne, b. (l998) "the new regionalism: security and development", in teunissen, j.j. (ed.), regional integration and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 18 sajems ns vol 3 (2000) no i multilateral cooperation in the global economy, 199-220, the hague: fondad. 11 laporte, g. (1993) "regional cooperation and integration in africa: an agenda for action at the national level" in regional cooperation and integration in the world today: 72, papers from the first open forum, maastricht, netherlands. 12 lavergne, r. (ed.), (1997) regional integration and cooperation in west africa: a multidimensional perspective: vii, trenton, n.j.: africa world press, inc. 13 morgenthau, r.s. (1977) "the developing status of africa"" annals of the american academy of political and social science, 432: 87. 14 nyerere, j.k. (1970) non-alignment in the 1970s 12, dar-es-salaam: government printer. 15 organization of african unity (1995), relaunching africa's economic and social development: the cairo agenda for action, ecml2: xvii, rev. 4. 16 organization of african unity, lagos plan of action for the economic development of africa, 1980-2000, geneva: institute of labour studies, 1981. 17 sloan, j. (1971) "the strategy of developmental regionalism: benefits, distribution, obstacles and capabilities", journal of common market studies, 10(2): 142. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 42 sajems ns vol i (1998) no 1 the role of openly communicated motives during the rationalization process of irrigation system buying behaviour c a bisschott graduate school of management, potchefstroom university for che abstract the article deals with the identification of the openly stated motives which farmers give to rationalize their buying behaviour in the mechanized irrigation industry. these motives are, in declining order of importance. "dealership orientation". "terrain suitability", "maintenance". "management", "mechanical performance", "design", "delivery schedule", "finance", "infrastructure". "technical specifications" and "professional influences". openly communicated motives are important to agricultural economists, financial and other advisory institutions since they can render better quality services to farmers if they know what are the reasons overtly given to rationalize other unspoken motives. the farmers can benefit from the results since they would be able to examine their own line of thought, and thus identify the motives of real importance applicable to their situation. marketers of irrigation systems can also benefit since their selling approach would be more motive-directed. introduction the article addresses the openly communicated motives which consumers employ in their buying behaviour with regard to a mechanized irrigation system. bisschoff & marais (1991) identified the underlying motives (or unspoken motives) which playa role in the consumer's buying behaviour. both these sets of motives are important since the consumer employs the openly communicated motives to rationalize the unspoken motives (ciba-geigy, 1991). a practical explanation of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr vol 1 (1998) nr 1 43 such a state of affairs could be that a person may claim that he bought an expensive german vehicle due its vast "safety features" and "durability" (communicated motives). while the motives which are not communicated openly may be those of "status" and "prestige". the significance of this state of affairs resides in the fact that the consumer does not regularly communicate his real motives to the other people involved, and looks for other "arguments" (or motives) to rationalize his purchase of the german vehicle. these motives are also used by the buyer to rationalize the purchase decision to himself, and playa significant role in the final purchasing decision. it is also important to note that if a strong underlying motive exists while the rationalization motives are absent, the buyer will seldom enter into the final stage of buying behaviour, namely the actual purchase of the product (ciba-geigy, 1991). the astute marketer would therefore attempt to identify the underlying motives at first, and then address the rationalization motives to obtain the actual sale. this article addresses the rationalization motives which pertain to the mechanized irrigation industry. the new irrigation area in the upper fish river valley served as the geographical area for the empirical research. the farmers were new to irrigation farming. water rights were allocated there from the orange-fish river tunnel during the course of 1987/88 (bisschoff, 1989: 2). advanced mechanized irrigation systems consist mainly of centre pivot and linear systems. both systems are technically highly advanced and apart from their main function of watering crops, they have a vast number of features and safety devices. the dualistic influence of motives in buying behaviour calls for a study of consumer motives, and since the underlying motives have already been discussed. the logical question remains the determination of the openly communicated motives which are employed to rationalize buying behaviour. readers can examine the theoretical base which applies to the empirical results by reading the mentioned article by bisschoff & marais (1991). problem deflnition the major concern dealt with in the article pertains to the rationalization effect which motives have on buying behaviour. the frrst problem refers to the identification of the underlying motives of the farmer in the mechanized irrigation industry, while the second problem deals with the rationalization role these openly communicated motives play in buying behaviour. since the frrst problem was r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 44 sajems ns vol i (1998) no i already addressed by bisschoff & marais (1991), this article logically deals onjy with the rationalization motives of the fanners. methodowgy the sampling frame consisted of fanners in the upper fish river valley. simple random sampling was employed to select the respondents for the research, and 48 farmers agreed to participate. a pilot srudy was conducted with 15 selected farmers to detennine the initial set of motives they had employed when they purchased their mechanized irrigation systems (bisschoff, 1988). the motives identified by the focus group were listed and used to compile a strucrured questiormaire which was used in the srudy. in the strucrured questionnaire the respondents had to record their responses on a seven point likert-scale to indicate the importance of each motive in their purchasing decision. these motives were presented in statement fonnat in the questionnaire. personal interviews were conducted with the farmers to ensure that infonnation required in the questionnaire was recorded accurately. a total of 46 questionnaires were usable. the sample amount is in excess of 80% of the mechanized irrigation fanners in the geographical area. the list of openjy communicated motives were identified from the completed questionnaires by means of principle factor analysis, employing the rotational method "varirnax", a cut-off communal value of 1 was used as filter to eradicate less significant statements from the interpretation of the data (cornrey, 1973: 223). however. since factor analysis is especially designed to identify underlying (or in this case "unspoken" motives). the factor loadings are not used as a classification tool (bisschoff. 1992: 165). the communal values of each statement was calculated and employed to categorize each motive. the communal values were calculated by the squared sum of the individual factor loadings per statement (bisschoff, 1992: 163). the variance explained by each statement is portrayed by dividing the communality by the nwnber of statements (wherry. 1984: 290; yates. 1987: 295-305), this value is shown in a percentage fonnat. in addition the variance of each specific motive was calculated. in essence, the communal value, which represents the variance explained by each specific statement, was employed to detennine each motive's relative importance. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sa teb nr vol 1 (1998) nr 1 45 empirical results the communality values of the statements were used to detennine the importance of each statement. since this study returned relatively high communalities as a result of the high factor loadings, most of the forty-eight statements explained a variance between 1.7% and 2.5%, and very few were eliminated by the initiated cut-off filter. the following 11 openly communicated motives were identified and labelled. these motives and their variance explained are shown in table 1. short discussions of each identified motive explains the labelling of these motives. the importance of the motives is portrayed by the variance explained in each case and they are discussed in descending order of importance. table 1: openly communicated motives motive variance cumulative explained variance explained dealership orientation 11.91 % 11.91 % terrain suitability 11.90% 23.81% maintenance 10.21 % 34.02% management 10.15% 44.17% mechanical performance 8.31 % 52.48% design 8.18% 60.66% delivery schedule 8.14% 68.80% finarx::e 8.07% 76.87% infrastrucrure 7.89% 84.76% technical specifications 6.19% 90.95% professional influences 6.14% 97.09% r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 46 sajems ns vol i (1998) no i dealersbip orientation "dealership orientation" relates to the statements regarding the consumer's relationship with the dealer, as well as the dealer's reputation which implies future expectations from the dealer (for instance: will the dealer still be in business to provide after-sales service?). the motive identified as "dealership orientation" indicates that the farmers use this motive as rationalization of their choice of irrigation system since the different dealers stock differently designed irrigation systems. the farmer could also claim that he bought an irrigation system from a specific dealer because the dealer would still be in available as a future business contact. terrain suitability as expected, farmers regard the suitability of the terrain as extremely important. the soil as medium for vegetated growth should be of a high quality if the farmer plans to irrigate it. consumers of advanced irrigation systems, therefore, regard the continual high quality of the soil as an imjx)rtant issue before erecting such an irrigation system. the motive explains a high variance of 11.90%. maintenance "maintenance" explains 10.21 % of the total variance explained, and relates to speedy repairs, availability of spares, quality of workmanship, as well as the cost of the repair package. in essence, "maintenance" relates to the after-sales service provided by the dealer. surely. a successful selling approach should incorporate this motive as rationale since the fact that the farmers identified "maintenance" as a motive indicates that they do not expect the irrigation system to supply lengthy. trouble-free service, but they rather expect the irrigation ~ystem to break down and wear out certain parts. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr vol 1 (1998) nr 1 47 management the ease of managing advanced irrigation systems is valued by fanners as an important motive. this can be seen by the high variance of lo.51 % explained by the motive. nearly all the statements regarding managerial aspects indicated that on an irrigation fann productivity is deemed to be of the utmost importance. the managerial motive specifically applies to the area since a large percentage of the respondents acquired irrigation systems to supplement their current farming activities, thus increasing the amount of work on the fann. mechanical performance issues regarding the macro-<iesign aspects identified the mechanical performance of the irrigation system. although closely related to the previously mentioned motive, the mechanical performance of the irrigation system also incorporates the structural composition as a motive. "mechanical performance" explains 8.31 % of the total variance. design the actual design of the system, thus the type of sprinklers used at which pressure rating, as well as the watering capacity, relates to the micro-design issues and explains 8.18% of the explained variance. these issues are related to the physical distribution of the irrigation water, and clearly differs from "mechanical performance" which refers to structural design. delivery schedule "delivery schedule" relates to the punctual delivery and activation of the irrigation system. it seems that farmers, therefore, plan their acquisition in order to erect the system shortly prior to the planting season, thus eliminating an unproductive period before the planting season. "delivery schedule" explains 8.14% of the total variance. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 48 sajems ns vol 1 (1998) no 1 quite surprisingly, consumers do not deem "finance" as one of the most important motives (explaining only 8.07% of the total variance). however, within the financial scenario, consumers deem the possibility of a hire-purchase or lease agreement more important than the original purchase price. of further importance to consumers is the length of the financing period once the irrigation system is bought on such an agreement. it seems, therefore. that farmers are more coocerned with the availability of credit, than with the purchase price itself. the employment of this motive as a rationale is a serious concern and calls for a warning to farmers who employ it to rationalize their purchase of an irrigation system. this is especially true sioce the initial purchase price determines the loan repayment amount. fortunately, this motive is not one of the more important motives identified by the farmers. infrastructure an existing infrastructure is identified as a motive by farmers wishing to erect an advanced mechanized irrigation system. although "infrastructure" explains 7.89% of the total variance explained. a reason for such a relatively low declaration may be the fact that farmers had grown accustomed to facilities such as electric power and unrestricted water quotas (especially in a specific area where water restrictions have never been introduced). technical specifications consumers regard "technical specifications" as a less important motive (6.19%) because automation is not regarded as a necessity during the acquisition of an advaoced mechanized irrigation system. for instance, the system does not need to shut down automatically. because it can be shut down manually. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sa teb nr vol 1 (1998) nr 1 49 professional influences fanners do not deem advice from professionals as imponant once they enter the buying behaviour activities of advanced mechanized irrigation systems. "professional influences" explains only 6.14% of the total variance explained, which incidentally, is the lowest percentage of variance explained. the various motives contributed to explain a cumulative variance of 97.1 st which is regarded as a favorable declaration of variance. table 1 highlights the fact that the motives decline in their contribution to the declaration of the variance explained. "dealership orientation" and "terrain suitability", therefore, explain a larger pan of the explained variance than any other motive, while "professional influences" proponionally explains the least. conclusion and recommendation the identified motives provide a simple framework which could be used as a guideline by different marketing institutions, agricultural economists and other advice-rendering institutions since it clarifies the intricate decision-making process with regard to the irrigation industry. the irrigation industry could, funhermore, employ the obtained results to develop strategies for market segmentation, promotion, positioning.and the training of sales personnel. this simplification of the initial set of data set cenainly reduces the number of motives, creating a more concise and manageable framework. the established framework could also aid consumers to understand decisionmaking in the advanced mechanized irrigation industry. one would like to see marketers as well as consumers making use of the analyses to aid them in their buying and selling behaviour. it is significant that their contribution to the variance explained, decreases from the first motive to the last, with "dealership orientation" and "terrain suitability" being the most imponant while "professional influences" is the least imponant of the identified motives. this phenomenon results in the recommendation that marketers of mechanized irrigation systems attempt to address the more imponam motives first, as farmers deem them the more imponant considerations during the buying process. additionally, by moving from the motives explaining the higher percentage of variance to those explaining r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 50 sajems ns vol 1 (1998) no 1 less, the marketer could obtain better salesman-productivity because the more imponant considerations are addressed prior to the less imponant ones. by dealing with the motives on an individual and on a group basis, marketers should be able to comprehend the market in the advanced mechanized irrigation industry better, and should therefore be able to optimize their sales efforts. finally, a pitfall in the absolution of the results resides in the fact that the openly communicated motives for buying behaviour were identified. due to the psychological rationalization process, these motives, or the order thereof, may not always be the true (or unspoken/hidden) motives. the example of the expensive gennan vehicle mentioned in the introductory section of this article should be kept in mind. however, openly communicated motives remain imponant in actual selling behaviour of sales personnel. in the case of the worst scenario of using openly communicated motives, the salesperson supplies the buyer with rationalizations which the buyer could use in his psychological framework (lewison, 1996: 142). the buying behaviour thus becomes rational since it can be motivated and explained (williams, 1982: 14-16). note i wish to acknowledge the financial assistance of the centre for science development of the human sciences research council. references 1. bisschoff. c.a. (1988). evaiu(l/ion criteria emplo.ved by conswners of centre pivot and linear irrigation systems. bcomm (honors) thesis. pretoria, unisa. 2. bisschoff. c.a. (1989). conswner purchasing behaviour in the advanced mechanized irrigation industry a factor analysis. mcomm thesis. pretoria, unisa. 3. bisschoff, c.a. (1992). factor identification in the agricuijurai tractor industry. dcomm dissertion. pretoria. unisa. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr vol 1 (1998) nr 1 51 4. bisschoff, c.a & marais, a de k. (1991). factor ide11lijication an analysis oj buyer behaviour during the acquisition oj an advanced mechanized irrigation system. agrekon, vol. 30(4): 237-240. 5. ciba-geigy (1991). advanced sales communication training course. northwestern co-operative, lichtenburg. 6. comrey, a.l. (1973). a first course injactor analysis. new york, academic state press. 7. lewison, d.m. (1996). marketing manageme11l. new york, dryden press. 8. williams, t.g. (1982). consumer behavior jundame11lals & strategies. new york, west publishing. 9. wherry, rj. (1984). c011lributions to co"eiajion analysis. san francisco, academic press. io.yates, a. (1987). muijivariate exploratory data analysis. new york. university state press. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction credit scorecard implementation strategies problem statement and objective literature review data and methodology results conclusion acknowledgements references about the author(s) nico kritzinger department of business mathematics and informatics (bmi), faculty of natural sciences, north-west university, south africa gary w. van vuuren department of business mathematics and informatics (bmi), faculty of natural sciences, north-west university, south africa citation kritzinger, n. & van vuuren, g.w., 2018, ‘an optimised credit scorecard to enhance cut-off score determination’, south african journal of economic and management sciences 21(1), a1571. https://doi.org/10.4102/sajems.v21i1.1571 original research an optimised credit scorecard to enhance cut-off score determination nico kritzinger, gary w. van vuuren received: 05 apr. 2016; accepted: 22 feb. 2018; published: 07 june 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: credit scoring is a statistical tool allowing banks to distinguish between good and bad clients. however, literature in the world of credit scoring is limited. in this article parametric and non-parametric statistical techniques that are used in credit scoring are reviewed. aim: to build an optimal credit scoring matrix model to predict which clients will go bad in the future. this article also illustrates the use of the credit scoring matrix model to determine an appropriate cut-off score on a more granular level. setting: data used in this article are based on a bank in south africa and are retail banking specific. methods: the methods used in this article were regression, statistical analysis, matrix and comparative study. results: the matrix provides uplift in the gini-coefficient when compared to a one-dimensional model and provides greater granularity when setting the appropriate cut-off. conclusion: the article provides steps to construct a credit scoring matrix model to optimise separation between good and bad clients. an added contribution of the article is the manner in which the credit scoring matrix model provides a greater granularity option for establishing the cut-off score for accepting clients, more appropriately than a one-dimensional scorecard. introduction one of the most important elements driving a bank’s existence and continuance is the ability to grant credit to the appropriate client who is less likely to go bad. two general techniques exist to assess possible future bads; firstly this can be done subjectively by a credit manager or loan officer, and secondly it can be accomplished objectively by means of credit scoring (allen, de long & saunders 2004:734–736). credit scoring (which surfaced in the mid-1900s) is a statistical tool allowing banks to distinguish between good and bad clients. in banking especially credit scoring has grown in the last 25 years (2015) mainly due to a wider range of banking products and large number of credit applications (abdou & pointon 2011:65). the general idea behind credit scoring is to use client characteristics from the past to predict whether the client to be financed will either be good or bad in the future. credit scoring has proved its worth in credit evaluation; however, the literature has been limited (abdou & pointon 2011:60). various modelling techniques exist to model credit scoring with most of them being statistical; for example, linear regression, discriminant analysis, probit analysis, logistic regression, decision trees, expert systems, neural networks and genetic programming (abdou & pointon 2011:66–68). given this range of statistical techniques, however, no optimal technique for scorecard construction exists (abdou & pointon 2011:68). various benefits exist for using scorecards for credit assessment; for example, less information is required to make a decision. credit scoring removes the bias by not only looking at accepted applicants, but by considering the entire application population, credit scoring considers characteristics of both good and bad applicants. credit scorecards are based on large data samples, include legally acceptable characteristics and demonstrate correlation between variables and repayment or bad behaviour. they also include a large number of characteristics, enjoy efficient processing time, minimise process time and cost and produce fewer errors. credit scorecards are based on real historical data and the interrelation between characteristics is considered (abdou & pointon 2011:61–62). given these benefits, however, various criticisms also exist for using scorecards for credit assessment. for example, no economic factors are considered, there are misclassification problems, any characteristic is up for consideration, indirect discrimination is possible, no standardisation exists across the market, training analysts is expensive, the final model is statistically ‘incomplete’ as not all characteristics are part of the final model, the data are historical, characteristics are assumed to be constant over time, and credit scoring imposes a dichotomous outcome (abdou & pointon 2011:62–63). credit scoring – which allows banks to determine a level of risk of an applicant or borrower – is based on statistical numerical scores to determine whether they would either be a good or bad client in the future (siddiqi 2006:5). in the credit scoring milieu, two types of credit scoring models have been employed, namely: application scoring and behavioural scoring (lim & sohn 2007:427). application scoring (as) is used where the scorecard is built for a specific credit organisation by utilising the credit organisation’s historical data. it is a credit assessment performed at the application stage. behavioural scoring (bs) indicates the way a borrower’s characteristics of payment behaviour change after the loan is made, and is based on time-dependent characteristics of borrowers (lim & sohn 2007:427). another form of scoring that exists is the credit bureau score (cbs) which can be described as an economic barometer of the way the borrower performs with other organisations. the cbs is a representation of how borrowers manage their existing credit obligations and the cbs is an external score, with external meaning that the scorecard was built by the bureau using data from various credit organisations. as with all scorecards, the credit bureau scoring model is constructed using history, but it does consider the probability of change in behaviour when the score is updated. the model is a dynamic one in this sense, but becomes historic in actual use. one of the key strengths of the cbs is the relatively complete nature of economic information on which it is based; that is, it consists of external risk-related data from diverse businesses contributing information on their own debtors to the credit bureau. in this manner a borrower is assessed on the actual credit performance with all his or her accounts with different institutions such as banks, finance houses, service providers, credit card companies, retailers, public authorities, tax registers, etc. (anderson 2007:285; transunion 2015). anderson (2007) also indicates the importance of credit bureaus: the facilitation of information gathering from public sources, especially court orders, and the sharing of borrower performance information (anderson 2007:10). the private nature of this kind of information and the credit bureaus’ ability, gives them a monetary incentive to collect, to record and to exchange reliable, valuable and up to date information on all credit performance (transunion 2015). in south africa there are four major credit bureaus: transunion, experian, compuscan and xpert decision systems (xds) which capture, update and store the credit histories of the credit active consumers in south africa. the credit bureaus obtain and build their scorecards on data regularly supplied by the credit lenders to the credit bureaus (transunion 2015). transunion emphasise that to reduce exposure to risk a predictive scoring system is needed (transunion & fair isaac corporation [fico] 2009:1). the bureau score of transunion is referred to as the empirica score which aims to assess risk at the origination stage, evaluate client risk in conjunction with expected performance, assess clients with no historical credit history, manage existing clients from a credit limit and collections perspective, rank clients according to credit risk and identify cross-sell opportunities and to grow the client base. the empirica score consists of five categories to assess the credit risk of a client: demographics, judgements taken against the client, defaults experiences of the client, payment profiles and enquiries of the client (transunion & fico 2009:2). as the objective of credit scoring is to distinguish between good (usually up to date or one payment in arrears) and bad (usually three or more payments in arrears, in legal or written off) clients the problems that arise from credit scoring would be related to classification (abdou & pointon 2011:66). problems that exist in credit scoring include the lack of a theoretical reason as to why characteristics are chosen in the final scorecard. siddiqi (2006) gave some guidelines regarding number of variables (characteristics) to be used within scorecards. scorecards should comprise between 8 and 15 characteristics to ensure a stable scorecard as the predictive power will remain strong even if the profile of one or two variables changes. scorecards containing too few variables are more susceptible to minor changes from the applicant’s profile making the scorecard unable to withstand the test of time (siddiqi 2006:88). anderson (2007) mentions that although a huge number of variables can potentially be used for credit scorecard developments usually only between 6 and 15 variables best explain consumer behaviour (anderson 2007:393). however, it is generally believed that there is no optimal number of variables to be used in scorecards (abdou & pointon 2011:67). in general, two scenarios which will be explained in the next section are considered when implementing a credit scorecard, namely maintaining the same reject rate or approval rate or keeping the same bad rate. however there is disagreement on the appropriate cut-off score when assessing credit at implementation and the determination of the sample size when building a scorecard (abdou & pointon 2011:67–68). in addition there is no optimal technique when building scorecards (abdou & pointon 2011:68). credit scorecard implementation strategies once an organisation has its credit scorecard built it is mostly used to set minimum levels of score which represents a threshold of risk called the cut-off score. this cut-off score could represent a level of accepting clients, profit level or any other level based on the objectives of the organisation (siddiqi 2006:146). a simple illustration of implementing a credit scorecard with a cut-off score strategy is presented in figure 1. figure 1: simple cut-off score strategy. from figure 1 the implementation strategy indicates that every client scoring below 180 will be rejected, in other words not being considered, a score above 215 will be accepted and clients scoring between 180 and 215 will be referred to credit managers for further analysis to determine whether the client will be rejected or accepted. in general when building a new credit scorecard it should outperform the previous credit scorecard, which should lead to an outcome of a higher approval rate when the same bad rate is maintained or lead to a lower bad rate when the same current approval rate is maintained (siddiqi 2006:148). this describes the two general scenarios when implementing a credit scorecard: firstly the lender may wish to implement its credit scorecard such that the lender keeps at the same reject rate or approval rate of clients to reduce bad rates in the future. this first scenario could be chosen when the company wishes to be conservative, where the aim is better risk management in a tough economic environment. secondly the lender may wish to keep at the same bad rate to gain market share to expand the business; this scenario could be chosen by the company in a competitive environment. according to anderson (2007), one of the most obvious approaches when setting a cut-off score is where any account is accepted that provides a profit. since the introduction of credit scoring, lenders have gained experience to apply scientific approaches to enhance the business, use credit scoring for forecasting and portfolio valuation, take potential profitability into consideration, use credit scoring for risk-based pricing, account management and incorporate other aspects of borrower behaviour such as response, revenue and retention. in the event of choosing the cut-off score strategy it should be noted that several assumptions were made during the credit scorecard development and a credit scorecard is a tool that must fit in with a company’s general strategies (anderson 2007:67, 240). credit scorecards play an important role when distinguishing good clients from bad clients; however, there has been disagreement on the most appropriate cut-off score when strategically implementing a credit scorecard. it is commonly known that there is no optimal cut-off score decision which is differently derived based on the environment and country (abdou & pointon 2011:67). problem statement and objective the aim of this article is to build a credit scoring matrix model (csmm) to address the issues raised, especially obtaining an optimal model (most favourable) and determining a more appropriate cut-off score when assessing credit of borrowers at the application stage of a loan. a more appropriate cut-off score, in this sense, refers to the cut-off made from the csmm. the primary objectives of this study are to improve credit risk measurement and management in the world of credit scoring and accurately determine the appropriate cut-off score. the focus includes credit risk, credit scoring and credit risk management. historical credit scoring modelling techniques are evaluated and the effectiveness of proposed primary objectives on credit risk management are assessed with the aim of implementing these in the retail banking environment. literature review statistical techniques used in credit scoring can be divided into two categories namely non-parametric techniques and parametric techniques. non-parametric statistical techniques do not require many assumptions about the underlying data, if any, whereas parametric statistical techniques require several (anderson 2007:172). this section gives an overview of the different types of non-parametric and parametric statistical techniques used in the credit scoring world. non-parametric statistical techniques expert systems expert systems involve the use of expert judgement or human expert knowledge to solve problems and explain the outcomes as to why certain credit applicants are rejected. abdou and pointon (2011) presented the three components of an expert system: relying on facts and rules, an interface communicating the expert’s conclusion, and updating the expert’s decisions and recommendations (abdou & pointon 2011:72). disadvantages of expert systems include subjectivity, inconsistency and individual expert preferences. advantages of expert systems include the use of qualitative characteristics within its judgemental evaluation and the vast experience of the expert from the past (abdou & pointon 2011:61). decision trees thomas, edelman and crook (2002) mentioned one of the earliest decision trees, which was a type of expert system with a rule set (anderson 2007:172–173). a decision tree or recursive partitioning analysis (rpa) is defined as a classification technique where a dependent variable is analysed as a function of continuous explanatory variables (abdou & pointon 2011:71). a decision tree comprises three nodes with the root node the start (at the top of the tree) followed by subsequent levels called the child nodes and the bottom of the decision tree referred to as the terminal nodes. the aim of a decision tree is to indicate a possible turn of events or consequences, with each event indicating the outcome. figure 2 presents a simple example of a decision tree. figure 2: decision tree. advantages of decision trees include the ability to identify patterns, finding and exploiting interactions, results that are transparent and easy to implement, computationally simple, and quick and easy identification of extremely high and low risk categories. disadvantages include decision trees becoming too busy, which could result in over-fitting and unreliable results. where interactions are not an issue regression techniques provide better results and decision trees prove to be relatively inflexible (anderson 2007:172–174). neural networks neural networks (nns) are structures which allow training processes to take place in which the linear and non-linear variables help to distinguish variables to obtain better decision-making results. andou and pointon (2011) alluded to the use of nns which could be successful in credit card fraud, bankruptcy prediction, bank failure prediction, option pricing and mortgage application (abdou & pointon 2011:73). disadvantages of nns include computational intensity, multiple iterations are required before a final model is obtained, they are expensive to implement and maintain, they are opaque and there is always a significant chance of over-fitting. in credit scoring nns are seldom used, but have advantages where there are fewer data. nns are also used for fraud scoring (anderson 2007:175). compared to more generally used techniques, such as discriminant analysis and logistic regressions, nns have the highest average correct classification rate and statistical measures indicate that they represent the data better than logistic regression (abdou & pointon 2011:73). genetic algorithms genetic algorithms – first proposed in the 1960s – are the use of genetic operations to transform data according to fitness value (abdou & pointon 2011:74; anderson 2007:176). genetic algorithms have been used in financial services, computer sciences and engineering. disadvantages of genetic algorithms include computational problems and slower run times. an advantage of genetic algorithms is that alternate solutions may be obtained when they are not readily apparent. the primary uses for genetic algorithms are: providing an exhaustive search if many solutions are possible, the aim is optimisation and not necessarily the best model, identifying good solutions which are not easy to find and when there are multiple targets. genetic algorithms work best in a rapidly changing environment where new solutions are to be found (anderson 2007:176). table 1 summarises the assumptions for the non-parametric techniques. table 1: non-parametric techniques assumptions. parametric statistical techniques discriminant analysis discriminant analysis is another statistical technique where the aim is to determine group membership where there are two or more known groups (anderson 2007:169). andou and pointon (2011) indicate the earliest proposal of discriminant analysis, where multiple discriminant analysis was applied while examining car loan applications (abdou & pointon 2011:69). discriminant analysis uses a classification tool to minimise the distance between cases in a group and maximise the differences between cases from different groups. the problem with discriminant analysis is that it suffers from all the assumptions associated with the statistical technique used. linear discriminant analysis is the most common, which suffers from high misclassification errors when predicting rare groups (anderson 2007:169–170). problems such as using linear functions instead of quadratic functions, group definitions, inappropriateness of prior probabilities and classification error prediction also surface when using discriminant analysis and multivariate normal distributions and equal variances are assumed (abdou & pointon 2011:70). probit analysis probit analysis aims to transform a linear combination of independent variables into its cumulative probability value from a normal distribution. under probit analysis normal distributions of the threshold values are assumed and the coefficient estimates can be tested individually for significance using a likelihood ratio test, which is not possible within discriminant analysis. a problem with probit analysis is that multicollinearity can cause incorrect signs for the coefficients which are not an issue within discriminant analysis applications (abdou & pointon 2011:70). linear regression galton (1889, quoted in anderson 2007) introduced linear regression, a statistical technique to explain linear relationships described by: in equation 1, yt is the dependent variable or endogenous variable value at time t, xjt is the independent variable or exogenous variable j at time t, and βj is the coefficient or change in predicted value y per unit of change in xj at time t. in equation 1 the dependent variable y is predicted by using the values of independent variables xj. the prediction of y is determined by calculating the coefficients β by minimising the sum of the squared error terms. the problem with linear regression is that it makes numerous assumptions such as linearity, homoscedasticity, a normally distributed error term, independent error terms, additivity, uncorrelated predictors and the use of relevant variables (anderson 2007:166–167). logistic regression logistic regression is one of the widely used statistical techniques used in credit scoring. the difference between linear regression and logistic regression is that with the latter the outcome variable is binary, that is, 1 or 0, good or bad, etc. (abdou & pointon 2011:71). anderson (2007) indicated that investigations on human populations were where logistic regression originated (anderson 2007:171). hand and henley (1997) indicated that a comparison between discriminant analysis and logistic regression in the world of credit scoring concluded that logistic regression gave superior classification results (hand & henley 1997:533). a logistic regression function can be presented as: in equation 2 p(g) is the probability of being good. the left-hand side represents the natural logarithm of the odds of being a good client. for logistic regression the regression coefficients (i.e. the β coefficients) in equation 2 are obtained by using the maximum likelihood (ml) method (harrell 2015:220). ml is a general statistical technique to estimate parameters and make statistical conclusions in various situations (harrell 2015:181). logistic regression follows assumptions which include categorical target variable, log odds linear relationship function, independent error terms, uncorrelated error terms and the use of relevant variables. a disadvantage of logistic regression is its intense computations; however, logistic regression has been the primary choice for building credit scoring models because it predicts a binary outcome, the final probability cannot fall outside of the boundaries 0 to 1 and logistic regression provides robust estimates of the actual probability (anderson 2007:170–171). table 2 summarises the assumptions for the parametric techniques. table 2: parametric techniques assumptions. data and methodology data data that were used in the research study are based on a bank in south africa and are retail banking specific. external credit bureau data were also used where applicable and were based on south africa specific credit bureau data. table 3 presents the frequency and source data used in more detail. table 3: data used for research study. methodology the credit scoring matrix model (csmm) may be split up into two components: firstly an internal application scorecard which is built from internal information and secondly, a credit bureau score obtained from credit bureaus. the methodology that is required to construct the internal application scorecard is presented in figure 3, which is further explained in the sections that follow. figure 3: scorecard methodology. bad definition a client’s historical performance can be divided into three categories namely ‘good’, ‘bad’ and ‘indeterminate’ (anderson 2007:138). a client who is seen as a ‘bad’ can be based on several considerations, such as organisational objectives, product, being risk-averse, being risk-seeking, an easily interpretable definition, accounting policies on write-offs, consistent definitions or regulatory requirements (siddiqi 2006:38–40). classifying a client as a ‘good’ client requires the same considerations as mentioned as when classifying a client as a ‘bad’ client. a client is classified as ‘indeterminate’ if the client does not conclusively fall into either the ‘bad’ or the ‘good’ category. as a rule of thumb, ‘indeterminates’ should not exceed 10% to 15% of the development sample used to build the scorecard (siddiqi 2006:43–44). maturity various methods exist to obtain reassurance that the correct ‘bad’ definition is determined. firstly there are the analytical methods such as roll rate analysis (comparing delinquency buckets from the past with delinquency buckets observed currently and then calculating which clients remained in the same delinquency bucket, which moved to a better bucket and which rolled to a worse delinquency bucket) (siddiqi 2006:41) and current versus worst delinquency comparison (comparing the worst ever delinquency status with the most current delinquency status) (siddiqi 2006:42). secondly, there is the consensus method where various stakeholders from the credit risk department, operational departments or other areas come together to obtain consensus on the definition of a ‘bad’ client (siddiqi 2006:40–43). one can also use the maturity approach where an outcome is determined which is sufficient to capture the ‘bad’ clients, for example of all clients booked at a specific vintage date which of them were ‘bad’ clients in the next ‘x’ number of months (siddiqi 2006:77). although one would wish to use as many outcomes as possible to capture most of the ‘bad’ clients, the current portfolio of the bank could be vastly different from the portfolio in earlier years. development window building a scorecard requires the identification of two windows: firstly the development or observation window which is the period where the data are observed and secondly, the outcome or performance window during which we measure the level of clients being ‘bad’ after a certain time period has elapsed for clients from the observation window (anderson 2007:77, 344). siddiqi (2006:35) mentions that the development window should be chosen where the level of bad rate is deemed to be stable; however, anderson (2007:344) indicates that one could come to a point where applications are not a representation of today’s applications the longer the outcome period, as also mentioned in the ‘maturity’ section. exclusions data used to build a scorecard should contain only information on which one intends to use them. clients such as frauds, staff, deceased, out of country, preapproved or underage should be excluded when building a scorecard because these clients are given finance based on non-score-dependent criteria. any client that is not a normal client or is not going to be scored should be excluded from the scorecard development (anderson 2007:338; siddiqi 2006:31). sampling to ensure that a group of representative clients is used during the scorecard development, sampling is used (anderson 2007:61). it is the general belief that a minimum of 1500 bads, 1500 goods and 1000 rejects are used when developing a credit scorecard. these minimum numbers were derived in the 1960s as the work required to obtain data was demanding and sufficient computer power was lacking (anderson 2007:350). two steps are required during the sampling phase when developing a scorecard: firstly, data are sampled which represent the client population (siddiqi 2006:63). generally, the total client population is sampled into a smaller data set, especially when working with a large amount of data which can take longer to process. secondly, the representative total sample is split up into a development sample on which the scorecard is built, and a validation sample on which the scorecard is tested (siddiqi 2006:63). it is important to note that random samples can pose difficulties as important subgroups of the total sample must also be adequately represented. to achieve this a technique such as over-sampling can be used. over-sampling in essence adjusts the subgroups’ distribution against the total sample (anderson 2007:351). reject inference application scorecards are built based on the through-the-door population known as the ‘all good bad (agb)’ scorecard, that is, all applications, not just accepted applications (siddiqi 2006:101). if application scorecards are built using only the accepted clients (known as the ‘known good bad (kgb) scorecard’) there will be bias towards accepted clients from the past when the new application scorecard is applied as the rejected clients from the past were ignored during development (anderson 2007:65). reject inference accounts for influence from past decision-making during the agb scorecard development process. as an example, reject inference accounts for ‘cherry-picked’ applicants; for example suppose 100 out of 1000 applications have a very high delinquency, credit managers decline 90 of the 100 and accept 10, with subsequent performance indicating that the 10 accepted applicants perform well and are classified as good accounts. building only a kgb scorecard would see these high delinquency accounts as good applicants. reject inference accounts for these ‘cherry-picked’ accounts. from a decision-making view reject inference provides expected performance based on all applications, that is, the through-the-door (ttd) population. suppose a bank rejects all applications below a score of 180; however, the bank feels it has been too conservative and now rejects all applications below a score of 165. if the bank has never accepted these applicants in the past, how will the bank account for this additional risk being taken when moving the cut-off? reject inference accounts for this through the estimated bad applicants for the rejected applications. it is important to realise that with the reject inference process there will always be a level of uncertainty; however, it can be minimised using better reject inference techniques. reject inference leads to better decision-making; however, it is not 100% accurate (siddiqi 2006:99–101). various rejection inference techniques exist, such as random supplementation, augmentation, extrapolation, cohort performance and bivariate two-step (anderson 2007:79). list of characteristics a scorecard consists of a group of characteristics to separate good clients from bad clients (siddiqi 2006:5). characteristics to be included in the development sample are an important step when building a scorecard and business input is recommended when characteristics are included. characteristics should be selected based on: expected predictive power, reliability and robustness, ease in collection, interpretability, human intervention, legal issues surrounding the usage of certain types of information, creation of ratios based on business reasoning, future availability and changes in competitive environment (siddiqi 2006:60–62). bucketing of characteristics bucketing of characteristics before the regression step has advantages such as: it is easier to deal with outliers, relationships are easier to understand, non-linear dependencies can be modelled with linear models, unprecedented control in the development process of the scorecard is allowed, increased knowledge of the portfolio, and the user may develop insights into the behaviour of risk predictors (siddiqi 2006:78). the predictive power of each characteristic attribute (a group of attributes form a characteristic) after bucketing can be determined by weights of evidence (woe) presented by equation 3 for each attribute i: the predictive power of each characteristic is measured by the information value (iv) presented by equation 4: in equation 4, is the distribution of the good clients for attribute i and is the distribution of the bad clients for attribute i. the iv of each characteristic is interpreted as follows (anderson 2007:192–193; siddiqi 2006:78–79): •  iv < 0.02   = unpredictive •  0.02 ≤ iv < 0.1   = weak •  0.1 ≤ iv < 0.3   = medium •  iv ≥ 0.3   = strong business logic woe and iv are used as statistical measures when bucketing characteristics as discussed in the ‘bucketing of characteristics’ section; however, business logic also needs to be considered. suppose a company under its policy rules refers clients to the credit managers that have a debt service ratio greater than 50%. then the debt service ratio, if a characteristic in the scorecard, should be bucketed with a break at 50% to minimise the distortion of the policy rule on the scorecard, as the clients affected by the policy rule are now isolated (siddiqi 2006:87). regression the pioneers of credit scoring are fair and isaac who started their consultancy, fair isaac, in 1956 (anderson 2007:40). in recent times fair isaac has become known as fico. in the ‘literature review’ section various statistical techniques were described that may be used in the world of credit scoring. fico in addition have their own methods, which is part of their modelling software called fico model builder (fico mb7) and one of these methods is called ‘scorecard – divergence’. the divergence statistic measures the distance between the scores of the bad clients’ distribution and the scores of the good clients’ distribution and is presented by equation 5 (anderson 2007:189–190): the ‘scorecard-divergence’ method in fico mb7 is a generalised additive model of bucketed predictors that provides pattern constraints and a penalty term to reduce over-fitting and smooth weight patterns. the fitting objective function optimises the model weights to maximise the divergence between binary outcome classes, subject to user-defined constraints (fico 2014). scorecard tests various scorecard measurements can be carried out to determine the predictiveness of the scorecard, such as akaike’s information criterion (aic), schwarz’s bayesian criterion (sbc) and the kolmogorov-smirnov (ks) statistic. the most common measurement used is called the gini-coefficient which provides a single value representing the predictive power of the scorecard over the entire range of possible scores (anderson 2007:205). statistics such as correlation between characteristics scores, the population stability index (psi)–which measures the stability of the scorecard – are also analysed when building a scorecard (anderson 2007:194–200). a psi less than 0.1 indicates no significant change from development, a psi between 0.1 and 0.25 indicates a small change in distribution from development that needs investigation and a psi greater than 0.25 indicates a significant shift from the development population (siddiqi 2006:137). out-of-time testing the out-of-time window is a validation period which falls outside the development window of the scorecard (anderson 2007:78). the out-of-time window is a validation period where the scorecard tests as mentioned in the ‘scorecard tests’ section can be carried out to test the scorecard on a period that did not form part of the scorecard building development window. results the csmm build consisted of two components, namely the internal application scorecard and the credit bureau score. the first part of this section will present the results obtained when building the internal application scorecard, after which the credit bureau score (empirica score) will be added as a second dimension to illustrate the optimal model. the section concludes with the illustration of improved cut-off score determination from the csmm. internal application scorecard the methodology followed when building the internal application scorecard was described in the ‘methodology’ section. firstly the ‘bad’, ‘indeterminate’ and ‘good’ definition is presented in table 4 and maturity analysis in figure 4. figure 4: maturity analysis. table 4: internal application scorecard ‘bad’ definition. figure 4 presents the bad rate percentage of booked clients for each vintage date, that is, for booked clients at a specific date the percentage that went bad after 3 months, 6 months, 9 months, 12 months, 18 months, 24 months, 30 months and 36 months. the 24-month outcome was used when building the internal application scorecard for two reasons: firstly, capturing as many bad clients as possible is desired and secondly, too much history is undesirable as applications at development could not represent the applications of today. based on the ‘bad’ outcome decision and data availability up to and including december 2014 (as mentioned in the ‘data’ section) the development window and out-of-time window are presented in table 5. table 5: internal application scorecard build windows. exclusions used in the development include company clients, as the scorecard is intended for individual consumers, staff clients, unemployed clients, clients with missing identification numbers (id), applicants aged-less than 18, non-south-african citizens, loan amounts larger than r500 000 (as this is not normal business for the company), frauds, deceased clients, application disputes and pending decisions. exclusions were approximately 11% for the development window. sampling was performed using a simple random sampling technique in the statistical analysis software (sas) and figure 5 presents the bad rate percentage for accepted clients between the total population after exclusions and the sample after exclusions. figure 5: accepted clients’ bad rate (%). reject inference (fuzzy augmentation technique) was carried out by using the bureau score at outcome from the credit bureau transunion to infer the rejected applications. the gini-coefficient for the bureau score at outcome was determined as approximately 81%, indicating this as a good proxy to infer the rejected applications. the bad rate after inference for the development window was calculated as 6.3%. figure 6 presents the rejects inference results. figure 6: bad rate for accepts and rejects (at observation). figure 6 illustrates the higher bad rate for rejected applications after reject inference (as expected). characteristics considered in the development of the internal application scorecard included 32 characteristics consisting of both borrower and transaction type characteristics. the bucketing of the characteristics was done in the fico mb7 software as follows: step 1: firstly auto-binning (‘coarse fine supervised’) in fico model builder was carried out step 2: secondly after auto-binning, bucketing was carried out such that: there should be a logical relationship between the bad rate and the characteristic buckets must contain at least 2% of total and not less than five bads per bucket a tail-end bucket can contain around or less than 2% of total population of the characteristic if the characteristic has at least three buckets step 3: apply business rationale after the bucketing process regression was carried out and based on the ‘scorecard-divergence’ method from fico. table 6 presents the predictiveness statistics of the internal application scorecard from the fico mb7 software. table 6: internal application scorecard performance measures results. table 6 presents predictive results for both the development sample as well as the hold-out or validation sample from fico model builder. the divergence, gini-coefficient and ks-statistic show deterioration from the development window to hold-out sample. table 6 indicates a gini-coefficient of 30.5%, which excludes bureau information and is based only on internal company information. no correlation (correlation above 50% is deemed significant) between characteristics was observed as indicated in table 7. table 7: correlation (development). figure 7 illustrates the score trend of the internal application scorecard. the score trends in figure 7 illustrate the high bad rates for low scores and the higher the score the lower the bad rate for both the development and hold-out sample. the correlation analysis and score trend for the out-of-time window (oot) are presented in table 8 and figure 8 respectively. figure 7: score trend (internal application scorecard). figure 8: score trend (internal application scorecard) for out-of-time window. table 8: correlation (out-of-time). no correlation (correlation above 50% is deemed significant) between characteristics was observed as indicated in table 8. the score trends in figure 8 illustrate the high bad rates for low scores and the higher the score the lower the bad rate. the psi which measures the change in distribution against the development sample is presented in figure 9. figure 9: population stability index. figure 9 presents the population distribution for the oot window. a psi less than 0.1 is considered to be stable (as evident from figure 9). bureau scorecard the credit bureau transunion in south africa provides on-request bureau scores (empirica scores) to the lending institutions. the gini-coefficient of the empirica score was calculated as 42.0% for the development window, as shown in figure 10. figure 10: empirica score gini-coefficient (development window). the score trend of the empirica score is presented in figure 11. figure 11: score trend (empirica score). figure 11 illustrates again how high the bad rates are for lower scores and the higher the score the lower the bad rate (as expected). credit scoring matrix model siddiqi (2006) presented three approaches to implementing a multi-scorecard solution: the sequential approach, the matrix approach and the matrix-sequential hybrid approach. in the sequential approach an applicant is scored sequentially on each scorecard with each scorecard having its own cut-off. the sequential approach is best used when ‘hurdles’ are being used, that is, an applicant must have a minimum bureau score before sequentially moving on to the next scorecard. in the matrix approach multiple scorecards are used concurrently with the decision-making based on a combination of the cut-offs from each scorecard (siddiqi 2006:144). this matrix approach is used when a balanced choice needs to be made from different types of ideally independent information (siddiqi 2006:144–145). the matrix-sequential hybrid approach is used when an applicant is firstly put through the sequential approach, after which the applicant goes through the matrix approach. the matrix-sequential hybrid approach is more versatile than the sequential approach and simpler than the matrix approach. this approach is best used when three independent scorecards are used, balancing several competing interests and used in conjunction with policy rules for applicants that are prequalified (siddiqi 2006:146). the csmm is a matrix approach except that the decision-making is based on a cut-off determined after the internal application scorecard and bureau scorecard are combined (discussed in the ‘cut-off score determination’ section). the csmm is represented as follows: in equation 6 ai represents internal application scorecard score i, bj represents empirica scorecard score j, cij represents the matrix’s score ij; i = 1 … x, j = 1 … y, x = score range of internal scorecard and y = empirica scorecard. in equation 6 c11 represents the matrix score where there is a low internal application score and low empirica score, cij represents a high internal application score and high empirica score, scores to the bottom left represent high internal application scores and low empirica scores and scores to the top right represent low internal application scores and high empirica scores. using the scores from the internal application scorecard and combining with the empirica scores, the bad rates for the csmm are represented in table 9. table 9: credit scoring matrix model (bad rate % per matrix cell). table 9 indicates high bad rates in the top left quadrant with low internal application scores and low empirica scores. the lowest bad rates are at the bottom right quadrant as expected (high internal application scores and high empirica scores). top right and bottom left quadrant are marginal client bad rates with either a low internal application score or high empirica score (top right quadrant) or high internal application score and low empirica score (bottom left quadrant). to illustrate the benefit of using the csmm from a predictive point of view the gini-coefficient was calculated. firstly, the gini-coefficient for the internal application scorecard was determined by grouping each score into the 10 score bands used in table 9 and was calculated as 29%. secondly, the gini-coefficient for the bureau scorecard (empirica score) was determined by grouping each score into the 10 score bands used in table 9 and was calculated as 41%. thirdly, the gini-coefficient for the csmm was calculated with a value of 46% by ranking the bad rates from the matrix from worst to best. the gini-coefficients are summarised in figure 12. figure 12: gini-coefficients: (a) internal scorecard & bureau score and (b) matrix. in figure 12 the uplift in gini-coefficient is . the theoretically correct way to compute the uplift from the csmm is to compare it to a one-dimensional scorecard containing both internal application information and external bureau information; it was calculated as 43%, indicating that the csmm still gives uplift. however it is not recommended to implement a one-dimensional scorecard containing both internal application information and external bureau information for various reasons: external bureau information is much stronger than internal application information, hence when building a one-dimensional scorecard containing both internal application information and external bureau information, the bureau information will completely overpower the internal application information. internal application information is more susceptible to application information manipulation, especially to a certain secured retail product. given that the application information can be manipulated, the second axis of the csmm acts as a hedge. converting the internal application information to one axis of a csmm opens the door to marginal clients, for example you can have applicants with high internal application scores, but low bureau scores and you can have applicants with low internal application scores, but high bureau scores; this opens up opportunities. in addition clients with no bureau history can now also be considered, as they would have internal application information. although the gini-coefficient of 30.5% of the internal application scorecard (excluding bureau information) might seem too low, the necessity of this information within the overall csmm is paramount, for example, in preventing the booking of high loan to value (ltv) applicants, which could have devastating effects. whenever there is a need to change to a latest bureau score it would be easier to change one axis of the csmm instead of doing an entire new scorecard rebuild, which will be the case if the bureau score is embedded within a one-dimensional scorecard containing both internal application information and external bureau information. the csmm in addition does not fully put reliance on bureau information or solely on internal processes; thus, if credit bureaus are unable to provide information or if internal processes fail one can fall back on either the internal application scorecard or bureau scorecard respectively in such extreme cases. given the uplift in gini-coefficient from the csmm against the bureau scorecard and the numerous reasons given above the csmm can be regarded as the optimal model (most favourable) from a credit scoring perspective in retail banking. the csmm is presented in figure 13. figure 13: credit scoring matrix model. cut-off score determination to illustrate the effectiveness of the csmm, consider a one-dimensional approach and assume only the internal application scorecard is available to score clients presented in table 10. the bad rate data in table 10 correspond to the bad rate data in table 9 for the internal application scorecard dimension. table 10: one-dimensional score (internal application score). using table 10, suppose that the decision was made that a bad rate of 8.24 or higher for applicants would not be considered, which will set the cut-off score at 568 for the internal application score. table 10 is a straight cut-off from the one-dimensional scorecard. secondly, assume the internal application scorecard and bureau (empirica) score in matrix format are at hand to assess an applicant. using table 9, suppose that the decision was made that a bad rate of 8.24 or higher for applicants will not be considered, which will have a diagonal cut-off presented in table 11. table 11: two-dimensional credit scoring matrix model. table 11 presents information that is not a straight cut-off as for the one-dimensional scorecard, but a more granular two-dimensional cut-off. having such a strategy cut-off has some advantages such as: clients with a low bureau (empirica) score, but high application score can be considered, clients with a low application score, but high bureau score (empirica) can be considered, negative effects of application form manipulation for internal scorecard are reduced because the bureau (empirica) hedges this manipulation and a greater dimension of information is taken into account to determine whether an applicant will be bad in future. conclusion in the last 60 years (to 2016), credit scoring played (and still plays) an important role in the credit industry, which mitigates and controls future bad clients. however, literature is limited, which encourages further research on credit scoring. in the last 25 years (to 2015) credit scoring has grown, particularly in the banking industry, making the separation between good and bad clients more critical to have effective credit risk management and to reduce future bad debts, which emphasises the significance of this research. this article presented a literature background on statistical techniques used in the world of credit scoring illustrating both weaknesses and advantages of each technique. the methodology then led to an application scorecard which includes the decision on the initial bad definition, outcome decision or maturity, development window, exclusions to be used in the development, sampling, reject inference, characteristics considered to predict bad clients, bucketing process, business intervention, regression technique, relevant scorecard tests and out-of-time testing. the contribution from this article is the construction of a scoring model to optimise the separation between good and bad clients in the form of a csmm. the csmm consists of two components, namely, the internal application scorecard (built from information specific to the organisation) and the credit bureau or empirica score (based on external data). these provide insights on client’s credit performance with all other credit organisations. the separation of internal organisation client credit performance information and external client credit performance information by the csmm is important. internal information, contained in the internal application score, indicates a direction of client credit performance; however, the external information contained in the empirica score acts as a hedge should the internal application score not capture all client-related credit performance. during the construction phase of the internal application scorecard it was decided to use a 24-month outcome period to capture appropriate number of bad clients and to work on a population, which is a reflection of the current portfolio. reject inference results indicated the higher bad rate for rejected clients (as expected). the internal application scorecard gave a gini-coefficient of 30.5% for the development window with the relevant scorecard tests indicating no correlation between characteristics and stability. combining the internal application scorecard with the empirica score a csmm was constructed that distinguishes between good and bad clients on a more granular level that in addition enables the setting of a more appropriate cut-off score, which was highlighted as a problem in past literature. it was illustrated that having a csmm gives a relative percentage uplift in the gini-coefficient of 12.0% to distinguish between good and bad clients more effectively. this will lead to fewer clients being initially selected, which would have resulted in future bad clients creating effective credit risk management and reducing future bad debts. how a csmm establishes the cut-off score more appropriately to accept clients than a one-dimensional scorecard by providing a greater granularity option, adds to the contribution of this work. possible future research includes the combination of an internal application scorecard with an internal bureau scorecard which can be built on specific bureau information that works best for the organisation in question. in addition, possibilities exist to investigate the optimal construction when building a matrix. acknowledgements i would like to thank my parents for all the assistance, guidance and opportunities. thank you to the faculty of natural sciences of the north-west university for giving me the opportunity to study. great thanks to gary van vuuren for his assistance in writing this article. competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions n.k. was fully responsible for the writing of this article, while g.w.v.v. was the appointed supervisor from the university and gave valuable guidance in writing this article. references abdou, h. & pointon, j., 2011, ‘credit scoring, statistical techniques and evaluation criteria: a review of the literature’, intelligent systems in accounting, finance & management 18(2–3), 59–88. https://doi.org/10.1002/isaf.325 allen, l., de long, g. & saunders, a., 2004, ‘issues in the credit risk modelling of retail markets’, journal of banking and finance 28, 727–752. https://doi.org/10.1016/s0378-4266(03)00197-3 anderson, r., 2007, the credit scoring toolkit, theory and practice for retail credit risk. management and decision automation, oxford university press, oxford. hand, d.j. & henley, w.e., 1997, ‘statistical classification methods in consumer credit scoring: a review’, journal of the royal statistical society: series a (statistics in society) 160(3), 523–541. https://doi.org/10.1111/j.1467-985x.1997.00078.x harrell, f.e., 2015, regression modeling strategies, 2nd edn., springer international publishing, cham, switzerland. lim, m.k. & sohn, s.y., 2007, ‘cluster-based dynamic scoring model’, expert systems with applications 32, 427–431. https://doi.org/10.1016/j.eswa.2005.12.006 siddiqi, n., 2006, credit risk scorecards, developing and implementing intelligent credit scoring, john wiley & sons, inc. hoboken, nj. thomas, l.c., edelman, d.b. & crook, j.n., 2002, credit scoring and its applications, siam, philadelphia, pa. transunion, 2015, credit bureau, credit reporting companies. learn about your credit, viewed 02 april 2015, from https://www/mytransunion.co.za transunion & fair isaac corporation (fico), 2009, empirica. minimise your credit risk. increase your profitability, transunion, johannesburg. 405 satednr vol 1 (1998)nr3 international income growth and convergence and the south african economy· l yadavalli national productivity institute, pretoria abstract this paper considers the growth experience of the south african economy during 1970-1994, against the background of the international convergence phenomenon affirmed by daumol (1986). convergence refers to the idea that countries with initially low real per capita income tend to grow faster than wealthier countries, and that their per capita income levels and growth rates will eventually reach a common end-state. this empirically observed catching-up process by the developing countries is assisted by their economic restructuring. here the growth performance of the south african economy is compared with some established and newly industrialised countries, using statistical dispersion and distance measures. jel 0 500 introducnon growth rates differ over time and across countries. higher growth rates yield higher productivity growth via verdoom's law. growth rate differentials can be explained by the catching-up or convergence phenomenon. countries with a lower real per capita income have the potential to grow faster than economically developed countries, through structural changes which boost the catching-up process. the present study concentrates on the growth path of some selected countries. south africa with its natural resources and diversified economy is a country with a great growth potential, and this paper also assesses its growth performance in the international context. sustained economic growth bridges the gap between the rich and poor nations. growth rates differ over time, since economies grow by passing from one developmental stage to another, with higher growth rates leading to greater productivity growth according to verdoom's law. • in memoriam g l de wet r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 3 406 development and growth the so-called convergence phenomenon has been empirically studied by, for example, abramovitz (1983). baumol (1986) and cornwall (1977). this phenomenon refers to the idea that countries with initially low per capita output tend to grow faster than economically more advanced countries, and that their per capita real income levels and growth rates will eventually converge. countries with low technological endowment can exploit existing knowledge and attain high rates of productivity growth, while countries within the more developed category have fewer opportunities for higher productivity growth. japan, given its scant natural resources, is an excellent example of restructuring through a four-phase product cycle and economic modernisation through structural change. this catching-up process was formulated by akamatsu (1962). to explain the design of japanese industrial growth, which he termed the "flying wild-geese pattern". this theory envisages a continuous shift of comparative advantage from economies in a higher phase of development to those in a lower phase. the advantage of economic backwardness is a rapid catching-up process, implying convergence that may result from deliberate government policy. some explanations of convergence state that technology is a public good, and the opportunity of obtaining technology and knowledge from the more advanced countries, through the so-called spill-over effect, thus benefit the less advanced countries. countries with a low initial level of productivity therefore grow faster than the more affluent countries (abramovitz, 1979). with a given ratio of investment to gop, poorer countries with low capital-labour and capital-output ratios, will also show a faster rate of growth of their capital stock. data sets developed by the world bank (summers & heston, 1991) provide economic information on international growth rate differences. structural changes between countries at the same point in time, may provide an explanation for observed growth rate differences. the gap between different economic outcomes may be measured by euclidean distance. the coefficient of convergence can be defmed as a mean value across countries of the percentage deviation from a postulated economic frontier (the usa). a decreasing value indicates convergence or catching-up, and an increasing value points to divergence. an important related concept is conditional convergence. unconditional convergence is the idea that countries move towards the same level of productivity, while conditional convergence suggests that forces push an economy towards a steady-state level of productivity and a steady-state rate of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 407 sateb nr vol 1(1998) nr 3 growth. with conditional convergence, observed growth rates of output per person depend inversely on the initial level of output per person. empirical studies show that there is strong negative correlation between growth rates and initial per capita income. the theory developed by olson offers a possible explanation for the general success of the catching-up model: special interest groups reduce the rate of growth along with the level of income. by using their power to block innovation. barriers to efficient resource allocation can also reduce the economic growth rate. countries where special interest groups have been abolished by, say, totalitarian government, foreign occupation or war, enjoy the greatest gains in economic growth (mueller, 1983). growth and convergence the catching-up hypothesis as formulated and tested by abramovitz (1979), unconditionally states that countries with a relatively low level of productivity should grow relatively faster. unconditional convergence includes the proposition that countries actuaily move towards the same level of productivity. conditional convergence is a more subtle notion and allows for "the possibility that there are forces pushing the economy towards the steady-state level of productivity and steady state growth rate. unconditional convergence is a result of a special case of the traditional neo-classical model. both the traditional and the augmented-solow models predict conditional convergence where the steady-state level of income depends on population growth and rates of capital accumulation" (crafts, 1995). conditional convergence occurs where observed growth rates of output per person depend inversely on the initial level of output per person, reflecting the scope of catching-up. as abramovitz has suggested, "the post-world war it decades .... proved to be the period when exceptionally the three elements required for rapid growth by catching-up came together. the elements were large technological gaps, enlarged social competence ... and conditions favoring rapid realization of potential" (abramovitz, 1986). ~uringconvergence so-called b-convergence is confirmed if there is a mean reversion in the gdp. so-called y-convergence again shows the decline in the cross sectional dispersion of real per capita gdp. the coefficient of variation is then diminishing over time. the test for conditional convergence has been to regress the growth rates of per capita gdp against the investment/gdp ratio, initial education levels, the initial level of per capita real income relative to that of the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 3 408 usa. the population growth rate and a constant. if the coefficient of the initial relative level of per capita income is negative, then convergence is confirmed. catching-up is a many-sided concept which has been used in historical studies (gerschenkron, 1962), neo-classical production function models (dowrick & nguyen, 1989), keynesian-type models (comwall,1977), and empirical studies in general (baumol, 1986 and abramovitz. 1983). evidence of convergence, or the tendency for poor countries to grow faster than the rich ones, is empirically supported by studies conducted by steve dowrick and duc-tho nguyen (1989), and the widely reported convergence of the oecd countries. the belief that economic growth depends on the expansion of a key sector of the economy, was stressed by the physiocrats and has persisted ever since. if the income elasticity of demand for the output of a sector is greater than one, then the share of that sector in total output will rise as the economy grows. the convergence view has been discussed by many authors, including moses abramovitz (1986, 1990), william j. baumol (1986), and baumol et al.(1989). using data collected by maddison (1982,1989), these authors provide evidence that incomes have in fact been converging over a fairly long period. for example, baumol (1986) finds a high inverse correlation between a country's productivity level (as proxied by gdp per work-hour) in 1870, and its productivity growth in terms of gdp per work-hour over the next 110 years. while these results have been shown to be very sensitive to the sample of countries selected (de long, 1988), there is also evidence that convergence has occurred among an ex ante chosen subset of oecd countries (baumol & wolff, 1988; baumol et al., 1989). it should be noted that the partial measure of productivity used in these studies, namely labour productivity , may also have influenced their results. the present study explicitly measures total factor productivity . steven dowrick and due-tho nguyen (1989) have added further evidence of convergence based on a sample of oecd countries in the post-world war ii period. they argue that one needs to distinguish between the catch-up or convergence of real per capita income (or income per work-hour) and total factor productivity (tfp) catch-up. following baumol (1986) and abramovitz (1986, 1990), dowrick and nguyen confirm that tfp catch-up is inversely related to a country's initial level of relative labour productivity. steven dowrick extended the dowrick and nguyen (1989) results by allowing for sectoral change. he found evidence that "gdp growth since 1950 has been systematically higher in those oecd countries which have been able to reallocate the greater proportion of their labour force out of agriculture". r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 409 sateb nr vol i (1998) nr 3 catching-up is also based on differences in marginal capital productivity between nations. countries at a lower level of development have a larger potential to grow faster than the developed countries (rebelo, 1991 ). most convergence studies are limited to the oeco countries and do not look at convergence between industrialised and developing nations. barrow and sala-imartin (1991) found convergence for the usa, regions of europe and japan at a rate of 2 per cent per year. paul m. romer (1989) and sergio rebelo (1991) again emphasised the lack of correlation between initial per capita gop and per capita growth rate for a sample of 100 countries, as evidence against convergence. neo-classical growth models developed by frank ramsey (1928), robert m. solow (1956), trevor swan (1956), and tjalling c. koopmans (1965) suggest that different steady-state economies are due to differences in government policy, the rate of saving, the nature of production, technology and so on. barro et al. (1995) report that after allowing for differences in investment rates, the initial stock of human capital and some other variables, countries converge conditionally at the rate of 2 per cent per year. labour productivity and per capita income levels in the industrialised market economies, have tended to converge over the last century. baumol found that 88 per cent of the variation in labour productivity in the growth rates across a sample of sixteen industrialised countries over the period 1870-1979, can be accounted for by a systematic tendency for the poorer countries to experience higher rates of growth. capital-deepening supports this evidence. baumol regressed the average annual rate of labour productivity growth over 1870-1979, on a constant and the log of labour productivity in 1870 for the "maddison sixteen" data, which provided a strong case for convergence. (this is a sample of developed capitalist nations, consisting of the following individual members: australia, uk, switzerland, belgium, netherlands, canada, usa, denmark, italy, australia, gennany, norway, france, finland, sweden and japan). but baumol's regression tells little about the strength of the forces making for convergence since 1870 among industrial nations. the sample suffers from selection bias because any nation that was relatively rich in 1870 but did not converge, failed reach the "maddison sixteen" group of countries (de long, 1988). studies that focus on the convergence or divergence of real per capita income, have been found to hold for a number of industrialised countries during the period 1870-1979. it is a common practice to compare a country's economic growth rate with the average growth rate from some related group of countries. olson (1982) thus found that "the united states has had the highest per capita income of all major nations". the other countries, however, at least had the opportunity to catch-up. in the context, kormendi and meguire (1985) found r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 3 410 that catching-up was statistically significant in their sample of 47 countries from the oecd and the middle-income market economies in the post-war period. dowrick and duc-tho nguyen (1989) suggest that some part of the convergence pattern is due to systematic variations in the sectoral composition of total output. thus, if the productivity growth in the service sector is lower than in the primary and manufacturing sectors, labour productivity convergence is explained by a higher rate of investment that tends to increase the capitallabour and output-labour ratios. baumol writes that "forces accelerating the growth of nations who were latecomers to industrialization and economic development give rise to a longrun tendency towards convergence of levels of per capita product or, alternatively of per worker product" (baumol, 1986). such ideas were already expressed by gerschenkron (1952) who pointed out that backwardness need not be without its advantages. distance funcfion the convergence hypothesis is tested here by means of data from the national productivity institute's productivity focus (l995).the difference between recorded output levels is measured by a distance function. if a one-to-one correspondence between all numbers in a system (xl ,x2 , ..... xn.) is possible, and if x is any point in the euclidean space rd of n-dimensions, then the distance between two points, if x = ( x), x2 , .... ,xn ) and y = s'l. y2, .• ···,yn ) iix yii = (xi yli + (x2 y2) + ........ (xn yni and this will satisfy the triangle inequality ix yi ~ ix zi + iy zi is (1) (2) to test the catching-up trend, a convergence coefficient is used. a decreasing value indicates convergence, while an increasing one indicates divergence. the distance between two production structures can be measured by minkowisoo's p-metric m d;j(p) =l[ixu.: -xjkplflp (3) .... 1 minkowiski's p-metric results in the euclidean distance. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 411 sateb nr vol 1 (1998) nr3 convergenceempuucs baumol (1986) analysed maddison's (1870-1979) data and showed that convergence has been strong among the industrialised nations. he regressed the average rate of annual labour productivity growth over 1870-1979 on a constant and the logarithm of labour productivity in 1870, and found an inverse relationship between them. baumol's regression line does however not identify the forces leading to convergence among the industrial nations. the independent variable is measured with error and there is a selection bias arising from maddison's data which includes nations that were relatively rich in 1870. baumol's findings imply that only one variable, namely a country's 1870 gdp per work-hour, matters, and that other factors such as the propensity to invest or policies to stimulate growth, do not. delong (1988) found that estimates of early per capita gnp for a wider spectrum of countries show that a less biased sample exhibits little sign of convergence. the period 1950-73 was considered a "golden age", as the experience of rapid economic growth was internationally shared. it was also a period of conditional convergence since policy reforms were successfully implemented (e.g. in ireland and spain) to speed up the growth process. verspagen (1996) found evidence that catching-up in the golden age led to a reduction of the technology gaps between countries. olson (1982) argued that established democracies are characterised by vested interest groups whose activities slow down the rate of economic growth. investment boom, capital accumulation, free trade, and competition all play an important part in the catching-up process. figure 1 demonstrates the growth experience of maddison's group of sixteen industrialised countries during 1985-95. the nations in maddison's sample of sixteen countries are among the richest nations in the world today. the negative slope indicates that 1985 and 1995 relative incomes are uncorrelated. a fair test of convergence requires an ex ante sample of countries that are likely to converge. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 3 412 figure i: the per capita gnp for maddison's sixteen-198s-95 per capita gnp for maddison's sixteen 1.14 on "l' on ~ 1.12 1 ~ 1.1 ~ 1.08 u . 9 be1giu~ • japan ., .. " ·austrla ,denm! rk ... •• f lance ~tcd~ki 1'~'7 ustraii ..... .u gdom .. ,. • in~~' ~d .~ 1.06 bunited sll ies i • it 1.04 • i:anada ~ ...:i 1.02 3.7s 3.8 3.8s 3.9 3.9s 4 4.0s 4.1 4.1s 4.2 4.2s log per capita income in 1985 south africa and convergence south africa with its abundant natural resources and relatively sophisticated infrastructure has an economy with great development potential. the economy is classified by the world bank in the category of developing "upper-middleincome countries". however, real per capita income in south africa still falls well behind its counterparts in the leading industrialised countries. much of the problem evidently lies in mismanagement and misallocation of available resources. mobilising savings into appropriate channels and producing new investment goods to increase the stock of capital, which inter alia depend on an efficient capital market, have slowed down and led to structural problems. in the present study the convergence phenomenon is tested mainly by means of data from national productivity institute. gdp per capita for 21 countries were taken from the period 1965-91 and ranked in descending order. six samples of countries were then drawn, consisting of a set of the top nine, thirteen, fourteen, sixteen, eighteen, and twenty countries. the coefficient of variation was calculated for each sample. the results showed divergence among the lower and convergence among the higher income countries. the coefficient of variation (cv) for each sample of countries is given in table 1. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 413 sateb nr vol 1 (1998) nr 3 table 1: the coefficient of variation for a sample of countries,19651991 . top 9 top 13 top 14 top 16 i top 18 top 20 1965 0.0025 0.0290 0.0319 0.0380 539 0.7200 1970 0.0240 0.0250 0.0290 0.0350 0.0450 0.0640 1975 0.0220 0.0230 0.0290 0.0340 0.0402 0.0620 1980 0.0210 0.0250 0.0320 0.0350 0.0397 0.0610 1985 0.0200 0.0240 0.0380 0.0400 0.0427 0.0650 1991 0.0200 0.0260 0.0394 0.0399 0.0401 0.0650 the above table supports the convergence phenomenon. cv is lowest for top 9 countries and it systematically increases with the addition of more countries. sta tistica (1996) was used for the above computation. the cv has dropped in 1991 as compared to 1965 and also showed an increasing tendency to fall as countries in the lower income groups were added to the sample. this tendency clearly suggests divergence among lower income countries and convergence among the higher income countries figure 2: the coefficient of variation for a sample of countries, 19651991 the coefficient of variation-t 965-1991 0.08 0.07 !-----0.06 ~ 0.05 0.04 0.03 t-. 0.02 0.01 o 1965 1970 ..... .--1975 1980 1985 1991 1....top 9 ---top 13 ..... top 14 ~topl6 ---top 18 --top 20 i r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 3 414 figure 2 shows the coefficient of variation for all six samples. a declining coefficient of variation suggests convergence. measuring the distance or gap the income gap between countries can also be calculated using the following formula qusa gap=ln (4) for equal values of per capita income the gap is zero. an increasing gap indicates divergence and a gap closer to zero indicates convergence. countries closer to the frontier (usa) have smaller growth rate differentials and countries further away from the frontier show divergence or greater growth rate differentials. convergence phenomena related to the gap measure are analysed by means of data from the national productivity institute (1994,1995). figure 3 shows the distance between some selected countries from 1985 to 1991, and comparable data for some east asian countries, plus south africa and usa, are shown in figure 4. fi ure 3: conve ence in some selected countries-1960-1991 gop per capita.,1960-1991 2/ 1.8 i-----_ •• _--~ .. 1.6 • 0.8 +---+---+---+---+---+---+---+----1 1960 1964 1968 1972 1976 1980 1984 1988 1991 ....... australia ---botswana ....... brazil -m-canada --chile -france --gennany uk usa r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 41s sateb nr vol i (1998) nr 3 fi re 4: conve ence in some east asian economies sa and usa gdp per capita-i960-i991 1.7 1.6 1.s 1.4 1.3 1.2 1.1 1 0.9 0.8 1960 1964 1968 1972 1976 1980 1984 1988 1991 i-+-japan -korea -.singapore -*"" south africa ......... taiwan ........ thailand -+usa i it appears that south africa's per capita gop (using distances) compares favorably with at least some of the newly industrialised countries (nics). south africa has in fact a great potential for convergence since it falls within the band of the relatively advanced nics as shown in figure s. figure 5: per capita gnp for some east asian economies and south alrica 1985-1995 per capita gnp for east asian economies and south africa 125,-------,-------,-------,--------,-------, phili 1.2 +--~~~=-----+__----._ ..... ..___--___,f__---_i 1.15 +----f-----+----+----'--'-'-~~~'a=_=---i l.lt------t--.-mdom:fcr~~~;;;;--_____t--_ 1.05 +-------+-------+--------.::----1--------+---------1 2 2.5 3 3.5 4 4.5 log per capita income in 1985 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 3 416 a regression was fitted for a sample of countries, and the results showed divergence in gdp per capita for the period 1965-1980, but convergence during 1985-1993. the regression equation is = in gdp'-n + e (5) a positive relationship between the two variables in equation (5) indicates bdivergence and a negative b indicates convergence. the regression was run for a sample of the top 20 and the top 13 countries, and the results are presented in table 2. table 2: regression results toil 13 top 20 1960-1980 1980-1991 1960-1980 1980-1991 0 0.2140 -0.0900 0.0220 -0.1400 intercept -20.2500 1.7440 7.4030 1.5803 r 0.2143 0.0882 0.0218 0.1375 rl 0.0459 0.0077 0.0005 0.0189 f 0.5290 0.0862 0.0085 0.3470 p 0.4820 0.7745 0.9272 0.5621 t -0.5052 1.1740 0.5008 3.5840 the results in table 2 clearly show that convergence took place during the period 1980-1991 for the top 13 and top 20 countries. a distance matrix giving euclidean distance is presented in table 3. the distance matrix gives the distance between any two countries. multidimensional scaling was used to find distances between countries. canonical correlation which gives the relationship between countries was also used. canonical correlation is unique in that it is a statistical procedure which assesses the relationship between two sets of countries. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . ~i "'" auskosins swe taiuk botbracachidenfrance gergreece usa ., -5!: ...... trarea gaaf-den wan swazil nada ie mark many fa lia pore rica na ~ aus.00 .34 .12 .64 .12 .43 .02 .68 .56 .07 .57 .72 .12 .24 .08 .66 i.-t tralia , korea .34 .00 .30 .44 .45 .10 .33 .35 .24 .41 .36 .38 .45 .41 .41 .48 q. singa.12 .30 .00 .54 .21 .39 .11 .64 .52 .16 ;53 .67 .)9 .27 .16 .62 ii lilt ,re 1;1 south .64 .44 .54 .00 .75 .41 .64 .45 .40 .69 . .67 .46 .73 .65 .69 .59 g' ;africa i sweden .12 .45 .21 .75 .00 .54 .12 .80 .67 .06 .64 .83 .03 .30 .06 .75 taiwan .43 .10 .39 .41 ,54 .00 .43 .25 .15 .50 .36 .29 .54 .48 .50 .46 f uk .02 .33 .11 .64 .12 .43 .00 .68 .56 .07 .56 .72 .12 .26 .08 .66 ibot.68 .35 .64 .45 .80 .25 .60 .00 .15 .75 .46 .04 .80 .71 .76 .50 swana brazil .56 .24 .52 .40 .67 .15 .56 .15 .00 .63 .46 .17 .67 .59 .63 .50 canada .07 al .16 .69 .05 .50 .07 .75 .63 .00 .62 .79 .05 .27 .02 .7) c.n chile .57 .36 .53 .67 .64 .36 .56 .46 .46 .62 .00 .49 .65 .67 .62 .52 ~ denmark .72 .38 .67 046 .83 .29 .72 .04 .17 .79 .49 .00 .83 .74 .79 .53 france .12 .45 .19 .73 .03 .54 .12 .80 .67 .05 .65 .83 .00 .29 .05 .75 ~ gemlany .24 .41 .27 .65 .30 .48 .26 .71 .59 .27 .67 .74 .29 .00 .28 .71 e: greece .08 .41 .16 .69 .06 .50 .08 .76 .63 .02 .62 .79 .05 .28 .00 .72 -usa .66 .48 .62 .59 .75 .46 .66 .50 .50 .71 .52 .53 .75 .71 .72 .00 ~ 00 -~ w r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 3 418 conclusions a learned paper by william j baumol (1986) has come to serve as a role model to which empirical convergence studies of the present kind are anchored. baumol found that a sample of 16 advanced market economies (known as maddison's sixteen) has shown a remarkable convergence ofgdp per capita in the long term. this was associated with a historically unprecedented growth in productivity. no such convergence was however, observed for the economically less developed countries. seeing that the south african economy has often been described as a .. blend of the first and third worlds", it seems fitting to ask: in which direction is it actually tending to move? alternatively expressed: does the convergence hypothesis also apply to the south african economy? if yes, south africa would show at least the affinity to gravitate towards the first world; if no, there would be at least a presumption that it rather belongs to the third world in order to test the convergence hypothesis, south africa was grouped together with various other states into country sets conditionally classified as either (i) developed market economies (like maddison's 16) or (2) newly industrialised countries (generally known as nics). the world bank classifies south africa as one of 17 "upper·middle-income" countries, a group that includes nics like malaysia, korea, brazil and chile. there is only one income group that is higher in the world bank's rank.arder, namely, the developed market economies (including 5 small states that might also be classified as "developing", according to criteria other than per capita income). the present research confirms that, in terms of per capita output, south africa belongs to neither the first nor the third world, but rather to an intermediate group together with the nics. within this intermediate group, however, south africa finds itself in the vanguard taking the united states to represent the grand frontier, the gap that separates south africa from the frontier, according to a distance function, is smaller than that for most nics. in terms of a euclidean distance matrix south africa had covered 0.59 of the way to the frontier during 1985-93, compared to, for example 0,52 for chile, 0,50 for brazil, 0,48 for korea, and 0,46 for taiwan. at the same time, it is evident that south africa had not yet caught up with such developed (or oecd) countries as france and sweden (both 0,75). canada and germany (l-i)th 0,71) and the united kingdom (0,66). the conclusion that south africa is at least moving (i.e. gravitating) towards the first-world countries as a group, is supported by measures of dispersion known r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 419 saleb nr vol 1 (1998) nr 3 as p-convergence and y-convergence. convergence over time would be indicated by a negative ij-coefficient and a y-coefficient of decreasing value. the convergence observed for the south african economy is, however, a fairly recent phenomenon, that has taken place in spite of south africa's rather indifferent growth record: during the period 1985-93 real gop per capita more often fell than rose. it must be however borne in mind that ''the golden age" of economic growth in the developed market economies had ended in 1973. since then the first-world growth path has followed a rather lower trajectory. although the causes of this secular change cannot be discussed here, these have been of a deep-seated institutional nature, where the growth-retarding influence of inre-rest groups" has been and remains an important factor" (mueller, 1983). is the evident convergence of south africa's real per capita income likely to continue in the future? an important demographic development has been the recent decline in fertility, and economic growth would accelerate if south african industry could rid itself of its currently wasteful production techniques. these are too capital-intensive given the country's relative resource endowment, thus resulting in an inappropriately high capital-output ratio. briefly put, there exists considerable scope for improvement in the productivity of both labour and capital. endnotes (1) the author is indebted to prof m.l.truu for valuable suggestions and comments that contributed towards the process of finalising this paper. (2) the author would like to acknowledge with gratitude the constant encouragement and support received from the national productivity institute. (3) this article is based on the author's o.phil. thesis economic growth and convergence in the south african economy, university of pretoria, 1997. data pertaining to specific aspects of this topic may be obtained on request from the author at the national productivity institute, p.o. box 3971, pretoria 0001. references 1. abramovitz, m. (1986)."catching-up, forging ahead and falling behind"; journal o/economic history. xlvi: 385-406 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 3 420 2. akamatsu, k. (1962). "a historical pattern of economic growth." the developing economies, (institute of african economic affairs), no.l,3·25. 3. barro, r.j., manklw, g.n. &. sala-l-martin, x. (l995)."capital mobility in neo-classical model of growth", american economic review, 85·95 4. baumol, w.j. (1986). "productivity, growth , convergence and welfare: what the long-run data show", american economic review, 76: 1070-85. 5. baumol, w.j. &. wolff, e.n. (1988). "productivity growth, convergence, and welfare, reply", american economic review, 78: 1155-1159. 6. cornwall, j. (19779. modern capitalism: its growth and transformation. london: martin robertson. "1 7. crafts, n.f.r. f(1995). the golden age of economic growth in western europe", economic literature review, xlvm: 429-47. 8. de long, j.b. (1988). "productivity growth, convergence, and welfare: comment", american economic review, 778: 1138-54. 9. dowrick, s. &. nguyen, d.t. (1989), "oecd comparative economic growth, 1950-85: catch-up and convergence", american economic review, 79:1010-30. 10. gerschenkron, a. (1952). economic backwardness in historical perspective. university of chicago press. 11. gerschenkron, a. (1968). continuity in history and other essays. harvard university press. 12. koopmans, t.c. (1965)."on the concept of optimal economic growth", in the econometric approach to development planning. amsterdam: north-holland. 13. kormandi, r. &. meguire, p. (1985). "macroeconomic detenninants of growth: cross country evidence", journal of monetary economics, 16: 141-63. 14. mueller, d.c. (1983). the political economy of growth, yale university press. 15. olson, m. (1982) the rise and decline of nations, yale university press. 16. productivity focus. (1994). national productivity institute. pretoria. 17. ramsey, f. (1928). "a mathematical theory of saving". economic journal, 38: 553-9. 18. rebelo, s. (1991). "long-run polary analysis and long-run growth, journal of political economy, 99: 500-21. 19. romer, p.m. (1989). "hwnan capital and growth", paper read at the carnegie-rochester conference on economic policy. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 421 satebnr vol i (1998)nr3 20. solow, r.m. (1956). "a contribution to the theory of economic growth", quarterly joumol 0/ economics, lxx: 65-94. 21. summer, r. & heston, a. (1991). ''the penn world table :an expanded set of international comparisons,1950-8t', quarterly joumol o/economics, cvi: 327-68. 22. swan, t.w (1956). "economic growth and capital accumulation", economic record. xxxii: 334-61. 23. verspagen, b. (1996). "technology indicators and economic growth in the european area: some empirical evidence", in b van ark & nfr crafts (eds.) quantitative aspects o/europe's post-war growth. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 90 women in agriculture technology in nigeria maadawo sajems ns vol 4 (2001) no i and appropriate department of economics, university of uyo, nigeria abstract there is no doubt that agricultural growth in nigeria has been on the decline. this is largely so because agricultural policies have a bias towards inappropriate technology, and fail to recognise women as the centrepiece in agriculture. the position taken in this paper is that women are in fact the pivot in nigerian agriculture, and whatever technology is developed, should be in line with their needs. such technology should involve a simple but mechanical fonn of weeding, the use of improved organic fertilizer and efficient methods of livestock husbandry. jelq 10 1 introduction women are a vital line in life, and agriculture is also a way oflife. every economy, be it industrial or agricultural, recognises the absolute need to feeds its population. nigeria had the historic glory of being a major exporter of agricultural produce in the 1960s, but changed to a net importer of food during the "oil boom" of the mid-1970s. from that time till now, nigeria has not been able to produce enough food for its teeming population. for example, food imports were ~085.1 million, w12597.2 million and w13,192.2 million for 1991,1992 and 1993 respectively (cbn, 1995: 165). apart from food being a necessity of life, agriculture occupies a prime position inproviding basic raw materials for some of our industries, whose capacities are regrettably underutilised mostly due to scarcity of raw materials (cbn, 1995: 92). yet the abundant literature on agriculture has consistently pointed out that agriculture employs about 70 per cent of the country's workforce. invariably, nigeria up till now depends on subsistence farmers for her food supply through traditional farming methods. at the centre of this farming r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no i 91 arrangement are the women. in the rural areas of nigeria, almost all economically active women are engaged in agriculture. incidentally, technological development in agriculture (if any) does not have women as the focal element in fanning but emphasis has rather been shifted to cash crops and perhaps plantation fanning. it is against this background that this paper sets out to link women with appropriate technology for improved farming. statement of the problem there has been a lot of policy fonnulation in nigeria's agricultural sector, some of which involves or influences the mode of technology adopted for improved agricultural perfonnance. but unfortunately these policies have failed to consider women as the centrepiece in nigerian agriculture. this omission is to a significant extent responsible for continuous decline in agricultural production and invariably affects both the immediate family (as women produce mostly for family consumption) and the income of women. objective of the study the objective of this paper is to examine the share of agricultural work (fanning) being carried out by women, which is evidence of their prominent role in nigerian agriculture. it also seeks to identify appropriate technology that would be women-centered and cost-effective to assist the achievement of improved agriculture in nigeria. metbod this work makes use of secondary data from already published sources. information on age-sex distribution of fann workers (expressed in percentages) was collected for both males and females from federal office of statistics, whose publications show which sex participates more in agriculture. moreover, information was collected on the percentage distribution of african women labour by kind of economic activity. the purpose here was to assess women's participation in productive activities, basically household activities and community work. simple tables were used to present the information. 2 women in agriculture women play both direct and supportive roles in traditional farming in nigeria. they identify themselves with subsistence or peasant type of fanning rather than commercial farming. this practice is prompted by their compelling need to feed r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 92 samms ns vol 4 (200 1) no i their immediate families and thus, by extention, the very nucleus of the nigerian society. women participate in agriculture by growing a mixture of crops on their farmlands. food crops range from cassava (manihot utilissima), maize (zea mays), yam (dioscorea rotundata), plantain (musa sapientum var. paradisiacal, banana (musa sapientum), cocoyam (xhanthosoma sagittifolium), melon (citrullus (colocynthis) vulgaris), cowpea (vigna unguiculata (sinensis», to rice (oryza sativa), vegetables include fluted pumpkin (telfairia occidentalis), water leaf (talinum triangulare), bitter leaf (vernonia amygdalina), green (amaranthus hybridus), etc. they also grow fruit trees like mango (mangifera indica), pear local (dacryodes edulis), pear avodaco (per sea americana), guava (psidium guajava), etc. in livestock farming women are not left out. they rear chicken, goats and sheep using their personal labour, children and housemaids. women also play a prominent role in food distribution. this includes: (i) getting farm products to the farm gate (sometimes this is done by carrying the produce on their heads where there are no motorable roads), (ii) taking the products to the market to sell to food dealers, and (iii) the processing of the food itself. table 1 age-sex distribution o( (ann workers in nigeria (per cent) 1998 age group male female f-m below 15 8.87 9.12 0.25 15-29 32.99 37.59 4.60 30-45 29.65 34.74 5.09 source: rural agnculture sample survey 1986/87, fos, lagos, p. 68. the author decided to concern himself with the age brackets 15-45 years, which is in his opinion the vibrant workforce for both sexes. from table i it is observed that for workers below 15 years, females outsupplied males by 0.25, between the ages 15 and 29 the female labour supply showed a positive difference of 4.60 and between 30 and 45 years the difference 5.09. this clearly shows that much more womenfolk participate in agriculture than men, mainly because women farm to feed their immediate family. this distribution of farm· labour only concentrates on the sexes; it however ignores the important facts of work discrimination and work intensification. detailed analysis of this would reveal that women also do most of the farming jobs, for example, clearing the bush, planting, weeding and harvesting. yet in most human endeavours including agriculture itself, women are discriminated against. this is done on grounds of land ownersnip, employment and educational opportunities, in technological development and agricultural services (iniodu, 1996: 135). in a survey carried out in 1986/87 by the federal office of statistics (fos) on land tenure for rural farming households in nigeria r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (200 1) no t 93 by state, it was discovered that 91 per cent of the land cultivated by rural households was on the basis of ownership, about 7 per cent was rented and 2 per cent cultivated under another type of tenure. in a typical traditional africanlnigerian society women do not inherit family lands, on the logic that women themselves are inheritable. this assertion is very much open to debate. despite this discrimination, women's participation in labour activities is still higher than that of men. ritchie (1977: 131) and okoji (1985: 165-73) have shown that over 50 per cent of economic activities in africa is carried out by women. table 2 a b c percentage distribution of african women's labour by activities activities percentage of women labour productive activities food production 70 domestic food storage 50 food processing 100 animal husbandry 50 brewing 90 marketing 60 supply of water 90 supply of fuel 80 household activities raising and childhood education of children 100 cooking for extended family 100 cleaning, washing 100 house buildin~ 30 house repair 50 community work self-help projects 70 source: iniodu, 1996: 133 from table 2, it is observed that in economic activities like food processing, cleaning, and washing, cooking, brewing, raising children and childhood education, women's contribution is looper cent. it is equally of interest to note that in the important project of house building women contribute at least 30 per cent. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 94 sajems ns vol 4 (2001) no 1 table 3 degree ofinvolvement of women in agriculture states in ni2eria percedt aoambra, benue imo 80 gon~ola, bomo, plateau, cross river 60-80 rivers ondo bendel 40-60 sokoti, kwara, kano, lagos, niger, abuja, oyo, ogun, 20-40 kaduna source: ekwe, 1996: 151 from table 3 it is clear that nigerian women participate in larger numbers in agriculture than men. however, the level of participation thins down in the northern states and central south, probably because of religious/cultural reasons. the mean value of women participation in agriculture is approximately 60 per cent. as quoted by ekwe (1996: 150) in world development (1978: 2), the level of women's participation in agriculture is 80 per cent in africa, 70 per cent in asia and 45 per cent in latin america. according to federal office of statistics (fos, 1984) 86 per cent of rural households in nigeria work in agriculture, 50 per cent in livestock husbandry and 4 per cent in fishing. 3 appropriate technology early american technology primarily depended upon the skills of the artisan. most of these skills were ages old, as were the basic tools of trade. "skill was the great requirement in this pattern of technology, e.g. anyone who had seen a barrel knew how the staves had been curved and shaved to produce a tight vessel. the design was wholly without mystery" (hindle, 1970: 9). this assertion confinns what might be described as the bedrock of technology, that is, developing technology from the available skills. pre-independence agricultural policy favoured export crops and resulted in the· . modernisation of cash crop production for export to britain. this brought improvements to the cash crop sub-sector at the expense of food crops produced predominantly by women, consequently impoverishing the women. if food crop production is to be emphasized, extention workers must interact with the food producers proper the women. the necessary supporting services must be compatible with appropriate technology, and this follows from the translation of relevant policies into action. technology can be developed by innovation, stolen or derived from adaptation. pursell (1980: 2) states that " ... machines would have to replace hands if jobs r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 95 were to be done." technology that develops from innovation and indigenous skills is most enduring and suitable to the environment. ogundinkpa (1985: 8) advocates adaptive technology and lists five steps to successful adaptation: (i) there must be awareness of the existence of the technology. (ii) there should be development of interest in technology. such technology should be able to solve the problems or the needs of the recipient country. (iii) the adapted technology should be one that emphasizes the welfare of the masses or group interest, not the benefits of a few or the ruling class only. (iv) there must be encouragement and empowerment to adapt the technology as perfectly as possible. (v) the final stage is the adoption of the technology, sequential to its responsiveness to the needs of the people. incidentally, past encouragement of technology in the direction of increased agricultural output emphasized mechanised farming, plantation farming and intensive farming with heavy use of non-organic fertilizer. this arrangement has some flaws: mechanised farming needs large tracts of land which the real farmers women do not possess. plantation fanning is most suited to tree crops most of which do not directly provide food application of fertilizer to intensive farming requires capital that most women farmers cannot afford. in summary, the agricultural technology so far adapted in nigeria largely bypassed the real farmers. this (in addition to the dutchdisease problem of petroleum) inadvertently affected the food supply of the nation negatively. appropriate technology that is required should de-emphasize inorganic fertilizer, and evolve a process of preparing organic fertilizer than women themselves can participate in, practice, and apply. instead of depending on herbicides that are alien to local vegetation, it would be desirable to produce a hand-motor weeding machine light enough to handle, easy to operate and to repair, and cheap to buy. seminars should be organised that carefully and meticulously teach the women seed multiplication and how to improve their quality. the agricultural extension officers should be prepared and able to do this. improved techniques of livestock husbandry should also be taught to the women. agricultural research r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 96 sajems ns vol 4 (2001) no 1 in this direction goes with immense benefits as the thus acquired skills are likely to be passed on to future generations. 3.1 appropriate technology and agriculture development of technology emanates from industrial policies, and such policies have not been lacking in nigeria. the fact that nigeria has not been technologically successful may well be a by-product of wrong policy assignment or poor implementation or both. spencer (1970) recognises technology as a dynamic force or catalyst for desirable change towards a nation's increase in wealth. tokaty (1975: 2) emphasizes the method and application of technology with the end result of value. this is supported by umenyi (1982: 52) and onyeonwu (1982: 43). it has been fashionable to emphasize advantages of latecomers to the technological domain in this context. the issue at stake is the much discussed transfer of technology, which has of course not been unopposed. so it is, because technology is a prized commodity and its intentional transfer is the least thinkable. however, for example hoelscher (1969: 365) and balz (1977: 269) (apostles of technology transfer) have been disproved, as the technology gap is still wide between the developed and the developing economies. ogundinkpa (1985: 8) has thus stated that in economies with over 70 per cent of the population in agriculture, the experience of imported technologies has taken little or no cognisance of their unique needs. 4 conclusion to sum up, the bulk of agriculture in nigeria is in the hands of women. it is therefore unfortunate that in terms of policy formulation, technology acquisition and application, land and credit allocation, women have been completely left out. this omission, the author of the paper believes, is one of the main reasons why agricultural productivity is on the decline. in other words, agricultural policies in nigeria over time have not focused on women as the centrepiece of agriculture. women have been bluntly denied land inheritance and sometimes land acquisition, and this is a serious barrier to agricultural productivity. the little effort made in the direction of agricultural technology has centred on mechanised farming, plantation farming and application of inorganic fertilizer. the arrangement has typically excluded women and this kind of discrimination has been counterproductive. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no i 97 even agricultural credit grants to a few fortunate applicants hardly ever include the women. yet again, one serious problem of agricultural productivity is the oversight of the real farmers women. it is thus proper to conclude by recalling a statement of poullain as quoted by reiss (1990: 11): " ... because natural powers had remained uncontaminated in women by the violence inculcated in men by the process necessary for the implementing of civil society, the evolution of that society now requires that women take leading roles." he continued that society might otherwise destroy itself. this is not less true of agriculture in nigeria. references balz, d.j. (1977) "exporting food monopolies", readings: economics guilford, connecticut dushkins publishing group, inc. 2 cbn (1995) central bank of nigeria, annual report and statement of accounts. 3 ekwe, s.n. (1996) "women in agricultural production in nigeria", in yomi oruwari (ed.), women development and the nigerian environment, lbadan, vantage publishers, (int) ltd. 4 fos (1987) rural agricultural sample survey, federal office of statistics, lagos. 5 hindle, b. (1980) "the artisan during america's wooden age", in c w pursell jr. (ed.), technology in america: a history of individuals and ideas, washington d.c. voice of america forum series. 6 hodscher, h.e. (1969) "technology and social change", readings in economics american society for the advancement of science, vol 166. 7 iniodu, p.u. (1996) "women in agriculture and rural development in eastern nigeria", in women in africa and the african diaspora: bridges across activism and the academy, indiana university, indianapolis. 8 okon, e.c. (1985) "the role of women in arable cropping enterprises in farming communities of southeastern nigeria: a case study", development and peace, 6 (autumn): 165-73. 9 onyeonwu, r.o. (1982), "technology transfer for nigerianconstraints and prospects", proceedings: second herbert macauley memorial lectures, nsukka, university of nigeria. 10 pursell, c.w. jr. (1980) "technology in america: an introduction" in c w pursell jr. (ed.), a history of individuals and ideas, washington d.c. voice of america forum series. 11 reiss, t.j. (1990) "revolution in bounds: wollstonecraft, women, and reason" in linda kauffinan (ed.), gender & theory dialogues on feminist criticism, oxford, basil blackwell ltd. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 98 sajems ns vol 4 (2001) no 1 12 ritchie, j.a.e. (1977) "impact of changing food production, processing and marketing systems on the role of women", proceedings: the world food conference of 1976, ames, iowa: the iowa state university press: 129-44. 13 spencer, d.l. (1970) technological gap in perspective, new york, spartan books. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction literature review data and methodology used results testing the appropriateness of the proposed models conclusion and suggestions for future research acknowledgements references footnote about the author(s) erika fourie centre for business mathematics and informatics, north west university, south africa tanja verster centre for business mathematics and informatics, north west university, south africa gary w. van vuuren centre for business mathematics and informatics, north west university, south africa citation fourie, e., verster, t. & van vuuren, g.w., 2017, ‘development and comparison of payment behaviour prediction models for two south african state departments’, south african journal of economic and management sciences 20(1), a1701. https://doi.org/10.4102/sajems.v20i1.1701 original research development and comparison of payment behaviour prediction models for two south african state departments erika fourie, tanja verster, gary w. van vuuren received: 17 nov. 2016; accepted: 24 may 2017; published: 10 oct. 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: no credit rating methodology currently exists for any of south africa’s sub nationals. aim: to develop a generic, quantitative credit rating methodology for the department of health and the department of education combined, as well as specific quantitative credit rating methodologies, for each department, individually. setting: a comparison between generic and specific subnational credit rating methodologies to assess which fits the south african subnational environment best. studies and results obtained from other nations were used to construct the approach. methods: in a typical credit rating methodology, both quantitative and qualitative information is considered. in south africa (as a developing economy), the quantitative information equates to a smaller portion of the final credit rating. a generic quantitative credit rating methodology, as well as specific credit rating methodologies, was developed. the appropriateness of these generic and specific models was tested with regards to prediction accuracies using red, amber or green (rag) statuses on a traffic light series. an illustration of the predicted versus actual ranks is provided, as well as an example to illustrate how model-predicted rag statuses, based on quantitative information, may be overlaid with more recent qualitative information to derive a final ranking. results: a generic, quantitative credit rating methodology for the departments of health and the department of education combined was developed, as well as specific credit rating methodologies for each department separately. the specific subnational credit rating methodology outperformed the generic methodology considerably; more precisely, the generic models predicted a maximum of 50% of the new cases correctly as opposed to the specific health and education models’ 78%. conclusion: the primary contribution of this study was to develop and compare generic and specific subnational credit rating methodologies. a further contribution was to test the appropriateness of these models’ prediction accuracies using rag statutes. the specific subnational credit rating methodology was found to outperform the generic methodology considerably. introduction credit risk, defined by scott (2003) as the risk that a borrower will be unable to make payments of interest or principal in a timely manner, should be assessed by banks and other investors before entering into a loan agreement. one way of assessing credit risk is the use of credit ratings. scott (2003) terms a credit rating as ‘a grading of a borrower’s ability to meet its financial obligations in a timely manner’. credit ratings can be used to rate issuers (e.g. companies, governments and subnational governments) and also issues (such as financial instruments or specific debt instruments). subnationals are defined as all tiers of government and public entities below the sovereign or national government, including states, provinces, counties, cities, towns, public utility companies, school districts and other special-purpose government entities that have the capacity to incur debt (liu & waibel 2008). south african subnationals are defined as provincial governments and departments for the purpose of this article. none of south africa’s defined subnationals are credit rated at present (2016). it is evident from the review of subnational credit rating methodologies documented by fourie et al. (2013) that special credit rating methodologies are required to rate subnationals because of the unique way that these governments are managed. one aspect that requires special attention is the rules and regulations set by the national government regarding financial management – especially rules and regulations related to borrowing. another example is the subnational’s economic profile, including demographics and social structures (fitch 2011). credit rating methodologies can be divided into generic and specific credit rating methodologies. the specific credit rating methodologies are developed to credit rate a specific population (e.g. a specific country’s subnationals) and the generic methodologies are developed to credit rate a wide range of different types of populations (e.g. a number of different countries’ subnationals). in a typical credit rating methodology, both quantitative and qualitative information will be considered and, specifically in south africa as a developing country, the quantitative information will equate to a smaller portion of the final credit rating. the primary contribution of this study is to develop and compare a generic with a specific credit rating methodology for south africa’s subnationals in order to predict payment behaviour, since no credit rating methodology currently exists for south africa’s subnationals as indicated by fourie, verster and van vuuren (2016). note that because of data availability the developed models will only relate to the quantitative part of the final credit rating. the secondary contribution is to test the appropriateness of these generic and specific models by comparing the predicted payment behaviour with the actual payment behaviour by using red, amber or green (rag) statuses or traffic light series. an example is also provided to indicate how qualitative information can be taken into account. the article is organised as follows: the ‘literature review’ section provides a literature overview of existing subnational credit rating methodologies as well as south african laws and regulations applicable to subnational borrowing. the ‘data and methodology used’ section describes the data and methodology used. the ‘results’ section applies the methodology to develop a proposed generic quantitative credit rating methodology for the departments of health and education combined, as well as specific credit rating methodology for each department separately. these two departments were selected because south africa’s national treasury (national treasury) indicates that these two departments’ total expenditure equates to the biggest portion of the provinces’ total expenditure. in the 2015–2016 financial year, the department of health’s total expenditure equated to 32% of the provinces’ total expenditure and the department of education’s total expenditure equated to 41%, thus a combined proportion of 73% (national treasury 2016). a total of eight linear regression models were built: these are tested in the ‘testing the appropriateness of the proposed models’ section. the ‘conclusion and suggestions for future research’ section concludes the article and provides recommendations and suggestions for future research. literature review the literature overview summarises the required background information and is documented in three sections. firstly, examples of existing generic and specific subnational credit rating methodologies are provided in the ‘existing subnational credit rating methodologies’ section. the ‘south african laws and regulations’ section documents south african laws and regulations applicable to subnational borrowing. this is followed in the ‘data and methodology used’ section by a discussion on the data and the methodology used to develop credit rating methodologies for south african subnationals. existing subnational credit rating methodologies a credit rating is a grading of a borrower’s ability to meet its financial obligations in a timely manner (scott 2003). credit ratings, or gradings, may be used to rate issuers (e.g. companies, sovereign governments and subnational governments), as well as issues, such as financial instruments or specific debt instruments. credit rating methodologies are required to rate the creditworthiness of issuers and issues. as mentioned earlier, these methodologies can be divided into generic and specific credit rating methodologies. some of the advantages of generic models in general are that they are freely available and less expensive. one of the advantages of specific models is that they are more accurate at predicting outcomes (burazeri, dhuci & kufo 2014). the three largest international credit rating agencies are fitch ratings (fitch), moody’s investors service (moody’s) and standard and poor’s financial services (s&p). these credit rating agencies all generate generic subnational credit rating methodologies that could be used to determine the creditworthiness of any subnational government, regardless of the country within which the subnational government presides. moody’s, for example, rated 306 regional and local governments in 35 countries outside the united states (liu & tan 2009). theoretically, these methodologies can be applied to south africa’s provincial governments, departments and municipalities because of the generic definitions of subnationals (i.e. local and regional governments). however, no provincial government or department in south africa is currently (2016) rated. on the other hand, all 278 of south africa’s municipal governments are rated by municipal iq, a data and intelligence service specialising in the monitoring and assessment of south africa’s municipalities (municipal iq 2015). fitch and moody’s also rate the municipalities, but only a few (less than 5%). in this study, proposed generic quantitative credit rating methodologies were developed for south african subnationals, more specifically, the departments of health and education collectively as well as specific credit rating methodologies for each department separately. the next section pays particular attention to some existing subnational credit rating methodologies, both generic and specific, because a thorough understanding of existing subnational credit rating methodologies is required in order to develop a credit rating methodology for south africa’s subnationals. this is largely based on the work of fourie et al. (2013). generic subnational credit rating methodologies the three international credit rating agencies’ subnational credit rating methodologies are recapped in this section. these methodologies are considered to be generic because they could be used to determine the creditworthiness of a number of different subnational governments, regardless of which country the subnational governments reside in. fitch ratings assesses the institutional framework within which the subnational government operates, as this provides the context within which the other factors interact. the four other factors are: debt and other long-term liabilities, finances, management and administration, and the economic status of the subnational government fitch ratings (2011). moody’s (2008) assesses two fundamental aspects: the stand-alone credit quality of the subnational and the probability of the subnational receiving extraordinary support (i.e. assistance provided by the national government, any other higher tier of government or the subnational’s peers to prevent the subnational from defaulting). the creditworthiness of a subnational is determined by evaluating six different factors, namely: the operating environment, institutional framework, financial position and performance, debt profile, governance and management factors, and the economic fundamentals of the subnational under review. s&p employs eight factors to determine the credit quality of a subnational government. firstly, the institutional framework factor reviews the institutional and legal background of the subnational government. the other seven factors are: economy, financial management, budgetary flexibility, budgetary performance, liquidity, debt burden and contingent liabilities. these focus on the subnational government itself and are used to determine the stand-alone credit quality of the subnational (s&p 2010). fourie et al. (2016) note that theoretically these can be applied to south africa’s provincial governments, departments and municipalities because of the generic definitions of subnationals (local and regional governments). however, to date no south african provincial government or department has been assigned a credit rating by moody’s, fitch or s&p. also, the data used in these existing credit rating methodologies do not necessarily exist, as will be seen in the ‘data and methodology used’ section. comparison of the three international rating agencies’ rating methodologies a comparison of the subnational credit rating methodologies used by the three major international credit rating agencies provides insight needed to develop a credit rating methodology for south africa’s subnationals. liu and tan (2009) state that there are two similarities and three differences evident when comparing the subnational credit rating methodologies used by the three major international credit rating agencies. similarities: the similarities are the rating criteria and the rating processes: the rating criteria used by the three rating agencies can be divided into five principal or broad factors, as illustrated in figure 1. these factors are the subnational’s economic conditions, the fiscal performance of the subnational, the financial and debt position of the subnational, the management quality and institutional strength of subnational, and sovereign factors, intergovernmental relationships and fiscal arrangements. the first four factors involve only the subnational, while the fifth element embraces the influence of sovereign factors, intergovernmental relations and fiscal arrangements on the subnational. if a proposed credit rating methodology will not be used on an international level, the fifth factor may be neglected as the national government will have the same effect on all the subnationals. this observation will be taken into account when developing south african subnational credit rating methodologies. the rating processes followed to credit rate subnational governments are similar to common credit ratings processes, but more emphasis is placed on qualitative aspects because these may provide information not necessarily revealed by published information (liu & tan 2009). figure 1: the five principal or broad factors found in the three international credit rating agencies’ subnational rating methodologies. differences: the three main rating criteria differences between the credit rating methodologies are: relative weights assigned to rating variables: the relative weights assigned to the rating variables, and thus broad rating factors too, differ according to the agency’s view of the importance of the variables, although the variables used are roughly the same. changes to relative weights over time: as a rating agency’s view of the importance of a variable changes over time, the relative weight assigned also alters. importance of qualitative variables: the importance of qualitative variables and factors vary between agencies (liu & tan 2009). specific subnational credit rating methodologies this section focuses on existing regional subnational credit rating methodologies. these are considered to be examples of specific credit rating methodologies since it is used to determine the creditworthiness of subnational governments within specific countries or regions, i.e. it applies to specific populations. the two examples of specific or regional subnational credit rating methodologies for developed economies are dominion bond rating service limited’s (dbrs) rating methodology for canadian subnational governments and australia ratings’ methodology for australian subnational governments. fitch’s credit rating methodologies for indian subnational governments, as well as the methodology used by credit rating information services of india limited (crisil) are discussed as examples of methodologies used for developing economies. dominion bond rating service limited assesses only two different types of factors to determine the credit rating of a canadian provincial government, namely, province-specific operating risk and province-specific financial risk. this methodology does not apply to the three territories that also form part of canada’s subnational governments (dbrs 2011). the funds needed to fulfil the principal responsibilities of the australian subnationals, that is, to provide the necessary public services and infrastructure, are provided by the national government. thus, australia ratings (2014) examines the current and future economic and financial situation of a subnational, as well as the strategy of the specific subnational government. the four different factors employed to do this are: economy, financial management, accounting and debt profile. fitch adjusted its international rating methodology to focus specifically on india. fitch employs the following five factors to determine the stand-alone creditworthiness of indian subnational governments: institutional and administrative aspects, economic and social profile, fiscal and budgetary performance, debt, liquidity and indirect risk, and management. credit rating information services of india limited (2011) assesses the credit quality of most of india’s state governments by making use of three main factors: the state’s economic structure, the government’s finances and the economic management. note that regional subnational credit rating methodologies never review the national governments because all subnationals reviewed within a specific country share the same national government, and thus the outcome of the factor will remain static regardless of which subnational is being credit rated. importance of key factors: developed versus developing economies although, the key factors used in the credit rating methodologies for developed and developing economies will generally be the same, the relative importance of these key factors will differ. the quantitative factors (financial fundamentals) and the qualitative factors (other key factors) included in the rating methodology for a developed country will be viewed as equally important. thus, both will equate to 50% of the credit rating. in a developing country, the quantitative factors will only equate to 30% of the credit rating and the qualitative factors to 70% (moody’s 2007). fourie et al. (2013) state that this principle is also relevant when developing a credit rating methodology for south africa’s subnationals. public sector risk management framework of south africa in the absence of a south african regional subnational credit rating methodology, the public sector risk management framework of south africa (psrmf) could be reviewed in order to gain background knowledge for the development of such a methodology. national treasury developed the psrmf in response to the pfma (public finance management act no 1 of 1999) to aid provincial governments and departments, among others, in their implementation and maintenance of effective, efficient and transparent systems of risk management and control (national treasury 2010). however, this framework is considered to be vague. for example, it states that management should provide risk management reports but not how frequent these reports should be provided and to whom. key findings from literature review two key findings were drawn from the literature discussed above. firstly, the variables used in subnational credit rating methodologies can be grouped into five broad factors, namely, the subnational’s economic conditions, the fiscal performance of the subnational, the financial and debt position of the subnational, the management quality and strength of subnational institutions, as well as the influence of the sovereign factors, intergovernmental relations and fiscal arrangements on the subnational. the other key finding is the difference in the importance of quantitative and qualitative information for developed and developing countries. typically, for a developed country the quantitative and qualitative information will contribute equally to a credit rating, whereas for developing countries the quantitative information usually equates to the smallest portion of a credit rating. both observations will be applied in the remainder of this article. currently, none of the south african subnationals are being credit rated (fourie et al. 2016). this article develops the quantitative parts of credit rating methodologies for south africa’s subnationals, focusing on the departments of education and health. the current situation in south africa although credit ratings are not assigned to the defined south african subnationals at present, the three largest international credit rating agencies do rate south africa’s national government. however, if the credit ratings resulting from the proposed methodology will not be used on an international level, the effect of the sovereign rating on the subnationals’ credit rating may be neglected since the national government will have the same effect on all nine subnationals. as previously mentioned, south africa’s municipal governments are indeed being credit rated by municipal iq, fitch and moody’s. the national treasury developed the psrmf to aid provincial (subnational) governments in the implementation and maintenance of effective, efficient and transparent systems of risk management and control. however, the framework is vague and impractical. national treasury (2010) states that the framework is under review to address some of the weaknesses. two concerns when developing credit scoring models, including subnational credit rating methodologies, are data availability and data quality (siddiqi 2006). a preliminary investigation into this matter revealed three possible data sources that could be used within the south african context, namely, the subnational government’s annual reports, the auditor-general’s reports, and, the section 32 reports compiled by the national treasury (see the ‘data’ section for a detailed discussion). south african laws and regulations in addition to knowledge regarding existing subnational credit rating methodologies, an understanding of the regulatory framework within which subnational governments operate is also required when developing a country-specific subnational credit rating methodology. these laws and regulations should be investigated because these set the parameters within which subnational borrowing may take place. the south african regulatory framework is summarised in the borrowing powers of provincial governments act (no 48 of 1996) – that is, the borrowing act – and the pfma, as well as the regulations that accompany this act, namely the treasury regulations for departments, constitutional institution and public entities. the borrowing act stipulates the borrowing powers of south africa’s subnational or provincial governments (south africa 1996). the purpose of the pfma and its treasury regulations is to ‘secure transparency, accountability and sound management of the revenue, expenditure, assets and liabilities of the institutions to which the act applies’ (south africa 1999, 2001). each of the acts has a different purpose. south africa (1996) states that the goal of the borrowing act is ‘to provide for norms and conditions in respect of the borrowing powers of provincial governments and for matters incidental thereto’, whereas the pfma’s purpose is stated as: to regulate financial management in the national governments and provincial governments; to ensure that all revenue, expenditure, assets and liabilities of those governments are managed efficiently and effectively; to provide for the responsibilities of persons entrusted with financial management in those governments; and to provide for matters connected therewith. (south africa 1999:1) it is important to ensure that these laws and regulations are adhered to if it has been decided to extend credit to a subnational (based on a credit rating derived from applying the models to be developed), as non-adherence could lead to unenforceable loan arrangements. an example of such a specification is that any loan raised for the purpose of bridging finance must be redeemed within 30 days after the end of the financial year, making the maximum loan duration 13 months (south africa, 2001). another example is that the issuing of guarantees, indemnities and securities is usually not permitted. data and methodology used this section encompasses the data used and the methodology applied in order to develop the proposed quantitative sections of a credit rating methodology. this is largely based on previous work by the authors – refer to fourie et al. (2016) for more details. data the data requirements were based on the information used in existing subnational credit rating methodologies and special focus was placed on the five broad factors identified in the ‘comparison of the three international rating agencies’ rating methodologies’ section. the final data sets included variables representing the four relevant broad factors (the fifth factor was omitted as all the departments reside within the same country). siddiqi (2006) states that data availability and data quality are concerning when developing credit scoring models. furthermore, liu and tan (2009) caution that data not kept in a consistent form often cause problems when developing subnational credit rating methodologies for a developing countries. for these reasons, much attention has been paid to the identification of reliable data sources. that resulted in reports from four different institutions were used as data sources: the provincial departments, the national treasury, statistics south africa (statssa) and the auditor-general of south africa (auditor-general). however, most of the data used in the existing subnational credit rating methodologies do not exist in the south african context: provincial departments of health and education’s annual reports: these reports are compiled per department positioned within the provincial governments. the necessary data were sourced from each province’s departments of health and education’s annual reports, namely gauteng department of education (2007–2013), western cape department of education (2007–2013), eastern cape department of education (2007–2013), northern cape department of education (2007–2013), north west department of education (2007–2013), mpumalanga department of education (2007–2013), kwazulu-natal department of education (2007–2013), limpopo department of education (2007–2013), free state department of education (2007–2013) and gauteng department of health (2007–2013), western cape department of health (2007–2013), eastern cape department of health (2007–2013), northern cape department of health (2007 – 2013), north west department of health (2007–2013), mpumalanga department of health (2007–2013), kwazulu-natal department of health (2007–2013), limpopo department of health (2007–2013) and free state department of health (2007–2013). a total number of 108 annual reports were used. national treasury: two reports assembled on a regular basis by the national treasury were used: fourth quarter year to date provincial budgets and expenditure report (preliminary outcome) 06/07 – 10/11 (national treasury 2007a–2011a), as well as the provincial statements of receipts and payments for the 4th quarter (end march 2007 to 2011) (national treasury 2007b–2011b). statssa: the two reports used from this institution are the gross domestic product. annual estimates 2003 to 2012. regional estimates 2003 to 2012. third quarter 2013. statistical release p0441 report (statssa 2013), as well as statssa’s (2012) interactive data set containing the mid-year population estimate. auditor-general: the consolidated general reports on the national and provincial audit outcomes of 06/07 to 10/11 (auditor-general 2007–2011) were also used. firstly, separate data sets were compiled for each department: the department of health and the department of education. the one interactive data set and 70 different reports containing 5 years’ worth of data for the nine provinces resulted in 45 data points for each of the departments. secondly, the department-level data were aggregated to construct provincial-level data, also referred to as the combined data set. this data set contained 90 data points. the data were captured manually, and data error identification and rectification measures were applied as an iterative process throughout the data compilation and model development phases. the constructed data sets are a secondary objective of this article and are available on request. note that the health and education data sets are department-specific, and thus contains data from a specific population. any credit rating methodology resulting from the department-level data will therefore be a specific credit rating methodology, but any credit rating methodology resulting from the combined data set will be a generic one. specific credit rating methodologies were considered because thomas (2000) as well as anderson (2007) state that these types of models normally perform better than generic models. on the other hand, siddiqi (2006) mentions that because of the costs involved it might not always be worthwhile to develop specific models. this specifically rings true for the south african environment because a number of different specific models need to be developed in order to assess all the provincial departments. some provinces have a total of 12 departments (south africa 2017) and an additional complication is the differences in the assignment of functions between these departments. for example, the eastern cape groups road and public works together, whereas gauteng groups roads and transport together and does not have a department specifically administering public works (south africa 2017). for these reasons, generic models were considered too. the constructed data sets contain only quantitative information. therefore, the models developed from these will only relate to the quantitative part of the final credit rating. the qualitative part may be taken into account as an intuitive overlay, as will be illustrated. linear regression methodology linear regression modelling was chosen to predict the quantitative part of the credit ratings for south african provincial departments. the principal advantage of linear regression is its simplicity, interpretability, scientific acceptance and widespread availability. linear regression is also widely available in statistical software packages and business intelligence tools (chambers & dinsmore 2014). also, the results of a linear regression model could be summarised into the symbols used by the credit rating agencies to indicate relative rankings of creditworthiness, for example, aa−, bbb+ and caa1.1 the aim of the models developed in this study is to rank south africa’s subnationals in terms of future payment behaviour. to forecast using linear regression models, the independent variables used to predict the dependent variable for the next year have to lag by 1 year. this also applies to this work as the aim is to predict the provincial departments’ credit ratings for the next financial year (e.g. 2015/2016) based on the current financial year’s data (e.g. 2014/2015). dependent variable the ultimate aim of a credit rating methodology is to predict default. default can be viewed as a department’s capacity and willingness to repay debt obligations in full and on time. the cash-based accounting system used by the provincial departments (national treasury 2013b) resulted in insufficient information available to provide an indication of whether a department’s debt obligations were paid in full and on time. the following proxy (equation 1), suggested by the national treasury, was used for the dependent variable instead (national treasury 2012): after various workshops and discussions with the national treasury, no monthly or quarterly variables for the target variable could be found (national treasury 2012, 2013a). because of this constraint that the dependent variable was only available yearly, only yearly independent variables were used (even if some were available quarterly). independent variables three data sets were constructed containing either 42 or 43 (one extra for the combined data set) independent variables. as mentioned previously, the data requirements were based on the information used in existing subnational credit rating methodologies – especially the broad factors identified by liu and tan (2009). seven of the independent variables included in the data sets relate to the broad factor economic conditions, 22 to fiscal performance, two to financial and debt position, and only one to management quality and institutional strength. the remainder of the independent variables were indicators and did not relate to a specific broad factor. methodology applied to develop linear regression models the following methodology was applied to develop the 30% quantitative part of a credit rating methodology for the combined, health and education data sets. multicollinearity was dealt with first by using variable clustering – one variable was chosen from each cluster of variables as the cluster representative. irrelevant independent variables were removed based on the variables’ correlations with the dependent variable. lastly, the stepwise variable selection technique and a significance level of 10% were used to choose the final independent variables. the models developed via this process will henceforth be referred to as the basic models. the basic models were further investigated to improve the r2 via two model advancement techniques, namely including interactions between the independent variables in the model (advanced models 1) and excluding outliers from the data (advanced models 2). all the models were developed using sas institute inc. (2011) software. note that kutner et al. (2005) state that models that include interaction terms are considered to be complex models and sas institute inc. (2010) states that the inclusion of polynomial terms complicates interpretation. hair et al. (2006) states that if there is no explanation available for an outlier, the analyses should be done with the outlier included and excluded since neither the inclusion nor exclusion can be warranted. as was the case for outliers found in this part of the study since outliers that were caused by data capturing errors they were corrected during the capturing phase. furthermore, one can argue that the models taking into account interactions and excluding outliers will always be the better models when used for explanation purposes. however, the aim of this study was to predict and therefore the developed models need to be able to generalise too. a common pitfall in predictive modelling is to overfit to the data. an overly complex model (which may be the case for advanced models 1 and 2) might be too sensitive to peculiarities in the development sample data set and therefore may not be able to generalise well to new data. however, using too simple a model (possibly the basic models) can lead to underfitting, where true features are disregarded (sas institute inc. 2010). for these reasons, the results of all three models per data set are reported next and are also later on compared in terms of predictability. results the results of the basic and advanced linear regression models from all three data sets are documented below. the parameter estimate of an independent variable indicates the change in the dependent variable per one unit increase of the corresponding independent variable when the other independent variables are held constant (kutner et al. 2005). the explanations provided for the independent variables’ effects on future payment behaviour assume that all other independent variables remain constant. generic linear regression models the methodology discussed in the previous section was applied to the combined data set to develop the generic linear regression models. the basic model has an r2 of 0.49, which means that it explains 49% of the variance of the dependent variable. the p-values of all six chosen independent variables are smaller than 0.1, the highest being 0.07 (see table 1). table 1: details of the generic basic model. the resulting generic basic model’s formula is: where i = 1,2,···,18. the r2 of generic advanced model 1 is 0.55, thus it improved from 0.49 to 0.55. the highest p-value is 0.08. the details are in table 2. no outliers were identified, thus no generic advanced model 2 was developed. table 2: details of the generic advanced model 1. the equation of the generic advanced model 1 including interaction terms is: where i = 1,2,···,18. specific linear regression models the results of the models specifically developed for the departments of health and education are documented next. the basic model developed specifically for the department of health (health basic model) has an r2 of 0.51. the p-values of all five independent variables chosen for this model are smaller than 0.1 (see table 3). the model can be expressed as: where i = 1,2,···,9. table 3: details of the health basic model, specifically developed for the department of health. the basic model developed specifically for the department of education (education basic model) has an r2 of 0.48, which means that it explains less than 50% of the variance of the dependent variable. details in table 4 below. the highest p-value of the independent variables chosen for this model is 0.06. the model can be expressed as: where i = 1,2,···,9. table 4: details of the education basic model, specifically developed for the department of education. for both the department of health and the department of education, two unique models resulted from the model advancement investigation. more details of these two models can be found in table 5 below. table 5: details of the advanced models (health advanced model 1 [model 2]), specifically developed for the department of health. the r2 of the health advanced model 1 increased to 0.74 and health advanced model 2 to 0.80. the p-values are all smaller than 0.1. the equation of the health advanced model 1 is: where i = 1,2,···,9. the equation of the health advanced model 2 is: where i = 1,2,···,9. both of the education advanced models’ r2s (0.70 and 0.74) were higher than that of the education basic model (0.48). all the independent variables’ p-values were smaller than 0.1. details of these two models are in table 6 below. table 6: details of the advanced models (education advanced model 1 [model 2]), specifically developed for the department of education. the equation of the education advanced model 1 is: where i = 1,2,···,9. the equation of the education advanced model 2 is: where i = 1,2,···,9. in total, two generic models and six specific models were developed. in the ‘testing the appropriateness of the proposed models’ section, these eight models will be compared and tested for appropriateness. assigning red, amber or green statuses the ultimate aim of the developed models is not to predict a department’s numerical value of the dependent variable (i.e. the proxy of payment behaviour), but rather to rank the departments’ expected future payment behaviours in terms of rag statuses. rag statuses can be assigned based on absolute or relative rankings. absolute rankings make use of the absolute values of the dependent variable. for example, a red status is assigned when the ratio of accruals 30 days plus/total expenditure is higher than 150% and a green status is assigned if the ratio is lower than 40%. literature suggests a number of different cut-offs that could be used to assign rag statuses in this manner, see for example moody’s (2008) and s&p (2010). however, as a proxy was used to determine payment behaviour, rag statuses are assigned based on relative rankings for the purpose of this article. the following procedure was used to allocate the rag statuses: the bottom third departments (bad payment behaviour based on high values of the payment behaviour proxy) are assigned red statuses, the middle third departments (average payment behaviour) are assigned amber statuses and the top third departments (good payment behaviour based on low values of the payment behaviour proxy) are assigned green statuses. testing the appropriateness of the proposed models the aim of this section is to test the appropriateness of the developed models, that is, to decide on a model to be used in future to predict payment behaviour. with this as aim, this article includes a comparison of, among others, the number of correctly predicted rag statuses of the basic models and the advanced models for both the generic and the specific developments (sections ‘validation’ and ‘model comparison’). this comparison is used in the ‘model recommendation’ section to provide recommendations with regard to which model should be used in future to rank the departments in terms of expected payment behaviour. the recommended model is then used to compare the rag statuses predicted by the model with the actual rag statuses of the financial year 2012/2013 in the ‘predicted versus actual ranks and red, amber or green statuses’ section. lastly, an example is provided in the ‘example: deriving the final ranking of gauteng’s department of health’ section. this illustrates how the rag statuses predicted by the models based on quantitative information can be overlaid with some more recent qualitative information to derive a final ranking or rag status. dashboards were constructed to illustrate this. validation kutner et al. (2005) recommend that, after development, new data should be collected and the model should be reapplied to verify its predictive ability. this method was used to validate the developed payment behaviour models. the data from the previously discussed sources were used, but for the next available financial years. thus, the 2011/2012 financial year’s data were used for the independent variables to predict the values of the dependent variable for 2012/2013. note that typically a 2012/2013 data set is only available in 2014. the rag statuses predicted were compared with the actual rag statuses and the number of correctly assigned rag statuses was counted as a measure of the model’s predictive ability. the lowest number of rag statuses correctly predicted by the models was two out of seven (22.2%) and the highest number was seven out of the nine (77.8%). model comparison the model comparison is based on the r2, the number of data points deleted, the number of terms and independent variables included in the models, the number of data sources needed to update the models, the number of factors represented by the independent variables, and the number of correctly predicted rag statuses of each of the three resulting models. this information is summarised in table 7. table 7: summary of the linear regression models. the model with the highest r2 is the health advanced model 2 at 0.80, with only one data point omitted. the minimum number of terms included in the models is four and the maximum is nine. the number of independent variables included range between two and 10. the data sources needed to update the models range between three and five. the independent variables included in the final models represented two to three of the broad factors. the two health advanced models and education advanced model 2 predicted seven of the nine (77.8%) rag statuses correctly. model recommendation when considering the generic models, generic advanced model 1 predicted nine out of 18 (50%) rag statuses correctly, taking into account that these models are used to predict the nine departments of health plus the nine departments of education’s payment behaviour simultaneously. health advanced model 2 and education advanced model 2 predicted 77.8% correctly. thus, the specific models outperformed the generic models and it is therefore recommended that the specific models (health advanced model 2 and education advanced model 2) should be used in future. literature also indicated that models tailored for specific populations outperform generic models (anderson 2007; thomas 2000). one explanation is that the difference in the functions that the departments perform equates to two different types of populations and causes different information to be important for the different departments. thus, different independent variables (and therefore models) are needed to predict the payment behaviour of the different departments. predicted versus actual ranks and red, amber or green statuses health advanced model 2 was the model with the highest r2 and also one of the models predicting the highest number of rag statuses correctly. thus, this model will be used in the illustrations provided. the ranks and rag statuses of the provinces’ departments of health predicted by the interaction model without independent outliers are shown in table 8. the predicted values for 2012/2013 are based on the information of the independent variables contained in the data of the financial year 2011/2012. the actual values are the ranks and rag statuses based on the true outcomes of the dependent variable, as documented in the annual reports of the financial year 2012/2013. only two provinces’ rag statuses were predicted incorrectly, namely limpopo and the eastern cape. table 8: predicted ranks and red, amber or green statuses resulting from the example payment behaviour model (using the specific model: health advanced model 2) versus the actual ranks and statuses. example deriving the final ranking of gauteng’s department of health an example (focusing on gauteng’s department of health) is provided next to demonstrate how the developed models could be used in future. the predicted ranking with regard to the other provinces, based on quantitative information, was nine. as mentioned previously, credit rating methodologies are normally based on a combination of quantitative and qualitative factors. qualitative information will be assessed by a team of analysts and then used as input in the model. typically, credit rating methodologies for developing countries comprise 30% quantitative factors and 70% qualitative factors (moody’s 2007). thus, qualitative information should also be taken into account. an example of qualitative information that should form part of the intuitive overlay is the news article issued by sabc news on 30 april 2014. this article states that the zola-jabulani hospital building project was finished 5 years later than planned and the actual costs were three times higher than what was budgeted (sabc news 2014). this might indicate a lack of management sophistication and poor financial planning. another example of inadequate management and financial planning is provided by a press release issued by the gauteng department of health (2014), where the department states that it did experience challenges of late or non-payment in the past, but the problem is being rectified. also, the department’s annual report of 2012/2013 reported that a turnaround strategy has been deployed, focusing, among other things, on financial management. the figures reported in this annual report did in fact illustrate an improvement in the debt repayment numbers. the ratio of accruals in excess of 30 days to total expenditure did improve in recent years (10.05% in 2011/2012, 4.49% in 2012/2013, 3.36% in 2013/2014). however, it is yet to be seen if this improvement is sustainable. typically, the above-mentioned information, as well as any other available qualitative information, will be reviewed by a team of analysts. the analysts will then rank gauteng’s department of health’s expected payment behaviour with regard to the other provinces by taking into account their qualitative information as well. however, this example focuses only on gauteng and therefore the other provinces’ qualitative information is not provided. for illustrative purposes, it is assumed that gauteng has an average red status, thus a ranking of eight, based on provided qualitative information. taking both the quantitative and qualitative rankings into account, the final ranking of gauteng’s department of health is about eighth. this is derived as follows: 30%×9+70%×8=8.3. thus, the rag statuses based on the quantitative (ranking = 9) and qualitative (ranking = 8) information, as well as the final rag status (ranking = 8) were all red. in this case, the qualitative information reinforced the red status that was assigned based on the quantitative information (illustrated in figure 2). figure 2: combining a predicted ranking with a qualitative overlay to derive a final ranking. conclusion and suggestions for future research the primary contribution of this study was to develop and compare both a generic and a specific subnational credit rating methodology (to date no such methodologies have been developed for south african provinces and departments). a further contribution was to test the appropriateness of these generic and specific models about prediction accuracies using rag statuses, where the specific subnational credit rating methodology was shown to outperform the generic methodology by far. models resulting from the combined data sets (i.e. generic models) should not be used for future predictions. the generic models predicted a maximum of 50% of the new cases correctly as opposed to the specific health and education models’ 78%. the payment behaviour models developed specifically for the department of health or education therefore performed better than the generic models in terms of predicting new data and should rather be used. thomas (2000) and anderson (2007) confirmed that models tailored for specific populations outperform generic models. again, one possible explanation in this specific case is the difference in the functions that the departments perform, which equates to two different types of populations and results in different information to be important to the different departments. thus, different independent variables (and therefore models) are needed to predict the payment behaviour of the different departments. for example, in order for the departments of health to deliver the required health services, sophisticated medical equipment is needed. in this case, independent variables containing surplus/deficit information is of importance since surpluses could be used to purchase the needed medical equipment. the department of education, however, must ensure that compensation to employees do not fall into arrears to avoid political unrest. therefore, personnel expenditure information is of interest. however, the independent variables containing surplus/deficit information and the independent variables containing personnel expenditure information represents the same broad factor: fiscal performance. thus, the same broad factors are represented by the independent variables included in the different department-specific models. lehmann (2003) has shown that the use of qualitative variables improves predication quality, which has been confirmed by the example used in the ‘example: deriving the final ranking of gauteng’s department of health’ section. because of the nature of the data used, the payment behaviour or subnational credit rating methodology developed in this article assesses only quantitative information, so models could be improved by also incorporating qualitative variables. other data sources should be investigated to collect more data to represent the broad factors for financial and debt position as well as management quality and institutional strength. these two principal factors are only represented by two and one variable(s), respectively. acknowledgements the authors gratefully acknowledge the valuable input given by anonymous referees. this work is based on research supported in part by the department of science and technology (dst) of south africa. the grant holder acknowledges that opinions, findings and conclusions or recommendations expressed in any publication generated by dst-supported research are those of the author(s) and that the dst accepts no liability whatsoever in this regard. competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions this article originated from e.f.’s phd. t.v. was the phd promotor and g.w.v.v. was the phd co-promotor. references anderson, r., 2007, the credit 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institute inc., 2010, predictive modelling using logistic regression course notes, sas institute inc., cary, nc. sas institute inc., 2011, the sas system for windows release 9.3 ts level 1m0, copyright© by sas institute inc., sas institute inc., cary, nc. scott, d.l., 2003, wall street words: an a–z guide to investment terms for today’s investor, 3rd edn., houghton miffin company, boston, md. siddiqi, n., 2006, credit risk scorecards: developing and implementing intelligent credit scoring, wiley, hoboken, nj. south africa, 1996, borrowing powers of provincial governments act 48 of 1996, viewed 11 november 2015, from http://www.gov.za/sites/www.gov.za/files/act48of1996.pdf south africa, 1999, public finance management act 1 of 1999, viewed 21 january 2011, from http://www.treasury.gov.za/legislation/pfma/act.pdf south africa, 2001, treasury regulations for departments, constitutional institutions and public entities. issued in terms of the public finance management act, 1999, viewed 21 january 2011, from http://www.treasury.gov.za/legislation/pfma/regulations/gazette22219.pdf south africa, 2017, provincial government, viewed 21 april 2017, from http://www.gov.za/links/provincial-government statssa, 2012, mid-year pop estimates by province, gender, age group and year, viewed 15 november 2012, from http://www.statssa.gov.za statssa, 2013, gross domestic product. annual estimates 2003–2012. regional estimates 2003–2012. third quarter 2013. statistical release p0441, statistics south africa, pretoria. thomas, l.c., 2000, ‘a survey of credit and behavioural scoring: forecasting financial risk of lending to consumers’, international journal of forecasting 16, 149–172. https://doi.org/10.1016/s0169-2070(00)00034-0 western cape department of education, 2007–2013, annual report, western cape department of education, cape town. western cape department of health, 2007–2013, annual report, western cape department of health, cape town. footnote 1. credit rating agencies summarise their opinions about the creditworthiness of an issuer or issue in ratings that are graded by symbols such as aa−, bbb+ and caa1. issuers or issues with the same rating symbols will portray the same credit characteristics and hence have the same relative creditworthiness. see for example moody’s (2014) and s&p (2011). abstract introduction employability research design results discussion and recommendations limitations and conclusions ethical consideration acknowledgements references about the author(s) jo-anne botha department of human resource management, college of economic and management sciences, university of south africa, south africa mariette coetzee department of human resource management, college of economic and management sciences, university of south africa, south africa citation botha, j-a. & coetzee, m., 2017, the significance of employee biographics in explaining employability attributes’, south african journal of economic and management sciences 20(1), a1636. https://doi.org/10.4102/sajems.v20i1.1636 note: this article is partially based on botha’s dissertation for the degree of master of commerce, in the subject human resource management, at the university of south africa, south africa, with supervisors prof. melinde coetzee and prof. mariette coetzee, received january 2014, available here: http://uir.unisa.ac.za/bitstream/handle/10500/13598/dissertation_botha_j-a.pdf?sequence=1 original research the significance of employee biographics in explaining employability attributes jo-anne botha, mariette coetzee received: 28 july 2016; accepted: 01 aug. 2017; published: 04 dec. 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: employability is the capacity of employees to acquire transferable competencies and individual capacities that enable them to adapt to, be innovative in and steer their own careers in a dynamic work environment. it is clear that employers would thus look for employees who are capable of proactive adjustment and action-oriented behaviours. aim: the aim of the study was to determine whether significant differences exist in the employability attributes of individuals from different gender, race and age groups and if so, how should such a diverse workforce should be managed. setting: this study was conducted at a distance education institution. the sample of respondents consisted of adult learners who are pursuing further distance learning studies in the economic and management sciences field in south africa. methods: correlational and inferential statistical analyses were used. a stratified random sample of 1102 mainly black and female adult learners participated in the study. results: the employability attributes framework identified three categories of employability: interpersonal, intrapersonal and career attributes. the research indicated that significant differences exist between gender, race and age groups with regard to employability. male and female participants differed significantly with regard to entrepreneurial orientation, proactivity and career resilience. the various race groups differed considerably regarding cultural competence and sociability of individuals. participants older than 50 years scored the highest on self-efficacy. conclusion and implications: the findings of this research could ensure that previously disadvantaged individuals are not further marginalised because of a lack of employability attributes and that the required employability attributes can be cultivated to ensure advancement and success in the work place. introduction in the information age, driven by a knowledge economy, the principal means of production is knowledge, which underpins innovative and productive capacity in individuals (bano & taylor 2015; boahin & hoffman 2013). bridgstock (2010) argues that employability extends beyond a specific list of generic skills listed by employers to incorporate the inculcation of competencies that would enable individuals to proactively steer and control their current and future careers, thereby enabling employees to successfully navigate the dynamic world of work in the new knowledge economy. in this economy, the employability of prospective and existing employees is of great interest globally (boahin & hoffman 2013). employers in the knowledge economy expect to have employees who are capable of flourishing in the rigorously demanding postmodern workplace (coetzee & potgieter 2014; coetzee & schreuder 2013; froehlich, beausaert & segers 2015; jones 2013). the desire for employees who are sufficiently lithe to cope in a mutable milieu is based partially on the rapidity of knowledge generation and its concomitant speed of obsolescence (bano & taylor 2015). the rapid changes in knowledge and technological applications require employees who possess both functional knowledge and cognitive capability reinforced by a rigorous work-based value system (coetzee & potgieter 2014; froehlich et al. 2015). according to williams et al.’s (2016) finding, one unified definition of the concept ‘employability’ is challenging. they indicate that the comprehension of the concept of employability can be classified into three broad dimensions: (1) the capital dimension, which includes human capital, social capital, cultural capital and psychological capital; (2) the career management dimension; and (3) the contextual dimension, which indicates the economic and labour market contexts of diverse employment opportunities. nurturing employability orientations and the ensuing agility it creates within an organisation may contribute to a high strategic significance for the organisation (de vos, de hauw & van der heijden 2011; van dam 2004). the importance of employability is emphasised by the fact that tertiary institutions are tasked with developing employability in their learners in order to increase the productive potential of employees of organisations (boden & nedeva 2010; coetzee 2012; eddy & garza-mitchell 2012). a workforce equipped to innovate in a dynamic world requires flexibility, independence, creativity, critical analysis, research skills and the ability to generate ideas. this means that higher education should focus on the development of transferable, generic skills. according to bunney, sharplin and howitt (2016), university education should be driven by economic and social imperatives both of which should be reconciled in the generic skills argument. unfortunately, tertiary institutions fail to recognise the contextual nature of generic skills and lack an explicit focus on employability skills (bunney et al. 2016). descriptions of employability range from the most basic – whether individuals are employed and/or how quickly graduates are able to secure employment, to a more holistic view of employability as a set of skills, personal attributes and/or human capital (boden & nedeva 2010; williams et al. 2016). employability employability attributes may be seen as a set of outlooks or intrinsic abilities that predisposes an individual to specific workand career-related behaviours as well as the deliberate cognitive adjustment of goals and behaviours as and when required (lent 2013; potgieter, coetzee & masenge 2012). employability attributes are related to individual dispositions and include self-esteem, emotional intelligence, intrinsic motivation, self-efficacy and autonomy (coetzee 2012; lent 2013). employability attributes such as career resilience, career self-management, proactivity and self-efficacy may positively influence individual job performance, organisational performance and personal career outcomes (lent 2013). adams (2014) listed 10 skills employers seek: ability to work in a team structure, ability to make decisions and solve problems, communication, ability to plan, organise and prioritise, ability to obtain and process information, ability to analyse data, technical knowledge of the job, computer proficiency and ability to draft written reports. in support of this, friedman, friedman and hampton-sosa (2013) identified five major skills and/or traits: (1) communication skills, (2)having a positive attitude, (3) adaptability, (4) teamwork skills and (5) being goal oriented. in an attempt to refine the list of generic skills, fischer and friedman (2016) developed the six c’s list. the six basic skills included (1) critical thinking, (2) communication, (3) collaboration, (4) creativity, (5) character and (6) curiosity or lifelong learning. by taking a thorough look at the skills listed, it should be clear that these skills are not normally taught by means of educational programmes. integrating generic skills into crowded curricula would require additional tuition and expertise that could be problematic. academics also do not necessarily have the expertise required to teach generic skills (bunney et al. 2016). williams et al. (2016) indicate that the evolutionary nature of the concept of employability requires that the concept should be deconstructed in order to develop a more accurate understanding of the concept. in south africa, the employability attributes framework (bezuidenhout & coetzee 2011) identifies a set of employability attributes that can be broadly grouped into three categories: intrapersonal, interpersonal and career attributes (botha 2014). these employability attributes allow employers to identify which learning or development opportunities to create for employees in order to facilitate the inculcation of the required attributes. intrapersonal attributes the employability attributes related to the intrapersonal dimension revolve around individualities that are equally significant in both the work context and the context of personal growth. the intrapersonal dimension of employability comprises proactivity, self-efficacy and emotional literacy. proactivity describes the ability of employees to adopt an agentic, active role in their employment career (coetzee 2012; bezuidenhout & coetzee 2011; potgieter 2012). there is a strong positive relationship between proactivity and extrinsic career success (converse et al. 2012; maurer & chapman 2013). in a study on lebanese entrepreneurs who lived and worked abroad, zgheib and kowatley (2011) found that proactivity was a strong predictor of internal locus of control, and thus, also self-directedness and a desire for proactive behaviour. self-efficacy denotes an inherent personal belief that sustained effort will lead to successful goal achievement in particular situations (bezuidenhout & coetzee 2011; coetzee 2012; potgieter 2012). self-efficacy refers to the individual’s belief in his or her capabilities to cope with a wide range of challenging or stressful demands (bezuidenhout 2011). self-efficacy describes the individual’s perception of the difficulty level involved in the pursuit of career-oriented actions, his or her belief in the personal ability to implement the required actions successfully and the persistence of his or her beliefs in adverse situations. self-efficacy is also associated with the personal belief of individuals in their ability to set goals successfully and to attain these goals in specific circumstances (potgieter 2012). individual autonomy and self-management, goal-directed behaviour, perseverance, proactive pursuit of learning opportunities and implementing creative solutions to problems comprise the construct of self-efficacy (coetzee 2012). employers nowadays require employees who can and do actively manage and control their own careers, with little help and/or input from the employer (coetzee 2012; fugate, kinicki & ashforth 2004; potgieter & coetzee 2013; sewell & pool 2010). positive, well-developed self-efficacy is positively associated with job satisfaction and successful careers (choi et al. 2011; guan et al. 2013; tews, michel & noe 2011). emotional literacy is the capability to be aware of and manage emotions – one’s own as well as those of others – or emotional situations in order to achieve positive social outcomes (potgieter 2012). converse et al. (2012) found a strong positive relationship between self-control and positive career outcomes, while coetzee and harry (2013) found that emotional intelligence was an important career competence in predicting individual career agility, inter alia, because of enhanced persistence in the face of challenges. emotional literacy is concerned with emotions on a personal level, whereas emotional intelligence is concerned with emotions that are directed towards the organisation. both emotional literacy and emotional intelligence have an influence on career competencies and hence employability. pool and sewell (2007) found a strong relationship between individual self-esteem and employability. interpersonal attributes the employability attributes associated with the interpersonal category describe individualities that are of equal importance in the work context as well as in general social interchanges. the interpersonal dimension of employability includes sociability and cultural adaptability. sociability is the capacity to initiate and cultivate formal and informal social networks and utilise networks to enhance career prospects (bezuidenhout & coetzee 2011; coetzee 2012; potgieter 2012). sociability refers to an openness both to establishing and maintaining social contacts and to utilising formal and informal networks for the advantage of one’s career (bezuidenhout 2011). sociability is seen as an aspect of an individual’s social capital and employability and has been related to perceived career success (bezuidenhout 2011; eby, butts & lockwood 2003). a lower confidence in one’s sociability capabilities gives rise to concern in the light of modern-day work requirements that place a high value on team working and networking skills (arnau-sabates et al. 2013; hinchliffe & jolly 2011). alarcon, edwards and menke (2011) found that social support was a strong predictor of the ability of individuals to cope with the demands of work. cultural adaptability encompasses the ability to successfully fit into culturally diverse contexts (bezuidenhout & coetzee 2011; coetzee 2012; potgieter 2012). cultural competence includes the capacity to accept and become familiar with the customs, values and beliefs of other cultures, self-confident participation in intercultural exchanges and embracing the notion of cultivating culturally diverse associations (coetzee 2012; bezuidenhout & coetzee 2011; potgieter 2012). sociable, culturally and interpersonally competent individuals seem to possess well-developed employability attributes, while individuals who are more deliberate and prefer a well-planned career path seem to possess less well-developed employability attributes (potgieter & coetzee 2013). lloyd and hartel (2010) suggest that individual intercultural competence may influence individual job satisfaction, trust and affective commitment to the job as well as the individual’s assessment of team effectiveness. career attributes lastly, the career dimension denotes explicit individual attributes that underlie behaviours allied to career success in the business world (botha 2014). the career dimension of employability consists of the attributes of career self-management, career resilience and entrepreneurial orientation. career self-management is the individual capacity to guarantee continued employability through an attitude of lifelong learning, and agentically planning and managing a protean career (bezuidenhout & coetzee 2011; coetzee 2012; potgieter 2012). bridgstock (2010) found a strong positive correlation between a highly developed graduate career self-management capacity and career success after graduation. the same study also found a positive link between intrinsic motivation, career success and career management ability. career resilience is the capacity to be agile in the rigorous work context of the 21st century working world. agile employees relish change and easily adapt to new work requirements (potgieter 2012). well-developed career resilience is positively associated with the effective use of a range of job-seeking strategies as well as with high levels of self-efficacy (koen et al. 2010; restubog et al. 2010). according to lent (2013), career resilience is akin to preparing for life as it is not always possible to foresee all the changes and issues that may impact on continued employment. restubog et al. (2010) found that high self-efficacy leads to greater career persistence but that the relationship is mediated by improved career decidedness. koen et al. (2010) found that career resilience positively predicted the willingness and capacity of job seekers to utilise varied job-seeking strategies to secure employment after a period of unemployment. an entrepreneurial orientation denotes those individuals who desire to be innovative and prefer to autonomously manage their careers (potgieter 2012). an entrepreneurial orientation entails valuing risks as opportunities, a tolerance for ambiguity as well as a preference for innovation, creativity and autonomous action in career management and advancement. entrepreneurial individuals acknowledge the value of creating something of significance (potgieter 2012). potgieter (2012) reported on the existence of a strong relationship between the employability attributes of career self-management, career resilience, sociability and proactivity. brown, hesketh and williams (2003) indicate that employability, as it is commonly understood, is not necessarily a universally accessible phenomenon. this is the so-called ‘consensus theory’ of employability. some authors believe that the drive towards inculcating employability attributes in those that are already privileged may enlarge social inequality because class, ethnic and gender differences in social status may inhibit the development of the required capacities – the ‘conflict theory’ of employability (brown et al. 2003). in addition, brown et al. (2003) indicate that a more inclusive conceptualisation of employability should be considered as relative to the current state of the economy and consequent availability of jobs in diverse labour markets – a labour market-specific conceptualisation of employability so to speak. the debate aside, in the context of the research reported on in this article, employability is taken to mean the individual capacity to wield personal psycho-social resources to successfully find, maintain or create employment through constant scrutiny of relevant work environments; proactive new competence development and the acquisition and active management of protean careers (coetzee 2012; fugate et al. 2004; van der heijde & van der heijden 2006). employability attributes have a positive effect on job performance, individual career prospects and career results (potgieter 2012; schreuder & coetzee 2011). what is unclear, particularly in the south african context, is whether there are significant differences in the employability attributes of diverse age, race and gender groups (botha 2014). as we cannot assume that the access to opportunities to develop employability as a passport to well-paid jobs is distributed equally across the diverse gender, age and race groups in south africa, thorough research on employees’ employability is vital in order to devise and support human resource management strategies (coetzee & schreuder 2008). in a society previously defined by gross inequalities in terms of access to quality higher education and equivalent jobs, and in the light of the debate on the veracity of employability to overcome socio-economic inequalities, investigation of possible discrepancies in employability attributes between different gender, race and age groups has become crucial. according to moreau and leathwood (2006) and morrison (2013), the dearth of research findings on the possible influence of biographic variables on employability affects the current standpoint of employability, and consequently, more research concentrating on biographical variables is needed (clarke 2008; themba, oosthuizen & coetzee 2012; williams et al. 2015). according to gerstein and friedman (2016), women seem to be better than men at social sensitivity but it is a kind of skill that can be taught. understanding the diverse career-related needs – including the cultivation of employability attributes – of individuals from different ages or life and career stages and those from different race groups have increased in importance in the light of the multicultural south african work environment (coetzee & schreuder 2008). the importance of generic skills in embracing diversity is emphasised by the fact that organisations that are made up of different kinds of people are more creative and productive than those that are homogeneous (gerstein & friedman 2016). research design research approach a quantitative survey method was used in the research study. a questionnaire consisting of a section on biographical data and a section on employability attributes (as developed by bezuidenhout & coetzee 2010) were mailed to the sample. the employability attribute scale (eas) was developed specifically for use in the south african higher education context and measures the required graduate attributes that will ensure continued employment in the 21st century work milieu. the eas is a lickert-type self-report scale consisting of 56 items that are collected into eight subscales namely: career self-management, cultural competence, career resilience, proactivity, entrepreneurial orientation, sociability, self-efficacy and emotional literacy. the scale was electronically scored by adding the responses for each subscale. the individual scores ranged between 30 and 60, with a high score per subscale indicating a highly developed ability in that subscale and a high score for the total scale indicating highly developed employability. research objectives the aim of the research was to investigate whether gender, race and age groups differ significantly regarding their employability attributes. research method population and sampling the total population of the study consisted of approximately n = 438 055 adult students currently registered for qualifications in the economic and management sciences field. a stratified, proportional, random sample of n = 10 500 adult students from different gender, race and age groups was drawn from the total population. the gender groups consisted of 37.2% males and 62.8% females, the four race groups consisted of 86.3% black people (african), 3.5% mixed race, 2.7% indians or asians and 7.4% white people. the ages of the respondents were grouped as follows: 18–25 years (39%), 26–30 years (24.3%), 31–40 years (24.3%), 41–50 years (9.3%) and over 50 years (1.6%). the response rate on the survey was 10.5% and produced n = 1102 useable questionnaires. statistical analysis descriptive, correlational and inferential statistical analyses were used to realise the empirical research objectives. an exploratory factor analysis (efa) provided confirmation of the construct validity and internal consistency reliability of the eas (bezuidenhout & coetzee 2010). the efa revealed eight subscales, namely career self-management, cultural competence, self-efficacy, career resilience, sociability, entrepreneurial orientation, proactivity and emotional literacy (bezuidenhout & coetzee 2010). the cronbach’s alpha coefficients obtained for each subscale were as follows and met the recommended minimum thresholds: career self-management (0.88), cultural competence (0.89), self-efficacy (0.83), career resilience (0.75), sociability (0.79), entrepreneurial orientation (0.80), proactivity (0.87) and emotional literacy (0.83), demonstrating high internal consistency for the eas. inferential statistical analyses (tests for significant mean differences) were performed to determine whether the gender, race and age groups differed significantly in terms of employability. the means for the eight subscales of the eas ranged between 4.27 and 4.80, with the highest mean score m = 4.80 (sd = 0.82) for the subscale career self-management, and the lowest mean score for the subscale sociability (m = 4.27; sd = 0.92). skewness for the eight subscales ranged between 0.370 and −0.75, thereby falling within the −1 and +1 normality range recommended for these coefficients (salkind 2012). the kurtosis values ranged between 0.051 and 0.584. the means, standard deviations, skewness and kurtosis of the eas are indicated in table 1. table 1: means, standard deviations, skewness and kurtosis of the employability attribute scale. statistical analyses commenced with a test for normality to establish whether parametric or non-parametric procedures should be used to test for significant mean differences followed by tests for significant mean differences. the test for normality indicated that the data were not normally distributed. consequently, the mann–whitney u (gender) and kruskal–wallis (race and age) tests were performed to determine the existence of significant mean differences. the indicators of statistical significance used for the multiple regression analyses were as follows: f(p) ≤ 0.001, f(p) ≤ 0.01 and f(p) ≤ 0.05 were considered as the cut-off for rejecting the null hypotheses. the mann–whitney u test is used to determine whether survey data in one population rank higher than similar data in another population using the median scores of the two samples (salkind 2012). although the mann–whitney u and kruskal–wallis tests are usually used in studies with small sample sizes (<100), they were used in this study because of the non-parametric nature of the data (salkind 2012). the indicators for interpretation of the magnitude of the practical significance of the results were the following: adjusted r² ≤ 0.12 (small practical effect size), r² ≥ 0.13 ≤ 0.25 (moderate practical effect size) and r² ≥ 26 (large practical effect size). because more than one of the variables of the eas were utilised in the analyses, the value of adjusted r² was used to interpret the results. in addition, because a high level of correlation between independent variables raises concerns about multicollinearity, which may create challenges in interpreting the beta coefficients as meaningful, collinearity diagnostics were employed in order to confirm that zero-order correlations were below the level of concern (r ≥ 0.80), that the variance inflation factors did not exceed 10, that the condition index was well below 15 and that the tolerance values were close to 1.0 (salkind 2012). results gender the results of the mann–whitney u test (gender) indicated that male respondents (m = 32.50) scored higher than female respondents (m = 31.48) on the eas with regard to proactivity (p = 0.014; eta-squared = 0.01; small practical effect) and entrepreneurial orientation (males: m = 32.67; females: m = 32.01) (p = 0.03; eta-squared = 0.003) variables. conversely, the female participants (m = 26.48) achieved a higher score than the male participants (m = 25.88) on the eas with regard to career resilience variable (p = 0.053; eta-squared = 0.003; small practical effect). it is, however, only with regard to proactivity that the difference between male and female is of significant value. the results are illustrated in table 2. table 2: differences in employability attributes with regard to gender. race the results of the kruskal–wallis test show that the indian respondents achieved relative higher scores than the other race groups on cultural competence (indian = 23.69; p = 0.002, eta-squared = 0.012; small practical effect) and sociability (indian = 29.49; p = 0.05, eta-squared = 0.005; small practical effect) variables. in addition, the white participants scored relatively lower on cultural competence (white people = 19.85; p = 0.002; eta-squared = 0.012; small practical effect) and sociability (white people = 27.84; p = 0.047, eta-squared = 0.005; small practical effect) variables. the results are illustrated in table 3. table 3: differences in employability attributes with regard to race. age the results of the kruskal–wallis test indicated that the participants aged between 41 and 50 achieved considerably lower scores compared to the other age groups on the self-efficacy variable (m = 27.53; p = 0.03; eta-squared = 0.01; small practical effect). conversely, the participants older than 50 scored considerably higher than the other age groups on the same variable (m = 28.94; p = 0.03; eta-squared = 0.01; small practical effect). the results are illustrated in table 4. table 4: differences in employability attributes with regard to age. the results provide evidence to support the research objectives – gender, age and race groups differ significantly with regard to employability attributes. table 5 summarises the findings and indicates which groups scored the lowest and highest on the various employability attributes. table 5: differences between the gender, race and age groups in terms of employability variables. discussion and recommendations the male and female participants in this study differed considerably in their employability attributes, with significant differences found in entrepreneurial orientation, proactivity and career resilience. the male participants appear to be more entrepreneurially oriented and proactive, while the female participants are apparently more resilient in their careers. as potgieter (2012) found a strong relationship between career self-management, career resilience, sociability and proactivity, it seems that organisational career management support should focus on cultivating career resilience in male employees and proactivity in female employees. race relates significantly to the cultural competence and sociability of individuals and different race groups appear to differ considerably regarding these attributes. interestingly, the white participants scored considerably lower on both cultural competence and sociability, yet these two employability attributes are closely related to career self-management. it seems that organisations could focus on cultivating these two attributes in their white employees. the older than 50 years age group obtained the highest mean score on self-efficacy, with the age group of 41–50 years obtaining the lowest mean score. the reasons for the low mean score of the 41–50 years age group cannot be determined, but may have been caused by factors such as multiple life roles. organisations may benefit from cultivating the self-efficacy of their employees in this age range. the high mean score of the older than 50 years age group provides a caution to employers. as the older participants appear to be stronger in self-efficacy, older employees should not be overlooked when training and development opportunities are provided in organisations, because older employees will probably be more successful in their development endeavours. although the dearth of current, south african research precluded the drawing of definite conclusions regarding any relationships between socio-biographical elements such as age, race and gender and employability as a holistic concept, this study highlighted the significant differences between various gender, race and age groups in the subscales of the employability attributes framework of entrepreneurial orientation, proactivity, career resilience, cultural competence, sociability and self-efficacy. the study makes a further significant contribution as being the first south african study to zoom in on the investigation of possible differences in employability attributes as defined by the employability attributes framework between various socio-biographical groupings. the current emphasis on employability implies that tertiary institutions and workplace learning professionals should rethink both their programme content and their teaching or training methods (boden & nedeva 2010). the use of learning goals or outcomes that require the measurement of learner’s learning performance instead of the memorisation of factual knowledge must be a priority for all tertiary institutions if they are to prove their effective and efficient utilisation of public funds (boden & nedeva 2010). in the current, turbulent, unpredictable working environment in which full-time employment for life is no longer guaranteed, it is essential that all employees develop generic skills that are transferable to the world of work (ehiyazaryan & barraclough 2009; morrison 2013). employees are required to understand both their job responsibilities and also the organisational setting of their jobs. in addition, employees should appreciate and be able to function successfully within the organisational culture. a thorough understanding of the organisation’s philosophy, values and norms is built through both formal and informal workplace learning and development (billet 2010; slev & pop 2012). employees who are involved in interesting and inspiring work think of themselves as being more employable (berntson, näswall & sverke 2008; van emmerik 2012). the purpose of training and development within the organisation is the provision of learning and development opportunities that broaden and deepen employee competencies for optimal performance of both current and future job tasks. in this way, the organisation hopes to ensure a competitive advantage by increasing the value which employees add to the organisation and also by developing employee adaptability (coetzee & schreuder 2013; du toit, erasmus & strydom 2010). training and development include both formal and informal workplace learning opportunities. the focus of such training and development is increased capacity and performance on the part of employees with its concomitant benefit for the organisation (cameron & harrison 2012; coetzee & schreuder 2013). training and development is associated with employability in organisations because of its focus on goal-driven employee training and development in order to enrich organisational dexterity. specific dispositional traits in employees, such as openness (being willing and eager to accept changes and new ideas), are positively associated with employability and may be used to predict the success of training interventions (van dam 2004). limitations and conclusions the demographic confines of the research study preclude the generalisation of the findings to the wider population of working people. the sample consisted only of adult, majority employed, students participating in open distance higher education in one south african university. the small percentage of south africans who enrol for tertiary education indicates that the findings cannot be generalised to include the wider public of south africans. as the sample reflected the student profile of the academic institution at the time of the study, the participants were mostly black women enrolled for undergraduate qualifications in the economic and management sciences field. consequently, the research findings cannot be generalised to the wider occupational, gender and race contexts in south africa. in addition, because of the self-reporting methodology used for gathering the data, the possibility of common method bias cannot be ignored. lastly, because of the dearth of available reported research on the possible socio-biographical differences in employability attributes both locally and globally, a comparison could not be made with other published research. nevertheless, these research findings on the possible socio-biographical differences between various gender, race and age groups are the only ones known of to report on socio-biographical differences in employability attributes in south africa. as differences were found between the various gender, race and age groups on a number of employability attributes in the employability attributes framework (bezuidenhout & coetzee 2011), more research on the socio-demographic differences that may influence the cultivation of employability attributes in various socio-biographical groupings is called for. this research is of particular importance in the business environment in order to ensure that previously disadvantaged individuals are not further marginalised because of a lack of employability attributes or insufficient opportunity to cultivate the required employability attributes to ensure development and success in the work place. conversely, although differences do exist between the various groups in terms of employability, many factors such as job context, culture of the organisation, willingness of the organisation to support training and the transfer of learning to the workplace could have an influence on employees’ employability. organisations would thus reap the benefits by implementing strategies that could enhance attributes of employability by focusing on 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https://doi.org/10.1080/13639080.2015.1102210 zgheib, p.w. & kowatly, a.k., 2011, ‘autonomy, locus of control and entrepreneurial orientation of lebnanese expatriates worldwide’, journal of small business and entrepreneurship 24(3), 345–360. https://doi.org/10.1080/08276331.2011.10593543 abstract introduction research methodology ethical consideration theoretical review conclusion acknowledgements references about the author(s) micheline j. naude school of management, information systems and public administration, university of kwazulu-natal, south africa nigel chiweshe school of management, information systems and public administration, university of kwazulu-natal, south africa citation naude, m.j. & chiweshe, n., 2017, ‘a proposed operational risk management framework for small and medium enterprises’, south african journal of economic and management sciences 20(1), a1621. https://doi.org/10.4102/sajems.v20i1.1621 original research a proposed operational risk management framework for small and medium enterprises micheline j. naude, nigel chiweshe received: 16 june 2016; accepted: 28 aug. 2017; published: 04 dec. 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the gap between small and medium-sized enterprises (smes) and large businesses that perform risk assessment is significant. smes continuously face many operational risks and uncertainties in their daily operations, and these risks threaten to reduce productivity, increase costs and reduce profits. aim: the purpose of this article was to develop an operational risk management framework that smes can use to identify and analyse risks in their operations and take corrective actions to mitigate these risks. setting: small and medium-sized enterprises in south africa do not view risk management as a key component of organisational success, despite evidence that businesses that adopt risk management strategies are more likely to survive and grow. methods: the article is exploratory in nature, and a conceptual analysis approach was used to formulate the framework. this study reviewed relevant literature sources on risk published between 2002 and 2017. results: the four process steps of risk management were used as a reference point and form the foundation for the operational risk management framework. the categories of operational; marketing; technical and financial risks were identified from a review of available literature on risk management. conclusion: there is a dearth of research that deals with operational risk management frameworks for smes. the expected contribution of this article, therefore, is twofold: firstly, it is envisaged that managers or owners of smes could use the proposed framework as a tool to appraise and minimise their operational risks; secondly, it will add to the current body of knowledge on risk appraisal for smes. introduction in this current business environment, businesses are required to compete in a global, volatile and dynamic market. as more markets have opened up for products, this has created the potential to increase sales and profits (cheng & kam 2008:345; cocca & alberti 2010:186; hoffmann, schiele & krabbendam 2012:1; simchi-levi, kaminsky & simchi-levy 2008:315). despite these advantages and opportunities, businesses face tough competition with regard to quality, cost and on-time delivery to market. consequently, businesses are required to improve their flexibility, quality standards and innovative capacities (islam, tedford & haemmerle 2012:2). to achieve this, businesses need experienced and trained staff, reliable machines, efficient processes, good relationships with suppliers and customers, a supply of quality materials and services and other value-adding processes throughout the operations system. this is rarely achieved and many businesses, especially small and medium-sized enterprises (smes), face a number of business risks in their day-to-day operations that threaten to reduce productivity, increase costs and liabilities and reduce profits (michalski 2009:213; smit & watkins 2012:6327). when businesses find themselves in a position where unexpected events cause disruption to normal operations, resulting in financial loss and damage to their reputation, this presents as a risk. shareholders expect businesses to identify and mitigate risks that may cause disruption (hopkins 2017:24). therefore, risk assessment is a necessary tool for all businesses (benton 2014:363; wu & olson 2009:362). even though tools for risk assessment like business scorecards are available in the market (wu & olson 2009:362), findings indicate that smes tend not to formally assess and manage their risks, but instead respond reactively by using risk avoidance and risk transfer techniques (islam et al. 2012:4; smit 2012:iii). the gap between smes and large businesses that perform risk assessment is significant. in south africa, a component of the king iii report on governance is risk management. the report states that ‘it is the duty of the board of a trading enterprise to undertake a measure of risk for reward and to try to improve the economic value of a company’ (king 2012:6). however, smes in south africa do not view risk management as a key component of organisational success (smit & watkins 2012:4). islam et al. (2012:4) suggest that risk management is less developed within smes, despite evidence that businesses that adopt risk management strategies are more likely to survive and grow. by failing to assess the risks to which they are exposed, smes may find their success, reputation and credibility at stake (dimopoulos et al. 2004:279). some causes of failure in smes include poor management planning and failure to adopt risk assessment (islam et al. 2012:4; smit & watkins 2012:6325). in many cases, risk can be predicted on the basis of experience, but it can be better managed through a risk management framework. this would include identifying risks, measuring their probable impact, mitigating the risks and eliminating or reducing their effect with the minimum investment of resources (verbano & venturini 2013:1). the adoption of risk management is important when considering interruptions that can be caused in operational activities such as timely delivery, global competition and the strict requirements of customers (servaes, tamayo & tufano 2009:94). accordingly, the purpose of this article was to present an operational risk management framework which smes could use as a tool to identify risks, assess them, take corrective action to mitigate them and thereafter monitor them. for the framework to be relevant it should, according to cocca and alberti (2010:187), not merely be a shortened version of a framework developed for large businesses; it should, moreover, remain simple and comprehensive; it should not be too demanding in terms of resources; finally, it must guide the owner-manager towards action or improvement. the proposed operational risk management framework presented in this study is based on the four process steps of risk management, namely risk identification, risk assessment, risk response and risk monitoring and control (sharma & bhat 2014:26; waters 2009:477; young 2008:1). these aspects were used as a reference point and formed the foundation for the framework. the various categories of operations risks were identified from academic texts and are embedded in this proposed framework. research methodology the article is exploratory in nature and a conceptual analysis approach was used to formulate the framework. conceptual analysis can be defined as a technique that treats concepts as classes of objects, such as words, themes or characters. the technique involves analysing and interpreting text by coding the text into manageable content categories (sekaran & bougie 2016:350). conceptual analysis was deemed appropriate to gain better insight into the risk management processes of smes, steps in risk management and the various types of risks. this study reviewed relevant literature sources on risk published in the period between 2002 and 2017. these included journal articles available on google scholar and science direct, academic texts, theses and reports dealing with smes, risk and risk management. in this way, the study examined: (1) the nature of smes, (2) risk and risk management, (3) the different categories of risk and (4) the importance of risk management. when this review was completed, a risk management framework was developed, which smes can use as management tool. ethical consideration ethical clearance through university of kwazulu-natal was obtained. theoretical review small and medium enterprises in south africa small and medium-sized enterprises are businesses in the private sector and across all industries employing between 10 and 200 employees. the definitions of smes by industry sector or subsector in accordance with the standard industrial classification are presented in table 1. these definitions are based on the national small business act no. 26, 2003 (south africa 2003). smes are usually independently owned and operated and are closely controlled by their owners. thus, the owners are responsible for the management of the business on a day-to-day basis, including areas such as marketing, production, human resources and finance (nieuwenhuizen 2007:2; smit & watkins 2012:6325). table 1: schedule of size standards for the definition of small and medium-sized enterprises in south africa. small and medium-sized enterprises play an important role in the economies of many countries and therefore governments globally focus on the development of the sme sector to promote economic growth. the contribution to most economies by smes is significant as they constitute the largest number of businesses and employ a significant proportion of the labour force (islam & tedford 2012:2; sousa & aspinwall 2010:476). the role of smes in south africa is no exception. according to the national development plan, south africa’s smes play a key role in the creation and promotion of employment, particularly in labour-intensive industries (davis tax committee 2014:5). smes are employers of unskilled labour and develop and nurture entrepreneurial skills (smit & watkins 2012:6324). however, smes are perceived as high-risk enterprises as their entry and exit levels in the market are high. it is estimated that 50% of the small businesses started in south africa have eventually failed (islam & tedford 2012:2). despite these high failure rates, smes continue to be a key part of the economy as they collectively employ a large overall workforce. it is estimated that the sme sector contributes 55% to private sector employment and accounts for approximately 40% of the gross domestic product of the country (radebe 2014:para. 2; sanlam financial services 2014:para. 7). small and medium-sized enterprises thrive on their adaptability, their agility based on their closeness to their customers, their openness to processes that enhance their efficiency and their ability to take risks (smit & watkins 2012:6324). nevertheless, while smes operate in the same environment as larger organisations, they do not have the resources of these larger organisations (sousa & aspinwall 2010:476). globalisation, legislation, market expansion and the removal of trade barriers have fuelled an increase in the competition faced by smes. moreover, they, in common with every business, are susceptible to unwanted internal and external setbacks in their daily operations (islam et al. 2012:2). the business environment is dynamic and highly competitive. to survive, businesses are under pressure to satisfy all their stakeholders and excel at the same time (cocca & alberti 2010:186). therefore, all enterprises including smes need to adopt a formal risk management strategy as a tool to survive and grow. kagwathi et al. (2014:9) found that, unlike the larger businesses in developing countries, there is a lack of formal risk management in smes which can identify and mitigate their risks. islam and tedford (2012:3) suggest that risk management is less developed in smes. despite the evidence that businesses that adopt a formal risk management strategy are more likely to survive and grow, smes are reluctant to do so as it is viewed as time consuming and entrepreneurs would rather focus their energies on running their businesses based on their known skills and experience. paradoxically, a formal approach to risk management and risk-mitigation could alert them to the realities of some of the threats and risks. risks one of the first definitions of risk can be ascribed to bernoulli, who in 1738 proposed measuring risk with a geometric mean and minimising risk by spreading it across a set of independent events (verbano & venturini 2013:187). risk is always linked to the uncertainty of the occurrence of a certain event that can cause loss or damage. it combines the probability and severity of a risk (aven 2016:4; islam & tedford 2012:258). the international organization for standardization (iso) defines risk as the effect of uncertainty on objectives. an effect is described as a deviation from the expected objectives and can apply at different levels, that is, financial, health and safety, reputation, natural environment and legal. the uncertainty is related to understanding or knowledge of an event and its consequence or likelihood (iso 2009). li and zeng (2014:45) define risk as the level of exposure to uncertainties that the business must understand and effectively manage as it carries out its strategies to achieve its business objectives and create value. to refine this from an operational point of view, operational risk can be defined as the risk of loss as a direct consequence from inadequate or failed processes, people and systems from external and internal events (garp 2014:41). the business environment constantly changes. in this changing environment, risk taking is a key element of the entrepreneurial function and ultimately crucial in the creation of economic value and innovation (dempster 2009:151). changes in factors such as interest hikes, material price increases and strikes influence the business environment and result in uncertainty about the future path of an enterprise. uncertainty about the future manifests itself as a risk (hugo & badenhorst-weiss 2011:97). operational risk and uncertainties are important in the academic and practical application. the field of operational risk management materialised as a result of several catastrophes and natural disasters, globalisation, intensified competition and integrated production methods (cheng & kam 2008:347). thus, operational risk management is a developing focus area in supply chain management research (aven 2016:3; hoffmann, schiele & krabbendam 2012:1). the sources of risks in operations are many and multifaceted and include strategy misalignment, regulatory requirements, changes in consumer preferences and the impairment of key assets (lavastre, gunasekaran & spalanzani 2012:829). other risks include skills shortages, unreliable suppliers, as well as economic, technological, social factors and information security (blome, schoenherr & eckstein 2014:309). consequently, entrepreneurs must be able to identify and mitigate potential risks, as failure to do so could result in reduced productivity or even lead to bankruptcy. for example, an sme may find the costs of enforced responsibilities such as a product recall or a site clean-up could reduce or eliminate expected profits (sanders 2012:394). risk management is not well defined, which can give rise to challenges in any organisation and specifically to smes (blanc-alquier & lagasse-tignol 2006:273). risk management risk management can be described as the process of identifying potential risks, assessing the likelihood of their occurrence, mitigating these risks before they occur or reducing the risk probability and putting contingency plans in place to mitigate the consequences if they do arise (monczka et al. 2016:259; waters 2009:277). the four concepts of risk management are illustrated in figure 1. figure 1: four process steps of risk management. identification of risks this is the first step in the risk management process, with the aim of identifying future potential risks so that they can be proactively mitigated. risk identification can be defined as the process of systematically identifying all potential internal and external risks which can cause loss or damage to the business (hallikas & lintukangas 2016:57; kodithuwakku & wickramarachchi 2015:122). it is about recognising and understanding possible risk sources (hoffmann et al. 2012:4). however, these risks might be difficult to identify, as they have not yet happened, but might happen sometime in the future (turner & keetelaar 2005:29). key to the process is that, when they are identified, they should be recorded and monitored (scarborough, wilson & zimmerer 2009:730; van weele 2010:175). the methods suggested for identifying risks are through brainstorming with staff and external stakeholders and through researching the political, economic, legislative and operating environment. it must, however, be noted that the identification of risks can be limited by the experiences and perspectives of the person(s) conducting the risk analysis (islam & tedford 2012:262; turner & keetelaar 2005:29). risk assessment this is the second step in the risk management process and can be described as evaluating or calculating the probability of occurrence of a possible risk and predicting its impact. risk assessment includes evaluating two variables, namely the likelihood that a risk will occur and the extent of its impact if the risk actually occurs (ho et al. 2015:132). the impacts can be on the finances, on health and safety, the natural environment or the reputation of the business and may have legal implications (ho et al. 2015:44; hoffmann et al. 2012:4; kannan & martin 2016:33). risk response the third step in the risk management process is the use of mitigation strategies to eliminate, reduce or counteract risks (hoffmann et al. 2012:4). there are three commonly used strategies to mitigate risk. these are: (1) risk informed – treatment of risk, avoidance, reduction, transfer and retention; (2) cautionary or precautionary – highlights features like containment, the development of substitutes, safety factors; and (3) discursive strategies – uses measures to build confidence and trustworthiness, through reduction of uncertainties. in most cases the appropriate strategy would be a hybrid of these three strategies (aven 2016:6; cucchiella & gastaldi 2006:4). a business may select and implement a risk response strategy depending on the type of risk it faces (yoon & lee 2012:32). risk monitoring and control the last step in the risk management process is regular risk monitoring. for example, indictors can be used to identify risk levels that are within limits but rising. this indicates future problems (hoffmann et al. 2012:4). risk management is a dynamic process as the probability of risks can change over time. therefore, the monitoring of risks is vital as it can provide as an early warning when risk levels are increasing, giving businesses time to react to these changes and to formulate mitigation strategies (chang et al. 2015:55; wagner & bode 2008:311). categories of risk there are many categories of risks that businesses will come across. some risks may have little impact on the business and can be managed easily, whereas other risks may threaten the survival of the business. therefore, understanding what the potential risks are and how to effectively manage these risks will help small and medium business owner-managers make the necessary decisions to ensure the best possible outcome for their businesses. there are various sources of risks in the operations of a business that have been identified by various authors and these can be grouped into various categories as presented in table 2. table 2: categories of risks. because the majority of the authors listed in table 2 categorised the risks into operational, market, technological and financial risks and the proposed framework concerns operational risk management, it is around these four categories of risks that the proposed operational risk management framework is built (figure 2). furthermore, to be effective, a risk assessment method needs to help identify potential risks in these four domains (keizer et al. 2002:214), and these four domains can be adapted for smes (kim & vonortas 2014:456). each of these is briefly explained below. figure 2: operational risk management framework. operational risk the operational risk deals with the internal organisation and management of the operations team for development, production, supply and distribution. operational risk encompasses the production, warehousing, distribution, staff challenges, systems and the processes that the company uses (islam & tedford 2012:258; keizer et al. 2002:214; young 2008:5). it is the uncertainty associated with supplier activities and relationships, poor quality, inventory risks and product demand among others (jüttner 2005:123; waters 2009:475). market risk the market risk refers to the market acceptance of the product, the potential actions of competitors and general market conditions. for example, understanding customer needs, who competitors are, the products they offer, their advantages and any potential and future competitors, the inability to identify future market needs, failure to design new products and retention of market share (keizer et al. 2002:214; kim & vonortas 2014:456; waters 2009:478). technical risk this type of risk refers to product design, production technology and intellectual property. under technical risks, the framework includes risks such as failure to identify, launch and design new products, which will result in a lack of growth and possible loss of market share (keizer et al. 2002:214; kim & vonortas 2014:456). financial risk this kind of risk refers to the tangible value investors lose if the business fails and to the financial aspects of a business (kim & vonortas 2014:456). it is considered to be the risk associated with commercial and business performance (islam & tedford 2012:259). it comprises all financial transactions, including payments, costs, prices, sourcing of funds, profit and loss to the company should legal claims be lodged and when a customer declares insolvency resulting in irrecoverable sales. it should also cover the customers’ debtors’ book (waters 2009:478). importance of risk management turner and keetelaar (2005:13) remark that risk management should be viewed from three perspectives: (1) why businesses would want to implement risk management; (2) why businesses should implement risk management; and (3) why businesses have to implement risk management. small businesses can expect many benefits from managing their risks such as: an improved understanding of the impact that management practices have on a business; increased competitive advantage; and increased efficiency and productivity (scarborough et al. 2009:730; smit 2012:20). likewise, there are many reasons why a small business should implement risk management, such as protection of assets and the longer-term viability of the small business (hoffmann et al. 2012:2; sanders 2012:394). lastly, there are legislative and regulatory requirements relating to risk management, for example, occupational health and safety legislation and fair-trading legislation (scarborough et al. 2009:736; turner & keetelaar 2005:13). the responsibility of managing risk requires the development of a framework which is not too cautious or too reckless and which guides the owner-manager towards action or improvement (cocca & alberti 2009:187). the framework must focus on the control of risk, the minimising of loss through prevention and avoidance and the exploitation of opportunities (kim & vonortas 2014:456). the management of risk offers businesses a sustainable competitive advantage by optimising the risk and return (andersen 2008:156; kim & vonortas 2014:456; smit & watkins 2012:6324; verbano & venturini 2013:186). though there are some existing frameworks on risk management, such as the risk management framework, the conceptualisation of risk management must be driven by the values and goals of the business (kim & vonortas 2014:455). dimopoulos et al. (2004) acknowledge that there are tools available to assess risk. however, smes generally do not assess risk or, if they do, they do not assess the risks they are exposed to properly, leaving them in a vulnerable position (islam & tedford 2012:3; kagwathi et al. 2014:9). small and medium-sized enterprise owner-managers need a good understanding of risk identification and analysis in order to successfully manage risks. the adaption of a risk management framework for smes is key as by using this they will be better suited to assess and manage their risks, thus benefiting from their resources and yielding a positive return (smit & watkins 2012:6324). operational risk management framework figure 2 shows the proposed operational risk management framework that smes could use. this proposed framework is underpinned by and analysed into the four process steps of risk, namely risk identification, risk assessment, risk response-mitigation strategy and risk monitoring and control. these terms head the four main columns across the top of the proposed framework, and the rows down the left side of the framework detail the four broad risk categories of operational risks, market risks, technical risks and financial risks. the columns listing the four process steps are further analysed into subcategories as are the four risk categories down the left side of the model. the details of the risk process steps, covering the various risk categories, are outlined below, to explain the construct of figure 2. risk identification this is the first key step for identifying and understanding the possible risk sources. to add depth to this process stage, the risk identification column has been split into three sub-columns of objective, description of risk and responsible person. the objective column will assist in identifying the broad business issue, the description column defines the specific risk and the responsible person column defines the responsibility for managing and mitigating the risk. this feature will be explained in more detail later. as can be seen in the rows of the framework, each potential risk area of the business, namely operational, market, technical and financial risks, is listed. the first broad category of risk is operational risks. operational risks encompass the various operational activities within the sme, including production, warehousing and distribution. the second risk category, after operational risks, is market risks. this includes risks such as understanding customer needs, future market needs, new opportunities and market share. the third risk category is technical risks and includes risks such as the current product range design, which can result in loss of position in the market and failure to identify, launch and design new products, which will result in a lack of growth and possible loss of market share. finally, the fourth risk category is financial risks. these risks may have legal and other implications for the sme. for example, legal risks could include loss to the company should legal claims be lodged and/or, if a customer declares insolvency, it could result in irrecoverable sales and financial losses. it must be pointed out that these risk categories are suggestions and that they would differ from sme to sme depending on the size and type of business. it is suggested that a cross-functional team be formed within the sme to discuss the objectives of the sme’s operations and identify potential operational risks. it is for this reason that in this proposed framework some generic risks are presented as examples that smes could use. by way of explaining figure 2, the category of operational risk has been split into the key operational activities of production, warehousing and distribution. production risks consist of risks that will impact on the production of the sme. these include supplier risks regarding quality and pricing, inventory risks, process risks, downtime risks and quality risks. even though the list of production risks is not exhaustive, these risks have the possibility of reducing competitiveness and may have financial implications for the sme. the risks that come under warehousing include sending products from the site to warehouse, holding slow-moving stock and protecting and safeguarding stock. under distribution are included risks such as accurate stock picking, effective control of stock and the transport of goods. in order to explain the risk management process and the use shown in figure 2, let us assume that a cross-functional team of key employees within the sme is undertaking this risk assessment or identification process. under the heading of production risk, the team would note the key potential business or operational issues that could negatively affect the production environment. the team would look at these issues from an objective or desired outcome perspective and create a positive statement that the sme would want to achieve in the production area. the idea here is that, if the sme achieved this objective or outcome, then any risk that could negatively impact on the outcome would have been eliminated or at least mitigated against. this becomes the measure against which the risk is gauged. in the example shown above of the operational category of production risk, a positive outcome or objective of source quality materials at competitive prices could be listed. the question to be asked of the cross-functional team is what the likelihood of this objective being achieved is and, if it cannot be achieved, what the issues are leading to its non-achievement. the identification of these issues results in a listing of the negative risks to be detailed under the description of risk column. an example of this risk could be the naming of a particular key raw material which is vital for the sme to produce a quality finished product. if the quality of this raw material from a supplier has in the past been variable, then this is a key risk to the business or, if the supplier has proven to be one that is unreliable from an on-time delivery basis, then again this is a risk. if the supplier is in the habit of increasing his prices based on, for example, a fluctuating exchange rate, meaning that he does not take forward cover for his inputs, then again, the sme could face risk exposure, this time from a cost basis. for explanatory purposes, let us assume that the issue of risk that will detract from the sme achieving the objective or positive outcome of source quality materials at competitive prices is a key raw material supplier rm steel who provides a raw material of variable quality 30% of the time. in this example, the actual risk to be listed in column 2, alongside the objective of source quality materials at competitive prices would be ‘variable raw material quality from rm steel’. the next and final step in the identification process is the nomination of the responsible person and this detail would be inserted in the third column. as the problem is related to the supply of raw materials, the buyer’s name would be placed in this third column. in this way, we have the objective or desired outcome listed in column one, the actual risk detailed in column two (there could be a number of risks related to the one objective) and, finally, the name of the individual who is responsible for managing and monitoring the particular risk. in the example of source quality materials at competitive prices, this could be the buyer. this is a key issue as it is important that someone within the sme takes ownership of achieving the positive outcome or objective, and of managing and mitigating the risks, or the risk management exercise will be futile. the three subheadings of objective, description of risk and responsible person represent the first step of the risk process, namely risk identification. the cross-functional team will now move to the next section, which is risk assessment, or risk priority. risk assessment the first column under the risk framework of risk assessment deals with the severity rating of the identified risk. here the risks are subcategorised according to the impact that the risk may have on the various aspects of the business, such as finances, health and safety, the natural environment and the reputation of the sme or the possible legal consequences (ho et al. 2015:44; hoffmann et al. 2012:4; kannan & martin 2016:33). the risks are then ranked on a severity rating scale from 1 to 10, with a 10 being of the highest severity. there could be many risks attached to any one objective. examples are ‘delayed supply’, ‘current supplier is unable to supply’, ‘quality of materials’, ‘uncompetitive price’ among others. in the example being explained under the first objective, source quality materials at competitive prices, the issue of ‘variable raw material quality from rm’ has been listed. this could have severe financial implications for the sme, as the final product produced by the sme using the materials from rm could be sub-standard, resulting in returns to the sme and financial loss. this issue could also negatively impact on the reputation of the company, which could in turn have financial and legal implications. further, it could impact on health and safety and the natural environment. however, because the severity rating may not be equally severe on all the business aspects, in our example the following ratings are assigned: financial (8), health and safety (1), natural environment (1), reputation (8) and legal (4). these ratings are then combined as follows: 8 + 1 + 1 + 8 + 4 = 22. the third column under risk assessment deals with the probability rating given to each risk. the smes must determine, on a scale from 1 to 10, the likelihood of this risk occurring. a score of 10 will be relative to a risk being probable. so, with regard to our previous example, what is the risk probability of receiving poor quality materials? it would depend on the supplier, but, for the sake of this example, the probability of this risk occurring might not be that severe. let us say that the cross-functional team decides that 30% of the time the quality of the raw material receipts is below standard; they could assess that there is a probability of 3 out of 10 chances of it happening. the last column under risk assessment scores the risk. in our example, the total of the severity risk rating is 22 and the probability of the risk occurring is 3. the severity risk rating is then multiplied by the probability rating as follows: 22 × 3 = 66 sixty-six is the total score. the higher the score, the higher the perception that the risk is likely to happen and impact on the business. each risk must be scored accordingly. the scores will highlight the more severe risks. this completes the risk assessment portion of the process. risk response (mitigation) the third step in the risk process framework presents the risk response-mitigation strategy. once each potential risk is scored, these should be sorted and ranked from top to bottom. the cross-functional team of the sme can then work their way down the list from more severe to less severe risks. it will be the responsibility of the cross-functional team to score all the risks identified and to deal with the highest scoring or most severe risks first. in our example, let us assume a score of 66 would lift this risk to the top of the value scale, meaning it would be viewed as a key risk requiring attention. the goal of the cross-functional team is to then look at what existing controls are in place and the additional measures needed to be implemented in order to mitigate the more severe risks. in our example, the buyer has been assigned the responsibility for managing the risk. in the open forum of the cross-functional team meeting, a discussion should take place and the buyer would be asked for his input or what his risk-mitigation strategy will actually be. an obvious point would be for the buyer to contact rm and to raise the sme’s concern with this supplier. this would be risk-mitigation step one. step two of the risk-mitigation strategy would be for the buyer to visit the rm with the sme’s quality controller to undertake a quality process audit on the production process to ensure that rm’s processes and procedures are under control and to check for consistency and repeatability, which is obviously lacking as problems arise 30% of the time. such an audit could identify system or process weaknesses, which the sme would insist that rm addresses. step three could be for the buyer to instruct the quality controller to conduct incoming quality checks of the incoming raw material from the supplier rm and to reject any product that does not conform. key to the success of the process is for the cross-functional team to be satisfied that the steps identified by the buyer will mitigate against the identified risks. risk monitoring and control using this process in relation to various production objectives, identifying risk types and scoring these risks will complete the final column of the risk framework. this is the fourth and final step. chang et al. (2015:55) and wagner and bode (2008:311) maintain that the monitoring of risks is important, because it can provide an early warning of increasing risk levels, thus giving the sme time to react to these changes and to formulate and/or adapt mitigation strategies. in the example shown in figure 2, the results of the actions taken against risk-mitigation strategy steps 1 to 3 as identified above would be written up in this column. this is done once the various actions have been completed and provides feedback to the cross-functional team, evidence that positive mitigating action steps have been taken. it is recommended that the risk management cross-functional team meets at least twice a year, which gives the various responsible individuals time to complete the mitigating action steps. at the next meeting of this team, a follow-up review of the risks should take place, and the team will be asked to re-evaluate the revised risk and rescore each identified risk, overwriting the original rating values. in our example, the original score of 66 will also be noted in the risk monitoring and control column, in order that the progress on the risk strategies can be monitored and progress confirmed. this may be compared with the new revised risk assessment score. this process is key to closing the risk management ‘loop’ and to ensure forward progress and momentum. it should be noted that the example outlined to explain figure 2 has assumed an sme with a number of employees and functional responsibilities, hence the possibility of a cross-functional team. the model could equally apply to a smaller operation with, for example, the cross-functional team comprising the owner and just one or two employees, such as the production supervisor and the bookkeeper. the benefit of the process of using cross-functionality is not relative to there being highly skilled functional department heads but is rather about individuals who know the sme and its functioning and who understand the risks that such an operation actually faces. figure 2 presents the proposed operataional risk management framework. it is suggested that the proposed framework complies with the requirements of scholars who specify that a risk management framework must focus on identifying risks, measuring the probability of the impact of risks, mitigating the risks and monitoring and controlling the risks (chang et al. 2015:55; sharma and bhat 2014:26; wagner and bode 2008:311; waters 2009:477). the proposed framework differs from the standard risk management process in that it includes the categories of risks and also includes the responsible person and a severity and probability rating to score each risk. conclusion operational risk can be defined as the risk of loss as a direct consequence of inadequate or failed processes, people and systems because of external events (garp 2014:41). the business environment is dynamic and competitive, and businesses face a number of risks that threaten to reduce productivity and to increase costs and liabilities, thus negatively impacting the bottom line. therefore, risk assessment is necessary for all businesses, including smes. it is vital that entrepreneurs can identify and mitigate potential risks as failure to do so could result in reduced productivity or even bankruptcy. within this context, the aim of this article has been to present an operational risk management framework that smes can use to assess and manage their risks. the various types of operational risks were explored and are embedded in this proposed framework. the limitation of this study is that even though the proposed framework can be used as a tool to identify, assess, mitigate and manage or control the risks of smes, the framework has not been tested. it is proposed that it be tested in a future study to determine whether the model is valuable and useful for smes. there is a lack of research dealing with operational risk frameworks for smes (verbano & venturine 2013:8); therefore, the expected contribution of this article is twofold. firstly, it is envisaged that managers or owners of smes could use the proposed framework as a tool to appraise and minimise their operational risks. secondly, it adds to the current body of knowledge of risk appraisal for smes. as stated by theodore roosevelt, ‘risk is like fire: if controlled it will help you; if uncontrolled it will rise up and destroy you’. acknowledgements we acknowledge that this is our own work and all sources we have used or quoted have been indicated and acknowledged by means of complete references. competing interests the authors declare that they have no financial or personal relationship(s) which may have inappropriately influenced them in writing this article. authors’ contributions m.j.n. was the project leader, made conceptual contributions and finalised the article. n.c. collected and analysed the secondary data and wrote up the literature review. references andersen, t.j., 2008, ‘the 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young, j., 2008, operational risk management: the practical application of a qualitative approach, van schaik, pretoria. 334 sajems ns vol 3 (2000) no 2 atmospherics and the establishment of longterm customer relationships in a retail environment i olivier and m fletcher department of marketing and communication management. university of pretoria abstract with the current focus on establishing long-tenn customer relationships, the enhancement of the entire shopping experience and the role of atmosphere and the emotional reactions it elicits, are becoming increasingly important. detennining the factors that contribute to the creation of pleasant or unpleasant shopping experiences can influence future strategic planning. the focus of this study falls on the way that the physical environmental factors of a store, more specifically the environmental odour, affect consumers' emotional responses. this is discussed on the basis of environmental psychology, using certain research findings as well as theoretical models to shed more light on this topic. jelm49 introduction managers of retail and service outlets realise nowadays that the store environment has a significant effect on sales (milliman, 1982 and 1986; smith and curnow, 1966; stanley and sewall, 1976), product evaluation (bitner, 1986; rappoport, 1982; wheatley and chiu, 1977), and consumer satisfaction (bitner, 1990; harrel, hutt, and anderson, 1980). often the customer's attitude towards the store environment plays a greater role in the choice of a store than the customer's attitude towards the trade goods themselves (darden, erdem and darden, 1983). atmospherics comprises the endeavour to manipulate the retail environment to elicit specific emotional reactions from consumers (kotler, 1974). this refers to the design of the environment through visual communication, lighting, colours, music and smell, which influence clients' perceptual and emotional responses and, in tum, their purchasing behaviour. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 335 most decisions to buy are based on emotions. of all human senses, the sense of smell has the greatest impact on emotion (levy and weitz, 1998). however the smell of the store environment is a field seldom researched in the study of the retail environment. speciality stores such as bakeries, coffee shops and tobacconists have for some time trusted in their aroma to attract consumers and in this way induce them to buy more (bone and ellen, 1994). these days, however, some service providers and store managers have stores with diverse product lines or product lines with no particular odour, who employ aroma consultants to develop customised fragrances for the store (miller, 1993). an example of such a company is atmospherics the first us environmental aroma company whose founder was paul roche. if a consumer walks into the premises of a thomas pink shirtmaker, the gende fragrance of newly laundered, starched linen greets him or her. "line-dried linen" is one of the corporate aromas that atmospherics has developed for businesses over the past five years. atmospherics: the impact of the physical environment atmospherics or in other words, the physical design and decor elements of a particular environment, have an effect not only on clients but also on employees in the retail and organisational context (bitner, 1992). impact on employees the work environment has an influence on employees' satisfaction, productivity and motivation (e.g. becker, 1981; davis, 1984; steele, 1986; sundstrom and altman, 1989; sundstrom and sundstrom, 1986; wineman, 1986). how much influence the physical environment will have, however depends on the nature of the employee's position. odour may improve the work practices of employees. peppermint, vanilla and apple scents may help to counteract tension while a hint of lemon could offset drowsiness which in tum would lead to fewer errors, especially in the case of fairly boring work (director, 1997). impact on clients research on consumer behaviour has traditionally revealed the strong influence of cognitive psychology. the focus has been on the traditional informationprocessing paradigm, and in using this to explain consumers' decision-making processes and the outcome of their decisions (bettman, 1979). it was thus found that the observed store environment could indeed elicit cognitive responses, that might influence clients' opinions about a place and the people and products encountered there. therefore, environment can serve as a form of non-verbal communication (broadbent, bunks and jencks, 1980; rappoport, 1982). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 336 sajems ns vol 3 (2000) no 2 the observed store environment also elicits emotional responses which influence consumer behaviour. an individual's mood may affect his or her behaviour without interfering with other cognitive processes (clark, 1982; clark and isen, 1982). in an investigation into people's emotional responses to environment, mehrabian, russel and their colleagues found that these responses could be classified into two categories, namely pleasure-non-pleasure (affect) and degree of excitation or arousal. the principles of affect and excitation are elements of environmental psychology. affect is defined as a general descriptor of a positive or negative state of emotion or feeling (spangenberg, crowley and henderson, 1996). therefore the most common theoretical basis for the study of the effect of odour, more specifically on the shopping environment, also derives from the field of environmental psychology. enveronmentalpsychology veitch and arkkelin (1995) defme env,ironmental psychology as a multidisciplinary behavioural science, both basic and applied in orientation, whose focus areas are the systematic interrelationship between the physical and social environments as well as individual human behaviour and experience. environmental psychology endorses the stimulus-organism-response [s-o-r] paradigm, which states that the environment is a stimulus[s] with clues that jointly affect one's internal evaluation[o], which in turn causes approach/avoidance responses[r). thus the characteristics of an environment jointly determine the degree of pleasure/affect or excitation in the observer. affect describes the positive or negative emotional status of a person. excitation or arousal is a psychological condition which can be determined directly through verbal reporting. according to environmental psychology, one of the constructs of excitation is load. a high-load pleasant or unpleasant environment will lead to approach or avoidance behaviour, but an environment with a low loading is not activatory enough to motivate any measurable behaviour. in a study by sherman, mathur and smith (1997), the authors attempted to reinterpret the conceptualisation of store atmosphere, client emotions and purchasing behaviour in terms of stimulus-organism-response in a way consistent with the approach taken in environmental psychology. to this end, they used a causal model which can be briefly described as follows below. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 337 tbe model: stimujus-organism-response • stimulus: in the model, the stimulus is the store atmosphere, as it affects the mood of the consumer. baker (1986) divides the elements of the store environment into three categories: social factors, design factors and environmental ("ambient") factors. "ambient" factors are the focus of interest in this study, and they comprise the non-visual elements of the store environment, such as odour and lighting. • organism: this refers here to the internal processes that intervene between the stimulus and fmal behaviour, and consists of perceptual, psychological, emotional and cognitive activities. it is expected that the elements of the store atmosphere will have a positive influence on the components of the consumer's emotional state (affect and excitation). • response: this is the consumer's final response or reaction, and includes psychological reactions such as attitudes as well as behavioural responses. consumers who are in a good mood continuously display higher approach responses, whereas those who reveal more negative affect in their behaviour display greater avoidance (donovan and rossiter, 1982). figure 1 sor model of retail purcbasing bebaviour stimulus organism response source: sherman, e.; mathur, a. and smith, rb. (1997). "store environment and consumer purchase behavior: mediating role of consumer emotions", psychology & marketing, 14(4): 361-378. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 338 sajems ns vol 3 (2000) no 2 approach responses include al1 positive behaviour which can be oriented to a specific place, for example (donovan and rossiter, 1982): • enjoyment of shopping and the store environment • returning (to the store) • attraction to and friendliness towards others • spending money • time spent in the store ("browsing") • exploring the store avoidance responses reflect the opposite, in other words, a desire not to linger, not to explore, work or associate. conceptual and empirical studies support the notion that there is a systematic covariance between the store environment and consumers' affective behaviour (gardner, 1985; darden and babin, 1994). consumers who are in a good mood continuously reveal greater approach responses; by contrast, those who experience a negative affective reaction display more avoidance responses. retailers' interests should however extend further than purchases. with the increasing emphasis being placed on building up relationships and retaining existing clients, satisfaction with the retailer is an extremely important consideration because it determines future behaviour. hence the next theme concerns consumer satisfaction and expenditure. influence of consumer mood on expenditure and satisfaction several rationa1es support a relationship between positive emotions and purchasing. firstly, people who are in a positive mood have a greater tendency to reach a decision (isen, 1989). experiments indicate that subjects who report a positive mood take less time to make consumer decisions. visitors to shopping centres, who had experimentally induced positive moods, tended to make a greater number of purchases than those whose mood had not been altered (isen, 1987). moreover, there is an intuitive rationale surrounding reciprocal treatment if the buyers' mood is improved by visiting a shopping environment, they might wish to reciprocate the favour bv purchasing something. similarly, people who are in a bad mood when visiting a store might not wish to reward the retailer by doing any business there. the study by babin and darden (1996) used a measure that included actual expenditure behaviour as well as supporting a direct association between consumers' shopping mood and satisfaction. they found a significant positive r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 339 relationship between positive mood and purchasing behaviour. it was determined that a unit increase in the positive mood of a consumer could lead to a 12 per cent increase in expenditure. but an increase in a negative mood did not lead to a noteworthy decrease in expenditure. the study also suggests that a negative mood among shoppers, even though it does not affect expenditure, does diminish satisfaction significantly more than a positive mood enhances satisfaction. figure 2 summarises the implications for patronage behaviour. figure 2 expected outcomes of changes in consumers' mood expenditure satisfaction increments in positive mood are associated with are associated with increased expenditure high satisfaction have little effect have the greatest impact on satisfaction increments in negative mood source: babin, b.1. and darden, w.r (1996). "good and bad shopping vibes: spending and patronage satisfaction", journal of business research, 35: 201-6. retailers who make substantial investments in the physical environment of the store, in an effort to improve consumers' moods and avoid negative moods, should feel encouraged by these findings. although positive moods do increase expenditure to some extent, the real reward is the greater consumer satisfaction that these moods engender. this research appears to indicate that environmental factors really do influence the consumer in various ways. since odour is one of the most easily manipulated and most common of factors, a background to this instrument of atmospherics is next considered. smell as an instrument of atmospherics retailers should carefully plan the odours that they use, according to the composition of their target market. the following background about this instrument may provide some insight into this. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 340 sajems ns vol 3 (2000) no 2 dimensions of smell most research distinguishes between odours on the basis of three different but not necessarily independent dimensions, namely: (i) affective quality of the odour (how pleasant it is); (2) nature of excitation (how likely it is to elicit a psychological response); and (3) intensity (how strong it is). the affective dimension of odour dominates perceptions of smell in existing research (engen, 1982; moskowitz, 1979; schiffinan, 1979; woskow, 1968). this is understandable because smell is processed in the limbic system of the brain, which is the centre of emotion (leukel, 1976; restak, 1984). the arousal dimension of smell has been proved by the effect of odours on both eeg (electroencephalogram) and respiratory patterns (long and schwarz, 1988; schwarz et al., 1986). the intensity dimension of odours has a negative association with evaluations of odours, meaning that as an odour becomes stronger, reactions to it become increasingly negative (doty et al., 1978; henion, 1971; richardson and zucco, 1989). this is generally valid for all odours. however, it is suggested that the relation between the intensity of the odour and the affective reactions depends on how pleasant the odour is. every stimulus has an optimum level of preference (spangenberg, crowley and henderson, 1996). research by mathur and smith (1997) indicates that the pleasantness of the store has a positive effect on the amount of money customers spend in that store, and on how much they like the store. the excitation element has a positive impact on the amount of money spent in the store, the time spent there and the number of items bought in the store. effect or smell most of the research on the effect of smell focuses on reactions to nonatmospheric smells, in other words localised smells for example in a flask or on a card, on a person, a product or an advertisement. it was found that evaluations of people and objects are more positive when they are scented. there is also a more positive relation when the aroma and the product are congruent (bone and jantrania, 1992). the effect of environmental odour in the marketing environment is a subject on which very few studies have been done so far. two studies on the effect of environmental odour on product choice have produced useful fmdings. in one study, participants undertook a catalogue shopping task in scented and unscented rooms. it was found that the participants spent more time on the task r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 341 in the presence of a pleasant environmental odour that without it (bone and ellen, 1994). in the other study a computer-aided experiment on product choice was done in differently scented rooms. in that experiment, the correspondence of odour and product category did influence various information-processing measures (mitchel, kahn and knaso, 1995). tbe influence of environmental smell 00 perception of time spangenberg, crowley and henderson (1996) shed some light on the subject in a study which noted the use of non-repulsive odour versus no odour, and the effect of these elements on approach/avoidance behaviour in a retail environment. it was found that the participants who were exposed to the scented environment perceived that they had spent less time in the store than did the people in the unscented environment the participants who were exposed to the no-odour conditions furthermore thought that they had spent far more time in the store than they actually had. these fmdings suggest that environmental odour may lead to improved subjective experiences on the part of retail clients. the time that consumers spend in investigating trade goods, waiting in queues and for assistance, could be subjectively shortened by using environmental odour in the store environment. conclusion the findings discussed in this paper provide guidelines and opportunity for managers of retailer stores to utilise the advantages of scenting the environment with pleasant or neutral odours. the message is clear: the presence of a pleasant aroma in a store is a relatively inexpensive and an effective way of improving consumers' reactions to the store and its trade goods. in addition the aroma encourages a positive feeling and satisfaction which help to establish long-term consumer relationships. references babin, rj. and darden, w.r. (1996) "good and bad shopping vibes: spending and patronage satisfaction", journal of business research, 35: 201-6. 2 babin, b.j.; darden, w.r. and babin, l.a. (1996) "positive and negative consumer emotions: affect or artifact", journal of business research. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 342 sajems ns vol 3 (2000) no 2 3 baker. j. (1986) "the role of environment in marketing services: the consumer perspective", the services challenge: integrating for competitive advantage, 79-84. 4 bitner, mj. (1992) "servicescapes: the impact of physical surroundings on customers and employees", journal of marketing. 56(april): 57-71. 5 bone, p.f. and swati, j. (1992) "olfaction as a cue for product quality", marketing letters, 3(july): 289-96. 6 darden, w.r and babin, b.j. (1994) "exploring the concept of affective quality: expanding the concept of retail personality", journal of business research, 29(februaiy): 101-10. 7 donovan, r and rossiter, j. (1982) "store atmosphere: an environmental psychology approach", journal of retailing, 58(spring): 34-57 8 doty, rl.; orndorff, m.m.; leyden, j. and kligman, a. (1978) "communication of gender from human auxiliary odors: relationship to perceived intensity and hedonicity", behavioral and neural biology, 23(july): 373-80. 9 engen, t. (1982) the perception of odors, new york: academic press. 10 gardner. m.p. (1985) "mood states and consumer behaviour: a critical review", journal of consumer research. 12(december): 218300. 11 henion, k..e. (1971) "odor pleasantness and intensity: a single dimension", journal of experimental psychology, 90(2): 275-9. 12 isen, a.m. (1987) "positive affect, cognitive processes, and social behavior", advances in experimental social psychology, 203-51. 13 kirk-smith, m.d. and booth, d.a. {l987) "chemoreception in human behavior: experimental analysis of the social effects of fragrances", chemical senses, 12(1): 159-66. 14 leukel, f. (1976) introduction to physiological psychology, st louis, mo: c.v. mosby 15 levin, j.m. and mcburney, d.h. (1986) "the role of olfaction in social perception and behavior", physical appearance stigma, and social behavior: the ontario symposium, 3: 179-217. 16 levy and weitz (1998) retailing management (3rd ed.) mcgrawhill companies inc. :usa 17 lorig, t.s. and schwartz, g.e. (1988) "brain and odor: 1. alteration of human eeg by odor administration", psychobiology, 16(3): 281-4. 18 mitchell, 0.1.; kahn, b.e. and knasko, s.c. (1995) "there's something in the air: effects of ambient odor on consumer decision making", journal of consumer research, 22(september): 229-38. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 343 19 moskowitz, h.r. (1979) "mind, body, and pleasure: an analysis of factors which influence sensory hedonics", preference behaviour and chemoreception: 131-47. 20 restak, r. (1984) the brain, toronto: bantam books 21 richardson, j.t.e. and gesualoo, m.z. (1989) "cognition and olfaction: a review", psychological bulletin, 105(3): 352-60. 22 schiffman, s.s. (1979) "preference: a multidimensional concept", preference behaviour and chemoreceptio: 63·81. 23 sherman, e.; mathur, a. and smith, r.b. (1997) "store environment and consumer purchase behavior: mediating role of consumer emotions", psychology & marketing, 14(4): 361-78. 24 spangenberg, e.r.; crowley, a.e. and henderson, p.w. (1996) "improving the store environment: do olfactory cues affect evaluations and behaviors?", journal of marketing, 60(april): 67-80. 25 woskow, m.h. (1968) "multidimensional scaling of odors," in theories of odors and odor measurement, n. tanyolac, (ed.) bebek, istanbul: robert college research center: 147-91. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 on the emergence institutions d mahadea of firms and department of economics, university of natal, pietermaritzburg abstract 109 sick organisations and firms are formed by people and entrepreneurs. firms can become sick just as people do. not all firms live forever. this paper examines the emergence of "sick" institutions. organisations can become unhealthy when there is a mismatch between goods and services they produce and the external environment in which they operate. survival and fitness of an organisation depend on its ability to respond and adapt cost-effectively to the changing environment. entrepreneurship, n-achievement and productivity of individuals are critical to an organisation's health. a thorough diagnostic framework of symptoms of organisational ills is required before prescribing any therapy, to bring about a healthy organisation. the future belongs to healthy firms, with adaptable strategies and resources that optimally fit the changing environment. jel d 21 introduction change is rapidly taking place in the domestic and the world economy. south africa has been successful in its political transformation process. to a certain extent, the political change has a parallel process at an organisational level. in this high-tech era of globalisation, firms have to adapt fast to a changing environment if they are to remain competitive. previously practised inwardlooking strategies may not work in the present situation. many firms in south africa and elsewhere are downsizing, re-engineering, retrenching, and adopting innovative strategies in response to changing economic, social, political and technological circumstances. on the other hand, these changes are providing scope for the birth of small entrepreneurial firms, although perhaps different from the transaction cost framework. at the same time, hazard rates among small firms are increasing. at a time when trade and tariff barriers are being dismantled globally, south african firms are being burdened with more levies, regulations, labour laws and trade union actions. all these drive up business costs, impact negatively on enterprise competitiveness, causing job losses and threatening the health of many firms. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 110 sajems ns vol 3 (2000) no 1 the changing environment poses formidable challenges to organisational leaders in their quest for the efficient production of goods and services. clearly many of the old organisational constructs may become casualties of this change if they do not innovate or transform to meet the new economic order. accordingly, entrepreneurs, managers and workers have to learn fast and implement new ways of doing things if their firms are to thrive on the challenges of tomorrow. otherwise, firms are prone to organisational "sickness"; this is more likely if the firm's strategies and internal systems are not apt to meeting market needs in a cost-effective manner. organisational sickness may be interpreted in diverse ways. a firm is often unhealthy because of unethical behaviour by the people working in it, due to weaknesses in the structures of the organisation, such as layers of management, decision-making procedures and control systems. however, for the purpose of this paper, an organisation is said to be "sick", when there is a mismatch between its internal system, or the goods and services it produces, and the broader environment in which it operates. this paper presents a somewhat fragmented analysis of the emergence of firms and sick institutions. it consists of three parts; the first gives the theoretical approach underpinning the emergence of the firm and its organisational structure; the second examines some characteristics of sick organisations, and some "cures" are suggested in the third and last section. the firm and its emergence a firm may be considered a planning unit for the conversion of inputs into output of goods and services. in an organizational framework, the word "firm" is used broadly and includes more than just entities producing marketable goods and services. as social institutions, firms have evolved to take various forms; these include single traders, partnerships, companies, non-profit organisations, public sector services and non-government organisations (ngos). the formation of a firm can be regarded as the gathering by the entrepreneur of signatures to an agreement binding members together by self-interest. the firm appears as a direct consequence of problem-solving activities by entrepreneurs (casson, 1991). ronald coase (1964: 339) defines the firm as "the system of relationships which comes into existence when the direction of resources is dependent on an entrepreneur". this system of relationships is based on the cooperation between factors of production and the contractual agent, the entrepreneur. owners of resources co-operate within the firm through bilateral contracts between each resource owner and the contractual agent. the contracts are so framed as to r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 iii reduce the transactions costs associated with exchange in the market (ricketts, 1994: 72), extending the work ofcoase, williamson (1985) argues that institutions are the mechanisms which govern transactions, and a transaction occurs "when a good or service is transferred across a technologically separable interface" (1985: 1). according to north (1 990a: 4) institutions are "a framework within which human interaction takes place". more specifically, "institutions are the humanly devised constraints that structure human interaction" (north, 1994: 360). they encompass formal rules (legal and regulatory environment), informal constraints (norms of behaviour, conventions and codes of conduct) and their enforcement characteristics, that guide human behaviour. the firm is an institution because transactions between departments or people represent interaction across a separable interface. goal orientation is basic to all economic activities of the firm. according to the neoclassical view, the objective of the firm is to maximise profits. in the neoclassical framework, it is assumed that the firm operates in an environment of perfect competition, there is no transaction costs (implicitly zero) and no agency problem. owners of the firm are assumed to possess perfect knowledge about prices and technologies, and all owners are fully competent in their pursuit of profit. profits are the means of survival of the firm. the selection criteria of evolutionary processes may account for the survival of profitable firms and the failure of unprofitable ones (demsetz, 1997: 67). in the context of competitive equilibrium, an actual firm will be the efficient firm when it is operating at the minimum point of its average cost. operating at a level below the minimum long run average cost implies that there are possibilities for reaping increasing returns to scale. beyond the minimum efficient scale, costs tend to rise. if the firm does nothing about controlling its costs and monitoring its activities, then initial signs of inertia and sickness start developing within the organisation. on this view, costs are determined not purely by the nature of the production function or technology, but by the effectiveness of the firm in decision-making. within the firm, resources move according to management direction and not necessarily in terms of price signals. lucas (1978) associates a firm with a manager, and posits decreasing effectiveness of management, as the scale of production is increased. in this institutional context, if there cannot be a replication of the entrepreneurial or managerial input, the quality of decision-making would suffer, and this can impact adversely on the overall health and functioning, as well as the size, of the organisation. some of the organisational inputs are fixed, at least in the short term, especially entrepreneurial talents. in equilibrium, firms with r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 112 sajems ns vol 3 (2000) no 1 superior talents will be larger than those with inferior ones. at individual enterprise level, the greater the talents of the entrepreneur, the greater is the size of the firm that he manages. organisational efficiency and efficient organisation size can be improved by increasing flexible division of labour, and making more effective use of information technology (piore & sabbel, 1994). organisational weaknesses may be minimised by changing or enlarging the pool of entrepreneurial talents. at times replacing the chief executive manager may be the solution to organisation inefficiency. bringing in more members expands the pool of resources, and provides scope for expanding the size of the firm. the expansion of firm size inevitably brings about additional bureaucracy and possibly some loss of control (williamson, 1985). in prescott and visscher (1980) the expansion of the firm, by changing a fixed organisational input that is not easy to replicate, exacerbates the inefficiencies arising from imperfect knowledge. holstrom (1989: 320) asserts that "to note that bureaucracy is viewed as an organisational disease is equally accurate". labour produces goods and services as a team (alchian & demsetz, 1972), although with team production it is difficult to separate the marginal product of each input. nevertheless. technology is such that efficient production involves teamwork. the management function then requires the monitoring of individual performances to identify slacking and to enforce an appropriate disciplinary system to deal with the slackers. without proper control of team production, a potential "free rider" problem exists, as an individual worker then . has the incentive to shirk. the monitor observes the behaviour and relations between the firm and workers. he has the power to discipline resource owners by terminating their contracts and hiring replacements. all this entails internal organisational costs. but then who monitors the monitor? it is the residual claimant, the "natural person". the firm therefore combines two cost saving mechanisms and one cost raising mechanism. by avoiding market transactions the firm saves on transaction costs. transaction costs transaction costs are defined by arrow (1969: 48) as "the costs of running the economic system". douglass north (1994:361) describes transaction costs as "the costs of specifying what is being exchanged and of enforcing the consequent agreements." the building block of transaction costs is the transaction itself. an agreement between two parties. such costs contain two main elements: information costs and contract costs, i.e. the cost of specifying what is being traded plus the cost of enforcing the contract. transaction costs can be avoided if economic coordination is undertaken within the firm. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no i 113 however, the firm itself would then have to undertake the task of arranging and policing, that would otherwise have been performed by the market. again costs (management) are involved for the firm which are the equivalent of transaction costs involved in using the market by taking advantage of specialisation and team cooperation, the firm gains a cost reducing method of production. by having an administrative structure to monitor performance, punish slackers and reward hard workers, the firm's costs increase. but as long as these costs are more than compensated for by cost-effectiveness gains, it pays to create the firm (coase, 1964). thus, the firm emerges as a means of economising on transaction costs. firms choose to perform activities internally rather than to purchase them in the market, when the costs of monitoring internal efficiency are less than the transaction costs of using markets. from this perspective, firms exist because producing for others, as compared to self-sufficiency, is efficient due to economies of scale, specialised activity and the prevalence of low transaction costs (demsetz, 1997: 11). in the transaction cost theory, if the transaction costs become lower, activities previously undertaken within firms are then performed in markets. should transaction costs tum out to be prohibitively high, the market is abandoned in favour of intrafirm allocation of resources. managed ailocation of resources within the firm becomes viable if the cost of coordinating resources through market arrangements (transaction costs) exceeds the cost of managing them within the firm (coase, 1964). in the coasian literature, a firm is viewed as an alternative to the market, as a resource allocating mechanism. in order to minimise transaction costs different types of governance are required for different types of transactions (williamson, 1975). transactions for which the market is a highly costly form of governance are withdrawn from market competition and internalised in the firm. in other words, administrative governance supercedes market allocation. the fact that market transactions involve costs does not necessarily imply that all market transacting will be superceded, because firm coordination also entails costs. depending on the nature of business, replacing market transacting may involve cost saving that is not of a sufficient magnitude to compensate for internal organisational costs. further, the existence of decreasing returns to the entrepreneurial function will imply that cost savings may decline as the firm expands. thus, coase's argument of "substitution on the margin" indicates that the equilibrium of the firm, or the boundary between the firm and the market, is determined by the condition that the marginal cost of firm coordination being equal to the marginal cost of market transaction. efficiency in the form of economising on transaction costs is an important cause of the emergence of firms. however, decision-makers often become lax over r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 114 sajems ns vol 3 (2000) no i time, especially when there is no proper monitoring, accountability and control. costs escalate and so-called x-inefficiency develops (leibenstein, 1987). on the governance side, bureaucratic costs increase and there is no organisational innovation, as rigidities and conflicts in labour relations lead to the firm disintegrating vertically. therefore, the efficient size of the firm is determined where the marginal intrafirm transaction cost equals the market transaction cost (coase, 1964). an important question is: what makes transactions costly? wiliamson (1985) suggests that three transaction characteristics are critical: frequency, uncertainty and asset specificity (as measured by the foregone economic benefits of discontinuing a relationship). each attribute is claimed to be positively related to the adoption of internal governance. as asset specificity increases, transaction costs increase too, and so do the potential benefits of vertical integration. when the level of specialised assets is high, each party is more at risk given that he must engage in more and more pre-transaction planning, during the transaction monitoring, and posttransaction enforcement costs that may become prohibitive (kreps, 1994). holmstrom and roberts (1998) argue that higher levels of uncertainty and higher degrees of asset specificity, especially when they occur together, result in a more complex contracting environment and a greater need for adjustment after commitments have been made. accordingly, a hierarchical relationship, in which one party has formal control over both sides of the transaction, is presumed to be easier in resolving potential disputes than does a market relationship. the frequency of a transaction also matters because the more often it takes place, the more widely spread are the fixed costs of establishing a non-market governance system (holmstrom and roberts, 1998). williamson (1975: 20) states that "it is always the joining of human with environment factors, not either taken by itself, that poses transactional problems". opportunism generates rent-seeking behaviour on the part of untrustworthy individuals, pursuing self-interest in deceitful ways. transactions and exchange then involve costly bargaining and monitoring. a high degree of trust is required if these rents do not result in squabbles. in order to limit the extent of opportunism, firms are likely to integrate (internalise) the transaction, where opportunism is controlled by fiat (williamson, 1975). bounded rationality creates problems (i.e. costs) as individuals' ability to seek optimising solutions to complex problems under uncertainty is limited. indeed, one party to a transaction may have more information than another, and may not adequately deal with contingencies because it may be costly to anticipate them or include provisions for dealing with them within a contract. after all, no r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 115 contract can spell out every contingency. all complex contracts are then unavoidably incomplete. in these circumstances, internal organisation in the administration of transactions may have advantages over market transacting. in sum, when the interaction of human and environment factors create substantial costs in market exchanges, "internal organisations" (firms) will emerge as an alternative to markets in order to economise on transaction costs. organisation within firms for a small firm, even a non-hierarchical, internal structure of planning and authority in the administration of transactions may be efficient. the governance mechanism within the small firm can be made up by peer groups (members who perform similar or integrated tasks within the organisation). the small peer-group organisation has some advantages over the market in certain circumstances, in that each member is firmly committed to the firm, making limited demands on its indivisible assets, thereby lowering unit costs and enhancing associational gains. monitoring in peer groups is informal. the group can handle the problems of adverse selection and moral hazards, given that it can tightly monitor free-riders and shirkers, and rigorously screen potential members (williamson, 1985). however, an optimal internal structure does not remain optimal indefinitely. as the firm evolves and its size increases, synergies develop, more complex tasks are tackled, and peer groups are usually replaced by simple hierarchies. as the complexity of business increases further, simple hierarchies may have to be linked up with more sophisticated (multistage) structures and monitoring systems. alchian and demsetz (1972) add that a hierarchical internal structure will evolve in response to market failures, which often occur in the presence of technological non-separability. co-operative relations in a firm cannot be maintained when opportunism is rampant and trust lacking. it is the crucial role of the organisational leaders to engineer a trusting environment so that both employers and employees act co-operatively rather than opportunistically. the provision of appropriate incentives and efficiency wages (akerlof & yellen, 1986; gibbons, 1998) as well as the adoption of productivity measurement and enhancement systems may help to generate an efficient internal administrative structure that minimises cost and enhances profit or service delivery (holmstrom & milgrom, 1994). under stable circumstances, trust engendered by repeated dealing might be a cost-minimising response, favourable to the development of the firm. the emergence of a relationship of coordination and trust that sustains cooperative arrangements may have a cultural dimension. a strong organisational r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 116 sajems ns vol 3 (2000) no 1 culture which encourages, for example, high degree of moral commitment among the members of a firm will make members more trustworthy. this reduces the need for supervision and lowers transaction costs. a reduction in transaction costs in turn becomes a source of competitive advantage that influences the economic performance of the firm (peters & waterman, 1982; casson, 1991; gibbons, 1998). a change in organisational culture is difficult to imitate in the short term. this may evolve over time with the development of the firm (nelson & winter, 1982). in the absence of a strong work ethic, individuals might show little or no personal loyalty to the firm and might 'legitimise' certain behaviour that raises agency costs, making the firm uncompetitive. but firms with a diversified, technical and moral culture encourage pragmatic incremental "tinkering" with both high and low levels entrepreneurship (casson, 1991). taking an evolutionary approach to the firm, nelson and winter (1982) argue that successful routines will lead a firm to expand into areas where the success can be replicated with new knowledge. chandler (1992) and jovanovic (1982) argue that the firm learns and grows with the benefit of experience. such growth is said to driven much less by the desire to reduce transactions or agency costs, but more by the wish to utilise competitive advantages accumulated through learning processes. organisational sickness firms and organisations consist of people, bound together by a common purpose to achieve certain objectives. douglass north (1994) in his nobel memorial lecture in economics stated that organisations include political (for instance, political parties or city councils), economic (firms, trade unions, family farms and cooperatives), social (church, clubs and athletic associations) and educational bodies (universities, schools, and vocational training centres). firms can become sick in much the same way as people do. the sickness of organisations in some ways reflects the behavioural illness of people, especially the key role players and entrepreneurs. people get old, tired, and slow down, usually becoming far less effective than when they were young. organisations can become unhealthy through a mismatch of their internal systems and external environment, through competition, legislation, economic conditions and traumatic circumstances. using a comparison with biology, marshall thought that not all firms could live forever. they are "organic" entities. entrepreneurs can identify opportunities, develop strategies, marshall resources, take initiatives and bring a firm into being. they can nourish it to adulthood. soon enough entrepreneurs die. succeeding managers are frequently less talented. new firms, fertilized by other, perhaps younger, entrepreneurs tend to emerge and flourish. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no i 117 nature still presses on the private business by limiting the length of the life of the original founders, and by limiting even more narrowly that part of their lives in which their faculties retain full vigour. and so, after a while, the guidance of the business falls into hands of people with less energy and less creative genius, if not with less active interest in its prosperity (marshall, 1961: 316). marshall examined the life-cycle of the firm by comparing it to trees in a forest. as saplings the trees compete for light and air against their larger neighbours and many stagnate, fail to develop and die. some small trees would however eventually grow and replace the larger trees, with the forest constantly evolving and changing. the more successful ones grow rapidly until they dominate the environment. their years of domination are, however, numbered, and the trees eventually lose vitality and are replaced by younger and more vigorous ones. the analogy may be applied to business firms. for the existing firms, organisational death may happen through failures, acquisitions and mergers. the exit rate may be particularly high for small and young small firms with limited resources. unlike the neoclassical theory, the firm is not a "black box". it operates in the real world of imperfect information. the firm needs information about the existence and attributes of rival products, and the main factors influencing actual and potential demand. the neoclassical result of perfectly healthy firms might only be obtained if transactions were costless. but in reality it is costly to transact business. decision makers have to search for the necessary information themselves. individuals' ability to handle complex information is limited. thus, information asymmetry (impacted information), bounded rationality and uncertainty, all mean that the perfectly efficient firm of the traditional theory is almost non-existent. however, in the real world, there are many firms that are efficient, fit and healthy. they exist to achieve objectives, and their entrepreneurs and chief executive officers, as top decision-makers, are determined to remain healthy to meet the continuing realities and challenges of the environment. the market is in a state of continuous change, and this brings about various opportunities and threats. firms that cannot meet the challenges of changing market conditions, or are too slow to adapt to changes, are likely to be overtaken by their more dynamic competitors, and might not survive in the long run. for organisations to keep their heads in the sand, not sensing the "atmospheric characteristics", both internal and external, is a sure way to illhealth and eventual demise. keeping up with internal and external pressures is the key element to organisational survival. survival and fitness depend on the adaptability of the firm and its ability to match its strategy to a changing world. this certainly requires a pattern of behaviour among the internal resources, input suppliers and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 118 sajems ns vol 3 (2000) no 1 entrepreneurs that is congruent with the overall mission of the firm. of centra) importance to the continued health of the firm is the quality of its leadership and entrepreneurship, or what penrose (1995) described as managerial and entrepreneurial versatility. organisations that face little competition can get fat, sluggish, lazy, and selfindulgent. this may be a symptom of a malady. the solution should be prevention, not to wait for a crisis to apply the cure. most markets are contestable in modem times (baumol, 1982). the market does not tolerate laziness. success achieved today, even through a degree of monopoly power, is no guarantee of success tomorrow. in this turbulent "information age", domestic and external competition imply that firms must take decisions fast. they must be flexible and responsive to customers, prepared to anticipate threats and opportunities, and consistently improve the quality of products and processes. competition should induce organisations to learn how to survive. learning entails developing a structure by which to interpret the signals received by the senses (north, 1994). in the long run, survival depends on developing superior core competencies in the niche fields in which the firm operates. to maintain success, the firm has to remain pro-active, always put the customer first and be innovative. any existing organisation goes down fast if it does not innovate. firms that fail to meet the changing needs of their consumers in a creative and cost-effective manner will not survive, because customers will go elsewhere. excellent customer service should be the guiding principle of the firm's operation; ultimately the consumer is sovereign. the sign of a healthy business is a satisfied customer. as drucker (1992: 230) puts it "the single most important thing to remember about any enterprise is that results exist only on the outside ..... inside an enterprise, there are only costs." some characteristics of unhealthy organisations there is a lack of fit between the firm's products and its market environment, or a poor "match quality" between the firm and its managers. 2 there is little personal commitment and investment in organisational objectives, except at top management level. "without such commitment, there is no enterprise, there is only a mob" (drucker, 1992: 229). the public expect prompt and efficient service delivery from workers or civil servants, but the latter attribute weaknesses to failures of service delivery management. management often blame workers for a lack of respect or commitment that is not in the workers' own career interests. the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no i 119 organisational objectives then range, or perhaps drift, from the "official" goals to those of institutional practice. 3 there is a conflict of interest between the principals and agents (side agency theory). people are interested in receiving income with consumption on the job, in shirking and excessive risk aversion. costs escalate as more units are hired, partly because of resistance, militant union action and inflexible labour legislation. real costs of the firm escalate as there might be little scope for utilizing labour-saving technical progress (baumol's cost disease). 4 individuals in the firm perceive that things are going wtong. but they do not care to do anything about the problems, possibly because of wtongly perceived self-interest, until the firm becomes subject to some form of external investigation. 5 management tries to get things done. but there is a lack of adequate communication or wrong information is transmitted. departments are starved of resources. out of individuals' greed and jealousy, decisions that have to go through the middle management filter, tend to be bottlenecked or sabotaged. decisions are made with inadequate information or advice, giving rise to opportunism. 6 there is a lack of transparency. mistakes and problems are not handled in an effective way. orders, policies and procedures are not followed. individuals may be leaming but the organisation is not. 7 people resist change when there is a need to cooperate and innovate. the organisation is too bureaucratic and slow to act. 8 systems of control and discipline become porous and almost defunct. incentives and opportunities exist for contractual non-performance. 9 for certain operations, market transactions are bypassed in favour of inhouse activities even though market transactions may be more costeffective and efficient than internalisation (bounded rationality and rentseeking). 10 there is a lack of team spirit in planning, controlling, leading, evaluating, organising and decision-making. ii rigorous financial, customer-focused and other performance criteria are not applied. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 120 sajems ns vol 3 (2000) no 1 a private firm will not survive if its activities do not generate enough revenue to cover its costs. a non-profit organisation, however, may somehow survive in the short term through external funding, possibly from the public sector or outside donor agencies. even ngos are now under pressure to account for their continued viability, in terms of cost effectiveness and maximum delivered value to customer or community service in a transparent manner. as major sources of funding dry up, and as actual and potential customers desert the firm for its innovative competitors' products, the outlook for the continued existence of the organisation becomes bleak. in the absence of "surgery", the firm goes through an inert or slack phase (leibenstein, 1987) before meeting its eventual demise in the long run, through either closure or merger/acquisition. however, the occurrence of a catalytic event provides scope for alert entrepreneurs to seize market gaps and spring into action, through refining the efficiency and effectiveness of existing organisations and creating new organisations. treatment as with individuals, firms have to live in and adapt to a rapidly changing environment. like people, organisations have to think how they can remain on the pathway of a healthy existence. various symptoms of illness have to be analysed within a diagnostic framework before any therapy can be applied to a firm, to be healthy and successful. as purposeful institutions, all firms have certain objectives to achieve, underpinned by mission statements and strategies. all these function through people. skillful use of strategic planning and control is vital for a healthy enterprise. sanctions or punishment should exist for irresponsible managerial behaviour. as every organisation is different; there might not be a common cure for each organisational problem. however, the nature of the sickness would determine the type of remedies to be applied. information is required to decide whether or not a firm is functioning well. in this regard, there should be trust and communication among different units of the firm so that all role players can keep in touch with what is going on in the firm and around it. members should understand and appreciate the operational and strategic thinking underlying the short and long term goals of the firm. financial criteria (such as profits, rate of return on investment, cash flows, growth of sales revenue), socio-economic targets (age of the firm, community involvement, social responsibility, average cost, employment and output growth), and behavioural norms (strikes, labour turnover, job satisfaction and morale) should represent the pulse of a firm. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vo13 (2000) no 1 121 the organisation has to unleash entrepreneurship and nourish an entrepreneurial culture at all levels within it. this requires management's commitment to invest in new technologies and human capital, to equip their employees with the necessary knowledge and analytical skills (bottom-up empowerment and collective learning), to improvise genuine self-renewal, without neglecting improvements to the efficient delivery of existing product offerings. organisational learning is an essential component of entrepreneurial selfrenewal. self-renewal is essential for tomorrow. accordingly, the firm has to fine-tune existing products and seek opportunities for new product developments in line with its core competencies. furthermore, it has to seek new ways of adding value and creating additional satisfaction for customers, to adapt more effectively to the changing environment. the firm has to match external opportunities to internal resources. what makes the difference between survival and extinction, is the ability of a firm to vary its responses to the market (mccrimmon, 1995). entrepreneurs and the management are responsible for the condition of health of their organisations. they need to constantly exercise pro-active measures, new ideas, risk taking, experimentation, feedback and adaptation on the basis of what succeeds or fails in the market. the firm needs a structure that sustains organisation development. in such an environment, employees are to be motivated to think and act as entrepreneurs. management should offer incentive structures and a value system that encourage individuals to make a wholehearted response to customer needs (gibbons, 1998). trustworthy relationships should be built between employees and managers. when leaders provide opportunities for people to express their potential at work, organisations become productive and healthy. productivity is a means to health for most people and organisations (hall and maritz, 1997). in addition, the firm should build on its strengths and develop strategic networks that reflect market orientation. adequate finance is a necessary but not sufficient condition for the continued health of an enterprise, especially small firms. as marshall states (1961: 311) "ability always finds the necessary capital"; and penrose (1995: 39) adds that .. there is a relation between entrepreneurial ability and the finance a firm can attract". the achievement motivation (n-ach) level of individuals are equally vital for enhanced enterprise effectiveness and economic prosperity (mcclelland, 1961). mcclelland associates high n-ach with personal effort, responsibility for solving problems and attaining goals, seeking concrete feedback on and information how to improve performance, capacity to plan ahead and be aware of the passage of time, and interest in excellence for its own sake. the n-ach levels of subjects can be aroused or augmented by appropriate training. individuals should be exposed to specific training in n-ach, for it r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 122 sajems ns vo13 (2000) no i impacts significantly on enhanced entrepreneurial effectiveness and organisational performance (boschoff and boer, 1998). conclusion the emergence of firms and different organisational structures are underpinned by efficiency considerations, in the form of coasian transaction costs economlsmg. the resultant internal structures may change from simple governance to hierarchies as firms' activities become more complex. firms are formed by entrepreneurs and people. organisations can become sick, just as people do. different firms may show different symptoms and might be afflicted by different ills. the behavioural sicknesses of firms may reflect the behavioural illnesses of people. the quality of entrepreneurship and management as well as the productivity of the work force are critical elements supporting an organisation's health. a thorough diagnostic framework is, therefore, required to study various "symptoms" and prescribe appropriate treatment to enable a firm to cure its ills and hopefully bring about a healthy, productive and effective organisation. the future belongs to healthy firms. they are the organisations with strategies and resources that optimally fit the environment, adapt and respond quickly to change, and reinvent themselves rapidly to exploit opportunities. healthy firms are better tuned to delivering value to present and future customers. references akerlof, g. a. & yellen, 1. l. (eds.) (1986) efficiency wage models of the labour market, cambridge university press, cambridge. 2 alchian, a. & demsetz, h. (1972) "production, information costs and economic organisation", american economic review, 62: 777-95. 3 arrow, kj. (1969) 'the organisation of economic activity', in the analysis and evaluation of public expenditure: the ppb system, joint economic committee, washington, dc. 4 baumol, w.j. (1982) "contestable markets", american economic review, 72: i-is. 5 boschoff, a.b. & boer, 1.h. (1988) "n-ach training, organizational climate and organizational performance", development southern africa, 5(1): 73-87. 6 casson, m. (1991) the economics of business culture: game theory, transactions costs. and economic performance, clarendon press, oxford. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 123 7 chandler, a.d. (1992) "organisational capabilities and the economic history of the industrial enterprise", journal of economic perspectives, 6 (3): 79-100. 8 coase, r. (1964) "the nature of the finn", economica, 1937,386-405, reprinted in readings in price theory, the american economic association, allen and unwin, new york: 331-51. 9 demsetz, h. (1997) the economics of the business firm, cambridge university press, cambridge. 10 drucker, p.f. (1992) the new realwe, new york, harper and row. 11 gibbons, r. (1998) "incentives in organizations", journal of economic perspectives, 12 (4): 115-32. 12 hall, j. and maritz, f. (1997) "leadership: turning potential into productivity", management today, july: 27-31. 13 holmstrom, b. and milgrom, p. (1994) "the finn as an incentive system", american economic review, 84 (4): 972-91. 14 holmstrom, b. and roberts, j. (1998) "the boundaries of the finn revisited", journal of economic perspectives, 12 (4): 73-94. 15 jovanovic, b. (1982) selection and the evolution of industry. econometrica, 50(4): 649-70. 16 kreps, d.m. (1994): a course in microeconomic theory, harvester wheatsheaf, london. 17 leibenstein, h. (1987a) "x-inefficiency xists reply to an exorcist", american economic review, 68: 203. 18 leibenstein, h. (1987) inside the firm: the inefficiencies of hierarchy, cambridge university press, mass. 19 lucas, r.e. (1978) "on the size distribution of business finns". bell journal of economics, 9: 508-23. 20 marshall, a. (1961) principles of economics, 8th ed., macmillan, new york. 21 mcclelland, d. c. (1961) the achieving society. van nostrand, new york. 22 nelson, r.l. and winter, s.g (1982) an evolutionary theory of economic change, harvard university press, mass. 23 north, d. (l990a) institutions, institutional change and economic peiformanc, cambridge university press, cambridge. 24 north, d. (1994) "economic perfonnance through time", the american economic review, june, 359-68. 25 penrose, e. (1995) the theory of the growth of the firm. oxford university press, oxford. 26 peters, t.j. and waterman, r. h. (1982) in search of excellence. harper and row, new york. 27 peters, t. (1987) thriving on chaos. alfred a knopf, new york. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 124 sajems ns vol 3 (2000) no 1 28 pi ore, m and sabbel, c. (1984) the second industrial divide: prospects for prosperity. basic books, new york. 29 ricketts, m. (1994) the economics of business enterprise, harvester wheatsheaf, london. 30 williamson. o. (1975) markets and hierarchies: analysis and antitrust implications: a study in the economics of internal organisation. free press, new york. 31 williamson, o. (1985) the economic institutions of capitalism: firms, markets relational contracting, collier macmillan, london. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . microsoft word 6 oberholzer sajems 15(4) 2012.doc 416 sajems ns 15 (2012) no 4 the relative importance of financial ratios in creating shareholders’ wealth merwe oberholzer school of accounting sciences, north west university, potchefstoom accepted: july 2012 the purpose of the study is firstly to use data envelopment analysis (dea) to aggregate the overall performance (technical efficiency) of firms to convert scarce resources into outputs that create wealth for shareholders, and secondly, to determine the degree to which this mentioned performance is reflected in a number of profitability and market value ratios. annual financial statement data were used for 55 manufacturing companies listed on the jse limited over a five-year period in a cross-sectional analysis. the study found that return on equity has the most significant relationship with technical efficiency, followed by return on assets. the market value ratios price/earnings and dividend yield have no significant relationship with technical efficiency. the value of this study is that it is the first of its kind where technical efficiency, which aggregated operating, profitability and marketability efficiencies, is used to determine the relative importance of not only the readily available profitability ratios, but also market value ratios. key words: data envelopment analysis, input-oriented, market value ratios, profitability ratios, technical efficiency, variable returns to scale jel: c140, d460, g110 1 background this article deals with the relative importance of different financial ratios, in the context where markets are associated with cycles of bubbles and crashes. a bubble is caused by the deviation between a share’s overpriced market value and its fundamental (intrinsic) value, which is followed by a crash to correct the market in this systematic over-pricing (cox & hobson, 2005:478). the drivers of fundamental value are often difficult to observe (hendershott, hendershott & ward, 2003:993), therefore, it is difficult to detect a bubble (fisher & statman, 2002:56). furthermore, bubbles come into existence as part of the naturally economic cycle or as a result of investor exuberance (girdzijauskas, štreimikienė, čepinskis & moskaliova, 2009:268) incited by a belief in the greater fool theory1 (posen, 2006:113). however, warren buffet2 does not think in terms of cycles with bubbles and crashes. market volatility will always exist and therefore he is not concerned about it. he is much more concerned about the overall potential of a firm, with the emphasis on longterm ownership in a company which is very capable of generating earnings, rather than share value growth (schroeder, 2008; investopedia, 2009). the rationale is that if earnings are good, market value will take care of itself. this study is concerned with measuring the overall performance of a firm and to determine how this is reflected in a number of readily available financial ratios. 2 statement of the problem the bottom line of any firm is to create shareholders’ wealth. there are many valuebased measurements that give substance to this performance of creating shareholders’ wealth, for example economic value added (eva), market value added (mva) and shareholder value added (sva). mva, which indicates the growth (or decline) in market values, is the difference between the market share price and its book value (stewart, 1999:184). the link between mva and eva is that mva is the present value of future eva values (baum, abstract sajems ns 15 (2012) no 4 417 saver & strickland, 2004:82; stewart, 1999: 153). sva is the corporate value less the market value of debt (rappaport, 1986). a problem is that value-based measurements, such as the above-mentioned, are not readily available and complex to measure (keys, azamhuzjaev & mackey, 2001:69) and they do not directly measure the growth and dividend components (stewart, 1999). financial ratio analysis, on the other hand, is easy to calculate and also readily available in sources such as financial databases, companies’ financial reports and market reports. in this study, financial ratios were investigated, which firstly included five market-based measures, i.e. market value ratios, which are one of three firm valuation methods3 (park & lee, 2003). the first market value ratio is the price/earnings (pe) ratio, which is an indication of how much investors would be willing to pay per rand of profit (fairfield & harris, 1993:591). the price/book value (pb) ratio is a market value ratio that provides an indication of expectations of future performance by relating the market price of a share to the book value of the share (dunis & reilly, 2004:231). the mcgregor database also uses a variation of the price/book value ratio, namely the price/net asset value ratio4 (pnav). the value of any organisation is the present value of the future free cash flows and therefore the price/cash flow ratio (pcf) is useful, especially where the price of a share is more related to cash flow than net income (park & lee, 2003:335). finally, there is the dividend yield method, which is an indication of the dividend yield (dy) relative to the share price (dunis & reilly, 2004:231). note that the share price is a common component in all five abovementioned equations. secondly, three profitability ratios, i.e. accounting-based measures, were used. profitability, which is the stepping-stone in creating shareholders’ value and paying dividends, gets substance in ratios, for example the ratios included in the du pont formula that have the strength that they aggregate the firm’s performance in three broad categories, namely income, investments and capital structure (correia, flynn, uliana & wormald, 2007:520). this analysis indicates how the net profit margin (pm) and asset turnover affect return on assets (roa), and how roa and leverage affect return on equity (roe) (asaftei, 2008:2337). this study will also include the above-mentioned three profitability measures. a weakness of financial ratios is that the literature cannot agree upon the relative importance of the different ratios, and it is only appropriate if firms focus on a single input or produce a single output (chen, 2002:201). other weaknesses are their lack of objectivity and the lack of a suitable benchmark to compare the ratios against (hassan al-tamimi & lootah, 2007:334). furthermore, no single financial ratio provides an adequate indication of an organisation’s performance (halkos & salamouris, 2004:207-208). what is needed is a measurement tool that can aggregate all inputs (for example, several scarce resources) and outputs (for example, the market value growth and dividend components that are not measured by the value-based techniques) in a single performance measurement. the two most widely used quantitative techniques for measuring relative productivity (or relative efficiency) are stochastic frontier analysis (sfa) and data envelopment analysis (dea) (coelli, rao, o’donnell & battese, 2005:6). dea is used in this study as an efficiency measurement because it lends itself more easily to the analysis where multiple outputs are used. the quest for value that benefits the firm and society is the result of directing ‘scarce resources to their most promising uses and most productive users’ (stewart, 1999:1). thus, the performance of any business is measured in terms of how scarce resources are used as an input to obtain the maximum output. dea can be helpful in this regard, to aggregate firm performance into a single measurement (avkiran, 1999:206). since financial ratios are readily available (but with the weakness that individually they cannot measure warren buffet’s idea, i.e. the degree to which the overall potential of a firm is achieved) the research question of the study is as follows: which readily available ratios can help the investor not to buy overvalued/ questionable shares and become trapped as the greater fool? thus, the core of the study is that it will investigate what the relative importance of financial ratios (market value and profitability ratios) is to reflect a firm’s overall performance, 418 sajems ns 15 (2012) no 4 measured by the technical efficiency (te) of using scarce resources to create shareholders’ wealth. therefore, the purpose of the study is twofold, namely firstly to use dea to aggregate the performance (efficiency) of firms to convert scarce resources into outputs that create shareholders’ wealth in a single measurement, and secondly, to determine the degree to which this mentioned performance (efficiency) is reflected in a number of profitability and market value ratios. the study used dea efficiency estimates as a measurement superior to financial ratios and therefore as a basis to determine the importance of the different market value ratios and profitability ratios, which are presented by the mcgregor database. section 3 is the literature review and an indication of this paper’s contribution, followed by the hypothesis (4) of the study. sections 5, 6 and 7 explain dea, the dea model, data sources and the methodology respectively. the findings of the empirical investigation are shown in section 8, and the study is concluded in section 9. 3 literature review and contribution of the paper many studies have used market value ratios as independent variables of performance. for example, ramcharran and kim (2008) used price/book value along with price earnings to predict market capitalisation values. while capaul, rowley and sharpe (1993) used only price/book value, dunis and reilly (2004) used it along with price/earnings, price/cash flow, dividend yield and market capitalisation to identify significant differences between the performance of ‘value shares’ (shares with a low price/book value ratio) and ‘growth shares’ (shares with a relatively high price/book value ratio). park and lee (2003) concluded in their empirical study that price/book value is the most accurate measure and outperformed ratios such as price/sales ratio and price/cash flow ratio in forecasting stock prices. on the other hand, fairfield and harris (1993) used price deviations from basic valuation models to test the intrinsic value of the dependent variable price/book value and price/earning anomalies. ramcharran (2003) used country risk data to also estimate several dependent variables, namely equity returns, dividend yield, price/ earnings and price/book value. some previous studies used dea efficiency estimates and compared them with profitability ratios and other financial ratios, for example halkos and salamouris (2004), oberholzer and van der westhuizen (2004), and yeh (1996), who found that dea efficiency estimates are tools aimed at compensating for the weaknesses of financial ratios and that they can be used as an alternative, or complement, to financial ratio analysis. hassan al-tamimi and lootah (2007:333) also found that financial ratios fail to consider multiple outputs that are provided by multiple inputs, and therefore, dea efficiency estimates are regarded as superior to financial ratios. chen (2002) solved the issue to some degree, i.e. the financial ratios versus dea efficiency estimates debate, by using only financial ratios as outputs in his dea model. none of these above-mentioned studies focused on market value ratios and they all used a single stage process. seinford and zhu (1999) developed a more advanced two-stage process where the first stage measures profitability efficiency and the second stage marketability efficiency. the inputs of the first stage are labour and assets, while revenue and profits are the outputs. the outputs of stage one automatically form the inputs for stage two and the outputs of stage two include market values, returns and earnings per share. the problem with this model is that adjustments should be made to reduce the outputs of the first stage in order to increase the efficiency of the second stage. these adjustments result in a situation where it is unknown where the dea frontier is. therefore, chen, cook and zhu (2010) developed an approach to deal with it. since the available software (zhu, 2004) cannot deal with this issue, a single stage approach was used that included both the profitability and marketability. a multiple input output dea model can measure company performance much more comprehensively than any financial ratio, which is only a singleinput-single-output measure. these previous studies will serve as a basis to develop a suitable dea model to estimate the overall performance of companies under review. however, in spite of a widespread adoption sajems ns 15 (2012) no 4 419 of measurements, such as market value ratios as dependent or independent variables and dea efficiencies versus profitability ratios, there has been no empirical linkage between dea and profitability ratios and market value ratios. there fore, this study extends the current literature by using both profitability ratios and market value ratios as independent variables, while dea efficiency will be the dependent variable to indicate the importance of financial ratios relative to a firm’s efficiency of using scarce resources to create shareholders’ wealth. accor dingly, this study will investigate 55 companies in three sectors on the jse limited over a fiveyear period to determine cross-sectional associations. the results of this study will indicate the relative importance of the different market value ratios and profitability ratios relative to the dea efficiency. dea will be used to estimate the annual technical efficiency of each company and spearman’s rank-order correlation analysis will be used to determine the relationship between these efficiency estimates and the different financial ratios. 4 hypothesis dea is a technique for combining all the input and output data about the firm into a single measure of productive (in this case, technical) efficiency, which lies between zero (meaning the firm is totally inefficient) and one (which signals that the firm is fully efficient). the profitability ratios indicate a firm’s profitability relative to sales, assets and equity, respectively. thus, the higher the ratio, the more profitable the firm is. market value ratios, such as price/ earnings, price/cash flow, price/book value and price/net asset value, are an indication of what investors think about a firm’s past, current and future risks and returns. these risks and returns determine share prices and thus market value (orlitzky, schmidt & rynes, 2003:407408). therefore, the higher these ratios, with other things held constant, the higher the prospects and/or the lower the risk. this is in contrast to dividend yield, where a higher ratio indicates lower prospective yield and higher risk (dunis & reilly, 2004:231). therefore, the conceptual framework of the study is that there should be a positive relationship between the technical efficiency (dependent variable) of a firm and its profit-ability and market value ratios; except for dividend yield, where a negative relationship is expected. if it is assumed that the more complicated technical efficiency indicates the overall performance of a firm, a high correlation with a specific readily available financial ratio (except dividend yield) will indicate that the ratio also has the ability to indicate the overall performance of a firm. a low or negative correlation between the technical efficiency and a specific ratio will indicate that the ratio does not have the ability to indicate a firm’s overall performance, but that it only helps the investor to be trapped as the greater fool, i.e. where low performance firms (shares) are indicated to have high prospective yield and/or low risk. the conceptual framework will be helpful to test the following null-hypothesis: h0: there is no monotone significant relation ship between technical efficiency estimates of creating shareholders’ wealth and the different financial ratios. 5 data envelopment analysis (dea) dea is a non-parametric linear programming technique that measures the relative efficiency of a comparative ratio of outputs to inputs for each decision-making unit (dmu), such as a firm (avkiran, 1999:206). a firm is efficient ‘if it cannot produce more output without a corresponding relative increase in inputs, or if it cannot reduce its inputs without a corresponding relative decrease in outputs’ (thomas & tripe, 2007:4). the traditional measurement of efficiency assumes only a single output divided by a single input (cronjé, 2002:33). the main advantage of using dea as a relative efficiency measure is that it accommodates multiple inputs, multiple outputs and other factors in a single model (halkos & salamouris, 2004). the main usefulness is its ability to identify inefficient firms, to generate potential improvement for them and indicate efficient firms that should be used as a benchmark by the inefficient ones (avkiran, 1999:206). dea can be used to estimate four main types of efficiency, namely technical, allocative, economic and scale efficiency. in practice, the 420 sajems ns 15 (2012) no 4 measurement of these efficiencies involves the estimation of production frontiers. dea effectively estimates the frontier by finding a set of linear segments that envelop the observed data. technical efficiency is an indication of how well inputs are converted into outputs, while allocative efficiency reflects the ability of a firm to use the inputs in optimal proportions, given their respective prices (avkiran, 1999: 206-207). a firm is economically efficient if it is both technically and alloca-tively efficient, and a firm is scale efficient if it operates on a scale that maximises productivity (oberholzer & van der westhuizen, 2009:69). dea can deter mine efficiencies from an input-orientated (input minimisation) or output-orientated (output maximisation) point of view (avkiran, 1999: 211; oberholzer & van der westhuizen, 2009: 74). furthermore, analysts choose between using constant return to scale (crs) or variable return to scale (vrs). the first implies a proportionate rise in outputs when inputs are increased, in other words, a firm’s efficiency is not influenced by the scale of operations (avkiran, 1999:211). ‘vrs implies a disproportionate rise or fall in outputs when inputs are increased’ (avkiran, 1999:211), in other words, if a firm grows in size, its efficiency will not stay constant, but it will either rise or fall. 6 dea model avkiran (1999:214) gives a guideline as to when inputs and outputs are selected – the outputs should be the key business drivers that are critical to the success of the business, and the inputs should be the resources that lead to the key business drivers. a combination of approaches was used to determine inputs. assets, and in some cases only tangible assets or fixed assets, were used by chen (2002), oberholzer and van der westhuizen (2009), and favero and papi (1995). shareholders’ equity was used by stavarek (2002) and oberholzer and van der westhuizen (2009). expenditure was used by hassan al-tamimi and lootah (2007). in this study, tangible assets, shareholders’ equity at book value and total expenditure were used as the input resources. although the modigliani-miller theorem states that the value of a company is independent of reinvestments and dividend pay-outs5, this is not true since both components are not free of costs (paulsen, 2008:2201). the reward that investors get from buying shares in a company is measured by the cash component and the value component, which are the dividend payouts and the growth in the market value of the shares, respectively (arnott & asness, 2003: 70-71; nel, 2005:5). growth (change) in market share value cannot be used as an output variable since it may take on a negative value as a result of the volatility in the market (jse, 2009). the reason is that a dea model requires positive data (luo, 2003:631; zhu, 2004:266). halme, joro and koivu (1998) also confirm that the most widely used models by charnes, cooper and rhodes (1978) and banker, charnes and cooper (1984) require that all the input and output data are strictly positive. market value of shareholders’ equity can be used as an output variable and that will be justified by the fact that its book value is used as an input value. market value was also used as an output value by seinford and zhu (1999) and chen, et al. (2010). profit can also be considered as an output value, but the problem is that it also can take on a negative value. therefore, sales revenue is used as an output value to justify total expenditure as an input. the following dea model was specified: outputs: y1 = sales (rand) y2 = market value of shareholders’ interest (rand) y3 = dividend payouts (rand) inputs: x1 = total expenditure (rand) x2 = tangible assets (rand) x3 = book value of shareholders’ interest (rand) the results of this model will give an aggregated measure of the operating efficiency (since sales is an output that is opposed to the input of scarce resources), profitability efficiency (since sales is an output that is opposed to total expenditure), and marketability efficiency (since the market value of shareholders’ interest and dividends as outputs are opposed to the input of the book value of shareholders’ interest). note that the management of a firm does not have equal control with regard to the efficiency needed to reach the outputs, for example, the management of a firm has much more control with regard to the operating and profitability efficiency than the marketability efficiency. but, this is not the point! this study sajems ns 15 (2012) no 4 421 is more concerned with how the technical efficiencies of a firm, and not of management, are related to the financial ratios. also note that market value is a component in all the market value ratios that will be compared to dea in the empirical study. 7 data sources and methodology companies use different year-end dates and performances are determined relative to these dates. the market volatility influences the market value of shares, therefore share prices of companies with different year-end dates cannot be compared at year-end. inflation may also influence values such as assets and shareholders’ interest if the year-end dates are different. therefore, only companies that use the same year-end dates will be grouped together. since differences can be expected between different sectors, it was decided to only include the following three sectors in the study rather than the whole jse. the study includes basic materials, industrials and consumer goods. the reason for choosing these sectors is that they all have manufacturing of tangible products in common. in order to reach the first objective of the study, income statement, balance sheet and market data were used in the dea model to calculate the input-orientated technical efficiency estimates for the selected companies. in total, 22 companies with december and 33 with june as their yearends were included in the study. companies with other year-ends than these did not provide a large enough sample to be investigated. the annual technical efficiencies for the companies in the two samples (22 and 33) were calculated relative to the other companies in that sample. the sample size of 22 and 33 observations is sufficient, according to avkiran (1999:207208), who states that it should be three times as large as the sum of the chosen variables, thus 22 > 3(3 + 3) and 33 > 3(3 + 3). data for the inputs included in the dea model were taken from the balance sheet, i.e. rand (book) value of total tangible assets and the rand (book) value of shareholders’ interest, and from the income statement, the rand value of expenditure was taken. the outputs included were calculated by using the number of shares issued multiplied by the share price at year-end. this was to determine a company’s efficiency that is only valid for the last day of its financial year. these efficiency estimates were compared to the financial ratios, also as calculated at the company’s financial year-end. furthermore, the output rand value of sales and the rand value of dividend payouts were taken from the income statement. data were taken for a five-year period, from 2004 to 2008. a comparison was made over the five-year period between the 55 companies in each year. a five-year period is used to determine whether the results are consistent among the years. the software package of zhu (2004) is purpose-built to solve the dea problem and has been used in this paper to generate estimates of annual input-orientated technical efficiency for each company over a five-year period. the input orientated approach promotes an emphasis on cutting input expenditure, capital and tangible assets rather than expanding sales, market value of shareholders’ equity and dividend payouts. although all the companies in the sample are involved in manufacturing, the variable return to scale approach was used rather than the constant return to scale approach, because of the divergent operations and sizes of the companies. in this study, the following dea formulae were used for an input-orientated model with a variable return to scale approach. this is where the inputs are minimised, while the outputs are kept at their current levels (zhu, 2004:5-13): .,....,2,10 1 ;,....,2,1 ;,....,2,1 )(min 1 1 1 11 nj srs mis tosubject ss j n j j rorri n j j ioiij n j j s r r m i i =≥ = ==− ==+ +− ∑ ∑ ∑ ∑∑ = + = − = = + = − λ λ γγλ θχχλ εθ the input-orientated formula calculates input minimisation (where θ indicates the efficiency score). each observation, dmuj (j = 1, ..., n), uses m inputs xij (i = 1, 2, ...,m) to produce s outputs yrj (r = 1, 2, ...,s), and where dmuo represents one of the n dmus under evaluation, and xio and yro are the ith input and 422 sajems ns 15 (2012) no 4 rth output for dmuo, respectively. in order to consider any slacks, the presence of the nonarchimedean ε effectively allows the minimisa tion over θ to pre-empt the optimisation involving the slacks, si and sr +. [for a more detailed discussion on the dea methodology, see cronje (2002), avkiran (1999), ray (2004) and zhu (2004).] to reach the second objective, market value ratios and profitability ratios were taken from the mcgregor database. although financial models rely heavily on normality of data, melas and ruban (2009) proved that financial data are not normally distributed. since normality is a prerequisite for linear regression analysis (levine et al. 2008:530), spearman’s correlation was used to determine the degree to which technical efficiency changes if there is a change in the financial ratios. the rank order correlation of spearman may be used to determine whether there is a monotone dependence between each of the eight independent variables (financial ratios) and the technical efficiency. rank order correlation is a non-parametric technique for qualifying the relationship between two variables. non-parametric means that the correlation statistics are not affected by the type of mathematical relationship between variables, unlike the least square regression analysis that requires the relationship to be linear (vose, 1996:33). the spearman rank order correlation coefficient is a more general measure of any kind of monotonic relationship between the dependent and independent variables. this measure is based on ranks and therefore not as sensitive to outliers (millard & neerchal, 2001:534). regression and correlation analysis with one independent variable requires a sample of at least ten observations (sekaran, 2006:294-297; hanke, wichern & reitsch, 2001:73). each sample provides 22 and 33 data-points per year. finally, the null-hypothesis is tested by using p-values at one, five and ten per cent significant levels. 8 empirical results the input-orientated technical efficiency of the companies under review was determined, and as a result of space restriction only the results of the 22 companies with a december year-end will be shown, as well as the annual averages of the 33 companies with june year-ends. table 1 indicates the relative efficiency of how the inputs (scarce resources) are converted to outputs that create shareholders’ wealth. six of the 22 companies (ams, hvl, gnd, ila, mob and pmv) were fully efficient during the period 2004 to 2008. the meaning of these estimates is, for example the first listed company (afe), that this company has on average a relative efficiency of 92.4 per cent, which indicates that it could reduce the consumption of its inputs by 7.6 per cent without reducing its outputs. the last company listed in the table (ton) is on average the most inefficient with an average estimate of 68.4 per cent. it is also clear that there are variations of the technical efficiency between companies, as well as variations between the annual averages of the two samples. also remarkable is the fact that the total averages of the two samples over the five-year period are almost the same, namely 91.3 per cent and 91.6 per cent for the december and june yearend companies, respectively. table 2 contains the descriptive statistics of the data for the two samples of companies investigated which were also used in table 3 to determine the relationship between the technical efficiency estimates and the financial ratios of the two samples, respectively. in table 2, no adjustments were made for outliers. it is clear that there are differences between the means and the medians (and in some cases huge differences, for example, the dividend yield of the first sample). this is probably the result of some outliers, large variances and a lack of normality of the data. there are also some major differences between the means of the two samples, for example, the dividend yield of the two samples. the latter will not be addressed since the issue is not to compare the means of the two samples, but only to determine independently whether there are differences when the financial ratios are compared to the technical efficiency in each sample. the first issue was expected (see section 7), therefore spearman’s correlation coefficient is used. sajems ns 15 (2012) no 4 423 t a b l e 1 input-orientated technical efficiency of companies, 2004-2008 december year-end companies (n = 22) company 2008 2007 2006 2005 2004 avg. afe 0.849 0.883 0.897 0.991 1.000 0.924 afx 0.929 0.885 0.868 0.874 1.000 0.911 ams 1.000 1.000 1.000 1.000 1.000 1.000 ang 1.000 0.608 0.628 0.858 1.000 0.819 acl 1.000 0.920 0.832 1.000 1.000 0.950 dta 0.971 0.548 0.514 1.000 0.822 0.771 exx 0.764 0.973 1.000 1.000 1.000 0.947 hvl 1.000 1.000 1.000 1.000 1.000 1.000 mrf 1.000 0.811 0.475 0.695 0.887 0.773 pam 0.784 1.000 1.000 1.000 0.382 0.833 bsr 0.964 1.000 1.000 1.000 1.000 0.993 bel 0.835 0.924 0.908 0.870 0.868 0.881 cnl 0.755 1.000 0.768 0.876 1.000 0.880 gnd 1.000 1.000 1.000 1.000 1.000 1.000 hwn 1.000 1.000 1.000 0.869 1.000 0.974 ila 1.000 1.000 1.000 1.000 1.000 1.000 mmg 0.934 1.000 1.000 1.000 1.000 0.987 mob 1.000 1.000 1.000 1.000 1.000 1.000 pmv 1.000 1.000 1.000 1.000 1.000 1.000 tre 1.000 1.000 0.528 1.000 0.957 0.897 mta 0.834 0.872 0.841 0.773 0.952 0.855 ton 0.791 0.564 0.649 0.637 0.780 0.684 average 0.928 0.909 0.859 0.929 0.939 0.913 june year-end companies (n =33) company 2008 2007 2006 2005 2004 avg. average 0.877 0.910 0.917 0.922 0.953 0.916 software package used: zhu (2004) t a b l e 2 descriptive statistics of variables: average 2004-2008 december year-end companies (n = 22) dea profitability ratios market value ratios te pm roa roe dy pe pb pnav pcf mean 0.91 10.35 17.03 13.00 9.14 7.69 2.48 2.53 6.70 std error 0.02 2.68 2.86 8.88 2.93 3.14 0.34 0.38 1.23 median 0.94 8.18 13.74 15.34 4.24 9.04 1.99 2.07 6.07 std deviation 0.09 12.56 13.40 41.63 13.74 14.72 1.57 1.77 5.78 variance 0 158 180 1733 189 217 2.5 3.1 33.4 kurtosis 0.16 1.05 1.20 3.36 9.72 4.64 -0.21 4.62 2.22 skewness -0.94 0.47 0.98 -1.62 2.85 -0.81 0.50 1.88 -0.58 range 0.32 58.26 56.55 174.93 61.13 80.06 6.01 7.94 27.39 minimum 0.68 -16.2 -3.95 -99.01 0.00 -35.2 -0.62 0.37 -9.34 maximum 1.00 42.11 52.61 75.92 61.13 44.87 5.39 8.31 18.05 confidence 0.04 5.57 5.94 18.46 6.09 6.53 0.70 0.78 2.56 june year-end companies (n =33) dea profitability ratios market value ratios te pm roa roe dy pe pb pnav pcf mean 0.92 4.01 12.57 13.00 2.30 13.03 2.30 2.05 4.27 std error 0.02 3.09 2.16 6.63 0.44 2.19 0.24 0.33 3.89 median 0.94 4.30 11.70 18.75 1.40 10.75 1.97 1.96 8.01 std deviation 0.10 17.74 12.38 38.08 2.53 12.57 1.39 1.88 22.35 variance 0.01 315 153 1450 6.42 158.0 1.92 3.52 500 kurtosis 4.28 9.52 1.50 19.15 0.08 3.95 5.40 8.46 9.45 skewness -1.90 -2.40 -0.37 -4.10 0.97 1.79 0.14 -2.19 -0.65 range 0.43 102.6 60.3 220.3 9.09 59.9 8.98 11.10 159.6 minimum 0.57 -70.4 -21.5 -174 0.00 -6.59 -2.2 -5.53 -79.8 maximum 1.00 32.29 38.83 46.42 9.09 53.3 6.76 5.57 79.8 confidence 0.03 6.29 4.39 13.50 0.90 4.46 0.49 0.67 7.93 software used: microsoft excel 424 sajems ns 15 (2012) no 4 table 3 indicates spearman’s correlation coefficient between technical efficiency and profitability and market value ratios. to test the null-hypothesis, namely that there is no monotone significant relationship between technical efficiency estimates of creating shareholders’ wealth and the different financial ratios, the p-values related to the abovementioned correlation coefficients were also determined. the null-hypothesis is rejected in some cases at a significance level of one, five and ten per cent, where ρ < α = 0.01, 0.05 and 0.10, respectively (two-tailed). it is also clear, according to both samples, that return on equity has significant positive relationships with technical efficiency for all the years. sample 2, 2008, indicates a significant level of ten per cent, implying a weak sample evidence, which is not statistically significant and cannot be used to reject h0 in favour of h1. the remaining significance levels are one per cent and five per cent, implying there is overwhelming strong sample evidence and strong sample evidence, respectively, to reject h0 in favour of h1 (wegner, 2007:266-267). return on assets has the second highest significant relationships with technical efficiency, where the significance levels are five per cent in five different years for the two samples. the correlation coefficients are only significant in some cases for price/net asset value, price/book value, price/cash flow and profit margin. both samples also indicate that there is never a significant positive relationship between technical efficiency and price/earnings and dividend yield ratios. t a b l e 3 spearman’s rank-order correlation between technical efficiency and profitability and market value ratios december year-end companies (n = 22) profitability ratios market value ratios pm roa roe dy pe pb pnav pcf 2008 0.313 0.486** 0.486** 0.035 -0.318 0.183 0.309 -0.024 2007 -0.236 0.415* 0.672*** 0.011 -0.236 -0.039 0.080 -0.088 2006 0.023 0.471** 0.536** 0.070 0.088 0.267 0.452** 0.059 2005 0.396* 0.349 0.598*** 0.057 -0.132 0.014 0.062 -0.637*** 2004 0.473* 0.415* 0.438** 0.213 0.143 0.218 0.384* 0.061 total 0.112 0.413* 0.592*** 0.005 -0.160 0.238 0.378* -0.070 june year-end companies (n = 33) profitability ratios market value ratios pm roa roe dy pe pb pnav pcf 2008 0.113 0.441** 0.382* 0.252 0.008 0.279 0.352* 0.143 2007 0.132 0.300 0.698*** 0.212 0.132 0.383* 0.303 0.088 2006 0.034 0.501** 0.690*** 0.297 -0.216 0.033 0.159 -0.301 2005 0.241 0.446** 0.574*** 0.152 -0.096 0.236 0.198 -0.035 2004 0.041 0.237 0.462** -0.239 -0.120 0.318 0.333 -0.163 total 0.129 0.398** 0.758*** 0.132 -0.086 0.219 0.188 0.083 * significant at 10% (two-tailed) ** significant at 5% (two-tailed) *** significant at 1% (two-tailed) software used: microsoft excel 9 conclusion this study investigated the annual performance of two sample groups of 22 and 33 companies listed at the jse limited in the basic material, industrial and consumer goods sectors from 2004 to 2008. the purpose of the study was firstly to use dea to aggregate the performance (efficiency) of firms to convert scarce resources into outputs that create shareholders’ wealth in a single measurement, and secondly, to determine the degree to which this mentioned performance (efficiency) is reflected in a number of readily available profitability and market value ratios. the study concludes that the dea model used is suitable to indicate in a single measurement the relative efficiency of firms to sajems ns 15 (2012) no 4 425 convert scare resources (for example, tangible assets, book value of shareholders’ interest and payments for resources such as labour, materials, equipment, transport) in sales, market value of shareholders’ interest and dividends. since dea models require positive data, these selected inputs and outputs are usually positive and will only be negative by exception, for example, a bankrupt firm with higher liabilities than assets will have a negative book value in terms of shareholders’ interest. the results of this model also give an aggregated measure of the operating efficiency, profitability efficiency and marketability efficiency. what is also important is that inefficient companies can also be identified and investigated further to detect the reasons for their poor levels of performance. furthermore, the efficient companies can be used as a benchmark for the inefficient ones. the practical implication of this study is that this model or similar models can be used to determine the overall firms’ performance, i.e. the relative efficiency to create shareholders’ wealth included a firm’s operations, profitability and marketability efficiencies. the study found, with regard to both samples, that return on equity has the most significant positive relationship with technical efficiency, followed by return on assets. the relationship is only significant for price/net asset value, price/book value, price/cash flow and profit margin ratios for a limited number of years. the market value ratios, that is, price/earnings and dividend yield, have significant relationships with technical efficiency in none of the years. therefore, the study also concludes that the overall performance of a company, namely to convert scarce resources into shareholders’ wealth, can easily be substituted by using the readily available return on equity, and to a lesser extent, return on assets. these two profitability ratios are, in the context of this study, relatively the most important, and outperformed the profit margin ratio and all the market value ratios, even while the dea model and all the market value ratios have market value as a common component. the practical implication is that return on equity, and to a lesser extent return on assets, is a sensible indication of the overall performance of firms, that is, the relative efficiency with which to create shareholders’ wealth. some of the remaining ratios, price/book value, its variation price/net asset value, price/cash flow and profit margin provide only a very limited indication of a firm’s relative operating, profitability and marketability efficiency. therefore, they should rather be grouped together with the relatively less important ratios such as price/earnings and dividend yield where no significant relationships were found. with reference to the research question, these market-based ratios should be used by investors only as short-term market indicators as they are excellent aids for speculation purposes, but tell nothing about the overall performance of a firm. thus, using these ratios will be helpful in being the lucky fool, if you can get rid of the shares before the bubble bursts, to avoid being the greater fool. the value of this study is that it is the first where the technical efficiency, determined by dea, which aggregated operating, profitability and marketability efficiencies, is used to determine the relative importance of not only profitability ratios, but also market value ratios. further research is necessary, since the element of risk is not included in the dea model. variations of the dea model can be used, for example, to include total assets instead of tangible assets as an input, and can be compared to the results of this study. a more advanced dea model can also be developed for further analysis to determine scale, allocative and economic efficiencies. endnotes 1 the greater fool theory is based on making money through buying probable overvalued or questionable shares and to sell them to someone (the greater fool) who is willing to pay a higher price for them. unfortunately, sooner or later the bubble will burst and someone will be the owner of shares that are worth much less than they were purchased for (cox & hobson, 2005:477-478; sanford, 2005:45). 2 warren buffet, an american investor, businessman and philanthropist, was, in 2006, ranked as the second richest person in the world. in 2006 he announced that he would donate 85% of his fortune, worth $37 billion, mainly to the bill and melinda gates foundation (schroeder, 2008:815-816). 426 sajems ns 15 (2012) no 4 3 the three different approaches of firm valuation are market value ratios (also known as multiples or relative valuation method), discounted cash flow method and contingent claims valuation method (park & lee, 2003). 4 according to the formula equity = assets – liabilities, the net asset value (nav), which is assets – liabilities, is the same as the book value of equity. however, the mcgregor database calculates nav as tangible assets – current and longterm liabilities. 5 in the literature, there are different opinions with regard to the influence of dividend payments (cash component) on market values. the point of view of one theory is that dividends lead to higher market values; a more radical postulates that it reduces value; and the middle-of-the-road theory, based on the work of miller/modigliani, is that dividends are irrelevant with regard to 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this is reflected in the inherent militancy which has characterized the practice of collective bargaining from its inception, and the accepted practice of confrontation rather than co-operation which is usual in the approach to collective bargaining. 2 moving from adversarialism acceptance of the universal truth stated in the introduction, has lead both academics and practitioners to recognize that collective bargaining tends to be counterproductive as a labour relations process, and that more often than not it leaves a legacy of tension and negative attitudes, even after settlement has been reached. understanding that sound workplace relationships must be the ultimate r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 443 objective of investing resources in the management of labour relations in general and in embarking on the process of collective bargaining in particular, draws attention to the undesirability of adversarial attitudes and approaches to the practice of labour relations, such as collective bargaining. this is nothing new, and many academics and authors have tried to find solutions to the problem of avoiding or eliminating adversarialism and militancy from collective bargaining, without denying what must be one of the most fundamental, universally recognized rights of people in the workplace. earlier authors such as mayberry (1958) and pigou (1959) tried to find formulae for collective bargaining that would eliminate or at least minimize adversarialism, by focussing on the "bargaining range", or the "distance" between the bargaining positions of the parties. the principle underlying this approach was to bring the parties as close as possible to each other, in a (futile) attempt to create the perception that neither party has much to lose or gain, in order to minimize the power play, coercion and threats which normally characterize collective bargaining, and make its consequences unproductive and perhaps destructive. even john dunlop (1958), regarded by many as the father of modem labour relations theory, tried to find a constructive approach to collective bargaining by describing it as a rule making process, which aims to create a "system of rules" for the management or governance of business, and to provide a framework for the interaction between management and labour. this approach stands in stark contrast to that of many other authors who describe collective bargaining as a power game, where one party attempts to coerce another to concede to demands which he/she in reality cannot or does not want to do. it is axiomatic that the result of such a process, however justified the positions of the respective parties may seem, must be a loss on the part of one or both of the parties and the possible breakdown of relationships. later theorists like walton and mckersie (1965), and chamberlain and kuhn (1965), tried to change the negative focus on and attitude to collective bargaining by formulating new concepts like "integrative" and "distributive" bargaining. these concepts were based on the principles of sharing, participation and co-operation as the basis of the process of collective bargaining. they relied on the earlier attempts to address this problem (golden & parker, 1955; rosenberg, 1960; deutsche, 1958 ), suggesting that adversarialism must be removed from collective bargaining through the building of relationships, changing perceptions and attitudes, and a focus on communality of interests. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 444 sajems ns vol 2 (1999) no 3 it was however not only academics and theorists who struggled with this problem. many practitioners like elliott jaques (1960-66) of brunei university in the united kingdom, sought to find solutions to the elimination of adversarialism in collective bargaining. as consultant to the glacier bearing company, he developed a system of employee representation and participation which had the effect that glacier did not have labour strikes of any sort during a six-year period, when industry in great britain was generally characterized by strikes. jaques attributed this positive achievement largely to the cooperative and supportive relationship which had developed over time between management and labour. because of the inherent adversarialism of the traditional collective bargaining process, almost all the theoretical models, like that proposed by walton and mckersie, failed to produce the expected outcomes and were eventually relegated to the academic archives. equally, systems which initially seemed to offer some prospects of co-operation and support, like the glacier project developed by elliott jaques, proved sustainable only as long as the initial champion remained committed to the project, thereafter sliding into disuse as relationships broke down and adversarialism again became prevalent. 3 interest based bargaining interest based bargaining represents one of the latest attempts to move away from adversarialiasm and confrontational approaches to collective bargaining. interest based bargaining developed as an approach to collective bargaining to meet the need for more productive and less costly alternatives. according to cameron (1997), it was the costly four months strike between the saskatchewan public service commission and the saskatchewan government employees union in canada, which convinced both parties to agree to explore new ways of approaching the substantive negotiations. this lead them eventually to agree to embark on interest based bargaining. similarly, it was the deterioration of the relationship, and the consequent growing tensions between the management of the salt river project in phoenix, arizona and the international brotherhood of electrical workers, following increased adversarialism and inflexible attitudes on both sides, which according to estes (1997) ultimately caused the parties to agree to try interest based bargaining too. in both above mentioned case studies, workplace relationships improved significantly as a result of the change to interest based bargaining. the parties r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 445 were henceforth able to settle their differences so that as relations became less confrontational and more co-operative, aggression decreased and trust developed between the parties. in fact, the improvement of the trust relationship between the parties has been the common denominator in every case where a change to interest based bargaining was accepted as a viable, and more attractive, alternative to confrontational, positional bargaining. the veracity of this statement may be found in the report by cameron (1997) where he says, " ... effective interest based bargaining ... requires trust, openness and understanding ... and shared/common values ... " moreover, " .. .it builds relationships ... ". he further expressed the view that it requires the sharing of infonnation. the above mentioned aspects of interest based bargaining, as well as the procedural steps which he proposes, all indicate that the vital success factor for interest based bargaining is the building of a relationship of trust. it is clear that success is not detennined merely by the decision to embark on interest based bargaining, but rather on the preparedness to commit time and energy to the building of the trust relationship. in the saskatchewan case study, cameron reports that it took 54 meetings over a period of five and a half months for this type of exercise to reach the point where the parties could actually start the interest based bargaining process itself. he called this a "record of brevity". with reference to the antecedents of the salt river project case study, estes (1997) says that in the past the salt river project management and the international brotherhood of electrical workers met on an agreed date, and proceeded to negotiate from pre-detennined "positions", presumably based on mandates from their respective principals. in describing how the parties moved into interest based bargaining from their traditional pattern of negotiation, he says that they decided to start talking around "issues of common interest", because " .. .it's less adversarial and more geared toward [finding] mutually beneficial solutions ... ". esters therefor confinns the need for a gradual build-up of the trust relationship over a period of time, using issues of common interest which are not emotionally loaded, and about which neither party has strong feelings or preconceptions. this is perhaps the first principle of interest based bargaining. while both cameron (op cit.) and estes (op cit.) mention it in their respective reports, it is cimini (1995), who specifically identified the need to begin on common interests, and further suggested the need for developing common values. he was reporting on the move to interest based bargaining between the minnesota nurses association and the metropolitan healthcare council because of the growing tensions and consequential deteriorating relations between the parties. these said tensions were the result of declining revenues r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 446 sajems ns vol 2 (1999) no 3 and increasing expenses in healthcare services which seemed to suggest the need for staff reductions. cahill (1995) also focussed on the importance of developing common values as a critical success factor for interest based bargaining, in his article on "interest based problem solving". from the above-mentioned views and statements, a second principle of interest based bargaining can be deduced, namely that the interaction between the parties must start with focussing on common interests. these are the issues about which agreement is likely to be reached without too much difference of opinion and the need for concessions by the parties. reaching agreement about such issues will create an atmosphere of co-operation and a "sense of oneness" (cahill & mccrary, 1995). the third principle which emerges from the various cases reported, is that a set of common values needs to be developed by the parties themselves, on which their interaction can be based and which will provide the framework within which a relationship of trust can be developed between them. there seems to be an important consideration which links this third principle of developing common values and the first principle of gradually building up a trust relationship over time. this relates to the understanding that interest based bargaining is not something which the parties can accept at a moment's notice, and then begin to practise immediately. it is clear enough that in all cases where interest based bargaining proved to be a viable alternative to traditional collective bargaining, it required careful planning, total commitment by both parties and, above all, the willingness to go through a fairly lengthy process during which there are bound to be setbacks, frustrations and in the beginning, quite probably considerable stress due to mistrust. although these aspects are not highlighted by the various authors, they are implicit in their reports. all the authors emphasize the need for developing sound interpersonal and intergroup relations, as well as for commitment to a communications process. this is clearly a key issue in building relationships and developing common values. it goes without saying that a relationship of trust will only develop once people get to know each other, and this will only happen once they start communicating and interacting. it is equally obvious that a shared value system will only develop once people communicate their values and beliefs to each other, and then begin to collectively examine these values until they find communality and preferably consensus. developing proper communications skills, as well as a commitment and preparedness to interact freely and openly, must be regarded as a sine qua non for effective interest based bargaining r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 447 another aspect which emerges from the presentation of the relevant projects without being specifically mentioned, is that success will not be achieved unless the parties have adequate information about each other, their respective views, beliefs, values and interests. all the authors who highlight this issue point to the need for information to be comprehensive and freely shared. it is in fact suggested that one party should not have to request any information from the other party, but that both parties should make available all information which they may have and consider relevant to the issue under discussion. this is likely to create a perception of openness, honesty, and commitment to a relationship to enhance mutual trust. unsolicited and complete information sharing must therefore be regarded as another important requirement for and guiding principle ofinterest based bargaining. a main cause of mistrust and reluctance to communicate openly, is the perception that a person may have about other people and their motives. it is well known that perceptions are the products of the underlying values and the stereotypes that people develop as a result of these values. one of the most important issues which has to be addressed in the development of a relationship of trust, is the preparedness to examine these perceptions, to correct fallacious and biased views and stereotypes, and to substitute correct perceptions based on common or shared values. in the cases studies mentioned above, the parties concerned seemed to accept that they would probably not be successful if they embarked on the formidable process of establishing a trust relationship, if they did not enjoy the assistance of a properly trained and neutral facilitator to guide them through the process. as is the case with various intragroup relationships, an intergroup trust relationship also has to be developed between the respective parties and the facilitator. it would of course speed up the process and make it much easier if they started off with trust in the facilitator. in most cases, the parties would trust the facilitator if they were convinced of his expertise, both as facilitator and bargaining expert, his integrity, neutrality and of course trustworthiness. recent experience in south africa has shown that interest based bargaining, as is probably the case with traditional collective bargaining as well, often meets with failure because the parties concerned have different or opposing views and positions on issues which are really peripheral to the actual negotiation agenda proposed by them. in a recent case attended by the author, the negotiations ended in deadlock, with the union side vehemently defending their demand for a 12% wage increase and the employer side refusing to make any concession on its offer of 8%. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 448 sajems ns vol 2 (1999) no 3 mediation of the dispute later revealed that it was not really the percentage of the increase which had causes the deadlock, but the actual amount of take home pay. what had happened, was that both parties had agreed to use "the inflation rate" as the basis for negotiating the wage increase. management had then proceeded to use the "official" (government) index produced by statistics south africa, while the union relied on a variety of newspaper and popular journal articles, to choose either the recorded inflation index or an "inflation plus" index decided on by themselves. when management responded, the positions were so disparate that the parties accused each other of dishonesty and reneging on the agreement to use the inflation index. accusations of "bargaining in bad faith" became the order of the day, the relationship deteriorated to the extent that anything said by one party was immediately questioned and contested by the other. public demonstrations by the union turned to violence and destruction of property. mediation also highlighted the fact that if management had not used the overall consumer price index, but relied on the sub-index for household consumables instead, then they would have reached almost exactly the same figure as the union, which had relied on a calculation based on a basket of goods. when asked subsequently whether they would have considered the offer/demand of the other party if it had been based on the "common" index, both parties responded without hesitation that they would have unequivocally accepted it. it is clear from the last mentioned case that if the nature and content of the "inflation index" had been jointly determined, agreement would probably have been reached on this item, without much negotiation. if this had happened, it seems reasonable to assume that the parties would have left the negotiations feeling good about themselves and each other, perhaps trusting each other more as partners in the employment relationship. this case raises another guiding principle of interest based bargaining, namely that mediation could serve a useful purpose in creating mutual understanding and values. communality of interests based on this principle could avoid obstacles that might otherwise negatively impact the trust relationship. apropos the above case, the following untested proposal may be put forward for consideration. if mediation seems able to serve the purpose of establishing common understanding, values and interests with regard to certain interest disputes and so to facilitate interest based bargaining, it seems reasonable to assume that arbitration could serve the same purpose. arbitration of disputes about rights, would obviate disruption of the bargaining process, as the parties r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 449 would then have clarity on these rights. this may even be a means of settling minor disputes about interests, so that the trust relationship is not affected. 4 conclusion to conclude, the following suggestions are made to promote interest based bargaining in general and the development of the trust relationship in particular. effective collective bargaining is an extremely taxing process because of the complex dynamics of the process itself, as well as the complexity and intensity of the forces that influence the process. a pre-existing device that may assist in reducing intensity and complexity, is for the parties to jointly develop the "rules of the game", and to formalize these rules in an enforceable agreement. stumbling blocks should be removed by mediation and arbitration, either prior to or during the actual negotiation process. commonalties should be explored, developed and established in joint sessions. finally, the negotiating process should be facilitated by a qualified, skilled and trusted person, whose task it is to guide the negotiation process and clarify the rules of the game. references adams, g. (1994) negotiation: why we do it like we do, source unknown 2 albertyn, c. (1994) "interest bargaining over wages", employment law, 11(2): 26-7. 3 barrett, b. (1990) "a win-win approach to collective bargaining: the p.a.s.t. model", labour law: 41-4. 4 barrett, b. (1990) "the pas.t. model of win-win collective bargaining", proceedings of the 44th annual meeting of the industrial relations research association: 1-2. 5 fisher. r. & ury, w.l. (1991) getting to say yes: negotiating agreements without giving in, business books, 2nd ed., london. 6 cameron, d. (1997) "saskatchewan's public service", business quarterly, 61(3): 45-7. 7 carl ton, p.w. (1995) "interest based collective bargaining at youngstown state university: a fresh organizational approach", journal of collective negotiations in the public sector, 24(4): 337-47. 8 cahill, ]. & mccrary, d. (1995) "interest based problem solving", credit union executive, 35(1): 11-13. 9 cimini, m.h. & muhl, c.]. (1995) "twin cities nurses reaches accord", monthly labor review, 118(8): 74-75. 10 chamberlain, n.w. (1951) collective bargaining, mcgraw hill, new york. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 450 sajems ns vol 2 (1999) no 3 11 chamberlain, n.w. (1995) a general theory of economic process: harper & row, new york. 12 derber, m.(l960) the local union-management relationship, institute of labor and industrial relations, university of illinois. 13 deutsche, h. (1958) "trust and suspicion", journal of conflict resolution, vo1.2: 265-79. 14 dunlop, j.t. (1958) industrial relations systems, holt inc., new york. (also southern illinois press, 1977). 15 estes, m. (1997)"adversaries find common ground", workforce. 76 (3): 97-102. 16 golden, e.s. & parker, v.d. (1948) causes of industrial peace under collective bargaining, mcmillan & co, new york. 17 jacques, e. (1966) the glacier project papers, brunei university press, sussex. 18 mayberry, j.s. (1958) collective bargaining and industrial relations, prentice hall, london. 19 moore, j.d. (1996) "minnesota deal satisfies union", modem healthcare, 26(15): 20. 20 murnighan, j.k. (1991) the dynamics of bargaining games, prentice hall, new jersey. 21 owen, l. (1997) "a new perspective on negotiation", people dynamics, 15(6): 14-17. 22 pigou, a.c. (1959) the economics of welfare (2 nd ed.), macmillan, london. 23 robinson, c. (1995) effective negotiating. kogan page, london. 24 rosenberg, m.1. (ed.) (1960) attitudes organization and change, yale university press, new haven. 25 stepp, j. & barrett, b. (1997) "new theories of negotiations and dispute resolution, and the changing role of mediation", daily labour reporter, f.1 f.5. 26 ury, w.l., brett, j.m. and goldberg, s.b. (1998) getting disputes resolved: designing systems to cut the cost of conflict. 27 walton, re & mckersie, r.b. (1965) a behavioural theory of labor negotiations. mcgraw hill book co, new york. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction conceptualising strategic thinking competency contextualising leadership effectiveness problem statement research objectives research design and methodology summary of empirical findings and conclusions managerial implications, limitations and recommendations for further research acknowledgements references about the author(s) samuel m. muriithi department of commerce, school of business and economics, daystar university, kenya lynette louw department of management, rhodes university, south africa sarah e. radloff department of statistics, rhodes university, south africa citation muriithi, s.m., louw, l. & radloff, s.e., 2018, ‘the relationship between strategic thinking and leadership effectiveness in kenyan indigenous banks’, south african journal of economic and management sciences 21(1), a1741. https://doi.org/10.4102/sajems.v21i1.1741 original research the relationship between strategic thinking and leadership effectiveness in kenyan indigenous banks samuel m. muriithi, lynette louw, sarah e. radloff received: 05 jan. 2017; accepted: 22 jan. 2018; published: 19 apr. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: leadership effectiveness is critical to organisational performance and survival. to be effective, organisational leaders must possess the right competencies. one vital leadership competency is strategic thinking, which is described as the ability to synthesise and utilise intuition and creativity in order for an organisation to achieve an integrated perspective. strategic thinking remains a critical area for research, owing to lack of supporting empirical literature, and to theories that give little or no guidance to leaders. aim: the purpose of this study is to empirically test the relationship between strategic thinking competency and leadership effectiveness in kenyan indigenous banks. setting: the setting of the study is the indigenous banks in kenya. methods: the study was based on a positivist research paradigm which is quantitative in nature and utilised a survey method to collect data. both probability and non-probability methods were used to determine the target population. the research instrument was a self-administered, closed-ended questionnaire. from a target population of 494 individuals, a total of 257 responses were received and analysed. the analysis was performed using structural equation modelling with confirmatory factor analysis, cronbach’s alpha and goodness-of-fit indices being used for analysis and testing relationships. results: the overall findings are that a positive relationship exists between strategic thinking and leadership effectiveness in indigenous banks in kenya. the study further establishes positive relationships between the strategic thinking competency and its sub-constructs of general strategic thinking, intent-focused and hypothesis-driven, but a negative relationship with intelligent opportunism. a similar positive relationship exists between leadership effectiveness and its sub-constructs of influence, follower commitment and versatility. conclusion: this research has established that strategic thinking is an important determinant of leadership effectiveness for indigenous banks in kenya, and therefore supports prevailing literature and theory indicating a positive relationship. the implication of the study is that bank management should strive to maintain strategic thinking competency for effective leadership, successful bank performance and stability. introduction the banking industry remains one of the greatest agencies of commerce in the contemporary world (ey 2015). in spite of its positive contribution to commerce, however, the banking industry is blamed for many economic upheavals and financial crises worldwide (brunnermerier 2009). for several decades, banking behaviour and practices have been associated with crises leading to dismal performances of most world economies, both developed and developing (grant thornton 2013). on the african continent, the bank industry is characterised by small-sized banks, unstable markets, poor economies, low deposits and a dominance of foreign banks (van ballekom 2013). compared with other world economies, africa remains the smallest player and contributor in the financial sense (mlachila, park & yaraba 2013). the continent has also experienced numerous financial crises over the last five decades associated with poor management and poor leadership (ambutsi 2005; mwangi 2012; njuguna 2013; sokpor 2006). these financial crises have not spared countries such as kenya, which experienced dismal performance in its financial sector from 1970 to 2005. during this period, more than 20 banks closed down or became bankrupt (ambutsi 2005; mwangi 2012; sokpor 2006). for banks to be successful, leadership effectiveness is critical (grant thornton 2013; kubicek 2011). such leadership can only be realised if bank leaders possess the right competencies to perform the required tasks effectively (al-zoubi 2012; mintzberg 1994). one vital leadership skill that is essential for organisational effectiveness is strategic thinking. different models developed by scholars such as amos (2012), barnes (2013) and schoonover (2011) have singled out strategic thinking as a major ability associated with leadership effectiveness. according to hogan, hogan and kaiser (2009), strategic thinking is the ability to plan, organise, coordinate, monitor and make use of available resources. chilcoat (1995) comments that effective leaders demonstrate more strategic thinking competency than ineffective leaders do, whether in the banking industry or in other situations. this point is supported by fairholm (2009:12) who argues that strategic thinking competency enables organisations to change and adapt to future challenges. goldman (2012) emphasises that leaders who think strategically are good decision-makers and contribute greater value to their organisations. personnel decisions international corporation (2001) further observes that strategic thinking competency is considered a major component of leadership requirements in the contemporary volatile environment. given the importance of strategic thinking as a leadership competency and the lack of research on strategic thinking competency focusing on kenyan banking leadership, this study aims to investigate the relationship between strategic thinking competency and leadership effectiveness in the indigenous banking industry in kenya. although there is some evidence in other industries that leadership effectiveness, in turn, impacts on organisational effectiveness (amos 2012; bonn 2001; fairholm 2009; goldman 2012), those findings are not relevant to the current study. firstly, a brief overview of the literature on strategic thinking and leadership effectiveness is given. this is followed by a discussion of the problem statement, purpose, objectives and hypotheses. the research methodology used in this study is then described, after which the study findings are presented. to conclude, the limitations and managerial implications of the study are provided. conceptualising strategic thinking competency the concept of strategic thinking competency has been debated by scholars and practitioners for the last 25 years in an effort to understand its meaning and impact on organisational leadership and performance. although the concept is gaining interest, it is still an area considered to be under-researched (jelenc 2008:6) as there is a lack of supporting empirical literature to clarify the role of strategic thinking in leadership effectiveness (liedtka & rosenblum 1998; rosche 2003). this has resulted in a lack of theoretical understanding, leaving little guidance for leaders (liedtka 1998). fairholm and fairholm (2009:2) conceptualise strategic thinking competency as a work in progress in the world of academic literature. the mere lack of a common definition for strategic thinking has led to the concept being considered indecisive (bonn 2001; goldman 2007) and even being confused and interchangeably used with other leadership and management concepts such as strategy, strategic planning and strategic management (bonn 2001; jelenc 2008; liedtka 1998). mintzberg (1994:110) states that ‘many practitioners and theorists have wrongly assumed that strategic planning, strategic thinking, and strategy-making are all synonymous’. however, recent studies have refined the existing literature on strategic thinking, thereby distinguishing it from the other strategy types (goldman 2012; haycock, cheadle & bluestone 2012; markides 2012). this reworking of the definition of strategic thinking is triggered by the popularity of and attention to this concept as being critical to leadership effectiveness (markides 2012). similarly, the uncertainty, complexity and turbulence of the contemporary world of business has demanded that organisational leaders and managers think strategically in order to ensure survival of their businesses (haycock et al. 2012; liedtka 1998). among the numerous definitions given by scholars, o’shannassy (2006:14) defines strategic thinking as ‘a particular way of solving strategic problems and opportunities at the individual and institutional level combining generative and rational thought processes’. mintzberg (1994) and raimond (1996) on the other hand see strategic thinking as the ability to synthesise and utilise intuition and creativity in order to give an integrated perspective to an organisation. jelenc (2008) and torset (2001) understand strategic thinking as a self-reflection on an organisation’s future that must be conceived as an organisational cognitive process which is performed and supported by a group through interaction and interdependence. for the purpose of this study, strategic thinking is defined as a mental process which involves synthesising, utilising intuition and creativity to identify and solve problems. the process is meant to improve organisational performance through innovative and creative activities that enhance overall leadership effectiveness (goldman 2012). in order to further examine and understand strategic thinking in this study, and based on previous research by liedtka (1998) and jelenc (2008), it was conceptualised and analysed in terms of six sub-variables, namely strategic thinking (general), thinking in time, intent-focused, intelligent opportunism, system perspective and hypothesis-driven. the definitions of the six sub-variables investigated in this study and their corresponding measures are indicated in table 1. table 1: the sub-variables of strategic thinking competency. contextualising leadership effectiveness in the contemporary world, effectiveness is defined as the ability to achieve set targets or objectives (yukl 1994, 2010). in terms of leadership, effectiveness implies the leaders’ ability to perform and successfully attain organisational set standards (green 2010; yukl 2010). however, over the years, measuring effectiveness has remained a controversial subject to both scholars and practitioners owing to different measures which depend on organisations and circumstances. this has similarly affected the measurement of leadership effectiveness which still lacks a universally accepted approach (arnold, cooper & robertson 1998). stogdill (1974) and later bass (1990) catalogued and interpreted over 5000 studies on leadership effectiveness in an attempt to identify major similarities and differences. burns (1978:2) further observes that leadership effectiveness ‘is one of the most observed and least understood phenomena on earth’. some of the definitions of leadership effectiveness are: the process of influencing other people’s behaviour in order to accomplish set goals (norma 1997). the ability to achieve set objectives, subordinates’ attitude towards the leadership and the leadership’s overall influence on the group’s performance (yukl 1994). the ability to successfully exercise personal inspirations and abilities resulting in attaining set organisational goals and objectives (cooper, fenimore & nirenberg 2012:1). in the current study, leadership effectiveness is seen as the leader’s influence and ability to successfully exercise personal influence on others, thereby resulting in the attainment of set goals and objectives. according to numerous studies, leadership effectiveness is measured using five main sub-variables of cross-cultural competency, influence, follower commitment, versatility and group organisation (cooper et al. 2012; green 2010; national centre for research in vocation education [ncrve] 1994). the definitions of the five sub-variables and their corresponding measures are shown in table 2. table 2: the sub-variables of leadership effectiveness. problem statement as mentioned in the introduction to this study, for more than four decades, the kenyan banking industry experienced poor performance (ambutsi 2005; mwangi 2012; njuguna 2013; sokpor 2006). this was attributed to credit problems, operational risks, poor management and poor leadership competencies, poor legal frameworks and weak control mechanisms, leading to insolvencies and the closure of many banks. an examination of the industry performance shows that a total of 24 financial institutions were liquidated while many were put under receivership. it is however notable that from 2003, many local banks started to institute changes meant to transform the sector – which resulted in positive performance (central bank of kenya 2010). it is clear that leadership and management skills are enhanced by having the right competencies (goleman 1998). one critical ability necessary to attain leadership effectiveness is strategic thinking (liedtka 1998). according to mintzberg (1994), effective leaders are strategic thinkers. in fact, a lack of strategic thinking competency has been associated with top executives’ failures and ineffectiveness worldwide (bonn 2001; chilcoat 1995; haycock et al. 2012). strategic thinking has also been associated with successful organisations in enabling them to respond to environmental challenges and adapt to future demands (fairholm 2009:12). as such, strategic thinking is a very important skill associated with effective leaders. although numerous studies have been done on the kenyan banking industry (ambutsi 2005; mwangi 2012; njuguna 2013; sokpor 2006), there is no study focusing on strategic thinking competency and leadership effectiveness. specifically, the impact of strategic thinking on leadership and its effect on the overall performance of indigenous banks has never been tested empirically in this industry. although the indigenous banks performed poorly for decades, as indicated above, they have performed better since 2005. because bank performance is associated with effective leaders who must possess the right competencies, this study aims to establish whether the improved performance is partially attributable to strategic thinking competency among the leaders. research objectives the study investigates the relationship between strategic thinking competency (independent variable) and leadership effectiveness (dependent variable) in the kenyan indigenous banking industry. the main objective of this study is to determine whether strategic thinking competency is positively correlated with leadership effectiveness leading to improved performance of the overall banking industry. the secondary objectives of this study are: to determine whether there is a positive correlation between strategic thinking competency and its sub-variables, namely strategic thinking (general), thinking in time, intent-focused, intelligent opportunism, system perspective and hypothesis-driven. to determine whether there is a positive correlation between leadership effectiveness and its sub-variables, namely cross-cultural competency, influence, follower commitment, versatility and group organisation. by investigating the relationship, it is believed that the findings will add value to the understanding of bank leadership effectiveness, which will in turn enhance bank performance. the hypothesised relationship results in the development of a theoretical framework and relationship as depicted in figure 1. figure 1: proposed hypothesised framework of the relationship between strategic thinking competency and leadership effectiveness. the following hypothesis and sub-hypotheses were formulated and tested in order to establish whether there is a positive relationship between strategic thinking and leadership effectiveness. main hypothesis h1: there is a positive relationship between strategic thinking competency and leadership effectiveness sub-hypotheses h1.1 h1.1: there is a relationship between the strategic thinking variable and its sub-variables: h1.1a: strategic thinking (general) h1.1b: thinking in time h1.1c: intent-focused h1.1d: intelligent opportunism h1.1e: system perspective h1.1f: hypothesis-driven sub-hypotheses h1.2 h1.2: there is a relationship between the leadership effectiveness variable and its sub-variables: h1.2a: cross-cultural competency h1.2b: influence h1.2c: follower commitment h1.2d: versatility h1.2e: group organisation research design and methodology the current study used a positivist paradigm to establish the relationship between strategic thinking and leadership effectiveness, considering the quantitative nature of the data gathered by means of a survey method. the population for this study consisted of 30 kenyan indigenous banks and their employees. the participating banks were ranked in terms of their market share, ranging from the smallest to the largest market shares. from this ranking, the top 15 (50%) of 30 indigenous banks were included in this study. however, only 13 banks finally participated in the study. a total of 494 respondents were targeted, from whom 273 questionnaires were returned, with only 257 of them being usable for statistical analysis, giving a response rate of 55.3%. according to literature, 257 usable questionnaires was considered adequate for analysis in this case, since it was within the structural equation modelling (sem) acceptable range of between 200 and 400 responses (farrington 2009). there are also scholars who support samples of between 100 and 200 cases (hair et al. 1998). measuring instrument development in order to collect data, a survey method using a self-administered questionnaire consisting of a cover letter and four sections was used. section 1 of the questionnaire consisted of 20 statements and gathered information pertaining to the kenyan indigenous banks’ existence, development, leadership and performance. section 2 covered strategic thinking competency, assessed using 38 statements, while section 3 focused on leadership effectiveness. statements in sections 2 and 3 were measured using a multi-item labelled five-point likert-type scale and respondents were required to indicate their level of agreement with listed items (where 1 = strongly disagree and 5 = strongly agree). finally, section 4 concentrated on demographic information of the respondents such as gender, age, education level, work position and bank rating. the operationalisation of the independent variable, strategic thinking, and the dependent variable, leadership effectiveness, the main sources and number of items for each sub-variable are provided in table 3. table 3: operationalisation of the independent and dependent variables. data collection the distributed questionnaire was accompanied by a covering letter explaining the purpose of research, the importance of confidentiality and the need for participants’ consent before participating in the research. through the use of research assistants, some of the questionnaires were physically distributed and collected, while others were administered and completed electronically, as preferred by some respondents. the actual data collection took place over a period of 4 months. data analysis the analysis of the data was performed using sem. the software programme amos (ibm spss statistics, version 21, 2013) was used for the sem. the analysis included confirmatory factor analysis (cfa) and cronbach’s alpha (ca) to assess the discriminant validity and reliability of the measuring instrument as well as the goodness-of-fit indices. ethical consideration to collect the required data, the researcher obtained necessary permissions and approvals. the process of data collection was twofold: firstly a permit was obtained from the national council for science and technology, a government body responsible for research conducted in kenya. secondly, the department of management at rhodes university granted permission for the research to be conducted after meeting the required university research ethical standards. the necessary permission from targeted indigenous banks was also received. empirical results sample description the descriptive statistics show that most respondents who participated in the study were women (52.1%) while 47.9% were men. the results further indicate that the majority of respondents were young bank employees aged between 25 and 40 years (63.8%). likewise, most respondents (54.4%) were university graduates who had worked in the banking industry for a period ranging between 1 and 10 years (84%) with more than half (52.1%) having worked between 1 and 5 years. more than half of respondents (64.2%) indicated that their banks had existed during the 1980s–1990s and had been exposed to the financial crisis period. discriminant validity and reliability results firstly, a cfa was conducted to determine unique factors in the data and assess the discriminant validity of the scales measuring the independent and dependent variables. the validity of the strategic thinking sub-variables (referred to as sub-constructs), namely strategic thinking (general), thinking in time, intent-focused, intelligent opportunism, system perspective and hypothesis-driven, were extracted and confirmed. in this study, only factor scores of 0.3 or above were accepted for further analysis (hair et al. 2006:128). from the results of cfa, only four of the six factors loaded successfully for strategic thinking. two sub-constructs, thinking in time and system perspective, failed to load as expected and were eliminated from further analyses. likewise, the thinking in time sub-construct did not load on any factor and was eliminated from further analysis. the system perspective sub-construct, on the other hand, loaded successfully on two items. in this study, a factor must have loaded on three or more measuring items to be accepted; the system perspective sub-construct was thus dropped from further analysis. the final results showed that only the strategic thinking (general), intent-focused, intelligent opportunism and hypothesis-driven sub-constructs loaded successfully and were therefore considered for further analysis. the final four sub-constructs and their factor loading values are shown in table 4. the factor structure that emerged from the cfa explained 47.6% of the variance in the data. all sub-constructs have eigenvalues of more than 1 indicating an acceptable level of significance (farrington 2009:388–389; hair et al. 2006:103). table 4: results for factor analysis for strategic thinking. the ca for the strategic thinking construct was calculated in order to determine the reliability of the scales of the measuring instrument. the ca score of 0.930 for strategic thinking was considered very reliable compared to the acceptable minimum score of 0.600 (hair et al. 2007). the specific ca scores for each of the strategic thinking sub-constructs were strategic thinking (general) (0.791), intent-focused (0.821), intelligent opportunism (0.731) and hypothesis-driven (0.833). these findings are in agreement with similar studies and are therefore acceptable (jelenc 2008). upon subjecting the leadership effectiveness construct to a cfa assessment, three sub-constructs (influence, follower commitment and versatility) loaded accordingly while two (group organisation and cross-cultural competency) did not load as expected and were consequently eliminated from further analysis. the leadership effectiveness construct explained 48.6% of the variance in the data. the results of the three sub-constructs that successfully loaded as expected are presented in table 5. table 5: results of factor analysis for leadership effectiveness. the ca score of 0.914 for the dependent variable, leadership effectiveness, was also considered very reliable. the ca scores for the sub-constructs were: influence (0.759), follower commitment (0.752) and versatility (0.738). the results indicated that items used to measure leadership effectiveness were reliable since all the scores, as previously justified, were greater than the 0.600 minimum acceptable score. the results are in agreement with similar studies (green 2010; ncrve 1994). revised hypotheses having conducted cfa tests and ca coefficients, the hypothesised framework and related sub-hypotheses required revision. it is notable that both the independent and dependent sub-constructs were revised, since some sub-constructs were eliminated for failure to load as expected, as explained in the previous section. the revised hypotheses are listed below. main hypothesis h1: there is a positive relationship between strategic thinking and leadership effectiveness sub-hypotheses h1.1 h1.1: there is a relationship between strategic thinking (construct) and its sub-constructs: h1.1a: strategic thinking (general) h1.1b: intent-focused h1.1c: intelligent opportunism h1.1d: hypothesis-driven sub-hypotheses h1.2 h1.2: there is a relationship between leadership effectiveness (construct) and its sub-constructs: h1.2a: influence h1.2b: follower commitment h1.2c: versatility results of structural equation modelling as highlighted previously, both the cfa tests and ca coefficients confirmed that four of the strategic thinking sub-constructs and three of the leadership effectiveness sub-constructs were appropriate for further analysis. as a result of the elimination of sub-constructs, the original proposed theoretical framework (referred to as a model from here onwards) was revised as shown in figure 2. figure 2: the revised hypothesised model of the relationship between strategic thinking competency and leadership effectiveness. the revised model and subsequent hypotheses were further tested using sem in order to determine the level of goodness-of-fit. to this effect, the validation and testing of the hypothesis and sub-hypotheses was done using sem. results of the relationships between strategic thinking and its sub-constructs the hypothesised relationships between strategic thinking and its sub-constructs are shown in sub-hypotheses h1.1a–d (figure 2). owing to space constraints, the structural relationship model of the study has not been included in this article. instead, the structural and measurement model for strategic thinking and its sub-constructs is shown in table 6. table 6: definition of structural and measurement model for strategic thinking and its sub-constructs. goodness-of-fit results to measure the fitness of the actual or observed input correlation or covariance in relation to the prediction assumed by a theoretical model, a goodness-of-fit test is required (hair et al. 1998:610–620; venter 2003:257). in the current study, the goodness-of-fit was determined using four measures, namely normed chi-square (the ratio of chi-square to degrees of freedom: χ/df), the root mean square error of approximation (rmsea), the goodness-of-fit index (gfi) and comparative fit index (cfi). the results of goodness-of-fit tests for the structural strategic thinking model are presented in table 7. table 7: goodness-of-fit indices for the structural strategic thinking model. the results of various tests shown in table 7 indicate the construct strategic thinking competency as fitting. the cmin/df value of 3.157 falls between 2.0 and 5.0, indicating a good fit between the data and the model strategic thinking competency (hooper, coughlan & mullen 2008; tabachnick & fidel 2007) the rmsea value of 0.092, on the other hand, was outside the acceptable range of 0.05–0.08 and was therefore considered a poor fit (maccullum, browne & sugawara 1996). the gfi value of 0.838 was less than 0.90 thereby indicating a weak relationship. however, according to hu and bentler (1999) a value of 0.838 is still within an acceptable fit. finally, the cfi value of 0.819 was within what is considered a good-fitting model as it was greater than 0.80 (hooper et al. 2008). the results of the analysis of goodness-of-fit showed that cmin/df, gfi and cfi were acceptable to good fits, thus confirming that the strategic thinking competency model was acceptable. this also agreed with the minimum number of tests required for a test to be accepted in this study (jaccard & wan 1996). the goodness-of-fit results mean that the four sub-constructs, namely strategic thinking (general), intent-focused, intelligent opportunism and hypothesis-driven are acceptable as fitting. structural model parameter estimates and p-values for strategic thinking similarly, the hypothesised relationship between strategic thinking competency and its sub-constructs was analysed. the results demonstrating the parameter estimates and the p-values are summarised in table 8. table 8: structural model parameter estimates and p-values for strategic thinking. as shown in table 8, a significant positive relationship (p < 0.001) exists between strategic thinking competency and three of its sub-constructs; strategic thinking (general) (estimate = 0.497; p < 0.001), followed by intent-focused (estimate = 0.486; p < 0.001) and hypothesis-driven (estimate = 0.402; p < 0.001). there was, however, a negative relationship with intelligent opportunism (estimate = –0.271; p < 0.001). overall, the results indicate that these are important components of the strategic thinking competency. the findings provide support for h1.1.a–d. the results show that the participating bank leaders had a general strategic view of their organisations, had intent-focused and hypothesis-driven leadership, and practised intelligent opportunism. the validation of strategic thinking sub-constructs is in line with similar studies that singled out lack of strategic thinking competency in organisations as a major source of leadership ineffectiveness (bonn 2001; jelenc 2008; liedtka 1998; rosche 2003). the negative relationship indicates that while intelligence opportunism was important in ensuring continuity and strategic focus, leaders must be aware of and be sensitive to changes that might negatively affect their efforts, thereby undermining their intended objectives or goals (jelenc 2008). results of the relationships between leadership effectiveness and its sub-constructs the hypothesised relationships between leadership effectiveness and its sub-constructs are shown in sub-hypotheses h1.1a–c (figure 2). owing to space constraints the structural relationship model has not been included in this article. instead, the structural and measurement model for strategic thinking and its sub-constructs is shown in table 9. table 9: definition of structural and measurement model for leadership effectiveness and its constructs. goodness-of-fit results in relation to goodness-of-fit indices, the analyses of the sub-model leadership effectiveness and its constructs showed a good fit between the proposed measurement and structural sub-model, therefore signifying acceptable approximation of the data (see table 10). table 10: goodness-of-fit indices for the structural model on leadership effectiveness and its constructs. as shown in table 10 the cmin/df value of 2.671 signifies a good fit between data and the sub-model, while the rmsea value of 0.081 slightly exceeds the accepted fit of between 0.61 and 0.08 (grimm & yarnold 2000). the gfi value of 0.924 is seen as a good fit, as it ranged between 0.90 and 0.95 accepted level (ghazali et al. 2013). finally, the cfi value was 0.921 which is seen as very good (hair et al. 2006) and well-fitting (hooper et al. 2008; hu & bentler 1999). the findings indicate that three of the tests (cmin/df, gfi and cfi) were acceptable to good fits, therefore confirming an acceptable goodness-of-fit in the leadership effectiveness model. the goodness-of-fit results mean that the three sub-constructs, namely influence, follower commitment and versatility are accepted as fitting. structural model parameter estimates and p-values for leadership effectiveness the hypothesised relationship between the leadership effectiveness construct and its sub-constructs (influence, follower commitment and versatility) was confirmed by use of sem. the results shown in table 11 demonstrate the parameters and the p-values of the data. table 11: structural model parameter estimates and p-values for leadership effectiveness and its constructs. the results from table 11 show that a positive relationship (p < 0.001) exists between the leadership effectiveness construct and its sub-constructs. the findings therefore provide support for sub-hypotheses h1.2a–c. in terms of importance, the influence sub-construct has the greatest impact as a measure of leadership effectiveness (estimate = 0.717; p < 0.001), followed by follower commitment (estimate = 0.664; p < 0.001) and versatility sub-constructs (estimate = 0.483; p < 0.001) respectively. from the results, it can be asserted that the more bank leaders exercise their influence, ensure follower commitment and versatility, the more effective they are in their operations. the relationship between strategic thinking and leadership effectiveness to achieve the main purpose of this study, the relationship between the strategic thinking and leadership effectiveness constructs was examined as shown in the main hypothesis: h1: there is a positive relationship between strategic thinking competency and leadership effectiveness. from the findings derived from sem analysis and the parameters and the p-values represented in table 12, there exists a strong positive relationship between strategic thinking and leadership effectiveness constructs. table 12: structural model parameter estimates and p-values for strategic thinking competency and leadership effectiveness. table 12 shows a positive relationship (p < 0.001) between the strategic thinking construct and the leadership effectiveness construct (estimate = 0.544; p < 0.001). the results provide support for hypothesis h1. this relationship is corroborated by literature which indicates the need for bank leadership to pay attention to strategic thinking competency (avolio & bass 2004; howell & hall-marenda 1999; samson & daft 2012). summary of empirical findings and conclusions the results of this study indicate that there exists a positive relationship between strategic thinking competency and leadership effectiveness among the indigenous banks in kenya. this means that bank leadership must possess the right strategic thinking competencies in order to make their banks effective and achieve the desired performance. however, to achieve the level of effectiveness desired, the right strategic competencies must first be identified and implemented. in this study it was hypothesised that six strategic thinking (independent variable) sub-constructs were critical to leadership effectiveness as derived from various empirical studies and literature, namely strategic thinking (general), thinking in time, intent-focused, intelligent opportunism, system perspective and hypothesis-driven. similarly, leadership effectiveness (dependent variable) was assumed to be influenced by five sub-constructs (cross-cultural competency; influence; follower commitment; versatility and group organisation). upon conducting several analyses and model tests ranging from cfa and ca to cfis, the findings revealed significant adjustments to the proposed sub-constructs. strategic thinking competency: from the cfa performed on strategic thinking sub-constructs, four sub-constructs loaded successfully, namely strategic thinking (general), intent-focused, intelligent opportunism and hypothesis-driven. however, two sub-constructs (thinking in time and system perspectives) failed to load accordingly and were eliminated from further analyses. the four sub-constructs that loaded successfully were subjected to a ca test with positive results. a hypothetical test to establish the relationship between strategic thinking competency (see figure 2) and its sub-constructs indicated the existence of a relationship. these findings provide support for all strategic thinking sub-hypotheses (h1.1a–d). in order of importance, strategic thinking (general) is the most important constituent of strategic thinking competency, followed by intent-focused, hypothesis-driven and intelligent opportunism respectively. the result implies that the bank leaders need to pay attention to the four sub-constructs of strategic thinking as being critical to these leaders’ effectiveness and overall bank performance. the indigenous banking sector’s leadership also needs to possess strategic thinking (general), intent-focused, intelligent opportunism and hypothesis-driven sub-competencies if leadership is to achieve the objectives of their banking and sustain successful performance levels. leadership effectiveness: from the cfa performed on leadership effectiveness sub-constructs, three sub-constructs loaded successfully, influence, follower commitment and versatility. however, two sub-constructs (cross-cultural competency and group organisation) failed to load as expected, leading to their elimination. further tests of the hypothetical relationship indicated that a strong relationship exists between leadership effectiveness and its sub-constructs. influence was found to be the most important sub-construct, followed by follower commitment and versatility respectively, thereby supporting h1.2a–c. the results imply that influence, follower commitment and versatility sub-constructs are essential measures of leadership effectiveness within the indigenous banking sector in kenya. the implications of the findings are that bank leaders should use industry-specific measures rather than rely on general leadership measures which are discussed in literature. the hypothetical relationship between strategic thinking and leadership effectiveness (h1) was tested. the results indicate a positive relationship (p < 0.001) between the two (estimate = 0.544; p < 0.001). this relationship is in agreement with various studies, all emphasising the need for the banking industry to pay specific attention to strategic thinking competency as a key ingredient in leadership effectiveness and overall banking performance. this means than bank leaders must strive to maintain strategic thinking competency as a prerequisite for their effectiveness. this will enable them to synthesise information and be creative in their leadership. managerial implications, limitations and recommendations for further research as indicated previously, four sub-constructs (general strategic thinking, intent-focused, intelligent opportunism and hypothesis-driven) were significant measures of the strategic thinking competency in this study. this finding has added significant value to a field of strategic thinking which is considered to be under-researched (fairholm & fairholm 2009; jelenc 2008). the few studies in strategic thinking have also not generated acceptable competencies or sub-constructs essential for leaders. for instance, liedtka’s (1998) study had five sub-constructs while jelenc (2008) had six sub-constructs. however, the four sub-constructs arising from this study are in agreement with liedtka (1998), who cautioned against developing concepts that may not be relevant to practising managers. these findings are relevant to the indigenous banks’ leadership that focuses on the four sub-constructs as being critical to their performance. the implication of these findings is that by paying attention to the four sub-strategic thinking competencies, bank leaders will be in a position to remain competitive and attain the desired strategic goal and leadership in their industry. in relation to leadership effectiveness, this study has established three attributes (measures) essential for bank leadership to be considered effective. it is notable that the measures arising from this study have support from scholars (erkutlu 2006; green 2010; yukl 2010) indicating their relevancy and the need for bank leadership to pay attention to them as determinants of their effectiveness. the implication is that leaders need to understand that they have influence over their employees which must be carefully exercised. they also need to clearly understand the role of follower commitment. it is only when followers are committed to a common cause that the banks can realise their set goals. likewise, understanding of versatility will enable them to work with and obtain results from others, which is a major determinant of effectiveness. to achieve effectiveness, bank leaders must pay attention to empowering themselves and their employees with appropriate knowledge and skills. scholars have noted that although strategic thinking competency is important, it remains a critical research area owing to a lack of supporting theory and empirical literature regarding its role in leadership effectiveness, thereby making this study a major contribution to the body of knowledge (liedtka & rosenblum 1998; rosche 2003). however, since this is the first study on strategic thinking within the banking industry in kenya, it is recommended that the banks devote time and resources to equip employees with appropriate skills in order to enhance their strategic thinking competency. while this study concentrated on strategic thinking competency and its relationship with leadership effectiveness, there are other competencies that may also influence leadership effectiveness, such as emotional intelligence, business acumen, personality, team-building, relationship-building and transformational leadership. it would be important to conduct further studies on these additional competences in order to determine their relevancy to strategic thinking and leadership effectiveness and overall bank effectiveness. acknowledgements the authors would like to acknowledge various institutions involved either at data collection level, or with funding of the research and permission to conduct research. among them are rhodes university, daystar university, national commission for science, technology and innovation (nacosti) and bank respondents who took part in this study. competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions s.m.m. was the principal investigator responsible for the fieldwork and data collection and co-writing of this article. l.l. was the supervisor, academic leader, designer, editor and and co-writer of this article. s.e.r. was responsible for all the statistical analysis of data, presentation and interpretation, testing research instruments and models. 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lyon. van ballekom, p., 2013, banking in sub-saharan africa: challenges and opportunities, european investment bank, luxembourg. venter, e., 2003, ‘the succession process of small and medium-sized family businesses in south africa’, phd thesis, university of port elizabeth, port elizabeth. yukl, g., 2010, leadership in organizations, 7th edn., pearson education inc, upper saddle river, nj. yukl, g.a., 1994, leadership in organizations, 3rd edn., prentice-hall, englewood cliffs, nj. sajems ns vol i (1998) no 2 potential influence of social and technological developments on direct marketing in south africa yolanda jordaan 306 department of marketing and communication management, university of pretoria abstract this article argues that social and technological events in south africa are leading to the development of the direct marketing industry. the article reviews various social and technological aspects as well as the influence that government intervention has on the direct marketing industry, especially in terms oflegislation regarding privacy. the role of the south african post office is put under the spotlight since the direct marketing industry is very reliant on the post office. the opportunities presented by the information age are discussed and future growth areas highlighted. although this paper mainly concentrates on direct marketing, it also tries to explain the potential role of direct marketing in an economic system approach, as a driving force of economic progress in developing countries. introduction direct marketing is a rapidly maturing industry in south africa. with increased consumer interest and use of direct marketing, the industry is becoming more competitive and turning from a selling mode to one involving a more sophisticated marketing orientation. with this change it is necessary to understand better consumer attitudes, needs, beliefs and behaviour in order to fine-tune products and services and the ways in which they are offered (pring, 1990). the rapid increase of dual-income families has meant more income. at the same time, trends toward physical fitness, do-it-yourself, and home entertainment have reduced the time available for shopping and increased the attractiveness of direct purchases. the rapid technological advancement of electronic media and computers has made it easier for the consumer to shop and for the marketer to reach desired r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 307 sateb nr vol i (1998) nr 2 target markets. direct marketing is alive and well in the world. certainly the interest level is high. the things being done successfully by direct mail, the telephone and television are truly astonishing. this will definitely be a stimulus to a country's economy, in other words, raise its level of economic activity. the present focus is on economic agents, which enables one to address the question of productive ability at the level of a firm, an industry and an economy in a systematic way. it places great emphasis on strengthening the organisational capabilities of economic agents in the process of economic development. attention is also given to the technical and managerial capabilities of economic agents, viewing the "market" as a collection of relational arrangements among them. although the paper will mainly concentrate on the issue of direct marketing, it will also try to explain the potential role of direct marketing in the present economic system approach (esa) as a possible driving force for economic progress in developing countries. definition there are several reasons why the definition of direct marketing is important. on the one hand, the definition of a business area contributes to its professional image among consumers and other businesses. moreover, the definition of a business area is used to delineate it for academic purposes of research and teaching, and for identification and communication among the practitioners and consultants in the area. any conceptual definition of a business area is perforce an abstraction of techniques and practices, and as it is probable that no one definition will perfectly describe the concept of direct marketing, different definitions are used for different purposes (bauer, 1992). at present, the most widely accepted definition of direct marketing, which has been adopted by the direct marketing association, is "an interactive system of marketing which uses one or more advertising media to effect a measurable response and/or transaction at any location" (belch & belch, 1995). the most common definitions include direct mail, mail order, and direct response advertising. all three concepts are related to each other. direct mail is a promotional medium where postal services provide the means of communicating with would-be buyers. these commercial messages come in different shapes and sizes letters, postcards, catalogues, leaflets, coupons. mail order is a device for advertising goods and services through a medium such as television, magazines, or newspapers. but orders are executed by mail. today, mail order has been expanded to the telephone. the modern customer r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 2 308 finds it easier to phone an order than to write it out on a standard form, stuff it into an often ill-fitting envelope, and remember to drop it into a mailbox on the way to work. whether the response is written or oral, the mail order technique is basically a method of product distribution. direct response advertising sends out sales messages by any medium, like the mail order, but does not confme itself to any narrow post office boundaries. in this respect, direct response advertising embraces the broadest range of activities (katzenstein & sachs, 1992). the direct marketing industry encompasses many different sales techniques, but essentially it includes every sales transaction where there is no face-to-face contact between seller and buyer. we use direct mail, telemarketing, mail order, direct response via television, radio and the printed media, and are now moving into the computer age with interactive marketing. what sets direct marketing apart from traditional above-the-line advertising, is its focus on the measurability of campaigns in terms of returns that can be directly attributed to each campaign, and the direct relationship with the benefits that the medium offers (ivins, 1996). over the years, various concepts have been used as synonyms for direct marketing, for example, mail order, direct mail and direct response. mail order is merely a distribution channel, direct mail is one of a number of media used for direct marketing, and direct response is an action-oriented type of advertising. to complicate matters still more, even today there is no agreement among practitioners whether direct marketing should really be called direct marketing. because of this, and the propensity of practitioners to adopt their own particular approach to direct marketing, various names for it have been coined, such as: • curriculum marketing • relationship marketing • personal marketing • integrated marketing • dialogue marketing • interdynamic marketing • database marketing • maxi marketing it therefore follows that the concepts above emphasise a variety of aspects of direct marketing and new developments in the field, in conjunction with technological, social, political and economic innovations that also bring about changes of name. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 309 sateb nr vol) (1998) nr 2 probably the most salient difference between traditional marketing and direct marketing can be found in the latter's prominent use of and dependence on some form of database. database driven direct marketing starts with an established and well-defined database founded on a history of past behaviour or information of known purchasing behaviour and needs. the objective is not only to clinch an immediate sale, but to build up a relationship with large numbers of individuals over time. direct marketers depend on continuous two-way communication with their clients. from this viewpoint, the purpose of direct marketing is to treat all current and prospective clients as individuals, and to build a relationship that would provide the consumers with tangible benefits and the company with growing profits (puth & de beer, 1996). social and technological developments in the middle 1970s, in response to changing social behaviour patterns and as a result of the efforts of some astute practitioners, direct response, which had been growing slowly but steadily, started to leap forward. more families had two working spouses, so there was less time to shop and direct mail and mail order became the way to save time. vast expansion of consumer credit through major credit cards gave direct mail shoppers a convenient way to pay for goods ordered by mail or over the phone. advances in data processing also helped direct marketers to become increasingly sophisticated in using and maintaining the lists, and later databases, necessary to target their campaigns more precisely. technological developments in the computer industry also helped to expand the use of effective, personalised mail business (bacon, 1992, pp. 4-5). the current evolution of the marketing database has mostly been technologygenerated. more and more instruments are becoming available as a result of the decreasing costs of additional computer power, and the ever increasing information available on customers and business prospects. the principles, methods and technologies of marketing databases are truly scientific. it has been proved that retaining customers is much more cost effective and profitable than finding new ones. it has also been proved that by creating and maintaining a constant dialogue with each individual customer, information will come to light that makes it possible for marketers to sell more products to the same customer (swigor, 1995). technology already exists for storing and profiling customer data. but focused management of marketing information is rare. certain preparatory steps in organisational structure may be necessary. advances in database analysis and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 2 310 customised printing technology will support the trend, as will predictive modelling techniques applied to much bigger databases of personalised information. predictive computer models will anticipate the future behaviour of certain types of individuals even when little exact information on past response patterns is at hand. the current emphasis is on maximising the value of existing customers. once data on general customer behaviour and typical spending or response patterns can be effectively modelled, the marketer will be able to seek out new customers anticipating that their future value makes the effort worthwhile. this means that the information management marketer will successfully trespass on the mass marketer's domain. already indications are that new technology will be rapidly harnessed and that information management is the key to success (hopkins, 1996). a confluence of social, economic and technological forces is rapidly transforming the structure of the retail industry. rapp and collins (1990) identified the following trends in and characteristics of the marketplace that favour direct response advertising: target markets (because of changing demographics and lifestyles); demands on personal time; overcrowding by too many new products, services and stores; weakening of the impact of television advertising; decline in brand and store loyalty; and clutter (overkill and waste of advertising). shopping at retail outlets will undoubtedly remain a vital social and a functional activity for a long time to come. there are, however, certain social and economic forces that make shopping from home attractive. some of these forces are: the annoyance and waste of traffic and shopping congestion, the wide spread deterioration in the quality of service in retail shops, increase in the number of career and professional women, greater emphasis on standardisation and branding of products, and the growing use of credit cards. rosenberg and hirschman also identified the willingness of consumers to change and their acceptance of the technology used to market products directly, as further reasons that make shopping from home attractive (terblanche & smit, 1996). direct marketing and the privacy issue until recently two pieces of legislation were at the centre of the so-called data privacy row in south africa: the bill of rights, which guarantees the right to privacy, and the open democracy bill. the direct marketing association (dma), in co-operation with other industries, successfully lobbied to have the bill of rights revised, and with the amendment of the constitution this legislation is no longer of significant concern. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 311 sateb nr vol 1 (1998) nr 2 the open democracy bill, on the other hand, is still in draft form, and expected to reach parliament in 1998. being prepared by the office of the deputy president, the bill was originally designed to ensure transparency in government. however, for what are widely regarded as political reasons, the scope of the bill was increased beyond its initially intended focus on open government to include specific aspects of the private sector, in particular, the credit bureaux industry. one such aspect, part of the draft bill since its inception, is of great concern to the direct marketing industry. section 50 of the bill rules out the use of personal data without that person's consent which calls into question many standard business practices. simple issues which the bill threatens, include whether a company may cross-sell products to an existing client, or even communicate with clients via newsletters or catalogues, without prior permission. as a dramatic development in the latest draft version, a new clause was suddenly added which would prevent the disclosure of personal data without permission. this new section clearly prohibits the sale or purchase of nominal lists. for the direct marketing industry, reliant as it is on personal data, these two clauses portend a catastrophe. recognising the danger posed by the bill, the dma formed a task force to determine its response. at the same time a multi-industry committee was formed by members of the direct marketing, life assurance, credit bureaux, insurance, and retail industries. this committee will also lobby government to reconsider the threat. the dma believes that once government recognises the real economic implications of the sections concerned, it may be quick to change its approach (ivins, 1996). the fact that abuses of privacy can and do occur either overtly or through the kind of end-runs around the law made possible by the new technology has been widely documented in the business press. a few years ago, illegal use of one million california voter registration records by metromail which, if the law had been fully enforced, would have carried a penalty of 50 cents each time an individual's record was used for a commercial purpose. some us state governments with revenue problems are actually encouraging such abuse by actively selling information from their databases, including driver's license registration information, without informing the persons concerned. we are also quickly moving from brokering lists, essential matters of public record, to the more lucrative, and potentially invasive, use of name appending and co-op databases whose popularity has seen remarkable growth. today, many business organisations display, at the risk of endangering customer trust and encouraging consumer backlash, an extraordinarily cavalier, business-asusual attitude regarding human privacy in traditional direct response advertising as well as internet-based promotion (morris-lee, 1996). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 2 312 the governments of several countries have already adopted draconian privacy laws, effectively barring their citizens from the global information economy. new zealand practically represents the new order of such legislative control. the new zealand privacy act not only determines that marketers ensure any information collected to be relevant and essential for an organisation's business purpose, but requires that personal information is collected directly from the individual. they must also actively seek the individual's authorisation to collect it. in addition, the act rules that reasonable steps are taken to make the individual aware that the information is being collected, why it is collected, and who is going to receive it. in addition, the name and address of any organisation collecting and holding it must be given, and the individual has the right to access and correct it. today, holland, germany, and a growing list of countries have already adopted similar legislation. and in july 1995, the council of europe's convention on data protection adopted a directive to protect the fundamental rights and freedoms of individuals, in particular, their right of privacy with respect to the processing of personal data (morris-lee, 1996). the role of the post office in direct marketing as long as government rtfuses to privatise postal services in south africa, direct marketers will continue to be reliant on the post office. while the post office is actively pursuing sound business principles in order to become profitable, and making wide-ranging changes to its service levels, it is still subject to political pressure from government. for example, government is insisting on the implementation of a universal postal service, regardless of the economics of the requirement. add to this government's subsidy withdrawal to the post office, and the post office's inability as a wholly government-owned operation to drastically cut staff levels, and one can appreciate its untenable position. the cut in government subsidy will inevitably be shifted on the consumer in the form of higher postal tariffs. unfortunately this will have an inflationary effect, which is not in line with service delivery and the basic need satisfaction of poorer households. dma has worked with the post office in search of solutions to their problems, like ways to minimise tariff rises, increasing volumes and the provision of additional services. the dma has a long-standing relationship with the post office, and a special committee dealing with postal affairs. it represents the industry on the national postal forum, and at the post office's national stakeholders' meetings. two recent successes achieved for the direct marketing members were the containment of tariff r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 313 sateb nr vol 1 (1998) nr 2 increases on standard mail and the agreement to delay the increase until service standards were at an acceptable level (ivins, 1996). as technology continues to produce better, faster and less expensive options to mail order marketers, the prospect of worldwide direct mail usage seems increasingly feasible and attractive. before these efforts can become reality, however, several major obstacles need to be overcome. these include major gaps in addressing information, lack of standards, different currencies, wide variations in national postal rates and procedures, and the need for uniformity to ensure the smooth flow of international mass mailings. these and other critical issues are being addressed by the international direct mail advisory council, which was created by the universal postal union (upu), a united nations organisation responsible for world postal affairs. upu has created a direct mail market development program designed to promote public/private partnerships in order to stimulate mail order market growth around the world (goldner, 1996). economic considerations and cultural differences are some of the several difficulties mail order marketers must address when seeking to operate on a global scale. the mere fact that postal rates and regulations differ from nation to nation may cause direct marketers a great deal of difficulty in planning and executing a mailing programme. another difficulty is the fact that many countries have conflicting customs about what should be mailed. these rules may grow out of cultural practices, moral beliefs or physical packaging requirements. the united states is the most advanced mail order marketer in the world today, with europe close behind and japan learning quickly. when one considers the enormous impact mail order has had on commerce in the united states, the prospects in developing countries are exciting. small companies would afford to do business across international frontiers, competing with the largest rivals. the fact that developing countries have difficulty in establishing new markets, might be overcome to a certain extent in this way. this might be the beginning of an outward trade policy by these countries, and the inflow of much needed foreign exchange could then be alleviated. the focus of the upu effort will include determining the current state of direct marketing in each country, defining addressing and postal standards, studying delivery mechanisms, payment methods and dealing with guarantee and return procedures, and so on (goldner, 1996). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (l998)n02 314 the information age opportunities in the retailing area traditionally, shops served as the primary distributors of retail products because consumers were accustomed to make their purchases there. few acceptable alternatives existed and the value of consumers' money exceeded the value of their time. the increased use of multiple channels for the distribution of retail products is a more recent marketing phenomenon. direct order retailing has become a more important component of many organisations' direct marketing efforts. technology increasingly enables organisations to embark on direct order marketing, which has led to mail order buying becoming an acceptable shopping format for an increasing number of consumers (terblanche & smit, 1996). a number of changing environmental conditions suggest that direct marketing will present opportunities to retailers internationally. first, convenience is now recognised as a fundamental lifestyle component due to changes in the status and employment of women, dual-career families, and other changes in family structure and responsibilities. convenience has been cited by consumers as an important reason for purchasing products and/or services through direct marketing channels. a second environmental condition contributing to the growth and importance of direct marketing is the increasing spread of technology. lower costs of data analysis and computerisation have made it possible to collect and analyse data on a more individualised basis. technology was ranked as the number one opportunity in both united states and overseas direct marketing. this would suggest that retailers are fairly optimistic about the application of technology to direct marketing. when coupled with the retailers' perceptions of consumer demand, a fairly positive future scenario of direct marketing results. however, this scenario needs to be tempered with the rather obvious concerns about government regulation, both at home and abroad. but there is still reason to be optimistic about the opportunities that technology presents. a recent study by akhter indicated that technological factors were closely related to direct mail volume in twelve european countries. technological innovations are numerous, but perhaps the most important to direct marketers are the combined forces of reduced computer costs and increased processing and storage capabilities, which have resulted in more effective marketing communications with customers (morganofsky, 1993). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 315 sateb nr vol 1 (1998) nr 2 the internet not so very long ago one might have asked marketers in south africa what the internet was, and they would probably have shrugged their shoulders as it was virtually unknown in the business community. used by the military and universities for many years, predominantly for information exchange via e-mail, the net is now undergoing fundamental change, as business is discovering it as a medium to transfer information quickly and cost-effectively. but as an inherently one-to-one communication medium, it also holds enormous marketing potential for companies big and small (rudolph, 1996). technology is not only having an impact on product development, but also on the ways we communicate with our markets. developments affecting direct marketing continue to accelerate seemingly at the speed of light. but probably the most talked about media form today is the internet. the area that probably receives the most attention from direct marketers is the world wide web (www). the internet, together with other emerging media such as interactive television and cd-rom (compact disc read only memory), are adding to the globalisation of electronic retail modes. this enables companies, often already under pressure to show more profits, to cast their net wider than their current markets which are often saturated. but the internet is not yet a proven marketing medium. the web is in its infancy as a marketing device, and as such is largely untested, unregulated and unrefined. it is moreover difficult to target, control and measure, and is growing extremely fast which makes promotional clutter a problem. today, the internet is used by rapidly growing interest groups all over the world, that increases exponentially by the hour. it is important to know and understand some of the following terms which will be used very often in the near future: • the internet is a network of networks, interlinked via satellite and undersea cable. the 'host' or 'server', the core of individual networks, usually carries all its clients' information and makes it available to anyone in the world who is 'online'. • world wide web: this was developed to make the internet into a visual, mediarich world of information accessible to anyone. it allows users to connect with other sites. • home page: this provides information on the company and its resources. it also links up with other company pages and other web sites. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 2 316 • the internet is mostly used by people between the ages of 18 and 34 years. two thirds of internet users seem to be male and more than one million new users sign up each month. predictions show 75 million users by the end of 1998. the internet is a potentially effective distribution vehicle costing marketers substantially less than newspapers and direct mail to advertise to consumers (raphel, 1996). • internet is the backbone of a variety of services, of which only e-mail and the www are of direct interest to the marketing community. e-mail allows one to send electronic messages to recipients (whose address is known beforehand) across the world; this is not limited to text, but can also be graphics, animations or spreadsheets. the www is an accumulation of hypertext documents, which mainly carry hyperlinks to other pages or sites, regardless of location. this enables one virtually to travel the world at the touch of a button. but this alone does not explain why the net is growing so fast, and why it has become so important to marketers. here are some more reasons (rudolph, 1996): • the net is an equaliser because no matter whether you are ibm, microsoft or just a one-man business operating from home far away from urban centres, you can offer your products and services to exactly the same customers. • the net is inexpensive compared to traditional ways of communicating. the net allows you to do all your correspondence for the price of a local phone call. to offer your services on the net can be as cheap as rioo per month, excluding the creation of your web pages. • the net is flexible because it allows you to communicate with existing and prospective customers on an individual basis. because of technological advances you can use various tools to assist you serve customers individually. • the net is responsive if you get the right message out to the right people. if you show them that you really care and that your products are worth considering, which includes the web site, you stand a good chance of attracting interested parties. technology allows you to enter into an inexpensive dialogue and feedback process with prospective clients. • but the net is also merciless. if you ignore the unwritten code of the internet, the so-called 'netiquette', you will bear the full brunt of those offended by your actions. interactive technologies put in simple terms, interactive marketing uses new technologies to help overcome practical database and direct marketing problems while building more rewarding customer relationships. the versatility of interactive technology can reduce the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 317 sateb nr vol i (1998) nr 2 anxiety surrounding the buying process, by giving viewers access to more information on a wider selection of products than traditional channels can do (steyn, 1996). when a buyer makes a purchase, an exchange of money for goods take place. the seller accepts the money as fair payment for the value he or she has created. the buyers know, or perceive, that the value they are getting equals the price they are paying. a deal is struck and value delivered equals value received: this is the ''value equation". interactive marketing technologies often have the power to alter the equation by adding value to one or both sides of the equation (cross, 1996). cd-roms are becoming widely used as technology marketing tools. cd-rom technology stand out from its sister interactive technologies in its ability to combine print, video and audio messages in a package that can also act like a random access database. the cd-rom can also be used together with other communications media to add even more content. for example, the cd-rom can be used in combination with commercial on-line services and the internet to retrieve updated and complementary material. it is, in a sense, not just one medium but a multimedium. like all good marketing uses of interactive media, the cd-rom's capabilities alter the value equation between buyer and seller.' with more information and variety, buyers can make better buying decisions faster, and with greater confidence (cross, 1996). another much discussed direct marketing medium is interactive television with its home shopping channels. yet another example is the so-called 'electronic brochures' or interactive disks. electronic brochures can be used on the internet or as a bulletin board service. this is one of the reasons why marketers need to plan viewer involvement and interaction carefully from the start, when considering new media like electronic brochures. south africa is in the "advantageous" position of trailing a few years behind the world in these new technologies. it provides us with the opportunity to observe and learn before employing new technologies in our own marketing activities. emerging technologies and media in direct marketing should be evaluated in the same way as new technologies in other fields. they should not be employed for the sake of innovation alone the decision should be based on sound market information as well as technological research to determine the features and benefits that they represent (swart, 1996). as more companies strive to keep pace with the technological achievements of the information age, they make larger investments in marketing databases. on the one hand, managers think "this is the right way to go," but on the other hand they worry "for what we're investing, this had better work." nobody denies the benefits of database marketing. however, often after many months or even years of building r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 2 318 technologically sophisticated marketing databases, marketing managers still cannot answer what they consider to be simple questions in a timely manner, if they can be answered at all. this realisation occurs when the product is near completion and tends to lower expectations about the capabil ities of the marketing database. as a result, frustration abounds among marketing managers who need to actively use this database, and the mis (management information systems) group which must support the database, with the one group not fully appreciating the demands made on the other (leeds, 1996). the future of direct marketing direct marketing is rapidly assuming the position of the most prominent marketing technique of the 1990s. this is borne out by the increasing use of direct response advertising in both print and electronic media as well as in telemarketing. add to this the tremendous possibilities of electronic cataloguing, and the face of traditional marketing may soon be very different from what we used to know. all these marketing approaches enable the consumer of today to be much more selective through more accessible product information and greater possibilities of comparison. however, this implies that the emphasis of marketing communication will have to shift from market penetration to product information and illustration. through modem technology, consumers of the future will have more control over their selection of marketing media and information. they will be able to access or ignore a much wider spectrum of media than in the past. obviously, such a shift in emphasis may totally change the nature of advertising agencies. particularly the traditional media department may have to move its focus to strategic database planning and management. advertising on interactive data networks, cd-rom and automated voice response systems may shift the emphasis from today's mass media to tomorrow's one-on-one interactive media options (puth & de beer, 1996). while mail order, both domestic and international, faces increasing competition from electronic commerce, there will always be a place for written communications to be posted and delivered. certain things can be communicated better via hard copy, like the personal touch of a hand-written note. mail order will grow as direct mail users, postal authorities and government officials come up with solutions for the obstacles to efficient delivery. in the years to come, effective marketers will have to know their trade very well and be ready to respond to new challenges. the key is not knowing where one will be five years from now, but being flexible enough to adjust to a world and a marketplace that is constantly changing at an increasingly faster rate (goldner, 1996). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 319 sateb nr voll (1998) nr 2 the consumers of the future will have access to technologies that put them in control of the marketing communications they receive, and they will then decide what to see, what to read, what to hear, and when to do it. although south africa is lagging behind the top industrial countries in some respect, it possesses the necessary infrastructure to develop and manage a relatively sophisticated direct marketing industry. toll-free telephone services, extensive production capacity, advanced data base management capabilities and direct order facilities, signal an exciting future for direct marketing in south africa. the 1990s will be good to direct marketing in south africa. the country has the people, an excellent direct marketing association and the desire to succeed (jutkins, 1990). conclusion south africa is currently going through a transition phase from state monopoly to a proliferation of private enterprises. new policies governed by the independent broadcasting authority (iba) are being implemented, south african broadcasting corporation (sasc) television channels have been reshaped and renamed, satellite television is a reality, community radio stations are proliferating and there has been technological innovation across all media types. the research challenge for planners and buyers of media will be to find good quality research which is based on reliable, quantifiable samples. we face a rapidly changing media scenario, deregulation of broadcast media, new media providers of new opportunities, and a fragmentation of media consumption (foster, 1996). the economic consequences of direct marketing in developing countries should not be underestimated. the fact that south africa has access to the necessary technology and also serves as a gateway to africa, could lead to increased trade interaction and economic integration in the region. direct marketing clearly has tremendous potential in south africa. many direct marketers have already achieved notable success. south africa offers adequate markets, advanced technology and high levels of locally manufactured as well as imported products which lend themselves to direct marketing. no doubt this form of marketing will increasingly become the preferred way of doing business in many product and service categories. as south africa is seen as the cornerstone in southern africa, this potential transfer of technology and knowledge may well lead to improved human development, which is essential for the economic development of the region. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 2 320 references 1. bacon, m.s. 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(1996). davy ivins interview. marketing mix, direct marketing supplement. july, p.6. 11. (1997). is there a pot of gold at the end of the rainbow nation? marketplace. 18(6), p.24. 12. james, e.l & cunningham, i.c.m. (1987). a profile of direct marketing television shoppers. journal of direct marketing. 1,4, pp. 12-23. 13. jutkins, r. (1990). i predict. marketing mix. january, p.56. 14. katzenstein, h. & sachs, w.s. (1992). direct marketing. second edition. united states of america: macmillan publishing company. 15. leeds, s. (1996). can your database answer your most important questions. direct marketing magazine. april, p. 52. 16. mccorkle, d.e., planchon, 1m. & james, w.l (1987). in-home shopping a critical review and research agenda. journal of direct marketing. 1(2), pp. 5-19. 17. morganosky, m.a. (1993). opportunities and problems associated with direct marketing journal of direct marketing.7 (2), pp.41-51. 18. morris-lee, 1. (1996). privacy it's everyone's business now. direct marketing magazine. april, pp. 40-43. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 321 sateb nr vol 1 (1998) nr 2 19. prlng, d.c. (1990). direct marketing and research. journal of direct marketinga(3), pp.34-40. 20. puih, g. & de beer, y. (1996). direct marketing. marketing mix, direct marketing supplement. july, pa. 21. raphel, m. 1996. how supermarkets capture customers with their 'net'. direct marketing magazine. may, pp. 15-16. 22. rudolph, h. (1996). marketing on the internet all for one or all for nothing. marketing & sales update. may, pp. 14-15. 23. rudolph, h. (1996). the land of confusion. marketing mix, direct marketing supplement. july, p.20. 24. steyn, c. (1996). introduction interactive. marketing mix, direct marketing supplement. july, p.l3. 15. swart, d. (1996). techno blitz. marketing mix, direct marketing supplement. july, p.ll. 16. swigor, t. (1995). marketing database: an art beyond science. direct marketing magazine. july, p. 23. 17. terblanche, n.s. & smit, e. (1996). determinants of the buylnon-buy decision in mail order retailing. paper read at the national productivity institute conference, port elizabeth, rsa, p.14. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction methods the global use of and effectiveness of tax incentives in changing environmental behaviour use of and effectiveness of tax incentives in encouraging investment in renewable energy and energy efficiency in south africa conclusion acknowledgements references appendix 1 about the author(s) mareli dippenaar school of accountancy, stellenbosch university, south africa citation dippenaar, m., 2018, ‘the role of tax incentives in encouraging energy efficiency in the largest listed south african businesses’, south african journal of economic and management sciences 21(1), a1723. https://doi.org/10.4102/sajems.v21i1.1723 original research the role of tax incentives in encouraging energy efficiency in the largest listed south african businesses mareli dippenaar received: 07 dec. 2016; accepted: 17 nov. 2017; published: 11 apr. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: south africa is faced with a significant challenge of securing the supply of electricity as well as reducing its greenhouse gas emissions. the implementation of energy efficiency (ee) and renewable energy (re) measures by energy consumers, especially businesses, is becoming increasingly important and a number of tax incentives have been introduced to promote ee and re. objective: the objective of this preliminary study was to determine the role that the available tax incentives play in the decision making of south african businesses regarding investment in re or ee projects. aim: to determine this role, the largest south african businesses were selected from the johannesburg stock exchange top 40 index. method: the study contained both empirical and non-empirical elements. a literature review was conducted to determine the role of tax incentives globally, while questionnaires were distributed to determine the role in south africa. results: findings highlighted that, while tax incentives do play a role in decision making, various other non-tax factors drive south african businesses’ decisions to invest in ee and/or re projects. these businesses do not perceive the available tax incentives as effective, nor do they regard them as sufficiently motivating for businesses to change their environmental behaviour. they also feel that the government should reduce the burden of complying with the requirements of section 12l (the ee allowance). conclusion: improving the available re and ee tax incentives in south africa might result in more businesses considering the implementation of re or ee projects. it is therefore recommended that the available tax incentives are expanded and/or the qualifying criteria simplified. introduction south africa is faced with a significant challenge of securing the supply of electricity, since the demand for electricity continues to grow within a supply-constrained environment. in addition to this challenge, south africa faces the challenge of reducing its greenhouse gas (ghg) emissions, which directly contribute to climate change. the country ranks among the top 20 global emitters of ghgs and carbon dioxide (co2) and is the largest emitter in africa, largely because of its energy sector. south africa has an energy intensive economy. coal provides for approximately 65% of the country’s primary energy needs and it is likely to provide the majority of the country’s primary energy for the next few decades, as it is a financially attractive and abundant source of energy (pbl 2016; republic of south africa 2015a). more specifically, coal is used to generate approximately 91% of the electricity in south africa (eskom 2016). coal combustion mainly results in co2 emissions, which is the main ghg that has been linked to climate change, in south africa (cohen & winkler 2014; republic of south africa 2004). the government of south africa is establishing and growing a renewable energy (re) industry, in line with its integrated resource plan, through the independent power producer procurement programme, in order to substantially reduce the country’s co2 emissions, to secure electricity supply and to diversify the country’s energy sources (ipp projects n.d.; republic of south africa 2010). in addition, the south african government has implemented measures to promote energy efficiency (ee), including the 2005 national ee strategy, the national ee action plan of 2012, the ee target monitoring system of 2014 and the post-2015 national ee strategy of which the first draft was issued for comment toward the end of 2016 (republic of south africa 2016c). the south african government recognises the country’s role in the global efforts to reduce ghg emissions and has ratified the paris agreement on climate change at the 21st session of the conference of the parties to the united nations framework convention on climate change (republic of south africa 2016b). market mechanisms, such as market-based instruments (mbis), are increasingly used by governments to promote environmentally friendly behaviour. such instruments are no longer used only by developed countries, but are also increasingly being implemented by developing countries (economy 2006, cited in nteo 2012). as a result of all the environmental challenges faced globally, attention has been shifted away from government regulations for environmental governance to the use of market mechanisms (economy 2006). some mbis use existing markets and aim to internalise unpriced environmental costs and benefits by incorporating them into price structures. examples of such instruments include fiscal measures, such as subsidies, tax instruments and user charges (republic of south africa 2006). there are various valid reasons for applying a combination of instruments, instead of only relying on a single instrument to address a given environmental problem. one such reason is that most environmental problems have ‘multiple aspects’ that need to be addressed. often the effectiveness and efficiency of both instruments are enhanced when two instruments are combined (braathen 2007). according to braathen (2007), the ideal situation is one where everyone that contributes to a given environmental problem should have an economic incentive to alter their behaviour to become more environmentally friendly. he found that, in many of the cases that he examined, significantly higher environmental effectiveness could be achieved if economic incentives to reduce emissions had been granted to key categories of polluters. the key to successful government intervention is to plan and design the appropriate policies thoroughly prior to implementation (geller et al. 2006). fiscal or financial incentives (which include tax incentives) are some of the most common government instruments that have proven to be effective in promoting a transition to a greener economy (kpmg 2013a). tax incentives have successfully encouraged ee in the netherlands (lomas 2012) and, when combined with other instruments, they can also encourage re (centre for resource solutions [crs] 2005). in addition, tax incentives also have the potential to encourage investment in research and development (r&d) of technologies for electricity generation and use that limit emissions, such as re and ee technologies (kpmg 2013b). it is not clear whether the tax incentives currently available in south africa are effective in terms of changing behaviour regarding energy use and whether they provide a sufficient financial incentive for businesses to invest in re or ee. consequently, the objective of this preliminary study is to determine the effectiveness of the currently available tax incentives in south africa in changing the environmental behaviour of businesses, by determining the role that the currently available tax incentives play in the decision making of south african businesses regarding investment in re or ee projects (even if through r&d). the findings are considered relevant to policymakers, as these could potentially highlight areas for consideration for improvement, as well as for businesses, as they highlight the tax incentives that are potentially available for them to utilise. methods study design the study contains both empirical and non-empirical elements and the following primary research questions are investigated: are tax incentives used globally to effect change in energy consumers’ environmental behaviour, specifically regarding investment in re and ee projects (even if through r&d), and is it an effective measure? are tax incentives used in south africa to effect change in businesses’ environmental behaviour, specifically regarding investment in re and ee projects (even if through r&d), and is it an effective measure? the second research question was addressed by investigating the following questions: what are the available tax instruments in south africa that can potentially stimulate investment in re, or ee projects (even if through r&d)? do businesses utilise the available ee and re tax incentives? how important is the existence of tax incentives to businesses in deciding to invest in re or ee projects? what factors drive the decision making of businesses regarding investment in re or ee projects? are the available tax incentives in south africa effective in changing behaviour and stimulating investment in re or ee projects? the method used to investigate the first research question was non-empirical, in the form of a literature review. the second research question was investigated by the use of questionnaires (i.e., empirical). study population and sampling strategy the companies were selected from the johannesburg stock exchange (jse) top 40 index (jse top 40), an index whereby the constituents of the all share index are ranked by market capitalisation, as at 29 may 2015 (mychajluk 2015). for the selection, the jse top 40 companies registered in south africa were identified. in the case of a dual-listed company structure where the company included in the jse top 40 is a holding company not registered in south africa, the related holding company that is registered in south africa, if any, was selected as part of the study. an example of such a structure is the mondi group. in terms of a dual-listed company sharing arrangement, mondi plc and mondi ltd agreed contractually to operate and manage their businesses as if it were a single economic entity, while retaining their separate legal identity and existing stock exchange listings. mondi ltd has a primary listing on the jse ltd, while mondi plc has a premium listing on the london stock exchange and a secondary listing on the jse ltd. mondi plc was selected for the study from the jse top 40 but, since it is registered in the uk, the questionnaire was sent to mondi ltd. this brought the total number of companies initially selected for the survey to 28. a representative of each company was requested to complete the questionnaire in respect of the south african group as a whole, where possible (in other words, representing the south african holding company included in the jse top 40 and all its south african subsidiaries). if this was not possible, possibly because the group is so diverse and consists of too many companies, each with different ee and re practices, they were requested to complete the form for the holding company only (i.e., the entity included in the jse top 40), as long as the holding company is an operating company and not merely an investment holding company. lastly, if neither of these could be done, the respondent was requested to identify the company’s south african subsidiary with the largest energy usage and complete the survey in respect of that entity only. one of the 28 companies initially selected is merely an investment holding company and has no subsidiaries, therefore it was excluded from the study. another company was also excluded, based on the fact that it operates in a decentralised environment and covers a host of industries and therefore the majority of the questions would be specific to the individual businesses. this group is also not energy intensive and the company with the largest energy usage is completely insignificant from a group context. a final number of 26 companies was therefore included in the study, and these received questionnaires. a list of these companies, together with the sectors that they operate in, is provided in appendix 1. the reason for selecting the population from the jse top 40 is that it is likely that these companies would have invested in ee or re and therefore that the questionnaire would be relevant to them. it is expected that investment in ee or re would be important to these companies, since sustainability, which includes environmental aspects such as ee and/or re, inter alia, is a core governance issue. the king code on corporate governance for south africa (the king code) recommends integrated sustainability performance and integrated reporting and it is recommended that the integrated report have sufficient information regarding environmental, social and governance issues (institute of directors southern africa 2009). although companies listed on the jse are not required to comply with chapter nine of the king code, which deals with integrated reporting and disclosure, it still needs to be applied by such companies on an ‘apply or explain’ basis (jse 2013). in addition, high costs are associated with investment in ee and re and it is expected that these large companies included in the jse top 40 would have the necessary resources or access thereto. a total number of 22 of the 26 companies in the population (and 30 of the jse top 40 companies) are also included in the jse’s most recent socially responsible index (sri) as at 27 november 2014 (jse 2014a). this further strengthens the expectation that these entities would have made some investment in ee or re, since this index identifies those companies listed on the all share index that meet certain environmental, social, governance and related sustainability criteria (jse 2014b). all of the respondents (100%) indicated that they either have completed ee projects or that they are in the process of implementing ee measures, while 10 of the respondents (63%) are generating their own renewable electricity, even if only on a small scale, and two others are either planning it for the future or still researching economically viable options to do so. ten respondents also indicated that their businesses are performing r&d activities relating to ee or re. this offers a strong measure of confidence about the relevance of the survey to the selected population. development of questionnaires the questionnaires were developed based on an understanding gained from performing a literature review. some questions were formulated based on questions and wording used by du plooy (2012), as well as an international survey performed by pricewaterhousecoopers (2010) to ensure that the questions are clear, unambiguous and appropriate for this study. du plooy conducted a study of south african vehicle manufacturers to investigate the possible implementation of a ‘feebate’ policy to reduce co2 emissions and to determine if the current tax incentives available to south african vehicle manufacturers to invest in reducing co2 emissions are utilised by them. as part of the pricewaterhousecoopers study, almost 700 global executives of 15 countries were interviewed during the period september to november 2009, to determine their perspectives regarding the impact of climate change, the government’s role in protecting the environment and which environmental policy tools they prefer, inter alia. the questionnaire that was issued covered the following broad areas, in order to address research questions 2.2–2.5: understanding businesses’ current and planned re or ee projects, including whether or not they utilise the currently available ee and re tax incentives. the importance of tax incentives to businesses in reor ee-related decision making. which factors (tax or non-tax) drive the decision making regarding investment in re or ee projects. the effectiveness of the available tax incentives in altering environmental behaviour by promoting investment in re or ee projects. administration and response rate the link to the electronic questionnaire, which was set up using surveys (a web-based survey program), was e-mailed to a representative of each of the companies selected for the study. their contact details were obtained either directly from the companies’ websites or from phoning or e-mailing the company. a total number of 26 questionnaires were sent out, of which 16 responses were received by the cut-off date. this represents a response rate of 62%. although this appears to be a relatively small sample from an already small population, statistical differences could still be detected using ordinal data. the questionnaires were completed either by a senior representative in finance, tax or sustainability, mostly in consultation with one another where there was uncertainty about answering certain aspects. data analysis the data from the completed questionnaires was analysed statistically using statistica 10.0 (statsoft inc.). to measure if, for a particular yes/no question, the number of yes’s reported is significantly more than the number of no’s (or vice versa), a conclusion is reached with a significance level of 5%, if the probability (p) of exceeding the observed number (x) of yes’s, assuming that there is no difference between yes and no (i.e., actually 50%), is less than 5%. consequently, whenever x = 11 or more from the n = 16 respondents, it was referred to as a statistically significant proportion of respondents. this number was determined using the binomial distribution, which is typically used to test for significance in qualitative data with only two options (i.e., yes/no answers). the results from the questionnaires are meant to provide insights for policymakers, rather than to recommend a specific incentive. since the percentages in the tables are rounded to integers, the sum of these proportions does not necessarily add up to precisely 100%. limitation only normal tax incentives available in south africa that can potentially stimulate investment in re or ee, were considered. the relatively small population of 26 potential respondents is regarded as the most significant limitation of the study and generalisations cannot be made for all businesses in south africa. however, this is only a preliminary study to determine the opinions of the largest market players in south africa, who have taken re and/or ee measures. consequently, any conclusions drawn in this study may not reflect the views of all south african businesses that have implemented significant ee and/or re measures, which are not expected to be many. regardless of the apparent small number of observations, statistical differences could still be identified using ordinal data, but not for nominal data. the global use of and effectiveness of tax incentives in changing environmental behaviour use of and effectiveness of tax incentives in general there are varied opinions about the effectiveness of tax incentives in successfully addressing environmental challenges and changing consumer behaviour. however, tax incentives are still widely used, both in developing and developed countries. ashiabor (2005) found that economic instruments, for example, fiscal incentives, can be useful in constraining pollution, if applied correctly. he also found that positive fiscal policy instruments, such as tax incentives, tax subsidies, tax credits and grants, have been the primary instruments for addressing the issues of fuel security and environmental protection since the 1970s (ashiabor 2005). certain researchers regard tax incentives as effective, but only when used in combination with other instruments (crs 2005). other economists and researchers argue that tax incentives are generally redundant and ineffective when attempting to stimulate investment (bird 2008). the benefits of investment tax incentives are often overstated, while the costs are often underrated or completely overlooked (nathan-msi group 2004). incentives focused on investment may be successful, but too often problems arise, inter alia, as a result of competing policies, substitutability between capital and other inputs, impact of long term incentives and competition from other countries. these problems can mitigate or exacerbate the impact of incentives (calitz, wallace & burrows 2013). tax incentives might be justified; however, it is important to remember that many other factors, including other economic, non-economic and social policy considerations, drive investment decisions (calitz et al. 2013). there is empirical evidence on the effectiveness of tax incentives, but a country’s overall economic characteristics may play a more important role than tax incentives (zee, stotsky & ley 2002). the nathan-msi group (2004) agrees that tax can affect investments, but that non-tax considerations are far more important in determining most investment decisions. nevertheless, tax incentives are still widely used and continue to play a significant role in the tax policies of both developing and developed countries, despite varied opinions and inconclusive evidence about the use and effectiveness thereof (calitz et al. 2013; nathan-msi group 2004; zee et al. 2002). although some believe that tax incentives distort investment decisions and are often ineffective, inefficient and prone to abuse and corruption (easson & zolt 2002), tax incentives are likely to remain part of development policies globally (calitz et al. 2013). there is no standard recipe or blueprint government approach that will effectively create a green economy and a combination of policy instruments, which might include tax incentives, is often required in order to reduce emissions (bierbaum & friedman 1992; nteo 2012; republic of south africa 2006). studies have indicated that it is likely that a combination of policy instruments is the most effective in realising the largest environmental and economic benefits (winkler 2005). a combination of complementary policies, including tax incentives, was used with success in denmark to encourage the development of its wind energy industry (wiser, hamrin & wingate 2002). according to nteo (2012), an array of country-specific characteristics must be considered and governments should establish a combination of instruments that is appropriate for their circumstances. having discussed the global use of and effectiveness of tax incentives in general, the following sections explore the global use of and effectiveness of tax incentives that target ee, re and r&d, respectively. use of and effectiveness of tax incentives that target energy efficiency according to niesing (2012), ee begins with a change in human behaviour and ee and demand-side management are significantly affected by government interventions, such as incentives. he believes that ee may have the largest positive effect in reducing the emissions in the world in the short term. furthermore, he points out that ee presents the lowest emission reduction cost option and presents financial benefits within a relatively short payback period. the european commission also agrees that increased ee is the most cost-effective and swift way to reduce co2 emissions (markandya et al. 2009). both tax incentives and disincentives are used by governments all over the world to address environmental challenges, when aiming to reduce co2 emissions and promote ee (kpmg 2013b). kpmg (2013b) found that the use of tax incentives and disincentives varies widely since each country is unique in the way that it manages its policy response to climate change and the reduction of co2 emissions. however, governments across the globe seem to be making increased use of both incentives and disincentives (chanel 2012). mbis, in the form of environmentally-related taxes and charges (disincentives), may address certain environmental concerns more efficiently than traditional regulatory approaches (republic of south africa 2006). according to cargill (2011), the use of mbis, which can include tax incentives and/or disincentives, is perhaps the most cost-effective manner to achieve environmental goals. bierbaum and friedman (1992) agree that market-based approaches, such as carbon taxes or marketable permits, can be effective in lowering emissions in the electric utilities sector, but point out that government regulations, such as limits on allowable emissions and ee standards, could also be effective in lowering emissions. in order to operate effectively, mbis, for example subsidies and taxes, require some form of regulatory measures, monitoring and enforcement (republic of south africa 2006). bierbaum and friedman (1992) and the department of national treasury (republic of south africa 2013) point out that a combination of regulatory and market-based policies is required to prevent global warming. in a united states study by yuan et al. (2011), it was found that a carbon tax would be the most cost-effective tool for lowering co2 emissions and that an energy tax would be the most cost-effective instrument to lower total energy consumption. developed and developing countries, however, have very different approaches when it comes to tax disincentives on non-renewable energy sources. kpmg studied 21 major economies of the world to establish which tax instruments are used in the area of environmental policies (kpmg 2013b). only the developed countries in its study make use of such penalties. developing economies appear to avoid using such tax penalties, presumably on the basis that such penalties could damage development and growth prospects (kpmg 2013b). anjum (2008) agrees that environmental taxes (disincentives) are not necessarily practical for developing countries, as they can affect a country’s competitiveness. there are, however, various measures that can be taken to reduce the impact on a country’s competitiveness. van schalkwyk (2012) also found that incentives to promote environmentally friendly behaviour are preferred to disincentives in developing countries. however, environmental tax disincentives can be effective in fighting climate change as they can lead to decreased pollution. in the long term, the circumstances of societies will improve and global warming will be reduced (anjum 2008). the perception exists that incentives, such as tax subsidies, tax credits and grants, have a much greater impact on consumer behaviour than taxes (disincentives), since they are perceived as a reward, while taxes are seen as punishment. there is, in fact, empirical evidence that incentives are generally more effective in swaying customers toward re and ee than environmental taxes (bennet & moore 1981). according to niesing (2012), government regulations alone are not enough to reduce demand for energy, and energy prices and incentives have a significant role to play. it has been demonstrated in a variety of contexts that investment, tax credits are powerful instruments for inducing investment and hassett and metcalf (1995) have found that tax incentives increase the probability of investing in ee capital. they also found that consumers (individuals) respond in a rational way to energy-conservation incentives. according to zhou, levine and price (2010), the use of tax and fiscal policies, such as taxes on energy consumption, tax rebates for ee and tax credits for investment in ee measures, inter alia, have been found to be effective instruments to encourage ee in certain countries. it is difficult to conclude on the effectiveness of tax instruments in achieving ee since evidence is sparse (kpmg 2013b), although one example of the success thereof is the dutch energy investment allowance scheme that contributed to the country’s increased business investment in ee in 2012 (lomas 2012). it is becoming more common for governments all over the world to adopt policies that combine re and ee. ee is often the preferred approach as an inexpensive and easy way of addressing the challenges of limited supply of electricity and climate change, as opposed to building new renewable electricity plants. the majority of the countries studied by kpmg use tax incentives to encourage ee in business (kpmg 2013b). it is, however, not sufficient to target ee in isolation. in the long term, it is important to also target the electricity supply side and re (winkler 2007). use of and effectiveness of tax incentives that target renewable energy as is evident worldwide, economic instruments, such as environmental taxes, fiscal incentives, market instruments and other direct regulatory measures, can be used to increase re generation (ashiabor 2005). the major driver of the strong growth in the global re industry is government incentives, including credits, grants, tax holidays, accelerated depreciation allowances and other non-tax incentives. disincentives in the form of, inter alia, taxes and penalties, such as carbon taxes, cap and trade schemes and energy taxes, are also used by governments to reduce emissions (kpmg 2013a). kpmg performed a study among 28 countries to determine the tax instruments and other incentives used by governments to promote an re industry. regulatory policies, fiscal incentives and public financing were used by the countries studied. fiscal incentives include grants, subsidies or rebates, as well as certain tax incentives (kpmg 2013a). deloitte (2010) found, similarly to kpmg (2013a), that a broad range of incentives are used globally to promote re. the incentives used vary from market mechanisms, like carbon credits and renewable obligation certificates, to feed-in tariffs and tax incentives, such as production tax credits. all these instruments have different complexities, strengths and weaknesses (deloitte 2010). even within individual countries, a combination of mechanisms is often used and many of these mechanisms co-exist. the world energy council (2010) and the department of minerals and energy (republic of south africa 2004) state that government intervention, in the form of financial incentives, can be used to promote an re industry. according to zhou, wang and mccalley (2011), a policy is said to be effective when it can stimulate increased investment in re (by improving the cost competitiveness of re in the short term) and accelerate re technology development in the long run. the use of fiscal incentives is one type of government approach that is proven to be effective in promoting an re industry (kpmg 2013a). according to kpmg (2013b), governments of both developed and developing countries are most active in using tax incentives in the re policy area, as opposed to the other eight environmental policy areas identified by kpmg, which include ee, inter alia. the crs (2005) examined a number of countries worldwide to learn from their tax incentive policies to promote re and concluded that tax incentives are effective, powerful and highly flexible instruments to promote re industries. the world resources institute (2008) and the intergovernmental panel on climate change (ipcc) agree that certain tax instruments are effective. according to the ipcc (2007, cited in nortje 2009), carbon taxes and tax incentives for the production, consumption and r&d of re, inter alia, are effective tax instruments to address the challenges of climate change. the united nations industrial development organisation (unido 2009) agrees that tax incentives are potentially effective as they found that tax credits, inter alia, have been used successfully to promote re in developing countries. tax incentives in isolation are, however, not the most effective instruments to promote an re industry (crs 2005) and, since it is unlikely that one financial incentive on its own will be sufficient, a combination of incentives that complement one another can play a significant role (gouchoe, everette & heynes 2002). use of and effectiveness of tax incentives that target research and development tax incentives aimed at encouraging r&d have the potential to encourage r&d of re and ee technologies, which could, in turn, contribute to the reduction of emissions from electricity generation. kpmg found that 18 of the 21 countries studied, use their tax systems to promote r&d. this is because innovation is critical to governments’ environmental policy goals. r&d drives down the cost of technologies, improves the business case for private sector investment, reduces costs to governments and enables solutions to be delivered at scale (kpmg 2013b). in his analysis of the research performed by others, sawyer (2005) found that incentives in the form of additional tax credits will generally be cost-effective and result in higher r&d expenditure levels. similarly, the ipcc (2007, cited in nortje 2009) determined that climate change can be addressed effectively by tax incentives for the r&d of re, inter alia. conclusion: the global situation literature suggests that tax incentives could effectively address environmental challenges and change consumer behaviour, although tax incentives are generally more effective in combination with other policy instruments. some argue, however, that tax incentives are ineffective, because non-tax considerations have a larger impact on investment decisions and many factors besides tax incentives or disincentives drive investment decisions. empirical evidence on the cost effectiveness of tax incentives also appears to be inconclusive. although there are varied opinions about the use and effectiveness of tax incentives, they remain an integral part of the tax policies of countries and it is expected that they will continue to be used globally. use of and effectiveness of tax incentives in encouraging investment in renewable energy and energy efficiency in south africa tax instruments available in south africa the south african government seems to prefer the use of tax incentives, rather than disincentives, to promote ee and re. this is in line with what the literature suggested about developing countries generally avoiding tax disincentives when promoting environmentally friendly behaviour. the normal tax incentives available in south africa (at the time of completion of the questionnaires) that can promote ee, re or the r&d of ee or re technologies, are provided in table 1. references to sections are to sections in the income tax act no. 58 of 1962 (republic of south africa 1962). table 1: energy efficiency or renewable energy tax incentives in south africa. section 12b has been subsequently amended to grant a 100% allowance in the first year, but only in respect of small scale embedded solar photovoltaic re with a generation capacity of less than 1 mw, instead of the three-year period for other re generators. this is effective for years of assessment commencing on or after 01 january 2016 (republic of south africa 2015b). section 12l has subsequently been amended and the benefit increased from 45 cents per kwh to 95 cents per kwh. this is deemed to come into operation for years of assessment commencing on or after 01 march 2015 (republic of south africa 2015b). the only tax disincentives applied in south africa that could have an impact on ee or re is an environmental levy of 3.5 cents per kwh that is levied on electricity generated from non-renewable sources and an environmental levy of 400 cents per incandescent light bulb sold, which is either manufactured in or imported into the republic of south africa (republic of south africa 1964). the environmental levy was increased to 600 cents per electrical filament lamp with effect from 1 april 2016. a carbon tax is, however, being considered by the south african government. a draft carbon tax bill was published in november 2015 and a revised version (considering public comments received) will be published for public consultation by mid-2017 (republic of south africa 2016a, 2017a). the proposed tax and its date of implementation will be considered further in parliament later in 2017 (republic of south africa 2017b). responses from industries to the proposed carbon tax have varied ‘from cautious acceptance to clear rejection’, with the main objection being that the tax will limit economic growth and impact negatively on job creation (barnard 2016). this is the same reason that the literature suggested why developing countries tend to avoid environmental tax disincentives. since the south african government mainly uses tax incentives rather than disincentives, this study continues to explore the effectiveness of the available tax incentives in successfully inducing investment in re and ee projects by large south african businesses. findings from questionnaires: the use of available tax incentives by businesses all of the respondents (100%) indicated that they either have completed ee projects or that they are in the process of implementing ee measures, while the majority (63%) are already generating their own renewable electricity to some extent. the majority (63%) of the respondents are also performing r&d activities relating to ee or re. none of the respondents have any cdm projects underway, although some indicated that they will establish such projects in the future. although the majority of the respondents have ee, re and/or r&d (relating to ee or re) projects, when asked whether or not the relevant tax incentives are utilised by them, not all of these respondents have actually claimed the incentives or are planning to claim them in the future. there are various potential reasons for this, which warrant further investigation. table 2 summarises the responses of those respondents that have indicated that they either have a completed ee, re, r&d (relating to ee and/or re), cdm or ipp project (as applicable), or are in the process of establishing such a project. responses presented include those that have already claimed the relevant tax incentives and those that are planning to claim the incentives in the future. table 2: respondents that utilise the available tax incentives. findings from questionnaires: the importance of tax incentives in decision making a non-significant majority of the respondents (63%) indicated that the availability of tax incentives was either not important at all or only slightly important to them when deciding whether or not to implement ee or re measures, as set out in table 3. the respondents, however, have varied opinions, since 38% of them indicated that it was actually fairly important to them. to make comparisons, ‘not important at all’ and ‘only slightly important’ were grouped together (as a ‘no’) and compared with the grouping of ‘fairly important’ and ‘very important’ (a ‘yes’). in addition, all of the respondents indicated that they would still have invested in ee or re, even if there were no tax incentives or no government incentives available at all. this highlights the fact that, although the availability of tax incentives is considered important to some businesses, non-tax factors seem to drive investment decisions regarding re and/or ee. the next section explores which factors are regarded as the most important to businesses when they consider investment in re and/or ee projects. table 3: importance of availability of tax incentives. findings from questionnaires: factors that drive decision making the top influencing factors that play a role in the decision making process of businesses regarding the implementation of ee or re measures, as indicated by a statistically significant proportion of respondents, are to save or conserve electricity, the fact that it will help reduce a business’ carbon footprint, that it will alleviate the strain on the electricity supply in south africa and the fact that it will result in cost savings for the business, as indicated in table 4. only 31% of the respondents indicated that the availability of tax incentives play a role in the decision making process. the top four influencing factors (in terms of the number of respondents that selected them) were compared using cochrane’s test for nominal data (yes/no answers). cochrane’s test statistics value is q = 3 with degrees of freedom (df) = 3 and p-value = 0.392, which is > 0.05, so these chosen influencing variables do not differ significantly. table 4: factors that play a role when deciding to implement energy efficiency or renewable energy measures. next, considering the ranking of these variables, a clearer picture emerges. the possible influencing factors were ranked in order of importance by the respondents. a value of ‘9’ was attributed to the most important aspect for businesses, while ‘1’ represented the least important aspect. the median was then calculated for each factor (refer to table 5), to determine the factor with the highest preference. it was clear that five respondents did not change the given order, when asked to list the nine factors in order of importance. since these answers most likely do not represent the true order of importance for these respondents, these five were excluded from the calculation of the medians. the top factor influencing business decisions regarding ee or re is cost savings, followed by saving electricity and reducing a business’ carbon footprint, as indicated in table 5. once again, the availability of tax incentives was only moderately important, based on a median of ‘5’. using friedman’s test for ordinal data (where friedman’s test chi square statistic = 29.92, df = 8 and p = 0.0002, which is < 0.05), it could be determined that these nine medians in table 5 differ significantly. table 5: order of importance of factors that potentially play a role in decisions. using a friedman-test in figure 1, it is clear that the values attributed to ‘cost savings’ by respondents ranged from ‘5’ to ‘9’ (on a scale of ‘1’ to ‘9’), with the distribution significantly skewed to the top (it has a median of ‘9’), that is to say, the majority of the respondents gave it the highest possible rating of ‘9’ (the most important aspect). the results of ‘tax incentives’ (given a median of ‘5’) vary and range from some respondents giving it a very low ‘2’ to others giving it the highest possible score of ‘9’. figure 1: statistical presentation of ranks of factors. based on the results in tables 4 and 5, it is clear that, even though the availability of tax incentives plays a role in decision making, other non-tax factors appear to drive businesses’ re and/or ee investment decisions. findings from questionnaires: effectiveness of tax incentives in south africa a large majority (76%) of respondent south african companies indicated that they do not perceive the currently available tax incentives to be effective in changing behaviour and stimulating investment in re or ee, or that they only regard them as slightly effective, as summarised in table 6. responses varied from ‘not effective at all’ to ‘fairly effective’, but none of the respondents regard the available tax incentives as very effective. a statistically significant proportion of respondents (76%) disagreed (either strongly or slightly) that the available tax incentives for ee and re in south africa are sufficiently motivating to induce a change in businesses’ environmental behaviour, as set out in table 7. table 6: perceived effectiveness of available tax incentives relating to energy efficiency or renewable energy in south africa. table 7: claiming the available tax incentives in south africa. the responses summarised in table 7 indicate the following: only 44% of respondents agree (either slightly or strongly) that it is clear how to apply for the available tax incentives and a statistically significant proportion of respondents (75%) agree (either slightly or strongly) that the south african government needs to reduce the burden of complying with the requirements of section 12l and simplify the process of claiming under that section. it should be noted that only 56% of the companies that either have completed ee projects or such projects underway, have already claimed a section 12l allowance or are planning to claim it in the future (table 2). the reasons for this warrant further investigation, but a possible reason could be that the meeting criterion for section 12l is perceived to be too onerous, complicated and costly. before an entity can claim this allowance, it needs an accredited professional to measure its energy savings. the expected benefit of claiming the tax allowance should therefore exceed the expenditure incurred in the measurement and verification process by the accredited professional before a company would be likely to utilise this incentive (thetard 2013). it is recommended that the process to claim the available tax incentives is simplified, the requirements are reduced or simplified and the financial benefit increased or more incentives made available to encourage businesses to implement re and/or ee projects and to claim the section 12l allowance, where applicable. south african businesses appear to favour tax and other financial incentives over non-financial incentives and disincentives, to encourage ee and re. table 8 indicates that a statistically significant proportion of respondents (82%) agree (either slightly or strongly) that the south african government needs to offer more tax incentives and 88% agree (either slightly or strongly) that more financial incentives, such as tax incentives, subsidies, grants or purchasing rebates, are needed to encourage ee and/or re in businesses. in order to make comparisons, ‘strongly disagree’ and ‘disagree slightly’ were grouped together (as a ‘no’) and compared with the grouping of ‘agree slightly’ and ‘strongly agree’ (a ‘yes’). a statistically significant proportion of respondents (69%) feel that the number of disincentives should not be increased. table 8: preference of government measures to encourage energy efficiency or renewable energy in south africa. the mean was calculated for each of the statements contained in table 8, using the following scale: 1=strongly disagree; 2=disagree slightly; 3=agree slightly; 4=strongly agree. using a non-parametric repeated measures analysis of variance test, i.e. a friedman’s test (where friedman’s test chi square statistic = 20.13, df = 3 and p = 0.00016), it is clear that the results of the first two statements (government should offer more tax incentives and more financial incentives) differ statistically significantly from the results of the second two statements (government should offer more non-financial incentives and more disincentives). this is illustrated in figure 2, using lettering from a bonferroni multiple comparisons procedure. financial incentives (including tax incentives) are clearly preferred to non-financial incentives and disincentives. figure 2: statistical comparison of government measures, indicating differences. conclusion: the south african situation the findings from the questionnaires suggest that not all businesses that potentially qualify for the existing tax incentives aimed at promoting ee and re, utilise the tax incentives. the reasons for this warrant further investigation. the respondents have varied opinions about the importance of tax incentives in decision making, with responses ranging from ‘not important at all’ to ‘fairly important’. the top influencing factors that drive decision making regarding the implementation of ee and/or re measures (as indicated by a statistically significant proportion of the respondents), are to conserve electricity, the fact that it will help businesses reduce their carbon footprint, that it will alleviate the strain on the electricity supply and that it will result in cost savings for the business. the top factor influencing business decisions regarding ee and re (when respondents were asked to rank a number of factors in order of importance) is cost savings, followed by saving electricity and reducing a business’ carbon footprint. although tax incentives play a role in the decision making of south african businesses, many non-tax factors drive investment decisions, similar to what the literature suggest about the global situation. a statistically significant proportion of respondents indicated that the current tax incentives for ee and re in south africa are not effective (or only slightly effective) in changing behaviour and stimulating investment in re or ee and are not sufficiently motivating to induce a change in environmental behaviour. in addition, they feel that the government should reduce the burden of complying with the requirements of section 12l (the ee allowance). conclusion the objective of the study was to determine the role that the currently available tax incentives play in the decision making of south african businesses regarding investment in re or ee projects. a literature review was conducted to determine the role of tax incentives globally, while questionnaires were distributed to determine the role in south africa. the literature review revealed that tax incentives could effectively address environmental challenges and change consumer behaviour, although tax incentives are generally more effective in combination with other policy instruments. some argue, however, that tax incentives are ineffective, because non-tax considerations have a larger impact on investment decisions and many factors besides tax instruments drive investment decisions. although there are varied opinions about the use and effectiveness of tax incentives, they remain an integral part of countries’ tax policies and it is expected that they will continue to be used globally. findings from the questionnaires highlighted the fact that, although tax incentives do play a role in decision making, various other non-tax factors drive south african businesses’ decisions to invest in ee and/or re projects. these businesses also do not perceive the available tax incentives as effective, nor do they regard them as sufficiently motivating for businesses to change their environmental behaviour. however, improving the available re and ee tax incentives in south africa, might result in more businesses considering the implementation of re or ee projects. south african businesses feel that the government should reduce the burden of complying with the requirements of section 12l (the ee allowance). it is therefore recommended that the process to claim the currently available re or ee tax incentives is simplified, the requirements are reduced or simplified and the financial benefit increased or more incentives made available to encourage businesses to change their environmental behaviour. alternatively, the implementation of the proposed carbon tax (a tax disincentive) in south africa could play a role in altering businesses’ environmental behaviour. acknowledgements competing interests 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paper evaluates the effects of the free trade agreement (ft a) between south africa and the european union (eu) on the south african orange industry. oranges account for ten percent of south african agricultural exports. the aggregate trade simulation model used here is designed on the programme stella, and consists of regional production models, a local market model, an export model and an exchange rate model. results indicate that the ft a is expected to have small positive effects on both south african producers and consumers. this is caused by increasing real free-on-board prices and decreasing real local prices of oranges. total area under oranges will increase more with the ft a, which thus results in a larger orange production too. jelq13 1 introduction in october 1999 south africa and the european union (eu) signed the trade, development and co-operation agreement. a major part of this agreement is the establishment of a free trade area between both parties, a free trade agreement (fta). as the eu is the major trading partner of south africa, this will have an important impact on the south african fruit sector which is the major export in the field of agriculture. within this sector oranges playa vital role. oranges alone account for approximately ten percent of all agricultural exports of south africa while 60 percent of all oranges are exported. the proportion exported is constraint by sanitary and phyto-sanitary requirements of the destinations. the majority of the remainder is processed, leaving less than 20 percent for the local fresh produce market. after a small dip in importance in the early and mid nineties the eu presently accounts for the destination of almost two thirds of all exported oranges. this paper evaluates the effects of the fta with the eu on the south african fresh orange industry. a trade simulation model is constructed to simulate future developments. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 485 sajems ns vol 3 (2000) no 3 2 trade simulation model the trade simulation model is developed on a graphical interface using the programme stella to indicate linkages between different variables (high performance systems, 1997). in the model it is possible to use stochastic distributions or random figures to quantify relationships. this has been done if the distribution is known or could be estimated. each scenario is run 100 times and results are statistically analysed. the trade simulation model consists of several linked sub-models. these include seven production models, a local market model, an exchange rate model and a model for the eu demand. the submodels will be discussed. 2.1 production models the production of fresh oranges occurs mainly in the following four regions within south africa: the lowveld region of the northern province and mpumalanga, the north-west province, the sundays river region of the eastern cape, and the olifants river region in the western cape. the two main cultivar groups are navels and valencias, each with different ripening seasons. as navels are not planted in the lowveld region, seven production models are included for regions and cultivar group. gross margins. cost and production data were used to derive the age of the orchard (ferreira and van zyl, 1997). the gross margins are based on cross-sectional data of the year 1995. information provided by bower (1999) is used to derive a seasonal production distribution within each production model. the supply response is simulated through planting new orchards while it is not possible to withdraw orchards before the end of the productive life-span. equation (i) shows the supply response. (1) where: to~ lnpl,~ = fj:,'!i + &, *in-~ c, in = natural logarithm pi = plantings of new orange orchards &s elasticity of supply to total orange turnover c = variable costs reg = production region (cultivar and locality) t = year. however, own estimates for a supply elasticity could not be derived because of lack of information about annual increase in acreage. khuele and darroch (1997) estimate the export supply elasticity for south african oranges to the united kingdom at 0.248. this estimate refers to production rather than orange growing area and it excludes the supply to other destinations, as well as the local r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 486 market. further, a supply elasticity of 0.128 for perennial products in italy has been obtained by sckokai and moro (1996) which is of a similar magnitude. approximately five to ten percent of total area is annually replanted or freshly planted. therefore, a supply elasticity in terms of area planted every year should be ten to twenty times as large, implying a supply elasticity of approximately 2.0 for planting. 2.2 local market about 40 percent of the south african orange production is either processed or sold locally. this section analyses the proportion sold on the local fresh produce markets. the monthly real prices at the four main south african fresh produce markets for oranges johannesburg, pretoria, durban and cape town are analysed to obtain a local demand function. an influential variable is the actual amount sold in a particular month. the lagged export price influences the local price, due to the linkage between both markets. a trend variable is included in the model to capture the change in consumer preferences over time, especially towards easy-peelers. ordinary least square (ols) is used to estimate the demand function (2) (t-values in parentheses). (2) in ·100 4.311-0.301.ln ~ + 0.2 16. in.!-.!.::l.---!.:::!-·_i_o_o 0.0036· trend, cpi, pop, cpi'_1 (8.9) (-16.9) f-value = 97.5 (3.1) (-5.0) adjusted r2 0.81 where: in = natural logarithm pr nominal monthly price for fresh oranges on south african fresh produce markets (rjton) cpi q pop ex trend t consumer price index in south afri-:a ( 1990 = 100) = total monthly fresh orange quantity traded on south african fresh produce markets (tons) total south african population ('000) entry price for fresh oranges in the european union (ecu/ton) exchange rate (rjecu) monthly trend variable (january 1990 1) 1, ... ,96 months (january 1990 until december 1997) signs of all variables are as expected. the durbin-watson test for autocorrelation is not reported because of missing values.the price flexibility of demand, approximately an inverse of the price elasticity, in the local market is estimated at -0.30 i which is lower than the -0.695 obtained by hayward-butt and ortmann (1994). this is expected as short term demand elasticities are r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 487 sajems ns vol 3 (2000) no 3 generally larger than demand elasticities based on annual data due to the possibility of short tenn storage (shepherd, 1972: 67-68). 2.3 exchange rate between south african rand and euro the exchange rate between the south african rand and the euro is important for a trade modej. south african producers are interested in the rand price received for their product, whereas consumers in the eu pay in euro. the euro has a fixed exchange rate to eleven european currencies which will be replaced by the euro in 2002. it was introduced in january 1999 as a single currency in eleven eu member countries to replace the ecu (european currency unit). the exchange rate between the rand and ecu is analysed from 1990 until 1996 to obtain a predictive function for the future exchange rate. in this study the eu market is represented by germany because of lack of infonnation about the eu monetary market prior to 1999. monetary models are based on the assumption of purchasing power parity. this was tested using the cochrane-orcutt two step procedure (3) (t-values in parenthesis). (3) lnex, p* inex,_, = 1.395 *(incpi/a p·lncpl,:~)-1.l79·(lncpi,g'r p·lncpl,~~r) (4.0) (-3.1) f-value 411.4 adjusted r2 = 0.91 d = 1.57 where: in natural logarithm ex exchange rate (r/ecu) cpi = consumer price index (1990 = 100) sa = south africa ger = gennany p = 0.961 coefficient ofautocorrela!ion (coch:ane-orcutt two-step) 1, ... ,84 month (january 1990 until december 1996) the coefficients have the expected signs. if the south african price level increases, the rand depreciates against the euro. the opposite is the case for the gennan price level. the statistical fit is excellent and results are in accordance with theoretical economic expectations. the purchasing power parity model is used to predict future exchange rates in the trade simulation model as the simulation period starts in 1997 the results of the first three years can be compared with the actual exchange rate (figure i). in the first part of 1997 the actual exchange rate was below the 95 percent confidence interval, but thereafter the exchange rate stayed within the interval. this even includes the period of rapid change in july 1998. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 figure 1 predicted and actual exchange rate between rand and euro 1997 until 1999 85.,---------------------7.5 ~ e 71-" .. i i i! 6.5 ~ 5.5 months source: de neder1andsche bank (2000) and own calculations 488 macro-economic indicators included in the model are consumer price index (cpi) on both sides, and producer price index (ppi) and population only on the south african side. the german cpi is expected to change according to the behaviour in the base period from 1990 until 1996. the south african cpi is expected to have decreasing rates of increase (nedcor, 1999). it is expected to decline from around seven percent in 1997 to five percent in 2011. the ppi is derived from the cpi in the model based on their historic relationship. the population in south africa is expected to increase at a decreasing rate. population predictions by sadie (1993) were used to design a population growth model for south africa. 2.4 european market the european union (eu) is the largest export market for south african fresh oranges. in the early and mid-nineties the eu share of south african exports has been declining, but it still accounted for 50 percent of total south african exports. recently, it increased again to almost two thirds. south africa is the second largest external supplier of oranges to the eu (table i). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 489 sajems ns vol 3 (2000) no 3 table 1 external imports of oranges by the european union in metric tons morocco south friea 1991 1992 1993 1994 349947 289287 254739 248 181 161510 175405 135007 178552 1995 1996 172 684 315 971 167283 228365 t=is_ra---.;e-:::l __ +--::-::--:-:-~-'-:-:'-'-::-=-+~=-=-:-:--t---:-:-::-:-:-+-93 402 115 247 brazil 98093 72 746 53887 62107 67269 90743 63997 52987 66961 4694 57062 52389 6469 5 185 8630 17200 17266 22845 22166 c rus 43764 59170 38374 42177 tunisia 20927 19190 20097 20356 20162 zimbabwe 6643 5626 3019 6325 13067 922925 885543 798112 846627 967499 source: eurostat due to its location in the southern hemisphere, south africa dominates the eu off-season. south africa is generally a price taker on the european market but during the months of july until october south africa can influence eu prices significantly. during the later months oranges originated in south africa account for two thirds of the eu market. for the other months the price of fresh oranges in the eu are seen as exogenous variables. the average real price of the years 1991 until 1996 ( 1990 prices) is taken as the baseline price and the generated price within the model. during the months of july until october a monthly price flexibility is calculated of the import demand fo, south african oranges. the following procedure was used. firstly an annual price flexibility for oranges in germany is calculated. germany is chosen because it is the main eu market and because of the availability of data. as independent variables, the income and the orange consumption per capita and a dummy variable for german unification are used. the resulting price flexibility is -0.479. this price flexibility calculated using data for germany was assumed to be a proxy for that of the eu in the model. secondly, monthly price flexibilities of the import demand for south african oranges are calculated in (4), using a procedure adapted from johnson (1971). (4) x. _x.! ps., d p s £: where: psa = import demand flexibility for south african oranges in the eu p = demand flexibility for oranges in the eu r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 490 d = total quantity of oranges demanded in the eu (metric tons) x = south african exports of oranges to the eu (metric tons) & 0.2 (supply elasticity of rest of the world to the eu market) s = quantity supplied by the rest of the world to the eu market (metric tons) the supply elasticity of the rest of the world on the eu market is derived from information from sckokai and moro (1996) for the italian market. the simulated monthly prices for fresh oranges in the eu are then transformed into free-onboard prices in south africa in euro. this is achieved by firstly deducting the tariff. in the months june to november a division by one plus the ad valorem tariff is carried out. for the rest of the year the entry price system in the eu is in force (swinbank and ritson, 1995). therefore, it has to be determined whether the entry price before tariffication is below the threshold. if this is the case, a tariff equilibrium has to be subtracted as well. i f not, the same process is used as for the other months. in all months, the cost of transport from the south african harbour to the eu point of entry has to be deducted. the transport costs are expected to stay constant in nominal terms at 150 euro per ton over the time of simulation. the 150 euro per ton derives from the difference in south african prices in the harbour and the eu between 1991 and 1996. information from fao (1994) implies constant nominal transport costs for wheat in united states dollars which is assumed to be the case e,f oranges in euro. to retain the prices in rand at the south african harbou:c the euro value is multiplied by the predicted exchange rate. 3 futurescenajuos this paper compares the future prospects of the south african fresh orange industry under the ft a to a base scenario without the ft a. the base scenario will use the current eu tariffs and the commitment the eu has submitted to the world trade organization (wto). the ft a scenario will use the same tariffs, but it will in addition use the outcome of the ft a. table 2 shows tariffs in the eu and inclusion in the ft a of fresh oranges in relation to date of entry. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 491 sajems ns vol 3 (2000) no 3 table 2 european union tariffs for fresh sweet oranges in 1999 and ft a treatment period tariff 1999 in entry price ft a treatment percent 1 january to 31 march 17.3 yes excluded 1 to 30 april 11.3 yes excluded 1 to 15 may 5.2 yes excluded 16 to 31 may 3.5 yes excluded 1 june to 30 september 3.5 no included 1 to 1 5 october 3.3 no excluded 16 october to 30 november 16.7 no excluded 1 to 31 december 16.7 yes excluded source: hauptzollamt klel (1999) and department of trade and industry (1999) the entry price system means that an additional tariff equivalent is charged if the entry price before tariffs falls short of the threshold price. the inclusion in the ft a will only occur at a later stage of the implementation period from 2000 until 2011. the included time period accounts for the majority of south african fresh orange exports to the eu. the tariff for south african fresh sweet oranges in the peak exporting season will be eliminated within the ft a. this could have an impact on the south african fresh orange industry. the simulation period covers from 1997 until 2011, hence fifteen years. the final year is set by the end of the implementation period of the ft a between south africa and the eu. each scenario is run 100 times and results are analysed. mean and standard deviation values are also reported. 4 results the impacts on both south african producers, as well as consumers are studied. in addition changes in the exchange rate and prices are reported. 4.1 exchange rate and orange prices no difference in the predicted exchange rate is expected between the scenarios as there is no interaction between the tariffs and the exchange rate within this model. table 3 presents the simulated annual exchange rate. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 492 table 3 predicted exchange rate between rand and euro 1997 until 2011 in rand 1997 1999 2001 2003 2005 2007 2009 2011 upper limit (95%) 6.10 7.42 8.57 9.49 10.66 11.89 13.08 14.37 lower limit (95%) 5.40 5.74 6.42 7.43 8.31 9.12 10.00 11.17 in section 2.3. the results for 1997 until 2000 are compared with the actual exchange rate. the local south african orange price is predicted to increase at less than the inflation rate. therefore the real prices for fresh oranges in south africa are predicted to decline. this is comparable with the local price development in recent years. table 4 indicates the mean predicted prices for fresh oranges at the fresh produce markets in south africa. table 4 november december predicted mean real prices for fresh oranges on the fresh produce markets in south africa 1997,2004 and 2011 in rand (1997) per metric ton base scenario 1997 2004 2011 1956 1456 1144 1637 1229 1015 1262 1148 2 1177 901 888 888 700 677 667 538 601 602 480 597 578 444 591 446 355 588 457 663 498 390 646 504 918 687 535 902 700 1212 906 722 1205 921 1590 1206 934 1542 1195 the means values of both scenarios are similar. a coefficient of variation of 10 to 15 percent was observed which implies that there is no significant difference between the scenarios. the estimates show a strong seasonality in the local south african market with low prices in the middle of the year which is the peak production season in south africa. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 493 sajems ns vol 3 (2000) no 3 an important result is the difference between domestic and international prices for fresh oranges. table 5 presents the free-on-board prices at the point of departure. the real free-on-board prices are predicted to increase during the simulation period. a difference between both scenarios cannot be observed despite a tariff reduction of approximately two percent from june until september. due to increased south african exports in this period, the eu prices decline slightly. this results in constant free-on-board prices in south africa. table 5 january february march april may june july august september october november december predicted mean real free-on-board prices for fresh oranges in south african ports 1997, 2004 and 2011 in rand (1997) per metric ton i base scenario free trade aereement 1997 2004 2011 1997 2004 2011 i 881 1535 1990 993 1634 1946 i 779 1387 1833 843 1339 1774 i 1002 1616 2064 1029 1603 1906 i 1271 1782 2120 1131 1817 2124 i 1410 1896 2297 1332 1876 2212 ! 1576 1855 2119 1590 1815 2084 1447 1747 1923 1490 1739 2054 1572 1812 1952 1552 1830 1974 i 1707 1990 2243 1727 2038 2251 1425 1555 1949 1353 1631 1850 i 1619 1962 2487 1499 2026 2298 i 1101 1647 2055 989 1636 1973 in the eu seasun the frt:e-on-board prices are especially low in the first years of the simulation period. one reason is the eu entry price system. an additional levy will be charged if the entry price falls under a certain threshold. due to wto commitments the threshold price also has to be reduced. therefore, the additional levy will be charged less often and the average free-on-board price will increase. the change in the exchange rate between rand and euro is the major cause for the increasing free-on-board price in south africa. there is no difference between both scenarios with regards to the free-on-board prices in south africa. even so, an increase of three percent in the months june until september is expected because of the tariff cut over these months. this is caused by an slight increase in south african exports to the eu, which has a slight reducing impact on the eu prices. the observed price difference between the months is lower than on the fresh produce markets. there is a slight increase towards the middle of the year, but otherwise the prices are relatively constant. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 494 the predominant observation in relation to real prices is the increasing difference between local and free-on-board prices (table 4 and 5). this observation can also be made for the current decade. this result implies that the export orientation of producers will increase in the coming years. bower (1999) however, expects that the export percentage will not change much in the future because of sanitary and phyto-sanitary requirements becoming more stringent. 4.2 orange production and area under oranges the analysis of the simulated development of the south african fresh orange production will be undertaken on an area, as well as on a production basis. the area used in this study was derived from total production and the yield information based on the gross margins of ferreira and van zyl (1997). therefore, only changes expressed in percentage terms, are used in the analysis. these percentages refer to well managed and high production orchards. table 6 shows the change in acreage in the seven production regions. table 6 ~eldon lowveld north-west sundays river olifants river total percentage change in total area planted with oranges by production region i base scenario free trade a2reement cultivar 11997 2004 1997 2011 1997 2004 1997 2011 valencias 3.75 % 10.04 % 4.75% 12.00 % navels -5.87 % -6.61 % 1 -5.35 % -5.46 % valencias 3.96% 10.55 % i 5.01 % 12.57 % navels -4.16 % -7.86 % -3.61 % -6.68 % valencias 4.96% 15.28 % 5.44 % 16.49 % navels -4.93 % -9.60 % -4.24 % -8.21 0/, valencias 4.42 % 14.56 % 4.71 % 15.60 % -0.07 % 2.42 % 0.68 % 3.97% the base scenario shows that there is a small overall increase in area planted with oranges at the end of the simulation period (table 6). the predominant result is the decrease of navel plantings. the area under valencias has increased by over ten percent in the simulation period. the difference between the development of navel and valencia orchards could also be observed in previous years (agrireview, 1999). the ft a scenario indicates that there will be a further increase in orange production area due to the ft a. this is not significant due to the high variability of results. but is consistent throughout the results. because of the long life span of orange orchards, even a 15 year period seems to be too short to observe significant differences. the problem in observing significant differences lies in the high variability of additional factors r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 495 sajems ns vol 3 (2000) no 3 influencing the production of perennial export crops. these are weather conditions, price fluctuations on local and overseas market and fluctuating exchange rates. the total orange production increases in the first five years of the simulation by approximately nine percent. this can be explained by an increased percentage of mature trees. thereafter, the changes are small as expected by the increase in area under oranges. the total increase during the simulation period under the base scenario is 9.11 percent and 10.48 percent in the case of the ft a scenario. in this analysis is expected that the change in supply is borne by a change in acreage. it is very likely that in the short run, south african exports are diverted towards the eu from other export markets as the eu becomes relatively more profitable as an export destination. this is limited by the extent of the tariff reduction and the export commitment of producers. in the long run an adjustment will happen on the production side. 4.3 gross margins and consumer surplus gross margins are a good indicator for the development of the profitability of orange production. table 7 shows the development of gross margins in the seven production regions. table 7 su river o hfants river total predicted percentage change in real gross margins by production region 52.61 % 32.16% 42.91 % 35.82 % 61.10 % 40.50 % 51.54% 94.69 % 45.56 % 51.45 % 67.75 % valencias 52.96 % 100.65 % 68.00% 109.19 % 45.54 % 75.17 % 52.84 % 82.42 % real gross margins are increasing dramatically in all regions. this is due to an increase in free-on-board prices and to increased production. even for the regions planted with navels an strong increase in real gross margins could be observed. in the later years of the simulation the difference between navels and valencias increases. the ft a scenario is more beneficial in relation to real gross margins. it is consistent within all results but not statistically significant. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 496 on the domestic consumer side the development of consumer surplus is of interest. the real consumer surplus increases over the simulated period by approximately 50 percent. it is two percent higher in the ft a scenario in the final years. this indicates that the local consumer benefits slightly from the ft a with the eu. 5 conclusions the results indicate that the ft a has a slightly beneficial effect for south african orange producers and domestic consumers. due to the high volatility of other influential factors, such as weather conditions, the exchange rate, and quality variation, these results are not statistical significant. the consistency of the results makes it very likely that a positive effect exists. the larger observed increase in acreage under the fta might result in a larger difference in production over time. due to the time delay between planting and maturity this will only occur later. a longer simulation period could be useful to obtain such results but this is limited by the assumptions about the orange industry underlying the development of the model. the observed and significant difference in the future development of area under navels and valencias is consistent with recent observations (agrireview, 1999). a total change from navels towards valencias seems to be unlikely. both cultivars have different ripening seasons which is beneficial for a more distributed utilisation of the labour force and packhouses. for the industry as a whole a longer production period is advantageous to be present on export markets. this is especially necessary for branding and advertising. the ft a is a win-win situation for south africa because both domestic producers and consumers are expected to benefit from the agreement. this is due to the contrary development of domestic and free-on-board prices. the domestic consumer benefits from lower real local prices. south african domestic prices are expected to fall as south african production increases as a constant percentage of south african production does not meet export requirements. whereas, this is more than offset by the increase in real free-onboard prices for the local producers. the effect in the eu will be limited. south african exports are expected to increase overall by ten percent over the fifteen year simulation period, whereof one percent is due to the ft a. the increased south african exports are expected to result in a small decrease of orange prices in the eu summer. this will have a very small impact on eu producers as that is their off-season. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 497 sajems ns vol 3 (2000) no 3 a small difference between both scenarios was expected a priori because the tariff cut for fresh oranges agreed upon in the ft a is small. the eu will eliminate the tariffs from june until september which are currently three percent ad valorem. a comparison with a scenario eliminating all eu tariffs on fresh oranges will result in information about the impact eu protection has on the south african fresh orange industry. an inclusion of other export markets might be beneficial to discover trade diversion between export destinations. endnote the financial assistance of the national research foundation towards this research is hereby acknowledged. references anon. (1999) "product review: citrus", agrireview, october 1999, standard bank, johannesburg, south africa. 2 bower, j.p. (1999) personal communication, professor of horticulture, university of natal, pietermaritiburg, south africa. 3 de nederlandsche bank (2000) exchange rates, online information hujl:\\www.dnb.nl. 4 department of trade and industry (1999) agreement on trade, development and co-operation, online information http://wwwdti.pwy·koy.za. 5 eurostat. intraand extra-eu trade (monthly data combined nomenclature), cd-rom, luxe'11bourg, l'lxembourg. various issues. 6 ferreira, s.g. and van zyl, j.l. (1997) "gross margins for citrus cultivars in different citrus producing areas", citrus journal, 7(2): 1925. 7 food and agricultural organization of the united nations (fao) (1994) fao yearbook trade vol. 47 1993, fao, rome, italy. 8 hauptzollamt kiel (1999) tariff information, kiel, f.r. of germany. 9 hayward-butt, p.r.n. and ortmann, g.f. (1994) "demand analysis of oranges in south africa", agrekon, 33(3): 141-4. 10 high performance sytems (1997) technical documentation: stella software, high performance inc., hanover, united states of america. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol3 (2000) no 3 498 ii johnson, p.r. (1971) studies in the demand for u.s. exports of agricultural commodities, economic research report no. 15, north carolina state university, raleigh, united states of america. 12 khuele, p.r.s. and darroch, m.a.g. (1997) "demand and supply factors in the export of south african fresh oranges to the united kingdom: 1976-1993", agrekon, 36(4): 542-60. 13 nedcor (1999) economic comments: facts and forecasts of key economic variables, online information huj;rllwww.nedcor.co.za. 14 sadie, j.l., (1993) a projection of the south african population. 19912011, bureau of market research report no. 196. university of south africa, pretoria, south africa. 15 sckokai, p. and moro, d. (1996) "direct separability in multioutput technologies: an application to the italian agricultural sector", european review of agricultural economics, 23( i): 95-116. 16 shepherd, g.s. (1972) agricultural price analysis, 51h ed. 1963, revised printing 1972, the iowa state university press, ames, united states of america. 17 swlnbank, a. and ritson, c. (1995) "the impact of the gatt agreement on eu fruit and vegetable policy", food policy, 20(4): 33957. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 157 managing diversity in israel: some applications for south africa r j petersen and l p vermeulen department of human resource management, university of pretoria abslract the management of diversity manifests itself in a very specific way in israeli society. this is so because the management process occurs at two levels: a national-political level (first order processes) and the individual enterprise level (second order processes). the interactive nature of the two processes ultimately results in most diverse national groups working together productively towards both nationaleconomic and individual goals. inclusiveness is a property widely found in the average israeli enterprise. the purpose of this paper is to describe the unique israeli approach to the management of their diverse workforce, with a view to identifying possible applications for south africa. the study shows that south africa has a lot to learn before we can hope to succeed in effectively managing our diverse rainbow nation. jel m 12 introduction and objective south africa is a country in transition. during this phase of radical change, issues such as workplace democracy, affirmative action and employee equity are high on the strategic agenda of most south african organizations. the strategic processes have already had an impact on the competitiveness of many companies. it is widely accepted that the future success of south african enterprises in the highly competitive international business community will largely depend on their ability to manage these transformational processes in a rapidly changing business and societal environment. this will go hand in hand with their efforts to develop and use the diverse talents of the so-called rainbow workforce. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 158 sajems ns vol 2 (1999) no i achieving competitive advantage through (diverse) personnel is becoming a key management reality. as more south african companies operate across national and cultural borders, managing diversity is moving from being a social ideal to being a practical business mandate (thomas, 1996: 17). at national-strategic level it is crucially important for south african authorities to contribute positively to a national climate in which the diverse talents of all population groups can be harnessed and available skills fully used. some captains of industry are understandably worried that politically inspired interference and intervention, such as forced affirmative action, could have the opposite effect and mean a further competitive setback for south african enterprises within the international business environment, due to its adverse effect on productivity. although most business leaders regard affirmative action and black empowerment as necessary, they are of the opinion that the private sector should not be forced to give jobs to the disadvantaged, but should be allowed to focus on creating wealth and economic opportunity (jeffery, 1996: 11-13). israel is a nation with a highly diverse population characterized by many religious, cultural and social groups, brought about by the fact that the state of israel has since its inception in 1948 applied a national policy of encouraging jewish people from all over the world to return to their ancient biblical homeland. the purpose was to strengthen the newly formed state militarily and to give expression to the zionist vision of recreating a home for persecuted jewish communities which were literally spread all over the world after the destruction of jerusalem in the year 70. this policy resulted in the mass immigration and relocation of millions of afro-asian and american-european jews to israel over the past so years. having lived among a diversity of foreign cultures for centuries, these people brought with them the diverse ethno-cultural practices of their countries of origin, which challenged the israeli authorities to mould them into a new nation and utilize their diversity as a national asset (hirsh, 1993: 195). national efforts to manage this diversity have been remarkably successful. strategic government plans for absorbing immigrant groups and integrating them into israeli society, created the basis for the effective management of diversity in the community at large. such intervention established a national climate conducive to the management of diversity which spills over into the israeli workplace, thus providing management with all the necessary ingredients to create/add value by utilizing the benefits of this diversity. the purpose of this article is to describe the israeli approach to managing diversity, with the view to identifying possible applications for south africa. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no i 159 meaning of the concept "managing diversity" workforce diversity refers to those differences in an enterprise or organization that have an influence on the perfonnance of the workforce. these differences are not limited to colour, gender, ethnicity, nationality or religion, and may even include differences in ways of thinking. ( buhler, 1993: 17-19). greater workforce diversity will undoubtedly present managers and human resource practitioners with new challenges, but it must also be recognized that diversity could contribute to organization effectiveness and responsiveness. diverse populations have different experiences, insights, values and approaches to workplace issues, resulting in different perspectives and alternative solutions to work-related problems (wilson, 1994: 27). cox and blake (1991:45-56) argue that diversity could be a source of greater creativity and innovation and enhanced organization flexibility. mary mcenrue (1993:18-29) is convinced that managing diversity is essential, "not simply something to do because it is nice .... but a competitive necessity ... a business imperative ... a strategic priority". in her studies of the strategies of american companies in los angeles to manage workforce diversity, respondents cited benefits like a better understanding of customer needs, improved employee relations, enhanced public image and lower labour costs as the results of the effective management of diversity. the author states however, that the potential benefits of workforce diversity are substantial but not automatic: the process of creating and capitalizing on diversity must therefore be carefully managed. daniel (1994:14) supports this point of view. he is of the opinion that south africa has no choice but to harness the talents and ideas currently available in its diverse labour pool. unless diversity is turned into an asset, it might become our downfall. most human resource practitioners define managing diversity within the context of creating a work environment in which obstacles to the realization of human potential are removed. table i indicates some such defmitions by various authors. f or the purpose of this article, we take the concept of managing diversity to refer to management processes aimed at the development of a work environment in which individual differences are accepted and valued, and management policies and practices aligned to enhance inclusiveness of all employee groups, in order to optimize economic perfonnance. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 160 sajems ns vol 2 (1999) no 1 table 1: some definitions of managing diversity fuhr (1994: 10) it has to do with creating a working environment in which everyone has a true sense of belonging and which removes the barriers that have hindered the fulfillment of : human potential. daniel (1994:14) managing diversity is a process for developing an environment that fosters awareness, value and acceptance of individual differences, that gives employees opportunities and judges them i fairly on their talents and contributions, 1thereby attempting to address expectations and remove or reduce biases and stereotypical behaviour. wingrove (1993:8) ! this concept is based on the premise that every individual is unique, bringing hisjher special talents and attributes to the workplace to be utilized for the benefit of the greater whole. thomas (1996: 10) managing diversity can be defined as a planned, systematic and comprehensive managerial process for developing an organizational environment in which all employees, with their similarities and differences, can contribute to the strategic and competitive advantages of the organization, and where no one is excluded on account offactors unrelated to 2foductivity. a strategic framework for managing diversity a literature search to find appropriate models for the management of diversity meets with. little success. such a model would be useful to compare the management of diversity in the countries concerned, namely israel and south africa. ann morrison (1992:42-48) proposes a 5-step model for the development of diversity management programmes. this model is however only of limited use, as it is meant to be a basic instrument for identifying so-called best practices for the management of diversity. mcenrue (1993:18-29) in her research describes a number of strategic dimensions that form the basis of diversity management programmes of large organizations in los angeles, but does not integrate these into a comprehensive r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 161 model. the relevant infonnation in the literature is of fragmentary nature and does not provide an adequate framework for the purpose of management planning. an effort to integrate the infonnation found into such a model is depicted in figure 1. figure 1: an integrated strategic framework for tbe management of diversity organization vision, mission and value system ,-' strategic .-----.\ steps --------, , , , , i i human resource vision i top management commitment i i i needs analysis i j i l i selection of practices i i i implement collective action i programme i i i measure changes i i dissemination of results i (source: petersen, 1998: 70) __ j ___ , , -, i output i , , , , -------policy and resources, affecting all organizational functions 'y benchmarking and base line determination • training and development, enforcement measures and exposure actions .., balanced and collective approach building blocks objectives and linkage to performance. management systems and networks i j this integrated framework serves as a guideline to managers in their efforts to manage diversity. it focuses on the following: r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 162 sajems ns vol 2 (1999) no 1 the vision, mission and value system of the enterprise as the point of departure for managing diversity. these concepts normally reflect the personal philosophy and values of the chief executive officer and top management, and describe the core values of the organization. the human resource vision: this is a subset of the organization's overall vision, and articulates its human resource dimension in specific terms. as far as diversity is concerned, values like respect for cultural differences, unique contributions and equal opportunity should be included. strategic steps and outputs: the following strategic steps and resultant outputs are important. obtain top management commitment with a view to ensuring supportive policy and practices, as well as the necessary financial means to execute the policy. needs analysis, including processes like measurement of perceptions, obtaining information and statistics, and benchmarking. selecting the best combination of practices to support the management of the diversity effort. these fall mainly into the categories of training and development interventions, enforcement practices and exposure activities. these practices may also include changes to existing practices, e.g. performance measurement and reward systems. the emphasis must fall on the right mix of practices, best suited to the organization's needs. it would appear that the current infatuation with so-called generic "best practices" is not supported by empirical facts (morrison, 1992:43). implementation of the collective action programme: the prime requirements for such a programme are that it should be a balanced approach founded on a thorough needs analysis, and include the right mix of practices. appropriate building blocks should be utilized to ensure the continuity of the programme. dissemination of results is necessary for periodic review and corrective action, in order to meet newly identified needs. as mentioned above, this proposed framework is offered as a guideline for management use. it goes without saying that dialogue and consultation with diverse groups are essential to ensure success. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 163 managing diversity in israel the management of diversity in israel is manifested at two levels, le. at macro-level as managed by the israeli authorities and at micro-level, in the efforts of an individual enterprise to manage its diverse workforce. this means that managing diversity consists of first order and second order interventions. figure 2: the process of managing diversity in israel overall national vision ·unity in diversityn top management commitment (nationall national strategy and allocation of resources national programme institutional framework and structures inclusive national climate • legal framework and practices • national interventions programmes at local level second order processes organization vision and commitment of executive management organization strategy and departmental budget allocation action programme • organization structure • supportive organizational structures • policy and hr practices • utilization of workforce diversity national and organizational competitiveness strategic direction (source: petersen, 1998:239) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 164 sajems ns vol2 (1999) no 1 first order management of diversity entails a comprehensive programme by the authorities, in order to absorb a great number of diverse immigrants into israeli society and to transform these people into a new national identity. second order management of diversity refers to the efforts of the israeli business community to manage a diverse workforce and to tum this into a strategic advantage. this situation is illustrated in figure 2. the first order process of managing diversity consists of a national programme by the authorities, aimed at integrating diverse immigrant groups into a collective identity. the result of these efforts is that it sets the scene for the management of diversity at the individual enterprise level, i.e. the second order management of diversity. the nature of these two processes is next briefly discussed. the first order process of managing diversity as illustrated in figure 2, the point of departure for the first order management of diversity is a national vision of diversity as a strategic advantage. the vision of israel is embedded in its zionist ideals of national reconstruction and renaissance, founded on a religious base. it focuses on the themes of jewish solidarity and the re-establishment of a collective identity, with the objective of including the jewish nation in the family of nations (eisenstadt, 1985: 86). this national vision is the driving force behind a programme of strategic interventions having the following central themes. national efforts to reconstruct jewish symbols and traditions the resurrection of a "dead" language, hebrew, as a common national language. hebrew is today a language of international significance, that meets the requirements of modern science and technology. it also forms a primary binding factor in the cultural structure ofisraeli society. the re-establishment of age-old jewish traditions and customs. this played an important role in the reconstruction process and formed the basis for the new identity of a new generation of israelis. as a result, a unique cultural format has developed over time, with a peculiar balance between the demands for tradition and modernity. this contributes to the reduction of friction between the religious and secular groups in israeli society. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no i 165 a need for new themes in the enhancement of a new collective identity developed over time. this resulted in the development of new symbols and legends, like the image of the toughness and courage of the israeli soldier and self-sacrifice in the defence of a beleaguered" nation under arms". in this way the image of the "sabra" developed as a symbol of the new generation of israeli's. "sabra" refers to a prickly pear and is supposed to describe the israeli psyche tough on the outside but sweet inside. the efforts to reconstruct jewish traditions and customs were very successful and this has undoubtedly contributed to the fact that israel today stands out as a nation characterized by cultural richness and unique identity. national-educational interventions israel is a multi-cultural and conflict-ridden society. this heterogeneity had a special impact on the development of the educational system. the israeli authorities were faced with the challenge of balancing their need to build a nation from immigrant groups of diverse origins, at the same time accepting the legitimacy of their cultural pluralism. in addition, a decision had to be taken regarding the nature of an acceptable educational system for the arab minority, taking in consideration their national and religious aspirations. as a result an educational system developed over time that is characterized by the following features: the initial approach to education, based on the melting pot principle, was replaced by a philosophy of multi cultural education. this new orientation entails creative curricula, with the emphasis on the uniqueness of ethno-cultural differences. the training programme of teachers was adapted with this in mind and now includes compulsory courses in concepts such as peaceful co-existence, majority-minority relations and workshops in heterogeneous teaching. state education for arab minority takes cognisance of the needs of the arab community and its cultural values (resh & kfir, 1990:13). with regard to language, it was decided to include both arabic and hebrew in the curriculum, effective from the first grade. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 166 sajems ns vol 2 (1999) no 1 it may therefore be concluded that the ideological shift to multi-cultural ism in education has resulted in a growing sensitivity to ethnicity and diversity, with teachers now being trained to deal with this in the classroom. the role of the israeli defense force (idf) as integratingfactor the functions of the idf are defined to include more than purely military tasks. the idf is used very effectively for purposes of nation-building and plays a significant role in the integration of diverse groups in israeli society. military service is the passport or "rite de passage" to israeli society. it is widely accepted that national service has the most important fonning effect of all national experiences, and that real integration into national life occurs during the years of national service (cohen, 1995:245). the nation-building role of the idf includes tasks like compensatory training for jewish immigrant groups from disadvantaged communities (adult education, literacy training), provision of temporary accommodation for immigrants, and special upliftment programmes for marginalized youths (drop-outs). in so doing the state harnesses the tremendous capacities of the idf for non-military use as a resource for the integration and utilization of human diversity. a national strategic absorption programme the large-scale absorption of immigrants into israeli society would not be possible without the policy action and resources of the state. the ministry of immigrant absorption and the ministry of trade and industry play an important role in this regard (israel government yearbook, 1991; 262-272). the ministry of immigrant absorption is responsible for the economic, vocational and social integration of immigrants during their first three years after arrival. it fonnulates related policy and co-ordinates the activities of public institutions which playa supportive role. the prime function of the ministry, for the purpose of this article, is the employment and placement of immigrants. it liaises with employers, monitors the labour market and is responsible for services like psychometric testing and vocational certification of new immigrants. it also promotes vocational training and retraining of immigrants, is responsible for language teaching schools, and runs four regional centers of career counseling and referral of prospective employees. the ministry undertakes special r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol2 (1999) no i 167 projects in co-operation with employers, for example, training and development of entrepreneurs and a centre for the absorption of scientists. the ministry of trade and industries contributes significantly to the utilization of diverse talents in the labour force, with special reference to new immigrants. it operates a number of important projects, e.g. the so-called technology incubator projects. the incubator programme is a national intervention, aimed at stimulating technological growth of the high-technology industry. this approach entails the establishment of projects, utilizing the inventions or specialized knowledge of immigrant groups, with the ultimate objective of producing viable commercial products and forming commercial companies. the stress falls on developing the entrepreneurial competence of new immigrants (e.g. from the ex-soviet region), as ownership of such companies will eventually go over to these project team members. not only have thousands of job opportunities been created through this programme these projects also serve as a hothouse for new ideas and technologies. municipal authorities play a supportive role in the integrating of immigrants into economic and social life. work creation projects are undertaken by some (e.g. artist village in jerusalem), research is done into the needs of immigrants, support is given to prospective entrepreneurs and services like training and information are provided (jdc brookdale institute, 1992). it may be concluded that local authorities serve as an extension of national policies for the integration of diverse population groups. these interventions by the state emphasize the strategic importance of diversity in the community. as a result the value of diversity is acknowledged at national level and this sets the scene and creates an underlying structure for the management of diversity at organization level. the second order processes for the management of diversity in israel it is clear from the foregoing outline that the first order processes create a foundation for the management of diversity at individual enterprise level. it is also interesting to note that the processes show remarkable similarities to the strategic framework proposed in figure 1. a literature search, supplemented by a survey of a number of top israeli companies (n=26), indicates that israeli enterprises are highly pragmatic in their approach to managing diversity (petersen, 1998:280). the results of the survey are summarized below. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 168 sajems ns vol 2 (1999) no i strategic direction little evidence can be found that israeli managers have formal strategic plans for managing diversity this corresponds to the fact that israeli managers have a more informal style of management than their south african counterparts. it is, however clear from the survey that the respondents do generally utilize diversity quite effectively. utilization of diversity as strategic advantage in local markets there are many examples of how israeli companies utilize diversity in local markets. black ethiopian israelis are often used for marketing products in their closed community, israeli arabs are employed to penetrate residentially segregated arab markets, and ultra orthodox israelis promote/sell kosher products in that segment of the market. utilization of diversity as strategic advantage in international business activities like south africa, israeli companies find that international and regional markets become more aceessible as a result of peace initiatives. israeli managers utilize their diversity in a very pragmatic way for the purpose of establishing themselves in these markets. many second and third generation israeli immigrants have good business contacts, family relations and a sound knowledge of the business culture of their country of origin, and thus access to business opportunities in the markets of those regions. a good example is the large number of russian immigrants who arrived in israel recently. they stili have family connections in russia, a thorough understanding of business conventions there, and naturally know the russian language. this diversity is effectively utlized by companies as strategic advantage to operate in the russian business environment. many similar examples were found in the study, including organizations which deliberately recruit diversity, with a view to promoting international business ventures. israeli companies are highly export-orientated and make good use of their diversity for this purpose. israeli arabs stand with their feet in both the israeli and the arab cultures. it therefore makes good business sense to use them as intermediaries for doing business r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 169 in regional markets like jordan and egypt, and many israeli companies are making good use of this example of diversity. human resource systems and practices for managing diversity respondents are generally convinced that their human resource systems and practices support the management of diversity. the principle of flexibility is embodied in most human resource practices. respondents who employ large numbers of female workers use flexitime widely, and have implemented special working arrangements for working mothers and single parents. day-care centres in the workplace are commonplace. some employers even allow mothers to work shorter hours for a period of two months after the birth of their babies. special arrangements are widely applied to accommodate religious differences. synagogues and kosher restaurants are commonly found on the premises, social functions are arranged separately for ultra orthodox groups, and employees are not used for tasks in foreign countries if they have dietary requirements that cannot be met there. the same measure of flexibility can be found in the remuneration system of some companies. remuneration systems are adapted to the diverse needs of especially scarce categories of employees, like young computer engineers, who prefer to receive more cash and fewer social benefits, e.g. pension contributions. recruitment practices are sensitive to the advantages of diversity. thus one respondent prefers to recruit female indian israelis for wiring tasks in the production of certain micro-electronic components, as these workers have special dexterity possibly of a cultural nature. special travel arrangements are made for such workers who live in rural areas. these examples of human resource practices and systems supportive of managing diversity are but a few of the total number reported in the study. unique practices for the development of disadvantaged employees (e.g. third world immigrants) were also reported. these examples indicate a built-in sensitivity to diversity and its benefits. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 170 sajems ns vol 2 (1999) no i organization climate and managing diversity survey respondents reported that average israeli companies have created a work climate that is conducive to managing diversity. most employers focus on the talents and performance of employees. they agree that the israeli business culture is characterized by tolerance and acceptance of differences. this is attributed to factors like the collectivist kibbutz system, the binding effect of military service and the increase in intergroup marriages. the combined effect of these factors permeates all institutions of the community, specifically the culture of the enterprise. despite the positive organization climate reported in the study, employers agree on one area of concern: israel is a chauvinistic society and the talents of women employees remain underutilized. it may be concluded that the business climate of israeli companies is generally positive for managing diversity, not so much because of formal strategies or business plans as the combined effect of the first and second order processes at work. within the context of the organization, managers do not think in terms of the cultural differences of the workforce, but focus on the potential contribution of people and their diverse abilities to organizational and individual objectives. some appllca tlons for south africa the management of south africa's human diversity is a complex task not to be underestimated. it should be viewed within a specific historic context and a particular set of circumstances, and it requires a unique problem-solving approach. a review of the israeli approach to managing diversity however provides us with some lessons that can also contribute positively to the south african situation. the following recommendations may well prove useful to south african decision makers. the need for an integrated national strategy for managing diversity the above research results indicate that this is the most important lesson that south africa could learn. the israeli success is the result of the interaction of all the various processes of managing diversity, especially the national vision and related policy interventions for the management of diversity, which create the right climate and establish the national value of appreciation of diversity. this in tum lays the foundation for managing diversity at the level of the individual enterprise. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (\999) no \ 171 although some aspects of a national strategy are discernible, south africa lacks a holistic approach that includes visionary leadership, an integrated programme of policy interventions, an adequate superstructure and appropriate management systems. one particular element of managing diversity, affirmative action, is overemphasized and does not have a long-term focus. in our opinion, a long-term integrated strategy for managing diversity could have the following positive effects in south africa. it could contribute to a national climate conducive to managing diversity. such a national climate would motivate business leaders to manage diversity in the workforce effectively, with emphasis on gaining a competitive edge. a favourable climate in the national context, presupposes a work environment in which all obstacles to realizing human potential are removed. this would require a commitment by the authorities at national level to create a strategic framework for the management of south africa's total rainbow nation, which would result in the empowerment and effective utilization of all groups of employees. a recent survey of south african business leaders with regard to the role that government should play in affirmative action, clearly showed that most respondents would prefer it to play no role at all they reasoned that the government should at most promote corrective action through incentive measures, e.g. tax rebates (jeffery, 1996: 11-13). this kind of argument is compatible with the strategy outlined above. a shift of emphasis towards a long-term approach for managing diversity, could help to counteract the probable negative effects of affirmative action. forced affirmative action is at present creating resistance to efforts of diversity management. the need for affirmative action is irrefutable, but the danger of a hardening of attitudes is growing due to the present short-term approach. this could eventually do irreparable damage to existing goodwill amongst those negatively affected by a politically inspired, short-term drive for affirmative action. it is hoped that emphasis on a long-term strategic approach to diversity would result in the establishment of a national culture of respect for the talents of all workers and that this would in tum motivate employers to elevate the management of diversity to the level of strategic priority. a comprehensive strategy should include national policy interventions, similar to those found in the israeli approach. examples are the creation of national symbols with a bonding effect, an education system based on respect for r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 172 sajems ns vol 2 (1999) no 1 differences, with teachers who trained to manage diversity in the classroom, and innovative cultural practices to enhance a new collective identity. our success in this regard has been limited, possibly due to the novelty of the south african situation. the short-term emphasis on affirmative action is partly to blame for the current net skills loss caused by the emigration of trained labour. appropriate national policy intervention should be formulated soon to prevent the further outflow of such skills. utilizing diversity as strategic business advantage the study of the management of diversity in israel reflects a number of excellent examples of how diversity in the workforce should be utilized as strategic business advantage. very little evidence exists that south african companies are utilizing diversity in such an effective way. the israeli approach of using representatives from specific communities for the purpose of marketing, could also be applied to south africa and african markets. the development of a south african based management approach to managing diversity this study has served to provide evidence of a unique israeli management approach, based on factors like the collectivism of kibbutz culture. in this style of management opportunities are provided for group work and high levels of social interaction, natural leadership is emphasized and recognition is given to the technical ability and integrity of workers. it may be concluded that this management approach is not only appropriate for the israeli workplace but in fact best suited to the diverse nature of its workforce. south africa is challenged to develop a similar indigenously based management style, suited to the local situation. a south african management approach should incorporate such aspects as the community concept, which brings to the fore images like supportiveness, cooperation and communalism (christie, lessem and mbigi, 1993:123). although the issue of an appropriate afrocentric approach to management is already receiving attention in academic and professional circles, there is little evidence that business performance would be enhanced in this way. in-depth research is urgently needed to develop indigenous models in this context. such models will have to take into account factors like ethnic differences in the workforce, the diverging interests of workers, biases of the past, racial polarization and even r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no i 173 clashing ideologies. the acid test will eventually be whether a south african-based style of management will enable south african businesses to compete in a highly competitive international environment. development of an organizational climate in which diversity can be effectively managed one particular fact that stood out during the above survey, was that the organizational climate of the average israeli business organization contributes positively to the management of diversity. three particular aspects of the organizational climate may be mentioned: openness to and awareness of the needs of diverse groups, tolerance of differences, and situational adaptability which confinns the value of diversity. the climate in israeli organizations unmistakably reflects the broader values of the community. the israelis, since the inception of statehood, have had to rely on the contributions of all groups for survival. as mentioned earlier, these values have their origin in a national vision and collectivist system, based on equality of and respect for individual contributions, together with tolerance and understanding of human differences. the positive nature of the climate within the typical israeli enterprise is characterized by the readiness to make comprehensive changes to management systems and practices in order to meet the needs of diverse population groups. this readiness to adapt communicates a culture of inclusiveness to employees. the application of this principle to south africa depends on the intrinsic value of inclusiveness. it emphasizes a strategic vision to strive for an organizational climate in which all employees are empowered to realize their potential. the israeli organizations in this study demonstrated that they are willing to invest in pragmatic, visible measures to promote the management of diversity something which they practise rather than preach. conclusion the study of managing diversity in israel indicates an important fact: that it must be viewed as a total process. the primary role-players in this process are the national r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 174 sajems ns vol 2 (1999) no 1 authorities and the individual enterprises. they need to work together as partners in order to co-ordinate their efforts into viable national and organizational objectives. at enterprise level, the study revealed the importance of inclusiveness. this brings to the fore the fact that the emphasis must fall on the effective management of people: managing diversity is all about the effective management of people and their individual talents for the common good of the organization and all its stakeholders (human, 1996: 4). references: i. buhler, p. (1993), "managing in the 90s",.supervision, 7-19. 2. christie, p. lessem r. and mbigi, l. (ed). (1993, "african management: philosophies, concepts and applications", knowledge resources, randburg. 3. cohen, s.a. (1995), "the israel defence force (idf): from a 'peoples army' to a 'professional military"', armed forces and society. 21(2) 237254. 4. cox, t.h. and blake, s. (1991), "managing cultural diversity: implications for organizational effectiveness", academy of management executive, 5(3), 45-56. 5. daniel, r. (1994), "diversity: it's good for business". human resources management, 14-17. 6. eisenstadt, s.n. (1985), the transformation of israeli society. westview press, calorado. 7. fuhr, i. (1994), "worlds apart: managing workforce polarisation", people dynamics, 8-13. 8. hirsh, e.{ed). (1993), facts about israel. israel center, jerusalem. 9. human, l. (1996), "diversity during transformation". human resources management, 12. 10. ministry of education and culture, information center. (1991), israel government yearbook 5750. jerusalem. ii. mc brookdale institute. (1992), the road to successful absorption. research report. lod. 12. jeffery, a. (1996), "business and affirmative action". report. southafrican institute of race relations. johannesburg. 13. mcenrue, m.p. (1993), "managing diversity: los angeles before and after the riots", organizational dynamics, 21,18-29. 14. morrison, a. (1992), "developing diversity in organisations , business quarterly, 57(1), 19-23. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 175 15. petersen, r.j. (1998), die bestuur van in diverse werksmag in die israelse besigheidsomgewing en paralelle toepassings vir suid-afrika. unpublished doctoral thesis, university of pretoria. 16. resh, n. and kfir, d. (l990), desegregation and effoctive schools: contradictory and complementary interventions. report. the ncjw institute for innovation in education. hebrew university. jerusalem. 17 thomas, a. (1996), beyond affirmative action. knowledge resources, randburg. 18. wilson, p. (1994), "cultural diversity: an organisational asset", public manager, 23, 27-30. 19. wingrove, t. (1993), affirmative action: a "how" guide for managers. sigma press, pretoria. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction and problem statement problem background theoretical framework literature review research approach results and discussion recommendations implications for future research and conclusion acknowledgements references about the author(s) patient rambe department of business support studies, central university of technology, south africa livingstone a.k. agbotame department of business support studies, central university of technology, south africa citation rambe, p. & agbotame, l.a.k., 2018, ‘influence of foreign alliances on the performance of small-scale agricultural businesses in south africa: a new institutional economics perspective’, south african journal of economic and management sciences 21(1), a2011. https://doi.org/10.4102/sajems.v21i1.2011 original research influence of foreign alliances on the performance of small-scale agricultural businesses in south africa: a new institutional economics perspective patient rambe, livingstone a.k. agbotame received: 05 july 2017; accepted: 28 june 2018; published: 04 oct. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: globalisation has accentuated the need for small-scale agricultural businesses (ssabs) to network horizontally and vertically into world markets. however, the capacity of ssabs to cement foreign alliances to capitalise on business opportunities that the expansion of global markets presents, while simultaneously mitigating against the negative forces of globalisation remains a grey area. aim: the study sought to contribute to internationalisation literature by examining: (1) the extent to which ssabs’ owner and/or managers in selected south african provinces establish foreign alliances, (2) whether there are any statistically significant differences in ssabs’ performance based on their extent of establishment of foreign alliances. setting: the setting for this study was vryburg-pokwani in the north west and northern cape provinces of south africa, respectively. method: a survey was conducted on 151 ssab owner and/or managers in the aforementioned study area. results: the results revealed that although a majority (51.7%) had some (i.e. few) foreign alliances, 48.3% of ssabs had no foreign alliances at all. the results also demonstrated that the establishment of foreign alliances was positively and statistically significantly related to the performance of ssabs in the vryburg-pokwani area. post-hoc comparisons (bonferroni) results showed that while ssabs with 1–2 foreign alliances perform better than those with no foreign alliances at all, those ssabs with 6–10 foreign alliances perform better than those with none, 1–2 and 3–5 foreign linkages respectively. conclusion: since ssabs with foreign alliances tended to outperform those that were dependent on domestic links, the extent to which the economic benefits derived from internationalisation are reinvested into the businesses for the continued sustenance of businesses needs more rigorous investigation. introduction and problem statement while the forces of globalisation such as trade liberalisation and structural adjustment programmes have led to the increased integration of world markets (reardon & barrett 2000; weilbach 2015), the irony is that only a few small-scale agricultural businesses (ssabs) in developing countries, such as south africa, have the ability and capacity to be integrated into these lucrative markets to derive substantial dividends (agbotame 2015; louw, nhemachena & van zyl 2008). south africa’s small national business act (2003) defines ssabs as those agricultural firms employing less than 100 employees, with a total annual turnover of less than r5 million and a total gross asset value of less than r5 million (national small business amendment act 2003). these should be differentiated from large agribusinesses, which are large companies (in terms of workforce, annual turnover, and asset value) that are involved in the production, processing, and marketing of value-added products and services. ssabs can also be distinguished from small agribusinesses, which are market and private business-oriented entities involved in the production, storage, distribution, and processing of agro-based products, the supply of production inputs, and the provision of extension and research services (gandhi 2014). louw (2007) defines agribusinesses as industries, ranging from suppliers of inputs and services to producers, to processors and marketers of agricultural products, manufacturers, exporters, retailers, the distribution systems, and consumers. therefore, although these enterprises deal with inputs, processes, and outputs that could be related to agriculture, their scope of production, marketing, and service provision extend beyond agriculture to include non-agricultural products such as retail and fisheries. the complexity of integrating ssabs (i.e. small-, micro-, and medium-sized agricultural firms involved in the production, processing, and marketing of value-added products and services) into the world markets can be attributed to several challenges. these constraints include lack of physical access to global markets due to information asymmetries (ha, bosch & nguyen 2015), lack of technical and managerial skills relevant to engage with global players (frimpong 2015; louw et al. 2008), and the low competitiveness of agricultural products from emerging economies (jabbar & akter 2008). furthermore, the high production costs, including the poor quality of products and services from these economies (dung & jenicek 2008; ha et al. 2015), further complicate their international competitiveness. although these challenges are not peculiar to ssabs but may resonate with the international competitiveness barriers of established businesses in developing countries, small ssabs in developing countries such as south africa tend to bear the brunt of smallness the most due to limited economies of scale and resource constraints. as such, the potential and possibilities of trade liberalisation have remained a mirage for most ssabs that fail to tap into the lucrative world markets. in view of the rapid transformation of food and agricultural markets, increased international competition due to trade liberalisation, and the rise of global agricultural firms, the need for higher levels of managed coordination, vertical integration and foreign alliances (kirsten & sartorius 2002; louw et al. 2008) cannot be over-emphasised. for south african ssabs, the need for stronger foreign alliances stems from their weak links to global markets and financial systems (wroblewski & wolff 2010), the need for rapid flexibility to sell high-quality products at competitive prices on the world markets (centre for rural legal studies 2003), and the importance of agricultural businesses’ accessing world markets faster, further, and deeper at comparatively lower cost (weilbach 2015). while the establishment of foreign alliances is critical to the integration of ssabs into the world economy (pwc agribusinesses insights survey 2014/2015), the scarcity of capital, the lack of infrastructure development in the rural areas, coupled with the high cost of farming inputs and utilities (frimpong 2015), often hinder ssabs’ ability to collaborate and engage with international partners to reduce the cost of exports and improve the efficiency of engaging in international business. while the formation of international alliances is critical to improving ssabs’ international competitiveness (agbotame 2015), what remains unclear is the extent to which such businesses engage in foreign alliances and the implications of such behaviour for their performance. to bridge this research gap, the current study sought to address the following pertinent questions: to what extent do ssabs in vryburg-pokwani areas establish foreign alliances? are there significant differences in ssabs’ performance based on their extent of establishment of foreign alliances? if so, what is the nature of such differences? although ssabs’ performance is often measured in terms of the profitability, growth, and survival of these businesses (madhoushi et al. 2011; wiklund & shepherd 2005), the most common measures of firm performance include the number of employees employed in the business, growth in pre-tax profit, gross turnover, and increase in exports as a percentage of annual turnover. the rest of the article is structured as follows: a problem background is rendered, the theoretical perspective and the literature review are provided, the research methodology is articulated, findings are presented and discussed, the implications and directions for future research are rendered, and then a conclusion is provided. problem background the importance of ssabs’ establishment of foreign alliances should be understood against the background of increased trade liberalisation, increasing international competition in global trade, and the predominantly export-oriented nature of the agricultural sector in emerging economies. while the sectors of the south african economy range from manufacturing, mining, agriculture, communications, tourism, wholesale and retail trade, finance, business services and investment incentives (media club south africa 2018), this study is preoccupied with ssabs, some of which belong to the agro-processing industry. the agro-processing industry is a sub-sector of manufacturing that deals with the conversion of products from field crops, horticulture, fisheries, and forestry from raw materials and inputs into semi-processed, processed, and value-added goods and products (fao 1997). trade liberalisation and agricultural constraints agbotame (2015) observes that when international sanctions were imposed on south africa from 1979 to 1994, the apartheid government heavily subsidised and protected ssabs from foreign competition to improve their self-sufficiency and absorb excessive external pressure. with the attainment of democracy in 1994, the resultant integration of the south african agricultural economy into the world economy and the anc government’s adoption of trade liberalisation exposed the formerly protected ssabs to global competition and the vagaries of international trade. the centre for rural legal studies (2003) highlights that the government’s adoption of trade liberalisation implied limited state intervention in economic management, which allowed the agricultural market to operate strictly on the basis of the law of supply and demand, and enabled competition throughout the economy. while it can be argued that 22 years into liberal democracy, ssabs have sufficiently acclimatised to the demands of global competition (e.g. improved resource efficiency, solid international networks, and high-quality products), multiple impediments continue to undermine their effective participation in the global economy. trade liberalisation has not substantially benefited south african ssabs due to: their predominantly rural location, poor road networks which increase the logistical costs of product and service provision, inadequate farming infrastructure (e.g. efficient irrigation and storage facilities), low agricultural incomes, volatile weather patterns, widespread poverty, and a lack of food processing industries (botha 2015). collectively, these agricultural barriers increase the cost of doing business, complicate optimal pricing, and undermine the efficient sale of agricultural commodities. increasing international competition as doyer et al. (2007) aptly observe, the process of deregulation and liberalisation which started in the 1980s exposed south african ssabs to international trends and competition, compelling them to shoulder responsibilities and risks in agricultural markets that government agencies previously assumed. they elaborate, that confronted with the need to improve their ability to compete in current and new markets with new competitors while focusing on expanding their domestic market presence and power, based on value-added products, south african agribusinesses including ssabs were compelled to assess innovative options in their governance structures. this unfolded in an environment characterised by increasing domestic and international competition, a new political and social environment based on equity principles, and increasingly complex consumer demands. it can be inferred from doyer et al. (2007) that the formation of strategic alliances with foreign partners and subsidiaries could contribute to improved sensitivity of ssabs to foreign consumer demands, flexible responsiveness to foreign market needs, and improvement of ssabs’ international competitiveness. export orientation of the agricultural sector this study’s preoccupation with ssabs’ foreign alliances is hinged on the understanding that the agricultural sector in south africa is export oriented, which makes the sector vulnerable to the vagaries of international trade. for instance, the centre for rural legal studies (2003) acknowledges that notwithstanding the agricultural sector’s limited contribution to south africa’s annual national income (or gross domestic product, gdp), the sector accounted for a relatively high share of the total goods exported from south africa. while agriculture contributes less to gdp (less than 3% for primary agricultural products), agriculture accounts for a relatively high share of south african exports: about 8% of total exports (agbotame 2015; department of agriculture, forestry & fisheries 2012). this large volume of agricultural exports compels ssabs to establish foreign alliances to expedite their sales, improve the competitiveness of such exports, and reduce the transaction costs of conducting business in foreign lands. the formation of strategic alliances cannot be ignored in the performative dimensions of small agribusinesses. pwc agribusinesses insights survey (2014/2015) reports that better penetration of new markets is regarded as one of the main determinants of the growth expectations of such businesses. the survey results affirm that accessing new markets allows agribusinesses to broaden their reach and increase their potential to sell products and services to more customers. theoretical framework the transaction cost approach (tca) is the central anchor of the new institutional economics (nie) theory. transaction costs encapsulate the costs that arise from the relations between individuals (or businesses) whenever agents want to make a deal, which may or may not take the form of a market exchange (matthews 1986; platteau 2008). besides the individual characteristics of partnering firms, alliances are also subject to transaction costs arising from the misalignment of partners’ goals (eisenhardt 1989) and the project-specific behaviour of partners (shah & swaminathan 2008). it can be assumed that ssabs’ ability to actively compete with their rivals on the global market is a function of their capacity to reduce the transactional costs (e.g. insufficient knowledge of the tax regimes and incentives of the foreign alliance partners’ countries, trade information asymmetries arising from transacting in new or unfamiliar regional contexts) of doing international business through their collaborations and engagements with foreign partners who are more familiar with the host market conditions than ssab owners or managers. literature presents two conditions under which transaction costs may arise from: (1) informational incompleteness and asymmetries, which happens when the parties miss information needed to determine whether the terms of an agreement are mutually acceptable and whether these terms are actually being met, or (2) the costs resulting from imperfect commitment (milgrom & roberts 1992; platteau 2008). imperfect commitment implies the inability of parties to bind themselves to follow through on threats and promises that they would like to make but which, having made, they would later like to renounce (platteau 2008). if mutual benefit arises from a ssab and foreign partner’s exchange of strategic marketing information on agricultural products in foreign niche markets less familiar to the ssab, the ssabs’ negation of such information that makes the alliance beneficial to the ssab would constitute a transaction cost to the ssab. by the same token, the ssab and foreign alliance partner’s inability to take advantage of the opportunities created within the global market (e.g. declining petrol prices, foreign currency fluctuations’ impact on export volumes), including failure to mitigate the threats associated with the vagaries of international trade, would be extra transaction costs for both entities (the ssab and foreign alliance partner). from the transaction cost perspective, the aim of institutions is to reduce transaction costs so as to allow agents to seize economic opportunities; therefore, an efficient institution is simply an arrangement that minimises such costs or one that maximises the joint wealth of all the parties concerned (allen & lueck 2002; platteau 2008). the ability of institutions to maximise the economic benefits, minimise the costs, and hence magnify the net worth of the foreign alliance rests on the quality of the resources these parties (ssab and alliance partner) possess, degree of risk involved in entering foreign markets, these alliance partners’ technological capabilities, and dynamic capabilities including the superiority of their knowledge of foreign markets. for the ssabs, which normally have a strong survivalist orientation and are profoundly resource squeezed, the need for institutions that minimise the transaction costs and increase the net worth of the foreign alliance partners cannot be ignored as ssabs have limited chances of making an international impression on the global market. literature review characterisation of foreign alliances the foreign alliances are a part of the broader business networking that leads to internationalisation of firms. such strategic alliances are voluntary collaborations between organisations that involve the exchange, sharing or co-development of products, technologies, and services to pursue common goals or meet critical business needs (gulati 1998; kishna et al. 2015; lin 2012). such international networking can take different formats such as the establishment of international subsidiaries, international collaboration with foreign firms through strategic alliances, international partnerships, contractual agreements, and production investments in foreign companies (mellen 2009; ndjike 2016). therefore, foreign alliances can take different forms: the formation of inter-firm alliances, bilateral relationships, production-related agreements, and foreign subsidiaries. all these institutional arrangements are integral components of the internationalisation of firms, which entails the firm’s involvement in international business through exportation, the presence of foreign subsidiaries, share ownership by foreigners, and the appointment of foreigners in the organisational structure of local firms (chelliah et al. 2010). since small agricultural businesses do not meet all attributes of large firms’ foreign alliances, such as having foreign subsidiaries, share ownership by foreigners, and appointment of foreigners in the business management structure of the local firm due to severe resource constraints, the current study’s conception of foreign alliances exclusively covers the establishment of strategic alliances and partnerships with foreign firms. the value of agro-processing alliances from an internal perspective, agri-food systems’ linkages with the rest of the economy are important preconditions for integrating rural firms into urban economies and are the long-term solutions for agricultural growth, poverty reduction, and economic growth (louw et al. 2010; memedovic & shephard 2009). the connectivity between local and urban agro-processing firms is just as important as the linkages between rural firms and their international partners and subsidiaries. for instance, small agricultural producers’ collective organisation (i.e. among themselves) in liaison with foreign partners improves their assimilation of global production and marketing practices into their systems and creates new local institutions that support local knowledge building (perez-aleman 2012). more so, the capacity of small agricultural producers to increase connections among themselves and with specialised organisations nationally and globally contributes to these producers’ effective acquisition and application of new knowledge and their improved capacity to innovate locally (perez-aleman 2012). foreign alliances are conceived to facilitate the development of sustainable innovations, which depend on capabilities and resources that are spread over organisations from different industries (van tulder et al. 2015). there is growing consensus that foreign networks with varied expertise facilitate learning by creating horizontal relations between producers, as well as links to external organisations that can act as knowledge bridges between different communities and knowledge resources (gomes 2006; mcdermott, corredoira & kruse 2009; perez-aleman 2012). from an international perspective, kawa and kaitira (2007) considered the strengthening of links between local and foreign firms in tanzania as critical to the strategic marketing of agricultural products and the promotion of optimal agribusiness returns based on a competitive, efficient, and equitable marketing system. yet south african ssabs tend to operate in predominantly rural communities where internet penetration, which increases virtual connectivity and the forging of alliances with distant communities, is conspicuously absent. therefore, the affordances of foreign alliances, such as the acquisition and exchange of complementary resources including entry into new markets and technologies (kishna et al. 2015; rothaermel & boeker 2008) may be difficult to contemplate for such rural-bound ssabs. studies on agribusinesses’ foreign alliances studies on the alliances of agribusinesses tend to focus more on the forward and backward linkages between the agribusinesses and various stakeholders within a domestic economy (industrial development corporation [idc] 2015; mucavele 2009; olomola 2013) and ignore the foreign alliances of these firms. in recognition of intraand inter-sector alliances, olomola (2013) highlights how discrimination against small-scale farmers in nigeria is evident in the lack of effective links with larger agribusinesses for the enhancement of productivity and improvement of access to markets. while the intraand inter-sector linkages perspective is useful for demonstrating the contribution of such domestic linkages to productivity enhancement within the value chain, such a perspective is insufficient for illuminating full comprehension of the dynamics of international trade, drawing on foreign networks. when an international perspective of alliances is considered, the focus of analysis turns to: conformity to global standards, which affects food safety and exploitation of local knowledge (perez-aleman 2012); agribusiness investors’ weak links to global financial systems and the associated liquidity risks (wroblewski & wolff 2010), and the trade arrangements established in the south african agricultural industry since the demise of the marketing boards (doyer et al. 2007). doyer et al. (2007) observe that in relation-based alliances (for example, joint ventures and partial ownership arrangements) agro-processing parties are ex ante interested in mutual benefit that might arise from the transaction and the ex post monitoring of the relationship to ensure that it continues and delivers the envisaged mutual benefits. other studies have focused on institutional arrangements that give effect to more competitive trade and the associated barriers to internationalisation (kawa & kaitira 2007; lloyd-reason, deprey & ibeh 2009). although not related to agriculture, kishna et al.’s (2015) study analysed the role of strategic alliances in creating legitimacy for an emerging sustainable technology. the study reported that firms increase their market and social legitimacy by accessing the sustainable technology of an alliance partner, by collaboratively developing a sustainable technology or increasing customers’ access to the technology of a partner and increasing production capacity. however, the establishment of foreign alliances and partnerships cannot be assumed to be without its own challenges and constraints. for instance, although foreign alliances in small-scale agricultural businesses are credited with increasing access to agricultural markets and services, scaling up small holder production through increasing the quantity, quality, and diversity of goods they produce for foreign markets, these partnerships have several challenges (the governing council 2013). for instance, these alliances require ssabs to abandon their hierarchical agricultural production approaches and blueprints, while demanding extensive consultation as no single agricultural partner (be they farmers, private investors, researchers, governments or donors) has comprehensive solutions to challenges confronting agriculture (the governing council 2013). more so, the thriving of foreign partnerships also depends on farmers’ training (which requires time, energy and financial investments), proper organised action based on effective partnership facilitation, and farmers’ extensive access to research and technology (berdegué, biénabe & peppelenbos 2008), conditions which are not normally obtained in rural areas where most ssabs operate. more so, the alignment of ssabs partners’ disparate interests and visions and the need to reach consensus, though critical to creating lasting commitments founded on value for money (fao 2016), are an inextricably complex matter. moreover, the definition of roles for partners in line with the unique capabilities, skills, and expertise they bring to the agricultural partnership, should be postulated in line with the provision of appropriate incentives designed to reward these roles (fao 2016). these require strategic thinking, ingenuity in terms of organisational skills, and durable commitment among partners, which cannot be assumed to be consistently prevalent among them. firm performance firm performance describes a contested, multi-dimensional construct, which embodies financial, non-financial and growth-related indicators such as sales growth, financial outcomes, and firm growth (agbobli 2013). financial measures include sales growth, return on investment; growth in pre-tax profit, gross turnover before tax and non-financial indicators, as well as growth in the number of employees and increase in exports as a percentage of annual turnover. therefore, firm performance is a multifaceted construct that covers financial and non-financial aspects such as business competitiveness, operational measures on customer satisfaction, and competitive advantage (bititci 1995; folan, browne & jagdev 2007; kaplan & norton 1992). that said, this slippery construct varies dynamically in its meaning, depending on its context of use, size of the businesses and sector in which it is applied. for the purpose of this study, performance focused on growth in pre-tax profit over the previous five years, growth in employment over the previous five years and growth in agricultural exports and imports. relationship between agro-processing alliances and firm performance in their study on enhancing tanzanian smallholder farmers’ market competitiveness, kawa and kaitira (2007) report that strengthening links between local and foreign firms increases these firms’ capacity to mobilise resources for investment in the agricultural marketing infrastructure in rural areas and improves the international competitiveness of agro-processing and value-addition chains. the ability of agro-processing businesses to engage in strategic alliances with other enterprises is considered to strengthen international collaboration and improve sustainable development capacities, which increase the effective realisation of long-term business goals (louw & emongor 2004; louw et al. 2010). a 2009 organisation for economic cooperation and development (oecd) working paper on small-, mediumand micro-enterprises (smmes) and entrepreneurship highlights top barriers and drivers to smme internationalisation. the study revealed that czech, french and spanish agencies’ support for smmes’ export alliances and networks reflect the observed importance of networks, supply chain links and social ties in stimulating smme internationalisation and export competitiveness (oecd 2009). in the same vein, the idc (2015) reports that value chain development in the agricultural and industrial sectors is critical to leveraging the impact of economic linkages on business competitiveness. however, the internationalisation process, especially the establishment of foreign alliances, has its own fair share of challenges. the extension of agro-processing business operations internationally to develop a regional or global footprint may not detract concentration risk. idc (2015) observes that concentration risk generally results from an uneven distribution of an institution’s exposure to industry and regional sectors, which can generate losses large enough to jeopardise its solvency or profitability. in particular, concentrations of credit exposures in sectors or regions can pose risks to the earnings and capital of any institution in the form of unexpected losses. although idc’s operations resonate more with sector concentration risk than regional concentration risk, a typical firm’s operations can trigger regional concentration risk due to the variability of trade advantages and the competitiveness of business operations depending on regional trading conditions. research approach the study adopted an exploratory, descriptive and quantitative approach. an explorative study is appropriate when the researcher lacks basic information on an area of interest (fouché & de vos 2011). in view of the limited information on the extent to which small, predominantly rural-based agro-businesses in south africa forge foreign alliances, an explorative study was ideal for providing insights into such a phenomenon. since the current study sought to render an informative picture of the extent to which ssabs forged alliances with other foreign businesses, a descriptive approach assisted in painting a vivid picture of the specific details of the situation at that particular time (krueger & neuman 2006). this empirical approach was relevant to this study because although foreign alliances are sufficiently theorised in mainstream literature, there is limited empirical literature in the south african context on the foreign alliances of rural-based ssabs. population, sampling frame and sample the co-author of this study approached agricultural departments in these areas, which revealed that there were approximately 3788 small-scale businesses in the vryburg–pokwani areas. the lack of accurate records on ssabs can be attributed to the high failure rate of ssabs, which complicate the compilation of current reliable statistics on such businesses. the sampling frame of the current study consisted of 899 ssabs situated in the vryburg-pokwani districts of the north west and northern cape provinces. this figure was based on estimates obtained from the various district departments of agriculture within the study area. subsequently, the sample size was computed out of the working population by using a macorr sample calculator at 95% confidence level. subsequently, a total of 269 agro-based businesses were randomly selected. of this number a total of 151 respondents successfully completed the survey, constituting a response rate of 56.1%. the research instruments section a of the questionnaire solicited information on the ssab owner or manager’s demographics such as their age, gender, academic qualification, business management skills, agricultural skills, and entrepreneurial skills. the same section also extracted business-related information such as the duration of operation of the business, main business activity, form of ownership, and number of employees the business employs. section b established the extent of ssabs’ engagement in foreign business, type of foreign business activities, and the number of foreign alliances or partnerships or collaborations the business engaged in. section c examined the relationship between such foreign alliances and firm performance. to establish the extent to which ssabs established foreign alliances, the ssabs were requested to highlight the number of foreign alliances they had. the options were provided on a five-point scale comprising ‘1’ (no foreign alliance), ‘2’ (1–2 foreign alliances), ‘3’ (3–5 foreign alliances), 4 (6–10 foreign alliances), and 5 (more than 10 foreign alliances). data analysis the data collected was analysed using the statistical package for the social sciences (spss) version 21. descriptive analysis, comprising percentage analysis and pie charts, was used for the descriptive summary of results. inferential statistics, especially analysis of variance (anova) was used to quantitatively ascertain the degree of relevance of the internationalisation indicator (e.g. foreign alliances) on the performance of small-scale agro-based businesses. correlation analysis was employed to examine the relationships between foreign alliances and business performance. validation of the research instrument the validation of the self-constructed structured questionnaire involved the determination of its construct validity and reliability. construct validity takes into account the measuring instrument applied, compared with existing theoretical measures (cooper & schindler 2011; zikmund et al. 2013). the measurement instrument applied in this study was developed from the existing literature on businesses’ engagement in foreign alliances, thereby ensuring construct validity. according to leedy and ormrod (2010), reliability is the consistency with which a measuring instrument yields a certain result when the entity being measured has not changed. a cronbach’s alpha coefficient was used to establish the reliability of the instrument and a value of 0.70 is normally considered to be an appropriate level of acceptable reliability. all four indexes (‘importance and/or relevance of globalisation’, ‘impact of globalisation’, ‘long-term performance expectations’, and ‘long-term performance expectations under globalisation’) demonstrated excellent reliability as their respective coefficients were 0.921, 0.906 and 0.885. a second measure of internal consistency is the extent to which each individual item correlates with its total score on the index. correlation coefficients were computed as estimates of such item-total correlations. a coefficient of 0.50 indicates a strong correlation. the item-total correlations ranged between 0.57 and 0.78, and the average-item correlations for each of the three indexes were 0.72, 0.69 and 0.65, all markedly above 0.50. results and discussion gender distribution of respondents of the 151 respondents, 20.5% were female while 79.5% were male as depicted in table 1 and figure 1. figure 1: gender analysis of respondents. table 1: demographic characteristics of owners and/or managers. the under-representation of women in ssabs could be attributed to the multiple financial, institutional, social, and cultural barriers which continue to impede women’s full participation in agro-processing and other agricultural value-addition services. prejudices against women, which constrain their access to loan credits (agbotame 2015; mpiti 2016), competing family responsibilities (agbobli 2013; rambe & mokgosi 2016), and power configurations in the family that create skewed access to finance and financial decision-making collectively undermine women’s participation in small business in general and agribusiness in particular. age distribution of participants the results of the study revealed that a sizable percentage (35.1%) of ssab owners or managers were aged between 41 and 50 years, followed by those between 51 and 60 years who constituted 26.5% of the sample. the age distribution of participants is illustrated in figure 2. figure 2: age of respondents. the dominance of the 41–60 years age group suggests the significance of prior knowledge and practical experience in related agro-industries prior to the creation and operation of their own agro-businesses. chiliya and roberts-lombard (2012) consider age to have a significant effect on operating a complex business profitably because the accumulation of prior technical and technological experience, business knowledge and business connections is critical to successful business operations. levels of academic qualifications the academic qualifications of the owners or managers were considered in order to ascertain their educational profile. the results in figure 3 show that respondents with tertiary education (tertiary qualifications, diplomas or degrees, postgraduate certificates) constituted 48.4% of the sample and represented the largest percentage of participants in the study. figure 3: levels of academic qualification. figure 3 reveals that although the majority of ssab owners or managers were not highly educated, most of them had good tertiary education (tertiary certificate, diploma or degree, or postgraduate qualification). dzansi, rambe and coleman (2015) highlight the significance of entrepreneurial and project knowledge (which are consequences of education and training) in successful venture creation and operation of business. level of business-related skills the study also examined the business management, basic agricultural, engineering, and entrepreneurial skills base of ssab owners or managers. business management skills included marketing skills, financial management skills, and personnel management skills. basic agricultural skills included soil management, animal husbandry and crop management while basic engineering skills related to fencing, erection of sheds, repairs of equipment and machinery. entrepreneurial skills comprise risk-taking and the organisation of the resources at owners’ or managers’ disposal. the results in figure 4 reveal that 30% of respondents had no business management skills, 33% had no agricultural skills, 50% had no engineering skills while 39% had no entrepreneurial skills. despite this, there was also a sizable percentage of ssab owners or managers with these skills. the results on the level of business-related skills possessed by respondents are summarised in figure 4. figure 4: level of education and skills acquired. a sizable percentage (39%) of these owners and/or managers had business management skills acquired at college, at diploma or degree and postgraduate levels. by the same token, 34% had agricultural skills acquired at college, diploma or degree and postgraduate levels, while 23% had engineering skills acquired at college level. a total of 29% of owners or managers had entrepreneurial skills acquired at the aforementioned levels of college education. it can be argued that ssab owners or managers were well positioned to run their firms as they had acquired diverse skills critical to successful business performance. number of years the business has been in operation since the number of years in business is critical to ssabs’ generation of the momentum significant to building foreign alliances, the study sought to establish the duration of operation of the business to determine the level of experience of owners or managers. the results show that 31.8% of these businesses had been in existence for 11–20 years, and 23.2% of them had been in operation for over 20 years. about 23.2% of the businesses had been in operation for 6–10 years. the results on the number of years that ssabs had been operating are summarised in table 2 and figure 5. figure 5: number of years that the business has been in operation. table 2: business characteristics. the analysis presented shows that 78.2% of the ssabs surveyed have passed the survival stage and this could mean that they stand the chance of growing both locally and internationally. nieman (2006) considers survival to describe those businesses that have been in operation for more than five years. taking this description into consideration, it can be argued that the majority of the agricultural businesses have survived as they have transited their first five years of existence. type of business activity the study also established the type of activities ssabs are involved in. about 40.4% of the small agricultural businesses were into large and small livestock farming, 28.5% of them practised crop farming, 18.5% were in agro-processing while those involved in both livestock and crop farming accounted for 11.9% of the total sample as indicated in table 3 and figure 6. figure 6: types of business activities the ssabs practised. table 3: comparison of mean scores on the ‘importance or relevance of internationalisation’ index and business performance characteristics. perhaps, the popularity of livestock business can be attributed to the relatively low start-up capital required to start this business. small-scale farmers often start with a few livestock that they rear on communal land free of charge before expanding their businesses and participating in large-scale cattle ranching. the farmers may erect simple, basic fencing and may not need large sheds as their herds are normally small (harwell & pinkerton 2017). form of business ownership forms of business ownership were analysed to unravel the ownership patterns of ssabs. the results revealed that sole proprietorship is the most dominant form of ownership and accounted for 65.6% of the respondents’ business ownership. perhaps ssabs’ preference for this business structure is explained by the relative procedural ease with which sole proprietorships are created compared to larger business establishments. figure 7 summarises the different forms of ownership of these ssabs. figure 7: form of business ownership. number of employees in the business the study also explored the number of employees that ssabs employed. the results revealed that 48.3% of the ssabs employed between 1 and 5 people, 18.5% of the businesses had 6–20 employees, 14.6% employed 21–30 employees while 6.6% employed 31–40 employees. consistent with the small business act 102 of 1996 and nieman’s (2006) classifications of smmes, this finding suggests that the largest proportion of businesses fell under the micro-enterprises. figure 8 illustrates the number of employees in the selected ssabs. figure 8: number of employees in the business. performance-related business issues the results of the study revealed that the majority of the ssabs studied were neither importing (92%) nor exporting (62.9%). since involvement in export and import business is one of the components of the internationalisation of business, it can be argued that most ssabs lacked a strong drive towards internationalisation. however, when this limited internationalisation posture is conceived in conjunction with the financial performance of the business, a different picture emerged. for instance, 64.9% of ssabs’ owners or managers reported that their pre-tax profit grew by between 1% and 20% in the previous five years, a phenomenon that is symptomatic of thriving business. in addition, about 42.3% of ssabs’ owners or managers also highlighted that their employment levels grew by between 1% and 20%. such evidence demonstrates that a sizable number of these businesses were on an encouraging growth path, judging from their employment performance. engagement with foreign business ssabs’ engagement with foreign businesses were analysed in order to understand the extent to which they were oriented towards globalisation. from the analysis, 45% of the ssabs surveyed had some foreign business involvement while 55% did not have any foreign business dealings. as indicated in figure 9, 45% of ssabs had some foreign engagements, 37.7% of them participated in foreign businesses, 37.1% participated in the exportation of products, while only 7.9% were involved in the importation of foreign technology. while ssabs’ involvement in foreign engagements point to their potential to internationalise, their actual level of involvement across different activities is an emerging phenomenon. the low level of import and export orientation means that although ssabs are incrementally benefiting from globalisation, they have not fully harnessed the potentialities and benefits created by globalisation. this finding somewhat supports the claim that small businesses such as ssabs have not sufficiently benefited from internationalisation due to their weak international networks, their weak resources base and limited knowledge of world markets (lloyd-reason et al. 2009). consistent with the transaction cost approach (tca), itself the backbone of the nie theory, the limited engagement of ssabs in international business (i.e. importing, exporting and foreign business ownership) may be a consequence of the high transaction costs arising from the complexities of locating dependable foreign partners and effectively exploiting global market information inherent in foreign networks. figure 9: engagement with foreign businesses. foreign alliances the study also examined ssabs’ extent of establishment of foreign alliances. the results in figure 10 reveal that although a considerable proportion (48.3%) of ssabs had no foreign alliances, the majority (51.7%) had some foreign alliances. the results show that 18.5% of these agro-processing businesses had 1–2 alliances, 14.6% had 3–5 alliances, 6.6% had 6–10 alliances and 11.9% had more than 10 alliances. these figures also demonstrate that the majority (51.7%) of the businesses had between 1 and 10 foreign alliances. figure 10: extent to which businesses have established foreign alliances. based on this information, it can be concluded that although ssabs had foreign alliances, only a few of them had many alliances. it can be inferred that although ssabs are gradually realising the critical importance of globalisation through forging foreign alliances, few of them have fully exploited and subsequently benefited from these globalisation strategies. these aforementioned low levels of internationalisation are somewhat inconsistent with nie thinking embedded in perez-aleman’s (2012) argument that the increasing integration of small agricultural producers in the world markets can be attributed to: (1) the increasing production capabilities of such firms, which impact their capacity to survive and compete on a global scale, (2) knowledge flows that trigger the adaption of foreign practices, which leads to foreign innovation, and (3) strong institutions that facilitate knowledge flows that build local producers’ capabilities to be conversant with global standards, conventions, rules, and shared expectations to ensure growth and competition in world markets. it can be inferred from the latter point that conversance with these global standards presupposes the prevalence of strong local regulatory and marketing institutions, which conduct research and advocacy work for ssabs. these institutions would also render ssabs with premium information on the technicalities of the world markets and their operating standards. while our evidence supported the prevalence of foreign alliances of varying scale, ssabs could not confirm the contribution of regulatory and marketing institutions. the study results also addressed the question: are there significant differences in ssabs’ performance based on their extent of establishment of foreign alliances? if so, what is the nature of the difference? analysis of variance (anova) was used to quantitatively ascertain the degree of relevance of the internationalisation indicator (i.e. foreign alliances) on the performance of small-scale agro-based businesses. the results highlighted the number of employees including the owner or manager (a component of performance) to be significant (f = 15.999; p < 0.05). this is an indication that the firm’s orientation towards internationalisation (e.g. formation of foreign alliances, importing or exporting business) will contribute to a 16% increase in the number of employees they employ. consistent with tca, it is logical to assume that a firm will not engage in internationalisation if its return on labour is less than the marginal productivity of the labour. this interpretation seems to buttress the view that partnerships help ssabs and small farmers to scale their business operations and capture the opportunities (e.g. employment creation) created by the growing demand for agricultural products internationally (the governing council 2013). however, this finding is somewhat inconsistent with literature that claims that smmes’ ability to internationalise, using foreign alliances, is often constrained by limited information on the location and analysis of markets, difficulties in contacting potential overseas partners, and complexities of obtaining reliable foreign representation (eu 2014). the analysis of percentage growth in size or employment over the previous five years was found to be significant (f = 4.836; p < 0.05). this may be an indication that firms which are engaged in internationalisation (e.g. those with foreign alliances, those importing or exporting) had a 4.8% increase in size or employment for the previous five years compared to firms that were not involved in internationalisation. this could be interpreted to mean that internationalisation potentially contributes to increases in ssabs’ product competitiveness and profitability, which positively impact ssabs’ capacity to expand the size of their workforce. the finding supports literature on the capacity of partnerships to generate employment through improvements in operational and economic efficiency among ssabs (fao 2016). this contradicts the claim that small firms may be incapable of handling international partnerships due to lack of expertise, their management’s lack of time investment due to their preoccupation with daily operations, and inability to integrate technology into their learning plans (hyder 1998). analysis of variance was conducted on the ssabs’ pre-tax profit for the previous five years to ascertain whether they are declining, growing or have remained stagnant. the analysis of percentage growth in pre-tax profit was found to be significant (f = 13.680; p < 0.05). this is an indication that firms that are engaged internationalisation (e.g. those participating in foreign alliances, importing and exporting businesses) realised a 13.7% increase in pre-tax profitability. the implication is that as firms engage in internationalisation, they might unlock their productive potential through sharing efficient methods of resource utilisation and effective methods of agricultural production, which contribute to an increase in their profitability. this growth in profits mirrors fao’s (2016) affirmation that the partnerships of small agricultural businesses tend to positively impact on net income through improved market access, increased productivity, improved product quality or reduced operational costs arising from the adoption of new technologies. the results showed that the formation of foreign alliances significantly and positively related to the performance of ssabs in the vryburg-pokwani study areas at p < 0.05 (significant). furthermore, post-hoc comparisons (bonferroni) results also showed that ssabs with 1–2 foreign alliances performed better than those with no foreign alliances, while ssabs with 6–10 foreign alliances performed better than those with no alliances, 1–2 and 3–5 foreign linkages respectively. this finding indicates that the more foreign alliances the ssabs created, the higher their performance. this finding buttresses the view that the international performance of small firms is bound to improve if they have potential overseas partners, contacts and customers that assist in identifying foreign business opportunities and locating or analysing markets and if the marketing barriers of these businesses are eliminated (oecd 2009). there is also evidence to support the view that foreign networks and lucrative supply chain links stimulate the performance of small firms (oecd 2009). the study demonstrates that there are positive and statistically significant differences in the performance of ssabs based on the extent to which they form foreign alliances. this finding supports the view that better access to international markets encourages farmers to invest in and increase the quantity, quality and diversity of goods they produce (international fund for agricultural development [ifad] governing council 2013) which are dimensions of business performance. there is also a reverse positive relationship as international partnerships help address the constraints smallholder farmers face in scaling up their businesses such as the high transaction costs of doing international business and lack of information on foreign markets (ifad governing council 2013). recommendations the comparatively lower participation of females in ssabs, compared to males, demonstrates the need to develop a gender-inclusive policy interventions in areas, such as the provision of financial, technical and managerial support to increase female involvement in such businesses. the mainstreaming of gender into agro-funding instruments and the provision of technical and managerial support systems would reduce the under-representation of women in agro-processing ventures. the dominance of ssabs male owners or managers above 40 years of age in agribusinesses suggests that farming is a fund-intensive activity, which is the predominant preserve of mature adults. the south african government’s funding, training and technical support should target the youth (that is, those aged 18–35 years) to leverage youth’s effective participation in ssabs and agribusinesses. therefore, the department of trade and industry (dti) should develop a pro-youth farming strategy and incentivise these industries to increase youth participation in small-scale farming. the emergent nature of foreign alliances of ssabs and their limited exploitation by these resource-constrained firms signal the need for new mechanisms for improving the value addition and innovation capabilities of ssabs to increase the attractiveness of their international collaborations and partnerships with foreign firms. foreign partners are only keen to forge alliances with firms if they bring particular resource mobilisation, cost efficiency and efficient product or service generation capabilities and complementarities which are of the essence to the foreign partner. idc (2015) highlights the fundamental importance of value chain development and innovation-oriented approaches that leverage economic linkages and enhance the competitiveness of firms. an institutional perspective to improving the international networking capabilities of ssabs requires them to consider a holistic approach to improving their international foothold on world markets through inter alia aggressive marketing of their activities and products, mobilisation of resources collaboratively with the private sector, and investments in research and development that improve the innovative capabilities of such firms. kawa and kaitira (2007) recommend the establishment of an institutional framework that covers multiple areas of small agribusiness, namely: improving the performance of the agricultural marketing systems based on needs assessments. strengthening public-private partnership dialogue in the agribusiness development agenda and advocacy of their activities. promoting investment in research and development in production, processing, storage, packaging, and handling technologies. these interventions will contribute to the facilitation of linkages between local ssabs and international firms, and promote locally-processed agricultural products in international markets (kawa & kaitira 2007). implications for future research and conclusion the study findings suggest that although the majority (51.7%) of ssabs had foreign alliances, a sizable percentage (48.3%) of these businesses had no alliances at all. future studies should establish whether those ssabs without such alliances are constrained financially from internationalising their businesses or do not perceive the benefits of internationalisation. future studies should also examine the reasons for the limited internationalisation of rural ssabs including the critical success factors for internationalising ssabs. since ssabs with foreign alliances tended to outperform those that are dependent on their domestic links, future studies should examine the extent to which the economic benefits (e.g. knowledge of foreign markets, foreign expertise, transfer of foreign technologies) derived from internationalisation are reinvested into the businesses for their continued sustenance. the study concludes that ssabs remain a predominantly mature adults (i.e. those above 40 years) and male dominated activity. future studies need to unravel the role played by age, gender and type of businesses in the transition of ssabs from being small entities to becoming large, established businesses. acknowledgements the authors wish to acknowledge the statistical analysis conducted by the statistician. competing interests the authors declare that they have no financial or personal relationship that may have inappropriately influenced them in writing this article. authors’ contributions p.r. wrote all sections of this article. l.a. conducted the data collection process. references agbobli, e., 2013, ‘the influence of entrepreneurial and market orientations on small-scale rural agricultural enterprises in the vryburg area’, unpublished phd thesis, central university of technology, free state. agbotame, l., 2015, ‘the impact of 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https://doi.org/10.1016/j.jbusvent.2004.01.001 wroblewski, j. & wolff, h., 2010, risks to agribusiness investment in sub-saharan africa, prepared for the agricultural policy and statistics team bill & melinda gates foundation, evans school policy analysis and research group, university of washington, seattle. zikmund, w.g., babin, b.j., carr, j.c. & griffin, m., 2013, business research methods, 9th edn., cengage learning, toronto. abstract introduction theoretical framework research design (methodology) findings regression analysis correlation analysis conclusion and recommendations acknowledgements references about the author(s) vivence kalitanyi department of business management, university of johannesburg, south africa edwin bbenkele department of business management, university of johannesburg, south africa citation kalitanyi, v. & bbenkele, e., 2017, ‘assessing the role of socio-economic values on entrepreneurial intentions among university students in cape town’, south african journal of economic and management sciences 20(1), a1768. https://doi.org/10.4102/sajems.v20i1.1768 original research assessing the role of socio-economic values on entrepreneurial intentions among university students in cape town vivence kalitanyi, edwin bbenkele received: 26 jan. 2017; accepted: 20 june 2017; published: 06 dec. 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: this article presents the findings of an empirical fieldwork study conducted in cape town, south africa. aim: the aim of the study was to establish how socio-economic values (income, economic development, employment or unemployment in the university students’ direct environment) shape their entrepreneurial intentions. setting and method: the study was built on ajzen’ psychological model on entrepreneurial intentions, and used a semi-structured questionnaire to collect data from 274 entrepreneurship university students. cronbach’s alpha was used to measure the reliability of the questionnaire, where six variables out of nine, had a coefficient alpha of more than 0.7, while the remaining three had a coefficient alpha of between 0.5 and 0.7. this instrument was assessed by both statisticians and academics who are experts in their fields to ensure its validity. multivariate tests of statistical significance were conducted, where correlation and regression statistics were used to analyse the data. results: findings suggest that socio-economic factors have an impact in shaping entrepreneurial intentions of the university students. conclusion: the study formulates the recommendations to the government, businesses, civil society organisations as well as the community within which students live. introduction around the world, researchers in the entrepreneurship field tend to agree that the decision to behave entrepreneurially is a result of cognitive aspects that are nurtured by environmental circumstances. it is mostly for this reason that the theory of planned behaviour (tpb) by ajzen (1991) has been widely used in recent studies as it focuses on the prediction of the human behaviour. education is one of those environmental factors, and mushtaq et al. (2011) and packham et al. (2010) refer to the fact that it significantly correlates with the intention to create new ventures. other factors of the environment are socio-economic and linᾶn et al. (2009) ascertain that there is a wide body of literature that analyse their role in shaping entrepreneurial intentions. studies by wennekers et al. (2005) about the u-shaped relationship between the economic development level and entrepreneurial activity, as well as the study by reynolds (1997) on unemployment levels, employment rate, productive structure and specialisation among other variables, are just a few and have all confirmed the claim that these macro-level values affect entrepreneurial intentions. using almost similar variables as ajzen (1991), pruett et al. (2009) concluded that one’s country, the presence of other entrepreneurs in the immediate environment, the expected family reaction, individual entrepreneurial disposition, how much weight an individual places on independence and opportunity for creative work, are the factors that positively influence entrepreneurial intentions. however, the extent to which socio-economic variables influence start-ups directly (such as in reducing opportunities, raising barriers, etc.) or through their effect on intentions (such as in reducing people willingness and self-perceived capacity to start a venture) is yet to be determined (linᾶn et al. 2009). in this sense, this study could provide some insight at least in the south african environment. the objective of this study is to examine the extent to which socio-economic values influence university students’ entrepreneurial intentions, and to be able to achieve this objective, the following hypothesis has been set: ‘the socio-economic factors of entrepreneurship students have a positive influence on their entrepreneurial decisions’. in light of this hypothesis, one can also illustrate the research model as seen in figure 1. figure 1: research model. theoretical framework socio-economic values like many other factors in the macro environment, socio-economic values play a major role in supporting entrepreneurial initiatives in any region. for instance, household wealth and household prices are expected to positively influence entrepreneurial start-ups. both of these variables measure the potential access to financial capital for a new business venture (nijkamp, moomaw & traistaru-siedschlag 2006:144). with regard to unemployment (another variable of socio-economic constructs), a study conducted by nijkamp et al. (2006:144) revealed that it had an undetermined impact on start-up rates across the regions or states of the european union (eu). paradoxically, unemployment rates are expected to positively correlate with the number of start-ups as people are forced to search new sources of income. education as a variable of socio-economic conditions has also proved to be ambiguous in terms of support to the entrepreneurship intentions. generally, educational attainment is expected to influence the number of business start-ups. however, guesnier ([1994] in nijkamp et al. 2006) found the propensity to create a new firm positively correlated with adults with bachelor’s degrees, while hart and gudgin ([1994] in nijkamp et al. 2006) found an inverse relationship with individuals with university degrees and the rates of new firm formation. this contradiction necessitates a further investigation. for the purpose of this study, socio-economic factors that were explored are income, economic development and level of employment. income traditionally, the influx of people into entrepreneurship has been motivated by the desire to earn income. however, shift from this perspective has been experienced as confirmed by carsrud and brännback (2009, 2011) that individuals behave entrepreneurially for social gains. however, this study argues that income can instil entrepreneurial intentions. luiz and mariotti (2011:60) posit that students from both the poorest and richest households are most likely to think that they will start up their own businesses. the authors elaborate further that there are, however, some diverging opinions concerning which type of business these students would like to open: those from a richer background think of opening an innovative business, while those with a poor background think about enterprises that are more basic. students from lower income groups feel and see entrepreneurship as a necessity, as a result of some doubt about their ability to find a job. to the contrary, students from higher income groups are more confident about finding jobs in large companies and the ability of building a career, thereby seeing entrepreneurship as a risky choice (luiz & mariotti 2011:60). the overall finding of luiz and mariotti’s (2011:60) study is that students from the poorest background appear to be more positive about starting their own businesses and also appear to have access to more information. these arguments are corroborated by most recent studies conducted by linᾶn, fernández and romero (2013) and pinillos and reyes (2011), who argue that in countries that experience some great disparities in income, people tend to have diverging interests in entrepreneurship. economic development farrington et al. (2012:333), mueller (2004) and shane (1992) postulated that the occurrence of entrepreneurial attributes varies across countries and cultures, while factors contributing to these differences have been identified as being the culture, level of economic development of the country and the political-economic traditions (mueller, thomas & jaeger 2002). kumar (1997) posited that entrepreneurship promotes capital formation, creates large-scale employment opportunities, promotes balanced regional development, reduces the concentration of economic power and stimulates wealth creation and distribution. entrepreneurship leads to increasing gross national product and per capita income, leads to improvement in the standard of living, promotes the country’s export trade, induces backward and forward linkages and facilitates overall economic development (kumar 1997). the previous paragraph clearly argues inversely with one of the arguments put forward in this study – that economic development enhances entrepreneurial intention of entrepreneurial behaviour. this is, therefore, an indication that entrepreneurship and economic development go hand in hand, and that they are mutually inter-reliant. furthermore, this confirms the necessity of this study to be able to bring to light the extent to which economic development enhances the entrepreneurial behaviour of the university students in the western cape. employment or unemployment level various types of research indicate a positive relationship between unemployment and firm formation (keong 2008:54). many business founders have stated that during the recession they opted to find their own businesses in order to avoid unemployment. keong (2008:54) further argued that many research results have revealed that comparatively high proportions of nascent entrepreneurs are among the unemployed. as such, the variables of unemployment situations can be assumed to have the strongest direct influence on behaviour and the current employment status is assumed to affect intention and conviction. work conditions can also be the catalysts of entrepreneurial intentions. noorderhaven et al. (2004), as cited by fayolle, liñán and moriano (2014), report that recent works on the role of alternative satisfactory employment opportunities in the incubation of entrepreneurial intentions is worth noting. if people cannot be satisfied by their employment conditions, and are not able to find better alternatives, they may form their intentions based more strongly on subjective norms (sn) (vinogradov, kolvereid & thimoshenko 2013). entrepreneurial intentions a number of models have been used to explain entrepreneurial intention, such as the maximization of the expected utility model (douglas & shepherd 2000), the entrepreneurial event model, the model of implementing entrepreneurial ideas (bird 1988) or shapero’s (1982). nevertheless, none of them has been as influential as the ajzen’s (1991) theory of planned behaviour (krueger, reilly & carsrud 2000; liñán & chen 2009; moriano et al. 2012; van gelderen et al. 2008). the tpb is explained in three antecedents, personal attitude (pa) towards behaviour, which means the individual’s overall evaluation of the entrepreneurial behaviour. it is the behavioural beliefs linking entrepreneurial behaviour to various outcomes and other attributes. secondly, there is sn which is the individual’s perception of the social pressures to undertake the entrepreneurial behaviour, and lastly, it is the perceived behavioural control (pbc), which is the people’s perceptions of their ability to perform that behaviour (fayalle, liñán & moriano 2014:681). gathungu and mwangi (2014:114) affirm that entrepreneurial intentions is a strong predictor of future (nascent) entrepreneurial behaviour. this pronouncement came as a conclusion to a number of studies (behave 1994; bull & willard 1993; carter et al. 2003; reynolds & white 1997; venkataraman 1996), especially towards the end of 20th century, where many studies that highlighted the importance of understanding the initial and pre-emergent phase of entrepreneurial behaviour and new ventures started to emerge. however, according to carsrud and brännback (2009, 2011), krueger and day (2010) and krueger (2007, 2009), more and more researches by means of entrepreneurial intention as a framework emerged and showed some new applications, mismatches and specifications. in this regard, krueger (2009) believes that entrepreneurial intentions is dead and calls for its revival and a deeper reconsidering of studies on the matter. fayolle and liñán (2014) indicate the existence of researches that could be used in order to swell and strengthen the importance and applicability of the various models of entrepreneurial intentions, particularly, paying attention to the link between intention and action. fayolle and liñán 2014 propose longitudinal studies in these lines whereby attention should be paid to the effect of environmental variables in the transformation of intention into effective action. this study is a response to this call as it takes into account the macro environment aspects: income, economic development and employment or unemployment. falsified. research design (methodology) approach the research approach used for this study was hypothetico-deductive method. by this method, researcher formulates a hypothesis to be tested by the observable data. important statistical operations were performed in order to test the specific hypothesis towards accepting or rejecting it. the study was conducted in the following five phases: the literature review on socio-economic values and entrepreneurial intentions was reviewed. the questionnaire was drafted, pilot-tested and finalised for easy use. data were collected in the classrooms from entrepreneurship students. data were captured with the use of spss22 to generate the statistical data. finally, the data were analysed and interpreted. research strategy the research strategy chosen was a survey-correlational. similar studies have frequently used it and neuman (2005:250) argued that a survey is often called correlational, whereas babbie and mouton (2001) posits that a survey usually adopts both qualitative and quantitative methodologies. this type of study makes use of sample from a population and analyse the data using statistics to make inferences about it. this study also used both methodologies, with statistical data to make it more accurate. techniques and procedures the population and sample for the 2014 academic year, the total number of students enrolled for entrepreneurship programme was as seen in table 1. table 1: determination of the population. as it happens in many cases, constraints arising from finances and time hinder researchers and affect their ability to use the whole population, even if it was possible. this study also succumbed to this constraint and chose to use a sample. in this process, the researcher was guided by the research advisors (2006) opinion that: it is possible to use one of the sample calculation formulae to construct a table that suggests the optimal sample size – given a population size, a specific margin of error, and a desired confidence interval. (p. 1) for calculating sample using research advisors’ formula, see equation 1 (krejcie & morgan 1970; the research advisors 2006:3): where n, size of sample needed; x², chi-square for the specified confidence level at one degree of freedom; n, size of the population at hand; p, proportion of the population (0.50 in the research advisors’ table); me, desired margin of error (expressed as proportion). table 2, as suggested by the research advisers (2006), illustrates the sizes of the population, the confidence levels, as well as the margin errors. this can be explained by an example that if you have 500 students and you wish to have enough sample to generate a 95% confidence interval and a 2.5% margin error, you should have feedback from at least 217 of all your students. table 2: sample and population. as far as this study is concerned, the universities that constituted the units of investigation totalised ± 966 entrepreneurship students and including students doing programmes that involved entrepreneurship modules, and with a 95% confidence level taken into account, and a margin error of 5%, a sample of between 260 and 278 was judged satisfactory. data collection this process was realised through collaboration between researcher and lecturer, where the former requested the later to spare a few minutes towards the end of the class for the students to complete the questionnaires. in all cases, the request was positively approved, and both lecturers and researcher were present during the questionnaire-filling process. analysis and interpretation data were coded and captured by means of the statistical program for social science (spss22). the spss helped to generate the descriptive statistics, as well as correlational statistics. univariate analysis was conducted with the use of descriptive statistics (frequency tables, pie chart and histograms), before regression and correlation analyses were carried out, using a combination of factor analysis, analysis of variance (anova) and chi-square for nominal data. findings personal details under this section, the researcher presents and analyses the data collected from entrepreneurship students from uct, us, uwc and cput. the following sub-headings were used: age category, gender, race, religion, residential area (whether it is metro, urban or rural) and study level. table 3 shows that the majority of the student respondents are in the age category of 21–25 (52.8%), with the category of up to 20 (35.1%) in second position; both groups represent a huge majority of 87.9% among the respondents. to justify this finding, one needs to consider the fact that the study took both undergraduate and postgraduate as well as full and part-time entrepreneurship students as the respondents. furthermore, respondents also included those students who had to work after their matriculation before going to university, while others had failed some subjects, thereby putting all these students in the age category of above 20. other facts include the fact that the average age of joining higher learning institutions (hlis) in south africa is 18, while the study involved a few master’s students, thereby justifying the fact that most of the respondents fell below the age of 25. table 3: age groups of respondents. reaching such a finding is also responding to the government initiative of establishing agencies, institutions and centres to enhance entrepreneurial behaviour in the country. it should start from young people, and the fact that many of them are attending entrepreneurship programme, suggest a move into right direction. as suggested by co and mitchell (2006:349), hlis can intervene in this initiative by: outlining to the students, the risks and rewards associated with entrepreneurship train them how to seek and recognise opportunity the creation and destruction of enterprise development of entrepreneurial traits among students, which is in line with the aim of this study. wilson, kickul and marlino (2004) appended the above argument by positing that it is important to provide access to entrepreneurship education as it strengthens the intentions of aspiring entrepreneurs. entrepreneurship education plays a key role in boosting the levels of self-efficacy among the students, thereby leading to the establishment of their own ventures. gender of respondents table 4 provides information about the number of respondents in respect to their genders. table 4: gender of respondents. table 4 reflects a significant percentage of 56.9 of the respondents that were female against 42.3% that were male. two of the respondents (0.7%) did not indicate their gender. this finding came with no surprise, as the number of female in south africa surpasses that of their male counterparts, and this seems as a trend in all the countries over the world. we then find this finding justifiable that this gender imbalance in south africa is also visible in the institutions of higher learning. we are also pleased to reach such a finding which is in line with government and movements for women emancipation that more and more women should participate in the economy, which can be easier once they have successfully completed their university studies. the participation of many female students in the entrepreneurship studies, can also be a suggestion that the future of women entrepreneurs in the country looks promising. racial group of respondents table 5 provides information about the number of the respondents with regards to their racial divides. table 5: racial group. table 5 reflects an attention-catching picture concerning the racial groups of the study participants. about half of them (46.4%) are africans (black people) while the 34.3% are white people. students of mixed race group were represented at 16.1% compared with 1.5% of indian descendant students. the group designated as ‘other’ scored 0.4% (one respondent) and the same score was for chinese respondents. this finding, though it does not represent the demographic characteristics of the south african society, reflects the real situation that black people (africans) are the majority (79.2%), followed by both white people and mixed race amounting to 8.9% each, indians or asians at 2.5% while the group designated as ‘other’ comprised 0.5% (statistics south africa 2011:17). this simply means that the demographical composition of races in south africa is not translated in the attendance of the entrepreneurship programme in these four universities at this point in time. it is worth noting that white people that are represented at 34.3% in this study have been the dominant racial group in undertaking entrepreneurial activity over the years. notwithstanding the fact that it is still the case even today, the fact that other races such as mixed race are represented in entrepreneurial courses beyond their real national statistical figures paints a picture that more and more other races are responding to the call about taking entrepreneurial orientation more seriously (kalitanyi & visser 2016). furthermore, the study unveiled that black people – (constitute the majority of the country’s population) – are more interested in entrepreneurship programmes indicates that the entrepreneurial spirit can gain momentum if they take their studies seriously and decide to practice what they learnt upon leaving school. regression analysis this analysis consists of an advanced statistical test to check, among the independent variables, those that influence the dependent variable. statisticians believe that to be significant, adjusted r-square must be greater than 0.05 (>5%) and have a par value of less than 0.05 (<5%). with the use of the logistic regression analysis, the items of the income variable influencing the entrepreneurial intentions were identified. the fitness of this model was individually checked, and the output revealed that the model fits the data, because the omnibus test of model coefficients indicates p = 0.000 < 0.05, while the summary model indicates 0.249. looking at the individual items in table 6 above, the item of using high income to open up a business venture was found significant with a p = 0.004 < 0.05. this means that this item contributes positively to the variable of income and, consequently, the variable slightly increases the chances of entrepreneurial intentions among students. table 6: regression between income and entrepreneurial intentions. the literature has also revealed a similar tendency as luiz and mariotti (2011:60) argued that students from lower incomes find entrepreneurship as a necessity consequent to their inability to secure employment. however, the researcher had predicted a positive correlation between these two variables, hence the hypothesis that ‘income stimulates entrepreneurship intentions’. the number of items that support this hypothesis is lower than predicted, and the possible reasons could be that many respondents came from a poor or lower income background and, therefore, could not rely on a non-existent income to undertake entrepreneurial ventures. the second reason could be that many students understand that people do not necessarily start businesses with their own money, and this is partly what the students are taught as part of the bootstrapping process in south african environment where capital is difficult to secure. by means of logistic regression analysis, the items that contribute more to the economic development have been identified. firstly, the fitness of the model was checked, and the output showed that the model coefficients p = 0.000 > 0.05 with the model summary indicated 0.249 > 0.05. by analysing the individual items in table 7, the item stating that the current economic development is conducive to the establishment of an entrepreneurial venture was found to be significant, with p = 0.022 < 0.05. this means that this item has a positive relationship with the variable, and therefore the variable increases the chances of entrepreneurial intentions among students. with very few details, mueller et al. (2002) posited that factors such as culture, level of economic development of the country and political and economic traditions of the country impact on entrepreneurial attributes. furthermore, these findings of this study match the results from the study conducted by falck and woessmann (2011), where they argue that the country’s level control variables to boost entrepreneurial intentions are gdp per capita among other factors. besides these two statements, the literature does not have sufficient data and information concerning the role of economic development in enhancing entrepreneurial intentions, and this study reached the same results. once again, this study becomes a huge contributor to the poor existing literature about the topic. table 7: regression between economic development and entrepreneurial intentions. the results provided by the regression analysis concerning employment level and entrepreneurial intentions show a statistical significance with p = 0.000 < 0.05, whereas the model summary indicates 0.318 > 0.05. this indicates that the model fits the data. table 8 shows how significant the item ‘i would choose employment over being employed’ is. with its model coefficient of 0.000, it shows that this item has a positive impact on the variable of employment level and, therefore, this variable increases the chances of entrepreneurial intentions among entrepreneurship students. table 8: regression between employment level and entrepreneurial intentions. this finding corroborates the results of a study conducted by dohse and walter (2012), when they argue that regional-level controls that support entrepreneurial intentions are unemployment among high qualified among other factors. similarly, this finding clarifies the earlier argument by nijkamp et al. (2006:144) that studies conducted on the role of employment towards the firm’s establishment reveal ambiguous impacts on start-up rates across the regions or states of the eu. nijkamp’s argument was actually against the researcher’s expectations, whose predictions are similar to keong’s (2008:54) argument that during a recession period, many people opt for business formation in order to escape unemployment and poverty. at work, a number of factors can motivate individuals to shape their entrepreneurial intentions. the profit the business makes, the independence of the entrepreneur, the flexi work hours they enjoy, as well as their lifestyle can motivate many employees to think of becoming self-employed. this is what keong (2008) reported as reasons why employed people become entrepreneurs in order to apply the knowledge and be more independent. correlation analysis statisticians believe that correlations (r) of 0.005 and 0.001, paired with a par value of 0.000, implies the existence of a relationship between two variables, and that the variable is statistically significant. in order to draw meaningful conclusions about the research findings on the relationship between socio-economic values against entrepreneurial intentions, the following process was followed: firstly, the relationships between the above variables had to be established. secondly, each of these relationships was interpreted and is discussed in this study. table 9 shows the items of the variable of income. this variable has a total of 10 items. after the bivariate analysis process, it was realised that only seven items have the required correlation value of above 0.005, paired with a par value of 0.000 for almost all the items except one. this shows that there is strong relationship between the independent variable of income and the dependent variable of entrepreneurial intentions, and that the independent variable of income is statistically significant. table 9: correlation between income and entrepreneurial intentions. in this study, the income variable was found to be a significant factor towards entrepreneurial intentions of students. this finding correlates with luiz and mariotti (2011:60) that students from both poorest and richest households are most likely to think that they will start up their own businesses, though there are diverging opinions concerning which type of business these students would like to open. those from a richer background think of opening an innovative business, whereas those with a poor background think about more basic enterprises. this finding also correlates with the fact that people with a higher income are always looking for investing the extra portion, hence they think of opening up businesses. in the south african context, this reminds one of the rationale behind the introduction of the close corporations act in 1984, before it was discontinued by the companies act of 2008. the variable of economic development as independent variable has a total of seven items. after the bivariate test, it was realised that only six items have the required correlation value of above 0.005, paired with a par value of between 0.000 and 0.033, as reflected in table 10. it therefore reflects that there is relationship between the independent variable of economic development and the dependent variable of entrepreneurial intentions, and this independent variable is statistically significant. table 10: correlation between economic development and entrepreneurial intentions. this finding came as a surprise, as throughout the literature review the researcher did not find information to support or to deny the existence of the relationship between the two variables. however, through the number of items supporting the variable, this study has found that a strong relationship does exist between the two. the researcher is therefore pleased to have enriched the literature in this regard, and recommends further research concerning this hypothesis. the independent variable of employment has eight as the total number of items. the bivariate test has revealed that only three items have the required correlation value of above 0.005, paired with a par value of 0.000 for all three items. this is an indication of an existence of a relationship between the independent variable of employment and the dependent variable of entrepreneurial intentions table 11). table 11: correlation between employment and entrepreneurial intentions. generally, the literature concerning the way through which unemployment supports or drives people into entrepreneurship is plentiful. through this study, the researcher discovered that many business founders stated that during the recession they opted to found their own businesses in order to avoid unemployment. similarly, keong (2008:54) posited that many studies conclude that high proportions of nascent entrepreneurs are among the unemployed. clearly, these statements are contradictory to the finding in the previous paragraph. from the finding of the same paragraph above, it can be argued that people develop ideas and methods of establishing and running businesses while they work. on the contrary, if people are pushed into entrepreneurship because of unemployment, it would be interesting to find which types of businesses, how far those businesses can grow and what the backgrounds of those businesses’ creators are. conclusion and recommendations the bivariate analysis showed an existence of a positive correlation between dependent variables of socio-economic values (income, economic development and employment or unemployment) and the independent variable of entrepreneurial intentions because 16 items out of 25 revealed that relationship. this positive relationship was further confirmed by the regression analysis results, during which four items were found to have a positive relationship, leading to the conclusion of accepting the hypothesis (that socio-economic values of entrepreneurship university students have a positive impact on their entrepreneurial intentions) set out in the beginning of this article. this existence of a positive relationship as a finding of this study supplements the findings of a study by reynolds (1997), who posited that socio-economic factors that may have an effect on starting up a venture are unemployment levels, employment rate, productive structure and specialisation, among other variables. however, studies conducted by other researchers in this field have reached the findings that are in line with those of this study. for example, nijkamp et al. (2006:144) articulated that household wealth and household prices are expected to positively influence entrepreneurial start-ups. both of these variables measure the potential access to potential financial capital for a new business venture. the recently approved minimum wage agreement between government, labour and businesses is a step in right direction as it will be injecting more income in the communities where respondents of this study live. it is therefore recommended that government, labour movements as well as the management of businesses continue to engage in discussions and assess the possibilities to further increase the amount of money that goes out in the communities, as it may be a tremendous booster of entrepreneurial activities. government, civil society organisations as well as the community leaders should engage in constant education about the proper utilisation of the income. it is also recommended to the government to continually work towards poverty alleviation in the communities, as this stimulates the entrepreneurial behaviour of the people living in the area, mainly to be able to keep a relatively higher standard offered to them. and finally, the study also discovered that unemployment stimulates entrepreneurial behaviour. with the current unemployment rate in south africa of 27.1%, it is hoped that many people would turn their minds towards self-employment as the first option rather than waiting to be employed. acknowledgements the authors wish to express deep gratitude to the following stakeholders without whose support this article would not have been completed: the faculty of management and department of business management at university of johannesburg as well as prof. cecile nuevenhuizen and prof. geoff goldmann at uj. competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions v.k. contributed to the topic 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s.a., 1992, ‘why some societies invent more than others’, journal of business venturing 7(1), 29–46. https://doi.org/10.1016/0883-9026(92)90033-n shapero, a., 1982, ‘social dimensions of entrepreneurship’, in c.a. kent, d.l. sexton & k. vesper (eds.). the encyclopaedia of entrepreneurship, pp. 72–90, prentice hall, englewood cliffs, nj. statistics south africa, 2011, south africa’s people: pocket guide to south africa 2011/2012, statistics south africa, pretoria. the research advisors, 2006, research methods • study design • statistical analysis, viewed 15 june 2013, from http://research-advisors.com van gelderen, m., brand, m., van praag, m., bodewes, w., poutsma, e. & van gils, a., 2008, ‘explaining entrepreneurial intentions by means of the theory of planned behaviour’, career development international 13(6), 538–559. https://doi.org/10.1108/13620430810901688 venkataraman, s., 1996, ‘some methodological challenges for entrepreneurial process research’, symposium paper presented at the academy of management meeting, cincinnati, august. vinogradov, e., kolvereid, l. & timoshenko, k., 2013, ‘predicting entrepreneurial intentions when satisfactory employment opportunities are scarce’, education and training 55(7), 719–737. https://doi.org/10.1108/et-06-2012-0067 wennekers, a.r.m., van stel, a., thurik, a.r. & reynolds, p.d., 2005, ‘nascent entrepreneurship and the level of economic development’, small business economics 24(3), 293–309. https://doi.org/10.1007/s11187-005-1994-8 wilson, f., kickul, j. & marlino, d., 2004, ‘our entrepreneurial future: examining the diverse attitudes and motivations of teens across gender and ethnic identity’, journal of developmental entrepreneurship 9(3), 177–198. 122 sajems ns vol i (1998) no i free trade and deregulated domestic markets: attitudes of commercial farmers in k wazulunatal r c stockil and g f ortmann department of agricultural economics, university of natal, pietennaritzburg abstract this study analyses farmers' attitudes towards free trade and deregulated domestic product and input markets using a survey conducted in 1996 among 112 commercial farmer~ in kwazulu-natal. most respondents were in favour of iiberalised trade and deregulated domestic markets, but expected a decline in product prices, farm profits and land values. logit analyses of farmers' personal and business characteristics that influence their attitudes towards free trade and deregulated domestic markets were conducted. results indicate that improved information on risk: management practices and impon tariff levels may help commercial farmers to adapt to a changing economic environment and reduce resistance to free trade. introduction the uruguay round of the general agreement on tariffs and trade (ga tn. which was formally concluded on 15 december 1993 among 117 participating countries, aims to iiberalise intemational trade (giardini, 1995). in 1990. south africa had 21 agricultural marketing boards which had a profound influence over domestic product prices. imports and exports, and the manner in which agricultural products were marketed. with the exception of most vegetables and subtropical fruit, marketing of primary food and fibre agricultural products was managed in some or other form by producer-dominated marketing boards (swart. 1996), r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr vol 1 (1998) nr 1 123 south africa is a signatory to the galt, resulting in increased market access here and abroad, reduced domestic support and export subsidies, and a revision of sanitary and phytosanitary measures (department of agriculture. 1994), consequently, the elimination of producer controls over imports, tarification of agricultural imports, the removal of most single channel marketing schemes and a general reduction in the authority of marketing boards has been experienced, the remaining 15 marketing boards perform mainly non-trade distorting functions such as generic advertising and market information (swart. 1996). amendments to international trade policy. together with improved dispute settlement procedures and monitoring provided by the committee on agriculture in the world trade organisation (wto). will create conditions favourable for more stable international agricultural trade flows. agricultural production will therefore be determined more by comparative advantage rather than the size of national budgets. trade iiberalisation will also increase import competition forcing industries to improve productivity through the adoption of innovations (maclaren. 1995). international prices of agricultural products are expected to increase in the medium term following reduced supply from developed countries that pay high export subsidies (department of agriculture, 1994). however, technological improvements may reduce prices in the long term (goldin and knudsen, 1990). a greater degree of price uncertainty faced by commercial farmers is also expected in the event of reduced government protection (lyne and ortmann, 1992). the objectives of this paper are (i) to ascertain farmers' responses to galt and deregulated domestic markets, and (2) to determine the factors influencing attitudes of commercial farmers in kwazulu-natal towards free trade and deregulated domestic markets by using logit models. education and improved information flows can· help farmers to survive in a changing policy and trade environment, and it is for this reason that factors affecting farmers' perceptions towards free trade are important. following kastens and goodwin (1994), this paper analyses farmers' attitudes regarding a non-specific policy environment in which no particular agricultural programme is evaluated, which differs from other studies. the paper concludes with a discussion of the management and policy implications of the results obtained. pasr research on a ti1tudes towards liberalised trade farmers are assumed to be rational, profit maximising decision makers and will therefore support agricultural policies in which they perceive the greatest benefit (orazem et ai, 1989; barkley and ainchbaugh, 1990). research in the usa has r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 124 sajems ns vol i (1998) no 1 shown that fann operators with higher levels of education and experience display a resistance towards policy liberalisation because they are better able to comprehend the complex regulations and resulting benefits of agricultural progranunes and are less suspicious of these programmes (kastens and goodwin. 1994; barkley and ainchbaugh, 1990). farmers who, assessed on a subjective basis, are less risk averse are less opposed to the riskier marketing conditions resulting from trade iiberalisation. farmers operating a greater proportion of rented land were more likely to support a free trade policy environment (kastens and goodwin, 1994). specialised farms. probably because of their riskier nature, are less likely to support liberalisation than diverse operations and farm types enjoying relatively high levels of government support, which are again expected to oppose policy liberalisation (kastens and goodwin, 1994). larger farms in the usa show a greater degree of support for policy liberalisation. tiris may be as a result of limitations placed on individual farmers' benefits, or may indicate that larger fanners perceive greater benefits from economies of sire in a free trade and free market environment. if farmers' perceptions are correct, policy iiberalisation may lead to increased farm sire (kastens and goodwin, 1994). edelman and lasley (1988) indicate that amongst usa fanners, acres owned and com acres were significantly positively related to pursuing an open market and there was a positive relationship between decoupling (which provides direct support to farmers but does not distort production, conswnption and trade) and farm sire. conversely, research by orarem et al (1989) indicates that the largest farms tend to oppose decoupling because it would result in lower crop prices and returns per hectare. as farmers' wealth (net worth) increases, their preference for a iiberalised policy environment rises (kastens and goodwin, 1994). farmers under financial stress are less likely to support market-orientated domestic policies or the elimination of domestic policies because of increased price risk (edelman and lasley, 1988). the greater the number of days worked off the farm, the lower is the support for the continuation of present government programmes as producers with significant off-farm income are less dependent on government programmes and are thus more likely to support market liberalisation (edelman and lasley, 1988; barkley and ainchbaugh, 1990). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sated nr vol 1 (1998) nr 1 125 data source a"'d characteristics of respol\'dests this study was conducted in 1996. the target population of 4436 corrunercial farmers in kwazulu-natal was stratified following lyne and ortmann (1996) and randomly sampled. the first stratum, constituting bioclimatic groups 1 and 2 (phillips, 1973), is termed the coastal belt. bioclimatic groups 3, 4, 5, 6 and 8 represent the kwazulu-natal midlands. whilst bioclimatic groups 7, 9, 10 and 11 comprise the lowveld region. a questionnaire was mailed to 578 farmers yielding 149 responses (25,8 percent) of which 112 (19,4 percent) were usable. the nonusable questionnaires were due to missing values, the sale of farming operations, or the retirement of some farmers. twenty-six usable questionnaires were received from each of the coastal and lowveld regions, whilst 60 usable questionnaires were returned by midlands farmers. respondents were on average 49,5 years of age, had 24,3 years of fanning experience and 14, i years of formal education. sixty percent of respondents were individual owners of their farm business. 12 percent of the operations were close corporations. 10 percent companies, nine percent trusts and nine percent of respondents operated partnerships. thirty-nine percent of respondents were employed to manage the fanning operations. computers were owned and used in the farm business by 64 percent of respondents, which is much higher than the 48 percent reponed by woodburn et al.(i994). the average area operated in the coastal belt was 511 hectares (median 313 hectares). 1121 hectares in the lowveld region (median 253 hectares. due to a predominance of irrigated sugar-cane farms and a few large extensive beef enterprises). and 866 hectares in the midlands (median 604 hectares). more than 70 percent of gross farm income was derived from sugar-cane production by 75 percent of farmers in the coastal belt. sixty-two percent and 15 percent of farmers in the lowveld region derived more than 70 percent of gross farm income from sugar-cane and beef production respectively. the midlands region is characterised by mixed farming activities. among the farmers who received 70 percent or more of their gross income from a single enterprise. 27 percent were beef farmers, 12 percent dairy farmers. 10 percent sugar-cane farmers. eight percent timber farmers and six percent pig farmers. about 86 percent of respondents were full-time farmers. median household income from off-farm employment (including spouse's income) was r47 375 for the 35 percent of respondents who indicated off-farm employment (by themselves or their spouse). estimated market values of assets, debt/asset levels and farm turnover (gross income) in a normal year for the three regions are presented in r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 126 sajems ns vol 1 (1998) no 1 table 1. the coastal belt had the highest mean twnover and debt/asset ratio, followed by the lowveld and midlands regions respectively. the debt/asset ratio should preferably be less than 0,5 (barry et ai., 1995). at a nominal interest rate of 15 percent, farmers will experience cash flow problems if borrowed capital exceeds one-third of the value of fannland. as the retwn to farmland in approximately five percent (nieuwoudt and vink, 1995). the ratios presented in table 1 indicate that sample farmers were solvent. ninety-two percent of respondents had ratios of less than 0,30. table 1: fann asset values, debt/asset ratios and turnover of sample fanns in three regions of kwazulu-natai, february 1996. asset value (rm) debt/asset ratio turnover (rm) n mean median n mean median n mean median coastal 25 5,612 3.691 18 0,149 0,141 22 2.086 1.471 (n=26) lowveld 25 5,676 3,800 25 0.131 0,116 26 1.594 1.076 (n=26) midlands 50 2,709 1.670 48 0,083 0,012 54 1.147 0,620 (n=60) land is cash-rented by 21 percent of respondents, with the area rented ranging from 10 to 900 hectares (mean of 264 hectares). two respondents were involved in share-lease agreements (50 and 100 hectares), while a single respondent rented out land (150 hectares). responses to gait and deregulated domestic markets given coverage of gait (today the wto) in the popular press and farming magazines, it was anticipated that most respondents would be aware of changes to international agricultural policy. gait focuses primarily on reducing tariff barriers to trade in industrial and agricultural products (schuh, 1995). signatories to gait are required to reduce internal support (giardini, 1995), all non-tariff barriers are to be convened to tariffs, individual tariff lines reduced and import opportunities must be allowed for to facilitate opening-up of markets (josling, 1993). the volume of subsidised exports is to be reduced and sanitary and phytosanitary (sps) measures revised and tightened (giardini, 1995). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr voll (1998) nr 1 127 only one respondent indicated that he was not aware of ga it. seventy percent of respondents gained information on gait by reading newspapers, whilst 45 and 31 percent obtained information from effective fanning and fanner's weekly respectively. twenty-eight percent indicated attendance at farmers' days whilst financial mail, latulbou weekblad and industry publications (eg sugar journal) were used by 23 percent of respondents to gain information on gait. private consultants were employed by 10 percent of respondents. nine percent read finance week, six percent read finansies en tegniek, and only five percent made use of extension officers. sixty percent of respondents intended seeking additional information on gait. fifty-two percent of respondents expected a decrease in their crop prices in the event of the successful implementation of the gait requirements, whilst 25 percent expected their crop prices to increase. a decrease in livestock prices was expected by 61 percent of respondents and 12 percent thought that livestock prices would increase. approximately equal proportions of respondents expected input prices to decrease (43 percent) and increase (39 percent). however, a greater proportion of crop and livestock producers (i.e. those who realised more iban 55 percent of their gross income from either crop or livestock production respectively) thought a decrease in input prices likely. as is shown in table 2, about one-half of respondents foresaw a decline in farm profits and 38 percent a fall in land values if the gait requirements are successfully implemented. following the reduction of import tariffs on meats in 1995. beef respondents experieoced a 24 percent decrease in beef prices. poultry farmers indicated a 29 percent reduction in broiler prices, mutton farmers a 16 percent decrease in mutton prices. and pork farmers a 17 percent decrease in pigmeat prices. seventy-seven percent of respondents did not know the level of import tariffs on the products they produced, whilst 90 percent did not know the levels of import tariff on the inputs they used. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 128 sajems ns vol 1 (1998) no 1 table 2: percentage of respondents expecting changes to product and input prices, farm profits and land values fodowing the gatt provisions, 1996. decrease increase no change uncertain (percent) (percent) (perrent) (percent) crop prices (n=103) 52 25 14 9 livestock prices (n=81) 61 12 10 17 input prices (n= 108) 43 39 11 7 crop farmers' (n=54) 45 35 11 9 livestock farmers . 49 38 8 5 (n = 31) farm profits (n = 109) 49 19 16 16 land values (n = 110) 38 14 22 26 "fanners who received more than 55 perrent of their gross income from either crops or livestock. a five-category scale, ranging from 'strongly disagree' with the statement given to 'strongly agree' (table 3), was used to elicit farmers' attitudes towards free trade. for the various questions posed, between 59 and 92 percent of respondents were in favour of free trade. ninety-two percent of respondents were in favour of the deregulation of domestic product and input markets, indicating that they perceived the recent deregulation of product marketing boards to be of benefit to their fann businesses. this conclusion may not apply generally as approximately 74 percent of the original 578 farmers in the sample did not return the questiormaire, while those who did may have definite views on liberalised trade. thirty-nine percent of all respondents, including 31 percent of livestock producers and 40 percent of crop farmers, would respond to further reduction in import tariffs by adjusting their farming operations. in the event of complete deregulation of domestic product and input markets, 48 percent of respondents, including 49 percent of livestock producers and 46 percent of crop farmers, would alter their farming operations. a greater proportion of crop farmers are corx:erned with further reduction in import tariffs, while nearly one-half of livestock producers are concerned with the complete deregulation of domestic markets. the recent high maize price, following on the deregulation of the maize industry. may be of concern to livestock producers. a large proportion of sugar-cane producers r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sates nr vol i (1998) nr i 129 in the sample may have been concerned about changes in the domestic sugar price resulting from reduced impon tariffs. of the respondents who considered altering their cost structure in response to successful implementation of the gait provisions, 29 percent would reduce labour employment, increase use of machinery, and maintain fenilizer use at current levels. of the 45 percent of respondents who would change the size and mix of enterprises currently operated, 46 percent would increase the size of current enterprises. both enterprise diversification (adding a new enterprise) and changing the relative sizes of current enterprises were suggested by 23 percent of respondents. reducing enterprise size (four percent of respondents) and changing farm enterprises totally (four percent) were also considered. table 3: response of sample farmers to statements regarding a free trade environment, 1996. percentage of respondents in each category statement strongly disagree • un~ agree strongly disagree certain agree free, unrestrained international 5 16 20 50 9 trade (without the interference of governments both here and abroad) is beneficial for souid african farmers (n= 109). a free. open market system of 2 18 13 51 16 trade (ie. one wiidout government intervention) should be pursued by all food exporting and importing countries by reducing all trade barriers (n=iio). farmers in all countries exporting 4 11 7 52 26 agricultural commodities should not receive any government support (n= iii). souid african farmers should 0 3 5 71 21 compete in a deregulated (free) domestic product market. if input markets are also deregulated i (n= i 10). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 130 sajems ns vol i (1998) no 1 of the 64 percent of respondents who would respond to reduced import tariffs and/or complete domestic market deregulation, 46 percent would seek additional marketing infonnation to aid management decisions and 44 percent would add value to their products. forty percent of respondents considered purchasing additional technology to improve productivity, 35 percent considered exporting products, 32 percent employing machinery contractors and 24 percent would employ labour contractors. employing the services of a private consultant or restrucruring debt commitments were considered by 22 percent of respondents, 19 percent indicated engaging in forward contracts, 18 percent borrowing less capital or reducing family drawings, and 10 percent would trade on the futures market (safex). the relatively small proportion of respondents considering trading on the futures market could possibly be due to the limited range of contracts currently available (eg there are no sugar contracts at present). selling land was considered by 12 percent of respondents, 10 percent intended seeking off-farm employment, nine percent would introduce capital invested off the farm into the farm business. and six percent would sell assets or borrow more capital. sample farmers were also asked to rate their level of management skill relative to other farmers in their district on a five-point likert-type scale (where 1 ;: low and 5 = high). the average rating for their managerial ability in farm production and overall farm management was 3,72, in farm finance 3.61, and 3, ii for product marketing. in the past, 21 marketing boards marketed about 90 percent of the total value of agricultural production (lyne and ortmann, 1992), thereby reducing the need for farmers to market their products. for farmers to survive in a deregulated policy and trade environment with increased price risk, product marketing skills will need to be improved and/or marketing experts employed. farmers' attitudes towards free trade and deregulated domestic markets the personal. financial and farm size characteristics of farm operators may be important factors influencing their attitudes towards free trade (kastens and goodwin, 1994). consequently, the objective of this section is to determine the personal and business characteristics of respondents that influence their perceptions regarding free trade. a logit model is developed for this purpose. the dependent variable (yi) is dichotomous, scoring one if the respondent agreed with free trade (or deregulated domestic markets), and zero otherwise. equation (i) can be used to estimate the log odds of the probability of an event occurring. in this case the probability that a respondent wiji favour a free· r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr vol 1 (1998) nr 1 131 trade enviromnent. respondents who 'strongly disagreed' or 'disagreed' with the statement regarding free trade (first question in table 3) were allocated a zero,while respondents who 'agreed' and 'strongly agreed' were coded a one. 'uncertain' responses were excluded from the analysis. n in [pd(l-p; )] = a + l f3kxki (1) k=l where pi is the probability of the ith respondent favouring a free-trade environment and xk the kth explanatory variable. the dependent variable in[p;/(l-pi)] is the natural log of the odds ratio in favour of the ith respondent being in favour of free trade (gujarati, 1995). independent variables considered in the model based on previous studies discussed above. personal characteristics considered include years of farming experience. level of education. and willingness to take risks. proponion of land rented, farm type. turnover (farm size). operator's wealth (net worth), off-farm employment. distance to nearest town. the debvasset ratio, and a measure of financial stress (incorporating both solvency and liquidity measures) were the business characteristics considered. exploratory analysis was also pursued to determine other factors affecting farmers' attitudes towards free trade. variables which were hypothesised to have an impact on free-trade attitudes are defined in table 4. hypothesised relationships between free-trade attitudes and exp. eou, rent, size, nworth and risk are consistent with those of past studies. increased price risk is expected with free trade, and thus farmers who have to contend with the additional fmancial risk associated with borrowed capital (01 a, fstress. ffopt and repay) are likely to oppose free trade. beef (beef) and sugar-cane (sugar) farmers are likely to be faced with reduced product prices under free-trade conditions (lower tariffs), and most beef fanners are unlikely to benefit substantially from reduced input costs under free trade owing to the extensive nature of production. these farmers are also expected to oppose free trade. milk is highly perishable and thus not easily exportable, and opportunities exist to add value to it. however, increased competition from dairy products originating mainly in the eu and new zealand may lead to lower r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 132 sajems ns vol 1 (1998) no i product prices. dairy fanners (dairy) are, therefore, hypothesised to oppose free trade too. comput is expected to have a positive effect on farmers' free-trade attitudes as it is a measure of farmer progressiveness. rapid information flows are vital in a free market, and farmers using computers can develop a competitive edge over other fanners due to more timeous information. dist is expected to have a negative relationship because proximity to markets is an imponant advantage to farmers if they are to market their own products. table 4: variable exp edu rent size nworth risk d/a fstress ffopt repay beef sugar definition of variables expected to influence farmers' attitudes towards free trade. definition expected relationship years of farming experience. years of formal education. percentage of the total area operated that is rented. annual gross income from farming operations (rand). net wonh of fann business (rand). + fanners' willingness to take risks relative to other + fanners in the district (measured on a liken-type scale ranging from 1 = much less willing to 5 = much more willing). debt to asset ratio. measure of financial stress (liquidity and solvency) scoring 0 if low up to 4 if high (orazem et ai, 1989). fixed financial obligations as a prop onion of turnover. value of medium and long term debt repayments (rloo 000). dummy variable = i if more than 55 percent of gross income is derived from beef production, 0 otherwise. dummy variable = 1 if more than 55 percent of gross income is derived from sugar-cane production, 0 otherwise. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr vol 1 (1998) nr 1 133 table 4 (continued) dairy dununy variable = i if more than 55 percent of gross income is derived from dairy production, 0 otherwise. com put dummy variable = 1 if a computer is used in the farm business, 0 otherwise. + dist distance of farm from nearest town (km). enviro rating of changes in environmental reg.ulations as a source of risk (i = low and 5 = high) . riskfac factor consisting of variability in crop prices. changes in the rand exchange rate, cham.!es in costs of inputs and further reduction of tariffs on i imported farm products as sources of risk, as per i section 5(b) (1 = low and 5 = high for all sources of risk). lprice rating of variability in livestock prices as a source of risk (1 = low and 5 = high). landp i dununy variable i if farmer expects land prices to increase if gatt provisions are successfully implemented, 0 otherwise. + landred rating of further land redistribution and/or i + restitution by government as a source of risk (i i low and 5 = high). mfinan self-rating of management skill in farm finance (i = low and 5 == high). + porf dununy variable 1 if respondent is involved full-time in the farming operation, 0 otherwise. porf is an inverse measure of off-farm income. tlevel dummy variable = i if respondent indicated some knowledge of tariff levels on products sold or inputs used, 0 otherwise . • all ratings. where i = low and 5 high. are based on a likert-type scale farmers who attach greater imporraoce to various risk sources are expected to have a negative attitude towards free trade (which gives rise to greater price risk). hence, the variables enviro, riskfac and lprice are expected to have a negative relationship with the dependent variable. note that riskfac was developed for the following reason: variability in crop prices, changes in the rand exchange rate, changes in the cost of inputs and funher reduction of import tariffs on agricultural products are sources of risk expected to influence respondents' r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 134 sajems ns vol 1 (1998) no 1 attitudes towards free trade. multicollinearity was anticipated among these variables owing to significant (one percent) zero-order correlation coefficients. a factor (rlskfac). explaining 51 percent of the variation in these variables. was therefore created. farmers expecting profits. and thus land prices (landp), to fall (rise) under free trade conditions are expected to have a negative (positive) attitude towards free trade. however, fanners who perceive further land redistribution as a source of risk (land red) may see an opportunity in free trade to secure their land base if they can become relatively more competitive. if this is the case, a positive relationship between landred and attitudes towards free trade is expected. mfinan is hypothesised to have a positive effect on free-trade attitudes. farmers who rate their financial skills highly most probably manage financial risk more effectively and are thus in a better position to manage increased price risk under free trade. previous studies have reported a positive relationship between off-farm income earned by farmers and their attitude towards free trade; these farmers are less reliant on income from government programmes (eg orazem et ai, 1989; barkley and flinchbaugh, 1990). heoce, a negative relationship is expected between porf and attitudes towards free trade. knowledge of tariff levels is also expected to influence free-trade attitudes. reduction of tariffs on imported products is expected to reduce local prices and heoce fanners' profits. however, lower impon tariffs on farm inputs are expected to have a positive effect on farmers' finances owing to lower input costs. hence, if farmers have more knowledge of (or are more concerned with) tariffs on imported !ann products than of input tariffs, a negative relationship between tlevel and attitudes towards free trade is expected. the general logit model can now be defined as: infpil(l-pl)] = {ja + pi expi + ,lhedui + forenti + fosizr + ,bsnworthi + ,bsriski + {jidiai + /lifstressi + ,&ffopti + piorepa yi + pilbeefi + pl2sugar.j + pi3dairyi + jjl.computi + pi~dlsti + pi6enviroi + jjl7riskfacl + jjlslpricb + pi9landpi + /hltlevel (2) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sa teb nr vol 1 (1998) nr 1 135 results of the analysis independent variables included in other studies proved to be poor determinants of fanners' attitudes towards free trade in this study. this may be due to a relatively small sample and lack of variation in the data. only variables with coefficients significant at the ten percent (or higher) level of probability were retained in the logit model. results of the analysis are presented in table 5. the model chi-square statistic is highly significant. the goodness of fit statistic shows no significant lack of fit in the overall model. the estimated model correctly classifies 92,59 percent (50 of 54) of those in favour of free trade and 75,00 percent (12 of 16) of those opposed to free trade, yielding an overall correct classification rate of 88,57 percent (62 of 70). large standardised parameter estimates indicate that a unit change in the independent variable will have a large effect on the log of the odds ratio of a respondent agreeing with free trade relative to other independent variables. riskfac has the largest effect on trade attitudes followed by landp and landred. computer adoption (compun, a proxy for a farmer's progressiveness, has a positive coefficient as hypothesised, implying that respondents who own and use a computer are more likely to favour a liberalised trade environment. progressive farmers are more likely to adopt relevant technologies which increase their competitive advantage. however, this variable may also caprure the effects of other factors such as farm size, farmer's age and level of education as larger, younger and better educated farmers are more likely to use a computer (woodburn et ai, 1994). a negative relationship for dist indicates that fanners more distant from a town will oppose free trade. in the past, 21 marketing boards reduced the need for farmers to market their products. in the event of trade liberalisation, farmers will be required to market their products (either themselves or by agents), and locality of potential markets will therefore be important. respondents who consider changes in environmental regulations (enviro) as a risk to their businesses are likely to oppose a free-trade environment, as evidenced by a negative coefficient. the south african commercial farming industry has relied on chemicals and commercial fenilizers to produce high yields (lyne and ortmann, 1992), whilst environmental restrictions under gait could include limits or bans on the use of fenilizers, pesticides and herbicides (lafrance, 1992). provisions under gait include revision and tightening of sanitary and phytosanitary measures (giardini, 1995). in addition to these concerns, issues r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 136 sajems ns vol 1 (1998) no i relating to the landscape, conservation, water quality. quality of foodstuffs and animai welfare are to be addressed (maclaren, 1995). adherence to certain environmental measures would require additional invesunent for farmers. thereby increasing their costs of production. environmental groups are also becoming an effective counter force to traditional farm lobbies (maclaren, 1995). a negative coefficient for riskfac indicates that respondents who perceive variability in crop prices, changes in the rand exchange rate, changes in input costs and further reduction in import tariffs as sources of risk. are opposed to liberalisation of trade. this is to be expected as crop prices would be more variable under free trade. changes in the rand exchange rate would affect the domestic cost of inputs and prices of imported products, whilst further reduction in import tariffs on agricultural products would also affect local product prices. as hypothesised. respondents who perceive these factors as important sources of risk to their operations would oppose liberaiisation of trade. this independent variable has the highest standardised parameter estimate and thus has the largest effect on free-trade attitudes relative to other independent variables. as expected, respondents who think that land prices (landp) will rise in the event of the successful implementation of gait are supportive of a free-trade environment. gait is synonymous with free trade and this response is therefore rational seeing that increased land prices are of benefit to land owners. la ndred , the importance of further land redistribution as a source of risk, is positively related to attitudes towards free trade. respondents' supportive of free trade probably consider themselves competitive and are likely to survive in a free-trade environment. respondents' perceptions may indicate that more productive units will not be redistributed ahead of other less competitive operations. as expected, variability in livestock prices (lprice) has a negative association with the dependent variable. operators who regard variable livestock prices as an important source of risk are likely to oppose free trade as livestock prices are likely to be more variable under free-trade conditions. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr voll (1998) nr 1 137 table 5: logit model of attitudes towards free trade by sample farmers in kwazulu-natal, 1996 (0=70) • variable parameter standard • asymptotic standardised estimate error i-statistic parameter estimate comput 3,2968 1,7066 1,93' i 1,5868 dist -0,1996 0,0732 -273'" i ' -2,7686 enviro ! -1,8245 0,6970 -2,62" 1_2,8680 riskfac -6,4153 2,2851 -2,81'" • -6,4153 landp ~3'8559 2,63" 3,5825 landred , 0,7684 2,63" 3,4635 lprice -1,0460 0,4452 -2,35" -2,1820 mfinan 2,8454 1,0248 2,78'" 2,4708 porf 3,8046 1,9115 1.99" 1.3373 ! repay -2.600 0.9552 -2.72'" -2,4226 tlevel -3,7165 1,7032 1-2,18" -1,5958 constant i -4,2732 2.8689 -1,49 7.2305 model chi46,163'" on 11 degrees of freedom square goodness of fit 27,393 (n.s.) on 58 degrees of freedom correct prediction (percent) total 88,57 agree 92.59 disagree 75.00 i , " ... note: " indicate significance at the 10 percent, 5 percent and i percent levels of probability respectively. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 138 sajems ns vol i (1998) no 1 respondents with a higher self-rating of management skill in farm finance (mfinan) are supportive of a free-trade environment. above-average financial managers are better equipped to manage iocreased price risk associated with market forces by controlling financial risk. following economic iiberalisation, farmers in new zealand reduced fixed financial repayment obligations by reducing debt levels (robinson, 1995). the positive porf coefficient suggests that full-time farmers are in favour of a iiberalised trade environment. this is contrary to expectations and the results reported by edelman and lasley (1988) and barkley and flinchbaugh (1990). in this study, respondents farming on a full-time basis may have a greater incentive to adapt to a rnarket-orientated economy in order to satisfy household consumption needs. these farmers may have more time available to investigate different marketing alternatives and to identify and respond to market signals. a negative relationship exists between attitudes towards free trade and debt repayment levels (rep a v). following economic iiberalisation in new zealand in 1984, the real price offarmland decreased from 1095 dollars per hectare in 1984 to 569 dollars per hectare in 1989 (johnston and frengley, 1991). consequently, farm households whose debt exceeded 50 percent of total assets increased from 10 pereent of households in 1985 to nearly 24 percent in 1986. this proponion of fanners with high debt levels subsequently declined due to debt restructuring and farm sales (johnston and frengley, 1994). lower levels of debt are now evident as fanners seek to have a fmaocial buffer to protect themselves from a future economic downturn (robinson, 1995). given the potential decline in land values, operators with higher debt levels are possibly aware of the probable effect of free trade on their debt/asset ratio. the anticipated iocrease in price risk associated with trade liberalisation, in addition to the level of financial risk associated with borrowed capital, may be a matter of coocem. respondents who indicated that they knew the level of impon tariffs on products they produced or inputs they used (flevel) were opposed to free trade. seventy-seven and 90 percent of respondents, respectively, did not know the tariff level on products they produced or inputs they used. more respondents have an expectation regarding the effect of tariff removal on reduced product prices (negative effect on farm business) than on reduced input prices (benefit to farm business), which might explain the negative relationship. this result may imply that fanners have not sought information, or need more information, on the level of tariffs on imported goods, particularly on the potential benefits (decreased costs) to the farm business of reduced (abolished) tariffs on imported inputs. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr vol 1 (1998) nr 1 139 logit model of attitudes towards deregulated domestic markets logit analysis was also used to establish the personal and business characteristics (considered in a previous analysis) influencing farmers' attitudes towards deregulated domestic markets. the logit model adapted from equation (1) is used to predict that a respondent will strongly agree with the statement given. only three percent of respondents disagreed with the statement regarding deregulated domestic product and input markets (last question in table 3). consequently, respondents who 'agreed' with the statement given were coded as zero, whilst those who 'strongly agreed' were coded as one. after investigating variables considered in the previous analysis, only variables with coefficients significant at the ten percent (or higher) level were retained in the model. these include dairy, exp, mfinan and risk all of which are defined in table 4. results of the analysis are presented in table 6. the model's chi-square statistic is highly significant. the goodness of fit statistic shows no significant lack of fit in the overall model. the estimated model correctly classifies 96,10 percent (74 of 77) of those who 'agree' and 42,86 percent (9 of 21) of those who 'strongly agree' with market deregulation, yielding an overall correct classification rate of 84,69 percent (83 of 98). zero-order correlation coefficients were all less than 0,19 and there were no relationships significant at the five percent level, thus multicollinearity is not suspected. of the independent variables included, mfinan has the highest standardised coefficient indicating the relatively large effect it has on attitudes towards market deregulation. respondents who derive more than 55 percent of their gross income from dairy production are more likely to strongly agree with deregulation of domestic product and input markets. these (dairy) respondents possibly perceive significant benefits from the deregulation of the maize (feed) industry and improved marketing opportunities, as product differentiation and adding value to milk (eg cheese and yoghurt) may be feasible alternatives years of farming experience (exp) is negatively related to deregulation attitude, indicating that less experienced farmers are more likely to agree with market deregulation than more experienced producers. the latter could be less suspicious of government programmes' complex regulations (kastens and goodwin, 1994). respondents who have a higher self-rating of management ability in farm finance (mfinan, which also has the highest standardised parameter estimate), are more likely to strongly agree with market deregulation. skilled financial r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 140 sajems ns vol i (1998) no i managers may be able to exercise prudent purchasing of inputs and should also be better able to manage increased price risk associated with deregulated markets. willingness to take risks (risk) was positively related to deregulation attitudes. increased price risk associated with the deregulation of product markets is less likely to be perceived as a problem by fanners who are more willing to take risks. table 6: logit model of attitudes towards deregulated domestic markets by sample farmers in kwazulu-natal. 1996 (n=98). variable parastandard asymptotic standardised meter error i-statistic parameter estimate estimate dairy 1,74943 1,1011 1,59' 0,3957 exp -0,0641 0,0261 -2,46" -0,8653 mfinan 1,3482 0,4602 2,93'" 1,1707 risk 0,7865 1 0,3427 2,30" 0.7756 constant -7,5856 2,3161 -3,28'" 1-1,9576 model chi-square 24,600'" on 4 degrees of freedom goodness of fit 90,266 (n.s.) on 93 degrees of freedom con-ect prediction (percent) i total 84,69 agree 96,10 strongly agree 42,86 note: ., ", ••• indicate significance at the 10 percent. 5 percent and i percent levels of probability respectively. conclusions most respondents support a liberalised trade environment but foresee a reduction in product prices, farm profits and land values if gait provisions are successfully implemented. a possible reason for this apparent anomaly is the additional source r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr voll (1998) nr 1 141 of risk associated with potential changes in government agricultural policy. following agricultural iiberalisation in new zealand, farmers were faced with changes in prices and the economic envirorunent but considered these more modest and predictable than government's reactions to political demands (robinson, 1995). respondents are also aware of the imponance of becoming more competitive on domestic and international markets. a large proportion of respondents, however, did not know the level of import tariffs on the products they produced (77 percent) or inputs they used (90 percent). the perceived knowledge of tariff levels (tlevel) negatively affects attitudes towards free trade because more farmers knew about the negative effect of reduced import tariffs on their product prices than about the cost-saving effect (positive) of lower tariffs on imported inputs. more information on import tariffs and their effects could improve farmers' perceptions of free trade, particularly information on how lower tariffs affect prices of imported inputs. information channels could include publications frequently used by farmers. more industryspecific information provided by industrial publications or the electronic media. sixty percent of respondents intended seeking additional information about galt. information regarding expected price changes and the implications of the galt provisions may also be useful to farmers in planning the future direction of their businesses. seeking more marketing information to aid management decisions and adding value to their products. were cited as responses to reduced agricultural support. production responses included increasing the size of current enterprises to take advantage of economies of size. adding a new enterprise (diversification) and changing the size and mix of current enterprises. opportunities exist for private consultants. who are considered by 22 percent of respondents as a potential source of information (but currently used by only 10 percent of farmers), to advise farmers in these areas, particularly in product marketing as farmers consider their skills in this area to be relatively poor. the low envisaged use of futures markets (by 10 percent of respondents) could be improved by increasing the range of futures contracts (eg more crop contracts) and/or educating farmers on the functions and principles of futures markets. this could help farmers in managing price risk as more variable prices are expected with trade iiberalisation. respondents who perceive sources of risk captured by enviro. riskfac and lprice to be important are opposed to free trade. farmers who are relatively risk averse (risk) are also less likely to favour market deregulation. high standardised parameter estimates for riskfac and landred indicate the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 142 sajems ns vol i (1998) no i relative importaix:e of these risk sources on perceptions of free trade. increased price risk is expected with free trade and market deregulation. to improve farmers' ability to survive in the changing policy environment and to avoid resistance towards trade iiberalisation from risk-averse producers. improved information flows and education regarding methods of altering financial. marketing or production techniques to manage risk could be pursued (barry el ai, 1995). self-rating of managerial ability in farm finance may improve, thereby reducing debt repayment levels which would also improve perceptions of free trade. small-scale emerging farmers are likely to have less information and knowledge of risk management strategies than large-scale commercial farmers. consequently, government extension services may have an important role to play in disseminating information and educating small-scale producers on risk management strategies in a changing trade environment. references 1. barkley, a.p. and flinchbaugh, b.l. (1990). faml operator opinion and agricultural policy; kansas survey resuljs. north central journal of agricultural economics. 12(2),223-239. 2. barry, p.j., ellinger, p.n., baker. c.b. and hopkin, j.a. (1995). financial management in agriculjure. fifth edition, interstate publishers. inc. danville. illinois. usa. 3. department of agriculture (1994). the general agreement on tariffs and trade: backgrouruj aruj implicajions for south africa. directoraje: marketing, pretoria. february 1994. 4. edelman. m.a. and lasley, p. (1988). an analysis of the agricultural aruj trade policy preferences of iowa operators. north central journal of agricultural economics, 10(2). 243-254. 5. giardini, g. (1995). farm policy reform in the european community: main features and trade effects. unpublished paper, institute of agricultural economics and policy. university of bologna, italy. 6. goldin, i. and knudsen. o. (1990). agricultural trade liberalization: implicajiotls for developing countries. organisajion for economic development. the world bank. washington dc, 475-485. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr vol i (1998) nr i 143 7. gujarati, d.n. (1995). basic econometrics (third ed.). mcgraw-hili publishing co., singapore. 8. johnston, w.e. and frengley, g.a.g. (1991). the deregulmion of new zealand agricu/jure: market intervention (1964-84) and the free market readjustment (1984-90). western journal of agricultural economics, 16(1), 132-143. 9. johnston, w.e. and frengley, g.a.g. (1994). economic adjustments and changes in financial viability of the fanning sector: the new zealand experience. american journal of agricultural economics, 76(5), 1034-1040. 10. josling, t. (1993). multilmeralism: a constraint on unilateralism and regionalism in agricultural trade. american journal of agricultural economics, 75,803-809. 11. kastens, t.l. and goodwin, b.k. (1994). an analysis of fanners' policy attitudes and preferences for free trade. journal of agricultural and applied economics, 26(2), 497-505. 12. lafrance, j.t., (1992). envirorunental policy and gatt negotiations: discussion. american journal of agricultural economics, 74(3), 782-784. 13. lyne, m.c. and ortmann, g.f. (1992). suggestionsforagricultural economics research in south africa. agrekon, 31(4), 205-209. 14. lyne, m.e. and ortmann, g.f. (1996), estimating the potentialfor creating additional livelihoods on commercial fannland in kwazulunatal. in m. lipton. f. ellis and m. lipton (eds.), land, labour and livelihoods in rural south africa, vol. 2: kwazulu-natal and northern province, ch. 3. indicator press, durban. 15. maclaren, d. (1995). the uruguay round agreement 011 agriculture: a new world order for agricultural trade? review of marketing and agricultural economics, 63(1). 51-63. 16. nieuwoudt, w.l. and vink, n. (1995). financing of land purchase by small-scale fanners. development southern africa, 12(4), 507-517. 17. orazem, p.f., otto, d.m. and edelman, m.a. (1989). an analysis of fanners' agricultural policy preferences. american journal of agricultural economics, 71(2),837-846. 18. phillips, j. (1973). the agricultural and related development of the tugela basin and its influent su"ounds. a report by town and regional planning, pietermaritzburg. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 144 sajems ns vol 1 (1998) no 1 19. robinson. s.a. (1995). trade policies and their effects 011 fanning: a new zealand fanner's experience. proceedings: tenth international farm management congress, university of reading, united kingdom. 23-35. s20. schuh. g.e. (1995). trade policies and their effects on famling. proceedings: tenth international farm management congress. university of reading. united kingdom. 9-35. 21. swart. pj.a. (1996). south african agriculture in the world economy. agrekon. 35(4), 200-203. 22. woodburn, m.r .• ortmann. g.f. and levin, j.b. (1994). computer use and factors influencing computer adoption among commercial fanners in natal province, south africa. computers and electronics in agriculture. 11. 183-194. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 423 sajems ns vol 3 (2000) no 3 market information to promote agricultural investment: the challenge a jooste and j a groenewald department of agricultural economics, university of the orange free state abstract the move towards more competitive agriculture in south africa, largely unburdened by regulatory constraints, is characterised by an undersupply of relevant infonnation in some cases and inadequate access to it in others. this affects the heartbeat of production, investment, financial and strategic decisions. the very nature of intersectoral agricultural linkages, as well as the differences between specific interest groups, suggest that infonnation needs are likely to differ too. there is, however, a common objective direct or indirect for all the users of agricultural infonnation. this is to maximise the returns to investment in the short, medium and long run. however, there exist various problems in providing infonnation, which impedes the ability of infonnation users to position themselves strategically in order to maximise returns. 1 introduction jel q 13 it is a capital mistake to theorise before one has data arthur conan doyle, 1930. the gradual deregulation of agriculture during the 1970s and 1980s gained momentum during the 1990s and culminated in the repeal of the marketing act of 1937 as amended, and the promulgation of the marketing of agricultural products act of 1996. furthennore, south africa complied with the marrakesh agreement reached under the auspices of the general agreement on tariffs and trade (gatt), now known as the world trade organisation (wto). these rapid changes (see e.g., brand et al. 1992; vink, 1993; jooste & van zyl, 1998) caused unprecedented changes in agricultural structure and management in south africa. at the same time, competition from overseas commodities increased substantially, whilst domestic producers and agribusiness are seeking new market opportunities abroad. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 424 ironically, the move towards more competitive agriculture in south africa unburdened by regulatory constraints, is characterised by an undersupply of relevant information in some cases, and inadequate access in others affecting the very heartbeat of production, investment, financial and strategic decisions. for example, before the abolishment of the agricultural control boards that had regulated agricultural markets for decades, agricultural outlook conferences (agrocon) were held annually since 1977, but discontinued after the abolishment of the control boards at a time when they are really needed. aisudeary (1982) cited by van niekerk (1995), goes further by stating that agriculture has the somewhat dubious distinction of being that field of human endeavour which exhibits the greatest gap between available knowledge and that what is actually practised. frick and groenewald (1998) conclude that in south africa, the official suppliers of agricultural data are not providing the necessary data that decision-makers, both public and private, in fact need. this state of affairs is disturbing when one considers that good information improves the competitiveness and the efficiency of markets (salin, thurow & elmer, 1996), and that the lack of information was, in the 1930s, cited as an important reason for the passage of the marketing act. 2 the need for agricultural information the very nature of intersectoral agricultural linkages, as well as the differences that exist amongst specific interest groups suggest that information needs are likely to differ. wu, just, zilberman and wolf (1999) state that since different groups make different kinds of decisions, one would also expect to see different information-seeking behaviour on the part of each group. there is, however, a common aim direct or indirect among all the users of agricultural information namely, to maximise the returns to investment in the short, medium and long run (see e.g. frick & groenewald, 1998; russell, 1983; craig, 1979). for example, policy makers need information to create the necessary environment for sustainable agricultural production, marketing and trade in order to promote investment. producers, on the other hand, have to make decisions on what to produce, what inputs to use, the combination of inputs and marketing channels necessary to maximise the return on capital. for this they need information. moreover, craig (1979) mentions that "it is also important to recognise that one person may fulfil many roles ... and may apply different criteria when acting in his different roles". this should be taken into account by information providers. furthermore, asymmetric information usually gives rise to different bargaining positions in the market. this may cause market failure, which in tum might result in more policies to regulate trade. however, if information is available on a symmetric basis, this could serve as a countervailing power to market failure. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 425 sajems ns vol 3 (2000) no 3 hence, instead of policies designed to counter market failure, government should create an environment where information can be accessed by all participants in the market. 3 the critical "vacuum" having access to information sources is one thing, knowing how to best use them is another thing altogether (metcalfe, 1988). this is emphasised by shultz (1975) who states that differences in capacity to process information are a major source of variation in human capital he also argues that differences in human capital could easily lead to the exclusion of certain users in information markets. this phenomenon is illustrated by van niekerk (1995) who states that although the information necessary to increase production levels is generally available, very few countries in africa are self sufficient in food production; the challenge for african information workers is to close the communication gap between theory and practise. in fact, klair, boggia and richardson (1998) state that providing information has become the most important part of extension activity. amongst other things, information entails training sessions, demonstrations in the field, and assessment, together with farmers, of the activities and results obtained. aina (1995) regards repackaging and dissemination of information as crucial to the provision of relevant and timely information to agricultural information users. in his view, this is the crux of the matter as it is the main source of the problem of providing agricultural information in africa. isnar (1993) reinforced this view by mentioning that the linkage between information staff and their clients is the weakest part of the information management chain. this state of affairs will undoubtedly have a negative influence on investment decisions and consequently the returns to caryital. this could eventually result in disinvestment in a sector of great importance for sustainable economic development, especially in sub-saharan african countries. 4 diversity of information needs the agricultural sector consists of many industries, with firms functioning at all levels of the farm-to-consumer market channel. some specialise in particular commodities while others produce, distribute, or sell a mix of products. some also specialise in one marketing function, for example wholesaling or procurement; other are vertically integrated. all these firms require information to assess their performance and formulate long-range plans in dynamic, competitive markets (krueger and salin, 1998). successful firms realise the necessity of information in striving for differential advantage, which is the basis of modern competition. it is, however, important to take cognisance of the fact r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 426 that marketing channels for finns/producer operations encompass various organisational fonns and sizes with different levels of human capital and infrastructure. this will influence their demand structure for primary data and value added infonnation. according to aina (1995) the majority of fanners in africa live in rural areas where the infrastructure necessary for access to infonnation is lacking or minimal. in addition, the majority of the fanners cannot read or write any language. still they fonn part of a complex marketing system and have to position themselves accordingly. this emphasises the importance of literacy and numeracy training which should be part and parcel of a development strategy in rural areas. wu et al. (1999) mention that one way to differentiate between infonnation on the same subject is by how easy it is to understand. for example, a large finn may have the human capital to diagnose huge matrices of numbers to make production decisions, while small fanners may need something more prescriptive to make the same decision. a small fanner may hire a consultant or subscribe to an agricultural newsletter that contains advice for the fanner. this state of affairs is also applicable to south african agriculture, particularly when one considers its dualistic nature. van niekerk (1995) mentions that history has left south africa with a legacy of two societies, namely a "first world" or "developed" sector, and a "third world" or "developing" sector. the fonner has the characteristics of a post-industrial or infonnation society, whereas the latter is mostly a rural subsistence economy aimed at selfsufficiency (zaaiman, 1985 as cited by van niekerk, 1995). the result is that there are large differences in objectives between the various agricultural sectors in south africa, and hence their bllsiness dt'cisions. however, there are similarities in their infonnational needs. both commercial and subsistence fanners need infonnation on input prices, markets for their surplus produce, the weather, and so on. the major differences are the way in which infonnation is disseminated and the fonnat (nature) of the infonnation. an infonnation system should cater for such differences. notwithstanding the above, it should be noted that different sub-sectors will have different infonnation needs. frick and groenewald (1999) investigated the agricultural statistics needs of agribusinesses in south africa. they concluded that, although there are similarities in the infonnation needs of different subsectors in agriculture, there are also considerable differences. for example, the need for statistics on the volume of production, area planted, cost of production, and so on, are rather similar for the field crop and horticultural sectors, but statistics on the quantity of imports and exports are considered more important for field crops. producer prices, on the other hand, are more important for the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 427 sajems ns vol 3 (2000) no 3 horticultural sector. frick and groenewald (1999) also found differences with regard to the time when infonnation is needed. according to wu et al. (1999) these differences can be traced to the fact that markets for different commodities behave in different ways. furthennore, different jobs within different commodity chains can require completely different qualities and attributes of infonnation. even for the same job, there may be differences in ability and understanding which cause a party to choose a specific type of infonnation (wu et al., 1999). it is of decisive importance for infonnation providers to recognise these differences, since each person in a finn contributes directly or indirectly to the positive/negative returns on capital. the old proverb comes to mind: "a chain is only as strong as its weakest link". 5 information and vertical integration: implications for investment coase's insight into the nature of the finn as cited by leathers (1999), provides another dimension of the ongoing debate on the infonnation issue. he states that vertical integration of processes takes advantage of the fact that infonnation within the finn is cheaper to collect and verify than in the market. this is, however, not an absolute principle, otherwise finns would integrate fully from one end of the production and marketing chain to the other. at some point, technological or managerial diseconomies outweigh the infonnational advantages of further vertical integration (leathers, 1999). in an essay on "infonnation asymmetry as a reason for vertical integration", hennesy (1997) gives an overview of the reasons for vertical integration, and specifically considers market failure in conveying infonnation about quality as a reason for vertical co-ordination. according to him, the incentive to invest in ensuring quality is reduced relative to the perfect infonnation scenario, because the difference in market revenues is lower than that which would maximise social surplus. as a result, underinvestment in the provision of quality occurs, and this may occur particularly for crops where it is difficult and/or costly to detect quality differences. the reason is that imperfect infonnation constitutes an externality. by increasing the average quality of a product, investing finns provide benefits that the market does not fully reward. vertical integration and, to a lesser extent, production contracts solve this problem because they remove the need to test for quality (hennesy, 1997). this situation is shown in figure 1. note that infonnation has benefits in tenns of productivity and/or money, as well as costs. if the finn's infonnation is less than oa in figure i, say ob, then the finn will try to increase it to oa. in other words, the finn should always strive to the point where the marginal value r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 428 product (mvp) of information is equal to its marginal factor cost (mfc). one may find that a situation can arise where business decisions have to be made without sufficient information. this will lead to forced action, and a higher probability of non-optimal decisions. figure 1 the optimal level of information mfc perfect information ol-----------------~&---b a c amount of optimum information the main issue of concern is that by internal ising the information problem, firms can overcome certain information failures. the extent to which firms can integrate is, however, also dependent on their ability to obtain and use information. in other words, the abilities (e.g. inborn ability, literacy, education, etc.) of firms (managers) to use and obtain information will differ. this will again influence the optimal level of information between firms. figure 2 demonstrates this situation. tt..! differences between the level of optimal information used by the two firms stems from differences in their marginal factor cost and marginal value product of information. this is again a function of the type of firm and the level of management. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 429 figure 2 sajems ns vol 3 (2000) no 3 differences in the level of optimal information between firms .i "'-. mfck , / mfcj ---finnj . finn k 6 information and the south african farmer 6.1 government vs. private information suppliers there is a growing demand for value-added infonnation by fanners in south africa. this is not surprising, seeing that the market in which they operate is quite different from what they were used to before 1996. this holds for both commercial and small-scale fanners, although the method of infonnation dissemination may differ. value-added infonnation is used by variolls parties in the agricultural sector to make infonneu decisions. infonnation can take various fonns, and varies from market analysis and forecasts for different commodities, to the social and economic impact of trade agreements and the effect of climate on the production of certain commodities in various geographical regions. value-added infonnation is furthennore usually tailor-made to specific needs and comes at a price for this reason. this means that certain may be excluded from sharing vital infonnation. a possible remedy for this problem may be to internalise the value-adding function, but this again introduces a new set of problems, since the production of value-added infonnation requires relatively highly skilled personnel, the necessary infrastructure and access to data networks. this can be rather costly. here the government can play a most important role, by extending the capacity to provide certain value-added services. this is not to say that government should take over the role of private entrepreneurs, but it might provide the means of better communication between infonnation providers and users. certain government functions can even be r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 430 outsourced to the private sector, with conditions attached that would further the aims of government in the information system. outsourcing may cause the system to be more effective and efficient, provided that competition exists between information providers. wu et al. (1999) state that it has been argued that government provision of information drives private information providers out of business, and undermines the market mechanism. it does, however, rather seem that government provides the very general information input used by private information providers to bring a specialised piece of information to a specific audience. the heterogeneity of the demand for information allows information suppliers to make a profit, despite government provision of information on the same topic for free. in a study conducted by wu et al. (1999) in the us, it was shown that intermediaries, such as extension workers, rely heavily on the government for information, but that end users do not this is strong evidence that government information does not drive private information sources out of business, but rather makes their role economically viable. it should be noted that if the government plays a too small part, this will certainly be to the disadvantage of the very farmers and businessmen which government in south africa wish to promote: the poor, small and emergent. private companies are likely to concentrate where profit opportunities are best. the small, poor and emerging farmers and businessmen will be neglected. this process has been described as "creaming" (kolderie, 1986). metcalfe (1989) also mentions that the trouble with information is that many think they know all about it and can do something to improve on it the result, inevitably, is chaos. he points out that there is much praiseworthy bl't uncoordinated effort. the challenge to information providers therefore lies in establishing a co-ordinated effort to supply relevant and timely information to a heterogeneous population of information users. this should not only enhance the efficiency with which information providers use their limited resources to provide information to specific target groups, but the target groups themselves would be in a better position to make strategic investment and marketing decisions. 6.2 the growing importance of informal information farmers constantly need information on a great variety of issues, for example, market prices of inputs, price movements, production prospects, cost and sources of capital, domestic and international market opportunities and dangers, as well as the availability and cost of natural resources. these data needs can be satisfied by sourcing information from either public or private information r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 431 sajems ns vol 3 (2000) no 3 providers. furthermore, one should consider the formal or informal nature of information. wu et al. (1999) define informal information as information that one cannot buy with money, but for which one must find time through conversation. personal observations will be part of this. with the deregulation of the meat board certain information ceased to exist, for example, accurate herd and slaughter numbers. estimates of this must typically be found in an informal manner. thus in the absence of a market for certain kinds of information, a firm could be driven to obtain the information through conversation with customers, or even competitors. to take another example, a firm may observe fruit orchards to derive an estimate of prospective yield. it could also be that a firm, after obtaining formal information, will use informal means to check the accuracy of the information. in this way, informal information could increase the marginal value product (mvp) of the formal information (wu et al., 1999). this would then influence the decisions made by farmers. amstutz (1998) mentions that as government intervention in agriculture continues to decrease worldwide, the need for reliable statistical information by all those involved in the business of agriculture will grow. this entails the investment of human capital and other resources by private firms, to obtain the information specific to their own needs. important in this regard is that information that is specific enough to be valuable is often proprietary information (salin el al., 1986). the result is that certain information will only be available to a certain (monopolistic) group, although there may be a wider demand for such information. conversely, several (smaller) groups may invest in information-gathering to obtain the same information. this, however, again raises the issue how co-ordination can be achieved without wasting time and money. as already mentioned, firms will tend to use information tailored for their specific markets and conditions and will protect such information, but the question is whether the basic information should also be exclusive to a specific group. if the information system is private, exclusivity should go to those who pay for it. this problem may be overcome by public funding of basic information, but again resistance can be expected in cases with a high degree of industrial concentration. the basic problem is that one group can exclude other users from basic information through its market power, thus raising the cost (time and money) of gathering informal information. this cost may be prohibitive. hence, smaller firms may eventually turn too less accurate sources of information for their business and investment decisions. the consequences of this may be even more costly. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 432 6.3 future markets as means of transmitting private information just (1983) quotes various authors who have demonstrated that, if futures markets are efficient and have no basis risk, then futures prices are the best price expectation that can be used to determine commercial decisions. even when basis risk is admitted, future market expectations are the only expectations that consistently lead to non-involvement of individual commercial decision makers in futures trading in the absence of transaction costs (just, 1983). since the transaction costs of futures trading are generally low, these arguments presumably also more or less hold when transaction costs are considered. just (1983) concludes that the fact that many commercial decision makers consistently do not trade in futures contracts, suggests that futures markets are indeed serving as instruments, directly and indirectly, for transmitting information to commercial decision makers. the question then arises whether futures markets are efficient, but the answer falls outside the scope of this paper. what can be said, however, is that futures prices of the south african futures exchange (safex) in south africa, maize in particular, are regarded as an important proxy for maize prices, and are widely quoted by various information providers. the extent to which this provides guidance to small-scale farmers in their decision-making processes remains an open question. one can presumably expect that these farmers rarely use futures prices, mainly due to the lack of organisational capacity to react to information transmitted to them via this medium that is, if the information actually reaches them in time to make informed decisions. a general lack of understanding of future markets by all farmers is one reason why they do not adequately hedge against "investment" risks. this presents a major challenge to all information providers. 7 challenges for the future according to bonnen (1975), an information system should include not only a data system, but the analytical and other capabilities necessary to interpret data. this is not to say that all capacity should be located at one central point, but rather that a co-ordinated effort in the management of information at different levels should receive the greatest attention in order to meet the information needs of a heterogeneous population. it is most important to bridge the information gap, as was repeatedly stressed in this paper. this gap exists not only between information providers and users, but also amongst providers and users. this source of inefficiency seriously impedes the effort to increase returns on investment, whether it is investment in human capital, business and even information itself. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 433 sajems ns vol 3 (2000) no 3 metcalfe (1989) mentions that planning for information requires knowledge of the following: • existing/potential users who they are and what are their needs? • what information sources exist, which can one reach, and how can new sources be created and maintained? • how to extract and analyse information from a combination of sources; and • how to communicate the required information to the users. these issues relate directly to what lindner (1998) sees as reasons for the shortcomings of information systems. they are: • information systems work in relative isolation from each other; • institutional rigidity, not sufficiently adaptive to changed statistical needs of the present and likely changes in the future; • lack of effective communication between providers and users; • growing resource constraints; and • sub-optimal use of (available) information technology. lindner also suggests three avenues that seem worthwhile to explore jointly if possible in order to improve the state of information services: • establish a forward-looking needs profile of statistics that are seen as the key to answering today's policy questions and those which are likely to become more important over the medium term; • review the ability of the system to meet needs and identify necessary steps to ensure better planning, co-ordination and synergy; and • optimise the use and proper application of information technology for database management. there rests an obvious and enormous responsibility on information providers in south africa to reconcile the need for and supply of information. 8 conclusion the south african agricultural sector at present experiences a great need of a well structured information system that encompasses the dualistic and heterogeneous information user population. this paper has discussed some important issues that need to be considered by all information providers. these include a proper inventory of specific needs, much improved co-ordination of effort and, probably the most important, closing the information gap between the various parties involved. the issues that need to be addressed are complex in r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 434 nature and would require a joint effort by both information suppliers and users to establish a system capable of catering for different user needs in order to facilitate different investment decisions on a sustainable basis. references aina, l.o. 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(1986) "two different concepts of privatisation", public administration review, july august 1986: 285-90. 12 leathers, h.d. (1999) "what is farming? information, contracts and the organisation of agricultural production: discussion", american journal of agricultural economics, 81 (3): 621-3. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 435 sajems ns vol 3 (2000) no 3 13 lindner, a. (1998) "issues and concerns for developed countries", paper presented at the agricultural 2000 conference, washington d.c., march 18-20, 1998. 14 metcalfe, j.r. (1989) "strategic issues in agricultural information, with special reference to developing countries" iaald quarterly bulletin, vol 34(3): 113·17. 15 russell, h.m. (1983) "agricultural user populations and their information needs in the industrialised world", quarterly bulletin of iaald vol 28(2): 40-52. 16 salin, v.; thurow, a.p. and elmer, n. (1996) "a preliminary survey of users of agricultural economics information: procedures and results", faculty paper series 97-4 texas a&m univerity, texas. 17 shul tz, t. (1975) "value of the ability to deal with equilibria", journal of economic literature, 13(3): 7-846. 18 van niekerk, r.v. (1995) "the state of agricultural information services in south africa", chapter 5: 57·66, in agricultural information in africa, aina, l.o., kaniki, a.m. and ojiambo, j.b. (eds.) third world information service limited. 19 vink, n. (1993) "entrepreneurs and the political economy of reform in south african agriculture", agrekon, 32(4): 153-66. 20 wu, s.; just, d.; zilberman d. and wolf, s.a. (1999) "demand for agricultural information", american agricultural economics association annual meeting, august 1999. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 2 measuring entrepreneurial culturally is it possible? a b boshoff and c hoole graduate school of business. university of pretoria abstract 234 attitudes internon*portability of constructs is seen as a potential problem in international research. studying attitudes as an approach to understanding entrepreneurs is seen as potentially profitable in order to understand members of this entrepreneurs. the construct validity of the entrepreneurial attitude orientation scale (as adapted) when used on a south african sample is psychometrically examined by means of exploratory and confirmatory factor analysis. it is found that the factor structure differs from that established on a north american sample. portability of constructs embodied in measuring instruments seems to be a significant problem when research is contemplated on an international scale. introduction according to a recent review of the literature on the characteristics of entrepreneurs hoole (1996) indicated that studies in this field had initially dealt with the personality traits and demographic/biographic backgrounds of entrepreneurs. this did not prove to be very fruitful and various other approaches e.g. dealing with the managerial behaviour of entrepreneurs (lau, 1992), were proposed in order to learn more about entrepreneurs and their functioning. according to hoole (1996) a further z (and later) determining the characteristics of entrepreneurs consisted of studying the attitudes of individuals engaged in entrepreneurial activities. an attempt was, for instance, made by robinson, stimpson, huefner and hunt (1991) to determine whether entrepreneurs and non-entrepreneurs differed in terms of certain attitudes, the argument being that attitudes are "closer" to behaviour than general personality traits and can be changed more readily than more fundamental characteristics which could be important and useful in terms of the development of entrepreneurs robinson et al (1991) also argued that certain attitudes i.e. towards achievement, innovation, self-esteem and personal control in business situations r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 235 sateb nr vol i (1998) nr 2 could possibly distinguish entrepreneurs from non-entrepreneurs. the authors developed an instrument i.e. the entrepreneurial attitude orientation scale (eaos) to measure these four attitudes (robinson et al 1991). validation of the instrument proved that it had adequate construct and discriminatory validity as well as adequate internal consistency when used in the united states of america. the question which will be addressed in this paper is whether it will also have acceptable psychometric qualities when used in another culture, viz in south africa. cross-cultural validity and reliability of measuring instruments are a major problem in international research (bhagat, kedia, crawford & kaplan, 1990). it seems as if words, phraseology, syntax even when the same language is used e.g. english is used, prove to interpreted differently by respondents from different cultures. problems in this regard were found with regard to such use of the robinson et al (1991) eaos by researchers (stimpson, huether, narayanan & shanthakumar 1992; stimpson, robinson, waronusuntikule & zheng, 1990). kerlinger (1986) indicates that a fundamental problem in social science research is that agreement on the constructs studied and their contents often does not exist. this makes replication of studies dlfficult and impedes accumulation of knowledge in a given field. under the circumstances it was decided to try to determine the factorial structure of the eaos and the contents of the hypothesised subscales when the instrument is applied to a south african (i.e. a sample from a culture which probably differs from that of the usa). method respondents the sample consisted of individuals from three occupational groups. the first group of respondents (n= 11 0) was identified as entrepreneurs. identification of individuals to be included in this group is described in the "procedure" subsection. the mean age of the entrepreneur group was 43.8 years (~) = 8.2, range 27-63 years). ninety-nine of the members of this group were males and 11 females. the second occupational group consisted of engineers (n=113). this group had a mean age of 34.7 years (£q 9.45, range 21-63 years). only 12 members of this group were females. to be regarded as an engineer potential respondents had to be r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 2 236 in a position where he/she did not have managerial or supervisory responsibilities, were to be regarded by the employing organisation as having "only an engineering role and, lastly, had to regard themselves as full-time professional engineers. the third group of subjects consisted of individuals (n=76) in managerial positions in organisations. included in the group were 69 males and seven females. this group had a mean age of 40.5 years (so = 7.3, range 27-57). the total group on whose responses the analyses were based had a mean age of 39.5 years (so 9.1, range 21-63 years). measuring instrument the respondents completed the eaos developed by robinson et al (1991) as added to by stimpson (1993). robinson et al (1991) argued that scales to measure attitudes had to be carefully constructed and validated before such scales could be used with confidence to distinguish entrepreneurs from non-entrepreneurs. they used four constructs which, according to a literature survey, were associated with entrepreneurial behaviour. these constructs were: economic innovation, achievement, locus of control and self-esteem. these constructs were used as the basis of a factor analytically developed scale, the eaos, which contained four subscales i.e. attitudes towards innovation, achievement, personal control and selfesteem. the four subscales consisted of 25, 23, 12 and 14 items respectively. stimpson (1993) added a further construct le. machiavellianism to the scale. this subscale contains 14 items. test-retest reliabilities of the attitudinal subscales are given as innovation .85; achievement .76; personal control. 71; self-esteem. 76. alpha coefficients were regarded as satisfactory at innovation .90; achievement .84; personal control .70 and self-esteem .73. (test-retest reliabilities and alpha coefficients are not available for the machiavellianism subscale). discriminatory validity was investigated by robinson et al (1991) by comparing, by means of manov a, the scores of entrepreneurs and non-entrepreneurs. a significant overall difference was found as well as significant differences in the total score and in the scores for the different subscales. discriminant validity of the scale was investigated by means of stepwise discriminant analysis. only attitude towards achievement did not enter into the model built. robinson et al (1991) concluded that the scale and subscales seemed to possess satisfactory psychometric qualities when used on north american respondents. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 237 sateb nr vol i (1998) nr 2 procedure an attempt was made to include members of three clearly distinguishable occupations in the sample. to be included as a member of the entrepreneurial group the respondents had to be a manager of a business organisation and/or the owner of the business or had to have started the business he/she was currently engaged in. the business had to be employing between five and 100 employees while the turnover had to be less than r3m per year if in retailing, less than r3m per annum ifin the manufacturing sector and below rim if engaged in the services area. total assets (excluding land and buildings) had to be less than rim. the entrepreneurial group was obtained by scrutinising 502 files of a venture capitalist. of this group 116 potential respondents were operating in areas where social unrest, violence or crime assumed levels which made it unfeasible to try and obtain data. the level of succes3 of 153 of the businesses could not be ascertained from the files. the survey population therefore consisted of 233 entrepreneurs. a letter (on the letterhead of the authors') university in which the purpose of the study was explained and participation requested was mailed to each of these individuals. participation was in this way obtained from 41 individuals. telephonic follow-up elicited promises of participation from 97 additional individuals. questionnaires were delivered to each of these (n=138) individuals who were willing to participate. one hundred and ten useable questionnaires were returned and included in the analysis. the questionnaires were completed in the presence of a field worker. the members of the second occupational group were au specialist engineers who, in their own and the view of their employers, did not have managerial responsibilities. the 113 respondents were all from the gauteng province and were employed by three different organisations in the chemical industry. the questionnaires were completed in the presence of a field worker during an appointment made about a week before. the respondents (n=76) in the third occupational group were managers who participated in a middle management course at the graduate school of management of the university of pretoria. this group completed the eaos, scored it themselves and were helped to interpret their scores during an introductory getting-to-know each other sessions of the three courses in which the respondents participated. data was analysed by means of the eqs set of programmes developed by bentler (1995). exploratory factor analysis and confirmatory factor analysis were used r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 2 238 to determine whether the factorial structure identified by robinson et al (1991) i.e. five factors consisting of 26, 23, 12, 14 and 14 items respectively would be replicated in terms of the responses of the 299 respondents included in the present study. results exploratory factor analysis was firstly carried out using the factor analysis subroutine in the eqs. in the first round of this analyses an attempt was made to replicate the five factor structure defined by the authors of the eaos (robinson, et ai, 1991). extraction of five factors, a scree test (plot of the eigenvalues), and a direct oblimin rotation were specified. the five highest eigenvalues were respectively, 10.67,5.11,3.97,2.90 and 2.67. the sixth eigenvalue was 2.18. in terms of the eigenvalues it is clear that a five factor solution seemed feasible a clear visual break is present between the fifth and sixth factors. the eigenvalue of the sixth factor is not as clearly different from that of the seventh factor. when five factors are extracted 58 items had factor loadings>.30 or higher on factor and did not load .30 or higher on more than one factor. a total of 31 items were therefore eliminated from further analyses. of the items eliminated 7 were seen by the developers of the instrument to as belonging to the subscale attitude to innovation with respectively .8, 4, 3, and 9 originally seen as part of, respectively, the subscales attitude towards achievement, self-esteem, personal control and finally machiavellianism. the 58 remaining items were subjected to a further round of exploratory factor analysis with five factors again specified. five eigenvalues of >2 were obtained, the highest being 7.49 and the fifth highest 2.031. using the same decision rules as before another six items were eliminated from further analyses. these items were, respectively, part of the subscales attitude to innovation (three items), achievement (one item), personal control (two items). this process of exploratory factor analysis was repeated. in the next (third) round the five highest eigen-values varied between 6.888 and 1.909. of the 52 items included in this analysis three did not meet the requirements (as stated before) for inclusion in further analyses and were therefore eliminated from the nest round of exploratory factor analysis. the items eliminated were originally part of the subscales innovation (one) and achievement (two). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 239 sa teb nr vol i (1998) nr 2 in the fourth round of the exploratory factor analysis only one item (no 77, originally included in the subscale attitude to innovation) did not meet the requirements for inclusion in further analyses and was eliminated. of the original 89 items in the scale 48 therefore loaded .30 or higher on one of the five factors identified without having a cross-loading of .30 or higher on another factor. the five factor structure is shown in table i. table i : factor pattern obtained from five factor solution (48 items) item factorifactor : factor i factor i factor i :2 13 .4 i5 vi i i ! 0.5387 i v2 0.3609 i , " v3 i 0.3339 i v4 i i 0.4910 v5 i 0.3308 v8 0.3543 i vi2 : 0.3359 vi3 0.4871 i vi5 0.4067 vl6 0.4422 vi8 0.3953 v21 0.3885 v23 0.4254 v28 0.5002 i i 0.4556 i '" v31 i 0.3988 v32 0.4060 v36 0.4492 v38 0.3869 ! v39 0.4862 i ,,40 0.3318 v41 0.4199 v44 0.4468 v47 0.5143 v48 0.4638 v50 0.3790 ~'" i v51 0.4607 v53 0.3384 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 2 240 v55 i i 0.4408 v56 0.4356 v57 0.4475 v58 0.5265 v59 0.3626 v62 0.4420 i v63 i 0.5088 i i v68 i 0.4652 ! i v69 0.5367 : : v70 0.4284 i i v71 0.5621 i i i vn i 0.4416 i v75 0.6267 i i v76 0.3869 i v78 , 0.4835 i i v79 . 0.4429 : v80 0.5536 i i v83 0.4031 : i i v84 i 0.5236 i i v89 i 0.4917 . ! confirmatory factor analysis was then carried out on the factor pattern shown in table i. the results are shown in table 2 from table 2 it can be seen that the factor structure in table 2 represented a poor fit with the data. the fit indices are low, unacceptably so. under these circumstances it decided to investigate the possibility that a four or even five factor model would represent a better fit with the data. the factor pattern shown in table 2 indicates that only 53.9% (48 out of 89) of the items in the original questionnaire would be retained in the five factor structure presented. the factor pattern did not replicate the one implied in the division of items into factors as proposed by robinson et al (1991) and stimpson (1993). the first factor contained loadings> .30 from 12 of the items included in the attitude to innovation of the original scale. two items from, respectively, the attitude to achievement and the attitude to personal control subscales in the original questionnaire also loaded significantly on this factor which seems to be identifiable as measuring attitude to innovation. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 241 sateb nr vol 1 (1998) nr 2 table 2 : indices obtained from confirmatory factor analysis carried out on 48 remaining items (five factor structure) index . value independence model chi~square (df= 1128) . 3844.977 chi-square (df=1069) 1%7.227 independence aic 1588.977 modelaic -170.7728 independence calc -3713.123 model calc ! -5195.547 ! bentler-bonett nonned fit index .488 bentler-bonett non-nonned fit index .651 comparative fit index .669 bollen (ifi) .676 mcdonald (mfi) .223 lisrel gfi .782 lisrel agfi .760 root mean square residual rmr .064 standardised rmr .11,) root mean square error of application .053 (rmsea) r.n.1. .669 the second factor extracted contained five items from the machiavellianism subsca1e, three from the attitude to self-esteem, one from the attitude to achievement and one from attitude to personal control subscales, respectively. this factor is difficult to interpret. it seems to be related to assertiveness and autonomy. the third factor identified contained items from originally the attitudes to achievement (6), personal control (3), self-esteem (i) and innovation (i). this factor was seen as related to the attitude to achievement subscale in the eaos. the fourth and fifth factors were difficult to interpret. only four items loaded on this factor. these items originally fonned part of the attitude to selfesteem (2), attitude to personal control (i) and the attitude to achievement (i) subscales in the original questionnaire. it was not seen as a factor which could be interpreted readily. the fifth factor had six items loading on it, two each from the attitudes to self-esteem, achievement and personal control subscales. inspection of the item wording indicated no clear interpretation of the factor. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 2 242 under these circumstances it was divided to do further analyses in order to see whether more interpretable factor structures could be obtained. it was also considered possible that more economical structures which would at the same time fit the data better could result from such analyses. the first part of the further analyses consisted of extracting, through exploratory factor analysis, four instead of five factors. a scree test and a direct oblimin rotation were again specified. the four highest eigenvalues were 10.67, 5.11,3.97 en 2.90 for the analysis based on the responses on the 89 items. of these items 34 did not load .30 or higher on one factor without loading at the same level on another factor. fifty five items therefore "survived" this analysis. the items which had to be left out from further analyses came from, respectively, the subscales attitudes towards innovation (6), achievement (8), self-esteem (9), personal control (5) and machiavellianism (6). a further round of exploratory factor analysis yielded 50 items which loaded .30 or higher on a factor without loading .30 or higher on more than one factor. the items which did not meet these criteria came from, respectively, the subscales for achievement (2), self-esteem (2), personal control (2). the responses to the other 50 items were again subjected to exploratory factor analysis. this yielded a factor structure in which all the items loaded .30 or higher on a factor without loading .30 or higher on any other factor. the factor structure is shown in table 3. table 3 : factor pattern in four factor solution (50 items) i factor i factor 2 i factor 3 factor 4 :1 i , v2 0.3817 i i v3 i 10.3602 v6 0.3558 i v7 i i 0.3347 i vi3 0.4847 i vis 10.4370 v16 10.3632 i vi9 10.3121 i v20 0.3381 i v23 .0.4718 v24 0.3996 v26 0.3302 i i v29 i i 0.3354 i r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 243 satebnr vol 1 (1998)nr2 v32 0.4050 i i v35 ! 0.3356 v37 i 0.5056 v38 : 0.4769 i v39 ! 0.4343 , v40 ; 0.3562 i v41 i ! 0.5204 i v44 ! ,0.3910 v47 i 0.5244 v48 i 0.4752 v50 ! ! 0.3258 v51 0.3297 ! v53 i 0.4044 v54 0.4846 v56 0.4742 i i v58 10.5352 i i v59 0.4146 v62 i 0.4711 i ! v63 0.5477 ! v64 10.3237 v65 i 0.3774 v66 i 0.5123 v68 .0.4779 i ~v69 • 0.5790 ...... v71 0.4661 ...... v72 0.4812 i v73 0.4321 v75 0.6231 v76 0.4004 i v77 0.4529 v78 10.5068 , v79 • 0.3789 v80 10.4669 v82 i 0.5501 v83 10.4579 v84 : 0.5381 v89 0.4847 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 2 244 from table 3 it can be seen that the four factors extracted had respectively 21, 27, 9, 3, items loading on them. the first factor contained iteitis from the original subscales for attitudes to innovation (16), achievement (3), personal control (1) and machiavellianism (1), the second items from the attitudes towards achievement (9), innovation (4), personal control (3), self esteem (i), the third items from the attitudes towards machiavellianism (7), personal control (1) and self esteem (1) while the fourth factor contained attitudinal items originally seen as part of the subscales for personal control (2) and self esteem (1). to determine the degree of fit between the factor structure based on the fifty items in the four factor solution and the data a confirmatory factor analysis was subsequently carried out. the indices obtained are shown in table 4. table 4: results of confirmatory factor analysis on four factor structure index value independence model chi-square (degrees of freedom (dt) 4319.153 1225) independence aic 1869.15267 ind~endence calc 3888.89071 model aic 74.32942 model calc 5549.14796 chi-square cdf 1169) probability value less than 0.001 2263.671 normal rls chi-square 2327.193 bentler-bonnett normed fit index 0.476 bentler-bonnett nonnormed fit index 0.629 comparative fit index (cfi) 0.646 bollen (ifi) fit index 0.653 mcdonald (mfi) fit index 0.160 lisrel gfi fit index 0.762 lisrel gfi fit index 0.740 root mean squared residual (rmr) 0.068 standardized rmr 0.128 root mean sq error of app. (rmsea) 0.056 relative non-centrality index 0.646 from table 4 if can be seen that the degree of fit could not be seen as high or even satisfactory. using the correction advocated by bagozzi and heatherton (1994) aggregates were made of the respondents' scores on groups items loading on each r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 245 sateb nr vol i (i 998) nr 2 of the factors. the aggregates consisted of the following items. aggregate i: items 2,6, 13, 19; aggregate 2: items 20,26,32,39; aggregate 2: items 40, 47,54,56; aggregate 4: items 58, 62, 63, 68; aggregate 5: items 69, 72, 75, 76, 77; aggregate 6: items 3, 7, 15; aggregate 7: items 16,23,24; aggregate 10: items 73, 78, 79; aggregate i i: items 29, 5 i, 64; aggregate 12: items 65, 80, 82; aggregate 13: items 83, 84, 89; aggregate 14: items 37, 50, 53. exploratory factor analysis was carried out using the' aggregate 14 scores as items. the aggregates loaded on the same factors as "their" items. confirmatory factor analysis was again carried out, this time using the aggregates as independent variables. the results are shown in table 5. from table 5 it can be seen that the fit between the four factor structure and the data appeared to be satisfactory but the indices did not represent a really good fit. an attempt was made to interpret the four factors in the structure. it seems as if the first factor could be seen as representing the attitude to innovation but also containing items from three of the original scales. the second factor contained mainly items from the attitude towards achievement but also from three other subscales. it can be identified (with some doubt) as an achievement factor. the third factor seems to be related to machiavellianism. the last factor does not lend itself to easy interpretation and also consists of only three items. personal control and self-esteem seemed to have disappeared as distinct factors. the four factor structure obviously differed substantially from the postulated (original) structure. it contained one doubtful, not easily interpreted factor as a final attempt to get greater clarity on the dimensions measured by the 89 item eaos a three factor extraction by means of exploratory factor analysis with a direct oblimin solution specified was subsequently attempted. exploratory factor analysis were carried out as before, using the same criteria for eliminating items and specifying a three factor solution. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 2 246 table 5: results of cfa on aggregates in four factor solution (50 items) value 1199.877 1017.87746 590.13709 19.68998 314.04151 159.054 0.865 0.895 0.910 0.920 0.859 0.929 0.895 root mean s uared residual (rmr) 0.299 standardized rmr 0.016 0.066 0.918 in the first round of the exploratory factor analysis with three factors extracted three eigenvalues >3 were obtained (respectively 10.67, 5.12 and 3.97). forty seven of the items did not meet the requirements for inclusion in further analyses. these items came from the subs cales attitudes to innovation (8), achievement (10), self-esteem (7). in the second round of exploratory factor analysis the loadings of two items did not meet the required standards and had to be eliminated from further analyses. these items came from the subscales for attitudes towards achievement (i) and towards self-esteem (i). in the third round of the exploratory factor analyses 50 items were therefore included. the factor loadings indicated that one item had to be eliminated from further analyses. this item was originally part of the attitude towards innovation subscale. in the fourth round of defining three factors by means of exploratory factor analysis 49 items were included. all these items met the requirements as stated before and the factor pattern as shown in table 6 was therefore accepted. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 247 satebnr vol 1 (1998)nr2 table 6: factor pattern for 3 factor solution (49 items) i factor! factor 2 factor 3 v2 0.3576 v3 0.3982 v6 ! 0.3909 , : v8 i 0.4269 : , i v13 i 0.5007 i i , v15 : , i 0.4709 v16 ! , i 0.4241 v18 i 0.3916 i v20 0.4036 , i , v23 i 0.5335 i v24 i i 0.4368 v26 i 0.3679 ! v29 i i 0.3982 i v30 , 0.3247 i v32 0.3802 i i v35 i ~ 0.3841 v37 i 0.3460 v39 0.4678 i i v40 0.3591 ! v44 i 0.3851 v47 0.5628 i v48 0.3597 v49 0.3626 v50 0.4017 v51 0.4660 i v53 0.3396 v54 0.4746 v55 0.3790 v56 0.5065 v58 0.5555 v59 0.4051 v62 0.5028 v63 0.4989 v64 0.3546 v66 0.4512 v68 0.5183 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 2 248 v69 i 05638 , v70 . 0.4041v71 0.4620 vn 0.4335 v73 0.3835 v76 0.4157 v77 0.4178 v78 i 0.4815 i v80 0.5316 i v82 , 0.4043 i v83 0.4369 i v84 0.5469 v89 , 0.4286 from table 6 it can be s~en that the three factors identified respectively contained 22, 11 and 16 items. the first factor contained 15 items originally from the attitude towards innovation subscale, three each from the attitudes towards achievement and the personal control subscales and one from the machiavellianism subscale. this factor was interpreted as representing an attitude towards innovation but somewhat differently constituted than the similarly named subscale in the original questionnaire. the second factor contained items which seemed to pertain to the concept of asserting oneself in business situations sometimes in a way which can be interpreted as negative towards other individuals. the factor was therefore named assertiveness. the third factor had mainly achievement related items loading on it and seemed to measure something akin to the attitude towards achievement in business situations identified by the authors of the original scale. it therefore seemed as jf the three factor solution rendered factors which could be interpreted quite readily. some of the factors included in the questionnaire disappeared when a three factor solution was specified with some of the items originally measuring these factors loading on one of the other factors but with most of their items being "lost" in the analysis process. of the 12 items in the self-esteem subscale only four were retained and of the 14 items in the personal control subscale only eight "survived" the analysis. to determine the degree of fit between the three factor structure and the data a confirmatory factor analysis was again carried out. the indices obtained are shown in table 7. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 249 sa teb nr vol 1 (1998) nr 2 table 7: results of confirmatory factor analysis on three factor structure (49 items) index value independence model chi-square (degrees of freedom (df) 4168.481 1176) independence aic 1816.48130 independence calc 3711.24034 modelaic 72.94098 model calc 5356,23955 chi-square (df 1124) probability value less than 0.001 2.175.095 nonnal rls chi-square 2194.608 ~bonnett nonned fit index 0.478 -bonnett nonnonned fit index 0.633 comparative fit index (cfi) 0.649 bollen (ifi) fit index 0.655 mcdonald (mfi) fit index 0.172 lisrel gfi fit index 0.769 lisrel agfi fit index 0.748 root mean squared residual (rmr) 0.059 standardized rmr 0.117 root mean sq error of app. (rmsea) 0.056 relative non-centrality index 0.6488 from table 7 it can be seen that the value of the indices indicated that the fit between the model and the data was not satisfactory. bagozzi and heatherton's (1994) adaptation was again carried out. the aggregates fonned can be identified as : aggregate 1: items 2, 6, 8, 13,20 aggregate 2: items 26, 32, 39, 40, 47, 76 factor 1 aggregate 3: items 49, 54, 56, 58,62, 77 aggregate 4: items 63, 64, 68, 69, 72 agwegate 5: items 18,29,37,84 aggregate 6: items 50, 51, 53, 89 factor 2 aggregate 7: items 80, 82, 83 aggregate 8: items 3, 15, 16,23 aggregate 9: items 24, 30, 35, 44 factor 3 aggregate 10: items 48, 55, 59, 66 aggregate 11: 70, 71, 73, 78 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 2 250 exploratory factor analysis indicated that the aggregates loaded on the three factors in the same way as the items out of which they were formed did. confirmatory factor analysis was carried out on the factor pattern obtained when the aggregates were used as independent variables. the indices obtained are shown in table 8. from table 8 it seems as if the indices obtained indicate a moderate to good fit of the model to the data. it seems as if this is the best fit obtained later than for the four and five dimensions structures. table 8: results of confirmatory factor analysis on aggregates (three factor solution, 49 items) index value independence model chi-square (degrees of freedom (dt) 1522.908 105) independenceaic 1312.90790 ! independence calc 819.36132 model aic 16.46015 model calc 392.47844 chi-square (df 87) probability value less than 0.001 190.460 normal rls chi-square 175.429 bentler-bonnett normed fit index 0.875 bonnett nonnormed fit index 0.912 comparative fit index (cfi) 0.927 bollen (ifi) fit index 0.928 mcdonald (mfi) fit index 0.841 lisrel gfi fit index 0.927 lisrej agfi fit index 0.900 root mean squared residual (rmr) 0.243 standardized rmr 0.021 root mean sq error of app. (rms~m 0.063 relative non-centrality index 0.927 discussion the present study was undertaken to establish the construct validity of the eaos scale when applied to a sample of south african respondents i.e. individuals from a r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 251 sateb nr vol 1(1998) nr 2 culture different from that of the united states of america, where the instrument had been developed. the results indicate that the five factor structure proposed by the authors of the instrument could not be replicated on the responses of the south african sample. the factor structure proposed by robinson et al (1991) and implied by stimpson (1993) could not be replicated in the present study possibly because so many of the items in all the subscales but especially in the self esteem en personal control subscales did not survive the analysis. in total 40 items had to be taken out of consideration. out of a total of 89 items this represents a loss of 44.9% of the items if the proposed three factor structure is taken as the best fit with the data while containing three interpretable factors. the three factors respectively contained items which were interpreted as measuring attitudes to innovation, assertiveness and achievement. the three factor solution was preferred as it had slightly better fit indices than the four factor structure when confirmatory factor analyses were carried out and the three factors identified were relatively easily interpreted while two of the four factors in the less parsimonious solution could not be interpreted readily. portability of at least two, probably three, of the original five constructs embodied in the eaos must now be in doubt. the items included in the personal control, self esteem and machiavellianism dimensions in the eaos as used in this study disappeared in the analyses. it seems as if some of the items from these subscales which did survive the analyses combined quite well and were interpreted by the respondents similarly to items in other subscales. the three factor scale therefore contained different constructs from those included in the five factor (eaos) scale. these results seem to indicate quite clearly that intercultural portability of constructs is indeed an important consideration when doing inter-cultural! international research. the present study clearly has limitations. it was carried out to determine the structural integrity of the eaos when applied to a non-united states sample. the predictive and the discriminatory validity of the instrument were not investigated, neither in its original form or in the form proposed as a result of the present study. the sample on which the present study was carried out was somewhat small. a nearer to ideal ratio would have been five to 10 respondents per item in the questionnaire against the 3.36 respondents per item on which the present analysis was carried out. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 2 252 future studies should probably be done on larger samples which should also be selected to represent more occupational groups. discrimin'atory and predictive validity of the instrument should be studied as well. the data on which the present paper is based will be used to carry out such a study on a limited basis. a large number of items were "lost" in the present study. attention should probably be given to these items in order to determine whether rewording might make them more "portable". cross-validation of the results of the present study on samples from other cultures, including samples from the non-white population groups in south africa, should take place if the instrument is to be used interculturally/internationally. references: 1. bagozzi, r.p. & heatherton, t.f. (1994). a general approach to presenting multifaceted personality constructs : application to state selfesteem. structural equation modelling, i, 35-67. 2. bentler, p.b. (1995). eqs structural equations programme manual. university of california, los angeles. 3. bahat, r.s. kedia, b.l., crawford, s.e. kaplan, m.r. (1990). cross-cultural issues in organizational psychology : emergent trends and directions for research in the 1990s. international review of industrial and organizational psychology, 5, 59-99. 4. hoole, c. (1996). assessment of structural equation modelling as method for predicting success of entrepreneurs. ma thesis, university of pretoria. 5. hoole, c. & boshoff, a.b. (1997). measurement qualities of the entrepreneurial attitude orientation scale when used interculturally. south african journal of economic and management sciences. 6. kerlinger, f.n. (1986). foundations of behavioural research (3,d ed). new york: holt, rinechart and winston, inc. 7. lau, t. (1992, june). the incident method an alternative way of studying entrepreneurial behaviour. paper presented at the int ent conference, dortmund. 8. robinson, p.b., stimpson, d.v., heufner, j.c. & hunt, h.k. (1991). an attitude approach to the prediction of entrepreneurship. entrepreneurship: theory and practice, 15(4), 13-31. 9. stimpson, d.v., heufner, j.e. narayanan, s. & shanthakumar, d. (1992). attitudinal characteristics of male and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 253 sa teb nr vol 1 (1998) nr 2 female entrepreneurs in the united states and india. paper read at 2nd conference on internationalizing entrepreneurship research, education and training. dortmund, june. lo. stimpson, nv., robinson, p.b. waronusuntikule, s. & zheng, r. (1990). attitudinal characteristics of entrepreneurs in the united states, korea, thailand, and the people's republic of china. entrepreneurship and regional development, 2, 49-55. ii. stimpson, d.v. (1993). letter for a.b. boshoff, march 1993. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction data methodology results trading strategy conclusion acknowledgements references about the author(s) leon b. sanderson centre for business mathematics and informatics, north-west university, south africa citation sanderson, l.b., 2019, ‘the performance of debt and equity markets in anglo american plc and bhp billiton plc in the period 2006 to 2015 through the lens of merton’s structural model’, south african journal of economic and management sciences 22(1), a1854. https://doi.org/10.4102/sajems.v22i1.1854 new perspective the performance of debt and equity markets in anglo american plc and bhp billiton plc in the period 2006 to 2015 through the lens of merton’s structural model leon b. sanderson received: 31 mar. 2017; accepted: 18 oct. 2018; published: 14 feb. 2019 copyright: © 2019. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract this article applies the merton structural model in evaluating the performance of the debt and equity markets in anglo american plc and bhp billiton plc in the period 2006 to 2015. we consider statistical and economic measures of the efficacy of the merton model in explaining observed market behaviour. we find strong but unstable statistical support for the merton model as a descriptor of market behaviour. we generated superior risk adjusted returns when applying the results of our analysis to an investment strategy. market prices deviate from model behaviour; however, the relationship appears to be mean reverting which supports the investment thesis. introduction equity and debt are both claims on the assets of a firm. debt is generally serviced first up to the contractual obligation with equity enjoying a residual but unlimited share thereafter. we consider it reasonable to expect the performance of both equity and debt to be related to the performance of the assets of the underlying firm. the firm’s assets encompass both physical assets and intangible assets. this spans plant and equipment, brand, human capital, know-how and licences among others. in our study we consider the physical assets of a firm to be the ultimate driver of performance of the firm’s debt and equity instruments. we note that this approach is relevant in firms with capital intensive activities and is unlikely to be applicable in firms dominated by intangible assets. capital structure research spans the early work of modigliani and miller (1958) which showed capital structure choices to be irrelevant under certain conditions to a variety of theories that guide the mix of debt and equity issued by firms. as described by myers (2001) these include the trade-off theory which balances the costs and benefits of debt finance, the pecking order theory which emphasises information differences between managers and investors and the agency costs theory which focuses on the relative gains and losses of managers and owners. merton (1974) provides a robust and simple conceptual bridge between the theoretical values of a firm’s debt and equity instruments and the characteristics of the assets underlying the operations of the firm. he offers a structural model of capital structure that is seen to be the genesis of the trade-off theory. he views equity as a long position in a call option on the assets of a company and debt as a risk-free instrument coupled with a short position in a put option on the assets of the company, in both cases struck at the face value of the debt which is assumed to be zero coupon in nature. numerous extensions to the conceptual framework, for example black and cox (1976) and geske (1977), have been explored but at the cost of added complexity. in the work of brennan and schwartz (1978) and leland (1994) a number of the limiting assumptions are relaxed and the potential tax benefits of debt and the deadweight costs of bankruptcy are introduced. the empirical analysis of the performance of the merton model and its successors, when applied to actual market data has been inconclusive with limited explanatory power observed (see delianedis & geske 2001; frank & goyal 2003; harris & raviv 1991; titman & wessels 1988) and numerous issues relating to measurement highlighted (see graham & leary 2011). we have chosen to make use of a simple expression of capital structure that limits the number of assumptions required. the primary innovation we introduce is in the measure chosen to assess the performance of the model. in this article we assess the capacity of the merton model as a tool to describe market behaviour. we test for statistical and economic significance of the model. statistical tests encompass regression and co-integration, whilst economic significance is evaluated by applying the model to an investment process and considering the resulting returns. the investment process is a pair trading strategy where positions in the underlying equity are offset with opposite positions in the underlying asset. we consider two firms, anglo american plc (agl) and bhp billiton plc (bhp), both of which are diversified mining companies. their financial performance is intimately linked to the prices they receive for the commodities they produce. we expect that the fortunes of both companies are related to the performance of their underlying commodity markets. in this instance we consider the physical assets of each firm to be the basket of commodities they sell. we argue that in both cases, the underlying assets of each of the firms can be reasonably described by the construction of proxy indices that are made up of observable metrics for underlying commodity markets. we consider semi-annual balance sheet data for each of the firms and make use of market prices for equity instruments and debt instruments to generate implied underlying asset value and asset volatility for each of agl and bhp using the merton structural model. we evaluate the relationship between the implied measures (asset value and asset volatility) and the value and volatility derived from the proxy indices. in addition, we construct a simple pair trading strategy that will be long (short) the proxy index and short (long) the relevant equity when large relative deviations from the average (of the ratio of the proxy index and the equity) are observed. the trading strategy takes advantage of the expectation that a strong relationship between the proxy index, which represents the underlying firm assets, and the equity will be observed. data all data are sourced from bloomberg and all charts, calculations and tables are undertaken in microsoft excel. we require data on the equity of the firm, the debt of the firm and underlying assets of the firm. we consider the period 06 january 2006 to 25 december 2015. the period was chosen to encompass the financial crisis experienced in 2008 and the period of significant commodity price weakness in 2015. we make use of weekly closing prices for equity markets, credit markets, us interest rate markets (treasury bills and notes) and foreign exchange markets. we make use of weekly closing prices for the ubs bloomberg cmci indices (constant maturity commodity indices that we use to construct proxy indices). we make use of balance sheet and income statement information for both agl and bhp. agl has a december year end and bhp has a june year end. we have interim financial statements and annual financial statements for both in june and december each year. agl and bhp report in us dollars, with their product lines, namely the commodities they produce, also denominated in us dollars. all the information is sourced from bloomberg. equity data are adjusted for historical splits and spin offs. we note that agl generally has a higher level of financial leverage (as expressed by total debt relative to the balance sheet) and that in the period leading up the financial crisis experienced in 2008, agl held a larger proportion of their debt in shorter dated instruments. we observed relatively larger swings in the prices of the debt and equity instruments of agl as compared to bhp. equity data agl and bhp are listed on a variety of stock exchanges and have a number of lines of equity. total equity is the sum of these distinct listings (or lines). agl has a primary listing on the london stock exchange (lse), with all other listings convertible or exchangeable into the lse line on a one for one basis. accordingly, agl equity is calculated as the price of the lse line multiplied by the total shares in issue converted into us dollars. bhp is dual listed, with distinct lines on the lse and the australian stock exchange (asx). all other lines are convertible into either the lse line or the asx line on a one for one basis. the asx line and the lse line are not interchangeable but have identical economic interests (dividends and votes). accordingly, bhp equity is calculated as the price of the lse line multiplied by the total shares in issue (of both the lse line and the asx line) converted into usd dollars. debt data data on secondary market trading of debt instruments for agl and bhp is limited. we make use of credit default swap (cds) data to provide summary information on the performance of the credit market. a cds provides the holder of the instrument with insurance against potential losses on an investment in bonds. in the event of default, the cds holder has the right to deliver bonds to the cds writer against receipt of a fixed nominal. this insurance has a fixed term, commands a regular premium and provides cover on a fixed nominal. a cds is effectively an american option whose premium is paid over the life of the instrument, where further premium payments are extinguished on exercise (namely default). we source standardised data on 5 year and 10 year cds markets. liquidity in these instruments is limited; however, daily pricing information is available. agl cds is only available in euros. we assume that agl cds in us dollars is equivalent to agl cds in euros. this assumption ignores the potential quanto effect in shifting currencies. as discussed in chan-lau (2009) this quanto effect is driven by the convertibility risk and the transfer risk between the underlying currency markets, which in this case, euros to us dollar, is considered negligible. in addition we note that our interest lies primarily in the changes in cds levels rather than the absolute values. we extract two distinct estimates for total debt for each of agl and bhp from the available balance sheet information. we denote these estimates as d1 and d2. the first (d1) is total liabilities (bloomberg field bs_tot_liab2). the second (d2) is total liabilities reduced by current assets (bloomberg field bs_cur_asset_report) and augmented by inventories (bloomberg field bs_inventories). the motivation for the choice of both d1 and d2 relates to the measurement issues highlighted in the introduction above. d1 is likely to exceed formal debt obligations but better reflects the obligations that must be met prior to value being available to service equity holders in the event of default. d2 is an attempt to adjust d1 to account for working capital. asset data many commodity markets do not have liquid, transparent price discovery mechanisms for the spot market but enjoy deep and liquid derivative markets. the ubs bloomberg cmci indices provide a blended and consistent mechanism for reflecting available prices for baskets of commodities (see ubs 2011 for detailed index methodology and calculation). the cmci family of indices covers many sectors, time frames and return profiles. we make use of the total return benchmark indices that encompass precious metals, industrial metals and energy. the bloomberg codes for these indices are cmpmtr index, cmimtr index and cmentr index. the data used in constructing the proxy indices is historical information that is available as at the relevant calculation date. we map each firm to a combination of these indices. agl and bhp provide a breakdown of divisional assets in their financial statements. these divisions are delineated by underlying commodities. we map divisional assets information from the agl and bhp financial statements for the financial years 2006 to 2015 to three distinct groups. precious metals includes gold, platinum and diamonds. industrial metals includes iron ore, base metals, aluminium, stainless steel, nickel, zinc and manganese. energy includes petroleum and coal. on the basis of this categorisation we determine proxy assets for each of agl and bhp. the proxy weights are adjusted on an annual basis to reflect the latest information available in the financial statements. proxy index values are calculated as a linear combination of the three cmci benchmark indices (precious metals, industrial metals and energy). we adjust the linear combination parameters every 6 months (in june and december) to reflect the relevant proxy weights (w), as determined from the latest annual financial statements. in the case of agl, over the period, precious metals (cmpm) contributed 25% to 36%, industrial metals (cmim) contributed 52% to 59% and energy (cmen) contributed 7% to 21%. in the case of bhp, over the period, precious metals (cmpm) contributed 3% to 4%, industrial metals (cmim) contributed 60% to 66% and energy (cmen) contributed 31% to 37%. the formulae for the proxy index values for each of agl and bhp on a given day, t, using the applicable weights for each of agl and bhp in the benchmark indices, are shown below. where is the weight for company x in benchmark index y applicable for period z. we calculate an historical volatility series for each of the proxy index values by generating a series of annualised standard deviations on the log changes of the weekly data points using a rolling 4 week window. in effect we are considering the 1 month historical variability of each of the proxy indices. in applying the merton model we are evaluating debt and equity by considering the underlying assets and their associated volatility. we use the calculated historical volatility (as described in hull 2012) of the proxy index series as an estimate for current volatility of the proxy index series. the formulae for the proxy historical volatility for each of agl and bhp on a given day, t, are shown below: the proxy index values and the proxy index realised volatility levels are shown in figure 1 and figure 2. figure 1: proxy index levels. figure 2: proxy index volatility levels. methodology in an efficient market we expect the market value of a firm’s assets to be equal to the market value of a firm’s liabilities. let us consider a simple firm funded with non-dividend paying equity and zero coupon debt. merton’s (1974) insight allows one to apply a standard option pricing model to solve for the value of equity and debt, given the underlying asset price and the associated asset volatility of a firm. equity and debt are both claims on the underlying assets. equity is the residual, if any, after debt has been fully serviced by the underlying assets. debt is a senior claim on the underlying assets, limited to the face value of the debt obligation. equity can be modelled as a call option on the underlying asset struck at the future value of the debt obligations. debt can be modelled as a risk-free zero coupon bond coupled with a risky component that reflects the potential for losses, namely that the assets will not be sufficient to fully service the debt obligation. the risky component of debt can be modelled as a put option on the underlying asset struck at the future value of the debt obligations. merton’s (1974) original formulation considered equity and debt instruments in the context of european options, with no intermediate payments. in effect he evaluated default only at the maturity of the underlying debt instrument, which is assumed to be a zero coupon bond. expressed mathematically, we have: where a is the value of the assets of the firm, e is the value of the equity and d is the value of the debt. at the maturity of the debt the value of the equity is given by: where k is the face value of the debt, which by definition is zero coupon and which has value today of d. prior to the maturity of the debt we make use of merton’s model for the value of equity, expressed as a call option on the assets of the firm. where and where n(x) is the cumulative probability distribution function for a standardised normal distribution and σ is the volatility of the firm assets. the value of the debt is arrived at by way of put call parity, rearranging terms and recognising that the debt value is equal to the asset value reduced by the equity value: where p is the value of a put option on the assets a struck at the face value of the debt k. this approach provides a mechanism for relating asset value and asset volatility to values for equity and debt. in general we have values for equity and debt, which we use to solve for the underlying asset price and the associated asset volatility. as detailed above in the data section, we have market data on both equity and debt for agl and bhp in the form of historical equity values and historical cds levels. we consider two distinct formulations when determining the face value of the underlying debt as reflected on the balance sheet (d1 and d2). agl and bhp have issued a variety of coupon bearing debt instruments. in our model we map these instruments to a single zero coupon debt instrument for each of agl and bhp. we set the term of this zero coupon bond to match the tenor of the cds instrument used (5 or 10 years). the face value of this representative zero coupon debt instrument is calculated by grossing up the face value of the coupon paying debt as reflected on the balance sheet (and calculated in d1 and d2) by the risk-free interest rate augmented by an assumed credit spread. this approximates the effective coupon paid by the underlying debt instruments. the risk-free interest rate used is the then prevailing relevant us treasury rate (either 5 year or 10 year). the credit spread applied is the average of the relevant cds over the full period under consideration (6 january 2006 to 28 december 2015). the higher the credit spread used, the higher the effective face value of the representative zero coupon debt instrument. the face values of these representative debt instruments are the effective strike prices in our application of the merton model. expressed mathematically we have where k is the face value of the grossed up representative debt instrument, dbs is the face value of the balance sheet debt (d1 or d2), r is the relevant risk-free interest rate (naca) and cs is the credit spread determined as the average of the relevant cds and t is the tenor of the relevant cds. we model equity as a call option on the underlying assets. the market value for this option is equal to the market value of equity as discussed in the data section above. we model debt as a risk-free zero coupon bond coupled with a put option on the underlying assets. this approach, widely applied in the literature and described in hull, nelken and white (2004), ignores both the early exercise nature of the cds as well as the contingent premiums and simply aligns the cds to a european put option. it is a simplification of the mechanics of the underlying instruments which attempts to capture the essence of their behaviour whilst limiting the complexity of the calculation. we proceed by solving for the premium of the put option. the strike price of both the call option and the put option is set equal to the calculated face value of the debt. the term of the option is set equal to the tenor of the cds (either 5 years or 10 years). we have assumed zero coupon debt, and as such over time the value of the debt outstanding will increase until the assumed maturity at which point the debt value equals the face value. a standardised cds assumes a fixed nominal. to cater for this discrepancy, we calculate the equivalent put option premium by multiplying the cds level by the average of the initial value of debt outstanding and the nominal of debt outstanding, multiplied by the tenor of the cds (reflecting the number of cds payments), present valued to today. this maps the annual payment of the cds premium as insurance on a fixed nominal to the firm’s growing debt obligation. the equivalent put option premium, p, is thus given by when evaluating options, we assume that the underlying asset pays no dividends, we apply the same risk-free rate as that used in determining the face value of the representative debt instruments and we set the term to match the tenor of the cds instrument used (5 or 10 years). we solve for the implied asset price (a) by way of put–call parity (shown below) as we have the market values for equity (call option) and debt (risk-free zero coupon bond coupled with a put option). we use the implied asset price together with the equity value to invert the black–scholes equation to solve for the implied asset volatility numerically (σ). we proceed by generating implied asset price levels and implied asset volatility levels at each time period, namely weekly for debt levels d1 and d2 and maturity 5 and 10 years. results we have four distinct series for each of agl and bhp. we consider 5 and 10 year terms across two distinct definitions of debt (d1 and d2). we will consider the relationship between changes in the proxy asset levels and changes in the implied asset levels, and changes in the historical proxy asset volatility and changes in the implied asset volatility. a direct comparison is not applicable, however, as there are changes to the quantum of debt and equity through time that must be accounted for (e.g. new equity issuance, new debt issuance, share buybacks or the retirement of debt, all impact on the balance sheet value of the company but are unrelated to changes in the underlying asset values). these changes are already reflected in the market data by way of adjustments in the total shares in issue, and adjustments to the liabilities on the balance sheet. at each data point we adjust the implied asset levels to reflect the cumulative change in debt (we adjust the face value) and equity (we adjust the total number of shares) from the beginning of the assessment period. in effect we reverse the impact of changes in the structure of debt and equity in an effort to focus on changes in value related to underlying asset price variability only. we then apply log differences to these adjusted implied levels as well as the proxy levels that were generated. we make use of linear regression models of the form: where y is the dependent variable, x is the independent variable, β0 and β1 are equation parameters and ε is the error term. we regress the log differences of the proxy asset levels on the log differences of the adjusted implied asset levels and consider the correlation between the two series. we regress the log differences of the proxy asset volatility on the log differences of the implied asset volatility and consider the correlation between the two series. the results of this correlation study are shown in tables 1 and 2. table 1: anglo american plc correlation study. table 2: bhp billiton plc correlation study. in all cases we find that asset levels are highly correlated but that asset volatility is not highly correlated. in an effort to understand the nature of the relationship between the volatility series we then consider the extent to which the proxy asset volatility and the implied asset volatility are co-integrated. we note that if two time series x and y (both i(1), namely with variance proportional to time t and as a result the time series is non-stationary) are co-integrated, then a linear combination of them, u, must be stationary (i(0), with a unit root): we make use of engle and granger’s (1987) two-step procedure to test for co-integration. we test the proxy asset volatility and the implied asset volatility time series and report the dicky–fuller test statistic in table 3. table 3: anglo american plc and bhp billiton plc co-integration results. at a 95% confidence interval, in all cases we find that proxy asset volatility and implied asset volatility are co-integrated. we consider the stability of the test results shown above by considering three distinct time periods, january 2006 to december 2009, january 2010 to december 2012 and january 2013 to december 2015. we repeat the tests outlined above (excluding the volatility correlation) on these three periods and reflect the results in tables 4–7. table 4: anglo american plc asset correlations across time periods. table 5: anglo american plc co-integration results across time periods. table 6: bhp billiton plc asset correlations across time periods. table 7: bhp billiton plc co-integration results across time periods. in addition we consider alternate values for the credit spread applied in determining the face value of the representative zero coupon debt instrument. we evaluated credit spread levels significantly below and significantly above the calculated average and found similar results. in summary we find strong, statistically significant relationships between our proxy asset levels and proxy asset volatility and the implied asset levels and implied asset volatility. however, these relationships are not particularly stable when considering sub-periods within the data. the disparity between the proxy asset volatility which is an historical backward looking measure and the implied asset volatility which is a market generated estimate of future variation, is noted. we believe that the issues highlighted above warrant further study. trading strategy we now consider a simple pair trading strategy that makes use of the insights gained in the evaluation above to test whether the observed relationships are of economic significance. we wish to highlight that whilst we employed statistical tools (linear regression and co-integration) to evaluate the relationships between equity, debt and assets, we do not make use of any of the derived parameters in constructing the trading strategy. given the fundamental relationship between equity and the underlying assets of a company, we expect to observe a strong link between the behaviour of the underlying assets and the behaviour of the equity. an increase (decrease) in underlying asset value should be accompanied by an increase (decrease) in equity value. a control for our experiment would be akin to a simple coin toss exercise that would drive an investment process which would have an expected return of zero. we include a naïve alternate trading strategy as a more relevant comparison. the naïve alternate trading strategy considers the proxy asset levels and the equity levels but ignores any implied asset values. we expect there to be a relationship between equity prices and underlying asset levels. we are evaluating whether applying the merton model, which incorporates the concepts of leverage and asset volatility, enhances this relationship. we apply the trading strategy for the period 06 january 2006 to 25 december 2015. in all instances of our trading strategy evaluation we consider transactions in the equity and proxy assets of agl and bhp, as these are tradable instruments (as distinct from the implied asset levels which are constructs). recall that the proxy assets are linear combinations of benchmark indices that are made up of tradable derivative instruments. the trading strategy formulation draws heavily on the work of gatev, goetzmann and rouwenhorst (2006) who evaluated a pair trading, relative value investment strategy. we construct our trading strategy as follows. we generate a trade ratio series (trs) such that at each point in time its value is the implied asset level (ial) divided by the proxy asset level (pal). we generate a trade average series (tas) that is the 12 period (approximately 3 months, given weekly data) mean of the ratio series. we generate a trade variability series (tvs) that is the 12 period standard deviation of the ratio series. we generate a comparison ratio series (crs) such that at each point in time its value is the equity level (el) divided by the proxy asset level (pal). we generate a comparison average series (cas) that is the 12 period (approximately 3 months, given weekly data) mean on the ratio series. we generate a comparison variability series (cvs) that is the 12 period standard deviation of the ratio series. the base assumption is that the ratio series (trs, crs) are mean reverting and as such over time the ratio series will drift back towards the average series (tas, cas). given this assumption, we have a buy signal on the ratio when the series is a defined distance below the average series (e.g. 1 standard deviation) and a sell signal on the ratio when the series is a defined distance above the average series (e.g. 1 standard deviation). in both cases we will close positions when the series breaches the average series. we consider three distinct strategies. in the comparison strategy, trade signals are generated by the control series. in the trading strategy and the adjusted trading strategy, trade signals are generated by the trading series. in the comparison strategy and in the trading strategy the nominal of both the long position and the short position on trade entry are set equal to $1 million. in the adjusted strategy the nominal of the equity position is set equal to $1 million; however, the nominal of the proxy asset position is determined by the calculated sensitivity of the equity to the underlying asset value. the delta of an option is defined as the change in option value for a given change in the underlying value (see hull 2012). in our application of merton’s model we generate a delta for the equity of the firm with reference to the underlying firm assets, where for a given move in the implied asset level we observe some quantifiable but variable move in the equity level. in the adjusted trading strategy we make use of the relevant delta to reflect a larger nominal exposure in the proxy asset. in all cases we assume that trades are undertaken at the closing prices of the relevant instruments. the impact of the equity delta on the nominal used in the adjusted trading strategy is outlined below. where npa is the nominal exposure of the proxy asset and δc is the equity delta. the results of the three trading strategies for both agl and bhp are reflected below. in each instance we consider the total number of trades undertaken over the period, the number of winning trades, the number of losing trades and the winning trade percentage. in addition we calculate the total revenue generated, the average trade return, the maximum trade return, the minimum trade return and the standard deviation of trade returns. finally we reflect a sharpe ratio, defined as the average return divided by the standard deviation of returns over the full period. we ignore any dividends paid or received on short or long positions in the underlying equity. tables 8 and 9 show a sample for each of agl and bil (10 year period and d1 as debt definition) of the detailed summary, where we consider the control strategy, the trading strategy and the adjusted strategy. table 8: anglo american plc 10 year d1 debt definition trading strategy performance. table 9: bhp billiton plc 10 year d1 debt definition trading strategy performance. summary data, encompassing total revenue generated (expressed as pnl) and the sharpe ratio across debt definitions d1 and d2 and 5 year and 10 year terms, are shown in tables 10 and 11. table 10: anglo american plc summary trading strategy performance. table 11: bhp billiton plc summary trading strategy performance. in almost all cases, the strategies – comparison, trading and adjusted trading – showed a positive return of at least 200% of nominal over the period. as shown in the summary data above, when considering agl the trading strategy outperformed the comparison on all measures. however, when considering bhp the trading strategy underperformed the comparison by some measures but outperformed the comparison in some cases in total revenue generated. in all cases the adjusted trading strategy outperformed the trading strategy in total revenue generated, winning trade percentage and sharpe ratio. we considered the sub-period performance across the three trading strategies. table 12 shows a sample for bhp (5 year period, both d1 and d2 for debt definitions). in general there was limited variability in summary statistics for the three time periods across the inputs for period and debt definition, although the trading strategy and adjusted trading strategy performed particularly well in the case of agl in the period 2013 to 2015, which coincides with extreme levels of commodity price volatility and high leverage in the company. table 13, for agl (5 year and 10 year period, d2 for debt definition), illustrates this point. table 12: bhp billiton plc summary trading strategy performance across sub-periods. table 13: anglo american plc trading strategy performance – 2013 to 2015. the results of the trading strategy are uniformly positive; however, the variability noted in the capacity of the merton model to describe behaviour detailed above, coupled with the use of a single pair of stocks over a fixed time period, suggests limited application and the need for further research. one criticism of the approach may be the lack of an out of sample evaluation; however, the only input that is dependent on the data in the full period is the credit spread applied in determining the face value of the representative zero coupon instrument. this is a constant throughout the evaluation. we evaluated credit spread levels significantly below and significantly above the calculated average and found similar results. this is to be expected as the trading strategy is not dependent on the calculation of specific descriptive statistics for the data period considered. conclusion in this article we considered the capacity of the merton structural model to describe market behaviour. we evaluated the merton model using both statistical and economic measures. we chose two firms whose underlying asset behaviour can be described by tradable market indices. we found strong but unstable statistical support for the merton model as a descriptor of market behaviour. we generated superior economic returns when applying the results of our analysis to a trading strategy, with particularly good performance in times of enhanced stress in market and firm conditions. however, the value of the results and the support they offer for the use of the merton model to describe market behaviour is limited by the fixed term under consideration and the application to a small sample (two) of relevant firms. the opportunities for further research include extended time periods and a wider universe of relevant firms. the application of the model to a specific trading strategy provided an alternative measure to that applied traditionally when considering the efficacy of the model. acknowledgements competing interests the author declares that he has no financial or personal relationships that may have inappropriately influenced him in writing this article. references black, f. & cox, j., 1976, ‘valuing corporate securities: some effects of bond indenture provisions’, journal of finance 31(2), 351–367. https://doi.org/10.1111/j.1540-6261.1976.tb01891.x brennan, m. & schwartz, e., 1978, ‘corporate income taxes, valuation, and the problem of optimal capital structure’, journal of business 51(1), 103–114. https://doi.org/10.1086/295987 chan-lau, j., 2009, ‘fx-adjusted local currency spreads’, ceme fellows research briefing series 1(2), 1–10. engle, r. & granger, g., 1987, ‘co-integration and error correction: representation, estimation and testing’, econometrica 55(2), 251–276. https://doi.org/10.2307/1913236 frank, m. & goyal, v., 2003, ‘testing the pecking order theory of capital structure’, journal of financial economics 67, 217–248. https://doi.org/10.1016/s0304-405x(02)00252-0 gatev, e., goetzmann, w. & rouwenhorst, k., 2006, ‘pairs trading: performance of a relative-value arbitrage rule’, the review of financial studies 19(3), 797–827. https://doi.org/10.1093/rfs/hhj020 geske, r., 1977, ‘the valuation of corporate liabilities as compound options’, journal of financial and quantitative analysis 12(4), 541–552. https://doi.org/10.2307/2330330 geske, r.l. & delianedis, g., the components of corporate credit spreads: default, recovery, taxes, jumps, liquidity, and market factors, december 2001, ucla anderson working paper no. 22-01. available from ssrn: https://ssrn.com/abstract=306479 or http://dx.doi.org/10.2139/ssrn.306479 graham, j. & leary, m., 2011, ‘a review of empirical capital structure research and directions for the future’, annual review of financial economics 3, 309–345. https://doi.org/10.1146/annurev-financial-102710-144821 harris, m. & raviv, a., 1991, ‘the theory of capital structure’, the journal of finance 46(1), 297–355. https://doi.org/10.1111/j.1540-6261.1991.tb03753.x hull, j., 2012, options, futures and other derivatives, 8th edn., prentice hall, upper saddle river, nj. hull, j., nelken, i. & white, a., 2004, ‘merton’s model, credit risk and volatility skews’, journal of credit risk 1(1), 3–27. https://doi.org/10.21314/jcr.2005.004 leland, h., 1994, ‘corporate debt value, bond covenants, and optimal capital structure’, journal of finance 49(4), 1213–1252. https://doi.org/10.1111/j.1540-6261.1994.tb02452.x merton, r., 1974, ‘on the pricing of corporate debt: the risk structure of interest rates’, journal of finance 29, 449–470. modigliani, f. & miller, m., 1958, ‘the cost of capital, corporation finance and the theory of investment’, the american economic review 48(3), 261–297. myers, s., 2001, ‘capital structure’, the journal of economic perspectives 15(2), 81–102. https://doi.org/10.1257/jep.15.2.81 titman, s. & wessels, r., 1988, ‘the determinants of capital structure choice’, journal of finance 43(1), 1–19. https://doi.org/10.1111/j.1540-6261.1988.tb02585.x ubs, 2011, ubs – commodities investment products, cmci technical document, ubs investment bank, zurich. 374 sajems ns vol 2 (1999) no 3 public expenditure and economic growth in a petroleum-based economy: nigeria 1960-1992 akpanhekpo department of economics, university of uyo, nigeria abstract the study analyses the contribution of government expenditure to the economic growth process in nigeria over the period 1960-1992. the results indicate that public expenditures on transport, communication and agriculture crowd-in private investment, while public spending on manufacturing and construction crowd-out private investment. also, expenditures on education and health have a positive influence on private sector investment. government must continue to perceive the creation of an enabling environment, at the least, as its own contribution to the economic growth process. jel 041 1 introduction it is useful to analyse the impact of government size on economic performance and growth. at the theoretical level, some scholars argue that a larger government size may adversely affect efficiency and economic growth because: (i) government operations often take place inefficiently; (ii) the regulatory process places excessive burdens and costs on the economic system; and (iii) several of government's fiscal and monetary policies tend to distort economic incentives and hence reduce the productivity of the system (ram, 1986). in this context, taxes and transfers distort market prices and thus reduce incentives for employment and investment. a critique of this position is that since taxes and transfers redistribute income from the rich, who tend to save a reasonably large fraction of their earnings, to the poor who spend all they can, government expenditures and taxes stimulate economic activity. the link here is between economic activity and the level as well as redistributive targeting of government revenues and outlays (kalecki, 1971; baran & sweezy, 1966). other scholars have posited that a larger government size is a more powerful engine of growth. this contention is based on the belief that government reconciles conflicts between private and social interests. also, the government seems to secure an increase in productive investment as well as providing a socially optimal direction for growth and development. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 375 developing countries, especially sub-saharan africa, despite the attempt to curtail public expenditures in recent times, still contend that public expenditures do play an important role in the development process. in other words, public expenditures are still vital in creating the enabling environment for growth and development. moreover, the present atmosphere of structural adjustment which implies, among other things, reduction in expenditure and/or expenditure switching, re-echoes the need to examine the role of public expenditure in the growth process. there are many existing studies on the public expenditure-cum-growth nexus. however, most of these studies are cross-sectional in nature, and thus their conclusions may not be utilised in making general statements concerning individual countries. a country like nigeria, given its size and huge public expenditures, may bias any cross-sectional study of sub-saharan african countries as a group. this paper examines the relationship(s) between public expenditures and economic growth via links with private investment in nigeria. in addition, the paper shows how each type of expenditure profile influences the growth process in the country. the paper is organised as follows: section 2 highlights the theoretical issues, while in section 3 i discuss components of public expenditure. an analysis of the results is presented in section 4. section 5 provides the conclusion and policy implications. this kind of analysis is significant in understanding the role of public expenditure in the economy's growth experience. 2 review of related studies! theorectical issues a simple keynesian argument implies that high levels of government consumption are likely to increase employment and also profitability and investment via multiplier effects on aggregate demand. others maintain that government consumption will "crowd-out" private investment by dampening any economic stimulus in the short-run and in the long-run by reduction in capital accumulation. either way, the relationship is between levels of government spending and economic activity rather than total factor productivity. there is no general agreement as to the exact relationship between government spending and economic growth. scholars have arrived at different results. using a sample of 96 developing countries, landau (1983) inferred that big government, measured by the share of government consumption expenditures in gross national product (gnp) or gross domestic product (gdp), reduced the growth ofper capita income. landau (1986) re-affurned these earlier findings by examining other sets of variables influencing economic growth; these variables included per capita r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 376 sajems ns vol 2 (1999) no 3 income, the structure of production, population features and global economic conditions. some researchers have concluded that a larger government revenue in gnp enhances economic growth mostly in poorer developing countries (rubinson, 1977). ram (1986) and grossman (1988) have found positive relationships between government spending and economic growth. the work of grossman (1988) utilised a simultaneous equation model making allowance for a non-linear relationship between growth in government and total economic growth, while that of ram (1986) was based on a production function approach. in a recent study, diamond (1989) used a sample of 42 developing countries and discovered that social expenditure does exhibit a significant impact on growth in the short-run while infrastructural expenditures showed little influence. in addition, he found that capital expenditures exert a negative influence on the growth process. interestingly, diamond's work confirms the significance of the growth of exports to the overall growth rates. it is important to note that most of the works referred to above were based on cross-country analysis. a country like nigeria, though a developing one, may be quite different when compared to other sub-saharan african economies, for example, she may not "suffer" from oil shocks. moreover, it is necessary to decompose the components of government spending not only into the usual capital and recurrent but also into social (education, health, welfare), productive, defence, etc. categories, if any empirical study is to make sense. many studies have concentrated on the use of capital expenditures because of its influence on technological change. at the analytical level, there is also some controversy regarding the influence of government expenditures on economic growth. it is agreed by some scholars that all government spending whether it is current or capital has a retarding effect on economic growth. this perception is based on the contention that government investment with its inherently centralised decision-making, absence of profit motive and lack of competition, is inefficient when compared with the private sector. assuming the lower productivity of government investments, "any increase in government expenditure, by increasing the share of productive resources used by the government, would slow economic growth in the economy as a whole and may impede the accumulation of human and physical capital and the pace of innovation in the private sector" (diamond, 1989: 5). this conclusion needs to be modified so as to take into account the fraction of government purchases of privately produced output in total expenditure increases, relative to government own-produced services. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 377 the controversy over the growth effects of government expenditures is partly due to our incomplete understanding of the growth process and the determinants of economic expansion. consequently, the following modified denison-style growth accounting methodology (denison, 1962) will assist our analysis: y=a+ b+ em +ck+ (l-c)h where y growth rate of real output; a = change in the efficacy of resource use of; b = rate of technical change; k physical capital growth; h human capital; and m = growth of intermediate imports. (i) in equation (l), the growth of real output is decomposed into four sources. an analysis of equation (l) illuminates the perceived significance of government expenditures. government capital spending influences physical capital. the effect will be positive if there is a net increase in physical capital however, if government tax and revenue-raising measures as well as the financing of government expenditures cause the investible surplus of the private sector to decrease, then an increase in government capital expenditure could slow down economic growth. government expenditure also affects human capital formation. the public sector invests in education and health in order to enhance the labour force's productivity. in the context of human capital formation, it is important to analyse the contribution of government current expenditure even though this aspect is not explicit in equation (i). it would be important to include current and capital expenditures in the social sector as explanatory variables in accqunting for the growth of human capital. there are recent studies that have stressed the importance of human capital in the growth process (otani & villanueva, 1989 & 1990). these studies seem to suggest a positive relationship between human capital and long-run economic growth. another likely influence of capital expenditures on the growth rate arises from its link to technological change. in developed countries, government expenditure on research and development has had spillover effects on the wider economy. developing countries like nigeria have also gained from research and development expenditures on, for example, new agricultural techniques. it is only the government that has invested huge sums of money on seed varieties and other aspects of the green revolution programme. it may be difficult to examine such an effect empirically, especially since the bulk of expenditure may fall under recurrent items. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 378 sajems ns vol 2 (1999) no 3 the influence of the efficacy of the efficient use of resources on the growth rate is not easy to quantify. the conventional reason for government intervention is the breakdown of the market system, implying a case of underinvestment in public goods. these public goods may be seen as essential inputs in the private sector production process. for example, internal security and public order is a necessary condition for a healthy investment environment, and could indeed be perceived as one of the variables influencing the "enabling environment" thesis. then there is the issue of intermediate imports which are now viewed as a factor of production especially when an economy is constrained by foreign exchange. a more generalised growth model will incorporate exports as an engine of growth. from the production side, increased output of export goods will result in the development of infrastructure, transport and communication system which in turn enhances the production of other goods and services (goldstein & khan, 1982; bardhan & lewis, 1970; chen, 1979; khand, 1987). on the demand side, "an increase in income results directly from a rise in demand for a wide range of products, including non-tradeables. these demand-pressures are reflected in an expansion in domestic supply and therefore, involve investment in facilities providing such products" (khan & villanueva, 1991: 8). there are significant links between public expenditure and private investment. those that stress the fmancing side of expenditure draw attention to the private investment crowding-out effects of government expenditure. when it is assumed that private investment has higher productivity than public investment, a negative effect on gowth is deduced. those that emphasize the expenditure side show the private investment crowd-in effects of public expenditure, since these will tend to enhance the absorptive capacity of the economy and the profitability of private investment. some scholars have hypothesized that the response of private investors depended on the stage of the business cycle, the availability of financing and the level of public investment. while the effect of the stage of the cycle appeared uncertain, that of available finance seemed less ambiguous. indeed, because the total amount of fmancing is limited and the price mechanism is not allowed to operate smoothly, it would seem legitimate to hypothesize that the private investor in a developing country is restricted by the level of available bank fmancing (blejer & khan, 1984: 386). however, the nature of capital markets in developing economies limits the financing of private investment to the use of retained profits, bank credit and foreign borrowing. for a country like nigeria, the liberalisation of interest rates has further increased the cost of investible funds. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 379 there is no doubt that public sector investment can crowd-out private investment if it uses scarce physical and fmancial resources that would otherwise be available to private investors. alternatively, the same scenario will occur if the public sector produces marketable output that competes with private output. in addition, the fmancing of public sector investment either through taxes, debt issuance or inflation will reduce the resources available to the private sector and therefore dampen private sector activities (chibber & dailami, 1990). some of the issues discussed above can be summarised in the following equations: r = r(f'u,ipri,fs,t-gc) cred cwu,ii'''\fs,t-gc) where r real interest rate; t tax revenue; fs foreign savings; gc government current surplus; cred credit availability; ipu public investment; and ipri private investment. (2) (3) from equations (i) and (2), it is assumed that both public and private investment will exert positive influence on the real interest rate, while foreign saving and government current surplus should be inversely related to the real interest rate. in an economy where credit availability is through credit rationing, private and public investment will be a priori negatively related to credit availability. foreign savings and government current surplus will have a positive relationship with credit availability. the estimated results of some variant of the above equations are presented in section 4 below. blejer and khan (1984) maintain that public investment which has some bearing on infrastructure and the provision of public goods, can be complementary to private investment. they show for a group of developing countries that longerterm infrastructural expenditures, rather than short-term public investment, positively induce private investment. the other types of government investment may be substitutes for private capital. in recent times, an attempt has been made to separate the independent effects of private and public sector investment on growth. khan and reinhart (1990) tested empirically the relative productivity of private and public investment for a crosssection of 24 developing countries. their results confirm the notion that private investment has a larger direct effect on growth than public investment. they also r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 380 sajems ns vol 2 (1999) no 3 re-affinn the indirect effects of public investment on growth through raising profitability of private investment and the absorption capacity of the economy. wagner's law which connotes that as income rises, the demand for government services increases more than proportionately, seems to explain the income effects caused by the increasing relative price of government production. this is so because of the technological requirements of industrialisation and the attendant urbanisation. 3 components of public expenditure table i below summarizes the growth rate of selected components of expenditure for the periods 1960-65, 1970-75, 1976-80, 1981-85, and 1986-1992. these periods have significance and represent important episodes in the nigerian economy. the 1960-65 period attempts to capture not only the beginning of the independence era but also the commodity export boom situation at the time. the years 1970-75 reflect the period of the windfall from oil; 1976-80 also incorporates part of the oil boom and the first austerity measures. the period 198185 was characterised by extensive austerity measures and various stabilisation packages. the structural adjustment period is represented from 1986 to 1992. capital expenditure grew negatively by 0.5 per cent during the period 1960-65. its lowest growth was in 1981-85 the era of austerity. it experienced the highest growth rate of 26.7% during the period characterised by the windfall from oil (1970-75). in mct, virtually all items in table i recorded very high growth rates during this period. education, capital and current, grew by 143.9% and 102.2% respectively. agriculture also experienced growth rates of 83.1 % and 43.7% for capital and current expenditures during 1970-75. transport and communication grew by 68.5% and 30.7% respectively for the same period. these significant jumps partially confinn the oil boom hypothesis. it is interesting to note that social services suffered during the independence and austerity periods. education (capital and current) grew negatively by 6.9% and 2.0010 respectively. one might have thought that the period after independence would have witnessed massive investment in the development of human capital. perhaps, the figures presented still reflected the initiatives left behind by the colonialists. it can be argued that the massive expenditure on education by the independence government had its impact later in the economy. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 381 health and education seemed to have fared poorly during 1981-85 in tenns of capital expenditures. this is understandable since during crisis, it may be anticlassical thinking for government to invest in or start new projects, especially as the various austerity measures and stabilisation policy canvassed a lesser role for government. another significant development is the growth of defence expenditure. its capital component grew by 4.8% during 1960-65; it increased to 52.1 % during the windfall from oil, grew negatively by 17.0% during the period of austerity and showed tremendous growth in the period of adjustment (38.7%). it is noticeable that some fonn of expenditure switching in favour of social services took place during structural adjustment. it is generally argued that during adjustment curtailment of expenditures through reduction or elimination of subventions on social services affect the poor, and that what government should do is to switch expenditures in favour of some basic social services in order to at least allow some minimum access by vulnerable groups. during adjustment in nigeria, the evidence in table i seems to suggest that health , education, housing and economic services like agriculture did not experience drastic cuts by government. gross domestic product in real tenns grew by 4.4% and 5.7% during the periods 1960-65 and 1970-75 respectively. during adjustment, gop recorded a growth rate of 1.5% improving from the previous year's negative growth of 0.6%. the marginal growth of 1.5% between 1986-90 may be due to the implementation of structural adjustment policy. table 1 item cap. exp. education health housing agriculture manufact. transport* defence curr.exp. education agriculture health nigeria: compound growth rate of selected components of expenditure and gross domestic product (gdp), 196()"92 (0/0) 1960-65 197()"75 1976-80 1981-85 1986-92 -.5 26.7 1.2 0.6 =3 3.3 -6.9 143.9 6.6 -10.3 3.8 15.3 17.9 27.1 -28.0 20.8 33.0 -4.5 15.8 7.0 83.1 26.2 -33.3 21.8 11.0 26.3 143.4 -21.8 21.5 22.8 68.5 12.2 -29.6 3.0 4.8 52.1 10.1 -17.0 38.7 4.2 5.2 -2.2 -1.8 11.2 -2.0 102.2 -0.5 -0.4' 21.6 10.8 43.7 24.8 5.1 34.5 8.9 3.2 15.6 8.1 22.0 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 382 sajems ns vol 2 (1999) no 3 table 1 continued item 1960-65 1970-75 1976-80 1981-85 1986-92 manufac. 19.2 26.8 26.3 -7.7 19.7 transport* 2.4 30.7 25.0 -0.2 20.4 defence 25.6 22.8 25.6 1.6 15.2 gdp 4.4 5.7 1.6 -0.6 1.5** source: computed by the author based on data from: (i) central bank of nigeria: economic and financial review, various issues, lagos. (ii) federal office of statistics, abstract ojstatistics. various issues, lagos. (iii) federal ministry of education, lagos. (iv) federal ministry of finance, lagos. notes: • includes communication; •• period 1986-90; manufacturing includes mining and quarring and construction. 4 analysis of the results the analysis here differs from previous efforts (blejer & khan, 1984) in that apart from being country-specific (non-cross sectional), it decomposes public sector investments into specific categories. furthermore, our efforts capture the periods of stabilization and structural adjustment. the regression results using ols with annual data for 1960-1990 for the public expenditure-cum-private investment nexus are presented below: ip = .00 i + 1.609dy + 1.37fs·· + .080 pe -.11 ope (4) (.166) (.458) (7.40) (.266) (-.826) r2 .96; f5,25 = 13 ij2 ip 22.32 + 1o.25cafr·· + 2.84cagr 1.20cam (5) (1.55) (5.86) (.90) (-.413) -.ooldy .l72fs (-.009) (.994) r2 .88; f6,24 = 29.81. ip 31.31· +21.375cae" +31.64cah·· +.012dy-.534fs·· (6) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 (1.86) (5.143) (2.175) (.078) (-3.049) r2 = .82; f5,25 = 22.8 ip 46.79 + 78.66cuh·+ 15.21cue· + 53.72cum-42.48cufr·· (1.594) (1.807) (1.738) (2.257) (-3.415) +59. 19cugr + .069dy + .100fs (.374) (.287) (.153) r2 = .65; f8,25 = 5.04. ip = 2.95 + .052dy 73.73pe + 73.481 pe' + .985ip-l··r (.623) (.563) (1.98) (9.62) +.047fs (.636) r2 .95; f6,24 = 85.71. ip 9.872+.814ip-l·· +.038fs+.560gc+.029dy+ .042cuxp (1.038) (6.687) (.450) (1.776) (.332) (.222) r2 = .95; f6,24 85.72 notes: * significant at the 10% level; ** significant at the 5% level; t scores are in parenthesis. definition ofyariables: ip gross private fixed capital foonation; y gross domestic product(gdp); pe public sector investment; cafr capital expenditure on transport and communications; cagr capital expenditure on agriculture; cam capital expenditure on construction and manufacturing; cae capital expenditure on education; cah capital expenditure on health; cuh current expenditure on health; cue current expenditure on education; cum current expenditure on construction and manufacturing; cuff current expenditure on transport and communications; cugr current expenditure on agriculture; dy accelerator; 383 (7) (8) (9) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 384 sajems ns vol 2 (1999) no 3 fs foreign saving; gc government current surplus; cuxp = total current expenditure; all variables are in real tenns. equations (4) (6) provide interesting results. the change in gdp (accelerator) exerts positive influence on private investment as expected, though it is not statistically significant. the change in public investment has a positive impact on private investment while the level of public investment crowds-out private investment. foreign saving has the expected sign implying that increases in foreign savings will bring in private investment. foreign saving is also statistically significant at the 5% level, two tail test. the coefficient of detennination r2 is .96 which reflects the fact that the explanatory variables to a very large extent explain the variation in private investment. that changes in public investment crowds-in private investment, is not surprising given the huge public sector capital expenditures in the economy. following the windfall from oil, government took over the commanding heights of the economy and participated actively in the ownership of companies. in equation (5), capital expenditures on transport and communications as well as agriculture crowd-in private investment. the transport and communications coefficient is statistically significant. in nigeria, government has invested massively in transport and communications though these results say nothing about the quality of services. construction and manufacturing crowd-out private investment. the result indicates that the private sector is better placed to invest in construction and manufacturing if allowed to do so by government. it is possible that manufacturing exceeded construction especially in the 1970s when government embarked on various heavy industrial projects. furthennore, defence expenditures may have captured most of the construction activities in the economy, epitomised by the building of barracks for the expansion of the armed forces. this scenario is suggested by the positive effect of defence spending on private investment (see ekpo, 1995 for details). capital expenditure on agriculture, though not statistically significant, influences investment positively. it follows that government expenditures on irrigation, extension services, etc. can stimulate private initiative. it is surprising that both the accelerator and foreign savings do not have the expected signs. capital expenditures on education and health have positive impact on private investment which invariably enhances growth; both coefficients are statistically significant. there is no question that private investment benefits from the stock of skilled manpower already trained by government. the nigerian government after the oil boom embarked on massive training of manpower. scholarships were provided at all levels of education. schools (primary, secondary, polytechnics, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 385 universities, etc.) were constructed and equipped by government. the private sector definitely taps from such public sector investment. in nigeria, health expenditures are provided by the federal, state and local governments. more than 50 per cent of public health expenditures occur at the state level, 15-23 per cent at the 10ca1level, and about 33 per cent at the federal level. there were huge investments in health care infrastructure following the oil boom of the 1970s; government invested in the construction of many hospitals, the buying of medical equipment and drugs as well as the training of health-care personnel. it is thus apparent that education and health contribute indirectly to economic growth via its crowding-in effects on private investment. current expenditures also contribute to the growth process via private investment. equation (7) shows that current expenditures on health, education, agriculture, construction and manufacturing crowd-in private investment. on the other hand, current spending on transport and communication crowd-out private investment. in addition, changes in both income and foreign savings have positive influence on private investment though they are not statistically significant. the result in equation (8) indicates that private investment (with a one-year lag) enhances present private investment and it is statistically significant. it is interesting that with the lagged private investment, the level of public sector investment crowds-out private investment while foreign saving and changes in output crowd-in private investment. in equation (9), government current surplus stimulates private investment. in fact, equations (8) and (9) confmn the expected results; all the variables have the expected signs with satisfactory test statistics. it must, however, be noted that only past investment and change in public sector investments are statistically significant, at the 5% and 10% levels of significance respectively. 5 conclusion i have analysed the contribution of government expenditures on the growth process in nigeria. the links between private investment and public expenditures were also investigated. there is no doubt that government expenditures on infrastructure complement and even stimulate private initiatives. regression results confirm that public sector investments, particularly those on transport and communications, and agriculture have positive impact on private investment. in aggregate terms, public sector investment crowds-in private investments while its changes crowds-out private investment. in terms of growth, private investment appears more efficient than r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 386 sajems ns vol 2 (1999) no 3 public sector investment. it was also shown that private investment benefits from govemment investment in human capital formation and the provision of health care. capital and current expenditures on education and health did not only have the correct signs but the capital components were statistically significant. in most of the regression results, foreign saving was positively correlated to private investment. it is clear that government in nigeria must continue to create the enabling environment by investing in large·scale irrigation projects, transport and communications as well as providing other utilities like electricity and water. the quality of govemment investment is important for ensuring the efficiency of the private sector. while this study confirms previous efforts on the positive contribution of infrastructural expenditures to the growth process, it also makes the point that it is important also to decompose the infrastructural aspects in order to explain better the govemment's role in the growth process. endnote i wish to acknowledge the african economic research consortium (aerc), based in nairobi, kenya for fmancing the study on which this paper is based the contributions of the aerc technical committee, resource persons, and workshop participants (group b) are appreciated. i also thank my colleagues at the joint facility for electives (jfe), karen, nairobi, august 14-0ctober 4, 1996 for useful comments. however, the usual caveat applies. references anderson, d. 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(1990) "private investment and economic growth in developing countries", world development, 18: 19-27. 27 khan, m.s. & villanueva, d. (1991) "macroeconomic policies and long-term growth",aerc special paper 13, nairobi, kenya. 28 khan, m.s. & kumar, m. (1993) "public and private investment and the convergence of per capita incomes in developing countries", imf working paper. washington dc. 29 khand, c. (1987) "export-led economic growth: the case of technology transfer", the &onomic studies quarterly, 38: 131-47. 30 kuznets, s. (1966) modern economic growth: rate. structure. and spread, new haven, yale university press. 31 landau, d.l. (1983) "government expenditure and economic growth: a cross country study", southern economic journal, 49(3): 783-92. 32 landau, d.l. (1985) "government expenditure and economic growth in the developed countries: 1952-76", public choice, 47(3): 459-77. 33 landau, d.l. (1986) "government expenditure and economic growth in less developed countries: an empirical study for 1960-80", &onomic development and cultural change, 35: 35-75. 34 lewis, w.a. (1955) the theory of economic growth, london, allen and unwin. 35 lindauer, d.l. & v alenchik, a.d. (1992) "government spending in developing countries: trends, causes and consequencies", the world bank research observer no.1, 7: 59-78. 36 mueller, d.c. (1987) "the growth of government:'a public choice perspectives", imf stajjpapers 34(1): 115-49, washington dc. 37 otani, 1.0. & villaneuv a, d. (1988) "determinants of long-tenn growth performance in developing countries", imf working paper 88/97, washington dc. 38 otani, 1.0. & villaneuva, d. (1990) "long-tenn growth in developing countries and its detenninants: an empirical analysis." world development, 18: 769-83. 39 ndulu, b. (1990) "growth and adjustment in sub-saharan africa", world bank conference, nairobi, kenya. 40 ram, r (1986) "government size and economic growth: a new framework and some evidence from cross-sectional and time-series data",american economic review, 76(1): 191-203. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 389 41 rubinson, r (1977) "dependence, government revenue, and economic growth, 1955-1970", studies in comparative international development, xii{2): 3-28. 42 solow, r.m. (1988) "growth theory and after", american economic review, 78(3): 307-17. 43 tait, a.a. & mueller, p. (l982) "international comparisons of government expenditures", imf occasional paper 10, washington. dc. 44 taylor, l. (1983) structuralist macroeconomics, basic books, new york. 45 von fursteinburgh, g.m. & b.g. malkiel (1977) "the government and capital formation: a survey of recent issues", journal of economic literature, 15(3): 835-78. 46 world bank (1991). world development report, world bank, washington, dc. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . microsoft word 3 akanbi sajems 14_3_ 2011 282 sajems ns 14 (2011) no 3 the macroeconomic determinants of technological progress in nigeria olusegun ayodele akanbi department of economics, university of pretoria accepted may 2011 this study empirically examines the macroeconomic determinants of technological progress (total factor productivity) in nigeria that is consistent with the endogenous growth theory. the estimations are carried out with time-series data from 1970 to 2006 using the johansen estimation techniques. the study is distinct from most of the existing literature since it made an attempt in generating a time-varying technological progress. it employs the kalman filter technique to determine the evolution of the solow residual estimated from a cobb-douglas production function. the results conform to the existing literature that macroeconomic instability, the level of financial development, and the level of human development are highly significant determinants of technological progress in nigeria. key words: technological progress, macro determinants, kalman filter, cointegration, nigeria jel: c13, 22, e23, o47 1 introduction the role played by total factor productivity in attaining sustainable economic growth and development is well recognised in the growth literature. a focus on achieving a rising growth in technology of any economy could be to a larger extent a driving force to increasing labour and capital employment of that economy. it is therefore, quite apparent that empirical research on technology performance is of great importance to the success of any country. based on the growth accounting literature, an economy’s production function is explained by the inputs of labour and capital and any residual not explained by these inputs is considered as total factor productivity growth, which also measures technological progress broadly (hayani, 2001). however, total factor productivity is a variable which accounts for effects in total output not caused by inputs. in the standard production function the constant parameter is regarded as total factor productivity, which can range from technology to human capital. this constant parameter has been measured mostly in the literature by the residual from the production function. therefore, since technological progress is found to be one of the biggest components of total factor productivity, they can be used interchangeably. given the combination of factor inputs (labour and capital), the production function is increased by the improvement in productivity. the standard neoclassical growth models (i.e. solow (1956), ramsey (1928) and the overlapping generation models of samuelson (1958)) see technological progress as exogenous in the long run growth determination. this line of thought has been challenged by the new growth theorists (i.e. romer (1986) and lucas (1988)), who consider technological progress as endogenous and the search for possible driving force. these possible factors have still not yet been established in the literature (akinlo, 2006). there is a large body of literature that has looked into the factors that determined technological progress across a number of countries. but there have been relatively few estimates of technological progress in nigeria (i.e. ogunleye & ayeni (2008), adenikinju (1998), and okojie (1995)) and an attempt to explore the determinants of technological abstract sajems ns 14 (2011) no 3 283 progress in nigeria at the macroeconomic level has been rare. akinlo (2006) explores the effects of macroeconomic factors on total factor productivity in 34 sub-saharan african countries. results from his panel econometric analysis shows that some macroeconomic variables (i.e. external debt, inflation and human capital) included in the estimation have a significant impact on productivity. therefore, policies geared towards reducing the rate of debt accumulation, low inflation and improvement in human development will boost total factor productivity in the continent. other macroeconomic variables such as openness and trade orientation have been investigated by miller and upadhyay (2000) as potential determinants of total factor productivity in a panel of some developed and developing countries. their results revealed that a higher level of openness and outwardoriented countries will experience a higher level of productivity. the level of human development is also found to have a positive and significant impact on productivity. edwards (1998) and gurney and englander (1994) likewise suggest that more open economies will experience faster productivity growth. against this background, the aggregate determinants of productivity in an economy can be attributed to the level of macroeconomic stability, human development, the level of openness of the economy and the role which the financial sector plays in providing funds to the system. these factors, which have been investigated by khan (2006) was found to have a robust and significant impact on total factor productivity. following khan (2006), this study attempts to establish the macro determinants of technological progress in nigeria by incorporating the idea of endogenous growth theory. these factors are also identified as the level of macroeconomic instability, the country’s financial development, and the level of human development. this idea is adopted since nigeria and most developing economies still face these challenges in the race to achieving their developmental objectives. the distinctive feature of this study is the attempt made in generating time-varying technological progress. a different approach is followed in this study by employing the kalman filter technique to determine the evolution of the solow residual estimated from a cobb-douglas production function. existing studies on this issue have adopted the neoclassical growth accounting framework in measuring the growth in technology over time. this approach is based on the assumption that technological improvements are exogenously determined and grow at a constant rate over time. however, production models need to allow technology to improve over time in order to be able to explain growth in the presence of constant, increasing and decreasing returns to scale production structures. 1 the results of the estimates are significant and consistent with theoretical expectation, revealing the impact of the selected factors on technological progress. hence, the analysis tends to shed light on the direction which policy makers should take to improve productivity in the country. the rest of the study is structured as follows. section 2 presents some stylised facts on productivity performance in nigeria while section 3 analyses the sources of growth in the different major periods experienced by the country. section 4 presents the empirical analysis, which contains the background of the production structure and technological progress in nigeria, the theoretical model, the methodology and the description of the data used in the study. it also presents the estimation results. section 5 concludes the study. 2 nigeria’s productivity performance: some stylised facts this section presents the growth in productivity of labour and capital in nigeria since 1970. few basic trends have emerged over the past few decades with regards to the pattern of factor inputs growth. 2 284 sajems ns 14 (2011) no 3 figure 1 growth in factor inputs source: world bank (world development indicators) as shown in figure 1, capital and labour productivity has been following a similar trend over the years since 1970. the average annual growth rate in productivity of about 3.5 per cent and 4 per cent were recorded for capital and labour respectively. with the exception of the outlier in 1973, the average annual growth in productivity of capital is found to be negative (0.5 per cent) while labour productivity recorded a positive growth of about 1 per cent in the same period. 3 the outlier reflects the effects of the huge growth in gdp which was caused by the boom in oil revenue. however, the above facts indicate the low level of factor productivity in nigeria over the past few decades as growth in productivity has been around zero in most years. however, is crucial to explore more deeply the nature and drivers of total factor productivity (technological progress) in nigeria at this point. this analysis will enable policy makers to identify the optimal economic policy for long-term growth potential of the country. 3 sources of economic growth: growth accounting exercise the basic determinant of a country’s economic performance and living standards is mainly that country’s physical capacity to produce goods and services with its available quantity of inputs (factors of production). but a nation’s output of goods and services does not only depend on the availability of its inputs (capital and labour) but also on the productivity of these inputs. empirical investigation of the various developed and newly industrialised economies for their sources of economic growth over a long period of time have shown explicitly how much the tangible inputs and their productivity have contributed to the long-term growth (kim and lau (1994), lau and park (2003), tahari et.al. (2004), senhadji (2000), and dike (1995). in an attempt to identify the structural changes that occurred in the nigerian economy over the years, it is imperative to decompose the growth performance into its primary sources. the sources of the nigerian economic growth from 1970 to 2006 is calculated according to the effectiveness with which capital and labour are used in the production process. the long run production function was estimated (under the assumption of constant returns to scale) with labour taking about 93 per cent share in total production while capital takes 7 per cent. -40 -20 0 20 40 60 80 100 120 1 9 7 1 1 9 7 2 1 9 7 3 1 9 7 4 1 9 7 5 1 9 7 6 1 9 7 7 1 9 7 8 1 9 7 9 1 9 8 0 1 9 8 1 1 9 8 2 1 9 8 3 1 9 8 4 1 9 8 5 1 9 8 6 1 9 8 7 1 9 8 8 1 9 8 9 1 9 9 0 1 9 9 1 1 9 9 2 1 9 9 3 1 9 9 4 1 9 9 5 1 9 9 6 1 9 9 7 1 9 9 8 1 9 9 9 2 0 0 0 2 0 0 1 2 0 0 2 2 0 0 3 2 0 0 4 2 0 0 5 2 0 0 6 p e r c e n ta g e g r o w th capital productivity growth labour productivity growth sajems ns 14 (2011) no 3 285 following solow (1956), a cobb-douglas production function using a constant return to scale technique was adopted in performing the simple growth accounting exercise. to experience economic growth under the assumption of constant returns to scale, there must be growth in the accumulation of capital, labour and total factor productivity (technological progress). the growth accounting equation states that output growth is equal to the weighted sum of capital and labour growth, plus the growth in total factor productivity or technology. this is presented as: l l k k a a y y         (1) where a a is the contribution of total factor productivity to output growth, k k  is the contribution of capital to output growth and l l  is the contribution of labour to the growth in output. the above equation is called the growth accounting equation. the contribution of total factor productivity to output growth can be derived from the equation since the growth rate of output, capital and labour are known. this is also called the solow residuals, which is that portion of growth left unaccounted for by increases in capital and labour 4 . by applying the growth accounting equation to decompose the sources of economic growth in nigeria from 1970 to 2006, table 1 presents the results of this analysis in four major periods experienced by the country 5 : • the pre-structural adjustment programme (sap) [1970-1984]. • the sap era [1985-1993]. • the period of deregulation [1994-1998]. • the return to democratic dispensation [1999-2006]. the long-term parameter estimates for labour (0.93) and capital (0.07) are used in decomposing the sources of growth for the four major periods. table 1 sources of economic growth in nigeria (per cent per year) 1970-1984 1985-1993 1994-1998 1999-2006 1970-2006 sources of growth labour 7.1 4.1 -3.24 3.5 4.5 capital 4.7 -0.2 -0.28 0.1 1.7 total input 11.8 3.9 -3.52 3.6 6.2 tfp -2.32 5.43 0 2.95 0.79 total output 9.48 9.33 -3.52 6.55 6.99 source: author’s own calculations table 1 gives the summary of the findings of what growth accounting says about the sources of nigeria economic growth. over the period 1970-2006, the country’s total output grew at an average rate of about 7 per cent per year. the contribution of labour to total output growth accounted for about 4.5 per cent per year. this may be due to the huge population of the country and the fact that more than one third of the population are in the labour force. likewise is the high rate of the informal sector participation rate in the country, which may have contributed to labour taking a large share of the economic activities. however, the contribution of capital stock to output growth during this period is accounted to be 1.7 per cent per year. therefore, combining the contribution of labour and capital gives the total inputs contribution which accounted for 6.2 per cent per year. taking the difference between the total output growth (6.99%) and the contribution of total inputs (6.2%) gives 0.79 per cent, which represents the total factor productivity (technological progress) per year. these results are similar to the findings by dike (1995) and senhadji (2000). the breakdown of the data into 4 different periods as mentioned above explains in more details how the long-run sources of growth in nigeria were achieved. column (3) represents 286 sajems ns 14 (2011) no 3 the sap (1985-1993) period in nigeria, and the contribution of capital stock to the total output growth during this period is found to be negative, while the average total growth for the period of deregulation is found to be negative. these are periods associated with continuous military rule, which coincided with huge mismanagement of the country’s resources. in these periods not much capital investment (capital expenditures) could be made in the economy, but the return to a democratic dispensation since 1999 has improved the country’s economic performance, and the contribution of capital stock to economic growth has increased by about 0.4 per cent from the previous period. the period between 1970 and 1984 recorded about 9.5 per cent growth in total output per year but this was accompanied by a slowdown in productivity during this period. this was not really a surprise since empirical evidence has also revealed that most countries (especially the us) experienced a slowdown in its productivity almost at the same period. although, no one is certain about the cause of the slowdown, many empirical studies related to the u.s economy (baily & gordon, (1988); denison, (1985); bishop, (1989); nordhaus, (1982); baily, (1982); jorgenson, (1990); greenwood & yorukoglu, (1997); and hobijn & jovanovic, (2001)) have suggested some alternatives associated with measurement error, legal and human environment, technological depletion and slow commercial adaptation, oil price, and the beginning of a new industrial revolution. some of these explanations may also be attributed in the case of nigeria; one cannot debunk the possibility of these causes of slowdown in productivity, but may rather say that there are many factors that have contributed to it. in the long-run, the sources of economic growth again confirm that productivity from labour and capital has been very low over the years. this gives an indication of why the level of human development has been deteriorating in nigeria, which can have an adverse effect on the rate of productivity growth in the economy (abel & bernanke, 2005:215). despite rising economic growth since 1999, real per capita income as at 2005 was about n1800 (local currency unit) which is similar to the 1970s level. this is a serious indication that the country is just breaking through from its past economic bondage of corruption and mismanagement but still facing a serious problem of severe poverty among its citizens. 4 empirical analysis 4.1 background: the production structure and technological progress an attempt is made to model the nigerian production function by employing the statespace model (kalman filter) to determine the evolution of the solow residual that is estimated from a simple cobb-douglas production function. the state-space model regained its popularity in the economic literature during the 1980s (i.e lawson, (1980); harvey, (1987)) and the development of these models were first seen in wiener, (1949) and kalman, (1960) who were control engineers in the technology of radar and aircraft. the application of the state-space model with stochastically time-varying parameters (constant coefficient of the technological progress in the cobb-douglas production function is allowed to vary over time) is adopted in this study in order to endogenise technological progress. this technique differs and hence may be a better approximation than the conventional ols estimation which uses the residual as a proxy for technology. an extensive econometrics application of the state-space models can be found in hamilton (1994:372-408). the dynamic representation of the statespace model of a (n1) vector yt, is given by the following system of equations: ttttt wxhxay  )]'([)( (2) 11 )(   tttt vxf  (3) where a(xt) describes an (n1) vector-value function, h(xt) an (rn) matrix-value function, and f(xt) denotes a (rr) matrix whose elements are a function of xt. t is a (r1) vector of unobserved state variables (i.e state vector). the (n1) and (r1) disturbance vectors wt and sajems ns 14 (2011) no 3 287 vt are assumed to be independent white noise. the first equation is known as the observation (or measurement) equation and the second is known as the state (or transition) equation. the role played by technology in the growth process of a nation cannot be undermined. technology has been seen as a catalyst to any country’s economic transformation. the assumption that technological progress occurs at a constant rate is very common in the growth literature (especially the exogenous growth theory). this may not be a very realistic assumption. a time varying technological progress generated in this study using the kalman filter procedure reveals the weakness of this assumption. figure 2 time varying technological progress for nigeria source: author’s own calculations figure 2 shows the upward and downward trend in the evolution of technology in nigeria. visual exposition revealed on average a similar trend with the technology from the growth accounting exercise calculated for each period as explained in the previous section. 4.2 the model existing theory on productivity growth (technological progress) has not provided a particular specification in determining the drivers of total factor productivity for an economy (akinlo, 2006). endogenising technological progress has not been very popular in the economic literature over the years. there is a large body of empirical literature that tends to explain the process of growth in a single or cross-country setting, but very little evidence has been found with respect to total factor productivity (senhadji, 2000). in line with the endogenous growth theory, the problem of how best to represent technological progress was investigated by budd and hobbis (1989) who applied their analysis to the uk production function. two main sources of technological advances were identified in their paper: (i) through domestic research effort; (ii) importing new technology from abroad. as mentioned earlier, khan (2006) investigated the macro determinants of total factor productivity in pakistan. these determinants are broadly categorised into macroeconomic stability, human resource development and financial sector development. 6 it is expected that research & development (r&d) will go a long way towards boosting technology. more important, is the extent of macroeconomic stability playing a huge role in r&d. however, due to data limitation, the r&d factor in long-term technology specification could be captured by the level of macroeconomic stability as investigated in khan (2006). in addition, the budget balance 0 5000 10000 15000 20000 25000 1 9 7 0 1 9 7 2 1 9 7 4 1 9 7 6 1 9 7 8 1 9 8 0 1 9 8 2 1 9 8 4 1 9 8 6 1 9 8 8 1 9 9 0 1 9 9 2 1 9 9 4 1 9 9 6 1 9 9 8 2 0 0 0 2 0 0 2 2 0 0 4 2 0 0 6 m il li o n s (l c u ) technological progress 288 sajems ns 14 (2011) no 3 will also be an important determining factor in the long-term technological progress, but this effect could be broadly captured from the financial development activities as the level of gross savings and changes in reserves will have a great impact. 7 as mentioned earlier, this study concentrates on the macroeconomic determinants of technological progress in nigeria. therefore, it does not debunk the fact that some institutional variables (i.e. political instability in the case of nigeria) may also have a huge impact in the long run. against this background, which is in line with the new growth theory, nigerian technological progress (tfp) is specified based on the standard romer (1990) framework:    1 ])1([)1[( laakay lk (4)  alakaba lk ][][ .  (5) therefore, ),,(   ttt fdhdmsftfpa (6) where tms a form of macroeconomic stability which is proxied by consumer prices (cpi), is the human development variable which is proxy by poverty level (povertyd_index), tfd represent the level of financial develop-ment (finconstr). 8 these variables are expected to influence the growth of technology in nigeria since most developing economies are characterised by these factors. an in-creasing level of macroeconomic instability which could be reflected in the rise in price level will have a negative impact on aggregate technology. likewise, will a rise in the level of poverty impact on the country’s technological advancement. a positive development in the financial sector (i.e. availability of credit) will boost the aggregate technology in the country. 4.3 methodology and data this study modelled the nigerian technological progress following khan (2006). in line with the johansen (1988) cointegration estimation technique, the reduced form vector autoregression (var) of equation (6) is respecified as: tjtjtt xxx    ....110 (7) where tx is a vector of variables: ]_ln,ln,ln,[ln' ttttt indexpovertydfinconstrcpitfpx  (8) cholesky decomposition is utilised for orthogonalisation, which means that the cholesky factor is lowered triangular. therefore, the technological progress variable will be contemporaneously affected by all the other variables. the need to have a meaningful impulse-response function from the vector error correction model (vecm) is dictated based on the ordering of the variables. based on the relationship that is captured in the long-run by the technology model specified in equation (8), a vecm of the following form is estimated to see the short-run dynamics in the technological progress function.      1 1 1 p i tititt xxx  (9) the procedure used in estimation can be explained as follows. firstly, the reduced form var in equation (8) is estimated and all the diagnostic tests are performed. secondly, the johansen cointegration test is performed and the cointegrating vectors and loading matrices are identified. thirdly, a vecm from equation (9) is estimated and the entire diagnostic tests are performed. 9 lastly, impulse responses analyses are performed. all the data used in this study were obtained from the imf (international financial statistics), world bank database: african development indicators and world development indicators, and the central bank of nigeria statistical bulletin. annual data series which cover the period 1970-2006 were used to estimate the parameters of the model and where appropriate the variables were transformed into real figures using the gdp deflator (2000 = base year). all the data used in the estimation process are in their natural logarithm form (ln). graphical exposition of all the data used in the study and their order of integration are presented in the appendix. in addition to the technological progress series generated, there is still a lack of availability of some time series data. therefore, the following time series had to be derived for the variables used in the model: sajems ns 14 (2011) no 3 289 financing of gross domestic investment (financial constraint) in a general equilibrium framework (i.e. system of national account), the financing of gross domestic investment equals total gross domestic investment (du toit, 1999). therefore, the financial constraint variable is defined as an identity which enters into the system of equations in the form: financial constraint = gross domestic savings + capital flows + changes in reserves + depreciation value this variable captures the financial sector development of the economy. rate of depreciation the rate of depreciation can take different values for an individual country depending on the structure of that particular economy. in general, it is common to assign a higher rate of depreciation to developing or low-income countries. a higher depreciation rate of 20 per cent is adopted in this study since nigeria allocates much lower revenues to maintenance expenditures (see bayraktar and fofack (2007), beddies (1999), and vera-martin (1999)). poverty index there are multiple dimensions of the measurement of poverty in the literature. the poor are generally classified as those without an adequate income or expenditure to cover their basic necessities. an index of poverty is derived for this study following the basic foster-greer-torbecke (fgt) indices as this is one of the most commonly used poverty indices in the literature. 10 this measure has three components: (a) the incidence of poverty, which shows the share of the population that are below the poverty line, (b) the depth of poverty, which shows how far the households are from the poverty line, and (c) the severity of poverty which relates to the distance separating the poorest households from the poverty line. these indices are calculated as follows:            q i z yz n p 1 1 (10) where n = population, q = % of population living below poverty line (proxy = poor population), z = poverty line (world bank estimate), y = household final consumption expenditure per capita,  = poverty aversion parameter.  = 0,1,2 for absolute, depth and severity of poverty respectively. since the incidence of poverty measures absolute poverty in an economy, this study adopted the depth of poverty as a measure of poverty gap. capital stock in the model, capital stock is derived through a perpetual inventory method. this means that the current stock of capital is equal to the investment in the previous period plus stock of capital from the previous period, net of depreciation. this is shown as: 11*)1(   ttt ikk  (11) where tk is the capital stock, ti is the gross domestic investment, and  is the rate of depreciation. since the initial stock of capital is very important and this is not known, it is assumed to be about 1.5 of the gross domestic product for that particular period. labour employment due to lack of time series data on labour employment/unemployment and on any labour market variables (both formal and informal), labour employment is generated based on the activities in the labour force. since a percentage of the labour force participates in the labour market, labour employment is derived as: employment ( dtn ) = labour force participation rate (lfpr)  labour force the lfpr on average is about 67 per cent per annum indicating about 33 per cent average unemployment in the country. 4.4 estimation results based on the nature of the data generating process (dgp) of all the variables, an appropriate model for technological progress in nigeria is selected and the results of the trace and maximum eigenvalue tests are presented in table 2. following the pantula principle of testing which version of the deterministic component should be used, the trace test identified one cointegrating vector 290 sajems ns 14 (2011) no 3 while the maximum eigenvalue test found no cointegration for a model with trend and intercept in the cointegrating equation. table 2 cointegration test results trace test maximum eigenvalue tests oh 1h  -trace stat. 5% cv oh 1h  -max 5% cv r=0 r  1 64.73** 63.88 r=0 r=1 30.32 32.12 r  1 r  2 34.41 42.92 r=1 r=2 20.28 25.82 r  2 r  3 14.13 25.87 r=2 r=3 11.37 19.39 r  3 r  4 2.76 12.52 r=3 r=4 2.76 12.52 using the cointegrating vectors from the trace test, the long-run part of the vecm is presented in equation (12). the long-run cointegrating vector identified the technological progress which is the equation of interest in this study.                                     1 1 1 1 312111 41 31 21 11 1 ' 1 ln ln ln _ln 1 t t t t tt tfp cpi finconstr indexpovertyd xx       (12) the estimated long-run technological progress equation is presented in equation (11) with t-values in parentheses. )22.5()5.5()20.6()00.6( 10.0_ln29.1ln18.0ln6.047.6ln ttttt trendindexpovertydfinconstrcpitfp   (13) the entire coefficients are statistically and economically significant and are consistent with the theoretical specification in equation (6). the results from the core specification confirm that macroeconomic instability, the level of financial development, and the level of human development are highly significant determinants of technological progress in nigeria. the ‘ ttrend ’ variable captures the possible upward trend in the time varying technological progress. the general price level is consistent with the existing literature and implies that a 1 per cent increase in price level will lead to about 0.6 per cent decline in technology. the results shows that a rise in the level of financial development (i.e. a stronger financial system and availability of credit) by 1 per cent will lead to about 0.2 per cent rise in the level of aggregate technology in the country. the rise in the level of poverty by 1 per cent causes aggregate technology to decline by about 1.3 per cent. the positive time trend in the longrun equation means that there was a general trend for technology to rise during the period 1970 to 2006. the magnitude of the coefficient of the human development sector reveals the importance of this sector in improving the level of productivity in the country. table 3 presents the short-run adjustment coefficient ( values or loading matrices) which shows the dynamic adjustment towards the long-run equilibrium path. as expected, the  values from the error correction estimates are all within the 0 to 2 range implying that all the cointegrating vectors enter into the shortrun determination of the nigerian technological progress, and therefore they can be regarded as not being weakly exogenous (ender, 2004:370). sajems ns 14 (2011) no 3 291 table 3 estimated loading matrices and weak exogeneity tests variables ttfpln tcpiln tfinconstrln tindexpovertyd _ln tinvln equation -0.09 (-0.96) -0.5 (-3.12) 1.74 (2.33) 0.09 (2.21) notes : t-statistics are given in brackets : the likelihood ratio test for binding restrictions is lr = 158.88. the probability of committing type i error in the parentheses. this test refers to both long-run and the above loading matrix restrictions. the positive and significant signs of the loading factors in both the financial and human development variables show that they tend to push the system away from its long-run equilibrium path. the technological progress and consumer price variables are found to be negative but insignificant in the former (tending to bring the system back to equilibrium). this implies that the price level plays a significant role in returning the longrun technological progress back to its equilibrium path. the graph of the estimated cointegrating relation in equation (10) from the vecm is presented in figure 3 below. the cointegrating relation is found to be appropriate since the graph reverts to equilibrium (zero). figure 3 cointegrating relation from vecm impulse-response functions based on the dynamic (lag) structure of the var, a shock to the i-th variable will not only directly affect the i-th variable but will also be transmitted to all the endogenous variables in the system. the impulse response reveals the effect of a one time shock to one of the innovations on current and future values of the endogenous variables. using the othorgonalised cholesky decomposition, the impulse responses are derived from the vecm as presented in figure 4. -.6 -.4 -.2 .0 .2 .4 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 cointegrating relation for technological progress equation 292 sajems ns 14 (2011) no 3 figure 4 response to one standard deviation shock over 30-year period figure 4 presents the responses of technology to a one standard deviation shock in the exogenous variables. the response of technology to its own shocks causes an upward revision of the forecast of technology over the 30-year period. it is expected that technological progress declines as the level of macroeconomic instability rises. macroeconomic stability plays a significant role in the determination of technology as revealed from a one standard deviation shock in the general price level. this led to a permanent fall in technology over the 30-year period. a one standard deviation positive shock in the level of financial development causes technology to rise over the 30-year horizon and as the level of human development deteriorates (rise in poverty) by one standard deviation, the level of technology declines over the same horizon. however, this confirmed the importance of the variables included in the vecm in explaining the movement in technology (factor productivity) in nigeria over the years. -06 -04 -02 .00 .02 .04 .06 .08 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 responseoftechnologytoits ownshocks -06 -04 -02 .00 .02 .04 .06 .08 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 responseoftechnologytoshocksinprices -.06 -.04 -.02 .00 .02 .04 .06 .08 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 responseoftechnologytoshocksinfinancialdevelopment -.06 -.04 -.02 .00 .02 .04 .06 .08 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 responseoftechnologytoshocksinpoverty response of technology to its owns shocks response of technology to its owns shocks response of technology to shocks in prices e response of technology to shocks in financial development response of technology to shocks in poverty sajems ns 14 (2011) no 3 293 5 conclusion the aim of this study is to secure the macroeconomic determinants of technological progress in nigeria. the idea of endogenous growth theory was adopted as the most suitable for estimating technology since it incorporates the human development sector as one of the drivers of economic growth. the results from the study confirm that macroeconomic instability, the level of financial development, and the level of human development are highly significant determinants of technological progress in nigeria. this is in line with the existing literature. these results have critical policy implications if an increased productive capacity and future growth in technology are to be achieved in the nigerian economy. there is an urgent need for policy makers to direct economic policies towards achieving a stable macroeconomic environment. the political environment needed to be more secure in order to attract private investment. the creation of access to credit facilities for both individuals and firms would not only enhance economic growth but also contribute significantly to the aggregate level of productivity in the economy (khan, 2006). future research should attempt to correct some of the shortcomings of this study. the lack of available long-time series on most of the variables used can be overcome in the future and this may give a better parameter estimate of the effect of macroeconomic variables on aggregate productivity in the country. endnotes 1 detailed review of the measurement and interpretation of total factor productivity can be found in mahadevan (2003). 2 labour and capital productivity are derived as the ratio of real gdp to employment and the ratio of real gdp to real capital stock respectively. 3 labour productivity is expected to have been lower if accurate data on employment are available. see data description for detailed analysis. 4 detailed explanations of the variables used are presented in the data description. 5 these periods can be regarded as crucial periods in the evolution of the nigerian economy. 6 the structure of the nigerian economy is closer to the pakistan economy than to that of the uk. 7 see data description on financing of gross domestic investment. 8 the rate of openness is excluded from the specification since the country has not benefited much from the external sector. over 95 per cent of its exports come from crude oil, while many of its imports are finished goods. this indicates a nondiversified economy. therefore, openness as a variable is found to be insignificant and could not provide a correct a priori sign in the estimation process. 9 all the diagnostic tests performed are presented in the appendix. 10 see louw, (2008) for detailed analyses of poverty measures and indices. references abel, a.b. & bernanke, b.s. 2005. macroeconomics (5th ed.). new york: pearson education inc. adenikinju, a. 1998. productivity growth and energy consumption in the nigerian manufacturing sector: a panel data analysis. energy policy, 26(3):199-205. akinlo, a.e. 2006. macroeconomic factors and total factor productivity in sub-saharan african countries. international research journal of finance and economics, 1:62-79. baily, m.n. & gordon, r.j. 1988. the productivity slowdown, measurement issues, and the explosion of computer power. brookings papers on 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the theory of economic growth. quarterly journal of economics, 70(2):65-94. tahari, a., ghura, d., akintoby,b. & aka, e.b. 2004. sources of growth in sub-saharan africa. international monetary fund working papers, no.176. washington dc. vera-martin, m. 1999. long-run growth in mali, niger and senegal. unpublished. imf, washington d.c. 296 sajems ns 14 (2011) no 3 appendix a order of integration for all the variables the univariate characteristics of the data were analysed using the augmented dickey-fuller tests to establish the order of integration since the actual data generating process is not known. the maximum lag structure that is used follows said and dickey (1984) who suggested a lag order equal to 3/1t with t the number of observations, which in this case is 37 (years 1970 to 2006). therefore, the maximum lag structure of 4 is used in the testing procedure. table a1 augmented dickey-fuller tests for non-stationarity, levels, 1970-2006 series model lags  ,  ,  3 , 1 ln_capital flows trend constant none 1 0 0 -2.57 -0.37 2.14 2.73 0.13 ln_cpi trend constant none 1 1 1 -2.51 -0.30 0.67 7.50** 7.02* ln_gross capital formation trend constant none 0 0 0 -2.82 -2.63* 1.17 4.39 6.93** ln_gross domestic savings trend constant none 0 0 0 -1.70 0.34 3.01 1.86 0.11 ln_labour force trend constant none 2 0 0 -2.95 0.70 12.97 3.35 0.49 ln_gross domestic product trend constant none 0 0 0 -3.33* -2.41 2.15 6.17* 5.81** *(**)[***] significant at a 10(5)[1]% level. a at a 10(5)[1]% significance level, the mackinnon critical values are -3.18(-3.50)[-4.15] when a trend and a constant are included (  ), and -2.60(-2.93)[-3.58] when only a constant is included (  ), and -1.61(-1.95)[-2.62] when neither is included (  ). the standard normal critical value is -1.697(-2.04)[-2.75]. b at a 10(5)[1]% significance level, the dickey-fuller critical values are 5.91(7.24)[10.61] when a trend and a constant are included ( 3 ) and 4.12(5.18)[7.88] when only a constant is included ( 1 ). the result of the adf-test for all the variables used in our estimations is reported in table a1. the first column shows the list of all the variables that are tested. the second column (model) shows whether the equation that is estimated for the testing purpose involves a trend and a constant (trend), or a constant only (constant), or neither a constant nor a trend (none). the third column shows the number of lags that are used for each model and they are significant at 10 per cent level. the fourth column is the adf t-statistic, called  (for trend and constant),  (for only constant), and  (for neither trend nor constant). the last column is the f-statistic 3 ( 1 ), testing whether the trend (constant) is significant under the null hypothesis of no unit root. from the result, it is clear that most of the variables are non-stationary [i(1)] in level form. b reduced-form var diagnostic tests all the roots have modulus less than one and lie inside the unit circle. table b1 presents other diagnostics tests for the var. the var passed all the diagnostic tests revealing a well specified model. sajems ns 14 (2011) no 3 297 table b1 diagnostic test on the reduced-form var 1h 0h test statistic prob. serial correlation no serial correlation lm-test2 (lag 2) 16.34 0.43 normality normally distributed jb-joint 4.31 0.83 error term kurtosis-joint 2.52 0.64 skewness-joint 1.79 0.77 heteroschedasticity no heteroschedasticity 2 114.11 0.16 c vector error correction estimates vector error correction estimates sample (adjusted): 1972 2006 included observations: 35 after adjustments standard errors in ( ) & t-statistics in [ ] cointegrating eq: cointeq1 ln_tfp_tot1(-1) 1.000000 ln_cpi(-1) 0.599566 (0.09988) [ 6.00279] ln_finconstr(-1) -0.179115 (0.02887) [-6.20416] ln_povertyd_index(-1) 1.286465 (0.23401) [ 5.49752] @trend(70) -0.104420 (0.02001) [-5.21906] c -6.474390 error correction: d(ln_tfp_tot1) d(ln_cpi) d(ln_finconstr) d(ln_povertyd_index) cointeq1 -0.085642 -0.497098 1.741438 0.087035 (0.08969) (0.15938) (0.74897) (0.03947) [-0.95482] [-3.11886] [ 2.32512] [ 2.20504] r-squared 0.318677 0.543025 0.191049 0.650760 adj. r-squared 0.201208 0.464236 0.051575 0.590546 sum sq. resids 0.091317 0.288344 6.367143 0.017684 s.e. equation 0.056115 0.099714 0.468569 0.024694 f-statistic 2.712853 6.892148 1.369779 10.80750 log likelihood 54.44048 34.31877 -19.83940 83.17020 akaike aic -2.768028 -1.618215 1.476537 -4.409726 schwarz sc -2.501397 -1.351584 1.743168 -4.143095 mean dependent 0.006330 0.181666 0.258146 0.025425 s.d. dependent 0.062786 0.136229 0.481140 0.038591 determinant resid covariance (dof adj.) 2.84e-09 determinant resid covariance 1.34e-09 log likelihood 158.8788 akaike information criterion -7.421643 schwarz criterion -6.132926 abstract introduction experiment ethical consideration analysis discussion conclusion acknowledgements references appendix 1: about the author(s) aylit t. romm ameru, school of economic and business sciences, university of the witwatersrand, johannesburg, south africa volker schoer ameru, school of economic and business sciences, university of the witwatersrand, johannesburg, south africa jesal c. kika research, coordination, monitoring and evaluation, department of basic education, pretoria, south africa citation romm, a.t., schoer, v. & kika, j.c., 2019, ‘a test taker’s gamble: the effect of average grade to date on guessing behaviour in a multiple choice test with a negative marking rule’, south african journal of economic and management sciences 22(1), a2542. https://doi.org/10.4102/sajems.v22i1.2542 original research a test taker’s gamble: the effect of average grade to date on guessing behaviour in a multiple choice test with a negative marking rule aylit t. romm, volker schoer, jesal c. kika received: 26 june 2018; accepted: 16 jan. 2019; published: 11 apr. 2019 copyright: © 2019. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: multiple choice questions (mcqs) are used as a preferred assessment tool, especially when testing large classes like most first-year economics classes. however, while convenient and reliable, the validity of mcqs with a negative marking rule has been questioned repeatedly, especially with respect to the impact of differential risk preferences of students affecting their probability of taking a guess. aim: in this article we conduct an experiment aimed at replicating a situation where a student enters an examination or test once they already have an average from previous assessments, where both this and previous assessments will count towards the final grade. our aim is to investigate the effect of a student’s aggregate score to date on their degree of risk aversion in terms of the degree to which they guess in this particular assessment. setting: a total of 102 first-year economics students at the university of the witwatersrand volunteered to participate in this study. the test used in this study did not count as part of the students’ overall course assessment. however, students were financially compensated based on their performance in the test. methods: following an experimental design, students were allocated randomly into four groups to ensure that these differed only with respect to the starting points but not in any other observed or unobserved characteristic that could affect the guessing behaviour of the students. the first group consisted of students who were told that they were starting the multiple choice test with 53 points, the second group were told they were starting with 47 points, and the third and fourth groups were told that they were starting with 35 and 65 points respectively. results: we show that entering an assessment with a very low previous score encourages risk seeking behaviour. entering with a borderline passing score encourages risk aversion in this assessment. for those who place little value on every marginal point, entering with a very high score encourages risk seeking behaviour, while entering with a very high score when a lot of value is placed on each marginal point encourages risk aversion in this assessment. conclusion: the validity of mcqs combined with a negative marking rule as an assessment tool is likely to be reduced and its usage might actually create a systematic bias against risk averse students. keywords: average score; risk aversion; risk seeking; guessing; multiple choice questions. introduction a multiple choice test with a negative marking rule is a typical situation in which an individual who does not have complete knowledge of the correct solution is faced with a gamble of either omitting a question and receiving no reward, or answering a question and being penalised for an incorrect response. hence, the performance or the associated payoff from such a test is dependent upon whether the student chooses to answer a question when confronted with such a gamble. the use and grading of multiple choice questions (mcqs) is a well-established and reliable method of assessing knowledge in standardised tests and examinations within the education space. these multiple choice tests are advantageous to both the instructor and the student. from an instructor’s perspective, these tests offer increased accuracy and reliability in scoring (walstad & becker 1994) as well as objectivity of the grading process (becker & johnston 1999). in addition, buckles and siegfried (2006) reveal that these tests enable instructors to cover a wide range of subject material, and facilitate the availability of comparative statistical analysis. from a student’s perspective, the objectivity of the grading process is welcomed, since it ensures consistent scoring, and eliminates instructor bias (kniveton 1996). the consistency and convenience of mcq testing are the main reasons for conveners of large university classes like first-year economics to adopt this assessment strategy. however, multiple choice testing is not without its critiques. incorrect answer options expose students to misinformation, which can influence subsequent thinking about content (butler & roediger iii 2008). in addition, students expecting to write a multiple choice test also spend less time preparing for the test (as opposed to essay-based tests) as the answer is selected, and not generated (roediger iii & marsh 2005). thus, mcq testing encourages surface learning rather than deep learning, with students relying on memorising answers to previous mcq tests instead of working through problems and understanding concepts (williams & clark, in: betts et al. 2009). furthermore, providing the student with the correct answer option amid a number of incorrect distractors still provides the option to simply guess the answer, which affects the validity of mcqs as an assessment tool (betts et al. 2009). especially with partial knowledge, students can increase the probability of guessing the correct answer to a question by eliminating unlikely choices (bush 2001). formula scoring rules, also known as negative marking, are frequently adopted as a means to discourage guessing by subtracting points for incorrect responses; unanswered questions are neither penalised nor rewarded (holt 2006). the penalty for an incorrect response serves to augment the reliability of tests through a reduction in the measurement errors induced by guessing. a basic property of such formula scoring rules is that the expected value of a pure guess is the same as the expected value from omitting a response (budescu & bar-hillel 1993). however, davis (1967) asserts that a limitation of the formula scoring rule is the failure to take into account the partial knowledge of examinees, which enables them to eliminate one or more solution options. as students with partial knowledge eliminate one or more solution options, the expected value of guessing exceeds the expected value of omitting a response, which therefore results in guessing being the optimal strategy. however, taking this gamble is a function of the student’s risk preference. bliss (1980) reveals that risk averse students are more likely to omit items for which they have partial knowledge regardless of the positive expected payoff, and these examinees are thus at a disadvantage compared to other students. more importantly, risk preferences are likely to be non-randomly distributed which could introduce systemic bias. ben-shakar and sinai (1991), marin and rosa-garcia (2011), burns, halliday and keswell (2012) and hartford and spearman (2014) show that females are more risk averse than males in the context of economic assessments under a negative marking rule. hartford and spearman (2014) show further that it is better performing female students that are most biased against under a negative marking rule, since better students are more likely to have partial knowledge regarding any particular question. the purpose of assessments is to measure the students’ knowledge through their responses to test questions. if the score obtained through mcqs not only reflects the student’s content knowledge but is also a function of other factors that affect the student’s probability of taking a guess, then the validity of mcqs as an assessment tool is reduced. in this article we conduct an experiment to show how performance in previous assessments influences a student’s degree of risk aversion in a subsequent assessment. our experiment aims to replicate a situation where a final grade for a course is calculated by finding the average of more than one assessment. in particular, this experiment looks at how a student might behave in a particular assessment once they already have an average from previous assessments, where both this and previous assessments will count towards the final grade. this is important for the literature on risk taking in general. more often than not, gambles do not occur in isolation but rather in the context of multiple gambles, where a final outcome will be a cumulative result of all such gambles. for example, a financial investment will probably be seen and assessed in the context of any other investments that an agent has undertaken. the experimental nature of this study offers an advantage over a study based on observational data that was not derived from a controlled experiment. differences in a student’s guessing behaviour as captured by observational data from an actual examination might be reflective of factors other than the student’s aggregate mark when entering the examination, while the controlled environment of the experiment aims to isolate the effect of the student’s aggregate mark. thus, the contribution of this article is twofold: firstly, the experiment has been set up in such a way as to allow us to isolate guessing behaviour by taking partial knowledge out of the equation. this is an advancement in the field of educational science in the sense that it has proven difficult to distinguish guessing behaviour from the effect of partial knowledge. secondly, guessing behaviour in any particular assessment has, up to now, been looked at in isolation. this study looks at the effect of framing (kahneman & tversky 1979), with respect to the effect of the score with which the student enters the assessment. in particular, we investigate the effect of the entry score on the degree of guessing in this particular assessment. this kind of framing effect, that is, aggregate score to date, has not been investigated in the economic or educational literature up to now and adds to the debate on the validity of mcqs as an assessment tool. our findings show that entering an assessment with a very low previous score encourages risk seeking behaviour. entering with a borderline passing score encourages risk aversion in this assessment. for those who place little value on every marginal point, entering with a very high score encourages risk seeking behaviour in the particular assessment, while entering with a very high score when a lot of value is placed on each marginal point leads to risk averse behaviour. this article will proceed as follows: the next section provides a description of the experiment conducted in this study. an analysis of the data and a discussion of the corresponding results is presented next and the last section concludes. experiment first-year economics students from the university of the witwatersrand were invited to participate voluntarily in the experiment. participating students were randomly allocated to four different treatment groups as they entered the venue for the experiment. however, an attempt was made to stratify allocation by gender by giving male and female participants different colour tickets with their respective group allocations to ensure that there was a sufficient number of male and female students within each group, thus permitting the analysis of possible treatment heterogeneities along gender lines. the decision-making experiment was conducted in a classroom setting. a multiple choice test (see appendix 1) consisting of 10 questions was presented to the students, and each question comprised of 3 possible solution options; the student needed to either choose one correct answer or omit the question. the test consisted of a number of questions that could not be answered, that is, none of the alternative solutions provided was correct, and a response to such a question was reflective of a pure guess (bereby-meyer, meyer & flascher 2002; slakter 1969). in order to create the perception of legitimacy of the multiple choice test, the first question was solvable and contained a correct solution; however, this solvable question was not considered in the final analysis of this study. a negative marking rule was adopted where each student received 2 points for a response that was predetermined by the research team as the ‘correct’ answer, and 1 point was subtracted for each response that was predetermined by the research team as an ‘incorrect’ response. in addition, no points were gained or lost for each omitted response. prior to the test, all students were informed about the negative marking rule and the potential payoffs (see appendix 1). the expected points from guessing are computed using the equation , in which g represents the number of points gained for a correct response, l represents the number of points lost for an incorrect response and c denotes the number of possible solution options. since each question comprised of three possible solution options and the student gained 2 points for a correct response, and lost 1 point for an incorrect response, the expected points from a random guess was 0 (ep = 0). a standard risk averse expected utility maximiser would not have guessed when the expected number of points from guessing was 0. participants were allocated to one of four experimental groups and were treated equally, aside from the points that they received before commencing with a multiple choice test. the first group consisted of students who were told that they were starting the multiple choice test with 53 points, the second group were told they were starting with 47 points, and the third and fourth groups were told that they were starting with 35 and 65 points respectively. the possible results of the multiple choice assessment ranged from 25 points to 85 points, encompassing the points that could be lost or gained in addition to the points that the students entered the experiment with. since this was not a real test counting towards the final grade for the course, in order to incentivise students to try and maximise their total scores (so that the situation would replicate a real test situation) a financial payout to each student was provided on a rand (r1) per point basis. in addition, participants were told that a bonus of r50 would be given to each student who reached a score of 50 points or above after completion of the test. the possible results of the multiple choice assessment, ranging from 25 points to 85 points, corresponded to a range with regard to the monetary payoff, from a low of r25 to a high of r135 (taking into account the r50 bonus). the bonus of r50 for students reaching or surpassing a score of 50 points created a reference for each group. two groups started off being close to the reference point (starting points 47 and 53) while the other two groups started off further away from the reference point (starting points 35 and 65). this allows us to investigate if the framing (relative distance to the reference point) affects the guessing behaviour of the students. the experimental nature of this study also enables a causal interpretation between the initial number of points received by each student and the tendency to guess. firstly, this relationship can be attributed to the exclusion of content knowledge as a covariate as participants could not reduce the number of possible solution options through their partial knowledge or obtain the correct answer to the question, since none of the alternative solutions provided was correct. secondly, the random allocation of participating students into the four groups tried to ensure that no other observable and unobservable characteristics could explain differences in the guessing behaviour of students. clearly, our interpretation of the results as a causal link depends on the assumption that the randomisation was successful in balancing our four groups in all other characteristics that might affect the guessing behaviour. while we try to test the balance of the four groups on a set of selected observed characteristics that are likely to be correlated with the students’ guessing behaviour, we cannot say with absolute certainty that the participants in the four groups only differ with respect to the allocation into the four groups. as such, it is possible that our results could still suffer from omitted variable bias. we then looked separately at participants willing to accept a wage of r500 a month, and those not willing to accept this wage. since the payoff in this study was in monetary terms, it was expected that students in greater financial need would attach greater value to every point. we proxied a student’s financial need status by the answer they gave to the question regarding whether or not they were willing to work for a wage of r500 a month. those willing to work for r500 a month (considered an extremely low wage) were assumed to be in greater financial need than those who were not. as such, the aim was to analyse how guessing behaviour changed, depending on the value students put on each mark. obviously students in more financial need would value each rand, and therefore each point in the test, more than a student who is financially better off. in a real test situation, students will differ in how they value each marginal point. while some students will be satisfied knowing they have a passing score (and not value each marginal point above that score), others will value each point they get over and above a passing score. similarly, some students who fail will not care by how many points they fail, whereas others, even though they know they might fail, will still value each point and attempt to maximise their score (perhaps because they would then be eligible for a supplementary – second chance – exam). in accordance with the university’s ethics policy, participation in this study was completely voluntary and participation or non-participation did not affect the students’ academic performance in any credit-bearing course. furthermore, the identity of participants remained completely anonymous as the findings are reported in aggregate format. in addition, participating students were made aware of the full range of possible financial payoffs before they made their decision on participation. ethical consideration this article was written with ethical clearance (protocol number: cecon/1031). analysis descriptive statistics the study sample consisted of 102 participating students. group 1 consisted of 28 students, group 2 of 25 students, group 3 of 24 students and group 4 of 25 participating students. as part of the experimental design, students were allocated randomly to the four groups. this is to ensure that the four groups differ only with respect to the starting points but not in any other observed or unobserved characteristic that could affect the guessing behaviour of the students. as a test (reported in table 1), we investigate if the four groups are balanced for a set of observed characteristics that are likely to affect their guessing behaviour; specifically we look at gender, their willingness to work for r500 per month, as well as their matriculation scores in english and mathematics. table 1: characteristics of composition of each group. as can be seen in table 1, despite the small number of participants in each group, the four groups are relatively balanced in their observed characteristics with respect to gender, willingness to work for r500 per month, as well as their academic performances in the final secondary schooling mathematics exams (matriculation). this was confirmed by the statistically insignificant f stats of the analysis of variance testing for these characteristics. however, the variance testing shows that group 3 does differ with respect to the final secondary schooling english exam marks compared to the other groups at a 10% level of significance. we address the potential differences in the groups in the regression analysis by including additional sets of covariates. figure 1 shows the outcome variable as the frequency of guesses taken by each group. students that were allocated to groups 3 (starting point 35) and 4 (starting point 65) were significantly more likely to take a guess compared to students that were allocated to groups 1 (starting point 53) and 2 (starting point 47). figure 1 also suggests that the difference is across the distribution and not driven by the guessing behaviour of just a few students but due to a significant shift of students that take a higher number of guesses. figure 1: frequency of guesses taken by allocated group. (a) group 1: starting point 53; (b) group 2: starting point 47; (c) group 3: starting point 35; (d) group 4: starting point 65. as is shown in table 2, both the mean and median number of guesses show that group 1, that is, those entering with 53 points, guess the least, while group 3, that is, those entering with 35 points, guess the most. this is also supported by the fact that only group 1 has a number of students who decided not to guess at all, whereas group 3 has by far the largest percentage taking a guess at all of the 9 unsolvable questions. table 2: guessing behaviour by group allocation. table 3 shows the frequency of guesses for those willing to work for r500 a month, and those who are not. we see in the first two columns of table 3 that when students place a higher value on every point, that is, in this case they are willing to work for r500 a month, students in group 2 (47 points) and group 4 (65 points) now guess less, that is, are more risk averse. in fact, their level of risk aversion now seems very similar to the group entering with 53 points. thus for the group entering with 65 points, even though it is impossible for them to fall below the 50 point level (at which point there would be a huge penalty), they still do not want to lose marginal points. for those entering with 47 points, even though they could jump above the 50 point level (which would result in a huge benefit), they are less willing to take the chance on losing marginal points. looking at table 3, when students place less value on each point, the level of risk seeking of group 4 (65 points) now seems to be very similar to that of group 3 (35 points). those in group 4 seem to care less about each marginal point, knowing that while they may lose marginal points, they can never fall below the 50 point level. table 3: effects by willingness to accept a monthly wage of r500. table 4 shows how these effects differ across gender. it seems that males and females act similarly near the 50 point reference mark where the stakes can be thought to be high, that is, in groups 1 and 2 the guessing behaviour of males and females is very similar. as one moves further away from the 50 point mark, that is, groups 3 and 4, females guess less than males, that is, they are more risk averse. table 4: gender effects. regression analysis with a successful randomisation, the analysis is simply a comparison of the differences in means. the analysis is therefore conducted using an ordinary least squares (ols) approach, with the average number of guesses for the nine unsolvable items in the multiple choice assessment as the dependent variable (y) regressed against the allocation into the four different groups (g) which enter the experiment with differential points. we use group 1 which received 53 points as the reference group. however, should the randomisation not have led to a balancing of other covariates, we need to test if the inclusion of additional covariates (d) mitigates the effect of being in any one of the four assignment groups. we initially test this by adding only gender and the willingness to work for r500 per month. additionally, we obtained english and mathematics matric scores but only for a reduced sample (for 90 students in total). as a robustness check, we reduce our sample to students for whom we have a full set of characteristics and test if the inclusion of the full set of covariates affects the group coefficients. thus, we estimate: in equation 1, ε represents the disturbance term. we conduct a second set of regressions which allows for the analysis of possible heterogeneities along the lines of gender and income status, in terms of how initial points affects guessing behaviour. this is done by using interaction terms such that: in equation 2, g*x is the interactive term between the group and a dummy variable representing either gender or participants’ willingness to accept a monthly wage of r500. table 5 shows the regression results of the ols regression represented by equation 1 for the full sample of participating students. column 1–3 reports the regression output for the full sample of 102 students. the first column in table 5 includes only the group allocation and shows that the guessing behaviour of students allocated to group 1 (53 points) and group 2 (47 points) do not statistically differ from one another, while students allocated to group 3 (35 points) and group 4 (65 points) took on average more guesses than students that were allocated to group 1. the point estimates for the groups are robust even when we control for gender and willingness to work for r500 per month. while the point estimate for males is positive, indicating that they are more likely to take a guess compared to females, the difference is not statistically significant. on the other hand, students that indicated that they are willing to work for r500 per month are significantly less likely to take a guess. table 5: regression results. the additional robustness test reported in columns 4 and 5 confirms the consistency of these findings. the average number of guesses taken by students in group 3 and group 4 remain above the number of guesses taken by students in group 1. while the randomisation seems to have been successful with respect to balancing the included observed characteristics, we can see that for the reduced sample the inclusion of the matric marks in english and mathematics marginally reduces the point estimate for group 3. however, the overall pattern remains consistent. the r-squared is low across the different specifications, which is not surprising given that a number of factors are likely to affect guessing behaviour. however, the aim of this study is not to predict guessing behaviour per se nor do we present a model that explains the variation in guessing behaviour. we are mainly interested in the relationship between the starting point at which the student enters the test (i.e. the allocation to one of the four groups) and the student’s guessing behaviour. similarly, while the f statistic is also low, the p value confirms that the variation between the groups is statistically significant at the 5% level of significance for the full sample and at the 10% level for the reduced sample. nevertheless, our results and interpretation do depend on the assumption that the randomisation was successful in balancing observed and unobserved characteristics across the four groups. table 6 shows various interaction effects. columns 1 and 2 represent the gender interaction effects for participants who are willing and not willing to accept a monthly wage of r500. in both cases the gender interaction with the group is insignificant, that is, the effect of being in a specific group does not differ significantly across gender. however, it does seem that when females are financially constrained (i.e. they are willing to work for r500 a month), they guess more than males (see the gender coefficient in column 1 where this group of females has an average of 2.6 more guesses than males). columns 3 and 4 show the interaction of financial need with the various groups for males and females. for both males and females, being in the position of being willing to work for r500 a month (i.e. being in financial need and valuing each additional rand) makes those in group 4 (i.e. those entering with 65 points) less likely to guess, or more risk averse. in particular, males in group 4 willing to work for r500 a month have an average of 2.7 guesses fewer than males in group 4 not willing to work for r500 a month, while females in group 4 willing to work for r500 a month have an average of 2.5 guesses fewer than females in group 4 not willing to work for r500 a month. table 6: regression results with interaction effects. discussion in this article we conduct an experiment aimed at replicating a situation where students enter an assessment with an existing average mark based on previous assessments. our aim is to analyse the effect of the average grade to date on students’ guessing behaviour in a multiple choice test with a negative marking rule. this is important for the literature on risk taking in general, in that a gamble should not be seen in isolation, but rather in the context of multiple gambles, where a final outcome will be a cumulative result of all such gambles. the experimental nature of this study offers an advantage over a study based on observational data that was not derived from a controlled experiment. differences in a student’s guessing behaviour as captured by observational data from an actual examination might be reflective of factors other than the student’s aggregate mark when entering the examination, while in the experimental setting we can isolate the effect of the aggregate mark. the incentive in this experiment is provided by way of a financial payout where money is paid for each marginal point, with a lump sum bonus being paid if the student’s final score is 50 points or above. this aims to replicate a situation where the vast majority of students would aim to pass a course (where 50 points here replicates a passing mark), with some students placing greater value on each marginal mark above or below that level than others. since the incentive provided here is monetary, we look at two groups of students, where one group is in greater financial need than the other. we assume students in greater financial need will place a higher value on each point, corresponding to each rand. we show that entering an assessment with a very low previous score (in this experiment 35 points) encourages risk seeking behaviour. entering with a borderline passing score (53 points) encourages risk aversion in this assessment. additionally, for those who place little value on every marginal point (here students in less financial need), entering with a very high score (65 points here) also encourages risk seeking behaviour in the particular assessment. in fact, the effect of valuing every marginal point is most prevalent for students entering with the highest amount of points (65), where students in this group who value every extra point are more risk averse, that is, guess less than students in this group who don’t place as much value on each extra point. the results can broadly be interpreted in the context of prospect theory as put forward by kahneman and tversky (1979), in which individuals seeing themselves in the loss domain are risk seeking, while those seeing themselves in the gain domain are risk averse. clearly, in this context this is prevalent at certain points only in these domains, that is, most risk seeking at extreme loss (35 points) (whereas in prospect theory one would expect individuals to be most risk seeking at a small loss), and most risk averse at small gain (53 points). whether or not students are more risk averse or more risk seeking at high gain (65 points) depends on the extent to which they value each point. these results are important in light of literature advocating that risk averse students are biased against in multiple choice settings, since in real test situations most students would have partial knowledge, so that the expected value of guessing would actually be positive. so far the literature has identified females and, in particular, better performing females as being biased against in this regard. here we identify a student’s existing average, apart from whether or not they are a good student (even though these are likely to be related), as a factor affecting risk aversion. indeed students entering with a borderline pass are most risk averse from this perspective, and thus most biased against. students with a borderline fail are second most risk averse. students entering with very low scores seem to be the most advantaged by such a multiple choice test with negative marking (especially if they have some content knowledge) in that they have little to lose from guessing. thus, previous results showing that worse students guess more could have a lot to do with the fact that they are entering with low scores. whether or not students entering with very high scores are risk averse depends on the degree to which they value each marginal point. students in this group who value each point are extremely risk averse, while those not valuing each point as much are extremely risk seeking. thus, top students might be biased against for two reasons: (1) as identified by previous studies they have better content knowledge, making the expected value of a guess positive; and (2) they are likely to be entering with a very high score and, if they place a high value on each point, as shown in this study, they will be more risk averse for this reason too. conclusion mcq testing is a popular assessment strategy for large university classes like first-year economics. however, in the light of our findings, the validity of multiple choice questions combined with a negative marking rule as an assessment tool is likely to be reduced and its usage might actually create a systematic bias against risk averse students. budescu and bar-hillel (1993) suggest that the ‘number-of-rights’ scoring method, that is, students getting 1 mark for a correct answer and 0 for an incorrect answer (also referred to as ‘lenient’ marking), may be better to assess candidates. however, the implications of such lenient marking on reliability and validity needs to be further researched as both negative marking and number-of-rights marking introduce validity concerns: negative marking can lead to systematically biasing risk averse students, while number-of-rights marking encourages guessing. course conveners need to consider this trade-off. nevertheless, both marking regimes affect the validity of mcq assessment marks as the final test scores not only reflect knowledge but also guessing behaviour. in response to this trade-off, lesage, valcke and sabbe (2013) propose a number of alternative scoring rules which may also be considered when using multiple choice as an assessment tool. acknowledgements funding was provided by african microeconomic research unit (ameru) for this study. competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contribution j.k. was involved in data collection and the preliminary analysis. a.r. and v.s. were involved in the design, analysis and contextualisation. references becker, w.e. & johnston, c., 1999, ‘the relationship between multiple choice and essay response questions in assessing economic understanding’, economic record 75(4), 348–357. ben shakar, g. & sinai, y., 1991, ‘gender differences in multiple choice tests: the role of differential guessing tendencies’, journal of educational measurement 28(1), 23–25. bereby-meyer, y., meyer, j. & flascher, o.m., 2002, ‘prospect theory analysis of guessing in multiple choice 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research unit, cape town. bush, m., 2001, ‘a multiple choice test that rewards partial knowledge’, journal of further and higher education 25(2), 157–163. davis, f.b., 1967, ‘a note on the correction for chance success’, the journal of experimental education 35(3), 42–47. eckel, c.c. & grossman, p.j., 2008, ‘forecasting risk attitudes: an experimental study of actual and forecast risk attitudes of women and men’, journal of economic behaviour and organization 68, 1–17. https://doi.org/10.1016/j.jebo.2008.04.006 hartford, j. & spearman, n., 2014, who’s afraid of the big bad wolf? risk aversion and gender discrimination in assessment, working paper 418, economic research southern africa, cape town. holt, a., 2006, ‘an analysis of negative marking in multiple-choice assessment’, proceedings of 19th annual conference of the national advisory committee on computing qualifications, pp. 115–118, 7–10 july 2006, wellington new zealand. kahneman, d. & tversky, a., 1979, ‘prospect theory: an analysis of decisions under risk’, econometrica 47(2), 263–291. kniveton, b.h., 1996, ‘a correlational analysis of multiple-choice and essay assessment measures’, research in education manchester 56(1), 73–84. lesage, e., valcke, m. & sabbe, e., 2013, ‘scoring methods for multiple choice assessment in higher education – is it still a matter of number right scoring or negative marking?’, studies in educational evaluation 39(3),188–193. marin, c. & rosa-garcia, a., 2011, gender bias in risk aversion: evidence from multiple choice exams, working paper 39987, munich personal repec archive, munich. roediger iii, h.l. & marsh, e.j., 2005, ‘the positive and negative consequences of multiple-choice testing’, journal of experimental psychology: learning, memory and cognition 31(5), 1155–1159. https://doi.org/10.1037/0278-7393.31.5.1155 slakter, m.j., 1969, ‘generality of risk taking on objective examinations’, educational and psychological measurement 29(1), 115–128. walstad, w. & becker, w., 1994, ‘achievement differences on multiple-choice and essay tests in economics’, american economic review 84(2), 193–196. appendix 1: test questionnaire: student number: ____________________ gender: ____________________ as a student, would you be willing to accept a job that pays a monthly wage of r500? yes ________ no ________ multiple choice questions: a group of modern economists who believe that markets clear very rapidly and that expanding the money supply will always increase prices rather than employment are the: monetarists post-keynesians keynesians what is the next term in the following sequence? 1, 1, 2, 3, 19, 34, 83, … … … … … … … 162 115 247 the independent labour and employment equity action plan was drafted by mbazima sithole in which year? 1996 1994 1999 who is the author of the book titled: ‘random walks and business cycles for dummies’? norman gladwell milton savage john friedman the law of diminishing demand states that: as more of a particular good is demanded by the economy, less of that good is demanded by an individual. if good a is preferred to good b, then a higher demand for good b implies a lower demand for good a. as more of a good is supplied in an economy, the less of that good is demanded by the economy. the depression of 1978 occurred as a result of: severe drought affecting subsistence agriculture and herding. a banking panic which came about as a result of depositors simultaneously losing confidence in the solvency of the banks and demanding that their deposits be paid to them in cash. a decline in the population growth rate. a pareto supremum refers to the allocation of resources in which: all resources are directed to a single individual and no one can be made better off. it is possible to make all individuals better off. a socially desirable distribution is acquired through all individuals having a higher income. the principle of malthusian dominance states that: gains in income per person through technological advances dominates subsequent population growth. an increase in the market price caused by an increase in demand dominates the higher price caused by a deficiency in supply. increased demand for subsistence consumption eliminates the non-productive elements of the economy. the population poverty index estimates: the percentage of the population living in poor regions. the number of people earning below $1 a day. the average worldwide population living below the poverty line. a walrasian balanced growth path refers to: the act in which excess market supply counteracts excess market demand. a situation in which output per worker, capital per worker and consumption per worker are growing at a constant rate. an efficient allocation of goods and services in an economy, driven by seemingly separate decisions of individuals. preamble to various groups group 1 good day welcome to this decision-making experiment. my name is (author name). before proceeding to the test questionnaire, please take note of the experimental instructions below. at the beginning of the test, you already have 53 points to start off with and you are now being placed in a test situation in which you may gain or lose points in addition to the 53 points. these additional points may be gained or lost through a multiple choice test with the following rules: you are required to answer a multiple choice test consisting of 10 questions in total. you will receive 2 points for each correct response; lose 1 point for each incorrect response; and no points will be gained or lost for each question that you choose to omit. your final amount of points will be calculated as 53 plus the number of points you obtain in the test. the payoff you receive will be on a rand (r1) per point basis, i.e. you will receive r1 for each of your final amount of points. in addition, you will receive a bonus of r50 if your final score is above 50 points on completion of the test. for example: if you receive 8 points for the test, your final amount of points will be 61 (53+8). in this instance, you will receive r61 + r50 bonus since your final score is above 50 points. therefore, your final payout will be r111. if however you receive –6 points (lose 6 points), for example, your final amount of points will be 47 (53–6). in this instance, you will receive a payout of r47 (you will not receive a bonus of r50 because your final score is below 50 points). note that your total payoff can vary between r43 and r123. you have 20 min to complete the test. please note that your participation in this experiment is completely voluntary, involves no risk and will not affect your academic results in any way. your answers to these questions are completely confidential and your identity will remain anonymous in the analysis of this study. if you have any questions regarding the instructions above, please feel free to ask. should you wish to withdraw from this experiment, you may do so at any stage. thank you for your consideration to participate in this experiment. should you wish to enquire about my study or access my final results, please feel free to contact me at (author email address). you may now proceed to the test questionnaire. kind regards <author name> group 2 good day welcome to this decision-making experiment. my name is (author name). before proceeding to the test questionnaire, please take note of the experimental instructions below. at the beginning of the test, you already have 47 points to start off with and you are now being placed in a test situation in which you may gain or lose points in addition to the 47 points. these additional points may be gained or lost through a multiple choice test with the following rules: you are required to answer a multiple choice test consisting of 10 questions in total. you will receive 2 points for each correct response; lose 1 point for each incorrect response; and no points will be gained or lost for each question that you choose to omit. your final amount of points will be calculated as 47 plus the number of points you obtain in the test. the payoff you receive will be on a rand (r1) per point basis, i.e. you will receive r1 for each of your final amount of points. in addition, you will receive a bonus of r50 if your final score is above 50 points on completion of the test. for example: if you receive 8 points for the test, your final amount of points will be 55 (47+8). in this instance, you will receive r55 + r50 bonus since your final score is above 50 points. therefore, your final payout will be r105. if however you receive –6 points (lose 6 points), for example, your final amount of points will be 41 (47–6). in this instance, you will receive a payout of r41 (you will not receive a bonus of r50 because your final score is below 50 points). note that your total payoff can vary between r37 and r117. you have 20 min to complete the test. please note that your participation in this experiment is completely voluntary, involves no risk and will not affect your academic results in any way. your answers to these questions are completely confidential and your identity will remain anonymous in the analysis of this study. if you have any questions regarding the instructions above, please feel free to ask. should you wish to withdraw from this experiment, you may do so at any stage. thank you for your consideration to participate in this experiment. should you wish to enquire about my study or access my final results, please feel free to contact me at (author email address). you may now proceed to the test questionnaire. kind regards <author name> group 3 good day welcome to this decision-making experiment. my name is (author name). before proceeding to the test questionnaire, please take note of the experimental instructions below. at the beginning of the test, you already have 35 points to start off with and you are now being placed in a test situation in which you may gain or lose points in addition to the 35 points. these additional points may be gained or lost through a multiple choice test with the following rules: you are required to answer a multiple choice test consisting of 10 questions in total. you will receive 2 points for each correct response; lose 1 point for each incorrect response; and no points will be gained or lost for each question that you choose to omit. your final amount of points will be calculated as 35 plus the number of points you obtain in the test. the payoff you receive will be on a rand (r1) per point basis, i.e. you will receive r1 for each of your final amount of points. in addition, you will receive a bonus of r50 if your final score is above 50 points on completion of the test. for example: if you receive 18 points for the test, your final amount of points will be 53 (35+18). in this instance, you will receive r53 + r50 bonus since your final score is above 50 points. therefore, your final payout will be r103. if however you receive –5 points (lose 5 points), for example, your final amount of points will be 30 (35–5). in this instance, you will receive a payout of r30 (you will not receive a bonus of r50 because your final score is below 50 points). note that your total payoff can vary between r25 and r105. you have 20 min to complete the test. please note that your participation in this experiment is completely voluntary, involves no risk and will not affect your academic results in any way. your answers to these questions are completely confidential and your identity will remain anonymous in the analysis of this study. if you have any questions regarding the instructions above, please feel free to ask. should you wish to withdraw from this experiment, you may do so at any stage. thank you for your consideration to participate in this experiment. should you wish to enquire about my study or access my final results, please feel free to contact me at (author email address). you may now proceed to the test questionnaire. kind regards <author name> group 4 good day welcome to this decision-making experiment. my name is (author name). before proceeding to the test questionnaire, please take note of the experimental instructions below. at the beginning of the test, you already have 65 points to start off with and you are now being placed in a test situation in which you may gain or lose points in addition to the 65 points. these additional points may be gained or lost through a multiple choice test with the following rules: you are required to answer a multiple choice test consisting of 10 questions in total. you will receive 2 points for each correct response; lose 1 point for each incorrect response; and no points will be gained or lost for each question that you choose to omit. your final amount of points will be calculated as 65 plus the number of points you obtain in the test. the payoff you receive will be on a rand (r1) per point basis, i.e. you will receive r1 for each of your final amount of points. in addition, you will receive r50 for participating in this test. for example: if you receive 10 points for the test, your final amount of points will be 75 (65+10). therefore, your final payout will be r125 (r75 + r50). if however you receive –10 points (lose 10 points), for example, your final amount of points will be 55 (65–10). in this instance, you will receive a payout of r105 (r55 + r50). note that your total payoff can vary between r105 and r145. you have 20 min to complete the test. please note that your participation in this experiment is completely voluntary, involves no risk and will not affect your academic results in any way. your answers to these questions are completely confidential and your identity will remain anonymous in the analysis of this study. if you have any questions regarding the instructions above, please feel free to ask. should you wish to withdraw from this experiment, you may do so at any stage. thank you for your consideration to participate in this experiment. should you wish to enquire about my study or access my final results, please feel free to contact me at (author email address). you may now proceed to the test questionnaire. kind regards <author name> sajems ns vol 2 (1999) no 1 origins of economic instability: real, financial or both? * part i: an account of minsky's financial instability hypothesis j s hart department of economics, university of natal, durban abstract the 1990s have put the issue of global economic stability under the spotlight. this calls for a re-examination of the economic theory surrounding the subject. here a three-fold classification is useful. the first grouping locates the source of stability in the workings of the real sector of the economy. a second, following hyman minsky, contends that instability arises in the financial sector. a third grouping draws on a distinction by schumpeter to argue that any effective analysis of stability or instability requires a theoretical framework that integrates both the real and financial sectors at the most basic level. in the light of the current financial crisis which originated in south-east asia, the second grouping appears most relevant. part ii will give an appraisal of minsky's theory. jel e 44 introduction the post-war stability of the 1950s and 1960s was widely regarded as evidence of the validity of keynesian theory and policy. it was generally accepted that while theoretically the market mechanism would, in the long run, lead to stable equilibrium levels of income and full employment, in the short run government intervention in the form of monetary and fiscal policy was necessary for economic stability. these were the heydays of keynesianism. it was believed that policy intervention could be so accurate that it was possible to 'fine-tune' the economy to a position of full employment with zero inflation. • part ii of this paper and the list of references ",ill appear in the next issue of sajems. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 2 sajems ns vol 2 (1999) no i the inability of keynesian fiscal and monetary policies to control the increasing inflation and unemployment of the 1970s eventually led to questioning of the theoretical base. rightly or wrongly keynesianism was blamed for the huge increase in government spending which was argued to be the underlying cause of the high rates of inflation and unemployment. the scene was set for a resurgence of faith in the ability of competitive markets to provide a self-regulatory mechanism which would ensure a stable full employment level of income without inflation. according to monetarists, interventionist policies could change levels of output and inflation, but only in the short run. the rational expectations hypothesis was advanced against even this possibility: rational market players would swiftly outwit and outperform policy planners. mckinnon (1973) and shaw (1973) argued against government regulation in financial markets, or 'fmancial repression'. according to the financialliberalisation perspective fmancial markets are inherently stable. over the last decade monetary policy came to focus almost exclusively on the single objective of price stability in the belief that this was the best, if not only, route to ensuring financial and economic stability (bordo & wheelock, 1998: 41). the dramatic stock market crash of september 1987, record levels of unemployment in the industrial economies, and increased instability in world financial markets in the 1990s have dampened expectations about the ability of free markets to ensure stable and optimal levels of income and employment. in the face of these developments keynesian economics appears to be staging a comeback (hutton, 1992). and monetarism is being questioned: arestis (1998) provides evidence that fmancial liberalisation in developing countries in the 1980s and 1990s has destabilised rather than stabilised these economies. even international fmancier george soros (1998) has called for some sort of regulation of global fmancial markets. the global economic instability of the 1990s calls for a re-examination of the literature on economic stability and instability. here a three-fold classification is useful. the first grouping locates the source of economic stability or economic instability in the workings of the real sector of the economy. neoclassical theory supports the view that free-market economies are permanently stable. by this is meant that they are stable self-regulating mechanisms. provided there is free competition, market forces in both the real and financial sectors can be relied upon to ensure stability. the stability arises from the free interaction of market demand and supply which are grounded upon stable real forces, e.g., productivity and thrift, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no i 3 rather than any monetary forces. only real forces matter for the stability of the system and money is seen to be essentially neutral as it has no real effects. while the marxian tradition also focuses on the real sector, it regards capitalist free-market economies as permanently unstable. the instability arises because of a long-run tendency for the rate of profit in the real sector to fall. the second grouping is that surrounding the writings of minsky (1975, 1977, 1982a, 1986a, 1986b). minsky sees capitalist economies as endemically unstable. the roots of this instability are to be found in the financial, rather than the real, sector. kregel (1998: i) views the current asian crisis as "a clear case of the minsky instability hypothesis". the third grouping draws on a distinction by schumpeter (1954) developed by rogers (1989). this grouping sees capitalist economies as potentially unstable. for rogers, analysis of the potential for instability must be based on a proper integration of real and monetary forces such as that achieved by 'monetary analysis' rather than 'real analysis' (schumpeter, 1954: 277-8). for minsky the increasing inflation, unemployment and exchange rate fluctuations of the 1970s were a return to the nonnal cyclical behaviour of a capitalist economy. minsky sees keynesian policies as having been able, though with increasing difficulty, to impart a degree of stability to the post-war industrial economies. this stability, however, was not pennanent because in minsky's view capitalist economies are endemically unstable. what he means by this is that they are inherently liable to both short-run cyclical instability and the constant threat of a 1929-type economic collapse. the roots of this instability are to be found in the financial sector of the economy. it is monetary forces rather than real forces which are the cause of the instability of the system. specifically, instability has to do with the relationship between money and debt in the process of financing investment (fisher, 1933). only continuous government intervention moderates cyclical instability and staves off imminent catastrophe. paradoxically, however, this very action by governments simply serves to delay the onset, sooner or later, of economic disaster. for rogers (1989) and the third grouping, the economy is neither liable to constant pressures of boom or bust nor is there some inherent tendency towards a 1929-type great depression. on the other hand, the view that free markets alone can be relied upon to ensure full employment and price stability is also rejected. rather, capitalist economies are seen to be potentially unstable. this means that there is only a fragile basis for the stability that does prevail. this is because certain key variables such as the wage rate and the interest rate are not grounded in any natural, objective or real foundation. following shackle (1967, 1974), rogers argues that the fonnation of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 4 sajems ns vol 2 (1999) no 1 these key economic variables depends upon social, subjective and arbitrary conventions and traditions which prevail in an economy at a particular point in time. but whereas others have discerned nihilistic implications in shackle's views, rogers (1989) develops a constructive interpretation by combining shackle's analysis with keynes's principle of effective demand to support the notion of a long-term equilibrium which could be one of less-than-full employment. this long-term equilibrium, he suggests, is potentially unstable. the neoclassical and marxian views (that only real forces matter), and minsky's view (that only financial forces matter), may be contrasted with the view that both real and monetary forces are integrally bound up with the stability of the system. rogers (1989) argues that today's received theory the neoclassical-keynesian synthesis, monetarism and the rational expectations hypothesis has not achieved a successful integration of real and monetary forces in explaining the workings of the world's industrial economies. conventional economic theory remains trapped within the tradition of real analysis. it is worth quoting at length schumpeter's distinction between real analysis and monetary analysis: real analysis proceeds from the principle that all the essential phenomena of economic life are capable of being described in terms of goods and services, of decisions about them, and of relations between them. money enters the picture only in the modest role of a technical device that has been adopted in order to facilitate transactions ... so long as it functions normally, it does not affect the economic process, which behaves in the same way as it would in a barter economy: this is essentially what the concept of neutral money implies. on the other hand, monetary analysis introduces the element of money on the very ground floor of our analytic structure and abandons the idea that all essential features of our economic life can be represented by a barter-economy model. money prices, money incomes ... no longer appear as expressions ... of quantities of commodities and services and of exchange ratios between them: they acquire a life and importance of their own and it has to be recognised that essential features of the capitalist process may r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 depend upon the 'veil' and that the 'face behind it' is incomplete without it (schumpeter, 1954: 277-8). 5 the appraisal of minsky's theory developed in this paper draws substantially on the ideas developed by rogers (1989) in arguing that the economy is potentially, rather than endemically, unstable. rogers contends that any fruitful analysis of the economic system has to be firmly rooted in the tradition of monetary analysis. in arguing that the economy is endemically unstable, minsky is at odds with keynes's principle of effective demand which defines a stable though not necessarily a full employment equilibrium. by contrast, rogers's view of the economy is consistent with this central concept of the general theory whilst simultaneously allowing for the potential of instability. in struggling to escape from the confines of real analysis where real forces are the ultimate economic determinants, minsky (1975) has adopted the polar opposite view that only monetary forces matter. although minsky's (1982b, 1986a) later contributions involve the recognition that real forces are also important, any integration is bound to fail because minsky's (1975) analysis cannot be simply extended to include real forces. instead it needs to be fundamentally revised so that monetary and real forces are integrated on the 'ground floor' in the tradition of monetary analysis. the paper is divided into six sections. in part i we begin with a statement of minsky's financial instability hypothesis. next, the criticisms that have been levelled at this theory mainly from a neoclassical perspective, are reviewed. the third section examines criticisms and interpretations of minsky's theory from a perspective influenced by the marxian tradition. in part two, the fourth and fifth sections consider post-keynesian interpretations and policy implications of minsky's theory. in the final section we consider the relationship between minsky's theory and monetary analysis. if minsky's theory is to be grounded in the tradition of monetary analysis, then this paper argues that it needs to be substantially re-worked. minsky's financial instability hypothesis minsky has developed his theory over the years from when it was first extensively set out in his john maynard keynes (1975). in minsky (1982b, 1986a) he extends his theory to take into account related developments in post-keynesian theory. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 6 sajems ns vol 2 (1999) no 1 these include a theory of the detennination of profits within the kalecki-robinson tradition. the 1975 statement: a financial theory of investment for minsky (1975: 94) "the core of the general theory is the theory of investment and why it is so prone to fluctuate". hicks's interpretation of keynes's theory of investment is described as a caricature of that theory. investment is not a simple function of the rate of interest. it depends on the difference between the demand price and the supply price of capital goods and is related "not only to prospective yields but also to ongoing financial behaviour" (minsky, 1975: 94). we will start by examining the factors underlying the demand price. keynes (1936: chapter 17) analyses the relative price of different types of assets. he distinguishes three characteristics or 'attributes' of assets which together detennine the total return expected from a particular asset. ... the total return expected from the ownership of an asset over a period is equal to its yield minus its carrying cost plus its liquidity premium i.e. to q c + i ... (keynes, 1936: 226). [this expected total return], i.e. [t]he explicit and implicit cash flow, q c + i, is capitalized to yield a value of the asset which is the demand price (minsky, 1975: 81). minsky (i975a: 91) writes this demand price as the following function: pk k(m, q, c c) (1) where m money supply, q = expected cash flows, c = acceptable cash payment commitments and c a particular liability structure embodying cash payment commitments. for a given money supply, expected cash flows and liability structure, the greater acceptable cash-payment commitments, the higher the price of capital assets. "the function will shift as the subjective views about prospective yields, the q's, and the value of liquidity, i, change" (minsky, 1975: 91). minsky uses the pk function to replace the liquidity preference function of standard analysis it refers to the prices of financial as well as real assets and to prices of units in the already existing stock r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol2 (1999) no 1 7 of assets. minsky (1975: 94-95) notes that keynes uses lower-case q's to refer to yields from capital assets when held in portfolios and upper-case q's to refer to prospective yields from capital assets used in production. these prospective yields are quasi-rents, the result of the scarcity of capital, and do not represent the marginal physical product of capital. it is much preferable to speak of capital as having a yield over the course of its life in excess of its original cost, than as being productive. for the only reason why an asset offers a prospect of yielding during its life services having an aggregate value greater than its initial supply price is because it is scarce ... if capital becomes less scarce, the excess yield will diminish, without its having become less productive at least in the physical sense (keynes, 1936: 213, emphasis in original). minsky emphasises that, for keynes, the scarcity yield of a capital asset varies over the business cycle whereas the marginal product of capital in orthodox theory is technologically determined. this is why keynes refers to the marginal efficiency, rather than the marginal productivity, of capital. while keynes himself says that there is no 'material' difference between his marginal efficiency of capital (mec) schedule and the demand curve for capital of 'classical' writers (keynes, 1936: 178), minsky argues that there is a significant difference. the 'classical' demand curve ties demand for capital in an almost one-to-one relationship with its productivity. keynes's mec schedule does not relate to productivity directly because there are two attenuating factors between productivity and investment, the first being, variability in the prospective yields and the second variability in the relation between the present value ... [which depends on the rate at which prospective yields are capitalized] and the market rate of interest on money loans (minsky, 1975: 99). these two attenuating factors introduce uncertainty into the investment decision. the second factor presents an alternative way (alternative to constructing the mec schedule) to analysing the investment decision: capitalizing the prospective yields generates a demand price for investment which may be compared to a supply price of investment output. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 8 sajems ns vol 2 (1 999} no i the fundamental relation in the theory of investment is the demand price of capital assets as determined by the capitalization of prospective yields ... the fundamental fact about this [relation] is that it is unstable (minsky, 1975:101, 105). so far we have been discussing only the demand price for capital assets (and investment). but the decision to invest depends on the demand price exceeding the supply price of investment output. we thus need to examine what factors underlie the supply price. over against the prospective yield of the investment we have the supply price of the capital-asset, meaning by this, not the market-price at which an asset of the type in question can actually be purchased in the market, but the price which would just induce a manufacturer newly to produce an additional unit of such assets, i.e. what is sometimes called its replacement cost (keynes, 1936: 135, emphasis in original). "the supply price of the capital asset can best be interpreted as a schedule, in which higher demand prices for capital assets will yield greater outputs of investment goods" (minsky, 1975: 95). this schedule is stable compared to the demand price for capital assets. changes in wage rates will shift this schedule (as will changes in user cost and productivity). this schedule along with the consumption function are the two stable functions in keynes's general theory. now that we have seen what lies behind the demand price and supply price of capital assets, we can turn to analyse the investment decision. the financial instability hypothesis in broad terms, minsky argues that a capitalist economy with a sophisticated fmancial system has an inherent tendency towards instability. while this tendency is inherent or endogenous, exogenous shocks may also generate instability. the tendency arises because, as investment (and indebtedness) increases, a boom mentality leads to progressive underestimation of investment risks until there exists a state of 'overindebtedness'. more importantly, the form of indebtedness changes: in minsky's terms, the financial structure becomes fragile. as long as cash flows are sufficient to cover debt repayment commitments, the system functions smoothly. however, when the system is fragile there is too small a margin between cash inflows and outflows. in this state of affairs any normal disappointment of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 9 expectations concerning cash flows is sufficient to trigger the onset of a minsky crisis. alternatively the crisis may be reached earlier if an increasingly fragile system receives an external shock such as a rise in the interest rate or in the wage rate. such a shock makes it more difficult for some firms with a particular form of indebtedness to repay their debts. others feel they too may soon be short of funds. there is an increased liquidity preference. once firms try to sell their assets a fall in asset prices starts minsky's debt deflation. this leads to a fall in investment which reinforces the crash. minsky is none too clear about the necessary length of the depression, but once the turning point is reached, the conditions are re-laid for a repetition of the cycle. figure 1: price of investment marginal lender's risk , e/ / price of pi( i-----------' __ ----------~--==------r-_t_----capital assets lender's risk ./ c ____________________________________ ;;..>'"~ __ _ i----------------~~-----------+~----p, a q i internal funds ... . , __________________ ~ __________ -l __________ ~ j o j investment as discussed earlier, minsky analyses the investment decision in terms of the demand price for capital assets (pk ) and their supply price (pi)' this is preferred over the mec method. although keynes used the mec method, he emphasised the importance of the role of the prices of capital goods (rather than the rate of interest) in bringing about equilibrium in the capital goods market. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 10 sajems ns vol 2 (1999) no 1 but the equality between the stock of capital-goods offered and the stock demanded will be brought about by the prices of capital goods, not by the rate of interest (keynes, 1936: 186n, emphasis in original). in a world of certainty, firms will demand an infinite amount of investment as long as pk > pi. but minsky points out that in keynes's world lender's and borrower's risk exists. figure i above (reproduced from minsky, 1975: 108) represents the financing behaviour of a representative firm. qiqi depicts the prospective yield which is available for internal funding of investment. it is drawn as a rectangular hyperbola to show it is independent of the individual firm's level of investment. likewise, the supply price of capital assets is assumed to be independent of the firm's level of investment. the amount of investment that can be internally financed, i, will be given by the quotient of qiqi and pi if the firm wants to invest at a level higher than i, it will have to use external funds. since these are assumed to be more expensive, there is a discontinuity in the pi curve at this point. the lender's risk curve then describes the supply price of investment goods and this increases along with lender's risk. lender's risk exists because of the risk to the lender of default on the loan. while lender's risk raises the supply price of the capital asset, borrower's risk selves to lower the demand price. borrower's risk arises because the entrepreneur is uncertain about the prospective yield. where the two curves intersect at di the level of investment, 11 is determined. in terms of averages, at 11 level of investment, oa will be internally financed, api debt financed, p /: the interest charges and cp k the profit. as we have seen in the previous subsection, pk and pi are determined in very different ways. minsky emphasises that pi is the supply price of current (consumption or investment) output and, as such, is closely linked to the level of wages: if these are stable, then pi will be stable. pi is given to the individual firm. pk on the other hand is dependent on the subjective estimate of the prospective returns (quasi-rents) the firm can earn from the asset. in contrast to pi which is a flow magnitude, it is a stock magnitude. in minsky's model, it is the lender's and borrower's risk which are the immediate determinants of investment. if these decrease (the curves shift outwards so that they intersect to the right of d 1) a higher level ofinvestment will be undertaken. because of the increased cost of external finance, the supply price of investment (pj) will rise once internally financed investment is exhausted. hence the lender's risk curve slopes upwards. to see the influence offinance on pk is not so easy. it would seem r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 11 that, in addition to the uncertainty surrounding the prospective returns which result in a particular pk, there is an increased risk once money is borrowed. ifwe adopt the borrower's viewpoint, we can see that the more he borrows, the greater will be the proportion of certain cash outflows to the uncertain cash inflows. these extra uncertain cash inflows will not be as highly valued as the ones obtainable without borrowing. the returns will thus be discounted at a higher rate (capitalized at a lower rate). this is reflected in a lower p k. hence the borrower's risk curve slopes downwards. the starting point for minsky is the idea that a decision to invest is simultaneously a decision to acquire debt. (unlike the neoclassical analysis saving does not precede investment see chick, 1983: chapter 9.) he accepts that retained profits are used to fund investment, but focuses his attention on the necessity to acquire debt if further real investment is desired. it is the funding of this further real investment which is the focus of minsky's analysis. keynes assumed that firms could acquire whatever funds they needed at the market rate of interest. minsky points out that we need to examine closely the manner in which firms acquire their debt we need to focus on the liability structure of firms. here the analysis is on the micro level. firms finance their investment projects by selling assets i.e. titles to wealth (equity and bonds). this occurs on the stock exchange and financial markets. minsky distinguishes three types of liability structures. the first, hedge financing, is where the firm funds most of its investment from internal sources and emits only a small amount of debt. hedge financing is where the cash inflows to the firms (quasi-rents) are sufficient to cover the cash outflows payments on debt in every period. speculative financing describes the position where cash inflows are not sufficient to cover debt commitments in every period (refinancing is thus necessary); however, by the end of the investment project period, cash inflows will be sufficient to cover the total debt commitment. ponzi financing is an extreme form of speculative financing whereby firms have to acquire more debt simply to pay the interest on the existing debt. it is minsky's contention that as a boom continues firms will be willing to finance more and more investment in a speculative way thus putting less and less of a premium on liquidity. this is because they are confident that future returns will be forthcoming which will more than cover the debt commitments. likewise, those wealth holders who are willing to lend the finance do so because they too have a low r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 12 sajems ns vol 2 (1999) no i liquidity premium. they are willing to acquire equity and bonds and hold minimal idle balances. the analysis leads us to an examination of the asset portfolio of wealth holders (which include non-financial firms, financial firms and householders). as the boom continues, so the liability structure becomes increasingly layered with debt built on debt: it becomes fragile. there is an inherent tendency for this to occur. this is because financial institutions profit out of selling debt: they are only too willing to supply the requisite funds. now, in this financially fragile environment, wealth holders increasingly become aware of the danger of the heavily-layered liability structure. it takes only a normal disruption of expectations concerning cash flows for confidence in the system to weaken. minsky sees nonfinancial firms selling assets to cover debt commitments. this may spread to other wealth holders, and if it does, the general selling of assets will lead to a fall in their prices and a consequent rise in the rate of interest. the increase in liquidity preference and the consequent drying up of finance curtails the volume of investment; in minsky's investment diagram we can visualise both the borrower's and lender's risk curves contracting. the reduction in investment will lead via multiplier-accelerator mechanisms to lower and lower levels of output and employment. we are in a debt-deflation process. unemployment and a depression may result. "if the decline is not severe, the conditions for a more severe decline are created" (jarsulic, 1988: 548). for minsky then, the basic instability of the economy arises in the financial sector. it arises because the prospective returns from investment occur over a long period whereas the investment project is funded with debt of a much shorter term: in this sense it is an investment theory of business cycles. the deep-seated cause of the instability of investment lies in the instability of portfolios and financial interrelations because it is these institutions which reflect changing (uncertain) views about the future. "keynes without uncertainty is something like hamlet without the prince" (minsky, 1975: 57). minsky sees the economy not as naturally tending towards a position of rest, but rather as one in which each current state of the economy is transitory. the economy constantly moves from a boom to crisis to deflation to stagnation to expansion and recovery. "each state nurtures forces that lead to its own destruction" (minsky, 1975: 128). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 13 extending the theory: post-1975 developments the question that arises naturally from the foregoing is what has prevented a largescale minsky-type debt deflation and deep depression from occurring to date in the usa? minsky (l986a) analyses the economic experience of the usa between 1975 and 1986. the reason the recession of 1975 did not turn into a deep depression is explained by minsky as being due to the impact of government expenditure as well as lender-of-iast-resort intervention by the central bank. however, the recession of 1982 was prevented from turning into a major depression simply by the central bank acting as lender of last resort: no government expenditure was needed. the theoretical explanation as to why massive government expenditure is sometimes also necessary (the 1975 us federal deficit increased to over five times the 1974 deficitminsky, 1986a: 29) is the task of minsky (1982b, 1986a). minsky (1986a: 141) points out that the role of prices in neoclassical theory is "limited to explaining how relative prices of currently produced goods adjust so that markets are cleared ... ". but prices accomplish more than resource allocation only. in particular, they need to ensure that (i) a surplus is generated, (2) incomes are imputed to capital assets (i.e., profits), (3) the market prices of capital assets are consistent with the current production costs of outputs that become capital assets, and (4) obligations on business debts can be fulfilled ... [in short] ... prices must carry profits (minsky, 1986a: 141-2, emphasis in original). prices, in addition to carrying profits, must also cover costs. firms base their prices on costs which comprise labour, materials, as well as financial costs. the prices are calculated as a mark-up on these costs. the size of the mark-up depends on the market power of the firm. minsky goes on to stress that investment depends on the difference between two price levels that exist in the economy the one for current output and the one for already-produced capital assets. the capital goods price, pk, must exceed the price of current investment output, pi, by a degree sufficient to ensure the required amount of investment. this means that both realised and expected profits must be sufficiently high. and this, in tum, leads us to ask how profits are determined. minsky proceeds to answer this question along kaleckian (1971) lines see minsky (1982b: 24-30; 1986a: 145n, 14n). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 14 sajems ns vol 2 (1999) no 1 several assumptions are made. firstly, there are workers who produce consumer and investment goods, and capitalists who receive profits. secondly, workers spend, and capitalists save, all their income. the demand for consumption goods thus stems solely from the total wage bill there is no demand from profit income. if consumption goods only were produced, the total wage bill would be w flc so that pcqc = w fl", which gives us (2) (3) where pc and qc are the prices and quantities of consumer goods. let we and wi be the wage rates in the consumer good and investment good sectors, nc and ni employment in the respective sectors, and x the profits or gross capital income. now if w ni represents the wage bill in the investment goods sector, then (4) (5) so that profits in the consumer goods sector equal the wage bill in the investment goods sector. the demand for invest!?ent goods, i, is i = pqi= wni + 7r1 (6) since, from (4) w ni, = xc we have i=nc+ 7ri=7r (7) thus, we arrive at kalecki's idea that profits equal investment. the conclusion is of course based on strong assumptions and minsky (i 986a: 147-170) proceeds to relax these conditions. the kaleckian theory explains how government expenditure may help avert a minsky crisis. any decline in investment expenditure can be countered by an increase in government expenditure so that demand and profits remain at a level sufficient to maintain the appropriate level of investment. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 investment or its equivalent in government deficits is necessary to sustain profits so that the inherited debt structure and historical capital-asset prices are validated (minsky, 1986a: 169-170). hence, a steady or increasing level of government expenditure can at least ameliorate the development of the crisis (jarsulic, 1988: 548). the neoclassical critics 15 this section deals with those criticisms of minsky which are made mostly from an orthodox position, i.e. the neoclassical-keynesian synthesis and monetarism. flemming (1982) says minsky's work does not do justice to mainstream theorists such as tobin (1969) who have emphasised aspects of finance and stability rather than instability. minsky's theory of investment relies on a two-sector model. this is not novel, he says, and cites hicks (1937) and witte (1963) as examples. hahn (1966) has also examined the possibility of instability when there are many assets, some of which are financial. flemming's next point is that minsky's conclusion that wage and price flexibility may generate instability does not follow from any arguments concerning the financial and debt structure upon which so much of minsky's thesis centres. instead the minsky mechanism that generates endogenous crises is extremely general it is not restricted to capitalism. his argument depends on agents failing to distinguish a run of good luck from a favourable shift in their environment. this implies that authorities should intervene randomly to promote stability. melitz (1982) argues that minsky's hypothesis is one of financial fragility rather than instability. the extent of speculative financing depends entirely on the term structure of debt: the shorter the term, the more speculative the form of debt. but the term structure of debt depends on the time profile of interest rates. for instance, if the long-term interest rate falls, the financial structure will become more robust! this means that the concept of speculative fmance depends entirely on the time unit in which income is measured. if there is a long enough income period, all debtors become "hedgers". if there is a short enough income period, all debtors become "speculators". for any given income period, debtors change status automatically from hedgers to speculators as the maturity date approaches. melitz questions whether this is a useful measure of speculative activity. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 16 sajems ns vol 2 (1999) no i in minsky's analysis the debt deflation process results from capital losses (on bonds) resulting from increasing interest rates causing falls in wealth. melitz points out that the extent to which capital losses reduce wealth depends on how many bonds people actually choose to sell. it also depends on the wealth and price elasticities of the net stock demand for these assets people may have enough money. while minsky's analysis sees fragility increasing the shorter the term of debt, it must be remembered that countering this, increases in the interest rate lower the capital value of shortterm assets by only a small amount. melitz questions whether minsky's hypothesis applies to capitalism as a whole or just to the united states. he contends that this is important since minsky's argument depends on particular institutional arrangements. for example, it may matter that in both france and japan extensive use is made of the lender-of-last-resort facility. tobin (1989) agrees with flemming (1982) that minsky has not done justice to his (tobin's) work on fmance and stability. in particular, he objects to being lumped together with monetarists and others who reject government intervention. on the contrary, he says, he altogether accepts the need for government intervention. paying tribute to minsky, he says he is not to be confused with the many economists who are currently concerned with the huge trade and federal deficits of the usa. his thesis has been around for three decades and his analysis of the problems of debt for the economy refers to much more than concern with recent deficits. tobin's (1989: 106) main criticism of minsky is that his 'post-keynesian', i.e. kaleckian theory "is not convincingly linked to [his] central message ... the financial theory of business cycles". another problem is that minsky does not present his financial instability hypothesis as a formal model "and without one, readers cannot judge whether an undamped endogenous cycle follows from the assumptions or not" (tobin, 1989: 106). this allows rational expectations theorists to argue that, with increased knowledge on the part of borrowers and lenders, the cycle would soon vanish. on the empirical side, while it is generally agreed that the world economy has become more crisis prone since 1965, this may be easily explained by pointing to the many external shocks of this period: the vietnam war and its financing, two oil supply and price shocks as well as the collapse of the bretton woods international monetary system. there is no need to invoke minsky's theory for an explanation. (this echoes flemming's criticism.) the reason why the economy's structure was vulnerable to these external shocks may quite easily be attributed to the old conflict between full employment and price stability. the recessions have been caused by r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 17 counter inflationary policies of the central bank. this implies the central bank's role as lender of last resort has not affected its ability to control the monetary system. this is supported by the fact that the severe 1929-type stock market crash of 1987 did not lead to a credit crunch, debt deflation or deep depression. tobin (1989) is not solely critical of minsky. while the fmancial system seems to be more robust than minsky's theory would have us believe, there are urgent reforms that need to be undertaken. and minsky is correct to reject "modigliani-miller" theorems that money does not matter, i.e. that ftnancial assets and debts cancel out in economic terms. instead, as minsky argues, fmancial relations have real economic consequences. minford (1987) contends that minsky's thesis that the capitalist system has a fatal flaw (the instability of its financial structure) is itself flawed. "his picture of overoptimism in boom and pessimism in slump is of course true after the event, but it is useless before it" (minford, 1987: 104). from a rational expectations perspective minford argues that it is "difficult to beat the market systematically ... [there is no general way of knowing] ... better than the market ... [whether credit should be restricted or not]" (minford, 1987: 104). here he bases his criticism on the assumption of an endogenous money supply. while generally critical of minsky's theory, he agrees with tobin (1989) that minsky is correct in urging reform in financial institutions. the lender-of-iast-resort function is one whereby the central bank lets the institution die and its shareholders lose their money, but ensures the liquidity of the whole financial system. this has been taken to include, besides injecting money, insuring small depositors, whose confidence in the system is necessary, but not the deposits by other financial institutions (minford, 1987: 103). minford bemoans the fact that in practice, the central bank has intervened to support not only small depositors, but also large depositors. this is in danger of eroding the discipline of the large depositors (who should know better). unlike minsky, he rejects the need for these bailouts (of the large depositors). left on their own, they will soon realise they must conform to market discipline. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 18 sajems ns vol 2 (1999) no 1 the 'profit -squeeze' critics these theorists adopt the marxian notion that there is a long-run tendency for the rate of profit to fall. minsky's theory is viewed from the perspective of marxist crisis theory. each of the articles by downe (1987), harrison (1987) and goldstein (1985) have common roots in the writings ofweisskopf, bowles & gordon (1983). these authors argue that the current crisis of capitalism is to be found in the squeeze on corporate profits. there are two sides to this squeeze: on the demand side we have a tendency towards underconsumption; on the supply side, especially since the 1960s, there has been a steady rise in the 'social' wage. harrison (1987) contends that they have not taken into account the increased international competition and the restructuring of large corporations. this restructuring has seen an increasing number of american finns operating as "financial holding companies with only a transitory interest in any particular product, service or market" (harrison, 1987: 78). consequently, there has been conflict between financial and production managers. international competition has added to the squeeze on profits. downe (1987: 440) integrates the taylor-o'connell (1985) model of minsky's theory with the "wage-detennining model based on bowles's (1985) model of the production process" and so attempts to extend minsky's model. after following the taylor-o'connell (i985) model, he locates the source of instability in the effect of the political business cycle on labour costs. in a boom these costs rise and lead to inflation. if profits are a mark-up on wages, they will be increased by keeping wages down and increasing the work intensity. thus a fail in inflation necessitates a fall in labour costs and this is achieved by raising the cost of being unemployed. this is what reaganomics is all about. thus, for downe (1987: 453) a solution is possible to minsky's crisis, "but with an anti-labor bias". goldstein's (1985) paper follows a similar structure. to him the source of the instability lies in the necessity for firms to have a variable mark-up if they want to preserve market share. in the long run, if a finn simply passes on any increases in wage costs in the fonn of price increases, it will find its market share eroded. the mark-up will generally increase from the trough to the mid-expansion of the cycle and then fall as unit labour costs rise. the finn now accepts a lower mark-up to preserve market share. the lower mark-up means lower investment. pollin (1983: 49) has criticised minsky for the "narrowness of his overall vision", i.e. he concentrates on the financial sphere to the exclusion of the spheres of production and distribution. absent in minsky is any systematic tendency such as a falling rate r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 19 of profit that might generate crises. pollin (1985: 349) contends that we need more than a "persistent boom psychology" to explain crises. in somewhat similar vein, rousseas (1986: 115) likewise argues that the instability of capitalism is not just a monetary phenomenon, but arises out of basic inequalities of wealth. dillard (1984) also questions whether inequalities of wealth and income are unrelated to the instability problem. he contends that minsky has still to provide a "systematic, integrated statement of his theory as a whole" (dillard, 1984: 1262). the overall criticism of these profit-squeeze critics is that minsky locates the roots of instability exclusively in the financial sector whereas they locate instability in the real sector. crotty (1990) has criticised both marxists (who root instability exclusively in the real sector) and post keynesians such as minsky (who root instability exclusively in the monetary sector) for providing only monocausai theories of instability. he argues that marx himself gave equal weight to both real and fmancial sources of instability. crotty directs his attention at "keynesians", in particular at tobin and minsky. the latter have wrongly adopted the neoclassical assumption that owners always dominate managers and so "conflate" the two. this leads them to the thesis that the roots of investment instability are to be found in the stock exchange and other financial markets. crotty (1990) argues that neither owners nor managers are completely independent. furthermore, they have different goals and perspectives. owners today are largely institutions who "turn over most of their portfolios in the course of a year" (crotty, 1990: 534). this means they adopt a very short-term perspective; may easily sell stock if profits fall; prefer greater risk and debt because this gives greater liquidity and opportunities for diversification, and are mainly interested in maximising dividends. managers, in contrast, adopt a longer-term perspective; are more interested in the growth and survival of the firm and so push capital accumulation beyond the point which maximises dividends. crotty (1990: 538) concludes: the fmancial theories of investment espoused by tobin, minsky, and the keynes of ch.l2 are simply wrong. to understand the determination of investment spending and theorize investment instability, we must study and model the managerial enterprise [i.e., the real sector] as well as financial markets; there is no legitimate shortcut through the conflation of agents. one implication of crotty's theory, that he fails to draw out, is that the longer-run perspective of managers' behaviour imparts a degree of stability to the system. to r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 20 sajems ns vol 2 (1999) no 1 the extent that his argument is correct, the economy will tend to be more stable than minsky's theory would have us believe. but the interesting point for the purposes of this paper arises from crotty's criticism of both marxists and "keynesians" for failing to give due weight to both real and financial sources of instability. crotty's criticism needs to be developed within the broader framework of the fundamental distinction raised in this paper between real analysis and monetary analysis. part ii addresses this issue. to be concluded in sajems ns vol 2 no 2 june 1999. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 99 the measurement of consumer satisfaction with selected elements of the total retail experience: an exploratory study of fast food and supermarket retailers n s terblanche department of business management, university of stell en bosch c boshoff department of business management, university of port elizabeth abstract although attempts have been made to identify some of the dimensions of retail shopping experience, these have been largely fragmented and uncoordinated. no attempt has yet been made to combine the efforts of many retailing students into a comprehensive model that accurately describes the total retailing experience. also, very little is known about the relationship between the individual dimensions of retail shopping and customer satisfaction. this study attempts to reduce this gap in south african retailing literature by, first modelling the total retailing experience and, then, assessing the influence of selected individual retailing dimensions on customer satisfaction. it also investigates whether the impact of these dimensions of the retailing experience differs between fast food restaurants and supermarket retailers. the empirical results suggest a fairly consistent pattern of relationships between fast food restaurants and supermarkets. jel l 81 1 introduction the retail environment worldwide is in a constant state of adjustment and adaptation. although competition, emanating from new entrants and formats as well as foreign sources, contributes to this constant flux, consumers also exert a major influence on this state of affairs. present-day consumers not only have more choices than ever before, they also have more information at their disposal than ever before. in addition, increasing pressure of time may decrease the propensity to remain loyal to a retailer. consumers often also assume that various rights and choices are owed to them (schriver, 1997). against this r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 100 sajems ns vol 4 (2001) no i background, many retailers attempt to differentiate themselves by implementing loyalty schemes to attract and retain customers. another avenue open to retailers to differentiate themselves, is to deliver exceptional service quality as part of their retailing strategy (berry, 1986; hummel & savitt, 1988; reichheld & sasser, 1990). the marketing literature of the past decade contains many pages devoted to service quality, especially to servqual, the instrument developed to measure service quality (parasuraman, zeithaml & berry, 1988). most of the studies using or assessing the servqual instrument were conducted in fairly "pure" services settings like banking, credit card services and securities brokerage. because a retail store experience involves activities such as browsing, price comparisons, search for merchandise, evaluating product variety and quality, and interaction with store personnel, the servqual instrument in its original form is not suitable to capture the unique blend of merchandise and service that makes up a retailing experience. recently dabholkar, thorpe and rentz (1996) proposed an instrument based on servqual, which they suggest measures service quality in a retailing environment. apart from the common dimensions that are likely to be shared by pure service environments and retail environments, this instrument also captures additional dimensions of retail service quality unique to the retail environment. the development of the instrument is justified on the grounds that current measures of service quality do not adequately capture customers' perceptions of service quality for retail stores (i.e. stores that offer a mix of goods and services). support for this view, inter alia, emerged from the findings of finn and lamb (1991) that tested servqual in four different types of retail store and did not find a good fit to the five-factor structure. they therefore concluded that servqual, without modification, could not be used as a valid measure of service quality in retailing. yet another alternative available to retailers, with which they can differentiate themselves, is to provide a positive total retail experience (tre) for their clients. our contention is that in retailing where a mix of goods and services is offered, the focus should rather be on the management of the controllable elements of the .. total retail experience, as opposed to a perspective restricted to the management of service quality only. when considered in this way, service quality is only a component of the consumer's total retailing experience. 2 the total retail experience: a brief overview of the literature berman and evans (1998: 19) defme total retail experience as all the elements that encourage or inhibit consumers in their contact with the retailer. the total r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no i 101 retail experience is influenced by two groups of components. the first group consists of the non-controllable components. these include aspects such as adequacy of street parking, timing of deliveries from suppliers and taxes, all of which are not controllable by the retailer. the controllable components, in tum, consist of a variety of elements that the retailer can indeed control, like the number of salespeople on the floor, variety of brands carried and stock on hand. in this study the emphasis is on the controllable elements of the total retail experience. the retail literature suggests that the dimensions of the controllable components may be grouped under seven dimensions. a brief description of the controllable components of the total retail experience follows below. 2.1 personal interaction as a dimension of the total retail experience loyal customers are the backbone of any retailer's business (schriver, 1997: 2021; reicheld, 1993: 68). it is thus in the interest of a retailer to enter into and maintain long-term relationships with customers. the personal interaction element of the total retail experience offers numerous opportunities for creating and fostering long-term bonds with customers. some of the typical activities that are suitable for personal interaction are selling and fmalising transactions, providing information, reducing perceived risk, providing accompanying services and handling complaints (davidson, sweeney & stampfl, 1988: 143; speer, 1996: 13-14). . 2.2 tangibles as a dimension of the total retail experience the tangibles that are elements of the total retail experience, are also components of the overall image that a retailer wishes to project to consumers. tangibles include such aspects as physical facilities, transaction documentation, and appearance of personnel and materials that enhance the service delivery and communication of a retailer (parasuraman, berry & zeitharnl, 1991 : 41 ; dabholkar, thorpe & rentz, 1996: 6-7). the tangible physical environment and atmosphere can assume a variety of roles in the marketing and management of a retailer (bitner, 1992: 67). insights and evidence from the environmental psychology literature support the notion that physical surroundings can influence the attitudes as well as the behaviour of consumers in a retail shop (donovan & rossiter, 1982; darden, erdem & darden, 1983; ridgway, dawson . & bloch, 1990). tangible store attributes can also be seen as the "means" by which a consumer is able to achieve a desired "end", like a satisfying total retail experience (kerin, jain &howard, 1992: 381). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 102 sajems ns vol 4 (2001) no 1 2.3 perceived product quality as a dimension oftbe total retail experience perceived product quality has been identified as a detenninant of a consumer's perceived value of a product (dodds, monroe & grewal, 1991; kerin, jain & howard, 1992: 382) and will therefore have an influence on the tre of a consumer. various researchers have also reported on the importance of the quality of products (merchandise) in consumers' perception and evaluation of retail shops (dabholkar, thorpe & rentz, 1994: 4). in a more recent study sirohi, mclaughlin and wittink (1998: 240) operationalised product quality for a supermarket with fifteen indicators. for some products their quality level is of great importance to the consumer, and some retailers position themselves mainly on this basis. retailers selling high quality, high priced, well-known luxury brands are examples of this. 2.4 product variety and assortment as a dimension of tbe total retail experience product variety and assortment are components of the conventional retail marketing mix (hasty & reardon, 1997: il). products are probably the most complex expectation customers have of retail shops, because they expect to find a variety or a selection of different kinds of products consistent with personal shopping intentions and preferences (davidson, sweeney & stampfl, 1988: 141). the range of food and other product lines that supennarkets, for instance, offer, illustrates the complexity of the product variety decision. consumers not only expect to find a variety of product lines, but also an assortment of different colours, brands, styles, models and sizes for each line. product variety and the depth of assortment will to a large extent be influenced by the image the retailer wishes to project. for example, a supermarket's product variety and assortment, is associated with the customer services and facilities of the supermarket (bishop, 1984; doyle, 1984). kerin, jain and howard (1992: 385) also reported that previous research and focus groups found overall variety and assortment to be indicators of the shopping experience. the importance of assortment and variety in retailing is also confinned by the fact that one of the items in the . index of consumer sentiment toward marketing deals with the adequacy of the selection of products offered by retail shops (gaski & etzel, 1986: 79). 2.5 store environment as a dimension of tbe total retail experience store environment includes all the elements that contribute towards a pleasant shopping atmosphere. these elements are shop layout, aisles that make it easy to shop, store cleanliness, well-spaced product displays and attractive decor. the retail literature suggests that customers value the convenience that physical aspects, such as store layout, contribute to shopping (gutman & alden, 1985; r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 103 hummel & savitt, 1988; mazursky & jacoby, 1985; oliver, 1981). dabholkar et 01. also found empirical support for the contribution of shop layout to shopping convenience (1996: 7). dabholkar et 01. (1996: 6) again treated store appearance and store convenience as two sub-dimensions of the physical aspects in their study. the marketing literature supports the notion that consumers use the physical environment to form attributions about service failures, and base purchase decisions on inferences they make from various elements of the physical environment (bitner, 1990; ward, bames & bitner, 1992; bloom & reve, 1990; zeithaml, 1988). 2.6 product prices as a dimension of the total retail experience gaski and etzel (i986) used price as a component in their index of consumer sentiment toward marketing. this stresses the importance of prices in consumer decision-making. in the absence of other cues, consumers tend to use price as an indicator of product quality (davidson, sweeney & stampfl, 1988: 143). price is a generally controllable extrinsic cue of a product that has an influence on the way shoppers perceive product quality (sirohi et 01., 1998: 226). price as an extrinsic cue is, for example, most relevant in a supermarket, as consumers do not regard the time and effort spent in evaluating intrinsic cues as significant (sirohi et 01., 1998: 227). price is therefore one of the extrinsic cues that has received a great deal of attention in research (dodds, monroe & grewal, 1991; mazursky & jacoby, 1985; rao & monroe, 1989). kerin, jain & howard (1991: 383) suggest that because of the variety of extrinsic cues available in a supermarket (e.g. cleanliness, assortment and variety), price and quality perceptions could co-vary and that consumers "get what they pay for". 2.7 policy as a dimension of the total retail experience policy as a dimension of the total retail experience captures those elements that are influenced by a shop's responsiveness to the customer's needs (dabholkar et 01., 1996: 7). typical policy elements would apply to areas of shop operations such as the return or exchange of purchases, shopping hours, payment options available and a system or process to deal with customer enquiries and/or complaints (westbrook, 1981; mazursky & jacoby, 1985; dickson & maclachlin, 1990; dickson & albaum, 1977). the way in which a retailer responds to a service failure is essential for the maintenance of customer loyalty (berry & parasuraman, 1991) as well as a positive tre because a service failure and the subsequent recovery efforts create strong memories for customers (zeithaml & bitner, 1996: 126). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 104 sajems ns vol 4 (2001) no i 3 objectives of the study the main objective of this study was to compare an "overall moder' based on data collected from 2063 customers of four retail sectors, namely clothing, hardware. supermarkets and fast food, with two identical models based on only the data from the fast food sub-sample (635 cases) and the supermarket subsample (665 cases). this comparison tried to assess the stability of the model. it was believed that if the three models returned similar fit indices in relatively diverse retail environments such as supermarkets and fast food, this would represent strong evidence of generalisability. the following propositions were considered: proposition 1: the model fit indices of the total sample, the fast food sample and the supermarket sample will not differ substantially. a second objective was to assess whether the three dimensions of the total retail experience modelled in this study as predictors of customer satisfaction would impact on customer satisfaction to a similar extent. the following proposition was considered: proposition 2: the path coefficients measuring the influence of the three dimensions of the total retailing experience (personal interaction. physical cues and product variety and assortment) on customer satisfaction, will be the same for the total sample, the fast food sample and the supermarket sample. the theoretical model that was tested empirically is illustrated in figure i. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 105 figure 1 the theoretical model r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 106 sajems ns vol 4 (2001) no i 4 method 4.1 generation of the questionnaire items despite the criticism levelled against servqual (buttle, 1995), the items used for the measurement of the various dimensions of service quality, are also regarded as suitable to measure some of the controllable elements of the total retail experience. for example, physical facilities, equipment, materials, business hours and various aspects of staff behaviour are covered by the items of servqual. the items of four of the servqual dimensions, namely responsiveness, reliability, empathy and assurance, were used in this study to measure the personal interaction component of the total retail experience (kerin, jain & howard, 1992; zeithaml, 1988; dabholkar, thorpe & rentz, 1996; sirohi, mclaughlin & wittink, 1998; baker, grewal & parasuraman, 1994; ghosh & mclafferty, 1987). servqual has proved to be an adequate measure of the reliability, responsiveness, empathy and assurance dimensions of service delivery. all of these dimensions are of prime importance in the interaction between customers and shop personnel (parasuraman, berry & zeithaml, 1991: 41). the product variety/assortment and product quality dimensions were measured with self-generated items and published scales. the three product quality items suggested by finn and kayande (1997) were supplemented with two selfgenerated items. product variety and assortment were measured with a five-item instrument. the tangible components involved in service delivery were measured with the original four items of servqual. all items were linked to a 7-point likert-type scale. satisfaction was measured by means of the following four items: will you continue to buy from xxx in the future? how do you rate the overall service of xxx ? how often have you complained about service at xxx ? how often have you returned unsatisfactory products to xxx ? 4.2 sample and data collection the procedure followed in this study was a combination of judgement, convenience and random sampling. four retail industries were selected on a judgmental basis, namely fast food, clothing, supermarkets, and hardware stores. these industries were selected because they offer a combination of both service and physical products, and their market offer cannot be described as a "pure" service, independent of any other service component. two organisations in each industry were then selected on a convenience basis and invited to participate in r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 107 the study. individual respondents (customers) to be interviewed were selected on a simple random basis. personal interviews, using a structured questionnaire, were conducted with customers of firms in these four industries, on the retailer's premises following a shopping visit. the interviews were conducted over a period of a month to include all the various types of clients in terms of time frequenting the retailers as well as cash and account customers. for example, it was necessary to conduct interviews at night-time with clients from the fast food retailers. a total of2 063 questionnaires were completed. 4.3 scale purification the first step in the data analysis process was to assess how many dimensions the data contained. for this purpose, a maximum likelihood exploratory factor analysis was done, specifying a direct quartimin oblique rotation (jennrich & sampson 1966) of the original factor matrix. several different factor solutions were considered. the most interpretable factor structure (factor loading exceeding 0.04 and no crossloadings) to emerge, was a 3-factor solution. all the factors in the 3-factor solution had eigen values above 1.00 and a sufficient number of items loading on them to a significant (0.40) extent (hair, anderson, tatham & black, 1998). table i shows the sorted rotated factor loadings matrix. the three factors that emerged were named personal interaction (measured by 3 assurance, 4 empathy, 2 reliability and 3 responsiveness items of servqual), physical cues (measured by i reliability and 2 tangibles items of servqual and 4 quality items) and variety (represented by 5 variety items). the items that did not load to a significant extent on a separate factor were excluded from subsequent statistical analysis. the remaining 24 items were then subjected to a reliability analysis to assess the internal consistency of the instrument. all three factors, as well as the overall instrument returned cronbach alpha coefficients above the 0.7 level suggested by peterson (1994). the reliability results are summarised in table 2. the theoretical model depicted in figure 2 was then subjected to empirical assessment. the structural equation modelling capabilities of the computer programme ramona (browne & mels, 1992) were used for this purpose. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 108 samms ns vol 4 (2001) no 1 table 1 sorted rotated factor loadings factor 1 factor 2 factor 3 personal physical product variety interaction cues and assortment pers 1 0.859 -0.024 -0.047 pers2 0.826 -0.080 0.022 pers3 0.798 -0.022 -0.032 pers4 0.758 0.050 -0.067 pers5 0.751 -0.048 0.038 pers6 0.740 -0.006 0.041 pers7 0.731 0.035 -0.016 pers8 0.662 0.117 -0.044 pers9 t0.626 -0.024 0.227 0.614 0.110 i§ pers 11 0.578 0.082 o. pers 12 0.458 0.281 o. phys 1 -0.087 0.826 phys2 -0.058 0.810 o. phys3 0.024 0.770 0.039 phys4 0.157 0.539 -0.014 phys5 0.075 0.448 0.155 phys6 0.272 0.444 -0.042 phys7 0.148 0.400 0.117 varli -0.007 0.086 0.805 varl2 0.042 -0.113 0.793 varl3 -0.046 0.099 0.660 varl4 0.038 0.118 0.659 varl5 0.146 0.166 0.434 eioen 6.196 2.940 2.486 table 2 reliability analysis results: total sample dimensions oc personal interaction .937 physical cues .863 variety .857 consumer satisfaction .725 overall .948 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 109 table 3 fit indices total sample fast food supermarket chi-square (df) 2243.49 (249) 1473.8 (344) 1240.5 (344) rmsea i 0.062 0.072 0.063 gfi 0.900 0.846 0.882 agfi 0.880 0.818 0.861 ecvi 1.566 2.520 2.056 parsimonious fit indices pnfi 0.826 0.761 0.818 pgfi 0.816 0.770 0.803 nfl 0.908 0.837 0.899 5 findings when comparing different models, the parsimonious fit indices produced by most sem programmes ought to be used (hair anderson tatham & black, 1998: 658). hair et al. (1998) suggest that when comparing two models, the parsimonious normed fit index (pnfi) is particularly useful differences between 0.06 to 0.09 are regarded as "indicative of substantial model differences". when comparing the pnfi of the fast food sample (model) with the supennarket model the difference is 0.057, and when comparing the total model with the supermarket model the difference is only 0.008 both less than the lower bound of the range for substantial model difference proposed by hair et al. (1998). when comparing the total model with the fast food model, the difference is 0.065 just inside the range proposed by hair et al. the total model is thus not quite as good a predictor of customer satisfaction for a fast food restaurant as it is for a supennarket. it appears as if the model fares slightly better in retail environments where physical products are dominant in the market offering as opposed to services (the fast food industry). however, given the relatively small pnfi differences, proposition 1 is accepted. the empirical results of the three empirical models (the total sample, and the fast food and supennarket samples) are depicted in figures 2, 3 and 4. in the total sample (figure 2) personal interaction (0.585; p<o.oi) and physical cues (0.312; p<o.o 1) are strong predictors of consumer satisfaction, while the variety and assortment dimension does not influence consumer satisfaction. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 110 sajems ns vol 4 (2001) no 1 figure 21) empirical results: determinants of satisfaction witb selected controuable elements ofthe total retail experience 1) all p values < 0.01 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 111 figure 3 tre fast foods r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 112 sajems ns vol 4 (2001) no 1 figure 4 tre supermarkets in the fast food and supermarket sub-samples a similar pattern emerged the same two dimensions being significant and variety and assortment being nonsignificant. the only difference is that in the fast food sub-sample, personal interaction is a stronger predictor of consumer satisfaction than physical cues, while the opposite is true for the supermarket sub-sample. thus, the pattern of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 113 associations is the same in all three models and proposition 2 is therefore accepted. it must be recognised, however, that the magnitudes of the path coefficients differ and that the relative importance of the dimensions influencing consumer satisfaction also differs. the empirical results summarised in figures 3 and 4 show considerable variability in the path coefficients between the fast food sample/model and the supermarket sample/model. in the case of personal interaction for fast foods, the coefficient is 0.634 compared to 0.454 for supermarkets, and for physical cues it is 0.349 and 0.516 respectively. for variety and assortment, the coefficients are almost identical. it is apparent that in the more service-orientated fast food industry/sector, personal interaction have a considerable stronger impact on consa t than in a supermarket environment where products and physical cues appear more dominant. although the variety and assortment of merchandise did not emerge as a variable that directly influences customer satisfaction, it should be noted that perceptions of variety and assortment are correlated with both the personal interaction dimension and the physical cues dimension. in other words, by enhancing perceptions of variety and assortment a retailer can indirectly improve customer satisfaction. 6 managerial implications in the fast food sub-sample, personal interaction is a stronger predictor of customer satisfaction than physical cues. these results thus suggest that a fast food retailer or store manager wishing to enhance the total retailing experience of its customers, will have to focus its efforts primarily on the interaction between its frontline employees and customers. employees who are always willing to help, who provide personal, individualised attention, who are courteous when dealing with customers no matter how "difficult" or demanding they may seem to be and who promptly respond to requests, will strongly improve customer satisfaction. in this way, retail firms will not only be able to differentiate themselves but also enhance customer satisfaction, which should in turn increase customer retention and loyalty. in the supennarket sub-sample, physical cues proved stronger predictors of customer satisfaction than personal interaction. it can thus be deduced that the physical cues which customers encounter are important when they enter a supermarket. customer perceptions of the quality of merchandise, the physical store environment (floor covering, lighting, and shelves) and even the appearance of supporting physical equipment such as shopping bags and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 114 sajems ns vol 4 (2001) no i catalogues, exert a significant influence on customer satisfaction. it must also be borne in mind that physical cues not only exert a great influence on customer satisfaction, but are also used as inferences on which customers base their purchase decisions. notwithstanding the fact that the level of service rendered in a supermarket by way of personal interaction between customers and staff is usually less than that in a fast food retailer, personal interaction also makes a great impact on customer satisfaction. our results show that in the case of managing a supermarket, the personal interaction between customers and staff also makes a great impact on customer satisfaction. despite the fact that most shopping in supermarkets takes place by means of self-service. 7 conclusions the main objective of this study was to compare and assess the stability of an "overall model", based on data collected from four retail sectors, namely clothing, hardware, supermarkets and fast food with two identical models based on only the data from the fast food sub-sample and the supermarket sub-sample. a second objective was to assess whether the three dimensions of the total retail experience modelled in this study as predictors of customer satisfaction, namely personal interaction, physical cues and variety and assortment would impact on customer satisfaction to a similar extent. in the total sample, personal interaction and physical cues are strong predictors of consumer satisfaction while the variety and assortment dimension does not influence consumer satisfaction. in the fast food and supermarket sub-samples, a similar pattern emerged the same two dimensions being significant and variety and assortment being non-significant. the only difference is that in the fast food sub-sample, personal interaction is a stronger predictor of consumer satisfaction than physical cues while the opposite is true for the supermarket sub-sample. the pattern of associations is the same in all three models. it must be· recognised, however, that the magnitudes of the path coefficients differ and that the relative importance of the dimensions influencing consumer satisfaction also differs. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (200 l) no 1 115 references 1 baker, j.; grewal, d. & parasuraman, a. 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(1996) services marketing, new york: mcgraw·hill. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 2 322 sector effect on working capital measures in south african industrial firms marolee beaumont smith department of business management, vista university abstract this paper reports research findings concerning the sector effect on working capital measures in south african industrial firms. thirteen working capital measures were computed for each of the 135 participating firms over 10 years. the appropriate nonparametric statistical procedure, the kruskalwallis test, was applied to the data to test the null hypothesis of no sector effect. the test inferred that there was a significant sector effect for 10 of the 13 working capital measures. however, when regulating for an overall 5 percent level of significance, less than half the tested measures registered a significant sector effect. these findings suggest that inter-industry differences in working capital measures in south africa might not be as significant as claimed in previous local and international research findings. introduction working capital management can be described as the management of short-term or current assets and liabilities, and their interrelationships, both with each other and with other balance sheet accounts. the short-term assets and liabilities of the firm are those items that can be converted into cash within one year (hampton & wagner, 1989:4). the management of working capital plays an important role in maintaining the financial health of the firm during the normal course of business. here the major decision making function revolves around the management of the various working capital accounts with regard to maintaining an adequate level of liquidity: too much liquidity and the level of profitability could suffer, too little liquidity and the firm is exposed to the risk of bankruptcy (scherr, 1989:5). the literature on financial management makes the assumption that firms belonging to the same industrial sector have similar degrees of managerial efficiency and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 323 sateb nr vol i (1998) nr 2 similar technologies, with "optimal" norms for the sector developing to which most firms are expected to adhere. hence there exist sizeable inter-industry differences due to dissimilarities in the underlying economic conditions affecting the various industrial sectors (gitman, 1994:45; hoffman, 1997:34-5). so the nature of the firm and the type of industry in which it operates will affect the firms' working capital requirements (see hampton & wagner, 1989:9). this paper reports on research undertaken in an effort to evaluate the sector effect on working capital in south african industrial firms. the research hypothesis the research hypothesis was that the working capital measures employed by south african industrial firms differ across industrial sectors. method of research data used in the empirical study was acquired from the pretoria university bureau of financial analysis (or bfa). the bfa database contains comprehensive financial information regarding firms listed on the johannesburg stock exchange, and produces standardised annual financial statements according to the requirements of the companies act of 1973. these include standardised balance sheets and income statements, and standardised sundry information. the financial statements of all jse industrial firms listed for the most recent 10 consecutive years at the time of the exploratory research formed the basis for the study. a longer period than 10 years was initially considered, however, this would have meant the exclusion of too many firms. after eliminating pyramid and foreign firms, a data set of 135 firms remained, the nature of which is reflected in table 1, by number of listed industrial firms per sector. table 1 indicates that most of the participating firms (16,3 %) are from the industrial holding sector, followed by clothing, footwear and textile firms (11,1 %). the steel and allied sector comprise one, and the transportation sector two firms only. despite the paucity of firms in some sectors, all sectors were retained as they represented all the jse industrial firms listed for the most recent 10 years at the time of the exploratory research. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 2 324 table 1: nature of participating firms sector sector description no of 0/0 code firms 15 industrial holding 22 16,3 20 beve 3 2,2 21 building and construction 12 8,9 22 chemicals and oils 7 5,2 23 clothing, footwear and textiles 15 11,1 25 food 13 9,6 26 electronics 10 7,4 27 furnit l=h 4,5 28 engineering 8.9 29 motor 6 4,5 30 paper and packaging 8 5,9 31 pharmaceutical and medical 3 2,2 32 printing and publishing ! 4 3,0 33 retailers and wholesalers 11 8,1 35 steel and allied i 0,7 37 transportation 2 1,5 total 135 100 source: bfa database working capital measures included in the study the measures included are traditional working capital position, activity and leverage ratios that are well represented in the literature, and alternative working capital liquidity measures that have more recently surfaced in financial management literature. see appendix a for derivations of the working capital measures included, which may be grouped as follows: r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 325 traditional working capital position ratios: current ratio quick ratio traditional working capital activity ratios: inventory turnover accounts receivable turnover accounts payable turnover traditional working capital leverage ratios: sales divided by net working capital sateb nr vol i (1998) nr 2 long-term loan capital divided by net working capital accounts receivable divided by accounts payable total current liabilities divided by gross fun,ds flow more recently developed alternative liquidity measures: cash conversion cycle net trade cycle comprehensive liquidity index net liquid balance divided by total assets. statistieal tests undertaken the research hypothesis implies that the working capital measures employed by the participating firms differ across the 16 sectors. the number of participating firms per sector is given in table i, indicating that the frequency of firms per sector ranges from a maximum of 22 industrial holding firms to a minimum of one steel and allied firm, manifesting a paucity of participants in several sectors. the appropriate statistical technique to test the research hypothesis is analysis or multiple analysis of variance. however, sample size is critical to these procedures. hair, anderson, tatham and black (1992:444) are of the view that while there is no uniquely correct sample size, recommendations are for a size ranging between 100 and 200. because of the dearth of participants in some sectors (this is not an unusual phenomenon on the jse; see muil, hamman & smit, 1992:23-8) a nonparametric procedure was considered appropriate to test the hypothesis. the mann-whitney u test is the nonparametric alternative, and can be used to test whether two independent samples come from populations with the same mean, where the actual values of the data are replaced by ranks. where there are more r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 2 326 than two groups (in this case there are 16 sectors), the kruskalwallis test determines whether several independent groups come from populations with the same mean, again with the actual values of the data replaced by ranks (unisa statistics guide for st a305-t, 1990: 117). the jse sector was used as class variable in the calculation of simple linear rank statistics based on wilcoxon scores (rank sums). these statistics were used to test if the distribution of a variable (or working capital measure) has the same location parameter across different groups (or sectors) (sas/stat user's guide, 1990b:li96). the statistical null hypothesis, ho, is that the location of the distributions is the same, that is, there is no sector effect. the test produces a chi-square approximation (chlsq) for testing ho and the asymptotic significance probability (prob > chlsq), of which the values for each working capital measure are reflected in table 2. the critical value at the five percent level of significance for 15 degrees of freedom (16 i sectors) is 24,99 (lapin, 1990:961). table 2: kruskal-wallis test scores for sector effect variable chisq prob> chisq current ratio 29,87 0,0124 quick ratio 22,94* 0,0855 inventory turnover 46,50 0,0001* accounts receivable turnover 42,76 0,0002* accounts payable turnover/ 37.97 0,0009* long-term loan capital/net working 21,26 0,1286 capital accounts receivable / accounts payable 35,71 0,0019* ! total current liabilities / funds flow 30,47 0,0103 sales / net working capital 8,35 0,9090 cash conversion cycle 44,72 0,0001* net trade cycle i 46,00 0,0001* comprehensive liquidity index 16,20 0,3686 i net liquid balance / total assets 24,67* 0,0545 the values in table 2 can be interpreted as follows: for the participating firms, and the current ratio with a chlsq score of 29,87, there is only a 1,24 percent chance that no significant differences occur in the means of the distributions of the variable r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 327 sates nr vol i (1998) nr 2 across the sectors. analogously, for accounts receivable divided by accounts payable with a clllsq score of35,71, there is (practically) a zero percent chance of no significant difference in the means of the distributions of the variable across the sectors. for turnover divided by net working capital with a clllsq score of 8,35, there is a 91 percent chance that there are no significant differences between the means of the distributions of the variable across the sectors. the highlighted values in table 2 indicate the instances where the null hypothesis is rejected, at the five percent level of significance, for all variables except the quick ratio (indicated with an asterisk in the chisq column) where the null hypothesis would be rejected at the 10 percent level of significance. concurrently, only three of the 13 working capital measures in table 2 do not exhibit any significant sectoral effect, namely long-term loan capital divided by net working capital, turnover divided by net working capital and the comprehensive liquidity index. the inference from this test is that there are significant differences in the means of the variables across the sectors (i.e. a significant sector effect) for 10 of the 13 working capital measures tested, at the 95 and 90 percent confidence levels. these findings are compared to three other studies that considered industry or sector effects. in a local study, jordaan, smit and hamman (1994:71) referred to the influence of the possible sector specific characteristics of their findings on the distributional properties of financial ratios. in another local study, hoffman (1997:197) found that the nature ofa firm's operations had a significant impact on working capital ratios. furthermore, research by fieldsend, longford and mcleay (1987:513) concluded that considerable digression from proportionality was accounted for by industry influence. the results regarding significant sector effect could not be accepted without considering that the 13 independent variables were evaluated in individual ranking procedures, each time using a five percent significance level. this creates a problem when attempting to control the overall type 1 error rate. across 13 separate tests, the probability of a type 1 error (rejecting the null hypothesis when it should be accepted) will lie somewhere between five percent and 1 .95 13 .49, signifying a 49 percent chance of making a type i error. in order to ensure an overall level of significance of five percent, we can compare the p-value (le., the {prob > chisq} value) of each of the variables to q (instead of comparing them to 0. = 0,05), where q = 0.1z; and z = number of response variables, in this case 13. so, the exceedence probability for an overall five percent r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 2 328 level of significance is no longer 0,05, but rather 0,05/13 = 0,0039 (hair et ai., 1992: 157). it is then observed in table 2 that, at an overall five percent level of significance, six (instead of 10) of the 13 variables (marked with an asterisk in the prob>chisq column) exhibit significant exceedence probabilities. hence, rejection of the statistical null hypothesis, indicating differences in the means of the variables across sectors, is feasible, for six out of the 13 working capital measures tested. these are the three working capital activity measures (inventory turnover, accounts receivable turnover and accounts payable turnover), one traditional leverage measure, namely accounts receivable divided by accounts payable, and two more recently developed liquidity measures, the cash conversion cycle and net trade cycle. the significance of these findings is that the sector effect in working capital measures in the participating south african industrial firms appears less significant than claimed by the literature and other research findings. summary the research hypothesis states that the working capital measures employed by south african industrial firms differ across industrial sectors. the paucity in numbers of participating firms in many of the 16 sectors precluded the application of parametric procedure3 to test this hypothesis. the nonparametric alternative to the t-test for more than two groups is the kruskal-wallis test, with the actual values of the data being replaced by ranks. the p-values of the test indicated that the statistical null hypothesis of no sector effect could be rejected for 10 out of the 13 working capital measures, indicating significant differences in the means of the variables over the sectors. however, when regulating for an overall five percent level of significance, a significant sector effect was found for only six (rather than 10) of the working capital measures. based on the kruskal-wallis test scores, at an overall five percent level of significance, the research hypothesis regarding significant sector effect on the working capital measures employed by south african listed industrial firms, would be accepted for six out of the 13 variables, that is, less than half of the working capital measures tested. such findings suggest that inter-industry differences in working capital measures in south african industrial firms might not be as significant as that advanced in previous local and international research findings. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 329 satebnr vol! (\998)nr2 references 1. bureau of financial analysis. (1989). the use of ratios in analysing the published annual financial statements of companies in the republic of south africa. pretoria: university of pretoria. report a.5e(r). 2. fieldsend, s., longford, n. & mclea y, s. (1987). industry effects and the proportionality assumption in ratio analysis : a variance component analysis. journal of business finance and accounting, winter. 3. gitman, lj. (1994). principles of managerial finance. 7th edition. new york: harpercollins. 4. hair, j.e., anderson, r.e., tatham, r.e. & black, w.c. (1992). multivariate data analysis with readings. 3rd edition. new york: macmillan. 5. hampton, j.j & wagner, c.l. (1989). working capital management. new york: wiley. 6. hoffmann, n. (1997). working capital management practices: an empirical analysis. mba research report. university of the witwatersrand, johannesburg. 7. jordaan, a.c., smit e. vd m. & hamman, w.d. (1994). an investigation into the normality of the distributions of financial ratios of listed south african industrial companies. south african journal of business management, 25(2). 8. lapin, l.l. (1990). statistics for modern business decisions. 5th edition. san diego: harcourt brace jovanovich. 9. mull, w.r., hamman, w.d. & smit, e. vd m. (1992). the distributional properties of the financial ratios of listed south african industrial companies: 1980-1989. de ratione 6(2), summer. 10. sas/stat user's guide: version 6. (1990b). 4th edition. cary, usa: sas institute. ii. scherr, f .c. (1989). modern working capital management: text and cases. englewood cliffs, nj: prentice-hall. 12. unisa statistics guide for sta305-t. (1990). university of south africa, pretoria. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 2 330 appendix a working capital measures defined current ratio: quick ratio: inventory turnover: accounts receivable turnover: accounts payable turnover: sales divided by net working capital: long-tenn loan capital divided by net working capital accounts receivable divided by accounts payable: total current liabilities divided by gross funds flow: cash conversion cycle: net trade cycle: comprehensive liquidity index: net liquid balance divided by total assets: current assets / current liabilities (current assets inventory) / current liabilities cost of sales / average inventory sales / accounts receivable (closing inventory + cost of sales opening inventory) / accounts payable sales / (current assets current liabilities) long-tenn loan capital / (current assets current liabilities) accounts receivable / accounts payable total current liabilities / profit after tax + non-cash flow items [(inventory x 365) / cost of sales] + [(accounts receivable x 365) i sales] [(accounts payable x 365 ) / (closing inventory + cost of sales opening inventory)] [(inventory x 365) sales] + [(accounts receivable x 365) / sales][(accounts payable x 365 ) / sales] cash + accounts receivable x [1-( l/accounts receivable turnover)] + inventory x [1 -(liinventory turnover) (l/accounts receivable turnover)] accounts payable x [i -(l/accounts payable turnover)] [(cash + marketable securities) (short-tenn borrowing + bank overdraft)] i total assets. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 125 factors that determine the corporate image of south african fast food restaurants c h van heerden, a n schreuder and m gouverneur department of marketing and communication management, university of pretoria abstract current operating practices of small businesses indicate that more time is devoted to the cosmetic side of corporate identity than managing service delivery. the main argument pursued in this paper is based on the view that both visual and behavioural corporate identity cues create impressions in the minds of corporate publics to form an overall corporate image. a set of bipolar adjectives was therefore used to test various visual, behavioural and core product elements of restaurant corporate image. a key finding was made that the joint customer service and employee dimension, was rated as the most important factor in the choice of fast food restaurants, which confirms that corporate image is created by visual and behavioural identity. jelm 37 1 introduction there are different views on what the concept of corporate identity actually means. one of the most popular myths is that corporate identity consists only of visual elements such as a well-known corporate name, a distinctive corporate logo and attractive corporate colours (van heerden, 1994). although these elements do initially attract the customer, it is the corporate personality, which consists of a diverse set of behavioural and visual elements, that creates or breaks long-term relationships with customers. another important point that all managers should take note of is that this set of behavioural elements creates perceptions in the minds of customers which lead to the formation of an overall corporate image. in other words, an attractive logo and well-designed corporate stationary will not compensate for unfriendly customer service or bad employee morale. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 126 sajems ns vol 3 (2000) no i 2 problem statement the main argument pursued in this paper is based on the view of van heerden (1999, 492) that "both visual and behavioural corporate identity cues create impressions or perceptions in the minds of corporate audiences to form an overall corporate image". selected restaurants from the fast food industry in south africa were investigated, with specific emphasis on identifying different cues that represent both the visual and behavioural elements of their corporate identity. the following hypotheses were tested: hi: respondents who indicate high levels of visual identity, have significantly more positive general impressions of the fast food restaurants than respondents who indicate a low level of visual identity. h2 : respondents who indicate high levels of behavioural identity (e.g. customer service), have significantly more positive general impressions of a fast food restaurant than respondents who indicate a low level of behavioural identity. h3 : respondents who have a high opinion of the core product ingredients (food & drink), have significantly more positive general impressions of that fast food restaurant than respondents who have a low opinion of the core product. h4 : respondents who have a high combined opinion of the behavioural and visual identity of a fast food restaurant, have a significantly more favourable impression of that fast food restaurant than those respondents who have a low combined opinion of the behavioural and visual identity of that fast food restaurant. 3 literature review 3.1 the nature of corporate identity and corporate image there are many authors who have different views on what corporate identity and corporate image are, and how they influence one another (barnard, 1991:4; drummond, 1995: 9; sampson, 1995: 36; stewart, 1991: 32; and miller, 1990: 30). carter (1982: 8) states that corporate image is the way a corporation is perceived through the eyes of its various audiences, while corporate identity is that part of the image which can be seen or heard. these images are usually the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 127 first impressions created in the minds of customers when they are exposed to corporate identity cues. croft (1989: 65) argues that the corporate identity is the total personality of an organisation as perceived by its audiences, and not only the visual aspects. it is also a statement of how a company is organised and run, how its products and services are being managed, and where the company is going. 3.2 visual and behavioural elements of the corporate identity every business has a particular image by virtue of its external appearance, internal layout or even the way they do things, and it is therefore important to ensure that a positive message is being conveyed to the consumer. research indicates that customers greatly value consistency and reliability in service delivery (croft 1989: 65). thus, when all competitors in a specific service sector deliver a similar core product, for example fast food, the evaluation of supplementary services and corporate identity would become some of the differentiating factors on which customers base their initial purchase choice and even later repeat business. corporate identity is therefore concerned with expressing three interrelated themes, namely, coherence, symbolism and positioning/differentiation: • first, the corporation wants its various parts (business units, operations and product/service output) to relate to each other so that people can find their way around its divisions, corporations, and brands that is, coherence; • second, the corporation wants to symbolise its vision and mission so that everyone who works for it can share the same spirit, and then communicate it positively to all other people who deal with the corporation symbolism; and • third, the corporation wants to differentiate itself and its products (food and drink) or services (speed of delivery) from those of its competitors in the market place positioning. these three themes coherence, symbolism, and positioning relate to the very core of a corporation (olins 1987: 87) and serve to focus the corporate strategy. when analysing existing corporate identity models (abratt, 1989; burrows, 1991; and skinner & von essen, 1991), certain general assumptions can be made: r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 128 sajems ns vol 3 (2000) no i • corporate personality, identity and image are elements of an ongoing cyclical process. • corporate identity should be aimed at all the publics of the corporation. • the implementation of the corporate identity strategy is done via visual and behavioural elements. gronroos (1992: 39) feels that corporate image is a third dimension of service quality. the corporate image can therefore be expected to be reinforced by the technical quality of the service (what the consumer receives in the service) and its functional quality (how the consumer receives the service). since services are inseparable from the provider, visual imagery plays an important role in the perceived quality of service delivery. prescribed elements are built around the core products to represent value-added supplementary services, which leads to another important factor in the image making process that of customer service (lovelock, 1996: 343). because service quality is so difficult to judge, corporations should take great care to keep quality consistent. a logo or trademark can thus even serve as a symbol that the service is of a certain standard. thus full service providers such as fast food restaurants must concentrate on linking their brands with the core values of trust, honesty and integrity, while listening closely to what each individual wants and offering value for money_ for services to grow and prosper, they must build new and lasting relationships with new customers, go back to basics and offer reliability, responsiveness, honesty, empathy and tangible proof of the organisation's commitment to quality service (denby-jones 1995: 66). the arguments of the above-mentioned experts underscore that corporate identity is internally generated by corporate strategy, but the corporate image is externally located as perceptions in the minds of corporate publics such as suppliers and customers. 4 methodology 4.1 introduction the focus of this study is on the relationship between the corporate logos of selected fast food restaurants and the perception customers have of these r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no i 129 companies. therefore not all aspects of the corporate identity have been covered in the investigation. the variables tested were the following: • visual elements independent variable • behavioural elementsindependent variable • core product independent variable • general impression dependent variable the reasons why south african fast food restaurants (as research subjects) and university students (as respondent group) were chosen are that: • fast food restaurants are highly visible and geographically dispersed. • fast food restaurants are widely used by different age groups (of which students represent a significant target segment). • competition between the companies is fierce, because of the vast number of consumers and the increased entry of international firms (such as mcdonald's) after political change which led to a higher awareness of their existence in south africa. • advertising and sponsorships occur frequently in the fast food industry. thus a fair amount of exposure is produced. • all fast food restaurants have distinguishable logos and corporate symbols. • most of the respondents (students) have either visited the selected fast food outlets or been exposed to marketing communication efforts such as advertisements and sales promotions. 4.2 research design 4.2.1 data collection and sample selection and size this was an exploratory investigation where quantitative measures (selfadministered questionnaires) were used. the following sampling approach was taken: • convenience sampling since students who attend marketing and communication management classes were easily accessible. • a sample of 200 respondents completed the questionnaire. 4.2.2 instrumentation procedures a structured self-completion questionnaire was used which consisted of: • a set of bipolar items generated and refined to represent a semantic differential scale. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 130 sajems ns vol 3 (2000) no i • respondent perceptions were cued through a specific concept/construct the corporate logo (a full colour copy of each logo was shown to the students on an overhead projector). • respondents were then expected to rate their perceptions of every fast food restaurant on each of the bipolar items included in the semantic scale while viewing a specific corporate logo. • method of data collection: » respondents were asked for their first impression of or immediate reaction to the logo of the fast food restaurant being measured. » respondents then indicated their impressions by selecting a position along a scale bounded by bipolar adjectives. » a repeated measure design was used, since respondents had to repeat the same process for each of the fast food restaurants. • subsequent data and statistical analysis was done with the aid of css st a tistica. techniques such as factor analysis, correlation and anov a were used to identify the number of factors that determined the corporate image of these companies. table 1 bipolar adjectives used to measure the core product (c), visual (v) and behavioural (b) elements of corporate identity bipolar adjectives for core product expensive vs inexpensive c tasteful vs tasteless c low quality vs high quality c healthy vs unhealthy c extra value vs no extra value c inconvenience vs convenience c bipolar adjectives for behavioural elements of corporate identity dishonest vs honest b friendly vs unfriendly b likeable vs unlikeable b bad service vs good service b reputable vs disreputable b unsuccessful vs successful b unhelpful staff vs helpful staff b irresponsible vs responsible b r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 131 table 1 continued bipolar adjectives for visual elements of corporate identity well known vs unknown v interesting vs boring v unattractive vs attractive v clean vs dirty v unbelievable ads vs believable ads v busy vs lazy v 5 findings 5.1 descriptive statistics all descriptive statistics took reverse scaling into account. reverse scaling was required since the adjective pairs had different directions of positive and negative order. this made direct comparison of adjective pairs easier. the results are summarised in table 2. in order to detennine the effect of the visual and behavioural elements and the core product-evaluation on the general impression of the restaurants, a combined mean had to be calculated for each independent variable. the following observations can be made from table 2: • the highest adjective variable was "well-knownlunknown" (4.646), whilst "successfullunsuccessful" (4.141) also showed a high mean score. • the lowest adjective variables was "expensive/inexpensive" (2.905), with the closely related variable "extra value/ no extra value" (3.126) also with a fairly low mean score. • on com.bined means the core product variables were the most favourable (3.394) and the behavioural variables the least favourable (3.729). it must be noted though that the variance between the combined means is too small to make any conclusive findings. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 132 sajems ns vol 3 (2000) no 1 table 2 the mean and standard deviation of each independent variable category mean standard deviation visual variables well-known! unknown 4.646 0.667 interesting! boring 3.480 1.036 unattractive! attractive 3.688 0.913 clean! dirty 3.764 0.942 believable adslunbelievable ads 3.404 1.076 busy! lazy 3.772 0.939 combined mean 3.792 behavioural variables honestidishonest 3.805 0.896 friendlylunfriendly 3.635 0.964 likeablelunlikeable 3.770 1.000 good service!bad service 3.659 0.957 reputableldisreputable 3.653 0.900 successfullunsuccessful 4.141 0.913 helpfullunhelpful 3.548 0.974 responsible!irresponsib ie 3.625 0.865 combined mean 3.729 core product expensive/lnexpensive 2.905 1.233 tastefulrrasteless 3.826 1.043 high qualityllow quality 3.613 0.966 healthylunhealthy 3.141 1.003 extra value! no extra value 3.126 1.070 conveniencelinconvenience 3.750 0.916 combined mean 3.394 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 133 figure 1 overall impression of respondents on four fast food restaurants visual behavioural core product o 2 4 6 8910 core product behavioural visual general iii mcdonald's 6.77 7.71 6.79 7.16 iiiikfc 6.65 5.66 5.86 6.46 ii steers 6.51 5.89 i 6.31 6.57 elnando's 7.02 6.47 i 6.8 6.89 the effects of current corporate identities of the four fast food restaurants can clearly be seen from figure 1, with particular refererence to: • mcdonald's achieved the best general impression amongst respondents, which is supported by the high score on both the visual and behavioural elements of their corporate identity. • nando's received the best score on core product evaluation, and scored a close second to mcdonald's in all other areas. 5.2 analytical statistics 5.2.1 reliability analysis a reliability analysis enables the researcher to test the consistency or stability of a measured quantity (cooper & emory, 1995: 153), that is, to calculate an index that registers the extent to which measured data are free from random error. if all items were perfectly reliable and measured the same true score, the coefficient alpha would be equal to 1. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 134 sajems ns vol 3 (2000) no 1 the total alpha-value of the instruments was 0.904, which is regarded as a significantly reliable coefficient. once the overall reliability of the instrument had been established, it was necessary to determine whether sufficient variance existed between the different fast food restaurants evaluated in this study. to demonstrate that the perception of the tested fast food restaurants differed from one another, the following significant differences in table 3 were determined with anov a. all responses with a p-value smaller than 0.05 were regarded as having a significant difference in perception. from table 3 it can be concluded that, with two exceptions, all adjective pairs showed significant differences (p<0.05) between the restaurants measured. the exceptions are: • extra value i no extra value (p=0.257) and good service i bad service (p=0.474) where p>0.05. there are therefore no significant differences. concerning value-added or service level, between the restaurants measured in this study. table 3 significant differences between tbe fast food restaurants category nando's steer mcdof· p-value nald's value visual variables well known i 4.47 4.68 4.81 4.64 8.309 0.000 unknown interesting / boring 3.69 3.27 3.18 3.79 16.689 0.000 unattractive / 3.85 3.57 3.52 3.82 7.068 0.000 attractive clean i dirty 3.84 3.53 3.46 4.24 28.171 0.000 visual variables believable advertise3.71 3.34 3.08 3.50 12.249 0.000 ments/ unbelievable advertisements busy i lazy 3.67 3.71 3.54 4.17 17.088 0.000 bebavioural variables honest i dishonest 3.92 3.68 ¥ 4.400 0.004 friendly i 3.74 3.20 24.326 0.000 unfriendly r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vo13 (2000) no 1 135 table 3 continued category nando's steers kfc mcdofp-value dajd's value likeable / 3.57 3.36 4.07 29.589 0.000 unlikeable good service i bad 3.84 3.70 3.74 3.81 0.836 v. service reputable / 3.75 3.32 3.31 4.26 44.200 0.000 disreputable successful / 3.66 3.53 3.59 3.84 4.365 0.005 unsuccessful helpful i 4.15 4.03 4.03 4.37 6~ unhelpful responsible i 3.67 3.60 3.45 3.79 5. 1 irresponsib ie core product expensive / 2.84 3.02 2.65 3.12 5.641 0.001 inexpensive tasteful i tasteless 4.00 3.80 3.91 3.60 5.352 0.001 high quality !low 3.79 3.53 3.58 3.56 2.881 0.035 quality healthy 3.34 3.02 3.06 3.15 3.902 i 0.009 !unhealthy extra value / no 3.17 3.08 3.04 3.23 1.349 0.257 extra value convenience i 3.68 3.68 3.67 3.98 5.362 0.001 inconvenience 5.2.3 factor analysis factor analysis assesses the interrelations among a large set of variables, to reduce a large number of responses to a smaller more basic set of hypothetical variables called factors (smith 1988: 167). a principal component factor analysis was performed with a normalised varimax rotation. the eigenvalue< 1 criterion was used for identifying a four-factor solution. the factor loading for the four-factor solution is illustrated in table 4. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 136 table 4 variable ei envalue sajems ns vo13 (2000) no 1 four-factor solution for corporate identity variables of fast food restaurants factor 1 factor 2 factor 3 factor 4 0.816 807 0.748 0.611 0.552 0.828 0.540 0.834 0.616 7.048 1.379 1.135 1.112 cumulative % of variance 35.24% ex lained 42.13% 47.80% 53.360/0 the following variables were not included because their loading were below 0.05: honesty (b), reputation (b), attractiveness (v), believability of advertisements (v) and convenience (c) although the factors are not entirely visual, behavioural and core representative, there is still sufficient evidence of these variables amongst the suggested factor solution. the underlying factors could then be classified as: factor i: behavioural identity a descriptive expression for this factor is at first glance rather difficult. one half of the adjective variables that were included in this factor were originally classified as behavioural and the other half as visual. the inclusion of "dirty/clean", "busyllazy" and "interestinglboring" can all be seen as tangible evidence of various behavioural issues, and as such could be part of a behavioural identity descriptor. finally, it was decided to describe this factor as a "behavioural identity" since the factor loading of the original behavioural variables was higher than the factor loading of those variables originally classified as visual. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 137 this factor thus represents the way customers are treated and the way employees and the organisation as a whole behave. factor 2 core product image the adjective variables included in this factor would best describe product related issues such as taste, quality and healthiness. factor 3 core value image this factor relates to value in tenns of expensiveness and value for money. factor 4 visual recognition this factor relates to the way customers recognise visual cues such as the corporate logos and buildings. table 5 correlation between visuaj, behavioural and core attributes itemvisual score iclean 0.507 / clean 0.541 iclean 0.525 it is important to note that the hygiene factor (dirty/clean) occurs in each correlated situation. thus the visual effect of cleanliness correlates positively with the behaviour and customer service levels of the employees. this is one of the most important findings of this study: customer service and employee behaviour was rated as the most important factor in the choice of fast food restaurants, which confinns that corporate image is created by visual and behavioural identity cues. 6 results and conclusions the stated hypotheses were tested by using andv a, which allows the researcher to test group differences that are attributable to a single independent variable. it also allows testing for significance (smith 1988: 130). table 6 contains a summary of the test statistics used in the andv a, as well as the acceptance or rejection of the various stated hypotheses. whenever a specific variable was labelled as high, scale values equal to and larger than 3 on a scale from i to 5 were used. consequently low levels on all independent variables were tested on scale values of less than 3 on as-point scale. all dependent variables were analysed as mean scale values on a 0 to 10 scale. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 138 sajems ns vol 3 (2000) no 1 table 6 test statistics of anov a: significance testing hypothesis 1 ~ independent dependen low level of visual identity general 5.894 0.0000 accept at 99% impression level high level of visual identity 7.862 hypothesis 2 independent dependent mean p-value decision low level of behavioural general 5.956 0.0000 accept at 99% identity impression level high level of behavioural 7.972 identity hypothesis 3 independent dependent mean p-value decision low opinion of core products general 6.378 0.0000 accept at 99% impression level high opinion of core products 8.257 hypothesis 4 independent dependent mean p-value decision low combined level general 5.944 0.0000 accept at 99% impression level high combined level 8.041 hi hypothesis result: accept hypothesis at 99% level of significance that respondents who indicated high levels of visual identity, have significantly more positive general impressions of a fast food restaurant than respondents who indicated a low level of visual identity. h2 hypothesis result: accept hypothesis at 99% level of significance that respondents who indicated high levels of behavioural identity, have significantly more positive general impressions of a fast food restaurant than respondents who indicated a low level of behavioural identity. h3 hypothesis result: accept hypothesis at 99% level of significance that respondents who have a high opinion of the core product, have significantly more positive general impressions of a fast food restaurant than respondents who have a low opinion of the core product. h4 hypothesis result: accept hypothesis at 99% level of significance that respondents who indicated a high combined level of behavioural and visual identity, have significantly more positive general impressions of the fast food r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 139 restaurants than respondents who indicated a low combined level of behavioural and visual identity. 7 research limitations this study is at most an exploratory investigation into factors that determine the corporate identity of some fast food restaurants that operate in south africa. other specific limitations should also be noted: only convenience sampling was done. the respondents used in this investigation (students) may not be representative of the south african population to make generalisations of the results possible. the list of bipolar items used in this semantic differential might have been more complete because the possibility exists that certain items were excluded or even overlapped. the use of semantic differentials may also have biased the instrument interpretation to different semantic meaning and understanding by various respondent subgroups. not .all fast food restaurants were tested in this study . . the factors identified as contributing to corporate image may only be relevant to fast food restaurants and not to other industries. the relationship between the independent and the dependent variables were not investigated in more depth to determine the relative importance of the various independent variables. 8 research and management recommendations further research suggestions and management recommendations may be summarised as follows: determine whether the corporate identity is more tangible or intangible· dominant this will eliminate any uncertainty whether the core product should also be tested. focus more research on how the core product (food and drink) influences the corporate image. create a more objective scale for the measurement of visual and behavioural elements. in this way a more clearly differentiated factor solution would emerge where separate factors for visual and behavioural identity could be found. investigate the possibility to change the scale methodology to that of a likert rating scale rather than a semantic differential scale. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 140 sajems ns vol 3 (2000) no 1 determine other visual and behavioural elements that could influence corporate image to enhance the measurement instrument. perform regression type analysis to investigate the relationship between various independent variables and corporate image. • test the independent variables of corporate image on other dependent variables such as loyalty, repurchase or customer retention. management should spend more time on aspects such as customer service levels and implementing appropriate management styles. 9 key findings and conclusion the most important finding is that the joint customer service and employee dimension was rated as the most important factor in the choice of fast food restaurants, which confirms that corporate image is created by visual and behavioural identity. the key findings can be summarised as follows: • visual identity plays an important role in establishing the perception of a fast food restaurant. a strong correlation between the visual and the behavioural elements was also found (h\ & h2)' the behavioural identity , also known as the customer service and employee dimension of corporate identity, was rated as the most important factor in the choice offast food restaurants (factor analysis) and thus plays a vital role in establishing the general impression of a fast food restaurant (h2). • there was no significant difference in the way the respondents rated the core products of the fast food restaurants, but this factor definitely has an impact on the overall perception of a fast food restaurant (h). it is comparable to the factor of safety in the case of airlines. the combined effect of visual and behavioural elements is significantly higher than each variable by itself. it therefore provided strong evidence that corporate image consists of more than just visual elements, and the importance of behavioural elements should in fact be regarded tegether with the impact of visual identity (~). this study thus leads to the conclusion that corporate behavioural traits also play a vital role in creating and maintaining a desired and positive corporate image. since a fast food restaurant operates with both tangible and intangible elements, the core product itself and various aspects concerning it were also tested. this showed that the core product (e.g. hamburgers, chips, salads and cold drinks) plays an important role in forming overall general impressions. it is r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no i 141 not yet conclusive though, whether all consumers regard the steers. burger better than the big mac of mcdonald's. the underlying intangible service delivery (e.g. speed of processing an order, friendliness of staff and speed of delivery) also plays an important role in supporting the tangible perceptions created by the core product. it is still inconclusive to what extent good service delivery can support a lower quality product before consumers switch their loyalty to a competing product. references abrati, r. (1989) "a new approach to the corporate image management process", journal oj marketing management. 5( 1): 63-76. 2 barnard, j. (1991) "marketing your business through corporate image", marketing management, 2(l1): 4-5. 3 burrows, m.m. (1991) "strategies on the marketing of intangibles with special reference to corporate image", paper read at the western cape marketing educators' national conference, november. 4 carter, d.e. (1982) designing corporate identity programs jor small corporations. new york: art direction book co. 5 cooper, d.r. and emory, c.w. (1995) business research methods. fifth ed., irwin: america. 6 croft, m. (1989) "beyond the corporate logo", accountancy, aug: 65-66. 7 denby-jones, s. (l995) "mind the gap", the banker, feb: 66-67. 8 drummond, g. (1995) "corporate branding focuses on service", below the line, oct: 9. 9 gr{)nroos, c. (1984) "a service quality model and its marketing implications", european journal oj marketing, 18(4): 36-44. 10 lovelock, c. h. (1996) services marketing, third ed., prentice hall international. ii miller, k. d. (1990) "building a corporate 10", black enterprise, 5( 10): 30-32. 12 olins, w. (1987) the corporate personality, mayflower books inc. new york. 13 sampson, j. (1995) "shining through: corporate branding under the spotlight", marketing mix, 13(4): 36-7. 14 smith, m.j. (1988) contemporary communication research methods, wadsworth: belmont. 15 skinner, c. and von essen, l. (l991) the handbook oj public relations, third ed., southern book publishers, halfway house, south africa. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 142 sajems ns vol 3 (2000) no i 16 stewart, k. (1991) "corporate identity: a strategic marketing issue, journal of bank marketing, 9( 1): 32-9. 17 van heerden, n. (1994) "there is more to corporate image than meets the eye, image & text a journalfor design, 4, december: 3-8. 18 van heerden, c. h. (1999) "developing a corporate image model", south african journal of economic and management sciences. 2(3), september: 492-508. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . microsoft word 8 vundla et al sajems 19(5) 2016.docx 814 sajems asset research ns 19 (2016) no 5:814-830 how to cite doi: http://dx.doi.org/10.17159/2222-3436/2016/v19n5a8 issn: 2222-3436 the opportunity cost of not utilising the woody invasive alien plant species in the kouga, krom and baviaans catchments in south africa thulile vundla1*, james blignaut2, 3, nonophile nkambule1, 4, tshepo morokong1 and shepherd mudavanhu1, 5 1asset research, pretoria 2department of economics, university of pretoria 3south african environmental observation network, pretoria 4department of agricultural economics and management, university of swaziland, swaziland 5department of agricultural economics, university of stellenbosch accepted: october 2016 this study estimates the opportunity costs of using woody invasive alien plants (iaps) for value-added products by estimating the net economic return from the value-added industries in south africa. by 2008, iaps were estimated at the national level to cover an area of 1 813 million condensed hectares in south africa. a market has formed around their use for value-added products (vap) like charcoal, firewood and timber in the kouga, kromme and baviaans river catchments in the eastern cape province of south africa. the net economic return from these value-added industries was estimated for the purpose of several management scenarios, and was then used to estimate the opportunity costs if they were not used. a system dynamics model was used to value and analyse the net present value of clearing in the study area and to estimate the opportunity cost of the non-use of vap. the study showed that the inclusion of vaps in the project would yield higher net present values for clearing. the findings from this study suggest that a cofinance option of the total economic returns from vap for clearing costs is the best management scenario for reducing the costs of clearing and maximising the net economic returns from clearing. the net economic returns of vaps by 2030 are estimated at r23 million without the co-finance option and r26 million with the option. the cumulative net income from vaps with co-financing over the period of valuation is estimated to be r609 million. key words: opportunity cost, alien invasive plants, direct use value, eradication through utilisation jel: q24, 25, 42 1 introduction biological invasions are a significant threat to land productivity, biodiversity and the ecosystem goods and services provided for society in general (nellemann & corcoran, 2010). in south africa the national department of environmental affairs: natural resource management (dea:nrm) is tasked with the management and control of invasive alien plants (iaps). as early as the 1900s, the potentially unfavourable impact of iaps on south africa’s natural fynbos vegetation was acknowledged (moran, hoffman & zimmermann, 2013). later, (cowling, 1992), the dea:nrm programme was commissioned in 1995 to control iaps (van wilgen, cowling & burgers, 1996; blignaut, marais & turpie, 2007; blignaut, mander, schulze, horan, dickens, pringle, mavundla, mahlangu, wilson, mckenzie & mckean, 2010). research on resource economics has been instrumental in providing motivation for the expensive dea:nrm programme, and several south african studies have used a cost-benefit analysis of clearing iaps to inform decision-making (e.g. van wilgen, cowling & burgers, 1996; higgins, richardson & cowling, 1996; hosking & du preez, 1999; hosking & du preez, 2004; turpie & heydenrych, 2000; de wit, crookes & van wilgen., 2001; wise, van wilgen & le maitre, 2012). this study is intended to contribute to the growing number of studies by investigating the potential benefit of private-sector investment in the dea:nrm programme. abstract sajems asset research ns 19 (2016) no 5:814-830 815 potential economic gains from iaps present an opportunity for government to source cofunding from the private sector for the control and management of iaps, and, in the process, support rural livelihoods through the sale of products derived from iaps (van wilgen & richardson, 2012; shackleton, le maitre, pasiecznik & richardson, 2014). however, there are challenges, especially when it comes to the extraction of iaps. mugido, blignaut, joubert, de wet, knipe, joubert, cobbing, jansen, le maitre & van der vyfer (2014) suggest on-site processing as a possible alternative to addressing the issue with transportation. it is also clear that conflict-of-interest species, such as black wattle, pine trees and prosopis, require innovative methods of management. currie, milton, & steenkamp (2009) conducted a cost benefit analysis (cba) of clearing pinus species and restoring fynbos in the assegaaibos mountain catchment area in the western cape province of south africa. they found that the npv of clearing pinus species and restoring fynbos was always negative, regardless of the discount rate used. however, if the economic value of the iaps is used to co-finance the operations, this could result in a feasible option. thus, this study sought to determine the costs and benefits of early restoration in the kouga-krom catchment area in the eastern cape province of south africa. as some of the species that are being cleared by the dea:nrm are of commercial value, this study estimated the opportunity costs of not using iaps for value-added industries. further, the study also estimated the unit reference value (urv) for clearing iaps in the kouga-krom study area. 2 site description the study area (referred to as kouga-krom) falls within the kromme, kouga and baviaans river catchments in the eastern cape province, near jeffrey’s bay. it spans a total of 5 234.24 km2, with a mean annual rainfall ranging between 500–2 000 mm per annum (saws, 2015). it consists of two biome types, fynbos (80 per cent) and albany thicket (20 per cent) (mander, blignaut, van niekerk, cowling, horan, knoesen, mills, powell & schulze, 2010), both of which are biodiversity hotspots and areas of high endemism (global biodiversity outlook, 2010; hoare, mucina, rutherford, vlok, euston-brown, palmer, powrie, lechmere-oertel, proches, dold & ward, 2006; myers, 1990) because of the geological features of the area. the fynbos biome is one of the most invaded biomes in south africa (richardson, macdonald, hoffman & henderson, 1997; kotzé, beukes, van den berg & newby, 2010). the study area comprises 14 sub-quaternary catchments, l81a-c, l82a-j & l90a-c within the fish to tsitsikamma river catchment. the majority of the land is under private land tenure (mander, blignaut, van niekerk, cowling, horan, knoesen, mills, powell & schulze, 2010), with intensive deciduous fruit, lucerne and citrus production (jansen, 2008). protected areas are limited to the upper regions of the study area in the baviaans catchment and it is recognised internationally as a world heritage site (jansen, 2008). the study area is largely rural, containing only small communities, while the population density is generally low, with 20–40 people/km2 and unemployment in the area is high, ranging from 30–40 per cent (statssa, 2011). the study area is under additional pressure from extensive farming and other agricultural activities in the area (mander, blignaut, van niekerk, cowling, horan, knoesen, mills, powell & schultze, 2010; jansen, 2008). iaps are an increasing problem, particularly in the lower regions, with acacia baileyana, a. dealbata & a. mearnsii (hereafter referred to as wattle spp) being one of the greatest threats in the area (mander, blignaut, van niekerk, cowling, horan, knoesen, mills, powell & schultze, 2010). table 1 outlines the current extent of invasion in the study area. these pressures increase the strain on the availability of water for the catchment 3 methods and material 3.1 data collected primary data was sourced during a series of site visits and group discussions, with experts, as well as implementing agents for the dea:nrm programme. the data gathered from experts and 816 sajems asset research ns 19 (2016) no 5:814-830 implementing agents was supplemented with data from the literature on the indicators required for an economic analysis. the condensed values for the iaps and related information were extracted from the. (2010) database for kotzé, beukes, van den burg & newby (see table 1). this study focuses exclusively on the five dominant species found in the areas noted by kotzé, beukes, van den berg & newby (2010). table 1 current extent of invasion in the study area and spread rates of the respective species species extent of invasion (condensed ha) spread rates (% per year) species density (%) wattle spp 8 584.38 10.00 4.18 hakea spp 3 761.88 8.80 4.72 other 2 483.08 0.14 pinus spp 2 055.51 8-15 0.55 acacia saligna 679.77 10.00 0.31 atriplex donax 254.06 10.00 0.21 sources: adapted from kotzé et al. (2010) and van wilgen & le maitre (2013) 3.1.1 value added products only the main benefits deriving from wattle spp. and acacia saligna and pinus species were considered in this study, as the benefits of the other iap species are not considered economically significant (cabi, 2016). wattle spp., for example, are australian acacia species and comprise a combination of acacia baileyana, a. dealbata and a. mearnsii. these were intentionally introduced into south africa for the ecological services they provide, such as serving as wind breaks and providing fuel (de wit, crookes, van wilgen, 2001; nyoka, 2003). wattle spp. have become one of south africa’s most widespread iaps (nyoka, 2003; versfeld, le maitre & chapman, 1998; dye & jarmain, 2004), and thus became the most targeted iaps, with almost a third of all the clearing costs attributed to the control of wattle spp. (wise, van wilgen, & le maitre, 2012). the investment in controlling iaps in the kouga-krom catchment for the period 2008-2014 is provided in table 2. table 2 historical nominal and real values for clearing data from dea: nrm: kouga-krom. year actual clearing costs (r) clearing costs in constant 2014 prices (r) area cleared (condensed ha) 2008 2 604 939.68 3 695 156.72 1 994.21 2009 3 446 823.56 4 612 627.45 793.05 2010 6 590 916.35 8 320 880.04 2 740.38 2011 8 669 108.25 10 325 046.63 3 339.05 2012 7 386 950.53 8 299 977.62 3 793.70 2013 5 998 088.38 6 357 973.68 481.42 2014 5 700 437.89 5 700 437.89 315.07 source: adapted from dea: nrm (2015) while it is important to control iaps with their detrimental effects on a range of ecosystem goods and services, such as water flows, they can be used to generate value through a range of valueadded products (vap), which are listed in table 3. sajems asset research ns 19 (2016) no 5:814-830 817 table 3 benefits associated with the five dominant species of the study area benefit description species tannins extracted from bark tanning agents used in the production of soft leather wattle spp. acacia saligna timber building materials and mining timber wattle spp. pine spp. acacia saligna pulp mainly exported, for the production of paper and other products wattle spp. pine spp. wood chips used in the production of paper wattle spp. pine spp. charcoal fuel used in barbecues wattle spp. pine spp. acacia saligna firewood an important fuel source for rural communities wattle spp. acacia saligna building materials used to support housing structures in rural areas wattle spp. carbon sequestration standing plantations and invasions store carbon as a counter to carbon build-up in the atmosphere, mainly from fossil fuel burning, which can potentially be traded wattle spp. pinus spp. acacia saligna nitrogen fixation addition of nitrogen through fixation by roots could be regarded as either a benefit or a cost in some areas wattle spp. acacia saligna medicinal products possible use as styptics or astringents wattle spp. combating erosion decrease erosion in severely degraded sites away from river courses wattle spp. pinus spp. aesthetic non-direct use, but appreciation of resource pinus spp. hakea spp. source: adapted from de wit et al. (2001) and cabi (2016) 3.2 development of an economic model the economic model used in this study is a system dynamics model based on the work of forrester (1961), and will be described below. vensin® software was used for the conceptualisation and development of the economic model to estimate the opportunity costs of not using iaps for commercial benefit (ventana systems, 2003). 3.2.1 model description the model investigated the benefits and cost of early restoration in relation to waiting until an area becomes heavily invaded. the model further investigates the potential benefits of value-added industries to the dea:nrm programme through recommending a policy variable co-financing to reduce the costs of clearing . the model was run for 22 years (2008–2030) and consisted of six sub-models, which were land use, clearing cost, value-added products, water consumption, carbon sequestration and economic factors. the sub-model for land use focused on the extent of alien invasion and clearance at the study area (see figure 1). the parameters informing this sub-model are listed in table 1. the stock variables are areas invaded by hakea spp., wattle spp., pinus spp., atriplex donax, acacia silinga and other species. the ‘other species’ represent the less dominant iaps found at the study site. each stock variable in the land-use sub-model depicts the extent of invasion, which is increased by regrowth and reduced by clearance. the iap regrowth is increased by the spread rate and the area invaded. the iap clearance is a function of person days which, in turn, are a function of the budget. regression models were run in the vensim® modelling software to estimate the functions. 818 sajems asset research ns 19 (2016) no 5:814-830 the value-added products sub-model in this study was concerned with estimating the net ecominc returns from vaps. the biomass values were allocated to a selection of vaps (see table 4) . the value-added industries considered were charcoal, firewood, briquette, pulp and timber. the quantities were corrected for losses and then multiplied by the corresponding prices to yield the total revenue from each. the summation of the total revenue multiplied by the profit margin ratio yielded the net income from vaps. the parameters informing this sub-model are listed in table 4. values that inform more than one sub-model are not repeated. to establish confidence in the developed model several validity test were applied in vensim ®. a short description of the validity test applied in this study in the appendix. figure 1 land use sub-model for the kouga-krom study area initial area hakea species initial area atriplex donax initial area wattle species initial area acacia saligna initial area pinus species area hakea species hakea species regrowth spread rate hakea species area pinus species pinus species regrowth spread rate pinus species area acacia saligna acacia saligna regrowth spread rate acacia saligna area atriplex donax atriplex donax regrowth spread rate atriplex donax area wattle spp wattle spp regrowth spread rate wattle spp initial area other species area other species other species regrowth spread rate others species grand initial alien area proportion of hakea species proportion of wattle species proportion of pinus species proportion of acacia saligna proportion of other speciesproportion atriplex donax person days effect of budget on person days budget (deak) effect of pd on ha cleared pinus species clearance atriplex donax clearance acacia saligna clearance other species clearance wattle species clearance elasticity of person days to budget elasticity of ha cleared to person days area cleared hakea species clearance <proportion of hakea species> <proportion atriplex donax> <proportion of acacia saligna> <proportion of pinus species> <proportion of other species> <proportion of wattle species> annual alien clearance <hakea species clearance> <pinus species clearance> <acacia saligna clearance> <other species clearance> <wattle species clearance> <atriplex donax clearance> cumulative invaded area <area atriplex donax> <area acacia saligna> <area hakea species> <area pinus species> <area other species> <area wattle spp> budget do nothing <time> co-finance proportion budget (deak+) sajems asset research ns 19 (2016) no 5:814-830 819 table 4 parameters informing the value-added products sub-model variable value units data source year timber price 600 r/ton pers. comm. (private producer) 2015 pulp price 800 r/ton cohen et al. (2015) 2015 biomass per ha pinus spp. 45 ton/ha mugido et al. (2013) 2014 biomass per ha wattle spp. 45 ton/ha mugido et al. (2013) 2014 biomass per ha acacia saligna 23.2 ton/ha mugido et al. (2013) 2014 biomass per ha atriplex donax 45 ton/ha mugido et al. (2013) 2014 biomass per ha hakea spp. 45 ton/ha mugido et al. (2013) 2014 firewood price 450 r/ton cohen et al. (2015) 2015 charcoal price 2 700 r/ton pers. comm. (private producer) 2015 briquette price 6 250 r/ton pers. comm. (private producer) 2015 biomass conversion ratio into briquette 0.3 dml pers. comm. (private producer) 2015 biomass conversion ratio into charcoal 0.2 dml pers. comm. (private producer) 2015 biomass conversion ratio into pulp 0.5 dml pers. comm. (private producer) 2015 biomass conversion ratio into timber 0.5 dml pers. comm. (private producer) 2015 proportion of acacia saligna to briquette 0.5 dml assumption 2015 proportion of pinus spp. to pulp 0.5 dml assumption 2015 proportion of pinus spp. to timber 0.5 dml assumption 2015 proportion of wattle spp. to briquette 0.33 dml assumption 2015 proportion of wattle spp. to charcoal 0.33 dml assumption 2015 proportion of wattle spp. to firewood 0.33 dml assumption 2015 proportion of acacia saligna to charcoal 0.33 dml assumption proportion of acacia saligna to firewood 0.33 dml assumption biomass conversion ratio into firewood 1 dml pers. comm. (private producer) the water consumption sub-model estimates the value of the water lost to iaps, using the agricultural value of water. the total iap water consumption is a summation of the water use by the various iaps which, in turn, is a product of the individual iaps water reduction per hectare and the area that was cleared. the iaps water consumption coupled with the unit value of water yields the water value potentially saved. the parameters and equations used are given in table 5 and appendix a respectively. table 5 model parameters used to estimate the consumption of water by iaps variable value units data source year water reduction per ha atriplex donax 116.27 m3/ha le maitre et al. (2013) 2013 water reduction per ha pinus spp. 2 550.32 m3/ha le maitre et al. (2013) 2013 water reduction per ha hakea spp. 2 992.74 m3/ha le maitre et al. (2013) 2013 water reduction per ha wattle spp. 1 434.73 m3/ha le maitre et al. (2013) 2013 water reduction per ha other species 0 m3/ha le maitre et al. (2013) 2013 water reduction per ha acacia saligna 634.81 m3/ha le maitre et al. (2013) 2013 unit value of water 1 r/m mander et al. (2010) 2010 the carbon sequestration sub-model demonstrates the net carbon value that is lost owing to clearing iaps at the study site. table 6 shows the parameters set for this sub-model. iaps use carbon during the photosynthesis process and, in turn, reduce greenhouse gases in the atmosphere. for this reason, the carbon sequestration potential is lost when iaps are cleared. the sequestrated carbon is a product of the species biomass, clearance, percent carbon (i.e. percent oven dry biomass) and the c:co2 ratio. the model equations are found in appendix a. 820 sajems asset research ns 19 (2016) no 5:814-830 table 6 parameters informing the carbon sequestration sub-model variable value units data source year carbon sequestration per ha atriplex donax 74.25 ton/ha mugido et al. (2014) 2014 carbon sequestration per ha pinus spp. 135.81 ton/ha mugido et al. (2014) 2014 carbon sequestration per ha hakea spp. 74.25 ton/ha mugido et al. (2014) 2014 carbon sequestration per ha wattle spp. 59.02 ton/ha mugido et al. (2014) 2014 carbon sequestration per ha acacia saligna 29.87 ton/ha mugido et al. (2014) 2014 carbon sequestration per ha other species 74.25 ton/ha mugido et al. (2014) 2014 carbon sequestration acacia saligna 29.87 ton/ha mugido et al. (2014) 2014 a factor correcting for net carbon 0.05 dml assumption 2015 unit price of carbon 120 r/ton national treasury (2013) 2014 while there are several potential land uses after clearing the iaps, we focus here on grazing. for this reason, the grazing value sub-model (see figure 2) models the net income that could be derived from livestock (mainly sheep) production at the study site once the iaps have been cleared. this sub-model therefore models only small stock units (ssu). the hectares grazed by ssu are given by the area cleared and corrected, as the entire area could not be used for potential grazing (i.e. the factor “% grazing under ssu”). the hectares grazed by ssu multiplied by the ssu weight production (ha/yr) yields the weight production by ssu. the ssu weight production is a product of the lsu weight production and the lsu to ssu conversion factor of 6,67. the weight production together with the unit price of ssu yields the total revenue from ssu. this is then multiplied with the profit-margin ratio to determine the net income from grazing ssu. a list of the parameters that informed this model is given in table 7. figure 2 grazing value sub-model % grazing under ssu lsu weight production: commercial ssu weight production:commercial lsu to ssu weight production (ssu) total revenue ssu ha grazed: ssu net income grazing: ssu <annual alien clearance> area livestock production <profit margin ratio> <unit price ssu> sajems asset research ns 19 (2016) no 5:814-830 821 table 7 grazing value sub-model parameters variable value units data source lsu weight production commercial 16 kg/ha /yr de wit et al. (2015) ssu to lsu 6.67 dml herling et al. (2009) unit price ssu 30 r/kg de wit et al. (2015) % grazing 0.5 dml assumption commercial grazing 1 dml assumption the clearing cost sub-model demonstrates the total cost of clearing the iapsfor the study site. the unit clearing cost is calculated by dividing the budget by the annual iap clearance. the budget denotes either the funds that were invested by dea to clear iaps at the study site between 2008 and 2015 and/or an exploration of various budget-related clearing interventions aimed at reducing iaps between 2015 and 2030. the product of the unit clearing cost and the annual iap clearance yields the total clearing cost. the economic sub-model estimates both the net income from clearing iaps at the study site and the urv. the applied discount rate for this study is 6 per cent, based on a suite of rates used by government. the net income from clearing iaps is the sum of i) the net income from vaps, ii) the value of the water saved, iii) net income from grazing, and less i) the net carbon value lost and ii) the cost of cleaing the iaps. the calculated cumulative pv clearing cost and cumulative pv water volume were used to determine the urv (unit reference value). the urv, which represents the cost of water per cubic metre over the lifetime of a water infrastructure project and is estimated for comparability with other study areas regarding the cost-effectiveness of various clearing operations is therefore calculated as: urv = 𝑃𝑉 𝑜𝑓 𝑐𝑜𝑠𝑡𝑠 / 𝑃𝑉 𝑜𝑓 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑜𝑓 𝑤𝑎𝑡𝑒𝑟 𝑖𝑛𝑐𝑟𝑒𝑚𝑒𝑛𝑡𝑎𝑙𝑙𝑦 𝑎𝑠𝑠𝑢𝑟𝑒𝑑 the model validation is performed to test and establish confidence in the model (forrester & senge, 1980). appendix b shows the model validation tests and the outcomes of each validity test. the study model assumes that the private producers would be willing to co-finance the expense of clearing. other assumptions in the data in the model include the proportional contribution of each vap to the net value of value-added industries. it was beyond the scope of this study to quantify the actual proportions of each vap in the net value of value-added industries. the model assumes that all the grazing value gained in the area is commercial when it comes to the land tenure of the study area, because an insignificant area is under communal land tenure. the model also assumes that only 50 per cent of the area gained from clearing would be suitable for grazing, as not all the cleared area goes to grazing. the final assumption made in the model is the carbon correction factor. this factor (0.05) is applied to cater for the fact that not all the carbon is lost in clearing, as there will be regrowth of some vegetation once the trees have been cleared from the system. 3.2.2 model scenarios three scenarios were develop to assess the value of the management options available to dea:nrm. the scenarios are described in table 8 below. table 8 model scenarios used in this study scenario description (i) do nothing clearing intervention for 2008-2014, then no clearing until 2030 (ii) deak clearing according to current dea budget and clearance rate (iii) dea k+ clearing according to current dea budget plus 20% co-finance by private sector 822 sajems asset research ns 19 (2016) no 5:814-830 4 results and findings 4.1 the ‘do nothing’ option the area cleared for the three management scenarios is shown in figure 3(a). following 2014 in the “do nothing’ option, no area is cleared. hence, the costs of clearing shown in figure 3(b) are zero. figure 3(c) shows the urv as estimated in this study. because no additional water is generated in this option, the urv is not considered. once clearing stops the value of carbon lost to clearing becomes zero, as can be seen in figure 3 (d). figure 3 vensim® system dynamics output (a) is the area cleared in ha/year, (b) shows the cost of clearing in r/year, (c) is the urv in r/m3, and (d) is the value of carbon lost to clearing as there are no clearing operations in this management scenario, no water is saved, as shown in figure 4(a). the water is essentially lost to invasion. infestation takes up the grazing areas. figure 4(b) shows that no grazing value is gained in this option. the total net economic returns from the vaps is estimated at zero as shown in figure 4 (c), as in this study we are concerned only with the sajems asset research ns 19 (2016) no 5:814-830 823 dea:nrm cleared biomass. the overall cumulative npv for this option is r65 million as shown in figure 4 (d). 4.2 business as usual option (deak) to clear a total area of 44 400ha by 2030 a budget of r139 million is required for the business as usual option. the areas cleared and the budget used for each year is shown in figure 3(a) and (b) respectively. the estimated urv value for this option is shown in figure 3(c), and is very similar to the deak+ option. the estimated average urv value is r1.83/m3 over the duration of the study period. the urv shows an increasing over-time trend. the carbon value lost to clearing in this management option is lower than that in deak+ (figure 3(d)) the benefits of clearing are highlighted in figure 4. the model finding estimates the net value of water saved at r63 million per annum for this management scenario. the trend in the value of water saved is shown in figure 4(a). another benefit of clearing is the grazing area made available following the clearing. the economic returns from grazing following the clearing operations is shown in figure 4(b) and is estimated at r25 000 per annum in the deak scenario. this benefit is lost in the do nothing option. the model output for the vap are shown in figure 4(c), the returns are estimated at r23 million per annum and this amount is entirely for private benefit. this management option yields a positive cumulative npv (figure 4 (d), because the benefits in the figure 4 outweigh the cost outlined in figure 3(a & c). 4.3 dea co-financed option (deak+) the co-financed option seeks to increase the social benefits of clearing by implementing a 20 per cent co-financing from private beneficiaries by means of a policy variable. this management option yields the highest area cleared using the same dea:nrm budget, with private co-finance. this is shown in figure 3(a) where about 51 000 ha over the duration of the simulation. figure 3 (b) shows the costs of clearing to be r6.8 million per annum (2015 to 2030 and r157 million over the period 2008-2030. this is owing to the increased budget from the co-finance option that is funding the operational costs of clearing. the clearing costs are higher than the business as usual option, owing to the 20 per cent co-finance. the urv value for this option is estimated at r1,81/m3 as shown in figure 3(c). this value is similar to that of the business as usual option. the carbon value lost, which is one of the costs of clearing, is illustrated in figure 3(d). the value of the water saved was estimated for the co-financed option, and the outputs are illustrated in figure 4(a). the value of the water saved is estimated at r7.2 million per annum. the grazing value gained through clearing is illustrated by figure 4(b). the co-financed option has the highest economic returns from grazing gained. figure 4(c), which illustrates the total economic returns from value-added industries shows that, through the private-public partnership, the net returns are higher than they would be without the cofinance option. this is evident through the value of r26 million per annum for the deak+ option compared to the r23 million of deak. this option yields a positive cumulative npv, as illustrated in figure 4 (d). the npv of r189 million for deak+ is slightly higher than that of r171 million from the business-as-usual scenario. 824 sajems asset research ns 19 (2016) no 5:814-830 figure 4 value of water saved by clearing invasive (a) and the grazing benefit of clearing that opens the area to grazing (b). the net economic returns of value added products is illustrated in (c) and the cumulative npv of clearing illustrated in (d). 5 discussion the results of this study showed that the current management strategy employed by dea:nrm (business-as-usual) is not the most economical option. this is mainly owing to the lower clearance rate and reduced benefits of this management option in comparison with other scenarios such as co-financed (deak+). npv of the co-financed scenario (i.e. deak+), which explores the feasibility of a public-private partnership through the introduction of a 20 per cent of returns contribution to the costs of the clearing policy variable, suggests that this management option is the best of the three scenarios. by not using the vaps, as illustrated in the do nothing scenario, the dea:nrm is running at a negative npv throughout the duration of the project’s lifetime. a positive npv outcome is seen from the production of the vap (deak scenario). however, the sajems asset research ns 19 (2016) no 5:814-830 825 income from the vap is not invested in the costs of clearing. the results of the study also suggest that investing back into clearing cost increases both the clearance rate and the biomass production of vap, thus increasing the net economic returns from vaps. with the inclusion of vaps, the dea:nrm could increase the clearing operations and decrease the public cost of clearing. for all the management options, the urvs are greater than 1, which shows that the present value (pv) of the project costs is higher than the pv of the project benefits. the urv value is, however, concerned only with the pv of water, but not the other benefits estimated in this study. the urv in south africa is an important tool, especially in water production. for instance, the south african national department of water affairs uses the urv to determine the cost-effectiveness of dam construction. erasmus, denys, scherman & van der berg (2013) note that the urv for raising the dam wall of kouga was estimated at r3.09/m3, which is almost twice the urv estimated for water generation through clearing. this suggest that clearing of invasive alien plants is a cost-effective option in protecting the value of the infrastructure as the opportunity cost of not clearing (r3,09/m3) is higher than the cost of clearing (r1,81/m3). the deak+ scenario yields the highest water value saved, and the vaps substantially increases the npv of clearing iaps, the water value saved, the area cleared and the grazing value gained. this makes it the best management option for achieving the most benefits from clearing. although, stubbings (1977) found that most private producers are resistant to the notion of cofinancing or paying for clearing iaps, this option may still be an achievable request. the benefits of early restoration are clearly seen throughout all the sub-models. a major cost quantified in this study is the loss of carbon stock when clearing the iaps. essentially, with greater clearance, more carbon stock is lost. carbon is valued at r120/ton by the national treasury. this value is probably an over-estimation because it does not take into account the regrowth of indigenous vegetation. a better estimate of the carbon gains and losses requires a comprehensive study. the ‘do nothing’ option yields only the carbon stock benefits, but at the expense of the other benefits, which is why its cumulative npv is negative. 6 conclusion and recommendations the main findings of this study suggest that the dea:nrm could significantly reduce the cost of clearing through partnering with value-added industries in the use of iaps through a co-finance of 20 per cent of the total revenue. this would also increase the rate of clearing of iaps while reducing the costs. both the amount of water saved and the increase in grazing value are benefits that would directly affect the surrounding communities. this study has shown that in projects in which the iaps are of commercial benefit, there is potential for the dea:nrm to partner with the industries in order to reduce the costs, and to increase the benefits of early restoration. the total contribution per annum is estimated at r26 million, which is shown to increase the efficiency of the clearing operations. the opportunity costs of not using the iaps vaps are high, and the use of iaps could significantly improve clearing operations and reduce the overall costs of clearing. endnote * corresponding author: thuli.vundla@gmail.com acknowledgements this study was funded by the dea:nrm programme, who have supplied the data for this analysis. the authors would also like to extend thanks to all the experts who contributed to the process and the private producers who were involved in the survey. a special thank you is also extended to gib and living lands, which provided data that formed a significant part of this study. 826 sajems asset research ns 19 (2016) no 5:814-830 references blignaut, j.n., marais, c. & turpie, j. 2007. determining a charge for the clearing of invasive alien plant species to augment water supply in south africa. 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(eds). the economics of biological invasions. edward elgar publishing limited. cheltenham. van wilgen, b.w., cowling, r.m. & burgers, c.j. 1996. valuation of ecosystem services: a case study from fynbos, south africa. bioscience, 46:184-189. van wilgen, b.w. & le maitre, d.c. 2013. rates of spread in invasive alien plants in south africa. council for scientific and industrial research, stellenbosch. van wilgen b.w., richardson d.m. 2012 three centuries of managing introduced conifers in south africa: benefits, impacts, changing perceptions and conflict resolution. journal of environment management, 106:56-68. ventana system. 2003. vensim® standard professional dss tutorial harvard, usa, 60 jacob gates road. versfeld, d.b., le maitre, d.c. & chapman, r.a. 1998. alien invading plants and water resources in south africa: a preliminary assessment. report no. tt 99/98. pretoria: water research commission. wise, r.m., van wilgen, b.w. & le maitre, d.c. 2012. costs, benefits and management options for an invasive alien tree species: the case of mesquite in the northern cape, south africa. journal of arid environments, 84:80-90. 828 sajems asset research ns 19 (2016) no 5:814-830 appendix a: model formulas description formula/value unit acacia saligna clearance (effect of pd on ha cleared-5612)*proportion of acacia saligna ha/yr acacia saligna clearance (effect of pd on ha cleared-5612)*proportion of acacia saligna ha/yr acacia saligna regrowth area acacia saligna*spread rate acacia saligna ha/yr aliens water value saved unit value of water*aliens water consumption r/yr annual alien clearance atriplex donax clearance+acacia saligna clearance+hakea species clearance+pinus species clearance+other species clearance+wattle species clearance ha/yr area acacia saligna acacia saligna regrowth-acacia saligna clearance ha area atriplex donax atriplex donax regrowth-atriplex donax clearance ha area hakea species hakea species regrowth-hakea species clearance ha area livestock production annual alien clearance ha/yr area other species other species regrowth-other species clearance ha area pinus species pinus species regrowth-pinus species clearance ha area wattle spp wattle spp regrowth-wattle species clearance ha atriplex donax clearance (effect of pd on ha cleared-5612)*proportion atriplex donax ha/yr atriplex donax regrowth area atriplex donax*spread rate atriplex donax ha/yr briquette (utilizable biomass wattle spp*proportion of wattle species to briquette*biomass conversion ratio into briquette*losses)+(utilizable biomass acacia saligna*proportion of acacia saligna to briquette*biomass conversion ratio into briquette*losses) ton/yr budget (deak+) co-finance proportion*"budget (deak)"(time) r cumulative invaded area area atriplex donax+area acacia saligna+area hakea species+area pinus species+area other species+area wattle spp ha cumulative npv krom npv rate r cumulative pv clearing cost pv clearing cost rate r cumulative pv water volume pv water volume rate m3 effect of budget on person days elasticity of person days to budget*ln("budget (deak+)") pd/yr effect of pd on ha cleared elasticity of ha cleared to person days*ln(person days) ha/yr firewood (utilizable biomass wattle spp*biomass conversion ratio into firewood*proportion of wattle species to firewood*losses)+(utilizable biomass acacia saligna*biomass conversion ratio into firewood*proportion of acacia saligna to firewood*losses) ton/yr grand initial alien area initial area atriplex odonax+initial area hakea species+initial area pinus species+initial area other species+initial area acacia saligna+initial area wattle species ha ha grazed: ssu area livestock production*"% grazing under ssu" ha grazed: ssu hakea species regrowth area hakea species*spread rate hakea species ha/yr aliens water consumption water use hakea spp+water use pinus species+water use wattle spp+water use other species+water use atriplex donax+water use acacia saligna m3/yr hakea species clearance (effect of pd on ha cleared-5612)*proportion of hakea species ha/yr net carbon stock removed (sequestrated carbon acacia saligna+sequestrated carbon atriplex donax clearance+sequestrated carbon hakea species+sequestrated carbon other species+sequestrated carbon pinus species+sequestrated carbon wattle spp)*a factor correcting for net carbon ton/yr net carbon value lost unit price of carbon*net carbon stock removed r/yr net income from clearing aliens in kouga-krom (net income vaps+aliens water value saved+"net income grazing: ssu")-net carbon value lost-total clearing cost r/yr net income grazing: ssu total revenue ssu*profit margin ratio r/yr area cleared effect of pd on ha cleared-5612 ha/yr charcoal (utilizable biomass wattle spp*proportion of wattle species to charcoal*biomass conversion ratio into charcoal*losses)+(utilizable biomass acacia saligna*proportion of acacia saligna to charcoal*biomass conversion ton/yr sajems asset research ns 19 (2016) no 5:814-830 829 ratio into charcoal*losses) net income vaps (total revenue briquette+total revenue charcoal+total revenue firewood+total revenue pulp+total revenue timber)*profit margin ratio r/yr npv krouga-krom net income from clearing aliens in krouga-krom/present value factor r/yr npv krouga-krom net income from clearing aliens in krouga-krom/present value factor r/yr npv rate npv krouga-krom r/yr other species clearance (effect of pd on ha cleared-5612)*proportion of other species ha/yr other species regrowth area other species*spread rate others species ha/yr person days effect of budget on person days-432746 pd/yr pinus species clearance (effect of pd on ha cleared-5612)*proportion of pinus species ha/yr pinus species regrowth area pinus species*spread rate pinus species ha/yr present value factor ((conversion factor+discount rate)^year of cost(time)) dmnl proportion atriplex donax initial area atriplex donax/grand initial alien area dmnl proportion of acacia saligna initial area acacia saligna/grand initial alien area dmnl proportion of hakea species initial area hakea species/grand initial alien area dmnl proportion of other species initial area other species/grand initial alien area dmnl proportion of pinus species initial area pinus species/grand initial alien area dmnl pulp utilizable biomass pinus species*proportion of pinus species to pulp*biomass conversion ratio into pulp*losses ton/yr pv clearing cost total clearing cost/present value factor r/yr pv clearing cost rate pv clearing cost r/yr pv water volume aliens water consumption/present value factor m3/yr pv water volume rate pv water volume m3/yr sequestrated carbon acacia saligna acacia saligna biomass*acacia saligna clearance*percent carbon*c:co2 ratio ton/yr sequestrated carbon atriplex donax clearance atriplex donax clearance biomass*atriplex donax clearance*percent carbon*c:co2 ratio ton/yr sequestrated carbon atriplex donax clearance atriplex donax clearance biomass*atriplex donax clearance*percent carbon*c:co2 ratio ton/yr sequestrated carbon hakea species hakea species biomass*hakea species clearance*percent carbon*c:co2 ratio ton/yr sequestrated carbon other species other species biomass*other species clearance*percent carbon*c:co2 ratio ton/yr sequestrated carbon pinus species pinus species biomass*pinus species clearance*percent carbon*c:co2 ratio ton/yr sequestrated carbon wattle spp wattle species biomass*wattle species clearance*percent carbon*c:co2 ratio ton/yr "ssu weight production: commercial" "lsu weight production: commercial"/lsu to ssu kg/(ha*year) timber utilizable biomass pinus species*proportion of pinus species to timber*biomass conversion ratio into timber*losses ton/yr total clearing cost unit clearing cost*annual alien clearance r/yr total revenue briquette briquette*briquette price r/yr total revenue charcoal charcoal*charcoal price r/yr total revenue firewood firewood*firewood price r/yr total revenue pulp pulp*pulp price r/yr total revenue ssu weight production (ssu)*unit price ssu r/yr total revenue timber timber*timber price r/yr unit clearing cost budget (deak+)/annual alien clearance r/ yr unit reference value cumulative pv clearing cost/cumulative pv water volume r/m3 utilizable biomass acacia saligna biomass per ha acacia saligna*acacia saligna clearance ton/yr utilizable biomass pinus species biomass per ha pinus species*pinus species clearance ton/yr 830 sajems asset research ns 19 (2016) no 5:814-830 utilizable biomass wattle spp biomass per ha wattle spp*wattle species clearance ton/yr wattle species clearance (effect of pd on ha cleared-5612)*proportion of wattle species ha/yr wattle spp regrowth area wattle spp*spread rate wattle spp ha/yr weight production (ssu) ssu weight production: commercial*"ha grazed: ssu" kg/yr appendix b: system dynamics validity tests test description result structure verification test tests the internal structure of the model pass dimensional consistency tests the unit uniformity of all model equations pass parameter verification tests the constant variable in the model against literature pass extreme condition evaluates the plausibility of extreme values and the model generated behaviour versus real life behaviour pass 269 sajems ns vol 2 (1999) no 2 productivity and export growth in the south african manufacturing sector 1 larette van rensburg and willem naude school of economics. money & banking, potchefstroom university for che abstract this paper empirically investigates the direction of causality between export and productivity growth in 22 south african manufacturing industries. data spanning the period 1972 to 1993 are used. standard granger-causality tests are complemented by cointegration analyses and the estimation of a theoretically derived regression model. bearing in mind methodology difficulties caused by inadequate data, little evidence of a statistically signiiicant relationship between export growth and productivity growth is found. only in case of the chemicals and wood processing sectors were statistically significant evidence found that export expansion could cause an increase in productivity. domestic demand expansion was found to be a possibly more significant determinant of productivity increases. jel f 43 introduction it is often claimed that there exist a positive association between export growth and economic growth (e.g. kavoussi, 1984). in the literature the view is that export growth will cause economic growth (edwards, 1992). the case for this particular causal direction can be explained as follows. first, an increase in exports may allow an increase in imported capital goods, which raises the growth rate of capital formation and thus stimulates productivity of labour and capital, leading to output growth (islam, 1998: 416). second, export-oriented industries, particularly in manufacturing, are argued to be more susceptible to productivity improvements (due to exposure to competition and foreign technology transfers) and these lead to more investment, scale-benefits and more rapid output growth (levine & reneh, 1992: 943). productivity growth is thus seen as central in the causality chain from export growth to output growth. kavoussi (1984: 241) states that a reason for the positive association between export and economic growth is due to "a favourable impact of exports on total factor productivity". r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 270 cross-country studies generally support the existence of a positive association between export and output growth. however, individual country studies based on time-series data tend to produce ambiguous results2 (fajana, 1979; goncalves & richtering, 1987). recently chand (1998: 15) even goes as far as to maintain that "the link between trade, trade policy and economic growth remains an open question". problematic in these studies is the issue of whether the associations found may be interpreted as a sign of causation between export growth and economic growth, since a significant correlation between variables does not necessarily imply that the one causes the other (lung & marshall, 1985; hsiao, 1987; chow, 1987). in south africa, the direction of causality between export growth and economic growth may be important due to the declared intention of the new government to pursue an export-led growth path (gear, 1996). a key strategy to achieve high export growth in south africa is the emphasis in trade and industrial policy on opening up the economy through trade liberalisation (coetzee, et ai, 1997). various incentive programmes have been introduced to stimulate exports especially of manufactured goods (see the appendix). if the direction of causality between export and output growth in south africa is indeed from export to output, then the above policy emphasis may be justified. however, if causality runs in the opposite direction, other measures which could raise economic growth may be more appropriately emphasised over the short and medium term. examples of these could include labour market policies and restructuring, government expenditure and taxation policies, and selective import protection (see also bell & cattaneo, 1998). it is the purpose of this paper to investigate the direction of causality between export growth and output growth. given the fact that south africa's trade liberalisation programme is relatively recent, being implemented in accordance with the uruguay round of the gait from january 1995, it may be to soon to pick up statistically significant effects of higher export growth on output growth from official data. the theoretical justification for the direction of causality from export growth to output growth implies a time-lag since higher export growth must first result in higher total factor productivity as a precondition for sustained higher output growth). therefore, to be able to obtain preliminary indications as to the direction of causality between export growth and output growth, this paper will focus on the relationship between exports and productivity. due to the prominence of the manufacturing sector in the tradable sectors of the economy, the relative stability of output prices, and the significant removal of trade protection measures from this sector, manufacturing data on the 25 main manufacturing sectors will be used. the use of data from the manutacturing sector is appropriate given kavoussi's (1984: 247) finding that the impact of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 271 sajems ns vol 2 (1999) no 2 exports from the manufacturing sector on total factor productivity is greater than that of primary exports. he states that "among middle-income countries (such as south africa), gains from export expansion are significant only in those economies that shift to exports of manufactured products". 2 exports and productivity the proposal that exports may raise productivity (i.e. that causality runs predominantly from exports to productivity) is a departure from the standard, neo-classical trade theory. in the neo-classical trade theory specifically the comparative cost theory associated at first with david ricardo4, labour productivity is treated as exogenous. in the comparative cost theory, each country will have a comparative advantage and will export those commodities for which its relative output per worker exceeds its relative money wage in that particular industry (i.e. where it has a particular productivity advantage). in this theory, the association between productivity and exports is clear: only those goods in which a country has more productive labour, will exports be successful (harberler, 1937). in reality, productivity is affected by a host offactors, such as r&d, innovation, accumulation of physical and human capital, infrastructure, economies of scale, market structure, demographic change, and the introduction of new technology (yadavalli, 1998b: 8). more recently the economic literature have begun arguing that most of these factors are influenced by a country's trade regime and degree of openness to international trade. the recent view in economic theory, inspired by the endogenous or "new" growth literature, is that higher exports may raise productivity (kunst and marin, 1989: 699-700). endogenous growth theory departs significantly from the assumptions of the classical and neo-classical growth theories with respect to growth and trade, specifically with respect to the endogeneity of productivity. productivity growth is associated with increasing returns to scale, learning-bydoing (lbo) and "spill-over" effects of export expansion (grossman & helpman, 1990; lucas, 1988; 1990; romer, 1986; 1990). regarding the positive impact of exports on productivity, the following related arguments can be put forward in justification (bhagwati, 1978; kavoussi, 1984): first, exports may facilitate the allocation (or re-allocation) of investment in the most efficient and competitive sectors of an economy. increasing specialisation in export-oriented sectors may stimulate productivity in those sectors (emery, 1967: 471; piazollo & wurth, 1995). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 272 second, higher export growth may enable manufacturing firms to achieve economies of scale because they now have access to international markets not only domestic markets and can thus make larger scale operations profitable (grossman & helpman, 1901: 243). third, increased international competitiveness due to exporting onto global markets may increase the pressure on export-oriented industries to keep costs relative to outputs low (teitel & thoumi, 1986: 466). the latter may create incentives for the introduction of technological change which improves productivity (geroski, 1989: 577). fourth, the growth of exports may be seen to have a positive influence on productivity of the whole economy of a country via externalities of exports on other sectors (bhagwati, 1978: 213). fifth, foreign contributions to the local stock of knowledge increase with the number of commercial transactions between domestic and foreign agents (grossman & helpman, 1990: 168). six, an increase in exports may permit a relaxation in a country's balance of payments constraint, which facilitates domestic growth through improved availability of essential imports (teitel & thoumi, 1986: 469). within recent "endogenous" growth theories the view has however also been put forward that the direction of causality may not be from exports to productivity, but rather the other way around. piazollo and wurth (1992: 272) describe these as technology theories of trade and/or "new" infant industry arguments. krugman (1984) and rodrik (1988) for instance, states that import protection may cause productivity gains by allowing domestic sales to expand. in this regard krugman (1984) shows that under a oligopolistic market structure with cournot behaviour import protection can lead to productivity gains which stimulate export expansion. according to this argument import protection may lead to productivity gains by allowing domestic sales to expand. import protection may thus under certain market conditions act as an export promotion policy. abeysinghe and yeok (1998) provide empirical evidence that import protection and the related or implied policy of exchange rate overvaluation has stimulated productivity and export growth in singapore. teitel and thoumi (1986) found empirical evidence that import protection may have stimulated productivity in certain industries in brazil and argentina. more particularly, they claim that the direction of causality runs from import protection to industrial "maturity" to higher productivity to higher exports.s they also perform back-of-the-envelope r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 273 sajems ns vol 2 (1999) no 2 calculations to show that average annual growth rates of 4.14% in total factor productivity (tfp) would be needed if infant industries in developing countries are to eliminate a 50% cost disadvantage relative to developed countries industries over ten years (teitel and thoumi, 1986: 465). more recently theories of intra-industry trade have emphasised a bi-directional causality between exports and productivity (piazollo & wurth, j992: 273). in these theories greater trade (exports) changes a country's market structure towards fewer firms, more concentrated declining cost industries and a larger proportion of resources in declining cost industries (helpman & krugman, 1985; 1989). 3 productivity and exports in south africa's manufacturing sector 3.1 summary statisti.:s tables 1 and 2 below summarise the salient features of productivity and export growth in south africa's manufacturing sector. in table i, the situation between 1972 and 1990 is summarised. table 2 summarises the situation between 1990 and 1996. the year 1990 has been selected as a cut-off date since the subsequent period represents south africa's reintegration into the international community. table 1 output, produdivity and exports in manucaduring, 1972 1990, (average annual growth %) l sedor ~rages tobacco textiles clothing leather products footwear wood and wood products i furniture paper and paper products printing and publishing chemical products rubber products output 2.6% 7.2% 4.81% -0.31% 3.96% 2.84% 4.05% 1.87% 2.99% 4.6% 1.45% 3.85% 6.11% mfp -0.52% 2.33% 3.11% -i.l 0010 2.06% 1.24% 1.54% 0.53% 1.63% 0.48% -1.31% -2.84% 5.48% export! output(%) 11.21% .26% 3.58% 12.8% 10.28% 15.99% 3.49% 7.95% 2.59% 8.87% 1.40% 9.15% 3.99% exports -1.13% 8.53% 14.15% 2.49% 3.07% 6.27% 5.84% 11.45% 15.07% 4.77% -1.07% 4.84% 4.78% r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 274 table 1 continued sedor output mfp export/outexports put (%) plastic products 8.65% 3.33% 1.18% 6.33% glass and glass products 4.85% 0.43% 5.98% 6.98% other non-metallic 0.64% -0.97% 6.18% 1.83% mineral iron and steel basic 1.58% -0.71% 19.85% 9.11% industries non-ferrous metal basics 055% 1.33% 27.41% 8.72% metal products -0.28% -1.83% 4.65% 0.77% machinery 2.8% -1.1% 9.97% -0.58% electrical machinery 3.89% -0.23% 3.69% 5.27% motor vehicles and parts 2.87% 0.38% 2.51% 7.55% (based on data obtained from the ioc's sectoral manufacturing data senes) table 1 shows that rubber products, tobacco production, and plastic production showed the largest increases in multi factor productivity (mfp) growth over the period 1972-1990, in each case of above 3% per annum. some sectors, e.g. chemicals, metal products and textiles experience negative growth rates in mfp growth over the period. when the average export growth rates are considered, table 1 shows that the fastest average export growth rates were experienced in the furniture (15%), tobacco (14%), wood and wood products (11%) and iron and basic steel industries (9%). the latter sector was also the sector with the highest proportion of exports in total sales (27%) over the period. in the case of tobacco and furniture there would seem to be a strong positive association between export growth and productivity; however, the iron and basic steel industry achieved high export growth despite a negative growth in mfp. based on table 1, the spearman rank-order correlation coefficient between export growth and mfp growth was calculated. its value of 0.60 would suggest that there is not a very strong statistical association between manufacturing industries that experienced rapid export growth and industries that experienced rapid productivity improvements. table 2 below show that between 1990 and 1995, the highest mfp growth was experienced by the textile and clothing industries, and the highest export growth by the clothing industry (2.9%), paper and paper products (11%), plastic products (8%), and non-ferrous basic metal products (4.7%). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 275 sajems ns vol 2 (1999) no 2 table :z output, productivity and exports in manufacturing, 19901995, (average annual growth 0/.) sector output mfp export/out. exports put (o/e) (1990-93) food -0.93% -2.50010 6.49% -1.28% beverages -0.61% -6.19% 4.52% 1.76% tobacco products -2.71% 0.95% 5.11% -12.90% textiles -1.55% 2.90% 20.33% -4.35% clothing 2.35% 2.50% 7.39% 2.94% leather products 1.23% -2.41% 22.35% 3.21% footwear -3.32% -1.09% 3.36% -3.20% wood and wood products -0.17% -1.25% 11.24% -3.14% furniture -0.39% -1.94% 7.30% 2.77% paper and paper products -2.12% -1.28% 11.l7% 11.68% printing and publishing -0.39% -3.29% .85% -14.9% chemical products 1.73% 1.53% 10.16% -3.13% rubber products 0.10% -3.25% 4.93% 0.15% plastic products 2.67% -3.99% 1.82% i 8.45% glass and glass products -1.09% -2.26% 6.16% -7.59% other non metallic -2.08% -0.48% 7.95% 1.13% ! minerals iron and steel basic -1.08% 1.72% 40.70% -0.75% industries ! non ferrous metal basic 3.64% -9.93% 40.99% 4.71% metal products -0.46% -0.73% 6.91% 2.29% machinery -0.29% 1.68% 10.44% 3.11% electrical machinery -0.52% -4.99% 6.58% 6.79% motor vehicles and motor 0.55% -3.72% 8.93% 22.22% vehicle parts table 2 indicate that iron and basic steel, non-ferrous metal basic industries in particular increased their export share significantly however in both these sectors productivity improvements was negligible. this could support the recent findings of iscan (1998: 123) based on a panel data study for mexico, that trade liberalisation has a short-term beneficial impact on productivity growth rates (as firms that did not export previously now become more competitive and reap bene tits from exports), but no significant long-term effect on productivity ~rowth rates. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 276 using the data in table 2, the spearman rank-order correlation coefficient between export growth and productivity growth between 1990 and 1993 was calculated. over this period the correlation between export and productivity growth declined to 0.43, suggesting the association between productivity and exports had weakened since 1990. 3.2 existing empirical findings for south africa existing studies into the relationship between trade policy and productivity, specifically exports and productivity, is largely lacking in south africa. the only existing publicly available studies are those by kohler and holden (1992) and piazollo and wurth (1992; 1995). these studies differ from the present study in that they are more concerned about the determinants of productivity and the relationship between trade liberalisation and output growth than with the direction of causality between exports and productivity. thus, although not explicitly testing for causality, kohler and holden (1992: 24) estimates a regression equation between south african manufacturing's relative export share and relative labour productivity. they find that "labour productivity appears to have been an insignificant determinant of export performance in south africa's manufacturing industries". piazollo and wurth (1992: 290) do not find strong evidence in favour of exportled growth in south africa. using standard granger-causality tests on south african manufacturing between 1972 and 1990, they find that "in all but one of the manufacturing sectors economies of scale due to an increased domestic demand seems to be the main determinant for the productivity growth" (piazollo & wurth, 1992: 290). furthermore, they found that exports contributed positively to productivity growth in only 6 industries, namely • beverages • footwear • wood and wood products • other plastic products • other chemical products • glass and glass products piazollo and wurth (1995) test for cointegration between total factor productivity (tfp) and production and tfp and exports using johansen's (1988) maximum-likelihood method. they establish that in only eight cases are there indications of significant cointegration between the variables. this would suggest, generally, that exports and productivity are not cointegrated in south r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 277 sajems ns vol 2 (1999) no 2 african manufacturing and that therefore there exists no stable long-run equilibrium relationship between exports and productivity as claimed in theory. moreover, the results would imply that additional variables ought to be included in the cointegrating equation until a cointegration relationship be found which would suggest that additional factors determines productivity growth and exports growth. piazollo and wurth (1995: 188) finds in this regard that "productivity development in south african manufacturing industries appears to be mainly due to domestic scale economies, as for 17 industries total production exerts a significantly positive influence on total factor productivity". 4 data and methodology 4. t des(!ription of data to test for the direction of causality between productivity and export growth in the manufacturing sector in south africa, 22 main manufacturing sectors was chosen. the "other" sectors were omitted. these sectors are appropriate representatives of export-oriented industries in south africa. their various shares of exports in total output averaged between 0.8% in case of printing and publishing and 40% in case of iron and basic steel industries between 1990 and 1995 as can be seen from table 2 above. annual data was obtained from the industrial development corporation's (ldc) sectoral data series, spanning the period 1972 to 1993, and from the national productivity institute (npi) spanning the period 1960 to 1996. the lack of a longer timeframe remains a significant weakness of the present study. the proxy for total factor productivity used in this paper is the idc's and npi's "multi factor productivity" variable. this has been obtained by dividing the production index of a sector by a weighed average of the labour and capital input indices. the latter are calculated by dividing the value-added index for a sector by its employment and fixed capita] index. the modelling framework used in this paper utilises firstly the concept of causality proposed by granger (1969). secondly, for those sectors where there is an indication that export growth affects productivity growth, an extended regression equation was estimated, following okuda (1997). 4.2 granger causality according to granger's (l969) concept of causality, a variable, say total factor productivity in this case (zt), is said to be "granger-caused" by a variable, say r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 278 exports (~), if the information in past and present ~ helps to improve the forecasts of the zt-variable (judge et ai, 1988: 768). formally, z, will be granger-caused by ~ iffor some period t the following obtain: (i) where 0 2 = the conditional mean square error (mse) of the optimal forecast of z,(\) given the information in q,; here q,\{xsls!>t} on the right hand side of(1) denotes all information in q( that is not in {xsls!>t}. it is standard to assume that (z .. ~) is generated by a stationary, normally distributed bivariate var with lagp process that can be represented as (2.1 and 2.2) x, will not granger-cause z( if and only if (3) and zt will not granger-cause x, if and only if a?1 i = a 21 2 = a 21 3 = ... == a 21 = 0 -. .. ." (4) thus, in estimation of (2) the null hypotheses are of no granger causality. these null hypotheses will be tested using a standard f-test to test the validity or otherwise of the imposition of the restrictions specified in (3) and (4). a bivariate system such as this where z, is caused by x, and xt is caused by z, is called a feedback system. the usual way to determine the appropriate lag length (p) in (2) is to use akaike's information criterion (alc) see akaike (1981). following piazollo and wurth (1992: 300) however, the maximum lag length chosen here is 4 in order not to loose too many degrees of freedom. 4.3 cointegration analysis standard granger-causality tests as described above are subject to a number of shortcomings (judge et al,). if there would exist a stable long-run equilibrium r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 279 sajems ns vol 2 (1999) no 2 relationship between variables so that they could be said to be cointegrated (see engle and granger, 1987) then an error-correction specification exists. in such an error-correction model, temporal causality can arise from two sources nonzero coefficients of lagged change variables (which corresponds to standard granger-causality tests) or through the error-correction terms. the standard granger-causality tests typically omit to take these latter effects into consideration (see miller & russek, 1990; kalulumia & yourougou, 1998). granger (1986) and engle & granger (1987) established that a vector of time series, all of which are stationarl only after differencing, may have linear combinations which are stationary without differencing. in such case, those variables are cointegrated. the concept of cointegration provides justification for the use of error correction models (ecm's). in this paper cointegration analysis was carried out by using engle & granger's two-stage modelling approach, whereby cointegration between variables is first achieved and the residuals from the cointegrating regression are used as a (stationary) levels term in the ecm. 4.4 extended regressions one of the weaknesses of granger-causality tests as described in 4.2 above is the lack of many relevant variables. for the sectors where there are an indication that export growth are significantly associated with productivity growth, the following equations was estimated, following kouda (1997: 371). 11 in tfp= a o +a,llin kl, +a2 1l in exprod, +a 31linpene, + a 4 1l1nprod, +e, where tfp total factor productivity (7) kl =:: the factor intensity of a subsector, defined as the amount of capital per worker exprod =:: the export ratio, defined as the ratio of exports to total production pene =:: the import penetration ratio, defined as imports/(production+importsexports) prod = the total real production of a subsector the above specification is intended to take into consideration such industrialisation-related variables as factor intensity, involvement in exports, and import iiberalisation. specifically, kl is included to capture the effect of capital r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 280 intensification associated with the expected industrialisation of the south african economy. the variable pene would measure the productivity impact of import liberaiisation. all estimations were done using either microfit (version 3) and/or pc-give 8.0 student version. 5 results 5.1 unit root tests betore estimating the equations presented in section 4 above, the various variables were subjected to tests for stationarity'. if in the above y, is generated by the following first-order autoregressive (ar) process z, = pz'_1 + ul , then yi will only be stationary if ipl < 1. if p = i then yi will be non-stationary. a variable is stationary if it does not have a unit root. for instance, if the firstorder ar process generating yi is re-written as (l-pl)z, = ub where l is the lag operator then the characteristic equation is (l-pl) = o. in this case there is only one root (l lip) so that stationarity requires that ipl < 1 (harris, 1995: 18) it is problematic if non-stationary data is used in regression analysis, as it can lead to "spurious regressions" which occurs as inferences based on standard tand ftests are invalid in case of non-stationary data (see banaijee, et al. 1993: 93-4). if a variable is non-stationary in its levels but stationary after first-dift'erencing, it is said to contain one unit root in its levels and can be described as integrated of order one, denoted ~i(l), correspondingly a stationary variable is denoted as being -1(0), more generally, a process is said to be integrated of order d (-i (d» if it needs to be differenced d-times to be stationary (engle & granger, 1987:252). before econometrically estimating the relationship between productivity and export growth as described in section 4 above, the various productivity and export variables used for the 23 main manufacturing sectors were tested for stationarity. for this purpose use was made of the augmented dickey-fuller (adf) unit-root tests (see dickey & fuller, 1981; naude, 1992). this test is a test based on the t-statistic on ~ in equation (8) : n l1y, a + pt + fjy,-1 + lyil1y,.i + u, (8) i=1 where n denotes the lag length. the null hypothesis is ho : ~=o, i.e. of unit root. rejection of the null implies that yi is -1(0), and failure to reject implies that yi is non-stationary, i.e. -1(1). critical values for the adf (n) tests are given in mackinnon (1991) and supplied with the pc-give 8.0 software. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 281 sajems ns vol 2 (1999) no 2 the results of an adf(4) test on multifactor productivity and exports in south africa's manufacturing sector is summarised in table 3 below. table 3 augmented dickey-fuller tests for stationarity of multifactor productivity in soutb african manufacturing sector produeexportcbaagein change in tivity levels levels productivity exports food 0.179 -u88 -2.356 -2.476 beverages -2.028 0.281 -0.916 -2.049 tobacco products -1.676 -1.190 -1.959 -1.934 textiles -1.303 -2.428 -1.653 -2.084 clothing -0.329 -2.414 -2.990 -1.665 leather products -1.899 -1.830 -1.869 -1.826 footwear -2.208 -1.577 -i. 775 -1.971 wood and wood -0.800 -2.824 -1.965 -3.471 * products furniture -2.646 0.667 -2.6118 -2.329 paper and paper -2.376 0.219 -3.012 -4.28\ ** products printing and 0.417 -2.349 -3.031 1.601 publishing chemical products -4.036** -1.295 -1.840 -2.515 rubber products -1.816 -0.025 -1.481 -2.263 plastic products -2.118 0.213 -2.524 -2.079 glass and glass -1.014 -0.964 -3.927** -2.569 products other non-metallic -0.813 -2.227 -2.697 -1.666 mineral iron and steel basic -1.517 -0.305 -3.325* -2.866 industries non-ferrous metal -1.516 -2.343 -2.488 -1.942 basic metal products -0.659 -1.606 -2.283 -2.088 machinery -0.558 -1.118 -2.488 -2.065 electrical machinery -0.149 0.020 -3.265* -1.887 motor vehicles and -1.339 -1.313 -2.068 -1.398 motor vehicle parts (an asterisk mdicates sigmficance at a 1% level of confidence and two astensks at a 5% level of confidence) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 282 table 3 indicates that the adf test fail to reject the null of a unit root in both the levels and first differences of the variables for all the sectors. the failure to reject the null in first differences is problematic8, but may be due to the inability of the test statistic to perform well given the short number of observations used (n 21). following naude, van heerden and van der merwe (1997) it is assumed here that levels variables of manufacturing sub-sectors are -i(l r subsequent results are dependent on this assumption and further research may be required to clarify this issue. it should be noted that tests on aggregate manufacturing data spanning the period 1948 1995 finds the levels variable to be-l(l). 5.2 co-integration tests table 4 contain the results of the co-integration tests (using the engle-granger two-step methodology) between productivity and exports for the 22 manufacturing sectors. table 4 cointegration tests for exports and productivity sector adf(4) for cointegrated cointegration p,x (yes/no) :1 •• food 0.14744 no ! beverages \.8683 no tobacco products -2.0932 no i textiles -0.5407 no • clothing 1.2665 no i. leather products -1.6335 no footwear -2.1939 no . wood and wood products 0.1382 no i furniture -2.2216 no paper and paper products -2.4365 no • printing and publishing -0.8302 no chemical products -2.4144 no rubber products -1.2583 no plastic products -1.9928 no glass and glass products -1.0174 no other non-metallic mineral products -0.2069 no ii iron and steel basic industries -1.7576 no r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . i 283 sajems ns vol 2 (1999) no 2 table 4 continued sector adf(4) for cointegrated cointegration p,x (yes/no) non-ferrous metal basic industries -2.3609 no metal products 0.7401 no machinery -0.5834 no electrical machinery -2.1891 no motor vehicles and motor vehicle parts -2.5105 no table 4 show that no evidence of cointegration can be found between productivity and exports in south africa's manufacturing sector. this may suggest that there exists no long-run equilibrium relationship between productivity and exports in south africa as proposed in theory. as discussed in section 4.3 this would require the standard granger-causality tests to be pertormed using first differenced variables. the results from such tests are reported in the following section. 5.3 granger-causality tests the results from the granger-causality test are summarised in table 5 below with the f-test statistics from applying the relevant zero restrictions on lagged values of the respective variables as explained in section 4 above. table 5 granger causality test for exports and productivity growth in south african manufacturing, 1972-1993. direction of causality sector exports to productivity to productivity exports i food f(4,9) 1.491 f( 4,9) 0.582 beverages f(4,9)= 0.116 f(4,9) = 0.365 tobacco f(4,9) 1.133 f(4,9) 2.982** textiles f(4,8) 0.186 f(4,8) 0.514 clothing f(4,9) 0.30 f( 4,9) = 0.186 leather and leather products f(4,9) 2.145 f( 4,9) = 0.246 footwear f(4,9) 0.914 f(4,9) 0.118 wood and wood products f( 4,9) = 8.107* f(4,9) = 1.619 furniture f(4,9)= 1.391 f( 4,9) = 0.496 paper and paper products f(4,9) = 0.720 f(4,9) 2.467 printing and publishing f(4,8) = 2.318 f( 4,8) 0.067 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 284 table 5 continued sector exports to productivity to productivity exports chemicals f(4,8) = 8.045* f(4,8) == 2.893** rubber products f(4,9) 0.591 f( 4,9) == 0,434 plastic products f( 4,9) = 0.527 f(4,9) == 0.205 glass and glass products f(4,9) 1.730 f( 4,9) = 0,485 other non-metal products f(4,9) 1.580 f( 4,9) = 1.70 i iron and steel basic industries f(4,9) 1.659 f( 4,9) == 2.307 non-ferrous metal basic industries f(4,9) = 0.823 f(4,9) == 2.008 metal products f(4,9) 2,406 f(4,9) = 5.781 * r~f"y f(4,9) 0.022 f(4,9) = 2.898** trical machinery f(4,9) = 0.093 f(4,9) 1.901 motor vehicles and motor vehicle f(4,9) 0.227 f(3,9) = 0.521 parts (note : an astensk mdlcates slgmficance at a 5% confidence level and two asterisks at a 10% level of confidence). table 5 shows that there exists significant causality from productivity to exports in only four manufacturing industries, namely machinery, metal products, chemicals and tobacco. in case of chemicals, there is evidence of bi-directional causality, although the evidence seems to favour a stronger causality from expol1s to productivity in the case of chemicals. table 5 indicates that there are only two manutacturing sectors where causality seems to run from exports to productivity, namely wood products and chemicals. it can be noted that piazollo and wurth (1992) also found that exports contributed to productivity growth in these sectors. generally, the results in table 5 support the findings in table 4, namely that little significant relationship seems to exist between productivity in exports in south africa's manufacturing industry. to further analyse the sectors where a significant relationship seem to exist, a regression equation (equation 7) as described in section 4.4 was estimated. 5.4 regression model results equation (7) was estimated for the following sectors: • chemicals • wood & wood products • tobacco r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 285 sajems ns vol 2 (1999) no 2 • machinery • metal products the results are summarised in table 6 below. table 6 regression results (t-ratio in brackets) seetor <xo iii 112 113 a... r-bar· chemical -0.022 -0.67 0.224 0.055 0.938 0.81 products (-1.53) (-6.27)* (2.851 ) ...... (0.451 ) (5.04)· wood and -0.021 -0.097 0.139 0.023 0.675 0.57 wood (-1.877) (-0.392) (2.841)* (0.337) (4.850)· products tobacco -0.057 -0.009 -0.065 0.459 3.226 0.42 products (-1.122) (-0.016) (-0.295) (2.265)* (4.053)* machinery -0.022 0.091 0.022 0.178 0.575 0.28 (-1.669) (0.334) (0.262) (1.213 ) (3.214)* metal -0.020 0.369 0.252 -0.09 0.62 0.78 products (-2.9)* (2.47)** (5.37)* (-1.38) i (0.64)* i table 6 shows that in case of those sectors where it was previously established that a significant relationship existed from exports to productivity, reasonably satisfactory coefficients of determination are obtained (0.81 and 0.57 respectively for chemicals and wood and wood products). in the case of chemicals, the coefficient on the capital:labour ratio (ad is highly signiticant and negative (-0.67) indicating that higher capital intensity in the chemicals sector has been accompanied by a decline in mfp. the coefficient on the export:output ratio (a2) is significant and positive (0.224) indicating that a 10% increase in the export share of chemicals will raise productivity in that sector by about 2.2%. the coefficient on output (a4) is also highly significant (0.9) and suggest that domestic economic growth will have a stronger effect on productivity than export growth. the result for the wood and wood products sector and metal products is broadly similar, with a 10% increase in the export:output ratio raising productivity by about 1.4% in the wood sector and 2.5% in the metals sector. in both instances it is found that domestic output expansion has a stronger positive effect on productivity growth than exports. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 286 in the cases of tobacco and machinery products, it is only the expansion of domestic demand that seems to have a significant positive effect on productivity growth. thus, exports may have a positive and significant effect on improving productivity in two of south africa's manufacturing sectors. however, this efiect may be relatively small, and that expansion of sector output through increases in domestic demand might have larger positive effects on productivity improvements. 6 conclusion the direction of causality between export growth and total factor productivity growth has important implications for the way trade and industrial policies may raise productivity growth in south africa. for instance, if causality runs from exports to productivity and to growth, then export-promotion policies such as a depreciation of the exchange rate and/or export promotion policies and tariff reduction may be sufficient. however, if there is causality from productivity to exports and growth, or bi-directional causality between exports and productivity, then r&d and/or output subsidies may be more effective to stimulate productivity growth (kunst & marin, 1989: 700). in light of this the purpose of this paper was to determine the likely direction of causality between export growth and productivity in south african manufacturing. due to the wide variation in the export growth and output growth rates of the various sub-sectors within manufacturing in south africa, particularly since it may be argued that these have been due to different rates of increase in productivity, the focus in this paper was on 22 main manufacturing sub-sectors. the results established in this paper, using conventional granger-causality tests as well as more recent cointegration techniques, were that there exist little evidence of one-way causality from exports to productivity growth in south africa's manufacturing sector. the only sectors for which exports may be significant in improving productivity are wood and wood products and chemical products. these results are consistent with evidence from multi-country studies by jung and marshall (1985) and hutchinson and singh (1987). it is also consistent with the findings of piazollo and wurth (1995) for south africa, especially in as far as the latter also found causality from exports to productivity in the case of wood and chemicals. according to kohler and holden (1992: 36) a possible explanation for the lack of causality between productivity and exports in south africa's manufacturing sector could be that r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 287 sajems ns vol 2 (1999) no 2 productivity (especially labour productivity) and labour compensation are highly and positively correlated over time i.e. industries with high levels of labour productivity also have relatively high labour costs. furthermore, it was established that although export expansion will positively affect productivity growth in two sectors of manufacturing, these effects are relatively small, having an elasticity of 0.22 and 0.13 respectively in case of chemicals and wood and wood products. in addition, these effects are exceeded by the positive effect of output expansion through domestic demand increases on productivity. the shortcomings of the methodologies employed in this paper caution against drawing policy recommendation from these results. although, as stressed above, the results are broadly consistent with international and local tindings, the poor quantity and quality of manufacturing sub-sector data in south africa would require that the issue remain on the research agenda. until further and better time-series data becomes available, firm-level studies, such as those by valodia (1998) for instance, may be the best way to investigate the direction of causality between export growth and productivity over the short-term. endnotes an earlier version of this paper was presented at the annual tips forum, 20 september 1998 at glenburg lodge, johannesburg. the authors are grateful to prof wilma viviers for comments and advice and also to various participants at the forum, particularly prof johannes fedderke. the tinancial assistance of the research focus area "decisionmaking and management for economic development" of the faculty of economic & management sciences, potchefstroom university, is hereby acknowledged. the usual disclaimer applies. for instance jung and marshall (1985) found no relationship between exports and growth in the philippines but found such a relationship in the case of thailand. hsiao (1987) found a positive relationship for hong kong but not for the other newly industrialised countries (nics). a reasons why time-series studies into the causal direction between exports and growth find mixed results may be that the causal models estimated in these studies are misspecified by not adequately incorporating the time lag between higher export growth and higher output growth that occurs via higher total factor productivity. david ricardo set out his doctrine of comparative costs in his "principles of political economy" in 1817. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 6 7 9 sajems ns vol 2 (j999) no 2 288 teitel and thoumi (1986: 466) claim that, with reference to brazil and argentina, that "substantial increases in domestic output provided the opportunity to accumulate operating knowledge and to improve the efficiency of production until domestic costs have become comparable to the international ones. in this way. exports also become possible, albeit sometimes requiring a measure of government support". by 'stationary' is meant that the first two moments of the data are invariant with respect to time. by 'stationarity' is meant that the first two moments of the data are invariant with respect to time. nelson and plosser (1982) have found that most macroeconomic variables have a univariate time series structure with a unit root. perron (1994: 116) argues that standard unit root tests such as the adf tests are biased towards non-rejection of the unit root null 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(i998b) "we're doing better", productivity sa, july! aug: 7 9. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction related literature review research methodology analysis of results limitations of the research conclusion and recommendations acknowledgements references about the author(s) bongani ngwenya graduate school of business and leadership, university of kwazulu-natal, south africa theuns pelser graduate school of business and leadership, university of kwazulu-natal, south africa talent chivaura graduate school of business studies, solusi university, zimbabwe citation ngwenya, b., pelser, t. & chivaura, t., 2018, ‘perceptions of post-multicurrency regime financial inclusion confidence challenges in zimbabwe’, south african journal of economic and management sciences 21(1), a1837. https://doi.org/10.4102/sajems.v21i1.1837 original research perceptions of post-multicurrency regime financial inclusion confidence challenges in zimbabwe bongani ngwenya, theuns pelser, talent chivaura received: 20 mar. 2017; accepted: 01 mar. 2018; published: 26 june 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract aim: the study sought to assess the informal trader’s perceptions of the post-multicurrency regime financial inclusion confidence challenges in zimbabwe and also through further future studies explore the potential of explicating a framework for achieving optimal financial inclusion in an economy recovering from a recession through further future studies. setting: a non-probability judgment sample of 1000 informal traders in the avondale area of harare was used in this study. method: the study established four potential financial inclusion construct pillars: demand side factors, supply side factors, behavioural factors and individual factors; these were largely influenced by age, which can be investigated in further future grounded theory studies to develop a framework. results: the results indicate that healing from the financial experiences of the hyperinflation era of 2008 still has not been achieved. the study suggests a need for zimbabwe to restore human rights, political stability, and ensure compliance with the financial action task force regulations regarding money laundering and terror financing in order to boost external confidence in the financial system of the country. conclusion: there is still a challenge of confidence in the country’s financial system. the proposed framework is envisaged to minimise the negative impacts of the mistrust of formal financial service providers and boost confidence in the financial system. it is hoped that the findings will aid government to craft policies that will be perceived as supportive of the informal sector to achieve optimal financial inclusion. the study further suggests penetration of the rural areas through technological advances such as mobile networks. introduction according to the zimbabwe national statistic agency (zimstat 2016) the zimbabwean economy started experiencing a severe liquidity crisis towards the last quarter of 2015 because of a declining money supply. when the country adopted the multicurrency regime in 2009, the monetary authority, the reserve bank of zimbabwe (rbz), ceded its monetary policy sovereignty. particularly, the rbz lost the ability to engage in seigniorage, which includes printing of bank notes, either to replace the worn notes or to meet money supply needs in response to productive demand in the economy. the money supply shortfall did not only affect money circulation, but also credit supply by financial institutions, as well as consumer spending propensity. deflation literature suggests that the net effect should be that bank deposits, not cash, should account for the bulk of the money supply in the economy (anderloni & carluccio 2006; braga 2006; corr 2006; memdani & rajyalakshmi 2013). the zimstat (2016) on money supply indicates that money supply had risen to $us4,75 billion by the end of 2015, attributing to improving confidence in the banking sector from the all-time low confidence experienced during the hyperinflation of 2008. it is worth noting that the banks’ lending portfolio is currently skewed towards lending for consumptive purposes, and bank deposits are largely skewed towards demand deposits. this phenomenon is not healthy for money creation and liquidity improvement. regardless of the growing domestic confidence after the hyperinflation era, a significant proportion of the population of zimbabweans is still financially excluded. studies conducted so far indicate that much of the zimbabwean population that is financially included, is so mainly for transactional purposes such as receiving salaries and other money deposits from employment and other sources (anderloni & carluccio 2006; bmrb 2006; braga 2006; corr 2006; kempson 2006; makoni 2010; noko 2011). the propensity to save is generally low because of average low disposable incomes. most adults in zimbabwe do not save because of lack of residual income after paying for living expenses, school fees and emergencies. usually the portion of income allocated for emergencies is kept as savings at home. on the other hand, bank deposit and savings interest rates that banks offer are significantly low and unattractive (makoni 2010). according to zimstat (2016) about $us7,4 billion is being speculated in the informal sector of zimbabwe’s economy. this has prompted the government of zimbabwe to formalise the operations of the informal sector in the country in fulfilment of the zimbabwe agenda for sustainable socio-economic transformation (zimasset). the government acknowledges that the fiscus is losing substantial amounts of money from this untapped sector and formalising such activities would go a long way to achieving the objective of financial inclusion. however, the challenge of domestic and external confidence still exists. zimbabwe currently has an investor confidence averaging -37.2 as of the last quarter of 2016 (zimstat 2016). this has prompted this study to examine the informal traders’ financial inclusion confidence challenges in zimbabwe, after the adoption of the multicurrency regime. from here the authors proceed as follows: a comprehensive literature review is undertaken, followed by an outline of the problem and research questions. the research methodology that informs the collection of data is critically examined, followed by the analysis of results, limitations of the study, recommendations and conclusions thereto. the background of multicurrency regime imf-zimbabwe (2010) says that the hyperinflation of 2008 saw the abandonment of the zimbabwe dollar in transactions and de facto widespread dollarisation or multicurrency regime adoption. the zimbabwe dollar was officially recognised as demised in february 2009, when the zimbabwean authorities established a multicurrency system. under the multicurrency regime or system, transactions in hard foreign currencies were authorised after having been taboo, payments of taxes became mandatory in foreign exchange, and the exchange system became largely liberalised. since the abolition of all surrender requirements on foreign exchange earnings and proceeds on 19 march 2009, there has not been a functioning foreign exchange market for the zimbabwe dollars that were finally demonetised in 2015. all the bank accounts that were denominated in zimbabwe dollars (equivalent to about $us6 million at the exchange rate of $z35 quadrillion per $us1) became dormant. the use of the zimbabwe dollar as domestic currency was initially scheduled to be discontinued until 2012. however, the multicurrency use was extended beyond 2012 for an indefinite period. there are five foreign currencies that have been granted official status in zimbabwe since 2009; however, the us dollar became the principal currency. since 2009, fiscal revenue estimates and fiscal expenditure allocations have been denominated in us dollars. the multicurrency regime provided significant benefits such as fostering the re-monetisation of the zimbabwean economy and financial reintermediation; it also helped enforce fiscal discipline by curtailing government inflationary financing of the fiscus, and brought in greater transparency in pricing of goods and services and accounting after the period of hyperinflation. accordingly, the price levels in us dollars started falling during 2009, while the economy started to recover and rebound (imf-zimbabwe 2010). related literature review the informal sector according to lee and viuvarelli (2004) it is noted that there is a direct relationship between economic structural adjustment programmes (esap) in developing countries and the growth of the informal sector, due to increased unemployment that the imposed structural programmes tend to cause. it is therefore beyond argument that esap in zimbabwe contributed significantly to structural unemployment in the country. with fewer persons of the income-generating age with families to support being employed, the trend of crossing the border to other countries such as south africa, to buy goods for resale has gained popularity (gupte, venkataramani & gupta 2012; nuewirth 2012). the international labour organisation (2015) broadly characterises the informal sector as consisting of units engaged in the production of goods or services with the primary objective of generating employment and incomes to the persons concerned. these units typically operate at a low level of organisation, with little or no division between labour and capital as factors of production and on a small scale. the informal sector can be classified into four perspectives which were propounded by hussmanns (2004) and reiterated in hm treasury (2004). firstly, it can be viewed in a positive way as a provider of employment and income to millions of people who would otherwise lack the means of survival. secondly, it can be viewed more negatively as a whole segment of society that escapes regulation and protection. thirdly, it can be romanticised as a place where entrepreneurship could flourish if it were not encumbered by unnecessary regulation and bureaucracy. fourthly, it can be condemned as a vast area of backwardness, poverty, unsanitary conditions for hazardous work, illegality and open use of child labour (cull demirgüç-kunt & lyman 2012; demirgüç-kunt & klapper 2012a; njaya 2015). financial inclusion financial inclusion as a key enabler for development is firmly placed on the agenda of most governments as a key policy priority (atkinson & messy 2013; chakravarty & pal 2013; morgan & pontines 2014; sarma 2008, 2012). financial inclusion or inclusive financing refers to the delivery of financial services at affordable costs to sections of disadvantaged and low-income segments of society (finca 2016). the reserve bank of zimbabwe financial inclusion (2016) report highlights that in the zimbabwean context financial inclusion is the effective use of a wide range of quality, affordable and accessible financial services, provided in a fair and transparent manner through formal or regulated entities, for all zimbabweans. kairiza, kiprono and magadzire (2016) are in support of the rbz report. the term financial exclusion refers to the situation where people have difficulties in accessing suitable financial services within the traditional financial market. finca (2016) defines financial exclusion as the unavailability of banking services to people with low income. consumers are not homogenous and the causes of exclusion are complex and varied (mago 2014; munyanyi 2013, 2014; ndlovu & ndlovu 2013). moreover, the number of consumers affected naturally depends on the product sector (finca 2016). according to financial inclusion centre of the uk (2016), there are various factors that lead to financial exclusion which include a combination of low disposable incomes and the economics of access in retail financial services. the financial scope survey zimbabwe (2016) reveals that the level of financial inclusion in the small and medium enterprises (smes) sector was significantly low with the following key statistics: (1) only 14% of sme owners are banked, that is, use formal financial products and services offered by a commercial bank; (2) the majority of business owners do not use or have a bank account for business purposes; (3) 50% of business owners (1.4 million) have or use informal mechanisms to manage their business finances; (4) 18% of business owners (475 000) are formally served, including both bank and other formal non-bank products and services. also worth noting is that only 30% of zimbabwe’s adult population made use of banking services as at 2014 (chitokwindo, mago & hofisi 2014; shankar 2007). the financial scope survey (2016) report notes that the majority (58%) of adult zimbabweans do not borrow. out of those who do not borrow, 48% cited the fear of debt as their reason for failing to borrow, while 45% indicated that they do not have an ability to borrow. the financial scope survey also indicated that there is reliance on informal sources of credit which catered for 30% of adult borrowings, while formal credit accounted for only 13% of adult credit in 2014. several studies in the literature suggest that financial inclusion is generally driven by population density, especially in africa (allen et al. 2014; arun & kamath 2015; de koker & jentzsch 2013). these studies emphasise that population density is linked more to bank branch penetration in africa than it is in other developing economies. however, most of the studies have found a nonlinear relationship between population density and banking sector development, with the largest gap between africa and the rest of the developing world experienced in those african countries trapped in the low density area. this suggests that the minimum, viable banking scale in africa is perhaps greater than elsewhere, zimbabwe inclusive (kodan 2011; lindsey et al. 2011; memdani & rajyalakshmi 2013; morgan & pontines 2014; sarma 2011, 2012). external environmental factors the global microscope (2015) reports that there are 12 indicators that enable the environment for financial inclusion. these include: government support for financial inclusion demonstrated by a country having a documented strategy on financial inclusion, as well as the government having a database containing customer level data that helps to understand low-income populations’ demand for financial services. regulatory and supervisory capacity for financial inclusion. there must be a recent technical support system that supervises operations, prudential regulation, the presence of appropriate entry and licensing requirements, as well as an enabling environment for ease of operations. regulation and supervision of credit portfolios exist along with interest rate caps for credit that do not distort the market. there is also active supervision of the status of over-indebtedness for credit portfolios, as well as a differentiated and comprehensive risk management framework for micro credit. regulation and supervision of deposit-taking activities, ensuring that there are ease-offering savings and products by regulated institutions as well as the existence of in-depth deposit insurance coverage. regulation of insurance targeting low-income populations; there must be delivery channels and consumer protection for insurance targeting low-income populations. regulation and supervision of branches and agents, the ease of setting up branches as well as agent operations. requirements for non-regulated lenders, the existence of information reporting and operational guidelines. electronic payments: the availability of infrastructure for financial inclusion and digital financial services. credit reporting systems: the information stored by credit reporting systems should be comprehensive, regularly updated and accessed by providers. there must also be protection for both borrowers and lenders. market conduct rules encompassed in the existence of a framework and institutional capacity to protect the financial consumer, disclosure rules and fair treatment rules. grievance redress and operation of dispute resolution mechanisms found in internal complaint mechanisms and the existence and effectiveness of a third-party redress entity. the financial inclusion centre of the uk (2016) notes that government and regulatory policy might have the unintended consequences of consumers inadvertently contributing to financial exclusion or making it more difficult for consumers to provide for themselves. the researchers agree with the two bodies that their findings are applicable to the zimbabwean situation. the zimbabwe economic policy analysis and research unit (zeparu 2014) indicates that riskiness of lending because of poor management and high rate of business failure, high administrative cost, low productivity, under-capitalisation, shortage of skills, aversion to disclosure of information and lack of collateral are some of the constraints that have been identified as hindering informal sector development. access to formal financing channels by the informal sector is a vital step in formalising their business (owusu-ansah 2000). societal factors ncube (2013) suggests that the informal economy is associated with criminal endeavours and tax evasion practices. siyaso in mbare and gazaland for example are traditionally regarded as the hub of all illegal trade where sale of stolen products and other criminal activities are done daily. this notion that being informal is illegal, discourages banks from advancing loans to the sector since, by law, they are not allowed to deal with criminals (financial inclusion centre uk 2016). the bulk of informal traders lack enough recognisable collateral and this is explained further by adisu (2006) who notes that a common characteristic in developing nations is that financial institutions are faced with a considerable default rate. beck and de la torre (2006) hold the view that some informal traders are discouraged from borrowing by the fact that their future earnings are usually less than the value of their assets. individual factors the rbz’s national financial inclusion strategy (2016) reveals that income levels and affordability are among the main contributory factors to the current levels of financial exclusion in zimbabwe. at the same time unemployment levels increase, while the level of disposable income decreases for the average individual and this affects the sales levels and profitability of the informal sector. the rbz national financial inclusion strategy (2016) further notes that the following are barriers to financial inclusion within the sme sector: (1) low incomes levels within the sme sector, (2) irregular incomes to support consistent loan repayment requirements, (3) information asymmetries regarding funding options at the disposal of the smes and cooperatives, (4) lack of product and service awareness and (5) high and uncompetitive interest rates and bank charges offered by financial institutions. demand side factors the barriers to access that can undermine consumers’ willingness to engage with financial services or affect capacity may be termed demand side factors. these barriers include: financial capability, the cost of doing business with financial institutions, consumer trust and confidence. the net result of these barriers is that consumers may self-exclude to a large degree (world bank 2016). demirgüç-kunt and klapper (2012b) suggest that price and income are the most notable economic detriments in the demand for payment and saving services. demand is not affected by economic factors only but also by socio-cultural ones such as religion which may lead to self-exclusion (claessens 2006). ghatak (2013) identifies accessibility, culture, assets, income and literacy as the main demand side factors that influence financial inclusion. shankar (2013) argues that financial literacy and financial capability are of utmost importance in the demand side factors influencing financial inclusion. financial literacy refers to the basic understanding of financial concepts, while financial capability refers to the ability and motivation to plan financials, seek out information and advice and apply these to personal circumstances (chakraborry 2003). behavioural factors according to the financial inclusion centre of the uk (2016), barriers to access that may undermine consumers’ willingness to engage with financial services and affect the ability to make effective, informed choices and decisions may be termed behavioural factors. these barriers include: low levels of consumer awareness of the need to plan and provide for the future, or shop around for better deals, and low levels of financial literacy, consumer trust and confidence. these could lead to self-exclusion. chakraborry (2012) concludes that barriers to financial inclusion include: low literacy levels, being a lack of awareness and understanding of financial products, irregular income, frequent micro-transactions, lack of trust in formal banking institutions as well as cultural obstacles such as religion and cultural values. supply side factors ghatak (2013) suggests that the key barriers to financial supply are: distribution inefficiencies, ineffective competition, overor under-supply in the market and diseconomies of scale, complex products, inefficient regulation, public policy interaction and basic economics of access. chakraborry (2012) cites outreach, regulation, business models, services, age and bank charges as the supply side factors influencing financial inclusion. the emergence of informal savings clubs, stokvels and burial societies point to the need for saving for the consumers who do not have access to formal financial services that are accessible and affordable. the report further says that the financially excluded are keen to be included but the financial systems shut them out. the combined mobile money subscriber base for example had reached 6 million as at 30 september 2015, and there were more than 30 000 mobile payment agents across the country, a huge growth from 6000 in 2013 (rbz national financial inclusion strategy 2016). problem statement and research questions the immediate benefits of the multicurrency regime were the taming of the hyperinflation over night, and instillation of financial discipline on the government’s part. however, the management of the supply side of the multicurrencies has been a nightmare for the government of zimbabwe, particularly the harnessing of the multicurrency circulating in the domestic economy through financial inclusion. financial inclusion is identified as one of the pillars for success of the zimasset. research on financial inclusion has become increasingly prevalent with the consensus being that the inclusion of everyone in the financial activities is the only way to go. a government prices, incomes, consumption and expenditure survey (pices 2012) report concluded that, while unemployment by conventional definitions is estimated at about 92%, those who are not necessarily employed but are gainfully engaged stand at over 90%, attributable to the economic evolution taking place, that is, economic informalisation. statistics released by the finscope survey of smes in 2012 supported this assertion by revealing that there are more than 2 million individual entrepreneurs and 800 000 smes with employees estimated to be way above the 2.9 million people marker. survey reports on financial inclusion estimated that the informal sector has as much as $us7.4 billion circulating outside the formal financial system, that is, depriving the economy the much-needed financial resources. this, therefore, prompted this study to seek to investigate the informal sector’s perceptions of financial inclusion challenges, post-multicurrency adoption (finscope 2016). the study premises that there is a critical need at macroeconomic planning level to understand the key factors that lead to a successful financial inclusion strategy; these are: external environmental factors, societal factors, individual factors, demand side factors, behavioural factors and supply side factors. the main purpose of this study is to investigate the informal sector’s perceptions of financial inclusion challenges that have become synonymous with the post-multicurrency regime adoption era in zimbabwe. the critical problem addressed by this study is the need for the government of zimbabwe and particularly the financial authorities to develop a contextualised framework for achieving the financial inclusion objectives of the zimasset. the study focuses on the following five critical research questions: what is the general status of financial inclusion among the selected informal traders in harare? to what extent do the selected informal traders in harare perceive the following as financial inclusion confidence challenges in zimbabwe? external environmental factors societal factors individual factors demand side factors behavioural factors supply side factors is there a difference in the perception of the financial inclusion confidence challenges in zimbabwe in relation to demographic characteristics of the selected informal traders in harare? what are the perceived dominant dimensions of financial inclusion confidence challenges as extracted by factor analysis? research methodology the study attempted to investigate and ascertain perceptions, attitudes and challenges that smes and other informal sector players have that have forced them to ‘shun’ the formal financial system. specific focus is on: establishing the challenges faced by people who make up the informal sector in accessing formal financial products and services. exploring options that are there for consideration to facilitate the inclusion of informal traders into the formal financial system. identifying policy constraints affecting the financial inclusion of the informal sector. coming up with recommendations on how the formal financial sector can rake in the financial resources that remain unbanked in the country. data collection and sample selection a survey of informal traders concentrated in the avondale area of harare, the capital city of zimbabwe, was conducted using a questionnaire. since the achievement of an all financial inclusive strategy by the financial sector planners in zimbabwe could be more affected by the perceptions and attitudes of the financially excluded sectors of the society, such as the informal traders, it was assumed that the informal traders are a homogenous representative of the financially excluded constituency of the zimbabwean society and would be more likely to have homogenous characteristics and representative interests. a purposive sample of 1000 informal traders from the registered 15 863 informal traders in the avondale area of harare were asked to complete a self-administered hard copy distributed questionnaire designed to gather data regarding their perceptions and attitude towards financial inclusion. the questionnaire requested data on the specific perception factor constructs surrounding the financial inclusion trajectory by the financial sector in zimbabwe: external environmental factors, societal factors, individual factors, demand side factors, behavioural factors and supply side factors. all 1000 responses were ultimately received and used for the purposes of this study. research questions 1 and 2 were answered by use of statistical frequencies, that is, to determine the demographic characteristics of the respondents and the general status of financial inclusion among the selected informal traders in harare. descriptive statistics of central tendency and measures of variability were used to answer research question number 3, that is, to measure the extent to which the selected informal traders perceived external environmental factors, societal factors, individual factors, behavioural factors, demand side factors and supply side factors as financial inclusion confidence challenges in zimbabwe. research question 4, which dealt with difference in the perception of the financial inclusion confidence challenges in zimbabwe in relation to demographic characteristics of the selected informal traders in harare, was answered by the t-tests, analysis of variance and post-hoc analysis. factor analysis was used to answer research question 5 and thus reduced the perception constructs on financial inclusion into four identifiable factors. demographic characteristics the sample from which data was collected was 1000 respondents drawn from various informal sector markets within harare. of the total respondents 47% were men and 53% were women as shown in figure 1. figure 1: gender. all the respondents were african with age frequencies of 8% for respondents aged between 18 and 30 years, 48% aged between 31 and 40 years, 30% aged between 41–50 years and 14% above 50 years (see figure 2). figure 2: age distribution. figure 3 shows that most of the informal traders who responded are selling clothing items, represented by the 36% and commodity brokers 35%. other business ventures being explored include hairdressing, airtime vending, dressmaking (tailors), car dealing and vegetable vending. figure 3: businesses run by respondents. figure 4 shows the number of years of employment within the informal sector. fourteen per cent (14%) had 0–5 years working experience, 59% had 5 to 10 years working experience, 24% had 10 to 20 years working experience and 3% had 20 or more years of working experience in the informal sector. figure 4: years of employment within the informal sector. the monthly income of informal traders plying their goods in the avondale area ranges from $0 to more than $2000. sixty-four per cent (64%) earn between $0 and $500, 27% earn between $501 and $1000, 6% earn between $1001 and $2000 and 3% earn more than $2001, as shown in figure 5. figure 5: monthly income. analysis of results descriptive statistics: general status of financial inclusion among the selected informal traders the study revealed that 68% of the respondents do not have a bank account while only 32% have a bank account. meanwhile 17% of the respondents have a bank loan such as a mortgage or personal loan and 63% do not have any loans with financial services providers. this points to most informal traders lacking bank accounts and not borrowing from financial services providers as depicted in figure 6. figure 6: respondents’ ownership of bank account. descriptive statistics: external environmental factors table 1 shows the basic descriptive statistics of central tendency and measures of variability for the external environmental factors, one of the pillars of financial inclusion, as indicated by variables q10–q13. table 1: descriptive statistics: external environmental factors. the range corresponds to the numerical value of 4. the minimum value (1) refers to the response ‘strongly disagree’ and the maximum value (5) refers to the response ‘strongly agree’, with the highest mean score turning out to be 3.93 for variable q13. the arithmetic average of the scores for variable q13 indicates that the informal sector comprises people capable of utilising formal financial services when given a chance. the lowest mean score turns out to be 2.11 for variable q10, indicating that the selected informal traders were not aware of the government policies put in place to support their operations financially. in statistical terms the standard error of the mean is a measure of how much the value of the mean may vary from sample to sample taken from the same distribution (pelser 2014). in this analysis, the values depicted are relatively low, indicating that the current sample of the selected informal traders does not vary much from or may only slightly vary from another sample. from the highest standard deviation of 1.095 for variable q11, and the lowest of 0.741 for variable q10, it is concluded that the sample of the selected informal traders is homogenous and as such the mean of the selected informal traders is consequently representative of the responses. the skewness measures obtained for the external environmental factor variables indicate that three of the variables (q10, q11, and q13) have negatively skewed distributions (values < 0). however, one variable (q12) has positively skewed distribution (values > 0). nevertheless, no variable falls outside the –1 range. this indicates normal skewed distributions. the kurtosis values obtained for all the variables in table 1 indicate relatively flat distributions (negative values). descriptive statistics: societal factors the descriptive statistics of central tendency and measures of variability for the societal factors, another pillar of financial inclusion, are depicted for variables q14–q17 in table 2. the range for variables q14–q17 is 4, with the minimum value (1) and maximum value (5) depicting the responses ‘strongly disagree’ and ‘strongly agree’ respectively. the highest mean score is 3.73 for variable q14 and the lowest mean score is turn 1.80 for variable q15. table 2: descriptive statistics: societal factors. the arithmetic average for the scores for variable q14 indicate that the selected informal traders believe or perceive that formal financial products and services are for the rich and big corporates only. the average for variable q15 indicates that the selected informal traders did not agree that the current zimbabwean financial services sector can be trusted from the experiences of the hyperinflation era of the 2008. in this analysis, the standard error of the mean values is relatively low, indicating that the current sample of the selected informal traders does not vary much from or may only slightly vary from another sample. from the highest standard deviation of 1.171 for variable q15 and the lowest of 1.003 for variable q14, it is concluded that the sample of the selected informal traders is homogenous and as such the mean of the selected informal traders is consequently representative of the responses. the skewness measures obtained for the societal factor variables indicate that two of the variables (q14 and q16) have negatively skewed distributions (values < 0). however, the other two variables (q15 and q17) have positively skewed distribution (values > 0). nevertheless, no variable falls outside the -1 range. this indicates normal skewed distributions. the kurtosis values obtained for all the variables in table 2 indicate relatively flat distributions (negative values) (pelser 2014). descriptive statistics: individual factors table 3 depicts the descriptive statistics of central tendency and measures of variability for the individual factors affecting the perception on financial inclusion as shown for variables q18–q22. the variables q18–q22 also have a range 4, with the minimum value (1) and maximum value (5) representing the responses ‘strongly disagree’ and ‘strongly agree’ respectively. table 3: descriptive statistics: individual factors. the variable responses have the largest mean value of 3.54 for variable q22, indicating that the selected informal traders perceived filling in bank forms not an issue and a problem. the smallest mean value of 2.00 is assigned to variable q21, indicating that the selected informal traders did not believe that the interest rates charged by banks are low. the standard error of the mean values in this analysis is relatively low, indicating that the current sample of the selected informal traders does not vary much from or may only slightly vary from another sample. from the highest standard deviation of 1.259 for variable q19 and the lowest of 0.816 for variable q21, it is concluded that the sample of the selected informal traders is homogenous and as such the mean of the selected informal traders is consequently representative of the responses. the skewness measures obtained for the individual factor variables indicate that three of the variables (q18, q19 and q22) have negatively skewed distributions (values < 0). the other two variables (q20, and q21) have positively skewed distribution (values > 0). however, there is no variable that falls outside the –1 range. this indicates normal skewed distributions. the kurtosis values obtained for all the variables in table 3 indicate relatively flat distributions (negative values) (pelser 2014). descriptive statistics: behavioural factors table 4 depicts the descriptive statistics of central tendency and measures of variability for the individual factors affecting the perception on financial inclusion as shown for variables q23–q26. the variable q23–q26 also have a range 4, with the minimum value (1) and maximum value (5) representing the responses ‘strongly disagree’ and ‘strongly’ agree respectively. table 4: descriptive statistics: behavioural factors. the variable responses have the largest mean value of 3.67 for variable q24, indicating that the selected informal traders perceived savings, investments, unit trusts or shares offered by registered financial service providers as important. the smallest mean value of 3.01 is assigned to the variable q25, indicating that the selected informal traders were adamant that they would rather use informal channels of saving as opposed to formal channels. the standard error of the mean values in this analysis is relatively low, indicating that the current sample of the selected informal traders does not vary much from or may only slightly vary from another sample. from the highest standard deviation of 1.340 for variable q26 and the lowest standard deviation of 0.950 for variable q23 it is concluded that the sample of the selected informal traders is homogenous and as such the mean of the selected informal traders is consequently representative of the responses. the skewness measures obtained for the individual factor variables indicate that two of the variables (q23 and q24) have negatively skewed distributions (values < 0), while the other two variables (q25 and q26) have positively skewed distribution (values > 0). however, no variable falls outside the –1 range. this indicates normal skewed distributions. the kurtosis values obtained for all the variables in table 4 indicate relatively flat distributions (negative values) (pelser 2014). descriptive statistics: demand side factors the descriptive statistics of central tendency and measures of variability for the demand side factors, another pillar of financial inclusion, are depicted for variables q27–q30 in table 5. the range for variables q27–q30 is 4, with the minimum value (1) and maximum value (5) depicting the responses ‘strongly disagree’ and ‘strongly agree’ respectively. the highest mean score is 3.87 for variable q30 and the lowest mean score is 2.67 for variable q27. table 5: descriptive statistics: demand side factors. the arithmetic average for the scores for variable q30 indicate that the selected informal traders strongly think that they would like to access a loan through a registered bank or registered micro finance provider, while that for variable q27 indicates that the selected informal traders did not agree that they often use their bank accounts for business transactions. in this analysis, the standard error of the mean values is relatively low, indicating that the current sample of the selected informal traders does not vary much from or may only slightly vary from another sample. from the highest standard deviation of 1.408 for variable q28 and the lowest of 0.807 for variable q29, it is concluded that the sample of the selected informal traders is homogenous and as such the mean of the selected informal traders is consequently representative of the responses. the skewness measures obtained for the societal factor variables indicate that two of the variables (q29, and q30) have negatively skewed distributions (values < 0). however, the other two variables (q27, and q28) have positively skewed distribution (values > 0). nevertheless, no variable falls outside the –1 range. this indicates normal skewed distributions. the kurtosis values obtained for all the variables in table 5 indicate relatively flat distributions (negative values) (pelser 2014). descriptive statistics: supply side factors table 6 depicts the descriptive statistics of central tendency and measures of variability for the individual factors affecting the perception of financial inclusion as shown for variables q31–q34. the variables q31–q34 also have a range 4, with the minimum value (1) and maximum value (5) representing the responses ‘strongly disagree’ and ‘strongly agree’ respectively. the variables responses have the largest mean value of 3.40 for variable q31, indicating that the selected informal traders were aware of the presence of several registered financial services providers that are available in their area. table 6: descriptive statistics: supply side factors. the smallest mean value of 1.80 is assigned to the variable q33, indicating that the selected informal traders did not believe that when they keep their money in the banks, it is easy to access it when they want it. the standard error of the mean values in this analysis is relatively low, indicating that the current sample of the selected informal traders does not vary much from or may only slightly vary from another sample. from the highest standard deviation of 1.164 for variable q33 and the lowest of 0.880 for variable q31 it is concluded that the sample of the selected informal traders is homogenous and as such the mean of the selected informal traders is consequently representative of the responses. the skewness measures obtained for the individual factor variables indicate that two of the variables (q31 and q32) have negatively skewed distributions (values < 0), while the other two variables (q33 and q34) have positively skewed distribution (values > 0). however, no variable falls outside the –1 range. this indicates normal skewed distributions. the kurtosis values obtained for all the variables in table 6 indicate relatively flat distributions (negative values) (pelser 2014). t-tests: difference in perception in relation to demographic characteristics of gender and age of the selected informal traders the t-tests, analysis of variance and post-hoc analysis were used to ascertain any differences in perception being attributable to demographics characteristics of gender and age of the selected informal traders. based on the statistical evidence from table 7, the independent samples’ t-test shows statistically significant results of p = 0.017 and p = 0.018 which are both below 0.05 on individual factors and supply factors respectively, indicating that gender differences existed with regard to the two respective variables. these statistical results are in line with gombrich (2014) who indicates that gender is a factor that affects perception. table 7: independent samples test. on external environmental factors, societal factors, behavioural factors and demand side factors, no significant differences were noted evidenced by p > 0.05 values of 0.856, 0.705, 0.181 and 0.067 respectively, implying that gender had no influence on the perception of the respondents on those variables. analysis of variance: difference in perception in relation to demographic characteristics of age table 8 indicates a statistical significance value of 0.000 in all variables indicating significant differences of perception in all the variables within the different age groups and a further post-hoc test was used to ascertain where specifically the differences in perception occurred within the age range group of the selected informal traders. table 8: analysis of variance. post hoc: test on age table 9 shows an analysis of the different age ranges of the selected informal traders, with the selected informal traders showing differences in perception of all the variables: external environmental factors, societal factors, individual factors, behavioural factors, demand side factors and supply side factors, evidenced by significant values ranging from 0.000 to 0.034. this implies that the age ranges of 18–30 years, 31–40 years and 41–50 years had differing views on the financial inclusion trajectory of the financial sector in zimbabwe. table 9: multiple comparisons. however, no significant differences were noted on external environmental factors by the age range of 50 and above years with a value of 0.524, p > 0.05, implying a similar perception on individual factors. there was also no significant difference in perception on supply side factors portrayed by the age group 41–50 years with a value of 0.709, p > 0.05. in summary, perception on financial inclusion was related to the demographic characteristic of the age of the respondents. factor analysis: perceived dominant dimensions of financial inclusion challenges as extracted by factor analysis the kaiser-meyer-olkin (kmo) value which measures how suitable the data collected was for this study is 0.952 as shown in table 10. statistically a kmo value of 0.952 is a good value to proceed with the test as it is a value above 0.9 which means the results provide valid conclusions. furthermore, the associated p-value for the bartlett’s test of sphericity is 0.000 which is less than 0.001. table 10: kaiser-meyer-olkin and bartlett`s test. the total variance in table 11 shows the eigenvalues and percentage of variance for the four factors of the initial solution which are regarded as important. that table shows that the first factor of the initial solution has a percentage variance of 56.559% and thus is clearly much important than the other three factors with 4.959%, 4.364% and 4.268% respectively. table 11: total variance explained. the importance of each of the principal components are shown in table 11 and only the first four have eigenvalues over 1.00, and together these four explain over 70% of the total variability in the data. thus, this leads to the conclusion that a four-factor solution may probably be adequate to explain the data for this study. according to table 12 there are four rotated factors which are plausibly just as good as the initial factors in explaining and reproducing the observed correlation matrix. moreover, table 11 details how the variables were distributed into four rotated factors. table 12: rotated component matrix the first factor has a relatively large number of variables including: ‘i often use my bank account for business transactions’, ‘i would use my bank account even if i had more regular income’, ‘it is easy to incorporate formal banking instruments such as point of sale machines in my business’, ‘i would like to access a loan through a registered bank or registered micro finance provider’, ‘the money i earn warrants the opening of a bank account’, ‘bank charges for doing transactions are low making formal banking desirable’, ‘interest rates that are charged by local banks are low’ and ‘filling in bank forms is easy’, just to mention a few. demand side factors: the authors believe that it seems reasonable to identify the first rotated factor as ‘demand side factors’, as all these variables speak of an individual’s need and perception towards utilising formal financial services. these variables also have high loadings on the factor. these are: low and irregular income, inadequate information on financial services and products, as well as financial literacy as demand side factors, which it proffers as the major factors constraining financial inclusion in zimbabwe. supply side factors: the second factor extracted has the variables: ‘it is easy to access a bank or financial services provider’ and ‘i am aware of the products offered by registered financial services providers’. these factors point to proximity of financial service providers and awareness of products that they offer. hence the authors believe that it seems reasonable to identify the second rotated factor as ‘supply side factors’. behavioural factors: the third factor has the following variables: ‘there are many registered financial services providers that are available to me in my area’, ‘savings, investments, unit trust or shares offered by registered financial services providers are important’ and ‘the informal sector comprises people capable of utilising formal financial services’. the researchers believe that it seems reasonable to identify the third rotated factor as ‘behavioural factors’. individual factors: the fourth factor has the following variables: ‘formal financial products are for the rich and big corporates’ and ‘it is my opinion that people who utilise formal financial products do so because they are willing to pay tax’. the researchers believe that it seems rational to identify the fourth rotated factor as ‘individual factors’. income levels and affordability contribute significantly to the current levels of financial exclusion. in summary, the factor analysis procedure identified or extracted these four factors as the perceived dormant dimensions of financial inclusion challenges. listed in order of significance, they are demand side factors; supply side factors; behavioural factors and individual factors. limitations of the research this study mainly focuses on the post-multicurrency regime financial inclusion confidence challenges of selected informal traders in the avondale area of harare, the capital city of zimbabwe. there are other sectors like small-scale mining, and small-scale resettled farming. their status with regard to financial inclusion could have broadened the scope of this study. conclusion and recommendations research in financial inclusion has become increasingly prevalent with the consensus that inclusivity of every citizen in the mainstream financial system of an economy is a vital cog that seems to be missing in most of the economies of the developing countries and emerging economies, zimbabwe included. the experiences of the hyperinflation era of 2008 in zimbabwe are still fresh in the minds of zimbabweans. the citizens lost their hard-earned savings in this wave of hyperinflation. confidence in the country’s financial and banking sector hit an all-time rock bottom during this hyperinflation period. the main aim of this study was to assess the perceptions of the post-multicurrency regime financial inclusion confidence challenges of the informal traders in zimbabwe and to explore the influence of the demographic characteristics of the selected informal traders in their perceptions. therefore the following research questions were addressed in this study: what is the general status of financial inclusion among the selected informal traders in harare? to what extent do the selected informal traders in harare perceive the following as financial inclusion confidence challenges in zimbabwe: external environmental factors, societal factors, individual factors, demand side factors, behavioural factors, supply side factors? is there a difference in the perception of the financial inclusion confidence challenges in zimbabwe in relation to demographic characteristics of the selected informal traders in harare? what are the perceived dominant dimensions of financial inclusion confidence challenges as extracted by factor analysis? research questions were addressed through descriptive statistics of central tendency and measures of variability. the descriptive statistics indicated that, despite the selected informal traders’ high level of literacy and understanding of the financial system in the country, they remain adamant that they would rather continue dealing and operating informally and not open a bank account, that is, keeping their money not circulating in the formal financial system. this raises a serious question of healing from the financial experiences of the hyperinflation era of 2008. there is still a challenge of confidence in the country’s current financial system. question four was addressed through t-tests, analysis of variance and post hoc statistical analysis, with statistical evidence that the demographic characteristics of age significantly influenced the perceptions of the selected informal traders, with the age group above 50 years seemingly indifferent. finally, question five was addressed through factor analysis of the financial inclusion challenges, and the analysis procedure identified or extracted the four factors as the perceived dominant dimensions of financial inclusion challenges. listed in order of significance, they are demand side factors, supply side factors, behavioural factors and individual factors. the current study contributes to knowledge in the fields of economic development and banking by propounding the latent dimensions extracted by factor analysis of potential construct pillars for achieving optimal financial inclusion in the informal sector of a multicurrency regime economy recovering from hyperinflation. this creates a good basis for further future grounded theory studies that could generate a theory or framework for achieving optimal financial inclusion in a country such as zimbabwe. the proposed construct pillars to mitigate the negative perceptions towards financial inclusion by the informal sector are the following: demand side factors, supply side factors, behavioural factors and individual factors, in that order. the envisaged future developed framework or theory would also minimise the negative impacts of the general mistrust of formal financial service providers, which seemed to be prevalent among the age group 18 years to 40 years of the informal traders, and would aid the government to craft policies that would be perceived to be supportive of the informal sector. the authors recommend a future case study, grounded in theory, to confirm in a concrete theory the current study’s claim on the framework developed. it is critical that the central bank, policymakers in government, bankers, financial institutions and captains of industries come together and formulate banking policies that are user friendly and beneficial to the informal sector in the country. there is a significant proportion of the population that is not formally employed but gainfully engaged economically, whose number is estimated at well above 90% of the potentially employable population. the study recommends policy consistency and good corporate governance to be observed by policymakers to instill trust and confidence in the informal sector and the general populace in the financial services sector in the post-multicurrency adoption period and hyperinflation era. the study also suggests a need for zimbabwe to restore human rights, political stability, and ensure compliance with the financial action task force (fatf) regulations regarding money laundering and terror financing in order to boost external confidence in the financial system of the country as well. however, compliance with fatf on money laundering and terror financing requirements may prove to be a significant obstacle to this cause. the cost of borrowing, such as interest rates, should be lowered and the processing of loan applications should be faster, to motivate the informal traders to believe that there is added business value in using formal financial services. given the high costs of developing viable banking systems particularly in the rural areas, technology advances, such as mobile banking (e.g. ecocash, 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administration and management, university of pretoria abstract citizen participation on any level of government is timeless. the dynamics and the relationships of citizen participation on all levels are unique, due to the fact that many problems and solutions have their roots in the activities of local government and its administration. furthermore the extension of democracy to all spheres of society and to all tiers of the administrative hierarchy, have been a central theme of the democratisation process in south africa. the notion of "bringing the government to the people" is important, not only in strengthening civil society, but also in mobilising the population to implement the programmes of reconstruction and development necessary to transform the civil society. jel h 11 1 introduction citizen participation on any level of government is timeless. the dynamics and the relationship of citizen participation on all levels of government are unique due to the fact that many problems and solutions have their roots in public administration activities. public administration plays a vital role in educating and mobilising the public with regard to sustainable development. furthermore, the extension of democracy to all spheres of society and all tiers of the administrative hierarchy has been a central theme of the democratisation process in south africa. the notion of "bringing the government to the people" is important, not only in strengthening civil society, but also in mobilising the population to implement the programmes of reconstruction and development necessary to transform the civil society. it should be pointed out that the history of the democratisation process in south africa has been a long and painful one. a feature of the apartheid era was systematic emasculation of government in the ongoing efforts to implement apartheid policy. the latter brought about, for example, township riots and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 217 campaigns of non-payment, the rent boycotts and non-participation by the citizens. the culture of non-payment, so effective in the struggle against apartheid continues to persist in the new dispensation too. payment, for local government services is however an essential prerequisite in the improvement of service provision. the government now seeks to break up this non-payment logjam by getting the citizen involved in government and its affairs. it should be born in mind that government, especially local government, is the main delivery agent for improvements in housing, health care and infrastructural development (such as electrification and water reticulation). in order to succeed it is therefore important that the citizen should become involved in government and its administration. as a point of departure, this paper gives a brief outline of the role and purpose of a government, that is, capacity to act, deliberation and openness. with role and purpose in mind, attention is then devoted to the problems and pitfalls of citizen participation in government administration. thereafter follows a discussion of mechanisms to improve citizen participation in government administration. 2 exposure to the role and purpose of a government citizen participation needs to be promoted if there is to be true democracy. democracy rests on the understanding between the citizens and government and its administration. the activities of the authorities should be observed and the individual should be able to participate in government in a constructive manner; if participation is neglected abuse of power may easily take place. greatest possible participation in public policy and decision-making requires acceptance of the ethical principle that each citizen of a country has the democratic right to participate in decision-making in all those areas that have a direct influence on that individuals life. this principle of democracy requires that all inhabitants should be involved in one way or the other in decisions on government affairs. the achievement of objectives rests upon the ability of the public administration to have the capacity to act, deliberation and openness. this is discussed below. 2.1 capacity to act a distinction between the act of controlling government and the act of governing should be made where representative democracy provides the mechanism of control while the bureaucracy, with its professional expertise, is central in the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 218 sajems ns vol 4 (2001) no 1 task of goveming. it is important that representative politicians must not take it on themselves the task of administration or drafting detailed legislation. democracy and skilled government complement each other and cannot be attained separately. to achieve a balance between these two functions is one of the most difficult and complicated tasks of government. in emphasising this, it is important to note that a system of good governance requires both the mechanisms of control and for effective action. openness and deliberation are to be valued, but they lose their lustre in a system that lacks the capacity to act with effective action (dubnick & rornzek, 1991: 196-8). good governance requires the capacity to act, and therefore bureaucracy and professional expertise are also central to good governance. the management context may vary and a particular organisational form may change, but a large part of the daily work of government is going to be undertaken by full-time professionals, administrators and other employees. from the point of view of the citizen, there are many attractions in letting such people get on with their complex variety of tasks. many "customers" will be satisfied but appropriate mechanisms are necessary to allow those that are dissatisfied to make themselves heard (hirschman, 1970: 75). a good system of governance may well be one in which many people do not exercise opinion, because they are satisfied with the services they receive from the government and its administration. furthermore people in a third-w orid situation are often reluctant to take the initiative, partly because they are not sure of themselves and partly because they are not used to it. they are used to the fact that some authority or organisation takes the initiative and, in most cases, they are quite willing to follow passively (swanepoel, 1992: 304). it should be noted that the capacity to act concerns more than meeting service delivery objectives, important as they are. in such major issues as unemployment, lack of suitable housing, poverty and crime, a capacity to act is required, which goes beyond the traditional role of state bureaucracy. what is needed is the blending of the resources of government with those of non-· governmental actors. the capacity to provide an integrated approach to social and economic issues rests on partners that are trying to bring together long-term relationships rather than secure for themselves access to immediate spoils. 2.2 deliberation people are recognised as having the right and the opportunity to take part in public life. many of their interventions may be specific to the consumption of a particular service. those interventions should be expected to be short-term, of low cost to the individual and elicit rapid response from the service organisation r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 219 in question. they are likely to deal with matters that are of direct material interest to the person concerned. this does not mean that the outcome win always lead to citizen satisfaction, resource and policy constraints may intervene, but the process should be straightforward and make relatively low demands on time and effort a citizen orientation of this nature is now justifiably regarded as a commonplace virtue in public service organisations although, of course, the practical situation will always have room for improvement. the concern with deliberation is a prominent theme in government and democracy (barber, 1984: 16). judgements in this content require the sharing of experiences and the give-and-take of collective deliberation. political institutions should be designed to enable citizens to relate to each other as deliberators or input providers and not as bargainers engaged in exchange (kymlicka, 1990: 220). deliberation should be central to the decision-making of political leaders (dye, 1984: 19). rules of procedure, pro rata membership and openness to the public are then part of the process of decision making. deliberative committees, on the other hand, are considered to be more informal opportunities for policy-making in which politicians can review options in confidence before presenting their final choice of public decisions. in practice, there are an array of working parties and panels for policy deliberation and formulation, alongside the formal decision-making committees. the question may be asked, why is it appropriate for such panels to operate in confidence? an element of reflection behind closed doors is plainly in essential in politics, but the spirit of deliberation being championed in this context argues for a more public process of debate, review and questioning. what may also have to be considered, is whether different institutional forms of political organisation would create a greater capacity for civic leadership (dubnick & romzek, 1991: 160). civic leadership does, however, require a commitment to deliberate issues in order to counteract the tendency towards the creation of regime of public and private actors who fulfil their own agendas and serve their self-interest with little regard for the wider concerns of the community (elkin, 1987: 173). the spirit of deliberation drawn from communitarian ideas requires that some consideration should be given to involving the broad spectrum of the public in a deliberative setting. public meetings, forums for the young or the elderly and neighbourhood assemblies could provide appropriate instruments. each of these instruments has a number of drawbacks in respect of the number and range of responses that they are likely to elicit from citizens. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 220 sajems ns vol 4 (2001) no 1 2.3 openness many people prefer to spend their time on non-political activities or they face social and economic constraints that limit their time for political activity. openness bas many echoes in a long tradition of liberal argument which in its many guises, shares the belief that we promote people's interests by letting them choose for themselves what kind of life they wish to lead (kymlicka, 1990: 199). the various instruments of democracy have been subject to critical assessment with regard to their strengths and weaknesses. the main thrust is to create a sovereign democratic state, a diversity of power centres and a world marked by openness, controversy and plurality (held, 1987: 274). in arguing for open governance, it is possible to draw inspiration from the liberal advocacy of democracy and at the same time recognise the need to meet some of the challenges and difficulties. party competition for elected offices on a first-pastthe-post basis does not represent the limits of democratic practice. the challenge is to extend citizen control in a way, which does not make excessive demands on their time and provides access to social interests (ismail, et al., and 1997: 26). as the world moves into the twenty-flrst century, it is necessary to progress beyond the watered-down practice of a representative democracy that dominates the system of governance. the scale, complexity and diversity of the system require one to delve much deeper into a variety of democratic forms and options. an open system of governance would provide scope for each of the three procedures of democratic decision-making: election of representatives, direct voting on issues and participation in meetings. representative democracy bas many attractions and there are many options for enhancing its effectiveness (gildenbuys, 1997: 32). opportunities for voting and other forms of direct participation (such as phonein lines, electronic networks, video interfaces, etc.) could also be introduced. direct voting could take the form of either referenda or citizen-initiated ballots. it is important to note that here are a number of issues to be considered in the case of binding citizen ballots: the role of pressure groups, stakeholders that are funding publicity, the impact on minority interests and, the oversimpliflcation of complex issues (caves, 1992). a form of democratic procedure is the involvement of sections of the public in face-to-face meetings. such procedures are attractive, due to the fact that they present opportunities for deep and intensive involvement. this could encourage participants to move away from a narrow concern with competitive self-interest towards a broader promotion of consensual areas of common concern. such meetings do, however, have their drawbacks. some individuals are more willing to participate in them than others. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 221 it should also be noted that meetings could create a sense of false consensus, masking substantial differences in minority interests and opinions. for these reasons, it is prudent to use face-toface meetings with circumspection, to restrict their use to debate less divisive issues or to confine their role to consultation rather than taking final decisions. the concerns about face-to-face meetings can however be overcome to some degree and should not be used as grounds to dismiss the contribution made by them to the openness of governance. there is a range of options that could be applied in practice, including the following (ismail et al., 1997: 110-14): public meetings organised to encourage debate on and discussion of a particular issue; neighbourhood forums; co-option of representatives onto governing bodies; user panels; public question-and-answer meetings. citizens may decide, on reasonable grounds, not to avail themselves of the opportunity to participate, believing that their interests are already well served or not being threatened. the value of openness does not depend on or assume large-scale and continuous direct participation. it rather depends on the richness of the prevailing democratic principles and available options for extending participation. these options should operate without making excessive demands on time and in a way that enhances broad social representativeness. 3 problems and pitfalls of citizen participation in government in order to evaluate citizen participation in government and its influence on the administrative function, it is important to consider the problems and pitfalls involved. it should be born in mind that south africa is a young democracy and that the legacy of the past also leads to these problems. the following are some of the issues to be noted: 3.1 literacy levels of the citizens education plays an important role in citizen participation and it is according to anderson (1984: 100) one of the most important means of fostering citizen participation. with this in mind, the education level in especially the rural areas is low due to the fact that many rural schools are poorly endowed with buildings, equipment and books, and without electricity and running water. this brings about high dropout and repetition rates, and long distances to travel to r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 222 sajems ns vol 4 (2001) no 1 school means that many children do not attend school. furtbennore, especially in rural areas, opportunities for secondary and adult education are scarce, and adult illiteracy is therefore much higher in rural than urban areas (reconstruction and development programme, 1995: 23). these factors mean that potential leaders are not equipped with basic knowledge and skills. this creates a gap where citizens will not be able to understand for example, the political process, policy and decision-making issues, as well as their role in accepting responsibility for their part in the administration of the country. lastly, illiteracy causes an inferiority complex. people are afraid to take part, thinking that they cannot make any worthwhile contribution. they believe that innovations must come from educated people of from the privileged, while citizen participation is specifically intended involve ordinary people. illiteracy also hampers organisational aspects of the administration such as keeping minutes, doing surveys and bookkeeping. 3.2 logistical problems, that is, transport problems and telecommunications in expecting citizens to participate in various forums and meetings, it is important that they should in fact be present there, but in developing countries this is a problem due to logistical difficulties especially for people living in remote areas. for example the backlog in the roads network in the rural areas of south africa is between 30 per cent and 50 per cent (rural development strategy, 1995). furtbennore, the lack of adequate public transport has resulted in struggles for monopoly of taxi ranks and routes, leading to what are now called "taxi wars". people who have vested interests in taxis and those who wish to destabilise communities through fear, intimidation and violence exacerbate conflict such destabilisation could result in the undermining of the democratic process and· also prevent citizens from participating in actions the government wants to take to reduce the influence of ''taxi lords" (taylor, 1995: 173). another example of logistical problems is represented by telecommunications, were there are 9.5 telephone lines per 100 people overall in south africa. it is estimated that there are 60 lines per 100 people in white areas, whereas there is only one line per 100 people in black areas (salrr, 1997: 778). the aforementioned is only an indication of some of the problems in citizen participation on account of the logistical problems of getting the citizens to a r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (200l) no 1 223 meeting or a forum, or to do telephone surveys or to inform the citizen about new developments. 3.3 inexperienced officials to deal with the needs and demands of the citizens most governments train their staff to be professionals. it is required of them in such professional fields as agriculture, health or civil engineering to be in possession of a diploma or degree from an accredited institution. in-service training, aimed at updating the employees' professional knowledge, will then follow up this formal education. while professional training is very important and necessary, it nonetheless poses a serious problem for citizen participation. officials are not trained in the basic theories of democratic practice, the practice of development and have not been trained to understand sociological phenomena that influence their work. they also lack psychosocial skills, with the result that they fmd it very difficult to work with people and to understand people's sentiments and actions (swanepoel, 1992: li2). 3.4 related problems that prevent citizen participation the abovementioned issues are only a few examples. the following may also hamper citizen participation in public administration: (swanepoel, 1992: 112) customs and traditions: people are obligated to follow customs and traditions even if they are involve in the administration. the submissiveness to traditional leaders (in south africa approximately 18 million people are under the rule of traditional leaders) and the inferior position of women are examples of this. this does not mean that customs and traditions are obstacles per se, on the contrary, they can be valuable resources. customs and traditions are not static; they have the tendency to adapt to suit modem times. however, where people keep them static for some reason, they can indeed become obstacles in the way of citizen participation. dependency: people may become so used to being dependent on the administration and other agencies, that receiving handouts becomes the norm. they are then loath to do anything for themselves and come to expect to be paid for any part of an effort to get them involved in the administration of the government. apathy: yet another issue that shou1d be noted of in this context, is that of apathy where people have become so used to being poor and suffering all the consequences of poverty, that they have no real wish to participate but only to survive. unfortunately they truly sustain their poverty and misery by accepting it as fate, and may be fearful to participate in initiatives r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 224 sajems ns vol 4 (200 i) no i undertaken by the administration because it could lead to even further suffering. the problems mentioned above cannot be ignored, and citizen participation should be to remove them. every government agency should take note of them (to ignore them will not make them to go away), address them and must, to a certain extent, also accommodate them. in short, these obstacles are real obstacles citizen participation in public administration, and ignoring them or trying to break them down by brute force will only be detrimental to it. 4 mechanisms to improve citizen participation in government and its administration there are number of traditional mechanisms to improve citizen participation in government and its administration. these traditional mechanisms include the introduction of user groups, liaison panels, public question-and-answer occasions, forums to improve planning, decision-making and policy implementation (starling, 1992: 160-61; ball, 1995: 15-20; barnes et al., 1996: 9-17). this part of the paper looks beyond the traditional mechanisms whereby the citizen would be actively involved and also accept responsibility. accepting responsibility means that there should co-operation between public administrators and citizens, so that there can be joint action and joint responsibility (thornhill & hanekom, 1995: 43). this section addresses the process of facilitating citizen involvement, enhancing the education of citizens and specifically stresses the role of mentorship and support, enhancing administrative capacity by equipping officials with the necessary skills to meet the demands of the citizens. attention is also given to the issue of providing a valuable service close to the citizen, building partnership and trust by following certain strategies and lastly maintaining citizen enthusiasm for participation in the administration of government. 4.1 facilitating citizen participation in order to facilitate community involvement, a number of options may be followed to enhance citizen participation. responsibility for implementing a project may lie with a community, a local, provincial or national authority. wherever it lies, the beneficiary community must be involved in all stages of project identification and development. once a project has been identified and agreement reached that it should be implemented, the beneficiary community should be made aware of this by using the media as well as passing information through established community organisations. the options below may be r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vo14 (2001) no 1 225 implemented to promote community participation (guidelines for enhancing employment opportunities in the delivery of infrastructure projects, 1998). 4.1.1 project steering committee the aim of the psc will be to look after the interests of the community. the implementation agent is responsible for making arrangements for the establishment of the psc and for drafting and agreeing with the psc terms of reference. representatives of the community should be the dominant force of the psc and represent the composition of the community with regard to the numbers of women, youth, unemployed people etc. the psc should include the political representative of the community, representatives of community organisations and local interest groups, for example, an environmental study group. 4.1.2 scope of social and development compacts social and development compacts are required to enable agreement to be reached at the level of the local authority, where its structure does not have the capability to co-ordinate development. where local authorities have established permanent structures to deal with development issues and to co-ordinate all development projects, it will not be necessary to establish a social compact. this structure can however successfully facilitate delivery and assist the beneficiaries in entering into a development compact. 4.1.3 appointment of a facilitator the appointment of a facilitator should take place as soon as the client organisation (funding institution) is committed to a project. the facilitator must be acceptable to the community and be able to communicate freely with community members. the facilitator should be a member of the community and the necessary training is to be provided. the facilitator should support the local authority and keep it fully informed ofrus activities. 4.1.4 community liaison officer the employment of a community liaison officer (clo) to act as go-between for the work force (project participants), the contractor and the psc has been found to be of benefit in avoiding potential conflict. the duties and employment conditions of the clo should be laid down in form of a contract of employment. the clo must be respected by the community and the method of appointment should be transparent and agreed upon between the client, pcs and contractor. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 226 sajems ns vol 4 (200 1) no 1 4.2 improving citizen education to enable citizens to participate and communicate intelligibly, frankly, legitimately and in a truthful manner, they should have a basic knowledge of and skills in the citizen participation process (thornhill & hanekom, 1995: 41). but active and knowledgeable citizenship is not something that develops without conscious effort to encourage it. citizens need certain stimuli to encourage participation in specific programmes and activities. education is one of the most useful means of deliberate action to equalise divergent approaches, for example, by affluent areas or disadvantaged groups. it should be borne in mind that the process of education is not a one-sided exercise; it is twofold where the public official has the duty to educate the members of a community in their various roles and responsibilities. on the other band education also is a task of the leaders in the community, and of community-based and non-governmental organisations. the stress on educating the citizen should be on the dynamics of political intentions and it is therefore important that target groups be guided in the correct way and in the desired direction with regard to the openness of government and its administration, certain basic principles should be followed. these could include: the right of citizens to express their ideas about management and administrative issues; a need for the opportunity to exchange ideas; and well-deliberated and sensible inputs for decision-making. in terms of education, support and mentorship, the administration should also play an important role. mentoring of citizens should not be seen as a one-way street on the part of the administration but as a means of providing experience to the citizen who wants to play an active role in the administration. mentors should perceive the need to contribute to the growth, development and . satisfaction of citizens. they should also be responsible for conveying and upholding the standards, norms and values of the community. the nature of the relationship between the mentor and the citizen should be formalised and allowed to develop over time. 4.3 improving administrative capacity by training officials although this may seem a cliche, the role of training in dealing with citizens cannot be ignored. therefore it should be noted that training means any action necessary to develop applied knowledge, expertise or inclination with the view r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 227 to better qualifying a person for work related to a government body, and it includes supplying guidance to members of government bodies. officials will have to be trained on a regular basis to facilitate a behavioural change and sensitise them to the changing needs and aspirations of the citizens. it is also true that officials may feel threatened or insecure about citizen participation in the administration. they may feel that drawing citizens into participation in government affairs will be just another way of rationalising their institutions, which could result in redundancies and early retirements. training programmes should therefore also be provided to officials to eliminate fear and misunderstanding (bekker et ai., 1995: 85-86). the selection of the right officials to deal with the community is critical it may be necessary to review an official's perfonnance regularly and make changes if needed. a trained official should be able to perfonn the following functions designed to encourage citizen participation: assist the community organisations in carrying out skills and resource audits. communicate on a regular basis with the citizens involved, to determine needs and aspirations. identify possible issues, which could disrupt relationships and trust between the community and the administration as soon as possible. ensure that citizens are infonned about their rights and privileges. 4.4 providing a valuable service to be close to tbe citizeu for a service to be of value to them it must be wanted by the citizens and be of an acceptable quality. getting closer to the citizen can only do this and although this of importance for all public services it should be borne in mind, that this is the only way to enable public service providers to respond to the changing needs oft:be citizens (constitution a/the republic a/south africa, 1996). public administration is moving away from the old one-way relationship with the citizens, in which people were simply seen as recipients of services. therefore, as public administration seeks to fonn closer relationships, it could utilise a number of ways to be close to the citizen in assessing the value of the service provided (atkinson & boyle, 1996: 22). this may include surveys, focus groups, consumer panels and general discussions. it is important to choose a method that is understandable at the level of education of the citizen. for example, the use of a questionnaire could be suspect due to the possible manipulation, and representation of views is difficult to collect, as people who have a specific concem or designation are far more likely to contribute to r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 228 sajems ns vol 4 (2001) no 1 research than those without. those who are visible and/or active during meetings are not necessarily those in greatest need (robinson & wolsey, 1996: 67). to avoid the problems mentioned above, the role of the facilitator as explained in 4.1.3 becomes increasingly important in assessing the real need for service delivery by the administration. 4.5 budding partnerships and trust with citizens one of the strengths of integrated public administration is that it recognises the linkages between development, delivery and democracy. public administrations require active participation by citizens at four levels: as voters, to ensure maximum democratic accountability of the elected politicalleadersbip for the policies they are competent to promote. as citizens, who express through various stakeholders associations their views before, during and after policy developments, so that policies reflect community preferences as far as possible. as consumers or end-users, who expect value for money, affordable services and courteous and efficient service. as organised partners, involved in the mobilisation of resources for development. in building participation and trust with the citizens, either the "top-down" or "bottom-up" approach could be followed. the first-mentioned is a one-way process, dominated by the public administration, whereas the last-mentioned process is a two way process that develops into a genuine dialogue between the administration and the citizen. it should be kept in mind that the reality is complex. with this in mind, a closer look is taken at each of the two processes below: 4.5.1 the top-down strategy in the top-down strategy the public administration remains firmly in control this means it will (young, 1996: 26): set up a one-way process; pass down information to citizens and interest groups about what the administration is doing; set the agenda and control it during the participation process; choose the policy to be followed and its priorities; dominate the participation process itself; and manipulate the process of participation to ensure that there is no real scope for change to its position after it has been completed. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 229 the top-down strategy usually occurs where the administration intends to publicise what it has been doing, and what it plans to do in future. this form of participation helps the administration to legitimise its activities (swanepoel, 1992: 108-9). it should be kept in mind that although this process is widely criticised for not allowing real input from citizens it could be used as a point of departure where the citizens have no wish to participate. this mechanism should then be used with great care and only if necessary. it may be noted that citizens in a third-w orid situation are often reluctant to take the initiative, partly because they are not sure of themselves and partly because they are not used to participation. they are rather used to the fact that some authority or organisation takes the initiative. in most cases, they are quite willing to follow passively. there may be very good reason for this attitude, for example that the opportunity for conflict in a society is much diminished when decisions are made externally. 4.5.2 the bottom-up strategy in contrast the bottom-up strategy may be followed and this approach could then lead to citizen empowerment. in this case the administration will follow a different approach in allowing the citizens to participate in the administration. the administration will then (white paper on transforming public service delivery, 1997): conceive participation as a genuine two-way dialogue based on the sharing of information and knowledge; • aim to reach out beyond the groups that are usually involved in participation, to give people a genuine role in shaping the decisions of the administration; follow a hands-off approach, listening stance and aim to empower people; leave the agenda open, which will then set by the citizens; • leave the direction of policy and the choice of the priorities open to discussion; share power with the participants: the participation process will then became part of day-to-day administration; and ensure that it has wide scope to change its position once the participation process is over. administrations promoting the bottom-up strategy should keep the following basic principles in mind (young, 1996: 29-30): the administration should develop a culture of listening, both at meeting and afterwards in internal discussions; r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 230 sajems ns vol 4 (2001) no i to encourage trust, it is important the administration brings in outsiders as convenors, chairs and facilitators. (outsiders are nonnally seen as unbiased); administrations should provide support for officials to for example, arrange meetings, distribute the necessary infonnation and take down the minutes. in the process of empowennent it is important that the citizens should also take over some work between the meetings; that a blank agenda should always be a starting point where the citizens set out their needs and aspirations; and that responsibilities are shared between the administration and the citizens in meeting these needs and aspirations. co-operative responsibility is then required. in building trust and partnership between the citizens and the administration, the latter should prevent a hands-on approach and rather adopt a more open-minded attitude than in the past, when citizens were merely seen as the receivers of services. 4.6 maintaining citizen enthusiasm to participate it is true that when people feel obliged to participate in the administration of government and that it could have a negative influence on those who really want to participate. for those who want to play an active role, it is important to maintain the enthusiasm to participate in government programme, be it planning, policy and decision-making issues or service projects such as roads, health care, housing or environmental issues. the following hints could serve to maintain enthusiasm (swanepoel, 1992: 9-10): that the collective objective is reachable in a short period. programme planning should make provision for regular milestones. milestones could be use as a measurement tool to encourage the participants to follow the objectives. programme planning should make provision for the unexpected failure and these failures should be communicated to participants who could assist in drawing up of alternative programmes. participants should be given credit for accomplishments on achievements. 5 conclusion the phenomenon of citizen participation has become a major challenge for public administration. public administrators are forced to take the initiative in identifying and implementing means to accommodate citizens needs and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 231 aspirations to participate in the processes of public administration, be it decision making or other activities. public administration in the democratic state starts and ends with the needs and the expectations of the citizens. it is therefore important for citizens to be qualified and willing to make their own inputs for obtaining satisfaction of their justified needs and expectations. education thus becomes an important condition for citizen participation in effective, deliberation and to be able to act accordingly. public administrators have the responsibility to make citizens aware of their role in effective participation through mentorship and support there is an increasing need for citizens to effectively work along with the government of the day to ensure successful governance. although traditional mechanisms are not to be neglected, it is important to look beyond these in order to promote the process of citizen participation. because the interests of the citizens are at stake, it is self-evident that they should take part in the activities of public institutions in providing the goods and services required for the maintenance and promotion of the general welfare. it is therefore important that citizens to be able to make specific inputs, in other words, they must serve as responsible partners of the government and administration. lastly, the most urgent challenge for any government that claims to be democratic, is to build a society motivated by participation. the requirements of democracy are met when the opportunities for citizen participation are present, irrespective of whether the citizen participates or not. references anderson, c. (1977) statecraft: an introduction to political choice and judgement, new york, wiley. 2 atkinson, s. & boyle, j. (1996) "young people and local authorities: what can we do to make them more interested should we bother?", local government policy making, 23(3). 3 ball, j. (1995) "community governance the arun experience", local government policy making, 22(3) december. 4 barber, b. (1984) strong democracy: participatory politics for a new age, california, university of california press. 5 barnes, m.; harrison, s.; mort, m.; sharlow, p. & wistow, g. (1996) "users, officials and citizens in health and social care", local government policy making 22(4), march. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 232 sajems ns vo14 (2001) no 1 6 caves, s. (1992) land use planning, the ballot box revolution. newbury, california, macmillian publishing company. 7 dubnick, m.j. & romzek, b.s. (1991) american public administration politics and the management of expectation, new york, macmillian publishing company. 8 dye, t.r. (1984) understanding public policy, (sill 00.), englewood cliffs, prentice-hall, inc. 9 elkin, s. (1987) city and regime in the american republic, chicago, university of chicago press. 10 held, d. (1987) models of democracy, cambridge, polity. 11 hirschman, a. (1970) exit, voice and loyalty: responses to decline in firms, organizations and states, cambridge, polity. 12 ismail, n.; bayat, s., & meyer, i. (1997) local government management, halfway house, international thomson publishing (southern africa)(pty) ltd. 13 gildenhuys, j.s.h. (1997) introduction to the management of public finance a south african perspective, pretoria, j.l van schaik publishers. 14 kymllcka, w. (1990) contemporary political philosophy, oxford. clarendon. is reconstruction and development programme, (1994) white paper, pretoria, government printer. 16 robinson, l. & wolsey, c., (1996) "considerations in developing the public service orientation", local government policy making 23(1) july. 17 starling, g. (1993) managing the public sector (41ll ed.) belmont, california, wadsworth publishing company. 18 south africa (republic) (1995) rural development strategy of the government of national unity, ministry in the office of the president. pretoria, government printer. 19 south afrlca (republic) (1996) the constitution of the republic of south africa, act no j08 of 1996, pretoria: government printer. 20 south afrlca (republic) (1997) white paper on transforming· public service delivery, department of public service and administration. pretoria, government printer. 21 south afrlcan institute of race relations (sairr) (1997) south african survey 1996-1997, johannesburg. 22 sw anepoel, h. (1992) community development putting plans into action, kenwyn, juta & co, ltd. 23 taylor, v. (i99s) community empowerment, in craig, g and mayo, m (eds.) social reconstruction and community development in the transition to democracy in south africa, london, ed books. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 233 24 thornidll, c. & hanekom, s.x. (1995) the public sector afanager,[hrrban,buttenno~. 25 young, s. (1996) "stepping stones to empowennent? participation in the context of local agenda 21", local government policy afaking, 22(4), march. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2 286 a financial model to determine the distortions in economic value added (eva) caused by inflation jude villiers department of business management, university of stellenbosch abstract this paper presents an algebraic model to study the extent to which inflation distorts economic value added (eva). the model consists of a theoretical finn in steady state, consisting entirely of projects with the same known internal rate of return. the eva this finn reports is then calculated, and compared to the true economic profit calculated from the known return of the finn. the model shows that both conventional eva and eva based on the current value of assets are distorted by inflation. the distortion in the latter is more systematic, and this could fonn the basis of an adjusted eva calculation to provide an estimate actual profitability. 1 .introduction economic value added (eva) is a new name for an old concept, economic profit. economic profit is the revenue generated by a finn after the cost of the capital it employs has been taken into account. stewart (1991) called this economic value added (and abbreviated it to eva, a tenn subsequently registered as a trademark by the finn stem stewart & co). stewart fonnalised the calculation of ev a and advocated its wide use in financial decision making. he recommends that managers should aim to maximise ev a instead of maximising profits, and that eva should be used for "setting goals, evaluating perfonnance, detennining bonuses, communicating with investors, and for capital budgeting and valuations of all sorts" (stewart 1991: 4). ev a is based on accounting profit. it is well known that the accounting return a firm reports is often a poor proxy for its true return. this discrepancy between accounting and true return is exacerbated by inflation. ev a will be distorted by inflation too. de viiliers (1997) studied this distortion and found that inflation distorts ev a to such an extent that it cannot be used under inflation to estimate r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 287 salems ns vol 4 (2001) no 2 actual profitability. de viljiers (1997: 289-91) provided a numerical example to show the distortions. the present paper provides the more general algebraic model to derive the relationships between the true return of a firm and the eva it reports. the basis of the model is the construction of a theoretical firm in steady state, made up entirely of projects with the same known internal rate of return. the return of the firm is known, since it is equal to the internal rate of return of the projects that comprise the firm. the eva that this firm will report under various circumstances can then be calculated. this is compared to the true economic profit to determine the distortion in reported eva. the true economic profit is known because the true return of the firm is known. this technique (constructing theoretical firms of known return and calculating the accounting figures the firms will report under various circumstances) was first used by harcourt (1965) to study the relationship between accounting return and true return. it has since become a standard method used in many studies [see de villiers (1997) for an overview]. the model to study the distortion in ev a under inflation is presented below in four sections. after the introduction, the second section specifies the cash flows of the projects comprising the theoretical firm. this includes calculating the annual trading surplus that will give a project a particular internal rate of return. the third section then determines the eva reported by the theoretical firm. to do this, it calculates the net operating profit after tax that the theoretical firm reports, and the book value of the assets of this firm. these are then used to calculate the ev a that the firm reports, and to compare this to the known true economic profit. the fourth section focuses on eva based on the current value of assets. it determines the current value of assets and then uses this in the eva calculation, again comparing to the known true economic profit to determine distortions. the fifth section concludes the paper. the model presented below comprises a theoretical firm consisting of a number of projects. the variables that are used to describe the firm and its projects refer to activity during a year or balance at the end of a year, as applicable. s, for example, refers to sales during a year, and c refers to creditors at the end of a year. it is necessary to distinguish between variables relating to individual projects and variables relating to the firm, and single or double subscripts are used to do this. double subscripts indicate a project variable; the first subscript relating to the year of the project and the second to the year the project was initiated. s2.3, for example, is the project sales during the second year of a project started in r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2 288 year 3, and c4 ,1 the project creditors at the end of the fourth year of a project started in year 1. a single subscript refers to a variable relating to the firm as a whole, thus, s5 is the total sales by the firm in year 5, and c 1 is the sum of the creditors of the firm at the end of year 1, the variables themselves will be defined as they are introduced. 2 project cash flows each individual project consists of an initial investment in current, depreciable and non-depreciable assets. the project runs for d years in which the annual turnover, expenses, and cost of goods sold stay constant in real terms. in these subsequent years no investment is made in depreciable or non-depreciable assets. current assets employed increase in nominal terms in line with the nominal increase in turnover, and this requires an annual investment in current assets. at the end of the project the depreciable assets are taken to have zero scrap value. current assets and non-depreciable assets have wound-up values equal to the initial investment in real terms, in any year n of the project initiated in year k, the annual cash flow (fn,k) consists of the cash received minus the cash paid out during that year. the cash received consists of payments for goods sold, and is equal to the annual sales (sn,k) minus sales on credit not yet paid for (debtors added during the year, d ~,k ) plus the payments received from the sales on credit during the previous years (debtors that paid during the year, d :,k ). the cash payments in any year n consists of payments to purchase inventory, cash expenses incurred during the year (xn,k)' depreciable assets acquired during the year (da :,k ), non-depreciable assets acquired during the year (na :,k ), and tax payments made during the year (tn.k). the payments to purchase inventory are equal to the amount of inventory acquired (i:,.), minus the purchases on credit not yet paid (creditors added during the year, c:.k ) plus payments for inventory previously purchased (creditors paid during the year, c:. k ). the total annual cash flow in any year n of the project initiated in any year k can therefore be expressed as: f.,. =(5 •.• d:k +d:k)-(i:.k cn~k +c:'k)-xn,k -da:k -na;k -tn.k (1) the firm is assumed to pay income tax on its accounting profits at a rate of t. taxable income is calculated according to historical cost conventions, and the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 289 sajems ns vol 4 (2001) no 2 tax is assumed to be payable immediately. the model assumes that no capital gains tax applies. in any year n of the project started in year k, the taxable income of the ftrm equals annual sales (s •. t) minus the deductible expenses. tax deductible expenses consist of the cash expenses (x •. k ), the inventory processed (l:.k ), and the depreciation of depreciable assets (da~,k)' the tax is payable at a rate t, and therefore: tn .• = t(sn,. x.,. i:'. da:.) (2) during any year n of the project the amount of debtors at the end of the year is equal to the debtors at the beginning of the year plus the debtors added during the year minus debtors that paid during the year, so that: d •.• ::;: d._1.k + d:k d:'k similarly for creditors and inventory: c ==c +c a -c p n,k if-l~k li,k li.k in,k = i._i,. + i:k i:'. (3) the model assumes that the project is initiated in year 0 and operates for d years until it is terminated in year d. we shall ftrst analyse the cash flows in year 0 of the project, then analyse the cash flows in any of the subsequent years of the project (except the last year), and ftnally analyse the cash flows in the last year of the project. 2.1 first year of the project in year 0 of the project (the year in which the project is initiated) no sales take place, no cash expenses are incurred, and no inventory is processed. therefore: so,k ::;: xo,k == it.. 0 no debtors, creditors or inventory exist before the project is initiated, and therefore: d_i,k = c_1,k = i_i,k = 0 if these are substituted into equation (3), and the resulting relationships rearranged and substituted into equations (2) and (1), then the cash flow in year o is: fe,. = -cae.. da;'. na;'. (4) where cao; (the current assets at the end of year 0) consist of the debtors plus inventory minus creditors at the end of year o. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vo14 (2001) no 2 290 2.2 subsequent years of the project we now proceed to analyse the cash flows in the subsequent years of the project (except the last year, which will follow later), in these subsequent years no investment is made in depreciable or non-depreciable assets. for any year j of the project (where o<j<d): (5) furthermore, because of the regular trading pattern debtors stay constant in real terms for the duration of the project. the debtors at the en.d of any year are therefore (1+i) times the debtors at the end of the year before. for year j, therefore: so that, by substituting into (3): because the trading pattern stays constant in real terms, the debtors at the end of any year are equal to the debtors at the end of year 0 increased by the rate of inflation. for year (j-l), therefore: substituting into the equation above: d r '(i ')/-id d p j,k = 1 +1 o,k j,k similarly for creditors and inventory: c a '(i ')j-l c cp j,k = 1 + 1 o,k j,j.: /:'k i(1 + i)j-l /o,k -/;,. the cash flow in any year j (fj.k ) can then be calculated by substituing into equations (i) and (2) from the above for debtors added (d:'k ), creditors added (c:'d, and inventory acquired (l:'d, and by substiting from equation (5) for r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 291 sajems ns vol 4 (2001) no 2 depreciable assets acquired (da:k ) and non-depreciable assets acquired (na 2. ), and then substituting (2) into (i), to leave (after rearranging): for simplicity we combine sales, cash expenses and inventory processed into a single variable we call the trading surplus (t~,k)' this is defined as the sales minus cash expenses minus value of inventory processed. because of the regular trading patttem we assumed, the sales, cash expenses and inventory stay constant in real tenns and therefore increase by the rate of inflation in nominal tenns. so does the trading surplus, and therefore: furthennore, because of straight line depreciation and the fact that all depreciable assets are purchased in year 0 of the project: d,ja daj',. ="7 (8) so that, after substituting (7) and (8) into (6): fj ., (1t)(l + 0,-1 ts1., i(l + wi ca,;" + -ft da,;~. (9) equation (9) shows that the annual project cash flow cash consists of three elements: the annual trading surplus, an additional investment in current assets to keep pace with inflation, and the depreciation tax shield. 2.3 last year of the project we now proceed to analyse the cash flows in the last year of the project (year d). the cash flows from the trading surplus, the additional investment in current assets, and the depreciation tax shield are calculated in the same way as for the preceding years. in addition, positive cash flows from the wound-up values of non-depreciable assets and current assets have to be taken into account. the level of current assets grows and the value of non-depreciable assets increases at the rate of inflation. after adding these to the amounts in equation (9), we obtain: (10) the cash flow in any year of the project can therefore be detennined from one of equations (4), (9), and (10) above. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol4 (2001) no 2 292 2.4 first year trading surplus required to construct a finn with a known true return, all the projects making up the firm must have the same internal rate of return. we therefore have to determine the project characteristics that will yield the specified internal rate of return. more specifically, our aim is to determine what the project's trading surplus has to be to yield the required internal rate of return. the internal rate of return of the project depends on the cash flows specified in equations (4), (9), and (lo) above. the trading surplus required to provide a particular internal rate of return can be determined by calculating the present values of the annual cash flows, making the sum of the present values equal to zero and solving for the trading surplus. if the project has an internal rate of return (in nominal terms) of r, then the net present value of the project cash flows (discounted at the rate of r) equals zero, or: d f l_j_',k_=o j=o (1 +r)1 substituting from equations (4), (9) and (10) for the annual cash flows, solving for tsj,k and simplifying, yields: ( [( 1 _1_ 1-: 1 ( r j\ (r-i) d.r \1+ ts1,k =. 'j"":'t cau + 1-t l_(i+ijd l+r \. (11) j equation (ii) specifies the first year's trading surplus required to yield the internal rate of return (r). this can be used to substitute for tsj,k in equations (9), and (lo), using equations (4), (9), (10) and (11) it is therefore possible to specify all the cash flows of a project from its initial investment in current, depreciable and non-depreciable assets, the project duration, its internal rate of return, the tax rate, and the inflation rate. this will be used in the following section to calculate the eva reported by a firm made up from these projects. 3 economic value added (eva) reported by the firm until now, we have focused on the cash flows of the projects comprising the firm. from now on we shall focus upon establishing the characteristics of the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 293 sajems ns vol 4 (2001) no 2 finn made up of these projects. this requires summation across the current projects of the finn. to calculate the eva requires calculating the net operating profit after tax (nopa t) reported by the finn, and the assets employed by the finn. these will be detennined in turn below, and then used to calculate reported eva 3.1 calculating the net operating profit after tax the net operating profit after tax reported by the finn is detennined first, by, calculating the profit before tax and, then, subtracting the tax payable. to calcula~e the accounting profit of the finn requires summatiorr across the current projects of the finn. the finn consists of (d+l) projects, each with an operating life of d years. one of the projects is just being started, one project is in its first year of operation, one in its second year of operation and so forth until the oldest project in its last (dth) year of operation. in the absence of real growth, each project is equally large in real tenns and (i +i) times larger in nominal tenns than the project started one year earlier (where i is the rate of inflation). once steady state is reached, a firm will tenninate its oldest project and start a new project every year. we shall calculate the nopat generated by the finn in year (k+l), which is the fitst year in which the project started in year k will be in operation. we therefore calculate the accounting profit reported by the finn in year (k+l) (earnings reported in year (k+ 1), ek+l)' this consists of the total sales in that year (sk+d minus the cash expenses (xk+l), inventory processed (/:+1)' and the depreciation reported (assets depreciated, da!i), so that: for simplicity, we have earlier combined the first three variables into a single variable called the trading surplus, or: and therefore: (12) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2 294 the firm consists of its current projects. in year k+ 1, the project initiated in year k+ 1 has not yet started to generate any turnover. the current projects generating turnover are therefore the d projects initiated in the d years prior to year k+ i. by separating the earnings components into the contributions from each of the current projects, it expands to: d d dat,k-(j-t) el<+l = z:tsj•hil ) z: (13) j=i j=i d because all three elements of the trading surplus of each project stay constant in real terms over the duration of the project, the trading surplus in any year is equal to the trading surplus in year 1 of that project, increa.sed by the rate of inflation, or: ts j.<-(j-i) = (i + itt ts1.k_(j_i) (14) furthermore, because each project is as large (in real terms) as the project started a year before, the first year trading surplus of any project is (1 +i) times larger than the first year first year trading surplus of the project started a year earlier. this increase is compound when compared to the first year turnover of earlier projects. therefore: tsl.k ts1•hj1i :: (1 + i) (15) and, from (14) and (15): tsj,k_u_i) = ts1,k (16) the value of depreciable assets acquired by projects in successive years increase by the rate of inflation, and therefore: d.!a daa . = nil): (17) a.hrl) (1 + i )j-i so that, after substituting (17) and (16) into (13): da:. z:d 1 e =dts ---' -hi l.k d (1 .)j-i j"i + i (is) the eva calculation requires the calculation of the net operating profit after tax (nopat). stewart (1991) suggests numerous adjustments to profits when calculating nopa t. none of these adjustments apply to the simplified model r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 295 sajems ns vol 4 (200 i) no 2 used in this analysis. tax at a rate t is payable on the earnings figure, and the nop a t of the firm is therefore simply the earnings calculated in equation (18) multiplied by (i-i). after multiplying by (l-t), summing the series, substituting from (ii) for tsl.k , gathering terms, and simplifying: nopat .. ! = d.r.cao•k ( (( )d)1 : i ( 1 : 1 , '1. d.r -~~ + d·lr-l d 1-(.!...!..!.. 'j l+r / (i t(i+.i y\ r 1 dj a \1+ + (d.(r i»)na a 1 ( 0.1 (19) 3.2 calculating book value of assets calculating eva also requires the calculation of the assets employed by the firm. the book value of the assets is calculated by summation across all the current projects of the firm. current and non-depreciable assets are valued at cost. straight-line depreciation over the total life of the assets is employed to calculate the book value of depreciable assets. the book value of the firm at the end of year k is equal to the book value of the current, depreciable and non-depreciable assets ofthe firm, or: separating this into the contributions of each of the current projects of the firm: (20) the current assets employed by projects increase annually at the rate of inflation, and the projects themselves increase in size also at the rate of inflation. therefore: the projects increase in size at the rate of inflation, and therefore: r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vo14 (2001) no 2 296 substituting into (20), summing the series, and simplifying: a dca . + i + i i da a i + i • i • na a [(1 'j (1 .\ [ 1 j] [(1 .\( (1 vi]] • 0,. + l-id,12 t dj2.(i+i)"'-1 0,. + \-j-) -ll+i) 0,. (21) 3.3 calculating eva the model assumes a firm in steady state, and the standardised eva the firm reports would be the same in any year (once steady state is reached). we calculate the standardised ev a reported by the theoretical firm in year k+ 1, the first year in which the project initiated in year k will be operational. given steady state, it would not have made a difference if we chose any other year. the capital value on which the ev a calculation is based, is the assets employed by the theoretical firm at the beginning of year k+ 1, which is the same as the assets employed at the end of year k. the eva reponed by the finn is therefore equal to: (22) where c' is the cost of capital of the finn, and nopah+-j and ak can be dete~ined from equations (19) and (21) respectively, to calculate the standardised eva (seva), divide the eva in equation (22) by ak and multiply by 100, so that: ioo{nopat.+l -c'l at j (23) where nopatk+ j and ak can be detennined from equations (19) and (21) respectively. 3.4 distortion in eva to study the distortion in standardised eva, we shall use equations (19), (21) and (23) to calculate the standardised eva reponed by a specific firm, employing a specific type of asset and with a specific true rate of return, inflation rate, and tax rate. we can then compare the reponed eva to the true r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 297 sajems ns vol4 (2001) no 2 economic profit, which can be calculated from the known true return. the difference between the two figures shows the extent to which eva is distorted by inflation. the distortion in eva depends upon the type of assets employed by the firm. one way of studying the pattern of distortions is to consider firms employing only one type of asset. five such firms are considered below. the first is a firm that employs only current assets (for example, a small retail operation renting the fixed assets it requires). we also consider three firms that employ only depreciable assets (for example, machinery in manufacturing operations). they consist of a firm employing depreciable assets with a life of four years, a firm employing depreciable assets with a life of years, and a firm employing only depreciable assets with a life of twenty years. the fifth firm considered is one that employs only non-depreciable assets (for example, land as its only asset). figure i shows the standardised economic value added these firms will report under different rates of inflation. each of the firms has a real return of 10 percent per year and a real cost of capital of 10 percent per year. the firms therefore all make zero economic profit, and should report a standardised economic value added of zero. the extent to which the reported standardised economic value added differs from zero, shows the extent to which this has been distorted. figure 1 shows that reported eva is distorted, even in the absence of inflation. at zero inflation the current asset firm and the non-depreciable asset firms report the correct eva (0 per cent). the other three firms report eva of 0.5 per cent (firm with 4 year assets) 1.4 per cent (firm with 10 year assets) and 2.8 per cent (firm with 20 year assets) respectively. this distortion stems from the use of straight-line depreciation, which differs from economic depreciation, even in the absence of inflation. figure 1 further shows that this distortion in reported eva is exacerbated by inflation. it is only the firm exclusively employing current assets that reports the correct eva (0 per cent). the reported ev as of all the other firms are distorted, including that of the firm exclusively employing non-depreciable assets. for all these firms, the distortions increase with increasing inflation. at an inflation rate of 10 per cent, the three firms employing depreciable assets report eva of 1.6 per cent (firm with 4 year assets) 5.3 per cent (firm with 10 year assets) and 12.5 per cent (firm with 20 year assets) respectively. the firm employing nondepreciable assets reports an eva of 2.5 per cent. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2 298 figure 1 standardised economic value added reported by a firm with a real return of 10 per cent per year and a real cost of capital of 10 per cent per year 25.0"10 ~~~-----------------_ 1l ~ 20.0";<' 1l ~ 15.0";<' .l:! ~ 10,0"/. ~ ••.•••. current assets .• _. machinery (4 years) _. _. machinery (10 years) machinery (20 years) --non-depreciating --~ ,-~ ,~ ,. ~~ ~ 5.0010 __ .... _-. _~_ ~ ---------1 o.tl%.f;. ~.:;,.;' ';:;-.:;,.;' -;:;..:;.;:: :-:7:~. :'-'7. ::-:-~ •• :7.:: .. : .. :-: .. ' -.. _ .. _ .. -.. -" _ .. -.. .. _ .. -.. _. '" ·5,0";<' --r----_-+--~ _____ __' __ ---'__+~-, o 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 inflation rate (%) it is clear from the illustrative figures above that the distortion in eva caused by inflation is large. unless this distortion can be compensated for, reported eva cannot be used under inflation to estimate actual profitability. to compensate for the distortion, it is necessary to understand the pattern of the distortion. this is difficult, because the distortion illustrated in figure i is caused by distortions in both the profit and the asset figures used in the ev a calculation. to understand the contributions of the two underlying distortions requires for the researcher to be able to separate their effects. the model must be expanded to include a study of the effect of inflation on the reported asset values. this is undertaken below. 4 economic value added based on current value of assets to separate the effects of a distortion in profits from a distortion in asset values, de villiers (1997) recommends that eva calculations be based on the current value of assets (as opposed to the historical value conventionally used). this reduces the distortion in eva to that part of the distortion caused by the distortion in the accounting profit figure, and makes the pattern of the distortion r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 299 sajems ns vol 4 (2001) no 2 easier to interpret. de villiers (1997) illustrates this by means of a numerical example. we now expand the more general model above to present an algebraic derivation of the relationship between the true return of the finn and the ev a based on the current value of assets. 4.1 calculating the current value of assets employed by a project to detennine the current value of assets, this analysis is related to on the future cash flow these assets will generate. in the model of the finn employed here, the future cash flows of all projects are known. it is therefore possible to detennine the value of the assets employed for each project or for the finn (the combination of its current projects), by discounting and summing across the future cash flows. when detennining the current value of the assets, the present analysis aims to exclude the increase in the value of assets that results from superior investments. it therefore calculates what the current value of the assets employed by the finn would have been if employed in an application that yields the finn's cost of capital. the value of the assets does therefore not increase as a result of deriving returns higher than the cost of capital. the procedure is therefore as follows. estimate the cash flows that would be associated with a marginal finn investing in marginal projects. the capital employed by the firm is then the present value of the remaining cash flows of the current projects employed by this finn. the net present value of every completed project of the marginal finn equals zero. the future projects of the marginal firm do therefore not add to its current value, and do not have to be taken into account. the cash flows of the remaining projects of the hypothetical marginal finn can be detennined from equations (9) and (10) (the annual cash flows) as well as equation (ii) (the trading surplus required to yield a specified return). since this is a marginal firm, we substitute the cost of capital (c *) for the return on the projects of the finn (r) in equation (ii). the value of the remaining cash flows of a project that was initiated in year k, at the end ofj years is: d f v. = " m.k j.k £... ( • 'yn-j m:j+l 1 + c j (24) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2 300 using (9) and (10) to substitute for fm.k in the equation above, and then using (11) (after substituting c" for r in equation (11», to substitute for ts1•k, this yields (after summing the series and simplifying): vj ,. = (1 + i)l cao,k + ~{l-(_i .)d-j }+ (l+i+*h~n){1 (~r) da;, d.c l+c ( l+i \1" . 1-i +c' ) (25) 4.2 calculating the current value of assets employed by the firm the value of the finn is the sum of the value of all its current projects, or: d-i vk = l:vm •k m m'=o substituting for the values of the individual projects from (25) we obtain an expression for the value of the firm in terms of the current assets, depreciable assets and non.depreciable assets at the end of the initial years of each of the firm's current projects. but: ca = cao•k o.k-m (i+it' daa daa = __ o.k_ and na o a., __ o.k-m (i + it .... substituting into the above, we obtain an expression for the value of the firm in terms of the current, depreciable and non-depreciable assets at the end of the initial year of the project started in year k. after summing the series and simplifying, this yields: vk d.cao•k +[ d~' {i;ihl:i)" ]:::i[o:i)" -(i+~'f ]1 + d~' hi +~. r lh 1-((1 +i)~(ih')r ::ii }]d";, (26) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 301 sajems ns vol4 (2001) no 2 4.3 calculating eva based on current value of assets the eva based on the current value of assets (eva c) is calculated in the same way as ev a on the book value of assets in (22), except that vk is used instead of ak as the asset base, so that: (27) where nopatk+ 1 and vk can be determined from equations (19) and (26) respectively. to calculate the standardised eva based on current value ~f assets (seva c), divide the eva in equation (22) by v. and multiply by 100, so that: seva;"i loo{ no~;r.+l c·) (28) where nopatk+1 and vk can be determined from equations (19) and (26) respectively. 4.4 distortion in eva based on current value of assets to study the distortion in standardised eva based on current value of assets, we shall use equations (19), (26) and (28) to calculate the standardised eva reported by a specific firm. in a similar analysis as the one employed previously to analyse the distortion in eva based on book value, we can then compare the reported eva with the true economic profit, which can be calculated from the known true return. the discrepancy between the two figures shows the extent to which ev a is distorted by inflation. we calculate the standardised eva the theoretical firm will report under different rates of inflation. in figure 1 the reported conventional eva was plotted for five firms that each employ only one type of asset. eva based on current asset values is shown in figure 2 for the same five firms. as in figure 1, each of the firms has a real return of 10 per cent per year and a real cost of capital of 10 per cent per year. the firms therefore all make zero economic profit, and should report an eva of zero. figure 2 shows that all the firms (with the exception of the all current asset firm) report standardised eva of less than zero. the reported eva based on current values of assets is still distorted and the distortion increases with increasing rates of inflation. the pattern of the distortion is much clearer than the pattern of distortion in figure i (eva on book value). the distortion is consistently higher r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2 302 for firms using longer life assets, and consistently lower for finns with shorter life assets. figure 2 standardised economic value added (based on replacement value of assets) reported by a firm with a real return of 10 per cent per year and a real cost of capital of 10 per cent per year 5.0% ,---------------------, 0.0% ·5.0% .• •• current assets -".. -----..... -.. -----15.0% • • machinery (4 years) • machinery (10 years) ·20.0% machinery (20 years) --non-depreciating -25.0"/0 +--'--+--....-,---,---+--+-i--'--+--+--i----_-'--+--i--i o 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 j7 18 19 20 inflation rate c%) de villiers (1997: 298) suggests that this consistent pattern of distortion be used to develop an adjusted ev a (aev a) calculation. the aev a calculation is based on the current value of assets. equations (26) and (37) above are used to calculate the required accounting return of the finn (it depends on the finn's cost of capital, the assets employed by the finn, the tax rate, and the inflation rate). the required accounting rate of return is multiplied by the current value of capital employed and the product subtracted from net operating profits after tax to produce the aev a of the finn. the aev a provides an estimate of the actual profitability of the finn under inflation. 5 conclusion this paper presents an algebraic model to derive the relationships that were illustrated by means of a numerical example in de villiers (1997). the results show that reported eva is distorted even in the absence of inflation. this r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 303 sajems ns vol 4 (2001) no 2 distortion is exacerbated by inflation, and reported eva cannot be used under inflation to estimate actual profitability. the paper then calculates a theoretical firm's reported eva based on the current values of assets employed. it shows that, like conventional eva, this version of ev a is distorted by inflation. the pattern of distortion is more systematic. ev a based on the current value of assets could form 'the basis of an adjusted ev a calculation to provide an estimate of the actual profitability of a firm under inflation. the model presented in this paper is not limited to the study of ev a, but could be adapted to study possible distortions in other accounting figures. this could form the basis of further research. endnote the author wishes to thank the editorship for helpful comments and suggestions on an earlier draft of this paper. references de villiers, j.u. (1997) "the distortions in economic value added (ev a) caused by inflation", journal of economics and business, 49: 285300. 2 harcourt, g.g. (1965) "the accountant in a golden age", oxford economic papers 17(1): 66-80. 3 stewart, g. (1991) the quest for value: a guide to senior managers. new york: harperbusiness. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . samms ns vol 4 (2001) no 2 304 appendix list of symbols used the mathematical model developed in this paper comprises a theoretical firm consisting of a number of projects. the variables used to describe the firm and its projects refer to activity during a year or balance at the end of a year as applicable. s, for example, refers to sales during a year, and c refers to creditors at the end of a year. subscripts are used to distinguish between variables relating to individual projects and variables relating to the firm. double subscripts indicate a project variable; the first subscript relating to the year of the project and the second to the year the project was initiated. s2.3, for example, is the project sales during the second year of a project started in year 3, and c4,1 to the project creditors at the end of the fourth year of a project started in year 1. a single subscript refers to a variable relating to the firm as a whole. s5 is the total sales by the firm in year 5, and c 1 is the sum of the creditors of the fmn at the end of year 1. the symbols used in this model are: a c c c c! ca ca a d d d ii' da daa dad e eva eva c f ] ]a t' na total assets (book value) at the end of the year cost of capital creditors at the end of the year creditors added during the year creditors that paid during the year current assets at the end of the year current assets acquired during the year project duration debtors at the end of the year debtors added during the year debtors that paid during the year depreciable assets at the end of the year depreciable assets acquired during the year depreciation of depreciable assets during the year accounting profit for the year economic value addded (based on book value of assets) economic value added (based on current value of assets) cash flow for the year inventory at the end of the year inventory added during the year inventory processed during the year inflation rate non-depreciable assets at the end of the year r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 305 naa nopat= r s seva = seva c = assets) t sajems ns vol 4 (2001) no 2 non-depreciable assets acquired during the year net operating profit after tax for the year internal rate of return (true rate of return) total sales during the year standardised economic value added (based on book value of assets) standardised economic value added (based on current value of income tax payable t income tax rate ts trading surplus (sales minus cash expenses minus inventory processed) v current value of assets x cash expenses incurred during the year r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction review of related literature study methodology empirical results and analysis conclusions and policy implications acknowledgements references about the author(s) grace ofori-abebrese department of economics, kwame nkrumah university of science and technology, ghana robert becker pickson college of economics and management, sichuan agricultural university, china sherifatu abubakari department of economics, kwame nkrumah university of science and technology, ghana citation ofori-abebrese, g., pickson, r.b. & abubakari, s., 2017, ‘assessing the impact of macroeconomic variables on pension benefits in ghana: a case of social security and national insurance trust’, south african journal of economic and management sciences 20(1), a1703. https://doi.org/10.4102/sajems.v20i1.1703 original research assessing the impact of macroeconomic variables on pension benefits in ghana: a case of social security and national insurance trust grace ofori-abebrese, robert becker pickson, sherifatu abubakari received: 18 nov. 2016; accepted: 10 july 2017; published: 24 oct. 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: one of the most pressing phases for all economic agents is post-retirement standard of living. irrespective of the higher returns on pension contribution and varied pension reforms, there are possible factors that can render these pension benefits inadequate, which can affect the longevity of retirees. studies conducted in other countries have concluded that inflation deteriorates the value of pension benefits. aim: this study, thus, sought to assess the impact of some major economic indicators in the ghanaian environment on pension benefits. setting: this study was carried out in ghana by obtaining quarterly data frequencies on pension benefits and economic indicators spanning the period 2000q1 to 2014q4. method: the auto-regressive distributed lag model was utilised to examine the long run and short run dynamics of some major economic indicators and pension benefits. results: the empirical evidence indicated that inflation deteriorates total pension benefits. increasing monetary policy rate and depreciation of the domestic currency should be an issue to contend with only in the short run rather than in the long run. the study also found the prominence of the implementation of the national pension reform in 2008. conclusion: the study concluded that if policy makers target the reduction in the monetary policy rate and the appreciation of the domestic currency in an effort to stabilise the value of total pension benefits in the long run, it would not be effective in the long run because of their insignificant nature. policy makers should rather target inflation as the prime tool for stabilising the standard of living of retirees in the long run. introduction one of the most pressing phases for all economic agents is post-retirement standards of living. this is justified because depending on the preparations made towards post-retirement, one is likely to live a life that can be either prolonged or shortened (kumado & gockel 2003). prior to the rising of modern states in africa, traditional societies saw the urgency to ensure measures are put in place to absorb major unforeseen contingencies via social and mutual help for one another in times of ageing. originally, the family was the main institution recognised for the provision of support for their members in times of economic deprivation, social isolation or even disability. nevertheless, with the world becoming a global village in this modern era coupled with the decline in the extended family system, there is gradual movement to the reliance on institutionalised forms and systems of social security (kumado & gockel 2003). across the globe, several sprouted pension systems are striving to deliver adequate retirement incomes coupled with financial sustainability because of the ageing population, which is characterised by increasing longevity and low fertility rates. many countries have, thus, launched significant pension reforms including higher retirement ages, savings in pensions and changes in the calculation of pension entitlements amongst others (organisation for economic co-operation and development [oecd] 2015). the urgency for pension schemes in ghana dates back as far as the second world war (1939–1945). the united trading company (utc) of the then gold coast formed the first social institution for the welfare of the utc employees. by 1946, the welfare of employees had expanded as a result of the adoption of the international labor convention, which catered for workers who were injured as well as those who passed on. this led to the enactment of the pension ordinance in 1946 (appiah 1999). the expansion of the various schemes subsequently led to the addition of certified teachers when the teachers’ pension ordinance was passed in 1955 (gockel 1996). also, with the increasing urbanisation caused by migration and the search for wage employment led to the high dependence on the magnanimity of the urban employers. the adverse socio-economic impact on the social welfare of migrants led to the establishment of a nationwide social security for migrants. the social security act was passed in 1965 which laid the foundation of the national social security scheme in the ghanaian economy (obiri-yeboah & obiri-yeboah 2014). currently, in ghana, social security and national insurance trust (ssnit) is the prominent fund trustee set up to manage the pension schemes and social security systems for employers and employees. ssnit is responsible for the administration of the basic national social security pension scheme. it thus provides protection for workers in both public and private sectors. it sees to the investment of employees’ contribution towards retirement, thus making the institution to be ranked amongst major stakeholders in the welfare of ghanaians. however, the scheme was not without fault as it underperformed in the delivery of retirement income security for its members which led to several pension reform schemes in order to improve its performance (gockel 1996). the first step that was evident in the 2008 pension reform was when ghana joined the league of chileans by adopting a three-tier pension scheme. this pension scheme was enacted under the national pensions act, 2008 (act 766) (government of ghana 2008) with its main purpose of being the provision of a universal pension scheme for all employers and employees in the country. act 766 thereby resulted in the establishment of the national pensions regulatory authority (npra) and corporate trustees amongst others, as part of the major efforts to bring to the barest minimum the inadequacies of pension benefits and the agitations about the low pension benefits received under the ssnit pension fund (kumado & gockel 2003). it is thus evident that most governments recognise the essence of providing sustainable pension funds to cater for the ageing population to ensure an increased post-retirement well-being of all economic agents. despite these pension reforms, employees argue that irrespective or regardless of their years of service to the country coupled with the contributions they make towards the scheme, they are normally given menial sums, which they feel do not match what they have contributed. it brings to question the relevance of these economic reforms in respect of pension benefits such that economic agents continue to battle with standards of living after retirement (agyeman 2011). pension schemes should provide adequate income for pensioners; nevertheless, in the midst of unfavourable economic factors, these increased benefits may not serve the intended purpose rendering it less useful. with the increasing level of volatility in the rates of inflation, the fast and unstable depreciation of the domestic currency as well as the unstable rates of interest amongst other major macroeconomic variables can serve as threat to pension benefits and thus the paltry sum pensioners receive. bulow (1982) stresses that, in the absence of post-retirement adjustments, the real value of pension benefits tends to fall in the presence of inflation and the rates of interest. this tends to affect the sustainability of households’ welfare, thus analysing pension benefits in the midst of major macroeconomic factors cannot be overemphasised as it would ensure the efficient allocation of resources by economic agents towards retirement as well as economic growth. the possible remedy lies in how to ensure that these pension reforms in the midst of other economic reforms remain financially sustainable by providing citizens adequate income for the retirement periods. much attention over the years has been given to the impact of macroeconomic forces on the returns that are earned from investing pension contributions. obiri-yeboah and obiri-yeboah (2014), kumado and gockel (2003) and agyeman (2011) in the ghanaian context have broadened our understanding about pension reforms, ssnit and returns on pension funds’ investments in the midst of macroeconomic forces. however, what is not well understood and completely ignored in the ghanaian context is the effect of these macroeconomic forces on the take-home pension benefits of economic agents. in other words, irrespective of the higher returns on pension contribution and varied pension reforms, there are possible factors that can render these pension benefits inadequate, which can affect the longevity of retirees. this study thus seeks to assess the impact of some major economic indicators in the ghanaian environment on pension benefits spanning 2000q1 to 2014q4. specifically, this study attempts to evaluate the impact of macroeconomic variables on pension benefits, and eventually analyse how well the 2008 pension reform has been able to improve pension benefits in ghana. the rest of the paper is organised as follows: the second section presents the related literature reviewed, the third section describes the study methodology, the fourth section uncovers the empirical results and analysis and the fifth section considers the conclusion and policy implications. review of related literature historical development of pension scheme and social security in ghana the urgency for pension schemes in ghana dates back as far as the second world war (1939–1945). the utc of the then gold coast formed the first social institution for the welfare of the utc employees. the utc was a multinational corporation formed by the basel mission in 1921. this development of the utc led to the formation of the african pension fund, which was the first social institution meant to cater for the welfare of the indigenous populations of the then gold coast. irrespective of this, it was not a national social security but specifically for employees of the utc. by 1946, the welfare of employees had expanded as a result of the adoption of the international labour convention, which catered for workers who are injured as well as those who passed on. this led to the enactment of the pension ordinance in 1946 after the second world war (appiah 1999). the main purpose of this pension ordinance was to provide a non-contributory scheme for the african senior civil servants, their widows as well as orphans. furthermore, the expansion of the various schemes subsequently led to the addition of certified teachers when the teachers’ pension ordinance was passed in 1955 (gockel 1996). also, increasing urbanisation caused by migration and the search for wage employment led to a high dependence on the magnanimity of the urban employers. the adverse socio-economic impact on the social welfare of migrants led to the establishment of a nationwide social security for migrants. in 1960, a compulsory savings scheme was established by the convention peoples party for all formal sector workers. the savings scheme was maintained through the deduction of monthly contributions from the wages and salaries of all formal sector employees, which was paid into a consolidated fund. by 1965, this savings scheme had failed because of the mismanagement of the consolidated funds. the social security act was then passed in 1965, which laid the foundation of the national social security scheme in the ghanaian economy. the social security act aimed at the provision of a provident fund of 22.5% contribution to be made each month by the employee and employers. 7.5% and 15% contributions were made by the employee and employer, respectively, each month (obiri-yeboah & obiri-yeboah 2014). currently, in ghana, ssnit is the prominent fund trustee set up to manage the pension schemes and social security systems for employers and employees. it was established under the national redemption council decree (nrcd) 127 in 1972. ssnit is responsible for the administration of the basic national social security pension scheme. it thus provides protection for workers in both public and private sectors. ssnit sees to the investment of employees’ contribution towards retirement, thus ranking the institution amongst major shareholders in the ghanaian economy. the social security and national insurance trust of ghana amongst the varied efforts made to provide social security in ghana for all employees, the passage of the nrcd 127 in 1972 was the major social security scheme in the ghanaian economy (kumado & gockel 2003). in an attempt to rectify the shortfalls of the 1965 parliamentary act 279, the nrcd 127 established an independent corporate body known as the social security and national insurance trust (ssnit) in 1972. in respect of its coverage, the act 279 of 1965 was amended by the nrcd 127 of 1972 to ensure the coverage of employees in any institution that employs a minimum of five workers by compulsion. establishments with less than five employees were given the choice to either join the scheme or not with no compulsion to do so. nevertheless, the following institutions and workforce were exempted by law from joining the ssnit pension scheme: the armed forces, the police service and the prison service foreigners in the diplomatic missions senior members of the university and research institutions according to the international labour organization convention 102 of 1952, a country is mandated to provide a minimum of nine basic social security services for its contributors. nevertheless, the provident fund operated by the ssnit has managed to ensure the provision of five major direct contingencies including: unemployment emigration invalidity sickness death or survivors the above-mentioned benefits enjoyed by contributors come in the form of lump sum payments made up of their actual contributions and up to a 3% compounded rate of interest. ssnit’s inability to provide the other four contingencies which include medical care benefit, employment injury benefit, family benefit and maternity benefits could be attributed to the developing state of the economy because of the low contributions made by contributors. given the bulk sum ssnit receives monthly as contributions, it remains one of the biggest shareholders in the country. the scheme defaulted because it underperformed in the delivery of retirement income security for its members, which led to several pension reform schemes to improve its performance (gockel 1996). overview of pension reforms according to whiteford and whitehouse (2006), the majority of oecd countries over the last 25 years have changed their retirement income systems. while some countries have undertaken single ‘big-bang’ pension reforms, others, on the other hand, have maintained a regular but increasing pension system. furthermore, countries such as australia and japan are the only countries that have reduced the accrual rate of public pension benefits. the usual expectation of pension benefits is its ability to increase to ensure a decent post-retirement standard of living. nevertheless, the justification for a reduction in pension benefits as demonstrated by japan and australia is to ensure the affordability of pension plans by the citizens of their countries. the higher the contribution made, the higher the benefits accrued upon retirement. the major motivation for all these efforts (either to increase or decrease) made under the pension schemes is to ensure a much more sustainable financial public pension system. the cut in pension benefits, however, has the tendency to result in the increase of inadequate income in retirement and consequently to lead to old-age poverty (whiteford & whitehouse 2006). irrespective of this, most of the reforms are geared towards the encouragement of low-income older people to take public pension plans while the middleand high-income earners embark on voluntary and private pension schemes. some of the significant changes that can be viewed under the pension reforms include the following: changing the valorisation of past benefits: in most oecd countries, past earnings are re-valued to take into account changes in the level of standard of living between the time pension benefits accrue and the time they are claimed. changing the indexation of pension benefits: in recent years, most developed and developing countries are moving away from a system of indexation of pension benefits to earnings towards an indexation with prices. the main purpose is to preserve the purchasing power of retirees and maintain financial sustainability of the benefits earned. linking pension benefits to higher life expectancy: the accrued benefits for pension are mostly related to the life expectancy in most countries, such that increasing life expectancy reflects a reduction in pension benefits. for example, japan, austria and germany aim to reduce pension benefits as life expectancy increases; however, it is accompanied by a reflection in financial sustainability. increasing eligibility age: most countries’ pension reforms equalise ages between men and women. thus, the implementation of age for pension tends to affect only or mainly women. some countries such as the united states, greece, japan and australia amongst others have increased the pension age that affects both men and women. in australia for example the pensionable age is 65 years or older for both men and women. it is further projected to hit 67 years by 2023 as the pensionable age increases by 6 months every 2 years. increasing the reward of continuing to work: most pension reforms across the globe have put measures in place to cater for early and late retirement ages. the number of years required to receive the full entitlement for any pension benefit has been increased by most countries such as the united states and the united kingdom. to this effect, penalties have been introduced for people opting for early retirement, while bonuses and incremental packages are available to those employees who retire after the normal retirement age. overview of the national pensions act, 2008 of ghana in december 2008, ghana joined the league of chileans by adopting a three-tier contributory pension scheme. this pension scheme was enacted under the national pensions act, 2008 (act 766) (government of ghana 2008) with its main purpose being the provision of a universal pension scheme for all employees in the country. the act further led to the formation of the npra to oversee the management and administration of registered pension schemes and trustees. these were part of the major efforts to bring to the barest minimum the inadequacies of the current pension benefits and the agitations about the low pension benefits received under the ssnit pension fund (kumado & gockel 2003). aside from the establishment of the three-tier contributory body of the national pensions act, there were three additional parts that fully made the pension act a whole. the second part of the act entailed the basic national security scheme, with part three composed of occupational pension schemes, provident fund and personal pension schemes as well as management of the scheme. the last part entailed the general provisions. the three-tier pension scheme the established three-tier scheme under the pension reform act of 2008 in ghana consists of: a mandatory basic national security scheme: this first tier incorporates an improved system of ssnit benefits and it is mandatory for all private and public sector employees. it involves the contribution of 13.5% of gross monthly salary of employees while the benefits from the contribution would be presented to pensioners in the form of monthly income. furthermore, in the event of death before retirement or unforeseen circumstances such as disability or death, disability benefits are given to the contributors or their dependents. a mandatory fully funded and privately managed occupational pension scheme: the second tier being a mandatory occupational scheme is originally to be managed by private fund managers and it involves the contribution of 5% of employee’s gross monthly salary. nevertheless, as opposed to the ssnit benefits, the benefits under this tier would be a lump sum payment to beneficiaries, which is projected to be higher than the benefits currently under the ssnit and cap 30 schemes. a voluntary fully funded and privately managed provident fund and personal pension scheme: the third tier enables every employee in the formal and informal sectors who voluntarily wants to enhance their pension benefits by making additional contributions. it is privately managed and supported by tax benefits incentives. empirical literature empirical literature that links the impact of economic variables on the pension benefits in ghana and across the globe is not expansive. amongst the earlier studies include grubbs (1979), bulow (1982), munnell and muldoon (2008), and karam et al. (2010). feldstein (1981) examined private pension and inflation in the united states. the study found retiree’s pension benefits to be continually on the decline with the rising price levels. also, in order to cater for the negative impact of inflation on these benefits, the study found it to be costly as a 6% adjustment of inflation on an annuity of a 65 year old pensioner would lead to a rise in the cost on pension by approximately 50%. this outcome he recommended could be financed by reducing wages and salaries or indexation of pension benefits. it thus concluded that inflation can be costly from both the trustees and pensioners perspective. also, clark and mcdermed (1982) further looked at inflation, pension benefits at retirement and found increasing rates of inflation to lower the present value of pension benefits and hence the accumulated pension compensations in the long run. the study was based on employee retirement decision as a function of the expected value of pension benefits; the study thus concluded work life could be prolonged because of the low value of pension benefits as a result of inflation. bulow (1982) evaluated the effects of inflation on the private pension system in the united states. according to the study, an increase in inflation causes the nominal interest rates (irs) to increase. he found inflation not to directly affect pension benefits but can do so through the channel of higher irs. using a three-period scenario and pension benefit guarantee corporation in the united states, the study found a change in either inflation or irs to significantly alter the value of the claims given to households, firms, and governments. an increase in irs tends to reduce both the pension benefits accrued and the benefits that are guaranteed to be paid by the pension trustees per the outcome of the study. united nations joint staff pension board (2008) explored the impact of currency fluctuations on the united nations joint staff pension board and pension benefits across the globe. making use of the data from united states, france, italy, switzerland, united kingdom and austria and on the basis of a 36-month average local currency exchange as a measure of exchange rate and income replacement ratio (i/r) as a measure staff pension benefits, the study found in the united states a constant i/r with respect to the us dollar, indicating a no-currency effect on such benefits. however, the rest of the countries outside the base found their i/r values to be declining during the period reviewed. munnell and muldoon (2008) also explored the impact of inflation on social benefits in the united states and found inflation to negatively impact the benefits enjoyed by retirees. according to their study, two major factors undermine much of the inflation protection that is offered by social security. increasing medical care premiums and the personal income tax for benefits, increasing medical care meant a greater portion of benefits goes into medical insurance while taxation reduces the benefits compelling purchasing ability at retirement to decline. the study thus recommended inflation protection for retirees (center for retirement research at boston college). karam et al. (2010) assessed the macroeconomic effects of public pension reforms using the global international monetary and fiscal dynamic stochastic equilibrium model. the study’s pension reform was limited to increasing retirement age, reduction in benefits paid to retirees and increasing contributions. the study then revealed pension reforms to greatly impact positively on economic growth in both the short and long run. the long run impact they established was because of the declining government debt while the rising consumption propelled the short run economic growth. nevertheless, the increasing retirement age yielded the most impact on economic growth because of the increasing demand effects from labour income. the present literature differs from these existing studies in a number of ways. whereas the previous literature limits the number of macroeconomic factors that may possibly affect pension benefits, the current literature takes into account multiple macroeconomic factors when it comes to the value of pension benefits. secondly, because of the scarcity or virtually no literature from the ghanaian perspective, the present study contributes to the body of knowledge in the ghana’s pension experience and possibly many developing countries with similar economic setting. study methodology theoretical model specification to uncover a robust and reliable model that captures the impact of macroeconomic variables on pension benefits in ghana, the study followed the structural hedonic model of compensating differential framework as a baseline model. this framework suggests that jobs are often seen to have non-wage benefits, which workers value differently from wage benefits. these benefits are largely identified to be pension benefits according to whiteford and whitehouse (2006). thus, emphasis is placed on the value of these benefits received. because of the value placed on pension benefits, the study posited the value of pension benefits could be influenced by major macroeconomic variables, which may either increase or decrease the value depending on the state of the economy. therefore, taking into account inflation, exchange rate and interest rate, the following baseline model was specified in equation 1 as: where pb denotes pension benefits, which is the dependent variable for the study. inf, ner and ir are inflation, nominal exchange rate and interest rate respectively. the function of the pension benefit in equation 2 was transformed into a parametric model in the form: it becomes prudent to introduce the log of the variables of interest to enable the interpretation of the partial elasticities, which looks at the degree of responsiveness of pension benefits to the respective economic variables as depicted in equation 3. data types and sources secondary sources of data were employed for this study. quarterly data frequencies on pension benefits and economic indicators spanning the period 2000q1 to 2014q4 were used. the time period for the study was chosen based on the accessibility and availability of data on pension benefits, which is the main point of focus for the study. the selected macroeconomic variables include the ner, ir and inf. the data on the pension benefits were obtained from the research department of ssnit, ghana. the macroeconomic indicators including inflation, exchange rate and the ir were obtained from two major sources made up of the international financial service of the international monetary fund and from the research department of the bank of ghana. measurement and a priori expectation of the variables pension benefits: being the dependent variable per the study is defined to mean the total amount of money paid by trustees to the various retirees. inflation: is defined as the sustained increase in the general prices of goods and services over a given period of time. inf was measured by the consumer price index. pension benefits are expected to be inversely related to the rates of inflation such that an increasing inf would cause a decline in the value of pension benefits. according to clark and mcdermed (1982) and thompson (1978), the general increasing price of goods and services affects the purchasing ability of retirees because the value of their benefits would decline and thus should be compensated by higher benefits. thus, inflation is expected to have a negative influence on pension benefits (i.e. δ2 < 0). nominal exchange rate: is seen as the actual rate of exchange on the foreign currency market. the study uses ghanaian cedi against the us dollar as its measure. an increase in the nominal exchange rate signals the depreciation of the domestic currency, whilst its decrease indicates appreciation of the ghana cedi. the depreciation of the domestic currency is also posited to cause a decline in the value of the benefits received by pensioners because it becomes expensive to undertake any international trading activity. the exchange rate is thus expected to have a positive relationship with pension benefit of retirees. therefore, the expected impact of ner on pension benefits is positive (i.e. δ3 > 0). interest rate: the return earned on a given amount invested is called the ir. the study made use of the monetary policy rate (mpr) as a measure of ir. the mpr is the rate at which the central bank lends to commercial banks. an increase in mpr by bank of ghana means an increase in the lending rates by the commercial banks to their clients. irs are also expected to be positively related to pension benefits. the higher the rates of interest, the higher the returns that would be earned on the benefits invested. hence, there exists a positive relationship between ir and pension benefits (i.e. δ4 > 0). estimation techniques cointegration test subsequent to the test for cointegration, the augmented dickey–fuller (adf) and the phillips–perron (pp) tests were deployed to examine the stationarity of the variables. the term cointegration mimics the existence of a long-run equilibrium to which an economic system converges over time. the study applied the auto-regressive distributed lag (ardl) bounds test to cointegration to test the existence of a long-run relationship amongst the variables of interest. the bounds test is an estimation procedure that is used to test the long-run relationship given the fact that the time series is strictly i(0) or i(1) or a combination of both. it makes use of the fand t-statistics to test for the significance of the lagged variables when there is uncertainty if the time series exhibits a trend or it is stationary at first difference. from the above-mentioned equation, we perform an overall f-test of the null hypothesis that there is no cointegration between the variables x and z as against the alternative that it is not true. the rejection of the null hypothesis implies that there exists a long-run relationship between the variables. the ardl bounds test gives an upper and lower boundary with which the overall f-statistic is to be compared. if the f-test score is greater than the upper boundary, we reject the null hypothesis while an f-test score lower than the lower boundary moots for the acceptance of the null hypothesis. the outcome is inconclusive because the f-test falls in between these two boundaries. the auto-regressive distributed lag model the case where the unit root properties of the data are uncertain applying the ardl procedure is the more appropriate model for empirical work. applying the adf and the pp tests for unit root, one may incorrectly conclude that a unit root is present in a series that is actually stationary around a one-time structural break. the ardl approach is useful because it avoids these problems. the ardl model specifies both the long run and short run impact of the independent variables on the dependent variable. the researchers considered the model of the form ardl(p,q,k). the long run ardl model was specified as the short run dynamics of the coefficient from the regression process was expressed by finding the error correction model associated with the long run estimates. where et-i represents the error correction factor and τ is the speed of adjustment. the error correction tells the speed of adjustment of the variables to the long run, should there be any deviation. the error correction factor should be negative and significant. the negative state spells out the fact that with any deviation from the long run, the variables would turn back to equilibrium. however, a positive error correction term tells the explosive state of the variables, an indication of no return back to its equilibrium. structural break analysis one of the main objectives of the study was to assess the significance of the 2008 pension reform introduced to cater for inconveniences and the lapses of social security systems, particularly pension benefits. the study considered this reform as a major structural change that can highly impact positively or inversely on the benefits received by retirees. to this effect, the researchers introduced dummy variables to capture this structural change. introduction of dummy variables: dummy variables are fictional variables created to represent the attributes of two or more distinct categories of things. they are proxy variables for a qualitative fact in a regression model. it usually takes binary forms of 0 or 1 to indicate the absence or presence of some intrinsic categorical effect that has the tendency to shift an outcome, in this case the 2008 pension reform. when the dummy takes 0, it is an indication that the explanatory variable’s coefficient has no role in influencing the dependent variables while when the dummy takes on the value of 1, its coefficient acts to alter the intercept and thus the dependent variables. dummy for pension reform 2008 = 1 for periods when the 2008 pension reform was effected 0 for periods prior to the 2008 pension reform. empirical results and analysis stationarity test table 1 presents the results of using adf and the pp tests for the stationarity of the variables concerned. table 1: results from the stationarity test. from panel a of table 1, only the null hypothesis of unit root for inflation was rejected at 5% and 1% level of significance using adf and pp tests, respectively. this implies that inflation is stationary at the levels, hence integrated of order zero [i(0)].the other variables were further first differenced in an attempt to ensure stationarity of the variables. from the outcomes in panel b of table 1, total pension benefits, exchange rate and ir were all statistically significant after their first difference, hence integrated of order one [i(1)]. it is, therefore, appropriate to estimate the model using the ardl bounds test specification. cointegration analysis the prime purpose of the cointegration analysis is to determine whether a group of time series variables has some form of long run relationships. table 2 presents the results of the ardl bounds test to cointegration. table 2: results from the auto-regressive distributed lag bounds test. the results in table 2 present two different models’ outcomes, the first model does not take into account the structural break of the national pension reform in 2008 while the second model does. the study considered the lower and upper bounds of the bounds tests at 1% and 5% level of statistical significance. the f-statistics of 14.64514 and 11.91449 from both models were found to be greater than their respective upper boundary at a 1% level of significance. hence, there exists a long running relationship amongst the variables with or without a structural break. there would have been no cointegration should the f-statistic fall below the lower boundary and become undetermined should it have fallen in between the upper and lower boundary. results from the auto-regressive distributed lag model this section of the empirical analysis presents the estimates of both the long and short run results from the ardl. the first part takes into account the longand short run estimates without a structural break pertaining to the national pension reform in 2008 while the second aspect factors the structural break as shown in tables 3 and 4, respectively. table 3: results of short and long run without structural break. table 4: short and long run results with structural break. short and long run analyses without structural break this section of the analysis presents model 1 and model 2, which are the results of both the short and long run results, respectively, without the incorporation of a structural break. this section thus underscores the impact of inflation, ir and exchange rate on total pension benefits without incorporating major pension reforms. model 1 presents the short-run results when the national pension reform is excluded. from the model, it was determined that inflation, the ner and ir were all inversely related to total pension benefits paid to retirees. this implies that inflation tends to negatively affect the total amount of benefits paid out. an increase in inf by a percentage results in a decline in the value of pension benefits by approximately 18% in the short run. also, a depreciation of the domestic currency (an increase in exchange rate) and an increase in the rate at which the central bank lends money to the commercial banks cause a decline in the value of pension benefits by approximately 9% and 8%, respectively. in the short run, however, inflation and ir were the only statistically significant determinants of the benefits paid out by the trustees of the fund all at 5% significance level. exchange rate proved otherwise but economically tends to decrease the value of pension benefits by about 9%. the insignificant nature of the local currency could be associated with low direct investments by the trustees and beneficiaries in the foreign financial market and thus fluctuations in the domestic currency could not affect pension benefits directly but perhaps indirectly. the sustained increase in the general prices of goods and services which tends to diminish the value of pension benefits paid out was expected to reduce the purchasing ability of pensioners. this tends to be detrimental to their post-retirement standard of living; the outcome of the study is consistent with the finding of munnell and muldoon (2008). they argued that most of the inflationary pressures come from varied medical care pertaining to hospital expenses and attempts to adopt healthy lifestyles associated with old-age eventually eat away the value of their post-retirement benefits. the study adds to the body of literature considering the ir, the recent frequent increase in the rate at which commercial banks borrow from the central bank has rather reduced the post-retirement investments of retirees (in order to make efficient use of their pension benefits). the study found such rates of interest to contemporaneously reduce the value of pension benefits by 8%. it is argued that, with an increase in ir, the cost of borrowing from commercial banks to undertake major investments becomes very expensive with its accompanying high interests on loans. these high interests in comparison to post-retirement benefit tend to trivialise the benefits. furthermore, the error correction model (ecm) term is statistically significant at the 10% significance level and the sign of its coefficient is also negative. the coefficient for the ecm is approximately –0.066 implying that, when there is a percentage shock or deviation of the variables from equilibrium, the long-run equilibrium relationship is restored at the rate of approximately 6.6%. in other words, the error correction suggests that just about 6.6% of the disequilibrium caused by the shocks in the current year is corrected in the long run. the speed of adjustment, though very low, spells the exact situation in the ghanaian economy because it takes a long time for overall pension benefits to be adjusted to fit the current economic situation. in the long run, however, it was inflation that remained a significant determinant of pension benefits; the rest of the macroeconomic variables did not matter in the long run. the negative consequence of inflation on pension benefits increased more elastically reducing pension benefits by more than 100%. this stresses the long-run effect of an uncontrolled fluctuation in the rates of inflation on the pensioners’ standard of living and the economy as a whole. structural break analysis one major objective was to assess the significance of the pension reform undertaken by ghana to make social security a better one. the study took into account the 2008 pension reform that brought into existence the npra with major efforts to bring to the barest minimum the inadequacies of the current pension benefits and the agitations about the low pension benefits received under the ssnit pension fund. the study, therefore, introduced a dummy variable denoted dpr in an attempt to capture the national pension reform as a structural break in the social security administration. the results are presented in table 4. model 1 in this second part of the analysis presents the short-run results when the national pension reform is included. from the model, inflation together with ir were all inversely related to total pension benefits paid to retirees just as in the previous analysis. this implies that inflation tends to negatively affect the total amount of benefits paid to pensioners. an increase in inf by a percentage results in a decline in the value of pension benefits by approximately 16% in the short run. the increase in the rate at which the central bank lends to the commercial banks also results in a decline in the value of pension benefits by approximately 10%. however, an appreciation of the domestic currency (a decrease in exchange rate) impacted positively on pension benefits. this implies that an appreciation of the local currency tends to increase the value of pension benefits by a 10% margin. the study also found the pension reform of 2008 to negatively affect pension benefits in the short run but merely by about 1.9%. all macroeconomic variables including inflation, ner and irs as well as pension reforms in ghana were all statistically significant determinants of the benefits paid out by the trustees of the fund all at 10% significance level with the exception of mpr, which was significant at 5%. in the long run, inflation and pension reform were the only statistically significant determinants of total pension benefits. pension reform impacted positively on pension benefits in the long run compared to its inverse relation in the short run. with the introduction of this structural break, about three major significant changes were observed in comparison to the model without the structural break. firstly, the study found the ner to be a significant determinant of pension benefit in the short run in the model with pension reforms. this brings to prominence that with the introduction of the pension reform, the ner tends to positively relate to pension benefits. this means that with efforts to make the pension benefits universal to include all employers and voluntary contributors around the globe, the investments made by the trustees in the foreign market tend to increase with the aim of improving the incomes and interest earned on the contributions. secondly, inflation and ir remained negative and significant just as in the model without the national pension reform. however, the magnitude of impact of the forces on pension benefits in the short run increased in value compared to the former analysis. the impact of ir increased from 8% to 10% and inflation declined from 18% to 16%. the decision to launch significant pension reform systems brings into light the exact magnitude of economic impact of these forces. above all, the study found the national pension reform itself to be a significant determinant in both the long and short run. the study underscores its negative impact in the short run, but tends to have a positive impact in the long run. the inverse relation of the national pension reform on pension benefits contemporaneously implies that the launch of the scheme with its positive intended purpose does not immediately take effect. this can be as a result of administrative and other adjustments of the scheme before it becomes effective in the long run. in the long run, however, consistent with the first model, inflation was the only highly significant economic variable that mattered. the speed of adjustment is much slower from about 6.6% to about 4% with the consideration of the structural break. the introduction of the national pension reform in 2008 meant a slower adjustment to the long-run equilibrium of pension benefits should there be any deviation. conclusions and policy implications the main objective of the study was to assess the impacts of some macroeconomic forces on total pension benefits paid out to retirees by the ssnit. specifically, the study sought to find out the impact of inflation, the ir and the ner on total pension benefits in ghana. also, the study sought to investigate how well the national pension reform of 2008 has been able to improve pension benefits on the average pensioner since it was launched. the empirical evidence supported conclusions that inflation reduces the value of total pension benefits. increasing ir and depreciation of the domestic currency should be an issue to contend with only in the short run rather than in the long run. the study revealed that the prominence of the implementation of varied pension reforms in the ghanaian economy, specifically the national pension reform of 2008, has significantly impacted on total pension benefits. however, it started by contemporaneously having a negative effect but in the long run it was worthy of its implementation as it positively affected pension benefits with a high magnitude of impact. it should be noted that for policy purposes, the distinction between short and long run is justified. the variables that are relevant in the short run and long run as opposed to those which are not relevant should be distinguished to enable effective policy implementations. in the short run, the behaviour of pension benefit is explained by inflation, ir, and the ner. inflation was further the only relevant variable in the long run as well. if policy makers target the reduction in the ir and the appreciation of the domestic currency in an effort to stabilise the value of total pension benefits in the long run, it would not be effective in the long run because of their insignificant nature. policy makers should rather target inflation as the prime tool for stabilising the standard of living of retirees in the long run. in line with the findings of the study, policy makers are recommended to ensure the reduction and stabilisation of inf to be the paramount policy option in order to increase the standard of post-retirement living. this would be effective when medical expenses related to old-age are gradually subsidised or reduced to the barest minimum to ensure a prolonged life after retirement because inflation in that direction tends to really affect retirees. also, gradual increase in the ir by the central bank of the economy at the initial stages rather than the outright increase in it would be useful to stabilise the value of pension benefits. furthermore, irs on loans are recommended to be moderately fixed rather than increasing it at a fast rate in order to attract and encourage investment by pensioners. lastly, the various pension reforms should be reviewed periodically, and implementation of more such reforms year after year should be done as it tends to positively impact total pension benefits paid out in the long run. acknowledgements the authors wish to acknowledge the comments and the helpful suggestions from the editor and the anonymous reviewers which gave shape to this article. competing interests the authors have declared that no competing interests exist. authors’ contributions this work was carried out in collaboration between all authors. all authors read and approved the final manuscript. references agyeman, a., 2011, ‘an assessment of the returns on employee pension fund investments and their impact on future benefit payments; a case study of social security and national insurance trust (ssnit)’, an unpublished master’s thesis, kwame nkrumah university of science and technology, kumasi. appiah, p., 1999, ‘utc as an off shoot of the basel mission in the daily graphic’, a ghanaian daily newspaper, 04 january, 1999, p. 15. bulow, j., 1982, the effects of inflation on the private pension system, university of chicago press, viewed 23 february 2016, from www.nber.org/chapters/c11455 clark, r.l. & mcdermed, a.a., 1982, ‘inflation, pension benefits and retirement’, the journal of risk and insurance 49(1), 19–38. https://doi.org/10.2307/252574 gockel, a.f., 1996, the formal social security system in ghana, freiderich ebert foundation, accra. government of ghana, 2008, national pensions act 766, ghana publishing, accra. grubbs, d.s., 1979, ‘the impact of inflation on pension plans’, record of society of actuaries 5, 983–1014. karam, p., muir, d., pereira, j. & tudlashar, a., 2010, macroeconomic effects of public pension reform, international monetary fund working paper wp/10/97, international monetary fund, washington, dc. kumado, k. & gockel, a.f., 2003, a study on social security in ghana, unpublished manuscript, university of ghana, legon. feldstein, m., 1981, ‘private pensions and inflation’, the american economic review 71(2), 424–428. munnell, a.h. & muldoon, d., 2008, ‘the impact of inflation on social security benefits’, centre for retirement research 2, 8–15. obiri-yeboah, d.a. & obiri-yeboah, h., 2014, ‘ghana’s pension reforms in perspective: can the pension benefits provide a house a real need of the retiree?’, european journal of business and management 6(32), 121–133. organisation for economic co-operation and development (oecd), 2015, pension at a glance: oecd and g20 indicators, oecd publishing, paris. thompson, g.b., 1978, ‘impact of inflation on private pensions of retirees, 1970–74: findings from the retirement history study’, social security bulletin 41(11), 16–25. united nations joint staff pension board, 2008, study on the impact of currency fluctuations on unjspf pension benefits, jspb/55/r.39, united nations, new york. whiteford, p. & whitehouse, e., 2006, ‘pension challenges and pension reforms in oecd countries’, oxford review of economic policy 22, 78–94. https://doi.org/10.1093/oxrep/grj006 sajems ns vol 3 (2000) no 3 344 the challenge of forward progress in south africa and across the region * lawrence h summers united states secretary of the treasury invited lecture jelo 55 thank you very, very much for that overly kind introduction. i've learned in political life that it is important to manage expectations, and i don't think you quite did that. i'm reminded slightly of what lyndon johnson once said when he was introduced by someone very nicely "i wish my parents had been here to hear that." he then continued, "my father would have appreciated it, my mother would have believed it." and you know this is a lot better than economists like myself usually get. it was not so long ago that i was introduced by someone who said, "larry, do you know what it takes to succeed as an economist?" and i said no. and the response was, "an economist is someone who's pretty good with figures, but doesn't quite have the personality to be an accountant." that was in moscow. and the audience there did not get the joke, which tells you a lot about the challenges that they face. i am very grateful to the leaders of pretoria and vista universities and to the universities themselves for hosting me on this occasion, and it gives me particular pleasure to return to a university environment. you know, in a new global economy where capital can move across international borders in a heartbeat, where ideas can move across international borders in no time at all, where what can be sold can be traded and moved around the world so easily. if you ask what it is that is distinctive about any of our nations the united states, south africa, any country it is our people. and that makes the institutions which shape our people and which shape our leaders so profoundly important. • lecture delivered at the university of pretoria, 15 june 2000. dr summers was introduced by professor sibusiso vil-nkomo, dean of the faculty of economic and management sciences. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 345 sajems ns vol 3 (2000) no 3 and i believe that in the next generation, even more than in the past, we will find that great universities and well-functioning institutions of higher education will be a crucial element of national economic success. indeed it's very much true within our own country. if you ask why silicon valley is located in silicon valley, the answer lay in its proximity to stanford university. if you ask why the technology community in massachusetts fonned where it did, the answer is the proximity to mit. the community in north carolina, proximity to universities there, the community in austin, proximity to universities there. so i am glad to go to universities because in addition to what led me into higher education in the first place, the pure spirit of academic inquiry, i believe that successful, well-functioning universities, such as those that you are working to create here, are absolutely crucial to the success of nations. what i'd like to do this morning is talk for a little while about three questions, some of the lessons of recent developments in sub-saharan africa. the particular opportunities and challenges that your country, south africa, faces today, and some crucial implications of the current situation for policy in africa and for the international community as a whole. i take it as a major sign of progress and cause for hope that i'm not going to find myself talking primarily about the importance of stable, macro-economic policies or the rule of law or healthy financial systems or the role of markets in private sector developments, because these ideas which were once controversial are now much more widely accepted and ingrained. and, there are, i think, other questions that perhaps are more at the cutting edge of thought and action today. i africa today when i came to africa last, in the spring of 1997, it was a period of fresh optimism. uganda, mozambique and many others were overcoming decades of poor policies to achieve significant, market-led growth. a new generation of africans was emerging out of the embers of the cold war. and the average investment banker was no longer considering the phrase "sub-saharan emerging market" to be a contradiction in tenns. the sense of new opportunities was palpable and nowhere more than here, in south africa. while i think these have been good years in south africa, the mood has changed somewhat with respect to the continent. the economist magazine, whose covers tend to be harbingers of change they declared the price of oil at a tenninallow point just before it tripled, for example the economist recently dubbed africa "the hopeless continent". the stories from the region and the global press are r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 346 again dominated by pictures of famine, conflict and disease. and we are reminded, once again, that average per capita gdp in sub-saharan africa today is still lower in real terms than it was in 1960. it is in this context tempting but i believe, badly misguided to conclude that the optimism of just a few years ago was simply misguided. but i believe the lessons of recent years are more complicated. they include these lessons: one lesson is that good policy is necessary, but it is not sufficient in subsaharan africa, where even the most committed governments must overcome some unique handicaps, including the tropical climate, poor soil and vulnerability to. infectious disease. and now there is the added burden of hiv/aids, which last year killed ten times more africans than all the region's various conflicts, and here in southern africa could reduce life expectancies to levels that were more characteristic of biblical times. a related crucial lesson is the one that president mbeki made very vividly during his recent trip to washington: that sub-saharan africa is not one place or one idea, subject to one solution, but 48 distinctive nations. and, even as some countries have fallen back into conflict and economic regress, we must remember that others have made crucial steps forward. notably: • i come here from nigeria, where i was able to congratulate president obasanjo ~arlier this week on the first anniversary of the first democratically elected civilian government in nearly two decades. i was able to offer him concrete u.s. support in the form of our support for a generous rescheduling of its paris club debts this year, and to indicate to him that provided that nigeria makes significant progress in meaningful economic, financial and social reforms the united states would support positive consideration by the official financial community of multilateral debt reduction for nigeria through the paris club. • in tanzania, where i spoke yesterday to president mkapa and his economic team about their efforts to chart a new course for their economy after decades of central planning, and where i was greatly moved by my visit to an independent hlv/aids clinic that is building the nations's social capital from the ground upwards working with the local community to educate young people about the virus and provide support networks for those that are already sick. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 347 sajems ns vol 3 (2000) no 3 • and mozambique, where democracy and rapid growth have replaced two decades of devastating civil war. in all the world, mozambique was one of the most rapidly growing economies for the entire decade of the 1990s. we will be speaking with officials in maputo tomorrow about their efforts to keep their reform strategy on track even as they manage the consequences of the floods this year and the threat of a major malaria epidemic. at the dawn of a new century, the world has an opportunity to support nations like these and to move forward in a region where too many countries are still falling behind. that is the opportunity that the leaders in the industrial countries seized in our support for a much strengthened debt relief initiative for africa last year. this initiative rests on two crucial principles: first, the education and health of african children, or poor children anywhere, should not be held hostage to the power of compound interest. in large parts of this continent, a child born today is more likely to die before the age of five than to reach secondary school, and more likely to be malnourished than to learn to read. that is not as it should be. governments in countries that are committed to investing in their people should not be prevented from making those investments by the need to divert large amounts of their scarce resources to paying off the misguided loans of the past. equally, though, as we support debt relief, it is essential that we recognize our obligations to those we are trying to help, to ensure that, this time, our assistance works by targeting it to countries and to programs that deliver results, and by applying appropriate conditions. tempting as it is to believe that simply providing support to countries and letting them use it as they see fit will be a panacea, the overwhelming lesson of history is that it isn't so. we have very clear, natural experiments to establish this proposition. the economic history of nigeria, venezuela, zambia and other countries with abundant natural resources offer concrete examples of the dangers of external finance without conditions. large increases in price in these countries led to [ringing of cellphone] well, that's an appropriate marshall spirit for my remarks and is a powerful you know i think the inability to tum cellphones off is a powerful testament to the connectivity that we are seeking to create in your country. again and again, we have seen that when resources come in without conditions, the result is palaces, corruption, swiss bank accounts, and very little tangible benefit to the people. it doesn't mean we shouldn't work to develop natural resources. it does mean that conditions are appropriate when financial assistance is provided. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 348 i believe that this hipc initiative gives us a opportunity to refocus development efforts in more effective ways: refocus them in particular on the importance of human development, reduction in poverty, promotion ofheaith and education. ii south africa's unique challenges and opportunities what about south africa in all of this? let me say first that i think it is difficult to over estimate the importance of south africa, for the african continent and for the global economy. there is almost no question that the next two or three decades will see substantial convergence between the economy of south africa and the other economies of sub-saharan africa. and the great question that will determine the future of africa and its people is whether that convergence is upwards convergence on behalf of the other economies or it is downwards convergence for sub-saharan africa. president mbeki and minister manuel recognize that and have, therefore, focused very much not just on strengthening this economy, but on policies towards africa as a whole. south africa comes with formidable advantages: traditions that emphasize the rule of law and at last, bringing to place law that is truly legitimate; a strong infrastructure, both in a physical and tangible sense and in an intangible sense, as well; a clear set of commitments to private sector-led development, to market forces; and a willingness to embrace technology. of the many statistics about your country, the one that i was perhaps the most struck by was the one that i encountered in my hotel magazine last night, and that is that yours may be the only country in the world that has more cell,hones than land phones. think about that. think about it because it speaks to some deep things. it speaks to your country's willingness to embrace connectivity, embrace communications, embrace modernity and their potential to leapfrog problems in many other countries. but that comparison works so well for two reasons: it works because there are a lot of cellphones, and it works because there aren't so many land phones for a country of your population, and that in turn is a manifestation of what is surely your greatest challenge: the manifest high levels of inequality and division that history has bequethed you. you know the statistics better than i do. five percent of south africans control 95 percent of your country's wealth. poverty among the non-white population is running at more than 60 percent. and upwards of one in four of your working age population is out of work. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 349 sajems ns vol 3 (2000) no 3 that makes more rapid economic growth a national imperative. because only in the context of more rapid economic growth will it be possible to more fully and properly distribute the fruits of a market economy. that is why i am so encouraged by the continuing commitment of the south african government, from the top down, to the pursuit of market-oriented, sound, healthy, financial policies. i look forward to discussing those issues in more detail with minister manuel in a little while. but my plea to you would be just this your country is very special and faces very distinctive challenges. certain laws of economics, that if you print too much money, you'll get higher prices, and not much else. that if people can't be secure that something they own today will still be theirs tomorrow. that if you don't invest in new capacity, you won't be able to produce more tomorrow than you are today. those basic laws of economics which have shaped the approach that president mbeki and minister manuel have taken are laws of economics that do not reflect political constraint or realities that we all have to deal with in helping our economies move forward. iii compelling priorities for the new africa these are crucial elements of policy here in south africa. let me conclude by just stressing three themes in economic development policy that i think are perhaps less centrally stressed and less frequently stressed by those concerned with finance and economics, but that i believe are crucial if south africa and sub-saharan africa are to succeed in the future. first, integration: economic integration is the transforming global dynamic of our time. it is success in integrating within a large country and then integrating with a global economy that is the reason why the united states has been successful over the last half century. only one country globally in the whole world botswana, where the circumstances are special has achieved rapid economic growth over the last half century without achieving rapid growth in manufacturing exports. that's why rapid labor-intensive growth is important for sub-saharan africa and it is important for south africa. i believe regional integration can make a very great contribution, and that is why the united states very much supports efforts to implement on a faster basis the sadc trade protocol, something i'll be discussing with sadc finance ministers later today. we equally believe that president mbeki is exactly right when he stresses that african integration has to be a complement to rather than a replacement for broader, global integration. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 350 and we recognize that if that is to take place, the united states has to do its part and so do the other major industrial countries. and that is why the president was so pleased, at last, to sign into law the african growth and opportunity act last month. that law will open up new, important opportunities for businesses in south africa and across africa by significantly expanding their access to the u.s. market, especially in apparel, and will offer strong new support for growth in private investment here in this region. second, the crucial role of education: the second theme that i would stress is the crucial role of education. it's no exaggeration to say that africa has little chance to succeed economically without improvements in education. no country, globally, has ever succeeded without a literacy rate weli in excess of fifty percent. yet, in sub-saharan africa today, close to half of the women cannot read. this will all become in so many ways ever more important in the years ahead, when increasingly machinery will do the work of physical labor and what we can all contribute will be determined more by what we know and can think about than what we can lift. education is important in other ways as well. democracy means little without an informed electorate and it is important in other ways. i was very struck by the worker who said to me in tanzania yesterday: all the advertising and information campaigns in the world regarding hiv/aids will matter little if people cannot read. that is why education plays a crucial role in the debtreduction initiative and that is why we will be discussing at the okinawa economic summit the priority we associate with concrete, multi-year targets for substantial increases in world bank lending for education. particularly for basic education, and particularly to narrow gaps between girls and boys. south africa, with the third highest education spending relative to the gnp, has much to contribute to this global effort. it is a leader in the very important respect of gender equality with very similar rates of education for girls and boys. and it is an impressive statistic that bears emphasis that relative to all the countries in the world, your level of spending on education is the third highest relative to your total income. priority in your country as in mine, though, has to now be not just the quantity of resources devoted to education, but also the quality of resources devoted to education. weli-paid teachers are important, but if the imperatives of the educational establishment come to be larger than the imperatives of providing textbooks for children or chalk for chalkboards or facilities for schools that work, then those priorities are setting education backwards and not forwards. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 351 sajems ns yol3 (2000) no 3 third, the importance of core investment in health: integration education. there's the third thing that must be said. and that is the importance of core investments in health. finance ministers are not health ministers and the details of health issues are not normally our primary concern. finance ministers around the world are becoming increasingly convinced that health investments in general, and investments with respect of hly/aids in particular, are not just a moral or humanitarian issue, but an issue of profound economic importance. at a time when 23 million africans are now infected with hly/aids, some 11 000 are added to the list every day, with i 700 of them south africans. a country where hly / aids is spreading fastest has to be a leader in educating itself and the world about this disease. i hope next month's global aids conference in durban could mark a turning point. on current trends, more than 5 million south africans will be infected by 2008. in some hospitals, already, more than a third of the beds are occupied by people with aids and business are beginning to realize the profound effect that this disease will have in declining productivity, rocketing health insurance costs, absenteeism and loss of skilled and experienced labor. more broadly, anyone who studies the statistics on hly/aids and other infectious diseases in sub-saharan africa has to conclude that without more effective approaches to these problems, no national economic policy, however well devised and implemented, is going to yield the results that it should. even before aids, it has been estimated that malaria alone reduced the growth rate of 31 countries in africa by enough to make their gnp nearly 20 percent lower today than it would otherwise be. that is why the united nations security council had its first meeting devoted to a health issue this january; why the president has declared hly / aids to be a national security threat to the united states and why we are making it a major budget priority as well. it is something that we will seek to be funding much more fully in the context of debt reduction initiatives and in the context of the work of the international financial institutions. i salute the president of the world bank wolfensohn's commitment to assure that no well designed aids program in sub-saharan africa goes unfunded. it is appropriated that we all work to hold the bank and the international community to that commitment by presenting them with well-designed programs. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 352 i think it's appropriate here in a major center of research to highlight the fact that there is the scope with respect to aids, with respect to malaria, with respect to tuberculosis, to respect with the very limited number of diseases that account for more than a million deaths each year, to bring to bear the power of modern science, if the right incentives are there. it cannot be right in the era of viagra, that of the 1233 new medicines that have been patented in recent years, only 13, or i percent, were for the tropical diseases that afflict 90 percent of the world's population and that of those 13 new products, only 4 came as a consequence of research projects that were aimed at curing humans. that is why there has been a mobilization of governments, of foundations, of the pharmaceutical industry to bring a new focus to this vital issue. we can do better in the 21 51 century than we did in the 20th • iv concluding remarks let me just conclude finally by saying this. there may be economic and financial issues that have more dollars involved than what happens in subsaharan africa. but there is no global, economic and financial issue that has greater human consequence than what happens on this continent. there is no country that will be more crucial to what happens on this continent than yours. and there will be no group within this country that will be more crucial to its future than those who are studying in its universities. i'm therefore very grateful to have had the opportunity to share these thoughts on africa's future and the united states interest in it with you. thank you very much. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction economic implications of the reverse yield gap past research the data the history of the reverse yield gap in-sample linear modelling out-of-sample forecasting forecasting gross domestic product over different economic periods conclusion acknowledgements references footnotes about the author(s) keren a. gossman school of statistics and actuarial science, faculty of science, university of the witwatersrand, south africa mark g. hayes department of mathematics and statistics, faculty of science and engineering, curtin university, australia citation gossman, k.a. & hayes, m.g., 2018, ‘an investigation into the ability of the reverse yield gap to forecast inflation and economic growth in south africa’, south african journal of economic and management sciences 21(1), a1638. https://doi.org/10.4102/sajems.v21i1.1638 original research an investigation into the ability of the reverse yield gap to forecast inflation and economic growth in south africa keren a. gossman, mark g. hayes received: 27 july 2016; accepted: 28 may 2018; published: 16 aug. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: monetary policy in south africa is carried out by the south african reserve bank (sarb) with the aim of keeping inflation within a target range of 3% – 6%. the sarb uses a variety of models to aid them, with the core model being the most significant. aim: the primary aim of this research is to determine whether the reverse yield gap (ryg) contains information that could be useful to the sarb when making monetary policy decisions. setting: the authors found no evidence that similar studies on the ryg have previously been done in the south african context. since the yield curve has been found to be significant in south africa at forecasting economic growth, yet insignificant in europe, the results for this research may too be different to the global experience. methods: the authors tested for linear relationships between the ryg and economic growth and inflation over the period 1960–2014. results: the results indicate that a slight linear relationship may exist in the case of economic growth, with the ryg based on earnings yields showing better out-of-sample forecasting abilities. further investigation indicates that the linear relationship is stronger during times of economic upturn. the results for inflation forecasting, however, show no signs of a reasonable linear relationship. conclusion: there is evidence for the sarb to consider whether the ryg can replace other economic variables in its core model without loss of predictive ability. interestingly, this study found evidence to suggest that the ryg has an inverse relationship to future economic growth in south africa, which is not what was expected. introduction the reverse yield gap (ryg) is generally given to be the difference between the gross redemption yield on long-term government bonds and the dividend yield (armah & swanson 2011; davis & fagan 1997) or the earnings yield on domestic equities (maio 2013). research on the usefulness of the ryg in predicting economic conditions such as future economic growth and inflation (armah & swanson 2011; davis & fagan 1997) as well as stock market returns (maio 2013) has been done in the united kingdom (uk) as well as the united states (us). nobili (2006) explains that if the prices of assets in the market are set by rational investors then it must be that yield spreads, such as the ryg, contain information about investors’ expectations for the future. armah and swanson (2011) investigate the use of a carefully chosen set of economic variables in predicting economic growth and inflation to assist with monetary policy decisions in the us. yield spreads, such as the ryg, are ideal variables for such models as they are simple to determine and can often be obtained before the values of other macro-economic variables are available (davis & fagan 1997; nobili 2006). this adds further interest to the idea of exploring the forecasting abilities of the ryg if the results found can be useful to the south african reserve bank (sarb) in monetary policy decision-making. the primary aim of this study was to determine if the ryg contains information that could be useful to the sarb when making monetary policy decisions. the focus of the research was not how the ryg could be used by the sarb, but rather to take the initial step of investigating how well the ryg can forecast economic conditions in south africa. the authors expect to accomplish this primary aim by achieving two subaims, the first being to investigate the ability of the ryg to forecast inflation levels in south africa. the second is to determine the ability of the ryg to forecast economic, gross domestic product (gdp) growth in south africa. under this aim the relationship between the ryg and economic growth will be investigated over the full data set used in the study and then over periods that are classified as economic upwards phases and economic downwards phases. this article has the following structure. the ‘economic implications of the reverse yield gap’ section describes the economic implication of the ryg; the ‘past research’ section is a literature review; ‘the data’ section gives a description of the data and variables; the ‘history of the reverse yield gap’ section reviews the history of the ryg; the ‘in-sample linear modelling’ section describes the in-sample linear modelling; the ‘out-of-sample forecasting’ section covers the out-of-sample forecasting models; the ‘forecasting gross domestic product over different economic periods’ section investigates forecasting economic growth during upwards and downwards business cycles; the ‘conclusions’ section details the authors’ conclusions. economic implications of the reverse yield gap prices of financial assets the notion that a yield spread contains information on future market conditions is driven by the idea that asset prices are set by rational investors based on their expectations of the future (nobili 2006). hence, current financial yield spreads contain useful information about future economic conditions (davis & fagan 1997). equity prices give an indication of the market’s expectations of future profitability, which should be affiliated to future economic growth (davis & fagan 1997). conventional bond prices should be more affected by future inflationary expectations, since equities are generally real assets which inherently provide investors with inflation protection. thus, the ryg can be expected to provide information on future inflationary expectations to the extent that these expectations affect the relative prices of conventional bonds and equities (davis & fagan 1997). the efficient market hypothesis one should note that the ideas presented in the ‘prices of financial assets’ section rely on the assumptions that, first, investors have access to all relevant information influencing future economic conditions and, second, that investors are rational and can accurately formulate expectations and price for them (timmermann & granger 2004). one needs to then consider the efficiency of the market concerned. a semi-strong form efficient market is one where all publicly available information is contained in asset prices, while a strong form efficient market is one where all public and privately available information is contained in asset prices (fama 1970; finnerty 1976). thus, the amount of information contained in asset prices, which are priced as suggested in the ‘prices of financial assets’ section, will depend on the degree of efficiency in the south african market. a strong form efficient market would be ideal; however, asset prices in a semi-strong form market may still provide sufficient information on future economic and market conditions. investigating the level of efficiency of the south african market is beyond the scope of this article; however, it is worth noting that if the ryg is not predictive it may be a result of inefficiency in the market or that investors are not rational. monetary policy in south africa monetary policy in south africa is carried out by the sarb with the aim of keeping the rate of increase in the consumer price index (cpi) within a target range of 3% – 6%.1 the use of various models is central to the process of monetary policy decision-making, with the core model being the most significant of these models (aron & muellbauer 2007; smal, pretorius & ehlers 2007). the sarb began developing the core model in 1974 to model the south african economy (smal, pretorius & ehlers 2007). the model is a quantitative, macro-economic model and comprises a number of stochastic equations for important factors (smal, pretorius & ehlers 2007). since its initial development, the model continues to undergo continual reviews and modifications (smal, pretorius & ehlers 2007). the core model is used to quantify the impact on the south african economy of different monetary policy decisions, with the main components of the model aimed at explaining inflation, gdp and the exchange rate (smal, pretorius & ehlers 2007). smal, pretorius and ehlers (2007) explain that while a successful model should incorporate large amounts of information there is still a desire for relative simplicity. the ryg would be a useful addition for forecasting inflation and gdp due to its simplicity and the ease with which financial spreads can be observed (davis & fagan 1997; nobili 2006). smal, pretorius and ehlers (2007) make no mention of the ryg already being included as a factor in the core model as at december 2006. it is unlikely that the ryg alone can provide sufficient forecasting ability; however, it may contain some marginal forecasting ability. thus, it may well be found that replacing a number of factors currently contained in the core model with the ryg could result in no significant loss of forecasting ability while at the same time reducing the number of variables and increasing the ease and simplicity of using the model. past research europe davis and fagan (1997) developed univariate models for european countries to predict inflation and economic growth. their initial models were autoregressive models using past data for inflation and economic growth to predict values. the ryg was then added to each model and they were tested for any improvements. their results show little evidence that the ryg could be used effectively as an indicator for future economic growth and inflation in european countries; however, the results for economic growth were slightly better than those for inflation. modelling techniques that allow for time variation of coefficients were used by nobili (2006) in an attempt to determine if this could improve the marginal predictive strength of the ryg. nobili measured the significance of the ryg by first constructing a benchmark model to forecast gdp and inflation in the euro area. his benchmark model was a bayesian vector autoregressive model with time-varying coefficients and economic explanatory variables. he found that the addition of the ryg as a predictor in the model made slight, statistically insignificant, improvements. the general consensus is that the ryg has poor out-of-sample performance in forecasting economic growth and inflation and that the estimated parameters are unstable over time (davis & fagan 1997; nobili 2006). duarte, venetis and paya (2005) found that when using some other financial spreads to forecast economic growth, a non-linear model yielded better results than their linear model and had more success at forecasting economic growth during periods of slow growth. investigating the use of non-linear models is, however, beyond the scope of this article. the united states armah and swanson (2011) aimed to show that a carefully chosen set of macro-economic variables can contain the same relevant information as a larger and more complex financial data set. the authors measured this relevance in terms of being useful for monetary policy decisions and forecasting economic conditions, in particular inflation and economic growth. armah and swanson (2011) found that the addition of the ryg, as well as some other financial spreads, did not improve the forecasting ability of their models. south africa the authors found no previous research on the usefulness of the ryg in predicting inflation or economic growth in south africa. clay and keeton (2011), however, found evidence that the yield curve can predict economic downturns in south africa. this is relevant because both davis and fagan (1997) and nobili (2006) investigated the forecasting abilities of the yield curve as well as the ryg, and in both cases these authors found that neither had significant forecasting abilities in europe. since the yield curve was found to be significant in south africa at forecasting gdp levels and yet insignificant in europe, this suggests that the results for the ryg in south africa may too be different to that of europe and the us. conclusions based on previous research as davis and fagan (1997) explain, when assessing the ability of one variable to predict another, the results are only relevant to the specific information set in which the model is tested. thus, the fact that the ryg did not improve on many of the models in the us and europe does not mean this holds true for south africa. clay and keeton (2011) confirm this statement by showing that an investigation done in south africa around the yield curve gives different results to similar investigations done in europe and the us. furthermore, while the ryg showed no predictive abilities above those already contained in the models of armah and swanson (2011), nobili (2006) and davis and fagan (1997), this is not to say that it contains no marginal predictive abilities in itself. one can, however, say that in the data set within which the models were tested, any predictive information within the ryg was already contained in the other considered variables. as discussed in the ‘monetary policy in south africa’ section, the authors are suggesting an improvement to the sarb’s core model by considering the replacement of several variables with the ryg. as such, this article considers the ryg in isolation to better understand its predictive ability. using the above reasoning, the authors believe that there is sufficient evidence to support the usefulness of this investigation within the south african environment. in addition, similar research has not yet been done in south africa and the authors are of the view that it is of interest to explore this gap and, similar to the work by clay and keeton (2011), investigate whether the south african economic factors behave differently to the us and european ones. the data the investigation is done using quarterly data, or monthly data which has been converted into quarterly results. the period under investigation is from 1960:1 to 2014:1, where the notation y:i defines the end of quarter i of year y. data was obtained from i-net bridge and the sarb online database.2 real gross domestic product for the purpose of this investigation, economic growth over a period of k quarters is measured as the real rate of gdp growth over that period, with annual forces calculated as follows: . where: is the annual force of real gdp over the k quarters from time y:i to y:i + k. gy:i is the value of real gdp in the south african i-net bridge series at time y:i. inflation similarly, inflation over a period of k quarters is measured as the change in the south african cpi, with annual forces of inflation calculated as follows: . where: is the annual force of cpi inflation over the k quarters from time y:i to y:i + k. hy:i is the value of cpi in the south african i-net bridge series at time y:i. long-term government bond yields the quarterly yield was calculated as the average over each quarter of the monthly annual implied yields on government loan stock of term 10 years or more that are traded on the bond exchange. earnings and dividend yields for the purpose of this study, the yields on the equity market will be measured by the yields on the financial times stock exchange (ftse) and/or johannesburg stock exchange (jse) all share index for the period 1995:2–2014:1. prior to this, the yields on the jse and/or actuaries all share index were used, as the ftse and /or jse all share only began in july 1995 (hayes & bertolis 2014). annualised quarterly forces were calculated as follows: . where: dy:i is the annual force of dividend or earnings yield for quarter i of year y. di:x is the annual dividend or earnings yield, compounded monthly, for month x of quarter i. the reverse yield gap the authors consider the ryg based on equity earnings yields or equity dividend yields. contemporary corporate finance concepts recognise that dividends are a tool that can be manipulated by companies, discussed in ‘the re-emergence of the positive yield gap’ section and the ‘modelling gross domestic product’ section (berk & demarzo 2007; leary & michaely 2011). thus, the authors a priori believe that the ryg based on earnings yields should be superior at forecasting gdp and inflation, as they are a truer reflection of the current state of the equity market. the ryg measures are calculated as follows: rygy:i = rfy:i − dy:i where: rygy:i is the value of the reverse yield gap for quarter i of year y. rfy:i is the annual force of return on the government bonds for quarter i of year y. dy:i is defined in the ‘earnings and dividend yields’ section. using the results given by fukui and kamiyama (2015), the ryg can be expanded. this can be done by assuming that when the market is in equilibrium the return on an equity investment is given by: and where: i is the required force of return on the equity investment. dy:i is defined in the ‘earnings and dividend yields’ section. g is the expected future force of dividend or earnings growth. rfy:i is defined above. erp is the equity risk premium. the ryg can then be expressed as: the history of the reverse yield gap the emergence of the reverse yield gap before the early 1960s, both globally and in south africa, it was generally true that the dividend yield on domestic equity was greater than that on conventional government bonds (jesse 1977). at that time, jesse (1977) states, this was thought to be a logical norm as it reflected the overriding view that equities were riskier than government bonds. but as disclosure and accounting standards began to improve, along with better management practices and tighter stock market regulation, the general riskiness associated with equities began to diminish (jesse 1977). business cycles became less pronounced and investors perceived a future with greater economic growth, which in turn meant greater dividend growth (jesse 1977). investors were thus prepared to accept a lower initial dividend yield on equities than on government bonds with the expectation that dividend income would at some point grow to outstrip that from the fixed income bonds and, hence, the yield gap turned negative and the ryg emerged (jesse 1977). in figure 1 it can be seen that the dividend yield ryg became positive in south africa at around 1960, while the earnings yield ryg only became positive later at around 1983. this unusual phenomenon was observed in sealy and knight’s (1987) empirical investigation into dividend policy influencing share prices on the johannesburg stock exchange. sealy and knight (1987) concluded that, over the period 1973–1981, south african listed companies that paid a larger proportion of their profits as dividends had to generate greater returns to shareholders, implying that shareholders preferred profit retention. a plausible explanation is that south africa taxed dividends during that period.3 general corporate finance theory suggests that companies paying taxable dividends would have to generate higher pretax returns to result in the same after tax position as companies that retain more of the profits, effectively incentivising profit retention (berk & demarzo 2007). figure 1: the reverse yield gap in south africa from 1960 to 2014. the re-emergence of the positive yield gap since the financial crisis of 2008, developed countries once again experienced negative earnings yield rygs (fukui & kamiyama 2015). as can be seen in figure 1, however, the ryg in south africa experienced only a few negative spikes in the earnings yield ryg. the ryg based on dividends yields appears to be smoother with less extreme dips than that of the ryg based on earnings yields. the likely explanation for this is dividend smoothing that describes a company’s practice of infrequently changing dividends, and generally upwards only, irrespective of the level of annual earnings (berk & demarzo 2007; leary & michaely 2011). in-sample linear modelling the linear models to investigate whether or not there is a relationship between the ryg and future inflation or real gdp, linear models were constructed in a similar method to duarte, venetis and paya (2005): where: is the annual force of either inflation or real gdp as defined in the ‘data’ section. rygt−l is the value of the reverse yield gap measure at time t – l, where l is the lag parameter in quarters. γ0 and γ1 are the intercept and slope values to be estimated. εt is the random error term associated with the value of at time t. it is assumed that the mean of εt is 0 and the variance is some constant σ2 for all t. the model coefficients were estimated for a number of different prediction horizons where k took on values of 1, 2, 3, 4, 5, 6, 8 and 12 quarters. for each different value of k the model was run assuming values for the lag parameter (l) of 0, 1, 2, 3, 4, 5, 6 and 7 quarters. these values for k and l are similar to those tested by duarte, venetis and paya (2005). for clarity, when using a lag of 0 in the linear model defined by equation 4, one is using the current value of the ryg to forecast the growth in gdp over the next k quarters. for the remainder of this article, the ryg based on earnings yields will be denoted by rygey, and by rygdy when based on dividend yields. comparative model statistics in order to narrow down the set of considered models, the authors choose models for each value of k over the different values of l that minimises the akaike information criterion (aic). the significance of the ryg measures as predictor variables is measured using newey-west standard errors to test for the significance of the slope parameter estimate, (duarte, venetis & paya 2005). the r2 measure and the root mean squared error (rmse) are indicators of goodness of model fit. one of the arguments against the use of the rmse is that it is not a good indicator of the average performance of a model as it places a higher weighting on larger absolute error terms (chai & draxler 2014). the authors of this article, however, suggest that in some cases this may be advantageous as it allows the measure to more accurately expose differences between different model fits. furthermore, when forecasting gdp and inflation, the authors are interested in the models being able to predict the sudden and sharp changes in gdp and inflation that may happen in reality and thus feel the rmse is appropriate as models that fail to capture these sharp changes should be penalised. modelling gross domestic product table 1 and table 2 summarise the results for fitting the linear models to the real gdp data over the period 1960:1 to 2014:1. table 1: summary of results for the linear models of gross domestic product using the rygey. table 2: summary of results for the linear models of gross domestic product using the rygdy. for both ryg measures, the value of the lag parameter that minimises the aic for all values of k is 0. this indicates that at any time t, the value of the ryg at that time is the best at explaining what gdp growth will be over the next k quarters. there are two interesting results to take note of. first, all of the slope parameter estimates are negative. when considering equation 3, a high ryg should indicate a high expected rate of future dividend or earnings growth, relative to the equity risk premium. the authors thus expected that a high expected future growth rate in equity yields, g, should indicate an expectation of high future profits and, hence, ceteris paribus, higher gdp growth. the results seem to indicate the opposite. a possible reason could be that an increase in the ryg is more attributable to a decreasing equity risk premium rather than a large value for g. this would be consistent with a change in market perception that equities have become less risky, for example the positive structural changes to south africa’s economy following democracy in 1994 (habib & padayachee 2000). an alternative reason for the apparently contradictory result is that investors’ expectations of future market conditions are flawed and hence the expected future growth, g, implied by the ryg does not align with the growth that happens in reality. the simplest reason; however, is that the g term indicates expected growth over a longer term than is tested in this article, that is, longer than 12 quarters ahead, and that if a longer term were tested the nature of the relationship between the ryg and gdp would change. the second interesting result is that all of the model statistics used indicate that the rygdy is better at explaining the gdp data than the rygey. this is unexpected since, as mentioned in the ‘reverse yield gap’ section, earnings yields are less open to direct manipulation. a possible reason for this result is the ‘dividend signalling hypothesis’ that states that managers declare dividends on the basis of future expectations in earnings, rather than current earnings that may be distorted through, for example, a once-off large expense (berk & demarzo 2007). this forecasting approach may therefore be a better match for future actual levels of gdp growth. the general pattern of results for the two sets of models is the same. the r2 and rmse values indicate that the best fitting models are when k is 12, followed by when k is 8 and then 4. it appears that the best model fits occur when modelling gdp growth over 12 quarters (3 years) ahead, with the overall best model being that for the rygdy. this model explained 31% of the variation in the 12 quarters (3 years) ahead gdp growth over the period of observation. modelling inflation table 3 and table 4 summarise the results for fitting the linear models to the inflation data. table 3: summary of results for the linear models of inflation using the rygey. table 4: summary of results for the linear models of inflation using the rygdy. again the value of the lag parameter that minimises the aic for all values of k is 0; however, there are some noticeable differences between the inflation and gdp models. all of the inflation model slope parameters are now positive. one possible explanation for this positive relationship is that if investors believe that inflation is going to increase in the future, but are unsure of the magnitude of this change, this could lead to an increase in demand for inflation protecting assets like equities. this would lead to a decrease in dividend or earnings yields relative to gross redemption yields on government bonds and hence an increasing ryg; see equation 3. note, however, that the rygey is not significant in any of the models and the rygdy is significant in only the first three. the maximum r2 values for each set of models are generally lower for the inflation models than for the gdp models, again suggesting that the ryg is less efficient at explaining future changes in inflation than gdp growth. another difference is that the r2 values for the inflation models reach maximum values when k is either 4 or 5 quarters as compared to 12 quarters (3 years) for the gdp models. when looking at the rmse statistics, however, the pattern is similar to that under the gdp models with minimum values when k is 12 and 8. it is not clear that there is any one best fit model out of the tested models for inflation; however, one can say that the results for the rygdy models appear better than those of the rygey. out-of-sample forecasting the forecasting model the out-of-sample forecasting is done by removing from the data the observations from 1996:1 to 2014:1. linear models for both gdp and inflation of the same form as equation 4 are then fit to the remaining data and used to make single period ahead forecasts. this is an iterative process in which once a forecast for the one period ahead value has been made, the next observation is added to the model and the parameters re-estimated to forecast the next one period ahead value. the rationale behind following this strategy is that if the sarb were to use the ryg to predict gdp or inflation over the next k quarters, at each subsequent quarter the newly observed market data would be added to their model. this process is followed for each considered value of k, the forecasting horizon, while the value of the lag parameter, l, is kept as 0. the models are then compared using a rmse approach applied only to the errors relating to the forecasted data and not to the fitted linear models. since, for each iteration, the model parameters are re-estimated, the significance of the slope parameters with regard to the newey-west standard errors will not be considered. the size of the rmse value will be somewhat swayed by the absolute values of the observations. thus, because the scale of the real gdp and inflation underlying data is different, one cannot compare directly the rmse values between the two sets of models, but rather only between the various models within each gdp and inflation category. a summary of the forecasting results can be seen in table 5. table 5: out-of-sample forecasting results. results for forecasting gross domestic product for each ryg measure, the minimum rmse values were obtained when forecasting gdp growth over 12 quarter periods (3 years). this is in line with the results found in table 1 and table 2. in contrast with the in-sample modelling, however, the rygey models outperform the rygdy in terms of the rmse statistic for all values of k and this requires further consideration. when comparing the error terms for the rygey and rygdy forecasting models where k is 12, it is seen that up to the end of 2003 the rygey model outperforms the rygdy model at every point and vice versa after 2003. by then observing the gdp data it is noted that from 1996:1 up to the end of 2003, there is a general upward trend in three-year gdp growth rates, after which there is a general downwards trend. in the ‘forecasting gross domestic product over different economic periods’ section, the authors investigate the nature of the relationship between the rygey and future economic growth during periods of upwards or downwards growth. the results indicate that the rygey has an improved linear relationship with future gdp growth during upwards economic cycles and little, if any, linear relationship with future gdp during downwards cycles. by reference to the upwards and downwards economic cycle periods obtained from the sarb, at least 74% of the months over this forecasting period are considered to be in an upwards cycle, whereas for the data before this period, only 57% are contained in upwards cycles. it is also observed that the period over which the rygdy performs at its worst compared to the rygey is during the time of the asian economic crisis, and that over this period there was actually a general pattern of increasing three-year economic growth in south africa. it is possible that market participants expected this crisis to result in a lower than observed growth rate in south africa and, as dividends are set by companies, this incorrect expectation was more pronounced in the rygdy than in the rygey. overall it is likely that the rapid economic growth experienced in south africa over the period 1996:1–2013:4 resulted in the better performance of the rygey model compared to the rygdy model over this period. figure 2 shows a graph of the best fit models for forecasting gdp. note that each point represents the force of gdp growth over the next 12 quarters (3 years), not the growth experienced at that date. figure 2: plot of annual forces of real gross domestic product over a 12 quarter ahead period. there appears to be little difference between the two models, except over the period 1996 to around 2001. both forecast models seem to follow the general trend of gdp growth but do not exhibit the extreme peaks and troughs as found in reality. this is disappointing, since what is of key interest when forecasting gdp growth is to be able to predict economic troughs and peaks. the sarb in particular would probably be interested in modelling the extreme possible future outcomes as a result of changes in current economic conditions. of particular concern is the steep decline in actual gdp growth over 2005–2009 where both forecast models seem to show almost level growth over this period. it is noteworthy that the forecasts under the ey and dy models are similar. brill and toerien (2011) found that directors in south africa generally believe that reducing dividends leads to negative consequences and that maintaining consistency with historic dividend policies is important. there is evidence of dividend smoothing in figure 1; however, the similarity of the model results suggests that dividends are not smoothed to such an extent that the underlying earnings’ patterns are masked. overall, it appears that while there may be some relationship between future gdp growth and the value of rygey and rygdy, these variables alone are not sufficient to reasonably assist the sarb in monetary policy decision-making. results for forecasting inflation the models that performed best at forecasting inflation were again the models with a forecasting horizon of 12 quarters. this is interesting as the results in table 3 and table 4 suggest that neither ryg measure is significant when k is 12; however, the results are consistent with the rmse minimum values from the original linear models. again, the rygey models outperformed the rygdy models for all values of k when forecasting inflation. figure 3 shows the graph for the two best inflation forecasting models and can be interpreted in a similar way to that explained for figure 2. figure 3: plot of annual forces of inflation over a 12 quarter ahead period. from figure 3 it is not particularly clear that either of the models reasonably follows the actual inflation observations. the forecasts do not appear to follow the general trend of inflation, nor do they capture the cyclical nature of actual inflation. as a result of the relatively poor fits, inflation will not be modelled further in this article. forecasting gross domestic product over different economic periods economic cycles davis and fagan (1997) state that cyclical effects play a large role in economic growth and it is important to take into account these effects when using financial spreads to forecast economic growth. the linear relationship between the ryg and future real gdp growth in south africa is therefore modelled separately over upwards business phases and downwards business phases. the dates for these different periods were obtained from the sarb quarterly bulletin for june 20154, where business cycles are identified by analysing business cycle indicators, of which a description can be found in venter (2011) and bertolis and hayes (2014). method and model descriptions the business phases begin and end on a monthly basis; thus, the quarterly data used in this study is allocated to a specific business cycle period only if the full quarter considered is contained within that cycle. similarly, when considering the gdp growth over a period of k quarters, this observed growth value is only allocated to a specific cycle if the entire k quarters under consideration are contained in that cycle period. this is to avoid ambiguity around interpreting results where some observations contain growth incurred in both upwards and downwards phases. the modelling process followed is the same as that in the ‘in-sample linear modelling’ section with the same model structure as equation 4. linear models are constructed for the upwards and downwards phase data for each of the forecasting horizons, k, and lag parameter values, l. due to the fact that the rygey models performed better under the out-of-sample forecasting of gdp growth, the models in this section only consider the rygey as a predictor variable. note the developed models for each different value of k are conditional models in the sense that each will indicate the relationship experienced during upwards (downwards) business cycles between the rygey some l quarters ago and the growth in gdp over the next k quarters, given that the business phase remains an upwards (downwards) phase over the next k quarters. in-sample modelling over different business cycles – results the lag parameters that minimise the aic values are no longer all 0 as was the case in table 1 and table 2. table 6 seems to indicate that a lag parameter of 1 or 6 is generally most appropriate when forecasting gdp over an upwards business cycle, while in table 7, the lag parameter of 0 is the most common. table 6: summary of results for upwards business cycle linear models of gross domestic product with rygey. table 7: summary of results for downwards business cycle linear models of gross domestic product with rygey. while the majority of slope parameters are negative, those for the downwards phase models where k is 5 and 6 are positive; however, only the value at k equal to 6 is significant at a 10% level. this positive relationship implies that an increase in gdp is associated with an increase in rygey; this is what was expected as per the explanation in the ‘modelling gross domestic product’ section. this may suggest that during economic down cycles the rygey and gdp growth have a positive relationship; however, the results are not conclusive and in fact it appears more likely that these two positive parameters are anomaly occurrences. the large r2 value of 97.61% when k is 12 for the downwards phase models is likely attributable to the fact that the downwards phases were in general much shorter than the upwards phases and as a result there were few, seven to be exact, observations of 12 quarter gdp growth during downwards cycles. as such the results for this model cannot be relied upon for credible conclusions. excluding the results for this model, the results for the upwards phase models are generally better than those for the downwards phase models, and in fact the lack of significance of slope parameters and poor r2 values indicate there may not even be a relationship between the rygey and gdp growth during periods of economic downturn. during upwards periods, the best r2 and rmse models are where k is 12 and 8. note that these results are an improvement on the results for the rygey models over the full period of investigation (see table 1) and the r2 value of 42.77% when k is 8 is the best obtained over this entire study. out-of-sample forecasting over different business cycles a general rule of thumb is that for a model to be able to credibly forecast results it should contain at least 20 observations (clemen & winkler 1986). the upwards phase forecasting models were thus developed by building an initial model on the first 20 observations and then iteratively forecasting the next one quarter ahead gdp result, as explained in the ‘out-of-sample forecasting’ section. due to fewer observations being available for the downwards phase forecasting models, the initial models were developed on the first 15 observations. note that no forecasting model was developed for the downwards data when k is 12 as a result of only having seven observations. table 8 summarises the results of the forecast models. table 8: out-of-sample gross domestic product forecasting results for different business cycles. the minimum rmse for the upwards phase models is obtained when k is 8 (2 years) and l is 1; this is an improvement on the minimum value of the rmse for the rygey when considering the entire data set and indicates that there may be a stronger linear relationship during upwards economic cycles. for the downwards phase models the minimum rmse value occurs when k is 4 (1 year) and l is 0, but this is not an improvement on the results for the full data set and again suggest that the linear relationship is weaker during downwards economic phases. graphs of these two best forecast models are given in figure 4 and figure 5. note that there are no dates on the horizontal axes as the data are grouped over all upwards or downwards phases and hence do not always occur over consecutive dates. instead, the actual observations of gdp growth have been plotted in increasing order along with the corresponding forecasted value at each point. if the forecasting model is accurate it should produce a similar upwards sloping graph to that of the observed gdp. figure 4: plot of ordered observations of annual forces of real gdp growth over an eight quarter ahead period during upwards business cycles. figure 5: plot of ordered observations of annual forces of real gdp growth over a four quarter ahead period during downwards business cycles. neither of the above graphs shows any signs of the forecasting models having a reasonable forecasting ability, and in fact neither seems to even produce a graph with a clearly upward sloping trend throughout. this indicates that it is unlikely that the rygey as a linear predictor of gdp growth will be a reasonably useful single tool to the sarb when considering the use of different models over upwards and downwards business cycles. conclusion forecasting economic growth a high ryg should indicate a high expected rate of future dividend or earnings growth, relative to the equity risk premium. the authors therefore reason that a high expected future growth rate in equity yields should indicate an expectation of high future profits and hence, ceteris paribus, higher gdp growth. from the in-sample linear modelling, however, all of the slope parameter estimates are negative indicating the opposite, which is unexpected. when considering the linear relationship between the two ryg measures and gdp growth over the entire investigation period, the rygey models have superior out-of-sample forecasting abilities and the relationship seems strongest with a lag parameter of 0 and a forecasting horizon of 12 quarters (3 years). the forecasted models, however, did not capture the extreme changes in gdp growth that sometimes occur in reality. this is disadvantageous as these extreme values are likely the ones the sarb is most interested in predicting. when modelling gdp growth over different business cycles it was found that the linear relationship between the rygey and gdp growth is strongest during upwards economic cycles, although when looking at the out-of-sample forecasted model, this linear relationship does not appear strong. the rygey may still be useful to the sarb since it appears to capture some aspects of the general trend in gdp growth and it may be found that the information contained within the rygey, although insufficient on its own, could replace a number of variables in the sarb’s core model without any significant loss in forecasting ability. forecasting inflation there does not appear to be any linear relationship between future inflation and either of the two ryg measures. the minimum rmse value was found when forecasting inflation over 12 quarters (3 years) with the rygey value at the current time t; however, this model did not appear to follow even the general trend of inflation over the investigation period. further research the following areas of research could be pursued to further the results found in this article: testing the ryg as a predictor of real gdp growth alongside other variables already considered by the sarb. testing if the forecasting ability of the ryg could be improved by use of non-linear models, such as was done by duarte, venetis and paya (2005). testing the ability of the ryg to forecast inflation during different times in the economic or inflationary cycle. acknowledgements the authors thank mr g. haltmann for assisting with some of the coding that was used to compute the models and model statistics. we also thank the anonymous reviewers for their helpful comments. competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions k.a.g. was the principal author, who instituted the study and undertook initial analyses and inferences. m.g.h. supervised the principal author and co-wrote additional analyses and inferences, with supporting references references armah, n. & swanson, n., 2011, ‘some variables are more worthy than others: new diffusion index evidence on the monitoring of key economic indicators’, applied financial economics 21(1/2), 4360. https://doi.org/10.1080/09603107.2011.523188 aron, j. & muellbauer, j., 2007, ‘review of monetary policy in south africa since 1994’, journal of african economies 16(5), 705–744. https://doi.org/10.1093/jae/ejm013 berk, j. & demarzo, p., 2007, corporate finance, pearson education, inc., boston, ma. bertolis, d. & hayes, m., 2014, ‘an 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granger, c., 2004, ‘efficient market hypothesis and forecasting’, international journal of forecasting 20(1), 15–27. https://doi.org/10.1016/s0169-2070(03)00012-8 venter, j., 2011, ‘business cycles in south africa during the period 2007 to 2009’, south african reserve bank: quarterly bulletin 260, 61–66. footnotes 1. this information was obtained from the south african reserve bank’s official website and can be found at: https://www.resbank.co.za/monetarypolicy 2. the sarb online database can be accessed at the following address: https://www.resbank.co.za/publications/quarterlybulletins/pages/qbonlinestatsquery.aspx 3. deloitte, haskins & sells (1987). a guide to the recommendations of the margo commission of inquiry into the tax structure of the republic of south africa. 4. the published dates for the south african business phases can be found on page s-157 of the statistical tables section of the sarb quarterly bulletin june 2015, which can be viewed at: https://www.resbank.co.za/publications/quarterlybulletins/pages/quarterlybulletins-home.aspx abstract introduction literature review methods and procedures results and discussion limitations of the study and areas for further research conclusions and implications for policy acknowledgements references about the author(s) olebogeng marumo department of agricultural economics, north-west university, south africa majola l. mabuza department of agricultural economics, north-west university, south africa citation marumo, o. & mabuza, m.l., 2018, ‘determinants of urban consumers’ participation in informal vegetable markets: evidence from mahikeng, north west province, south africa, and implications for policy’, south african journal of economic and management sciences 21(1), a1743. https://doi.org/10.4102/sajems.v21i1.1743 original research determinants of urban consumers’ participation in informal vegetable markets: evidence from mahikeng, north west province, south africa, and implications for policy olebogeng marumo, majola l. mabuza received: 08 jan. 2017; accepted: 13 dec. 2017; published: 12 apr. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: this article seeks to examine the perceptions of urban dwellers towards participating in informal vegetable markets and determine the underlying factors shaping their decisions to participate in such markets. aim and setting: the objectives were achieved by using cross-sectional data obtained from a random sample of 230 households from mahikeng in the north west province of south africa. households’ perceptions were measured using numeric responses to several questions, which covered various issues related to vegetable marketing and consumption. principal component analysis (pca) was employed to draw dominant perceptions from the set of responses. method: the probit model was used to determine factors influencing households’ decisions of whether or not to participate in informal vegetable markets. explanatory variables included demographic and socio-economic factors as well as perception-related factors, which were proxied by the dominant principal components (pcs) obtained from the pca results. results: two pcs were found dominant, representing safety and quality perceptions as well as the convenience and bargaining opportunities provided by informal traders. the probit regression results indicated that households’ preference for the informal vegetable market were positively influenced by age of household head, low level of education of adult household members, and convenience provided by informal markets. however, households’ wealth status and the perceptions on safety and quality of vegetables were found to have a significant negative influence on participation in the informal market. conclusion: given that informal vegetable trade forms an integral part of the urban economy by offering easy access to food in public spaces and connecting with the formal economy where informal traders source their supplies, the study concludes by highlighting policy interventions aimed at improving the quality of food traded in the informal sector. introduction consumers in urban areas generally access fruits and vegetables from two primary sources. these are formal and informal markets. formal markets are described by rajiv (2010) as those outlets that are characterised by high quality produce and food safety standards and where the activities of marketing agents can be monitored with relative ease. operations in such markets are also regulated by law and owners are subjected to annual tax payments. examples of formal market outlets include supermarket chain stores and retail outlets that specialise in fruits and vegetables. informal markets, however, are found in temporary settings and are not regulated or protected by law. their operators also do not pay tax (roesel & grace 2015). examples of informal markets include street hawkers and traders who buy agricultural products from the formal markets in bulk for onward sales through informal channels (potts 2008). urban dwellers are more likely to purchase these than produce fruits and vegetables, given the opportunity cost of labour as most of them are engaged in salary or wage employment. in addition, while urban agriculture could have a role to play as a source of food for urban dwellers (see for example smart, nel & binns 2015), this may not be attainable due to land constraints and the existence of by-laws that prohibit certain agricultural activities in some municipalities (frayne, mccordic & shilombeleni 2014; prain & lee-smith 2010). given such limitations, urban dwellers find themselves with fewer options other than to access fruits and vegetables from the formal or informal sources of supply. between the two main sources of fruits and vegetables supply, the informal sector seems to be gaining popularity in urban south africa (battersby 2011; jackson 2010; van rooyen, mavhandu & van schalkwyk 1997). the emergence of this sector, as observed by van rooyen et al. (1997) and peyton, mosely and battersby (2015), is linked to the inability of the formal sector to serve township markets as outlets such as supermarkets are often incompatible with consumption strategies of poor households. in the south african context, informal vegetable markets have several advantages, including the improvement of food security in the urban sector, particularly in high-density areas such as townships (peyton et al. 2015). by virtue of being consumer oriented, informal markets are demand driven and provide a valuable source of income for many township dwellers (van rooyen et al. 1997). with south africa experiencing an unemployment rate of about 24% (statistics south africa 2015a), which is largely linked to the decline in the labour absorption capacity of the formal economy, the informal sector which currently accounts for about 2.5 million jobs (statistics south africa 2015b) could be used to create opportunities in urban areas. therefore, policy interventions targeted at improving informal market are likely to bring more positive changes in the economy. for instance, besides improving the welfare of market actors, interventions in the informal market could also advance the food security situation for urban dwellers. however, prior to making specific policy suggestions in this regard, it is important to analyse the socio-economic situation that may determine the long-term sustainability of informal vegetable markets in urban areas. informal vegetable markets will be viable as long as there is substantial consumer demand from urban dwellers. to this end, it is essential to first understand what factors condition urban consumers’ choice of vegetable retail outlets. ngiba et al. (2009) indicates that very few studies have been conducted in south africa in this regard; hence, this study is an attempt to address this research gap. outside south africa, with the exception of maruyama and trung (2010), okello et al. (2012) and kapoor and kumar (2015), studies in this area have been very scant. this study, however, differs from previous attempts by exploring a different methodological approach. for instance, while maruyama and trung (2010) and okello et al. (2012) highlighted the importance of consumer perceptions in shaping their choices of point of purchase, the perception variables in their analytical models were predetermined, an approach that could have influenced the ultimate results. households’ perceptions in this study were captured using numeric responses to several questions, which covered a number of contextual issues related to the two alternative markets. principal component analysis (pca) was then applied to extract dominant perception-related factors that were subsequently used as explanatory variables in a discrete choice model to determine their effects on the respondents’ choices of vegetable market outlets. kapoor and kumar (2015) did not include perception-related factors in their discrete choice model despite their importance in shaping consumer decisions. in addition, perceptions are usually influenced by past experiences; hence, the inclusion of perception-related variables in a discrete choice model, as was done by maruyama and trung (2010) and okello et al. (2012), could lead to problems of endogeneity (bontemps & nauges 2016). this study, therefore, further differs from previous attempts in that exogeneity tests were conducted to ascertain the validity of the empirical findings. specifically, this study attempted to: (1) examine the perceptions held by urban consumers towards informal vegetable markets and (2) determine the underlying factors influencing urban consumers to purchase vegetables from either formal or informal points of sale. the above objectives were achieved by using evidence from the ngaka modiri molema district municipality in mahikeng, north west province. mahikeng has experienced significant expansion of supermarket chain stores as well as fruit and vegetable specialty outlets. in addition, it has a large concentration of consumers with varied socio-economic attributes that have made both formal and informal vegetable trade relevant. the rest of the article proceeds as follows: the next section provides a succinct review of the literature, followed by an outline of the methods and procedures. this section is followed by the empirical results while the last section presents the conclusions and implications for policy. literature review vegetable trade in most developing countries has for many years been dominated by on-farm and informal points of sale, particularly open-air and roadside markets. however, in recent years food retailing (including fruits and vegetables) has seen the emergence and rapid growth of non-traditional or formal outlets such as supermarkets and specialty stores (weatherspoon & reardon 2003). the literature identifies various geographic and socio-economic factors responsible for supermarket diffusion in developing countries (crush & frayne 2011; seto & ramankutty 2016). in areas characterised by spatial separation of socio-economic groups, supermarket operators normally prioritise higher-income areas. however, in areas with no spatial separation of economic groups, supermarkets are accessible even to lower-income consumers, even though their use may not be the same (okello et al. 2012). for instance, given that major supermarkets carry elaborate grocery sections that feature a wide variety of fresh agricultural produce, some consumers find multi-stop shopping in many small stores more costly than the one-stop shopping in such supermarkets (goldman & hino 2005). for households with access to reliable transport and proper storage for larger food quantities, sourcing vegetable supplies from supermarkets becomes even more cost effective (crush & frayne 2011). the procurement of perishables from supermarkets can also be linked to the increased demand for fresh supplies with specific quality attributes by consumers, particularly in the urban areas (minten & reardon 2008). these are consumers with high purchasing power who have become more selective with regard to quality and source of food. therefore, they source their supplies from outlets they consider safe or perceive to offer quality food. such consumers are more particular about the source of food given the increased awareness of the medical health dangers of consuming foods grown using unsafe practices as well as the widespread food safety scandals (wongprawmas, canavari & waisarayutt 2014). okello et al. (2012) indicate that despite the changing nature of fresh vegetable retailing in developing countries, particularly in sub-saharan africa, informal points of sale have remained significant for many urban dwellers who have resisted the enticement of modernity. in conformity, goldman and hino (2005) indicate that in some instances, lower-income consumers who purchase small amounts and shop frequently get lower benefits from shopping in supermarkets. while this may not be apparent to some researchers, such consumers put high value on attributes associated with small informal outlets, such as personal attention by store owners and operators, social interactions during shopping and being part of an informal economy centred around these outlets. roesel and grace (2015) add that through the social capital that develops from constant interactions, informal traders can exchange their products with consumers on credit. other consumers are reported by goldman, ramaswami and krider (2002) to use supermarkets for selected items while they rely on informal markets for perishable commodities like vegetables. such consumption behaviour could be related to the underdeveloped and fragmented supply system for perishable foods or supermarkets’ space limitations, particularly in developing countries. as a result, some supermarkets could end up offering a limited variety and quality compared to the traditional or informal sector. goldman, krider and ramaswami (1999) also attribute the limited use of supermarkets for perishable products to cultural values, which determine consumers’ attitudes towards food and their own definition of ‘quality’ and ‘freshness’. for instance, some consumers may prefer meat from recently slaughtered animals to frozen meat normally found in supermarkets (roesel & grace 2015). methods and procedures empirical model past studies (e.g. lichtenstein, netemeyer & burton 1990; meng et al. 2014) provide a natural setting within which consumers’ decisions to purchase similar commodities from alternative points of sale can be analysed. the choice between formal and informal markets as a source of vegetable supply is based on consumers’ utility maximisation. given that the decision to purchase from either of the two markets is dichotomous, a probit model was used for analysis (maddala 1983). to construct the dependent variable, respondents were asked to indicate their most preferred point of sale for vegetables. the options were presented as follows: 1 = pick n pay, 2 = spar, 3 = fruit & veg (food lover’s market), 4 = shoprite, 5 = hawkers, 6 = roadside stands, 7 = door-to-door, 8 = spaza shop, and 9 = farmers day, where options 1–4 constitute the formal market while options 5–9 constitute the informal market. the literature suggests that households’ purchasing decisions can be shaped by demographic, socio-economic attributes, and perceptions (carpenter & moore 2006; meng et al. 2014; okello et al. 2012). for this study, the demographic attributes that were considered include age and gender of household head, proportion of adult household members (18–60 years) with primary, secondary, matric or tertiary education, household size (in adult-equivalents), effective dependency ratio, and race. consideration of other household members with regard to education was based on previous evidence (e.g. mabuza et al. 2016) where it was found that in a typical african household, members who have come of age can, in various ways (e.g. physically, financially, psychologically, or otherwise), influence the household’s purchasing behaviour and food security direction. socio-economic factors considered in the model included main sources of income (e.g. salary or wage, self-employment, or grant) and wealth. the variable for wealth, which was in continuous form, was computed from an estimated value (in rands) of household assets that were identified by the respondents. the decision to use a wealth variable, as opposed to income, was based on the fact that most households are generally not comfortable with sharing financial information. following evidence from the literature (e.g. goldman, ramaswami & krider 2002; maruyama & trung 2010; okello et al. 2012), an additional variable was included in the model to account for the influence of consumers’ perceptions towards the two alternative main sources of vegetable supply. perceptions can either develop from gaining information or from one’s previous experience with vegetable markets. households’ perceptions were captured using numeric responses to 11 questions, which covered a number of contextual issues related to the two alternative markets (see table 2). principal component analysis was then applied to extract composite measures of perceptions from the responses, which were subsequently used as explanatory variables in the discrete choice model. the perception variables were measured in 5-point likert-type scale. two prominent principal components (pcs) were identified by showing eigenvalues greater or equal to 1. pc1 was found to represent safety and quality perceptions whereas pc2 was found to represent convenience and bargaining opportunities. principal component analysis results are presented in table 2 and discussed in the section ‘urban households’ perceptions on informal vegetable markets’. given that the respondents’ perceptions on informal markets could be shaped by previous experiences, there is a possibility that perceptions are endogenous (bontemps & nauges 2016). in view of the above likelihood, exogeneity was tested by estimating two stata ivprobit models where the perception variables were respectively instrumented by the frequency of purchase of 14 vegetables that were commonly consumed by the respondents. for each vegetable, frequency of purchase was measured as follows: 0 = never, 1 = seldom (1–2/month), 2 = sometimes (1–2/week), 3 = often (3–4/week), and 4 = daily. therefore, given that there were 14 commonly consumed vegetables, each household had a variable generated as a score out of 56, which was labelled ‘frequency of purchase’. the choice of this variable was premised on evidence from goldman and hino (2005) that consumers’ perceptions on food markets develop from past experiences with the respective markets. the reliability of the instrument was ascertained by applying di falco, veronesi and yesuf’s (2011) falsification test, where the results indicated that the selected instrument was valid. the instrumental variable was statistically significant in explaining the households’ perceptions (f = 3.41 [p = 0.06] – first equation [quality perception]) and (f = 6.09 [p = 0.014] – second equation [convenience and bargaining perception]), but not statistically significant in explaining the respondents’ choice between the formal and informal points of vegetable sale (lrχ2 = 0.19 [p = 0.663] – first equation) and (lrχ2 = 0.24 [p = 0.623] – second equation). however, with both ivprobit models yielding non-significant χ2 values for the wald test of exogeneity (χ2 = 0.47 [p = 0.492] – first equation) and (χ2 = 0.04 [p = 0.838] – second equation), it was concluded that perception factors were not endogenous in this study. therefore, the ‘ordinary’ probit model, whose results are presented in the ‘results and discussion’ section, was used to identify the factors influencing households’ decisions to purchase vegetables from either the formal or informal market. all estimations were conducted on stata 13. sampling and data collection procedure the study was carried out in 2015 in mahikeng local municipality, situated in the north west province of south africa. the municipality has 18 701 urban households, which are divided into 25 sections (statistics south africa 2011). this study, however, used 60% of the urban areas, which were selected randomly. having applied the krejcie and morgan (1970) procedure, a sample size of 370 households was selected for cross-sectional data gathering through the use of a structured questionnaire. the number of sampled households from each location was estimated with probability proportional to population size. through the assistance of 11 trained enumerators, data were obtained through face-to-face interviews with household heads between july and september 2015. however, due to some households not being willing to participate in the survey, a total of 230 questionnaires were eventually analysed. given that one of the specific objectives of the study was to measure consumers’ perceptions on informal vegetable markets, reliability of the questionnaire had to be ascertained. to this end, test-retest reliability was conducted during the pre-testing phase. it was during this phase that some questions had to be revised so that the captured data would help achieve the objectives of the study. results and discussion this section has three sub-sections: the descriptive statistics for variables used in the discrete choice model are presented first, followed by a discussion of the pca results. the last subsection presents the empirical results of the probit regression model. demographic and socio-economic description of respondents table 1 presents descriptive statistics of variables used in the probit regression model. the results indicate that with respect to gender, age group, race, household size, and major sources of income, households that preferred to purchase vegetables from the two markets had no statistically significant differences from one another. with respect to race, over 80% of the respondents were black south africans and the remainder were mixed race south africans, indian south africans and white south africans, respectively. in terms of the choices of vegetable sources, the results indicate that all races had more preference for the formal market while none of the white respondents showed preference for the informal market. table 1: descriptive statistics of variables used in the probit regression model, 2015 (n = 230). however, in terms of dependency ratio, households that were more likely to opt for the informal market had more members who were unemployed and generated less or no income at all. consequently, such households were more likely to opt for a source that offers vegetables at a relatively lower price. these findings were confirmed by the variable for wealth (proxy for household income). table 1 also indicates that wealthy households preferred to source their vegetables from the formal market as opposed to the informal one. households that bought from the two predominant sources were also found to differ significantly in terms of the educated proportion of adult members as well as their perceptions on informal markets. urban households’ perceptions on informal vegetable markets presented in this subsection are the pca results, which gave an indication of consumers’ perceptions on informal vegetable markets in the study area. given that the perception variables were measured in the same unit (5point likert-type scale), pca was applied using a covariance matrix (krzanowski 1987). the results presented in table 2 indicate that the use of pca was found appropriate to provide significant reductions in dimensionality as evidenced by the kaiser-meyer-olkin and bartlett’s test of sphericity. having applied the kaiser criterion of retaining pcs with eigenvalues 1 or greater, two pcs, which together accounted for 52% of total variation in the original variables, were retained and later used in the probit model as explanatory variables. applying the rule of thumb proposed by koutsoyiannis (1992) for observations above 50, pc loadings greater than │0.30│ were considered to indicate a strong association between the original scores and the pcs. these loadings are highlighted in table 2 in bold print. table 2: principal component analysis of urban households’ perceptions on informal vegetable markets, 2015 (n = 230). the first pc in table 2 was found to represent safety and quality perceptions. accounting for 38% of the total variation in the original variables, the dominant indicators for pc1 were d6, d7, d9 and d10. these results suggest that urban consumers’ perceptions were largely influenced by the cleanliness of the environment from which the vegetables were sold as well as the quality of the vegetables themselves. pc2 was found to represent perceptions related to bargaining between buyers and sellers and the convenience that informal traders provide urban consumers. the dominant indicators for pc2 were d2, d3, d4, d5 and d7. however, d7 had more impact on pc1 than pc2. these results imply that urban consumers’ perceptions on informal vegetable markets were also influenced by the fact that informal traders help them towards improving their food security status, allow them to bargain, and provide them with a comparatively less costly option of accessing vegetables consistently. factors influencing urban consumers’ choice of vegetables sources of supply the probit regression results are shown in table 3 and the discussion focuses on the factors that were found to have a significant influence on urban households’ decision on whether or not to purchase vegetables from the informal markets. the overall estimated model was statistically significant as the estimated wald χ2 value was significant at the 1% level of probability. the model also correctly predicted about 80% of the households’ decisions, suggesting that it fitted the data quite well. prior to estimating the probit model, the variables were tested for possible multicollinearity using pairwise correlations and variance inflation factor (vif). with the results indicating that the variables were reasonably independent of one another, the model was subsequently estimated with robust standard errors to address possibilities of heteroscedasticity. table 3: probit estimates of factors influencing urban consumers’ choice of vegetables source of supply in mahikeng, 2015 (n = 230). contrary to okello et al’s (2012) findings, the results in table 3 indicate that households headed by relatively old people (members within the age bracket of 46–59 years in this case) were found to be significantly more likely to participate in the informal market. available evidence (e.g. sahyoun, zhang & serdula 2006) specifies that as humans grow older, the consumption of healthy foods such as vegetables becomes more important. older adults are at high risk of developing chronic conditions; therefore, prevention becomes a better option. as such, households headed by relatively old people may decide to purchase vegetables from a nearby convenient source, which in this case is the informal market. another tentative reason behind this result is the fact that prices in the informal markets are comparatively low. therefore, due to the high consumption need for vegetables, such households would prefer to purchase vegetables from sources that are capable of providing more in terms of quantity at a low retail price. another estimated coefficient that was found to be statistically significant was the proportion of adult household members with primary education. households with a greater proportion of members in this category were more likely to participate in the informal as opposed to the formal vegetable market. in relation to this result, table 3 further indicates that as adult members become exposed to further education, their decisions or willingness to participate in the informal vegetable market are likely to change. this was evidenced by the estimated coefficient for the proportion of adult household members with tertiary education which was positive. although not statistically significant, this result, which conforms to previous findings (e.g. kapoor & kumar 2015; meng et al. 2014), implies that with further education, urban households would prefer to purchase their vegetables from the formal market. better educated household members are more likely to have improved access to market-related and food information that significantly influences their decision-making. better educated members could also be earning relatively high salaries; hence, they can afford to source food supplies from the formal market. the estimated coefficient for wealth was found to be positively and statistically significantly related to households’ participation in the formal as opposed to informal vegetable market. wealthy households are more capable of paying the price premium charged by formal vegetable outlets for food safety and quality as well as labelling. table 3 further indicates that the two estimated coefficients for households’ perceptions on informal vegetable markets were both statistically significant. the results indicate that households that are mostly concerned about food safety and quality are significantly less likely to participate in the informal vegetable market. however, households that prefer to bargain when they purchase vegetables were found to be significantly more likely to purchase their vegetables from the informal market. by virtue of trading in highly perishable commodities, which are usually displayed in the open as opposed to refrigerated containers, informal traders are more likely to bargain with their customers as they intend to sell their stock within the shortest possible time. if the vegetables remain unsold for a number of consecutive days, they will lose form and end up being sold at very low prices or discarded due to spoilage. related to bargaining is the issue of convenience. this factor is also important considering that most informal vegetable outlets are located along roadsides that urban dwellers use especially when travelling to and from work. some are within residential places rather than in the central business district, while others are mobile enough to do door-to-door sales, making it very convenient for the consumer who ends up saving on transport costs. an attempt was made to find out from the respondents if they were likely to change their preferred market outlets for future purchases, particularly in the wake of food scares linked to vegetables. the responses revealed that the number of consumers who would prefer the formal market under the circumstances increased from 176 to 194 while 36 indicated that irrespective of such food scares, they would remain loyal to the informal market. this underlines that, ceteris paribus, vegetables sold through formal channels are generally perceived to be consistent in quality. despite the fact that over 75% of the sampled households indicated that most of their vegetables are sourced from the formal market, the study accentuates the importance of informal vegetable markets in the urban sector. it also underlines that the main characteristic of food security in urban areas is not food production, but access to food. accessibility hinges primarily on the household’s ability to purchase, which in turn depends on household income, the price of food and location of food outlets. so, if informal markets are valued by urban vegetable consumers, how can informal traders be assisted to address the food safety and quality concerns raised by respondents, and whose responsibility is this? worth indicating is that the municipality has tried over the years to have informal fruit and vegetable traders work collectively so that whatever programmes meant to assist them are coordinated easily. in some instances, fixed stalls have been erected in certain locations where traders are expected to pay a nominal monthly fee for maintaining the facilities. however, because informal traders have neglected these facilities, instead electing to conduct their businesses in strategic areas where they can easily make contact with consumers, working as a collective seems to suppress their entrepreneurial abilities. limitations of the study and areas for further research this study focused on urban consumers, but did not factor in the concerns and circumstances of informal traders. given the above, further research is required, perhaps to study the perceptions of urban-based informal vegetable traders on the sustainability of their economic activities in the light of consumers’ food safety and quality concerns. the proposed study would also provide information on how informal traders would prefer to be capacitated so that they not only assume a position where they are able to address consumers’ concerns, but manage to increase their market share in an industry that continues to be monopolised by supermarket chain stores. in addition, a risk pathway analysis along the informal vegetable chain, compared with the formal market is recommended. the novelty of the proposed risk pathway analysis emanates from the observation that a considerable percentage of the vegetables traded in the south african informal market are either sourced from the formal market or the same primary suppliers (see jackson 2010 for details). another interesting dimension linked to the proposed risk pathway analysis relates to recent findings reported by roesel and grace (2015), where food sold through formal markets in east and southern africa, though commonly perceived to be safer, had lower compliance with standards than informally marketed food. conclusions and implications for policy the study sought to examine the perceptions of urban dwellers towards participating in informal vegetable markets and determine the underlying factors shaping their purchasing decisions. these specific objectives were addressed by using cross-sectional data obtained through the use of a questionnaire from a sample of 230 households that were identified through a multi-stage random sampling technique. having used pca to analyse consumers’ perceptions on vegetable markets, two pcs were found to be dominant, representing safety and quality perceptions as well as the convenience and bargaining opportunity provided by informal traders. the probit regression results suggested that households’ preference for the informal vegetable market were positively influenced by age of household head, low level of education of adult household members, and the convenience provided by informal markets. households that fall under the low-income bracket and are headed by relatively old members were found to have difficulty in accessing the formal market, which provides vegetables at a comparatively high price. besides the price premium, which is linked to the quality and labelling of supplies in the formal sector, given the location of most of the supermarket chain stores, consumers have to incur additional transport costs in their attempt to access vegetables sold through the formal market. in contrast, convenient delivery and lower prices (reflecting lower handling and processing costs) that characterise informal markets are the principal benefits for consumers. however, households’ wealth status and the perceptions on safety and quality of vegetables were found to have a significant negative influence on participation in the informal market. given that informal vegetable trade forms an integral part of the urban economy by offering easy access to food in public spaces and connecting with the formal economy where informal traders source their supplies, policy interventions are required to improve their circumstances and the quality of the food they sell. to achieve the above, it is important that the role played by the informal sector is first recognised at the national government level. currently, the south african government does recognise the employment creation capacity of the informal sector. however, national initiatives such as the national development plan do not have defined and explicit programmes on how existing informal sector operators will be supported so that they reach a stage where they are better organised and can swiftly respond to market requirements. this is one area that needs to be addressed as a matter of priority. secondly, reflecting on the results of this study, it is recommended that through the national informal business upliftment strategy, currently being driven by the department of small business development, an integrated programme should be introduced to provide the necessary capacity to informal food traders to improve their services, particularly on matters related to food quality. such initiatives can go a long way in improving the value of their businesses while ensuring urban food and nutrition security. acknowledgements the authors are grateful to the nwu food security and safety niche area as well as the fast research committee for funding different aspects of the study. the opinions expressed in this paper are those of the authors and do not necessarily reflect the views of the funders, north-west university; food security and safety niche area and the fast research committee fund. competing interests the authors declare that they have no financial or 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implications for agri-food systems and the rural poor’, development policy review 21(3), 333–355. https://doi.org/10.1111/1467-7679.00214 wongprawmas, r., canavari, m. & waisarayutt, c., 2014, ‘are thai consumers willing to pay for food safety labels? choice experiment of fresh produce’, paper prepared for presentation at the eaae congress, agri-food and rural innovations for healthier societies, ljubljana, slovenia, 26–26 august. sajems ns vol 3 (2000) no 3 debt sustain ability and exchange stabilisation: towards a new theory olivier basdevant and theuns de wet department of economics. university of pretoria abstract 436 rate the sustainability of debt is a crucial issue in developing and transitional economies. in this paper, it is showsnthat a bubble in the real exchange rate could result in a sudden collapse in the sustainability of a country's debt. furthermore, it is shown that monetary authorities may be unable to control the exchange rate, as its dynamics also depends on that of the debt. hence, the only feasible policy measure to stabilise the real exchange rate is to increase domestic non-price competitiveness to ensure an improvement in the trade balance of the economy. 1 introduction this article deals with the problem of debt sustainability in developing and transitional economies, with particular emphasis on the south african economy. in most studies of debt sustainability, the problem is analysed from a long-run perspective. these studies emphasise the need to keep the rate of gt)p growth equal to the real interest rate, with a balanced budget, in order to maintain a constant debt to gdp ratio (see cuddington (1997) for a review). this study does not analyse debt sustainability in the long run only, but also motivates the need to keep exchange rate expectations constant in the short run, especially in the case where a country's debt significantly comprises foreign debt. the change in the rate of growth of a county's debt not only depends on the interest rate or gdp growth, but also on the change in the real exchange rate. hence, the dynamics of the exchange rate could very rapidly render debt unsustainable. the reason for this is simple: in the case of a country with significant foreign debt, a depreciation of the country's currency will increase its debt burden in terms of domestic currency. this increase in the debt burden will encourage the outflow of capital on the financial account of the balance of payments that, in tum, further increases the downward pressure on the exchange r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 437 sajems ns vol 3 (2000) no 3 rate. hence a vicious circle arises in the case where a weak currency induces a change in exchange rate expectations, which then increases the debt burden and further weakens the currency. it is therefore important that this chain of events be analysed in the short run, because it could rapidly lead to the unsustainability of a country's foreign debt (i.e. within some weeks). this could lead a country into bankruptcy even if the gdp rate of growth remains above the interest rate in the long run. the conclusion of this article applies to transitional or developing economies that usually face difficulties in financing their public deficit by issuing domestic debt, and have to use foreign debt to finance public expenditure. in such a case, the need to keep the real exchange rate stable seems to be a prerequisite for debt sustainability and also to avoid a possible currency crisis stemming from the unsustainability of foreign debt. this of course emphasises the importance of the various measures of controlling net international reserves. 2 the model in this section we derive a model of the effect of real exchange rate fluctuations on foreign debt sustainability. an accounting approach is applied to a growing economy with a debt burden consisting solely of foreign debt. in addition, one homogenous product in the economy is assumed. 2.1 an accounting approach to sustainability in this section, we derive the basic properties of a very simple theoretical framework based on the accounting approach to debt sustainability. tn this accounting approach the debt burden of a country is usually expressed as a ratio, usually to the gross domestic product of a country. the presentation of the model starts with an equation that expresses the growth of debt i as a function of the nominal interest rate, debt, government expenditure, taxation and money creation: (1) e"lhentb+(g t)+ m where dots represent the derivative with respect to time, and en is the nominal exchange rate, b is nominal foreign debt in domestic currency, ( is nominal interest rate on the debt, g is government expenditure, t is the total amount of collected taxes and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 438 m is the creation of money by the central bank. this model can be simplified by defining the primary surplus of the government as: (2) s=t-g m and the nominal exchange rate as: (3) . en =~ p with e the real exchange rate, p* a foreign price index and p the domestic price index. by substituting equations 2 and 3 into equation i, the change in debt can be expressed as: (4) ~b .. e b-j;.s i p p or: (5) b s -=1 b eb however, because the accounting approach usually expresses debt as some ratio and because it is preferable to consider the debt to gdp ratio for a growing economy (see mccallum (1984), hakkio and rush (1991», the debt is expressed as a ratio to gross domestic product. if we let y be the gdp, the debt to gdp ratio is defined by the following equation: (6) b=~. b. p y from this equation it follows directly that oe:8p"y (7) -=-+ ---b e b p' y and by combining equations (5) to (7), the change in the gro\\<th of debt becomes: (8) with: (9) (10) o e s r -g+--b e b p _ s se'py r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 439 and (ii) y g y sajems ns vol 3 (2000) no 3 equation 8 indicates that debt sustainability not only depends on the difference between the rate of growth of the gdp and the interest rate, but also on the rate of change in the real exchange rate. this result can further be interpreted to show that the primary surplus required to keep the debt to gdp ratio constant over time is defined by2: (12) s {r' -g+;). the above approach to debt sustainability can also be useful in assessing whether different government objectives are feasible or not. for example if gdp growth, as well as the primary surplus and the real exchange rate should remain constant, the debt to gdp ratio will also be constant. however, the but simple but significant result from this equation is that when debt is denominated in foreign currency, stabilising the exchange rate is a key aspect of debt sustainability. it is important because this variable is likely to be more volatile than either the gdp rate of growth or the interest rate. the importance of this result is emphasised further by the fact that the change in the real exchange rate depends crucially on exchange rate expectations. these expectations, in tum, also depend on investors' perceptions of the sustainability of the debt and more generally of the sustainability of the economic policy adopted by the government to sustain this debt. it is therefore important to investigate how economic agents form their exchange rate expectations. 2.2 introducing exchange rate expectati(>lls the previous section has described the traditional approach to analysing debt sustainability and shows how fluctuations in the real exchange rate can affect debt sustainability. a problem that may arise in a developing economy, is that the exchange rate may influence debt sustainability and in the process induce a negative feedback effect on the exchange rate. hence debt can rapidly become unsustainable in the short run, and could lead a country into bankruptcy because of an unstable dynamic relationship that links the debt of a country and the exchange rate. the aim of this section is to analyse the conditions under which this is possible, and also the economic policy recommendations which could avoid this. to understand the evolution of the exchange rate, one must understand how economic agents form exchange rate expectations, and then incorporate it in the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 440 equation defining the exchange rate. one approach that is used quite often to determine how agents form their expectations, is that of rational expectations. this approach assumes too much information on the part of agents, especially in a developing or transitional economy. another approach that could be used, is to incorporate a learning process in building expectations. it can be assumed that agents' expectations are on average correct, but that they only have a limited set of information available. with such an approach it is possible to present expectations in a rather simple way, avoiding systematic errors in a model similar to those of feige and pearce (1976), hall (1987), hall and garrat (1995) and (1997), in which agents are assumed to use only a univariate model to form their exchange rate expectations. following a range of models like blundell-wignall, fahrer and heath (1993); tarditi (1996); basdevant (2000) and basdevant, brink and koekemoer (2000), the exchange rate is modeled as dependent on the current account deficit. the pattern of exchange rate change should, in the long run, depend on fundamentals that are derived from internal and external equilibrium (see bayoumi, clark, symansky and taylor (1994); barrell, anderson lansbury and sefton (1996) or brink and koekemoer (2000) for a south african application). this study focuses on external equilibrium and it is assumed that the exchange rate stabilises around a value that equilibrates the current account. let cur be the current account (not including portfolio investment for simplicity). it is defined by: (13) cur tb j'b where tb is the trade balance. normaliy we could assume that exchange rate expectations depend on cur, but we consider for simplicity that agents take into account the ratio of reserve variation over gdp, in real terms. equation (\3) then becomes: (14) cur tb j'b e let tb be the trade balance to gdp ratio: (15) tb tb hence, we can simply write the rule governing of expectations as the following: (16) : -f(t i:b j r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 441 sajems ns vol 3 (2000) no 3 where fo is an increasing function, with f(o) o. thus, when there is an increase (decrease) in net international reserves, the exchange rate is decreasing (increasing). the dynamics of the exchange rate is then basically stable. the dynamics of the system can be illustrated in a phase diagram. the locus where the exchange rate is constant is given by: (17) ( "b) "b ft-~ o::::>e=\. we have to determine the locus where the debt to gdp ratio is constant. from equations (8) and (16) can be shown that: (18) ~ r' g f( t 5 b hence b is constant if the following holds: (19) j'b fi (' 5) e t+ r-g-t; which defines b as an increasing function of e. comparing equations (17) and (19) shows that the locus e 0 is always above the locus b = o. we can then construct the following phase diagram: figure 1 sustainable and unsustainable debt b i debt unsustainable l e-o r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 442 3 economic policy it is evident from the above theoretical analysis that a stable real exchange rate is a prerequisite for debt sustainability. this section considers some policy suggestions to avoid a sudden depreciation in a currency. according to the international monetary fund, global trade imbalances have increased because of the emerging market crises during the nineties. these imbalances may give rise to destabilising movements in exchange rates and may also increase protectionist pressures. these destabilising movements in the exchange rate must be prevented to ensure debt sustainability. it seems as if the only solution to this problem is to not make use of short-run monetary policies but rather to implement policies that will ensure positive trade balances in the long run. a direct result from equation (16) is that the dynamics of the exchange rate depend on the net international reserves and, if portfolio investment is ignored, it means that it depends on the trade balance. equation (16) has shown that the exchange rate dynamic will be stable if the trade balance is positive. more precisely, policies encouraging exports to the rest of the world should be implemented. a traditional approach is used to analyse the trade account balance, where: (20) tb=fly:(,~j with y = domestic income, y* = foreign income and e = real exchange rate. the signs under the variables in equation (20) show the expected direction of the effect of these variables on the trade account. because domestic authorities cannot influence foreign income or foreign prices, the only economic variables that the domestic authorities can use to ensure a trade balance surplus are domestic income, domestic prices and the exchange rate. although a decline in domestic income will reduce imports, this is clearly not a viable option to pursue and will have negative welfare effects and will also cause the debt to gdp ratio to rise. this leaves the two price variables in the function to be used as policy tools. many policy makers consider a depreciation of the exchange rate as a means to stimulate exports and discourage imports. the model and discussion in sections 2.1 and 2.2 have indicated however that this will not be an option as a policy measure because a sudden depreciation in the exchange rate could result in the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 443 sajems ns vol 3 (2000) no 3 sudden unsustainability of foreign debt when a developing economy has a substantial volume of foreign debt. the one remaining policy tool that can be used to ensure a positive trade balance are domestic prices, which are used to stabilise the exchange rate. a decrease in domestic prices relative to foreign prices will improve the trade balance in that it will stimulate the demand for exports and reduce the demand for imports. but this is quite risky, as it may initiate a vicious circle, with a depreciating currency inducing a snow-ball effect on debt. the only sustainable policy is then to focus on structural competitiveness that will depend on goods quality, rather than their price. south africa appears to be lagging behind its major trading partners in non-price competitiveness. there are a number of measures that can be implemented to improve this kind of competitiveness, which includes increasing the flexibility of domestic labor markets, decreasing the cost of doing business in the country and an increase in competition. another prerequisite is an increase in measures to stimulate the supply side of the economy. an increase in investment on new and improved capital stock is necessary as well as an improvement in the technology used in the economy. improved education and training of the labor force is also a measure that must be implemented. the policy proposals may be summarised in stating that the only feasible policy to ensure a sustainable trade account balance and therefore a stable exchange rate, is to increase non-price competitiveness in the domestic economy. a depreciation of the exchange rate is a short-run solution only, which may cause the domestic economy's foreign debt to rapidly become unsustainable. 4 conclusion in this paper, we focused on the importance of keeping the exchange rate stable in order to prevent a situation where the foreign debt of a country becomes unsustainable. this conclusion was derived by applying an accounting approach to debt sustainability. the resulting model showed that, although the growth in the gdp of a country and the interest rate on debt are important factors to evaluate in determining debt sustainability, changes in the exchange rate can have such an impact on foreign debt that it could render debt unsustainable in a very short time. the last section of the paper identifies policies that can be pursued to ensure a positive trade balance. the only feasible policy for a developing economy is to increase the non-price competitiveness of the country. although this is a longrun policy suggestion, it will ensure a stable exchange rate, which in tum will r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 444 ensure that the foreign debt of the developing or transitional economy will remain sustainable. endnotes 1 for simplicity we assume that there is no foreign debt. 2 this account relation can be derived from the transversal condition of the lender's utility maximisation problem (see mccallum (1984) or o'connel and zeldes (1988) for a growing population). references barrell r.; anderson, b.; lansbury, m. and sefton, 1. (1996) "feers for the nles. exchange rate policies and development strategies in taiwan, korea, singapore and thailand", national inslilule of economic and social research: 1-42. 2 basdevant, o. (2000) "an econometric model for the russian federation" forthcoming economic modelling. 3 basdev ant, 0.; brink, s. and koekemoer, r. (2000) "modelling the south-african exchange rate: a timenarying parameter approach" mimeo. 4 ba youmi, t.; clark, p.; symansky, s. and taylor, m.p. (1994) "robustness of equilibrium exchange rate calculations for alternative assumptions and methodologies" imf working paper, 17. 5 blundell-wignall, a.; fahrer, j. and heath, a. (1993) "major influences on the australiatl dollar exchange rate" in a. blundell-wignall (ed.) the exchange rate. international trade and the balance of payments, conference proceedings, reserve bank of australia. 6 brink, s. and koekemoer, r. (2000) "the economics of exchange rates: a south african model" forthcoming south african journal of economic and management sciences, 3( i): 19-51. 7 cuddington, j.t. (1997) analysing the sustainability of fiscal deficits in developing countries, working paper, economics department, georgetown university, washington d.c. 8 feige, e.l. and pearce, d. (1976) "economically rational expectations: are innovations in the rate of inflation independent of innovations in measures of monetary and fiscal policy?" journal of political economy 84: 499-522. 9 hall, s.g. (1987) "a forward-looking model of the exchange rate" journal of applied econometrics, 2: 47-60. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 445 sajems ns vol 3 (2000) no 3 10 hall, s.g. and garratt, a. (1995) "model consistent learning: the sterling deutschmark rate in the london business school model" economic modelling, 12: 87-96. 11 hall, s.g. and garratt, a. (1997) "the stability of expectational equilibria in the lbs model" in macroeconomic modelling in a changing world, c. allen and s.g. hall (eds.), john wiley & sons ltd. 12 hakkio, c. and rush, m. (1991) "is the budget deficit 'too large'?" economic inquiry, 29: 429-45. 13 mccallum, b. (1984) "are bon-financed deficits inflationary? a ricardian analysis", journal of political economy, 92: 123-35. 14 o'connel, s. and zeldes, s. (1988) "rational ponzi games" international economic review, 29(3): 431-50. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 189 the relationships of type a behaviour, organisational and personality variables among pharmacists and accountants a further analysis r van wyk and ab bosboff department of business management, university of pretoria abstract this paper is a follow-up of a previous study on the correlates of type a behaviour among professional workers in south africa. in the previous study, data were analysed for a joint group of375 pharmacists and accountants. in the present study, the two professions are analysed separately. product-moment correlation and stepwise multiple regression analysis are used to determine the relationships between job satisfaction, job involvement, a number of personality variables and type a behaviour in samples of accountants (n = 175) and pharmacists (n = 200). differences between the results for the two occupations were found to exist and are discussed in this paper. jelj20 introduction the two groups of participants, accountants and pharmacists, included in the current study, can be seen as different professional cultural groups. the statement is forwarded that a professional cultural milieu is developed in each of the two professions. anastasi (1990) warns that cultural differences may affect the responses to particular psychometric instruments due to group differences, thus reducing the validity of measuring instruments for specific groups. members of the two professions analysed here have widely different work milieus which may also lead to different cultural milieus. in terms of holland's (1985) classification of occupations, pharmacists and accountants may be seen as belonging to two separate career categories with personality types that are mutually exclusive. pharmacists are found in the holland (1985) categories of highly investigative, moderately artistic and weakly realistic. the accountant profession falls in the categories of remarkably conventional, somewhat enterprising and vaguely social individuals. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 190 sajems ns vol 3 (2000) no 2 in the previous study, referred to as van wyk et al. (l999a), some personality and organisational variables were related to type a behaviour scores when the responses of pharmacists (n = 200) and accountants (n = 175) were comhined. in the present analysis. the two groups are treated as separate subsets and the relationship between type a behaviour and personality and organisational variables investigated. the high demands that westernised urban societies make on workers, professio.llals in particular, may well lead to high levels of stress. such a degree of stress may be the antecedent to type a behaviour, or lead to certain outcomes resulting from this behaviour pattern (byrne, 1987). further investigation of possible antecedents of type a behaviour therefore seems warranted. a discussion on the origin of type a behaviour and the relationship with variables investigated in various studies is available in van wyk et al. (i 999a). method sample the present sample consists of 375 professionals from two occupations, namely, pharmacists (n = 200) and accountants (n = 175). the total sample had a mean age of 41.6 years (range: 22-84; so 12.46). the mean ages of the subsamples were: pharmacists 39.46 years; (range"" 22-84; so = 12.70) and accountants 44.05 years (range = 24-82 years; so = 11.95). of the total sample, males formed 58.9% (n = 221) and females 41.1% (n = 154). the males consisted of pharmacists (n = 68, 30.8%) and accountants (n = 153, 69.2%). the females consisted of pharmacists (n = 132, 85.7%) and accountants (n = 22,14.3%). the home languages of the participants were given as: english (n = 211, 56,3%), afrikaans (n = 158,42.1%), venda (n = 1,0.3%), zulu (n = 2, 0.5%), north sotho (n = 2, 0.5%). the home language of one participant was unknown. the home languages of the pharmacists were: english (n = 105, 52.5%), afrikaans (n = 90, 45.0%), venda (n =1,0.5%), zulu (n = 1,0.5%), north sotho (n = 2, 1.0%) and unknown (0.5%). the home languages of accountants were: english (n = 106,60.6%), afrikaans (n = 68, 38.9%), zulu (n = 1,0.6%). of the total sample of 375 participants, 201 (53.6%) identified themselves as employees of organisations, 169 (45.1%) saw themselves as private practitioners and 5 (1.3%) did not provide information in this respect. of pharmacists, 46 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 191 (23%) were in private practice and 153 (76.5%) worked as employees. one pharmacist (0.5%) did not provide information in this respect. the responses of accountants indicated that 123 (70.3%) were in private practice and 48 (27.40%) worked as employees. four (2.3%) of the accountants did not provide information in this respect. the number of jobs occupied by participants prior to the study varied between one and eight. the majority of participants (93%) had held fewer than five jobs prior to the study, with pharmacists (mean = 2.73, so = 1.54) having had numerically fewer jobs than accountants (mean = 3.18, so 1.47). the number of years worked until the time of the study varied between 1 and 60 for the total sample. pharmacists worked between 1 and 58 years and accountants between 1 and 60 years. members of the total sample had worked a mean number of 18.7 years (so = 12.56), pharmacists a mean of 15.3 years (so = 12.04) and accountants a mean of 21.3 years (so = 12.39). the average number of organisations worked for prior to the study by the total sample was 2.83 (so = 1.56). the corresponding figures for the two groups were pharmacists 2.73 (so = 1.51) and accountants 2.95 (so = 1.62). the marital status of the total sample of participants who provided information were: married n = 295 (78.7%), single n = 62 (16.5%) divorced n = 10 (2.7%), widowed n = 6 (1.6%) and cohabiting n = 2 (0.5%). the marital status of the two occupational groups were: pharmacists: married n = 148 (74%), single n = 41 (20.5%), divorced n = 8 (4.0%), widowed n = 1 (0.5%) and cohabiting n = 2 (1.0%); accountants: married n = 147 (84%), single n = 21 (12%), divorced n = 2 (1.1%) and widowed n 5 (2.9%). the majority of the participants (n = 289, 77%) indicated that they grew up in an urban environment (pharmacists n = 150, 75% and accountants n = 139, 79.4%). the gauteng province of south africa is indicated as the region in which most of the participants (n = 213, 57%) grew up (pharmacists n = 113,56.5% and accountants n = 101,57.7%), with a more or less even distribution over the other eight provinces. procedure details concerning the procedure followed are found in van wyk et al. (l999a). results statistical analyses were done to determine the possible relationships between type a behaviour, as shown by the pharmacists and accountants, and the different variables measured in the study. the factor scales identified for each instrument (van wyk et al. (1999b) are listed in table l r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 192 sajems ns vol 3 (2000) no 2 table 1 list of identified fadors for each instrument jfi jenkins factor 1 achievement jf2 jenkins factor 2 hard drivinwcodlj)etitive jf3 jenkins factor 3 speed and impatience jfg jenkins g jenkins global lci i locus of control i internal lc2 of control 2 external lc3 locus of control 3 vicissitudes of life col career orientations 1 service dedication co2 career orientations 2 job security c03 career orientations r entrepreneurial c04 career orientations 4 life style integration n job involvement jsl job satisfaction 1 general js2 job satisfaction 2 intrinsic js3 job satisfaction 3 supervision sci self-concept i power sc2 self-concept 2 task accomdlisbmentimorai sc3 self-concept 3 likeability enti entret>reneurial attitude i economic innovation ent2 entrepreneurial attitude 2 achievementlpersonal control ent3 entrepreneurial attitude 3 self~esteem the inte!'correlations among the scores on the factor scales for the two professions were measured. due to the very extensive results and the shortage of space. these statistics are not reproduced here but available from the firstmentioned author on request. stepwise multiple regression was used to construct multivariate models of the relationships between the different personality and organisational variables and the level of type a behaviour. separate models were built for pharmacists and for accountants. the global scores on the jenkins instrument and the type a su~scale scores served as dependent variables. the results are shown in tables 2 to s. in these tables the independent (predictor) variables are shown in the order in which they entered into the multiple regression model with the different jenkins type a variables as dependent variables. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 193 table 2 results of stepwise multiple regression analysis of sub-scale scores on jenkins activity survey scores as dependent variable for pharmacists dependent variable: jenkins global score (phannacists n = 200) independent f(df) p rl(model) c(p) variable sci 55.9060 0.0001 0.2202 40.1751 power (l;199) sc3 14.7688 0.0002 0.2746 25.7042 likeability (2; 198) lc 1 12.3185 0.0006 0.3175 14.7124 internal (3;197) lc2 5.5773 0.0192 0.3364 10.9645 external (4;196) js i 7.3026 0.0075 0.3605 5.6741 general i (5;195) dependent variable: jenkins 1: achievement (phannacists n = 200) independent f(df) p rl c(p) variable (model) co 1 22.2977 0.0001 0.1012 72.2469 service (1;199) sc3 15.6316 0.0001 0.1673 54.5267 likeability (2;198) sc2 21.4251 0.0001 0.2493 32.0369 task (3; 197) accomplishment sc 1 12.9012 0.0004 0.2959 20.1344 power (4;196) co2 5.5530 0.0194 0.3155 16.2869 job security (5;195) i job involvement 4.4256 0.0367 0.3309 13.7075 (6;194) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 194 sajems ns vol 3 (2000) no 2 table 1 continued dependent variable: jenkins 2: hard driving/competitive (pharmacists n = 200) independent f(df) n r2(model) . variable sc 1 48.5268 0.0001 0.1968 power (l;199) lc2 9.6390 0.0022 0.2343 external (2;198) js 1 4.6391 0.0325 0.2520 general (3;197) dependent variable: jenkins 3: speed and impatience (pharmacists n = 200) lddepeadent f(df) p r2(model) variable is 3 4.3884 0.0375 0.0217 supervision 0;199) co2 4.5982 0.0332 0.0440 job security (2;198) c(p) 10.9442 3.2909 0.7292 c(p) 17.7645 14.8888 from table 2 it can be seen that in the pharmacists sample, global type a could be predicted by four personality sub-scales and one organisational variable (n = 2(0). global type a scale score had 36.5% common variance with the five predictor variables. the jenkins factor 1 (achievement) was predicted by five of the personality sub-scales and by lob involvement yielding a common variance between the dependent variable and the predictors of 33.09%. the second jenkins factor (hard driving/competitive) had 25.20% common variance with the three independent variables (two personality variables and one organisational factor) included in the predictor model. the model for predicting scores on jenkins factor 3 (speed and impatience) included one personality subscale and one organisational variable. only 4.4% common variance existed between the dependent variable and the predictors in this model. farther stepwise multiple regression analyses were done on the pharmacists' responses. the total scores of the variables measured by means of personality and organisational variables were regressed on the global type a score for pharmacists. only the variables on which a total score made theoretical sense were included as independent variables in this analysis. the results of this r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 195 analysis with the independent variables in the order in which they entered the multiple regression model are shown in table 3. table 3 results from stepwise multiple regression analysis of total scores on global jenkins activity survey score as dependent variable for pharmacists dependent variable: jenkins global (pharmacists n = 200) independent f(df) p rl (model) c(p) variable self-concept 34.2358 0.001 0.1474 18.9702 (1;198) job involvement 12.4053 0.0005 0.1979 8.2353 (2'197) job satisfaction 5.1676 0.0241 i 0.2185 5.0402 (3.196) as can be seen from table 3, the prediction model for the global type a score included one personality variable and one organisational factor. this model yielded a total prediction of the variance in the dependent variable of21.85%. stepwise multiple regression analysis was also done on the responses of the accountants sample (n 175) in order to predict the type a behaviour pattern global score and sub-scales scores as dependent variables, with the personality and organisational sub-scale scores as independent variables. the results are shown in table 4. table 4 results from stepwise multiple regression analysis of subscale scores on jenkins activity survey scores as dependent variable for accountants dependent variable: jenkins global (accountants n = 175) independent variable f(df) p rl(model) c(p) lc i 58.0951 0.0001 0.2514 44.9631 internal (1;174) ent 1 14.2838 0.0002 0.3088 30.4035 economic innovation (2;173) i sc i 6.7510 0.0102 0.3350 24.8302 power (3'172) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 196 sajems ns vol 3 (2000) no 2 table 4 continued independent variable f(dj) p rl(model) c(p) co2 6.4517 0.0120 0.3594 19.8162 achievementlpersonal (4;171) control sc3 5.1362 0.0247 0.3783 16.3650 likeability (5;170) sc2 6.6780 0.0106 0.4020 11.5079 task accomplish (6;169) lc2 4.2336 0.0412 0.4168 9.2427 external locus of (7;168) control dependent variable: jenkins 1: achievement (accountants n = 175) independent variable f(dj) p rl(model) c(p) ent 1 40.1622 0.0001 0.1884 60.3247 economic innovation 0'174) sc2 11.6814 0.0008 0.2400 47.6134 task accomplishment (2'173) sc3 8.3018 0.0045 0.2752 39.5840 likeability (3~172) lc 1 7.1250 0.0083 0.3044 33.2740 internal locus of (4;171) control lc2 10.4357 0.0015 0.3448 23.7427 external locus of (5;170) control ent2 5.0400 0.0261 0.3639 20.3036 achievementipersonal (6;169) control lc3 4.7791 0.0302 0.33812 17.2595 vicissitudes (7;168) sc 1 4.3546 0.0384 0.3974 14.7540 power (8'167) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 197 table 4 continued dependent variable: jenkins 2: hard driving/competitive (accountants n = 175) independent f(df) p rl c(p) variable (model) sc i 53.9297 0.0001 0.2376 -0.7709 power i 0'174) ent i 3.9495 0.0485 i 0.2548 -2.5921 econonllclnnovation (2;173) dependent variable: jenkins 3: speedllmpatience (accountants n 175) independent f(df) p rll c(p> variable (model) co2 6.2983 0.0130 0.0351 i 7.6395 job security 0'174) c03 4.9036 i 0.0281 0.0619 i 4.6878 entrepreneurship (2;173) it is' seen from table 4 that in the case of global type a behaviour, the prediction models included seven of the personality sub-scales, yielding a total prediction of 41.68% of the variance in the dependent variable. the model for predicting jenkins factor 1 (achievement) scores contained eight of the personality sub-scales, with a total prediction of 39.33% of the variance in the dependent variable. the models built to predict both the second and third jenkins sub-scales (hard-driving/competitive and speed impatience respectively) each contained only two of the personality sub-scales with a common variance of 25.48% and 6.19% respectively with the dependent variable. the total (scale) scores on the same variables as for pharmacists were regressed on the global type a scores of accountants. the results are summarised in table 5. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 198 sajems ns vol 3 (2000) no 2 tables results from stepwise multiple regression analysis of total scores on global jenkins activity survey score as dependent variable for accountants (n = 115) dependent variable: jenkins global (accountants n = 175) independent f(df) p r2(model) c(p) variable self·concept 54.92 0.0001 0.2410 23.4964 (l;173) entrepreneurial 14.32 0.0001 0.3176 5.8536 attitude (2;172) job involvement 4.64 0.0326 0.3356 3.2331 (3;171) it can be seen from table 5 that the model to predict the global type a scale scores contained two of the personality scales scores plus one organisational variable. a common variance of33.56% between the dependent variable and the predictors was found. the multiple regression analyses of which the results are presented in table 5, seem to indicate that the two occupational groups possibly differed from each other in terms of the variables included in the present study. to investigate this possibility, stepwise discriminant analyses were carried out. this procedure was preferred to the use of analysis of variance seeing that anova is not robust against large samples. a stepwise discriminant analysis with occupational group (pharmacists vs. accountants) as dependent variable was firstly carried out. scores on the su~ scales of the instruments for measuring type a behaviour, locus of control, career orientations, job involvement, job satisfaction, self-concept and entrepreneurial attitude served as independent variables. the discriminant model was developed over five steps with general job satisfaction, security career orientation, entrepreneurial career orientation, intrinsic job satisfaction, job involvement entering into the discriminant model, in this order. the model yielded a wilks' lambda of 0.76 (f(5;369) = 23.81, p = 0.000 i). the classification obtained showed that 70010 (n = 140) of the pharmacists group were placed correctly. the corresponding figures placed correctly for the accountants were 72.6% and n = 127. in total, 71.2% or 267 of the 375 participants were placed in the correct occupational group, with 28.8% or 108 of the total group placed in the incorrect occupational group. when a jackknifed classification was carried out 70010 (n = 140) of the pharmacists and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . samms ns vol 3 (2000) no 2 199 70.3% (n = 123) of the accountants were placed in the correct occupational group. using such a solution 263 of the 375 respondents were therefore placed in the right occupational group. an attempt was also made to determine how well the members of the two occupational groups could be classified by means of the respondents' total scores on the scales measuring type a behaviour, job involvement, job satisfaction, self.concept and entrepreneurial attitude. the other scales were not included in this analysis, because scores on these variables did not make conceptual and statistical sense as potential predictors of membership of the two groups. a stepwise discriminant analysis yielded a model into which only job satisfaction and job involvement (in this order) entered. wilks' lambda in this model had a value of 0.93 (f(2;372) = 13.40, p = 0.0001. the model classified 55.5% or iii of the pharmacists and 1 16 or 66.3% of the accountants correctly into their occupational groups. of the total sample (n = 375) 227 (60.5%) were classified correctly into their occupational groups. when a jackknifed classification was carried out 110 (55%) of the pharmacists and 116 (66.3%) of the accountants were classified correctly. in this classification correct categorisation of226 (60.3%) of the respondents was therefore obtained. discussion the results obtained are placed into perspective by comparing the findings of the present analysis, in which responses of accountants and pharmacists were analysed separately, with that of the previous research by van wyk et al. (1999a), in which the members of the two professions were treated as one group for the purposes of the statistical analysis. the findings of the present study are related to results of previous studies found in the literature. the relationship between global type a and personality factors the results of the present multiple regression analyses regarding the prediction of global type a scores and those of the study reported by van wyk et al. (1999a) are summarised in table 6. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 200 sajems ns vol 3 (2000) no 2 table 6 summary of significant correlations between global type a scores and personality variable sub-scales over two analyses. variable total sample pharmacists accountants r r r r r r locus of control i 0.47··· x 0.41··· x 0.50··· x locus of control 2 x x x locus of control 3 career orient 1 0.38··· 0.30··· 0.45··· career orient 2 x career orient 3 0.20··· 0.25·· career orient 4 job involvement 0.29··· x 0.30··· 0.23·· job satisfaction i 0.25··· x 0.26··· x 0.17· job satisfaction 2 0.19·· 0.23·· job satisfaction 3 self-concept 1 0.49··· x 0.47··· x 0.49··· x self-concept 2 0.26··· x 0.22·· 0.35··· x self-concept 3 x x 0.15· x ent. attitude 1 0.44··· 0.36··· 0.49··· x ent. attitude 2 0.31"· x 0.25·· 0.40··· ent. attitude 3 -0.23··· -0.27··· .p < .05 •• p < .01 ••• p < .001 x variable entered into multiple regression model significant correlations between global type a and lci, col, 11, sci, sc2, ent! and ent2 were found for both professions. in both professions the selfconcept sub-scales of power (sci) and likeability (sc3) and the internal and external locus of control factors (lci and lc2) entered the multiple regression model with global type a as dependent variable. it seems that both the self-concept and locus of control variables play an important role in the prediction of global type a behaviour for both professions. in the case of pharmacists, the general job satisfaction (jsi) variable also entered the prediction of the global type a model. the global type a prediction model in the case of accountants also contained economic innovation (enti), acbievementjpersonal control (c02) and task accomplishment (sc2). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 201 compared to the multiple regression of the previous study (vanwyk et ai., . i999a) of the analyses of the joint responses of the two professional groups, a more differentiated picture is obtained from the multiple regression analysis of the responses of the two separate groups. the following sub-scales entered the multiple regression model for the two groups when combined: sci lcl, sc3, lc2, ent2 jsi, sc2, jobin. the pattern for the two separate professional groups is somewhat different as shown above. the two groups were differentiated on the basis of their scores on two of the personality variables measured, that is, the security career orientation and the entrepreneurial career orientation and three of the organisational variables, that is, general job satisfaction, intrinsic job satisfaction and job involvement. global type a and locus of control in previous studies, global type a correlated significantly with internal locus of control (volkmer & feather, 1991 and morrison, 1997 common variance 13.7% and 5.8% respectively). the study by gomez (1997) yielded a significant but low (3.5% common variance) relationship between global type a and external locus of control. the fmdings of the present study support the view that perception of the source of control is related to type a behaviour (glass, snyder & hollis, 1974; glass, 1977; newton, 1989; hinton, rotheiler, gemmel and shewan, 1991; lawler, schmied, armstead & lacy, 1991 and clark and miller, 1991). global type a and career orientation van wyk et al. (1999a) reported a significant correlation between global type a scores and the service and entrepreneurial career orientations (common variance of respectively 14 and 4 percent), though none of the career orientations variables entered the stepwise multiple regression model built in that study. in the current analysis none of the career orientations variables entered the prediction model in the case of pharmacists, but the achievementlpersonal control career orientation (co2) did so in the case of accountants. a previous study by burke (1983) where career orientation correlated with the global type a score, is difficult to compare with this study, as the factorial structure of the measuring instruments used in this study differs considerably from. that in other studies. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 202 sajems ns vol 3 (2000) no 2 global type a and job involvement van wyk et al. (1999a) found a 7,8% common variance between job involvement and type a behaviour. this is in agreement with the fmdings of chusmir and hood (1986 & 1988) which showed a significant relationship of respectively 5.3 and 12.3 per cent common variance between global type a and job involvement and organisational commi1ment. van wyk et al. (1999a) further indicate that job involvement entered the stepwise multiple regression model in the prediction of global type a. in the separate analysis of the responses of the individuals in the two occupations, however, job involvement did not enter in the stepwise multiple regression model. global type a and job satisfaction van wyk et al. (1999a) found significant but low correlations between type a global and general job satisfaction (jsl) and intrinsic job satisfaction (1s2), with common variances of respectively 6.3 .and 3.6 per cent. a significant negative relationship is reported between job satisfaction and global type a in the studies of chusmir and hood (1998), byrne and reinhart (1990), gamble and matteson (1992) as well as byrne and reinhart (1994), with common variances varying between 1.21 and 4.41%. other research shows a significant positive relationship between job satisfaction and global type a (bedeian, mossholder & touliotos, 1990; day & bedeian, 1991; kushnir & melamed, 1991; norden, 1995). the common variances in these studies varied between 0.64 and 3.61 per cent. van wyk (1998) reports a variety of studies that found no relationship between type a global and job satisfaction. in the stepwise multiple regression analysis carried out by van wyk et ai. (l999a) general job satisfaction (1s1) entered the model obtained as predictor of global type a scores. in the separate analysis of the responses of the two occupational groups however, general job satisfaction only entered as predictor of global type a for pharmacists but not for accountants. global type a and self-concept van wyk et al. (1999a) found a significant relationship between global type a and power (sci) as well as with task accomplishmentimorality (sc2) with 24% and 6,8% common variance respectively. in the study by van wyk et al. (1999a), both the task accomplishmentimorality and likeability sub-scales entered the stepwise multiple regression model with global type a as dependent variable. in the present study, both power (sci) and likeability (sc3) entered the models based on the two separate groups as predictors of global type a. in the case of accountants, task accomplishmentimoral (sc2) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 203 entered additionally as predictor. in the study by wolf et al. (1981) which showed a negative correlation between self-concept and type a behaviour, the conclusion is reached that type as have a deep sense of insecurity due to a lack of an internalised standard of excellence which may lead to a low self-concept. lobel (1988) reports type as to have a significantly lower self-concept than type bs. it should be noted, however, that in the present study the three factors in the self-concept scale were all significantly positively correlated with global type a. global type a and entrepreneurial attitude van wyk et al. (1999a) found a significant positive relationship between global type a and economic innovation (entl), achievementlpersonal control (ent2) and a negative relationship with self-esteem (ent3) indicating common variances of respectively 19.4, 9.6 and 5.3 per cent. in the study by van wyk et al. (1999a), only the achievementipersonal control (enti) subscale entered the stepwise regression analysis. in the present study, entrepreneurial attitude sub-scales did not enter the stepwise regression model for pharmacists, but did so in the case of accountants (entl, economic innovation). the relationship between jenkins factor 1 (achievement) and personality and organisational variable sub-scales the results of the present analyses regarding the prediction of jenkins factor one (achievement) scores by means of personality variables, compared to the findings reported by van wyk et al. (1999a), are summarised in table 7. table 7 summary of significant correlations between jenkins factor one (achievement) and personality and organisational variable sub-scale scores over two analyses variable total sample pharmacists ! accountants r r r r ~ locus of control 1 0.34··· x 0.28··· 0041 x locus of control 2 x x locus of control 3 x career orient 1 0.36··· 0.32··· x 0041··· career orient 2 0.15·· 0.17· = x career orient 3 0.03· career orient 4 job involvement 0.27··· x 0.31··· x 0.23·· r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 204 sajems ns vol 3 (2000) no 2 table 7 continued variable total sample pharmacists accountants r r r r r r lob satisfaction 3 self-concept i 0.31*** x 0.29*** x 0.34*** x self-concept 2 0.29*** x 0.29** x 0.34*** x self-concept 3 x -0.20** x x ent. attitude i 0.34*** 0.25** 0.43*** x ent. attitude 2 0.29*** x 0.18** 0.41*** x ent. attitude 3 -0.16* *p < .05 **p < .01 ***p < .001 x variable entered into multiple regression model type a achievement and locus of control van wyk et al. (1999a) report a significant relationship between achievement (lsi) and internal locus of control with a 11.56% common variance between the variables. in the stepwise multiple regression model both internal and external locus of control entered as predictors of achievement. the relationship between achievement type a and internal locus of control is confinned by furnham (1983), volkmer and feather (1991) and spector and o'connell (1994), reporting common variances of respectively 7.3,22,1 and 3.2 per cent. in this analysis of the responses of the two occupational groups, locus of control variables did not enter into the stepwise multiple regression model with achievement (if1) as dependent variable for pharmacists, but all three locus of control sub-scales were included in the case of accountants. type a achievement and career orientations in the van wyk et al. (1999a) study, the type a achievement factor significantly correlated with the career orientations of service and lob security with common variances of respectively 13.0 and a low 2 per cent. in the stepwise multiple regression analysis of the same study, service (col), job security (c02) and entrepreneurial (c03) were included in the model predicting type a achievement. in the separate analysis of the responses of the two occupational groups in the current study, the service (col) and lob security (c02) career orientations entered the prediction only in the case of pharmacists. none of these variables entered the prediction model in the case of accountants. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 205 type a achievement and job involvement the van wyk et al. (1999a) study indicated a significant relationship between achievement (jfi) and job involvement with 7.3 per cent common variance. job involvement did not enter the stepwise regression model with achievement as dependent variable in the van wyk et al. (1999a) study, while in the present study it did so for pharmacists but not for accountants. type a achievement and job satisfaction van wyk et al. (1999a) report a significant relationship between achievement (jfi) and general as well as intrinsic job satisfaction, with low common variances of respectively 2.6% and 2.3%. in the stepwise multiple regression analysis with achievement as dependent variable, general job satisfaction entered as predictor. in the separate analysis of responses of the two occupational groups, general job satisfaction (js i) entered the prediction model in the case of pharmacists but none of the job satisfaction sub-scales entered in the case of accountants. the conclusion can be drawn that job satisfaction could be a predictor of type a achievement, depending on the occupation of the individual the relationship does not appear to be strong. type a achievement and self-concept van wyk et al. (1999a) report a significant relationship between achievement (jfi) and power (sci) and task accomplishmentimorality (sc2) with a common variance of 9.7% and 8.4% respectively. in the stepwise multiple regression analysis done in that study with achievement as dependent variable, both task accomplishmentimorality (sc2) and likeability (sc3) entered the prediction. in the current analysis of the two separate professions, likeability (sc3) and task accomplishment (sc2) entered in the case of both pharmacists and accountants. in addition, power (sci) entered in the case of accountants. self-concept variables therefore seem to be related to the achievement dimension of type a behaviour. type a achievement and entrepreneurial attitude van wyk et at. (1999a) identified the following significant relationships between achievement (jfi) and variables that are part of entrepreneurial attitude: economic innovation (enti); achievementipersonal control (ent2) and self-esteem (ent3) with common variances of respectively 11.6%, 8.4% and a low 1.2%. in the stepwise multiple regression analysis carried out in that study with achievement as dependent variable, economic innovation (ent i) entered the prediction. with the separate analysis of the responses of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 206 sajems ns vol 3 (2000) no 2 the two occupational groups, entrepreneurial attitude variables did not enter as predictor in the case of phannacists but economic innovation (ent1) and achievementlpersonal control (ent2) did enter as predictors of achievement in the case of accountants. entrepreneurial attitude as predictor seems to be occupationally specific to type a achievement scales. the relationship between jenkins factor 2 (hard driving/competitive) and personality and organisational variable sub-scales the findings of the van wyk et al. (1999a) study and the analyses carried out in the present study, regarding the relationships between jenkins factor 2 (hard driving/competitive) scores and personality and organisational variables, are summarised in table 8. table 8 summary of significant correlations between jenkins factor two (hard driving/competitive) and personality and organisational variable sub-scale scores over two analyses variable total sample pbarmacists accountants r r r r r r locus of control 1 0.40*** x 0.38*** 0.38*** locus of control 2 ·0.21*** ·0.29*** x locus of control 3 career orient 1 0.23*** 0.16* 0.30*** career orient 2 -0.18** x -0.15* career orient 3 0.20*** 0.14* 0.18* career orient 4 job involvement 0.19*** 0.18** job satisfaction 1 0.24*** x 0.28*** x job satisfaction 2 0.15** 0.15* 0.16* job satisfaction 3 self-concept 1 0.48*** x 0.44*** x 0.49*** x self-concept 2 0.12** 0.21** ;= self-concept 3 0.16*** 0.15* 0.24** ent. attitude 1 0.35*** 0.28*** 0.38*** ent. attitude 2 0.21"* 0.23** 0.22** ent. attitude 3 -0.32*** -0.36*** -0.22** *p < .05 **p < .01 ***p < .001 x variable entered into multiple regression model r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 207 jenkins hard driving/competitive and locus of control van wyk et al. (1999a) report a significant positive relationship between internal locus of control (lci) and hard driving/competitive (jf2) with a 15.2 per cent common variance. a significant negative relationship was reported with external locus of control (lc2) with a low common variance of 4.0 per cent. internal locus of control entered the stepwise regression model with hard driving/competitive as dependent variable. in the analysis in the present study external control (lc2) entered the prediction model in the case of pharmacists, while none of the locus of control scales entered in the case of accountants. jenkins hard driving/competitive and career orientations the van wyk et al. (1999a) study indicated weak but significant relationships with the career orientations of service (col, 4.8% common variance), job security (c02, 3.2% common variance), entrepreneurial (c03, 3.6% common variance). only job security entered the stepwise multiple regression model as independent variable. in the analysis of the responses of the two separate occupational groups, none of the career orientation sub-scales entered the stepwise multiple regression model with hard driving/competitive as dependent variable. jenkins hard driving/competitive and job involvement van wyk et al. (1999a) reported that hard driving/competitive correlated with job involvement with a 3.6 per cent common variance, but this variable did not enter the stepwise multiple regression analysis model as independent variable. in the current analysis with the separation of the two occupations job involvement also did not enter as a predictor of hard driving/competitive as dependent variable. it did correlate significantly with hard-driving/ competitive behaviour. but the relationship was not strong. jenkins liard driving/competitive and job satisfaction van wyk et al. (1999a) report low positive but significant relationships between hard driving/competitive (jft) and the job satisfaction sub-scales of general (jsl, 5.8% common variance) and internal job satisfaction (js2, 2.3% common variance). general job satisfaction entered the stepwise multiple regression model with hard driving/competitive as dependent variable. in the current analysis of the responses of the two occupational groups, general job satisfaction (jsl) entered as predictor of hard driving/competitive only in the case of pharmacists. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 208 sajems ns vol 3 (2000) no 2 jenkins hard driving/competitive and self-concept van wyk et ai. (1999a) report hard driving/competitive to show a significant positive relationship with the self concept scales of power (sci), task accomplishmentlmorality (sc2) and likeability (sc3) with common variances of respectively 22.1 %, 1.7% and 2.6%. with hard driving/competitive as dependent variable only power entered the stepwise multiple regression model. the re-analysis of the responses of the responses of the two separate occupational groups showed power (sci) to enter the stepwise multiple regression analysis with hard driving/competitive as dependent variable for both pharmacists and accountants. power as a self-concept variable seems to be a strong and consistent predictor of hard driving/competitive type a behaviour. jenkins hard driving/competitive and entrepreneurial attitude van wyk et al. (1999a) found that entrepreneurial attitude orientation subscales that showed a significant positive relationship with type a hard driving/ competitive were economic innovation (enti) and achievement! personal control (ent2) with a significant negative relationship with self-esteem (ent3) yielding common variances of respectively 12.3,4.4 and 9.6 per cent. the stepwise multiple regression analysis did not enter any of the entrepreneurial attitude orientation sub-scales with hard driving/competitive as dependent variable into the prediction model. in the present study the variable entl (economic innovation) was included in the multiple regression model for the prediction of hard-driving/competitive behaviour in accountants. speed and impatience (jf3) the findings with regard to the prediction of speed and impatience (type a sub-scale 3) are summarised in table 9. table 9 summary of significant correlations between jenkins factor three (speed. and impatience) and peneaslity and organisational variable sub-scale scores over two analyses variable taalsample pharmacists accountants ... r r r r r locus of control i 0.11* 0.15* locus of control 2 locus of control 3 0.13* x 0.14* r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 209 table 9 eontinued variable total sample pharmacists aeeountants r r r r r r career orient i ±+ career orient 2 i x 0.19* career orient 3 0.18*** x 0.15* 0.17* career orient 4 job involvement job satisfaction i job satisfaction 2 job satisfaction 3 -0.12* -0.15* x self-concept i 0.13* self-concept 2 self-concept 3 ent. attitude 1 ent. attitude 2 ent. attitude 3 *p < .05 **p < .01 ***p < .001 x variable entered into multiple regression model speedllmpatienee and different variables in the van wyk et al. (l999a) analysis the speedllmpatience sub-scale (jf3) showed only a few significant but low correlations with the different sub-scales (common variances in brackets): internal locus of control (lci; 1.2%), vicissitudes of life (lc3; 1.7%), entrepreneurial (c03; 2.9%), supervision (js3; 1.4%), power (sci, 1.7%). only the vicissitudes of life (lc3) and entrepreneurial (c03) sub-scale entered as predictors of speedlimpatience in the stepwise multiple regression analysis. the separate analysis of the responses of the two professional groups showed speedlimpatience as dependent variable in the stepwise multiple regression analysis related to supervision (js3) and job security (c02) as independent variables in the case of pharmacists and job security (c02) and entrepreneurship (c03) in the case of accountants. speed and impatience was weakly predicted in all three cases. conclusion in the present study 36.05% of the variance in the global type a scores of the pharmacists could be predicted by means of the scores on the measured personality variables. the corresponding figure for accountants is appreciably r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 210 sajems ns vol 3 (2000) no 2 higher at 41.68%. it therefore seems that at least some of the personality and organisational variables in the present study are related to global type a behaviour. it was previously concluded (van wyk. 1998) that the type a construct should be seen as a learned behavioural pattern, not a personality type. the results of the present study seem to indicate that personality variables are indeed involved in the behaviour pattern. the possibility that social environmental factors influence the development of both type a behaviour as well as the personality and organisational variables associated with this kind of behaviour, can therefore be hypothesised as the basis of a further study. from the results it is also clear that some of the dimensions of type a behaviour, as identified in this study, are quite clearly related to some of the personality and organisational variables included in the study. in the case of pharmacists, 33.09% of the variance in the scores on the achievement type a sub-scale could be predicted by means of personality and organisational variable subscales with the corresponding figure per accountants being 39.74%. a numerically lower common variance of 25.20% between predictors and the type a dimension hard-driving/competitive was found for pharmacists with the corresponding figure for accountants being 25.49%. the relationship between the third type a dimension, speed and impatience, and predictor variables was less strong. in the case of pharmacists, the common variance amounted to only 4.40%, the corresponding figure for accountants being 6.19%. the locus of control and self-concept variables seem to be quite consistently related to type a behaviour variables, as was also observed by van wyk et al. (1999a). the present study has contributed some more clarity with regard to the origins of type a behaviour and its various dimensions. further work is obviously required, seeing that the present study included only two professional groups. these groups cannot be seen as representative of all professional or knowledge workers in the south african society. in this study data was gathered by means of questionnaire only. some of the relationships found may therefore be the result of mono-method bias. future studies should aim to cover a wider spectrum of respondents. in the south african context, the inclusion of more individuals from the majority group of black people should make for potentially interesting comparisons with the present results and the results of comparable studies in other countries. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 211 references the complete list of references is available in: van wyk, r., boshoff, a.b. and bester, c.l. .(1999) "correlates of type a behaviour among professionals", south african journal of economic and management sciences. ns 2(2): 315-34. van wyk, r, boshoff, a.b. and bester, c.l. (i 999a) "correlates of type a behaviour among professionals", south african journal of economic and management sciences, ns 2(2): 315-34. 2 van wyk, r, boshoff, a.b. and owen, r. (1999b) "factor structure and internal validity of psychometric instruments developed in the usa among professionals in south africa", south african journal of economic and management sciences, ss l(november): si-s72. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction theoretical model and specification methodology results and discussions conclusion acknowledgements references footnotes about the author(s) greenwell matchaya international water management institute, pretoria, south africa charles nhemachena international water management institute, pretoria, south africa sibusiso nhlengenthwa international water management institute, pretoria, south africa citation matchaya, g., nhemachena, c., nhlengenthwa, s., 2018, ‘income growth, population and savings in the southern africa development community region’, south african journal of economic and management sciences 21(1), a1772. https://doi.org/10.4102/sajems.v21i1.1772 original research income growth, population and savings in the southern africa development community region greenwell matchaya, charles nhemachena, sibusiso nhlengenthwa received: 31 jan. 2017; accepted: 06 aug. 2018; published: 16 oct. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the southern africa development community (sadc) faces pervasive income stagnation, high inequality, increasing population growth rates and poverty. for example, despite that half of sadc countries are low middle income (as opposed to low income), high inequality implies that many people in the region still live in poverty. while literature is replete with theories linking low incomes to population growth and savings, empirical evidence is context specific and often mixed. aim: there is a dearth of strong empirical evidence that shows empirical linkages between population growth rates, incomes and savings in the sadc and this article aims to investigate these linkages. specifically, the aim is to empirically understand the impact of population growth, savings and investment in human capital, on incomes. setting: we focus our investigation on the southern africa development community (sadc), which comprises 16 countries namely, angola, botswana, namibia, lesotho, swaziland, south africa, malawi, mozambique, zambia, zimbabwe, tanzania, democratic republic of congo, madagascar, mauritius, seychelles and comoros. methods: to achieve the goals of this study, we analyse data from 1977 to 2014 obtained from the world bank databases and use ordinary least squares, fixed effects, random effects and arellano-bond dynamic panel-data estimation techniques to investigate the relationships between incomes, population growth and savings. results: our findings support the existence of a negative relationship between high population growth rates and income per capita, as well as a positive relationship between capital accumulation (human capital), savings and income per capita growth. shares of savings in relation to gross domestic product (gdp) of countries in the sadc stand at under 16% of gdp (compared to shares of over 30% in developed countries) and are particularly worrisome. conclusion: there is a case for a concerted effort by the sadc member states to control population growth, encourage schooling and, further, encourage a ‘savings culture’ in order for the sadc region to achieve its aspirations of eradicating poverty and hunger as outlined in agenda 2063 and even the sustainable development goals. introduction the goal of this article is to examine the effects of various factors including population growth and human capital on income per capita. a great abundance of literature, including mankiw, romer and weil (1992), mcquinn and whelan (2007), barrow (1989) and lucas (1988), appears to converge on the conclusion that economic growth affects the rate of population growth, and vice versa, and the exact relationship between the two is often contextual. for example, economic development may affect population growth in several ways including: availability of modern methods of birth control which may control birth rates, availability of medicines which may increase life spans, availability of high wage employment which increases the opportunity cost of maternity leave such that women would prefer to work rather than looking after children. in other studies, sinesi (2003) and lindh and malmberg (1999) applied the life cycle consumption model and argued that the propensity to save was related to the age structure of the population. higher proportions of old people in the population implied low saving rates. the proportion of old people was negatively related to savings and growth. they, therefore, argued for a negative relation between population ageing (due to slow population growth) and saving and growth. the savings argument needs to be discussed further because of its importance in standard economic growth models. according to standard economic growth models (e.g. solow 1956), one of the factors that affects growth is the aggregate rate of savings. higher aggregate rates of savings are often correlated with higher economic growth (barro & sala-i-martin 1995). studies have shown that high population growth rates, however, lower the rate of aggregate savings. this happens simply because high population growth eats into aggregate income (ray 1998). if it is true that the rich save higher fractions of their income, then savings rates may be adversely affected because high population growth entails high growth of the poor proportion of society (ray 1998). more importantly, faster population growth shifts the age structure of the population towards the very young and in so doing increases the dependency ratio in families. because children consume more than they produce, this tends to lower savings rates as well (ray 1998:331). of course, the other side of the argument is that it is possible that population growth may spur technological progress out of the pressures created by high population density (boserup 1981). it is technological progress that ensures growth of an economy in the long run. on the other hand, population growth creates a large pool of potential innovators and, therefore, a larger stock of ideas and innovators that can be put to economic use (kuznets 1960; simon 1977). this would imply that high population growth rates are associated with high income per capita. unfortunately, most literature cited on the nexus between population growth, income per capita and savings, focus on countries outside southern africa, thereby creating an empirical gap in this area of study. again, it is noted that perhaps owing to data challenges in the past, studies have been based on shorter time periods with limited variation which can render findings imprecise. this article attempts to fill this gap by investigating the determinants of income growth within the southern africa development community (sadc). the investigation involves employing the solow model framework both in its basic textbook form and augmenting it with human capital in the examination of determinants of income per capita. theoretical model and specification the approach espoused in this article involves tackling the question of population growth and income per capita from two perspectives. the first step is to outline the solow model, derive the first order differential equations, then estimate the solow model in its basic as well as augmented forms. the solow model is summarised below. the solow growth model the standard solow model takes the rates of savings, population growth and technological progress as exogenous, and further assumes two inputs in the production function namely capital (k) and labour (l), both of which receive their marginal products as returns (see mankiw et al. 1992). assuming a cobb-douglas production function with diminishing marginal returns to scale (where α + β < 1), production at time t is given as shown in equation 1. y is output, a is technological progress. labour and technology are assumed to grow exogenously at rates n and g, as depicted in equations 2 and 3: the number of effective units of labour a(t)l(t) then grows at the rate n + g. solow’s model assumes that a constant fraction of output, s, is saved and reinvested. defining y as the level of output per effective unit of labour, y = y/al, and k as the stock of capital per effective unit of labour, k = k/al, the evolution of k is governed by equation 4: δ is the rate of depreciation. the steady state value k* to which k converges is defined by equation 5: this implies that the steady state capital relates negatively to population growth rates but positively to savings rates. in order to establish the relationship between income and savings and population growth (the gist of solow’s model), substitute equation 5 into the production function and, upon taking logs, the steady state income per capita can be summarised as equation 6: since the model assumes that factors of production, that is labour and capital, are paid according to their marginal products, it predicts the signs of the coefficients. it also predicts the magnitudes of the coefficients on savings and population growth. for example, if we make use of the a priori knowledge that the share of capital (α) in income is roughly one-third (see mankiw et al. 1992), the model implies an elasticity of income with respect to savings rate of about 0.5 and an elasticity with respect to n+ g + δ of approximately −0.5. of course, if the shares of capital in income are different, the elasticities will also be different, but the higher that share α, the higher the positive impact of savings on income per capita. specification of the model when estimating the solow model, therefore, it is of interest to investigate whether income per capita is higher in countries with higher savings rates and lower in countries with higher n+ g + δ. here it is assumed that the technology advancement (g) and depreciation rate (δ) are constant across countries because technology changes affect many countries at a time, whereas there is no solid theory that may imply that depreciation rates can vary across countries. initial technology endowments, a(0), constitute not only technology at that time, but also other idiosyncratic characteristics at country level and may differ across countries. assuming it is governed by equation 7. α is constant and ε is country level idiosyncratic, then equation 6 defining income per capital can be specified stochastically as equation 8: if it is assumed that ε is independent of s and n (which is at times a reasonable assumption as under isoelastic utility, permanent differences in levels of technology do not affect savings and population growth rates) then equation 8 can be estimated with ordinary least squares (ols) regression. of course, in the event that the assumption of orthogonality between s, n and ε does not hold, ols is inconsistent and another estimation procedure may be preferable. in this study, both ols and models that account for possible endogeneity – including generalised method of moments (gmm) and generalised least squares (gls) – are estimated and the results are presented and discussed. again, if the estimated coefficients for s and n + g + δ are different from the predicted 0.5 and −0.5 then there may be reason to believe that the ols estimation may be wrong (mankiw et al. 1992). the solow model augmented with human capital assuming that the omitted variable human capital is a significant variable, then accounting for it may improve the fit of the model besides altering the magnitude of the parameters estimated previously. once human capital is added, the model evolves differently such that the production function in equation 1 may be rewritten as equation 9: h is the stock of human capital while everything else is as predefined. if sk is the fraction of income invested in physical capital and sh that part invested in human capital, the evolution of the economy is determined by equations 10a and 10b h = h/al and stands for human capital per effective quantity of labour. again, it is assumed that the same production function as before applies and that it has diminishing returns to scale. from above, we can formulate equations 11a and 11b: substituting equation 11 into the production function and taking logs yields an income per capita equation similar to equation 6 such that we arrive at equation 12. so, again, the evolution of income per capita depends on the accumulation of physical and human capital, as well as on population growth. the implication of this model is that the presence of human capital accumulation increases the impact of physical capital accumulation on income through the effect of the β. as before, α is expected to amount to one-third of the share of capital in income. if the levels of human capital are available, equation 12 can be expressed differently by combining equation 10 with equation 9 to yield income per capita as a function of population growth rate, the rate of investment in physical capital and the level of human capital as shown in equation 13. equation 13 is similar to equation 6 and now by implication means that savings and population growth are related to human capital, so that omitting it as in the first estimation yields potentially biased estimates. in the results that follow, model equation 13 is also estimated. methodology the data and empirical specifications of model variables as stated a priori, the discussion on the interface between incomes and population growth is one that can be taken in various ways in the sense that population growth can affect incomes, whereas incomes can also affect population growth. in terms of multivariate econometric analysis, one would consider this fact as one that immediately invokes the issue of endogeneity and the problems that it presents, while attempting to isolate what actually determines the other. the approach in this article is to, firstly, discuss the present descriptive statistics in various variables that may determine income per capita, and postulate prima facie through scatter graphs, the likely linkages between income and such different factors. then a series of ols regression analysis is performed in the article to establish partial correlations between population, incomes and savings. we further perform estimation within the framework of gls models assuming fixed effects, as well as random effects and compare the results. finally, we also fit the system dynamic panel-data estimation (gmm). in each case we compute various statistics for model fitness and for the gls estimation, we compute the hausman specification test to ascertain any differences between the random effects formulation and the fixed effects model and we report all the results in one table. the main policy conclusions are based on the ols because the coefficients approximate those predicted in mankiw et al. (1992), and yet we should also state that the qualitative conclusions are almost unchanging across estimation procedures. results and discussions the data in table 1 shows single points of data on gross domestic product (gdp) per capita, birth rates, death rates and population growth rates. table 1: gross domestic product per capita, birth, death and population growth rates for selected countries. it is clear from table 1 that there is an observable pattern between death rates, birth rates, population growth rates and income per capita. in fact, most countries with lowerincome per capita are also the ones associated with higher population growth rates. this relationship is further investigated later in this article. table 2 similarly presents the same kind of information but using more recent data and only for the sadc region, and also expands the exposition to include savings rates for each country at that particular year of observation. table 2: table incomes and population growth rates by 2014. in summary, therefore, both tables 1 and 2 show that high population growth rates are associated with low income per capita and they exist together with high mortality and high birth rates. this of course implies that policies that seek to reduce population growth can also increase income per capita and vice versa. for the sadc region, it is interesting to note that even among the sadc countries, the countries with highest population growth rates are usually those associated with low income per capita. for example, malawi, tanzania, zimbabwe, madagascar have close to 3.0% population growth, whereas the middle-income countries generally have a lower growth of 1.9% (see south africa, botswana, swaziland, lesotho, namibia and mauritius). this is further evidence of a negative correlation between population growth rates and income per capita. notice that the last column in table 2 shows country level savings rates. as was discussed earlier, the relationship between population growth and income per capita reflects in a number of ways including through savings decisions and the capacity of the population. it also deserves repeating that for the sadc region, high savings rates, are on average associated with low population growth rates and are further associated with higher incomes. in the next paragraphs we now discuss statistical analyses to confirm the prima facie evidence discussed a priori. if one considers both the sadc and outside sadc data in tables 1 and 2 and fits a regression model to understand the nature of the relationship between the two variables, income per capita and population growth, the resulting statistics can be summarised in figure 1. figure 1: population growth and incomes (annual %). this figure shows that there is indeed a highly significant inverse relationship between income per capita and population growth, which perhaps is evidence that one of the pathways, discussed previously (savings), is responsible for bringing this relationship to the fore. the implication is, of course, that countries with high population growth rates may unlikely be the ones reducing poverty over time, unless they find a way of applying the high population economically, or unless they create policies that will reduce consumption and enhance savings. if the effects of population growth on income per capita goes through savings, then it must be confirmed statistically that there is a negative relationship between population growth and savings. as discussed previously, savings are one of the key elements through which population growth impacts on income growth. figure 2 shows trends of savings for groups of countries including the upper middle-income countries of the world (umi), sub-saharan african countries (ssa), the world saving averages (world), sadc, sadc middle-income (sadc mi), and sadc low income (sadc li). of course, the first trend to note is that, at around 15% of gdp, the saving rates in the sadc region are very low compared to those in umi countries which stand at around 30% and above and are also lower than the world averages which are just under 25% of gdp. again, it is not surprising perhaps to note that within the sadc region, sadc mi countries are associated with higher (around 20%) savings, compared to the sadc li countries whose saving rates are often below 10% of gdp. again, considering that the sadc li countries are also associated with higher population growth rates, it would appear that population growth and savings rates are negatively related. of course, another important observation is that savings rates for various groups tend to remain around the same level for longer periods of time and, although there is intertemporal variation, such variation appears to be contained within tight bounds. figure 2: country-specific savings rates. as discussed previously under the theory section, population growth affects incomes through a number of ways, including savings. usually a country whose population grows very fast ends up having high dependency ratios. the continent of africa does not have a big problem of an ageing population, but rather with a youthful one, who consume more than they can produce. savings then are impacted because they can be conceived as gross income minus consumption. in practice, if this relationship was in operation, then a regression of savings on population growth, needs to depict a negative relationship and if such a relationship is significant, it consolidates the evidence. figure 3 shows that indeed savings appear to be affected by population growth rates and that the statistical relationship is significant at 0.035 level of significance. this then supports the theory of savings and population growth, in other words, ceteris paribus, higher rates of population growth depress savings of a household and a country. figure 3: statistical test of savings and population growth for the all southern africa development community countries. population growth effects in the sadc appear to be complicated by the fact that, life expectancy is generally low and, at any point in time, children constitute a huge proportion of the population. a simple regression model of income per capita that recognises the differential impact that age groups have on income per capita, shows that indeed in the short run, an increase in children (0–14 years) in a population negatively affects income per capita, whereas an increase in the working population (15–64 years) is good for increasing incomes (see table 3). table 3: impact of age on income per capita. the results in table 3 remain unchanged even if the model is estimated in the form of lags to account for the fact that the effect does not have to be contemporaneous. population growth that spurs as a result of high fertility, unlike one that ensues as a result of reduced death rates among the adult population, is likely at odds with the goals of fast economic growth, as it eats into incomes and leaves very little for savings and investment and future economic growth. of course, the next step is to confirm whether savings and income per capita are related positively. evidence that growth rates in income per capita and savings are positively related would strengthen the indirect linkage that population growth has on income growth. figure 4 shows the relationship between savings of a country and rates of income growth, and it is clear that the two are related positively in a highly significant relationship (p-value = 0.000). figure 4: savings and economic growth. results from the basic solow model in estimating the solow growth model this article follows mankiw et al. (1992) and first deals with ols estimation which in most cases should suffice, unless the data reject the orthogonality assumption needed for consistency in the model, or unless the results deviate significantly from what the solow model predicts about the signs and magnitudes of the coefficients. the data used herein, obtained from the world bank as well as national sources, include savings as a share of gdp, working population in every country, defined as population aged between 15 and 64 years, income per capita for each country in the sadc, and population growth. the contribution of technology growth and capital depreciation are assumed to amount to 0.05 across the board in line with literature on the topic. it is interesting to note in table 4 that over the period (1977–2014) income per capita in the sadc averaged us$1947 with some countries registering incomes of as low as $102 despite other countries enjoying as high as $15700 per capita, implying a mix of countries. average savings rates were 15.8% of gdp, with a standard deviation of 15.5, and average population growth stood at 2.3%. human capital is proxied by the number of people entering primary and secondary school and particularly primary school enrolment. in developing countries such as those of the sadc, primary school enrolment can proxy the levels of investments by government in human capital improvement. this information is then used to estimate the solow growth models. table 4: descriptive statistics of the model variables. interestingly, the data for the sampled period and countries appear to fit the solow model quite well. table 5 shows that the estimated coefficients for log of savings and log of n + g + δ are 0.452 and −0.518 and they are highly significant at the 1% level of significance. these coefficients are not only similar to the solow model predictions in terms of signs, they are also similar in terms of predicted magnitudes of 0.5 and −0.5. in both cases, the implied magnitude of α is around 0.31 and 0.34 which are also the ones expected from theory and literature as capital’s share in income (which is about one-third). the test about equality of the coefficients for log of savings and log n + g + δ also confirms the observation that the two are equal in magnitude save for signs. table 5: combined results from the all solow models (ordinary least squares with huber-white standard error)† from these results, this article concludes that although the explanatory power of the model is 0.27 and may suggest that there are other variables that may explain income determination, the solow model cannot be rejected outright and in fact in the sadc region, countries that have high savings rates are associated with high income growth rates, whereas those with high population growth rates are likely to be associated with low income growth rates. this confirms some of the priori findings explained earlier in this article. since a test for constant variance was rejected, the standard errors for all ols regressions are obtained using the huber-white methodology by utilising the ‘robust’ subcommand in stata. results from the augmented solow model the adjusted r-square improves with addition of human capital, and the model is still consistent with solow in terms of the coefficients for savings and n + g + δ. however, one notes that human capital, as proxied by the gross enrolment rate at primary school level, which is a proxy for schooling investment, is significant and has a coefficient of 1.5 implying that ignoring human capital omits a variable in table 5. it may thus be argued that because human capital is significant in this model and it was omitted in the previous one, then perhaps the coefficients of savings and population growth were biased in the previous ols estimation. this would confirm that, in theory, the level of human capital is positively related to the savings rate (as more good human capital relates to more savings), as well as negatively related to population growth (as high population growth implies less capital saved). the inclusion of human capital also marginally reduces the elasticity of physical capital on income per capita and improves the fit such that now the model explains 33% of cross-country variation on income per capita in the sadc. allowing for human capital eliminates biases due to variable omissions and improves the fit of the model although the share parameters α are about 0.3 in each case. the potential variable omission motivates the need for the search for other estimation techniques. various estimation techniques accounting for endogeneity, including arellano-bond dynamic panel-data estimation, as well as system dynamic panel-data estimation, were fitted and the results are presented. they yield findings that are slightly different from the predictions of the solow model, but all qualitative conclusions regarding direction of effects and significance of parameters appear to suggest that estimates obtained by ols estimation1 remain valid. thus, whereas population growth may impact on economic growth in various ways, it appears that one of the ways, which is also supported by theory, is through savings. an increase in population growth, ceteris paribus, depresses the prospects of high savings because most output is consumed and the marginal propensity to consume is high. empirically it is also confirmed here in that savings are important for economic growth in the sadc region. the gls estimates using the fixed effect (fe) estimator were not different from those obtained using the random effects (re) estimator and, in fact, a hausman specification test to confirm any systematic differences in coefficients rejected the presence of such differences between fe and re estimates2. at about 0.19 for savings and −0.26 for population growth, the estimated coefficients in both gls models were similar, but in each case smaller compared to the 0.4 and −0.4 magnitudes obtained through ols for the savings and population growth. the coefficients for human capital appeared similar and, in any case, suggested that a 1% increase in human capital would yield a more than 1% increase in income per capita. the system dynamic panel-data estimation (gmm) yielded even smaller coefficients in every case but with similar direction of change. for this specific estimation technique, human capital had a positive sign but was not significant. because of the similarities between the ols, gls and gmm results, we base our conclusions on ols estimates in line with literature and so this should not be considered a limitation (see mankiw et al. 1992). again, whereas time series data generally presents problems of multicollinearity, and auto correlation, the variables herein did not present multicollinearity problems and tests for autocorrelation rejected autocorrelation. while homoscedasticity assumption was rejected (chi2(1) = 5.68; prob > chi2 = 0.01), we used the huber-white standard robust errors to correct for heteroskedasticity. the coefficient of savings indicates that in a typical sadc country, a 1% increase in savings as a share of gdp would yield closer to a 0.5% increase in income per capita, but if the population growth in that country increases by 1%, then income per capita could decrease by 0.5%. this implies that economic growth without controlling population growth may have no effect on poverty reduction. again, a 1% increase in human capital may lead to a more than 1.4% growth in income per capita implying that a country that invests in human capital development stands to gain more in terms of poverty reduction in the long term. thus, it is important to ensure that sadc governments prioritise human capital development, a savings culture and should control population growth. figure 5 shows the effects of a 50% increase in human capital, and a 50% increase in savings within the sadc countries as well as a 50% reduction in population growth. the results show through an upward shift in income per capita that in each case income per capita would increase by several hundred us$, but that human capital improvements lead to more increase in income per capita than an increase in savings or a decrease in population growth. population decay ranks second as a means of increasing income per capita3. figure 5: graphs summarising shocks in (a) savings, (b) population and (c) schooling. if human capital had improved by 50%, by 2011 the average income per capita in the sadc would have been us$2440 (i.e. e^7.8) which is more than, and almost double, the actual $1339 (e^7.2). for the same year, if population growth had been cut by half, income per capita would have been improved to $1998 (i.e. e^7.6) from $1339 (e^7.2). on the other hand, a 50% increase in savings around 2011 would have been associated with an average income per capita of around $1636 (i.e. e^7.4) which is more than the actual $1339 for 2011. conclusion this article’s objective was to analyse the links between income per capita growth, savings and population growth. using partial correlations and both the solow basic growth model and the augmented solow model, this article finds evidence to support the existence of a negative relationship between very high population growth rates and income per capita, as well as a positive relationship between savings and income per capita. an increase in population growth, ceteris paribus, depresses the prospects of high savings because most output is consumed and the marginal propensity to save is low. the basic solow growth model with labour and capital appears to fit the data well, although the fit improves with the inclusion of the levels of human capital involved. investment in human capita, and investments in physical capital appear to positively affect income growth, whereas population growth negate income per capita. countries, including malawi, tanzania, madagascar and lesotho among others, need to reduce overexpenditure by government and invest more in productive capital (see, e.g., matchaya, chilonda & nhlengethwa 2014). there is need for the sadc region to embark on a campaign to increase savings rates which currently average under 16% of gdp to closer to 30%, in line with what is observed in developed countries, as well as to reduce population growth which in some cases is as high as 3.2 % to under 2%. acknowledgements we are grateful to the bill and melinda gates foundation, the united states agency for the international development (usaid) and the international food policy research institute (ifpri) who supported the researchers with funding for various activities in support of the comprehensive africa agriculture development program, one of which led to this article. competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions g.m. conceptualised the article content and completed the first draft. c.n. and s.n. revised and made conceptual contributions, additions and refined the article. references barro, j. & sala-i-martin, x., 1995, economic growth, macgraw-hill, new york. barrow, r., 1989, economic growth in a cross section of countries, nber working paper 3120, national bureau of economic research, cambridge, ma. boserup, e., 1981, population and technological change: a study of long run trends, university of chicago press, chicago, il. kuznets, s., 1960, ‘population change and aggregate output’, in demographic and economic change in developed countries, national bureau of economic research special conference series, princeton university press, princeton, nj. lindh, t. & malmberg, b., 1999, ‘age structure effects and growth in the oecd, 1950–1990’, journal of population economics 12, 431–449. https://doi.org/10.1007/s001480050107 lucas, r.j., 1988, ‘on the mechanics of economic development’, journal of monetary economics 22, 3–42. https://doi.org/10.1016/0304-3932(88)90168-7 mankiw, n.g., romer, d. & weil, d.n., 1992, ‘a contribution to the empirics of economic growth’, the quarterly journal of economics 107, 407–437. https://doi.org/10.2307/2118477 matchaya, g., chilonda, p. & nhlengethwa, s., 2014, inter-temporal trends and patterns in agricultural investment spending in southern africa, international food policy research institute (ifpri) and the international water management institute (iwmi), washington, dc and colombo. mcquinn, k. & whelan, k., 2007, ‘conditional convergence and the dynamics of the capital-output ratio’, journal of economic growth 12, 159–184. https://doi.org/10.1007/s10887-007-9013-3 ray, d., 1998, development economics, princeton university press, princeton, nj. simon, j., 1977, the population of economic growth, princeton university press, princeton, nj. sinesi, p., 2003, ‘population dynamics and life-cycle consumption’, journal of population economics 16, 389–394. https://doi.org/10.1007/s001480200127 solow, r.m., 1956, ‘a contribution to the theory of economic growth’, quarterly journal of economics 70, 65–94. https://doi.org/10.2307/1884513 world bank, 2014, world development indicators, world bank, washington, dc, viewed december 2014, from http://databank.worldbank.org/data/views/variableselection/selectvariables.aspx?source=world-development-indicators. footnotes 1. results for gmm estimation are not reported here but amount to the same conclusions. 2. chi2(3) = (b-b)′[(v_b-v_b)^(−1)](b-b) = 1.53; prob > chi2 = 0.6760 3. the y-axis shows the natural logarithm of income per capita. samms ns vol 3 (2000) no 1 245 a classification of different phases of development in the export sector of nigerian agriculture richard liorah department of economics. university of the north abstract the nigerian agricultural export sector has been through three different development phases: transition, peak, and de-agriculturalisation. blending simple international trade theory with actual facts, this study supports the notion that production during the transition phase enjoyed a classical "vent for surplus" type of growth, involving increased utilisation of available factor inputs, which in turn produced increased per capita income. coupled with the classical factors were several technological packages introduced to fanners in later years. these led to the attainment of output peaks mainly in the 1950s and 1960s. finally. the study argues that the foundation for de-agriculturalisation was already laid during the peak phase when fanners were taxed heavily, and several agricultural projects were biased against them. jelq18 1 introduction the development of the export sector of nigerian agriculture may be classified in three different phases: transition, peak and de-agriculturalisation. agriculture was introduced into the money economy by the colonial masters in the transition phase that ranged from the late 1800s to the early 1950s. there was a relative switch in production from food crops to export crops during the period. in the peak phase that stretched over most part of the 1950s and the 1960s output of the export crops boomed generally. agriculture was the engine of growth of the nigerian economy during the period. the de-agriculturalisation phase began generally in the second part of the 1960s and continued through the succeeding decades. in the de-agriculturalisation phase, nigeria became more or less an importer of the same agricultural products that it had exported earlier. the agricultu.""al products in question include cocoa, palm produce (palm oil and palm kernels), groundnuts, cotton and rubber. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 246 sajems ns vol 3 (2000) no 1 the relative switch from food to export crops production that characterised the transition phase was not a switch from backward to modern agriculture, since the newly introduced export crops did not alter the traditional farming methods. the switch rather involved increased utilization of available factor inputs, which in turn produced increased per capita income. by 1929, increases in agricultural output had registered annual growth rates of 7 percent for export value and about 6 percent for the volume, and a total contribution to gdp of between five to seven percent (helleiner, 1966: 5). included in the exports were nonagricultural commodities such as coal, tin ores and other m,inerals, though agricultural exports were dominant. growth in commodity markets and production was halted during the great depression of the 1930s that extended to the first half of the 1940s, affecting agricultural exports in both value and volume. the purchasing power of exports dropped by about 38 percent already in 1931 and was not fully regained until after world war ii. in the period 1929·1945, the entire export crops put together recorded only about 20 percent increase in export volume (helleiner, 1966: 18). the removal of price ceilings in the usa after the war resulted in a boom in many commodity prices. production increased above pre-war levels in all sectors of the export crops, and the trend continued generally into the 1950s and the most part of the 1960s. all export crops recorded output peaks during the period but for the cocoa sector where output peak was recorded in 1970. a record level of about 293 600 tons of cocoa was attained in 1964, reflecting a growth rate of about 281.3 percent based on the 1945 level, to be followed by yet an all time high of 302 400 tons in 1970, implying a growth rate of 292.7 percent. in the groundnut sector, an output peak of about 1 026 600 tons of groundnuts was recorded in 1966, reflecting a growth rate of about 482.6 percent based on the 1945 level. output peaks of 201 300 tons of palm oil and 462 100 tons of palm kernels were recorded in 1953 and 1961, respectively. these peaks meant growth rates of 76.3 percent for palm oil and 60 percent for palm kernels, based on their levels in 1945. output peak of about 69 000 tons of cotton was recorded in 1963, and 70 300 tons of rubber in 1966. these peaks represented growth rates of over 6000 percent for cotton and 546.7 percent for rubber, based on their 1945 output levels. agriculture also became a substantial employer in nigeria, accounting for over 70 percent of the country's labour force. its share of gdp rose to about 50 percent. the export crops accounted for more than 55 percent of the nigerian export revenues until the mid·1960s, when mineral oil (petroleum) became a significant source of foreign exchange (fos, review of external trade (various issues». agriculture was therefore the engine of growth of the nigerian econ?mr particularly during the peak phase. this study explores the main r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 247 factors that promoted agricultural production in nigeria during the transition and the peak phases. the study proceeds by looking at the structure of agricultural production in nigeria. thereafter, it blends a simple international trade theory with actual facts to analyse the initial expansion of agricultural output for export. it proceeds to discuss the growth rates in key sectors of the economy, including non-agricultural sectors, during the 1950s and part of the 1960s. more emphasis is given to the agricultural sector though and, in particular, the main factors that geared production towards attaining output peaks during the period. finally, the study discusses the origin of de-agriculturalisation, followed by a brief conclusion. 2 the structure of agricultural production in nigeria agricultural production in nigeria for export has early been regionally specialized. the regional specialization has been dictated by the physical environment such as soil, climate and vegetation prevailing in the different regions of the country. the regions belong to different ecological areas. the northern savannah region is responsible for production of over 80 percent of the country's groundnuts and cotton. it is characterized by low rainfall, a short wet season, and low humidity. the southern thick forest regions, comprising of the west, mid-west and the east, on the contrary, receive heavy rainfall, have a long wet season and high humidity. the southern regions have climatic conditions favorable for production of the tree-crops, namely, cocoa produced in the west, rubber produced in the mid-west, and palm products (palm oil and palm kernels) produced in the east. the export sector of nigerian agriculture is based on many small farms of usually not more than 5 acres per farm. although over 80 percent of the adult male population in the peasant communities are farmers, only a little over 50 percent are full-time farmers. in the country as a whole, an average of around 30 percent of the population is engaged in part-time farming or work as farm labourers (agboola, 1979: 15). the farm labourers usually complement family labour to satisfy labour requirements, particularly during peak periods. the initial expansion of nigerian agriculture for export was a response by indigenous peasant farmers to various external forces introduced by the british colonial administration. among such forces were the development of transport and communication, the establishment of a suitable land policy, and the maintenance of law and order. hogendorn (1978: 6) noted that the overwhelming colonial military technology, by diffusing the then political unrest, diverted man-hours spent for defence to more economic ends such as production for trade. a major obstacle to the growth of agricultural exports was thus removed. direct foreign investment in agricultural production was r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 243 sajems ns vol 3 (2000) no i prohibited (oluwasanmi, 1966). this prohibition by the land and native ordinances of 1910 and 1917 was aimed at preserving farming land exclusively for the nigerian fanners. foreign finds were, however, allowed to invest in trading activities, and thereby serving as links between nigerian fanners and the world market. consequently, important consumer goods such as textiles, salt, spirit, and tobacco were made available. these goods accounted for over 50 percent of the value of imports, and their availability helped to boost fanners' incentives toward further production. fanners subsitituted leisure for more hours of work and brought more land into production. food production for domestic consumption increased simultaneously with the production of export crops. the increased productive activities in the agricultural sector did not necessitate labour or capital imports into that sector (eicher, 1970: 10). 3 the initial expansion of production for export myint's (1959) "vent for surplus" model of international trade provides a suitable tool for the analysis of output expansion from a subsistence to a trade level. it builds on adam smith's idea that international trade is the only route through which the smallness or the narrowness of a domestic market could be overcome. an outlet for a country's surplus product above domestic needs is thereby created. myint's argument is that increased output per head in the less developed countries (ldcs) has been due to factors such as: (i) once-for-all increase in productivity accompanying the transfer of labour from subsistence to money economy. (ii) increase in working hours and in the proportion of gainfully employed labour relative to the semi-idle labour of the subsistence economy. (iii) expansion of land under cultivation with the same methods of cultivation as used in the subsistence economy. a key feature of myint's model is that the country is assumed to have considerable surplus agricultural potentials consisting not only of unutilized land but also of unutilized labour, which could be mobilized for the expansion of material output. it implies that surplus productive potentials could act as a source of motivation for fanners to undertake production for export. this is in line with a different version by just (1975) in which he argues that fanners are risk-averse. the degree of risk aversion increases when the margin of resources above that required for minimum subsistence output is negligible. it means that transition from subsistence to export production is only acceptable for peasant fanners who posses surplus resources that enable them to produce the export crops in addition to their subsistence production. non-agricultural goods, including imported ones, acquired by fanners through the exploitation of the surplus productive capacity are regarded as a clear net gain attained merely by putting extra labour and land into export crops production. the relevance of the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 249 ''vent for swplus" model is very obvious in the analysis of the initial development in the export sector of nigerian agriculture. a the cocoa sector cocoa is a perennial crop that requires very little attention to produce maximum yields after planting. nigerian cocoa trees begin to bear fruits after about 5-7 years from initial planting. production becomes substantial during the seventh to tenth years, with peak production occurring between the tenth to fifteenth years of the trees life (galletti et a1., 1956: 188). the old trees may continue to bear fruits for up to 40 years, although a continuous decline in production sets in after about 25 years of the plants' age. the harvest comprises plucking and picking the cocoa fruits as well as extracting the seeds from the fruits. thus, very simple and unmechanical techniques are required. usually, hired labourers are needed to meet production needs, especially during peak periods. a typical cocoa farmer in nigeria cultivates the trees on land holdings of sizes 1.25-2.5 acres (galletti et at., 1956: 149). cocoa was introduced in western nigeria, particularly in ibadan and ondo, in the 1890s (berry, 1970: 18). the initial expansion of production was heavily influenced by factors such as: (i) extension of a railway in the early 1900s from the sea port of lagos, where already many traders were stationed, to ibadan, a major producing area. (ii) development of additional feeder-roads to other growing centres such as ondo, ogun, and oyo, all in western nigeria. (iii) a system of labour employment (mostly in cases where demand is beyond a family-household supply) involving casual or seasonal employment. (iv) modification of tenure (land) arrangements according to the requirements of the cocoa farmer. an example of this type of modification was a change from communal form of land ownership to that of individual property rights (berry, 1970: 18-19). b the palm produce sector the oil palm products are also produced from a perennial tree. unlike cocoa trees, the oil palm trees grow wild and are indigenous to tropical west africa. the products, palm oil and palm kernels, serve both as domestic food (mostly the palm oil) and export products. the palm oil is extracted from the pericarp or the pulp of the palm fruit through crushing. the palm kernels, on the other hand, are obtained by cracking the nuts contained within the palm fruit. palm kernels are produced almost exclusively for export. the palm trees have a life span of up to 60-70 years, with output declining after about 35 years. the young trees begin to bear fruits after about 10 years. since the trees grow wild (in farmlands owned by individuals or in groves that are communally owned), very little or no effort is required in planting as well as in other care-taking (helleiner, 1966: 94). most labour is needed for plucking the fruits from the trees, extracting the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 250 samms ns vol 3 (2000) no 2 oil, and breaking up the nuts to take out the kernels. the palm trees produce fruits for harvest throughout the year, although production peak periods are mostly from march to may. palm produce belongs to the main nineteenth century export crops in nigeria (zeven, 1965; eicher, 1970: 10). at the early part of the twentieth century, it accounted for about 80-90 percent of nigeria's export trade (eicher, 1970: 9; agboola., 1979: 115). with increases in demand from within and abroad, coupled with improvement in transportation that provided accessibility of former remote areas, more land and labour were brought into production. c tbe groundnuts and cotton sectors the production of groundnuts and cotton is handled by peasant farmers in the northern nigeria. the production process involves very simple technologies. in the groundnuts sector, about 5.8-8.7 acres of land per peasant household is devoted for production, particularly in the main producing northern areas, such as katsina and kano (luning, 1963: 27, 50). production for export at the turn of the 20th century was stimulated by demand from europe, although production for domestic consumption was already in progress as far back as the 1850s (agboola., 1979). high demand for groundnuts as raw materials in european margarine industries raised prices substantially for the first time during the second half of the 1910s (hogendom, 1978: 39). already at that period, a railway line was under construction from lagos seaport to kano, a major producing area. the railway was opened for general traffic in april i, 1912 (hogendom, 1970: 32). there was also surplus productive resources such as labour and land to raise output to match the increased demand from abroad. cotton, just like palm produce, also belongs to the main nineteenth century export crops in nigeria (eicher, 1970: 10; agboola., 1979: 137). it is produced in the northern region just like groundnuts. it therefore benefitted from the same factors as groundnuts did for its initial expansion. among such factors were improved transportation system, abundant productive resources (labour and land). cotton also benefitted from a high demand from abroad, especially from the lancashire cotton mills in britain (hogendorn, 1978, chapt. 2). d tbe rubber sector rubber is a perennial crop, just like cocoa and palm produce. the supply from peasant farmers with small land holdings of about 3-4 acres accounts for about 95 percent of total output. the remaining 5 percent comes from plantations owned by the nigerian government. the crude rubber that is exported is developed from the latex obtained from the bark of the tree after cutting. about 5·7 years is usually required for the rubber'trees to attain producing age. the trees reach their production peak at the age of about 15 years, after which production gradually diminishes. production is customarily stopped after about r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 251 20-25 years of their lives (blanckenburg, 1971). increases in output during the transition period, particularly in the 1940s, was geared by the japanese occupation of the main south-east asian suppliers (heljeiner, 1966: 120-2). to increase supply to meet the increased demand from abroad, there was support from the very usual factors such as improved transportation system from the major producing mid-westem areas to the ports of shipment in lagos, and exploitation of the otherwise idle productive resources such as labour and land (eicher, 1970: 10). figures 1-6 show exports of the main agricultural crops during the period 19121985. see appendix a. the quantity of export captures output domestic consumption of the crops was negligible. exceptions were palm oil and groundnuts that were consumed domestically as food. even with these food crops, and the others that were in the later years consumed domestically in significant quantities, purchases by users were, to a large extent, made directly through government initiated marketing organizations such as the commodity marketing boards (emb). as shown in figure 1, the output of cocoa followed an upward trend in the transition period, 1912-1950. there were fluctuations though during the years, the most pronounced having occurred in the 1940s that was part of the great depression period which began in the 1930s. for example, in 1942, output was almost halved to around 60 000 tons from its level of about 113800 tons in 1939. production increased after 1945 and, but for sharp decreases in 1954 and 1957 to 85 000 tons and 75 600 tons, respectively, it maintained an upward trend until the fltst peak level of about 293 600 tons was recorded in 1964. there were decreases of 38 percent and 35.6 percent in 1965 and 1968, respectively, based on the output level attained in 1964. a record output peak of about 302 400 tons of cocoa was attained in 1970. thereafter, output deteriorated and continued during the remaining period with only intermittent minor improvements that could not compare with the preceding peaks. in general, the period 1960-1970 represented the most favorable for cocoa output in nigeria. figure 2 shows the output of palm oil during the period 1912-1985. output showed a more or less steady improvement during the period 1912-1930 but for a sharp decrease in 1921. it remained stagnant during the first haif of the 1930s when the average output level attained was about 125 000 tons. there was a tremendous improvement in 1936 when output level recorded about 162 800 . tons. the trend changed during the depression period of the late 1930s and the first half of the 1940s. the effect of the depression on output was mostly pronounced in 1938 and 1945/46 when output decreased by 32 percent and 20 percent, respectively, based on the preceding peaks attained in 1936 and 1942. output, however, recovered after 1946. it is difficult (in the absence of reliable r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 252 sajems ns vol 3 (2000) no i data} to detennine the extent to which production for domestic consumption of palm oil has drained production for export. however, as shown in the figure, the main output peak was attained in 1953, after which production more or less continued to decline. a very poor output level became more pronounced since the second half of the 1960s. the period 195()"1960 remains the most favorable in the history of palm oil production in nigeria. the development in the palm kernel sector followed a similar pattern as in the palm oil sector. see figure 3. already in 1912, a substantial amount of palm kernel (about 184 600 tons) was produced. output increased most of the time recording the first pronounced peak in 1936 with a level of 386 100 tons. a sharp decrease of about 61 percent was recorded in 1921 based on the 1936 level. other significant decreases in output were experienced in 1940 and 1945/46 with rates of 39 percent and 26.2 percent, respectively, based on 1936 level. after 1946, output improved and remained generally favorable in the 1950s and the first half of the 1960s. output deteriorated generally after 1965, with only minor improvements that remained far below the levels attained in the preceding decade. the output of groundnut was negligible during the very early 19008; the highest level attained before the 1920s was 57 600 tons in 1918. during the second half of the 1920s, output improved and rose to about 325 900 tons in 1937. see figure 4. thereafter, the trend changed showing a poor output performance particularly during the period 1938-1945 that coincided with world war ii period. production was generally revived after 1945, following a more or less upward trend but for sharp decreases experienced at nearly five-year intervals. the greatest decrease during the period occurred in 1951 when output fell by 62.6 percent, based on the preceding peak in 1949. the main peak in the sector was attained in 1966 with a record level of about 1 026 400 tons of groundnuts. a continuous deterioration has characterized the output trend during the post1966 period but for slight improvements in 1968 and 1972. the output of cotton during the transition phase, 1912-1950, was very erratic, fluctuating strongly around an upward trend. see figure 5. a peak was attained in 1942, recording an output level of about 19000 tons. there was hardly any output at all in 1945, with a level of just about 1 000 tons. output increased after 1945, reaching an all time high of 69200 tons in 1963. there were fluctuations though along the way, characterized by sharp decreases, particularly in 1960 and 1962 with rates of about 29.5 percent and 45 percent, respectively, based on the preceding peaks in 1958 and 1961. output slowed down after the peak attained in 1963. it has shown a continuous deterioration since 1978. generally, the output of cotton was most favorable during the period 1958-1977 in nigeria. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 253 at the tum of the twentieth century, the output of rubber was already over 1 200 tons. yet there was no clear output trend until the middle of the 1920s. see figure 6. until 1942, improvement in output was rather slow, with slight interruptions in 1932 and 1941. a significant improvement was started in 1942 and, but for minor decreases in 1947/49 and 1952, it continued generally until 1966 when a peak output level of about 70100 tons of rubber was recorded. the first real shock on rubber output occurred at the wake of the nigerian civil war in 1967. output then was, for the first time since 1950, decreased by as much as 31.9 percent from the preceding year's level. in the early post-(civil) war period in 1971, output was slightly improved, but fell again in 1972 by about 19.7 percent compared to the level in 1971. there was a sharp increase by about 48.8 percent in 1974 and that level was maintained even in 1975 after which output decreased successively during the remaining years, except for slight improvements in 1984 and 1985. 4 sectoral growth rates and the contributing factors the key economic sectors of the nigerian economy experienced steady growths generally during the 1950s and the first-half of the 196os. such key sectors and their average annual growth rates are as follows: large scale manufacturing, 15 percent; construction, 7 percent; export crops, 5 percent; small scale industries, 3 percent; food production for domestic use (including fishery and livestock), 2.5 percent; and mining (excluding oil), 1 percent (lewis, 1967: 10-11). oil (petroleum) sector growth was negligible. compared to the growth rates attained in the large scale manufacturing and construction sectors, the rate in the export crops sector with its third position might appear unimpressive. however, in terms of the export crops sector's contribution to the expansion of transportation and distribution, fmancing of imports through its export proceeds, financing of government services through its taxes, and its general contribution to employment, the exportable crops have made much greater contribution than the other sectors (lewis, 1967: 15-16) in nigeria, manufactured goods are not produced in appreciable quantities for domestic consumption or for export. the economy's import volume can therefore be used as an important indication of its ability to produce primary crops for exports. in other words, the economy's ability to pay for its imports is determined by its primary export (export crops) earnings. in the i 950s, nigeria's export and import values seemed to move positively with each other. for example, in 1950, export earnings stood at n176.8 million and the import expenditures at n123.6 million. four years later, export earnings increased to n292.4 million and the import expenditures also increased to n228 million r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 254 . sajems ns vol 3 (2000) no 1 (fos, review of external trade, various issues). with regard to sectoral contributions to tax revenue, duties on export crops and .export (crops)-financed imports together accounted for approximately half of the nigerian government revenue as compared to less than 10 percent from direct taxes on income. between 1950 and 1955, export duties mainly on agriculture alone averaged more than 20 percent of total government revenue (fos, national accounts of nigeria, various issues). the growth of manufactures, on the other hand, was heavily dependent on an import substitution strategy through tariffs and other control instruments (forest, 1982). the impressive growth rate also reflected the very small base from which the nigerian industrial sector took off. in terms of shares of gop, the agricultural (including food production for domestic use) contribution of over 50 percent far surpassed that of manufacturing sector of just about 4.7 percent (lewis, 1967: 10-11). the enonnous difference was partly due to the fact that manufacturing employed mostly imported machines that were in turn supervised mainly by expatriates. the proceeds in fonn of value added in large scale manufacturing received by nigerian nationals represented just a small fraction of what left the country in fonn of remittances by the expatriates. a similar explanation would be relevant for construction sector since its staff were also mainly foreign experts. the output of export crops in nigeria responded to improved prices after world war ii. export grew at an average annual rate of 4.8 percent during the period 1948-1958. although this growth rate decelerated to 4.1 percent per annum during the period 1958-1964, production growth was fully maintained at 5.1 percent on average per annum (lewis, 1967: 17). the difference between production and export was diverted to domestic use through the government commodity marketing boards (cmbs). during the period 1959/60, about 19.5 percent of groundnuts produced was supplied as raw materials to groundnut crushing mills in kano, 7.2 percent of output of palm produce was diverted to local soap and margarine producing establishments, 7.1 percent of cotton output was absorbed into domestic industries, and 0.1 percent of rubber output was supplied to local industries manufacturing foot-wear, foam rubber, tyres, etc (carter, 1963). apart from the effect of improved prices, other factors contributed also to boosting production during the post-war decades. increased cocoa output was to a large extent caused by technological improvements, with only small increases in land and labour. estimates in 1954 by western region ministry of agriculture indicated cocoa plantation to have covered about i million acres of land. during the period 1950-1953, the average purchase of cocoa in one season . was about 110 000 tons. that implied an average yield of about one-ninth ton or r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000}no i 255 about 250 pounds per acre. by the early 1960s, although there was only about 15 percent increase in cocoa acreage, there was more than 50 percent rise in cocoa production above that of the early part of the 1950s. (see figure 1.) that indicated a productivity increase. among the factors responsible for the productivity increase were: (i) improved age distribution of cocoa trees. more frequent planting of cocoa trees was undertaken by farmers in expectation for improved prices. even when prices failed to meet expectations, output continued to improve since very little or no financial resources were required to maintain the cocoa trees. besides, the opportunity cost of cocoa farming was very low, since the cocoa farmers lacked other skills (berry, 1975: 88 -9). (ii) increased use of insecticides and fungicides both of which were promoted by the authorities through subsidies, credit-schemes, and extension services. the fungicide and insecticide sprays, introduced in 1956 and 1957, respectively, protected the cocoa plants against diseases such as black pods, capsid infestation, and swollen shoots. by 1962, the insecticide sprays were estimated to have covered about one-third of the entire cocoa acreage (helleiner, 1966: 84). (iii) distribution of improved cocoa seedlings to farmers. the principal variety, amelenado cocoa, which on average and if properly managed could yield up to 800 pounds of cocoa per acre, was complemented with a new variety called amazon cocoa. this variety could surpass the amelenado variety with as much as per acre yield of more than 50 percent (helleiner, 1966: 84). the pattern of expansion of output of palm produce during the peak phase remained the same as in the transition phase. production remained the indigenous method of cultivation, care and harvesting. the output expansion that took place was geared by international trade and was followed up by established smallholder-farmers with minimal innovation in the cultivation and harvesting of the product. early attempts to promote smailholder production came in form of distribution of improved seedlings. the seedlings were palms of selective genetic material (purvis, 1970: 268-9). the seedlings were to be grown in straight lines to the exclusion of food crops, and involving laborious inter-row weeding and fertilizing. the idea was to depart from the historical pattern of output expansion. the technological change was meant to be land-saving and requiring investments in the then wild crops. a smallholder rehabilitation scheme for palm produce sponsored by a production development board (pdb), was launched in 1953 to achieve this goal (purvis, 1970: 268-9). in the scheme, every participating farmer was allotted a limit of 5 acres of land to manage and the pdb agreeing to finance subsidies of about ~10 per acre. the amount was meant for felling, clearing, planting, and maintenance over a period of 4 years. the scheme lasted until 1957 and then ceased to exist. the pdb could not fulfill their financial obligations and that created suspicion and loss of confidence in the scheme. farmers felt that the scheme was not worth the trouble when its advantages as a paying proposition was uncertain (oloko, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 256 sajems ns vol 3 (2000) no i 1963). besides, fanners did not have enough resources for a change from a classical "vent for surplus" type of growth, requiring little or no costs of investments, to a neo-classical type of growth affecting changes of resource use and high cost of growth through investment (purvis, 1970: 275). the innovations that got positive reception, mainly in the 1950s, were exclusively in processing and marketing. these resulted in remarkable improvements in product quality rather than in output expansion (purvis, 1970: 267). in the groluldnuts sector, improvement in production was attributed to many factors among which were: (0 gradual expansion on the extensive margin. more land was brought into production. for example, there was an expansion of groluldnut cultivation land from about 1 million acres. in 1937 to over 1.6 million acres in 1960 (cmb annual reports, various issues). (ii) improvement in real prices. the real price of groundnuts in 1963/64 was over 50 percent higher than its level in 1948 (cmb annual reports, various issues). fanners obviously responded positively to such price developments. (iii) increase in productivity through the introduction of high yielding breed of ground-nuts. an initiation of a pilot scheme in 1951 by the northern region development corporation introduced a new breed of groluldnut called k50. fanners welcomed the new breed since it had similar cultivation method as the traditional one that was already in use. the result of the scheme was that by 1957, the per acre yield of groundnuts was raised by 38 percent (helleiner, 1966: ii3). (iv) fertilizer campaigns of the 1950s. during the period 19501952, large-scale issues offertilizer (super-phosphate) were allotted to fanners free of charge (hogendom, 1978: 147). the campaigns were so successful, with the resulted productivity increases so obvious, that fanners generally accepted the positiv~ effects qfusing the fertilizers. (v) improvements at post-harvesting stages of the production process. the use of pestle and mortar, which was the traditional method of shelling the nuts, was in many areas of the producing region replaced with a better technique called mechanical decorticators. (vi) introduction of sprays against pests. with the introduction of the sprays, pests called trogoderma granarium that attacked groundnuts during storage, and which in 1954155 destroyed up to 8.1 percent of total groundnut output, were by 1959/60 completely eradicated (helleiner, 1966: 113). until the 1 950s, a breed of cotton known as ishan a, with a strong but characteristic roughness, was the most common one grown in nigeria for export (agboola, 1979). a new breed called allen longstaple was later on introduced, to be followed by other breeds such as the samaru strains, 26c and 26j. the newly introduced breeds proved to thrive very well in the nigerian soil. at the same time, several programmes were in progress to boost output. the programmes included: (i) the use of "cotton cultivation officers" for the improvement of husbandry and cultivation practices. (u) further improvement r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 257 and extension of marketing facilities. to reduce certain problems associated with sales, several markets for cotton were created and placed closer to farmers. the markets were usually within 16 kilometres from each other. (iii) installation of several cotton ginneries in the main producing centres. these ginneries separated the seeds from the cotton lint. the seeds were in tum dressed with protective chemicals (fungicides) that reduced the incidence of diseases, and then redistributed free of charge to farmers. such measures boosted productivity and also guaranteed that the quality of cotton produced met export requirements. (iv) a policy of paying equal prices at all buying stations. this policy acted as an incentive to remote cotton growing areas towards increased production (choyce, 1968). the area under rubber production increased by about 33 percent in the 1960s. f ao (1966) estimated that about 120 000 persons were engaged in rubber production before the first-half of the 1960s. that figure excluded farmers working in government plantations. by 1971, the total number of rubber farmers, including those working in the government plantations, had gone down to 100000 (agboola, 1979: 114). a combination of the acreage expansion in the growing areas and the decrease in the number of persons working in the farms, would imply that the increase in rubber output during the peak phase was partly due to expansion on the extensive margin, and partly due to a boost in productivity. improvement in productivity was a result of government-led projects that were started in the 1950s, namely the government-owned model plantations. although accounting for only one-eight of the estimated total rubber acreage by 1962, these plantations had served enormously to improve the skills needed by farmers to maintain their rubber farms. the most important of the skills were in rubber tapping and processing. during the period 1957-1962, about 49 000 farmers had been trained in tapping, 17 000 farmers in rubber processing, and about 1 400 farmers in cultivation and maintenance (agboola, 1979: 114). other government-led projects that boosted productivity included distribution of high-yielding seedlings at heavily subsidized prices. the seedlings produced quality changes in nigerian rubber exports. government official figures revealed that in 1956, the three categories of rubber produced in nigeria had the following composition: crepe natural rubber, 5456 tons (14.3. percent); higher grade natural rubber, 5 215 tons (13.7 percent); lower grade natural rubber, 27 486 tons (72 percent). in 1962, the composition had improved to the following: crepe natural rubber, 32518 tons (54.5 percent); higher grade natural rubber, 20 120 tons (33.7 percent); lower grade natural rubber, 7 010 tons (11.8 percent) (fos, trade reports, 1964). obviously, increases in labour and land alone cannot explain the remarkable increases in nigerian export crops production during the peak phase. considerable increases in productivity had contributed to the expanded r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 2s8 sajems ns voll (2000) no 1 production during the period. the cocoa sector was a typical example where productivity gains played a significant role, though there also occurred increases in acreages cultivated. the palm produce sector was on the opposite extreme, however. in that sector, production continued with the classical "vent for surplus" type of growth, since fanners were not particularly receptive to new farming methods. output peaks attained in the palm produce sector were therefore mainly a result of expansion on the extensive margin. for groundnuts, cotton, and rubber, the output peaks attained were through a combination of gradual expansion on the extensive margin and increases in, productivity. fanners in those sectors responded to a large extent to the technological packages that were introduced by the authorities. remarkable though was the fact that all the export crops thrived nearly during the same period and thereafter deteriorated, marking the de-agriculturalisation phase. 5 the origins of de-agriculturalisation the role played by the agricultural sector after the mid-1960s had decreased both in relative and absolute terms. its share of gdp had by 1970 fallen to under so percent and further down to about 22 percent in 1982 (oyejide. 1986: 13). the period 1970-1975 experienced an output decline by about 17.3 percent, and the situation was not improved through the 1980s and the 199os. during the period 1973-1982, the total real output of agricultural export crops declined at an annual rate of about 30 percent (oyejide, 1986: 14). purchases by the government commodity marketing boards (cmb) for export, which was considered the most adequate measure of the output growth (teal, 1983), had more or less ceased in the palm produce and grqundnut sectors, even before the cmb was officially dissolved in april 1986 (andrae and beckman, 1987: 52). (recall figures 1-6.) the cmbs had, since their formation in the late 1930s and early 1940s, taxed away, in form of withdrawals, a substantial amount of income generated by nigerian export crops fanners. because of the gap between world market prices and producer prices, created by the cmb, there were indications that farmers' income fell relative to per capita income in the country. table 1 below shows the magnitude of the tax deductions on export receipts that reached the farmers for the sales of their cash crops. the generally downward trend followed by the price ratios in nearly all the commodities, but for rubber, during the period before the mid-1970s, implied that the taxes on the export crops followed an upward trend. in an argument against the cmb taxes on export crops, lewis (1967: 63) noted, "producer prices have been driven so low that farmers' income is much less than it was is years ago. the incentive to plant export crops has been diminished, and the engine of growth is in danger of being r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 259 slowed down. yowlg men are leaving the cowltry-side, because the tenns of trade are heavily against fanning". rubber was an exception because it was not wlder the control of any government marketing organisation wttii 1977 (cbn, annual report and statement of accowlts, 1977: 3). the table shows that subsidies to farmers only became common as from the first half of the 1970s. that move by the authorities was wldoubtedly a result of the diverted attention to the petroleum sector as the main source of government revenue during the period, and also a desperate attempt by the government to revive the seriously deteriorated agriculture. the subsidy payments were most visible in the palm produce (palm oil and palm kernel) and growldnut sectors. cotton and cocoa farmers continued to be taxed unabated even in the 1980s. table 1 coidldodity cocoa pliiin kernel pliiin 00 ground dats cottod rubber tbe ratio of producer price to world price for the principal nigerian agricultural export commodities, 1945-1985 1945 1950 19s5 1960 1965 1970 1975 1980 1985 98.2 63.5 97.6 58.9 41.1 55.4 72.1 89.3 71.7 70.8 79.0 68.1 59.8 49.1 54.1 140.2 106.4 154.1 75.8 78.6 53.4 57.1 53.2 52.7 87.5 136.2 121.4 77.4 43.8 58.1 68.7 58.7 37.0 100.0 155.6 234.4 100.0 15.9 19.8 24.8 19.9 23.5 36.2 30.1 56.1 100.0 100.0 100.0 100.0 100.0 100.0 100.0 58.0 115.9 sources: computations are based on data from: fos. annual abstracts of statistics (various issues); annual report of the commodity marketing boards (various issues); fao, annual production statistics (various issues); cbn, economic and financial review (various issues), and annual report and statement of accowlts (various issues). at the same time as farmers suffered great income losses through withdrawals by the cmbs, unskilled urban workers. and farmers employed in government farms settlements and plantations, enjoyed regular minimum wage increases. dmidg tbeperiod 1961/63, the minimum wage was increased by about 200 percent lbat increase was nothing compared to the benefits enjoyed by the urban educated elite. lewis (1967: 42-3) noted that whereas in britain university graduates and miners received about the same wage, the nigerian graduates expected to be paid wages equivalent to that of four miners or nine farmers. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 260 sajems ns vol 3 (2000) no 1 the nigerian government awareness of the agricultural deterioration became pronounced in 1973, when it undertook a reformation of the commodity marketing boards. the main objective of the reform was to tum the trend of output upwards by improving producer prices (kirk-green and rimmer, 1981). taxes on some of the export crops were relaxed, and removed completely on the others. subsidy payments which were very rarely awarded farmers in the past became more frequent other measures taken by the government to improve agricultural production included the establishment of government-directed projects such as agricultural banks, farm settlements and plantations, and irrigation schemes (forest, 1980: 222-58). the agricultural banks were supposed to give credits to farmers for the purchase of production inputs such as fertilizers, and cash crops seedlings, among others. unfortunately, it turned out later that political pressures dominated the activities of such banks, with the result that a vast majority of the peasant farmers never did benefit from the credits (forest, 1980). not only was it impossible for the farmers to produce the collateral securities needed to guarantee them the loans, but as okowa (1982: 182) noted, most peasant farmers were simply not aware of the existence of the credit facilities. the facilities were located in the urban areas while farmers who were supposed to make use of them lived in the rural areas. as an example, the nigerian agricultural bank had by 1978 approved loans of about frot286 million, with the actual disbursed amount estimated to about frotl24 million. of the total amount disbursed as loans, 58 percent went to state government corporations and cooperatives, at 3 percent interest for on-lending. at 5 percent interest rate, the remaining 42 percent went to private companies and a class of individuals that, according to collier (1983: 212), were better classified as "over-night" farmers recruited from urban business people, civil servants, and army officers. the idea with the low interest rates was that the bank should not operate on commercial basis (forest, 1980). the bank, however, had other stringent lending conditions that made it practically impossible for poor peasant farmers to obtain the loans. yet in the official government declaration for creating the agricultural bank, it was "in order to bring its lending facilities closer to the farmers for whose benefit the nigerian agricultural bank was established" (the nigerian trade journal, 1975: 10). the bank's attitude lends weight to one of the common lender behavior assumptions that formal lenders are overly risk averse (spio and groenewald, 1997). the establishment of government farm settlements and plantations was begun already in the 1960s with follow-ups on the project in the 1970s. the farm settlements were operated in such a way that a settler was an integral part of the establishment, and the farm he operated could ultimately become his after he had repaid development costs. (settlers were predominandy males.) in contrast, . a farmer remained an employee in the plantations (agboola, 1979: 186), the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajbm.s ns vol 3 (2000) no 1 261 government fann settlements had important goals among which were to depart from subsistence agriculture, and to make farming an attractive means of earning a living for able-bodied schoolleavers (roider, 1971). the size ofland under the care of each settler varied from 4.9 to 5.7 hectares in the eastern region of the country, and 8.1 to 10.1 hectares in the western region (un, fao, 1966; floyd and adinde, 1967). to meet the goals, the authorities provided social facilities and offered comparatively high wages. what the authorities neglected, however, was the necessity of first considering properly local labour requirements before going into vast expenditures on housing and the social facilities for expected migrant labour. it turned out that because of the capitalintensive nature of the agricultural projects their capacity to create jobs was limited (eicher et ai., 1970). in the western region, it was reported that by the end of 1966/67, a total cost of n12.8 million had been incurred. that was equivalent to about n8 000 per settler an amount that represented double of what was originally projected (forest, 1980). un, fao (1966) estimated the cost per settler to be about ni0 000. apart from the over expenditure caused by poor planning in the western region, the oil plllm plantations and the settlement schemes encountered somewhat different problems in the eastern region. the participants lacked the right incentives, the main cause being their dissatisfaction with the commodity marketing boards taxes that would eventually affect their export receipts (saylor, 1968). irrigation schemes were also given priorities by the authorities in their drive to revive tbe deteriorated agriculture. the schemes were supposed to serve as sources of water supply to some of the farm settlements and plantations, particularly the ones located in the more arid areas in the northern region. the irrigation projects turned out, later on, to be failures. the projects were a total of eight in number at the very beginning in the 1960s, with varying sizes of 201094 hectares. yet by 1974, only about 5.5 percent of projected irrigable area had been developed (agboola, 1979). the only success achieved was on rice, despite the initial plan that they should cover cotton and groundnuts areas, as well as wheat to substitute imports. based on data from forest (1980), the wheat produced on irrigated fann land was, by 1970, only about i percent of total wheat import into nigeria. so when more money was allocated to irrigation projects in the 1970s, as a follow-up on the projects from the 1960s, some critics argued dmt the government's drive towards such projects was due to prestige considerations (essang and olayide, 1975). others argued that it was a continuation of goyemment import substitution strategy (forest, 1980), and that such projects had only succeeded mainly in massive appropriation of peasant lands but to very limited utilization of peasant labour (collier, 1983: 210-11). the nigerian irrigation projects were capital intensive in nature, with development costs estimated to about n592 per hectare. one of the great r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 262 samms ns vol 3 (2000) no 1 problems encountered with the projects. apart from the high development costs, was that it was not always clear what particular cropping patterns should be employed to realize yields high enough to cover the high costs (agboola, 1979: ni93). obviously, the government had good intentions by embarking on the projects. unfortunately, the projects mainly raised wages in the rural communities at the expense of agricultural production. the predominantly agricultural rural labour simply rushed to the government-directed projects in search of higher paid jobs, deserting their farms. it was a situation that could be characterized as a coexistence of labour shortages in the rural agriculture and a big pool of unemployed persons in search of higher paid jobs. the consequence was a decreased agricultural production, particularly since the government-directed projects never succeeded in producing enough to substitute the lost output of the rural agriculture that was exposed to uncompetitive high labour costs. according to agboola (1979: 193), the estimated output of some of the export crops by the farm settlements and plantations, at their production peaks, as a percentage of total output of the respective export crops in the country, ran as follows: cocoa 1 percent, palm produce (palm oil and palm kernel) 3.5 percent, and rubber 5 percent. the government projects never paid off with the result that the authorities ran into difficulties of mobilizing revenues for maintenance. a positive achievement, however, was the use of fertilizers that became widespread among farmers when some of the projects were first introduced in the 1960s (adegboye et ai., 1969). conclusion no significant part of the expansion of output of cash crops during the transition period can be attributed to any revolutionary changes in production techniques. mechanized farming did not exist in nigeria during the period. expansion of output was achieved because there existed surplus labour and land both of which could be mobilized without much risk of reductions in local levels of consumption of domestically produced output. transportation systems were also improved. however, increases in labour and land alone cannot explain the output peaks attained during the 1950s and some part of the 1 960s. the agricultural sector experienced increases in productivity following the introduction of some technological packages by the authorities. biological research processes had begun in the 1940s with their results being felt as from the 1950s. the technological packages were mainly in the form of insecticide and fungicide sprays, fertilizers, improved seedlings, extension services and infrastructural facilities. remarkable though with the trend of development of nigerian export agriculture was the fact that all the export crops flourished r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 263 nearly during the same period and thereafter started to deteriorate and therefore marking the de-agriculturalisation period. an important.argument by this paper is that the foundation for de-agriculturalisation was actually laid during the 1950s and the 1960s, ev.en though the period also corresponded with the output peak phase. not only were farmers heavily taxed by the government instituted commodity marketing boards during the period, but the government credit facilities were made very difficult to obtain, particularly for the grassroot farmers. in other words, the government credit policies were biased against the grassroot (peasant) farmers who were responsible for a greater part of the total agricultural production. those who gained from the credit facilities were mainly government corporations and cooperatives, private companies, civil servants and army officers. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . product (1000 ions, i i ~ .. 8 '" .. $ $ i 1912 :a i i ~ 191 .. ijq i: ; 1918 j. £ 1920 1922 0 i: 192.& .t; 1926 i: .... 1928 0 "'" 1930 n 0 1932 s 11134 = ..-.. -1936 \0 -1938 n i 1940 -\0 1m2 00 v. '-' 19.&.& 19.&6 :19.&6 .. ~ 19s0 1962 1954 1956 1956 1960 1962 196.& 1966 1966 1970 1972 197.1976 1978 1980 1982 19m v xicln::iddv z on (oooz) £ loa sn sw3fvs t9z r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . product (logo tons) ~ ... ... g g <:> ... <:> g 1912 i • '!l'l 1914 rio = "i 1916 ~ 1918 n 1920 1922 0 = -"ci 1924 = -1926 c ... 1928 "= » 1930 1932 a 1934 0 = 1936 ,-. -1938 i.,q hi i 1940 i.,q co 1942 vi '-' 1944 1946 ~ 1941 . ~ 1950 1952 1964 1956 1968 1960 1962 1964 1_ 1_ 1970 1972 1974 1976 1978 1980 1982 1984 ~9z z; on (oooz) e loa sn swruvs r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 266 samms ns vol 3 (2000) no 2 1jt6~ ~86~ 8l6~ sl6~ u6~ 686~ 996~ 1:96~ 096~ l.h~ ts6~ ,..-... ..,.. ~s6~ 00 0'1 :-8t1h ~ i ~ sk~ 0'1 -'-' m~ ~ c: .. 8c6~ ~ 9£6~ e -; ct6~ ii\.o ... ou~ c> .. :s a8~ c. .. :s tl!6~ 0 1.z6~ f'i'l 8~6' f :s s~6~ ii!) ~ tun i ! iii 0 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . samms ns vol 3 (2000) no 2 267 -~ ~86~ li.l.6~ sl6~ zj.6~ 696~ 996~ £96~ 0116~ lh~ ts8~ ,-,. 1.1") 00 cf\ ..-. ~s6~ i -~:. c"i -cf\ sk~ -'-' l:"l ::i s:: -= 6t6~ s:: ::i 9tn co 10. 0 tt6~ .... co ot6~ -::i =.. lu~ -::i 0 n6~ ~l:6~ ..,. gi 8l6l 10. ::i ~ 5~6~ ~ n6~ 0 !! '" '" (iii r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 268 sajems ns vol 3 (2000) no 2 t1i6~ ~~ 086~ 8l&~ 'l&~ tl&~ l:l&~ ol&~ -~ -~ t1i6~ l:8&~ 086~ 8s&~ 8s&~ k&~ ~&~ o!ltn ~ n&~ ! n&~ --. 00 ""~ 00 c'i l:t&~ ..... i n ok~ ..... c'i 8t&~ ..... '-' ....1 c = te&~ -mn = u on~ ... = il:&~ -:i il:u c. n&~ :i 0 u&~ ol:&~ iii 8~~ qj .. .~~ :i qi) t~~ fi: n&~ 0 0 • .. 0 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . product (1000 tons) c> ;; ~ l!: ~ ! ! cl cd c 1912 1914 ~ (jq = 1916 '"i t'i> 191. 0'1 1920 1922 0 1924 = .... 1926 'c = .... 1926 c> 1930 .... ::0 1932 = =1934 =t'i> 1936 '"i 1938 'j:j 1940 ...... iv 1942 i 'j:j 1944 00 vt i_ '-' t: 1948 i! ~ 19!1o 1952 1954 1966 1_ 19110 1962 1964 1966 1968 1970 1972 1974 1975 1971 1980 1982 1984 69z z on (oooz) £ loa sn swffi'vs r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 270 sajems ns vol 3 (2000) no 2 references adegboye, r.o.; basu, a.c. and olatunbosum, d. (1969) "impact of we stem nigerian farm settlements on surrounding farmers", nigerian journal of economic and social studies, 11: 229-40. 2 agboola, s.a. (1979) an agricultural atlas of nigeria. oxford university press, oxford and london. 3 andrae, g. and beckman, b. (1987) industry goes farming (the nigerian raw material crisis and the case of textiles and cotton), research report no. 80, scandinavian institute of african studies, uppsala. 4 berry, s.s. (1970) "cocoa and economic development in western nigeria", in eicher, c.k. and liedholm, c. (eds.) growth and development of the nigerian economy, michigan state university press, east lansing, michigan. 5 berry, s.s. (1975) cocoa, custom and socio-economic change in rural western nigeria, clarendon press, oxford. 6 blanckenburg, p. von (1971) "rubber farming in benin area: a study of some socio-economic factors influencing rubber production", nigerian institute of social and economic research, lbadan. mimeographed. 7 carter, n.g. (1963) "an input-output analysis of the nigerian economy, 1950-1960", working paper. school of industrial management, mit, cambridge. 8 choyce, m.a. (1968) "a review of cotton development in nigeria", samaruagricultural newsletter, 10: 44-57. 9 collier, p. (1983) "oil and inequality in rural nigeria", in ghai, d. and radwan, s. (eds.) agrarian policies and rural poverty in africa. international labour office, geneva. 10 eicher, c.k. (1970) "the dynamics of long-term agricultural development in nigeria", in eicher, c.k. and liedholm, c. (eds.) growth and development of the nigerian economy, michigan state university press, east lansing, michigan. 11 eicher, c.k., zalla, t., kocher, j. and winch, f. (1970) employment generation in african agriculture. michigan state university press, east lansing, michigan. 12 essang, s.m. and olayide, s.o. (1975) "pattern of estimated agricultural expenditures in the 1975-80 nigerian plan: some implication", the nigerian journal of economic and social studies, 17 (3): 245-61. 13 floyd, b. and adinde, a. (1967) "farm settlements in eastern nigeria: a geographical appraisal", economic geography, 43: 189-230. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 271 14 forest, t.g. (1980) "agricultural policies in nigeria, 1900-1978", in . heyer, j., roberts, p. and williams, g. (eds.) rural development in tropical africa. macmillan, london. 15 forest, t.g. (1982) "recent development in nigerian industrialization", in fransman, m. (ed.) industry and accumulation in africa, heinemann, london. 16 galletti, r., baldwin, k.d.s. and dina, 1.0. (1956) nigerian cocoa farmers, oxford university press, london. 17 helleiner, g.k. (1966) peasant agriculture, government, and economic growth in nigeri, richard d. irwin inc., homewood, illinois. 18 hogendorn, j.s. (1970) "the origins of the groundnut trade in northern nigeria", in eicher, c.k. and liedholm, c. (eds.) growth and development of the nigerian economy, michigan state university press, east lansing, michigan. 19 hogendorn, j.s. (1978) nigerian groundnuts exports: origins and early developments, ahmadu bello university press and ox.ford university press, zaria and ibadan. 20 just, r.e. (1975) "risk response models and their use in agricultural policy evaluation", american journal of agricultural economics, 57: 836-43. 21 kirk-green, a. and rimmer, d. (1981) nigeria since 1970: a political and economic outline, hodder and sloughton, london. 22 lewis, w.a. (1967) reflections on nigeria's economic growth. development centre, oecd, paris. 23 luning, h.a. (1963) an agro-economic survey in katsina province. government printer, kaduna. 24 myint, h. (1959) ''the classical theory of international trade and the underdeveloped countries", economic journal. 68: 17-337. 25 okowa, w.j. (i982) the distributional impact of public policy in nigeria:a dualistic approach, unpublished ph.d. thesis, uppsala university, uppsala. 26 oloko, o. (1963) a study of socio-economic factors affecting agricultural productivity in annang province, eastern nigeria, nigerian institute of social and economic research, ibadan. 27 oluw asanmi, h.a. (1966) agriculture and nigerian economic development. oxford university press, london. 28 oyejide, t.a. (1986) the effects of trade and exchange rate policies on agriculture in nigeria. research report 55, international food policy research institute. 29 purvis, mj. (1970) "new sources of growth in a stagnant smallholder economy in nigeria: the oil palm rehabilitation scheme", in eicher, c.k. and c. liedholm (eds.) growth and development of the nigerian economy, michigan state university press, east lansing, michigan. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 272 sajems ns vol 3 (2000) no 2 30 roider, w. (1971) farm senlementsjor socio-economic development: the western nigerian case, weltforum verlag, munchen. 31 saylor, rg. (1968) a study ofobstac/es to investment in oil palm and rubber plantations. nigerian institute of social and economic research, ibadan. 32 spio, k. and groenewald, j.a. (1997) "rural financial markets: an overview", agrekon. 36 (2): 121-38. 33 teal, f. (1983) "the supply of agricultural output in nigeria. 19501974", journal of development studies. 19: 191-206. 34 un, fao (1966) agricultural development in nigeria, ]965-]980, rome. 35 un, f ao, annual production statistics (various issues). 36 zeven, a.c. (1965) "oil palm groves in southern nigeria: part 1, types of groves in existence", journal of nigerian institute of palm oil research, 4 (1): 43-54. offidal nigerian publications annual reports of the commodity marketing boards (various issues). central bank of nigeria (cbn), annual report and statement of accounts (various issues). cbn, economic and financial review (various issues). federal office of statistics (fos), review of external trade, lagos (various issues). fos, trade reports, lagos, 1964. fos, annual abstract of statistics, lagos (various issues). fos, national accounts of nigeria, lagos (various issues). the nigeria trade journal, vol. 22, no.1, 1975. western region ministry of agriculture, ibadan, 1954, 1955. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction literature review and hypotheses methodology findings discussion recommendations suggestions for future research limitations of the study acknowledgements references about the author(s) christiaan j. naude department of business management, university of pretoria, south africa a. johan vögel department of business management, university of pretoria, south africa citation naude, c.j. & vögel, a.j., 2018, ‘repatriation turnover revisited: a focus on south african multinational enterprises’, south african journal of economic and management sciences 21(1), a1680. https://doi.org/10.4102/sajems.v21i1.1680 original research repatriation turnover revisited: a focus on south african multinational enterprises christiaan j. naude, a. johan vögel received: 24 oct. 2016; accepted: 22 jan. 2018; published: 19 apr. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the topic of repatriation turnover as a major source of concern for repatriates and their multinational enterprise has been covered extensively in the literature over the years, with the literature showing that between 15% and 38% of repatriated expatriates leave the employment of their multinational enterprise within the first year after repatriation. however, no such study has focused on the repatriation of south african expatriates. aim: the primary aim of this study was to determine if there is a correlation between the repatriation practices of south african multinational enterprises and their repatriation turnover rates. the secondary aim of the study was to determine why repatriated employees leave the employment of south african multinational enterprises. method: this quantitative study surveyed 41 expatriate managers of south african multinational enterprises, with the mann-whitney u test and spearman’s correlation coefficient being used to test for correlations between the repatriation practices of south african multinational enterprises and their repatriation turnover rates. results: the results revealed positive correlations between appointing a mentor to an expatriate to assist with the repatriation process, conducting an orientation programme prior to repatriation and supporting the expatriate with various initiatives during repatriation and lower repatriation turnover rates. meanwhile a negative correlation was found between when a multinational enterprise starts with an orientation programme prior to repatriation and repatriation turnover rates. conclusion: these findings provide valuable insights for south african multinational enterprises into practices they can employ to reduce their repatriation turnover rates. introduction over the years, expatriation has been covered extensively in the literature with the challenges associated with foreign assignments and expatriate management receiving the lion’s share of the attention (hill 2005:629; stahl et al. 2009:91; van aswegen 2008:2; vidal, valle & aragon 2008:1683). recent studies, however, have directed the attention to the importance of expatriates and repatriates – ‘former international assignees who have returned to their domestic organisation after completing their international assignment’ (berthoin antal in burmeister & deller 2016:69) – as vehicles for knowledge transfer and organisational learning, the processes that constitute the foundation of organisational competiveness in a global economy (lazarova & cerdin 2007:405; vidal, valle & aragon 2016:3). but with multinational enterprises (mnes) experiencing problems in retaining employees after their return from international assignments (goss & hynes 2005:97; lazarova & cerdin 2007:404; vidal et al. 2008:1683) many mnes are not able to capitalise on this opportunity (o’sullivan 2013:265; shen & hall 2009:793). to put this problem into context, according to grant (1997:166), 15% of us repatriates leave their enterprise within 12–18 months after repatriation, increasing to 40% after 3 years. in a more recent study the brooksfield global relocation trends report 2010 (in kraimer, shaffer, harrison & ren 2012:399) found that 38% of repatriated employees leave the employment of their mne within the first year after repatriation. while the 2016 report found that 14% of mnes saw an increase in their repatriation turnover, 12% saw a decrease and 75% saw no change (brooksfield global relocation 2016). the cost of these failures can range from a loss of the initial development investment in employees when they take up employment with another mne (allen & alvarez 1998:31; caligiuri & lazarova 2001 in kraimer et al. 2012:399) to the inability to recruit high potential employees for future assignment as they see an international assignment leads to career derailment (allen & alvarez 1998:31; o’sullivan 2013:265). south africa is the second biggest emerging market source of foreign direct investment (fdi) into africa (unctad 2013) and ranked ninth overall with 28 fdi projects in africa (financial times 2016:6). these figures are of particular concern given the fact that the availability of key skills is considered to be the greatest challenge facing ceos in africa. this while 88% of enterprises in pricewaterhousecooper’s (pwc’s) 17th global ceo survey indicated that the importance of global mobility has increased (pwc 2014). although the topic of repatriation turnover as a major source of concern for repatriates and their mne has been covered extensively in the literature over the years (lazarova & cerdin 2007:404), no such studies have focused on the repatriation of south african expatriates (vögel 2015). however, in a study focusing on the preparation, support and training requirements of south african expatriates, it was found that discussing the expatriate’s long-term career path prior to the international assignment and assigning a mentor to an expatriate were rated second and third respectively as the requirements with the greatest gap between what expatriates require from their mne and what they received (vögel, van vuuren & millard 2008:36). both of these have been identified as important elements in ensuring the successful repatriation of expatriates (allen & alvarez 1998:34–35; ambrosius 2016:3–4). thus, given the increasing presence of south african mnes in africa, the shortage of key skills in the continent and the lack of knowledge of repatriation in south african mnes, the primary aim of this study was to determine if there is a correlation between the repatriation practices of south african mnes and their repatriation turnover rates. with a practice being defined as ‘the customary, habitual, or expected procedure or way of doing something’ (english oxford living dictionaries 2017) and repatriation defined as the process of integrating expatriates back into the home enterprise (allen & alvarez 1998:30; peng & meyer 2011:497), repatriation practices can be defined as the customary, habitual or expected procedures followed by an mne when integrating expatriates back into the home enterprise. the secondary aim of this study was to determine why repatriates leave the employment of south african mnes once repatriated. literature review and hypotheses when the repatriation process is not executed properly, uncertainty is created, dissatisfaction is experienced with the repatriation process and the repatriated employee can perceive the international assignment as career limiting, ultimately resulting in resignation (lazarova & cerdin 2007:406; macdonald & arthur 2003:3). this experience is referred to by herman and tetrick (2009:71) as career derailment. furthermore, negative repatriates can influence the rest of the workforce considering international assignments, as top performers will not be interested in international career opportunities (herman & tetrick 2009:72; o’sullivan 2013:265; vidal et al. 2008:1685). meanwhile poor performance and departure after repatriation cause both a heavy expense burden and business risks for an enterprise (baruch, steele & quantrill 2002:660). over the years a number of factors have been identified as contributing to repatriation turnover, namely the financial shock related to the forfeiting of allowances, the psychological shock related to the loss of autonomy and authority, a lack of career advancement and reverse culture shock resulting from unrealistic expectations that nothing in the home country has changed (goss n.d.:5–8; herman & tetrick 2009:69,72; lazarova & cerdin 2007:406; macdonald & arthur 2003:6; paik, segaud & malinowski 2002:635). lazarova and cerdin (2007:405; o’sullivan 2013:265), however, put forward a second argument explaining repatriation turnover, stating that repatriation turnover occurs not so much as a consequence of a lack of organisational attention and support as due to the availability of better employment opportunities outside the repatriate’s current employer and the need for individuals to manage their own careers. on the flip side, research has identified perceived enterprise support during the assignment, perceived effectiveness of the repatriation process and long-term career advancement and growth opportunities as critical to the successful repatriation of expatriates (benson & pattie 2009:64; herman & tetrick 2009:69; kraimer, shaffer & bolino 2009:31; stahl et al. 2009:90,93,95). repatriation, however, remains a costly expense in terms of time, money and human capital (kraimer et al. 2009:30; stahl et al. 2009:103). but in the case of repatriation turnover not only will the opportunity for reverse knowledge transfer be forfeited but it will also be detrimental to the mne’s leadership and development as well as affecting the global career plans in terms of the loss of a cadre of international employees available for future placement (kraimer et al. 2009:30; stahl et al. 2009:104; vidal et al. 2008:1684). this being said, no matter how sophisticated the career development and repatriation management processes are, turnover should be expected in some cases (o’sullivan 2013:266; stahl et al. 2009:105). according to martin and anthony (2006:620), the repatriation process consists of four phases, namely pre-expatriation, during expatriation, prior to repatriation and during repatriation. in order to examine the repatriation process in more detail, these four phases were used as a broad structure for this study. phase 1: prior to expatriation the focus during this phase is creating and building support for the programme and selecting the right candidates for international assignments coupled with career planning and orientation prior to departure. a major component of this phase is also the creation of a formal repatriation programme (martin & anthony 2006:621). the worldwide erc global benchmarking survey has, however, found that only 51% of enterprises had a formal repatriation programme. in particular, this was the case in 87% of asian enterprises compared to 45% of us enterprises (tinder n.d.:2). during the initial phase, career development is planned and goals for the assignment are communicated to the expatriate, while a mentor should be assigned to monitor and work with the expatriates, including informing the expatriate of future assignments. mentorship prior to departure can form a basis of future interaction and determine the frequency of communication (allen & alvarez 1998:34; o’sullivan 2013:267). initially, the focus should be on adjustment, but thereafter the focus should move to career development. the development of a repatriation education programme (i.e. exploring the issues, concerns, challenges and rewards of living abroad) should also form part of this phase (de valk 2004:42; martin & anthony 2006:622). prior to departure, career expectations should be defined in terms of how the international assignment fits into the employee’s career path and possible domestic job opportunities on return. conversations about the employee’s post-assignment job placement should commence before the international assignment and continue throughout the expatriate period (ambrosius 2018:3–4; martin & anthony 2006:623). an important briefing during this phase is to emphasise that expatriates must be realistic about the post-assignment, back in the home country. these sessions should be mandatory for all employees and family members (tinder n.d.:7). partner orientation is also part of this phase and has a substantial influence on the relationship of the expatriate with the enterprise. ensuring that the partner is properly trained to relocate can increase the possibility of the expatriate completing the assignment and staying with the enterprise on return (martin & anthony 2006:623). in considering a foreign assignment policy, it should be kept in mind that such a policy should be a set of guidelines for relocating persons around the world while maintaining the corporate culture, and not rigid rules (greenberg 2009:18). according to martin and anthony (2006:622), in those instances where senior management is involved in formulating the policy and not merely approving the policy, there is a higher occurrence of best practice activities. in those cases, it is more likely that there are career discussions with expatriates, that expatriates are given special attention in succession planning, mentorship programmes exist and, perhaps more importantly, there is much greater planning for an expatriate’s return. jassawalla, connelly and slojkowski (2004:41) are of the opinion that the presence and quality of foreign assignment policy guidelines seem strongly linked to repatriation effectiveness. hence the first hypotheses: h1a: there is no correlation between the implementation of a foreign assignment policy and the repatriation turnover rates of south african multinational enterprises in year 1 after repatriation. h1b: there is no correlation between the implementation of a foreign assignment policy and the repatriation turnover rates of south african multinational enterprises in year 2 after repatriation. h1c: there is no correlation between the implementation of a foreign assignment policy and the repatriation turnover rates of south african multinational enterprises in year 3 after repatriation. phase 2: during expatriation the major components of this phase include: adjusting to the overseas environment, keeping up with organisational priorities and not being out of sight, out of mind, with communication being paramount (greenberg 2009:18–19; martin & anthony 2006:623; o’sullivan 2013:275–276). communication throughout the duration of the international assignment is considered to contribute to re-entry adjustment (tinder n.d.:7). as a result, from a repatriation point of view, the focus of this phase should be on keeping the expatriate up to date with organisational changes. during this phase, mentors can perform a critical role in updating expatriates on structural changes, revised policies and procedures and strategy updates (allen & alvarez 1998:34; martin & anthony 2006:624). in particular, the enterprise’s objective in assigning a mentor is to establish a formal communications network involving the expatriate, the mentor and corporate human resources (oddou 1991:306; swaak 1997:30). the so called ‘out of sight, out of mind’ syndrome can largely be attributed to the separation from the home country; not being involved can have disadvantages when important hr decisions are tabled and the expatriate is excluded from career-enhancing jobs. mentorships can bridge this gap, but when mentors are reassigned, the loop of information is interrupted (martin & anthony 2006:624). the responsibility for keeping in contact is, however, not only the responsibility of the enterprise; the expatriate should also play a proactive role (allen & alvarez 1998:37–38; tinder n.d.:7) by for example developing close relations with several other informal sponsors and developing rapport with several other managers who supervise positions considered to be attractive target repatriation positions (allen & alvarez 1998:37). as a result, the following hypotheses were stated: h2a: there is no correlation between an expatriate manager perceiving assigning a mentor to a repatriate as being important and the repatriation turnover rates of south african multinational enterprises in year 1 after repatriation. h2b: there is no correlation between an expatriate manager perceiving assigning a mentor to a repatriate as being important and the repatriation turnover rates of south african multinational enterprises in year 2 after repatriation. h2c: there is no correlation between an expatriate manager perceiving assigning a mentor to a repatriate as being important and the repatriation turnover rates of south african multinational enterprises in year 3 after repatriation. phase 3: prior to repatriation during this phase the mne should focus on creating realistic expectations, starting with repatriation counselling, conducting career planning and addressing issues that could lead to resignation (kulkarni, lengnick & valk 2010:543; martin & anthony 2006:624). de valk (2004:42) stresses the importance of starting this process several months prior to the expatriate’s return to his or her pre-assignment workplace. keogh (2003:38) is of the opinion that although some mnes start this process 2–6 months before the return of the expatriate, mnes that effectively set goals start planning the return of expatriates even before the assignment starts. as this phase focuses on creating realistic expectations, the intentions of the mne should be clearly communicated to the expatriate. it is also essential to address family support as soon as possible during this phase. enterprises should thus help to create these realistic expectations about the work and non-work lives before repatriation (kulkarni et al. 2010:542; martin & anthony 2006:624–625). programmes where expatriates and their families are invited to a 2-day seminar 6 months prior to repatriation can address issues like return adjustments, clarifying career objectives, expenses to be incurred on return, the elimination of allowances and lifestyle adjustment on return. (martin & anthony 2006:625; o’sullivan 2002:598). meanwhile kulkarni et al. (2010:543) suggest sending the expatriate back to their home country prior to the official repatriation to see first-hand any changes before repatriation. the role of the mentor during this phase continues to be important in keeping the expatriate informed, liaising with hr to finalise re-entry and conducting re-entry discussions (conference board report in martin & anthony 2006:627; o’sullivan 2002:598). as a result, it was hypothesised that: h3a: there is no correlation between when south african multinational enterprises start the repatriation process and their repatriation turnover rates in year 1 after repatriation. h3b: there is no correlation between when south african multinational enterprises start the repatriation process and their repatriation turnover rates in year 2 after repatriation. h3c: there is no correlation between when south african multinational enterprises start the repatriation process and their repatriation turnover rates in year 3 after repatriation. h4a: there is no correlation between an expatriate manager perceiving the introduction of enterprise initiatives such as an orientation programme as being important prior to repatriation and the repatriation turnover rates of south african multinational enterprises in year 1 after repatriation. h4b: there is no correlation between an expatriate manager perceiving the introduction of enterprise initiatives such as an orientation programme as being important prior to repatriation and the repatriation turnover rates of south african multinational enterprises in year 2 after repatriation. h4c: there is no correlation between an expatriate manager perceiving the introduction of enterprise initiatives such as an orientation programme as being important prior to repatriation and the repatriation turnover rates of south african multinational enterprises in year 3 after repatriation. phase 4: during repatriation the focus in the last phase of the process should be on reducing reverse culture shock, repatriation adjustment, managing expectations, welcome-home orientation and the repatriation role of the mentor. using the newly acquired skills and valuing the international experience of the repatriate to the benefit of the enterprise is also critical during this phase (janush 2003:52; martin & anthony 2006:626). reverse culture shock in particular is normally associated with re-entry adjustment, stress management and work performance (martin & anthony 2006:626). it is, however, in the enterprise’s best interest to proactively address the repatriation phase of the assignment through training, mentoring and career planning (de valk 2004:42). these proactive initiatives can include a re-entry seminar 1 month after repatriation (tinder n.d.:9), counselling (preferably with an external consultant to encourage open and honest communication), assistance to partners seeking employment, customised sessions with children, and another follow-up 6 months later (martin & anthony 2006:627). it should be kept in mind that re-entry adjustment is often more complex and more difficult than cultural adjustment when embarking on an international assignment with the duration of a foreign assignment affecting the re-entry adjustment. the longer the period of an international assignment, the more difficult the adjustment back into the home country will be (martin & anthony 2006:626; vidal et al. 2008:1685). the stress factor associated with re-entry into the home environment originates from children adapting to new schools, different learning curriculums, a new social environment (i.e. making new friends) and new working environments for both the repatriate and partner (o’sullivan 2002:598). work performance is often affected by new job responsibilities, a new supervisor, peers, subordinates and goals to achieve in the new working environment (martin & anthony 2006:626). the time it takes for the repatriate to adjust back into the home country and new position can vary from 1 month to 3 years and should be managed by the enterprise as part of the re-entry adjustment (janush 2003:52; martin & anthony 2006:627). when looking at the management of expectations, the mne should consider a number of factors such as expectations of expatriates to be placed in high-profile positions, applying their new skills and receiving the support and interest of colleagues as well as an acceptable living environment and manageable cost of living (jassawalla et al. 2004:43; martin & anthony 2006:627). repatriates themselves can address these expectations by scheduling meetings with their home country supervisor about their newly acquired skills and how these skills can be utilised on the job (de valk 2004:42), as one of the great concerns of expatriates is that their knowledge should be put to use (tinder n.d.:9). based on the aforementioned discussion, it was hypothesised that: h5a: there is no correlation between an expatriate manager perceiving offering repatriation support to repatriates as being important during repatriation and the repatriation turnover rates of south african multinational enterprises in year 1 after repatriation. h5b: there is no correlation between an expatriate manager perceiving offering repatriation support to repatriates as being important during repatriation and the repatriation turnover rates of south african multinational enterprises in year 2 after repatriation. h5c: there is no correlation between an expatriate manager perceiving offering repatriation support to repatriates as being important during repatriation and the repatriation turnover rates of south african multinational enterprises in year 3 after repatriation. methodology sample with this quantitative study focusing on the repatriation practices of south african mnes, the target population was all south african mnes who employ expatriate staff. consequently, the inclusion criteria used were that the mnes had to be headquartered in south africa and, secondly, that they had to employ expatriate staff. as a result of the specific inclusion criteria, coupled with the fact that the population size was difficult to ascertain, non-probability judgement sampling was used. next the unit of investigation was identified as the expatriate managers of these south african mnes as they were deemed to be in the best position to provide information on the repatriation practices in their respective mnes. in drawing the sample, two self-developed databases containing the contact details of south african mnes were used. the first database contained the names and contact details of 170 south african mnes with no indication of whether they employed expatriates or not. the second database contained the names and contact details of an additional 40 south african mnes who employ expatriates. next, the 170 mnes on the first database were contacted telephonically to determine whether they made use of expatriates, and if so what the name and contact details of their expatriate manager were. the result of this process was that this database was reduced from 170 to 61 mnes providing the researchers with a sample of 101 mnes. the 101 expatriate managers at these mnes were then sent a self-administered questionnaire electronically, with 41 expatriate managers completing the survey, translating into a 41% response rate. this response rate compares favourably with similar repatriation studies, with response rates ranging from 35% to 44% (caligiuri & tung 1999:769; kraimer et al. 2009:33). when looking at the sample characteristics, the wholesale and retail trade industry represented 27% of the 41 respondents, followed by the information and communication technology industry, with 15%, and the manufacturing and construction industries with 10% each. the enterprises in this study ranged in size from 465 employees to 70 000 employees, while the number of expatriates on assignment ranged from 3 to 6000. of the 41 respondents, 38 assign expatriates to african countries, followed by europe, with 19 enterprises, asia, with 17, south america with 11, north america with 9 and lastly australasia with 8. instrument the self-developed questionnaire contained both structured and unstructured questions. the first three questions ensured that the participant complied with the inclusion criteria and agreed to participate in the study voluntarily, followed by eight demographic questions. the third section of the instrument focused on martin and anthony’s (2006) four-phase approach to repatriation, namely prior to expatriation, during expatriation, prior to repatriation and during repatriation. in particular, seven statements tested the importance of actions prior to expatriation, five statements tested the importance of assistance during expatriation, six statements tested the importance of assistance before repatriation and eight statements tested the importance of initiatives during repatriation. these statements were tested on a five-point likert scale where the respondents had to indicate their level of agreement with the statements by choosing from the following options: ‘not at all’, ‘slightly’, ‘moderately’, ‘very’ and ‘extremely’. finally, the last 10 questions focused on general repatriation questions, in particular the mnes’ repatriation turnover rates and the reasons for repatriates leaving the mnes. the repatriation turnover rates were tested using an open-ended question and the reasons why repatriates leave the mnes were tested using a multiple-choice, multiple-response question. the instrument was then pre-tested by five employees from a south african mne with extensive expatriate and repatriation management knowledge. analysis due to the low number of responses in this study (n = 41), cronbach’s alpha was not used as the minimum sample size for coefficient alpha is commonly suggested at 200, 300 or 500 (yürdugül 2008:403). an exploratory factor analysis prompts a similar debate regarding sample size. however, maccallum et al. (1999:84–89) argue that the minimum sample size for an exploratory factor analysis is dependent on the level of communalities of item variables. thus, due to the small sample size, an exploratory factor analysis was conducted on each of the four constructs focusing on the four phases of the repatriation process in order to determine if each represents a single construct. eigenvalues greater than 1 determined the number of factors, while the loading for each variable was scrutinised to decide which variables to classify under each factor. based on the eigenvalues, two factors emerged for actions prior to expatriation (construct 1), two factors for assistance during expatriation (construct 2), one factor for assistance prior to repatriation (construct 3) and two factors for initiatives during repatriation (construct 4). each variable was classified under the factor in which it loaded the highest, except for construct 3, where only one factor emerged. no variables had to be eliminated due to double loading or low loadings (loadings smaller than 0.300). the results for each construct are subsequently discussed. actions prior to expatriation factor 1 was named ‘preparation’, as it represents the enterprise’s actions to prepare the expatriate and family members for the foreign assignment. factor 2 was named ‘employee selection’ as it involves the selection of the right candidates to fill the expatriate positions (see table 1). the two factors account for 67.22% of the total variance in the data space (see table 2). table 1: factor matrix with sorted rotated factor loadings. table 2: eigenvalues and variance explained. actions during expatriation table 3 shows the factor matrix with sorted rotated factor loadings, where factor 1 was named ‘expatriate support’, as it summarises the enterprise’s actions to assist with the adjustment process upon arrival as well as during the assignment. factor 2 was named ‘staying connected to the home country’, as it involves all communication initiatives and home visits to prevent the ‘out of sight, out of mind’ syndrome. the two factors account for 69.14% of the total variance in the data space (see table 4). table 3: factor matrix with sorted rotated factor loadings. table 4: eigenvalues and variance explained. actions prior to repatriation factor 1 consists of six variables and accounts for 61.21% of the total variance in the data space (see table 5). table 5: eigenvalue and variance explained. this factor was named ‘assistance prior to repatriation’ to align with the third phase of the employee repatriation process, namely ‘actions prior to repatriation’ (see table 6). table 6: factor matrix with sorted rotated factor loadings. actions during repatriation this construct was made up of two factors which cumulatively account for 75.35% of the total variance in the data space (see table 7). table 7: eigenvalues and variance explained. factor 1 was named ‘repatriation support’, as it combines the actions necessary to reintegrate the repatriate and his or her family back into the domestic environment. factor 2 was named ‘utilising and valuing international experience’, highlighting the importance of assigning the repatriates to challenging positions to benefit from their newly acquired skills and to guide future assignees, if required (see table 8). table 8: factor matrix with sorted rotated factor loadings. finally, hypothesis 1 was tested using the mann-whitney u test, while hypotheses 2–5 were tested using spearman’s correlation coefficient. findings demographic profile the majority of south african mnes in this study assign their expatriates for periods ranging from 25 to 35 months (37%), followed by 13 to 24 months, 36 to 47 months and longer than 48 months, with 17% each. when looking at the age of south african expatriates, the majority are between the ages of 35 and 44, followed by 45 to 54. responses on the gender of expatriates showed that male expatriates (89%) still outnumber female expatriates (11%), a finding that supports an earlier study by vögel et al. (2008:35). lastly, when looking at the repatriation turnover rates of south african mnes for the first 3 years after repatriation, it was found that the average turnover rate increased from 9% in year 1 to 11% in year 2 and 13% in year 3. this marginal increase over the 3-year period is lower than international trends, with reported turnover rates ranging between 15% and 25% for the first year, increasing to 40% after 3 years (andreason & kinneer 2004:13–14; black & gregersen 1999:57; frazee 1997:24; jassawalla et al. 2004:39; klaff 2002:40; larson 2006:55; martin & anthony 2006:626; oddou 1991:306; richard 2004:19). foreign assignment policy and repatriation turnover rates of the 41 mnes that participated in this study, 31 (76%) had an implemented or operational foreign assignment policy. this was followed by eight (20%) whose foreign assignment policy was under development and two (5%) who felt that a foreign assignment policy was not required. based on the findings of the mann-whitney test (see table 9) no statistically significant difference could be found in reported repatriation turnover rates in year 1, 2 and 3 after repatriation between enterprises that had implemented a foreign assignment policy and those that did not. table 9: implemented foreign assignment policy and repatriation turnover rates. as a result none of the following three hypotheses could be rejected: h1a: there is no correlation between the implementation of a foreign assignment policy and the repatriation turnover rates of south african multinational enterprises in year 1 after repatriation. h1b: there is no correlation between the implementation of a foreign assignment policy and the repatriation turnover rates of south african multinational enterprises in year 2 after repatriation. h1c: there is no correlation between the implementation of a foreign assignment policy and the repatriation turnover rates of south african multinational enterprises in year 3 after repatriation. mentors and repatriation turnover rates a weak positive statistically significant correlation was found between an expatriate manager perceiving assigning a mentor to a repatriate as being important and the repatriation turnover rate in year 2 after repatriation (r = 0.342, p < 0.05) (spearman’s correlation coefficient), while no statistically significant correlation could be found for years 1 and 3 after repatriation (see table 10). table 10: assigning a mentor and repatriation turnover rates. given these results, hypothesis h2b, stating there is no correlation between an expatriate manager perceiving assigning a mentor to a repatriate as being important and the repatriation turnover rates of south african multinational enterprises in year two after repatriation, could not be accepted. while hypotheses h2a and h2c could not be rejected. h2a: there is no correlation between an expatriate manager perceiving assigning a mentor to a repatriate as being important and the repatriation turnover rates of south african multinational enterprises in year 1 after repatriation. h2c: there is no correlation between an expatriate manager perceiving assigning a mentor to a repatriate as being important and the repatriation turnover rates of south african multinational enterprises in year 3 after repatriation. start of the repatriation process and repatriation turnover rates when looking at the start of a repatriation process, it was found that 44% of the respondents commence with the repatriation process 6 months before repatriation. this is followed by 29% who start 2–5 months before repatriation, while 12% start 1 month before repatriation. only 5% of the respondents start with the repatriation process more than 6 months before repatriation, while 5% provide no repatriation support to their returning expatriates at all and 5% start with the process less than 1 month before repatriation. from table 11 it can be seen that there is a moderate negative statistically significant correlation between when the enterprise starts with the repatriation process and the repatriate turnover rates in year 1 after repatriation (r = −0.361, p < 0.05) (spearman’s correlation coefficient). no statistically significant correlation could be found between the start of the repatriation process and repatriation turnover rates in years 2 and 3 after repatriation. table 11: start of the repatriation process and repatriation turnover rates. consequently, hypothesis h3a could not be accepted: h3a: there is no correlation between when south african multinational enterprises start with the repatriation process and their repatriation turnover rates in year 1 after repatriation. while hypotheses h3b and h3c, could not be rejected: h3b: there is no correlation between when south african multinational enterprises start with the repatriation process and their repatriation turnover rates in year 2 after repatriation. h3c: there is no correlation between when south african multinational enterprises start with the repatriation process and their repatriation turnover rates in year 3 after repatriation. repatriation initiatives and repatriation turnover a weak positive statistically significant correlation was found between an expatriate manager perceiving the introduction of enterprise initiatives such as an orientation programme as being important prior to repatriation and the repatriation turnover rates in year 1 after repatriation (r = 0.330, p < 0.05) (spearman’s correlation coefficient). a moderate positive statistically significant correlation was found between an expatriate manager perceiving the introduction of enterprise initiatives such as an orientation programme as being important prior to repatriation and the repatriation turnover rates in year 2 after repatriation (r = 0.434, p < 0.01) (spearman’s correlation coefficient) (see table 12). no statistically significant correlation could be found, however, for year 3. table 12: repatriation initiatives and repatriation turnover. based on these finding the following two hypotheses could not be accepted: h4a: there is no correlation between an expatriate manager perceiving the introduction of enterprise initiatives such as an orientation programme as being important prior to repatriation and the repatriation turnover rates of south african multinational enterprises in year 1 after repatriation. h4b: there is no correlation between an expatriate manager perceiving the introduction of enterprise initiatives such as an orientation programme as being important prior to repatriation and the repatriation turnover rates of south african multinational enterprises in year 2 after repatriation. meanwhile hypothesis h4c could not be rejected: h4c: there is no correlation between an expatriate manager perceiving the introduction of enterprise initiatives such as an orientation programme as being important prior to repatriation and the repatriation turnover rates of south african multinational enterprises in year 3 after repatriation. repatriation support and repatriation turnover rates a moderately positive statistically significant correlation was found between an expatriate manager perceiving offering repatriation support to repatriates as being important during repatriation and the repatriation turnover rates of expatriates in year 2 after repatriation (r = 0.446, p < 0.01) (spearman’s correlation coefficient) (see table 13). no statistically significant correlation could be found for years 1 and 3 after repatriation. table 13: repatriation support and repatriation turnover rates. as a result hypothesis h5b could not be accepted: h5b: there is no correlation between an expatriate manager perceiving offering repatriation support to repatriates as being important during repatriation and the repatriation turnover rates of south african multinational enterprises in year 2 after repatriation. hypotheses h5a and h5c, could not be rejected: h5a: there is no correlation between an expatriate manager perceiving offering repatriation support to repatriates as being important during repatriation and the repatriation turnover rates of south african multinational enterprises in year 1 after repatriation. h5c: there is no correlation between an expatriate manager perceiving offering repatriation support to repatriates as being important during repatriation and the repatriation turnover rates of south african multinational enterprises in year 3 after repatriation. reasons for repatriation turnover finally, table 14 provides a summary of the most frequently cited reasons for repatriates leaving the employment of south african mnes with a reduction in compensation once repatriated being the most cited. two reasons came in joint second, namely the fact that their newly acquired skills are not utilised or valued by the mne and the lack of challenging assignments on return home. table 14: reasons why expatriates leave after repatriation. discussion with repatriation failure rates of 9% in year 1, 11% in year 2 and 13% in year 3, south african repatriation failure rates were found to be lower than those of other studies, where failure rates of between 23% and 25% were reported in year 1 after repatriation, increasing to 40% in year 3 (macdonald & arthur 2003:3; tinder n.d.:2). so what can we learn from these mnes? as indicated by martin and anthony (2006:620), the repatriation of employees from an international assignment should start even before the expatriate departs for the assignment and should continue throughout the assignment up until the expatriate is successfully repatriated to his or her home country. however, according to jassawalla et al. (2004:39), ‘most foreign assignments seem hastily designed, signalling the poorly planned, ad hoc nature of foreign assignments from the expatriate manager’s perspective’, not only contributing towards uncertainty, but also anxiety among expatriates. the presence and quality of a foreign assignment policy, however, not only lessens this anxiety but also seems to contribute to the confidence with which expatriates leave for and return from foreign assignments, and as a result is strongly linked to repatriation effectiveness (jassawalla et al. 2004:41). having said this, no statistically significant correlation could be found between having an implemented foreign assignment policy and the repatriation turnover rates of south african mnes. this supports the view of jassawalla et al. (2004:41) that not just the presence but also the quality of such a foreign assignment policy is important for repatriation success. when looking at specific practices, holtbrügge and ambrosius (2015:279), o’sullivan (2013:267) and allen and alvarez (1998:34) are of the opinion that appointing a mentor to an expatriate not only assists with the successful repatriation of an expatriate, but also supports an expatriate during the international assignment. in fact, mentors have a role to play during each phase of the international assignment (anderson 2001:35; oddou 1991:306; scelba 1996:42; swaak 1997:30). this was also found to be the case for the south african mnes in this study with a weak positive statistically significant correlation being found between expatriate managers perceiving the appointment of a mentor to be important and reduced repatriate turnover rates in year 2 after repatriation. this shows that in mnes where it is considered important to appoint a mentor to an expatriate, the repatriation turnover rates have been lower in year 2 after repatriation. klaff (2002:42) however, is of the opinion that the mentor’s association with the repatriate should continue for at least 6 months after the return home. having said this, vögel et al. (2008:36) in a study focusing on the preparation, support and training of south african expatriates found that south african mnes are not providing the mentoring support required by their expatriates. this phenomenon is also supported by pattie, white and tansky (2010:367) who found that only 7% of enterprises provide a mentor for repatriates to guide them through the re-entry process. preparing for repatriation, keogh (2003:38) is of the opinion that mnes should start with a formal repatriation programme at least 6 months prior to the return of an expatriate to his or her home country. such a programme – which should involve both the expatriate and his or her family – can address issues like clarifying career objectives, expenses to be incurred on return, the elimination of allowances and lifestyle adjustment on return, among other things (martin & anthony 2006:625; o’sullivan 2002:598). this was supported by the findings of this study when a moderate negative statistically significant correlation was found between when the mne starts with an orientation programme and the repatriate turnover rates of south african mnes in year 1 after repatriation. in this study, 44% of mnes heeded the call by keogh (2003:38), starting with a repatriation programme 6 months in advance of the repatriation and 5% started even sooner. a weak positive statistically significant correlation was also found between expatriate managers perceiving the introduction of repatriation initiatives such as an orientation programme to be important and repatriation turnover rates in year 1 after repatriation. meanwhile a moderate positive statistically significant correlation was found between expatriate managers who perceive the introduction of initiatives such as an orientation programme to be important and repatriation turnover rates in year 2 after repatriation. consequently, not only was it found that in south african mnes where initiatives such as orientation programmes were considered to be important that repatriation turnover rates were lower, but also in those mnes where such initiatives were started sooner repatriation turnover rates were lower in year 1 after repatriation. these programmes benefit not only the mne but also the returning expatriate (de valk 2004:42; keogh 2003:38). for the repatriate, proper advance planning and communication can help reduce anxiety and resentment and can ultimately have an impact on productivity and turnover rates (vermond 2001:33), while for an enterprise, it can result in improved retention and return on human capital (jassawalla et al. 2004:40). financial changes affecting the repatriate’s lifestyle was the primary reason cited by south african mnes for repatriates leaving the enterprise, and a reduction in job status and autonomy in terms of responsibility and prominence in the community was the fourth most cited reason. thus, addressing these and other issues prior to returning home are of the utmost importance. having said this, in a study by vidal et al. (2008:1691), it was found that for spanish repatriates, the change in compensation was not considered to be a factor in their perception of the effectiveness of the repatriation process and consequently in their desire to leave the mnes. lastly, the study found a moderately positive statistically significant correlation between south african mnes who perceive offering repatriation support to repatriates during the final phase of the repatriation process to be important and repatriation turnover rates in year 2 after repatriation. this indicates that in those south african mnes where repatriation support was considered to be important, repatriation turnover rates were lower in year 2 after repatriation. according to allen and alvarez (1998:37), these support initiatives can include creating a repatriate directory to assist the enterprise to utilise former expatriates for special assignments. by calling on a repatriate’s international experience an mne sends a clear signal to the repatriate that they are valued and appreciated. this is of particular importance given that not valuing and utilising their newly acquired skills and the lack of challenging assignments on return home were the joint second most reported reason for repatriates leaving the employment of south african mnes. recommendations this study contributes towards our understanding of repatriation in south african mnes by showing that repatriation practices, such as the appointment of a mentor to assist the expatriate during each phase of the expatriation process, providing an orientation programme to assist expatriates with the repatriation process, starting with such a programme well in advance of their repatriation and providing repatriation support to expatriates during the repatriation process, can contribute to reduced repatriation turnover rates. the study has, however, also identified that south african mnes are still faced with repatriation turnover – albeit lower than reported cases in other countries. in particular, it has been determined that four of the eight reasons for repatriation turnover relate to job-related issues once repatriated. this highlights the importance of linking the successful completion of an international assignment to a specific position once repatriated. preferably, this position should be communicated to an expatriate prior to the commencement of the assignment. although a positive correlation was found between providing initiatives such as orientation programmes to expatriates prior to their repatriation and lower repatriation turnover rates, addressing the negative effect of financial changes once repatriated needs to receive special attention during such a programme with this being the primary cause of repatriation turnover. preparing an expatriate for reduced status back in the home office and country should also receive considerable attention. finally, although a correlation was found between providing repatriation support and lower repatriation turnover rates, feelings of isolation and rejection still persisted among repatriates. consequently, repatriation support initiatives should focus on reducing these feeling of isolation and rejection. suggestions for future research this study set out to determine if there was a correlation between the repatriation practices of south african mnes and their repatriation turnover rates. in doing so a distinction was made between repatriation turnover rates in years 1, 2 and 3 after repatriation. in the process, correlations were identified in some years while not in others. the study did not, however, set out to determine why there might be discrepancies between the 3 years; as a result, future research should focus on determining: why there is a positive statistically significant correlation between an expatriate manager perceiving assigning a mentor to a repatriate as being important and the repatriation turnover rates in year 2, but not in years 1 and 3. why there is a negative statistically significant correlation between when the enterprise starts the repatriation process and the repatriation turnover rates in year 1, but not in years 2 and 3. why there is a positive statistically significant correlation between an expatriate manager perceiving the introduction of enterprise initiatives such as an orientation programme as being important prior to repatriation and the repatriation turnover rates in years 1 and 2, but not in year 3. why there is a positive statistically significant correlation between an expatriate manager perceiving offering repatriation support to repatriates as being important during repatriation and the repatriation turnover rates in year 2 but not in years 1 and 3. limitations of the study a limitation of this study is the small sample size, as this limited the use of more advanced statistical analysis. the small number of respondents could possibly be attributed to the fact that only expatriate managers working for mnes 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35(1), 397–405. journal 1.indd 392 sajems ns 12 (2009) no 4 an investigation into the role of listed property shares in a retirement fund portfolio in south africa mkhethwa mkhize wits business school, university of witwatersrand vuyani bekwa independent researcher abstract the main aim of this research paper was to investigate the role of listed property shares in a retirement fund portfolio in south africa, one objective being to determine the appropriate weightings to be allocated to listed property shares. this research paper uses data collected from january 1995 to december 2004. the elton and gruber computer programme is used to test the data to give optimal weightings to the listed property sector and to produce an efficient frontier. the results of this research paper demonstrated the benefits offered by listed property shares and revealed that the sector should be treated as a separate asset class from equity owing to low correlation of returns between these two classes of assets. results also demonstrated that an increase in the allocation to the listed property sector results in better investment performance over the study period. jel g12, 23 1 introduction real estates are everyone’s investment tools, whether in the form of home ownership or commercial use. real estates are believed to be alternatives to other forms of investment assets. “these alternatives range from passive investments in companies that own and manage real properties to active investments in which the individual owns properties and rents the space” (mayo, 2002: 767). most scholars in favour of real estate investments anticipate two main benefits of investment in real estates, namely: diversification and inflation-hedged benefits. as an alternative to owning real estates, investors invest in shares of real estate investments trusts. these shares are “bought and sold like the stocks of other companies (mayo, 2002: 784). it could therefore be inferred that portfolio/investment managers must invest either directly in real estate (property) or indirectly in real estate shares (listed property) in order to maximise benefits (in the form of diversification and inflation-hedging) of their investment portfolios. however, the alexander forbes l arge manager watch survey (2004) shows that investment managers in south africa have not recognised the full benefits offered by listed property, owing to the low allocation of funds to this sector. the i-net bridge (2004) database shows that listed property shares pay out a major portion of their income during periods of downward trends in capital markets. according to chen and mills (2004), any portion of total return that is achievable with greater certainty limits the potential downside of an investment and lowers the vulnerability of the investment returns to negative surprises. the implications are that listed property shares possess unique attributes that contribute directly to low riskiness of any portfolio. portfolio managers are constantly evaluated on how they perform, that is, the total return they achieve for the investor. an overriding sajems ns 12 (2009) no 4 393 objective on the part of a portfolio manager is therefore to maximise returns while minimising risk. unfortunately, even though the portfolio manager might be aware of the risks, the returns from listed property have been more difficult to quantify because listed property in south africa is poorly researched (maritz & miller, 2004). these authors point out that academic research on the role of listed property in investment portfolios has received little attention, both internationally and locally. this implies that listed property will continue to be regarded as a neglected asset class as long as the latter is not researched with far more diligence. to achieve such an outcome, this paper attempts to investigate the role of listed property shares in a retirement fund portfolio in the south african context. the specific intention is to investigate some of the most important facets of the listed property sector, such as its relationship with equities, its portfolio risk-reduction ability and its general performance relative to equity. 2 literature review according to a report by datamonitor (2004), australia was one of the first countries to follow the united states’ lead with the introduction in 1960 of real estate investment trusts (reits). canada followed suit, but only in the early 1990s. reilly and brown (2003) describe reits as investment funds that hold portfolios of real estate investments. table 1 (below) summarises the value and growth rates of reits in the global market. table 1 global real estate investment trusts sector value: 1999–2003 year total value (us$ billions) growth rate (%) 1999 167.5 n/a 2000 166.0 –0.9 2001 187.2 12.8 2002 200.8 7.3 2003 273.4 6.31 source: datamonitor (2004) global real estate investment trusts: industry profile datamonitor’s (2004) report shows that the reits market in the united states, according to which many other countries have based their framework, dominates the global market, accounting for about 80 per cent of the global sector’s value in 2003. in the united states (us), the employee income security act (erisa) was passed in the mid-1970s to limit abuse in the pension fund world by creating a series of regulations to govern plan sponsor behaviour (winograd & mcintosh, 2002). according to winograd and mcintosh (2002), erisa was inspired by modern portfolio theory to promote prudent portfolio diversification in order to reduce overall risk and stimulate pension fund investment in property. hudson-wilson, fabozzi and gordon (1990) identified four main reasons why a portfolio should be exposed to property. firstly, overall risk-reduction of the portfolio would be accomplished by combining asset classes that respond differently from expected and unexpected market conditions. secondly, it would achieve returns above the risk-free rate and deliver strong cash flows to the portfolio. in other words, this would improve risk-adjusted performance of a portfolio as measured by the sharpe index. thirdly, it would hedge against unexpected inflation, ensuring that the portfolio produces positive real returns. finally, it would constitute part of a portfolio that is a reasonable reflection of the overall investment universe and the economy. 394 sajems ns 12 (2009) no 4 according to a number of authors, investment management attention has shifted from an emphasis on asset allocation to a more balanced emphasis on diversification and the interrelationship of individual asset class characteristics within the portfolio. karlberg, crocker and greig (1996) suggest that a 9 per cent allocation to real estate is optimal, rather than the 20 per cent figure suggested in other studies. hoesli, lekander and witkiewicz (2003b) found that investing directly in offshore real estate reduced portfolio risk. in a study by hoesli, lekander and witkiewicz (2004) and in support of hoesli, lekander & witkiewicz (2003a), property was found to be a very effective portfolio diversifier in seven countries on three continents over the 1987–2001 study period. other authors doubt the ability of property to reduce portfolio risk. for example, glascock, lu and so (2000) show that, from 1987 to1991, listed property was segmented from equity, but was co-integrated from 1992 to 1996. these authors argue that the benefits of including listed property in a multi-asset portfolio have diminished since 1992. glascock et al. (2000) show that over their study period listed property was co-integrated with unsecuritised property. their results suggest that the ability of listed property to reduce portfolio risk was reduced. on the other hand, liang and mcintosh (1998) argue that the benefits of diversification from including listed property in a multi-asset portfolio increased after 1992. they conclude that the uniqueness of listed property as a risk diversifier is enhanced and listed property should form a significant part of any portfolio. tarbert (1966: 77) defines a perfect hedge against inflation as “an asset where the nominal returns perfectly co-vary with inflation”. in general, property has been perceived as providing a hedge against inflation. most research into the ability of property to hedge against inflation shows that, in the long run, property seems to provide a better hedge against inflation than does equity (hoesli, 1994). fraser, leishman and tarbert (2002: 354) suggest that there is a “low correlation between conventional gilts and property, as the former is inflation prone and the latter is generally viewed as an inflation hedge”. given the four anticipated benefits of investing in listed property as reported by hudson et al. (1990), this research paper attempts to carry out an investigation into the role of listed property shares in a retirement fund portfolio in south africa. specifically, it establishes the optimal allocation of listed property that would increase the returns of the portfolio. 3 research design 3.1 data data were collected from two electronic feed sources namely: i-net bridge and the jse securities exchange on each of the different asset classes. these sources form part of reliable databases in south africa. proxies for asset classes were used to create a portfolio of mixed asset classes. equities are represented by the jse all share index. bonds are represented by the 7–12 year (medium-term) bond index, the all bond index (albi). the reason for the use of the albi is that the modified duration1 of property is similar to that of medium-term bonds. cash was used to represent a risk-free asset. listed property is represented by the property unit trust index, the j255 index. data used in this research paper consist of the weekly closing prices of well-established benchmarks, namely the market indices of the alsi, the j255 and the albi for the ten-year period from january 1, 1995 to december 31, 2004. these data were downloaded from a reliable i-net bridge research database. 3.2 data manipulation total returns are calculated for each different asset class. as reported by msweli-mbanga and mkhize (2007), affleck-graves, burt and cleasby (1988) and van den honert, barr and smale (1988) share/index price returns (r index ) are computed using the following formula: (r index ) = p p – p ×100 0 1 0 c m< f (1) where: p 1 is the price of an index at the close of the last trading day in a week. p 0 is the price of an index at the opening of the trading day sajems ns 12 (2009) no 4 395 in a week. investment income is assumed to be incorporated in the market share price. that is semi-strong market efficiency. the formula is adopted here in order to compute weekly index returns. weekly returns of these indices were thereafter compounded to calculate an annualised return. all annualised returns were, in turn, averaged in order to obtain a single average return over the study period. weekly returns were regressed each year in order to obtain standard deviations for that particular year. in addition, weekly returns of indices were regressed against each other to obtain their correlation coefficients over the study period. 3.3 research methodology after data manipulation, resultant data were fed into an investment management programme called the elton and gruber’s markowitz module (the investment portfolio, version 1). this programme is used to produce the markowitz efficient frontier. this module calculated covariances between indices (asset classes). after prompting for portfolio weightings (if any), the elton and gruber module is ready to produce the markowitz efficient frontier, which assists in determining optimal allocation weightings of listed property, as measured by the j255 index in this study. prompting for weightings is a crucial step because it affords portfolio managers the opportunity of adhering to prudential investment guidelines, as different investors stipulate different policies and guidelines. in order to construct a traditional portfolio, initial alsi and albi weightings of 75 per cent and 25 per cent respectively are assumed. these maximum weightings are suggested by legislated prudential investment guidelines, which are intended to ensure a conservative investment spread for retirement funding products in order to protect the investor from loss of value due to risky investment selection. furthermore, prudential investment guidelines state that the weightings to listed property should be limited to 25 per cent. this weighting of 25 per cent to listed property is fed into elton and gruber’s markowitz module in order to determine the role listed property may play in a retirement fund portfolio. however, the elton and gruber markowitz module will recommend weightings of an optimised portfolio without stating the anticipated performance of such a portfolio. in order to do that, the risk-adjusted performance of both traditional and optimised portfolios is computed using the sharpe index. fabozzi (1999) argues that the sharpe index is a measure of the reward-to-risk ratio, and that the risk of the asset is measured by the standard deviation (sd) of that asset. as reported by mswelimbanga and mkhize (2007), mayo (2005) states that the sharpe index (si) is given as follows: si = sd r – r i i f^ h (2) where r i is the average return of the j255, alsi or albi index. r f is the return received from investing in a risk-free asset. cash is a proxy for a risk-free asset in this research paper. sdi is the standard deviation of the j255, alsi or albi index. the higher the sharpe index, the better the risk-adjusted performance of a variable under consideration. 4 research results annualised returns of indices over the study period are presented in table 2 below. table 2 annualised returns of indices: 1995–2004 year j255 (%) alsi (%) albi (%) cash (%) 1995 12.05 13.93 36.39 13.38 1996 –11.34 3.35 3.65 16.31 396 sajems ns 12 (2009) no 4 1997 22.94 –5.80 30.58 17.22 1998 3.67 –5.91 3.38 17.79 1999 55.99 70.56 31.18 15.72 2000 27.64 –0.05 20.97 10.95 2001 8.15 30.55 20.38 10.61 2002 22.80 –6.62 16.20 11.53 2003 40.22 13.91 21.11 12.78 2004 41.78 24.85 17.91 8.22 annual standard deviations of indices over the study period are depicted in graph 1 below. graph 1 standard deviations of indices table 3 (below) shows averaged returns of indices, as well as correlation coefficients and covariances between indices over the study period. table 3 averaged returns of, correlation co-efficients and covariances between indices: 1995–2004 variable j255 (%) alsi (%) albi (%) cash (%) total returns 22.39 13.88 20.18 13.45 standard deviations 19.11 22.62 10.33 3.04 sajems ns 12 (2009) no 4 397 correlation co-efficients j255 (%) alsi (%) albi (%) cash (%) j255 100 58.2 53.4 –32.4 alsi 58.2 100 41.8 –13.4 albi 53.4 41.8 100 –12.9 cash –32.4 –13.4 –12.9 100 covariances j255 (%) alsi (%) albi (%) cash (%) j255 3.65 2.51 1.05 –0.19 alsi 2.51 5.12 0.98 –0.09 albi 1.05 0.98 1.07 –0.04 cash –0.19 –0.09 –0.04 0.09 traditional portfolio asset class weightings (%) historical returns (%) weighted returns (%) alsi 75 13.88 10.41 albi 25 20.18 5.05 total portfolio 15.46 optimal portfolio asset class weightings (%) historical returns (%) weighted returns (%) j255 12 22.39 2.69 alsi 13 13.88 1.80 albi 75 20.18 15.14 total portfolio 100 19.63 table 4 (below) presents the risk-adjusted performance of the market indices used over the study period. table 4 sharpe indices of indices: 1995-2004 variable standard deviation (%) average return (%) sharpe index = (r i –r f )/sd i j255 19.11 22.87 0.47 alsi (market) 22.92 13.88 0.02 albi 10.33 20.18 0.65 cash (risk-free) 0* 13.45 not applicable * the standard deviation of cash is assumed to be zero because it is generally accepted as a risk-free asset. 398 sajems ns 12 (2009) no 4 5 discussion and conclusions according to table 2, the yearly property returns ranged from -11.34 per cent in 1996 to 55.99 per cent in 1999. equity returns ranged from -6.62 per cent in 2002 to 70.56 per cent in 1999. in the case of bonds, yearly returns were at the highest rate of 36.39 per cent in 1995, slumping to a low of 3.38 per cent in 1998. the risk-free rate was at its highest point of 17.79 per cent in 1998 and reached the lowest rate of 8.22 per cent in 2004. over the study period, the highest rate achieved by any asset class was 70.56 per cent, realised in the equity market in 1999. the lowest rate (highest loss) of -11.34 per cent was experienced by the property market in 1996. graph 1 shows that listed property experienced the highest risk (standard deviation) of 3.18 per cent in 1998 and the lowest risk of 1.15 per cent in 1995. in the equity market, the highest level of volatility was at 4.63 per cent in 1998 and the lowest level of risk (1.61 per cent) was achieved in 1996. in the bond market, risk reached its lowest level of 0.76 per cent in 2003 and was at its highest level of 3.07 per cent in 1998. graph 1 also shows that the highest risk recorded for cash is 0.42 per cent in 2004. this risk level may be immaterial to investors who regard cash as a risk-free asset. as expected, the higher level of nominal returns realised in the equity market is accompanied by a high level of risk. for example, the period from 1995 to 1996 shows a low level of risk, and from 1998 to 1999 there is a high level of risk. nominal returns are at their highest during the 1998 to 1999 period and, on average, at their lowest over the 1995 to 1996 period. because the risk-free rate is high over the 1998 to 1999 period, the equity market risk premium is not increased over the 1998 to 1999 period. consequently, the performance of the equity market is not superior over the 1998 to 1999 period. in conclusion, the result of this study suggests that the 1995 to 1996 period was the low-risk period on the south african capital market. on the other hand, highest levels of risk were experienced across the combined south african capital market from 1998 to 1999. generally, bonds are less risky than equities, which is why an initial weighting to equity is limited to 75 per cent. this is in accordance with legislated investment guidelines intended to protect the investor from loss of value due to risky investment selection. when constructing a traditional portfolio comprising only bonds and equity, and limiting weightings to equity to 75 per cent as mandated on the investment guidelines for a retirement fund industry in south africa, the total return of 15.46 per cent is realised. however, when listed property is taken into account and investment guidelines for a retirement fund industry which includes this asset class in a portfolio are adhered to, different sets of results are realised. the elton and gruber’s markowitz module is used to compute optimal portfolio weightings. results of this programme show that the exposure to the listed property should be 12.41 per cent (approximately 12 per cent), while the alsi exposure should be 12.589 per cent (approximately 13 per cent). according to the programme, the highest exposure to bonds should be 75 per cent. this research paper uses these recommendations to calculate new total return of an optimised portfolio according to the elton and gruber markowitz module. results displayed in table 4 (above) indicate that total returns of a portfolio increase from 15.46 per cent to 19.63 per cent. elton and gruber’s markowitz module’s results also show that the security market line of an efficient frontier, given the above-mentioned weightings, starts at 13.45 per cent. this risk-free rate of 13.45 per cent therefore represents the compounded cash returns over the study period of this research paper. however, rates of return, discussed above, are simply market-risk premiums. in order to make economic sense and to indicate the role of listed property in a retirement fund portfolio, sharpe indices of both the traditional and optimised portfolios are computed. table 4 presents the sharpe indices of the listed property sector, equity market and bonds market. results shown in this table indicate that the bond market yields the highest returns on a risk-adjusted basis, followed by listed property and then the equity market. in fact the equity market realised a loss sajems ns 12 (2009) no 4 399 of 6.1 per cent on a risk-adjusted basis over the study period. table 3 also shows the correlation co-efficient between indices. these results show that the correlation co-efficient between the equity market and listed property sector of 0.582 is larger than the correlation co-efficient between the listed property sector and the bonds market. as a result, it would be more profitable to combine listed property assets with debt owing to low correlation than it would be to combine listed property assets with equity. results also show that most diversification benefits (illustrated by lower correlation co-efficient) will be realised when combining equity with debt in a portfolio. this is also supported by the low risk associated with bonds or higher sharpe index of bonds. these correlation co-efficient results (in table 4) are in support of risk-adjusted performance (refer table 4) of a portfolio consisting mostly of bonds and listed property, as suggested by the markowitz module. in conclusion, the sharpe index of the listed property sector is higher than that of the equity market; and the correlation coefficient between the listed property sector and the equity market is approximately 0.5. these results support the hypothesis that listed property presents unique attributes, different from those presented by the equity market. these results also suggest that listed property contributes significantly in a positive way to the performance of a retirement fund industry in south africa. in other words, listed property plays a positive role in the riskadjusted performance of a retirement fund portfolio in south africa. future research may focus on the qualitative factors that fund managers consider when investing or not in listed property. endnote 1 “duration is a measure of the average (cashweighted) term-to-maturity of a bond. there are two types of duration, macaulay duration and modified duration. macaulay duration is useful in immunisation, where a portfolio of bonds is constructed to fund a known liability. modified duration is an extension of macaulay duration and is a useful measure of the sensitivity of a bond’s price to interest rate movements”, author unknown [online] (http://www.finpipe.com/duration.htm) [accessed 16 february 2008.] references affleck-graves, j.f.; burt, g.h. & cleasby, s.j.m. 1988. the premium on acquisition in south african mergers: an empirical evaluation. south african journal of business management, 19(4): 55–160. alexander forbes large manager watch annual survey, 2004. african harvest joins the ranks of large managers, [online] url:http:// www.africanharvest.co.za/shared/news/a_quarter_ past/a_quarter_past_mar_2004.pd chen, l. & mills, t. 2004. global real estate investment going mainstream, ubs real estate research, [online]. url:http://www.irei.com/ uploads/ marketresearch/ 55/ marketresearchfile/global_real_ estate.pdf. datamonitor. 2004. [online] url:http://www. marketresearch.com/browse. asp?categoryid=161&sor tby=t&g=1&page=7. fabozzi, f.j. 1999. investment management (2nd ed.), new jersey: prentice-hall. fraser, w.d., leishman, c. & tarbert, h. 2002. the long-run diversification attributes of commercial property. journal of property investment and finance, 20(4): 354–373. hoesli, m. 1994. real estate as a hedge against inflation: learning from the swiss case. journal of property valuation and investment, 12(3): 51-59. hoesli, m., lekander, j. & witkiewicz, w. 2003a. further evidence on the integration of reit, bond and stock returns. the journal of real estate finance and economics, 20(2): 177–194. _______ 2003b. real estate in the institutional portfolio: a comparison of suggested and actual weights. journal of alternative investments, 6(2): 55–59. _______ 2004. international evidence on real estate as portfolio diversifier. journal of real estate research, 26(2): 161–207. hudson-wilson, s., fabozzi, f.j. & gordon, w. 1990. why real estate? journal of portfolio management, special real estate issue, september: 12–27. i-net bridge, 2004. [online] url: http://iis-host1. inet.co.za/intrahosted/i-net/jseindicesnewweb.htm. liang, y. & mcintosh, w. 1998. reit style and performance. journal of real estate management, 4: 39–47. maritz, j. & miller, k. 2004. property – a neglected asset class: a quantitative survey of listed and directly-held property in south africa. cadiz financial 400 sajems ns 12 (2009) no 4 services, february, [online] url:http://www.cadiz. co.za/bo/ assetmanagement/overview.asp. mayo, h.b. 2002. investments (8th ed.) ohio: thomson south-western. msweli-mbanga, p. & mkhize, h.m.a. 2007. the risk-adjusted performance of companies with female directors: a south african case. south african journal of economic and management sciences, 10(2): 207–213. reilly, f. & brown, k. 2003. investment analysis and portfolio management (8th ed.). mason: mcgrawhill. tarbert, h. 1996. is commercial property a hedge against inflation? a cointegration approach. journal of property finance, 7: 77-98. van den honert, r.c, barr, g.d.i. affleckgraves, j.f. & smale, g. 1988. merger announcements and share price return –the role of the relationship between acquiring and target firms. south african journal of business management, 19(1): 1–10. winograd, b. & mcintosh, w. 2002. revisiting the case for including real estate in a mixed-asset portfolio. journal of real estate portfolio management, 3: 107–115. sajems ns vol 3 (2000) no i the economics of exchange rates: a south african model s brink and r koekemoer department of economics. university of pretoria abstract 19 this paper attempts to capture the determination of the south african exchange rate in a theoretically plausible model with reliable forecasting ability. a stickyprice, dornbusch-type monetary model of the rand/dollar exchange rate is proposed. the three-step engle and yoo cointegration procedure is applied and the test results indicate that the nominal exchange rate is cointegrated with relative real output, the relative money supplies and the inflation differential. an error correction model is estimated and shocks are applied to each of the long-run variables. some policy implications are derived from these sensitivity tests. finally, a fundamental equilibrium exchange rate (feer) for the rand/dollar rate is defined and the feer values are estimated until the year 2000. jel c 51, f 31 1 introduction the south african currency unit (the rand) has for some years been sensitized both politically and with respect to other fundamentals. as a result, fluctuations tend to be more than moderate and, in some cases, in an unexpected direction. the openness of the economy is one of the vehicles of growth, employment and an equitable distribution of income and wealth in the much-publicized macroeconomic strategy of the government, where a stable exchange rate, or at least a less unpredictable one, is a prerequisite for a successful outward policy. in short, it is essential to make sense of the propellants of the exchange rate. attempts to model the south african exchange rate have, despite its importance for the outcome of the above-mentioned macroeconomic strategy and unlike its major counterparts (e.g. the dollar/pound rate or the deutsche mark/pound rate), been surprisingly few and generally not very successful. in this paper, a model of the rand/dollar exchange rate is proposed. it conforms to the sticky-price dornbusch version of the monetary model, and therefore belongs to the assetapproach class of models. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 20 sajems ns v crl 3 (2000) no'l the validity of the monetary approach to exchange rate determination has been frequently questioned, due to the lack of empirical support reported by most researchers in the field. irrespective of whether the monetary model's empirical failure stems from inadequate statistical techniques or fundamentally flawed theoretical content, its application to the south african exchange rate model requires some justification. in an effort to provide this, the asset-market approach to exchange rate determination, to which the monetary approach belongs, is briefly recapitulated below to illustrate the absence of clear alternatives. some perspectives on the empirical status of the monetary model and an elaboration of the version used in the rand/dollar model then follow. after that, the rand/dollar exchange rate is modelled, using the three-step engle and y 00 cointegration technique and reporting the results thereof. finally, some relevant policy implications are considered and a fundamental equilibrium exchange rate (feer) is proposed, given certain criteria for internal and external equilibrium. 2 selecting the theoretical foundation: the asset approach recapped markets for foreign exchange came to be viewed as asset markets during the latter half of the 1970s. the asset approach may be contrasted with the traditional flow approaches, in the sense that the latter allows shocks to affect trade flows via shifts in the terms of trade or an altered relationship between domestic absorption and output. an expansionary monetary or fiscal policy, for example, will therefore raise the demand for imports and consequently for the foreign currency, depreciating the domestic currency. conversely, an improvement in the current account in the flow model signifies an appreciation of the exchange rate. the contrasting "asset" models do not assign adjustments in the relative prices of goods more than a fairly minor supporting role. the asset approach models commonly view the exchange rate as the foreign currency price that equilibrates the net stock demands for financial assets denominated in different currencies (frankel, 1980: i). in principle, the two modelling strategies can be synthesized. the exchange rate would then be viewed as equilibrating the total demand for and supply of foreign currency, with complete integration of the current and capital accounts of the balance of payments. in this case, flows should be consistent with the corresponding asset stock requirements. most research has, however, emphasized one approach at the expense of the other, and since the advent of the 1973 float the asset-market view has become dominant. asset-market models have occupied most of what has been written on exchange rates for the past 25 years. rather than elaborating on the contrast between the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 21 traditional flow models and the asset approach models, distinguishing between the different asset-market models may prove useful for the purpose of this study. the monetary approach to exchange rate determination ranks prominently among the latter class of models: virtually all the considerable number of models developed since 1973 to clarify the volatility of floating rates, feature an adjustment process that assigns the equilibration of national money markets a prominent role. the monetary approach undoubtedly falls short of an adequate explanation of the observed volatility in major currencies. however, consensus suggests that better results would not be obtained by disregarding financial market implications. stress should primarily fall on an improved specification of asset-market models (boughton, 1988: 2). non-monetary asset models are collectively referred to as portfolio-balance models. all the asset-market (i.e. monetary and non-monetary) models share the perfect capital mobility assumption. that is, the absence of substantial transactions costs, capital controls, or any other constraints on the flow of capital between countries is implied. exchange rates thus adjust instantly, with the empirical implication that they may exhibit a degree of variability exceeding that of their underlying determinants (frankel, 1980: 1). the taxonomy of asset-market models establishes a particular dichotomy according to which the monetary and portfolio balance models are distinguished: if domestic and foreign bonds are regarded as perfect substitutes, portfolio shares become infinitely sensitive to expected rates of return and bond supplies become irrelevant. determination of the exchange rate then shifts towards the money markets (op. cit.: 4). in the non-monetary or portfolio balance class of asset-market models, the perfect substitutability assumption is relaxed and asset holders allocate their portfolios across shares that are well-defined functions of expected rates of return (op. cit.: 4). the perfect mobility of capital assumption is retained and a distinction between perfect mobility and perfect substitutability can evidently be drawn: the first implies the absence of impediments to capital flows whereas the second is the much stronger assumption that asset holders are indifferent as to the composition of their bond portfolios, provided that the expected rate of return on the two countries' bonds is identical when converted to a common numeraire (op. cit.: 2). the portfolio balance model is considered to be the most general model of exchange rate determination. its empirical validity is, however, flawed on two counts: a test of the complete model is close to impossible given the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 22 sajems ns vol 3 (2000) no 1 unavailability of appropriate data and, in truncated fonn, it generates poor results, even for the early period of the 1973 float. although there can be i ittle doubt that a suitable exchange rate model should reflect the asset-market approach as opposed to the traditional flow approaches, the portfolio balance model is not a natural choice on account of data considerations. in early versions of the rand/dollar model presented in this paper, first, a portfolio balance approach and, later, a hybrid model of the monetary and portfolio balance approaches were followed. in both cases, substantial difficulty was encountered in assembling the data, and the test results were unsatisfactory. instead, a simple monetary model is proposed for and adapted to south african circumstances. given the empirical shortcomings of the monetary model, the selection of the monetary approach as a basis for the rand/dollar rate needs some justification: the monetary model is generally regarded as the "standard workhorse" in intemational finance (frankel & rose, 1994: 3). in addition, the monetary model provides a useful tool for exchange rate analysis because it, firstly, clearly defines the role of speculation among the exchange rate detenninants and, secondly, gives a simple definition of the equilibrium exchange rate. moreover, it directly relates the equilibrium rate to the underlying instruments of monetary policy (bilson, 1978: 48). most importantly, an obvious altemative is clearly lacking. the sticky-price dombusch model of the rand/dollar rate yielded unexpectedly good results for the sample period. the rand/dollar model, which closely resembles the "standard workhorse" variant of the monetary model, was adjusted in earlier attempts to improve empirical results. current account data was introduced to obtain a variant similar to the hooper-morton model. also, attempts were made to capture driskill's imperfect substitutability assumption or, alternatively, to specify a hybrid monetary-portfolio balance model. finally, variables similar to those proposed by throop (1993) were introduced without success. these variables included the budget deficit, the price of oil and a gold price/oil price tenns-of-trade type of variable. all the attempts to find a better model proved fruitless or were prematurely frustrated by the unavailability of data. as a result, the "standard workhorse" variant of the monetary model was retained. ideally, a truly sophisticated exchange rate model should accommodate forwardlooking expectations. rational expectations with time-in variate parameters as embodied in the efficient market hypothesis, may be introduced. the rand/dollar model implicitly contains rational expectations in the sense that expected future values are assumed to materialize. expected future values therefore equal actual future values. altematively. expectations with time-variate parameters, as embodied in the learning models, may be introduced. although plausible, a r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 23 learning model was not simulated in this study due to technical constraints, but will be pursued in future research. regrettably, an intertemporal optimizing model was also excluded from the empirical work, as it requires an approach with strong micro foundations, which is beyond the scope of this study. the focus of this study is mainly on a simple, structural long-run macro-model. as with learning, intertemporal optimization will undoubtedly receive the attention it deserves in future empirical work on the south african exchange rate. 3 empirical status of the monetary model friedman (1953: 158) in his argument for flexible exchange rates, stated that: "the ultimate objective is a world in which exchange rates, while free to vary, are in fact highly stable: instability of exchange rates is a symptom of instability in the underlying economic structure". the monetary model, as part of the asset approach, was induced by the failure of the traditional trade-flow models, to define the elements of the "underlying economic structure" that have been responsible for the erratic exchange rate movements. it may be said that the monetary approach has for the past two decades become the standard point of departure for the literature on exchange rate determination. admittedly, the monetary approach fails to provide an adequate explanation of the movements in major currency values during the floating-rate period that commenced in 1973. the causes of this failure will be subsequently examined. after initial claims of success (the so-called first-period tests for the present float prior to 1978), the empirical failure of a simple monetary model with flexible prices became apparent (frankel and rose, 1994: 5). the coefficient estimates and empirical fit of such models were less than reassuring, with the possible exception of hyperinflation conditions. in addition, the observed volatility of real exchange rates and the highly positive correlation of nominal and real exchange rates became obvious enough to warrant explicit treatment (op. cit.: 6). moreover, the models forecasted poorly out-of-sample. the apparent contradiction of the assumption of flexible prices emerging from these [mdings, naturally led to the assumption of sticky prices. the essence of the sticky-price overshooting, or dornbusch model is captured in a simple, yet strong, statement that proportionality exists between the real exchange rate and the contemporaneous real interest differential (op. cit.: 8). early tests of the overshooting model focussed on more complete models than the simple proportionality between the real exchange rate and the real interest differential. such· tests of exchange rate models with sticky prices met with initial success, but eventually fell apart both in and out-of-sample (op. cit.: 11). the emphasis has subsequently shifted to subjecting the simple testable result of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 24 sajems ns vol 3 (2000) no i the model relating the real exchange rate to the contemporaneous real interest differential to increasingly sophisticated time-series econometrics. meese and rogoff (1988) applied the engle-granger test for cointegration and found no evidence of such a relationship. similarly. campbell and clarida (1987) reported a lack of supporting evidence. it has been noted that the poor results could be attributed either to the existence of a missing variable or, alternatively, the weak power in the tests (frankel and rose, 1994: 11). subsequent studies employed increasingly powerful econometric procedures (such as the johansen procedure) and included other variables. for example, evidence of cointegration between the real exchange rate and real interest differential was reported after the incorporation of a measure of the cumulated current account (op. cit.: 12). strong results were reported in a subsequent study by throop (1993), after allowance for several other variables has been made: a lagged effect of the real interest differential, the budget deficit, the real price of oil and a measure of the relative price of non-traded goods. 4 developing the monetary equation a general statement of the monetary approach comprises five hypotheses: i. purchasing power parity (ppp) holds over some time horizon. 2. uncovered interest parity (uip) holds at all times. 3. the demand for real money balances is a stable function of a small set of real variables. 4. the supply of money is determined by a stable process. 5. expectations are (in some sense) rational (boughton, 1988:4). the joint hypotheses of ppp in the long run and uip at all times call for some remarks. the relative version of ppp can be written in its ex' ante expectational form as: with e(de) the log of the expected depreciation in the domestic currency, e(dp) the log of the the expected domestic inflation rate and t(dpi the log of the expected foreign inflation rate. equation (i) states that the expected exchange rate depreciation equals the expected inflation differential. uip states that the expected depreciation is equal to the interest differential: e(de) = i-if (i) (2) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 25 equations (1) and (2) can now be rewritten and combined to establish ex ante real interest parity (rip): i.ir -l.irf = [i -&(dp)}[i,&( dp i)] with r denoting the real interest rate. equation (3) states that rip holds if both ppp and uip hold. the joint hypothesis of ppp and uip therefore also imply the rather strong hypothesis of rip. as deviations from ppp are assumed not to occur in the long run and such deviations are generally caused by exchange rate or inflation forecast errors, such errors are assumed not to exist. in addition, deviations from uip caused by risk premia or exchange rate forecast errors are assumed to be absent. the first two hypotheses in the list above should therefore be recognized as the stringent assumptions that they are: simultaneous ppp, uip and rip are implied and all sources of deviation from any of these parity conditions are assumed not to exist (marston, 1997: 289). the fundamental equation in the monetary approach is a conventional money demand function: m= p+¢y-ai where m = the log of the domestic money supply, p = the log of the domestic price level, y = the log of domestic real income, i = the nominal domestic short term interest rate, ¢ = the income elasticity of the demand for money and a, = the interest rate semi-elasticity of the demand for money. a similar money demand function is formulated for the foreign country: (3) (4) m,= p,+¢y,-ji, (5) a relative money demand function is obtained by subtracting equation (5) from equation (4): uncovered interest parity is implied by the perfect substitutability or single-bond assumption: i -i, = &(de) where e(de) represents the expected depreciation of the do",!estic currency. the relative price level can be obtained by rewriting equation (6): (p pf) = (m m,)¢(yy,)+ j(t if), equations (7) and (8) are subsequently combined: (p p,) = (m m, ) ¢(y y,) + a.&( de) (6) (7) (8) (9) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 26 sajems ns vol 3 (2000) no i equation (9) states that relative prices are determined by the domestic money supply relative to the foreign money supply, domestic income relative to foreign income and also by the expected depreciation in the domestic currency. a long-run version ofppp is now introduced: (10) with the bars over the variables signifying long-run relationships and e == the log of the spot exchange rate, reflecting the domestic price of foreign currency. equation (9) can be combined with (10) and rewritten as: (11 ) in its expectational form, ppp equals the expected depreciation to the expected inflation differential: (12) a long-run version of exchange rate determination can now be obtained by combining equations (11) and (12): ---e = (m mf)¢( yyf)+ jl( e(dp}e( dpf} (13) equation (13) states that, in the long run, the exchange rate as the relative price of currency, is determined by the relative supply of and demand for money. if the domestic money supply expands, a proportionate depreciation results. similarly, an increase in domestic income or a decline in the expected inflation rate, stimulates the demand for domestic money and results in an appreciation. it is assumed that expectations are rational, that the system is stable, that income growth is exogenous (or random with mean zero) and, finally, that monetary growth follows a random walk as a benchmark specification. the expected inflation rates, domestic and foreign, are consequently replaced by the actual rates, to render the final form of the exchange rate equation: e = (mmf)¢(yy f}+jl(n nf) (14) with n denoting the actual inflation rate. the long-run exchange rate is therefore determined by relative money supplies, relative income levels and relative inflation rates. short-term deviations from ppp may occur, resulting in deviations from rlp. a real interest differential (rld) could arise as follows: r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 27 short-run adjustments (depreciation) towards the long-run equilibrium exchange rate are assumed to take place at a rate 0: &(de) = -(}(e e) while the long-run depreciation is reflected by relative ppp: &(de) = (il-il j ) (15) (16) combining equation (15) with (7), uip, and then with equation (16) results in a rate of adjustment proportional to the real interest differential: j e-e --o[(i-il}-(;j"il j )] (17) it is important to note that a real interest differential could only arise from deviations from either ppp or uip or both. deviations from vip over any time horizon are ruled out by the hypotheses; while deviations from ppp are provided for only in the short run. it therefore follows that the only deviation from these parity conditions accommodated in this model, is a short-run deviation from ppp which will result in a short-run deviation from rip. equation (17) may then be said to capture the short-run deviations from parity conditions and thus the shortrun overshooting of the exchange rate. a general equation of exchange rate determination may be expressed as: e = (mmj)¢(yy j)+ l(ilii i }-~{(j. il}-(;j" ill)] (18) with the last term, rid, signifying short-term overshooting. in the long run, however, all of ppp, vip and rip are observed and this term will become zero, indicating that overshooting in the long run is ruled out. 5 the sticky-price, dornbusch model of the randidollar exchange rate 5.1 the theoretical model the theoretical model of the rand/dollar exchange rate is representative of the dornbusch, sticky-price class of models. the specification includes the following variables: exch = f(m3, gop, !nfl) (+ + ) with exch = ln(the spot exchange rate in rand/dollar) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 28 sajems ns vol 3 (2000) no i m3 = ln[(sa m3 money supply)/(usa m3 money supply)] gop ln[(sa real gop)/(usa real gop)] infl sa inflation rate usa inflation rate. the specification corresponds to the long-run version of the dornbusch model (equation (13) above), except that the inflation differential is substituted for the differential between the expected rates of price changes. the spot rand/dollar exchange rate therefore depreciates (exch increases) if south africa's monetary discipline becomes slack in comparison to monetary discipline in the us. likewise, if the increase in the cpi accelerates domestic prices compared to the us, exch rises, signalling a depreciation in the dollar value of the rand. economic growth may again effect an exchange rate appreciation, provided the domestic expansion of the gdp exceeds that of its foreign counterpart. 5.2 the data all south african data were taken from the quarterly bulletin of the south african reserve bank. the consumer price index (cpi) was used to calculate the inflation rate. the 3-month bankers' acceptance rate was considered the representative short-term interest rate, which was deflated and subsequently featured in the error correction model (ecm), to be discussed below. the international financial statistics of the international monetary fund was the source for data on the united states. the 3-month treasury bill rate represents the short-term us interest rate and appears in the ecm, after the us inflation rate was deducted, as the real short-term interest rate. the sample period commences in 1979, despite the ready availability of earlier data, and is decidedly shorter than what would be ideal. the reason for this is that south africa maintained some form of fixed exchange rate system even after the demise of the bretton woods system until 1979. it was only from 1979 onwards that the exchange rate was permitted to float. a structural break thus manifested itselfin 1979, and it appeared meaningful to restrict the sample period to the era of floating. although all relevant data for 1996 were available, 1995 was taken as the cut-off date of the sample period. it appears that 1996 was by no means an ordinary year for south africa's foreign exchange markets. unsubstantiated rumours of an overvalued currency triggered speculative sales resulting in a capital outflow and a sharp depreciation in the rand during february 1996. in addition, a mild subsequent recovery during march was rapidly reversed into a second run on the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 29 rand in april, when balance of payments difficulties became apparent. as a result, the rand lost 20,6 per cent of its dollar value during the first four months of 1996. an exchange rate model comprising the fundamentals of exchange rate determination loses most of its explanatory power on such occasions as the 1996 currency crisis, when negative psychology prevails. the years 1997 and 1998 were no more normal in the sense that the exchange rate failed to stabilize and continued to be dominated by non-fundamentals. it is hoped that in future, with the benefit of hindsight, sense can be made of this interlude. an explanatory list of all the variables included in the long-run co integration relationship and the ecm is presented in table 1: table 1 list of variables exch ln(spot rand/dollar exchange rate) m3 ln(relative m3 money supply) gop ln(relative real gop) !nfl inflation differential rs real short-term interest differential dum dummy variable 1 in 1990, 1991 and 1992 tests for stationarity were subsequently performed. data plots for exch, gop, m3, infl and rs respectively (see figure 1) indicate that exch and m3 show defmite upward trends. a similar trend in infl is less conspicuous, although the augmented dickey-fuller test results (see table 2) unambiguously indicate that it is integrated of order i. the variable rs tests potentially stationary. inspection of its data plot reveals a slightly upward trend, with what appears to be a structural break in 1986. incidentally, a similar break is observed in the !nfl series in 1986. . r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 30 sajems ns vol 3 (2000) no i figure 1 data plots for exeh, gdp, mj, infl and rs: 1979 1995 1.6 1.2 0,8 0,4 0.0 -0,4 80 82 84 86 88 90 92 94 80 82 84 86 88 90 92 94 exchi -2.8 20..-------------------------, -3,0 -3,2 15 -3.4 -3.6 10 -3.8 -4.0 5 -4.2 -4.4 o~~~~~ __ ~~ __ ~~~ 80 82 84 86 88 90 92 94 80 82 84 86 88 90 92 94 i m31 i infl! 4~--------------------~ o -12 80 82 84 86 88 90 92 94 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 31 the results of the augmented dickey-fuller tests for non-stationarity are reported in tables 2 and 3. all variables appear to be integrated of order one, except for the variable rs which is stationary. table 2 series exch gdp m3 infl rs augmented dickey-fuller tests for non-stationarity, levels; 1979 -1995 model lags tt,t".to $),$,0 trend and intercept 0 -1,49 1,29 intercept 2 -1,88 2,66 none 3 0,03 trend and intercept i -3,06 4,17 intercept 0 -0,44 0,19 none 3 2,65 trend and intercept i -2,25 3,18 intercept 0 0,66 0,44 none i -1,84 trend and intercept 0 -1,56 2,32 intercept 0 -2,06 4,27 none ° -0,49 trend and intercept 1 -3,32 3,68 intercept 0 -1,98 3,93 none 0 -2,03* *(**) slgmficant at a 5(1)% level. table 3 series exch gdp augmented dickey-fuller tests for non-stationarity, first differenced; 1979 -1995 model lags tt,t",to $j.$,o trend and intercept 1 -4,22* 6,18* intercept : none trend and intercept 0 -3,01 6,13* intercept 2 -4,23** none r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 32 sajems ns vol 3 (2000) no i table 3 continued series model lags tt.tp.to $j.$io m3 trend and intercept ° -2,23 2,49 intercept ° -2,23 4,95* none infl trend and intercept 1 -5,01 ** 8,97** intercept none rs trend and intercept 0 -3,37 5,67* intercept 0 -3,5* 12,27** none *(**) significant at a 5( 1)% level. 5.3 the estimation results of the cointegration model the engle and yoo (1991) three-step estimation technique was employed, whose first step tests whether the set of variables specified in the cointegration equation is co integrated, that is whether the particular combination of variables is in fact consistent with a long-run equilibrium relationship. the cointegration results for the first step are reported in tab ie 4. table 4 first step estimation results, dependant variable: excht variable coefficient std. error t-statistic probability m3, 0,842896 0,059393 14,19182 0,0000 gdp, -1,107141 0,078135 -14,16952 0,0000 infl, 0,041884 0,007885 5,312114 0,0001 r-squared 0,951247 f-statistic 136,5808 adjusted r-squared 0,944282 prob(f -statistic) 0,000000 figure 2 compares the actual values with the fitted values generated by the cointegration equation: r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 33 figure:z the cointegration equation: actual, fitted and residual values 0.5 0.3 0.2 0.0 0.1 0.0 ,-----l -0.5 -0.1 -0.2 -0.3 80 82 84 86 88 90 92 94 the cointegration regression augmented dickey-fuller test statistic was -2,86. this test consists of a unit root test on the residuals of the co integration equation. critical values for the relevant response surfaces can be found in mackinnon (1991). the response surface for any number of regressors, excluding any constant and trend components, 1~6, can be calculated as c(p) ~<jiiti+<ji2t2, where c(p) is the p per cent critical value. the residuals can thus be accepted as stationary, and the variables in the regression may be considered cointegrated. s.4 the error correction model the second stage of the engle and yoo procedure consists of an estimation of the short-run dynamics by means of an error correction model (ecm). it incorporates the equilibrium error (residual term) estimated from the long-run equilibrium relationship. in addition, the ecm provides an indication of the rate of adjustment towards equilibrium. a summary of the estimation results is given in table 5. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 34 sajems ns vol 3 (2000) no 1 table 5 error correction estimation results, dependent variable: aexcht variable coefficient std error t-statistic probability residualt_1 -0,702699 0,112142 -6,266169 0,0008 mnflt 0,053977 0,007028 7,680255 0,0003 ars t 0,029294 0,003987 7,347016 .0,0003 agdpt_1 -2,171331 0,486008 -4,467682 0,0042 agdpt_2 -2,297158 0,431819 -5,319719 0,0018 arst1 0,012482 0,002872 4,345738 0,0048 aexcht_1 0,382221 0,083693 4,566949 0,0038 dumt -0,054181 0,020826 -2,601659 0,0406 r-squared 0,968753 f -statistic 26,57362 adjusted r-squared 0,932297 prob(f -statistic) 0,000415 in table 5, dum refers to a dummy variable of unity which was activated for three consecutive years: 1990, 1991 and 1992. an underestimation of the exchange rate for those three years prompted the inclusion of dum. it appeared that factors which could not be captured in the model may have caused the exchange rate to perform better during those three years than could be explained by the variables at hand. it is commonly accepted that the latter half of the eighties was a particularly dismal spell for the south african economy. years of growing international discontent with south africa's political dispensation, culminated in the debt standstill arrangement after president botha's infamous rubicon speech in 1985. south africa's external relations were distorted by trade and financial sanctions, and extreme measures were taken to protect our international reserves and the exchange rate. political liberalization commenced in 1990 and brought substantial relief from international economic pressure. the international community endorsed the steps towards an equitable political dispensation by means of a rapid normalization of relations with south africa. the exchange rate responded positively to international sentiments of optimism, the effect of which was prevalent particularly during 1990, 1991 and 1992. the euphoria then seemed to subside r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 and nonnality returned. a data plot of the actual and the fitted values of .6.exch is shown in figure 3. figure 3 the actual, fitted and residual values of aexch i i i i 0.04 i 0.02 . 0.00 .q.02 .q.04 r-----------------------,-0.6 0.4 0.2 -0.2 82 83 84 85 86 87 88 89 90 91 92 93 94 95 i -residual ._ ...•• actual ---fitted 35 several diagnostic tests were perfonned on the ecm. the results of these tests are reported in table 6. it should be borne in mind, however, that the conclusiveness of these tests is reduced by the relatively small size of the sample. table 6 diagnostic test results purpose of test test ! test statistic! . probability nonnality jarque-bera 18(2)= 1,499815 0,472410 heteroscedasticity arch nr2( 1 )=0,517441 0,471935 serial correlation breusch-godfrey lm nr 2(2)=13,09462 0,001434 stationarity of residuals lung box q q(6)=3,7457 0,71i specification ramsey reset lr(2)=o,836750 0,658115 parameter stability cusum, cusum of squares, recursive all indicative of stability estimates, recursive residuals figures in brackets denote degrees of freedom. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 36 sajems ns vol 3 (2000) no i the white test for heteroscedasticity could not be perfonned because the sample contains fewer than the minimum number of observations required. the third step in the engle and y 00 procedure was subsequently perfonned. 5.5 cointegration correction and adjusted coefficients the third step corrects the first-step estimation ofthe long-run parameters of the model to ensure that distributions return to a nonnal distribution. for this purpose, the coefficients and t-statistics are adjusted to their true values. tables 7 and 8 summarize the third-step estimation results and the adjusted coefficients. table 7 third-step estimation results variable adjustment of coefficients 0,702699*m3. -0,007906 0,702699*gdp. 0,017437 0,702699*inflt 0,002570 tables cointegratlon correction, dependent variable: exch. variable engle and engle and standard adjusted granger yoo adjusted error t-statistic coefficients coefficients m3! 0,842896 0,834990 0,022389 37,294653 gdp. -1,107141 -1,089704 0,023212 -46,945717 infl. 0,041884 0,044454 0,003570 12,4521 the three-step engle and y 00 procedure is thus concluded and the final version of the model is obtained by combining the longand short-run characteristics. the overall fit of the model is depicted in figure 4. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 37 figure 4 the actual and fitted values of exch 4~------------------------__________ ~ r/$ 3 2 1 80 82 84 86 88 90 92 94 1actual ----fitted 6 dynamic response properties and policy implications the rand/dollar model was subsequently subjected to sensitivity testing. sensitivity testing in the fonn of dynamic simulations will detennine whether the resulting multiplier effects are consistent and therefore whether the model is stable and robust. in addition, the dynamic response properties reveal some of the policy implications of the model the response characteristics and some policy implications are discussed in this section. 6.1 sensitivity tests the variables were shocked, one at a time, as follows: firstly, a shock was applied to gop, aliowing the south african gop to rise 10 per cent above its baseline level from 1982 onwards. ideally, the shock should result in a convergence of the dependant variable, exch, on 10 per cent of the estimated coefficient of the shocked variable, gop. the second shock consisted of an increase of 3 percentage points in the domestic inflation rate from 1982 onwards, and exch should converge on the estimated coefficient ofinfl multiplied by 3. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 38 sajems ns vol 3 (2000) no 1 the final shock was a i ° per cent increase in the south african m3 money supply, also from 1982 onwards. similarly, exch should converge on 10 per cent of the estimated coefficient of the m3 variable. on practical grounds, 1982 was considered appropriate to commence with each of the three shocks respectively. the shocks could not be applied later, because the sample period is short and sufficient time for the multiplier effect to develop had to be allowed. nor could it be applied sooner, to allow for two-period time lags. table 9 indicates the divergence in the long-run equilibrium value of the exchange rate by the end of the sample period, 1995. table 9 variable m3 gdp infl difference between the baseline forecast and forecasts with shocked variables, dependent variable: exch coefficient expected change divergence in in exch1 exch in 1995 0,834990 0,083499 0,083603 -1,089704 -0,108970 -0,106392 0,044454 0,133362 0,134085 the results of the sensitivity tests in table 9 are shown in figures 5, 6 and 7. 2 the expected change in exch will be 10 per cent of the relevant coefficients in the case of the m3 and gop shocks, and in the case of the infl shock, the coefficient of infl multiplied by 3 should provide an indication of the expected adjustment in the long-run equilibrium value of exch. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 39 figure 5 dynamic adjustment properties (in percentage of change) with a 10 per cent increase in the south african m3 money supply, dependent variable: exch 10 8 6 4 2 0 -2 80 82 84 86 88 90 figure 5 shows that a domestic monetary shock in 1982 results in a sharp depreciation in the rand (an increase in exch), amounting to a maximum of just below 10 per cent in 1985, followed by a relatively smooth adjustment path towards a new long-run equilibrium which, by the end of the sample period in 1995, stabilizes around r4,08/dollar compared to the baseline forecast ofr3,77. this constitutes a depreciation of8,36 per cent in the dollar value of the rand. the mild initial response of the exchange rate to the money supply shock is consistent with what may be expected. it should be borne in mind that the upper boundary of the annual money supply growth has been around 10 per cent for some years. this target was exceeded by far, particularly during the eighties when monetary growth at times doubled the target rate. the 10 per cent shock introduced in 1982 therefore constitutes a relatively small shock, which would explain why the initial exchange rate response is a moderate one of less than 10 per cent. naturally, monetary expansion is likely to ,be inflationary and, moreover, it creates inflationary expectations. the exchange rate could be expected to depreciate in such a climate. the new long-run equilibrium is at a plausible level, depreciating 8,36 per cent from the baseline forecast, given the magnitude of the shock applied to the money supply. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 40 sajems ns vol 3 (2000) no 1 figure 6 dynamic adjustment properties (in percentage of change) with a 10 per cent increase in the south african gdp, dependent variable: exch 10~----------------------------------, % 0+-----. -10 -20 -30 80 82 84 86 88 90 92 94 figure 6 shows that a 10 per cent rise in the sa gdp relative to the us gdp has a pronounced impact on the exchange rate. having been dealt the gdp shock in 1982, the exchange rate appreciates dramatically (exch declines) to a turning point of a just below 40 per cent appreciation in 1984, and almost returns to its pre-shock level in 1987. although the magnitude of the initial response is somewhat unexpected, it must be borne in mind that a 10 per cent shock is, in terms of national outputs, sizeable. south africa's annual gdp growth for the 1982 to 1995 period was, on average, slightly above 1 per cent. a 10 per cent shock to the south african gdp therefore represents a substantial shock. given the openness of the economy, an expansion in the gdp is commonly preceded by an increase in exports, which in tum supports the exchange rate. a close to 40 per cent initial appreciation in the exchange rate is therefore not implausible, considering the order of magnitude of the gdp shock. the exchange rate then adjusts relatively smoothly to a new long-run equilibrium level of r3,39, compared to the baseline forecast of r3,77, signalling an appreciation of 10,64 per cent. the new long-run equilibrium is consistent with the model coefficients and intuitively plausible. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 41 figure 7 dynamic adjustment properties (in percentage of change) with a three percentage point increase in the south african inoation rate, dependent variable: exeh 25~--------------------------------~ % the average annual inflation rate for the period 1982 to 1995 exceeded 13 per cent. a 3 percentage points shock to the south african inflation rate is therefore sufficient to trigger a significant exchange rate response. a year after the shock is applied, the exchange rate depreciation reaches its maximum where after the new inflation differential is discounted. the initial depreciation exceeding 20 per cent is reversed in 1983 and a partial recovery is followed by a smooth adjustment path towards a long-run equilibrium value. in 1995, the exchange rate with the inflation shock settles at r4,27, compared to the baseline forecast of r3,77, constituting a depreciation of 13,41 per cent. 6.2 policy implications some simple policy recommendations may be construed from the sensitivity tests performed in the previous section. it would seem that monetary 'stability is important, but much more so, particularly in the short run, are economic growth and price stability. domestic economic growth has a pronounced short-run effect on the exchange rate: an appreciation of almost 40 per cent within two years for every ten per cent gdp growth, ceteris paribus. the long-run effect is also significant as indicated by the relatively high gdp elasticity of -1,09. domestic policies aimed at the expansion of economic activity are not primarily intended to support the exchange rate. the unprecedented level of unemployment is undoubtedly the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 42 sajems ns vol 3 (2000) no i most pressing policy priority in south africa. however, the current growth and employment strategy (commonly referred to as the growth, employment and redistribution strategy, or gear) relies heavily on the potential contribution of a competitive export sector and, in this regard, the level of the exchange rate is clearly a deciding factor. economic growth supports the exchange rate and, although it eases the pressure on the balance of payments when it serves to attract foreign capital, export competitiveness may be eroded. it should be borne in mind that several other structural considerations, the importance of which outweighs the threat posed by an exchange rate appreciation, constrain our export performance. the amelioration of the structural constraints will in all probability further reduce the importance of an exchange rate effect on our export competitiveness. in short, economic growth is a sine qua non in the quest for adequate labour absorption; if policymakers envisage to attain that via a vigorous export performance, the exchange rate effect of growth may prove detrimental to export competitiveness, and should be offset by removing structural constraints on competitiveness. monetary stability is a prerequisite for both the internal and external stability of the rand. it has a significantly smaller short-run effect on the exchange rate; a 10 per cent expansion in the domestic money supply results in a less than 10 per response in the exchange rate. similarly, the long-run exchange rate effect is smaller than in the case of economic growth, as is evident from the lower elasticity of 0,83. monetary stability is consistent with the gear objectives of sustained, export-led, long-term growth. moreover, monetary discipline was probably never more important for an emerging economy to dispell fears of a looming financial collapse in the wake of the asian crisis of 1997. price stability is equally important for exchange rate stability, as is evident from the sensitivity tests in the previous section. it is therefore, apart from the other gear objectives, also important from the perspective of exchange rate stability, to check the expansion of the money supply and the rate of increase in consumer prices. put differently, monetary and fiscal discipline needs to be adhered to with perseverance. in summary, the gear objectives are an increase in the labour absorption capacity and a more equitable distribution of income through sustained, exportled, long-term growth. for this, demand-management policies need to be disciplined and consistent, and supply-side measures should be directed at appropriate structural adjustments to enhance export competitiveness and establish an attractive investment haven. exchange rate stability, which is a crucial element of the strategy, will not be derailed by such policy measures, with r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 43 the possible exception of an appreciation in the currency should the vigor of the economy be revived. the resulting threat to export competitiveness would be countered if significant structural impediments are effectively dismantled. 7 the fundamental equilibrium exchange rate (feer) the concept of an equilibrium exchange rate has frequently been misinterpreted as a normative or even subjective concept (barrell et ai., 1996: 5). the real equilibrium exchange rate is an objective rate inasmuch as it is consistent with equilibrium of the underlying fundamentals. it should be conceded though, that in the quest for a purer construct of feers (or in imf terminology, the desired equilibrium exchange rate, deer), the definitions encountered may vary considerably and that the feer concept may be subjective in the sense that it corresponds to a subjective set of assumptions. it remains undisputed that an equilibrium exchange rate is one which is consistent with prevailing relative prices and some definition of internal and external equilibrium. purchasing power parity may be used to determine feers (barrell et ai., 1996: 6). alternatively, the feer may be considered the real effective exchange rate where both internal and external macroeconomic equilibrium are achieved, and to then solve for the real exchange rate consistent with the particular definitions of internal and external equilibrium (bayoumi et ai., 1993: i ). internal equilibrium is usually defined to occur at potential or fullemployment output and is determined independently of the real exchange rate. external equilibrium is often defined in terms of a desired balance on the current account, which should correspond to a presumed level of capital flow and stock of net foreign assets (op. cit.: 3). a version of the latter approach will be applied to the exchange rate model described in section 5 above, and a unique defmition for equilibrium is subsequently formulated. 7.1 defining fundamental equilibrium several south african policymakers have repeatedly confirmed their commitment to the government's comprehensive macroeconomic (gear) strategy. the gear is fairly specific, albeit somewhat ambitious, about the target (or desired) levels of macroeconomic fundamentals until the year 2000. consequently, fundamental equilibrium, or simultaneous internal and external equilibrium, is defined as the level of macroeconomic fundamentals consistent with gear targets. naturally, some assumptions have to be made about the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 44 sajems ns vol 3 (2000) no 1 corresponding us fundamentals. all that remains then, is to solve for the exchange rate consistent with the gear targets and to call it the fundamental equilibrium exchange rate. 7.2 target (desired) levels of the fundamentals the gear projections of the relevant fundamentals are given in table 10. table 10 projections for economic growth, the inflation rate, monetary growth and interest rates: variable 1996 1997 1998 1999 2000 growth 3,3% 2,0% 2,5% 2,9% 3,3% inflation 8,4% 10,9% 9,6% 9,3% 9,1% monetary growth 11,7% 12,9% 12,1% 12,2% 1 12,4% real short-term 6,45% 2,95% 3,25% 3,05% 2,45% interest rates monetary growth was calculated as the sum of economic growth and the inflation rate for each year. monetary growth is not specified in the gear beyond the explicit commitment to monetary discipline. the reserve bank's target for annual growth in the m3 money supply has for many years had 10 per cent as its upper boundary. in reality, monetary growth has been well outside of the growth targets for a number of years. despite the weakening link between the inflation and economic growth rates on the one hand and the rate of monetary expansion on the other, it was decided to predict a monetary growth rate consistent with the gear targets for inflation and economic growth. the reason for this was simply that the reserve bank's targets appeared to have severed the links with reality and were not well ensconced in the context of the gear targets. similarly, the real short-term interest rate is not expressly forecasted in the gear. future movements in the bank rate are specified, however, and similar movements were then imposed on the 3-month ba rate to obtain a forecast of the nominal short-term interest rate. gear inflation rates were then used to predict the trajectory of the real short-term interest rate. assumptions had to be made regarding the corresponding us fundamentals. it was assumed that economic growth in the usa continues steadily at 3 per cent per annum. the inflation rate was assumed to remain at 3 per cent and 8 per cent was considered a reasonable annual rate of monetary expansion. the real shortr ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vo13 (2000) no 1 45 tenn interest rate was obtained by subtracting the assumed 3 per cent inflation from the project link forecasts for the nominal 3-month treasury bill rate. 7.3 the feer for tbe rand the model specified in section 5 was then estimated again, taking the forecasted data for 1996 to 2 000 into account. figure 7 shows the development in the dependent variable, exch, with actual data until 1995 and then with predicted data until 2000. figure 8 actual and fitted values (1979 to 1995) and the fundamental equilibrium exchange rate (1996 to 2000); dependent variable: r/$ exch 5~----------------------------------~ 4 3 2 00 ~ m 00 m 00 ~ m % w 00 1actual ----fitted{82-95) & feer{96-2000) the trajectory coincides with the earlier version of the model until 1995, after which exch develops along a path consistent with gear targets. the fitted values for 1996 to 2000 therefore constitute the fundamental equilibrium exchange rate, or feer. table ii reports the feer values generated for 1996 to 2000. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 46 sajems ns vol 3 (2000) no 1 table 11 the fundamental equilibrium exchange rate (rand/dollar) for 1996 to 2000 year value of feer 1996 3747166 1997 3505590 1998 3410756 1999 3867370 2000 4124758 of the feer values reported in table ii, the values for 1996, 1997 and 1998 may be compared with the actual exchange rates observed. these actual rates were r4,2964/dollar, r4,6073/dollar and rs,53 16 respectively, compared to the corresponding feer values of r3,7472/dollar, r3,5056/dollar and r3,4108/dollar. clearly, the rand is performing sub-optimally, or may be considered undervalued compared to the equilibrium rate. given that the feer values are consistent with the gear target levels of fundamental variables, any deviation of these underlying fundamentals will result in a deviation of the exchange rate from its feer value. the factors which contributed to the undervaluation of the exchange rate were, firstly the sulroptimal performance of the economy in terms of the level of economic activity. the growth rates of 1996,1997 and 1998 were significantly lower than the rates envisaged in the gear. in addition, the m3 money supply expanded at a rate much higher than projected. the actual inflation rates compare more favourably with the gear projections, but not sufficiently so to avoid an undervaluation of the exchange rate. the undervaluation has the advantage that it supports south africa's export competitiveness, but the balance of payments and level of reserves are almost constantly under pressure. for the future exchange rate to converge on the equilibrium rate, a robust economic recovery will have to materialize and the expansion of m3 will have to be kept in check. 8 conclusion this study set out to establish an appropriate theoretical approach to modelling the rand/dollar exchange rate, given that none of the possible approaches escapes r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no i 47 all imperfection. the monetary approach was selected despite its shortcomings and poor empirical record, mainly because a clear alternative is lacking. an equation for the estimation of the rand/dollar exchange rate was then specified, and the engle and yoo three-step procedure applied to estimate the model the results indicated that the exchange rate, gop, m3 money supply and inflation variables, specified in table i, are cointegrated. the real short-run interest differential and a dummy variable for the years 1990, 1991 and 1992 were added to explain the short-run dynamics of the model and, finally, the third step was applied to adjust the long-run coefficients to their true values. the dynamic adjustment properties were investigated by applying exogenous shocks to each of the long-run variables separately. in each case, the adjustment path after the initial shock was smooth and the deviation of the new long-run exchange rate from the baseline converged to the expected value as indicated by the magnitude of the relevant coefficient. subsequently, sensitivity tests were interpreted to derive some policy implications, given the firm commitment of policymakers in south afiica to adhere to the proposals of the gear strategy. it was found that, should the labour absorption and economic expansion envisaged in the gear materialize, an overvalued exchange rate may well be the result which, in turn, poses a threat for sustained export-jed growth. however, should the policy making authorities manage to honour their commitment to price stability and monetary discipline, the resulting exchange rate stability will be conducive to an export-driven road to economic recovery. finally, an attempt was made to reconcile the exchange rate model with the ideal or target values for the underlying fundamentals specified in the gear. the result is considered a fundamental equilibrium exchange rate, or feer, where the latter is defined as the rand/dollar exchange rate consistent with the gear targets. for 1996, 1997 and 1998 actual observations of the feer variables were compared with their estimated values, and it was concluded that the actual exchange rate appears to have been undervalued in both periods, given that some of the fundamentals clearly fall short of the gear targets. the definition of the feer as the exchange rate consistent with the gear targets is however purely arbitrary, and alternative definitions may certainly be useful, particularly if the gear should lose further credibility. however, the feer projections defined here do seem credible, if the effect of the asian crisis on the rand/dollar rate is separated from the exchange rate level dictated by fundamentals. had south africa been spared the misfortunes of the other emerging markets of the past three years, the actual exchange rate would have deviated from the feer only to the extent that gear targets were not met. this inevitably raises questions about r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 48 sajems ns vol 3 (2000) no i the usefulness of structural models such as the monetary rand/dollar model: its forecasting reliability collapses during crises when it is most needed. realistically, it should be added that the purpose of a structural model is hardly to forecast a crisis. much rather, in this instance at least, it serves as an indication of whether the current exchange rate is overvalued or undervalued and also how adjustments in the fundamentals may be expected to affect the rand. 8 references argy, v. 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(1993) "the monetary approach to the exchange rate: rational expectations, long-run equilibrium and forecasting" imf staff papers, 40(1): 89-107. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 51 42 . macdonald, r. (1995) "long-run modeling: a survey oftbe recent evidence", imf stajjpapers, 42(3): 437-89. 43 mackinnon, 1. (l991) "critical values for cointegration tests", in long-run economic relationships, engle, r.f. and granger, c.w.j. (eds.), oxford university press. 44 marston, r.c. (1997) "tests of three parity conditions: distinguishing risk premia and systematic forecast errors", journal of international money and finance, 16(2): 285-303. 45 obstfeld, m. and rogoff, k. (1995) exchange rate dynamics redux. journal of political economy, 103(3): 624-60. 46 taylor, m.p. (l995) "exchange rate modelling and macro fundamentals: failed partnership or open marriage?" british review of economic issues, 17(42): 1-42. 47 taylor, m.p. (1995) the economics of exchange rates. journal of economic literature, 33: 13-47. 48 throop, a.w. (1993) "a generalized uncovered interest parity model of exchange rates", frbsf economic review, 2: 2-16. 49 williamson, 1. (1994) estimating equilibrium exchange rates. institute for international economics, washington. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction literature review innovation and economic growth in brazil, russia, india, china and south africa data and empirical model specification ethical consideration estimation results conclusion acknowledgements references appendix 1 footnotes about the author(s) brima sesay school of economics, wuhan university of technology, china zhao yulin school of economics, wuhan university of technology, china fang wang school of economics, wuhan university of technology, china citation sesay, b., yulin, z. & wang, f., 2018, ‘does the national innovation system spur economic growth in brazil, russia, india, china and south africa economies? evidence from panel data’, south african journal of economic and management sciences 21(1), a1647. https://doi.org/10.4102/sajems.v21i1.1647 original research does the national innovation system spur economic growth in brazil, russia, india, china and south africa economies? evidence from panel data brima sesay, zhao yulin, fang wang received: 13 aug. 2016; accepted: 05 oct. 2017; published: 22 jan. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract the question as to whether the national innovation system (nis) plays a significant positive role in influencing economic growth has been intensely debated by academics as well as policy analysts. the main controversy, however, is the fact that the ongoing empirical evidences on the relationship between innovation and economic growth are still mixed. the aim of this paper is to provide further evidence on the relationship between the nis and economic growth using consistent and reliable data from a sample of emerging economies (brazil, russia, india, china and south africa [brics]). the research has a brics focus and constructs nis using historical panel data set for the main variables, that is, university enrolment rate for science and engineering students, government research and development expenditure, high-tech export and the enclosure of control variables covering the period 2000q1–2013q4. the study employed a dynamic panel estimation technique with a view of evaluating the relative impact of the nis on economic growth in brics. the results revealed that the nis as a whole has a positive effect on economic growth in brics economies. an important policy implication emerging from this study is that extra efforts are needed by emerging economies to promote the development of a nis so as to explore the potential growth-inducing effects of a well-functioning nis. consequently, findings from this study have offered some persuading indicators for brics economies to explore the development of a nis as a potential opportunity to speed up their economic growth. introduction contemporary suppositions of economic growth draw attention to endogenous technological change to explain the growth pattern of world economies. according to the endogenous growth models, established by romer (1986; 1990), technological innovation which is known today as technovation is generated in the research and development (r&d) sectors using human capital and the existing stock of knowledge. it is then utilised in the production of finished goods and results in constant increase in the output growth rate. at the centre of these models, it is their notion that innovation that can be determined endogenously will enable sustainable economic growth, if there are constant returns to innovation with respect to human capital used in the r&d sectors. in general, empirical works of endogenous growth models entail examining the outcome of r&d variables on total factor productivity (tfp) growth. for example, in evaluating the soundness of growth models based on r&d, jones (1995) employs the plots of tfp growth and the rate of growth of the number of engineers and scientists in japan, germany, france and the united states using time series. however, in his study, there is no evidence of positive correlation between these variables. aghion and howitt (1998) give clarifications for the contradicting results of jones (1995). first and foremost, the growing complexity of technology makes it essential to increase r&d over time just to maintain the rate of innovation constant for every product. secondly, innovation in each product tends to affect a smaller proportion of the economy as a whole when there is an increase in the number of products and, thus, has a lesser relative spillover effect on the total knowledge stock. they subsequently contend that gross domestic product (gdp) share of r&d investment is supposed to be employed to account for the size of the economy instead of the number of the engineers and scientists. scherer (1982), griliches and lichtenberg (1984), aghion and howitt (1998) and zachariadis (2003) offer solid evidence that tfp growth and r&d investment are positively related in the us economy. however, innovation in emerging economies in recent years has been exceptional and has contributed to the overall economic growth of countries. a good number of empirical studies had shown that there is a positive relationship between innovation and economic growth, and innovation has now become a major component of growth of economies across the globe. this article investigates the impact of national innovation system (nis) on the economic growth of brazil, russia, india, china and south africa (brics) between 2000 and 2013. nevertheless, understanding about brics’s innovation potential and capacity is very crucial for a better understanding of the existing concept. has the nis played a role in the economic growth of brics in the past decade? what are the major components of brics’s nis? how can the nis be enhanced? these are some of the questions that are to be explored in this study. a comprehensive understanding of these questions is essential for policy-making and hence the transformation of the economic growth model of brics towards a sustainable pattern. in the existing literature, there are many studies that investigated the contribution of tfp changes to economic growth (see frantzen 2000; griffith, redding & van reenen 2002). innovation in those studies is considered as part of the role played by tfp or the leftover of economic growth which is not explicated by changes in factor inputs as it is clearly understood that markets relying on only input resources and price signals will not always be as effective in spurring higher productivity and hence economic growth. this study expands the existing literature by focusing on the major components of national innovation with an enclosure of control variables and by evaluating innovation from a different approach. the latter is based on brics official data and perhaps endeavoured for the first time in this article. the rest of the paper commences with a brief review of literature and the main issues associated with innovation in brics. this is followed by the description of the analytical framework and empirical model specification. the estimation results and discussions are then presented. subsequently, relative analysis is accomplished in order to check the robustness of the main models. the article finally ends with a summary of the main findings and some concluding remarks. literature review the concept of national innovation system was first proposed by freeman as a response to the washington consensus and to the neoclassical approaches to growth. in this way, the concept of the nis has always been inherently linked to public policy. for freeman and others, technological change and innovation are central to economic growth – a notion freeman pointed out as obvious since the industrial revolution had already been well established by schumpeter (1969). however, in view of this, innovation is not only perceived as the work of individual business entities but also as a collective effort that needs a different set of knowledge resources and know-how. as such, different countries will have different capabilities for innovation. unlike the neoclassical view of growth, the nis concepts put forward that governments and supportive agencies can play an essential coordinating role in the creation as well as the diffusion of innovation in a national economy. freeman (1982) made this point quite understandable in his analysis of japan’s post-war ‘catching up’ policy. in other words, institutions matter. they can create and support an environment through which collective knowledge and resources can be more easily exchanged for the pursuit of new ideas and opportunities. while the nis concept took hold as a policy prescription for catching up and was further strengthened by the popularity of porter’s (1990) theory of the ‘comparative advantage of nations’, early concept of the nis came under increasing criticism for being too blurred, open to misunderstanding and extremely broad to the point of losing practicality, as well as hesitations that the national prominence of the concept missed what was felt to be the more important underlying processes through which innovation actually came about. as a result, several concepts were developed that, while grounded in innovation systems, theory and ideas of collective learning and path dependency, considered innovation ‘at other stratum of the economy than the nation state’. as was initially mentioned, the first approach was the technology systems approach that was put forward by carlsson and stankiewicz (1995) which commences with a specific technology and looks at what players and institutions affect its development and diffusion. the second was the sectoral systems of innovation approach developed by breschi and malerba (1997) who argued that innovation could be best understood by looking at a set of products and a diverse set of representatives who work together through a system in the creation, production and sale of those products. these representatives cleave to sector-specific knowledge and their connections are influenced by institutions that may have local and international elements. notably, breschi and malerba contend that looking at innovation at the sector level presents better understanding on how sectors and hence sets of technologies interplay and change with time. the third approach was the regional innovation systems (ris) concept which proposes that innovation is best understood as a local or regional phenomenon where interplay, exchange of knowledge and learning take place by connecting actors and institutions that are location bound. the concept of ris hinges on the surveillance that technologically advanced (high-tech) inventive activities seem to hold in a selected number of modern regions of high capacity – made up of government organisations, legal and financial institutions, research universities and skilled labour – and that the tacit and asymmetric knowledge flows that characterise innovation are best channelled via face-to-face communication which co-location makes easy. exploring beyond the main structural framework presented by the nis concept, approaches to innovation systems such as those mentioned above looked to not only how innovation systems enhance the emergence and diffusion of innovation but also the degree to which such systems are successful in doing so. to this end, jacobsson and johnson (2000) proposed a functions approach to innovation systems which set out to first identify the primary functions of an effective innovation system and to then determine the relative importance of various functions and related interactions pertaining to both the innovation process and the growing capacity of a particular innovation system. what was somewhat novel about this approach is that while it was applied primarily to technology innovation systems (i.e. the micro system level), the set of functions ultimately recognised can indisputably be used for comprehending the innovation systems at diverse stages of analysis, starting from technological and subdivision system levels right through to the regional systems levels and national systems levels. empirical studies a vast amount of study has focused on the factors that influence growth via innovation in emerging economies. most of these studies use r&d and patent as a measure of innovation in determining the influence of innovation on growth. gould and gruben (1996) investigated economic growth rates across many countries to a simple index of patent strength and other variables. they found a significant positive impact when patent was interacted with a measure of openness to trade. that is, growth increases by 0.66% on average because of the impact of stronger patents in open economies, suggesting that market liberalisation in concert with stronger intellectual property rights (iprs) increases growth. ginarte and park (1997) arrived at a similar finding in investigating the influence of iprs on growth and investment. they found a strong correlation of patents on substantial savings and r&d expenses, which in turn enhance growth performance. hall and ziedonis (2001) had focused on patents in the us semiconductor industry. they explored the strengthening of patent policies of the 1980s using quantitative analysis of firm-level data on r&d and patenting and industry interviews. they found that large-scale manufacturers appear to be engaged in ‘patent portfolio races’. falvey, foster and greenaway (2006) used panel data for 80 countries in investigating the impact of iprs on economic growth. findings of their study showed that iprs are significant and positively correlated for low-income and high-income countries but not for middle-income ones. mccalman (2005) tested the endogenous model for 27 most developed countries. findings of the study showed that in the short run the majority of the countries’ losses are because of a distribution of wealth to foreign owners of technology. however, in the long run, when the trips1 provided incentives to research efforts, all countries benefited. smith (2001) examined the simultaneous impact of ipr protection on us exports, affiliated sales and licenses to unaffiliated foreign firms in a sample of 50 developed and developing countries using a variant of the gravity equation. results suggested that strong ipr protection increases the benefits of locating abroad and leads to an increase in affiliate sales and licensing relative to exports, particularly in countries with strong initiative abilities. patricia hiqino schneider (2005) investigated the role of high technology, iprs and foreign direct investment in determining a country’s rate of innovation and economic growth by employing a distinctive panel data set of 47 developing countries from 1970 to 1990. the results are broadly consistent and suggested that (1) high-tech imports are necessary in explaining domestic innovation both in developing and developed countries; (2) the per capita gdp growth has a stronger impact on foreign technology; (3) iprs have a significant impact in developed countries in terms of innovation. however, fdi results were inconclusive. dutta and sharmat (2008) investigated the effect of iprs on innovation using panel data on indian firms between 1989 and 2005. results suggested that indian firms increased their r&d expenditure after trips in more innovation-intensive industries. the r&d spending after trips was an average of 20 percentage points higher in an industry with a one standard deviation higher value of innovation intensity. intarakumnerd, chairatana and tangchitpiboon (2002) investigated the concept of the nis in developing countries that are said to be less successful in catching up with regard to technology. the study used thailand as a case study and found that the development level of the nis in thailand has no link to the structural development level of its economy. they found that although thailand experienced structural changes from agriculture-dominated economy to an industrial predominantly oriented one, its nis remains feeble and fragmented. yanrui wu (2012) used regional data in examining the impact of innovation on economic growth in china. his findings revealed that innovation affects china’s economic growth positively and r&d positively impacts china’s regional innovation. in the same line, hulya ulku (2007) assessed the relationship between r&d, innovation and economic growth with a panel of 20 oecd and 10 non-oecd countries. he found a positive relationship between gdp per capita and innovation in both oecd and non-oecd countries even though the effect of r&d stock on innovation was significant in only the oecd countries with large markets. literature gaps enormous empirical literature has been developed to examine the relationship between innovation and growth as a whole; however, the outcomes on empirical substantiation are different depending on the selection of country, time frames and the applied methodology. this study’s objective is therefore to complement the existing literature in two ways: to the knowledge of the authors, there is a need of logical study on identifying the major components in a nis that influence economic growth in brics vis-à-vis that of other emerging economies. there is limited research that disaggregates the major components of the nis and accounts for control variables in determining economic growth in emerging countries. this study therefore aims to examine in a more holistic framework the role of the nis, with a disaggregation of its major components and the enclosure of control variables as potential contributors to economic growth in emerging economies. innovation and economic growth in brazil, russia, india, china and south africa innovation capacity explains much of the gdp growth in brics in the past decade, especially in china and india. their development of the nis via heavy investment of r&d expenditure and personnel, patents and high-tech and service exports reinforce the capacity of their innovativeness. through connecting the science sector with the business sector, providing incentives for innovative activities and complementing the import of technology and indigenous r&d effort, these countries experienced rapid economic growth in recent years. the degree to which these five countries have reallocated to the national system approach of innovation may to some extent be reflected in the trends of their research allocations, as reflected in the rate of expenditure on r&d to their gdp. this may present a mere signal of a move towards a firm national base for the control of the means of innovation. the trends of r&d expenditure (% of gdp) of brics are presented in table 1 as well as in figure 1. figure 1: research and development expenditure (% of gross domestic product) table 1: research and development expenditure (% of gross domestic product). the brics member country that shows the strongest upward trend is china followed by brazil. the indicator for india remains relatively constant over the 14 years for which data were collected, while the one for russian federation shows a fluctuating performance. in the case of south africa, we see a slight deterioration over the last 2 years, caused by a drop in r&d expenditure. although this measure may be too comprehensive to provide anything more than a basic indicator of the shifting knowledge base of the various economies, it is interesting to note that the measure for most of the brics countries still lies considerably within this method. the rates of growth of this indicator for china and brazil over the 14-year period are impressive, especially in the case of china which shows a continuous upward trend. development of innovative activities has become a focal point of two major organisations: world intellectual property organization and the international business school insead, which measure innovative development via a global innovation index. another indicator of the closely defined nis for the brics is provided in figure 2 which illustrates high technology exports (high r&d intensity) as a percentage of manufacturing exports that shows similar patterns with slight variations for brazil, russia, india and south africa though china has the highest performance for brics member countries. figure 2: high-tech exports as a percentage of manufacturing exports. figure 2 clearly gives an idea about the upward movement of the chinese nis, not only with respect to size or its export-led growth but also in the high knowledge intensity of its export base. additional science and technology indicators which may be used as rough substitutes for intensifying the technological base of the different niss in the brics countries are accounted for in the model and their graphical representations are shown in the appendices. patent data have increased consistently in all of the brics countries over the period 2000–2013 (except for south africa), with china demonstrating the highest growth rate (appendix 1). patent grant data (figure 3) show that in the case of russia by far the greater portion of patents that were granted had been consistently filed by residents throughout the 14-year period. this is perhaps owing to the historical improvement of a very strong research base and the training of engineers and scientists (scientific personnel) prior to the formation of the russian federation. the chinese scenario, the only other brics member country where patent grants to residents surpasses those granted to foreigners, is different altogether. it is not just the complete scale of patents which is remarkable by the brics standards. the data also show an exponential rise in patents over the period with a reversal of the resident/non-resident ratio of patents granted from 2009 and a skyrocketing increase in the proportion of indigenes in the approved patents statistics. figures 3–7 show patent grants by source for the brics economies. figure 3: patent grants by source for brazil. figure 4: patent grants by source for russia (thousands of people). figure 5: patent grants by source for india (thousands of people). figure 6: patent grants by source for china (thousands of people). figure 7: patent grants by source for south africa (thousands of people). another significant element contributing to the development of an overall innovative environment is the economic freedom of a country. it should be noted that the notion of economic freedom has been intensely debated to be an important factor encouraging innovative activities by nations across the globe (valetina, sergey & sergey 2013). it is therefore imperative that transferring responsibilities and some of the economic functions of the state to the private sector as a rule will lead to a significant increase in social welfare. thus, governments sustaining a policy of economic freedom create an enabling environment for innovation which eventually leads to growth. according to the world ranking of economic freedom in 2013, south africa was ranked 74th in the overall list of 176 countries, whereas brazil, india, china and russia were ranked 96th, 123rd, 136th and 140th, respectively. however, all the brics members were below the average score2 except south africa (the global economy 2013). nevertheless, the indicators explained above refer to the narrow science and technology description of the nis and can be ambiguous as indications of the capacity of the broader nis to adjust to the post-industrial approach of innovation. the inconsistencies inherent in the broad capitalist approach of innovation, especially between growth and human development, are inevitable throughout the brics economies. this study had tried to bridge this gap by accounting for control variables in explaining the impact of the nis on growth. based on the literature reviewed, the nis basically consists of three segments: universities, governments and the businesses, with each segment interacting with the others, while at the same time playing their individual roles. figure 8 is a simple illustration of how these three key players come to form the nis. it is also important to note that the nis is a complex conglomerate of interacting independent parties that has to do with the ability to plan and integrate policies and institutions. figure 8: disaggregated components of the national innovation system. the universities play the role of undertaking basic science and technology research, and educate scientists and technologists needed by governments and business. governments in turn play the role of designing ipr systems for universities and businesses, commissioning science research, for example for defence purpose, subsidising business r&d and financing universities. businesses then play the role of conducting r&d to develop commercial products, launch innovative products and start up new firms to exploit new science. the study, therefore, estimates a set of major components of the nis which form an integral part of the three key players (business, university and government) with an enclosure of control variables that have potential in influencing economic growth. data and empirical model specification data source the study envisages the collection of consistent and reliable panel data spanning from 2000 to 2013 for the selected emerging economies, namely brazil, russian federation, india, china and south africa. the essential data set for the selected countries was sourced from the international financial statistics, world intellectual property organization statistics database and the world bank database 2014. the selection of the variables was however limited to data availability and the common characteristics of the economies involved in the present study. the panel data set was transformed to quarterly data from 2000q1 to 2013q4, owing to the availability of data so as to increase the sample size. the quarterly data were obtained through interpolation of the annual time series data using e-views version 7.2. this was done using the low frequency to high frequency method and the quadratic match average and quadratic match sum for each observation of the low frequency series. empirical model specification and estimation techniques following an endogenous growth framework, the study specifies a model that best captures the effect of nis on economic growth. given the growing empirical evidence supporting the positive effect of innovation on economic growth (ulku 2007; wu 2012), we control for other factors that influence long run growth and generalise the specification of a growth equation that accounts for the effects of the nis on economic growth. thus, in deriving our empirical model for estimating this relationship for brics, we posit that: the independent variables are defined as follows: ue = university enrolment rate for science and engineering students as a proxy for university rd = government research and development expenditure as a proxy for government tm = value of high-tech export as a proxy for business pt = total number of patents sp = scientific personnel sja = scientific and technical journal articles ef = economic freedom ԑ = error term βi = measures the relative effect of the nis on growth λi = set of parameters measuring the relative effect of the control variables. equation 1 is the basis of estimating the relationship between economic growth and our measure of the nis. the application of the pooled ols estimation will be appropriate if the unobserved country-specific effects, ɳi, are uncorrelated with the independent variables. in contrast, the pooled ols estimation will be unbiased and inefficient in a situation where a strong correlation exists between the unobserved individual effects, ɳi, and the independent variables. in such a scenario, the fixed effect model will be more appropriate in estimating the parameters of the model. in a situation where the assumptions of the standard random effect holds given that the model does not in fact contain unobserved effects, the pooled ols will not only be efficient but the associated statistics will also be asymptotically valid. the study employs an ar(2) test for serial correlation in verifying for the absence of unobserved effect. this test’s appropriateness is built on the assertion that the idiosyncratic errors are serially uncorrelated under the null h0: δ2ɳ = 0, when the independent variables are exogenous. using this approach in detecting serial correlation amongst the idiosyncratic errors implies the existence of unobserved effect. the point in using panel data in a good number of research applications is to allow for the unobserved effect, ɳi, to be randomly correlated with the set of independent variables, thereby necessitating the application of a fixed effect estimation procedure. the choice for employing either the fixed or random effect model estimation in the present study will be based on the outcome of the hausman test result. the value of the hausman test statistics will lead to either the acceptance or rejection of the null hypothesis. the null hypothesis will be rejected with a significant probability value of the hausman test statistic and leads to the conclusion of the presence of fixed effects. following the works of hulya ulku (2007) and yanrui wu (2012), the study in addendum uses a dynamic panel technique in addressing potential problems of endogeneity in the data adopting the procedures by arellano and bover (1995) and blundell and bond (1998). this kind of dynamic panel framework is developed by the application of first difference transformation depicted by the following equation: yi,t – yi,t-1 is real gdp per capita growth, xi,t denotes the set of independent variables including our measure of the nis, ɳi denotes the unobserved country-specific effect and ԑi,t denotes the error term. we continue by rewriting equation 2 as: transforming equation 3 into first difference yields: it is clearly shown in equation 4 that the lagged difference in gdp per capita is correlated with the error term, which by implication of the potential endogeneity of the independent variable x triggers the use of instrumental variables. in addressing this problem, the system difference estimator uses the lagged level of the independent variables as instruments in the assumption that the lagged levels of the independent variables are weakly exogenous and that the error term is serially uncorrelated. following the works of blundell and bond (1998), we employ two tests of specification. we first use the sargan test to verify for over-identification restriction to test the validity of the endogenous instruments. second, we test for second-order serial correlation of the error term to verify whether the error term in the differenced equation model follows a process of first order moving average. ethical consideration the authors have strived to honestly report methods, procedures, data and results. they have endeavoured to avoid bias in all aspects of the research where objectivity is expected or required. the authors have also honoured copyright and other forms of intellectual property rights, and they have given credits where due and properly acknowledged all contributions to the research. estimation results in investigating the possibility of non-stationarity in the data set, it is crucial to first determine the existence of unit roots in the data series. in the present study, we have employed levin, lin and chu (2002), im, pesaran and shin (2003), adf-fisher (dickey & fuller, 1979) and pp-fisher (phillips & perron 1988) panel unit root tests at first difference indicating that all the variables in the model are i(0). the results in table 2 clearly show that the null hypothesis of a panel unit root (non-stationarity) at the levels of the series can be rejected. table 2: unit root test results. as mentioned earlier in the methodology section, the study made use of the hausman specification test in choosing between the fixed effect and random effect model in our estimation. from the results of the hausman specification test presented in the lower section in table 3, the individual unobserved country-specific effects are uncorrelated with the explanatory variables, suggesting that the fixed effect model is preferable to the random effect model for the regression estimates. we therefore consider only the fixed effect estimate in the level analysis. however, we also estimated the random effect model for sensitivity purpose in order to make a meaningful comparison. we also used the arellano-bond approach of the gmm as it accounts for endogeneity problem3 in estimating the parameters of the dynamic panel model. the sargan test result shows validity in the instruments employed in correcting potential endogeneity in the data set used in estimating the dynamic panel model. finally, the residual of the dynamic panel model does not suffer from any serious problem of second-order serial correlation. since the relative effect of the explanatory variables on gdp per capita growth is accounted for from the dynamic panel model, interpretation of the relative effect will be based on the results from the dynamic panel model. table 3: panel estimation results. in the regression model shown in table 3, the adjusted r-squared value for the fixed effect model which has been selected against the random effect model for this analysis is 0.9268, which explains 92% variation in the growth rate of gdp in brazil, russia, india, china and south africa. the value of the f-statistics is 421.597, and its associated probability value is 0.000 which shows that the results are jointly statistically significant and the null hypothesis of the explanatory variables having no effect on growth in the five countries is rejected. furthermore, university enrolment rate of science and engineering students, government expenditure on r&d, high-tech market, patent and scientific and technical journal articles are statistically significant in the fixed effect model. the coefficients of these variables as a measure of the nis are positive and statistically significant at the 1% and 5% levels of significance which implies that the nis as a whole has a positive effect on economic growth in brics economies and in consequence spurs their economic growth. with regard to the relative effect which is explained by the dynamic panel model, the coefficients of university enrolment rate of science and engineering students, government expenditure on r&d, high-tech market and scientific personnel are also positive and statistically significant in explaining the growth rate of gdp in brics except for scientific and technical journal articles which show a negative impact in this model. the results as a whole have shown a positive impact of the nis on the economic growth of brics. for instance, the coefficient of the variable representing university enrolment of science and engineering students (ue) is positive and statistically significant at the 1% level of significance for both the fixed effect and dynamic panel model. therefore, university enrolment of science and engineering students has a significant positive effect on economic growth which means, by implication from the dynamic panel model, enhancing university enrolment of science and engineering students by 10% will spur economic growth by approximately 0.11%. similarly, the coefficient of the variable representing government expenditure on r&d is positive and highly statistically significant in both the fixed effect and dynamic panel model which means, by implication from the dynamic panel model, increasing government r&d expenditure by 10% will induce economic growth by approximately. 0.13%. this finding is in conformity with theories and in line with findings by hulya ulku (2007) and yanrui wu (2012) that there is positive relationship between r&d expenditure and economic growth and that increase in r&d expenditure will eventually induce economic growth. the coefficient of high-tech market is also positive and statistically significant at the 1% level of significance for both the fixed effect and dynamic panel model estimates. from the relative effect by the dynamic panel model, enhancing high-tech market development by 10% will promote economic growth by approximately 0.15%. unlike the panel dynamic model, the coefficient of the variable representing patent is positive and statistically significant at the 1% level of significance in the fixed effect model. this implies that an increase in the number of patents by 10% will induce economic growth by approximately 0.02%. also, the coefficient of scientific personnel is positive and significant only in the dynamic panel model. this implies that augmenting the number of scientific personnel by 10% promotes economic growth by a margin of 0.09%. finally, the relationship between scientific and technical journal articles and economic growth is positive and statistically significant in the fixed effect model estimate. this implies that encouraging scientific journal publication is as well very important in boosting economic growth in brics economies. however, economic freedom was not found to be statistically significant for the study, which means that economic freedom is not contributing significantly towards growth amongst brics member countries. this can be attributed to the fact that, unlike for south africa, brics countries are below the average economic freedom score of countries as reported by the global economy in 2013. it can also be the case that most of the brics countries, especially china, have a strong government with a lower level of degree of freedom, but the high-tech export is high and the nis is efficient. it means that authoritative government could make the nis more effective than countries who have free market economy. robustness check for panel regression estimates in order to ascertain the relative stability of our regression estimates, we carry out robustness checks by introducing new explanatory variable openness. imports plus exports scaled up by gdp are denoted as (open) in the base regressions. the exercise entails comparing the new parameters obtained by introducing a new explanatory variable in the new model to the original estimates of the base regression. the idea is to check if the parameter estimates from the new regression do not change much in terms of the signs and level of significance from those of the base regression; we therefore consider the estimates from the base regression as robust. the results of the robustness checks with the new instrument (open) are reported in table 4. the results from the robustness checks reveal that the coefficients of all the variables in our base regressions fail to vary significantly from those of the new estimates, therefore implying that the parameter estimates from our panel regressions are robust. this confirms the appropriateness of the estimations techniques and that the model has been well specified. the r-squared values (coefficient of determination) reasonably explained the proportion by which the regression model is best fitted. table 4: robustness check of the panel data estimate. conclusion this study, which in essence aims at unearthing the relationship between the nis and economic growth in brics, employs an endogenous growth framework to better capture the impact of the nis on growth. consistent and reliable panel data spanning from 2000 to 2013 for the selected emerging economies were sourced from the international financial statistics, world intellectual property organization and the world bank database. the panel data set was then interpolated to increase the sample size so as to be able to draw conclusion out of it. a panel estimation approach was employed using hausman specification test in choosing between the fixed effect and the random effect model in our estimation. from the results of the hausman specification test, the individual, unobserved country-specific effects were found to be uncorrelated with the explanatory variables, which suggested the preference of the fixed effect over the random effect model. the sargan test result for over-identification restriction also shows validity in the instruments employed in correcting potential endogeneity in the data set used in estimating the dynamic panel model. findings from this study reveal that developing a nis in brics economies is exceptionally crucial in advancing a constructive approach for promoting sustainable growth in emerging economies. results from this study as a whole reveal that increasing the role played by universities, governments and businesses will eventually lead to an increase in economic growth. an important policy implication emerging from this study is that extra efforts are needed by emerging economies to promote the development of a nis so as to explore the potential growth-inducing effects of a well-functioning nis. consequently, findings from this study have offered some persuading indicators for brics economies to explore the development of a nis as a potential opportunity to speed up their economic growth. acknowledgements the authors acknowledge professor wei long, dean, school of economics, wuhan university of technology, for his brilliant research assistance, and all anonymous referees for their valuable comments and suggestions. this research was supported by the china national social science fund (no. 11azd081) and the china national natural science fund (no. 71203172). competing interests there is no competing interest. authors’ contributions mr. brima sesay is the first author and has focused mainly on the structure of the article and data analysis and interpretations. professor zhao yulin is the second author and has focused mainly on the literature review, identified gaps in the literature and provided guidance on the selection of the variables. associate professor fang wang assisted in reviewing the manuscript and made adjustments on it. references aghion, p. & howitt, p., 1998, endogenous growth theory, the mit press, cambridge, ma. arellano, m. & bond, s., 1991, ‘some tests of specification for panel data: monte carlo evidence and an application to employment equations’, the review of economic studies 58(2), 277–297. https://doi.org/10.2307/2297968 arellano, m. & bover, o., 1995, ‘another 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of western australia, discussion paper 10.10, viewed 03 jan. 2016, from https://timedotcom.files.wordpress.com/2015/04/10-10_innovation_and_economic_growth_in_china.pdf zachariadis, m., 2003, ‘r&d, innovation, and technological progress: a test of the schumpeterian framework without scale effects’, canadian journal of economics 36(3), 566–686. https://doi.org/10.1111/1540-5982.t01-2-00003 appendix 1 figure 1-a1: intellectual property filings and economic growth for (a) brazil, (b) russia, (c) india, (d) china and (e) south africa footnotes 1. trips is an agreement formulated in 1994 in an attempt to bridge the gaps in the way and manner ipr are protected around the globe. for more detailed analysis, see dutta and sharmat (2008:2). 2. the average economic freedom overall index for 2013 was 59.78 index points. the overall index of economic freedom has 10 elements clustered into four broad categories: rule of law, limited government, regulatory efficiency and open markets. http://www.theglobaleconomy.com/rankings/economic_freedom/ 3. the gmm yields consistent estimators provided that the data do not have ar(2) and the regressors are not correlated with the error term. the results of the ar(2) test and the sargan test (which tests the correlation between regressors and the error term) are reported at the end of the gmm estimation results. for more technical details of this estimation, see arellano and bond (1991), and arellano-bond linear gmm estimator in the reference book of stata 8. about the author(s) zhixiang zhou school of economics, hefei university of technology, china nelson amowine school of business, hohai university, china dechun huang department of economics and international trade school of business, hohai university, china citation zhou, z., amowine, n. & huang, d., 2018, ‘corrigendum: quantitative efficiency assessment based on the dynamic slack-based network data envelopment analysis for commercial banks in ghana’, south african journal of economic and management sciences 21(1), a2689. https://doi.org/10.4102/sajems.v21i1.2689 note: doi of original article: https://doi.org/10.4102/sajems.v21i1.1717 corrigendum corrigendum: quantitative efficiency assessment based on the dynamic slack-based network data envelopment analysis for commercial banks in ghana zhixiang zhou, nelson amowine, dechun huang published: 10 dec. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. in the initial published version of this article, nelson amowine’s affiliation was incorrectly displayed. his correct affiliation is the school of business, hohai university, china. the error has been corrected in the pdf version of the article. the author apologises for any inconvenience that this omission may have caused. 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potential evaluation criteria for post-mortem analysis of a business rescue event? conclusions and industry implications acknowledgements references about the author(s) marius pretorius department of business management, university of pretoria, south africa citation pretorius, m., 2018, ‘business rescue decision-making: post-mortem evaluation of an “orgy”’, south african journal of economic and management sciences 21(1), a1622. https://doi.org/10.4102/sajems.v21i1.1622 original research business rescue decision-making: post-mortem evaluation of an ‘orgy’ marius pretorius received: 17 june 2017; accepted: 12 dec. 2017; published: 11 apr. 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: sensemaking of the extreme vagaries and external considerations that influence decision-making and judgement during business rescue events (bres) are currently sparse but details about evaluation criteria are desperately needed. aim: learning from and applying post-mortem analysis (pma) is investigated to propose an evaluation framework. setting: following the problems by and expectations of the regulator to ‘govern’ the business rescue (br) industry, a recent decision to decentralise the accreditation of business rescue practitioners (brps) changed the landscape significantly. methods: from literature and interviews, the study identified seven interactive evaluation criteria from pma thinking to be included in a conceptual framework. results: following the determination of the contextual difficulty evaluation, the measurement criteria included: taking management control, initial feasibility judgement, viability analysis, decision-making, brp competencies, the rescue plan and compliance within the supreme task. one mediating factor, namely the brp dominated. secondly, the evaluation process can be costly to ensure validity of the data, collection and evaluators. finally, bre evaluators (executors/decision makers) require a high level understanding of contextual issues that may disproportionately influence an evaluation. expert and master level competencies are required to inform the proper judgement of the evaluation criteria and variables. conclusion: the study addresses educators’ need for a framework for pma to guide the teaching of brp competencies, direct the regulatory authorities (and professional bodies) accreditation framework for licensing brps, inform banks as creditors to enhance their information systems, advise upcoming brps on outcomes while courts may consider the framework as useful for judging issues. introduction paradox in business rescue is endemic. no better understanding is required than king’s (1975) quotation of arnold’s (1943) statement about the feasibility of corporate reorganisation when he postulated: the ritual of corporate reorganization … is perhaps the most interesting of all our legal rituals from a ceremonial point of view, because it is the most complicated mystery of all. … [it] is a combination of a municipal election, a historical pageant, an antivice crusade, a graduate-school seminar, a judicial proceeding, and a series of horse trades, all rolled into one – thoroughly buttered with learning and frosted with distinguished names. here the union of law and economics is celebrated by one of the wildest ideological orgies in intellectual history. men work all night preparing endless documents in answer to other endless documents, which other men read in order to make solemn arguments. at the same time practical politicians utilize every resource of patronage, demagoguery, arid coercion beneath the solemn smoke screen. although to the casual observer the complications seem most forbidding, actually the dialectic of this process is very simple. it consists in the endless repetition in different forms of the notion that men must pay their debts, in a situation in which neither men nor debts in any real sense are involved. (p. 304) from this insight using the orgy as metaphor, one can derive several obvious paradoxes, namely the ‘complicated mystery’ of an orgy versus the ‘very simple process’ it uses, the rituals that exist for a long time and are probably followed without sufficient questioning versus the uncertainty (smoke screen) and crisis events where law and economics intersect and, finally, the role focuses on those involved. indeed, paradox is the rule, not the exception to make sense of by decision-makers in a business rescue event (bre). the views that are taken within these bre circumstances depend on who the observer is, suggesting that such an ‘orgy’ may be perceived as simple, complicated, complex or even chaotic (kurtz & snowden 2003) and influenced by its unique specifics. turnarounds, rescues and the involved professionals are judged continuously, especially when affected parties to a bre feel aggrieved. when one must make sense of a business rescue (br) and potentially judge the success thereof, there is little replacement for experience and a contributor to the sensemaking process. chapter 6 of the 2008 south african companies act provides for the business rescue practitioner (brp) to file substantial implementation as a ‘measure’ to judge successful execution of the rescue plan – unfortunately, substantial implementation is ill defined as to what exactly such a measure consists of. br portal (2013) reported the reputation of business rescue as clouded in vagueness and the role of the brps as a critical scenario driver for the rescue industry. evaluating the outcome of a rescue for a distressed venture (firm or organisation) has become an immensely important process because of the potential consequences that the re-appointment of a brp may have for future creditors, shareholders and affected persons considering br. baird and lorence (2012:21) postulate that within the turnaround industry there are currently no broadly accepted tools, systems or processes to predict the success of turnarounds. similarly, for the evaluation of bre, the questions that arise are: ‘what evaluation criteria should be included when executing a post-mortem (pm) evaluation of a bre that can guide the regulator and professional bodies concerning the accreditation of the brp profession?’ and ‘what are the variables that would constitute each indicator to support the evaluation process?’ the intertwined nature of these questions calls for a framework to enhance business rescue evaluation in line with trahms, ndofor and sirmon’s (2013) call for further research in this field. at present, there remains inadequate regulation (bradstreet 2010) and the proposed selection guidelines for brps remain a bone of contention for the regulator, as well as directors of distressed businesses who want to appoint them. it appears that the number of removal and replacement attempts (section 139) support that all is not well for the ‘success’ perspective in the industry. at the same time, brps are reported as both successful in some of their cases (reported by themselves and their website claims) while simultaneously complaints circulate about their ‘colossal’ failures in others as reported by creditors, directors who appointed them as well as court judgements. on enquiry, brps then easily blame some or other technical aspect for the ‘failed bre’. such excuses range from non-existence of reasonable prospect from the start to abuse of the business rescue process by directors to absence of willing post-commencement finance (pcf) providers and several other reasons. within the industry and chapter 6 of the act, there is no meaningful evaluation system for business rescues, which is the problem that this article addresses. anticipating the role of evaluation on their reputations, the ‘better’ practitioners have begun recording the number of ‘refusals when asked to act as a brp for a specific rescue’, as well as the number of times they are approached to ‘replace an already appointed brp’ in an existing bre. removals are court processes mostly driven by creditors who are unhappy with the appointed brp. these refusal figures are used by brps to promote their number of successes and market their services. despite the trustworthiness of such numbers being questionable, they support the lack of measures to describe the success of br. pretorius (2015) reported the success rate as 9.4% in a report on the industry after 3.5 years (inception may 2011) of implementation of chapter 6. he warns, however, that the figure must be contextualised, while he believes that it might be closer to 5% partly because of the twin definitions of the purpose of br as described in section 129(3). business rescue practitioners (including turnaround managers) face complex assignments with unclear measurements in practice. each rescue has unique circumstances which make these judgements subject to the perception of ‘whoever is asked’, be it the brp, creditor, directors, legal advisor or other affected persons (elliot, pers. comm., 2015). also, no formal scientific research to support the descriptors by the act for this ‘new phenomenon’ exists to guide the companies and intellectual property commission (cipc), the appointed regulator. while there is a need to advise distressed businesses that want to file for rescue, as well as future applicants who want to be certified, on the competence requirements for certification of brps, two obvious stakeholders are foremost in driving the need for an evaluation framework. firstly, educators would welcome evaluation methods, as currently these are unclear. teaching of standard business management measurements is insufficient, as businesses in distress face more complex circumstances, which midanek (2002:24) refers to as having ‘war zone’ circumstances. yet the particular processes to apply remain elusive. secondly, the professional bodies whose members embark on the brp profession urgently require monitoring frameworks to govern their processes. finally, banks as the largest creditors can benefit from the feedback to reduce their future risks. this article builds on four key activities describing the tasks for brps (section 141) to execute during rescue, and takes cognisance of a fifth ‘supreme task’ identified by pretorius (2013) and the associated competencies required (pretorius 2014) for navigating a business rescue by a brp. the paper then expands and builds on the directives of conradie and lamprecht (2015) for the measurement of rescue success to establish an evaluation framework and propose the considerations for a bre evaluation through pm analysis. this article briefly summarises the relevant aspects of chapter 6 of the act and its prescriptions and requirements as boundary conditions. secondly, it reports briefly on the relevant key principles of pm analysis (or review) and critical incident technique (cit) with their specific contributions as cornerstones of the research, namely finding the main measurement criteria of success and substantial implementation. it then presents the methodology of this research to use existing theory in guiding practical application. fourthly, it reports the findings and, finally, proposes a conceptual evaluation framework. the proposed framework describes the evaluation criteria and contextual considerations underlying the evaluation framework to be executed after a bre. the resulting framework could be used to direct the industry and to trigger debate about both rescue and brp competence measurement, based on its findings. research question at this point, the regulator has no distinct guidelines other than the vague disqualifications from the act (section 138) for brp appointments and none for the evaluation of substantial implementation and success of a bre. at the same time, the act suffers from vagueness and courts depend on previous and earlier judgements to establish direction. this aspect is important, as the rescue industry is just about 7 years old, following the legislation since chapter 6 of act 71 of 2008, as amended, which came into effect on 1 may 2011. the cipc, as regulator of the rescue industry, has recently decided to abolish the ad hoc licensing approach in favour of pre-screening with professional bodies that take responsibility (vetting) for their member qualifications and accreditation framework. a proposed evaluation framework is the design outcome of this article. the research question is thus: what are the evaluation criteria (and their associated variables) to be considered during post-mortem analysis of a business rescue event? the research objectives are to design and propose a conceptual evaluation framework, firstly by drawing from literature and informing it by inteviews. secondly, the potential criteria and their variables are expounded. after that, weight allocation is addressed to inform the framework. finally, the proposed variables are then rated to demonstrate the working of the framework. answering these questions then allows for proposing an analysis and evaluation framework to guide decision-making when executing such a post-mortem evaluation of a bre. background to rescue and rescue practitioners as this article aims to add and apply theory, this section briefly summarises the context of business rescue for the reader and expounds substantial implementation based on post-mortem analysis (pma) and how the research gives direction to constructing an evaluation framework for evaluation bres. summarised essential process of business rescue and its evaluation in south africa without fully expanding on the technical aspects of br in detail, this section highlights the process and issues of br relevant to this article in a narrative form. a brp is appointed through a voluntary or court process to rescue a distressed firm. after basic investigation, the brp obtains support (or informs) at the first creditors’ meeting that he will pursue the rescue based on his reasonable prospect perception and judgement. the brp can do so for either reorganisation or better return than an immediate liquidation (bril) as objectives prescribed in the act. he then compiles a rescue plan on which the creditors must vote at the second creditors’ meeting. if supported, especially by pcf providers, the brp must then implement the plan until substantial implementation (section 152(8)) has been achieved or, alternatively, terminate the rescue (section 141(2)bii). often various and unplanned ‘incidents’ may happen during the process, which may alter the conditions or derail the planned rescue. rescues may then result in incapacitating court battles, failed rescues for multiple reasons and often eventual liquidation after amassing significant costs to company and losses to the creditors. affected parties then, in retrospect, blame various aspects that the brp did not ‘execute correctly’, depending on the ‘stakes’ they held in the firm that determined their perceptions. during the process, information asymmetry and data integrity underscores the variety (often opposing) of the perceptions. elliot (2015) suggests that the success of a recue depends wholly on ‘who you ask’, confirming the non-factual nature of ‘success’ in br. the number of variables in a distressed venture associated with the turnaround situation or event are many. these may even multiply during the rescue, making it difficult to ‘pinpoint’ a single measure when the bre is evaluated. there are multiple stages at which such bre judgements are required, however, substantial implementation or termination of the rescue being the most important infliction points. this then requires retrospective judgement. pma, well used in project evaluation, lends itself to this type of evaluation. next, the principles of pma and cit are explored to determine their relevance and usefulness to the bre evaluation. changes in licensing requirements from the act for business rescue practitioner appointment from the onset, brp licensing has rested on section 138(1), prescribing requirements such as: member in good standing of a legal, accounting or business management profession. not subject to an order of probation. would not be disqualified from acting as a director of the company. does not have any other relationship with the company. no mention was made of the specific knowledge, skills, ability or competency requirements except for those implied in the licensing requirements. these are left to the interpretation of the regulator. until recently, these brp licenses were conditionally awarded for a specific rescue project after being nominated by the relevant distressed company. licenses were allocated on the basis of relevant experience and appropriate references (track record), together with some exclusion provisos to the granting of the once-off license. no prescribed system or set of absolute prerequisites were established for licensing practitioners. the regulator has, to date, reported several problems that gave rise to the alternative licensing system now pursued. evaluation of brp track records has now become highly relevant. following these problems by and expectations of the regulator to ‘govern’ the business rescue industry, a recent decision to let professional bodies take responsibility for the accreditation of their members as brps changed the landscape significantly. simultaneous to this process, the minister of trade and industry has informed the regulator that the ‘implementation and monitoring the effectiveness of business rescue’ has been identified as a key policy from 2016/2017 onwards by his office (davies 2016). this study, therefore, aims partly to provide directives for a bre analysis framework, firstly to guide future licensing through better understanding of the exact measurements required for the work that brps perform and, secondly, to address accreditation requirements and guidelines as a part of monitoring business rescue. evaluation guidelines by the act are vague. competency requirements are guided by understanding why brps may be disqualified, namely in cases of incompetence or failure to perform the duties of a business rescue practitioner of the particular company. section 139(2) describes incompetence as the ‘failure to exercise the proper degree of care in the performance of the practitioner’s functions; engaging in illegal acts or conduct; if the practitioner no longer satisfies the requirements.’ other guidelines which are difficult to measure are set out in section 138(1) under the disqualifying variables of: … conflict of interest or lack of independence … or if the practitioner is incapacitated and unable to perform the functions of that office, and is unlikely to regain that capacity within a reasonable time. here, brp competency is implied through delineating incompetency conditions but without specific details about the competency required. no associated guidelines exist for substantial implementation of a rescue plan. tasks and competencies of business rescue practitioners section 141 of the act prescribes what brps must do on taking control of the business, investigating the affairs thereof, compiling a rescue plan and implementing it if approved. pretorius (2013) claims a fifth task namely the ‘supreme task’ to comply with the legal process requirements. he thereafter describes the competencies that brps require to include analysing, sensemaking and integration through collaboration competencies (pretorius 2014) in order to navigate a business rescue. several court judgements now support the importance of these competency requirements as evidence. many allegations exist in the industry about the absence of these skills. success in business rescue conradie and lamprecht (2015) ventured into the evaluation of success in business rescue. they compared evaluation criteria used in four international bankruptcy regimes (usa, canada, australia and uk) that can serve as key indicators towards br evaluation. they further suggested the consideration of short-term and longer-term success evaluations. to be considered as successful, their identified goals included that the company must emerge as a going concern and remain economically viable; if not, bril should be achieved and finally protection of all stakeholders should be achieved. for these goals, they reported 10 evaluation criteria (based on international regimes), namely five business-related goals (number of entities saved, return to economic viability, comparative return, approved br plan and key operations remaining) and five that are financial ratio comparisons (restored liquidity, restructured debt, restored profitability, change in asset size and comparative share portfolios). given the status of data integrity and information asymmetry reported in the br industry, it is doubtful whether these evaluation criteria are at all useful for any other than public companies registered on the stock exchange. their study reiterated the absence of clear, objective and applicable measures for generic determination of a business rescue success and they call for the ‘development of a scorecard or matrix to give proper weight to the different criteria’ (p. 25). research on the status of the br industry (pretorius 2015) commissioned by the regulator after the first 3.5 years of the regime, reported a 9.4% success rate. at the same time, it reports a general misunderstanding of what success means in br. the fact that pursuing a bril is also considered as success often clouds the perceptions (pretorius 2015:5) of what normally is associated with a reorganisation of a distressed business. what the report does expound is the complexity of the variables that are associated with success, namely the creditor’s vote and its dependence on the rescue plan, the role of the brp within the process, the impact of the reasonable prospect judgement for creditor support and new investment (pcf) and, finally, the need for general education for brps, affected persons and the public alike. why post-mortem as a technique the value of pm processes will not be argued; rather its principles and reasons for use will be investigated. fischhoff (1980) already postulated that we do retrospective analysis to answer three basic questions: firstly, are there patterns upon which we can capitalise so as to make ourselves wiser in the future? secondly, are there instances of folly in which we can identify mistakes to avoid? and, finally, are we really condemned to repeat the past if we do not study it? that is, do we really learn anything by looking backwards? to evaluate a bre meaningfully, retrospective analysis after implementation of the br plan is proposed for use in this study. also, when termination of a br is filed after a long attempted rescue, the pm analysis becomes crucial to establish improved sensemaking of possible wrongdoing. within the project management body of knowledge, the concept of pm analysis has been well established for many years. pma has several variants suggesting minor alterations during application to adjust to different contexts (myllyaho et al. 2004). pma is also known as pm review. the benefits of pma relevant for bres are reported to include: it helps project teams to better understand different perspectives; it identifies hidden problems; it documents good practices and problems. pma takes aim at those areas with maximum potential for improvement (collier, demarco & feary 1996:66), thus purporting a positive slant on the retrospective view of an event. underlying it all appears to be the goal of learning based on the event because the consequences only become clear afterwards. edvardsson and roos (2001) critically evaluated related techniques associated with pma referred to as critical incident technique (cit). the principles of both also have value although it has not been applied in business rescue, which is one discrete incident containing many sub-processes and elements. what is relevant for br is that applying cit allows for the making of judgements by subjects about the patterns and consequences of a particular incident. underlying all the techniques is the principle of retrospective judgement based on the experiences of the subjects interviewed. this appears to have great value for business rescue and the proposed framework for sense-making. bjornson, wang and arisholm (2008) add a more in-depth pma technique to understand the root cause of project problems. while the root cause is not the aim of pma in general, for this article it is important to understand the connection to more in-depth analysis that may follow the standard pma. based on the above techniques, this study responds to the need for research to conceptualise the measurement criteria required during the process of evaluating a business rescue and, simultaneously, to point out the key concepts associated with the required evaluation criteria. this research proposes a conceptual organising framework for the pma of a bre. methodology the research aims to propose a bre pma framework leaning firstly on the pm literature and, secondly, on the measurement criteria obtained from brps who must evaluate their peers during pma. finally the method was applied to two random rescues to seek credibility and observe its potential practical limitations. it therefore involves description, understanding but mainly sensemaking and interpretation supplied by the subjects. research design table 1 summarises the research design and is followed by a detailed description of the design elements. table 1: research design of this study. in attempting to answer the research question, the researcher was aware of his own beliefs, experiences, philosophical assumptions and methodological values. these assumptions could influence how the research was conducted and are stated in order to understand the ‘intellectual climate’ in which the research was conducted. the theory of knowledge (epistemology) of the researcher describes how one can discover underlying principles about social phenomena and how one can demonstrate knowledge. the researcher’s personal experience with business failure ignited his interest in business rescue. at the same time, as an academic and experienced turnaround consultant, he has a preference for factual directives. to mitigate these potential biases and subjectivity, a structured data-gathering method through interviews was used to capture the activities and experiences of the subjects during their evaluations. thus, the research was interpretative and thus the researcher’s sensitivity towards his potential positivist biases. an ontological position comprises the researcher’s view on the very nature and essence of the research reality. the researcher, as an objective practicalist, believes that knowledge comes from facts associated with real-life cases and their context. if the researcher found repeated mentions of practices and praxis, he could generalise from them. at the same time he acknowledges the importance of the subjects and their views based on their practical experiences. his interest was mainly to identify directives to establish a tool to assist accreditation. the interview setting, process and sample as the researcher knows many rescue practitioners and often interacts with them, both individually and collectively, access to subjects was easily achieved. he perceived every interaction with brps as a research opportunity as it allows informal personal narratives to appear. the nature of the context lent itself to unstructured interviews. brps were asked two main questions whereupon informal probing took place. this turned into a ‘dialectic conversation’ as the subjects were challenged as if by a ‘devil’s advocate’. the primary ‘trigger’ questions were: how should one evaluate a rescue to judge its success or not? subjects would give pointers leading to a dialectic conversation and thereafter were challenged on their statements. how should one go about a peer evaluation of a brp? inadvertently, specific ‘other’ brps were named while subjects explained their ‘wrongdoings’ – many insights were gained through this question. unfortunately, this depended entirely on the extreme level of trust between researcher and subject and no recording of the interviews was agreed upon. for the subjects it was an opportunity to reflect on and progressively enrich their own thinking about the evaluation of their own work. the process of data collection thus constituted an opportunity for the subjects to expand their possibility of acting in the world, not only to draw on their experiences but also to draw on their creativity. a purposive sampling strategy was used. brps who had been licensed as senior brps several times before were selected for participation. the sample was limited to senior brps as it is believed that they could contribute most based on their 10-year minimum experience requirement. saturation was observed after eight interviews. however the interviews were continued (and are still ongoing) beyond 12 as there was always the possibility of discovering unique variables. finally there were 16 interviews considered. data collection procedures firstly, the literature on pma and cit relating to evaluation prescriptions was studied to guide indicator development for the bre evaluation. secondly, an interview process was applied to senior brps during personal interactions with the researcher to collect primary data. the ultimate output of the full study was to create a practical evaluation framework based on subject feedback but interpreted by the researcher. the approach was one associated with an evaluation format completed by the researcher. the boundaries between the subjects and their rescues were not clear, as they had had direct involvement with their own experiences (rescues performed). this meant that the researcher could pursue different angles of evidence to seek convergence and divergence. in addition, because their experiences were recent, there was sufficient access to short-term memory and associated learning from their practical experience. being a small industry, all were knowledgeable about the facts and aware of the rumours circulating about one another. subjects participated voluntarily. it was found that they were relaxed during interviews as there was a trust relationship, as shown by their open responses and even bantering about rescue. it is believed that these positive conditions led to biased (wanted) sharing and meaningful contributions drawn from the prompting. strategies for ensuring quality data and interpretation while there was only one source of evidence (brps), the researcher also sought confirmation by ‘sensemaking discussion’ with peer academics (legal, financial and business), as well as bank representatives. these discussions assisted firstly in ‘outsider checking’ as well as identifying leads and probes to use during interviews. as the focus was exploratory (asking ‘what’) and explanatory (asking ‘how’), the process elicited the perceptions of the subjects, thus improving internal validity (yin 2003:34). brps wrote their own responses. as there was only one researcher, he depended on several readings of the notes taken. on the basis of his experience in rescue and his extensive preparation, variables and evaluation criteria were identified iteratively and eventually meaningful indicator categories could be constructed. once categories were obtained, each was populated in an iterative process with variables to balance the number of variables per indicator, with the aim of developing a balanced instrument (questionnaire). this led to the developed evaluation criteria being challenged and occasionally reallocation of variables took place during iterations, until balance was achieved. finally, when a variable could support more than one evaluation criterion, the researcher allocated it to the appropriately judged category, based on the most ‘useful’ association with the criterion. data analysis although there was only one key source of evidence (the subjects’ contributions), the researcher used grounded theory principles to develop themes that became the eventual evaluation criteria (corbin & strauss 1990; henning 2011:138). to extract as much richness as possible, the framework depended on the researcher’s sensemaking when interpreting the subject contributions. notes on the researcher’s insights gained during the interviews were the main source of data. the research style was exploratory, to identify and describe the evaluation criteria for measurement (directed by first-order variables) and how they can be applied in the execution process of the evaluation. eventually, after understanding how variables related to the bre evaluation process, the subjects proposed sources of data, as well as verification of the information from the rescue plan. on the basis of the overall insights gained, the researcher conceptualised and proposed a pma framework for discussion. findings firstly, bre evaluation requires decisions starting with an assessment about the complexity of the specific rescue context as all rescues differ in several aspects (see table 2), namely: (1) the nature of the turnaround situation faced, such as underperformance, strategic distress, distress while performing well or crisis as described by pretorius (2008). secondly, (2) the severity associated with the decline of the specific bre with its associated difficulty to turn around should be considered. this is influenced by (3) multiplicity which describes the complexity of the organisational structures as far as divisions, branches, industry types and product ranges are concerned. if (4) extraordinary events (once-off) such as key customer failure, contract withdrawals or deliberate legal action against the firm triggered the bre, they may complicate difficulty and severity. under conditions where (5) shareholder disagreement exists or where they are blamed for ‘abuse’ or suspect objectives, complexity increases. this is often associated with (6) lack of data integrity (pretorius & hotzhauzen 2008) which may be a deliberate ploy by filing management. when a brp is forced to use forensic audit processes to trace funds and confirm transactions, it increases complexity. finally, there are (7) extenuating factors such as tax structuring associated with fraud that may add to the overall complexity judgement for a bre. table 2: evaluating the complexity of the rescue context for the specific event under investigation, where variables were rated on a 5-point likert scale (with 1 = very easy and 5 = very tough or difficult). it is contextually critical that evaluators must be clear that individual bres vary significantly and variables may (or may not) feature at various levels depending on the specific context of the bre. thus, based on the above, there may be overlaps between some variables visible, for example where severity and the nature of the turnaround situation are associated variables. this is addressed by weight allocations and expanded in the discussion. the weightings shown in table 2 therefore vary for each bre subject as to their appropriateness. in-depth knowledge of the specific bre is therefore paramount and may eliminate the novice evaluator. similar to decision-making models used in strategy evaluations, the weighting in a specific category should add up to total of 1.0 allowing the evaluator some freedom in prioritising the variables. this is also expanded after the criteria are explained. while reporting the rest of the findings, quotation marks are used to show direct responses from the subjects. it seemed that the variables of this study showed similarity in nature to those identified as indicators by conradie and lamprecht (2015:20). the findings further pointed towards seven evaluation criteria each with variables of relevance to the evaluation of a bre. table 3 is presented at this early juncture to visually enhance the categorisations and report the variables within each indicator that can contribute to the evaluation. it also shows potential weight contributions of variables to be considered and suggests the potential sources of the data and the metric that might be useful for each variable. for example, one subject stated that ‘if you suspect abuse, you focus more on financial control than management control’; therefore, the weightings for that specific bre will change from one event to the next. this weight allocation is therefore a key principle in the proposed process. table 3: evaluation criteria and variables in the proposed evaluation framework for business rescue events. the variables associated with each criterion are discussed individually later in the article. each evaluation criterion is now explored briefly in search of the relationships with variable factors within. evaluation criteria are reported in operational sequence rather than apparent importance or contribution. following the proposed evaluation criteria is a discussion of variables relevant to the categories in table 3. table 3 is presented at this early juncture to guide the discussion of the evaluation criteria. table 3 further shows a rating for each variable resulting in the data point within figure 1. figure 1: outcome example for the post-mortem analysis of a business rescue event. evaluation criterion 1 – taking control and execution of the business rescue event by the business rescue practitioner taking management control of the bre by the brp appears to be of the utmost importance and relates to the first task prescribed within section 140 of the act, as well as reported by pretorius (2013) for brp tasks. taking control is when the brp becomes the main decision-maker (whether autocratic or democratic) in the rescue. one subject suggested that ‘it’s maybe less important to take control – it’s more about taking control away from existing management as they created the problem’. this management control incorporates the following variables: (1) managerial (including the board) control, (2) financial control and (3) employee control and support with (4) clarification of roles of all affected parties, especially existing management. management control also depends on (5) communication and meeting with affected parties while sharing the (6) implementation steps and, finally, (7) control of the change management process. it is obvious that these are all associated with the brp tasks and responsibilities. evaluation criterion 2 – feasibility analysis feasibility as a concept is typically associated with start-up projects and business but also acknowledged as a test in bankruptcy proceeding (baldiga 1996). feasibility basically investigates whether the ingredients exist for a project to be successful and what king (1975:303) refers to as ‘workable’ where workable suggests that the value of these components (ingredients) combined meaningfully is more than the sum of the individual production factors (assets) in liquidation. this is a prerequisite for the first creditors’ meeting and better known as the existence of ‘reasonable prospect’ as described in section 129(1)b of the act. gottfredson, schaubert and hirzel (2008:29) further equate this feasibility analysis to ‘determining the point of arrival’ compared to a viability analysis as ‘determining the point of departure’ in the turnaround process. the variables required for a feasible business model should therefore exist if these are combined appropriately when a profitable future venture could ensue. typically these variables should include (1) feasibility of demand, capacity (resources, process and assets) to generate an economic or business (profitable) model and the ability for cash generation. feasibility depends largely on the (2) identification of the turnaround situation which requires clarity on the (3) causality of the current distress (sections 129(1)b and 152(1)b). it appears that the (4) operating mindset (brp’s belief around existence of current operations and maintaining it) and feasibility are important requirements. how the brp responded to the (5) contextual difficulty (matching turnaround strategy to the problem) is critical and a (6) basic analysis (section 150[c]) of the bre at this point is required. finally, cognisance of any (7) caveats (fatal flaws or constraints) determines how well the feasibility was calculated. practitioners must judge whether they have a business to save (corpse vs potential life metaphor). frequently, feasibility judgement depends on perceptions, insights, experience and the intuition of the practitioner, founded on the initial information as gathered before the first creditors’ meeting. one subject explained it as follows: ‘at the first creditors’ meeting, the emotions and blame fly high – all they want to know is if there is a prospect of getting their money back’. the brps report this to creditors if they believe there is a reasonable prospect of creating a rescue plan to do so. often, at this early stage, feasibility judgements suffer from the liability of data integrity phenomenon (pretorius & holtzhauzen 2008) and asymmetry of information (pretorius 2016), which is the motive behind the viability analysis where verification is done. once feasibility is determined and agreed upon by the creditors, the brp proceeds to the next indicator, namely viability analysis (due diligence). evaluation criterion 3 – viability analysis viability analysis (often synonymous with due diligence) typically seeks an intensive review and verification of all aspects of the bre and its context to (1) overcome the data integrity liability. comparisons are made with (2) liquidation benchmarks (section 150[2]aiii of the act) followed by proper verifications of (3) cash status, the (4) balance sheet status (solvency), (5) a pre-filing investigation of the firm’s management and finance, (6) the bank’s role and involvement with management. the execution of (7) forensic reports and the requirement to do so completes the viability analysis and satisfies this part of the post-mortem. most relevant to the viability question is that the information needed to answer it must be incorporated into the rescue plan to be presented at the second creditors’ meeting to assist decision-making for voting (section 150[2]). midanek (2002:23) linked it to a ‘glass assessment’ – transparency for creditors and affected parties. this is supported by kieurlff and peterson (2009:45), who advanced that understanding of the financials, cash flow and verification of data (data integrity) are key turnaround management practices. viability analysis follows feasibility closely through verification of assumptions made during feasibility analysis under the task of ‘investigating the affairs’ (section 141). evaluation criterion 4 – business decision-making decision-making is what bres depend on as shown by king’s quotation in the introduction. to evaluate bre decision-making, there are key variables to consider, including (1) the decision to pursue br in the first place, which may be influenced by type i and type ii errors to pursue likely and unlikely rescues as described by argenti (1976). decisions to control (2) retrenchment of staff (always likely in retrenchment actions) need evaluation (schmitt & raisch 2013:1218). decision-making in the (3) daily operations is followed by the (4) choice (motive) for pursuing reorganisation versus bril as options. decisions taken regarding the (5) protection of demand, (6) responding to the so-called ‘5 to 12 issues’ (last-moment crises) that may have appeared and, finally, (7) blatant omissions and mistakes made during the bre complete the evaluation of decisions during the process. again the decision-making depends largely on the competencies of the brp as the core decision-maker. evaluation criterion 5 – business rescue practitioner competencies and skills much has been written and reported about the competencies of brps (mccann 2009). it remains ‘the’ bone of contention where brps are still widely criticised for incompetence. a banker confirmed several subjects who referred to ‘rogue brps in the industry’. therefore, the need that this study addresses includes the competency evaluation of the brp and the proposed alteration of the accreditation and appointment process. pretorius (2014) has previously elaborated on the specific competencies for brps. this study however proposes adding: (1) brp impartiality to the (2) sensemaking competency; how (3) ethical the governance pursued by the brp and the (4) skills match to the turnaround situation influence how the competencies are perceived (industry knowledge and experience). finally, a judgement on the (5) collaboration during the bre, the (6) use of advisors (legal, financial, forensic specialists) and how well (7) integration was achieved during implementation of the plan covers the key associated competencies. evaluation criterion 6 – the rescue plan preparing the rescue plan is a key task (sections 128[b]i and 150), which subjects suggested to be the ‘unique task’ of the brp and their main duty (loubser 2010a:105). in this research it appeared that the compilation of the rescue plan is a central variable of ‘everything rescue’. as one subject suggested, ‘show me the plan and i will show the competence of the brp’. evaluating the rescue plan requires judging whether the (1) basic variables were included (section 150), (2) all alternatives were investigated and the (3) ‘point of arrival’ is sufficiently described for meaningful (4) pcf decision-making (du preez 2012; pretorius & du preez 2013). next and crucially, the plan is judged for the (5) appropriate strategy (in response to the context, tas and causality). here, subjects pointed to certain brps who operate purely by debt restructuring over longer terms (in all their rescues) while they never fix the problems sustainably within the bre – a significant allegation. finally, it is important to know whether the (6) plan was voted for and, lastly, its (7) executability (it cannot be ‘pie in the sky’, as suggested by one subject). the rescue plan is also the main source of information for the pma (see table 2 and table 3) and should be sufficient for a large portion of the data barring the opinions of affected parties for confirmation and verification. evaluation criterion 7 – following protocols staying within the act is very important, as stated by a subject: ‘no matter what, move within the legal process – there is sufficient case law’. following protocols directly alludes to (1) compliance with the act (section 129) as far as (2) timelines, (3) compilation of a creditor claim system, obtaining (4) board disclosure statements and proper (5) record keeping (time sheets and costs). finally, (6) adherence to section 132(3) requirements of notifications and consideration of (7) cipc document submissions are useful for judging this indicator. several of the variables contained in the various evaluation criteria appeared to be associated with other evaluation criteria, as well as being interrelated (not statistically determined). the researcher judged the appropriate allocation based on his view of the most relevant category. discussion of findings, key theoretical components and insights from the study to enhance meaningful coverage of the findings, this section deliberates on important aspects of the findings as they may influence the evaluation, as well as direct theory formation. the findings are then elaborated on and explored for improved understanding of the proposed framework for post-mortem analysis of a bre. variable weights and contribution several variables are contained within each indicator but with different relevance and importance depending on the specificity of the bre. it is known that while there are generic principles across bres, every event has unique features and variable manifestations as already alluded to. in this proposed framework, the above is addressed by the allocation of weights (total = 100% per indicator) to the variables based on their relevance within the specific bre. for example, when evaluating context complexity, multiplicity may be irrelevant for many smaller rescues and therefore can be weighted at zero contribution so as not to force a judgement. other variables are then weighed at higher values. the benefit of this weighting lies in the flexibility it provides to the ‘evaluators’. data and information sources the liability of data integrity has been identified as a key to the meaningful analysis of a bre. the proposed framework suggests the application of various sources to verify information. the sources of information identified by the subjects are shown in both table 2 and table 3 but are not limited to those. experienced investigators can enhance these with additional tools and techniques. when testing the process in two different cases, it appeared that the brp and rescue plan are the primary sources of information. unfortunately the brp is also an indicator which made the information supplied subject to ‘self-serving bias’. therefore secondary and tertiary sources need to be incorporated for verification. a key source is the creditors’ committee which must involve the bank. this, however, will depend largely on the specific variable under discussion. interviews with various parties are suggested as sources of information. these are known to be time-consuming but the verification through data source triangulation is a known benefit especially where it is expected that biased responses – especially from the brp – are a natural occurrence. the evaluators will start with the plan, clarify through the brp interview and then confirm through interviews with the bank, creditors, employees, shareholders, other affected parties and even outsiders who may be industry experts. the rescue plan as a source of information appears crucial and presentation of a comprehensive and proper plan means there is less demand for extensive interviews to verify the evidence presented. table 3 shows that the rescue plan should be the source of almost 50% of all the variables, hence the crucial value of the plan in the overall post-mortem analysis. this researcher has studied many plans and the word ‘appalling’ comes to mind in many cases. unfortunately there is little pressure (and none by the act or regulator) for submission of plans as part of compliance. several reasons for this status can be proposed. evidence to make decisions and obtain knowledge that guides one’s beliefs about the evaluation criteria call for evidence from the sources of information. while different evaluators may use different evidence, table 2 and table 3 also provide for potential metrics to use as evidence. the value of the proposed metrics to use is twofold: firstly, not to submit to personal bias and, secondly, to attempt some form of standardisation that will support credibility. again, for different bres metrics may or may not exist, for example attempted removals of brps by affected persons are not relevant in all cases thus removals, if they exist, will carry high weightings. kahneman (2011) suggests that decision-making often hinges on the concept of ‘what you see is all there is’, which requires a judgement based on less than all the information. it is more important to make the judgement and potentially improve it rather than make no judgement at all. variable rating finally, the proposed framework allows for rating each relevant variable after it has been weighed based on its contribution. generally a 5-point scale is proposed. the context variables are rated based on their contribution to difficulty (as per the perception of the evaluator, with 1 = very easy and 5 = very difficult). the indicator ratings are also on a 5-point scale based on an agreement scale (1 = totally disagree and 5 = totally agree). typically, an overall rating of below 2 will be regarded as poor while 4 and above is regarded as good performance. the neutral value of 3 is used for unknown information as it does not ‘skew’ the overall indicator performance. very important is the direction of the rating such that a negative evaluation (absence of difficulty) has a low rating because the interest of the indicator is the complexity of the bre. additional observations while seven evaluation criteria are proposed to determine the success of a bre retrospectively, the research shows that the brp and his role, tasks directed by the act, influence and powers act as a disproportionate influencer during the rescue. the brp is the inherent centre of the process (jacobs 2012). as all the evaluation criteria relate to the brp, they are proposed as the mediating factor in the rescue process. the link to appointment, training and accreditation is therefore expounded exponentially. this accreditation requirement led to the proposed framework to report the variable elements of the brp competencies indicator as a separate category. the final outcome of the framework is shown in figure 1 to contain three diagram constructs, namely the contextual difficulty, the brp evaluation and the overall bre performance. who does the evaluation is also crucial to the meaningful use of such a framework. it appears that evaluator competence should be that of expert or master level competencies and not novices, proficient or even competent as described by dreyfus and dreyfus (1980). this suggests that such a process may become very costly. therefore, the suggestion of using peer-review processes as used by the engineering council of south africa (ecsa 2016) when evaluating failed projects. answering the research question: what are potential evaluation criteria for post-mortem analysis of a business rescue event? the compilation of the framework has clearly confirmed the complicated environment in which the brp must operate. seven evaluation criteria with 49 interrelated and overlapping variables have been identified by the research for consideration during the pm process. this seems to be in line with collett, pandit and saarikko (2014:123) who identified 23 generic decline and recovery variables in a literature review. a visual depiction of the evaluation criteria is shown in figure 1. during practical application of the proposed framework, evaluators must take cognisance of the context factors and the mediator role of the brp in the process. for that reason, both context and the brp competencies are expanded to show deeper analysis, which addressed the usefulness for application in accreditation and new applications to become brps. from figure 1 it is clear that the outcome of the proposed framework application points to three important constructs as a result of the pma. firstly, the bre context and strategic br complexity of the bre that informs about the difficulty of the specific rescue. ‘all rescues are not the same’ was voiced by most subjects. secondly, the evaluation criteria are shown and may suggest where problems may have occurred – these can then be further investigated. thirdly, the brp evaluation that can be directly related to the accreditation for future appointments needs consideration. pretorius (2014) proposed that navigating the business in rescue towards the new ‘best’ position is the ultimate assignment of brps. to evaluate this navigation by the brp, the evaluation criteria can direct the judgement. evaluation criteria cannot be addressed in isolation but should be used in ‘concert’, as proposed by schoemaker, krupp and howland (2013:2). the interdependence of the variables, within and between evaluation criteria requires that every business rescue evaluation requires master competence level insight and experience to be meaningful. evaluators require a keen sense of context. finally, figure 1 confirms the vast number of issues when executing the bre pma. add to it the evaluation situatedness (who makes the judgement) and it sanctions the complexity of the proposed procedures. conclusions and industry implications this study set out to extend the tasks and activities (input perspective) of brps during business rescue as reported by pretorius (2013). his findings (pretorius 2014) are competencies described requirements (process perspective) while this study approaches br from an output perspective. it extends the directives of conradie and lamprechts (2015) about measurement of br success. it is proposed that the framework be used to elicit conversation about a sensitive and difficult but necessary topic in the br industry. the framework is a first step and calls for vigorous debate and critique on its assumptions, processes, application, usability and value. the framework’s main value is found in the flexibility of using the weightings of variables as these variable weightings respond to the unique contextual situatedness of the distressed venture on entering the rescue process. finally, the evaluation criteria gave direction to the tasks, competencies and success criteria proposed by previous research. navigating the rescue is the task assigned to the brp at the start of the process. to measure successful navigation appears to be more complex than just measuring outcome. these evaluation criteria and their manifestation within a context express additional direction towards how education for brps could be enhanced, as well as point towards the potential prerequisites of brp accreditation in future. implications for the rescue industry several contributions and improved insights for theory application were observed when compiling the proposed framework. firstly, the overlapping nature of variables within and across the evaluation criteria is highlighted. in particular complex rescues: multiple units and corporate structures may affect the complexity of the bre and require judgements of the variables at expert levels. the related competencies and level of the brp are then screened much more intensely. the brp therefore is disproportionately judged because of their tasks and decisions during the rescue. the question arises whether such variables should be deemed relevant as training content for brps, or should they be assumed to be part of the make-up of future application processes? selection and accreditation of a brp is probably the most important decision for boards, directors and the courts. it may be useful to look towards the professional bodies to provide accredited members to prospective filing directors. professional bodies can use the framework to accumulate data based on the outcomes of such evaluations. secondly, reflecting on the proposed framework confirmed that the rescue plan is a key source of evidence and its preparation appears to be the unique and main contribution of the rescue practitioners. the rescue plan is the central document (loubser 2010b) but the requirements in section 150 of the act for the plan appear insufficient for proper decision-making. it is known that some practitioners ‘copy and paste’ from other plans without removal of the specific information and names from the plan they copy. while there is research on rescue plans (pretorius & rosslyn-smith 2014; rosslyn-smith & pretorius 2015) there remains a lack in this area as to the variables of a good rescue plan. often the success of a rescue is as good as the implementation of the plan. it is proposed that the rescue plan moves up the ladder of importance for future research. thirdly, the proposed framework highlighted the intersection of the brp and the br and their inseparability. as a matter of fact, the framework turned out to be one that evaluates the decisions made by the brp in its entirety barring the contextual evaluation. while the aim was to evaluate the rescue, it turned out to be a test of the brp as much as of the rescue. it can be stated that the brp is totally embedded in the rescue where embedded refers to the instilling of practices (behaviours, actions, beliefs and attitudes) about something (decision-making) into the surrounding mass (bre) to become an integral part of all aspects of the rescue. fourthly, while it was unintended, the evaluation framework turned out to be useful as a competency framework for brps, making its contribution to guide professional bodies in accreditation processes even more significant. to address the problem of ‘who evaluates’ the bre, it is proposed that a small-team investigation be done to create conversation about the status, weights, ratings and credibility of the sources used, which are specifically relevant to the bre under investigation. fifthly, education institutions could apply the findings by incorporating the evaluation criteria as topics into brp training courses. the regulator, for example, as the governing body controlling br could now use the proposed framework to investigate complaints received. the framework should be investigated through further research and be established as the continuous measurement in brp accreditation after formal training. finally, competence measurement was addressed in this article. the key question that arises is where expert and master brps are going to be found for evaluation purposes. while peer evaluation was proposed, there are few brps who can operate at this level. limitations and future research despite the data being directly obtained from the subjects, the main limitation of this research is potential researcher bias during both the data analysis and interpretation of results phases. secondly, the dependence of the framework on human judgement and its associated subjectivity remain a huge barrier and therefore a challenge for future research. one could rightly ask why the framework is balanced with seven variables per criterion and if the subjects identified them as such. the answer is ‘no’ as the framework is the conceptualisation of the researcher that should now be scrutinised by further research. the relevance (weighting) of each variable remains subject to the interpretation of the evaluator considering the specific context for each bre. it is uncertain if the application of this proposed bre pma outcome would serve as sufficient evidence in a court. probably, the evaluators will be subjected to more scrutiny than the bre itself. future research should therefore seek validation and refinement of the evaluation framework and expansion to a formal accreditation model. evaluator criteria and rating also require future research. preparing the rescue plan should become a research focus and formal guidelines should be developed by educators. acknowledgements competing interests the author declares that he has no financial or personal relationships which may have inappropriately 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p.j.h., krupp, s. & howland, s., 2013, ‘strategic leadership: the essential skills’, harvard business review january-february, 131–134. trahms, c.a., ndofor, h.a. & sirmon, d.g., 2013, ‘organizational decline and turnaround: a review and agenda for future research’, journal of management 39, 1227–1307. https://doi.org/10.1177/0149206312471390 yin, r.k., 2003, case study research: design and methods: applied social research methods series, 2nd edn., 5, sage, london. sajems ns vol) (1998) no 2 254 on the meaning of central bank independence g mwessels department of money and banking, free state university abstract this article aims to clarify the meaning of the multifaceted tenn central bank independence. such independence cannot be understood in an absolute sense, because the elected government in a democratic society remains the highest authority in respect of economic policy-making too. nevertheless, central banks globally are currently endowed with strong relative independence. this may be separated into two broad categories, namely fonna) and infonnal independence. political and economic independence are identified as elements of the fonner, and their various subcategories are expounded below. infonnal independence is then highlighted as the more important component of independence, of which personalities, professionalism and public support are crucial. however, an ideal combination of the detenninants of independence is hard to find. introduction the field of central bank independence has received much attention during the past two decades and attracted a considerable amount of research. this is in step with practical developments in the european monetary union, the fonner east bloc states, chile, the uk, france, new zealand and a number of other countries where central bank statutes have been amended or completely revised in order to strengthen their independence. independence for its central bank also received attention in south africa during the constitution-making phase, in that independence was debated and eventually included in the constitution. although theoretical and practical deliberations have extensively considered the motivations for strong independence and ways to institute it, the important prior question of what independence means has been dealt with scantily. this question merits attention in its own right and represents the focus of this article. the article does therefore not debate the necessity for independence but stresses the meaning r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 255 sateb nr vol i (1998)nr2 of the concept. the fact that independence is a multifaceted notion which cannot be compressed into a simple and straightforward definition, and an elusive topic which takes on different meanings in different contexts, forms the scope of the paper. after describing what independence is not, an attempt is made to provide some perspectives on the meaning of independence, as well as a distinction between formal (de jure) and informal (de/acto) independence, their nuances and significance. the clarification of these matters should provide the necessary point of departure for further discussion of the many other dimensions of central bank independence. the meaning of independence what independence is not the meaning of "independence" may be pursued, maybe paradoxically, by starting not with an exposition of the maximum freedom and power for implementing central bank policy decisions, but by focussing on the restrictions and limitations on central bank actions. it should be stressed that an independent central bank is not an omnipotent institution devoid of supervision and accountability, but part of a democratic society. as such, there are limits to its powers and restrictions on the scope of its discretion and policy. viewed broadly, the elected government in a democratic society has the ultimate power to formulate and implement the macroeconomic policy of the country and is also responsible for it. independence for a central bank does therefore not mean that the bank occupies the position of a state within a state; it is impossible to have two sovereign authorities in a single state. in the final analysis, the economic policy of a country cannot be anything but the policy of the elected government. independence, therefore, does not and cannot imply policy decisions and actions without accountability (mittra, 1978 : 38). no country has ever granted complete or absolute independence to its central bank and none is likely to do so. this is neither practical nor in a democratic framework feasible. independence, furthermore, does not imply that central bank policy should be devoid of critical discussion and shielded from scrutiny. a supreme central bank above discussion and criticism, not accessible to public scrutiny in its public functions, is out of the question. independence cannot, therefore, be equated with complete isolation of the central bank from any supervision and public accountability (greenspan, 1993: 1101). in fact, a central bank exempt from all authority and responsibility, would be the strongest argument against central bank independence. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 2 256 in a relational context, it is important to stress that a central bank cannot operate in a constitutional vacuum without a relationship with, or responsibility to, a higher political or economic authority (zijlstra 1979: 148). these authorities and their constitutional powers place limits on the sphere of central banking and its scope of decision-making. tietmayer (current president of the bundesbank) correctly states that "an independent central bank should, and must, accept the limits of its responsibility and power" (banking world. 1994: 26). it is always within a limited area and range of responsibilities that a central bank is independent. although government has the final say and none has granted absolute independence to its central bank, governments do grant or delegate monetary powers to central banks. mandated independence means that the bank is insulated from day-to-day political interference and short-term affinity. it provides the bank with the means to resist political expediency and subserviency, and to withstand populist pressure for trade-offs that lead to inconsistency and inefficiency in policy. the emphasis on such independence is greater in federal states (e.g. germany, switzerland and u.s.a.) whose constitutions were drafted with the specific aim of curbing government's financial powers (fair, 1979: 31). relative independence: tbe central bank/government relation ifindependence is not to be taken literally, as argued above, it should be viewed in a relative context, emphasising the degree of independence. in line with recent tendencies and discussions of central bank independence, "independence", though not absolute, is to be understood as strong independence. this implies that the control of money in the economy should be separated from the uncertainties of political life. it also means that, although the central bank may be established and some of its officers even appointed by the state, the bank should nevertheless enjoy a position of strong independence. the expertise and professionalism of the central bank as a technocratic institution with specialised knowledge, is thereby acknowledged. this realisation requires the insight by government that in a democracy it is often not the exercise of power, but the restraint on its use that matters (mittra, 1978: 200). legal provisions that put the bank in the position of the main executor of monetary policy, will also provide it with the required formal independence. the bank will then possess a mandate giving it the necessary authority to implement its policies, e.g. to fight inflation and maintain purchasing power stability of the currency unit. although acting in a generally non-interfering manner in such a framework, the government will, no doubt, intervene directly and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 257 sateb nr vol i (1998)nr2 determinedly in the event of an emergency or crisis that threatens the national interest. the aforesaid independence may, or should, entail that government be obliged to consult with the bank when considering policies of a financial and economic nature (woolley, 1977: 171). such a position of independence does not preclude any contact and consultation with treasury officials on the initiative of the bank itself. on the contrary, it is imperative that close and professional relations be maintained between the two entities. however independent a central bank was on establishment, it needs the support of government (treasury) not only to avoid policy clashes, but to make its monetary policy effective (bockelman, 1991: 135). the credibility of the policy of an independent central bank will therefore also depend to a large extent on a close co-ordination with fiscal policy (blackburn and christensen, 1989: 27; walshe,199l:113). in order to further illuminate the meaning of "independence", a more structured description is needed. it should be stressed, however, that the term is difficult to encapsulate and that no unique measure or criterion exists with which it can be sufficiently identified. with this qualification, a more precise description of independence requires a distinction between formal (de jure) and informal (de facto) independence. in addition, formal independence should be further divided into political and economic independence to elucidate their different meanings and contents. fo~alindependence formal independence is conferred by statutory provisions which enshrine independence in a legal framework. it entails establishing an institutional framework which provides the central bank with independence. this framework should include as many informal aspects of independence as possible. the higher the degree of legal independence granted to the central bank in this way, the firmer should be its commitment to adhere to its long-term objective. structuring the various relationships between the bank and the government, should also enhance the credibility and accountability of the bank's policy by making the exact locus of responsibility more transparent. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 2 258 political independence political independence refers to the ability of the central bank to choose its economic policy without constraints or influence by government. the following features of a central bank may be used to assess its political independence: the tenure, appointment and replacement of the bank's chief executive officers to protect the independence of the bank, the governor and the board of directors should be guaranteed a sufficiently long tenn of office. short tenns of office could make them vulnerable to dim-sighted political pressures because of the uncertainty around the possible extension of their appointment. independence will therefore be enhanced if the officers have long, staggered tenns of service. their tenns should be longer than that of parliamentarians, and staggered to avoid the simultaneous replacement of all officeis by a new government, which would create uncertainty as to the consistency of monetary policy. furthennore, independence will be strengthened if the governor of the bank is not appointed by the government, or if government has to consult with the board of the bank before appointment (goodman 1991: 330). the same principle of independence applies to other executive officers: the less government authority there is with regard to their appointments, the stronger will the central bank's independence be. independence will also be strengthened if replacement of the governor of the bank by the government (save for personal reasons) is excluded in the bank's statute, or if legal procedures are envisaged to deal with possible confrontations regarding such replacement. these procedures promote the transparency of deliberations and prevent any arbitrary removal of officers. summarising, the independence of the central bank will be enhanced if: • the governor is not appointed by government. • the governor is appointed for more than 5 years. • the board is not a!jpointed by government, or • if more than half of the board members are appointed independently of government. • the board is appointed for more than 5 years. government's role and dictates in policy matters independence is also stronger where government has no explicit statutory participation through an appointed government official in the deliberations of the board of the central bank, or has no representative with veto powers on the board. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 259 sateb nr vol 1 (1998) nr 2 government officials, if any, who may attend board meetings should be observers or discussants only, without a say in the final policy decisions of the central bank. the statutory enforcement of a policy directive by government which may overrule the policy decisions of the central bank, is logically untenable for maintaining the independence of the bank. such an enforcement must be avoided, if it does not at least contain an arbitration clause that prescribes a public debate on the matters at issue between government and central bank. main formulator of policy if the central bank is legally appointed the main executor of monetary policy in the country and does not need any prior consent from government to implement its policy, then its independence will be strengthened. in addition, if the government is required by law to seek policy advice from the central bank on economic affairs, the same end will be served. legally assigned roles and responsibilities of monetary management, and the absence of instructions subjecting the central bank to government, obviously promote the independence of the bank (as mentioned above, this does, however, not exclude the need for consultation with other authorities. ) a single and clear policy objective independence requires an explicit, clearly defined single objective which is statutorily determined (grilli a.o. 1991: 368). to avoid political pressure and interference that lead to sub-optimal policy trade-offs thereby creating uncertain and inconsistent policies the statute of the central bank should state a single uncompromised policy objective, and give the bank a mandate to follow it. such an objective supports the status of the bank as a distinctly non-partisan organisation whose functions are removed from political intervention (bums, 1976: 22). there is, however, considerable debate on who should determine the single policy objective of the central bank. if the central bank alone chooses the objective and the government does not necessarily concur, it is more than likely that conflict will arise and detract from the bank's consistent pursuit of its goals. if, on the other hand, the bank together with government set a common policy goal which the bank then has a mandate to pursue steadfastly, it may be taken to mean that the bank has less than "total" goal independence. however, given instrumental independence to apply whatever policy measures it deems necessary, the bank actually ends up with more than "total" independence. in other words, having instrumental independence r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 2 260 but not goal independence, can provide the bank with more independence than having both types of independence. . economic independence economic independence refers to the ability of the central bank to use without restriction the monetary policy instruments it deems necessary to pursue its task. the following criteria can be used to measure economic independence: budgetary independence although subject to external auditing and accountable to parliament or another such body, a central bank must nevertheless have budgetary independence. apart from the obligation to transfer its financial surplus to government, it must have internal control of its own financial affairs in order to exclude any political influence on its operations via manipulation of its budgetary or financial resources. restrictions on the financing of government by the bank because excessive government financing by central banks has been a primary cause of many previous inflations world-wide, a curb should be placed on this practice. such a curb is especially important in countries with high public debt levels. the less automatic and the more market related the central bank finance is, the more independent the bank will be. limits on finance should not only entail advances and direct loans, but also the issue of government securities to the central bank. the bank must have a voice in determining the value and tenure of loans and the relevant interest rates (cukierman, 1992: 273). the more stringent these limits and prescriptions, the stronger is the resistance the bank can offer to debt monetisation and the fiscal imprudence stemming from this kind of finance, and the sharper the focus of the bank on the pursuit of monetary stability. in summary, the central bank will be more independent if: • a credit facility to government is prohibited, or if it exists, • the credit facility must not be automatic, • the facility must be based on market interest rates, • the facility must be temporary, and • the facility must be of a limited amount. • the bank must not participate in the primary market for government debt. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 261 sateb nr voll (1998) nr 2 control over policy instruments the independence of a central bank is strengthened if it has full command of its monetary policy measures. changes in short-term interest rates are the most important variable under the control of the central bank, and it is crucial that the bank, and not the treasury, has unfettered control over them. if the bank's discount rate is determined without the prior consent of government, and if the bank has access to sufficient government securities (or can issue its own securities) to pursue open market operations, its independence will be enhanced (grilli a.o., 1991: 369). this will be even more the case if the instruments are indirect and market related in their operation. direct and selective instruments are susceptible to political and pressure group manipulation, which may compromise the bank and seriously endanger its independence. the monetary policy of the bank should also be separated from the public debt management of the government. conflicts between the goals and instruments of the two policies can easily arise when the central bank must attend to both. this is especially true of the management of interest rates and the amount of liquidity in the economy, where clashing ends are often experienced. such conflicts compromise the central bank and bring its dedication and credibility into question. ownership of capital although the capital of most central banks is state-owned, a few cases of privately owned capital do occur. private ownership may be interpreted as reflecting greater independence, since government not does seem to "own" the bank. however, the stock of a central bank has a different meaning and function than usual, and does not endow stockholders with the normal rights associated with company stock. the ownership of central bank capital, therefore, is of a more symbolical nature and not regarded significant for the behaviour or independence of central banks (woolley, 1977: 160). tbe incompleteness and fragility of formal independence the foregoing features of an independent central bank can be arranged, and do occur, in various combinations in practice, leading to different models of central bank independence. the formal criteria used for the definition of independence, although illuminating, do not fully reveal the meaning, background and scope of independence. the criteria are also not equally important and must be complemented with various background factors and country-specific details, in r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol i (1998) no 2 262 order to give a fuller picture of the meaning of independence. they do, however, convey a structured idea of what independence means and what some of the essential characteristics of an independent central bank are. furthermore, as already mentioned, the independence conferred by these legal attributes is of a fragile nature. the central bank statute through which independence is accorded, can be easily changed by a majority vote in parliament, which, in case of one party having a substantial majority, can be done without much resistance. however, criticism of the bank and its independence based on economically trivial grounds or because of political expediency and which may endanger its fragile legal independence can be countered by entrenching central bank independence in the constitution of the country. such independence that cannot be as easily amended as an ordinary law, seems prudent and will render independence less vulnerable to political or other forms of pressure. informal independence although legal arrangements and statutes may provide a striking picture of bank/government relations, they cannot account for all the various nuances of independence amongst central banks, and fail to do justice to the meaning of real independence. however elegantly worded and drafted, the legal stipulations may be dead letters if the government's attitude or the general socio-political climate do not support it. the (officially required) objective recommendations and advice of the central bank will have no practical relevance if, in practice, they are not accepted by government. such independence will be as fragile as it is, if the policy and irrelevant leadership ofthe bank are under suspicion. what is more important than formal criteria and statutes, is a deeply rooted respect and a reputation for objectivity and technical competence on the part of the central bank, to resist the pressure of political expedience (woolley, 1977: 161). another reason why informal independence needs to be emphasised, stems from the fact that formal independence covers only part of all the contingencies of practical monetary policy, and de facto independence can, therefore, deviate substantially from the letter of the law (cukierman, 1992: 360). the less complete, or the more vague the statute that governs the formal independence of the bank, the more scope is there for other especially politicalforces to influence monetary policy. these forces are fluid and not always easily detectable, but remain of the utmost importance in the determination of the degree of central bank independence. by granting the central bank de facto independence, the government limits the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 263 sateb nr vol i (1998) nr 2 influence of these forces and reduces the number of instances when price stability might be sacrificed for other (short-term) goals. informal independence, therefore, implies a practical acceptance of the central bank by government and the public. the following aspects underlying de facto independence may be discerned: public support the public's support of the central bank and its policies is a major consideration. the greater the voting public's dislike of inflation and its consequences, the greater will be the cost to government of neglecting conservative economic policies, and the more it will be willing to delegate power to an independent central bank (goodhart, 1988: 3). the strength of central bank independence therefore also depends on the political constituency and public support, whatever else the formal position of the bank may be with regard to independence. public support for conservative economic policies would also benefit an independent monetary policy indirectly,through fiscal discipline and an appropriate monetary/fiscal mix, which will result in a healthier overall macroeconomic policy. the establishment of a tradition of public support for anti-inflationary policies, apart from well-articulated formal stipulations about independence in a central bank charter, forms the basis of informal independence in countries like germany and switzerland. such a tradition may have its roots in historical experiences of high inflation, but also depends on the moral character, work ethic, integrity and far-sightedness of the rulers and population of a country. the quality of government, the degree oflaw abidance and respect for authority, public awareness and information, and the general level of education in a country, together with the maintenance of political stability, all play an important role in the establishment of such a tradition or culture. they are all joint determinants of the willingness by government and the public to grant independence to the central bank. here, then, lies the very substance of independence, namely whether the central bank is given the authority to pursue its basic responsibilities concerning monetary stability, and whether it has the public's support in doing so (cargill, 1989: 32). pursuing the discussion further, it may be said that formal independence is neither necessary nor sufficient for the central bank to achieve financial and monetary stability. independence really exists when a central bank, regardless of its formal relations with government, is permitted to fulfil its basic responsibilities. however, the bank will only enjoy such permission if it performs its task effectively. in other words, the bank will have to deserve its independence. prestige and confidence cannot be taken for granted by the bank. the bank must make itself indispensable through a committed policy, based on sound principles which, through good results r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 2 264 and goal achievement, will earn the bank a positive track record. once credibility and respect have been earned, the public and the government will not only be inclined towards strong independence for the bank, but government itself will benefit from the policy success of the central bank. this is because the success also reflects favourably on the government (mancera, 1991: 73). professional competence as an important informal determinant of independence, professionalism involves the quality of personnel and management, and indicates that the bank is well managed and performs its functions and policies competently. staff selection, training and promotion should promote professionalism, expertise and continuity. it is necessary to provide a solid empirical data base for outstanding research, and to survive passing political and ideological fads and fallacies (erb, 1989: 12). outstanding economic knowledge and in-depth knowledge of the institutional structure of the country, supported by good public relations, will enhance the respect for and therefore also the independence of the bank even further. good liaison work will not only garner support for the bank, but explain the reasons for a particular policy stance, making the bank's operations more transparent and accountable. in addition to employing professional and career-orientated officers, the bank deals with money and monetary functions, and must therefore have a corruption-free record and incorruptible staff. bank statements must be non-partisan in nature and convey the image of freedom of speech within the organisation. the statements should also be an integral part of the bank's communication function by means of which it explains its policies. reports, articles, speeches, panel discussions, submissions to parliamentary committees etc., should all be part of the bank's mode of communication and accountability, which enhances its stature and independence and explains what its policy can and cannot do. personalities because policies are drawn up and implemented by people, their personalities play a major role in determining their acceptance and success, especially in the case of monetary policy. the extent to which various viewpoints are sought and the degree to which consultation and policy co-ordination of economic policies are conducted and therefore the likelihood of policy success depend crucially on the personalities engaged in the exercise. the major driving force behind monetary policy is in most cases the governor of the central bank; chairmanship is the key to r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 265 sateb nr vol i (1998) nr 2 both accountability and effective perfonnance (reagan, 1961: 75). the extent to which he or she enjoys the support and confidence of the country's head of state, a good working relationship and open communication with the treasury as well as sound relations with the financial community, is decisive for the independence, support and respect accorded to the central banle not only should he/she be able to speak out convincingly on behalf of the bank and sound monetary policy, but this should be done objectively and tactically. aware of the importance of the bank's contribution to economic policy, yet mindful of the limitations on the bank and the scope of its responsibilities, the bank governor should pursue the general welfare and public interest, not yielding to political or sectoral pressure. to be efficient and purposive, rather than popular, should be the bank's guiding principle. it remains a classic function of the central bank to swim against the current. however, too much concentration of power in the chair should be avoided, since overbearing behaviour is not reconcilable with infonnal independence and the need for consultation. (it may be necessary to establish decisions about policy not with the chainnan alone, but with a broader committee in the manner of collective responsibility.) nevertheless, the policy stance of the bank and its governor should be expounded with vigour, for as volcker (1991: 65) has said, "the status and prestige of the central bank lie with the public attitudes, with the strength of the people running the bank and how independent they are and how much they are willing to fight for what they think is important in terms of stability, or whatever" (italics added). the above exposition once again testifies to the fact that it is informal rather than formal autonomy which matters, albeit a complex mix as difficult to maintain as it is to define and study. it also shows that this kind of independence is closely related to the intellectual and moral status of those who run the government and the bank, while heavily relying on the support and views of the general public too. conclusion central bank independence is a complex, multifaceted concept that is difficult to encapsulate precisely. it should be seen within a context of limitations and restrictions, not of unlimited power or unrestricted scope. the different criteria of measuring independence occur in various combinations, leading to various kinds of central bank independence. independence has both a fonnal and an infonnal dimension. the fonner consists of political and economic elements. there is, however, no specific blueprint for the ideally independent central bank in a fonnal r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 1 (1998) no 2 266 sense. different countries may construct different types of formal independence models along a spectrum of possibilities. in the final analysis, informal independence is what forms the actual substance of central bank independence. informal determinants of independence range from institutional, cultural, and social to personal, moral and intellectual factors. the importance of these variables shows that the independence of a central bank cannot be fully safeguarded by laws and statutes alone. it also needs wisdom and statesmanship by the government and the directors of the centr,,-l bank, together with the support of the general public. furthermore, independence should not be pursued purely for its own sake; its presence must make a difference to policy-making. in addition, it must be earned rather than given, even though this has become a popular tendency in recent times. to live up to the meaning of independence, a central bank should realise that this requires a continuous educational programme to explain what central bank policy can and cannot do. references i. banking world (1994). hans tietmeyer. president of the bundesbank, sept.: 23-35. 2. blackburn, k. and christensen, m. (1989). monetary policy and policy credibility: theories and evidence. journal of economic literature march: 1-45. 3. bockelman, h. (1991). credibility and consistent central bank policy : an insider view, in eckstein, z. (ed). aspects of central bank policy making. berlin: springer verlag. 4. burns, af. (1976). the independence of the federal reserve system. challenge jul.-aug: 21-24. 5. cargill, t.f. (1992). central bank independence and regulatory responsibilities: the bank of japan and the federal reserve, monograph series in finance and economics, 2. new york university press: new york. 6. cuklerman, a (1992). central bank strategy, credibility, and independence: theory and evidence. m.i.t. press: cambridge (mass.). 7. erb, r.d. (1989). the role of central banks. ensuring long-term price stability and the health of financial systems are important tasks. a view from the i.m.f., finance and development 26(4) : 11-13. 8. fair, d. (1979). the independence of central banks. the banker oct: 31-35. 9. goodhart, c.ae. (1988). the political economy of monetary policy decisions. kredit und kapital 21(1): 1-7. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 267 sateb nr vol i (1998) nr 2 10. goodhart, c.a.e. (1994). game theory for central bankers: a report to the governor of the bank of england. journal of economic literature march: 101-114. ii. goodman, j.b. (1991). the politics of central bank independence. comparative politics april: 329-349. 12. greenspan, a. (1993). statement before the committee on banking, finance, and urban affairs, u.s. house of representatives, oct. 13, 1993. federal reserve bulletin 79(12): 1100-1107. 13. grilli, v., masciandro, d. and t abellini, g. (1991). political and monetary institutions and public finance policies in industrial countries. economic policy 13 : 342-392. 14. mancera, m. (1991). structure of the central bank, in perspectives on the role of a central bank. washington: imf publications. 15. mayer, t. and wilett, t.d. (1988). evaluating proposals for fundamental monetary reform, in willett, t.d. (ed.). political business cycles. the political economy of money, inflation and unemployment. duke univ. press: durham. 16. mittra, s. (1978). central bank versus treasury : an international study. washington: university press of america. 17. reagan, m.d. (1961). the political structure of the federal reserve system. american political science review (55): 64-76. 18. volcker, p.a. (1991). structure of the central bank, in perspectives on the role of a central bank. washington: imf publications. 19. walshe, t.o. (1991). managing a central bank: goals, strategies, and techniques, in downes p. and r. vaez-zadeh (eds), the evolving role of central banks. washington: imf publications. 20. woolley, j.t. (1977). monetary policy instrumentation and the relationship of central banks and governments. annals of the american academy of political and social science nov.: 151-173. 21. zijlstra, j. (1979). central banking a moderate monetarist's view. the role of central banks in economic decision-making. proceedings of a conference held in jerusalem on the occasion of the 25th anniversary of the bank oflsrael, jerusalem: nov. 1979. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 451 quality management amongst south african agribusiness firms: the role of iso 9000 quality assurance standards c r turner and g f ortmann school of agricultural sciences and agribusiness, university of natal, pietermaritzburg abstract worldwide, the iso 9000 quality assurance standards have received considerable support from firms seeking to improve their competitiveness. a postal survey was conducted amongst 92 south african agribusiness firms to determine the extent of the adoption ofiso 9000, reasons for certification and to identify the costs and benefits of adopting these standards. about 36 percent of the respondent firms were certified. the desire to improve customer service, a basis for quality improvement and the need to improve operational efficiency were the most important factors influencing certification. respondents reported financial, managerial and production benefits following certification. broadly speaking, certified firms operate as private or public companies, have parent company affiliations, are involved in manufacturing, and are established firms with large annual turnovers. jel q13 1 introduction due to changes in both the local and international policy and economic environments, south african agribusiness firms are faced with increasing competition in both domestic and international markets. to be competitive, firms need to respond to customer demands and at the same time become more cost effective relative to competitors. thus, to succeed in a highly competitive environment, firms have to improve product and service quality, whilst at the same time reduce production and transaction costs. a strategy that fmns can use to achieve these objectives is to adopt internationally recognised quality standards, including the iso 9000 quality assurance standards. the purpose of this paper is to present some important results of a postal survey conducted amongst south african agribusiness firms. the objectives of the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 452 sajems ns vol 2 (1999) no 3 postal survey were to detennine the extent of adoption of the iso 9000 quality assurance standards, the reasons for certification and to identify the costs and benefits of adopting these standards. the questionnaire also investigates the orientation of agribusiness finns to other quality systems, namely hazard analysis critical control point (haccp) and total quality management (tqm). 2 iso 9000, haccp and tqm in 1987, the geneva-based international organisation for standardisation (iso) published a series of quality assurance standards which were collectively known as iso 9000. the iso 9000 series consists of five standards, iso 9000-9004, of which iso 9001-9003 list the certification requirements for quality systems of variable comprehensiveness, decreasing from iso 9001 to 9003 (schiefer, 1994). the iso 9000 standards are voluntary principles of good practice and have been adopted by the european union and much of the industrialised world (schiefer, 1994; schuler et ai., 1996). at the end of 1997, over 226 000 certifications had been awarded in 129 countries worldwide, of these south africa holds 1915 certificates (iso, 1998). europe (excluding united kingdom), the united kingdom, far east countries and north america held 39, 25, 14 and ii percent of these certifications respectively. the standards represent a quality assurance system, not a product certification scheme (schuler et ai., 1996). according to hendry (1991), the system aims primarily at preventing nonconfonnity at all production stages, from design through to servicing. the objective of the iso 9000 series is to promote worldwide standards which will improve quality, operating productivity and efficiency, and reduce costs (schuler et ai., 1996). to achieve iso certification, a company must obtain the guidelines (from a certifying body), adapt them to its own particular needs, prepare documentation, train employees, follow the documentation procedures and submit to an audit by an external registration organisation which is accredited by the iso standards organisation. continuous monitoring and verification of the quality management system ensures that the system does not deteriorate. surveillance audits are conducted by third-party auditors usually every six months with a full reassessment every three years. the key objective of the haccp principles is to ensure food safety, particularly the control of chemical, microbiological and physical hazards (caswell & hooker, 1996). bredahl and holleran (1997) report that greater food safety legislation is forcing food companies to adopt risk management tools, such as the haccp principles. an effective haccp system will identify key (critical) points along the processing chain where potential hazards are likely to occur, implement preventive measures to contain hazards and establish monitoring r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (i 999} no 3 453 procedures (caswell & hooker, 1996; unnevehr & jensen, 1996). faced with sanitary and phytosanitary regulations (non-tariff barriers), food companies applying haccp principles will be at a competitive advantage (caswell & hooker, 1996). according to develin and hand (1993), tqm is a system of behaviour which encompasses everyone within an organisation and determines their relationships with the outside world. tingey (1997) reports that tqm is a comprehensive set of management tools, management philosophies and improvement methods which include customer orientation, the empowerment of employees, management participation and continual process improvement. the focal point of tqm is the customer, and every aspect of an organisation centres on satisfying the needs of the customer (schuler et al., 1996). 3 study methodology agribusiness firms in the context of this study include agricultural input suppliers (seed, feed, fertiliser, agrochemical, equipment and machinery manufacturers), agricultural output processors (wineries, tanneries, canneries, dairies, textiles, sugar and grain millers, sawmills, abattoirs and other farm product processors), as well as agricultural service providers (fruit exporters, pack-houses, agricultural retail suppliers). since no mailing list of agribusiness firms in south africa is available, all means to locate these firms (e.g. telephone directories, mailing lists from relevant associations, magazines, south african bureau of standards (sabs) register (i 998)) were used. a mailing list of 280 south african agribusiness firms was assembled in this way. a questionnaire was compiled, based on the work by bredahl and holleran (1997) and sabs (1995). a pilot survey was conducted during march 1998 amongst four agribusiness firms, two of which were iso 9000 certified. from constructive feedback, possible problems and misunderstandings regarding certain questions were identified and rectified. a postal survey was conducted during july and august 1998. owing to generally poor responses to postal surveys, the whole population of agribusiness firms (280) was surveyed in an attempt to ensure sufficient responses for statistically valid results. written reminders were sent to firms which had not responded after one month and these firms were also contacted telephonically. from the 280 questionnaires sent out, 44 percent (124) of questionnaires were returned. of these, only 92 questionnaires were usable whilst 32 non-usable responses were received from companies not willing to participate in the study. the usable response rate of 32,9 percent for a postal survey can be regarded as r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 454 sajems ns vol 2 (1999) no 3 satisfactory. van der wiele and brown (1997), manchester business school (1996), scicchitano (1996) and a south african study (sabs, 1995) reported response rates of 32, 28, 26 and 36 percent for their respective postal surveys. 4 general characteristics of respondents this section deals with the characteristics of the sample of south african agribusiness firms that responded to the questionnaire. the characteristics include iso 9000 certification status, types of business arrangement, firm size, financial aspects and export orientation. 4.1 iso 9000 certification in this study 35,9 percent of the sample firms (n = 92) indicated they were iso 9000 certified. of these 33 firms, 94 percent (31) were certified in the iso 9002 model with the remaining two firms being iso 900 i certified. the iso 900 i model is the most comprehensive in the series (covers 20 elements: quality assurance in design/development, production, installation and servicing) whilst iso 9002 contains 18 elements (excludes design/development considerations) (schuler et al., 1996). of the remaining respondent firms (n = 59), 15 percent (9) were "intermediate" whilst 85 percent (50) were not certified. intermediate firms had initiated iso 9000 implementation but were not certified at the time of the survey. in the remainder of this paper, iso 9000 certified firms are referred to as "certified" firms, whilst firms which had initiated iso 9000 implementation and firms which were not certified are referred to as "intermediate" and "non· certified" firms respectively. 4.2 nature of business the majority of respondents (84 percent) are involved in manufacturing, with 16 percent being involved in the service sector. manufacturing includes processing firms. service firms include retailers, importer/distributors, brokers. consultants, exporters and research, development and marketing firms. manufacturing comprised 94 percent of certified firms compared with 78 percent of intermediate and non·certified firms respectively. when asked about the type of products or services their firm produces/provides, a wide spectrum of products/services were listed (21 categories in all). to facilitate data analysis it was necessary to reclassify the products/services into three broad classes. table i describes the three classes and which products/services each supplies. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 455 table 1 class description products derived from agricultur aloutput products used as agricultur al inputs agricultural service providers classification of products and services among a sample of south african (sa) agribusiness firms, 1998 (n = 92) percenpercenpercenproducts/services n tage tage intertage noncertified mediate* certified firms firms firms dairy, maize, sugar, 46 45,7 8,6 45,7 poultry and fruit products etc., textiles, canned fruit, foodstuffs, timber, tea/coffee, wine and spirits, hides and skins fertiliser, agricultural machinery and equip40 30 7,5 62,5 ment, feed manufacturers, agrochemicals, seed producers and feed premixes buying and selling of agricultural products, 6 0 66,7 33,3 property marketing, consultants, exporters, i agricultural retail suppliers . ... * intermediate firms had initiated iso 9000 implementation but were not certified at the time of the survey. forty-six percent of products derived from agricultural output and 30 percent of products used as agricultural inputs originated from certified firms. although the iso 9000 quality assurance standards had not yet been adopted by any of the service agribusiness firms in this study, they can be adapted to any type of business (schuler et al., 1996). of the six firms in this class, four (67 percent) are currently implementing iso 9000. the average age of agribusiness firms in the sample was 38 years 5 months (median = 30 years). the lower median age suggests that a few older firms skew the distribution. the mean age of certified, intermediate and non-certified firms are 55 years 3 months (median = 50 years), 17 years 8 months (median =: 12 years) and 30 years 4 month (median 24 years) respectively. the difference in mean age between certified and non-certified firms (24 years 11 months) is statistically significant at the one percent level of probability. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 456 samms ns vol 2 (1999) no 3 4.3 business arrangements the most common business arrangement among respondent agribusiness finns (n = 92) was the private company (67 percent), followed by the public company (25 percent) and the cooperative (4 percent), with the remaining three finns being individually owned, a partnership and a close corporation. of the sample certified finns (33), 70 percent operate as private companies, 27 percent as public companies, with a partnership making up the remaining three percent. intennediate finns (9) comprise private companies (78 percent) and public companies (22 percent). the majority of non~certified finns are private companies (64 percent), 24 percent public companies and cooperatives (8 percent). the close corporation (i) and individual ownership (1) were also represented. of the total respondents, 75 percent had parent company affiliation, of which 73,5 percent were south african parent companies. a greater proportion of certified finns had parent company affiliation (91 percent) compared to intennediate (67 percent) and non-certified finns (66 percent), with 72 percent of certified finns, 67 percent of intennediate and 76 percent of non-certified finns having south african parent companies. 4.4 export orientation of respondent firms of all the respondents 79 percent are involved in the export market. about 82 percent of certified and 89 percent of intennediate companies export their products compared to 76 percent of non~certified firms. table 2 summaries the proportion of physical production sold on the export market and turnover derived from exports. the mean proportion of physical products sold on the export market and turnover derived from exports are higher for certified than non-certified finns. the mean turnover from exports (n 53) amounts to r126,7 million whilst the median value is considerably less (ri6,5 million). mean turnover from exports for certified finns (n = 19) equals r 100,9 million (median == r35 million) which is lower than the r528,5 million (median = r106,3 million) of intennediate finns (n = 6) but higher than that of non-certified finns (n = 28) which amounts to r58,2 million (median r7,6 million). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 457 table 2 proportion of production sold as, and turnover derived from, exports of a sample of sa agribusiness firms, 1998 all firms certified intermediate non-certified firms firms firms proportion of physical products sold on export market (percent) mean 26,6 (n = 65) 25,1 (n = 23) 54,8 (n = 8) 20,9 (n = 34) median 10 10 60 15 range 0,5 100 i 100 i 100 0,5 90 proportion of turnover from exports (percent) mean 23,2 (n = 62) 21,7 (n = 21) 40,7 (n = 8) 19,9 (n = 33) median 10 6 25 12 range 0,55 100 i 100 5 100 0,55 96 when considering the destination of exports, the majonty of exports (54,2 percent) were destined for the african continent, with europe (25,1 percent) and asia (10,4 percent) being other significant markets. table 3 summarises the export destinations of exporting firms in the study. when comparing certified and non-certified firms, some broad conclusions can be made. relatively speaking, exporting to australasia and asia has a positive influence on certification. exporting to africa does not necessitate certification but, interestingly enough, results suggest that this is also true for europe. as the iso 9000 standards originated in europe and have received considerable support there, this result seems contrary to expectations. the result might be explained by the fact that alternative (substitute) quality assurance systems are in place in non-certified firms and at present these satisfy european customer requirements. however, there may be increasing pressure on non-certified firms to adopt the iso 9000 standards as the future demand for such standards increases among importing countries. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 458 sajems ns vo12 (1999) no 3 table 3 percentage of total exports to various continents, sample of sa agribusiness firms, 1998. continent africa europe asia austranorth south lasia america america all companies (n = 67) mean 54,2 25,1 10,4 5,2 3,1 2,0 median 70 2 0 0 0 0 range 0-100 0-100 0-90 0-100 032 0-27 certified firms (n = 23) mean 50,6 16,0 17,0 10,4 3,5 2,5 median 60 0 8 0 0 0 range 0-100 0-100 0-90 0-100 0-32 0-27 intermediate firms (n = 8) mean 50,3 33,4 ¥b 7,0 ~'i median 49,8 14,5 0,5 0 2,5 ~,68 range 0-100 0-88 030 0 lrms (n = 36) mean 57,4 29,1 6,4 3,0 2,1 2,0 median 88,5 7,8 0 0 0 0 range 0-100 0-100 0-60 090 0-27 0-26 4.5 firm size and financial position firm size was measured according to two factors, namely firm turnover (gross sales) and number of employees. table 4 summarises the annual turnover and number of employees of respondent agribusiness firms. the total number of people employed by these firms was 77 963 people. the total turnover of respondent agribusiness firms (n = 72) was r26,4 billion. comparing mean and median values, both turnover and employee numbers were higher for certified than non-certified firms. the mean difference in annual turnover between certified and non-certified companies (r329,131 million) is statistically significant at the five percent level of probability. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 459 table 4 annual turnover and number of employees, sample of sa agribusiness firms, 1998. all firms certified firms intermediate non-certified firms firms annual turnover (r million) mean 366,503 541,885 (n = 72) (n = 24) median 199,0 477,5 4,5 2429,0 range 2,5 2429,0 10 2337,4 ____ l-__________ ~ ________ _ number of employees mean 847 (n = 92) 1155 (n = 33) 339 (n = 9) 736 (n 50) ~--~-4----~--~--~--~~--4---~--~-4 median 420 200 190 range 9 8000 10 1100 12 10000 to determine the financial position of the agribusiness firms, they were asked to supply their current and net capital ratios (table 5). the current ratio (current assets/current liabilities) indicates business liquidity whilst the net capital ratio (total assets/total liabilities) measures firm solvency. table 5 current and det capital ratios, sample of sample sa agribusiness firms, 1998. all firms certified firms intermediate non-certified firms firms current ratio mean 1,93 (n = 44) 1,67 (n 15) 1,38 (n = 4) median 1,57 1,44 1,16 range 0,43 6,50 0,9 3,61 1 2,20 net capital ratio ,79 (n = 42) 2,95 (n 15) 1,49 (n = 3) 2,86 (n = 24) median 1,72 1,80 1,38 1,63 range 1,32 8,82 1,22 1,87 0,19 10,00 given the favourable liquidity situation of non-certified companies, if the decision was made to adopt the iso 9000 standards, these firms should be in a position to meet the associated costs involved. the presence of a substitute r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 460 sajems ns vol 2 (1999) no 3 quality assurance system could explain why these finns are not certified at present. this aspect will be discussed in the next section. 5 quality control and supplier relationship when asked if their finn had a system to address deviations from quality specifications, 92 percent of respondents (n 92) indicated they had a system in place. in all, iso 9000 was mentioned in 46 percent of cases, which is higher than the reported certified companies (36 percent) as some companies are in the process of implementing iso 9000. all certified companies (n = 33) had systems in place (sometimes in combination with haccp or in-house quality assurance systems), but interestingly enough 86 percent of non-certified companies (n = 50) reported using some fonn of quality assurance system(s). these include: in-house quality assurance systems (71,5 percent), confonnance with external standards (19 percent) and haccp (9,5 percent). half of the intennediate finns mentioned iso 9000, in-house quality assurance systems were reported by the remaining finns. in this category no mention was made of haccp. in-house quality assurance systems are those systems which are developed and monitored internally whilst external standards are stipulated by external bodies (government specifications, veterinary and medical regulations, etc.). the mean age of respondent finns' (n 79) current quality control sy.stem(s) is 103 months (8 years 7 months), but more important is the difference in age between certified, intennediate and non-certified finns' current quality control system(s). the mean age of quality control system(s) for certified finns is 53 months (4 years 5 months) compared to 13 years 6 months and 10 years 11 months for intennediate and non-certified finns respectively. of the respondent finns, 84 percent indicated that their employees receive quality control training, whilst 89 percent said that training was continuous. all employees of certified companies receive quality control training (intermediate finns 87,5 percent) compared with 73,5 percent of non-certified finns, with 94 percent of employees of the fonner receiving continuous training (intennediate finns = 100 percent) compared to 82 percent of the latter. about 88 percent of certified and 80 percent of non-certified finns indicated that their customers require the presence of a quality assurance system. of 89 respondent finns, at present only 45 percent require their suppliers to have a quality assurance system in place, whilst the majority (77 percent) said it would be a future requirement. presently, only 42 percent of certified and 44 percent of intennediate finns required suppliers to have a quality assurance r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vo12 (1999) no 3 461 system compared to 47 percent of non-certified firms, but in the future 75 percent of certified, 89 percent of intermediate and 76 percent of non-certified companies would make it a requirement. when asked which quality assurance system would be a future requirement, iso 9000 was mentioned by 70 percent of certified respondents (n =23). with intermediate companies (n = 7), iso 9000 was mentioned in 71 percent of responses. the main quality assurance systems mentioned by non-certified companies (n = 31) included iso 9000 (29 percent) and customised systems (26 percent), with 13 percent of respondents being unsure. a greater proportion of certified (73 percent) and intermediate companies (78 percent) work with suppliers on quality assurance compared to 64 percent of non-certified firms. when asked about the single most important reason for adopting a quality assurance system, 41 percent of respondents (n 91) cited firm-driven or internal reasons (improved operational efficiency, cost reduction, etc.), whilst 54 percent indicated customer-driven or external reasons (gain market share, customer requirement, etc.). about six percent cited a combination of both firmlcustomer-driven reasons. most certified companies (51,5 percent) cited firm-driven reasons compared to 56 and 61 percent of intermediate and noncertified frrms which reported customer-driven reasons. when questioned if the adoption of a quality assurance system was standard business practice for a firm in its line of business, 63 percent (n = 92) indicated that locally it was standard business practice whilst 88,5 percent (n = 87) felt that it was standard business practice in the international arena. in the questionnaire, standard business practice was defined as "widely accepted by sectoral participants (i.e. producers, buyers, sellers and regulators)". interestingly, only 58 percent of certified companies (intermediate firms = 56 percent, non-certified firms = 68 percent) felt that the adoption of a quality assurance system was a standard business practice locally, whilst 81 percent (intermediate frrms 100 percent, non-certified firms = 91,5 percent) thought it was an international standard business practice. of the total respondents (n 92),55 percent can be classified as agri-food firms. when asked about their familiarity with haccp, 72 percent of the agri-food respondents were familiar with this concept. of the certified (n 19) and intermediate (n = 7) agri-food companies, 84 and 71 percent were familiar with haccp compared to 62,5 percent of non-certified agri-food firms (n 24). of the agri-food respondents, 52 percent had adopted haccp principles whilst 44 percent thought that haccp is commonly adopted in their respective lines of business. about 63 percent of the certified agri-food companies had implemented haccp compared to 46 percent of non-certified agri-food firms. of the certified agri-food firms, 68 percent felt haccp is applicable to a firm in r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 462 sajems ns vol 2 (1999) no 3 their line of business whilst only 25 percent of non-certified agri-food firms held the same view. these results suggest that certified agri-food companies are more aware of and concerned with quality issues and more likely to adopt systems to address these issues, for example haccp. in addition, the results support the findings of early and shepherd (1997: 395) that haccp and iso 9000 are compatible. as iso 9000 is not a product quality system, incorporating haccp principles into a iso 9000 system would satisfy food safety requirements. of all the respondents (n 92), 75 percent indicated it was not difficult to identify input suppliers whilst 25 percent sometimes had difficulty in identifying suppliers. when asked if it is relatively time-consuming to draft supply specifications, 52 percent of respondents answered no, whilst 35 percent indicated it was sometimes time-consuming and 13 percent said that it was timeconsuming. a greater proportion of certified companies (21 percent) fall into the "time-consuming" bracket as compared to non-certified companies (6 percent). only 12 percent of certified companies indicated that searching for a supplier is a frequent monthly activity as compared to 16 percent of non-certified companies (intermediate firms 25 percent). a greater proportion of certified (45,5 percent) and intermediate (62,5 percent) firms had over 50 suppliers to choose from compared to non-certified firms (30 percent). the percentage of certified companies that inspect a supplier's product before signing a contract (91 percent) was greater than the 70 percent of non-certified companies (intermediate firms = 89 percent). most certified companies (67 percent) negotiate long-term contracts with suppliers compared to only 54 percent of non-certified firms (intermediate firms == 89 percent). the fact that certified companies find it time-consuming to draft supply specifications, inspect products before signing contracts and work with suppliers on quality assurance is consistent with the finding that certified companies are more likely to negotiate long-term contracts and therefore reduce the frequency of searching for input suppliers. of the respondents (n = 92), 63 percent have farmers as suppliers. fewer certified firms (58 percent) have farmers as suppliers as opposed to non-certified companies (62 percent). the inputs (products) supplied by farmers are presented in table 6. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 463 table 6 input (product) supplied by farmers to a sample of sa agribusiness firms, 1998 all firms certified internonfirms mediate certified firms firms input (product) n % n % n 0/0 n % milk 7 12,3 6 86 1 14 0 0 grains and other 19 33,3 4 21 3 16 12 63 crops sugar-cane 7 12,3 5 71 0 0 2 29 fruit and vegetables 6 10,4 i 17 i 17 4 66 chickens 2 3,5 0 0 0 0 2 100 animal products 3 5,3 0 0 1 33 2 67 and grains timber 3 5,3 0 0 0 3 100 seed 3 5,3 0 i 33 2 67 wine/grapes 2 3,5 i 50 0 0 i 50 animal products 3 5,3 1 33 0 0 2 67 fruit and wine 2 3,5 i 50 1 50 0 0 total 57 100 19 i 8 30 from table 6 it is clear that given the same input (product), some companies have adopted iso 9000 while others have not. this may indicate that there exists scope for these non-certified companies to go the iso 9000 route too. the incidence of certification is much higher amongst firms using milk and sugar cane inputs. as yet, no companies sourcing seed, timber, chickens and combined animal/grain inputs have sought certification. of the firms having farmers as suppliers, 93 percent indicated that they required minimum quality standards from farmers. more certified companies (95 percent) required minimum standards from their farmers than non-certified companies (90 percent). all intermediate firms required minimum quality assurance standards from their farmers. considering the vertical supply chain concept (i.e. raw material supplier (farmer) ~ processor ~ retailer), respondent firms were asked if they thought the incorporation of quality control measures at farm level could make the supply chain more productive and cost-efficient. almost all certified companies (95 percent) answered yes whilst 87,5 percent of intermediate and 79 percent of non-certified companies agreed. firms were asked if they thought the iso 9000 quality assurance standards could facilitate r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 464 sajems ns vol 2 (1999) no 3 such control measures. the majority (67 percent) of certified companies said yes, with equal proportions of the remaining respondents (33 percent) answering no and uncertain. of the non-certified firms, 28 percent, 31 percent and 41 percent responded with yes, no and uncertain respectively. 6 iso 9000 certification 6.1 general characteristics of firms although one firm gained iso 9000 certification in 1988, 76 percent of all certifications (n = 33) occurred during the last five years. of the certified respondents, 76 percent hold their certification with the sabs, 12 percent with sgs whilst the remaining four firms (12 percent) hold certification with the following certification bodies: dekra, eqnet and dqs, dar and lloyds. the majority of certified firms were introduced to the iso 9000 quality assurance standards by their company headquarters (55 percent), with clients and the sabs accounting for 13 percent each. the remaining 19 percent comprises media (6 percent), competitors (3 percent) and other (10 percent). just over a quarter of respondents (26 percent) indicated it was necessary to hire a consultant to assist with documentation, while the majority (74 percent) said it was not necessary to do so. when implementing a quality assurance system, an organisation may utilise internal resources, outside consultants, or a combination of both (guerin & rice, 1996). if internal resources are employed, a quality assurance supervisor or administrator has to be appointed, working full-time up to two years. according to hendry (1991), departmental managers can expect to spend about 20 percent of their time for two years on iso 9000 implementation. in addition, at least 24 hours training per employee is required. if time is an important factor, then a consultant could be commissioned to assist in implementing iso 9000 and keep teething problems to a minimum. consultants can assist with the process of organisation, documentation and meeting the iso 9000 quality assurance standards. it is important to see the consultants' client lists to determine how much experience they have had with iso 9000 and with similar companies. the mean number of pre-certification audits among respondents was 1,621 (median = i). one firm achieved certification with no pre-certification audits whilst one firm needed six. certified firms were also asked whether they considered iso 9000 certification to be a standard business practice for a firm in their line of business in terms of time (presently and in the future) and scope (locally and internationally). about 64 percent felt certification to be a standard business practice locally at present, while 90 percent felt it would be a standard business practice locally in the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 465 future. on the other hand, about 78 percent of respondents felt certification was a standard business practice internationally at present, but all respondents indicated it would be a standard business practice internationally in the future. 6.2 factors which motivated iso 9000 certification when asked to give the single most important reason for adopting the iso 9000 quality assurance standards, 42 percent of certified firms (n = 33) cited internal firm-driven reasons, 42 percent reported external customer-driven reasons whilst 16 percent indicated a combination of the two. internal factors include procedural efficiency, staff motivation, and reductions in error rates, wastage and costs, whilst external reasons include customer requirements and the desire to gain market access and market share. from their british study, bredahl and holleran (1997) report that firms become iso 9000 certified for both internal (firm-driven) and external (customer-driven) reasons internal reasons accounted for 52 percent of iso 9000 certifications, 36 percent related to external reasons and the remaining 12 percent were influenced by both factors. of the certified respondents in this study (n = 33), 61 percent indicated that their principal customers did not require certification at present, but 78 percent of certified firms thought that certification would be a future customer requirement. this point reinforces the fact that the external or customer-driven reason for certification is not the main driving force at present, but in the future it may become the dominant reason. to investigate the motivating factors in more detail, certified respondent firms were asked to indicate the importance of these factors on a three-category scale ranging from "not important" to "important" and "very important". the proportion of firms which indicated "important" or "very important" for each influencing factor is given in table 7. the factors were ranked according to these proportions. table 7 factors which motivated iso 9000 certification among a sample of sa agribusiness firms, 1998 (n = 32) factor mode* percentage of firms rank indicating "important" or "very important" improved customer service 3 too 1 a basis for quality improve 3 96,9 2 improved operational efficiency 3 90,7 3 (reduce wastage) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 466 sajems ns vol 2 (1999) no 3 table 7 continued factor mode* percentage of firms rank indicating "important" or "very important" access to foreign markets 3 87,5 4 reduction in operating costs 2 87,5 4 gain market share 3 84,4 6 customer requirement 2 84,4 i 6 unite various quality systems 2 81,3 8 certification will be a future 3 80,7 9 requirement industry requirement (stay in 2 75,0 10 business) corporate mandate 2 67,7 11 reduction in transaction costs 2 56,3 12 other(n = 2) ... where 1 = not important, 2 = important and 3 = very important the desire to improve customer service was the most influential factor, followed by a basis for quality improvement and the desire to improve operational efficiency (reduce wastage). although the importance of certification in reducing transaction costs was only ranked twelfth, it is evident from other factors (such as improved customer service, improved operational efficiency, access to foreign markets, certification being a future requirement and uniting various quality systems) that it is an important motivating factor. the following additional factors that motivated certification were raised by two finns: a) to ensure unifonnity between plants, b) retain existing customers, c) improve utilisation of facilities, d) improve skills, knowledge, attitude and ability and e) clear transmission of infonnation. the respondents rated each of these five factors as being very important. zaibet and bredahl (1997) believe that the main motivating factors for finns to become iso certified include: a) coordinating operations in different plants, b) improving internal communication, c) enhancing the finn's competitive position (maintain or increase market share) and d) increasing finn efficiency by improving food safety whilst reducing total costs. according to guerin and rice (1996: 27), companies seek iso 9000 registration for a number of reasons, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 467 which include customer pressure, quality benefits, market advantage and eu regulation requirements. van der wiele and brown (1997: 300) cite the following driving forces of iso certification: market related factors, customer service, quality and efficiency improvement, and as a "kick start" for quality improvement. a south african study (sabs, 1995) ranked the reasons for becoming certified as follows: a) the desire to improve existing management systems, b) to gain competitive/market advantage and c) realising the value of becoming certified (improve management and production efficiency, and financial returns). 6.3 impact of iso 9000 certification respondents were asked to score on a five-point scale, ranging from i (highly negative) to 5 (highly positive), the impact of certification on each performance indicator. the ranking of performance indicators was based on the proportion of respondents indicating a "positive" or "highly positive" impact (table 8). table 8 rating of performance indicators, sample of sa agribusiness firms, 1998 performance indicator mode* percentage of firms rank indicating "positive" or "bigbly positive" documented process (e.g. record5 96,9 i keeping) (n = 32) overall firm performance (n = 32) 4 93,8 2 • quality of output (n = 32) 4 93,7 3 error rates (decrease) (n = 32) 4 90,6 4 customer service (n 31) 4 90,4 5 quality of purchased inputs (n = 32) 4 81,3 6 competitiveness (n = 32) 4 75,0 7 sales (n = 31) 4 74,2 8 inter-firm communication (n 32) 4 71,9 9 productivity (n = 32) 4 71,9 9 worker satisfaction / employee 4 68,8 ii morale (n 32) market access (n = 32) 4 68,8 11 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 468 sajems ns vo12 (1999) no 3 table 8 continued performance indicator mode* percentage of firms rank indicating "positive" or "highly positive" wastage ( i.e. scrap costs) (decrease) 4 68,8 ii (n= 32) profits (n = 32) 4 68,7 14 overall operating costs (decrease) (n 4 65,6 15 =32) market share (n = 32) 4 56,3 16 .. ·where 1 = highly negative impact, 3 = no impact and 5 highly positive impact certification had a positive impact on most performance indicators, in particular on documented processes (e.g. record-keeping), overall firm performance and quality of output. in addition, certification has had a positive impact on reducing error rates, customer service and quality of purchased inputs. factors ranked i, 5, 6, 9 and 11 show the positive impact of certification on reducing transaction costs. similar findings have been reported by market and opinion research international (1996), manchester business school (1996), hendry (1991), sabs (1995) and zaibet and bredahl (1997). certified firms were asked to provide information (before and after certification) of any improvements in performance measures resulting from certification. a summary of the certified companies' experiences is shown in table 9. clearly, substantial benefits have been achieved from certification. substantial cost savings can be achieved through improvements in conformance to specifications, less reject products/returns and scrap material, and less customer complaints will ensure continued customer satisfaction and support. improvements in certain performance measures (indicated by an asterisk in table 9) are expected to lead to lower transaction costs. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 469 table 9 actual improvements in performance measures as reported by a sample ofiso 9000 certified firms, 1998 (n = 19) improvement n before certification after certification , confonnance to 10 mean improvement = 15,9 percent (n = 8), specifications* range = 5 25 percent problem solving i problems were not problems solved followed up much faster management 1 management were not management totally so quality conscious involved less customer 4 mean improvement = 394 percent (n 2), complaints* range = 188 600 percent reduced product 4 mean improvement = 314 percent, returns/rejects* range = 91 666 percent suppliers' input 2 85%(n= i) 195% (n i) confonnance* documentation i overall improvement efficiency* calibration* 2 mean improvement = 48 percent range =47 49 % employee discipline 1 overall improvement scrap material* 1 2,0% of final product 1,3% of final product product losses 1 ±r 700000 per annum ±r40000opa after 1,5 years corrective action i haphazard corrective standardised action corrective action system penalties due to non1 r45514 0 confonnance* * improvements which reduce transaction costs 6.4 costs of iso 9000 certification certified finns were asked to estimate the costs of iso 9000 implementation, pre-certification auditing fees and iso certification (table 10). all costs shown in table 10 are expressed on a 1997/98 basis and have been classified according to finn turnover to account for finn size. iso 9000 implementation costs include items such as staff training, documentation procedures, hiring of consultants, redeployment of internal resources and the acquisition of equipment for r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 470 samms ns vol 2 (1999) no 3 calibration. certification costs depend upon firm size, complexity (nature of processes) and the iso 9000 series chosen. table 10 costs of iso 9000 certification among a sample of sa agribusiness finns, 1997198 = 100. costs of iso 9000 group * n mean(r) median range(r) (r) implementation a 7 56256 50943 11880 154957 b 6 144228 100101 14200 300000 c 6 302949 146711 50943 1045440 pre-certification a 5 8046 7642 5043 11880 auditing fees b 3 8070 4632 1500 18078 c 7 24901 10189 6113 70296 certification a 4 8235 7301 6457 11880 b 3 27704 21300 15496 46316 c 6 39883 24453 7030 99792 total cost a 6 67541 50934 12000 167871 b 6 162115 136975 14200 322826 c 7 318758 163019 19911 1188000 total cost per a 6 664,04 522,00 198,00 1554,36 employee b 6 453,77 137,30 14,35 2137,92 c 6 583,27 399,24 20,17 1321,35 percent percent percent total cost as a a 6 0,301 0,157 0,027 1,024 percentage of b 6 0,041 0,048 0,003 0,065 turnover c 6 0,045 0,019 0,011 0,140 .. * group a = company turnover < r 100 mllhon group b = company turnover ~ rioo million but < r650 million group c = company turnover ~ r650 million to account for firm size, total costs of certification are expressed as a percentage of annual turnover and total certification costs per employee. zaibet and bredahl (1997) reported that the total cost of achieving iso 9000 certification did not exceed 1,5 percent (range 0,07 1,5 percent) of turnover of four firms in their united kingdom meat sector study. they concluded that these costs should not represent a constraint toward achieving certification. the results of this study suggest that the costs of certification may be prohibitive for very small firms, as smaller firms show the highest cost per rand of turnover and per employee. there is also some evidence of diseconomies for very large firms. however, the means computed for the largest firms were skewed by one firm that reported r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 471 certification costs in excess of rl million (this finn achieved iso 9001 certification). the median values presented in table 10 indicate size economies across the full range of turnover, but higher certification costs per employee for very small and very large finns. of the iso 9000 certified finns (n = 33),88 percent indicated that the benefits of iso 9000 certification outweigh the costs incurred. ofthese 29 finns, 79 percent said benefits significantly outweighed the costs whilst 21 percent reported small net benefits. of the certified finns, 97 percent believed that adopting the iso 9000 quality assurance standards could benefit south african agribusiness firms. being an importer and distributor of agricultural equipment, the remaining finn felt that as long as overseas suppliers were certified, local certification was not necessary. 6.5 disadvantages of iso 9000 certification when asked to list any disadvantages of iso 9000 certification, some 85 percent of certified finns related their experiences. nearly 40 percent of respondents (n 28) indicated there were no disadvantages/drawbacks of certification, while cost considerations were mentioned by 10.5 percent of respondents. excessive documentation load/paperwork was mentioned in 25 percent of cases. other drawbacks mentioned also reflect the following disadvantages of iso 9000 reported in other studies (sadgrove, 1995; van der wiele and brown, 1997): a) it is bureaucratic, b) excessive ongoing paperwork, c) it is internally focused (internal processes), d) staff feel that standards are imposed on them, and e) iso 9000 does not encourage continuous process improvement. 6.6 iso 9000 and tqm after a brief introduction of the total quality management (tqm) concept, 58 percent of the certified finns indicated they had adopted the principles of tqm. of the certified finns that had not adopted tqm (n 14), 43 percent had considered and rejected tqm, and an equal percentage was currently considering implementing tqm, while 14 percent bad never come across the concept. iso 9000 and tqm are not equivalent, but iso 9000 fonns part of the quality management process. the iso 9000 and tqm approaches have both similarities and differences. management responsibility, corrective/preventive action and training are common objectives in both cases. however, iso 9000 does not totally encompass the tqm principles of continuous quality improvement, customer focus and the training and empowennent (human management) of workers (fowler & lord, 1995; yung, 1997). unlike iso 9000, tqm does not r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 472 sajems ns vol 2 (1999) no 3 place sufficient emphasis on documentation (yung, 1997). according to schiefer (1997), to meet continuous quality improvement, a tqm programme has to be integrated into an organisational structure which allows for its documentation, enforcement and control. the iso 9000 quality assurance standards can provide this necessary structure (schiefer, 1997; schuler et al., 1996). sadgrove (1995:107) added that "without iso 9000, a tqm company often lacks a systematic approach to quality". whilst tqm focuses on corporate culture, iso 9000 looks at corporate systems (sadgrove, 1995). the marketing advantages of iso 9000 certification and its documentation procedures could enhance a tqm system. according to yung (1997), the iso technical committee are trying to revise the iso 9000 series (vision 2000) by incorporating some of the principles (quality improvement, management commitment, customer satisfaction) oftqm. 7 conclusions an importing finding of this study is that the majority of sampled south african agribusiness firms are aware of the importance of adopting quality assurance standards. although just over one third of respondents had sought certification, non-certified firms indicated that through monitoring future market and customer requirements, a decision will be taken on the need for certification. broadly speaking, certified firms can be said to have the following characteristics: a) they operate as private and public companies, b) have parent company affiliation, c) are involved in manufacturing, d) are older established firms, e) have larger annual turnover and f) are more familiar with haccp. the desire to improve customer service, a basis for quality improvement and the need to improve operational efficiency (reduce wastage) were the most important factors influencing certification. the importance of certification in reducing transaction costs was also evident. certification had a positive impact on all performance indicators, in particular on documented processes, overall firm performance and quality of output. results show that certification can yield real benefits (financial, managerial, production) to enhance firm competitiveness, whilst the costs of certification per rand of turnover are low. two additional points need to be considered. firstly, barriers to trade, which have steadily declined following international trade agreements (through the general agreement on tariffs and tradelworld trade organisation), could be replaced by non-tariff barriers such as iso 9000 certification and haccp (caswell & hooker, 1996). although at present iso 9000 certification remains a voluntary standard, it could become a compulsory requirement (standard business practice) in future international trade. the marketing advantages ofiso 9000 certification (securing new customers and gaining market share) would r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 473 then disappear; being certified would only ensure that a firm can trade internationally. secondly, as more firms in an industry become iso 9000 certified, the competitive (marketing) advantages to a single certified firm will decrease (van der wiele & brown, 1997). although the marketing advantages of iso 9000 certification would decrease, potential cost savings (management, production and transaction costs) could still be exploited. being a relatively new concept, further research on iso 9000 certification needs to be conducted. factors that differentiate between certified and non-certified firms need to be determined. by thoroughly identifying and quantifying the costs and benefits of certification, proper feasibility studies can be done. in addition, monitoring the progress of certification amongst south african agribusiness firms would determine the extent of adoption amongst the various firm types and sizes. comparisons could then be made between different industry sectors and international experiences. endnote the authors would like to thank the national research foundation (nrf) for their financial assistance towards this research. opinions expressed and conclusions arrived at are those of the authors, and are not necessarily to be attributed to the nrf. references bredahl, m.e. & holleran, e. (1997) "food safety, transaction costs and institutional innovation", in: schiefer, g. and helbig, r. (eds.), quality management and process improvement for competitive advantage in agricultural and food. proceedings of the 49th seminar of the european association of agricultural economists, university of bonn (ilb), germany: 51-67. 2 caswell, ja & hooker., n.h. (1996) "haccp as an international trade standard", american journal of agricultural economics, 78 (3): 775-9. 3 develin, n. & hand, m. (1993) total quality management: breaking down the barriers. institute of chartered accountants in england and wales, london. 4 early, r. & shepherd, d. (1997) "a holistic approach to quality with safety in the food chain", in: schiefer, g. and helbig, r. (eds.), quality management and process improvement for competitive advantage in agricultural and food. proceedings of the 49th seminar of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 474 sajems ns vol 2 (1999) no 3 the european association of agricultural economists, university of bonn (ilb), germany: 391-400. 5 fowler, c. & lord, b. (1995) "iso and tqm", chartered accountants journal of new zealand, 74 (10): 33-8. 6 guerln, j.m. & rice, rw. (1996) "perceptions of importers in the united kingdom, germany, and the netherlands regarding the competitive advantages ofiso 9000", forest products journal, 46 (4): 27-31. 7 hemenway, c.g. (1996) "ten things you should know about iso 140oo'"sabs-bu//etin, 15 (8): 12-14. 8 hendry, i. (1991) "quality assured: a stamp for survival", pulp and paper international, 33 (8): 16-23. 9 iso (1998) the iso survey of iso 9000 and iso 14000 certificates the seventh cycle: up to and including 1997, international organisation for standardisation, online information: http://www.iso.ch. 10 market and opinion research international (1996) "attitudes of 'captains of industry' towards iso 9000", survey commissioned by sgs yarsjey international certification services, iso 9000 news, 5 (6): 12-14." iso 9000 does it work?", survey commissioned by sgs yarsley international certification services, iso 9000 news, 5 (6): 4-1 l 11 sabs (1995) marketing research study amongst sabs iso 9000 certified companies, south african bureau of standards, pretoria. 12 sabs (1998) sabs register, mainor ltd, auckland park, sa. 13 sadgrove, k. (1995) making tqm work, kogan page ltd, london. 14 schiefer, g. (1994) quality management in agriculture and food: management principles, system requirements and development directions, report b-9412, university of bonn (ilb). 15 schiefer, g. (1997) total quality management and quality assurance in agriculture and food. in: schiefer, g. and helbig, r. (eds.), quality management and process improvement for competitive advantage in agricultural and food. proceedings of the 49th seminar of the european association of agricultural economists, university of bonn (ilb): 13956. 16 schuler, c., dunlap, j. and schuler, k. (1996) iso 9000: manufacturing, software, and service, delmar publishers, new york. 17 scicchitano, p. (1996) "survey takes snapshot of iso 9000 in the usa", iso 9000 news, 5 (4): 6-9. 18 tingey, m.o. (1997), iso 9000, malcolm baldrige and the sei cmm for software, prentice hall ptr, upper saddle river, usa. 19 unnevehr, l.j. & jensen, h.h. (1996) "haccp as a regulatory innovation to improve food safety in the meat industry", american journal of agricultural economics, 78 (3): 764-9. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 475 20 van der wiele, t. & brown, a. (1997) "iso 9000 series experiences in small and medium-sized enterprises", total quality management, 8 (2/3): 300-4. 21 yung, w.k.c. (1997) "the values of tqm in the revised iso 9000 quality system", international journal of operations and production management, 17 (2): 221-30. 22 zaibet, l. & bredahl, m. (1997) "gains from iso certification in the uk meat sector", agribusiness: an international journal, 13 (4): 37584. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . microsoft word 1 editorial de wit sajems 19(5) 2016.docx 690 sajems asset research ns 19 (2016) no 5:690-701 how to cite doi: http://dx.doi.org/10.17159/2222-3436/2016/v19n5a1 issn: 2222-3436 another look at economic approaches to environmental management and policy with reference to developments in south africa editorial martin de wit school of public leadership, university of stellenbosch the wide acceptance of economic approaches to environmental management and policy, masks increasing heterogeneity in the field. this editorial addresses the question whether the economic approach is still warranted and under which conditions. a broad outline of the trends in both orthodox and heterodox economic approaches is also presented. the traditional split between environmental and ecological economics is not doing justice to recent developments in the field. instead it is proposed to rather refer to environmental, resource and ecological economics (eree), ecological-economic systems (ees) and socio-ecological systems (ses) approaches as well as heterodox approaches to environment and sustainability (hees). the contributions made to this special issue are placed within their respective subfields of influence. it is concluded that a deeper, self-critical exposition of moral philosophies and values as well as models of reality are needed. a strategy of engagement in an attitude of self-criticism, humility and in participation with others is proposed as a viable way forward. for such a process to be successful two conditions are required, namely valuing the human person and accepting the reality of a nondeterminate world full of meaning. key words: environmental management, environmental policy, environmental economics, ecological economics, heterodox economics, sustainability, ethics, values, ontology, participation jel: q01, 56, 57, h23, b52, a12 1 introduction in recent years, both internationally and in south africa, the economic approach to environmental management and policy has become widely accepted and has become the norm in the green economy. at the same time, other researchers point towards a crisis in natural resource and environmental management; a failure to explain resource collapse and continued environmental deterioration and rising impacts. it remains uncertain whether the economic approach to environmental management and policy accurately represents reality and what is valuable. however, the question posed in the book sustainable options: development lessons from applied environmental economics (blignaut & de wit, 2004) is still relevant: “could economic development and the principles of prudent environmental management be honoured simultaneously in a developing country?” there is no evidence that sustained economic growth guarantees a country to outgrow its social and environmental problems (blignaut & de wit, 2004:29). lumby (2007) asked, more specifically, how the demands of modern economies can be reconciled with biophysical constraints. in many instances, environmental problems have economic costs that cannot be mitigated at firm or household level only. the challenge, therefore, became increasingly centred on finding macroand sector-level policy solutions that are costeffective and environmentally sustainable, that are within biophysical limits, while being sensitive to social and ethical concerns. more and more micro-level valuation studies that measure individual willingness-to-pay for environmental quality, have been used to inform macro-, sectoral and spatial level tools and policies towards sustainable development. we argued that internalising externalities or “getting the prices right”, is not a sufficient condition for prudent environmental management. it is also necessary for policy instruments to adhere to ethical norms outside abstract sajems asset research ns 19 (2016) no 5:690-701 691 economic efficiency and adaptive and flexible environmental policy should be designed to account for changing realities (blignaut & de wit, 2004:439). how have these conditions played out in south africa in the last decade or so? is the economic approach to environmental management still warranted? if yes, under which conditions? if no, what viable alternatives are there in a globally economised world? this editorial discusses the progress made in employing an economic approach to environmental management and policy with reference to the south african experience. the objectives are (i) to present a broad outline of trends in the economic approach to environmental management and policy, (ii) to place contributions made in this edition within the broader narrative of such an economic approach, and (iii) to highlight the opportunities and limitations of the economic approach to environmental management and policy. this task would not be possible without considering the definitions of the various economic schools of thought in support of environmental management and policy that have emerged in the last decade or so. first, the traditional split between environmental and resource economics and ecological economics is no longer deemed useful and a classification as environmental, resource and ecological economics (eree) more accurately describes these shared theoretical foundations. second, the rise of systems approaches to environmental management have led to two related, but distinct schools of thought, namely the ecological-economic systems (ees) approach and the socio-ecological systems (ses) approach. lastly, various strands have developed that are called the heterodox economics of the environment and sustainability (hees) approach, notably biophysical economics and social ecological economics, and also the more traditional heterodox economic approaches such as evolutionary-, post keynesian-, institutionaland marxist economics (douai, mearman & negru, 2012). 2 environmental, resource and ecological economics (eree) the central focus of the economic argument is to locate the rise of environmental problems within the failure of markets and capture the true costs of economic activity on the environment. the two main strategies that have been followed are (i) to correct costs of natural resources and the environmental quality through a regime of taxes, charges and subsidies, or (ii) to assign property rights to common or publicly held natural and environmental resources. these approaches led to a large number of studies to assess the costs of environmental damage and the value of natural resources owned privately or publicly, mostly relying upon non-market values generated through shadow pricing, proxy measures for market prices, preferences revealed through behaviour or measuring preferences asserted (willingness-to-pay) through surveys (blignaut & lumby, 2004). economic theory holds that when the true value of a natural resource is included in the price, the resource will be allocated to the most efficient users. economic evaluation tools, such as cost–benefit analysis and cost-effectiveness analysis, are expanded to include the value of natural resources and the cost of environmental damage. black, turpie & rao (2016) compare conventional engineering and ecosystem-based adaptation techniques for wetland rehabilitation in pastoralist systems adapting to climate change using a cost-effectiveness analysis (cea). they conclude that conventional engineering of wetlands is more cost-effective from the land-owners’ perspective, but when additional social concerns like poverty alleviation are included, ecosystem-based adaptations are more viable. the results suggest dedicated policy intervention to achieve broader social objectives. the normative value governing an environmental and resource economics approach is to achieve economic efficiency by allowing for the unpriced damages of environmental externalities and the optimal use of natural resources. in theory, sustainable development would be achieved if the total stock of capital remains constant over time with the assumption that natural and environmental resources can be substituted by other forms of man-made capital (solow, 1993). economic policy proposals, therefore, tend towards improved monetary valuation of individual willingness-to-pay, internalising external costs through enhancing the efficiency of market-based 692 sajems asset research ns 19 (2016) no 5:690-701 policy instruments and strengthening the institutional capacity to assign and enforce property rights (nahman, wise & de lange, 2009). the theory (known as the environmental kuznets curve (ekc)) is that as incomes rise, the willingness-to-pay for environmental quality will rise and countries will experience a reversal of environmental damage over time (grossmann & krueger, 1995). there is no evidence to support the idea that developing countries will automatically be able to “tunnel through” an ekc, suggesting the need for deliberate policy to respond to increasing environmental damages as the economy grows (blignaut & de wit, 2004:11-12). although still contested, empirical research also does not find a robust relationship between rising income and declining pollutants (stern, 2004; harbaugh, levinson & wilson, 2002). likewise, support for an ekc in south africa is at best ambiguous – implying that if an ekc does not exist the country will have to sacrifice growth to reduce emissions (nasr, gupta & sato, 2015). this finding is supported by the study by van heerden, blignaut, bohlmann, cartwright, diederichs & mander (2016). they calculate the impact of the recently-introduced carbon levy on the national economy using a dynamic computable general equilibrium model (dcge) and concluded that it will have a negative impact on gdp. the manner in which the tax revenue is recycled back into the economy plays a major role in reducing the net costs to the economy, suggesting the need for careful design of carbon tax and revenue recycling schemes. kohler (2016) is concerned with water scarcity in south africa and proposes an economic approach to water demand management. kohler uses decomposition analysis to calculate water use intensity, and regression analysis to calculate the main drivers of change in the south african economy. he concludes that water use generally reflects the level of capital stock in the country and that capital stock is only very gradually becoming more water efficient. he suggests the use of a mixture of water management options to incentivise innovation and technological adoption of water saving measures. both aforementioned studies (van heerden et al., 2016; kohler, 2016) point to the fact that economic activity, environmental damage and the use of natural resources are closely associated and can only be changed through deliberate policy interventions. persistent critiques against the “market solution” of environmental problems are that environmental goods and services are not priced efficiently enough to avoid the degradation of natural resources and the environment, and that intergenerational welfare is not guaranteed (lumby, 2007). ecological economics has emerged as an alternative, more precautionary approach, starting with biophysical limits on the economy and the ability of technology to circumvent them (costanza, 1989). production processes are subject to the laws of thermodynamics. therefore, biophysical rules are needed for the management of renewableand non-renewable resources and pollutants to ensure long-term sustainability (daly, 1992). environmental quality can be diminished through economic activity, but only if there are no ecological thresholds in danger of being breached. the normative value governing an ecological economic approach is to achieve ecological sustainability, which is defined in terms of ecological stability and resilience (holling, 1973). like ere approaches, monetary valuation techniques are used, but focussing on the value of ecosystem services aggregated across time and space. aggregated values are typically much larger in magnitude than marketed goods and services in the world economy (de groot, brander, van der ploeg, costanza, bernard, braat, christie, et al., 2012), in effect increasing the shadow prices used for evaluating the impact of economic expansion on the environment. the assumption is that increased prices for environmental quality will send out signals that would change behaviour towards sustainability. the argument continues that the benefits of ecosystem services from publicor common goods does not mean that such services should necessarily be privatised. sustainable development would be achieved if the stock of natural capital (or at least what is referred to as critical natural capital) remains constant over time (ayres, 1998). ecological economic policy proposals tend to favour an allocation of resources through market incentives, but only in a policy hierarchy after issues of ecological scale or damage as well as distribution have been regulated in the political process (cumberland, 1994). sajems asset research ns 19 (2016) no 5:690-701 693 environmental, resource and ecological economics as outlined here, adhere to the same foundations in theories of capital and value. rebranding the combined research field under the term “sustainability economics” has been suggested by some (baumgartner & quaas, 2010), but dismissed by others as a process already ongoing within the field of ecological economics (spash, 2013). common and perrings already argued in 1992 that solowand holling-sustainability are disjointed. price changes may alter the optimal allocation of natural resources, but it is not clear how this will achieve ecosystem stability and resilience. efficient prices may yield hollingsustainability, but it is not an obvious outcome. the key difference lies in concepts of value; efficiency achieved through prices (or measuring contingent value in the case markets fail) or through biophysical concepts derived from ecosystem stability and resilience. 3 ecological-economic systems (ees) approach both environmental and resource economic and ecological economic approaches start with an abstraction that the natural environment can be represented as capital, although using different rules of substitutability between forms of capital. valuing and managing the stock of wealth in a firm, household or country is a concept well-documented in the classical and neo-classical thought on economic development and growth. when coupled with growth factors such as savings and investment, these provide the basis of all macro-economic accounting and growth modelling. by using the capital theory approach, the eree methods keep the door open for a conversation with mainstream economics on environmental management and policy. in such a capital-theory approach (cta) several accounting frameworks and indicators have been developed that provide useful, but partial, information to policymakers. the complexity and dynamics of ecosystems as well as the social contexts are not integrated into the capital theory approaches of eree (de wit, 2000). in an effort to better understand the flow of services from natural capital, it is argued that integrative and dynamic modelling methods that include environmental, economic, social and institutional realities would better recognise complexities of sustainable development at disaggregated levels and over time. these have been proposed as the real contribution of an evolving ecological economic approach (perrings, 2006). integrated ecological-economic system dynamics modelling was developed as an answer towards bridging the gap between solowand holling-sustainability through a combination of economic optimisation models and system dynamic simulation models (hediger, 1999). the focus on quantitative accounting and modelling for decision-making and control remains, as is also evident in more static versions of the cta. modelling steps are closely controlled by either the modeller him or herself or the broader group of research participants and decision-makers. for example, boundaries for space and time are chosen by the modelling team and should theoretically be sufficiently long for dynamic behaviours to be seen (ford, 1999). the focus of such integrated and dynamic approaches is to influence the decision-making processes and policies of natural and environmental resource managers or market participants aimed at enhancing control and management. system dynamics stock–flow modelling approaches share a worldview of an objective, ordered reality with neo-classical economics and can be successfully employed to study integrated ecological-economic questions (crookes & de wit, 2014). integrated eesa modelling is an extension and enrichment of the cta to sustainable development. these trends and debates have also run their course in south africa. from an ecological point of view it has been argued that monetary valuation studies should estimate values based on a better understanding of ecological systems (turpie, 2004). in the last few years world-wide and in south africa, a proliferation of studies were done on integrated ecological-economic system dynamics modelling using the language of ecosystem services as an integrative concept (le maitre, o’farrel & reyers, 2007). these ecological-economic models are generally focussed on a better understanding of the benefits derived from a stock of natural capital through the flow of ecosystems services over time (crookes, blignaut, de wit, esler, le maitre, milton, mitchell et al., 2013). the outflow of this work on a micro-level is to adjust prices for the benefit and damages on ecosystem services. on a macro-level it is to include the value of ecosystems and 694 sajems asset research ns 19 (2016) no 5:690-701 natural resources in environmental impact assessments, green accounting, integrated environmental economic indicators and macro-economic modelling approaches. several studies in this edition contribute to a better understanding of ecological-economic interactions using a system dynamics modelling (sdm) approach. three of them (morokong blignaut, nkambule, mudhavanhu & vundla, 2016; mudavanhu, blignaut, nkambule, morokong & vundla, 2016; vundla, blignaut, nkambule, morokong & mudavanhu, 2016) use sdm to support cost–benefit analyses that include the dynamic interaction between economic and ecological sub-systems. morokong et al. (2016) consider the feasibility of clearing invasive alien plants (iaps) to improve the flow of water rather than building the de hoop dam in the olifants river catchment in south africa. they calculate the unit reference values (urv) over the lifecycle of the two options – an integrated indicator of net present value (npv) and water yield – and concluded that the clearing of iaps is a cost-effective option for catchment management in the olifants river. mudavanhu et al. (2016) and vundla et al. (2016) consider the use of iaps as a resource for both electricity generation and value-added products respectively. mudavanhu et al. conclude that the production of electricity using rooikrans at the de hoop nature reserve in south africa is feasible as a biomass electricity generation strategy when compared to a diesel generation option. vundla et al. (2016) conclude that the cost of clearing iaps can be reduced through the development of a public-private co-financing partnership with industries that benefit from value-added products. crookes and blignaut (2016) use a predator-prey system dynamics model to simulate the dynamics between steelmakers, the automotive sector and the iron ore industry in south africa. the lotka-volterra model they employed, has its roots in population ecology and was first used to describe the dynamics of biological systems in which two species interact. it has however been applied in various ways in economics. this approach explicitly allows for alternatives for steelmakers, whose growth is restricted because of capacity constraints. the authors conclude that steelmakers do not have to forfeit their business, but can rather opt for less resource-demanding technologies. an eco-labelling scheme for steel is proposed as a policy option. van loeper, musango, brent & drimie (2016) respond to the relevant question of how smallholder farms can play a role in improving food security in the south african context. they develop a system dynamics model on the underlying forces between participants in agricultural value chains in south africa and conclude that banks can play a key role in stimulating/ encouraging smallholder farm production. much of this work on integrated ecological-economic systems modelling points toward a need to strengthen the institutional environment and the governance of ecosystems. these are needed before ecosystems services can be effectively allocated through economic incentives (such as payments for ecosystem services (pes)) within the boundaries of environmental sustainability. policy instruments such as pes can play a role in improving environmental governance, but it cannot be expected that they can completely solve complex policy problems (muradian, arsel, pellegrini, adaman, aguilar, agarwal, corbera, et al. 2013). in other words, the ees approach contributes a great deal in better understanding the interaction between physical process and value judgements made in economy-environment interactions, but does not solve questions on how to engage with the social realities of actual human behaviour, institutional functioning and governance. eree and ees approaches all tend towards a normative approach to economic policy, whether focussing on efficiency alone or allowing for other values such as ecological sustainability and justice. the realisation that institutions and property right regimes are pivotal in environmental and natural resource management is not new, but have recently joined with a systems approach in what has become known as the socio-ecological systems approach. 4 socio-ecological systems (ses) approach the ses approach, rooted in both a systems approach and new institutional economics, emphasises the role of institutions and property rights in the management of natural resources such sajems asset research ns 19 (2016) no 5:690-701 695 as fish, water, land, grazing and forests (berkes & folke, 2000). apart from man-made and natural capital, explicit distinction is made for cultural capital which refers to “the factors that provide human societies with the means and adaptations to deal with the natural environment and actively modify it” (berkes & folke, 2000:6). humans are seen to be specifically included in the ecosystem where feedback from the environment and learning processes inform and shape policy and management. traditional knowledge and local expertise are seen as valuable resources in environmental management. socio-ecological systems (ses) are conceptualised as resource users who self-organise to maintain resources and achieve sustainability under certain conditions (ostrom, 2009). the modelling approach is bottom-up by allowing macroscopic properties of complex adaptive systems emerge from the non-linear dynamic interactions of humans in relation to each other and at lower levels to their environment (levin, xepapadeas, crépin, norberg, de zeeuw, folke, hughes, arrow, barrett, daily, ehrlich, kautsky, mäler, polasky, troell, vincent & walker, 2012). modifications to the system are focussed on achieving greater sustainability, increasing resilience and co-evolution, but not excluding human intervention. technological innovation can at times be required to enhance resilience (farley & voinov, 2016). the prescriptive expectation is that human values and ethics will have to adapt to be in tune with the development of societies that are ecologically sustainable (berkes & folke, 2000:431). such prescriptions have led to the critique that the ses approach needs to include aspects of power and competing values to better be able to address the question for whom resilience is desired and at what cost (cote & nightingale, 2012). 5 heterodox economics of the environment and sustainability (hees) not everyone is comfortable with the close association between ecological economics and neoclassical economic approaches, despite more realistic interpretations of complex and dynamic human-environment interactions in the ees and ses methods. some have argued that such developments do not go far enough and that the future of ecological economics lies firmly among heterodox economic schools of thought and in ideological opposition to existing institutional structures (spash, 2012). some ecological economists are in discussion with more traditional heterodox economic schools of thought such as post-keynesian economics, marxist economics and institutionalism (douai et al., 2012). three strands of thinking are highlighted here, namely biophysical economics, social ecological economics and evolutionary economics. 5.1 biophysical economics the biophysical economic approach uses basic ecological and thermodynamic principles to analyse the economic process (cleveland, 1999). this is a vastly different approach to valuation and implies different ethical positions from neo-classical economics (ayres, van den bergh & gowdy, 2001). solowand holling-sustainability differ on the substitutability of natural capital with other forms of capital, such as human labour and man-made capital. standard production function models allow combinations of inputs and per definition admit perfect substitution, yet the possibility and limits of substitutability between factors such as capital, labour, energy and other forms of economic activity are questioned (ayres, 2008). the argument is that limits to a continued supply of natural resources, a clean environment and energy need to be explicitly acknowledged and included in growth modelling approaches. material and energy flows through the economy are important indicators of system sustainability and cannot just be assumed to be an outcome of applying capital and labour to natural resources. environmental constraints are treated as normative prescriptions to economic activity and human actions need to conform to the physical realities for the good of mankind (cleveland, 1999). empirical testing of the relationship between movements of market prices for material and energy and indicators of material and energy scarcity (such as eroi) is required before such a claim can be generalised as norm. the increasing scarcity of oil, for example, is already included in market prices that would stimulate a transition away from oil towards alternative energy, 696 sajems asset research ns 19 (2016) no 5:690-701 although such price signals are not sufficient to guarantee a smooth transition (heun & de wit, 2012). the reality of non-perfect substitutability and limited time frames of transitions point towards the need to steer towards smoother transitions. 5.2 social ecological economics social ecological economics rejects neo-classical principles altogether, is located in modern political economy, and provides an ideological and methodological critique on economic approaches to environmental management and policy (spash, 2013; spash & ryan, 2012). the economic system is “regarded as totally infused with power relationships and embedded within social structures” (spash & ryan, 2012:1100). the implication is that social and environmental problems are seen as inseparable. 5.3 evolutionary economics evolutionary economics has developed on the premise of change in technology and economic organisation and the analogy of natural selection for profitable firms in markets (nelson & winter, 1982). it seeks to develop from an evolutionary basis of human behaviour and morality (hodgson, 2012a). theoretical concepts such as co-evolution, bounded rationality, path dependence, diversity and selection as well as the process of technological change and innovation constitute the evolutionary economic approaches to environmental management (van den bergh, 2007). evolutionary economics has revealed an extended neglect of environmental and natural resources. biophysical limits are acknowledged, but are rather seen as starting points for innovation (faber & proops, 1990). economic policy emphasises diversity rather than efficiency or even ecological sustainability. a diversity of options would provide the space for adapting to changing circumstances and preferences through selection and new innovations (van den bergh, 2007:60). policies aimed at transitions towards sustainability are therefore not a search for an optimal policy, but instead suitable environments for innovation and selection. transitions are not merely technical, but operate across multiple levels in various economic, social and political contexts (baker, newell & phillips, 2014). 6 discussion on the opportunities and limitations of economic approaches the main opportunity for economic approaches to environmental management and policy is its general acceptability and application in the formulation of environmental policy. in the words of harrington, morgenstern & sterner (2004:1): “if in fact we are all environmentalists now, the central issues today are what works, what doesn’t, and what it costs”. economic approaches are also used to support south africa’s transition to greener growth, most notably policy instruments such as carbon emissions taxes, fuel taxes, feed-in-tariffs for renewable energy, water pricing, waste water discharge charges, levies on plastic bags, deposit-refund schemes on recyclables, payments for ecosystem services, and biodiversity offsets. in certain cases cap-and-trade systems have developed, most notably water trading schemes among farmers (nieuwhoudt & armitage, 2004). balancing the norm of economic efficiency with other norms such as justice and sustainability remain an important focus area in developing economies like south africa, characterised by high inequality and high ecological footprints. investment into ecosystems and greener urban infrastructure to increase the chances of a steady flow of ecosystem services, and attribution of value to dis-incentivise exploitation (e.g. through pes schemes) are important opportunities for using economic approaches to environmental management and policy. apart from those who argue that economic approaches are not sufficient to achieve stronger forms of sustainability – an ongoing debate between solow and holling definitions of sustainability – a main limitation of mainstream economic approaches to environmental management and policy, lies in its claim to be value-free. contrary to much of modern economic thought, ethical analysis does play an important role in understanding how economies function. not only do the values of human beings influence both behaviour and economic outcomes, but sajems asset research ns 19 (2016) no 5:690-701 697 their moral convictions are also influenced by the way economists analyse and describe them (haussmann & mcpherson, 1993:674). in an earlier editorial for this journal, blignaut (2002) pointed towards notable progress achieved by the application of economic theory to environmental and natural resource management, but concluded that the search for a new economic system away from the contemporary newtonian/smithsonian had to continue. in another contribution, he argued that such a system is characterised by a kantian/rawlsian rule-based economic ethic and system of governance that emphasises values of fairness and justice (blignaut, 2004). developments in ecological-economic systems approaches have emphasised complexity and dynamics in response to the reductionism and static approach of neo-classical economics. managerial and contractual approaches are mainly used in the hierarchical governance model. developments in socio-ecological systems approaches have also embraced a theory of complexity and dynamics, but have propagated in favour of a decentralised and collaborative governance approach. in contrast, a veblian/darwinian system of self-organisation and complex adaptation, with a keen focus on micro-level human behaviour, is continually developed in the heterodox fields of evolutionary, institutional and complexity economics, with a network-orientated governance approach (beinhocker, 2007; van den bergh, 2007). biological and cultural foundations for morality have been proposed as an alternative to the metaphysical/transcendental foundations of kantian/rawlsian morality and the utilitarian morality of mainstream economic theory (hodgson, 2012b). despite only touching on the subject of morality and ethics, it is clear from this short discussion that a deeper exposition of moral philosophies and ethical theories in the further development of economic approaches to environmental management and policy is needed. the distinction between facts and values, central to the development of economics at least since the enlightenment, cannot be assumed to hold as a heuristic principle. another limitation is that the methodologies and models used by economists, which are only partial interpretations of reality, are regarded as reality itself. this poses a real risk to economic, social and ecological systems, as decisions are made on the basis of a caricature of reality. the models of reality (ontology) that are used, need to be exposed and interpreted in terms of reality itself. the mandatory choice between objective and subjective realities will be challenged. spash (2012) argues that such a rethink on ontology will have a ripple effect on epistemology, methodology and ideology. yet, there is a difference in an approach that falls into what can be referred to as “untenable idealism”, which is rooted in some form of “transcendental control of human development” or an approach that takes both transcendent and immanent norms “of realized possibilities of a practice as it enters in human living” (sauer, 2003:19). an understanding of economic approaches to environmental management and policy is a process of correlation between transcendent norms and actual practice. such a process is open, fallible and reflective as it is “inherent in the human condition” (soros, 2013). such a reflexive system does not choose between objective or subjective realities, but leaves place for both in a two-way relationship. without a doubt, this will generate tension, but the controls of understanding and value judgement are not closed prematurely through a focus on either empirical reductionism or moral idealism. one way to bridge the gap between modernistic objectivism and post-modern hyper-subjectivism is to engage in a process of selfcriticism done in humility. economists need to expose their models of reality (ontologies), epistemologies, methodologies and ideologies to criticism, pondering what the late south african theologian david bosch states as “the possibility that truth may indeed differ from what we have thought it to be” (bosch, 2010:360). 7 conclusion the objectives of this editorial were as follows: (i) to present a broad outline of trends in the economic approach to environmental management and policy, (ii) to place contributions made in this edition within the broader narrative of such an economic approach, and (iii) to highlight the opportunities and limitations of the economic approach to environmental management and policy. 698 sajems asset research ns 19 (2016) no 5:690-701 first, it can be concluded that at the same time as the mainstream economic approach to environmental management and policy have become accepted in the new green economy and the results are becoming clear, a deeper critical reflection has emerged that cannot be addressed with categories used even ten years ago. ecological economics is largely becoming a subset of mainstream environmental and resource economics and can more fruitfully be referred to as environmental, resource and ecological economics (eree). this field is deepening in its acceptance of complexity and dynamics focussed on ecological-economic systems (ees) and socio-ecological systems (ses), respectively. these shifts have also brought a clearer articulation of heterodox positions, notably biophysical economics, socio-ecological economics and evolutionary economics that are in discussion with traditional orthodox economic schools of thought. a second conclusion is that contributions to this south african edition are largely leading to a better understanding of ecological-economic systems using a system dynamics modelling approach as well as evaluating the impact of natural resource limits and pollution taxes on the broader economy. researchers working on economic approaches to environmental management and policy in the eree and approaches are increasingly faced with matters relating to institutions and governance, components that are central to research arising from the new institutional economics and socio-ecological systems (ses) approaches. third, economic approaches to environmental management and policy are being accepted worldwide and in south africa. these are exciting times to work on such approaches and great opportunities are presented to contribute towards greener economies, communities, households and individual behaviour. yet, there are serious limitations in the treatment of values and morality in economic thought as well as the views on reality assumed in human behaviour and economic modelling. the way forward amidst such heterogeneity is to actively engage various economic approaches to environmental management and policy within strongly scientific empirically grounded research and applications, while correlating the research with deeper questions on value, ontology and epistemology. this means not to reject objectivity nor subjectivity a priori, but rather deploy a strategy of engagement in an attitude of self-criticism, humility and in participation with others. research programmes that involve various disciplines and include participation from various roleplayers are important for moving in this direction (esler, downsborough, roux, blignaut, milton, le maitre & de wit, 2016). one challenge to such approaches is that a reflective process on values, morality, ontology, epistemology and even the methodology of the natural sciences and economics is not possible without a well-developed sense of disciplinary self-criticism and professional humility by the participants. several approaches in the natural sciences and mainstream economics share a worldview of an ordered, objective and material reality and may very likely see any form of subjective reality and contingency as a slippery slope into subjectivism. this does not have to be the case, as accepting contingency does not mean that everything becomes contingent and is thus devoid of logical necessity. however, to test the proposal made in this editorial for a way forward would require an open, fallible and reflexive process that attempts to correlate both actual practice and norms into a fruitful process of learning. such a process would require at least two conditions, namely valuing the 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(eds.) selected readings in environmental economics. new york: norton:179-187. soros, g. 2013. fallibility, reflexivity, and the human uncertainty principle. journal of economic methodology, 20(4):309-329. spash, c.l. 2012. new foundations for ecological economics. ecological economics, 77:36-47. spash, c.l. 2013. the shallow or the deep ecological economic movement? ecological economics, 93:351362. spash, c.l. & ryan, a. 2012. economic schools of thought on the environment: investigating unity and division. cambridge journal of economics, 36:1091-1121. stern, d.i. 2004. the rise and fall of the environmental kuznets curve. world development, 32(8):14191439. turpie, j. 2004. the role of resource economics in the control of invasive plants in south africa. south african journal of science, 100:87-93. van den bergh, j.c. 2007.evolutionary thinking in environmental economics. journal of evolutionary economics, 17:521-549. van heerden, j., blignaut, j., bohlmann, h., cartwright, a.p.j., diederichs, n. & mander, m. 2016. the economic and environmental effects of a carbon tax in south africa: a dynamic cge modelling approach. sajems, 19(5) in print. von loeper, w., musango, j., brent, a. & drimie, s. 2016. analysing challenges facing smallholder farmers and conservation agriculture in south africa: a system dynamics approach. sajems, 19(5) in print. vundla, t., blignaut, j., nkambule, n., morokong, t & mudavanhu, s. 2016. the opportunity cost of not utilising the woody invasive alien plant species in the kouga, krom and baviaans catchments in south africa. sajems, 19(5) in print. sateb nr vol 1 (1998) nr 1 145 the willingness of south africans to support more green reporting c de villiers department of accounting, university of pretoria abstract the purpose of the article is to establish the willingness of south africans to support more environmental corporate reporting. a questionnaire was used in the empirical study. the views of three groups were obtained, namely the preparers of financial statements (directors of companies were regarded as such), auditors of financial statements and their users. seeing that accountability was chosen as the uppermost reason for disclosure in financial statements, the views of users were regarded as most important. however, the views of the other groups may well become more important should environmental legislation or regulation of reponing be considered in future. in analysing the results it was found that there were few cases of significant difference of opinion between the three groups. the preparers, auditors and users of financial statements were generally quite positive about more environmental corporate reporting. they were even in favour of making such disclosure compulsory. introduction the environment is increasingly discussed at all levels in society. business enterprises often have a major and visible impact on the environment. they can, therefore, hardly avoid drawing the attention of environmentally concerned individuals and groups to themselves. one of the methods that corporations employ to improve their image is green (or environmental) reporting. disclosure is, however, still mostly voluntary and without any structure (bogiages & vorster, 1993:53). shareholders, foreign capital suppliers, government, employees, customers and potential customers as well as the general public all claim a right to r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 146 sajems ns vol 1 (1998) no 1 environmental information (canadian institute of chanered accountants, 1993: 12). 1be question arises whether green reporting should be increased or whether the status quo should be maintained. the question can be answered by determining the willingness of different stakeholder groups to support more green reporting. reasons for corporations to disclose green issues the reporting of green issues is not necessarily a philanthropic exercise. nor is it always championed by executives with a particularly soft spot for nature. apart from any ethical arguments in favour of green reporting. there are also some argurnents that make good business sense. for example, the image of the company can benefit from green reporting, which could in rum translate into increased profits. a number of reasons for green reporting are mentioned by gray (1993:211). a summary is contained in table i. the canadian institute of chanered accountants (1993:3-8) mentions, amongst other things. peer pressure and pressure from the capital markets as further reasons for making environmental disclosures. peer pressure would be fe it if most of the players in a corporation's industry already make disclosures. in such circumstances it may be prudent to conform to industry norms. the capital markets are important to any corporation as a future source of funds, be they in the form of shares or foreign capital. the emergence of ethical investment funds could result in increased disclosure of envirornnental information to ensure future access to those funds. externalities can be regarded as a reason for environmental reporting. corporations use natural resources such as fresh air without accounting for the costs involved (estes, 1976:103). 1bese costs are external to the organization and are paid for by others (chua. 1990:2). according to rubenstein (1992:31) the goal of financial statements should be to supply statements which measure the ability of a corporation to produce goods and services after accounting for environmental costs. in order to ensure fairness. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr vol i (1998) nr i 147 table 1: reasons for voluntary disclosure or non·disclosure disclosure: • if not done voluntarily it will become mandatory • to legitimize current activity • to distract attention from other areas • to develop corporate image • to build up expertise in advance of regulation • positive impact on share price • reduction of perceived (company or information) risk • political benefits • competitive advantage • shareholders' and other stakeholders' right to know • to explain expenditure patterns • the desire to tell people what the company has done/achieved • forestall disclosure by other panies noo·disclosure: • obverse of the above • no need/motivation to do so • wait and see • cost • data availability (and related costs) • secrecy • absence of demand for the information • absence of a legal requirement • never thought of it • prioritizing areas for disclosure source: gray. 1993 : 211 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 148 sajems ns vol 1 (1998) no 1 amongst the many reasons mentioned and alluded to, accountability is chosen as the most imponant reason for environmental reponing in this paper. accountability is suggested in table 1 by the item of "shareholders" and other stakeholders "right to know". according to the accounting framework of the international accounting standards committee (also adopted by the south african accounting profession), the aim of financial statements is to provide information regarding the "financial position, performance and the changes in the financial position" of a firm (south a friean institute of chartered accountants, 1990: 12). this information should be useful to a range of users for the purpose of economic decision-making. financial statements will not necessarily reflect non-financial information (saica, 1990:13). accountability is also mentioned in the accounting framework as part of the purpose of financial statements (saica, 1990:14). management has to account for the resources under its control. ijiri (1975:32-3; 1983:75-81), gray, owen & maunders (1987) and gray (1994:1-51) have proposed that the concept of accountability be used as the basis for an accounting theory. another influential repon that mentioned accountability was the corporate repon of the institute of chartered accountants in england and wales (1975:15). accountability theory is similar to agency theory, seeing that principals and agents are also central to it. however, whereas agency theory concentrates on the selfish nature of individuals and the resultant agency costs, accountability theory emphasizes the information rights of principals (gray, 1994:28). the normal principal and agent relationships envisaged in a corporation would be those between the shareholders and the directors as well as between the directors and the managers. gray (1994:28), however, proposes an extension to acknowledge the fact that there are also other stakeholders in corporations apan from shareholders. gray (1994:26) argues that accountability theory is, therefore, able to cater for all accounting, not just the financial variety. accountability theory thus suggests that the purpose of accounting is for managers to account to all stakeholders for the management of the resources under their control. this view is in line with the accounting framework, although only as far as information is useful for economic decision-making. tozer (1992:22) and sandborg (1993:57) concur that the preparers of financial statements must incorporate a social-environmental dimension to achieve the degree of accountability increasingly demanded. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr vol 1 (1998) nr 1 149 green reporting practices in south africa there are no laws or rules specifically dealing with green reponing in south africa (rabie, 1992:83). of course, generally accepted accounting practice (gamp) does call for green reporting in certain circumstances, for instance, in the case of contingent liabilities, where the contingency may be of an environmental nature. however, many companies repon more than the gamp requirements. a number of studies have been done on the green reponing found in annual financial statements. amongst others, there is an annual study by the university of pretoria. as can be expected from a situation of voluntary reponing on potentially sensitive issues, the reponing is mostly in the form of general declarative statements, with no assurance that bad news will ever be published (savage, 1994:3). several surveys have been undertaken to determine the level of environmental reponing by the south african business community. some typical results are: • in a study by clulow (1991 :107),60% of the companies in the survey made no mention whatsoever of the environment in their annual financial statements. • in a study by savage (1994:3), 63% of the companies in the survey did mention the environment in some form or other. • in a study by steyn and vorster (1994:24), only 10% of the companies in the survey disclosed their environmental objectives. savage (1994:3) notes that environmental reponing "tends to be ... partial and unsystematic". bogiages and vorster (1993 :53) conclude that, although environmental reponing could be regarded as limited in the annual reports of european and us companies, south african companies even lag behind the practice in those countries. although environmental reponing is on the increase, according to steyn and vorster (1994:44), it can still not be regarded as satisfactory. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 150 sajems ns vol i (1998) no i research methodology introduction the aim of the present study was to establish the willingness of individuals of different stakeholder groups to suppon more comprehensive envirorunental corporate reponing. this was established with the use of a questionnaire. the development of the questionnaire is discussed below, as well as its method of distribution and the population. the response rate and the representativeness of the results are then also discussed. questionnaire content one of the imponant objectives in the empirical study was to ensure a high. response rate. it was felt that the length of the questionnaire should be limited to ensure this. the questionnaire was, therefore, limited to just 11 questions (refer to appendix a). in the empirical study, 40% of the questionnaires sent out in the user group were addressed to accountants. however, two questions were included in the survey to establish whether the accountants could justifiably be classified as users. these questions related to whether they are employees of companies and whether they own shares in companies. the questions in the main section of the questionnaire were based on a questionnaire used in a study by de villiers and vorster (1995:44-66). the questions in that survey were based on the recommendations of the united nations, the canadian institute of chanered accountants and the institute of chanered accountants of england and wales (de villiers & vorster, 1995:5154). the de villiers and vorster study had cenain shortcomings that were corrected in the current survey. however, the questions in the current survey used the same wording in order to ensure comparability. table 2 gives an indication of which of the three institutions recommended the different kinds of disclosures listed in the survey. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sates nr vol i (1998) nr i 151 table 2: which institution recommended each type of disclosure in the questionnaire question 6a 6b 6c 6d 6e 6f united nations reference 1991. p.19 1991, p.19 1991. p.19 1991. p.19 1991, p.20 distribution of the questionnaire cica icaew reference reference 1993. p.19 1992. p.41 1993. p.19 1992. p.37 1993. p.19 1992. p.47 1993, p.20 1992, p.46 1993, p.19 1992, p.50 1993. p.20 1992, p.44 the questionnaires were distributed to the survey sample during october 1995. the covering letter. the questionnaire (refer to appendix a) and a window envelope for returning the response were sent out. the questionnaire was reproduced on the back of the covering letter. the same package. but with the message "second request" printed in bold lettering on the covering letter, was sent out during november 1995 to the members of the sample from whom no response had been received by that time. population introduction it was assumed that follow-up action would have to be taken to ensure a high response rate. record was, therefore. kept of who responded to the survey. in order to ensure that it would be practical to follow-up the questionnaire, sample sizes were to be kept to a minimum. to ensure that the sample sizes would still yield useful information, the relevant statistical measure considered was r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 152 sajems ns vol i (1998) no i the coefficient of variation of the mean. a coefficient below 10% was regarded as acceptable. the responses of the sample must be known as well as the number of points on the scale. the responses were not known at the planning stage and, therefore, the worst-case scenario was assumed. this would entail half the respondents answering at the one end of the scale, with the other half responding at the other end. with a sample size of 50 and a five-point scale, this still yielded a coefficiem of variation of below 10%. it was, therefore, decided to limit the sample sizes to 50 for each of the three groups (preparers, auditors and users). managers the directors of companies listed on the johannesburg stock exchange (jse) were regarded as the population of managers. the 50 directors were chosen from the jse handbook of september 1995 to february 1996. a total of 655 companies are listed. the companies are listed in alphabetical order. a random sequential sample would therefore approximate a random sample. a random sequential sample of 50 companies was, therefore, taken. one director was then chosen from each of the companies on a random basis. auditors a list of members as at 30 june 1995 was obtained from the south african institute of chartered accountants. the list was in alphabetical order. the members' names and postal addresses were on the list, with an indication if the member was a resident of a country other than south africa. non-residents were excluded from the sample. the list of members had 15 519 names. because the names were in alphabetical order and there was no pattern of occurrences in the order of the names, a random sequential sample would again approximate a random sample. fifty names were, therefore, selected on a random sequential basis. the following four subgroups represent the users of information : r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sa teb nr vol i (1998) nr i 153 chartered accountants not registered with the public accoulualus and auditors board the 20 names were drawn from the same list of south african institute of chartered accountants members mentioned in the section entitled auditors. the sample was drawn on a random sequential basis in such a way that the names were distributed throughout the list. stockbrokers the 20 names were drawn from the lse handbook of september 1995 to february 1996. a total of 356 panners of the various stockbroker firms are listed. the full list of partners is given in each city where the parmership has offices. after the elimination of duplications, a random sequential sample of partners was selected. bankers the five banks were personally identified. the names of corporate managers at these banks were obtained by telephone. assurance company portfolio managers the five assurance companies were personally identified. the names of portfolio managers at these assurance companies were again obtained by telephone. summary a summary of the various groups and the sample sizes is contained in table 3 in the following section. results of the empirical study there might be bias in the responses to a postal survey because of the tendency of individuals who are knowledgeable or enthusiastic about a particular subject, to respond to a questionnaire on that subject. by the same reasoning, less knowledgeable or enthusiastic individuals may not be inclined to respond. it was in fact possible to find out what the responses of non-respondents might have been, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 154 sajems ns vol i (1998) no i because a record was kept of those who responded and who did not. the method is explained in the following section. table 3: summary of mailings and respondents population mailed to respondents managers ± 4(0) 50 auditors ± 5(0) 50 users ± 9500 50 19 of which: chartered aces. ± 9(0) 20 stockbrokers 356 20 banks 62 5 assurance cos. 20 5 totals ±18500 156 possible bias managers and auditors response rate 15 19 38% 4 5 5 5 s3 30% 38% 20% 25% 100% 100% 3s% in order to determine whether the respondents and the non-respondents agreed or disagreed on the issues raised in the questionnaire, a random sample of 5 nonrespondents was selected from the auditor group and 5 from the manager group. an effon was made to obtain the answers of the 10 individuals chosen in this way. it proved, however, impossible to get hold of one auditor and one manager. this does not influence the bias of the group whose opinions were obtained in this way. the fact that it was not possible to get hold of someone has no bearing on hislher opinions regarding environmental reponing. the 8 responses that were obtained by telephone can, therefore. be regarded as representative of the non-respondents in the auditor and manager groups. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sa teb nr vol 1 (1998) nr 1 155 the aggregate of the auditor and manager responses received by mail was now compared to the aggregate of the auditor and manager responses obtained by telephone for each question. the number of respondents was too small to rely on a chi-squared test. fisher's exact test at the 5% level was therefore regarded as an indication of the significance in difference between the two. the tests in fact indicated no significant differences between the mailed and the telephone responses. the fmal sample, therefore, consisted of the responses received by mail and those obtained afterwards telephonically. in the case of auditors. this amounted to (19 + 4) 23 and in the case of managers (15 + 4) 19 cases. users the responses in the user group consisted of 9 received by mail from a total of 40 sent out as well as 10 responses solicited on the telephone. the telephone respondents were identified by asking the receptionist at predetermined organizations to put the researcher through to someone with a specific job-title. in the case of banks this was a manager dealing with corporate clients. and in the case of life assurers a portfolio manager. a response was obtained from each individual so identified. in other words, no one refused to co-operate. it is. therefore. assumed that the responses by telephone would be a good indication of the answers that might have been obtained had all 40 of the mailed questionnaires been completed and returned. the 9 mailed responses were compared with the 10 telephone responses using fisher's exact test at the 5% level. this indicated that there were only two instances of significant difference, namely in questions 2 and 6b. for questions 2 and 6b. the fmal sample, therefore, consisted of the responses received by mail and those obtained afterwards on the telephone. the telephone responses are regarded as representative of the (40 9) 31 non-respondents in the user group. therefore. the telephone responses were multiplied by (31110) 3.l. the result was added to the mail and the telephone responses. these numbers were then multiplied by 19 and divided by 50 to arrive at the final result. the total respondents (users) for these two questions would, therefore, still seem to be 19, although this is the result of a transformed total. for the questions other than 2 and 6b, the final sample consisted of the responses received by mail and those obtained afterwards by telephone. this gave a sample size of 19. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 156 sajems ns vol i (1998) no 1 ymaj number of respondents the final number of respondents is summarized in table 4 below. table 4: ymal number of respondents medium of response mailed to mail phone total managers 50 15 4 19 auditors 50 19 4 23 users 50 19 19 of which: chartered aces. 20 4 4 stockbrokers 20 5 5 banks 5 5 5 assurance cos. 5 5 5 totals 150 53 8 61 representativeness of the results resp/ mail 38% 46% 38% 20% 25% 100% 100% 41% in the section discussing population, the appropriate sample size was mentioned. the coefficient of variation of the mean actually calculated was found to be below 10% in all cases. the sample is, therefore, assumed to be representative of the population. responses to the questions in the study the differences between the responses of the three groups (managers, auditors and users) were analyzed by way of fisher's exact test of significance at the 5% level. the chi-squared test was not deemed appropriate because of the small number of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr vol 1 (1998) nr 1 157 responden£s. where significaru differences (at the 5% level) were found, the fact is mentioned directly after the display of the full resul£s. the purpose of the questions in this section was to ensure that the chartered accountan£s (sa) in the user group can justifiably be called users. do you own shares in a company? 50% answered yes. are you an employee of a company? 100% answered yes. according to the definition of users in the accounting framework (saica, 1990:09), shareholders, employees and customers are, inter alia, users of financial statements. the accountan£s in the user group who responded are all employees of companies, and half of them also own shares in a company. it would also be safe to assume that they are all customers of companies. main section: willingness to support more comprehensive disclosure in the annual report the purpose of the questions in the main section was to establish the willingness of individuals to support more comprehensive environmental corporate reporting in the annual fmancial statemen£s. the answers to the questions were given on a five-point scale. the possibilities were "strongly agree", '''agree'', "uncertain or does not matter", "disagree" and .. strongly disagree" . the responses in the main section of the questionnaire were measured in two ways. firstly, an average score was calculated for each of the three groups. this was done on the basis of a score of 5 for strongly agree, 4 for agree, 3 for uncertain/does not matter, 2 for disagree and 1 for strongly disagree. an average score of 3 would therefore indicate no specific preference. an average of above 3 would indicate agreement and below 3 disagreement. the questions were set in such a way that agreement would indicate a willingness to support more comprehensive environmental corporate disclosure. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . is8 sajems ns vol 1 (1998) no 1 the second measure used was that of percentage agreement. the number of respondents who "strongly agreed" and those who "agreed" were expressed as a percentage of all questionnaires returned in the particular group. a particular question with many "uncertain" respondents could therefore have an average score of more than 3, but a percentage agreement below so%. an average of more than 3 can be regarded as agreement by a group, but a percentage agreement of so% or more is a very strong indication of agreement. the averages of the responses and the percentages agreed for each of the questions and each of the stakeholder groups (managers, auditors and users) are given in table s. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . table 5: summary of research results managers managers auditors auditors users average % positive average % positive average environmental disclosure i more disclosure voluntary 4.2 89 4.0 78 4.0 2 more disclosure compulsory 3.5 s8 3.3 57 4.1 3 part of annual statements 3.9 84 3.6 70 4.2 4 more financial information 3.8 74 3.9 78 41 5 more non-financial info 3.9 89 3.8 74 4.2 ... ~ --------_l_____ _ _______ specific disclosure 6a overview of risks/impacts 4.1 89 4.1 87 4.5 6b environmental policy 4.3 95 4.0 87 4.0 6c measurable targets 3.7 63 3.7 74 4.0 6d performaj1~l)n targets 3.7 68 3.8 78 3.9 6e environmental costs 3.7 74 3.6 74 4.0 6f !':nvironmental audit 3.2 37 3.4 57 4.0 -----in the average column, 3 would indicate no preference, whereas 5 would indicate that everyone answered ·strongly agree" users % positive 90 89 79 89 100 84 74 74 79 84 i ci:i i z ;:o:l 2: ~ z ,., .... t..h 10 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 160 sajems ns vol i (1998) no 1 discussion of the results for each of the 11 questions, the difference in the responses between the groups was compared by way of fisher's exact test at the 5% level. significant differences were found only for questions 6e and 6f. for question 6e there was a significant difference between the responses of auditors and users. for question 6f there was again a significant difference between the responses of managers and users. each group scored an average of more than 3 for each of the questions. this indicates that managers, auditors and users are on average all in favour of more environmental corporate reporting. the more strict percentage measure indicates that more than 50% of each group are in favour of each question, except one. only 37% of managers were positive about third-party environmental audits. more comprehensive disclosure of envirorunenja[ matters is needed on a vo[unjary basis. the the manager, auditor and user groups are on average all positive about more disclosure on a voluntary basis. 78% or more of each group agreed with this. the manager group seem to be most positive with 89% agreement, but they were not significantly more positive than auditors and users, according to fisher's exact test at the 5% level. the reason why managers were so positive about this question may have been that they wanted to emphasize that environmental disclosures should be on a voluntary basis. more comprehensive disclosure of envirorunenjai matters is needed on a compulsory basis. the respondents of all three groups were in favour of more environmental disclosure on a compulsory basis. although users appear on the face to be more positive, fisher's exact test indicates that this is not significantly so. questions 1 and 2 deal with the issue whether environmental reporting should be done on a voluntary or a compulsory basis. this was dealt with in theory in section 2.8. where the conclusion was drawn that it should be made compulsory. according to the above responses, there would seem to be support for this view from various stakeholders. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sa teb nr vol i (1998) nr i 161 all environmental disclosure should be published as pan of the annual financial statements or an addendum thereto to ensure accessibility. the three groups were all in favour of the disclosure of environmental information in the annual financial statements. there were no significant differences between the responses of the different groups. the annual financial statements seem increasingly to be regarded as a source of information regarding all the activities of an organization. more comprehensive environmental disclosure of a financial nature is needed. the respondents in the various groups were equally in favour of environmental disclosure of a financial nature. auditors seem to be more positive about fmancial information than managers, but the difference is not significant. more comprehensive environmental disclosure of a non-jinancial nature is needed, such as descriptive information or information in physical units. respondents were also equally in favour of the disclosure of environmental information of a non-financial nature. managers seem to be more positive about non-financial information disclosure than auditors. although the difference is again not significant. the environmentoj policy of the organization. the respondents felt that the environmental policy of an organization should be published as part of its annual financial statements. the three groups had no significant difference between their responses to this question. such broad agreement also applied to the following items : measurable targets in physical units and in money amounts. where applicable. based on environmental policy. e.g. emissions; performance against environmental targets and comparative figures (previous year); r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 162 sajems ns vol i (1998) no 1 enviro.runental costs (energy; waste handling, treatment and disposal, legal compliance, packaging; fines, rehabilitation; recycling. etc.) !jy category, charged to operating expenses during the period; /ndependant third party attestation oj all the aspects agreed to above. the three groups agreed on the disclosure of third-party environmental audits. managers were, however, an exception, when the percentage agreed method was used. users were significantly more in favour of this kind of reponing than managers. this is in line with the pattern that emerged throughout the analysis of the responses to both questionnaires. managers seem to be reluctant to concede to the demand for information from users. comparison with the results of a previous study the results of this empirical study were compared (0 those obtained in a previous study by de villiers and vorster (1995:44-66) by means of fisher's exact test at the 5% level. for example. the auditors' responses to question 1 were compared to the auditors' responses to the corresponding question in the de villiers and vorster study. this resulted in 33 tests, one for each of the three groups for each of the ii questions. apart from question 6f (see table 2), the tests indicated no significant differences between the responses to the current study and the previous de villiers and vorster study. the above question deals with independent attestation of environmental reponing. and significant differences were found between the auditor, manager and the user categories. the three groups were all significantly more in favour of reporting the results of independently performed environmental audits in the current study than in the previous de villiers and vorster study. a smaller number of environmental items to be reponed will apparently be more acceptable. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sates nr vol 1 (1998) nr 1 163 conclusion it can be concluded from the empirical study that south africans are willing to suppon more comprehensive environmental corporate reponing. even on a compulsory basis. users of financial statements are in many cases more positive about this than the preparers and the auditors of these statements. users. according to accountability theory, have the right to the information they require. measures should therefore be taken to ensure that users of financial statements do get environmental information that they require too. the accounting profession and the government are in a position to make more environmental corporate reponing compulsory by, for example, amending the fourth schedule to the companies act and/or introducing a new accounting standard. the items of environmental reporting in the appended questionnaire can be used as a point of depanure for such amendments/statements. the environment has long been overlooked as an imponant issue by business enterprises. this will become increasingly difficult in the future as the general public demands responsible environmental management practices from business. the right of environmentalists and other representative bodies to corporate information is also increasingly acknowledges, for example, by the south african institute of chartered accountants (1997:04) and the institute of directors in southern africa (1994:2). these information rights should be entrenched by making environmental corporate disclosure compulsory. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 164 sajems ns vol i (1998) no i appendix a to: fax no: all answers will be treated as strictly confidential and will be used for statistical purposes only qufstionnaire on environmental reporting • please indicgle the mosi acculllle opuoill7y marking it iilth a cro.<s • please indicgle your olin pel'lonji \iews i. 2. do you own shares in a company? are you an employee of a company? yes no yes no willingness to suppon more comprehensive disclosure in the annual repon to what degree do you personally agree/disagree with the following statements: &4 a strongly agree agree d sd u uncertain/does not matter i. more comprehensive disclosure of environmental matters is needed on a volunrary basis 2 more comprehensive disclosure of environmental matters is needed on a compulsary basis 3 all environmental disclosure should be published as pan of the annual financial statements or an addendum thereto to ensure accesibility 4. more comprehensive environmental disclosure of a financial narure is needed 5. more comprehensive environmental disclosure of a non-financial narure is needed 6. the following items should be disclosed by organisations: a) a descriptive overview of themajor environmental risks and impacts of the organisation b) the environmental policy of the organisation c) measurable targets in physical units and rand amounts, where applicable. based on the environmental policy e.g. emissions disagree strongly disagree i sa a!u d 2 sa a u d 3 sa a u 0 4 sa a u 0 5 sa a u d a sa a u d b sa a u d c sa a u d sd sd sd sd ! so i so i so so r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sateb nr voll (1998) nr 1 d) e) performance against environmenlal targets and comparative figures (previous year) environmenlal cost (energy; waste handling, trealltlenr and disposal; legal compliance; packaging; fines; rehabilitation: recycling; etc.) by category, charged to operanng expenses dunng the period 165 d sa i a u d sd e sa a u d sd , f) ::n~dth:~~va; attestation of all the i f i sa i a i u i d i sd i please send me a summary of the research results r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 166 sajems ns vol i (1998) no 1 references 1. bogiages, g.h. and vorster, q. (1993). green reponing in the republic of south africa. pretoria: department of accounting, university of pretoria. 2. chua, f.c. (1990). externalities: one of the most dijjicult aspects of social accounting. palrnerston north: department of accountancy, massey university. 3. canadian institute of chartered accountants. (1993, july). reponing on environmental perjonnance. toronto, the canadian institute of chartered accountants, discussion paper. 4. clulow, d.a. (1991, april) financial reponing in all enviroruneluconscious world. accountancy sa, 105-109. 5. de villiers, c.j. and vorster q. (1995). more corporate environmental reponing in south africa? meditari,44-66. 6. estes, r. (1976). corporate social accounting. new york, wileyinterscience . 7. gray, r., owen, d. and maunders, k. (1987). corporate social reponing: accounting and accountability. englewood cliffs, n.j., prentice-hall. 8. gray, r.h. (1993). accowuing for the environment. london, paul chapman publishing. 9. gray, r.h. (1994). accowuing, the accountancy profession and the environmental crisis (or can accountancy save the world?). meditari, lsi. 10. ijiri, y. (1975). theory of accowuing measurement. sarasota, florida: american accounting association. 11. institute of chartered accountants in england and wales. (1975). the corporate repon. london: the institute of chartered accountants in england and. wales, disgussion paper. 12. institute of chartered accountants in england and wales. (1992). business, accowuancy and the environment: a policy and research agenda. london, the institute of chartered accountants in england and wales, a policy and research agenda. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sated nr vol 1 (1998) nr 1 167 13. institute of directors in southern africa. (1994). the king report on corporgle governance. johannesburg, the institute of directors in southern africa. 14. liiri, y. (1983). on the accountability-based conceptual framework of accowuing. journal of a accowlting and public policy, 2, 7 5 8 1. 15. rabie, m.a. (1992). nature and scope of environmenral law. in: fuggle, r.e and rabie, m.a. (eds.). environmental management in south africa, cape town: juta, 83-98. 16. rubenstein, d.a. (1992, march). nglural capital and invisible interests in natural resources. cpa journal, 62(3), 28-33. 17. sandborg, v. (1993. autumn). producing an annual environmenral report. journal of environmental regulation. 3(1), 57-68. 18. sa vage, a.a. (1994). corporate social disclosure practices in south africa: a research note. social and environmental accounting, 14(1), 24. 19. south african institute of chartered accountants. (1990). statement ac 000: framework for the preparglion and the presenrglion of financial stglemenrs. johannesburg, the south african institute of chartered accountants. 20. south african institute of chartered accountants. (1997). stakeholder commumcglion in the annual report. joharmesburg, the south african institute of chartered accountants. 21. steyn, j.o. and vorster, q. (1994). green reporting in the republic of south africa second edition. pretoria: school of accounting sciences, university of pretoria. 22. tozer, l.e. (1992). the accowuing implicglions of the new zealand resource management act 1991. palmerston north, depanment of accountancy, massey university. 23. united nations (1991). accowuing for environmental protection measures. new york, un ctc isar, paper etc. lotac.3/i99i/5. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2 306 economic basics of tourism kaya ngqaka department of economics, university of pretoria abstract this paper sets out to discuss the potential of tourism as a development instrument for underdeveloped economies. this is done by drawing on economic theory as well as evidence from the real world. while it is acknowledged that tourism development is one of the growth options for these countries, it is a policy often pursued against a background of a narrow resource base and serious balance of payments difficulties. however, only by observing sound economic principles can tourism be expected to achieve its economic goals. jel 010 tourism is perhaps the only sector of economic activity in which the principles of free trade still apply. more important, it is now possible for underdeveloped countries to improve their economies, not by increasing exports via low-cost production, but by tourism ,(nay lon, quoted in oppermann & chon, 1972: 16). 1 introduction the growth of international tourism during the second half of the twentieth century has been called "phenomenal"; for example, between 1960 and 1990 it was reportedly more than 600 per cent (harrison, 1992:3). the upsurge in tourist numbers has moreover caused the study of tourism to develop into an independent specialism tourism management rather more rapidly than was the case with, say, the economics of agriculture or transport economics in the past. in the process, the close relation between tourism and basic economic principles, though never denied, has sometimes tended to shift into the background. yet specialisation is at the base of economics and tourism alike. the purpose of this paper is to make this basic relationship explicit, with particular reference to the goal of economic development. given this bias, the frame of reference here is the developing rather than developed world, though harrison (1992: 8) showed that, in 1989, the latter attracted 65 per cent of all r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 307 sajems ns vol 4 (2001) no 2 revenue from tourism. also, though the paper is concerned with international tourism, it may be noted that this is in fact often largely eclipsed by domestic tourism (oja, 2001). finally, the frequently used (world tourism organization) definition that a tourist is a "temporary visitor staying at least 24 hours in a country" seems rather inappropriate as it really refers to human mobility in general, not tourism in particular. a more meaningful definition is found in the new oxford dictionary of english, to the effect that tourism is "the commercial organization and operation of holidays and visits to places of interest". a tourist, then, is "a person who is travelling or visiting a place for pleasure", from whose point of view tourism is therefore a luxury good. 2 economic basics 2.1 national accounting the essential macroeconomic role of tourism is, at least in principle, captured by the national accounting equation y = c + i + g + (x z), where x includes expenditure by foreign tourists, as one form of a country's export receipts. it is, of course, not an autonomous figure, but more than likely to be positively related to z, the country's import payments. harrison (1992: 60-61) gives the following example, with specific reference to economically developing countries (ldcs): .. tourism is a complex product of which developing countries only supply a part primarily accommodation and some transportation, as well as goods and services supplied by such small-scale establishments as local shops and restaurants. tourism retailing and much of the transportation used by tourists is supplied by firms based in industrialised countries. the costs and benefits that developing countries obtain from international tourism thus largely depend on contractual relationships between firms located in destination countries and those in the industrialised countries, from which most tourists originate. such export-import interdependence is not confined to tourism. for example, south africa's pre-1970 policy of "import substitution" at times gave rise to additional import payments for the necessary capital goods, that actually exceeded the import payments saved by means of this policy (brand, 1976: 173). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2 308 2.2 regional economics another, even more explicit, point of contact between tourism and economics may be found in regional economic analysis, in the form of a simple "gravity" model expressed in the following terms (lsard, 1960: 68): mij = pjldij.f(zj wheremij f(zj migration to destination i from source j some function of zj which measures the attractive force of destination i population of source j and distance between sourcej and destination ithe advantage of this model is that the significance of both tourism and economics can now be measured in human numbers. briefly put, the gain in human numbers of a region or country i depends positively on an attractive force z and negatively on the distance d that people must cover, which may be generally interpreted as the obstacles to be surmounted between source j and destination i. of paramount importance is the population p at the source. in the present case, p may represent the potential tourists from the economically developed countries (dcs) who are likely to be attracted by the sights to see in the developing countries (ldcs). given the necessary statistics, the model lends itself to the analysis of both international and domestic tourism, though our present concern is only with the former. 3 links 3.1 development tourism is a major force in global trade and plays an important role in the social, cultural and economic development of both dcs and ldcs. governments therefore often invest in infrastructure in order to promote tourism (copeland, 1991). in the ldcs there has been, still is, considerable debate on how to promote tourism as part of their development strategy. most ldcs are beset by problems like low levels and uneven distribution of income and wealth, high rates of unemployment, small size of their domestic markets which tends to hamper industrial development, heavy reliance on agriculture for export earnings, and widespread foreign ownership of assets. as has been pointed out by mathieson and wall (1982), a rapid injection of tourist expenditure and foreign investment into the ldcs can have a significant r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 309 sajems ns vol 4 (2001) no 2 impact on the economy, more so than if the same sum of money were spent in the developed economies. economic growth and development however requires ldcs to undergo radical economic transformation, for example, from a traditional agricultural economy to a modem industrial one. but, such transformation would normally require more capital and loans than the ldcs as the net exporters of primary products, can raise in order to finance it. the advocates of tourism therefore believe that tourism is in this case both relevant and necessary. the idea of "sustainable development" is particularly relevant to any naturalresource based tourism development. the most straightforward and commonly used definition of it is given by the world commission orr environment and development (1987) in its so-called brundtland report: "sustainable development is development that meets the needs of the present without compromising the ability of future generations to meet their own needs." in other words, natural resource exploitation should take account of long-term effects, including those on future generations, since certain decisions taken in the present impose costs likely to be borne by future generations too. butler, (in briguglio 1996) again defines sustainable tourism development as: "tourism which is developed and maintained in an area (community, environment) in such a manner and at such a scale that it remains viable over an indefinite period and does not degrade or alter the environment (human and physical) in which it exists to such a degree that it prohibits the successful development and wellbeing of other activities and processes". ldcs tend to have a high-income elasticity of demand for basic needs and lowincome elasticity for environmental protection. this is often because the majority of the population is at the margin of subsistence. tourism development in these countries has often reflected these priorities. for example, kenya's coastal tourism development has been characterised by high population growth and over-harvesting and excessive use of resources, for example, high demand for fish and prawns, sewage pollution, deforestation and shortage of fresh water (de beer et ai., 1997). this has led to the deterioration of the tourism industry. an environmentally based development which fails to take care of the environment itself is therefore clearly not sustainable (tisdell, 1999). at least the following requirements have to be met if tourism development is to be sustainable (odendal & schoeman, 1990): development should not disrupt ecological systems, over-exploit natural resources, or damage cultures and societies; technology used should be appropriate to the needs, skills, training and finances of the people using it; and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2 310 development should be based on the needs, efforts and ideals of the local community and ensure self-reliance. however, a major problem with the concept of sustainable development is that it may take a long time to ascertain whether or not an activity is actually sustainable (butler in briguglio et al., 1996). for poor and uneducated communities in the ldcs, it is particularly difficult to make accurate predictions about the future of potential tourism projects. the position should naturally improve, as these communities become more affluent and better educated. 3.2 employment since tourism is a labour-intensive industry, it creates a significant number of jobs fairly quickly, particularly for semi-skilled and unskilled workers. the jobs created are of a low-cost nature, compared to economic activities like manufacturing. tourism is thus regarded as more efficient than many other industries in generating employment in a less developed region or country with limited opportunities for development (ioannides, 1995). tourism may therefore be viewed as an appropriate development strategy for ldcs, seeing that most have a combination of low income and labour in abundance. employment arising directly from tourism, such as hotel jobs, normally absorbs a relatively small number of local residents. indirect employment is however likely to be created in other sectors of the economy that do not directly depend on tourism for their existence but are linked to it, for example, public transport, restaurants, bars and retail outlets, places of entertainment, as well as arts and crafts. induced employment would then arise from a general increase in demand for goods and services as a result of increased tourist expenditure. according to gamble (1989), in an employment survey conducted in tunisia, in 1974, it was estimated that for every extra hotel bed, 5.2 jobs would be created, that is, 1.1 directly in hotels and restaurants, 1.4 indirectly in the supporting industries and 2.7 in investment-related construction. according to archer, cited in harrison (1992), tourism in bermuda was responsible for the direct employment of almost two thirds of the labour force in 1985. the caribbean tourism organisation (cto) in 1989 estimated that, on the basis of 1.19 jobs per hotel room, direct employment in accommodation establishments in the caribbean, bermuda included, amounted to 141 000 people. it went on to estimate that the total number of jobs generated by tourist demand was approximately three times that number. in a recent survey by the world travel and tourism council (wttc), quoted in south african tourism (2001), it was shown that for every eight tourists visiting r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 311 sajems ns vol 4 (2001) no 2 south africa, one job is created directly in the tourism industry. for every 19 tourists visiting south africa one job is created indirectly in other economic sectors. the number of jobs directly created in tourism from 1995 to 1998 in south africa increased by 23 per cent. this shows that tourism has meaningful potential as a major contributor to employment and economic growth. however, other authors claim that tourism's contribution to employment has been exaggerated. bachmann (1988), cited in harrison (1992), claims that in kenya the tourism industry in 1979 employed 0.5 per cent of all kenyan workers, that is, the modern sector contributed 32 000 jobs and was indirectly responsible for another 25 000 work opportunities. but though tourism created some jobs, in reality it did not resolve the regional unemployment problem, because quite a large number of unemployed people moved from other parts of kenya to tourist centres like malindi and watarnu, thus increasing the proportion of unemployed people in those areas. rodenburg cited in harrison (1992), found that international hotels create more jobs than smaller local hotels, pay higher wages and earn more foreign exchange, but also import more, have fewer linkages with local infrastructure and provide few entrepreneurial opportunities to the local population. however, mayer quoted in harrison (1992) claims that in thailand the locally-owned hotels are more successful than large internationally-owned hotels, as far as creating more jobs, income and government revenue are concerned. 3.3 miscellaneous numerous other links between tourism and the economy exist as well, of which the following are briefly mentioned below: entrepreneurship, multiplier effect, economic structure andforeign exchange. entrepreneurship: seeing that tourism has backward linkages, various external economies arise. this is, for example, evident in the construction of hotels, improvement of national as well as local transportation networks, and provision of water and electricity all due to increasing demand in the tourism industry. however, according to mathieson and wall (1982), the establishment of linkages between the tourist sector and local entrepreneurs, depends on the following: the type of suppliers and producers with which the tourist industry's demands are linked. the capacity of local suppliers to meet these demands. the historical development of tourism in the destination area. the type of tourist development. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2 312 linkages stimulate demand for local products, but the effects of this may be constrained by outdated technology and increasing competition from foreign parties. it would therefore be commendable to reduce reliance on foreign agents and intensify links with local entrepreneurs, in order to maximise the positive effects of tourism development. this can, for example, be achieved by developing domestic small, medium and micro enterprises. substantial financial support and training of local initiative in running suitable tourist enterprises in economically less developed regions therefore makes sense. multiplier effect: pearce cited in lea (1993: 41) defines the tourism multiplier effect as the way in which tourist spending filters through the economy, thereby stimulating other economic sectors too. the tourism multiplier can be more precisely defined as the ratio between the ultimate effect of tourist activity on the economy and the immediate expenditure by the tourists themselves (curry in johnson & barry, 1993). the initial benefits of tourism-related expenditure are thus amplified and spread through the domestic economy. the tourism industry has the potential to generate high multiplier effects, provided large leakages through imports can be avoided, for example, by promoting local industry. economic structure: it is likely that tourism development will be accompanied by other changes in the economic structure of tourism areas, like an increase in industrial production brought about by the increasing demand of the tourism industry. many changes in economic structure are prompted by radical transformation from a primary producing economy (e.g. small-scale farming), to one characterised by tourism (e.g. construction of hotels and airports). foreign exchange: it emerged from section 2.1 above that receipts from international tourism are classified as export earnings. tourism is in fact one of the five top export categories for 83 per cent of all countries and the main source of foreign currency for at least 38 per cent of them (world trade organization, 1998:4). 4 cost and risk 4.1 overdepeodence although tourism is a growth industry, it is vulnerable to many influences, such as price and income changes, political developments, the state of the economy, the availability of energy and seasonal factors. a decline in tourism demand due to a change in one or more of the above-mentioned variables in a particular destination area, may result in under-utilisation of resources and services, falling income and even loss of jobs to a greater or lesser extent. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 313 sajems ns vol4 (2001) no 2 it is therefore important for a destination area not to depend entirely on tourism, seeing that it is subject to fluctuating demand. according to mathieson and wall (1982), these areas should try to promote diversity both within the tourist industry and the base economy. at the same time foreign ownership of the tourist resources should be kept at minimum, as this has some negative implications for the welfare of the local population. moreover, tourism increases competition for land use, and consequently land prices are likely to increase in general. 4.2 cost tourism involves various costs and is exposed to potentially devastating risks. often overlooked are the opportunity costs of tourism; what benefits might the population have derived if the resources applied to tourism had been invested in another sector of the national economy? then there are pecuniary supply costs (including maintenance) of tourist services, that range from the principal attractions themselves (e.g. game parks, natural sites, recreational facilities and resorts) to auxiliary services (e.g. accommodation, transport, tour guides). the success of tourism itself may well give rise to additional costs and risks that impinge on supplier and tourist alike: pollution, congestion, environmental degradation, vandalism, crime, increased dropout rates from schools as children prefer jobs in the tourism industry to education, and so on. above all, it is necessary to protect the "goose that lays the golden egg", in other words, to maintain intact the assets (both natural and man-made) which serve to draw the tourists in the first place. 4.3 risk the potential risks in the tourism industry are legion, for example: unrest and war, adverse climatic conditions, epidemics and natural disasters, and economic factors like recession and competition. all these are not only likely to lead to underutilised capacity, but loss of income and jobs as well. 5 conclusion in spite of the costs associated with it, tourism may well serve as a remedy for the sick economies of developing countries. tourism can lead to economic growth and development, thus raising human living standards. as pointed out above, this may be achieved through the creation of employment and investment opportunities, also earning revenue for governments. many different sectors of the economy are influenced by tourist expenditure and therefore benefit from it. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (200 i) no 2 314 the success story of countries like spain, one of the developed countries today, can largely be attributed to tourism development. it is important for the ldcs to realise that they can in fact utilise assets that may have been regarded as "useless", for example, sun, beaches, untapped landscapes and other natural resources (le. eco-tourism) for export and profit. every kind of economic activity has its downsides, and these may be particularly deplorable, even repugnant, in tourism like alcohol misuse, drug trafficking and sexual abuse of children. but like money laundering, these are international problems that call for international countermeasures. some success has already been achieved in this respect; european governments, in particular, now keep an eye on the behaviour of their nationals abroad. not only the points made in section 4 above, but the often seasonal nature of tourism call for expert management. little wonder, then, that tourism has developed into an independent specialism. however, the economic considerations discussed here remain sine qua non. references brlguglio, l. (1996) sustainable tourism in islands and small states, new york, s1. martins press. 2 copeland, b.r. (1991) "tourism, welfare and de-industrialisation in a small open economy", economica, 58: 515-29. 3 de beer,g.r.m., elliffe, s.p., spangenberg, p.p. & wheeler, b. (1997). "the socio-economic impacts of tourism-led development the case of the kenyan coastline from malindi to mombasa", development bank of southern africa specialist business unit, johannesburg 4 gamble, w.p. (1989) tourism and development in africa: case studies in developing countries, london 5 harrison, d. (1992) tourism and the less developed countries, great britain, belhaven press. 6 isard, w. (1960) methods of regional analysis: an introduction to regional science, cambridge, the mit press. 7 johnson, p. & barry, t. (1993) perspectives on tourism policy, great britain. 8 lea, j. (1993) tourism and development in the third world. great britain, rouledge. 9 mathieson, a. & wall, g. (1982) tourismeconomics, physical and social impacts. united kingdom, longman. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 315 sajems ns vol 4 (2001) no 2 10 odendal, a. & schoeman, v. (1990) "tourism and rural development in maputoland: a case study of the kosi bay area", development southern africa, 7(2), 195-207. 11 oja, m. (200 i). hnp://www.postimees.ee/aprilq420qi/arvamus/mallqja. 12 oppermann, m. and chon, k. (1997) tourism in developing countries, united kingdom, alden press. 13 tisdell, c. (1999) biodiversity, conservation and sustainable development, cheltenham: edward elgar. 14 world commission on environment and development (1987) our common future, new york, oxford university press. 15 world tourism organization (2000) www.worldtourism or~:83/omt/wtich.htm .. 16 world trade organization (1998) http://www.wtq.orb/edblish/traptqlle/sery e/w51.doc. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 188 origins of economic instability: real, financial or both? 1 part ii: an appraisal of minsky's financial instability hypothesis j s hart department of economics, university of natal, durban abstract part i of the paper discussed hyman minsky's instability hypothesis and its main critics. part ii now gives a general appraisal of minsky's theory. minsky and the 'structural' endogenous money supply approach in keynes (1936), and in monetarist and neoclassical theory, the money supply is determined exogenously. what this means is that the money supply is determined (by the central bank) independently of the demand for money_ in contrast, post keynesians have argued that the money supply is determined endogenously, although there is disagreement over the nature of this endogeneity. pollin (1991) has distinguished two theories of money supply endogeneity: the 'accommodative' and the 'structural' approaches. the accommodative approach to money supply endogeneity has developed from the writings of kaldor (1970) among others. the best known proponent of this view is moore (1988). though with a somewhat different perspective, lavoie (1984) adopts a broadly similar view on the endogeneity of the money supply. the accommodative approach argues that the central bank has no control over the quantity of money created: all it can do is set the price (interest rate) at which credit is available. the money supply curve is horizontal at this rate of interest. this contrasts with the orthodox view that it is vertical at some quantity of money determined by the central bank. the importance of this 'horizontalist' view of the money supply is its implications for minsky's financial instability hypothesis. minsky argues that as r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 189 sajems ns vol 2 (1999) no 2 a boom develops. so financial fragility increases. eventually, a credit crunch. debt deflation and deep depression may follow. from a horizontalist perspective a credit crunch cannot occur. any increase in the demand for money will be automatically accommodated by the central bank. there is no necessity for interest rates to rise. the central bank may raise them if it so wishes, but need not. this view seems then to undercut the roots of the minskian process of financial instability. whether this is so or not will be explored in the final section. by contrast the structural approach to the endogeneity of the money supply appears to be more in keeping with minsky's ideas. the changing views on liquidity preference as the boom develops lead to an increase in interest rates, which spark off the process of debt deflation. the increase in interest rates occurs because the central bank is assumed not to fully accommodate the (increased) money demand. this approach views the money supply as a stock, rather than a flow: it may be analysed as a (very liquid) asset in terms of the portfolio approach to the demand for money. the interest rate is determined by both the demand and supply of money as in the general theory and money's role as a store of value, rather than a medium of exchange, is stressed. according to rogers (1989: 39-43), the neoclassical synthesis sees money more as a medium of exchange than as a store of value, and adopts the loanable funds view of money and the interest rate. this sees the demand and supply of loanable funds mirroring the demand for investment and supply of savings in real terms. the determination of the interest rate in real terms, ensuring the equality of savings and investment, means that say's law always holds. this rules out the possibility of the existence of involuntary unemployment. but as rogers (1989) has argued neoclassical monetary theory is subject to serious criticisl11s. underlying the neoclassical view that the natural interest rate is deterl11ined by real saving and investment, is the idea that saving precedes and is necessary to finance investment. post keynesians argue the reverse: investment determines incol11e and hence saving (chick, 1983: chapter 9). foster (1986: 962) has argued that [t]he conclusion that the quantity of money is endogenously determined in the keynesian system follows necessarily from the saving-investment relationship. in orthodox economics, the causal sequence is from saving to investment. in the keynesian system the sequence is the reverse, from investment to saving. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 190 it is in this context that minsky's theory, on how financing decisions are crucial to the level of investment that occurs, should be seen. finance and credit determine investment. saving is a residual. the structural approach views liquidity preference as important because it affects the financing of investment, not because it can upset the equality between real saving and investment. it is in this light that dow and dow ( 1987) have argued that endogenous money creation does not diminish the importance of liquidity preference. in their discussion, they analyse the ways in which changes in liquidity preference can affect expenditure plans even if the central bank pursues accommodating behaviour towards the commercial banks. it is in clarifying the meaning of an endogenous money supply and the idea that investment determines saving that we come closer to the heart of the debate surrounding minsky's theory. for the horizontalists, investment demand cannot be constrained by a lack of funds. there is no necessity for a credit crunch and consequent rises in the interest rate as in the structuralist approach. we have seen how a speculative boom can lead to a minskian crash, in terms of the structural endogeneity approach to money. the process may be analysed in terms of keynes's finance motive, an extension to his theory of the demand for money. the finance motive brings out the significance of time. according to keynes (1937: 246) some of the investment decisions of firms generate a "temporary demand for money before it [actual investment] is carried out..." this demand for money to finance planned investment is particularly important during an investment boom. "it is, to an important extent, the 'financial' [le. credit] facilities which regulate the pace of new investment" (keynes, 1937: 248, emphasis in original). finance, to keynes, is a 'revolving fund'. with investment proceeding at a steady rate, the 'flow of new finance required by current ex ante investment is provided by the tlnance released by current ex post investment'. but when ex ante investment greatly exceeds the flow of ex post investment, the problem of finance asserts itself full force. during the short-run interregnum period 'finance is wholly supplied ... by the banks', and it is this fact that makes 'their policy... so important in determining the pace at which new investment can proceed', and since the central bank determines the amount of finance that banks have to offer, it is central bank policy that plays the key role in determining the pace of investment (rousseas, 1986: 37). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 191 sajems ns vol 2 (1999) no 2 it is because structuralists, like rousseas, view central bank behaviour as only partially accommodative that an investment boom can lead to a credit crunch, with rising interest rates. these might spark off a minskian crisis. rousseas (1986: 91-6) points out that in times of tight money, higher interest rates lead to financial innovation and so velocity increases. thus, the central bank will not succeed completely in restricting the growth of credit. however, it has sutlicient control to cause the probability of a credit crunch. it is against this background that a minskian crash can take place. dow and earl (1982) adopt a structural-portfolio approach to money supply and demand. they are among the more sympathetic critics and interpreters of minsky. one of their concerns (dow and earl, 1982: 139) in interpreting minsky's theory is to correct various 'mistakes' in the diagram he uses to explain his theory see figure 1 in part 1. for example, minsky, in his diagram, refers to quantities of investment on the horizontal axis. in view of the ditliculties surrounding the two cambridges capital controversy, dow and earl (1982) suggest the following changes. the p k borrower's risk curves remain demand price for capital functions though they now slope downwards as a result of diminishing returns as well as increased risk. the pi curve becomes an index of new asset prices and lender's risk curves now become supply price of finance functions. it is clear that this latter is different from the supply price of capital. these three changes (index of new asset prices, finance functions and diminishing returns) help the analysis to overcome ditliculties raised by the capital debate. in dow and earl's reformulation of minsky's model, they stress the importance of speculative activity as the source of instability. the boom starts in the real sector and moves to the financial sector as prices start rising. individuals resort to speculation partly as a means of making their wealth inflation proof. as more and more climb on the bandwagon, the artificial demand pushes prices up to levels where the (financial) returns on (financial) assets are way above the returns which could be earned on real assets. keller and carlson (1982) emphasise this aspect: the crash occurs some time atter the speculative marginal efficiency of capital (mec) becomes greater than the objective mec. dow and earl (j 982) list five reasons why the boom comes to an end. most of these are non-speculative factors. examples include unsound investment schemes being exposed, yields diminishing, mistakes being exposed, a general running out of investment ideas. these non-speculative factors indicate that the objective, is less than the speculative, mec. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 192 speculation and the signalling device of the interest rate loom large in the structuralist account of min ski an booms and crises. we now turn to look at the accommodative approach. minsky and the 'accommodative' endogenous money supply approach the accommodative approach is more at odds with minsky's theory. neither an investment nor a speculative boom need run into a credit crunch since all demands for money will be fully accommodated at the given rate of interest. this means that there is no necessity for the interest rate to rise in a boom. this section will describe the accommodative approach as outlined in the writings of moore (1988), rogers (1989) and lavoie (1985). it will then summarise the debate between the accommodationists and the structuralists. this provides the background for understanding lavoie's (1985) criticisms of minsky's financial instability hypothesis. the accommodative approach to (full) endogeneity of the money supply has a long history: the idea of an endogenous money supply, however. is not quite the post-war "discovery" it is sometimes made out to be. in less rigorous form, and lurking somewhere in the background to which it had been assigned, the 'banking principle' supported the notion of the money supply spontaneously accommodating 'the needs of trade' via a passive financial structure as opposed to the dominant 'currency school', which was based on the 'real bills' tradition ... (rousseas, 1986: 65). the accommodative approach had its post-war revival in the radcliffe report (l959) and the writings of kajdor (1970, 1982) and moore (1979, 1984, and 1988). rogers (1989: 174) points out that this approach views liquidity preference as determining only the short-run money market rate of interest. in place of the wicksellian long-run natural rate, it sees the long-run rate of interest as set exogenously by the central bank at some conventional rate. this conventional rate does not, however, reflect the real forces of productivity and thriti: (dutt and amadeo, 1990: chapter 5). the money supply is perfectly elastic at this rate of interest. moore (1988: 3) quotes wicksell (1898) on this point: it is no longer possible to refer to the supply of money as an independent magnitude, differing from the demand for money. no r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 193 sajems ns vol 2 (1999) no 2 matter what amount of money may be demanded from the banks, that is the amount which they are in a position to lend (so long as the security of the borrower is adequate). the banks have merely to enter a figure in the borrower's account to represent a credit granted or a deposit created. when a cheque is then drawn and subsequently presented to the banks, they credit the account of the owner of the cheque with a deposit of the appropriate amount (or reduce his debit by that amount). the 'supply of money' is thus furnished by the demand itself. the radcliffe report (1959) concluded that because of rapid institutional change, conventional monetary policy had ceased to be effective. in the event of a tight monetary policy being imposed there need be no limit to the velocity of the circulation of money (rousseas, 1986: 63). kaldor (1970) went further than this and argued that the money supply was fully endogenously determined. in doing so, he indicated that the issue of the determinants of the money supply was not simply related to post-war institutional change but to the revival of a long standing theoretical issue: the banking versus currency schools controversy. moore (1988) argues that only commodity or metallic money is exogenous. only in these circumstances can the reserve bank be seen as a causal influence supplying reserves which provide the base for commercial banks to increase the money supply via the money multiplier process. the quantity of credit money, by contrast, is determined by the demand for bank credit. moore (1984) distinguishes between the behaviour of banks in retail and wholesale markets. in retail markets, where they are interested in extending their quantity of profitearning assets, they seek to make as many loans as they can: they are quantity takers and price setters. the non-bank public take as many loans as they wish at a price set by the bank. the banks then use the wholesale markets to borrow (or lend any excess) the required quantity of funds at a price set ultimately by the central bank. the supply of money schedule must be viewed as horizontal in every short-run period, essentially at whatever short-term interest rate the central bank chooses to supply liquidity (kaldor, 1982). the central bank's primary obligation is to ensure the liquidity of the financial system, by standing ever ready to provide lender-oflast-resort facilities. consequently, it can never quantity-constrain bank reserves ... (moore, 1994: 106, emphasis in original). it follows that there are no effective quantity constraints to the money supply. the only constraint is a cost one central banks can choose the discount rate and thereby set the short-term market interest rate. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 the direction of causality implied by the conventional multiplier model is more like the reverse of what actually occurs. reserves are the result, rather than the cause, of movements in deposits (moore, 1984: 107, emphasis in original). 194 the idea is that banks, as profit-making institutions, seek first to grant as many loan requests as are demanded. this then gives rise to deposits within the banking system. the commercial banks then set about acquiring the required amount of reserves from the central bank. pollin (1991) has sought to test the accommodative versus the structuralist approaches to money endogeneity. he argues that if central bank and non-bank reserves are perfect substitutes at the ruling interest rate and the supply of reserves is perfectly elastic at this rate, then an increase in loans should lead to a proportionate increase in reserves. if this were the case, it would provide support for the accommodative view. the results of his tests show, however, that reserves do not increase proportionately to loans. the central bank does not fully accommodate the commercial banks' demands for reserves. (the implication is that reserves borrowed through the discount window of the central bank are not perfect substitutes for non-bank reserves.) this is what one would expect from a structuralist approach. it explains the growth of liability management: because accommodation is not complete, quantity constraints on reserves can be eased by making the limited reserves support a greater volume of deposits. with rising interest rates, liability management attracts funds out of deposit accounts with high reserve requirements into ones with low requirements such as certificates of deposit, federal funds and eurodollars. all this is in accord with minsky's financial instability hypothesis. these financial innovations occur within a given institutional structure in response to rising interest rates. but these financial innovations, pollin (1991) argues, lead to a new institutional financial structure with a new set of interest rates. liability management is seen as relieving only temporarily the liquidity shortage occasioned by lack of full accommodation by the central bank. in this situation, the scene is set for an eventual credit crunch, financial turbulence and minskian cnsls. moore (1991) attempts to summarise the substantive issue at stake. structuralists say the central bank can and does control reserves, but that quantity restrictions are offset by innovative bank liability management. the money supply curve slopes upward. the accommodative approach argues that the central bank can set only the supply price of funds and that both the base and the money supply are endogenously determined. the money supply curve is horizontal in the short run. he feels the structuralists may agree to the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 195 sajems ns vol 2 (1999) no 2 horizontal nature of the short-run curve, though not the long-run curve. but he argues that the long-run interest rate is based on expectations of future shortterm rates and so the long-run curve will also be horizontal. for moore (1991) there simply is no money supply function. the rate of interest does not adjust to equilibrate the demand and supply of money. the interest rate is an autonomous political instrument. moore (1991) replies to points raised by pollin (1991). the fact that reserves do not increase in direct proportion to loans does not prove the central bank is not fully accommodative. the relation between loans and reserves is complicated by deposits. while individual banks may not be able to borrow from the central bank, they are always able to borrow on the financial markets at the going interest rate. for the system as a whole, only discount window reserves increase total reserves. on the issue of substitutability between borrowed and non-borrowed reserves, moore maintains that since total required reserves are pre-determined by the existing deposits and total non-borrowed reserves by open market operations, the monetary authorities must provide the residual reserves. individual banks may show differences in propensities to borrow reserves. moore's approach implies that it is institutional change that has resulted in the money supply becoming fully endogenous. wray (1990: 149-50) rejects the idea that originally commodity money was exogenous and as the form of money developed, so it became more endogenous. he argues that money has always been endogenous. this is because it is intrinsic to the process of production in capitalism. like kaldor (1970), his intervention is another contribution to the long-standing banking school versus currency school debate. this also applies to the writings of rogers and lavoie. it is along these lines that rogers (1989) and lavoie (1985) argue. according to rogers (1989: 175) bank money "because it is generated in the process of production or speculation appears as part of a process and often as effect rather than cause". the integration of money in the economic system must not be done when output is already specified, as in the exchange economy of general equilibrium models ... but rather money must be introduced as part of the production process ... those who organise production require access to existing resources, mainly human labor. this access is provided by credit money. any flow of production requires a flow of new credit or the renewal of past flows of credit. the banking system creates the necessary credit ... money is introduced into the economy through the productive activities of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 the finns, as these activities generate income. there can be no (bank) money without production (lavoie, 1984: 773-4). 196 for lavoie, money must be analysed as a credit tlow and not as a stock of commodity money. viewing money as a credit flow linked closely to the process of production can be seen as the other side of the coin to minsky's view of money as debt which must be entered into prior to production. here minsky's theory is in accord with the accommodative approach. this, therefore, appears to be an inconsistency in minsky's theory which falls within the framework of the structuralist approach. lavoie (1985: 75) contends that some post keynesians have not managed to completely break out of orthodox thinking with regard to money endogeneity. they argue that money is not completely endogenous and that interest rates must rise when income rises. he cites the case of davidson (1972: 226) who recognises the money supply can be created endogenously yet on the next page (1972: 227) asserts that the central bank can control the stock of money. he explains this apparent inconsistency as resulting from a reluctance to break with keynes's portfolio approach. lavoie (1985: 77) takes issue with minsky's (1982a: 124) statement that "the financing needs of the investment boom raise interest rates": according to minsky, this seems to be the result of both the rapid increase in the demand for financing (1982a: 140) and the abandonment of safe assets consequent to euphoric expectations (j 982a: 123). this explanation borders on the lack-of-savings thesis and is quite contrary to both post-keynesian monetary theory and keynes' view of the trade cycle. in chapter 23 of the general theory, keynes makes it quite clear that rises in interest rates were consequential to the crisis. they were not the cause of it. he argues, along with rogers (\989) and moore (1988), that interest rates are not determined via liquidity preference interacting with the supply of money. there is thus no necessity why they should rise in a boom. lavoie ( 1985: 77) argues that for minsky (1982a: 140) interest rates rise in a boom in terms of a "modified excess demand for loanable funds theory". new loans granted during the boom lead to an excess supply of money which, via monetarist-type reasoning, generates increased aggregate demand. central banks raise interest rates as an anti-inflationary measure. this line of reasoning presumes an excess supply of money. he denies this can ever exist and quotes kaldor and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 197 sajems ns vol 2 (1999) no 2 trevithick (1981: 7): "the recipients of such an excess would use it to diminish their liabilities and the money so used would be 'extinguished as a result of the repayment of bank debt' " (lavoie, 1985: 77). in line with rogers (1989), lavoie (1985: 78) argues that interest rates are basically "the result of a convention (townshend, 1937), a consensus between those who can manipulate and those who can benefit from interest rates". lavoie (1987) has interpreted minsky's financial instability hypothesis from the perspective of a completely endogenous approach to the supply of money. he argues that minsky's hypothesis depends on two main phenomena: during the course of a boom (i) the financial system becomes more fragile, and (ii) interest rates rise. he accepts minsky's arguments for the first phenomenon, but uses different reasoning to account for the second. financial instability may prevail, but not only for minsky's reasons. an appraisal of minsky's financial inst ability hypothesis the last two sections have viewed minsky's theory trom the structural and accommodative approaches to money supply endogeneity. this section will evaluate minsky's theory from a perspective which adopts points from both the structural and accommodative approaches. in so doing, it will draw on rogers (\989) and shackle (1967,1974). the thrust of the argument is that minsky fails to make a sufficiently coherent and convincing case for his endemic instability thesis, i.e. that we are constantly threatened with a 1929-type crisis. this does not mean that minsky's theory should be discarded. instead, it can be reconstructed to support the notion of potential instability. minsky's theory tits in mostly with the structuralist approach to money supply endogeneity. this sees money as a stock than as a tlow, as an asset than as a debt. indeed, the view of money as a safe asset is central to minsky's argument that when confidence fails, there is a move towards a preference for greater liquidity. if the money supply is structurally endogenous this drives up interest rates. the scene is set for a minskian crisis. but minsky's theory is also consistent with the accommodative approach to the endogeneity of the money supply. this approach stresses the credit nature of money the other side of the coin to minsky's view of money as debt. it also emphasises money as a flow which is generated with the process (flow) of production. again, this fits in with minsky's emphasis on the necessity tor financial flows to be maintained: uncertain revenue inflows must validate certain fixed wage and other cost outflows. this view stresses the potential of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 198 instability arising from credit money. since its cost of production is negligible, credit 'mountains' can easily be built up. this too is the kind of scenario in which a minskian crisis can take place. because minsky's theory draws on aspects of both the accommodative and structural approaches, there seems to be a prima facie case that his theory involves conflicting statements. these might be resolved if the ditlerences between the structural and accommodative approaches could be reconciled. palley ( 1991) has attempted such a reconciliation. he argues that in normal circumstances central bank practice accords with the structural approach. the central bank does not immediately and fully accommodate commercial bank demands for reserves. instead, it exercises its authority and seeks to control inflation and the exchange rate. in these circumstances, increases in the demand for money can lead to rises in the interest rate and the scene is set for the development of a credit crunch and minskian crisis. but once it is clear that abnormal circumstances prevail and a crisis might occur, central bank practice accords with the accommodative approach. the central bank fulfils its role as lender of last resort and fully accommodates the demands of the commercial banks. the foregoing coincides with minsky's account of how potential crises develop, but are prevented from occurring by the intervention of the central bank. it also appears to resolve conflicting statements in minsky's theory. up to the point of crisis, the structural approach holds sway. only in preventing its consequences, does the accommodative approach become relevant. unfortunately, things are not quite as simple as this. much of the role of money in minsky's theory in 'normal circumstances' is in accord with the accommodative approach. in minsky's view of the process of investment, a decision to invest is a decision to incur debt. the role of money as a flow is fundamental to distinguishing between the various types of debt financing from hedge to speculative to ponzio increasing amounts of debt-financed investment occur without significant increases in the interest rate. the reason for these conflicting aspects of minsky's theory may stem from wider shortcomings in his approach. minsky locates instability in the financial sector. he stresses repeatedly that instability is rooted in monetary relations rather than real relations. crotty (1990), we have seen, describes theories which root stability in either the monetary or the real sector as monocausal. he argues that both marxian and neoclassical theories generally view instability as arising r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 199 sajems ns vol 2 (1999) no 2 from the real sector. minsky is correct to argue that the phenomenon of instability can be analysed only in money terms (and not real terms). but this does not mean to say instability arises only in the monetary sector. we need to analyse instability from the perspective of monetary analysis as outlined by rogers (1989) and schumpeter (1954). we will consider minsky's theory from the perspective of three major characteristics of monetary analysis: the nature of production, the role of credit money and the principle of effective demand. rogers (1989: 167) stresses that it is the capitalist nature of production rather than the recognition of the importance of money that is fundamental in monetary analysis. much of minsky's view on production accords with this characterisation. for example, minsky follows kalecki's theory of prices which links profits to the classical notion of surplus. minsky, we have already noted, has been criticised for explaining the tendency for sustained good times to tum into credit crunches and potential crises in terms of a "persistent boom psychology" (pollin, 1985: 349). there must be a more fundamental, objective reason to explain this instability. but as downe (1987), among others, has pointed out minsky does not adopt the marxian notion of a falling rate of profit. this could, as has been argued by the 'profit-squeeze' theorists, provide fundamental and objective reasons for minskian crises. neither can minsky tum to the neoclassical concept of diminishing returns to explain the tendency of booms to peter out. the returns that minsky uses in his theory are of course keynes's quasi-rents and these are not as he himself emphasises measures of marginal physical productiv ity (minsky, 1975: 96). on both the neoclassical and marxian arguments there would be some necessity even deterministic necessity for returns to diminish. given constant costs, the boom must come to an end. the model can be closed. if minsky were to adopt the tradition of monetary analysis, he would be in a better position to emphasise the uncertainty of capitalist production and the subjective nature of keynes's quasi-rents. there are no objective reasons for the boom to begin or to end. the model cannot be closed. fuither, minsky would do well to adopt the accommodative approach to money supply endogeneity. as discussed earlier, key aspects of minsky's theory depend on this approach's viewpoint that money is a flow of credit. although lavoie (1987) has given a formal account of how changes in interest rates (which rise in times of a minskian crisis) can be accounted for in terms of the accommodative approach, this approach can also explain a minskian crisis without the necessity for it to be sparked off by an interest rate rise. this may r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 200 be done by making use of keynes's distinction between the industrial and financial circulations of money. according to rogers (1989: 168) the "industrial and financial circulations become the transactions and speculative demand in the general theory". whereas the demand for money in the industrial circulation, like the transactions demand, is stable, the demand for money in the financial circulation depends on "the comparative attractions in the mind of the depositor of [savings-deposits] and of alternative securities" (keynes, 1930, i: 38, emphasis added). this allows uncertainty to play an important role and explains the greater volatility of the tinancial sector of the economy. rousseas (1986: 34) points out that keynes, in the treatise, analysed the potential conflicts that might exist between the financial and industrial demands for money. in this regard a speculative boom which took place in the tinancial sector (assuming a partially endogenous money supply) could well end up "stealing resources from the industrial circulation" (keynes, 1930, i: 254). if full accommodation from the central bank were not forthcoming, interest rates would rise causing deflation and a fall in output in the industrial sector. if full accommodation was forthcoming, interest rates would remain low, but the speculative boom might lead to a runaway speculative bubble, which would eventually burst in a crash similar to that of 1929. according to rousseas (1986: 35) keynes proposed selective credit controls to deal with this potential problem. thus monetary analysis is capable of explaining minskian crises. but, in terms of monetary analysis endemic instability, i.e. the ever-present threat of a potential i 929-type crash occurring, is unlikely. rather than envisaging a series of short-run minskian booms and crises, monetary analysis adopts an interpretation of keynes's principle of effective demand which supports the notion of a potentially unstable equilibrium. this concept of equilibrium provides a fundamental benchmark for analysis something which is missing from minsky's theory. within the tradition of monetary analysis, the potential instability of the economic system depends on the degree of stability of certain key independent variables. amongst these the two most important are the wage rate and the interest rate. both of these variables are determined mainly by convention. they do not reflect any underlying natural forces. this framework also explains ongoing and persistent unemployment which minsky's theory does not explain. in minsky's theory unemployment in the slump would alternate with full employment in the boom. rogers ( 1989) argues that because the rate of interest is a conventional rate, there exists no automatic mechanism whereby it could adjust to that rate which would yield full r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 201 sajems ns vol 2 (1999) no 2 employment. in monetary analysis it is the 'real' rate of return which adjusts to the 'money' or conventional rate of return and not the other way around as is the case in neoclassical and real analysis (rogers, 1989: 214). the possibility for the conventional rate not to adjust in the long term then explains persistent involuntary unemployment. although the fmmework of monetary analysis would seem to imply greater stability, this is not really so. the instability is still present and is basically that of the keynesian kaleidics of shackle (1974). it follows from the fact that the independent variables upon which the stability of the system rest do not have an objective basis "such as costs of production or the forces of productivity and thrift ... " (rogers, 1989: 268). instead, they depend on the subjective notion of the maintenance of a convention. this should make plain enough that the "stability that we do enjoy has a rather fragile basis" (rogers, 1989: 269). the interest-rate in a money economy. this was the enigma that led keynes to the nihilism of his final position ... the interest-rate depends on expectations of its own future. it is expectational, subjective, psychic, indeterminate. and so is the rest of the economic system. the stability of the system, while it lasts, rest upon a convention: the tacit geneml agreement to suppose it stable. the stability, once doubted is destroyed, and cascading disorder must intervene before the landslide grounds in a new fortuitous position. such is the last phase of keynesian economics. but keynes had shown governments how to prolong the suspension of doubt (shackle, 1967: 247, emphasis in original). conclusion in many respects, the global economic instability of the 1990s appears to be better explained in terms of minsky's theory than that of the financial liberalisationists (mckinnon, 1973; shaw, 1973). according to the financial liberalisation perspective financial markets are inherently stable. yet, those south-east asian countries which liberalised their tlnancial systems found that banking and financial crises ensued. according to arestis (1998: 9), financial liberalisation encouraged short-term speculation rather than long-term productive investment. this fuelled a minskian speculative boom. kregel ( 1998: i) points out that most of the lending to firms and financial institutions was in foreign currency, yen and us dollars. this meant than, unlike the 1975 and 1982 experiences in the usa, the local central bank was unable to act as a lender of last resort due to its limited foreign reserves. kregel goes on to argue that the imf misjudged the crises as flow problems: they essentially arose out of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 202 balance of payments problems due to imports exceeding exports. the fund therefore believed that constraining domestic demand (by cutting government expenditure and implementing tight monetary targets) would stabilise exchange rates. "but the problem was a stock problem, as firms and banks tried to liquidate their stocks of goods and assets to liquidate their stocks of foreign exchange debts. in keynesian terms it was a problem of a shift in liquidity preference, not a problem of a shift in spending propensities that had to be achieved" (kregel, 1998: 15). the imf policies were therefore "exactly the opposite" of what was needed to stop a minskian debt-deflation crisis. while the above provides support for minsky's theory in explaining the asian crisis, problems arise from minsky's contention that such crises are endemic to the economic system. in this respect minsky fails to make a sufficiently coherent and convincing case for his thesis that the economy is endemically unstable. rather, as it has been argued above, the economy is potentially unstable. this view accords more closely with the greater degree of stability that exists in today's industrial economies than is implied by minsky's theory: the 1987 wall street crash, for example, did not lead to a i 929-type depression. moreover, keynes's principle of effective demand which defines the existence of an equilibrium level of output and employment for the economy implies that instability is potential rather than endemic. our conclusion is therefore that minsky's theory needs to be set firmly within the tradition of monetary analysis. minsky (1988: ix) correctly points out that when instability returned in the late 1970s "orthodox economics offered no support for the efficacy of interventionist policies to maintain income and employment". while the financial instability hypothesis explains why interventionist policies are needed, his theory requires a firmer base from which to answer criticisms such as tobin's (1989: 106) that "minsky's excellent account of asset pricing and investment decisions is separable from his theory of prices, wages and profits". monetary analysis provides such a base and in addition allows the development of a consistent theoretical framework for analysing the process of production and the relations between surplus or profit and interest notions central to minsky's theory. further it will enable the results of the debate on the nature of money supply endogeneity to be applied to minsky's theory another crucial area for his financial instability hypothesis. this is not to imply that the only path lies within the tradition of monetary analysis. account needs to be taken of the criticisms raised by both the neoclassical and profit-squeeze theorists. one of the criticisms raised by rousseas (1986) and pollin (1983) is that aspects of politics and social relations, the problem of aggregation (chick, 1983: chapter 3) and the problem of income distribution should be integrated into the analysis. in particular minsky needs to r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 203 sajems ns vol 2 (1999) no 2 set his theory within a wider vision of how the economic system operates. neither the marxian nor the laissez-faire visions are open to minsky and his fellow post keynesians: their position stands separately from these two established traditions. progress towards developing a coherent post-keynesian vision has been slow. dutt and amadeo (1990) have gone some way toward clarifying keynes's (1936: xxi) 'third alternative'. fitzgibbons (1988) provides an important step towards reconstructing the broad and major philosophical insights contained within 'keynes's vision'. however, much work remains to be done. references i. arestis, p. 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(1990) money and credit in capitalist economies, aldershot: edward elgar. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 118 sajems ns vol 4 (2001) no 1 an analysis of affirmative action in a south african public sector department h e brand and s stoltz department of human resources management, university of pretoria abstract the south african labour market is characterised by a diversity of ethnic and cultural groups. the public sector is experiencing pressure from social, economic, political and legislative circles to make the workplace more representative of the population. this study investigated the affll1llative action process in a national public sector department in terms of its employees' perceptions of that process. a questionnaire was developed and used as measuring instrument on a random sample of the department's employee population. results show that the affnmative action process did influence employees' perceptions of their working life and career, and that the majority of respondents perceived the affirmative action process not to be successful. jelj 53 introduction south africa's history of so-called state controlled inequity played a major role in causing the main fundamental right of the national constitution to be equality. de waai, currie and erasmus (1998: 153) mentions in this regard: " ... there can be no doubt that the guarantee of equality lies at the very heart of the constitution. it permeates and defmes the very ethos upon which the constitution is premised". clause 9(2) of the constitution addresses the issue of affirmative action and clearly indicates that affirmative action does not infringe on a person's fundamental right not to be discriminated against on the basis of race, sex, religion, etc. according to gerber, nel and van dyk (1998), the broad concept of affirmative action can be viewed as an instrument in the process of national reconstruction or even transformation, to eliminate the inequality due to discrimination in the past. most countries with a heterogeneous population composition, had to implement affirmative action at some stage in their history to redress inequalities due to unequal opportunities (skretny, 1996). affnmative action should be used in the national interest with the aim to support those people in the population who have r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no i 119 been disadvantaged by discriminatory laws and regulations, enabling them to develop and maintain themselves in society (luhabe, 1993). in south africa, the need for affmnative action originated from problems relating especially to unequal land distribution, as well as unequal economic, socio-economic, and political issues (wingrove, 1995). unequal representation of members of different population groups in management positions in the public sector is an important issue that often causes conflict and friction. affinnative action is seemingly the most acceptable process to redress this situation. this process should be used as a form of redressing on the basis of merit, and should not be seen as a process to seize power. thus the emphasis should be on correcting and not on discrimination (white paper on affirmative action in the public service, notice 564, 1998). the process should also focus on creating opportunities for those who were discriminated against on the basis of race, sex, religion or language. transformation in the south amcan public sector was inspired by a vision of person-centered or person-driven public administration characterised by the principles of equality, quality, high ethical standards and professionalism (white paper on the transformation of the public service, notice 1227, 1995). the objective of affirmative action in the public sector is defined in the following manner in the white paper on affirmative action in the public service, notice 564, 1998: "the goal of affirmative action in the public service is to speed up the creation of a representative and equitable public service and to build an environment that supports and enables those who have been historically disadvantaged by unfair discrimination to fulfil their maximum potential within it, so that the public service may derive the maximum benefit of their diverse skills and talents to improve service delivery." affirmative action can thus be conceptualised as a strategy for achieving employment equity by addressing inequalities in the areas of organisation culture, personnel composition, human resource practices, service provision and by improving the circumstances of groups and individuals in the workplace. these aspects are to be realised through the creation and utilisation of legislation, programmes and activities to remove injustice and discrimination from the workplace (white paper on human resource management in the public sector, notice 2011, 1997). this study in the light of the necessity for and problems related to the implementation of an affirmative action policy in the south african public sector, a prominent, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 120 sajems ns vol 4 (2001) no 1 national public sector department contracted the authors to do a study of its affirmative action process in tenns of its employees' perceptions of this sensitive process, and this is the main objective of this study. the study is also aimed at identifying possible shortcomings of the process and proposing guidelines for more positive and effective affirmative action. as the study focuses on the department's employee perceptions of the affirmative action process, which involves no comparisons of variables, no hypotheses to be tested were formulated research method the research method followed in this study is discussed under the headings of research strategy, research group, sample, response rate and data analysis. research strategy the survey method, to determine the impact of an affirmative action process on the perceptions of employees of the public sector department, was considered to be the appropriate research method for this study. a questionnaire, using a fivepoint likert scale, was developed and applied to a sample drawn at random from the employees of the department concerned. the questionnaires were distributed together with an information brochure, indicating the motivation for and characteristics of the study, as well as all relevant instructions. employees were also informed that the study was conducted with the approval and support of the department's top management. the following are the particulars of the questionnaire: the questionnaire was developed on the basis of a thorough literature study of the theory and practice of human resource transformation and affmnative action. it contains 70 items and is divided into three sections. these are: section a :biographical information (occupational category, race, gender, age and length .. of employment), section b: evaluation of perceptions relating to the transformation process, and section c: evaluation of perceptions relating to the affirmative action process. the information gathered in sections b and c, can be described as follows: section b: evaluation of the transformation process: items 6-11: respondents' perceptions relating to the transformation strategy and process in the department. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . samms ns vol 4 (2001) no 1 121 items 12-17: respondents' perceptions relating to the management style of the department. items 18-21: these questions focus primarily on management staff and test respondents' knowledge of strategic management. section c: evaluation of the affinnative action process: items 22-32: respondents' perceptions relating to affirmative action in the department. item 33: respondents' opinions relating to whether the affirmative action process in the department can be judged successful or not. items 34-43: respondents' opinions relating to factors that possibly relate to the failure of the afflnnative action process. items 44-52: respondents' indications of factors that should form part of an afflnnative action process. items 53-64: respondents' perceptions of the results of affmnative action after it was implemented in the department. items 65-70: respondents' indications to what extent they themselves are creating opportunities for advancement in the department. the likert-scale is used for the evaluation of the items in the following manner: 1 completely 2 to a larger extent 3 to an extent 4 to a lesser extent 5 not at all the reliability of the questionnaire was determined from the data obtained in this study. the spearman-brown split-half method was used, yielding a reliability coefficient of 0.72. research group the research group consists of employees of a national, prominent public sector department. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 122 sajems ns vol 4 (2001) no i sample a random sample of 800 employees from a total employee population of 12391 was utilised . response rate with an expected response rate of about 50 per cent, 800 questionnaires were distributed, of which 355 were returned, indicating a response rate of 44.38 per cent data analysis after the questionnaires were completed by the respondents, the data were captured in order to obtain statistical information for analysis and interpretation. the data derived from the questionnaires were analysed by means of descriptive and inferential statistics of the spss-windows computer programme. the five biographical variables are presented in frequency tables below. the arithmetic means and standard deviations of the various elements and items of the questionnaire were used to determine significant tendencies, if any. the oneway analysis of variance technique was used to determine the statistical significance of differences between two or more groups on one variable. results of the study description of the sample: the five biographical variables are shown in the following five frequency tables: table 1 broad occupational categories in the department occupatio frequency per cent cumulative percentage judiciary 137 38.6 38.6 human resource 143 40.3 78.9 management support staff 27 7.6 86.5 corporative services 48 13.5 100 total 355 100 table 1 indicates that most respondents belong to the human resource management occupational category, followed by judiciary, corporate services and support staff.. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vo14 (2001) no 1 123 table 2 race distribution race frequency per cent cumulative percentage asian 25 7.0 7.0 coloured j 41 11.5 18.6 black 104 29.3 47.9 white , 185 52.1 100.0 total 355 100 according to table 2, white employees form the majority of the sample, followed by black, coloured and asian employees. table 3 gender gender frequency per cent cumulative percentage male 176 49.6 49.6 female 179 50.4 100.0 total 355 100 table 3 shows that male and female employees are almost equally represented in the sample, with female employees slightly in the majority. table 4 age distribution age frequency per cent cumulative percentage 18-25 57 16.1 16.1 26-30 77 21.8 37.9 31·40 129 36.4 74.3 41 + 92 25.9 100.0 total 355 100 table 4 indicates that the majority of employees in the sample are in the age group 31 to 40 years, followed by those in the age groups 41+, 26 to 30 and 18 to 25 years. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 124 sajems ns vol 4 (2001) no 1 table 5 length of employment no. of yean freqnency per cent cumulative percentae:e 0-5vean 131 36.9 36.9 6-14vean 131 36.9 73.8 15-24 years 62 17.5 91.3 25 yean + 31 8.7 100.0 total 355 100 according to table 5, employees in the groups 0-5 and 6-14 years of service fonn the majority in the sample, followed by employees with 15-24 and 25+ years of service. the questionnaire: the results of the questionnaire items (sections b and c) are shown in table 6. table 6 descriptive statistics of the questionnaire item arith.mean std. std. error variance number deviation width 6 2.685 1.110 0.059 1.234 7 2.921 1.122 0.060 1.259 8 2.701 1.162 0.062 1.351 9 2.318 1.151 0.061 1.325 10 2.451 1.039 0.055 1.079 11 2.096 1.141 0.061 1.302 12 2.777 1.225 0.065 1.502 13 2.746 1.252 0.066 1.568 14 3.237 1.233 0.065 1.520 15 2.980 1.165 0.062 1.358 16 3.101 1.135 0.060 1.289 17 3.242 1.173 0.062 1.376 18 0.344 0.806 0.043 0.650 19 0.580 1.258 0.067 1.583 20 0.600 1.275 0.068 1.625 21 0.569 1.261 0.067 1.591 22 2.346 1.330 0.071 1.769 23 2.741 1.440 0.076 2.074 24 2.637 1.428 0.076 2.040 25 1.963 1.074 0.057 1.154 26 2.946 1.221 0.065 1.491 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vo14 (2001) no 1 125 table 6 continued item aritb. mean std. std. error variance number deviation width 27 3.079 1.183 0.063 1.401 28 1.972 1.171 0.062 1.372 29 2.220 1.218 0.065 1.483 30 2.746 1.433 0.076 2.054 31 2.659 1.327 0.070 1.762 32 3.504 1.389 0.074 1.929 33 1.561 0.623 0.033 0.388 34 2.915 1.369 0.073 1.874 35 3.082 1.300 0.069 1.691 36 2.7j5 1.286 0.068 1.653 37 2.831 1.313 0.070 1.723 38 2.769 1.292 0.069 1.670 39 2.727 1.366 0.072 1.866 40 2.493 1.268 0.067 1.607 41 2.721 1.234 0.066 1.524 i 42 2.724 1.236 0.066 1.528 43 2.538 1.184 0.063 1.402 44 1.713 0.967 0.051 0.934 45 1.676 0.935 0.050 0.875 46 i 1.679 i 1.054 0.056 1.111 47 2.828 1.366 0.072 1.866 48 2.231 !~ 0.064 1.455 ~ 2.490 0.063 1.409 2.349 1.217 0.065 1.482 1.887 1.068 0.057 1.140 1.742 1.085 0.058 1.178 2.901 1.139 0.060 1.298 54 3.217 1.184 0.063 1.402 55 2.690 1.221 0.065 1.491 56 2.882 1.149 0.061 1.319 57 3.158 1.136 0.060 1.291 58 3.166 1.199 0.064 1.438 59 2.794 1.214 v. 1.475 60 3.183 1.161 0.062 1.348 61 3.155 1.047 0.057 1.154 62 3.358 1.119 0.059 1.253 63 3.389 1.135 0.060 1.289 64 3.192 1.144 0.061 1.308 65 2.473 ! 1.215 0.064 1.476 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 126 sajems ns vol 4 (2001) no 1 table 6 continued item aritb. mean std. std. error variance number deviation width 66 1.775 0.977 0.052 0.955 67 1.642 0.885 0.047 0.784 68 1.921 1.223 0.065 1.479 69 2.335 1.232 0.065 1.517 70 2.986 1.411 0.075 1.991 the following inferences can be drawn from table 6: section b: evaluation of the transfonnation process items 6-11: average value of 3 most respondents seem aware of the transformation strategy being followed and feel that they possess the necessary knowledge and experience to partake in the process. items 12-17: average value of 3 respondents seem to have a positive attitude towards the organisation culture and management style of the department. items 18-21: average value of 1 the management staff of the department apparently indicate that they perceive strategic management as an important process in the public sector. they also seem to perceive the reaching of affirmative action objectives as part of the performance criteria for management. section c: evaluation of the affinnative action process items 22-32: average value of 2 respondents seem to have reasonable knowledge of the affirmative action process in the public sector. they also seem to feel that the different cultures and values of employees should be taken into account to a certain extent, and that the public sector and the department apply affinnative action due to political and economic pressure. item 32 shows an average value of 4, seemingly indicating that respondents strongly feel that affirmative action should not carry more weight than merit. item 33: average value of 2 respondents seem to be of the opinion that affmnative action in the department is not being experienced as successful. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vo14 (2001) no 1 127 items 34-43: average value of 3 respondents seem to indicate that there are certain factors that do relate to the failure of the affirmative action process. items 44-52: average value of2 respondents indicate that there are certain important factors that should be a part of a successful affirmative action process. items 53-64: average value of 3 respondents also indicate that there are certain important actions that their employer (the public sector) should execute more effectively. items 65-70: average value of 2 respondents evidently indicate that they are actively creating opportunities for advancement in the department for themselves. one-way analysis a/variance: the results of this analysis are shown in tables 7 to 10. table 7 one-way analysis of variance: occupational category variable f-value p-value perceptions of the transformation process 3.6033 0.0000· perceptions of management style 1.7043 0.371 • knowledge of strategic management 5.640 0.0000· perceptions of the affirmative action 1.7243 0.0339* process factors that should be part of the 1.7070 0.0366* affirmative action process * p::;;0.05 table 7 indicates that occupational category has a significant effect on all five variables in the table post hoc comparison with the scheffe test, however, showed the following: no significant differences between the various occupational categories regarding perceptions of the transformation process. no significant differences between the various occupational categories regarding management style. no significant differences between the various occupational categories regarding perceptions of the affirmative action process. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 128 sajems ns vol 4 (2001) no i table 8 one-way analysis of variance: race variable f-value p-value perceptions of the transfonnation process 18.6324 0.0000* perceptions of management style 20.7134 0.0000* knowledge of strategic management 2.5862 0.0767 perceptions of the affinnative action 10.0961 0.0001* process factors indicating a failure of the 3.3195 0.0373* afftnnative action process opinion relating to factors being part of a 1.7156 0.1814 successful affinnative action process factors reflected after implementation of 11.8515 0.0000* transfonnation & afftnnative action processes advancement opportunities 4.3005 0.143* * p ~0.05 table 8 indicates that race has a significant effect on the variables: perceptions of the transfonnation process. perceptions of management style. perceptions of the afflnnative action process. factors indicating a failure of the affinnative action process. factors reflected after implementation of the transfonnation and affinnative action processes. advancement opportunities post hoc comparison by means of the scheffe test showed that white respondents differ significantly from black respondents in tenns of perceptions of the transfonnation process. table 9 one-way analysis of variance: age variable f-value p-value advancement 0.2706 0.7631 opportunities p ~0.05 table 9 indicates that the research group members' perceptions of advancement opportunities that they create for themselves in the department, do not have a significant effect on the various age groups. post hoc comparisons with the scheffe test also showed no significant differences between the age groups. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 129 table 10 one-way analysis of varianee: length of employment variable f-value p-value advancement 0.0581 0.9436 opportunities p ~0.05 table 10 indicates that research group members' perceptions of advancement opportunities that they create for themselves in the department, do not have a significant effect on the various length of employment groupings. post hoc comparison with the scheffe test also indicated no significant differences between the various groupings. conclusions and recommendations conclusions with regard to the questionnaire are the following: results from the questionnaire indicate that most of the respondents are aware of the fact that a formal transformation strategy and process operate in the department. they also feel that they do possess the necessary imowledge and experience to partake in the process. they do. however, indicate that they would like more information about the transformation process, and want to be timeously informed of all decisions being taken, all legal implications of the process, the exact nature of the process and how it is progressing. respondents seem to feel reasonably positive about the organisation culture and leadership style of the department. management staff indicated that they perceive strategic management as important within the transformational process, and are of the opinion that affirmative action objectives should also serve as performance evaluation criteria for management. respondents seem to have reasonable imowledge of the affirmative action process in the department. they feel that the different cultural backgrounds and values of personnel should be considered in the process, and that the department and the public sector as a whole apply affirmative action because of political and economic pressures. respondents strongly feel that affirmative action should not be more important than personal merit. most respondents indicated that affirmative action in the department is not experienced as successful. they indicated that the following elements should be part of a successful affirmative action process : high employee performance standards ability transparency qualifications and seniority the determination of quotas r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 130 samms ns vol 4 (2001) no 1 equity the long tenn development of employees conclusions with regard to the one-way analysis of variance are the following: the independent variable "race" has a significant effect on the following dependent variables: the transformation process management style the affirmative action process failure of the affirmative action process factors that should be part of the affirmative action process advancement opportunities in tenns of the variable perception of the transformation process, black and white respondents showed significant differences. this tendency can possibly be attributed to white respondents' more negative feelings related to changes in departmental structures and processes. in terms of the variable perception of the affirmative action process, white respondents differed significantly from black, coloured and indian respondents. this might be attributed to the tendency that white respondents experience affirmative action as discriminatory, and feel that promotions is not based on merit. in terms of the variable factors that could relate to the failure of the affirmative action process, white respondents differed significantly from coloured and indian respondents. in terms of the variable factors reflected in the department after implementation of the transformation and affirmative action processes, white, black, indian and coloured respondents differed significantly from one another. in tenns of the variable advancement opportunities, black and white respondents differed significantly from one another. this can possibly be attributed to a tendency by black respondents to feel that they are entitled to promotion because of past discrimination against them. white respondents seem to feel very unsure about their future career. no significant differences between the various age and length of employment groups were indicated in relation to this variable. in terms of the variable knowledge of strategic management, the various race groups did not differ significantly from one another. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 131 the independent variable "occupational category" has a significant effect on the following dependent variables : the transfonnation process. management style. strategic management. the affirmative action process. factors that should be part of the affmnative action process. in tenns of the variables perceptions of the transformation process, perceptions of management style, as well as perceptions of the affirmative action process, no significant differences were indicated by the various occupational groups in the department. with the experiences and results gained from the study, the following recommendations are suggested : all organisations in south africa should accept the fact that statutory intervention to enforce affrrmative action, is a reality. positive and successful affirmative action and employment equity, however, demand effective management. affinnative action should not be perceived to be executed in addition to other administrative tasks, but as an essential part of the organisation's strategic and operational objectives. the implementation of affirmative action and employment equity depend on the organisation's culture and the critical role and functions of certain people. the following specific recommendations for improving the affirmative action process in the department, are: the whole department should be included in the process. an affmnative action manager should be appointed, and line management should bear the responsibility for implementing the programme, not the human resource department. the organisation culture should change, so that affirmative action and employment equity, which include planning, structures, recruitment and selection, can be executed as part of total organisation strategy. special training programmes should be presented to ensure that employees in certain designated groups acquire the necessary skills and qualifications. quantifiable goals to be reached should be drawn up, as well as a timetable for reaching each goal. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 132 sajems ns vol 4 (2001) no 1 internal procedures or processes should be designed to monitor and evaluate the implementation of the affirmative action programme. the final responsibility for the affirmative action programme should rest with a senior manager in the department. ail employees must receive regular feedback regarding the affirmative action process and all related issues. references de waal, j.; currie, i. & erasmus, g. (1998) the bill of rights handbook, cape town, juta. 2 gerber, p.p.; nel, p.s. & van dyk, p.s. (1998) human resources management, (3n1 ed.), goodwood, southern book publishers. 3 luhabe, w. (1993) "affirmative action: creating the reality", people dynamics, 11(8). 4 skretny, j.d. (1996) the ironies of affirmative action: politics, culture and justice in america, london, university of chicago press. 5 wlngrove, t. (1995) affirmative action: a "how" guide for managers, pretoria, knowledge resources. 6 white paper on affirmative action in the public service, notice 564 of 1998, government printers, pretoria. 7 white paper on human resources management in the public service, notice 2011 of 1997, government printers, pretoria. 8 white paper on the transforma non of the public service, notice 1227 of 1995, government printers, pretoria. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 152 sajems ns vol 3 (2000) no 1 regulation, deregulation and bank marketing in nigeria (mob eakpan department of banking and finance, university of uyo, nigeria abstract bank marketing is deregulation friendly in nigeria. this observation derives from the emergence of strong marketing orientation in banks following the sap-induced liberalization of 1989. advertising, product development! innovation, up-front payment of interest on deposit and personal service that came with liberalization, started to wane in 1993 when government reintroduced some controls. however, marketing must not be seen as a tool needed only in a liberalized environment. it is necessary even in control regimes. jelg 21 1 introduction to a keen follower of nigeria's banking development, two issues prompt sharp attention. they are regulation and deregulation. by banking regulation, we mean the imposition of control measures by the monetary authority(ies) with regard to how the banks, on the one hand, and the public with whom they conduct business, on the other hand, are to exercise their defined (something implied) duties, responsibilities and rights. the intention of government in approving and mounting the associated measures is not unrelated to its desire to lay a sound foundation for efficient and effective financial performance in the light of the pi:votal role the banks play in the savings investment process and, by extension, in economic development. deregulation of banking denotes the contrary and defines'a conscious lessening and/or removal of controls on the banks thus allowing them some freedom to do their business their own way, relying on the market forces (demand and supply) as they accept from and extend credit facilities to customers (ojo, 1993; adb, 1995; fry, 1988; agu, 1988). controversies are however rife on whether the state should regulate banking activities et all. dooley and mathieson (1987) and shaw (1973) do not see any virtue in government's control of banking r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no i 153 operations; to them, the banks should be set free and allowed to exercise discretion in the conduct of their business. the two perspectives (regulation and deregulation) carry some implications for bank marketing and point to a long history that predates the independent nigeria. initially, there was no legal framework for banking. however in 1952, the colonial government promulgated the first banking law, the banking ordinance (nwankwo, 1980). subsequently, the period spanning 1952 and 1970 witnessed a much more regulated banking environment with no less than four laws passed (details given in section 2). similar development, through in a lesser degree, followed in the 1970s. however, in the 1980s, a sharp contrast set in when government introduced a deregulation programme that systematically changed the face of banking. this article is written to address the two fronts (regulation and deregulation) and their impact on and implications for bank marketing. in addressing its subject matter, the article divides into four sections. following this introduction (section i), section 2 traces the history of banking in nigeria, and reviews the universe of its regulation and deregulation. this is done to give readers the background of the nigerian banking system. in section 3 how bank marketing fared under the two regimes; we emphasize the activities of commercial and merchant banks. other banks are not considered here, seeing that their operations are relatively limited in scope, often not prominent enough to reflect the ebb and flow of economic activity. section 4 contains some policy implications and concluding remarks. the judgement of the impact of regulation and deregulation on bank marketing is based on a number of variables such as personal service, product development, advertising for business and information technology. a chronological framework that weaves the evolutionary trends of the banks against the enabling/regulatory laws and policies provides a means to explore bank marketing before and after the structural adjustment programme (sap) of 1986. 2 banking: development, regulation and deregulation 2.1 development available records show that the history of banking in nigeria traces back to 1892, when the african banking corporation (abc) is said to have been established in lagos to offer banking services to expatriate companies that existed at the time (nwankwo, 1980). in 1894, the bank of british west africa r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 154 sajems ns vol 3 (2000) no 1 (now first bank) was founded and made to take over the affairs of abc. it took 18 years thereafter before another bank, barclays bank, dominion, colonial and overseas (now union bank), came into being. in 1933, the national bank of nigeria was founded and in 1949, what is now the united bank for africa was established, its original name being the british and french bank. in-between them there were other (indigenous) banks, but this development was short-lived as a spate of failures jolted customers and jeopardized the economy. it is also on record that not less than 20 banks failed between 1930 and 1952 (nwankwo, 1980: 46). moreover, between 1947 and 1952 (a period often referred to as the free banking period) no less than 185 banks were granted registration of which 145 took place inl947 and 40 in 1952. a point to note is that most of these banks were indigenous; they lacked a solid capital base, had weak administrative machinery and low patronage compared with their expatriate counterparts. expatriate banks were favoured; not only were they properly funded by their parents, but quality staff were often sent from britain to manage their affairs. foreign commercial and industrial companies were ever ready to buy their services. in comparative terms, indigenous banks were virtually not there, and a few that operated were severely constrained. after 1952, the development in the banking system became cautious. the caution spanned the 1960s and was sustained into the 1970s with some improvement. in 1960, there were about six banks, the number increased to 15 in 1970 (14 commercial banks and one merchant bank), 22 in 1975 (17 commercial banks and five merchant banks), 26 in 1980 (20 commercial banks and six merchant banks). there was a sharp increase in 1985, when the number of commercial banks jumped to 28 and that of merchant banks to 12, thus giving a combined figure of 40 for the two banking groups. the situation remained unchanged in 1986 except that one commercial bank was added to the list (cbn, 1994). a dramatic change in bank registration took place between 1987 and 1990. five commercial and four merchant banks were registered in 1987 alone, eight in 1988, five and 10 in 1989, ii and 15 in 1990, seven and five in 1991 respectively. in aggregate terms, nigeria had 50, 66, 81, 106, 119 and 120 banks in those years, the respective incremental rates being 22%,32%, 12% and 0.8%. the figure of 120 was retained in 1992, however, the collapse of some banks brought the number down to 119 in 1993, 117 in 1994 and 115 in 1995. in february 1998,26 banks (12 commercial and 13 merchant) had their licences revoked, thus reducing the number of banks further to 89 (table i, appendix a). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 155 2.2 regulation and deregulation the two concepts were stated in section 1, and it was noted that they are always in conflict. until recently, developing countries believed in the magic power of the state (government) in creating the desired direction for the economy. the banking system, being crucial in the scheme of development, often becomes the first to fall under governmental control. so it has been in nigeria too. in the wake of the dismal consequences of pre-independence free banking, governmental control of banking business was initiated in 1952. the banking ordinance of that year served to check the indiscriminate registration of banks, that resulted in widespread failures as noted above. the feeling was that the banks failed because they were given too much freedom in terms of capital requirement and general business conduct. thus banks were required by the ordinance to register before the commencement of business. a sum of ~25 000 was fixed as the minimum paid-up capital, authorized capital was ~50 000 for indigenous and ~200 000 for expatriate banks. in addition, every bank was required to create a reserve fund into which 20% of annual profits was to be paid until the fund equalled the paid-up capital. each bank was to maintain adequate liquidity, not to pay dividends until capitalized expenditure was written off, not to lend on the security of its shares, and not to grant credit of more than jof600 to its directors. these provisions were later toughened when it became evident that bank failures were not abating. government then enacted another ordinance in 1958. in it, the minimum paid-up capital for indigenous banks was increased to ~50 000 while that of expatriate banks was fixed at ~oo 000. still in 1958, the central bank of nigeria (cbn) ordinance was promulgated. the ordinance which created the cbn also gave it the power to administer other banks, to curb the failures that were staring the country in the face. in 1961 and 1962, there were amendments to the banking laws to "deal with issues relating to liquidation and capital adequacy of banks" (ojo and oloyede, 1998: 6). in 1969, another law, the banking decree served to raise the paid-up capital of indigenous banks to jof600 000 and that of expatriate banks to ~ 1.5 million. in addition, banks were to maintain a reserve ratio of 1: 10 between their paid-up capital plus statutory reserves and total deposits; they were not to openly campaign for deposits; were to operate under a regulated interest rate system where upper and lower limits were prescribed for them by government. the financial markets that might have facilitated banking development were poorly developed and rigidly controlled. in the money market, government r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 156 sajems ns vol 3 (2000) no 1 securities dominated, banks were not allowed to invest in corporate securities in the capital market. by and large, before 1986 the banking system was heavily regulated, and government extended its monitoring hand to all aspects of banking, the prime target being interest rates which were fixed with minor variations. lending and borrowing rates ranged between 9.5% 13% and 7.5% 8% respectively, and banks were required to maintain a prescribed ceiling on their annual credit expansions. in 1983, they were not permitted to advance credit beyond the prescribed ratios of 25% for big and 35% for small banks over their 1982 total loans and advances. (previously the ratios were 30% and 40%, and had remained so since the 1978179 fiscal year.) however, smaller banks with loan portfolios not exceeding hi 000 were allowed to increase their lending up to 35% or to 60% of their total deposits, whichever was the higher. (total deposits excluded government lodgings with maturity of less than six months.) sectorally, lending by banks was also not discretionary. prescribed ratios were always readily determined by the cbn on behalf of government. between 1980 and 1985, allocational ratio ranges were as follows (akpan and ayandele, 1999): agriculture export domestic trade overall productive sector 8% -10% 2%-3% 19% 11% 59%60% the period 1986 to 1993 witnessed a great change in the complexion of nigerian banking. within the framework of an unprecedented restructuring programme (structural adjustment programme), governmental control of banking declined opening previously closed doors to banking and encouraging sundry entrepreneurs to join the system. the removal of regulatory controls was indeed phenomenal, introducing new and unconventional banks, lifting the interest rate ceiling thus allowing market forces to determine deposit and lending rates, and freeing banks to campaign for business which caused rapid growth in the volume of deposits (ojo, 1993). government relinquished its ownership interest in commercial and merchant banks, withdrew public sector deposits from the banks and introduced an auctioning system in the sale of treasury bills. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vo13 (2000) no 1 157 3 marketing bank services in a book that details the structure of the nigerian financial system in the 1970s, nwankwo (1980) described bank marketing as the conscious attempt by a bank to identify the financial needs of its customers, with a view to packaging its services in ways that would meet these needs at a profit. need identification as used here, presupposes a profile of the customer's background, emphasizing his income bracket, business dealings as well as the opportunities and threats presented by the environment, both internal and external. however, nwankwo was quick to add that nigeria's banking market was a seller's market. bank officers knew that customers would come to them, first because of the paucity of banking facilities and, second, because of their customers' ignorance that their support was crucial for the survival of the bank. customers should rather have been sought by the banks, not the other way round. in the event, banks exploited the supply shortfall to dictate to their customers, showing little or no interest in personal service which is normally crucial in a business like banking where trust is the watchword that breeds confidence and attracts patronage. nwankwo's observations were supported in a 1996 review of banking developments prior to the deregulation of the late 1980s. akpan (1996) the reviewer, was quick to point out that the pre-deregulation banking caused banks to operate in "straitjacket", always waiting for customers to call on them, taking little initiative to reach out for business. the banks could not have done better in a regulated framework that prescribed how they were to carry out almost every aspect of banking. we may recall that they were forbidden to advertise for business and invest in company shares, and that interest rates were fixed for them. mixed with the limited number of banks which made customers scramble for the existing few, the controls engendered an uncaring attitude in bank staff, who would rather delight in long customer queues and an enormous bureaucracy in bank transactions. wadiri (1981), looking at the problem at an annual seminar organized by the nigerian institute of bankers (nib) in 1980, summarized it as follows: (a) poor counter services arising from a low degree of efficiency by bank officials and the inability of nigerian banks to adopt innovations which have eased bank services elsewhere in the world; (b) indifferent and discourteous attitude of bank staff; (c) the absence of a convenient network of bank branches in most rural parts of the country; (d) the slow procedure in granting bank facilities; (e) cumbersome processes associated with the opening of accounts; (t) low capital base; r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 158 sajems ns vol 3 (2000) no i (g) the irregular issue of statements of accounts. the above inefficiencies were seen by wadiri as particularly unfortunate in view of the fact that the ultimate business of the bank is service predicated on promptness, efficiency and honesty. difficult attempts to lodge and withdraw money at the banks where characteristic, occasionally resulting in the physical collapse of people in the queues and even subsequent loss of life. a number of them were driven into informal finance, noted for the freedom of entry and simplicity of operation (bauman, 1995). excuses for this were many. wadiri (1981: 163) again has this to say: ... most routine business invariably involves a long period of waiting. in some cases, the waiting has to be undertaken in overcrowded and iilventilated banking halls without comfortable seats. added to this is the irritating indifference and brazen rudeness many customers endure from bank staff. in the words ofnwankwo (1980: 66): it could take as much as an hour or more to refer a cheque and in some cases, one appears to be left with the impression that the counter staff take pride in the long queues and the number of people seeking their custom. mail transfers take as long as three to four weeks to reach their destination within the country and almost as long before the beneficiary is finally paid in the case of cash payments. a dramatic change however came in 1989 when, at the order of government, the banking system was deregulated. the deregulation ignited a new marketing orientation which made banks compete openly for business by placing adverts in various media, offering different rates of interest to customers (depending on how they perceived them and the volume of business the customers offered) and recruiting attractive and mentally sharp personnel to deal with the emergent and growing market. between 1989 and 1992, adverts of diverse wording and intentions found their ways into the electronic and print media, pleading with the public for patronage. formerly absent, official vehicles of banks began to wear identification symbols, all in an attempt to woo customers. more importantly, new products were introduced into the banking market and older ones (very limited in number) were repackaged for greater appeal. electronic fund transfers, credit cards, up-front payment of interest, computerization of activities, currency counting machines and the like, became entrenched in banking practice and narrowed the gap between nigerian and foreign banking, thus attracting more people into the banking culture. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no i 159 the sharp increase in the business of banking did not take long to reveal its weak personnel base. swift and unprecedented recruitment of staff became a feature of the banking boom. labour tumover increased, witnessing, in most cases experienced staff leaving the bigger and older banks for the smaller and newer ones, that were ready to pay more to acquire mature skills in order to take advantage of the potential of the deregulated economy (akpan and ayandele, 1999). also, the universities and polytechnics harbouring people with a financial background lost them to the banks. the boom had its own side-effects. fraud became prolific. the expected loss to fraud by commercial and merchant banks was estimated to have been n2 167 million between 1989 and 1997 (table ii, appendix a). commercial banks were dominant, sharing n2 075 million between them; merchant banks lost n92 million. in addition to fraud, widespread financial distress struck the banking system. it first affected eight banks in 1991; the number grew to 42 in 1994,60 in 1995,41 in 1997 and provisionally 15 in 1998 (nolc, 1998). the combined effect of the two problems (fraud and distress) in 1993 made government introduce what is called "guided deregulation" a "two way traffic" in which regulation and deregulation are woven together for a sounder financial performance. government, while deregulating the banks, maintains some control to check excesses on the part of the banks, some of which may overstep their bounds in exercising their freedom. the banks are almost brought to status quo (regulation era); they become cautious once again lessening advertising, divesting from product development, relaxing employee recruitment and training, among other functions. these happen in spite of the fact that governmental measures do not affect the variables except interest rate (ceiling reintroduced), bank registration (embargo placed) and up-front payment of interest (abolished). 4 policy fallout/conclusion the foregoing discussion indicates that bank marketing is deregulation friendly at least, in the context of nigeria. what never took place when the banking system was regulated, became evident between 1989 and 1992 (deregulation period) and began to thin out in 1993 when government brought back some controls. a worrying question that follows, is why did the marketing of bank services tend to deteriorate after 1992 when, in fact government's guided deregulation does not affect marketing variables like advertising, product development and improvement, personal services, etc? r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 160 sajems ns vol 3 (2000) no 1 the banks themselves must answer this question, in the light of the fact that banking business is development oriented and it therefore becomes relevant whether banks operate in a regulated of deregulated environment. the two frameworks are meant to provide an enabling atmosphere for banking, depending on the objective of government that institutes them. since marketing is needed in every aspect of business and, more importantly, in a personalized sector such as banking, the basic marketing variables discussed above do not need to wane as long as they remain within the law. is the deterioration in bank marketing due to a sharp fall in profits of the banks? is it because of the slowing down of public patronage for banking on account of a loss of confidence in the banking system? or is it out of incompetence or inadequacy of bank staff? these questions demand the urgent attention of bank managements. we proffer some suggestions. on the first question, it is a challenge for the banks in nigeria to break new ground, now that the potential of the foreign exchange market has declined. such new ground in our view relates to the traditional role of the banks that of financing real investment. experience has shown that banks have been shying away from financing real investment (akpan, 1999), their excuse being that its gestation period is long and could therefore not bring quick benefit. they rather finance commerce, often violating monetary policy rules when more than the allowed credit allocations made to this sector. in a typical developing economy such as nigeria, the need to finance real investment cannot be overemphasized; the banks should realize this and adapt their credit policies accordingly. there are many investors in agriculture, manufacturing and construction begging for bank financing. on liquidity squeeze (financial distress) we suggest that a concerted effort be made to re-capitalize the banks as demanded by the monetary authorities. the n500 million minimum capital base is a sufficient cushion to support routine commitments like advertising, computerization, and product improvement and development. with a revamped liquidity position and subsequent improved marketing of services, the banks would more than ever before attract public confidence and patronage, which at present are not encouraging. added to increased liquidity, proper credit management policies must be put in place to address the problem of maturity mismatch between deposit liabilities and loan assets. lastly, banks must embrace manpower development, always seeking to secure the best staff and getting ready to train them both on and off the job. the solution to incompetence, low productivity and impersonal service is a radical recruitment policy that hinges on professionalism and training. banking is no r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no i 161 more a free-for-all profession, harbouring people whose qualifications have little or nothing to do with the art and science of shifting money from the surplus economic units to deficit units in a manner that brings about economic growth and development. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . appendix a table i: growth of commercial and merchant banks (selected years) 1970 1975 1980 1985 1986 1987 1988 1989 1990 1991 1992 1993 ~4 1995 1996 1997 no of 14 17 20 28 29 34 42 47 58 65 66 66~ 66 64 65 64 commercial banks no of i 5 6 12 12 16 24 34 48 54 54 53 51 51 51 51 merchant banks --106 i19 total 15 22 26 40 41 50 66 81 120 119 117 115 115 115 source: akpan and ayandele (1999: 78), ndic annual reports and statements of accounts (1995-1998). 1998 • 51 38 89 -~ ; cil z cil 2: w 't::i o -9 'l' r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . samms ns vol 3 (2000) no i 163 table ii: returns of banks on frauds and forgeries (1989 1997 h' million) year amount involved expected loss i -commercial banks ! 1989 98.2 15.3 • 1990 788.8 22.4 • 1991 360.2 25.5 • 1992 351.9 64.8 t!! 1 377.2 241.0 2655.7 883.6 1006.3 226.4 1996 1542.9 371.1 1997 3590.3 224.5 sub total 11 771.5 2074.6 year amount involved exdected loss merchant banks 1989 6.7 0.1 1990 15.4 0.03 1991 28.3 1.2 1992 59.8 8.3 1993 41.9 5.3 1994 743.7 67.1 1995 5.1 2.8 1996 57.8 4.2 1997 187.6 2.9 subtotal 1 146.3 91.9 grand total 12917.8 2166.5 source: akpan and ayandele (i999: 84); ndic annual reports and statements of accounts, 1996-1997. references adb (1995) african development report, african development bank: abidjan. 2 agu, c.c. (1988) nigerian banking structure and performance, africana-feb publishers: onitsha. 3 akpan, i. (1996) "management of financial distress: implications for individuals, organizations and economies", nigerian journal of economic and social studies, 8(1): 53-64. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 164 sajems ns vol 3 (2000) no 1 4 akpan, i. and ayandele, i. (1999) "conservatism versus aggressiveness: a review of banking development in nigeria, 19801995", international journal of social sciences, 1(1): 76-94. 5 bauman, fj.a. (1995) "rotating and accumulating savings and credit associations: a development perspective", world development, 23(3): 371-84. 6 cbn (1994), statistical bulletin, lagos. 7 dooley, m.p. and mathieson, d.j. (1987), "financial liheralization in developing countries", finance and development: 31-4. 8 fry, mj. (1988) money, interest and banking in development, the john hopkins university press: baltimore. 9 ndic (1995), annual report and statement of accounts, ahuja. 10 ndic (1995) ndic (1996) annual report and statement of accounts: ahuja. i i ndic (1997) annual report and statement of accounts: ahuja. 12 ndic (1998) annual report and statement of accounts: ahuja. 13 nw anko, g.o. (1980) the nigerian financial system, macmillan: london. 14 010, a.t. and oloyede, j.a. (1998) "deregulation, concentration and profitability in the nigerian banking system", nigerian journal of banking and financial issues, i (i): 1-24. 15 010, m.o. (1993) a review and appraisal of nigeria's experience with financial sector reform, cbn: lagos. 16 shaw, e. (1973) financial deepening in economic development, oxford university press: london. 17 wadirl, b.p. (1981) "marketing and improving bank services" in domestic and international banking services, cibn: lagos. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 390 sajems ns vol 2 (1999) no 3 survivor syndrome: effects on middle managers in south africa r wiesner department of human resource management and employment relations. university of southern queensland l p vermeulen department of human resource management, university of pretoria c r littler department of human resource management, queensland university of technology abstract the impact of organisational downsizing on employees who remain has been the subject of intense research, particularly in the usa. the issue of so-called survivor syndrome is critically important in relation to productivity growth and the success of restructuring. however, current conceptualisation has been based largely on american research. there has been little data on downsizing in the south african context. the purpose of this article is to discuss the extent of survivor syndrome in organisations that have restructured and downsized in south africa. we ask the questions: does downsizing inevitably result in high levels of survivor syndrome; which factors intensify and modify survivor syndrome; and is there a restructuring cycle? the database constitutes 421 south african organisations. jelm 12 introduction the increasing number of articles on the "best" ways to downsize an organisation, suggest a growing realisation that mismanaged reductions in the organisational workforce can have substantial negative consequences amongst the remaining workers (brockner, 1992; caudron, 1996; beam & pine, 1992; boroson & burgess, 1992; dbm australia, 1995; moskal, 1992; and white, 1996). these employees generally experience a "downsizing survivor syndrome". the downsizing survivor syndrome is a subject of extensive international economic and social debate. however, it has been based largely on american research and data. there has been little data from other countries, including r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 391 south africa. an international research team attempted to bridge this gap, and this paper reports some initial findings. after conducting a national survey, a database of 421 organisations across manufacturing and services was constructed for both the public and private sectors of the south african economy. what is the restructuring trend in south africa? sixty percent of the south african respondents indicated that they had been involved in downsizing during 1994 to 1996. what about the frequency of downsizing? our prior case study data in australia and new zealand showed that the frequency of downsizing is a key factor in causing negative worker reaction. the south african data showed that 57% of the organisations surveyed had downsized twice or more over the two-year period 1995-1996. many more south african firms are in the first stages of restructuring. however, in 1996 (at the time of the national survey) there was no sign of the process letting up 44% of south african managers expected the restructuring cycle to continue for the next two years. it seems that the south african economy is still in the midst of a downsizing cycle today. given the above snapshot observations, what have been the effects of downsizing? much of the research in this area is organised around the notion of "survivor syndrome". this is the focus of the present article too. the two major research questions we address in this article are: what is the impact of downsizing on south african middle managers? what factors intensify and modify the survivor syndrome? in defining the limits of this study, it should be noted that the unit of analysis was the organisation, not the individual employee. therefore, we asked human resource managers to access a variety of employee attitudinal factors including morale, staff commitment, perceived promotion opportunities, motivation, job satisfaction and concern about job security. downsizing survivor syndrome what is the "survivor syndrome"? it is normally defined as the set of emotions and behaviours exhibited by employees who remain in the organisation after the process of downsizing. little attention was paid to the downsizing survivors in organisational research until joel brockner and colleagues conducted a series of studies on the subject in the mid-1980s (brockner et al., 1985, 1986, 1987, 1988a, 1988b, 1990a, 1 990b, i 990c). prior to this research, the emphasis was on the problems of the downsizing victims the unemployed. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 392 sajems ns vol 2 (1999) no 3 brockner (1988: 215) argued that layoffs engender a variety of psychological states among survivors guilt, inequity, anger, relief, and job insecurity. moreover, these psychological states have the potential to affect the survivor's work behaviour and attitude, including level of performance, motivation, job satisfaction and commitment. such arguments were based on equity and organisational stress theory. "management sometimes believes that the surviving employees will be so relieved to still have a job, that they will eagerly get down to business; however, often any relief felt by survivors is overwhelmed by less pleasant emotions of downsizing survivor syndrome" (rubach, 1995: 25). these feelings encompass guilt, loneliness, depression, plummeting morale, destroyed trust, reduced goodwill to the company, lowered confidence and job insecurity (caudron, 1996; littler et al., 1996; skopp, 1993; moskal, 1992; lincoln, 1995; boroson & burgess, 1992; allan, 1996). feelings of being powerless and trapped can thus occur, especially if the external job market is bleak when a "doom loop" is established (moskal, 1992). the bulk of research on survivor syndrome has been based on the united states experience. the american research has consistently found that the negative effects of downsizing as a strategy, have occurred at the human resource level: low morale, decreased productivity, and the hollowing out of company cultures have been repeatedly reported (e.g. elmuti & kathawala, 1993; downs, 1995; van hom & dorris, 1996). van hom and doris (1996: 95) suggest that the american work environment "has become a survival camp where morale, productivity, organizational efficiency and absenteeism have run amuck." the american management association (ama) surveys of managers and workers also show very negative human resource outcomes morale, commitment, job satisfaction and company loyalty are all down (filipowski, 1993: 71). the impact of downsizing on job satisfaction job satisfaction is affected by restructuring, and positive reactions have been recorded in some cases: "we may have more work to do as a result of the cutbacks, but it's much more interesting than before" (brockner, 1992). however, many others feel role ambiguity and overload (brockner, 1992; littler et al., 1996; morin, 1994; smith, 1994; lincoln, 1995). for example, chartered professional accountants are doing more routine bookkeeping and engineers carrying out drafting (buch & aldridge, 1990). this has a very negative impact on the job satisfaction of survivors. our case study research in australia and south africa, also indicate that the negative effects of downsizing on the job satisfaction of survivors far outweigh positive reactions. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 393 the impact of downsizing on staff motivation and commitment as in the case of job satisfaction, brockner (1988, 1992) found that the effects of downsizing on victims are not always negative. survivors respond very differently, even within the same organisational work group. feelings of "survivor guilt" can actually lead to increased performance after mild layoffs, among survivors with a strong work ethic, some of whom prefer the resulting greater variety and autonomy (brockner, 1992: 19). pre-existing stress levels, closeness to layoff victims and the attitude to the fairness of the layoffs affect the ultimate reaction. brockner's research (1992) also led him to conclude that if the survivors had been close to the retrenched workers, then their level of productivity was subsequently often lower, and their commitment and motivation to work lessened, particularly if survivors believed the layoffs had been unfair or if the organisation had been overly generous with retrenchment packages. therefore, the way that layoffs are handled is important to survivor commitment (foulkes, 1980; brockner, 1988; morin, 1996). as caudron (1996: 40) recorded from an interview with compaq computer: " if survivors knew we were helping their friends who were leaving the company, they would feel more positive about downsizing". lowered commitment was also shown by lincoln (1995), smith (1994) and burke (1991). however, conflicting with the evidence of negative reactions to downsizing, is the following comment recorded by brockner (1992): "i feel that some people had to be let go, but frankly, like the organisation, they will probably be better off for it over the longer haul." on the other hand, conflicting emotions and increased workloads, often without training for those new to areas of control, lead to rise in the stress levels felt by survivors, which often leads to lower productivity (morin, 1994; rubach, 1995; steward, 1992; buch & aldridge, 1990). littler et al. (1996: 9) coined the phrase "anxiety intensification through downsizing (aids)" in comparing the process to disease. in addition, grossman (1996), kozlowski et al. (1993) and hamilton (1996) all contend that a grieving period is essential after downsizing, in order for survivors to move forward and overcome feelings of guilt, and rebuild the spirit within the workforce for without this spirit the long-term regeneration and rebuilding of the organisation cannot happen. "future restructuring cannot work if the co-operation and commitment factor is awaiting the last rites. innovation, adaptability, flexibility will all show a decline" (littler et al., 1996: 10). sundram (1996) and pearlstein (1996) claim that downsizing has robbed r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 394 sajems ns vol 2 (1999) no 3 companies of the spirit of their workforce and has loosened the bond between workers and employers. the impact of downsizing on the concern about job security increased feelings of job insecurity seem to be universally experienced by the survivors (allen, 1996; burke, 1991; caudron, 1995; foulkes, 1980; skopp, 1993; boroson & burgess, 1992; moskal, 1992), particularly if layoffs are mismanaged and the changes represent threats rather than opportunities (brockner, 1992). insecurity is also heightened if there is multiple downsizing over a period of time, and people remain in the state of "fearful expectancy" (buck & aldridge, 1990), not knowing "when the rain is going to stop" (smith, 1994: 44). burke (1991) found the effects of job insecurity to be similar to job loss itself, and caudron (1996: 39) found that it could even overwhelm the relief of retaining one's job. however, brockner (1992: 15) also found that survivors might not necessarily feel insecure if there are considerable job opportunities in the labour market. in a repeated study, dekker (1995) found that, contrary to expectations, neither support from colleagues, nor management, nor unions seem to protect job incumbents from negative effects. withdrawal from the job and the organisation, as well as symptoms of psychological stress and burnout may follow. the issue of job security is affected by the notion of a changing psychological contract. a number of writers, for example morin (1994) and caudron (1995), indicate that there is a significant change from a psychological contract which involves elements of job security to one which involves "employability". we do not discuss issues pertaining to a change in the psychological contract in this paper. however, see littler, bramble & mc donald, 1994. the impact of downsizing on staff morale survivors are often ignored before, during and after the restructuring process, yet it is they who will be the linchpins of future profitability. they are the ones counted on to make decisions. and competently execute their jobs. unfortunately, survivors are typically an afterthought, as management is so accustomed to thinking of whom to let go and when to do it, that little thought is given to the emotional workplace needs of the survivors (moskal, 1992: 14). a big risk in downsizing is that it will do nothing to change the way people work; there will be fewer employees who must simply work harder (allen, 1996). the result may well be a disparate group of hardened cynics (lincoln, 1995) that will be overworked and burnt out. productivity often stays the same or deteriorates (lincoln, 1995) and the company may end up hiring the labour back. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 395 frank (1996) questioned the very nature of downsizing, claiming that the resulting fall in morale would cause reduced productivity and an increasing need for overtime. thus, initial short term gain does not always result in long term profit. the impact of downsizing on perceived promotion opportunities the final attitudinal parameter to be analysed in this paper is the survivors' feelings towards their future promotion opportunities (career path). downsizing processes often occur in tandem with delayering (see littler, bramble & mcdonald, 1994). boroson and burgess (1992: 43) found that downsizing caused an increase in job search activity and acceptance of new jobs. changed career paths, reduction of confidence in upward mobility and diminished career expectations were common occurrences (buch & aldridge, 1990; skopp, 1993). the consultants drake beam morin (dbm) australia (1995), conclude that organisations which support and encourage employees in the development of career management skills, will make the effects of further restructuring less traumatic and less costly for both the organisation and the individual. with the current extensive organisational restructuring, career plateaus will appear earlier and in greater proportion than before (tremblay, roger & toulouse, 1995). methodology the primary purpose of the investigation was to obtain national empirical data on downsizing. the survey method was used to obtain the data. a questionnaire was developed by littler et al. (1996) to measure downsizing and delayering in organisations. this questionnaire was first used in australia and new zealand, and then standardised for the south african study. the questionnaire consists of five sections applicable to the organisation, staff numbers, structure and responsibilities of line managers, workforce reduction (including the impact of downsizing on employees), delayering and demographics. despite the widespread use of the term "survivor syndrome", it has not been adequately or operationally defined. we have defined it in terms of six key human resource management variables. respondents were asked to assess these items according to three categories: increased, decreased, unchanged, plus don't know if they were unable to decide. these items were then used to generate an interval scale of "survivor syndrome" scoring 0 to indicate "no survivor syndrome" up to 6 for the worst kind of survivor syndrome (see table 1 in the next section). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 396 sajems ns vol 2 (1999) no 3 the six key human resource management variables are job dissatisfaction, staff motivation, staff commitment, morale among staff, concern about job security and perceived promotion opportunities. these factors were used consistently across the survey questions in relation to the workforce in general other factors could have been incorporated, such as stress levels, but we wished to keep the construct as simple as possible and avoid problems of weak convergent validity. the work of broclrner et aj. (1985), greenhalgh and jick (1989), and cameron et al. (1993) suggests that the above factors are common across a range of studies and should have convergent validity. in addition, analysis of our case survey data (not reported here) also indicated high convergent validity. it should be noted that we asked human resource managers about their perceptions of employee morale and other factors. the data are therefore not based on employee self-reports. however, it is reasonable to assume that if any bias occurred, the human resource managers would under-report employee downturns in morale and commitment. this lends even more weight to our findings. the modus operandi of the sampling in this study was to obtain a broad crosssection of larger organisations throughout south africa employing 50 or more people, and our sample is thus skewed towards these organisations. this size parameter was chosen because of the primary focus on downsizing and delayering. therefore, we constructed a three-part sample: all organisations, organisations which had downsized, and organisations which had delayered. there was a significant overlap between the latter two samples. the time frame of administering the questionnaire has some relevance because of certain minor variations. the questionnaire was administered in south africa in may 1996, and as several questions refer to "the past two years", it should be noted that this means the period 1994-1996. sampling frame it was reasoned that staff working in the human resources area of organisations, would have a perspective on restructuring that is reasonably well informed and more detached than line managers who may be directly affected by such organisational change. the sampling frame was derived from the professional register obtained from the south african board for personnel practice. one thousand two hundred names were randomly picked from the register, and the sample represents more organisations than those noted on the johannesburg stock exchange. a questionnaire, accompanied with a covering letter, was mailed to each member of the sample. a reminder and an additional copy of the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 397 questionnaire were sent to approximately five hundred organisations six weeks after the initial mailing. of the questionnaires originally sent out, 421 responses were received, which represented a rate of 35.08%. of the 421 questionnaires sent back, 17 were spoiled and 22 returned unopened or unanswered. statistical analysis for the purpose of this paper, descriptive statistics were employed in order to demonstrate comparative trends in the data. in addition, we constructed the "negative-survivor-syndrome-scale" index as a measure of "survivor syndrome" in the three countries and across organisations. this consisted of six items (job dissatisfaction, staff motivation, staff commitment, morale among staff, concern about job security and perceived promotion opportunities) which research has shown to have significant convergence in a downsizing context. these items were added into a single score ranging from 0 to 6. the index is unweighted, so that the composite score is a sum ofthe multiple indicators. at the lower end (0,1) the score indicates low survivor syndrome. at the upper end (6,5) the score indicates worrisome levels of survivor syndrome. it is important to appreciate that we are for example not measuring "morale", directly. the causal linkage to downsizing arises from the nature of the question ("consider the effects of workforce reduction over the past two years on staff generally in your organisation. please indicate for each {of the above factors} whether they have increased, decreased or remained unchanged.") overall research methodology in addition to the survey data we conducted a number of interviews in south africa to examine the long-term effects of downsizing and delayering. we do not attempt to present the latter data here, but it affects some of the conclusions drawn from the cross-sectional data. results what have been the results of this restructuring and downsizing and, given the us data on the effects of downsizing, how does the south african experience feature? at the macro level, there had been a period of economic growth and labour productivity had improved. for example, sa breweries, the largest employer in south africa (l1o 100 workers), improved its turnover per employee by 14% over a five year period (financial mail, 1996). however, the results of this research confirm that restructuring cannot be seen exclusively in r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 398 sajems ns vol 2 (1999) no 3 economic tenns. restructuring in general, and downsizing in particular, have the potential to create new obstacles to sustained profitability and growth. the comparative frequency distributions of the "negative-survivor-syndrome" are summarised in table i. table 1 comparative frequency distributions of the "negative-survivorsyndrome-scale" value on scale south africa (n=229) f (%) 0 21 (9.2) i 29 (12.7) 2 to (4.4) 3 19 (8.3) 4 41 (17.9) 5 61 (26.6) 6 48 (21) scale: the lowest value 0 = no survivor syndrome and the highest value 6 = the worst survivor syndrome outcome. the survey results showed that south african organisations have been affected in a negative way by the effects of downsizing (see tables i and 2). the mean response on the "negative-survivor-syndrome-scale" is 3.768 with a standard deviation of 1.9832. tables i and 2 confinn that south africa suffers from a bad case of survivor syndrome. both tables are impact measures of downsizing on surviving employees. for example, table 1 shows that 21% (48) of south african organisations had maximum "survivor syndrome" scores. the distribution is clearly skewed towards significantly negative impacts. sixty five percent of organisations scored more than 3 on the 6 point scale, 47.6% scored 5 or 6, while only 9.2% of organisations had a zero impact scores. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 399 table 2 survivor syndrome in south africa human resource management variables increase decrease morale staff commitment 68.8% perceived promotion 0 rtunities 43.2% motivation 70.8% job dissatisfaction 20.8% concern about job securi 7.6% table 2 summarises effects of downsizing on morale, staff commitment, perceived promotion opportunities, motivation, job dissatisfaction and concern about job security. according to table 2, employee morale fell in 75.4% of cases, commitment decreased in 68.8% of cases, and motivation decreased in 70% of cases, while concern about job security rose in 80% of cases. perceived promotion opportunities is against the trends in table 2. in some ways these results are not surprising, because part of the mix of downsizing and restructuring in south africa, has been the change in political climate. that is, the end of apartheid and a policy of affirmative action have given black south africans a foothold on the organisational career ladder. due to affirmative action, many competent black managers find themselves in an enviable position with regard to promotion. many white managers however find themselves more on a career plateau with restricted future opportunities. this policy of affirmative action is said to explain the moderated effect of downsizing on promotions in south africa. the following written comment by a white male respondent summarises the perception: "affirmative action has resulted in many people skipping the normal promotional steps. this has led to a decreased perception of promotional opportunities by especially white people, and inefficiency caused by delays, while they (the new managers) learn the job and often learn by their mistakes. the latter has led to a high level of frustration on the part of many colleagues. stress levels has increased enormously". however, affirmative action and empowerment of at least some black people do not explain the whole south african picture. slashing and cutting jobs is easy. managing the results is not. middle managers who have survived the period of restructuring are now struggling with far greater levels of responsibility, spans of control and workloads. eighty three percent of firms thought the workloads of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 400 sajems ns vol 2 (1999) no 3 middle managers had significantly increased during the past two years (littler & wiesner, 1996). what do these greater work pressures amount to? in one word burnout. surrounding these pressures is the insecurity of "job today gone tomorrow." south african job insecurity has not been helped by the extent and depth of the public sector restructuring: 300 000 public service jobs were to be shed in three years (pretoria news, 1996). headlines like "public servants in panic over an uncertain future" (pretoria news, 1996: 19) appear regularly, boosted by statements by politicians like "no public servant should feel ensured of a job in the public service in three years time" (pretoria news, 1992). large firms in the private sector also continue to diminish (financial review, 1996: 48). the south african downsizing issue cuts across both economic sectors. the figures in table 2 reflect a scene of managers in crisis as restructuring erodes old securities. though there are idiosyncratic factors (such as affirmative action policy effects), the data suggest a consistent pattern which confirm the negative effects of downsizing on worker behaviour. discussion the downsizing literature also suggests that depth of cutting (10% versus 20% for example) is an important factor in causing negative worker reaction. for example, brockner {1988: 230-3l} found that layoff severity was negatively associated with organisational commitment. this notion has been expanded to a more complex explanation by some researchers. for example, hermann (1969) found that worker reactions to cutbacks depend on what he called time pressure dimensions. two of these dimensions are "forewarning information" and "clarity". forewarning information refers to advance notice to the effect that cutbacks will occur and when this will take place. clarity is defined as the degree of ambiguity of the information associated with the expected events. jick (1985: 93) hypothesised that the less forewarning information and clarity there was, "the higher the likelihood of experienced stress/uncertainty when the cuts finally occur." this hypothesis is strongly supported by existing literature (see for example shaw, 1994: 18-19). jick and murray (l982) combined all of these factors and used the expression "big bomb" to describe a situation of little forewarning and lack of clear-cut information, associated with cutbacks of great severity (i.e. deep job cuts) and time pressure. the depth of job cutting may not be the key factor in survivor syndrome outcomes. the critical factor is the frequency of cutting, related to a sense that management knows what it is doing. as mentioned in the introduction, 57% of the south african organisations had downsized twice or more over the two-year r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 401 period 1995-1996. repeated reductions undermine the morale of remaining employees and their confidence in management's leadership and direction. one way of conceptualising this, is to build on jick's work and make frequency a key factor, as indicated in figure 1. this suggests that survivor syndrome outcomes are intensified or modified by the depth of workforce reductions ("severity"), time pressure ("forewarning information" and "clarity") and the frequency of downsizing. implicit in this type of explanation is that the quality of change management at the organisational level has not been very effective in south africa. our conclusion on this can only be tentative, but it is indicative nonetheless. figure 1 a typology of downsizing situations hijdl high unanticipated major cuts "big bomb" effect low anticipated major cuts "time bomb" effect one-off __ downsizing leaves set of effects as indicated s e v e low high stress unanticipated high to moderate stress depending on management anticipated minor < converts all situations ("firecrackers " or "bombs") into major set of survivor syndrome minor cuts "short-fused r cuts "long-fused repeated -dowdsizing i firecracker" frrecracker" effect effect t moderate low stress stress problems respondents were asked: "over the past 2 years, how often has your organisation engaged in workforce reduction?" consequently, high frequency responses are likely to involve a high recency factor. in other words, given the time frame, if you have done it frequently, you are likely to have done it recently. this means that the frequency variable cannot be insulated from some contamination by a recency effect. this is a difficult factor to control for, and requires further longitudinal research. the recency argument has not been fully articulated in the literature, with the possible exception of the grief model applied to organisational change. but it r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 402 sajems ns vol 2 (1999) no 3 often functions implicitly. downsizing and restructuring cause considerable problems, at both personal and structural levels. people often resist change. however, in time the situation "cools off', people adapt and "grief' problems are finally resolved by acceptance. labour turnover will increase. many people will leave the organisation, especially those who are most dissatisfied. therefore, underlying both the frequency correlations and the restructuring cycle may be recency effects. south africa started extensive downsizing and restructuring only in 1993-1994, although some restructuring efforts date as far back as the late 1980s. our case study and survey results indicate that survivor syndrome outcomes are extremely negative in south africa. the negative impact of downsizing was still fresh in respondents' minds at the time of the survey and it was obvious that the situation had not "cooled off', people had not yet adapted and the "grief' problems had not been resolved by a final stage of acceptance. in a duplicate study in new zealand, the situation proved much more positive than in south africa. however, the respondents in that study had gone through downsizing much earlier and the situation seemed to have "cooled off' by the time of survey. this implies that a restructuring cycle involving a "cooling down" survivor syndrome process is a reality. however, it is possible that frequency of downsizing has an independent effect on the survivors. if a restructuring cycle does exist, then it is important to conceptualise this explicitly. so far, this has not been done in the literature. it should be underlined that we are not referring to a business cycle here. a restructuring cycle is a set of organisational processes involving significant attitudinal shifts by the workforce within a specific time frame, associated with changing organisational structures and downsizing. in particular, such factors as organisational commitment, motivation and concern about job security, seem to be critical. the process of change in such factors is significant in relation to productivity growth, and the success or failure of organisational restructuring. conclusions our concern was to investigate the impact of downsizing on survivors. in this article we have presented some of our initial results. it is evident from the results that the impact of downsizing has hit south african managers hard. the corporate strategy of downsizing can be seen as the modem equivalent of a schumpeterian process of creative destruction, such that downsizing will never end (maurer, 1996). opposed to this linear view is the notion of a restructuring cycle. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 403 until recently, few voices were raised against downsizing as a corporate strategy. however, as disenchantment with downsizing as a strategy has spread in the usa, it has been taken up as restructuring strategy in several other economies. the paradox is that many us firms are now expressing misgivings about the principle of downsizing. this partly relates to the widespread phenomenon of the survivor syndrome in america. such a phenomenon implies that the objectives of downsizing and organisational restructuring are often contradictory (urcot, 1996: 1). downsizing on its own, can minimise or negate any productivity improvement sought from a leaner workforce and job redesign. downsizing can work. it is not always the wrong decision, but nor is it a substitute for a comprehensive restructuring strategy. organisations cannot simply downsize their way to excellence. an addiction to repeated job cuts leads to the collapse of morale, hollowing out, and nipping a possible recovery in the bud. the usa has been undergoing a downsizing cycle since the early 1980s and, perhaps, that cycle is nearing its end. hence the debate rhetoric is now shifting in the usa (ama, 1997). south africans are however still living with the cycles of downsizing and dislocation. endnote this paper is part of a broader project on organisational restructuring, downsizing, delayering and management labour markets, co-ordinated by professor craig r. littler (queensland university oftecbnology) in conjunction with dr. retha wiesner (university of southern queensland), professor richard dunford (victoria university of wellington), dr. tom bramble (university of queensland), and professor leo vermeulen (university of pretoria). professor andrew hede's (sunshine coast university college) input and initiative have been invaluable. references allen, e. 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(1996) "some companies try to rebuild loyalty", wall street journal, september: b 1. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction and background research methodology literature review and approach to analysis results and discussion summary of main findings and conclusion limitations and areas for further research acknowledgements references footnotes about the author(s) pieter van der zwan school of accounting sciences, north-west university, south africa daniel p. schutte school of accounting sciences, north-west university, south africa waldo krugell school of economics, north-west university, south africa citation van der zwan, p., schutte, d.p. & krugell, w., 2018, ‘an evaluation of interest deduction limitations to counter base erosion in south africa’, south african journal of economic and management sciences 21(1), a1816. https://doi.org/10.4102/sajems.v21i1.1816 original research an evaluation of interest deduction limitations to counter base erosion in south africa pieter van der zwan, daniel p. schutte, waldo krugell received: 06 mar. 2017; accepted: 18 apr. 2018; published: 30 july 2018 copyright: © 2018. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the organisation for economic cooperation and development (oecd) made a number of recommendations in relation to interest deduction limitations as part of the base erosion and profit shifting (beps) project. in 2016 the south african national treasury indicated that the interest deduction limitations contained in the income tax act would be reviewed in the light of these recommendations. aim: this paper aimed to describe funding structures of companies in south africa liable for tax and how this relates to other characteristics, including ownership, of the companies. setting: the research was performed using data from tax returns submitted by companies liable for income tax in south africa. methods: this paper reports on descriptive analyses of the research conducted. results: the results showed that the mean interest-to-earnings before interest, taxes, depreciation, and amortisation (ebitda) ratio for certain foreign-owned entities differed significantly from that of domestically owned entities. conclusion: the results may present evidence of profit-shifting activities. they also highlight trends in interest-to-ebitda ratios that may be of relevance for future legislative developments. further related research is required if interest deduction limitations in the south african tax legislation are to be reviewed in light of the oecd proposals. introduction and background as part of the organisation for economic cooperation and development (oecd)/group of twenty (g20) project on base erosion and profit shifting (beps), the oecd identified the deductibility of interest for purposes of calculating taxable profits as one of the areas that required attention (to counter beps) (oecd 2013). this led to an analysis under action 4, ‘limiting base erosion involving interest deductions and other financial payments’, of the oecd/g20 beps project. the final action 4 report, issued during 2015, notes that: the use of third party and related party interest is perhaps one of the simplest of the profit-shifting techniques available in international tax planning. the fluidity and fungibility of money makes it a relatively simple exercise to adjust the mix of debt and equity in a controlled entity. (oecd 2015:15) it contains recommendations (best practice) for governments to implement proposed measures to address the risks posed to the corporate tax base by interest payments and the related tax deductions. the suggested approach includes a general interest limitation (core rule) based on an interest-to-profit ratio. this is coupled with de minimis exclusion rules, exceptions for highly geared groups, and specific anti-avoidance rules to target identified instances not addressed by the general interest limitation rule (oecd 2015). the south african income tax act (act 58 of 1962) (the act) contains certain measures aimed at countering the risk of base erosion through interest deductions. since its introduction, section 31 of the act has contained anti-avoidance provisions in the form of transfer pricing adjustments that apply to interest incurred at excessive rates or interest paid on excessive amounts of debt (thin capitalisation) by taxpayers in relation to foreign funding by connected persons. during 2014 and 2015, focused anti-avoidance rules that limit the deduction of interest incurred in respect of debt used to fund certain reorganisation transactions (section 23n), as well as interest paid to connected persons where such interest is not taxed in south africa in the hands of such recipients (section 23m), were introduced into the act. both of these provisions apply an interest limit based on the ratio between the particular interest and a tax proxy for interest-adjusted earnings before interest, taxes, depreciation, and amortisation (ebitda) (national treasury 2014b). the deductible interest ratio applied in these provisions is based on a formula that varies according to changes in the repurchase rate set by the south african reserve bank, and has a ceiling rate of 60% of the interest-adjusted ebitda proxy (national treasury 2014b). in addition, a withholding tax on interest paid to foreign persons was introduced with effect from 01 march 2015, as a method of countering base erosion (national treasury 2013). even though south africa is not a member of the oecd, it participated actively in the oecd/g20 beps project. the recommendations stemming from action 4 should therefore be considered by the national treasury and the south african revenue service (sars). in this regard, a number of key differences exist between the current south african measures to address the risk of base erosion from interest deductions, as discussed above, and the best practice approach suggested by the oecd. these include that the south african reliance on the arm’s length approach to provide an overall protection mechanism is relatively high, while the oecd questions the effectiveness of this approach (oecd 2015). in addition, the south african measures implemented focus on interest paid in respect of related party debt, while the oecd’s proposal suggests an overall interest deduction limitation that would apply to both multinationals and stand-alone domestic entities (oecd 2015) but notes that countries should decide what is best for their economies. the range of acceptable levels of interest in relation to profits suggested by the oecd (10% – 30%) appears to be significantly lower than those contained in specific south african anti-avoidance provisions. from this brief analysis, it is evident that the implementation or partial implementation of the oecd’s recommendations from action 4 is likely to result in stricter interest deduction limitations in south africa. in the 2016 budget review, the national treasury highlighted heavily geared financing structures that lead to excessive interest deductions and erosion of the corporate tax base as being of concern. if further measures are introduced to limit the tax deductibility of interest more closely aligned with the oecd’s recommendations, this may confirm the above view regarding stricter limitations (national treasury 2016). however, the limitation of interest deductions and related anti-avoidance rules can have a direct impact on returns earned by investors (haufler & runkel 2012). if this is the case, it might influence the attractiveness of south africa as an investment destination. the need to increase investment and attract foreign direct investment is clear, and has been recognised by government (department: trade and industry 2016; south african government 2016). such investment is a source of foreign currency, and multinational corporations can provide technological spillovers and skills transfers that increase productivity and drive economic growth. a fine balance needs to be struck between protecting the tax base by considering the recommendations flowing from action 4 of the oecd/g20 beps project and creating an attractive environment that will encourage investment activity to contribute to the growth of the south african economy. to strike this balance, a thorough understanding of the relationship between funding structures of companies operating in south africa and the characteristics of such companies must be gained. to provide a balanced perspective on the position of south african companies and the effect of the oecd recommendations in this context, the research reported in this article aimed to answer the following research question: what describes the funding structures of different types of entities, in particular foreign-owned entities and domestically owned entities, and how is it related to other characteristics of the firms? research methodology the above question was primarily considered through descriptive analysis of data contained in a data panel constructed using information from corporate tax and employees’ tax returns submitted by companies as described by pieterse, kreuser & gavin (2016) (this data panel was described as the cit-irp5 panel data). this panel contains an observation for each year of assessment for each company that submitted a tax return from 2008 to 2016. other than the generation of new variables from the existing data in the panel to calculate certain financial ratios, no other modifications were made to the panel data for purposes of the research. to compare the positions of foreign-owned and domestically-owned companies, the data are described for three categories of taxpayers identifiable in the panel, namely entities indicated as being foreign-owned,1 foreign branches2 and all entities that do not fall within these two categories (assumed to be domestically owned). the distinction can only be drawn using information obtained from the revised corporate tax return (itr14), which came into use from may 2013, as the information was not previously requested from taxpayers in the it14 return. the research was therefore only performed in respect of companies that filed itr14 returns. this inherently limits the results to returns submitted from may 2013 to 2016. since there were only a limited number of returns included for the 2016 year when the panel data was compiled, the information pertaining to the 2016 year was also omitted. as a result, the returns primarily relate to years of assessment ending during 2013 to 2015. the findings described in section 5 below only relate to this portion of the population. the number of observations for tax returns submitted by the respective categories of entities is presented in table 1. table 1: classification of observations submitted using itr14 returns. the theoretical underpinning as well as the variables generated and reports drawn based on these underpinnings are discussed in section 3. literature review and approach to analysis firms’ operations are generally financed from two main sources, namely debt and equity. in terms of the pecking order theory (myers & majluf 1984), managers will tend to prefer debt over equity, so as to avoid ‘external ownership’ in the company. advantages of debt include increased tax shields, while the downside may be that high debt levels increase the risk of financial distress. from a tax perspective, debt financing is normally preferred because interest payments reduce the taxable income of a company while dividends and share repurchases do not (langedijk et al. 2014). this often encourages excessive debt financing, which results in complex financial transactions and high leveraged ownership, which would not exist under normal business circumstances (hemmelgarn & nicodeme 2010; lloyd 2012; shackleford, shaviro & slemrod 2010; shaviro 2009). besides the general debt bias from which both domestic and multinational entities can benefit, the preference for debt funding often increases in circumstances where the funding is advanced directly or indirectly by an entity affiliated to the borrowing company. for example, the owner or shareholder may be indifferent as to the choice of instrument, given that this does not necessarily impact on the company’s risk exposure (buettner et al. 2012; gajewksi 2013). this often results in minimal equity funding and high levels of internal debt, known as thin capitalisation, to enjoy the benefits of the tax deductibility of the interest on debt (buettner, overesch & wamser 2016; gopalan, nanda & seru 2007). in this regard, multinationals can strategically place (shift) debt in high-tax jurisdictions so as to reduce taxable profits that are subject to relatively high effective tax rates in comparison with affiliates in other jurisdictions (oecd 2015). over the years, many jurisdictions have implemented thin capitalisation rules that effectively limit the deduction of interest in respect of affiliated entity debt (buettner et al. 2012, 2016; wamser 2014). the oecd (2015) notes that methods to counter base erosion through interest deductions include transfer pricing mechanisms, such as arm’s length tests, and withholding taxes. thin capitalisation mechanisms generally involve the use of explicit threshold levels for the debt-to-equity ratio (buettner et al. 2016). erosion of the tax base through interest deductions may also be prevented by provisions allowing specified percentages of interest or limitations on the amount of interest deductible for tax purposes (oecd 2015). such measures have been implemented by a number of european countries since 2008, including germany, the netherlands, the united kingdom, and italy. these measures are often not limited to interest in relation to debts from affiliated persons only, but also apply to interest on external debt (giacometti & meloni 2008; knauer & sommer 2012; marino & russo 2008; saparoea 2009). in addition, the oecd (2015) states that countries may consider introducing rules targeted at interest arising from specific transactions. for purposes of corporate finance and management, the debt-to-equity ratio is an indication of the solvency and level of financial gearing of an entity (els et al. 2010:70). to optimise shareholder value, an optimal mix between debt and equity is required (els et al. 2010:76). as such it is submitted that a debt-to-equity ratio provides valuable information about the capitalisation of an entity from a commercial perspective. traditionally many jurisdictions have used a balance sheet approach (normally a ratio between debt and equity) as an indicator of whether an entity is thinly capitalised or not (webber 2010a:687). this approach provides taxpayers and tax authorities with a method that is relatively simple to apply (oecd 2015:21; webber 2010a:685). however, the balance sheet approach has been criticised, as it does not take into account the productivity of a firm (mardan 2013:2). this shortcoming of a fixed balance sheet ratio can be addressed by using an earning-stripping approach to limit interest deductions. prescribing a limit by reference to ebitda, as opposed to the relative amount of debt-to-equity, has the advantage that it is linked directly to the tax base that needs to be protected (barnes 2014). in contrast, if a balance sheet approached is followed, the absolute acceptable level of debt, and therefore interest deductions, can be increased by increasing the equity amount (von brocke & perez 2009:29; webber 2010b:19). miesel, higinbotham and yi (2003:2) posit that multinational entities might enter into transactions that independent parties would not normally enter into – for example, funding entities, whether through debt or additional equity, that are loss-making or less profitable but that have some strategic importance – and thus make it difficult to achieve comparability analysis as suggested by oecd guidelines. yao (2013) agrees with miesel et al. (2003) that the arm’s length approach is aimed at increasing tax revenues in a perfect market. related parties may be willing to increase their equity contributions to an investee in order to create a larger base for advancing debt to such an entity. even though this would make the return on investment low or unproductive, it might hold certain tax benefits for an investor as a result of the deductible interest incurred on the debt. the tax base can therefore still be eroded even though the debt-to-equity ratio appears acceptable. multinational entities may be willing to enter into such funding arrangements for this purpose. given this, different entities of the same group may be allowed different levels of interest deductions depending on their location and the tax rates applicable, even if profit levels are similar, which could lead to base erosion (barnes 2014). in addressing the potential weaknesses of balance sheet methods and debt-to-equity ratios the oecd (2015) indicates that a best practice approach is based on a fixed ratio rule which limits an entity’s net interest deductions to a fixed percentage of its profit, measured using ebitda. following on the aforementioned discussion and due to the potential design flaws of balance sheet methods and other rules to counter thin capitalisation and excessive interest deductions, the descriptive analysis considers interest coverage ratios, specifically the interest-to-ebitda ratio, for the companies included in the panel data. hence this ratio was generated for purposes of the descriptive analysis based on firms’ accounting profits, rather than profits for tax purposes, adjusted for interest and depreciation. the effect of using accounting data, as opposed to tax data, was considered for all ebitda ratios. a comparison of the ebitda amounts calculated using accounting and tax data was also prepared. the comparison between ebitda calculated using tax and accounting data showed that for both south african branches of foreign entities and domestically owned companies, ebitda calculated using tax and accounting data did not differ materially for at least 80% of the population, with some exceptions at the outer ends of the population in both directions (i.e. accounting ebitda exceeding tax ebitda, and in other instances, tax ebitda exceeding accounting ebitda). the variance was more notable in the case of foreign-held companies. results and discussion the mean interest-to-ebitda ratio for the overall population rendered results that were significantly different from ratios that may have been anticipated based on norms such as the ratio applied in section 23m or those suggested by the oecd. further analysis revealed that this was caused by a number of factors, including negative ratios and entities with a low profit base compared with their net interest cost. certain categories of observations that had characteristics that would cause the interest-to-ebitda ratio to be different from the anticipated ratio were identified. hence, the population was disaggregated to separate it into categories of observations that would have a distortionary effect on the interest-to-ebitda ratio, and ultimately to produce a residual category of observations that could be viewed as normal entities (i.e. not falling within any of the exceptional categories identified) in respect of which meaningful analysis could be performed. the categories into which the population was disaggregated are the described below. exceptional category 1 – observations with a negative interest-expense-to-ebitda ratio: an entity will have a negative interest-to-ebitda ratio if the denominator (ebitda) is negative. an analysis of this category of entities revealed that this was the case for mainly two groups of entities. firstly, an entity that borrows funds and on-lends this to earn interest income is likely to have a negative ebitda (representing operating costs incurred) due to the fact that its primary revenue source (interest income) is excluded from the ebitda indicator. this scenario will arise if the entity acts as a conduit for funds. the second type of entity is one that incurs interest expenditure but does not have any operations income (turnover). the presumption exists that this class of entity is likely to be a start-up business that is incurring interest costs. exceptional category 2 – observations with a positive interest-expense-to-ebitda ratio but negative total equity balance: the fact that an entity has a positive interest-to-ebitda ratio indicates that the entity was profitable (in ebitda terms) for the current period or tax year. however, the fact that the entity has a negative total equity balance indicates that the entity was at some stage in the past not profitable and therefore recorded accumulated losses that caused the total equity balance to be negative. the high interest cost incurred by these entities compared with the level of profitability would suggest that this entity is in a stage of recovery, and that the interest-to-ebitda ratios may therefore be distorted while this recovery is underway. however, these observations were clearly distinguishable based on the high interest-to-ebitda ratios. exceptional category 3 – observations with a positive interest-expense-to-ebitda ratio, positive where interest income exceeds interest expenditure: these entities are not in a net interest-paying position. the interest-to-ebitda ratios, which the oecd suggests should be used as a basis for interest deduction limitations, would therefore be negative and distort the overall view of the population. these entities were therefore excluded from the normal entities category. this category should include entities that do not have significant levels of debt, but that do have cash reserves. the observations included in this category are likely to overlap with the exceptional category 2 identified for the purposes of the debt-to-equity analysis. normal entities: any observations remaining in the residual part of the population after excluding the above exceptional items were classified as normal entities. these entities represent entities with a positive net interest-cost-to-ebitda ratio that have a positive total equity balance. the descriptive analysis was performed in respect of these entities, hereafter referred to as normal entities. table 2 provides an overview of the composition of the population into the four categories explained above and only presents entities with some form of performance (profitability), whether this was positive or negative. table 2: breakdown of population to describe interest-to-ebitda ratios. the mean interest-to-ebitda ratios for the normal entities category are provided in table 3. this forms the basis for the subsequent analysis of interest-to-ebitda ratios in the remainder of this article. on face value the mean interest-to-ebitda ratio for foreign-held companies is higher than the same ratio for domestically owned companies. in order to gain an understanding of this finding, the normal entities category was also divided into percentiles to describe the distribution of the mean across the entities. table 3: distribution of mean interest-to-ebitda ratios. in addition to describing the distribution of the mean interest-to-ebitda ratios, the mean interest-to-ebitda ratios for various sizes of businesses were also disaggregated. in order to present more meaningful information, the respective mean ratios were presented for a number of percentiles in each category. turnover was used as an indicator of the size of the business. the thresholds used were r1 million (based on the threshold to qualify for turnover tax) and r20 million (based on the threshold to be classified as a small business corporation in terms of section 12e of the act). the results of this disaggregation are provided in table 4. table 4: mean interest-to-ebitda ratios according to entity size. discussion of the overall level of interest-to-ebitda the basis level of interest limitation in section 23m(3)(b) is set at 40%, which may be adjusted upwards or downwards depending on the repurchase rate. the oecd proposed a limit of between 10% and 30% (oecd 2015). previous statistics released by statistics south africa indicated that interest-to-ebitda ratios ranged between 10% and 15% (national treasury 2014a). it is submitted that table 4 contributes to the understanding of the levels of interest-to-ebitda of south african companies. this information would be of value if policymakers were to consider lowering the threshold to be in line with the level of interest suggested by statistics south africa, which appears to be in line with the oecd recommendations. table 3 indicates that approximately 50% of normal companies have interest-to-ebitda ratios of approximately 10% or lower. however, companies between the 50th and 80th percentiles have interest-to-ebitda ratios ranging between 10% and 40%. this would suggest that the current level of interest limitation threshold is likely to be appropriate in the south african context, given the large number of taxpaying companies that have interest-to-ebitda ratios in the range between the oecd’s suggested threshold (10%) and the current south african threshold (calculated from a basis rate of 40%). a reduction in the threshold to 10%, as suggested by the oecd, will impact on approximately 25% of taxpaying south african entities. a further important observation is that up to the level of an interest-to-ebitda ratio of approximately 40% there is no significant difference between the mean ratios of the three categories of entities. no clear evidence of manipulation of interest cost is suggested by this finding. the information in table 4 suggests that this observation holds true for entities with turnover exceeding the r1 million threshold (with the exception of foreign-held companies in the bracket between r1 million and r20 million, discussed below). it appears that the ratio for smaller companies (turnover of less than r1 million) is significantly higher. it is submitted that in both a domestic and a cross-border context, an entity with a turnover of less than r1 million is small and is likely to be a start-up operation. this should explain to a large degree the relatively high cost of interest-to-ebitda. comparison of the level of interest-to-ebitda between the categories of entities the mean ratio for foreign-held companies starts to increase relative to the other two groups from the 75th percentile, as is evident from the results in table 3 and is also illustrated in figure 1. the difference between the mean ratios for this group and the other two categories of entities increases more significantly for each percentile greater than the 75th percentile presented. it is submitted that this trend identified for foreign-held entities may be an indication of more aggressive tax behaviour in the form of high interest deductions. it is further submitted that this is the area that beps actions should be aimed at. figure 1: comparison of interest-to-earnings before interest, taxes, depreciation, and amortisation (ebitda) ratios. the information in table 4, as illustrated in figure 2, shows that the mean interest-to-ebitda ratio for foreign-held companies in the turnover bracket between r1 million and r20 million is significantly higher than the other two groups of entities across all percentiles. figure 2: interest-to-earnings before interest, taxes, depreciation, and amortisation (ebitda) ratios for companies with turnover between r1 million and r20 million. in the context of foreign companies establishing their operations in south africa, a turnover of r20 million is still relatively low. it is therefore submitted that the high ratios in this turnover bracket may be a reflection of this fact, rather than of possible aggressive planning behaviour. the trend in the ratios of the larger companies in table 4 and the upward trend in table 3, as illustrated by figure 3, appear to be similar for companies falling within the 75th percentile and upwards. figure 3: trend in interest-to-earnings before interest, taxes, depreciation, and amortisation (ebitda) ratio for 75th percentile and upwards in companies with turnover exceeding r20 million. it is therefore concluded that the main finding from the data described in table 3 and table 4 is that foreign-held entities, especially larger entities with a turnover of more than r20 million, have a higher interest-to-ebitda ratio than the other groupings of entities considered. in order to gain an understanding of these entities, entities in the 75th percentile and upwards are further described in the remainder of this article. description of entities in the 75th percentile and upwards based on interest-to-ebitda ratios the further description of entities in the 75th percentile and upwards was done on the basis of the size of the entities in this group, the industry in which the entities were involved, and the country in which the controlling group company was located for foreign-held companies. table 5 shows the number of entities in the 75th percentile and upwards in each of the three size categories used earlier. table 5: composition of companies in the 75th percentile and upwards by size. table 5 shows that the majority of foreign-held companies in the 75th percentile and upwards are larger companies with turnover exceeding r20 million, compared to a larger percentage of companies within the r1 million to r20 million turnover range for both south african branches of foreign companies and domestically owned companies. for the purposes of this analysis of foreign-held companies the contribution of each industry sector to the whole population was determined based on the number of entities across all percentiles. the composition of the entities included in the 75th percentile and upwards was similarly determined. following this, the relative change in contribution of each industry sector from the contribution to the whole population to the contribution of the group of entities in the 75th percentile and upwards were considered. the change in contribution provides an indication of industries that have more entities present in the 75th percentile than across all percentiles. this is an indication of the industries where the high interest-to-ebitda ratios are particularly prevalent. figure 4 presents industries with a greater presence in the 75th percentile upwards than across all percentiles, sorted according to increases for foreign-held companies. figure 4: change in contribution for 75th percentile and upwards: foreign-held companies. figure 4 shows that the three industries that have an increased presence in the 75th percentile and upwards, when compared to the contribution across all percentiles, are real estate activities, financial and insurance activities, and agriculture. the entities in the financial and insurance activities industry have special characteristics that need to be taken into account before any conclusion can be drawn on their ratios. in the light of this, it is not possible to accurately explain the reason for their contribution to the higher mean interest-to-ebitda ratio from the 75th percentile upwards. real estate activities and agriculture are both capital intensive sectors, which may explain their increased presence in the higher ratio brackets. the value of this information is that these sectors may require special consideration by the policymakers when it comes to future legislative changes to interest deduction limits. in addition, such research would further assist in identifying industries where aggressive tax planning behaviour that results in profit shifting and base erosion is not present despite high interest-to-ebitda ratios. lastly, the countries from which investment is made into south africa in the form of the establishment of foreign-held entities were considered. figure 5 provides an indication of the change in contribution to total investment by country (based on the number of entities) from all percentiles to the 75th percentile. this analysis would provide insight into companies from certain countries with a greater presence in the 75th percentile and upwards. figure 5: top 10 countries3 according to increase in contribution above 75th percentile. figure 5 suggests that a number of lower-tax jurisdictions or jurisdictions that may provide certain tax benefits for investors have a greater presence in the 75th percentile and upwards. this may support the earlier observation that the entities in this percentile may be involved in aggressive tax behaviour. it is recommended that further research be performed in relation to the specific foreign-held companies that appear in the 75th percentile and upwards to determine whether further indicators of aggressive behaviour can be identified. summary of main findings and conclusion in summary, the descriptive analysis of the data contained in the cit-irp5 panel data revealed a number of notable observations. firstly, the mean interest-to-ebitda ratio for entities up to the 75th percentile does not differ significantly among the three categories of entities considered. the interest-to-ebitda ratios for these entities up to the 75th percentile range are between 0% and 33%. however, from the 75th percentile upwards the mean interest-to-ebitda ratio increases significantly more for foreign-held companies. this trend is likely to be caused by ratios of larger entities (turnover exceeding r20 million).3 secondly, approximately 80% of the taxpaying companies in south africa have an interest-to-ebitda ratio of around 40% or less. in addition, approximately 25% of the population falls within the interest-to-ebitda range between 10% and 40%, and would be affected by a decrease in the interest deduction limitation threshold. on the basis that approximately 80% of the taxpaying companies, and in particular those where there is no clear indication of profit-shifting or aggressive tax planning behaviour, have interest-to-ebitda ratios of up to 40%, it is submitted that the rate of 40% for the limitation under section 23m appears to be appropriate. thirdly, the number of entities in the 75th percentile and upwards includes a greater proportion of companies involved in real estate and agricultural activities than the overall population of foreign-held companies considered. these sectors therefore appear to have higher interest-to-ebitda ratios than other sectors. this fact should be considered in any legislative changes as these sectors of the economy may be impacted adversely by such changes due to the funding requirements of the sector, as opposed to profit-shifting behaviour. a similar trend exists for entities in the financial services and insurance activity sector. however, entities in this sector may have certain characteristics that need to be taken into account before it is possible to express further views on the implications of this trend. finally, the proportionate representation of foreign-held companies owned by controlling companies situated in a number of low-tax jurisdictions (including mauritius, the british virgin islands, cyprus, and guernsey) is relatively higher from the 75th percentile upwards than for the overall population of foreign-held companies. this may suggest profit-shifting behaviour. limitations and areas for further research the results described in this article are subject to a number of limitations, as indicated in the discussion. these limitations present an opportunity for further research to be performed using the panel data. firstly, the indicator for entities that have a foreign controlling group company was only included in the itr14 return. the analysis can be extended if it is possible to combine a number of indicators in a manner such that the status indicated on the itr14 return can be imputed accurately to earlier periods for which a return was submitted using the it14 return. the data available in the panel only allowed an analysis of total interest in relation to the interest-to-ebitda ratios. ideally, separate analyses should be performed in respect of the level of interest for both total interest and interest incurred in respect of connected persons. this is an area to improve the results of the research, if it is possible to obtain this information from the original data from which the panel was constructed. it is recommended that further research be performed by analysing the characteristics of the individual foreign-held companies that appear in the 75th percentile and upwards to determine whether further indicators of aggressive behaviour can be identified. this research would further assist in identifying industries where such behaviour is not present despite high interest-to-ebitda ratios. as noted, some variances existed between ebitda calculated for accounting and tax purposes, particularly in the case of foreign-held companies. a number of tax developments occurred during the period between 2013 and 2015, for example the introduction of a real estate investment trust tax regime. it is submitted that these developments may have caused the variances noted. further research to gain an understanding of the adjustments that cause this variance would be of value, given that section 23m (or any other tax legislation) would use a measure of ebitda calculated using tax data. acknowledgements this study has been prepared within the unu-wider project on regional growth and development in southern africa. competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions p.v.d.z. and d.s. were responsible for the literature review and data analysis. w.k. reviewed the article and made critical input to it. references barnes, p., 2014, 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764–781. https://doi.org/10.1111/obes.12040 webber, s., 2010a, ‘thin capitalization and interest deduction rules: a worldwide survey’, tax notes international 60(9), 683–708. webber, s., 2010b, thin capitalization and interest deduction regulations, copenhagen research group on international tax – discussion papers, viewed 27 february 2017, from http://corit-academic.org/wp-content/uploads/2011/12/corit-8-thin-capitalization-and-earnings-stripping-regulations-2-1.pdf yao, j., 2013, ‘the arm’s length principle, transfer pricing and location choice’, journal of economics and business 65, 13. https://doi.org/10.1016/j.jeconbus.2012.09.004 footnotes 1. the field in the itr14 requires a taxpayer to indicate whether it is a controlled group company in relation to a foreign company. a foreign entity would be the controlling group company in relation to a south african company if that foreign entity, together with controlled group companies, holds at least 70% of the equity shares and voting rights of the south african entity (refer to definition of ‘group of companies’ in section 1 of the act). the south african controlled group company is taxed as a person separate from its controlling group company. 2. the field in the itr14 requires a taxpayer to indicate whether the return was submitted in respect of a branch, permanent establishment or agency of a foreign company. the branch is not a separate taxpayer from the company that it forms part of. the foreign company is liable for tax in south africa on the taxable income earned from a south african source. in instances where the branch represents a permanent establishment, an allocation of profits towards the permanent establishment is required. 3. the south african companies included in figure 5 may represent intermediate south african holding companies that are ultimately owned by foreign parent companies. sajems ns 12 (2009) no 1 115 using information technology governance, risk management and compliance (grc) as a creator of business values – a case study osden jokonya and sam lubbe school of computing, unisa abstract the relationship between information technology (it) governance, risk management and compliance (grc) and organisation business values continues to interest academics and practitioners (it governance institute, 2003). like governance, risk management and compliance generally, it grc is about the decision rights and accountabilities that encourage desirable behaviour in the use of it (it governance institute, 2003). a case study approach was used in an organisation with many business units. the organisation selected is a mining company, riozim, situated in zimbabwe. data was collected from business units on it issues and business values. the interviews centred on the it grc practices based on responsibility and authority for it decision-making. the results suggest that it grc does not adequately support business values. the study revealed that business values should drive it grc and it grc should be the responsibility of executives and all business units. jel l20, l86 1 background to the study corporate executives and boards of directors look at it as they would any other business unit, and they expect the same level of efficiency, reliability and economic return from it as they do from other parts of their organisations. the main reason for this is that the it department has moved from being a commodity service provider to a strategic partner where it is viewed as a tool for increasing business growth rather than just an expense (weill, 2004). according to ward and peppard (2003), the position of it resources in the organisational structure has been problematic since computing began. peterson, o’callaghan and ribbers (2000) add that, as the business environment changes, technologies evolve to ensure that it helps to sustain innovation (it governance institute, 2005b). investments in it are growing, and business managers often worry that the benefits of it investments might not be as great as expected. in order to address the concerns of business and it executives about it expenditure, it grc management should enable the business and it to understand how it contributes to the achievement of business values (weill, 2004). 2 background to the literature it is a broad subject concerned with technology and other aspects of managing and processing information, especially in large organisations. it deals with the use of electronic computers and computer software to store, process and transmit information. in the competitive market, it-based real-time systems, which provide real-time access to information or data, are essential. mckenna (1997) claims that life in the high-tech information age is a real-time experience – events occur in real time. in highly technological industries, it technical standards are established by dominant firms, 116 sajems ns 12 (2009) no 1 thus giving them the monopoly. silk (1991) classifies the generic it impact, which he refers to as “benefit classes”. these classes are efficiency, effectiveness and competitive advantage. an efficiency impact is felt where it has made savings on other resources. a strategic advantage impact can be detected where it has changed some aspect of what a business does, by improving that business. this results in growth, defined as an increase in revenue, throughput or profit or whatever the relevant indicator is for the given organisation. 3 it grc ross and weill (2004) argue that it grc is a decision rights and accountability framework for encouraging desirable behaviour in the use of it. it grc is seen as a framework that ensures that it decisions consider the business goals and values. in the same way that compliance aids an organisation in ensuring that key decisions are consistent with the corporate vision, values and strategy, it grc ensures that it-related decisions match companywide values. it is a major component of large organisations’ capital spending. it grc should, therefore, be one of management’s significant concerns. the discipline of it grc is derived from corporate governance and deals primarily with the connection between the business focus and the it management of an organisation. the it governance institute (2003) adds that much of the complexity of it grc arises from the conflicting pressures of dealing with the different stakeholder groups, business executives, it executives and users who all utilise and thus have legitimate and often vital interests in the it systems within their companies. all the groups have conflicting goals, interests and incentives. the need for better management of it is one of several reasons organisations around the world are taking a new look at it grc. it has become a support and strategy tool, and few business processes can function without its support. according to the it governance institute (2003) study, most organisations have not been very effective at it grc because many executives do not make decisions about it – the it department is forced to make decisions regarding priorities and investments. it grc provides a structure for ensuring that decisions about it support business values. it ensures that the right projects get the funding they need to address competitive threats or pursue new opportunities. it ensures that the it organisation and the lines of business share accountability for it investments and it provides a framework for measuring it effectiveness. according to weill (2004), in deciding on the organisation of it resources, the key questions are: what aspects of it are best managed centrally and which are best devolved; and should it activities be managed by specialist it functions or should they be managed by business management? in addressing these questions organisations need to define the authority, responsibilities, policies, mechanisms and procedures surrounding it. organisations make major it decisions on five it management domains: principle, architecture, infrastructure, application and investment (weill, 2004). according to broadbent and weill (1997) it principles are high level statements about how it is used in a business. agarwal and sambamurthy (2002) maintain that the strategic role of it is to facilitate innovative business strategies and processes. peppard and ward (1999) indicate that, where an it function is perceived as providing a value-added contribution to a business, it has an impact on that business’s performance. it is advantageous for a business to have an objective view of the current role and contribution of its it – the role and contribution of the it function itself, and of the perception of this from the rest of the business. return on investment analysis is often not meaningful in evaluating infrastructure investment since it does not measure the unquantifiable benefits of strategic systems. new methods for justifying it investment which identify and quantify the intangible benefits are needed. organisations need to understand the context in which an evaluation is taking place and then apply the appropriate technique (brynjolfsson, 1993; haynes & thompson, 2000). according to weill and vitale (2002), the term it architecture lacks a universally accepted definition. more often than not it architecture sajems ns 12 (2009) no 1 117 refers to an organisation’s list of technology standards. according to sauer and willcocks (2002), the power of it architecture lies in synergy – aligning business goals (established and anticipated) and it needs and resources. they highlight that the role of it architecture is to bring order to the otherwise chaotic world of it by defining guidelines and standards and then ensuring adherence to these. organisations recognise that short-term profit maximisation is rarely the best approach to achieving sustained corporate growth and profitability. a key element in any business planning process is to set business values. these are usually described by reference to profitability, growth, market share and social responsibility. business values must reflect the values held by the organisation, its management and major shareholders. in order to achieve their business values, organisations must measure the performance of their it activities. according to weill (2004), the best it grc is the one that is linked to corporate business values. figure 1 maturity levels of it deployment (source: morton, 1991) organisations first set those business values which are aligned with it. some of the organisation’s business values include the use of it to enable the organisation to exploit business opportunities and maximise it benefits. these values can be achieved through using it resources responsibly and managing itrelated risks appropriately. it activities increase automation, decrease cost and manage risk. the organisation will need to compare the set of values and it activities to provide direction and measure performance. the role of it grc should therefore be to support business values (it governance, 2003). 3.1 research questions although in theory it grc can assist an organisation to achieve business values, this is not the case for many organisations. the main aim of this study was to determine if an organisation can benefit from it grc. the study objectives have been excluded from this 118 sajems ns 12 (2009) no 1 report because of the limitation on the length of the publication; the objectives, of course, support the research questions. this study also aimed to answer the following research questions: 1. are it contributions the same for various business units and departments in the same organisation? 2. are business units’ users aware of their business values and the importance of it in achieving them? 3. do business units know the value of it committees for achieving their business values? 4. are the business units within an organisation able to identify areas in which it can help to achieve their business values? 3.2 summary despite increasing recognition that it and business are indivisibly linked, consolidating across-business it processes and applications remains an on-going challenge for many organisations. the resulting it complexity not only drives up redundancy and cost, but is also detrimental to the organisation’s competitive advantage. in order to address this challenge, since business and it are increasingly interdependent environments, important responsibilities should fall within both camps. business management cannot realistically formulate strategies without sufficient knowledge of the underlying it issues and then expect the technology to deliver differentiation. in other words, business management cannot afford not to involve it in business planning. 3.3 research approach the case study approach was found to be more appropriate for the study of a single organisation with many business units. this study used both qualitative and quantitative research approaches. the qualitative approach was particularly concerned with the context in which events were taking place (robson, 2002). although the research adopted a mainly qualitative approach to data collection this does not mean that quantitative data were excluded. quantitative data used in the research were obtained from primary document sources such as company accounts and a variety of secondary documentary sources including official reports. the case site was selected based on a combination of accessibility (to business executives and business managers), interest (in the issues of it grc) and diversity (diversity of business units in size and operation). the sampling frame was the current population of executives, business unit managers and functional heads within the organisation’s four strategic business units. the research collected the primary data from 30 respondents who represented the total population of heads of departments and sections from riozim’s four strategic business units. accessibility was made easier since the researcher had previously worked for riozim. apart from structured interviews, data were also gathered from a variety of sources (primary and secondary) including internal company reports, minutes from meetings and official reports. the researchers opened a research day-book in which notes, ideas and questions were recorded (saunders, lewis & thornhill, 2003). pattern matching was used to analyse qualitative data (yin, 1994) and this involved reading respondents’ comments (questionnaires and interview transcripts). spss was used to analyse quantitative data. the summarised data were then subjected to a variety of statistical measures to identify patterns or trends (descriptive statistics) and assessed to determine what inferences could be made from the data about the general population (inferential statistics) (ghauri, gronhang & kristianslund, 1995). 3.4 demographics this section presents the frequencies of the demographic variables of the respondents in terms of age, sex, level of education and occupation. thirty respondents participated as part of the census in the research. the majority (29) of the respondents were more than 30 years old. the number of respondents above 30 years is attributed to the fact that the research targeted the heads of the departments and sections in the organisation. the majority (27) sajems ns 12 (2009) no 1 119 of the respondents were male. the gender imbalance can be explained by the fact that most mining environments are dominated by males. few women are attracted to working in the mining environment. the majority (25) of the respondents have a bachelor’s degree or higher. five of the respondents have college diplomas. education and experience are often prerequisites for being a head of department or section. seven of the respondents were engineers, either mechanical or electrical engineers. four accountants, four personnel officers and four metallurgists also responded. four it administrators and three purchasing officers participated in the study. the remaining respondents were one geologist, one safety officer, one surveyor and one miner. 3.5 data discussion the research collected the primary data from 30 respondents who represented the total population of heads of departments and sections. a third of the respondents were from administration and two-thirds of the respondents were from technical departments. this was found to be the case after the data were regrouped based on technical and non-technical employment. the distribution was based on the research design which had the objective of being representative of all departments and sections in the organisation (see broadbent & weill, 1997). most respondents (24) argued that they were aware of their business values. although the responses on values were evenly distributed, most of the respondents mentioned increasing production as their main business objective. most of the respondents (29) noted that they considered it to be important in achieving business values. when asked to explain the importance of it in achieving their business values, eight said it was essential for communication, nine said it was important for information availability and decision-making and six mentioned that it helped in improving productivity. more than half of the respondents (18) were not sure if an it committee existed. interviews conducted with the directors revealed that the organisation does not have an it committee but that the directors meet from time to time to discuss it issues within the organisation (also confirmed by itgovernance, 2005c). however, there were no minutes to indicate that it issues were being discussed as per their claims. all the respondents said they were not members of an it committee. while the organisation does not have an it committee, 17 of the respondents were members of other committees in the organisation. ten respondents said that they discuss it issues in their meetings. the remainder did not belong to any committees and was not therefore applicable. most of the respondents (27) noted that it committees are of benefit to organisations. the respondents argued that it committees can help by discussing it issues involving users and raising awareness of the capability of it. the respondents (17) stated that their it needs were not being met by the it department, particularly in the hardware, software and training areas (peppard & ward, 1999). many respondents (22) stated that they were not consulted regarding decisions made on it (see mckenna, 1997). of those who felt they were consulted, their opinions were usually only sought on specialised systems such as scada and plc systems. the respondents (11) from the technical departments noted that they want to be consulted on applications, hardware and training. the majority of the respondents (28) stated that users should be involved in it issues within the organisation. about half of those who said users should be involved in it issues highlighted that user involvement would benefit the organisation by ensuring systems that met users’ needs and thus improved it delivery. when users were asked to rank five important areas where it could assist their business units, 11 respondents argued that it could assist in improving inventory and cost tracking and 13 respondents said it could help to improve cost control in their departments. many respondents (18) noted that it could help to improve productivity. half of the respondents indicated that it is important in improving process controls within an organisation. 3.6 cross-tabulation this section shows the results though crosstabulation of the respondents’ answers by business units. it was crucial to establish whether 120 sajems ns 12 (2009) no 1 the respondents’ answers were affected by their being in their individual business units. sixtyseven per cent of the head office respondents knew their business values compared to 88 per cent for msasa respondents, 89 per cent respondents for empress nickel refinery (enr) and 71 per cent respondents for the renco mine. enr and msasa had the highest percentage of respondents who knew their business unit values. the results of the crosstabulation of departments and the importance of it in achieving business values are as follows: 100 per cent of head office respondents, 100 per cent of the msasa and renco respondents, and 89 per cent of the enr respondents stated that it was important in achieving their business values. the results also show that most of the respondents thought that an it committee would be of benefit to the organisation. fifty per cent of the head office respondents said their it needs were being met by the it department compared to 13 per cent for msasa, 44 per cent for enr and 71 per cent for renco. renco had the highest percentage of respondents whose it needs were being met by the it department and msasa had the lowest. one third of head office respondents had been consulted on it decision-making issues compared to none for msasa. only 22 per cent of enr respondents said they were consulted on it decision-making issues whilst 57 per cent of renco respondents said they were consulted. renco had the highest percentage of respondents who were consulted on it decision issues whilst msasa had no respondents who were consulted. all of the head office and renco respondents argued that user departments should be involved in it issues, while 88 per cent and 89 per cent of the msasa and enr respondents respectively said users should be involved in it issues in the organisation. 3.7 areas it can help improve per business unit the results are categorised by business unit. the majority (67 per cent) of the head office respondents said it could improve inventory and cost tracking compared to 43 per cent of the renco respondents. msasa had the fewest respondents (13 per cent) who said it could improve inventory and cost tracking followed by the enr respondents (33 per cent). many of the head office respondents (67 per cent) said it could improve cost control compared to 57 per cent of the renco respondents, 38 per cent of the msasa respondents and 22 per cent of the enr respondents. some of head office respondents (67 per cent) said it could help improve productivity in their business unit compared to 63 per cent of the msasa respondents, 56 per cent of the enr respondents and 57 per cent of the renco respondents. only 33 per cent of the head office respondents said it could help improve process controls compared to half of the msasa respondents. most of the enr respondents (56 per cent) and 57 per cent of the renco respondents stated that it could improve process controls. only head office had less than half (33 per cent) of its respondents who thought it could help improve process controls. most (57 per cent) of the renco respondents stated that it could help improve business processes compared to 50 per cent of the msasa respondents, 22 per cent of the enr respondents and 17 per cent of the head office respondents. most of the enr respondents (67 per cent) said it could help in early detection of potential production problems compared to 13 per cent of the msasa respondents, 17 per cent of head office respondents and none of the renco respondents. the reason why enr has the highest percentage is that it is the only location with an automated manufacturing plant, hence the importance of early detection of potential problems. 56 per cent of the enr respondents argued that it could improve equipment utilisation compared to 38 per cent of the msasa respondents, 33 per cent of the head office respondents and 29 per cent of the renco respondents. the higher percentage for enr is attributed to the fact that it is used for running their plant and maintenance systems. many of the respondents (60 per cent) from the administration departments said they know their business values. the majority (90 per cent) of the respondents from the technical departments said they know their business values. the results show that, according to the respondent’s answers, a higher percentage of technical staff know their sajems ns 12 (2009) no 1 121 business values. all of the respondents from the technical departments said they consider it important in achieving their business values compared to 90 per cent of the respondents from the administration departments. only 30 per cent of the respondents from the administration departments said they belong to a committee compared to 80 per cent of the respondents from the technical departments. the results show that technical departments have more committee members than administration departments. most of the respondents (90 per cent) from both the administration and technical departments agreed that it committees could be of benefit to the organisation. the results seem to support the literature review which indicates that committees are important for it decisions in organisations. half of the respondents from the administration departments said that their it needs were being met by the it department compared to 40 per cent of the respondents from the technical departments. the results show that the administration departments have a higher percentage of respondents whose it needs are being met by the it department. all (100 per cent) of the respondents from the administration departments said that the user departments should be involved in it issues compared to 90 per cent of the respondents from the technical departments. 3.8 areas of it contribution more than half (60 per cent) of the respondents from the administration departments said it could help in improving inventory and cost tracking compared to 30 per cent of the respondents from the technical departments. many of the respondents (60 per cent) from the administration departments said it could help improve cost control compared to 35 per cent of the respondents from the technical departments. half of the respondents from the administration departments said it could help improve productivity compared to 65 per cent of the respondents from the technical departments. the results show that productivity is important for the administration and the technical departments. half of the respondents from both the administration and technical departments said it could help improve process controls in the organisation. forty per cent of the respondents from the administration departments said it could improve inefficient business processes compared to 35 per cent of the respondents from the technical departments. thirty-five per cent of the respondents from the technical departments said it could improve the detection of production problems, while only 10 per cent of the respondents from the administration departments confirmed this. early detection of potential production problems is the responsibility of the technical departments. 3.9 correlation there is a positive correlation between knowledge of business unit values and those who consider it to be important in achieving business values (0.392*1). this suggests that those who know their business unit values believe that it is important in achieving those values. there is a positive correlation (0.371*) between achieving business unit values and improving quality levels and reducing defects. the results show that respondents consider it important in achieving the business unit values of improving quality levels and reducing defects. there is a positive correlation (0.467**2) between knowledge of business unit values and improving inefficient business processes. the result shows that the improvement of inefficient business processes is achieved through knowledge of business unit values; in order to improve the inefficient business processes it is necessary to know one’s business unit values. there is a positive correlation (0.418*) between membership of the specific business units and the belief that it can be used to improve the control of labour costs. the results suggest that some business units consider it important in achieving the objective of improving the control of labour costs. the differences in the units’ views can be attributed to the different natures of the individual business units. in operational business units where employees are paid daily, clocking systems can be important for the business units to control labour cost. without integrated systems and processes business units will pay ghost workers. 122 sajems ns 12 (2009) no 1 there is a correlation (0.415*) between it’s importance in achieving business values and improving the control of labour costs. the results suggest that it is considered important in achieving business values since it assists in improving the control of labour costs in the business units. the results suggest that those who consider it important for the organisation to achieve business values believe it can improve control of labour costs. there is a positive correlation (0.411*) between those who think it can improve inefficient business processes and those aware of their business unit values. those who know their business unit values believe that it is important to improve inefficient business processes. the results suggest that it is important in achieving business unit values through improving inefficient business processes. there is a strong positive correlation (0.541*) between membership of committees in the organisation and a belief in it improving inefficient business processes. most of the members of the various committees believe that it is important in improving inefficient business process within the organisation. the results suggest that members of committees are more aware of it’s contribution to improving inefficient business processes than those who are not members of any committees. 3.10 analysis of variance (anova) according to the results from table 1 there is a difference between the administrative business units and the operational business units in terms of knowledge of business unit values, as shown by an f value of (0.003). in addition there were differences in the perceptions of the contribution of it in achieving business values on inventory control, as shown by an f value of (0.010). the f value indicates that there is a significant difference among three or more sample means. the degrees of freedom indicate the effective number of observations which contribute to the sum of squares in the analysis. the large effect leads to significance as shown by the f–test. the results suggest that there is a variation in the awareness of business unit values and of it’s role in improving inventory control, the variation is based on business unit function. the result shows that it contributes differently to different business units. table 1 anova by business unit function sum of squares df mean square f sig. are you aware of your business unit values? between groups 5.952 1 5.952 .003 .958 can using it improve inventory and cost tracking? between groups 2.381 1 2.381 .010 .923 there are differences in the departments’ perceptions of it’s contribution to business values for two variables. the differences are in the perceptions of it improving process controls, shown by an f value of (0.049) and it improving business processes, shown by an f value of (0.035). the results suggest that there is variation in the perception of it’s contribution to improving process controls and inefficient business processes based on department. this means that it’s contribution is not the same for all departments. 4 discussion although the literature review indicated that it grc can add more value in it investments, whether business units in organisations agreed was another matter. the researchers addressed this matter in several phases. firstly, the researchers analysed the importance of it in the organisation to each business unit and department. variables that were used to indicate the it contribution to the organisation were sajems ns 12 (2009) no 1 123 extracted from the literature analysis. however, there were some weaknesses in the research caused by sample size. some departments had fewer respondents. this affected the statistical results. furthermore, based on the literature review of it grc, much attention was paid to the nature of the mining industry and the different contributions that it can make to organisations in this industry, as this may have some effect on the level of it contributions in riozim. secondly, a research methodology was designed. thirdly, the data collected were analysed and interpreted. 4.1 research questions this section presents the findings obtained regarding the research questions which formed the basis of this research project. are business units’ users aware of their business values? the results of the study have shown that respondents are aware of their business units’ values. the majority of the respondents (24) knew their business values. in addition 29 of the respondents considered it important in achieving their business values. although the results showed that respondents believe that it can contribute to achieving their business values, the results varied by business unit and department. this is an indication that business units and departments have different views of it’s contributions. this agrees with the literature review which indicated that it is viewed differently by different business units. ross and beath (2002) argue that organisations should distinguish it investments from one another. even though they may be simultaneous, these investments will deliver different values to different parties. do business units know the value of it committees? whilst the organisation does not have an it committee the results show that the business units view it committees as important in achieving their business values. the respondents mentioned that it committees would help them to discuss it issues thereby involving users in it decision making. the results agree with the literature that committees are important for it decision-making in organisations. ward and peppard (2003) note that steering committees appear to be an obvious necessity in managing it resources. marchand, kettinger and rollins (2000) add that organisations must emphasise the importance of a strong business/ it relationship and instil appropriate behaviours and values regarding information and its use in the organisation. gupta and raghunathan (1989) conclude that steering committees are among the most effective ways of improving an organisation’s it planning, by assisting the integration of the it function with business and by coordinating planning activities. 4.2 areas it can help improve per business unit the results of the study showed that business units can identify areas in which it can help achieve business values. many respondents indicated that productivity and cost control were areas where it could help in achieving business values. whilst respondents were able to identify areas where it could help, further analysis using cross-tabulation revealed that these areas differ by business unit and department. the results show a positive correlation between business and the control of labour costs. this agrees with the literature which says that it can help in achieving business values. according to the literature it can be used to support organisational strategies such as low cost strategies or differentiation strategies. this supports guldentops’s (2003) view that it can offer means of increasing productivity besides supporting and shaping new strategies. applegate, mcfarlan and mckenney (1999) add that it should be positioned with respect to the importance it holds in the business under review. they add that organisations must classify their it needs. 4.3 managerial guidelines for organisations to benefit from it investment they must implement it grc structures. the it grc structure will assist by clarifying decision rights in matters relating to it within 124 sajems ns 12 (2009) no 1 the organisation. in order to involve business in it issues organisations should establish it committees which will provide a platform for discussing the organisation’s it issues. it committees will help in identifying users’ needs which may vary per business unit. the results of the study show that it grc can help organisations to achieve their business values through user involvement. by involving business units in it decisions, organisations can identify areas where it investment can contribute more to achieving their business values. the findings of the study suggest that organisations should invest in it based on the contributions of it to their business values. this is supported by agarwal and sambamurthy (2002) who say that the strategic role of it is to facilitate innovative business strategies and processes. the it governance institute (2003) highlights that those organisations that actively design top-level it grc structures make and implement better it-related decisions. the boston consulting group (2004) adds that successful companies have established business and it interfaces to help reach consensus. 4.4 managerial implications although this research cannot claim to be fully representative of all companies, given that it was based on only one organisation, its depth of investigation into it grc’s contribution to business values serves as testimony to the relevance of the research project. from a managerial perspective, business leaders need to understand the value of the contribution of it grc to achieving their business values. organisations should pay attention to how it grc can help them in achieving their business values through business unit involvement. according to the literature review, it grc can add value to it investments in organisations taking into account the different levels of contributions needed which are based on the natures of the individual business unit and department values. however, the results of the data analysis indicate that most respondents in the study believed that it grc was important in achieving their business values. they highlighted that it is important in that it provides up-to-date information for decision-making. furthermore, business units and departments have different perceptions about it’s contribution to their business values. as observed from the study and literature, some departments or business units need it more than others. nevertheless, the results of the data analysis show that all the business units agreed that it grc could make a contribution to their business values. the results of the data analysis show that there are significant differences between business units regarding the contributions of it grc to achieving their business values. the differences are based on the nature of the core business of the strategic business’s operation. organisations should therefore address it issues at different levels if they are to realise high returns on it investments. with it providing a competitive advantage to industries, organisations should address the needs of business units individually. this is more critical if the organisation has diverse business units. failure to do so may result in missed opportunities in it investment. in addition, organisations should involve users in it decisions if they are to gain from it investments. endnotes 1 *correlation is significant at the 0.05 level 2 ** correlation is significant at the 0.01 level references agarwal, r & sambamurthy, v (2002) “principles and models for organizing the it function”, mis quarterly executive, 1: 1-16. applegate, lm; mcfarlan, fw & mckenney, jl (1999) “corporate information systems management: text and cases” (5th ed.) homewood, il: irwin. the boston consulting group (2004) “from it complexity to commonality: making your business more nimble”, available online at: http://www. bcg.com [accessed 22 september 2005]. broadbent, m & weill, p (1997) “management by maxim: how business and it managers can create it infrastructures,” sloan management review, 38(3): 77-92. brynjolfsson, e (1993) “the productivity paradox of information technology” communications of the acm, 36(12): 67-77. sajems ns 12 (2009) no 1 125 ghauri, pn; gronhang, k & kristianslund, i (1995) research methods in business studies, london: prentice hall. guldentops, e. (2003) governing information technology through cobit, idea group publishing: hershey, pa. gupta yp & raghunathan ts (1989) “impact of information systems steering committees on is planning”, decision sciences 20 (1989), pp. 777–793 haynes, m & thompson, s (2000) “the productivity impact of it deployment: an empirical evaluation of atm”, introduction oxford bulletin of economics and statistics, 62(5): 607-619. it governance institute (2003) board briefing on it governance (2nd ed.) available online at: http://www.itgi.org/template_itgi.cfm?/template= /search/itgisearchdisplay.cfm [accessed 22 september 2005]. it governance institute (2005b) “it governance domain practices and competencies – optimizing value creation from it investment”, available online at: http://www.itgi.org_template_ itgi.cfm_section=itgi&template=_ contentmanagement_contentdisplay.pdf.pdf [accessed 04 december 2005] it governance institute (2005c) “it governance domain practices and competencies – measuring and demonstrating the value of it”, available online at: http://www.itgi.org_ template_itgi.cfm_section=itgi&template=_ contentmanagement_contentdisplay.pdf [accessed 04 december 2005] marchand, da; kettinger, w & rollins, jd (2000) “information orientation: people, technology and bottom line’, sloan management review: 69-80. mckenna, r., (1997) real-time, preparing for the age of the never satisfied customer, boston: harvard business school press. morton, ms (1991) the corporation of the 1990s: information technology and organizational transformation, new york: oxford university press. peppard, jw & ward, jm (1999) “’mind the gap’: diagnosing the relationship between the it organization and the rest of the business”, the journal of strategic information systems, 8: 29-60. peterson, rr; o’callaghan, r & ribbers, pma (2000) “information technology governance by design: investigating hybrid configurations and integration mechanisms”, proceedings of the 21st international conference on information systems, australia, brisbane, queensland, pp. 435-452. robson, c. (2002) “real world research” (2nd ed.) blackwell: oxford. ross, jw & beath, cm (2002) “beyond the business case: new approaches to it investment”, mit sloan management review, 43(2): 51-59, [accessed 04 december 2005] . ross, j & weill, p (2004), “recipe for good governance,” cio magazine, 15 june, available online at: http://www.cio.com/archive/061504/keynote.html sauer, c & willcocks, lp (2002) “the evolution of the organizational architect”, sloan management review: 41-49. saunders, m; lewis, p & thornhill, a (2003) research methods for business students (3rd ed.) london: prentice hall. silk, dj (1991) planning it: creating an information management strategy, london: butterworthheinemann. ward, j & peppard, j (2003) strategic planning for information systems (3rd ed.) chichester: john wiley & sons ltd. weill, p (2004) “don’t just lead, govern: how top performing firms govern it”, mis quarterly executive, 8(1): 1-17. weill, p & vitale, m (2002) “what it infrastructure capabilities are needed to implement e-business models?”, misq executive (1:1): 17-34. yin, rk (1994) case study research (2nd ed.) newbury park, ca: sage publications. samms ns vol 5 (2002) no 2 277 can the environment wait in a developing country? john a dixon and gayatri acharya the world bank, washington abstract can the environment wait in developing countries? should countries focus on growth first and wony about cleaning up later? is there an optimal mix between growth, development, and environmental management? these are all real issues facing the world's community of developing countries. the following presentation suggests that the answer to this question is that the environment does not have to wait. jelq28 a tale of two counnhes azerbaijan and costa rica may seem to have little in common and, yet, recent work in both countries provides some interesting comparative, if anecdotal, data. first, consider azerbaijan, one of the world's first oil states. a hundred years ago baku, the capital, and azerbaijan were an important center of oil production. the oil boom that began at that time resulted in a number of impressive buildings in baku grand avenues, an imposing opera house, an impressive array of mansions and apartments buildings. just outside baku, however, one is met by wasteland all along the shores of the caspian sea that is the direct result of the oil boom and associated production. kilometers of rusty pipelines, pools of blue/greenlblack water and piles of industrial waste line the shore. it is a true environmental disaster, and much valuable caspian sea-front real estate is unusable. azerbaijan is a classic cautionary tale of the danger of the "grow first, clean up later" mentality. those who benefited from oil extraction over the decades are gone, lost in time and in changes of governments. now all that remains from the past oil boom are a number of grand buildings in a very poor country, and a tremendous bill for clean-up or remediation measures. although new oil production may hold out hope for addressing some of these problems, the new r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 278 sajems ns vol 5 (2002) no 2 developers rightly maintain that they should be held responsible for their actions only, not for the environmental blunders of 10 to 50 years ago. nonetheless, the costs associated with those blunders will be borne by society at large. better governance and a different set of political and historical conditions may well have resulted in different outcomes for the country. after all, many of today's developed countries have reached their current levels of economic prosperity despite, and some may argue, because of, over-exploitation of their natural resources. the choices available to countries today are however significantly different due to increased pressure on resources and changes in global, national and local awareness regarding patterns of economic development. azerbaijan, like other mineral rich countries, faces an interesting choice today of making the most of its oil resources by wisely re-investing the rents from oil exploration in society, thereby achieving more sustainable economic development. now consider the case of costa rica, a small central american country that has relied on its natural resources for growth. originally coffee and bananas were the backbone of the economy, and now tourism eco or otherwise forms a major share of the economy. costa rica has successfully marketed itself internationally as a green, environmentally-friendly country and receives large numbers of international visitors each year. in its international advertising it uses the slogan "costa rica no artificial ingredients" to sell itself and reinforce this image. costa rica faces all the problems most middle-income developing countries (including a high deforestation rate). but cost rica has successfully identified a strategy to "grow green" and take care of environmental problems to the extent possible, realising that this benefits both the environment and good for the economy. an important part of this process has been a partnership between the government, the people of costa rica and the private sector, all of whom realise that they have an incentive in addressing environmental problems and that these problems affect all of them. is there an environment-development dichotomy? as these two case studies suggest, there are different paths for development for resource-based countries. it has been suggested that the environment is a luxury good for the rich. a related view is that a country should get rich first and worry about the environment later. these hypotheses are now examined. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 279 tbe environment as a luxury good there is no doubt that in some ways the environment is a luxury good. in economic terms, this merely means that the environment has an income elasticity of demand greater than 1 (that is, if income grows by 10 per cent, demand for a the "environment" will grow by more than 10 per cent). there is no doubt that some uses of the environment are in fact luxury goods for example, the demand for scuba diving or unique wilderness experiences. for most other types of environmental goods and services, however, demand is usually positive, if not in the luxury good category. positive income elasticity merely means that as incomes grow, demand for the environment also grows. as such, the demand for a healthy, cleaner environment will grow as incomes increase. in this sense the environment can be considered as an appreciating economic asset its value will grow in the future as incomes rise. in addition, the environment is a central part of their production system for many: farmers, fishermen and loggers all depend directly on the environment to produce income. in fact, it is precisely the poorest who are most directly dependent on the environment as a source of production. there are also important social-economic linkages between the environment and health and other social factors. in the case of the link between poor water resource management and lack of sanitation, for example, it is found that the negative impacts on health fall heavily on the poorest members of society and that the opportunity costs of time spent collecting drinking water may be much higher than normally thought. in both cases the economic benefits from improved water supplies (both in terms of quality and quantity) may be quite large. the cross-sectoral linkages (especially in terms of health and productivity implications for the poor) of investing in sectors such as water and clean energy are often overlooked by policy makers and growth advocates who suggest that environment is a luxury good. tbe "grow first, clean up later" bypothesis as mentioned earlier, there is a wide-spread belief that countries should focus on traditionally-measured economic growth first and only be concerned about the environment afterwards. while it is true that this is the growth path followed by the us and much of europe, this is known to be a sub-optimal approach. this is true for a number of reasons: cleaning up after problems have been created (especially from pollution of the air or water) is much more expensive than prevention. many studies have shown that environmentally friendly development (one that r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 280 sajems ns vol 5 (2002) no 2 minimizes air or water pollution, or natural resource degradation) often only costs i to 3 per cent more in initial investment costs (and avoids damages that are much costlier to restore afterwards). as seen in azerbaijan, growing first and cleaning up later often results in no one accepting responsibility for the clean-up all the funding has dried up and those who created the situation are no longer around. the us has implemented an expensive superfund program to clean up abandoned toxic and hazardous waste sites all over the country. the grow first, clean up later philosophy may also result in extinct species and lost genetic opportunities, which consequence is of a permanent nature. since many environmental problems disproportionately affect the poor, the emphasis on growth without consideration of environmental issues necessarily implies a more limited set of options for poorer communities. a false dichotomy but a difficult path to charter the supposed development-environment dichotomy is in fact a false dichotomy. the following examples prove this. the tremendous learning of the past 40 to 50 years has shown that it is possible, both technically and economically, to "grow greener" without large, or in some cases, any additional economic costs. whereas the famous environmental kuznets curves (ekc) hypothesized that as economies grew the environment would initially suffer and only later improve, it is now clear that there are many possibilities to "tunnel through" the kuznets curve and grow in an environmentally-friendly manner. this is due to technological change as well as policy intervention. for example, modem transportation and energy production are much less polluting than they were 30 or 50 years ago. similarly, the advent of the computer and high speed communications means that it may be possible to leap frog certain traditional stages in growth. environmental kuznets curves (see figure 1) are also more complex than initially thought. although the classic ekc shape is shown in the middle two curves, with urban concentrations of particulate matter and sulphur dioxide, other ekcs take quite different forms: populations without access to safe water or sanitation both decline steadily as incomes increase. more troubling however, is that other measures increase directly with income, as seen in the lower two ekcs representing municipal waste per capita and carbon dioxide emissions per capita. for some pollutants, there is no turning point. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 281 the original kuznets curve suggested that a deterioration in income distribution in the early stages of economic growth would be followed by an improvement later. this however, can be a long-tenn outcome and one that is less than desirable in the face of growing poverty levels across the globe. figure 1 environmental kuznets curves environmental indicators at different country income levels population without safe water urban population without adequate sanitation perce 100 1,000 1,000 10,000 p<lr eapiia income (doilars,1og .scale) per capita income (dollars, log scale) 100,00 urban concentrations of particulate matter urban concentrations of sulphur dioxide per capita income (dollars, log scale) municipal wastes per capita ki'~~ ________________ -, per eapiia income (dollars, log scale) carbon dioxide emissions per capita toils 100 1,000 10,000 100,00 100 p<lr capita income (dollars. iog.scale) per capita income (dollars, log scale) l ____ ~--~=--~~~~~----~----~~----------~ source: world bank, world development report, 1992 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 282 sajems ns vol 5 (2002) no 2 similarly, environmental degradation can exacerbate poverty, including vulnerability, and could, in some cases, be irreversible. there is no reason countries should today develop in the same way as they have in the past. a major lesson from the ekc literature is that it is possible to flatten many of the curves via appropriate policy interventions, and that income growth facilitates much of this. the challenge is to grow in a greener manner and reduce unnecessary environmental costs. this thinking is reflected in the natural capitalism literature whereby technological options allow one to switch from high energy/high throughput consumption patterns to lower energyllower throughput consumption patterns, thereby reducing one's environmental footprint and affecting the shape of the ekcs. in addition, growth, development and environmental protection can be mutually supportive rather than in conflict in many resource~dependent economies. this can be seen in the admade or campfire programs in africa, or in costa rica or the tourism~dependent economics in the caribbean, and community managed programs in india and nepal; the potential for positive synergies between growth, development and environmental protection clearly exists. the difficulty lies in ensuring that the benefits of such programs reach those communities that are directly dependent on these resources andlor act as caretakers for these resources. the transference of property rights from the state to village communities, and from the individual to communities increasingly proves to be an important factor in addressing both community development needs and environmental quality. in other locations, the growth of direct payments for ecosystem services can be witnessed. two well-known examples are those of new york city and heredia in costa rica. in each case the municipal authorities have made direct payments to those who own watershed lands to protect these sources of water supply. in new york, the payments (of several billions of dollars) are used to buy land in the catchment area for new york city and to provide incentives for farmers to reduce the use of agricultural inputs. this should avoid the even larger costs associated with increased treatment of water supplies if the catchment becomes degraded. before 1996, new york city water was unprocessed and cleansed by the natural filtering services provided by the watershed. subsequently, with increasing changes in land use, these natural, and free, ecosystem services were damaged by sewage and agricultural externalities. the city estimated a replacement cost of $1010 over ten years and initially proposed the building of filtration plants to replace the watershed services. it was however determined that it would be less costly to restore the natural ecosystem, at a cost of$1.5x109 and this is what the city opted for. this example, albeit from a developed country, clearly demonstrates the need to account for alternative options, including investing in natural capital. without examining the potential net r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vols (2002) no 2 283 benefits associated with alternative investment options, countries may be excluded from more socially efficient development decisions. similarly, in heredia, a small university town in costa rica, a small extra charge (measured in cents per cubic meter) is added to the monthly bill of all water users to create a fund that will assist farmers in the catchment area to use less environmentally degrading management practices. this helps to protect the quality and quantity of water coming from the catchment. various other countries have started to determine systems to evaluate and capture rents associated with ecosystem services that maintain productive and consumptive economic activities. developments since stockholm (1972) and rio (1992) however, even with these positive developments, the challenge of sound environmental management with social and economic growth remains. the stockholm meeting of 1972 launched the modern environmental movement and rio, 20 years later, represented its coming of age. unfortunately, despite the initial optimistic feelings after the 1992 rio earth summit, it is now realized that "growing green" is going to be harder than anyone anticipated. this is true for a number of reasons. first, even the supposedly easy "win-win" policy changes (i.e. policy measures such as energy or water subsidy reduction, with both economic and environmental benefits, and higher fuel prices for more energy efficient transportation or manufacturing) have proved much harder to implement than envisaged. it turns out that vested interests and politically powerful groups that receive these subsidies, are often able to block subsidy reduction. governments have often not been willing to take on this politically difficult task, and the costs to the treasury and the environment remains high. this is commonly observed in both developed and developing countries. in the us for example, energy prices have remained low and powerful lobbies successfully oppose even the smallest attempts to increase gasoline prices, thereby reinforcing patterns of living and commuting that are highly energy-inefficient. a world bank study in 1998, estimated that global fishing subsidies amount to approximately us$ 1113.5 billion, while oecd in 1997 estimated total subsidies of us $6.38 billion for industrialized countries alone. trade regulations and restrictions are often used to create trade patterns that encourage inefficiencies in production and consumption, often at the expense of poorer groups. second, institutional development has likewise proved much harder than anticipated. ten or twenty years ago few countries had environmental management institutions either in government or outside of government. even r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 284 sajems ns vol 5 (2002) no 2 with major financial and human commitment, it is now realized that the process of building strong, competent environmental management institutions is a longterm undertaking. building strong institutions for improved management includes more than training people, passing laws, and building laboratories and an inspection system. it is also necessary to create the political and public support so that these institutions can effectively argue their case with the traditionally powerful ministries that manage fmance, the economy, and industrial or agricultural production. in too many countries the environmental ministries the weakest portfolios in government and is the environment considered as a second priority. as noted earlier, the cross-cutting issues associated with investing in the environment are often missed by both mainstream development practitioners and by environment advocates. third, all too often it has taken a major environmental jolt to focus attention on environmental management. given the complacency of governments, and the powerful role of vested interests, it has unfortunately often required a powerful jolt or a disaster, to focus public and private attention on the role of the environment. the infamous "killer fogs" of london in 1952 led to important work on identifying the links between air pollution and health outcomes; chernobyl and bhopal focused attention on industrial pollution and accidents, and the full potential implication of nuclear power. landslides and flooding in countries around the world (nicaragua, turkey and china among many others) focused attention on the links between land use patterns, location of settlements, and susceptibility to land slides and mass destruction. these are expensive (in terms of lives and economic activity) ways to focus attention on the links between the environment and sustainable economic growth. eight reasons why the environment cannot wait in developing countries this quick overview of some of the links between economic growth and the environment, highlighting both the positive dimensions and the internal tensions, illustrates the magnitude of the environment/development challenge. experiences of countries around the world support the view that it is a false dichotomy to consider the environment and development in conflict. in fact, they can be and should be mutually supportive. this optimistic view is supported as follows: 1. the environment is a major economic asset. whether it is for direct production of food or fiber, or for indirect production of value through r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 285 cleaner air or water, or for sale via tourism, the environment is an important economic asset that plays a central role in the economic health and sustainability of most countries. for some countries. like many of the small caribbean islands, the environment is their main economic asset and its sale via tourism accounts for 30 per cent to 60 per cent of their gdp. any economic asset of this importance needs investment in management and maintenance. 2. prevention is cheaper than cure. experience around the world convincingly demonstrates that it is cheaper to prevent environmental pollution (or resource degradation) than to try to correct the same problems after they have happened. many studies have shown that prevention costs usually only add i to 3 per cent to initial capital costs, while damages from degraded environments or pollution often result in 5 or 8 or more per cent in annual10sses of national gdp. the problem is complicated by the fact that the investment costs are borne by individuals or fmns now while the damages that are potentially avoided accrue to a much wider group in the population over a longer period of time. 3. private gains from the use of the environment are often sufficient to pay the costs to avoid externalities. just as prevention is cheaper than cure at the national level, the potential benefits to individuals and private fmns from use of the environment are often sufficiently large to allow appropriate costs for environmental management or pollution reduction and still profit. this form of the "polluter-pays-principle" means that improved environmental management is often funded by the private sector, provided that governments are tough, perform the appropriate analyses, and act as the stewards of the nation's environment. a major example of the potential for this approach is in such areas as recreation or tourism, whereby tourism operators, tourists and the government are all part of a partnership with shared responsibility for environmental management. 4. equity issues matter environmental degradation hurts the poor more than the rich. environmental degradation generally affects the poor the more. either they are directly dependent on the soil or the seas for their livelihood, or they are disproportionately affected by polluted air or water. in any case, there is a strong equity argument for improved environmental quality. the rich can often protect themselves from environmental pollution by means of appropriate housing or life-style adjustments. the poor often do not have similar options and governments must frequently intervene on their behalf. one must be careful not to confuse the desire for improved environmental quality (the demand side) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 286 sajems ns vol 5 (2002) no 2 with the ability to pay for it (the supply side), especially among poor people. furthennore, access to environmental resources and improved options for income generation are critical for reducing income inequality and vulnerability of the poor. 5. healthy economies need healthy environments for sustained streams of individual and social benefits. the links between healthy natural environments and production, and the links between clean air and water and health, are widely observed. healthy environments support healthy economic growth. the converse is also true; poor economics are often characterized by bad environmental quality and poor health. although the direction of causality is often debated in the literature do poor people create degraded environments or do degraded environments create poor people? it is very clear that as incomes grow, people and societies demand (and have the ability to pay for) cleaner environments. 6. partnerships that promote environmental issues are likely to support positive social objectives (and vice versa). just as there are positive economy-environment links, there are also important positive links between environmental partnerships and social equity. since improved environmental management takes social welfare and justice into account, and requires a broader perspective, those societies where the environment is an important element in the public arena, also tend to be more inclusive, irrespective of level of income. this is just as true in costa rica as it is in switzerland or sweden. access to environmental goods and services and the choice of being involved in decision making (whether this is exercised or not, participation is also a matter of choice and is not always the desired option for an individual) support the broader concepts of defining poverty and opportunity as defmed in the 2001/2002 world development report or amartya sen's recent writings on development and freedom. 7. the increased importance of private investment will determine a country's environmental future. at present private annual investment flows are 20 times as large as those of oda (official development assistance). this is both an opportunity and a challenge. the opportunity is to work with these very large financial flows to build towards a more sustainable future, while the challenge is to set up incentivesl rules of the game that make private investments part of the process of sustainable development. if governments ignore private flows and just focus on government investments and oda, they risk winning the (environmental) battle but losing the war. private sector interventions in water supply and opportunities presented by the clean development mechanism are r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 287 interesting examples of partnering with private interests to achieve desired development and environmental outcomes. 8. the final reason why the environment cannot wait in developing countries is that it is the right thing to do. the poor care about a cleaner and sustainable environment just as much as the rich, but their willingness-to-pay is not matched by their ability-to-pay. governments, therefore, have a responsibility to invest in the environment and its management, and to establish environmentally-friendly "rules of the game" that influence private individual and corporate behavior. for certain types of issues (e.g. global public goods like genetic stock or greenhouse gas reductions) the global community also has a responsibility to support these investment decisions. this is happening increasingly. while growth continues to be important for developing countries in order to rise out of poverty, this growth should not come at the expense of environmental health and opportunities for the poor. the future challenge in conclusion, the intimate links between environmental quality, environmental management, and economic development, make a strong case for addressing both concerns the environment and economic growth simultaneously, this will not happen automatically, however, and there is an important role for government, as well as for an informed public, in making this happen. the responsibility is huge, but the costs of not addressing these issues are even larger. the costs of inaction, as is becoming increasingly clear, are being paid by the more vulnerable and economically disadvantaged groups. also, such costs will be borne not just by this generation but by future generations as well it would, in short, be a wasted opportunity for achieving sustainable and equitable patterns of development, if developing countries waited to grow frrst and address environmental issues later. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 77 technical efficiency analysis of fiji's sugar industry: an application of the stochastic frontier production function approach mahendra reddy centre for development studies, university of the south pacific john f yanagida department of agricultural resource economics, university of hawaii abstract small developing countries have for long acquired significant benefits through preferential trading arrangements. however, these benefits have led to a proliferation of inefficient industries in the recipient countries. with the recent changes in the gait, these inefficient industries may close and thus lead to major economic and social problems in the recipient countries. this paper utilizes the frontier production function approach to examine the efficiency status of fiji's sugar industry. the analysis reveals that a significant level of inefficiency exists at the farm level of fiji's sugar industry. some of the factors that were found to effect the level of efficiency are farming status, land class and ethnicity. these factors are then used to derive policy implications. jel 10 1 introduction efficiency and productivity analysis of agricultural enterprises has always been a major focus for applied economists. this role has been accentuated given the recent changes in the general agreements on tariffs and trade (gait) which has brought agriculture into the world free market. a key argument for trade liberalization resulting from the uruguay round (ur) of the gatt is that it would lead to a more efficient resource allocation in the world (devadoss and kropf, 1996). this implies that industries, which are inefficient, will be pushed out of the market and resources, which were previously tied up in these industries, will now be allocated to alternative enterprises. developing countries, especially those, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 78 sajems ns vol 2 (1999) no 1 which, in the past have made enormous amount of industry specific capital investments, are now scrambling in search of avenues to increase productivity of those industries. fiji's sugar industry is now in this situation. this industry over the years has received substantial benefits from the sugar protocol of the lome convention where it gained access to the european market at subsidized prices, which continue to be higher than the world free market price. the short run impact of a fall in price, especially on peasant farmers of developing countries can lead to a major crisis, such as increased poverty. it is in this regard that efficiency analysis, which identifies the level of inefficiency and the determinants of this inefficiency, can playa very crucial role in policy formulation that can be used to avert this crisis. this paper uses standard neoclassical economic theory to evaluate economic efficiency of fiji's sugar cane industry. a stochastic frontier production function approach is utilized taking into account the implications of production characteristics of the two ethnic communities, land tenure system and farm sizes. results from the study will be used to help formulate policies for fiji's sugar industry. for countries with similar problems and farming systems, the policy implications derived here could be utilized in those countries. 2 litera ture review this paper utilizes the stochastic frontier production function method proposed independently by aigner, lovell and schmidt (1977) and meeusen and van den broeck (1977). this model has been applied and modified in numerous studies including battese and corra (1977), lee and tyler (1978), stevenson (1980), pitt and lee (l98i), jondrow et al. (1982), kalirajan (1981), bagi and huang (1983), kalirajan and flinn (1983), huang and bagi (1984), schmidt and sickles (1984), waldman (l984) and coeli (1985), battese and coelli (1988), battese et al. (1989), and battese and coelli (1992, 1993). bauer (1990) provides a summary of developments in the econometric estimation of frontiers. there has also been. wide application of this methodology in the agricultural industries. battese (1992), bravo-ureta and pinheiro (1993), and coelli (1995) provide surveys of applications in this field. some of the recent studies include battese and coelli (1995), trewin et al. (1995), battese et al. (1996), coelli and battese (1996), bravo-ureta and pinheiro (1997), and heshmati and kumbhakar, (1997). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 79 battese and coelli (1995) specify a stochastic frontier production function and a technical effects model for which au parameters involved can be estimated simultaneously. the model is estimated with a panel of fourteen farmers over a ten year period from the village of aurepalle in india. trewin et al. (1995) utilized the stochastic frontier model to obtain an estimate of technical efficiency over time of rice farmers in west java, indonesia. the mean technical efficiency obtained for both wet and dry season farmers was approximately 15%. one of the key policy implications drawn from this study was the use of better extension practices that would enhance utilization of correct farming practices by farmers. battese et al. (1996) apply a single stage model for estimating technical inefficiencies of production for wheat farmers in four districts of pakistan. results from the analysis indicate a mean technical efficiency ranging from 57% to 79% for the four districts. apart from some variables having mixed results, the two key variables, age and education had consistent effects on technical inefficiency for all four districts. with respect to age, older farmers displayed lower levels of technical inefficiency. for education, increases in the years of formal schooling had a negative effect on the level of technical inefficiency. coelli and battese (1996) applied the stochastic frontier methodology along with a model of technical efficiency effects to indian farmers. the results of the study showed the three villages in the study had an average technical efficiency of 73%. the technical effects model suggests an inverse relationship between inefficiency and variables such as farm size and time. this implies that technical inefficiency has declined over time in the study area. with respect to farm smaller farms had a higher level of technical inefficiency relative to larger farms. bravo-ureta and pinheiro (1997) applied the frontier production function approach to peasant farmers in the dominican republic. results from the study reveal that peasant farmers in the dominican republic had mean technical, allocative and economic efficiencies of 70%, 44% and 31 % respectively. an analysis on the determinants of technical efficiency point to two key factors, farm size and farmer's age. smaller farms are associated with higher levels of inefficiency relative to larger farms. for age, younger farmers displayed a greater level of efficiency relative to older farmers. heshmati and kumbhakar, (1997) applied this approach to pseudo panel data for swedish crop farmers. results from the study found that the technical efficiency of farmers varied from 62% to 71 %. this study also found that small farms had the highest level of inefficiency. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 80 saiems ns vol 2 (1999) no 1 3 theoretical model the stochastic frontier production function can be expressed as follows: y, x;p+e,. (1) and (2) where y; denotes output for the ith sample firm ,2, .... ,n); xi is a (1 x k) vector of inputs associated with ith sample finn; p is a (k xl) vector of the coefficients for the associated independent variables in the production function; vi are assumed to be independent and identically distributed as n (0, cr2 v), independently distributed of vj; ui are non-negative, technical inefficiency effects, which are assumed to be independently and identically distributed non-negative random variables, which can follow such distributions as half nonnal, truncated normal, exponential and gamma distributions (aigner, et al. 1977; greene, 1980; meeusen and van den broeck, 1977). the maximum likelihood estimation of equation (1) yields consistent estimators for p, ie, and cr2, where p is a vector of unknown parameters, a= cr,/crv and cr2 = cru cr}. 10ndrow et al. (1982) have shown that inferences about the technical inefficiency of individual farmers can be made by considering the conditional distribution of u given the fitted values of e and the respective parameters. based on the assumptions: v~n(o, cr/), u~1 n(o, cr} )1, and e(v)=o, he computed the conditional mean ofu; given e; = v; u; as a measure of technical efficiency as: (3) where f* and f* are, respectively standard nonnal density and cumulative distributions evaluated at e)jcr, cr2=cr/+cr}, a=cru/cr., and cr*=cr/cr/lcr2• the estimates of cr2, fe, and parameter vector p are obtained by maximum likelihood estimation. jondrow et al. (1982) also derived a similar fonnula for the exponential distribution while greene (1990) derived a fonnula for the gamma distribution. replacing e, cr., and a by their estimates in equation (1) and (3), we derive the estimates for v and u. subtracting v from both sides of equation (i) yields the stochastic production frontier: r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 81 y* = fixi;~)-u = y-v, (4) where y* is defined as the farm's observed output adjusted for the statistical noise contained in v (bravo-ureta and rieger, 1991 and bravo-ureta and pinheiro, 1997). 4 empirical model the specification of the empirical model requires the choice of an appropriate functional form. in this study, the cobb-douglas functional form was chosen since a more general functional form like the translog model may be not be possible to estimate due to the large number of explanatory variables examined in this study. studies on the impact of functional form on efficiency estimates such as kopp and smith (1980) conclude that functional specification has very little impact on the estimated efficiency. therefore, the stochastic frontier production function for sugarcane farmers of a given farm size and ethnic group is assumed to be: in yi = ~o + ~i in(k) + ~2in(l) + ~3 in(fl) + ~4 in(hl) +~5 in(bh) + ~6 in(th) + ~7 in(fq) + ~8in(cq) + vi-ui (5) where the subscripts i refers to the ith farmer; ln denotes natural logarithm; y denotes quantity of sugarcane harvested (in tons); k denotes capital (total value offarm equipment's in f$); l denotes land area under crop (in acres); fl denotes total amount offamily labor used (in hours); hl denotes total amount of hired labor used (in hours); bh denotes total amount of bullock labor used (in hours for a pair of bullocks); th denotes tractor use (in hours); fq denotes quantity offertilizer applied (in number of 10 kg bags); cq denotes quantity of pesticide used (in number of 4 liter containers); and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 82 sajems ns vol 2 (1999) no i vi are assumed to be independently distributed normal random variables with mean, zero, and variance, a 2 v> independently distributed of ui; u i are non-negative technical inefficiency effects, which are assumed to be independently distributed and arise from the truncation (at zero) of the normal distribution with variance, a 2, and mean, !li defined by where: ag sy fst lt lc fs eth denotes the age of primary decision-maker (in years); represents the maximum years of formal schooling of the primary decision maker; farming status (dummy variable used, 1 if full time and 0 if part time); land tenure system (discontinuous variable used, 0 for native land, i for crown land and 2 for freehold land); and land class (discontinuous variable used, 0 for 1 st class arable, i for 2nd class arable, 2 for 3rd class arable and 3 for marginal arable) i; farm size measured in acres; and ethnicity of farmer measured using a dummy variable (0 for fijian fanner and i for an indian farmer). the ~ and 0 coefficients are unknown parameters to be estimated, together with variance parameters which are expressed in terms of a,2=a,2+ a 2 and y = a 2 fa," where the parameters have values between zero and one. (7) (8) a priori, the signs of all production function parameters specified above are expected to be positive. with regard to the inefficiency model, all variables except the land class variable are expected to have a negative sign. generally, a negative sign with respect to age implies that with increasing age, farmers become more experienced and thus become more efficient. the education variable's negative sign implies that higher education will lead to a more efficient resource allocation and thus an increase in efficiency. the land tenure variable, as specified, is expected to have a negative sign. the first type of land, native land, is leased land, which have a high degree of uncertainty with regard to the renewal of land leases. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no i 83 the second type of lease, crown land, is regarded as better in tenns of lease renewal given that it is state owned. the third type of land is the freehold land, which is devoid of any risk and uncertainty. therefore this variable is expected to have a negative sign. the land class variable is divided into 4 classes with class 1 designating the most arable land while class 4 being the poorest land. in this case, the expected sign of this variable is positive. farm size variable is expected to have a negative sign indicating that as farm size increases, inefficiency will decline. the ethnicity variable is used to examine if there is any significant differences in efficiency between the two ethnic farming groups. the inefficiency model can only be estimated if the inefficiency effects are stochastic and have a particular distributional specification. therefore the null hypothesis that the inefficiency effects are not stochastic (ho: y=0) will be tested. furthennore, the null hypothesis that the coefficients of the variables in the model for the inefficiency effects are zero (l1v: 01 = ... =04=0) will also be tested. these null hypothesis are tested using the generalized likelihood-ratio statistic, a, defined by: (9) where l(ho) and l(h i) are values of the likelihood function under the specifications of the null and alternative hypothesis, ho and hi. 5 data the data for this study were obtained from a survey carried out over a 2 month period. a stratified random sampling approach was used to collect the data where the stratas were defined primarily by the two ethnic communities and to some extent by different farm sizes. a total of 397 farmers were included in this analysis. this sample comprised of 319 indian farmers and 78 fijian farmers. more details on sampling framework and data collection are presented in reddy (1998). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 84 sajems ns vol 2 (1999) no 1 6 empirical results and discussion ols estimates of the production function were used as a basis to determine the goodness of fit of the model (appendix 1). the model displayed a fairly good fit with an adjusted r2 value of 88%. maximum likelihood estimate of the frontier production function were obtained using the frontier 4.1 program (coelli, 1994). the model was estimated under the two common specifications for the one-sided error term, the half normal distribution and the general truncated normal distribution. a likelihood ratio test was used to determine which functional form of the one-sided error term was more appropriate. based on these results, the null hypothesis of a half normal distribution for the error term was rejected. the maximum likelihood estimates, of the frontier production function is presented in table i. the signs of all the variables in the production function conform to a priori expectations. the y parameter value is close to 1.0. this implies that the technical inefficiency effects are significant in the stochastic frontier model and that the traditional production function, with no technical inefficiency effects, is not an adequate representation of the data. the null hypothesis that the inefficiency effects are not stochastic was also rejected at the 5% level of significance. similarly, a likelihood ratio test for the null hypothesis that all the coefficients of the inefficiency model are equal to zero was also rejected. this implies that the explanatory variables have a significant effect on the level of the technical inefficiency. table 1: maximum-likelihood estimates for parameters of the stochastic frontiers and inefficiency models for sugarcane farmers in fiji, 1997 variable i parameter estimate constant i ~o 1.281 (0.036)* capital ~i 0.031 (0.005)* land 0.664 (0.027)* family labor p2 0.034 (0.016)* hired labor ~3 0.014 (0.007) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no i table 1 continuted variable parameter i bullock hours ~4 tractor hours ~5 fertilizer quantity i ~6 chemical quantity ~7 i ine[l1ciency" model constant 80 i age 8) education 82 farming status 83 land tenure 84 land class 05 fann size 86 ethnicity 87 variance parameters cr/ y log-likelihood function number of iterations mean technical efficiency i (%) note: (a) figures in parentheses are asymptotic standard errors. (b) ... denotes 5% level of significance. 85 estimate 0.046 (0.009)* 0.038 (o.oo§)* 0.073 (0.011 )* 0.056 (0.016)* -0.147 (0.154) 0.003 (0.002) -0.002 (0.005) -0.188 (0.047)* 0.024 (0.023) 0.196 (0:q59)* -0.012 (0.007) -0.355 ( 0.084)* 0.029 (0.004)* 0.771 (0.045)* 361.79 34 94.41 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 86 sajems ns vol 2 (1999) no 1 results from the analysis reveal that on an average, the sugarcane farmers in fiji are operating with 5.6% technical inefficiency (see table i). with such a large magnitude of inefficiency level, an investigation of the factors that may cause such level of inefficiency can help for policy making. therefore, the inefficiency models' primary aim was to identify those socioeconomic and other land characteristics, which contribute to technical inefficiency. the results, presented in table i, are again interesting. the inefficiency model consists of seven variables, namely age, education, farming status, land tenure and land class, farm size and ethnicity. the age variable is expected to have a negative sign implying that older farmers are more experienced and thus will be more efficient. the results obtained are in contrary. the positive sign of this variable implies that the effects of old age and poor health conditions override the experience factor of the farmers. the education variable has the result expected. the negative sign implies that, farmers with more years of formal education are associated with a higher level of efficiency. the positive sign of the land class variable indicates that poor land used in sugarcane farming has contributed to increased inefficiency. the farming status variable indicates that part-time farmers are associated with higher levels of inefficiency. the land tenure variable has a positive sign, however, this variable has an insignificant effect on farm efficiency. the insignificant coefficient for this variable may be due to the fact that the impact of uncertainty can not be captured in a static framework. a more realistic approach would be to utilize time series data in modeling how uncertainty, as it increases with time2, leads to inefficiency and productivity loss. this was obviously not possible in this study due to unavailability of time series data. the inefficiency model also reveals that larger farms are associated with higher efficiency, though not significant at 5% level of significance. these results confirm the findings by sen (1966), mazumdar (1965), bardhan, (1973), feder, (1985), khandker et al., (1986), and khandker et al., (1987) that small farms do not use the least-cost input combination. the dummy variable on ethnicity also has a significant effect on farm efficiency. the indian farmers are relatively more efficient than the fijian farmers. 7 conclusion and policy implications this study involves the application of neoclassical production economics theory to fiji's sugar industry. the primary objective of this study was to investigate ways in which the industry could survive in periods of lower output price. one such r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no i 87 period may not be too far away as fiji's sugar industry is expected to enter the world free market. in past years, the free market price has been significantly lower relative to the price fiji's producers have received from preferential treatment in the eu market. in such a case, efficient allocation of available resources will not only increase crop yields but also can lead to a reduction in average costs. as such, this study is primarily geared towards the estimation of the degree of inefficiency that may exit in fiji's sugar industry at the farm level and in such a case, to identify the various determinants of inefficiency, which can then form the basis for policy formulation. results from this study indicate that there is potential to increase productivity by 5.6% via increased efficiency (table 1). there are various ways this could be achieved. the move towards plantation agriculture should be made with caution. first, further research needs to be done to verify the hypothesis on efficiency and optimal farm size. furthermore, the social implications of such moves should also be examined. this move may meet opposition from farm households as amalgamation could lead to their eviction and thus hardship in life. however, a large portion of farmers, may anyway face eviction, after non-renewal of their land leases. therefore, this may be the opportune time to amalgamate the small farms into large plantations. another variable that significantly affects efficiency is land class. this suggests that one way productivity on fijian farms could be increased is via improvements such as; erosion control practices, provision of irrigation and other soil improvement practices that would enhance nutrient retention and uptake. the result pointing to the significant impact of education on farm efficiency verifies the importance of formal education on the long term viability of the agricultural sector. the land reform stage can also look into the future of part-time farmers in the sugar industry. there are a number of other factors, which were not accounted for in the inefficiency model. two of these factors include the age of crop (ratoon age) on each farm and the portion of cane harvested after burning. if farmers are encouraged to reduce the age of ratoon and keep more "plant cane", this would significantly boost farm productivity. furthermore, secondary data have shown that burning cane adds significant losses both to the farmer and the industry. if cane burning prior to harvesting were discouraged, this would contribute to significant increases in farm productivity. this study investigated the technical efficiency status of fiji's sugar industry. this study can be taken one step ahead by examining allocative and the overall economic r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 88 sajems ns vol 2 (1999) no 1 efficiency of the fann. this would require time series data, which currently is not available. time series data can also be used to examine how efficiency has changed overtime in the industry. appendix a: estimates of average (ols) cobb-douglas production function variable constant ~o capital ~l land ~2 family labor ~3 i hired labor ~4 hock hours 135 tor hours p6 fertilizer quantity ~7 chemical quantity ~8 ioi{ iikelihoodfunction adjusted r' f-statisticfor crs (a) figures in parenthesis are standard errors. (b) * denotes 5% level of significance endnotes parameter 1.132 i (0.034) 0.042 fi\ (106)* 0.663 (0.024)* 0.042 (0.017)* 0.013 (0.008) 0.045 (0.011)* 0.040 (0.010)* 0.091 (0.014)* 0.067 (0.017)* 325.02 0.88 0.054 1 ,\ class arable: flat, very few limitations, suited to a wide range of crops. improvement not needed. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 1 89 2nd class arable: flat to gentle slopes, moderate limitations, similar to 1;[ class arable, 3,d class arable: moderately steep, severe limitations, suited to a narrow range of crops, improvements required, marginal arable: steep slopes, very severe limitations, major improvements required, the implication here is that as the lease expiry date approaches, the uncertainty with regard to its renewal and the associated risk increases, references 1, aigner, d" lovell, c'a.k and p,schmid, t. (1977), "formulation and estimation of stochastic frontier production function models", journal of econometrics, 6(1 ):21-37. 2. bagi, f.s. and huang, c.1. (1983), "estimating production technical efficiency for individual farms in tennessee", canadian journal of agricultural economics, 31(2):249-256. 3. bardhan, p.k. (1973), "size, productivity and returns to scale: an analysis of farm level data in indian agriculture", journal of political economy, 81(6):1370-86. 4. battese, g.e. (1997), "a note on the estimation of cobb-douglas production functions when some variables have zero values", journal of agricultural economics, 48(2):250-252. 5, battese, g.e, (1992), "frontier production functions and technical efficiency: a survey of empirical applications in agricultural economics", agricultural economics, 7(1):185-208, 6, battese, g,e, and corra, g,s, (1977), "estimation of a production frontier model: with application to the pastoral zone of eastern australia", australian journal of agricultural economics, 21 (2): 169-179, 7. battese, g.e. and coelli, t. j. (1995) "a model for technical inefficiency effects in a stochastic frontier production function for panel data", empirical economics, 20(1):325-532. 8. battese, g,e, and coelli, t.1, (1993) "a stochastic frontier production function incorporating a model for technical inefficiency effects", working papers in econometrics and applied statistics, no. 69, department of econometrics, university of new england, armidale. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 90 sajems ns vol 2 (1999) no 1 9. battese, g.e. and coelli, t 1. (1992) "frontier production functions technical efficiency and panel data: with application to paddy farmers in india", journal of productivity analysis, 3(2): 153-169. 10. batiese, g.e. and coelli, tj. (1988) "prediction of firm-level technical efficiencies with a generalized frontier production function and panel data", journal of econometrics, 38(1 ):387-399. 11. battese, g.e., coelli, t.j. and colby t. c. (1989) "estimation of frontier production functions and the efficiencies of indian farms using panel data from icrisa t's village level studies", journal quantitative economics., 5(2):327-348. 12. batiese, g.e., malik, s.j. and gill, m.a. (1996) "an investigation of technical inefficiencies of production of wheat farmers in four districts of pakistan", journal of agricultural economics, 47(1 ):37-49. 13. bauer, p.w. (1990) "recent development in the econometric estimation of frontiers", journal of econometrics, 46(2):39-56. 14. bra vo-ureta, re. and pinherio, a.e. (1993) "efficiency analysis of developing country agriculture: a review of the frontier function literature", agricultural and resource economics review, 22(1 ):88-1 0 1. 15. bravo-ureta, b.e. and pinherlo, a.e. (1997) "technical, economic, and allocative efficiency in peasant farming: evidence from the dominican republic", developing economies, 35(1):48-67. 16. bravo-ureta, re, and rieger, l. (1991) "dairy farm efficiency measurement using stochastic frontiers and neoclassical duality", american journal of agriculture economics, 73(1):421-28. 17. coelli, t.1. (1992) "a computer program for frontier production function estimation: frontier, version 4.1 ", department of econometrics, university of new england. 18. coelli, t.j. (1985) "a generalized frontier production for crosssectional, time-series data", unpublished b.app.ec (honors) dissertation (university of new england, armidale, n.s.w). 19. coelli, t.j. (1995) "recent developments in frontier estimation and efficiency measurement", australian journal of agricultural economics, 39(2):219-245. 20. coelli, t.j., and battese, g. (1996) "identification of factors which influence the technical inefficiency of indian farmers", australian journal of agricultural economics, 40(2):103-128. 21. devadoss, s and kropf, 1. (1996) "impacts of trade liberalization under the uruguay round on the world sugar market", agricultural economics, 15(1):83-96. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol2 (1999) no 1 91 22. feder, g. (1985) "the relation between fann size and fann productivity", journal of development economics, 18(2/3):297-314. 23. greene, w.h. (1990) "a gamma-distributed stochastic frontier model", journal of econometrics, 46(1):141-163. 24. greene, w.h. (1980) "maximum likelihood estimation of econometric frontier functions", journal of econometrics, 13(1 ):27-56. 25. heshmati, a., and kumbhakar, s.c. (1997) "estimation of technical efficiency in swedish crops fanns: a pseudo panel data approach", journal of agricultural economics, 48(1 ):22-37. 26. huang, c.j. and bagi, f.s. (1984) "technical efficiency on individual fanns in northwest india", southern economic journal, 51(1):1 08-115. 27. jondrow, j., lovell, c.a.k, materov, ls. and schmidt, p. (1982) "on the estimation of technical inefficiency in the stochastic frontier production function model", journal of econometrics, 19(2/3):233-238. 28. kalirajan, k.p. (1981) "an econometric analysis of yield variability in paddy production", canadian journal of agricultural economics, 29( l):283-294. 29. kalira-jan, k.p. and flinn, j.c. (1983) "the measurement of fann specific technical efficiency", pakistan journal of applied economics, 28(1):167-180. 30. kalirajan, k.p., and shand r.t. (1992) "causality between technical and allocative efficiencies: an empirical testing", journal of economic studies, 19(2):3-17. 31. khandher, s.r., mestelman, s. and feeny, d. (1987) "aijocative efficiency, the aggregation of labour inputs, and the effects of fann size and tenancy status: tests from rural bangladesh", journal of development studies, 24(1 ):30-42. 32. khandher, s.r., mestelman, s. and feeny, d. (1986) "fann size, tenancy status and technology: production relationships in rural bangladesh", canadian journal of development studies, 7(2): 257 -68. 33. kopp, r.j. and smith, v.k. (1980) "frontier production function estimates for steam electric generation: a comparative analysis, southern economics journal, 47(1): i 049-1 059. 34. lee, l.f. and tyler, w.g. (1978) "a stochastic frontier production function and average efficiency: an empirical analysis", journal of econometrics, 7(2):385-390. 35. lund, pj. and hill, p.g. (1979) "fann size, efficiency and economies of size", journal of agricultural economics, 30(2): 145-58. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 92 sajems ns vol 2 (1999) no 1 36. mazumdar, d. (1965) "size of farm and productivity: a problem of indian peasant agriculture", economica, 42( 126): 161-173. 37. meeusen, w. and van den broeck, j. (1977) "efficiency estimation from cobb-douglas production functions with composed error", international economic review, 18(2):435-444. 38. mensah, y.m. (1994) "a simplification of the kopp-diewert method of decomposing cost efficiency and some implications", journal of econometrics,60(1/2):l33-144. 39. pitt, m.m. and lee, l.f. (1981) "measurement and sources of technical inefficiency in the indonesian weaving industry", journal of development economics, 9( 1 ):43-64. 40. reddy, m. (1998) production economics analysis of fiji's sugar industry, unpublished ph.d dissertation, university of hawaii. . 41. schmid,t.p., and lovell, c.a.k.. (1980) "estimating stochastic production and cost frontiers when technical and allocative inefficiency are correlated", journal of econometrics, 13(1 ):83-100. 42. schmidt, p. and sickles, r.c. (1984) "production frontiers and panel data", journal of business and economic statistics, 2(1 ):367-374. 43. sen, a.k. (1966) "peasants and dualism with or without s~rplus labor", journal of political economy, 76(5):425-450. 44. stevenson, r.e. (1980) "likelihood functions for generalized stochastic frontier estimation", journal of econometrics, 13( 1 ):57-66. 45. trewin, r., weguo, l., erwidodo, and bahri, s. (1995) "analysis of the technical efficiency over time of west javanese rice farms", australian journal of agricultural economics, 39(2):143-163. 46. vlastuin, c., lawrence, d., and quiggin, j. (1982) "size economies in australian agriculture", review of marketing and agricultural economics, 50(1 ):27-50. 47. waldman, d.m. (1984) "properties of technical efficiency estimators in the stochastic frontier model", journal of econometrics, 25(1 ):353-364. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 445 sajems ns vol 4 (2001) no 3 globalisation: the political dynamics robert a schrire department of political studies, university of cape town abstract globalisation is a multidimensional phenomenon and should be conceptualised as a process rather than an outcome. economic, political, cultural and societal elements are involved in the complex set of interactions we candefine as globalisation. however, a key factor, which is frequently ignored is the importance of politics in shaping and guiding this process. for example economic liberalisation and deregulation, the form which economic globalisation has thus far taken, did not emerge from impersonal market and technological forces. governments, especially those of the united states and great britain, followed explicit policies of currency controls relaxation, the reduction in trade barriers, and the retreat in the role of the state in the economy generally. despite the power of the economic forces thus released, politics remains a key potential player and giobalisation is not necessarily irreversible. given the indeterminacy of the outcomes of giobalisation, four alternative theories of the future are presented and analysed. jelf 02 introduction globalisation has since the early 1990s become one of the most frequently used concepts in the social sciences! and is a strong contender for the most commonly used term in the public debates. it is often used indiscriminately to describe almost all modem developments good and bad and thus usually generates more heat than light. indeed social science methodology confirms that a concept that purports to explain everything in fact explains nothing. this threatens to be the fate of the concept of globalisation. protestors representing a wide range of diverse views and operating from such geographically distant cities as seattle and genoa, mobilise against its alleged evils while bureaucrats from the international monetary fund. world trade organisation, and world bank are staunch in its defence. because the concept is so rarely defined with care and rigour, it has tended to become a catch-all concept which is often used to express widespread discontent with modernity and its disruptions. yet even before we begin the task of defining and analysing a complex and dynamic r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (200 i) no 3 446 concept, a moment's reflection should convince the rational observer that globalisation, however defined, cannot be held responsible for the wide array of popular grievances attributed to it. for example, many environmentalists blame globalisation for the decay of the environment. however, given that systems of production are located in geographically defined states, it is the actions and inactions of governments in states such as china, india and the united states that must shoulder the responsibilities for pollution. globalisation has little if anything to do with these realities. similarly, the decline in the viability of small farms and village business centres is not a consequence of the forces of globalisation, but reflects the economies of scale which favour large agribusiness and hypermarkets. what is globalisation? or phrased differently, if concepts are neither true nor false in and of themselves, how best can we think about the complex range of changes which are subsumed by the ideas of the critics and supporters of "globalisation?" globalisation is clearly a multi-dimensional phenomenon. economists tend to equate globalisation with the process of economic liberalisation and deregulation. the contemporary global market is in the process of transcending the boundaries of the state system. if this process reaches its logical conclusion without major political interference, an economic system liberated from the restraints of political sovereignty will have been created. empirically this would be measured by the growth in transnational capital flows, the liberalisation of trade and, arguably, by the emergence of large corporations controlled and managed free from the restraints of a particular nation. transnational corporations would be owned and managed by a global constituency of shareholders and managers. for many sociologists, globalisation is viewed as the process, which is creating a global culture characterised by the dominance of the english language rationalism, materialism and individualism. many political scientists tend to see globalisation as the process that is carrying liberalism and democracy to universal victory. some analysts maintain that this process is threatening the state system itself because its defining characteristic sovereignty is being undermined 2 • two problems emerge from this brief discussion. first, it is clearly dangerous to divide a complex phenomenon into discrete disciplinary specialties. it has long been recognised, and bemoaned, that economists and political scientists have generally ignored each other's work even in areas where there are considerable overlaps. secondly, globalisation must be conceptualised as a process and not as an outcome. while it should be possible to analyse empirically the determinants of globalisation, the outcomes are not path dependent and must thus be considered indeterminate. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 447 sajems ns vol 4 (200 i) no 3 what are the processes driving globalisation? almost all scholars agree that technology, especially in the field of communications, is perhaps the most important influence on contemporary economic and political life. the world today is profoundly different from the past. technology for example, has made possible actions, which enable vast magnitudes of funds to be transferred almost instantaneously to any part of the world. similarly, the ability of a global audience to have instantaneous access to information about political riots in the middle east, the forcible confiscation of land in zimbabwe, or the confusions around americas recent presidential election, all have profound implications. how should we defme globalisation? it follows logically from the discussion above that globalisation, however defined, must be conceptualised as both a process and as a multidimensional phenomenon. incorporating elements of anthony mcgrew's defmition3, i would define globalisation as the processes, based upon technology, which increase both the speed and scope of linkages across state boundaries in areas including the economy, polity and culture. the implications of this defmition are profound and cannot be explored in detail here. but the following should be noted: 1) the process of globalisation need not be irreversible, 2) globalisation in one sphere may not be matched by similar dynamics in another, and 3) the processes of globalisation in the various spheres may, in fact, be in conflict with each other. in the remainder of this article, i will briefly examine some of the implications of these factors for the politics of globalisation in the context of the larger processes of change. political dynamics from a legal perspective, international politics is still based upon the westpha�ian legacy of independent and sovereign political states. indeed, the most universalistic global institution, the united nations, was established by sovereign states and its founding charter pays explicit tribute to sovereignty and noninterference in the domestic affairs of its members. during the cold war, this state oriented paradigm retained considerable relevance. the world was locked in a titanic struggle between two superpowers, each with its associated vassals and allies. despite the ideological pretensions of this struggle, there were also important geo-political and nationalistic elements. indeed, many theorists argue that the distribution of power in an international system dictates the kind of configurations of conflict in that system 4 • the bipolar contest between 1945 and 1990 had several important characteristics. firstly, economics was frequently subordinated to the political requirements of the contest. national interests, defined largely in terms of power, were paramount. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 3 448 from a policy perspective, the distribution of gains (and losses) was more important than the absolute gains. the market was to a large extent subordinate to the polity. for example capital, was not permitted to seek freely its highest return, trade was guided in political directions; many products were not allowed to be exported to potential rivals while allies frequently received special preferences. thus, the then soviet union subsidised the economies of allies such as cuba and the german democratic republic both to bind them closely to the superpower and to prevent internal dissent in the periphery. similarly, france tried to protect its political influence in francophone africa through policies such as currency arrangements and preferential trading agreements. these political imperatives did not totally override the market except in the soviet bloc. but even the western capitalist states limited the autonomy of the market to create and distribute economic values. a second important consequence of the cold war was the dovmplaying of the importance of domestic factors in the choice of both allies and foes. although the superpower conflict was ostensibly solely over ideological concerns, the reality is that realpolitik overrode ideology. for example, the united states, despite its liberal and capitalist orientation, supported overtly and consistently a wide range of authoritarian regimes such as chile and, in the 1960s and 1970s, south africa, as well as several market unfriendly regimes in africa and latin america. the key to american support was not primarily the nature of a state's political economy but its foreign policy orientations. states that were avowedly anti-communistic were almost automatically assured of us support. similarly the soviet union, despite its more explicit ideological self-image, supported a wide range of african and asian states such as ghana, angola and cambodia whose actual economic policies bore little resemblance to genuine socialism. a third implication of the end of superpower bipolarity has been the decline in the autonomy of many small states. during the cold war, states such as zambia had some scope for maneuver because they could playoff one superpower against the other. given the importance then of bilateral aid, this could be a rewarding strategy. the end of superpower competition has made such a strategy unviable with significant implications. for example, contemporary zambia has international debts of about six billion dollars about twice the size of its national income. it only survives on global handouts which constitute half the governments budget. the world can now dictate the terms of its engagement with zambia. in the past, zambia would have retained some autonomy under cold war conditions, president chiluba would not have been forced to abide by the constitutional prohibition on seeking a third term. during the cold war the international system was structured around the principle of a balance of power which also largely served to ensure order. the so-called r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 449 sajems ns vol 4 (2001) no 3 universalistic organisations such as the united nations had no independent capabilities and were essentially paralysed by the mutual veto enjoyed by its permanent members. economic organisations such as the imf and world bank: were for western states only while the soviet union created its own exclusive organisations such as comecon. the fall of communism when the cold war ended in the early 1990s, bipolarity ended with it. the world became characterised by the effective hegemony of the united states as the world's only superpower. however, in a world where many different types of power exist, the united states alone was not able to dominate all aspects of the global political agenda. but if the us could not dominate, it exercised veto power in most areas of public international policy. the attention of intellectuals turned to the new paradigm of "globalisation". most observers, aware of both the growing complexity of the modem world and the inability of the remaining superpower to dominate the system in its entirety, sought a systemic explanation for this seeming paradox. the thesis that new forces led by the markets had emerged outside of political control seemed to provide a useful explanation. this is, however, a profoundly ahistorical perspective. globalisation did not emerge ab initio from uncontrollable systemic forces. political decisions with intended and unintended consequences made possible the spread oftechnology. major powers, following their own perceived interests, set in motion policies of economic liberalisation. when the perceived political imperatives of a marxist challenge began to decline, the major powers, especially the united states and great britain, liberated the market on a global scale. the process of trade liberalisation, which began with the formation of gait, continued with the inclusion of the former soviet union and most of its allies. capital was largely liberated from regulations and controls the result of deliberate government decisions, first in the united states and great britain and then spreading throughout the industrialised world. with the unimportant exceptions of a handful of states such as cuba and iraq, trade was largely liberated from political controls. implications and trends in economic theory the consequences of economic liberalisation are unambiguous and generally positive. a large literature, both theoretical and empirical exists describing the outcomes of economic integration, trade liberalisation and capital mobilitys. we have case-studies of the empirical outcomes in the united r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 3 450 states and increasingly the european union. unimpeded by political factors, economic globalisation will lead to the emergence of a global economy in which resources are allocated on the basis of efficiency rather than geography or politics. however, in the political sphere the implications of globalisation for both domestic and global politics are problematic and probably indetenninate at this stage of history. economic liberalisation has advanced far more rapidly than political integration. although the scope of economic globalisation has been exaggerated6, we can nonetheless trace empirically an emerging global economy. however as noted earlier, the political system remains based, frequently fictitiously, on the notion of sovereignty. generally, the most important of the existing trends can be said to be: the discontinuities between economic globalisation and the state system; the rapid pace of technological change; the power and spread of western ideas; and the tentative emergence ofa nascent global civil society. while all of these would require a rigorous analysis, this is not possible for the scope of this article. however, it may be useful to explore some of the possible outcomes of these forces. given our conceptualisation of globalisation as a process, what are the possible political outcomes? broadly, we can distinguish between the following possibilities: the re-emergence of realpolitik; the end of sovereignty; the return of the state, and/or global governance. the re-emergence of realpolitik the end of the cold war largely liberated the market from political controls. although many market optimists believe that this victory is irreversible (see below), others argue that this victory is a delusion. the political kingdom is far too well entrenched in human society to be so easily vanquished. conflict is endemic and will re-emerge sooner or later in one fonn or another. one of the most prominent advocates of this position is samuel huntington? he argues that globalisation is bringing western ideas to all parts of the globe while economic integration is penetrating many non-western societies. contrary to the view of the optimists, growing contacts will lead not to harmony and a shared materialism but to increased conflict and turbulence. the conflicts will not be based upon traditional state conflicts or ideologies but upon a clash of civilisations. in huntington's view, "the most important conflicts of the future will occur along the fault lines separating these civilisations from another"s. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 451 sajems ns vol 4 (2001) no 3 other pessimists reject the huntington analysis but agree that conflict cannot be eliminated from global affairs. they maintain that states will remain the key players in the future and that the present harmony which characterises relations between the major powers will be temporary. in the view of nea-realists it will be systemic forces, which lead "states [to] balance against hegemons,,9. the present dominance of the united states will in time produce an inevitable countervailing force. one possibility would be for a politically united europe to challenge us hegemony. more destabilising for political stability would be the emergence of new and revisionist superpowers like china and india which would be unlikely to accept a world created in western, and especially, american images. and the former superpower represented by contemporary russia could, in time, become an important revisionist power. recent negotiations between china and russia to establish the shanghai five might be seen as the beginning of such a process. the end of sovereignty the high priests of economic globalisation like ohmae lo and friedman believe that the conflict between the state and the market is already largely over and the market has emerged victorious! the imperatives of economic liberaiisation have overcome the reactionary forces represented by the state. grand ideologies and petty but destructive nationalisms are largely dead. where they do still exist in bosnia, china and nigeria they are restricted to backward societies, which represent the past rather than the future. in all of today's advanced and dynamic societies in north america, western europe, australia and japan governments have rejected the destructive nationalisms of the past while the populace has rejected the grand designs of the state. people there seek personal fulfillment and improved material welfare. and they will use their vote to punish any political movement, which seeks to return to the past. in the words of then american presidential candidate bill clinton, "its the economy stupid!" in addition, the costs of attempting to unravel the threads of today's economic liberalisation would be too high for any rational government to even consider. power now lies squarely with the giant corporations, which control the world's major accumulations of capital and dominate the creation and dissemination of technology and intellectual capital. even formerly radical states in africa, asia and latin america are competing fiercely with each other to become integrated into the global economy. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 3 452 the return of the state neo-realists reject both the return to conflict paradigms and these economically deterministic conclusions. they believe that the extent of globalisation has been grossly exaggerated. the state remains a key player especially the united states. the state economy remains far more important than the global economy. thus, they reject the claim that transnational corporations are becoming dominant players. indeed they reject the basic concept of a transnational company. corporations may have global operations but they remain state based: they operate from geographically defined headquarters, they are legal creations of particular jurisdictions, and states remain the dominant authority in regulatory and tax policies ii. indeed the policies of states towards private enterprise, property rights and education remain a vital element in the prospects for success or failure of the corporate sector l2 • politics thus remains in controlat least in the major states. if countries like peru, thailand, ghana and namibia lack genuine autonomy, this is not the consequence of globalisation. historically, minor powers have never had real power in a world dominated by the consequences of the inequalities in the distribution of power. globalisation is not an explanation for powerlessness but a conceptual confusion resulting from an ahistorical mode of analysis. above all, neo-realists see the contemporary world as in large part the creation of the major players, especially the united states and great britain. to put it in the words of susan strange, these major powers had "structural power", i.e., ''the power to decide how things shall be done, the power to shape frameworks within which states relate to each other, relate to people, or relate to corporate enterprises" 13 • with the end of the cold war they perceived that their interests, and those of their citizens, would be served by a liberal economic order. if economic liberalisation is the result of political decisions, then it can in principle be controlled. no mainstream scholar has advocated a return to autarchy. however they reject the argument that globalisation is the outcome of systemic forces which can be neither controlled nor reversed. globalisation remains in the interests of the superpowers and their domestic elite. and should these interests change, states acting singly and collectively would have both the power and the will to reassert political control over the market. governance the fmal perspective is more complex and nuanced than any of the preceding approaches. the governance perspective accepts the important role that the state has to play in resolving conflicts, providing public goods including security, and regulating an increasingly complex society and environment. proponents of the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 453 sajems ns vol 4 (200 i) no 3 governance perspective argue that although the state is not obsolete, it cannot continue with business as usual in a complex and interdependent context. the key global players have transcended conflicts of the past be they based upon state, culture or ideology. however it is utopian to expect a global system of government to emerge under present circumstances. they also reject the hyperglobalist argument of the victory of the market, which implies that politics is of very limited importance. however, despite the absence of a global government or system of authority, the global community is not in chaos. the functions of government can be performed even in the absence of government. a system is emerging in which a complex web of institutions and groups is performing some of the functions of government. contemporary global organisations like the wto have far more actual authority than an earlier generation of institutions like the un system and the world bank because it is not legally dominated by any power. and unlike the un and, de facto, the jmf and world bank, the wto does not have a veto mechanism. new global institutions, despite their fragility, are increasing and are being complemented by regimes systems of rules and norms, which sovereign states are increasingly accepting voluntarilyl4. self-interest does not have to produce a hobbesian world of conflict and anarchy. rational actors can learn from experience how to cooperate with other independent players. although this emerging system is not directly democratic, it is being supported by a range of ngos, which now constitute the beginnings of a global civil society. ecologists, human rights activists and others concerned with global issues are using modern technology to cooperate across state boundaries. a new political dynamic is developing not as a replacement for states and governments but as democratising and supplementing forces. governance without government is epitomised by the emergence of tribunals for justice. despite the admonition against interference in the domestic affairs of sovereign states, a global sense of community is slowly emerging. the arrest of former chilean dictator augusto pinochet in britain at the request of a spanish prosecutor was a harbinger of this development this trend has accelerated with the arrest and prosecution of former yugoslav leaders including milosevic. this new direction in global affairs is now becoming formally instutionalised. in 1993, the international criminal tribunal for the prosecutions of persons responsible for serious violations of international humanitarian law committed in the territory of the former yugoslavia was established and in the following year a similar body was established for rwanda. both bodies were created under the auspices of the security council. a more ambitious development is the proposed international criminal court also under the auspices of the united nations. thus far, thirty six of the sixty states required for its establishment have ratified the proposal if it is established it will represent a major advance in givr ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 3 454 ing meaning, through possible retribution, to the commitment to the protection of global human rights. discussion it has been a central contention of this article that the future has not yet been irrevocably written. unlike advocates of a "return to history" or "sovereignty-atbay", i believe that various outcomes remain possible. the key weakness of theories, which predict the re-emergence of realpolitik, is that they are trapped in a view of history where peoples and states are caught in a world of conflict. despite the publicity accorded to huntington's "clash of civilizations", few conflicts today are exclusively or even primarily about culture, however defined. similarly, although it is possible that revisionist states like china may emerge to challenge the status quo, it is not inevitable that this will happen. and thus far no state has advocated a global system fundamentally different from the contemporary world. rather than transformation, critics are demanding fairness in the composition of the security council, in voting weights in the imf, and in general for greater democracy and transparency. similarly, proponents of the view that markets have or will override the polity have a simplistic and deterministic view of causation in human societies. a central theme of this article has been the political dynamic behind economic liberalisation. and what the polity has created, it can also destroy. many useful insights are contained in the works of the advocates of a "return of the state" and "global governance". politics, domestically and globally, remains dominant. power politics has not been eliminated. however, the world has changed dramatically and it is not business as usual in global politics. new issues have arisen ecology for example while sovereignty takes a different form in a world of interdependencies and hyper-complexity. technology makes cooperation between individuals and groups and organisations possible in a way that was unthinkable in the past. the future will look both similar to and different from our recent past. there will be continuities and discontinuities. states will continue to be the principal actors but they will share the stage with ngos, regional bodies and global organisations. power and security will continue to be central issues but they will be joined by issues of human rights, the protection of the environment, and the pursuit of justice. the past, present and future will be joined simultaneously! r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 455 sajems ns vol 4 (200 i) no 3 conclusions the end of the cold war then, has witnessed the general decline in the importance of explicitly political factors in the formulation and implementation of economic policy, the rise in the importance of economic values and thus the increased importance in the role of the market in shaping resource allocation and distribution decisions. one major, consequent problem has been the growing imbalance between the market and the polity. while economic forces have been largely liberated from state regulation, no global mechanism has been created to perform the traditional functions of governance. this problem is most urgent in the area of capital flows. in a single polity with a common currency, the movement of capital has limited political relevance. however, in a world in which states remain the organisational framework, the free movement of capital can have profoundly destabilising consequences. this is compounded by the relative immobility of labour. historically, mass migrations have been a powerful redistributive force which have dramatically contributed to the reduction in inequalities between states. the implications for economic stability and macroeconomic policy of the imbalance between political and economic globalisation fall outside the scope of this article. but in the sphere of hot money, i.e., the billions of dollars floating through the system derived from drugs and other criminal activities, the lack of a global authority or regulatory mechanism has important consequences for the conduct of political life. more generally, the problem lies in the failure of states to develop a mechanism for global political governance. the decline in economic autarchy has taken place in the context of sovereign states who are reluctant to cede any of their legal authority. none of the so-called international organisations are genuinely international. from the united nations system to the international monetary fund and the world trade organisation they remain state-based. the world's only superpower dominates this system and few, if any, significant decisions can be made without us support. it should be stressed that this problem has not been created by globalisation. for most states, historically and up to the present, the idea of equality and autonomy has always been a myth. the major powers in all systems, from the seventeenth century to the present, have been dominant. if the superpowers have always made history, the minor powers have had to adjust to that reality. globalisation has simply made this reality more stark. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 3 456 endnotes busch, a. (2000) "unpacking the globalization debate: approaches, evi~ dence and data", in hay c. & marsh d., demystifying globalization, london: macmillan press. 2 see, for example, susan strange (1996) the retreat of the state: diffusion of power in the world economy, cambridge: cambridge university press. 3 anthony mcgrew (1992) "a global society?", in hall s., held d. & mcgrew a. (eds.) modernity and its futures, cambridge: polity press. 4 kenneth waltz (1979) theory of international politics, new york: ran~ dom house. 5 see, for example, world bank (1996) "liberalization, stabilization and growth" in world development report: from plan to market, washing~ ton d.c.: world bank. 6 robert schrire (2000) "the duality of globalization", cambridge review of international affairs, 14(1): 52-58. 7 samuel huntington (1993), "the clash of civilizations?", foreign af fairs, summer. 8 ibid, p.25. 9 christopher layne (1993), "the unipolar illusion: why new great powers will rise", international security, 17(4). 10 kenichi ohmae (1990) the borderless world, london: collins; and (1995), the end of the nation state, new york: free press. ii p. doremus, w. keller, l. pauley & s. reich (1998), the myth of the global corporation, princeton: princeton university press. 12 michael porter (1990) the competitive advantage of nations , new york: free press. 13 susan strange (1988) states and markets: an introduction to international political economy, london: pinter: 24-25. 14 see, for example, robert o. keohane (1984) after hegemony: cooperation and discord in the world economy, princeton: princeton university press. references busch, a. (2000) "unpacking the globalization debate: approaches, evidence and data", in hay c. & marsh d. (eds.) demystifying globalization, london: macmillan press. 2 doremus, p., keller, w., pauley, l. & reich, s. (1998) the myth of the global corporation, princeton: princeton university press. 3 mcgrew, a. (1992) "a global society?", in hall s., held d. & mcgrew a. (eds.) modernity and its futures, cambridge: polity press. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 457 sajems ns vol 4 (2001) no 3 4 huntington, s. (1993) "the clash of civilizations?", foreign affairs, summer. 5 keohane, r.o. (1984) after hegemony: cooperation and discord in the world economy, princeton: princeton university press. 6 la yne, c. (1993) "the unipolar illusion: why new great powers will rise", international security, 17(4). 7 ohmae, k. (1990) the borderless world, london: collins. 8 ohmae, k. (1995) the end of the nation state, new york :free press. 9 porter, m. (1990) the competitive advantage of nations, new york: free press. 10 schrlre, r. (2000) 'the duality of globalization", cambridge review of international affairs, 14(1): 52-58. ii strange, s. (1988) states and markets: an introduction to international political economy, london: pinter. 12 strange, s. (1996) the retreat of the state: diffusion of power in the world economy, cambridge: cambridge university press 13 waltz, k. (1979) theory of international politics, new york: random house. 14 world bank (1996) "liberalization, stabilization and growth" in world development report: from plan to market, washington d.c.: world bank. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 446 factors influencing perceptions and expectations of corporate social performance in south africa: an exploratory empirical study d a l coldwell school of economics and management, university of natal abstract this paper analyses the effects of gender and ethnic group in the perceptions and expectations of corporate social performance (csp) in a sample of students controlled for age, education and academic discipline. instruments to measure perceptions and expectations of csp are devised using likert-type scales. the reliability and construct validity of the measuring instruments are assessed using cronbach alpha coefficients of internal consistency and factor analysis. a backward elimination multiple regression incorporating dummy variables, indicates that gender and ethnic group are significant predictor variables in perceptions and expectations of csp. the findings are discussed with regard to the utility of carroll and buchholtz's (2000) csp model in the south african situation. 1 introduction the importance of ethics in business has never been greater than today both within south africa and overseas. today's business organizations are expected by consumers and society at large to perform a much greater role than in the past. today business is expected to provide inter alia: a safe and satisfying working environment, a clean external physical environment and socioeconomic benefits to the community in which it operates and the social system in which it is located. in order to gain some insight into the perceptions and expectations of corporate social performance (csp) of south african consumers, it is useful first to examine this phenomenon in a multi-cultural context that is characteristic the south african business situation. it is suggested that a convenient and valid way of doing this is to analyze a group of emerging potential managers such as those that are likely to be found among university third year commerce students. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 447 sajems ns vol3 (2000) no 3 the overriding objectives of this study are: • to develop instruments to measure perceptions and expectations ofcsp, and • to explore individual variations in the perceptions and expectations of csp. it was considered important to control for age and education, as these factors have been shown to be salient in moral development (kohlberg, 1971 and kutnick, 1986) and thus are likely to have a strong influence on perceptions and expectations ofcsp. clearly, individuals at different levels of moral development would be expected to have qualitatively different expectations of csp. thus controlling for this aspect allows other factors to emerge in the analysis that account for variations in individual perceptions and expectations of csp. carroll and buchholtz's csp model carroll and buchholtz (2000) present a model of the actual and expected csp gap indicated in figure i. figure 1 society's expectations versus business's actual social . performance (adapted from carroll and buchholtz, 2000) social perfonnance expected and actual 1960s time '\ society's expectations of business perfonnance 19905 business's actual social perfonnance carroll and buchholtz (2000) suggest that a revolution of rising expectations has occurred in the west over the past 30 years. this they define as: ... an attitude or a belief that each succeeding generation ought to have a standard of living higher than that of its predecessor and that its expectations of major institutions, such as business, should be greater also. building on this line of thinking, one could argue that business is criticized today because society's expectations of its performance have outpaced r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 448 business's ability to meet these growing expectations. (carroll and buchholtz,2000: 13). a social problem is created when a gap exists between society's expectations of socio-economic conditions and present socio-economic realities. at the level of business organizations the social problem becomes the gap between society's expectations of businesses' social performance and its actual social performance. corporate social performance is defined by robbins (1994: 123) as: " .... a business firm's obligation, beyond that required by the law and economics to pursue long-term goals that are good for society". boone and kurtz (1999: 54) define csp as: " ... management's acceptance of the obligation to consider profit, consumer satisfaction, and societal welibeing of equal value in evaluating the firm's performance." finally, wood (1994: 122) defines csp as: " ... a business organization's configuration of principles of social responsibility, processes of social responsiveness and observable outcomes as they relate to the firm's social relationships. " in the current study the concept of csp is operationally defined as the obligation of businesses operating in south africa to society and the community beyond their purely legal and economic ones. the concept of csp as it is used here thus specifically embraces both conducting business ethically and mobilizing business resources for social upliftment. it is maintained that although carroll and buchholtz (2000) offer a useful theoretical model at the macro level of analysis, they suggest a degree of homogeneity in individuals' perceptions and expectations of business's social performance that is clearly at loggerheads with circumstantial empirical evidence. also, their model is confined to a description of circumstances in the developed world and its adequacy, as a descriptor of circumstances in the developing world such as south africa, nee~s empirical confirmation. method research design and sample a cross-sectional/correlational research design was used. a high proportion of accounting students enter business on completion of their studies; with many entering the ranks of management on leaving university. therefore, all those students studying auditing 3 at a university situated in kwazulu-natal were selected for the sampling frame (n=260) and a representative sample of 133 students consisting of 28 white, 29 black and 76 indian students were ultimately used. four coloured students were not included because they comprised too small a sample for analysis. there were 67 male and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 449 sajems ns vol 3 (2000) no 3 66 female students in the sample. the remaining students were lost through nonresponse, non-attendance and incomplete/incorrect completion of the questionnaire. the research design incorporated controls for age and education. as regards age, 79% of the students in the sample were 19 to 21 years of age, with 93% of students being between 19 and 22 years old. education was controlled by means of the students selected in the sample having achieved roughly the same level of competence in a specific university discipline. the selection of university students studying the same subject matter suggests a degree of homogeneity in their cognitive ability /intelligence which had also been identified by kutnick (1986) as a salient factor in moral development. finally, commerce students might also be expected to have more focused perceptions and expectations of what constitutes csp than those studying noncommercial disciplines. the questionnaire and measuring instruments a self-completion questionnaire consisting of biographical items and specific instruments for measuring perceptions and evaluations of moral business behaviour was used. the questionnaire was distributed to students before the start of an auditing 3 lecture. also a brief preamble regarding its purpose, method of completion and an assurance of confidentiality were given. biodata included: age, gender and ethnic group. a likert-type format with items arranged on 5 point scales ranging from "strongly agree" to "strongly disagree" was devised to measure perceptions (morper) and expectations (morexpec) of csp. the morper measuring instrument was adapted from a scale used by trevino and nelson (1995), while the author developed the morexpec instrument with assistance from honours students at the university. examples of morper items which tried to focus on perceptions of the actual or "is" business situation are: "business persons only care about making a profit" and "the profit motive pressures managers to compromise their ethical concerns". examples of morexpec items which aimed to uncover expectations of corporate social performance are: "business must spend more on social upliftment" and "an ethical business is one where moral business behaviour is conducted in spite of lower profits for the company". r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 450 statistical techniques the study incorporated analyses of multiple regressions, internal consistencies and factor structures. a brief overview of the psychometric properties of the measuring instruments as regards their internal consistency and construct validity is required, given the fact they are newly composed and untested. the findings of the study reliability and validity analyses cronbach alpha coefficients were obtained for the morexpec and morper measuring instruments after the initial number of 20 items had been reduced to 6 items in each scale. after deleting the items recommended in the analysis, alpha coefficients of the following magnitude were obtained: morexpec=0.71 morper =0.78 both measuring instruments used in the study thus attained acceptable levels of internal consistency. factor analysis of the measuring instruments was conducted to obtain some insight into the construct validity of the morexpec and morper measuring instruments. a kaiser meyer-olkin measure of sampling adequacy of 0.678 was obtained which is considered "middling" (kaiser and rice, 1974) on a scale of 0 to 1, but was considered acceptable for an exploratory investigation. a principal component method of factor extraction was adopted and an oblimin rotation with kaiser normalization used. a non-orthogonal rotation method was used because it seemed reasonable to use an approach that would test the conceptual underpinnings of the morexpec and morper constructs more rigorously. only factors with eigenvalues greater than 1.0 were removed in line with the roots criterion. the variance explained by the five components conforming to this criterion was 66%. only items loading 0.33 and above were interpreted after rotation as this generated a simpler structure. the items with the largest loadings under factors 1 and 3 of the rotated solution suggested that the underlying dimension explained by both could be interpreted as the perception of actual csp. (thus confirming the original construct morper.) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 451 sajems ns vol 3 (2000) no 3 factor 2 loaded above 0.33 on 5 of the 6 items of the morexpec scale. therefore the validity of the original construct was confirmed and interpreted as individual expectations ofcsp. multiple regression analyses multiple regression analyses were used to find the best biodata predictors of respondents= scores on the morexpec and morper measuring instruments. the assumption of normally distributed residuals was investigated using normal probability plots of regression standardized residuals for both dependent variables and expected normal and observed values approximated a straight line in both instances. however, a degree of multicollinearity was encountered in the independent variable "indian" where a cramer's v association in excess of 0.5, p < 0.01 was found between it and the "black" and "white" independent variables. however, it was decided to include the indian variable in the regression as it comprised a large section of the sample and explained additional variance of both the morexpec and the morper dependent variables than in the regression equations when it as excluded from the analysis. a stepwise backward elimination multiple regression technique was used with ethnic groups and gender entered as dummy variables in the analysis. tables 1-3 indicate the findings of the multiple regression analysis with morexpec as the dependant variable. table 1 model summary model r ! r square adjusted square i .290a .084 2 .2891> .083 3 .279c .078 a predictors: (constant), white, gender black, mdlan b predictors: (constant), gender, black, indian c predictors: (constant), black, indian .057 .064 .065 r std error of the estimate 5.8255 5.8060 5.8031 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 table 2 anovas model i sum of df i mean squares square 1 regression 428.684 4 107.171 residual 4683.204 138 33.936 total 5111.888 142 2 regression 426.301 3 142.100 residual 4685.587 139 33.709 total 5111.888 142 3 regression 397.257 i 2 198.628 residual 4714.632 140 33.676 total 5111.888 142 a predictors: (constant), white, gender black, indian b predictors: (constant), gender, black, indian c predictors: (constant), black, indian table 3 coefficients u nstandardized standarcoefficients model std. dized b • coefficients error 1 (constant) 21.567 1.912 gender -.934 1.020 -.916 indian 2.842 1.963 .237 black 4.142 2.153 .279 white -.569 2.147 -.038 2 (constant) 21.153 1.097 gender -.943 1.016 -.079 indian 3.260 1.167 .272 black 4.563 1.447 .307 3 (constant) : 20.632 .941 i indian 3.421 1.153 .286 black 4.368 1.431 .294 452 ..,. : sig . . i 3.158 .016" 4.215 .007° 5.898 .003< • t sig. 11.283 .000 .361 1.448 .150 1.924 .056 -.21''i .791 19.290 .000 -.928 .355 2.794 .006 3.154 .002 21.916 .000 2.967 .004 3.053 .003 the best solutions for the morexpec dependant variable, in terns of r square, significance of t and significance of f were obtained in steps 2 and 3 of the analysis. in step 2 only 8% of the variation of morexpec scores was explained by gender and ethnic group variables (black and indian) with r 2 =8.3%, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 453 sajems ns vol 3 (2000) no 3 r2 (adj)=6,4%). analysis of variance indicated that f=4.215, p=0.007 for the model. however, the t value of the coefficient for gender was not significant at the 5 percent level (t=-0.9l6, p=0.355), but was significant for ethnic groups (black and indian) with t=3.154, p=0.002 and t=2.794, p=0.006 respectively. in step 3, a similarly small percentage of variance was explained by ethnic groups (indian and black); r2= 7.8%, r2 (adj)=6.5%. analysis of variance indicated that f=5.989, p=0.003 and the t values for ethnic groups (indian and black) were significant with t=2.967, p=o.004 and t=3.053, p=o.003 respectively. the small amount of variance of morexpec explained by the biodata in the equation might be expected given the variance explained by age and education in moral development (kutnick, 1986) and thus individual perceptions and expectations of corporate social performance. tables 4-6 present the multiple regression analysis with morper as the dependant variable. table 4 model summary model r rsquare . adjusted r square 1 .329" .108 i .082 2 .329b .108 i .089 • predictors: (constant), white, gender black, mdlan b predictors: (constant), white, gender, indian table 5 anovas model sum of df mean squares square i regression 956.520 4 239.130 residual 7896.138 138 57.218 total 8852.657 142 2 regression 955.589 3 318.530 residual 7897.068 139 56.813 total 8852.657 142 • predictors: (constant), white, gender black, mdlan b predictors: (constant), white, gender, indian ! std error of the estimate i 7.5643 i 7.5375 f sig. 4.179 .003" 5.607 .001b r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 454 table 6 coefficients u nstandardized standari coefficients model std. dized t sig. b coefficients error i (constant) 22.791 2.482 9.182 .000 gender -2.982 1.325 -.189 -2.251 .026 indian 3.728 2.549 .236 1.462 .146 black -.356 2.795 -.018 -.128 .899 white 3.842 2.788 .194 1.378 .171 2 (constant) 22.540 1.510 14.930 .000 gender -3.003 1.310 -.191 -2.292 .023 indian 3.987 1.539 .253 2.590 .011 white 4.104 1.874 • .207 • 2.190 . .030 the best solution for the morper dependent variable was obtained in step 2 where gender and ethnic groups (white and indian) were found to be the best predictors (r2= i 0.8%, r2 (adj)=8.9%). analysis of variance indicated f=5.607, p=o.ooi. the t value of the coefficient for gender was significant at less than the five percent level (p=0.02), while the values for ethnic groups (white and indian) were significant, p=<0.05 in both cases. in short, the regression analysis suggested that being a member of the black and indian ethnic groups best predicted scores on the morexpec dependent variable. also the analysis indicated that gender and ethnic group (white and indian) were the best predictors of scores on the morper dependent variable. in sum, the multiple regression analyses have shown the importance of gender and ethnic group in predicting scores on the dependent variables. the implications of this finding in terms of the theoretical model put forward by carroll and buchholtz (2000) is investigated further in the following section that summarizes respondents' mean scores on the dependent variables. respondents' mean scores on the morexpec and morper measurmg instruments table 7 summarizes the mean scores of the respondents on the morexpec and the morper measuring instruments. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 455 sajems ns vol 3 (2000) no 3 table 7 morexpec and morper mean scores by gender and ethnic group male female total ethnic n mean mean n mean mean i n mean mean group mor~ mormormormormorexpec per expec per expec per white 16 20.7 24.0 12 20.0 26.0 28 20.35 25 ~ 22 25.3 19.0 7 23.8 24.0 29 24.5 21.6 29 22.6 23.0 47 24.8 26.8 76 23.7 24.9 total 67 22.8 22 66 22.8 25.6 133* 22.8 23.8 *nb the 4 coloured students were excluded from the analysis because the group was considered too small to analyze; 6 students had missing information and could not be included in the analysis. table i indicates that females on average obtain identical morexpec scores to males. however, females score a higher mean score on the morper measuring instruments than males. the data was subjected to paired sample t tests to ascertain significant differences between scores on the measuring instruments. differences between perceptions and expectation mean scores are particularly evident for white females (morper>morexpec=6, t=2.65, p=0.02). this suggests that for white females business in south africa is perceived as acting socially responsibly. in fact, these groups seem to regard business as going beyond the call of duty or, in other words, what it ought to be doing in terms of its social responsibility. table i also indicates that the differenc:e between expectation and .,erception mean scores are largest for black males (morexpec>morper=6.3, t=-3.08, p=o.006). this suggests that black respondents feel that business ought to be doing more in fulfilling its social responsibilities than it is perceived to be doing currently. discussion of the findings the findings suggest that variations in individual perceptions and expectations of csp are evident in a sample of third year university students. the multiple regression analyses and paired group t tests have indicated that gender and ethnic group affect perceptions and expectations of csp when defined in terms of doing business in an ethical manner and using business resources for social upliftment. this would suggest that it is therefore problematical to regard r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 456 peoples' perceptions and expectations of csp as being consistently unifonn as suggested by carroll and buchholtz's (2000) model. the study has shown quite clearly that interpersonal variations do exist in perceptions and expectations of csp between males, females and members of different ethnic groups. however, the external validity of these findings is tentative and further studies incorporating larger samples with different sampling frames are required to be able to do this. also, the amount of variance explained by the regression models is small and other independent variables such as socio-economic status, work experience and others need to be investigated. the findings suggest that there are at least two distinct perspectives of csp in the south african situation, which correspond approximately to two specific theoretical approaches. on the one hand friedman (1970) suggests that business is exclusively business. business should concentrate on making profits rather than behaving ethically, so long as it remains within the law. it is not the responsibility of business to uplift the community. this is the concern of government which, was elected to perfonn this role and to which business pays its taxes. on the other hand there exists the socialist view that business's overriding focus must be to serve the community and to use its resources primarily, if not wholly for this purpose. however, apart from these two views there is a third view that embraces the modem view of business ethics. this is that business is indeed in business to make profits, but that such profit-making should not be seen as an end in itself. business must also behave morally and with a sense of social responsibility, not only to fulfill its moral obligations to the community in which it is inextricably entwined, but also to flourish as a business in a socially aware milieu. this view sometimes called the socioeconomic view (robbins, 1994), suggests that: "maximizing profits is a company's second priority not its first. the first is ensuring its survival" (gellennan, 1986: 89). the findings suggest that black males and females feel that business ought to be more socially responsible than it is currently. blacks in this exploratory study at least, seem to hold either a socialist or socioeconomic view of business. whites see business as behaving with more social responsibility than is strictly required of it. they thus appear to endorse the "business of business is business" paradigm expounded by friedman (1970). conclusion this exploratory study using hitherto untried instruments on a relatively small sample controlled for age and education, indicates that gender and ethnic group have a significant effect on perceptions and expectations of corporate social perfonnance in south africa. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 457 sajems ns vol 3 (2000) no 3 the study reveals that blacks expect business to playa more socially responsible role in south africa than it does currently. whites view business as doing more in terms of social responsibility than is required from a strictly business point of view. these findings are important in so far as they have shown in a fairly rigorous empirical research design, that gender and ethnic group are independent variables in the explanation of perceptions and expectations of csp. also the findings have suggested that carroll and buchholtz's (2000) theoretical model that indicates expectations of csp as being uniformly and consistently above actual perceptions of csp, may not be valid in the south african situation. from a practical point of view, the findings also indicate that an emerging elite of future black managers perceives south african businesses as under-performing socially. business needs to take cognizance of this problem and to explore further how it can upgrade its csp, as persistent neglect may ultimately affect its financial performance detrimentally. endnote the author acknowledges with gratitude the assistance of ms v. ireland, ms s. khatree and mr c. hubbertson in the research process. references boone, l.e. and kurtz, d.l. (1994) business and society, new york: harper collins. 2 carroll, a.b. and buchholtz, a.k. (2000) business and society: ethics and stakeholder management, united states: south-western. 3 friedman, m. (1970) "the social responsibility of business is to increase its profits", in white, t.i., business ethics, new york: macmillan. 4 gellerman, s.w. (1986) "why 'good' managers make bad ethical choices", in robbins, s.p. management, new jersey: prentice-hall. 5 kaiser, h.f. and rice, j. (1974) "little jiffy mark iv", educational and psychological measurement, 34: 111-17. 6 kohlberg, l. (1969) "stages and sequence: the cognitivedevelopmental approach to socialization", in goslin, d.a. (ed.) handbook of socialization theory and research, chicago: rand mcnally. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 458 7 kutnick, p. (1986) "the relationship of moral judgement and moral action; kohlberg's theory, criticism and revision", in modgil, j. and modgil, c. (eds.) lawrence kohlberg: consensus and controversy, basingstoke: the falmer press. 8 robbins, s.p. (1994) management. new jersey: prentice-hall 9 trevino, l.k. and nelson, k.a. (1995) managing business ethics. new york: john wiley. 10 wood, oj. (1994) business and society. new york: harper collins. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . read online: scan this qr code with your smart phone or mobile device to read online. page 1 of 2 reviewer acknowledgement http://www.sajems.org open access00 acknowledgement to reviewers in an effort to facilitate the selection of appropriate peer reviewers for the south african journal of economic and management sciences, we ask that you take a moment to update your electronic portfolio on https://sajems.org for our files, allowing us better access to your areas of interest and expertise, in order to match reviewers with submitted manuscripts. if you would like to become a reviewer, please visit the journal website and register as a reviewer. to access your details on the website, you will need to follow these steps: 1. log into the online journal at https://sajems.org 2. in your ‘user home’ [https://sajems.org/index. 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in economics, as in other disciplines, one often comes across the term "whig" or its derivatives. one will find, for example, a particular account being branded as whiggish. butterfield, who was a historian, introduced the idea of a whig interpretation of history in 1931. since then the term has usually been used to classify an approach which views the present as the culmination of a march of progress. this paper provides a brief background to the origin of the term and why butterfield criticised what he called the whig interpretation of history. jelb49 introduction nearly seventy years ago butterfield (1931) criticised the so-called whig interpretation of history in which history is viewed as a triumphal march of progress. butterfield pointed out that in such an approach events of the past are viewed through the eyes of the present, whereas in his opinion the correct way of writing history was to interpret the past through the eyes of the past. since butterfield's essay, the term "whig" and its variations have been employed in many disciplines and economics is no exception. today the term "whig" is often used in a critical vein. if a writer brands a particular account as "whiggish" his or her intention could very well be to criticise the approach taken. butterfield, of course, intended the term to be worn as a badge of shame, but there are those who would prefer to wear it as a badge of honour (samuelson, 1991). this essay will show where the term comes from and how it is used. the whigs and the tories butterfield borrowed the term whig from the political arena. the whig political party was once one of the major political parties in britain. as a political party it no longer exists, having become the liberal party in the second half of the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 53 nineteenth century. the opposing party was the tory or conservative party. we can place the tories in the conservative, right wing part of the political spectrum, and the whigs in the liberal, left wing part. as a start it may be useful to view the whigs as those in favour of change and the tories as those against change. the views of the tories and whigs in eighteenth and nineteenth century britain can be contrasted by considering their view on the monarchy. a tory would tend to side with the monarchy, whereas a whig would want the absolute power of the monarchy curtailed through parliament democracy and a bill of rights. here the magna carta played an important role, as the whigs tended to consider it as a bill of rights. butterfield (1957: 109) notes: horace walpole certainly knew what he meant when he called himself "a whig", and indeed he was a whig of the traditional type. in 1756 he had described how on one side of his bed hung "magna charta" and on the other side the warrant for charles i's execution "on which i have written major charta". to be a whig, in his view, meant to oppose the personal power ofa king, and to be a tory meant to support that power ... although the idea later fell into disfavour, there was a time when whigs argued that the notion of parliamentary democracy came from ancient customs. common law, it was argued, stemmed from time immemorial. there was no need to justify common law, its success in surviving from ancient times provided its own justification. pocock (1987: 37) notes that: the idea of the immemorial ... took on an absolute colouring ... it ceased to be a convenient fiction and was heatedly asserted as literal historical truth; and the more that came to be known about remote ages, the more vigorously it was insisted that the law was before abraham. the common law was by definition immemorial custom. in the whig scheme of things, the power of the monarch was tempered by an ancient constitution: ... belief in the antiquity of the common law encouraged belief in the existence of an ancient constitution, reference to which was constantly made, precedents, maxims and principles from which were constantly alleged, and which was constantly asserted to be in some way immune from the king's prerogative action; and discussion in these terms formed one of the century's chief modes of political argument. parliamentary debates and pamphlet controversies involving the law or the constitution r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . s4 sajems ns vol 3 (2000) no i were almost invariably carried on either wholly or partially in terms of an appeal to the past made in this way (pocock, 1987: 46). for the whigs, the problem with the time immemorial argument was that it could be used against them. if a whig could find rudiments of parliamentary procedure in the time of edward the confessor, a tory could argue that solomon provided evidence in favour of monarchical prerogative. if the monarchy issue provided a quick litmus test as to whether someone harboured whig or tory views, an even quicker test was one's view of william the conqueror. a whig would tend to regard william as the "accursed norman" (colboum, 1965: 7) who rode roughshod over the ancient liberties enjoyed by anglo-saxons prior to the invasion. a tory would be inclined to view william as someone who restored stability to a dishevelled kingdom. although everybody agrees that william landed near hastings in 1066, there is little agreement on the social and political conditions prior to that expedition and none on the consequences of the invasion. douglas (1946: 16) remarks that "the posthumous career of william the conqueror in english letters is almost as remarkable as his actual career in british history." to take a view on william the conqueror, you also have to take a view on the conquered. in a number of delightful sketches, douglas shows how some historians have viewed those about to be conquered as a group of pot-bellied, gluttonous, degenerates stumbling around the anglo-saxon countryside in an alcoholic mist. so hastings was a pushover, and the decadent got what they deserved. a whig, however, would paint william as a foreign tyrant who interrupted the glorious democracy being enjoyed by righteous rather than riotous anglosaxons, assisted in no small measure by the discipline of an ancient constitution, which protected them from the king's prerogative. in this view society was not prior to the invasion arranged along feudal lines. instead, feudalism came across the channel with the normans, prior to which parliament had controlled the king rather than the king parliament. fortunately for the righteous, some semblance of normality was restored when the people obtained from king john in 1215 the magna carta, a document which enshrined political and personal rights. such was the picture painted by the whigs. by now, however, it should come as no surprise to hear that attempts have been made by some historians to view the magna carta as a "feudal document in a feudal setting" (butterfield, 1931: 10). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 55 the previous two paragraphs indicate that the issue of theory-laden facts is not an issue that is confined to the natural sciences. mcmullin (1979: 65) points out that ..... the writing of history of science is shaped by the preconceptions that are brought to it. it is no more theory-neutral than is observation in science itself." the discussion so far has provided a very brief background to whig and tory views. what, however, is the whig interpretation of history? and what do historians mean when, with faint praise, they damn a historical account as whiggish? a whig interpretation of history is not necessarily a historical account provided by somebody with whig sympathies, although it may be. in other words you don't (or didn't) have to vote whig in order to write a whig interpretation of history (burrow, 1981: 2). butterfield illustrates the whig interpretation of history with the aid of examples drawn from the catholic-protestant divide. if today there is religious liberty, whom do we have to thank for this? in the whig interpretation, we have luther to thank for setting the reformation in motion, a movement that culminated in the religious tolerance of the twentieth century. the whig interpretation is a story of progress progress from religious intolerance to religious tolerance. in such a story the whigs and the protestants are cast as the progressives and the tories and the catholics as the reactionaries. the whig interpretation is a story of progress told by the victors the progressives. the past is viewed through the eyes of the present. the whig historian stands on the top ofa mountain and tells the story of his ascent in terms of the conquest of lesser peaks rising cumulatively to the summit the valleys do not feature in this abridged version. butterfield (1931: 5) points out that a historian who adopts a whig point of view "very quickly busies himself with dividing the world into the friends and enemies of progress." butterfield argues that historians should attempt to understand the past in terms of the past. the movement towards religious liberty was not simply the result of progressive forces, but often the result of compromise between opposing forces. in centuries gone by, the state was on the side of the catholic church and it was unthinkable that the church and state would allow heretics to promote unorthodox views. when those propounding unorthodox views became numerous it appeared that the only way to resolve the issue was by force. after an immense quantity of blood had been spilt, the unthinkable view started emerging that perhaps the way out was for the state to allow both sides their places in the sun. such a view may have played no role at all in luther's attempt to reform the church. butterfield points out that luther can be interpreted as a reformer who wished to cleanse the roman catholic church from within. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . s6 sajems ns vol 3 (2000) no 1 the state now started playing the role of referee, and a good referee is a disinterested referee. the emergence of religious toleration cannot therefore only be seen as the triumph of progressive over reactionary forces. in the whig interpretation, however, we are presented with ..... the workings of an obvious principle of progress, of which the protestants and whigs have been the perennial allies while catholics and tories have perpetually formed obstruction" (butterfield, 1931: 12). the whig idea of liberty as an ancient idea was subsequently replaced by the idea that it was modem, and that constitutional innovation was required to ensure political and individual rights (burrow, 1981: 21). in the new view, ancient anglo-saxons could not have enjoyed modem day liberties because the constitution had not yet developed to its modem form. the whig interpretation of history encapsulates this idea that modem is good, since history is viewed as a story of progress. butterfield (1944) later acknowledged that we all harbour some or other whig interpretation, and perhaps one of the chief virtues of butterfield's original polemic was to draw attention to the fact that if we are writing whig history, we should be aware that we are so doing, and caution our readers accordingly. conclusion butterfield regarded the whig interpretation of history as the wrong way to go about doing history. he attempted to show that a historical reconstruction should consist of an attempt to understand the past in terms of the past. in the whig approach, the past is interpreted in terms of the present. in the process, he showed that a whig interpretation of history boils down to a story of progress told by the victorious. it is the idea of the present as the culmination of a triumphal march of progress that is usually at issue when somebody terms a particular approach as whiggish. we end off with a couple of examples to illustrate how important it is to identify the conquered and the conquerors. those who have conquered will obviously wish to see the present as a march of progress. in 1991 samuelson presented a keynote address at a history of economics society in boston in which he took an unashamedly whiggish view on the development of economic theory. in his view, there is no doubt at all that economic theory has made remarkable strides this century. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vo13 (2000) no 1 57 about half a century ago, samuelson published his foundations of economic analysis. samuelson was obviously not the first economist to present economic ideas in mathematical terms, but with the benefit of hindsight (a whig device) his foundations can be viewed as an important milestone on the road to the mathematization of economics. those who do not agree that such mathematization is a good thing could argue that the mathematical developments over the last half-century represent a regression rather than a progression. a further example concerns the introduction of rational expectations into economic theory. the rational expectations approach requires the model builder and the agents in the model to entertain similar expectations. somebody who takes the view that most are by their very nature speculative, would not necessarily rejoice in the present ascendancy of the rational expectations approach. the essence of a speculative market is that the agents involved entertain different expectations and the rational expectations approach has difficulty in accommodating divergent expectations. if you embrace the rational expectations approach and if you embrace the mathematical approach to economics, you are on the side of the victorious and it would be natural for you to believe that economics has progressed in the last fifty years. if you are languishing in the ranks of the defeated, you would not regard such recent developments as progress. references balt as, a. (1994) "on the harmful effects of excessive antiwhiggism", in trends in the historiography of science, eds k. gavroglu, j. christianidis and e. nicolaidis, dordrecht: kluwer: 107-119. 2 blaug, m. (1990) "on the historiography of economics", journal of the history of economic thought 12: 27-37. 3 burrow, j.w. (1981) a liberal descent. victorian historians and the english past, cambridge: cambridge university press. 4 butterfield, h. (1931) the whig interpretation of history, london: g. bell and sons. 5 butterfield, h. (1944) the englishman and his history, cambridge: cambridge university press. 6 butterfield, h. (1957) george iii and the historians, london: collins. 7 colbourn, h.t. (1965) the lamp of experience. whig history and the intellectual origins of the american revolution, chapel hill: north carolina press. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 58 sajems ns vol 3 (2000) no 1 8 douglas, d. (1946) the norman conquest and british historians, glasgow: jackson, son & company. 9 mcmullin, e. (1979) "the ambiguity of 'historicism''', in current research in philosophy 0/ science, eds p.o. asquith and h.e. kyburg, east lansing, michigan: philosophy of science association: 55-83. 10 pocock, j.g.a. (1987) the ancient constitution and the/eudallaw. a study 0/ english historical thought in the seventeenth century, cambridge: cambridge university press. 11 samuelson, p.a. (1991) "out of the closet: a program for the whig history of economic science", keynote address at history of economics society, boston meeting, june 20, 1987. reprinted in the historiography o/economics, ed. m. blaug, aldershot: elgar: 181-190. 12 torr, c.s.w. (1999) "some pair-wise classifications employed in historiography". mimeo. 13 vincent, j. (1995) an intelligent person's guide to history, london: duckworth. 14 williams, l.p. (1975) "should philosophers be allowed to write history?" british journal/or the philosophy o/science, 26: 241-253. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 26 sajems ns vo14 (2001) no 1 factors contributing to the success of benchmarking: a south african perspective jshuman momentum group limited, centurion m shotter school of accountancy, university of pretoria abstract this study aims to identify the factors that have an influence on the success of benchmarking projects, and finds that listed south african manufacturing companies achieve a high degree of success with their benchmarking projects. the key success factors are a cost-benefit analysis and the formulation of an implementation plan during the planning stage of the process. other factors include limitation of the scope and length of the project, an optimum number of four partners, the selection of partners of similar size and the inclusion of partners from other industries. it was also found that the compliance with a code of conduct by all the partners and the consideration of ethical and legal aspects are essential elements of success. jelm21 1 introduction benchmarking can be described in a number of ways. one of the most basic defmitions would be the practice of being humble enough to admit that other organisations perform better at something, whilst at the same time being wise enough to learn how to match and preferably surpass identified performance levels (andersen & pettersen, 1996: 3). some of the elements to be found in. most definitions include the investigation of one's own products, processes and strategies, comparison with the best performance of other organisations, and improved performance due to the implementation of identified improvements. for the purpose of this article we adopt the definition of elnathan, lin and young (1996: 40), namely that benchmarking is a process by which an organisation targets key areas for improvement, studies the best practice of others and implements processes and systems to enhance its own performance. the outward orientation of benchmarking distinguishes it from performance measurement, which is the comparison of performance with internally sajems ns vol 4 (2001) no 1 27 detennined nonns (thor, 1995: 3). whereas perfonnance measurement contributes to the evaluation of the effectiveness of an organisation, benchmarking evaluates its competitiveness. however, perfonnance measurement is a prerequisite for benchmarking as it provides the nonns against which the perfonnance of other organisations are measured in order to detennine perfonnance gaps. there are several fonns of benchmarking and classification nonnally depends on the approach to a project (maxon & trefiy, 1997: 7). where benchmarking is approached in tenns of the choice of partners, the project can be classified into internal, external and competitive benchmarking. if the topic is the focus of the project, benchmarking can be classified as product, process or functional, best practice or generic and strategic benchmarking. finally, if classified according to the method followed, benchmarking can be categorised as desk research, interviews, benchmarking databases, consortium benchmarking and partnership benchmarking. 2 research problem although the benefits of benchmarking are far-reaching, it is generally an expensive process. the time spent by managers, employees and external benchmarking consultants on a project are only some of its direct costs. frequently the results of a benchmarking project also require that employees undergo a total cultural change (elnathan et al., 1996: 49). there are several possible pitfalls when conducting a benchmarking process. where a project is abandoned due to a lack of support by senior management, the initial investment is wasted. if a project is drawn out, the infonnation collected might become obsolete and irrelevant. choices of benchmarking partners and methods of collecting infonnation are also factors that can influence the success of a project (elnathan et al., 1996: 42-48, lincoln & price, 1996: 33-35). the aim of this study is to identify the factors that contribute to the success of benchmarking, bearing in mind that it is a relatively new practice, that it is expensive and that there are several factors that might cause a benchmarking project to fail. the factors that contributed to the success of benchmarking in other countries are identified by means of an extensive literature review. the purpose of the empirical work is to establish which of these factors that were identified in 28 sajems ns vo14 (2001) no 1 overseas studies are also significant contributors to the success of benchmarking projects in south africa. 3 factors contributing to the success of benchmarking a literature review of case studies and surveys conducted in europe, the usa and japan indicates that a number of factors have contributed to the success of benchmarking projects. the benchmarking portfolio (tbp) (1997: 15) ascribes the success of companies like xerox, motorola and hewlett-packard to these factors as described in 3.1 to 3.17. 3.1 integral part of corporate strategy an organisation should formalise and understand its own strategy before embarking on a benchmarking project, in order to avoid the implementation of measures that are not in accordance with its overall strategy. for benchmarking to be effective, it should form part of a regular management agenda and organisational strategy (bendell, boulter & kelly, 1993: 198). a strategic benchmarking project can provide insight into the strategy of benchmarking partners, thus enabling the company that initiated the project to formulate its own (miller, de meyer & nakane, 1992: 22). companies should be aware of the areas in which they have a competitive advantage and those in which their performance is unsatisfactory, in order to direct benchmarking projects to where change will be most beneficial. japanese companies, in particular, employ benchmarking to improve their competitive advantage and to reduce the performance gap where they do not perform as well as their competitors (zairi & leonard, 1994: 190). 3.2 involvement of senior management it is the responsibility of senior management to create a culture within an organisation where benchmarking forms an integral part of its activities. they should set targets that would result in improved performance, communicate the results of benchmarking projects throughout the company and form networks within and outside the company that may be used for collecting information (tbp, 1997: 17). the involvement of senior management provides the attribute of transparency to a project (zairi & leonard, 1994: 190). the public image of a company can be destroyed if certain of its actions are labelled as industrial espionage. according sajems ns vol 4 (2001) no 1 29 to bogan and english (1994: 69), involvement of senior management will also raise the motivation of the team members of the project, since this should assure that sufficient resources will be allocated to the project and that it will not be abandoned after months of hard work. involvement by senior management will also increase the probability that the project forms an integral part of the corporate strategy (tbp, 1997: 16). if unsupervised, middle management might undertake a benchmarking project that results in changes beneficial to a certain department but detrimental to others and the company as a whole. it is the responsibility of senior management to prevent this from happening. 3.3 focus on critical success factors critical success factors are those few key areas where things "must go right for the company to flourish" (lincoln & price, 1996: 34). these factors will differ amongst companies and include customers, competitive advantages, financial stability and strategy. to stress these factors during a benchmarking process, will ensure that information is collected in areas with the greatest influence on the company's success. critical success factors should be borne in mind when selecting the object of the benchmarking process, in the development of key performance measures and in identifying benchmarking partners. it should also be considered in the development of a survey questionnaire and the preparation of the final analysis and recommendations. benchmarking should only be conducted if it can add value to the decision making process (spendolini, 1992: 68). due to the fact that it is a costly process, companies that follow a structured approach to problem solving should restrict benchmarking to identify solutions for critical problems. it should not be employed to resolve routine obstacles. 3.4 performing a cost-benefit analysis a benchmarking project should only be undertaken if the expected advantages outweigh the expected costs (tbp, 1997: 23). although it is often difficult to express increased client satisfaction, productivity, market share and quality in monetary terms, the estimated value of these advantages should be compared to the best estimate of the costs of the project. 3.5 the length of the project according to lincoln and price (1996: 33) it is not uncommon for a benchmarking project to last from nine to twelve months. team members might leave a company or be transferred to another department during such a long 30 sajems ns vol 4 (2001) no 1 period, whilst changes in rr.:magement can lead to the abandonment of a project after months of hard work. furthermore, circumstances might change within the area that is the focus of the project, thus causing recommendations to become obsolete. several steps can be taken to ensure that the length of the project is limited to an acceptable time span. sufficient human resources should be allocated to the project. team members should be relieved from some of their responsibilities to enable : i !em to devote sufficient time to the project (lincoln & price, 1996: 33), and external consultants may be appointed to facilitate the project, conduct research and approach benchmarking partners. a culture of continuous improvement will ensure that processes are continuously inspected and documented, that client expectations are monitored and actual performance is measured against expected performance on a regular basis (lincoln & price, 1996: 34). these factors can contribute to limiting the scope of projects to a manageable size. 3.6 the subject of the project when considering a suitable topic for a benchmarking project, two aspects should be borne in mind, namely the purpose and the extent of the project. with regard to the purpose, a selection of a subject that is widely known to be a problem within the organisation, normally results in a successful project (andersen & pettersen, 1996: 139). the benchmarking project will be associated with. the answer to a specific difficulty, which can increase the support for benchmarking within an organisation. another consideration is the extent of the project. according to elnathan et al. (1996: 44), the motivation of a benchmarking team suffers when trying to achieve too much with a single assignment. lincoln and price (1996: 34) recommend that one should either choose a broad-and-shallow approach or a narrow-and-deep approach. this means that one should either collect general information on a few areas or detailed information on a single area. when trying to collect detailed information on a few areas, the project will be drawn out too long. the suggested procedure is to initially pursue a broad-and-shallow approach, followed by a narrow-and-deep approach in a next project. 3.7 studying the company's own product or process knowledge of the products and processes of one's own company forms the basis for studying those of other companies (tbp, 1997: 32). if a benchmarking team is unfamiliar with their own products and processes, it will be impossible to determine a performance gap and identify opportunities for improvement. it would then also be difficult for a firm to answer any questions by its external partners regarding its own products and processes. karl6f and ostblom (1993: sajems ns vol4 (2001) no 1 31 58) concur and suggest that internal benchmarking should be carried out prior to external benchmarking, in order to provide the team with the opportunity to practice various techniques and methods internally, before launching a project with external partners. 3.8 previous bench marking experience the likelihood of lower costs and greater success with benchmarking projects increases as an organisation acquires benchmarking experience (elnathan et al., 1996: 44). karlof and ostblom (1993: 70) suggest that project teams should always include employees with benchmarking experience, in order to increase the level of knowledge within the team and to reduce total training costs. companies with prior benchmarking experience will normally be able to make more informed decisions on the subject matter of the project, the most effective manner of data collection and choice of benchmarking partners (elnathan et al., 1996: 43). normally, organisations with benchmarking experience will also be contacted more frequently by other companies who would like to become involved in benchmarking projects. 3.9 the compilation of a benchmarking team when selecting a team, the required areas of specialisation for the project, the time needed from team members as well as the optimum combination of internal employees and external consultants should be considered. by combining the areas of specialisation of a group of individuals, the project can be completed more efficiently. team members should be able to spend at least 25 per cent of their time on the project, whilst the team leader should devote a minimum of 50 per cent ofhislher time to the task (tbp, 1997: 28). the use of external, professional benchmarking consultants should also be considered (karlof & ostblom, 1993: 69), since they normally have useful contacts with a number of potential partners and their experience in project management should be an asset. consultants can play an important role in competitive benchmarking projects, where results may be provided in a blind [onnat, thus avoiding sensitive information being directly exchanged between competitors (tbp, 1997: 31). 3.10 training of team members a perception exists that benchmarking does not require any special knowledge, resulting in organisations being unprepared for the projects (bogan & english, 1994: 73). in fact, the success of benchmarking largely depends on the amount of training that the team members receive in the benchmarking techniaues. 32 sajems ns vol4 (2001) no 1 process, philosophy and method. there are two schools of thought in respect of benchmarking training (tbp, 1997: 31). the first school believes in the socalled xerox approach that all the employees should be trained in benchmarking, whilst the second school believes that all employees should be informed about benchmarking, but that only team members should be trained extensively. the second approach is probably more practical. 3.11 the selection of bench marking partners when a company decides to conduct external benchmarking, there are a number of factors regarding partners that might influence the success of the project. these factors include the size and number of the partners as well as their industry and geographical location. further aspects that should be considered are the position that the partners occupy in their respective industries and the degree of trust between the organisation and the partner(s) (elnathan et al., 1996: 47). there is no single best-in-class company, nor is there a list that contains a bestin-class company in each functional area (lincoln & price, 1996: 35). it is important that the organisation that initiates the project selects partners that are suitable to their unique circumstances. furthermore, partners should not be limited to the organisation's geographical location, since technology today enables companies to conduct benchmarking projects across the globe (tbp, 1997: 34). in order to facilitate a comparison of information, adjustments can be made to compensate for differences in products, processes, market conditions, cost structures, the age and size of companies as well as differences in regulations (karlof & ostblom, 1993: 153). however, after the data has been normalised to compensate for differences, any remaining performance gap should be accepted and addressed (andersen & pettersen, 1996: 73). 3.12 the availability of resources the resources required to successfully conduct a benchmarking project, are mostly employee time, finance and equipment (bogan & english, 1994: 80). in companies with an established culture of continuous improvement, the resources are normally forthcoming when the existence of a performance gap can be proved (zairi & leonard, 1994: 192). resources allocated to a benchmarking project should be closely monitored by means of a budget, and care should be taken to ensure that they are optimally employed. the effective use of computer equipment, in particular, can substantially decrease the total costs of the project (bogan & english, 1994: 76). sajems ns vol4 (2001) no 1 33 3.13 the methods and techniques of data collection andersen and petters en (1996: 56) distinguish between methods and techniques of data collection. methods of data collection refer to the manner in which a partner is contacted, for example by post, telephone, personal interview or teleconference, whilst techniques include questionnaires, interviews, direct observation and reversed product design. the last-mentioned technique describes a situation where the product of a competitor is purchased and dismantled, in order to get a better understanding of their manufacturing process. when deciding upon a suitable method and instrument for data collection, the planned time span, budget, availability of personnel, past experience, complexity of the information and the skills required to conduct the specific technique of collection should all be considered (andersen & petters en, 1996: 56, zairi & leonard, 1994: 73). regardless of the method of data collection, a written questionnaire should always be prepared, since it provides guidance to the information required and ensures that all the relevant information is collected (tbp, 1997: 35). background information on the company initiating the project, as well as the objectives of the project, should be forwarded to partners prior to commencing with data collection (spendolini, 1992: 157) and the questionnaire should be tested internally before contacting a partner. only questions that the initiating organisation would also be prepared to answer should be included (bogan & english, 1994: 98). the questionnaire should be limited to a reasonable length and questions should be asked in a logical sequence, with general questions first followed by specific questions (karlof & qstblom, 1993: 136). it is important that a balance is maintained between quantitative and qualitative information, and questions based on ratios are preferred to absolute values, since this increases the probability of maintaining confidentiality. 3.14 the development of a culture of learning benchmarking flourishes in an organisation with a culture of learning, since employees are encouraged to be outward looking, compare their own performance with those of others and to make recommendations for improvements (bogan & english, 1994: 77). in a culture of learning, employees are encouraged to think holistically, systematically and creatively, and to share information across functional borders. the objective is to develop rather than to control employee potential, and managers are seen as advisers and mentors. normally there are no job descriptions in such an organisation, in order to encourage employees to experiment and to take on responsibility on their own 34 sajems ns vol 4 (2001) no 1 initiative (mansell, 1997: 62). this creates the ideal climate for implementing the improvements suggested by a benchmarking project, since employees are part of an environment where change is encouraged (mansell, 1997: 63). 3.15 ethical and legal aspects of benchmarking benchmarking involves an outward looking stance on the practices of other companies, with potentially negative ethical and legal consequences (scheffler, 1997: 167). from a legal point of view, claims can be lodged against a company, whilst unethical behaviour can cause irreparable damage to a company's image. the international benchmarking clearinghouse in conjunction with the benchmarking council of the strategic planning institute, developed a benchmarking code of conduct (scheffler, 1997: 167). if a company adheres to this code, obtains necessary legal advice and treats its benchmarking partners in the same way as it expects to be treated, it should not encounter any difficulties regarding the ethical and legal aspects of benchmarking. 3.16 conducting a pilot run it is especially important for companies undertaking benchmarking for the first time, not to contact benchmarking partners directly after the preparatory work has been completed (tbp, 1997: 32). inexperienced team members may not know how to phrase questions correctly and how to interpret the response of the person being questioned, and may also have insufficient knowledge of the subject of the project. a pilot run can overcome most of these difficulties and also provides an opportunity to identify and correct problems with the questionnaire. 3.17 communication and implementation of improvements to ensure that the greatest number of people are informed about the outcome of a project, a database should be created with all the relevant information and with easy access for all employees (karlof & ostblom, 1993: 178). a formal report should be compiled and stored in the database. according to spendolini (1992: 181) a company like dec only conducts a benchmarking project after a specific decision has been taken that change is needed, whereupon there is normally little resistance to the implementation of improvements. a plan of implementation should be formulated which covers the sequence of activities involved, persons responsible as well as the budget and timetable for the implementation of improvements (karlof & ostblom, 1993: 176). sajems ns vol4 (2001) no 1 35 4 research method used in empirical work the aim of the empirical research was to establish the factors that contribute to the success of benchmarking in south africa. the research instrument consisted of a questionnaire, with a question on the success of the most recently completed benchmarking project representing the dependent variable, whilst the questions on the extent to which each factor contributed to the success of that project represent the independent variables (human, 2000: 127). the questionnaire was circulated among 178 manufacturing companies listed on the johannesburg stock exchange during march to august 1999. only manufacturing companies were included in the population in order to limit it to a manageable size, and also because the majority of the examples mentioned in the literature are manufacturing companies (human, 2000: 119). the focus on listed companies is based on the finding by randall (1995: 94) that there is a greater likelihood that large companies in south africa will perform benchmarking. due to the difficulty of determining the monetary value of the benefits of a benchmarking project, the extent to which the project met the expectations of the financial manager (or the person nominated by hirnlher), was used to measure the success of the project. this is explained in the questionnaire (human, 2000: 124). statistical tests performed on the collected data included correlation analysis and t-tests. the outcome of a correlation analysis test is a value between -1 (perfect inverse correlation) and 1 (perfect direct correlation), with 0 indicating no correlation at all. spearman's product moment coefficient was used to determine whether a statistical relationship exists between each factor and the success of the project. t-tests were applied to indicate whether there is a statistically significant difference in the average values of two groups, and thus whether the finding can be extrapolated to the population. 5 empirical results 5.1 introduction in total 49 (27,5 per cent) questionnaires were returned, of which 22 respondents indicated that they had conducted benchmarking in the past, whilst 24 had never carried out a benchmarking project. three respondents returned the questionnaires uncompleted with a note that it is not their company's policy to participate in studies like this. one respondent considered the benchmarking project to have been unsuccessful, whilst 15 perceived it as successful and six extremely successful. companies conducting process and product benchmarking had a higher rate of success than companies performing benchmarking for the mere purpose of collecting information to measure comparative performance. 36 sajems ns vol4 (2001) no 1 5.2 summary of the results the results of the empirical work can be divided into three categories. firstly, factors were identified where a statistical relationship between the factor and the success of the project is found (key factors). the second category consists of factors where the results were arranged in such a way that it appears likely that a relationship does exist between the factor and the success of the project for the companies that participated in this study (important factors). thirdly, certain factors were identified where no meaningful conclusion could be made that a relationship exists between the factor and the success of the project, although most of the companies that achieved success with their project applied these factors (other factors). the results of the empirical work are summarised in table 1 according to these categories and also classified according to planning, employment of human resources, benchmarking partners, length and scope of the project, ethical and legal aspects as well as completion of the project (human, 2000: 170-71). table 1 summary of empirical results key factors important factors other factors a) planning conduct a cost-benefit integrated with corporate conduct internal before analysis strategy external benchmarking formulate a plan of integration of critical use a questionnaire for implementation success factors data collection study the subject of the conduct a pilot run project allocate sufficient decide beforehand that resources change is required keep to a timetable stay within a budget b) employment of human resources involvement of senior management involvement of people with prior experience of benchmarking sajems ns vol4 (2001) no 1 37 table 1 continued key factors important factors other factors involvement of external consultants sufficient training encouragement of employee inputs c) benchmarkin~ partners partners of comparable choose mix of direct and size non-direct competitors at least four partners choose mainly south african partners partners from other industries d) length and scope of the pro.ject limit the length of the limit scope of the project project e) ethical and le2al aspects consider ethical and choose trustworthy sign a confidentiality legal aspects partners agreement abide by a code of conduct f) completion inform employees of the compile a final report results of the project 5.3 discussion of the key factors as indicated above, some of the factors show a statistically significant relationship with the success of a benchmarking project. this includes the costbenefit analysis where all the respondents with extremely successful projects and 67 per cent of the respondents with successful projects performed a costbenefit analysis before embarking on the project. the only respondent with an unsuccessful project did not carry out such an analysis. the relationship between the cost-benefit analysis and success might be ascribed to the fact that a costbenefit analysis can aid organisations in determining in advance whether a project will be in the long-term interest of the company. thus avoiding investments where the expected costs exceed the expected benefits (human, 2000: 172). 38 sajems ns vol4 (2001) no 1 all the respondents with extremely successful projects and 93 per cent of the respondents with successful projects prepared a fonnal plan to implement improvements, prior to launching the project. the respondent with the unsuccessful project again did not fonnulate such a plan. the results of the ttests indicate that the difference in the average values of the success between the two groups is statistically significant, thus implying a better chance of success if a fonnal plan is fonnulated. the best explanation for this probably lies in the fact that there is a risk that improvements will never be implemented if they are not fonnalised in a plan of action which is followed up by the relevant people within the company (human, 2000: 173). the t-tests indicated that benchmarking projects with partners that are smaller or of similar size are more likely to succeed than projects with bigger partners, where 64 per cent of the respondents conducted benchmarking with companies of similar size, 13 per cent with smaller companies and 23 per cent with bigger companies. this tendency might be ascribed to the greater comparability of infonnation between companies of similar size or the possibility that infonnation was not nonnalised correctly to provide for differences between partners (human, 2000: 180). it was possible to prove a positive statistical correlation between the number of benchmarking partners and the success of the project. this means that projects with more partners were generally more successful than those with fewer partners. the optimum number of partners proved to be four. where companies had more benchmarking partners they were less successful. when a certain stage is reached, the additional processing costs of infonnation outweigh the benefits of increased comparative infonnation, which resembles the law of diminishing returns (human, 2000: 174). scores between 1 and 4 were allocated to indicate the success of a project, where 1 indicates complete failure and 4 an extremely successful project. the average score for the success of projects where all the partners were from the same industry was 3.1, versus 3.5 where partners from other industries were also included in the projects. the results of the t-tests indicate that this difference in the measured average value for success is statistically significant. the best perfonners are thus not necessarily operating in the same industry as the company that initiated the project, and a search for the best perfonners across industries could therefore result in more successful projects (human, 2000: 175). an inverse statistical correlation was found between the length of the project and its success. this means that the longer it takes to complete the project, the lower the probability of success. the longer the project runs the higher are the sajems ns vol 4 (2001) no 1 39 costs incurred and the less relevant are its recommendations (human, 2000: 175). the results of the t-tests indicated that the success ofbenchmarking projects was statistically significantly higher when the ethical issues were increasingly taken into consideration. moreover, the success of benchmarking projects was statistically significantly higher where it was agreed with partners to abide by a code of conduct. it was also possible to prove a positive statistical correlation between the extent to which legal aspects were considered and the success of a project. it seems as if the respondents are in fact aware of the negative implications of ignoring the ethical and legal aspects of benchmarking (human, 2000: 175). 6 conclusions the purpose of this study was to identify which factors have the greatest influence on the success of benchmarking. these factors were identified in the literature and tested among listed south african manufacturing companies. it appears as if listed south african manufacturing companies achieve a high degree of success with their benchmarking projects. ninety five per cent of respondents experienced their latest benchmarking project to have been successful, whilst none of the respondents indicated that their most recently completed project was a complete failure (human, 2000: 179). the study reveals that benchmarking projects at mostly south african companies of similar size were the most successful, which indicates that the comparability of information is an important consideration. it is however possible that information collected from larger, international companies was not normalised correctly in order to reflect the unique circumstances of the company that initiated the project. another finding is that the optimum number of benchmarking partners is four. this might be ascribed to the law of diminishing returns, where increased processing costs outweigh the advantages of more information. references andersen, b. & petters en, p.g. (1996) the benchmarking handbook, chapman & hall, london. 2 the benchmarking portfolio, volume four (tbp) (1997) strategic direction publishers limited, uster-zurich. 40 sajems ns vol4 (2001) no 1 3 bendell, t.; boulter, l. & kelly, 1. (1993) benchmarkingfor competitive advantage, pitman publishing, london. 4 bogan, c.e. & english, mj. (1994) benchmarking for best practices, mcgraw-hill incorporated, new york. s elnathan, d.; lin, t.w. & young, s.m. (1996) benchmarking and management accounting: a framework for research", journal of management accounting research, 8: 37-54. 6 human, j.s. (2000) "die faktore wat bydra tot die sukses van nonnering", unpublished masters dissertation, university of pretoria. 7 karlof, b. & 6stblom, s. (1993) benchmarking a signpost to excellence in quality and productivity, john wiley & sons, chichester. 8 lincoln, s. & price, a. (1996) "what benchmarking books don't tell you", quality progress, march: 33-6. 9 mansell, a. (1997) the benchmarking portfolio, volume one, strategic direction publishers limited, uster-zurich. 10 maxon,1. & trefty, b. (1997) the benchmarking portfolio, volume one, strategic direction publishers limited, uster-zurich. 11 miller, 1.g., de meyer, a. & nakane, 1. (1992) benchmarking global manufacturing, irwin, illinois. 12 randall, n.h.i. (1995) "benchmarking a manufacturing perspective", unpublished masters dissertation, university of the witwatersrand, johannesburg. l3 scheffler, s. (1997) the benchmarking portfolio, volume one, strategic direction publishers limited, uster-zurich. 14 spendolini, m.l (1992) the benchmarking book, amacom: new york. 15 thor, c.g. (1995) practical benchmarking for mutual improvement, productivity press, portland. 16 zairi, m. & leonard, p. (1994) practical benchmarking: the complete guide, chapman & hall, london. p026-040_0050 p026-040_0051 p026-040_0052 p026-040_0053 p026-040_0054 p026-040_0055 p026-040_0056 p026-040_0057 p026-040_0058 p026-040_0059 p026-040_0060 p026-040_0061 p026-040_0062 p026-040_0063 p026-040_0064 sajems ns vol 5 (2002) no 2 379 hedonic approaches to estimating the impacts of open spaces: a case study in the cape hugovanzyl independent economic researchers cc, cape town anthony leiman schoolojeconomics, university ojcape town abstract preliminary desktop studies have been carried out to illustrate the potential value of metropolitan open space areas in durban and cape town using speculative estimates derived mainly from values in the international literature. this paper investigates the effects that a selected open space (zandvlei in muizenberg) has on nearby property values and attaches values to the space using a combination of estate agent interviews and statistical analysis (hedonic pricing). the results indicate that using statistical analysis generates reasonably similar valuation estimates when compared to the use of estate agent interviews. the property price premiums or discounts associated with open spaces are found to be case specific, but certain trends are discernable that should apply to all areas. finally, the strengths and weaknesses of the property price approach are discussed. jelqoo,q26 introduction recently, two studies into the metropolitan open spaces of cape town (common ground, 2000) and durban (markowicz et al., 1999) extrapolated estimates from the international literature to obtain preliminary values of open spaces. these studies alerted city personnel to the services provided by open space areas, and to the use of environmental valuation tools in assessment and management decision-making. the result was a more detailed investigation of cape town's open spaces, one part of which (their effects on property values) is detailed in this paper. l hedonic theory presumes that property prices capture not only the physical characteristics of houses and properties, but also environmental and social characteristics such as proximity to open space, views and security. this link allows the valuation of these environmental characteristics. this paper uses r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 380 sajems ns vol 5 (2002) no 2 hedonic theory to investigate the effects of open spaces on nearby property values in a selected part of cape town (the residential areas surrounding zandvlei in muizenberg). the approach differs from the norm in using both a characteristics approach, based on estate agent interviews, and a more conventional statistical technique. the applicability of the valuation results to other similar areas in cape town is also briefly discussed. methodology methodological approach basic hedonic valuation begins with a regression. the price of property being a function of its characteristics, one regresses a vector of property prices against the corresponding vectors of those properties' characteristics. the coefficients of the independent variables provide partial derivatives. if one of these parameters is 'distance from open space', then its coefficient is a marginal value. note, however, that this is not the value of an incremental square metre of open space, but rather the disamenity of moving an incremental distance further from that space. once one has an idea of the limits to this effect one can measure the impacts of open spaces on surrounding property prices. a priori, the further a house is from the open space, the less the influence of that space on the property's price. finding an appropriate form for the regression was an initial concern. estate agent interviews suggested that the impact of an open space on property prices would fall to zero within four rows of housing from the space itself. this opened a number of paths. for example, the reciprocal of the distance from the open area could be used as the relevant independent variable. this sounds reasonable, but the resulting asymptotic decline (if one assumes that open space generates a price premium) as one moves away does not accord with estate agents' opinions. an intuitive response might be to use dummies: using the suggestion that impacts are exhausted once the fourth row of houses from the open space has been reached, simply ascribe a row number to each property. those facing the vacant land would be ascribed a value 3, those in the second row a value 2, in the third row a value 1, and all others a value of o. however, the choice of dummy values is arbitrary, and the physical distance of the second and subsequent rows of houses from the edge of an open space will be affected by the widths of the intervening stands. stand sizes clearly vary as one moves from high-income to low-income suburbs. given these constraints and the opinions of estate agents, a simpler dummy variable approach (borders open space/doesn't border open space) was used, in combination with a simple distance scale, in which the premium or discount in the prices of intervening r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 381 houses was the difference between their actual sale price and the calculated sale price if the house had been located in the sixth row from the open space. it needs to be stressed that the hedonic discount (or premium) is not a welfare measure, merely an indicator of impacts on market prices. the premium can, however, be used as a welfare measure within any area with homogeneous residents. this was recognised in the seminal literature on hedonic pricing: "if buyers are identical, but sellers differ ... single cross-sectional observations trace out compensated demand functions" (rosen, 1974: 51). this requires the strong assumptions that both incomes and utility functions are identical over all households in the data set. failing these, one should proceed to one of the second steps recommended by rosen himself, by nelson (1978) and freeman (1979, 1994)2. in this study, the impacts of open spaces were localised and generally fell in areas with relatively homogeneous communities. while this justified the use of a one step approach, it meant the use of multiple and relatively small data sets. the majority of published hedonic pricing applications have used a two-step approach with large (city wide) data sets into which all available variables have been inserted. there is merit in following this approach, but it requires a high level, often heroic, aggregation across suburbs and unique areas within suburbs. this aggregation increases the risk of misinterpreting local realities. in this paper we have used a different approach. our basic premise is that a set of micro-samples (of at least forty or fifty sales figures properly de-trended), taken on a suburb by suburb basis, can be more useful when analysing local effects, provided it is informed by extensive estate agent interviews. these interviews would have to be conducted using the same 'hedonic'or 'characteristics'-based approach that underpins the statistical technique. where there is insufficient local sales data for statistical analysis, carefully structured interviews with estate agents can still offer useful information on values. the study therefore comprises a series of independent regressions, each using data from areas with a homogeneous population. the results are expressed in monetary terms, but since the marginal utility of money varies between the affluent and the poorer suburbs, the results do not allow comparisons of utility between suburbs or even aggregation of the figures to give a total utility equivalent.3 the approach used only allowed estimation of the relative (i.e. localised) effects of open spaces on properties in close proximity to them. it did not capture the full influence of open spaces on property prices at a larger (city wide) scale. thus it could not answer the question, 'does cape town property command a premium over that elsewhere in south africa because of cape town's open spaces?' it also does not capture inter-suburb variations in value. to have done so, comparisons between suburbs similar in all respects apart r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 382 sajems ns vol 5 (2002) no 2 from the amount of open spaces would have been necessary. apart from time and budget constraints, the potential pitfalls of such an approach, in particular the development of indices of open space quantity and quality, were prohibitive and it was not attempted. application the open space valuation process commenced with interviews of four estate agents operating in the study arca.4 these provided opinions on the effects of open spaces on property prices, but more importantly helped to identify the key variables driving property prices in specific areas. a previous study using property transaction data in cape town (leiman & van zyl, 1998) had shown that: the multiplicity of housing and property variables, together with the generally low number of relevant property transactions in any area, could cause problems through inadequate degrees of freedom. house characteristics (number of bed-rooms, servants quarters, number of garages, pool, stand size, roof size etc) often demonstrated significant colinearity. consequently, with small samples, the explanatory power of any regression could be enhanced by simply using roof area as a proxy for many house related variables, after controlling for double story houses, duplexes and flats. issues such as proximity to schools, noisy roads, and pubs, could be significant local factors. these 'neighbourhood' factors are not generally recorded and are easily overlooked. it was initially hoped that the agents would have ready-evolved rough 'characteristics-based' valuation formulae, as they have in certain of the city's other suburbs. the variables in these could then be tested and used for further statistical valuation exercises. unfortunately, few agents in the areas involved took such an approach to the valuation process. most claimed to base their valuations on experience and intuition. however, asked to explain further, these proved to be merely combinations of previous prices achieved for the house in question, those achieved for houses nearby, and a judgment of the state of the property market. s in discussion what emerged was that an implicit hedonic approach was actually followed. an estate agent's valuation of a property is a function of a vector of characteristics .. the property's and the neighbourhood's .. and the prices of similar houses in the area, or of the property's own historic sale prices and the relative 'state of the market'. this approach is fairly standard in the literature, though the functional forms used vary widely.6 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 383 detailed property sales data available from cape property services (cps) over the four-year period january 1998 to april 2001 were used in the analysis. the cps records indicate the final selling price, the asking price, and the time taken to sell the property. the first of these was used as a dependent variable after detrending for inflation, but clearly the potential exists for a more sophisticated model that could take cognisance of all three price aspects. also included are the following, from which independent variables were chosen: house size, stand size, condition of the house, number of garages, numbers and types of rooms (living-, bed& bathrooms), and special features, such as roof (thatch, tile, iron), pool, north facing, servants' quarters, etc. this offered another justification for the use of a simplified vector of property characteristics, since a number of these would have had to be dummies whose coefficients would have added little to the analysis. since each analysis focused on a separate area proximate to a given open space, and no comparisons were intended, neighbourhood variables could be omitted. the distance of each house from the nearest open spaces was measured using maps with erf numbers and street addresses provided by the municipality. two study areas were specified by the city of cape town as valuation case studies of interest to them: metro south and metro south-east. in the former, zandvlei was chosen for specific analysis as an example of a large open space of ecological as well as recreational importance. zandvlei also presented the opportunity for an interesting case study, as the areas surrounding it are characterised by a mix of conventional and marina type housing. finally, it was chosen due to the availability of abundant house sales data. 7 valuation results the study area zandvlei is a natural vlei used for recreational canoeing, sailing and windsurfing (see figure i below for a map of the area). its western shores are lawned parkland, equipped in places with barbeque and picnic spots and also a boating clubhouse. it is surrounded by four residential areas: lakesidelmuizenberg north to the west, muizenberg to the south, marina da gama to the east, and sheraton park and frogmore estate to the north. the portion of lakesidelmuizenberg north between the vlei and the railway line that runs approximately three hundred metres to the west is similar to the portion of muizenberg that borders on the vlei to the south. residential housing in both these areas offers easy access to the vlei and, in some cases, a viei view. marina da gama on the eastern shores also offers these benefits, but is distinct in having been designed as an enclosed (and therefore secure) marina. sheraton r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 384 sajems ns vol 5 (2002) no 2 park, on the other hand, borders on reed beds and is fenced off from the vlei offering neither access nor views. figure 1 zandvlei and surrounding residential areas results of interviews with estate agents lakeside estate agents would only speak confidently about the influence of the vlei on property values in the portion of lakeside between the vlei and the railway line running next to main road. for this area, it was felt that proximity to the vlei yielded a positive premium. the premium for the first row of houses facing onto the landscaped areas on the vlei's shores was estimated at between 7 per cent and 12 per cent. this premium captured the view and sense of open space as well as recreational access. the interviewees provided insights that conventional hedonic studies would have missed. in particular, they argued that the premium would not be constant along the first row of housing. some agents felt that the houses south of the yacht club overlooking the barbeque facilities enjoyed no premium and might even sell at a discount due to the disturbance in this area over weekends. in this case, some recreational uses of the vlei by day trippers clash with values that could be derived by residents. from the second r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 385 row back towards the railway line, for approximately five rows of houses, recreational access was estimated to add no more than 3 per cent to values. beyond that point, estate agents doubted any premium. this implies that the view and sense of open space, enjoyed by those whose properties actually face onto the water, add a 4 per cent to 9 per cent premium. the area between main road and boyes drive not only offers relatively easy access to the vlei, but also a view of the vlei that should add value. however, it is also on the slopes of muizenberg mountain. extensive interviewing of residents would be required to separate the value specifically added by the view of the vlei from that added by the view in general and by. proximity to the mountain. estate agents described security as one of the most important considerations for buyers. an example used was the difficulty of selling houses near the unlandscaped northern section of the vlei, an area of dense reed-beds. potential buyers were deterred by a belief that criminals could gain easy access via the vlei. by contrast, houses facing westlake golf course (which is fenced and offers no access to residents) command higher prices than similar houses close by, which border on unmanaged open space (to which they do have access). the golf course, to which access is strictly controlled, is seen to lower residents' security risks while the nearby open space is seen to raise them. muizenberg muizenberg borders on the southern and south-eastern parts of the vlei. interviews with estate agents suggested that the vlei's effects on property prices would be similar to those at lakeside (le. 7 per cent to 12 per cent premia in the row of houses bordering the vlei and 3 per cent premia for those in the second to the fifth rows from it). this is not surprising as the landscaped park areas of the vlei offer similar views and recreational opportunities to residents of these two areas. marina da gama the marina da gama complex was designed with zandvlei (and the views and recreational options associated with water frontage) as its main selling point. consequently position in relation to the water is a primary determinant of prices. estate agents argued that having water-frontage was key. a house without water-frontage would lose value markedly, and it would make little difference if it was two rows or five rows from the water. an average house in the marina without water frontage or views sells, at the time of this study, for approximately r400 000. interviewees argued that the same house with water frontage and south-facing would sell for approximately r500 000 (a 25 per cent r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 386 sajems ns vol 5 (2002) no 2 premium). the price would rise to r600 000 if the house were north-facing (a premium of 50 per cent). most of the abovementioned southand north-facing houses have a view over an arm of water onto the houses on the opposite side of the channel. the largest premia are achieved by the few houses that face westward and have uninterrupted views over the vlei. within this group are two subsets. the first are the prime properties in the marina looking out over park island an attractive island that is covered in well-maintained indigenous vegetation, has good bird life and only offen; low-key recreation in the form of walking trails. estimating premia for these houses is difficult as they are the largest in the marina and there are no similar houses for comparison. premia for this group are, however, likely to exceed the 50 per cent achieved by the north-facing houses. the second group offers a less attractive view over the peninsula in the south of the vlei, which is a grassed public park area used for high intensity recreation and picnics. not only is the view less attractive, there is less privacy and there is a possibility of disturbance by recreational users. estimating premia for these houses is also difficult as some of the negative influences on house prices have been recently mitigated; there is as yet no indication of how the market will adjust. positive improvements include stricter control for recreational access, only allowing access before seven in the evening, and limiting noise levels. premia for this subset are estimated at between 25 per cent and 50 per cent. sheraton park and frogmore estate sheraton park and frogmore estate border on reed beds and are fenced off from the northern part of the vlei, offering neither access nor views. estate agents felt that proximity to the vlei did not add to property values and, due to security concerns, could even detract from them. the extension of steenberg road along the northern boundary of the vlei to link up with prince george drive has been mooted for many years. this has curtailed expenditure on management measures to upgrade the open space (as it has been earmarked for potential road works), further discouraging buyers. separating out these expectations-based effects again proved difficult. the information from estate agents outlined above was used to estimate following premia for each area: r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 387 table 1 property price premia associated with proximity to zandvlei generated using estate agent interviews lakeside muizenberg marinada zandvlei au gama areas average house price r300000 r300000 r400000 row of houses away from oj)en space premium as percentage of 9.50% 9.50% 37.50% average house price premium per house r28500 r28500 r150000 ~umber of houses affected 28 65 583 . 676 total premium r399000 rl 852500 r87450000 r89 701500 i second row of houses away from open sl ace premium as percentage of 2.25% 2.25% 0% average house price premium per house r6750 r6750 0 number of houses affected 26 65 198 289 total premium r175500 r438750 0 r614250 third row of houses away from open space premium as percentage of 2.25% 2.25% 0% average house price premium per house rr6750 r6750 0 number of houses affected 26 57 61 144 total premium r148500 r384750 0 r560250 i fourth row of houses away from open s~ ace premium as percentage of 2.25% 2.25% 0% average house price premium per house r6750 r6750 0 number of houses affected 22 50 51 123 total premium r148500 r337500 0 r486 000 fifth row of houses away from open space premium as percentage of 2.25% 2.25% 0% average house price premium per house r6750 r6750 0 number of houses affected 22 45 30 97 total premium r148500 r303750 0 r452250 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 388 sajems ns vol 5 (2002) no 2 table 1 continued lakeside muizenberg marinada zandvlei au gama areas all rows of houses i lnumber of houses affected i 124 282 923 1329 total premium iri 047000 r3 317250 r87 450 000 ir91 814250 assumptions: average premia were used based on estate agent estimates. roughly half of the houses bordering on the vlei in lakeside have no premium due to the disturbances associated with picnicking, particularly south of the yacht club. the total premium for this row has thus been halved to account for this. hedonic analysis house sales data for the last four years were collected, de-trended and then analysed for the hedonic model using st a tistica. fortunately the vlei had not undergone any major changes in the past four years. an analysis that uses a small sample and many variables can easily run into 'degrees of freedom' problems. fortunately, we could eliminate conventional hedonic issues like proximity to shops and major roads, pollution sources, etc. as inapplicable to the sample. this left only house characteristics and proximity to open space driving differences in property prices. preliminary linear regressions were performed for each of the three areas surrounding the vlei to determine whether statistically significant relationships existed between distance from open space, house characteristics and house price. significant relationships were found for marina da gama, but not for muizenberg and lakeside. proximity to open space was rejected as a candidate independent variable for muizenberg and lakeside when forward step-wise regression was performed (using a standard alpha of .05). this was not unexpected considering the small samples sizes (16 for muizenberg and 14 for lakeside) coupled with the relatively low expected premium based on estate agent interviews. the data for muizenberg and lakeside were excluded from further analysis. a step-wise regression was then performed on the marina da garna data (n = 80) in order to ensure only statistically significant independent variables were included. using a dummy to indicate whether a house had water frontage generated results with only marginally better explanatory power than using distance away from the vlei in metres (adjusted r2 == 0.66 vs. adjusted r2 :: 0.63). the choice of the dummy approach was informed by this result and the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 389 fact that it confonned better to the views expressed by estate agents. the results of the regressions were as follows: table 2 zandvlei property price hedonic regression results r2= .68081453, variable water frontage dummy (1 131578.4 = on waterfront, 0 = not house size in m 1453.7 stand size in m 199.2 number of 58104.3 adjusted r2= .66401529 stimate: 1474e2 studeutt p-level (76df) coefficient 35577.3 3.698 .000408 261.4 5.562 .000000 108.34 1.839 .069879 31292.3 1.857 .067212 excluding stand size and number of garages as independent variables was considered because of their relatively high p-ievels (these should ideally remain below 0.05). however, they were ultimately included because their p-levels were not significantly above 0.05 and their inclusion did marginally improve the model's explanatory power (adjusted r2 = 0.664 vs. adjusted r2 0.629). including only one of the two variables was also considered, but rejected as they had reasonably low levels of correlation (correlation coefficient = 0.466), and because doing so would have lowered the adjusted r2 (including only stand size resulted in an adjusted r2 of 0.653 while including only number of garages gave an adjusted r2 of 0.654). the results of the statistical analysis in below compare well with those of the estate agent interviews for marina da gama (r76.7 million using statistical analysis vs. r87.5 million using estate agent interviews). there was insufficient data for the statistical analysis of property prices in muizenberg and lakeside to reveal a relationship between house price and proximity to open space. there is, however, no reason to believe that this rmding poses a challenge to the views of estate agents that a relationship does indeed exist. table 3 property price premia associated witb proximity to zandvlei (hedonic analysis) i marina da gama number ofbouses affected i 923 in area, 583 with water frontage premium per bouse r131578 total premium associated with vlei i r76.7 million r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 390 sajems ns vol 5 (2002) no 2 applicabllxfy of results to other areas as mentioned before, the results for zandvlei reported here formed part of a broader study on the effects of open spaces on property prices in cape town (turpie et al., 2001). the study focused on a small set of suburbs with significant areas of open space in the form of parks, sports fields, areas of natural vegetation, agricultural fields and vacant lots. between them, these areas covered a spectrum of household incomes from relative afiluence to absolute poverty. the property price premia or discounts associated with open spaces were found to be highly case-specific in the study. for example, a park in kuils river created a premium while one in claremont generated a property price discount. clearly this implies that extrapolation of premia or discounts is inadvisable without site-specific investigations. however, the following trends appeared at zandvlei and the other areas investigated as part of the broader cape town study: most open spaces lead to premia or discounts of less than 10 per cent. however, areas surrounding major environmental attractions such as zandvlei can attract substantial premia often above 10 per cent or even 20 per cent. this is particularly true of areas that have been purpose-built to make the most of the environment. it is also interesting to note that the areas that showed the highest premia in the broader cape town study included water as a major component of the open space. security is a key determinant of property prices. a perception exists that open space allows easier access for criminals unless specific security-linked provisions have been made. the value of an open space depends on the quality of its management. "well-managed" typically means well-manicured, secured, and free of vagrants and other users who generate disamenity to residents. the preservation of botanical diversity and indigenous flora is problematic. trimmed lawns are often preferred to dense growths of fynbos that are seen as increasing fire and security risks. vacant land discounts may be influenced by expectations of future developments and by uncertainty over the strictness with which zoning and building regulations will be enforced. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 391 critical appraisal of methods one of the main strengths of the property price approach is that it derives values from actual market transactions and known trends. this gives ease of understanding and credibility in the eyes of the public and policy-makers. however, effective hedonic analysis using property price effects presupposes adequate data about both the property transactions and the households involved. data can prove inadequate for a number of reasons, most of which were encountered during the course of this study: if open space as a whole is to be appraised, independently of individual sites, then details of the purchasing households are needed. in particular, income, race, education, and tribal or language group seem likely to be influential factors. the conventional approach, which only treats income as a key 'indirect' variable, seems inadequate given the complexities of a city such as cape town. in reality neither it, nor any of the other 'indirect' variables mentioned, are recorded when property transactions take place. this means one has to work on a zonal basis, relying on local buyer homogeneity. in any local area the number of houses traded may be low. this limits conventional hedonic analysis to larger open spaces with large numbers of homes bordering them. the fonnal property market in the suburbs analysed needs to have been sufficiently active to generate the sales data required. sales data for areas where the property market is not well developed tend to be scarce. this is a particular problem in high-density suburbs. effectively, the implications of open space for low-income black city dwellers are not adequately evaluated. the method requires fewer assumptions and less complex analysis when analysing localised property price effects. it seems reasonable that a feature of desirable suburbs is that they are well-wooded and have substantial areas of open space. unfortunately, the property price approach used here is not suited to such broad scale analysis. some of the problems mentioned above can be avoided by making use of estate agent interviews. a caveat is needed, however: it soon became clear that some estate agents were more aware than others of issues and factors driving prices and their movements. care needs to be exercised when interpreting such inputs. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 392 sajems ns vol 5 (2002) no 2 conclusion the key rmding of the study was that open space does not have an identifiable external value per se. it generates flows of services and disservices that impact on the welfare of local residents and are captured in local property prices. indeed the external values captured were in large measure driven by the activities of the city council in maintaining and regulating greenbelt areas, and in establishing clearly-defined, stable, and policed zoning regulations. the results of the evaluation indicate that property values can be enhanced by well-managed, secure open spaces free of frequent public disturbances. effectively we found that the value was not so much determined by the open space itself (or its ecological integrity) as by the quality of its management and the public's perception of its role in social issues such as crime. there is no reason to believe that this finding would change for other areas. this was not an anticipated conclusion. property price evaluation based on estate agent interviews proved a reasonably fast way of getting information for all types of open space, while data constraints meant that hedonic analysis had to be more selectively applied. as we performed it, hedonic analysis captured only local effects of open spaces on properties proximate to them. it did not capture the full influence of open spaces on property prices at a larger scale, such as at suburb level. most importantly, it did not reflect the very real possibility that the property premium cape town commands over other cities in south africa may be a consequence of the city's extensive open spaces. endnotes the authors would like to thank the city of cape town for funding the research that made this paper possible. special thanks to the two anonymous reviewers for their valuable comments and suggestions. the aim of the city study (turpie et al., 200 1) was to ascertain the full value of open spaces and the trade-offs between open spaces and other land uses within the cma. 2 some texts simply argue for weak separability in the utility function. in this study, weak separability means that one's preference for open space is not affected by the other features of the house one lives in (independence) and are not locally satiated. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 393 3 we have serious reservations about valuations which purport to aggregate utilities across an entire population. aggregating monetary values don't pose a problem, mention of utility in this aggregate way does. 4 the following estate agents for their inputs with regard to poperty price effects at zandvlei: derek ross & partner (pam golding), megan wells (relmax), carol mcfarlane (cape coastal properties). 5 price records over the preceding seven years for the house in question and for nearby properties can be sourced from the south aftican property transfer guide database. 6 contrast this with the conventional hedonic approach which uses the same vector of characteristics, but then adds the characteristics of the buyer. . 7 for examples of the use of the property price approach to attach values to wetlands such as zandvlei, see mahan (1997), lupi et al. (1991) and doss & taff(l993). references common ground (2000) value of open space services in the cape metropolitan area, cape town: cape metropolitan council. 2 doss, c.r. & taff, s.j. (1993) the relationship of property values and wetland proximity in ramsey county, minnesota, st. paul, mn: university of minnesota department of agricultural and applied economics report 93-4. 3 freeman, a.m. (1979) the benefits of environmental improvement: theory and practice, baltimore, md: john hopkins university press for resources for the future. 4 freeman, a.m. (1994) the measurement of environmental and resource values: theory and methods, washington: resources for the future. 5 leiman, a. & van zyl, h.w. (1998) economic evaluation of conservation proposals for the aeciisomchem site in somerset west, stellenbosch: csir water, environment and forestry technology. 6 lupi, f., graham-tomasi, t. & taff, s.j. (1991) a hedonic approach to urban wetland valuation, st. paul, mn: university of minnesota department of agricultural and applied economics staff paper p91-8. 7 mahan, b.l. (1997) valuing urban wetlands: a property pricing approach. alexandria, va: u.s. army corps of engineers, institute for water resources. 8 markowicz, t., martens, a., mander, m., nicols, g., campbell-gillies, s. & collins, s. (1999) durban metro open r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 394 sajems ns vol 5 (2002) no 2 space system: framework plan, durban: environment branch, durban metro council. 9 nelson, j.p. (1978) "residential choice, hedonic prices, and the demand for urban air quality", journal of urban economics, 5(3): 357· 68. 10 rosen, s. (1974) "hedonic prices and implicit markets: product differentiation in pure competition", journal of political economy, 82(1): 34-55. 11 turpie, j.k., joubert, a., van zyl, h.w., harding, b. & leiman, a. (2001) valuation of open space in the cape metropolitan area: a pilot study to demonstrate the application of environmental and resource economics methods for the assessment of open space values, cape town: city of cape town environment directorate. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 292 south african competition law and the diamond "cartel" w duncan reekie e p bradlow professor. department of business economics. university of the witwatersrand abstract de beers central selling organisation is a co-operative marketing agreement its objective is price stabilisation not collusive monopoly gain. collusive agreements do not last. nevertheless the cso has persisted. cartels can persist if government helps and this may have occurred up to 1950. today only two (complementary) explanations remain. the "box" and "sight' system is the least-cost method of organising a distribution channel given bargaining and uncertainty and it stabilises prices for a product whose demand depend on a veblenian mystique. recent competition law does not allow for the transaction cost and demand analyses which explain this co-operative marketing agreement as non-collusive. jel m30 this paper assesses the relationship of the central selling organisation (cso) with diamond producers on the one hand, and cutters and polishers on the other. the cso is the marketing arm of de beers, which itself operates as a diamond miner and recoverer. in addition to examining the international diamond market the paper looks at some implications of the new 1998 competition act tor the south african diamond industry. the cso is found to be a cooperative marketing agreement, but not one with collusive monopoly gain as its objective (it is shown that alternative structures could better achieve this). one of the cso's goals is raising, maintaining or stabilising price while expanding output. monopoly, to the contrary, has as a defining objective quantity reduction. this intuitively illogical pairing of apparently mutually exclusive objectives is due to the presence of the "veblen" effect in demand for diamonds. price collapse would both damage the diamond market worldwide, diamond holders and consumers everywhere, as well as the south african industry and those dependent on it. another goal is transaction cost reduction. in short, the horizontal and vertical agreements underlying the production and marketing of diamonds by-and-large fall within the "trade-off" conditions of the act. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 293 sajems ns vol 2 (1999) no 2 section i examines basic cartel theory and the reasons why cartels tend to collapse. section ii indicates that while the cso meets these conditions, nevertheless it has persisted. section iii, looking at the monitoring and enforcement mechanics of the cartel, shows that these provide further reasons why the cartel will be weak. section iv indicates that while government support is the traditional way of overcoming the problems discussed in section ii and ill, such support for the cso was only present in the first half of the 20lh century, not the second. section v looks for two alternative reasons for the cso's persistence. if these reasons are valid and consumers and the economy at large benefit from the cso, section vi shows that implementation of some parts of the competition act of 1998 could negate these benefits. i why anti-competitive cartels do not persist when a group of sellers acts in collusion, tacitly or explicitly, as if it were a single economic entity this is often termed collusive or cartel behaviour. decisions are taken with group welfare in mind, rather than being prompted by a rivalrous desire to get one step ahead of competitors. price changes may then be initiated only when there.is good reason to expect that all sellers will benefit from a similar change, whether it is upwards or downwards. the belief is that pro rata shares of profits resulting from collective wealth maximising behaviour will be greater than if individualistic, but self-defeating motivates dominated. the social costs of noncontestable monopoly (for example lower volumes and higher consumer prices than would otherwise exist) would theretore be incurred. cartels are either tacit or explicit agreements which, because of rivalry, seldom last. cartelisation is understandable but it will not persist (see stigler, 1966: 230). there are several strands to the argument: i) individual firms belonging to the cartel will always have an incentive to chisel or cheat on any explicit or implicit price agreement. such cheating will eventually be noticed and be followed by competing price reductions (leading to lower, non-collusive prices and tending to normal returns). 2) to guard against chiselling firms set up monitoring mechanisms (of each other) or allocate shares of market revenues or territories for exclusive use. this is costly to initiate and/or agreement and enforcement may be difficult. the less likely is agreement (e.g. efficient fitms do not like feather-bedding inefficient ones, each likes r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 294 a "fair" share of profits, which of course is difficult to define} the more likely is cartel breakdown. 3) cartel breakdown through chiselling is also more likely the higher is the ratio of fixed to total costs in an industry. given a relatively high burden of fixed costs, a "voluntary" short-term reduction of the flow of cash revenues (by "agreeing" to high uniform prices and to forego chiselling) may create financial difficulties. this is particularly true in times of demand depression or its supply side corollary capital outlay growth. also, with a given cost structure, volatility of market demand can motivate cheating in times of famine and cartelisation in times of feast. and 4} if existing firms do not cheat and pull prices down to lower levels, then, as in any contestable monopoly, new firms will enter the industry and achieve the same result. indeed even the threat of their entry can have this result. (again, as in monopoly, the situation must be contestable, and entry easy to activate.) ii the cso does persist the cso, however, has persisted over several decades. is it, therefore, a cartel? newspapers frequently post headlines such as "the cartel lives to face another threat" (e.g. the economist, january, 1987). the fact that the cso has travelled such a long road, however, begs the question. take stigler's four conditions for cartel breakdown. they have long existed. first, sales (including those of stolen stones) outside of approved channels in the days of south africa's near monopoly of production resulted in the illicit diamond buying (idb) laws. more recently, russian and angolan diamonds have frequently been "leaked" onto the market ("cheating"). second the cso is the means of monitoring and apportioning sales of uncut stones. it is not (in absolute terms) an inexpensive arrangement and de beers (which currently produces only one half of world diamond production by value) frequently has protracted and costly negotiations with other producers to ensure both their continued membership of the cso and their adherence to its procedures including that of purchasing all of their output of rough. that output, however, is dependent on a quota system based on supplying a certain proportion of de beers' sales. thus when markets are weak, the absolute value of each quota falls. third, much but not all diamond recovery is capital intensive (particularly underground or submarine) while both the supply of and demand for diamonds are volatile. yet the centripetal forces making for marketing through the cso apparently continue to be consistently greater than the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 295 sajems ns vol 2 (1999) no 2 centrifugal ones. finally, the flow of new entrants into diamond production over the history of the cso has not been trivial. congo, angola, australia and canada have or are about to join the list of major diamond-producing countries often with no immediate de beers involvement. indeed, australia's argyle mine initially seemed determined (see economist, 1987) to sell outside the cartel. nevertheless, despite the presence of all four of stigler's conditions for breakdown being present the cso persists. one can therefore speculate that if the cso is indeed a cartel it must have some very different features from the cartel norm as experienced in other collusive arrangements. iii the unique collusive weaknesses of the cso for a given cartel to be effective (and so persist) it must be arranged or organised in such a way that the conditions for breakdown are minimised. or to put it another way, is the cso superior (for the purposes of anti-competitive collusion) to more normal types of cartel arrangement? successful collusion requires the following: 1) a good price monitoring system to tacilitate the detection of "cheating" by sellers (i.e. diamond producers). this requires monitoring the up-take of buyers (i.e sight-holders, or cutters and polishers). it is buyer purchasing behaviour after all, which indicates whether they have been the beneficiaries of secret price shading by sellers; 2) an effective enforcement mechanism for market sharing or output quota allocation. this in tum requires a "punishment" mechanism, for example the ability to increase supply (as a "swing" producer or stockholder) temporarily to reduce price for the given product below a level the "cheater" would find attractive; 3) removal of the incentive to "cheat" at times of excess supply, while maintaining the collusive incentive at times of excess demand; and 4) the erection and maintenance of effective entry barriers against newcomers. only point (3) is ambiguous. certainly as a first approximation, a cartel which is successful at "smoothing-out" the flow of diamonds onto the market will increase or decrease "cheating" and "collusion" incentives by equal amounts r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 296 over time. the cso is apparently successful at such "smoothing" but this implies little about its net effectiveness in maintaining itself over time. however, on point (1) the cso's "box price" system at prearranged "sights" obscures rather than highlights post-cheating buyer behaviour. boxes are blends or assortments of diamonds. a cartel which did not use such a system of assorting diamonds could more easily detect cheating. (for example, boxes could be replaced by sales of single diamonds, or by sales of lots of diamonds of a similar quality or source). price transparency would be increased and "cheating" by cartel members i.e. buyers and sellers dealing outside of the cartel framework would be easier to measure and detect. recall that it is buyer behaviour which signals cheating by a seller. a buyer who is indeed the beneticiary of price shading will have benefitted (if buying, say, from a mine) by having purchased stones with the particular, specific characteristics of output from that mine. other things equal it will want to purchase substantially fewer such stones from the cso. in a non-assorted market that drop in demand would be readily noticed. a box of such stones would simply be rejected. with the sight and box system, however, it is much less easy for this drop in specific demand to be monitored. buyers might not want the stones, but as they will make up only a fraction of the assorted box they will tend (even if relucwntly) to be accepted. (certainly in the weeks leading up to a "sight", information can be gathered by the cso about preferred buyer behaviour, but that is not the same as observing outright rejection of a given type of stone.) is the cso an efficient enforcement mechanism point (2)? cartel enforcement normally takes the form of the "swing" producer flooding the market with the product which has been the subject of cheating (punishing the seller), or withholding from the market the relevant product so holding up prices and protecting market participants who have stayed loyal. which route is taken depends on which party the swing producer believes it will be easier to get back in line after enforcement, and, of course, on the swing producer's ability to adopt one or other approach. (increasing supply requires access to stones, withholding supply requires either production which can be stockpiled, or a willingness to buy-up large quantities of the product being leaked on to the market.) the cso no doubt applies these tactics (see the economist, january, 1987). but does it do so with optimal enforcement efficiency? again the sight system of heterogeneous boxes dilutes the impact of swing producer behaviour. buyers would still obtain "boxes" even if a particular type or source of stone was being withheld (and de beers sells over 3000 types economist, 1987). further, since the cso explicitly sells heterogeneous boxes to sight holders, "nooding" the market with one particular source of stone has a much more diffuse impact on r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 297 sajems ns vol 2 (1999) no 2 the "box" price than it would have had, had the "sights" been sales of stones by explicit source. indeed, since the "box price" system blends not only diamonds of heterogeneous sources, quality and caratage, the prices of individual stones are obscured. sellers receive today's cso price per stone less 10 per cent for cso overheads plus a margin. come the date of sight, due to the lead time, sellers will then find it much more difficult to assess if they are getting a "fair deal" in the allocation system. if the cartel was organised on more conventional jines (e.g. by allocating ultimate revenues received by the cso by caratage or some other indicator) transparency would be increased. since the cso's ultimate selling price will differ from the buying price it paid to the mine quite apart from any obscurantism due to the "box" system there is little to suggest that perceptions of "fairness" are increased and that this is therefore an efficient monitoring mechanism. this lack of clarity as to whether an apparent price is a punishment or reward dulls the impact of the enforcement mechanism and may even prompt further attempts to get around the monitoring system. finally, on point (4), there are few if any entry barriers to new competitors, as the development of mines in canada and australia by large mining companies other than de beers indicates. in short the cso, although it persists, does not seem to have any special advantages as a collusive mechanism. indeed the reverse would seem to be the case. a mechanism is present, but is sub-optimal for both monitoring and entorcement of anti-competitive collusion. in short, the "sight" and "box" system explains how the cartel works, it does not explain why it works. other explanations must therefore be sought for the persistence of the cso. such reasons must either more than offset its weak collusive abilities. or the design of the agreement, and the agreement itself can be presumed to exist for reasons other than cartel-oriented profit maximisation. iv the need for an alternative hypothesis for cso persistence if an economist finds something a business practice of one sort or other that he does not understand, he looks for a monopoly explanation. and as in this field we are very ignorant, the number of ununderstandable practices tends to be rather large, and the reliance on a monopoly explanation frequent. .. .if we ever achieved a system .... clearly seen to be competitive, we would r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 have no explanation at all for the way in which the activities performed in the economic system are divided between firms. 298 ronald coase [p.67] recovery of a mineral, on the one hand, and advertising to consumers, market research and distribution to processing intermediaries on the other, are distinct activities usually undertaken by distinct firms. because a separation of mining and later distribution in its various forms is so common, economists often regard it as the competitive norm. de beers, however, is a mining tirm which also carries out these other activities through the cso. moreover, it restricts other firms' opportunities to sell rough diamonds and also restricts the opportunities of cutters and polishers to purchase them. such restrictions are business practices that are not well understood; yet, conventional wisdom to the contrary, the practices appear not to arise from normal cartel-style behaviour. in this and the next section we look at three alternative hypotheses: government backing, transaction cost minimisation, and consumer price optimisation. the role a/government in cartels hypothesis a cartels are groups of producers which agree to act together to avoid the rigours of competition. but usually collusion neither works nor persists because at least some of the parties have an incentive to chisel on the deal. if this does not occur, newcomers will be tempted into the market. but cartels can indeed survive if there is a body standing above the producers, most obviously a government, which can enforce agreement. the organisation for petroleum exporting countries, unlike a government dealing with firms inside a sovereign state, was powerless without such a body. by this token the cso and the international diamond market differs significantly from the oil industry. this hypothesis can indeed be advanced to account for the persistence of the cartel. and it appears to have considerable support. newbury (1989: 360) argued: the "ghost at this long historical banquet of diamond riches in south africa is the state" (meaning the union government or its provincial predecessors). moreover, in his penultimate chapter (p. 357) he draws on many previously unavailable documents (both corporate and governmental to emphasise how the strategic demands of world war 2 enabled the imperial government to create an "identity of interests" between itself and the cso which "was at least as great as the longer and stormier relationship between the corporation and south africa". newbury's research presented a detailed gloss on these two assertions. he cited government documents from as early as 1876 which regarded the (government-imposed) limitation on claim holdings as an impediment to the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 299 sajems ns vol 2 (1999) no 2 formation of large companies and, therefore to increased revenues for the fiscus. large companies could be taxed more highly since "the diggers could not be pressed for more" not, be it noted, because of inability to pay but because "the political risk was too great" (p. 42). what happened from then on was that government adjusted its stance towards corporations and became the outside policeman which helped maintain the diamond cartel. government ensured stability in a number of ways. when a new entrant like premier ignored the now successfully established single channel of distribution, government encouraged compliance by proposing a conference on output agreements in 1914. by 1919 government was chairing the meetings to determine output quotas. it ensured that the south west african producers would not suffer confiscation for wartime reparations, being sold voluntarily instead to what was to become consolidated diamond mines a de beers associate. government also went to extreme and largely successful lengths to stop idb on the alluvial fields (this was partly to stop the damage to price due to sales of stolen gems but partly to ensure that approved channels for legally acquired gems were not by-passed). the great depression of the thirties saw the premier mine closed. the oppenheimer-led syndicate tried to manage the market and newbury's pages are replete with phrases such as "depended (on) ... the approval of the union government for this strategy" (p. 306) and it "was welcomed by the department of finance and the inland revenue". however, the very early thirties were still unprotltable for the industry and "smuts intervened personally at the (british) colonial office ... inviting the secretary of state to assume powers to limit sales from ... notably the gold coast (now ghana) and sierra leone" (p. 317). the late thirties saw demand increase for industrial diamonds as the vehicle, metal and defence industries began to expand. this demand was continuous: industrial diamonds are not forever they wear out and have to be replaced. world war 2 accentuated this trend and, as in world war i, diamonds became a strategic mineral with london unchallenged by occupied antwerp or amsterdam as a conduit for allied requirements. the pivotal role of london (whose influence was wider than pretoria's) strengthened the cso and its power was demonstrated by the imperial government's refusal to permit direct exports to the us. but, and here is the flaw with the hypothesis, this argument may have been valid from 1900-1945, but has it been so in the last fifty years? if not then there must be further alternative explanations for the cso's persistence. the british empire has evaporated. so the imperial government is no longer a cartel policeman. the pretoria government certainly maintains idb laws in place in south africa. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 300 but since the 1930s south africa's share of world diamond production (by caratage) has slumped from close on 100 per cent to between to and 20. so local lob laws, even if intended for cartel maintenance, can have little atlect on international prices. yet the cso survives and indeed prospers. moreover, it does so despite continued new entry, despite temporarily threatened free-riding by a diamond buying office in liberia in the mid-1980s, and another in moscow in the late 1990s, and despite theoretical predictions to the contrary. newbury's book does not answer why the cartel has survived since 1950. both theory and history say the reason must be government. but what government? and since it is now clearly not a government-policed arrangement, are there now, in the decades from 1950-2000, other and more plausible hypotheses for the cso's persistence? v two alternative but complementary hypotheses: efficiency and demand any business agreement (or contract) is a device for making a profit. the contract can be anything from a spot deal, through longer-tenn agreements, through to incorporation of an integrated firm. the issue is whether the de beers: cso agreement exists to maintain profits "as if' it were a monopoly (the conventional cartel rationale implying higher prices due to withheld quantities) or whether it exists to maximise profits subject to competitive market forces. the traditional cartel rationale seems weak. first, cartels are unstable and relatively short-lived. this is not so here. second, they will select optimally efficient monitoring and enforcement mechanisms. this does not apply here either. third, a superior body to the cartel is required for longevity. this has not been so since mid-century when a globally influential government disappeared, and when south africa's role as an overwhelmingly dominant producer also ceased. yet the cartel retains its existing membership and continues to recruit new members. clearly this must be because members believe individually that profits will be greater inside than they would be if they operated outside the cartel. but the motives and rationale may well differ from those provided by traditional cartel theory. if the cso is a competitive response to the efficiency requirements of the market, on the one hand, and to consumer wants on the other then two further hypotheses are suggested: i) the transactions costs of operating in the diamond industry are less (and so profits greater) inside the cartel than outside. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 301 and 2) sajems ns vol 2 (1999) no 2 the nature of the product is so unique that cartel breakdown, in and of itself, poses a major threat to the continued existence of the industry and so to the profits and welfare of each and every cartel member, and these benefits filter through to, and are appreciated and highly valued by the final consumer. this uniqueness in turn means that cartel membership itself provides or underwrites a major part ofthe final product's value. in such circumstances can the mechanics of the cartel be better understood? does the sub-optimal monitoring and enforcement mechanism provide signiticant benefits to cartel members in and of itself? do other activities of the cartel lead to increased output (and consumption) of diamonds at higher prices (in a manner totally alien to normal cartel or monopoly theory which presumes lower output and higher prices)? i f the answer to these questions is in the affirmative then a reinterpretation of the cso cartel in terms of anti-trust or competition policy is perhaps overdue. minimising transaction costs hypothesis b the presence of transactions costs as obstacles to value-maximising trades benefitting all parties was first identified by ronald coase in 1937. in 1972 coase's insights were still only accepted by a few (supra). in 1991 coase received the nobel prize for his work on the subject (basically for 2 seminal papers, in 1937 and in 1960). by the 1980s the whole new discipline of law and economics had burgeoned on the foundations laid by coase and is now commonplace even in textbooks. in essence business persons have always been expected to maximise profits by finding out how they can most accurately assess what the consumer wants, and providing goods or services at a price and cost which yield a proht. in the absence of monopoly behaviour, the larger the profit the better they have succeeded in tailoring their product to customer demand, and the more efficiently they have produced their output in terms of achieving lower costs. after coase (and his successors), economists and lawyers have understood that many joint value maximising trades beneficial to both buyers and sellers fail to occur because of the presence of transactions costs. businesspersons thus have an additional task namely identifying and minimising transactions costs to permit trades to take place. important transaction costs include the presence of information asymmetry before the deal is concluded. a well-known example is the low price which can be obtained for second-hand cars. buyers are fearful that a seller will try to sell r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 302 them what she/he knows is a "lemon" but whose qualities the buyer cannot know. purchasers refrain from entering the market and the price falls. as a consequence "good" second-hand cars are withheld from the market and far fewer trades take place than otherwise would. sometimes also known as adverse selection, such pre-contractual opportunism also exists elsewhere. for instance where poor health risks may conceal non-identifiable but relevant information from insurers, who, aware of this, offer in turn a premium based on the population average. those in the population with a better risk profile opt out since they are now getting a bad deal. the average premium must rise, and again the market may either collapse at the extreme, or many joint value maximising trades do not take place as the good risks who would happily have paid a fair premium have dropped out of the market. overcoming such problems is not cheap. the methods chosen to minimise the problems may as coase indicated, be wrongly interpreted as monopolistic practices. in our own text on managerial economics (1995: 67) crook and i draw on kenney and klein's (1983) paper and use it for teaching purposes. the "sight" and "box" system in transactions cost minimisation terms is explained as follows: the cso economises on pre-contractual opportunism, information search costs, measurement costs and bargaining costs as follows. it restricts buyers to selected and approved dealers who have indicated interests in purchasing stones of particular sizes and qualities. they are offered a packet, or 'sight' of such stones roughly corresponding to their wants on a strict take-it-or-ieave-it basis at a price based on gross characteristics. neither the contents nor the price of the package is negotiable and refusal to purchase results in exclusion from participation in future 'sights' and hence effective exclusion from the trade. [this] ... [explains] how the cartel minimises transaction costs. [why does that, in its turn, explain the cartel's existence?] bargaining and value assessment stone by stone would be time consuming and costly (the gems have not yet been cut hence value to either buyer or seller would be relatively difficult to determine). buyers need not inspect too carefully in looking for "lemons" since the packages have not been rejected by other buyers as deficient in quality. while the seller, by refusing to bargain (on penalty of withdrawal of future sight rights) saves on bargaining today being used opportunistically to make possibly dishonest claims that higher prices would be offered in future. (this forces buyers in their turn, to forego and hence save on their bargaining costs.) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 303 sajems ns vol 2 (1999) no 2 the cartel is, therefore, an organisation which raises profits by reducing transaction costs. the ways in which it does so are not optimal (i.e. they are less than efficient) from the view of a monopolistically motivated cartel. that is, monopolisation and collusion to hold prices at high and stable levels, while restricting quantity, could be achieved, as already explained, in a different and less costly manner than the "box" and "sight" system as it exists. nevertheless, as the quote above indicated, the transaction cost explanation deals with how the cartel operates, it explains how the cartel aims to improve total profits (at least from the cost side), and thereby it explains why it becomes attractive to join. but it only explains why the cartel sticks together from the supply side. to complete the picture we must look at the revenue side of profits. optimising revenues and price hypothesis c diamond demand and supply are both volatile, the latter depending on new discoveries, and the former on fashion's ebb and flow, disposable income, the economic cycle, and interest and exchange rates. diamonds are seen as intrinsically precious and desirable, not as an investment implying later resale, but as a visible embodiment of an illusion, love, sex and romance which will presumably last forever. some of these attributes would seem to place diamonds outside of the realm of economic analysis. to the contrary. leibenstein explained the theory (on the demand side) in 1950. leibenstein was puzzled that normal demand theory failed to account for the realities which exist in certain markets. his article was theoretical and did not mention examples such as diamonds, but is highly relevant here. the usual assumption is that market demand is a relationship between price and quantity. that relationship in normal theory is obtained by adding together the individual demands of all consumers (which are assumed to be independent of each other and dependent only on the inherent attributes of the good itself). but, leibenstein argued, what if there is also a "veblen effect"(named after veblen's theory of conspicuous consumption)? here leibenstein distinguished between the good's functional utility and the utility attached to its price; the latter is the conspicuous consumption element. it is this conspicuous component of price which matters; the higher the conspicuous price the more other people are impressed, and so the greater the satisfaction of the purchaser. individual demands, contrary to standard theory, are indeed affected by the demands of others, and in particular by the prices others are paying. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 304 certainly each consumer has a normal demand schedule refer to figure i. on the basis of given expected conspicuousness of price, say pi, p] or pii" these could be aggregated to produce market demand curves 0 1• o2 or oil< depending on the conspicuous price. only one point on these aggregated mark.et demand curves is relevant, as shown in the figure. if consumers expect the conspicuous price to be pi, the demand curve will be db but if it turns out to be p] , they will move up to operate on demand curve d]. and so on. if conspicuous consumption is an important determinant of demand for the good, the higher the conspicuous price the higher the demand at all price levels. a line can then be drawn through the expected conspicuous price level of each of these demand curves and this produces the 'true' demand curve d", the remarkable feature of this demand curve is that it is upward-sloping. this suggests that an upwardsloping demand curve is conceivable, at least for certain ranges of prices on certain luxury goods. if diamonds lost their intrinsic preciousness and desirability because of a low conspicuous price demand would collapse. the law of demand, that quantity is inversely related to price, may seem violated but actually is not. algebraically the law states that q = f (iip). with diamonds the equation must be amended slightly to q = f(llp, po) indicating that quantity is still inversely related to price (as in d .. d2 or dn) but is also positively related to price as a conspicuous indicator of apparent intrinsic preciousness (p") as in d,. unlike normal monopolistically motivated cartels, therefore, where profit maximisation requires raising price (and so withholding quantity) in order to maximise collective profits (thereby damaging consumer welfare), with a veblen effect good such as diamonds the reverse is true. explicitly raising and maintaining price raises demand ceteris paribus. enhances profits (or the business activity which permits the new price would vanish) and, in addition, improves and maintains consumer welfare. (the improved consumer welfare can be measured, for competition policy purposes in the conventional manner by comparing the consumer's surplus triangles above pi ei and above pil en). the maintained consumer welfare is measured by the fact that all existing owners of diamonds would have their ownership satisfaction destroyed if prices collapsed. all participants in the diamond industry, therefore, from mines through to consumers, have extremely low time discount rates. each has an interest in price levels which will maximise hislher own profits and/or satistaction over a very long run. no operator in the industry with the possible exception of smallscale individual diamond diggers, has a short time horizon. the cso cartel, with its mechanism of controlled buying and controlled selling of uncut stones in the light of changes in supply or demand, acts in the interests of ail this is r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 305 sajems ns vol 2 (1999) no 2 why it stabilises final prices. but, unusually for a cartel, the "all" includes current and also previous final purchasers. the sight system further enhances profits by reducing transaction costs. there is no governmental body standing above producers to keep them in line. the sight system, as a monitoring and enforcement mechanism for a monopolistically motivated cartel, could well be improved upon (but at the expense of increasing transaction costs). but it appears not to be monopolistically motivated. the cartel holds together rather because its mechanics are efficient in meeting the aims both of its members and of consumers, reinforced by unique characteristics of product demand which would result in permanent market collapse if cartel discipline was breached. the cso is a market driven institutional outcome. it is there to meet a market demand, to maximise the joint value of mutually beneficial trades (including those with ultimate consumers, past, present and future). monopolistically motivated cartels exist to maximise the value of trading to one set oftraders only (buyers or, more usually, sellers). an efficiency-motivated cartel exists tor the former reason. the cso, marketing goods with a strong veblen effect built-in to their demand, exists for that reason. it simultaneously engenders very long time horizons in the decision-taking processes of all of its participants. breakdown, contrary to monopoly cartel theory, then becomes unlikely. the cso, of course, would be easy to break up. legislative rulings to that ehect would be quite enough. this, in turn would impact on the entire industry. if the argument above is correct viz., that diamonds are a veblen good, there could then be very great hardship indeed for all industry members, miners, cutters and polishers, and consumers. vi how the competition act (1998) could impinge on the de beers/cso arrangements de beers is a south african-registered company, while the cso has its headquarters in the uk. the "sight" system operates in london, lucerne and johannesburg, with approximately 170 sight holders of whom 17 operate exclusively at the johannesburg sights. the diamonds offered in johannesburg "boxes" are of a higher quality on average than those offered in london or lucerne since johannesburg sight-holders and the cutters they represent cannot economically purchase, cut and so dispose of diamonds of a lesser value. (south african cutting costs per hour are high, unlike those in india, and they are not yet offset, as they are in tel aviv, by entrepreneurial flair.) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 306 the particular legislative and export duty arrangements which permit de beers to export its relatively heterogeneous local output but offer a relatively homogeneous quality of box to south africa sight holders are not discussed here, except to note that the intention of the law is to encourage the existence and growth ofa local diamond-cutting industry. turning in particular to the act. section 4.1. prohibits restrictive horizontal agreements. this could be interpreted as applying to de beers and other miners as they agree with each other to participate in the eso. if it is so interpreted then it should be regarded as an exceptional agreement under section 4.1 (a), in which case the prohibition falls away since there are "efficiency, or other pro-competitive, gains" which result from the agreement. (transactions costs are lower, market throughput is stabilised, and, without the protection given to the veblen effect, the market would collapse and not exist at all). however, section 4.1.(b) prohibits horizontal restrictive practices which 2) directly or indirectly fix a purchase or selling price 3) establish production quotas 4) divide markets by allocating goods 5) include collusive tendering. each of these four is a possible reason for the sight system to be investigated by the authorities. unlike section 4.1(a) no trade-off argument or exception is permitted. given the discussion above this could prove to be a major deficiency in the act, and have major negative implications for the industry. section 5 prohibits restrictive vertical agreements, although a competition! efficiency trade-off argument can again be used for exceptions. the minescso-sight-holders relationship is vertical. furthermore, it can be argued again (as under section 4.1 (a» that the agreements do not lessen but permit competition, since without them the market would not exist at all again it can also be argued that the efficiency defence holds. section 7 indicates that de beers and the eso can be regarded as dominant firms in terms of the act. (they have over the legal threshold of 45 per cent of the market.) however, dominance per se is not illegal. dominant firms must not (section 8a) charge excessive prices to the detriment of consumers. as argued this is not applicable to the diamond industry, due to the veblen effect. (and to competition from other luxury goods.) a dominant firm (sections 8c and 8d) must also not engage in various "exclusionary acts". the "box" and "sight" system could be regarded as exclusionary. but again both can be defended under the act on the competitive and efficiency grounds already discussed. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 307 sajems ns vol 2 (1999) no 2 vii summary the so-called diamond "cartel" is not a product of anti-competitive practices. it has its economic (although not necessarily its historical) origins in costreduction and consumer satisfaction requirements. the 1998 competition act is unlikely to pose a legal challenge to the cartel's existence with the exception of section 4.i.(b) which strangely (in the context of other provisions in the act) is a per se prohibition allowing for no defence from an accused party which can demonstrate that its activities are welfare enhancing from an economic perspective. this defect in the act should be remedied. endnote i would like to thank h.f. kenney and d.f. leach for commenting on this paper. references i. coase, r.h. (1937) "the nature of the firm". eeonomica. vol 4. 2. coase, rh. (1960) "the problem of social cost", journal of law and economics, vol. 2. 3. coase, rh. (1972) "industrial organisation a proposal tor research" in v.r. fuchs (ed.) policy issues and research opportunities in industrial organisation, columbia university press. 4. competition act 1998, no 89 of 1998 published in the government gazette, no 19142, office of the president, pretoria. 5. kenney, rw. & klein, b. (1983) "the economics of block booking", journal of law and economics, vol. 25. 6. leibenstein, h. (1950) "bandwagon, snob and veblen effects in the theory of consumer's demand", quarterly journal of economics, vol 64. 7. newbury, c. (1989) the diamond ring: business. politics and precious stones in south africa: 1867-1947, clarendon press. 8. reekie, w.o. & crook, j.n. (1995) managerial economics. (41h ed.) prentice hall. 9. stigler, gj. (1966) the theory of price. (3'.1 ed.) macmillan. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 511 aligned commitment and the high performance organisation jg kotze potchefstroom business school, potchefstroom university for christian higher education abstract in attempting to achieve high performance levels within the enterprise, the manifestation of aligned commitment is a very desirable goal to aim for. it is instrumental in the realisation of the full potential of organisational members and in focusing their efforts and performance on the strategic vision of the enterprise. a model, which introduces, describes, and integrates the various processes, steps and actions required in the development of aligned commitment, is suggested. guidelines, derived from research findings as well as experience gained in the actual implementation of the various constituent elements of the model, are supplied. these guidelines should assist in the successful establishment and maintenance of a value-driven, aligned commitment culture within any enterprise. jel j20, j50, l20, mi2 introduction the evolving business environment of the 21 51 century is making new and unique demands on the modern manager and leader. today's executive needs to be competent in leadership, which is defined as "influencing and directing the behaviour of individuals and groups in such a way that they work willingly to purslie the objectives of the organisation" (smit & cronje, 2000: 279). those husincss leaders who arc not successful in this regard, "risk being overwhelmed hy factors such as bureaucratic infighting, narrow-minded politics, destructive power struggles, and the like which regularly reduce initiative, innovation, morale and excellence in the organisation" (kotter, 1985: 3). the influencing and directing of the performance of subordinates (team members) to the pursuance of organisational objectives has become known as commitment (meyer & allen. 1997: 12; kreitner & kinicki. 1995: 162; mowday, et al., 1982: 27) or as aligned commitment (kotze. 2001: 11; coetsee, 1996: 23). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 512 sajems ns vol 5 (2002) no 3 in the last three decades, the construct of aligned commitment has been thoroughly researched. this research has yielded several definitions of aligned commitment (sheldon, 1971: 143; hall, schneider & nygren, 1970: 176; in meyer & allen, 1997: 12; mowday, et al., 1982: 27; kreitner & kinicki, 1995; wiener, 1982: 421). these definitions identify and stress different aspects of aligned commitment. the majority of the distinguishable facets of commitment contained in the definitions are reflected in the definition of commitment formulated by mowday, et al. (1997: 235): "an employee's belief in and acceptance of the values and beliefs of the organisation, coupled with the willingness to exert considerable effort on behalf of the organisation, and a strong desire to maintain membership therein". aligned commitment and performance meyer & allen (1997: 67) have identified and defined three broad components of commitment namely; affective, continuance, and normative commitment. these components are all, to a certain degree, reflected in the mowday definition above. affective commitment is the employee's emotional attachment to, identification with and involvement in the organisation or group. employees with a strong affective commitment continue membership because they want to do so. the same authors (1997: 30) have pointed out that the definition of affective commitment is clearly based on the values of the employee being congruent with that of the organisation. continuance commitment refers to an awareness of the costs associated with discontinuing the relationship with the organisation. employees whose primary link to the organisation is based on continuance commitment, remain because they need to do so. normative commitment reflects a feeling of obligation to continue the relationship. employees with a high level of normative commitment feel that they ought to remain with the organisation. normative commitment has been shown to be the weakest of the three dimensions, while affective commitment has proven to be the strongest dimension (meyer & allen, 1997: 28-35; mowday, et ai., 192: 15; myers & miller, 1997: 17). the two stronger dimensions of commitment have been shown to relate to different organisational consequences. continuance commitment has been linked to general decreases in employee turnover as people cannot afford to leave their organisation, but has not been linked with any aspect ofpenormance (angle & perry, 1981; hom, katerberg & hulin, 1979; porter, et al., 1976; werbel & gould, 1984 in angle and lawson, 1994: 1540). research r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 513 evidence for an aligned commitment-perfonnance link, has been rare. where such a linkage has been found, it has related only to affective commitment. meyer, et al. (1989) in angle & lawson, (1994: 1541) found a positive link with job perfonnance for affective commitment, but not for continuance commitment. an interesting conclusion following exhaustive research in a fortune 500 company by angle & lawson (1994: 1544) was that affective commitment was positively related to two of the four perfonnance facets measured, namely dependability and initiative, but was unrelated to accomplishment or judgement. this supports the intuitive perception that perfonnance is inevitably a multidimensional manifestation. furthennore, this multidimensional perfonnance is the product of both ability, as well as motivation (mullins, 1996: 444). the definition of affective commitment stresses its motivational nature. this implies that the linkage between perfonnance and affective commitment is predicated upon the latter's effect on team members' willingness to exert additional effort (porter, et al., 1976; angle & lawson, 1994: 1547). these researchers found no implied relationship between affective commitment and ability. angle & lawson (1994: 154748) conclude that the positive relationship between affective commitment and dependability and initiative can be explained by the reasonable assumption that these two perfonnance facets rely more on effort and motivation and less on ability. the two unrelated perfonnance aspects of judgement and accomplishment are more dependent on ability than on motivation and, consequently, on effort. a general conclusion from prior research into aligned commitment and perfonnance therefore, is that the following desirable organisational consequences can be obtained from a committed workforce: a decrease in turnover, an increase in motivation and effort, decreased absenteeism, greater initiative and dependability and job satisfaction (myers & miller, 1997: is; bateman & stasser, 1984; mowday, porter and steers, 1982; mowday, porter and steers, 1979; mathieu & jujac, 1990; clegg, 1983; cotton & tuttle, 1986 in becker, billings, eveleth & gilbert, 1996: 464). the latter researchers also found that overall aligned commitment to direct supervisors (superiors) is positively related to job perfonnance and is more strongly linked to perfonnance than overall commitment to the organisation itself (becker, billings, eveleth & gilbert, 1996: 467). the three implications for a proposed model of aligned commitment to elicit high overall perfonnance in the organisation, are the following: the importance of shared values as one of the elements required for aligned commitment; r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 514 sajems ns vol 5 (2002) no 3 ability (competencies) should receive as much attention in the model as effort (motivation) does; the relationship on all organisational levels between superior and immediate subordinates is of critical significance in developing aligned commitment in the enterprise. a model to facilitate aligned commitment the following model (figure 1) is suggested as an integrated guideline to facilitate aligned commitment and to achieve high, overall performance levels in the enterprise. this model is derived from the kotze (2001: ii) model of aligned commitment in strategy implementation, the coetsee (1996: 112) model for the creation of a motivating climate, and the kreitner & kinicki (1995: 142) job performance model of motivation. each element of the model will now be discussed and integrated with the other elements. • the strategic plan the achievement of aligned commitment and high performance, like all other desirable business outcomes, starts with an "appropriate" and ''winning'' strategy. appropriate business strategies are well suited to the future demands and characteristics of the macro, as well as the operating environment of the enterprise; they contribute to sustainable competitive advantage and lead to superior financial results. winning business strategies emphasise the critical importance of knowledge and intellectual capital (competencies), the flexibility of business processes and systems, the continuous reinvention by means of innovation and creativity, a culture of strategic thinking and organisational learning and the essential ability to manage time effectively (kotze, 200 i: 3-4). during the formulation of appropriate and winning strategies, three additional elements of the high performance, aligned commitment model are developed. these elements, namely the objectives, vision statement and the core values are contained within the statement of "organisational purpose". "(s)trategies can engender strong, enduring emotional attachments only when they are embedded in a broader organizational purpose" (bartlett & ghoshal, 1994: 49). this requires the creation of an enterprise with which employees can identify, in which they share a sense of pride and to which they are willing to commit. "in short, senior managers must convert the contractual employees of an economic entity into committed members of a purposeful organization" (bartlett & ghoshal, 1994: 51). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . figure 1 high performance and aligned commitment .. , i expectations ~ ---c.;;;;p;;wcl;; kpas kpis sources: kotze, 2001: 11; coetsee, 1996: 112; kreitner & kinicki, 1995: 142 ~ ~ cij z cij e: ul t3 § z o w ul -ul r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 516 sajems ns vol 5 (2002) no 3 • objeetives setting objectives converts the strategic vision into specific perfonnance targets. objectives represent an organisational and managerial commitment to the achievement of specific outcomes and results. objectives must be stated in quantifiable (measurable) tenns, and they must contain a deadline for achievement. objectives, along with the vision statement and the core values, are an important part of the statement of organisational purpose of the enterprise. there are few more powerful or public signals of what an enterprise stands for than the way in which it defines and measures perfonnance. a great deal of thought and attention should, accordingly, go into the fonnulation of appropriate objectives, and the right balance between objective-driven perfonnance and value-driven perfonnance. the objective-driven perfonnance yields the tangible results required by the strategic plan. this may be described as the "what" of perfonnance. the remaining element consists of the value-driven perfonnance. this may be visualised as the "how" of perfonnance. how was the what attained? did the employee act in a manner conducive to the overall, long term best interests of the enterprise? did the employee, in achieving the desired tangible performance result, contribute positively to the image and long-tenn strategic capacity and potential of the enterprise or did he/she hann these critical aspects? (kotze, 2001: 36). • the organisation structure once an appropriate and winning strategy, incorporating vision, core values and objectives, has been fonnulated, the focus shifts to the conversion of these aspects into actions and high perfonnance. the proficient implementation of the fonnulated strategy is heavily dependent on: an effective, strategy-supportive organisation structure competent people who are: output (results) directed focused on core values empowered a leadership/managerial capacity to meet the needs and expectations of the organisation's people, and to realise their full potential. the organisation structure, as key element of the aligned commitment model, can be described as being effective, and strategy-supportive, if it facilitates the following desirable results (kotze, 2001: 109-10): r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 efficiency effectiveness strategy support excellent horizontal and vertical communications effective co-ordination of all activities, functions and actions 517 realisation of the full, p~ctically-realisable benefits of the optimum trade-off between centralisation and decentralisation development, protection, maintenance and wide-spread establishment of core competencies within the organisation aligned commitment on all organisational levels. this organisation structure should be peopled by competent, empowered teams who are continually supported to exercise initiative and to realise their full potential. this requires the effective delegation of sufficient authority to the subordinate to balance the responsibility and accountability the person is expected to accept (smit & cronje, 2000: 281). managers wishing to unlock the full performance potential of aligned commitment in their organisations, will continually attempt to build the skills and self-confidence of their subordinates (team members). they will delegate authority, share information and allow subordinates to participate in decision-making. these actions tend to optimise the internal motivation, self-control and commitment of team members (yuki, 1981: 134). these managers will seize every opportunity to empower their team members. true empowerment requires the superior to furnish those reporting to him/her with the means, ability and accountability to do what is required of them. without all three, the superior disables, rather than empowers (schuitema, 2001: 24). harvey and brown (1996: 227) define empowerment as "the process of giving employees the power to make decisions about their work" while beatty & ulrich (in jick, 1993: 71) describe empowerment as "a movement away from leader and expert problem solving to a system where everyone is continually involved in improving the organisation". high perfonnance and aligned employees in the organisation also need to be output and value focused. in modern performance management processes, the tasks (inputs) performed by individuals and teams are unimportant. primary concern falls on the results (outputs), normally identified in the form of key performance areas (kpas) and measured by key performance indicators (kpis). a kp a is an individual/team result which has high value to the organisation in terms of its strategic plan, as well as the demands placed upon the organisation by the key success factors of the industry in which it operates. the objectives and values of the organisation, already discussed, form the foundation of the formulation of kp as and kpls. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 518 sajems ns vol 5 (2002) no 3 between every level in this strategy-supportive organisation structure, there are implicit expectations, downwards, as well as upwards. managers expect certain actions and performance levels from their immediate subordinates; the latter, in tum, expect leadership, guidelines and other inputs from their superiors. these expectations must be made very explicit. they must be identified, classified and communicated. unrealised expectations usually lead to misunderstandings, grey areas, disillusionment and lack of commitment. the heart of aligned commitment is to be found between these organisational levels and in the relationship between superior and immediate subordinates. recall the cited research conclusions that aligned commitment to direct superiors is positively related to job performance and is more strongly linked to performance than overall commitment to the organisation itself. this is amplified by the finding that superior performance is elicited by an effective intemalisation of the core values of the superior. it is in this direct organisational relationship that the constituent elements of aligned commitment in the form of strategy, objectives, key performance areas, core values, vision, people's self concepts, their loci of control, their abilities and their needs and expectations come together. if the manager/leader handles all these aspects and the balances between them sensitively, intelligently and patiently, the full benefits of aligned commitment may be realised in the enterprise. it is as if a strong magnet is placed behind the vision block in figure 1. this magnetic force exerts a pulling power on all the arrows and focuses them on one single future point, namely the compelling destination symbolised by the vision statement. a misguided handling of these factors may lead to some or all of the following negative consequences over time: people lose enthusiasm the best people leave the organisation productivity goes down management's credibility suffers most people do not realise their full potential service to clients deteriorates and resistance to change increases exponentially. • the core/shared values coetsee (i 996: 20) identifies a shared value system which guides the behaviours of employees, as a pre-requisite to aligned commitment. what is required are values that pervade the organisation and that establish the guidelines under which the enterprise's decisions, actions and opinions are framed. the benefit of shared values is that decision-makers have a focus for their decisions, causing r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 519 them to be more consistent. to the extent that values are widely held, the need for complex control mechanisms is lessened (kotze, 2001: 15). desirable values in an organisation are usually derived from the vision statement, as well as the implicit implications of this statement. o'reilly & chatman (1986: 493) identify three independent bases, for an individual's psychological attachment to an organisation, namely, compliance to stated expectations for specific, extrinsic rewards, identification based on a desire for affiliation and "intemalisation predicated on congruence between individual and organizational values". the last (intemalisation) basis of commitment links closely with the definition of affective commitment discussed previously. "having a membership that shares the organizations .... values can ensure that individuals act instinctively to benefit the organization" (ouchi, 1980; williamson, 1975; in o'reilley & chatman, 1986: 497). according to bartlett & ghoshal (1994: 50) it is more difficult to identify, communicate and shape core values than it is to articulate and advocate a strategic vision. they explain this by pointing out that the value establishment process relies less on analysis and logic, and more on emotion and intuition. this effort is, however, very worthwhile, as organisations with clear and boldly asserted core values typically attract and retain employees who identify with organisational values and become more deeply committed to the organisation that embodies these values. hughes, ginnet & curphy (1999: 286) point out that values playa key role in strategic vision development (as also the latter, in value identification and articulation), and that it also "serves as a moral compass for aligning leaders' and followers' actions with desirable strategic initiatives". two examples of widely implemented, desirable strategic initiatives of the 21 51 century and their attendant values, are the following: an internal locus of control: values which emphasise the internal locus of control behaviour are those of: responsibility and ownership acceptance of responsibility and exercising of initiative respect for oneself and for others mutual trust creativity and innovation. a learning organisational climate: typical core values of learning organisations include the following: openness or transparency innovation and creativity r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 520 sajems ns vol 5 (2002) no 3 acceptance of reasonable risks trustworthiness growth. from the above, the key role played by the vision and the values in forging strong emotional links and attachments to the organisation and its purpose, is evident. it is again necessary to add the proviso that, in implementing the proposed model of aligned commitment, efforts should be focused on commitment to supervisors rather than on commitment to organisations. an especially strong predictor of superior performance in the organisation appears to be based on "the propensity to become committed to a supervisor (especially a propensity based on intemalising the supervisor's values)" (becker, billings, eveleth & gilbert, 1996: 468). in developing, refining and instilling core values, the critical role played by the direct supervisor must be appreciated. • incentive compensation the role of compensation in the pursuit of aligned commitment has been thoroughly researched by lawler (1992172); cummings & worley (2001 :392); byars & rue (1997: 312). in an organisation with a high level of aligned commitment, a significant portion of the compensation of team members should be dependent on the performance levels of the organisation. the quoted research findings also stress the importance of a creative balance between extrinsic (tangible) rewards and intrinsic (intangible) incentives. an effective performance based, incentive system can contribute significantly to continuous improvement in team member and work group performance. it can also produce high levels of employee satisfaction. • the vision statement the statement of vision is arguably the most important element of the entire aligned commitment model. "aligned", in the term, refers to the directing (focusing) of the performance outputs of employees on all organisational levels, towards the ultimate realisation of the formulated vision. the vision is accordingly the end result (destination) of the construct of aligned commitment. it is, of course, also the successful end result of the entire process of strategy formulation, as well as implementation. in a similar vein, "commitment", in the term, refers to the influencing of employee's attitudes towards the organisation and it's vision through the four r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 521 identifiable phases of awareness, support, involvement, and commitment (coetsee, 1999: 210-213). again the passionate involvement and organisational citizenship behaviour, known as commitment, is focused on the vision and values of the enterprise. the crucial role played by vision is aptly summarised by schuitema (2001: 24): "the role of a vision is to provide people with an excuse to suspend their self interest." a vision can be described as a "desired reality" (parker, 1990: 2) while collins and perras (1991: 34) call it a "shaping force" in coetsee (1999: 213). the majority ofresearchers, for example richards and engle in jick, (1993: 83) and taylor (1994: 71) in coetsee (1999: 213) tend to stress the motivating or pulling force of visions, as well as the aligning and focusing role of vision statements. the vision should, therefore, reflect the phuosophy and specifically the values of the organisation (jick, 1993: 97). an effective and well-developed vision statement is characterised by the following: (kotze, 2001: 15): it addresses values as well as performance. it provides direction to the members of the enterprise, signaling in which direction anticipated future change is headed. it is symbolic, providing a common frame of reference, identification and commitment. it is educational, assisting employees to understand the environment and changes in the environment. it unleashes energy. it is short; expressed in one or two sentences. it is expressed as an end result ... a desired destination. it expresses a dream an intelligent dream. it is emotional and motivating, it addresses the heart as well as the mind. other characteristics of excellent vision statements are the following: they should not be too broad or too narrow. too broad strategic visions convey little meaning or guidance to employees on lower organizations levels. too narrow visions make it difficult or impossible to generate organizations involvement in interpreting, refining and operationalising the vision (bartlett & ghoshal, 1994: 57-8). people on all organizations levels should be, as far as practically possible, involved in the development and converting into action of the vision statement (bartlett & ghoshal, 1994: 55); gratton, 1996: 291; beer & nahria, 2000: 133-34). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 522 sajems ns vol 5 (2002) no 3 it seems reasonable to conclude then, that an excellent vision statement fonns a significant part of an energising organisational purpose that according to taylor (1994: 71) in coetsee (1999: 213) gives people's lives and work a semblance of meaning. conclusion in this article, the highly desirable manifestation of aligned commitment was described and a model developed. successful implementation of all the different aspects of the model and the effective integration of these aspects should contribute significantly to the realisation of the benefits of aligned commitment. these benefits are numerous but might be summarised as follows: "an effectively committed work force will be an innovative, dynamic, competitive and motivated one. individual self-interest and fragmented departmental/ sectionavunit interests are minimised and people work together to achieve the shared vision" (myers & miller, 1997: 19). this is a desirable option as south african organisations struggle to compete internationally. this brings us full cycle to the strategic plan which was illustrated as being the starting point in the aligned commitment model. the ultimate, successful bottom-line result of a superior strategy fonnulation and implementation process is the conferring of sustainable competitive advantage on the winning enterprise in its industry. the real benefits come from advantages that competitors cannot easily imitate. to be sustainable, competitive advantage needs to be deeply embedded in the organisation its human resources, their skills and competencies and the appropriate culture and leadership style. a key enabler to ensure sustainable competitive advantage is found in the right corporate culture and values, the ability of the organisation and the individual member to learn and change, the strength of the core competencies of the organisation and the willingness of the organisational members to go the extra mile. additional research efforts can productively be applied in detennining the structures, processes, and management styles, most conducive to enabling individual and organisations learning and knowledge management. a failure to develop and maintain the passionate psychological attachment to organisational vision, values and objectives (aligned commitment) in south african organisations will mean that few will ever become internationally competitive, that sustainable competitive advantage will remain an elusive concept, and that they will have to bear the increased costs associated with more detailed and sophisticated control systems. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 523 references angle, h.l. & lawson, m.b. 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(2000) "achievement of aligned commitment toward continuous improvement initiatives in the absence of direct line authority within a petro-chemical company", mba dissertation, potchefstroom business school, pu for che. 45 smit, pj. & cronje, gj. de j. (eds.) (2000) management principles: a contemporary edition for africa (3 rd ed.) kenwyn: juta. 46 wetlaufer, s. (1999) "organising for empowerment: an interview with aes's roger sant and dennis bakke", harvard business review, 77(1). 47 wiener, y. (1982) "commitment in organizations: a normative view". academy of management review, 7: 418-28. 48 wilson, p.a. (1995) "the effects of politics and power on the organizational commitment of federal executives", journal of management, 21(1): 101-18. 49 yukl, g.a. (1981) leadership in organizations, englewood cliffs, new jersey: prentice-hall. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 387 sajems ns vol 3 (2000) no 3 downsizing and the survivor syndrome: the south african case leopold vermeulen department of human resources management, university of pretoria retha wiesner department of human resource management and employment relations, university of southern queensland abstract the purpose of this study was to obtain empirical data about the effect of workforce reduction on "survivors" in the public (n=158) and private (n=71) sectors in south africa. analysis of the effects of workforce reduction indicated that downsizing affected the survivors negatively. employee morale, staff commitment and motivation plummeted, while job dissatisfaction and concern about job security increased conspicuously. it was found that the negative effects were more prevalent in the public than the private sector. depth and frequency of downsizing seem not to intensify the survivor syndrome. jel m12 introduction in the recent past, say since 1994, south african organisations have had to cope with socio-political changes, new governmental regulations, a re-introduction to global markets and pressure on costs and margins as well as the demands of affinnative action. in addition, specific south african business trends such as unbundling, industry deregulation and the privatisation of public sector companies created new competitive forces in certain industries which necessitated organisational change. an increasingly persuasive response to this experience (to change) was to engage in some fonn of organisational restructuring, which included downsizing, right-sizing and re-engineering. these concepts all share one common assumption, namely workforce reduction and job elimination. south african companies in the private sector first showed signs of staff reduction during the course of the eighties. since 1990 the number employed in the industrial sector have continued to diminish with an overall low in 1996. an r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 388 indication of the total number of job cuts since 1991 is given in table 1 and is reflected in figure i. table 1 cut in staff of the top 100 companies in the industrial sector listed on thejse 1991 1992 1993 1994 1995 1996 companies 37 i 37 33 43 55 48 increased staff new appointments 25426 82673 52809 39828 40 416· 43457 companies 63 63 67 571 451 52 decreased staff • staff reduction -89656 i -81 532 -82798 • -164265 -39847 -64 192 jobs gained/lost -64230 +1 141 -29989 -124437 +569 -20735 source: adapted from supplement to the fmanclal mali (1990/97) the labour utilisation data of the major employers in south africa, reflected that the percentage of companies that downsized their staff reached its *highest level in 1993 with the employment cycle at its lowest point in 1994. after a period of growth in 1995, private sector employment started dropping in the third quarter per cent of 1995, with declines of 5.8%, 3.6% and 2.8% in the first threequarters of 1996 (see figure i). figure 1 employment trends in south africa: 1991-1996 (index 1991 = 100) 100 ----95 90 85 80 105 --100 ~1.mpioym.nl (nonagricultural) --...... -__ -----j,.. -........... private .ictor 95 _______ ~ public •• ctor 90 ------~~~--____ ------~ 85 ~ 80 indices: "1990 = "100. seasonally adjusted 1991 1992 1993 1994 1995 1996 source: sa reserve bank r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 389 sajems ns vol 3 (2000) no 3 however, in 1996 (at the time of the national survey) there was no sign of the process letting up 44% of south african managers expected the restructuring cycle to continue over the next two years (1997/98). the reserve bank figures showed that 104 000 jobs were lost in the first nine months of ) 997 and in its most recent survey statistics sa reported that 186 000 jobs were lost during 1998 (williams, 1999: i). in south africa many public sector corporations, city councils and even the public service have undergone restructuring to adjust to the imperatives of the new south africa. most of the larger utilities have cut their payrolls since june 1994. transnet, one of the largest transport public sector companies for example, downsized 27 059 workers from 1994 up to 1996 (segal, 1997: 351-2). another major emphasis of government is the "right-sizing" of the public service. 300 000 public service jobs had to be shed in three years (19961718). to this end 18 184 jobs were lost during 1996/97 (swart, 1998: 8). based on the above summary of trends in downsizing and job elimination in south africa, the question arose as to what the effects of downsizing are on the survivors. much of the research in this area is organised around the notion of the "survivor syndrome" (littler, bramble & dunford, 1995; littler, dunford, bramble & hede, 1996; vermeulen, wiesner & littler, 1999). in this paper the focus is on the effects of workforce reduction on the survivors in the private and public sectors in south africa. the major research questions we address in this article, are as follows: • what is the impact of downsizing on south african employees in the private and public sectors? • what factors intensify and modify the survivor syndrome? downsizing survivor syndrome the toll of job elimination and downsizing on human resources in a company is often extremely negative. survivors of workforce reductions experience a wide range of emotions grief and shock at the loss of their colleagues, guilt from feeling responsible for everyone's suffering, uncertainty about their competence and job identity, relief at being spared,fear that at the next round of cut-backs they may not be so fortunate and anger that the company they trusted has changed the "rules of the game" (npi, 1996: 20; stevenson, 1998: 42). downsizing frequently results in the so-called "survivor syndrome". this syndrome is apparent among both lower-level and managerial staff, with the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 390 latter in particular undergoing a commitment crisis. employee loyalty and motivation is jeopardised during downsizing, particularly in those companies that fail to share information both during and after the downsizing (brockner et al., 1987; brockner, 1988; brockner, 1992). management experiences diminishing expectations regarding their chances for advancement, leading to a decline in commitment to the company and increased staff turnover. managers who find that the organisation's vision, values and direction are no longer compatible to their own beliefs, have their expectations and dreams shattered. they may work their way out of this predicament by creating alternative options for themselves within or outside the organisation (stevenson, 1998: 42). as a result, downsizing fundamentally alters the terms of the psychological contract that binds workers to organisations. this has a wide impact on the companies concerned as the resulting low morale and lack of trust have ripple effects on virtually every people-related aspect of business activity (cascio 1993: 101-3). unless a company is wiiiing to undertake the hard but necessary work of developing a new contract to replace the old one, employees wiii just feel betrayed and this shows in many ways including lost loyalty, poor morale, health problems and reduced customer service (challenger in laabs, 1999: 6). to summarise, survivor syndrome involves a decline in organisational commitment, a loss of morale, a lack of trust and a focus on personal security rather than any corporate goals. these may have long-term outcomes in relation to performance, innovative capacity and organisational learning in south africa (roos, 1993; louw, 1995; thomas, 1996; stevenson, 1998). method a~d resl.arch procedure the primary purpose of the investigation was to obtain empirical data with regard to the effect of downsizing on employees in south africa. littler's organisational change survey questionnaire was used in a survey of employees' reactions on downsizing in the private and public sectors. the questionnaire was developed and standardised by littler et at. (1995) to measure downsizing and dejayering in australia and new zealand. the questionnaire consists of five sections. in this study the data of the following three sections were used, i.e. the organisation, the effect of workforce reduction and the demographics of the respondents. despite the widespread use of the term "survivor syndrome", it has not been adequately or operationally defined. littler et al. (1996) defined it in terms of six key human resource management variables i.e. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 391 job dissatisfaction; staff motivation; staff commitment; morale among staff; concern about job security; perceived promotional opportunities. sajems ns vol 3 (2000) no 3 (increased levels) (decreased levels) (decreased levels) (decreased levels) (increased levels) (decreased levels) these factors were used consistently across the survey questions in relation to the workforce in general. other factors could have been incorporated, such as stress levels, but littler et al. (1996) wished to keep the construct as simple as possible to avoid problems of weak convergent validity. the works of brockner et al. (1985), greenhalgh & jick (1989), and cameron et al. (1993) suggest that the above factors are common across a range of studies and should have convergent validity. in defining the limits of this study, it should be noted that the unit of analysis was the organisation, not the individual employee. we asked hr managers about their perceptions of a variety of employee attitudinal factors including morale, staff commitment, perceived promotional opportunities, motivation, job satisfaction and concern about job security. respondents were asked to assess these items in relation to three categories (increased, decreased and unchanged). it is reasonable to assume that if any bias occurred the hr managers would under-report employee downturns in morale and commitment. the questionnaire was administered in south africa during may/june 1996. statistical analysis the ordinale scale was used as the level of measurement. for the purpose of this paper, descriptive and non-parametric statistics were employed in order to demonstrate comparative trends in the data. to determine differences between the private and public sectors on the effects of downsizing on key human resource variables. the mann-whitney u-test was used. to determine the effect of depth and frequency of downsizing in respect of the survivor syndrome the kruskal wallis rank order analysis of variance was used. the spearman rank order correlation coefficient was calculated to determine whether depth and frequency of downsizing are related to the intensity of the survivor syndrome. the spss for windows statistical package, release 6.1, was applied for all statistical procedures. it was reasoned that staff working in the human resources area of organisations would have a perspective on restructuring, which is reasonably well-informed r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 392 and is more detached than line managers who may be directly affected by such organisational change. the sampling frame was derived from the professional register obtained from the south african board for personnel practice. one thousand two hundred names were randomly picked from the register, and the sample represents more organisations than those noted on the stock exchange. a questionnaire, accompanied with a covering letter, was mailed to each member of the sample. a reminder and an additional copy of the questionnaire were sent to approximately 500 respondents six weeks after the initial mailing. of the questionnaires originally sent out, 421 responses were received. this represented a rate of 35.08%. of the 42 i questionnaires sent back, 17 were spoiled and 22 returned unopened or unanswered. the number of usable questionnaires received from each industrial sector for south africa is shown in table 2. table 2 respondent industry profile industrial sector frequency percentage (n) (%) agriculture 17 4.5 mining 45 11.8 manufacturing 87 22.8 electricity and gas 27 7.1 construction 8 2.1 trade and catering 31 8.1 transport, storage and communication 33 8.6 finance 50 13.1 public adn.inistralion 25 6.5 community service 48 12.6 other ii 2.80 total 382 100 the distribution of the responding organisations in terms of sector and number of employees is provided in tabel 3. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 393 sajems ns vol 3 (2000) no 3 table 3 characteristics of participating organisations organisational variables or anisatjonal sector number of em 10 ees 0-500 501-1000 over a 1000 total results comparative trends frequency n 266 115 381 n 84 55 243 382 percentage 0/0 69.6 30.4 100 0/0 22.0 14.4 63.6 100 of the 382 organisations in south africa participating in this study, 60.4% indicated that they had been involved in downsizing during 1994 to 1996. downsizing were more prevalent in the public sector (62.8%) than in the private sector (59.6%). table 4 downsizing trends in south africa: 1994 -1996 country sector south africa private public downsized n=381 n=266 n=155 yes 60,4% 59.6% 62.8% not at all 39.6% 40.4% 37.2% depth of workforce downsizers • downsizers downsizers reduction n=229 n=158 n=71 1-10% 59.8% 57.0% 66.1% 11-20% 24.5% 27.2% 18.3% 21-30% 7,4% 7.6% 7.1% more than 30% 8.3% 8.2% 8.5% frequency of workforce reduction once 39.3% 52.2% twice 16.8% 15.2% 19.7% 3 or more times 40.5% 45.5% 28.1% r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 394 the data in table 4 show that the majority (59.8%) of the south african organisations had a workforce reduction of between one and ten per cent. fifty six (24.5%) of the employers reduced their workforce between 11% and 20% and seventeen (7.4%) reduced their workforce between 21% and 30%. only nineteen organisations reduced their workforce by more than 30%. forty three per cent of the south african organisations downsized once, 16.8% downsized twice and 40.5% were engaged in workforce reduction three times or more. the data indicated that only 28.1 % of the organisations in the public sector had downsized three or more times over the two year period 1994/1996. this figure is significantly lower than the private sector which had downsized three or more times in 45.5% of cases. survivor syndrome the downsizing survivor syndrome is normally defined as the set of emotions and behaviours exhibited by employees who remain in the organisation after the process of downsizing is completed. table 5 summarise the comparative effects of downsizing on morale, staff commitment, perceived promotion opportunities, motivation, job dissatisfaction and concern about job security. table 5 the effects of workforce reduction: downsizing syndrome outcome hrm variables country south africa n=229 sector public inc dec _i~i::!;n!.:::c_ i-----------i---"=-j--..=-=.. i morale staff commitment perceived promotional ortunities vation job dissatisfaction concern about job secun 9.2% 75.4% i 12.8% 13.8% 68.8% 18.4% 32.5% 43.2% 40.6% 12.6% • 61.6% 2.8% 88.7% 48.6% o 21.9% 59.4%· 18.8% 80% 6.5% 84.5% 9.9% according to table 5, employee morale fell in 75.4% of cases, commitment decreased in 68.8% of cases and motivation decreased in 70% of cases, while concern about job security increased in 80% of cases. a comparison between the perceived effects of downsizing by the private and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 395 sajems ns vol 3 (2000) no 3 public sectors respondents disclosed a similar pattern. however, the survey results showed t~at the public sector was more affected by the negative effects of downsizing. of the cases surveyed, employee morale decreased by 87.3%, staff commitment decreased by 88.7%, perceived promotional opportunities decreased by 64.8% and motivation decreased by 88.7% of cases. concern about job security increased in an overwhelming 84.5% of cases. the mann-whitney v-test confirmed significant differences (p<o.oi) between the public and private sectors in relation to four of the survivor syndrome variables i.e. morale, staff commitment, perceived promotional opportunities and motivation. table 6 differences between the private and public sectors in respect of the effects of downsizing on the survivors hrm variables private public n=156 n=71 mean rank mean rank v-value 2-tailed morale amonll staff 120.62 99.45 4505.0 0.0028'" staff commitment 122.84 88.80 3749.0 0.0000'" perceived promotional 124.02 90.53 3871.5 0.0001'" opportunities staff motivation 121.67 89.87 3825.0 0.0000'" job dissatisfaction 103.01 118.55 4309.0 0.0635 concern about job 110.53 security 116.75 5130.0 0.3386 "'p<o.oi% an analysis of tables 5 and 6 confirms that workforce reduction has a negative effects on the survivors and that downsizing leaves people bruised and far less committed. it also destroys employee trust in the organisation. discussion in some ways these results are not surprising, because added into the mix of downsizing and restructuring in south africa, there was the change in government, the loss of political power by whites, the end of apartheid and the introduction of affirmative action. the ratios of 4:3 in promotion opportunities in the private sector and 2:6 in the public sector were rather surprising. these results may be due to the policy of affirmative action, which has become a mainstream labour practice in the public sector since 1994. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 396 due to affirmative action, many competent black managers in the public sector find themselves in an enviable position with regard to promotion. many white managers find themselves on a career plateau with restricted career opportunities. the following written comment by a white male respondent summarises the perception: "affirmative action has resulted in many people skipping the normal promotional steps. this has led to a decreased perception of promotional opportunities by especially white people, and inefficiency caused by delays, while they (the new managers) learn the job and often learn by their mistakes. the latter has led to a high level of frustration on the part of many colleagues. stress levels have increased enormously". however, affirmative action and empowerment of at least some black people do not explain the south african picture. the south african downsizing story cuts across both sectors. the figures in table 5 reflect a scene of civil servants in crisis as restructuring erodes old securities. south african insecurity indigestion has not been assisted by the extent and depth of the public sector restructuring. 300 000 public service jobs are to be shed in three years. headlines like "public servants in panic over an uncertain future" (pretoria news, 1996: 19) circulate regularly, fuelled by statements from politicians like "no public servant should feel ensured of a job in the public service in three years time!" (pretoria news, 1992: 19). though there are idiosyncratic factors (such as the affirmation action policy effects), the data suggests a consistent pattern which confirm the negative effects of downsizing on worker behaviour. however, literature (litter c r et al., 1996) suggests that the intensity of the survivor syndrome may be influenced by the depth, frequency and recency of downsizing. for the second objective of this paper, we try to identify the factors that influence the survivor syndrome outcomes. the question we try to answer is: what factors intensify and modify the survivor syndrome? depth of downsizing the downsizing literature suggests that depth of downsizing (10% versus 20% for example) makes a difference to the hrm outcomes. for example, brockner (1988: 230-1) found that lay-off severity was negatively associated with organisational commitment. this notion has been expanded to a more complex explanation by some researchers. however, no significant (p>o.05) correlation (rho) was found between the depth of cutting and the six key hrm variables which represent the survivor syndrome (table 7). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 397 sajems ns vol 3 (2000) no 3 table 7 spearman rank order correlation between depth and frequency of workforce reduction and the effect of downsizing on the survivors (n=226) effect of downsizing workforce reduction ! (hrm variables) depth frequency rho rho morale among staff -0.052 -0.042 staff commitment -0.009 -0.031 perceived promotional opportunities -0.126 -0.082 staff motivation -0.028 -0.052 job dissatisfaction -0.009 0.026 concern about job security -0.135 0.002 p>o.05 in order to determine whether depth of workforce reduction (1-10% to more than 30%) makes a difference to the hrm variables, the kruskal wallis rank order analysis of variance was executed in respect of all the south african data as well as for the public and private sectors data. the analysis yields no statistically significant difference (p>0.05) between depth of workforce reduction and the intensity of the survivor syndrome. the depth of cutting seems to have no effect on the survivor syndrome outcomes (table 8). table 8 kruskal wallis rank order analysis of variance for depth in workforce reduction in respect of the effect of downsizing on the survivors (n=226) effect of downdepth of workforce reduction chisignifisizin! square cant hrm variables 1-10% 11-2i~ 12~~10:o 30%> n=135 n=5 n=19 x rank x rank x rank x rank morale among staff 116.13 107.25 108.66 117.32 1.5686 0.6665 staff commitment 1l1.99 110.46 111.31 34 0.0342 0.9983 perceived promotion 118.74 108.56 100.72 95.95 3.6758 0.2987 opportunities staff motivation 112.69 106.21 i 108.13 115.42 0.8049 0.8483 job dissatisfaction 112.71 105.96 102.43 78.67 5.8274 0.1203 concern about job 111.73 115.30 113.78 102.66 1.1446 0.7663 security • p>o.05 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 398 frequency another factor which may influence the survivor syndrome is the frequency of downsizing. as we mentioned in the introduction, 40.2% of the south african organisations had downsized three or more times over the two year period 19941996. in the private sector 45.5% of the organisations have downsized three or more times over the two year period. 52% of downsizing organisations in the public sector had downsized once and only 28.1 % downsized three or more times over the two year period. the frequency of downsizing has been less in the public sector than the private sector and this may be due to the fact that the restructuring cycle is still relatively new in the public sector. according to jeffrey pfeffer, a professor of organisation behaviour at the stanford graduate school of business, case studies show that repeated waves of downsizing are crushing to morale, reduce credibility and trust in management and make high performance work practices difficult, if not impossible, to implement (laabs, 1999: 10). this view is not supported by louw (1995). he found that organisations that had downsized before, and then downsized for a second time, experienced less of a negative impact on job focus than they did the first time round. the results of our study also revealed no empirical evidence of a relationship (rho) between frequency of downsizing and the six key hrm variables which constitute the survivor syndrome (table 7). the kruskal wallis rank order analysis of variance also yields no statistically significant difference (p>o.05) between the frequency of workforce reduction and the survivor syndrome. the frequency of cutting jobs also seems to have no significant impact on the intensity of the survivor syndrome (table 9). table 9 kruskal wallis rank order analysis of variance for times engage in workforce reduction in respect of the effect of downsizing on the survivors (n=226) effect of downsizing frequency of workforce chisignifireduction s uare cant once twice three+ hrm variables n=95 n=39 n=92 x rank x rank x rank 116.52 112.64 111.95 0.4369 0.8038 113.40 113.76 109.81 0.2652 0.8758 promotion 120.57 104.29 109.81 2.5205 0.2836 0 ortunities r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 399 sajems ns vol 3 (2000) no 3 table 9 continued effect of downsizing frequency of workforce chisignifireduction square cant staff motivation 114.55 110.49 108.67 0.6076 0.7380 job dissatisfaction 104.67 117.19 107.75 1.2418 0.5375 concern about job security 110.82 120.20 111.03 1.3257 0.5154 p>0.05 recency of downsizing the third possible factor that may influences the survivor syndrome outcomes is recency of downsizing. the recency argument has not been fully articulated in the literature, with the possible exception of the "grief model" applied to organisational change. downsizing and restructuring cause considerable problems at both a personal and structural level according to stevenson (1998). the results of job loss on displaced people have been studied by psychologists for many years and findings show indisputably that redundancy has traumatic effects on people who lose their jobs. those who have to carry out the task of job termination and those who stay behind in the organisations are similarly affected. a form of organisational trauma is experienced which impacts on productivity and profitability. however, over time the situation "cools down", people adapt and the "grief' problems are finally resolved by acceptance. many people will leave the organisation including those who are most dissatisfied (stevenson, 1998: 42). the public sector only started extensive downsizing and restructuring since 1994, althougn some restructuring efforts date back to the early nineties. our survey results indicate that survivor syndrome outcomes are extremely negative in the public sector (see table 5). the negative impact of downsizing was still fresh in respondents' minds at the time of the survey and it is obvious that the situation had not "cooled down" yet. people have not adapted and the "grief' problems have not been resolved to a final stage of acceptance. the respondents in the private sector have gone through downsizing much earlier and the situation seemed to indicate that the effect of the downsizing was not as intense as in the case of the public sector. these results imply that the recency of downsizing may influence the intensity of the survivor syndrome. further longitudinal research is needed to confirm this view. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 400 conclusions we aimed to investigate the impact of downsizing on survivors. in this paper we have presented some of the initial results. it is evident from the results that the impact of downsizing has hit south african employees hard. the results of the study confirm previous findings on the "survivor syndrome" (brockner et ai., 1985; brockner et al., 1987; brockner, 1988; louw, 1995; littler et al., 1996). although in the south african environment other factors such as wide-spread socio-political changes and policies of affirmative action could have impacted on the negative outcomes, the data suggest a consistent pattern confirming the negative human resource effects of downsizing. downsizing is not a temporarily phenomenon that will soon disappear. until recently, few voices have been raised against downsizing as a corporate strategy. however, as disenchantment about downsizing as a strategy has spread in the usa, it has been taken up as the restructuring strategy in many other economies. the paradox is that many u.s. firms now express misgivings about the principles of downsizing. it partly relates to the widespread phenomenon of survivor syndrome in the united states. such a phenomenon implies that the objectives related to downsizing and organisational restructuring are often contradictory (laabs, 1999: 1-10). downsizing as a stand-alone strategy can minimise or negate any productivity improvements sought from a leaner workforce and job redesign. endnote this paper is part of a broader project on organisational restructuring, downsizing, delayering and management labour markets co-ordinated by professor craig r. littler in conjunction with dr. retha wiesner (university of southern queensland), professor richard dunford (victoria university of wellington), dr. tom bramble (university of queensland), and professor leo vermeulen (university of pretoria). the authors would like to thank the national research foundation (nrf) for their financial assistance towards this research. opinions expressed and conclusions arrived at are those of the authors, and are not necessarily to be attributed to the nrf. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 401 sajems ns vol 3 (2000) no 3 references brockner, j. 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(1999) "organisational downsizing and the survivor syndrome: comparative data from south africa and australia" proceedings of the sixth european congress ofpsycho!ogy, july: 462-3. 28 williams, f. (1999) "sa in werkloosheid-moeras. geleenthede vir 186000 het verlore gegaan", sake-beeld. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction background to the study social media and business networks business networks and competitiveness stakeholder theory research design presentation and discussion of findings recommendations conclusion and implications for future research acknowledgements references about the author(s) lentswe mosweunyane department of business support studies (bss), central university of technology, bloemfontein, south africa patient rambe department of business support studies (bss), central university of technology, bloemfontein, south africa dennis dzansi department of business support studies (bss), central university of technology, bloemfontein, south africa citation mosweunyane, l., rambe, p. & dzansi, d., 2019, ‘use of social media in free state tourism small, medium and micro enterprises to widen business networks for competitiveness’, south african journal of economic and management sciences 22(1), a2780. https://doi.org/10.4102/sajems.v22i1.2780 original research use of social media in free state tourism small, medium and micro enterprises to widen business networks for competitiveness lentswe mosweunyane, patient rambe, dennis dzansi received: 16 aug. 2018; accepted: 16 jan. 2019; published: 29 apr. 2019 copyright: © 2019. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: while the proliferation of social media is hailed for increasing corporate business networking and competitiveness, this claim has not been sufficiently tested in tourism small, medium and micro enterprises (smmes) in african emerging economies where traditional communication modes tend to dominate. setting: this study investigates the use of social media in tourism smmes to widen their business networks to increase competitiveness. aim: this study contributes to the debate on business networking among stakeholders within the tourism sector. methods: to close the research gap, the current study employed stakeholder theory and survey data of 123 hospitality smmes to explore the influence of social media utilisation for business networking with stakeholders and its effect on business competitiveness. results: findings showed that the majority of tourism smmes used social media technologies to retain their customer base, solicit feedback from customers, assert their dominance in the market, maintain contact between their co-workers and share information. moreover, the findings indicate that there is a significant positive relationship between social media business networking and competitiveness of these firms. the study recommended that tourism smmes should create a policy framework for comprehensive stakeholder engagement that serves the interests of all individuals. conclusion: to increase the competitiveness of such firms, smmes should incorporate social media into their formal internal and external information strategy. keywords: social media; networking; stakeholder; small, medium and micro enterprises; business competitiveness; smmes. introduction social media networking, which denotes the use of social media to engage with a business’ internal and external stakeholders, seems to have attracted the attention of large corporations that have resource endowments to generate a large customer base and shape the public image of their brands. the established body of literature focuses on large corporations’ use of social media for advancing business competitiveness (aimiuwu 2012; pereira medina 2014). however, the emerging phenomenon of small, medium and micro enterprises (smmes) in developing economies using social media to advance their competitiveness has been under explored in literature (meske & stieglitz 2013). for the purpose of this study, business competitiveness describes the ability of a business to regularly and successfully yield products or services that meet the requirements of an open market and enable the business to stay operational by gaining market share (sipa, gorzeń-mitka & skibiński 2015). yet the need to understand the influence of social media business networking on the competitiveness of smmes cannot be ignored as it promotes and markets business brands (ananda, hernández-garcía & lamberti 2015) and develops new products and improves customer service for business (arca 2012). antoldi, cerrato and depperu (2011) suggest that a network indicates a social structure that includes a set of relationships between different individuals. the popularity of social media networking as a field of study seems to stem from the important role it plays in binding and bringing individuals and businesses together. in the context of this study, this network includes employers and employees (internal network) and customers, suppliers, competitors, regulators and surrounding communities (external network). furthermore, social media are platforms that can smoothe the construction of social interactions among these different networks and provide opportunities for them to share suggestions, concerns, interests and activities through connections (oyza & edwin 2015). tourism smmes are small businesses that employ fewer than 200 employees and offer tourism products or services to consumers (pierce 2011) in emerging economies. however, smmes’ lack of a competitive plan to improve the sustainability of their business operations and their failure to utilise the increasing importance of social media as interaction and communication tools undermine their competitiveness. dahnil et al. (2014) concur that smmes are known to have limitation and acceptance barriers in utilising emerging technologies such as social media for networking. one of the major limitations to smmes’ use of technologies stems from the poverty of resources within these businesses (ghobakhloo et al. 2012). despite this failure by tourism smmes, social media networking gives businesses a voice and a way to communicate with stakeholders (ndekwa & katunzi 2016). it personalises the brand and assists businesses to spread their message in a relaxed and conversational way (ndekwa & katunzi 2016). hence, technological innovation is a significant component in today’s knowledge economy. ludmila and stanislava (2015) state that social media technologies (smts) are important resources of competitiveness for businesses; thus the use of social media may play an important role in the competitiveness of smmes. lim (2010) observes that the tourism sector is slowly gaining momentum with regard to technology adoption and smmes are unwilling to adopt these technological advances. besides, the tourism sector also fears social media because they think that it could be detrimental to employee productivity or fear that social media has the potential to harm the business’ reputation. social media may have negative implications on employee productivity in the workplace (hettiarachchi 2017; mohamed et al. 2017). furthermore, zeng and gerritsen (2014) add that the tourism sector is faced with the possibility that social media, if not managed properly, can be a source of negative influence from dissatisfied customers. therefore, the industry has not taken advantage of the power of social media and they have not incorporated it in their marketing initiatives. lim (2010) posits that social media is an alternative platform for tourism smmes to enrich their knowledge and extend their network of connection. therefore, these smmes should take advantage of these emerging technologies to expand and influence both their internal and external network to gain competitiveness. in view of the above, this study addresses the following research questions: to what extent do tourism smmes utilise social media to broaden their business networks (i.e. supply chain networks)? what impact does smmes’ utilisation of social media technologies have on business competitiveness? background to the study small, medium and micro enterprises play a substantial part in the creation of employment and are considered one of the key drivers of economic growth (brand, du preez & schutte 2007; dahnil et al. 2014). this assertion also includes tourism smmes. tourism seems to be a growing sector in south africa to address the nation’s social challenges of overcoming poverty, unemployment and inequality. xasa (2017) concurs that the south african tourism economy is one of the best performing economic sectors in south africa, outperforming many of the traditional south african sectors, and also creating permanent jobs as well as stimulating job creation. this is because tourism is labour intensive (aynalem, birhanu & tesefay 2016; meyer & meyer 2015). in many developing and transition economies, tourism has emerged as the dominant tool for economic growth. this is supported by mihalic (2014) who states that most developing economies conceive tourism development as their chance for economic development. the same applies to the free state province of south africa. tourism smmes in the free state are mostly bed and breakfast establishments and guesthouses. some of these smmes are informal establishments that have turned their homes into a business. this micro focus might be the reason these businesses may not be using social media for networking with their business stakeholders. the desirability of business networking for small, medium and micro enterprises the globalisation and growing competitiveness of the tourism market demand greater flexibility within tourism businesses (borodako & kožić 2016). borodako (2011) affirms that in a tourism sector dominated by smmes, flexibility may be realised by support for a range of stakeholders internal and external to the business. even so, the literature concerning ways of cooperation in the tourism business is rather uncommon (borodako & kožić 2016). nevertheless, internal and external networking within this sector is important for its competitiveness. sosa, roy and bautista (2015) concur that social media business networks are central in demonstrating what the business stands for and this indicates that they are involving their internal and external networks. the social media business networks have evolved to a point that they now allow people to use them to generate sales and increase the competitiveness of enterprises. tourism smmes should also utilise this prominent phenomenon in order to increase their competitiveness. networking is often an informal way of attaining a mutual goal, but its time frame is not usually limited (borodako & kožić 2016). according to borodako and kožić (2016) the external drive of networking is created by the business environment, in particular globalisation, rapid technological changes, climate change, humanity’s increasing mobility, and escalating competition between tourism destinations and businesses. the internal drive for cooperation networks is mostly dependent on resources, the need for a cooperating partner in the market is especially prevalent among smmes. this is especially predominant in the tourism sector as customers are globalised and therefore the competition is high. hence, de la garza and contreras (2016) hypothesise that networks are an option for competitiveness enhancement, giving basis to multiple interactions, internal and external, for the benefit of all stakeholders. tourism smmes’ use of smts as a channel of communication to different networks can ease the interaction described above. the plethora of smts are among the opportunities available to businesses in their bid to connect with existing and prospective customers and other stakeholders. moreover, oyza and edwin (2015) advance that relationship building and interactions are the main motives for embracing of smts by individuals. however, businesses can also take advantage of this phenomenon by using it to build relationships with their stakeholders. oyza and edwin (2015) concur that businesses leverage the universal usage of these technologies and see them as platforms on which to interact directly with existing and new stakeholders. also, floyd (2015) suggests that the use of emerging technologies to promote modern communication enhances interactivity and significance within the business environment both internally and externally. thus, social media connects people globally irrespective of differences and geographical boundaries (sawyer 2011). in the same breath, businesses can also use social media to link them with different players within the organisation (internal) as well as outside the organisation (external) and thus affect competitiveness. therefore, from the above assertions, the authors postulate that smts may facilitate the internal and external networks between a business and its stakeholders for business competitiveness. social media and business networks esse, szántó and wimmer (2012:99) postulate that the domination of internal performance indicators has been disappearing and a growing emphasis on external factors has emerged. based on this, smmes should also use external networks to increase performance without neglecting internal networks. thus, tourism smmes may utilise smts as a channel to engage both internal and external networks. furthermore, walters, bhattacharjya and chapman (2011) affirm that there is increasing evidence for the suggestion that shifting customer markets are increasing the significance of flexibility for business success and that smts are easing the development of business models that embody this characteristic. this means smts have an indirect influence on competitiveness of businesses as it serves as a channel to internal and especially external networks. hence smts give businesses an opportunity to engage with their different stakeholders wherever they are. walters, bhattacharjya and chapman (2011) concur that the critical part is how businesses use the capacity that technology offers to generate opportunities for richer communication and global reach. therefore, a well facilitated cooperation of tourism smmes with its internal and external networks will likely lead to competitiveness. in concurrence, de la garza and contreras (2016) posit that networks are a choice for competitiveness enhancement, being a source of several relationships, internal as well as external, which will define the relationships’ strength to the benefit of all stakeholders, especially in matters of innovation. if tourism smmes use smts to engage in networking, more businesses will reach a wider stakeholder base thus achieving competitiveness. hence, curley and noormohamed (2014) speculate that there is much excitement about social media platforms and their possible effect on global marketing. tourism smmes should also take advantage of this opportunity by adopting these emerging technologies to be able to compete with other larger businesses by networking with their various stakeholders. in relation to this assertion, curley and noormohamed (2014) advise that social media marketing is becoming a richer vehicle to allow businesses to network with various stakeholders. this is because of the view that in today’s connected world, people are not just observing the shifting environment; they are active and willingly devoting more time online (sedereviciute & valentini 2011). this assertion is especially critical for tourism smmes who compete internationally as well. sedereviciute and valentini (2011) posit that the most significant opportunity of networking through social media is the prospect of communicating directly with stakeholders without the mediation of other entities. businesses are gradually becoming keen to use social media for business purposes, in particular for communication, marketing and recruitment. likewise, tourism smmes’ customers, stakeholders and regulators are able to communicate and share information in inexpensive ways from anywhere around the world. as such, tourism smmes’ underutilisation of social media can contribute to the limited effectiveness of their competitive strategy. business networks and competitiveness competitiveness is crucial for a business’s sustenance as it displays a business’s ability to innovate and fulfil customers’ changing needs thus giving a positive signal to business networks. competitiveness is the ability to generate and sustain superior performance relative to competitors (centenaro & laimer 2016:67). lakhal et al. (1999) state that business networking to become internationally competitive forms the base of strategic decisions in many businesses. this can be true especially for tourism smmes who compete internationally. tourism smmes use informal networks to collect information on a mix of issues. ludmila and stanislava (2015) concur that networks are strategic for development and expansion of new ideas and innovations and thus the attainment of competitiveness. networks provide access to resources, knowledge and skills required for the development and exploitation of new business opportunities (ludmila & stanislava 2015). through a business’s access to stakeholders, whether internal or external, it can acquire the resources essential for increasing its competitiveness. centenaro and laimer (2016:67) affirm that competitiveness is associated with the business’ capability to compete in the market and gain superior performance to its competitors. consequently, competitiveness is related to a number of factors in a given market, which is part of the interdependence between companies (centenaro & laimer 2016). equally, for businesses, a competitive factor (e.g. cooperative relationships through networking) becomes viable for a business that is measured by their performance. in the tourism sector, relationships and cooperation of different stakeholders can be crucial for increasing sustainability, competitiveness or even survival in terms of destination competitiveness, but also at the level of individual tourism businesses (perić, đurkin & lamot 2014). moreover, centenaro and laimer (2016:67) postulate that network relationships can then provide an increase in the business’ competitiveness and, as a consequence, vary its performance in relation to those businesses that do not network with others. ludmila and stanislava (2015) concur that using business networking has resulted in crafting solid relationships in firms, thus building a stronger network and gaining competitiveness for smmes. accordingly, cooperative relationships are a determining factor of business competitiveness, enabling the business to engage in cooperation for superior performance in relation to its competitors that operate in isolation (centenaro & laimer 2016). in view of the above, it is imperative that tourism smmes should formalise their business networking internally and externally in order to become competitive. in accordance with this, ludmila and stanislava (2015) affirm that networking appears to have a positive effect on growth and it is a foundation of benefits for businesses. the simplest way to achieve this is through the utilisation of smts as a channel to access different stakeholders in this network. this article has presented literature on how tourism smmes may employ social media to increase their business networks to gain competitiveness. the next section discusses the theory underpinning the study. stakeholder theory stakeholder theory is a useful perspective for addressing important issues in business (harrison, freeman & abreu 2015). these authors further maintain that this theory is effective in that stakeholders that are well taken care of tend to reciprocate with a positive attitude towards the business. stakeholder theory involves attending to the interests and well-being of all business stakeholders (harrison, bosse & phillips 2010). hence, this theory’s purpose is to create value not only for business owners but for stakeholders as well. thus, stakeholder theory is drawn on in this article to show how it could be relevant to understanding tourism smmes’ stakeholders within social media environments. since its emergence, social media has reached into the business world and taken over (pietarinen 2014). it offers easy, interactive and cost-efficient possibilities to interact with various stakeholders (krumay & geyer 2016). it is evident from practice to suggest that social media is a suitable way to establish stakeholder involvement within a business. pietarinen (2014) states that many businesses have difficulties grasping what social media is and why it has become such a phenomenon, although they aim to benefit from it through developing strategic goals and reaching specific stakeholder groups to become competitive. competitiveness is the core issue of strategic management in which stakeholder theory is rooted (wu 2012). wu (2012) further states that a business’ competitiveness is achieved by its strategic choice. therefore, the competitiveness of the business can be achieved through the integration of social media and stakeholder theory. the next section discusses the methodology followed in the research. research design this article adopted a quantitative descriptive research method. the researchers conducted a thorough literature review and developed a likert scale based questionnaire. the free state department of economic development, tourism and environmental affairs estimated that there were approximately 600 tourism smmes in the free state province. using a sample size calculator at a confidence level of 95%, the researchers established a target sample of 234 tourism smme owners or managers. they employed probability sampling to select a simple random sample to ensure the probability of generalising to the study population (maree 2013). data collection a closed-ended structured questionnaire was developed based on reviewed literature and research questions used to collect data. through the process of constructing the instrument, different phases were followed and a statistical expert’s advice was adhered to. only 123 questionnaires were completed correctly, representing a 53% response rate. a response rate of 50% is adequate for analysis (bryman & bell 2011) as there is growing evidence that achieving a good response rate may be difficult when surveying a small business population. the study also considered ethical issues such as informed consent and privacy of the participants. with the help of research assistants, it took approximately 2 months to collect data. the authors also administered the data collection instrument to the smme owners and managers at times convenient to them to avoid disturbances of their routine business. data analysis data from collected questionnaires was coded and captured into excel and exported into statistical package for the social sciences (spss) version 21 for detailed analysis. the study employed descriptive statistics such as frequency tables to establish the extent of use of smts for external and internal networking. inferential statistics, in particular correlation analysis and regression analysis, were employed to examine the relationships between competitiveness and stakeholder variables (which comprise internal and external networks and stakeholder variables relating to smts). reliability of data a preliminary check ensured reliability of the variables used in the analysis. the variables constructed for analysis are external networking, internal networking, suppliers, competitors and investors, regulators and competitiveness. cronbach’s alpha coefficient calculations determined whether the variables are reliable. the coefficients are presented in table 1. table 1: cronbach’s alpha’s reliability test. a cronbach’s alpha value above 0.6 indicates a reliable variable (rahimnia & raude 2013). table 1 shows that all the constructed variables have a cronbach’s alpha coefficient that is above 0.6 which means that these variables are reliable and further statistical analysis could be conducted. validity of data to address the objectives of this study, factor analysis was instrumental in determining the validity of the constructs used in the analysis. the variables constructed for further analysis are external networking and internal networking. the results in tables 4 and 5 indicate that the latent factor (factor loading) for the items measuring each construct were predominantly above 0.6. rahn (2018) considers this valid to measure the constructs in question for a factor analysis. presentation and discussion of findings demographic data table 2 indicates that 62.6% of respondents were managers and only 17% were owners. the interpretation of this could mean owners prefer to hire managers rather than run their own business. about 63% of respondents were between 21 and 40 years old, showing that the majority were in the economically active population. the majority of respondents (65.6%) studied up to tertiary education. also, the number of years in business as illustrated in table 2 indicates that the majority (78.3%) of businesses have been in operation between 1 to 10 years. this indicates that the tourism smmes in the province have survived long enough. table 2: sample demographics. the majority (82.9%) of respondents indicated that they use smts while only 17.1% do not use it. the willingness of tourism smme owners and managers to adopt smts resonates with meske and stieglitz’s (2013) revelation that these technologies are significant to the routine operations of tourism smmes. moreover, table 3 shows that 67.5% (22.8% advanced and 44.7% intermediary) of respondents were knowledgeable about smts. it further illustrates that several respondents (15.4%) used these technologies despite being beginners or novices. this indicates the importance of these emerging technologies and respondents’ willingness to use them for business operations. table 3: status and utilisation of social media technologies. table 3 shows that almost half of respondents (46.7%) use smts to attract new customers while only 10.7% of respondents use them to network. this attitude is confirmed by cesaroni and consoli (2015) who postulate that the popularity of smts among smmes disturbingly coexists with the failure to utilise them effectively. consistent with this finding, only 30.1% of respondents consider social media important for their business. despite 46.7% of respondents considering smts important for business, only 15.4% use them to communicate with stakeholders. the findings indicate that irrespective of the majority (82.9%) of owners and managers using social media, most do not see social media as important for business operations. clearly, there is a lack of stakeholder approach as evidenced from this finding. siti-nibiha and saad (2015) concur with this statement that the stakeholder engagement practice in tourism is selective in nature. business external networking table 4 presents frequencies and descriptive statistics for statements related to businesses’ use of smts for external networking. the frequency distribution shows that 67.5% of the businesses respond to questions and comments from customers and potential customers posed on smts. in support, leung et al. (2013) posit that facebook offers an alternative web-based tool for tourism smmes to provide information, promote products and services, and respond to customer inquiries. leung et al. (2013) add that a probable reason for this finding is that practitioners usually regard smts as a marketing and information distribution channel. table 4 further illustrates that 62.6% of respondents agree that their businesses are significantly broadening customers’ awareness of their products using smts. these statistics illustrate many tourism smmes use smts to network externally with their stakeholders especially customers. such external networking with external stakeholders will provide smmes with a wide range of benefits in additional areas, including consumer marketing (bughin, chui & manyika 2012). table 4 further indicates that about 57.9% of the businesses use smts intensively to retain existing customers. the interpretation is that communication is a key to business success as it assists businesses in communicating with existing stakeholders. baruah (2012) concurs that smts are good for customer interaction, customer feedback and customer support, and new business contacts are necessary for networking purposes. table 4: external networking. the frequency distribution shows that 49.6% of the businesses use facebook discussion forums to increase their dominance in the market. about 44.3% of the businesses collaborate with customers on whatsapp to interact and improve their brand. moreover, 41.5% of the businesses use google+ to connect with and increase their market share. although the usage of smts could increase the market share as indicated in the findings, the percentage is not satisfactory bearing in mind the popularity of smts among the customers and potential customers. a further 25.2% of the businesses employ linkedin to connect their product range to potential customers, whereas 18.7% of the businesses encourage customers to follow their personnel on twitter. the above findings show that social media bridges the space among different business stakeholders through external networking (baruah 2012). business internal networking table 5 presents frequencies and descriptive statistics for statements related to business use of smts for internal networking. table 5: internal networking. about 53.7% of the businesses agree that their employees use social media to contact co-workers when they are unreachable by other means. employees need each other to be productive and clearly smts are useful in connecting them when unreachable. in addition, just over half (50.4%) of the businesses agree that their employees maintain contact with other people in the organisation through social media. this can help employees to share information that will help in production processes. chin et al. (2015) concur that an internal employee network not only promotes camaraderie but it also promotes information sharing which will lead to productivity. kasavana, nusair and teodosic (2010) further agree and propose that smts utilised among employees constitute a collaboration of organisational intelligence, optimisation of employee talents, facilitation of communication, and shared insights related to the work environmental situation. it must, therefore, be stressed that social media impact on the nature and quality of employees’ job performance (mohamed et al. 2017), thus aiding competitiveness of the business. about 37.4% of the businesses surveyed agree that their personnel are actively present in smts for marketing purposes. contrary to the results for external networking on table 4, these findings indicate that tourism smmes in the study area do not adequately utilise social media to communicate internally. social media utilisation to broaden business networks in order to address this objective, the mean percentages of the statements of external and internal networking, suppliers and competitors and investors in relation to smts were calculated. table 6 presents the means and percentages of networked stakeholders. table 6: mean percentages of networking, suppliers, competitors and investors. the percentage of internal networking is 66.2%, which is a high percentage indicating that most businesses use smts for internal networking. this finding is substantiated by meske and stieglitz’s (2013) survey on german smmes, which affirms smmes’ use of smts to support collaboration among employees and to improve knowledge management. the percentage of external networking is 63.8%, indicating that most of the businesses use smts for external networking. however, table 3 indicates that tourism businesses network mainly with customers. this is perhaps because tourism smmes perceive customers as the most important stakeholders for their business. in support of this view, popp and woratschek (2017) affirm that to manage relationships with customers is a common driver of large enterprises and smmes. however, harrison and wicks (2013) affirm that smmes should network with all stakeholder groups such as customers, suppliers, competitors and investors rather than focusing on just one. furthermore, the percentage for competitors and investors is above half (58.1%) while for suppliers it is 52.4%, which indicates that about half of the businesses use smts to communicate with their suppliers. similarly, these findings illustrate that these businesses are indeed using smts to generally network with their stakeholders. moreover, fosso-wamba and carter (2014) concur that social media tools can assist with improved communication and collaboration between the business and its stakeholders. however, those tourism smmes (a sizeable number) that do not use social media to network with their stakeholders stand to miss these advantages. this is based on the assertion that social media is important and can improve the competitiveness of any business (gomez, chalmeta & sosa-varela 2012; lutz & hoffmann 2013). furthermore, gomez et al. (2012) advance that through social media channels, businesses can create and promote two-way communication processes where they can include and engage stakeholders in discussions that can profit both parties. the influence of stakeholder networking on competitiveness table 7 indicates that only the p-values for internal networking are below 0.1 which means that the businesses’ use of smts for internal networking has a significant impact on competitiveness. moreover, the coefficient of the variable internal networking is 0.088, which is a positive impact on competitiveness. the positive coefficient means that an increase in the business’s use of smts for internal networking will lead to an improvement in the competitiveness of the business. in support of this finding, bulankulama, khatibi and shokri’s (2014) study on the effect of the utilisation of social media on competitive advantage affirms that employee interaction and exchange of knowledge and information will increase tourism smmes’ competitiveness. in concurrence, mohamed et al. (2017) establish that social media has become a common channel of communication for employees to join forces, integrate and share information with colleagues within the business. furthermore, gomez et al. (2012) claim that utilising social media to network offers countless advantages for a business competitiveness. table 7: regression analysis (competitiveness versus stakeholder variables relating to smts). the networking of different stakeholders within the tourism sector can assist smmes in encouraging collective promotion of tourism products and overcoming issues that are the result of competition (pjerotić, rađenović & tripković-marković 2016). when it comes to managing competitiveness of tourism, the role of networking, especially externally, should be highlighted. recommendations although internal networking had significant positive influence on competitiveness, there is a need to balance the internal and external networking of these tourism smmes and stakeholders. besides, if tourism smmes improve their networking with all their stakeholders and do not focus mainly on customers it will be of benefit not only to their businesses but to all the stakeholders as well, and will further increase competitiveness through spillover effects, such as building of social trust, creation of entrepreneurial social capital and building social cohesion. the results show that the tourism smmes’ external networking is focused predominantly on customers rather than other stakeholders. in view of this, there is a need for more inclusive and robust stakeholder engagement and business management should therefore identify all relevant stakeholders. the engagement policy framework would assist most tourism smmes to cease focusing on customers solely and target other stakeholders. tourism smmes can also benefit from clearly articulating their needs, expectations and desires to their stakeholders through the creation of an inclusive stakeholder engagement policy framework that serves their interests and reconciles perceived conflicts of interest among stakeholders. given the importance of tourism in the south african economy and the proliferation of smts in recent years, this study sought to establish interventions for increasing the competitiveness of tourism smmes in such a highly competitive complex globalised sector. sharing of technological knowledge, information, processes and systems through networking can further improve the competitiveness of the smmes. most scholars generally concur that the use of social media is important to the competitiveness of tourism smmes (aspasia & ourania 2014; baruah 2012; kiráľová & pavlíčeka 2015; surugiu & surugiu 2015). in view of the above, there is a need for tourism smme managers and owners to ensure their business’s competitiveness through networking with business stakeholders. therefore, for competitiveness to occur, stakeholder management needs to be part of the tourism smmes’ strategy. to increase the competitiveness of such firms, the formal internal and external information strategy of these businesses can be integrated into social media to improve their competitiveness. networking relationships with stakeholders are an important foundation for competitiveness of businesses. conclusion and implications for future research this study examined the utilisation of social media to broaden business networks and its impact on competitiveness. the utilisation of social media on an ad hoc and informal basis by tourism smmes in the study area indicates that there are no formal policies on the use of these technologies. perhaps future studies should investigate the formalisation of smts within smmes. additionally, the findings indicated that there was over-concentration of the use of social media on customers. perhaps, future studies may also need to do a comparison study on competitiveness of smmes adopting social media for one purpose and those adopting smts for wider use. acknowledgements this research article would not be possible without the guidance of my mentors who are also co-authors of the article. above all, i would also like to thank my family for the love and support throughout 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27–36. https://doi.org/10.1016/j.tmp.2014.01.001 abstract introduction personal income tax in the south african tax system defining the tax gap tax gap methodologies calculating south africa’s personal income tax gap data and methodology findings and discussion conclusion acknowledgements references footnotes about the author(s) chengetai dare department of economics, faculty of economic and management sciences, stellenbosch university, stellenbosch, south africa sophia du plessis department of economics, faculty of economic and management sciences, stellenbosch university, stellenbosch, south africa ada jansen department of economics, faculty of economic and management sciences, stellenbosch university, stellenbosch, south africa citation dare, c., du plessis, s. & jansen, a., 2019, ‘tax revenue mobilisation: estimates of south africa’s personal income tax gap’, south african journal of economic and management sciences 22(1), a2817. https://doi.org/10.4102/sajems.v22i1.2817 original research tax revenue mobilisation: estimates of south africa’s personal income tax gap chengetai dare, sophia du plessis, ada jansen received: 18 sept. 2018; accepted: 25 apr. 2019; published: 15 july 2019 copyright: © 2019. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: tax evasion is one of the factors impeding tax revenue mobilisation. although there are efforts to reduce non-compliance, the extent and nature thereof remain fairly unknown in many developing countries, including south africa. to adequately address tax evasion, it is imperative to determine the tax gap (i.e. the difference between the theoretical tax liability and the actual tax revenue collected). aim: to estimate the extent and nature of south africa’s personal income tax gap, disaggregating the gap by the type of income (salaried and non-salaried). setting: the study looks at the south african personal income tax system. methods: this study employs a micro-simulation approach using data from the income and expenditure survey of south africa for the periods 2005/2006 and 2010/2011. results: the findings reveal that south africa lost tax revenue of r60.1 billion in 2005/2006, and r26.2 bn in 2010/2011 (in 2017 prices). of the total compliance gap in 2005, 28.5% emanated from taxpayers with salaried income, and 71.5% from non-salaried income taxpayers. in 2010, salaried income taxpayers contributed 1.1% to the total compliance gap. conclusion: despite an overall improvement in the individual compliance rate, non-salaried income taxpayers (self-assessment reporting) are the main contributors to south africa’s personal income tax gap. keywords: tax gap; non-compliance; tax evasion; personal income tax; micro-simulation; salaried income; non-salaried income. introduction tax revenue plays an integral role in the fiscal space to ensure the provision of public goods and services. indeed, it is a major source of public revenue for most countries including south africa. tax revenues also finance redistribution initiatives. hence, an efficient tax system is a precursor for inclusive and sustainable growth. while taxes are crucial to mobilise public revenue, they generally place a burden on taxpayers. the behavioural response of taxpayers reflects in attempts to evade and avoid taxes, which lead to significant losses of revenue. for example, the us lost $450 billion worth of tax revenue in 2006 (gemmell & hasseldine 2012:4); the uk, £34 billion ($41.5 billion) in 2014 (whicker & white 2015:4), while pakistan lost rs397.4 billion ($4.2 billion) in 2005 (ahmed & rider 2013:336). even though efforts to improve tax compliance are mounting, the extent of taxpayers’ non-compliance (or the tax gap) and the nature thereof remain fairly unknown in many (developing) countries. for south africa, it is only the value added tax (vat) gap that has so far been established (see ueda & thackray 2015). less attention has been given to the tax gap in respect of personal income tax1. there are basically two broad categories of the tax gap, the compliance gap and the policy gap. the compliance gap refers to the amount forgone by the authorities due to compliance-related issues (ahmed & rider 2013:335). in contrast, the policy gap captures the amount of revenue forgone by the government due to the impact of the policy (toro et al. 2013:11). the international monetary fund (2015:3) refers to the policy gap as the difference between theoretical revenue, given a hypothetical policy framework and potential revenue, given the current policy framework. knowledge about the extent and scope of the tax gap is a useful first step towards controlling non-compliance and preventing its occurrence (european commission 2016:13). for instance, it may serve as a tool to measure the effectiveness of a tax policy. it may also serve as a measure of administrative efficiency, as a higher tax gap may indicate poor administrative performance. tax gap estimates can provide information on the sources of the tax losses, which may assist in enforcing compliance more effectively. considering fiscal constraints in south africa, knowledge on the extent and nature of the tax gap will aid authorities to raise additional revenue. it is against this backdrop that this study estimates south africa’s personal income tax (pit) gap (compliance gap and policy gap), with a particular focus on the sources of the tax gap (i.e. its composition by type of income). the remainder of the article is organised as follows: the next section gives an overview of south africa’s pit system. section ‘defining the tax gap’ defines the tax gap and section ‘tax gap methodologies’ explains various approaches to estimate the tax gap. section ‘calculating south africa’s personal income tax gap’ reviews some empirical application of these approaches. the pit gap is then calculated, and the results discussed in section ‘findings and discussion’. section ‘conclusions’ concludes this article. personal income tax in the south african tax system tax revenues finance approximately 87% of south africa’s national budget, the bulk of which comprises pit, which contributes over 30% of the total tax revenue (see figure 1). pit is applied using a progressive structure, with the highest marginal tax rate for the 2018 fiscal year set at 45% (national treasury 2019:193). most individuals receive their income in the form of wages or salaries, annuity payments or pensions, and investment income (national treasury [nt] & south african revenue service [sars] 2018:31). hence, pit paid stems from salaried or non-salaried income. employees’ income tax liabilities are calculated on employees’ salaried income and are withheld by the employer (paye). thus, settlement of income tax liabilities on remuneration income is done through third-party reporting. this mechanism is credited for minimising non-compliance since employers have little incentive to under-report employees’ taxes (paulus 2015:9). paye contributes over 90% of the total pit revenue. figure 1: composition of main sources of tax revenue, 2007/2008–2017/2018. unlike salaried income, non-salaried income earners pay taxes through the method of provisional tax payment. this method allows the taxpayer to pay income tax across the relevant assessment year, as two advance payments are expected, with a possible third payment at the end of the tax year, if required (south african revenue service [sars] 2018). non-salaried income earners are suspected to be the main source of non-compliance within the south african pit system (see marcus 2007:156). in south africa provisional taxes constitute on average 7% of the total pit collections. figure 2 shows the trend of paye and provisional tax payments for the period 2007/2008 to 2016/2017. figure 2: paye and provisional tax payments, 2007/2008–2016/2017. defining the tax gap taxpayers tend to adopt measures that reduce their tax liabilities. for instance, taxpayers take advantage of legal loopholes within the tax system to reduce their tax liabilities, a phenomenon called tax avoidance. on the other hand, taxpayers may, in contravention of the law, intentionally under-report their taxable income – an act referred to as tax evasion. tax evasion includes under-reporting taxable income, overstating deductions, and late and non-filing of tax returns (gcabo & robinson 2007:358). in some instances, governments may introduce tax expenditures (e.g. exemptions, special credits, rebates and preferential tax rates) to reduce taxpayers’ liabilities, to better align the income tax with the ability to pay principle. all these measures reduce the tax liabilities, which reduce the revenue yield below its potential which creates a tax gap (alm & martinez 2003:1). as outlined previously, the tax gap is the difference between the potential tax revenue and the actual collections, where potential revenue is the amount of tax that the government should collect if every taxpayer complies with the tax legislation (toro et al. 2013:14). it is classified into the compliance gap and the policy gap: the former denotes the value of revenue losses due to the impact of compliance-related issues (such as deliberate evasion, tax losses due to taxpayers’ misunderstanding of tax legislation, tax authorities’ poor record-keeping and other errors; ahmed & rider 2013:335). the policy gap reflects the amount of revenue forgone by the government due to the impact of the policy (toro et al. 2013:11), and includes tax forgone due to tax avoidance and tax expenditures. put succinctly, the policy gap is just a normalised measure of tax expenditures (keen 2013:436). tax gap methodologies there are broadly two approaches to measure the tax gap, namely the top-down and the bottom-up approaches. the top-down (or macro-) approach relies on macro-economic data and the theoretical (or potential) tax liability is calculated from a single estimate of the tax base (rubin 2011:109). toro et al. (2013:33) indicate that to estimate reliable tax estimates using this approach, data must be representative enough of the tax base, and it must be derived from sources other than taxpayers’ records. the advantage of such data is the independence from intentional misreporting by taxpayers. other benefits of this approach include its simplicity, and the timeous release (or production) of national data, which allows for the release of timely estimates. despite these strengths, the top-down approach has two fundamental shortcomings. firstly, it provides a single broad estimate of the tax gap, thereby providing little insight into the nature and causes of the tax gap. more precisely, the top-down approach is not capable of estimating the tax gap by its components. such an estimate does not adequately capacitate the government to assess its performance in the collection of revenue and provides little guidance on how to reduce the tax gap. in fact, tax gap estimates from the macro-approach provide little insight into how to improve compliance. to circumvent the shortcomings of the top-down approach, many researchers prefer the bottom-up approach (micro-approach), which uses individual-level (i.e. (micro-) data to determine the tax gap. this approach ‘does not depend on the value of a single estimate of the tax base’ (rubin 2011:111), neither does it rely on macro-economic data (fuest & riedel 2009:20), but uses data obtained from tax audit records and surveys. the main advantage of this technique is that it establishes the tax gap by its components (i.e. by type of income, sector of the economy and in some instances, by the causes of the gap) (see ahmed & rider 2013:340–343). calculating south africa’s personal income tax gap a bottom-up approach is employed to estimate south africa’s personal income tax gap. for a reliable estimate of the potential tax liability, an objective measure of the tax base is required (ahmed & rider 2013:339–340). it is in this regard that survey micro-data, that is nationally representative, are most ideal for estimating the personal income tax gap. however, such data are susceptible to under-reporting, especially with regard to high income earners. this is generally because people (particularly high income earners), prefer their income worth to be a secret (see ahmed & rider 2013:343). data and methodology following the methodology of ahmed and rider (2013), this study uses the income and expenditure survey (ies) data of the 2005/2006 and 2010/2011 surveys to estimate south africa’s personal income tax gap. statistics south africa (statssa) conducts the iess every 5 years and its primary task is to capture household consumption data to update the consumer price index (statssa 2012:1). the 2005/2006 and 2010/2011 data sets include samples of 21 144 and 25 328 households respectively, collected nationwide (stats sa 2008, 2012). the study is limited to these two data sets as they used the same data collection methods (i.e. the diary and recall methods), and both surveys used the same classification of expenditure items: the classification of individual consumption by purpose (coicop). a static micro-simulation model is applied to estimate the pit gap. this methodology allows us to incorporate the progressive nature of the tax rate structure, a critical aspect in estimating individual tax liabilities. the income tax liability is determined from the taxable income that includes remuneration income, business income, fringe benefits, taxable capital gains, interest and rental income (black, calitz & steenekamp 2015; sars 2016a). more specifically, to determine the tax liability, exclusions (e.g. in-kind income, unrealised capital gains and imputed rent) are removed from the total comprehensive income to arrive at gross income. exemptions such as the tax-free portion of income (i.e. amount below taxable threshold), the tax-free portion of interest, and some pension income (e.g. war veteran’s pensions and disability pensions) are deducted from the gross income, after which allowable tax deductions (such as pension contributions, medical contributions, depreciation allowances and donations to an approved public benefit organisation) are subtracted from the income balance, to produce the taxable income (black et al. 2015:256). the tax due is determined by applying the tax rate schedule to the taxable income. the tax threshold (i.e. the taxable income at which a taxpayer starts to pay taxes) will generate a tax liability equivalent to the rebate (sars 2016a:9). table 1 summarises how the tax liability is calculated. table 1: calculation of personal income tax liability. a micro-simulation model is constructed in stata (software), in line with the tax calculation illustrated in table 1. using a tax calculator2, a line by line estimation of the tax liabilities is performed on all positive taxable income. the estimated tax amounts are then grossed up to national levels using household weights, where the weight is an inverse of the household’s probability of selection. grossed up tax liabilities are added together to produce the total amount of tax revenue that the state should collect if every taxpayer complies with the tax legislation. in this study, the calculation of the pit gap is carried out in three phases. first, the tax calculator is applied to gross income (income inclusive of tax expenditures, which is a hypothetical policy framework). this gives the amount of tax revenue the state would collect in the absence of tax expenditures such as rebates or deductions for medical expenses. second, the potential tax liability is calculated from the total taxable income. the discrepancy between these two theoretical tax liabilities (i.e. from the gross income and the total taxable income) gives an estimate of the policy gap. the theoretical tax liability derived from the total taxable income is then compared to the personal income tax collections (obtained from sars). the difference between the estimated potential tax liability from taxable income and the actual collections represents the compliance gap. third, the tax calculator is applied to salaried income to estimate the theoretical tax liability for this income source. the estimated potential tax liability is matched against the actual paye collections and the difference gives the salaried income tax gap (ahmed & rider 2013:340). the theoretical tax liability for non-salaried income is calculated by subtracting the salaried tax liability from the total theoretical tax liability. the estimated potential tax liability for the non-salaried income is then compared with the actual tax collections from provisional taxpayers, and the discrepancy between these two figures is the tax gap in respect of non-salaried income earners. however, it is important to note that the actual collections may not be what is expected for a particular tax period, given that the current year’s collections would exclude late payments for the (current) year while including late payments for previous years. furthermore, as outlined previously, this study uses gross household income, and this could lead to variations in the tax gap estimates (as the tax unit is the individual and not the household). other causes of variations include the fact that the ies data is not equivalent to the tax year – hence income estimations in the survey data are not equivalent to what one would expect in the tax year associated with the particular survey data set. given the data constraints, the tax gap estimates from this study remain an approximation of the gap and should be treated as such. for both tax years (2005/2006 and 2010/2011), the major exemptions and deductions included war veterans’ and disability pensions, medical expenses and medical aid contributions, donations to public benefit organisations, pension fund contributions, retirement annuity fund contributions, legal fees, doubtful debts and wear and tear (sars 2010:220–221). however, war veterans’ and disability pensions, donations to public benefit organisations, legal fees, doubtful debts and wear and tear were not used in the study’s calculations as they were not captured in the survey data sets. deductions in respect of pensions and retirement contributions were limited to 7.5% and 15% of the taxable income. however, in both survey data sets, pensions and retirement annuity fund contributions were combined with provident fund contributions, which are not deductible. to separate provident fund contributions, the study assumed that one-third of the combined funds constitutes contributions to the provident fund. the tax calculators for the micro-simulation models were constructed, based on the guidelines for the 2005/2006 and 2010/2011 tax years, in accordance with the income tax return for individuals (the itr12). personal income tax brackets for the 2005/2006 and 2010/2011 tax years are shown in table 2. table 2: 2005/2006 and 2010/2011 personal income tax brackets. in calculating the taxable income, it is worth mentioning that both the 2005/2006 and 2010/2011 data sets do not reveal how medical expenses were settled. thus, it is not explicit whether the payment was done by the employer, household member or by a medical aid. the data do, however, reveal that approximately 25% of household income was spent on medical aid contributions. the analysis therefore assumed that 75% of medical expenses were paid by medical aid insurers. deductions for medical expenses and medical aid contributions’ deductions were each limited to r500 and r625 per month in 2005/2006 and 2010/2011. in the event that the medical aid contributions made by the employer exceeded these thresholds, the excess amount was taxed as a fringe benefit. this excess amount is presumed to be a medical expense paid by the employer and, as such, it is deducted from the medical aid contributions made by the employee (sars 2010:221). however, as outlined previously, this study used household survey data (to proxy individual data), as the data sets do not specify the main member of the fund. medical deductions were therefore calculated from the household medical contributions, which may overestimate the expenditures. below follows a summary of the steps in the micro-simulation model to calculate the potential tax liability. first, it calculates the taxable income (taxy) for every household (i), defined as the difference between gross income (yi) and deductions (deduci): second, the tax liability (xi) is calculated by applying the tax rates and rebates to taxable income for the year of assessment: third, the tax liabilities are grossed up to national levels using household weights (ωi). the grossed up tax liabilities are added together to produce the theoretical tax liability: to establish the compliance gap, actual collections (z0) are subtracted from the theoretical tax liability: to establish the amount of tax the government would collect in the absence of tax expenditures, the tax liability for each household is calculated by applying the tax rates to the gross income for the year of assessment: the tax liabilities are grossed up to national levels using household weights (ωi), and added together to produce the gross theoretical tax liability: the discrepancy between the theoretical tax liability (from taxable income) and gross theoretical tax liability provides the policy gap: findings and discussion in the absence of tax expenditures, the government could collect potential tax revenue of r382.3 billion from individual taxpayers in 2005/2006, and r449.6 billion in 2010/2011. the granting of tax expenditures reduced it to r276.4 billion and r316.6 billion. this implied that the policy gaps (the amount of revenue forgone due to the impact of policy) for the 2005/2006 and 2010/2011 tax years were r105.9 billion and r133 billion. in both years, approximately 30% of pit revenue remained uncollected due to tax expenditures. relative to the total pit gap, it is estimated that the policy gap constituted about 64% in 2005/2006, an estimate that increased to 84% in 2010/2011. these are definitely very large policy gaps, implying that the government has been losing significant amounts of revenue in its effort to reduce taxpayers’ burdens. the authority had the potential of collecting r276.4 billion worth of pit revenue in 2005/2006. however, only r216.3 billion was collected, producing a compliance gap of r60.1 billion. this implied a compliance rate of 78.3%. the tax revenue forgone (due to non-compliance) is equivalent to 21.7% of the potential tax revenue. in 2011, the government lost r26.2 billion worth of revenue, which is 8.3% of the potential tax revenue. although this is a commendable improvement from the 2005/2006 tax year, the extent of evasion is still significant. in 2005/2006, of the r276.4 billion potential pit revenue, r218.2 billion should have been raised from employed individuals’ taxes (i.e. paye). however, paye collections amounted to r201 billion, implying a paye tax gap of r25.6 billion and a compliance rate of 92.1%. in 2010/2011, instead of raising r265.1 billion worth of paye, the government managed to collect r264.8 billion and lost r0.3 billion through non-compliance (a 99.9% compliance rate). the potential tax liability (from taxable income) for provisional taxpayers was found to be r58.2 billion for the 2005/2006 tax year. however, the actual payments totalled r15.3 billion, thus creating a compliance gap of r42.9 billion and a compliance rate of 26.3%. in 2010/2011, instead of collecting r51.5 billion from this same group of taxpayers, only r25.6 billion was collected, thus implying a tax gap of r25.9 billion and a compliance rate of 49.7%. although this is an improvement compared to the 2005/2006 tax year, it is worth noting that over 50% of the non-salaried potential tax revenue remained uncollected in 2010/2011. the tax gap results are depicted in table 3. table 3: summary of tax gap estimates. in terms of the composition of the total pit compliance gap, the gap by salaried income contributed 28.5% in 2005/2006, an estimate that declined to 1.1% in 2010/2011. in 2010/2011, and despite a significant improvement in their compliance rate (from 26.3% to 49.7%), the share of the gap emanating from non-salaried income (as a percentage of share of the total tax gap) increased from 71.5% to 98.9%. the significant improvement in the compliance of salaried individual taxpayers could be ascribed to reforms the tax authorities introduced in the tax system, in particular modernisation initiatives (see sars 2016b). for instance, sars introduced an electronic queue management system, the branch queue management system (bqms) – a system that is meant to improve the administration of queues at branch offices during tax seasons. the bqms uses ‘mobile smart devices to issue tickets to the queuing taxpayers’ (sars 2016b:406). the system reduced the average queuing times by 57% in 2010 (rasool 2011:34). furthermore, the tax authority introduced an e-filing facility, which has made the submission and processing of tax returns more efficient. these reforms made it relatively less costly to comply, which motivated taxpayers to oblige with the requirements of the tax legislation. the cost of collecting tax revenue decreased from 1.5% of total revenue in 2005/2006 to 1.1% in 2010/2011 (national treasury and sars 2011). a further initiative that can explain the significant increase in compliance rates of salaried taxpayers is the government’s rollout of an individual taxpayer policy registration programme in 2010, which required all formal employees to be registered as taxpayers regardless of their tax liabilities. the programme led to an increase in the number of individual registrants to 10.3 million in 2010, up from 5.9 million in 2009. this compulsory registration of employees could be one of the main explanatory factors of the significant increase in salaried taxpayers’ compliance rates. non-salaried taxpayers’ compliance can also be attributed to sars’s educational campaigns, strengthened deterrent measures and the 2010 reprieve (the voluntary disclosure programme). the higher non-compliance rate of non-salaried income earners in both years (2005 and 2010) supports the hypothesis that self-reporting of non-salaried income is more prone to non-compliance than salaried income (submitted through third-party reporting). paulus (2015:9) highlights that because there are fewer incentives for employers to misreport employees’ income, employees would have to collude with the employers to evade taxes. depending on the availability of such opportunities, it is more difficult to evade salaried income tax than non-salaried income tax (paulus 2015:24). ahmed and rider (2013:343) also argue that a withholding tax regime is an effective revenue mobilisation technique. conclusion this study provides some fundamental insights into the performance of south africa’s pit system. the granting of tax expenditures reduced revenue from r382.3 billion to r276.4 billion in 2015/2006 and from r449.6 billion to r316.6 billion in 2010/2011, creating policy gaps of r105.9 billion and r133 billion. this is approximately 30% of pit revenue for both years and 64% and 84% of the total pit gap for 2005/2006 and 2010/2011. these are definitely very large policy gaps, implying that the government has been losing significant amounts of revenue in its effort to reduce taxpayers’ burdens. although tax expenditures play an important role in reducing tax burdens, there is a need to examine the possibility of reducing the policy gap as its reduction may raise a significant amount of revenue. the authority had the potential of collecting r276.4 billion worth of pit revenue in 2005/06 and 316.6% in 2010/2011, if everyone complied with the legislation. however, r216.3 billion was collected in 2005/06 and r290.4 billion was collected in 2010/2011, producing compliance gaps of r60.1 billion and r26.2 billion – implying compliance rates of 78.3% and 91.7% in that order. in terms of the composition of the pit compliance gap, the gap by salaried income constituted 28.5% in 2005/06, an estimate that decreased to 1.1% in 2010/2011, while the balance constituted the gap by non-salaried income. thus, non-salaried income constituted the bulk of south africa’s pit compliance gap. overall, south africa has a well-functioning pit system (with a compliance rate of 91.7%). however, its compliance rate is lower than that observed in developed countries, such as the uk and sweden where pit compliance rates are around 95% (see bäckman 2014; whicker & white 2015). apart from having a high pit compliance rate, south africa’s vat gap for the period 2007–2012 ranged between 5% and 10% of its potential revenue, which is low by international standards – below that typically observed in european and latin american countries (ueda & thackray 2015:2). this implies that the country has a sound and well-functioning tax system. it would be even more insightful to compare south africa’s pit gap with other developing countries’. unfortunately, knowledge about tax gaps in developing countries is limited (aside from the pakistan study which reported a compliance pit gap of 41.1%; [see ahmed & rider 2013:339]). although the south african tax system has a high compliance rate, further measures are required to stimulate increased compliance of provisional taxpayers. these measures may include formalising the underground economy, further strengthening deterrent measures and building taxpayers’ trust in the authorities (i.e. improving citizens’ perception of the government). it would even be more enlightening to estimate the tax gap following the her majesty’s revenue and customs (hmrc) approach, which uses audited data (that correspond to the tax year) made available by the tax authority. however, due to confidentiality of taxpayers’ information, such data is not easily accessible for academic research, particularly in south africa. given the data constraints, the tax gap estimates from this study remain an approximation of the gap and should be treated as such. acknowledgements we would like to convey our sincere gratitude to prof. mark rider (georgia state university) for his considerable input in designing the tax simulation model. competing interests the authors have declared that no competing interest exist. author’s contributions this article is part of a phd thesis. c.d. (the student) is the principal author while a.j. and s.d.p. (the supervisors) are co-authors. funding this research received no specific grant from any funding agency in the public, commercial, or not-for-profit sectors. data availability statement data sharing is not applicable to this article as no new data were created or analysed in this study. disclaimer the views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of any affiliated agency of the authors. references ahmed, r.a. & rider, m., 2013, ‘using microdata to estimate pakistan’s tax gap by type of tax’, public finance review 41(3), 334–359. https://doi.org/10.1177/1091142113475697 alm, j. & martinez, j., 2003, institutions, paradigms, and tax evasion in developing and transition countries, edward elgar publishing ltd, cheltenham. bäckman, j.-e., 2014, the development of the tax gap in sweden 2007–12, the swedish tax agency, solna. black, p.a., calitz, e. & steenekamp, t.j., 2015, public economics, oxford university press, cape town. dtc, 2014, addressing base erosion and profit shifting in south africa, viewed 27 june 2016, from http://www.taxcom.org.za/docs/new_folder/1 dtc beps interim report the introductory report.pdf. european commission, 2016, the concept of tax gaps: report on vat gap estimations, fiscalis tax gap project group (fpg/041), european commission, brussels. (fpg/041). fuest, c. & riedel, n., 2009, tax evasion, tax avoidance and tax expenditures in developing countries: a review of the existing literature, oxford university centre. prepared for the uk department for international development (dfid), london. gcabo, r. & robinson, z., 2007, ‘tax compliance and behavioural response in south africa: an alternative investigation’, sajems ns 10(3), 357–370. https://doi.org/10.4102/sajems.v10i3.695 gemmell, n. & hasseldine, j., 2012, ‘the tax gap: a methodological review’, working papers in finance 09/12, victoria university of wellington. imf, 2015, south africa: revenue aministration gap analysis program – the value added tax gap, international monetary fund, washington, dc. keen, m., 2013, ‘the anatomy of the vat’, national tax journal, 66(2), 423–446. http://dx.doi.org/10.17310/ntj.2013.2.06 marcus, m., 2007, ‘a qualitative and quantitative analysis of the south african tax system (1995–2005)’, phd thesis, university of cape town. national treasury, 2019, 2019 budget review, national treasury, pretoria. national treasury (nt) & south african revenue service (sars), 2011, 2011 tax statistics, national treasury and sars, pretoria. national treasury (nt) & south african revenue service (sars), 2015, 2015 tax statistics, national treasury and sars, pretoria. national treasury (nt) & south african revenue service (sars), 2016, 2016 tax statistics, national treasury and sars, pretoria. national treasury (nt) & south african revenue service (sars), 2017, 2017 tax statistics, national treasury and sars, pretoria. national treasury (nt) & south african revenue service (sars), 2018, 2018 tax statistics, national treasury and sars, pretoria. paulus, a., 2015, ‘income underreporting based on income-expenditure gaps: survey vs tax records’, iser working paper series. no. 2015–15, institute for social and economic research, essex. rubin, m., 2011, the practicality of the top-down approach to estimating the direct tax gap, her majesty’s revenue and customs, london. rasool, f., 2011, sars system boosts ‘who am i online’, viewed 23 october 2016, from http://www.itweb.co.za/index.php?option=com_content&view=article&id=42048. income tax south african revenue service (sars), 2006, guide on income tax and the individual (2005/06), viewed 10 september 2016, from https://www.sars.gov.za/alldocs/pages/default.aspx. south african revenue service (sars), 2010, notes on south african income tax 2010, south african revenue authority, pretoria. south african revenue service (sars), 2016a, income tax guide on income tax and the individual (2015/16), south african revenue authority, pretoria. south african revenue service (sars), 2016b, ‘implementation of the modernisation programme’, in j. hattingh, j. roeleveld & c. west (eds.), income tax in south africa: the first 100 years 1914–2014, pp. 404–410, juta and company (pty) limited, cape town. south african revenue service (sars), 2018, provisional tax, viewed 20 april 2019, from https://www.sars.gov.za/taxtypes/pt/pages/default.aspx. stats sa, 2008, income & expenditure of households 2005/2006. analysis of results: report no. 01-00-01, statistics south africa, pretoria. stats sa, 2012, income and expenditure of households 2010/2011, statistics south africa, viewed 18 november 2016, from http://www.statssa.gov.za. toro, j., ogata, k., hutton, e. & caner, s., 2013, united kingdom: assessment of hmrc’s tax gap. international monetary fund, washington, dc. (13/314). ueda, j. & thackray, m., 2015, revenue administration gap analysis program – the value-added tax gap, fiscal affairs department, imf, washington, dc. whicker, h. & white, a., 2015, measuring tax gaps 2015 edition: tax gap estimates for 2013–14, hm revenue & customs, london. footnotes 1. the davis committee (a tax review committee appointed by the government), in its 2014 interim report, pointed out that the definite size of the tax gap is unknown to sars (dtc 2014: 25). 2. the tax calculator is the model designed to calculate (simulate) the tax liabilities. samms ns vol 5 (2002) no 3 625 street vending in the eastern cape: survival strategy or conduit to entrepreneurship? dmahadea school oj business. university oj natal abstract although south afiica consistently registered positive economic growth rates since the democratic government took office in 1994, this economic expansion has not been accompanied by a surge of new formal sector jobs. the public and private sectors have been shedding labour, partly in response to globalisation and domestic economic realities. consequently, more and more individuals are taking to street vending to create jobs for themselves. this article examines the dynamics of street vending and investigates whether it is merely a survival mode of existence or a conduit to formal entrepreneurship. the results of the study indicate that only 15 per cent of the surveyed operators may graduate to formal entrepreneurship in the medium or long term. it seems highly unlikely that a substantial number of high profile entrepreneurs would emerge from this mass of survivalist traders. for most street traders, the informal economy is not a conduit to entrepreneurship, but a survival strategy. from a development perspective, the way forward for street vendors is to transform their ventures into more value-adding operations that can provide sustainable livelihoods for themselves, and in due course jobs for others. jel 017 1 introduction south afiica consistently registered positive economic growth rates in the five years 1995-2000, ranging from 3.4 per cent in 1995 to 2 per cent in 1999 and 3 per cent in 2000 (sarb, march 2001). although this post-apartheid growth performance is significantly higher than the i per cent average growth rate over the 1985-1994 period, tbis economic expansion has not been accompanied by a surge of new jobs. this pattern of output growth without a major expansion in formal sector employment is presently a troubling aspect of the south african economy. the country bas produced a striking case of jobless growth, although some success has undoubtedly been achieved in the provision of basic services to disadvantaged communities and in meeting certain elements of the government's growth, employment and redistribution strategy (gear). the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 626 sajems ns vol 5 (2002) no 3 unemployment rate (expanded definition) increased from 31.5 per cent in 1994 to 37.5 per cent in 1998, despite the gear program. in terms of the official definition, the unemployment rate increased from 20.3 per cent to 25.2 per cent over the same period, and to 26.4 per cent in 200 i (stats sa, 200 i ) while unemployment across south africa has remained a serious problem, in the former transkei (part of eastern cape province), unemployment and its associated poverty is apparently much worse than 5 years ago (mahadea, 2001). this situation follows from the closure of previously subsidised industries in the 1990s, the restructuring of public sector corporations, and the relocation of the administrative capital with its government offices from umtata to bisho. at the national level, efforts to enhance competitiveness and exert fiscal discipline have led to restructuring and hence downsizing or rightsizing in both public and private sector employment. in effect, some 187000 jobs have been lost between the first quarter of 1997 and 1998 (sarb, 1998), and another 81 000 formal sector jobs lost from december 1998 to september 1999 (sarb, march 2000). comparing the average employment level in the frrst threequarters of 2000 with that of the corresponding period in 1999, there was a further annual decline of 2.7 per cent in formal sector employment (sarb, march 2001). given its thin industrial base, the transkei area is especially vulnerable to any public sector squeeze on jobs. furthermore, trade union actions and stringent labour legislations have reduced the scope for much-needed labour market flexibility for employment creation (the economist, 1012/01: 75). in 2000, for instance, 500 000 workdays were lost owing to strikes and work stoppage actions (sarb, march 2001). as the labour absorption capacity of the formal economy has been declining steadily and dangerously, to under 10 per cent of the total adult population in the late 1990s and early 20oos, more and more people are turning to informal sector entrepreneurship for employment. the gdp elasticity of formal employment was a negative 0.55 during the period 1990-1996, confrrming the view that new employment growth would be most likely to emerge from the informal economy (loots, 1998). small-scale entrepreneurship is one occupation available to many individuals. recent growth in self-employment and informal sector trading raises some key questions. can the informal sector be the sponge to realistically absorb the flood of new entrants into the labour market? would there be a critical mass of operators moving out of informal activities and graduating to formal entrepreneurship over time? is street vending in urban centres becoming a permanent mode of survivalist activity for operators? what are the characteristics, conduct and performance of the street enterprises run by men r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 627 and women in their attempts to gain a livelihood outside the formal economy? can one infer that problems and prospects of male operators are the same as those of their female counterparts in different urban places in the eastern cape? beyond these practical issues lies the central policy question: can the informal sector provide a lasting solution to unemployment? at present there is 'only a poor understanding' (kaplinsky. 1990: 45) of the underdeveloped situation of informal sector activity in south africa. this paper seeks to shed more light on the street vending part of the informal sector and to advance our appreciation of its role in the south african economy. based on a survey of 475 street vendors from four towns in the eastern cape province, the results of the study may provide some answers to the above questions. the paper consists of four parts. the first briefly examines the economic and development studies literature on the informal sector. the second describes the research methodology process. the third presents and discusses the survey results. the last section offers concluding remarks regarding street vending in the eastern cape as a survival strategy or conduit to entrepreneurship. 2 the informal sector and economic significance there is no generally accepted definition of the informal sector. the informal economy is an "utterly fuzzy concept" (peattie, 1987: 851), with many faces (preston-whyte & rogerson, 1991: 146). according to nattrass (1987: 863) the informal sector consists "of all people outside formal wage employment in the large-scale officially recognised and regulated sector, as well as all enterprises which function outside government rules and regulations and which operate on a small scale using labour-intensive technology". in many countries, including south africa, the informal sector is regarded mainly as a survival strategy for the poor, and an alternative path to ~evelopment outside the mainstream economy (elson & pearson, 1997). the world bank seems to believe that the informal sector (with low capital intensity) would be the dominant source of growth in the manufacturing industry in africa (agarwala, 1990: 164). although the informal sector contributes significantly to meeting some lowincome basic needs and generating employment opportunities at low cost, all micro-firms are not high value-adding ventures, and their ways of "doing things" are not homogenous (peattie, 1987). informal sector operators are engaged in a wide range of legal and illegal activities, some in socially and economically low productivity activities. many are led by women, often assisted by extended family members. these enterprises may be distinguished r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 628 sajems ns vol 5 (2002) no 3 in tenns of ease of entry, reliance on locally available resources, family ownership, labour-intensive and adapted technology, skills acquired outside the fonnal school system, and markets that are unregulated and competitive (ilo, 1972). the lives of the majority of ordinary south africans have somehow been touched by the infonna1 economy in recent times (rogerson & preston-whyte, 1991: i). many individuals, migrating from rural to urban areas in search of employment and attractions of city life, end up in infonnal employment activities, ranging from pirate taxi driving, to hawking, street vending and shebeening. the rising unemployment is, no doubt, forcing many others to engage in crime, prostitution and drug activities. driven by the necessity to survive, a top policy maker argued that some south africans are "forced to beg, rob and murder to ensure that they and their own do not perish from hunger" (the economist, 1999). the informal sector in south africa is estimated to contribute between 6 and 12 per cent to the country's gross domestic product (gdp), (kirsten & sindane, 1994; abedian & desmidt, 1990); recent trends indicate that this contribution is increasing. the bureau of market research (bmr) (1996) indicated that this 'grey' economy contributed 6.7 per cent to the gdp in 1994; in terms of value added this represents an estimated r26 billion. but according to the 1995 central statistical service (css) household survey, the infonnal sector contributed r32.4 billion a year to gdp, about 7 per cent oftotal value added in the economy. with regard to employment, almost 1.6 million people, i.e. about 15.4 per cent of the labour force in south africa were employed in the infonnal sector (bmr, 1996). the 1995 css household survey indicated that at least 1.74 million were engaged in this underground sector, making a monthly contribution of r2.7 billion to the economy in tenns of goods and services. the 1998 october household survey indicated that overall employment increased from 9.3 million in october 1996 to 9.4 million in october 1998, resulting largely from "prominent increases in informal-sector employment" (sarb, june 2000). indeed, according to the most recent national household surveys, between 1996 and 1999 infonnal employment increased from 1 million to 1.9 million in 2000 (financial mail, 29 june, 2001). the february 2001 labour force survey indicates that the jobs in the informal sector increased from 1.9 million in 2000 to 2.7 million in 2001. on the income side, the earnings of the "underground" operators in south africa vary considerably. the 1995 css study indicates that average salary in the informal sector is below r500 monthly. but within the infonnal sector, some r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 629 individuals are engaged in criminal or socially unacceptable activities, such as armed robberies, drug trafficking and hijackings. certainly, the pay-off from such high-risk activities are high, to the extent that individuals engaged therein are not always brought to justice (baumol, 1990). these villainous aspects of entrepreneurship do not contribute to society's welfare. however, most lawabiding citizens in the informal sector prefer to earn income through decent means. accordingly, the informal sector has pockets of both comfortably off and poor people. 3 research method against the background of rising unemployment and worsening poverty, this study examined the employment creation potential and dynamics of street vending entrepreneurship in the eastern cape province. it was conducted by means of a random sample survey. the sample consisted of 475 street traders, proportionally drawn from the four main urban centres of the northern half of eastern cape (umtata, butterworth, king williamstown (kwt) and east london). sampling was done in proportion to town populations: accordingly, 214 street vendors were randomly selected from east london, 114 from kwt, 107 from umtata and 40 from butterworth. the subjects were 346 female and 129 male micro-traders. data was obtained by means of questionnaire-based interviews. the questionnaire was tested initially on a sub-sample of 50 traders in the surveyed areas. it sought information on the socio-economic attributes of the respondents. their access to start-up and development finance, sales, job creation and perceived business prospects as well as business needs. the questionnaires were then administered in all the surveyed areas, with the help of research assistants and translators. 4 results 4.1 socio-economic characteristics 4.1.1 marital status and migration females dominate street vending. about three-quarters of the surveyed traders were female (72.8 per cent). with regard to their marital status, the majority (54 per cent) was single, 27 per cent were mamed, 3 per cent were cohabiting and the remainder were either divorced or separated. although all the vendors in the four cities were trading on the streets near the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 630 sajems ns vol 5 (2002) no 3 taxilbus ranks, markets and shopping complexes, nearly all of them were living outside the trading location and their birth districts, reflecting that there was substantial provincial migration to the towns. of the 475 traders, 304 (64 per cent) were internal migrants within the province, 139 (29 per cent) were born in the district of the interview, only 13 (2.7 per cent) were born in another province of south africa, and 19 (4 per cent) were born outside south africa. this pattern of internal migration tends to be in line with the harris-todaro model (ingham, 1995), in that many unemployed individuals left low-productivity subsistence agriculture activities of rural areas for jobs in the urban areas. there was a small proportion (4 per cent) of 'international' migrants, all males originating from neighboring african countries, nigeria, sierra leone and senegal, and from pakistan. they claimed to have refugee status in south africa. about two thirds (65.5 per cent) were residing in townships, about a quarter (23.5 per cent) in rural locations, another 9 per cent in squatter camps and the remainder inhabited areas close to their trading cities. 4.1.2 dependants table 1 street traders and number of dependants gender no 1-2 3-4 5-6 7-8 9& more total child chilchilchilchilchildren dren dren dren dren female 28 92 93 84 30 19 346 (5.8%) (19.4% (19.6%) (17.7%) (6.3%) (4%) (73%) male 28 36 29 29 4 3 129 (5.8%) (7.6%) (6.1%) (6.1%) (0.8%) (0.6%) (27%) total 56 128 122 113 34 22 475 (11.6%) (27%) (25.7%) (23.8%) (7.1%) (4.6%) (100%) (figures are rounded off to 1 decimal place) many individuals engage in informal trading as a survival strategy, enabling them to support their dependants. only 11.6 per cent of the respondents had no children (table i), while 76 per cent had between one and six children to support, and about 5 per cent had nine or more children to maintain. the traders were supporting, on average, four children. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 631 figure 1 age distribution 180 i 170 i'.l 160 i n 140 '" " ~ 120 .., 100 ~ 80 '" " '13 60 '" .., '" 40 cr i!! 20 ... 0 20-below 21-30 31-40 41-50 51-60 61above age categories 4.1.3 age the age distribution of the street vendors ranged from under 20 (5.5 per cent) to over 60 (1. 7 per cent), with 36 per cent in the 21-30 group, 34 per cent in the 3140 category and another 23 per cent in the 41-60 age group (figure i). thus, about 70 per cent fall in the most productive and fertile period (21-40) of the human life-cycle. the mean age of the respondents was 35 years. 4.1.4 education the urban micro traders have varying levels of education. of the 475 traders, 8 per cent had grades 4-5 education, 19 per cent had between grades 6 and 7, another 30 per cent had between grades 8 and 9, 20.8 per cent had between grades 10 and 11, and the remainder had a matric or higher level of education. figure 2 below compares the education levels of males and females, and it reflects that proportionally, females have higher educational levels than males. about a third (1l3 females and 44 males) of the traders surveyed, had an education of standard 8 and above. at the grade 8-9 level, the proportion of males having that level of education was 25 per cent, whereas for females the figure was 32 per cent, and at grades 6-7, the proportion for females was 20.5 per cent and that of male 13.2 per cent. the mean education standard attained by the respondents was between grades 8 and 9, reflecting a low level of acquired human capital. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 632 sajems ns vol 5 (2002) no 3 figure 2 gender and level of education 25~-~--------------~~-------------.. ~ 15 t-~~-~---~-5 i:! i 0 .,c-_ ... ~_ .. ____ ~_ ce o std 0-1 std 2·3 sid 4-5 std 6·7 sid 8-9 std 10+ level of education 4.1.5 training feif~e1 .• f~~i~i.1 • male ------ii as far as fonnal skill training is concerned, over four fifths (81 per cent) of the respondents had no exposure to any fonn of training (table 2). however, ii per cent (46 females and 9 males) had received training in tailoring and sewing, 1 per cent in bricklaying and 0.4 per cent in small business management. the mean duration of fonnal training was only two months. table 2 gender and skills training gender no sewing! brick small others total training tailoring laying business female 285 46 0 0 15 346 (60%) (9.7%) (3.16%) (73%) male 100 9 6 2 12 129 (21%) (1.89%) (1.26%) (0.42%) (2.53%) (27%l total 385 55 6 2 27 475 (81%) (11.6%) (1.26%) (0.42%) (5.7%) (100%) 4.2 motives for venturing into street trading a mixture of push and pull factors attracts individuals to start a business of their own. in this study, the overwhelming majority of the traders were pushed into street vending because of a lack of wage employment opportunities in the eastern cape, and the need to support their families, having little or no r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 633 alternative source of income. specifically, of the 475 vendors, 62 per cent stated that lack of stable employment was a problem, 20 per cent mentioned the need to find money to support their families, 5 per cent had been retrenched and another 2 per cent had resigned from their previous employment (table 3). overall, therefore, almost 90 per cent of the respondents were thrust into street trading businesses as a subsistence strategy for themselves and their families. table 3 motives for starting informal trading gender no stable start reresigned other total female total there were, however, almost 9 per cent (42) of the surveyed individuals who went into street trading by choice, drawn by pull factors to start their own ventures. comparing the motives of males and females, it was found that lack of stable employment and the need to earn income to support the family, were key factors motivating the individuals to engage in street vending in the urban areas in the eastern cape. most of these people stay in the informal sector by obligation rather than by choice. among those who had some exposure to formal employment prior to engaging in street vending, 108 individuals (about 23 per cent) were labourers, another 81 (17 per cent) were domestic workers, 15 (3 per cent) were security guards and 29 (6 per cent) were salespersons. some gender occupational discrimination was present here, in that a concentration of women were domestic workers, labourers and sales individuals. these categories of jobs require little formal education and training, and until recently, have had little formal legal protection and security. the average duration of formal employment of the surveyed individuals was 2.4 years, and the average monthly income received by them was rl88 during these 2.4 years. a high proportion of the respondents had never been in any wage employment before. specifically, about 49 per cent of the micro-traders had no exposure to wage labour at all. furthermore, females were more adversely placed; in absolute terms 174 females (50.3 per cent) and 57 males (44 per cent) had no former exposure to wage employment at all. however, there was a higher r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 634 sajems ns vols (2002) no 3 proportion of females (16.8 per cent) in wage employment for 3-4 years than males (1s per cent). although a high proportion of the surveyed traders was without any exposure to the formal sector employment, this does not mean that all the individuals had not searched for employment. of those who sought wage employment, 10 per cent searched for a period of 1 month or less, 20 per cent searched for 2-3 months, about 9 per cent searched for 4-s months and another 30 per cent looked for wage employment for over a year (table 4). the average duration of their search was 9.9 months. the majority of the respondents searched for jobs over long distances, and for varying duration, within the same province. their search locations were essentially local or provincial, because of resource and network limitations. only 6.7 per cent of the surveyed individuals searched for jobs outside the eastern cape, and this group comprised of is males and 17 females. table 4 months looking for wage employment duration (mths) frequency percentage 0 103 21.7 i -less 51 10.7 2-3 94 19.8 4-5 41 8.6 6-7 24 5.1 8-9 12 2.5 10-11 8 1.7 12 + 144 30.3 the above seem to confirm the severity of the unemployment problem in the eastern cape. many internal migrants, against their wishes, have never had wage employment, despite undergoing months of protracted search processes both in cities of the eastern cape province (ss.4 per cent) and in other provinces (23 per cent). to find sustenance,' most of these individuals became 'discouraged workers' and took refuge into urban street vending activities. 4.3 nature of business activity street vendors are engaged in a range of activities. they operate on streets and pavements at taxi ranks, around shopping complexes, and at certain other public places. the surveyed traders were dealing in fruit and vegetables, cooked food, drinks, raw meat, shoe repairs, ornaments and toys, and traditional medicine. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 635 table 5 nature of informal street trading business gender fruits & food & clotb & orna& sboe trad. ·otbers total vf2 drinks wears toys repairs moo. female 140 99 73 31 1 2 0 346 (29.5%) (20.8%) (15.4%) (6.8%) (0.2%) (0.4%) (73%) male 9 26 41 35 9 6 3 129 (1.9%) • (5.5%) (8.6%) (7.4%) (1.9%) (1.3%) (0.6%) (27%) total 149 125 114 66 10 8 3 475 (31.4%) (26.3%) (24%) (14.2%) (2.1%) (1.7%) (0.6%) (100% ) a proportionately smaller number of the vendors were trading in shoe repairs and traditional medicine. the majority of the traders were involved in fruits and vegetables (31.4 per cent) and food and drinks (26.3 per cent) (table 5). about half of the female vendors concentrated in these two categories of trade, reflecting ease of entry in terms of skills and capital and some elements of gender specialisation. table 6 distribution of street business activity by regions regions fruits food & i cloth orna& shoe trad others total &veg drink • & wear toys repairs moo °10 umtata. 6.7 3.2 8.4 3.2 1.0 0 0 b'wth 1.7 1.7 3.2 1.2 0.4 0.2 0 8.4 east 15.6 14.6 7.4 6.1 0.2 0.8 0 45 london kwt 7.4 7 5.0 3.4 0.4 0.6 0.6 24 total 31.4 26.5 24 i 13.9 i 2.0 1.6 0.6 100 activity-wise, 31.4 per cent of the traders surveyed dealt with perishable goods, such as fruits and vegetables. regionally, 6.7 per cent were based in umtata, 1.7 per cent in butterworth, 15.6 per cent in east london and 7.4 per cent in kwt (table 6). with regard to clothing items, 24 per cent of vendors were involved in this activity, with umtata accounting for 8.4 per cent, butterworth 3.2 per cent, east london 7.4 per cent and kwt 5 per cent. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 636 sajems ns vol 5 (2002) no 3 4.4 capital 4.4.1 initial capital the initial amount of capital to commence a street business varied significantly among the individuals, ranging from r20 to r7000. over half of the traders (57.5 per cent) started off with an initial capital of r100 or less, another 17 per cent started with a capital of rioir200, and only 6 per cent had a launch capital of over riooo (table 7). the mean launch capital was r343. a significant correlation was found to exist between initial capital and standard of education (r=0.33; p=0.04), suggesting that even among the street vendors, individuals with higher levels of education tend to start in business with high levels of capital. the more skilled vendors may have access to loans from financial institutions. table 7 distribution of launch capital capital (rands) frequency (%~ 100 and less . 273 (57.5) 101-200 81 (17.1) 201-300 20 (4.2) 301-400 15 (3.2) 401-500 28 (5.9) 501-600 9 (1.9) 601-700 i (0.2) 701-800 5 (1.1) 801-900 1 (0.2) 901-1000 13 (2.7) 1001 + 29 (6.1) total 475 (l00) 4.4.2 sources o/iaunch capital the initial capital of more than half (52.6 per cent) of the pavement traders came from their own savings (table 8). friends and family financially assisted another 40 per cent of the members. a few female operators (0.8 per cent) succeeded in raising finance from banks. the eastern cape development agency (ecda), and the rest from informal lenders and other formal traders. however, proportionately more women than men started off their trading from accumulated personal savings (52 per cent) and family funds (31 per cent). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 637 table 8 sources of starting-up capital gender personal family friends bank ecda other savings funds loans loans loans female 180 118 26 2 2 18 (37.9%) (24.8%) (5.5%) (0.4%) (0.4%) (3.8%) male 70 38 12 0 0 9 04.7%) i (8%) (2.5%) (1.9%) total 250 156 38 2 2 27 (52.6%) (32.8%) (8%) (0.4%) (0.4%) (5.7%) although only a few of the street vendors obtained loans from financial institutions, this does not suggest that they were not integrated into the fonnal sector. of the street traders, only about 8 per cent have a savings account with the post office, another 42 ner cent have a similar account with banks, but about half of them do not have any savings account. this paucity of savings among the traders reflects that street vending activity is a highly over-traded activity with low productivity, generating very little returns to many operators. with regard to sources of supply, 97 per cent of the traders procure from wholesalers and retailers; and the remainder source their products themselves, from farming. credit facilities are obtained by only a handful few street traders (2 per cent). while nearly all the respondents (98 per cent) buy stock on a cash basis from suppliers, a significant number of them (31 per cent) sell on credit, ranging from one week to one month, to their customers, who are mostly low income earners. financial records are essential for making business decisions. without a record system to keep track of the operating results, street vendors may lose direction of their meagre assets and liabilities. however, of the surveyed vendors, 79 per cent do not keep any records. while about a third of the traders operate on credit tenns, only 18 per cent claimed to keep a cash register; a high proportion of the latter group have had an education above standard 5. 4.5 income 4.5.1 business sales daily sales vary significantly among the traders, depending partly on the nature of activity and location. obviously there are days when sales turnover is usually good, such as at the end of the month after the payday. the traders in fruit and vegetables, traditional medicine and shoe repairs earn a little amount of money, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 638 sajems ns vol 5 (2002) no 3 ranging from r20 to r80 a day. the traders dealing in clothing, food and ornaments earn about r200 and more per day. these are the ones having the potential to save some money, after meeting business expenses. table 9 average daily sales taking amount (rands) frequenc~ e'/o} 20-40 130 (28.4%) 41-80 141 (29.7%) ~.---81-120 64 (13.5%) _ .. __ .. 121-160 23 (4.8%) r-----161200 35 (7.4%) 201 + 8217.3%1 after subtracting weekly expenses, the profit, on average, made from street vending is rather low for most of the operators. about one third (36 per cent) claimed to have a weekly profit of between r20 and r40 and only 17 per cent had a net income, on average, of r240 or more (table 9). 4.5.2 other sources o/income virtually all individuals have responsibilities and needs to meet from their limited income. the overwhelming majority (8 i per cent) of the street operators asserted that they do not get enough money from their business to support their family, and did not have any other alternative source of income. however, 4 per cent of the vendors could augment their household income through spouse's salaries, another 11 per cent through parents' pensions, and just under 1 per cent through remittances. the low income earned from street trading clearly reflects that the urban informal sector is merely a survivalist strategy for most operators. 4.6 job creation government policy on the informal sector is premised on the ground that it has high prospects to create jobs with low capital investment. however, results of this study indicate that the job creation ability uf tli\;; infullnal i>;';c1\)1 is fathe! low; 78 per cent of the businesses created personal employment for the selfoperator only (table 10). in only 16 per cent of the ventures, two jobs were created, one for the operator and another for a wage earner. only 5 per cent (27 cases) of the surveyed operators were able to employ two or more people. out of 15 people offering employment to self and to two additional individuals, a marginally larger proportion of male traders was able to employ two other individuals. in the higher employment category of at least five persons, women r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vo15 (2002) no 3 639 (\.5 per cent) had a relative edge over men (0.4 per cent). the wage offered varied from r70 a week to r450 a month. table 10 employment creation gender self self & 1 self & 2 self & 3 self & 4 + persons total female 2 male total 4.7 problems and needs the major problems, as perceived by the street traders, affecting their business are related to infrastructure, security and market constraints. for 30 per cent of the operators, lack of shelters was a major problem (table ii). about 16 per cent mentioned lack of security, as they have been victims of crimes and robberies while conducting street vending. another 16 per cent mentioned that business was not progressing on account of competition and demand constraints. however, just over a quarter indicated that they have no problem with their business. table 11 problems of street vendors nature of problems frequency (%) lack of shelters 142 (29.9%) lack of security 74 (15.6%) competition 79 (16.6%) city police 12 (2.5%) foreigners 5 (1.1%) limited space 15 (3.2%) others 16(3.4%) r-" no problem 132 (27.8%) total i 475 (100%) when it comes to assistance needed for advancing street vending, 40 per cent indicated the need for finance and loans. another 24 per cent mentioned the need for shelters to be provided by the municipality and for which they would be prepared to pay a rental, 2 per cent expressed the need for greater security, and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 640 sajems ns vol 5 (2002) no 3 24 per cent indicated that they wanted employment. however, none had suggested the need for entrepreneurship training. 4.8 future prospects the vendors were asked to rate the prospects of their businesses. the ratings are categorised as poor, fair, good and growing, and excellent according to the street entrepreneurs themselves, the prospects are not that encouraging, but these are realistic perspectives. over half (54 per cent) rated their businesses as poor, 34 per cent as fair, 12 per cent as good and growing, only one male trader rated his business as excellent (figure 3). proportionately, men seem to rate their street selling activities more positively than women. of the 129 male vendors, 45 per cent, 37 per cent and 17 per cent classified the business as poor, fair and good respectively. figure 3 business prospects poor fair good excellent business ratings 5 policy implications and conclusion the majority of the respondents eame from the urban poor, for whom street vending made a contribution, albeit an often insufficient one, to family subsistence. they had been drawn into the informal economy because of a lack of employment opportunities in the eastern cape, and in south africa at large. clearly, any policy directed towards the informal sector must be formulated on the basis of an awareness of its dynamic potential. the data reviewed here have shed light on the question of whether one could consider this type of activity as a conduit for entrepreneurship rather than a mere survival strategy. it seems highly unlikely that in the next few years a substantial number of high r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 641 profile entrepreneurs would emerge from this mass of survivalist traders. most of them (84 per cent) are not committed to staying in the informal sector if an alternative formal employment should emerge. only 15 per cent of the street traders indicated that they would prefer to stay on with their business even if a formal job with attractive prospects is offered. probably, it is from this latter group of traders that job opportunities might emerge in the future. they are the ones who might create more vibrant enterprises in the informal economy and perhaps graduate to more sustainable ventures in the formal sector as business conditions improve over time provincially and nationally. for most of the street traders, however, the informal economy is not a conduit to entrepreneurship, but a survival strategy. the respondents have, on average, spent far more time in the informal economy as street vendors (5.2 years) than in the formal sector as wage labour (2.4 years). accordingly, one may infer that eking out an existence through street trading has become almost an entrenched way of life for the majority, even though they eam uneconomic rewards for the long hours they put into their ventures. from an informal sector development standpoint, the way forward for the street vendors is to transform their ventures into more value~adding operations that can provide sustainable livelihoods for themselves, and in due course jobs for others. from a development policy standpoint, support measures should focus on identifying their shortand medium-term business development needs. findings of the survey suggests that there are quite good prospects for helping street vendors to surmount some of the obstacles constraining the development of their businesses. based on the actual demand of the operators themselves, the measures which would be most helpful would involve a combination of better access to fmance, help with the trading infrastructure and contributions to streetlevel security. endnote a revised version of this paper was presented at the 13th south african entrepreneurship & small business association (saesba) conference, 13 august 200 i, caesars, johannesburg. the author gratefully acknowledges funding received from the hsrc for this research and would like to thank an anonymous referee and steve butters of the university of middlesex, uk for their helpful comments. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 642 sajems ns vol 5 (2002) no 3 references abedian, j. & desmidt, m. 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(eds.) south africa's informal sector, oup, cape town. 19 sarb, (1988/2000/01) south african reserve bank, quarterly bulletins, no. 210-216 and 219, pretoria. 20 statistics south africa (2001) labour force survey: february 2001, statistical release p021 0, pretoria: statistics south africa. 21 the economist (2001) "the worst way to lose talent", 10 february: 75. 22 the economist (1999) "funky for a day at least", 16 june: 64. 23 world bank (1990) annual report, 1990. world bank. washington, d.c. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . journal 7.p65 ������������ ��� ����� � � ������������������ � ���������� �� �������������� ���� �� ��� �� �� ��� ����������������� ���������� � ��������� ������ ���� ��� ����� ����� ����������� �������� ����� � �������� ����� ���� � ���� ��� �� �� ���� �� � ��� �� �� ������ ���� ������������ �� ���� � �� � �� ��� ���� ��� ������ ������ �� ������ ���������� �� ������ ����� ������������� ��������� ������������������ ��������������������� ���������������������� ������� ����������� �� ����� ���� ���� ������ ���� �� �� ������� �������� ���� ��� ������������� ������ ��� ������ � �������������� �� ��� �� �������� � �������� � ���� �� � � �� � ����� ����� �� � �� �� ��� �� �������� � �������� ��� � ���������� ����������� ������ ����� ��� � ���������� ���������������������������������� ������� �������� � �� �� � �� � ��� ��� ���� ������� �� �� � ��� �� ���� � � � � �� � ����� ����� ��� ���� � ������� ��������������������� ���� ���� ����� ����� � �� ��� � ������� � �� ��������� ���� � �� ������������� ������� ��� ����� � �� ���������� �������� ��� ����� ����� ��������������������� ������������������������ � ��������� ���������������������� ��� ������� � ������ ���������� ������� ���� �������� ������� �� ��� ��� ��� ��� ����� �������������� �������� ������������������ ���� ������������� �� ����� � ������� ����������������� �� � �� �������� � � ���� �� ������� ����������� ���� �� � ����!��������������������"���������#���� � � ������� ��������������������� ������$������ ����� ������� �� �� �������� ������������ ��� ���� ������ ����������� � ��� ��"������������ ���� ��� ����� �� �� #� ��������� ��������� ���� ���������������� �� � ���������������������� ��� ������ � ��� ��� ����������� �� � ������� � ������� �� ����� ������� ���� �� ��� �������� �� ������������������ ���%�������� ���$������������ ������������ �� ��� ����� � ��� ����$��� �� �� ��� �������������� �������� �� � � ������� �� ������� ��"���������� &����� ���� ��������� �� ���� � � � � ���� ��������� ����� ���� ����� �� � ����� ���� ������� � �� �� ��������� �� � ���� �� ���� ����������� ������� �� �� � �$������� ���������� �� ��������������������� ���' �� ������������� ������������� �(��� ��)*+,-.��� �&����)*+,-. � � ��������������������������� ������ ����������� �� ���� ����� � ���� ������� ��� &���� � ���� ���������� ��������� ���� ������� ����� ����� ����/���������� ���������������������������� � � ��������������������������� �� ���� �������� ����������� ��� ��� � ������ �����%���������� ��������� ������������������������ ���������� ��� ����/���������� �������������� �������������� ������� ��� ���� � ������� �������� �����0�� &������������� ��� ��� '����� �� � ������ ����� ���� 1��� 2�3�������� )*+45�� *+4-� 6 *+47.��8������)*+49.��( ������)*+49.��� �/�� )*+4,.�� ����������������������������������� � ����� ���� ������ ������������������������ ��� � ���������� �� � ������ �� �������� ��� ������� )� �.�� ������ ��� ��� ���� �$���� ���� � � �� ��� ��� �� �� ���� �������� ������� ������#��������������������� �� ������������������� ����������'���0���&���������������� ���������� ��� ����� ��� ����� ������ ��� ��������� ��� ��� � ������ ��������� ����� �� �� ����� ����� ����� � ���� � ��� ������ ������������ ��� �� ��� ��� � ����� �� �������������$������ ��� ������������ ������������������������������ ����������� ����� �� � ������������������ ��� � ������������� ����� � � ������������ ��� ����� ������ � ��� ������� ���� �������������������� '�������� ���� �� ������������������������� ������������������������ ������������"���������� �� �� ��� �������� ������� ���� �� �������� ��� � �������� �����������"������������� �� �� ���� � ��� ������� ���� ��� :�� �� �������� ���� ����� ���� ���� ���������� ����������� ����� ��� ������������� ������� �� ����� ���������� ��� �����������'������ ����� ���������������� � ��� ����� ��� ���������� �������������������� ���������������������� ������������� � ����������� ������������� ���������)&���(������������*++5� � �� �� � ������������ ����������� ������� � ������������������ ��. 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++;� �a�9� � ,0: � 8�� &#---(� @���%���.���� � �� ������ � � � a%� �� �� � ����� � � � ��� � �b ������� �������� #����. � +c;� �'+a#-'� � � �e0) � 6�� &�'9+(��������� ������� ��� ����� ����������� �� ���������" �������� � 3$�� � � �� ����� � ��;� , �� <� �� � # =0,� )�4,768:6, � ��� &�'?#(� @���������� � � �� ���� ��� �� �� �� ���%���.���� � ������ �;� � f�� ������� � � ������� ��� ������ "� �b �������� � ����������� ��������� � �-;�++a�d'� � + =0,� )�4,768:6, � ��� &�'?+(� @� � ��� �� �� �� � �� � � >2��b ������� � �������� ��������� � �#;� 1++a1c#� � 1 =0,� )�4,768:6, � ��� &�'?c(� @��� �a �� ����� �� ���� ��� ��� � �� � � %� �� � � �� �� �;� ��������� � ������ �� � ������ "� �b ������� � ����������� ��������� � �?;� c1�acc1� � c =0,� )�4,768:6, � ��� &�'?d(� @6$��� � � �� �� �� � �� � �� ���%���.���� � ������ �� � � � ���� �� ��� � � �b ��������� ������������ ��������� � #+;� ##9a#19� sajems ns vol 3 (2000) no 2 273 the changing role of the travel intermediary blubbe department of tourism management, university of pretoria abstract this article gives an overview of the changes and developments in the travel industry and the way travel intennediaries like travel agents are responding to them. these changes include the deregulation of airlines and the advent of global distribution systems, the pressure from airlines for lower distribution costs, rapid and fundamental changes in technology and consumer preferences. the responses by travel agents include rapid integration and consolidation within the industry, the use of technology to streamline operations and expand market reach, and the review of traditional revenue models to make way for new approaches to revenue generation. in conclusion, some future scenarios for both leisure and corporate travel distribution are outlined. jell84 introduction the worldwide tourism distribution system is experiencing major transformation. the beginning of this transformation phase can probably be traced to the deregulation of airlines and the advent of global distribution systems, which initiated a period of greater accessibility and availability of information to travel intermediaries, with concomitant benefits to the travel consumer. the decrease in fares, and pressure from airlines for decreased distribution costs have made travel intermediaries vulnerable in terms of their traditional role as the link between supplier and consumer. rapid and fundamental changes in technology have enabled consumers to deal directly with travel suppliers in an increasingly simple way, and this has proved a further impetus for change in travel distribution. together with these trends, consumer preferences have also changed fundamentally. travellers today seek different types of experiences from their predecessors and this, together with greater accessibility and availability of infonnation, presents the travel industry with its greatest challenges. this article gives an overview of these agents of change and of how the travel distributor and intermediary are coping with them. the article begins with a r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 214 sajems ns vol 3 (2000) no 2 review of the traditional chain of distribution and then examines the trends and factors that are bringing about the changes to this traditional approach. then it examines the reaction of travel intennediaries to these changes, and the survival strategies that they are implementing. the paper concludes with a possible future scenario for tourism distribution. the travel distribution structure in south africa a traditional travel distribution system links the suppliers of travel products to the end customers. this system can be described as a predominantly linear chain of distribution, because it follows the traditional path from supplier to wholesaler and/or retailer and finally to consumer. the number of channel levels may vary from simple, direct marketing where the supplier sells directly to the consumer, called direct distribution, to complex distribution systems involving several layers of channel members such as retail travel agents, tour wholesalers/operators and speciality intermediaries, called indirect distribution. the basic structure of the south african travel industry is graphically illustrated in figure 1. the public or conswners can be seen as the driving force they purchase travel services from retail travel agents or directly from the suppliers of travel services. the tour wholesaler's role is that of consolidating the services of airlines and other carriers with the requisite ground services into one package that can be sold either through travel agents to the consuming public or directly. the legal and regulatory environment in which the industry operates may be viewed from two perspectives: firstly, the role of the government and other public bodies, and secondly, the role of industry associations such as lata (international air transport association) and asata (association of southern african travel agents). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 275 figure 1 the hasic structure of the sgutb african travel industry government. ~ asata. lata, other suppliers f i i ~ airlines any tour & other ---. carriers wholesaler i hotels i ------1 gos i other retail travel destination agent or other services retail outlet i ... "i public 1 the role of the travel suppliers is to provide travel and transport related services to consumers. because of the intangibility of the tourism product, they rely on the distribution of information. the information is stored in global distribution systems (gdss) such as amadeus, galileo, sabre and worldspan, and disseminated to the consumer via the travel intermediaries, who are linked to these gdss. the last-mentioned have traditionally been the main tool used by the travel industry to distribute information about air travel and other products, such as package holidays, hotel accommodation and car hire. travel intermediaries may be divided into wholesalers and retailers. the tour wholesaler buys different components of the tourism product, like transportation, accommodation and sightseeing, from suppliers to create packages that are sold via the travel agent to the consumer. the travel agent has traditionally been the dominant sales channel for airline and tour operating r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 276 sajems ns vol 3 (2000) no 2 companies. for many years, airlines have been dependent on travel agents to sell their seats, with approximately 80% of all sales being done through travel agents. this holds true even today, despite the growth in direct distribution through the internet. in 1998 there were approximately 71 international scheduled and non-scheduled airlines servicing south africa. before 1990, only 22 international carriers did so, which means that there has been a rapid increase in the number of new destinations accessible to the south african traveller. thus between 1990 and 1998, travel agents and tour wholesalers had to increase their range of products rapidly, and expand their information systems to meet the new demand. according to lata, international airline ticket sales in south africa through travel agents amounted to approximately r4 billion in 1996, while domestic airline ticket sales were approximately r2 billion in that year. in 1998, total airline sales through travel agents amounted to r8,45 billion. the number of domestic and regional airlines in south africa has also increased during the last few years. south african airways (saa) remains the largest carrier, with other airlines, like british airways/comair, sa express, nationwide air and sa airlink, also serving the regional and domestic routes. apart from government . licensing, airlines are regulated by lata. the retail travel industry consists of licensed as well as unlicensed travel agents. in 1998 there were approximately 1 000 travel agencies in south africa, of which 820 were licensed by lata. these agencies range from independent neighbourhood and small-town travel agencies to large organisations (e.g. rennies travel) that are part of jse-listed holding companies, like bidvest. travel agencies may also be part of a national franchise like sure travel, which has over 125 independent city outlets, or international franchises, like harvey world travel. a number of airlines have provided franchising opportunities for travel agencies (e.g. saa city centre travel agencies), and alliances are also formed between local travel agencies and global partners. examples are the affiliations between concorde travel and the global giant carlson wagonlit, and rennies travel and btl (business travel international). while travel agencies require lata licences to issue air tickets, asa t a is the industry association that represents the travel trade. the growth in the travel agency market, and the importance of travel agents in south africa, are evident from the increase in the total number of airline sales processed through travel agencies: r3,6 billion in 1993 to r8,45 billion in 1998. the rapid rise in the number of destinations available to the south afiican traveller since 1995, has compelled the travel trade to become quickly familiar with more countries than it ever had to deal with in the past. according to satour r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . samms ns vol 3 (2000) no 2 277 (bayman, 1998), outbound overseas travellers in 1996 amounted to 549 379 persons, of whom 416 041 were holidaymakers, 123043 business travellers and 10 ;295 academics and others travelling for study purposes. in 1997 a total of 518 514 south africans travelled overseas; 387 408 (a drop of almost 7% from 1996) travelled on holiday, 120890 on business (a drop of 1,75%) and 10216 travelled for study purposes (a drop of 0,77%). at present there are approximately 22 asata-registered outbound tour wholesalers in south africa, some of the larger being world leisure holidays, ato, thompsons tours, beachcomber tours, absolute tours and travel vision. the south african tour operators association (satoa) represents the outbound tour sector of the industry. the inbound tourism sector has grown substantially since 1994, and according to caras (1998: 47-8) there are approximately 460 operators providing ground tours in south africa, about 15 of whom may be considered major players in the sector. a satour survey (caras, 1998: 48) shows that 27% of the foreign visitors to south africa, over 300 000 tourists a year, participated in organised tours a significant increase from the 17% in 1995. inbound tour operators handled about 220000 tourists in 1995. two industry organisations, namely satsa (the south african tourism services association) and asinto (the association of inbound tour operators), which is part of asa t a, represent the interests of the inbound tour market apart from the changes in south africa's circumstances over the last number of years, changes in the overall tourism industry have and are occurring so rapidly that it is necessary to examine how distribution in travel is being impacted and how transformation in the industry is taking place. changes impacflng on travel distribution changes in three important areas can be identified as having the greatest impact on the way in which travel is distributed. these are: • deregulation in the airline industry • rapid advances in technology • changes in consumer demand and behaviour they are next discussed in tum. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 278 sajems ns vol 3 (2000) no 2 deregulation since 1978, when deregulation of the airline industry was introduced in the usa, competition in this and related travel industries has bwgeoned. this increase in competition caused declining yields for many travel suppliers and a subsequent squeeze on revenues, and ways were therefore sought to reduce costs and increase market share and profitability. as far as airlines are concerned, deregulation and increased competition brought about a number of changes, which directly impact on travel distribution. these are: the formation of alliances. the alliance trend amongst airlines began in the mid· 1 980s. the main aim with alliances is to extend the market reach of airlines, control costs and possibly limit competition in the global air transport sector. while some concern has been expressed as to how alliances affect the consumer, it can be argued that they have vastly extended passenger choice. these alliances include collaborative pacts ranging from equity stakes to codesharing agreements, joint services, block seat or block booking arrangements, joint marketing agreements, joint fares and franchise agreements (french, 1997). not only does south african airways form part of a strategic alliance (the star alliance) together with lufthansa, united airlines, air canada, sas and thai airways international, it also has various code-share agreements with other carriers such as singapore airlines. saa has also found an equity partner in swissair. another south african airline, comair, has a franchising agreement with british airways, the latter having bought a 18,3% share in comair. these alliances bring about changes in ticket distribution methods that directly affect the retail travel industry in terms of preferred supplier relationships and revenue. franchising travel retailers as preferred suppliers of certain airlines are also very much in evidence in south africa., as the rapid growth of the saallufthansa city centre travel centres has shown. a strong move to cut distribution costs. as the level of competition increases airlines continue to look for ways to offset declining profits. this has resulted in a move to reduce distribution costs, which represent 20-25% of total costs. this move by airlines has resulted in the implementation of commission caps in the usa commission cutting has started in south africa., with saa cutting commission on international ticket sales from 9010 to 7% and other airlines following suit commission capping and other changes in commission structures have severely affected the major source of travel agents' revenue, and will continue to do so. introduction of more competitive and flexible fares. this has meant a decrease in the cost of air travel to the consumer. new airlines increasingly enter the market and compete with national carriers, traditionally protected by government r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 279 subsidies and regulation. the flexibility of fares on the johannesburgllondon route offered by british airways, saa and vrrgin atlantic is an example of the wider range of options available to the consumer. introduction of airline loyalty programmes. a factor that should not be underestimated in its impact on travel distribution, is the implementation and growth of the so-called frequent flyer programmes. these are designed to create brand loyalty among passengers, and according to lewis and talalayevsky (1997) tend to reduce the use of travel agents. the frequent flyer passenger will be inclined to deal as much as possible with a single airline (or airlines operating within the same alliance, where frequent flyer points are transferable) for future redemption of points. frequent flyers will be tempted to deal with the airline directly, having decided beforehand on a carrier. airlines have more information on frequent flyers than other passengers, because it supports their marketing and scheduling decisions, and they will want to make optimal use of such information. this leads to strategies where the travel intermediary may be bypassed in order for airlines to strengthen their relations with frequent flyers. these trends in the airline industry have bad a major negative impact on the revenues of travel intermediaries, particularly of the travel agent. rapid advances in technology the travel industry bas used information technology for more than twenty years. this technology bas become indispensable in lowering the cost of business processes such as reservations, accounting and administration, as well as improving customer service, human resource and financial management. while information technology is a key competitive weapon in the travel industry, it also holds the biggest potential threat to the way that travel agencies operate and even to their very existence. as travellers begin to make more of their own reservations electronically, thus bypassing the travel agent, the role of the travel agent will change towards a greater emphasis on advice and planning. information technology is making a significant impact on all organisations. in the past five years, direct electronic communication with consumers bas become possible through the internet, online services, and the use of telephones to communicate directly with computers. according to lewis and talalayevsky (1997), it is no longer in doubt that it will be possible to bypass intermediaries, who are no longer necessary for the coordination and management of information. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 280 samms ns vol 3 (2000) no 2 the internet the relatively low barriers to entry, the perception of a demographically attractive and expanding international user base, and growing media attention, have prompted a sharp rise in the number of internet sites with a travel and tourism focus. using the internet removes the limitations of time, place and products. as more people become computer literate and familiar with the internet, travellers will increasingly start to make their own bookings for flights, hotels and car rentals. the internet provides a means of reducing costs by removing intermediaries from the distribution chain and allowing consumers to deal directly with travel suppliers. olivier (1996) calls the bypassing of the travel agent disintermediation. the internet is one of the prime forces that could bring about such disintermediation. the cost to suppliers of receiving a customer's booking is the most compelling issue here. according to inkpen (1998) it has, for example, been estimated that the cost of making a booking via a telephone service centre is around us$10, and via a gds around uss3.s0. to secure that same booking via the internet costs only 2s cents. intermediaries represent a substantial element of supplier distribution costs. as their role declines, profit margins along the value chain will be redistributed to producers and consumers. it has been estimated that over 100 million people would be on the internet by the turn of the century (olivier, 1996). the travel industry is not exempt from this trend, with increasingly more hotels, airlines, tourist offices, et cetera, establishing themselves on the internet, which has also been used to auction 'late availability' airline seats. for example, south african airways held its first auction on the internet in april 1997. here ten seats were auctioned on local commercial flights, with the johannesburgldurban seats going from r130 (as opposed to a normal single fare of approximately rsoo) and the johannesburg/cape town seats going for around r260 (as opposed to a normal single fare of approximately r900). electronic ticketing some airlines offer travellers the option of booking flights without tickets. the traveller obtains a boarding pass at the airport on confirmation of his or her identity. inkpen (1998: 71) describes e-ticketing as a crs supported function that can be used to book the following: • airline seats sold directly to customers by the carriers themselves. british airways/comair has a system whereby passengers prebook their flight, pay by credit card and go directly to the check·in desk at the airport, where they are issued with a boarding pass on swiping their credit card and showing their acknowledgement, already faxed through to them. british airways has a machine at heathrow airport that accepts standard credit cards for self·booking flights. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajemsns vo13 (2000) no 2 281 • airline seats sold to customers via the travel agents. travel agents have access to e-ticketing functions via their gdss, which are connected to the airline's crs. so, for e-ticketing to be possible from a technical standpoint, the airline's crs and the travel agent's gds must both support e-ticketing functions. some reservations systems are introducing "electronic ticketing" into south africa, which would enable travel agents to issue electronic tickets. intranets intranets are systems developed from the internet, mostly private networks owned by companies. these tailor-made networks can be accessed only by company employees using a special password. the intranet allows company staff to make their own travel arrangements direct from their laptop computers anywhere in the world. these systems are expected to be available in south africa from the year 2000. self-service kiosks these are intelligent a tm-type machines activated by customers. they have a link to suppliers' electronic distribution systems and provide direct access to the consumer. smart card technology smart cards look like credit cards, but have a computer chip embedded in the card that can store, read and dispense large quantities of information on command. people have come to expect a "travelling office" (cole, 1996) that will give them connectivity and technical support at every stage of their journey. telephone voice recognition this is a system where computers "speak", which can be used by airlines and other suppliers to answer enquiries about reservations, lost baggage, schedules, et cetera. telephone conferencing south african companies are increasingly using telephone conferencing and international phone cards as cost-efficient ways of communication, and an alternative to international travel. paradigm shift webb (1997) suggests that technology is making it easier for travel distribution channels to come under the control of powerful industries, for example, retail grocery chains. retail groups like pick 'n pay and computicket have the critical mass and technology to move into simple travel transactions. this is also seen in r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 282 sajems ns vol 3 (2000) no 2 acquisition of related companies or alliances with such firms (e.g. rennies travel). these pressures on the travel industry require a restructuring to meet the demands of the future, that will be a challenge to their managers. changes in consumer demands and behaviour changes in consumer behaviour, expectations and values represent another of the main forces behind the pace and direction of industry developments (andersen consulting, 1998). in the leisure market, consumers are becoming less satisfied with traditional holiday packages. "mass tourism" has been replaced by the so-called "new tourism", which is strongly emerging in south africa too. mass tourism was the logical outcome of the key social, economic, political and technological influences following world war ii. this form of tourism began with the introduction of jet aircraft in 1958. post-war peace and prosperity, paid holidays, charter flights and cheap oil resulted in massive changes in the tourism industry. sun-worship, inexperienced tourists, the availability of cheap package tours to attractive destinations and "plastic cards" all boosted the demand for mass tourism. this is also called mass standardised rigidly packaged (msrp) tourism, because identical holidays were rigidly standardised and mass-produced. the holidays were consumed en masse by a seemingly identical group of mass travellers, with no consideration for the environment., or the values and culture of the host society. technology greatly facilitated the development of mass tourism because it made possible the standardisation, management and distribution of mass tourism services on a global scale. by the 1970s and 1980s, mass tourism had become "best practice". new tourism, which is in the process of emerging in south africa, is fundamentally different from mass tourism. new tourists are more experienced, more "green", more independent., more flexible, more quality conscious and harder to please than mass tourists. the previous generation of tourists wanted only to go to a place and be able to prove they had been there, whereas new tourists go on holiday to experience something different. quality and value for money are vital to them and they are spontaneous, unpredictable and hybrid in their choice of holidays. they want to affirm their individuality and to be in control as familiarity with new technologies increases, the consumer experiences an added element of control and convenience of how travel services are bought. the industry is therefore seeing a shift from the traditional push of products by travel suppliers to the pull of products by consumers, based on the growing availability of transparent., easy-ta-use technology (andersen consulting, 1998). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 283 in response to these destabilising trends, travel intennediaries have reacted and developed in three important ways. the frrst is the consolidation of travel companies through mergers, acquisitions, franchising and the formation of consortiums. the second is through their increased use of technology to benefit both client and travel company. a third fundamental change that is taking place in the way travel intennediaries do business, is the restructuring of their revenue base, where a strong move is emerging away from the traditional revenue model of commissions to a more flexible, service-fee model. travel industry responses to changes consolidation and integration of travel companies the increasing number of consolidations in the travel industry comes from the growing recognition of the benefits of co-ordination of travel services in response to the challenges facing the industry. travel intennediaries have shown more and more appreciation of the difficulties they face in achieving the benefits from the traditional chain of distribution and their position along this chain. integration in the fonn of acquisitions, alliances, mergers, franchises and consortiums has followed a rapid path in the travel industry, both worldwide and in south africa. integration achieves three basic benefits for organisations: • competitive advantage through speed and flexibility. through integration of sophisticated technology, rationalisation is possible, and with a wider product range to offer the organisation's image is enhanced. • cost control through efficiency and rationalisation. organisations achieve greater negotiating power with suppliers, save on fixed costs, gain access to broader industry experience and have greater access to technology. • extending market reach through access to wider markets. the five above-mentioned fonns of integration are next discussed in turn. acquisitions: a good example of integration in the tourism industry is that of the tourism investment corporation ltd (tourvest ltd), a company listed on the johannesburg stock exchange. the vision of tourvest is to be one of the top 10 global tourism companies, and it has already acquired numerous companies in the inbound and outbound tourism markets as well as related sectors. tourvest believes that the benefits that accrue from its acquisitions are: • buying power • cross-selling within the group • sharing skills and expertise, thereby creating a tourvest culture • unifonn budget and business planning tools r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 284 sajems ns vol 3 (2000) no 2 • central support providing strategic input and management support • integrated electronic product • implementation of a comprehensive database alliances: alliances are a form of contractual agreement that allows two organisations to benefit from each other's strengths (kotler, bowen & makens, 1996). local travel agencies are increasingly forming alliances with global travel management organisations through which they gain access to international systems. examples of alliances formed in south africa are concorde travel and carlson wagonlit, which has 4 000 outlets in 125 countries, and rennies travel and bti, which has 2 750 outlets worldwide. these types of alliance provide the consumer with more choices and a greater degree of security while travelling. this puts pressure on the small independent travel agency, which does not have the same purchasing power and credibility overseas. mergers: a merger can be defined as the combining of two or more entities through direct acquisition by one of the net assets of the other, either friendly or hostile, for cash or stock. a new corporate entity is not created, but a newlymerged organisation resembles a new organisation due to changes that follow the merger. a recent example (1998) ofa merger in south africa is that between beachcomber tours, one of the largest tour wholesalers in south africa, and creative tours. beachcomber tours is a leading wholesaler of holidays to mauritius, and to expand on the mauritius side of the business it bought creative tours after splitting beachcomber into two companies. the first company remains beachcomber tours with its primary focus still on mauritius, and the second company, called absolute tours (and incorporating creative tours) now focuses on the uk, the continent of europe, australia and south africa. franchising: traditionally the travel agency business has not been suitable for franchising. it has always been a relatively low-revenue producing, low-income business not able to support franchise fees, yearly service fees and other such expenses. however, in a business environment that is becoming less and less regulated, the travel agency industry is likely to experience a growth of nationwide and even worldwide chains. independent agencies are increasingly feeling the need to enjoy the benefits of strong advertising and a corporate image. internationally~ franchising began in the travel industry in the early 19805. uoiglobe in caaada exemplifies this rapidly expanding business form. it was founded in 1980, has currently 850 units operating in north america and has now started operating in south africa too. operation was launched in the united kingdom in 1990 and has rapidly expanded to 70 outlets. the core business is the corporate travel agency market. in south africa some of the more wellknown franchises are the saalcity centre franchises, sure travel and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 285 concorde travel. south african airways, as an alliance partner of lufthansa, launched its saalcity centre travel agency franchising concept early in 1997. the rapid growth since 1995 of the sure travel franchise, which has over 125 franchise outlets in south africa, indicates the growing need for travel agencies to link together to form strong management structures. smaller independent agencies increasingly feel isolated and disadvantaged in terms of buying power and access to global services, hence the rapid growth of franchising. consortiums: consortiums also provide small independent agencies with the opportunity of increasing their buying and marketing power. for example, the independent travel agents consortium (itac) was launched in 1997 with a membership of 49 travel agencies and a combined buying power between r500 and r600 million, with the aim of negotiating better deals for its members with product suppliers (bims, 1 997). although consortiums may be similar to franchising in terms of payment of membership and monthly fees and their aim of increasing individual members' buying power, a key difference is that they normally allow members to retain their own corporate identity and management independence. an interesting example of the combination of alliances, joint ventures and franchising that can take place is provided by rennies travel. as already mentioned, rennies travel have formed an alliance with btl. in 1997 they also signed a 50-50 joint venture agreement with an australasian company called harvey world travel to develop a leisure-based travel franchise in south africa. they have also linked up with computicket, the leisure retail company, to allow computicket to make foreign exchange transactions for foreigners (getz, 1997). according to cole (1996) the future operation of the large, global companies will be quite different from that today as a result of the consolidation of travel agencies. for example, travel agents will become more specialised, with a vast fund of data and experience to draw on for the traveller contemplating, say, a safari or a scuba-diving expedition. greater specialisation and a fuller range of products also open the way to a fee-based revenue model. the use of technology by travel intermediaries travel agents and other travel intermediaries have traditionally used information technology mainly for information retrieval and reservations, electronic ticketing and computerised back-office systems. gds terminals are the major information and booking tools used by travel agents for all types of travel products. the major systems available to travel agents are sabre, apollo/galileo, worldspan, systemone, amadeus and abacus. in south africa galileo is used by 90 percent of agents with amadeus making steady inroads. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 286 sajems ns vol 3 (2000) no 2 these gdss are constantly providing extra tools to increase the travel agency's efficiency. windows interfaces have been developed that allow agents to move between applications. travel agents are also using technology such as cd-rom to enhance their selling of destinations. cds are used as an alternative to brochures. the installation of cd-rom applications, whereby descriptions of destinations can be done via colour photographs, sound and video clips, has become necessary as increasing amounts of information are distributed. another way in which agents have improved their service, is by setting up satellites in the offices of their bigger corporate clients, thus allowing immediate discussions, advice and instant ticket issue to take place. while travel agencies are under threat from the internet, it also provides additional business opportunities. an ever-increasing number of travel agents in south africa are gaining access to the internet through their gds. some travel agencies offer services on the world wide web, giving them a much broader geographic consumer base than they could acquire by traditional methods. travel agencies on the internet can receive bookings from clients through the internet and can either send tickets by post, by hand or electronically, or can book the passenger on ticketless flights. communication with suppliers can also be done via e-mail. there are a number of electronic travel agencies on the web, such as expedia, biztra vel.com and tiie trip.com. internationally, the travel industry has been active and aggressive in deploying consumer-oriented ecommerce applications focused on the distribution aspects of travel services. as a result most of the leading travel providers, gdss and travel agents have now established sites enabling consumers to obtain information and, in many cases, book and pay for tickets via the internet (andersen consulting, 1998). in south africa the leading company in the sphere ofweh-based travel is etravel, closely pursued by leisure travel and computravel. a new agency revenue model historically, travel agencies have earned their revenue through commission paid to them by suppliers such as airlines, hotels, car rental companies and other service providers. this revenue was sufficient to cover the agencies' fixed and variable costs. however, traditional commission rates are giving way to fees based on value-added services (paid by the traveller). this will transform the travel agent into an agent for the traveller rather than for the travel provider. the shift away from commission-based revenue to fees, is becoming increasingly important with distinction being made between fees charged for handling corporate accounts and fees relevant to individual travellers. dr robert joselyn, president and ceo of joselyn, tepper &. associates, inc. in arizona, suggests that fees should be charged for the following services : r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 287 • those which do not generate income commensurate with cost of service or investment in service. • those where the agency is capable of adding value. • those where customers view fees and service charges as fair and reasonable. where the small business account and leisure traveller are concerned, and with constant emphasis on the right kind of service, joselyn proposes fees such as: • penalty charges that are designed to recover costs and/or to compensate for lost income from efforts which have already incurred cost, or to compensate for costs incurred for redoing work already done. • service fees for performing services (generally a combination of time and transaction expertise/capability) for which no income or inadequate income is anticipated. • professional fees for experience and expertise that are either not compensated, or inadequately compensated. the fee structure for corporate accounts should be negotiated with corporate clients on a contractual basis. revenue from corporate accounts can range from commission to the agent (with commissions and overrides from preferred suppliers going to the agent only), a fixed management fee structure or profit sharing between the corporate account and the agent. other agreements or variations of these types of fees can also be negotiated based on the types of service required. a future scenario for travel distribution rapid technological advance has brought about new electronic distribution channels like the internet, personal digital assistants, self-service kiosks and interactive television, which have enabled the consumer to reach the supplier directly and, in so doing, to bypass traditional distribution organisations like the travel agent. these electronically based channels have also provided the consumer with a greater choice of products. the use of these new channels depends on consumers' technological know-how and traveller sophistication. andersen consulting (1998) suggests that in future, these new channels will run parallel to the traditional channels of distribution, with customers selecting the channels according to the complexity of the travel experience and its occasion or purpose. the retail travel agency as we know it today, will all but disappear in the transformed corporate travel distribution system. according to andersen r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 288 sajems ns vol 3 (2000) no 2 consulting (1998) there will be a move towards self-booking where the individual business traveller makes direct contact with the gds or the supplier inventory system, particularly if travel arrangements are relatively simple. this will be done through corporate intranets accessible via personal computers, personal digital assistants or telephones using voice recognition systems. journeys and itineraries that are more complex will still require the services of a travel consultant. the travel consultant will no longer be an "order-taker" but an adviser and consultant in the true sense of the word, providing information and advice and adding value to the travel transaction. for corporate travel, where large travel accounts are handled, global travel management companies will emerge to replace the traditional retail travel agency. these companies will serve the needs of their clients by managing their travel portfolios. traditional sources of revenue, such as commissions, will no longer apply and global travel companies will work on a basis of client fees. the model for leisure travel will be more complex, with traveller sophistication, technological know-how and buyer values determining the future "look" of distribution. similar to the corporate market, the traveller with a relatively simple itinerary will tend to bypass the retail travel agent and book directly with the supplier through personal computers, television and self-service kiosks. when travel is more complex, andersen consulting (1998) suggests that distribution will be split along direct and traditional channels. travel that was previously regarded as complex will become increasingly simple, as packages are developed that reduce the complexity of travel. consumers are increasingly able to access information previously regarded as complex but now becoming relatively simple to access online. however, leisure travellers will continue to rely on retail travel agents offering value-added services to assist in planning more complex, adventurous itineraries. in such cases, travellers will still choose to visit a retail travel agent's shop to obtain advice in a face-to-face context. summary this article looked at the trends that are emerging in the travel industry, with particular reference to travel agencies. it is evident that the industry is currently experiencing probably its greatest changes and challenges since the 1 960s. travel agencies began as independent organisations serving a relatively simple market, but greater specialisation in types of travel, more discerning travellers, the deregulation of airlines and tremendous technological advances have resulted in the growth of complex alliances, partnerships and franchises. not only are these trends posing a threat to the small independent travel agency, they are also fundamentally changing the traditional chain of distribution. the distribution system will look different in the future, with multiple channels . running parallel to one another and serving different market segments. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 289 references andersen consulting (1998) the future of travel distribution. research report, johannesburg: andersen consulting. 2 bayman, f. (1998) "report overstated drop in travellers", travel news weekly. 1554: 5. 3 birns, h. (1997) "itac launched with 49 members", travel news weekly, 1494: 24. 4 caras (1998) tourism talk: a bulletin on tourism and its allied industries. johannesburg: kessel feinstein consulting. 5 cole, j. (1996) "the impact of infonnation technology on travel and transportation", a public affairs paper from ibm, asata technology workshop, johannesburg. 6 french, t. (1997) "global trends in airline alliances", travel & tourism analysis. 4: 81-101. 7 getz, m. (1997) "rennies signs accord with australasian finn", pretoria news business report. 8 october: 3. 8 inkpen, g. (1998) information technology for travel and tourism. essex: longman. 9 kotler, p, bowen, j and makens, j. (1996) marketing for hospitality and tourism. upper saddle river: prentice-hall. 10 lewis, i and talala yevsky, a. (1997) "travel agents: threatened intermediaries" transportation journal, 36(3): 26-30. 11 olivier, aps. (1996) "the revolutionaiy impact of the internet on the travel agent: friend or enemy?" paper presented at the iris 1996 conference on the future, 10 13 august, goteberg. 12 webb, g. (1997) "pick 'n pay penetrates retail market", travel news weekly, 1463: 2. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction literature review methodology results discussion limitations of the study acknowledgements references about the author(s) emma-louise webber department of business management, university of pretoria, pretoria, south africa adolf j. vögel department of business management, university of pretoria, pretoria, south africa citation webber, e-l. & vögel, a.j., 2019, ‘the preparation, training and support requirements of expatriate trailing spouses’, south african journal of economic and management sciences 22(1), a2703. https://doi.org/10.4102/sajems.v22i1.2703 original research the preparation, training and support requirements of expatriate trailing spouses emma-louise webber, adolf j. vögel received: 20 july 2018; accepted: 11 sept. 2019; published: 27 nov. 2019 copyright: © 2019. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: decades have passed since trailing spouses were first identified as the primary causes of expatriate failure. this has led to numerous studies to determine how best to avoid such failures. in particular, it was determined that through the preparation, training and support of trailing spouses multinational enterprises (mnes) can not only assist with their adjustment to the host country, but also reduce the likelihood of expatriate failure. aim: with the impact of the trailing spouse still being a major concern for the success of an international assignment decades after it was first identified as such, this research aimed to determine the preparation, training and support requirements of trailing spouses prior to, and during an international assignment. setting: the article includes the responses from trailing spouses who at the time of the study were on assignment in 52 countries on six continents. methods: both non-probability judgement sampling and snowball sampling were used to identify the 218 respondents who completed a self-administered questionnaire which respondents were able to access online. the data was then analysed using exploratory factor analysis, cronbach’s alpha, a t-test and paired t-test. results: statistically significant differences were found between the preparation, training and support required by trailing spouses and what was offered to them by mnes for all the specific forms of preparation, training and support measured in this study. conclusion: mnes are still falling short of the preparation, training and support needs of trailing spouses. in particular, mnes seem to focus on some operational aspects of spousal adjustment while the social aspects are still not sufficiently addressed. keywords: expatriates; international assignments; trailing spouses; international human resource management; adjustment; preparation; training; support. introduction the inability of an expatriate’s spouse to adapt to the host country has consistently been found to be the most common cause of expatriate failure (anderson 2005:568; briscoe, schuler & claus 2009:165; haile, jones & emmanuel 2007:101; tung 1981:76). expatriate failure can be defined as the underperformance by the expatriate during the international assignment, the premature return of the expatriate, or repatriate failure on returning to the home country (briscoe et al. 2009:180; harzing & van ruysseveldt 2004:274; shen 2005:657; swarts & du plessis 2007:48; templer 2010:1754). this can be attributed to the fact that spouses are confronted with obstacles in the host country, such as culture shock, isolation, differences in work-related norms, health care systems, housing and schooling (andreason 2008:386; briscoe et al. 2009:185; mendenhall, dunbar & oddou 1987:331). although expatriate spouses are likely to be less sheltered from the foreign environment and more exposed to the culture than the expatriates and in some cases even the accompanying children, they tend to be excluded from selection and training processes and receive less in-country support, making it harder for them to adjust (andreason 2008:382–387; mcnulty 2012:418; tung 1982:65; wilson 2011:9). deen (2011:10), harvey and moeller (2009:280) and haslberger and brewster (2008:2008) acknowledge that these obstacles tend to create high levels of stress and tension for spouses, leading to conflict within the family and affecting the expatriate’s morale and ability to perform their job effectively. many multinational enterprises (mnes), however, fail to recognise the relationship between expatriate success and the trailing spouse’s adjustment, and as a result they neglect to include the spouse in the expatriation process. in fact, according to cartus and primacy (in mcnulty 2012:421), mnes’ interest in providing assistance to expatriates’ trailing spouses and families is on the decrease with only 13% of enterprises being interested in improving these assistance programmes. consequently, it is not surprising to note that overall organisational support continues to disappoint trailing spouses (mcnulty 2012:430; selmer & leung 2003:17), with trailing spouses believing that mnes are not genuinely interested in their wellbeing (mcnulty 2012:430). in fact, between 80% and 90% of expatriates are accompanied by their spouses (ali, van der zee & sanders 2003:564; van erp et al. 2011:58; wu & ang 2011:2690) but only 50% of mnes offer some form of support for trailing spouses, 87% of which provide assistance only when necessary. this while as little as 13% have formal policies in place regarding trailing spouses (briscoe et al. 2009:183). thus with the impact of the trailing spouse still being a major concern for the success of an international assignment decades after it was first identified as such (tung 1982), this research aimed to determine the preparation, training and support requirements of trailing spouses prior to and during an international assignment. this article contributes to the existing literature as it contributes to mcnulty’s (2012:432) call for more quantitative studies on the topic, and in doing so it develops our knowledge of this field. literature review spousal support of the expatriate, the assignment, and their adjustment and satisfaction during an international assignment is considered crucial for assignment success (cole 2012:309; long 2010:75; wang, bullock & oswald 2011:74). consequently, gupta, banerjee and gaur (2012b:26) and vögel and van vuuren (2008:80) emphasise the importance of spousal preparation, training and support prior to and during the international assignment. preparation requirements a survey by cigna international (brown 2008:1030) found that 53% of enterprises felt they provided sufficient preparation for expatriate families, while only 32% of expatriates felt that their families received adequate preparation and support prior to and during the international assignment. cherry (2010:133) and dewald and self (2008:357) state that the involvement of the spouse in pre-departure preparation regarding the assignment, including supplying them with information on the foreign country’s culture and living standards, aids in their general adjustment. while the opposite is also true, spouses with unrealistic expectations soon become dissatisfied with the country, culture and living conditions, which inhibits their cross-cultural adjustment and often results in the family’s premature return (kim & tung 2013:1042). consequently, enterprises should provide families with a realistic preview of everyday life in the host country, as well as accurate and up-to-date information about the country, its people and culture (cherry 2010:139; kim & tung 2013:1045; purgal-popiela 2011:39; vögel & van vuuren 2008:85). in particular, cascio (2006:645), sharma (2012:15) and vögel and van vuuren (2008:85) recommend that enterprises organise orientation visits to the host country for potential expatriates and their spouses before their final departure. these orientation visits provide expatriates and their spouses with invaluable first-hand information regarding the host country and culture, which may reduce spousal uncertainty and aid in the spouses’ adjustment during the assignment (ghafoor et al. 2011:338; rosenbusch & cseh 2012:63; sharma 2012:15; sims & schraeder 2004:76). the opposite can, however, also be true, with harvey and wiese (1997:368) and sims and schraeder (2004:76) warning that the pre-departure orientation visit can become a ‘tourist’ visit or holiday, leaving the expatriate couple with an unrealistic perception of the host country’s culture and customs. as a result, the couple can experience severe culture shock on their arrival in the host country, as they realise that the culture and lifestyle they experienced on their orientation visit differs significantly from the reality. additionally, it has been suggested that enterprises should offer relocation, housing and placement assistance, and provide expatriates and their spouses with lists of property agents, appropriate schools, shopping centres and medical clinics prior to the assignment (cherry 2010:139; kim & tung 2013:1045; purgal-popiela 2011:39). kupka, everett and cathro (2008:1774), however, found that the majority of trailing spouses were rarely prepared for the foreign environment they were to encounter. as a result, the following hypothesis was stated: h1: there is no difference between the preparation required by trailing spouses and the preparation provided to them by the multinational enterprise prior to the assignment. training requirements the trailing spouses’ need for training prior to their departure is emphasised throughout the expatriate literature (fischlmayr & kollinger 2010:471; mohr & klein 2004:1197; smart 2011:64; vögel & van vuuren 2008:85). expatriates and spouses who are prepared for and aware of the host country’s religious, cultural, language, and lifestyle differences, will have a mental idea of potential situations that may arise during the assignment. this mindset of being prepared should increase their confidence in the assignment, eliminate uncertainty, and ease their adjustment in the local environment, reducing the chance of premature return (cho, hutchings & marchant 2013:1053; gupta et al. 2012b:18). in particular, this training should include a focus on both objective and subjective characteristics of the foreign culture, with the objective characteristics focusing on tangible and observable characteristics such as architecture, language and currency, while the subjective characteristics will focus on intangible characteristics such as values, norms and beliefs (shay & tracey 1997:34–35). according to shaffer and harrison (2001:243), differences in the host country’s language and cultural novelty will, however, have a greater impact on the accompanying spouse than on the expatriate, with cultural novelty defined as ‘commonplace features or everyday customs’ of a country’s culture. spouses often struggle to adjust as they become confused, stressed and overwhelmed by their lack of knowledge and understanding of the new, foreign culture and its customs (caligiuri, tarique & jacobs 2009:257; ghafoor et al. 2011:337; gupta, banerjee & gaur 2012a:3560; van erp et al. 2011:75). while expatriates have the stability of a familiar work environment, the spouse tends to be more immersed in the local culture on a daily basis, interacting with locals who may not speak their language and who are not accustomed to dealing with foreigners (andreason 2008:386; cole 2012:313; purgal-popiela 2011:33; wilson 2011:9). kupka et al. (2008:1783) and mohr and klein (2004:1194) found that spouses who acquired a basic repertoire in the foreign language had a more positive international experience, and adjusted more easily than those who made no attempt to learn the language. language and communication problems create social barriers, making it difficult to cope with everyday tasks, form friendships, find employment, and adjust and integrate with the locals (cherry 2010:137; kim & tung 2013:1033; purgal-popiela 2011:38; rosenbusch & cseh 2012:73; sharma 2012:16). enterprises should therefore provide relevant pre-departure and post-arrival training, to assist spouses with adjusting to the host culture and language, and with developing social competences and networking skills (cherry 2010:140; lund & degen 2010:70; okpara & kabongo 2011:29). spouses in general, however, do not receive relevant pre-departure training from mnes, and are sent to the host country unprepared, without any briefing about the new culture they will experience (gupta et al. 2012b:17–21; lund & degen 2010:70; mansour & wood 2010:387; rosenbusch & cseh 2012:63). sims and schraeder (2004:76) found that many managers believe that pre-departure training for expatriates and their spouses is expensive, time consuming, and often ineffective in reducing culture shock. as a result, due to previously high expatriate failure rates multinationals are unwilling to invest in such training programmes. consequently, programmes that do exist tend to be ineffective and run by unqualified individuals (lund & degen 2010:70). as a result, the following hypothesis was stated: h2: there is no difference between the training required by trailing spouses and the training provided to them by the multinational enterprise prior to the assignment. support requirements international assignments usually require trailing spouses to give up the current and familiar structure and stability in their lives, increasing their uncertainty and stress levels and inhibiting their ability to adjust (cherry 2010:133; cho et al. 2013:1052; wilson 2011:38). one of the primary stressors for trailing spouses is the anticipated loss of social support provided by family and friends in the home country. this lack of support increases the spouse’s feelings of isolation, which has been known to cause conflict within the family, resulting in decreased spousal adjustment and expatriate productivity (cherry 2010:133; crowne & goeke 2012:10; mäkelä, känsälä & suutari 2011:190; mohr & klein 2004:2004; smart 2011:31; wilson 2011:38). trailing spouses therefore require strong social support from host nationals as well as the enterprise, in order to successfully adjust in the host country and to reduce failure that often occurs within the first year of an assignment. according to cole (2012:313), fischlmayr and kollinger (2010:472), long (2010:178), wilkinson and singh (2010:178), and wilson (2011:17–18), social support has a significant effect on psychological well-being and personal growth, reducing uncertainty and allowing spouses to get advice from host nationals, form friendships, and share experiences with like-minded people. additionally, recent trends have indicated that the number of dual-career couples sent on international assignments is growing significantly. a dual-career couple is a couple where both the husband and wife are employed, psychologically committed to their work, and earn an income for the family (konopaske, robie & ivancevich 2005:408; mäkelä et al. 2011:186). dual-career couples are often faced with many issues and problems when an expatriate manager accepts an international assignment. these problems often arise when trailing spouses seek employment in the host country, as spouses are often unable to find suitable or satisfying work, or are ineligible to work in host countries with conservative cultures. when giving up their careers, trailing spouses experience role changes and feel a loss of identity and self-esteem. the anticipated loss of additional income and career development may also reduce the expatriate family’s living standards, and lead to disagreements within the family (cho et al. 2013:1053; lauring & selmer 2010:61; shaffer et al. 2012:1295). the resultant stress experienced by spouses in this situation often has a crossover effect on the expatriate’s work performance and adjustment, increasing the likelihood of failure (gupta et al. 2012a:3560; mcnulty 2012:421–422; rosenbusch & cseh 2012:63). alternatively, andreason (2008:388) and rosenbusch and cseh (2012:63) have found that spouses who do not experience a change in their employment status adjust more easily on an international assignment. consequently, enterprises can provide trailing spouses with employment assistance, as spouses who are employed in the host country receive social support, and learn culture-specific behaviours from their host-national colleagues in the workplace. enterprise assistance may include the creation of a position within the foreign subsidiary, assistance with obtaining the necessary work permits, recommending the spouse to other enterprises operating in the host country, or the payment of a spouse’s further education expenses (cole 2012:313; mäkelä et al. 2011:188; vögel & van vuuren 2008:85; wilson 2011:67). kupka and cathro (2007:960) have, however, found that only 10% of trailing spouses who were employed in the host country were assisted by the enterprise in their job search, while 85.7% of spouses struggled to obtain work by themselves. in a study by mcnulty (2012:428) it was found that due to visa or work permit restrictions only 36% of trailing spouses were able to continue with their careers in the host country. in light of these facts, expatriates often refuse an international assignment or their spouse may refuse to accompany them as they are committed to their own careers (cho et al. 2013:1053; els 2007:23; fischlmayr & kollinger 2010:458; mäkelä et al. 2011:188). a statement supported by cartus (in wilson 2011:22) reported a 6% decrease in enterprise spousal support programmes between 2007 and 2010, which was accompanied by a 15% decrease in the number of trailing spouses who accompanied expatriates on international assignments. as a result, forster (1997:427) states that mnes should therefore provide support for the spouse during the assignment, in the form of employment assistance, mentoring programmes, expatriate communities, enterprise social gatherings, health clubs, or regular visits back home, to reduce stress associated with adjusting to an unfamiliar environment. enterprise assistance may also include housing, shopping, schooling advice, counselling, stress monitoring, and supporting work-life balance by introducing the family to leisure, social, and cultural activities (cole 2012:313; crowne & goeke 2012:10; gupta et al. 2012b:1; lauring & selmer 2010:61; rosenbusch & cseh 2012:63; wilkinson & singh 2010:173–174). as a result, the following hypothesis was stated: h3: there is no difference between the support required by trailing spouses and the support provided to them by the multinational enterprise during the assignment. methodology measuring instrument the research was preceded by a comprehensive study of the expatriate literature in order to determine the preparation, training and support requirements of expatriate trailing spouses, before and during an international assignment. qualtrics – a system used to create online surveys (qualtrics 2019) – was then used to construct a self-administered questionnaire which respondents were able to access online through a link contained in an email. the questionnaire contained 34 demographic questions and 22 statements linked to a four-point likert scale. the 22 statements were divided as follows: five statements related to preparation, four statements related to training and 13 statements related to support. these 22 statements were displayed across two columns, one column to measure what trailing spouses felt was required by them in order to adjust and the other to measure whether they received this from the mne. sample non-probability judgement sampling was used with sample members selected based on whether they were trailing spouses currently accompanying an expatriate on an international assignment. these spouses were considered to be in the best position to respond to their needs as well as to what they received from the mne. initially 196 mnes were contacted to determine whether or not they made use of expatriate employees. for those enterprises that employed expatriates, the relevant human resource or expatriate manager was contacted telephonically or via email to request their assistance with distributing details of the study to expatriate spouses. only 17 of these enterprises provided formal consent for their expatriates’ spouses to participate in the study. snowball sampling, although not initially intended as a sampling method, was also used, as trailing spouses who completed the questionnaire encouraged others within their networks to participate in the research. international relocation enterprises, foreign expatriate organisations, expatriate online forums, and expatriate linkedin and facebook groups were also contacted to assist in connecting with potential respondents. finally, 443 responses were received, of which 218 were valid for data analysis. due to the nature of the sampling, the response rate could not be determined as it could not be confirmed how many trailing spouses received the link to the online questionnaire. data analysis firstly, an exploratory factor analysis was conducted to determine whether each of the constructs represented a single or multiple factors. next the internal consistency of the measurement tool was tested using cronbach’s alpha. this was followed by an individual t-test to determine if there were statistically significant differences between the preparation, training and support requirements of expatriate trailing spouses and the preparation, training and support that they were provided with. lastly, a paired t-test was conducted to determine if there were statistically significant differences between the mean scores of the preparation and training requirements and that which was provided to the trailing spouses. ethical considerations this article followed all ethical standards for carrying out research without direct contact with human or animal subjects. results demographic profile of the sample table 1 summarises the most important demographic characteristics of the sample. from this it can be seen that the trailing spouse in this study were predominantly female (91.7%), were between the ages of 41 and 50 (35.3%) and 42.7% felt adjusted to the host country. additionally, 72.9% of the respondents were employed before the assignment, while only 20.6% were employed during the assignment. lastly, the respondents were assigned to six different continents and 52 different countries, asia being the most represented continent, represented by 40.6% of the respondents, followed by africa with 35.0%. table 1: sample characteristics. exploratory factor analysis the number of factors was determined by how many factors had eigenvalues greater than 1 (pallant 2010:192). consequently, one factor emerged each for preparation required and preparation provided prior to departure and one factor each for training required and training provided prior to the assignment. support required and the support provided during the assignment consists of two factors each. each variable under support required and support provided was classified under the factor where it loaded the highest, with table 2 providing a summary of the exploratory factor analysis results. table 2: combined results of the exploratory factor analysis. reliability in total there were 22 variables measuring the preparation, training and support required by trailing spouses and that which was provided to them by the mne. table 3 provides a summary of the cronbach’s alpha values of the variables measuring required factors and those provided for each of them. according to milfont and gouveia (2006:76) and tappen (2010:131), a cronbach’s alpha value that is above 0.70 is regarded as an indication of reliability. as can be seen from table 3, a cronbach’s alpha value greater than 0.70 was achieved for all of the factors. table 3: factor reliability as described by the cronbach’s alpha values. preparation required versus provided all five of the preparation variables showed statistically significant differences (p < 0.0001) between the preparation required by trailing spouses and the preparation provided to them, with the mean scores for what was required all being greater than the mean scores for what was provided (see table 4). table 4: individual t-test results for preparation required versus preparation provided. training required versus provided all four of the training variables showed statistically significant differences (p < 0.0001) between the training required by trailing spouses and the training provided to them, with all the mean scores for training required being higher than the mean scores for training provided (see table 5). table 5: individual t-test results for training required versus training provided. support required versus provided the study found statistically significant differences (p < 0.0001) between the support required by trailing spouses and the support provided to them, with all the mean scores for support required being higher than the mean scores for support provided (see table 6). table 6: individual t-test results for support required versus support provided. paired t-test a paired t-test was conducted for the preparation required versus preparation provided factors as well as for the training required versus training provided factors. the test could, however, not be conducted for the support construct, as the two factors making up the support required construct and the two factors making up the support provided construct consisted of different variables. when looking at the results, a statistically significant difference was found between the preparation required by trailing spouses and the preparation provided to them by the mne (t-value = 15.705) (p < 0.0001). a statistically significant difference was also found between the training required by trailing spouses and that which was provided to them by the mne (t-value = 13.945) (p < 0.0001). these paired t-test results support the results of the individual t-test by showing that mnes are not providing trailing spouses with the preparation or training that they require prior to an assignment. consequently, the following hypotheses could not be accepted: h1: there is no difference between the preparation required by trailing spouses and the preparation provided to them by the multinational enterprise prior to the assignment. h2: there is no difference between the training required by trailing spouses and the training provided to them by the multinational enterprise prior to the assignment. although a paired t-test could not be conducted to test the support hypotheses, it is clear from the individual t-test results that the trailing spouses in this study do not perceive the mnes to be meeting their support requirements. descriptive statistics all the variables focusing on preparation required had a mean score of above 2.5 on a four-point scale, with ‘advance notice of relocation’ being the most required preparation requirement (see table 7). table 7: mean scores for preparation required. meanwhile ‘training regarding similarities and differences between the home and host countries’ objective characteristics’ was the training variable most required by trailing spouses (see table 8). objective training refers to observable and tangible characteristics of a culture such as currency, architecture, and so forth, as opposed to subjective characteristics such as punctuality, attitude to work and the like (shay & tracey 1997:34–35). table 8: mean scores for training required. financial support to further the trailing spouse’s education was the most required vocational support requirement (see table 9), while enterprise-provided visas, work permits and so on was the social support most required by trailing spouses (see table 10). table 9: mean scores for vocational support required. table 10: mean scores for social support required. discussion the expatriate literature suggests that the preparation, training and support of trailing spouses will improve their adjustment to the host country and consequently the success of the international assignment. having said this, decades after first identifying trailing spouses as the primary cause of expatriate failure, this study has found that mnes are still falling short of the preparation, training and support needs of trailing spouses. in particular, this study has found that the largest discrepancy between the preparation required and provided to trailing spouses was for information sessions covering cultural differences between the home and the host country, followed by the need for reading material on the host country, both emphasising their need for information on the host location. these findings support the literature which emphasises the importance of information sessions to enable spouses to understand what it means to live in the host country and to foresee potential issues that might arise, thus enhancing their cross-cultural adjustment (miser 2010:4; simeon & fujiu 2000:597; yu et al. 2005:191). advance notice, despite being the preparation requirement with the highest mean score, was found to be the preparation requirement with the smallest difference between what was required and what was provided to trailing spouses, which highlights a focus on the operational aspects of an assignment. with an increase in dual-career couples, sufficient notice to explore career options in the host country before deciding whether or not to accept an international assignment is vital (moore 2002:64). the longer in advance the notice, the better prepared the spouses will be to cope with their relocation (forster 2000:69; spera 2009:289). with sims and schraeder (2004:76) stating that managers believe pre-departure training for spouses is often ineffective in reducing culture shock, it is interesting to note that the largest differences between training required by spouses and what was provided to them were for objective and subjective cross-cultural training. enterprises are therefore falling short not only in terms of the need for information on the host country, but also in terms of providing the cultural training that expatriate spouses require. thus, a number of studies have emphasised the importance of training programmes to improve spousal adjustment (gupta et al. 2012b:1053; konopaske & werner 2005:1161; miser 2010:2; mohr & klein 2004:1197), as these training programmes would reduce uncertainty and ease adjustment into the local environment (cho et al. 2013:1053; gupta et al. 2012b:18; jenkins & mockaitis 2010:2696; smart 2011:90). in particular, training on the host country’s objective characteristics was found to be not only the variable with the biggest difference between what was required and ultimately provided, but also the training variable most required by trailing spouses. although language training allows spouses to effectively communicate with host country nationals and consequently helps them form friendships and cope with everyday tasks (mohr & klein 2004:1194; sharma 2012:16), of the four types of training tested in this study, language training was found to be the least sought-after requirement. this could, however, be attributed to the fact that 51.4% of the trailing spouses were able to speak the host country language prior to the assignment. in an earlier study by moore (2002:63), it was found that 73% of dual-career couples considered spousal employment opportunities a major factor when deciding to accept an international assignment. however, only a quarter of spouses reported having received career assistance from the mne. based on the finding of this study, this seems to still be a problem, with the largest gap between support required and support provided being for ‘employment counselling’; spouses feel they need counselling in order to establish or advance their career during the assignment. financial support for education enhancement and enterprise-provided visas or work permits were two other important requirements. in both cases, these would enable trailing spouses to upgrade their skills, gain international experience and further their careers prior to repatriation. spouses who are unable to work in the host country may become bored and frustrated and often experience a loss of professional status and self-esteem, which affects their ability to adjust (mohr & klein 2004:1193; shaffer & harrison 2001:241; wilson 2011:38). the findings also indicate a large gap in terms of introducing spouses into expatriate spousal networks, with these networks allowing spouses to get feedback and advice, form friendships and share experiences with others (fischlmayr & kollinger 2010:472; long 2010:178; wilson 2011:18). multinational enterprises focusing on the operational adjustment of spouses over social adjustment was again highlighted, with the smallest discrepancy in respect of support required and provided being for ‘accommodation within an expatriate community/compound in the host country’. a surprising finding was, however, that the least required social support requirement was for a coach or mentor during the assignment as mentoring programmes have been found to relieve stress and anxiety and assist with problem solving (kupka et al. 2008:1771; miser 2010:5). an introduction into expatriate spousal social networks was, however, the second most required social support requirement; possibly indicating that spouses prefer informal mentoring over formal mentoring. in conclusion, the findings of this study show that even though we have been aware of the fact that trailing spouses are the most common reason for the failure of expatriate assignments and we are well aware of the needs of trailing spouses, mnes are still not providing sufficient preparation, training and support to them. seemingly, mnes rather focus on the operational aspects of the assignment and fall short in trailing spouses’ social adjustment needs, supporting an earlier finding by mcnulty (2012:430). limitations of the study although the respondents in this study were assigned to six continents and 52 countries, a possible limitation of the study is that north america, oceania and south america were under-represented as host locations compared to africa, asia and europe. finally, the study only focused on trailing spouses who at the time of the study were on an international assignment. these spouses were considered to be in the best position to identify their preparation, training and support needs as well as what they were offered by the mne. however, a more comprehensive view of the current situation might be gained by extending this study to the expatriate managers of mnes as well as repatriated trailing spouses. acknowledgements the financial assistance of the national research foundation (nrf) towards this research is hereby acknowledged. opinions expressed and conclusions arrived at are those of the authors and are not necessarily to be attributed to the nrf. competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions the problem was conceptualised by both e-l.w. and a.j.v., while e-l.w. was primarily responsible for the data collection and analysis with the assistance of a.j.v. 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https://doi.org/10.1108/10569210580000196 476 sajems ns vol 2 (1999) no 3 the stimulation of an internal locus of control in employees in a manufacturing industry m j c olivier and s rothmann programme in industrial and personnel psychology, potchefstroom university forche abstract south african society is characterised by rapid change as a result of various forces. this results in feelings of frustration, helplessness and uncertainty in employees, which affects their work performance. helplessness, frustration and uncertainty are directly related to an external locus of control, whereas an internal locus of control is related to autonomy, a sense of responsibility and job performance. a two-group design was used to detennine the impact of a training programme aimed at the stimulation of an internal locus of control on employees within manufacturing industry. the training programme contributed to increasing the internal locus of control and psychological optimality of participants, whereas their need for external support decreased and they started to act more autonomously. jelj24 introduction south african society is characterised by rapid change because of international competition, new organisation structures and pressure with regard to affirmative action (morobe & raubenheimer, 1994). as a result of past laws, some groups within south african society have been educationally deprived, which means that they are not adequately equipped for the pressures and demands of a changing work environment (bothma & schepers, 1997; uys, 1993). consequently employees often experience feelings of frustration, powerlessness and uncertainty, which are related to dysfunctional coping strategies and specific personality variables, one of which is locus of control (marais, 1997; raubenheimer, 1998). marais (1997) and raubenheimer (1998) have found that there is a relationship between external locus of control and dysfunctional coping strategies. agathagelou and rothmann (in press) found that locus of control is related to job satisfaction. moerdyk (1986) showed that a clear correlation exists between r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 477 external locus of control on the one hand and passivity, slow decision making and unrealistic expectations of the work environment on the other. in addition, rahim (1996) found that persons with an external locus of control are not capable of managing the pressures, uncertainties and challenges of a demanding work situation. it would therefore appear that various researchers relate an internal locus of control to better work performance. furthermore, it would appear that passive and dependent behaviour is considerably reduced when an internal locus of control is stimulated (day & matthes, 1991; van den berg, 1988). according to zenger (1996), research on programmes for the stimulation of an internal locus of control in the work situation has not received much attention. in addition, it is generally acknowledged that the contents of such programmes are often outdated and that they are not based on fundamental scientific research. furthermore they only comprise the passive acquisition of skills and/or focus on the improvement of educational qualifications (zenger, 1996). the aim of this research is to determine the effect that a training programme aimed at the stimulation an internal locus of control has on employees within a manufacturing industry. locus of control theory the concept locus of control developed from social learning theory (rotter, 1966) and attribution theory (heider, 1958). social learning theory emanated from the view that the strengthening of behaviour leads to an increase in the expectation that the specific behaviour or a special occurrence will be followed by that strengthening of behaviour in future (rotter, chance and phares, 1972). when the individual perceives that strengthening follows one's own behaviour, but is not the result of it, this is typically seen as the outcome of luck, fate or the influence of others, or as something unpredictable. if the occurrence is perceived in this way, it is defined as external locus of control. should the person perceive the occurrence to be the result of own behaviour, abilities or personal characteristics, it is defined as internal locus of control (lefcourt, 1966; phares, 1976). according to plug, louw, gouws and meyer (1997) the concept locus of control is a personality dimension which has to do with the extent to which people feel that they themselves (internal control) or factors within the situation (external control) determine their behaviour. the concept locus of control is related to work performance, autonomy, sense of responsibility and decision making (burke & gottesfield, 1986; erwee & pottas, 1982; moerdyk, 1986). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 478 sajems ns vol 2 (1999) no 3 with reference to the development of an internal locus of control, meichenbaum and goodman (1971) found that the addition of explicit self-instruction to modelling techniques adds to a significant change in behaviour because the individual develops the sensation of internal control. hazareesing and bielawski (1991) found that a significant relationship exists between cognitive selfinstruction combined with didactic competency training and the development of an internal locus of control. according to heider (1958) the attribution theory is concerned with the way in which the individual utilises information from the environment to provide explanations for occurrences (collins, 1974). this theory makes it possible to focus on the individual's method of processing information during training opportunities in order to influence hislher attributes and feeling of control. during individual counselling people can be made aware of their own attributes (e.g. self-concept) and the influence this have on their internal or external control (yamauchi, 1988). in this respect training should focus on cognitive self-insight and improvement of the self-concept. analytical theory (jung, 1971) focuses on opposing sub-systems (attitude and functions) within the person. a balance between these polarities and the transition of an outwardly to an inwardly directed adaptation can lead to a feeling of control over self and the external environment (meyer, moore & viljoen, 1994). jung's theory (1971) relates the individualisation process to the experience of internal control. individualisation not only comprises the initial development of dominant attitudes and functions, but also involves the consciousness of non-dominant attitudes and functions which lead to better adaptation and relationships (day & matthes, 1992). exposure to a growth group eases this individualisation process as group members are encouraged to consciously experience their non-dominant attitudes and functions through continuous feedback from other group members (whitrnont, 1964). the consciousness of blind spots in the psyche leads to self-awareness and a feeling of internal control (day & mattes, 1992; diamond & shapiro, 1973). rogers's person-centred theory (1961) offers a structure for individual and group counselling aimed at the stimulation of an internal locus of control. according to this theory, the individual moves away from the idea of living according to the standards of others towards the perception of himlherself as a self-directed person with standards and values formulated through own experiences (rogers, 1970, 1973). rothrnann, sieberhagen and cilliers (1998) found that individuals accept greater responsibility based on the application of the methods in this theory in a training program. related to this cilliers and wissing (1993) found that a development programme in sensitive relating also contributes to the development of an internal locus of control r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 479 from the above-mentioned theories it is clear that the development of an internal locus of control is also related to self-development or self-actualisation (rothrnann & sieberhagen, 1997). it could therefore be deduced that methods directed at facilitating self-actualisation will be instrumental in stimulating an internal locus of control (see cilliers & wissing, 1993; rothrnann & sieberhagen, 1997). various forms of competency training are related to the stimulation of an internal locus of control. james, charlton, leo and indoe (1991) made use of individual counselling combined with competency training (e.g. reading and spelling) in order to simulate an internal locus of control. the results, however, gave no indication of significant changes in the participants' locus of control. the implication for the work situation is that training in technical skills, conflict management, interpersonal skills and problem-solving may be related to developing an internal locus of control. nurco et al. (1995) found that training in effective problem solving, communication, assertiveness and stress management contributed to respondents developing greater internal control. johnson and johnson (1991) found a statistically significant improvement in the direction of the internal locus of control as a result of exposure to a programme which focused on the acquisition of assertive behaviour, career skills, independence, building family ties and selfperception in encounter groups. shechtman, gilet, fos and flasher (1996) found that a training programme focused on problem solving, conflict management skills and group counselling, contributed to the development of an internal locus of control. zhang (1994) studied the relationship between effective conflict management and the stimulation of an internal locus of control, as well as a better selfconcept and better academic performance. the content of the training programme covered the following four areas: prevention of violence, basic negotiation skills, the application of negotiation skills and basic facilitation skills. the results indicate that the acquisition of effective conflict management skills in conjunction with social support is directly related to an internal locus of control and an improved self-concept. gendron, lemberg, allender and bohanske's (1992) trammg programme is aimed at the improvement of intrapersonal and interpersonal skills, and aspects such as identity, perfectionism and intimacy are included in this programme. in contrast with various other studies, this study found no statistically significant change in the development of an internal locus of control (gendron et al., 1992). yong-she (1990) found that an internal locus of control and sense of responsibility could be improved in significant ways through instruction. he r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 480 sajems ns vol 2 (1999) no 3 found that various forms of instruction as well as the level of intelligence and age-various types were consequential to the development of an internal locus of control and a greater sense of responsibility. various studies have been conducted aimed at self-talk and cognitive selfinstruction. meichenbaum, gilmore and fedoravicius's (1971) programme involved the learning of self-talk styles by means of modelling in order to develop an internal locus of control. knight (1994) found that interventions aimed at the awareness of new perspectives led to a greater internal locus of control. fertrnan and chubb (1992) studied the relationship between personal empowerment programmes and the self-concept, as well as internal locus of control. the workshop comprised smalland large-group activities focused on leadership, communication, assertiveness, stress management and decision making. although the results of this study did not show a significant difference in locus of control, the locus of control in the experimental group became more internalised, while the locus of control in the control group became more externalised. stirling and reid (1992) developed a training programme focused on participant control in order to stimulate a greater internal feeling of control in the sample individuals. the training programme was aimed at the learning of skills such as sensitivity, goal setting, communication, problem solving, the collection of information and the interpretation of behaviour. the results indicate that training in these competencies leads to a feeling of internal locus of control and a positive self-concept. wege and moller (1995) found that competency training in problem solving gives rise to the development of an internal locus of control and post-testing after two months confirmed that results are permanent over the long term. the development of self-insight often leads to the identification of a gap in skills. if skills in problem solving, conflict management, communication and assertive behaviour are learned, the individual experiences more autonomy and internal control in situations. it therefore makes sense to integrate the competency training of individuals in group counselling. individual counselling, followed by an intensive growth group experience with concomitant skills training through active participation, will apparently lead to internal control and should be investigated more intensively by trainers within the industry. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 481 method researcb design a two-group (pre and post-test) design was used to evaluate the training programme (huysamen, 1993). the aim of this design was to determine the effect of the independent variable (training programme) on the dependent variable (self-actualisation and locus of control of participants) (huysamen, 1993). composition of tbe training programme the training programme compiled was based on techniques, methods and personality theories from behaviouristic, humanistic and psycho-analytical paradigms. the training programme had the following components: individual counselling sessions. the purpose of the individual counselling sessions was to create a climate of trust and openness. this offered the participant the opportunity to think about hislher self-actualisation. the discussion lasted approximately 30 minutes per person. growth group. two days of the training programme were presented in the form of a growth group experience, more specifically as an encounter group (rogers, 1974). the purpose was to give the participants the opportunity to develop by awakening their intraand interpersonal awareness in the situation that they found themselves to be. the growth group lasted 17,45 hours. a total of 14 hours were spent on group sessions and 3,45 hours on tea and meals. competency training. the competency training component of the training programme was presented in one day and lasted 8 hours. a total of 6,15 hours were spent on training and 1,45 hours on tea and meals. the competency training focused on assertiveness, interpersonal skills, conflict management and problem solving. participants also had the opportunity of applying theoretical knowledge and newly acquired self-knowledge to practice so that learning could be transferred to the work situation. sample the sample was drawn from various plants in the chemical industry. a random sample of 28 persons (white and black), fluent in afrikaans and/or english, was involved. these persons were randomly assigned to the experimental group (n = 14) and the control group (n 14). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 482 sajems ns vol 2 (1999) no 3 measuring instruments the following standardised measuring instruments were used to evaluate the effect of the training programme: the personal orientation inventory (poi) (shostrom & knapp, 1966) to measure the components of self-actualisation (see table i). table 1 tbe poi-scales primary scales time ratio (tc) measures time competency, i.e. a reality-orientated awareness of the present, where experience from the past and future expectations exist in a meaningful continuity. support ratio (i) measures reaction from the self in an independent and autonomous way, based on internalised principles and motivation. sub-scales self-actualising measures the confirmation of primary values of a selfvalue (sav) actualising person. existentiality (ex) measures the ability to act according to the demands of a situation i.e. to act existentially, without the rigid maintenance of principles. feeling reactivity measures responsiveness to own feelings and needs. (fr) spontaneity (s) measures the freedom to act spontaneously or to be oneself. self-regard (sr) measures the confirmation of the self based on own values or strengths. self-acceptance (sa) measures the confirmation of the acceptance of the self despite weaknesses or shortcomings. nature of man (nc) measures the degree to which a constructive awareness regarding human existence is held. synergy (sy) measures the ability to be synergistic i.e. to transcend opposites. acceptance of measures the ability to accept own natural aggression in aggression (a) contrast with denial, or a defensive attitude regarding aggression. capacity for intimate measures the ability to develop meaningful, intimate contact (c). relations with other persons, without expectations and duties. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 483 the reliability of the poi varies between 0,41 and 0,82 (schulz, 1994). the poi comprises construct validity, as is apparent from the significant correlation with the sixteen personality factor questionnaire (l6pf). the support ratio correlates positively with emotional stability, self-assertion and enthusiasm (as measured by the 16pf). fouche (1998) found internal consistency coefficients varying between 0,24 and 0,75 at a tertiary education institution. regarding the validity of the poi, she found that the construct validity of the poi was acceptable. the locus of control questionnaire (lcq) (schepers, 1995) to measure the locus of control or participants. the lcq consists of three scales, namely external control, internal control and autonomy. external control measures the extent to which the respondent attributes performance to forces outside hislher control (luck, fate. circumstances or influential people). internal control measures whether the respondent attributes performance to causes within hislher control (ability, behaviour, or personal characteristics). autonomy measures whether the respondent believes in hislher ability, acts independently with self-confidence, and decides and takes action to solve problems. the three scales in this instrument were subjected to an item analysis and the reliability was higher than 0,80. significant correlations with the following instruments confirm the construct validity of the lcq: the general scholastic aptitude test, the sixteen personality factor questionnaire; the lung personality questionnaire; the personal, home, social and formal relationship inventory and the survey of study habits and attitudes (schepers, 1995). with regard to criterion related validity, it was found that the questionnaire correlated with a composite criterion of job success (r = 0,62) statistical analysis data were processed with the aid of the sas package (sas institute, 1985). ttests were used to determine the significance of the differences between the averages in the pre-and post-measurements of the experimental and control groups, and to determine whether there was a significant difference in the changes between the two groups (christensen & stoup. 1991). results are considered significant if the p-values are smaller than 0,05. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 484 sajems ns vol 2 (1999) no 3 the practical importance of the results (effect sizes) is noted if the final p-values are statistically significant. cohen (1988) identifies the following cut-off points with regard to effect sizes: d 0,2 small effect d = 0,5 medium effect d 0,8 large effect the practical importance (effect sizes) with regard to the comparison between the experimental and the control group is identified by the following symbols (steyn, 1999): where x e = the mean of the difference between the measurements of the experimental group, x k = the mean of the difference between the measurements of the control group, and smax = the maximum standard deviation between the experimental and control group. the practical importance is set at a significant level of d 0,8, but the medium effect (d = 0,5) is also taken into account. results the differences between the lcq results of the experimental and control group with regard to the different measurements are depicted in table 2. table 2 item external internal autonomy the differences between preand post-measurement in respect of locus of control of the experimental and control groups eg cg p d (n=14) (n=14 x s x s -2728 18,06 6,07 8,81 00001* 11,11' 14,64 11,73 -5,93 8,40 00001* 1,75++ 21,50 1736 -4,29 4,95 0,0001* 1,49++ * difference is statistically significant: p s 0,05 ++ difference is practically significant: d ~ 0,80 (large effect) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 485 based on the results in table 2, it would appear that statistically significant and practically significant differences (of large effect) exist between the pre-and post-measurement of the experimental and the control group. it therefore follows that the training programme contributed significantly to the improvement of the experimental group's internal locus of control and autonomy. the programme also contributed significantly to the decrease of an external locus of control on the basis of the results it is concluded that the experimental group ascribes their performance to consequences within their own control, not to causes outside of their control, while steps were confidently taken to solve problems. the difference between the poi results of the experimental and the control group is shown in table 3. table 3 the differences between preand post-measurement in respect of the poi of the experimental and control groups item eg cg p (n=14) (n=14 x s x s tc 0,50 335 -0,21 2,83 0,5474 i 79,36 8,20 70,71 8,31 0,010* sav 236 3,15 0,21 2,36 0,052 ex 293 5,08 1,86 301 0,502 fr 1,71 375 021 2,04 0,203 s 2,07 2,33 1,21 2,49 0,355 sr 1,79 2,64 0,14 1,23 0,048* sa 2,07 2,73 0,00 2,57 0,048* nc 0,92 2,34 0,36 2,28 0,517 sy 1,86 1,51 0,00 1,57 0,003* a 2,36 3,82 -0,29 3,91 0,081 c 4,79 5,10 2,21 3,00 0,115 * difference is statistically significant: p ~ 0,05 + difference is practically significant: d ~ 0,50 (medium effect) ++ difference is practically significant: d ~ 0,80 (large effect) d 1,04068+ 0,630,761 18on the basis of the results in table 3, it would appear that a statistically significant and practically meaningful difference (of medium effect) exists between the preand post-measurement of the experimental and control groups with regard to the sav dimension of the pol statistically significant and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 486 sajems ns vol 2 (1999) no 3 practicaliy significant differences (of large effect) exist between the preand post-test of the experimental and control groups with regard to the i, sr, sa, and sy dimensions of the poi. the experimental group showed increased reaction from within the self and reached decisions independently, while striving increasingly towards selfactuaiisation. an increasing feeling of self-regard was experienced by the experimental group, which is characterised by self-acceptance in spite of shortcomings or weaknesses. it is clear from the experimental group's actions that they increasingly possessed the ability to act synergistically and see opposites in a meaningful relation. as a result, it follows that the training programme added to the improvement of the participants' self-actualisation. discussion the training programme in locus of control and self-actualisation did contribute to the participants' internal locus of control and positively influenced their psychological optimality, as measured by the various instruments used to determine this. concerning external locus of control, it can be predicted that participants will be less inclined to ascribe performance to causes outside their control, such as luck, fate or influential people. with regard to autonomy it can be expected that the participants would believe in their own abilities following the training programme and will act independently and with self-confidence in decision making and problem solving. in relation to personality characteristics, the training programme succeeded in increasing the experimental group's level of psychological optimality. this was in contrast to the control group. the following dimensions, as measured by the relevant instruments, are indicative of the experimental group's selfactualisation: with regard to the support ratio, it may be expected that participants will act independently and autonomously. they will be more inclined to act from internalised principles and motivation and succeed in taking decisions independently, immediately following the training programme. regarding selfactualisation, it may be expected that participants will strive towards self-actualisation immediately following the training programme. this tendency indicates that participants live according to values belonging to selfactualisation. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 3 487 concerning self-regard, it may be expected that the participants' feelings of selfworth will improve immediately following the training programme. with regard to self-acceptance it may be expected that participants will accept their own weaknesses and shortcomings immediately following the training programme. regarding synergy, it may be expected that the participants will possess the ability to see and transcend opposites meaningfully immediately following the training programme. a combination of stimulating self-awareness and self-development through individual counselling and a growth group experience (day & matthes, 1992), and training in conflict management, interpersonal effectiveness as well as problem solving (nurco et al., 1995; shechtman et aj., 1996) may lead to employees accepting responsibility from an internal locus of control. it is clear from the literature study that the locus of control cannot be seen in isolation and that various personality dimensions, as measured by the ppi, are related to the locus of control. self-assurance, a healthy self-concept, socioeconomic status, job autonomy, contentment and meaningful interpersonal relationships have been related to the locus of control by various researchers. the empirical research results of this study are therefore supported by other . research in the literature too (see day & matthes, 1992; hazareesing & bielawski, 1991; rothmann et ai., 1998). the empirical research included members from various job levels within the chemical industry. this led to a very heterogeneous experimental and control group, which could have influenced the results of this study. the nature of the research however placed restrictions on the size of the research group. the experimental group was limited to 14 participants which limited the generalisation of the results. half the control group (n = 7) were not employed in the industry after three months, and the long term results of the programme could therefore not be determined. certain sections in the industry where the research took place were characterised by authoritarian supervisors, which resulted in the desirability of the internal locus of control being questioned and regression to a lower internal locus of control and higher external locus of control being highly likely. from a systems approach, it is recommended that variables within the organisation, which exercise a limiting influence on the development and maintenance of internal locus of control and leads to weaker performance, be researched. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he 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(1990) "development of 'locus of control' related to responsibility in middle-school students", school psychology international, 11(3): 209-15. 54 zenger, j.h. (1996) "great ideas revisited", training and development journal, 48-51. 55 zhang, q. (1994) "an intervention model of constructive conflict resolution and cooperative learning", journal of social issues, 50(1): 99-116. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol5 (2002) no 2 297 the integration of economics and the environment through incentives: an overview of the costa rican success story j n blignaut department of economics, university of pretoria hj anderson centre for &ientific and industrial research, pretoria abstract conservation is often perceived as the responsibility of the landowners. if landowners fail to benefit from conservation, they inevitably view it as profiteroding and it becomes less attractive than alternative land-use practices. costa rica has successfully internalised the benefits provided by forestry environmental services. valuable lessons could be learnt from the costa rican experience in using economic incentives for environmental management. jelq23, q28 1 introduction failure to internalise the benefits of conservation results in conservation being viewed as mainly an expenditure item that should be borne by the landowners, both public and private. this causes landowners to perceive conservation as a cost that reduces profits, and thus potentially their sustainability as a business. the inability of landowners to benefit from the environmental services provided by their land causes them to invest in other land use practices where their economic and financial return is greater. in developing countries, where rural communities depend on the natural environment for their survival, the situation is especially troubling. this is so since the continuous use of the environment not only threatens the sustained delivery of ecological services, but the reduction of natural resources implies less livelihood means (anderson & de wit, 2002). the above scenario was also evident in costa rica, but after decades of deforestation, bold steps have been taken to internalise the benefits provided by forestry environmental services (see castro, 1999; castro et ai., 2000 and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 298 sajems ns vol 5 (2002) no 2 chomitz et at., 1999). this paper focuses on the costa rican experience in using economic incentives for environmental management, with the purpose of making recommendations for south africa on how to go about capturing the value of its environmental services. 2 costa rica in a nutshell costa rica is a predominantly spanish speaking latin american country covering 51 000km2 (compared to south africa's 1.2 million km2), initially almost all covered by tropical forest. it has a population of approximately 3.6 million, and its economy currently relies on tourism and the production of bananas and coffee. costa rica's forests are rich in biodiversity, and despite its small size, costa rica contains an estimated 4 per cent of the world's species (chomitz, brenes & constantino, 1999). the country has a stable democracy, with an inflation rate of approximately 17 per cent (imf, 2000) and an annual gdp per capita ofus$4 194 in 1999 (world bank, 2001). the world bank classifies costa rica as a lower middle-income country whereas south africa is classified as an upper middle-income country. from this evidence it is clear that costa rica is not more wealthy than south africa. rather the contrary; the problems that it faces are perhaps even more daunting. 3 motivation for the use of economic incentives as an environmental management tool 3.1 deforestation in costa rica while in 1950 more than half of costa rica had been covered by forest, by 1986 merely 29 per cent of the country was still covered by forests. the decades of deforestation had been driven by rapid expansion of the road system, cheap credit for cattle and land titling laws that rewarded deforestation. the underlying policies that supported the harvest of the forests are embedded in the conventional wisdom that growth in man-made capital equates development and indicates progress. this implies a tax on the environmental services rendered by forests vis-a-vis man-made capital, or, viewed differently, that the investment in man-made capital was subsidised due to the inappropriate valuation of forestry services. this is also proven by the fact that agriculture, and especially pasture, had replaced forest cover, and of the 35 per cent pastureland only 8 per cent is believed to be suitable for that use (chomitz et at., 1999). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 299 3.2 forestry environmental services after the results from a national land cover survey in 1979 had become available, costa rican authorities realised drastic measures were necessary to reduce the rate of deforestation. this decision was based on a new understanding that it was necessary to preserve forests because of the many environmental services that they provided. these include: biodiversity or the diversity of species, hydrological services, carbon sequestration, eco-tourism and scenic views. it is important to conserve biodiversity for its bioprospecting value (various products use material from natural flora and fauna, including perfumes, cosmetics, pesticides and pharmaceutical products), eca-tourism value, and for its ecosystem services, such as the provision of healthy habitats for animals. well-functioning watersheds also provide important hydrological services since the loss of forests in important watershed areas may result in soil erosion and subsequent sedimentation in rivers and streams. this sedimentation can reduce the quality of drinking water and cause losses in hydroelectric production potential. it also increases the risk of flooding, which in turn may result in further losses in potential electricity generation (chomitz et al., 1999). the loss of forest cover has therefore very real economic cost implications over and above the services that forests provide. forests and woodlands provide valuable carbon sequestration services. carbon sequestration can be seen as the direct removal of from the atmosphere, and the subsequent long-term storage of carbon dioxide. through the maintenance of primary forests, and the promotion of plantations or secondary growth, the costa rican landowners assist in the reduction of atmospheric concentrations of carbon dioxide, thus reducing the negative economic impacts of climate change (anderson & de wit, 2002). 3.3 valuing the natural wealth of forests given the new understanding of the services forests render and that the presence of forests can prevent damage to man-made capital, attempts have been made to estimate the average annual value per hectare of forestry environmental services. however, this is not simple, due to the fact that there are no relevant markets within which to capture the value of these services. furthermore, the value of forestry services varies among different plots, in accordance with the ecological features of each. in table 1 are kishor and constantino's (1993) estimates of these ecological values. it is clear that values for carbon sequestration are quite large and dominate the values for the other services. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 300 sajems ns vol 5 (2002) no 2 table 1 estimated environmental values of primary forests (in 1989, suslba) type of benefit i. hydrologic benefits a) water supply for urban centers b) loss of hydroelectric production potential c) protection of agricultural land d) flood control total 2. carbon sequestration 3. ecotourism (non-consumptive use values) 4. future pharmaceuticals ( option values) 5. funds transfers (existence and option values) total net present value at 8% i average annual value 2.3 4.6 10 20 0.25 2.0 4-9 -17 36 60 120 -13 25 0.15 -13 32 -102 214 -1277 2671 source: castro, tattenbach, gamez & olson, 2000, originally adapted from constantino & kishor, 1993 having realised the importance of their forests and in an effort to protect then, costa rica has developed legal instruments and institutional arrangements that allow the internalisation of these benefits. landowners now have an incentive to conserve their forests and safeguard the integrity of their land. 4 developing the relevant legal and institutional regimes the mid-1990s saw the establishment of a remarkable set of innovative institutions to harness the new philosophy described above. the key legal instrument was a new forestry law, ley forestal #7575, adopted in 1996. this law recognises the value of the ecological services rendered by forests and provides the legal and regulatory basis to compensate forest owners for" the environmental services offered by their lands. the law addresses four key environmental services provided by forests: carbon fixation, watershed protection, biodiversity and protection of natural forest ecosystems in life zones of particular importance. subject to certain provisions, such as a certified forestry management plan, this empowers the forestry authority to contract with forest owners, and to compensate them for the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 301 environmental services their lands offer (castro, tattenbach, gamez & olson, 2000). to coincide with the new forestry act, 1996 also saw the establishment of the costa rican office for joint implementation (ocic). this office had the authority to formulate policy for joint implementation (n) and activities implemented jointly (aij) programmes and reports to the ministry of environment and energy (minae). the office established project approval criteria and originally assisted in the development of over is project proposals. more recently, its strategy has exclusively been to promote three national projects, focusing on the consolidation of parks (protected areas project), natural forest management (private forestry project) and renewable energy. these national-scale projects reduce the transaction costs associated with developing and marketing projects. these costs constitute one of the biggest obstacles to developing countries wishing to participate in ji and au (castro et al.,2oo0). the national forestry financing fund (fonafifo) was established within the environmental ministry (minae) in 1991 to provide incentives and loans for reforestation. in 1997, however, based on the new forestry act and the jii aij office, fonafifo became involved in managing the domestic administration and finances of the national forestry incentives, and in executing payments to landowners under the forestry environmental services program (fesp) (castro et al., 2000). thus, by 1997, several institutions saw to it that landowners were compensated for the benefits that their land provided. incidentally, 1997 was also the year of the kyoto meeting and costa rica was therefore ready to take advantage thereof. 5 how the system functions 5.1 forestry environmental services program by 1998, the payment for forestry environmental services program (fesp) compensated three types of activities: reforestation, natural forest management and forest protection; and provisions were made for a fourth activity, namely forest regeneration. in return for the payments, the landholders had to cede their carbon and other environmental service rights to fonafifo for five years, whereas they promised to manage or protect the forest for a period of 20 years (or is in the case of reforestation). this obligation was registered in the public land register and would apply to any future purchasers of the land. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 302 sajems ns vol 5 (2002) no 2 monitoring is currently the responsibility of each participant's supervising forester (who was also responsible for drawing up the forestry management plan for the property) (chomitz et ai., 1999). at present three payment levels exist. one for each type of activity under fesp (chomitz et ai., 1999). the main competitive land use with which the fesp must compete is the grazing of cattle livestock, as pasture land accounts for one third of the country. the opportunity cost approach values the benefits of environmental protection in terms of what is being foregone to achieve it (garrod & willis, 1999). this approach forms the basis for estimating value of the compensation payments. it is thus relevant to ask what the opportunity cost would be to cattle ranchers if they were to dedicate their land to the fesp. analysis has indicated that the cattle sector has shown profits of between us$8 and us$125 per hectare per year, depending on such aspects as management and ranching practices and land characteristics and location. thus, it is clear that most landowners would switch to reforesting their land under the fesp program, as under this they are offered us$96 per hectare per year (assuming an approximate exchange rate of 250 colonesius$, march 1998) (chomitz et ai., 1999). similarly, if a landowner within the cordillera central area had been renting a hectare of pasture at the current average rate of us$20 to us$30 for that area (castro et ai., 2000), he would be fmancially better off by conserving the remainder of the natural forest on his land. this is based on an incentive payment of us$40 per hectare per year for forest protection, under the fesp program (chomitz et al., 1999). castro (1999) for instance has found that the annual rent necessary to switch from coffee to forest protection was $1 186 per hectare per year for a farm just outside of la amistad. this demonstrates the variability in the productive value of land that could be earmarked for conservation. this also highlights the dilemma created by the current three fixed payments for the different forestry activities within fesp, which do not take into account the marginal value of the land. it is believed that the program has had substantial excess demand for participation, which is a clear indication as to the level of general acceptance by the landowners of the programme. since there is a smplus supply, the applications need to be prioritised. these prioritisation criteria include: hydrological importance, significant biodiversity and close proximity to existing protected areas. a program such as this, which involves a number of micro enterprises and activities on grassroots level, involves substantial transaction costs, making participation for smallholders relatively more expensive. a number of ngos have therefore adopted the role of intermediary between government and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 303 landowners; they also bundle together collections of smaller, individual projects (chomitz et al., 1999). 5.2 financing environmental services payments the main source of funding for the fesp is a tax of 15 per cent on fuel sales, dedicated to the reduction of greenhouse gases and the protection of biodiversity, established under ley 7575 in 1996. one third of this (5 per cent) is dedicated to forestry through fonafifo (chomitz et al., 1999). in addition, mlnae established a carbon fund in 1997 to distribute 'rights' or 'credits' in exchange for monetary deposits from domestic and international sources. the carbon fund will also be able to finance jllaij activities, while fonafifo can only compensate private landowners for environmental services (castro et al., 2000). the secondary source of funding is the sale of certifiable tradable offsets (cto) (the costa rican version of a certifiable emission reduction (cer», a fmancial instrument designed by costa rica to transfer (sell) greenhouse gas (ghg) offsets in the international market. the offset amount is the difference between the actual carbon emissions and the baseline emissions, i.e. those that would have been emitted in the absence of the project. this is expressed in carbon equivalent units sequestrated (chomitz et al., 1998). the costa rican verification process certifies ctos, although investor confidence could be strengthened if a third party monitoring the certification process were to be established. ctos are pre-approved; thus they should appeal to investors who wish to avoid the costs of developing and submitting a ji project for evaluation. cros are also fully transferable and guaranteed by mlnae for 20 years (castro et al., 2000). the operation of fesp is shown in figure 1. from this diagram it is clear that landowners sell offsets (environmental services) to the national forestry financing fund and are, in tum, compensated for these offsets. the funds to pay for the offsets originate from firstly the fossil fuel tax levy and secondly the carbon or greenhouse fund. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 304 sajems ns vol 5 (2002) no 2 figure 1 the forestry environmental services payment scheme 5% fossil fuel tax source: castro et ai., 2000 eto. 6 financial impacts and initial capital flows based on the scheme discussed above, the following initial transactions took place: july 1996 saw costa rica's first sale ofctos. costa rica signed a contract with norway, for us$2 million worth of carbon sequestration services, at us$ i olton. the money contributed to the private forestry project, and more specifically to the expansion and reconstruction of a hydroelectric facility. a cooperation project with the dutch government was the first non-carbon sequestration ctos project. this project involved the anaerobic treatment of organic waste from coffee processing, resulting in annual reductions of 500 tons in methane emissions. the centre for financial products, launched at the chicago board of trade (in 1993) is promoting the development of the cto market. the centre has a contract to broker four million tons of costa rican carbon over the next twenty years. this will generate over us$40 million in revenues. furthermore, two major bioprospecting agreements have together resulted in fimding of us$4million to inbio, costa rica's national institute of biodiversity (castro et ai., 2000). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 305 the success of the costa rican forestry incentive program has also encouraged the world bank and the global environment facility (gef) to finance the eco-markets project. this project aims to support the development of markets at the local level for the forestry environmental services, at the regional and national level for energy, and at the global level for carbon offsets. most recent is the proposed fund for renewable energy (frer), which aims to support the development of small renewable energy projects to meet increased demand for energy within costa rica and its neighbouring countries (project idea note, 2000). 7 lessons for south africa from the experience of costa rica, it is clear that a small developing country can make an international contribution to the reduction in ghgs through the protection of environmental services and contribute to local development simultaneously. costa rica showed that smalland large-scale sustainable forestry that includes rewards for environmental services is viable and feasible. a country wishing to develop an environmental services payment scheme faces a number of challenges. these include: adequate finance; deciding on an equitable payment structure; the additionality requirement (which involves establishing which offsets are additional to the business as usual-scenario); lastly, recognising that the environmental services provided by properties differ in quality and quantity, and also that costs of participation can differ dramatically. some specific factors that must be considered by south africa when seeking to implement an environmental services payment scheme are the following: landowners have implicit rights to take actions that could result in carbon dioxide emissions and biodiversity loss. landowners provide environmental services by refraining from these actions, which is in contrast with the pol/uter pays principle (chomitz et al., 1999). south africa must therefore derme its property rights and environmental services. landowners could in principle sell each service independently in different markets, but there are strategic and practical advantages to having a monopsonist, who purchases all the landowner's services and resells them on the domestic or foreign markets. (in costa rica this role is held by fonafifo.) a strategic advantage is that the monopsonist can appropriate r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 306 sajems ns vol 5 (2002) no 2 some of the rents, and use this revenue to secure, for example, biodiversity services, which may not have a market (chomitz et al., 1999). if a monopsony is used, a pricing strategy must be defined. the choice here is between fixed and differentiated prices. the fesp program adopted the fixed price approach, due to its simplicity and appearance of equity. however, if prices are set high enough this can generate excess demand for participation, and would-be-participants need to be prioritised. fixed prices may also be socially and fiscally inefficient, and may cause favourable properties, needed for watershed protection, not to enrol in the program (chomitz et al., 1999). alternatively, differentiated pricing can be used. this would enable properties to be compensated for the bundle of services they provide. this scheme achieves social efficiency, but does not yield excess revenues for the implementing agency, unless an administration fee is added. another option would be to hold a reverse auction, where the implementing agency's budget is revealed and property holders bid for placing their property under protection. the agency can then finance the lower bids first or apply a prioritisation criteria (chomitz et al., 1999). a prioritisation strategy will be necessary regardless of the pricing strategy, as biodiversity preservation cannot be left to an entirely decentralised or market-orientated approach. different priority-setting systems exist, that weigh various criteria, or benefits and costs, thus developing an appropriate scoring system. an example of this is the us conservation reserve program's environmental benefits index (chomitz et al., 1999). 8 conclusion after decades of deforestation, costa rica has taken bold steps to internalise the benefits provided by forestry environmental services. they have developed the necessary legal and institutional regimes, thus enabling landowners who choose to conserve or reforest their land to benefit from their actions by receiving financial payments. this indicates that creative and innovative thinking coupled with the boldness to act upon it through the establishment of an appropriate institutional and operational infrastructure can have major consequences. south africa can only gain from such an approach. the challenge for south africa is to develop its own version of a conservation cum development scheme. this scheme would have to encourage landowners and producers to limit their environmental footprint and to market the environmental services of the rich biodiversity of south africa, whilst developing the country. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 307 references anderson, h.1. & de wit, m.p. (2002) "capturing the value of environmental services: lessons for south africa", csir. report no. env-p-c 2002-007. 2 castro, r. -( 1999) "valuing the environmental service of permanent forest stands to the global climate: the case o( costa rica", unpublished doctoral thesis. 3 castro, r., tattenbach, f., gamez, l. & olson, n. (2000) 'the costa rican experience with market instruments to mitigate climate change and conserve biodiversity", environmental monitoring and assessment journal, 61(1): 75-92. 4 chomitz, kom., brenes, e. & constantino, l. (1999) "financing environmental services: the costa rican experience and its implications", science of the total environment, 240(1-3): 57-169. 5 garrod, g. & willis, k. (1999) economic valuation of the environment: methods and case studies, cheltenham: edward elgar. 6 imf (2000) international financial statistics (ifs), washington dc: imf. 7 project idea note (2000) "costa rica: fund for renewable energy of the ecomarkets project", unpublished. 8 world bank (2001) the little green data book, from the world development indicators, washington dc: world bank. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 no 3 542 globalisation of the tourism industry: future trends and challenges for south africa e heath department of tourism management, university of pretoria abstract the pressure of globalisation is having a major impact on tourism destinations throughout the world. the implications for destination marketers are profound and the response will require a new strategic focus and approach. this paper focuses on the changing global tourism environment, with particular emphasis on the key trends and developments that are likely to occur in the early part of the twenty first century. the paper concludes with an outline of the key factors that need to be addressed to ensure competitive success for developing tourism destinations such as south africa. jel 010 introduction attempting to understand and interpret the impact of globalisation and the future of tourism is very much like peering into a crystal bail it may not be possible to bring the future into a clearly focused picture, but the powerful light of a dynamic and ever-changing industry is glowing at the core of the crystal bail the one feature that will increasingly distinguish the "new" tourism from the "old" tourism is the fact that not only will rapid globaiisation and change be increasingly evident, but it will be accepted as inevitable and therefore tourism organisations will need to manage change. in this paper, the changing global tourism environment is explored with particular emphasis on the key trends and developments that are likely to occur in the early part of the twenty first century. particular emphasis will be placed on the possible implications of these trends to the tourism industry in southern africa. all indications are that in the first decades of this century there will be certain predominant global drivers of change. whereas in the mid-nineteenth century and the early decades of the twentieth century transport developments were key drivers of tourism change, major technological advances and the maturing of the tourism marketplace have characterised changes in the tourism industry since the mid-nineties. this suggests that some of these variables are already evident, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 543 sajems ns vol 4 (2001) no 3 appropriately states, "to cope with future tourism planning, management and research, tourism professionals should be renaissance men and women". this statement is particularly relevant to the southern african tourism industry, which has abundant tourism potential, but is also faced with major challenges. to optimise the tourism potential of the sub-continent, tourism professionals will increasingly have to innovatively and pro-actively imagine, anticipate and gauge the future as a basis for future planning, development and management of the tourism industry. 2. globalisation as a megatrend of strategic importance to tourism as the concept ofa "global village" increasingly becomes a reality, mainly as a result of technological advancement in transportation and communications, the world faces several questions of sustenance, peace, economy, stability and survival. globalisation of tourism is indeed one of the many factors responsible for the above. it has been described as a "megatrend", which is associated with different dimensions and consequences both positive and negative (adejuwon, 1996). in a generic tourism sense, globajisation comprises three basic elements. first, there is the geographical side. the term covers intraregional and interregional travel, and the extension of tourism to a worldwide scale. second, globalisation can be seen in terms of convergence in world tastes, product preferences, and life styles, which leads to growing standardisation and market homogenisation (a trend towards similar customer preferences worldwide). a third basic element is the existence of internationally similar practices around the world, such as distribution systems, marketing practices, product development, etc. the first and second characteristic is more demand orientated, while the third is supply orientated (vanhove, 1996). the globalisation of the tourism industry has several significant strategic implications. it increases competitive pressures by bringing more entrants into the market. it increases the complexity of doing business, from learning to find and manage employees with a diverse background in the different countries to designing and delivering products uniquely suited for special interest travel markets. it also requires a new knowledge base. for example, with economic and business activity becoming increasingly internationalised, there is a great need for managers of both private and public tourism organisations to interact with the complex global environment. in the next decade tourism managers will require a global perspective in order to respond positively to a myriad of crises, such as overcrowding of tourist attractions, overuse and destruction of natural r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 no 3 544 resources, resident-host conflicts, loss of cultural heritage, increased crime and prostitution, inflation and escalating land costs, and a host of other political, socio-cultural, economic and environmental problems that may be brought about or exacerbated by tourism development (moutinho, 2000: 315). technological progress in the fields of transport and communications has created the conditions for increasing globalisation of the economy and of our culture. the speed of travel has improved dramatically in recent history. towards the end of the 19th century, it took a whole day for the mail coach to cover 160 kilometers. today a jet airplane spans more than 1000 kilometers in a single hour. the introduction of the market economy in many countries, and their integration at the same time into the world economy, is creating an even larger world market while increasing economic growth on a global scale (as outlined in figure i). figure 1 globalisation of the tourism marketplace market expanintegration sion in the world with the arrival economy of new destinai tions i i i i globalisation i process i i i growth competition of international between destinatourism at varytions based on i ing speeds price and quality source: kellar (1996) globalisation is changing the nature of international tourism. growing prosperity in the emerging nations, and the increasing international division of labour will make tourism the most important economic sector on a worldwide scale in this millennium. the market has undergone a significant expansion in recent years. new destinations have sprung up. large tourism companies have been created, that are not dependant on any particular nation and have branches all r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 545 sajems ns vol4 (2001) no 3 over the world. they take advantage of the new technologies and offer increasingly professional, industrially standardised, unifonn products (kellar, 1996). 3 the key globalisation drivers of change impacting on tourism an important part of the tourism management process is the understanding of the key drivers of change impacting on tourism and detennining appropriate responses to these changes. broadly speaking, there are two types of influences. on the one hand, there are a number of influences that are outside the control of tourism itself and yet will have an impact upon its development (e.g. political developments, environmental disasters, etc.). these can be termed external or uncontrollable variables. on the other hand, the changing nature of the tourism industry itself is also driving change internally within the sector. these can be tenned tourism-related variables. on a practical level many of these variables and trends are interlinked and are combining to accelerate the pace of global tourism change. for example, while there is no doubt that the economic, political and social trends that will be identified in the next section, will continue to encourage the growth of tourism, the future direction and shape of the market will also change with consequent implications for the management of destinations and products. for instance, the trend towards more frequent, yet shorter trips will demand more leisure facilities close to generating markets. the key tourism-related factors that individually and collectively have a bearing on the future sbape and direction of tourism are outlined in table land discussed below. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol4 no3 546 table 1 globalisation and the tourism interface key global drivers of i impacting on the: tourism change critical success factors to eni sure destination competitiveness f---= • emergence of the "new" tourist· technological advances. tourist (consumer) level: changing travel patterns, attitudes, requirements and expectations . . tourism business unit level: . , understanding the new rules of global competition anticipate and responding to the strategies of leading global "best practice" destiglobal economic drivincreasing mergers, ac-i' ~ __ ~~~ ____ ~~~ __ +-__ ~ __ ~ ____________ ,-__ ~n~a~ti~0.n7s'~~ __ ~ ____ ~--i capitalise' on the unique and distinctive characteristics of destinations and , · ers. quisitions, strategic al: liances and networks. environmental awarea strategic and marketi---=:--.,--__ -:-___ ,--_,--... ~__:-__:c-_:_-+_---'b:::r=:and accordingly. make quality tourism experiences and the profitable delivery of tourist (costumer) value the key focal · ness and sustainability factors. demographic shifts. intensification of competition. an increasingly important relationship between tourism and peace. regional trade blocks and the rise of the citystate. increasing importance of safety, health and ethical issues. increasing focus on human resource devel: opment and knowledge i transfer. , driven focus becoming increasingly importantdestination development i • and marketing level: :.m. • increasing emphasis on i' responsible, sustainable and participative touri ism practices. • destination marketing , increasingly innovative, strategic, participative and focused on technology-based market-: ing tools. i' i i source: author's own construction point think globally, plan regionally and actjocaliy. manage the integrity and authenticity of destinations in a sustainable marmer. acknowledge "people power" as the key to successful and sustainable tourism. develop the vision, leadership, culture and mechanisms to continuously adapt to global "waves" of change. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 547 sajems ns vol4 (2001) no 3 3.1 the emergence ofthe "new tourist" the conventional ways of addressing tourist motivation and behaviour are rapidly becoming outdated. for example, it is no longer possible to predict the purchasing habits of tourists simply by labeling a group as "upmarket" or "price conscious". in the current tourist market various paradoxes in tourism behaviour are emerging where existing opposites occur simultaneously. greater risk taking and greater security and greater sameness and greater diversity increasingly occur side by side. for example, it is not strange to fmd chartered accountants getting back to nature with bungee jumping and river rafting, but then also campers who drive luxury, air conditioned 4x4 vehicles to "rough it" in the nature areas of botswana. the same individuals may shop at both a budget-oriented discount store and a famous department store and buy take-aways from kentucky for lunch and dine at an exclusive upmarket restaurant for dinner. the reality is that tourism, leisure and recreation lifestyles are increasingly contradictory and inconsistent. of particular relevance to the tourism industry in southern africa is that tourists from knowledge-based economies (e.g. western europe and the usa, which comprises approximately 70 per cent of south africa's overseas visitor arrivals) are increasingly found to be more experienced, more discerning, and more demanding. in particular, they are seeking more individualised experiences, often characterised as special-interest travel. such travelers "are more interested in enriching their lives with experience rather than hands-off entertainment. they seek interactive, highly involved, quality travel experiences, focusing on indepth coverage of the special interest topic or destination at hand" (mcintosh et ai., 2000: 689). in terms of the future demand for international tourism, it is increasingly fashionable to talk of the rise of the "new tourist", a term coined by poon (1993). a "new tourist" is described as an individual who will shun the homogenised, mass market tourism products and destinations in favour of a more adventurous, active and individualised approach to holiday taking. the "new tourist", which is increasingly drawn from an older age group, is knowledgeable, well travelled, educated, discerning, demanding, environmentally aware and prepared to pay a premium for high quality products and services. this shift has major implications for tourism providers in southern africa, as the motivations for travel move away from passive sun, sand and sea experiences towards educational and curiosity motives. at the same time it is argued that travel will increasingly be shaped by flexible working practices and early retirement. this increasingly knowledgeable and sophisticated new tourist can now be catered for by a tourism industry that is firmly embracing the marketing r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 no 3 concept, and which is further facilitated by technological developments such as the intemet, global distribution systems and database marketing. a key question that emerges in southern africa is at what rate the traditional annual family holiday mostly spent at a beach resort, may be gradually superseded by multi-interest travel and a range of creative and innovative travel experiences (such as activity, adventure, learning and nature-based experiences). cooper et al. (1999: 454) argue that, particularly with regard to international tourists, these trends will see the relative importance of conventional tours decline in favour of independently organised tourism. a practical trend that could increasingly impact on the tourist travel patterns from southern africa's key source markets was highlighted in .the wto report (1999) on leisure time. it was found that pressures on job security are growing in the industrialised world to the extent that employees are increasingly voluntarily working longer hours and foregoing some of their paid leave entitlement. this leads to growing difficulty in scheduling leave periods, particularly for dualincome households. one of the implications of this growth of "time poor-money rich" people will be to pursue leisure activities which maximise their available time (e.g. short break holidays, theme parks, cruise holidays). for others, the release from their job pressures will be manifested through a desire for complete relaxation without the need to make any decision or engage in exacting activity a scenario that augurs well for the further growth of all-inclusive resort holidays. the preceding perspectives clearly indicate that the emergence of the "new tourist" has various implications for the tourism industry. so, for example, the emergence of the knowledge-based society is significant for tourism as travel products are merged with education and entertainment. this creates opportunities for info-tainment or edu-tainment at destinations and specifically at commercial attractions through interprepretation and education programmes. the increased sophistication of the "new tourist" will also impact upon product development throughout the industry. it can safely be assumed that not only will there be increased requirement standards of product design, efficiency and safety, but the tourist will also be more critical of products and services and have the experience to compare offerings. furthermore, as the "new tourist" becomes increasingly conscious of value for money rather than simply price, other elements of the marketing mix will become more important. this could mean that quality will remain a key attribute in tourism product development and the "new tourist" will increasingly expect customer convenience in its various forms. in southern africa it can be argued that as international tourism expands, the number of "new tourists" will undoubtedly grow, but for the foreseeable future, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 549 sajems ns vol 4 (200 i) no 3 their numbers will still be overshadowed by the bulk of tourists who will continue to buy packaged holiday products, visit popular destinations and make their holiday choices primarily on the basis of price. 3.2 the acceleration of technological advances one certainty about the future of technological advances is that the rate of change will continue to increase. technology has already revolutionised the organisation, management and day-to-day running of businesses in the tourism industry. it has helped to reduce some of the costs of business operations. the introduction of crss and gdss has assisted in the globalisation of tourism business activity and the impact of the internet is all embracing. many destinations, tourism suppliers and airlines have world wide websites and many now offer incentives to book on-line, with discounts to offset the commission normally paid to travel agents. the use of technology will certainly continue as tourism suppliers increasingly target the on-line booker, providing the flexibility of booking in your home. 3.2.1 technology will enable the jet aircraft of the future to travel further, faster and carry more people continuing developments in transportation will reduce travel times and make the remoter regions of the world more accessible to tourists. key changes and developments that are underway, include: • airbus lndustrie of europe is currently working on a model, the a3xx, which is projected to have 15 per cent to 20 per cent less operating costs than the boeing 747. it will seat 550 economy, business and first class passengers. • airospatial of france is researching a concorde successor, which will be able to fly 300 passengers across 10 000 km at supersonic speeds. • nasa estimates that in the first years of the 21 51 century there will be orders for more than 500 sst planes (moving at twice the speed of sound) worth a totalofus$200. on the sst, a flight from tokyo to los angeles would be cut from ii hours to 5 hours (hanni fin & le quesne, 1998). a major implication of the development of the new range of jet aircraft as outlined above, will be the further reinforcement of the "hub and spoke" transport network arrangement with main airports as the hubs of regional transport systems. there is intense competition between countries and airports to encourage the large passenger airports to use their airport as a hub before passengers are redistributed to other destinations. for example, east asia has seen a spate of airport development and redevelopment in recent years, such as bangkok, hong kong, kuala lumpur and singapore, in order to compete for hub status (hall & r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (200 i) no 3 550 page, 1999). in south africa, johannesburg international airport is being upgraded and positioned as the hub airport for southern africa with a wide array of spokes into the rest of the sub-continent. 3.2.2 the explosion in communication technology arguably the most significant impact that technology will have on the tourism industry is in terms of advances in communication technology. one of its most direct impacts has been the role of the internet. internet usage is currently doubling in volume every 100 days and the value of commerce transacted on the internet is now expected to multiply by a factor of 50 to us$6 billion by 2002 (king, 1998). the internet will not only increasingly impact on promotional channels, but will also be instrumental in cutting out some tour wholesalers and retailers from the travel product supply chain, thereby enabling direct communication between the supplier of the tourism product and the consumer. the overall impact on travel agencies and other suppliers is as yet unqualified but it is sure to be substantial (sheldon, 1997). furthermore, information technology has the ability to dramatically impact on destination images and by implication, visitor flows. technology will without a doubt increasingly influence the way that tourism products are promoted and sold; for example, the viewing of virtual reality simulations of resort facilities prior to making a booking and sales via networked computer systems such as the internet (youell, 1998). from a transactional perspective it is projected that in the next decade tourists will increasingly use smart cards at destinations for travellers cheques and for discounts. before travelling, the internet will increasingly make it possible for visitors to view different rooms and facilities at a hotel in real time through strategically placed cameras. cd-rom brochures will eventually replace paper brochures. on-line booking via the internet and e-ticketing will become established and grow strongly in the next few years. databases on traveller information about preferences and lifestyle will also increasingly be sold on a commercial basis (vellas & becherel, 1999). 3.2.3 the impact of technology advances on the built tourism environment of the future according to futurologists william zuk and douglas olesen, hotel and resort design will be revolutionised with smart building materials, super-structural systems and environmental and energy advances (op. cit., 1998). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 551 sajems ns vol 4 n03 we may see super-structures with high-rise buildings up to 500 stories high. whole areas could be covered using geodesic domes to protect against the elements and extreme climates and resorts may be built on platforms above the water. solar panels used for both cooling and heating, smart walls that keep rooms at constant temperatures and portable inexpensive fuel sources will help save energy (wolff, 1998). possible future developments in terms of the built environment are: • massive multi-storey,floating hotels moored offshore and containing restaurants, shopping arcades, gymnasiums and glass-enclosed elevators that carry tourists directly to the sea floor. • underwater hotels that attract the more adventurous leisure travelers who can peer at the undersea life through their bedroom windows. • the theme parks of the future will be individual-experience centres where technology will let people role play almost anything. for example, in california a victorian-style high-tech house has been constructed that transports visitors back into a romantic version of the previous century. the house includes a three-dimensional film theatre that employs vibrating chairs to simulate motion, a scent-projection device that is coordinated with images on the screen and a state-of-the-art sound system (moutinho, 2000). 3.2.4 can virtual reality become the substitute for the actual tourism experience? a key point of debate is whether technological innovations such as virtual reality (vr) could possibly replace the authentic travel experience. by simply strapping on a body suit and plugging into a vr programme one can be transported to the sights, sounds and sensations of, say, the okavango delta, the serengeti and the kruger national park, virtually within minutes. the tourist can safely experience the destination without being at the risk of the side effects of travel. however, the destination also forfeits the positive effects of income and jobs creation and regional development. while one view is that the possibility of "experiencing" a destination without actually visiting it is merely a fantasy, it does seem logical that such an approach could fmd acceptance among members of a knowledge-based society. if successful, there can be no doubt that "virtual reality tourism" could have significant implications to the tourism industry. while the debate continues regarding the potential impact of vr on tourism, it is unlikely to completely remove the pursuit of "getting away" to relax in a different environment and place. in terms of technology, one of the most significant changes occurring globally is r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 n03 552 the continued growth of artificial environments for tourism and leisure activity. this is reflected in the global theme park industry, which generates us$ll bn a year, with an estimated 119 theme parks spread across the world. these parks received in excess of 300 million visitors in 1996, many attracting over one million visitors each a year (page et al., 200 1). proponents say that, as cocooning behaviour increasingly positions the home as a central and secure base for leisure activities, vr may suppress demand for the real thing. opponents contend that vr will simply wet the appetite for more travel through enhanced exposure to, and awareness of, the product (cooper et al., 1999). the technological advances outlined above may make life simpler and more convenient for tourism service providers and tourists. however, many (possibly the majority of) travellers, still seem to value the personal touch of dealing with another human being. most people, especially older travellers, do not view doing-it-themselves as saving time, but as an unnecessary added effort (cook et al., 1999). 3.2.5 will global technology trends revolutionise the tourism industry in south africa? the wto (1999: 36) postulated the following technological developments that could revolutionise the tourism industry in the next decade and beyond: • the increasing use of smart card destination loyalty schemes where the user gets discounts for using the card at a destination and, in return, the destination gains valuable marketing information about its customers; • plastification of travellers' cheques, again using smart card technology; • internet video telephony whereby consumers can "test drive" a prospective holiday by viewing current pictures through cameras placed in hotels, clubs, restaurants, and other sites in the destination and transmitted via the internet; • intelligent agent computer programmes which are a combination of preentered information (e.g. likes and dislikes in respect of holidays) and observed behaviours in use of on-line booking patterns to make suggestions on possible options for the user, thus saving time in "surfing" the internet; • cd roms are likely to be increasingly used as electronic brochures, saving time in the inspection of paper brochures. these are likely to be sponsored by both tour operators and destinations; « on-line booking via the internet is certain to grow rapidly over the next decade with access available to most of the population of industrialised countries. though transfer of such access to usership in respect of travel bookings may take time, it is clear that this medium will achieve increasing uptake in the next 10 to 15 years; r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 553 sajems ns vol 4 (200 i) no 3 • e-ticketing (or ticketless travel) is being operated on a limited basis already, by a number of airlines; • central databases of traveller information will provide extensive insight into individual travellers' preferences and behavioural patterns, and will be available commercially. 3.3 globalisation and the economic drivers of tourism growth two of the most important driving forces behind changing travel patterns in this millennium are globalisation and economic growth. although economic growth rates in much of the developed world are expected to stay relatively low in the short and mid-terms, several developing countries are expected to maintain relatively high levels of growth (hall, 2000). eventually, as many as nine of the top 15 world economies will be from today's third world nations. for example it is projected that within a generation, china will overtake the usa as the world's largest economy. according to world bank figures, the top ten economies are likely to be china, usa, japan, india, indonesia, germany, south korea, thailand, france and taiwan (youell, 1998). the long-term implications of growth in these tourist-generating regions for world tourism cannot be overestimated. with their large populations the emergence of a new middle class with increased leisure time and greater discretionary income will have repercussions throughout the tourism system, which may be likened to the significance of growth in japanese outbound travel in the late twentieth century (hall, 2000). 3.4 the globalisation and convergence of tourism, leisure, sport add entertainment one of the most significant global trends in tourism is the convergence of the tourism, leisure, sport and entertainment industries. developments in communication technology have provided coverage for global sports, events and entertainment, enhancing the capacity of events to increase their televised audience. in such a scenario the desire of growth coalitions to bid for and host events may be expected to increase (hall, 2000). 3.5 the growth in international alliances another dimension of economic globalisation with implications for tourism is the growth of international alliances between various airlines and other parts of the tourism industry, including the accommodation and hospitality sectors. although airline deregulation and freer trade arrangements may provide for new entrants in the aviation industry, the economies of scale of the existing alliances r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 no 3 554 will make it extremely difficult for new entrants to compete. the supply of these transnational corporations could have major consequences for some destinations, as their capital is shifted according to the ability to take advantage of differences in labour costs, exchange rates and tax benefits from government. simultaneously, the ability of secondary tourism businesses to adapt and survive in the international political economy of tourism in the 21st century will very likely depend on the creation of appropriate network arrangements between businesses (buhalis & cooper, 1998). 3.6 trends towards "sameness" and "distinctiveness" one of the key outcomes of increased globalisation is the trend towards "sameness" around the world, but with indications that there are increasingly strong counter pressures to maintain individuality and cultural distinctiveness. a visit to any major city in the world demonstrates how information, economic pressures and the tendency to imitate, has left the world "less different" than it was decades ago. mcintosh et at. (2000) however argue that the human entity, while recognising the pragmatic value of sameness, is determined at the same time to make every effort to preserve and enhance his or her unique identity. creating unique and distinctive tourism experiences that are true to the theme and character of a particular destination, may be one of the key challenges facing tourism developers and destination marketers in this millennium. 3.7 tbe increased concentration of economic power a major trend that could have significant implications in the long run, is that the concentration of capital is increasingly in the hands of a few major players in the tourism sector; a trend that also drives tourism towards the performance indicators and business practices demanded by the finance industry. the pace of concentration being generated by both horizontal and vertical integration is such that for medium-sized companies in tourism the days ahead may be difficult. a particular problem associated with this trend is that most of the larger corporations do not have a committed longer-term relationship with a specific destination. some commentators feel that they will therefore be less sensitive to the impact of their operations on the host environments, economies and communities. in addition, small and medium-sized tourism enterprises and local destinations fear the relationships that can emerge from dealing with large companies. to complement these global players a new breed of successful, smaller, niched, operators are emerging as influential in the future of tourism (cook et al., 1999). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 555 sajems ns vol 4 (2001) no 3 3.8 geographic boundaries are becoming obsolete from a tourist perspective key challenges brought about by giobalisation are, among others, that tourism service offerings must have universal appeal, and product development must stress adaptability to succeed in a global marketplace. from a consumer perspective, boundaries and territories are becoming obsolete, replaced by the universal appeal for the latest, newest and best value in both products and services. moutinho (2000) warns that winners will recognise globalisation as the macro force for success, while losers will be those who fail to understand or adapt to it. 3.9 the importance of developing countries in the future tourism scenario in spite of the globalisation of tourism, many developing countries are still in several ways removed from the mainstream of international tourism except for the newly industrialised countries, which are also new tourism markets. a critical evaluation of the situation at the turn of the century indicates that both in terms of visitors and revenue tourism has been concentrated in three main regions, namely europe, north america (usa and canada) and the far east and pacific countries. in 1997 these three regions accounted for 84.3 per cent of international visitors and 87.3 per cent of revenue. it follows that international tourism accounts for only 15.7 per cent of visitors and 12.7 per cent of income in all african countries, latin america, the caribbean, the middle east and south asia (vellas & becherel, 1999). on a positive note, there are various factors that could contribute to the growth of tourism in developing countries during the first decades of the new millennium. these include: • opportunities offered by electronic distribution channels: developing countries and new markets can be represented on an equal footing in the global market, using electronic distribution channels such as the internet. it is becoming increasingly affordable and cost-effective to set up a website that can be accessed by any computer linked to the global network. • the need for tour operators to offer new destinations (geographical diversification): developing countries can respond to the needs of the main generating markets by offering alternative destinations. • the need for tour operators to offer new products (product diversification): tourism demand is increasingly orientated towards new types of experiences, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (200 i) no 3 556 particularly cultural and environmental. new markets in developing countries often have a rich natural, cultural and historical heritage, which tour operators are promoting to cater to changing demand (op. cit., 1999). 3.10 increasing environmental awareness and sustain ability factors from the literature it is apparent that the environment is increasingly taking "center stage" in tourism. as the tourism policy forum pointed out: "development must, in the future, be compatible with the environment". the forum also emphasised " .. that tourism is among the better alternatives for land use". while such compatibility is positive and encouraging, there are other areas where compatibility between tourism and the environment is more complex. for example, the use of fossil fuels for transportation and their polluting effect can have major implications in the future (mcintosh et al., 2000). as a consequence, the sustainability of tourism in the long term could be seriously jeopardised unless alternative nonpolluting energy sources become available and are utilised. on a practical level, there is a wide range of environmental variables that will significantly impact on the future of tourism. these include long-term factors such as global warming and the erosion of the ozone layer. on the demand-side, fear of skin cancer and eye cataracts may reduce the demand for products such as beach tourism that, in turn, will impact upon destinations and product development. on the supply-side, the raising of the earth's temperature and the consequent impact on winter sport destinations, as well as rises in sea levels, will increasingly affect tourism. as much of tourism investment is found in locations flinging the coastline, and as vital tourism resources such as the flora and fauna of destinations could permanently be altered by global warming, tourism stakeholders are faced with major challenges in the future (cooper et ai., 1999). of major concern for the future of tourism is the extent to which population growth and demands for increased material standards of living, will put pressure on the planet's scarce natural resources. despite the assurances of some futurists such as naisbitt (1994) that technological solutions will be found, there are still natural limits to growth that the goals and values of sustainable development are seeking to address. in tourism terms it raises questions about the increased cost of fuel from about the year 2020 onwards (hall, 2000). 3.10.1 visitor management a key to sustainability the growing demand by tourists to visit some of the world's "honey pots" is causing many destinations to consider methods to manage visitors more effectively, for their own enjoyment and also for the protection of the product itself. so, for example, the popularity of certain national parks in the united kingdom r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 557 sajems ns vol 4 (2001) no 3 and the united states has led to the consideration of a ban on motor vehicles entering some of the parks. during peak months, florence insists that coaches prebook if they want to visit the centre of the town. time-controlled ticketing for attractions has also been implemented at many key european attractions, and certain ones have been declared off-limits to tourists, such as stonehenge in the uk (wto, 1999). hall (2000: 93) warns that growth in tourist numbers as well as overall pressures stemming from population growth, particularly in developing countries, will mean that access to tourism facilities will need to be restricted if their environmental value is to be maintained; often by the adoption of a user-pays philosophy in order to maximise returns to govemment or private agencies. 3.10.2 the increasingfocus on green issues green issues are expected to dominate the future strategies of tourism businesses and destinations. vellas and becherel (1999) argue that tourism businesses will increasingly incorporate environmental policies into their strategies in order to attract more business either by making the environment the focus of their product or to target specific consumers, and/or by using their environmentalawareness credentials to enhance their image. on a practical level, one technology that is being embraced by the tourism industry is recycling. for example, the national restaurant association in america has reported that more than 7 out of 10 operators purchased products made from recycled materials and roughly 3 out of 4 operate recycling programs (cook et ai., 1999). more green hotels are appearing internationally, but also in southern africa. in a green hotel, for example, guests place a card on their pillow that indicates whether or not they would like their sheets changed and only the towels left on the floor are replaced. these simple practices save millions of litres of water and prevent the release of tons of detergents into the environment. from an operations standpoint, it saves on the cost of linen, labour and equipment. most employees and guests are embracing green hotel practices with enthusiasm. recycling holds the future promise of additional operating efficiencies and environmental benefits (cook et ai., 1999). destinations will also increasingly develop and promote sustainable tourism and eco-tourism to enhance their appeal to a wider tourism audience. a note of caution is however sounded by vellas and becherel (1999: 310) that in practice these strategies may not in all instances represent genuine consideration by the organisations towards green and sustainable issues. there is concern that envir ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 3 558 ronmental issues are increasingly used and sometimes exploited as a marketing ploy to tout for more business. 3.10.3 agenda 21 and sustainable tourism in the future agenda 21 is a comprehensive programme of action adopted by 182 governments in 1992 at the united nations conference on environment and development (unced), better known as the "earth summit". it provides a blueprint for securing the sustainable future of the planet, from now on into the 21 si century. in short, agenda 21 represents a commitment to an important strategic thrust, which now requires specific initiatives from all levels of society and from business communities (youell, 1998). the wttc (1995) has translated agenda 21 into a programme of action for the tourism industry, highlighting priority points for both the public sector and commercial operators. for govemment departments, national tourism organisations, companies and representative trade organisations, the wttc sees the overriding aim in relation to agenda 21 as establishing systems and procedures to incorporate sustainable development considerations at the core of the decision-making process and to identify actions necessary to bring sustainable development into being. building on the philosophy and foundations provided by agenda 21, the tourism industry itself is increasingly demonstrating that it is indeed responsible and acting to curb some of the excesses of past development. so, for example: • the wttc, (referred to above), has introduced an environmental awareness programme, green globe. • the pacific area tourism association (pata) has launched an environmental membership and endorsement entitled green leaf. • "green suitcase" sets out environmental quality standards for resorts, accommodation and travel agents in europe, developed by okologischer tourisrnus in europe. • companies have initiated awards, such as tourism for tomorrow by british airways (cooper et ai., 1999). 3.11 demographic shifts shaping the future direction of tourism possibly the key demographic factor that will affect the future of tourism is the ageing of the world's population. this substantial demographic change has occurred because of dramatic improvements in health care and is predicted to continue well into the coming centuries, as long as the world's resources are able to support the increases in population. currently, 11 per cent of the population is r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 559 sajems ns vol4 (2001) no 3 aged 60 and above. by 2050, one out of five will be 60 years or older; and by 2150, one out of three persons will be 60 years or older. however, the older population itself is ageing. the increase in the number of very old people (aged 80 and older) between 1950 and 2050 is projected to grow by a factor of from 8 to 10 times on a global scale. as well as general ageing of the world's population, there are also substantial regional differences in the aged population. for example, currently one out of five europeans is 60 years or older, but one out of twenty africans is 60 years or older (hall, 2000). in some developed countries today, the proportion of older persons is approximately one in five. the united nations predicts that during the first half of the next century this proportion will reach one in four and, in some countries, one in two (united nations, division for social policy and development, 1998). based on the fact that the majority of the world's tourists come from the developed countries (wto, 1996), such a demographic shift will have major implications for the international tourism industry. not only will certain types of tourism such as cruising and soft adventure tourism, continue to grow in popularity, but also the provision of health and related facilities for retirees may become increasingly important in destination development strategies. other demographic factors could also be significant. for example, the breakdown of the traditional nuclear family in many western countries marked by increased single parenting, people marrying later, more people never marrying, and many people never having children, will not only influences demographic characteristics but will also affect the pattern of holiday taking and leisure travel (hall, 2000). 3.12 moving into an era of alliances and hyper competition alliances and partnerships in tourism development and promotion is growing at various levels in the tourism industry. in countries that are still developing their tourism industry or where the private sector is weak, the public sector will remain at the forefront of destination marketing as it is today. however, where tourism is well established it is increasingly apparent that the role of the public sector is more of a supporting, facilitating and enabling nature. in the private sector, airlines have pioneered the development of cooperative alliances to gain greater brand recognition and operating synergies. for example, the alliance between british airways and american airlines that signaled possible dominance in the north atlantic marketplace, gave rise to the competing star alliance. the star alliance created a global airline network consisting of united, lufthansa, air canada, sas, thai airways, and varig, which together serve almost 600 cities in over 100 countries. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (200 i) no 3 560 a trend that seems likely to continue in the foreseeable future is the development of partnerships between the government and the private sector. such cooperative relationships already exist: from the world tourism organisation (wto) through to national, provincial and local governments (wto, 1998). given the fact that direct government funding for tourism is increasingly under stress, the creation of such relationships is hardly surprising. an increasing global trend that is also manifesting itself in southern africa, is the increase in subcontracting of many functions needed to support guest ser· vices. operations such as cleaning, laundry, and food service will increasingly be performed by outside contractors. in some situations the operating company will own the facilities and equipment and rely on the expertise of outside contractors to provide and manage labour. in other situations space will be leased to subcontractors, who in tum will make the investments in equipment as well as manage the entire operation. this trend is already becoming evident in the number of fast-food outlets that are appearing in hotels, airports, theme parks, service stations and food courts in malls. on another level, hyper competition in the tourism industry is intensifying at many levels and is being perpetuated by four broad processes. these are: • customers require improved quality at lower prices • rapid technological change, enhanced through the use ofit • the expansion of very aggressive companies which are willing to enter mar· kets for a number of years with a loss leader product; with a view to destroying the competition so that they will harness the market in the long term • government barriers towards competition are progressively removed throughout the world, with some markets still holding back on the deregulation in the aviation sector (d' aveni, 1998). the implications of hyper competition and technological change for the tourism sector are that the role of the consumer will become increasingly important, especially in relation to service quality. service quality will therefore continue to be a major component of the future shape of tourism provision. 3.13 the increasing emphasis on the relationship between tourism and peace the vital relationship between tourism and peace is receiving increasing attention, particularly since the ftrst groundbreaking global tourism conference on the very important theme "tourism: a vital force for peace" held in vancouver, canada during october 1988. this conference, which has been a major building block in progressing the relationship between peace and tourism, was attended r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 561 sajems ns vol 4 (200 i) no 3 by more than 600 delegates from 64 countries around the world. the main focus of the conference was to explore ways in which the world's hundreds of millions of international travellers could, by increasing interests, improving attitudes, and engaging in various social and other activities, contribute to better mutual understanding and appreciation an important contribution towards world peace (mcintosh et al., 1995). one of the key outcomes of the conference, which could have particular relevance to the future of tourism, particularly in southern africa, was the credo of the peaceful traveller. the credo of the peaceful traveller grateful for the opportunity to travel and to experience the world, and because peace begins with the individual, i affirm my personal responsibility and commitment to: • journey with an open mind and gentle heart, • accept with grace and gratitude the diversity i encounter, • revere and protect the natural envirorunent that sustains life, • appreciate all cultures i discover, • respect and thank my hosts for their welcome, • offer my hand in fiiendship to everyone i meet, support travel services that share these views and act upon them, and • by spirit, words and action, encourage others to travel the world in peace. source: mcintosh et al., (1995) the vital and often fragile link between tourism and peace in southern africa is without doubt critical for the future. in this regard it is important to recognise how much progress has taken place since the dark years of sanctions and isolation, which is reinforced by the announcement that mpumalanga will host the continent's first afiican peace through tourism conference in march 2002 (travel now, may 18,2001). 3.14 regional trade blocks and the rise of the city-state a trend that is becoming increasingly apparent is the growing importance of regional trade blocks. one of the best current examples in this regard is the new "borderless europe", which is fast becoming a reality. the north american free trade agreement has created another block. in response to these two initiatives, the asian nations are starting to reflect on the need for an equivalent arrangement (mcintosh et al., 2000). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 3 562 one of the major goals of regional integration (e.g. in europe) is to arrive at common standards, a common currency, and a more common political system. a key implication from a tourism perspective is the effective elimination ofborders, which could greatly facilitate travel flows. at the same time, it is postulated that over time, it will greatly reduce national distinctiveness and thus the appeal of a particular country as a unique travel destination. there is increasing evidence that as a reaction to the decline of national identities, there will be a reactive rise in the importance of major metropolitan centers or city-states. mcintosh et a/., (2000) argue that these city-states may become the focal point for both economic development and for individual identity. of particular relevance to tourism is the possibility that the new city-states may also become the primary basis for destination development and promotion whether it is as cultural centres (such as dublin), gateway centers (such as johannesburg) or for hosting major events (such the 2008 olympics in beijing). 3.15 the increasing importance of health, safety and ethical issues in tourist decision-making the terms "tourist health" and "tourist safety" relate to concerns for the wellbeing, welfare and wider safety of the visitor not only while travelling from the origin area to the destination area, but particularly the way in which their health and personal safety are affected by their activities in the destination. in the area of physical (as opposed to economic) security, it is increasingly apparent that risk of physical danger diminishes the prospects of a given tourism destination or travel-related firm. war and turmoil in parts of africa, eastern europe and the middle east have affected tourism both locally and worldwide. terrorism aimed at us air carriers has diverted traffic to competitors (mcintosh et a/., 2000). the horrific terrorist attacks on the world trade centre in new york and the pentagon in washington during september 2001, has possibly changed the shape and direction of tourism for decades to come. concern for health is of increasing importance, particularly for older travelers. in a different but related vein, the growing threat of aids has added yet another dimension of concern only this time for younger segments of the population. tourists' behaviour too, is a threat to tourism as the spreading of aids may render some otherwise attractive destinations no-go areas while increasingly intense campaigns against sex tourism may also alter tourism flows and motivations. in some parts of world disease and decreasing levels of safety will constrain the expansion of tourism (cooper et a/., 1999). at the macro-level, the above factors are largely beyond the control of tourism and their consequences may be severe, yet at the micro-level, the tourism indusr ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 563 sajems ns vol 4 (2001) no 3 try will increasingly work towards managing issues such as safety and security at the destination. according to clift and page (1996) there is increasing evidence that adverse experiences (e.g. accidents, injuries and health problems associated with visiting unfamiliar environments) may pose major problems for the tourism industry, particularly given its image as a business selling positive holiday experiences to improve one's quality of life. in extreme cases public perception of the destination may affect the volume of tourist visits, where tourists report a high incidence of health problems during their visit. page et a/. (200 1) argue that although a number of studies have examined the media impact and effect of crime and security issues for tourists and the tourism industry (e.g. pizam & mansfeld, 1996), current thinking and research efforts have not grasped the concept of tourist well-being, preferring to focus on individual dimensions for safety that impact on tourists' experiences (e.g. crime, health and food safety). tourist accidents can also have a major impact on tourism, e.g. in adventure tourism, which is one of the fastest growing sectors of the southern africa tourism industry. of particular significance is the fact that various southern africa adventure activities such as white water rafting and mountain recreation, appear to present an unacceptably high risk of serious and fatal injury to the clients. aside from injuries, there is growing evidence that tourists as consumers are becoming willing to take legal action when their tourism experience falls below the minimum acceptable levels. there are even legal firms specialising in taking action against tour operators on behalf of their clients where their holiday experience was totally unacceptable, due to service breakdowns. for the tourism industry, health and safety issues are an area that will become more important as the consumer becomes more litigious (page et ai., 2001). in its 2020 vision, the wto (1999: 30) summarises the following key issues pertaining to tourism safety in the future: • the safety of air traffic control systems is certain to playa major part in overall air travel safety in the coming years. with the large growth in air travel, many air traffic control systems, even in the us, are struggling to cope. • tourism will not flourish in destinations in civil turmoil, at war, or where tourists' health or security is perceived to be under threat. tourist kidnappings appear to be on the increase with incidents worldwide doubling in the last five years. terrorist groups are becoming more aware that killing or holding tourists for ransom makes good news. • the importance of health within countries and resorts has recently been highr ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 no 3 564 lighted by the withdrawal of many tour operators from the destinations, where many hotels were declared "unclean" after several tourists were taken ill. outbreaks of disease have a temporary impact on tourists travelling to worldwide destinations, but the longer-term damage to tourism would be caused if a disease were actually transmitted from its origin around the world through air travel. 3.15.1 the increasing targeting of tourists by terrorist groups a very unfortunate and more insidious trend in the political dimensions of tourism will possibly be the increased targeting of tourists by terrorist groups for political ends and hostage taking of tourism for ransom and/or publicity. the ability to raise almost instant international media profile through attacks on tourists provides many opponunities for terrorist groups to attempt to achieve their political ends .. furthermore, the continuing growth in major international events and the numbers of travellers to peripheral tourism regions for reasons of adventure, nature and/or culturally orientated motivations can only serve to create further potential for attacks on tourists, particularly when the division between rich and poor in terms of wealth and access to resources continues to grow in the developing world (hall, 2000). 3.16 ethical behaviour a key tourism priority in the future an issue which is receiving increasing attention is the growing concern with ethical business practices in tourism which is reflected in the wto (1999) development of a global code of ethics for tourism in recognition of the need to enshrine many of the principles of global action on the environment, the rights oftourists and workers considering global legislation from other bodies and out comes such as agenda 21. the full text of the code can be viewed at: httpllwww.world-tourism.org/pressreilcodeofe.htrn. table 2 a global code of ethics for tourism the basic principles k tourism's contribution to mutual understanding and respect between people and societies tourism is a vehicle for individual and collective fulfillment • tourism as a factor of sustainable development • tourism as a user of the cultural heritage of mankind and contributor to its enhancement r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 565 sajems ns vol 4 n03 table 2 continued · tourism as a beneficial activity for host countries and communities · obligations of stakeholders in tourism development · rights to tourism · liberty of tourism movements · rights of workers and entrepreneurs in the tourism industry · implementation of the principles of the global co de of ethics for tourism source: wto (1999) this code of ethics is a wider recognition of the understanding and complexity of tourism as an activity that has wide ranging implications for the tourist, the tourism employee, countries and the natural environment. linked to these concerns are the legal and moral concerns with the spread of sex tourism and the impact on children, as reflected in establishment of the child prostitution and tourism watch by the wto and other non-government agencies. a website has been established to uncover, isolate, prevent and eradicate this unacceptable face of tourism. in the new millennium there is increasing evidence that these unacceptable elements of tourism are now gaining public condemnation and will become an increasing issue of strategic concern to stakeholders in the tourism industry. 3.17 increasing focus on human resources development the tourism industry is increasingly under pressure; changing markets, industry restructuring and more competitive domestic and international markets are placing great burdens on the available tourism expertise in the industry. the ability to succeed, and the future performance of tourism and related activities will depend largely upon the skills, qualities and knowledge that managers will be able to bring to their business. this will place increasing pressure on educators and trainers to play a larger role in facilitation, innovation, encouraging empowerment, motivating the workforce and, in partnership with industry, working to overcome the specific problems of tourism. in the future, tourism education and training will have to be responsive to the changing needs of the sector. in this regard, three major trends can be identified: deepening within the subject area. an evolution is taking place in tourism education and training that recognises the need for a broad-based education system. whereas in the past the focus was predominantly on hospitality and travel agency elements, the inclusion of other key elements of the tourism chain in these programmes will ensure that the accommodation sector is well r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 3 566 managed, but also that the country's attractions, transportation, events and ground handling will be professionally managed with high standards of service, destination management and guiding. • broadening to other subject areas. a second trend is the shifting balance between tourism course content and core management and business areas such as finance marketing, economics, accounting, etc. in the future, the tourism manager will need to be knowledgeable in say, generic marketing approaches, but will also have to be able to apply that expertise within a tourism context. • development of quality standards. a third trend is the involvement of international bodies such as the wto (through their tedqual certification system) to integrate quality standards into tourism education and training (cooper et ai., 1999). 3.18 tbe key implications of tbe drivers of tourism cbange as is apparent from the preceding analysis of the key drivers, changes in tourism are a reality as also is the fact that tourism growth is inevitable. this means that, not only will more tourists be seeking authentic experiences in new destinations, but also that most destinations will be seeking to take advantage of these heightened levels of demand to boost income and employment. this is the case for most regions of the world, even the ones that have not traditionally been regarded as potential destinations. all of this means that it will be much more difficult for destinations and tourism businesses to be successful, particularly given the potential impacts of the key drivers of change outlined in this section. the challenge facing every destination and tourism stakeholder will therefore be to identify the key drivers of change; to determine their potential shape and direction; to evaluate the possible implications of the trend; and importantly, to develop appropriate strategic responses. 4 conclusion in conclusion, the various globalisation trends and developments outlined in this paper which indicate that in the future tourism will be increasingly flexible, segmented, customised and diagonally integrated rather than the mass, rigid, standardised and packaged, can be synthesised into the following key global trends that will, according to all indications, dominate the shape and direction of tourism in the 21 5t century (adapted from wto, 1999; cooper et ai., 1999; hall, 2000): • increased globlalisation and localisation, forcing tourism stakeholders to ''think globally, plan regionally and act locally". r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 567 sajems ns vol4 (2001) no 3 • technology and telecommunications will permeate and dominate in virtually every sphere of the future tourism industry. • major emphasis in the travel process will be placed on speed, efficiency, safety and convenience. this trend will be particularly dominant in the tourism transportation sphere. • customers will increasingly "call the shots" through technology such as cd rom atlases, internet inspection of hotels and other facilities, brokers offering discounted rooms on websites, last minute e-mail low fares, etc. • a polarisation of tourism tastes will increasingly evolve (e.g. comfort-based versus adventure-orientated). • globalisation in all its facets will result in a "shrinking tourism world" with increased emphasis on "off the beaten track places". • targeted product market development (especially theme based) will be primarily orientated to one of the three es entertainment., excitement and education. • destination image development., positioning and branding will become increasingly important in tourism marketing, more destinations focus on "image" as a prerequisite to the diversification and expansion of drawing power. • consumers will place increasing importance on sustainable tourism development and ethical business practices when deciding on tourism destinations and the tourism facilities they patronise. • intensified conflict between the increased urge to travel and the consumers' socio-environmental consciousness can be expected to manifest itself at various levels in the industry. when interpreting these trends the view of john naisbitt (1994), one of the foremost futurists is very relevant, namely: trends tell you the direction the industry is moving in. the decisions are up to you. but trends, like horses, are easier to ride in the direction they are already going. when you make a decision that is compatible with the overarching trends, the trend helps you along. you may decide to buck the trend, but it is still helpful to know it is there. from the key trends outlined in this paper it should be apparent that managing change in a fast moving business sector such as tourism will continue to pose enormous challenges for tourism businesses and destination managers and marketers in the 21 st century. what will be increasingly critical in the future will be tourism managers' ability to be adaptable and flexible to change, particularly in fast moving areas such as tourism. increasingly, tourism managers will have to undertake not only the role of management, but also the dynamic role of "agents of change". tourism managers will increasingly have to understand how systems and organisations work and function to create desired outcomes. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 no 3 568 the key global trends outlined in this paper particularly highlighted the fact that the strategic management process in tourism boils down to planning based on uncertainty. the challenge facing tourism stakeholders is to appreciate that dealing sensibly with globalisation trends is not a byway on the road to responsible tourism management decisions, it is central to it. to cope with future tourism planning, management and research, tourism professionals will increasingly have to be renaissance men and women, particularly in the southern african context. the need to passionately imagine, perceive and gauge the future is paramount professional attributes of the tourism professionals oftomorrow. references adejuwon, f. (1996) "globalisation of tourism and its effects on africa with special regard to nigeria", in: keller, p. (ed.), globalisation and tourism, aiest, st. gallen. 2 bulhalis, d. & cooper, c. (1998) "competition or co-operation? small and medium sized tourism enterprises at the destination", in embracing and managing change in tourism: international case studies, (eds.) laws, e., faulkner, b. and moscardo, g. london: routledge: 32446. 3 clift, s. & page, s. (1996) health and the international tourist, london: routledge. 4 cook, r. yale, l. & marqua, 1. (1999) tourism: the business 0/ travel, new jersey: prentice hall. 5 cooper, c., fletcher, 1., gilbert, d. & wanhill, s. (1999) tourism principles and practices (2nd ed.) new york: longman. 6 d' a yeni, r. (1998) hypercompetition closes in, financial times. 7 goeldner, c.r., ritchie, j.r. & mcintosh, r. (2000) tourism: pinciples, practices and philosophies, (8th ed.) new york: john wiley & sons. s go, f. (1996) "a conceptual framework for managing global tourism" tourism recreation research, vol. xxi, no.2. 9 hall, m. (2000) "the future of tourism: a personal speculation", tourism recreation research, vol. 25(1): 85-95. 10 hannifin, 1. & le quesne, n. (1998) "flights of fantasy", time asia, 151 (24) june 22. ii heath, e. (2000) "key trends in destination marketing: lessons from global 'best practice' destinations", in: ruddy, j. and flanagan, s. (eds.), tourism destinations: gaining the competitive edge, tourism research centre, dublin institute of technology. 12 keller, p. (1996) globalisation o/tourism, aiest, st gallen. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 569 sajems ns vol 4 (2001) no 3 13 matas, r. (1998) "south african at meeting backed by ottowa", the canadian globe and mail. 14 mcintosh, r., goeldner, c. & ritchie, b. (1995) tourism: principles, practices and philosophies (7th ed.) canada: john wiley and sons. 15 moutinho, l. (2000) strategic management in tourism, new york: cabi publishing. 16 naisbm, j. (1994) global paradox, new york: warner books. 17 page, s. brunt, p., busby, g. & connell, 1. (2001) tourism: a modern synthesis, london: thomson learning. 18 pizam, a. & mansfeld, y. (1996) tourism, crime and international security issues, chichester: john wiley and sons. 19 poon, a. (1993) tourism, technology and competitive. strategies. wallingford: international. 20 popcorn, f. (1996) clicking, harper collins: london. 21 sheldon, p. (1997) tourism information technology. wallingford: cab international. 22 southern africa's travel now, 28 july 2000. 23 travel now, may 18,2001, 24 vanhove, n. (1996) "globalisation of tourism demand: the underlying factors and the impact on marketing strategy", in: keller, p. (ed.) globalisation and tourism, aiest, st. gallen. 25 vellas, f.a. & becherel, l. (1999) the international marketing of travel and tourism: a strategic approach, london: macmillan press. 26 wolff, h. (1998) a tour of the future, wimberly allison tong & goo, finan publishing. 27 world travel and tourism council (1996) progress and priorities 1996, london: wttc. 28 world tourism organisation (1996) tourism highlights. madrid: wto. 29 world tourism organisation (1998) "governments' role in tourism", wto news. september/october. 30 world tourism organisation (1999) tourism 2020 vision, madrid: wto. 31 youell, r. (1998) tourism: an introduction, essex: longman. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 123 steering in uncertain territory: e-business, globalisation and the south african automotive components industry! sagren moodley school of development studies. university of natal abstract significant and sustainable growth of the south african automotive components industry is contingent upon its ability to compete in a global, e-business-enabled opemting environment. the key challenge facing the south african automotive component industry today is one of connectedness to global trade networks, the genemtion of export volumes and industrial upgmding in global-scale value chains. the domestic components industry will need to levemge e-business for supply chain management and to take part in global trade networks, thus making it urgent for firms to develop it capabilities. by not making the tmnsition to e-business, component firms may be placing themselves at risk of becoming less competitive in the globally interconnected market, impacting on both their current market positions and long-term viability. if this were to happen, it would have adverse development implications for the country, such as job losses, a decline in revenue growth and an eroded export base. jeld20, l62 1 introduction the south african automotive components industry currently finds itself under threat as a net result of: (i) increased international competition due large?, to rapid and sweeping libemlisation of the south african trade policy regime; (2) a stagnant domestic market; and (3) the rapid erosion of local sourcing by south african original equipment manufacturers (oems) as they become increasingly integmted into the global stmtegic operations of their parent companies. according to barnes (2000b: 70), ''uncompetitive firms with poor international linkages will disappear from the (components) industry, but those firms that improve their competitiveness and create appropriate linkages with international firms could benefit from burgeoning export sales". the automotive components industry thus urgently needs to reposition itself in global-scale value chains in order to consolidate relationships with oems and facilitate exports. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 124 sajems ns vol 5 (2002) no 1 transnational companies' (tncs) control of international production and trade networks makes it extremely difficult for domestic automotive component firms to export independently. hence, the issue of connectedness to oems or to tnc first tier component suppliers has become fundamentally important for the longterm survival and growth of the south african automotive components sector. from a development perspective, this exploratory study is important because export growth prospects for the components industry hinge increasingly on leveraging information and communication technologies (icfs) as a means of promoting industrial upgrading within global-scale value chains. in the global automotive industry, tncs are moving quickly to electronically integrate global supply chains. most tncs in the automotive industry are in the process of setting up procurement and supply chain systems. the south african automotive components industry will need to be able to use the internet to take part in these global production networks, thus making it urgent for domestic fums to develop ict capabilities. in a few years time, south african component manufacturers may fmd themselves bidding for business within a global, internet-connected automotive industry. the industry's need to enter export markets and to compete with new entrants in the domestic market has become critical to its long-term survival and growth. flows of information is one critical mechanism through which fums could improve or consolidate their position within the value chain. gaining access to global-scale trade networks is crucial, and digitally connecting to advanced markets whether it is through complex sourcing relationships or through the export of fmished products is critically important. the use of the internet to coordinate production through domestic and cross-border, inter-firm networks is likely to have a significant impact on the competitiveness of the south african automotive components industry. the potential of the internet to create seamless, collaborative supply networks has recently come under academic scrutiny (gereffi, 2000). network-oriented icfs through the compression of space, time and knowledge allow for unprecedented reach, speed and complexity in the management of the automotive supply chain. theoretically, the internet holds great potential for revamping traditional supply chains to improve data flow and streamline operations. the challenge for south african automotive component firms is one of how to position themselves within the evolving intemet-connected global supply chains in order to gain competitive advantage and capture value. drawing on evidence from 19 component firms that are part of the eastern cape (ecbc) and kwazulu-natal (knbc) benchmarking clubs, we explore the uptake, potential and challenges of e·business for the south african automotive components sector. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 125 the objective of this exploratory paper is to provide a preliminary analytical foundation to help focus the policy debate. the. paper is structured as follows. first, it provides a synopsis of the key challenges facing the south african automotive components industry. the importance of an outward orientation, global connectedness to transnational production and trade networks, the generation of export volumes and industrial upgrading for the survival of the domestic components sector is stressed. the next section introduces the eastern cape and kwazulu-natal benchmarking clubs, which provides the research population for this study. this section provides an overview of the clubs, and flags some of the supply chain problems experienced by club members. there is, therefore, scope for e-business to streamline the supply chain and reduce infonnation-related uncertainties. the following section presents a conceptual definition of e-business, and discusses its importance for the south african automotive components sector. next follows some speculation on what kind of impact the internet is likely to have on the components value chain, especially as it pertains to supply chain management. we believe that this is important considering that e-business is still in an early stage of development, and that the current academic research base is quite thin. having established the theoretical foundation for the empirical research, the next section reviews the empirical research fmdings that emanated from the survey of 19 automotive component firms that belong to the eastern cape and kwazulu-natal benchmarking clubs. the fmal section concludes the study. 2 the south african automotive components sector: an overview with the exception of the gennan-owned oems and their global lead source component suppliers, the south· african automotive industry is generally characterised by weak global networking links. the inward-orientation of the south african automotive components sector has been fostered by a history of state protectionism and import-substitution industrialisation (lsi) during the apartheid era (joffe et al., 1995). this inward focus was reinforced by trade isolation, disinvestment and the imposition of economic sanctions during the 1980s and early 1990s. as a result, nationally-based producers were for a long time insulated from the cut and thrust of international competition. since the transition period (post-1994), however, the south african automotive industry landscape has been substantially altered by the twin pressures of globalisation and the rapid liberalisation of the trade policy regime. moreover, in september 1995, the government launched a motor industry development programme (midp) to promote greater integration of the domestic automotive assembly and component industries into the global automotive arena. the primary objective of the midp was to improve the international competitiveness of the south r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 126 sajems ns vol 5 (2002) no 1 african automotive sector, and to grow the assembly and component industries, especially through exports. the south african automotive industry involves multiple players in logistically complex supply chains. the automotive industry can best be described as a "producer-driven" supply chain with multi-layered production systems that are organised hierarchically into tiers (i.e. oems, first, second and third tier component suppliers) (gereffi, 1999) (see figure i). figure i clearly shows that with the exception of a few independent aftermarket suppliers, the south african automotive industry is to a large extent controlled by seven oems, i.e. toyota sa, volkswagen sa, bmw sa, mercedes benz sa, samcor, automakers and delta. currently, the domestic aftermarket provides enough scope and volume to sustain a number of independent component manufacturers of relatively stable technology products such as air filters and batteries. the relationships within and between the automotive value chains tend to be fixed, linear and clearly demarcated. enormous potential, therefore, exists in creating an environment in which relationships between these players can be more direct, cost efficient and interactive. the south african automotive industry is the 18th largest in the world, but accounts for less than 1 per cent of the world market. the industry employs about 82 000 people and accounts for approximately 6.4 per cent of total manufacturing gdp (barnes, 2000b: 52). there are approximately 180 component fums in south africa who supply primarily to the automotive industry, and a further 200 producers who are secondary suppliers (barnes & kaplinsky,2000a: 801). the south african components sector is being forced to adjust to fundamental changes taking place in the assembly industry, le.: (1) the re-incorporation of the previously locally owned and locally controlled domestic assembly industry under global ownersbip; and (2) the increasing integration of the oems into their parent companies' global manufacturing operations (barnes & kaplinsky, 2000a: 799; moodley, 2001)? toyota sa and the delta motor corporation are the two exceptions, as they still have majority local ownership and are still largely inwardly focused. 4 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no i 127 figure 1 south african automotive value chains: a schematic overview potebdallmpact of e-busllless on tbe automotive value challis seamless electronic interand intra·fum communication and infonnation flows icf architecture based on open neiwoib underlided by piii'tiienlbips and tiust in the value chain electronic 8lb tnmsactions high degree oflcf ~ llltegration and interoperabillt high capacity icf netwotting capabilities digital buyer-supp1ier linkagl:s intemet-enabled supply chain iii.iiiligeilult and logistics icf -enabled global connectivity icf -enabled value chain upgrading icf -enabled innovation and leamins curves source:own valne cballll original equipment supply (oes) market for replacement parts & valuechalll2 aftennarket for automotive parts & accessory sales through independent retailers & repair shops value cha1113 south african manufacturers of vehicles and automotive components are becoming increasingly dependent on exports. for example, in 1999, vehicles, parts and accessories comprised 6.5 per cent of total exports; this category did not even feature in 1990 (finance week, 27 october, 2000). in the new liberalised trading environment, the domestic oems have effectively been set free:from local purchasing requirements and now operate in a more or less duty:free tariff structure. the net effect of this is that there has been a recent trend on the part of domestic oems to import components that were previously sourced domestically (barnes & kapiinsky, 2ooob: 232). survival of the south african components industry will, therefore, depend to a large extent on finding a space r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 128 sajems ns vol 5 (2002) no i in increasingly international production networks, largely controlled by tn"cs. thus. greater connectivity of domestic finns to tnc component finns who effectively control design, marketing and technology developments for high value-added products is critical (barnes & kaplinsky, 20ooa, b; barnes, 20ooa, b). 3 the automotive benchmarking clubs the eastern cape (ecbc) and kwazulu-natal benchmarking (kzbc) clubs have as their prime objective the continuous improvement of their members' operational competitiveness through the generation of comparative domestic and international benchmarks. the clubs are effectively a joint partnership between the department of trade and industry through the sector partnership fund and local automotive component finns. club members are component finns who are seeking to improve their competitiveness through a learning network. figure 2 provides an indication of how important the component manufacturers are as a source of employment in both kzn and the eastern cape. figure 2 illustrates the average employment figures for thirteen (out ofa total of nineteen)s club members only. figure 2 shows that average employment levels peaked in 1996 (455 for the eastem cape and 263.5 for kzn). thereafter it has steadily declined, reaching a low of216.04 in kzn and 335.0 for the eastem cape. figure 3 indicates the average turnover figures for the club members, and hints at the potential contribution that the clubs make to the regional and national economy. it is important to bear in mind that figure 3 does not include the turnover figures for 6 component manufacturers.6 according to figure 3, average turnover figures for the eastern cape benchmarking club peaked in 1997 (r99 737 000), and thereafter it has steadily deteriorated by contrast, average turnover figures for the kzn benchmarking club has improved between 1996 (r47 345922) and 1999 (r60 779 499). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no i figure 2 average dumber of employees average number of employees (component manufacturers) ~ 500.00 oj 400.00 ,., 0 1i 300.00 e 200.00 ll.l '0 100.00 0 z 0.00 1994 1995 1996 1997 1998 1999 iliieastern cape (n=5) elkzn (n=8) source: industrial restructuring project (irp) database figure 3 average turnover average turnover (component manufacturers) 150,000,000,----------------------, 1 100,000,000 ii! 50,000,000 o 1995 source: irp database 1996 1997 1998 1999 eleastern cape (n~3) elkzn (n-8) 129 we now look briefly at the comparative inventory performance of ftrms belonging to the eastern cape and kzn benchmarking clubs against their international counterparts. this comparison is based on close benchmarking of like-for-like component manufacturers. inventory level measurements provide a rough proxy for the level of integration in the supply chain. the key inventory control measures considered are: total inventory levels, raw material inventory levels, work in progress levels and finished goods inventory levels. the objective is to present an outline of the variance in inventory performance amongst club members and their international comparators. figure 4 clearly shows that whilst improvements in number of days of total inventory have been signiftcant, the general performance of club members is still well below what is required for international competitiveness. the ftgures suggest that whilst raw r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 130 sajems ns vol 5 (2002) no 1 material (figure 5) and work in progress (figure 6) levels have on average improved significantly, fmished goods inventory holding (figure 7) has significantly deteriorated at many finns. this, however, is in most cases, reflective of an increase in exporting growth rather than actual performance deterioration per se, i.e. many club members are holding on to increased finished goods stock because of monthly or bi-weekly shipping schedules to foreign customers. nonetheless, figures 4 to 7 clearly show that club members have a supply chain management (scm) problem, in that they lag their international counterparts, as it pertains to inventory performance7 inventory, excess capacity and stock--outs are the key consequences of information-related uncertainties in the value chain. e-business, in theory, offers club members the possibility of closer synchronisation of the supply chain with the aim of reducing inventory and shortening cycle times. the uptake of this is that frrms jointly manage inventories across the supply chain, forecast sales together, and plan collaboratively to keep levels of component and completed product inventory down to a bare minimum. figure 4 number of days of total inventory _."dop.,,_-....y.chii> ___ ~ !1imi01111, • '" • ---.. • . --.. ----. i • ' .. ' . .. • it • ,. ,. ,--clutb_(p121 an .1.21 -r:,--~ .. , .... source: irp database r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 figures raw material inventory bolding r.w matetl.! inventory holding: club m.mb.,.. verau. intern.'uon.' count.rpam (i.ntoill./ "r---------~ .. ------~----------------~ '5t---~~~--------------~~~------------~ 30t-----------------------------~~~=_----__, 25t---..... ~.~----~~~--------------------~~ .o+-----------------·----·-·--·--·-·~·~·~~~~~=_~ source: irp database figure 6 work in progress levels wort< in progr __ : club _1mni "" .. u.tnr.m.uon.1 _,""rparla ct.sto t_) 1e 14 ~ 12 ~ 10 i • . " .. ". --. f • 2 0 111$ i ltm i lm7 i i_ f-+-club ........... ( .. 1~ ius 14.11 12,23 11.27 1-. ' __ iml .. 12 7.40 '.a .... '.20 source: irp database ~ -.. i lhe 'on ui 131 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 132 sajems ns vol 5 (2002) no 1 figure 7 finished goods inventory holding f'nlah.d loods inv .... tory holdlnl: club me",".' ••• rsua inc.,n.lion.1 count.rparta (11.5 10 au, •• ~ /' -............. .. 11 .. 12 ,. . -. .......~ ... ./ ~ • ....... ~. -. .... . 2~·----------------------------------~ 111" 1111 'h7 ,.11 ill' --c ........ b.n .-12 '.17 12,'2 ;".21 1'.17 11.14 .. ~.11,1' .... s 11,$4 v .. , source: irp database 4 e-business: towards a definition economic globalisation is being driven by pervasive ict use, deregulation, the opening of markets and global trade expansion (cohen et ai., 2000; dicken, 1998). icfs now fonn an integral part of the accelerated pace of globalisation, linking together nation states into complex webs of transnational exchanges (castells, 1996; gereffi, 2000).8 the internet is becoming a key enabler of the global, digitally networked economy. moreover, economic progress is becoming increasingly knowledge-driven, and ;nfonnation and knowledge are becoming primary wealth-creating assets (castells, 1996; evans & wurster 2000; fine, 199&). although the precursor of the internet appeared in the late 1960s, e-business is primarily a product of six significant transfonnations in the global economy: the globalisation of markets; shift towards an economy based on knowledge and infonnation; the growing prominence of icfs in the economy; innovations in business organisation and practice (such as lust-in-time production, total quality management, knowledge management, etc.); the hberajisation of the telecommunications sector in primarily oecd countries; and technological innovations such as email, the world wide web, internet browsers, and the expansion in the volume and capacity of communication networks (viz. optic fibre, digital subscriber line technologies and satellites). these six factors are closely linked to the emergence of e-business. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . salems ns vol 5 (2002) no 1 133 the term e-business bas no widely accepted definition. in a very broad sense, it means doing business over the internet. we define e-business as any form of commercial or administrative transaction or information exchange that takes place via an internet-based, computer-mediated network. e-business thus entails the application of the internet to the complete value chain of business processes. e-business places a premium on openness, transparency and trust. the internet offers a wide spectrum of potential commercial activities and information exchange (figure 8). this paper focuses exclusively on businessto-business (b2b) internet interactions (i.e. the shaded block in figure 8). there are two main reasons for this focus: (1) our concern is primarily with the potential of the internet for enhancing inter-firm supply chain management, and (2) because current trends seem to indicate that b2b e-commerce will far outstrip that ofbusiness-to-consumer (b2c) e-commerce (intelligence: business in the internet age, may 2000). one of the reasons for the expected exponential growth in b2b e-commerce in the automotive industry is the expected migration of supply chain management from relatively expensive, proprietary (i.e. closed) edl networks to the open network communication system of the internet. b2b e-commerce refers to procurement, logistics and administrative processes occurring between frrms. in b2b e-commerce, companies use the internet to integrate the value-added chain which can extend from the supplier of raw materials to the final consumer. inter-business e-commerce can be divided into two categories: open marketplace-based trade and direct trade between business partners. the former takes place at various internet-based auctions or exchange sites (e.g. covisint), whilst the latter occurs either through a firm's web site which has an online purchasing function or an edl-type network. it bas been argued that b2b e-commerce is likely to spread globally and grow rapidly primarily because of its potential for: (l) controlling business costs (associated with inventories, sales execution, procurement and distribution), (2) connecting to markets through greater geographical reach, (3) value creation, (4) increasing productivity gains and systemic efficiencies in the value chain, and (5) advanced supply chain management (cohen et al., 2000; mm 2000). it appears, therefore, that the south african automotive components industry could, in theory, benefit substantially from adopting e-business. it is to this issue that we now tum. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 134 sajems ns vol 5 (2002) no 1 figure 8 e-business matrix government business consumer employee government g2g g2b g2c g2e business d",g b2b b2c b2e consumer c2g c2b c2c c2e employee i e2g e2b e2c e2e source: own s potential impact of e-business on the south african automotive component value chain: theoretical evidence in the simple, physical value chain, the flow of goods is linear (figure 9), the traditional value chain is seen in tenns of a series of anns-iength, value-adding links from raw materials to end-eustomer (figure 9). in other words, the traditional value chain consists of a sequence of activities with clearly demarcated points of input and output. this value chain model (figure 9) deals with info,rmation as a supporting part of the value-adding process, and not as a source of value itself. contrast this with the intemet-enabled value chain (figure 10) where the value-adding steps are perfonned through and with infonnation. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vot5 (2002) no 1 135 figure 9 a simple physical value chain design production outbound consumption raw materials, inbound logistics, & logistics, marketing, recychng & -j transfonning sales l---l inputs, packaging, etc. pbysical value-adding stages linear and serial rather than interactive source:own the intemet-enabled virtual value chain, on the other hand, is non-linear (figures 10 and 11). rayport and sviokla (1994, 1995) argue that firms today compete in both the physical world of goods (the marketplace) and the virtual world of information (the marketspace). to quote rayport and sviokla (1995: 83), the virtual value chain consists of "a matrix of potential inputs and outputs that can be accessed and distributed through a wide variety of channels". with the virtual value chain, information can be captured in real-time at all stages of the value chain, and can be analysed electronically to improve performance at each stage of the value chain, and co-ordinate across it. in a value chain that is completely networked, the intemet connects every node in the value chain (le. the ''pull'' system becomes operational) (figure to). materials are pulled through the supply chain ultimately by customer request. the logic being that flrms should hold minimum inventory and to make just what is needed when it is asked for and not before. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 136 sajems ns vol 5 (2002) no 1 figure loa virtual corporate value cbain '" web-e.abled euterprije demaudslde :;e !-< supply side resource planaiii2ierp) .. er ~ researcb&. <: iy :> ::::> outbound logistics ttl .... development ::::> marlcding .. 0 cd .. desil!ll " \ ::::> sales .. <> q. c financials &. human ::::> customer service n ~ resources -l .. operations planning &. ~ .. c 0 execution u ::r s pu:rclwing ~. inbound logistics <> :§l z 0 raw materials the corpo d production processes charlldel1atics or the ibtra-ol'lliabatlollll1 blrormadod system: ~ a corporate ponal: a centralised home page with links to various departments and services. includes corporate procedures, rules and regulations; lis well lis corporate news, views and vision. ::> the borne page is used lis the entrance to a network designed to pull all the old 'legacy' computer systems together. ::> seamless information flows through tightly integrated ict links, which promote connectivity and collaboration within the enterprise (b2e), including remote employees. ~ ict -enabled intemal and external processes to improve efficiency and effectiveness within the company. ::> streamlined intemal communications and business processes. the intranet affects the way managers communicate with staff, and staff with eacb other. ~ an information-integrated channel: a high level of overlap and inter-dependency between frontand back-office systems. ~ the intranet provides a way to build a corporate culture to bind employees together. ~ changes in the organisation of work toward flatter hierarchies, the decentralisation of decisionmaking and semi-autonomous project-based teams. the intranet enhances team-building, and encourages (within the company) the emergence of horizontal communities hound together by a common function or interest. ~ the intranet is a quick way to help employees come to terms with changing business methods and terms of competition. ~ knowledge management: involves efficiently connecting employees wbo know with employees wbo need to know, and converting personal knowledge into organisational knowledge. the intranet provides the ideal platform for pooling the creativity, skills and knowledge of a workforce. ::> running online training programmes ror employees. ::> focus is on getting information to key decision-makers. soun:e:own r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 137 gereffi (2000: 2) argues that: "the new digital era of globalization is characterized by an explosion in connectivity that is melting the infonnational glue that holds corporate value chains and global value chains together". with virtual integration, the links are no longer stand-alone, rather there is a proliferation of strategic, infonnation-defined inter-relationships between the various players in the value chain (figure 12). cross-enterprise virtual integration blurs the traditional boundaries and roles of the players in the value chain (figure 12). the linkages between fmos are likely to become more fluid; interactive; pervasive; customised; spontaneous; and potentially, mutually beneficial. further, the digital links enable the finn to become more flexible and responsive to change. the virtual value chain should be seen as an integrated system (figure ii) rather than as "a set of discrete though related activities" (figure 9) (rayport & sviokia, 1995: 78). finns use the internet to integrate the value-added chain which can extend from the supplier of raw materials to the final consumer (figure 11). figure 11 an integrated value cbain raw materials overlap indicates flexible, responsive cligltallinks between the vatu_deling stages end consumers web-based it integration oftbe upstream and downstream businesses ~----------~ higb-eapacity networking capabilities source:own r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 138 samms ns vol 5 (2002) no 1 figure 12 e-business-enabled extended enterprise seamless, internet-enabled information flows vlrllllllliiika: web-based i.terta •• ¢.1 ~ bwdlless-t.busillesa (b2b) supply chaia uuu j i the enterprise ! bu&iaeu-to-customer (b2c) i commddlatiou uau hain i => deployment o~ an intranet" 1 => e-commerce (i.e. e-sales) relationship => integrated siipply c i which streamlmes the fmn' s ! management i internal business functions, and ! => customer service => e-coill!llel'ce (i.e. ei connects individual 1 => customer procurement) : workstations (including remote i management => stock management i empjoyees). . 1 => interactive marketing => integrated fom:asting ! => web-based mternal business: => demand r. . ; process efficiency and j orecastmg => quality systems management 1 effectiveness 1 => orders management => extension ofa firm's intranet l => web-enabled enterprise 1 => extension of a firm's intranet to sii(lplien (i.:;; deployment 1 resource planning (erp) 1 to customers (i.e. deployment of an extranet) : => intemet..:onnected frontand: of an extranet) => move from independence to l back-oflice systems and i => etc. mterdependence i processes 1 => etc. i => cross-fun<:tional orientation ; i => use of collaboration and! i knowledge management tools i l => a move to responsive i i knowledge workers i ~etc. ~ ; ; high speed networldag capabilities a powerful ¥irtwii enaldeel mterprbe (en ..... ) ~---------------~ value generating stream source: own r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 139 figure 11 illustrates how the integrated internet-based systems in place provides firms with the ability to visualise their value chains from end-to-end, i.e. as an integrated whole. the firm can add real value by focusing on what it does best and then collaborating with other firms involved in the overall supply chain. the internet facilitates collaboration both within and betwe.en firms by dynamically sharing information in real-time (figure 12). figure 10 illustrates how the internet enables the networked or virtual organisation to connect, dynamically in real-time, the supply and demand side of the company. through the use ofintranets, companies link their employees, providing them with a new communication platform, and a new way to access up-to-date information that is relevant to them. the next step would be establishing an extranet, in which suppliers and customers have access to real-time and relevant information by linking into an enterprise's internet system. thus making it easier for the company and its constellation of suppliers, customers and partners to work together more effectively (figure 12). the firm focuses on its distinctive capabilities, and then forms strategic alliances with other firms in the overall value chain. increased dependence upon suppliers thus becomes a requirement of the fum, anrl has a major impact on the buyer-supplier relationship. for example, in the global automotive industry, the buyer-supplier relationship which has traditionally been armslength and adversarial is now moving towards a closer collaborative relationship, as a defence against the complexity and uncertainty of markets (humphrey, 1999). the internet holds great promise for the south african automotive components sector in three key areas: (1) increasing the efficiency of internal processes (figure 10), (2) streamlining inter-firm linkages (systemic efficiencies) and (3) connecting to markets (figure 12). dell computer's internet-enabled build-toorder business model, for example, illustrates the power of a fully integrated internet-based assembler/production system (www.dell.com; magretta, 1998). apart from improving intra-firm and inter-fum process efficiencies, the internet can also play a key role in facilitating supply chain learning and innovation. b2b internet-based collaborative interactions and real-time communication is likely to sharpen the competitive edge of the participating firms, reduce information asymmetries, and improve the quality of information embodied in business relationships. however, there are also risks associated with e-business, i.e. cost cutting. pricebased supplier relationships and competitive switching. electronic links theoretically make it easier for buyers to begin and end supplier relationships. component suppliers will lose the protection afforded by familiar inter-firm relationships and the assemblers: and first tier component manufacturers' r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 140 samms ns vo15 (2002) no 1 incomplete infonnation about alternative supply sources. the pursuance of short-tenn price advantages and the concomitant "factory hopping" and "competitive switching", on the part of the assemblers and first tier component manufacturers, is, of course, at odds with upgrading the positioning of south african component manufacturers in local and global-scale value chains. therefore, the building of trust, loyalty and reciprocity to reduce the threat of opportunism and to make it difficult to break long-tenn network relationships is important. 6 empirical evidence table 1 uptake of e--business (n=19) e-business technology: internet edi web site? yes 100.0 percent 73.7 per cent 63.2 per cent the internet is being used mainly for: communication order processing production engineeriogffechnical inventory management logistics sales marketing procurement services & support management of distribution channels research r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no i box 1 key e-business drivers in the ecbc & kznbc ./ globalisation ./ trade iiberalisation ./ customer requirements ./ closer integration with customers & suppliers ./ increased competitiveness ./ connectivity ./ agilityfbusiness flexibility ./ joint ventures ./ market expansion ./ customer retention ./ improved efficiencies ./ cost control ./ customer & supplier information exchange ./ accelerated speed to market ./ the need to streamline business processes ./ spread of the internet box 2 benefits of the internet according to the ecbc & kznbc ./ reduces the cost of information ./ improves inventory management ./ greater geographical reach: increases domestic and international market access ./ gives the firm a competitive edge ./ reduces transaction costs ./ shortens order-ship-bill cycles ./ speed combined with flexibility 141 the previous section reviewed the theoretical evidence supporting e-business in the components sector. we now review the findings that emerged from our empirical survey of 19 south african component manufacturers. according to table 1, all club members have access to the internet, but only 63.2 per cent have a web site. the fact that club members connect with the internet, however, does not mean that internet use is extensive. nonetheless, club members claimed to be using the internet for a wide variety of purposes (table 1). club members are only just beginning to use the internet for supply chain management. currently, the internet is used most extensively for intraand inter-firm communication and for marketing and lead generation, rather than for inter-business transactions. respondents cited inadequate let systems integration and the lack of standards for sharing b2b e-commerce data as the main barriers to fully-fledged e-business. the researchers conducted an internet survey of club members' web sites, the results of which show that they are invariably not much more than a front end, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 142 sajems ns vol 5 (2002) no i an online catalogue with orders being emailed, faxed in, and/or taken over the telephone. customers are unable to check, for example, on service call status, order shipping status and delivery information via the internet. four firms use their web sites to take orders and deliver products but have not added any capabilities such as customisation or interactivity to distinguish the service from other types of direct selling. this does not necessarily constitute e-commerce per se because the firms have not developed a fully transactional internet sales channel. it would appear as if too much emphasis is being placed on establishing a web presence and too little stress is placed on ensuring that the ict infrastructure is able to support online procurement, trading, marketing and customer sales. most of the club members are at the stage of basic online "brochureware". companies have developed static information on a web site, with minimal ability for any interaction beyond email, company background, and in a limited number of cases, the placing of orders. a substantial 73.7 per cent of club members have an electronic data-interchange (edi) system in place (table i). edi entails considerable investment in dedicated software and in establishing proprietary networks. for inter-firm communications to take place effectively, buyers and suppliers need matching software and hardware, a common language for communications, a standard layout for documents and a common communication network. a major limitation is the one-to-one nature of edi transactions. therefore it is not suitable for companies engaged in occasional (or ad hoc) purchases, or even for regular low-volume business. this is exactly the kind of business that smes are involved in. the major drawback with edi is that it makes it uneconomical to link small suppliers into the system. the cost and supply chain management advantages of edi creates a tendency for large companies to purchase from suppliers with existing, compatible edi links. these forces tend to narrow and concentrate supply chains within a quasicooperative framework, which could, in principle, limit the scope of a fmn's sourcing options. notwithstanding this, those companies which have experience using edi will probably make the transition to internet-based ebusiness to streamline the supply chain faster than companies with no edi experience. in this sense, b2b e-commerce via the internet should be seen as an extension of the existing edi network. in contrast to the private interactions of the edi structure, the new virtual, open marketplace is likely to increase competition amongst suppliers and push down purchasing prices. box i indicates the key drivers for e-business in the south african automotive component sector, as identified by the club members themselves. box 2 lists what club members perceive to be the major benefits of the internet. this would seem to suggest that club members are, by and large, quite positive about r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vols (2002) no 1 143 the need for e-business, especially regarding the strong forces promoting a rapid uptake of e-business (box 1) and the expected benefits ofinternet use (box 2). table 2 reveals that internet-enabled supply chain management is very much in its infancy in the benchmarking clubs. the sluggishness of these companies is reflective of the caution with which enterprises view an ict tool that is still developing. many club members feel that a misplaced step into the b2b ecommerce space will not just result in the loss of substantial investment, they fear that they are also "betting the fmn" on the move. integrating functions across businesses, such as workflow arrangements in a supply chain situation, is predicated on working, integrated. internal systems. table 2 reveals that many component manufacturers do not have fully automated and integrated back and front office systems. a major challenge for the sector is, therefore, one of converging legacy ict systerns with the internet. the supply chain efficiencies promised by the internet are dependent on full internet-based integration of the value chain, offering a broad range of collaboration and integration between the trading partners. reaching this ideal is going to be expensive and requires the sort of industry-wide co-operation not generally prevailing in the south african automotive component industry today. component suppliers embarking on a fully intemet-enabled system at this early stage in the development of e-business, might fmd the return on investment to be quite low. in other words, the benefits might not justify the costs incurred in the short-term. but as more suppliers and customers use the internet to webenable their frontand back-office systems (internal functionality) (figure 10), and to connect with their trading partners (collaboration functionality) (figure 12), the benefits ofb2b e-commerce are likely to become more pronounced. e-business has to be placed in a relative context, i.e. how fast is adoption compared to competitors. if the rate of b2b e-commerce uptake is lower than that of competitors, this may result in declining value-added and market shares. until sufficient numbers of their main customers (both domestic and foreign) and suppliers participate in e-business initiatives, there is little incentive for individual fmos to develop a web-based customer and supplier interface, and to become engaged in e-business themselves. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 144 sajems ns vol 5 (2002) no 1 table 2 internet-enabled scm (n=19) => use of the internet for scm yes => do your suppliers' have access to real-time infonnation of your company's sales and stock levels? yes => do your customers' have access to real-time infonnation of your company's stock levels? yes => are your finn's internal operations electronically integrated with that of your customers? yes => are your fmn's internal operations electronically integrated with that of your suppliers? yes 31.6% 10.5% 31.6% 21.1% 15.8% => does your company have the e-business capacity to access your suppliers': production capacity? 21.1% available inventory? lead times? delivery flexibility? => are your frontand back-office systems electronically integrated? 21.1% 21.1% 21.1% yes 1.6% => does your company require suppliers to make use of e-business tecbnologies? yes 26.3% => does your company have a supply chain development programme yes 0.00% => does your company use e-business tecbnology for b2b procurement? yes 78.9% => does your company use e-business technology for b2b sales? yes 47.4% r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no i 145 unlike the tnc [ust tier suppliers, domestic [ust tier suppliers are not taking responsibility for upgrading and coordinating their own supply chains. in his survey of 46 south african component suppliers, barnes (1998) found that there was very little supply chain development activities from first tier suppliers down to the second and third tier suppliers. moreover, barnes and kaplinsky (2oooa: 805) describe the supply chain upgrading activities of the south african oems as "modest". this means that possibilities for upgrading the ict capabilities of component suppliers, especially lower-tier firms, are very limited. this is likely to constrain the widespread diffusion of e-business in the automotive components sector. the issue of online b2b trading exchanges has recently received a great deal of attention in the automotive industry; especially with the launch of covisint, the giant detroit-based global automotive virtual marketplace for procuring car components, supplies, services and information.9 only 36.8 per cent of club members are presently part of an online b2b trading hub, but it must be stressed that actual trade via the hubs have, thus far, been very limited (table 3). nonetheless, club members listed a number of benefits that are likely to emerge from these unified b2b supply chain enterprise networks (table 3). club members, however, also recognised a number of possible risks associated with internet-based b2b trading exchanges (table 3). further, club members stressed three main conditions for a trading hub to be successful: (i) openness and transparency; (2) trust and loyalty; and (3) a critical mass of value chain participants. e-business is not yet a strategic imperative in the south african automotive components sector. the majority of firms in the industry are unable to support e-business ventures today, because they do not have the integrated customer and supplier ict interfaces in place (table 2). box 3 lists the barriers to the adoption of e-business, that have been identified by club members. we, however, believe that the primary e-business impediments are: (i) the armslength and adversarial nature of the relationships that currently exist between value chain participants, both vertically and horizontally; (2) the nature of the automotive value chain, namely that it is overwhelmingly cost-driven rather than innovation and knowledge-driven; (3) a pervasive "wait and see what happens" mindset on the part of club members; and (4) evolutionary path dependencies which have locked firms into an insular. inward-oriented way of thinking. the latter, for instance, manifests itself in firms' reluctance to bring their customers, suppliers and business partners inside the "corporate machine". what is needed therefore is a new strategic direction in the industry, which is likely to entail a sea change in business mindsets. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 146 sajems ns vol 5 (2002) no i table 3 internet-based b1b trading bubs (n=19) => is your company linked to an internet-based b2b trading exchange? yes 36.8% no 63.2% => what are the benefits of the b2b trading exchange? .,/ sets standards .,/ cuts costs .,/ speed: internet-based transactions are instantaneous, interactive and rich .,/ supply chain efficiency: enables direct interaction between manufacturers and suppliers, eliminating the need for intermediaries. this is likely to reduce procurement costs .,/ market transparency: by being brought into one open platform, suppliers will be able to bid for contracts they may not previously have known about .,/ improves operating efficiencies .,/ economies of scale: the system should enable buyers with similar requirements to link together to order large quantities of inputs jointly, creating economies in production that will be reflected in lower purchasing prices => what are the disadvantages of the b2b trading exchange? .,/ rationalisation of the supplier base .,/ potential oligopolistic control and manipulation by transnational assemblers and tne lsi tier component suppliers .,/ privacy concerns .,/ pressure on prices .,/ threat to ~stablished partnerships, relationships & alliances => what are the main conditions for a successful b2b trading hub? .,/ openness & transparency .,/ trust & loyalty .,/ a critical mass of participating firms r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no i box 3 barriers to the adoption of e-business (ecbc & kznbc) ./ low use of e-business by customers &, suppliers ./ more pressing corporate priorities ./ security concerns ./ lack ofstandanls ./ seniot executives who do not support e-business ./ uncertainty over the returns which e-business will deliver ./ lack of e-business skills ./ a lack of clea:r understanding of the potential of the internet on the part of top management table 4 levels of e-business development levels 1 :z 3 sphere · functional · integrating · cross-entetprise orientation across involvement functional departments rationale · departmental · integrated · a virtual ecosystem that focus business connects employees, · the purchasing activities via suppliers and customers & sales departinternet! by extending existing ment, using edi intranet edi. · individual applications. · the extranet quns to: departments build trust and increase developing customer satisfaction; specific internet increase collaboration applications. and knowledge sharing e.g. a marketing between customers and website. suppliers; and maximise synergies to lower costs, improve efficiencies and increase quality. levers · technological · business · cultivating knowledge infrastructure processes workers and software (process effi· developing and applications ciencies exploiting intellectuai within the capital to create fum) opportunities · building relationships source:own 147 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 148 sajems ns vols (2002) no i the progression of component finns to higher levels of e-business capabilities is likely to be slow and incremental. there are two critical success factors of ebusiness, centred around the networking of internal and external business interactions, which component suppliers will need to seize and rapidly exploit in order to be globally competitive. firstly, strengthening the bonds between an enterprise and its value chain through an internet-based system is important. apart from enhancing inter-enterprise electronic communication, firms will also need to focus on their intra-organisational connectivity in order to tie transactional flows together within the organisation. currently, most of the component firms' prime focus is still on a functional orientation (level i in table 4) or on operational efficiency across the enterprise (level 2). none of the farms are using e-business to increase the organisation's effectiveness outside the enterprise by linking across the internet with suppliers and customers to create virtual supply chains (level 3). 7 conclusion in the relatively small, captive south african market, competitiveness has previously revolved more around marketing effectiveness and price competition than production and systemic efficiencies. the small scale and volumes of the south african market perhaps made the viability of fully-fledged business information systems questionable (moodley, 2002). however, the current pressures of globalisation and the challenge to direct overseas market expansion underscores the importance of e-business for the local component manufacturing industry as a means of acquiring a competitive edge over rivals. the integration of ict systems within the finn and across the value chain is a necessary but not sufficient condition for global competitiveness. the critical mass needed to reap positive network externalities is not, as yet, present in the south african automotive components sector. this requires leadership by several of the powerful oems and the large first tier suppliers to defme e-business standards for all value chain participants, and create incentives that attract more companies to it. the catalytic role that early adopters can play is also critical in promoting the diffusion of e-business in the components sector. in addition, the following four factors will potentially lead to a quicker adoption of e-business in the components sector: (i) a defensive reaction to competitors engaging in e-business; (2) pressure by oems and first tier suppliers that all of their suppliers link into their e-business system as a condition of trade; (3) if online trading portals achieve a critical mass of members and become established as a trading platfonn of choice; and (4) if the cost-reduction and value creation potential of the internet begin to be realised in practice. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no i 149 the components sector critically needs to be outwardly oriented to generate the economies of scale and scope required for global competitiveness. significant and sustainable growth of the south african automotive industry is contingent upon its ability to compete in a global operating environment. moreover, as tncs integrate the internet into their cross-border business operations, south african firms run the risk of being excluded from global value chains if they are unable to establish electronic ties with the major players. the policy challenge for the south african automotive components sector is, therefore, how to use the internet to: leverage, consolidate and deepen their links with the global economy; access global internet-based trading portals; take advantage of the potentials of globalisation; and exploit the systemic and productivity-enhancing possibilities inherent in e-business. e-business might well become an order-qualifying criterion which producers need as a prior condition for participating in global markets. e-business then, in theory, could be seen as a competitive advantage when competing for global supply contracts. in the context of upgrading and opening up, e-business capability is likely to become influential in determining export success. e-business is still at a very early stage in its development, and the notion that internet application may lead to a sustained higher level of economic efficiency is still very much at the level of theory, and will need to be rigorously explored in practice. moreover, achieving these efficiency gains is contingent on a number of factors, including: (i) access to e-business systems and the needed skills; (2) firms' willingness to open up their internal systems to suppliers and customers; (3) a significant re-engineering of the firm's current organisational structure, i.e. its complex combination of assets, legacy systems, resources and managerial processes and (4) more generally, a firm's evolutionary path dependencies. by not making the transition to internet-based business, south african automotive component firms may be placing themselves at risk of becoming less competitive in the globally interconnected market, impacting on both their current market positions and long-term viability. if this were to happen, it would have adverse development implications for the country, such as job losses, a decline in revenue growth and an eroded export base. the pressure on automotive component firms to re-organise to tap the advantages of e-business is, currently, not high. this is likely to change soon, as e-business becomes a powerful competitive tool for component suppliers to maintain what sturgeon (2000) calls "geographic agility" and "output agility". the internet holds great potential for integrating the backward and forward linkages in the automotive components value chain, and digitally connecting all r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 150 sajems ns vol 5 (2002) no i phases of the value chain from raw material supply, to design, production, marketing, distribution, consumption and fmally recycling (figures 10 and ii). hence, e-business could play an important role in: (i) facilitating (networkbased) dynamic learning and innovation curves in the value chain; and (2) improving the ability of automotive component firms to move to more profitable, knowledge-intensive, higher value-added economic niches in international trade networks. industrial upgrading could take place through harnessing and exploiting the information flows and learning potential associated with internet-based buyer-supplier links. thus, the intemetconnected digital network could, at least in theory, be used to create a new source of competitive advantage for the south african automotive components sector in export-oriented development. that said, though, the benefits of the internet for the automotive components industry are only potentials, and such potentials have to be sought for and released. automotive component firms will have to weigh the importance of protecting existing relationships, which account for most of their current revenue, against the advantages of establishing future strategic positions and revenue streams through e-business. internet impact can be fully examined only as a long-term phenomenon. initial assessments, especially at such an early stage of e-business development, are at best inconclusive. there is therefore a need for long-tenn analytical studies by independent researchers on the impact of the internet on business relationships in the south african automotive components sector. oems developing long-term obligational relationships and investing in their suppliers' let capabilities are critical for crafting a knowledge-intensive value chain upgrading path for automotive component manufacturers in south africa (sako, 1992). there is, therefore, an urgent need for oems to adopt a conscious policy of building stable, long-term relationships with their suppliers based on the transfer of complex information across the inter-firm link. in other words, stronger ihter-firm "informational" and "knowledge-based" relationships between oems and their suppliers are essential for component suppliers upgrading into quality-driven market segments which offer high returns. the upgrading challenge appears to be tightly bound up with the e-business challenge of creating dynamic, high performance networking between buyers and suppliers to cope with the "new competition" (best. 1990; porter, 1998). the ideal situation is when a company's internet-based infrastructure supports all aspects of the extended electronic enterprise, enabling the fum to interoperate and collaborate with any number of business partners (figure 12). in the south african context, fully internet-enabled supply chain models are a long way off. there is no blueprint or silver bullet that fums can take to be ready for e-business. they need, however, to go beyond the traditional view of just r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no i lsi looking at their own corporate capabilities; and understand that their growth and profitability will increase by managing and improving the end-to-end process that delivers products to the customers. the internet is not in itself a panacea or a quick-fix solution for all supply chain difficulties, rather the idea is to use the technology's reach and ubiquity to enable fums to get closer to their employees, customers, suppliers and business partners. this does not mean that e-business capabilities will, in and of itself, automatically lead to greater domestic and export sales volumes for south african component manufacturers. the future of the domestic automotive components industry is also heavily dependent on achieving international competitiveness through revitalising internal performanc~ capabilities in conformance with world class manufacturing principles. what it does mean, however, is that a failure by domestic component manufacturers to adopt ebusiness will undermine their ability to survive the onslaught of global competition, and will further squeeze them into the low value-added manufacturing segment of the automotive value chains, where the barriers to entry are low and price-based competition is most intense. endnotes the international development research centre (idrc) of canada provided the funding for this study. their generous f'mancial support is sincerely appreciated and hereby acknowledged. i am grateful to raphael kaplinsky of the institute of development studies, university of sussex, for his constructive comments on an earlier draft. the remaining errors, omissions and weaknesses are mine alone. 2 at a rate much faster than that required by wto regulations. 3 this is especially true of the german oems, i.e. bmw, mercedes benz and volkswagen. 4 toyota sa is 72.2% locally owned, and the remaining 27.8% is owned by the toyota motor corporation of japan. delta, on the other hand, is 51 % locally owned, and 49% is owned by general motors (barnes and kaplinsky 2oo0a: 799). 5 12 k.zn club members and 7 eastern cape club members. 6 some club members regard turnover figures as private. hence, the missing cases. 7 scm examines how information can be used to change how and when products are moved to increase efficiency. companies use scm to link sales, marketing, distribution, manufacturing processes, and customers, suppliers and business partners together for a more unified approach to the market. the establishment of these links means that firms are able to r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 152 samms ns vol 5 (2002) no 1 build relationships with customers, suppliers and camers to more effectively reduce operating cost, improve customers service and expand into new markets. 8 castells (1996), for instance, writes about a globalised and networked "informational" capitalism. 9 covisint has been developed by general motors, ford and daimlerchrysler, and has been recently joined by renault-nissan (www.covisint.com). 10 internet-based networks for use by a company and its business partners. 11 internet-based network for company-use only. references barnes, j. (1998) "competing in the global economy: the competitiveness of the south african automotive components industry", csds research report no. 13, durban: school of development studies, university of natal. 2 barnes, j. (2oooa) "changing lanes: the political economy of the south african automotive value chain", development southern africa, 17(3): 401-15. 3 barnes, j. (2ooob) "global trends in the automotive industry: their likely impact on south african automotive assembly and component manufacturers", transformation, 43: 52-74. 4 barnes, j. & kaplinsky, r. (2000a) "globalization and the death of the local firm? the automobile components sector in south africa". regional studies, 34(9): 797-812. 5 barnes, j. & kaplinsky, r. (2000b) "globalisation and trade policy reform: whither the automobile components sector in south africa", competition & change, 4: 211-243. 6 best, m. (1990) the new competition, cambridge, massachusetts: harvard university press. 7 castells, m. (1996) the information age: economy, society. and culture, vol. i: the rise of the network society, oxford: blackwell. 8 cohen, s.j., delong, b. & zysman, j. (2000) ''tools for thought: what is new and important about the 'e-conomy"', brie working paper no. 138, berkeley: university of california, berkeley. 9 dicken, p. (1998) global shift: transforming the world economy, london: paul chapman. 10 evans, p. & wurster, t.s. (2000) blown to bits: how the new economics of information transforms strategy, boston, massachusetts: harvard business school press. 11 finance week, 27 october 2000. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 153 12 fine, c.h. (1998) clocks peed: winning industry control in the age of temporary advantage, reading, massachusetts: perseus books. 13 gereffi, g. (1999) "a commodity chains framework for analysing global industries", background notes for ids workshop on the spreading of the gains from globalisation, institute of development studies, university of sussex, brighton, uk, 15-17 september. 14 gereffi, g. (2000) "beyond the producer-drivenlbuyer-driven dichotomy: an expanding typology of global value chains, with special reference to the internet", unpublished paper, 14 september, http://wwwjds.ac.uk/ids/global/bella.html. 15 humphrey, j. (1999) "globalisation and supply chain networks: the auto industry in brazil and india", in: gereffi, g.,. palpacuer, f. & parisotto, a. (eds.), global production and local jobs, geneva: international institute for labour studies, forthcoming. 16 ibm (2000) making e-business deliver: business guide, london: caspian. 17 intelligence: business in the internet age, may 2000. 18 joffe, a., kaplan, d.e., kaplinsky, r. & lewis, d. (1995) improving manufacturing perfonnance: the report of the isp, cape town: ucr press. 19 magretia, 1. (1998) "the power of virtual integration: an interview with dell computer's michael dell". harvard business review, marchapril: 73-84. 20 moodley, s. (2001) "e-business and supply chain management in the automotive industry: preliminary findings from the eastern cape and kwazulu-natal benchmarking club surveys", research report no. 35, durban: school of development studies, university of natal. 21 moodley, s. (2002) "internet-enabled supply chain integration: prospects and challenges for the south african automotive industry", development southern africa, forthcoming. 22 porter, m. (1990) the competitive advantage of nations, london: macmillan. 23 ra yport, 1.f. & j.j. sviokla (1994) "managing in the marketspace", harvard business review, november-december: 141-150. 24 ra yport, j.f. & j.j. sviokla (1995) "exploiting the virtual value chain". harvard business review, november-december: 75-85. 25 sako, m. (1992) prices, quality and trust: inter-finn relations in britain and japan. cambridge: cambridge university press. 26 sturgeon, tj (2000) "how do we define value chains and production networks?", unpublished paper prepared for the bellagio value chains workshop, rockefeller conference centre, bellagio, italy. 27 web sites: www.covisintcom www.dell.com. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 459 sajems ns vol 3 (2000) no 3 the role of exhibitions in the marketing mix in south africa smccoy strategy and business development, ksdp, johannesburg p j du plessis department of marketing and communication management, university of pretoria abstract exhibitions are a recognised component of a company's marketing mix, the medium however suffers from a distinct lack of integration and understanding in the broad marketing fraternity. little research on the subject has been done and published, especially in south africa. this exploratory study focuses on the use of the exhibition medium as a part of a company's marketing effort. respondents question the return on investment and the measurability of the medium, while the benefits are in agreement with other published literature. future research on the effectiveness of the medium and the impact of technology is recommended, as well as the viability of the medium on the marketing of services. introduction exhibitions have been used as a marketing medium throughout the world for more than a century. due to their cost-effectiveness, they are an integral part of the marketing mix of companies. this tool is increasingly being used to penetrate new markets as a powerful sales, marketing and general business platform. in the south african context, trade exhibitions have formed part of marketing for more than 30 years. they have displayed exponential growth with the new political dispensation and reintegration into the global economy. notwithstanding this accelerated growth, it is evident that in many cases the real potential of the medium is not being recognised and it is either poorly or underutilised in terms of integration with other aspects of the marketing mix or a company's business objectives generally (de wet, 1997). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 460 conceptual framework an important picture is emerging in the broader media sector, of which exhibitions are an important part. although this deviates slightly from the core focus of this exploratory study, it is regarded as fundamentally important to the future of exhibitions as a tool in the marketing mix. schutte and jack (i 997} refer to the definition of media as a communications platform. this is subdivided into entertainment-based and non-entertainment media. the emergence of narrowcast media in an environment of audience fragmentation is highlighted. narrowcast media is defined as targeted media that can deliver to advertisers, clearly defined interest groups and/or demographics. the examples of radio, specialist publishing, direct marketing and specialist marketing are used. the nature of the group excluded the exhibition medium, but it is clear that exhibitions do fit into this brief and form an integral part of the findings. another important aspect of the research is the postulation of the ice age, which is defined as the integration of the information, communication and entertainment industries. in this context, numerous references are cited that highlight the total lack of integration, or the need to further integrate marketing communication options in an attempt to enhance the performance of the medium. these research findings are supported by a pricewaterhousecoopers survey (finance week, 1999) in which the tice model is presented, representing the integration of technology, information, communication and entertainment. there can be little doubt that the media industry has experienced prolific developments and options in recent years. exhibitions represent a stable, unique and dynamic marketing communications tool and could prove to be significantly more effective if integrated into mainstream marketing thinking. because of the fragmented approach to exhibitions in the south african marketing mix so far, marketing circles question whether exhibitions are efficient and yield good return on investment. international experience seems to contradict the south african trend. in many leading market economies, exhibitions playa fundamental role in marketing and are regarded as crucial tools for stimulating trade in specific industries and even between countries. accordingly, they occupy a larger proportion of the marketing budget and are integrated into the marketing strategies and activities of several leading corporations. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 461 sajems ns vol 3 (2000) no 3 exhibitions fit into the marketing communication mix as part of sales promotion activities. there is little mention in literature of exhibitions as a marketing tool, or as a theoretical marketing concept, in the context of marketing or strategy. there is no detailed classification of or extensive theoretical debate around the concept. exhibitions are mainly discussed in terms of their benefits (all wood & montgomery, 1989; brassington & pettitt, 1997; weisgal, 1997). kotler (2000) only devotes four sentences to exhibitions as a promotional tool; churchill and peter (1998) not much more. the following favourable contributions and functions of exhibitions are mentioned: product launch and demonstration; marketing and business window; interactive two-way communication; learning and training experience; generation of leads; relationship building; market presence and enhancing corporate image. it is deemed that there is still much scope for improvement regarding the awareness, utilisation and understanding of the medium in this country. objective the objective of the research is to evaluate the use of the exhibition medium as a component of a company's marketing effort, and its perceived effectiveness as a marketing tool. this is done by comparing exhibitions with other marketing tools and determining to what extent a company adopts an integrative approach to its marketing initiatives. the exercise is seen as an exploratory study in the south african market. approach a total of 107 companies were taken as a sample of actual and potential exhibition users, representing a cross-section of industry. the sample was chosen from leading sectors in industry, including manufacturing, mining, building and construction. this group represents some 45% of south africa's gross domestic product (business monitor international, 1998). a questionnaire was e-mailed and faxed to the sales manager, marketing manager, managing director or general manager of the organisation. the focus of the questions was directed at issues such as the objectives of exhibition participation, effectiveness of the medium and the extent to which exhibitions are integrated with a company's marketing strategy (or mix). in-depth interviews were also conducted with senior management of the 10 largest companies, to facilitate and promote information sharing. in addition, the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 462 questionnaire was discussed with three of south africa's leading exhibition organisers. results the findings are restricted to issues relevant to the research objective, and serve to summarise the common denominators among participating companies. the feedback represents both positive and negative issues. findings are both quantitative and qualitative, not necessarily listed in order of importance below. a total of 27 returns were received, in addition to the 10 companies that participated in the in-depth interviews. the questions in the in-depth interviews were similar to those of the structured questionnaire, and the responses are incorporated in the results accordingly. although the sample of respondents might seem on the small side, the results of this study do add to the body of knowledge, if one considers the lack of other published research in south africa on this subject. bearing in mind that this was an exploratory research project and the sample size is relatively small, the results cannot be rigorously tested and findings do not reflect true percentage responses, but only the majority/minority opinions of respondents to statements in the questionnaire. the positive findings of the survey are: the majority of respondents find that the medium is effective for doing business, and that the intensity of sales and generation of leads are higher in comparison to other marketing options. conversely, they are of the opinion that they would only like to attend one or two major shows a year, rather than a plethora of small ineffective events. • supporters of the exhibition medium find it very useful to be able to interact with existing key customers, as well as meeting future clientele. • many regard exhibitions as the ideal environment to launch new equipment, products, services and technologies, and to display competitive advantages to a captive audience in a specific target market. • the medium is very suitable for establishing and/or maintaining a corporate image in a specific industry. • less than 40% of the respondents indicated that exhibitions are important as a component in the integration of the marketing mix. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 463 sajems ns vol 3 (2000) no 3 • several respondents appreciate that exhibitions reach a broader section of a particular market than the key decision-makers. this means that employees in lower positions can influence the type of products and technologies purchased, even though they do not make direct buying decisions. this in effect allows companies to share knowledge with its user base and expand the learning process within an industry. • exhibiting companies wishing to export products, find it a cost-effective way of penetrating offshore markets, that is, being able to exhibit their products in a targeted country. the medium facilitates agency agreements, joint ventures, and licensing arrangements in both domestic and international markets. the negative feedback from respondents points to a need to educate the market about the potential of the medium and its advantages over other marketing media. • respondents regard exhibition participation as an extremely costly exercise compared to other options in the marketing mix. these costs comprise not only the direct cost of participation, such as space costs, stand design, promotional material and exhibit transport, but also indirect cost in terms of staffing, and resources. • because the revenue generated does not match the perceived and actual expenditure of participation, respondents question the return on investment. • exhibitors find it very difficult to objectively measure the impact of the medium, claiming that they are unable to determine the effectiveness of a show. it is therefore uncertain what the medium actually yields. this highlights the need for a comparative system of measuring yields (or benefits) of exhibitions as against other marketing options. • certain exhibitors feel that they are compelled to participate in an event, merely because they would otherwise lose out in the face of competition -not because they have any real wish to do so. • companies that provide services find exhibitions unsuitable for marketing them, while tangible products can be clearly displayed and demonstrated. respondents perceive that an intangible product or service is not suited to the medium. • exhibitions in south africa are costly, as they account for more than 13% of the average budget and are second only to print advertising. • there is general concern that the exhibition medium has become highly fragmented and that there are simply too many shows, making excessive demands on limited marketing budgets. exhibitors feel that exhibition organisers should get together with the object of regulating the medium and enhancing its effectiveness. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 464 • some companies feel that south african exhibitions on the whole, do not match the scale and significance of their international counterparts, particularly those in europe. this seems to suggest that key decision-makers in the local market would rather attend specific industry events in other parts of the world. organisers apart from respondent analysis, a perspective of providers of the exhibition medium is given too. the feedback of leading south african, and effectively southern african, exhibition organisers is typical of the current status of the industry and the perceived role that it plays in the marketing mix in this region. • leading organisers perceive that many exhibiting companies make poor exhibition choices, which taint the medium amongst both exhibitors and the public. they emphasise that it is essential for exhibiting companies or potential exhibitors, to carefully select high quality, industry-focused exhibits that will deliver an effective return on investment. detailed analysis of these considerations falls outside the scope of this paper, but it is essential, as with any other business, that the right marketing channel is selected. • according to organisers, exhibitors do not set clear objectives for participation and are therefore uncertain, particularly about what they hope to achieve. linked to the lack of clear objectives, is the fact that it is particularly difficult to objectively measure results, without any means of comparing their respective effects. • it often seems that marketing and sales teams are at opposite ends of the exhibition decision. "marketing" buys into the concept and sets about delivering a result, while "sales" is opposed to the concept from the start and perceives it as a waste of time. exhibition organisers feel that this problem condemns an exhibition campaign even before it has started. • organisers are also concerned about inadequate training of the staff manning stands, and employing the wrong kind of stand personnel. according to organisers, a company's most senior and competent personnel should be involved in selecting personnel to promote the image of the firm to the best advantage. • exhibition organisers are concerned that exhibiting companies do not integrate other aspects of marketing, to make their campaigns more effective and realise the full potential of the medium. the organisers therefore support a more cohesive and coordinated approach to exhibition participation in general. • exhibition organising companies regard the medium as unique, and with great advantages over other marketing options. they do acknowledge, however, that they can and should do more to promote and develop the medium in south africa. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 465 sajems ns vol 3 (2000) no 3 • organisers criticise the lack of government support of and involvement in the use of the medium. in many international markets, governments fund exhibition venues because of the great benefit gained for local and national economies in the form of airline travel, accommodation, business tourism and entertainment. governments fund exporting companies through generous financial assistance for exhibition participation. while the matter has to some extent been addressed by the department of trade and industry, the south african government does not support exhibition venues, apart from limited local metropolitan or council support, for example the international convention centre in durban. • organisers also question the role of advertising agencies in the promotion and development of the medium. in this country, they are inclined to avoid recommending the medium to clients, because they receive no direct financial incentive to do so. even though international agencies also do not receive media commissions, they recognise the benefit they receive in additional design revenue, consultation fees and media placements. these often divergent qualitative findings, obtained from surveying both exhibiting companies and exhibition organising companies, emphasise the need to work towards a common goal of realising the full benefit of a more integrated approach to the exhibition medium as a tool of the overall marketing strategy of business enterprises in south africa. managerial implications this study provides insight into the value and perceived role of the exhibition medium within the broader business marketing communications mix. local publications carry articles on aspects of the medium and the industry, often on an superficial level. exhibition organisers do however conduct research which helps businesses develop objectives by profiling exhibitor and visitor feedback on the performance of a particular event or exhibition the most important issues that emerge from the study are the following: • the exhibition medium has grown in stature over the last five years and enjoys a higher level of awareness in the marketing and business community in south africa than before. • local and international research show that the exhibition medium offers a unique means of profiling company image and exposing products and services and generally providing a powerful means of advertising and promotion. • although it has been proven that the medium improves sales, it should be viewed in terms of long-term returns. exhibitions seem to benefit products rather than services. • because it is so difficult to measure the benefits of exhibitions, exhibitors r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 466 question their potential value. organisers argue that poor preparation and organisation by certain exhibitors have a detrimental effect on the value of exhibitions. • certain exhibiting companies also question the return on investment that exhibitions offer. this however remains a value judgement, as there is no formal procedure or formula that can determine returns accurately. future research should address this problem. • other components of the marketing mix should be integrated with the exhibition medium, in order to realise the full potential of and achieve the optimum effect for the exhibitor. • this research shows that exhibitions in south africa represent 13.4% of the average marketing budget of a business, which makes them the second most expensive means of advertising. local exhibition organisers were surprised by these statistics, as they had previously believed that exhibitions received a disproportionately lower percentage of the typical marketing budget of their international counterparts. future research the limitations of the present study at least serve as a useful basis for recommending future research. • in the first place, the size of the research sample could be increased and allow for replication of this exercise to determine the consistency of trends. • such replication could also be related to specific exhibitions in specific industries, to establish normative standards in various sectors of the economy, rather than assume averal?,es. • the sample population in this study has been limited to established users of the medium. research addressing the perceptions and attitudes of local nonusers could also prove valuable and interesting. • research should be done in the measurement of the medium, possibly with a view to developing an industry standard or model. such research should take into account measurability in terms of effectiveness as well as return on investment. • this study has focused on exhibitions as a business-to-business medium. this does not take into account broad-based events or consumer shows, and research in this area would probably reveal a different set of data and findings. • the integration of technology, information, communication and entertainment is a broad and challenging one. the impact on the exhibition industry could prove valuable. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 467 sajems ns vol 3 (2000) no 3 • in a sense, the research conducted has been static and not incorporated the effect of technological progress. given the extent of technological impact on most industries, local research on an issue that is being probed globally should prove valuable, here too. • the formation of a marketing strategy, integrating components of the marketing mix, could help to improve the understanding of problems and limitations that marketers encounter when considering exhibitions. • the value of the medium as a sales tool through the stages ofa product's life cycle, is a further recommendation. this would help to measure the effectiveness of the medium in the generation of direct sales. • although it would also be rather detailed, research regarding the marketing of services would prove valuable in measuring the effectiveness of the medium. conclusion where do exhibitions fit in? an exhibition is a combination of direct selling and advertising. sales personnel man a stand in order to generate business and the stand itself is designed to create awareness, explain and demonstrate a product or service, and to answer market questions. in essence, exhibitions can and do play a cost-effective role in the marketing mix, across the complete life cycle of a product. notwithstanding the limitations identified and the considerable recommendations for further research, this research project has shown that exhibitions have a definite role to play in the south african marketing. it has helped to understand. assess and improve this product in profiling south african businesses. references all wood, j. and montgomery, h. (1989) exhibition planning and design: a guide for exhibitors. designers and contractors. london: batsford. 2 brassington, f. and pettitt, s. (1997) principles of marketing, london: pitman publishing: 812-17. 3 business monitor international (1998) south africa 1998: annual report on government. economy, the business environment, capital markets and industry. june: 119-46. 4 churchill, g. a. and peter, j. p. (1998) marketing: creating value for customers, 2nd ed. boston, massachusetts: irwin mcgraw-hill: 490. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 468 5 de wet, k, (1997) "global approach set to propel local exhibition industry." southern african pr journal. february: 16-19. 6 finance week, 1999 pricewaterhousecoopers survey. september: 8-9. 7 kotler, p. (2000) marketing management. the millenium edition, new jersey: prentice hall: 603. 8 schutte, j and jack, m. (1997) "primedia: lights, camera, action!" south african media/entertainment research. merril lynch. december. 9 weisgal, m.b. (1997) show and sell: j 33 business building ways to promote your trade show exhibit. new york: amacom. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . f:\ejour\ecoman\index\ecoman_v6_n2.prn.pdf sajems ns vol 6 (2003) no 2 274 internal risk financing with special reference to contingency funds ________________________________________________________________ f j mostert department of business management, university of stellenbosch ________________________________________________________________ abstract enterprises can manage risks in two fundamental ways, namely by physical risk control and by risk financing. the latter comprises external and internal risk financing. as this paper focuses on the latter of these concepts, due attention is paid to the main forms of internal risk financing. charging losses to current operating profit, arranging loan facilities and implementing equity financing programmes are different forms of internal risk financing. the nature, advantages and various types of captive insurance companies are considered as holding companies can utilise this form of internal risk financing. special attention is paid to the use of contingency funds as a way of internal risk financing by applying a modelling approach. the conclusions reached should be valuable to business enterprises in particular, but also to non-profit organisations and individuals. jel g13 1 introduction for the purpose of risk management, risks are defined as uncertain future events with possible detrimental results that need continuity planning (savage, 2002: 254-61). risks can be managed by enterprises in two fundamental ways, namely by means of physical risk control or by utilising risk financing. risk avoidance and risk reduction are the main methods for applying physical risk control, while risk financing represents an attempt to provide the necessary financing capacity/funding to counter possible negative effects of risks, which can either be arranged externally or internally (schneier & miccolis, 1998: 10-14). external risk financing focuses primarily on obtaining insurance from a shortterm insurer or professional reinsurer, or by outsourcing/transferring the business activities concerned in order to avoid the possible detrimental results thereof (preston & thomas, 2002: 66-8; bowers, 1999: 30-1). firms and insureds who are more at risk and do not have the necessary financial strength sajems ns vol 6 (2003) no 2 275 tend to choose insurance, especially during soft market cycles when the insurance rates and conditions are favourable. the choice of internal risk financing will depend inter alia on the objectives of the enterprise, the nature of the operations, the prevailing market conditions, the enterprise’s potential accumulation of risk, and the management’s attitude towards risk (gjertsen, 1997: 37-8). self-insurance may also lead to better loss control by an enterprise (bradford, 1999a: 3-5). internal risk financing can take various forms, mainly by charging losses to current operating profit, by arranging loan facilities, by implementing an equity financing programme, by utilising captive insurance companies, or by establishing a contingency fund (diacon & carter, 1992: 82). these forms of internal financing will receive due attention in what follows. 2 objective of the research the development of an overall risk management strategy by an enterprise is required before risks can be addressed. the objective of this research paper is the improvement of financial decision making by enterprises when internal risk financing is chosen as the appropriate way to manage risks. in order to achieve this objective, taking cognisance of the various forms of internal risk financing is essential as the starting phase. thereafter, a modelling approach is applied in order to construct a contingency fund and to determine the feasibility of such a way of internal risk financing. the conclusions reached should be valuable to business enterprises in particular, but also to non-profit organisations and individuals. 3 various forms of internal risk financing an enterprise should start by developing an overall risk management strategy. when opting for internal risk financing in the employment of the strategy, the following five forms present the main choices: 3.1 charging losses to current operating profit the detrimental financial results of risk situations can be deducted from the current operating profit of enterprises. in this way, the enterpris e receives a tax benefit as the taxable profit, as well as the taxation payable, decreases. the actual size of a loss after taxation is therefore equal to: gross loss x (1 – t) (1) where: t = the applicable tax rate. sajems ns vol 6 (2003) no 2 276 the main disadvantage of this form of internal risk financing relates to the fact that the loss is determined by using the book value of the assets which were lost and that the replacement value of the assets is not taken into consideration. this form of internal risk financing may be applicable when relatively small losses are considered, but large detrimental results will need a more appropriate form of internal risk financing. 3.2 loan facilities enterprises with acceptable credit risk and sound solvency may consider this form of internal risk financing (altman & saunders, 1997: 1721-40). two kinds of approaches are evident, namely that the loans may be arranged before or after the occurrence of the loss situation. although an arrangement before the loss situation occurs looks very attractive, one has to take into account that an availability fee will be charged in the meantime and that the actual interest rate will be determined when the loan is granted. redemption conditio ns may also be unfavourable. it is realistic to accept that an enterprise’s solvency may deteriorate after a loss situation has occurred and that applying for a loan afterwards will inevitably lead to high interest rates and strict repayment stipulations. furthermore, research has shown that due to the asymmetric nature of loan contracts, banks are not properly equipped to deal with systematic risk (for example real exchange rate fluctuations) (kildegaard & williams, 2002: 357). due to asymmetric contracts, banks are not in a position to diversify across borrowers, and therefore should find already diversified borrowers. for a non-diversified enterprise, this result may provide an important obstacle to obtaining loan facilities. 3.3 equity financing programmes an equity financing programme creates a situation in which an investment company concludes an agreement to subscribe to a predetermined number of ordinary or preference shares of another company at a predetermined favourable price in the event of a specified catastrophe (zolkos, 1996: 1-3). the enterprise that is impaired will therefore receive a guaranteed amount of equity that will not only improve the liquidity, but also the solvency of the enterprise. it is obvious, however, that an equity financing programme will bring about periodic charges for the company, which are payable to the investment company in exchange for the benefit of having an equity financing programme in place. furthermore, in the event of issuing ordinary shares to the investment company, sajems ns vol 6 (2003) no 2 277 there may be a shift in the control of the damaged company, while the net asset value of the shares may also be diluted. 3.4 captive insurance companies a captive insurance company actually is the subsidiary of one (or more than one) hold ing company and is usually operated by experienced insurance professionals. as the subsidiary acts as the insurer of the holding company, it is reasonable to assume that the insurance business provided by the holding company or companies should be adequate to justify the economic existence of the captive insurance company. research showed that there is no evidence to suggest that the establishment of a captive insurance company changes the systematic, unsystematic and financial risks posture of a holding company (adams & hillier, 2000: 1804). it is believed that the holding company tends to have a superior loss ratio and that the captive insurance company can therefore manage the particular risks. the establishment of a captive insurance company provides several potential advantages to a holding company (diacon & carter, 1992: 82-3). the insurance provided by the subsidiary to the holding company may be more flexible than that which may be available in the insurance market. the cost of insurance may also be lower, as the underwriting profit made by the captive insurance company may be distributed to the holding company by means of a dividend (mcdonald, 2001: 9). furthermore, the captive insurance company may provide coverage that may not be available in the insurance market. a captive insurance company has direct access to the reinsurance markets, but due to the law of large numbers, the reinsurance may be more expensive (anderson, 2001: 35; bradford, 1999b: 36). tax benefits (which will be discussed later) may also emerge from the application of this form of internal risk financing. the utilisation of captive insurance companies is very popular when the insurance cycle hardens and the insurance rates are increased (howard, 2001: 7). the control that the holding company has over the captive insurance company adds value to the situation (zolkos, 2000: 3-4). three prominent types of captive insurance companies will be discussed (although there are other types as well (costle & schauer, 2000: 310-11)), the first being onshore companies. the insurance premiums paid by the holding company to the subsidiary may be deducted for tax purposes, as the subsidiary will be taxed by the local authorities on the profit made during a financial year. as dividends paid by the subsidiary to the holding company are based on profit after taxation, the dividends will usually not be taxable in the hands of the holding company (huxham & haupt, 2000: 222). the local authorities are at peace with this type of captive insurance company. sajems ns vol 6 (2003) no 2 278 the second type of captive insurance company is known as an offshore company (insurance advocate, 2000: 30). as the subsidiary is established in another country (and often in a tax haven (hampton & christensen, 2002: 1660)), the profit of the subsidiary cannot be taxed by the local authorities. if the holding company wants to deduct the insurance premiums paid to the offshore captive insurance company for tax purposes, the holding company has to convince the local authorities that it does not involve a scheme to avoid taxation, but is merely part of a comprehensive risk management strategy. the last type of subsidiary is called a cell captive insurance company as it consists of various “cells” which are independent when insolvency occurs (pilla, 2001: 86; veysey, 2000: 33-4). each holding company can obtain a particular cell and can canalise its insurance needs through it. the cell captive insurance company however is registered as one insurer and the administration is undertaken by a centralised organisation. it may therefore be less expensive for a holding company to run a particular cell of a cell captive insurance company than to run its own captive insurance company. 3.5 contingency funds a contingency fund represents the investment of money in a particular fund with the sole purpose that the accumulated amount will immediately be available when a loss situation occurs (zolkos, 1998: 3-4). the contingency fund is the property of the enterprise and the enterprise consequently controls the application of the accumulated funds. a contingency fund is created by application of two sources of financing, viz.: (1) periodic payments made by the enterprise, which should be increased periodically by a growth rate in an attempt to provide for the higher replacement value of the property. as these payments are not tax deductible, an enterprise applies funds that are available after taxation. to the contrary, although short-term insurance premiums paid by enterprises are tax deductible, the insurance premiums may actually be higher due to taxes levied on the insurance industry (huxham & haupt, 2000: 70; ke, petroni & shackelford, 2000: 99-120). (2) periodic interest allocations received by the enterprise based on the accumulated amount of the contingency fund. the interest received by the enterprise will usually be taxed according to the definition of gross income in the income tax act (huxham & haupt, 2000: 6). as already indicated, the sole purpose of a contingency fund is to provide an accumulated amount when a lo ss situation occurs. the amount needed in a particular case will be determined by the following two factors: sajems ns vol 6 (2003) no 2 279 (1) the replacement value of the assets concerned when the contingency fund is actually established. (2) the annual inflation rate which is applicable on the particular kinds of assets as price increases have different impacts on different assets. it is of prime importance that the accumulated amount of a contingency fund should continuously be compared with the current replacement value of the particular asset. should the replacement value of the asset exceed the accumulated amount of the contingency fund, financial distress may prevail on the occurrence of a detrimental event. a possible deficit in the event of a loss situation may lead to the reduction of the enterprise’s activities and the abolishment of potential investment opportunities. it is therefore often necessary to combine a contingency fund with other forms of risk financing in order to cover asset losses sufficiently. 4 modelling approach for a contingency fund a modelling approach for a contingency fund is presented in table 1, where the following six independent variables are used: (1) interest rate after taxation (denoted by i) = 6 per cent per annum; (2) initial annual payment (payable in advance) (denoted by p) = r1 200 at the starting point; (3) growth rate of annual payments (denoted by g) = 9 per cent per annum; (4) initial replacement value of property (denoted by v) = r100 000; (5) inflation rate applicable to property (denoted by f) = 8 per cent per annum; and (6) number of years (denoted by n). the initial annual payment of r1 200 approximately represents the annual insurance premium for the content of houses with a replacement value of r100 000 in low risk areas (brandsen, 2002: personal interview). the content of houses was chosen for illustration purposes because the level of risk is regarded as higher than that of buildings, but lower than the risk associated with motor vehicles. the annual payments are payable in advance as the same condition usually applies in the case of insurance premiums. sajems ns vol 6 (2003) no 2 280 table 1 comparison of the final value of a contingency fund and the replacement value of property in the following conditions: interest rate after taxation (i) = 6 per cent per annum; initial payment (p) = r1 200 at the starting point; growth rate of payments (g) = 9 per cent per annum; initial replacement value of property (v) = r100 000; and inflation rate applicable to property (f) = 8 per cent per annum end of year final value of contingency fund replacement value of property column (b) as % of column (c) (a) (b) (c) (d) 0 1,200 100,000 1.20 1 1,272 108,000 1.18 2 2,735 116,640 2.34 3 4,410 125,971 3.50 4 6,322 136,049 4.65 5 8,497 146,933 5.78 6 10,964 158,687 6.91 7 13,755 171,382 8.03 8 16,905 185,093 9.13 9 20,454 199,900 10.23 10 24,444 215,892 11.32 11 28,922 233,164 12.40 12 33,940 251,817 13.48 13 39,554 271,962 14.54 14 45,827 293,719 15.60 15 52,827 317,217 16.65 16 60,630 342,594 17.70 17 69,318 370,002 18.73 18 78,982 399,602 19.77 19 89,721 431,570 20.79 20 101,644 466,096 21.81 21 114,872 503,383 22.82 22 129,535 543,654 23.83 23 145,776 587,146 24.83 24 163,755 634,118 25.82 25 183,643 684,848 26.82 26 205,630 739,635 27.80 27 229,924 798,806 28.78 28 256,751 862,711 29.76 sajems ns vol 6 (2003) no 2 281 table 1 continued end of year final value of contingency fund replacement value of property column (b) as % of column (c) 29 286,361 931,727 30.73 30 319,026 1,006,266 31.70 31 355,044 1,086,767 32.67 32 394,742 1,173,708 33.63 33 438,477 1,267,605 34.59 34 486,641 1,369,013 35.55 35 539,662 1,478,534 36.50 36 598,008 1,596,817 37.45 37 662,193 1,724,563 38.40 38 732,775 1,862,528 39.34 39 810,369 2,011,530 40.29 40 895,645 2,172,452 41.23 the results of column (b) in table 1 are calculated by using the formula for the final value of a geometric progression/series (conradie & schoeman, 2001: 86), viz.: p (1 + i) [(1 +i)n – (1 + g)n] / (i – g) (2) where: n = number of years, i ≠ g and the annual payments are payable in advance. the results of column (c) is arrived at by applying the following well-known formula: v (1 + f)n (3) column (d) shows the final value of the contingency fund as a percentage of the replacement value of the property at the end of each year. it is clear that, by applying the given values of the independent variables, the contingency fund will only be able to provide 41,23 per cent of the replacement value of the property after 40 years have expired. the same exercise was repeated several times and the results are presented in the three figures provided below. annual interest rates of 6, 10, 14 and 18 per cent are used in all three figures. the annual inflation rate applicable to property, according to figure 1, equals 6 per cent, that of figure 2 is 10 per cent, while an annual inflation rate of 14 per cent is applied in figure 3. the annual growth rate of the annual payments (payable in advance) remains constant at 9 per cent throughout. sajems ns vol 6 (2003) no 2 282 figure 1 value of contingency fund as percentage of the replacement value of property when the growth rate of annual payments and inflation rate are respectively 9 per cent and 6 per cent per annum and different annual interest rates apply 0 200 400 600 800 1,000 1,200 1 4 7 10 13 16 19 22 25 28 31 34 37 40 years p er ce nt ag es 6% 10% 14% 18% figure 2 value of contingency fund as percentage of the replacement value of property when the growth rate of annual payments and inflation rate are respectively 9 per cent and 10 per cent per annum and different annual interest rates apply 0 50 100 150 200 250 300 1 4 7 10 13 16 19 22 25 28 31 34 37 40 years p er ce nt ag es 6% 10% 14% 18% sajems ns vol 6 (2003) no 2 283 the preceding figures lead to the following results: figure 3 value of contingency fund as percentage of the replacement value of property when the growth rate of annual payments and inflation rate are respectively 9 per cent and 14 per cent per annum and different annual interest rates apply 0 50 100 150 200 250 300 1 4 7 10 13 16 19 22 25 28 31 34 37 40 years p er ce nt ag es 6% 10% 14% 18% (1) in only four of the 12 situations which are presented in the figures, the value of the contingency fund as a percentage of the replacement value of property could equal or exceed the 100 per cent level during the period of 40 years. such situations occur when the interest rate, growth rate of the annual payments and the inflation rate respectively are as follows: ≥10 per cent, 9 per cent, 6 per cent per annum; and 18 per cent, 9 per cent, 10 per cent per annum. when the location of the assets of an enterprise is geographically diversified, distribution of the associated risk takes place. this form of internal risk financing may then be acceptable, as full replacement value of all the assets may not be necessary. (2) when the annual interest rate increases by only four percentage points (i.e. from 6 to 10 to 14 to 18 per cent), the value of the contingency fund as a percentage of the replacement value of property at the end of 40 years, each time increases by more than 100 per cent for a given annual sajems ns vol 6 (2003) no 2 284 inflation rate. in the long run, the level of the annual interest rate is therefore of prime importance for the feasibility of a contingency fund. (3) when the annual inflation rate increases by only four percentage points (i.e. from 6 to 10 to 14 per cent), the value of the contingency fund as a percentage of the replacement value of property at the end of 40 years, each time decreases by more than 75 per cent for a given annual interest rate. the extent of the annual inflation rate over the long term therefore plays a significant role when the sufficiency of a contingency fund is assessed. (4) the value of the contingency fund as a percentage of the replacement value of property shows an increasing tendency over the period of 40 years, except for two situations in figure 3. these situations occur when annual interest rates of respectively 6 and 10 per cent are applied and the growth rate of the annual payments remains at 9 per cent per annum, while the annual inflation rate equals 14 per cent. in these two cases, a turning point in the results is experienced after respectively 18 and 25 years have expired. it seems that, in these cases, the annual interest rate, as well as the growth rate of the annual payments, could not deal with the impact of the high annual inflation rate in the long run. the fact that the inflation rate exceeds the annual interest rate and annual growth rate cannot provide an explanation for the turning point in the results, as it does not occur when the interest rate, growth rate of the annual payments and inflation rate is respectively 6, 9, 10 per cent per annum, as in figure 2. the turning points in the results provide an opportunity for future research. in order to assess whether the value of the contingency fund is adequate to provide for the replacement value of property for a particular situation, an alternative approach can be used. given the five remaining independent variables of the modelling approach, the annual inflation rate of property provided for by the contingency fund is determined by applying the following equation (which is derived by using formulas 2 and 3): f = [p (1 + i) {(1 + i)n – (1 + g)n } / {(i – g) x v}]1/n – 1 (4) where the symbols have the same meaning as before. the results obtained when the initial replacement value of the property equals r100 000, the first annual payment (payable in advance) to the contingency fund is equal to r1 200 and thereafter increases annually at a growth rate of 9 sajems ns vol 6 (2003) no 2 285 per cent, and different annual interest rates and periods are applied, are presented in table 2. table 2 annual inflation rates of property provided for by a contingency fund, classified according to different annual interest rates of the contingency fund and different periods annual interest rates of contingency fund (percentage) periods 6 8 10 12 14 16 18 5 years -38,9 -38,2 -37,6 -36,9 -36,2 -35,5 -34,8 10 years -13,1 -12,3 -11,4 -10,5 -9,5 -8,6 -7,7 15 years -4,2 -3,2 -2,3 -1,3 -0,3 0,7 1,8 20 years 0,1 1,0 2,0 3,0 4,1 5,2 6,4 25 years 2,5 3,4 4,4 5,4 6,5 7,7 8,9 30 years 3,9 4,9 5,9 6,9 8,1 9,3 10,6 35 years 4,9 5,8 6,8 7,9 9,1 10,4 11,7 40 years 5,6 6,5 7,5 8,6 9,9 11,2 12,5 the preceding table leads to the following important results: (1) the negative inflation rates in the table indicate that the initial replacement value of the property should decrease annually by that percentage if the contingency fund has to provide full indemnity. no provision for possible price increases of the property is therefore available in these cases. (2) it is important to note that, even when the annual interest rate of the contingency fund is as high as 18 per cent and the payments to the contingency fund increase annually at a growth rate of 9 per cent, the contingency fund will be in a position to provide for an annual inflation rate of only 12,548 per cent after 40 years have expired. the reason lies in the fact that the contingency fund starts with an initial payment of r1 200 while the initial replacement value of the property equals r100 000. (3) when the annual interest rate of a contingency fund remains constant, the annual inflation rate provided for by the contingency fund increases annually as the period increases, but the increments show a decreasing tendency. for example, with an annual interest rate of 10 per cent, the annual inflation rate provided for by the contingency fund increases by an increment of 2,4 percentage points (from 2,0 to 4,4 per cent) when the period increases from 20 to 25 years; by an increment of only 1,5 percentage points when the period increases from 25 to 30 years; and by sajems ns vol 6 (2003) no 2 286 an increment of only 0,9 percentage points when the period increases from 30 to 35 years. 5 conclusions the following conclusions are reached in respect of the various forms of internal risk financing: (1) charging losses to current operating profit, arrangement of loan facilities and implementation of equity financing programmes are not necessarily without disadvantages. enterprises should therefore be careful when relying on these forms of internal risk financing only. (2) onshore, offshore and cell captive insurance companies are important facilities for internal risk financing which should be considered by enterprises due to the number of advantages which they provide. (3) a contingency fund often does not provide 100 per cent or more of the replacement value of property over a period of 40 years. when the location of the assets of an enterprise is geographically diversified, distribution of the associated risk takes place. this form of internal risk financing may then be acceptable, as full replacement value of all the assets may not be necessary. (4) it has been determined that, in the long run, the level of the annual interest rate is of prime importance for the feasibility of a contingency fund. the extent of the annual inflation rate of the assets concerned over the long term also plays a significant role when the sufficiency of a contingency fund is assessed. the value of the contingency fund as a percentage of the replacement value of property usually shows an increasing tendency over the long term, although a turning point in the results may sometimes be experienced. (5) it is important to note that, even when the annual interest rate of the contingency fund is as high as 18 per cent and the payments to the contingency fund increase annually at a growth rate of 9 per cent, the contingency fund will be in a position, after 40 years have expired, to provide for an annual inflation rate of only 12,548 per cent. the reason lies in the fact that the contingency fund starts with a single initial payment, while the initial replacement value of the property represents a significant amount. sajems ns vol 6 (2003) no 2 287 (6) when the annual interest rate and the annual growth rate of the annual payments of a contingency fund remain constant, the annual inflation rate provided for by the contingency fund increases annually as the period increases, but the increments show a decreasing tendency. the four preceding conclusions culminate in the observation that an enterprise should take the following aspects into consideration when assessing the feasibility of a contingency fund for its own circumstances: (a) whether the assets of the particular enterprise are geographically diversified; (b) the level of the expected annual interest rate of the contingency fund in the long run; (c) the extent of the anticipated annual inflation rate of the assets concerned over the long term; (d) the fact that the value of the contingency fund initially has a significant backlog compared to the replacement value of the assets; and that (e) when the annual interest rate and the annual growth rate of the annual payments of a contingency fund remain constant, the annual inflation rate provided for by the contingency fund increases degressively as the period increases. references 1 adams, m. & hillier, d. (2000) “the effect of captive insurer formation on stock returns: an empirical test from the uk”, journal of banking & finance, 24(11): 1787-807. 2 altman, e.i. & saunders, a. (1997) “credit risk measurement: developments over the last 20 years”, journal of banking & finance, 21(11-12): 1721-42. 3 anderson, m.e. (2001) “pickup trucks and captives”, best’s review, 101(11): 35-8. 4 bowers, b. (1999) “swiss recentralized alternative risk transfer”, best’s review / property-casualty insurance edition, 99(10): 30-1. 5 bradford, m. (1999a) “captives driving growth in self-insurance vehicles”, business insurance, 33(7): 3-5. 6 bradford, m. (1999b) “reinsurance troubles may await captives”, business insurance, 33(49): 36. 7 brandsen, a. (2002) personal interview, alexander forbes risk services, stellenbosch, 19 march. 8 conradie, w.j. & schoeman, a. (2001) renterekening met finansiële sakrekenaars, (3rd print), stellenbosch: universiteit van stellenbosch drukkery. sajems ns vol 6 (2003) no 2 288 9 costle, e.r. & schauer, k.a. (2000) “the captive alternative: a regulatory perspective”, journal of insurance regulation, 19(2): 304-22. 10 diacon, s.r. & carter, r.l. (1992) success in insurance (3rd ed.) london: john murray. 11 gjertsen, l.a. (1997) “risk financing for the middle market”, national underwriter, 101(17): 37-38. 12 hampton, m.p. & christensen, j. (2002) “offshore pariahs? small island economies, tax havens, and the re-configuration of global finance”, world development, 30(9): 1657-73. 13 howard, l.s. (2001) “global captive use grows in hard market.” national underwriter, 105(11): 7 & 25. 14 huxham, k. & haupt, p. (2000) aantekeninge oor suid-afrikaanse inkomstebelasting, (19th ed.) rogge bay: h & h publications. 15 insurance advocate (2000) “risk management consultant predicts increased use of offshore captives, including segregated account companies”, quoted in: insurance advocate, 111(50): 30. 16 ke, b., petroni, k.r. & shackelford, d.a. (2000) “the impact of state taxes on self-insurance”, journal of accounting & economics, 30(1): 99-122. 17 kildegaard, a. & williams, p. (2002) “banks, systematic risk, and industrial concentration: theory and evidence”, journal of economic behavior & organization, 47(4): 345-58. 18 mcdonald, c. (2001) “captives 101: three success stories”, national underwriter, 105(21): 9. 19 pilla, d. (2001) “captivating growth”, best’s review, 102(1): 85-6. 20 preston, l.w. & thomas, b.b. (2002) “reassessing the value of insurance”, best’s review / property-casualty insurance edition, 103(4): 66-8. 21 savage, m. (2002) “business continuity planning”, work study, 51(5): 254-61. 22 schneier, r. & miccolis, j. (1998) “enterprise risk management”, strategy & leadership, 26(2): 10-4. 23 veysey, s. (2000) “will new options supplant captives?”, business insurance, 34(23): 33-4. 24 zolkos, r. (1996) “alternative risk financing grows”, business insurance, 30(50): 1-3. 25 zolkos, r. (1998) “captives may be used to tap capital markets”, business insurance, 32(48): 3-4. 26 zolkos, r. (2000) “role of captives changes with market”, business insurance, 34(48): 3-4. sajems ns vol 4 (2001) no i the political economy of capital gains taxation in south africa i part i: the public finance of capital gains taxation zane a spindler simon fraser university. canada visiting professor. school of economics. university of cape town 2001 abstract public finance and public choice principles are used to analyze the ideological and practical basis for the proposed introduction of a capital gains tax into the income tax system of south africa. the paper concludes that this is a flawed tax whose time has passed especially for countries like south africa. jelh24 a foolish consistency is the hobgoblin of little minds adored by little statesmen and philosophers and divines. with consistency a great soul has simply nothing to do. rw emerson, spiritual laws, 1803-82. 1 introduction in its 2000 budget, the south african national government proposed that a capital gains tax (hereafter, cgt) be introduced as of i april 2001. in its 2001 budget, the minister of finance said: "while it is imperative that this fundamental change be made, it is proposed that the implementation be deferred to i october 2001." with luck, and some greater appreciation of post-modem public finance, by the time i october 200 i arrives, the cgt proposal will be shelved permanently. when the current proposal was first introduced, the usual rationales were given for adding such a tax to an income-based, ability-ta-pay, tax system; namely, the improvement of consistency and equity of the tax system. this essay will analyze those motives to suggest that they are based on misconceptions of consistency and equity; namely, 1) that achieving consistency on one margin necessarily involves creating inconsistencies on other, potentially more important, margins, and 2) that achieving equity should be judged with tax r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 2 sajems ns vol 4 (2001) no 1 incidence in mind. these propositions are based on the well-known economic theories of the second best and tax incidence. further, the essay will argue that the supposed problems actually arise from existing features of the income tax system; namely, i) the lack of full integration of the personal and corporate income taxes and 2) the difference between the average and marginal tax rates. changing these features directly may be more appropriate as a way of establishing consistency and equity, as well as possibly raising more revenue (hall & rabuska, 1995). in addition, consideration will be given to the political basis for introducing and maintaining a capital gains tax as part of a tax system. initial support may quickly erode as the incidence of the tax and its real burden becomes more extensive and more apparent. experience from other countries with capital gains taxation suggests that, in general, net revenue prospects may not justify the introduction of what amounts to a tax on capital rather than on capital income (grubel, 2000; katz, 1996). that experience also suggests that capital gains taxation often evolves into a more intrusive and distorting fonn over time. finally, the essay will argue that globalization of the capital market has made the taxation of capital by developing countries a policy which is most beneficial to the most developed countries that already have such taxation in place, rather than the developing countries that are attempting to hannonize their tax systems as a conduit to "joining the civilized world". this essay will explore many novel ideas not usually brought into play for tax policy analysis. the latter generally pays more heed to standard public fmance and accounting traditions. these alternative perspectives suggest that the capital gains tax proposed for south africa (hereafter, za) is the wrong tax at the wrong time for the wrong country. the essay will be organized and published in two parts, of which this is part i. part i has two major sections beyond the introduction and ends with a·· conclusion. these next two sections will look at taxation, in general, and at cgt,in particular, from a modem public finance perspective. however, they will take an unorthodox twist by considering the internal and joint consistency, and the appropriateness, of public finance principles used to justify the inclusion of a cgt in actual taxation systems. in part ii, there are two more major sections. one of these will consider public choice perspectives on tax policy decisions with respect to including a cgt as part of a polity's tax system. the other will discuss broader perspectives of the cgt for south africa's global future and macroeconomic growth prospects. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 3 these will take what i choose to call a post-modern, political economy perspective. a brief summary and concluding remarks will end part ii and the essay. what follows in both parts will tend to be more of a philosophical nature about capital gains taxation, in general and for countries like south africa in particular, rather than a set of specific criticisms of the current south african cgt proposal (such specific critiques can be found in black:, 2000; grote & fletcher, 2000; and steenekarnp, 2000). the south african capital gains tax proposal (hereafter, za-cgt), in any case, may well change substantially before or after implementation. the force of most of the arguments in this essay will not be blunted by any likely modifications, other than its permanent shelving, of course. however, references to specific features of the za-cgt are included where the general principles apply. 2 the public finance of income taxation as a discipline, public finance simultaneously offers a number of principles or ideals of taxation that are mutually inconsistent, not only on the basis of logic, but also on the basis of its own analysis. once these inconsistencies are noticed, one is tempted to suspect that, if public finance specialists are not schizophrenic, they at least must have what psychologists call logic-tight compartments. otherwise, it seems they might have been more hesitant about using these principles jointly as a rationale for specific taxes or tax systems. of course, it may simply have been a matter of not challenging a received discipline (who are you to disagree?); conventionalism (that is the norm, follow itl); division of labour specialization (hiding the forest from the trees.); or worse, not undermining professional market potential for giving expert advice (successful experts must not appear ambivalent!). as appealing as these spurious arguments may seem to the opponents of cgt, this essay will offer a public choice rationale that suggests individual rationality or consistency, but systemic irrationality and inconsistency. here is the basic consistency problem as it applies to income taxation in general and cgt in specific (chant, 1999). most simply stated, it is that the accepted ideal about what to tax is not compatible with the accepted ideal about how to tax. the explanation is a bit more complex. first, we will consider the "what to tax" issue and its own inconsistencies. then we will explore the "how to tax" issue. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 4 sajems ns vol 4 (2001) no 1 without dwelling too much on its own rather shaky foundations, we will show why it cannot be achieved given the choice of what to tax. 1.1 what to tax since at least the publication of r a musgrave's modem classic the theory of public finance text in 1959, which really defmed modem public finance, mainstream public finance theorists have considered the appropriate base for income taxation to be what is known as the "schanz-haig-simons" (hereafter sbs) notion of comprehensive personal income (katz, 1996; haig, 1921; simons, 1938). as south africa's own katz commission noted: under this defmition, personal income "is given by the market value of consumption plus the net change in the value of assets or property rights during the period in question" (katz 1996). since capital gains either increase the net value of an individual's assets, or allow a higher level of consumption, the sbs comprehensive defmition implies that capital gains should be regarded as income and taxed as such. in 1967, this accrual definition was given practical importance by canada's carter commission, which advocated its application to the canadian income taxation system, and popularized the comprehensive definition under the tautological slogan "a buck is a buck". since then, the sbs comprehensive, consumption plus net accretion, definition has featured prominently in almost every income tax reform proposal especially for those concerning capital gains. indeed, the katz commission harks back to these sixties' notions to provide the ideological rationale for cgt and other proposals. the underlying idea is simple. people should be compared on the basis of their potential well-being during a given tax year. a person's potential well-being is thought to depend on the maximum consumption she could undertake without changing the value of her assets. if saving is assumed to be zero, maximum potential consumption would then equal that year's income, measured on an accrual basis. this seems like a very good idea as long as one does not think too hard about how this would apply in the real world. that is because sbs is based on the simplest possible, and most easily understood, economic model of human behaviour the one-period model. more realistic two-period, life cycle, or overlapping generation models would not generally consider a given period's (year's) consumption and net wealth accretion to necessarily represent income earned during that period. indeed, professional and academic economists generally believe that an asset's market r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . samms ns vol 4 (2001) no i 5 value represents an associated discounted expectedfuture income stream. which is not necessarily related to its associated income flow, or any other income flow, during the past tax year (lang & shackelford, 2000). the shs concept of yearly taxable income may well have seemed more appropriate when it was first developed at an early stage of economic modeling (smetters 1999) especially given the requirements of the fiscal budget cycle for yearly revenue. however, it is hardly appropriate as a theoretical concept today, when multi-period modeling is so common both theoretically and practically, and second-best theory suggests that improving consistency on some but not all margins is not necessarily desirable. further, shs has never been practical for direct, consistent application. shs's accrual notion of income is seldom applied because of the impracticality of accurately measuring asset values yearly and of taxing incremental value. in practice, most income taxation is on a realized, not an accrual basis, and unusual gains or losses are often averaged over previous years or carried over to subsequent years. further, it turns out that "a buck is not often fully a buck" when it comes to treating certain realized receipts as income. canada, for example, counts a receipt of employment income, capital gains, and lottery winnings as 100%, 75%, and 0% per cent of "bucks", respectively, for pwposes of detennining taxable income. so much for the canadian legacy of the carter commission! treating such obvious windfall gains as those from lotteries, on a more favourable basis than the treatment of real capital gains due to successful investment, or even than phantom capital gains due to changes in absolute or relative prices, is hardly consistent with the comprehensive definition of income. unfortunately, the south african government's cgt (hereafter za cgt) proposal follows this very same inconsistent treatment perhaps with an eye to the revenue generating potential of its new lottery and the lottery's interaction with the tax system. 2.1.1 an instructive example: the shs notion of comparing individuals' yearly income on an accretion basis does not successfully meet the theoretical desiderata of treating equals equal1y. this can easily be seen by the comparison of a production worker who, say, receives employment income of r40 000 per year, with a retiree living off the interest on bonds of r20 000 per year. suppose during the current year the retiree experiences a r20 000 capital gain on the market value of her bonds due to a downward deviation from average of the interest rate during the tax year in question. then both the retiree and the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 6 sajems ns vol 4 (2001) no 1 if the retiree did not have to worry about maintaining her consumption during following years, she could indeed consume as much as the production worker during this specific tax year by selling off a portion of bonds to realise her momentary capital gain. however, that would require the retiree to be very short-sighted (or short-lived). further, income tax systems supposedly based on the comprehensive, accretion concept, recognize the harm and burden imposed if the concept were strictly applied in this case; they do not in practice treat the capital gain on bonds as income until it is realized. 2.1.2 a common mistake: now a casual observer might be inclined to think that the retiree was somehow better off than the worker, because she has wealth in the form of financial assets, which the worker does not. professional and academic economists especially those in public finance should not make such an elementary, wealth-measurement mistake. de facto, the worker owns his own human capital, the value of which would be measured by capitalizing his r40 000 at the appropriate interest rate. this latter interest rate may be higher than that used to capitalize bond coupon payments given that human capital is not alienable in the same way, and, hence, is not as liquid, as fmancial capital. however, the capitalization rate would have to be double the rate applicable on bonds for the value of the worker's wealth to be less than the retiree's wealth. further, a general decline in interest rates raises the capital value of both human capital and financial capital. both the worker and the retiree will experience an increase in wealth and both could potentially increase their consumption during the period in question. both the retiree and worker could borrow more against their respective assets, albeit at different interest rates. 2.1.3 please note: the important point to consider about this example is that both individuals are capitalists who have experienced a temporary capital gain during the period in question. therefore, including the unmeasured worker's capital gain on the same basis as including the retiree's unrealized capital gain would make them distinctly unequal for tax purposes. the retiree has a lower taxable capacity than the worker, which would be recognized by taxing only realized money income as would be done by an income tax without cgt. fairness under the comprehensive accretion concept would require including the worker's unmeasured and imputed capital gain on the same basis as the retiree's unrealized capital gain. however, it would be far simpler, and equally fair, to forget about this worrisome comprehensive definition, and treat both on a realized income basis. this is exactly what the za-cgt proposal does, despite its shs rationalization! r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 7 thus, real world, income-tax systems, supposedly based on the comprehensive accretion concept, quite sensibly ignore both changes in period-spending potential. however, such tax systems do treat realizations differently as a result of including the realized capital gains from marketable capital, but not the realized in-period increase in borrowing and purchasing power associated with temporary interest rate reductions. indeed, some macroeconomic and real business cycle models imply that workers' labor supply will vary directly with interest rates so that this worker's labor income may actually be lower than normal or permanent income in this situation. hence, applying the comprehensive, accretion concept on a yearly rather than life cycle basis would promote a vertical inequity as well as a horizontal inequity, if judged from the longer perspective. finally, if interpersonal equity is a goal of a tax system, rather than inter-income equity, the shs comprehensive definition must be applied over individual life cycles or even over generations. indeed, the more recent research on income and capital gains taxation does consider intergenerational modeling and, in one recent article (atkinson et al., 1999) finds that the optimum rate for a cgt is zero! also, intergeneration equity has been attacked from a slightly different angle, (possibly unintentionally) designed to provide the basis for intergeneration rent seeking, by corak (ed.) (1998). if the supposedly common pattern of "rags-to-riches-to-rags in three generations" generally applies, in-period redistribution would be less appropriate. real life is less like a hundred-metre dash, than like a relay race, or even more like a series of dashes and relay races. sensitive handicapping in taxation, as in sport, would work better if it takes account of such realities. we do not demand that, at each change of the baton in a relay race, the differences so far achieved be reversed. that would change the nature of the race and relayrace fans would think it quite unfair! in life's race to the top, we should also be wary that inappropriate interventions reduce the incentive to race. from that perspective, we would see that progressive tax rates and capital gains taxation, in practice, have more to do with holding back the poor than with pulling down the rich, whose relative position is generally unchanged as a result. we would benefit more, in general, without such anti-productive, anti-growth impediments. somehow the wrong, static, conception of the world has crept into, and taken up residence in, modem policy analysis, just like the proverbial camel creeping, small end first into the tent. for the sake of the poor, and the tax-system disadvantaged, this textbook notion must be purged and replaced with a realistic, dynamic, conception. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 8 sajems ns vol 4 (2001) no 1 in summary, the sus, comprehensive-accretion definition of yearly taxable income does not have a sound foundation in economic and public fmance theory and it is impractical and often ignored in practice. in fact, its sole practical purpose seems to have been to provide an ideological rationale for including capital gains in income tax bases. however, a principle, which is so inconsistent and discriminatory in application, is really no principle at all. 2.2 how to tax there are two classic principles of taxation which modem public fmance has vested with special meaning: the benefit principle and the ability-to-pay principle. the benefit principle (hereafter, bp) states that taxes should be paid by those whom benefit from government provision of goods. in the case of governmentprovided, private goods, the taxes should simply be user fees similar to the market prices that would prevail if such private goods were privately provided. in the case of what have come to be known as pure-public goods goods which are non-exhaustive and non-excludable taxes would also be like user fees but not directly comparable to market prices which either may not exist or may not determine the relevant margin for such goods. because of the alleged non-excludable and/or non-exhaustive character of public goods, it is presumed not possible and/or desirable to collect prices for such goods, once they are provided, because of the so-called free-rider problem. supposedly, those who benefit from a good may enjoy it whether or not they have paid for it. thus, there is an incentive not to payor to free ride. since private, for-profit firms require payment to survive and prosper, there may be too little, or no, incentive for them to provide public goods. consequently, this free-rider hypothesis provides the ideological rationale for government, and government provision of public goods, fmanced by taxes.2 in its modem fonn, the bp requires that such taxation be according to individual marginal benefit given the free-rider problem, individual marginal benefit may not be readily apparent, but there are procedures to fmd an approximation to the bp in practice (gradstein, 1999; rondeau et al., 1999; hines, 2000; knight, 2000). with these procedures for publicly-provided, public goods and with user fee pricing for publicly-provided private goods, free riding is controlled, bp applied, and tax avoidance is avoided. however, these proposals have seldom played a major role in modem tax systems or in tax reform proposals. this is probably because they are ill suited for financing a government's redistribution activity, especially when redistribution has little or no efficiency rationale, as in the case of pure transfer seeking (tullock, 1981). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 9 enter the second classic principle of taxation. originally, the ability-to-pay (hereafter, atp) principle was probably based on, or evolved from, pragmatism or administrative economy. a money tax could simply not be collected where there was no money. however, atp need not only refer to taxes in money, but also in kind, as was more common historically before the emergence of money-based economies. equal sacrifice in kind for (say) labor time might lead to equal taxes on all individuals since nearly every individual at birth has an equal expected endowment of "person-years of labor time". or, equal sacrifice in terms of burden or disutility of labor might tax the rich less because their time was more valuable in other pursuits! not so strangely, these alternative, equally valid, concepts of atp have not succeeded politically in modem times. instead, modern public finance attempted to give atp more popular appeal, and moral justification, by relating ability to utility and taxation to sacrifice or burden as measured by utility forgone. horizontal and vertical equity concepts were interpreted in terms of equal sacrifice of utility or equal burden in terms of forgone utility. whether utility sacrificed should be equal total, equal average (proportional) or equal marginal has never been (nor could it be) determined in abstract without political considerations. however, none of these measures is operational under economically reasonable and politically acceptable assumptions. yet, egalitarians were most pleased with the equal-sacrifice reformulation because, under certain assumptions about the shape and commonality of utility functions, disproportionate taxation of the rich, indeed, even a levelling of incomes, could be "scientifically" justified. the fact that the enabling assumptions could not generally be justified, much less measured or empirically validated, typically is mentioned satta voce and, thus, gave faint pause to "the emperor's fashion consultants". thus, progressive tax rates are the norm for income tax systems throughout the world and generally justified on some notion that an extra dollar is worth less to a rich person than to a poor person. not so strangely, the buzz-phrase, "a dollar is a dollar", is not applied when the dollar in question is held by people of different means. however, even here there is not consistency. public finance specialists sometimes argue that credits should be used instead of deductions because deductions would deliver more dollars to those taxed at higher, progressive rates as indeed they should. if comparable diminishing marginal utility determines r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 10 sajems ns vol 4 (2001) no 1 both the rate structure and that each dollar is worth less to the richer person, then more dollars in compensation are required for those richer in order to yield an equal sacrifice to those poorer. that is, consistency would dictate deductions not credits. political and financial expediency dictates otherwise. more importantly, atp is not applied at the point of final burden and this is the crux of the fundamental inconsistency between the shs concept of taxable income and the atp principle of taxation, as both are currently applied to justify existing income tax structures or reform proposals. the shs concept concerns where the income tax is levied, while the sacrifice or burden concept of a tp must be judged by where the tax ends up creating a burden or sacrifice. however, modem public finance most scientifically valid theoretical and empirical exercise, tax-incidence analysis, generally concludes that these are not at the same place for many types of income especially capital income. that is, it is inappropriate to judge equity on the basis of who initially pays the tax. 3 the public finance of capital gains taxation simply stated, the problem is as follows for the capital gains tax. a fully anticipated tax placed on owners of capital, in a small country that must compete internationally for capital, in the long run will not be borne by the owner of capital, but rather by the workers and consumers of that country (see graham, 1999; hindriks, 1999; jones, 2000; kneller, 1999). thus, an attempt to use capital taxation to reduce the after-tax income disparity between the rich and the poor may have exactly the opposite effect. the before-tax income of the working poor will fall possibly as much or more than the after-tax income of the rich who still choose to remain in, and/or migrate to, this country. if the tax is not anticipated, those who already have their capital resident in the country will suffer a capital loss as the new tax is capitalized. but creative accounting, gain-loss realization timing, and official corruption can minimize that burden or even shift it back on the tax system and the general taxpayer. the same result would apply with respect to new taxes, or taxes at higher progressive rates, applied to the incomes of owners of specialized human capital assets which are internationally marketable and internationally mobile. these human-capital owners would immigrate, or fail to emigrate, to the point where local supply was reduced enough to raise their before-tax incomes and restore their after-tax compensation to previous levels. an important point must be made here, given recent misleading public statements by some ministry of the treasury (formerly department of finance) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 11 and south african revenue service officials. just because some foreign countries already have a cgt, even if at higher tax rates, does not mean that foreign and domestic investment in south africa will not be affected by south africa's adoption of a cgt. any major event that changes the expected riskreturn balance of investors' portfolios will eventually provoke a portfolio adjustment. such adjustments may well involve increased net capital outflows, the magnitudes of which are difficult if not impossible to measure and predict accurately. even in a closed economy, there would be a similar reduction in the well-being of the working poor, as well as for the economy in general. both rich and poor individuals would have less of an incentive, and ability, to save and invest in either human or non-human capital that improved the formal sector market productivity of the economy. there would instead be substitution into leisure and non-market activities and investment. these very well-known and thoroughly studied incidence results3 from modern public finance are seldom juxtaposed against the similarly well-known, studied, and advocated shs and atp concepts. as my colleague, john chant (1999), has wittily observed, public finance specialists "fail to practice what they teach!" as in other areas of economics recently, there may be some redistribution "policy irrelevance" theorems still to be explored, and claimed, in post-modern public finance. hopefully, this discussion has made it clearer that: the shs comprehensive concept of income is not theoretically or practically useful in guiding taxation aimed at establishing either horizontal or vertical equity with respect to real persons. further, shs has been most misleading about the very nature of capital gains. it is time for greater clarity. 3.1 what [s income? economists will generally say that income is a flow of services from a stock of assets, such as human and non-human capital, as embedded in humans, intangible assets (bonds, stocks), and real assets (including land and buildings and equipment thereon). these real service flows may be given nominal values by the use of their respective, nominal market prices or may be assigned a real value, individually or in total, if appropriately weighted by their relative (or real) market prices. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 12 sajems ns vol 4 (2001) no 1 national accounts economists would further stress the distinction that these service flows contribute to value-added to the newly produced goods and services in the circular income and expenditure flow. that is, from a national accounts perspective, an individual's yearly income is the sum of her valueadded to measured gross domestic product (gdp). the economy's net income is similarly the sum of yearly net value-added to net domestic product (ndp). for those who seek consistency in taxation, it is curious that the value-added standard has not played a more prominent role. it would be consistent with national income accounting standards. it would also make empirical macroeconomists very pleased to be able to reconcile government fiscal action with the national accounts' effects thereof. however, this standard is not without its own problems for actual taxation, since it is also accrual based. but many of these accrual problems, like that of depreciation or imputed income, are already dealt with creatively by both national revenue and national income accountants the latter usually without resorting to counting capital gains. specifically co-ordinating these efforts and standards would go a long way toward achieving consistency between two branches of government the national revenue and national statistics branches. we must note before leaving this section, capital gains are not included as income in the national accounts, for the very good national accounting reason that: capital gains are not income. thus, a value-added concept of income may be more practical than a sus comprehensive concept, and it would not require or justify capital gains taxation. 3.2 what are capital gains? simply stated, capital gains (losses) are the increase (decrease) in the market (or implicit) value of an asset, or set of assets, between two dates. for an asset whose intrinsic nature has been neither augmented nor diminished between such dates, there has been no real capital gain. the "asset is the asset", just like "the dollar is the dollar". 3.2.1 temporary gains: the change in the asset's market value may be only due to temporary and reversible changes in relative prices between assets, relative prices between assets and consumption flows, and relative prices between present values and future flows (more commonly called interest or discount rates). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 13 reversible, temporary changes in value do not represent appropriate tax targets if full loss offset is allowed. revenue gained on the upside of the cycle is lost on the downside, with a great deal of private and public administrative cost in between. one might take exception with this statement, in the case of traders who make their current income from trading in such markets. to the extent that they are successful, their income flow will always be positive. however, their net gains are balanced by others' net losses for a perfectly symmetrical cycle. partial loss offset may allow some net revenue, but only by playing the intrinsically unfair game "heads, i win, tails you lose" with the taxpayer. that game is never popular and often induces extra lobbying and political costs, evasion, and disrespect for law and government, when losses are concentrated for any group. again, unfortunately, that is the "game" that the minister of finance proposes to "play", in part, since losses under his za-cgt proposal will only be allowed to offset capital gains, with a carry forward, but an offset against other income is not allowed. 3.2.2 permanent gains: permanent, or long-term, changes in relative prices may require changes in asset holders' portfolio composition or their production or consumption mix in order to maintain efficient allocation when there are variable rather than fixed proportions that apply in asset holders' portfolio balance, production, and/or consumption functions. this may require realization of supposed capital gains, but will not necessarily represent a welfare gain for asset holders. indeed, the readjustment may be required just to maintain efficiency in the face of otherwise larger welfare losses. the information required to make a scientifically based judgement here is usually too costly, if not impossible, to obtain. but otherwise, the presumption of welfare gain is not warranted. perhaps some examples here would clarify what might otherwise be an obscure point to non-economists not familiar with isocost, isoquant, and isoutility curves and the hicksian concept of real income. example i: first, let us take our retiree, who (say) bought a sea point flat in the days when sea point was a much different place than it is today. the initial intrinsic or real value of the flat to the retiree may well have been higher than the current intrinsic value to her, because of the social and/or physical changes that have occurred in the interim. we can imagine that the real value to her today might well be less than it was previously. indeed, she tnight be willing to sell out to those who, because of those changes, now place a higher nominal market value on the flat than it had when she originally bought it. she could just sell for a higher than original money price, which, in the eyes of shs, should r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 14 sajems ns vol 4 (2001) no i attract a capital gains tax if not exempted on compassionate or administrative grounds. currently, that is currently the case for the za cgt proposal if this flat is her principal residence and if her money "gain" does not exceed one million rand (this is approximately the current value of middle-class housing in cape town. eventually, inflation will create many more cgt payers among those who now imagine themselves exempt). however, selling may not be a realistic consideration for her unless she can buy alternative accommodation that is at least as satisfactory as currently. indeed, unless she can use the proceeds of her sale to buy accommodation that is at least as satisfactory as originally, she is not, in reality, better off for having experienced a measured capital gain. putting her back in her original position with respect to the intrinsic value of her housing services may be quite expensive especially, if it entails moving offshore in the face of capital controls on foreign exchange. if a capital gain tax is levied on the difference between the nominal purchase and sale prices, it decreases the ability of the retiree to maintain her capital assets at present real value, much less to restore that value to its original level. this may well prevent a sale that would be efficient from the standpoint of reallocating assets from less to more efficient use. at the extreme, it may forestall the sale forever, or until the death of the retiree and her heirs. this is one example of the so-called "lock-in effect" of capital gains taxation. example 2: the same scenario could be played out for a business, which uses an asset (say, business premises in hillbrow), in the production of real income in the value-added sense (say, selling books on a particular religion popular in hillbrow at that time). over the years, changes in the intrinsic nature of that asset made it less appropriate for this specific business while making it more appropriate for other businesses. consequently, while the market price of this asset may have risen, its intrinsic value to the business firm falls relative to its original value, which justified its initial purchase. however, an ongoing business firm would only sell this asset if it could be replaced with one of at least the same current value. othelwise, the owner(s) would not gain from the sale relative to his (their) current position (as bad as it may otherwise be, moving may only make things worse). the fu111 would only regain its original real position if it could sell the asset in question for a high enough price to replace it with an equivalent asset, in this case, a business location elsewhere in a community that would re-establish its original profitability. only if the current market price were high enough to finance better premises would there have been a real capital gain for the owner(s). again, taxing the nominal capital gain will simply forestall an otherwise appropriate rer ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 15 allocation of capital. again, the lock-in effect delivers an inefficient result that would not otherwise occur in the absence of cgt. 3.3 market versus personal gains: notice that the above examples stressed a change in relative (that is, real, not necessarily nominal) market prices, which moved in the opposite direction to that of intrinsic or real value to the original owner, because of events external to the owner. that is, the owners in both cases experienced what economists call negative externalities. generally, economists, and sometimes others, are sympathetic to those who suffer externalities at least to the extent of agreeing that they should not suffer further as the result of government action. indeed, if anything, they would urge the government to compensate those sufferers. this would especially be the case if the government had played any role in creating conditions promoting these negative externalities (such as relaxing zoning restrictions and crime prevention). otherwise, economists would say that the government should tax, or the individual( s} should sue, those who are responsible. indeed, compensation paid to those who suffer, as with an insurance or tort payout, that essentially restores them or their damaged property to its original condition, escapes income taxation, as do depreciation allowances intended to restore the original condition of the asset when renewed or replaced. the za-cgt proposal, in fact, will also not tax such compensation. however, economists' sympathies might be different if the intrinsic value of an asset changed due to a change in the owners' taste or production possibilities, since to some extent, the owner might well be considered responsible even though the same principle concerning real personal gain might apply. example 3: consider an actual, but little known, south african case. it did not go to court and it was not publicized. the tax authorities eventually saw the "light of the train headed down the track" at them if they persisted and the prospect was not particularly pleasant: a wealthy, but "culture-impaired", individual started to develop a taste for art. at first, her taste was not very good, in absolute or subsequently self-evaluated terms, and the art initially purchased was eventually sold in a market flooded by the desires of others similarly newly endowed with (mediocre) art appreciation and enabling means. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 16 sajems ns vol 4 (2001) no 1 as the tastes of our protagonist changed (improved), her previously collected works lost their intrinsic value for her. from time to time, she would sell these works whenever she was able to get prices that enabled her to purchase new works to restore her initial intrinsic value of her collection. over the years, the gains from these sales mounted, as did the quality of the art on her walls, until the attention of the receiver of revenue was provoked by a disgruntled snitch. however, a very clever legal scholar was eventually able to convince the authorities that it was not in their interest to pursue a case where the individual in question had not made any gain in real value. instead, she had merely substituted from what the public (she) now valued more (less) to what the public (she) now valued less (more). thus, it could not actually be proven that she made any real gain that warranted attracting a tax, either in terms of her own taste or in terms of the taste of current market participants. 4 while correct in principle, this perspective would gain little widespread sympathy especially from those "robin hoods" determined to redistribute from the "haves" to the "have-nots". however, all the above examples support the idea that a real capital gain is not the difference between the original price and the current sale price. rather: real capital gain is the difference between the current price of the asset sold and the current purchase price of the alternative, currendy available asset(s) that would currendy make the individually equally wed off as originally. since the latter would be difficult for a tax assessor to determine with certainty, the "precautionary principle" (so popular these days with envirorunental groups) would require not taxing rather than risk inflicting uncompensated damage. 3.4 nominal capital gains more sympathy can be generated for those who lose real value due to a change in the general price level or exchange rates (in the case of foreign investors) ... this is so well known and widely appreciated even by tax specialists that advise the goverrunent that it need not be laboured further here. unfortunately, the concern and advice seldom affects the tax code on capital gains. specifically, it virtually never leads to tax code provision of full relief. this fact might be taken as prima facie evidence of the hypocrisy of those who legislate, design, and write the tax code. they seem to have little apparent interest in establishing horizontal equity or vertical equity for real persons by being consistent on the appropriate margin. rather, they pay lip service to those ideologies in order to justify another revenue grab. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 17 of course, that is exactly a major problem with the current za-cgt proposal there is only the slightest recognition that gains may be only nominal, not real, and there is no bow to indexing of any kind. there is only the hypocritical, but untrue, rationale that at the za-cgt's proposed low introductory tax rate and the gradually lower inflation rates, this will not be an important matter of equity or efficiency. not that there is anything unusual about such subterfuges. this is normal and predictable behaviour from a public choice perspective. however, foreign investors will likely be fmther discouraged by the taxation of domestic appreciation in rands that merely maintains an asset's foreign currency value. such taxation can too easily be avoided by not investing in south africa. fortunately, at the moment, foreign investors are exempt from the za-cgt proposal. nevertheless, domestic investors who intend to migrate, or to send money to their family members already established elsewhere, cannot be indifferent to the za-cgt introduction and evolution. 3.5 real capital gains consider some examples of how real capital gains arise in a modern economy. 3.5.1 flow-based gains: i) current-period, formal-sector income could be saved, rather than consumed, and invested in formal-sector assets at an internal rate of return equal to the going external capitalization rate for that class of assets. the expected stream of future earnings will increase and its capitalization will result in an appreciation of the assets' value by an amount equal to the saving (investment). taxing this gain is equivalent to attempting to tax income at a higher rate if saved (invested) than if consumed. a growth-oriented government would presumably want to do exactly the opposite. la) suppose the income came from the informal or underground sector. then, taxing that gain, taxes only saving (and productive investment), but not consumption, from that otherwise untaxed income. some extra revenue might be collected in this way. lb) however, it might also provide an incentive to reinvest that income in informal sector assets, that is, in assets whose capital gain and subsequent future stream of earnings might fmther and forever escape the taxman's attention. potentially. more revenue could be lost thereby. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 18 sajems ns vol 4 (2001) no 1 taxing the future stream of formal-sector earnings taxes the original saving (investment) indirectly, even with avoidance. 2) alternatively, the investment might be made at a higher (lower) internal than external rate of return. that would lead to an even higher (lower) stream of expected future earnings and, possibly a higher (lower) capitalization multiplier, hence, yielding a gain (or even a loss) in value greater (less) than the amount of saving (investment). taxing this extra gain (or refunding the loss) is equivalent to taxing efficiency-increasing investing (subsidizing efficiency-decreasing investing). again, a growth-oriented government would want to do exactly the opposite! 3) individuals may reduce their market participation, or their leisure, to devote time to augmenting their human and non-human capital by (say) studying, creating an interesting social and artistic environment (improving personal growth), creating a viable business plan, and/or remodeling or building a primary (vacation) home (improving personal well-being). market or non-market income may be forgone or reallocated to other non-market use thereby, for the market income portion of opportunity cost, escaping direct taxation. thus cgt may also be avoided if this investment activity is directed primarily at augmenting human capital for which a capital value is not normally available. while taxing the resulting gains on business or select personal assets might capture the successfully invested portion of such non-market income, one might well question the incentive effects of such taxation. an extreme form of such an approach was observed in the former ussr where subjects tended to be relatively "human-capital rich" and "non-human capital poor" because the lack of effective property rights in non-personal assets constituted a 100% tax rate on capital accumulation. 3.5.2 a misleading fiction: further, a common, but misleading, fiction (or myth) has been maintained in cases 1-3 directly above. the fiction is that capital gain can arise from current income. the examples show how saving from current market or non-market income might compare with a change in an asset value. but whether there is any capital gain depends, not on current income, but on a current investment decision, which given the incentives, is made more or less successfully or unsuccessfully. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vo14 (2001) no 1 19 that is, it is the decision-making, and, specifically, the desire and ability to do it well, that is the key to capital gain or/oss, not current income. 3.6 taxing tbe future from a forward-looking perspective, so-called capital gains are always capitalized expected future income gains, not present income. taxes on capital gains are taxes on future income, not present income not, at least, the sort of present income that most public finance specialists say they are worried about avoiding income taxes. rather, it taxes productive (as opposed to unproductive) investment decisions, which for the most part, are based on information whose production generally does lead to taxable income in the current or previous periods. economists have never argued that decision-making per se (such as deciding to consume or invest in x rather than y) should be taxed. from economists' own cultural perspective, good decision-making creates more value-added than bad decision-making. those who make more good decisions than bad may well earn a market or implicit fee or income for such services. but typically, when such commissions are explicit they are taxed in the present, and they generally do not represent more than a small fraction of the gains expected to be created thereby. the latter is value-added expected, and quill! properly taxed, in the future. thus, if the goal is to tax current income, which would otherwise escape taxation in the current (or previous) tax year(s), capital gains should not be taxed. in summary, the reasons are as follows: 1) there is no necessary reilltionship between capital gains and current income otherwise escaping current taxation. 2) capital gains taxation actually taxes good decision-making with respect to creation of future taxable income thereby potentially decreasing the future tax base, as web as future income and the future capital stock. 3) increments to future income, due to increments in real non-human and human capital, are taxed in the future. from a forward-looking perspective, a cgt is simply a special type of "transactions tax". that is, it is a tax on transactions in marketable assets which have been held for longer periods than the limit (generally one to two years)5 set in the tax code as determining such transactions as part or a normal, for-profit business operation. indeed, although it has often been called a voluntary tax (because it can be avoided by avoiding the transaction), from a forward-looking perspective, this is a bit of a misnomer. from the case studies presented above, and a bit of knowledge about the determinants of business and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 20 sajems ns vol 4 (2001) no 1 personal choice, we can see that the tax leads to an involuntary postponement of a transaction, which might otherwise have been optimal to pursue sooner. 3.7 systemic problems usually, public fmance specialists advocate taxation of corporate income and capital gains as a way to insure and protect the revenue productivity of the personal income tax. they fear that those who have an unequal ability to shift their de facto current income to the de jure havens of corporations or capital assets (if untaxed), will have an unequal advantage in avoiding personal income taxation. such shifts, on a large scale, might imperil the personal income tax base and, hence. revenue collections. such fears are ultimately due not to potential taxpayer choices but rather to legislative and administrative choices made over base definition and differential tax rates on different bases. 3.7.1 tax base: first. consider the primary problem of base specification. where we meet again the ugly. out of date, and confusing role played by the shs concept of income. a canadian example may again be instructive. under the carter commission conception of shs, the corporation was not an appropriate object of income taxation theoretically only practically. for carter, only real persons enjoyed shs income. income earned by corporations. according to carter, should be attributed to owning individuals. where taxes on it are properly paid at the marginal tax rate applicable to each individual. respectively. thereby, horizontal and vertical equity could be easily achieved at one stroke for each individual income recipient presuming. very cavalierly, that there was no tax shifting. at most, corporations should just serve to as withholding entities for capital income, just as they were already doing for labour income. the beauty of this conception of an income tax system was truly astounding at least to the carter commission and its fans (at the time, including me). the canadian politicians thought otherwise and delivered their own extensively revised version of the carter report nearly four years later in finance minister benson's 1971 white paper. even that was subsequently further revised before it emerged as legislated tax reform in 1972, which retained separate, un-integrated taxation of corporations and introduced a capital gains tax to wary canadian taxpayers and ecstatic canadian tax accountants (who thereby, saw their consulting income prospects skyrocket!). the carter recommendations simply proved to be too impractical both for revenue canada and for the liberal government. the ideological. if r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 21 not practical, thrust of shs was retained, however, because some rationale was needed to justify refonns and especially the introduction of a capital gains tax. the end result of attempting to improve consistency along the shs-carter model was to make the tax system differently inconsistent. by attempting to eliminate avoidance more opportunities for avoidance were created. while an integrated tax base would have eliminated a certain type of avoidance, it was not politically or practically feasible. 3.7.2 tax rate: second, given the non-integration of corporate and personal income, there is the progressive rate structure problem. a capital gains tax on corporate equity (but not on non-corporate assets) might be justified as a way to reduce avoidance of personal income taxation by the route of corporate retained earnings. whether this is a substantial problem that needs to be addressed in this way depends crucially on a comparison of the top personal and corporate marginal tax rates. if they are the same, or close, there is no or little incentive to use the corporate form to avoid tax, 6 and hence, little justification for a capital gains tax specifically on corporate owners or on any asset or anyone else, for that matter. of course, this problem would be easily resolved by dropping the ambition and pretence of achieving vertical equity. then, the progressive rate structures could be flattened or even eliminated. that would reduce or eliminate the main reason that taxpayers might want to substitute between tax bases.7 indeed, a flat tax rate structure would reduce or eliminate many of the problems inherent with income taxation, along with their partial, prospective solutions such as cgt, income averaging, dividend credits, tax credits versus deductions, etc. (hall & rabushka, 1995). it would also eliminate the need for bloated tax collection bureaucracies and the diversion of scarce accountants, and less scarce lawyers, into the tax-avoidance industry. strangely, orthodox public finance specialists seldom consider this route to "consistency". 4 conclusion in a sense, south africa is starting with an almost clean slate with respect to certain kinds of income taxation. it should strive to keep that slate as clean and simple as possible. in the name of consistency, the introduction of capital gains taxation in any form, will multiply, not reduce, the system's inconsistencies. in the name of equity, it will multiply the inequities. it will not raise substantial net revenues. but it will be a source of ongoing lobbying activity, and that will undermine social cohesion. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 22 sajems ns vol 4 (2001) no 1 in the short l1lil, za-cgt may yield political and financial benefits for the governing party. in the long run, if that party's constituents' market prospects improve as a result of other government policies and/or market developments, its own prospects are likely to suffer. every time a constituent's income earning or wealth gaining prospects are blocked or reduced by the presence of a cgt, votes and financial support wih be threatened. the "fmancial cows" will increasingly avoid that party's "milk house'" other parties will offer alternatives in order to farm this ever more fertile avoidance field. the prospects for the economy will be diminished by the incentives to divert resources from market to political opportunities. endnotes thanks are due to d. allen, j. chant, h. grubel, d. hammes, r jones, r krelove, and j. stuart. 2 notwithstanding the following: a) most of the goods provided by modem governments are not pure public goods (see blomquist & christiansen, 1999, for a rationale). b) modem theoretical analysis, experimental results, and real world observation suggest that the free riding hypothesis does not strongly apply in practice or can be managed privately with technological or contractual fixes (for example, rondeau et al., 1999). c) government itself is a public good, which under the strong version of the free-rider hypothesis would not be spontaneously provided (that is, the free-rider hypothesis undermines evolutionary explanations for the existence of government). d) modem public choice analysis suggests that government provision promotes rather than reduces free riding (de jasay, 1989). 3 these are not uncontroversial results. see lee (1995) for some counter· arguments with respect to the us. it rnight be noted in connection with his critique and in anticipation of the arguments in the next part, that the theoretical results apply to changes that are expected to be permanent. however, few rational political and financial observers of the us would regard any reform as more permanent than the composition of the· legislature that passed it or the special-interest groups that supported it. 4 this example, with a slight change in identity to protect or impugn the innocent, was told to me by c. prlsman of cape town, who further states: "of course, the revenue department was seeking to tax income and to treat the whole venture as a profit making exercise but how could it be? taste changed and taste is not a venture. when once the intention was to acquire permanently to enjoy value was irrelevant. as enjoyment ceased, what to do then? well to buy what you now enjoy is the reason for the sale, not the issue of obtaining income." r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no i 23 ceased, what to do then? well to buy what you now enjoy is the reason for the sale, not the issue of obtaining income." an extension of prism an's idea was given me by david hammes: suppose you have a "patron" who likes to buy work by new, up-and-coming artists .. .if slhe cannot sell their "old" paintings and buy new ones repeatedly (the effect of imposing a capital gains tax is to keep assets whose returns would be taxed "frozen") then the market for new artists shrinks substantially. who is likely to be poorer? older, established, artists or new, up-and-coming artists? so, the cgt actually is borne by the poorer part of the population. 5 south african tax law (section 9b) provides that under certain conditions the proceeds of the sale of listed shares held for a period of at least five years may be regarded as of a capital nature. see katz (1996). 6 when marginal rates were in the 90% range while corporate rates were in the 50% range, as was the case in the usa for quite a while, the incentive was very large and widely experienced. with top marginal and corporate rates within around 10 percentage points of each other, as is currently the case for south africa, the incentives, and those motivated by them, are probably not great enough to justify a special legislated tax, as opposed to tax code procedural changes. 7 as far as i know, public fmance has yet to justify scientifically any specific progressive rate structure guaranteed to deliver vertical equity in practice. (most recently, plug et al. (1999) made a heroic, efficiencypreserving attempt based on the assumption that everyone has the same utility function of a particular form.) actual progressive rate structures are politically determined by bargaining with affected lobby-groups under the justifying general interest ideology of vertical equity. the latter, to a professional con man, would simply be known as "the hook", which is the premise on which any successful con game must be based. references atkinson, a., chari, v.v. & kehoe, pj. (1999) "taxing capital income: a bad idea", minneapolis frb: quarterly review, 23(3): 3-17. 2 black, p. (2000) "capital gains tax: critical notes", the south african journal of economics, 68 (4): 805-9. 3 blomquist, s. & christiansen, v. (1999) "the political economy of publicly provided private goods", journal of public economics, 73 (1): 31-54 4 chant, j. (1999) "two-handed economists: do we practice what we teach?", the fraser institute symposium on capital gains taxation: vancouver. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 24 sajems ns vol 4 (2001) no 1 6 de jasay, a. (1989) "the return of the free rider", in his social contract and free ride, claredon press: oxford, 219-44. 7 grad stein, m. (1999) "optimal taxation and the fiscal constitution", journal of public economics, 72 (3): 471-85 8 graham, j. r. (1999) "do personal taxes affect corporate financing decisions?", journal of public economics, 73 (2): 147-85. 9 grote, m. and fletcher. k. (2000) "capital gains tax in south africa", the south african journal of economics, 68 (4): 786-96. 10 grubel, h. g. (2000) unlocking canadian capital: the case for capital gains tax reform, the fraser institute: vancouver. 11 haig, r. m. (1921) "the concept of income economic and legal aspects", in r m haig, (ed.), the federal income tax, columbia university press: new york. 12 hall, r and rabushka, a. (1995), the flat tax, hoover institution press: stanford. 13 hindriks, j. (1999) "the consequences of labour mobility for redistribution: tax vs. transfer competition", journal of public economics, 74 (2): 215-34. 14 hines, j. r. jr. (2000) "what is benefit taxation?", journal of public economics, 75 (3): 483-92. 15 jones, r. w. (2000) globalisation and the theory of input trade, mit press, cambridge. 16 katz, m. (1996) katz commission report, bttp"//www \loy zalrcports/1996/katz bt. 17 knight, b. g. (2000) "super-majority voting requirements for tax increases: evidence from the states", journal of public economics, 76 (1): 41-67. 18 kneller. r., bleaney, m. f., & gemmell, n. (1999) "fiscal policy and growth: evidence from oecd countries", journal of public economics, 74 (2): 171-90. 19 lang, m h & shackelford, d. a. (2000) "capitalization of capital gains taxes: evidence from stock price reactions to the 1997 rate reduction", journal of public economics 76 (1): 69-85. 20 lee, j. (1995) "capital gains myths", tax notes, (may 8). 21 minister of finance, web site: www.fmance.gov.za. 22 plug, e. 1. s.; van praag, b. m.s. & hartog, j. (1999) "if we knew ability, how would we tax individuals?" journal of public economics, 72 (2): 183-211. 23 rondeau, d.; schulze, w. d. & poe, g. l. (1999) "voluntary revelation of the demand for public goods using a provision point mechanism", journal of public economics, 72 (3): 455-70. 24 simons, h. c. (1938) personal income taxation, university of chicago press: chicago. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 25 25 smetters. k. (1999) "ricardian equivalence: long-run leviathan". journal of public economics. 73 (3): 395-421. 26 steenekamp. t j. (2000) "good tax practice and taxing capital gains''. the south african journal of economics, 68 (4): 798-804. 27 tullock g. (1981) "the rhetoric and reality of redistribution". southern economic journal, 895-907. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract background and introduction research objectives research method terminology of the foreign services reportable arrangement provision the empirical study the sample conclusion acknowledgements references about the author(s) marlene oosthuizen school of accountancy, faculty of economic and management sciences, stellenbosch university, stellenbosch, south africa cara thiart school of accountancy, faculty of economic and management sciences, stellenbosch university, stellenbosch, south africa citation oosthuizen, m. & thiart, c., 2020, ‘a critical analysis of the foreign services reportable arrangement provision of the tax administration act of south africa’, south african journal of economic and management sciences 23(1), a3248. https://doi.org/10.4102/sajems.v23i1.3248 original research a critical analysis of the foreign services reportable arrangement provision of the tax administration act of south africa marlene oosthuizen, cara thiart received: 03 july 2019; accepted: 01 may 2020; published: 27 july 2020 copyright: © 2020. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: an additional reportable arrangement was added to south african tax legislation by way of a public notice in section 2.6 of the government gazette no. 39650 of 3 february 2016 (hereafter referred to as the foreign services reportable arrangement provision). this reportable arrangement relates to service fee payments made by a south african resident (or non-resident with permanent establishment in south africa) to a non-resident. the services include consultancy, construction, engineering, installation, logistical, managerial, supervisory, technical and training services. aim: the aim of this study was twofold: to critically analyse the reportable arrangement provision by examining undefined terminology contained in this provision and to develop a decision tree that may assist taxpayers in the application of this provision. setting: relevant south african literature and tax partners, directors and tax managers at leading audit and legal firms in south africa. methods: the study commences with a review of available south african literature in an attempt to define the terms ‘arrangement’ and ‘anticipated’, as applied in the foreign services reportable arrangement provision and continues with survey research to validate some of the conclusions drawn in the literature review. results: from the literature review it was determined that although there are south african literature available providing persuasive value to the meaning of some of the undefined terms used in the foreign services reportable arrangement provision, there is no single consolidated source of information which clarifies the exact meaning of the terms in the context of this provision. hence, survey research was performed to apply the available south african literature in the context of the foreign services reportable arrangement provision. the majority of the respondents in the survey research agreed and validated the assumptions and conclusions drawn from the literature review. conclusion: it is therefore submitted that the presented findings may contribute to the limited existing south african literature on the foreign services reportable arrangement provision. keywords: foreign services reportable arrangement; service fee; government gazette no. 309650; arrangement; anticipated; tax administration act. background and introduction in 2013, the organisation for economic cooperation and development (oecd) issued a report on base erosion and profit shifting (beps) which is regarded as the first step towards the review and analysis of beps (oecd 2013). overall, the report identified 15 areas of focus, one of which is action plan 12 dealing with mandatory disclosure rules. the oecd explains that the intention of action plan 12 is to give countries an extra tool for tackling beps by providing tax administrations with early information on cross-border tax planning (oecd 2015a). in 2017, the national treasury (2017) explained south africa’s position regarding mandatory disclosure on the oecd action plan by stating that the tax administration act (no. 28 of 2011) contains rules addressing reportable arrangements. treasury held that these rules require taxpayers who have entered into reportable arrangements, to report the details of these arrangements to the south african revenue service (sars) (national treasury 2017), who uses the reported details of the reportable arrangements to respond to tax risks through timely risk assessment and audits (oecd 2015a). section 35 of the tax administration act specifies reportable arrangements. while section 35(1) lists specific arrangements, section 35(2) states that any arrangement is considered as reportable if that specific arrangement is listed by the commissioner in a public notice. on 03 february 2016 the commissioner published a public notice constituting a revised list of reportable arrangements in the government gazette no. 39650 of 03 february 2016 (south african revenue service [sars] 2016; hereafter referred to as the foreign services reportable arrangement provision). this public notice lists an additional reportable arrangement in section 2.6 pertaining to a particular type of service fee that is paid by a resident (or non-resident with a permanent establishment in south africa) to a non-resident. these services are defined to include consultancy, construction, engineering, installation, logistical, managerial, supervisory, technical and training services. the need for this inclusion was the observed increase in cross-border payments, which warranted attention from the sars (ens africa 2015). significant amounts of money were found to be flowing out of south africa on an annual basis due to payments for service fees. a task team, known as the davis tax committee, investigated the matter. their interim report found that 51.60% of all payments flowing out of the country in 2011 related to legal, accounting and management consulting fees (davis tax committee 2014). non-residents are only subject to tax with regard to receipts and accruals of income derived from a source in south africa (in terms of the definition of ‘gross income’ in section 1(1) of the tax administration act). however, where an international tax treaty is applicable, the service fee income received by the non-resident is only taxable in south africa to the extent that it has created a permanent establishment in south africa and the relevant income is attributable to such a permanent establishment. base erosion occurs when the non-resident service provider fails to register as a permanent establishment in south africa and does not declare its income that is taxable in south africa (national treasury 2013). this could lead to the fiscus being compromised as the resident (or non-resident with a permanent establishment in south africa) who receives the foreign services would likely claim a tax deduction in terms of section 11(a) of the tax administration act for the expenditure incurred while no corresponding income is taxable in south africa. hence, section 2.6 of the foreign services reportable arrangement provision was included as a measure to address this context. the foreign services arrangement is reportable when it meets all of the following criteria: 2.6 an arrangement for the rendering to a person – that is a resident; or that is not a resident that has a permanent establishment in the republic to which that arrangement relates, of consultancy, construction, engineering, installation, logistical, managerial, supervisory, technical or training services, in terms of which – a person that is not a resident or an employee, agent or representative of that person– (aa) was or is physically present in the republic; or (bb) is anticipated to be physically present in the republic, in connection with or for purposes of rendering those services; and the expenditure in respect of those services under that arrangement – (aa) incurred or to be incurred, on or after the date of the publication of this notice, exceeds or is anticipated to exceed r10 million in aggregate; and (bb) does not qualify as remuneration for purposes of the fourth schedule to the income tax act, 1962. the provision followed the long awaited 15% withholding tax on service fees, which was repealed with effect from 01 january 2017 (national treasury 2016). the withholding tax on service fees was revoked as national treasury argued that if the two regimes were applied simultaneously, it would result in extra administrative functions for the sars and a compliance burden for taxpayers (national treasury 2016). the goals of both regimes are to identify undeclared permanent establishments, to collect revenue from non-resident taxpayers providing technical, management or consulting services in south africa (national treasury 2016) and to protect the south african tax base from extortion (national treasury 2013). consequently, national treasury decided that these goals can rather be reached by the reportable arrangement regime. however, while the aim of the foreign services reportable arrangement provision is laudable, there is cause for concern relating to its implementation. to date, no guidance relating to this provision has been issued by the sars. currently, there is only one guide – the reportable arrangement guide, which was issued by the sars in 2005 (sars 2005). this guide is outdated, and still refers to the repealed section 76a of the income tax act (no. 58 of 1962), which dealt with reportable arrangement rules. to the knowledge of the authors, no single consolidated source of information exists that clarifies the exact meaning of the terms used in the context of the foreign services reportable arrangement provision. consequently, several terms used in the foreign services reportable arrangement provision are ambiguous as they are not defined in south african tax legislation. the vagueness gives rise to uncertainties regarding the application of this provision (gilmour 2017). the inadequate guidance provided by the sars and limited literature available can therefore restrict the effectiveness in achieving the above intended goals, as taxpayers may raise technical points related to ambiguity of legislation to avoid reporting the arrangement. when the repealed section 76a of the income tax act (the old reportable arrangement rules) came into force in 2005, the sars admits, taxpayers raised technical points in order to avoid reporting (sars 2008). research objectives following the above, the primary objective of the study was to critically analyse ambiguous terms in the foreign services reportable arrangement provision. derived from the critical analysis, the secondary objective was to determine how the monetary threshold of the provision should be determined. the final objective was to develop a decision tree that may assist taxpayers in applying the provision. research method the research methodology used in this study consists of both a qualitative research approach and an empirical study. the qualitative approach will consist of a literature review. the literature reviewed includes local statutory law, relevant books, court decisions, academic articles, theses and publications by regulatory bodies. the empirical aspect of the study utilised a survey as the research instrument. the survey is designed to test the validity of the statements and assumptions made by the authors on the subject of determining how the term ‘anticipated’ should be interpreted and applied, as well as how the r10 million monetary threshold should be applied. furthermore, the survey is designed to provide greater clarity on the ambiguities identified in this study by obtaining the opinions thereon from tax professionals in south africa. the tax professionals surveyed were tax partners, directors and tax managers at leading audit and legal firms in south africa. the relevant literature and results of the survey questions are incorporated in the development of a decision tree that could be utilised by taxpayers in the identification and application of a foreign services reportable arrangement. the research methodology of the survey research is explained at greater length in a later section. terminology of the foreign services reportable arrangement provision introduction the way in which the terminology in the provision is interpreted and applied is vital in determining whether and when an arrangement is reportable. determining whether and when a foreign services arrangement becomes reportable is significant as any participant who fails to disclose a reportable arrangement is liable to a penalty for each month that the failure continues, limited to 12 months (section 212 of the tax administration act). although the term ‘arrangement’ is defined in south african tax legislation, the terms used in the definition itself are not defined. the term ‘anticipated’ appears twice in the foreign services reportable arrangement provision. however, the meaning, interpretation and application of the term are not clarified in south african tax legislation. south african courts have also not yet considered its meaning and interpretation. hence, to determine whether and when a foreign services arrangement becomes reportable, the meaning and interpretation of the terms ‘arrangement’ and ‘anticipated’ are examined to assign a meaning to the undefined terms in the context of the foreign services reportable arrangement provision. the application of the term ‘anticipated’ and its effect on the r10 million reporting threshold as contained in this provision are further investigated. rules of interpretation for south african statutes for botha (2005) the interpretation of a statute relates to the understanding of its legal applicability by considering the different rules and principles with regard to the interpretation of the statute. the interpretation of statutes is complex due to the fact that south african law of statutory interpretation continues to be characterised by inconsistencies and uncertainty (clegg & stretch 2017). this is because south african courts tend to not apply the rules of interpretation consistently (clegg & stretch 2017). it is, however, beyond the scope of this article to discuss the complexities and difficulties in interpreting fiscal legislation relating to the rules of interpretation. south african courts apply the common law rules of interpretation when interpreting tax statutes as south african tax laws have no built-in interpretation provisions (kafesu 2011). according to the common law rules of interpretation, the two broad approaches to the interpretation of statutes are the traditional and the modern approach (van schalkwyk & geldenhuys 2009). in the case of the traditional approach, the general theories of interpretation are literalism and intentionalism, whereas with the modern approach, the general theories to the interpretation of statutes are purposivism and contextualism (van schalkwyk & geldenhuys 2009). de ville (2000) states that no matter which approach to the interpretation of statutes is followed, the role of the courts is to ensure that the interpretation of statutes complies with the requirements of the constitution. as a result, the rules of interpretation are to be derived from the constitution. the constitution of the republic of south africa (act no. 108 of 1996) was promulgated in 1993 and is the supreme law of south africa (section 2 of the constitution). hence, section 39 of the constitution is taken into account when interpreting tax statutes. sections 39(1) and (2) of the constitution state the following: when interpreting the bill of rights, a court, tribunal or forum – must promote the values that underlie an open democratic society based on human dignity, equality and freedom; must consider international law; and may consider foreign law. when interpreting any legislation, and when developing the common law or customary law, every court, tribunal or forum must promote the spirt, purport and objects of the bill of rights. these constitutional provisions compel the judiciary, when interpreting any legislation, to promote the protection of the freedom of a person, their property and the enforcement of the principles of human dignity, equality and fairness (goldswain 2008). for goldswain (2008), consideration of these contextual constraints and guidelines is central to the purposive approach. it therefore means that the interpreter consults external contextual factors before considering the legislative text (botha 2005). the modern purposive approach to the interpretation of tax statutes is already authoritative in south africa. in natal joint municipal pension fund v endumeni municipality 2 all sa 262, wallis ja approved the modern purposive approach to the interpretation of statutes. in this case, wallis ja expressed the view that the appropriate approach to interpretation of legislation to be followed in south africa is: consideration must be given to the language used in the light of the ordinary rules of grammar and syntax; the context in which the provision appears; the apparent purpose to which it is directed and the material known to those responsible for its production. (p. 263) wallis ja said that from the outset, one considers the context and the language together, with neither one predominating. accordingly, this literature review considers their ordinary, grammatical meaning (which is found in dictionaries) and the meaning that the courts have ascribed to the terms. the applicability of the grammatical meaning and meaning assigned by the courts are further considered against the purpose and goal of the reportable arrangement provision. before the foreign services reportable arrangement provision can apply, an arrangement must first be entered into. as a starting point the meaning of the term ‘arrangement’, in the context of the provision, must be examined. arrangement the term ‘arrangement’ is defined in section 34 of the tax administration act as ‘any transaction, operation, scheme, agreement or understanding (whether enforceable or not)’. the terms in this phrase are not defined in south african tax legislation. the ordinary grammatical meaning of the terms ‘transaction’, ‘operation’, ‘scheme’, ‘agreement’ or ‘understanding’ are listed in table 1. table 1: dictionary definitions of terms. considering the above clarification of terms, it appears as if the legislature adopted an inclusive conceptualisation of an ‘arrangement’. it can therefore be argued that the term ‘arrangement’ is defined in broad terms to include all forms of transactions entered into by the taxpayer. this broad understanding of ‘arrangement’ and ‘transaction, operation, scheme, agreement or understanding’ is supported through the case of newton v fct, 2 all er 759. lord denning expressed the view: the word ‘arrangement’ is apt to describe something less than a binding contract or agreement, something in the nature of an understanding between two or more persons. [par. 763] this case implies that an ‘arrangement’ requires a conscious involvement between two or more parties who reach an understanding (de koker & williams 2018). de koker and williams (2018) are of the opinion that there needs to be consensus or a meeting of minds between the parties to reach an understanding with regard to the terms and conditions of an arrangement. the term ‘transaction, operation or scheme’ was considered in meyerowitz v cir (3) sa 863 25 satc 287. the appellate division (now the supreme court of appeal) held that the word ‘scheme’ has an extensive meaning that is wide enough to cover a series of transactions. the court further held that it is not necessary that these transactions be in contemplation from the beginning for it to constitute a scheme (meyerowitz v cir (3) sa 863 25 satc 287). the courts validated the above interpretation in cir v louw 45 satc 113. corbett ja held that the term ‘scheme’ is wide enough to cover situations in which later steps in a course of action were left unresolved at the outset. corbett ja stated: if there is sufficient unity between this ultimate step and what has gone before, having regard to the ultimate objective, then together they may be regarded as being part and parcel of a single scheme. (p. 135) however, the meaning and the scope of the terms ‘agreement’ and ‘understanding’ have not yet been determined by south african courts (loof 2013). satumba (2011) notes that the term ‘understanding’ also includes any gentleman’s agreement, letter of wishes or a verbal understanding. loof (2013) observes that the mutual distinguishing feature found in the terms ‘transaction’, ‘operation’, ‘scheme’, ‘agreement’ and ‘understanding’ is the element of consensus. in other words, when two or more people agree to be involved in a ‘transaction, operation, scheme, agreement or understanding’, it may meet the reporting criteria of the foreign services reportable arrangement provision. this view is supported by innes ja in the court case of woods v walters 1921 ad 303. innes ja held that a written agreement was not essential for a contract to be valid and enforceable. the consensus of the parties therefore does not need to be evidenced in writing. this is affirmed by de koker and williams (2018). they conclude that an agreement of a proposed future transaction will constitute an ‘arrangement’ irrespective of whether it is in writing or not and, therefore, records all the terms and conditions or whether it is a verbal understanding. however, as there is no physical documentation, verbal agreements or understandings may be difficult to prove. this would make it difficult for the sars to identify a verbal arrangement, using the criteria in terms of the foreign services reportable arrangement provision. nonetheless, it is clear that the term ‘arrangement’ should be interpreted widely. this suggests that the sars used the term ‘arrangement’ in an attempt to apply this provision to any possible ‘transaction, operation, scheme, agreement or understanding’. this is evident by the fact that there has never been a reported case where the sars has failed on the grounds that there was no ‘transaction, operation or scheme’ (broomberg 2007). the above view is supported when considering the context in which this provision appears. as one of the main aims of the foreign services reportable arrangement provision is to protect the south african tax base from extortion, the terms in the phrase ‘transaction, operation, scheme, agreement or understanding’ should be interpreted as widely as possible. this is due to the fact that the legislator would want to include all forms of arrangements to protect the south african tax base from extortion. anticipated the term ‘anticipated’ is applied twice in the foreign services reportable arrangement provision. the first application of this term is in section 2.6(b)(i)(bb). this section states that where it is anticipated that the non-resident will be physically present in south africa in connection with or for the purpose of rendering the foreign services, the arrangement may, among other things, become reportable. the second use of the term ‘anticipated’ is in section 2.6(b)(ii)(aa). here it states that where it is anticipated that the expenses to be incurred will exceed r10 million in aggregate, the arrangement may, among other things, become reportable. the oxford english dictionary defines the term ‘anticipated’ as ‘regarded as probable; expect or predict’ (oxford english dictionary [oed] 2017). to date there remains no reported case law that deals with the application of the term ‘anticipated’ in the context of the foreign services reportable arrangement provision. the available literature on how the term ‘anticipated’ should be practically applied is therefore inadequate and restrictive. by referring to common law principles, the authors identified likely factors that may aid in determining how the term ‘anticipated’ should be practically applied in the context of the foreign services reportable arrangement provision. these factors identified by the authors were included in the survey conducted for the purposes of this research. the following factors might provide persuasive attributes to determine whether it will be anticipated that the non-resident will be physically present in south africa in connection with or for the purposes of rendering services: the nature of the services. the terms negotiated between parties. the terms and conditions specified in the service level agreement (sla). the history of similar services rendered in the past. similarly, to determine whether it is anticipated that the expenditure incurred or to be incurred will exceed r10 million in aggregate, the following factors might contribute: the terms negotiated between the parties involved. the type and length of the services to be rendered by the non-resident service provider. the cost of similar services rendered in the past. it is clear from the language used in the foreign services reportable arrangement provision that the r10 million reporting threshold is applicable to all of the services rendered by the non-resident to the south african resident or non-resident with a permanent establishment in south africa on or after 03 february 2016. this provision is not applicable on a per contract or arrangement basis. it is therefore submitted that the taxpayer will have to consider all arrangements made with the foreign service provider in order to assess whether a reporting obligation exists both in terms of whether the expenses is ‘anticipated’ to exceed r10 million in aggregate, as well as whether there is an ‘anticipated’ physical presence in south africa. the next subsection will examine the application of the r10 million monetary threshold as contained in the foreign services reportable arrangement provision. r10 million monetary threshold a requirement of the foreign services reportable arrangement provision is that the expenditure in respect of the foreign services under the arrangement incurred or to be incurred on or after 03 february 2016 exceeds or is anticipated to exceed r10 million in aggregate. this expenditure must not qualify as remuneration for purposes of the fourth schedule to the income tax act. uncertainties exist with regard to how this r10 million reporting threshold should be applied since the meaning of the term ‘arrangement’ and the meaning and application of the term ‘anticipated’ as contained in the foreign services reportable arrangement provision influence the manner in which this reporting threshold is applied. the lack of guidance from the sars further contributes to the uncertainties. in many cases, an agreement between parties will not only be for consultancy, construction, engineering, installation, logistical, managerial, supervisory, technical or training services but may also contain goods relating to that services, resulting in a mixed contract. to determine how this r10 million monetary threshold should be applied, it needs to be determined whether and how a mixed contract with a single composite price ought to be apportioned. to define a mixed contract, the ordinary grammatical meaning of the terms ‘mixed’ and ‘contract’ are investigated. the oxford english dictionary defines the term ‘mixed’ as ‘consisting of different qualities or elements’ (oed 2017). ‘contract’ is defined as ‘a written or spoken agreement’ (oed 2017). consequently, a mixed contract is for example a supply and installation agreement (supply and services), as such a contract consists of different elements (pwc 2016). a mixed contract is therefore a contract that consists of another element other than consultancy, construction, engineering, installation, logistical, managerial, supervisory, technical or training services. it is not clear how the foreign services reportable arrangement provision should be applied in a mixed contract situation (pwc 2016). for example, it is unclear whether the contract price should be apportioned between the different components or whether the contract price as a whole should be taken into account to determine whether the arrangement is reportable. it is imperative to determine whether the contract price should be apportioned between the different components of a mixed contract, as the contract price might exceed the reporting threshold whereas the apportioned prices for the individual supply and service do not. a logical assumption to make is that the price of a mixed contract (specifically a supply and services contract) should be apportioned between the different components since the reportable arrangement provision is only applicable to foreign services. in terms of the provision these foreign services include consultancy, construction, engineering, installation, logistical, managerial, supervisory, technical or training services. this submission made by the authors was tested by means of a survey. the oecd recommends that when dealing with a mixed contract one should break down the total amount payable under the contract on the basis of the information contained in the contract and then apply the appropriate tax treatment to each portion (oecd 2015b). it is submitted that when the participant in the arrangement apportions the price of a mixed contract according to the specifications of the contract, the participant in the arrangement must be able to demonstrate to the sars that the results of the apportionment calculation is reasonable. conclusions made from the literature review to be tested through survey research the literature review studied the meaning of and reviewed ways in which the term ‘anticipated’, as used in the context of the foreign services reportable arrangement provision, could be interpreted and applied. a lack of a clear definition provided for uncertainties regarding the interpretation and application of the term in the context of the provision. the meaning of the term ‘anticipated’ was examined by noting its ordinary, grammatical meaning: ‘regarded as probable, expect or predict’. due to the observed dearth of existing literature on the subject, the authors identified certain factors that might contribute in determining how the term ‘anticipated’ should be applied in the context of the foreign services reportable arrangement provision. when it comes to determining whether it will be anticipated that the non-resident will be physically present in south africa, the authors submit that one can consider the nature of the services, the terms negotiated between parties, the terms and conditions specified in the sla and the history of similar services rendered in the past. moreover, the authors submit that the terms negotiated between the parties involved, the type and length of the services to be rendered by the non-resident service provider and the cost of similar services rendered in the past may help in determining whether it is anticipated that the expenses incurred, or to be incurred, will exceed r10 million in aggregate. the ordinary grammatical meaning of the terms ‘mixed’ and ‘contract’ determined that a mixed contract consists of different elements. a mixed contract therefore includes an agreement that consists of both a supply and a service element. it is submitted that the price of a mixed contract (specifically a supply and services contract) should be apportioned between the different components since the reportable arrangement provision is only applicable to foreign services. in order to test the validity of the statements and conclusions made above, a survey was sent to a sample of tax partners, directors and managers at leading audit and legal firms. the empirical study follows in the next section. the empirical study research design the survey research is qualitative in nature as it seeks to develop an understanding through detailed description and to build a theory that can be tested empirically in later research (cooper & schindler 2008). the research design of the survey research was modelled on both the work of venter and stiglingh’s (2006) study and steenkamp and cramer’s (2012) study as these two studies had the same purpose for their survey research, which was to validate the conclusions reached in the literature review against the opinions and judgements of tax and accounting professionals in south africa. the unit of analysis and the population the unit of analysis consisted of highly qualified tax professionals in south africa. the tax professionals surveyed in this study were tax partners or directors and tax managers at leading audit and legal firms. these two groups form the defined population for this study. in an attempt to increase the quality of the answers, the survey was sent to these two focused target groups. venter and stiglingh (2006) conducted a survey to clarify uncertainties regarding the recognition and timing of a deferred tax asset for unused secondary tax on companies credits. the survey was conducted in south africa and was sent to accounting lecturers teaching accounting at postgraduate level at south african universities, accounting partners specialising in technical accounting matters at the eight largest auditing firms and to leading tax partners at the eight largest auditing firms in the country (venter & stiglingh 2006). in a similar vein, steenkamp and cramer (2012) conducted a survey to determine the completeness, accuracy and usability of an alternative model created to determine when an arrangement, as contained in sections 80m – 80t of the income tax act, should be disclosed. the surveys were distributed to a sample of 40 tax partners at leading audit and legal firms. venter and stigllingh (2006) included accounting lecturers in their study, as well as accounting partners specialising in technical accounting matters, as they were understood to be knowledgeable in accounting standards, requirements and best practice. as this study focuses on a specific tax matter and not an accounting topic, accounting lecturers and partners specialising in technical accounting matters were not included in the sample. it is expected that the inclusion of accounting lecturers and partners specialising in accounting mattes will not increase the quality of the answers received in the survey. steenkamp and cramer (2012) included only tax partners or directors at leading audit and legal firms. this research differs in that tax partners or directors and managers at leading audit and legal firms were included in the research sample. it was expected that these participants were actively involved in practical tax work and hence familiar with complicated tax matters. the sample sampling method this study made use of non-probability sampling. according to cooper and schindler (2011), there are two major types of non-probability sampling namely judgement sampling (also known as purposive sampling) and quota sampling. this study made use of judgement sampling, which is when a researcher selects their sample in accordance with some criteria (cooper & schindler 2011). as noted, one of the criteria of the foreign services reportable arrangement provision is that the expenditure incurred or to be incurred is anticipated to exceed r10 million in aggregate. it would be expected that larger established companies (based on income earned and size) are more likely to conclude service contracts with non-residents where the expenditure is expected to exceed r10 million in total. for this reason the authors surveyed tax professionals involved in providing tax advice for these larger companies. hence, the tax professionals surveyed were tax partners, directors and tax managers at leading audit and legal firms, as they provide tax advice for larger companies. with many years of practical first-hand experience in complicated technical tax matters, it is expected that they have in-depth knowledge of the workings of the foreign services reportable arrangement provision and would be appropriate to provide insight into how this provision should be interpreted and applied. non-probability sampling, specifically judgement sampling, is therefore considered to be both appropriate and adequate for this empirical study as the sample selected conform to the above criteria. a limitation or restriction of judgement sampling (also known as purposive sampling) is that other experts would likely come up with different elements from the target population in terms of key features and typical components to be in the sample (battaglia 2011). another limitation of purposive sampling is that the researcher runs the risk of introducing unknown bias as it assumes that the researcher knows in advance what the relevant key features are (vogt 2011). however, judgement sampling is often the only solution to increase representativeness in field research and it can be an improvement over simple convenience sampling (battaglia 2011). sample selection the study included a total sample size of 20 firms, which comprises 15 audit firms and 5 legal firms. a listing of the top 15 audit firms in the world, based on available fee income figures for 2016 was obtained from the international accounting bulletin (2017). all the top 15 audit firms had offices in south africa. these 15 firms are listed in table 2. table 2: the 15 audit firms, in alphabetical order, that were included in the sample. the legal firms were included in the sample as they specialise in providing tax and legal advice for their clients. the five largest legal firms in south africa were selected based on the most recent available data reflecting the number of attorneys in their employ at the time the survey was administered. the information was obtained from wikipedia (2017), who combined the information of major south african legal firms by using data from their websites to compile a listing of the rankings. the use of wikipedia was deemed appropriate, as it followed steenkamp and cramer’s (2012) study. the legal firms included in the study are listed in table 3. table 3: the five legal firms, in alphabetical order, that were included in the sample. one tax partner, director or manager was identified per firm to complete the survey. this was deemed appropriate as the respondent identified to complete the survey was seen as the expert in the field of reportable arrangements in the applicable firm. the tax partners, directors and managers of the leading audit and legal firms in south africa were identified by the information contained on their websites and contacted via email to request their participation in the survey. the tax partners, directors and managers were asked to identify an expert in the field of reportable arrangements if they felt they weren’t the most suitable person to complete the survey. some of the targeted respondents who were unable to participate in the survey due to time constraints, provided contact details of an appropriate tax partner, director, manager or other staff member with similar experience. as the respondents are experts in the field of tax, the total sample size of 20 firms (one respondent per firm) was deemed appropriate. background to the survey before the research commenced, ethical clearance was obtained from human research ethics at stellenbosch university. the survey was web-based and developed using sunsurveys. the respondents first received an email with an extract of the foreign services reportable arrangement provision. a link to the survey was then distributed to the respondents via email through the use of sunsurveys. the respondents first gave informed consent before the survey commenced. the respondents completed the survey directly on sunsurveys. the same sample of respondents was used to answer all the survey questions. respondent confidentiality was ensured in the survey. the survey did not require the disclosure of any personal information, and hence survey responses cannot be linked to individual respondents. profile of respondents the profiles of the respondents are shown in table 4. table 4: profile of respondents. as table 4 reveals, 43% of the respondents are either partners or directors at their respective audit or legal firms, while 43% are tax managers. the ‘other’ category refers to staff members who had practical experience with the foreign services reportable arrangement provision. where the tax partner, director or manager was unable to complete the survey due to time constraints, the survey was forwarded to an appropriate ‘other’ staff member. as table 5 demonstrates, 36% of the respondents have less than 10 years’ experience working in the field of south african tax legislation. altogether 14% of the respondents have between 10 and 15 years’ experience working with south african tax legislation and 50% of the respondents have more than 15 years’ experience with south african tax legislation. table 5: work experience of respondents. the results regarding the experience of these tax professionals are shown in table 5. the majority (64%) of the respondents have at least 10 years’ experience working with south african tax legislation. it can therefore be expected, considering the skills and experience of the respondents, that their responses add credibility to the results of the survey and enhance the reliability of this research study. response rate of the 20 surveys disseminated, 14 surveys were completed, resulting in a response rate of 70%. the response rate of 70% was considered satisfactory as the majority (64%) of the respondents had at least 10 years’ experience working with south african tax legislation. the respondents’ response to the survey questions are statistically summarised next. statistical summary of the results tables 6–10 set out the results of the responses received to the survey. table 6: results of whether the term ‘anticipated’ is unclear. table 7: results of the meaning of the term ‘anticipated’. table 8: results of contributing factors that help in determining anticipated physical presence. table 9: results of the contributing factors that help in determining the total anticipated service expense. table 10: results of whether a mixed contract should be apportioned. unclear meaning of the term ‘anticipated’ respondents were asked whether they agreed that the meaning and application of the term ‘anticipated’ is unclear. the survey results confirmed the conclusion drawn from the literature review, namely that the meaning and application of the term ‘anticipated’ is unclear as the term is not defined in south african tax legislation. as table 6 demonstrates, a clear majority of respondents (64%) agreed or totally agreed that neither the tax administration act, nor the income tax act nor the sars provides clarity on how the term ‘anticipated’ should be interpreted and applied. the term ‘anticipated’ can be interpreted as ‘regarded as probable, expect or predict?’ as table 7 demonstrates, all of the respondents (100%) supported the conclusion drawn from the literature review, namely that the term ‘anticipated’ can be interpreted by looking at the ordinary grammatical meaning, that is, ‘regarded as probable, expect or predict’. therefore, among other things, when it is expected, predicted or estimated that the non-resident will be physically present in south africa or when it is expected, predicted or estimated that the arrangement will exceed r10 million in aggregate, a reporting obligation may exist. factors to determine anticipated physical presence respondents were asked to indicate which factors can help determine whether it is anticipated that a non-resident service provider will be physically present in south africa in connection with or for the purposes of rendering those services. the results are shown in table 8. these results validate the assertion that the above factors can help determine whether it is anticipated that the non-resident service provider will be physically present in south africa in connection with or for the purpose of rendering those services. table 8 shows that all the respondents (100%) agreed that considering the nature of the services that will be rendered by the non-resident can help to determine whether it is anticipated that a non-resident service provider will be physically present in south africa. moreover, all respondents agreed that one may determine whether it is anticipated that the non-resident service provider will be physically present in south africa by looking at the history of similar services rendered in the past by the non-resident to any resident or non-resident with a permanent establishment in south africa. thirteen respondents agreed that the terms and conditions specified in the slas between the non-resident and south african resident (or non-resident with a permanent establishment in south africa) can provide an indication as to whether one may anticipate a non-resident’s physical presence in south africa. three respondents agreed that one can anticipate whether the non-resident will be physically present in south africa by looking at the terms negotiated between the non-resident and south african resident or non-resident with a permanent establishment in south africa. none of the respondents identified any other possible factors that may determine how the term ‘anticipated’ should be applied. factors to determine total anticipated service expense the survey results validate the factors proposed to aid in the determination of whether one can anticipate that the service expense incurred or to be incurred will exceed r10 million in aggregate. as table 9 demonstrates, 71% of the respondents agreed that the following two factors can help determine whether the expenses incurred or to be incurred will exceed r10 million in aggregate: (1) the terms negotiated between the non-resident service provider and the south african resident or non-resident with a permanent establishment in south africa and (2) the type of service to be rendered, as well as the length of the service to be rendered by the non-resident service provider. thirteen of the respondents agreed that one can anticipate whether the expenses incurred or to be incurred would exceed r10 million in aggregate by looking at the cost of similar services rendered in the past. three respondents (a tax partner, tax manager and other) noted other factors which could aid in anticipating whether the expenses incurred or to be incurred would exceed r10 million in aggregate. their responses are summarised as follows: a tax partner noted that one can look at the extent of the work and what similar service providers will charge for similar services. a tax manager noted that one can inspect contractual terms (liability for overruns). the contractual terms will specify which party is responsible to pay any overruns. if the south african resident (or non-resident with a permanent establishment in south africa) is responsible for paying the overruns, this will increase the foreign service expense which then may exceed the r10 million reporting threshold. a senior staff member noted that it would depend on the relevant individual circumstances of each transaction. apportioning of a mixed contract as table 10 demonstrates, the vast majority of the respondents (93%) agreed with the statement made in the literature review that a mixed supply contract (specifically a supply and services arrangement) with a single composite price should be apportioned between the services and non-service component for the purposes of the foreign services reportable arrangement provision. findings of the empirical study the majority of the respondents agreed that the meaning and application of the term ‘anticipated’ is unclear as neither the tax administration act, income tax act nor the sars provides clarity on how it should be interpreted and applied. all of the respondents agreed that, in the context of the foreign services reportable arrangement provision, the term ‘anticipated’ can be interpreted by looking at its ordinary grammatical meaning. the respondents agreed that the factors identified by the authors may aid in determining whether it is anticipated that the non-resident service provider will be physically present in south africa in connection or for purposes of rendering services. the respondents agreed that the factors identified by the authors may aid in determining whether it is anticipated that the expenses incurred or to be incurred will exceed r10 million in aggregate. respondents further noted that one can look at the extent of the work and what similar service providers will charge for similar services and one can inspect contractual terms to determine who is responsible to pay for any overruns. the respondents agreed that a mixed contract with a single composite price should be apportioned for purposes of the foreign services reportable arrangement provision. the literature review and survey results are incorporated to develop a decision tree. the decision tree, together with the literature review, can be used by national treasury when updating the reportable arrangement guide or when issuing an interpretation note for the foreign services reportable arrangement provision. the summarised literature review and decision tree from this study could also be utilised by taxpayers in the identification of a foreign service reportable arrangements. this could be of value to taxpayers when considering the tax implications of this reportable arrangement provision. this decision tree may also provide clarity to taxpayers on how this provision should be applied in practice. the decision tree can be seen in figure 1. figure 1: decision tree. note 1: the following factors may aid in determining whether it will be anticipated that the non-resident service provider will be physically present in south africa in connection with or for the purposes of rendering services: the nature of the services. terms negotiated between parties. the terms and conditions specified in the sla. the history of similar services rendered in the past. note 2: the following factors may aid in determining whether it will be anticipated that the expenses incurred or to be incurred will exceed r10 million in aggregate: the terms negotiated between the parties involved. the type and length of the services to be rendered by the non-resident service provider. the cost of similar services rendered in the past. the extent of the work and what similar service providers will charge for similar services. the contractual terms (liability for overruns). conclusion the goal for the sars with the implementation of the foreign services reportable arrangement provision was to identify undeclared permanent establishments, to collect revenue from non-resident taxpayers who provide services in south african and to protect the south african tax base from extortion. the inadequate guidance provided by the sars and limited literature available about this provision restrict the effectiveness in achieving the above goals. it was determined that without clear guidance, there is a danger that the interpretation of undefined terms will be subjective, which could lead to uncertainty pertaining to the correct application of the provision. the objective of this study was therefore to critically analyse the foreign services reportable arrangement provision by assigning meaning to some of the undefined terms in the provision and to develop a decision tree that may assist taxpayers in applying the provision. the analysis of the term ‘arrangement’ indicated that this term should be defined in broad terms as the sars used this term in an attempt to apply the foreign services reportable arrangement provision to any possible ‘transaction, operation, scheme, agreement or understanding’. an analysis of the term ‘anticipated’ supported by the survey research determined that this term can be defined as ‘regarded as probable, expect or predict’. several factors were confirmed to have an influence in determining whether it is anticipated that the non-resident will be physically present in south africa in connection with or for the purposes of rendering services. these factors include the nature of the services, terms negotiated between parties, the terms and conditions specified in the sla and the history of similar services rendered in the past. this study was also able to confirm that various factors could assist in determining whether it is anticipated that the expenses incurred or to be incurred, will exceed r10 million in aggregate. participants may look to the terms negotiated between the parties involved, the type and length of the services to be rendered by the non-resident and the cost of similar services rendered in the past. the research concluded that the contract price of a mixed contract (specifically a supply and services contract) ought to be apportioned between its different components, as the ‘supply’ portion of the contract does not fall within the ambit of a ‘service’. the manner in which the contract price is apportioned between the different components will depend on the specifications of the contract. the participant in the arrangement must, however, be able to demonstrate, on request, to the satisfaction of sars that the result of the apportionment calculation is reasonable. it is recommended that sars issue an updated guide or interpretation note on the application of the foreign services reportable arrangement provision as evidence from the study indicates that uncertainties exist in practice. acknowledgements competing interests the authors have declared that no competing interests exist. authors’ contributions all authors contributed equally to this work. ethical consideration stellenbosch university research ethics committee (rec) humanities, ethical clearance number: 6381, 05 april 2018. funding information this research achieved no specific grant from any funding agency in the public, commercial or not-for-profit sectors. data availability statement survey results are available. disclaimer the views and opinions expressed in 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‘section 80a(c)(ii) of the income tax act and the interpretation of tax statutes in south africa’, meditari accountancy research 17(2), 167–185. https://doi.org/10.1108/10222529200900018 venter, e.r. & stiglingh, m., 2006, ‘recognising an stc liability versus recognising a deferred tax asset for unused stc credits according to the iasb framework: a comparison’, meditari acountancy research 14(1), 103–120. https://doi.org/10.1108/10222529200600007 vogt, p., 2011, dictionary of statistics and methodology, sage, viewed 25 february 2020, from https://methods-sagepub-com.ez.sun.ac.za/reference/dictionary-of-statistics-methodology/n1547.xml?fromsearch=true. wikipedia, 2017, big five (law firms) in south africa, viewed 02 february 2018, from https://en.wikipedia.org/wiki/big_five_(law_firms)_in_south_africa. woods appellant v walters respondent 1921 ad (1921) appellate division. sajems ns vol 4 (2001) no 2 risk analysis and evaluation of capital investment projects j h hall department of accounting and finance, university of pretoria abstract 398 in determining the feasibility of projects where capital investments are concerned, various methods are used. the focus of these methods is on return per se, so it is often asked to what extent any of these methods take the risk concept into account. the main objective of this study was to investigate the importance of risk with regard to capital investment projects. secondly, with the aid ofan empirical study, the study tried to establish whether risk is incorporated when south african companies evaluate capital investment projects. the empirical analysis indicated that risk analysis and evaluation in practice are to a large extent neglected by south african companies. it was found that nearly a quarter of companies estimate their annual cash flows using management subjective estimates alone. jel m 21 1 introduction the evaluation of capital investment projects can be regarded as one of the most important tasks of any financial manager. undertaking and accepting viable investments is crucially important, not only for the long-term growth of a firm and the creation of shareholder wealth, but also the creation of wealth for the inhabitants of a country. the substance of capital investment evaluation methods is return per se, but it is often asked to what extent any of these methods takes risk into account. it may be argued that the discount rate used in the application of these methods does take the relevant risk factors into account, and that no further risk assessments should be deemed necessary. the main problem with this point of view, however, is that the discount rate used is often subjectively determined. in some cases, the discount rate is derived from a weighted average cost of capital (w acc), which refers to the required rate of return in a specific company. although this is not incorrect, one should realize that the w acc of a particular r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 399 sajems ns vol 4 (2001) no 2 project may be quite different from that of the company evaluating the project, thus resulting in either a higher or lower required rate of return being used in the evaluation process. there are different methods to evaluate capital investment decisions. the feasibility of a capital investment project should therefore not only be determined by evaluating the expected rate of return of such a project, but the risks which impact on the outcome of the investment decision should also be considered. 2 research objectives the primary objective of this paper is to investigate the importance of risk evaluation in capital investment projects, and to formulate guidelines for the application of such an approach. this is done by means of a literature study. secondly, with the aid of an empirical study, the paper also tries to establish whether risk is incorporated in the evaluation of capital investment projects by south african companies. the hypotheses tested in this study are the following: hypothesis 1: although there are different approaches in the determination of risk, companies in general do not follow these approaches in making to their capital investment decisions. hypothesis 2: the incorporation of risk in the capital budgeting decision should not be altered by the size of the capital budget. hypothesis 3: companies do make adjustment for inflation when analyzing capital investment decisions. 3 the capital investment decision 3.1 concept definition: risk the term risk has many different meanings today. in financial circles, however, risk has a definite and distinctive meaning. risk refers to the situation where decisions are based on the calculation of probabilities that alternative outcomes r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2400 will materialize, or where probabilities, based on historical information and statistical frequency distributions, are known. the relationship between risk and capital investment decisions is well described by petersen (1994: 463). she states with regard to capital investment opportunities that "... for an evaluation of any investment to be meaningful, we must represent how much risk there is so that the cash flows of an investment will differ from what is expected in terms of their amount and timing. risk is the degree of uncertainty". the execution of the capital investment decision thus requires the decisionmaker to evaluate and analyze the risks involved. it requires a systematic evaluation of capital investment proposals. poor decisions may have an enormous negative impact on the profitability of a firm, as decisions usually cannot be revoked. to address risks, the financial manager should adjust his/her capital investment decisions in one of the following two ways: either the required rate of return should be adjusted to provide for the additional risk involved, or an adjustment should be made to the relevant cash flows. various techniques are used to evaluate investment opportunities. the most important techniques are: internal rate of return (irr), present value payback (pvp), accounting rate of return (arr), the profitability index (pi), and net present value (npv). theoretically, risk can be incorporated or accounted for in each of these methods, when they are applied to evaluate the capital investment decision. the question of how management should go about evaluating the risk associated with capital investment decisions is next addressed. a number of techniques to incorporate risk in the capital budgeting decision are briefly discussed. 3.2 mean, variance and coefficient of variation the calculation of the mean, variance and coefficient of variation is a very widespread method and relatively easy to use in the evaluation of risk. with the computation of the coefficient of variation and the correlation coefficient, the relative risk of the projects concerned can be compared. the lower the coefficient of variation, the smaller the degree of relative risk. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 401 sajems ns vol 4 (2001) no 2 3.3 certainty equivalent method the certainty equivalent method is a recognized technique for the adjustment of risk in capital investment decisions. it is a method based on the principle that risky cash flows can be converted into corresponding risk-free cash flows. it is therefore an adjustment of cash flow estimates. the method allows for risk preferences to be included in the investment decision, as each risky cash flow is converted into its risk-free equivalent by multiplying it with a conversion factor. the decision-making rule which applies when this method is used for capital investment decisions, is that if the certainty equivalent npv is greater than or equal to zero, the project can be accepted. 3.4 risk-adjusted discount rate method the risk-adjusted discount rate method for investment projects is relatively simple and consequently widely used. the method is based on the assumption that adjustments for risks associated with capital investment projects can be made by means of the discount rate or cost of capital the expected cash flow is discounted at a rate that both provides for the time value of money and shows the risk of the cash flow of projects. the adjustment for risk thus requires the expected risk for cash flows to be discounted at a higher discount rate than when the probability distribution of expected cash flows (and hence risk) is relatively smaller. 3.5 sensitivity analysis sensitivity analysis is used in order to improve the accuracy and reliability of cash flows. it requires the examination of the sensitivity of some variable to changes in another variable. the primary purpose of sensitivity analysis is not to quantify risk, but to establish how sensitive the npv and the irr are to changes in the values of key variables in the evaluation of investment projects. 3.6 computer simulation unlike sensitivity analysis, computer simulation allows the evaluation of the impact of changes in several variables simultaneously. some elaborate computer programmes even perform analyses that cover the entire distribution of potential outcomes. computer simulation may result in highly complex models, as interdependencies amongst variables need to be recognized if the model is to reflect reality. one of the most popular simulation models is the monte carlo model r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2 402 it may be concluded that the evaluation of risk in order to maximize shareholder wealth is an essential and difficult task. the present empirical study was conducted in order to detennine how south african fums evaluate risk and whether they incorporate risk in making their capital investment decisions. the next section sets out the method used in conducting the empirical study. 4 research method 4.1 comparative studies one of the key decision areas facing the contemporary financial manager, namely the capital investment decision and the results derived from it, is central in moulding a fum's future opportunities. academics have, over the years, pleaded the use of more sophisticated approaches to capital investment analysis, and it has been strongly suggested that adjustments for risk should be made. various studies have been conducted in the usa into the techniques of evaluating risk in capital investment decisions. gitman and forrester (1977: 6671) found that 71 per cent of their respondents explicitly took into account risk and uncertainty. it was moreover found that 42.7 per cent of these respondents adjusted for risk by increasing the minimum rate of return or the cost of capital. the popularity of the risk-adjusted rate of return is not surprising, since it is one of the easiest approaches available for risk adjustment. however, a major problem with this approach is that the adjustment for risk can itself be subjective, seeing that risk cannot be quantified precisely in all cases. in a similar study by jog and srivastava (1995: 3743) in canada in 1991, the use of subjective, judgmental, and non-standard techniques in the estimation of cash flows were found to be relatively high. in addition, nearly a quarter of their respondents did not have a fonnal risk analysis technique in place. similar studies have also been conducted in south africa. the two most prominent were undertaken in 1986 by andrews and butler (1986: 31-37) and by parry and firer (1990: 52-58). with regard to fums adjusting for risk and uncertainty, andrews and butler found that nearly 25 per cent of the fums responding were using subjective judgment alone to allow for risk. it is of particular concern that they found a wide gap between theory and practice, with nearly a quarter of their respondents (apart from the 25 per cent who only use subjective judgment) stating that they made no allowance for risk and uncertainty. the research found that increased sophistication of the capital investment process correlated positively with a fum's perfonnance. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 403 sajems ns vol 4 (2001) no 2 the study by parry and firer (1990) found that approximately one third of their respondents did not use any quantitative technique to assess risk or adjust for it. of the remainder, almost all respondents used the relatively unsophisticated sensitivity analysis technique. although few finns used sophisticated methods of risk adjustment, it transpired that capital intensive finns made greater use of quantitative risk-analysis tools. most of these companies used the irr as the chief method. 4.2 description of tbe population the population chosen was companies listed in the industrial sector of the johann~sburg securities exchange (jse). industrial companies were selected for the research because the capital investment decision figures relatively prominently in these companies as it closely relates to production capacity. 4.3 source of data the infonnation used in this study was obtained in collaboration with the bureau of financial analysis at the graduate school of management of the university of pretoria. a questionnaire was sent to the selected sample. 4.4 sample selection there were 358 companies in the industrial sector on the jse when the study was done in 1998. given fmancial and time constraints, these companies were listed alphabetically and only the first 300 were selected in the sample. 4.5 questionnaires the questionnaire consisted of 24 questions divided into three sections. the first section pertains to the company and decision-maker profile, necessary to categorize the data from the various responses. section two examined the capital budgeting techniques used in the investment process with specific reference to the techniques most often used in assessing the viability of different operations. the results of these sections were dealt with in a previous article (hall, 2000: 353-68). the present article deals with the third section, which examined the various techniques used for risk evaluation. this section comprised five questions. 4.6 data collection and analyses as was stated above, an address list of all the companies in the industrial sector of the jse was made available by the bureau of financial analysis at the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2 404 graduate school of management of the university of pretoria. questionnaires were sent to 300 companies, during the second half of 1998. responses were encoded with the assistance of the graduate school of management. the data were computerized using the computer software package sas (statistical analysis system). a spreadsheet reflecting the respondents' answers was compiled and encoded for use as input into the sas-programme. 5 empirical results 5.1 introduction in analyzing the data from the questionnaires, it was found that although the majority of questions only have one logical answer, the respondents sometimes selected more than one answer. in order to apply a consistent approach in capturing the data, the first answer given to a specific question was regarded as the respondent's answer for this purpose. 5.2 response the total response from the population of 300 amounted to 70 questionnaires (23.3 per cent), which were categorized as "usable" and "non-usable" responses. the "usable" responses amounted to 65 questionnaires, giving a response rate of 21.7 per cent. in analyzing the data, it was found that the questionnaires had been completed mainly by the financial directors of the various companies (55.4 per cent). completion by fmancial managers amounted to 29.2 per cent, while the remaining 15.4 per cent were completed by either the chief executive officer (7.7 per cent), the company secretary (2.5 per cent), the treasurer (1.5 per cent) or other senior management (3.7 per cent). the majority of the respondents (l3.8 per cent) were in the stores sector while 12.3 per cent indicated that they were in the industrial holdings sector and a further 12.3 per cent were in the food sector. table 1 below illustrates the respondents' annual sales and the size of the annual capital budget. annual sales were more than ri00 million for 83.1 per cent of the respondents, while 41.5 per cent of the respondents' annual capital budget was more than r50 million (24.6 per cent more than riog million and 16.9 per cent between r50 million and riod million). the importance of the capital investment decision can thus be clearly seen when one analyses the amount spent on capital investment projects. for instance, if 24.6 per cent of the 65 respondents, as r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 405 sajems ns vol 4 (2001) no 2 indicated, spent more than rioo million on their annual capital budget, it amounts to more than r1.6 billion in capital investments per annum. table 1 annual sales and size ofannual capital budget item annual sales annual capital budget less than r2 million 0.00 10.80 between r2 million and r5 million 1.50 12.30 between r5 million and rio million 0.00 12.30 between rio million and r25 million 0.00 12.30 between r25 million and r50 million 4.60 10.80 between r50 million and r100 million 10.80 16.90 more than r 1 00 million 83.10 24.60 i 100% 100% 5.3 interpretation and discussion of results respondents were asked to indicate which risk analysis techniques they used when analyzing risk with regard to capital investment decisions. table 2 shows that 36.9 per cent of respondents do not make use of any formal technique. this finding is significant since it means that these respondents do not make any allowances for risk. table 2 risk analysis techniques risk analysis technique percentage i ranking no formal technique in use 36.90 1 sensitivity analysis 30.80 2 adjusting required rate of return 12.30 3 shortening payback period 6.20 4 standard deviation 4.60 5 simulation 4.60 5 probability theory 1.50 6 calculated bail-out factor 1.50 6 other 1.50 6 n=65 100% r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2406 as stated above, sensitivity analysis is used to improve the accuracy and reliability of cash flows. the primary purpose of sensitivity analysis is not to quantify risk, but to establish how sensitive the npv and the irr are to changes in the values of key variables in the evaluation of investment projects. the fact that 30.8 per cent of the respondents indicated that they use sensitivity analysis as a risk analysis technique may seem to be an anomaly. although the primary purpose of sensitivity analysis is not to quantify risk, its use as indicated by respondents, enables them to detennine the sensitivity of key variables to changes in the operating environment. in this context, larger companies indirectly recognize the importance of return related risks in sensitivity analysis. although the risks per se are not quantified, sensitivity analysis offers companies a relatively easy and cost-effective method to adjust for return related risks associated with capital investment decisions as they can assess influences on key outputs of the investment process and assist with decision making. another interesting finding was that none of the respondents indicated that they used variance, coefficient of variances, decision trees, monte carlo simulation or the certainty equivalent method in risk analysis. similar results were found in a uk study by pike (lumby, 1991: 494), which indicated that only 37 per cent of companies analyzed risk fonnally. for these, sensitivity analysis and the risk adjusted discount rate were equally popular. when the 67 per cent of sample finns which did not use risk analysis were asked why they did not do so, some rather confused reasons were given, such as: "risk was impossible to quantify", "too time-consuming", "too complex" and "such an analysis brought undesirable negative pressure on decision-makers and went against the true entrepreneurial approach". an analysis of the respondent's answers according to the size of their annual capital budget as illustrated in table 3, shows that the majority of companies with an annual capital budget exceeding rso million used sensitivity analysis as a risk analysis technique. the majority of companies with an annual capital budget between rio million and rso million did not use a fonnal risk technique, although the use of sensitivity analysis was relatively high. an interesting finding is that companies with an annual capital budget below rs million, to a large extent, did not make use of any fonnal risk technique. a tendency can thus be observed to the effect that the larger the size of a company's annual capital budget, the more that company is inclined to rely on sensitivity analysis as a fonnal risk analysis technique. it can thus also be concluded that the smaller a company's annual capital budget, the less it is inclined to use any fonnal risk technique. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 407 sajems ns vol 4 (2001) no 2 table 3 risk analysis technique according to annual capital budget more rsom rlsm riom rsm rlm less risk analysis than to to to to to than technique rioom rloom rsom rlsm riom rsm rlm (n=16) (n=l1) (n=7) (n=8) (n==8) (n=8) (n=7) no formal technique 25,0 27.3 42,8 37,5 12,5 50,0 85,7 in use sensitivity analysis 37.4 45.4 28.6 37.5 25.0 25.0 0.0 adjusted required 12.5 18,2 14.3 12.5 25.0 0,0 0.0 rate of return shortening payback 6.3 0,0 0.0 0.0 25.0 12.5 0.0 period' standard deviation 12.5 0,0 0.0 0.0 12.5 0.0 0,0 simulation 6.3 0,0 0.0 12.5 0.0 12.5 0.0 probability theory 0.0 0.0 14.3 0.0 0.0 0.0 0.0 calculated bail-out 0.0 0,0 0.0 0,0 0.0 0.0 14.3 factor i other 0.0 9,1 0.0 0.0. 0.0 0.0 0.0 100 100 100 100 100 100 100 respondents were asked to indicate which adjustments they made to accommodate possible fluctuations in the inflation rate. rappaport & taggart (aggarwal, 1993: 18) stated that the effects of inflation on the various cash flows and on the discount rate should have a negative impact on the attractiveness of capital expenditure, from the summary in table 4 it can be seen that the majority of companies use various inflation rates for different annual cash flows (55.4 per cent), indicating an adjustment for inflation effects on cash flows of investment projects. although 18.5 per cent of respondents indicated that they use a single inflation rate for different annual cash flows, this percentage rate may indicate that the risk associated with the ekect of inflation on the cash flows of investment projects is, to a large extent, ignored. also, 23.1 per cent of the respondents did not make any allowances for inflation when estimating their future cash flows. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2 408 table 4 adjustments made to accommodate fluctuations in the inflation rate item percentage no allowances are made for inflation 23.10 use various inflation rates for different annual cash flows 55.40 use a single inflation rate for different annual cash flows 18.50 other 3.10 100% table 5, where the adjustments made for inflation are summarized according to the size of the respondents' annual capital budget, shows that the majority of all respondents (irrespective of the size of their annual capital budget) used various inflation rates for different annual cash flows in order to make adjustments for inflation. among companies with an annual capital budget less of than r2 million, the trend was to use a single inflation rate for different annual cash flows. table 5 inflation adjustments according to annual capital budget more rsom r25m riom rsm r2m less than to to to to to than risk analysis technique r100m rloom rsom r25m riom rsm r2m (n=16) (n=l1) (n=7) (n=8) (n=8) (n=8) (n=7) no allowances made 25.0 27.3 0.0 50.0 25.0 0.0 28.5 for inflation various inflation 56.3 45.4 71.4 50.0 37.5 100 28.5 rates different annual cash flows single inflation rate 12.5 27.3 14.3 0.0 37.5 0.0 43.0 different annual cash flows other 6.2 0.0 14.3 0.0 0.0 0.0 0.0 100 100 100 100 100 100 100 westwick and shohet (lumby, 1991: 493) found that 77 per cent of their sample attempted to take inflation into account, whilst pike (lumby, 1991: 493) found that 89 per cent of companies considered inflation in investment appraisal. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 409 sajems ns vol 4 (2001) no 2 6 summary of results and recommendation 6.1 summary of results the results of the first part ofthis study were reported in a previous article (hall, 2000: 353-68) and indicate that south african companies prefer roj and irr as methods to determine the feasibility of capital investment projects. the results reported in the present article indicate that risk analysis and evaluation in practice is, to a large extent, neglected by south african companies. the research results show that nearly a quarter of companies estimated their cash flows using subjective estimates by management alone, while 36.9 per cent of respondents explicitly stated that they used no formal risk analysis technique in the evaluation of capital investment projects. there is a correlation between the size of a company's armual capital budget and the technique used by that company: the larger the armual capital budget, the more a company tends to use sensitivity analysis, while smaller companies tend not to use any formal risk technique. although the primary purpose of sensitivity analysis is not to quantify risk, but to determine the sensitivity of key variables to changes in the operating environment, larger companies indirectly recognize the importance of retumrelated risks in applying sensitivity analysis. although the risks per se are not quantified, sensitivity analysis offers companies a relatively easy and costeffective method to adjust for return related risks associated with capital investment decisions. hence the popularity of this approach. many south african companies do not make adjustments for the inflation rate when assessing the viability of a capital investment project. this can be clearly seen in the estimation of future annual cash flows, where the research found that nearly a quarter of companies do not make any adjustment for inflation. although the majority of companies do use various inflation rates for different annual cash flows, 18.5 per cent used a single inflation rate for different armual cash flows, while 23 per cent made no adjustment. again, it seems the latter applies more to companies with an annual capital budget less than r2 million. this corresponds to the fact that smaller companies also tend not to make any allowances for risk. it therefore seems that smaller companies in particular do not analyze or evaluate return-related risks associated with capital investment projects. although larger companies make an effort to at least identify the risk factors likely to influence the outcome of their investment decisions, the quantification of risk per se is neglected in south africa. this is a cause of great concern, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2 410 especially if the large rand value of capital investments in the south african economy is taken into account. financial decision-makers in south african companies are highly qualified personnel; the majority have post-graduate qualifications. the failure to quantify risk by the available techniques is therefore not necessarily a result of ignorance, but should rather be attributed to the difficulty of quantifying returnrelated risks. the fact that companies operate in a dynamic environment exposes them to continuous change, where key risk factors change constantly, adding to the difficulties associated with the use of scientifically sound methods of quantifying risk. in testing the hypotheses under research objectives above, the following were found: hypothesis 1 tested positive. approaches to the detennination of risk and their application to capital investment decisions are generally not used by south african companies. hypothesis 2 tested negative. companies with a smaller capital budget make even less use of risk-adjusted methods in evaluating capital investment decisions than companies with a relatively larger capital expenditure programme. hypothesis 3 tested positive. nearly 56 per cent of companies make adjustment for inflation in the capital budgeting process. 6.2 recommendations in order to enable decision-makers to analyze and evaluate return-related risks associated with capital investment projects more effectively, the following recommendations are suggested for further investigation: as there is no single statistically sound and scientifically correct approach to the analysis and evaluation of capital investment projects, academics and practitioners should strive to find an approach that would at least enable them to progress in that direction. the development of such a model should assist both small and large companies to quantify the risks associated with the capital investment decision, helping financial decision-makers to manage investments more efficiently. the neglect of risk factors occurs mainly in smailer companies, and the construction of a model ought to be investigated which would enable them to quantify and measure risk. this model should be simple to use. it should be r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 411 sajems ns vol 4 (2001) no 2 based on a matrix where techniques or formulas are applied which would make it possible for decision-makers to weigh the consequences of failure against the probability of failure, by establishing values on the matrix. the development of such a model should be investigated especially for use by non-listed companies. with regard to the education of postgraduate students, there should be an emphasis on the practical application of risk analysis techniques, with a view to encouraging the more general application of such techniques. endnote the author would like to thank mr pg vosloo and prof lm brummer for their inputs. references 1 aggarwal, r. (1993) capital budgeting under uncertainty. englewood cliffs, new jersey: prentice-hall, 292p. 2 andrews, g.s. & butler, f. (1986) "criteria for major investment decisions", the investment analysts journal, may 1986: 31-7. 3 gitman, l.j. & forester, j.r. jr. (1977) "forecasting and evaluation: practices and performance, a survey of capital budgeting techniques used by major u.s. firms", financial management, fall: 6671. 4 hall, j.h. (2000) "investigating aspects of the capital budgeting process used in investment projects", south african journal of economic and management sciences, (3)3: 353-68, september 2000. 5 jog, v.m. & srivastava, a.k. (1995) "capital budgeting practices in corporate canada", financial practice and education, falllwinter: 3743. 6 lumby, l. (1991) investment appraisal and financing decisions (4 th ed.) london: chapman & hall, 518p. 7 parry, h.m.a. & firer, c. (1990) "capital budgeting under uncertainty an empirical study", south african journal of business management, 21(3): 52-8. 8 petersen, p.p. (1994) financial management and analysis, new york: mcgraw-hill,864p. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction research design analysis and presentation of the data results implementation evaluation discussion conclusion acknowledgements references appendix 1 appendix 2 about the author(s) rachéle paver research group work, organisational and personnel psychology, ku leuven, belgium optentia research focus area, north-west university, vanderbijlpark, south africa hans de witte research group work, organisational and personnel psychology, ku leuven, belgium optentia research focus area, north-west university, vanderbijlpark, south africa sebastiaan rothmann optentia research focus area, north-west university, vanderbijlpark, south africa anja van den broeck optentia research focus area, north-west university, vanderbijlpark, south africa work and organization studies, ku leuven, brussels, belgium roland blonk optentia research focus area, north-west university, vanderbijlpark, south africa healthy living, toegepast natuurwetenschappelijk onderzoek (tno), leiden, the netherlands department of human resource studies, tilburg university, tilburg, the netherlands citation paver, r., de witte, h., rothmann, s., van den broeck, a. & blonk, r., 2020, ‘a systematic literature review of the implementation and evaluation of the jobs programme: a suggested framework for south africa’, south african journal of economic and management sciences 23(1), a3049. https://doi.org/10.4102/sajems.v23i1.3049 original research a systematic literature review of the implementation and evaluation of the jobs programme: a suggested framework for south africa rachéle paver, hans de witte, sebastiaan rothmann, anja van den broeck, roland blonk received: 28 feb. 2019; accepted: 06 nov. 2019; published: 25 feb. 2020 copyright: © 2020. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: south africa is challenged with high levels of unemployment, comprising many people with low levels of education and also individuals who have never held a job before. despite having many vulnerable participants, interventions aimed at the unemployed generally exclude psychosocial training and are methodologically weak. aim: the jobs programme, a scientifically sound intervention, has been developed specifically to help people affected by unemployment to cope with the psychological effects. as a means of applying such a programme in south africa, this study aimed to develop a framework based on the insights gained on the implementation and evaluation of the jobs programme. methods: the study comprised a systematic review of literature regarding the jobs intervention and its derivatives (n = 34). results: the results revealed that populations similar to the unemployed in south africa had benefitted significantly regarding re-employment and mental health outcomes. conclusion: suggestions derived from the literature included aiming the programme at the most vulnerable unemployed in south africa: the youth and long-term unemployed. furthermore, expanding the programme by adding an entrepreneurial component may yield positive results, considering the lack of employment opportunities in south africa. keywords: jobs programme; employment interventions; systematic literature review; unemployment; south africa. introduction south africa is facing an unemployment crisis: currently 29.1% of people in south africa are jobless (stats sa 2019). while statistics may indicate the magnitude of the problem at hand, they fail to depict the nature and severe impact of unemployment. unemployment is not only associated with societal and economic ramifications; it also has serious psychological consequences for those who are unemployed (see strandh et al. 2014; wanberg 2012). numerous interventions have been implemented to alleviate unemployment (independent evaluation group 2013; mccarthy 2008). despite the benefits of evidence-based practices (see heckman, lalonde & smith 1999; ravallion 2008), it is startling to see that most vocational interventions are consensus-based – implying that the interventions are based on what the stakeholders think is necessary, without the supporting evidence to prove what is really needed (marais & matebesi 2013). considering the urgency of unemployment, the shortage of evidence-based practices in south africa is a concern. one profound example of a scientifically sound employment initiative is the jobs programme (caplan et al. 1989). the jobs intervention seeks to enhance the employability of jobseekers by equipping them with the necessary job search, social and problem-solving skills to support them in their job search efforts. several factors contribute to the achieved outcomes. two of the strengths of the programme are its strong theoretical foundation and empirically tested evidence (vinokur & price 2015). likewise, the comprehensive protocol guiding the programme contributes significantly to successful dissemination undertakings (curran, wishart & gingrich 1999). extensive evidence of the effectiveness of the jobs programme has previously been reported (price & vinokur 2014). due to the encouraging results, several jobs derivatives have been implemented in other countries. these programmes include the työhön job search programme in finland (vuori et al. 2002), the jobs in china programme (price & fang 2002), the job-search programme in israel (shirom vinokur & price 2008), the winning new jobs (wnj) programme in ireland (barry et al. 2006) and the jobs intervention in the netherlands (brenninkmeijer & blonk 2011). although these programmes have proven to be reliable in different economic contexts (vinokur et al. 1995a), they have been implemented mainly in developed countries, except for china. the lack of evidence-based practices in south africa, together with the successful replication of the jobs programme, creates an opportunity to explore whether such an intervention can be tailored to suit the south african context. much effort has been devoted to developing materials that explicitly explain the procedures and dynamics of the jobs programme (curran et al. 1999). yet investigating literature pertaining to the execution and subsequent outcomes of the jobs programme may assist further dissemination. a greater understanding of typical components of an intervention – implementation and evaluation – can be used to serve as guiding principles for application and assessment in the south african context. based on the above statement of the research problem, the objectives of this research were: to review literature regarding the implementation (context and process aspects) and evaluation (promoting and impeding effects) of the jobs programme and variations of it. based on the previous findings, to develop a framework to assist with the implementation and evaluation of the jobs programme in south africa. to make recommendations for future research and practice. research design research approach a systematic literature review was done to achieve the objectives of this study. a systematic review identifies the main scientific contributions relevant to a specific topic by conducting extensive literature searches of published and unpublished studies (tranfield, denyer & smart 2003). this review aimed to identify literature containing information about the jobs programme and variations of it. transparent and reproducible procedures were used to enhance the quality and outcomes of the review process. research method targeted body of literature before starting with the review, the founders of the jobs programme and the web page of the michigan prevention research center (mprc) were consulted to obtain information regarding the jobs programme and its dissemination. electronic searches were undertaken to allocate articles identified on the web page. next, a search was conducted to ascertain whether possible articles were excluded. databases such as google scholar and ebscohost (academic search premier, africa-wide information, american doctoral dissertations, psycarticles and psycinfo) were utilised to find the relevant articles. search terms and selected criteria it was anticipated that the articles worth including in the review would refer to the jobs programme in the articles themselves. therefore, numerous searches were conducted by including the authors involved (as obtained from the dissemination page) with the term job opportunities and basic skills programme (e.g. author: vuori; in-text: ‘jobs program*’). because another programme, called the jobs program, yielded additional results when searching for ‘jobs program*’, it was necessary to include the various authors. the search string consisted of two search concepts joined by the boolean operator and; the second string contained a list of authors joined by the boolean operator or. the following search string was entered in the databases: [1] in-text: ‘jobs program*’ [2] author: ‘barry’, ‘caplan’; ‘choi’; ‘kessler’ ‘price’; ‘schul’; ‘van ryn’ ‘vinokur’ and ‘vuori’. to prevent the omission of essential articles, a complementary search was performed. reference lists of the selected articles were reviewed for more relevant publications. during the process, it became evident that there were indeed articles that did not refer to the jobs programme in their content. therefore, an additional search was conducted using the authors involved from the different variations of the jobs programme and each of the different jobs variations (e.g. author: ‘barry’; in-text: ‘winning new jobs’). the second search string again consisted of two search concepts joined by the boolean operator and; the first string contained a list of names for variations of the jobs programme and the second a list of authors, with both strings joined by the boolean operator or. the following search string was entered in the databases: (1) in-text: jobs in china project, job-search intervention, työhön job search program, or winning new jobs (2) author: ‘blonk’, ‘brenninkmeijer’, ‘choi’, ‘donaldson’, ‘fang’, ‘friedland’, ‘ling’, ‘shirom’, and ‘turner’. criteria for including articles were as follows: articles and chapters had to be peer-reviewed. articles and chapters had to be written in english. articles had to be about the jobs programme or variations of it. the study population had to be unemployed people. gathering the data conference proceedings and papers to which access was limited or where no full-text papers were available were excluded. price and vinokur (2014) mention that the jobs programme has previously been executed in sweden and south korea; however, the literature seemed limited and unavailable. furthermore, the jobs programme has also been implemented in organisational and school contexts. considering that the circumstances of the participants are not the same, these studies were omitted. the inclusion and exclusion criteria narrowed the scope of this review. finally, 34 articles met all the inclusion criteria (figure 1). figure 1: flow chart of study selection and inclusion. analysis and presentation of the data implementation and evaluation aspects were studied to gain a better understanding of the jobs programme and its derivatives. implementation is described as the process of putting a plan into action to achieve objectives (miller, wilson & hickson 2004). to ensure sufficient programme fidelity and to effectively replicate the jobs, it seemed necessary to study the various components involved in executing such a programme. evaluation can be described as the determination of the merit, worth and significance of an area of interest using criteria directed by specific standards for purposes of decision-making (richards & schmidt 2002). evaluation practices are a crucial component in the success of evidence-based programmes (jané-llopis et al. 2005). to develop a framework aimed at guiding the implementation and evaluation of the jobs programme in south africa, the following aspects of the papers included in the systematic literature review were studied (table 1). table 1: reviewed implementation and evaluation aspects of the jobs programme. assessment of methodological quality an additional reviewer – a researcher involved in the broader project – was consulted to ensure methodological quality. after the duplicates had been removed, both the researcher and reviewer were involved in selecting studies to remain in the systematic review based on their abstracts and full content. ethical considerations ethical clearance was obtained from the humanities and health research ethics committee (hhrec), north-west university, with ethical clearance number: nwu-hs-2018-0006. results the literature review comprised 34 studies. the predetermined criteria, as per table 1, guided the systematic review. the main aspects regarding the implementation and evaluation of the jobs programme and variations of it were tabulated. the summarised findings are reported below. implementation this section contains information about the context in which the various programmes were implemented as well as participant and programme specifics. context the jobs programme has been implemented in numerous states and countries, in all of which the context has differed to some degree (see appendix 1). the unemployment rates, as reported in the studies included, varied from 4% to 20% (brenninkmeijer & blonk 2011; vuori et al. 2002). additionally, the unemployed seemed to be supported by welfare benefits, also safeguarding them against severe financial hardship. unemployment grants differed, depending on the social policies of the countries involved (vinokur & price 2015). participants biographical variables according to vinokur and price (2015), benefits of the jobs programmes did not seem to be distributed equally to all the participants. some findings are reported below; yet it should be noted that only a few of the studies included mentioned the impact of demographic variables on the intended outcomes. findings regarding participants’ demographic variables were not always consistent and sufficient to substantiate these relationships. compared to other demographic variables, education had the strongest impact on the outcomes of the job search interventions. gender: female participants seemed to suffer greater economic losses and experience more difficulties regaining employment (vinokur et al. 2000). yet women generally benefitted more from the programme than their male counterparts (mprc 2003). they were more likely to (1) obtain employment six months after the intervention (shirom et al. 2008), (2) score higher on participant engagement (caplan et al. 1989), (3) experience positive group participation (vuori et al. 2005) and (4) participate voluntarily (vuori et al. 2002). age: unemployed people between the ages of 16 and 65 were generally the targeted population. the mean age of participants in the studies included was 36 (standard deviation [sd] = 9). vuori et al. (2005) state that younger participants were usually more positive and found employment more easily than older participants, but showed a higher tendency of non-participation (van ryn & vinokur 1992; vinokur et al. 2000; vinokur, price & caplan 1991a). the training programme seemed to also have a positive impact on older participants regarding improved job search skills and increased self-confidence (price & choi 2001). level of education: the majority of participants in the programmes involved had a secondary level of education (equivalent to 12 years of schooling; mean of all the studies: 40.65%). participants with higher levels of education more often gained in terms of obtaining re-employment (mprc 2003), increases in job search self-efficacy (choi, price & vinokur 2003), a lower likelihood of major depressive episode diagnosis (vinokur et al. 2000) and non-participation (caplan et al. 1989; van ryn & vinokur 1992; vinokur et al. 2000), and higher levels of voluntary participation (vuori et al. 2002). despite these positive findings, in some other studies, it was evident that the programme also clearly yielded mental health benefits and economic benefits for those less educated and most disadvantaged in terms of the job market (price & choi 2001; vinokur, price & schul 1995b). duration of unemployment: the jobs programme was originally designed to prevent further deterioration in mental health among the unemployed and was not specifically intended to deal with potential problems associated with long-term unemployment (caplan et al. 1989). therefore, the majority of the initial studies included only those who had been unemployed for less than 13 weeks (caplan et al. 1989; price et al. 1992; van ryn & vinokur 1992; vinokur et al. 1991a, 1991b, 1995a, 2000; vinokur, price & caplan 1996; vinokur & schul 1997). however, because the long-term unemployed were reported as the most vulnerable, more recent developments included participants who had been unemployed for longer periods (brenninkmeijer & blonk 2011; malmberg-heimonen & vuori 2005; price & choi 2001; reynolds, barry & gabhainn 2010; vuori et al. 2005). population, sample size and recruitment population: eligibility criteria required individuals to be aged between 16 and 65. prospective screening questionnaires were used in some studies to determine participants’ risk score for poor mental health (vinokur et al. 1995b). however, those who showed major signs of mental illness, serious psychosocial problems or behavioural problems or who scored extremely high on depression symptoms were omitted from the study (brenninkmeijer & blonk 2011; vinokur et al. 1995a). sample size: most of the studies included were conducted as a part of large-scale field experiments, ranging from 1087 to 3402 participants. smaller-scale studies ranged from 125 to 672 participants. sample sizes did not seem to influence the results achieved or the sustainability of the programmes. it was rather the use (or lack) of effective methods that seemed to have an impact on the outcomes (price & vinokur 2014). recruitment: the primary method used to recruit participants was through recruiters who approached individuals eligible for employment benefits while collecting grants at employment offices. in studies including an experimental and control group, participants were told about the two programmes on job-seeking methods. one programme was described as a workshop consisting of five half-day sessions (the experimental condition); the other was described as a self-guided programme, in which participants received a booklet with job search information (the control condition). to prevent biases, participants had to show no preference for a type of intervention (experimental or control condition; caplan et al. 1989; vinokur et al. 1995a). voluntary or enforced participation: participants from some programmes had to participate in the job search workshop to qualify for welfare benefits (brenninkmeijer & blonk 2011; lee & vinokur 2007). when studying the impact of voluntary or enforced participation, a finnish study showed that enforced participation did not increase re-employment; however, it impaired the positive mental health impacts of the programme. further analysis demonstrated that enforced participation in job search training decreased re-employment among the longer-term unemployed workers (malmberg-heimonen & vuori 2005). dropout rates: in the us programmes, on average, 59% (varying by 5%) of participants failed to show up for the intervention (caplan et al. 1989; vinokur et al. 1995a). consequently, dropout rates could be anticipated and, therefore, twice as many participants were recruited and allocated to intervention groups in the israeli study (shirom et al. 2008). in the malmberg-heimonen and vuori (2005) study, it was surprising to find that response rates did not differ much among the enforced, voluntary and control groups (94%, 92%, and 91%). programme the information presented below was derived from the jobs training manual (curran et al. 1999). delivery the jobs programme entails two main processes. on the one hand, job search skills (the actual content of the programme) are taught to participants, while, on the other hand, empowerment of the participants, by applying the programme’s underlying principles in the method of delivery, is the true underlying mission of the workshop. the following aspects guided the method of delivery used by the trainers: referent power: moderate self-disclosures shared by facilitators create an environment in which participants feel safe to reveal their concerns and experiences. these also contribute to creating an atmosphere of unconditional acceptance and to enhancing feelings of being normal and valued. guiding behaviour: specific positive feedback is given to participants to reinforce positive behaviour. strategies used to generate positive feedback include active listening, observation and reflecting on what participants have shared as a means of showing participants that they are valued. inoculation against setbacks: the group is encouraged to identify potential setbacks and difficulties in the job search process. strategies are developed to overcome the identified challenges and, consequently, participants realise that their problems can be solved. participants are asked to commit themselves to action by selecting and vowing to undertake a solution most appealing to them. social support: social support forms an integral part of the underlying processes, as exercises are specifically designed to create opportunities for facilitators and participants to support each other. an environment where participants are unconditionally accepted is created. such a safe environment contributes to participants feeling comfortable to express their opinions and reveal their feelings. active leaning: the learning process relies greatly on participants’ knowledge and skills. participants acquire job search skills by using active learning methods, elicited using group discussions and brainstorming sessions. in contrast to traditional top-down, trainer-focused training methods, the jobs programme relies heavily on its individual-focused approach. the delivery principles mentioned above contribute to the strong individual-focused approach. principles are continuously applied and integrated and form the basis on which the content is delivered. content the programme consists of five sessions. during the first session, participants discover their job skills; the second session focuses on dealing with obstacles related to employment; the third session is used to introduce participants to some job search techniques; the fourth session covers topics such as curriculum vitae writing and preparing participants for job interviews; during the fifth session participants rehearse skills acquired throughout the week. the workshop concludes with a certificate ceremony, during which facilitators boost participants’ confidence by highlighting their strengths and skills and providing each participant with a sincere and inspiring message. the jobs protocol describes the programme processes meticulously. yet these processes are flexible and can be altered, depending on the needs of the groups, without losing the intended effects of the programme. the majority of the disseminated versions of the jobs programme were implemented strictly according to the protocol. the content differed in terms of minor language, cultural, procedural and scheduling changes to suit different contexts. to maintain the standard of the jobs programme, all materials were piloted and approved. it is worth mentioning that, when the protocol was somewhat neglected, it was reported that the programme was less successful in achieving the intended outcomes (shirom et al. 2008). incentives participants were rewarded monetarily for participation or each returned questionnaire (varying between $5.00 and $15.00, depending on the currency of the country). in cases where questionnaires were not returned, an additional amount was issued on the completion of their questionnaires. this incentive was reported to result in a substantial increase in response rates (about 20%; shirom et al. 2008). participants in the jobs programme and netherlands jobs programme also received a certificate of participation for completing the programme (brenninkmeijer & blonk 2011; caplan et al. 1989). researchers obtained higher response rates when offering incentives: in cases with relatively high dropout rates, no mention of rewards or incentives was evident (barry et al. 2006; reynolds et al. 2010; shirom et al. 2008). the same finding was, however, not true in the wnj california studies, which managed to retain approximately 70% of their participants, seemingly without the use of incentives (choi et al. 2003). facilitators pairing: teams consisting of one male and one female trainer are prescribed by curran et al. (1999) to complement each other well. an untested assumption existed that a pair of trainers reduced deviation from the principles of the jobs programme. however, the assumed benefits of having male–female pair facilitators have not yet been tested. benefit-cost research could determine whether the cost of using two trainers, rather than one, is outweighed by the benefits that are generated (price et al. 1998). prerequisites: facilitators were generally social workers, labour advisors, educational counsellors or high school teachers. it was suggested that facilitators ought to be skillful in working with people (public speaking and communications backgrounds). because trained individuals (that is, mental health professionals, such as counsellors or clinicians) might execute strongly embedded techniques not necessarily consistent with unemployment-related counselling methods, professional training was not a prerequisite (caplan et al. 1989). programme-related training: facilitators had to undergo extensive formal training. the content of the training covered understanding of group processes, theoretical foundations of the programme and extensive rehearsal in the form of pilot studies. the duration of training varied from 6 to 30 days (48 h–240 h). the reason for the extensive training was that facilitators were not only conveyors of information, but also experts in navigating the group processes, with the ability to connect emotionally with the participants and facilitate interactions in a group setting. to promote conformity, trainers’ performance was evaluated by trained supervisors. duration of the programme some of the findings yielded by the original jobs trial encouraged the revision of the programme, which consequently led to the development of the jobs ii intervention (vinokur et al. 1995a). the first version (the jobs i programme) spanned eight 3 h sessions, over a two-week period (four mornings per week; caplan et al. 1989). to increase programme efficiency and the attendance of participants, meeting hours were reduced by 30%, delivered over five 4 h sessions in a one-week period in the jobs ii (vinokur et al. 1995a). the majority of disseminated versions of the jobs programme continued to apply the programme following the jobs ii protocol. in some groups, the finnish programme was delivered over four days, as the first day was used to deal with recently laid-off workers’ negative emotions (vuori et al. 2002) – an illustration of how the programme can be altered to meet the needs of the group, without affecting the outcomes. group sizes guidelines of the jobs programme suggest groups consisting of 12–20 participants (curran et al. 1999). there were exceptions, where the groups ranged from three to 110 participants per group (median = 11; malmberg-heimonen & vuori 2005). although only a few studies reported on the impact of group sizes, larger groups seemed to have more negative experiences than smaller groups (vuori et al. 2005). venue of training venues such as community centres, school classrooms, churches and union halls, easily accessible to participants, were mostly used. venues had to be large enough to accommodate 25 people and furnished with movable chairs, arranged in a semicircular layout. such a layout was reported to be most effective in delivering the group intervention (curran et al. 1999). stakeholder involvement crucial to the success of the wnj programme in ireland was that the developers of the original jobs programme were involved from the outset and contributed to obtaining buy-in from strategic stakeholder agencies. despite a substantial initial investment of resources for demonstration, neither the wnj in california nor the jobs in china project continued beyond their initial stages, as commitment of resources for continuation was not offered by the government or other stakeholders. therefore, the success of programme dissemination depended considerably on the involvement of, and support received from, stakeholders (vinokur & price 2015). evaluation this section is comprised of information regarding evaluation of the processes and the impact of the jobs programme. methodology data collection method self-administered questionnaires were used to assess participants’ attitudes, intentions, various behavioural components and experience of the workshop (van ryn & vinokur 1992). in cases of unreturned questionnaires or where participants failed to show up for the workshop, telephonic interviews were conducted (barry et al. 2006). research design and data collection intervals randomised field study designs were used to investigate the intervention effect between experimental and control conditions (caplan et al. 1989; vinokur et al. 1995a; vuori et al. 2002). programmes that made use of a randomised field study design had three to four interval times, namely pre-intervention (two weeks before the programme), post-intervention (directly after the programme), post-post-intervention (between two and six months after the programme) and long-term follow-ups, varying from 12 to 32 months after the intervention (barry et al. 2006; brenninkmeijer & blonk 2011; vinokur et al. 1991a). other programmes only tested pre-intervention and post-intervention to determine the impact of the programme (lee & vinokur 2007; shirom et al. 2008). process evaluation to determine the internal validity and the strength and integrity of the jobs programmes, two types of analysis were generally conducted. these process measures consisted of testing the integrity of randomisation and strength of the programme (vinokur et al. 1995a). effectiveness of randomisation the first check to determine the validity of the programme was to determine whether the statistical analyses were conducted on a randomised (true) experimental design. this was established by comparing the demographic and other tested variables of the experimental and control conditions at baseline to identify possible differences. in cases where differences were found, these variables were controlled for in further analyses (vinokur et al. 1995a). manipulation checks, integrity and strength of the intervention the second test was to test the strength and integrity of the intervention through self-reported questionnaires at the end of each session. participants were asked to evaluate their experience of facilitators and the programme. these evaluations were used to determine whether various intervention elements had been implemented and had operated as designed (vinokur et al. 1995a). participants who scored high on these measures also reported higher levels of internal control and job-seeking self-efficacy (choi et al. 2003), decreases in depression and anger, and increases in self-esteem and quality of life (caplan et al. 1989). also, trainer skills (one of the evaluated variables) exhibited during group interactions contributed to increased re-employment, even at the 12-month follow-up (reynolds et al. 2010). two additional methods were used to ensure the quality of the programme and a high level of trainer adherence to the protocol. firstly, members of the research team frequently observed programme trainers: after each session, constructive feedback was given to trainers. secondly, the facilitators met weekly to discuss skill-related topics they encountered during their sessions (vinokur et al. 1995b). impact evaluation outcomes the positive outcomes of the jobs programme were documented amply. below are some of the most prominent findings related to the two core objectives of the jobs programmes: prevention of poor mental health and promotion of re-employment, and other post-hoc outcomes. prevention of poor mental health: participation in the intervention resulted in increased self-esteem, self-efficacy and social assertiveness among participants; consequently, participants also showed improved psychological and mental health and well-being (lee & vinokur 2007; reynolds et al. 2010). furthermore, long-term effects of the programme revealed that participants experienced lower symptoms of depression (price et al. 1992; vuori & silvonen 2005), improved self-esteem (reynolds et al. 2010) and an enhanced ability to deal with setbacks. a noteworthy finding is that participants screened for showing higher risk for depression seemed to benefit the most in terms of mental health and re-employment outcomes (vinokur et al. 1995b). promotion of re-employment: several programmes demonstrated increased rates of re-employment, with an average of 46% after the intervention, compared to the control group, with an average of 18% (brenninkmeijer & blonk 2011; caplan et al. 1989; donaldson 2012; shirom et al. 2008; vuori et al. 2005). programme participants also showed higher motivation to persist in job search efforts (caplan et al. 1989), were employed in better jobs (in terms of earnings and job satisfaction) (vinokur et al. 1991b), were employed faster, had less recurring episodes of unemployment (vinokur & price 2015) and experienced reduced economic hardship after being employed (barry et al. 2006). results remained over time, as long-term effects of the programme revealed that participants, compared to their counterparts, experienced higher re-employment (brenninkmeijer & blonk 2011). another crucial finding is that both the työhön and the netherland’s jobs programmes confirmed the effectiveness of the intervention to help even the more vulnerable long-term unemployed gain employment (brenninkmeijer & blonk 2011; vuori et al. 2002). consequential outcomes: finally, the jobs programme demonstrated substantial cost-benefit effectiveness because the higher earnings led, on average, to higher tax revenues and decreased welfare grants for governments (vinokur et al. 1991b). discussion the purpose of this study was to review literature regarding the jobs programme and variations of it, with the intention of developing a framework that could guide the successful implementation and evaluation of the jobs programme within the south african context. to gain a better understanding of the components related to the implementation of the jobs programme, the contexts in which the programme have previously been implemented and the targeted population, as well as aspects regarding the programme, were studied. based on the findings of the systematic review, as well as context-specific matters, a framework is proposed for the implementation and evaluation of the jobs programme within the south african context (see appendix 2). in terms of contextual differences between developed countries (where the jobs programme has previously been implemented), and developmental countries (e.g. south africa), some differences are crucial to consider when implementing an employment programme, such as the jobs intervention. while the unemployment rates of the involved developed countries averaged 12%, more than 27% (37.3% when including those who have stopped looking for employment; stats sa 2018) of south africans are currently unemployed. moreover, it has been reported that 69% of these individuals have been unemployed for longer than a year (stats sa 2018). in south africa, unlike the other countries, unemployment grants safeguarding people from financial hardship are not available. also, the unemployed are generally situated in rural areas isolated from major economic activity. with limited job opportunities, jobseekers feel discouraged, and deprived of a chance to compete in the labour market (du toit et al. 2018). fortunately, the jobs programme is specifically designed to deal with such conditions, yet it remains important to be cognisant of the impact of contextual factors on potential participants’ state of mind. with regard to participant-related matters, the reviewed literature showed that young and old, educated and less educated participants had previously benefitted from the jobs interventions. however, it is important to note that south africa has a youth unemployment rate of 52% (aged between 15 and 24; stats sa 2018); 62% of the unemployed population have never even held a job before (stats sa 2017); and 57% of south africans have an education of less than matric (grade 12). therefore, although the unemployed in general could benefit from the programme, it is suggested to target vulnerable populations, such as younger, less educated and long-term unemployed individuals, as it may yield promising results. furthermore, participants from previous studies were reached at employment services offices. because unemployment grants are not available in south africa, participants cannot be reached on a large scale in a similar way. therefore, different strategies of reaching the intended population should be considered. suggestions include making use of newspaper and radio advertisements, and government agencies working with jobseekers, or working with youth and community leaders. one programme in particular tested the effectiveness of forced versus voluntary participation. findings revealed that enforced participation did not increase re-employment and impaired the positive mental health impact of the programme (malmberg-heimonen & vuori 2005). giving participants the autonomy to participate voluntarily in the programme seems to yield more positive benefits. this may be an important finding for policymakers, as a precondition for receiving unemployment grants is often enforced attendance of a job search programme. yet responsibility also rests with workshop trainers to be particularly devoted in creating an environment to which participants choose to return. considering the possibility that participants showing a preference to partake in employment programmes may be somewhat more intrinsically motivated, at the same time, it is those who show a higher risk of depressive symptoms that may benefit more (vinokur et al. 1995a). thus, careful attention should be paid to recruitment measures, ensuring that both the motivated and those who may be at risk of depressive symptoms are reached through recruitment methods, as they are equally important in achieving intended programme outcomes. similarly, some programmes made use of screening questionnaires to identify participants at risk of poor mental health (vinokur et al. 1995b); those who scored exceptionally high on depression symptoms or showed major signs of mental illness were omitted from the programme (brenninkmeijer & blonk 2011). as previously mentioned, given that many of the unemployed in south africa may be severely discouraged, it is recommended to refrain from screening participants to identify high-risk cases, as it may result in the exclusion of participants who may benefit from the programme. the next implementation aspect investigated related to programme-related matters. in line with previous adaptations of the jobs programme, it is suggested to tailor the content of the manuals and activities to better suit the context and to increase cultural acceptability (barry et al. 2006; brenninkmeijer & blonk 2011). due to slow economic growth and the lack of skills in specific disadvantaged populations, changes in conditions of obtaining a job may be difficult (vinokur & price 2015). a solution that may fill both of these voids could be to consider fostering an entrepreneurial mindset among programme participants. people working in the informal sector often have a lower education level (although not lower wages) compared to those employed in the formal sector (kim 2002), which may be a suitable solution within the south african context. furthermore, the ability to facilitate and understand group processes, build feelings of competence and create an environment of unconditional acceptance were essential requirements for facilitators. yet education levels of the facilitators were not reported as particularly important. due to the great demand for social work in south africa, a shortfall of qualified social workers exists, which often results in employing people at social services offices who are less skilled and experienced (collin 2017). failure to grasp the importance of, and means of executing, the principal components of the programme may be problematic for the successful execution of the programme. consequently, involving trainers knowledgeable and experienced in this area, while at the same time having the ability to relate to participants, should be considered. these may typically include individuals with higher degrees, coming from a similar background, who can also serve as role models for participants. additionally, trainers should have the ability to adopt an individual-focused training approach, aimed at the enhancement of active learning among participants, instead of taking on the traditional role of teacher. a noteworthy lesson was that the success of the programme lies greatly in the adherence to the designed protocols, as fewer of the anticipated outcomes were achieved when the protocol was neglected (shirom et al. 2008). the majority of workshops included between 12 and 18 participants per group, as it was effective and economical. ideally, delivery was guided by two training facilitators, as two were more capable of monitoring the behaviour and reactions of participants (vinokur & price 2015). also, five half-day sessions, compared to longer two-week sessions, seemed to be more effective in keeping participants engaged. a vital lesson could be learned from the finnish study that allowed for a debriefing day. during this session former appointed employees had an opportunity to deal with negative emotions caused by their dismissals (vuori et al. 2005). providing participants with such a venting opportunity may have made them more receptive to the programme. lastly, the founders of the jobs programme strongly advised involving an effective champion, advocating for the programme at the policy level from the outset. it was also suggested that service delivery agencies be included that were open to applying innovative initiatives. furthermore, a continuous flow of resources and funding seemed fundamental to the success and sustainability of large-scale programmes (price & vinokur 2014). in the south african context, economic development departments in local governments, supported by training providers, could act as champions of the jobs programme. this study also explored three elements (methodology, process and impact) related to the evaluation of the jobs programme. the investigated studies were either conducted with a randomised field or quasi-experiment design as the chosen methodology, with self-reported questionnaires as the main data collection method. considering the effectiveness of these designs in reporting the effectiveness and changes over time, it is suggested to use a similar approach. furthermore, attrition was a pervasive problem experienced by most of the studies. however, offering incentives and recruiting more participants due to anticipated dropouts yielded higher attendance rates (caplan et al. 1989; shirom et al. 2008). aspects contributing to the process evaluation of the intervention included randomisation and manipulation checks of the studies included. to ensure internal validity, comparisons between the control and experimental groups’ demographic and other variables were tested for possible biases. furthermore, the strength and integrity of the various interventions were assessed by means of self-reported questionnaires at the end of each workshop. several benefits can be gained from delivering a programme that is valid and reliable. firstly, as mentioned earlier, adhering to programme protocols is strongly recommended, as the intended outcomes are achieved through reliable practices. secondly, ensuring that participants experience the programme positively has previously been shown to increase engagement and, consequently, has led to other outcomes, such as decreased depression and anger, increased internal control, job-seeking self-efficacy and self-esteem (vinokur et al. 1995a; vinokur & schul 1997). with regard to the jobs programme’s impact, one of the most significant findings was the beneficial re-employment outcomes for those who had been unemployed for a moderate length of time (longer than a year; brenninkmeijer & blonk 2011; vuori et al. 2002). likewise, findings from examined literature also showed beneficial mental health and re-employment outcomes, particularly for high-risk participants (vinokur & schul 1997). these findings are valuable as it was found in a south african study that approximately 70% of the unemployed population was categorised as desperate or discouraged (van der vaart et al. 2018). the unemployed in both clusters generally came from poor socio-economic backgrounds, had relatively low levels of education, had limited opportunities for odd jobs or temporary employment, and were quite pessimistic. given the capability of the jobs programme to produce significant outcomes for high-risk participants, it appears that it could hold valuable outcomes, also for those who have been unemployed for long periods and may be truly discouraged. limitations and recommendations some limitations of this study need to be considered. firstly, only peer-reviewed articles and book chapters that were written in english were included in the current study. since the jobs programme has been implemented in the netherlands, israel, finland and china, where other official languages occur, the possibility of excluding potential articles exists. secondly, access to some articles (jobs in china project and työhön trainers’ manual) was limited, or they could not be found, resulting in their omission from the review (i.e. fang & ling 2001; mäkitalo, tervahartiala & saarinen 1997; price 2001). in the third place, due to the nature of intervention studies, it is possible that only studies yielding significant results were published. although all versions of the jobs programme known to the developers were reported, it is possible that there may be unpublished efforts. consequently, meaningful lessons that could have been learnt from these papers were not available. however, much effort was invested in systematically searching for and including all possible studies. lastly, the study did not include articles where the jobs programme had been applied in work-to-school and organisational contexts. although these programmes may have yielded valuable findings, these studies were omitted, as the aim of this study was to specifically focus on the most effective methods to assist the unemployed. conclusion this study reviewed literature about the jobs programme as a means of extending our knowledge of applying such a job search intervention in a south african context. therefore, core aspects regarding the implementation and evaluation of the jobs programme and variations of it were investigated. specifically, implementation features such as contextual factors, participant characteristics and programme aspects were studied, while evaluation features included impact and process evaluation components. evidently, the success of the jobs programme largely depended on following the protocol. thus, studying the previously performed methods and outcomes of the jobs programme, in various contexts, may serve as a valuable guideline to prescribe possible best practices. the integration of included literature and important aspects regarding the south african context produced a framework that could be valuable in the implementation and evaluation of the jobs programme in south africa. acknowledgements this work was supported by the experiences of unemployment research project funded by the flemish interuniversity council – university development cooperation (vlir-uos). we are truly grateful for this opportunity. competing interests the authors have declared that no competing interest exists. authors’ contributions this publication was based on the phd thesis of r.p. h.d.w., s.r. and a.v.d.b. were co-authors as well as supervisors of the project. r.b. made conceptual contributions to the manuscript. funding information flemish interuniversity council – university development cooperation (vlir-uos), zein2013pr397. data availability statement the main aspects regarding the implementation and evaluation of the jobs programme and variations of it were tabulated. a summary table can be requested from the first author. the literature review comprised 34 studies; these articles can be requested from the first author. disclaimer the views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of any affiliated agency of the authors. references barry, m., reynolds, c., sheridan, a. & egenton, r., 2006, ‘implementation of the jobs programme in ireland’, journal of public mental health 5(4), 10–25. 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organizational behavior 26(3), 275–291. https://doi.org/10.1002/job.308 wanberg, c.r., 2012, ‘the individual experience of unemployment’, annual review of psychology 63, 369–396. https://doi.org/10.1146/annurev-psych-120710-100500 appendix 1 the context of the countries and states in which the jobs programme have been implemented. table 1-a1: summary of the context of the countries and states in which the jobs programme have been implemented. appendix 2 the overall findings regarding the implementation and evaluation of the jobs programme. table 1-a2: a summary of the results pertaining to the implementation and evaluation of the jobs programme. microsoft word vol6no3'3.doc sajems ns 6 (2003) no 3 498 evaluating sectoral training: a utility tool for setas ___________________________________________________________________________ gregory john lee* school of economic and business sciences, university of the witwatersrand ________________________________________________________________ abstract the south african skills development framework has mandated sectoral education and training authorities (setas) to initiate sector-specific training programmes. if seta planning is to be proactive, the evaluation and forecasting of improvements in industry outcomes from these training programmes (such as productivity or profitability metrics) should be of concern. this article pursues this end through the well-established area of decision theoretic utility analysis. it suggests a method whereby setas may forecast or estimate the industry gains from a given training programme. it is suggested that percentage increases in output may be the utility output of greatest interest and use to setas. the national accounts of south africa are used to estimate the appropriate input data for each industry in these techniques. other issues in application and research are also suggested. jel j24 1 introduction under the south african skills levy system, one of the primary mandates of sectoral education and training authorities (setas) is to initiate sectoral training initiatives, especially in smaller and medium sized enterprises (department of labour, 2001). underlying assumptions of such training are that increased skill levels among employees will stimulate sectoral output, firm profitability, economic growth and employment levels (ibid: 2). however, one of the difficulties of such programmes is estimating in advance the impact on industry productivity or profitability. while it may be possible to guess that certain training may increase metrics such as output or profitability, it would be far better if tools could be made available to help setas predict improvements. such tools would enable setas to choose between programmes, and therefore to prioritise. it would also help them to budget and account for their activities. sajems ns 6 (2003) no 3 499 while complex econometric methods exist, these techniques require highly skilled experts to apply and interpret, and often have considerable data requirements. however it would not be feasible for setas to retain or hire such experts on a long-term and ongoing basis. setas need estimates that are quicker and easier to develop. therefore accessibility of the methodology is an issue. this article will accordingly propose a simpler solution, stemming from the well-established industrial psychology theory of decision theoretic utility analysis. therefore, after a brief introduction to training evaluation and a statement of the problem, classic decision theoretic utility analysis is reiterated (for the training case) and south african data is presented as inputs to the model. various implementation issues and examples are given, and recommendations for further research made. 2 training evaluation classic training evaluation theory holds that there are four levels of training evaluation. from least to most difficult and useful, these are (kirkpatrick, 1996): level 1. reactions: how positively do trainees react towards the training? did they enjoy training, are they satisfied, inspired etc.? level 2. learning: do trainees acquire the desired knowledge, skills, attitudes etc.? level 3. behaviour: do actual on-the-job behaviours improve? level 4. outcomes: are key business indicators, such as profitability or productivity, being improved by the training? level one evaluation is generally seen as inadequate for business use. levels two and three evaluations are the most commonly utilised, usually through experimental designs. here companies will test the effect of the training on control and treatment groups, attempting to establish if any difference can be detected. differences in knowledge, skills, attitudes or behaviours between control and experiment groups are measured as a standardised �effect size�. if the effect size is measured as metric, it is linked fundamentally to the t-statistic. obviously, however, knowledge of business and industry results (level four evaluation) is most desirable to decision makers. for seta training specifically, the ultimate construct of interest is productivity or profitability within a whole sector due to grant-funded training. sajems ns 6 (2003) no 3 500 unfortunately, it is often unfeasible to measure level four outcomes at the level of the individual employee. to calculate the profitability of an individual worker requires complex cost accounting techniques, tailored to the specific job and situation (schmidt et al., 1979: 615). this is an unfeasible task in normal firmbased evaluation. the difficulty in this case is compounded by the fact that the evaluations are being conducted by setas, who have to generalise across companies without reference to the specific operations of each one. therefore, as alluring as the possibility of actually calculating level four outcomes at the individual level may seem, it is generally not feasible. however decision theoretic utility analysis is a method that has long been used to shortcut this problem. this is achieved by making an overall estimation of increased productivity or profitability attributable to an intervention, without need to measure this at the individual level, therefore solving the inherent measurement problem. the way in which such estimations of increased value are made is through an intermediate level two or three measurement. that is, as long as it can be proved that training is increasing knowledge, skills, attitudes or behaviour, and it can also be illustrated that variance in the level four outcome is dependent on variance in the intermediate variable, then an overall judgement of increased value can be made. this relationship is seen in figure 1 below: figure 1 simple training intermediate variable value relationship take, for example, the training of welders. in a pre-training experiment, setas can relatively easily assess whether the knowledge or skills about welding, or indeed the welding itself, has improved due to the training. this level two or three evaluation is useful, but now increases in productivity or profitability are desired. by estimating the variance in level four outcomes attributable to variance in welding knowledge, skills or ability, one has a link by which overall gains from the training can be estimated. this essentially is decision theoretic utility analysis, which will be derived and adapted to the seta situation next. better knowledge/ skills (level two) better performance (level three) higher economic value (level four) sajems ns 6 (2003) no 3 501 3 decision theoretic utility analysis for training the following sections will derive traditional decision theoretic utility analysis, although framing it specifically for seta training. first, it is worth explaining why the general statistical approach (in this case linear) is taken. it has been established that setas, or firms, implement management interventions such as training with the ultimate intention of impacting a hard-tomeasure dependent variable. in the case of training, the worth of employee behaviours to the industry or organisation is the variable of final interest. now, there are different ways of operationalising employee worth. one could conceive of worth in monetary terms, which is of course the variable of real interest to firms. one could also measure employee worth in terms of his/her output (which, it is argued below, is of greater interest in the industry-wide case). when looking at levels two or three evaluation, it is immediately apparent that one is measuring exactly the same underlying worth in behavioural, attitudinal or skill terms. at the enterprise level, most commonly rating scale points (i.e. performance appraisals) are seen as a surrogate for worth. the same underlying construct is being measured, just in different ways. what stops these measures of worth (monetary value, output, rating scale points etc.) being exactly equal? first is measurement error, in other words if one or all of them poorly measured then they won�t come out the same. performance appraisals, for example, are generally subject to much error. error will be dealt with later, assume for now that there is no measurement error, in other words that true monetary worth and true performance scale worth can be assessed accurately. the other reason that measures of worth are not the same is that they are measured in different units: one performance appraisal �unit� is generally not worth one rand (monetary worth) or one unit of output. because both true (without error) monetary value (yt) and true performance scores (rt) are measuring the same underlying construct (employee worth), they are therefore perfectly linearly related (congeneric), with the intercept and slope of the linear equation defined only by the difference in units (by true we mean with no measurement error). that is (raju et al., 1990: 4): bary tt += remember that there is assumed to be no measurement error. actually, measurement error in terms of intra-rater reliability is only problematic in individual or small-group measurements, not in aggregate measures over large groups. this is because classical test theory says that the group mean of an observed score is equal to the group mean of the true score (raju et al., 1990:4). sajems ns 6 (2003) no 3 502 also, the expected value (mean) of an error term in large groups is generally zero. therefore the only measurement error worth worrying about is scale or inter-rater reliability. this will be discussed later. therefore, the basis for decision theoretic utility analysis is linear regression (raju et al., 1990: 4; schmidt et al., 1979: 613). as mentioned before, it approximates the aggregate productive gain (in the chosen units of analysis) due to increase in an intermediate variable (knowledge, skills, attitudes or behaviour) arising from a management intervention of some kind. in order to approximate the final monetary gain, the technique uses an estimated linking variable that translates intermediate change into value. the linking variable is generally amenable to global judgmental or empirical estimation techniques. brogden (1946 & 1949) and cronbach & gleser (1965) first developed the decision theoretic technique for the analysis of a selection method. later, schmidt et al. (1982) derived a version for training (or any performance enhancement intervention), which will be derived here (although using a different derivation to theirs). a succinct statement of the problem is as follows. a seta wishes to estimate the total change in the result-based �utility� that the training brings about (productivity or profitability increases of some kind, hereafter to be called �utility�). the problem is that the utility for the trained group cannot be measured every time that the training is being done. estimation is needed. the estimation model can be developed as follows (schmidt et al., 1979: 61112). let the independent variable x be any intermediate, level two or three measure, i.e. knowledge, attitudes, skills or behaviours. let the dependent variable y be any results-based dependent variable, such as productive output. based on the previous discussion a linear model can be assumed, so: ezy yx ++= µβ 1 where y = the monetary value of job performance; β = the linear regression weight on test scores for predicting job performance; x = knowledge, attitudes, skills or behaviours (the predictor of individual value); yµ = mean value of job performance of random untrained employees; and e = prediction error. this equation applies to an individual. if it is to be applied to a selected sample, the following is achieved: ( ) ( ) ( ) ( )eeezeye yxs s ++= µβ 2 sajems ns 6 (2003) no 3 503 since e(e) = 0, and β and yµ are constants, this can be rendered as: yxzy µβ += 3 in a case where the average knowledge, skills, attitudes or behaviours (the level two or three predictor, x) differs between the control and experimental groups (designated �c� and �e� respectively), then the average change in utility can be said to be: ce yyu −=∆ ce xx zz ββ −= 4 since generally in a congeneric case xy βσσ = (judiesch et al., 1993: 904): y x ce xxtraineeu σ σ − =∆ / ytd σ= 5 where dt is the effect size of the training spoken of earlier (i.e. the standardised change in the predictor x brought about by training). to achieve a utility formula, therefore, only the following is necessary: 1. calculate the effect size of the training on the intermediate variable (dt). this requires a comparison between the performance ratings of the trained group and a control group, both standardized on the control group�s standard deviation. 2. calculate σy. see below on various estimation techniques to do this. the above utility equation is formulated for one time period (generally per year), and for one trainee. generally, users multiply by the number of years (t) and people being trained (n) to come to a complete measure of utility. also, if there are direct costs attributable to the training (such as loss of productive time) it is common practise to subtract these (�c� below) from the utility estimates. thus overall utility becomes: ( )( )( )( ) dyt cdtnu −=∆ σ 6 the direct cost term is not included below, merely for purposes of brevity, although it should always be included in practise where relevant and calculable. sajems ns 6 (2003) no 3 504 it is also possible that the effect of training (i.e. the knowledge or skills incorporated by employees from training) may degrade over a certain number of years (t) at constant rate i, in which case (if utility is cumulative) the equation becomes: ( ) ( )( )( )∑ =       + =∆ t t ytt dn i u 1 1 1 σ 7 equations 6 and 7 represent ways of calculating how big a productivity or profitability increase can be expected by a seta or firm when training with a certain effect size is implemented. one issue that has not been discussed fully is what measures of productivity or profitability can and should be used, and consequently how σy is to be estimated. as will be seen next, this is perhaps the area in which the practise will differ for firms as opposed to setas. 4 calculating the standard deviation of y (σy) as can readily be seen, the calculation of the standard deviation of y is the crux of the decision theoretic utility procedures. this construct is the linking variable which translates the effect size of a change in x directly into utility terms. therefore it is crucial. it is however also the most difficult variable to estimate. while cost accounting techniques can be used, these are very time consuming and costly, which was the main reason for the slow adoption and application of decision theoretic utility in organisations prior to the 1980s (schmidt et al., 1979: 615). however over the past two decades, several feasible techniques have been introduced for estimating σy. these include the following: 1. schmidt et al. (1979: 619-25) were perhaps the first to suggest a usable methodology. they suggested that a global estimate of σy be estimated through judgment. several subject matter experts are asked to estimate the level of the dependent variable (y) corresponding with employees at the 15th, 50th and 85th percentiles of x, therefore giving a global estimation of σy (one may take an average of the three, or subtract the upper from the middle or the middle from the lower figures). 2. analyses of empirical studies of σy found that its lower and upper limits correspond with 40 per cent and 60 per cent of wages and salary respectively (schmidt et al., 1983: 407). therefore, if the measure of utility y is monetary value, a short estimation method is simply to take 40 sajems ns 6 (2003) no 3 505 per cent of average salary. this does, however, give a somewhat conservative value for σy (judiesch et al., 1992). 3. cascio and ramos (1986) derived the so-called crepid method (�cascio ramos estimate of performance in dollars�). this eight step procedure essentially estimates σy through salary (as a surrogate for employee worth) weighted by the estimated importance of each principal activity undertaken by the employee. raju et al. (1990: 7) suggest that the crepid method can be summarised in the following equation: ia k i ia pwmy ∑ = = 1 where ay = the economic value of employee a, m = average annual salary, k is the number of principal job activities, wi = the proportional importance of principal activity i (such that σwi = 1.00) and p = the performance rating for employee a on principal activity i (with p always between zero and two). for more on this procedure see cascio and ramos (1986). note that the crepid procedure assumes that the dependent variable (y) is monetary value. 4. cascio (1999: 240-243) lists several other methods, such as the �system effectiveness technique�, for use when salary is a low proportion of the value added of productivity (eaton, wing & mitchell, 1985 in ibid) and the �superior equivalents technique�, which uses an alternate but fairly closely related methodology to the global estimation of schmidt et al. (1979) above (eaton et al., 1985, in cascio, 1999: 241-43). having reported very briefly some of the many methods for estimating σy, this article will next explore the specific issues in decision theoretic utility for seta training, and suggest ways in which setas could maximise their planning from these techniques. 5 an industry-wide and output-based application for setas in decision theoretic utility analysis, the measure of ultimate utility could be almost anything of interest to the users (raju et al., 1990: 8), as long as a statistical relationship between predictor and explanatory variable exists (linear in this case, although lee, 2003 has derived a methodology for binary dependent variables). earlier the examples of monetary value, output and various others were mentioned as possible measures of utility. in initiating sector-wide training, setas will very often be interested more in sectoral output than the profitability of individual firms. this is because the profit is largely a contextual, organisation-based construct. however output is at the heart of standard productivity measurements, and is a vital input into sajems ns 6 (2003) no 3 506 competitiveness statistics. profitability is also overly based on and affected by external factors to be a reliable metric for industry-wide evaluations. if output is standard across the industry (i.e. units of output are the same across firms), then the best way of estimating σy for changes in output probably remains the schmidt et al. (1979: 619-25) judgmental approach. in such a case, subject matter experts from across the industry would estimate the output for a certain standard task resulting from employees at the 15th, 50th and 85th percentiles of x (or at least for the 50th and one of the other percentiles). see schmidt et al. (ibid) and further publications (e.g. cascio, 1999: 226-32) for more on this procedure. of course, for this to work, output would have to be fairly standard and measurable (as it might be in standard production environments). this condition does not always hold. in cases where output is not standard enough to directly be converted into common units, which may be often, schmidt et al. (1983) suggest a procedure for assessing percentage increases in output. this is a far more general construct, and should be especially useful in an industry context. the procedure involves substituting �σp� (the standard deviation of changes in output) instead of σy. σp is more properly defined as the standard deviation of output as a percentage of mean output. this procedure could, of course, also be used if output is standard, although as will be seen below, it may be less reliable. σp can be approximated from the 40 per cent rule. schmidt and hunter (1983) do so by multiplying the 40 per cent by the percentage of output made up by wages and salaries. they estimated that this figure is 57 per cent for the u.s. economy. if y is defined as output (such that ∆u is percentage increases in output from training), then using the 40 per cent rule σp should be 23 per cent of average salary (57 per cent of 40 per cent of salary). again, this gives percentage increases in output, not absolute increases. in south africa, an output calculation based on the 40 per cent or 70 per cent rules would require different adjustments. as can be seen in data from the national accounts (statistics south africa, 2003) suggest that wages and salaries have constituted approximately 49 per cent of the value of goods and services produced by the whole economy over the past ten years. if this figure were to be used, the linking variable for increases in output should be 49 per cent of 40 per cent = 19.6 per cent of salary. there are however significant fluctuations in this figure over industries. as can be seen in table 1 through table 6, industry averages of wages as a percentage of output have ranged from 31 per cent (agriculture) to 98 per cent (other) over sajems ns 6 (2003) no 3 507 the past ten years. this suggests that each setas should adjust for output calculations by its appropriate sectoral figure, not by the national percentage. table 1 wages as percentage of gdp, whole of s.a. and government services south africa general government services output wages % output wages % 1993 r426,132 r218,159 51.2% r62,375 r55,255 88.6% 1994 r482,119 r242,166 50.2% r71,278 r63,435 89.0% 1995 r548,099 r274,676 50.1% r80,831 r72,021 89.1% 1996 r617,957 r308,120 49.9% r96,214 r86,292 89.7% 1997 r685,729 r340,071 49.6% r107,744 r96,416 89.5% 1998 r738,927 r371,638 50.3% r116,484 r103,526 88.9% 1999 r800,699 r397,014 49.6% r123,453 r108,704 88.1% 2000 r888,057 r424,958 47.9% r132,519 r115,850 87.4% 2001 r982,944 r458,416 46.6% r142,974 r124,504 87.1% 2002 r1,098,714 r497,843 45.3% r157,936 r137,659 87.2% 10 yr ave r726,938 r353,306 49.1% r109,181 r96,366 88.4% source: statistics south africa (2003). all figures are in millions table 2 wages as percentage of gdp, primary industries agriculture, forestry, fishing mining and quarrying output wages % output wages % 1993 r16,284 r5,069 31.1% r30,052 r15,827 52.7% 1994 r20,252 r5,680 28.0% r32,111 r16,516 51.4% 1995 r19,317 r6,406 33.2% r34,830 r18,452 53.0% 1996 r23,721 r6,908 29.1% r38,768 r19,969 51.5% 1997 r25,140 r7,398 29.4% r40,524 r22,061 54.4% 1998 r24,287 r7,911 32.6% r43,439 r22,622 52.1% 1999 r24,996 r8,380 33.5% r46,175 r23,612 51.1% 2000 r26,060 r8,904 34.2% r54,951 r25,717 46.8% 2001 r31,060 r9,519 30.6% r67,161 r28,487 42.4% 2002 r37,674 r10,276 27.3% r80,586 r30,371 37.7% 10 yr ave r24,879 r7,645 30.9% r46,860 r22,364 49.3% source: statistics south africa (2003). all figures are in millions sajems ns 6 (2003) no 3 508 table 3 wages as percentage of gdp, secondary industries construction manufacturing output wages % output wages % 1993 r12,318 r9,577 77.7% r82,642 r46,111 55.8% 1994 r13,797 r9,954 72.2% r92,068 r50,761 55.1% 1995 r15,774 r10,909 69.2% r106,180 r56,484 53.2% 1996 r17,631 r11,414 64.7% r114,125 r59,965 52.5% 1997 r19,829 r12,285 62.0% r124,604 r63,532 51.0% 1998 r21,687 r13,460 62.1% r129,017 r70,678 54.8% 1999 r22,325 r13,770 61.7% r136,016 r74,554 54.8% 2000 r23,843 r14,091 59.1% r150,198 r78,439 52.2% 2001 r25,532 r14,715 57.6% r166,415 r83,762 50.3% 2002 r27,545 r15,517 56.3% r188,182 r90,358 48.0% 10 yr ave r20,028 r12,569 64.3% r128,945 r67,465 52.8% source: statistics south africa (2003). all figures are in millions table 4 wages as percentage of gdp, tertiary sectors (utilities, transport/communication) electricity and water transport and communication output wages % output wages % 1993 r13,930 r3,906 28.0% r33,972 r17,811 52.4% 1994 r15,975 r4,317 27.0% r38,296 r19,364 50.6% 1995 r17,408 r4,943 28.4% r44,538 r22,275 50.0% 1996 r18,602 r6,098 32.8% r51,787 r25,295 48.8% 1997 r19,929 r6,663 33.4% r57,874 r27,536 47.6% 1998 r22,534 r7,228 32.1% r63,278 r30,728 48.6% 1999 r21,741 r7,922 36.4% r70,868 r31,815 44.9% 2000 r22,657 r7,761 34.3% r80,799 r34,104 42.2% 2001 r22,630 r7,671 33.9% r88,161 r37,010 42.0% 2002 r23,905 r8,065 33.7% r96,086 r40,252 41.9% 10 yr ave r19,931 r6,458 32.0% r62,566 r28,619 46.9% source: statistics south africa (2003). all figures are in millions sajems ns 6 (2003) no 3 509 table 5 wages as percentage of gdp, tertiary sectors (trade, finance) wholesale / retail trade, hotels, restaurants finance, real estate, and business services output wages % output wages % 1993 r56,468 r29,174 51.7% r62,861 r21,035 33.5% 1994 r62,474 r31,373 50.2% r70,491 r23,931 33.9% 1995 r71,768 r35,343 49.2% r82,162 r28,136 34.2% 1996 r79,463 r38,417 48.3% r94,122 r31,676 33.7% 1997 r85,858 r42,132 49.1% r110,488 r36,689 33.2% 1998 r89,814 r45,069 50.2% r123,778 r41,915 33.9% 1999 r95,595 r48,877 51.1% r143,545 r47,550 33.1% 2000 r107,299 r51,478 48.0% r160,936 r53,230 33.1% 2001 r118,737 r54,511 45.9% r177,217 r58,751 33.2% 2002 r132,691 r58,691 44.2% r194,591 r64,335 33.1% 10 yr ave r90,017 r43,506 48.8% r122,019 r40,725 33.5% source: statistics south africa (2003). all figures are in millions table 6 wages as percentage of gdp, tertiary sectors (other services, all other industries) community, social & personal services other output wages % output wages % 1993 r9,435 r4,087 43.3% r10,505 r10,306 98.1% 1994 r11,349 r5,001 44.1% r12,054 r11,833 98.2% 1995 r13,690 r6,100 44.6% r13,855 r13,607 98.2% 1996 r15,368 r6,691 43.5% r15,671 r15,395 98.2% 1997 r17,374 r7,863 45.3% r17,803 r17,496 98.3% 1998 r19,390 r8,682 44.8% r20,154 r19,819 98.3% 1999 r21,521 r9,662 44.9% r22,527 r22,168 98.4% 2000 r24,049 r10,834 45.1% r24,930 r24,550 98.5% 2001 r27,551 r12,443 45.2% r27,463 r27,042 98.5% 2002 r31,066 r14,191 45.7% r28,592 r28,128 98.4% 10 yr ave r19,079 r8,555 44.6% r19,355 r19,034 98.3% source: statistics south africa (2003). all figures are in millions an illustration might be in order. take a simple example with the following parameters: � the construction seta (ceta) is planning a training programme for welders. sajems ns 6 (2003) no 3 510 � the effect of training on the predictor variable x (in this case a set of work sample assessments) is evaluated on control and experiment groups, on a scale of 0 to 200. using standard experimental design, it is shown that the experimental group on average score 120 (xe) and control group only 108 (xc) after training, with no difference in pre-training. � the standard deviation of x scores in the control group (σx) is 24. following equation 5, it is first necessary to estimate the standardised effect size brought about by the training (dt). since it is highly unlikely that assessments of welding skill are perfectly reliable, dt for scale or inter-rater unreliability is also adjusted for ( xxr ). schmidt et al. (1982: 336) substitute the commonly utilised empirical estimate (based on meta-analyses of prior reliability studies) of .6 for rxx. dt is therefore calculated as: xxx ce t r xx d σ − = 59.0 6.24 108120 = − = now that dt is estimated, it is multiplied by σp. using the 40 per cent rule, σp can be found simply by taking 40 per cent of the percentage of wages and salaries that make up output in the construction seta. from table 1 is can be seen that, for the construction sector, wages and salaries make up 64 per cent of output (the ten year average). therefore σp is estimated by 40 per cent of this figure. overall, therefore, percentage increase in output is expected to be: ( )( )ptdu σ=∆ = (.59)(.4)(.64) = .15 thus an improvement of approximately 15 per cent in output can be expected (without skills decay) from welders exposed to this training programme. note that in this case, time or number of people trained is not multiplied into the equation, as the percentage figure calculated is proportional across these. of course, should absolute output be quantifiable in unitary form (e.g. number of welding hours per r100 000 of production), then one can multiply this percentage by the average output of trainees, the number of trainees and the time given to come to an absolute increase in welding output. sajems ns 6 (2003) no 3 511 if, due to staff turnover or knowledge / skill degradation, a 10 per cent degradation in this effect (i) can be expected over ten years (t), then the expected actual percentage improvement in output is expected to be: ( ) ( )( )ptt diu σ     + =∆ 1 1 ( ) ( )( )( )64.4.59.1 1 10       + = i =0.058 note that the discounting term is not additive here, as in equation 7, because the output percentage is not a cumulative construct. that is, being a percentage, it is constant or constantly decaying over time, and not compound. thus an improvement of only 5.8 per cent can be expected in the case of the stipulated skills decay from welders exposed to this training programme. these figures for the percentage improvement in output can now be used as an input into overall industry calculations of productivity. it must be emphasised that these are relatively rough calculations � as stated above, the 40 per cent of salary rule has been shown to give conservative utility totals. in addition, various factors have been shown to affect utility. hunter, schmidt & judiesch (1990) found that σp increases with complexity of the job. furthermore, schmidt et al. (1983) illustrated that σp is lower for jobs with incentive pay (especially piece rates) than for purely salaried jobs. it is probably preferable to get a better estimate of σp, if possible through a global estimation procedure such as that developed by schmidt et al. (1979). however the utility estimates achieved through procedures such as this need not be perfect. it is enough that setas are confident that at least sizeable gains are being made in industry output. furthermore, even with relative unreliability, setas can still compare programmes using this methodology, choosing to implement the most productive training. thus it is proposed that this sort of utility formulation could be very useful to setas, as it has been proved to be in firms. 6 recommendations for further research within the context of skills development, research is still at the validation level. concrete evidence is required of the impact upon crucial outcomes, both of the skills levy in general and normative suggestions such as that suggested here. unfortunately, the complexity underlying productivity in any given industry sajems ns 6 (2003) no 3 512 makes it unlikely that research could detect whether utility estimates do in fact lead to the overall changes. however it may be possible and indeed desirable to create experimental situations to assess this. task environments with standard output should be easiest in this regard. within the decision theoretic utility framework, ongoing and industry-specific research on the reliability of each element (effect size calculations, estimations of standard deviation etc.) should be conducted. most pressing is a validation of the 40 per cent of salary rule for south african conditions. since the suggested methodology for calculating σp consists of multiplying the 40 per cent rule by the percentage of industry value added made up by wages and salaries, it is vital that local conditions comply with the former heuristic. finally, it may be useful for future researchers to consider how techniques such as this could be used to evaluate the more general training funded out of the national skills fund. perhaps a way could be found to adapt the techniques to utilise employment as the output, although obviously employment is at least partially demand-driven, and relies imperfectly on supply of skills. however, in the right contexts, it may be possible to estimate the effect of general training on employment chances or even levels. 7 conclusion the skills development system in south africa has begun to settle down to a �business as usual� phase. it is important that the money being funnelled into the system get utilised in as efficient a manner as possible. intuitive analyses as to what training is needed in any given industry should, if possible, be complemented by hard estimates of productivity or profitability improvements. this paper has therefore suggested one possible technique in this vein. based on decades of research, and adapted for south african statistics, it is a natural addition to the skills development system. easy conversion into a computerised information system should ease any computational jitters and resistance to implementation, and hopefully make for improved seta and nsf decisions. references 1 boudreau, j.w. (1983) �economic considerations in estimating the utility of human resource management productivity improvement programmes�, personnel psychology, 36: 551-76. 2 brogden, h.e. (1946) �on the interpretation of the correlation coefficient as a measure of predictive efficiency�, journal of educational psychology, 37: 64-76. sajems ns 6 (2003) no 3 513 3 brogden, h.e. (1949) �when testing pays off�, personnel psychology, 2: 171-85. 4 cascio, w.f. (1999) costing human resources (4th ed.) south western. 5 casico, w.f. & ramos, r.a. (1986) �development and application of a new method for assessing job performance in behavioral/economic terms�, journal of applied psychology, 71: 20-28. 6 cox, d.r. & snell, e.j. (1989) analysis of binary data (2nd ed.) chapman and hall: london. 7 cronbach, l.j. & gleser, g. (1965) psychological tests and personnel decisions, university of illinois press: urbana, il. 8 department of labour (n.d.) sector skills plan guide, http://www.labour.gov.za/docs/legislation/skills/docs/sector-skills.pdf (downloaded 2003-03-22). 9 hunter, j.e. & schmidt, f.l. (1982) �fitting people to jobs: the impact of personnel selection on national productivity�, in m.d. dunnette and e. fleischman (eds.) human performance and productivity, 1: 23384, erlbaum: hillsdale nj. 10 judiesch, m.k., schmidt, f.l. & mount, m.k. (1992) �estimates of the dollar value of employee output in utility analyses: an empirical test of two theories�, journal of applied psychology, 77: 234-50. 11 kirkpatrick, d.l. (1996) �evaluation�, in r.l. craig (ed.) the astd training and development handbook (2nd ed.) new york: mcgraw hill. 12 lee, g.j. (2003) �decision theoretic utility analysis of binary workplace outcomes�, wits university business economics research seminar working paper, march. 13 raju, n.s., burke, m.j. & normand, j. (1990) �a new approach for utility analysis�, journal of applied psychology, 75: 3-12. 14 raju, n.s., burke, m.j.; normand, j. & lezotte, d.v. (1993) �what would be if what is wasn�t? rejoinder to judiesch, schmidt, and hunter (1993)�, journal of applied psychology, 78: 912-16. 15 schmidt, f.l., hunter, j.e. & pearlman, k. (1982) �assessing the economic impact of personnel programmes on workforce productivity�, personnel psychology, 35: 333-47. 16 schmidt, f.l., hunter, j.e. (1983) �individual differences in productivity: an empirical test of estimates derived from studies of selection procedure utility�, journal of applied psychology, 68: 407-14. 17 schmidt, f.l., hunter, j.e., mckensie, r.c. & muldrow, t.w. (1979) �impact of valid selection procedures on work-force productivity�, journal of applied psychology, 64: 609-26. 18 statistics south africa. (2003) gross domestic product: fourth quarter 2002 (25th feb), http://www.statssa.gov.za/default3.asp (downloaded 2003-03-21). sajems ns vol 4 (2001) no 1 133 attitudes towards credit buying among the youth: an exploratory study m birkholtz and g g rousseau department of industrial psychology, university of port elizabeth abstract the main objective of the study is to investigate attitudes of young consumers towards credit purchasing behaviour by means of store charge cards. data were gathered by using an administered questionnaire from a multicultural sample (n=265) of learners and students attending various secondary and tertiary institutions in port elizabeth, as well as from observations of young shoppers at various retail outlets in the city. results indicate that young consumers differ across gender, age, and home language in terms of attitudes towards credit. findings suggest that there is a lack of knowledge and understanding by the respondents of the consequences of buying on credit, especially accountability for their financial actions. implications are that education and training in personal money management are crucial for ensuring that marketers do not give rise to up a body of future debtors, stemming from financial illiteracy. jel d 12 introduction south africa is a poor country trying to live like a rich one doing so primarily by means of debt (swart, 1997). credit facilities have always performed an important role in assisting people to achieve home and car ownership, which though apparently unavoidable, is still exploited by consumers who overcommit themselves in terms of their total budget; either because of poor money management, or a deliberate decision to live above their means. debt has become a key word of the new millennium. a bad word a generation ago, it has now become a socially acceptable fact of life and a respectable norm for most families (collins & mammen, 1998; kaye, 2000; usher, 2000). debt is an increasing social problem in most developed countries at present (davies & lea, 1995). corresponding to the increase in problem debt, there has been a recent increase in research on debt by a variety of social scientists (including sociologists, lawyers and political scientists) (davies & lea, 1995), surprisingly, economists have made little contribution to such research, which has primarily focussed on two questions: what factors cause some people to use r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 134 sajems ns vol 4 (2001) no 1 credit more than others, and what factors cause people to get into difficulty. the concept of consumer debt 1 credit has numerous dimensions, each with its own causal variables, consequences and implications. this study exclusively focuses on a single psychological aspect of consumer debt (attitudes), a specific group of consumers (the youth, aged between 13 to 23 years), and a particular behavioural manifestation (buying on store "charge cards"). credit use among young adults in general is an important issue, and there is some indication that they may be high users of credit (ford, 1992, cited in davies & lea, 1995). generally automatic teller machine (atm) cards and store charge cards serve as the entry point for young consumers into the world of fmance, financial independence, and personal money management it is a widely held belief in behavioural science that childhood experiences are of paramount importance in shaping patterns of cognition and behaviour in later life. marketing literature suggests that childhood and adolescent consumption experiences affect patterns of consumer behaviour in adult life (saunders, 1984). the youth in the south african market, making up more than half of the population, has become a high focus area for marketers. according to most recent census results (1996), approximately 43 per cent of south africa's total population are between the ages of 5 and 24 years. all south africans under the age of 24 constitute approximately 54 per cent of the total population (statistics south africa, 2000). more recent statistics released by the all media and product survey (amps) report this figure to be approximately 55.4 per cent (south african media facts, 2000/2001). youth spending in south africa currently tops at r4 billion a year (alleman, 20ooa). marketers in south africa have come to recognise this as a multibillion rand marketing tool, and called it "pester power" (mulrooney, 2000). the youth as consumers there are indications, both locally and abroad, that increasingly "permissive" child-rearing practices have contributed to earlier and greater independence of thought and action by children (roberts, 1998; saunders, 1984). mulrooney (2000) reiterates this sentiment in noting that the youth of today have a much shorter period to be young and are more independent than their counterparts of previous generations. this youthful market segment, called the millennium generation or generation y, was born after 1990 and is primarily characterised by the fact that it grew up surfmg the internet generation y have exceptional pester power and also substantial discretionary income. it is considered the largest generation to enter the global market since the baby boomers. pentstone and codrington (2000) note that although generation y is not older than ten r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 135 years in south africa, they are between five and twenty years in the united states. today's youth are brought up in a material world and they know it. they are acutely aware of what they want and like. they are sophisticated, discerning, and well aware of their surroundings, also being brand loyalists (mulrooney, 2000). these are only a few of the consequences of direct advertising and great marketing exposure directed at children via the printed and electronic media, product and movie clubs, banks, bookstores and clothing boutiques. today's adolescents also grew up with debt and thus use credit freely (roberts, 1998). the money involved in credit transactions, whether using credit cards, or making purchases on account, becomes abstract and unreal. this behaviour is the result of credit cards being viewed as a convenient and relatively painless way of spending, moreover, the use of credit is becoming socially acceptable. this is even more so when adolescents are permitted to make purchases on a parent's or guardian's account, yet not required to pay for the purchases. credit is becoming increasingly available to the average consumer in south africa. this is especially so for new entrants into the market (teenagers 18 years and older and young adults), due to the fight for market shares among retailers and the competition from cash stores. these trends have lead to attitudes towards debt becoming increasingly tolerant and relaxed, as debt becomes more socially acceptable. a further negative spin-off is a tendency to save less. the average south african saves only 1.5 per cent of hislher personal disposable income (swart, 1997) and expends 66 per cent of net disposable income on servicing debt (wakeford, 1998). this sets a bad example for young consumers. whereas buying on credit effectively results in the forgoing of future consumption, saving is consumption deferred. pile (2000) states that in the age of instant gratification, saving money in the bank is not the most attractive prospect for youngsters. a number of authors (gaskill, 1999; merrick, 1999; zimmerman, 1999) maintain that american children and teenagers lack financial knowledge and do not understand the basics of personal money management. young males are reported as most likely to use credit and use it excessively (personal communication, 2000, ltc). this trend, however, applies only to total credit and not retail cards. the overriding majority of retail cardholders are reported to be female, a trend confumed by store managers. a study carried out by roberts (1998) on compulsive buying among college students, found that credit card use and accessibility stimulates spending and, compared to cash purchasing, credit cards lead to greater imprudence. it was also found that credit cards are easily accessible to students and marketed aggressively to them, thus resulting in more rapid growth of debt. collins and mammen (1998) found that r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 136 sajems ns vol 4 (2001) no 1 young adults responded moderately regarding their attitudes toward credit purchases and were more tolerant towards debt. fifty-eight per cent of respondents felt that credit was a "good idea", and only twenty-eight per cent thought it was a "bad idea". the incidence of credit use by young adults is further supported by studies by davies and lea (1995) and weissman (1999). feinberg (1986) found that because credit card stimuli are so closely associated with spending, it increases the motivation to spend, the amount spent, and the probability of spending, while decreasing decision time when spending, thus resulting in unplanned impulse spending. a study by rousseau and venter (1999) to gain a better understanding of consumers' attitudes towards money, found that significant differences existed between various language groups. these findings suggest that there is an underlying influence of cultural and economic factors on attitudes towards money and supports the notion that the symbolic meaning of money to an individual is largely determined by his / her culture, religion and life experiences. such differences may also be inferred to exist for attitudes towards debt, although more research is needed to confirm the underlying cultural and socio-economic factors in this regard. rousseau and venter (1999) used language as a proxy for culture in their research. in the present study it is assumed that young english, afrikaans and xhosa speaking respondents would represent different cultural backgrounds, which may impact on their attitudes towards credit buying behaviour. a multicultural sample was therefore chosen for the research. objectives the main objectives of this study is (1) to investigate the relationship between the attitudes of young consumers towards buying on credit and certain demographic variables and (2) to determine young consumers' attitudes towards debt. based on the available literature, the following hypotheses were formulated: differences in attitude towards credit exist across gender groups (roberts, 1998). differences in attitude towards credit exit across language groups (rousseau & venter, 1999). differences in attitude towards credit exist across age groups (davis & leas, 1995). young consumers show tolerant attitudes towards debt (collins & mammen, 1998). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 {200l} no i 137 non-credit purchasers were excluded from the sample as these young adults probably pay cash and are therefore less likely to fall into debt. only personal and indirect credit users were included, as young consumers below 18 years do not qualify for an open account. their only access to credit is a store charge card linked to the account of a parent or guardian, who uses the open account facility at a store. alternatively, they may have access to their parents' or guardians' open account by means of a letter addressed to the store, giving them permission to do so. observation suggests that young consumers have easier access to store charge cards than normal bank credit cards. method tbesurvey an item scale was developed by modifying various items used in previous studies (roberts, 1998; rousseau & venter, 1999), as well as by generating additional items. respondents were asked to rate twenty-one items on a fivepoint likert scale, in order to measure their attitudes towards buying on credit. in order to ensure a more realistic reflection of respondents' buying behaviour, a behaviour-based component was incorporated in the questionnaire. responses to questions relating to the dominant method of payment (cash or account), frequency of account purchases per month, responsibility for payment of credit purchases, and reasons for having an account or wanting to open one, were included. demographic details of respondents concluded the questionnaire. sample: a probability cluster sample (n=265) was employed in the study, drawing random samples from seven clusters (four high schools and three tertiary institutions) in the port elizabeth metropole. from each cluster, 30 to 70 respondents were selected on the basis of certain criteria (le. they had to be account buyers). respondents varied in age between 13 and 23 years and represented various race and language groups in the area. procedure: fieldwork was carried out by the authors who visited the various institutions and administered the questionnaire in suitable locations such as the library, cafeteria or school hall. during administration, the researchers remained at the venue to assist respondents with semantic and language problems. the questionnaire was printed in english and afrikaans. no time limit was set for completion. a visual-aid explanation was given prior to the administration of the questionnaire. data analysis: data analysis employed the computer program bmdp 4m (frane, jenrich and samson, 1979) to perform exploratory factor analysis on the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 138 sajems ns vol 4 (2001) no 1 twenty·one items in the questionnaire. the method of principal component analysis was used with direct quartimin rotation. results are summarized in table i. descriptive statistics and correlations were calculated by means of bmdp programs 20, 4f and 8d respectively. the statistics are reported in table 2. the bmdp program 10 was used to calculate mean factor scores for the selected biographical variables. these results are shown in table 3. the bmdp program 2v was subsequently used to perform analysis of variance (anov a) to identify which of the biographical variables are significantly related to the factors. these results are presented in table 4. to test the statistical significance of factor score differences between the various biographical groups, on~way analysis of variance, bmdp program 70 was performed. these results are also reflected in table 3. results summarized in table 5 were obtained from content analyzing responses to questions 24 to 26 in the questionnaire. these results were not subjected to statistical analysis. results attitudinal results table 1 shows the results of the factor analysis performed on the twenty.one items of the attitude scale. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . .~~~~~~~~~. -----------------factor 1 ~~~~~~~~. ----------~~~ criterion materia!ism 5. price is not important when i buy on account 0.406 16. i sometimes buy things i don't really need because i 0.545 can buy them on account 10. buying on account allows me to buy all the latest 0.553 fashions and best brand names 14. it is important to own nice things 0.554 17. by buying on account, you always have a way 0 0.567 owning the latest things 18. your friends admire you if you own the latest fashions 0.646 and brand names 12. i like to follow the latest trends 0.698 3 i am cautious with the money i spend 9. 1 keep careful; track of my expenditures 19. i follow a careful budget 20. "buy now and pay later" is a good idea 1. buying on account is a convenient way to manage my money. 6:~~~i3~l1ying on account is more convenient than paying cash factor 2 factor 3 factor 4 cautious conveliving bespending nience yond means 0.696 0.805 0.836 0.554 0.641 0.791 1-1 factor 5 ., cr -debt i'd -aversion 0 cr c:: ,.q s: i'd a it a s' a = ., ., i ~ iii' s ., ... a· i~ ~ z til < 2~ 'i:) <:> <:> .... '-" ~ .... w \0 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . factor 1 factor :1 criterion materiacautious lism spending 11. people would not be able to afford all their purchases ifthey could not buy on account 21. when i buy on account, i don't mind paying more for something 7. buying on account causes people to buy things that they can't afford 8. buying on account frees up your money for other more important purposes 4. buying on account allows me to afford items immediately without having to save up for them over a long period of time 15. buying on account is a good solution if you don't have enough cash 2. you should have enough money in the hank to pay cash whenever you choose to buy on account 13. getting into debt by buying on account can make you l=--'worry percentage of total variance explained 34.3% 64.6% cronbach's coefficient alpha 0.67 0.72 sample size n = 265 factor 3 factor 4 conveliving benience yond means 0.631 0.361 0.388 0.533 0.613 55.6% 31.6% 0.60 0.43 factors debt aversion 0.592 0.657 0.660 47.8% 0.45 '"'.i -;. ~ ;" """ i i ~ ~ ..... ~ -'-" ~ r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . samms ns vol 4 (2001) no 1 141 the analysis revealed five factors namely materialism, cautious spending, convenience, living beyond means, and debt aversion. only items with factor loadings in excess of 0.36 are reflected in the table. the cronbach's alphas exceeded the required 0.60 criterion for reliability on the first three factors (materia/ism, cautious spending. convenience). in view of the exploratory nature of the study, more items need to be added to the attitude scale to increase its overall reliability. the percentage of total variance explained by factors is also reflected in table 1. table 2 shows the descriptive statistics and correlations. table 2 descriptive statistics and correlations correlations factor 3 4 -0.0790 0.2311 .. 02620 0.0503 0.0640 0.84 02311 0.2653 4 living 258 2.48 0.58 0.2620 .. 0.0640 0.2653 .. -0.1266 .. be ond means 5debtaverslod2582.50 0.8 -0.1007 0.0810 -0.2741*-0.1266 * • significant at 95% c.l. (r>=o.124) • significant at 99% c.l. (r>=o.l62) as can be seen from the table, moderate significant positive correlations occur between materialism and convenience (factor 1 and 3), as well as between materialism and living beyond means (factor i and 4). materialistic individuals could be assumed to be more likely to live beyond their means in order to satisfy their desire for status and branded possessions. employing credit as the means to finance their elevated aspirations thus becomes not only acceptable, but also convenient, hence the correlation between convenience and materialism. convenience correlates significantly negatively with debt aversion (factor 3 and 5), and also correlates significantly positively with living beyond means (factor 3 and 4). if individuals perceive making purchases on credit to be a form of transaction convenience, it may be inferred that such individuals would not be averse to incurring debt in the form of store credit, and may thus also be more likely to live beyond their means. conversely, debt averse individuals would not consider incurring debt, even for the sake of convenience, to be acceptable. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 142 sajems ns vol 4 (2001) no 1 living beyond means shows a significant negative correlation to debt aversion (factor 4 and 5). individuals who are thus more conservative in their attitudes towards debt ( debt averse) would not be inclined to live beyond their means. avoiding incurring debt to fmance an elevated lifestyle. conversely, individuals living beyond their means would need to finance their elevated lifestyle. and would therefore not be averse to use credit to do so. table 3 shows the descriptive statistics for the biographical variables obtained from the sample. table 3 descriptive statistics by gender, age and home language materialism ' caatioasspendm2 convenience n i mean sd n mean sd n mean sd igender. ~ male 2.109 0.827 62 2.163 0.824 female 2.182 0.848 191 2.702 0.835 ia2e: 13 15 vrs 44 2.779 0.563 45 2.252 0.894 44 2.72 0.877 16-17 93 2.917 0.62 93 2.194 0.86 93 2.624 0.856 18-19 80 3.096 0.674 80 2.15 0.83 77 2.766 0.795 20-24 39 3.128 0.767 38 2.018 0.767 39 2.598 0.803 lbome laapqe: enalish 96 2.875 c 0.647 96 2.257 0.933 93 2.738 0.829 afrikaans 98 3.111 d 0.658 99 2.141 0.888 100 2.677 0.841 xhosa 57 2.945 0.657 56 2.06 0.562 55 2.57 0.843 total sample 265 2.9829 0.65952: 2.1673 0.8461 2.6761 0.83631 significant differences: gender ab** age home language cd* matrices of mean factor scores for biographical variables are shown in table 3. this table also indicates those factor score differences which are significant between the various biographical variables. in the table, a low score indicates a positive response, while a high score indicates a negative response. the five point rating scale used in the questionnaire comprised of verbally anchored points ranging from agreeing completely (one) to disagreeing completely (five). from table 3, it is evident that english-speaking male respondents aged between 13 and 15 years scored most positive on materia/ism (factor 1). this may be an indication of the sophisticated generation y consumer who is growing more aware of fashion trends and branded merchandise at increasingly younger ages. this trend is consistent with previous research fmdings by r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 143 mulrooney (2000). significant differences also exist between males and females in tenns of materialism, this may possibly be an indication of increasing male awareness of fashion and branded status merchandise, which is consistent with the reports given by the store managers interviewed. xhosa-speaking males aged between 20 and 24 years scored most positive on cautious spending (factor 2), and may therefore be rather worried and careful about spending money. this fmding conflnns those of rousseau and venter (1999) in their study on consumers' attitudes towards money. with regard to convenience (factor 3), xhosa-speaking males aged between 20 and 24 years again scored the most positive. table 3 shows that significant differences exist between english and afrikaans language groups, with english-speaking respondents scoring significantly more positive on materialism than afrikaans-speaking respondents. as far as gender is concerned, male scores were on average more positive than females scores on all factors, though differences were only significant for factor 1 (materialism). table 4 shows which biographical variables are significantly related to factor scores. table 4 analysis of variance to determine relationships between biographical variables and factors materialism i i cautious convenienee spending i df f i p ! f p f p geuder 1 2.88 i 0.09l. i 0.06 0.8112 0.27 0.6007 age 3 1.471 0.22231 1 0.38 0.7687 0.65 0.5862 home 2 3.161 0.0444 1 *: 0.95 ! 0.3872 0.79 1 0.4553 lan2uaae n = 254 *p<0.05; **p,o.oi results reflected in table 4 suggest that home language is the only biographical variable which is significantly related to materialism. english-speaking respondents tended to be more materialistic than the other language groups. beba vioural results responses to the behavioural questions revealed that of the total number of respondents (n = 265), 87.5 per cent were permitted to buy on the account of a parenti guardian. of account holders, 83.1 per cent more frequently bought on r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 144 sajems ns vol 4 (2001) no 1 account rather than paying cash at the stores listed in the survey. the majority of these respondents (62.5 per cent) purchased on account at least once a month. of non-account holders, 82.8 per cent of respondents more frequently bought on account rather than paying cash at the stores listed in the survey, and the majority (68.9 per cent) purchased on account at least once a month. only 54.5 per cent of respondents expressed the desire to open their own account. results indicate that where almost two-thirds of account holders are responsible for paying for their own credit purchases (64.6 per cent), only a very small minority of non-account holders are responsible for payment of their credit purchases (24.6 per cent). the infonnation presented in table 5 describes the reasons (grouped into five broad categories) for respondents acquiring, or wanting to acquire, accounts. tables reasons for acquiring, or wanting to acquire an account respondents with respondents without own accounts own accounts lfwhy have an account) why want an account) cate20ry n=61 n= 108 independence 6.5% 38.0% responsibility; money 14.7% 20.3% management !buy now, pay later 42.7% 34.4% convenience 36.1% 21.3% irresponsibility 4.8% 12.9% miscellaneous 9.8% 2.8% total 114.6%* 129.7%* multtple responses occurred reasons grouped under "independence" refers to both financial independence, and being able to shop independently of parents (not having to be accompanied). "responsibility" and "money management" includes such reasons as wanting to .. improve cash flow, learning responsibility, and improving money management. the "buy now, pay later" category includes a number of reasons encompassing being able to afford expensive items now without having the necessary cash available; and deferring payment over a number of instalments. the "convenience" category includes reasons such as not having to carry cash around all the time, as well as general transacting ease. the category entitled "i"esponsibility" includes reasons such as parents paying for purchases, wanting an account, liking the idea of having an account, and being able to buy whatever whenever without paying for it. the last category includes reasons not r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no i 145 encompassed by any of the other categories, for example, wanting to open an account for emergencies, or buying on approval (appro). the percentages in table 5 do not sum to 100, as respondents often gave more than one reason in their answer. table 5 shows that only 61 or 23 per cent of all respondents (n = 265) had their own accounts. as can be seen from the table, account holders gave reasons of "buy now, pay later" and "convenience" for having accounts, whereas nonaccount holders gave reasons of "independence" and "buy now, pay later" for wanting to open accounts. "buy now, pay later" was given as one of the primary reasons for having, or wanting to open, an account in the behavioural section of the survey. reasons provided by both account and non-account holders clearly indicate that not only has debt become more acceptable to young consumers, they also believed it to facilitate their lifestyle and purchasing behaviour (ability to buy and transactions ease) in terms of the convenience and independence offered by credit facilities. hypotheses testing bearing in mind the exploratory nature of the study, only tentative support for the four hypotheses were found. results reflected in table 3 showed differences in mean factor scores for gender, age and language groups on all factors, though they were significant only in the case of factor 1 (materialism) for gender and language. results obtained on inspection from table 5 also suggest a tendency toward buying on account, thus exhibiting tolerant attitudes toward debt. conclusion the broad research aim of this exploratory study was to enhance the existing knowledge of consumers' attitudes towards buying on credit, specifically focusing on the young. the attitudes towards credit, and the credit-purchasing behaviour of young consumers aged between 13 and 23 years were investigated. this was done by specifically investigating the attitudes of these consumers towards purchasing on account by means of a store charge card. a behavioural component was incorporated into the survey to give some indication of actual credit purchasing behaviour. a multicultural sample, drawn from four secondary education institutions and three tertiary education institutions throughout port elizabeth and surrounds, was comprised of english-, afrikaansand xhosa-speaking respondents. based on previous research, four design hypotheses were formulated. these hypotheses postulated that differences in attitudes towards debt would be r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 146 sajems ns vol 4 (2001) no i observed across gender, age and home language groups. it was further postulated that young consumers exhibit tolerant attitudes towards debt. results of the study showed that five factors emerged from the factor analysis performed on the first 21 items in the questionnaire. they were materialism, cautious spending, convenience, living beyond means, and debt aversion (refer to table i). only the first three factors were found to be moderately reliable, with cronbach coefficient alphas greater than 0.6. findings of the study revealed significant positive correlations between materialism and convenience, as well as between materialism and living beyond means. a further significant positive correlation was also found between convenience and living beyond means. both convenience and living beyond means were significantly negatively correlated with debt aversion (refer to table 2). a rigorous inspection of the biographical variables gender, age and home language (as a proxy for culture) and the measured constructs revealed that home language is significantly related to materialism (refer to table 3). sufficient statistical evidence does not exist to infer that gender and age are predictive variables of the measured constructs. differences in mean scores for all variables on the three factors were observed, though they were found to be only significant for materialism. (factor i) (refer to table 3). it is interesting to observe that cautious spending (factor 2) scored the low average value of2,is on the five-point scale, the lowest of all factors (bearing in mind that a low score indicates a positive attitude). this is consistent with the findings of collins and mammen (1998), that although young adults perceived themselves as cautious money handlers, in reality, they had very high debt to income ratios. although respondents perceived themselves to be cautious spenders and non-materialistic, the behavioural component of the survey provided an indication of materialistic and irresponsible credit purchasing behaviour patterns. table s suggests that 12,9 per cent of respondents without own accounts indicated a need to buy whatever, whenever without paying for it themselves, whereas only 4,8 per cent of those with an own account expressed a similar view. results of this study have thus highlighted the apparent lack of knowledge and understanding by young consumers of the mechanisms of credit. results further indicated that although differences in mean scores of variables for factors did exist, these were not significant. significant differences only occurred between male and female respondents, and englishand afrikaansspeaking respondents for factor 1 (materialism). finally, findings of the study could be instrumental and serve as a basis for developing personal money management curricula, to be implemented in primary and secondary education institutions. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 147 the results and implications of the study amount to an initial step in understanding the attitudes of young consumers towards credit in the multicultural context of the new south africa. it is recommended that follow-up studies with larger samples in different urban and rural areas be undertaken to verify the tentative trends observed in this investigation, as well as to detennine a more comprehensive set of predictive variables of the attitudes of young consumers towards credit. the young consumer as a credit consumer represents a challenge for marketers, educationalists and public policymakers. as previous research suggests that they may be high users of credit (ford, 1992, cited in davies & lea. 1995). the social and economic implications of financial illiteracy, especially in the mechanisms of credit, necessitates further, rigorous research into the attitudes and behaviour patterns of this consumer group. references alleman, l. 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(1984) "an investigation into the buying behaviour of black adolescents in soweto", unpublished m.comm dissertation, university of port elizabeth, port elizabeth. 15 south african media facts (2000/2001) supplement to marketing mix, 18(5): 8·9. 16 statistics south africa (2000) census in brief [internet document]. www.statssa.iqv.zalcensus96lhtmvdefault.htm. 17 swart, h. (1997) "leen en leefvrolik", die burger, oct. 6: 10. 18 usher, r. (2000) "debt easy", time magazine, jan. 17: 3843. 19 w akeford, k. (1998) "how personal debt cripples economies", eastern province herald. febr.6: 17. 20 weissman, r.x. (1999) "teenagers lack financial knowledge", american demographics, 21, (8): 80. 21 zimmerman, m. (1999) "educators emphasizing money matters", pacific business news, 36,49, febr. 19: 28. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . f:\ejour\ecoman\ftp\ecoman_v6_n1.prn.pdf sajems ns vol 6 (2003) no 1 72 does trust influence the informal lending decision? an investigative analysis ________________________________________________________________ ntiedo john umoren department of business management, university of uyo ________________________________________________________________ abstract this study analysed the role of trust in informal lending decision-making process. by applying verbal protocol analysis, this paper empirically examined the role of trust and cooperation in lender’s initial reaction to potential lending opportunities, and the lender’s assessment of the intermediary responsible for providing the initial referral of the lending opportunity. the results corroborate earlier findings, and provide sufficient evidence to confirm that about 93 per cent of lending opportunities presented to informal lenders are rejected. it also shows that considerable reliance is placed on the brokers presenting the opportunities. the result also indicates that the dearth of entrepreneurial development in nigeria is tied implicitly to the instant trust and instant cooperation paradigm. jel g29, m00 1 introduction informal lending institutions and settings constitute a major component of most economies, especially in sub-saharan africa where markets for informal financial products are enormous. as would be expected, informal lending sources seek sound and safe investment opportunities hence they derive their primary clientele from new and developing entrepreneurial ventures. like the informal venture capital market, research in this area focuses on the characteristics of the markets and their policy implications, but without any appropriate theoretical frameworks. the few isolated studies tend to concentrate on the outcomes of the lending/investment process and ignore the issues surrounding the process of such informal lending. in order to address these two issues, this paper attempts to develop a framework for the clarification of the concepts of instant trust and instant cooperation. this will facilitate the development of an operational framework for analysing trust and cooperation, which can be applied to informal lending-decision making. the sajems ns vol 6 (2003) no 1 73 study applies verbal protocol analysis on the lender’s reactions in real time on two particular investment opportunities. this approach facilitates the empirical examination of the role of trust and cooperation in lender’s initial screening of potential lending opportunities, and the lender’s assessment of the intermediary responsible for providing the initial referral of the lending opportunity. in nigeria, and indeed africa, as in the united states and parts of europe, a good number of studies have focused on the role of informal lending and investment directed at entrepreneurial activities (see ekpo, 1987; freear, sohl, & wetzel, 1996; mason & harrison, 1996a). these studies continue to provide empirical evidence to support the presence of informal lending activities, and due to its prescriptive emphasis, exert strong influence on public policy. studies from some of the contributors to the subject matter such as mason (1996), and umoren (1998) dwell more on the understanding of how the informal lending/investment markets operate, and by so doing identify the methods by which the markets could be made to work more efficiently. as harrison, dibben & mason observed, “research on informal venture capital has not been characterized to date by a high level of theoretical sophistication” (1997: 64). this paper will therefore attempt to explore the relevance of the concept of trust to the analysis of the informal lending market. in spite of the adoption of trust as a major element of economic relations particularly within the entrepreneurial context (see fiet, 1991; larson, 1992; fukuyama, 1995), the role of trust at the preliminary stages of the lending/investing process has not been adequately explored. for purposes of clarity and the avoidance of ambiguity, trust in this context is “construed as a means of speeding decision making and negotiations by reducing transaction costs between individuals in organizations under conditions of risk” (harrison et al., 1997: 64). hence, the key focus of this paper is the analysis of the role of trust at earlier stages of the informal lending process. in the sections that follow, a theoretical concept of instant trust and instant cooperation and their relevance in the informal lending/investing process is discussed. the third segment develops a model of the informal lending decisionmaking process based on the harrison et al., model of the informal investment decision-making process, and applies this model in search of evidence of trust relationships. the last section contains the implications on entrepreneurial development in nigeria, conclusion, and references. sajems ns vol 6 (2003) no 1 74 2 typical informal lending decision situation following an elaborate analysis of the investment decision process by tyebjee & bruno (1984) as extended by hall & hofer (1993), and mason & rogers (1996), it is inferred that there are five basic stages of the lending process. they include screening, evaluation, negotiation, monitoring and recovery. a sixth distinct element that is also associated, albeit independently, with this process is the intermediary factor. these six situational domains therefore provide the basis for our understanding of the role and influence of trust relations in the informal lending decision-making process. as indicated by fukuyama, trust is “the expectation that arises, within a community, of regular honest and cooperative behavior, based on commonly shared norms, on the part of other members of that community” (1995: 26). this definition corroborates the underlying assumption that “trust is something that emerges over time” (harrison et al., 1997: 65). thus, this definition can only be applied directly to our sixth situational domain where prior knowledge exists, and where the endorsement of others may be obtained. but it is not immediately relevant to the other five domains where “trust” as defined has not yet been established. in order to include the other five domains within a trust setting, this paper focuses on how trust that is associated with lending decision-making is established within a relatively short period of time. for instance, the length of time required to institute trust is very short in the initial screening domain. and in the absence of a trust relationship, the lending decision may be negatively skewed. it is within this context that this study applies the concept of “instant trust” as a basis for cooperation between lender and borrower. this premise permits the exploration of the relevance of the concept of trust to the explication of informal lending decision making as well the processes that lead up to the development of trust relations in the first instance. earlier exploratory analyses within the entrepreneurial context for instance (see low & srivatsan, 1993) have shown that trust is essential for cooperation. 3 instant trust according to harrison et al. (1997) ‘instant trust’ as conceptualized by meyerson et al. (1996) was meant to address the emanation of trust relations in situations where the individuals have a limited knowledge or history of each other. in other words, instant trust emerges in temporary situations, and in most cases in temporary group settings. under such circumstances, each member of the group ex ante of prior knowledge or experience confers instant trust. by sajems ns vol 6 (2003) no 1 75 direct analogy, informal lenders often comply with the characteristics of such temporary systems, and confer instant trust based on faith in the recipient’s own ability to honour his/her obligations. since temporary groups have limited time to develop in order for a stronger form of trust to emerge, the instant trust is only expected to be resilient enough to survive the life of the group. however, where there is a central figure, the like of a coordinator with a strong and trustworthy reputation, the instant trust would retain a longer life span primarily due to the integrity of that central figure. in effect, the conferring of instant trust ex ante by individual members within the group is essentially influenced by the level of risk associated with the trust, the expected outcome of the association, and the coordinator’s perceived ability to make the right choices. even though it is important to understand what originates, sustains and destroys trust, this paper contends that the most important element of trust in interpersonal relations is how trust develops and how it influences relationships (see also gambetta, 1990, lewicki & bunker, 1996). this assertion is founded on the premise that trust resides within the individual, and that it manifests in phases. thus, trust is perceived as a recurring process that assumes a different character at three different stages of a relationship. it is against this background that lewicki & bunker (1996) opined that there are three categories of situational trust, namely, calculus-based-trust, knowledge-based-trust, and identification-based trust. calculus-based-trust is “an on-going, market-oriented, economic calculation whose value is derived by determining the outcomes resulting from creating and sustaining the relationship, relative to the costs of maintaining or severing it” (lewicki & bunker, 1996: 120). in other words, it is the trust that evolves during the “sizing-up” process between individuals during the early stage of their relationship. they also define knowledge-based-trust as that trust that “exists between two individuals who know each other well enough for the parties to have a history of interaction that allows each to make predictions about the other” (harrison et al., 1997: 66). this type of trust is founded on the parties’ ability to identify their common traits and similarities. the third category of situational trust is the identification-based-trust, which is described as the trust that develops “because the parties effectively understand and appreciate the other’s wants to such an extent that each can effectively act for the other.., and substitute for the other in interpersonal interactions” (lewicki & bunker, 1996: 157). sajems ns vol 6 (2003) no 1 76 whereas the knowledge-based-trust and the identification-based-trust deal with trust that evolves and develops over time, calculus-based-trust remains the most desirable in time-compressed circumstances. beyond the identification of these three categories of situational trust however, there exists the need to determine the key factors that may foster trusting cooperation. harrison et al. (1997) submit that there are four factors that may influence a categorical prediction of trusting cooperation. the four determinants include perceived risk, importance, utility of the situation for the trusting individual, and the trusting individuals’ perceived competence of the trusted individual. by drawing on marsh’s (1995) computation trust formalism, and our established trust criteria and the cooperation criteria as stated above, this paper developes a model for the analysis of trust in the informal lending field, and suggests how trust concepts have been handled in the empirical analysis that is given below. 4 trust and cooperation protocol following the above discussion, this paper condenses the protocol that forms the basis for analysing trust in informal lending situations and how the concept of trust has been applied in our empirical analysis. it lays out all the fundamental elements that are necessary for the understanding of trust relations. in particular, it encompasses the trust criteria here represented by calculus-based-trust, knowledge-based-trust, and identification-based-trust, as well as the cooperation criteria, namely, utility, importance, risk, and competence. due to the similarity in context and character of lending and investment, this study adopts the harrison et al. (1997) postulations on the four factors that influence the informal investment decision-making process, and transposes them to the lending decision-making process. the four propositions are that: 1 the greater the perception of utility, the greater the possibility of trusting, cooperative behavior (where utility is associated with futuristic economic benefit). 2 the greater the perception of importance, the greater the possibility of trusting, cooperative behavior (where importance is associated with the potential of non-economic value of a situation). 3 the greater the perception of risk, the lesser the possibility of trustingcooperative behavior (where risk is associated with the potential for economic or social loss). 4 the greater the perception of competence, the greater the possibility of trusting, cooperative behavior (where competence is associated with the professional ability of the individual desiring trust). sajems ns vol 6 (2003) no 1 77 the initial listings of venture capitalists and business angels were obtained from the venture capital report and bureau of cooperative listings. from these sources, it was possible to assemble a data set with sufficient informational content on private funding arrangements in nigeria and the united states of america. since the study focused on the initial screening of borrowers’ application by lenders for possible consideration, the data used for the study were collected from primary sources in nigeria and the united states of america. the application of the verbal protocol analysis methodology enabled us to capture the informal lenders’ decision-making in real time. based on the theory that a vocalized thought takes the form of inner speech, the verbal protocol analysis methodology requires respondents to voice out their thought while performing a particular task. the choice of this methodology instead of the more conventional interview technique was informed by the desire of the investigators to test the efficacy of this rather new technique. it was assumed that the results would be as reliable and valid as those obtainable through the other methods. respondents were presented with an abridged version of a loan proposal that was presented to a merchant bank by apico limited, a government owned property and investment company. in this proposal, apico sought for a medium term loan of n1.bn to finance the development of housing units in uyo, the akwa ibom state capital. the company has land concessions in excess of 20 hectares across akwa ibom state, and the loan application is fully backed by the state government guarantee. akwa ibom state is experiencing a boom in industrial growth, a situation that has triggered a huge demand for residential accommodation in the state. apico marks up the value of each completed home by 33 per cent and completes the sale for cash within 30 days. each housing unit is completed within a 90-day construction-to-sale cycle. the chief executive officer of apico is a seasoned architect with a strong background in management. a total of 30 respondents drawn from informal financing outlets in nigeria were asked to review this loan proposal, which falls within the ambit of their regular business opportunity profile. they were required to verbalize their thoughts as they read this loan proposal. in other words, they were asked to say out loud, whatever thoughts came to their mind as they read the proposal. the verbalized thoughts were manually recorded and coded according to statement type protocol (table 1). another group of respondents was presented with a similar loan-based investment opportunity. in this proposal the company sought a short-term loan of $45,000 (forty-five thousand us dollars) to strengthen its liquidity position following a cash buyout of a competitor. with this purchase, the company’s sajems ns vol 6 (2003) no 1 78 market share rose from 16 per cent to 22 per cent, and a growth potential of 2.7 per cent annually. as collateral, the company offered its combined inventory of seasonal goods currently valued at $172,000 (one hundred and seventy-two thousand us dollars). a statement type protocol was also employed for this group. a total of 30 informal venture capitalists and business angels located in and around the washington metropolitan area in the united states of america were asked to review this loan proposal. another group of 30 respondents from nigeria and the united states were also asked to review a mixture of the two opportunities through two reputable brokerage firms. the same verbal protocol analysis was applied in all cases in order to explore the role of trust in informal lenders’ decision-making at the application screening stage. this approach would also enable the researcher to examine how instant trust may be influenced by the involvement of the brokerage firms. the result is presented in two segments. the first segment deals with the outcome of the verbal protocol analysis as applied to the first situational domain − the screening stage of the loan application. the second presents evidence of the influence of an intermediary on instant trust and instant cooperation. 5 evidence of trust and cooperation eighty-five (or 95 per cent) of the respondents rejected the proposal as an investment opportunity, while five (or 5 per cent) sought clarification from the potential borrower that would enable them to consider further examination of the loan proposals. this result is consistent with similar studies on investment behaviors of business angels that have since established that “between 93 per cent and 97 per cent of investment proposals received by business angels are rejected” (harrison et al., 1997: 70). on average, each potential lender spent between five and 35 minutes reviewing the proposals. as the summary of the 582 coded thought units later reveals, lenders that spent the least time on the proposals appear to have preconceived rejection. the matrix of the evaluation criteria and statement type reveals that the dominant situational trust is the calculus-based-trust while the dominant thought units are preconception and inference. at the lower rung of the thought units are question, comment, recall, action and description (in that order) that account for the least thought units advanced by the informal lenders in our study. from this result, the traditional notion of fragility of calculus-based-trust tends to be confirmed. this situational domain seems to explain why most of the sajems ns vol 6 (2003) no 1 79 lenders in our study tended to look for reasons to reject the loan proposals that were presented to them for consideration. by design, this study did not advance to the next two situational domains, namely, knowledge-based trust and identification-based trust in order to verify informal lenders’ decision at these levels. at the level of instant cooperation, the analysis revealed that the dominant thoughts were on the competence of the entrepreneur (37 per cent). this is consistent with the perceived view of the importance of the management team in informal investment decision. the ranking of the remainder of the cooperation thought units are risk thoughts that account for 21 per cent, coordinator judgment accounts for 20 per cent, utility ranks accounts for 13 per cent, while importance ranks the lowest at 5 per cent. the results in tables 3, 4 and 5 indicate a very strong positive correlation particularly at the thought unit levels where preconception is dominant. the bias becomes slightly more visible when the result from nigeria is placed side-byside with the respondents from the united states of america. table 1 thought segment protocol statement type description non-evaluative statement consisting of verbatim or paraphrased quotation of information presented in the plan recall non-evaluative information based on the past experience of the respondent preconception judgmental statement based on previous experience/background knowledge inference statement that involves a judgment on some part of the plan question statement that seeks further information action statement of intention or action to be performed (e.g., to search for source of information) comment irrelevant statement that cannot be coded source: harrison et al., 1997 sajems ns vol 6 (2003) no 1 80 table 2 evaluation criteria a instant trust criteria description 1 calculus-based trust trust that is formed between individuals on the basis of what each sees he/she can get out of the relationship characterized by intimation of difference between individuals, and a lack of shared knowledge of the product/market situation. 2 knowledgebased trust trust that is formed between individuals with shared knowledge of the product/market situation. characterized by intimations of the agreement between individuals, leading to perceptions of predictability and thus reductions of uncertainty. 3 identificationbased trust trust that is formed between individuals with a high degree of identification with the wishes/intentions of the other party. characterized by strong agreement between the individuals, and intimations of the mutual sharing of values. b instant cooperation criteria description a utility an individual’s perception of the potential economic value of a situation. b importance an individual’s perception of the potential of noneconomic value of a situation. c risk an individual’s perception of the potential loss from a situation. d competence an individual’s perception of the professional ability of another individual. characterized by comments regarding (e.g.) market analysis, data availability, quality, etc. e coordinator judgment an individual’s perception of the coordinating party’s ability to select potentially successful opportunities for investment. f other comments on any other aspects of the business that cannot be coded in any other category. harrison et al., 1997 sajems ns vol 6 (2003) no 1 81 table 3 verbal protocol frequency analysis for 30 nigerian lenders legend: (refer to table 1) legend: (refer to table 2) a = description cbt = calculus-based trust b = recall kbt = knowledge-based trust c = preconception ibt = identification-based trust d = inference u = utility e = question i = importance f = action r = risk g = comment c = competence h = total number cj = coordinator judgment i = total percentage o = others a b c d e f g h i cbt 17 23 1 41 17.4 kbt 1 2 2 5 2.1 ibt u low 3 5 1 1 10 4.2 u med 3 3 2 8 3.4 u high 2 1 3 1.3 i low 3 3 2 8 3.4 i med 1 1 2 0.8 i high 1 1 2 4 1.7 r low 1 3 1 5 2.1 r med 11 1 1 13 5.5 r high 1 2 15 2 1 1 22 9.3 c low 1 8 28 14 4 6 61 25.8 c med 5 1 6 2.5 c high cj low 1 1 9 2 3 5 21 8.9 cj med 1 1 2 4 1.7 cj high 3 1 2 6 2.5 other 6 4 2 3 2 17 7.2 total 2 13 82 84 23 10 22 236 100.0 (%) 0.8 5.5 34.7 35.6 9.7 4.2 9.3 100.0 sajems ns vol 6 (2003) no 1 82 table 4 verbal protocol frequency analysis for 30 american lenders legend: (refer to table 1) legend: (refer to table 2) a = description cbt = calculus-based trust b = recall kbt = knowledge-based trust c = preconception ibt = identification-based trust d = inference u = utility e = question i = importance f = action r = risk g = comment c = competence h = total number cj = coordinator judgment i = total percentage o = others a b c d e f g h i cbt 1 23 19 3 46 25.3 kbt 1 1 2 1.1 ibt u low 6 4 10 5.5 u med 1 3 4 2.2 u high 1 1 0.5 i low 2 2 1.1 i med 1 1 2 1.1 i high 1 1 0.5 r low 1 1 2 1.1 r med 6 2 1 9 4.9 r high 1 7 4 2 1 15 8.2 c low 10 19 16 1 2 48 26.4 c med 9 1 10 5.5 c high cj low 2 6 1 5 2 16 8.8 cj med 1 1 2 1.1 cj high 2 1 3 1.6 other 4 3 1 1 9 4.9 total 2 6 70 65 25 3 11 182 100.0 (%) 1.1 3.3 38.5 35.7 13.7 1.6 6.0 100.0 sajems ns vol 6 (2003) no 1 83 table 5 verbal protocol frequency analysis for 30 brokers legend: (refer to table 1) legend: (refer to table 2) a = description cbt = calculus-based trust b = recall kbt = knowledge-based trust c = preconception ibt = identification-based trust d = inference u = utility e = question i = importance f = action r = risk g = comment c = competence h = total number cj = coordinator judgment i = total percentage o = others a b c d e f g h i cbt 21 22 1 44 26.8 kbt 1 2 3 1.8 ibt u low 2 7 1 2 12 7.3 u med 1 1 1 3 1.8 u high 1 1 0.6 i low 1 1 0.6 i med 0 0.0 i high 1 1 0.6 r low 0 0.0 r med 7 2 9 5.5 r high 1 1 6 4 1 13 7.9 c low 2 7 13 8 3 33 20.1 c med 4 4 2.4 c high 0 0.0 cj low 1 9 3 9 3 25 15.2 cj med 1 1 2 1.2 cj high 3 2 5 3.0 other 5 1 1 1 8 4.9 total 2 5 62 60 18 2 15 164 100.0 (%) 1.2 3.0 37.8 36.6 11.0 1.2 9.1 100.0 sajems ns vol 6 (2003) no 1 84 table 6 consolidated verbal protocol frequency analysis for all categories legend: (refer to table 1) legend: (refer to table 2) a = description cbt = calculus-based trust b = recall kbt = knowledge-based trust c = preconception ibt = identification-based trust d = inference u = utility e = question i = importance f = action r = risk g = comment c = competence h = total number cj = coordinator judgment i = total percentage o = others a b c d e f g h i cbt 1 61 64 5 131 22.5 kbt 3 2 5 10 1.7 ibt u low 11 16 2 3 32 5.5 u med 1 3 7 3 1 15 2.6 u high 4 1 5 0.9 i low 3 5 3 11 1.9 i med 1 2 1 4 0.7 i high 1 1 4 6 1.0 r low 2 3 1 1 7 1.2 r med 24 5 2 31 5.3 r high 2 4 28 10 3 3 50 8.6 c low 3 25 60 38 5 11 142 24.4 c med 18 2 20 3.4 c high cj low 1 4 24 6 17 10 62 10.7 cj med 1 2 1 4 8 1.4 cj high 8 1 5 14 2.4 other 15 8 3 5 3 34 5.8 total 6 24 214 209 66 15 48 582 100.0 (%) 1.0 4.1 36.8 35.9 11.3 2.6 8.2 100.0 sajems ns vol 6 (2003) no 1 85 6 implications for the development of entrepreneurial initiatives in nigeria this study identified two types of influence that instant trust and instant cooperation can have on entrepreneurial development strategies and prospects in nigeria. a first way in which instant trust and instant cooperation have an influence on entrepreneurial development in nigeria is via the explicit conditionalities imposed by the larger society. one of the most important conditionality imposed by the nigerian society is the cultural conditioning that is particularly potent in shaping entrepreneurial pursuits. nigeria’s cultural conditioning encourages unstructured proprietorial capitalism, otherwise known as ‘underground economy’. in nigeria, as is the case in other developing countries, the underground economy is sizeable and solid. the structural composition of the nigerian business climate allows for the recognition and acceptance of the towering influence of underground business activities. informal lending practices are common wherever underground economies exist. the very essence of underground economies is the measures of informalities that provide avenues for eliminating legal constrains associated with organized settings and structures. a second type of influence exerted by instant trust and instant cooperation on entrepreneurship is implicit conditionality. this concept refers to the ethnic and tribal divisions that exist in the nigerian body polity. discrimination along ethnic, tribal, religious, and even denominational lines are never laid out explicitly. yet, they constitute the main factors that the informal lenders take into account in allocating their loan and investment funds. the never-ending religious, and ethnic riots have not supported entrepreneurial development as such actions can only invite negative tendencies within the ranks of informal lenders. for example, the matasini riots of the early 1980s in northern nigeria, and the present spate of sharia-induced riots in kaduna, zamfara, and other northern states of the federation cement the applic ation of the aforementioned unwritten rules of engagement by the informal lenders. 7 conclusion this research examined the trends in the role of instant trust and instant cooperation in lending decisions by informal lenders in nigeria and the united states of america. the result indicates a sizeable influence of instant trust and instant cooperation on lending decisions during the initial stages of the lending process. there are slight disparities in the results between the evidence from nigeria and that of the united states of america, particularly when the services sajems ns vol 6 (2003) no 1 86 of third parties or brokers are involved. in nigeria for example, lenders employ trust as raw tools for analysing their risk-return continuum under conditions of ‘limited information’ thus making trust the sole deciding factor under conditions of ‘limited rules and inadequate legal protection’. by direct analogy, this study observes that any structural setting that is founded on informalities can only enhance the application of the instant trust paradigm to determine the level of instant cooperation that informal lenders may be willing to give to would -be borrowers. this limited opportunity for venture capital from informal lenders and business angels can only stifle entrepreneurial development to say the least, particularly in such economies where the formal finance sector is plagued with inconsistencies and frequent policy shifts. where would -be entrepreneurs cannot raise capital from the formal finance sector for lack of collateral, and from the informal lenders where instant trust may be rightly construed to be a ‘collateral’, entrepreneurial initiatives may be subdued. as the result indicates, the initial reaction of the informal lender to the lending opportunity is paramount. and until a borrower scales through this first hurdle, the dream of securing a loan for entrepreneurial initiative would only remain a dream. admittedly, the two types of influence − explicit conditionality and implicit conditionality − will impact local economies in the same way. however, there are visible distinctions by region and state, based on traditional business practices and established norms founded on each region’s cultural settings. in the final analysis, trust must be established for cooperation to take place. this article thus opines that the dearth of entrepreneurial development in nigeria is fundamentally connected to the instant trust and instant cooperation paradigm. the study tends to confirm the view expressed by harrison et al. (1997) that in time compressed situations, calculus-based-trust remains the most desirable tool. it also indicates that there are four key factors that may determine a categorical prediction of trusting cooperation, namely, perceived risk, importance of the trusting situation, utility of the situation for the trusting individual, and the trusting individual’s perceived competence of the trusted individual. by way of recommendation, this paper advocates the enhancement of policy dialogue between the federal, state and local governments, and informal/voluntary business groupings in nigeria. this will provide the basis for supportive public policies at government level. the federal government must also be willing to provide the financial resources and incentives to encourage both the informal lending channels, and the prospective entrepreneurs. sajems ns vol 6 (2003) no 1 87 references 1 cary, l. 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(1996) “informal venture capital: is policy running ahead of knowledge?”, international journal of entrepreneurial behaviour and research, 2: 4-14. 14 mason, c.m. & harrison, rt. (1996a) “informal venture capital: a study of the investment process, the post-investment experience and investment performance”, entrepreneurial and regional development, 8: 105-26. sajems ns vol 6 (2003) no 1 88 15 mason, c.m., & rogers, a. (1996) “understanding the business angel’s investment decision”, working paper no. 11, venture finance research project, dept. of geography, university of southampton. 16 meyerson, d., weick, k.e. & kramer, r.m. (1996) “swift trust and temporary groups”, in r.m. kramer, & t.r. tyler (eds.) trust in organizations: frontiers of theory and research: 357-89. thousand oaks, ca: sage publications. 17 umoren, n.j. (1998) “the first five critical pathways to entrepreneurial development”, an unpublished paper presented at a workshop on entrepreneurial development. university of uyo, uyo. 18 tyejbee, t. & bruno, a. (1994) “a model of venture capitalist investment activity”, management science, 30: 1051-66. sajems ns vol 4 (2001) no 2 3]6 south african farmers' needs of agricultural data j a groenewald department of agricultural economics, university of the free state a frick uni grain trading company and university of the free state abstract data on agriculture are required by decision-makers, including farmers, to solve problems and make business decisions. the needs of decision-makers have changed over time. since information systems are designed to aid decisionmakers, their needs should be determined. a mail survey among farmers indicated that they are chiefly interested in information regarding producer prices, prices of field crop inputs and statistics on imports and exports of livestock products. there is also interest in employment data and statistics on economic, institutional and infrastructural matters. 1 introduction it is generally accepted that farmers, like all other business people, become increasingly dependent on data and information for the functioning of their businesses in a globalising, increasingly information based economy and society. this is true, irrespective of whether information or data is needed for long-, mediumor short-term decision-making. however, different types of data are needed for different types of decisions and for different decision-making terms. in most countries that have succeeded to achieve rapid technical progress and growth in agriculture, the socialisation of agricultural research and extension has been deliberately employed as an instrument to modernise agriculture (hayami & ruttan, 1985: 87). governments have also accumulated data and processed information, both for purposes of their own policy formation and for informing entrepreneurs about the nature of their environment. this has been done with respect to all economic sectors, including agriculture. however, despite the long history of government involvement in agriculture and acknowledgement of the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 317 sajems ns vol 4 (2001) no 2 need for accurate and valid data, there is a lack of documented evidence on the actual requirements of those who need agricultural data (barnard, 1979: 74; russel, 1983: 40). 2 the agricultural information system 2.1 terminology the terms data and information are often used interchangeably. however, they refer to two different, although closely related concepts. the common but confused vocabulary which erroneously equates data with information fails to distinguish between the different steps in the process by which data and information are produced (bonnen, 1975: 754). the terms data and information are discussed first. data are a symbolic representation of concepts, quantities which are the direct product of measurement or counting (bonnen, 1975: 754). larson and narain (1998: 3) define data as given facts about a place, person or thing, for example, the production or price of a commodity. however, in real statistical terms, output, prices or inter-industry flows are certainly not independent of the statistical operations involved in their measurement. these data are constructed by means of statistical measures that are operationally meaningful through various levels of aggregation, valuation, basic units or counts and weighting schemes that are determined against a theoretical background and with some analytical aim in mind. data on agriculture can be classified as market or structural data (just, 1983: 872-81). market data consists of data on price, acreage, production, livestock numbers, stocks, consumption and exports, while structural data include data on income, employment, productivity, nutrition and distribution of resources. information however involves more than data. it usually combines data from various collection processes and subject matters, always within some analytical interpretation (bonnen, 1975: 755); it results from modelling, formatting, organising or converting data in a way that increases the level of knowledge and its usefulness for the user (burch et al., 1974: 4 cited in de waal & van zyl, 1991: 284). information is data endowed with relevance and purpose. converting data into information requires knowledge (drucker, 1990: 202, 203). information can be technical, commercial (including marketing information), social and cultural and also legal information (aina, 1995: 1-11). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2 318 2.2 the agricultural information system an agricultural infonnation system is a logical configuration of significant infonnation for problem solving and decision-making in agriculture (eisgruber, 1967: 1541-52). the system is a product of some basic process of enquiry which classifies and gives meaning to data (barnard, 1975: 294); data only become infonnation after the required analysis and interpretation are made by the decision-makers (riemenschneider & bonnen, 1979: 149) or by analysts for use by decision-makers. an appropriately designed infonnation system should therefore reduce uncertainty and manage undesired consequences (bonnen, -1975: 759; fao, 1986: 4, 5) and aid in the interpretation of the complexity of agriculture (fao, 1986:4). vlasin et al. (1975: 900-09) specify three purposes of data and infonnation systems, namely (i) reacting to past problems and planning for present concerns, (2) responding to predicted future scenarios and planning towards the future and (3) planning for and creating a desired future. the infonnation system contains three elements: (1) a data system, (2) an infonnation system which includes the analytical capability necessary to transfonn data into infonnation and (3) the decision-makers. 2.2.1 the data system every data system involves an attempt to represent reality by describing empirical phenomena in some system of categories usually in quantified fonn (bonnen, 1975: 755; riemenschneider & bonnen, 1979: 147). since reality appears infinitely complex and is not reality grasped by the human mind, it is necessary first to break down phenomena into a set of categories or classes that lend themselves to measurement. data are the result of counting or measurement. this presupposes a concept. concepts are abstract and cannot be measured directly. operational defmitions are then devised to represent the concepts, and these are measurable. 2.2.2 the information system data are rarely directly used in the raw fonn by decision-makers (bonnen, 1975: 760; eisgruber, 1967: 1543; drucker, 1990: 202). data must be transfonned into infonnation before it has much utility; infonnation processing systems are therefore necessary (riemenschneider & bonnen, 1979: 149). beside the production of data, the system involves the analysis and interpretation of the data in some purposeful decision or problem solving context. data are transfonned by intervening acts of interpretation, that is, through statistical and economic analysis, policy and political evaluation etc., to place them in the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 319 sajems ns vol 4 (2001) no 2 context of specific problem and thus make the data meaningful to a particular decision-maker. an information system should include not only a data system but also the analytical and other means necessary to interpret the data (bonnen, 1975: 760). any theory of information must have a multidisciplinary perspective to be useful in understanding information systems (eisgruber, 1967: 1541-43). 2.2.3 the decision-makers information systems in agriculture are designed to help public and private decision-makers make decisions designed to solve problems that arise at the farm, firm, industry or national economy level (riemenschneider & bonnen, 1979: 150). the goals and values of the decision-makers must impact on the design of the information system, since these goals and values provide insight into the nature of the problem on which the system focuses. therefore, the objectives of an information system should be viewed in the context of decisionmaking (barnard, 1979: 75), problem solution (eisgruber, 1967: 1544; barnard, 1979: 76) and knowledge (gardner, 1975: 895 and juster, 1973: 139-40). in order to achieve these objectives, the system needs to take into account the entire range of economic, social and other information at the household, firm, local, regional, national and even international level (eisgruber, 1967: 1540). however, information designed for farm policy decisions by government policymakers would differ from information used by a farmer in the day-to-day operation of a farm business; there are different categories of decision-making (riemenschneider & bonnen, 1979: 152). 2.3 the supply of agricultural data primary data (also called raw, basic or unprocessed data) spring from three main sources: experimental sources, farms and a miscellany of other organisations related to the agricultural sector, such as government departments, markets, marketing boards and commercial firms (barnard, 1975: 291). data are obtained either by experimental or non-experimental means (barnard, 1975: 303). the former rely heavily on testing relationships between phenomena by eliminating or controlling as many extraneous variables as possible, and apply mainly to natural and biological science. by contrast, the latter depend largely on various forms of censuses and surveys (barnard, 1975: 304; usda, 1987: 7 and fao, 1986: 4) and farm account projects (plaunt, 1967: 1529). 2.4 agricultural data in south africa this paper deals with only non-experimental means of data collection. the collection of market data on south african agriculture began in 1915 with a r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2 320 system of monthly crop and livestock reports by the department of agriculture. structural and market data on agriculture were included in the population census of 1904 and the agricultural and population census of 1911. the data sources were initially samples of evenly distributed farmers in various districts and reports of livestock inspectors and other officials of the department. later in the early 1 920s, the districts were divided as far as practicable into small areas of four farms, with one farmer being appointed as a crop respondent (department of agriculture, 1922: 1-3). the crop respondent had to complete a monthly report, which normally included livestock and crop conditions. this report was forwarded to the magistrate of that district where it was processed, scrutinised, weighted and averaged before transmission to pretoria. since the system depended on the farmers as a source of data, the government in return had to keep the farmers well informed with related information that was in turn estimated from the data the farmers supplied. the estimates were subsequently validated by agricultural censuses and surveys, conducted by the department of census (department of agriculture, 1907-1927). the late 1930s and 1940s were characterised by the establishment of control boards, which regulated the marketing of the most important agricultural products in south africa. statutory measures (article 52 of the marketing act) enabled marketing boards to collect data by means of compulsory returns. these data supplied by the marketing boards, came to be regarded as reliable sources by decision-makers. as a result, the system of crop and livestock reports was reduced to only forecasts and final estimates of summer and winter field crops, and estimates of livestock numbers. agricultural censuses and surveys were valuable sources of structural as well as benchmark data for crop forecasts and livestock number estimates. however, problems were encountered with the inconsistency of definitions (nieuwoudt, 1973: 20), the discrepancies between census data and other official data sources (groenewald, 1989: 90) as well as delayed publishing dates. the deregulation of marketing in the 1990s was characterised by the disbandment of marketing boards, resulting in a decrease and in some cases, the discontinuation of the supply of administrative data (willemse, 1996: 3). for some products like grain and oil seeds, cotton, deciduous, citrus, dried and canned fruit, lucerne, wool, mohair, milk and meat, alternative organisations were established under the marketing of agriculture products act of 1996 to continue with the collection of agricultural data (national agricultural marketing council, 1998). however, these organisations still rely on compulsory or in some cases on voluntarily returns for the collection of data. budgetary constraints also led the central statistical service (now statistics south africa) to postpone the agricultural census planned for 1998. a dearth of available data relative to needs may be expected in the future. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 321 sajems ns vol 4 (2001) no 2 2.5 users of agriculture data anyone who is in business with a profit objective without which no business is sustainable has to identify existing and potential markets, the requirements and rules of these markets and prices that can be realised on these markets. the same principle still applies although much of agricultural information is subsidised and provided to the user free of charge (metcalfe, 1989: 114). the most meaningful classification of users of agricultural data appears to be one as policy-makers, researchers, agricultural service industries, farmers and extension offices (aina, 1995: 1-11; plaunt, 1967: 1531; russel, 1983: 45-6). farmers represent both the beginning and the end of the data-and-information chain. seen from the perspective of management theory, one would expect farmers to demand both technical and marketing information. this information, if required, will dictate the nature and extent of raw data requirements. the remainder of this paper will be devoted to an attempt to determine the data and information needs felt by farmers in south africa. only if these needs, together with those of the other user groups are satisfied, will the official data collection and dissemination branches of officialdom be able to claim success in meeting their main task. 3 research approach mail surveys were used to determine the needs of three categories of agricultural data users: agribusinesses, researchers and farmers. the rest of this article discusses the results obtained from the farmers. mail surveys have previously been used to determine agricultural data needs in other countries too, for example, the usa (ebling & ahlgren, 1954: 1226-39; blanch, 1955: 1038-46; american agricultural economics association committee on economic statistics, 1972: 1072) and new zealand (new zealand, 1998: 10). some studies were also done in south africa by the bureau of financial analysis of the university of pretoria (1990) regarding fresh product markets, the department of agriculture (1992) and, on a more limited scale, the south african agricultural union (du toit, 1999). since there is no complete list of the farming population, a sampling frame as described by scheaffer et al .. (1990: 111-20) was constructed. addresses were obtained from the decidious producer trust, the national crop estimates committee and some other organisations which supplied addresses conditional on anonymity. a total number of 17 300 addresses was thus obtained. farmers were, for this purpose, stratified into three main groups, namely producers of field crops, horticultural products and livestock. in an effort to obtain 100 sampling units for each of the three main groups, and assuming a response of 50 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2 322 per cent, it was decided to include 600 farmers in the sample. the systematic sampling method was used. the questionnaires consisted of four sections. firstly an introduction, containing questions on characteristics of the sampling units. the second section was concerned with the need for current statistics. it contained questions on the priority and frequency of need of statistics pertaining to field crops, horticulture and livestock. questions were also asked concerning forecasts, sources and types of decision for which statistics are needed. a third section of the questionnaire was concerned with the need for basic statistics. the question type was similar to that of the second section. a fourth section was concerned only with statistics supplied by the national department of agriculture; these results are not discussed in this paper. 4 results 4.1 introduction from the 600 questionnaires sent out, 105 were received back. of these, 99 were used in the analysis. taking into account 17 undelivered questionnaires, this means a response rate of 18 per cent. farmers in general tend to have a low response rate to questionnaires and although the response rate is disappointing, it is still acceptable. it does, however, also indicate low interest in statistical data. of the 99 respondents, 42.7 per cent were older than 50 years, 34.4 per cent between 41 and 50 years and the remaining 22.9 per cent younger than 40 years. the majority, 63.5 per cent, had had more than 12 years of school education (including tertiary education such as diplomas or degrees); the remaining had had between 7 and 12 years school education. full-time farmers represented 89.6 per cent of the respondents. 4.2 the need for current statistics 4.2.1 field crops the need for current statistics on field crops is summarised in table 1. producers' prices and prices of production inputs are indicated by 60 per cent and more of the respondents as very important. utilisation of products and area planted to perennial crops are desired by fewer than 30 per cent of the respondents. the statistics needed are mostly yearly, while statistics on stock of products, volume of production and consumption are needed quarterly. prices of production inputs and quantity of import and exports are needed monthly while producer prices are needed weekly. the need for producer prices on a weekly basis could be due to both volatile prices and the readily availability of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 323 sajems ns vol 4 (2001) no 2 prices of maize, wheat and sunflower on the south african future exchange (safex). the statistics, on average, are mostly wanted on the national level (61.8 per cent of the respondents). in order of importance, statistics are wanted for maize, wheat, sunflower, soybeans and dry beans. table 1 the need for current statistics by farmers field crops item priority frequency very yearly quarterly. monthly i weekly important ! : producer prices 69.2% 20.0% 14.5% 21.8% 43.6% prices of production 61.5% 28.3% i 26.4% 34.0% 11.3% inputs ~t of production 58.8% 34.6% 26.9% 30.8% 7.7% quantity of imports and 55.1% 18.2% 20.0% 38.20/0 23.6% exports i yield forecasts 47.7% 38.5% 25.0% 28.8% 7.7% stocks of products 47.7% 17.6% 41.2% 31.4% 9.8% volume of production 46.9% 34.6% 34.6% 23.1% 7.7% area planted to annual 44.6% 28.8% 28.8% 36.5% 5.8% gops consumer prices of 43.1% 20.8% 30.2% 22.6% 26.4% iproducts value of imports and ! 43.1% 28.3% 28.3% 22.6% 20.8% exports i area harvested estimates 35.4% 52.9% 13.7% 25.5% 7.8% consumption of products 32.3% 35.8% 37.7% 22.6% 3.8% area planted to perennial 26.2% 50.0% 34.8% 10.9% 4.3% crops i utilisation of products 24.6% 36.0% 40.0% 22.0% 2.0% 4.2.2 horticulture the listed results (see table 2) indicate that 65.s per cent of the respondents regard producer prices as very important. utilisation of products and area planted to annual crops seem not as important, with only 24.1 and 26.7 per cent of the respondents, respectively, regarding these as very important. the statistics wanted are mostly yearly; however, consumption and utilisation of products are wanted quarterly, stocks of products and quantity of import and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2 324 export are needed monthly and producer and consumer prices of products weekly. the statistics, on average, are mostly needed on the national level (so.3 per cent of the respondents) while statistics on a provincial level are desired by 23.1 per cent of the respondents. the statistics needed are for deciduous and other summer fruits, viticulture, citrus and subtropical fruits and vegetables. table 2 the need for current statistics by farmers horticulture item priority frequency very • important! yearly quarterly '-monthly weekly producer prices 6s.s% 27.6% 20.7% 20.7% 31.0% volume of production s1.7% 40.7% 18.5% 29.6% 11.2% stocks of products s1.7% i1.s% 26.9% 34.6% 27.0% consumer prices of products 48.3% 2s.9% 14.8% 29.6% 29.7% cost of production 48.3% 40.7% 2s.3% 22.5% 11.5% yield forecasts 44.8% 55.6% 25.9% 7.4% ll.l% prices of production inputs 44.8% 37.0% 25.9% 25.9% 11.2% consumption of products 44.6% 22.2% 33.3% 29.6% 14.9% area planted to perennial 41.4% 62.1% 20.7% 17.2% 0.0% crops quantity of imports and 41.4% 32.1% 17.9% 32.1% 17.9% exports area harvested estimates 34.5% 59.3% 18.5% 18.s% 3.7% value of imports and exports 31.0% 44.0% 12.0% 32.0% 12.0% area planted to perennial 26.7% 52.2% 13.0% i 30.4% 4.4% crops utilisation of products 24.1% 34.6% 34.6% 23.1% 7.7% 4.2.3 livestock the need for current statistics of livestock is shown in table 3. producer prices and quantity of imports and exports are indicated by 60 per cent and more of the respondents as very important. herd composition, number of animal in feedlots, utilisation of products, and farm slaughter volumes appear to be less important; fewer than 30 per cent of the respondents classified these as very important. mostly monthly statistics are needed, while producer prices are needed on a weekly basis. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 325 sajems ns vol 4 (200 1) no 2 statistics are mostly needed on the national level (by 74.4 per cent of the respondents). statistics on provincial level are needed by 25.8 per cent of the respondents. the products for which the statistics are needed are, in order of importance, cattle and calves, sheep and goats, dairy (including fresh milk), pigs and wool. table 3 the need for current statistics by farmers livestock 'item priority frequency ! very yearly quarterly monthly i weekly important producer prices 73.2% 11.9% 20.9%22.4% 44.8% quantity of imports and 63.4% 10.9% 26.6% 32.8% 29.7% exports i consumer prices of products 54.9% 14.1% 25.0% 31.00/0 29.9% cost of production 51.2% 20.3% 32.8% 28.0% 18.9% prices of production in~uts 48.8% 20.3% 29.7% 29.9% 20.1$ value of imq..orts and exports 46.3% 14.5% 27.4% 37.1% 21.0% livestock numbers by 41.6% 47.6% 25.4% 20.5% ! 6.5% category consumption of products 41.5% 17.7% 30.0% 37.8% 14.5% abattoir slaughter volumes 36.6% 25.0% 20.0% 33.3% 21.7% farm slaughter volumes 24.4% 33.3% 21.1% 29.7% 15.9% utilisation of products 24.4% 32.2% 32.2% 27.1% 8.5% number of animals in feedlots 23.2% 32.8% i 19.7% 41.0% 6.5% herd composition 23.2% 56.7% 25.0% 16.7% 1.6% 4.2.4 general of the 99 farmers, 89.5 per cent need forecasts. the products for which the forecasts are needed are maize, cattle and calves, sheep and goats, as well as deciduous citrus fruits. most farmers indicated that they would like to have the data one month after the date of collection (45.6 per cent of the respondents), 26.7 per cent of the respondents would settle for 3 months after the date, while 22.2 per cent of the respondents would be satisfied if they received them after 6 months. sources of statistics include mainly landbouweekblad, the internet and also agents and marketers. farmers indicated their level of confidence in these sources to be between average and good. decisions made with the aid of statistics include planning, production and marketing. the level of the accuracy required by the respondents are 90 per cent (50.6 per cent of the respondents), 80 per cent (33.3 per cent) and 70 per cent (16.1 per cent of the respondents). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2 326 4.3 the need for basic statistics basic statistics are next discussed according to the needs of employment, economic and institutional or infrastructural issues. questions were also asked about statistics on particulars of farmers and basic household matters; however, respondents indicated a very low need for those statistics, which are therefore not discussed further here. the results related to the need for basic statistics on employment are listed in table 4. it appears that none of these statistics is regarded as very important by 60 per cent or more; salary or wage rate and remuneration of employees are regarded as very important by over 40 per cent of the respondents. number of regular and family workers do not seem to be regarded as important. the statistics are needed yearly. table 4 the need for basic statistics by farmers employment item priority frequency very 10 5 2 . yearly i important yearly yearly yearly salary or wage rate 44.9% 6.6% 6.6% 22.4% 64.4% remuneration of employees 42.7% i 8.0% 6.7% 20.0% 65.3% number of unemployed 33.7% 8.8% 20.6% 20.6% 50.0% workers number of family workers 28.1% 10.1% 21.7% 21.7% 46.50/0 number of regular workers 24.7% 11.1% 20.8% i 19.4% i 48.7% the need for economic statistics are listed in table 5. income from farm activities and value of land are indicated by respectively 53.6 per cent and 52.3 per cent of the respondents as very important. non-farm expenditure, household expenditure pattern, income from non-farm activities and rent payments do not seem to be regarded as important. the statistics are needed yearly. the results of the need for institutional and infrastructural matters are listed in table 6. methods of marketing is indicated by 50.6 per cent of the respondents as very important. the methods of irrigation, area under irrigation, quantity of land purchased or sold, capital structure, sources of water supply, level of mechanisation and land utilisation do not seem to be regarded as important. the statistics are needed yearly. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 327 sajems ns vol4 (2001) no 2 table 5 the need for basic statistics by farmers economics item priority frequency very 10 yearly i 5 yearly 2 yearly yearly important income from farm 53.6% 7.7% 3.8% 23.1% 65.4% activities ~1o.4% value ofjand 52.3% 5.2% 20.8% 63.6% amount of farming debt 45.5% 6.8% 9.6% 20.5 0 63.1% interest payments 40.9% 8.6% 18.6% 22.8% 60.0% intermediate production 33.0% 8.3% 6.9% 27.9% 56.9% expenses rent ~ayjnents 29.5% 11.8% 13.2% 20.6% 54.4% income from non-farm 21.6% 18.8% 13.0% 26.1% 42.1% activities household expenditure 17.0% 18.8% i 9.4% 32.7% 39.1% ipattern non-farm e;'penditure 14.8% 18.8% 12.5% 34.3% 34.40/0 the statistics are mostly needed on a magisterial district level (35 per cent of the respondents). statistics are also needed on a national level (32.6 per cent of the respondents) . of the respondents, 46.9 per cent indicated that they need statistics for the commercial sector, while 2.5 per cent indicated a need for the developing sector. the majority, 50.6 per cent, indicated that they need the statistics for both the commercial and developing sectors. respondents indicated that they mostly need the statistics 6 months after the date of the collection of the data (31.8 per cent of the respondents). among the respondents some indicated that they need the statistics only i and 2 years after the date of collection. the sources of the statistics are mainly media publications, farmer associations and agents. the level of confidence in the sources is between average and good. decisions that farmers make with the aid of these statistics include planning, marketing, management and business viability. the level of accuracy needed is between 80 per cent (44.1 per cent of the respondents) and 90 per cent (42 per cent of the respondents). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2 328 table 6 tbe need for basic statistics by farmers institutional or infrastructural item priority fre€luencv very 10 5 2 yearly yearly important yearly yearly methods of marketing 50.6% 12.7% 25.4% 59.1% access to credit and finance 40.9% 4.2% 11.3% 21.1% 63.4% access to training and 36.0% 6.9% i 15.3% 26.4% 51.4% development access to government support 32.6% 7.0% 16.9% 22.5% 53.6% fertiliser or chemical usage 31.5% 7.5% 17.6% 32.4% 42.5% ~susage 31.5° 7.4% 19.1% 29.4% 44.1% lisation 27.0° 11.8% 17.6% .4% 41.2% level of mechanisation 27.0% 7.2% 29.0% 23.2% 40.6% sources of water supply 27.0% 9.0% 26.9% 23.9% 40.2% capital structure 23.9% 7.2% 23.2% 30.4% 39.2% iquantity of land purchased or sold 22.5% 9.0% 19.4% 26.9% 44.7% area under irrigation 16.9% 8.5% 31.0% 25.4% 35.1% methods of irrigation 16.9% 10.3% 29.4% 25.0% 35.3% 5 conclusion as mentioned above, the low response rate to the questionnaire survey is an indication of a lack of interest in agricultural statistics by many farmers. this conclusion may to some degree be ameliorated by the apparent satisfaction derived by some respondents from statistics appearing in a popular farming magazine (landbouweekbladj it is remarkable that the majority of farmers who did respond have had more than high school education. this would suggest that it is mostly the more advanced farmer-operator who feels he can utilise statistics for decision-making. many of these farmers are likely to belong to the innovator and early-adopter farmer categories. the respondents in this study showed interest mainly in information regarding producer prices of farm products, prices of inputs for field crop production and in the case of livestock products, statistics on imports and exports. they are also interested in data on employment, economic, institutional and infrastructure matters. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 329 sajems ns vol 4 (2001) no 2 it would be in south africa's interest to supply to agricultural entrepreneurs the kind of statistics and business information they feel a need for. perhaps this survey can be of use to providers of such information. references aina, l.o. 0995) "information and agriculture in africa", in: aina, l.o., a.m. kanilo j.b. ojiambo (eds.), agricultural information in africa. london: third w orid information service limited. 2 american agricul tural economics associa tion cpmmmee on economic statistics (1972'") "our obsolete data systems: new directions and opportunities", american journal of agricultural economics, 54: 1069-81. 3 barnard, c.s. (1975) "data in agriculture: a review with special references to fann management research, policy and advice in britain". journal of agricultural economics, 26: 289-333. 4 barnard, c.s. (1979) "concepts and structures", in: blackie, n.j. & j.b. dent (eds.) information systems for agriculture, london: applied science publishers. 5 blanch, g.t. (1955) "new data requirements by areas: how can they be met?" journal of farm economics, 37: 1038-46. 6 bonnen, j.t. (1975) "improving information on agriculture and rural life", american journal of agricultural economics, 57: 753-63. 7 buro vir finansiele analise (1990) inligtingsaangeleenthede met betrekking tot die bemarking van varsprodukte in die republiek van suid-afrika, pretoria: rgn-reeks: varsprodukte-ondersoek. 8de waal, g.j. & van zyl, j. (1991) "information systems in developing agriculture with special reference to project management in ciskei", agrekon, 30: 282-6. 9 departement van landbou (1992) ondersoek na die daarstelling van 'n nasionale inligtingstelsel aangaande die ekonomiese en finansiele posisie op boerderyvlak vir beleidsdoeleindes. unpublished report: pretoria. 10 department of agriculture, (1922) crops and markets, 1(2): 1-3. 11 drucker, p.f. (1990) the new realities, london: mandarin. 12 du toit, lp.f. (1999) minimum inligtingsbehoeftes van bedryfsorganisasies en boere, pretoria: suid-afrikaanse landbou-unie. 13 ebling, w.h. & ahlgren, h.l. (1954) "agricultural data: agricultural data requirements national, state and county", journal of farm economics, 36: 1226-39. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2 330 14 eisgruber, l.m. (1967) "microand macro-analytical potential of agricultural information systems", journal of farm economics, 49: 1541-52. 15 f ao, (1986) food and agricultural statistics in the context of a national information system, rome: f ao statistical development series, food and agricultural organisation of the united nations. 16 gardner, b. (1975) "strategies for long-run investment in rural, social, and economics statistics", american journal of agricultural economics, 57: 892-99. 17 groenew ald, la. (1989) "discrepancies in agricultural data from two official sources", agrekon, 28(1): 90. 18 hayami, y. & ruttan, v.w. (1985) agriculturat development, an international perspective, (revised ed.) baltimore and london: the 10hns hopkins university press. 19 just, r.e. (1983) "the impact of less data on the agricultural economy and society", american journal of agricultural economics, 65: 872-81. 20 juster, f.t. (1970) "micro data, economic research and the production of economic knowledge", american economic review, 60: 138-48. 21 larson, l.o. & narain, p. (1998) international standards and definitions for agricultural statistics and requirements for world census of agriculture, unpublished paper presented at the agricultural statistics 2000 conference, washington, d.c., 18-20 march 1998. 22 metcalfe, lr. (1989) "strategic issues in agricultural information determining the real needs". quarterly.bulletin of iaald 34(3): 11317. 23 national agricultural marketing council, (1998). press release regarding the status of the deregulation of the control boards. pretoria: national agricultural marketing council. 24 new zealand, (1998) the review of agricultural statistics report wellington: government statistician. 25 nieuwoudt, w.l. (1973) "data problems in agricultural economic research", agrekon, 12(1): 20-26. 26 plaunt, d.h. (1967) "canada's experience in and aspirations for a comprehensive farm data system", journal of farm economics, 49: 1526-40. 27 riemenschneider, c.h. & b onnen , it. (1979) "national agricultural information systems: design and assessment", in: blackie, 1.1., & dent, lb. (eds.) information systems for agriculture, london: applied science publishers. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 331 sajems ns vol 4 (2001) no 2 28 russel, h.m. (1983) "agricultural user populations and their infonnation needs in the industrialised world", quarterly bulletin of imld, 28(2): 40-52. 29 scheaffer, r.l., mendenhall, w. & oit, i. (1990) elementary survey sampling (4th ed.) california: duxbury press. 30 united states department of agriculture, (1987) basic agricultural survey statistics and methods, washington, dc: national agricultural statistic services, training course material. 31 vlasin, r.d., libby, l.w. & shelton, r.l. (1975) "economic and social infonnation for rural america. priorities for immediate improvement". american journal of agricultural economics, 57: 900909. 32 willemse, j., (1996) information in south african agriculture: frustrations and opportunities, pretoria: agrocon '96 conference. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vols (2002) no 2 271 the search for a new economic system continues 1 introduction much work has been done in south africa and indeed everywhere in the world to close both the intellectual and the policy gap in the understanding of the interface between the economic and environmental systems. how far has this search progressed? some will argue very far. they will quote the increasing importance of carbon trading and the introduction of international treaties such as the convention on biological diversity and the kyoto protocol as important milestones and a watershed. the notion of clean technology has also begun to penetrate the marketing arena under green labelling or branding and as such has considerable fmancial value for a firm. without detracting from these successes, actually in an effort to support and intensify the current research and policy trend, this editorial adopts a rather different view, asking the question: has economic theory changed symbiotically to the change in world philosophy that took place during the last number of years? unfortunately the answer to this question is negative. in addressing these issues, the origins of modem economics are briefly examined. thereafter, the change in current philosophy and by contrast, the stagnation of economic theory are discussed and a brief look at the ongoing research trends concludes. 2 the origins of rational self-interest the 1700s witnessed a change in the general philosophy or world-view of the time. the incumbent philosophy accentuated the importance of the human ability to reason, of individual freedom and the fulfilment that man had to derive from life itself. this new philosophy was personified by jean jacques rousseau (1712-1778) and neither the dwindling influence of the roman catholic church nor the fledgling reformation movement at that stage could change or halt this surge in humanism (schumpeter, 1954: 107-15). it was in this climate that adam smith (1723-1790) wrote an inquiry into the wealth of nations (1776). it is therefore not surprising that smith accentuated individual self-interest, savings, capital accumulation and the division of labour as necessary factors to accomplish the set ideal of increased national product (or economic growth). a deterministic r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 272 sajems ns yol5 (2002) no 2 newtonian self-regulatory mechanism, an invisible hand, i.e. the market forces, would ensure this required economic growth (heilbroner, 1985: 65-66). heilbroner refers to this smithsonian economic system as a growth model, illustrating it as a propulsive force that will put society on an upward growth path, as well as a self-correcting mechanism that will keep it there. ever since smith, this underlying philosophy has not changed, as clearly highlighted by shiva (1988: xvi-xvii): the rise of a patriarchal science of nature took place in europe during the fifteenth and seventeenth centuries as the scientific revolution. during the same period, the closely-related industrial revolution laid the foundation of a patriarchal mode of economic development in industrial capitalism. contemporary science and development conserve the ideological root and biases of the scientific and industrial revolution even as they unfold into new areas of activity and new domains of subjugation. long before shiva, however, schumacher (1973: 13) has foretold the potential impact of this smithsonian system of subjugation: modern man does not experience himself as a part of nature but as an outside force destined to dominate and to conquer it. he even talks of a battle with nature, forgetting that if he won the battle, he would find himself on the losing side. until quite recently, the battle seemed to go well enough to give him the illusion of unlimited powers, but not so well as to bring the possibility of total victory into view. this has now come into view, and many people, albeit only a minority, are beginning to realise what this means for the continued existence of humanity. today the evidence or result of the battle between man and nature that schumacher has referred to, is all around us and highlighted in all the articles in this volume. but why the perpetuation of this system that is threatening the existence of humanity? 3 from rational self-interest to a search for a new design smith introduced a new and modernistic economic system during a time when the global world-view or philosophy changed. not unlike the era during which smith lived and wrote, post-modernism is currently replacing modernism. the differences between these two opposing world-views are summarised in table l. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 273 table 1 modernism and post-modernism modern paradigm post-modern paradigm human being as a rational, autonomous human being as a relational being being universe (nature) as object of the n~s universe (nature) as a dynamic of the human being organism absolute, deterministic influence of science: chaos and qualitative science and technology general optimism with regard to the. development and progress scarcity prospects of development and growth i and limitations i.e. improvement truth as objective and neutral truth, objectivity and neutrality subject to the role of belief and value systems cosmoloai cal view stable unstable/chaos closed ()pen (holistic) determined relative/randomness/ indeterminacy predictable/measurable/controllable complex adapted from: sohnge (1995) the impact of this change from modernism to post-modernism is visible over a wide front, as is shown in table 2 with regard to corporate management systems. from table 2 it is clear that the management style of the 21$1 century did not just amend the 20th century management style it is a completely new design. the problem, however, in economics is that a post-modem replacement (or new design) for the smithsonian system is still to be found. this search for a postmodern economic system resembles the search for a unified theory of gravity as illustrated in a brief history of time by hawking (1988). modem-day economics, still taught in almost all universities of repute, is based on the microeconomic premise that the collective outcome of rational individual decisions in pursuit of self-interest for the maximisation of either producer or consumer surplus will lead to optimal resource allocation and efficiency. this premise, however, relies heavily on a large number of assumptions. failure to uphold them will inevitably lead to failure on a larger scale and to negative environmental externalities. from a macroeconomic perspective, the natural environment is treated equally neatly under the ceteris paribus clause, as if the stock and quality of natural resources do not change. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 274 sajems ns vol 5 (2002) no 2 table 2 comparison between two management and organisational behaviour styles characteristics 10m century n it century corporation corporation organisation the pyramid the web or network reach domestic global focus intemal external structure seif·sufficiency interdependencies operations vertical integration virtual integration resources • atoms: physical assets bits information source of strength stability change style structured flexible leadership dogmatic inspirational motivation to complete i to build workers employees employees & free agents (outsourcing) job expectations security personal growth strategy top-<iown bottom-up products mass oroduction mass customisation financials ouarterlv real-time inventories months hours improvements incrementa! revolutionary quality affordable best no compromise source: bryne (2000) frequent attempts have been made to rectify some of the problems intrinsic in the system; for example the work by pigou (1932) with regard to environmental taxes and by coase (1960) with regard to property rights and externalities. a large number of similar attempts to address the deficiencies in the smithsonian system across a wide variety of fields are also currently in progress. these attempts may be compared to sincere efforts to improve the efficiency of the internal combustion engine of a motorcar by, among others, improvements in its catalytic converter, but it still remains an internal combustion engine running on fossil fuel. it therefore does not reflect a new engine design, just an improved internal combustion engine. 4 where are the answers? the search for a new design of the economic system will invariably, first and foremost, lead to a discussion regarding sustainable development. the concept of sustainable development is hard to comprehend and allows very different interpretations varying from the classical brundtland definition of sustainable r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 275 development (development that will not compromise future development) to sustainable returns to shareholders. it should be clear following from the vastly different defmitions of sustainable development that the debate is also often nuanced by different political and institutional agendas. more often than not, these agendas reflect the power of vested interests, historic inequalities or biases, dogmatism and inability or unwillingness to change. the net effect is a general perpetuation of the old system with some isolated changes visible on the fringes. as yet, sustainable development, irrespective of the definition used, remains a dream, a vision, and does not represent a departure from the theoretic principles upon which current economics are built. consider again the analogy with the combustion engine. on another level, there are individuals and even institutions who devote their time and effort to a sincere search for solutions. classic examples of these are hawkin, lovins and lovins (2000) and brown (200 i), who attempted to reveal a picture of how some technological changes (which are currently feasible) combined with certain policy changes can lead to a new way of production and a lower level of resource consumption without compromising quality of life. these attempts, though praiseworthy and supported morally and practically, do not resemble (and were never intended to be) a new economic theory. the problem is that, without a new economic theory, the old problems and systems will persist. while the search goes on, only the quality of the catalytic converter improves, but the design remains unchanged, to re-use the earlier analogy. the search for a new economic theory that can replace the smithsonian system therefore continues. 5 living with the search while the search for an economic system and theory continues, every possible effort should be made to reduce the ecological footprint of the current generation. to this end, this volume contributes by addressing aspects such as whether environmental issues can wait until development has taken place, followed by a search for solutions and a number of case studies. a variety of issues are addressed such as climate change, trade and the environment, water resource as well as land use management. these examples serve to illustrate that even while the search for a redesigned economic theory is underway, notable progress can be made towards improvement in quality of life, alleviation of poverty and the proper and appropriate use of natural resources. j nblignaut professor of economics, university of pretoria r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 276 sajems ns vo15 (2002) no 2 references 1 brown, l. (2001) eco~economics, new york: norton. 2 byrne, j.a. (2000) business week, 21-28 august. 3 coase, r. (1960) "the problem of social cost", the journal of law and economics, 3: 1-44. 4 hawken, p, lovins, a. & lovins, l. (2000) natural capitalism: the next industrial revolution, london: earthscan. 5 ha wklng, s. (1988) a brief history of time, london: bantam press. 6 pigou, a.c. (1932) the economics of welfare, london: macmillan. 7 schumacher, e.f. (1973) small is beautiful, london: harper and row. 8 schumpeter, j.a. (1954) history of economic analysis, oxford: oxford university press. 9 shiv a, v. (1988) staying alive, london: zed books. 10 sohnge, w.f. (1995) "education and political transition: a transformational or paradigmatic issue?" sase 21 st anniversary conference: windhoek. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . microsoft word vol6no3'3.doc sajems ns 6 (2003) no 3 591 organisational training perspectives in a changing south africa ___________________________________________________________________________ f w struwig and e e smith department of business management, vista university, port elizabeth d j l venter institute for statistical consultation & methodology, university of port elizabeth ________________________________________________________________ abstract this article focuses on organisational training perspectives within a changing south african context. to achieve the aim of this research project, a literature study, including an internet-based search, and empirical research were undertaken. during the empirical research, a self-administered questionnaire was sent to 365 training practitioners in order to investigate various training perspectives and its relationship with organisational change. five null hypotheses are tested to investigate the relationship between training and change variables. the traditional role of training has become obsolete, because of organisational change. training should be placed at the centre of human resources planning programmes and the strategic plans of the organisation. it is emphasised that actions should be taken to ensure that training programmes affect change and that trainees involved in the change process are effectively managed. jel m51, 53 1 introduction the important role of training in an organisation is highlighted by eagar (1996: 61) and stamelman (2000: 34) who contend that there is a growing need to develop an adequate quantity and quality of talent in contemporary organisations. the challenge of achieving higher productivity and skills levels, therefore, places increasing demands on the capacity to educate and train large numbers of people in south africa. this can, however, not be achieved by a one or two-day course or workshop. instead, training should be viewed as a planned process of bringing about fundamental change in the organisation and its employees (ogbonna, 2002: 1). sajems ns 6 (2003) no 3 592 this article focuses on important directions, trends and perspectives of training in south african organisations and its facilitating role in managing organisational change. research literature on the topic of training appears to be quite extensive (see the contributions of davis & davis, 2001; hardingham, 1997; honold, 2000 and kempl & pace, 2001). adonisi (1991: 27) maintains that �the rapidly changing socio-economic and political climate in south africa poses formidable challenges to management in general and human resources managers in particular.� what is of importance is the challenge facing organisational leaders to create self-renewing organisations that will provide the capacity to handle the tide of change. erasmus and van dyk (1996: vxii) concur that one of the crucial challenges facing south african organisations is how to manage change. according to bowin and harvey (2001: 179), employee training will become increasingly important in the new millennium, because of the pressures to reduce costs, increase productivity and to accelerate change. winning organisations will be those that respond quickly to changing conditions and the critical issue of training related issues. training should be viewed as a process which begins with the orientation of the new employee and continues throughout an employee�s career. teke (1997: 24) further emphasises the important role of training in empowering the workforce to be creative and innovative in meaningful business activities. manning (1996: 10) also stresses that of all tasks facing contemporary organisations, training and development of people is the most crucial there is no other way to productivity, profitability or survival in the new business arena. in this article, a theoretical overview of training will first be given. training trends and issues, the development of a training philosophy and policy, strategic training implications and the role of training in managing organisational change will be highlighted. thereafter, the hypotheses and research method will be outlined. lastly, the results and main conclusions and recommendations will be dealt with. 2 training perspectives: a theoretical overview 2.1 training trends and issues carroll (1998: 1) stresses that it is important to understand the changing picture of the world in which organisations operate, as this provides the context in which to consider the future of training management. buckley and caple (1992: 229), however, argue that many of the ideas and beliefs about training �represent a utopian world of training� which they cannot imagine ever being realised. despite this notion, this section will provide an overview of contemporary trends and issues in training. sajems ns 6 (2003) no 3 593 the open learning technology corporation (1995: 1) emphasises that there has been a renewed focus of attention on the role of training in equipping people for productive and satisfying careers. elements of training reform include: encouraging more people to participate in training; joint school-industry training programmes, increasing the number of and access to workplace entry level training and improving the performance of the vocational training system. jarvis (2002: 1) further stresses the freedom of movement through common vocational qualifications across occupations and professions and the right to receive training throughout working life. berggren (2000: 3) indicates the shift in orientation from viewing training as a cost centre and �one-size-fits-all� training programmes to view training as a source of competitive advantage and tailor-made training programmes. masie (2002:1) outlines the following three general trends in corporate training: training will become e-learning (learning with technology); intranet learning (learning within the organisation by means of an internal e-business and from everyday work) and knowledge management. human (1991: 199) alleges that the presence of a learning and training culture in an organisation is not indicated by the size of its training budget, but woven into the value and belief system of organisational members. table 1 provides a summary (as suggested by american society for training and development, 2000; lippitt, 1997 and setaro, 2002) of the most important directions and trends in training. table 1 trends in corporate training author most important training trends 1 increased skill requirements because of change 2 a more educated and diverse workforce 3 corporate restructuring and its affect on employee morale 4 change in size and composition of training departments american society for training and development (2000) 5 advances in technology will revolutionise training delivery 6 creating supporting networks of providing training services 7 more focus on performance improvement 8 re-examining of training�s role in the organisation 9 organisations will transform into learning organisations 10 increased emphasis on human performance management lippitt (1997) 1 customisation of training programmes 2 training should address organisation-wide issues 3 multi-skilling or cross training 4 development of activities for individual career building 5 large scale change efforts involving all stakeholders 6 computer-based training (e-learning) 7 training to be conducted at multiple sites sajems ns 6 (2003) no 3 594 table 1 continued author most important training trends lippitt (1997) 8 training on-the-job by means of teams 9 top management involvement in training setaro (2002) 1 shift from classroom to computer-based instruction 2 application of synchronous training models 3 increased used of threaded discussions to facilitate training 4 decline demand for �canned� training programmes 5 complex training materials use external training 6 development of partnerships/agreements in e-learning 7 cooperation between tertiary sector & e-learning providers 8 content/presentation of training incorporating new findings 9 relying on organisations providing comprehensive training management systems 10 shift from private ownership of learning towards one of public ownership in analysing the above-mentioned trends, it appears that training should position itself as a strategic tool. developers of training programmes should therefore take note of these directions in training when designing training programmes in order to ensure its effectiveness. the different approaches to training are outlined in table 2 below. table 2 modern approaches to training approach characteristics fragmented training is: * a cost not an investment * not linked to organisational goals * perceived as a luxury * directive oriented * taking place in the training department only * primarily knowledge-based courses formalised training is: * systematic (part of planned career development). * linked to human resources needs * linked to appraisal/individual needs * knowledge-based courses and focussing on skills * linked to career development * carried out by trainers and line managers * linked to the job by means of course work * a continuous learning process sajems ns 6 (2003) no 3 595 table 2 continued approach characteristics formalised * essential for organisational survival * a competitive weapon * linked to organisational strategy and individual goals * on-the-job and specialist courses focussed training is: * self-selected * usually non-directive * line manager�s responsibility source: osbaldeston and barham (1992: 22) the focussed approach depicted in table 2 views training and continuous learning by individuals as a necessity for survival and fosters the flexibility needed to keep pace with change in a competitive environment. baird, schneier and laird (1983: 286) attest to the fact that �employees will see training as a right rather than an amusing and interesting sideline... this will produce a maturity and professionalism in training never realised in the past.� 2.2 training philosophy and policy issues erasmus and van dyk (1996: 44) view a training philosophy as management�s attitude or perception of the importance of its human resources potential in the organisation. van dyk, nel, loedolff and haasbroek (1997: 161) assert that the following assumptions could serve as a basis for a training and development philosophy in the south african context: an employee should not be employed and trained in order to acquire skills and experience and then leave the organisation; an employee must be selected for training, based on the belief that he or she will become a lifelong member; an employee is an asset which appreciates in value and an organisation has a social responsibility to invest in employees by means of training. the training philosophy states the organisation�s intent in utilising its human resources potential and should be regarded as the starting point in the training process (gomez-mejia, balkin & cardy, 2001: 259). it appears, however, that this is the most neglected aspect of training management. an organisation�s training philosophy is manifested through its training policy which provides a guideline for the conduct of affairs with regard to training. these training philosophies and policies could be justified in terms of various management theories. these theories emphasise the important role of people and investment in human capital. training of employees could be seen as such an investment in human capital. the human relations approach views employees as human beings sajems ns 6 (2003) no 3 596 with certain rights and not as machines (smit & cronje, 1997: 43). the systems approach emphasises human resources inputs which goes through a transformation/change process to deliver effective and productive employees (hellriegel & slocum, 1996: 55). according to hammer and champy (1993: 12) people is the key driving force in affecting drastic organisational change and human resources programmes should be closely coordinated with the reengineering effort. table 3 highlights some broad policy options of a strategic nature, which reflect the training aspect of the human resources development policy environment in which contemporary organisations operate. it provides an outline of possible training policy options for south africa. managers and training practitioners must therefore ensure that the training policy of the organisation is in alignment with these broad and general policy options mentioned in table 3. from what has been discussed with regard to training policies, it should be clear that the setting of a training policy is of vital importance to organisations that wish to implement successful training. only when there is a thorough understanding of the function of training throughout the organisation, can training play an effective role. table 3 possible training policy options for south africa policy option description 1 align human resources development policies with economic and social development policies. 2 introduce measures to turn around the current enrolment ratios of universities to career institutions. 3 establish strategic partnerships between the state and organisations that are based on trust, co-determination and sharing of responsibilities. 4 institute a world-class education system that will instill a culture of learning and respond to the needs of the economy. 5 revitalise the current vocational education and training system. 6 target the informal sector as an area of intervention by using training as an instrument to transfer knowledge, skills and attitudes. 7 training provided to the unemployed should form an integral part of active labour market policies. source: adapted from van dyk et al. (1997: 27) training activities should not be viewed as a separate specialised function, but rather as an integral component of management action. all sections of the sajems ns 6 (2003) no 3 597 organisation should be given the opportunity to review activities in the context of a training policy. 2.3 strategic training implications nickols (2000: 4) criticises the traditional approach to training in which the future is ignored and the main focus is only on past performance, data and competencies. to reorientate training to a strategic approach (which is consistent with human resources� grand strategy), training practitioners must become familiar with the organisation�s strategic plans. corporate training consultants (2000: 2) alleges that the strategic management process optimally positions the organisation in the competitive environment, to ensure both the survival and growth of the organisation. the need to integrate human resources planning (and therefore training as well) into the organisation�s strategic planning process has been advocated by several authors (see for example, buckley & caple, 1992 and erasmus & van dyk, 1996). budd (1996: 5) contends that the success of training efforts is experienced if training is not only managed professionally, but also linked to the organisation�s mission and goals. according to nickols (2000: 4), training has several strategic roles in the implementation of a human resources strategy. it is a potential tool for creating a supply of talent within the organisation. training also serves as a tool for equipping individuals with knowledge, skills and attitudes needed to implement the organisation�s strategy. a further strategic role of training is that it stimulates conditions which may be experienced as the organisation implements a new strategy in a changing environment. training also provides individuals with the necessary skills to think strategically. it should be clear that training is a powerful tool in the implementation of a human resources strategy. gerber, nel, van dyk, haasbroek, schultz, sono and werner (2001: 557) emphasise the following main strategic benefits of integrating strategic planning and human resources and training management: improved understanding of the implications of strategic organisational planning for human resources; pro active recruitment of required and experienced human resources; improved human resources development activities; improved analysis and control of costs related to human resources. the traditional and functional role of training, therefore needs to be revised in a changing environment. human resources, in the context of strategic human resources development, are therefore seen as a vital factor in business planning and survival. this implies moving human resources development from a series of fragmented activities to a situation where training is systematically linked to the master or strategic plan of the organisation. sajems ns 6 (2003) no 3 598 2.4 the role of training in managing organisational change dawson (1994: 176) asserts that �training can be used as a vehicle for informing employees of the nature, consequences and opportunities afforded by change.� blunt and jones (1992: 311) believe that the upgrading of managerial capabilities is a continuing need in situations of rapid change. according to joyce and woods (1996: 255) there is a need to develop strategic managers. much of the training of strategic managers has however been limited in its applicability to contemporary conditions. thompson and mabey (1994: 218) argue that there are two ways in which training (a component of human resources development) can influence the management of organisational change. the first role is to respond to externally driven changes at organisational level (shifts in strategic action). the second role is an internal one − developing and shaping the appropriate competencies, practices and attitudes which will assist the organisation to deliver its products and services. bowman and jarrett (1996: 220) and thompson (1995: 172) also indicate the use of training as a strategy to facilitate the transition of change. educating and training people for change beforehand can assist in understanding why the change is necessary. for training to serve as a vehicle for change, change agents must ensure that training is used for the correct purposes. the crucial role of training in the stage of planning the proposed change is emphasised by burnes (1996: 332) who highlights that training is the key element in any change project. the result of training can be the development of new skills, that people are left with the ability to pursue continuous improvement or that they are made aware of the need for change. besides the key role of training in planning the change, brill and worth (1997: 62) indicate the role of training in initiating the change process. through a seminar or workshop, people can examine personal needs, levels of morale and leadership styles. this new insight and perspective can help people to disconnect from old habits and to open up to initiating change in the organisation. according to kanter, stein and jick (1992: 510), the use of training during the implementation of change is also important. this means that people need to be reoriented, redirected or engaged in new activities which require new knowledge, motivation or skills. tobin (1993: 198), on the other hand, advocates the creation of a virtual training organisation and states that the �traditional training organisation�, if it is to assist with organisational change, needs to transform itself. the traditional training organisation focuses on the development of individual skills, does not participate in the organisation's planning efforts and is not a change agent. several specific organisational characteristics serve as variables in this study. these include: size of the organisation as measured by the number of sajems ns 6 (2003) no 3 599 employees, the existence of a fully developed training department in the organisation and type of environment in which the organisation operates. from the aforementioned, the following three null hypotheses are formulated: h01 the number of employees (size of organisation) is not related to the role of training in managing organisational change. h02 there is no relationship between an organisation which has a fully developed training department and the role of training in managing organisational change. h03 there is no relationship between the environment in which an organisation operates and the role of training in managing organisational change. the main objective of this article is to investigate various training perspectives in a changing south africa. a more specific focal point is to analyse the role of training in managing organisational change. in analysing the literature on change management, three topics continually came to the forefront: organisational development (see for example larwood, 1984: 450 and robbins, 1996: 736), the learning organisation (dawson, 1992: 209 and hendry, johnson & newton, 1994: 230) and transformational leadership (bowditch & buono, 1994: 235 and hersey, blanchard & johnson, 1996: 521). it could, therefore, be said that organisational development, the learning organisation and transformational leadership, form the architecture or building blocks of the interaction between training and change. these building blocks are used as the change variables in this project. an in-depth discussion of these topics, however, falls beyond the scope of this article, but are empirically tested. it should be mentioned that this article and its results forms part of a bigger project. based on this reasoning and background, the following two null hypotheses are formulated: h04 there is no relationship between the facilitating role of training and the application of organisational change processes. h05 there is no relationship between the role of training and managing organisational change. training must therefore not only be seen as a functional area in the organisation, but needs to possess the capabilities necessary to help change the organisation. sajems ns 6 (2003) no 3 600 3 research method 3.1 sample selection for the purpose of this research project, the target population was chosen from south african organisations. all organisations with a training department or section, headed by a training practitioner or director, could therefore be regarded as the target population. the sample selected for this project was drawn by the south african board for personnel practices (sabpp). it would be impractical to include all organisations in south africa. the database provided, included all registered training practitioners with the sabpp (probability sampling). a total sample size of 365 was used. 3.2 questionnaire design based on the size of the sample (365), a mail survey by means of questionnaires was best suited to this project. the questionnaire consists out of three sections: � section a deals with organisational change variables. three organisational change constructs/factors are tested, namely organisational development (10 variables, the learning organisation (15 variables) and transformational leadership (15 variables). � section b covers various perspectives on training. two constructs are tested, namely the facilitating role of training in the application of organisational change processes (11 variables) and the role of training in managing organisational change (14 variables). � section c provides classification data (demographic characteristics) about respondents. the type of ordinal scale used in section a and b of the questionnaire is a fivepoint likert-type scale. section c of the questionnaire contains a nominal scale of measurement in which respondents were asked to provide some classification data about themselves and their organisations. a factor analysis was also conducted. the bmdp statistical software package (programme 4m) was used to perform the factor analysis. factors were extracted using principle component analysis with direct quartimin oblique rotation to allow for intercorrelations between factors. to confirm that all items load on a single factor and to explain the percentage of variance, cronbach�s alpha was calculated, as indicated in table 4. sajems ns 6 (2003) no 3 601 table 4 cronbach�s alpha for section a and b of the questionnaire section variables factor cronbach�s alpha % of variance 1-10 organisational development (a1) 0.92 57.6 11-25 learning organisation (a2) 0.95 59.5 a 26-40 transformational leadership (a3) 0.95 60.3 1-11 the facilitating role of training in the application of the building blocks of change (b1) 0.94 62.0 b 12-25 role of training in managing organisational change (b2) 0.92 49.9 table 4 highlights the internal reliability of the measuring instrument. cronbach�s alpha should be above 0.7 to indicate internal reliability. it can therefore be concluded that all factors are internally reliable (cronbach�s alpha > 0.7). the percentage of variance refers to the percentage of variance of the items constituting each factor, as explained by each factor. the highest percentage of variance is for the facilitating role of training in the application of organisational change processes and explains 62.0 per cent of the variance of the items or variables constituting this factor. the face validity of the measuring instrument was ensured by means of consulting secondary sources in order to incorporate theoretical aspects and a pretest of the questionnaire. 3.3 pilot study due to the fact that the questionnaire had never been used before in any research project, it was issued to 40 organisations (convenient sample) in the port elizabeth-uitenhage area for pilot testing. wherever possible, it was issued to human resources managers and training specialists to complete. the questionnaire was also given to academics in the field of management, training, industrial psychology and statistics in order to identify any problem areas, to obtain suggestions for improvement and to ensure face validity. sajems ns 6 (2003) no 3 602 3.4 data collection a total of 365 covering letters, questionnaires and return-paid envelopes were posted and a reminder postcard was sent a week later. various measures were implemented to deal with the aspect of low response rates associated with mail surveys. the response rate of this survey is 54,25 per cent (198 questionnaires from a possible 365 included in the sample). the effective response rate (usable questionnaires) is 49,86 per cent (182 responses from a possible 365). 3.5 data processing and analysis questionnaires which were received from respondents were inspected, edited, coded and transferred for storage. the coding of questionnaires was carried out by the researcher in conjunction with the statistician responsible for assisting with the analysis of data. the following are examples of the techniques used during the data analysis stage of the research project: descriptive statistics, factor analysis, analysis of variance and correlation coefficients. 4 survey results 4.1 descriptive statistics section b of the questionnaire concentrates on various perspectives of training, and more specifically, the role of training in managing organisational change. the variables tested whether training is important to affect change in the organisation. a summary of the descriptive statistics for these variables reveals that all the mean values lie between point three (neutral) and point four (agree slightly) on the five-point likert scale. the median values indicate that most respondents agree slightly (point four on the scale) with the variables in this part of the questionnaire. the first quartile (q1) shows that 25 per cent of the distribution lies on or below point three of the scale (neutral) and the third quartile (q3) suggests that 75 per cent of the distribution lies on or below point four of the scale (agree slightly). the standard deviation scores indicate no large deviation between the values of these variables. the frequency distribution results are illustrated by means of a histogram in figure 1 below. sajems ns 6 (2003) no 3 603 figure 1 histogram of the frequency distribution results of the role of training in managing organisational change figure 1 reveals that 18 per cent of respondents (3 per cent + 15 per cent) disagree with statements regarding the role of training in managing organisational change. twenty-four percent of the respondents neither agree nor disagree with the variables in this part of the questionnaire. the majority of respondents (58 per cent) indicate agreement with the aspects regarding the role of training in managing organisational change (39 per cent + 19 per cent). it can be deduced that most of the researched organisations do implement the aspects mentioned and therefore use training as a mechanism to bring about change in the organisation. the distribution can be regarded as negatively skewed and is leptokurtic. 4.2 anova to establish the relationships between the independent and dependent variables, various analyses of variance procedures are conducted. table 5 highlights the relationship (differences) between the classification data and training variables. analysis of variance conducted, revealed relationships (differences) with only three of the classification data variables: number of employees (small organisations <100-199 employees; medium size organisations 200-499 employees and large organisations 500-1000+ employees), existence of a 3 15 24 39 19 0 5 10 15 20 25 30 35 40 45 1 2 3 4 5 disagree agree sajems ns 6 (2003) no 3 604 training department (yes or no) and type of environment (static, moderate changes and dynamic). no other relationships (differences) exist between the classification data and training variables and is, therefore, not significant to report. table 5 analysis of variance results to investigate the relationship between the independent variables (classification data) and the role of training in managing organisational change variable sum of squares degrees of freedom mean square f-test p-value number of employees 0.92098 2 0.46049 1.24 0.2930 training department 12.74529 1 12.74529 34.22 0.0000** environment 9.05278 2 4.52639 12.15 0.0000** error 63.68698 171 0.37244 ** significance level of 0.01 the anova results in table 5 shows that the f 2, 171 values of 1.24 and the pvalue of 0.2930 fails to reject the null hypothesis, h01. the calculated values fall outside the rejection region (p > 0.05) and indicate that there is no relationship (difference) between the role of training in managing change and the size of the organisation. the high f 1, 171 statistic of 34.22 and the p-value of 0.0000 (p < 0.01) indicates that the calculated values fall within the rejection region and h02 can therefore be rejected at a significance level of 0.01. there is a relationship (difference) between an organisation which has a fully developed training department and the role of training in managing organisational change. the null hypothesis, h03, can be rejected, based on the following analysis: f 2 , 171 value of 12.15 and p-value of 0.0000. at an alpha level of 0.01, it appears that there is a highly significant relationship (difference) between the role of training in managing organisational change and the environment in which an organisation operates. table 6 shows the anova results which investigate the relationship (difference) between training and organisational change variables. the training variables included in the two factors of section b of the questionnaire are used as the independent variables. the change variables included in the three factors of section a of the questionnaire are used as the dependent variables. sajems ns 6 (2003) no 3 605 table 6 analysis of variance results to investigate the relationship between the independent variables (training) and organisational change variable sum of squares degrees of freedom mean square f-test p-value b1 23.3714 2 , 179 11.6857 21.02 0.0000** b2 50.5434 2 , 179 25.2717 57.83 0.0000** ** significance level of 0.01 b1= the facilitating role of training in the application of organisational change processes b2= the role of training in managing organisational change the f 2, 179 value of 57.83 and the p-value of 0.0000 shows that the null hypothesis, h04, can be rejected (p < 0.01). the facilitating role of training is therefore related to the application of organisational change processes. the f 2 , 179 value of 21.02 and the p-value of 0.0000 proves that the null hypothesis, h05, can be rejected (p < 0.01). there is a relationship (difference) between the role of training and managing organisational change. 4.3 correlation the pearson product-moment correlation coefficient (notation is r) assesses or measures the degree of association or relationship between two variables and varies between -1 (perfect negative correlation) and +1 (perfect positive correlation). the correlation coefficient indicates the magnitude or strength of the relationship and the direction of the relationship (presence or absence of a minus sign) in a single value. table 7 highlights the correlation matrix of the variables or factors used in section a (change) and section b (training) of the questionnaire. table 7 pearson product-moment correlation coefficients: section a and b of the questionnaire factor a1 a2 a3 b1 b2 a1 1.0000 a2 0.8620 1.0000 a3 0.7840 0.8727 1.0000 b1 0.5920 0.6867 0.7410 1.0000 b2 0.5734 0.6733 0.7258 0.8394 1.0000 sajems ns 6 (2003) no 3 606 a1= organisational development a2= the learning organisation a3= transformational leadership b1= the facilitating role of training in the application of change processes b2= the role of training in managing organisational change in analysing the r-values of the correlation matrix in table 7, the critical value used to interpret these r-values, at a significance level of 0.01, is 0.1720 for a sample size of 182 (effective response rate). the interpretation of person�s r begins by noting that the relationships are positive (as determined by the sign of the calculated values). a positive r describes a positive relationship. all the calculated values of r are greater than the critical value (r > 0.1720) which indicates that the relationship between the variables is statistically highly significant. based on these correlation results, the stated null hypotheses, h04 and h05, can be rejected at an alpha level of 0.01. highly significant relationships exist between the independent variables (training) and the dependent variables (organisational change). 5 conclusions and recommendations increased emphasis should be placed on understanding the changing picture of the world in which organisations operate, as this provides the context in which to consider the future of training management. continuous, rapid learning must become a priority for organisations in order to keep up with new methods, changing trends and advanced technology. the following relationships between the independent variables (classification data), and the role of training in managing organisational change, were identified: � it appears that the employment size of an organisation has no relationship with the role of training in managing organisational change (h01 not rejected). organisations with different employment sizes do not differ with the regard to the role of training in managing organisational change. � there is a highly significant relationship between an organisation which has a fully developed training department and the role of training in managing organisational change (h02 rejected). organisations in which a fully developed training department exist, differ from those organisations in which training is not a fully developed function or department regarding the role of training in managing organisational change. � the type of environment in which an organisation operates is related to the role of training in managing organisational change (h03 rejected). organisations operating in a dynamic environment differ from sajems ns 6 (2003) no 3 607 organisations operating in a moderate or static environment regarding the role of training in managing organisational change. the following conclusions can be drawn from the relationship between training and change variables: � there is a highly significant relationship between the role of training and managing organisational change (h04 rejected). training could therefore be used to manage change in an organisation. � there is a highly significant relationship between the facilitating role of training and the application of organisational change processes (h05 rejected). the implementation of change processes in the organisation could be facilitated by training. in order to meet the new requirements of the marketplace, training should undergo some kind of transformation. a focussed approach (as opposed to a fragmented and formalised approach) should view training as: a continuous learning process, a competitive weapon, self-selected and non-directive and a means to link organisational strategy and individual goals. it is important to realise that many training experiences lack positive results because of unrealistic expectations. training cannot alter personalities or habits overnight. it is important for management to have an overall view of training so as to effect change in employee behaviour and to realise that some kind of learning must occur if change is to take place. the following could serve as general guidelines and recommendations for implementing training perspectives as a tool to manage organisational change (based on the training perspectives empirically tested): � the training process in the organisation should be related to the context of the external environment in which the organisation operates. � it should be realised that training for change is vital for the long-term survival of the organisation. � training programmes should enhance the capacity of people to cope with change. � organisations should upgrade managerial capabilities in situations of rapid change. � training programmes should respond to shifts in strategic actions of the organisation. � training initiatives should be linked to the mission of the organisation. � training people for change, prior to it taking place, could assist in understanding why change is necessary. sajems ns 6 (2003) no 3 608 � management should not only view training as a functional area, but one which possesses the necessary capabilities to help transform the organisation. � training should assist people to become change agents in the organisation. � management should realise there is a need for a new approach to training which will promote continuous adaptation in the organisation. the following extract by harri-augstein and webb (1995: 146) is appropriate with which to conclude this article: �many attempts ... have failed, because intentions to change are organised around a theory or idea ... a fundamental change in the role of training involves a shift in attitudes from a traditional view of training towards the more radical view of enabling learning ... this shift involves truly recognising the implications of a transfor mation ...� references 1 adonisi, m. (1991) �training as a corporate strategy�, ipm journal, 10(1): 27-30. 2 american society for training and development. (2000) �employee orientation and training − training trends�, http://www.bsad.uvm.edu/hrm/training/trendsarticle downloaded: 200205-22. 3 baird, l.s., schneier, c.e., & laird, d. (1983) the training and development source book, human resource development press: massachusetts. 4 berggren, r. (2000) �corporate training: lifelong learning in a global marketplace�, http://www.eist.uib.no/eucen-conference downloaded: 2002-05-22. 5 blunt, p., & jones, m.l. (1992) managing organisations in africa, walter de gruyter: berlin. 6 bowditch, j.l. & buono, a.f. (1994) a primer on organizational behaviour, john wiley & sons, inc: new york. 7 bowin, r.b., & harvey, d. (2001) human resource management, prentice-hall: new jersey. 8 bowman, c., & jarrett, m.g. 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(1992) analysing organisations, the macmillan press, ltd: hampshire. 17 dawson, p. (1994) organisational change: a processual approach, paul chapman publishing, ltd: london. 18 eagar, m. (1996) �workplace learning as a tool for transformation�, people dynamics, 14(11): 60-64. 19 erasmus, b.j., & van dyk, p.s. (1996) training management: a practical approach, international thompson publishing: johannesburg. 20 gerber, p.d., nel, p.s., van dyk, p.s., haasbroek, g.d., schultz, h.b., sono, t.j., & werner, a. (2001) human resources management, oxford university press: cape town. 21 gomez-mejia, l.r., balkin, d.b., & cardy, r.l. (2001) managing human resources, prentice-hall: new jersey. 22 hammer, m. & champy, j. (1993) re-engineering the corporation: a manifesto for business revolution, new york: harper. 23 hardingham, a. (1997) designing training, institute for personnel development: london . 24 hellriegel, d. & slocum, j.w. (1996) management, southwestern publishing company: ohio. 25 hendry, j., johnson, g. & newton, j. (1994) strategic thinking: leadership and the management of change, john wiley & sons: chichester. 26 hersey, p., blanchard, k.h. & johnson, d.e. (1996) management of organizational behaviour, prentice-hall, inc: new jersey 27 honold, l. (2000) developing employees who love to learn. daviesblack publishing: california. 28 human, l. (1991) educating and developing managers for a changing south africa, juta & company, ltd: cape town. 29 harri-augstein, s., & webb, i.m. (1995) learning to change, mcgraw-hill book company: london. sajems ns 6 (2003) no 3 610 30 jarvis, c. (2002) �trends in the 90's − related movements�, http://www.solbrunel.ac.uk/jarvis/bola/training/trends. downloaded: 2002-05-22. 31 joyce, p., & woods, a. (1996) essential strategic management: from modernism to pragmatism, butterworth-heinemann: oxford. 32 kanter, r.m., stein, b.a., & jick, t.d. (1992) the challenge of organizational change, the free press: new york. 33 kempl, s.f., & pace, r.w. (2001) training across multiple locations, berrett-koehler publishers: san francisco. 34 larwood, l. (1984) organizational behaviour and management, kent publishing company: boston. 35 lippitt, m. (1997) �trends in corporate training�, http://www.jalmc.org/. downloaded: 2002-05-22. 36 manning, t. (1996) �managing minds − something different�, productivity south africa, 22(4): 7-10. 37 masie, e. (2002) �trends and barriers in the future of corporate training�, http://www.lotus.com/news/n../public, downloaded: 2002-0522. 38 nickols, f. (2000) �training a strategic view�, http//www.home.att. net/nickels/strategic_view. downloaded: 2002-05-22. 39 ogbonna, j. (2002) �the role of training in the management of change related to information technology�, http://spica.soi.city.ac.uk/project, downloaded: 2002-05-20. 40 open learning technology corporation (1995) �open learning and general trends in education and training�, http://www/ educationau.edu.au/archives/olsat, downloaded: 2002-05-22. 41 osbaldeston, m., & barham, k. (1992) �using management development for competitive advantage�, long range planning, 25(6): 18-24. 42 robbins, s.p. (1996) organizational behavior, prentice-hall, inc: new jersey. 43 setaro, j.l. (2002) �trends in training�, http://www.thinq.com/pages/ new_wp_trendsintraining, downloaded: 2002-05-22. 44 smit, p.j. & cronje, g.j.de j. (1997) management principles, juta: kenwyn. 45 stamelman, m. (2000) �s.a. corporations must become players in the world-class global village�, people dynamics, 18 (5): 32-34. 46 teke, m. (1997) �empowering the south african worker�, people dynamics, 15(10): 23-31. 47 tobin, d.r. (1993) re-educating the corporation, oliver wight publications, inc: essex junction. 48 thompson, r. (1995) managing people, butterworth-heineman: oxford. sajems ns 6 (2003) no 3 611 49 thompson, r., & mabey, c. (1994) developing human resources, butterworth: oxford. 50 van dyk, p.s., nel, p.s., loedolff, p van z., & haasbroek, g.d. (1997) training management: a multi disciplinary approach to human resources development in south africa, international thompson publishing: johannesburg. sajems ns vol 4 n03 458 some perspectives on globalisation 5mbrink department of economics. university of pretoria abstract much has been written about globalisation. something truly insightful rarely comes to light. this article is no such attempt, it merely atternpts to reconcile disparate views and tie some loose strands on the subject of increasing international integration. more specifically, the features and implications of current trade and investment patterns are awarded attention. the prominence of technological innovation is emphasised, as is the role offdi in the diffusion oftechnical progress. globalisation has implications both for developing and developed economies; for instance, its effect on growth, the consequences for macroeconomic stability and the effect on income inequality particularly for low-skilled workers. trade invites arbitrage in social values; social tension and populist demands for protectionism arise from this. also, globalisation heightens economic risk and while the pressure on governments to mitigate this rises, their ability to respond effectively is dwindling, eroding the social consensus required to maintain open markets. jel f 15 introduction although generalised use of the term "globalisation" sterns from recent times, more or less the 1980s, the concept is by no means new or even modem. a centuries-old debate has acquired a new face and this article attempts to highlight some of its prominent features. globalisation refers to the increased integration of national economies through predominantly trade and fmancial flows. however, it also refers to increased production linkages, a growing web of treaties and institutions and the movement of people and knowledge. in virtually every year since the second world war, the growth in international trade has outstripped the expansion in world gross domestic product (gdp). the upsurge in cross-border financial flows is perhaps the most obvious manifestation of globalisation; these flows have grown more rapidly than trade, and foreign direct investment (fdi) has increased faster than overall capital flows. the cross-border purchases of bond and equities in r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 459 sajems ns vol 4 (200 i) no 3 the g-7 countries have grown from approximately 4 per cent of the annual gross national product (gnp) of these countries in 1975 to 200 per cent in 2000. presently, cross-border securities transactions exceed gnp for several large countries. in addition, the daily turnover in foreign exchange in private markets is greater than the entire reserve holdings of the central banks of the world and amounts to nearly twenty times world output (crockett, 1999: 178). many measures, however, would indicate that the world economy was more integrated at the height of the gold standard in the late 19th century than it is now. in the united states and europe, trade volumes peaked before the first world war, collapsed during the inter-war years and surged again after 1950. conventional measures of openness, for example the ratio of trade to national income, indicate that the united states and europe are not significantly more open now than a century ago. japan currently exports less of its output than during the inter-war years (rodrik, 2000: 229). the phenomenon of highly integrated national economies is therefore nothing new. the dynamics of late 20th century globalisation varies from that of the late 19th century imperialist expansion. underlying patterns may be similar, but the specific forms of integration are quite different. trade flows have changed from inter-sectoral to intra-industry and intra-firm trade. capital flows have shifted from the primary sector to the manufacturing and service sectors and from developing country recipients to developed country recipients. financial flows have changed from productive investment by banks to largely unproductive but lucrative activities by institutional investors. rigid immigration laws have replaced relatively unrestricted mobility of labour (sachs, 2000: 218 and crockett, 1999: 179). in addition, key participants have changed from imperial nation states to large multinationals representing international industrial capital and fmancial interests. gun-boat diplomacy has made way for market diplomacy of industrial and finance capital, negotiated by multilateral institutions. it is argued that both periods of international integration displayed a striking asymmetry. the asymmetry in the present system has emerged from the willingness of developing countries to provide access to their markets without corresponding access to technology and to accept capital mobility without corresponding access to labour mobility (nayyar, 1997: 5). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 3 460 perspectives on the current state of international trade and investment during the last two decades, the erosion of geographical and market barriers has gained massive momentum and appears irreversible. the present tide of globalisation has developed distinct characteristics; some promising, others controversial and a few of them truly undesired. a prominent feature is the profound role of recent advances in technology. technological innovation is generally acclaimed as the driving force behind globalisation and has transformed economic processes in almost every sector, but fundamentally so in the fmancial sector. the information available to economic agents has greatly increased, while the cost of cross-border transactions has been reduced dramatically. traditional structures and methods of providing fmandal services have become obsolete. complex new financial instruments and innovative ways of hedging against risks have evolved. many administrative restrictions and controls previously characterising the financial system have been rendered ineffective (crockett, 2000: 183). in short, technological advance has enormously enhanced the ability to make economic judgements and act on them. it has become easier and faster to complete international transactions. it has also defmed the relationship between rich and poor as acutely as any divisive ideology. second, the flow of modem trade and investment has adopted a particular profile, the global economic implications of which have sparked more than heated debate; the recent g-8 summit finally witnessed a fatality following vehement protesting. globalisation has implications for both the developing and developed world; prominent among these are the following; the effect of globalisation on growth, the consequences for macroeconomic stability and the effect on income inequality particularly for low-skilled workers. the world trade organisation (wto) has had at least some part in the evolution of current trade patterns. a brief look at the current state of the wto, its recent successes and immediate challenges may shed some light on the international phenomena presently perceived (sachs, 2000b: 99). third, multi-national businesses, which serve as the most important vehicle for fdi, are at centre-stage in the globalisation process. the size, direction and composition of fdi affect the size, direction and composition of world trade and vice versa. fdi is generally viewed as a gateway to fmancial resources to supplement domestic savings, to firm-specific foreign technology, to high-quajity managerial skills and to global distribution networks. multinationals take advantage of intra-firm and international division of labour and facilitate smooth trade flows in correspondence with comparative and competitive advantage. this r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 461 sajems ns vol 4 (2001) no 3 inflows have, however, become very concentrated. in addition, mergers and acquisitions appear to be the most favoured route to production abroad with parent companies based in developed countries. consequently, control over the bulk of international production resides with the world's 100 largest multinationals that is, with no more than 0.3 per cent of multinational businesses (gupta. 1997: 3). finally, the issue of trade in global values has to be considered. heightened integration not only facilitates arbitrage in the markets for goods, services, labour and capital, but also exerts pressure towards another kind of arbitrage: arbitrage in national nonns and social institutions. this is a consequence of the rising cost of maintaining divergent social arrangements. open trade may come into conflict with long-standing social contracts that provide varying degrees of protection against the relentlessness of the free market. tension may clearly arise from this. related to the issue of trade in social values, is the social pressure stemming from the consequences or, more correctly, casualties following the heightened competition imposed by globalisation. the need for social insurance and safety nets has anything but diminished. coupled with retreating govemments and reduced social obligations, the pressure on governments to mitigate the risks of globalisation may prove to be a future source of tension (rodrik, 2000: 233). each of these features of modem trade, i.e. the role of technology, the implications of modem trade and investment patterns, the role of fdi and the social repercussions of globalisation, is now addressed. the technological divide the end of the cold war signalled the end of old ideological divisions. however, a new, more intractable division is taking hold. at the core of this global divide, is the vast inequality in technological innovation and diffusion. nearly all technological innovation is undertaken by some 15 per cent of the globe's population, while perhaps a further 50 per cent has the ability to adopt these in production and consumption. the remainder of the world's population approximately a third is neither innovating nor adopting foreign technologically and remains predictably disconnected and in the grip of a poverty trap (sachs, 2oo0b: 99). ironically, these regions' greatest obstacles require technological solutions inaccessible to them. if the technology is available offshore, it is often unaffordable on the required scale. alternatively, the appropriate fonn of technology is nonexisting and the incentives for local research and development (r&d) inadequate. the technologically-excluded two bi11ion people may graduate to techr ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 3 462 quate. the technologically-excluded two billion people may graduate to technology-adopters and even innovators and then reap the benefits of globalisation, but this transition is everything but automatic. conventionally, development has been viewed as the outcome of the accumulation of physical and human capital. less-developed countries where capital is scarce and the return on new investment high, presumably have an advantage to attract offshore capital and encourage saving, provided that they are well governed. this should promote convergence that is, the narrowing of the richpoor gap (op. cit.: 99). technology is less likely to converge. increasing returns to scale in innovation favours environments already rich in advanced technology. existing ideas are recombined to produce chain reactions of innovation. however, a critical mass of ideas, technology and a market sizeable enough to support r&d are prerequisites. in addition, the public-goods aspect of innovation requires academia, government and industry to work in harness. in poor countries, cooperation of this nature is virtually unheard of; they rarely even have an official scientific adviser. technological capacity can also be adopted via the following channels: the import of technology embodied in capital and consumer goods, licensing from patent holders, or fdi. all three instances require that the importing country should be successfully exporting to afford the foreign technology. geographical considerations are also important. not all developing countries are equally well located to absorb technology; proximity to big markets and principal sea routes attracts technology, whereas remote mountainous regions, landlocked developing regions and regions far from seaports generally fail to do so. failure to keep up with global technology often leads to the collapse of a country; they are unable to maintain living standards, much less improve it. they rely on a limited range of primary exports with declining profitability. the continual deterioration in their terms of trade is itself a side effect of technological innovation. in addition, demographic pressures resulting from rapid population growth exacerbate their plight. urbanisation, the education of women and a reduction in childhood mortality eventually lead to reduced fertility, but these factors are subdued in technologically-stagnant regions. demographic strain also adds to environmental harms like deforestation (op. cit.: 100). the international globalisation strategy needs to be reconsidered on several fronts, failing which two billion or more of the global population may be excluded from the benefits of global growth. the issues of public health and the control of infectious disease require more than sharpened attention: a serious efr ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 463 sajems ns vol 4 (200 i) no 3 fort in terms of donor support would be the start of the battle against debilitating and lethal disease. marginalised regions need to be connected to the world economy with a focus on market access for the poor countries. global shipping has become cartelised, with the trade routes linking marginal traders with major markets far less competitive than high-volume routes. preferential approaches to some marginalised regions have been advantageous for immediate beneficiaries, but more remote regions then forfeit even more trade and fdi. information technology (it) offers the opportunity to overcome distance and should present the comparative advantage possibilities for landlocked regions. this would require the support and deliberate effort of these countries' political leadership in cooperation with leaders in the it industry cop. cit.: 101). the problem at the core of the global divide is the huge inequality in the innovation and diffusion of technology. existing grants and lending to promote science and technology in the developing world are vastly inadequate. in addition, grant aid should be targeted on knowledge. a global technological strategy should focus on participation from academia, government and industry, also from the first world. long-term collaborative research coupled with public funding aimed at push-strategies subsidising r&d efforts directed at poor-country problems and pull-strategies comprising rich-country commitments to buy new technologies on behalf of poor countries. in short, the global community should, on government level, firmly commit themselves to the promotion of scientific and technological capacity in poor countries. global implications of the new trade models in the wealth of nations, adam smith declared that the discovery of america and a passage to the east indies by the cape of good hope are the greatest and most important events in the history of mankind. his vision was one of dynamic, mutual gains from trade a unified world enabling the most distant regions to relieve each other's wants and encourage each other's industry. even smith later conceded that imperialist expansion deprived the native inhabitants of the new world and the east indies of the benefits of globalisation. more recently, mutually beneficial trade was, at least from the perspective of the developing world, frustrated by two world wars, the great depression and four decades of protectionism following the second world war (sachs, 2000a: 219). one has to wonder whether the present tide of globalisation will fmally see smith's vision of globally advantageous trade into fruition. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 n03 464 growth and gains from trade the concept of dynamic gains from trade continues to be at the core of endogenous growth models. long-term growth depends on heightened innovation and productivity. the incentives for both of these depend on the scope of the market, as was envisaged by smith two and a half centuries previously. true enough, the rapidly growing developing countries of the past twenty years have been the ones to successfully establish new export growth, particularly in manufactures. isolationist economies sheltering behind high trade barriers have not grown nearly as rapidly. the manufactured exports originating from the fast-growing, export-led developing world exemplify a further principle strongly advocated by smith that of the benefits of international division of labour. in virtually all cases, these exports are part of a sophisticated system of labour division. final goods are produced in multi-site operations, the labour-intensive processes of which are reserved for the developing countries (op. cit.: 220). the result is a complementary production relationship between advanced and developing economies a situation unthinkable during the early, protectionist post-war days. theoretically, globalisation could benefit both sides of the income divide: the scope of developed countries' market for irmovation is expanded and developing countries get to share in the advantages of those innovations and to participate in global production. however, as is empirically known and demonstrated by exceptions to standard theory, the gains in growth are not necessarily shared by all. the chances for extensive and beneficial trade are extremely limited in geographically isolated regions. the cost of transport between a national economy and world markets should be low enough to permit substantial interaction and gains from trade. paul krugman has pointed out that increasing returns to scale coupled with high transport cost may result in an accidental concentration of economic activity in some regions at the expense of others. adverse climates that is, climates conducive to infectious disease and poor agricultural conditions may also impose obstacles to development, despite the generally beneficial effects of globalisation (sachs, 2000a: 221). the dynamic "dutch disease" effect presents a further exception to the smithsian tenet of mutually beneficial trade. producers of natural resources might get trapped in an unsatisfactory specialisation of trade and in the process block the industrialisation necessary for economic development. this happens when a country successfully exports natural resources, strengthening its currency and undermining the competitiveness of nonresource-based industries. the specialisation in primary goods rather than manufactures, which offer better opportunir ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 465 sajems ns vol 4 (2001) no 3 ties for long-tenn productivity growth, leads to long-tenn loss of growth. empirical findings suggest that countries with large natural resource bases are uncompetitive in most manufacturing sectors and are hampered by low long-term growth. the reason for this probably is that manufacturing offers better opportunity for innovation and increased productivity in the long run. in principle, some form of non-market intervention, like the protection or subsidisation of manufacturing may remedy a case of dutch disease, but these measures are subject to heated debate and international controversy. global stability economic theory predicts that countries will gain from trade in fmancial assets in ways similar to trade in goods. the potential gains from international fmancial trade are two-fold: it allows greater diversification of risk and allows a national economy to intertemporally optimise investment and consumption patterns. recent experiences, for example the mexican crash and the east asian financial crisis, have illustrated how globally destabilising unfettered fmancial flows from advanced to developing economies could be. globalisation appears to amplify rather than dampen certain key fmancial market weaknesses. globalisation of the capital markets has also had immensely beneficial consequences. emerging markets had access to a larger pool of savings to augment resources available for development. foreign investment has also served as vehicle for the transfer of managerial know-how, encouraging productivity growth, and market disciplines rapidly curtailed unsustainable policy developments. globalisation imposed increased competition, significantly reducing the margin between the interest rates paid by users of funds and the returns received by savers in major fmancial centres. the development of new fmancial instruments has also offered market participants greater protection against a broader range of financial risk. all of this enhanced the efficiency of resource use and the rate of output growth (crockett, 1999: 180 and sachs, 2000a: 221). simultaneously, the increased size, sophistication and complexity of the financial system have led to greater costs when a crisis strikes. in addition to dramatic output losses, domestic absorption and living standards suffered a harsh blow in the affected economies due to the reversal of capital flows and enforced turnaround in the current account of the balance of payments. capital inflows on average added 6 per cent to the spending power in the east asian economies. after the crisis, capital outflows reduced spending power with 9,5 per cent (crockett, 1997: 181). three types of instability associated with globalised capital markets emerged during recent years. they are the volatility in international capital flows, contar ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 3 466 gion of crises to economies previously perfonning satisfactorily and internal financial fragility resulting from the capacity of national banking and fmancial sectors to develop deep-seated weaknesses that emerge during costly crises. these three are interrelated and the worst-case scenario is when they occur simultaneously, as was indeed the case during the east asian crisis. the excessive volatility of capital flows is the result of macro-economic policy weaknesses in borrowing countries and herd behaviour by lenders incited by inadequate information. in emerging economies performing satisfactorily for some time, lenders optimistically and unrealistically extrapolate the continuance of good times. lenders then accept inflated collateral values, questionable fixed exchange rate policies and investment schemes. a cycle of euphoric capital inflows ends when economic weaknesses emerge, followed by a scramble for the exit. thus, if a debtor starts to weaken, a panicked withdrawal of short-term loans by risk-averse creditors may rapidly lead to the illiquidity of the debtor and then to bankruptcy, even if the debtor is fundamentally sound. both debtors and creditors lose during a financial panic, since it produces a pure loss of market value (sachs, 2000a: 223). financial fragility in borrowing countries presents a second source of instability. as in the case of volatility in capital flows, fmancial fragility arises from banks and financial institutions having built up portfolios of loans and other claims reliant on the continuation of a strong domestic economy. some further weaknesses are that underregulated and undercapitalised banks speculate rather recklessly with depositor funds, since profits are assumed to accrue to themselves, while losses are viewed as the responsibility of national governments. the international fmancial liberalisation of a poorly capitalised banking system invites over-borrowing and eventual crisis. also, political interference in lending decisions, excessive lending to connected enterprises, currency and maturity mismatches, dependence on collateral with inflated values, the absence of effective bankruptcy legislation, weaknesses in internal controls and lax and inexperienced banking supervision have in some way contributed to a financially frail environment in emerging markets (sachs, 2000a: 222). the third, complex source of instability is contagion, or the transmission of economic disturbances. this transmission does not happen entirely indiscriminately; weaker economies are usually hardest hit. although economies with sound policy and financial systems usually weather disturbances better, it served as no guarantee to escape fmancial turmoil. it is disturbing that also countries that had reasonably good domestic policies found their implementation threatened by external factors. economies are rendered unnecessarily vulnerable by the tendency of certain categories of investors to countries into a specific asset class. in the short run then, prices move in accordance with what the market in r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 467 sajems ns vol 4 (2001) no 3 general thinks, even if it deviates from fundamental indications. put differently, it is the reactions of other market participants that have to be correctly anticipated, irrespective of whether they are well informed, rather than market fundamentals (crockett, 1999: 182). the dramatic experiences of the past decade have inspired second thoughts in many quarters, if not the officialdom in washington, about the rapid liberalisation of international capital flows. the aim is to slow capital movements to prevent fmandal market panics, at least until the fmancial system has been strengthened by means of some necessary reforms and the underlying sources of market failure corrected. income distribution increased trade is alleged to have adverse effects on income distribution in advanced and developing economies. international economics theory predominantly deals with two types of trade. first, intra-industry trade, which occurs within an industry, in similar products and between similar countries. this kind of trade is based on the gains from specialisation under increasing returns to scale and results in a win-win situation for both parties; consumers in both trading countries benefit from a wider range of more reasonably priced products than would have been the case under autarky. in addition, no one suffers a loss of income, absolute or relative. the second kind of trade, inter-industry trade, is motivated by differences in factor endowment. for example, the united states specialises in products that are intensive in technology, physical capital and skills, and imports inexpensive labour intensive products from asia. according to standard trade theory, both inter-industry trading partners could gain overall, but workers within both may be worse off as a result of trade. less skilled workers in the united states face increased low-wage competition, while skilled workers in asia may lose their jobs as a result of skill-intensive imports from the unites states. in general terms, the heckscher-ohlin-samuelson theory of trade implies that unskilled workers in advanced economies may suffer a relative and even absolute decline in income, while the same applies for skilled workers in developing countries. interindustry trade is strongest between dissimilar countries, typically between advanced and developing countries. therefore, the income-distributional implications of rich-poor country trade are particularly threatening to specific social groups; as a result, the increasing rich-poor country linkages have proven particularly challenging politically (sachs, 2000a: 224). a contentious issue is the rise in income inequality within advanced economies during the period of dramatic globalisation; more specifically, low-skilled workr ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 3 468 ers in these countries, for example the united states, have suffered a loss of income. although this is consistent with conventional trade theory, it is unlikely that trade is the sole cause of the widening income gap. technological advance may also have contributed in the sense that it favours skilled workers. it is most likely a combination of globalisation and technological change that was responsible for the deterioration of unskilled wages in advanced economies, with the preponderant weight on technology according to recent studies. globalisation may affect income distribution through additional channels not recognised by conventional trade models. the exposure to foreign low-wage competition may have reduced the bargaining power of union workers compared to capital. capital mobility and the outsourcing of production have greatly increased the substitutability of labour across borders and also the economic insecurity confronting workers in addition to exerting downward pressure on their wages. the suggestion that the growing income inequality is caused by more than interindustry trade is supported by evidence from developing countries witnessing a similar rise in the salary premium of skilled workers. although empirically unexamined, it appears as if the scale of the world market has dissimilar effects on skilled and unskilled workers. this has led to a global rise in the market premium for skilled workers, while the opposite is observed for unskilled workers (op. cit.: 224). the world trade organisation a prominent feature of globalisation is the increased harmonisation of economic institutions. there was a significant rise in international treaty obligations regarding trade, investment policy, tax policy, intellectual property rights, banking supervision, currency convertibility, foreign investment policy and even the control of bribery. an ever-expanding web of treaties links nations through multilateral, regional and bilateral obligations (sachs, 2000a: 218). the world trade organisation (wto) is not the only international organisation involved in the orchestration of freer trade and investment flows, but it is the only international institution specifically entrusted with the task and therefore the only one discussed here. the wto appears to be in a sound state. the results of the uruguay round have been implemented largely on schedule and two prominent liberalisation agreements have been signed since. the negotiations on fmancial services are continuing and may be concluded soon. the new dispute settlement procedures are operating smoothly and the single-undertaking nature of the wto, combined with the accession of several middleand lower-income developing countries, has given rise to an active wto programme of technical assistance. also, the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 469 sajems ns vol 4 n03 ministerial conference in singapore resulted in a clear political endorsement of multilateralism (blackhurst, 1997: 528). despite these successes, the wto also faces a number of challenges. for instance, the integration of a large number of least-developed and other lowincome developing countries into the wto system is posing several difficulties. many of the current members of the wto and the majority of the countries in the process of acceding, fmd the "single undertaking" attached to wto membership challenging. two-thirds of the least developed wto members have no representation in geneva, which is problematic since the wto is a memberdriven organisation in which delegates participate more actively in daily activities than is true of other international economic organisations. these members also have vastly inadequate back-up support in their capitals. it is questionable whether these countries will be able to participate meaningfully in wto negotiations and the demand for technical assistance will by far exceed the ability of the wto secretariat to deliver it (op. cit.: 530). further cause for concem is the threat that regionalism poses to multilateralism. during the post-war era, free-trade areas and customs unions complemented the multilateral trading system due to what now appears to be special circumstances or luck even. there is no reason to believe that the post-war complementarity will persist, partly because regional agreements can be either outward or inward orientated, and partly because of the controversy surrounding the operation of existing wto rules and procedures governing regional agreements. it may prove particularly challenging to deal with the backlash against globalisation. there are growing signs of a public reaction against the continued integration of the world economy due to the following alleged repercussions of increased trade and capital flows. for instance, job losses among the unskilled workers, the widening gap between skilled and unskilled wages and pressures for cutbacks in social welfare programmes. critics in developing countries add their voices with the claim that globalisation is marginalising poor countries and widening the gap between rich and poor countries (op. cit.: 531). the response to these concerns will clearly include the wto argument that a return to protectionism will only make matters worse. governments are accused of a lack of candour regarding the effects of globalisation: although the nation as a whole benefits, some groups in the economy will lose. similarly, although globalisation opens the door to tremendous opportunities, it also raises the cost of bad policies like inflexible labour markets, over-regulation, sub-standard education and crowding out of private investors due to chronic budget deficits. the role of the wto has been changing dramatically during the last decade, driven by the forces of globalisation, the collapse of central planning, the develr ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 n03 470 oping countries' willingness to embrace export-led growth strategies and the approaching near universal membership. should these forces persist, it is envisaged, at least within wto ranks, that the wto may become the pre-eminent international economic organisation (op. cit.: 533). foreign direct investment it has already been stressed that the diffusion of knowledge has been an important determinant of the post-war patterns of trade, growth and development. foreign direct investment is intimately connected to the transfer of technology between nations and is therefore influential in the shaping of post-war economies. its importance is however more than qualitative; fdi has expanded dramatically over the past two decades, following the removal of national barriers to capital movement. the vast majority of investment was between developed countries, particularly within the oecd. as in the case of the trade models, the pattern of fdi flows suggests that conventional models, which stress relative factor endowments and relative factor costs to explain fdi, need to be augmented to explain the fdi flows between similar countries. comparative advantage is viewed as historically contingent. models explaining the location of production activities need to allow for imperfect competition, product differentiation, and the benefits from the agglomeration of complementary activities (barrel & pain, 1997: 1772). two central determinants of the pattern of production and investment amongst advanced nations appear to be knowledge-based, firm-specific assets and the evolving structure of trade barriers between and within large regional markets, like the eu and nafta. the existence of knowledge-based assets might, particularly in some industries, gradually lead to a substitution of fdi for exports. firms are encouraged to rather undertake direct foreign investment than license foreign firms to undertake production. firms producing tradeables may also invest abroad to improve market access or to bypass trade barriers. the internationalisation of production has coincided with a growth in regional trade agreements, where external barriers remain while internal barriers are gradually dismantled. barrel and pain report that non-tariff contingent barriers, like the instigation of anti-dumping cases, have significantly affected the scale and pattern of japanese fdi in europe and north america (op. cit.: 1773). in order to understand the channels through which new technology continues to flow, it is important to understand the long-run determinants offdi, in terms of the home country and industry and in terms of the host country. barrel and pain r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 471 sajems ns vol 4 (2001) no 3 significant effect between sectors over time and innovating sectors invest more abroad. barrel and pain suggest that new products, processes and techniques may be expected to come with inward foreign investment (op. cit.: 1775). the same study found that the timing of foreign investment was affected by domestic financial factors, such as interest gearing, the ratio of interest payments to cash flow, business sector profitability and the growth of real equity prices. the preferred indicator varied from country to country. tighter domestic fmancial conditions are associated with a lower level of foreign investment. exchange rate stability and labour market conditions in the host country were found to affect the ability to attract inward investment fdi may alter the production possibilities of a host country since it is primarily undertaken by technologically progressive sectors and comes with new technologies and additional capital. resistance against fdi is experienced in many developed countries; the benefits of fdi are alleged to be limited because it predominantly consists of mergers and acquisitions rather than investment in greenfield sites (op. cit.: 1777). in all likelihood, the reorganisation of existing capacity and introduction of new ideas associated with take-overs may raise the rate of technical progress and long-run growth potential without adding to fmal demand directly. microeconomic evidence indicates that the spill-over effect of these inflows of new technologies and working practices from multinationals may significantly benefit local firms in the host country. foreign ownership is viewed as more than the relabelling of companies; it is the potential transformation of economies (op. cit.: 1778). it is widely acknowledged that inward fdi has raised the growth rate in many developing countries. less is known about its impact on economic performance in developed economies, for example the european economies. us affiliates have a greater propensity to undertake r&d and a higher average labour productivity than domestic firms in european host countries. manufacturing activities received a particularly high level of inward investment; this has proven important in the economic development of smaller european economies such as belgium and ireland. it is also claimed that inward fdi has contributed to the supply-side transformation in the united kingdom. also, the contribution of foreign affiliates to employment and exports in the tradeables sector of many economies is rising. however, this offers no proof that inward investment has also served to raise the income levels of the factors of production in the host economies. preliminary studies indicate that fdi flows may potentially affect the pace of economic growth in advanced economies, but that it is not the only factor behind the growth in technical progress or total factor productivity (op. cit.: 1782). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 3 472 fdi not only affects patterns of output and technical progress; it also affects trade patterns. the effect of inward investment on trade is simply that it changes the range and technological profile of host-country output, which profile is an important determinant of trade performance. outward investment may serve as a complement to exports either by enhancing market access and sales facilities, or as a substitute for them. fdi in low-cost locations might also raise imports and substitute domestic production in the home country. often the additional flow of income from existing investment in knowledge eventually raises national income. although both inward and outward investment may create or substitute for exports under particular circumstances, there appears to be a complementary relationship between inward investment and exports, while the evidence regarding the relationship between outward investment and export performance is generally mixed. early cross-sectional studies indicated a complementary relationship; it was later reported that both fdi and exports have risen due to general economic growth and that there is little evidence of substitution between outward investment and exports. this fails to address the crucial question of whether rising fdi enhances or inhibits national export performance (op. cit.: 1783). later studies were consistent with the hypothesis that, on average, multinational companies shift their production of exports from home to host countries. barrel and pain found that net outward stock has a significant effect on export performance, with a higher level of net outward fdi negatively related to exports over time. this suggests that fdi benefits host countries, while it is not without cost to the home country. however, a full general equilibrium crosscountry analysis is required to take account of endogenous linkages between trade, investment and technological change. globalisation, social values and the goverl'.'ment labelling everyone ill at ease with the consequences of international economic integration a self-interested protectionist does not contribute to the understanding of why broad popular support for free trade is lacking. trade distributes income among nations. a defense of free trade cannot be constructed without addressing the issue of fairness and legitimacy of the practices that generate the distributional cost. traditional trade theory treats divergent sets of values, norms and institutions like any other differences that determine a country's comparative advantage. the source of a nation's comparative advantage matters, however. for instance, low-wage foreign competition arising from an abundant labour force is different from competition based on foreign labour practices that violate domestic social r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 473 sajems ns vol4 (2001) no 3 nonns. a scenario where history and demography give rise to low wages is very different from one where government repression of unions results in low wages (rodrik, 2000: 234). trade invites arbitrage in national norms and social values. it may come into conflict with long-standing social contracts and becomes contentious when it unleashes forces that undermine social norms; hence the widespread populist reaction to globalisation. once it is recognised that trade has implications for domestic norms and social arrangements and that its legitimacy depends on its compatibility with these, the notions of fair trade and leveling of the playing field are not as ridiculous as they are often made out to be by purists. the anxieties generated by globalisation should also be seen in context of the expanding demands on national governments to perform social-welfare functions. it was only during the postwar period that it became part of governments' agenda to ensure adequate levels of employment, to establish social safety nets, to provide medical and social insurance and to care for the poor. the implicit postwar social bargain in the advanced economies included the provision of social insurance and safety nets or some form of safeguarding against heightened economic risk in exchange for the adoption of freer trade policies. lids bargain is falling apart. employers are less willing and less able to provide benefits like job security, because increased global mobility has reduced their dependence on the goodwill of the local labour force and because of increased competition. governments' ability to sustain social safety nets is eroded, partly because of the increased mobility of capital rendering part of the tax base footloose, but also because the ideological onslaught against the welfare state paralysed them to respond to the social needs of a more integrated economy (op. cit.: 230). empirically, there is a strong correlation across countries between the degree of exposure to trade and the importance of government in an economy. the positive association between openness to trade and the amount of spending on social programmes is not confined to oecd or advanced economies. the same pattern is observed in developing economies. rodrik (2000: 232) concludes that the social welfare state appears to be the flip side of the open economy. the dilemma posed by globalisation is the following: it simultaneously increases the demand for social insurance and constrains the ability of governments to respond to that demand. it is to be expected that, as international integration progresses, the social consensus required to maintain the openness of domestic markets weakens. social safety nets played a vital role in enabling the postwar trade expansion and if allowed to dwindle, the tension between globalisation and the demands to mitigate economic risk may give rise to protectionist pressures. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 3 474 conclusion phases of a high degree of economic integration are a historical phenomenon ~ in its current guise it is referred to as globalisation. the influence of globaiisation over the evolution of the world economy has become highly contentious. some believe it to be at a crossroad. it has undoubtedly generated unprecedented prosperity, but has also witnessed a widening rich-poor gap within advanced countries, and between the developed and the developing world. several distinct features characterise current globalisation; among them the prominence of technological innovation and diffusion, and foreign direct investment. moreover, a particular trade pattern has evolved and although globalisation benefits nations overall, clearly not everybody stands to gain from it ~ a truth not conveyed by the political process canvassing for public support of open markets. in addition to undesired economic ramifications, such as an altered income distribution, harming low-wage earners in developed and developing economies, and the increased likelihood of financial crises, social values and implicit social agreements are threatened. this erodes the social consensus required to maintain open trade and gives rise to populist demands for fair trade. the need for social security and safety nets to mitigate economic risk in an increasingly competitive environment is rising at a time when the capacity of governments to meet these demands is diminishing. in an era where the welfare state is on the retreat, tension between the forces of globalisation and social needs is mounting. clearly a return to protectionism is inconceivable. the tide of globalisation is in all likelihood irreversible in any case. in its current form, however, the weaknesses are only too apparent and will have to be addressed. this cannot be achieved by the institution of trade barriers and other guises of protectionism, but by appropriate international trade policy and political candour to safeguard the potential gains from trade and investment to be reaped from open world markets. references barrel, r. & pain, n. (1997) "foreign direct investment, technological change and growth within europe", the economic journal, 107 (november): 1770-86. 2 blackhurst, r. (1997) the wto and the global economy, blackwell publishers ltd. usa. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 475 sajems ns vol 4 (2001) no 3 3 crockett, a.d. (1999) "international financial stability how can it be restored and maintained", south african journal oj economic and management sciences, 2(2): 176-87. 4 gupta, s.d. (1997) dynamics oj globalization and development, kluwer academic publishers, massachusetts. 5 na yy ar, d. (1997) "globalisation, the game, the players and the rules", in gupta, s.d. (ed.) dynamics ojglobalization and development, kluwer academic publishers, massachusetts. 6 o'rourke, k.h. & williamson, j.g. (2000) globalization and history, the evolution oj a nineteenth-century atlantic economy, mit press, cambridge, massachusetts. 7 rodrik, d. (2000) "international economics: unlocking the mysteries of globalization", in o'meara, p. et a/. (ed.) globalization and the challenges oj a new century, indiana university press, bloomington: 227-39. 8 rubin, r.e. (2000) ''no guarantees, real risks", lse magazine, 12(1): 12-14. 9 sachs, j. (2000a) "international economics: unlocking the mysteries of globalization", in o'meara p. et a/. (ed.) globalization and the challenges oj a new century, indiana university press, bloomington: 217-26. 10 sachs, j. (2000b) "sachs on globalisation, a new map of the world", the economist, june 24:99-101. 11 slaughter, mj. & swagel, p. (1997) does globalization lower wages and export jobs?, economic issues, imf, washington. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . microsoft word 5 conradie & garcia sajems 16(2) 2013.docx 170 sajems ns 16 (2013) no 2 an estimate of the recreational value of the agulhas plain, south africa, with special reference to the value of plant biodiversity beatrice conradie and maria garcia school of economics and centre for social science research, university of cape town accepted: november 2012 the agulhas plain is a remarkable recreational site which combines the attraction of a pristine marine environment with exceptional plant biodiversity, rural tranquility and the novelty of being at the southernmost tip of africa. the resource is a public good to which the market cannot assign a full value. this paper presents an estimated recreational value based on individual travel cost models and a sample of 370 visitors surveyed in 2010. trip demands were estimated with zero truncated negative binomial models to account for over-dispersion. the study established a recreational value of r2.167 billion in 2010 prices for the site as a whole. by partitioning the sample into visitors who indicated having been attracted or not to the area by its nature and biodiversity, a net biodiversity value of r2 866 per trip was calculated. allocated between marine and terrestrial resources based on the proportion of activities related to each type of resource, the value of plant biodiversity was estimated to be r2 268 per hectare in 2010to 2010 prices. key words: recreational value, biodiversity valuation, individual travel cost model, agulhas plain jel: q260, 210 1 introduction recreational sites are recognised as public goods which are undervalued by the market and therefore depend on public investment for their support. over the last twenty years, individual travel cost models have emerged as the preferred way of measuring the use value of recreational sites (creel & loomis, 1990; freeman, 1993; eglin & shonkwiler, 1995; gurmu & trivedi, 1996; garrod & willis, 1999; ward & beal, 2000; shrestha, seidl & moraes, 2002; martínez-espiñeira & amoakatuffour, 2008). the main objective of this paper was to estimate the recreational value of the agulhas plain as a single destination. the agulhas plain is the coastal lowland between hermanus and the estuary of the breede river, an area covering 335,335 hectares. the site offers a pristine coastline with many excellent opportunities for whale watching, shark-cage diving, recreational fishing and diving. two thirds of the world’s whale and dolphin diversity occurs along this coast. the agulhas plain is equally well known for exceptionally rich plant biodiversity. an area total of 1,751 plant species, including 99 endemics, 112 red data book species and 46 vegetation types have been described (thwaites & cowling, 1988; cowling & holmes, 1992; cowling & mustart, 1994; lombard, cowling, pressey & mustart,1997; privett, 2002; raimondo, von staden, foden, victor, helme, turner, kamundi & manyama, 2009). almost a third of the land surface area is formally protected in the agulhas national park, which also includes the southern tip of africa and the agulhas lighthouse, as well as de hoop nature reserve, the nuwejaars wetland private protected area and a handful of smaller wildflower reserves. it is estimated that about half a million people visit the area every year, causing the number of inhabitants in the many coastal settlements to increase ten to twentyfold during the holiday seasons of christmas and easter. the secondary objective of this paper was to extract a plant biodiversity value from the overall recreational value of the site. this need abstract sajems ns 16 (2013) no 2 171 arose in the context of the agulhas biodiversity initiative, which attempted to secure private farmland for conservation. the two main conservation-compatible enterprises identified for the area were wildflower harvesting and eco-tourism (lochner, weaver, gelderblom, paert, sandwith & fowkes, 2003). at an income of less than r220 per hectare in 2010 prices (conradie, 2010), wildflower harvesting did not compete with wheat or canola. private eco-tourism revenues could not secure conservation, as the agulhas plain gives open access to large tracts of coastline and untransformed vegetation. conservation on private land therefore had to be incentivised. in order to raise the funding for this, conservation managers had to come up with a unit value for natural vegetation. turpie, heydenrych & lamberth (2003) provided one such attempt in which the total valuation of the environmental resources in the cape floristic region was calculated in 2010 prices as r4 570 per hectare of untransformed land. this estimate referred to all natural resources, so it could be improved upon for the purposes of landscape conservation by extracting a biodiversity value for terrestrial resources only. the standard travel cost methodology was followed in this paper. data collection, the modelling implications of zero truncated count data, the trip demand specification and the welfare calculation are discussed in the section on methods. the results contain descriptive statistics, the econometric estimates for the trip demand functions and the value estimates. the paper ends with a discussion and conclusions. 2 methods a data collection the visitor survey began on the easter weekend of 2010 (2nd april) and the data collection period lasted for four weeks. all economically active adults were surveyed. in total, 196 surveys were completed, which represented a total of 411 adults and 106 children (defined as being under 16 years of age). of the adults, the 370 who were defined as economically active were of interest for the study. the questionnaire was located at four of the five cape agulhas tourism bureaux, agulhas, bredasdorp, napier and elim; it was also located at two of the overberg tourism bureaux, gansbaai and stanford. we recognised that the emphasis on sampling at tourist bureaux could result in a non-random sample, which is why the help of members of the tourism association was enlisted in hosting the questionnaire. owing to the expensive and extensive manpower requirements of administerring a questionnaire randomly across such a large geographical area, the resources available for this study did not permit the use of a more complex sampling design, such as stratification or clustering, which should be considered in future studies of this nature. b modelling with zero truncated endogenously stratified count data sampling visitors at recreational sites is standard, but the nature of the data generated in this way requires special attention to be paid to functional form during estimation. trips are a count data variable, which is usually poisson distributed, meaning that a small number of people visit quite frequently while most visit rarely. however, since survey data almost never meet poisson’s stringent requirement of the mean being equal to the variance, a poisson regression produces biased and inconsistent coefficients (creel & loomis, 1990; grogger & carson, 1991). the mean equals variance requirement of poisson is relaxed in the negative binomial regression by including a parameter alpha to capture the degree of over dispersal in the sample (martínez-espiñeira & amoaka-tuffour, 2008). a likelihood ratio test of alpha=0 determines the choice between poisson and a negative binomial regressions (eglin & shonkwiler, 1995). a sample of visitors collected at site is, by definition, zero truncated. there are two ways in which to account for zero truncation in estimation. in the presence of limited overdispersion, one could simply be subtracted from the reported number of trips before estimating with an ordinary negative binomial regression (fix & loomis, 1997; loomis, 2003; martínez-espiñeira et al., 2006). however, this simple fix does not account for endogenous stratification, which arises from 172 sajems ns 16 (2013) no 2 frequent visitors having a greater chance of being sampled at the site than infrequent visitors have. the solution is to estimate a negative binomial regression which is corrected for zero truncation as well as endogenous stratification (eglin & shonkwiler, 1995). the zero truncated endogenously stratified negative binomial regression significantly increases the computational burden over that of the standard negative binomial regression (martínez-espiñeira & amoaka-tuffour, 2008), which is problematic when the sample size is limited. for this reason only, following fix and loomis (1997) and loomis (2003), we did not correct for endogenous stratification but instead corrected for zero truncation by defining the dependent variable as trips other than the current one taken during the past twelve months. c trip demand specification the demand for total visits per annum was modelled as a function of travel costs, income, tourist characteristics and location-specific factors. when constructing the dependent variable (number of previous visits to the region per year), we had to assume that a visitor’s previous trips in that year shared the same characteristics as the visit during which he or she was surveyed, as it was unrealistic to expect a visitor to describe the characteristics of all previous trips (kerkvliet & nowell, 1999; garrod & willis, 1999; markandya harou, bellù & cistulli, 2002). self-reported trip expenditure was recorded in the survey, but, given the complex journeys many people undertook, it was decided, for the sake of consistency, to construct a total travel cost variable for each visitor. where transport was shared, costs were divided equally between economically active adults. when it came to self-drive holidays, the distance travelled from home to the agulhas plain and back was multiplied by a standard car-running cost, including fuel, maintenance and tyre factors (automobile association, 2010). the arrive alive campaign’s route planner (2011) was used to establish distances travelled. for those who flew into cape town and then rented a car or went by bus to the agulhas plain, the proportion of total-trip travel cost included was dependent upon whether the visitor had planned to come to the agulhas plain before leaving home. if the agulhas plain extension had been decided on after arrival in south africa, only the distance from the last point outside the area and back was included in the travel cost estimate. for spur of the moment visitors, the decision had usually been made in cape town or along the garden route. for visitors who had planned to come to the agulhas plain all along, a share of airfares was counted based on the proportion of days spent in the area (kerkvliet & nowell, 1999). we followed bellù and cistulli (1997) in leaving out the value of tourists’ time in order to avoid the problems described by cesario and knetsch (1970, 1976), freeman (1993) and common, bull & stoekl (1997). a missing expenses dummy variable was constructed to indicate observations for which travel costs were omitted. as a fundamental determinant of demand, the price of substitute sites that a visitor could have considered ought to have been included in the demand model. in practice, the price of substitute sites was not universally included in the literature. some studies omitted it for good reason; for example, once a license for hunting at a specific site had been purchased, the site no longer had relevant substitutes (creel & loomis, 1990). other studies omitted the price of substitute sites for convenience (rosenthal, 1987; common et al., 1997; garrod & willis, 1999; liston-heyes & heyes, 1999). du preez & hosking (2011) did not include a price but used a round-trip travel time between a respondent’s home and his or her best alternative destination as a proxy. while omitting the price of substitutes might have led to an upward bias in the value estimate (listonheyes & heyes, 1999), this omission was considered small enough, as only 38 per cent of our respondents indicated that they would have gone on an alternative trip had they not come to the agulhas plain. the income question on the survey presented respondents with a list of eight monthly income brackets as follows: inc1 (less than r4 999), inc2 (r5 000–9 999), inc3 (r10 000–14 999), inc4 (r15 000–19 999), inc5 (r20 000–24 999), inc6 (r25 000– 29 999), inc7 (r30 000–39 999) and inc8 (r40 000 or over). the responses to this categorical variable were converted into a sajems ns 16 (2013) no 2 173 continuous variable by taking the midpoints of each income bracket. although the theoretical relationship between recreational trips and income is positive, empirical results often fail to confirm this (du preez & hosking, 2011). tourist characteristics were modelled with two indicator variables plus party size. the dummy variables recorded whether or not someone was on a more extensive trip within south or southern africa (1 = yes) and whether he or she enjoyed travelling (1 = yes). since more comprehensive journeys are characteristic of foreign visitors, who tend to visit the agulhas plain less frequently than locals do, the expected sign of the larger trip dummy variable was negative, while the expected sign on the “enjoy travelling” dummy variable was negative. it was constructed from the responses to a five-point likert scale, of which the categories “enjoy a lot” and “enjoy somewhat” were combined into “yes” responses. party size was defined as the total number of adults and children travelling together and could include multiple households. we had no prior expectation regarding the sign of the party size coefficient; on the one hand a positive sign on party size could point to the family-friendly nature of the agulhas plain destination, but, on the other hand, people on extended journeys tend to travel in larger groups. the questionnaire presented visitors with a list of twelve possible reasons for visiting the agulhas plain. the categories were constructed from a question which read: “how influential or not were the factors below on your decision to come to the agulhas plain on this visit or previous visits?” options included “i/we own property in the region”; “whale watching”; “nature and biodiversity unique to the agulhas plain”; and so on. each potential reason for visiting had to be rated on a four-point likert scale labelled “extremely”, “quite”, “hardly” and “not at all”. the categories “extremely important” and “quite important” were combined to form the “yes” responses in a series of attraction dummy variables. a factor analysis using a principle component extraction method yielded four factors with eigen values of greater than one. these four factors together explained almost 55 per cent of the cumulative variance. an oblique rotation was used to identify the factor loadings presented in table 1 below. nature and biodiversity and ecotourism offerings both loaded strongly onto factor 1, with rotated factor loadings of 0.855 and 0.754 respectively. novelty loaded strongly onto factor 2 (0.728) and proximity loaded strongly onto factor 3 (0.833). for factor 4, the strongest loading (0.918) came from shark-cage diving. novelty, proximity and shark-cage diving were included as dummy variables in the trip demand model. t a b l e 1 factor analysis of the agulhas plain’s main attractions using principle component extraction and oblique rotation (n=370) reasons for visiting the area rotated factor loadings (values of <0.3 suppressed) factor 1 factor 2 factor 3 factor 4 uniqueness property ownership -0.780 0.327 activities offered 0.393 -0.353 0.366 0.548 southern tip 0.416 0.372 0.320 0.631 whale watching 0.351 0.555 shark cage diving 0.918 0.233 destination is close by 0.833 0.312 nature and biodiversity 0.855 -0.425 0.362 eco-tourism offerings 0.754 0.449 desire to visit specific locations 0.479 0.358 0.504 recommended to me 0.336 0.669 new destination 0.728 0.406 cheap destination 0.345 0.598 0.437 eigen value 2.476 1.769 1.288 1.037 cumulative variation explained 0.206 0.354 0.461 0.547 174 sajems ns 16 (2013) no 2 property ownership and attitudes to nature were used to partition the sample for the purpose of estimating profile-specific trip demand functions. model 1 referred to all visitors who answered “no” to the question “was nature and biodiversity unique to the agulhas plain influential on your decision to come to the agulhas plain on this visit or previous visits?” (n=79), while models 2 and 3 referred to visitors who answered “yes” to this question (n=231). for model 2, some people answered “no” to the question: “was the fact that you/your family own property in the region influential in your decision to come to the agulhas plain on this visit or previous visits?” (n=170), while those who answered “yes” were allocated to model 3 (n=61). a fourth model was estimated for the unpartitioned sample (n=310). a the welfare calculation there is a strong tradition in cost benefit analysis of simply using consumer surplus as an indication of value. in travel-cost modelling, consumer surplus was defined as the integral of the trip demand function between an individual’s travel-cost expenditure and a choke price, where the number of visits per annum demanded is “choked” to zero by excessive distance to the site (eglin & shonkwiler, 1995; bellù & cistulli, 1997; markandya et al., 2002). for count data models, consumer surplus per visit was calculated as 1/βtc (creel & loomis, 1990). a further concern has been raised in the literature, that the marshallian consumer surplus is strictly inappropriate where the empirical income effect is positive (ziemer, musser & hill, 1980; carr & mendelsohn, 2003), but in practice this is of little concern, as measurement errors in the demand function are likely to be far larger than the difference between the marshallian and hicksian consumer surplus values (eglin & shonkwiler, 1995; campbell & brown, 2003). total site value was calculated by multiplying the average consumer surplus per trip by the total number of trips to the site per year. since the agulhas plain is not gated, finding reliable visitor numbers proved challenging. the most reliable figures were for recorded visits at the cape agulhas lighthouse, de hoop nature reserve and the shark boats at gansbaai. this estimate represented a serious undercount, because we knew that local people were unlikely to be counted in any of these activities. recorded visits were adjusted upwards with a factor of 4.02, based on information from the survey, which revealed that people who were attracted by property in the area visited 4.02 times more frequently than people who did not indicate that property to have attracted them to the site. estimates of visits per type of visitor relied on the assumption that the composition of visits (not observations) in the sample was representative of visits made by the population as a whole. b procedure for calculating a perhectare value of plant biodiversity separate demand functions were recorded for the three-visitor types defined above. the value of the group who did not care about nature and biodiversity could logically be attributed to nature and biodiversity. the average value per trip for this group was subtracted from the average value generated by the two groups of visitors who indicated being influenced by nature and biodiversity. for the group attracted by nature and biodiversity as well as property ownership, the value of property also had to be subtracted from the net willingness to pay for nature and biodiversity. partitioning the value of nature and biodiversity between marine and terrestrial resources proved to be another challenge. both subjective ratings of the importance of nature (turpie et al., 2003) and the amount of time spent at a particular natural feature (turpie & joubert, 2001) had been used to apportion tourism values to particular features. in this study, reported activities served as the basis for allocation. to obtain a per-hectare value of terrestrial biodiversity, the share of recreational value apportioned to terrestrial resources was divided by the size of the protected area on the agulhas plain. protected areas away from the coast offered the cleanest match with the single activity of viewing untransformed fynbos landscapes, but since these areas are quite small, the resulting value per hectare was overinflated. moreover, geelkop nature reserve near elim (450ha), platbos near gansbaai sajems ns 16 (2013) no 2 175 (30ha) and fernkloof nature reserve in hermanus (1 800 hectares) are not the only places where visitors can enjoy natural landscapes. including de hoop nature reserve (34 000 ha), agulhas national park (28 000 ha) and the nuwejaars wetland farmers association’s private protected area (42 000ha) increased the total protected area on the agulhas plain to be included in the per-hectare calculation to 106 700 hectares. 3 results a descriptive statistics table 2 reports descriptive statistics for variables used to model per-capita trips demanded. in addition, it shows the results for a number of demographic variables which did not significantly explain the variation in the number of visits demanded per annum. the respondents’ ages varied from 18 to 78 years, giving an average of 43 years. women comprised 53 per cent of the sample. almost half of the visitors reported holding a university degree while a further 28 per cent held a non-university tertiary qualification. the majority of visitors lived in the western cape (61 per cent), or abroad (19 per cent). the sample included 36 per cent first-time visitors. the 64 per cent of the sample who had been to the area before stated that they had made 934 separate visits to agulhas in the previous twelve months. almost four in five visitors said they were likely to return within the next twelve months. on average, people were away from home for fourteen days in total and on the agulhas plain for five days. the non-response to the income question was 16 per cent, which was considered a good response rate for a question of this type (rea & parker, 2005; nardi, 2006). the most frequently recorded category was an after-tax income of over r40 000 per month (25 per cent), followed by an after-tax income of r10 00014 999 per month (22 per cent). the median reported that after-tax income was about r300 000 per annum. the average number of visits demanded was 3.52 per annum. one in five visitors indicated having been attracted by local property ownership. those who listed property in the region as a main attraction visited on average 8.33 times per annum, while people who did not mention property reported visiting 2.07 times on average per annum. party size, including children, varied from one to seven with an average of 3.09 persons per party. despite the strong representation of all age groups, it was worth noting how few parties travelled with children. only 24 per cent of parties included children, with an average child-to-adult ratio of 0.24 and an average of 1.86 children per party travelling with children. of the 34 per cent of respondents who were on a more extensive trip through south africa or southern africa, 48 per cent had not planned to visit the agulhas plain when they set off from home. the average calculated transport cost was recorded at r799 per trip and the average expenditure on airfare attributable to the agulhas plain was estimated to be r531 per trip. the average stated budget for the agulhas plain portion of a given trip was r2 386 per person. this implies an average budget, excluding transport cost, of r1 682 per person per trip. these figures include respondents’ expenditure on behalf of non-economically active partners and minor children in the party. b estimated trip demand functions the estimation results by type of visitor appear in table 3. a negative binomial regression was used in each case, which was appropriate, given the results of the likelihood ratio tests of alpha=0 printed at the bottom of table 3. model 1, estimated over 79 observations, and produced a mcfadden’s r2=0.1920 and a log likelihood statistic = -139.36. model 2, estimated over 170 observations, and produced a mcfadden’s r2=0.1427 and log likelihood statistics =-183.54. model 3, which had a sample size of only 61 observations, produced a mcfadden’s r2=0.1532 and a log likelihood statistics =-129.00. model 4, estimated over the full sample of 310 observations, produced a mcfadden’s r2=0.1189 but a log likelihood statistic =-533.40, which indicated that the portioned sample had improved the fit. all four models passed their wald likelihood ratio specification tests. 176 sajems ns 16 (2013) no 2 t a b l e 2 summary statistics of a sample of agulhas plain visits in 2010 variable n mean sd min max age 368 43 13 18 78 gender (1 = female) 368 0.53 0.50 0 1 education 349 incomplete high school 2% high school completed 16% trade certificate 28% bachelor’s or honours degree 36% master’s or phd 13% other 4% origin 370 western cape province 61% gauteng province 10% rest of south africa 11% international 19% duration of agulhas visit 370 5 7 1 90 duration of full journey 370 14 36 1 365 first visit d 370 0.36 0.48 0 1 income distribution 312 inc1 ≤ r4 999 6% inc 2 r5 000 – 9 999 11% inc 3 r10 000 – 14 999 22% inc 4 r15 000 – 19 999 12% inc 5 r20 000 – 24 999 4% inc 6 r25 000 – 29 999 10% inc 7 r30 000 – 39 999 10% inc 8 ≥ r40 000 25% visits per annum 370 3.52 5.44 1 46 if property is listed as an attraction 86 8.33 8.94 1 46 if property is not listed as attraction 284 2.07 2.34 1 31 party size 370 3.09 1.53 1 7 child to adult ratio 370 0.27 0.47 0 2 parties travelling with children 29% larger trip d 370 0.34 0.47 0 1 enjoy travel d 370 0.84 0.36 0 1 property attraction d 370 0.23 0.42 0 1 biodiversity attraction d 370 0.76 0.43 0 1 shark cage diving attraction d 370 0.26 0.44 0 1 missing expenses d 370 0.19 0.40 0 1 calculated travel cost agulhas portion (r) 370 799 2 293 18 30 402 tickets agulhas portion (r) 370 531 2 287 0 30 000 trip budget agulhas portion (r) 241 2 386 4 466 250 60 000 budgeted less transport agulhas (r) 241 1 682 2 611 16 29 598 in model 1 the travel cost coefficient marginally missed being significant at p≤0.15, but all the other variables, except for the sharkcage dummy variable, were significant at this level. all the signs confirmed our prior expectations. visitors who did not report travel expenses visited 0.923 times fewer in a year than visitors who reported travel expenses. each additional r1 000 of income per month increased the expected number of visits per year by 0.032, while each additional party member (including additional children, increased expected trips by 0.457 trips per year. those who indicated that they enjoyed travelling sajems ns 16 (2013) no 2 177 visited 0.746 times a year more that those who indicated that they did not. the expected number of trips per year by those who indicated being on a larger trip through southern africa was 2.370 trips fewer than those who indicated that they were not on a larger trip. visitors who indicated proximity to their homes as one of the main reasons for visiting the agulhas plain reported coming on 1.87 more trips to the agulhas plain than those for whom proximity to home did not matter. the effect of the new destination dummy was also quite large; those who stated the site’s novelty as a major reason for visiting came on 3.33 trips fewer than visitors who did not indicate that the novelty of the agulhas plain was a major attraction. t a b l e 3 trip demand functions by agulhas plain visitor profile explanatory variables not influenced by nature and biodiversity influenced by nature and biodiversity all visitors not influenced by property influenced by property coef. [se] dy/dx coef. [se] dy/dx coef. [se] dy/dx coef. [se] dy/dx travel cost (r1000/trip) -1.246 -1.358 -0.273† -0.130 -0.128† -0.517 -0.297*** -0.395 [0.949] [0.187] [0.080] [0.094] missing expenses d -1.085* -0.923 -0.470 -0.196 -1.762** -3.549 -0.734*** -0.784 [0.641] [0.341] [0.782] [0.258] income (r1000/month) 0.029† 0.032 0.021** 0.010 0.024*** 0.098 0.038*** 0.050 [0.020] [0.010] [0.01] [0.007] party size 0.419** 0.457 0.102 0.049 -0.067 -0.270 0.169*** 0.225 [0.201] [0.082] [0.071] [0.051] enjoy travel d 0.835* 0.746 0.643† 0.246 -0.923*** -4.957 0.374† 0.443 [0.486] [0.410] [0.235] [0.237] larger trip d -2.156*** -2.370 -0.690** -0.300 -0.285 -1.022 -0.928*** -1.065 [0.616] [0.320] [0.359] [0.225] shark cage diving d -0.078 -0.084 -1.686*** -0.579 -0.855*** -2.748 -0.255 -0.319 [0.601] [0.559] [0.268] [0.236] proximity §d 1.272*** 1.870 0.654*** 0.337 0.445** 1.743 1.000*** 1.498 [0.455] [0.249] [0.212] [0.184] new destination d -2.618*** -3.330 0.124 0.059 0.709** 3.842 -0.874*** -1.150 [0.605] [0.239] [0.329] [0.195] constant 0.033 -1.434*** 1.706*** -0.770** [1.018] [0.510] [0.543] [0.356] n 79 170 61 310 log likelihood stat -139.36 -183.54 -129.00 -533.40 mcfadden’s r2 0.1920 0.1427 0.1532 0.1189 wald lr statistic 66.24 *** 61.14 *** 46.68 *** 143.99 *** alpha 1.263 0.597 0.080 1.216 lr (alpha=0) 88.59 *** 10.82 *** 6.97 *** 408.21 *** ***significant at p≤0.01, ** significant at p≤0.05 , * significant at p≤0.10, † significant at p≤0.15 the missing expenses dummy variable, party size and the new destination dummy variable were not significant in model 2. the other coefficients carried the expected signs, including a negative sign on the travel cost variable and a positive sign on income. each additional r1 000 of travel expenditure translated into 0.273 fewer trips per annum, while a similar income increment resulted in 0.01 fewer trips per annum. according to model 2, visitors who enjoyed travelling would take 0.246 more trips per annum than people who did not enjoying travelling. those who said they were on a larger trip recorded 0.30 trips fewer per annum than visitors who were not on a larger trip. the impact of shark-cage diving as a major 178 sajems ns 16 (2013) no 2 attraction was -0.579 trips per annum, while the proximity impact was 0.337 trips per annum. in model 3, everything except party size and the larger trip dummy variable was significant. income and missing expenses both had much larger marginal effects than before. the missing expenses dummy variable had a marginal effect of -3.549, twenty times larger than the corresponding coefficient in model 2. income had a marginal effect of 0.098, which was ten times larger than the corresponding coefficient in model 2. the impact of the enjoy travel dummy variable was to reduce annual visits to the agulhas plain by 4.957 trips per annum. where the enjoy travel dummy variable carried positive signs in the other models, it was not surprising that it had a negative sign in model 3, since people who enjoy travelling are likely to spend more time abroad and therefore less time at their beach houses on the agulhas plain. the marginal effect of the shark-cage and the proximity dummy variable were -2.748 and +1.743 trips per annum respectively, while the novelty dummy variable had a marginal effect of 3.842 trips per annum. the combined model produced significant coefficient estimates for all the variables except for the shark-cage dummy variable. each additional r1000 of travel cost had a marginal impact of -0.395 trips per annum, while each additional r1000 of monthly income had a marginal effect of 0.050 trips per annum. compared with visitors who did not report travel expenses, those who did report them visited 0.784 fewer times per annum. the marginal effect of party size was 0.225 visits per annum. the outcome of enjoying travelling was to visit 0.443 times more a year, while the result of taking larger trips was to visit 1.065 times fewer per annum. the marginal effect of the shark cage dummy variable was -0.318, while those who indicated proximity to home as a main reason for visiting would visit 1.498 times more per annum than those who did not list proximity as a reason for coming. visitors who indicated the agulhas plain’s novelty as a main reason for visiting did so 1.15 times fewer per annum than people who did not list novelty as an attraction. c welfare estimation the cape agulhas lighthouse attracted an average of 25 251 visitors per annum between 2005 and 2009. over the same period, the average number of visitors to the de hoop nature reserve was 14 890 per annum, while the shark boat operators indicated that they received more than 60 000 visitors per annum. this put the total recorded visits at 100 141 per annum. recorded visits were inflated by a factor of 4.02 to produce an estimate of unrecorded visits per annum. when totalled, these two figures produced an estimated 503 124 total visits to the site per annum. t a b l e 4 the value of the agulhas plain as a recreational site welfare calculation not influenced by nature or property influenced by nature total all visitors not property also property observations 79 170 61 310 310 βtravel cost -1.24623 -0.27266 -0.12808 -0.29659 significance 0.189 0.144 0.108 0.002 consumer surplus r/trip 802 3 668 7 808 3.372 trips /person /year 4.69 1.92 6.83 3.52 consumer surplus r/year 3 763 7 042 53 326 11 868 % of observations 25% 54% 20% 100% 100% % of reported visits 33% 29% 38% 100% 97% estimated total visits 165 406 145 714 192 093 503 124 490 285 value of total visits rm 133 534 1 500 2 167 1 696 % of value 6% 25% 69% 100% 79% value of nature and biodiversity per trip r/trip – 2 866 2 866 2 866 2 866 total rm – 418 551 968 931 sajems ns 16 (2013) no 2 179 the value of the agulhas plain as a recreational site is summarised in table 4 by type of visitor in columns 1, 2 and 3. these three separate estimates were added up in column 4, while the valuations for the unpartitioned sample appear in column 5. line 1 contains the sample size, line 2 the estimated travel cost coefficient and line 3 the significance level of the estimate. line 4 inverted line 2 to calculate the travel cost per trip. the answers ranged from r802 per trip for people who indicated that they did not care about nature and biodiversity to r7 808 per trip for regulars who indicated being attracted to the site by nature and biodiversity as well as property. the undifferentiated estimate of value was r3 372 per trip. these estimates encompassed the total recreation value for the site. the reported number of trips per person per year appears in line 5, which was multiplied by trips per year to calculate the consumer surplus per person per annum in line 6. lines 7 and 8 expressed each sub-sample as a proportion of the total in column 4, first for observations and then for visits. in line 9, the estimated total number of visits per annum of 503 124 was apportioned to each of the subsamples based on its share of visits (not observations). in line 10, these visits were multiplied by the consumer surplus per trip from line 4 to produce estimates of the total recreational value derived from each subsample. in line 11, the shares of the site’s recreational value were calculated as follows: 6 per cent to visitors who do not care about nature and biodiversity, 25 per cent to visitors who care about nature but not about property and 69 per cent to people who are attracted by nature as well as their property in the area. the total recreational value of the agulhas plain across these three groups was r2.167 billion per annum. if the sample was not partitioned, the total valuation would be 21 per cent lower at r1.696 billion per annum. lines 12 and 13 extracted nature and biodiversity’s share of the total valuation, first as a share of the consumer surplus per trip, and then, by multiplying with total visits, as a total biodiversity value. the first sub-group by definition derived no value from nature and biodiversity. by subtracting r802 from r3 668, the net value of nature and biodiversity was established as r2 866 per trip for the second group. this same biodiversity value was assigned to group 3, which implied a beach house to account for r4 796 of recreation value per annum. it seemed reasonable, as the investment in a beach house was probably made in the first place because people value the area. the final estimate of the value of nature and biodiversity on the agulhas plain was r968 million per annum in 2010 prices. t a b l e 5 participation rates in selected holiday activities (n=3 771) holiday activities participation rate (%) lighthouses, harbours, fishing villages, arniston cave 22 beach and water sports 20 museums maritime 11 sharks and whales 8 nature reserves coastal, de hoop whale trail 8 hiking, horse-riding, quad-biking 10 nature reserves away from the seafront 7 breweries and wineries 6 riverboat at stanford 1 photography 0 hunting 0 napier toy museum, elim museum, klipgat archaeological site 5 the data in table 5 was used to divide the total value of nature and biodiversity into the value of marine and terrestrial resources. marinebased activities accounted for 69 per cent and terrestrial resources, including agriculture, for 25 per cent of all reported holiday activities. visits to cultural attractions accounted for the remaining 5 per cent of total visits. marine and 180 sajems ns 16 (2013) no 2 terrestrial resources were therefore estimated respectively to be worth r668 million and r242 million per annum. the terrestrial value, interpreted here as the value of plant biodiversity, was r2 268 per hectare of protected, untransformed vegetation. 4 discussion the consumer surplus travel cost valuation is exceptionally sensitive to the specification of the demand curve and the number of visits per annum, by which it is scaled up from the sample to the population of visitors. despite modest sample sizes, we are quite confident of having produced tight estimates of the demand curves for each visitor type. unfortunately, we are less confident of our estimate of the number of annual visitors. for resource managers in the region to have more confidence in the valuation, better visitor statistics must be kept. for example, a survey of car traffic into the area at peak holiday times or even subjective measures of beach congestion could address this issue in a cost-effective way. the per trip consumer surplus estimates could then simply be multiplied by the revised visitor numbers to update the valuation. nonetheless, the most directly comparable estimate of the recreational value for the agulhas plain appeared in the work by turpie et al. (2003), who reported the cape floristic region’s share of annual tourism expenditure to amount to r2 556 per untransformed hectare in 2000 prices. updated to 2010 prices, this valuation increased to r4 570 per untransformed hectare, which is double the value estimated in this study. for local tourism product owners, the great loyalty expressed towards the region by all the visitors ought to be very reassuring. regardless of specification, the demand for visits per annum was highly inelastic in transport expenditure; people who are going to visit the agulhas plain will continue to come, even if travel costs increase dramatically. however, an inelastic demand for visits is not quite the same as an inelastic demand for accommodation or entertainment. even in the presence of inelastic travel demand, it is still possible for local product owners to price themselves out of the accommodation or restaurant food market, or for the municipality to raise rates and taxes to the extent that beach house owners relocate to cheaper destinations. furthermore, one should keep in mind that the recreational values we discuss here arise from a public good and thus cannot be captured by private landholders. if society wants to change land use, landowners must be incentivised to do so. these results suggest that society could spend up to r2 866 per hectare per annum; without the incentive, private landholders will continue to raise wheat at r1 981 per hectare per annum. finally, this study presented clear evidence that plant biodiversity might be substantially less valuable than is popularly believed; in the eyes of visitors, terrestrial resources are not as important as marine resources by any stretch of the imagination. this means that the maintenance and development of marine resources ought to be prioritised over the maintenance and development of terrestrial resources whenever resource managers face a budget constraint. unfortunately this is not encouraging for conservation managers, who have been very hopeful in making a business case for fynbos conservation. 5 conclusion this paper set out to produce an estimate of recreational value for the agulhas plain as a single destination, and to derive from this total an estimate of the value of plant biodiversity per hectare of untransformed land. the recreation value of the agulhas plain was estimated to be r2.139 billion per annum and natural vegetation was estimated to be worth r2 866 per hectare. while the certainty of the estimate might be improved by keeping better visitor statistics and the total area by which biodiversity value should be spread might be debatable, we are quite confident that terrestrial biodiversity does not account for more than a quarter of the overall recreation values. sajems ns 16 (2013) no 2 181 acknowledgements the research was funded by cape agulhas tourism under the auspices of the agulhas biodiversity initiative. we would like to thank cat staff and product owners for assistance with the survey. comments by tony leiman, brain child and two anonymous reviewers offered valuable input. any remaining errors are our own. references arrive alive campaign. 2011. route planner. available at: http://www.arrivealive.co.za/ routeplanner.aspx [accessed 2011-08-31]. automobile association of south africa. 2010. calculating the operating cost of a vehicle. archived reports june 2010. available at: http://www.aa.co.za/content/1247/june-2010/ [accessed 2011-08-31]. bellù, l. & cistulli, v. 1997. economic valuation of forest recreation services in the liguria region (italy). cserge technical paper 97-08, university of east anglia, norwich, and university college: london. campbell, h. & brown, r. 2003. benefit-cost analysis: financial and economic appraisal using spreadsheets. cambridge university press:146-176. carr, l. & mendelsohn, r. 2003. valuing coral reefs: a travel cost analysis of the great barrier reef. royal swedish academy of sciences, 32:353-357. cesario, f.j. & knetsch, j.l. 1970. time bias in recreation benefit estimates. water resources, 6:700-704. cesario, f.j. & knetsch, j.l. 1976. a recreation site demand and benefit estimation model. regional studies, 10:97-104. conradie, b. 2010. farmers’ views of landscape initiatives: the case of the agulhas plain, cfr. cssr working paper 278. available at: www.uct.ac.za/cssr/ [accessed 2013-05-27]. common, m., bull, t. & stoeckl, n. 1997. the travel cost method: an empirical investigation of randall’s difficulty. cres, working papers in ecological economics, number 9705, anu. cowling, r.m. & holmes, p.m. 1992. flora and vegetation. in: cowling, r.m. 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62:136-141. abstract introduction dimensions of non-profit financial health and associated ratios data and method results and discussion conclusion acknowledgements references appendix 1 about the author(s) mark bunting department of management, rhodes university, grahamstown, south africa citation bunting, m., 2020, ‘dimensions and indicators of non-profit financial condition: evidence from south african public universities’, south african journal of economic and management sciences 23(1), a2974. https://doi.org/10.4102/sajems.v23i1.2974 original research dimensions and indicators of non-profit financial condition: evidence from south african public universities mark bunting received: 10 jan. 2019; accepted: 20 dec. 2019; published: 11 mar. 2020 copyright: © 2020. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: more than three decades of research have failed to achieve convergence on a method for the measurement of non-profit financial condition, with the literature reporting a bewildering array of financial dimensions, and more than 100 ratios and indicators. aim: this article offers a contribution to a broader discourse in non-profit financial analysis by recognising, and taking action in response to, the potential threat to research validity arising from the generally unchallenged presumption that accounting numbers provide a complete, unbiased and error-free representation of an entity’s underlying economic reality. setting: the 23 south african public universities in continuous existence for the 10 financial years from 01 january 2007 to 31 december 2016. methods: from the non-profit financial analysis literature, three foundational models are identified, and 24 associated ratios are specified as candidate indicators of financial condition. these are calculated for each university from accounting numbers which have been adjusted in mitigation of inadequacies of the financial reporting rules. principal component analysis is applied to evaluate the indicators, and eliminate those which lack significant association with the emergent dimensionality of financial condition. results: the financial condition of south african public universities is positively associated with liquid discretionary financial assets, which are interpreted as representative of financial resilience and defensive capacity in the presence of economic shock. unrestricted equity has incremental relevance, suggesting that the universities derive financial benefits from a capital structure in which assets are funded through sources that are burdened with neither debt obligations nor donor restrictions. conclusion: this research appears to be among the first to propose a dimensionality for non-profit financial condition that is developed on a foundation of responding to the need for mitigation of inadequacies in the financial reporting system. keywords: non-profit financial condition; university financial health; higher education finance. introduction although south african public universities are subject to state oversight and steering (south africa 1997), they are not directly state-owned. each university is constituted under its own private statute (south africa 2002), which confers substantial independent decision-making capacity upon council, senate, management, students, and other stakeholders. furthermore, even though south african universities in 2007–2016 received an average of 46% of their revenues from conditional state transfers, this still means that the majority of their income is derived from private sources. in addition, the regulatory context (south africa 2014) requires that the universities report under international financial reporting standards, not public sector accounting rules, and that they are to be scrutinised by private sector audit firms, not the auditor-general’s office. despite their descriptive title, therefore, there are important differences between south african public universities and the municipalities, provincial authorities, and government departments which are clearly identifiable as state agencies. the universities also exist within an economic frame of reference that is significantly different from that which applies to companies and other business enterprises. one of the key theoretical elements underpinning such entities is their owners’ expectation that they will receive future dividends. another is the existence of a profit-maximising production function. neither of these economic conditions applies to the south african public universities, which have no shareholders, and which exist in order to achieve social outcomes, not to generate profit. the universities examined in this article are therefore members of neither the governmental nor the private sectors of the south african economy. instead, they exist within a third economic partition, known as the non-profit sector. hansmann (1980:838) defines a non-profit entity as one that ‘is barred from distributing its net earnings, if any, to individuals who exercise control over it.’ it is this formal condition, generally referred to as the non-distribution constraint, that has emerged as the seminal defining characteristic of the non-profit organisation. the dominance of this definition over an earlier one focused on mission (newhouse 1970) is, perhaps, less unexpected when considered against the pervasive existence of mission statements across all parts of the economy, including public and private sectors. weisbrod, ballou and asch (2008:2) describe the operational and financial context of the university as a two-good framework in which it is obliged simultaneously to pursue ‘both lofty social missions and crass money-making activities.’ primacy of mission and the absence of a profit-making motive do not, therefore, mean that the universities are able to ignore financial concerns, which exist as pivotal enablers – or inhibitors – of institutional mission, thus explaining an enduring academic and practitioner interest in identifying defensible and decision-useful indicators of non-profit financial health. in a commercial context, a number of approaches are available for the evaluation of financial condition. firstly, there is broad consensus (as in, for example, penman 2013) that the relevant financial dimensions of a commercial operation are its liquidity, solvency, profitability, and efficiency. secondly, there exists a family of methodologies for valuing the ownership interest of a business (feltham & ohlson 1995; ou & penman 1989). thirdly, there is a corporate failure-prediction group of models derived from altman (1968) and ohlson (1980). these analytical approaches necessarily accord prominence to matters such as profitability and the valuation of shares or bonds, and it is therefore unsurprising that they have proven not to be directly transportable into a non-profit environment. chabotar (1989) represents one of the first attempts at bridging the divide between commercial and non-profit financial analysis, arguing that the universality of financial management concerns is such that a commercially styled analysis is equally suitable for the non-profit sector. tuckman and chang (1991) disagree, and are more influential, identifying four specialised indicators for use in the evaluation of non-profit financial vulnerability. one thread of subsequent research (greenlee & trussel 2000; hager 2001; parsons & trussel 2009; trussel 2002; trussel & greenlee 2004) applies multivariate analyses in order to add methodological rigour to the essentially descriptive tuckman-chang framework. their results are, however, inconclusive, generally finding support for only subsets of the original four indicators, as well as evidence of variability in their significance across different types of non-profit entity. other researchers explore alternative avenues. chu et al. (1991), prentice (2016), ritchie and kolodinsky (2003), trussel and parsons (2008), watkins (2000), and zeller, stanko and cleverley (1996) apply factor analysis to identify a variety of non-profit financial performance factors, each with a different set of associated ratios, none of which is completely congruent with the tuckman-chang formulation. kingma (1993) adapts modern portfolio theory to model revenue interactions in the non-profit sector, finding neither theoretical nor empirical support for the tuckman-chang income diversity indicator. tinkelman and donabedian (2007) propose an alternative four-factor framework for the decomposition of a non-profit entity’s financial performance that is inspired by the dupont analysis of return on equity. bowman (2011:39) asserts that his framework ‘represents the first comprehensive alternative in 20 years to the tuckman-chang model.’ in summary, almost three decades of research have failed to achieve either conclusive support for the tuckman-chang construct or convergence on an alternative model, with the literature reporting a bewildering array of dozens of financial dimensions, and more than 100 ratios and indicators. the situation suggests that there is much that we still do not know about non-profit financial condition. although it might seem implausible that this study’s consideration of a small population of south african universities would have anything incremental to offer such a discourse, there are at least three potentially interesting ways in which this research differs from that which has come before. firstly, this article differs from established methodology in non-profit financial research in that no financial database exists for the organisational population of interest. although the absence of a database is not, of itself, especially significant, the fact that the data require manual retrieval provides an important opportunity. chang and tuckman (2010) and mitchell (2017) draw attention to pervasive evidence of serious errors, omissions, and misallocations in the databases commonly used in large population non-profit research. a response to this concern is offered by this study’s use of accounting data which were collected by hand from, and rigorously cross-checked against, primary sources with a reasonable presumption of reliability (being the institutions’ audited financial statements). secondly, robinson et al. (2009) and white, sondhi and fried (2003), among others, demonstrate the need to reformulate and repair accounting data in order to achieve optimal levels of representational validity and decision-usefulness. such corrections and adjustments are made in none of the large database studies cited above. in contrast, this article provides a detailed account of the deficiencies (both systemic and institution-specific) in the universities’ financial reports and makes the necessary adjustments to the data in order to mitigate inadequacies of comparability and correspondence with economic reality. the possibility that the lack of consensus on the defining characteristics of non-profit financial condition may (at least partially) be attributable to data errors and accounting problems remains unexplored in the international literature. by carrying out error-checking that goes substantially further than, say, a crude winsorising of the data, and by paying careful attention to the idiosyncratic consequences of the accounting rules, this article therefore carries at least some potential for shedding light on the matter. thirdly, this article offers a contribution to a south african frame of reference which is characterised by an absence of comparably comprehensive academic studies of university financial health. admittedly, these institutions have not been ignored in the literature, but by far the dominant line of financial enquiry has been directed specifically at the state subsidy mechanism, with de villiers and steyn (2009) appropriately representative of the genre. (a rather lesser number of studies consider other isolated aspects of south african university finances, such as wangenge-ouma 2012, on tuition fees.) furthermore, the practitioner space is characterised by a large number of competing narratives of south african university financial condition, including most notably the annual financial reviews prepared by university management structures (using self-selected and non-standard ratio sets), and the annual reports of statistics south africa (based on an opaque methodology involving cash-based numbers of unknown provenance which defy reconciliation with the universities’ accrual-basis audited financial statements). among the many available academic and practitioner considerations of non-profit financial condition, three are selected as appropriate sources of indicators for this research. in recognition of its historical persistence, the first of these is the tuckman and chang (1991) framework. although this approach has faced accumulating challenges to its suitability as a unified non-profit financial analysis mechanism, there still exists a measure of support for its ratios, when considered individually. for reasons of practitioner relevance, the second source of indicators is kpmg (2010), a model created specifically for universities. although focused on the united states, it has been applied outside this context, including europe and australia, and some of its ratios appear in a recent review of south african university financial health (pricewaterhousecoopers 2014). the kpmg model adopts a normative approach, and the specification of its various benchmarks is obviously dependent on economic context. however, this study imports none of the foreign baselines, making use only of the ratios themselves. furthermore, it is reasonable to suppose that the authors, as experienced audit and advisory professionals, may have an interesting perspective to offer those who are concerned with financial analysis in the higher education sector. finally, bowman (2011) explicitly positions his study as a challenge to the tuckman-chang model, and proposes a number of questions for future research. most of these have yet to be addressed in the literature, and the current study offers one response, by including in its consideration the bowman indicators of non-profit financial capacity and sustainability. the remainder of this article proceeds as follows. from the three foundational models, a set of 24 indicators is identified, each indicative of an expectation about the relevance of a particular financial characteristic of the universities to a consideration of its financial condition. in the section on data and method, an explanation is provided of the standardisation adjustments made to the accounting numbers, following which the analytical techniques of this study are described. these methods are applied in order to identify a parsimonious set of non-profit financial indicators that satisfactorily explains the data set’s total variability, as well as the institutional financial dimensions with which those indicators are most closely associated. subsequent to this, the results of these procedures are reported and discussed. more than half of the proposed ratios are eliminated on the basis that they are found not to provide a usefully incremental contribution to the financial evaluation of the universities. the remaining indicators are shown to be closely associated with relative measures of the universities’ expendable resources, as well as their unrestricted equity. evidence is presented that the consideration of the financial condition of the south african public universities appears to be dominated by liquid discretionary financial assets, the absence or availability of which may be indicative of institutional defensive capacity in the presence of financial shock. unrestricted equity is also found to be relevant, suggesting that university financial condition is positively associated with a capital structure that funds institutional assets through sources that are burdened with neither debt obligations nor donor restrictions. the article concludes with a discussion of its implications and limitations, and suggestions for future research. dimensions of non-profit financial health and associated ratios tuckman and chang (1991) identify four indicators (see table 1), all postulated as representative of institutional resilience to financial shock. their first ratio measures equity adequacy (calculated as total equity divided by total revenue [tetr]) and is indicative of a university’s ability to replace lost revenue by making use of reserves, as well as the accessibility of supplemental funding from financial institutions (which, the authors argue, are likely to look more favourably upon a loan request from a university with a higher tetr ratio). table 1: tuckman and chang indicators. the second tuckman-chang indicator is revenue source concentration (conc), which is measured using a hirschman (1964) concentration index (calculation details are provided in table 1). this is the only indicator in the current article that has the expectation of an inverse association with financial condition. a university with diversified revenue sources (and therefore a lower conc indicator) is postulated to be less vulnerable to downturns, because negative events are unlikely to have uniform consequences across different revenue streams. thirdly, cost structure flexibility (measured as operating expenses divided by total expenses [oxtx]) is expected to exist for organisations that have the ability to engage in cost reduction when faced with financial shock. in the south african context of the current study, this ratio is operationalised as an indicator of the proportionate size of the university’s non-staff costs, because an institution with higher salaries and wages will, all else being equal, have lower recourse to cost-cutting measures than one with lower proportionate financial exposure to its employees. lastly, the total surplus to total revenues ratio (tstr) is included on the basis that surplus is the source of all self-funded growth in the institution. furthermore, surplus offers a margin of safety, should there be a decline in revenue, and a negative tstr ratio is directly indicative of a decrease in the institution’s financial resilience. only one of the kpmg (2010) ratios (total surplus to total revenue: tstr) intersects with the tuckman-chang set. three of the remaining indicators (see table 2) are scaled measures of expendable assets, defined as those that are both liquid and unrestricted. infrastructure (fixed) assets and restricted financial assets are not immediately available to management for discretionary funding of new projects or institutional expenses. these are therefore excluded from expendable assets, which are calculated as cash plus investments less restricted equity. the first two ratios evaluate the sufficiency of a university’s liquid and unrestricted wealth in relation to its long-term obligations. they are calculated as expendable assets divided by either total debt or total liabilities (xatd or xatl, depending on relative exposure to financial institutions; in this study, both are included as a result of high variability in debt levels across the south african system). similarly, the ratio of expendable assets to total expenses (xatx) evaluates the sufficiency of expendable assets in the short-term context of annual institutional expenses. finally, long-term sustainability is measured on the basis of ongoing institutional ability to set aside sufficient resources, calculated as total surplus divided by total equity (tste). table 2: kpmg indicators. bowman (2011) presents four ratios (see table 3), none of which appears in the tuckman-chang or kpmg models. all are positively associated with financial health, as follows. in the long term, financial capacity is dependent on the institution not being overexposed to debt and is therefore measured as the proportion of assets that have been funded through equity (total equity divided by total assets [teta]). long-term sustainability depends on organisational ability to maintain expenses at a lower level than income (thereby ensuring that equity increases over time) and is measured by the ratio of total surplus to total assets (tsta). turning attention to the short term, financial capacity is determined by the immediate availability of resources that are both liquid and unrestricted. although these are the same expendable assets that appear in the kpmg framework, the bowman ratio scales them more narrowly against those expenses that involve actual outflows of cash. thus, xacx is calculated as expendable assets divided by cash expenses, being total expenses minus depreciation. short-term sustainability focuses on capital preservation, measured by the ratio of unrestricted surplus to cash expenses (uscx). table 3: bowman indicators. between them, the three financial health models therefore propose a total of 12 different ratios as being relevant to the determination of institutional financial health. however, in the specific setting of the current study, it is appropriate to evaluate the sufficiency of these particular ratios as a plausible candidate indicator set. table 4 provides the context for this consideration, by tabulating descriptive statistics for selected financial components across this study’s full 230 university-year panel. (all data are from this study.) table 4: descriptive statistics: south african universities 2007–2016 (common-size analysis). the first concern relates to the existence of a restricted-unrestricted partition in the capital structure of all institutions in this study. a substantial proportion of south african universities’ capital (2007–2016 mean: 23.9%) exists under legally binding restrictions imposed by donors or funders, and is unavailable for at-will deployment by institutional management. tuckman and chang (1991) emphasise the importance of equity restrictions in the evaluation of financial resilience, but accord no further recognition to the matter in their final choice of ratios. apart from the bowman (2011) short-term sustainability indicator (uscx), the other two models similarly ignore the fundamental difference between restricted and unrestricted equity, and include only considerations of total equity and total surplus. therefore, the applicable ratios are extended in order to provide incremental focus on the expected positive relationships between financial health and unrestricted equity (ue), unrestricted surplus (us), and unrestricted revenue (ur). in this manner, ueta, usta, usue, usur, and ueur are added as alternative versions of the relevant ratios in the three models. next, the short-term components of the existing ratios provide comparative measures of expenses in only two dimensions: cash and total. however, the south african universities’ staff costs are the largest functional expense exposure, at an average of 54.7% of total revenues. therefore, xamx and usmx (expendable assets and unrestricted surplus, divided by employee expenses) are included and, for symmetry of expense analysis in the bowman (2011) short-term dimension, the ratio of unrestricted surplus to total expenses (ustx) is added as a sustainability indicator. this research finds clear evidence that some south african universities treat the financial reporting boundary between cash (including cash equivalents) and financial assets as porous, with a number of unexplained inter period reclassifications between the two asset categories. there are also obvious cross-sectional differences in institutional accounting policies and, as a result, this study considers cash, cash equivalents, and financial assets in combination. defined in this manner, total investments (ti) is the largest asset category for the universities, with a 10-year mean of 47.3% of total assets. the existence of spending restrictions on investments is given recognition in the three models, which all use expendable assets as the applicable numerator. however, this gives rise to a potential mismatch with some of the associated denominators, because the accounting system requires that expenses be reported as a combined total of restricted and unrestricted activities. therefore, total investments is included as an alternative numerator for the cash, employee, and total expense ratios, thereby adding ticx, timx and titx as plausibly relevant indicators. finally, the relatively high coefficient of variation for investment returns as a ratio of total revenue (irtr, at 0.769 the third highest in this study) suggests the appropriate inclusion of this indicator as an extension of the tuckman and chang (1991) consideration of financial flexibility. data and method the audited annual financial statements for the entire population of 23 south african public universities in continuous existence for the 10 financial years from 01 january 2007 to 31 december 2016 were obtained from the institutions’ websites or, when unpublished by the institution, from the south african department of higher education and training. the starting point for the data series was selected in order to allow for the passage of at least two stabilising years following a series of institution-level mergers and campus carve-outs which ended in 2005. these actions affected the majority of the south african universities and reduced the institutional population from 36 to 23. three newer institutions, all less than three years old in 2016, were excluded from the study. line items from the universities’ financial statements were manually entered into classification cells in spreadsheet files created for this purpose. cross-checking during the initial data capture process was reinforced by applying the natural articulation of financial statements to identify imbalances requiring investigation and resolution. all apparent data anomalies were traced back to the component accounting numbers and corrected or confirmed. because all data were extracted from primary sources (audited financial statements) rather than secondary ones (financial databases), no outlier eliminations were made. attention was then turned to addressing limitations in the applicable financial reporting system. these arise from the availability of choice in accounting method (which degrades the comparability of the financial numbers), as well as functional flaws in the accounting rule set (which impair their correspondence with the relevant underlying economic phenomena). therefore, property, plant and equipment (ppe) were restated, where necessary, so that all physical assets are measured at depreciated historic cost. a number of south african universities apply a revaluation model, in terms of which ppe is recorded at amounts approximating fair value. there is a vexed academic, practitioner and regulatory debate concerning the relative usefulness and reliability of historic cost versus fair value information (see for example cascino et al. 2013; christensen & nikolaev 2013; whittington 2008). however, in this study, the decision to restore comparability through the uniform application of historic costs, rather than fair values, is an unavoidable one based on data availability: the accounting rules require those universities applying the revaluation model to provide additional disclosure of the counterfactual historical cost amounts, while the reverse requirement does not apply. in south africa, state funding for infrastructure development projects is commonly transferred to the recipient institution in advance. during the time that the related building work is incomplete, the unexpended amounts are reported in institutional balance sheets as deferred income. most of the universities choose to treat this as a liability, although a few treat the item as equity. the appropriate classification is not directly addressed in the accounting standards. in such situations, best practice requires the universities to consider the fundamental definitions of liability and equity in the conceptual framework for financial reporting. for the purposes of this analysis, all deferred income balances are allocated to restricted equity, on the basis that such classification more accurately represents a situation in which the state has never made demands for the refund of infrastructure grant transfers. further adverse effects on comparability arise at the point of expenditure of infrastructure grants on ppe. one of the accounting alternatives allowed (and which is applied by a number of the universities) is the recognition of a reduced cost, net of the state grant, for the relevant asset. application of this method to a building costing, for example r80 million entirely funded through a state transfer, results in the complete absence of the new building from the institution’s balance sheet, because its deemed cost under the accounting rules is nil. for analytical purposes, this accounting outcome is repudiated as being devoid of meaning and its effects are, accordingly, reversed. south african universities offer a variety of retirement benefits to their employees, including defined benefit plans, which include final-salary pension promises and post-employment medical plans. until the end of the 2012 financial year (and therefore affecting 6 out of this study’s 10 years), the accounting rules allowed a number of alternatives for calculating the related liability. some of these methods involved only partial recognition of the liability, asserted to be appropriate on the basis of market volatility as well as the fundamental unknowability of the distant future. in general, financial analysts reject the assertion that the partial recognition of a defined benefit liability provides decision-useful information and make the necessary adjustments to restore the measurement to its full economic extent (robinson et al. 2009; white et al. 2003). this study follows suit, reformulating all financial statements in order to bring onto the university balance sheet all unrecognised actuarial gains and losses and unrecognised past service costs. most of the universities hold financial investments, typically comprising money market instruments, bonds and equities. the effective analysis of investment performance requires the calculation of total holding period returns (stewart, piros & heisler 2011), calculated as the rand amount earned over a year divided by the rand amount invested at the start of the year. the numerator of this equation includes realised and unrealised gains and losses from price increases and decreases, as well as income distributions in the form of dividends and interest. the accounting standards produce disclosures of investment returns that are almost completely at odds with the needs of professional investment practice, scattering the information on dividends, interest and capital gains and losses throughout the financial statements. in some cases, the investment return numbers are allocated to four, five, or even six different places in two different primary financial statements. for the purposes of this analytical framework, these numbers are recombined in order to establish a single usable measure of each institution’s total annual return on financial investments. the accounting rules require the division of the income statement into two parts. one of these displays the components of institutional revenue and expense, and the other contains various accounting numbers asserted by the standard-setter as being appropriate for exclusion from the main part of the income statement. items in the latter category are referred to as other comprehensive income. in the context of this study, the relevant transactions for the south african universities include fair value changes to financial assets, revaluation adjustments to physical assets, and gains and losses relating to defined benefit plans. rees and shane (2012) draw attention to the absence from the standards of a coherent definition of other comprehensive income, suggesting that the rules for allocations of income and expenses to this category appear to be entirely arbitrary. as a result, financial analysts have long been sceptical of the standard-setters’ assertions of the decision-usefulness of such a structure. penman (2013:263), for example, describes as ‘appropriately pejorative’ the ‘clean’ and ‘dirty’ surplus terms commonly used to describe the two bottom lines in the divided income statement. therefore, in this study, all items of other comprehensive income are reassigned to the relevant revenue and expense lines of the income statement in order to restore it to a unified state. the reporting regulations require that the south african universities maintain a ‘separation between recurrent and non-recurrent income and expenditure [which] must be strictly observed’ (south africa 2007:9). given the regulatory prominence accorded to this separation (and even the attention paid to capitalising the words in question), it is curious that no definitions are stated, nor is guidance provided on the bases in terms of which accounting items are to be allocated between the recurring and non-recurring categories. a substantial number of university income statements during the review period simply ignore the distinction. among those universities that do classify income and expense items on the basis of their nature as recurrent or non-recurrent, little consistency prevails, with clearly negative consequences to comparability. in addition, managerial decision-making on the likelihood of recurrence of a particular income or expense item is, demonstrably, arbitrary. however, neither lack of definition nor erratic compliance is of consequence to the study, because there is no support in modern practitioner or academic non-profit literature for the presumption that such a categorisation provides decision-useful information. therefore, all recurring and non-recurring lines of the income statement are combined on a like-for-like basis in order to create a reunified document. prior year accounting restatements are made when an accounting policy is changed, or a material prior year error is detected in the current year. in either situation, the current year’s financial report is published alongside reference (comparative) numbers from the prior year that differ from those originally published. according to the standard-setter, this requirement enhances the relevance and reliability of financial statements, as well as their comparability over time. this is a questionable assertion, for the following reason (the explanation is illustrated with an example based on actual events and amounts derived from this study, without naming the south african university involved). consider a university that makes an error, undetected at the time, in its 2015 financial statements, involving expenses of r347 million incorrectly recognised as ppe assets. the 2015 (audited) report therefore overstates institutional surplus, equity and assets by r347 million. these are the numbers used at the time by regulators and others in making subsidy funding and other economic decisions. in 2016, the error is discovered and reported. the accounting rules require that the correction be made against the previously published 2015 numbers; the only number from 2016 that is adjusted is the opening equity balance. this has the dramatic consequence that the accounting numbers affected by the error effectively disappear as reference points in the decision-making record. this happens because, firstly, the missing r347 million expense does not appear in the 2015 income statement at the time it was being used by decision-makers and, secondly, the amount remains unreported as an expense in the 2016 income statement. a further problem is that retrospective restatement of the current year’s opening equity balance immediately breaks the logic of the intertemporal links in the financial statements, thereby obfuscating the effective longitudinal analysis of trends in the accounting numbers. in order to mitigate these negative effects, this study responds by reallocating the amount of prior year restatements to the relevant revenue and expense items in the current year. decades of academic research on the distortive effects of lease accounting rules (imhoff, lipe & wright 1991; lipe 2001) were eventually followed by a reaction from the accounting standard-setter, which from 2019 requires the recognition of all lease assets and liabilities on the balance sheet. however, for the entire time frame of this study all operating lease obligations remain off balance sheet. the amounts involved are sometimes very large, in both absolute and relative terms. in 2012, for example, one of the smaller universities reported r872 million in (off balance sheet) future operating lease commitments; the total institutional capitalisation of this university was, in comparison, r898 million at the same date. both academic and practitioner literature recommend the constructive capitalisation of operating leases, which results in the creation of a right-of-use asset and a corresponding liability, measured as the present value of future non-cancellable lease payments. this study follows suit, applying south african prime overdraft rates to discount the operating lease payments disclosed in the notes to the universities’ financial statements. table 5 provides a summary of the accounting problems and the mechanisms applied in response. table 5: summarised accounting transformations. all ratios for each institution, for each financial year, were then calculated from the standardised accounting numbers. using stata software, a total of 10 separate principal component analyses (pca, one for each year; the technique is unsuitable for time-series or panel data) were then applied, taking into consideration the implications of the small number of cases in this study (n = 23 universities). mundfrom, shaw and ke (2005) and preacher and maccallum (2002), among others, discuss minimum sample sizes for pca. all present forceful critiques of the prescriptions and heuristics that are common in the standard textbooks. de winter, dodou and wieringa (2009:147) show that, under the conditions applicable to this study, ‘data are well conditioned … [and] can yield reliable results for n well below 50.’ jung and lee (2011) demonstrate the validity of pca for n as low as 15. for each of the 10 years of the review period, a correlation matrix was generated for the applicable variables. the suitability of the matrix for pca was evaluated using partial correlations and the kaiser-meyer-olkin (kmo) (kaiser 1970) measure of sampling adequacy. hair et al. (2010) suggest that 0.50 be used as a kmo benchmark. in this small-n situation, the minimum acceptable level for kmo, for both individual variables and the overall matrix, was set substantially higher, at 0.70. in an iterative process, the single variable with the lowest kmo less than 0.70 was deleted, and the correlation matrix was recalculated, until a correlation matrix was generated that passed the minimum kmo benchmark, as well as the bartlett (1950) test of sphericity. each year’s results were then inspected for compliance with the following benchmarks. although hair et al. (2010) recommend a minimum loading (i.e. correlation of each variable with each component) of 0.70, de winter et al. (2009) suggest that a higher level is appropriate in a small-n context (although they do not quantify this). in response, the minimum acceptable loading was set at 0.80. for communalities (i.e. the sum of the squared loadings, across all components, for each variable), the hair et al. recommended minimum is 0.50. in this situation, the small-n guidelines of preacher and maccallum (2002) were instead applied, and the communality benchmark was set at 0.70. variables not meeting the loading and communality criteria were eliminated, one by one (lowest first), until the principal component solution was in compliance with both benchmarks. kaiser (1960) establishes a minimum acceptable value for component eigenvalues (i.e. the column totals of squared correlations) at 1.0. the cattell (1966) scree test is commonly used in confirmation of the eigenvalue criterion. however, these tests are vulnerable to challenges of arbitrariness and subjectivity, and therefore this study applied horn’s (1965) parallel analysis to identify the number of components to retain in each year. as reported below, this method resulted in the retention of one component throughout the research’s time frame, and therefore neither orthogonal nor oblique rotations were applied. results and discussion the results of these procedures identify, for each year from 2007 to 2016, a single component that explains 80% or more of the total variance in the universities’ financial characteristics. in each year, between 7 and 10 ratios from the original set of 24 display the required minimum loading benchmark of 0.80. furthermore, all ratios consistently return positive correlations with the retained component, which is therefore interpreted as a single composite indicator of south african university financial health. table 6 summarises these findings. table 6: results of principal component analyses, 2007–2016. the two kpmg (2010) financial viability ratios, which measure the relationship between expendable assets and liabilities or debt (xatl and xatd), appear in all 10 years of the results. this suggests support, within this study’s frame of reference, for the postulated long-term financial capacity dimension. a further two indicators, xacx (expendable assets as a ratio of cash expenses) and xamx (with employee expenses as a denominator), are associated with the principal component in 9 out of 10 years. these findings are consistent with the bowman (2011) short-term financial capacity interpretation, as well as those of at least three academic studies (bennett, iossa & lengrezi 2010; bowman, tuckman & young 2012; fisman & hubbard 2005) and two practitioner monographs (tschampion et al. 2012; weisbrod et al. 2008). the persistence of the four expendable asset ratios corroborates the proposition that liquid and unrestricted resources provide defensive financial capacity to the institution. when multiplied by 365, for example, the expense-focused ratios measure the number of days that discretionary assets could support the relevant expense category. this analysis is reinforced by the presence of the total investment ratios in 7 of the 10 results: ticx (measuring the sufficiency of total cash and financial assets in relation to annual cash expenses), titx (total expenses), and timx (employee expenses, also known as staff costs). therefore, comprehensive measures of the institutional pool of cash and financial assets are similarly indicative of financial condition, when scaled on expenses that are broadly defined to include both restricted and unrestricted categories. three equity-related ratios are present in the results. the original tuckman and chang (1991) measure of equity adequacy, total equity divided by total revenue (tetr), appears in only two years. however, this study’s variables include an alternative interpretation of this ratio based on unrestricted equity, and ueur (with unrestricted revenue as the denominator) is found to be rather more persistent, with four occurrences. this indicates some support for the relevance of unrestricted equity as a component of university financial resilience. unrestricted equity as a ratio of total assets (ueta), this study’s variation of the bowman (2011) long-term capacity indicator, also appears in four years, and is similarly indicative of a direct relationship between financial condition and the proportion of total institutional assets that have been funded through capital sources that are neither debt nor restricted by donors. this interpretation aligns with the analyses of calabrese (2011, 2013), denison, fowles and moody (2014), and jegers and verschueren (2006). the final ratio that emerges from the analysis is the proportion of investment-source revenue to total revenue (irtr). this is present in eight years of the analysis, and is consistent with the heutel and zeckhauser (2014) expectation that a productive pool of financial investments contributes positively to the financial condition of a university. the findings are as interesting for absent dimensions and ratios as they are for those that make an appearance. firstly, none of the surplus-related ratios appears in the results, and therefore no evidence is found for the financial sustainability dimension, whether in long-term or short-term frames. the surplus indicators are all based on a predicate of financial capital preservation, achieved by keeping expenses lower than income, with the resultant surplus making a contribution to increasing equity over time. this seems secure as a theoretical construct, and the findings are therefore unexpected. however, further investigation suggests that this result is attributable to the small relative size and high volatility of annual surplus, rather than theoretical inconsistency. kpmg (2010) provides implicit support for this interpretation, allocating a combined weight of 30% to the two surplus ratios in their composite financial health index, in contrast with the 35% weight for each of the two expendable asset indicators. similarly, bowman et al. (2012), calabrese (2013), and ryan and irvine (2012) argue that it is accumulated surplus (in other words, equity) that is a central source of financial sustainability. the absence of the surplus ratios from this study’s results may therefore be attributable to an interpretation in which a single year deficit has little incremental consequence on financial condition. a university with a substantial equity balance has the financial capacity to cope with the situation, and one that is undercapitalised has already been identified by the indicator set as being in poor financial health. secondly, the revenue diversity indicator is absent from all 10 analyses. this outcome is less surprising, in light of challenges in the literature to the tuckman and chang (1991) proposition that financial stability is achievable through brute minimisation of an index originally designed for the economic analysis of market concentration. kingma (1993) appears to be the first to apply portfolio theory to argue that an optimal mix of institutional revenue sources is achievable through a consideration of their variances and covariances, rather than by means of naïve diversification. the hung and hager (2019) meta-analysis of 40 subsequent investigations reports generally weak, non-existent, or negative relationships between revenue diversity and financial health. the current study is offered in modest support of these findings. finally, it is interesting to observe that differences in infrastructure intensity (which, for example, could be lower for universities focused on humanities rather than science and medicine) also appear to have no immediate relevance to the consideration of financial health. however, this outcome is attributable to the inherent nature of property and equipment as being illiquid and therefore unavailable for financial purposes (even though such assets are central to the university’s mission). in addition, overinvestment in infrastructure (variously attributable to inter-university competitive pressures, managerial hubris, or corruption, among other factors) directly displaces the university’s holdings of liquid financial assets, thereby contributing incremental financial pressures. indicators representative of this dimension of financial health are prominent components of this study’s results. attention is now turned to a consideration of the plausibility of the university financial health interpretation that has emerged from this research. for each institution in each year of the analysis, factor scores (calculated using the regression method) are extracted from the pca results in order to determine a single composite measure of financial health. the 10-year mean, minimum, and maximum financial health scores and ranks are reported by institution in table 7. table 7: selected financial data by institution, 2007–2016. for the 10-year period of this analysis, the maximum (best) composite financial health score is 6.19 and the minimum is −4.67. the factor scoring method uses normalised versions of all variables, and so the 10-year mean score is, as expected, exactly 0.00. four institutions are ranked in first place on the basis of the financial health composite at least once during the review period, and three are placed 23rd at least once. some universities display considerable 10-year stability in score and rank, with little variation between mean, minimum and maximum, while others are substantially more mobile. table 7 also reports 10-year means for each institution’s unrestricted surplus and savings. because neither quantity was included in the pca phase, they provide an alternative context for evaluating the validity of the institutional financial health scores. unrestricted surplus is presented here as a single long-term mean, in contrast with its inclusion as 10 separate one-year quantities in the original phase of the analysis. savings is defined as net annual transfers of cash into (positive) or out of (negative) the institutional pool of cash and financial assets. given the demonstrated significance of a university’s year-end stock of liquid unrestricted assets, there is a reasonable expectation that the related annual flows would be similarly indicative of financial health. four universities (su, ufs, unisa, and up) are placed in the highest quintile of mean financial health scores. their 10-year average annual unrestricted surpluses are large in both absolute amount (r300 million or more) and as a percentage of unrestricted equity (minimum 8.0%). furthermore, annual surplus for this group has low levels of relative annual volatility (maximum coefficient of variation: 1.0). three institutions in this group have consistently high savings rates, with a minimum r178 million annual average net additions to financial assets. the single exception is unisa, whose large net investment drawdowns in the last three years of the review were accompanied by a deterioration in both financial health score and rank. four universities (mut, ufh, ukzn, and wsu) have mean financial health scores in the lowest quintile. all have operated at an average annual deficit (in absolute terms, relative to equity, or both) over the 10-year review period. although all four made net average annual cash additions to investments, the amounts involved are small. furthermore, the individual savings transfers show substantial year-on-year inconsistency, with generally high variation coefficients. in the central quintiles, the universities display a range of unrestricted surplus and savings metrics that generally associate in the expected manner with this study’s overall financial health composites. for example, uj is placed in the second-highest financial health quintile. although it has surplus data which are comparable with universities in the highest group, its savings rates are noticeably lower and have higher annual volatility. similarly, cut is in the second-lowest group, and is distinguished from institutions in the category below on the basis of having an average annual surplus (albeit small) rather than a deficit, while also reporting the same net average withdrawals from savings that are characteristic of the lowest-ranked universities. it is neither the objective nor within the scope of this research to carry out a detailed financial review of the entire population of universities. however, there appears to be a coherent relationship between the composite financial health scores and two separate indicators which were excluded from the main analysis, on the basis of their absence from this study’s three foundational models. in general, the financial health score is found to be positively associated with 10-year mean surplus and savings, and negatively associated with volatility in the same indices. individual nuances in this interpretation are not reported, but were separately investigated and found to be explainable in terms of longitudinal trends in institution-level financial data. in particular, these additional considerations included a comparison of 10-year comparative growth rates in income, expenses, assets, and equity. the example of uct provides illuminating detail for this additional analysis. this institution is placed outside the top quintile in this article’s results, despite displaying mean surplus and savings data that are comparable to the highest-ranked institutions. however, further examination reveals that this university’s 10-year growth rate in total revenues (average annual rate: 11.3%) compares unfavourably with both total expense growth (12.1%), and the expansion rate in total assets (12.9%). neither situation is generally supportive of long-term financial sustainability. in particular, the revenue-expense growth mismatch, if continued long enough, will have the initial consequence of eliminating the university’s annual surplus, followed by a persistent and growing series of deficits, with negative consequences on equity. similarly, the revenue-asset growth mismatch is an adverse financial signal of decreasing self-funding capacity for this institution. other characteristics of the south african universities are now considered, in order to determine whether these provide incremental support for this study’s evaluation of institutional financial health. table 8 reports each university’s administrative classification, historical context, circumstances of merger, geographic separation, and institution size (in both financial and enrolment terms). the last column of table 8 places each institution in a financial health quintile on the basis of this study’s 2007–2016 average composite factor scores. table 9 provides average financial health scores for each characteristic, classified into the relevant categories. table 8: selected characteristics of the universities: institutional details. table 9: average financial health score by characteristic. a number of interesting associations are evident, although some characteristics lack any clear relationship with financial condition. for example, financial health is not coherently distributed among south african public universities on the basis of the classification framework applied by the department of higher education and training. table 8 shows that institutions in each of the three regulatory clusters (traditional universities, universities of technology, and comprehensive universities) are scattered across the financial condition continuum, with one notable result being that the group of three institutions evaluated as having the poorest financial condition includes a member of each of the three clusters. although table 9 indicates that universities of technology have a substantially lower average financial health score, this outcome appears to be explainable by historic context rather than administrative classification, as discussed below. given generally high levels of heterogeneity in mission and educational focus among institutions within each cluster, the absence of a discernible relationship between administrative group and financial health is arguably an unsurprising result. in terms of historical context, there were 36 public higher education institutions in south africa in 2001. four years later, a series of mergers, campus carve-outs, and dissolutions had reduced this number to 23. the necessity for this process was attributed by the then minister of education to a system still burdened by apartheid, which remained fragmented on race lines. although the merger policy framework also specified the efficient use of limited resources, no substantive details were provided on the mechanisms by means of which the reduced set of public universities was also to achieve financial sustainability. mergers are famously risky endeavours, in both commercial and non-profit frames of reference. of particular interest for the current study is the stahl and voigt (2006) cultural difference hypothesis, in terms of which incongruent histories have lasting adverse consequences on the effective integration of the merged entity. in south africa, such cultural incongruences arose in two main ways (which sometimes intersected): the merger of technikons and traditional universities to form comprehensive universities, and the merger of historically black and historically white institutions. a number of south african studies (arnolds & boshoff 2004; hay & fourie 2002; wyngaard & kapp 2004) concentrate on adverse social effects, variously describing depression, fear, loss of self-esteem and reduced organisational commitment in post-merger universities. mabokela and wei (2007) and sehoole (2005) argue that inadequacies in institutional leadership may explain the lingering negative effects of complex mergers of south african universities. bunting (2006) describes black higher education institutions in pre-1994 south africa as being characterised by authoritarian governance structures, a lack of administrative capacity, and the absence of financial autonomy. it therefore seems reasonable to expect that, in 2016, these adverse historical conditions would continue to have social and financial consequences for the affected south african universities. in seeking support for its construct of financial health, this article fortuitously offers some evidence in support of the matter. as reported in table 9, the low-impact merger group (comprising universities unaffected by merger, and those that incorporated only a local campus or school of another university) has a dramatically higher average financial health score than the group of universities formed from major (institution-level) mergers. a similar result is found when the universities are categorised on the basis of formation from a precursor historically black institution. the average financial health score for this group of institutions is materially lower than for all other south african universities. finally, merged universities with geographically distant campus locations face incremental administrative challenges, as well as higher cost structures, which are likely to have detrimental effects on financial health. table 9 provides support for this analysis, with the financial health score showing a clear association, in the expected direction, with campus separation. institutional size in 2016 is reported in table 8 in financial terms (measured by total annual revenues) as well as on the basis of student enrolments. calabrese (2013), lecy and searing (2015), and mosley et al. (2012) report a positive relationship between non-profit organisational size and financial strength. in contrast, this study finds only equivocal support for this proposition. there is no monotonicity in the relationship between the size of a south african university’s annual revenues and its financial health score, although the largest universities (measured on a revenue basis) do have the highest average levels of financial health. a plausible interpretation is that the blurring of the expected relationship in a south african context is attributable to the persistent consequences of historical circumstance. in addition, when the relative sizes of total revenues and student enrolments are considered in combination, substantially higher average levels of financial health are found for those south african universities whose financial size exceeds (or at least equals) student enrolment size. thus, this study’s financial health score is consistent with an interpretation of financial vulnerability arising from a situation in which a university with relatively low revenues in comparison with its peers is burdened with a relatively high student enrolment level. conclusion the south african universities that are the subject of analysis in this article exist within an economic partition substantially different from that which applies to corporations. this calls into question any presumption that a financial analysis approach designed for the latter context will, self-evidently, be suitable for the former. although the matter has attracted considerable international academic attention, no definitive solution has yet emerged in response to the problems of identifying the dimensionality of non-profit financial condition, or the applicable ratios. furthermore, south african universities have not been subjected to comparably comprehensive academic studies of financial condition – although this national context is, in contrast, notable for its significant number of competing practitioner and regulator models. however, this study represents neither a mere replication of established methods in a lesser examined frame of reference, nor an attempt to establish a normative framework with asserted suitability for the financial management of south african universities. instead, the article offers a contribution to the literature in the following ways. firstly, despite the well-known existence of serious errors in the data sources, non-profit research has, to date, provided no substantive response to the problem. in this study, the data were directly obtained from primary sources and subjected to rigorous cross-checking, and all anomalies were investigated and resolved, rather than being eliminated as so-called outliers. a second unaddressed concern in accepting the results of prior research relates to deficiencies of representational validity and comparability in the accounting numbers which populate the commonly used non-profit databases. actions in suitable mitigation are taken in none of the existing large database studies. in contrast, this article makes the necessary adjustments to the data in order to respond to inadequacies of comparability, as well as to increase the level of correspondence between each problematic accounting number and the related real-world economic phenomenon. the international literature has not explored the question of whether the lack of consensus on the defining characteristics of non-profit financial condition may (at least partially) be attributable to data errors and accounting problems, and this study therefore contributes to filling a gap in the research record. finally, the country of focus in this article is a place in which both history and current realities have brought about a society that remains ‘fundamentally flawed by inequities, imbalances and distortions’ (national commission on higher education 1996:1). an important contribution of this study therefore lies in its acceptance of the challenge to evaluate its postulated construct of university financial health within a unique national setting that is marked by heterogeneity of historical circumstance, administrative classification, circumstances of merger, geographic separation, and student enrolments. the method and findings of this research may be summarised as follows. three prominent but competing models of non-profit financial condition were selected from the literature on the basis of prominence of citation, practitioner relevance, and recent innovation. each ratio from these models was given an equal opportunity to present itself as demonstrably representative of university financial health. this approach allowed for one of three different outcomes for the research: that one of the models would be found to dominate the other two, because its full ratio set crowded out all alternatives, or that a subset of ratios from different models would be associated with financial condition, or that all ratios would be found to be irrelevant. in this manner, the three models were considered both as unified constructs, as well as in terms of their individual indicators. none of the models is found to provide a unified and coherent representation of south african public university financial health. in addition, none of the tuckman and chang (1991) indicators emerges in its original formulation as having convincing relevance in this frame of reference. however, evidence is presented in support of the existence of the kpmg (2010) financial viability dimension, as measured by two ratios which scale the university’s expendable assets against its indebtedness to financial institutions, as well as against its liabilities, more broadly defined. two ratios from bowman (2011) are also identified as relevant to the consideration of south african university financial condition, reinforcing an interpretation of financial capacity as being associated with indicators that measure the adequacy of expendable assets in relation to expenses. these results corroborate the conjecture that liquid and unrestricted resources provide defensive financial capacity to the institution. the article also finds support for the relevance of capital structure as a component of university financial condition, with a number of indicators (including one that is reformulated from the tuckman-chang set) linked to unrestricted equity. these suggest an association between university financial condition and a balance sheet that is funded through accumulated surplus rather than borrowing, conditional donations, or restricted transfers. this article represents, in the first instance, an academic endeavour, intended for placement within a body of literature on the characteristics of university financial health. although it is also offered as a contribution to those for whom the well-being of south african public higher education is a matter of personal, institutional, or regulatory concern, the framework is not claimed to be appropriate, without careful consideration, as a financial managerial or state policy instrument. however, it may well be the case that this study contributes some utility to informing the development of normative financial models for the universities. at the very least, it seems reasonable to suggest that the indicators might be helpful in telling the higher education analyst or university manager where to start looking for reasons that an institution’s financial condition is in an unsatisfactory state. in this respect, one potentially useful mechanism might be the longitudinal and cross-sectional consideration of four ratios: expendable assets as a percentage of both assets and expenses, and unrestricted equity as a percentage of both capital and expenses. a decreasing trend in any of these indicators, or persistently unfavourable comparison with the national averages, is likely to be a red flag for institutional financial health that warrants managerial investigation and response. the applicable 10-year review period for this research includes the international financial crisis which commenced in 2008. although the interpretation of university financial condition maintains reasonable stability of construct during the global economic turmoil, more recent developments in south africa will also have significant financial consequences for the universities. this article’s findings predict that institutions with greater relative proportions of both expendable assets and unrestricted equity will prove to be more capable of withstanding the adverse financial effects of widespread student protests, a government-imposed fee freeze for 2016 (partially extended into 2017 and 2018), and service staff in sourcing (re-employment) demands. however, this conjecture remains untested for the time being. it is also appropriate to acknowledge the three new south african public universities that were constituted after 2014, and therefore excluded from the study. the decision-usefulness of this article’s indicator set, within a context that is expanded to include institutions in their very early developmental phases, is not self-evidently secure. at this point, the matter remains a question for future research. other potentially fruitful lines of academic enquiry are available for future consideration. notably, it will be interesting to extend this study’s methodology to some of the other small-population frames of reference that are in widespread existence outside europe and the united states. cross-country and multinational investigations of university financial condition hold particular promise, given that this article finds substantial support for its financial condition indicators when these are considered in the context of national history and current circumstance. in addition, the possibility exists that a consideration of hybrid organisations (battilana & dorado 2010; glynn 2000; heimer 1999) and new public management (hood 1995; manning 2001; talib 2003) might usefully inform the determination of university financial health. finally, watkins (2000) and tinkelman and donabedian (2009) argue that the lack of consensus on non-profit financial condition is indicative of a need to turn to mission-focused (non-financial) data. however, the findings of this article suggest that such a conclusion may be ahead of its time, with at least equivalent promise being plausibly obtainable through an extension of non-profit financial condition research to a wider range of countries, as well as paying closer attention to the information quality of financial databases in common use in large-population studies. acknowledgements the author acknowledges the helpful comments of two anonymous reviewers. competing interests the author declares that there are no financial or personal relationships that may have inappropriately influenced the writing of this article. author’s contributions the author declares that he is the sole author of this research article. 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appendix 1 table 1-a1: the south african public universities 2007–2016.† abstract introduction anticipation and development of the psychological contract mental schemas and the anticipatory psychological contract obligations towards and pre-employment violation of the anticipatory psychological contract role of entitlement in the anticipatory psychological contract method results discussion conclusion acknowledgements references about the author(s) werner g. gresse school for industrial psychology and human resource management, faculty of economics and management sciences, north-west university, potchefstroom, south africa barend j. linde school for industrial psychology and human resource management, faculty of economics and management sciences, north-west university, potchefstroom, south africa citation gresse, w.g. & linde, b.j., 2020, ‘the anticipatory psychological contract of management graduates: validating a psychological contract expectations questionnaire’, south african journal of economic and management sciences 23(1), a3285. https://doi.org/10.4102/sajems.v23i1.3285 note: this article is partially based on the author’s dissertation for the degree philosophiae doctor in labour relations management at the north-west university, potchefstroom campus, south africa, with supervisor prof. b.j. linde, received october 2018, available here: https://repository.nwu.ac.za/bitstream/handle/10394/31452/gresse_wg.pdf?sequence=1&isallowed=y original research the anticipatory psychological contract of management graduates: validating a psychological contract expectations questionnaire werner g. gresse, barend j. linde received: 23 july 2019; accepted: 06 july 2020; published: 26 oct. 2020 copyright: © 2020. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: it was proposed that if we assess an individual’s mental schema, it may facilitate a better understanding of the psychological contract formation process. this will add a theoretical contribution to the anticipatory psychological contract research, as it will enhance our understanding of the specific terms of the psychological contract, which are only present during the organisation entry phase. aim: we aimed at developing and validating an instrument to measure the psychological contract expectation of university graduate labour market entrees. this information could enhance our knowledge of both the anticipatory psychological contract and psychological contract development. setting: the research was conducted on third-year students from two different campuses of a south african university. the sample consisted of a total of 316 participants. methods: we used an exploratory quantitative research approach to measure prospective employees’ anticipatory psychological contract. the newly developed psychological contract expectations questionnaire (pceq) was administered and analysed. results: results indicated that some of the instruments within the pceq are reliable and valid to measure the anticipatory psychological contract of graduates. the descriptive statistics and correlation coefficient results clearly enhanced our understanding of how the anticipatory psychological contract works. conclusion: our research contributes to anticipatory psychological contract research by introducing the pceq questionnaire to effectively measure the anticipatory obligations, anticipatory expectations, entitlement and anticipatory state of the psychological contract of prospective employees’ mental schema. keywords: entitlement; anticipatory psychological contract; graduates; expectations; obligations. introduction upon organisational entry, an occupational newcomer holds an already established set of implicit expectations and obligations – a rudimentary psychological contract – based on expectations of unspecified rights and obligations that becomes more elaborate throughout their professional career as they gain experience (de vos, buyens & schalk 2005; rousseau 2001; shore & tetrick 1994). these beliefs by the workplace newcomer are not necessarily based on the actual employment relationship and the resulting legal contract, but rather from social, normative and implicit contract sources. a great deal of attention has been given to how the psychological contract develops once an individual is employed (for instance adams, quagrainie & klobodu 2014; o’leary-kelly et al. 2014; tomprou & nikolaou 2011), but relatively little attention has been given to the anticipatory psychological contract that precedes employment, with only a few publications on this topic (for instance de vos, stobbeleir & meganck 2009; gresse & linde 2020; gresse, linde & schalk 2013; linde & gresse 2014). it should however be noted that there has been an increased call for research involving the anticipatory psychological contract in recent years (bruins 2019; janani 2019; ruchika & prasad 2019). based on this, we aimed at developing and validating an instrument to measure the psychological contract expectations of graduate labour market entrees, which could enhance our knowledge of the anticipatory psychological contract and psychological contract development. to understand this proposed measure, a literature review in the anticipatory psychological contract is required. anticipation and development of the psychological contract the general consensus is that the beliefs regarding the mutual obligations of the psychological contract are formed in the recruitment and socialisation phase when an employee applies for a job (rousseau 2001), and this phase is still regarded as a critical period for the employment relationship, since the new employee learns how to adapt to the world of work and the boundaries of the exchange relationship between employee and employer get tested and established (debode, mossholder & walker 2017; de vos & freese 2011; thomas & anderson 1998; woodrow & guest 2017). a crucial part of the psychological contract develops during this socialisation process; this is due to prospective employees actively engaging in information-seeking behaviour and research in response to perceived employer incentives and employee contributions (de vos, buyens & schalk 2003; de vos & freese 2011; thomas & anderson 1998). the knowledge that is obtained during the socialisation period lays the foundation of psychological contract development (woodrow & guest 2017). payne et al. (2008) believe that some parts of the psychological contract develop prior to organisational entry – due to the individual’s pre-entry expectations, beliefs and entitlement – in the form of an anticipatory psychological contract, which acts as a precursor of new employees’ involvement in socialisation activities. coyle-shapiro (2006) believes that an individual’s anticipatory psychological contract gets developed during adolescence and is influenced by their family, friends, media, peers, school, contact with working individual and personal experiences. delobbe, cooper-thomas and de hoe (2016) and payne et al. (2008) studied the role of employees’ anticipatory psychological contract in the socialisation process and found that the perception of obligations of prospective employees towards their future employer, prior to organisational entry, did affect their perception and involvement in some of the socialisation activities, specifically in terms of training and interactions with supervisors and peers. other authors (including de vos et al. 2009; eilam-shamir & yaakobi 2014; gresse et al. 2013; linde & gresse 2014; ruchika & prasad 2019) have also accepted that the anticipatory psychological contract plays an important role in the development of the exchange relationship between employer and employee and can be especially important in recruitment and talent retention (zupan, mihelič & aleksić 2018). sherman and morley (2015) argue that to enhance our understanding of how the psychological contract is created, one should look through the theoretical lens of schema theory, which these authors consider an underdeveloped area within psychological contract research. mental schemas and the anticipatory psychological contract the anticipatory psychological contract can be defined as pre-employment beliefs and perceptions that individuals have (de hauw & de vos 2010), and includes the expectations and entitlement they hold regarding future employment (gresse et al. 2013), and promises they are willing to make to their future employers (de vos et al. 2009). employees entering the labour market already have certain expectations about the job they will do, the organisation they will work for and the employment relationship, which together function as the foundation of the psychological contract formation process (thomas & anderson 1998). the schema theory is nothing new to psychological contract research as it has been implied in rousseau’s (1990) reconceptualisation of the psychological contract, from the employee’s perspective. schema theory provides a theoretical lens to evaluate how the psychological contract works, which emphasises how information is used when parties come to an agreement (sherman & morley 2015). research suggests that individuals already have an established mental schema of what they expect from their future employer, even if they have no prior employment history (coyle-shapiro & parzefall 2008; de vos et al. 2009; gresse et al. 2013; gresse & linde 2020; linde & gresse 2014), although it is suggested that occupational newcomers’ psychological contract is constructed based on a naïve and imperfect schema (anderson & thomas 1996; ruchika & prasad 2019). de vos et al. (2009) have suggested that this mental schema that individuals have will be used to determine the degree that their expectations match the actual exchange relationship, after commencing employment. morrison and robinson (2004), as cited by alcover et al. (2017), explain that schemas develop early in an individual’s life when they learn generalised values about mutuality, quid pro quo rules, and rewards for effort exerted, and these value sets are influenced by their family, schools, peers, stereotypes, employment perceptions and interaction with working people. this indicates that the key to deciphering the psychological contract of a person may lie in analysing their mental schema, before organisational entry. gresse and linde (2020) reported on qualitative research conducted, which explored the mental schemas of graduates who have not yet entered formal employment and found that their mental schema already included short-term and long-term career projections and beliefs. these graduates were also result-oriented (in their minds the employment relationship was primarily concerned with what they get out of the deal) and desired status and power. gresse and linde (2020) also established that the mental schema of graduates included a predisposition towards turnover intent (ti) due to the perception that their employer will not fulfil some of their obligations – a feeling normally associated with psychological contract breach. obligations towards and pre-employment violation of the anticipatory psychological contract a general overview of obligations and the experience of breach in the psychological contract are required to provide context for obligations and pre-employment violation (pev) in the anticipatory psychological contract. the psychological contract contains beliefs about the employer’s obligations to the employee and the employee’s obligations to the employer (bordia et al. 2017; chen, tsui & zhong 2008; rousseau 1995), which is also referred to as the contents of the psychological contract. many researchers (bal, chiaburu & jansen 2010; kasekende et al. 2016) have indicated that the perceptions of employers and employees about the fulfilment of their unwritten expectations and obligations are important, since it could result in a perception of psychological contract breach. a breach of the psychological contract can occur when any of the psychological contract obligations were perceived as not delivered (bordia et al. 2017). the undesirable consequences of employees’ behaviour, if their employer failed their obligations, are well documented in psychological contract literature (conway & briner 2009; montes & zweig 2009; robinson & morrison 2000). when an individual experiences a breach in the psychological contract and the breach is perceived as significant, it will constitute a violation (morrison & robinson 1997; paul, niehoff & turnley 2000). empirical research has suggested a positive relationship between breach of employer obligations and breach of employee obligations (bordia et al. 2017; coyle-shapiro & kessler 2002; coyle-shapiro & neuman 2004). bordia et al. (2017) explains this relationship as existing due to the norm of reciprocity, which forms the ideological basis of social exchange theory, where employees minimalised their contribution to the company because they felt their employer did not fulfil its obligations. gresse (2018) have found that prospective employees already have a form of pev in their anticipatory psychological contract, based purely on subjective beliefs of non-fulfilment of employer obligations. according to the principles of psychological contract theory, the expectations that employees have automatically become the obligation of the employer, and vice versa (kasekende et al. 2016). kasekende (2017) defines obligations as a promise of future action, which the parties have agreed upon, even though the terms of the promise, the execution thereof and degree of mutuality open the contract to disagreements. some of these obligations and expectations in the psychological contract develop prior to organisational entry (de vos et al. 2009; gresse et al. 2013; rousseau 2012), which indicates that an individual’s perception of obligations, including their obligation towards their employer and their employer’s obligation towards them, can be created without an existing agreement between the parties. this can be perceived as problematic, considering that expectations and obligations existing in the anticipatory psychological contract are based only on the perception that individuals hold, even if they have never met their employer (gresse, 2018). gresse (2018) confirms some anticipatory expectations (pre-employment expectations) that occupational labour market entrees hold, which include autonomy in their work, personal space to conduct their work in, a positive work-life balance, some workplace guidance to assist them in adapting in the workplace, meaningful work, status in the workplace and attractive remuneration and benefits. gresse and linde (2019) also identify some of the expectations that employers have of inexperienced occupational newcomers, in that they should be willing to learn, be adaptable, take instruction from their superiors, take responsibility for their actions, be committed and loyal to the company, have realistic expectations and have the necessary hard and soft skills associated with employability. graduates’ perceptions of their fulfilment of their obligation towards their future employer become the graduates’ anticipatory obligations. in this study, the anticipatory state of the psychological contract (aspc) was used to refer to psychological contract fulfilment beliefs that an employee holds regarding future employment. to fully understand the anticipatory psychological contract of an individual, one needs to take the entitlement perception of that individual into account, which has been established as an influencing agent of a person’s expectations (gresse et al. 2013; linde & gresse 2014). role of entitlement in the anticipatory psychological contract the word ‘entitlement’ is mentioned in earlier psychological contract studies (paul et al. 2000; rousseau 1998), but there is no clear distinction between entitlement and expectations. gresse et al. (2013) drew a distinction between entitlement and expectations in psychological contract research and regarded entitlement as ‘psychological entitlement’. psychological entitlement is defined as a stable and pervasive sense of deservingness, where a person expects high levels of reward and preferential treatment in the absence of actual ability and performance levels (campbell et al. 2004; harvey & harris 2010). entitlement in the workplace is a cause for concern for managers (harvey & harris 2010) due to their subordinates’ inflated self-perceptions and feelings of deservingness of praise and recognition, regardless of actual performance (campbell et al. 2004; naumann, minsky & sturman 2002). entitled employees tend to overestimate their performance and still expect certain performance rewards (campbell et al. 2004; harvey & martinko 2009) and believe they should receive better treatment than their co-workers do (campbell et al. 2004; exline et al. 2004). unrealistic entitlement beliefs in employees have been associated with unethical workplace behaviour, perceived inequity, high pay expectations, lower job satisfaction, high turnover intention, corruption and conflict with supervisors (harvey & harris 2010; harvey & martinko 2009; kets de vries 2006; levine 2005). research regarding entitlement and psychological contract breach has found that employees with a strong sense of entitlement were more likely to experience depressive mood states after the perception of psychological contract violation due to their belief that the organisation owes them (priesemuth & taylor 2016). entitled individuals tend to arrive at their jobs with high levels of demands and expectations (crampton & hodge 2009; de hauw & de vos 2010). gresse et al. (2013) found that the anticipatory psychological contract of an individual includes entitlement beliefs of employees, which have a positive relationship with the expectation levels that an individual holds, especially regarding career aspirations and workplace benefits (linde & gresse 2014). gresse et al. also found that final-year university students’ sense of entitlement was influenced by factors relating to self-perception (perception regarding organisational contribution, experience levels and self-efficacy), academic factors (the obtainment of a qualification) and environmental factors (association with a social group, labour market tendencies and cost of living). in understanding graduate entitlement, the role of ‘academic entitlement’ cannot be discarded. academic entitlement is defined as a tendency of students to have predetermined attitudes, opinions and expectations that they deserve academic success in absence of justifiable academic scores and performance (chowning & campbell 2009; finney & finney 2010; kopp et al. 2011; lippmann, bulanda & wagenaar 2009; peirone & maticka-tyndale 2017). peirone and maticka-tyndale (2017) reported a positive relationship between academic and pre-employment entitlement, which indicates that academic entitlement also impacts the anticipatory psychological contract. in interviews conducted with graduates, gresse (2018) found that they had a predisposition toward ti in their anticipatory psychological contract, which was established as being based on entitlement. it was further reported that graduates felt entitled to being successful and that they are impatient about how long it will take for them to advance in their careers. sherman and morley (2015) argue that assessing an individual’s mental schema may facilitate a better understanding of the psychological contract formation process. these authors add that such research will add a theoretical contribution to psychological contract research, as it will enhance our understanding of specific terms of the psychological contract, which is only present during the organisational entry phase. at this stage, there seems to be no standardised measuring instrument to measure the anticipatory psychological contract from a schema perspective. therefore, the objectives of this study are: objective 1: to develop and validate the psychological contract expectations questionnaire (pceq) on prospective employees by determine its validity and reliability. objective 2: to report on the descriptive statistics and correlation coefficients of prospective employees by using the newly developed pceq. method procedure and participants we used an exploratory quantitative research approach to measure prospective employees’ anticipatory psychological contract. the theoretical population of this research was university graduates who have entered the labour market and are searching for employment in their field of study but have not yet acquired any. due to the large number of uncountable variables that impact expectations and experiences of participants from different study disciplines, it was decided to focus on a single discipline in our research. the study population was derived from the theoretical population, being graduates with a degree related to management sciences who have not yet entered formal employment but were in the final phase of entering the labour market. due to the difficulty of getting access to a large number of such participants, it was decided that the sample would consist of students in the final phase of their degree who will enter the labour market within the next couple of months. therefore, the sample was third-year students of management sciences who had no intention to further their studies in the following year. ethical clearance and university management approval was firstly obtained. to get a greater representation of the south african student profile, the research was conducted on the mafikeng and potchefstroom campuses. a list of third-year subjects was obtained and the largest classes for management sciences were selected as potential options, although only some lecturers agreed to provide us access to the class. the students were then informed and invited to participate in the study to measure their anticipatory psychological contract by filling out an anonymous paper-and-pencil questionnaire at the end of their class; students who did not fit the criteria or did not want to partake in the data gathering session were excused, and thus participation in the research was completely voluntary. the actual sample consisted of a total of 316 (n = 316) participants. the sample included both male and female participants, and represented african (49.7%), white (43.4%), mixed race (3.8%), indian (1.6%) and chinese (0.3%) participants. for the purpose of determining entitlement, it was also decided to report on participants’ main source of tertiary education funding. just over 2% (2.2%) of the participants paid for their qualification themselves; the sources of tertiary education funding of the rest of the participants included: parents or other family (57.6%), government funding (26.9%), private institution funding (4.4%), study loan (5.7%) and other sources (1.9%, including friends or acquaintances). instrument the pceq was developed to explore the anticipatory psychological contract of the participants. the questionnaire was based on the structure of the psycones questionnaire (psycones 2006), which is still widely used in psychological contract research (e.g. kasekende 2017; snyman, ferreira, & deas 2015; surujlal & dhurup 2017), and its contents are based on research findings from gresse et al. (2013), gresse (2018), and linde and gresse (2014). the items that were developed under the constructs of the psychological contract framework were different from those of the psycones questionnaire, due to the psychological contract not being part of an employment contract. the pceq consists of six sections or instruments, namely biographical information, anticipatory employee expectations (aex), anticipatory employee obligations (aeo), aspc, ti, anticipatory pev and entitlement. ethical consideration a letter and research proposal were sent to the ethics committee of the north-west university requesting the approval of the research study. this research was approved by the human resource research ethics committee, mafikeng campus, and the north-west university institutional research ethics regulatory committee. once consent had been received from the ethics committee of the north-west university to proceed with the research study, the author continued with the research with a valid ethics number (nwu-00310-15-a9). results validation of the psychological contract expectations questionnaire the first objective was to develop and validate the pceq on prospective employees; this was achieved by statistically analysing each of the sections of the pceq by using ibm spss (version 25). obtaining the validity and reliability was achieved by doing exploratory factor analysis and determining the cronbach’s alpha coefficient for each of the five sections of the pceq (excluding biographical information). anticipatory employee expectations the aex refer to the expectations that employees have regarding future employment. a total of 18 items were developed based on the exploratory research findings of gresse et al. (2013) and gresse (2018). the main themes of these items were autonomy expectations (3 items), reward and recognition expectations (5 items), meaningful work expectations (3 items), attractive remuneration expectations (4 items), personal space expectations (3 items) and work-life balance expectations (2 items). the participants were asked to rate the aex questions based on whether they think that their future employer will make the corresponding promises to them and to what extent they believe that their employer will fulfil their promise, on a six-point likert scale (1 = ‘my future employer will make no such promise’; 2 = ‘yes, my future employer will make such a promise, but this promise might not be kept at all’; 6 = ‘yes, my future employer will make such a promise and it might be fully kept’). an example of some of the aex items are: ‘will provide you with the freedom to decide how to do your job’, ‘will provide you with interesting work’ and ‘will recognise you as an expert in your field’. referring to both aex and aeo, ‘no’ (1) and ‘yes’ (2–6) refer to the measurement of the contents of the anticipatory psychological contract. the scale from 2 to 6 refers to future fulfilment beliefs of the anticipatory psychological contract, after the content of the psychological contract has been determined. therefore, the items that refer to an exclusion of the contents (‘no’) were not included in the statistical analysis. the rest of the scale was then recoded into a five-point likert scale ranging from 1 = ‘yes, my future employer will make such a promise, but this promise might not be kept at all’ to 5 = ‘yes, my future employer will make such a promise and it might be fully kept’. an exploratory factor analysis confirmed that all the items could be grouped together to form a single component – aex – with loadings above 0.45 and communality values (h2) higher than 0.45. the cronbach’s alpha coefficient was 0.92 (α = 0.92). devellis (2003) states that an ideal cronbach’s alpha coefficient is above 0.7 (which confirms reliability). the exploratory factor analysis for aex can be seen in table 1. table 1: factor loadings of anticipatory employee expectations. anticipatory employee obligations the aeo refer to the promises that employees are willing to make to their future employer. a total of 21 items were developed based on the exploratory research findings of gresse (2018). the main themes of these items were workplace learning (3 items), accountability (3 items), employment obligations (5 items), commitment (3 items), adaptability (3 items) and subordination (4 items). similar to the likert scale with the aex, participants were asked to rate the aeo questions based on whether they are willing to make such a promise to their future employer and to what extent they will fulfil this promise, on a six-point scale (1 = ‘i will make no such a promise’; 2 = ‘yes, i will make this promise to my future employer, but my promise might not be kept at all’; 6 = ‘yes, i will make such a promise and it will be fully kept’). examples of some of the aeo items are: ‘commit yourself to skills development opportunities’, ‘work extra hours without compensation’ and ‘do work outside your job description’. these aeo items were used in the statistical analysis. an exploratory factor analysis suggested that the aeo items should be grouped into three different components. based on this suggestion, the first component was labelled aeo general employment (cronbach’s alpha coefficient of 0.89), and the second component was labelled aeo additional duties and hours (cronbach’s alpha coefficient of 0.80). the results of the exploratory factor analysis can be seen in table 2. table 2: factor loadings of anticipatory employee obligations. due to a low cronbach’s alpha coefficient of the last component (α = 0.58), it was decided to split it into two single-item components; therefore, the last two components for aeo were: aeo accountability and aeo accountability for subordinates. anticipatory state of the psychological contract to measure the aspc of prospective employees, a total of eight items were developed based on the exploratory research findings of gresse (2018). participants were asked to rate whether they agree with various aspc statements, on a five-point likert scale (1 = ‘not at all’; 5 = ‘totally’). examples of some of the items are: ‘do you believe that you will be fairly rewarded for the effort you will put into your future job?’ and ‘do you believe that your future manager will treat you fairly?’ an exploratory factor analysis confirmed that all the items could be grouped together to form a single component: aspc with loadings above 0.45, communality values (h2) higher than 0.45, and a cronbach’s alpha coefficient of 0.85 (α = 0.85). turnover intent the pceq had three items that measured the ti of prospective employees and was developed based on findings from gresse (2018). participants were asked to rate whether they agreed with the following statements: ‘i do not plan to work very long for my first employer’ and ‘i will keep applying for better positions once i start working’. they had to rate these questions using a five-point likert scale (1 = ‘not at all’; 5 = ‘totally’). students were also asked to rate how many employers they believe they will work for in the first 10 years of employment based on another five-point scale (1 = ‘one employer’; 2 = ‘two employers’, 3 = ‘three employers’; 4 = ‘four employers’, 5 = ‘five or more employers’). due to two different scales and a low cronbach’s alpha coefficient (α = 0.58) and inter-item correlation, it was decided to report on the items separately in terms of immediate ti, continuous ti and long-term ti. pre-employment violation the pceq had four items that measured the pev of prospective employees. pre-employment violation refers to a finding in gresse (2018) where graduates already had a sense of psychological breach due to them believing that their future employer will not be able to meet their expectations, thereby failing to retain them. participants were asked to rate whether they agreed with four pev statements, on a five-point likert scale (1 = ‘not at all’; 5 = ‘totally’). an example of one of these statements is: ‘i believe that i will have to find alternate employment when i start working due to personality clashes with my future supervisor’. due to a low cronbach’s alpha coefficient (α = 0.53) and inter-item correlation, it was decided to report on the items separately in terms of pev better offer (anticipate better offer from another company), pev field of study (anticipate that a position outside their field will provide a better salary), pev conflict with supervisor (anticipate clashes with their supervisor) and pev low position (anticipate lower job level). we believe that the low cronbach’s alpha coefficient might be due to the highly individualistic nature of violation experiences in the anticipatory psychological contract. entitlement to measure the entitlement of prospective employees, a total of five items were developed based on research findings by linde and gresse (2014), gresse et al. (2013) and gresse (2018). the common theme of the items was sense of deservingness of the participants. participants were asked to rate whether they agree with five subtle entitlement statements, on a five-point likert scale (1 = ‘not at all’; 5 = ‘totally’). examples of some of the items are: ‘due to my qualification, i deserve a very good job’ and ‘i believe that i will be the best candidate for any job in my field’. an exploratory factor analysis confirmed that all the items could be grouped together to form a single component: entitlement (ent). entitlement displayed a cronbach’s alpha of 0.61 (α = 0.61), which is lower than the ideal of 0.7, as suggested by devellis (2003). however, pallant (2013) stated that cronbach’s alpha values are sensitive to the number of items in a scale, especially in scales with fewer than 10 items; therefore, it is better to report the mean inter-item correlation for the items. briggs and cheek (1986), as cited in pallant (2013), recommended that the optimal range for inter-item correlation is between 0.2 and 0.4. table 3 displays a summary of the item statistics for ent. table 3: summary of entitlement item statistics. based on table 3, the inter-item correlation mean was 0.25 with a range of 0.3, which is within the optimal range as suggested by briggs and cheek (1986); therefore, ent can be regarded as a reliable instrument. measuring graduates’ anticipatory psychological contract the second objective was to report on the descriptive statistics and correlation coefficients of graduates by using the pceq. the statistical analysis was carried out with the ibm spss program (version 25). descriptive statistics were used to determine the minimum, maximum, mean standard deviation, skewness and kurtosis. results of the descriptive statistics can be seen in table 4. the table shows that, in most cases, the distribution of data is normal with a skewness and kurtosis between the values −1 and 1. anticipatory employee obligations general employment (−1.02), continuous ti (−1.05) and pev better offer (−1.25) all fall outside the barriers of what is considered normal distribution for skewness, and aeo accountability (−1.12) and aeo accountability for subordinates (−1.1) fall outside barriers of what is considered normal distribution for kurtosis. these, however, are very close to acceptable standards. table 4: descriptive statistics of the psychological contract expectations questionnaire. the mean (m) provides some interesting insight into the anticipatory psychological contract of these participants. in terms of aex, the majority of participants displayed average levels of expectations (m = 2.75). the aeo level was also quite average for most participants, in that they were willing to make certain promises to their future employer and in most cases keep those promises. participants were slightly more reluctant to fulfil their obligation towards additional duties and hours, but then again, they were more than willing to make up for that by keeping their promises if their obligations were related to general employment, which is supported with a much higher mean (m = 3.74). in terms of general employment, the results suggest that graduates tend to promise more, but expect less from their future employer. it is encouraging to see that most participants have a positive opinion of their future exchange relationship, which is supported with a high mean (m = 3.5) for the aspc. from the results, it is evident, and alarming, that graduates do already have a predisposition regarding ti with a higher than average mean for immediate ti (m = 3.17) and an extremely high mean for continuous ti (m = 4.06). most participants also display high levels of pev where they believe that their future employer will not be able to retain them, especially in terms of their employer matching or beating an offer from another company (which can also be a position outside their field of study). overall, these participants can also be regarded as being entitled (m = 3.36). gresse et al. (2013) reported that various factors can influence the entitlement perception of individuals, which was confirmed when looking at the descriptive statistics (specifically the mean) based on the different groups in the biographical information. for instance participants studying on government funding displayed considerably higher levels of entitlement (m = 3.66) than students whose main source of financing comes from themselves (m = 3.31), parents or family (m = 3.29), private institutions (m = 3.12), study loans (m = 2.96) and other sources (m = 3.1). female participants (m = 3.44) also displayed a slightly higher entitlement than male participants (m = 3.25). the results of the correlation coefficient between the different variables are displayed in table 5; this correlation coefficient describes the degree of relationship between two variables (trochim & donnelly 2008). table 5: pearson’s product-moment correlation coefficient of the psychological contract expectations questionnaire. the results show that all significant correlations (p < 0.05 and p < 0.01) between the variables had a positive correlation (r > 0), which means that both variables move in the same direction. there is no relationship between aex and the pev constructs, with the strongest correlation being between aex and pev conflict with supervisor that only displayed a statistically significant correlation (r = 0.11, p < 0.05). in terms of aex, a relationship was established between aex and aeo general employment (r = 0.44, p < 0.01). there was no practical significant relationship between aex and ent (r = 0.20, p < 0.01), as well as aex and continuous ti (r = 0.16, p < 0.01), although the correlation was statistically significant for both with p < 0.01. the highest relationships that involved aex were between aex and the aspc (r = 0.56, p < 0.01). the aeo variables all had significant relationships with one another, although the strength of the relationships was relatively weak, with the highest being between aeo accountability and aeo accountability for subordinates (r = 0.41, p < 0.01). there was a relationship between: aeo general employment and aspc (r = 0.38, p < 0.01); aeo general employment and continuous ti (r = 0.33, p < 0.01); and aeo general employment and pev better offer (r = 0.38, p < 0.01). there is no practically significant relationship between aeo general employment and ent (r = 0.15, p < 0.01) although the correlation is statistically significant at the 0.01 level. anticipatory employee obligations additional duties and hours had a very weak practically significant relationship with aspc (r = 0.26, p < 0.01) and pev low position (r = 0.22, p < 0.01) with both displaying a statistically significant correlation (p < 0.01). anticipatory employee obligations accountability displayed a very weak practically significant relationship with pev low position (r = 0.23, p < 0.01). there was no practically significant relationship between aspc and continuous ti (r = 0.15, p < 0.05); aspc and pev better offer (r = 0.12, p < 0.05), and aspc and pev conflict with supervisor (r = 0.13, p < 0.01) even though the correlation is statistically significant with p < 0.05. there was, however, a weak practically significant relationship between aspc and ent (r = 0.38, p < 0.01). there was almost no practically significant correlation between the ti variables, although there were some statistically significant correlations. there was also no practically significant relationship between immediate ti and pev better offer (r = 0.20, p < 0.01) and immediate ti and pev conflict with supervisor (r = 0.13, p < 0.05), although both had a statistically significant correlation with p < 0.05. continuous ti did display a practically significant relationship with some of the pev variables. there was a relationship between continuous ti and pev better offer (r = 0.39, p < 0.01) and continuous ti and pev field of study (r = 0.30, p < 0.01). in terms of the relationship between ent and ti, there was no relationship between ent and immediate ti or continuous ti. there was a relationship between ent and long-term ti (r = 0.27, p < 0.01), although the practically significant relationship was weak. all the pev variables had weak practically significant relationships between themselves, although they were statistically significant (p < 0.05). the highest inter-variable relationship was between pev conflict with supervisor and pev low position (r = 0.30, p < 0.01), although the strength of the practically significant relationship is still considered weak. there was a weak relationship between ent and pev better offer (r = 0.24, p < 0.01); ent and pev field of study (r = 0.27, p < 0.01); and ent and pev low position (r = 0.21, p < 0.01). the strongest relationship regarding violation and entitlement was between ent and pev conflict with supervisor (r = 0.32, p < 0.01). discussion validation of the psychological contract expectations questionnaire to validate the pceq it was necessary to analyse each of the sections or instruments of the pceq. the pceq included instruments for measuring the aex, aeo, aspc, ti, anticipatory pev and ent. in terms of validity, the exploratory factor analysis showed that the instruments that measured aex, aeo, aspc and ent are considered valid. the cronbach’s alpha results also supported the reliability of these instruments, it should however be noted that the instrument for entitlement was not considered reliable in terms of its cronbach’s alpha, due to a low item count, but was considered reliable when looking at its mean inter-item correlation (pallant 2013). to increase the effectiveness of the pceq in assessing the anticipatory psychological contract, the measurement for entitlement could be further developed to include more relevant items. in terms of ti and pev, validity could not be statistically established, which directly resulted in low reliability of these two instruments. in this research we mainly reported on single-item results for ti and pev. on face validity these items are related to the construct that they measure, but our statistical analysis could not support this. according to trochim and donnelly (2008) there can be various reasons why an instrument can display low validity, for example small sample size, faulty measuring instrument or insufficient statistical power. it can be assumed that the main reason why these items were not valid was that they are new to psychological contract research (gresse, 2018), and the proper theoretical knowledge needed to develop valid items, is lacking. measuring graduates’ anticipatory psychological contract sherman and morley (2015) suggest that using a theoretical lens of the schema theory and looking at employees’ mental schema in the final stages before organisational entry may enhance researchers’ efforts to understand how the psychological contract develops. our research and delobbe et al.’s (2016) findings largely support sherman and morley’s perception in that we both found that the anticipatory psychological contract directly impacts the actual exchange relationship. the descriptive statistics highlighted the collective mental schema of south african students. the first notable aspect was that these participants can be regarded as being entitled due to a high mean. entitlement being associated with graduates has already been documented in education research (i.e. abrahams 2017; scully 2013), as well as psychological contract research (gresse et al. 2013; gresse, 2018; linde & gresse 2014). the second notable aspect was that these results confirm gresse’s (2018) finding that graduates had a predisposition towards continuous ti; in other words, tendency toward job-hopping. previous studies have confirmed a positive relationship between breach of employee obligations and breach of employer obligations (bordia et al. 2017; coyle-shapiro & kessler 2002; coyle-shapiro & neuman 2004). it would seem as if the same principle applies in the anticipatory psychological contract where individuals’ perception of future fulfilment (ascp) had a positive relationship with both anticipatory expectations and anticipatory obligations. it was found that if employees held a positive belief that their future psychological contract beliefs will be fulfilled by their future employer, they were more inclined to have higher expectations and higher obligations toward their future employer. the same principle applied to them having a lower perception of future fulfilment. this relationship makes sense due to the norm of reciprocity (bordia et al. 2017), according to which employees will have lower expectations if they think that their employer will not fulfil their perceived contractual obligations, and vice versa. there was a stronger practically significant relationship between the anticipatory expectations and the anticipatory obligations that the participants had than there was between anticipatory obligations and the aspc. this might indicate that prospective employees’ anticipatory expectations might play a bigger role in determining their anticipatory obligations. this means that the anticipatory expectation level of occupational newcomers might determine to what degree they will keep their employment promises. an interesting relationship from the results is that there was a positive relationship between the pev variables and the anticipatory expectations, as well as with the anticipatory obligations. the logical assumption will be that when you perceive violation, you will automatically expect less and will also be less likely to fulfil your obligational promises (bordia et al. 2017; coyle-shapiro & kessler 2002; coyle-shapiro & neuman 2004). from the descriptive statistics, it was clear that these participants had high levels of pev, which was supported by relatively high means of all the violation variables, especially regarding violation due to the anticipation of a better offer, which was overall the highest-rated item of the questionnaire. the results of the correlation coefficient displayed no relationship between pev variables and anticipatory expectations. the results displayed a positive relationship between pev and anticipatory obligations, which suggests that higher experiences of violation are accompanied by a higher tendency of the individual to fulfil their promises, a finding that is inconsistent with literature. we believe that this correlation exists due to cognitive sense-making in the anticipatory psychological contract. in employment, if a breach of the psychological contract is experienced, the employee will first go through a cognitive sense-making process to determine whether the breach is significant, before deciding on action (dulac et al. 2008; louis 1980; weick, sutcliffe & obstfeld 2005). rousseau (2001) based her theory of the psychological contract on the schema theory, and focused specifically on how employees made sense of their psychological contracts. our results confirm prospective employees’ mental schemas already include a pev perception, in that they believe that their future employer will not be able, or might not be willing, to match or beat another company’s employment offers. during the phase leading up to labour market entry, prospective employees might get new employment information from the various sources that influence their mental schemas (as suggested by morrison & robinson 2004), or by actively taking part in information-seeking activities (de vos et al. 2003; de vos & freese 2011; thomas & anderson 1998). this information might contradict their current beliefs, which already formed part of their mental schema. therefore, it can be assumed that prospective employees might be experiencing a breach in their anticipatory psychological contract and will try to make sense of what they are experiencing, like the sense-making process when an individual experiences psychological contract breach in employment. the result of this sense-making process will determine whether the outcome will get established in the mental schema, which was the case in this study, due to a high mean of participants to always accept a better offer from another employer. the mental schema of an individual acts as blueprint for how employment information is processed (sherman & morley 2015) and we now add that there is the potential that a sense-making process can influence what gets established in the mental schema, requiring certain reactions. a similar situation was reported in gresse (2018), who found that new working graduates experienced one or more discrepancies between their expectations and employment reality, even though the majority experienced a healthy exchange relationship and were overall happy with their employer; this should have clearly constituted psychological contract breach or violation. it was also suggested that the sense-making process associated with psychological contract breach was the reason for this occurrence. therefore, we suggest that some aspects that are established in the mental schema of an individual will directly influence their preand post-employment behaviour. this suggestion is also supported by our findings due to a relationship between pev regarding anticipation of a better offer and continuous ti, which can also be interpreted as job-hopping behaviour. in this case, violation was experienced that triggered the sense-making process to determine its significance; when the individual perceives the violation as significant, it will contribute to undesirable behaviour (supported by the relationship between pev better offer and continuous ti) and if it is insignificant, it will be discarded from the individual’s mental schema. if this is the case, it confirms gresse (2018) assumption that pev experience is actually a psychological defence mechanism used to diminish disappointment in employment. the relationship between pev regarding the anticipation of a better offer and anticipatory obligations exists due to the link between pev and job-hopping tendencies. when an employee commences employment, they tend to display certain behaviours to self-manage the advancement in their career, including networking behaviour (getting to know influential people), visibility behaviour (drawing attention to work accomplishment), positioning behaviour (pursuing valuable job opportunities), behaviour related to developing themselves (pursuing training and education opportunism), validating behaviour (proving competence) and behaviour relating to controlling work-life balance (jonker 2011). we believe that the reason why there is a positive relationship between pev and anticipatory obligations is due to a person’s perception that these career self-managing behaviours are essential in employment with their future employer in order to make themselves visible and viable for employment in other companies. in most cases, an application for a job in another company will require a positive reference (letter of recommendation) from previous employers. gresse (2018) established that new employees had some form of pev in their anticipatory psychological contract, but it was never confirmed whether entitlement has a relationship with these violations. the results indicate that there was almost no relationship between pev variables and entitlement. the only notable relationship was between entitlement and pev due to employees anticipating conflict with their future supervisors. harvey and harris (2010) have confirmed that psychologically entitled employees had a higher tendency to have conflict with their supervisors. this indicates that the more entitled an employee is, the greater the chance that they anticipate conflict with their supervisor. this does not explain why entitled employees will anticipate this conflict if they have no prior work experience. the only logical explanation might be that individuals who are regarded as entitled might have experienced conflict earlier in life with authority figures (for instance parents, teachers, lecturers, etc.) and therefore it will happen again with future authority figures (supervisors). although entitlement only had a relationship with one of the pev variables, it should be noted that there might exist other pev experiences (which were not assessed in this study) in the anticipatory psychological contract of employees who may have a relationship. this assumption is supported due to the highly individualistic nature of entitlement, as suggested in psychological entitlement’s definition (campbell et al. 2004; harvey & harris 2010), as well as all the factors that can influence an individual’s entitlement perception (gresse et al. 2013). our results also indicate that there was a positive relationship between entitlement and the aspc. linde and gresse (2014) confirmed that entitlement leads to higher expectations; therefore, we can conclude that entitlement impacts on the anticipation of future employment (aspc). the higher an individual’s entitlement perception is, the more likely it will be that they will have a positive perception regarding future psychological contract fulfilment, which can be attributed to their deservingness perception in terms of performance rewards (campbell et al. 2004; harvey & martinko 2009) and better treatment (campbell et al. 2004; exline et al. 2004) in the absence of actual abilities and performance levels (campbell et al. 2004; harvey & harris 2010). conclusion the schema theory approach in trying to explain psychological contract development is perceived to be an underdeveloped area within psychological contract research (sherman & morley 2015), especially with regard to the anticipatory psychological contract. markovi and stoilkovska (2015) also drew the conclusion that studies regarding the anticipatory psychological contract are quite rare. our research contributes to anticipatory psychological contract research by introducing the pceq questionnaire to effectively measure the anticipatory obligations, anticipatory expectations, entitlement and aspc of prospective employees’ mental schema, with all the results supporting validity and reliability. the results however showed that the instruments used to measure pev and ti within the pceq was not regarded as valid or reliable. this indicates that further research is needed to support the development of adequate ti and pev measurement instruments within the anticipatory psychological contract framework. a correlation coefficient confirmed a positive practically significant relationship between the aspc and anticipatory obligations, as well as a positive relationship between the aspc and anticipatory expectations. it was also suggested that pev had no relationship with anticipatory expectations, although it had a positive relationship with anticipatory obligations. it was then concluded that this relationship exists due to a sense-making process that occurs in the mental schema of a prospective employee. entitlement had a positive relationship with the aspc, as well as with one of the pev variables. acknowledgements competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions all authors contributed equally to this work. funding information this research received no specific grant from any funding agency in the public, commercial or non-profit sectors. data availability statement participant data are regarded as confidential. the data are however kept safe for record purposes. disclaimer the views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of any affiliated agency of the authors. references abrahams, j., 2017, ‘honourable mobility or shameless entitlement? habitus and graduate employment’, british 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communication management, university of pretoria ________________________________________________________________ abstract branding is a key strategic tool used to create awareness, reputation and build the organisation’s image. marketers consider brands as carriers of values, and the development and implementation of branding strategies and programmes have lately expanded to include more than the traditional corporate, product and service domains of branding. in this article we set out to define and briefly discuss the nature of branding and indicate how brands are used to define the product to the customer. one of the major challenges facing south african business and marketing executives in the new millennium is to create world class brands that will put south african brands on the national and international map. jel m31 introduction brands exist in the mind. they help us reduce the anxiety of the unknown by providing the assurance of an old friend. dr edward de bono, 2001. in today’s volatile and competitive markets brands are under constant pressure. mergers, acquisitions and major changes in the business environment demand the continuous management of the organisation’s brands. all brands, “…whether product, service or corporate require constant evaluation and conscious rejuvenation” (mccoy, 2001: 1). for many customers and consumers, the brand “is the product”. therefore, branding is a key strategic tool used to create awareness, reputation and build the organisation’s image. marketers consider brands as carriers of values, and according to mccoy (2001), can even be a more efficient way than segmentation to find your target market. in order to build customer trust and loyalty, a brand must be easy to identify and consistent in quality. the development and implementation of branding strategies and sajems ns vol 6 (2003) no 1 160 programmes have lately expanded to include more than the traditional corporate, product and service domains of branding. retail branding, for example, aims to fully engage the customer and reach beyond merely staging an experience (levy & weitz, 2001). the rapid growth in the leisure industry is placing great demands on leisure branding (mccoy, 2001), while the emergence of ecommerce has demonstrated the importance of digital branding (duncan, 2002; mccoy, 2001). there is general agreement in the marketing literature that a brand is more than the name given to a product; it embodies a whole set of physical and socio psychological attributes and beliefs (simões & didd, 2001: 217). in consumer marketing, brands often provide the primary means of differentiation between competitive offerings. as such, brands can be critical to the success of companies (wood, 2000: 662). it is estimated that half of the market value of the fortune 250 companies are tied up in intangible assets such as brand equity (court, leiter & loch, 1999: 101). aaker (1991: 7-8) suggests that strong brands provide higher profit margins and better access to distributio n channels, as well as a broad platform for product line extensions. it is clear that brands directly influence the sustainability of a business and its growth. brands are also directly responsible for generating shareholder value. in this article we set out to define and briefly discuss the nature of branding and indicate how brands are used to define the product to the customer. we discuss the role that brands play in companies, and touch on the process of brand management so as to give practical insight into this important yet illusive management tool. special emphasis will be placed on the development of brands and branding from a south african perspective. to illustrate the value and “power” of branding to a company, and serve as an introduction and background to the topic, a case study of a well-known global brand, namely heineken beer, is presented first. case study: heineken beer the traditional global beer market has hardly grown over the last decade. this has prompted brewers to expand into non-traditional beer drinking markets, such as those in traditional wine drinking countries (vrontis, 1998: 76). the traditional beer drinking nations of northern europe (countries such as uk, germany, belgium and ireland) have, for example, recently experienced stagnating or falling beer sales due to consumers switching to low alcoholic beers, wine and soft drinks. sajems ns vol 6 (2003) no 1 161 brewers essentially regard beer as a homogeneous product, and thus rely largely on differentiation to create consumer preferences. in an industry where product differentiation especially differentiation relating to image and segmentation is of paramount importance, the creation and maintenance of a strong portfolio of brands is critical in terms of achieving a sustained competitive advantage (vrontis, 1998: 77). heineken, one of the three most recognised beer brands in the world, is available in more than 170 countries (ac nielsen, 2001: 4). the company was founded in 1864, when a 22-year old businessman, gerard adriaan heineken, bought the haystack brewery in amsterdam. since then, heineken has grown with leaps and bounds to the point where it currently is the third largest brewer in the world with a production volume of 97.9 million hectolitres, and profits in the region of eur 621 million (http://www.heinekencorp.com/). the globalisation drive by heineken can be traced back to the vision of alfred heineken who, in 1942, saw the potential of a beer that can travel around the world. as grandson of g.a. heineken, he went to america to learn how the americans market their beer. currently only 21 per cent of the company’s sales occur within the netherlands. the encyclopaedia of consumer brands (1994) states that in the early 1990s heineken achieved a 9 per cent market share in western europe, increasing its status to that of the largest european beer brewery. the heineken brand is sold in 170 different countries and brewed in 19 of them. while the company possesses more than 70 different brands, its principal strategy is to market four corporate brands on a worldwide scale. these brands are: heineken, amstel, buckler (alcohol-free) and murphy’s irish stout. only the first two (heineken and amstel) are marketed in south africa. these global brands are supported by the remaining brands in the product line, which tend to be national or regional in identity. the decision was however taken to brand heineken international under the same brand logo to project a single standard quality image internationally (http://www.heinekencorp.com/). a closer examination of heineken’s marketing strategy (4 ps) clearly shows how the brand is integrated into the product and vice versa. in table 1 heineken’s european marketing strategy is compared to their south african strategy. sajems ns vol 6 (2003) no 1 162 table 1 heineken’s marketing strategy: a comparison between europe and south africa strategy europe and uk south africa product price place promotion brand name: heineken and heineken export premium 90 breweries outside europe sponsorships and traditional promotional tactics heineken and amstel premium distributed through sa breweries sponsorships and traditional promotional tactics the power of the heineken branding is quite evident from the entry of heineken into the hong kong beer market. carlsberg and san miguel traditionally dominated the hong kong beer market. today they account for only 45 per cent of the market, while heineken accounts for 20 per cent. this growth was accomplished by using a key asian value, namely popularity. the company asked staff of restaurants and bars to leave heineken bottles on the tables. very soon, little green bottles where being drunk by white-collar workers everywhere (robinson 1996: 57). using the quality associated with generic heineken in traditional markets and the visual connotation of the green branded bottle, heineken successfully entered a closed market at a relative low cost. global brands ac nielsen, the global marketing research firm, recently published a report on the world’s leading global brands entitled “reaching the billion dollar mark: a review of today’s global brands”. the report identifies those brands that have sales over a billion dollars as well as a geographic presence in all of the major regions of the world. a brand had to meet three main criteria to be included in the ac nielsen study: • the cumulative sales for the year ending march 2001 had to be us $1 billion or more. • the brand had to have a measurable presence in each of the following four geographic regions, namely latin america, asia pacific, north america and europe, as well as the middle east & africa. • sales outside of the home market had to represent at least 5 per cent of the global sales value. sajems ns vol 6 (2003) no 1 163 the findings presented in the report are based on data from thirty countries. although one may question whether this is truly a global study, these 30 key markets account for 90 per cent of the world’s gross domestic product (gdp) and are spread across all of the core geographic regions. over two hundred brands were researched for this study. of the 200 plus brands investigated, only 43 brands actually met the criteria of having a global presence in each region and having over a billion dollars in sales. these 43 brands represent 23 global manufacturers and a total of more than $125 billion in sales (see table 2). a glance through this list of “global leading brands” inadvertently leads one to ask the following questions: “what makes these brands so unique?” and “why are these brands so successful?” these are undoubtedly difficult questions to answer. tilley (1999: 182) argues that the world’s leading brands are “… those which consistently deliver their promise to their customers and are able to create lasting value for them”. she has identified some distinguishing characteristics of so-called “leadership brands”: • they influence the behaviours, thoughts and feelings of a significant number of people, or of a market. rather than following rules and markets, leadership brands create them. • they effectively communicate a meaning which is more than just the function of the product or the market they serve. the most effective meanings are based on a deeply felt human need. this enables leading brands to enter new markets or develop new products which address this need. • leadership brands embody their meaning in all they do. they exemplify it and this embodiment is visible at all times. • they are consistent and eloquent in every aspect of their communication so that people always understand what the brand stands for. • they are dynamic, constantly changing and developing to meet new needs so that they remain relevant, even when their original product is obsolete. • leadership brands have social responsibilities and inspirational roles. they hold certain beliefs, values, attitudes and behaviours which earn the respect of consumers and other stakeholders. sajems ns vol 6 (2003) no 1 164 table 2 a review of today’s global brands brand (# of countries included 30 maximum) segment sales ye q1 2001 (in constant us $) total coca-cola (30) coca-cola (regular)** diet coke/coca-cola light** marlboro (25) marlboro (regular)** marlboro lights** carbonated beverages tobacco over $15 billion total pepsi (30) pepsi (regular)** diet pepsi/ pepsi light** carbonated beverages $5 15 billion budweiser (25) campbell's (21) kelloggs (27) pampers (27) beer soup cereal diapers $3 5 billion benson & hedges (21) camel (24) danone (25) fanta (29) friskies (24) gillette (29) huggies (25) nescafe (29) sprite (30) tide (11) tropicana (17) wrigley's (27) tobacco tobacco yoghurt carbonated beverages pet food blades & razors diapers coffee carbonated beverages laundry detergent still beverages chewing gum $2 3 billion colgate (29) duracell (28) heineken (26) kodak (13) l&m (18) lay's (22) pedigree (25) toothpaste batteries beer consumer films tobacco chips & snacks pet food $1.5 2 billion sajems ns vol 6 (2003) no 1 165 table 2 continued brand (# of countries included 30 maximum) segment sales ye q1 2001 (in constant us $) always (22) doritos (20) energizer (28) gatorade (22) guinness (23) kinder (28) kleenex (26) l'oreal (27) maxwell house (19) minute maid (16) nivea (29) pantene (30) philadelphia (25) pringles (30) seven-up/ 7-up (30) tylenol (9) whiskas (24) sanitary protection chips & snacks batteries sports beverages beer chocolate facial tissue colorants coffee still beverages moisturizers & cleansers shampoo & conditioners cheese chips & snacks carbonated beverages otc pain remedies pet food $1 1.5 billion * brands are in alphabetical order within each sales range ** sub brands that independently meet the global billion dollar mark source: ac nielsen, 2001. the six characteristics discussed above suggest that a brand is more than just a label, name, or package. but what exactly is a brand? we will attempt to answer this question in the next section. the nature of a brand different authors define the term “brand” differently. wood (2000: 664) explains that the different approaches to defining the brand construct partly stem from differing philosophies (such as product-plus and holistic branding) and stakeholder perspectives (i.e. a brand may be defined from the consumers' perspective and/or from the brand owner's perspective). in addition, brands are sometimes defined in terms of their purpose, and sometimes described by their characteristics. sajems ns vol 6 (2003) no 1 166 de chernatony & riley (1997: 89) point out that much of the literature on brands is based on the 1960 american marketing association (ama) definition of a brand: a name, term, sign, symbol or design, or combination of them, intended to identify the goods or services or one seller or group of sellers and to differentiate them from those of competitors. this definition has been criticised by writers on the subject as being too mechanical, too concerned with the physical product, too input orientated, with little reference to the manufacturer’s strategic thinking or visions for the brand, and failing to recognize that the brand acquires connotations in consumers’ minds through their experiences with it (de chernatony & riley 1997: 90). de chernatony & riley (1997: 90) has identified nine themes regarding the nature of a brand from a review of relevant literature in this regard. these nine themes include conceptualisations of a brand as: • a legal instrument – since branding represents an investment by a firm, firms seek legal ownership of a title to obtain some protection against imitators. at is simplest, a brand can, therefore, be regarded as a legal “statement of ownership”. • a logo – the conceptualisation of a brand as a logo is in line with the traditional ama definition cited earlier. this definition stresses the importance of the brand’s visual features as the basis for differentiation. • a company – many service organizations use corporate branding where the company’s name is used to identify the entire product offering (cravens 1997: 308). such a perspective stresses a coherent focus for all the company’s offerings, with a consistent message to all its stakeholders (de chernatony & riley 1997: 91). • an identity system – this perspective stresses the need for developing a holistic, integrated desired positioning for the brand. in this regard, de chernatony (1999) distinguishes between the image, reputation and identity of the brand. brand identity is a firm-centred concept that can be defined as a unique set of brand associations that the brand strategist aspires to create or maintain (louro & cunha, 2001: 860). from the firm’s perspective, the brand identity is an expression of how the firm wants the brand to be perceived by its customers. brand image, on the other hand, is a customer-centred concept which can be defined as a holistic impression held by customers about the relative position of a brand among its perceived competitors (de chernatony, 1999: 165). de chernatony (1999: 159) argues that brand image concerns the latest perceptions and that it changes continually. sajems ns vol 6 (2003) no 1 167 he believes that managers should rather focus on brand reputation that is more stable and represent the distillation of multiple images over time. the latter construct is defined as: “a collective representation of a brand’s past actions and results that describes the brand’s ability to deliver valued outcomes to multiple stakeholders” (harris & de chernatony, 2001: 445). • an image in consumers’ minds – as suggested above, one can look at a brand from the firm or customer’s point of view. brand image is defined as “consumer perceptions of a brand as reflected by the brand associations held in consumers’ memory” (louro & cunha, 2001: 863). de chernatony & riley (1997: 91) explain that there is growing support for the brand image conceptualisation. adopting an image definition forces management to face the challenge of dealing with perceptual filters which change consumers’ cognitions of the brand (de chernatony & riley, 1997: 91). de chernatony & riley (1997: 93) summarise four complementary views of brands that consumers might hold: at its simplest, a brand may simply be a means of identifying an offering. research indicates that consumers often do not remember the names of products they buy regularly, but rely on packaging to identify what they are looking for. a brand can also be a guarantee of consistent quality and thus act as a risk reductio n mechanism. brands can also act as a shorthand device encapsulating all the mental connections people have around them. this enables rapid information recall and facilitates product choice. at the most abstract level, brands enable consumers to project aspects of their self-concepts. several studies have shown that, in the case of products that are consumed conspicuously, consumers often choose brands they perceive to be congruent with their self-concept. • a personality – de chernatony & riley (1997: 92) point out that brands are often presented as symbolic devices with personalities that users value beyond their functional utility. according to aaker (1997: 347), brands often serve a symbolic or self-expressive function because consumers imbue brands with human personality traits. she defines brand personality as “the set of human characteristics associated with a brand” and has developed a scale to measure brand personality along five dimensions, namely sincerity, excitement, competence, sophistication, and ruggedness. • a relationship – de chernatony (1999: 169) argue that once the brand’s personality has been defined, a relationship develops between the brand and the consumer defined by the values inherent in the brand’s personality. • adding value – simões & dibb (2001: 220) explain that customers generally buy brands rather than products. competition among brands, sajems ns vol 6 (2003) no 1 168 therefore, no longer occurs at the core-product level but according to the added functional capabilities and symbolic features that the brand represents (de chernatony & riley 1998: 1081). these functional or emotional values represented by the brand enable firms to achieve a competitive advantage. • an evolving entity – according to goodyear (quoted in de chernatony & riley 1997: 92) brand evolve through different stages: from unbranded commodities, to brands as references where the name is used for identification, to a situation where brands develop a personality by offering emotional appeals in addition to functional benefits. the implication of this view is that different definitions should not be considered as conflicting, but rather as expressions of the evolutionary development of brands. brand strategy: a typology of brand types and brand strategies several authors have developed classification schemes to categorise different brand types as well as different brand strategies used by firms (see laforet & saunders, 1994 & 1999 as well as cravens, 1997: 307-312). brand types relate to a classification of the type of brand name used for a specific individual product, while brand strategy refers to a firm’s broader approach to the branding of its product range(s), or as laforet & saunders (1999: 51) explain, to: “… the ways firms mix and match their corporate, house, and individual brand names on their products”. laforet & saunders (1994: 64-76) have identified a hierarchy of six brand types based on a content analysis of 400 leading brands in the uk grocery sector. these six brand types include: • corporate brand names – this brand type involves the use of the company name as a brand name and is often used by service firms. companies such as shell, avis, kellogg and heinz have made their company names synonymous with a product class. sometimes the corporate brand appears as the only brand identity, as in the case of heinz tomato sauce, or along with another brand name such as nestlé’s classic double. • house brand names – diversified companies sometimes use the names of divisions or strategic business units (sbus) to promote products in different markets or market segments. volkswagen, for example, has the volkswagen and audi brands. • family brand names – according to laforet & saunders (1994: 67), family brand names are names used to cover a family of related products. sajems ns vol 6 (2003) no 1 169 family brand names differ from house names in that there is no relationship between the brand name and the company’s organizational structure (e.g. the brand does not relate to a specific sbu or subsidiary). family brands often result from a situation where a strong mono brand name is used to launch new related brands. • mono brand names – a mono brand name refers to the use of a single unique brand for each individual product. according to laforet & saunders (1994: 67), mono brands are the dominant form used by many leading marketers. however, the number of mono brands is diminishing as firms engage in brand extensions. many firms are also moving away from mono brands to a mixed brand type consisting of a corporate and product specific brand name (e.g. nestlé kit kat) or a family and product specific brand name (e.g. crosse & blackwell branston pickles). • virtual brand names – occasionally, virtual brand names appear as suffixes used to identify variants of a brand or as a qualifier to a brand name. nestlé’s pet foods division, for example, markets friskies gourmet and friskies gourmet a la carte. these are two distinct products differentiated by the addition of the virtual brand name “a la carte” (laforet & saunders 1994: 67). • brand variant descriptions – laforet & saunders (1994: 67) explain that a variant of a brand is often described with a descriptor (e.g. cross & blackwell mayonnaise light) the content analysis conducted by laforet & saunders (1994: 67-69) also suggests a classification of brands strategies into a mix of four elements, namely: corporate dominant, house dominant, mixed brands, and brand dominant. the true corporate dominant brand structures are quite rare in the fast moving consumer goods (fmcg) sector. corporate brands do, however, occur quite frequently in the service sector (simões & didd, 2001: 219). in the fmcg sector, corporate brands are normally used when a company operates in a tightly defined homogeneous market. laforet & saunders (1994: 68) explain that acquisitions have caused composite corporate dominant firms to emerge such as cadbury schweppes and colgate-palmolive where parts of the corporate name are associated with different product classes, for example, cadbury with chocolate and schweppes with cold drinks. according to laforet & saunders (1994: 68 & 73), house-dominant brand structures are more common in the fmcg sector than corporate ones. this happens because most major marketers of fast moving consumer goods are highly diversified and consist of a large number of different sbus. house brands are also appropriate when a firm diversifies outside the names suiting sajems ns vol 6 (2003) no 1 170 their corporate name, or when acquired businesses have their own useful established reputations (laforet & saunders, 1999: 65). many fcmg marketers use mixed brand structures. mixed brands gain symbiotically from the reputation of the corporate name and the individuality of a unique brand name (laforet & saunders, 1999: 65). however, if taken too far, this symbiosis can degenerate into parasitism and a loss of brand identity. the final brand structure mentioned by laforet & saunders (1994: 68-69) is a brand dominant brand structure. by using a brand dominant strategy, companies can differentiate their products and position themselves for diverse target markets. brand-dominant strategies also suit decentralised businesses with a wide brand portfolio (laforet & saunders, 1999: 64). firms using a brand dominant structure either use a different mono brand for each of their products (in this case, the company name and corporate logo is not prominently displayed, but usually do appear somewhere on the packaging) or use furtive brands (where the name of the manufacturer does not appear on the packaging at all). pet food manufacturers often use the latter approach to reduce the link between food for pets and food for humans. cravens (1997: 308) mentions two additional brand strategies that are not covered by laforet and saunders (1994). these include having no brand identity and private label branding. according to cravens (1997: 308), smalland medium-sized manufacturers often do not have an established brand identity (no brand identity) and lack the financial and marketing capabilities to build buyer awareness in the marketplace. firms in this situation often rely on wholesalers and retailers to encourage buyers to purchase their brand. private-label offerings carrying the brand of a well-known retailer has recently become very popular. dunne and narasimhan (1999: 41) point out that one fifth of all grocery sales in the united states are now sold under retailer’s names. private labels account for a quarter of all grocery sales in canada, and in europe the proportion is even higher. these authors argue that, contrary to conventional wisdom, major brand manufacturers can gain by supplying private label products, especially premium private label products, to retailers (see dunne & narasimhan, 1999: 41-52 for a comprehensive discussion of this issue). laforet & saunders (1994) as well as cravens (1997: 309) point out that companies often use more than one of the strategies mentioned above for different product lines or product categories. in addition, firms competing in the same market often use vastly different brand strategies (laforet & saunders, 1999: 51). in the uk confectionary market, each of the major competitors, sajems ns vol 6 (2003) no 1 171 cadbury schweppes, nestlé and mars, for example, have different brands strategies (saunders & guoqun, 1996: 29). why is this the case? while the conventional view is that branding is consumer-driven, research by laforet and saunders (1994 & 1999) suggest that a firm’s brand strategy is shaped by three major forces, namely standardization, differentiation and symbiosis. these three major forces are in turn influenced by a large number of factors that relate to the firm’s history, structure, corporate philosophy, strategy, market structure, segmentation approach, and product range. laforet and saunders (1999: 64) point out that many factors or forces shape a firm’s brand strategy. these are the issues that brand managers must consider in their choice of an appropriate brand strategy. some important issues in the strategic management of brands will be highlighted next. important issues in the strategic management of brands the findings of a recent study by copernicus, a us marketing consulting firm, and the international marketing research house market facts suggest that most companies have commoditised their products and services despite spending billions on marketing and branding. by "commoditised", copernicus and market facts mean that a company's products and services are amazingly similar to competitor products and services in features, advertising, and price. the study, conducted among a nationally representative sample of 615 us consumers, investigated the performance of 50 different product and service categories in terms of whether they are becoming more homogenous (i.e. the brands are becoming more similar or commodity-like) or heterogeneous (i.e. differentiated) over time. the questionnaire used three different measures: the first asked respondents to evaluate whether the two leading brands in a category were becoming more similar or different (see table 3); the second queried respondents about the category as a whole; while the third focused on whether a low price vs. brand features or benefits were becoming increasingly important to respondents. the results indicate that none of the 50 product and service categories studied are becoming more differentiated over time and that 90 percent are actually declining in differentiation. market facts also asked consumers to rate the leading brands in each of 48 product and service categories in terms of whether they are becoming more sajems ns vol 6 (2003) no 1 172 similar or different over time. this measure of brand differentiation was then converted into a scale ranging from +100 (much more similar) to -100 (much more different). more positive scores indicate increasing similarity between brands and a move towards commoditisation. results indicating the similarity score of 17 selected brands are shown in table 3. table 3 perceived similarity among some leading brands in different product/service categories pairs of leading brands similarity score 1. credit cards: visa / mastercard 45 2. hair care products: l'oreal / clairol 37 3. gas stations: mobil / shell 34 4. bookstores: barnes & noble / borders 34 5. bottled water: aquafina / evian 32 6. health & fitness clubs: bally's / gold's gym 28 7. athletic shoes: nike / adidas 27 8. long-distance telephone service: at&t / mci 27 9. online toy stores: toysrus.com / etoys.com 25 10. cars: toyota / honda 23 11. online bookstores: amazon.com / barnesandnoble.com 21 12. personal computers: ibm / compaq 21 13. potato chips: lay's / ruffles 16 14. diapers: huggies / pampers 16 15. cars: mercedes-benz / bmw 9 16. cigarettes: marlboro / camel 4 17. cola: coke / pepsi -7 average score 18 source: adapted from copernicus marketing consulting and research, 2001 clancy & trout (2002: 22) ascribe the slide of brands towards commodity status to two factors: first, marketers are relying too much on short-term promotional programmes that focus consumers’ attention on deals and distract them from the brand and the inherent value thereof. and second, advertisers don’t develop distinct messages that “… help consumers tell one brand from another”. the results of the aforementioned study points to the challenges involved in building and managing brands in an era of intense competition in many product and service categories. cravens (1997: 305) describe product/brand management as an activity that consists of “… planning, managing and coordinating strategy for a specific product or brand”. cravens points out that these responsibilities sajems ns vol 6 (2003) no 1 173 include market analysis, targeting, positioning strategy, product analysis and strategy, identification of new product needs, and management and coordination of product / brand marketing activities. as this description suggest, brand management has a strong strategic focus. this is accentuated by the fact that ceos surveyed by ernst & young judge brand to be among the most important keys to their companies’ future success (docters, 1999: 9). saunders & guoqun (1996: 29) also argue that because brands have value, the way a company uses its portfolio of brands is a top management decision. unfortunately, brand managers are often describ ed as “young, inexperienced, overloaded with quantitative skills, and short-term focused”. in addition, they are accused of lacking a customer orientation (de chernatony & riley, 1997: 93). brands and branding in south africa the listing of brands in south africa exceeds 32 000 at present (www.the marketingsite.com). according to krige (2001) the gathering of information and recording of the development of brands and branding in south africa, relies heavily on the marketing community. although the list contained in the 2000 edition of the encyclopaedia of brands and branding in south africa may not be complete, it provides a comprehensive review of this topic in the south african context. in an introductory article to the sixth edition of the abovementioned publication, dr edward de bono (in the encyclopaedia of brands and branding in south africa (encyclopaedia of brands), 2001: 15,16) refers to seven types or categories of brands that exist in the minds of consumers. one of them (called "hooks") is extremely powerful when not much can be done to distinguish the brand directly from similar products. an example of this is the de beers diamond. for decades the "hook" has been "a diamond is forever" – recently voted the best advertising slogan of the twentieth century. now the south african mining firm is going to laser its name onto each diamond it sells for retail use, to ensure that the buyer can see that it is this stone that has been bought for all time. one of the major challenges facing south african business and marketing executives in the new millennium is to create world -class brands that will put south african brands on the national and international map. robertson (in the encyclopaedia of brands, 2001) is of the opinion that the creation of global brands are an imperative for the future of south africa. since the ending of apartheid and the opening up of south africa's own market to international competition, creating global brands has to take a high priority (especially in the light of the high unemployment rate in the country). how then, can south african marketers create a brand that will engage the customers and build longsajems ns vol 6 (2003) no 1 174 term sustainable relationships? robertson (in the encyclopaedia of brands, 2001: 20-22) offers the following as key elements to create powerful brands: • whether it is a new brand or an existing one, it has to have a "reason to be". this means that the brand and product concept has to be distinctive, relevant and appealing to the consumer. nothing should be taken for granted and the changing lifestyles and attitudes of the consumers should be kept in mind. • create a cohesive brand. the importance of ensuring that the functional experience delivers the added value of the brand promis e cannot be stressed to strongly, as there is sometimes a temptation to focus solely on the image. • emphasise the role of brand values. "brand values are critically important to brands as they are key drivers and measures in both brand delivery and the behaviour of the people within the organisation" (robertson in the encyclopaedia of brands, 2001: 21). figure 2 shows how the brand operates from the centre of the business, (sometimes called "inside out branding"). • strive to build unique and robust brands. the uniqueness can come purely from a original offer, or creating a space in the global marketplace. figure 2 brand drivers source: robertson (in the encyclopaedia of brands, 2001: 21) burgess (in the encyclopaedia of brands, 2001) adds to the above by listing the following skills needed to develop and manage brands in south africa: brand drivers product development people policy channels service price internal marketing partnerships external comm's sajems ns vol 6 (2003) no 1 175 • skill 1: understanding purchase and buying behaviour. the firm must understand the brand and product associations that live in consumers’ minds. • skill 2: defending local brands. to defend local brands against international competition, burgess says, one must require global insights. • skill 3: understanding competition. according to burgess (in the encyclopaedia of brands, 2001: 45) “…firm-to-firm competition has shifted to competition between supply chains”. south africa could do much to improve teamwork. • skill 4: managing interaction via smart cards, internet and bulletin boards. some commentators predict that 60 per cent of sales to consumers will go through electronic channels within the next 10 years. • skill 5: focus. getting everyone in the organisation focused on constantly enhancing customer and stakeholder value. and lastly, some advice from mohale (in the encyclopaedia of brands, 2001) to market south africa and africa as a brand. he believes that we need a regional african brand and by extension, an african continent brand just like the european union brand and the asian market brand. he suggests we move from the humble beginnings of the “…apartheid brand to the rainbow nation brand to the ‘two nations in one brand’” (mohale in the encyclopaedia of brands, 2001: 26,27). according to this author africa is the world’s most mis marketed and under-marketed continent. the well-known saying “build a brand and the world will beat a path to your door” will only become a reality, says mohale, if we start building african brands such as “african wildlife”, “african sunshine” and “african hospitality”. conclusion it is clear that the role of the brand extends beyond the traditional opinion of a logo that can be used to identify a product. the drive of the branding process has become an integral part of an organisation and all the stakeholders involved as to communicate and convey the core values that can be attributed to the brand. managing the brand requires a long-term perspective that has to coincide with a company’s long-term strategic goals. at the end of the day creating value is what business is all about. the brand has the potential to create shareholder value as a long-term strategic tool ensuring stable growth and prolonged revenue generation. the challenge facing south african companies is to engage in serious brand building programmes and follow in the steps of some of the world’s leading brands, which started their brand building operations more than a century ago. sajems ns vol 6 (2003) no 1 176 the nokia brand, for example, was founded in 1865, coca cola in 1886, ibm in 1911, general electric in 1913, and mcdonald’s in 1955. these are the success stories of companies who “…evolved into being a brand, and through total focus moved from being a small domestic player, throwing all its resources, energy and passion in one direction and emerging as a global giant” (sampson in the encyclopaedia of brands, 2001: 65). south african marketers need to reach out to this “old friend”! references 1 aaker da. (1991) managing brand equity, new york: the free press. 2 aaker j. (1997) “dimensions of brand personality”, journal of marketing research, 34(august): 347-56. 3 nielsen, a.c. (2001) “reaching the billion dollar mark: a review of today’s global brands”, http://acnielsen.com/billion/. downloaded: 200204-03. 4 berry, l.l. (2000) “cultivating service brand equity”, journal of the academy of marketing science, 28(1): 128-137. 5 clancy, k.j. & trout, j. (2002) “brand confusion”, harvard business review, 80(3): 22. 6 copernicus marketing consulting and research, (2001) “most products and service brands commoditizing, not differentiating, reports new copernicus-market facts' study, press release issued on 1 january. internet: www.copernicusmarketing.com/ about/docs/brandcommods.htm and www.copernicusmarketing.com/ about/docs/brandtables.htm. downloaded: 2002-04-06. 7 court dc, leiter, m.g. & loch, m.a. (1999) “brand leverage”, the mckinsey quarterly, (2): 101-110. 8 cravens, d.w. (1997) strategic marketing (5th ed.) irwin mcgrawhill: boston. 9 de chernatony, l. & riley, f.d. (1997) “the chasm between managers’ and consumers’ views of brand: the experts’ perspective”, journal of strategic marketing, 5: 89-104. 10 de chernatony, l. (1999) “brand management through narrowing the gap between brand identity and brand reputation”, journal of marketing management, 15: 157-79. 11 docters, r.g. (1999) “branding: rifle or shotgun?”, journal of business strategy, july/august: 9-14. 12 duncan, t. (2001) imc: using advertising and promotion to build brands, mcgraw-hill: new york. 13 dunne, d. & narasimhan, c. (1999) “the new appeal of private labels”, harvard business review, (may/june): 41-52. sajems ns vol 6 (2003) no 1 177 14 harris, f. & de chernatony, l. (2001) “corporate branding and corporate brand performance”, european journal of marketing, 35(3/4): 441-56. 15 hatch, m.j. & schultz, m. (2001) “are the strategic stars aligned for your corporate brand?”, harvard business review, (february): 129-34. 16 heineken, n.v. (2002) http://www.heinekencorp.com/. downloaded: 2002-04-08. 17 laforet, s. & saunders, j. (1994) “managing brand portfolios: how the leaders do it”, journal of advertising research, sept/oct: 64-76. 18 laforet, s. & saunders, j. (1999) managing brand portfolios: why leaders do what they do”, journal of advertising research, (february): 51-66. 19 levy, m. & weitz, b. (2001) retailing management, mcgraw-hill: new york. 20 louro, m.j. & cunha, p.v. (2001) “brand management paradigms”, journal of marketing management, 17: 849-875. 21 mccoy, s. (2001) ksdp, strategic brand consultants, johannesburg. 22 robinson, c. (1996) “asian culture: the marketing consequences”, journal of the market research society, 38(1): 55-62. 23 saunders, j. & guoqun, f. (1996) “dual branding: how corporate names add value”, marketing intelligence & planning, 14(7): 29-34. 24 simões, c. & dibb, s. (2001) “rethinking the brand concept: new brand orientation”, corporate communications: an international journal, 6(4): 217-224. 25 the encyclopaedia of brands and branding in south africa (2001) affinity: johannesburg. 26 tilley, c. (1999) “built-in branding: how to engineer a leadership brand”, journal of marketing management, 15: 181-91. 27 vrontis, d. (1998) “strategic assessment: the importance of branding in the european beer market”, british food journal, 100(2): 76-84. 28 wood, l. (2000) “brands and brand equity: definition and management,” management decision, 38(9): 662-9. sajems ns vol 4 (2001) no 1 234 the political economy of capital gains taxation in south africal part ii: the public choice of capital gains taxation and public policy zane a spindler simon fraser university, canada _ visiting professor, school of economics, university of cape town 2001 abstract public finance and public choice principles are used to analyze the ideological and practical basis for the proposed introduction of a capital gains tax into the income tax system of south africa. the paper concludes that this is a flawed tax whose time has passed especially for countries like south africa. jelh 24 it is unfortunate politics outweighs sense at such a critical time in south africa's growth. there's no doubt in my mind capital gains .tax is to be introduced for political, not fundamental reasons. it's a trade-off for concessions from labour over issues like privatisation. mark shuttleworth, cape argus 13/2/2001.2 1 introduction this is the second part of an essay about the proposed capital gains tax for south africa (hereafter, za-cgt). the za-cgt was scheduled for introduction 1 april 2001, but postponed until 1 october 2001. the essay argues that, indeed, such a tax does not make sense. it should not be introduced, or even just be postponed again in october, but rather permanently excluded from consideration in the future. it is paramount for south africa's future development and growth, and for arresting and reversing its recent fall of savings rates, that investors, large and small, domestic and foreign, be signalled that the government intends to be "capital friendly". r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 235 sajems ns vol 4 (2001) no 2 while the arguments in this essay do have support in recent public finance and public choice literature, they are admittedly used in a way that supporters of zagt may characterize as "political". this is unavoidable, given that the acceptance or rejection of any tax is inevitably political. those who expect to be harmed will lobby against the tax; those who expect to gain by it will lobby in favour. often their opposition or advocacy is based on the anticipated impacts of the tax on their own special interests, even though economists, in contrast, argue that the ultimate effects usually differ from the expected impacts. in light of the foregoing, the objective of this essay is to consider the issue from the standpoint of the so-called "general interest" or "public interest". the framing question is: "will this tax be beneficial for most south africans?" the answer given here is: "no!" that "no" is not only an analytical, economic judgement, but also a political judgement. however, it is not "political" in terms of taking sides against the government or particular political parties or particular special interests, because the governing party and most special interests, as well as most individual south africans will be ultimately better off without the za-cgt "albatross". positive proof of that is impossible, given that it involves the future and many unknown but determining events. thus, this essay is unashamedly aimed at affecting rational beliefs and expectations by the use of informed and rational argument. 2 the public choice of capital gains taxation 2.1 a primer public choice differs from public finance in that it subjects the political sphere of an economy to the same analytical methodology as the commercial sphere. in this approach to the political "game", the individual players, that is, the voters, politicians, bureaucrats, etc., regard their own self-interest as foremost in determining their behaviour within the confines of political institutions and structures administrations, bureaucracies, legislatures, interest groups, etc. politics is exchange exchange between voters and politicians, between politicians to form administrations and agree on public policies, between administrations and bureaucracies and lobbyists for interest groups, and so forth. for example, tax and spending proposals will attract the attention of affected interest groups and they will often use real resources to promote or defend their interest through the political system (becker, 1983; alesina & rosenthal, 2000) and even the court system (farmer & pecorino, 1999). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2 236 public choice analyzes these political competitions with a view to assessing their efficiency with respect to establishing individual-, group-, and publicinterest outcomes (choices), as well as their overall economic effects on the economy as a whole. unlike the usual neoclassical analysis of competition, public choice does not find competition to be costless. besides those costs analyzed in the transactions cost literature, such as infonnation, negotiation and enforcement costs with respect to particular contracts, there are transferor rent-seeking or rent-defending costs over the very rights subject to contract. these "meta" or "political" transactions costs are known as "tullock costs", after their modem discoverer, gordon tullock (1967). tullock costs can under, over-, or exactly dissipate the net welfare or social surplus from political and/or legal action. 2.2 economists' role the public choice approach involves a much different role for economists as public finance advisers. namely, economists are not just advisers but also a source of ideology and another interest group. as policy advisers, they may be a strategically placed interest group in that they may more directly have politicians, bureaucrats, and/or the public's rapt attention but they are usually not a group with political clout in their own right (unless they actually become politicians and achieve higher office as indeed a select few economists have done). however, in the past, economists have usually served at providing economicsbased, general-interest rationales for policies that are politically viable on other grounds usually again, based on the winning or dominant special-interest groups' own interest. indeed, education or re-education, and promotion of mainstream or neo-mainstream ideas, have generally been economists' main political functions. often textbooks, as well as advanced treatises, are simply political platfonns seeking a sponsor or a constituency just like machiavelli with his own self-serving treatise, the prince. in a sort of "economic darwinism", the political system selects those economists whose ideas are most useful in constructing dominant and winning coalitions of interest groups or economists who are best at providing the technical support for those ideas. we need not question the sincerity or the technical competence of economists and public finance specialists elevated by this darwinian process. in this respect, it is the political incentives that are responsible for apparent inconsistencies between theory and practice, not the individuals per se. practice follows the "winning" theory! the winning theory on any occasion need not be logically consistent with winning theories on other occasions as long as it is essential in reconciling dominant political interests. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 237 sajems ns vol 4 (2001) no 2 we can easily imagine that this may well have been the case for capital gain taxation (hereafter, cgt). public finance advisers, from much before samuelson and musgrave in the 1950s to much after the 1967 canadian carter commission, have provided general-interest rationales and slogans. the "scbanz-haig-simons" (hereafter shs) consistency notion is characterized by the slogan "a buck is a buck". simon's horizontal equity notion is characterized by the slogan "equal treatment of equals". the carter commission's concern with aiiocation efficiency for corporations is characterized by the slogan "dividend stripping". this sloganeering is aimed at supporting tax code changes to provide political fixes. it elevates a simple problem to the status of a necessary desiderata or an unnecessary evil mainly intended to attract public attention and support for remedying public action. somehow, these consistency-driven programs never result in the perfect "fix" or "reform". periodically, the "fix" must be redone. the tax system is "reformed" periodically by fiddling with the tax rates or specification of the tax base. this has been characterized this as a "tax reform cycle" (spindler & walker, 1988). 2.3 wby a cgt now? recently for south africa, katz (1996) gave a realistic and balanced presentation of the pros and cons of cgt, finally coming down on the "con" side because of administrative inadequacy at the time of the report. what changed since 1996 to alter the force of katz "not for now" recommendation? the casual observer would probably say "not much" at least with respect to administrative competence, where press reports of inadequate accounting for funds are at least as embarrassing to south africa's governments as one might find in (say) canada (which should know but cannot do better). unfortunately, in almost every country throughout the world, governments' appetite for control exceeds their ability to control. is there an excess supply of well-trained accountants and auditors available to buttress the government's revenue bureaucracy (and to enhance the avoidance ability of their private counterparts). if so, perhaps they could have a more fortuitous effect on the government's deficit (surplus?), and/or on its productivity, by deploying them to achieve better financial and production control over all its bureaucracies. introducing a new tax, with innumerable prospects for avoidance and evasion, will likely decrease the availability to government of trained auditors and accountants as they are hired away by private firms, where they will be more productive and, hence, better paid. 2.3.1 bureaucrats' interest: however, the revenue bureaucracy has an interest in being a major supporter, and even an in-house lobby, for such increases in r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2' 238 demand for its services and the associated increase in budgets. even evidence of public lobbying can be found in recent newspaper advertisements (e.g. cape argus, february 16, 2001) placed by the south african revenue service (sars) rationalising the za-cgt (under the guise of explanation) before it is even approved by parliament a clear violation of the principle of civil service neutrality. as a result of their support and lobbying, bureaucratic salaries will rise with the associated increased public sector demand and increased private competition for their services. their government salaries may not approach the levels privately available, but they will generally be disproportionately high compared to the time required and the talent displayed. this interest group has a definite interest in more complex tax systems. here, at least, revenue bureaucrats will be very consistent! of course, to the extent that they manage to generate net revenue over and above the marginal administrative cost of a new tax, they will also get the support of other bureaucrats in other bureaucracies, which will compete within government for the right to deploy extra funds disproportionately. in the za-cgt, however, other sa bureaucracies will be disappointed, since the cgt is famous for being relatively unproductive of net revenues (see burman, 1995, 1999; grubel, 2000; katz, 1996; lee, 1995; and zodrow, 1995).' . indeed, for a government that is "competence-challenged", cgt may be a net user of funds, when all government money costs are counted. recently, the ministry of the national treasury (finance ministry) has partially privatised tax collection in south africa. thus, instead of bureaucrats in the receiver's office having a vested interest in tax complexity, that interest is transferred by privatisation to private professional firms. 2.3.2 private interests: other private interests on cgt, both pro and con, might be noted. private tax accountants and tax lawyers have an obvious professional interest in a more complicated, but professionally understandable, tax code (see richardson, 2001). indeed, they are often called, or they offer, to give testimony on the practicality of tax changes. when they are representing their profession, they will be concerned with maintaining their profession's set of standards which gives them the unique property-right, and the quasi-monopoly professional restrictions that may make their profession, their professional qualification, and their own human capital, more valuable. this will often take the form of devising and advising a sufficient degree of tax-code "encryption" in order to put valuable avoidance schemes allowable under the new legislation just beyond the understanding of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 239 sajems ns vol 4 (2001) no 2 the above-average, non-professional taxpayer, while yet within the range of understanding of the above average professional. the testimony and lobbying of these professionals may, on occasion, be on behalf of their clients and their clients' interest. in these cases, special exemptions will be sought on behalf of their clients or their clients' interest group. these special interest exemptions will be said to be in the general interest, as on occasion they may well be especially in the case of legislation that is not generally beneficial. in the case of the cgt, the exemption may involve some special feature of clients', businesses or occupations. for example, the sale-of farms may be exempted from the cgt. alternatively, some special, clever application that only a specific tax or law firm understands may earn that firm a very valuable "property right" to additional consulting and income. also, professional firms, and even charismatic professional individuals, might be quite entrepreneurial in developing special-interest groups under their control to provide financing for their lobbying activities. of course, special interest groups might also develop spontaneously to lobby cgt pro or con. or, groups existing for other purposes, for example, farmers' organisations, may find that they are economical conduits of their members interest re lobbying the cgt as well as lobbying for their original purposes. "not that there is anything wrong with" such private actions. that is how representative, democratic government works when it works at all. 2.3.3 international interest: other national governments, and often by extension, international agencies like the imf, the world bank., the wto, etc., might also from time to time act to influence a country's government in order to pursue their own policy objectives, or, sometimes worse, policy objectives that they think are in the interest of that economy or the world economy. needless to say, on some occasions their political pressure, not to mention political contributions, may be hard to ignore or resist. in south africa's case, there may still be considerable pressure to comply with conventions which are more beneficial to those applying the pressure, and the nations they represent, than to south africa, per se. among other conventions governments attempt to make common are those applying to tax systems. it is, of course, in the interest of a country with a high tax regime, that other countries co-ordinate their taxes and tax rates with theirs so as to reduce avoidance by their citizens moving their capital and/or themselves to countries with more favourable tax regimes (see jones, 2000). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1: 240 frequently, a number of countries with high tax regimes will not only act to coordinate their tax systems with each other, but they will also mutually attempt to pressure low tax countries or tax havens into compliance, sometimes under a banner of serving the general interest ofthe world community. an example of the latter may be the us attempts to pierce swiss banks' veil by using arguments about international crime or drug control, or retribution for holocaust victims. when major countries act together to co-ordinate taxes, they are a de facto "tax cartel", which like the oil cartel, opec, might be expected to act in their members interest at the expense of non-members (jones, 2000). in south africa's case, it can only be observed that the imf has regular visits and position papers on various economic and public finance issues, and the us, as well as canada, has moved to restore tax conventions which were dropped during the latter years of apartheid. indeed, in his comments on his 2000 budget initiatives the finance minister did mention that the za-cgt proposal would help south africa "rejoin the civilised world", which could be read as a buzz phrase signalling that tax co-ordination objectives were at play. 2.3.4 politicians' interest: ultimately, in a democracy, politicians, and their parties, must promote and deliver public policies that attract the support of a sufficient number of citizens and voters to enable policy implementation and to win (re-) election. when the general public is non-homogeneous with respect to political interests, as is often the case in modern, especially multi-ethnic and multi-cultural, societies, parties and politicians will attempt to package together many diverse and sometimes contradictory and inconsistent policies to fonn coalitions of interest groups within the society. 3 the object is to achieve and maintain a dominant coalition that will provide for a single party and a select group of politicians the basis of the power to govern. that is, this political group captures, perhaps only momentarily, until the next election, or for life, the legitimized and jointly held property right to govern on behalf of other interest groups and in the name of the general public. the essence of this winning or dominant coalition is that its constituent groups have paid for policies favouring their interest by accepting policies that favour the interest of other groups in coalition (tullock, 1997). the latter is the price that must be paid by each group that joins and/or remains in the coalition. generally, policies favouring the special interests of coalition supporters will be designed to "concentrate the benefits" (to its sponsoring special interest group and perhaps to other coalition members as well) and "disperse the costs" (beyond the sponsoring interest group and preferably beyond other coalition members to the more general public). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 241 sajems ns vol 4 (2001) no 2 the south african government's cgt proposal may be considered in light of this public choice insight on the political market place. the present cgt proposal is relatively limited with respect to assets covered and groups immediately affected. its intended targets (victims!) are south african companies and relatively wealthy individuals resident in south africa essentially, the white, business community and foreign permanent residents. these targets are relatively well organized along interest group lines and recently (post-transition) have been supporters of the government's relatively pro-business, pro-growth policies. for them, accepting the cgt (after appropriate modifications, as previously described) may be simply a price that must be paid for the policies favouring them and delivered" by the governing parties. the governing parties must also worry about keeping its own coalition of interest groups, and its more general supporters, on side by delivering policies favouring them and ideologically favouring the general interest. seven years after south africa's "transition", it is still the case, that the general interest is often interpreted as being served by redistribution policies under various justifications.4 here, the cgt may be viewed as serving as a "token" complying with that presumed ethic -perhaps in lieu of more substantive, but economically more destructive redistribution policies. it is a digression from the de facto policy of "talldng left, acting right" during the post-transition. 2.4 who is burdened? however, the governing parties must also look to the future. it may be that richer sa whites may seem to pay this tax at first. however, the rest of the population will eventually be the ones paying, as well as bearing the cgt burden because: a) the cgt base will inevitably be broadened. b) the tax will be shifted by avoidance reactions. c) as the rest of the population advances economically if other government policies are successful enough to offset or overcome the economic effects of this one they will increasingly find themselves subject to this tax.5 2.4.1 in specific for example, ambitious entrepreneurs, like (say) the cape flats' enterprising squatter-builder-landlords, may well find themselves subject to excessive capital gains taxation when they sell their accumulated holdings because these assets will appear to have a (formal) zero cost base. the explanation that the government is trying to prevent them from escaping income tax on the accumulation of their (unpaid) labour and entrepreneurial services, will not make them happier, when they are poorer as a result. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2242 however, they may perceive that their best response to the prospect of paying this tax is to avoid having sales flow through the formal sector. if that proves impossible, or if the receiver of revenue is likely to discover and close off this avoidance route, their next best response may be to join and/or financially support the governing parties in an attempt to be exempted from the cgt's bite. business people of all races, creeds and ideologies often seem to sense these political opportunities very quickly. indeed, that sense is their specialized ability that often yields them excess returns. that leads us to our next public choice point. 2.4.2 is cgt a "cinch"? it is well known among us historians that during the 19 th century, us politicians and political parties often proposed bills that were mainly intended to raise political contributions from the apparent nonbeneficiaries or "victims" of the bill at that time, these were known as "cinch bills". more recently, they have become kno\\'n as "milker bills" (mcchesney, 1987) because they are intended to milk campaign and lobbying contributions from potential targeted industries, groups, or individuals. is it really being too cynical, as public choice is often challenged, to imagine that the za cgt might be such a throwaway item? we will see who is "fooled" thereby next i april 2001. (this last line was written prior to the 2001 budget announcement that the za-cgt would be delayed, so i have kept it in as a potentially confirmed speculation. 1 october 2001 may be the occasion for more "fooling"!). in practice, few potentially footloose businesses especially those that are multinational pay taxes at legislated tax rates. rather, they pay at "negotiated" rates that apply only to them, or at "net" rates after subsidies that apply only to them. the "consideration" offered as a quid pro quo for special rates may be extra domestic investment, the use of politically favoured or politically affiliated factor suppliers, contributions to parties and politicians, and so forth. those in the know can tell such stories even about south africa. in this regard, it is particularly disingenuous, and just not credible, to promote the cgt as important for improving the consistency of the south african revenue system. whether it stays or goes, its actual effect will most likely be quite the opposite. 2.5 cgt social cost we are now in a position to suggest that the net social costs of the cgt may be quite high. when compared to the expected social benefit of this tax, it may be the case that there is no social gain, or perhaps, even a net social loss. of course, public choice economists might be the first to admit that this is difficult to prove one way or the other in practice for any specific case. the argument is r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 243 sajems ns vol 4 (2001) no 2 mainly theoretical and relies on the presumption that open competitions among well-informed individuals eventually exhaust the surplus subject to the competition. the exact mechanism has been demonstrated theoretically in the becker article mentioned previously. political competitions induce both competitors to spend more, sometimes in real resources representing real social costs, than without the competition. 6 the analysis of the immediately preceding sub-section suggests that it may be in the interest of political parties to induce such competitions whereby the party and their members benefit whether or not they win elections and or hold the balance of political power. again, if this uses real resources, this may be seen as a social cost. however, we also must stress that this may not be an avoidable cost and that efficient political parties and political interest groups will have a joint interest in minimizing such costs, if they can capture and share the resulting surplus. by the "comparative-institutions approach", no set of institutions can be said to be inefficient or to fail unless there is a better institution realistically available. however, a superior mechanism for making public (private) choices may be efficient (relative to realistic alternatives) but still costly. in this regard, we might consider whether the proposed cgt is really the best way to accomplish government and party financing. the record elsewhere suggests that cgt is one of the most frequently lobbied taxes (other than, say top marginal rates or specific exemptions). the social costs are likely to be higher than alternatives if this experience generalizes to south africa. 3 www, globalism, postmodernism,7 policy welcome to the 21 51 century! let's rethink the future. 3.1 discard modernism and public it is a good time to sort out and finally leave behind the unfortunate ideological baggage from the recent past and to carry forward with only those ideas that will serve us well in the future. considerable discarding was done already during the last decade or so ofthe 20th century, but much more remains to be done in that regard. the fall of the communist monolith dealt the deathblow to one version of what has been called "corporatism" an ideology that essentially defined what it meant to be modern with respect to government forms (todd, 1995). another r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol4 (2001) no 1. 244 venal version of corporatism, fascism, was extinguished at mid-century, though remnants struggled on for a while in non-central societies such as with spain's franco, portugal's salazar and with south africa's apartheid until they gave way to more democratic fonns. but democratic corporatism is still very much with us. indeed, it is still the major vehicle of advancement for those inclined toward stable careers while simultaneously entertaining a lust for power over others in the name of others' own good, of course! it is arf1able whether corporatist obsessions were on balance beneficial during the 20 century. the problem was that there were no natural checks to the concentrated and unfettered power that such ideology justified, except for the ambitions of other corporatist states, and catastrophic events such as war, revolution, social collapse and other excuses for mass genocide, democide, and excessive non-productive government expenditure. however, during the closing decades of the 20th century, the market re-emerged as a credible voluntary alternative to coercive government for solving social problems. 3.2 back to the future in some ways, that has set the stage for more rapid and better-balanced growth like that which occurred during the 19m century, when the world economy was far more global than it was during most of the 20m century. labour was certainly more internationally mobile then (passports were generally not required) as were goods (tariff and non-tariff barriers were far lower then than now, even after many rounds of gatt and \'\'to negotiations). only capital may de arguably claimed to be more mobile now. but that may be due more to the rapidity of capital movements rather than on the basis of relative size. the internet or world wide web has become a vehicle for democratizing or individualizing capital movement both of the human or non-human variety either real or virtual. at a touch of a mouse and keyboard one's wealth can be transferred, and one's income earned, away from any jurisdiction that taxes excessively for the government services provided, or that issues its currency excessively in a desperate attempt to gain revenue at the expense of long-run credibility . individuals, not states, will be sovereign or at least, this is the well-argued vision of davidson and rees-mogg (1997). even if their vision only reaches fruition in part and/or eventually, governments will have to reconsider their redistributionist ways. otherwise, like robert mugabe, and dozens of other despotic kleptocrats, they will find it ever more costly to redistribute less and less, as the productive capacity of the economy is starved and gutted by human and non-human capital flight virtual or real. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 245 sajems ns vol 4 (2001) no 2 perhaps major states, spanning large geographical areas may seem relatively immune from these influences. however, the fall of the ussr demonstrated quite convincingly that even superpowers can collapse from within (and some argue that the internet played a facilitating informational role). there is little doubt that smaller states can only ignore these worldwide institutional and technological advances at their own peril. the implications for tax systems are crucial. 3.3 the magic of flight even the anticipation of differential taxes on capital and/or capital income might produce capital flight that would reduce the revenue base immediately even before the tax is in place. among other things, this complicates the measurement of the impact and ultimate effect of any anticipated tax, if these effects are presumed to occur after the tax is legally in place (the "post hoc, ergo proctor hoc fallacy.") further, labour income, or rather income from human capital, can also avoid taxation by emigrating virtually or de facto, failing to immigrate in response to other economic incentives, or, perhaps the worse curse for developing economies, never developing in the first place. what statistician or econometrician can reliably measure data that has not occurred? what social scientist sherlock holmes will ask about "the [data] that did not bark"? 3.4 comparative [tax) advantage postmodern development theory is returning to the view that an open economy and privately motivated, directed and internationally transferred capital, both human and non-human, along with their embodied technology, are absolutely essential for rapid development that can catch-up with and surpass the mature economies (jones, 2000). differential domestic taxes on internationally mobile factors are the equivalent of tariff and non-tariff barriers and capital controls in that they retard capital movement today and development tomorrow. the proposed za-cgt will be introduced at a relatively low rate, say, in comparison with mature economies like the us, the uk, and especially with high cgt rate canada. it might be argued, as sa technocrats recently have stated publicly, that such a low rate is unlikely to induce massive or even any capital flight from here to there. a minor counter argument is that it might just tip the balance (see endnote 1) encouraging emigration and discouraging r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2 246 immigration of both human and non-human capital. this may be especially the case for people who are already dissatisfied with the post-transition state of the economy and society, or for those prospective immigrants who fmd home affairs immigration procedures (often time and resource wasting for those rich in human and non-human capital) much too constraining for their own good as well as south africa's. those who can and will move freely are often exactly those who government needs to convince (not coerce) to come and to stay. another less minor argument is that this may be just the tip of the capital-gainstaxation rate iceberg. historically most cgts have been introduced with low rates and limited coverage only to be raised and extended, respectively, as governments search in vain for that mother lode they expect must ultimately be uncovered by their efforts.s rational investors and economic migrants will anticipate eventual compliance with this pattern in south africa as well. the major counter argument to the za cgt promoters' "low introductory rates as benign" argument is that south africa is not in competition with those more mature economies with respect to promoting rapid development. it is in competition with countries like the asian tigers, most of which have no capital gains taxation, low, flat, rates of tax on income, and few redistributive social programmes. south africa should not attempt to harmonize its tax system with systems in mature economies. their low per capita growth rates would never do much good here for those seeking a more advanced standard of living. instead, south africa should harmonize its system with those who still are on their way up at exceptional rates of gro\\1:b year after year. like the famous ad for e f hutton, whenthose rapid growth countries' policies "speak", south african policymakers shou1d listen. advisors from mature western economies, and/or international agencies have their own vested interests, and the "gifts" they bear may prove too costly in the end. to emulate and compete with the most successful asian tigers, south africa should not only avoid taxing capital or capital gains directly, but should also avoid indirect capital taxes like foreign exchange controls, property-transfer tax rates exceeding administrative transfer costs, and taxing on the basis of residence rather than source.9 further, coordination of company and personal taxes should be achieved by using the same low top marginal rates or, even better, low flat rates for both. finally, tax revenues should be used to fund productive government infrastructure maintenance and improvement (which generally leads to greater direct and indirect employment prospects), rather than used to fund unproductive transfers (which generally divert the recipients from productive employment to the status of impoverished "rentiers"). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 247 sajems ns vol4 (2001) no 2 while south africans in total shoulder a relatively low tax burden as measured by the ratio of government revenues to gdp (roughly 28 per cent), actual taxpayers shoulder an excessive burden because they are so few as a proportion of the total population (roughly 4 out of 40 million for income tax). there is indeed a scarcity of taxpayers that will not be remedied by introducing extra tax bases that hit the same over-burdened taxpayers. rather, lower, or even zero, rates must be deployed to encourage an expansion of fonnal-sector economic activity and an increase in the number of actual fonnal-sector taxpayers. indeed, all south africans would benefit by south africa becoming a relative tax haven for capitalists especially those developing or bringing their own "intellectual capital". this would expand the existing income and vat tax bases and increase government revenues to a greater extent than any tax tending to drive capitalists away or into hiding. indeed, it would also hasten every south african toward becoming a capitalist (as an owner of human and/or non-human capital), as will be required in a truly globalized future. a little known, or appreciated, fact is that south africa was on par with japan in 1957 in tenns of per capita income. at about the same time, zimbabwe (then rhodesia) was about on par with south africa. reflecting on the differences between those countries' past policies and their current real per capita incomes should provide a sound basis for drawing some sober conclusions. i) institutions matter. 2) political redistributions to special interest groups tend to handicap an economy. 3) economies open to trade, and especially capital . . rfi 10 movement, generate supenor per capita pe onnances. 3.5 handicapping freedom such observations for particular countries have now been generalized for nearly the entire world following the development of economic freedom indexes, which are highly correlated to many of the desiderata of advanced, postmodern life including per capita income and (surprising to some) its favourable (market) distribution. tax rates playa major role in detennining the value of these freedom indexes. south africa was ahead of other african countries by these measures even before its transition. but following that event, the new government has, up to now, perfonned well enough for south africa to leapfrog 8 rankings over its rivals between 1990 and 1997. however, it is still far from the highest ranked countries. 11 capital unfriendly taxes will ultimately lead to a lower ranking, and, eventually, poorer development results. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2248 3.6 postmodern public finance one cannot help but be impressed by the difference between the ideological thrust of major public finance textbooks and that of the articles contained in academic journals specialising in public finance. while both might be said to share the modernist preference for state intervention, and both tend to ignore the warnings of public choice (though the journal articles much less often), the latter are much more ideologically and analytically diverse in their perspective. in true postmodern form, they often tend to contradict and/or challenge their predecessors sometimes with a self-conscious promotion of pre-modern ideas especially ideas favouring efficiency over equity (see coleman, 2000; fuest & huber, 2000; lansing, 1999; parker, 1999; sillamaa, 1999; ueng & yang, 2000). perhaps the time is right for a great, public finance synthesizer, much like r a musgrave of two generations earlier, to arise to present a new consistent version of the discipline. perhaps! but we might well be the worse for it. there is always the chance that, like with musgrave's, or even keynes's, "discipline revolution", an entire generation of policy analysts, and, hence, government policy actions, may be misled as a result. however, to avoid such misadventures, it is important for political observers, critics, and policymakers to recognize the lack of consistency and consensus in the discipline. again, in true postmodern form, it might be said that the discipline has become multi-cultural! many ideologies and technologies are in active' competition for political influence. in this context, attempting consistency to some outmoded standard or ideal may be true folly with unfavourable, if not self-defeating results. keynes really said it best: "madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back." who could he have had in mind when he said that? many of the modem politicians, as it turned out. it is now time for politicians to be postmodern. 4 conclusion (parts i & ii) in a sense, south africa is starting with an almost clean slate with respect to certain kinds of income taxation. it should strive to keep that slate as clean and simple as possible. in the name of consistency, the introduction of capital gains taxation in any form, will multiply, not reduce, the system's inconsistencies. in r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 249 sajems ns vol 4 (200 i) no 2 the name of equity, it will multiply the inequities. it will not raise substantial net revenues. but it will be a source of ongoing lobbying activity, and that will undermine social cohesion. in the short run, za-cgt may yield political and financial benefits for the governing party. in the long run, if that party's constituents' market prospects improve as a result of other government policies and/or market developments, its own prospects are likely to suffer. every time a constituent's income earning or wealth gaining prospects are blocked or reduced by the presence of a cgt, votes and financial support will be threatened. the "financial cows" will increasingly avoid that party's "milk house"! other parties will offer alternatjves in order to farm this ever more fertile avoidance field. the prospects for the economy will be diminished by the incentives to divert resources from market to political opportunities. our "modern" past is now prologue to our "postmodern" future. modernist failures were very costly lessons for those who have learned well enough to create a more successful future. in brief, some of the more important of the lessons and ideas essayed, but not proved, here with respect to za-cgt are: consistency is economically and politically elusive. capital gains are not past income that avoided taxation. capital gains taxation reduces available capital and wealth. capital gains taxation is inefficient and uneconomic. efficient tax policies promote equity, not vice versa. south africa should be more of a "tax competitor" than a "tax cooperator". south africa will develop faster without a cgt. each of these is arguable and subject to caveats, but nevertheless captures some essential truth that can be worthwhile believing. convincing policymakers and their constituents to listen to and to understand these lessons will not be easy. but this essay is a start. endnotes thanks are due to d. allen, j. chant, h. grubel, d. hammes, r. jones, b. kantor, r. krelove, j. seinfeld, and j. stuart. 2 the rest of south africa's first it billionaire's prescient quote in response to cape argus reporter nazila peer's question: "what do you think of the capital gains tax?" is: it's essentially a very complex, bureaucratic tax that introduces r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2250 uncertainty, when we should be encouraging economic gro\vth and wealth creation. [paragraph quoted in text fits here.] i don't believe a capital gains tax will bring significant inflows into the treasury. more resources will be diverted into the hands of accountants and financial advisors than will actually create economic gro\vth. in early march 2001, it was reported that mr. shuttleworth just emigrated to the uk, for reasons of business and remaining sa exchange controls. he denied that the proposed cgt was responsible, although it is the main new intrusive element on sa's business horizon, and revealed preference theory suggests otherwise. 3 that such packaging can easily cause confusion among1>olitical observers is well demonstrated by an article entitled "our government suffers from ideological schizophrenia" by s. mulholland in the 18 march 2000 sunday times. 4 "robin hood" (rich to poor transfers): "manifesto" ("from each according to her ability, to each according to his need"); retribution (compensation for previous government induced injuries); or restoration (restoring entitlements gained by defeating others but taken away when last defeated). in south africa, various claimant groups have what might be called "entitlement myths". each group's myth specifies that its group was historically the first claimant to various land tracts, or indeed the entire country. under the age-old rule "first in time, first in right", that myth then justifies their claim for restoration of rights, which, in fact, their specific forebears may never have held, or may have voluntarily sold ·or simply taken away from others who came before them. the historical evidence seems to be that this region was continuously occupied from the dawn of time by peoples who may no longer be well represented in sa's existing population. strictly speaking, then, no current group would have a dominant claim on the "first in time" basis. but practically, if a group has a majority or even a controlling minority, as did the afrikaners for a while it has the power to make its own myth operational. other myths, even that these myths are myths, then become politically incorrect and precluded. 5 this suggests the need for a "golden rule" principle of taxation. the golden rule is seldom discussed in public finance literature, but quite relevant in a dynamic especially an inflationary context as progressive taxation eventually expropriates its own earlier supporters. further, it may be noted in this context that those who are exempt from taxation, such as imf advisors, are inappropriate tax advisors. finally, "rule of law" ideology of equal treatment under law, even for advisors, bureaucrats, legislators, and other politicians, has a certain logic for promoting incentives to make and enforce more reasonable law. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 251 sajems ns vol 4 (2001) no 2 6 where will this political competition, or rent seeking, costs, occur for the new za-cgt, or for any new tax rule or law? let me count the ways: 1. preparation. 2. legislation. 3. administration. 4. compliance. 5. avoidance. 6. revision. 7. repeal; and so on possibly in a cycle. at each stage there will be costs for the government as well as all of the competitors, which must be summed for the total social cost. 7 this term bas not been used often in economics, although it is indeed appropriate. for those unfamiliar with postmodernism, here is a definition: a term used to designate a multitude of trends in the arts, philosophy, religion, technology, and many others that come after and deviate from ~e many 20th -century movements that constituted modernism. [ ... ] widely debated with regard to its meaning and implications, postmodernism has also been said to relate to the culture of capitalism as it has developed since the 1960s. in general, the postmodern view is cool, ironic, and accepting of the fragmentation of contemporary existence. [ ... ] and [challenging] a wide variety of traditional cultural values. (the columbia encyclopedia: sixth edition. 2000). 8 again, canada provides a bad example. since its 1972 introduction, the relative rate on capital gains has increased and the exemptions have decreased to the point where only first home rollovers are exempt. 9 unfortunately, south africa has already moved to residence based income taxation. this is a major mistake perhaps even more so than a cgt and a very bad signal to foreign capitalists who might want to personally direct their south african investments by taking up residence in south africa. it discourages such direct investments and/or encourages dishonesty and subterfuge about offshore assets and income. only countries that have large internal markets and the military muscle and financial leverage necessary to pierce other countries' secrecy and privacy rights, like the us, can gain from using a revenue-based, rather than a source-based system. any country moving to a revenue-based system will only make the us, and actual tax havens, seem more attractive. 10 for a quick, non-technical survey of the lessons to be drawn from the successes and failures of "modem" development during the 20th century, one should read pj o'rourke's ironically entitled eat the rich. it is the best, popular-press book on economic development since adam smith's wealth oj nations. however, it is not alone in the field, as many new treaties on "why capitalism won" have been published over the last decade since the "fall of socialism". ii south africa's 1997 index rating: 6.5 (out of 10); ranking: 56 (out of 119 countries); 1990 index rating: 5.4 (out of 10); ranking: 48 (out of 1 i 1 countries). see economic freedom oj the world: report 2000 at www.freetheworld.com. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2 252 references ales ina, a. & rosenthal, h. (2000) "polarized platforms and moderate policies with checks and balances", journal of public economics, 75 (1): 1-20. 2 becker, g. (1983) "a theory of competition among pressure groups for political influence", quarterly journal of economics, 98: 371-400. 3 burman, l.e. (1999) the labyrinth of capital gains tax policy, brookings institution: washington. 4 burman, l.e. & randolph, w.c. (1995) "measuring permanent responses to capital gains tax changes in panel data", american economic review, 84: 794-809 5 coleman, w.j. ii (2000) "welfare and optimum dynamic taxation of consumption and income", journal of public economics, 76 (1): 1-39. 6 davidson, jd & rees-mogg, w. (1997) the sovereign individual, simon & schuster: new york. 7 farmer, a. & pecorino p. (1999) "legal expenditure as a rentseeking game", public choice, 100: 271-88. 8 fuest, c & huber, b. (2000) "is tax progression really good for employment? a model with endogenous hours of work", labour economics 7 (i): 79-93. 9 grubel, h. g. (2000) unlocking canadian capital: the case for capital gains tax reform, the fraser institute: vancouver. 10 jones, r. w. (2000) globalization and the theory of input trade, mit press, cambridge. 11 .ka tz, m. (1996) katz commission report, http://www.gov.zalreports/1996lkatz.ht. 12 lansing, k.j. (1999) "optimal redistributive capital taxation in a neo-classical growth model", journal of public economics, 73 (3): 42353. 13 lee, j. (1995) "capital gains myths", tax notes. (may 8). 14 mcchesney, w. (1987) "rent extraction and rent creation in the economic theory of regulation", journal of legal studies, 16: 101-18. 15 minister of finance, web site: www.finance.gov.za. 16 parker, s.c. (1999) "the optimal linear taxation of employment and self-employment incomes", journal of public economics, 73 (1): 107-23. 17 richardson, c. (2001) "over-hasty tax likely to hurt those it should help" cape times business, january 31. 18 sillamaa, m.a. (1999) "how work effort responds to wage taxation: an experimental test of a zero top marginal tax rate", journal of public economics, 73 (1): 125-34. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 253 sajems ns vol 4 (2001) no 2 19 spindler, z.a. & walker, m.a. (1988) "canadian tax refonn as public choice", contemporary policy issues (october) 70-84. 20 todd, w.f. (1995) from constitutional republic to corporate state: the federal reserve board, 1931-1934. monograph number 51, charlotte n.e.: committee for monetary research and education. 21 tullock, g. (1967) "the welfare costs of tariffs, monopolies, and theft", western economic journal, 5: 224-32. 22 tullock, g. (1997) "where is the rectangle", public choice 91: 14959. 23 ueng, k.l.g. & yang, e.c. (2000) "taxation with little administration", journal of public economics, 75 (1): 145-56. 24 zodrow, g.r. (1995) "economic issues in the taxation of capital gains", canadian public policy, 21 (nov.ldec., supplement): 27-57. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 369 sajems ns vol 3 (2000) no 3 the impact of tourist spending in south africa: spatial implications andrea saayman, melville saayman and wim naude faculty of economic and management sciences, potchefstroom university for che abstract in south africa tourism is regarded as a growth catalyst and a contributor towards the economic upliftment of poorer regions. the magnitude of the impact of tourist spending depends on the extent of leakages from the region, and the ability of the region to create backward and forward linkages. it is argued that the spatial implications of tourism might, inter alia, depend on the relative impacts of domestic versus international tourist spending. using an input-output model, support was found for the notion that, from a regional development perspective, there should be an emphasis on the development of the domestic tourism market in the short tenn. as a long-tenn strategy, investment in transport services and infrastructure to reduce path dependency effects, more inherent in international tourism, is proposed. jel l 84, r 11 1 introduction tourism, as well as infonnation technology and telecommunications, are recognised as industries with significant growth and development potential in a global economy (kruger-cloete, 1995: 751). the tourism industry in particular has been described as the largest global industry (satour circular, 1996; van der merwe, 2000: i). it is also one of the most rapidly expanding industries with tourist arrivals growing by 2.4 % worldwide in 1998 (wto, 1998; brynard, 1995: 12; hicks, 1996: 7). after petroleum and petroleum products and motor vehicles, international tourism is the third largest export industry globally (kruger-cloete, 1995: 271). the tourism industry consists of a number of different but interlinked service industries, particularly accommodation and catering, food processing and beverages, transport, as well as entertainment and other support services (paton, 1985: 64). increasingly, many developing countries are recognising a potential r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 370 comparative advantage in tourism and are, as a consequence, adopting tourism development strategies to further growth and development. particularly in africa, tourism has been argued to have significant development potential. due to its geographic and climatic diversity, ecology, biodiversity and exotic fauna and flora, africa may be argued to have a comparative advantage in tourism that has so far been unexploited. assuming that political and social stability will be maintained, the impact of a growing tourism industry in developing countries may depend on its forward and backward domestic linkages, the nature of its regulation (affecting sustainability) as well as the relative emphasis on domestic versus international tourism. in most countries the development of tourism will also have a specific regional (or spatial) impact, due to the geographic distribution of tourism attractions and supporting services. relatively little research has so far been focused on this aspect of tourism promotion as a development strategy. this paper is an initial (and tentative) attempt to contribute towards filling this vacuum. it will do so by arguing that the spatial outcome of tourism development may depend, in part, on the relative emphasis on domestic versus international tourism. an input-output model of south africa, an upper middleincome developing country with a possible unexploited comparative advantage in tourism, will be used to find an empirical basis for the assertion that domestic, relative to international, tourism has a differential spatial impact on economic development. the paper is structured as follows: section two discusses the merits and demerits of foreign tourism promotion in south africa. section 3 explains the methodology used to determine the contribution of domestic and international tourist spending to the south african economy. in section 4 the results of a 10% increase in domestic and international tourism, respectively, are presented. section 5 discusses the implications of these results for spatial (or regional) development in south africa. section 6 provides a concluding summary of the findings. 2 foreign versus domestic tourism promotion 2.1 definitions tourism per se can be defined as "the activity of persons travelling to and staying in places outside their usual environment for not more than one consecutive year for leisure, business or any other purpose" (wto, 1999). anyone who spends at least one night away from home is thus classified as a tourist. when travel takes place within the country of residence, it is referred to r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 371 sajems ns vol 3 (2000) no 3 as domestic tourism (wto, 1999). while international tourism usually refers to all tourists from foreign countries, this paper uses the term international tourism for tourists from foreign countries, excluding tourists from africa. foreign tourism is the term used in the context of this paper to describe the sum of international tourists (as defined above), including tourists from africa. 2.2 the case for domestic tourism since 1994, following south africa's democratic transition and the signing of the uruguay round of the gatt, foreign tourism to south africa has increased substantially (msimang, 1995: 20). foreign tourist arrivals have, for instance, shown a steady increase of more than 10% per annum on average since 1988 (saayman, 1999). this makes south africa one of the world's fastest-growing tourism destinations and has raised expectations as to the impact of foreign tourism on the development of the economy (van der merwe, 2000: 2; wood, 1995: 29). this high rate of current growth could be reflecting a "catching-up" phase during which south africa's tourism share is converging on that of similarly endowed international tourism destinations. for example, south africa's tourism sector is currently contributing around 4% to gdp, compared to the above-mentioned 10% contribution of the industry to the economies of the united states and europe (de beer et ai., 1998: 2). in a globalising economy, where increased international competition is a defining feature, and path-dependence effects in tourism may have to be overcome for south africa to be competitive enough to maintain these growth rates of tourist arrivals and thus successfully converge on international trends, government promotion of foreign tourism might be justified. in effect, the argument for government promotion of tourism in south africa can be based on overcoming the path-dependency effects (due to history), as well as addressing the high fixed costs in tourism, which may create obstacles to entry into international markets for south african tourism service providers. given, however, that the opportunity cost of government expenditure is high in this country, which is in need of basic social services such as housing and education (muller, 1997: 10), the impact of international tourism on the domestic economy, for example as measured by its multiplier effect, must be sufficiently high for social welfare to be maximised. another argument in favour of significant government promotion of foreign tourism has recently been voiced. this states, simplistically, that foreign tourism is often promoted to the detriment of domestic tourism and that this bias is not justified. in south africa, domestic tourism contributes approximately 60% to r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 372 total tourism income (wood, 1995: 29). it has been argued that the domestic tourism market has significant growth potential, also based on a "catching-up" effect, if it is made accessible to south africa's previously disadvantaged population groups (futter & wood, 1997: 58; wood, 1995: 29). the expectation is therefore that tourism may be one sector through which the concept of "growth through redistribution" might be applied. it has also been argued that the domestic tourism sector has to act as a buffer against unpredictable fluctuations in international tourism demand, and thus fluctuations in foreign exchange earnings (de beer et at., 1998: i). 3 methodology 3.1 the model tourism (including foreign tourism) impacts on a country's level of development through its effects on employment, income (or gross domestic product gdp), foreign exchange earnings and prices (saayman & saayman, 1999; saayman & saayman, 1997; niedermeier & smith, 1995; hugo, 1992). the magnitude of tourism's impact on the economy is dependent on the magnitude of leakages from the economy (mainly via imports) and the ability of the economy (or region) to create backward linkages (niedermeier & smith, 1995; strydom & lourens, 1995: 51). the typical approach in economic literature to quantify the impact of tourism spending on the economy, is to use a standard input-output table and model the effect of an exogenous change in spending on final demand. this analysis makes use of matrix algebra to determine final net output lmd can be used to estimate the level of income, employment and production required to satisfy a cenain level of tourism demand. this analysis also generates multipliers, which include secondary impacts, in an impact analysis (see kottke, 1988). alternative methods used elsewhere, such as cge models and sam-based multiplier models (see e.g. zhou et at., 1997; wagner, 1997 or wang, 1995) were not considered in the present case since the most recent sam available for south africa is for 1995 (and is basically an adjustment from the 1992 base year which, in tum, is based on a 1986 input-output table). the weaknesses of an input-output analysis include that industry as a whole and not individual firms are dealt with, that multipliers are subject to misinterpretation (kottke, 1988: 123) and that tourism data are usually inadequate for the detailed requirements of an input-output analysis (archer, 1997). nevertheless, wanhill (1994) indicates that it is still the most popular tool to determine the impact of tourism on the economy and has been used, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 373 sajems ns vol 3 (2000) no 3 among others, by researchers such as wang (1997), andrew (1997), bergstrom et al. (1990), fletcher (1989), heng and low (1990), loomis (1995) and smeral (1999). 3.2 the data in the present paper, the recently released 1996 south african input-output (10) table (conningarth consulting economists, 1999) was used as the basis of the model. data on tourist spending were obtained from the south african tourism board (sa tour) and the south african reserve bank (sarb). the magnitude of tourist spending and the breakdown categories are defined in sa tour surveys. for further refinement, published sarb figures for tourism traffic and travel expenses were also included. data for 1996 were used to be comparable with those of the 1996 input-output table. 3.3 the simulations given that tourists to south africa have been increasing by 10% per annum on average over the past five years, the simulations attempted to analyse the impact of a 10% increase in both domestic and foreign tourism spending. this of course assumes a linearly homogenous relationship between tourist arrivals and tourist spending. whilst overall magnitudes of foreign and domestic tourist spending are available, it is not obvious how these should be allocated in an input-output model to the various economic sectors. additional information on tourist spending patterns, taken from satour surveys, had to be used for this purpose. these allocations determined the simulations (or shocks) performed. 3.3. j modelling a j 0 per cent increase in domestic tourist expenditure based on the 1996 sa tour survey, domestic tourist spending contributed ri9 112 billion to gdp. south africans undertook 22644 million trips in that year, spending an average of r844 per trip (satour, 1997: 17). the breakdown of domestic tourist spending into different categories is indicated in table 1. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 374 table 1 breakdown of domestic tourist spending (1996) expenditure category percentage average total amount amount (r) (rm) accommodation 27.02 228 5166 food and drink 23.34 197 4463 transport 24.17 204 4622 other 25.47 215 4871 tal 100 844 19122 (source: satour, 1997: 17) these expenditure categories were attributed to various sectors in the 1996 1-0 table according to the proportions of consumer expenditure reflected in the 1-0 table. 3.3.2 modelling a 10 per cent increase in international tourist expenditure the volume and expenditure patterns of international tourists to south africa differ from that of domestic tourists. the likely (or possible) differential impact which it might have on the local economy (and its regional/spatial impact), can be modelled and compared to that of domestic tourist expenditure. international tourist spending is estimated to have contributed r12.7546 billion to south africa's gdp in 1996. approximately 1.2 million international tourists (excluding african tourists) visited south africa that year (rhodes & saayman, 1998). the average spending per tourist was ri8 600 (sa tour, 1996: 17). according to the august 1996 survey done by satour, the r 18 600 was spent as follows (table 2): table 2 breakdown of international tourist spending (1996) expenditure category percentage average total amount amount (r) (rm) airfare 43 7998 9597.6 prepaid expenses 22 4092 4910.4 shopping, souvenirs and gifts ii 2046 2455.2 food and drink 6 1 116 1 339.2 accommodation 10 1860 2232.0 local transport 3 558 669.6 recreation, culture and dance 2 372 446.4 other 3 558 669.6 total 100 18600 22320.0 (source: satour, 1996: 17) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 375 sajems ns vol 3 (2000) no 3 according to the south african reserve bank quarterly bulletin (1998), the airfare to travel to south africa (via south african airways), amounted to r2 235 million. using the tourism traffic figure from the sarb quarterly bulletin, the amount of prepaid expenses entering south africa was determined at r2 707.6 million. if it is assumed that most prepaid expenses are for pre-booked tours, the following assumptions (table 3) regarding prepaid expenses entering south africa can be made: table 3 assumption regarding prepaid expenditure expenditure cate20ry percenta2e rand amount (rm) local transport 30 812.28 accommodation 30 812.28 food and drink 5 135.38 recreation, culture and dance 2 81.228 other 3 54.152 business services (profit) 30 812.28 total 100 2707.60 f or the purpose of this analysis, the international tourist spending categories and totals are summarised in table 4: table 4 total international tourist spending (1996) per category expenditure category percenta2e rand amount (ra local transport 29.14 3716.88 accommodation 23.87 3044.28 shopping, souvenirs ahd gifts 19.25 2 455.2t1 food and drink 11.56 1 474.58 recreation, culture and dance 4.14 527628 other 5.67 723752 business services (profit) 6.37 812.28 total 100 12 754.60 these expenditure categories were allocated to the corresponding sectors in the 1996 1-0 table. in total, the above implies that a 10% increase in foreign tourist expenditure increases domestic demand with r1.23 billion. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 376 4 results 4.1 impact of domestic tourism a 10% increase in total domestic tourist expenditure increases domestic demand with r 1.82 billion. in order to determine the multiplier effect thereof, and the sectoral impact, the x-vector of final demands in the 1-0 model was adjusted by the above increase. the results can be classified as macroeconomic effects and sectoral effects. the macroeconomic effect of a 10% increase in domestic tourist expenditure was found to lead to an increase in output of r3.s8 billion. this implies a multiplier coefficient of 1.96. this multiplier indicates the increase in production or output, and such output multipliers are generally greater than income multipliers (wang, 1997: 42). the sectoral effects were as follows: table 5 sectoral effects of a 10 per cent increase in domestic tourist spending sector increase in output percentage of (rand bn) total agriculture 0.31 8.68 mining 0.03 0.84 manufacturing 1.31 36.7 electricity and water 0.10 2.8 construction 0.03 0.8.:"! trade 0.22 6.16 catering and accommodation 0.s4 is.13 transport and communications 0.61 17.09 services 0.42 1l.77 table s shows that the sector to benefit most from the increase in tourist expenditure is manufacturing (r 1.31 bn), followed by transport and communications (ro.61 bn). it is noteworthy that the catering and accommodation category benefited third most. the detailed results indicated that within manufacturing, the food and food processing sector (ro.67 bn) and the beverage sector (ro.17 bn) benefited the most. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 377 sajems ns vol 3 (2000) no 3 4.2 impact of international tourism as in the case of domestic tourism, the results can be categorised as macroeconomic and sectoral results. the macroeconomic results indicated an increase in total output of r2.34 billion. given the original exogenous injection of r 1.23 billion, this implies a multiplier of 1.9 somewhat lower than that of domestic tourism, but not significantly so. the sectoral results are given in table 6: table 6 sectoral effects of a 10 per cent increase in international tourist spending sector increase in output percentage of (rand bn) total agriculture 0.14 5.96 mining 0.02 0.85 manufacturing 0.63 26.81 electricity and water 0.06 2.55 construction 0.02 0.85 trade 0.16 6.81 catering and accommodation 0.32 13.62 transport and communications 0.47 20.0 services 053 22.55 table 6 shows that, as in the case of domestic tourists, the manufacturing sector benefited most (ro.63 bn). within manufacturing, food and food processing is the sector that benefits most. nex' to manufacturing, the services sector (which includes business services related to recreation) benefited 'the most (ro.53 bn), followed by transport (roa7 bn) and catering and accommodation (ro.32 bn). the table also indicates that, compared to domestic tourism, agriculture benefited less from international than domestic tourists (ro.14 bn versus ro.31 bn). 5 spatial implications the above results may have the following spatial (provincial) implications for tourism in south africa: firstly, both international and domestic tourism have a positive impact on economic development in south africa, with multipliers of 1.9 and higher. an r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 378 important finding is that the overall multiplier effect of domestic tourism is not significantly different from that of international tourism. according to the white paper on tourism (south africa, 1996) provincial authorities (i.e. regional governments) are responsible for the development and promotion of domestic tourism. the national agency, satour, is responsible for marketing south africa as an international tourist destination. to maximise the benefits from tourism, provincial governments should become more active in marketing their products to new markets within south africa. a second implication is that international tourism has more benefits for services, which are currently more developed in affluent regions, such as the provinces of gauteng, western cape and kwazulu-natal. these provinces also attract the most domestic as well as international tourists (see appendix a) (rhodes & saayman, 1997). a further advantage of these three provinces is that they offer the three international gateways to south africa, increasing their accessibility to tourists. table 7 shows the percentage share of total gross geographical product (ggp) for different sectors of the economy which can be attributed to different provinces in south africa. the significance of this is that it supports the argument that tourist spending benefits certain provinces more than others. for example, if trade and accommodation increase because of an increase in demand from more tourists, gauteng will benefit most, followed by western cape and kwazulu-natal. it is the same with services, transport, printing and publishing, to name but a few. de beer et al. (1998) support the notion that tourism can lead to an unequal spread of benefits. unemployment, which is a major problem in regions such as the eastern cape, northern province, northern cape, north west and the free state, will thus not be alleviated with current tourism strategit"'i. new strategies should consider that provinces need to develop their transport systems to make them more accessible particularly road networks and airports. this view is shared by mkhize (1994). the spatial development initiatives (sdis), which should increase traffic to these provinces, can help in this regard (de beer e/ al., 1998; saayman & saayman, 1999). where possible, these provinces will also have to supply their own goods and fresh produce instead of "importing" them from gauteng, western cape and kwazulu-natal in order to minimise leakages to these more affluent provinces. provinces should also improve tourism-related services, for example recreation, entertainment, tour operators and tour guides, which will also benefit international tourism. another element of a tourism strategy could be for provinces to focus primarily on the domestic market. looking at the effect of tourism on employment, the results in section 4 showed r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 379 sajems ns vol 3 (2000) no 3 that the sectors benefiting most from tourism are manufacturing, transport and communications, catering and accommodation, services and agriculture. of these, only catering and accommodation, services (non-financial) and agriculture can be classified as relatively labour-intensive industries (see appendix b). food and food processing and beverages (the manufacturing industries which benefit most) can be seen as moderately labour-intensive and relatively capital-intensive industries respectively (see appendix b). table 7 percentage share or total sector ggp (1994) sector wc ec nc gp mp np nw kzn fs agriculture 20 9 4 5 14 6 10 18 14 gold mining 0 0 0 33 27 4 15 2 20 other mining 1 0 16 4 6 17 45 6 5 food processing 20 6 i 33 7 3 3 21 5 beverages 28 5 1 41 3 3 3 13 4 tobacco 25 2 0 69 0 0 4 0 0 textiles 23 15 0 9 5 0 0 47 1 clothing 43 2 1 13 0 0 0 37 4 leather products 36 23 1 25 0 0 0 13 2 footwear 22 9 0 4 0 0 0 61 4 wood & wood 15 8 0 17 32 5 1 19 3 products furniture 18 3 0 46 2 3 3 21 4 paper & pulp 13 4 0 25 12 1 0 44 i printing & publishing 24 4 0 55 0 0 1 14 2 chemicals 13 4 0 32 22 0 2 17~ rubber products 2 52 0 22 0 0 0 23 • plastic products 21 3 0 56 1 1 i 13 3 non-metallic 10 3 2 55 3 i ii 12 3 minerals 51= r-o basic iron & steel 1 0 0 64 23 0 2 r---non-ferrous metals 1 0 0 46 0 0 0 0 fabricated metals :10 3 0 69 3 1 2 12 2 machinery 9 3 0 72 2 0 3 9 2 electrical machinery 8 10 0 69 0 0 7 6 0 motor vehicles 3 35 0 54 1 0 1 6 1 other transport 22 3 0 40 0 0 1 31 4 other 11 10 0 41 10 3 1 18 5 manufacturing electricity 10 3 2 20 41 7 2 8 8 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 380 table 7 continued sector wc ec nc gp mp np nw kzn fs construction 15 8 i 39 5 3 6 16 6 trade & 18 8 2 42 4 3 3 16 5 accommodation transport & 15 10 3 37 4 2 2 22 6 communications financial services 18 7 2 47 3 2 3 13 5 community services 13 ~h 53 3 2 3 [t f+ i government services 15 41 4~8 5 non-classified 20 41 i 2 2 4 15 total (avera2e) 15 6 2 39 i 8 4 6 15 6 (source: coetzee & joubert, 1998: 7) 6 conclusions it has been argued in this paper that the spatial implications of tourism development might depend, inter alia, on the relative impacts of domestic versus international tourist spending. using an input-output model, support was found for the notion that there should be greater emphasis on the development of the domestic tourism market in south africa, as the macroeconomic effect is greater and more beneficial to sectors prominent in poorer provinces. it was also found that regions such as gauteng, western cape and kwazulu-natal benefit most from an increase in the number of international tourists to and in south africa. for these provinces are suppliers of services and manufactured products. thpy are also the gateways to south africa. this situation leads to an unequal distribution of tourism benefits, where the provinces which need development and revenue the most, receive the least. the implication is that substantial path dependency effects will operate on a regional level in the case of international tourism. improvements in infrastructure and transport services are vital if these effects are to improve. it may therefore be concluded that regional governments (particularly of the poorer regions) in south africa should focus more on domestic tourism as a shortterm tourism development strategy. here the path-dependency effects may be smaller. however, they should complement this policy stance by increasing investment in transport services and infrastructure, as part of a mediumto longerterm strategy for the development of the international tourism market. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 381 sajems ns vol 3 (2000) no 3 appendix a: table al provincial domestic tourism market share (1996) province percentage of all trips northern cape 1.8 western cape 12.4 eastern cape 14.0 kwazulu-natal 29.6 mpumalanga northern province 5.3 north west 8.7 free state 6.2 gauteng 15.2 (source: sa tour, 1997) table a2 provincial international tourism market share (1996) province percentage visitors· northern cape 4.5 western cape 51.5 eastern cape 16.0 kwazulu-natal 28.5 mpumalanga 20.5 northern province 4.5 north west 7.5 free state 5.0 gauteng 66.5 *note that the percentages do not add up to 100% because most international tourists visit more than one province while staying in south africa. (source: rhodes & saayman, 1998) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 382 appendixb table bl 1996 capital-labour ratios for different sectors of the economy (1995=100) sector fixed capital : labour i labour: rank stock (rm) capital rti~i.culture 45299 800000 1 : 56624 2 mmg 102356 i 566469' i: 180691 5 .... __ . manufacturing 176 188 i 1 456501 i: 120967 4 construction 6157 323585 i : 19027 i transport and 196474 203 178 i : 967004 6 communication -d . tra e, catenng & 60709 764 384 i : 79422 3 accommodation financial institutions 275218 214234 1 : i 284661 7 (source: sarb quarterly bulletm, 1999) table b2 1996 capital-labour ratios for tbe manufacturing sector (1990=100) sector rank i fixed i labour i labour: . capital stock. i capital i (rm) . . .. ~ processed food i 10916.71 i 177000! 1 :61676 14 ~t":rages 7 642.36 31 000 i i: 246 528 22 textiles ! 2397.47 79000 i 1: 30 348l clothing, excl. footwear i 390.14 150 000 : i : 2 60 i i ~;;~~~~sand leather i 125.06--s000: i: 15633: 4 footwear i 265.69 25 000 1 . 10628 3 wood and wood products 1003.20 60 00 i 1 16720 5 paper and pap~r products i 4 691.50. 48 000 i i: 97 7 40 .~ printing and publishing 1479.43! 53000. 1:27914 7 industrial chemicals i 33344.66. 29000 ii : 1 149816 25 other chemical products=l.:l~05.75-t_~qoo i i: 57 663 i 13 -.b,ubber prod~cts .. __ ~ ... _. j 126.5~+~oo ll 62 586 16 ..fil1stic_produ(;~~___ _~~29.63 '_47_0gcll-j:}8 928 t ii glass and glassp"'roducts_~. __ 934.9jj __ ~.q..qoo~j-=-23 495~_20 _ r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 383 sajems ns vol 3 (2000) no 3 table b2 continued sector fixed labour labour: rank capital stock capital (rm) non-metallic mineral 4192.88 66000 1 : 63 528 17 products basic iron and steel 21303.08 59000 1 : 361 069 23 products non-ferrous metal 6859.41 14000 1: 489 958 24 . products metal products, excl. 2996.74 124000 1 : 24 167 6 machinery non-electrical machinery 2519.83 77 000 i : 32 725 10 electrical machinery 2476.66· 86000 1 : 28 798 8 professional equipment 435.62 7000 1 : 62231 15 etc. motor vehicles, parts and 5464.45 82000 1 : 66 652 18 accessories other transport equipment 847.60 12000 1 : 70633 19 furniture 445.50 48000 1 : 9 281 2 other manufacturing i 163.11 27000 1 : 43 078 12 (source: npi, 1998) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 384 references andrew, b.p. 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(1997) "estimating economic impacts from tourism", annals of tourism research, 24(1); 76-89. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction literature review study purpose and research questions methods results conclusion acknowledgements references footnotes about the author(s) michael harber department of accounting and finance, university of cape town, cape town, south africa ben marx department of accountancy, university of johannesburg, johannesburg, south africa citation harber, m. & marx, b., 2020, ‘auditor independence and professional scepticism in south africa: is regulatory reform needed?’, south african journal of economic and management sciences 23(1), a2912. https://doi.org/10.4102/sajems.v23i1.2912 original research auditor independence and professional scepticism in south africa: is regulatory reform needed? michael harber, ben marx received: 01 dec. 2018; accepted: 11 dec. 2019; published: 26 mar. 2020 copyright: © 2020. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: quality financial reporting, which requires high quality auditing outcomes, aids the smooth functioning of capital markets. setting: the south african audit regulator argues that the key auditor attributes of independence and scepticism are dangerously compromised in south africa, resulting in impaired audit quality. the regulator responded in june 2017 with the issuance of mandatory audit firm rotation (mafr) regulations, effective april 2023. this ruling has caused considerable debate and opposing views in the audit industry. aim: this study explores the state of auditor independence and the degree to which professional scepticism is being exercised by south african auditors of exchange-listed companies through an analysis of the perceptions of experienced key stakeholders. the findings contribute to the rationale behind the regulator’s argument for the necessity and efficacy of mafr. method: the study uses a survey methodology across four key stakeholder groups experienced in matters concerning the audit process, auditor appointment and reliance on the audit outcome on the johannesburg stock exchange. results: respondents do not believe that auditor independence and professional scepticism are impaired, nor that existing regulations and codes of practice need amendment. in addition, audit failures and corporate financial scandals are not believed to be a result of compromised auditor independence and professional scepticism, nor do longer audit firm tenures impair independence and professional scepticism. conclusion: these perceptions provide evidence against the rationale for mafr adoption and indicate that it may not be necessary or effective. the study contributes to the south african audit profession in its objective to maintain audit quality. as such, it is relevant to regulators, standard-setters and stakeholders in south african capital markets. keywords: auditing; corporate governance; audit quality; auditor independence; professional scepticism; auditor rotation. introduction due in part to the continued occurrence of corporate financial scandals and fraudulent financial reporting, auditor independence and professional scepticism have received a great deal of attention from regulators globally (glover & prawitt 2014; knechel 2016; the economist 2018a, 2018b). financial scandals have produced a growing unease among investors and regulators about the adequacy of auditor independence, especially in regard to threats perceived to be presented from long auditor tenures and the impact of non-assurance services (casterella & johnston 2013). auditors have been accused of lacking the requisite degree of independence and professional scepticism to prevent, detect or ‘blow the whistle’ on corrupt or negligent behaviour in companies (independent regulatory board for auditors [irba] 2016; maroun & solomon 2014). this criticism of auditors and the consequent loss of confidence in their work may be the result of auditors falling short of societal expectations – a phenomenon referred to as the ‘audit expectation-performance gap’ (porter, hógartaigh & baskerville 2012; the economist 2018b). this gap, considered an international phenomenon, refers to the performance-expectation difference between auditors and the users of the financial statements (hay 2015; porter et al. 2012). as a result of these concerns, audit regulators have looked to apply stricter auditor rotation regulations to safeguard auditor independence, most notably mandatory audit firm rotation (mafr). by forcing periodic firm rotation, over and above the more traditional partner rotation, the length of audit firm tenures can be reduced. the aim is to preserve independence by limiting the opportunity for auditors to develop relationships with clients, which in turn mitigates the threat to audit quality from compromised independence and professional scepticism (casterella & johnston 2013; jackson, moldrich & roebuck 2008). illustrating the international divide around auditor rotation regulations, the european union decided to implement mafr in 2014 (european commission 2014; kpmg 2014) while the united states has continuously decided against it, favouring partner rotation. proponents of mafr argue that long audit firm tenures lead to audit failures from compromised independence and professional scepticism. opponents counter that it is longer tenure that improves audit quality because it allows the auditor to develop client-specific and industry-specific knowledge and expertise over time. in june 2017, the independent regulatory board for auditors (irba), the south african statutory body responsible for regulating the auditing profession, followed the european union’s ruling in favour of mafr for all ‘public-interest entities’, effective 2023, on a 10-year rotation basis (irba 2017b). this regulation would include all companies listed on the johannesburg stock exchange (jse). the irba is moving, therefore, beyond the current system of mandatory audit partner rotation on a five-year rotation basis to firm rotation. whereas some countries have adopted mafr in recent years, most have decided against it (lennox 2014; shango 2017), continuing to favour partner rotation, as recommended in the international federation of accountants (ifac) code of ethics for professional accountants (iesba 2018). the primary reason for implementing mafr in south africa is the concern by the irba that the quality of audits performed by audit firms on exchange-listed companies is deteriorating (harber & marx 2019). according to the irba (2016), this lack of independence and professional scepticism is evidenced by recent high-profile financial reporting scandals and the poor results of regulatory inspections of audit work. the irba performs annual reviews of select audit work performed by audit firms and audit practitioners. the past few years have produced unsatisfactory findings, some of which the irba believes are due to a deterioration in independence and growing professional scepticism (irba 2017e, 2018, 2019). these concerns are commonly expressed by regulators and inspectors globally as the root cause of audit deficiencies (nolder & kadous 2018). the purpose of this study is to better understand the state of auditor independence and professional scepticism in south africa, as a means of contributing to the ongoing debate concerning the necessity and potential efficacy of mafr. this study thereby conducts an exploratory analysis of the views of experienced auditors, audit committees (acs), chief financial officers (cfos) and institutional investors in this regard. according to ewelt-knauer, gold and pott (2013), there is a gap in the literature around the views of experienced role players, those parties within the audit process, as well as those responsible for auditor appointment. the study addresses this gap and contributes to the controversial and ongoing debate in south africa regarding the need to strengthen independence regulations and, by implication, the need for mafr. literature review auditor rotation regulation is designed to improve audit quality by limiting auditor-client tenures (casterella & johnston 2013; knechel 2016). the concept of audit quality is important to auditing research, especially when assessing the impact of regulation (hay 2015); however, this notion is problematic to define and measure. this problem arises partly because stakeholders of organisations have differing needs with respect to audited financial information, and partly because audit quality cannot be directly measured. researchers, therefore, resort to the use of imperfect and highly criticised proxies (knechel et al. 2013). similarly, with regard to the concept of professional scepticism, glover and prawitt (2014) argue that despite its relative simplicity, there is a lack of common understanding or practical guidance on how to define professional scepticism and how this concept can be demonstrated. nolder and kadous (2018:1) state that ‘professional skepticism [sic.] is a foundational construct in auditing’, a description which is consistent with extensive literature reviews performed by tepalagul and lin (2015) and casterella and johnston (2013), which confirm the importance of auditor independence and auditor scepticism in preserving the quality of the audit outcomes. audit quality knechel et al. (2013) explain that: … the problem of audit quality being in the ‘eye of the beholder’ is reflected in the broad range of diverse, and sometimes divergent, definitions that have been offered by numerous authorities and individuals over the past 20 years. (p. 387) deangelo (1981:186) provides a helpful definition which, although not all-encompassing, is used in many studies1 on audit quality: ‘audit quality is the probability that the auditor will uncover a breach of statutory or regulatory requirements (particularly financial in nature); and report the breach to the appropriate parties.’ an alternative definition is proposed by the international auditing standards, which defines a quality audit as one which is performed in accordance with the standards (international standard on auditing) ‘to obtain reasonable assurance’ about whether the financial statements reported by the company to stakeholders are ‘free from material misstatement, whether due to fraud or error’ and to communicate such findings and opinions to the users of the financial statements and relevant regulatory bodies (ifac isa 200, 2009:para.11). it can be clearly seen that the definition provided by deangelo (1981) and that of the international standard on auditing are consistent. linking audit quality to mandatory audit firm rotation the literature establishes that both high audit quality and an acceptable audit outcome require two auditor attributes. the auditor needs to be both independent of the client and competent and capable (knechel 2016; tepalagul & lin 2015). a compromise in either attribute will necessarily compromise the quality of the audit. as long audit‒client relationships are considered threats to independence in theory (iesba 2018) and by regulators (irba 2016; roush et al. 2011), auditor rotation requirements (whether partner or firm rotation) are designed to preserve audit quality. therefore, it stands to reason that if independence is not compromised in south africa, and if audit failures are a result of a lack of competence, then mafr may not be necessary or effective. many of the audit firms have used this argument against the irba position (harber & west 2017) and as such, this reasoning underlies rq1 and rq2 (refer below). auditor independence and professional scepticism similarly, professional scepticism is also difficult to define and measure (hurtt et al. 2013). according to nolder and kadous (2018:1), ‘the professional skepticism [sic.] construct remains ill-defined and measurements used in research do not map well into practice’ and a more definitive conceptualisation of professional scepticism is needed to aid researchers. in terms of professional standards, auditor scepticism is necessary throughout the audit engagement to produce appropriately high-quality audits (iaasb 2018; iesba 2018; ifac 2017) and, as such, enhance the degree of user confidence in audited financial statements. this confidence, in turn, aids the proper functioning of capital markets by lowering the risks inherent in financial decision-making (firth, rui & wu 2012). scepticism comes from the greek word ‘skeptikos’ which means ‘inquiring or reflective’. being a sceptic is often associated with questioning, careful observation, probing reflection, and suspension of belief. ‘professional’ scepticism incorporates these attributes within a professional setting, requiring due diligence and a standard of care (glover & prawitt 2014). the international auditing standards define professional scepticism as ‘an attitude that includes a questioning mind, being alert to conditions which may indicate possible misstatement due to error or fraud, and a critical assessment of audit evidence’ (ifac isa 200, 2009:77). these standards go further and assert that scepticism reduces: … the risks of overlooking unusual circumstances, over-generalizing when drawing conclusions from audit observations, and using inappropriate assumptions in determining the nature, timing, and extent of the audit procedures and evaluating the results thereof. (ifac isa 200, 2009:a19) thus, professional scepticism can be viewed as the force that drives auditors to recognise potential errors and irregularities and to investigate misstatements, should they exist, hence the link between scepticism and audit quality. aschauer et al. (2017) explain that auditors are obliged to maintain their professional scepticism, which they explain as being the propensity of an auditor to defer drawing conclusions until the evidence provides sufficient support for one alternative or explanation over another. if the auditor does not maintain professional scepticism or is not independent of the client, due to bias in the client’s favour, there is a risk of not seeking sufficient (quantity) or appropriate (quality) auditory evidence upon which to form an opinion. this limitation may result in unreasonable conclusions being drawn regarding accounting, fraud or financial reporting matters. therefore, the proper application of professional scepticism requires that auditors question the reliability of evidence, remain alert to indicators of fraud and management bias and critically assess the evidence (iesba 2018; nolder & kadous 2018). hurtt et al. (2013) extend the framework adopted by nelson (2009), proposing that a lack of scepticism can either be the result of: (1) a failure in problem recognition, including a lack of sceptical judgement, or (2) a failure to act on a problem recognised, meaning a lack of sceptical action. the literature and the professional standards show that auditor scepticism and auditor independence from the client are related yet different attributes, both necessary for the production of a high-quality audit outcome. furthermore, a distinction is made between what the professional standards refer to as ‘independence in mind’ and ‘independence in appearance’. the ifac code of ethics for professional accountants explains that independence in the context of the audit comprises both the: … [s]tate of mind that permits the expression of a conclusion without being affected by influences that compromise professional judgment, thereby allowing an individual to act with integrity and exercise objectivity and professional skepticism [sic.] [independence in mind] … [as well as] the avoidance of facts and circumstances that are so significant that a reasonable and informed third-party would be likely to conclude, weighing all the specific facts and circumstances, that a firm’s or audit team member’s integrity, objectivity or professional scepticism have been compromised [independence in appearance]. (iesba 2018:118–119) these explanations confirm that the reality of being independent and sceptical, as well as appearing as such to outside parties, is important both to safeguard audit quality and to provide the necessary degree of comfort to users of audited financial information. these two concepts of auditor ‘independence’ are always presented together in the ifac code of ethics for professional accountants and the ifac auditing standards (iesba 2018; ifac isa 200, 2009). despite having different meanings, the two concepts are closely related and used together in the mafr professional debate and in practice (harber & west 2017; irba 2016). an auditor who lacks independence will likely lack professional scepticism. as such, the research objectives (refer below) do not deal with each concept separately. long audit firm tenures consistent with the professional ifac code of ethics for professional accountants (iesba 2018), the literature review study of tepalagul and lin (2015) illustrates that, in principle, longer auditor tenures (partner or firm tenures) may increase the risk of impaired independence and professional scepticism. proponents of mafr are concerned with ‘client affiliation’ and especially the ‘auditor tenure’ risks that may occur over long periods during which the auditor-client relationship develops. this close connection is considered to be an incentive for the auditor to acquiesce to client preferences in financial reporting, which are sometimes fraudulent or unreasonable (bamber & iyer 2007). this compliance has also been attributed to the fact that in south africa, like in most jurisdictions, the audit profession is a for-profit and competitive enterprise as well as a service of public and investor protection (bergner 2011; harber 2016). profit motives may ‘incentivise’ auditors to succumb to client pressures, compromise their integrity and allow management misconduct and improper financial reporting to go unchallenged. in an extensive review of the research examining the causes and consequences of auditor switching, stefaniak, robertson and houston (2009) note that most studies look at the association of auditor tenure and various measures of audit quality. in general, they find that audit quality is higher when there is a longer auditor-client relationship, a finding that would seem to mitigate against a policy of mafr (defond & francis 2005; stefaniak et al. 2009). consistent with the findings of stefaniak et al. (2009), using archival data, geiger and raghunandan (2002) find longer auditor tenure is associated with less audit failure, again providing evidence against mafr. ghosh and moon (2005), johnson, khurana and kenneth reynolds (2002) and myers and oetzel (2003) also find that longer auditor tenure does not reduce financial reporting quality, indicating that mafr would not lead to improved reporting quality. consistent with these findings, an extensive review of literature performed by tepalagul and lin (2015), reviewing ‘published articles during the period 1976–2013 in nine leading journals related to auditing’ found that ‘most studies concluded that long auditor tenure does not impair independence’ (tepalagul & lin 2015:101). studies investigating audit firm rotation specifically provide more mixed results but again favour the conclusion that audit firm rotation does not improve auditor independence and professional scepticism. therefore, it appears that the literature does not provide evidence supporting mafr, considering that mafr is a regulatory tool designed to limit audit firm tenure. study purpose and research questions the purpose of this study is to explore whether auditor independence and professional scepticism are indeed considered to be compromised in south africa, as claimed by the irba (irba 2016, 2017c). thereby this study contributes to the debate concerning the necessity for, and efficacy of, mafr regulation. the research questions addressed in this study are as follows: rq1: do south african auditors of exchange-listed companies lack the required degree of independence and professional scepticism? rq2: are audit failures in south africa a result of compromised auditor independence and professional scepticism? rq3: in addition to existing measures, will mafr regulations further increase auditor independence and professional scepticism? rq4: does the investing public believe that auditor independence and professional scepticism are compromised concerning the audits of exchange-listed companies? interviews with 14 experienced auditors in south africa by harber (2016), conducted with managing directors and senior leadership within their respective firms, reveal strong sentiments by auditors that their independence and professional scepticism are not compromised, and that long audit firm tenures do not reduce independence. official letters from audit firms to the irba on the mafr debate again demonstrate strong ‘push-back’ against mafr, primarily because they do not believe auditors lack independence or professional scepticism.2 the cfo forum, a discussion group for jse exchange-listed company cfos, submitted a letter to the irba suggesting that cfos are unconvinced that auditor independence and professional scepticism are compromised (ramon 2016). this study seeks to extend the research of harber (2016) to more stakeholder groups, on a larger and more representative sample. the stakeholder groups deemed best suited to provide an informed perspective on auditor independence and scepticism concerns in the south african context are audit partners (audit practitioners), cfos, ac chairs and institutional investors. it is submitted that these stakeholder groups represent experienced role players and participants in the audit function in south african capital markets. the ac chair and the auditor represent the two engaging parties in the audit, both with statutory responsibilities to assess and maintain audit quality and independence. the ac conducts a due diligence of the appropriateness of the auditors and annually recommends them to shareholders for appointment at shareholder meetings. the ac also assesses the outcome of the audit, including issues uncovered during the audit and the auditor’s recommendations to management. the cfo is the most senior member of the financial function in a company, ultimately responsible for financial decision-making, and the production of the company’s financial statements to be distributed to shareholders and other stakeholders. as such, it is the cfo who is responsible for dealing with the auditors during the audit process and for the payment of the audit fees. the investors are here represented by equity fund managers – the senior staff of asset management companies who are responsible for managing large amounts of funds on behalf of clients by investing them in shares (equity) of companies and, thereby, representing a significant degree of shareholding in these companies. ewelt-knauer et al. (2013) conclude that there is a need in the literature to explore the perceptions of shareholders specifically concerning the mafr debate. a survey performed in 2012 by the organisation for economic co-operation and development (oecd), across its 35 member states, illustrates the role that large institutional investors can play in providing a source of stable, long-term capital. with the goal of optimising returns for targeted levels of risk, as well as for prudential regulation, institutional investors diversify investments into large portfolios, many of them having investments in thousands of companies (oecd 2011). institutional investors are significant long-term shareholders of companies and represent a major force in many capital markets, with a large degree of influence in corporate governance (callen & fang 2013; mccahery, sautner & starks 2016; pozen 2015). the largest portion of shareholding in south african companies is managed by institutional equity fund managers (harber 2017). methods this empirical study employs a questionnaire (survey) methodology, with electronic questionnaires distributed by email to participants within the four targeted stakeholder groups, namely audit partners (registered audit practitioners), cfos, ac chairs and equity fund managers. the same questionnaire with respect to independence and scepticism was distributed to each group. the questionnaire was sent to audit partners accredited to audit jse-listed companies as per the latest jse listing requirements (irba 2017d; jse 2017). this list was obtained directly from the jse and contained 305 registered auditors, after excluding the auditors who had retired since the compilation of the list. the 305 audit partners represented 20 accredited audit firms, with 192 auditors from the big four3 firms (63%). the questionnaire was distributed to the group-level cfos of the top 100 companies listed on the jse according to market capitalisation, excluding companies with a secondary listing on the jse exchange (i.e. companies that have a primary listing on a foreign exchange, usually the london stock exchange). each cfo was requested to send the questionnaire to their group-level ac chair. this list of companies and cfo contacts was obtained directly from the jse and, according to jse market statistics as at february 2018, the jse has a total equity market capitalisation of r14.8 trillion (main board and alt x). excluding secondary listings, the total market capitalisation of the remaining top 100 companies is approximately r8 trillion (jse 2018; sharenet 2018), representing approximately 92% of total market capitalisation. as such, this proportion of companies represents a wide spectrum of stakeholders’ interests in south african capital markets. according to a review of the latest company records and annual reports for each of the 100 companies, it was determined that 7 individuals act as ac chair on more than one company in the target group of 100. considering that these individuals would only complete the questionnaire once (as the tool is not company-specific), the total population is 93. the questionnaire was distributed to equity fund managers from the 10 largest equity asset and investment management companies in south africa, responsible for investing third-party monies in equity investments. these companies represent the 10 largest equity asset managers in south africa by way of funds under management, as determined by the records of the association for savings and investment south africa (asisa). all the companies are members of, and actively involved with, the asisa. based on a consultation with the ceo of asisa and the records of funds under management as at 30 june 2017, the top 10 companies account for over 85% of the total equity third-party funds under management by south african asset managers. the questionnaires were constructed based on existing academic literature and the professional south african debate, as presented in the literature review outlined in this study. a five-point likert scale design using t-tests, which is commonly employed in survey research (brunzell, liljeblom & vaihekoski 2015; daugherty et al. 2012; de winter & dodou 2010), captured respondents’ attitudes and opinions, together with opportunities for typed (open-ended) comments. validity and reliability tests were performed in pilot testing of the surveys with experienced representatives from each participant group. the tables in the analysis of findings below present each separate question or statement in the questionnaire, numbered 1–13. response rates achieved from the 305 audit partners, 112 complete and usable responses were received, resulting in a 36.7% response rate. of the 112 questionnaires received, 66 were from big four firm partners (59%) and 46 (41%) from non-big four partners. from the cfos and ac chairs, 53 and 41 complete and usable questionnaires were received, resulting in response rates of 53.0% and 44.1%. with regard to the equity fund managers, at least one response was received from each of the 10 companies. twenty-one complete and usable responses were received in total, resulting in an average of 2.1 responses per company. the questionnaire was only sent to one senior executive at each company, this being the company’s chief investment officer (cio) and representative on the asisa investment committee. a request was made by the researchers and the ceo of the asisa to forward the questionnaire to the ‘senior equity fund managers’ at the company. since there is no official definition of an ‘equity fund manager’, the distribution of the questionnaire was left to their discretion. baruch and holtom (2008), in an examination of organisational survey research response rates, found that the average response rate for studies using data collected from individuals was 52.7%, with a standard deviation of 20.4. the average response rate for studies that used data collected from organisations was 35.7%, with a standard deviation of 18.8. reviewing similar auditing and accounting research, daugherty et al. (2012) achieved a 46% response, bamber and iyer (2007) 23% and brazel, carpenter and jenkins (2010) 48.8%. hatfield, jackson and vandervelde (2011) justify even a 12.4% response rate for mailed surveys. based upon these figures, the response rates achieved in this study across all four participant groups were deemed comparable and acceptable. ethical consideration the university of johannesburg fefs research ethics committee approved the study’s ethical clearance with number fefsrec2017081401. results table 1 presents the findings on perceptions of the current status of south african auditors’ independence and professional scepticism, as related to jse-listed company audits (addressing rq1). the table also presents opinions on the adequacy of existing safeguard measures. it is clear from the findings that responding auditors, ac chairs and cfos strongly believe (statement 1; all means > 4; p < 0.001) that auditors possess the required high degree of independence and professional scepticism. similarly, these three responding groups express strong agreement that current regulations and professional standards in south africa are sufficient to regulate auditor independence and professional scepticism (statement 1; all means < 2; p < 0.001). these findings are statistically different from the neutral value of 3 at a 99.9% confidence level. table 1: perceptions concerning the current status of independence and scepticism. with regard to statement 1 and statement 2, equity fund managers expressed mixed feelings, with findings that do not differ significantly from neutral. however, the means (3.30 and 2.70) show a slight favour in agreement with the other participant groups. it could be concluded that equity fund managers are furthest removed from the audit appointment, engagement negotiation, audit process and independence assessment relative to the other three participant groups. as such, equity fund managers may be less biased in favour of protecting the status quo as they do not stand to gain or lose directly from any change of regulation and do not themselves directly assess the auditor or their work, as do the auditors and audit committees. in addition, it could also be argued that equity fund managers, since they are not directly involved, are the less informed participants in this study. separating big four from non-big four firms regarding the auditors, it is important to separate the views of the big four firm respondents from the non-big four firm respondents (addressing rq1). doing so reveals that both groups are in agreement concerning independence, professional scepticism and the adequacy of regulations. however, the big four firm partners expressed more conviction with respect to the standard of auditor independence (statement 1; mean = 4.52) as opposed to non-big four partners (mean = 3.83). this was again the case with respect to the regulatory and professional framework governing independence (statement 2; means = 1.42 and 1.89). the agreement between big four and non-big four firm partners is perhaps surprising considering that big four firms have been accused of bias against mafr on the grounds that they stand to lose clients to non-big four firms from the increased competition and tendering that will result to secure appointments. it appears that neither group believes auditor independence, nor the current regulatory framework safeguarding independence, is a concern. considering that mafr is primarily designed to improve audit quality by limiting audit firm tenure and, thereby, reducing the alleged familiarity and bias of the auditor towards company management (irba 2016, 2017a), the findings in table 1 provide evidence against its necessity. table 2 explores respondents’ sentiments concerning independence and scepticism ‘in mind’, as opposed to ‘in appearance’, as well as the mafr debate on the impact of audit firm tenure (addressing rq1 and rq3). table 2: perceptions concerning audit failure and audit firm tenure. statement 3 shows that all responding groups attribute audit failures to reasons other than a lack of auditor independence and professional scepticism. the comments make it clear that respondents believe audit failures are due to ‘negligence’ and ‘shoddy work’ rather than compromised independence. as one respondent articulated, a: ‘… lack of knowledge/skills and experience is a bigger risk for failure to detect misstatements because of fraud and error.’ (ra38, audit partner). according to the literature, audit quality can deteriorate due to either a lack of independence or a lack of capability or competence (tepalagul & lin 2015). if auditor failure is a result of poor quality audit work caused by deficient skills and capability or negligent behaviour, this is not likely to be rectified by audit firm rotation. statements 4–6 provide results that do not favour adoption of mafr. responding auditors, ac chairs and cfos reject the premise that longer audit firm tenures result in less independence and professional scepticism (p < 0.001). mafr is not believed to produce more diligent and attentive auditors (statement 5) nor will it increase the independence of auditors (statement 6). however, the fund managers again expressed mixed findings, with means close to neutral. interestingly, each mean result shows a tendency to the opposite opinion of the other three groups, even though not statistically different from neutral. in the comments, one cfo explained that audit work and financial statements were reviewed: ‘… by irba, [the audit firm’s] own rigorous internal review procedures and the jse.’ (ra5, audit partner) thereby ensuring a high degree of quality. in the words of another cfo: ‘… audit working papers are already subject to irba, jse and internal firm reviews − surely that’s adequate?’ (cfo27, chief financial officer). a different cfo stated that: ‘… auditors do not need mafr to worry about the quality of their work. the jse, irba, other regulators and public are enough pressure.’ (cfo44, chief financial officer). in addition, a common theme that emerged was the feeling that: ‘… auditors will not have their independence impaired for a client as they risk their livelihoods.’ (ra7, audit partner). the risk of lost reputation and litigation against the auditor was a deterrent to compromising audit quality. further comments from the cfos include: ‘in the two decades i have been dealing with our current firm i have never had the impression that they ever lacked independence. it depends on individual people and some will always remain independent while others may lose their independence on day 1. i have developed very strong professional relationships with our auditors, but they will always remain independent.’ (cfo10, chief financial officer) ‘in my 23 years of experience in financial reporting, i have never had any reason to even come close to questioning the independence of any of the audit firms that i have dealt with.’ (cfo6, chief financial officer) furthermore, contrary to the irba reasoning that longer tenure impairs independence, respondents argued that independence may actually be a concern early in the tenure, not after years of appointment, because: ‘the new auditors will try hard to build and establish good relationships at the new audit client which will also have an unintended consequence of staying clear of certain contentious accounting, auditing, taxation, etc. points.’ (ra91, audit partner) this view is the result of opposite reasoning to that of the irba’s which is in favour of mafr. as expressed by one auditor, the: ‘… [newly appointed] auditors will be on the back foot and will have to concede on a lot of important judgemental points because challenging well-established professional management of these complex clients will make them look less astute that the previous auditor.’ (ra56, audit partner) this lack of experience in comparison to the outgoing audit firm may impair the independence of the auditor, resulting in acquiescence to the judgement of management with respect to complex company-specific or industry-specific accounting matters. given the size and complexity of large, exchange-listed multinational companies, mafr may have the unintended consequence of incentivising new auditors to: ‘… stay clear of certain contentious accounting, auditing, taxation, etc. points.’ (ra91, audit partner). this reasoning by some respondents is contrary to the pro-mafr position and is consistent with the opinions expressed by senior managing partners in the interview-based study conducted by harber (2016). the argument of independent regulatory board for auditors inspection findings and corporate failures the irba argues that inspections of auditors and audit work reveal increasing instances of non-compliance with ethical and independence regulations which provides evidence that independence is compromised (irba 2016). the findings highlight non-compliance with ethical and independence requirements, the root cause of which is described by the irba as the: ‘… failure to fortify the importance of professional scepticism and the independence of the engagement team so as to overcome the threats that could develop as a result of their relationship with clients.’ (irba 2015:13) as another key argument for the necessity of mafr, the irba highlights the continuing occurrence of corporate failures that result from management fraud and misconduct, claiming that these incidents provide further evidence of impaired auditor independence. respondents’ views regarding these two arguments were collected in statement 7 and statement 8, as shown in table 3 (addressing rq1 and rq2). table 3: perceptions concerning the independent regulatory board for auditors’ inspection findings and corporate failures. it appears that while responding fund managers believe that these irba inspection findings add credibility to the irba reasoning, the other three participants do not. it is submitted that the auditors are most affected by, as well as most informed regarding, the public inspections process as it is their engagement audit files and their firms’ policies and procedures that the irba is ‘auditing’. the responding partners would have all had experience of the inspectorate’s reviews of their audit firms, as well as individual audit engagements in which they acted as the engagement partner. from a review of responding auditor comments regarding these inspection findings, partners expressed that these findings most likely reflect instances of poor documentation of ethical consideration and should not be confused with actual compromised independence. the auditors explained that ‘signing ethics confirmations are considered to be independence findings’ for the irba and this view is unreasonable because independence is a state of mind and action. as such the irba conclusion that ethics are compromised ‘is misleading’. this interpretation presents an important distinction the auditor respondents make concerning the irba findings – it is not a representation of impaired independence: ‘we have not seen evidence that the irba findings are independence-related.’ (ra91, audit partner) ‘the issues raised in the irba findings relate more to the formal documentation of thought processes applied by the independent auditor than [to] a state of mind issue regarding the need to remain independent.’ (ra90, audit partner) even the cfos’ comments raised these concerns: ‘i would question whether the “unsatisfactory inspection results” and auditor independence is fully correlated and potentially question whether there are not several other, less severe reasons behind the perceived deterioration.’ (cfo26, chief financial officer) ‘to my knowledge, irba has not published any report on audit failures where there was a failure in auditor independence.’ (cfo10, chief financial officer) respondents appear to believe that the inspection results show evidence of poor documentation of ethical and independence considerations and procedures; however, this outcome is not indicative of poor independence in ‘fact and mind’. respondents also raised serious concerns regarding the quality and intention of the irba practice reviews, indicating that they believed the system and processes of the irba regarding these reviews were flawed and needed improvement: ‘the regression in inspection results is due to the poor quality of reviews by the regulator and their unpractical approach to reviews.’ (ra67, audit partner) ‘inspectorate currently lacks knowledge, level of inspections are very shallow, with not enough balance being given to risk and judgement. to a large extent this is as a result of the calibre of individuals performing the inspections. tends to be a tick box exercise.’ (ra12, audit partner) although the findings for statement 8 suggest mixed feelings from responding fund managers, the general consensus among the other participant groups is that the occurrence of high-profile corporate failures and the alleged questioning of auditor independence by investors does not provide evidence in support of the mafr ruling. as will be discussed below, it does not appear that the respondents believe that the investing public are questioning auditor independence. in addition, the results from statement 1 and statement 2 (table 1) show that the respondents do not themselves believe auditor independence is compromised. respondents stated that there were multiple reasons for corporate failures and that most of them related to factors other than audit failures and independence concerns. a common theme in the comments is that they were: ‘… not aware of any case where corporate failures have been attributed to lack of auditor independence …’ (ra48, audit partner) and: ‘… not one corporate failure in south africa has been linked to independence issues.’ (ra12, audit partner). ‘i am not aware of any corporate failures in south africa which can be directly attributed to the role and independence of auditors. there is a tendency to attack the last man standing when a corporate failure occurs i.e. the auditors. there are many reasons for corporate failures.’ (acc10, audit committee chair) some respondents argued that even the current, highly topical and controversial alleged audit firm failures in south africa were yet be proven as resulting from a dearth of auditory independence as opposed to ‘shoddy work’ such as a lack of competency, as discussed above: ‘there is no direct correlation between corporate failures and the issue of auditor independence. most corporate failures are as a direct result of lack of honesty and integrity by management. you cannot legislate against dishonesty!’ (ra109, audit partner) the findings from statement 7 and statement 8 again provide evidence against the irba position and the mafr ruling. independence in appearance finally, the aspect of ‘independence in appearance’ is considered (addressing rq4). whereas ‘independence in mind’ impacts audit quality, it is in fact auditor ‘independence in appearance’ that impacts investor trust in the audit function and, consequently, the integrity of financial reporting. the irba believes that the mafr ruling will result in a much-needed increase in investor confidence with regard to auditor independence and audit quality (irba 2016). however, the findings from table 4, statement 9, indicate that responding auditors, ac chairs and cfos do not believe that the investing public has lost trust in auditors and do not generally call into question the quality of the audit opinion and function of the auditor as a whistle-blower (means > 3; p < 0.01). the responding fund managers again expressed a neutral view. table 4: perceptions concerning independence and scepticism ‘in appearance’. the comments provided by respondents suggest that it is not investors who have lost trust in the quality of the audit opinion, but rather sections of the general public. some respondents’ comments stated that the general public sometimes expresses views that auditors lack integrity or independence, but this was not true of the more informed investing public. the general public was believed to have ‘a perception driven by financial journalism’ which, in the view of some respondents, distorted the real state of affairs in the profession and misinterpreted the role and function of the auditor. this view is consistent with the expectation gap theory (hay 2015; monroe & woodliff 1994; porter et al. 2012). all participant groups have considerable experience in attending company shareholder meetings, especially the annual general meetings (agms). findings from statement 11 and statement 12 show that investors are not in the habit of querying the board at agms concerning auditor independence nor do they commonly vote against the reappointment of the auditor on grounds of long tenure (all means > 3.60; p < 0.001). the findings from statement 10 also suggest that when investors are concerned about compromised independence and professional scepticism, it is not on the grounds of familiarity threats and bias produced by long audit firm tenures. as one auditor explained with regard to investors considering only audit firm tenures: ‘in the absence of the full picture, as auditors would explain to the audit committee annually how they manage their independence, to leave it to the public/investment community to decide on independence using one factor is downright silly and misleading.’ (ra107, audit partner) this comment highlights the argument by opponents of mafr that audit committees are best informed, skilled and experienced, as those charged with governance, to properly assess − on the shareholders’ behalf − the independence of auditors. this claim is perhaps understood by most investors and is a reason why the findings of this survey suggest that investors do not question the audit committee’s choice of auditor. after all, it is this audit committee, which comprises only non-executive directors in south africa (for exchange-listed companies), that the shareholders have appointed. comments were made by respondents to the effect that the irba is confusing the perceptions of informed investors with those of the relatively uninformed general public with respect to auditor independence and long firm tenures, thereby concluding that the public has lost trust in the external audit function. lastly, findings from statement 13 show that responding auditors, ac chairs and cfos do not agree with the irba that mafr will be effective in changing investor perceptions. the fund managers expressed statistically neutral sentiments, suggesting that, unlike the other stakeholder groups, they are less confident that mafr will not be effective in this regard. the results for responding fund managers in statements 9, 10 and 13, although all statistically neutral, suggest that the fund managers were not as assured as the other responding groups in their disagreement with the irba. overall, however, once again these findings do not provide support for the irba position on mafr in south africa. summative results the findings shed further light on the perceptions of stakeholders within the south african mafr debate and the perceived ‘crisis in the audit profession’ (hannington 2015; hay 2015) which some believe is caused by compromised auditor independence. the findings (addressing rq1, rq2, rq3 and rq4) present considerable evidence against the irba position on the state of auditor independence and professional scepticism in south africa and the necessity for, or potential efficacy of, mafr regulation. responding auditors, ac chairs and cfos have extensive experience with respect to the management, governance (including auditor appointment) and financial reporting of large public-interest companies in south africa, and it can be concluded that they do not believe that: auditor independence and professional scepticism are impaired (statement 1). current regulations and standards over auditor independence and professional scepticism need improvement (statement 2). audit failures are a result of a lack of auditor independence and professional scepticism (statement 3). longer audit firm tenures impair independence and professional scepticism (statement 4). mafr will increase the independence of auditors (statement 6). the irba inspection results or the occurrence of corporate failures strengthen the irba position on mafr (statement 7 and statement 8). investors are concerned or exhibit distrust of the independence of auditors and their ability to apply professional scepticism (statement 9). the equity fund managers, however, provide a better representation of investors in south african companies and hence their views are particularly important. the findings have shown mostly neutral views and more research is needed to understand with clarity their position on these matters. the only statistically significant results from responding fund managers were those in response to statements 3, 11 and 12. these responses provide evidence against the irba position, especially the findings from statement 3 which show that fund managers’ experience of audit failures is not considered to be due to compromised auditor independence and professional scepticism. as with other participant groups, audit failures are considered instead to be a result of negligence or a lack of skill and competence on the part of individual auditors. these results provide evidence in support of the findings of stefaniak et al. (2009) and tepalagul and lin (2015), which maintain that auditor tenure does not compromise auditor independence. concerning the audit expectation-performance gap, as a result of which auditors often fall short of society’s expectations, and are quickly blamed for corporate failures (porter et al. 2012), as has been the case in recent years in the media (hill 2018; peyper 2017; the economist 2018a, 2018b), the results of this study suggest that investors do not believe auditor independence is to blame. conclusion the results of this study provide evidence against the benefits of introducing mafr and reinforce views expressed by auditors (harber 2016) and other responding parties (harber & west 2017) to the irba during the consultation process. in addition, this research contributes to the perception-based research on mafr and the strong ‘push-back’ from many stakeholders internationally against mafr (choudhury 2016; ewelt-knauer et al. 2013; fontaine, khemakhem & herda 2016). overall, the study’s findings indicate that experienced audit industry participants do not believe mafr is necessary, nor will it be effective, contrary to the view of the irba. as such, this study has implications for future research, as well as for regulators, both within and outside of south africa. the opinions of these experienced key stakeholder groups should be considered by the irba as they support the united states’ position of rejecting mafr in favour of audit partner rotation, as is currently the practice in south africa (until april 2023). the irba should seek further evidence and reasoning as to why mafr is necessary and consider the options of amending or retracting the legislation accordingly. if auditor independence is indeed not impaired, or if limiting audit firm tenures will not improve independence, then it stands to reason that mafr is not necessary. this research has certain limitations. care should be taken when drawing inferences from its results, because this study reports only the perceptions of stakeholders, albeit those experienced with auditor appointment. further, it is acknowledged that ac chairs, cfos and especially auditors may have a preconceived dislike for mafr and, therefore, the data could suffer from demand effects due to bias. in addition, there may be bias from respondents since mafr becomes only effective in april 2023 and hence the regulations could be influenced, amended or appealed before this date. these facts may incentivise respondents to overstate the costs of mafr while understating its benefits. the researchers attempted to counter this problem by starting the questionnaire with a clear explanation that the intention of mafr is to protect audit quality and auditor independence. finally, considering the professional roles, seniority and experience of the individuals targeted in this study, it is submitted that the risk to the quality of the data from these biases is limited. acknowledgements competing interests the authors have declared that no competing interest exists. authors’ contributions both authors contributed equally to the research, the writing of the article, as well as the review process to finalise the article for submission. funding information this research received no specific grant from any funding agency in the public, commercial or not-for-profit sectors. data availability statement the data generated by this study are available on reasonable request from the corresponding author. disclaimer the views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of any affiliated agency of the authors. references aschauer, e., fink, m., moro, a., van bakel-auer, k. & warming-rasmussen, b., 2017, ‘trust and professional skepticism [sic.] in the relationship between auditors and clients: overcoming the dichotomy myth’, behavioral research in accounting 29(1), 19–42. https://doi.org/10.2308/bria-51654 ball, f., 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accounting literature 28, 47–121. tepalagul, n. & lin, l., 2015, ‘auditor independence and audit quality: a literature review’, journal of accounting, auditing & finance 30(1), 101–121. https://doi.org/10.1177/0148558x14544505 the economist, 2018a, ‘reforming the big four – shape up, not break up’, the economist, 24 may, viewed 24 june 2018, from https://www.economist.com/leaders/2018/05/24/reforming-the-big-four. the economist, 2018b, ‘the great expectations gap. what is an audit for?’, the economist, 26 may, viewed 24 june 2018, from https://www.economist.com/finance-and-economics/2018/05/26/what-is-an-audit-for. footnotes 1. this is a useful definition that has been adopted in numerous recent studies such as those of ball, tyler and wells (2015), fontaine et al. (2016), hakwoon, hyoik and jong eun (2015), jackson et al. (2008), kwon, lim and simnett (2014), lennox, wu and zhang (2014), lu and sivaramakrishnan (2009) and tepalagul and lin (2015). the definition is important because it identifies the purpose of auditing. 2. refer to bam (2017), bourne (2017), harber and west (2017), oddy (2017) and shango (2017). 3. the ‘big four’ refers to deloitte, ey, kpmg and pwc, the four largest international audit firm networks. sajems ns vol 5 (2002) no 2 395 economic valuation of increased malaria due to climate change: a south african case study randau spalding-fecber! energy and development research centre. university of cape town sbomentbree moodley minerals and energy policy centre, johannesburg abstract malaria is one of the world's most serious and complex health problems. it is also one of the diseases identified as most likely to be affected by climate change, because transmission is sensitive to temperature and rainfall. the objective of this paper is to provide an initial economic valuation of the increased incidence of malaria due to projected changes in climate in south africa, excluding costs and benefits of prevention and adaptation. we use market based economic valuation tools for morbidity, including cost of treatment and lost short term productivity, and report lost disability adjusted life years from malaria mortality due to climate change. we also discuss how human capital and willingness to pay approaches could be used for mortality valuation. the results show that the opportunity cost of increased morbidity from malaria would be between r277 million and r466 million in 2010, while the lost disability adjusted life years from increased mortality would be from 11 800 to 18 300 years in that year. jelqoo 1 introduction malaria is one of the world's most serious and complex health problems. more than 40 per cent of the world's population is at risk of malaria, with over 270 million cases per year and more than 1 million deaths (murray & lopez, 1997; who, 1998). the impacts of malaria, however, go well beyond the immediate effects of the illness to affect economic growth and development. controlling for factors such as geography, colonial history and isolation, countries with severe malaria had income levels in 1995 two thirds less than countries without malaria (gallup & sachs, 1998). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 396 sajems ns vol 5 (2002) no 2 malaria is also one of the diseases identified as most likely to be impacted by climate change, because transmission is sensitive to temperature and rainfall (kovats, menne, mcmichael, corvalan & bertollini, 2000). the burden on africa, where the vast majority of deaths occur, is likely to be greatest. while some analysis is available in south africa on the increased risk of malaria from climate change, and the current illness costs of malaria, these two disciplines have not been brought together. the objective of this paper is to bridge the gap between the climate and malaria risk modelling in the south africa climate change country study vulnerability and adaptation assessment and the economic valuation of malaria in south africa. our purpose, therefore, is not to apply new valuation techniques through primary data collection, but to apply the valuation literature to this climate change risk. we present a first order estimate of the cost of malaria from climate change, before adaptation has occurred. we use a three step methodology to estimate the economic impacts of increased malaria due to climate change: estimate the number of excess cases of malaria due to climate change, based on: increased population at risk of contracting malaria because of climate change; and the share of population at risk that is likely to contract malaria (i.e. incidence ratios). estimate the economic cost of malaria morbidity due to climate change, based on: the direct cost of treating the additional cases; and short term productivity losses from patients or their caregivers being unable to work. estimate the economic cost of malaria mortality due to climate change, based on: . lost work years due to premature death from malaria; and willingness to pay for reduced risk of death, adapted from the international literature. it is important to emphasise at the outset, however, that the uncertainties in each step of this process are quite significant. even understanding the future population at risk depends on complex models of how climatic conditions impact malaria parasite and mosquito survival, how to translate very coarse global climate model results into higher resolution predictions for rural south africa, and how population distribution will change as a result of increasing urbanisation. each of these modelling processes adds another level of complexity and uncertainty. we have tried, therefore, where possible to express our assumptions and results in terms of ranges and to discuss where r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 397 uncertainties are greatest. the second major challenge of this work is how to realistically describe an impact "before adaptation has occurred" because, in reality, adaptation to malaria risks has already occurred in south africa. given that control programmes are already in place in south africa, and have reduced the population at risk from much higher historical levels, these controls would still be expected to be present in the future. when we say 'before adaptation has occurred', then, we really mean before additional measures have been put in place, such as dramatically expanding existing programmes. the next two sections introduce the relationship between malaria and climate change and the background of malaria in south africa. section 4 presents our analysis of increased malaria morbidity and mortality. sections 5 and 6 present our estimates of the economic impacts of morbidity and mortality, respectively, followed by a short summary and conclusion. this paper also forms part of a larger study on economic valuation of climate change impacts on south africa (turpie, winkler, spalding-fecher & midgley, 2001). 2 malaria and climate change links malaria risk is governed by a large number of environmental factors, many of which are seasonal, that affect the intensity of transmission and duration of the high risk season. of all factors, climate is considered the most important limiting factor (craig & sharp, 2000). temperature, rainfall and humidity all playa role in determining survival of the vector the anopheles mosquito and the parasite itself. of course, the actual risk of malaria will be affected by adaptation measures, including eradication programmes and public health interventions. some of these are already in place to combat existing malaria risk. the purpose of this analysis, however, is to make a first order estimate of the increased cost of malaria from climate change, before additional adaptation has occurred. recent modelling of the impact of climate change on malaria distribution suggests that an additional 260 to 320 million people could be at risk by 2080 because of climate change (martens, kovats & nijhof, 1999). the areas where this change will be most dramatic are those where malaria transmission is currently marginal because of low temperature or insufficient rainfall, among other factors. this means that, while tropical african countries, where malaria risk is already very high, will not see increased risk due to climate change, highland areas in eastern and southern africa, or areas with currently r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 398 sajems ns vol 5 (2002) no 2 insufficient rainfall, could see significant increases in populations at risk (kovats et al., 2000). 3 malaria in soum africa malaria was intensely endemic to large areas of south africa before the 194os, including in major urban areas such as pretoria and durban, with more than 22 000 people dying in an epidemic in kwazulu-natal in 1932 (sharp, craig, curtis, mnzava, maharaj & kleinschmidt, 2000). systematic control measures in the following decades, including indoor insecticide spraying and active treatment of the disease, reduced the areas of risks for the disease to the northeastern borders of the country (craig & sharp, 2000). current high risk areas include 24 rural districts in the easternmost parts of northern province, mpumalanga and kwazulu natal (sharp et al., 2000). through the early 1970s, cases had dropped to less than 500 per year with almost no fatalities. this trend, however, has reversed since the 1970s, with exponential growth in incidence of malaria for the last fifteen years. the number of cases jumped from 4 693 in 1991, to 27 035 in 1996, to 61 253 in 2000 (doh, 2000). malaria experts point out that this increase is not due to changes in climate (e.g. excessively warm and wet years), however, but to increasing drug resistance, an influx of migrants from neighbouring countries where malaria is not controlled, and reduced spraying with insecticides such as ddt (craig & sharp, 2000; sharp et al., 2000). 4 impact of climate change on malaria incidence in south africa the first step in assessing the economic costs of increased malaria due to climate change is to estimate how many more people will get malaria, and how many more will die from it. this is based on both the increased population that it as risk due to future climatic changes in south africa, as well as the likelihood that people in high risk areas will contract malaria or die from it. 4.1 increased population at risk the south african country study for climate change (sacscc) vulnerability and adaptation (v&a) assessment included a chapter on malaria (craig & sharp, 2000). in this analysis, researchers from the medical research council applied a model that linked temperature (both average and minimum winter) and rainfall to climatic suitability for malaria transmission (craig, snow & r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 399 lesueur, 1999), this model was checked against historical data for a number of african countries to verify that it gave a reasonable estimate of the area in which malaria is endemic (i.e, stable transmission every year). the science of climate change involves the use of sophisticated models of the global atmosphere, oceans and landmasses that link changes in atmospheric concentrations of greenhouse gases. the models at a global scale are called 'global circulation models', and give fairly coarse resolution predictions in other words, they can only identify the change in rainfall, temperature, etc. for a fairly large unit area. to get consistent results, the various studies within the v&a assessment (e.g. health, agriculture, forestry) all used the same future climate scenarios the hadley centre global circulation models (see met office, 2000), in addition, the hadley models used present two scenarios of future climate one that includes the effect of sulphates on climate change and one that does not. contrary to greenhouse gases such as carbon dioxide and methane, sulphates actually exert a local or regional cooling effect on the atmosphere. however, sulphates only stay in the atmosphere for a short time, so in the context of tighter sulphur emissions standards in south africa (rsa, 2001), they are unlikely to be an important influence over the climate in coming decades. for this reason, we use the results from the v &a study that exclude the impact ofsulphates (midgley, 2001), as we mentioned before, one difficulty with these global circulation models is that their resolution is quite coarse. predictions of current average temperature in south africa from the hadley models, when compared to more detailed local climate models (hutchinson, nix, mcmahan & ord, 1995; schultze, 1997), for example, vary by 2 to 4 degrees celsius in many areas (craig & sharp, 2000). as craig and sharp (2000) note in the v &a study on health impacts, "the difference between the present [hadley] models and actual climate are therefore much greater than the difference between the present and future [hadley] scenarios," an additional challenge is that the population growth projections for 1996 to 2010 in the v &a assessment are based on 1990 to 1995 actual growth rates, most of the current research on demographics in south africa, however, suggests that deaths due to hiv/aids will significantly slow population growth rates in the coming decades (ssa, 2000). for example, national population grew at 2.2 per cent per year from 1991 to 1999 (ssa, 1998, 2000), but for 2000 to 2010, hiv/aids deaths could reduce projected population growth from 2.3 per cent to 1.5 per cent (absa group economic research, 200 i). the united nations projects population growth rates of under i per cent in 2000~2005, falling to 0.2 per cent in 2010-2015 (un population division, 2000). on the other hand, as the share of the population that is immuno-compromised due to hiv i aids increases, so will the susceptibility to r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 400 sajems ns vol 5 (2002) no 2 contracting illnesses such as malaria. the predicted populations at risk from the craig and sharp (2000) study should therefore be seen as an upper bound. the projected populations at risk based on the local climate models and the hadley model with and without climate change are presented below in table 1 below. table 1 1995 1996 2000 2005 2010 estimated populations at risk based on different climate models and climate scenarios present climate i hadley model no sulphates hutchinson schultze present future increase chmate chmate 9,101,875 7,854,638 5,049,654 8,603,783 7,819266 4.912.228 10,662,127 9,241 847 5,977,839 10622,127 10,966,172 7,174,761 30637,710 23,462949 15133,780 13,211,391 8,703,941 36,300,636 27,596,695 source: (craig & shaip, 2000) note: the first two columns 'present climate' are from detailed models of the current sa climate (hutchinson et al., 1995; schultze, 1997), with growth in population at risk only due to growth in population. 'hadley model no sulphates' are projections based on the climate outputs (e.g. temperature and rainfall) from the hadley climate models in each year. the 'future climate' column is based on hadley model projections of climate outputs in the future given continue climate change. all of the climate models, including those based on local data such as hutchinson and schultze, overestimate the current population at risk, because of the adaptation measures already in place, as mentioned earlier. a more detailed assessment suggests that only about 3 million people live in districts where the malaria cases are greater than 1 per 1000 people per year (sharp et al., 2000). to try to reflect what prevention measures are already in place, we use the percentage change in population at risk in the climate models, rather than the absolute numbers. the hadley models predict that climate change will increase the population at risk of malaria by 417 per cent in 2010 primarily because the malaria risk area in the future includes the heavily populated witswatersrand area. note that, compared to the hutchinson and schultze data, the hadley model underestimates the present population at risk although the hadley model estimates are closer to more detailed studies mentioned above (sharp et al., r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 401 2000; tren, 2001). we have conservatively assumed almost no net population growth overall between 2000 and 2010 (un population division, 2000), and applied the 417 per cent increase to the 3 million based on the detailed analysis of population at risk in 1999, for a total population at risk in 2010 of 12.6 million. in other words, climate change by 2010 would put an additional 9.6 million people at risk of contracting malaria. 4.2 increased morbidity and mortality 4.2.1 methodology a wide variety of socio-economic, environmental and health factors influence the share of the population at risk that will actually contract malaria. as many studies of climate change and disease point out, the spread of vector borne diseases could spur new efforts to control or eradicate these diseases. in this study, however, we have explicitly not considered adaptation beyond what is already happening although this is clearly an important area for future work. for this reason, our best reference point for malaria incidence ratios is to look at current cases of malaria relative to populations at risk. as described in the previous section, however, establishing the size of population at risk is not a simple matter. based on the detailed estimates by sharp et al. (2000), 3 million people were in high risk areas in 1999. given 51 535 cases of malaria in 1999 (doh, 2001), this means an incidence ratio of 17.1 per 1000 persons at risk. note that this is not a general incidence ratio for south africa, but only for those relatively small areas with high risk. for comparison, the incidence ratio in high risk areas (defmed as areas where climatic suitability is > 0.5) in southern africa is 11 cases per 1000 (snow, craig, deichmann & marsh, 1999). under the climate scenarios explained earlier, the future change in climate would, in theory, make some major metropolitan areas in south africa climatically suitable for stable malaria transmission. in practice, however, the incidence ratios in these areas even without significant new prevention programmes will be much lower than in poorer rural areas. to be conservative, we have used a range of incidence ratios, which are 25 per cent to 50 per cent lower than the current incidence in rural areas. for mortality estimates, we used the average share of malaria cases resulting in death in the last three years in south africa, or 0.7 per cent of cases (doh, 2000). the southern african average is 1 per cent (snow et al., 1999). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 402 sajems ns vol 5 (2002) no 2 4.2.2 results the projected incidence ratio for 2010 is between 8.6 and 12.8 cases per 1000. applied to a population at risk of 12.6 million, this means 107000 to 161 000 cases. only the cases due to the increased area of climatic suitability, however, can be attributed to climate change. applying these ratios to the 9.6 million who are at risk due to climate change, therefore, we have 82 000 to 126000 additional cases of malaria due to climate change. out of these additional cases, we would expect 600 to 900 deaths per year, given current mortality rates. 5 valuation of increased morbidity to place an economic value on increased morbidity, we have used two tools: the cost of treatment and the opportunity cost of lost work days. the treatment cost is the full costs of treating a particular illness with one or more treatment regimens. treatment cost if often used as an input to cost effectiveness analysis, where the input costs of two alternative treatment regimens are compared with their health outcomes in other words, how much it costs to avoid illness, death, or further medical treatment (zweifel & breyer, 1997). the opportunity cost of being ill can be measured in terms of lost income from being unable to work. treatment cost is often called the 'direct' cost of an illness, while lost productivity or opportunity cost is referred to as the 'indirect' cost. what these two methods do not address, however, is the actual physical and emotional pain and suffering that accompanies illness, or the impacts this has on quality oflife and society more broadly. these measures, therefore, can only serve as a lower bound for the economic value of morbidity. 5.1 treatment costs 5.1.1 methodology weare interested in the direct and indirect costs of medical treatment for patients contracting malaria. we must assume that the costs of treating the additional future patients due to climate change will be similar to the cost of treating patients today in real terms. the most detailed recent study on the costs of treating malaria in clinics and hospitals in south africa is work by justin wilkins at univ~sity of cape town (wilkins, 1999). this study looked at the costs of medic3ipersonnel, drugs, and all hospital costs associated with alternative therapies for first line malaria treatment. building on this work, richard tren of the uk lnstitute of economic affairs analysed the costs of malaria treatment in south africa, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 403 including the costs of the malaria control programme (tren, 2001). the malaria control programme sends health care workers into the field to identify, test and treat malaria cases in rural areas, as well as provide preventive measures such as insecticide spraying. at least part of the costs of this programme should also be included in treatment costs for malaria, since much of the treatment occurs in the field. it was not possible to identify the share of personnel expenditure (the largest item in the programme budget) that was devoted to treatment. expenditure for insecticides was subtracted, however, since this is clearly a preventive measure. 5.1.2 results table 2 shows the cost per patient of treatment in hospital and in the field. the malaria control programme is an order of magnitude greater that hospital costsbut this is to be expected because 42 per cent of cases are diagnosed and treated in the field, while another 32 per cent are treated as outpatients at clinics and hospitals (tren, 2001). a more detailed allocation of the malaria control programme costs to treatment versus prevention would improve this estimate. table 2 treatment costs per malaria patient (rands) 1996 1997 1998 cost of treating and hospitalising 300 276 260 ipatients malaria control programme 2301 2925 3016 less preventive expenditures 190 242 249 total (current year r) 2410 2959 3026 total (2000 r) 3097 3502 3352 source: (tren, 2001), own analysis the average cost per patient ranges from r3 097 to r3 502. table 3 shows the results for the direct costs of treatment, ranging for r253 to r429 million. note that this is only the costs of the treating the excess cases due to climate change. table 3 treatment costs of excess malaria cases due to climate change, 2010 low hie:h cost per patient (r2000) 3097 3502 number of cases 81 700 122500 total cost (r2000 million) 253 429 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 404 sajems ns vol 5 (2002) no 2 5.2 lost short term productivity 5.2.1 methodology lost productivity due to illness depends both on wages and days out of work. for wages, tren (200 i) analysed the average wage of employed persons in districts in the three provinces with endemic malaria. weighted average wages for those employed were rl93 per day in 1997, which is equivalent to r224 per day in 2000 (sarb, 2001). only 47 per cent of the population of these districts, however, had formal employment, while a further 12 per cent were employed in the informal sector. as tren correctly points out, even people who are not formally employed in rural areas would contribute to subsistence agriculture, so it is reasonable to use an agricultural wage (r36 per day adjusted to 2000 wages) for the unemployed and informally employed as a proxy for their lost productivity. for the 11 per cent of malaria cases that occur in children under 5, a caregiver will need to take time away from work during the illness. even for those in the 5 to 15 age group (30 per cent of reported cases), it is likely that either a caregiver will have to take time away or that some of these youth would have been involved in supporting subsistence activities. for these reasons, we assume that all malaria cases will result in lost productivity. days of lost work depends on the severity of the case and treatment regimen, which are also affected by the age of the patient. children under 5, for example, are always hospitalised for 4 days treatment, so all of these cases will result in at least 4 lost productive days. for children ages 6 to 15, we assume that a caregiver will need to take part of the time off work for an average of 2 days. for cases ages 16 and up, the days lost depends on severity. cases identified actively (i.e. through field workers in the malaria control programme) will by defmition not be as severe, with only one day lost. for those that come to a clinic or hospital, 55 per cent are assumed to be treated as outpatients with oral medication and 40 per cent will be hospitalised and given oral medication both of these groups lose 4 days productive time. for the 5 per cent ofhospitai cases that require intravenous quinine, 7 days of productive time will be lost (tren, 2001). for each of these groups, we apply the share of employed, unemployed, and informally employed to match wages to days of lost productivity . 5.2.2 results table 4 below shows the lost productivity per case, depending on how the case is treated and the employment status or wage of the patient. using this table r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 405 and the share of cases falling into the different categories within the matrix, we calculate a weighted average productivity loss of r299 per case. this implies a total lost productivity of r24 to 37 million from malaria cases due to climate change. table 4 lost productivity per case, based on case type and employment status (r2000) types of malaria case employed i uneminformally i ployed employed age <5 years* ~ 142 age 5-15 years* 71 71 age> 15 years identified by fieldworkers; oral 224 36 36 treatment given in the field oral treatment as outpatients or in 897 142 142 hospital intra-venous treatment in hospital 1570 i 249 249 *thls value captures the lost productivity of the person canng for the sick child 6 valuation of increased mortality valuation of the loss of life is one of the most difficult areas of environmental and health economics. whether it is appropriate to equate a life, or the prolonging of life, with money, is an important ethical and moral question. the critical issue, however, is that every public decision on spending related to health (or any private expenditure) does implicitly place a value on statistical lives or, more precisely, on the statistical risk of reduced length of life. this is particularly true with decisions on public expenditure to reduce health risks: policy makers need some kind of metric to help weigh decisions about what type of investments to make and how their benefits may outweigh their costs. there are two broad approaches to dealing with valuation of reduced life expectancy_ the frrst is based on assessing individuals' willingness to pay to avoid risks, or willingness to accept compensation for taking on risks. this is based on basic principles in economics that individual preferences are the most important source of value, and that welfare, as perceived by the individual, is the appropriate metric (zweifel & breyer, 1997). if we know what all individuals in society are willing to pay to avoid a certain risk, we then know exactly how much society should spend on avoidance investments. the difficulty, however, is how to elicit these preferences accurately_ the most r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 406 sajems ns vols (2002) no 2 direct approach is the contingent valuation method (cvm), where survey respondents are asked hypothetical questions about their willingness to pay for reduced risks (or accept compensation for those risks) (klose, 1999). the practical challenges in designing these studies, and the cost of executing them, has meant that relatively few studies have been conducted in developing countries. the only way to utilise this approach in many developing countries, therefore, is to use values from industrialised countries and somehow adjust them for local conditions (discussed in more detail below). this limits our ability to choose between alternative approaches, such as willingness-to-pay versus willingness-to-accept. the second method is called the 'human capital approach', and equates the value of the lost statistical life with the net present value of lost future contribution to gross national product (zweifel & breyer 1997). in other words, when society loses this person, they lose the value added (e.g. wages less personal consumption) that the person would have contributed to the economy for the remainder of their natural life. there are obvious problems with this approach, most importantly that, from an ethical standpoint, there is no reason that an individual's value (to themselves or to others) should be related to their economic output (zweifel & breyer, 1997; fankhauser, tol & pearce, 1998). the possibility that the life of a pensioner or someone who is disabled could be zero (or negative) goes against other social values although if we use average gdp per capita for the whole population, we can avoid this problem within a given country. worse yet, gnp is not necessarily an appropriate measure of social welfare in any case (daly & cobb, 1989). at best, the human capital approach should only provide an absolute minimum estimate of economic costs (dixon, scura, carpenter & sherman. 1994). despite these serious theoretical drawbacks, the practical reality facing researchers and policy makers in developing countries is that willingness to pay studies simply are not available. the human capital approach is relatively simple to implement, and so it still used in many developing countries (parikh, parikh, muralidharan & hadker, 1994). moreover, it avoids some of the serious problems with transferring willingness to pay values across countries (discussed in more detail below). because of the ethical issues related to this type of analysis, many health economists use measures such as 'disability adjusted life years' (dal ys) lost. this is a standard health care analytical tool that combines years of life lost and years of life disabled, measured relative to incidence of the illness. although we present the economic analysis below to illustrate how use to the two major types of valuation tools, we have also chosen to limit our final results to dal ys lost because of the ethical issues surrounding mortality valuation. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 407 6.1 human capital: lost productive years of life 6.1.1 methodology we use two approaches to estimating human capital. the first is to estimate the average years of life lost in south africa and the contribution to economic output that the average individual would have made over those years based on gdp per capita. this gives a direct estimate of years of productive life lost. the second possibility is to use the measure of dal ys lost per case and gdp per capita to then place a value on those dal ys. while there are no daly values for malaria in south africa, the global burden of disease study estimates that, for sub-saharan africa, dal ys for malaria are 0.145 per incidence of illness (murray & lopez 1997). this takes into account the age at death, years lost, and a discount rate of 3 per cent for future years lost. 6.1.2 results for lost work years, age at death is based on tren's (2001) reporting of deaths from malaria in mpumalanga in 1997 and 1998, where the average age at death was 22.9 years. according to the undp's human development report, life expectancy in south africa is 54.7 years (undp, 1999), so this means a loss of 32 years of economically active life. if the mortality rate for malaria is 0.7 per cent, then the dal ys lost per incidence of malaria is 0.1492 (using a 3 per cent discount rate for future years as in murray & lopez, 1997). because we are evaluating the impacts of deaths in 2010, we should use per capita gdp in 2010, which is estimated by absa group economic research (2000) as r22 360 (in 2000 rands). table 5 summarises the range of dal y s lost per incidence of malaria, and the economic valuation using gdp per capita. table 5 dalys lost and economic valuation for malaria mortality using gdp per capita, 2010 low high dal ys lost per case 0.145 0.149 total dalys lost 11800 18300 lost economic output (r2000 million) 265 408 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 408 sajems ns vol 5 (2002) no 2 6.2 willingness to pay and benefits transfer 6.2.1 methodology as discussed above, using contingent valuation to determine willingness to pay relies on large scale surveys on individual to ask them to evaluate what they would pay to avoid a certain additional risk. or what they would accept as compensation for that risk. where primary research is not available in a given country, as is the case for many developing countries, we can adapt these values using the concept of 'benefits transfer'. with benefits transfer, we use the relative gdp per capita of the two countries to adjust the valuations. in other words, if we want to apply a wtp value to a country with one tenth the per capita income, then would should divide the wtp value by 10. the problem with this approach is that, if we use it to place a value on the mortality risk, it appears that we are again setting people's value equal to their economic output. this would mean that people in poor countries are worth less than those in rich countries (ekins, 1995). this has provide particularly problematic in global valuation exercises such as those for the potential damages from climate change (fankhauser, tol & pearce, 1997). while economists have proposed ways to address this problem (fankhauser et ai., 1997), this study does not have to tackle the international dimension of the problem because it looks only at domestic health impacts. we present the below for illustrative purposes only. 6.2.2 results a survey of economic valuations of health risks by zweifel and breyer (1997: 40) found that the value of a statistical life can vary greatly, in part because "considerable risk reductions of about 1: 1 03 do not call forth a substantially larger willingness to pay then reductions of around i: 105 to 1: 106.,. for studies that looked a higher risks (1:103), values for two studies were between 120 and 300 000 us dollars (2000 dollars)(cited in zweifel & breyer, 1997). this is much lower than studies done for lower risks, where values of $1 million or more were common. in the case of malaria, however, the risk of dying is on the order of i: 105 for those in endemic areas. zweifel and breyer also look at valuation studies based on observed consumer behaviour for example, how much additional wages people are willing to accept to compensate for more dangerous work and how much consumers will spend on purchases like smoke detectors, homes in areas with better air quality, or choices they make about driving speed and use of seat belts. values from the wage risk studies may exceed $1 million, and different studies often differ by several orders of magnitude. values from consumer behaviour studies tend to range from $300 000 to $900 000 per statistical life. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 409 our conclusion is that, given the lack of study in south africa (or africa) on these issues and the uncertainties in how comparable the overseas studies are, it is difficult to apply these results to the present analysis. for illustrative purposes, we could assume a range of $300 000 to $1 million. when adjusted for 2000 exchange rates (sarb, 2001) and relative gdp per capita between the us and south africa (world bank, 2000), this means a total valuation of mortality from malaria due to climate change of r360 million to ri 700 million. 7 conclusions table 6 below summarises the direct and indirect economic costs of increased risk of malaria due to climate change, but only provides a valuation for morbidity. based on the assumptions and analysis described in this study, the opportunity cost of increased morbidity from malaria would be between r277 million and r466 million in 2010. because we are using market values for both morbidity in other words, direct opportunity costs of lost time, treabnent costs, and lost future productivity and have not included a monetary measure of the increased mortality, these figures should be seen as an absolute minimum estimate of damages. table 6 summary of opportunity costs of increased malaria due to climate change in 2010 (2000 rands) cateeory dama2es low hi2h opportunity cost of excess morbidity cost of treabnent (r million) 253 429 productivity losses (r million) 24 37 total 277 466 mortality impact disability adjusted life years lost (dal ys) 11800 18300 one of the most important conclusions from this work is the need to understand both the costs and effectiveness of prevention measures as a subcategory of what are referred to in the climate change literature as adaptation measures. as craig and sharp (2000) point out, for malaria to become endemic in pretoria again would require an almost complete breakdown of the public health system and malaria control measures. there will clearly be some adaptation and increased need for preventive measures. on the other hand, the exponential growth of malaria cases in the last decade clearly indicates the challenge facing r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 410 sajems ns vol 5 (2002) no 2 costing study, that clearly identifies the potential effectiveness of increased malaria control measures over lager parts of the country, as well as their cost, is the essential next step for policy development for malaria and climate change. endnotes this research was supported by usaid and administered by the joint center for political and economic studies inc. under a subcontract agreement from nathan associates inc. comments and inputs from marlies craig, jane turpie, harald winkler, mampiti matete, james blignaut, and jan van rensburg are greatly appreciated. all errors remain solely the responsibility of the authors. 2 this also includes the weighted average of 2.7 days of disability 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(1997) health economics, oxford, oxford university press. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction overview of rating agency methodology literature review current banking practice south african case study suggestions on the incorporation of agencies’ data and methodologies into internal ratings models conclusion acknowledgements references about the author(s) tanja verster centre for business mathematics and informatics, north west university, potchefstroom, south africa riaan de jongh centre for business mathematics and informatics, north west university, potchefstroom, south africa simon greenberg independent validation unit, group risk, absa, johannesburg, south africa erika fourie centre for business mathematics and informatics, north west university, potchefstroom, south africa dries de wet centre for business mathematics and informatics, north west university, potchefstroom, south africa citation verster, t., de jongh, r., greenberg, s., fourie, e. & de wet, d., 2019, ‘a motivation for banks in emerging economies to adapt agency ratings when assessing corporate credit’, south african journal of economic and management sciences 22(1), a2818. https://doi.org/10.4102/sajems.v22i1.2818 original research a motivation for banks in emerging economies to adapt agency ratings when assessing corporate credit tanja verster, riaan de jongh, simon greenberg, erika fourie, dries de wet received: 20 sept. 2018; accepted: 20 nov. 2018; published: 25 mar. 2019 copyright: © 2019. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: this article considers whether south african banks should utilise the credit ratings provided by us-based credit rating agencies when assessing the creditworthiness of corporate borrowers. aim: a review is conducted of the relevant literature and specifically the methodologies used by the credit rating agencies for ranking corporates in emerging markets. setting: the three largest international credit rating agencies are fitch ratings, moody’s investor services, and standard and poor’s. these agencies’ credit ratings cover the global spectrum of corporate, sovereign, financial and other public entities and the securities and obligations they issue. the analytical frameworks used to produce these ratings are referred to as credit rating methodologies. method: a review of moody’s ratings for south african corporate entities was undertaken to examine claims of a sovereign ceiling influencing the external ratings obtained by these institutions in emerging markets. results: only 14 of the 200 global south african ratings pierced the sovereign ceiling. conclusion: the study concludes that the use of unmodified external ratings by banks to assess a corporate borrower should be discouraged. high-level suggestions are provided on how the methodologies and data used by the external agencies may rather be used to arrive at more suitable internal ratings. keywords: sovereign ratings; credit ratings; country ceiling; emerging markets; modification of external ratings. introduction this article assesses the applicability of credit ratings provided by the three (primarily) us-based rating agencies (moody’s investor services, standard and poor’s, and fitch ratings) in assigning creditworthiness of corporate entities in emerging markets. when a corporate client approaches a bank for a loan, the bank assesses the creditworthiness of the corporate. more specifically, the bank must assess the risk involved in the specific transaction, usually by establishing a credit rating for the corporate. this is an inherently difficult exercise because corporates seldom fail, so default data are sparse. however, it is important to model these rare events as accurately as possible because of the effect corporate failures could potentially unleash on the country’s economic milieu. many factors are considered in the assessment of risk from the bank’s point of view; one example is: if the corporate is part of an international conglomeration, would the parent provide implicit support for the loan or not? most banks have established their own internal rating systems to deal with these sorts of problems, which allow them to establish credit ratings that can be converted into a probability of default (pd) estimate, which could be used in subsequent pricing and capital calculations. external ratings can also be used in these internal rating systems. external rating agencies rate emerging entities by taking a generic global lender’s view (i.e. the ratings are not conditional on the lender type or position) and take only into account the borrower and transaction characteristics. the ratings issued by the external agencies also seem to depend on the sovereign rating through a full or partial application of sovereign ceilings. emerging markets’ sovereigns typically have low credit ratings and the corporates within such a country are almost always ranked at the same level or lower. the following questions may thus be asked: is the use of unmodified external ratings appropriate for banks operating in emerging markets and lending in local currency to local corporates? if external ratings should be adjusted to make them relevant in the local context, how could this be undertaken? these issues are deliberated by: reviewing the methodologies used by the rating agencies to rate the creditworthiness of corporates. scrutinising the available literature on the appropriateness of these ratings. reflecting on the present banking practice when using these ratings. learning from the state of affairs in south africa. providing suggestions on the incorporation of agencies’ data and methodologies into internal ratings models. the conclusion of our article is that banks operating in emerging markets should not use unmodified external ratings of corporates to determine their creditworthiness; rather, banks should consider how the methodologies and data of the external agencies might be used to arrive at more suitable internal ratings. overview of rating agency methodology before evaluating the applicability of rating agency methodologies, an overview is given of these methodologies. the three largest international credit rating agencies are fitch ratings (fitch), moody’s investor services (moody’s) and standard and poor’s (s&p). these agencies’ credit ratings cover the global spectrum of corporate, sovereign, financial, and other public entities and the securities and obligations they issue (for more detail see fitch 2014; moody’s 2016b; s&p 2016). the analytical frameworks used to produce these ratings are referred to as credit rating methodologies. several methodologies that relate to a particular industry, sector, class of issuer or transaction exist and each methodology could result in one or more rating types (e.g. global issuer rating, pd rating, bond fund ratings, counterparty risk assessment ratings). furthermore, an issuer rating can be split into various categories (e.g. long term, medium term, short term, domestic, foreign, secured and unsecured). taking moody’s as an example, the agency has more than 600 methodologies with more than 100 rating types. santos (2012) provides a summary of the generic corporate methodologies used by fitch, s&p and moody’s. the analytical framework, or rather the credit rating methodology, establishes the key analytical factors that the agency believes are the most important determinants of credit risk for the relevant sector. all three of the major credit rating agencies use their own methodologies, but in general they are similar. quantitative as well as qualitative assessments of various criteria are used, followed by a process of weighting and tweaking, which finally results in a single rating score. the two main factors considered are economic and political factors. economic factors may relate, among others, to income levels, international trade involvement, level and composition of debt, economic structure, flexibility and growth. the political dimension includes, for example, political stability, the history of debt-related policy actions, and the degree of democratisation or quality of institutions. moody’s sovereign rating methodology (moody’s 2015b), for example, uses four key factors to determine the sovereign risk: economic strength (e.g. gdp per capita), institutional strength (e.g. inflation levels), fiscal strength (e.g. government debt as a ratio of government revenue) and susceptibility to event risk (e.g. political risk). moody’s mining rating methodology (moody’s 2014, 2018) uses five key factors to determine a mining corporate’s credit rating: scale (e.g. revenue), business profile (e.g. competitiveness), profitability and efficiency (e.g. earnings before interest and taxes [ebit] margin), leverage and coverage (e.g. debt/earnings before interest and tax and amortisation [ebitda]) and financial policy (e.g. financial risk tolerance). although the credit ratings and the associated methodologies are publicly available, it is not possible to obtain a precise understanding of how a particular rating was determined. in most instances, the methodology and detailed quantitative rules associated with the methodologies are provided, but the precise approach used to determine the final rating is proprietary to the relevant agency. these publicly available methodologies simply outline key qualitative and quantitative factors used by the agency in determining ratings. qualitative factors include, but are not limited to: the quality of the financial policy the effectiveness of management political and reputational risk business diversification. quantitative factors include, but are not limited to: annual revenue profitability as measured by earnings before interest and tax and amortisation (ebitda) divided by annual revenue profitability as measured by net income divided by tangible assets leverage as measured by debt divided by total capital economic variables such as gdp growth. the common use of the term ‘credit rating’ normally refers to global credit ratings. the terminology used by moody’s (2016b) is ‘global scale ratings’ (gsr). these include all of the rating types and are intended to be comparable across industries, markets, obligation type, countries and geography. such a credit rating is the evaluation of credit risk in order to rank an institution’s ability to honour its debt obligations. credit ratings issued by agencies are relative rankings of creditworthiness, meaning that an issuer or issue with a higher ranking is considered to be of better creditworthiness than an issuer or issue with a lower ranking (s&p 2016). the agencies themselves make it clear that ratings should be regarded as opinions, not facts, and therefore cannot be described as ‘accurate’ or ‘inaccurate’ (fitch 2014). while global credit ratings are intended to provide a measure of relative creditworthiness of institutions across industries and countries, national credit ratings are also issued for some of the institutions with global credit ratings. national credit ratings provide a measure of relative creditworthiness of institutions within a specific country. the terminology used by moody’s (2016b) to indicate these types of ratings is ‘national scale ratings’ (nsr). fitch uses the term ‘national ratings’ (fitch 2014) and s&p refer to ‘national scale credit ratings’ (s&p 2016). moody’s assigns nsrs to provide greater differentiation among a country’s issuers when gsrs are concentrated in the lower portion of the scale, typically for emerging economies. the nsr can be mapped to the gsr rating, using the sovereign rating of the particular country as the anchor point. note that nsrs have no inherent absolute meaning in terms of default risk or expected loss; rather, they should be regarded as ordinal rankings of creditworthiness relative to other domestic issuers within a given country (moody’s 2016a). a historical pd or an expected loss consistent with a given nsr can be inferred from the gsr that was used at that specific time, since these mappings are documented by the agencies. however, both the pd and the expected loss of an nsr may change if and when a country’s national scale is remapped (moody’s 2016a). credit rating agencies typically rate all institutions within a country at or below the sovereign rating. a few exceptions exist, but then the institution is not ranked higher than at most two notches above the sovereign rating. the principal reason is that sovereigns are viewed by the agency as the lowest credit risk in their local market or currency (moody’s 2015a). although rating agencies deny the strict application of sovereign ceilings to the global credit ratings of corporates in the particular country, it is typically the case as shown in sections 4 and 5. not all countries and institutions have external ratings since rating agencies only provide ratings for entities that approach (and pay) the agency for such a rating. literature review the following discussion of the literature will refute the use of unmodified external ratings for banks operating in emerging markets and lending in local currency to local corporates. credibility of rating agencies’ ratings rating agencies’ ratings should not be considered accurate, even by their own accord, and are intended as opinions about the riskiness of entities. rating agencies have been severely criticised on various fronts, principally stemming from the 2008/2009 financial crisis (ryan 2012) and events that occurred thereafter (e.g. the crisis in the sub-prime mortgage market in the united states developed into a full-blown international banking crisis with the collapse of the investment bank lehman brothers). scully and mclaughlin (2017) noted that the crisis could not have happened without the rating agencies. credit rating agencies were unable to foresee the economic crisis, and often exacerbate a crisis by making sudden downward adjustments amidst the turmoil (haspolat 2015). the predictive quality, accuracy and timeliness of the credit ratings of securities have also been questioned (nguyen & knyphausen-aufseß 2014). although agencies stress that their ratings should be regarded as opinions and that they cannot be evaluated as ‘accurate’ or ‘inaccurate’, many studies conclude that the external ratings should definitely not be regarded as ‘accurate’ (see e.g. fourie et al. 2013; fuhrmann 2011; haspolat 2015; nguyen & knyphausen-aufseß 2014). another key criticism is that the institutions themselves must pay the credit rating agencies to rate their securities, which creates potential conflicts of interest. ryan (2012) reserves severe criticism for the rating agencies, observing that there is a lack of competition and accountability, a dearth of truly independent external credit rating agencies, and a frequent adjustment of ratings (mostly during crises). banks and external ratings credit-granting institutions, particularly banks, should not only use the external ratings provided by the agencies to determine the creditworthiness of institutions, but rather incorporate these external ratings into internal rating models. fuhrmann (2011) warns institutions not to rely on external ratings and emphasises that institutions should perform their own due diligence in determining the safety levels of debt and related securities. the opinions of the credit rating agencies can help banks reach a conclusion, but as events of the last decade illustrated, the agencies can be just as off base as any other institution when it comes to the more extreme credit events. treacy and carey (2000) argue that a bank typically has close relationships with its customers and therefore possesses more comprehensive information than external credit rating agencies. in a similar vein, kräussl (2003) warns against a growing reliance on credit rating agencies that could undermine the credit risk analysis expertise within the banking community in the long run, since portfolio managers and controllers could become increasingly habituated to relying on external risk assessments rather than on their own research. guidelines given by the prudential regulation authority (pra) of the united kingdom on the use of external agencies’ ratings in the internal ratings-based (irb) approaches expect firms using external agency ratings to still have their own internal rating scales and use all other relevant information (pra 2015). the pra specifically warns not to automatically assign obligors ratings based on the external agency ratings. they further expect the institution to ensure that it does not adjust its individual ratings with the objective of making them closer to the external ratings, as this would be counter to the philosophy of an internal rating approach (pra 2015). emerging markets in emerging markets, the corporate ratings are heavily influenced by sovereign risk through the application of a sovereign ‘lite’ ceiling. literature opposes the use of unmodified external agencies’ credit ratings to determine the creditworthiness of local institutions for local lending, specifically in emerging countries. several authors (e.g. luitel, vanpee & de moor 2016) claim that the agencies favour their home countries and corporates, alleging that the ratings for other countries and especially emerging markets tend to be conservative. yalta and yalta (2018) show that credit rating agencies indicate a strong home country bias towards the united states while there seems to be no special biases against an individual group of countries. the application of the so-called ‘sovereign ceiling’, applied when agencies rate in-country corporates (borensztein, cowan & valenzuela 2013; mohapatra, nose & ratha 2017), also influences emerging market ratings. borensztein et al. (2013) regressed s&p corporate credit ratings against four sets of components: dummy variables indicating specific year, industry and country, firm-level determinants of idiosyncratic risk, country-level macroeconomic variables that affect the risk level of all firms in the economy, and the s&p sovereign credit ratings. they concluded that sovereign credit ratings remain a significant determinant of corporate credit ratings, more so in emerging countries. similar arguments are found by triandafil and brezeanu (2008), who examined the influence of sovereign rating on corporate rating (emerging versus developed country). cantor and packer (1996) note that apart from affecting large sovereign bond markets, sovereign ratings also influence the credit ratings of private firms. nguyen and knyphausen-aufseß (2014) review existing research on the relationship between a sovereign’s creditworthiness and corporates within as well as beyond its border. they conclude that studies generally agree that higher sovereign credit risk, as reflected in lower sovereign ratings, is associated with a more restricted access to debt capital for corporate borrowers. nguyen and knyphausen-aufseß (2014) also note that, despite the common agreement that the influence of sovereign on corporate ratings exists, there are still deviating notions on the extent to which this influence manifests itself and that more research is needed on this topic. ferri and liu (2002) conclude that sovereign ratings have a particularly strong effect on corporate ratings in developing markets and that a country’s information quality influences the relationship. ferri and liu (2002) further argue that the sovereign ceiling also has an impact on low-rated firms, as rating agencies wish to preserve the graduation in corporate rating levels. hence, they contend that ‘the sovereign ceiling would tend to push down the scale of private ratings rather than affecting only those firms that are right against the constraint’. this observation somewhat contradicts the claim of durban and ng (2005) who state that the ceiling only bears relevance for firms with ratings constrained by it. borensztein et al. (2013) confirm the presence of a sovereign ceiling ‘lite’ policy by the agencies and conclude that it tends to affect corporate ratings negatively. other studies focus on the sectors that are more severely affected by sovereign creditworthiness (nguyen & knyphausen--aufseß 2014). for example, nguyen and knyphausen-aufseß state that, while the export-oriented resources sector is barely affected by sovereign credit risk, the telecommunications sector and the financial sector (both with close regulatory ties) are more likely to be sensitive in this regard. export-oriented resource sectors like mining firms are predominantly influenced by the industry in which they operate (rather than the country), because mining firms’ profits are consistent across the industry, being commodity-price driven. these arguments might be true in most developed economies, but in some emerging economies, specifically in south africa, mining firms’ profits are driven by two main factors, namely commodity prices and currency (i.e. exchange rate, which relates directly to sovereign risk). no research was found on how these region weights differ between emerging and developed economies. lewis (2015) suggested a framework to analyse the sovereign credit risk exposure of financial institutions. nguyen and knyphausen-aufseß (2014) also mention the dependence of financial institutions on their government’s creditworthiness in times of a financial crisis. this is again confirmed by a recent newspaper article by bloomberg (oyamada & mathis 2018), stating that money managers say rating actions are mostly backward-looking – referring specifically to emerging markets. the influence of sovereign credit ratings on specifically subnational credit ratings is discussed by fourie et al. (2013). fourie, verster and van vuuren (2016) build on this and develop a credit rating methodology for a subnational within a specific country, and therefore in essence omit the sovereign effect completely. nguyen and knyphausen-aufseß (2014) also note the potential effect of sovereign rating changes on non-financial corporates, but recommend that further research be done regarding a more differentiated perspective on the effects relating to firm-specific characteristics. we are not aware of similar research for non-financial corporates, and research on this topic is required. cross-border lending the use of external agency ratings to measure cross-border risk should be employed with caution. although the focus of this article is the assessment of the creditworthiness of corporates by banks within an emerging market country, some remarks on the differences between in-country and cross-border lending should also be made. when considering cross-border lending, an additional risk, namely transfer risk, might arise. transfer risk is when government imposes restrictions on the transfer of funds by debtors in a country to foreign creditors (claessens & embrechts 2002). this phenomenon is almost exclusively related to foreign currency exposure when involved in cross-border lending. nguyen and knyphausen-aufseß (2014) list some examples of transfer risk: governments in financial distress may impose foreign currency payment restrictions on corporations; they may expropriate private assets or impose higher taxes on corporations to compensate for higher sovereign borrowing cost, thereby reducing corporations’ ability to serve their debt; and they can implicitly or explicitly render financial support to private borrowers in distress, that is, grant payment guarantees. claessens and embrechts (2002) found that although internal and external ratings (measuring transfer risk and sovereign risk) are driven by similar factors and both underestimate cross-border risk, external ratings are somewhat slower in adjusting to specific events. current banking practice the agencies’ ratings are commonly used by banks because of regulatory pressures, as a benchmark, and for low default portfolios. adjustments are prevalent. on the one hand, the rating agencies have extensive experience and on a global scale banks do not necessarily have better information or methodologies to rate corporates than do the agencies. on the other hand, banks should not be outsourcing their risk mangement responsibilities by using unmodified external ratings. a methodology is required to enable the internal use of external ratings. under the basel guidelines, banks that use the regulatory advanced internal ratings based approach (airb approach) are not compelled to use external agency ratings or pds. however, external ratings are currently widely used by banks, either directly or as a benchmarking tool for internal rating models. in the interest of consistency across industries, it is important to develop guidelines for the use and adjustment of external agency ratings in emerging markets, taking into account both borrower and lender characteristics. although regulators do promote the development of internal rating systems, this is not uniform across the globe. the standardised approach to regulatory capital calculation is the only one available in many countries and is dependent on the rating agency ratings. in many developing countries, the banks do not have an option to use the foundation internal ratings-based (firb) or airb approach for regulatory capital calculation. in the absence of internal rating systems, the de facto approach is to use agency ratings for impairment or pricing purposes. even where firb or airb approaches are available, regulators are reluctant to approve internal rating systems in low-default environments, where the performance of the system cannot be explicitly illustrated on data representative of the bank’s portfolio. so, although an firb/airb bank will have internal rating systems, it will often continue using rating agency ratings for sub-portfolios where there is insufficient data to build an internal system. furthermore, even where the internal rating systems are approved and implemented, agency ratings continue to be used indirectly as a benchmarking tool. regulations require firb/airb internal rating systems to be benchmarked and agency ratings are a readily available source of benchmarking data. however, in terms of our research, the use of unadjusted agency ratings is not suitable for the benchmarking of internal rating systems (specifically in south africa). credit professionals take into account agency ratings as part of the credit-approval process, over and above the ratings produced by the internal system. where the gap between the internal and agency rating is concerning, this is challenged and illustrated. a scientific analysis of the rating or pd assignment methodologies followed by external rating agencies for sovereigns, banks, non-bank financial institutions and corporates is ultimately sought. in the process, the characteristics of the intended consumers of these ratings must be assessed to determine whether they are consistent with those of south african banks. south african case study south africa’s sovereign rating clearly plays a definitive role in the determination of the ratings of local corporates. this section provides further evidence and motivation for some of the statements made in the literature section. these are: global external agency ratings do not differentiate well in terms of institutional creditworthiness within a country, as a result of the compression effect of the sovereign rating. the influence of the sovereign rating therefore dominates and negatively influences the external ratings of corporates, especially in emerging markets. only a limited number of south african institutions have been assigned an external agency rating. therefore, it is recommended not to use the unmodified external rating to assess the creditworthiness of corporates within south africa. south african sovereign ceiling and institutions’ ratings only 14 of the 200 global south african ratings pierced the sovereign ceiling. in the remainder of this section, only the moody’s ratings are reported on for conciseness and as illustration. south africa’s sovereign long-term issuer rating (domestic) assigned by moody’s is baa2. the associated short-term issuer rating (domestic) assigned is p2. both are part of the lower investment grade broad-risk group. moody’s has assigned 305 ratings to 65 institutions in south africa. when municipalities and other government entities are excluded from this total, 252 ratings are available for 48 institutions. of these 305 (252) ratings, 200 (166) are global ratings, of which 37 (20) are global long-term domestic issuer ratings. only 14 of the ratings issued pierced the sovereign ceiling of baa2 (p2). the ratings that did pierce the south african ceiling are listed in table 1. table 1: moody’s credit ratings piercing the baa2 level of the sovereign rating (september 2016). remarks: the sovereign domestic issuer long-term rating of south africa is baa2; the short-term rating is p2. none of the ratings that pierce this ceiling are issuer ratings and the comparability of the ‘backed’ ratings is debatable because the issuer ratings are secured ratings. long-term ratings pierce the sovereign ceiling by no more than one notch (and short-term ratings by no more than two notches). note that the focus of this research is on local (domestic) currency ratings. the main distinction between local and foreign currency ratings is that local (domestic) currency ratings describe the capacity and willingness of the government to honour its debt/bonds payable in local currency in a timely manner, whereas foreign currency ratings relate to the default risk of bonds/debt issued in a foreign currency (peter & grandes 2005). when considering domestic or implied domestic ratings, only 13 ratings pierced the sovereign long-term domestic issuer rating, of which 8 were listed explicitly as a domestic rating. note that when all the ratings are considered, only 14 of the 200 global ratings pierced the sovereign ceiling. note that only ratings with domicile (country) indicated as ‘south african’ were considered. even though the country of the bank of china is listed as domicile ‘south africa’, this is not a south african-based company. some of the top 40 jse listed companies appear to have no external rating. an initial analysis indicated that less than 50% of the top 40 companies are assigned a moody’s/fitch/s&p rating. initial analysis also revealed that in some of the top 40 jse listed companies, the domicile is listed other than south africa (e.g. billiton is listed as an australian company). when a rating pierces the south african sovereign rating, it is in general only one of the institution’s ratings that pierces. for example, moody’s assigned nine global ratings in total to standard bank. only one of the nine assigned ratings, namely the counter party risk assessment rating, was higher than the south african sovereign rating of baa2 (or p2), whereas the remaining eight ratings are exactly equivalent to the sovereign rating. rating changes in some sectors severely restricted by sovereign risk confirmation of the literature stating that some sectors (e.g. financial) are more severely affected by sovereign creditworthiness than others (e.g. mining). consider rating changes by moody’s for mining and banking institutions in south africa. the rationale for any rating changes for the mining companies was connected with specific mining factors whereas for banks they were primarily related to sovereign risk. for example, on 16 september 2016, moody’s (2016c) affirmed anglogold ashanti’s baa3 rating (changed the outlook to positive from stable), mainly because of an improvement of the debt/ebitda ratio. moody’s (2016d) also affirmed the ba1 rating of gold fields and changed the outlook from stable to positive, because of the improvement of financial ratios. moody’s remarked that the rating could be adjusted upwards if gold fields’s cash flow improves. moody’s (2016e) confirmed the ratings of the five largest south african banks to a negative outlook on 10 may. according to moody’s, in light of the correlation between sovereign and bank credit risk, the banks’ standalone credit profiles and ratings are inevitably constrained by the rating of the government. on the question of what could move the banks’ ratings up or down, the following is reported by moody’s (2016e): as indicated by the negative outlook on the sovereign rating, any deterioration in the creditworthiness of south africa would exert downward pressure on the banks’ ratings, in view of their sizeable holdings of sovereign debt securities. in addition, the banks’ ratings could be downgraded if operating conditions worsen more than currently anticipated, leading to significantly higher loan loss provisions that prompt deterioration in the banks’ earnings and capital metrics that exceed the agency’s expectations. conversely, any upwards rating momentum of the banks’ ratings is currently limited as their baseline credit assessments are constrained by the sovereign rating (p. 2). suggestions on the incorporation of agencies’ data and methodologies into internal ratings models three ways of incorporating external agencies’ data and methodologies into internal ratings models are discussed below. the first two are based on the data of peers provided by external agencies such as key financial ratios and relative credit health scores, while the third employs the quantitative rules from the methodologies as a benchmark. several authors (e.g. nguyen & knyphausen-aufseß 2014; ryan 2012) have stated that the publicly available rating methodologies are too opaque. in most instances, the methodology and detailed quantitative rules associated with the methodologies are provided, but exactly how the final rating is determined is proprietary to the agency that issued the rating. financial ratios adjusting an internal model using industry-specific financial ratios. moody’s (2013) outlines key financial ratios across industries for global non-financial, non-utility corporates. for example, the distribution of the median of the ratio debt/ebitda by broad rating category can be summarised as shown in figure 1. figure 1: debt/ebitda by rating category. the median debt/ebitda ratio for baa-rated institutions is 2.7. this may be disassembled into industry components, as shown in figure 2. figure 2: components of baa-rated institutions debt/ebitda. note that the telecommunications industry has the lowest median ratio, but it is still greater than the a aggregate. on the other hand, the transportation sector has the highest debt/ebitda ratio, exceeding the ba aggregate. these financial ratios (based on moody’s ratings) can be used to adjust or benchmark internal rating models. as can be seen in figure 2 (debt/ebitda), the interpretation of accounting ratios differs for specific industries, because of industry-specific idiosyncrasies. these industry-specific interpretations may be used in model development on a more granular level. adjustments can be made to internal models to more accurately reflect the credit risk associated with a counterparty in a specific industry. example: adjusting an internal model for the transportation sector suppose the internal model consists of three risk grades, namely 1, 2 and 3, where 1 indicates the lowest default probability. usually an internal model would be generic for all industries, but the need may arise to adjust the results from such an internal model. assuming the current internal model uses a debt/ebitda ratio of ‘< 0.6’ for a risk grade 1. further, suppose a large transportation corporation received a risk grade of 2 from the internal model, but this company is known (credit analyst and/or expert knowledge) to be of very low risk. assuming this transportation corporation has a debt/ebitda ratio of 1.2. from figure 2 it is observed that the transportation sector has the highest debt/ebitda ratio and the credit analyst/expert might decide to adjust the level of ‘< 0.6’ in the internal mode to, for example, ‘less than 2’. this will result in the specific transportation corporation in our example receiving a risk grade of 1 rather than 2, to more accurately reflect the credit risk associated with transportation corporations. note that this example is only on how to adjust one financial ratio for one transportation company. this needs to be done by a credit analyst or expert for each company for each financial ratio. usually the adjustments are done per industry (the same type of suggested adjustments are usually grouped per industry). nevertheless, the expert will decide if the ‘industry suggestions’ will be applied for all the companies in a specific industry. in our example above, the ‘industry suggestions’ showed that in general the debt/ebitda ratio of transportation companies are higher. the expert needs to decide if this guideline will be applied to all transportation companies and they also need to decide to what degree the guideline will be applied. credit health score evaluating the creditworthiness of a chosen entity relative to a unique group of industry peers. the credit health score (chs) (s&p 2013) is a workflow tool designed to aid the evaluation of the creditworthiness of a chosen entity relative to a unique group of industry peers. the key analytical element of the chs tool is the relative credit health score. the chs is a relative quartile ranking (top, above average, below average and bottom) that expresses the creditworthiness of the entity relative to its unique peer group. the chss are delivered at three levels for each entity: overall score for the entity, financial panels’ scores (operational, solvency, liquidity panels) and fundamental metrics scores. the chs methodology consists of three steps and is summarised below. step 1: create a unique peer group for the entity that must be rated the first step creates a unique peer group for the entity that must be rated. for example, for anglogold, a typical peer will be gold fields. usually a minimum of 5 and a maximum of 41 companies are chosen as peers. step 2: perform comparisons of fundamental metrics within the peer group the second step performs a comparison of fundamental metrics within the peer group. s&p (2013) utilises a total of 24 fundamental metrics to analyse an entity’s relative credit health. these fundamental metrics are grouped into three equally weighted panels: operational-related metrics (e.g. ebitda/revenue), solvency-related metrics (e.g. net debt to ebitda and debt/ebitda), and liquidity-related metrics (e.g. total revenue). step 3: apply an iterative scoring methodology in step 3 an iterative scoring methodology is applied. if the financial metric of the entity falls in the first quartile of all the peers (identified in step 2), two points are added, if in the second quartile, one point is added, if in the third quartile one point is subtracted, and if in the fourth quartile two points are subtracted. this is done for all three metrics (operational, solvency and liquidity) and averaged over these three for a final chs. the chs seeks to provide a consistent, quick snapshot of an entity’s relative financial performance versus a unique group of peers or companies. example: adjusting an internal model for a transportation corporation using chs using the same large transportation corporation from our previous example, suppose the corporation has a debt/ebitda ratio of 1.2. this chs will show the relative debt/ebitda ratios of its peers (other transportation corporations) as well as the combined result of all financial ratios considered. for illustrative purposes we can assume that the debt/ebitda ratio of other large transportation corporations have a median value of 3.8 (motivated from figure 2). it can then be concluded that this transportation corporation (taking into account the debt/ebitda ratio) ranks in the top quartile of its peers. therefore, relative to its peers, it seems that this company is one of the most creditworthy transportation corporations. this comparison with peers could also be used to adjust the internal model. the peer analysis as done by the chs score usually accentuates the difference between industries as a result of industry-specific idiosyncrasies. adjustments (based on the peer analysis) can be made to internal models to more accurately reflect the credit risk associated with a counterparty in a specific industry (similarly to the previous example). again, this example showed how to adjust one financial ratio for one transportation company. this needs to be done by a credit analyst or expert for each company for each financial ratio. usually the adjustments are done per peer group, but the expert needs to decide if a specific peer group guideline will be applied to all companies, as well as to what degree the guideline will be applied. incorporation of quantitative rules from external methodologies into internal models adjusting the internal rating of an entity to an alternative benchmark model created for a sector using the key financial ratios (quantitative rules) used by a rating agency’s industry for that sector. the third implicit use is to create an alternative model (benchmark model) using financial ratios (quantitative rules) from the external methodology. the first step will be to score the entity with the existing internal rating model. the second step will be to score the entity with the external agency methodology but only using the quantitative rules (this is usually financial ratios). the final step will be to compare these two scores, using the model in the second step as a benchmark model to adjust the internal rating model or to validate the internal rating model. these steps are discussed in more detail below, with an illustrative example. example: adjustment for mining sector step 1: score with internal rating model choose an industry, for example mining. determine which financial ratios are used in the internal rating model to rate this industry; assume ebitda/assets (70%) and ebitda/interest expense (30%). the weight of each financial ratio is indicated in brackets. assume the internal rating model for mining (for illustrative purposes) (see table 2). run the south african mining companies through the internal rating model. example: company xyz has a ratio of 13% of ebitda/asset and a ratio of 16% for ebitda/interest expense. internal rating model will give score 2 for ebitda/asset and score 1 for ebitda/interest expense = 70% × 2 + 30% × 1 = final score of 1.7 (rounded to 2). add the qualitative component (if applicable). table 2: assumed internal rating model for mining (illustrative example). step 2: score with external rating methodology (using quantitative rules) research the external rating methodology used for rating this industry (mining). determine which financial ratios are used in external rating methodologies to rate this industry. the moody’s mining methodology (moody’s 2014) (see table 3). the detail can be found in (moody’s 2014), for example for factor 4: leverage and coverage (35%) (see table 4). assume a simplified external model for mining: only two financial ratios are used, say debt/ebitda (75%) and debt/total capital (25%). assume simplified quantitative rules of the external agency methodology for mining can be found in table 5. obtain a mapping (expert-based) from the internal rating/score to external rating (see table 6). run the south african mining companies through this external rating model (using only financial ratios). example: company xyz has a debt/ebitda ratio of 5 (resulting in a score of 3) and a debt/total capital ratio of 40% (resulting in a score of 2). the external methodology (only quantitative) would give a score of 75% × 3 + 25% × 2 = final score of 2.75 (rounded up to 3). adjust for industry and country factors (e.g. currency) if applicable. table 3: moody’s mining methodology. table 4: detail of factor 4 (leverage and coverage) of moody’s mining methodology. table 5: assumed simplified quantitative rules of the external agency methodology for mining. table 6: mapping from the internal score to the external rating (illustrative example). step 3: compare these two scores (from step 1 and 2) this comparison (internal model’s final score of 1.7 vs external methodology, resulting in a score of 2.75) can be used to benchmark the internal rating model or to adjust the internal rating model. example: if these scores are the same using the internal rating model as well as the external rating methodology, we can be confident that the internal rating model captures the risk sufficiently. however, in our example, the two scores differ (1.7 vs 2.75) and this could initiate discussion surrounding these differences. the combination of data analysis and expert judgment could then result in possibly adjusting the internal rating model. both the internal model and the external rating methodology are a set of quantitative rules. most of the time, these rules are given per industry (i.e. for each industry, there is a different model). each company needs to be run through the model. the example given only included two financial ratios. usually 8 to 20 financial ratios are considered in a quantitative model. summary rather than using unmodified external ratings, suggestions were presented in this section on how to incorporate methodologies and data of external agencies into internal rating models. the first idea was to calculate key financial metrics ratios from the external agency data, the second suggestion was to calculate a relative chs using data from the external agency (focusing on peers) and the third idea employs the quantitative rules from the methodologies as a benchmark model. practical implementation is, however, required to ensure practical or business value. guidlines will likely differ on the type of the borrower (sovereign, bank, non-bank financial institution, large corporate) and the industry of the borrower as well as local versus in-country business. it is important to articulate the lender or borrower characteristics (e.g. domicile, legal environment, borrower type, lender type, industry, loan characteristics) that should be incorporated. implementation falls outside the scope of this article. conclusion the literature emphasises that external ratings provided by rating agencies cannot be regarded as entirely accurate. also, in emerging markets, the application of the sovereign ceiling to the rating of corporates leads to a compression effect that results in lower ratings, as confirmed by a recent newspaper article (business tech 2018). the case study demonstrates that less than 10% of ratings assigned to local corporates pierce the sovereign ceiling by no more than one notch long term (and by no more than two notches short term). given the latest widespread criticism on the rating agencies, it is recommended that banks in south africa refrain from using unmodified external ratings when rating local corporates, but rather adjust these ratings as set out above and summarised in figure 3. figure 3: summary of recommended ‘local ratings’ approach. as far as the adjustment of the external ratings for the use by local banks is concerned, more research is required to address this complicated question appropriately. the methodologies provided by agencies cannot be used to arrive at a final rating. however, aspects of the methodology and the data used might be utilised to benchmark or adjust internal rating models. section 6 proposed a few possible suggestions. acknowledgements this work is based on research supported in part by the department of science and technology (dst) of south africa. the grant holder acknowledges that opinions, findings and conclusions or recommendations expressed in any publication generated by dst-supported research are those of the authors and that the dst accepts no liability whatsoever in this regard. competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contribution all authors contributed equally to this article. references borensztein, e., cowan, k. & valenzuela, p., 2013, ‘sovereign ceilings “lite”? the impact of sovereign ratings on corporate ratings’, journal of banking & finance 37(11), 4014–4024. https://doi.org/10.1016/j.jbankfin.2013.07.006 business tech, 2018, time to upgrade south africa’s credit rating, viewed 21 february 2018 from 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f:\ejour\ecoman\index\ecoman_v6_n2.prn.pdf sajems ns vol 6 (2003) no 2 289 predicting turning points in the south african economy ________________________________________________________________ elna moolman department of economics, university of pretoria ___________________________________________________________________________ abstract despite the existence of macroeconomic models and complex business cycle indicators, it would be beneficial to policymakers and market participants if they could look at one well-chosen indicator in predicting business cycle turning points. if one indicator accurately predicts business cycle turning points, it provides an easy way to confirm the predictions of macroeconomic models, or it can eliminate the need for a macroeconomic model if the interest is in the turning points and not in the levels of the business cycle. the objective of this paper is to investigate whether turning points of the south african business cycle can be predicted with only one economic indicator. jel e32, 37 1 introduction the modern literature on business cycles dates back to the seminal work of burns and mitchell (1946). they defined the business cycle as follows: “a cycle consists of expansions occurring at about the same time in many economic activities, followed by similarly general recessions, contractions and revivals that merge into the expansion phase of the next cycle: this sequence of change is recurrent but not periodic” (burns and mitchell, 1946: 3). this definition remains the basis of business cycle analysis, and specifically, it is the foundation of several recent studies that model the characteristics that distinguish expansions from contractions. this study will model the two features of the burns and mitchell definition, namely the occurrence of expansions and contractions, and the common movements of each of the two phases with certain economic indicators. specifically, the relationship between the turning points of the business cycle and several individual leading indicators will be modeled. accurate predictions of business cycle turning points will help investors to increase profits by knowing when asset prices will reach a maximum or minimum (based on the relationship between the asset’s price and the business cycle), producers can sajems ns vol 6 (2003) no 2 290 improve their inventory planning and if the selected leading indicator is a policy variable it will assist policy-makers in understanding the time lag with which policy affects the real economy. despite the existence of macroeconomic models and composite indices of leading business cycle indicators, policymakers and market participants can benefit significantly if it is possible to look at only a single indicator such as the stock exchange or an interest rate in predicting business cycle turning points. if a single indicator can accurately predict business cycle turning points, it provides a quick and easy way to confirm the predictions of macroeconomic models, or if the economic agent is only interested in the turning point and not the level of the business cycle, he doesn’t need a macroeconomic model but can simply use this indicator. the objective of this paper is not to model or predict the level of the business cycle, but rather to select the best single leading indicator for predicting turning points in the business cycle. the study is organized as follows: the next section gives a brief overview of the relevant literature. section 3 describes the econometric technique and section 4 describes the leading indicators used in the empirical analysis . section 5 presents the results of the empirical analysis, while section 6 provides the conclusion. 2 literature review estrella and mishkin (1998) compared the performance of various financial variables, including four term structures of interest rates, stock prices, monetary aggregates, indices of leading indicators and other economic variables such as gdp, cpi and exchange rates, as predictors of us recessions. they estimated probit models with quarterly data for the period 1959 to 1995, and evaluated the performance of the leading indicators by using the pseudo-r2 value developed for dichotonomous models by estrella (1998). their results indicated that the interest rate spread outperforms the other indicators for forecasting beyond one quarter ahead. they also tested the performance of all the possible models that includes both the interest rate spread and one other indicator as explanatory variables. several studies confirmed the result of estrella and mishkin (1998) that the interest rate spread is successful with predicting business cycle turning points. estrella and hardouvelis (1991) were the first to empirically analyze the term structure as a predictor of real economic activity. regressions of future gnp growth on the slope of the yield curve and other information variables showed that a steeper (flatter) slope implies faster (slower) future growth in real output. sajems ns vol 6 (2003) no 2 291 the forecasting accuracy in predicting cumulative changes is highest 5 to 7 quarters ahead. in addition, they also used a probit model to analyze the predictive power of the term structure on a binary variable that simply indicates the presence or absence of a recession. bernard and gerlach (1996) tested the ability of both the domestic and foreign term structures to predict business cycle turning points in eight industrial countries for the period 1972 to 1993. using probit models, they show that the domestic term spreads are statistically significant in explaining business cycle turning points in all eight countries. the period over which the domestic term spread successfully forecasts the turning points vary across countries, but the optimal forecast period ranges from two to five quarters. nel (1996) studied the relationship between the term structure of interest rates and the south african business cycle. he found that they were cointegrated, in other words a contemporaneous relationship exists, despite a poor overall fit. cook and smith (2001) assessed the effectiveness of transplanting a forecasting method based on a probabilistic approach in the south african context. they tested the ability of some of the components of the composite index of leading indicators to predict both the official reserve bank turning points as well as the mechanistic turning points of the composite index of coincident indicators. this is done by estimating a probit model with all the chosen leading indicators simultaneously as explanatory variables. their results indicate that the model could accurately forecast business cycle turning points in the 1980s. however, in the 1990s, the model displays a diminished capacity to forecast the turning points. the present study differs from their study in several ways. instead of evaluating the joint performance of the leading indicators, we are evaluating the performance of the leading indicators individually to find the individual leading indicator that most accurately predicts business cycle turning points. methodologically, we use the pseudo r2 developed by estrella (1998) for models with dichotonomous dependent variables to evaluate the models, unlike their qualitative evaluation. 3 the techniques 3.1 the probit model several authors have used probit models to model business cycle turning points (see e.g. estrella and hardouvelis, 1991; dueker, 1997; dotsey, 1998; estrella and mishkin, 1998; bernard and gerlach, 1996). the probit form is dictated by the fact that the variable being predicted takes on only two possible values – sajems ns vol 6 (2003) no 2 292 whether the economy is in a recession or not. the model is defined in reference to a theoretical linear relationship of the form: tt * kt x*y ε+β+α=+ (1) where *ty is an unobserved variable that determines the occurrence of a recession at time t, k is the length of the forecast horizon, εt is a normally distributed error term, and xt the value of the explanatory variable at time t. the parameters α and β are estimated with maximum likelihood. the observable recession indicator rt is related to this model by rt = 1 if *ty >0, and 0 otherwise. (2) the form of the estimated equation is p(rt+k = 1) = f(α + β*xt) (3) where f is the cumulative normal distribution function. the model is estimated by maximum likelihood. the recession indicator is obtained from the south african reserve bank, that is, rt = 1 if they classify the economy to be in a downward phase at time t, and 0 otherwise (see table 1). table 1 business cycle phases according to sarb since 1978 upward phase downward phase january 1978 august 1981 september 1981 march 1983 april 1983 june 1984 july 1984 march 1986 april 1986 february 1989 march 1989 may 1993 june 1993 november 1996 december 1996 august 1999 3.2 pseudo-r2 for models with dichotonomous dependent variables estrella (1998) developed a pseudo r2 that measure the goodness of fit in the context of a dichotomous dependent variable, which corresponds intuitively to the widely used coefficient of determination in a standard linear regression. let the unconstrained maximum value of the likelihood function l be lu, and its maximum value under the constraint that all coefficients are zero except for the constant as lc. denote the number of observations with n. then sajems ns vol 6 (2003) no 2 293 pseudo r2 = )l(log)n/( c u c )llog( )llog( 2 1 −       − . (4) the form of this function ensures that the values 0 and 1 correspond to “no fit” and “perfect fit” respectively, and that intermediate values have roughly the same interpretations as their analogues in the linear case. estrella’s pseudo r2 is easy to apply. first, a probit model with only a constant as explanatory variable is estimated to calculate the maximum value of the restricted likelihood function (lc). next, a probit model is estimated with the appropriate number of months ahead of the explanatory variable in order to calculate the unconstrained maximum likelihood (lu). these two values are simply substituted into the formula of the pseudo r2. these r2-values are comparable and the model with the highest is the best model. 4 indicators examined and data used the primary focus of this paper is to compare the performance of different individual economic indicators in predicting business cycle turning points. variables such as interest rates, international indicators, stock price indices and monetary aggregates are examined. the performance of these individual indicators will also be compared with the performance of the composite index of leading indicators compiled by the south african reserve bank. most of the components of the composite index of leading indicators, for example share prices, money supply and the number of residential building plans passed, are also tested individually. it should be kept in mind that the objective of the composite index of leading indicators is not solely to predict the turning points of the business cycle, but also to provide information regarding the levels of economic growth. it is therefore possible that an individual indicator, even a single component of the composite index, can outperform the index in terms of predicting turning points, even though the index itself is better at predicting the course of the business cycle. all the variables included in the analysis are well-established leading economic indicators, and the selection is based on that of estrella and mishkin (1998). financial variables such as different stock indices are commonly associated with the expectations of future economic events. according to the dividend model of williams (1938), stock prices are the sum of expected future dividends discounted by future interest or dis counting rates. this means that stock indices sajems ns vol 6 (2003) no 2 294 are forward-looking indicators of expected economic conditions and interest rates and should therefore be good leading economic indicators. following estrella and mishkin (1998), the overall stock index as well as the financial, mining and commercial share indices and the price-earnings ratio were included in the analysis. two monetary policy variables, namely short-term interest rates and (different definitions of) money supply, were also included in the study. in addition, the long-term interest rate was included since it should reflect expected future shortterm interest rates according to the expectations hypothesis. recently the yield spread, defined as the difference between the long-term interest rate and the short-term interest rate, as leading indicator has received considerable attention in the literature (see e.g estrella & hardouvelis (1991), bernard & gerlach (1996), and estrella & mishkin (1998)). intuitively, assume that the country is currently enjoying high growth, so that there is a general agreement among investors that the country is heading for a slow-down or recession in the future. consumers want to hedge against the recession, and therefore purchase financial instruments (e.g. long-term bonds) that will deliver pay-offs during the economic slowdown. the increased demand for long-term bonds causes an increase in the price of long-term bonds, in other words a decrease in the yield on long-term bonds. in order to finance these purchases, investors sell their shorter-term assets, which results in a decline in the price of short-term assets and an increase in the yield on short-term assets. in other words, if a recession is expected, long-term interest rates will fall and short-term interest rates will rise. consequently, prior to the recession, the slope of the term structure of interest rates will become flat (or even inverted), which means that the yield spread declines. similarly, long-term interest rates rises while shortterm interest rates falls when an expansion is expected, so that an upwardsloping yield curve predicts an expansion. south africa is a small, open economy and is therefore extremely vulnerable to changes in economies in the rest of the world, especially those of our trading partners and the dominant economies such as the us and europe. this is increasingly the case since the early 1990s when south africa re-entered the international economy after economic sanctions were lifted, while globalization generally increased economic interdependence amongst countries. this motivated the inclusion of the composite index of leading indicators of south africa’s trading partners as well as that of the us. since south africa is such an open economy, exchange rates have a significant influence on the performance of the economy, and since it takes time for changes in the exchange rate to affect domestic prices and hence economic growth, the exchange rate could be a leading indicator of the economy, especially when using higher frequency data. sajems ns vol 6 (2003) no 2 295 lastly, some macroeconomic indicators such as building plans passed and unfilled and new manufacturing orders are included on the basis that they reflect the expectations of economic agents. table 2 list of variables series description transformation used interest rates rs (rss) short-term nominal (real) interest rate (3 month ba rate) rl (rrl) long-term nominal (real) interest rate (10-year government bond yield) spr yield spread, defined as the long-term minus the short-term interest rate (rlrs) monetary aggregates m3 (rm3) nominal (real) m3 money supply year on year growth m2 (rm2) nominal (real) m2 money supply year on year growth m1 (rm1) nominal (real) m1 money supply year on year growth stock prices jse all share index year on year growth fs financial shares index year on year growth ms mining shares index year on year growth cs commercial shares index year on year growth pe price-earnings ratio international indicators nee nominal effective exchange rate year on year growth ree real effective exchange rate year on year growth r$ rand-us$ exchange rate year on year growth us us composite index of leading indicators year on year growth tr composite index of leading indicators of trading partners year on year growth macroeconomic indicators bp building plans passed inf cpi inflation uo manufacturing, unfilled orders year on year growth no manufacturing, new orders year on year growth cil composite index of leading indicators year on year growth sajems ns vol 6 (2003) no 2 296 5 empirical analysis monthly data for the period march 1978 to march 2001 was used in the empirical analysis. forecasts for 1 to 18 months ahead, in other words up to a year and a half, were considered. 5.1 performance of individual leading indicators the pseudo r2 developed by estrella (1998) (see section 3.2) is used to compare the forecast performance of each individual leading indicator in forecasting business cycle turning points for 1 to 18 months ahead. the pseudo r2 values of the models are given in table 3. three different transformations of each variable were tested, namely the series in levels, in first differenced form and the year on year growth in the series. only the transformation of each series that performed best is reported, the rest of the results are omitted for brevity and are available from the author upon request. the transformation of each series that was used is reported in table 2. the highest r2 value of each indicator is indicated in bold print. table 3 pseudo r2-values of leading indicators lead month spr rs rl rrs m3 rm3 rrl inf us r$ 1 0.409 0.517 0.158 0.285 0.008 0.083 0.075 0.016 0.141 0.231 2 0.478 0.583 0.160 0.314 0.010 0.077 0.075 0.016 0.131 0.266 3 0.540 0.641 0.163 0.341 0.018 0.074 0.075 0.016 0.119 0.287 4 0.587 0.684 0.163 0.362 0.033 0.079 0.076 0.017 0.108 0.283 5 0.618 0.705 0.162 0.372 0.059 0.091 0.097 0.018 0.099 0.268 6 0.635 0.714 0.160 0.373 0.087 0.108 0.075 0.018 0.093 0.253 7 0.643 0.720 0.160 0.364 0.122 0.131 0.071 0.017 0.089 0.234 8 0.627 0.691 0.160 0.342 0.155 0.158 0.065 0.016 0.082 0.214 9 0.578 0.622 0.152 0.307 0.194 0.190 0.059 0.016 0.076 0.196 10 0.536 0.562 0.144 0.275 0.238 0.230 0.053 0.015 0.071 0.173 11 0.483 0.492 0.132 0.238 0.283 0.270 0.045 0.015 0.068 0.152 12 0.424 0.416 0.118 0.198 0.340 0.324 0.036 0.014 0.066 0.134 13 0.358 0.342 0.106 0.157 0.383 0.368 0.028 0.014 0.068 0.120 14 0.297 0.279 0.096 0.121 0.421 0.406 0.022 0.013 0.071 0.116 15 0.245 0.226 0.090 0.089 0.452 0.439 0.015 0.012 0.074 0.120 16 0.203 0.190 0.088 0.061 0.466 0.398 0.010 0.010 0.078 0.131 17 0.172 0.162 0.087 0.041 0.452 0.446 0.006 0.009 0.082 0.148 18 0.150 0.141 0.087 0.024 0.455 0.450 0.005 0.008 0.088 0.170 sajems ns vol 6 (2003) no 2 297 table 3 continued lead month bp cil pe uo nee cs no ms fs tr 1 0.037 0.644 0.435 0.173 0.132 0.118 0.340 0.228 0.153 0.017 2 0.052 0.691 0.450 0.139 0.137 0.146 0.274 0.258 0.168 0.023 3 0.064 0.713 0.462 0.114 0.139 0.159 0.229 0.285 0.180 0.028 4 0.084 0.705 0.469 0.099 0.134 0.160 0.228 0.272 0.159 0.031 5 0.113 0.665 0.470 0.083 0.127 0.162 0.187 0.271 0.156 0.033 6 0.120 0.618 0.463 0.074 0.118 0.164 0.152 0.283 0.158 0.037 7 0.143 0.553 0.448 0.070 0.108 0.153 0.140 0.268 0.145 0.040 8 0.174 0.478 0.428 0.064 0.100 0.129 0.116 0.254 0.131 0.043 9 0.192 0.393 0.410 0.064 0.096 0.104 0.102 0.218 0.110 0.047 10 0.227 0.310 0.391 0.065 0.096 0.076 0.084 0.182 0.084 0.052 11 0.258 0.234 0.373 0.068 0.101 0.048 0.069 0.144 0.058 0.058 12 0.269 0.167 0.359 0.074 0.111 0.028 0.067 0.106 0.036 0.065 13 0.287 0.114 0.348 0.078 0.125 0.014 0.067 0.076 0.019 0.073 14 0.298 0.072 0.341 0.082 0.145 0.009 0.069 0.056 0.012 0.079 15 0.301 0.041 0.337 0.086 0.168 0.002 0.031 0.036 0.009 0.084 16 0.302 0.022 0.341 0.088 0.191 0.009 0.080 0.029 0.008 0.088 17 0.294 0.012 0.341 0.091 0.216 0.010 0.085 0.021 0.009 0.091 18 0.295 0.008 0.337 0.093 0.241 0.012 0.089 0.012 0.011 0.096 from the results in table 3 it is clear that the short-term interest rate leading 7 months has the highest r2 value, followed by the year on year change in the reserve bank’s composite index of leading indicators leading 3 months, and the yield spread leading 7 months. these three models explain 72.0404 per cent, 71.2595 per cent and 64.3182 per cent respectively of the variation in the dependent variable. however, the composite index of leading indicators is only available with a four to five month lag, and is subject to revision. in other words, the optimal number of months ahead is not available in time for forecasting. the months that are available yield lower r2 values than the yield spread, which should be kept in mind when using these indicators for forecasting purposes. both the short-term interest rate and the yield spread are immediately available and not subject to revision, and both of them has the same optimal forecasting period. 5.2 probit models table 4 presents the results of the probit models with the composite index of leading indicators, the short-term interest rate and the yield spread. each of the models was estimated with only one explanatory variable and a constant, with the leading time chosen on the basis of the pseudo r2 values in table 3. the sajems ns vol 6 (2003) no 2 298 parameters were estimated with maximum likelihood and their standard errors are reported below in parenthesis. table 4 probit models explanatory variable lead (months) constant coefficient pseudo r2 spr 7 0.246 -0.493 64% (0.107) (0.050) rs 7 -7.425 0.519 72% (0.818) (0.056) cil 3 0.361 -0.273 71% (0.119) (0.030) the results in table 4 are interpreted as follows: p(rt+7 = 1) = f(0.246 – 0.493*sprt) (5) p(rt+7 = 1) = f(-7.425 + 0.519*rst) (6) p(rt+3 = 1) = f(0.361 – 0.273*cilt) (7) where f is the cumulative normal distribution, rt is a dummy variable that takes on the values one if the economy is in a recession in period t, and p(rt+i = 1) is the probability that the economy is in a recession in period t+i. these results are consistent with a priori expectations. according to the results in equation 7 there is a negative relationship between the composite index of leading indicators and the probability of a recession, which means that an increase in the composite index of leading indicators predicts a decline in the probability of a future recession. in other words, an increase in the composite index of leading indicators indicates a higher probability of an economic upswing, which is consistent with the construction of the composite index of leading indicators. equation 6 indicates that an increase (decrease) in the shortterm interest rate is associated with an increase (decrease) in the probability of a future recession. in other words, lower interest rates stimulate the economy since it increases (decreases) the likelihood of a future economic upswing (downswing). according to equation 5 there is a negative relationship between the interest rate spread and the probability of a recession in future, which means that increases in the interest rate spread lowers the probability of a future recession. this is consistent with the theoretical relationship between the interest rate spread and economic activity, according to which the interest rate spread will decline prior to a recession (see section 4). sajems ns vol 6 (2003) no 2 299 given these formulas, the probability of a recession associated with certain values of the explanatory variables can be calculated easily. for example, a short-term interest rate of 13 per cent in a certain period indicates that the probability that the economy will be in a recession 7 periods ahead is 25 per cent. the recession probabilities of some of the possible values of the explanatory variables are given in table 5. the last row in table 5 presents the values of the three economic indicators associated with the probability of a recession of exactly 50 per cent. in other words, an interest rate spread below 0.499 per cent and a year-on-year growth in the composite index of leading indicators below 13.22 per cent predicts that the economy is more likely to be in a recession than an expansion seven or three months ahead respectively. on the other hand, a short-term interest rate above 14.306 per cent predicts that the economy is more likely to be in a recession than an expansion seven months ahead. table 5 probability of a recession two quarters ahead as a function of the short-term interest rate, the interest rate spread and the composite index of leading indicators sprt p(rt+7 = 1) rst p(rt+7 = 1) clit p(rt+3 = 1) -6 1.00 4.00 0.00 -13.00 1.00 -5 1.00 5.50 0.00 -10.00 1.00 -4 0.99 7.00 0.00 -7.00 0.99 -3 0.96 8.50 0.00 -4.00 0.93 -2 0.89 10.00 0.01 -1.00 0.74 -1 0.77 11.50 0.07 2.00 0.43 0 0.60 13.00 0.25 5.00 0.16 1 0.40 14.50 0.54 8.00 0.03 2 0.23 16.00 0.81 11.00 0.00 3 0.11 17.50 0.95 14.00 0.00 4 0.04 19.00 0.99 17.00 0.00 5 0.01 20.50 1.00 20.00 0.00 6 0.00 22.00 1.00 26.00 0.00 0.499 0.5 14.306 0.5 13.322 0.5 figures 1 to 3 plot the estimated probability of a recession derived from each model. the shaded areas denote periods of actual recessions as classified by the south african reserve bank, and the lines indicate the probability that the economy is in a recession in that period. sajems ns vol 6 (2003) no 2 300 figure 1 recession probability predicted by short-term interest rate figure 2 recession probability predicted by interest rate spread the lines in figures 1 to 3 represent the probability that the economy will be in a recession in a particular period as calculated by the three different probit models using the short-term interest rate, the interest rate spread and the composite index of leading indicators respectively as explanatory variables. if the probability of a recession is above (below) 50 per cent, it will be regarded as a predicted recession (expansion). these predicted recessions can be compared with the official dates of the south african reserve bank presented by the shaded areas. for example, the composite index of leading indicators predicted a recession early in 1981 (when the probability of a recession exceeded 50 per cent) compared with the actual recession that occurred at the end of 1981. 0.0 0.2 0.4 0.6 0.8 1.0 78 80 82 84 86 88 90 92 94 96 98 00 0.0 0.2 0.4 0.6 0.8 1.0 78 80 82 84 86 88 90 92 94 96 98 00 sajems ns vol 6 (2003) no 2 301 figure 3 recession probability predicted by composite index of leading indicators none of the three models missed any cycle. however, the model with the composite index of leading indicators gave a false signal of a downswing in january 1996 and an upswing in january 1997. in addition, the model with the composite index of leading indicators gave a false signal of a downswing in january 2001. in general, all three models performed fairly well. the models with the short-term interest rate and the yield spread seems to have performed somewhat worse at the beginning of the sample with the 1983-1984 upswing, while they performed quite well for the rest of the period. on the other hand, the performance of the model with the composite index of leading indicators seemed to have deteriorated over the sample period. the deteriorating performance of the composite index and the improving performance of the interest rate models might be the result of important structural change in the economy. and, unlike the composite index, neither of the interest rate models gave any false signals. in addition, the optimal forecast period of the interest rate models are both seven months compared to three months in the case of the composite index, and the interest rate variables are available in time and are not revised. therefore, both interest rate models are preferred to the model with the composite index of leading indicators. in general, the model with the short-term interest rate performed slightly better than the model with the yield spread. 0.0 0.2 0.4 0.6 0.8 1.0 78 80 82 84 86 88 90 92 94 96 98 00 sajems ns vol 6 (2003) no 2 302 6 conclusion the objective of this study was to find the individual leading indicator that is best at predicting turning points of the south african business cycle. the pseudo r2 indicated that the three best individ ual indicators are the short-term interest rate, the yield spread and the composite index of leading indicators compiled by the south african reserve bank. they led the turning points with seven, seven and three months respectively. a close inspection of the probit models of these three individual indicators as explanatory variables indicated that the two interest rate models are preferred to the model with the composite index. data availability is better in the case of the interest rates, and unlike the composite index, neither of them gave any false signals. in general, their performance seemed to have improved over the course of the sample period, while the performance of the composite index seemed to have deteriorated over the course of the sample period. performance at the end of the sample is obviously more important for forecasting purposes. in addition, these trends might also be reflecting an underlying structural change in the economy, which makes the interest rate models even more desirable since it seems as if they are better at predicting the new structure than the composite index. references 1 bernard, h. & gerlach, s. (1996) “does the term structure predict recession? the international evidence”, bank for international settlements working paper no 37. 2 burns, a.f. & mitchell, w.c. (1946) measuring business cycles. new york: national bureau of economic research. 3 cook, m.p. & smit, e. v.d. m. (2001) “forecasting cyclical turning points by means of a probabilistic approach: some south african evidence”, journal for studies in economics and econometrics, 25(3): 75104. 4 dotsey, m. (1998) “the predictive content of the interest rate term spread for future economic growth”, federal reserve bank of richmond economic quarterly, 84: 31-51. 5 dueker, m.j. (1997) “strengthening the case for the yield curve as a predictor of us recessions”, federal reserve bank of st. louis review, 79: 41-51. 6 estrella, a. (1998) “a new measure of fit for equations with dichotomous dependent variables”, journal of business and economic statistics, 16(2): 198-205. 7 estrella, a. & hardouvelis, g.a. (1991) “the term structure as a predictor of real economic activity” the journal of finance, 46: 555-75. sajems ns vol 6 (2003) no 2 303 8 estrella, a., & mishkin, f.s. (1998) “predicting u.s. recessions: financial variables as leading indicators”, the review of economics and statistics, 80: 45-60. 9 ivanova, d., lahiri, k. & seitz, f. (2000) “interest rate spreads as predictors of german inflation and business cycles”, international journal of forecasting, 16(1): 39-58. 10 mishkin, f.s. (1998) the economics of money, banking, and financial markets, addison-wesley. 11 nel, h. (1996) “the term structure of interest rates and economic activity in south africa”, the south african journal of economics, 64(3): 161-74. 12 williams, j.b. (1938) the theory of investment value, massachusetts: cambridge press. f:\ejour\ecoman\ftp\ecoman_v6_n1.prn.pdf sajems ns vol 6 (2003) no 1 89 an exploratory study of group adverse impact in a recruitment and selection strategy ________________________________________________________________ r j snelgar and t potgieter department of industrial and organizational psychology, university of port elizabeth ________________________________________________________________ abstract the adverse impact model was developed by the judicial system of the united states of america and the united kingdom as a practical method to make legal judgements to determine whether designated groups are being unfairly discriminated against at any stage of an assessment process. the model has been used to assess various recruitment and selection instruments and measures. this study has been groundbreaking in that the application of the adverse impact model within the south african employment scenario is relatively new. an exploratory research design was used to analyse adverse impact at each stage of a recruitment and selection strategy. the model was applied to assess whether the instruments used, had an adverse impact on any of the designated groups. jel j70 1 introduction ensuring fairness should be the priority of any selection strategy, particularly in south africa, where attempts are being made to rectify past practices that have had a discriminatory effect on certain sections of the population. the south african employment equity act awards priority to the issue of group representivity in employment outcomes and ensures equal representation in all occupational categories and levels in the workplace (mdladla, 2001). affirmative action is a strategy for manoeuvering equal opportunities in the workplace. although the purpose is to redress the disadvantages in employment experienced by certain groups, there are restrictions and limitations to enforcing this policy. an objective appraisal of the inherent abilities of specific job applicants is still a procedural requirement (taylor, 1999). thus, because of the vital importance of fairness, the issue of fairness should be based on the end to end process of the entire recruitment and selection strategy, and not be isolated to one aspect of measurement. any recruitment and selection decision is based on one or other selection model of decision-making. the sajems ns vol 6 (2003) no 1 90 question that must be asked is whether the model itself is “fair”, as well as whether or not the instruments of evaluation and assessment employed, allow for equal treatment of all candidates. ensuring fairness, therefore, should be the priority of any selection strategy. an overview of the literature shows that there is a real and pressing need to explore the concept of adverse impact in more detail, particularly regarding the role it plays in determining the fairness of recruitment and selection strategies. research on adverse impact has revealed that the ongoing search for objective measures, on which all applicant groups perform the same (thus resulting in no adverse impact and equality of employment results) has generally not been productive (barrett, 1995; barrett, 1996; schmidt, rodgers, chan, sheppard & jennings, 1997; wollack, 1994). the adverse impact model or 4/5th's rule has been developed by the courts of the united states of america, and has also been adopted by enforcement agencies in the united kingdom as a practical way of making legal judgements on whether designated groups are being unfairly discriminated against at any stage of an assessment process (barrett, 1996). as a result of the search for objective measures, the adverse impact model has been used as a means for the assessment of various measures, and the research results have been used to improve selection strategies (hattrup, rock & scalia, 1997; ironside, guion, & ostrander, 1982; maxwell, 1993; mckinney & collins, 1991; raju & edwards, 1984; robertson & kandola, 1982; ryan & ployhart, 1998; sackett & ellingson, 1997). 2 adverse impact muchinsky (1987: 132) defines adverse impact as: the results of any selection method that causes a disproportionate percentage of people of a given category to be hired compared to another group. adverse impact exists if the selection ratio associated with a particular passing score on a test for one sub-group of job applicants is less than 4/5th’s or 80 per cent of the selection ratio for the largest sub group of applicants. adverse impact represents a difference in selection ratios for members of different groups and is generally the result of whiteblack mean differences on ability tests that are approximately one standard deviation in magnitude. since policy promoting an investigation of a company’s selection program is evidence of adverse impact, companies hire people (white/black, male/female) sajems ns vol 6 (2003) no 1 91 in proportions that comply with government standards (taylor, 1999). thus, adverse impact has become a useful tool to determine the differences in selection ratios such that these proportions may be complied with. adverse impact is based on the logic of proportionality. ratios of accepted/rejected applicants are compared across designated and non-designated groups with the assumption that these ratios should be similar across groups if unbiased decision-making is occurring (muchinsky, 1987). the advantage of this approach is that it provides a simple decision rule for checking potential biased assessment outcomes in organisations. a disadvantage may be that the shortage of black skills in certain areas will necessitate the distortion of ratios, but the magnitude of the ratio differences provides valuable information for analysis. the data needed for adverse impact analysis is simply the number of designated and non-designated applicants who are accepted and rejected at each hurdle in the assessment process. if it is established that a difference of less than 80 per cent exis ts in the acceptance ratios for different groups, then the organisation would be required to explain the circumstances and if necessary demonstrate the validity of any assessment hurdle which may be associated with the adverse impact finding. the 80 per cent figure is accepted by courts as a reasonable indicator of similarity in outcomes in comparing the selection ratios of groups, since in reality it is unreasonable to expect identical outcomes (barrett, 1996). from the above it may be noted that one of the positive features of the adverse impact model is the simplicity of its application. equal employment opportunity asserts that all selection tests that result in adverse impact must be validated (disability information partnership, 1999). if adverse impact is found to exist, the employer is obligated to validate the selection procedure to prove that the resulting personnel decisions were indeed based on a correct and valid method. psychological assessment instruments are, however, likely to provide useful and objective means of assessing candidates, as long as the test or instrument measures attributes required to achieve job success. employers need to justify and defend their decision-making processes by relating criteria on which these decisions are based, to the requirements of the job (saville & holdsworth, 1997). this way they can identify exactly what the requirements of the job are to ensure selecting the most competent applicants and ensuring that all employees are trained to perform at their optimum potential. new legislation has therefore forced organisations to look more closely at the requirements of the organisation and the people employed within the sajems ns vol 6 (2003) no 1 92 organisation. research on adverse impact indicates that it is evident that there is the potential for this technique at any stage of a selection process (muchinsky, kriek & schreuder, 1998: 195-210). 3 research methodology this research took place in a telecommunications call centre environment. there were sixteen vacancies in the department. the call centre selection strategy consisted of a validated battery of instruments and measurements. the validity and effectiveness of a selection procedure, to a large degree, depends on how the organisation uses the information. the success or failure of the selection system depends on effective construction of the process for gathering predictor information. applicants are rarely selected using only one selection procedure. the telecommunications call centre recruitment strategy consisted of a combination of measuring instruments and selection "obstacles". using multiple procedures can provide more complete information and allows the selection process to be adjusted in response to particular situations (milkovich & boudreau, 1994). the multiple hurdle approach was adopted for the telecommunications call centre recruitment process. in this approach, each predictor operates independently. applicants must pass the first hurdle to proceed to the next, and failure in a particular hurdle resulted in the applicant's rejection from the process. applicants needed to comply with the minimum qualifications in their curricula vitae to proceed to the psychological testing stage, and needed to qualify on the ability tests to proceed to the role-play exercise. applicants who demonstrated required competencies and potential in the role-play progressed to the interview stage. 3.1 aims the aims of this study are: • to identify whether adverse impact occurs in the call centre selection strategy. • to ensure fairness in future selection outcomes. • to deliver recommendations to the management team regarding the strengths and limitations of the research. sajems ns vol 6 (2003) no 1 93 3.2 research design an exploratory research design was employed in this study. this research method was chosen as an appropriate way of gathering the data in order to meet the aims of the study since insufficient published research has been conducted in the area of adverse impact in the south african context. 3.3 sample the population under investigation includes all the candidates that applied for the position of service representative, cfh (customer fault handler) in the call centre, central region. the population consisted of 150 candidates. the majority of the candidates (105) were internal applicants (n=150). forty-five of the applicants were from outside the company, and were introduced into the sample via placement agencies. due to the fact that all candidates who applied for the positions in the call centre were included in the research study, no particular sampling method was used. the requirement for inclusion in the sample was grade 12, with mathematics and/or science, irrespective of age, culture or gender. the original sample consisted of 150 applicants. a shortlisting exercise was initiated and job relevant criteria were assessed based on information presented in the curricula vitae. this process resulted in a compressed shortlist of 25 candidates. 3.4 measuring instruments the following evaluation instruments were applied in the recruitment and selection strategy: (i) job analysis; (ii) pre-screening exercise; (iii) ability tests; (iv) role-play; (v) interview; (vi) job-compatibility questionnaire and (vii) performance evaluation. each of the seven instruments measures certain job-related competencies. the adverse impact model was used as the foundation of the study and the 4/5th's formula was applied at the testing, interview and appointment stages of the selection process to determine the extent to which adverse impact was evident. the job analysis formed the basis of the entire selection strategy as critical competencies were classified at this point. the pre-screening and ability testing comprised stage 1 of the adverse impact analysis. the role-play was administered but due to internal complications, there was insufficient information for analysis. the interview represented the second stage of analysis. the appointment phase was analysed in stage 3. the job sajems ns vol 6 (2003) no 1 94 compatibility interview and performance evaluation aspects provided additional information pertaining to person-environment congruence. these aspects were not exposed to an adverse impact analysis. 4 results table 1 reveals the results of the adverse impact analysis at stages of the recruitment and selection strategy. adverse impact analysis has been conducted for population as well as for gender groups. table 1 adverse impact analysis designated groups no. of qualified applicants (meet min. req.ments) a selected to undergo testing above cut-off on learning potential test b percentage of a all black 23 21 12 12/21x100=57 white 2 2 2 2/2x100=100% adverse impact analysis 57 / 100 = 57% adverse impact black female 5 4 3 3/4x100=75% male 20 19 11 11/19x100=57% adverse impact analysis 57/75x100=76% adverse impact males total 25 designated groups selected for an interview above cut-off in the interview c percentage of b employed d percentage of a all black 23 11 11/23x100=47% 14 14/23x100=60% white 2 2 2/2x100=100% 2 2/2x100=100% adverse impact analysis 47 / 100 = 47% adverse impact black 60 / 100 = 60% adverse impact black female 5 3 3/5x100=60% 3 3/5x100=60% male 20 10 10/20x100=50% 13 13/20x100=65% adverse impact analysis 50/60x100=83% no adverse impact 60/65x100=92% no adverse impact total 25 sajems ns vol 6 (2003) no 1 95 the first stage of the impact analysis was the testing stage. the all black population group reflected adverse impact at this stage. the all black group consisted of african, coloured and indian population groups. the male gender group also reflected adverse impact at this stage. the interview phase was the next level of analysis. once again the all black group has reflected adverse impact. neither of the gender groups reflected adverse impact at this stage. the next stage of analysis involved the appointment step. the analysis in this division was based on the number of candidates appointed in relation to the number of candidates who met the minimum criteria (n=25). 16 candidates were appointed. based on the four fifth's formula it is interesting to see that the all black group was the only group that evidenced adverse impact in the final stage. once again, there was no adverse impact indicated in terms of gender comparisons. it is imperative to remember that the adverse impact at each stage be calculated in isolation from the next stage, and dealt with accordingly. one cannot assume that if there was no evidence of adverse impact in the final and probably critical stage of the selection process that the complete strategy is free from adverse impact. prior to 1982, adverse impact was defined using the bottom-line principle, which meant that there was no cause for action if the overall impact rate fell above the 80 per cent line. however the united states supreme court in 1982 overturned this rule making it possible to bring an action against any part of a process that had adverse impact (barrett, 1996). it is commonsensical to determine the level of impact at each assessment obstacle so that the fairness of each hurdle can be verified. the validity of each assessment hurdle needs to be confirmed. 5 recommendations and conclusions over the longer term a spin-off from this study will signify the use of the adverse impact model as a method of ensuring fairness in recruitment and selection. proposals will be made to encourage all hr practitioners to consistently benchmark outcomes of selection strategies against this model. based on the extent of the adverse impact sustained in this selection strategy, recommendations will be made to the management team regarding the fairness of this procedure. a summary of the findings of the study will be presented to sajems ns vol 6 (2003) no 1 96 the management team with the recommendation of reviewing the current selection process and assessment instruments. a further suggestion will be made to conduct a more recent job analysis to confirm whether the job requirements have remained the same and whether the psychometric tests are measuring the relevant attributes. if the job analysis reveals changes in the requirements of the job, alternative ability tests and competencies will need to be considered. in order to prevent, or at least minimise the extent of adverse impact, companies need to embark on an ongoing search for objective measures on which all applicants perform the same, thus resulting in no adverse impact and equality of employment results. companies need to continually examine the relevance of the selection instruments they use before including them in the selection procedure, and if required, redesign and revalidate the strategy. companies should also assess the level of the psychometric test to ensure that the tests being administered are aligned with the appropriate norm group. if it has been determined that the level of the test is too high they should explore the possibility of using an alternative version of the same test. south african legislation today encourages companies, and specifically human resources practitioners, to keep record of every stage of a selection process, should the necessity to defend an employment decision emerge. affirmative action and employment equity policies have their function and are meant to speed up the racial re-engineering of the workplace. nevertheless, managers should not ruthlessly dispense with objective assessment of the inherent abilities of applicants to the job (taylor, 1999). ignoring the presence of adverse impact could result in inequalities in selection as well as erroneous selection and rejection. if talented people are consistently and systematically disqualified from employment opportunities, then these excluded people represent wasted human resources. the legal implication of unfair and discriminatory recruitment and selection is formidable. personnel practices that have a differentiated approach to certain groups are illegal, unless these differences can be justified as necessary for the safe and efficient operation of the business, and are work-related. if group adverse impact is disregarded, the elimination of unlawful employment practices will be compromised. no matter how well intended the elimination of objective employment standards are in the pursuit of equal employment results, neglecting to attend to the development of alternative solutions, may well contribute to a productivity decline. sajems ns vol 6 (2003) no 1 97 although the concept of adverse impact and the use of 4/5th’s rule are not built into employment equity legislation in south africa, it is likely to be a very important tool in south african organisations. there is an increasing demand for institutions to be accountable and to demonstrate that the assessment instruments and procedures that they use, are not only psychometrically valid and reliable, but also fair, free from bias, and thus being in line with the concept of adverse impact. references 1 barrett, r.s. (1995) adverse impact: fair employment strategies in human resource management, london: quorum books. 2 barrett, r.s. (1996) person-environment congruence. fair employment strategies in human resource management, london: quorum books. 3 disability information partnership (1999) the law and legal issue. summary of the employment equity act, 55 of 1998, available: http://www.ability.org.za. 4 hattrup, k., rock, j. & scalia, c. (1997) “the effects of varying conceptualizations of job performance on adverse impact, minority hiring and predicted performance”, journal of applied psychology, 82. 5 ironside, g.h., guion, r.m. & ostrander, m. (1982) “adverse impact from a psychometric perspective”, journal of applied psychology, 67. 6 maxwell, s.e. (1993) “the search for predictors with high validity and low adverse impact”, journal of applied psychology, 78. 7 mckinney, w.r. & collins, j.r. (1991) “the impact on utility, race, and gender using three standard methods of scoring selection examinations”, public personnel management, 20. 8 mdladlana, m.m.s. (2001) “code of good practice on key aspects of disability in the workplace”, employment equity act no 55 of 1998, available: http://www.labour.gov.za. 9 milkovich, g.t. & boudreau, j.w. (1994) human resource management, boston: irwin. 10 muchinsky, p.m. (1987) psychology applied to work: an introduction to industrial and organisational psychology, homewood, illinois: dorsey press. 11 muchinsky, p.m., kriek, h. & schreuder, a. (1998) personnel psychology, cape town: thompson international. 12 raju, n.s. & edwards, j.e. (1984) “note on adverse impact from a psychometric perspective”, journal of applied psychology, 69. sajems ns vol 6 (2003) no 1 98 13 robertson, i.t. & kandola, r.s. (1982) “work sample tests: validity, adverse impact and applicant reaction”, journal of occupational psychology, 55. 14 ryan, a.m. & ployhart, r.e. (1998) “using personality testing to reduce adverse impact: a cautionary note”, journal of applied psychology, 83. 15 sackett, p.r. & ellingson, j.e. (1997) “the effects of forming multi-predictor composites on group differences and adverse impact”, personnel psychology, 50. 16 saville & holdsworth (2000) “reliability study”, research and development, available: http://www.shl.co.za. 17 schmidt, n., rodgers, w., chan, d., sheppard, l. & jennings, d. (1997) “adverse impact and predictive efficiency of various predictor combinations”, journal of applied psychology, 82. 18 taylor, j. (1999) “using the adverse impact model to achieve fair assessment outcomes”, unpublished paper, society for industrial psychology conference, csir convention centre. 19 wollack, s. (1994) “confronting adverse impact in cognitive examinations”, public personnel management, 23. microsoft word vol6no3'3.doc sajems ns 6 (2003) no 3 514 contribution of support and incentive programs to entrepreneurial orientation and start-up culture in south africa ________________________________________________________________ marius pretorius and jurie van vuuren department of business management, university of pretoria ________________________________________________________________ abstract this paper discussed the role of an entrepreneurial orientation (eo) and start-up culture to enhance economic development. it investigates the proposition that the south african culture is conducive to eo. secondly, this paper investigates the available programs from an entrepreneurial culture perspective. programs are categorised to delineate their different focuses. key issues reported include the program focus, the level of venture development aimed at and their target groups. finally it questions the contribution of these programs to entrepreneurial culture and suggests remedies. the paper concludes that despite the number of different programs that exist, the concept of entrepreneurial culture to improve eo is not addressed. jel m13 1 introduction in the rush to stimulate entrepreneurial activity, policy makers often rely on success stories, anecdotes and cases to demonstrate the utopia that will result when entrepreneurial activities take off. in south africa, as in many other countries, the national strategy for the development and promotion of small business in south africa identifies small business development and the empowerment of entrepreneurs as the most important avenue for economic growth. (act 102, 1996: 10). gorman, hanlon and king (1997: 56) confirm that there is widespread recognition that entrepreneurship is the engine that drives the economy of most nations. timmons (1999: 4) also refers to entrepreneurship as america�s secret weapon and argues its value as the main contributor to the superior position that the usa holds as part of the global economy. he suggests entrepreneurship to be the fundamental difference in the american culture where 37 per cent of the sajems ns 6 (2003) no 3 515 population is somehow involved in their own ventures apart from their regular jobs. this opinion underscores the need for large numbers of entrepreneurs for a successful economy as described by sunter (1994: 4). however, four years later, sunter (1998: 2) still calls for entrepreneurial development and again highlights its importance when he states, �it is only through the creation of millions of enterprises that millions of jobs will be created�. today, the use of the phrase entrepreneurial development has become a buzzword in the speeches delivered from almost every public platform, but the question could rightly be asked; what has changed in entrepreneurship, small business development and economic growth since the initial call? driver, wood, segal and herrington (2001) in their annual global entrepreneurship monitor (gem) reports an overall lack of entrepreneurial elements from the culture of south africa. factors such as: attitude towards entrepreneurship, entrepreneurial role models, negative mindsets towards confidence, initiative and creativity, negative perception towards entrepreneurship as a career choice and negative attitude towards failure are all sited to contribute towards the south african entrepreneurial culture. 2 purpose of the article the focus of this paper, thus, centres on entrepreneurial culture and its role and effect within the society under the premises that when it exists or is high, growth in numbers of entrepreneurs and their associated business ventures will benefit economic development. understanding cultural influences on the development of entrepreneurial potential is crucial to the internalisation of entrepreneurship theory and the development and implementation of policy initiatives to encourage entrepreneurship. 2.1 entrepreneurship the construct of entrepreneurship is both complex and controversial as there is no agreement on the definition. kaufmann and dant (1998: 7) categorize entrepreneurship based on the different contemporary representative definitions found in the literature. they conclude that three perspectives can be determined by the definition focuses namely: � definitions stressing the characteristic traits or qualities supposedly possessed by entrepreneurs including risk taking, leadership, motivation, ability to resolve crises, creativity, low level of risk aversion, decision making ability and more. sajems ns 6 (2003) no 3 516 � definitions stressing the process of entrepreneurship and it�s result including the creation of new enterprise, introduction of new combinations of production factors and new, unique and valuable combinations of resources in an uncertain and ambiguous environment. � definitions focussing on the activities entrepreneurs perform including connecting to new markets, overcoming market deficiencies, creating and managing contractual arrangements and input transforming structures, supplying resources lacking in the marketplace, activities to initiate, maintain and develop profit oriented business, to fill currently unsatisfied needs and to take operational control of the organization. the study of kaufman and dant (1998), however, concludes that consensus about the construct of entrepreneurship remains elusive. morris (1997: 17) defines entrepreneurship as the process through which individuals and/or teams create value by bringing together unique packages of resource inputs to exploit opportunities in the environment. it can occur in any organizational context and results in a variety of possible outcomes, including new ventures, products, services, processes, markets and technology. given this broad definition of entrepreneurship, its applicability is much broader than merely limiting it to the discipline of business only. this paper, however, is concerned with entrepreneurial thinking, orientation, activities and the way of being entrepreneurial as found specifically in its manifestation within individuals and how it is viewed and supported by the society and the impact of the culture as a contextual factor determining the entrepreneurial way of being. 2.2 entrepreneurial culture and entrepreneurial orientation the assertion that there is a greater predisposition or propensity towards entrepreneurship in some societies than others points to the implicit role of culture. thomas and mueller (2000: 289) quote weber (1904) who argues that at the society level, differences in entrepreneurial activity could be explained by cultural and religious factors. they also quote mcclelland (1961) who suggested that socialization factors such as parental influences determine the need for achievement, which in turn generates entrepreneurial propensity within a society. he further predicted that societies with cultures that emphasise achievement would exhibit greater levels of entrepreneurship than societies that did not. culture considers the shared values, beliefs and norms of a society and is an important contextual factor affecting the number of potential entrepreneurs in a given community, ethnic group, region or country. maasdorp and van vuuren sajems ns 6 (2003) no 3 517 (1998: 727) propose a model that includes the population (society, supporting and cooperative environments to determine the number of entrepreneurs entering the economy through venture start-ups. they suggest these factors influencing entrepreneurial environment include several aspects including: the acceptability of entrepreneurship in the society, availability of financing, training and development programs, deregulation and even infrastructure. meuller and thomas (2000: 52) conclude that some cultures are more conducive for entrepreneurship than others. culture, it appears, may condition potential for entrepreneurship, generating differences across national and regional boundaries. the question is therefore: how do cultural mores, values and beliefs either encourage or discourage individuals from entrepreneurial activity. understanding the nature of the relationship between culture and entrepreneurship can provide valuable information to policy makers to motivate new venture creation and thereby increase employment and economic growth that is so desperately needed. thomas and mueller (2000) describe four dimensions of culture for different countries and identify differences between countries and even within regions of the same country. the four dimensions they used to describe culture are based on hofstede (1980) and include: � innovativeness, which include creativity, imaginative, inventive, enterprising, original, resourceful and farsighted. � internal locus of control, which is closely related to individualism compared to collectivism on the profile of hofstede (1980). � risk taking, which is closely related to the opposite of risk avoidance described by hofstede (1980). � energy, which is associated with individualism as described by hofstede (1980) as well as time usage. these authors conclude that three of the above traits associated with entrepreneurial potential, namely internal locus of control, moderate risk taking propensity and high energy level decrease in frequency as cultural distance from the united states profile increases where the us is taken as the benchmark in fitting the culture dimensions supporting entrepreneurial activity and orientation. anonymous (2001: 60) in the economist reports some visible changes taking place within the korean corporate culture namely: ! fear of failure is no longer the deterrent to starting new business in south korea than it once was, a big step forward in a country in which failed businessmen have traditionally been looked down on. sajems ns 6 (2003) no 3 518 ! performance based pay schemes to motivate employees to develop achievement orientation (internal locus of control). ! abandoning of lifetime employment for movement between jobs, which encourages risk taking. considering these changes it seems that components of entrepreneurial culture are more subject to change than factors generally associated with culture. billig (1994: 679) also suggests that entrepreneurial culture may not be as deeply entrenched than other cultural determinants. it is therefore more flexible in its response to changes in the political, economic and social conditions. dana (1995: 95) suggests that social values may cause entrepreneurs to be looked up to, or down upon, depending on the beliefs of society and their prominent moral code of behaviour. he sites the case of men in laos that embraces the traditional values of theravada buddhism, a belief system that opposes achievement motivation as it proposes the elimination of �desires�, which in that culture is the root of all evil. a respectable person within the laos culture, then, should not work towards the satisfaction of materialistic desires. however, it is acceptable for women to do so and the result is women entrepreneurs who works and trade. the lack of enterprise and entrepreneurial studies at school, in vocational education and training in higher education forms part of the reason why there is not a strong small business culture in australia (donnely, 1995: 21). education forms a crucial part of the fixation of a culture. lee and peterson (2000: 403) quotes berger�s statement that culture serves as the conductor while entrepreneurship is the catalyst for the development of an entrepreneurial orientation within individuals. lee and peterson (2000: 410) also proposed a model depicting the relationship between culture and entrepreneurial orientation and how it relates to global competitiveness (see figure 1). they compare different countries (cultures) including the united states, former russian countries, japan, china and mexico and show clearly that entrepreneurial orientation is very different between those measured. they conclude that a culture that is low on power distance, weak in uncertainty avoidance, masculine in nature, individualistic, achievement oriented, and universalistic will engender a strong entrepreneurial orientation, characterised by autonomy, pro-activeness competitive aggressiveness, innovativeness and risk taking. such a strong entrepreneurial orientation will ultimately lead to increased entrepreneurship and global competitiveness. sajems ns 6 (2003) no 3 519 arguing that entrepreneurship and the manifestation thereof within the culture are complex constructs, the understanding of the relationship cannot be less complex. meuller and thomas (2000: 52) indicate that culture is only one of many contextual factors that contribute to the rate of venture creation. it is argued that the components of culture are often vague and depends on perceptions, intention and even the motivational level of the researcher. suffice it to say that the ideas associated with this paper have as aim to open what is generally perceived as a �taboo� subject in the south african context as culture is generally viewed a racial issue and very sensitive. the authors are of the opinion that a core issue hampering entrepreneurial development may be covered up by being politically correct, as seen in the figure below. rather than opening a can of worms that may lead to meaningful discussion, research and action to improve the current situation if it proves to be relevant, people tend to shy away from the risk of being politically incorrect. the authors believe that it is worth the risk if it can make a difference and based on the evidence cited, it is very relevant. this paper concentrates on south african context but could have wider application especially cited in the context of the rate of globalisation. it is argued that while there are several programs available to enhance economic development, few, if any, impact on the development of an entrepreneurial culture as suggested in this text. three of the key programs of south african service providers are investigated. the key vehicles in south africa that have to do with entrepreneurial development is the department of trade and industry (dti) and its implementation arms namely the idc, ntsika and khula. this research evaluated the goals of their programs and involvement in the economic development through business creation. sajems ns 6 (2003) no 3 520 figure 1 model depicting the relationship between culture and entrepreneurial orientation as it relates to entrepreneurship and global competitiveness (lee & peterson, 2000: 410) 3 propositions firstly it is required to determine whether the south african culture is conducive to entrepreneurial orientation and therefore the proposition is set that the south african culture is conducive to an entrepreneurial orientation rather than not being conducive. secondly it is required to determine whether development and support programs contribute to the enhancement of entrepreneurial start-up culture and therefore environment • political • education • economic • social culture • power distance • uncertainty avoidance • individualism • masculinity • achievement • universalism entrepreneurial orientation • autonomy • competitive aggressiveness • pro-activeness • innovativeness entrepreneurship global competitiveness sajems ns 6 (2003) no 3 521 the proposition is set that official development and support programs contribute to the enhancement of entrepreneurial start-up culture rather than not contribute. 4 methodology firstly, the literature was searched for references to south african or african culture and its impacts on entrepreneurial orientation and possible relationship to the culture dimension as described by lee and peterson (2000: 405) based on the framework of hofstede (1980) and trompenaars (1994) that they cited. thereafter, the most well known programs namely those of the dti and its associated implementation bodies (idc, khula and ntsika) with their different programs were investigated as a cross sectional secondary data study. the programs have different goals and target groups as part of their overall aim to improve economic growth and development. the available programs were evaluated based on how they are described in the promotional material and web sites of the dti with an investigative evaluative method. the descriptions of the goals and prerequisites for each program were evaluated and classified into categories for business size and growth stage of the venture the programs are aimed at. figures were developed to depict the difference between programs. 5 findings table 1 depicts references from the literature that are directly related to south african, african, sub sahara african and even to developing economies where african is implied and its relationship to the dimension of culture. table 1 categorising african culture for the main dimensions that may impact on entrepreneurial orientation based on lee and peterson�s evaluation cultural dimension1 conducive to entrepreneurial culture2 categorisation for african culture reference for african evaluation uncertainty avoidance weak strong themba et al. (1999: 110) driver et al. (2001: 4) sono (1994) sajems ns 6 (2003) no 3 522 table 1 continued cultural dimension1 conducive to entrepreneurial culture2 categorisation for african culture reference for african evaluation power distance low high themba et al. (1999: 110) fadiman (2000: 82) sono (1994) masculinity masculine féminine themba et al. (1999: 113) individualism individual collective rutashobya (1999:39) themba et al. (1999: 112) fadiman (2000: 80) sono (1994) achievement achievement ascription rutashobya (1999: 39) driver et al. (2001: 42) universalism universal particular olomi (1999: 166) sono (1994) dimensions based on lee and peterson 2000: 405 1 power distance � degree of tolerance for hierarchical or unequal relationships where low power distance is conducive to entrepreneurial orientation. uncertainty avoidance � degree of acceptance for uncertainty or willingness to take risk. individualism � degree of emphasis placed on individual accomplishment. masculinity � degree of stress placed on materialism and wealth (masculine) versus harmony and relationships (feminism). achievement � describes how power and status are achieved either through competition and hard work (achievement) versus birthright, age or gender (ascription). universalism � describes the norms for regulating behaviour either through a code of laws that apply equally to all (universalism) that are conducive to entrepreneurial orientation versus some who enjoy special rights or privileges because of their status (particularism). 2 coincides with the evaluation of the us culture. figure 2 depicts the distribution of the programs offered by the dti, idc and khula according to their focus, size and level of its target market. although the categories are subjective, the programs are positioned according to their focuses used. sajems ns 6 (2003) no 3 523 figure 2 graphical presentation showing that the program focuses of idc, dti, and khula programs lean towards larger ventures and growth rather than smme and start-ups (own compilation) combined program focuses � khula idc dti external investors growth pre start / innovation / incubation life cycle stage vs size survival prospect micro small medium large other: training market research competitiven ess & export expansion / recapitalize finance bridging start-up / acquisition 18 27 327 24 12 3 9 10 30 2 19 11 15 16 35 13 17 1 proposed existing 21 33 29 30 34 22 4 20 8 25 26 6 31 23 also shown on figure 2 are two lines categorising the �existing� focus versus the �required� focus where it is believed that programs will contribute to more start-ups. the focuses of the ntsika programs are differently depicted in figure 3. the core target markets are the service providers to a large extent and the entrepreneurs to a lesser extent. sajems ns 6 (2003) no 3 524 figure 3 graphical presentation showing that the program focuses of ntsika programs lean towards service providers more than towards smme�s (own compilation) n ts ik a p ro g ra m fo c u s e s s m m e p o o l w ith n e e d s fo r s e r v ic e s s e r v ic e p r o v id e rs (l b s c �s ) g o v t d e p t�s s m m e �s 1 2 3 4 5 6 7 8 9 1 01 1 1 2 1 3 1 4 1 5 1 6 1 7 6 conclusion from table 1 it seems that the available literature points towards a culture in south africa that is not supportive to the development of an entrepreneurial orientation. although empirical research is required to prove or disprove this generalisation, indications are clear to those who have the nerve to postulate it that: the evaluation points that entrepreneurial orientation and start-up culture levels are oppositely valued especially for uncertainty avoidance, individualism and achievement. power distance, masculinity and universalism appear to be evaluated as sending mixed signals about their status within the south african society. based on the literature evidence, it is fair to reject the first proposition that the south african culture is conducive to entrepreneurial orientation. empirical research in this regard is, however, required. figure 2 shows that there is a general program convergence on the level of medium and large ventures although some programs tend towards small sajems ns 6 (2003) no 3 525 business. the core focuses of the programs from khula, idc and dti include finance, growth, expansion and competitiveness (through export) that are more relevant for existing business than for start-ups. figure 2 also shows that there is a general tendency of the khula, dti and idc programs to focus on the larger and existing ventures as their target audience. very few programs are aimed at micro and small business. although some programs do focus on start-up the prerequisites suggest that they are more relevant for larger ventures. the question arises whether this could be construed as a latent acknowledgement that real growth comes from true entrepreneurs, which eventually create larger businesses than the conventional small businessperson. this, despite the general thinking that growth depends on smmes as described earlier in this paper. could this also be support for large businesses as they are the real employment creators and therefore the focus rather than micro and small business? one could argue further that these programs were not designed to influence anything else than what they are doing. the question is whether they could contribute to enhancement of entrepreneurial culture and if so, how? there, however, seems to be no indication that these programs contribute directly towards the development of entrepreneurial orientation. apparently the role of ntsika is more towards the assistance of small business and the creation of more micro business where one would tend to find programs that are more related to entrepreneurial culture. figure 3 further shows the focuses of the ntsika programs. the majority of the programs are focused on assisting their service providers. a smaller portion of the ntsika programs focus directly on the entrepreneurs that are the proposed beneficiaries of the programs whether directly or indirectly. the question is whether figure 3 shows any support to the issues related to improvement of entrepreneurial orientation. ntsika�s strategy requires a strong service provision sector to impact on the smme pool that requires its services and therefore explains the larger portion of the programs that are aimed at the service providers. the question arises that if the service providers need such an amount of inputs from ntsika before they can operate, what is the level of entrepreneurial orientation within these service organisations. based on the evidence presented its seems that the second proposition that official support programs contribute to the enhancement of entrepreneurial orientation and start-up culture should be rejected and the opposite accepted. sajems ns 6 (2003) no 3 526 7 recommendations accepting that these programs do not support the enhancement of entrepreneurial orientation and start-up culture opens the debate for how these can be influenced. figure 1 shows the role of the environment and the social and specifically the education environment should be investigated. further research is, therefore, proposed into the role of entrepreneurship education within the primary and secondary school curricula to impact at the earliest potential intervention point rather than at the stage where idc, dti, khula and ntsika incentives are focused. the dti may investigate entering into discussions with the department of education to labour this issue. based on the general line of the discussion in this paper, table 2 identifies some speculative issues that require further research. when looking at entrepreneurial orientation and start-up culture, al of these factors may be relevant. table 2 contributors to entrepreneurial culture based on speculative perceptions to stimulate debate (own compilation) environmental contributors relevant for entrepreneurship speculative perception of the typical south african scenario speculative perception of the typical us scenario general view towards failure bad � shows poor judgment good − show perseverance achievement motivation someone will do it for you i want to do it myself innovation this is how it works � don�t tamper with it i can do it better i�ll find an alternative way locus of control i can�t change the way things works i am in charge risk propensity don�t make a mistake find right answer only try to win the lotto there will be more chances if this doesn�t work. energy passivity and wait for someone to do it fired up to do something yourself typical role models lack of entrepreneurial role models achievers in business and sport through hard work aspirations don�t hurt the other make a difference sajems ns 6 (2003) no 3 527 endnotes 1 paper originally presented at: south africa entrepreneurship and small business association, (saesba) conference at sun city, 4-6 august 2002. awarded best paper prize. 2 the assistance of the officials from the different institutions is hereby acknowledged. opinions expressed in this paper and conclusions arrived at, are those of the authors and are not necessarily to be attributed to the institutions and programs investigated. references 1 act 102 (1996) the development and promotion of small business in south africa isbn 0-621-17478-5. 2 anonymous (2001) �entrepreneurial fresh air�, the economist, 01/03/2001, 358: 60. 3 billig, m.s. (1994) �the death and rebirth of entrepreneurism on negros island, philippines: a critique of cultural theories of enterprise�, journal of economic issues, 1283: 659-72, sept. 4 donnely, k. (1995) �education without enterprise�, ipa review, 48(1): 21-23. 5 dana, l.p. (1995) �small business in a non-entrepreneurial society: the case of the loa people�s democratic republic�, journal of small business management, 33(3): 95-102. 6 driver, a., wood, e., segal, n. & herrington, m. (2001) global entrepreneurship monitor: south african executive report. november. 7 fadiman, j.a. (2000) south africa�s black market � how to do business with africans, intercultural press inc. isbn: 1-877864-79-x. 8 gorman, g., hanlon, d. & king, w. (1997) �some research perspectives on entrepreneurship education, enterprise education and education for small business management�, international small business journal, 15(3): 56-77. 9 kaufmann, p.j. & dant, r.p. (1998) �franchising and the domain of entrepreneurship research�, journal of business venturing 14: 5-16. 10 maasdorp, e.f. de v. & van vuuren, j.j. (1998) in: ondernemingsbestuur (2nd ed.): 727-28 jl. van schaik. 11 morris, m. (1997) entrepreneurial intensity. sustainable advantage for individuals, organizations and societies, quorum books. 12 meuller, s.l. & thomas, a.s. (2000) �culture and entrepreneurial potential: a nine-country study of locus of control and innovativeness�, journal of business venturing 16: 51-75. sajems ns 6 (2003) no 3 528 13 lee, s.m., & peterson, s.j. (2000) �culture, entrepreneurial orientation, and global competitiveness�, journal of world business, 35 (4): 401-16. 14 olomi, d.r. (1999) �entrepreneur characteristics and small firm performance: knowledge gaps and priority research issues�, in: african entrepreneurship and small business development, rutashobya, l.k. & olomi, d.r. (eds.) dup (1996) ltd. university of dar-es-salaam. 15 rutashobya, l.k. (1999) �african entrepreneurship and small business development: a conceptual framework�, in: african entrepreneurship and small business development, rutashobya, l.k. & olomi, d.r. (eds.) dup (1996) ltd. university of dar-es-salaam. 16 sono, t. (1994) dilemmas of black intellectuals in south africa. unisa press. 17 sunter, c. (1994) the casino model. the casino model. tafelberg publishers. isbn 0 642 03330 9. 18 sunter, c. (1998) �we need to focus on creating an entrepreneurial class�, entrepreneurship update, november: 2. 19 thomas, a.s. & mueller, s.l. (2000) �a case for comparative entrepreneurship: assessing the relevance of culture�, journal of international business studies, 31(2) (2nd quarter): 287-301. 20 themba, g., chamme, m., phambuka, c. a. & makgosa, r. (1999) �impact of macro environmental factors on entrepreneurship development in developing countries�, in: african entrepreneurship and small business development, rutashobya, l.k. & olomi, d.r. (eds.) dup (1996) ltd. university of dar-es-salaam. 21 timmons, j.a. (1999) new venture creation entrepreneurship for the 21st century, irwin mcgraw-hill. isbn 0-07-116790-0. 526 sajems ns vol 5 (2002) no 3 on the long-run interdependence of stock markets: a tale of correlations, autoregressions and decompositions elna moolman department of economics. university of pretoria suzanne mccoskey university of pretoria and the united states naval academy abstract it seems as if national stock markets within certain groups of countries, for example within europe and asia, are interdependent. but to what extent are stock markets between these groups interdependent? is it still possible to diversity among these groups, or have globalization tied world markets together to such an extent that diversification is no longer feasible? in this study we use time series techniques to analyze the interdependence among four of the most important groups of economies, namely europe, latin america, asia and the us. this will show whether it is still possible to diversify between the stock markets of these groups of economies, since stock markets within these groups seem to be interdependent to such an extent that diversification within these groups is no longer possible. on a methodological level, we compare the results of the ols-v ar with an fm-v ar model, which is a more robust estimation procedure in the presence of non-stationary or co integrated series. jel gio 1 introduction portfolio theory suggests that investing in less than perfectly correlated asset markets will result in greater diversification effects. this resulted in a search for diversification gains, which has been aggressively extended in investing internationally in the hope of additional diversification. in the mean time, financial globalization caused revolutionary and irreversible changes in financial markets. international capital transactions have accelerated, and innovations and deregulation have changed financial market structures. more instruments and markets have developed, and technological development has made a portfolio comprising international assets universal (handley & mills, 1996: 74). the ongoing relaxation of foreign investment restrictions and foreign exchange r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 527 controls in many countries has led to the speculation that world equity markets have become more integrated than ever, and that the diversification gain from investing internationally might have been reduced significantly. this calls for an examination of the intermarket relationships and dynamic linkages between international stock markets as the interdependence structure has important implications for market efficiency, profitable investment opportunities, risk diversification and international policy co-ordination. if markets are inefficient, the transmission of shocks from one market to another will involve systematic lagged responses that may be exploited by informed investors. on the other hand, lack of interdependence among markets will engender opportunities for risk diversification. many studies have been conducted on the interdependence of different national stock markets, using different econometric techniques. for example, masih and masih (1997, 1999), chowdhury (1994) and palac-mcmiken (1997) analyzed the interdependence among asian markets while dheeriya (1993) and choudhry (1996) analyzed interdependence in europe, and christoffi and perich (1999) and choudhry (1997) analyzed interdependence among latin american markets. stock market interdependence in the emerging markets in asia seems to be a widely accepted fact. masih and masih (1999) examined relationships among the stock markets of thailand, malaysia, the us, the uk, japan, hong kong and singapore from 1992 to 1997. the most important finding of their study is that asian stock market fluctuations are mostly explained by the regional markets, rather than by the developed markets. they found that these markets are cointegrated, and their vector error correction modeling (vecm), variance decomposition and impulse response functions confirmed a high level of interdependence between these markets. masih and masih (1997) used the same econometric techniques, but a different group of asian markets and data for the period 1982 to 1994. consistent with their later findings (masih & masih, 1999), they found co integration among the markets of taiwan, south korea, singapore, hong kong, the us, the uk, germany and japan. again, their vecm, variance decomposition and impulse response functions confirmed a high level of stock market interdependence. other authors examined different groups of asian markets, but their results are consistent with those of masih and masih (1997, 1999) since they all found their respective stock market groups to be interdependent. palac-mcmiken (1997) found cointegration in the monthly asean markets (indonesia, malaysia, the philippines, singapore and thailand) during the period 1987 to 1995. chowdhury (1994) used variance decomposition and impulse response functions r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 528 sajems ns vol 5 (2002) no 3 to examine the relationships among hong kong, korea, singapore, taiwan (that is, the asian newly industrialized economies (nies», japan and the us, using daily data for the period january 1986 to december 1990. he found that the us led the nies and that there were significant linkages between the markets. in general, these studies used different techniques and different sample periods, but they all found that the emerging asian markets are interdependent. although there is substantially less literature on stock market interdependence in the emerging latin american markets, all the available results indicate that the stock markets in this region are also interdependent. christofi and pericli (1999) used a vector autoregressive (v ar) model in their study on the stock markets of argentina, brazil, chile, columbia and mexico from 1992 to 1997. they found significant spillover effects among these latin american markets. choudhry (1997) investigated interdependence among the stock markets of argentina, brazil, chile, colombia, mexico and venezuela, and by using cointegration techniques, found a common stochastic trend in these markets. therefore, consistent with the results of the emerging asian markets, the emerging latin american markets are found to be interdependent. in a study on european stock prices, choudhry (1996) used co integration techniques to analyze the long-run relationships, which should indicate the presence of common stochastic trends among indices. he used monthly data for the 1920s and 1930s of czechoslovakia, france, italy, poland, spain and sweden. his results indicate a stationary long-run relationship during 1925-1936 and also during the pre-1929 crash period (1925-1929), but not during the postcrash period (1929-1936). dheeriya (1993) used geweke's causality test to study the direction of causality and feedback between the stock markets of australia, austria, belgium, canada, denmark, france, gennany, ireland, italy, japan, netherlands, norway, spain, sweden, switzerland, the uk and the us, by using daily data for 1987 and 1988. the impact of the stock market crash of october 1987 on other national stock markets is investigated by dis aggregating the data into preand post-crash periods. his results showed that almost all markets react to other markets' past and present movements. however, very few stock markets (only the us and uk) influenced other markets significantly, and the traditionally major markets of japan, france and canada, did not seem to be influential at all. from the literature it seems as if stock markets of countries within certain groups, for example within europe, latin america and asia are interdependent. for example, masih and masih (1997, 1999) and palac-mcmiken (1997) detected interdependence among certain asian stock markets, chowdhury (1994) found interdependence among certain european stock markets and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 529 christoffi and perich (1999) indicated interdependence among latin american stock markets. but to what extent are stock markets within these groups interdependent? the results suggest that the gains from diversification within these groups of countries have decreased significantly. is it then still possible to diversify among these groups, or are they so interrelated that diversification is no longer feasible? in this study we analyze the interdependence among some of the well-known groups of economies, namely europe, latin america, the us and asian economies. this will show whether it is still possible to diversify between the stock markets of these groups of economies, since stock markets within these groups seem to be interdependent to such an extent that diversification within these groups is no longer possible. we use time series techniques to address several important issues regarding the long-term relationships among major stock market groups. in particular, we use granger causality tests, vector autoregressive (v ar) analysis, impulse response functions and variance decompositions. the first issue is quite simply whether a direction of causality can be determined amongst the different groups of stock exchanges. this issue is addressed through tests for granger causality, which test the null hypothesis that one stock market does not granger cause another stock market. this test is conducted for every possible combination of stock markets, in every possible direction of causality to determine between which stock markets there is causality and in which direction. secondly, it can be asked whether the stock markets inform forecasts of other stock markets. for this variance decompositions can be used, which describe the proportion of the forecast error variance that can be explained by each stock market including the stock market itself. if almost all the forecast error variance is explained by innovations in the series itself, the series is largely exogenous. this would indicate that the particular stock market is not interdependent on the other markets, but is determined exogenously. on the other hand, if a substantial part of the forecast error variance of a series is explained by innovations in other series, it suggests that the variable is not exogenous but interrelated with the other markets. thirdly, we use vector autoregression (var) analysis to analyze the dynamic interactions among the markets. we will initially estimate the var model with ordinary least squared (ols), and then check these results against that of an fm-v ar estimation, which is a more robust estimation procedure in the presence of non-stationary and cointegrated series. if dynamic interactions are found, impulse response functions can be used to track the length of the dynamic shocks to the system. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 530 sajems ns vol 5 (2002) no 3 the article is outlined as follows: section 2 summarizes the data and section 3 explains the theory of stock market interdependence. section 4 summarizes the time series techniques used in the study. the empirical results are given in section 5, and section 6 provides some concluding thoughts. 2 the data it is a well-known fact in econometrics that the span of the data, and not the frequency, should be taken into account when looking at long-term trends (hatanaka, 1996: 25). by using annual data for a relatively long period 34 years instead of 1 or 2 years like most of the studies we are able to look at long-run trends instead of short-run fluctuations, which may not be persistent or may reflect special circumstances. the long span of the data also makes it possible to compare performance over a number of market cycles. we use the stock market indices of 4 of the major groups of countries, namely europe, the us, latin america and the asian economies. the standard and poor 500 index is used to represent the us stock market index. the indices of the united kingdom, germany, france, italy, switzerland, netherlands, belgium, spain, denmark, norway and sweden are included in the european index. the latin american index includes argentina, brazil, chile, columbia, mexico, peru and venezuela and the asian index includes hong kong, india, israel, malaysia, pakistan, philippines, singapore, south korea and taiwan. these aggregated indices were obtained from global financial data (http://www.globalfindata.com). in order to make the indices directly comparable, all the indices are measured in us dollars. the indices are capitalization-weighted annual stock price indices for 1919 1999 (except for latin america and asia where data was only available since 1936 and 1967 respectively), with 1969 as the base year. by looking at the graphs of the composite indices in figure i, several broad patterns emerge. in general, there has been a significant increase in all the indices since the globalization of the nineties. however, the us and european indices show a steady increase while the asian and latin american indices were extremely volatile during their increases. when the us is compared with europe, the difference is relatively small, except for a slightly larger gap during the period 1982 to 1992. similarly, there has been a remarkable co-movement between the latin american indices. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 531 figure 1 stock market indices of asia, europe, latin america and the us .... ,_ 3000 j 1200 2000 800 10"" 400 q 0 '" :iq 30 -asla. -europe 4000 ,_ 3000 1200 :iqqq boo 100q ..,. 0 :iq 30 la nh amefuca -us the simple correlations between these groups (see table 1) suggest very high correlations between these groups. it also shows very high correlation between the relatively undeveloped stock markets of asia and latin america, and between the developed stock markets of the us and europe. table 1 correlations between stock market groups, 1967-1999 asia europe latin america us asia 0.859554 0.912211 0.801067 europe 0.859554 1.000000 0.885803 0.990116 latin 0.912211 0.885803 1.000000 0.865556 america us 0.801067 0.990116 0.865556 1.000000 3 theoretical explanation of stock market interdependence in general, there are three categories of explanations as to why there is comovement among different stock markets. the first category is the so-called r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 532 sajems ns vol5 (2002) no 3 contagion effect, which is the part of stock market co-movement that cannot be explained by economic fundamentals. the second category is economic integration, which means that the more the economies of two countries are integrated, the more interdependent or integrated their stock markets will be. economic integration includes not only trade relationships, but also comovement in the economic indicators that influence stock market returns, such as interest rates and inflation. the third and last category includes stock market characteristics that influence the extent of stock market interdependence, namely industrial similarity, volatility and market size. in general, therefore, the extent of interdependence between two stock markets (or groups of stock markets) should be a function of the following variables: 3.1 contagion contagion, as defined by the academic profession, is the co-movement of asset markets not caused by a common movement of fundamentals (wolf, 1998: 220). contagion is not measurable in itself, but rather estimated with the residual from the co-movement that is not explained by fundamentals. there are two broad categories of literature on this field, either based on informational factors or based on institutional factors (op. cit.: 220). the category of informational factors is based on the well-known comparison between the stock market and the keynesian "beauty contest", where each judge votes the way he thinks the other judges will vote. in the same way, investors will sell their investments in a specific asset class if they believe that other investors will sell their investments in that asset class. this provides some explanation of the herd behavior of stock market traders which leads to a sell-off of emerging market securities if a sufficient number of investors believe that other investors have become disenchanted with the emerging markets asset class. the herd behavior of investors will lead to a widespread decline or upswing in emerging markets, and if this widespread movement is not caused by fundamentals, it is, by definition, contagion. the category of institutional factors focuses on issues such as forced redemption and two-stage investment strategies (op. cit.: 221). a substantial proportion of the inflows to the equity markets of emerging countries come through openended mutual funds. when these funds are faced with large-scale withdrawals or a reduction in inflows, they may be forced into redemption. global mutual funds will then sell off their assets in the most liquid markets. in other words, if these markets were not affected previously. they will be affected by the forced redemption. this redemption thus creates a contagion effect in which several markets decline simultaneously without justifying changes in fundamentals. the same occurs when global mutual funds try to exploit perceived mispricing via r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 533 purchases in the most downtrodden markets, financed through sales of equities in less-affected markets (op. cit.: 221). with two-stage strategies, some fraction of the overall portfolio is allocated to the emerging-market category, and is then sub-allocated according to some index weighting. this provides the second of the institutional explanations for contagion to the extent that first-stage decisions, even if motivated by factors relevant to some emerging markets, may also affect markets for which these factors are of little importance (chuhan, 1994). 3.2 economic integration from a macroeconomic perspective, there are two broad categories of economic variables that influence the degree of stock market interdependence, namely the extent of bilateral trade and factors that influence stock prices according to the cash flow model. 3.2.1 bilateral trade when two countries have a strong bilateral trade relationship, their economies and stock markets are expected to be highly interdependent. if a substantial portion of country a's total exports are exported to country b, then a downswing in country b will cause a decline in its imports from country a. there will be a decline in country b's stock market associated with the domestic downswing in country b, and at the same time a decline in country a's stock market due to the reduction in exports to country b. the stock markets of the two countries will thus exhibit a co-movement due to their bilateral trade ties. the more important the trade ties, the higher the degree of co-movement in the stock markets. therefore, the bilateral trade relationship between two countries is expected to explain some of the correlation or co-movement between their stock markets. 3.2.2 the cash flow model stock prices (p) can be written as the expected discounted stream of dividends: p = e(c) k (1) where c is the dividend stream and k is the discount rate. it follows trivially that the systematic forces that influence stock prices, and hence returns, are those that influence the discount factors, k, or the expected cash flows, e(c) (chen et al. 1986). any factor that influences the stream of cash flows or the discount r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 534 sajems ns vo15 (2002) no 3 rate will systematically influence stock prices. since the seminal article by chen et al. (1986), the influence of interest rates and inflation on the discount rate, and of industrial production growth on the expected cash flows and hence on stock prices has been well established. these macroeconomic variables influence the stock market performance of an individual country, which means that in two countries in which these variables are similar, the stock market performance will be similar. for example, if the interest rates of two countries show the same trend over time, perhaps due to similar monetary policies, the effect of interest rates on stock prices will cause a co-movement in the two stock markets. therefore, larger interest rate, growth and inflation differentials will cause a smaller amount of co-movement. 3.3 stock market characteristics apart from the economic variables discussed in the previous section, several other variables have been discussed in the literature as having the potential to influence the extent of stock market correlation. these factors are stock market size, stock market volatility and industrial similarity. 3.3.1 size the effect of the size of a firm on its stock market performance is a welidocumented phenomenon (see for example banz, 1981; berk, 1996; keppler & traub, 1993; asness et al., 1996). smaller firms command higher returns due to less liquidity and the higher transaction costs associated with trading their equity. by extension, the size of a national equity market may reflect its stage of development, and may also indicate the degree of market liquidity and the level of information cost and transaction cost associated with trading equity in that market. from this perspective, a large disparity in market sizes may indicate large differences in the liquidity, information costs and transaction costs between the two markets, which should result in less co-movement. 3.3.2 volatility the basic principle on which all investment models are based is that the returns on any asset should be a positive function of its risk. according to the capital asset pricing model (capm) of sharpe (1964) and lintner (1965), stock market returns should be a positive function of the risk of the stock market, where risk is measured as the volatility or variance of the returns. since the returns of any stock market are a function of its volatility, two markets with more or less the same volatility should be more interdependent than two markets with substantially different volatilities. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 535 3.3.3 industrial similarity the effect of industrial similarity on stock market correlation has received a substantial amount of attention in the literature (e.g. serra, 2000; wolf, 1998; roll, 1992). the performance of any index is partly determined by sectoral composition, and partly obscured by idiosyncratic noise (wolf, 1998: 224). for example, consider two emerging market indices dominated by equities in a single sector, say petroleum. a decrease in the world demalld for oil may lead to a substantial decrease in the equity prices of oil companies in both economies. thus, when two markets are both dominated by the same type of industry, their stock markets will reveal co-movement to the extent that the general performance of their stock markets is based on that industry. this does not only happen in the extreme case when two markets are dominated by the same sector, but also the extent of industrial similarity between the two stock markets generally increases the extent of their co-movement. a priori theory therefore suggests the following about the relevant variables and their coefficients: + interdependence= f{trade, inflation differential, interest rate differential, size + differential, volatility differential, growth differential, industrial similarity}; (i) trade: the more important the trade relationship between two countries, the more correlated their stock markets should be. (li) inflation differentials: since inflation influences stock prices, the inflation differential of two countries is expected to influence the extent of interdependence between their stock markets negatively. the bigger the inflation differential, the bigger the difference in stock prices will be, and hence the lower the level of interdependence between the markets. (iii) industrial production growth: industrial production growth influences stock market behavior through the cash flow model, and therefore the difference between two countries' industrial production growth rates will be negatively correlated with the extent of their stock market correlation. (iv) interest rates: interest rates influence the discount factor of the cash flow model and hence stock prices. therefore, the interest rate differential between two countries should be negatively correlated with their stock market correlation. (v) size: since the size of a stock market reflects its liquidity and transaction costs and therefore influences stock prices, the size difference between any countries' stock markets will have a negative relationship with the correlation of their stock markets. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 536 sajems ns vol 5 (2002) no 3 (vi) volatility: the risk of a stock market is measured by its volatility, and stock prices are positively influenced by volatility since investors demand higher returns for tolerating higher risk. this means that in two stock markets whose volatilities converge (diverge), the prices should also converge (diverge). therefore, the correlation between two stock markets should be a negative function of the ratio of their volatilities. (vii) region: stock markets within a region can be interdependent due to policy coordination, or simply due to contagion caused by investors' treatment of the asset markets within a region as one asset class. therefore, the correlation between two countries that are in the same region is expected to be higher than that of two countries in different regions. 4 testing methodology 4.1 granger causality yl causes another time series xi in the granger sense if series xl can be predicted better by using past values of series yi than by using only the historical values of series xi' to test whether yi granger eauses xt, granger (\969) proposed the following regression equation: ax. = co + idjtj.yh + icjtj.xt _i + v, 1=1 j~1 (2) where m is the appropriate autoregressive lag length as determined by the akaike and schwartz criteria, and vi is white noise. the test for granger causality is testing the null that yi does not granger cause xi> by comparing the following f-statistic to the relevant critical values of the f(m, t-2m-l) distribution: f (seer -sseu)!m sse,,!(t-2m-l) (3) \\ here sse r is the sum of squared residuals from a restricted regression equation, in other words no lagged yi in equation x, sseu is the sum of squared residuals from equation x, and t is the number of observations. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 537 4.2 vector autoregressive analysis (v ar) the v ar modeling technique is an effective means of characterizing the dynamic interactions among economic variables by reducing dependence on the potentially inappropriate theoretical restrictions of structural models. the general v ar specification can be written as: (4) where xi is a (n xl) vector containing each of the n variables included in the var ao is a (n x 1) vector of intercept terms ai is a (n x n) matrix of coefficients et is a (n xl) vector of error terms the t-statistic computed for the coefficients of each of the lagged variables indicate whether that particular lagged variable is significant in explaining some of the variation in the relevant dependent variable. since only lagged values of the endogenous variables appear on the right-hand side of each equation, there is no issue of simultaneity, and ols is generally regarded as an appropriate estimation technique. however, although ols is consistent, it may be biased. as described by phillips (1995), fully modified (fm) estimation of the var model should improve the ols results in the presence of non-stationary regressors, 1(1) processes and even cointegrating relationships. in addition, the fm-estimation procedure is valid without pre-testing for the exact cointegrating relationships or even the number of unit roots in the system. the fm-procedure specifically takes into account the possible serial correlation and endogeneities of the system. in this study, we will initially estimate the v ar model with ols, and then use the fm-var procedure outlined by phillips (1995) to verify its robustness. 4.3 impulse response functions impulse response functions characterize the dynamic structure of the estimated model by showing how each endogenous variable responds over time to a shock in that variable and in every other endogenous variable. it traces the effect of a one standard deviation shock to one of the innovations on current and future values of it he endogenous variables, in other words, it trades the response of the endogenous variables to such shocks (pindyck & rubinfield, 1991: 385). in other words, it can be used to analyze the persistence of shocks in the system, as r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 538 sajems ns vol 5 (2002) no 3 well as the return of the variables to equilibrium levels after shocks in the system. in the same way that a autoregressive (ar) process can be written as a moving average (ma) process, a vector autoregressive (v ar) model can be written as a vector moving average (vma). for example, equation x can be written as ., xl == j.l + l <p j 6,_i i=o (5) h ... ax,.. d'" ax;, .. were "', = -,,--, an (",jij '" --' -. ue, oe j , a plot of ($s)ij as a function of s is called the impulse response function, and it describes the response of yi,t+s to a one-tiine impulse in yjt with all other variables dated t or earlier held constant (hamilton, 1994: 319). 4.4 variance decomposition impulse response functions trace the effect of a shock to an endogenous variable on the variables in the v ar. by contrast, variance decomposition decomposes variation in an endogenous variable into the component shock to the endogenous variables in the var. therefore the variance decomposition gives information about the relative importance of each random innovation to the variables in the v ar, by showing the proportion of the movements in a sequence resulting from its own shocks versus shocks to the other variables (enders, 1995: 311, pindyck & rubinfield, 1991: 385). the s-period head forecast error is: s-j x/+s x/+s11 2:~el+s-i. idj the mean squared error of this s-period-ahead forecast is: = t {var(uj,)x[aja~ +!ll,aja;!ll; + ... +!llaja;!ll~d} ]=:1 (6) (7) where q=e(etet'), the contribution of innovation j to the mse of the forecast error, in other words the proportion of the variance of the s-period ahead forecast of y due to variable j, is: var(uj,)x[aja: +<fjlaja~<fj; +...+<fjaja~<fj;_,l. (8) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 539 5 empirical results 5.1 granger causality fwtests for granger causality address the question of causality and its direction. in each case a lag order of 2 was allowed, and the test was perfonned for the period 1967w1999. the results are given in table 2. table 2 f-tests for granger causality, 1967w 1999, 2 lags asia europe latin us america 8.04705*** 4.65389** 3.72338** 2.39163 3.78015** 4.08371** 4.62679** 3.62351** 5.23372** 4.26565** 1.32013 3.24299* * statistically significant on 10% level ** statistically significant on 5% level *** statistically significant on i % level the f-statistic in each cell in table 2 represents tests of the null hypothesis that the country in that column does not granger cause the stock markets in that row. for example, the f-statistic of the test that the asian stock market group does not granger cause the european stock market group is 2.39163, while the fstatistic of the test that the european stock market does not granger cause the asian market is 8.04705. in other words, the european market granger causes the asian market, but the asian market does not granger cause the european market. the results indicate that bi-directional causality exists between most of the stock markets, except that europe does not granger cause the us and the asian market does not granger cause the european market. this suggests that there is a substantial level of interdependence among the stock market groups. since almost all the relationships are significant, it is difficult to make conclusions regarding the specific relationships. however, the results of the granger tests indeed indicate a high level of interdependence, and the v ar, impulse response functions and variance decompositions will be used to analyze the specific relationships in more detail. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 540 sajems ns vol 5 (2002) no 3 5.2 the ordinary least squares vector autoregressive (ols-var) model to further the dynamics of the system, we estimate vector autoregression (var) models. the number of lags was chosen on the basis of the akaike (aic) and schwartz (sc) criteria, and the estimation was done for the period 1967-1999. the results are given in table 3, with t-statistics reported below in parenthesis. significant variables (based on the cut-off value of 1.69) are indicated in bold print. table 3 ols-var, 1967-1999,2 lags asia europe ladn ~us america asia(-l) 0.888866 -0.024921 . 0.506012 044314 (3.08940) (-0.78663) (2.32994) -1.85548) asia(-2) -0.698915 0.024407 -0.267701 0.030144 --'... (-2.23979) (0.71035) (-1.13652) 0.16375) europe(-i) -1.450122 0.784556 -3.473493 0.122299 (-0.40153) (1.97292) (-1.27416) (0.40796) europe(-2) 9.148660 -0.018465 2.258657 -0.008328 (2.44511) (-0.04482) (0.79972) :<-0.02682) latin -0.494690 0.005816 0.078944 0.010586 america( -i) ( -1.39917) (0.14940) (0.29580) (0.36072) latin 0.735197 0.025967 0.584775 0.028779 america(-2) (1.85268) (0.59429) (1.95223) (0.87367) use -i) -2.462753 0.216585 -0.745697 0.945164 (-0.62705) (0.50082) (-0.251sw-t(2.89911) us(-2) -2.526701 0.190616 4.0695 0.093593 (-0.58108) (0.39812) (1.23985) (0.25930) c t(~399961 -6.955426 -184.4471 -14.09604 .05206) (-0.39153) (-1.51453) (-1.05254) akaike • 47.92386 schwarz 49.62119 the asian market seems to be the most vulnerable for changes in other stock markets, since it receives feedback reaction from all the markets except the us market. as explained in section 3, the strength of the bilateral trade relationship between two countries (or groups of countries) positively influences the extent of interdependence between their stock markets. the asian countries have extremely open economies and strong trade ties with all three the other groups. therefore one would expect high interdependence between the asian and other stock markets. on the other hand, the european economies are much less open r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 541 than the asian economies, which explain why the european stock markets are less vulnerable than the asian stock markets. the asian market group also seems to be extremely influential in this system, since all the markets, except the european market, receives feedback reaction from asia. in addition, lags in the asian stock market influence three groups of stock markets (asia, latin america and the us), while lags in the european and latin american stock markets only influence two groups each (themselves and asia), and the us only influences itself. the fact that the asian markets are so influential could be evidence of the so-called "asian-contagion" effect. chen and zhang (1997) have shown that not only the extend of total bilateral trade, but specifically the extent of imports influences the vulnerability of one stock market to changes in another. in other words, the higher the imports from a specific country (or group of countries), the greater the influence of that country's (or group of countries') stock markets will be on the domestic stock market. this explains why the asian stock markets are so influential, since all three other stock market groups are net importers from asia. if the analysis was done with daily data, the leading opening times of the asian stock markets could also explain why asian is so influential, but this should not play a significant role when annual data is used. most of the feedback effects between markets are positive, except for a number of negative effects that are evidence of cyclical adjustments, which are common in v ar specifications. for example, the feedback from asia lagged one and two periods on itself is positive and negative respectively. 5.3 variance decomposition once the v ar model is estimated, the dynamic responses of each of the markets to a shock in a particular market are analyzed using the simulated responses of the estimated v ar system. these dynamic simulations help to measure the relative importance of each market in generating unexpected fluctuations of returns to a particular market. this, in tum, indicates the causal ordering among the six stock markets. the variance decomposition analysis explains the forecast error variance of returns in a particular market due to innovations in its own or a foreign market over a given horizon. the ordering was done on the basis of the relative influence that each series have on the system, as indicated by the results of the v ar model. lags in the asian stock market influence the asian, latin american and us stock markets. lags in the european stock market influence the asian and european markets, while lags in the latin american stock markets influence the asian and latin american markets. lags in the us stock r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 542 sajems ns vol 5 (2002) no 3 market influence only the us market. therefore the asian market influences three markets, the european and latin american markets influence two markets each and the us market only influences one market. on this basis the ordering was from asia to europe to latin america to the us. (when europe and latin america were reversed, there were no significant changes in the results.) the averages of the variance decompositions for a 10-year period are given in table 4. table 4 variance decompositions of the var model average percent due to innovations in: variation in: asia europe latin us america asia 65.55207 20.9565 4.202181 ! 9.289251 europe 1.861681 72.55007 10.8073 14.78095 latin america 34.8441 i 28.4092 32.28106 4.465642 us 11.93285 39.59079 14.9137 33.56265 the result of this analysis highlights a number of interesting facts. except in the case of the us most of the 10-period-ahead prediction error of each of the variables is explained by innovations in itself. on average, 65 per cent of the prediction error in asia, 75 per cent ofthe prediction error in europe, and 37 per cent in the prediction error in latin america is explained by innovations in itself. on average, 50.8 per cent of the prediction error in the us is explained by innovations in the european market which is more than the 33.56 per cent explained by innovations in itself. the strong interdependence between the emerging stock markets of latin america and asia that was indicated by the correlation coefficients (see section 2) is confirmed by the results of the variance decompositions. innovations in the asian stock markets explain most of the forecast error variance of the asian as well as the latin american markets. likewise, innovations in the european ~to~'k markets arc the largest contributor towards the forecast error variance of the european and us stock markets. this is probably due to the self-fulfilling cxpc.:tations of investors that assets in the emerging market asset class (e.g. latin american and asian stocks) will all behave alike, and likewise, that assets in the developed stock markets will behave similarly, as explained in section 3. if almost all of the forecasting error in a series is explained by innovations in itself, it suggests that the series can be viewed as largely exogenous. the results of the variance decompositions indicate that less than half the variation in the forecasting error of any stock market group is explained by innovations in itself. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 543 this is evidence that the groups are interdependent, since none of them can be seen as exogenous. 5.4 impulse response functions impulse responses that summarize the short-run and long-run effects of various shocks to the system are displayed in figure 2. the same ordering as in the variance decompositions was used. figure 2 impulse response functions response of asia to one s.d. innovations response of europe to one s.d. innovations ~.--------------------m,-----------------__ -, 40 ·200 ·20 -\-~ ______ --________ __l 2 3 4 5 6 7 8 9 10 3 4 5 6 7 s 9 10 eiti!lfqino labn america : --~europe ---tallied stales response of latin america to sd.lnnovations 300.,.----------------------, 200 3 4 s s 7 8 9 10 i e;nergi1lq ~ li;ilm ametiea ---~ e~ --'i.bt8d s!aies response of us to one s.d. innovations 00,----------------------, in the first graph, the effect of a shock in the asian market on itself lasts only for 8 periods after which it converges to the long-run equilibrium level. shocks in any of thr other markets initially have a negative impact, but the effects of the european, latin american and us markets tum positive within 2, 3 and 6 periods respectively. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 544 sajems ns vol 5 (2002) no 3 according to the third graph, latin america's reaction on innovations in other stock markets is similar to that of the asian stock market. just like the asian market, innovations in the european and us markets cause an initial decrease in the latin american market, but within 6 periods both effects have turned positive. the effect of the innovations in the asian market is again initially positive, but instead of converging to equilibrium after 8 periods like the asian markets, it decreases. in general, both the asian and latin american markets increase after a few periods in response to innovations in the european and us markets, and fail to return to equilibrium afterwards. both markets increase initially after innovations in the asian market and then either return to equilibrium or decrease slightly. the second graph shows that the european market reacts positively to innovations in any of the markets, except the asian market, and keeps on increasing without returning to the equilibrium level. on the other hand, shocks in the asian market cause a decrease in the european market, and again the european market does not return to the long-run equilibrium level. similar to the european market, the us market also decreases after a shock in the asian market, and increases after a shock in any other market. the european and us markets are extremely susceptible to shocks, since they both react dramatically to a shock in any other market. the sharp, sustained increases indicate that these two markets have a propensity to grow positively. the reactions of the two groups of developing countries, latin america and asia, are remarkably similar. this is evidence of the contagion effect discussed in section 3. investors see the developing stock markets as a single asset class, and this creates a self-fulfilling expectation that the developing stock markets react in the same way to shocks. likewise, the developed stock markets are to some extent seen as a single asset class of assets that are safe and stable relative to the developing markets. this creates self-fulfilling expectations that the developed markets will react similarly to shocks. 5.5 the fully modified vector autoregressive (fm-var) model the results of the fm-var model are given in table 5, with t-statistics reported below in parenthesis. the t-statistics are asymptotically valid. significant variables (based on the cut-off value of 1.69) are indicated in bold print. the parzen kernel with three autocovariance terms is used for the non-parametric estimation required by the fm-var. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vo15 (2002) no 3 545 table 5 vector autoregression model estimated with fully modified estimation, 1967-1999, 2 lags asia europe latin us america asia(-i) -1.72387 -1.91433 -1.92799 -1.67551 (-2.76848) (-1.20e-3.22971) (-0.01952) aasia(-i) 1.952248 1.228926 1.223189 1.521034 (2.933149) (0.012842) (0.009464) (1.143083) europe(-l) 7.502776 0.570328 -0.08179 -1.4106 jo.064725) 0.590763) (-0.10106) (-0.01569) ~europe( -1 ) -21.1874 -12.0202 -12.0304 -14.2974 (-23.4803) (-0.11994) (-0.10177) (-20.6061) us(-i) 13.88939 19.28605 19.9176 22.2027 (0.131008) (30.99154) (0.000125) (34.91805) ~us(-i) -23.7059 -26.4232 -26.3262 -30.3022 (-0.00013) (-44.2366) (-0.30655) (-0.26125) latin -0.37651 -0.58523 -0.57765 0.046704 america( -1 ) (-0.00412) (-0.00474) (-0.56174) (0.054178) &atin 1.690678 2.399907 2.397096 1.8411 america( -i) (1.750195) (2.963587) (0.026653) (0.017355) c -1299.89 -1298.44 -1305.58 -1475.94 (-13.5771) (-11.498) (-1969.66) (0.00868) while the ols-v ar estimates only lagged variables, the fm-var estimation estimates first order lagged innovations and first order lagged variables. therefore the results of the two procedures are not directly comparable. however, with little mathematical manipulation the fm-var results can be rewritten in a fonnat that is comparable to the ols-v ar estimation. these results are given in tables 6 and 7. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 546 sajems ns vol 5 (2002) no 3 table 6 comparison of lagged effects, 2 lags asia europe fm ols fm ols i asia(-i) 0.22838 0.888866 -0.68541 -0.024921 asia(-2) -1.952248 -0.698915 -1.228926 0.024407 europe(-i) -13.6846 -1.450122 -11.4499 0.784556 europe(-2) i 21.1874 9.14866 12.0202 -0.018465 us(-i) -9.81651 -2.462753 -7.13717 0.216585 us(-2) 23.7059 -2.526701 26.4232 0.190616 latin 1.31417 -0.49469 1.814676 0.005816 america( -i) latin -1.690678 0.735197 -2.399907 0.025967 america (-2) table 7 comparison of lagged effects, 2 lags us latin america fm ols fm ols asia(-l) -0.7048 -0.044314 -0.15447 0.506012 asia(-2) -1.223189 0.030144 ·1.521034 i -0.267701 europe(-i) -12.l122 0.122299 -15.708 -3.473493 europe(-2) 12.0304 -0.008328 14.2974 2.258657 usc-i) -6.40859 0.945164 -809946 -0.745697 us(-2) 26.3262 0.093593 30.3022 4.069549 latin 1.819446 0.010586 1.887804 0.078944 america(-i) latin -2.397096 0.028779 -1.8411 0.584775 america (-2) in this type of analysis, the signs of the coefficients are more important than their magnitudes, since the magnitudes of the coefficients are usually not interpreted. we therefore focus on the signs of the coefficients in our comparison of the ols-v ar and fm-var results. the coefficients of which r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 547 the signs have changed when the model was re-estimated with fully modified instead of ordinary least squares, are indicated in bold print. only four of the previously significant variables have different signs in the fm-var than in the ols-v ar. there is more evidence in the fm-v ar of cyclical adjustments between the stock markets, which might give a more stable system. in addition, phillips (1995) has shown that the fm-v ar is more robust when non-stationary or cointegrated series are included. however, the limited degrees of freedom make it questionable whether the fm estimates truly eliminate the ols bias. 6 conclusion in this study, we used time series techniques to investigate the relationships among four of the most important groups of economies, namely europe, latin america, asia and the us. overall, we found evidence of a high level of interdependence among the stock market groups. in particular, there are a substantial amount of evidence that support the hypothesis of interdependence between the developing stock markets of asia and latin america, and between the developed stock markets of the us and europe. this is probably an example of contagion, where investors group the developed and emerging markets as two asset classes, and then build self-fulfilling expectations that stocks in each of the two asset classes will behave similarly. the results suggest that diversification between developed (european and us) and emerging (asian and latin american) markets are still possible, even though the interdependence within these groups is so high that diversification is no longer possible. references asness, c.s., liew, i.m. & stevens, r.l. (1996) "parallels between the cross-sectional predictability of stock and country returns", working paper, new york: goldman sachs asset management. 2 banz, r.w. (1981) "the relationship between return and market value of common stocks, journal o/financial economics, 9: 3-18. 3 berk, j. (1996) "an empirical re-examination of the relation between firm size and return", university of british columbia: unpublished manuscript. 4 chen, n. f., roll, r. & ross, s.a. (1986) "economic forces and the stock market", journal o/business, 59: 383-403. 5 chaudhry, t. (1996) "interdependence of stock markets: evidence from europe during the 1920s and 1930s", applied financial economics, 6: 243-9. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 548 sajems ns vol 5 (2002) no 3 6 chaudhry, t. (1997) "stochastic trends in stock prices: evidence from latin american markets", journal of macroeconomics, 16: 629-51. 7 chowdhury, a.r. (1994) "stock market interdependencies: evidence from the asian nies", journal of macroeconomics, 19: 285-304. 8 christoffi, a. & perrcll, a. (1999) "correlation in price changes and volatility of major latin american stock markets", journal of multinational financial management, 9: 79-93. 9 chuhan, p. (1994) "are institutional investors an important source of portfolio investment in emerging markets?" world bank, wps 1243. 10 dheeriy a, p.l. (1993) "further evidence on causality and feedback across international stocks", journal of economics and finance, 17: 160-7. 11 enders, w. (1995) applied econometric time series, new york: john wiley & sons. 12 handley, a. & mills, g. (1996) "the south afiican economy in the 1990s", johannesburg: south afiican institute ofinternational affairs. 13 hatanaka, m. (1996) time-series-based econometrics, new york: oxford university press. 14 keppler, a.m. & traub, h.d. (1993) "the small country effect: small markets be large markets", journal of investing, fall: 17-24. 15 lintner, j. (1965) "the valuation of risk assets and the selection of risky investment in stock portfolios and capital budgets", review q{ economics and statistics, 47: 13-37. 16 llu, y.a., pan m.s. & shieh, j.c.p. (1998) "international transmission of stock price movements: evidence from the us and five asian-pacific markets", journal of economics and finance, 22: 59-69. 17 palac-mcmiken, e.c. (1997) "an examination of asean stock markets: a cointegration approach", asean economic bulletin, 13: 299-311. 18 phillips, p.c.b. (1995) "fully modified least squares and vector autoregression", econometrica, 63: 1023-78. 19 pindyck, r.s. & rubinfield, d.l. (1991) economic models and ecol/omic forecasts, singapore: mcgraw-hill. 20 roll. r. (1992) "industrial structure and the comparative behavior of international stock market indices", journal of finance, 47: 3-41. 21 serra, a.p. (2000) "country and industry factors in returns: evidence from emerging markets' stocks", emerging markets review, i: 127-51. 22 sharpe, w. (1964) "capital asset prices: a theory of market equilibrium under conditions risk", journal of finance, 19: 425-42. 23 wolf, h.c. (1998) "determinants of emerging market correlations, in: levich, r. (ed.) emerging markel capital flows: 219-35, great britain: kluwer academic publishers. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 290 sajems ns vol 3 (2000) no 2 the application of psychometric tests in human resource management r p van der merwe department of industrial and organisational psychology, university of port elizabeth abstract psychometric tests are widely used as aids in occupational decisions, including the selection and classification of human resources. recent and ongoing developments in south african labour legislation, especially the implications of the employment equity act, highlight once again the importance of validating all instruments used for assessment and selection purposes. this is a follow-up study, reporting on an investigation into psychometric testing in industry today. information was gathered to establish which psychometric tests are presently used, and for what purpose. biographical information on each company concerned is supplied, including the number of employees. the role of psychometric tests in the selection procedure is discussed, as well as the levels at which the tests were applied. the various tests used, as well as the users, are indicated, and comments, recommendations· and shortcomings discussed. jelj29 1 introduction one of the critical elements in the pursuit of outstanding organisational performance, is the selection and development of the best possible staff. intemational as well as local research has demonstrated the role that psychometric assessment can play in significantly enhancing the selection process for both new entrants and internal promotions. effective psychometric assessment can also play a key role in staff development processes an important challenge facing south africa. psychometric tests are commonly employed as aids in occupational' decisions, including the selection and classification of human resources. from the assembly-line operator or filing clerk to top management, there is scarcely a type of job for which some kind of psychometric test has not proved helpful in r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 291 such matters as hiring, job assignment, transfer, promotion, or termination (anastasi & urbina. 1997). according to owen and taljaard (1996), it appears that psychometric tests can contribute to the efficiency of selection and placement in industry, if carefully and responsibly used. friedenberg (1995) refers to research which compares different selection procedures (application forms, letters of reference, interviews, testing) and confirms that although each technique has its own merits, standardised tests are psychometrically the soundest. moerdyk, in an article by mittner (1998), reportedly mentions that if psychometric tests are handled with insight and sensitivity, they remain the most effective means of predicting behaviour. kemp (1999) says that tests are an aid in the selection process, and if properly used, supply invaluable information which is not easily gleaned in interviews. according to van der walt (1998), experience has proved that tests are generally more reliable and valid than other available techniques. studies in trade and industry have indicated that psychometric tests are about four times more effective than screening interviews. given the high costs of staff turnover and the heightened importance of identifying key staff from previously disadvantaged population groups, psychometric assessment can make a major contribution to human resource management in south africa. in the light of the above-mentioned points, it was decided to investigate the application of psychometric tests in human resource management. this study is a follow-up report on the fmdings of such ongoing exploratory research (van der merwe, 1999), undertaken to establish which psychometric tests are used and for what purpose, in industry today. 1 recent legislation to protect the public against abuses, the use of psychometric tests is legally specified (medical, dental and supplementary health service professions act, 1974). specialised training is required to determine which tests will give the best results in particular circumstances, and to interpret the results responsibly. tests may only be used by registered psychologists, or other suitably qualified and registered persons under the supervision of psychologists. recent and ongoing developments in south african labour legislation, also emphasise the need for the responsible use of psychometric tests and other psychological assessment procedures. according to eckstein (1998), the employment equity act highlights the importance of the validation of any r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 292 sajems ns vol 3 (2000) no 2 instrument to be used for assessment and selection purposes. this represents a definite move towards making selection decisions more scientific. kriek (1998) also welcomes this legislation which, according to him, can only help to improve current assessment practices in south africa. according to roodt (1998), one purpose of the act is to ensure that psychometric tests are used in an unbiased manner, resulting in fairness. the employment equity act (1998: 8) inter alia determines the following: "psychological testing and other similar assessments of an employee are prohibited unless the test or assessment being useda) has been scientifically shown to be valid and reliable; b) can be applied fairly to all employees; and c) is not biased against any employee or group" to deal with this in practice, one will first of all need a good and accurate method of job analysis breaking down the job into dimensions or competencies. next one would need simple and verifiable tests for these jobrelated competencies such as work sample tests or assessment centres. one would of course also have to keep statistics of applicants at all stages of the selection process, so as to defend oneself against any allegations of differential impact. 3 the selection process there is no fixed, generally accepted, standard selection procedure that is at present used by everybody. a selection procedure may be fairly simple or very complex, .depending on the nature of the organisation, the task for which individuals are being selected, and the philosophy of the human resource management (aiken, 1994). the vast majority of employee selection programmes are based on the successivehurdle technique. this means that to be hired, applicants must successfully pass various screening devices. some candidates are rejected at each step or hurdle. psychometric tests can be of great value in employee selection because of their objectivity and validity (schultz & schultz, 1998). it must however be regarded as one possible step in the selection process merely an aid, never to be used on its own, or to replace the whole selection procedure. the general nature of the selection process is set out in figure 1. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 293 figure 1 the selection process i recruitment of candidates ~ i application forms ~ i preliminary screening 1 r i reference checking e 1 j i psychological testing e i ~ c 1 interview: human resource dept. t ~ i i interview: line management .. 0 ~ n i medical examination .. l ~ successful unsuccessful candidates candidates 4 method 4.1 sample a non*probability convenience sample of organisations was drawn from the port elizabeth and uitenhage area of the eastern cape province. the research can r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 294 sajems ns vol 3 (2000) no 2 thus be regarded as a qualitative investigation. background infonnation about the various organisations selected is supplied in table i. table 1 participating organisations organi -iiauod type of business employees a branch of large insurance company (nationwide ± 13 000 i 600 employees) i b branch of large banking group (nationwide ± 37 000 1300 employees) c government department responsible for security, law and 19000 order 0 branch of large beverage company (nationwide ± 8000 1000 employees) e motor manufacturing company 6500 f regional office of telecommunications company (nation4500 wide + 57 000 employees) g motor manufacturing company 4000 h technical and network services business unit of 2000 i telecommunications company (nationwide ± 57000 employees) i tyee manufacturing company 2000 from table i it appears that the participating organisations cover a wide range of different kinds of economic activities. 4.2 procedure postgraduate students in industrial and organisational psychology acted as field workers in this study. they were thoroughly briefed by the researcher on the interviewing procedure used. the data were collected by means of individual interviews that these students conducted with a designated representative from the human resource department of each organisation involved. mostly these representatives were personally responsible for the testing in their organisations. where this was not the case, the representative was the person locally involved with the testing arrangements and administration in an organisation. these people provided the infonnation that was used in this research, by discussing the testing policy of their organisation with the interviewers. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . samms ns vol 3 (2000) no 2 295 4.3 data analysis all the data gathered by means of these interviews, were analysed by means of content analysis. inferences were made on inspection of the data collected. 5 results the results of this research are presented in the following format: brief testing policy of the organisation tests used in the organisation test users (administrators) in the organisation comments by organisational representatives based on the questions asked during the interviews, the following information on each organisation, was made available. 5.1 brief testing policy the role of psychometric testing in the selection procedure, as well as the levels at which tests are applied in each participating organisation, is discussed next. organisation a organisation a makes use of a clearly defined selection procedure which includes the following: application blanks, preliminary interviews, psychometric tests, final selection interviews and reference checking. psychometric tests are merely used as an additional aid in the selection process and are required to be culture-fair and non-discriminatory. employment equity enjoys a high priority in this organisation. in addition, tests are used for selection and management information, more so at the lower levels of employment. at management level, assessment centres are used for selection and promotion purposes. organisation b this organisation uses a clearly stated and defined selection procedure, in different steps. these were recently revised to comply with the latest labour legislation. the attitude is that it is not always equally important to use psychometric tests in the selection process. the specific job under consideration r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 296 sajems ns vol 3 (2000) no 2 will indicate whether it is necessary to do testing or not. tests are never used on their own always together with an interview and other input. tests are used at all levels in this organisation for selection, placement, promotion and strategic restructuring. in this case, assessment centres are not used because they are regarded as too expensive and time consuming. organisa non c organisation c makes use of a clearly stated selection procedure which includes: application forms, reference checking, testing and diagnostic interviewing. tests are never chosen at random a thorough job analysis is first conducted to determine the skills that are needed to perform the job successfully. tests are used at all levels in this organisation: for selection, placement, training and transfers, but not for promotions. although use was previously made of assessment centres, this is no longer so. organisa non d this organisation uses a clearly stated selection procedure and policy, in which it makes use of application blanks, preliminary interviews, psychometric tests, diagnostic interviews and reference checking. psychometric tests are regarded as important in this organisation's selection process. the purpose of psychometric tests is to provide specialist information in support of managerial decision-making, by improving the accuracy of decisions regarding the selection, promotion and development of employees. the assessments should also assist individual employees in gaining insight into themselv;:s, for the purpose of their self -development. tests are used in this organisation for all positions from shopfloor level to higher positions. they are however also used for certain positions where specific psychometric and psychological make-up is deemed necessary (e.g. apprentices and bursars). organisa non e this organisation makes use of a selection procedure, which inter alia includes interviews. all information gathered during the selection process is used by the organisation in making final appointment decisions. tests are mainly used for r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 297 selection purposes, mostly at managerial level, though a few also at entry grade levels. organisation f organisation f makes use of a clearly stated selection procedure, which includes curriculum vitaes, psychometric testing, assessment centres, interviews and reference checking. the approach is not to use tests in isolation, but rather as a means of verifying the information obtained from other selection devices. tests are used to facilitate selection, placement and promotion decisions, also for development and training purposes. tests are administered at all levels, from auxiliary, lower-level to management positions. organisation g this organisation makes use of a structured selection procedure. the main instruments used are the interview, application blanks, psychometric testing, reference checking and sometimes assessment centres. it is however moving away from the use of assessment centres. the main reasons for this are that it is very expensive, extremely time consuming and that there has to be fairly intensive training of the adjudicators involved. the organisation employs psychometric tests for selection, placement, promotions, as well as to establish training needs. tests are used at the lower levels of the organisation, as well as when selecting candidates for supervisory positions or management level. organisation h in this organisation a very strict selection procedure is followed. psychometric tests are used in conjunction with the interview as well as application blanks. the results of the tests are evaluated along with the outcomes of the other procedures used. tests are mainly used for selection purposes. when dealing with higher level positions, case studies and simulations are occasionally also applied. organisation i oganisation i has a clearly stated selection process in which use is made of application blanks, reference checking, interviews, assessment centres and psychometric testing. psychometric testing is also used for promotion purposes, to detennine training needs, and for counselling. it is however regarded as an additional tool to try to inject some objectivity into what might otherwise be a very subjective process. it is extensively used at worker entrance level, as well as for recruitment at management level. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 298 sajems ns vol 3 (2000) no 2 5.2 tests used in table 2 the various tests used by the various organisations are indicated. some tests are used by two or more organisations, and the most widely applied test is the 16 pf, which is used by seven organisations. note that in most cases, a specific test is used by one organisation only. for the sake of clarity, a brief description of the abbreviations used for the various tests is given after table 2. table 2 tests used by tbe various organisations organi· a b c d e f g h i satlon: tests: 16pf x x x x x x x sort x x tat x mbtl x x x mmpi x 19 fii x hlbat x x intbat x x x norm bat x sat x x x x aat x pab x sawais x x x cpa x dover x x giexerc x presentax non in-basket x hlfct x x x sos x opq/ccsq x x ptb x ttb x x ppa x sixteen personality factor questionnaire (16 pf): this measures 16 primary personality traits and is inter alia used by industry and business in the selection, placement and promotion of employees by predicting important job.related r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 299 criteria such as work efficiency, tolerance of routine etc. (huysamen, 1996; spangenberg, 1990). st:riictured-objective rorschach test (sort): the sort is based on the traditional rorschach test, and its aim is to obtain psychologically meaningful data by means of which a broad overall picture of the individual can be obtained (spangenberg, 1990). together with data from other tests, this can then be used for coum.elling, selection and the prediction of job success. thematic apperception test (tat): this is a projective personality test which is regarded as especially suited to assessing motivation, such as the need for achievement or affiliation (huysamen, 1996). myers-briggs type indicator (mbti): this test was designed to implement jung's theory of type, as understood by the author (isabel myers). more specifically, the aim is to identify the basic preferences of people with regard to perception and judgement. these preferences are: extraversion-introversion, sensing-intuition, thinking-feeling, and judgement-perception (spangenberg, 1990). minnesota multiphasic personality inventory (mmpi): this is a broad-band test designed to assess a number of the major patterns of personality and emotional disorders. to a certain extent it highlights signs of pathology in the people tested (aiken, 1994; anastasi & urbina, 1997). nineteen field interest inventory (19 fii): this inventory measures occupational interests with respect to 19 broad fields of activity. it also measures the extent to which a person is actively or passively interested in the 19 fields, as well as the extent to which the interests are workor hobby-related (owen & taljaard, 1996). high level battery (hl bat): this battery provides a measure of general intelligence, arithmetical ability and certain language abilities. it can be used for vocational guidance as well as the selection and classification of high level employees, and is suitable for testees with matric or higher qualifications (huysamen, 1996; owen & taljaard, 1996; spangenberg, 1990). intermediate battery (int bat): this battery was designed to measure certain mental abilities, including mental alertness, arithmetical ability, some aspects of language, and clerical skills. it can be used in vocational guidance as well as for the selection of persons who have had not more than 12 years of schooling (huysamen, 1996; owen & taljaard, 1996; spangenberg, 1990). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 300 sajems ns vol 3 (2000) no 2 nonnal battery (norm bat): this battery was designed to measure a number of mental abilities, including mental alertness, computation and certain language skills. it can be used in vocational guidance as well as in the selection of persons with 9 to 10 years of schooling (huysamen, 1996; owen & taljaard, 1996; spangenberg, 1990). senior aptitude tests (sat): this test was designed to measure a number of aptitudes and the results can be used for vocational guidance and selection purposes (huysamen, 1996; owen & taljaard, 1996). academic aptitude test (aat): the aim of this test is to serve as an aid in the guidance of senior pupils with regard to subject and career choice. more specifically, it provides an assessment of general intellectual, verbal, mathematical and spatial ability. it may also be of value in selection and placement decisions (spangenberg, 1990). programmer aptitude battery (p ab): this. battery measures aptitude for computer programming. it is intended to be used on individuals who have little or no experience in computer programming, although it might also be useful in selecting existing programmers. it should not be used on persons who have not passed matric (owen & taljaard, 1996). south african wechsler adult intelligence scale (saw a1s): this scale is a verbally administered individual test designed to evaluate the intellectual functioning of the older child and adult (huysamen, 1996; spangenberg, 1990). career path appreciation (cpa): this is based on a stratified systems theory and assesses a manager's ability to deal with challenges of varying complexity. judgement in making decisions under a variety of conditions of uncertainty is assessed, along with ability in long-term and short-term thinking. this form of evaluation works on a semi-structured interview system. dovernienna test system (dover): this is a machine with lights of different colours, and the testee is expected to coordinate the hand switches with the different lights of the machine as they come on and go off. the performance of the candidate is scored automatically. performance under stress, orientation ability, levels of productivity, and learning ability, are some of the aspects evaluated by this system. group interaction exercise (gi exerc): this can be regarded as a group problem solving exercise. the group of candidates is given a problem to discuss and within fifteen minutes they must arrive at a solution. afterwards, the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 301 contribution of each group member is evaluated, and it is considered whether it contributed to the fmal outcome reached by the group as a whole. presentation: this exercise is similar to the previous (group interaction exercise) one, except that the candidate works as an individual. the candidate is given a problem and allowed five minutes to think about a way of solving it. then the candidate has to make an oral presentation, arguing and demonstrating how the problem can best be solved. in-basket exercise: this exercise consists of samples of typical items or activities found in the department in which a vacancy exists. candidates are asked to indicate what action should be taken with regard to each item or activity. in other words, it is a type of simulation exercise in which the person must deal with a pile of paperwork letters, reports, phone messages, and so on typical of what might be found in a manager's in-basket. high level figure classification test (hl fct): this is a non-verbal pencil and paper test, which assesses abstract reasoning ability. it is intended for use in selecting staff for positions that require a moderate to high level of abstract conceptual functioning more than mere routine activities (spangenberg, 1990). self-directed search questionnaire (sds): the rationale of this questionnaire is to measure interest. the questionnaire fits into the broad context of career planning, since it provides important information about an individual's occupational interests, and supports the link between personal and occupational infonnation (owen & taljaard, 1996). shl occupational personality questionnaire (opq): this questionnaire is applied to assess a comprehensive range of personality characteristics, including: relationships with people; thinking and problem solving style; emotions, motivation and drives; team working styles; leadership or subordinate styles; selling and influencing styles (shl, 1996). shl customer contact styles questionnaire (ccsq): this questionnaire has been designed to measure sixteen dimensions of personality relevant to nonsupervisory staff working in sales or customer service roles (shl, 1996). shl personnel test battery (ptb): this is a battery consisting of various tests, used to select clerical and administrative staff. emphasis is on practical skills and the needs of the modem workplace, including equal opportunity issues (shl, 1996). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 302 sajems ns vol 3 (2000) no 2 shl technical test battery (ttb): this is a battery consisting of various tests. it is used in the selection of a wide range of technical staff, including school leavers and candidates with work experience (shl, 1996). thomas personal profile analysis (ppa): this is a questionnaire where the person being evaluated has to select the words which most, and least, apply to himlher. by charting these choices scientifically, insight is obtained into how this person would behave at work. it can provide helpful understanding of how this person copes with hislher environment and what hislher attitudes are likely to be. it also provides insight into possible performance in a particular function (thomas international, undated). 5.3 test users (administrators) table 3 shows the persons responsible for testing in the various organisations. note that they are the test users and not necessarily the same people as those who provided the information about each organisation. table 3 test users in tbe various organisations organ1test user sadod a psychometrists or psychologists: special manager at head office overall responsible for testing in company and correct procedures and standards of testing. b psychometrists or psychologist. c psychometrists or psychologists. d use external consulting psychologists: consulting psychologist available at head office. e no qualified test user: interpretation done by external consulting psychologists. f psychometrists or psychologists. g psychometrists: use is also made of external consulting psychologists. h psychometrists or psychologist i external psychologist and other consultants from table 3 it appears that most of the organisations have their own psychometrists or psychologists. the others make use of consulting psychologists. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 303 5.4 comments by organisational representatives in organisation a they are satisfied with the tests they are using in some areas, less so in other areas. tests are however useful in the identification of the potential of individuals whose schooling background is not up to standard. presently the organisation is looking at the validity of the tests used, scxhooling and attempting to implement tests more equitable in terms of culture. according to the feedback from organisation b, a test is only as good as the person who uses it. it is strongly felt that tests must be used in the right way, and that we still have a long way to go to achieve culturally fair tests. in general, organisation c is satisfied with the tests used there. as long as the tests are used for the purpose for which they were intended, they are seen to be a useful aid. many of the tests used are however outdated in some respects, and should be updated. because they question the culture-fairness of the tests used, industrial psychologists at head office have standardised most of the tests for the organisation's workforce, with the result that nonds differ for different culture groups. given the problems relating to culture-fairness, the organisation no longer uses psychometric tests in the promotion of employees (to evaluate leadership potential). it now makes use of a method called targeted selection (also known as the assessment interview). . in the case of organisation d there is a perception that too much emphasis may be placed on test results. to improve the level of interpretation of results, test results and work performance results are frequently correlated at head office. the organisation is very much committed to culture-fairness in their testing, as a result of which the 16 pf was removed from the batteries oftests. organisation e seemed generally satisfied with the tests being used there, because these proved to test what they actually purported to test. it however questions the culture-fairness of the 16 pf. overall, in organisation f there is satisfaction with the tests being used. it is felt that some of the tests are possibly outdated, especially regarding the nonds being used. to an extent the unions are questioning their use of psychometric testing and until tests can undisputedly be shown to be culture-fair, the role of testing is expected to decline in this organisation. there is a feeling that many uncertainties surround the use of tests in the new south afiica. this is one of the reasons why the organisation started using the tests from shl (which shl maintains to be cu1ture-fair). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 304 sajems ns vol 3 (2000) no 2 in organisation g the general feeling is that the tests used are culture-fair, but the accompanying norm tables are badly outdated. to an extent it also questions the reliability and validity of the tests. the wish is to employ tests that are more culture-fair, and the various selection instruments are at present being reconsidered very carefully. according to organisation n, the lack of culture-fairness is a major problem in psychometric testing. this organisation feels very strongly about culture-fair tests because of its multicultural work force. it appears that organisation i is satisfied with the psychometric testing it employs the actual intention is to use these tests even more in future to establish individual potential. it is however emphasised that testing is only an additional tool to be used, to try and inject some objectivity into what could otherwise be a very subjective process. 6 discussion and recommendations from this study of the application of psychometric tests in human resource management, it appears that psychometric tests are not used just on their own in practice. as an additional aid in decision making, the tests normally form part of a defined procedure which includes certain different, interrelated, and specific . steps, as well as other tools. these seem to be used not only for selection purposes, but for placement, promotion, transfers, training and development. furthermore, it appears that these tests are often used at different levels in the organisations which participated in this study. the tests used by these organisations (see table 2), are all mainly south african-specific and -validated material, distributed by the human sciences research council and a few other organisations. most test administrators of these organisations (see table 3) are trained and qualified test users, well aware of the laws and rules that govern psychometric testing in south africa. to conform to these regulations, some of the organisations even make use of the services of external consulting psychologists. the author therefore concludes that psychometric testing is conducted at a professional level in the organisations surveyed. this is contrary to a recent worldwide investigation of testing and the use of tests (batram & coyne, 1998), which found that almost 60010 of test users were not specifically trained in the use of psychological tests. from comments by the organisation representatives interviewed in the present study, it appears that they are largely satisfied with the tests being used. mention was made that some of the tests and test material used were outdated. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 305 it is also stressed that test users must be well trained and tests must be used for the purpose for which they were designed. bartram and coyne (1998) found in their survey that there is a worldwide lack of appropriate training in testing and test use. they also found a perception that test misuse is a worldwide problem, and that the best way to counter it is through training and increased public understanding. according to huysamen (1996), one of the major stumbling blocks regarding the use of psychometric tests in south africa, stems from the complexity of designing tests that may be used across a diversity of language and cultural backgrounds. of major concern are the implications of possible discrimination, and therefore many organisations are presently working towards the validation of tests in their own work environments. the definite need for culture-fair tests was frequently expressed by the representatives of the organisations that participated in this investigation. it thus appears that their intention is to implement fair and equal treatment to all individuals. in this regard it is interesting to note that the 16 pf is the one test used by most of these organisations, all except two (organisations d and h). organisation d recently removed it from their batteries of tests because it was found not to be culture-fair. another organisation (organisation e) still using it, also questions the culture-fairness of the 16 pf in particular. muniz, prieto, almeida and bartram (1999) studied test construction and test use in spanishand portuguese-speaking countries. they found the translation and adaptation of tests to be an especially relevant problem. according to them, the most common problems in the application of tests were: failure to respect the copyright of the test, use of tests inappropriate to the case, use of out of date tests, and failure to check the interpretation of tests with colleagues. the five most commonly used tests in the countries they studied, were (in order of frequency of use): wechsler scales, mmpi, rorschach, raven's and 16 pf. except for the rorschach and the raven's tests, these tests were all used in the present study too. in evaluating the findings of the present study, one has to bear in mind that this was initial, superficial, exploratory research, which involved a very small sample. nevertheless, the findings are indicative of the typical issues that south african organisations are faced with, when implementing psychometric testing in human resource management today, and therefore cannot be disregarded. psychometric testing and development is at present undergoing an unstable period. it does however appear that organisations are attempting to adapt r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 306 sajems ns vol 3 (2000) no 2 themselves to the instability and uncertainty, while continuing to identify and develop the human resource potential of south africa. chad., drasgowand sawin (1999) warned that test developers and test users should pay attention to the "shelf life" of their tests especially large~scale and well~blished non~gnitive measures such as, inler alia, the 16 pf. it therefore seems a sensible suggestion that test manuals and other test material (also norms) should be updated more· frequently by the distributor of a test. consideration should also be given to the development of new tests, with special emphasis on culture-fairness which might be enhanced by competency-based assessment, seeing that it is jo~related rather than norm-based at present it is very important that tests be validated for the different organisations in which they are used. this also implies that in each organisation, for each specific job, the validity of the test battery used, must be ensured. once again, this is something that might be enhanced by also making use of competency~based assessment, which is directly linked to job content and inherent job requirements. one must however bear in mind that there are psychological factors which competency measures cannot capture, such as learning or developmental potential. this study was a qualitative investigation, and it is not always possible to obtain all the detailed information normally required by this type of research. one reason for this is that organisations often regard some psychometric infonnation as confidential. with regard to follow-up research, an expansion of the sample is strongly required. this would also lead to a more in-depth study of the entire field of psychometric testing in human resource management. endnote the cooperation of everybody involved in this study, including all participating organisations, is greatly appreciated. references 1 aiken, l.r. (1994) psychological testing and assessment (8th ed) massachusetts: allyn & bacon. 2 anastasi, a. and urbina, s. (1997) psychological testing (7th ed.) new jersey: prentice-hall inc. 3 bartram, d. and coyne, i. (1998) the itciefppa survey of testing and test use in countries world-w'ule narrative report. paper presented at workshop of international test commission, dublin. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 2 307 , 4 chan, k., drasgow, f. and sawin, l.l. (1999) "what is the shelf life of a test? the effect of time on the psychometrics of a cognitive ability test battery", journal of applied psychology, 84(4): 610-19. 5 eckstein, s. (1998) "testing times", people dynamics, 17(6) 54-5. 6 employment equity act. (1998) no.55, republic of south africa. 7 friedenberg, l. (1995) psychological testing: design, analysis, and use, massachusetts: allyn & bacon. 8 huysamen, g.k. (1996) psychological measurement. an introduction with south african examples, pretoria: j.l. van schaik. 9 kemp, n. (1999) "psychometric testing is not dead, people dynamics, 17(3): 14-17. 10 kriek, h. (1998) "fairness and equity: new legislation will help to increase the best practice of occupational testing", juvaug newsline, shl south africa. 11 medical, dental and supplementary health service professions act. (1974) no.56 as amended, republic of south africa. 12 mittner, m. (1998) "psychometric tests under fire", f & t weekly, 26 june, 56. 13 muniz, j., prieto, g., almeida, l. and bartram, d. (1999) "test use in spain, portugal and latin american countries", european journal of psychological assessment, 15(2): 151-7. 14 owen, k. and taljaard, j.j. (1996) handbook for the use of psychological and scholastic tests of the hsrc, pretoria: hsrc. 15 roodt, g. (1998) "challenges in psychological assessment", people dynamics, 16(11): 30-4. 16 schultz, d.p. and schultz, s.e. (1998) psychology and work today, (7th ed.) new jersey: prentice-hall inc. 17 shl (1996) assessment materials, saville & holdsworth ltd. occupational psychologists. 18 spangenberg, h. (1990) assessing managerial competence, cape town: juta. 19 thomas international (undated). increasing people effectiveness, proceedings of a two day workshop presented by thomas international management systems. 20 van der merwe, rp. (1999) "psychological assessment in industry, journal of industrial psychology, 25(3): 8-11. 21 van der walt, h.s. (1998) "psychological tests: refmed instruments for reliable information to decision-makers", in focus forum, 5(4): 16-17. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction methodology results conclusion acknowledgements references about the author(s) jilson zimuto department of business management, university of pretoria, pretoria, south africa rachel maritz department of business management, university of pretoria, pretoria, south africa citation zimuto, j. & maritz, r., 2019, ‘modelling effect of valuable resources on franchise outlet performance: dynamic sensing capability as mediator’, south african journal of economic and management sciences 22(1), a2706. https://doi.org/10.4102/sajems.v22i1.2706 original research modelling effect of valuable resources on franchise outlet performance: dynamic sensing capability as mediator jilson zimuto, rachel maritz received: 23 july 2018; accepted: 17 apr. 2019; published: 09 july 2019 copyright: © 2019. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: competitive advantage and superior firm performance depend on resources and dynamic capabilities. aim: this study aims to provide insight into the franchising industry where research on the value-dynamic sensing capability-performance relationship as part of the resource-based theory (rbt) seems to be novel. drawing on the rbt, this study examines how valuable resources and dynamic sensing capability impact franchise outlet performance. setting: based on a cross-sectional design, a sample of 224 south african franchise outlet managers and owner-operators in the fast food and retailing categories was surveyed. methods: hypotheses were tested using a single-level structural equation model for value, dynamic sensing capability and performance. results: the results contribute to research on rbt in the context of franchises by providing support for the assumption that firm resources and capabilities improve performance. conclusion: the findings are expected to provide a strong base from which franchise managers and owner-operators can strategise for competitive advantage in an emerging economy like south africa. keywords: resource-based theory; resource-based view; strategy; dynamic sensing capability; performance; franchises. introduction the debate over the ability of dynamic capabilities (teece, pisano & shuen 1997:509) to align and realign resources (eisenhardt & martin 2000:1106) in a turbulent environment for competitive advantage is rife in research. the rationale is that the resource-based view (rbv) of the firm has not adequately explained how and why certain firms have a competitive advantage (eisenhardt & martin 2000:1106) and dynamic capabilities by which firm managers integrate, build, and reconfigure resources (teece et al. 1997:516) to become the source of sustained competitive advantage. the rbv has matured into the resource-based theory (rbt) and still has theoretical relevance and applicability in today’s competitive strategy environment and is widely acknowledged as one of the most prominent and powerful theories for describing, explaining, and predicting organisational relationships (barney, ketchen & wright 2011:1300). barney et al. (2011:1309) remark that further studies on the rbt should also take into account the environment in which individuals find themselves and test the relationships as they are conditioned by context. this study therefore contributes to literature by examining relationships within the proven rbt framework but focusing on the specific context of franchises in an emerging economy. from previous theoretical and empirical studies (for example, akremi, perrigot & piot-lepetit 2015:145; gillis, combs & ketchen 2013:449; mumdziev & windsperger 2011:449) it is clear that little has been done in the context of franchising. findings from the cited studies all support the positive impact of resources in franchising. akremi et al. (2015:145) found that dynamic capabilities (for example, training and experience) are some of the independent variables that positively impact on performance of franchised chains. mumdziev and windsperger (2011:449) found that innovation assets affect decision rights allocations. other scholars have established and emphasised the characteristics of a firm’s resources and capabilities as the source of the performance differences among firms. for the purposes of this study, rbt, which evolved as a clear framework from the rbv of the firm, and the literature on dynamic capabilities are adopted to provide an empirical analysis of the variables contained in the rbv and their influence on south african franchise outlet performance. the aim of the study is to provide insight into the effect of resources that are deemed valuable on firm performance and at the same time to explore the influence of capabilities on achieving firm performance in the franchise environment. drawing on a comprehensive literature review it became clear that the relationship and influence of resources on the value-dynamic sensing capability-performance relationship as part of the rbt are novel in rbt research. using the rbt as a launching pad the study examines how valuable resources and dynamic sensing capability impact franchise outlet performance. south africa boasts over 600 franchised brands and about 39 000 franchised outlets (franchise association of south africa [fasa] 2016:15). wingrove and urban (2017:1–8) argue that researching franchised fast food restaurant brands is important for an emerging market context such as south africa, especially considering their sizeable influence on the economy. in addition, kpmg (2016) reports that franchising industry growth reflects over 31 050 franchise outlets in south africa, employing 323 519 people nationally (kpmg 2016:2). of these 323 519, 34% are employed in retailing and direct marketing while 27% are in fast foods and restaurants (fasa 2016:16). in addition, schwarzer (2017:5) reiterates ‘similarly, when franchising economic output is measured as a share of a country’s overall gross domestic product (gdp), south africa emerges in the top five – with 11.5% of its gdp generated by franchises’. to this gdp, fast foods and restaurants, inter alia, generated annual turnover of r52.2 million, while retailing contributed r8.9 million (fasa 2016:13). wingrove and urban (2017:2) posit that research needs to emphasise how franchising impacts organisational performance and drives growth. hence franchising in south africa becomes a fertile ground for academic research because both the franchisor and the franchisee resources play a major role in the performance of their outlets. following assumptions of the rbt, superior performance of the franchises is attributed to the resources of the franchisor and resources of the franchisee. resources may be tangible or intangible. financial, physical, organisational, intellectual and human resources possessed by a franchise firm are expected to be valuable, rare, inimitable and non-substitutable (vrin). vrin resource characteristics (barney 1991:99) of rbv of the firm are the empirical drivers of firm performance if used in combination (penrose 1959:25). underlying theory rbv of the firm, which has evolved into a theory (barney 1991:99), postulates a firm as a bundle of resources (penrose 1959), and the resources are controlled by the firm (amit & schoemaker 1993:35). building on the rbv of the firm assumptions, barney (1991) published his seminal work clearly defining the rbt. however, studies from other scholars (for example, afuah 2013:1; eisenhardt & martin 2000:1105; henderson & cockburn 1994:63; parmigiani & holloway 2011:457) still refer to this theory as the rbv of the firm. this article builds on the premise of the rbt which again crystallised from the rbv. as such the article will explain the premises for both the rbv and the rbt. barney et al. (2011:1303) postulate that the rbt has reached a level of maturity as a theory, where scholars are increasingly using the term resource-based theory instead of resource-based view. they argue that this indicates that resource-based research has reached a level of precision and sophistication to such an extent that it more closely resembles a theory than a view. one prominent spin-off perspective from this theory, the rbt, is that of dynamic capabilities (barney et al. 2011:1303; teece et al. 1997). it is also this dynamic capabilities perspective that this article explores in the relationship between value and performance, where the dynamic sensing capability is examined as a mediator variable between valuable resources and performance. according to the rbv, firms are expected to have capabilities or capacities to deploy resources (amit & schoemaker 1993:35). these resources and capabilities are explained as heterogeneously distributed among firms and imperfectly mobile (barney 1991:99). such assumptions propound the existence of differences in firm resource endowments and these differences persist over time (barney 1991:101). the rbv of the firm studies hypothesise that firms that possess and exploit resources and capabilities that are valuable and rare attain a competitive advantage. second, if these resources and capabilities are also both inimitable and non-substitutable, the firm will sustain this advantage, and they will enable the firm to improve its performance (amit & schoemaker 1993:33; barney 1991:99; eisenhardt & martin 2000:1105; henderson & cockburn 1994:63; powell 2001:875). however, barney (1995:56) argues that for a firm to fully realise this potential, it must also be organised to exploit its resources and capabilities. this implies that resources and capabilities are vital for a firm if organised, deployed and implemented. in addition, other scholars (teece et al. 1997) extended the rbv with the dynamic-capability view (dcv) to evaluate the influences of dynamic markets (helfat & peteraf 2015:831). teece et al. (1997:509) regard dynamic capabilities as a transformer for converting resources into improved performance. however, the empirical research to examine the relationships between all the resource characteristics, dynamic capabilities and performance has not been given much attention in the literature. hence there is very little empirical research operationalising value, rarity, inimitability and organisation (vrio). conversely, vrin has received considerable attention, although the studies are still few. for example, lin and wu (2014) investigated vrin but did not operationalise it as individual characteristics; morgan, vorhies and schlegelmilch (2006) used only inimitability and non-substitutability, while newbert (2008) employed only rareness and value. this study addresses the gap by assessing how individual value resource characteristics can be converted into performance through dynamic sensing capability. theoretical and empirical suggestions for strategic decisions regarding resources and dynamic capabilities are provided. resource-based view of the firm and the franchising industry there is now a move toward a rbv of franchising (gillis et al. 2013:451) and this is supported by franchising research called the symbiosis perspective (perryman & combs 2012:368), which explains resource effects on franchising. although several empirical studies have examined the performance implications of governance decisions and firms’ resource characteristics in the franchising context (barthélemy 2008:1451; combs & ketchen 1999:196; perdreau, le nadant & cliquet 2015:121; yin & zajac 2004:365), this may not be a true reflection of the franchising sector of vrin resources-dynamic capabilities-performance relationships in south africa. that is why gillis et al. (2013:449) have offered preliminary evidence that the rbt has merit as a complementary explanation for franchising. the above studies are evidence that rbv/rbt is vital in explaining franchising because it can be assumed also that the franchisor/franchisee has specific resources and capabilities that can result in competitive advantage. the higher these resources and capabilities of the franchisor/franchisee, the higher the rent-generating potential of the resources (combs et al. 2011). the use of rbt would allow more in-depth explanation regarding resources, organisational capabilities and competitive advantage of franchise chains. through rbt, it is possible to make sound decisions because fasa (2016:11, 14) argues that it takes a long period before a new franchisee breaks even and that there are also challenges of customer satisfaction and knowledge of the business. on this basis, this study proposed to complement existing studies on franchising by the modelling of franchise chain resources (financial, human, intellectual, organisational and physical) effects on its performance (market share, growth in market share, sales volume, and growth in sales volume) through dynamic sensing capability. furthermore, dynamic capabilities have emerged as an approach that is useful to help us understand why some chains are more likely to drive performance (akremi et al. 2015:145). the dynamic capabilities approach is an offshoot of the resource-based view (barney 1991:99; eisenhardt & martin 2000:1105) and the ability of a firm to ‘integrate, build, and reconfigure internal and external competencies to address rapidly changing environments’ (teece et al. 1997:516) is a critical source of superior performance. this approach is a relevant theoretical lens for deepening our understanding of factors that influence performance in franchising (akremi et al. 2015:146). dynamic capabilities demonstrate that the manipulation of resources, in particular knowledge resources, is especially critical in the franchising context and emphasise the importance of replication and learning (teece et al. 1997:516; zollo & winter 2002:339). for example, hotels or restaurants that can integrate and reconfigure are probably going to experience superior performance. conceptual model and hypothesis development hypotheses were developed about the effects of valuable resources on franchise outlet performance as mediated with dynamic sensing capability (figure 1). first, the focus was on value (barney 1991:106; newbert 2008) as an independent construct which was hypothesised to have direct effects on dynamic sensing capability. second, the hypothesis tested the mediating role of the dynamic sensing capability between valuable resources and performance. this was premised on the fact that performance differentials are produced by resource heterogeneity among competing firms (barney 1991:103; mol & wijnberg 2011:77). performance (morgan et al. 2006:627; wilden & gudergan 2015:190) as a dependent variable emphasised sales volume, growth in sales volume, market share and growth in market share (newbert 2008:766). figure 1: conceptual model to test valuable resources-dynamic sensing capability-performance relationship. valuable resources and franchise outlet performance resources are by definition the source of firm performance (andersen 2011:88). also, resources are always a prerequisite for all firms to function, and all other steps to achieving high performance are dependent on the possession of resources (andersen 2011:89). no firm can enjoy competitive advantage without valuable resources. considering how fast food restaurants were created to expedite the delivery of food to customers in a hurry, technology has stepped forward to make that service even speedier. digital displays furthermore allow outlets to change their menus efficiently and when restaurants add innovative technology to the menu, it leads to better service and food options. it shows that it resources are and can be used to improve firm performance (cohen & oslen 2013:246). this postulates the potential of resources to influence customer perceptions of value. mol and wijnberg (2011:81) argue that resources need to be valuable first before other strategic considerations can be made with regard to their deployment. they explain three dimensions of resource value which they consider as paramount in facilitating sustained performance. the three dimensions of resource value are (1) by either allowing a firm to enter the selection system or prevent its rivals from doing so, (2) by creating product characteristics that have value according to product selectors, and (3) by either allowing a firm to engage in competitive imitation or preventing its rivals from doing so (mol & wijnberg 2011:79). the first dimension suggests that for the competitive advantage of the firm to be generated the value of the resources should be analysed with reference to the competitive process taking place in the product market (bowman & ambrosini 2001:501). other preceding dimensions describe competitive processes in terms of the selectors who contribute to value (gemser & wijnberg 2001:563; priem 2007:219). for example, when buying a new car tyre, consumers often rely on evaluations by experts, such as product critics who rate tyres (bridgestone, dunlop, firestone etc.) on price, durability or usage. santos and eisenhardt (2005:497) argue that organisational boundaries should be set at the point that maximises the value of the firm’s resource portfolio. the value of some resources is more difficult to determine than others (mol & wijnberg 2011:85). understanding the value of resources in terms of their functionality in the product market helps address this issue and can be used to assess the logic underlying complex or bundled resources (denrell, fang & winter 2003:977; lippman & rumelt 2003:903; wernerfelt 1984:393). further, mol and wijnberg (2011:88) propound that if it becomes easy to identify the value of superior resources, the sustainability of the organisational performance is jeopardised. on the other hand, if managers are not able to adequately estimate the value of resources and reward them accordingly, their capacity to select and deploy them effectively is significantly hampered and hence organisational performance suffers (makadok 2001:387). therefore, managers are encouraged to have an appreciation of resource value from competitors, so that they are provided with enhanced opportunities for better performance. managers create value by developing resource bundles that enable firms to undertake novel and appropriate tasks, services, jobs, products, processes, or other combinations perceived to be of value in producing greater utility or lower unit costs in use (lepak, smith & taylor 2007:183). resource bundles represent unique combinations of resources that enable firms to take advantage of specific market opportunities when effectively deployed (peteraf & barney 2003:309). thus, firms realise a performance advantage when managers synchronise the resource management processes within and between interdependent bundles such that organisational performance is optimised (holcomb, holmes & connelly 2009:458). this explains the opinion that a firm’s management and synchronisation of resources promote organisational performance. in the franchising industry literature, the proportion franchised is influenced by efforts to organise franchisor-owned and relational strategic assets so that their value can be best leveraged to meet key strategic goals (gillis et al. 2013:449). franchisees are granted the right to use intellectual capital (watson et al. 2005:25) which refers to intangible resources (knowledge-based components) and encompasses all the information, experience, skills, structures, culture, and relationships of a firm that collectively help to create wealth (wexler 2002:393). for example, a franchise chain with a strong brand reputation is well known and respected among consumers (davis & mentzer 2008:435). barthélemy (2008:1451) showed that franchising networks with a valuable brand name and tacit business practices tend to perform better when they have a low proportion of franchised outlets. however, performance issues have received little attention in the franchising context (perdreau et al. 2015:123). hence it can be hypothesised that: h1: the value of the resources that a franchise outlet exploits will be positively related to its performance. valuable resources and dynamic sensing capability dynamic capabilities are a category of resources (day 2014:27; kozlenkova, samaha & palmatier 2014:6). a dynamic capability is the firm’s potential to systematically solve problems, formed by its propensity to sense opportunities and threats, to make timely decisions, and to implement strategic decisions and changes efficiently to ensure the right direction (li & liu 2014:2794). dynamic capabilities are the capacity of an organisation to purposefully create, extend or modify its resource base (helfat et al. 2007:1). drawing on teece et al. (1997:516), dynamic capabilities emphasise the importance of coordination, learning, sensing and integrating. it implies that a firm with dynamic capabilities can integrate and redeploy resources, and as a result obtain greater performance. for the purposes of this study, dynamic sensing capability is of interest. sensing capability is defined as the ability to spot, interpret, and pursue opportunities in the environment (pavlou & el sawy 2011:243). in franchising, chains must sense the environment to gather market intelligence on market needs, competitor moves, and new technologies in order for managers to identify opportunities. basic routines of the sensing capability are: generating market intelligence (galunic & rodan 1998:1193), disseminating market intelligence (kogut & zander 1996:76), and responding to market intelligence (teece 2007:1319). generating market intelligence relates to identifying customer needs (teece 2007:1319), being responsive to market trends (amit & schoemaker 1993:33), identifying market opportunities (day 1994:37), recognising rigidities (sinkula 1994:35), and detecting resource combinations (galunic & rodan 1998:1193). disseminating market intelligence relates to interpreting market intelligence (kogut & zander 1996:76), making sense of events and developments, and exploring new opportunities (teece 2007:1319). given this logic, it can be concluded that the dynamic sensing capability must be used in combination with resources. hence, it can be hypothesised that: h2: the valuable resources that a franchise outlet exploits will be positively related to its dynamic capability. the mediating role of dynamic sensing capability between valuable resources and franchise outlet performance extant literature posits that resources should be transformed into capabilities that help firms get more rents (chandler & steven 1994:331). a capability represents ability to perform a coordinated set of tasks utilising organisational resources (helfat & peteraf 2003:999). this is supported by castanias and helfat (2001:661) who argue that rents derive not from random or misguided initiatives, but rather from properly motivated and well-directed strategic effort. dynamic capabilities thus are considered a transformer for converting resources into enhanced performance (lin & wu 2014:411). this implies that if a firm employs resources without dynamic capabilities, it would be operating on misguided initiatives. being responsive to market intelligence also relates to initiating plans to capitalise on market intelligence (d’aveni 1994), and pursuing specific market segments with plans to seize the new market opportunities (teece 2007:1319). the sensing capability of franchised chains is proposed to enable the reconfiguration of their existing valuable resources. this provides an example to demonstrate how sensing capability positively mediates resources into improved performance. hence it can be hypothesised that: h3: a franchise outlet’s dynamic sensing capability will mediate the relationship between its valuable resources and performance. methodology in order to test the hypotheses of this study, a questionnaire was administered through qualtrics, and telephone and face-to-face interviews from june 2017 to october 2017. according to fasa (2016:15), south africa has over 600 franchised brands and almost 39 000 franchised outlets. so the target population of this study comprised franchise outlet managers and owners from the fasa registered member listing (fast food and restaurants; retailing and direct marketing categories) in gauteng province who had been in franchising since 2014. researchers used the purposive sampling because the respondents (managers and owner-operators) were chosen according to the managerial level criterion. the selected franchise outlet managers and owner-operators to whom questionnaires were sent were initially 500 from which 224 usable questionnaires were received. hypotheses were tested on a representative sample (224 respondents) of active franchisees (owner-operators and managers) in the fast food (n = 128) and retailing (n = 96) categories in the gauteng province of south africa. the franchise category did not influence the results as the findings were aggregated and not split between the different categories of franchises with the emphasis on the mix of resources and capabilities across all franchises. owner-operators (n = 80) and managers (n = 144) were taken to be the subject of this study because they must be responsible for firm resources and administering dynamic capabilities. the questionnaire was emailed to respective outlets through qualtrics and the interviews were carried out at a franchise outlet where respondents could be easily located. after data cleaning, 224 remained for analysis. from the total, 77 respondents were interviewed by telephone (34.4%), 53 by qualtrics (23.7%) and 94 face to face (41.9%). the critical socio-demographic information that was used included the category of franchising, the position in the organisation as well as experience in franchising. of these 224 respondents, 96 (42.9%) were from the retailing and direct marketing category while 128 (57.1%) were from fast food and restaurants. the majority of respondents who participated were managers (64.3%), with owner-operators consisting of just more than a third of respondents (i.e. 35.7%). the managers are those who are in charge of the resources at the outlets and run or supervise the day-to-day business operations. the respondents were grouped in terms of their experience in franchising. the less experienced (up to 5 years) constituted 89 (39.7%), moderate experience (from 6 years up to 10 years) was 67 (29.9%) and more experienced (from 11 years up to 40 years) amounted to 68 (30.4%). measures questions and items used were established in literature on a seven-point likert scale. value items were adapted from newbert (2008:766) and perez-nordtvedt et al. (2008:739). performance items were adapted from morgan et al. (2006:627), newbert (2008:766) and wilden and gudergan (2015:190). this meant to explore to what extent valuable resources owned by a franchise outlet affect its performance through dynamic sensing capability. hence, value with three items was measured based on five different resources as established in newbert (2008:766). moreover, performance was measured with four items (sales volume, growth in sales volume, market share and growth in market share). on the other hand, sensing capability was adapted from previous research (pavlou & el sawy 2011:268; wilden & gudergan 2015:190). in order to operationalise this construct, the five items were adapted and adjusted accordingly. they were measured using seven-point likert scales. results we applied structural equation modelling with amos 24. the model was assessed for internal consistency and the reliability of the applied constructs (hutter et al. 2013:346). table 1 displays factor loadings and reliabilities of factors. table 1: summary of factor analysis on five constructs. all the indicators comprised good factor loadings and cronbach’s alphas were quite high, exceeding the required reliability (table 1) (cronbach 1971). model fitness the overall causal model was evaluated using multiple fit indices: these included absolute fit index and incremental fit indices. the absolute fit index is the root mean square error of approximation (rmsea). the incremental fit indices are the tucker-lewis coefficient (tli), comparative fit index (cfi) and normal fit index (nfi). drawing on structural equation modelling (sem) that was used for data analysis, an acceptable fit was produced. the indices considered were rmsea (0.077), tli (0.8278), cfi (0.8353) and nfi (0.7455). the incremental indices (tli and cfi) were acceptable because they were between 0.80 and 0.90 (ullman 1996). mediation analysis the mediating effect of dynamic sensing capability between valuable resources and performance (sales volume and market share) was explored. first, regressions were run to predict franchise outlet performance from valuable resources predictor. the unstandardised regression coefficients for the prediction of franchise outlet performance from valuable resources predictor (highly valued resources, valuable exploiting resources and valuable efficient resources) were established. it was confirmed that all the independent variables were statistically significant predictors of the dependent variable, p < 0.001.the results show that valuable resources are significantly related to performance. hence the first hypothesis is accepted. next, the analytical results demonstrate that the valuable resources that a franchise outlet exploits are positively related to its dynamic sensing capability, p < 0.001. hence the second hypothesis is supported and accepted. the findings also support the rbv’s argument that valuable resources can strengthen the development of dynamic capabilities. this result about the relationship between valuable resources and dynamic sensing capability extends the conclusions from previous studies (lin & wu 2014; newbert 2008). hence, when viewed in the context of resource-capability combinations, findings posit that such combinations must be considered first before competitive advantage or performance. after controlling for the effects of dynamic sensing capability on performance, the effect of valuable resources on performance was no longer significant. hence the third hypothesis is supported and is accepted. findings resonate with the rbv idea that accumulating valuable resources and developing dynamic capabilities to mediate resources can enable firms to improve their competitive advantage and thus performance (teece et al. 1997). the magnitude of mediated effect drawing on warner (2013), when variables are measured in meaningful units, it is helpful to think through the magnitude of the effects in real units. the units of measurement have some real-world practical interpretation. figure 2 guides the practical interpretation. figure 2: unstandardised path coefficients. from the first regression analysis the coefficient for the total effect of valuable resources on franchise outlet performance was c = 0.211. for example, each 1 unit increase in valuable resources can predict an increase in franchise outlet performance of 0.2%. in addition, the assumption that franchisees aim to mobilise valuable resources into a distant future implies significant valuable resource-related increases in franchise outlet performance. from the second regression, the effect of valuable resources on dynamic sensing capability is a = 0.429; this was statistically significant. as an illustration, for a 1 unit increase in valuable resources, one can predict almost a 1.5% increase in dynamic sensing capability. this implies that the more a franchise outlet increases its valuable resources, the more dynamic sensing capability is also required. the final regression provides the two paths, b and c. the b coefficient which represents the effect of dynamic sensing capability on franchise outlet performance was b = 0.259; again it was statistically significant, based on the t-test (5.060). for the dynamic sensing capability increase, it predicts almost a 0.3% increase in franchise outlet performance. given this logic, franchisees may gain dynamic sensing capability over the long haul, and this would imply dynamic sensing capability is related to increases in franchise outlet performance. in conclusion, the indirect effect of valuable resources on franchise outlet performance is found by multiplying a × b (warner 2013). in this case the product of 0.429 and 0.259 = 0.111. this implies that for each 1 unit increase in valuable resources, a 0.11% increase in performance is predicted through the effects of valuable resources on dynamic sensing capability. on the other hand, the direct effect of valuable resources on performance is still significant. hence, over and above any dynamic sensing capability-related increases in performance, there is still a substantial increase in performance for each additional valuable resource. summary of hypotheses testing a compilation of the three research hypotheses is presented in table 2. the table also indicates that all three of the research hypotheses can hence be accepted. table 2: hypotheses. conclusion managerial implications the study contributes to the understanding of the rbt as applied in the franchising environment by showing that a definite relationship exists between valuable resources, dynamic capabilities (specifically sensing) and firm performance. the study contributes to the theory by expanding the perspective of the dynamic capabilities (barney et al. 2011; teece et al. 1997). it adds additional rigidity to the theory as it proves that the dynamic sensing capability will mediate the relationship between valuable resources and performance. it also adds to the understanding of the relationship between valuable resources and performance by proving that the value of resources that a franchise outlet exploits is significantly related to its performance, and that valuable resources is significantly related to the dynamic sensing capability. managers and owner-operators are likely to improve their outlet performance if they own valuable resources in combination with dynamic sensing capability. franchise owner-operators as well as franchise managers can therefore focus efforts on improving their dynamic sensing capability in conjunction with their valuable resources to increase firm performance. since the analytical results indicate the importance of valuable resources in developing dynamic sensing capability, franchisees can take a leaf from this study. physical resources (plant and equipment, geographic location, etc.), financial resources (working capital, cash, etc.), human resources (training, experience, etc. of individual employees), intellectual resources (patents, trademarks, etc.) and organisational resources (relationships with buyers, creditors, etc.) are key for the success of the franchise outlet. managers whose outlets exploit resources of great value are capable of enjoying high performance, whereas exploited resources may attain low performance if they are of marginal value. the sensing capability can help managers to identify customer needs, respond to market trends when the industry is affected, identify market opportunities (day 1994), recognise rigidities (sinkula 1994), and detect resource combinations (galunic & rodan 1998). some of these sensing issues are made possible by attending fasa professional activities and conferences. they must continually use established processes to identify target market segments, changing customer needs and customer innovation. also there is a need to observe the best practices in the sector, such as reengineered menus and recipes in fast foods or merchandising and customer database in retailing. limitations and future research drawing on barney and mackey’s (2005) call to explore rbt using primary data, this study collected primary data from franchisees (managers and owner-operators). although most franchise outlets use franchisor resources, they are run independently and privately. hence managers might have felt uncomfortable or uneasy to respond freely without bias. this might have caused response bias although managers were better positioned to respond to questions that deal with resources, dynamic capabilities and performance. newbert’s (2008) study operationalised the resource-capability combinations as suggested by penrose (1959), because the argument is to understand and acknowledge the symbiotic relationship that exists among them. hence this study did not use the vrin-capabilities combinations. this might have limited the findings that firm’s resource-capability combinations result in greater advantage as a result of their exploitation. although this study has limitations, they envisage directions for future research opportunities. structural equation modelling failed to give a perfect or good fit. hence future research must aim to establish the challenges with vrin, dynamic capabilities and performance. secondly, the theoretical underpinnings of rbt propositions and dynamic capabilities are to be explored in other industries with more constructs and items since rbt is criticised for tautology. franchisees may not be the best population to deal with since most of the resources are franchisor initiated or oriented. hence, a similar study can be replicated with the franchisors. another option may be to do a comparative analysis of franchisees and franchisors. franchise categories were also not distinguished in the results, which could add an additional layer of meaning. this could be explored in future research studies. moreover, drawing on newbert (2008:747) it should be noted that future research must explore independent variables as resource-capability combinations instead of treating them as slices of empirical indicators. again, the findings in this study also indicate interesting directions for future research in that the model was statistically sound. hence it can be further tested in large firms where resources and capabilities are idiosyncratic. acknowledgements thank you to dr marthi pohl at the university of pretoria for her guidance and support with the statistical modelling. competing interests the views expressed in this article are the authors’ own and not an official position of the university of pretoria. authors’ contributions the initial research formed part of a phd study conducted by dr jilson zimuto under the supervision of dr rachel maritz. both contributed equally to the development of the article. funding this research received no specific grant from any funding agency in the public, commercial, or not-for-profit sectors. data availability statement data sharing is not applicable to this article as no new data 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methods to determine the feasibility of a project. the use of these methods is influenced by the size ofa company's annual capital budget, as there is a correlation between a company's annual capital budget and a preference for these methods. jelm20 introduction during recent years many opportunities arose for local com;::anies because international trade restrictions have been lifted. there was suddenly an opportunity to do business in the global market. this resulted in vast expansions of capital investment projects as many companies increased their production capacities at home and abroad. these investments took the form of production equipment purchases. investments in and an expansion of production facilities and larger investments such as acquisitions and even mergers. from 1991 to 1994 south africa's gross domestic fixed investment remained constant in real terms. however, during the period 1994 to 1998 there was an increase of 7.20 % per year in real values (qb, march 1999). there are several methods to evaluate capital investment decisions. given the importance of capital investment, not only for the country as a whole, but also for the creation of shareholder wealth for individual firms, it may be helpful to r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 354 investigate the practices used to evaluate these projects. the findings are compared with the theoretical principles and with the results of similar studies. research objectives the joint objective of this study is to give a brief overview of the capital budgeting process. first, an overview of the literature is sketched. then, an empirical study investigates a number of aspects of the capital budgeting process as practised by south african companies in the evaluation of capital investment projects. hypotheses although the hypotheses tested in this study are statistical rather than deterministic in nature, they are stated below as if they were deterministic simply to keep the terminology as close as possible to everyday language. the hypotheses tested in this study are the following: hypothesis 1 the most important stage in the capital budgeting process is financial analysis and project selection. hypothesis 2 cash flow forecasting methods are based on quantitative methods. hypothesis 3 the most popular capital investment techniques applied by decision-makers are based on percentages which they derive from the internal rate of return and return on investment. hypothesis 4 the capital budgeting method used should not be influenced by the size of the annual capital budget. hypothesis 5 capital investment decisions are mostly accepted on financial criteria. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 355 sajems ns vol 3 (2000) no 3 the capital investment decision this section provides a brief overview of aspects of the capital budgeting process. in its simplest form, an investment decision can be described as a firm's decision to make a cash outlay in order to receive, in return, future cash inflows (lumby, 1991: 23). du toit, neuland and oost (1997: 2) define capital budgeting as the identification, evaluation and selection of the long-term or fixed assets that will increase shareholder value. tomorrow's business success depends on investment decisions made today. procedures or aspects of the investment decision that are used to help management make investment decisions are often inadequate and misleading. business organisations are continually faced with the problem of deciding whether the commitment of resources time or money -is worthwhile in terms of the expected benefits. if the expected benefits are likely to accrue over a relatively long time, the solution is more complex and chances of making an incorrect decision increase (bien nan & smidt, 1993: 4). the capital budgeting process can be divided into four stages, namely: tj identification and development of investment proposals; tj financial evaluation of projects; o implementation of projects; and tj project review. various aspects of this process are investigated in the empirical st11dy. a number of techniques are used to evaluate investment opportunities. the most important techniques are internal rate of return (irr), present value payback (pvp), accounting rate of return (arr), the profitability index (pi) and net present value (npv). it falls beyond the scope of this study to explain or elaborate further on these techniques. as a capital budgeting criterion, the irr is the most popular criterion because people are taught since childhood that measurements should be conducted in terms of a percentage rate. it may be argued, however that the irr is not a good criterion due to its inferiority with regard to poor reinvestment rate assumptions, the fact that it violates the value added principle, and that more than one irr can result for the same project. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 356 the empirical study is conducted in order to address the various hypotheses set out above. the method used to conduct the empirical study and the research results are discussed below. research method description of the population the population chosen was companies listed on the industrial sector of the johannesburg stock exchange. industrial companies were selected for the research due to the fact that the capital investment decision features more prominently in these companies because it relates closely to production capacities. source of data the information used in this study was obtained in collaboration with the bureau of financial analysis at the graduate school of management at the university of pretoria. a questionnaire was sent to the selected sample. sample selection at the time of the study (1998), there were 358 companies in the industrial sector listed on the johannesburg stock exchange. owing to financial and time constraints, these companies were listed alphabetically and only the first 300 were selected as a sample. questionnaires the questionnaire consisted of24 questions divided into three sections: the first section focussed on the company and decision-maker profile, which is necessary to categorise the data of the various responses. it gives an indication as to the seniority of the decision-maker and hislher background. it also indicates the amount budgeted to be invested in capital projects as well as the extent of the company's operations. nine questions were asked in section one of the questionnaire. section two of the questionnaire examined the capital budgeting techniques used in the capital investment process with a specific focus on the techniques that are most often used to assess the viability of different operations. this section consisted of ten questions. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 357 sajems ns vol 3 (2000) no 3 the last section deals with the incorporation of risk into the capital budgeting decision and is discussed in a subsequent article. data collection and analysis as stated above, a list of all companies in the industrial sector of the johannesburg stock exchange with addresses was made available by the bureau of financial analysis at the graduate school of management at the university of pretoria. questionnaires were sent to 300 companies, during the second half of 1998. responses were encoded with the assistance of the graduate school of management. the data was computerised using a computer software package called sas (statistical analysis system). a spreadsheet reflecting the respondents' answers was compiled and encoded for use as input to the sas~ programme. empirical results introduction when the data from the questionnaires was analysed, it was found that, although the majority of questions have only one logical answer, the respondents in some instance selected more than one answer. in order to apply a consistent approach in capturing the data, the first answer given to a specific question was regarded as the respondent's answer for capturing purposes. general observations on the data the total response from the population of 300 amounted to 70 questionnaires (23.33%), which were categorised as 'usable' and 'non-usable'. the 'usable' responses amounted to 65 questionnaires, giving a response rate of21.67%. when the data were analysed, it was found that the questionnaires had been completed mainly by the financial directors of the various companies (55.4%). forms completed by financial managers amounted to 29.2%, while the remaining 15.4% were completed either by the chief executive officer (7.7%), the company secretary (2.5%), the treasurer (1.5%) or other senior management (3.7%). the respondents generally have a high level of experience within their respective companies, as 60% of them have been with their companies for more r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 358 than five years. of the remaining 40%, only 24,6% have been with the company for less than two years. they are highly skilled people (all respondents have a tertiary qualification) and 61.5% have a postgraduate qualification (honours or masters). the majority of the respondents (13.8%) are in the stores sector while 12.3% indicated that they are in the industrial holdings sector, and a further 12.3% are in the food sector. table 1 and table 2 illustrate the respondents' total assets, the amount of annual sales and the size of the annual capital budget. the analysis shows that the respondents fall in two main categories, namely, 35.4% with assets between rloo million and r500 million and 32.3% with assets of more than ri billion. table 1 the amount of total assets total assets 0/0 less than r50 million 9.20 between r50 million and r i 00 million 10.80 between rioo million and r500 million 35.40 between r500 million and ri billion 12.30 more than rl billion ! 32.30 100 table 2 annual sales and size of annual capital budget item a'1nual annual sales capital bud2et less than r2 million 0.00 10.80 between r2 million and r5 million 1.50 12.30 between r5 million and rio million 0.00 12.30 between rio million and r25 million 0.00 12.30 between r25 million and r50 million 4.60 10.80 between r50 million and rioo million 10.80 16.90 more than rioo million 83.10 24.60 --,-. .. i 100 100 annual sales are more than rioo million for 83.1% of the respondents while 41.5% of the respondents' annual capital budgets are more than r50 million (24.6% more than rioo million and 16.9% between r50 million and rioo r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 359 sajems ns vol 3 (2000) no 3 million). the importance of the capital investment decision can thus be clearly seen when one analyses the amount spent on capital investment projects. for instance, if 24.6% of the 65 respondents as indicated spend more than rioo million on their annual capital budget, this will amount to more than r1.6 billion in capital investments per annum. stages in the capital budgeting process as table 3 illustrates, the majority of respondents regard project definition and cash flow estimation not only as the most important stage in the capital budgeting process but also as the most difficult. financial analysis and project selection are regarded as the second most important and difficult stage. this implies that these decision makers have a thorough understanding regarding the care that should be taken when capital investment decisions are evaluated, because the successful outcome of a decision depends on the accurate estimation of cash flows and efficient financial analysis of the proposed alternative. although the respondents generally regard the project implementation stage as more important than the project review stage, more companies deem the project review stage more difficult. table 3 most important and most difficult stages in the capital budgeting process item most most i important difficult ' project definition and cash flow estimation 66.2 46.2 financial andysis aed project selection 26.2 29.2 project implementation 4.6 9.2 project review 3.1 15.4 100 100 cash flow forecast method used a list was provided to the respondents with several options, requesting them to indicate which cash flow forecasting methods they use. table 4 presents these findings. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns yol3 (2000) no 3 360 table 4 cash flow forecasting methods used cash flow forecasting method percentage ranking management subjective estimates (mse) 20.00 3 consensus of expert opinion (ceo) 1.50 7 quantitative methods (qm) 3.10 6 mse&ceo 12.30 4 mse&qm 23.10 2 ceo&qm 0.00 8 i mse&ceo&qm 35.40 1 ~()tsay 4.60 i 5 100 the majority of respondents utilise a combination of methods to estimate their cash flows. the most popular combination seems to be management subjective estimates in conjunction with consensus of expert opinion and quantitative methods (35.4%). the combination with the second highest popularity seems to be management subjective estimates in conjunction with quantitative methods (23.1 %). it is clear that the use of different combinations of cash flow forecasting methods in estimating future cash flows are used quite extensively, as these combinations amount to a total of 70.8%. an interesting finding, however, is the fact that 20% of the respondents use only management subjective estimates. if this percentage is added to the 4.6% of respondents who indicated that they are not able to say, we find that no less than 24.6% of the respondents do not use a formal cash flow forecasting method to estimate future cash flows. techniques used in the capital budgeting process when the respondents were asked to indicate which technique they considered to be the most important capital budgeting method, 33.8% indicated that roj and 32.3% indicated that the irr should be regarded as the most important capital budgeting method. the remaining respondents regarded npy and pyp as the most important with a percentage distribution of 16.9% for each of these two techniques. table 5 illustrates these preferences regarding the capital budgeting method to be used. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 361 sajems ns vol 3 (2000) no 3 table 5 preferences regarding the most important capital budgeting method to be used item importance ranking return on investment (roi) 33.8 1 internal rate of return (irr) 32.3 2 net present value (npv) 16.9 3 present value payback (pvp) 16.9 3 profitability index (pi) 0 n/a accounting payback (ap) 0 n/a 100 in south africa another study, parry and firer (1990: 55) also found that the irr was the most popular (43%), followed by the roi (32%). npv was reported as being a primary technique by only 10% of their respondents. a uk study by pike (lumby, 1991: 49 i) showed similar results, with the irr being consistently more popular than the npv. pike's study also asked firms for their reasons for choosing the methods they use. the irr was thought to be a good device for ranking projects, it was easy to understand as it gave a percentage rate of return and the technique did not require a discount rate to operate. the npv came in for considerable adverse comment, such as that it was difficult to understand, unnecessary for short-lived projects, difficult to use because of changing hurdle rates and a questionable technique to use in periods of high inflation (lumby, 1991: 492). a usa study by scapens, sale & tikkas (lumby, 1991: 492) found that discounted cash flow (dcf) techniques generally were more widee;>read used in the usa than in the uk. they found that in their sample 84% of usa companies used dcf techniques, as against only 54% in the uk. if the preferences for capital budgeting methods used are analysed according to the size of the annual capital budget as illustrated by table 6, it is clear that companies with an annual capital budget in excess of ri00 million regard the irr as the most important capital budgeting method (68.7%). roi is regarded as the second most important method (25%). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 362 table 6 most important capital budgeting method in terms of annual capital budget • more than r50m rl5m riom i r5m rlm less rioom to to to • 10 10 than technique r100m r50m rl5m i riom r5m rlm (n=16) -<n=li} (n=7) (n=8) (n=8) (n=8) (n=7) return on investment 25.0 18.2 • 14.3 37.5 25.0 75.0 • 57.2 (roi) internal rate of return 68.7 45.5 14.3 25.0 12.5 0.0 14.3 (lrr) net present value 6.3 9.1 42.9 25.0 25.0 25.0 0.0 (npv) present value payback 0.0 27.2 28.5 12.5 37.5 0.0 28.5 (pvp) profitability index (pi) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 accounting payback 0.0 0.0 0.0 0.0 0.0 0.0 0.0 (ap) i i 100 100 100 100 100 100 100 companies with an annual capital budget between r50 million and rioo million regard internal rate of return as the most important (45.5%) and present value payback as the second most important method (27.2%). companies with an annual capital budget between r25 million and r50 million and between rio million and r25 million regard net present value (42.9%) and return on investment (37.5%) as the most important method respectively. they respectively deem the present value payback (28.5%) and internal rate of return in conjunction with the net present value (both 25%) as the second most important methods to be used in capital investment decisions. where the annual capital budget is between r5 million and rio million, companies seem to regard the present value payback as the most important method to be used (37.5%) while the return on investment in conjunction with net present value (both with 25%) are regarded as the second most important methods to be used. companies with an annual capital budget between r2 million and r5 million and those less than r2 million regard return on investment as the most important method to be used with percentages of 75% and 57.2% respectively. these companies respectively regard net present value (25%) and present value payback (28.5%) as the second most important methods to be used. an interesting fact is that not one of the respondents regarded profitability index or accounting payback as an important method to be used in the capital budgeting process. this may indicate that these methods are of little value in r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 363 sajems ns vol 3 (2000) no 3 capital investment decision-making. the study by parry and firer (1990: 55) also found a difference between the techniques used by high and low capital intensity firms. according to their study 65% of high capital intensity firms prefer the irr compared to only 24% of low capital intensity firms. the most popular method for low capital intensity firms is roi (47%), which is an indication of lower sophistication in capital budgeting techniques by companies with a smaller capital budget. this finding is supported by several studies cited in lumby (1991: 492), which showed that dcf techniques are more popular for larger projects and that larger companies were more likely to use dcf techniques. with regard to the capital budgeting techniques used, respondents were asked to indicate which capital budgeting technique they most often use when assessing the viability of capital investment projects in general and more specifically with regard to particular operations. six different operations were identified, namely expansion in new and existing operations, foreign operations, abandonment, general or administrative projects and social projects. social projects were defined as projects which do not generate any income for the firm and include rdp-projects, pollution control and rehabilitation and environmental programmes. a summary of the various responses is given in table 7. table 7 techniques most often used in assessing different operations technique irr npv pi pvp apb roi quesother tion n/a capital investment 27.7 21.5 4.6 15.4 3.1 27.7 0.0 0.0 projects expansion in existing 30.8 9.2 4.6 18.5 3.1 32.3 1.5 0.0 operations expansion in new 29.2 12.3 7.7 12.3 0.0 38.5 0.0 0.0 operations foreign operations 20.0 3.1 4.6 16.9 0.0 32.3 21.5 1.5 abandonment 20.0 10.8 7.7 10.8 4.6 30.7 9.2 6.2 general i administrative 12.3 10.8 7.7 20.0 10.8 21.5 6.2 10.8 projects social projects 4.6 15.4 1.5 6.2 3.1 7.7 23.1 38.5 as can be seen from table 7, 21.5% of respondents are not involved in foreign operations, 9.2% do not have abandonment activities while 6.2% do not apply capital investment techniques in general or administrative projects. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 364 when assessing the viability of capital investment projects in general, the majority of respondents indicated that the most often used capital budgeting techniques are lrr and roi with a percentage rate of27.7% each, followed by npv (21.5%) and pvp (15.4%). with regard to the various operations where applicable (except social projects), all the respondents stated that the most often used and second most often used capital budgeting techniques are roi and lrr respectively. with regard to social projects, 38.5% of the respondents indicated that they use other techniques to assess the viability of these type of projects. these techniques can be divided into five groups, namely, social responsibility and moral (ethical) issues, derived strategic benefits, not seen as capital, legal requirements, and subjectiveness. table 8 illustrates the distribution amongst the groups of all respondents who indicated that they use another technique to assess the viability of social projects. table 8 distribution per group using other techniques to assess social projects item percentage ranking derived benefits i 30.43 1 social responsibility and moral issues 26.09 2 subjectiveness 21.74 3 not seen as capital 13.04 4 legal requirements 8.70 5 as can be seer. from the. table 8, social projects are, to a great extent, evaluated on a subjective basis where management weighs the possible benefits that can be derived against the amount invested in the specific project. these benefits may take the form of goodwill achieved within a community and the perceived fulfillment ofa company's social responsibility. although the above table ranks legal requirements quite low, it should be noted that legal requirements play an important role in the evaluation of social projects. for instance, not only must companies comply with environmental legislation in terms of pollution control, rehabilitation programmes and conservation standards, these companies are forced to comply with legislation that involves more general spheres of life such as the equity bill as well as the constitution. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 365 sajems ns vol 3 (2000) no 3 table 9 non-financial criteria used in major investment decisions item percentage ranking investments never accepted on non-financial 33.80 i grounds safety of employees or the public 21.50 3 necessity of maintaining existing programmes 20.00 4 or product lines other 24.70 2 100 table 9 gives a summary of non-financial (qualitative) criteria that respondents use in major investment decisions. it is clear that 33.8% of all respondents indicated that investments are never accepted on non-financial grounds, whilst 21.5% of respondents indicated that the safety of their employees or the public influences their capital investment decision. some 20% responded that maintaining existing programmes or product lines influences their capital investment decision. other international studies also support the finding that qualitative or nonfinancial criteria playa large role. fremgen (lumby, 1991: 491) found in a usa survey that 97% of his respondent companies admitted to having approved investment projects for which the quantitative appraisal techniques had advised rejection. carsberg and hope (lumby, 1991: 491) found that one third of their respondents ranked 'judgment' as the most important appraisal method. one of the reasons proposed by the authors for this was that the use of managerial judgment fitted in with the concept of managerial 'tlair' and entrepre~eurship. the stage in the capital budgeting process that the respondents consider to carry the highest risk is illustrated in table 10. it was found that 46.2% regarded project definition and cash flow estimation as the most risky. this correlates with the stage respondents regarded as the most important as well as the most difficult. however, comparing the second most risky stage with the second most important and most difficult (table 3), we see that the respondents regard project implementation as the second most risky stage in contrast with financial analysis and project selection as second most important and most difficult. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 366 table 10 highest risk stage in capital budgeting process item ~ighest risk project definition and cash flow estimation 46.20 financial analysis and project selection 24.60 project implementation 29.20 project review 0.00 100 this trend signifies a possible absence regarding the evaluation of risk in itself, as the focus is placed on the ability to manage the project implementation stage. it seems that as long as the project has been defined and the accompanying cash flows have been estimated, the tendency is to do a financial analysis, select a project and then to implement with a risk focus at the latter stage. table 11 gives an indication of the preferences according to the size of the annual capital budget. companies with an annual capital budget exceeding r50 million regard project definition and cash flow estimation as the most risky stage in the capital budgeting process. table 11: most risky stage according to annual capital budget stage more r50m r25m ri0m r5m rum less than to to to to to than ri00m ri00m rsom ru5m riom rsm r2m (0=16) (0=11) (0=7) (n=8) (0=8) (0=8) (n=7) project definition and 62.5 45.5 14.4 50.0 62.5 37.5 28.6 cash flow estimation financial analysis and 6.3 18.2 42.8 12.5 12.5 62.5 42.8 project selection project implementation 31.2 36.3 42.8 37.5 25.0 0.0 28.6 project review 0.0 0.0 0.0 0.0 0.0 0.0 0.0 100 100 100 100 100 100 100 project implementation is regarded as the stage that carries the second highest risk. respondents with an annual capital budget between r25 million and r50 million seem to regard the risk element associated with financial analysis and project selection as being the same as that of project implementation. incidentally, these respondents do not regard project definition and cash flow r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 367 sajems ns vol 3 (2000) no 3 estimation as the stages that carry the highest risk. respondents with an annual capital budget between r5 million and r25 million have the same preferences as those with an annual capital budget exceeding r50 million in what they regard as the most risky and second most risky stages in the capital budgeting process. companies with an annual capital budget less than r5 million state that financial analysis and project selection is the stage that carries the highest risk. conclusion testing the hypotheses, the following results were obtained: hypothesis i tested negative as the most important stages in the capital . budgeting process appear to be project definition and cash flow estimation and not financial analysis. hypothesis 2 is difficult to assess as most cash flow forecasting depends on a combination of methods among which quantitative methods appear to be of least value. hypothesis 3 tested positive as roi and irr are the most generally applied capital investment techniques used by decision-makers. this finding contrasts with the generally accepted view that npv is superior to other capital budgeting techniques. hypothesis 4 tested negative, as companies with smaller capital budgets prefer pvp, medium spenders npv, and companies with relatively large capital budgets rely consistently oj! irr to evaluate capital investment projects. hypothesis 5 also tested negative as 64% of respondents have at some time used non-financial criteria when assessing projects. an important finding of this research is that in the evaluation of capital investment projects, the preference of south african companies seems to be roi and irr as methods to be used in determining the feasibility of a project. the use of these methods is influenced by the size of a company's annual capital budget as there is a correlation between the annual capital budget and a preference for roi and irr. as the annual capital budget increases, the tendency is to use these methods more extensively. the subject of future research on this topic will deal with the question of how well risk is incorporated into the capital investment decision. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 3 368 endnote acknowledgement is hereby given to mr pg vosloo and prof lm brummer for their inputs into this article. references bierman, h. and smidt, s. (1993) the capital budgeting decision, 8 th ed. new york: macmillan. 2 du toit, g. s.; neuland, e.w. and oost, e. j. (1997) capital investment decisions, pretoria: unisa press. 3 lumby, l (1991) investment appraisal and financing decisions, 4th ed. london: chapman & hail 4 parry, h.m.a. and firer, c. (1990) capital budgeting under uncertainty: an empirical study, south african journal of business management, 21(3): 52-8. 5 south african reserve bank (1999) quarterly bulletin, march (qb). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction literature review economic policy uncertainty index constant parameter vector autoregressive model time-varying parameter vector autoregressive model concluding remarks acknowledgements references appendix 1 footnotes about the author(s) theshne kisten department of economics, faculty of economics and management science, university of pretoria, pretoria, south africa citation kisten, t., 2020, ‘macroeconomic implications of uncertainty in south africa’, south african journal of economic and management sciences 23(1), a3350. https://doi.org/10.4102/sajems.v23i1.3350 original research macroeconomic implications of uncertainty in south africa theshne kisten received: 15 aug. 2019; accepted: 06 nov. 2019; published: 18 feb. 2020 copyright: © 2020. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract aim: this article explores the extent to which economic policy uncertainty (epu) influences selected macroeconomic variables in south africa (sa). methods: to this end, i construct a constant parameter vector autoregressive (var) model and a time-varying parameter (tvp) var model, where the latter model evaluates if the impact of uncertainty on the macroeconomic variables has changed over time. setting: the models are estimated using quarterly south african data over the period 1990 to 2015, which include industrial production growth, consumer price inflation, 10-year government bond yield, real effective exchange rate, and economic policy uncertainty. cholesky ordering of the variables are imposed to recover the orthogonal shocks. results: the results of the constant parameter var model suggest that an unanticipated positive shock to the uncertainty index results in a decline in industrial production and real effective exchange rate, while fostering an increase in the general price level and 10-year government bond yield. time-varying impulse responses show that the impact of uncertainty shocks on the selected macroeconomic variables has declined systematically over time. this is perhaps intuitive as the new unanticipated information is gradually picked up by media over time and incorporated into rational agents’ decision-making. conclusion: the transmission of a positive uncertainty shock to the real economy has time-varying implications. keywords: uncertainty; south africa; var; time-varying; macroeconomic. introduction over the past few years, a growing number of official local and international publications have mentioned political uncertainty as a major factor influencing macroeconomic dynamics in south africa (sa). for instance, the most recent international monetary fund (imf) world economic outlook publication released in october 2017 stated that ‘in south africa, growth is projected to remain subdued … as heightened political uncertainty saps consumer and business confidence’. given this, my article will attempt to quantify the impact of economic policy uncertainty (epu) on selected macroeconomic variables in sa by constructing a constant parameter vector autoregressive (var) model. in addition, i will attempt to examine if this impact changes over time, by constructing a time-varying parameter (tvp) var model. my article contributes to the emerging market literature in two ways. firstly, it extends the evidence that uncertainty shocks result in drops in real activity in developing countries. secondly, it provides evidence on the time-varying impact of epu shocks on the macroeconomic dynamics of an emerging market economy (sa in this case), by allowing for the variance of the structural shock, as well as the coefficients to vary over time. to my knowledge, the analysis of the time-varying impact of uncertainty, especially within a south african context, has not been examined in previous studies. redl (2015) examined the impact of uncertainty shocks on the south african economy by means of a constant parameter var, finding that an unanticipated shock in the uncertainty index is linked to a decline in investment, private sector employment, output and industrial production, while resulting in an inflationary shock. however, the author did not examine if this impact changes over time. as such, my article aims to fill the gap in literature by estimating a constant parameter var model and a tvp var model for the south african economy, employing a measure of uncertainty constructed by hlatshwayo and saxegaard (2016). a five-variable var system using quarterly data over the period 1990–2015 is estimated for both the constant and time-varying specifications. the models include industrial production, inflation, 10-year government bond yield, real effective exchange rate (reer), and the epu index. the impulse responses in the constant parameter var model suggest that an unanticipated positive shock to the uncertainty index is associated with a decline in industrial production and reer, while fostering an increase in the general price level and 10-year government bond yield. markov chain monte carlo (mcmc) methods in the context of a bayesian inference are employed, following primiceri (2005) and nakajima (2011), to estimate a precise and efficient tvp var model with stochastic volatility. the dynamics of volatility over time is presented by the posterior estimates for stochastic volatility of the structural shock, which differ across variables. in this case, the constant parameter var model estimates would be biased in terms of the error covariance matrix and the autoregressive coefficients due to the misspecification of the dynamics of the parameters. the time-varying impulse responses for the specified dates (1994q4, 1999q4, 2004q4 and 2009q4) show that the impact of uncertainty shocks on industrial production, the reer and the price level has moderated slightly over time (with the timing of the change of the price level coinciding with the introduction of inflation targeting in the economy), while the impact on the bond yield has remained fairly stable. while the time-varying impulse responses of the macroeconomic variables for the 2, 4, 8 and 12 period ahead, following an unanticipated shock to the economic policy uncertainty index, show a diminishing impact over time, as the new unanticipated information is gradually picked up by media and incorporated into rational agents’ decision-making. the remainder of the article is organised as follows. in section 2, i review the literature on uncertainty shocks. section 3 describes the epu index used and its construction. section 4 presents the estimation procedure and empirical results of the constant parameter var model. section 5 presents the estimation procedure and results of the tvp var model, and section 6 concludes. literature review theoretical literature highlights three broad reasons for why uncertainty matters, which include real options, risk aversion and growth options effect. uncertainty influences growth via negative channels (real options and risk aversion) and positive channels (growth options) (bloom 2014). however, the majority of empirical studies tend to lend support to the negative channels rather the positive channel. the idea of the real options effect is that firms face a number of investment projects that they may delay in the event of uncertainty. however, certain prerequisites are needed for this to have macroeconomic implications: firms must be subject to adjustment costs that cannot be easily reversible, must have the ability to wait in terms of bringing their product to the market, and finally firms’ investment actions today should influence the returns to actions taken tomorrow (for example, operate in an environment characterised by decreasing-returns-to-scale technology). when uncertainty is high, these effects can dampen the reallocation of resources across firms aimed at enhancing productivity, as productive firms expand less, while unproductive firms contract less as both are now cautious. according to bloom, baker and davis (2015), this can result in pro-cyclical productivity and link these uncertainty shocks to the business cycle. since risk averse investors require a higher return in the event of uncertainty, this means that greater uncertainty results in increasing risk premia, which raises the cost of borrowing and hence the probability of defaulting. the increase in the cost of borrowing has negative microeconomic and macroeconomic growth implications, due to the amplification of financial stress (arellano, bai & kehoe 2016; caldara et al. 2013; christiano, motto & rostagno 2013). considering an increase in uncertainty from the households’ perspective, risk aversion causes households to increase their precautionary savings, reducing consumption expenditure. this is likely to have a contractionary effect on the economy in the short run but stimulate growth in the long run through rising investment. however, in small highly open economies there could be a substantial reduction in domestic demand as much of the households’ savings flows abroad (fernandez-villaverde et al. 2011 cited in bloom 2014). if nominal rigidities are strong, prices and interest rates will not decline sufficiently following the drop in demand, leading to a recession in any economy (leduc & liu 2015). an increase in uncertainty can also be interpreted as positive on a macroeconomic level, although empirical literature has consistently proved otherwise. the growth options effect hinges on the idea that uncertainty can encourage investment to the extent that it increases the size of the potential return (by creating call options). the possible reason for why this effect is rarely observed in empirical studies is perhaps due to the ‘ambiguity aversion’ of agents. such agents tend to assume the worst case scenario of the possible distributions they consider, thus an increase in uncertainty concerning future profits would lower the worst-case return on the investments (bianchi, ilut & schneider 2017). since the global financial crisis of 2008, a growing amount of empirical literature has dealt with the measurement of uncertainty and how it affects macroeconomic variables. bloom (2009) initiated the development of proxies for uncertainty by using united states (us) stock market volatility as a measure of uncertainty. he found stock market volatility to be a leading indicator for declines in employment, industrial production, and federal funds rate (ffr) which tend to display a short recessionary effect (however, ffr experienced a much more persistent drop). however, a period of positive catch-up growth recovery followed this decline. this pattern occurs since following higher uncertainty, real activity drops as hiring and investment plans are paused, but can be quickly recovered as this uncertainty dissipates. baker, bloom and davis (2013) developed an epu index for the us, based on newspaper-coverage frequency on uncertainty stories about the economy, monetary and regulatory policy, the number of federal tax code provisions set to expire, and the extent of forecaster disagreement over future inflation and government purchases. employing a var analysis, the authors find that increases in the epu index result in sizable persistent declines in output, investment, consumption expenditure and employment. a similar methodology was conducted for the united kingdom (uk) by dendy et al. (2013) cited in redl (2015), however, based on economic rather than policy uncertainty composed of disagreements among forecasters on economic variables, a news-based index, and remarks pertaining to uncertainty in financial stability reports (fsrs) and monetary policy committee (mpc) minutes of the bank of england. the findings of the study were similar to baker et al. (2013), while there was no evidence of positive growth catch-up as in bloom (2009). an index of economic uncertainty for sa was developed by redl (2015), using a similar methodology proposed by baker et al. (2013). redl employed three sources to construct the economic uncertainty index, including data on professional forecaster disagreement concerning macroeconomic conditions, mentions of uncertainty in the quarterly economic review of the south african reserve bank (sarb) and a count of newspaper articles (domestic and international) discussing economic uncertainty in sa. the author finds that an anticipated shock in the uncertainty index is linked to a decline in investment, private sector employment, output and industrial production, while resulting in an inflationary shock contradictory to us and uk evidence. similar results were found when the author included control variables related to financial stress and consumer confidence. similarly, gupta, bonga-bonga and jooste (2015) investigated the macroeconomic effects of uncertainty shocks in india, constructing a structural model that decomposes uncertainty into positive and negative contributions. they find that an increase in uncertainty results in a reduction in prices and industrial production, increases interest rates and fosters exchange rate depreciation, while a decrease in uncertainty reduces prices, increases industrial production, fosters exchange rate appreciation and slightly increases interest rates. however, they find that the macroeconomic response to uncertainty is insignificant. baker, bloom and davis (2016) extend their analysis by constructing country-specific measures of economic policy uncertainty. these measures are based on newspaper-coverage frequency, and are found to be positively correlated with fluctuations in policy-related economic uncertainty. for instance, the us epu index peaked during wars, tight presidential elections, the 9/11 terror attack, the failure of lehman brothers, and a number fiscal policy encounters. in their analysis, the authors find that increased policy uncertainty in the us foreshadows a reduction in output, investment and employment while resulting in an increase in stock price volatility in the country. this result was largely confirmed by a panel var modelling 12 major economies. hlatshwayo and saxegaard (2016) construct a news-based measure of south african epu by counting the number of articles that match a certain search algorithm containing words related to aggregate economic and aggregate policy uncertainty. the authors explore the relationship between exports, foreign demand, reer and the uncertainty index and they discover that the responsiveness of exports to relative price changes diminishes following an increase in policy uncertainty. this is because the increase in uncertainty increases the real option value of firms adopting a ‘wait and see’ approach when it comes to making large, exporting-related fixed cost investments (which supports the idea of the real options effect explained by bloom 2014). the results were found to be robust to alternative explanations that consider credit constraints, supply chains, and threshold boundary effects. furthermore, the unadjusted reer was outperformed by a measure of competitiveness that adjusts for uncertainty and supply-side constraints in tracking exports performance in sa. the exploration of the time-varying nature of macroeconomic dynamics to uncertainty shocks have been quite limited, especially for emerging market economies. alessandri and mumtaz (2014) investigate the potential non-linearities related to the impact of uncertainty shocks but do not examine whether the impact experiences gradual changes over time. while benati (2014) employs a time-varying var to estimate the importance of policy uncertainty shocks but focuses on the great recession rather than considering structural changes over an expanded time period. mumtaz and theodoridis (2014) fill these gaps by developing an extended factor augmented var to investigate the time-varying impact of uncertainty shocks on the us economy by allowing for both the parameters and error variances to vary over time. they find that the impact of uncertainty shocks on us financial and real activity variables has moderated over time, while the impact on the short-term interest rate and inflation has remained fairly stable. a similar study obtaining similar results was constructed for the uk by mumtaz (2016). however, the author finds that the impact of uncertainty shocks on interest rates and inflation has also moderated over time, with the timing of the change coinciding with the introduction of inflation targeting in the economy. economic policy uncertainty index i make use of the ‘news chatter’ epu index constructed by hlatshwayo and saxegaard (2016) for the purpose of investigating the macroeconomic implications of uncertainty.1 the index, which is standardised to range between 0 and 100, is based on a count of articles related to aggregate economic and aggregate policy uncertainty. search algorithms were employed by the authors (via the dow jones factiva news aggregator) sourcing articles that contain words related to ‘economics’, ‘policy’, ‘government’, ‘politics’ and ‘uncertainty’ within 10 words of ‘south africa’. the methodology of constructing the index was similar to that employed by baker et al. (2016) – the authors championed the ‘news chatter’ approach to measuring uncertainty in the press, as such a measure has the ability to detect the threat or anticipation of volatility, irrespective of whether it comes to fruition or not. figure 1 shows the periods during which the uncertainty index reached its peaked levels above its average level for the period 1990–2015. the 1990s was clouded by a high degree of political turbulence, resulting in the index peaking during the 1992–1994 period of democratic transition (release of political prisoners and the unbanning of political organisations, convention for a democratic south africa negotiations to end apartheid) and 1996 (new constitution and violent political unrest). the south african currency depreciated by almost 50% during the 2000–2002 period following capital flight associated with the destabilising effects of the earlier asian crisis and collapse of long term capital management in 2000. economic policy uncertainty spiked again in the late 2000s due to external pressure, investment regulatory uncertainty and an energy crisis. figure 1: economic policy uncertainty index. while global pressures loomed large during 2008–2009 due to the global financial crisis, domestic pressures were also present. domestic pressures in 2008 included electricity shortages during the early part of the year, due to the near collapse of the national electricity grid, and the split of the african national congress (anc) into various parties which aroused concerns by many as to whether south africa would adopt more populist policies. uncertainty increased in 2012 due to domestic pressure emerging from the heavy protestinfested marikana mining tragedy (worse strike action since post-apartheid era), and external pressure from the eurozone crisis (sparked concerns related to central banks of developed economies raising interest rates above zero). concerns loomed in south africa during the 2014–2015 period following deepening drought conditions affecting food production and prices, and the double replacement of the finance minister in four days in late 2015. the figure also displays the recessionary periods of the south african economy, which do not necessarily coincide with spikes in uncertainty, suggesting that the measure picks up aspects of uncertainty beyond economic volatility. constant parameter vector autoregressive model data and estimation procedure in this section, i estimate a structural vector autoregressive (svar) model with constant parameters to analyse the extent to which uncertainty impacts upon selected macroeconomic variables. the benchmark model that is estimated is represented as: zt is a vector of (k × 1) observed variables which include log of industrial production (‘ip’), log of consumer price inflation (cpi) index (‘cpi’), 10-year government bond yield (‘yield’), log of reer (‘reer’) and the economic policy uncertainty (epu) index. c0 is an intercept term, b1,… … . …,bs are (k × k) matrices of constant coefficients, t is a linear time trend, and et ~ n(0: ∑). the data is obtained from various sources on a quarterly basis for the period 1990q1 to 2015q4.2 all variables with the exception of the epu index (stationary in level) were found to be trend stationary, hence i include a linear time trend (t) in the specification to de-trend the data. three of the criteria (lr test statistic, final prediction error, akaike information criterion) of the lag length criteria test suggest inclusion of two lags in the model. estimation of the var with two lags produces fairly robust results, which is confirmed by the diagnostic tests for the residuals, and furthermore the stability condition is satisfied as all roots of the characteristic polynomial lie within the unit circle.3 to recover orthogonal shocks, i use the cholesky ordering of variables as above, ordering slower moving variables first before faster moving variables (redl 2015 and related literature). the epu index is ordered last as it mainly accounts for agents’ expectations, which can change quickly. empirical results figure 2 and figure 3 display the quantitative empirical results for the time-invariant var model, analysing the response of the macroeconomic dynamics in sa to shocks to epu, and the contribution of uncertainty in explaining the forecast error variance of the selected variables. figure 2: impulse responses of selected macroeconomic variables to a positive economic policy uncertainty shock: (a) response of ip to epu; (b) response of cpi to epu; (c) response of yield to epu; (d) response of reer to epu. figure 3: contribution of economic policy uncertainty index to forecast error variance. the impulse responses in figure 2 suggest that an unanticipated positive shock to the uncertainty index (i.e. a 1% increase in the uncertainty index) is associated with a decline in industrial production and reer, while fostering an increase in the general price level and 10-year government bond yield. industrial production experiences a more pronounced decline with a peak fall of about 0.8% after 1 year, before increasing and returning to equilibrium after 10 years. the response of industrial production to uncertainty is largely in line with literature (bloom 2009; gupta et al. 2015; redl 2015). the reer experiences a more immediate impact of about 0.5% decline after two quarters, before increasing by 0.4% in two years and thereafter moderating to equilibrium after about five years. this finding of the immediate depreciation in the exchange rate following a positive shock to uncertainty is supported by gupta et al. (2015). in support of the study by redl (2015) but in contrast to gupta et al., the price level experiences a peaked increase of about 0.3% after five quarters, before returning to equilibrium after six years. the yield on 10-year government bonds rises by close to 0.1% after 2 years following an increase in uncertainty, before moderating and returning to equilibrium in around 10 years. this supports the risk-aversion effect of uncertainty as increased uncertainty results in increasing risk premia, which raises the cost of borrowing and hence the probability of defaulting. variance decompositions in figure 3 show that almost 14% of the forecast error variance of industrial production is explained by uncertainty shocks. the uncertainty index is also an important component of the variance of the price level (explains almost 5% of its variation) but explains less than 2% of the forecast error variance of the reer and 10-year government bond yield. time-varying parameter vector autoregressive model data and estimation procedure in order to capture the possible time-varying nature of macroeconomic dynamics in the south african economy to shocks in uncertainty, i estimate a time-varying parameter var model with stochastic volatility.4 since stochastic volatility imposes difficulty in estimating a precise and efficient tvp var model because the likelihood function becomes intractable, i employ mcmc methods in the context of a bayesian inference, in order to overcome the difficulty.5 the five-variable tvp var model that is estimated for the period 1990q1–2015q4 is specified by: t = s + 1, … … …, n, zt is a (k × 1) vector of observed variables which include the same variables that were specified in the time-invariant parameter var model – however, all variables with the exception of epu (in natural log terms) are in natural log-differenced terms (10-year government bond yield is differenced but not in natural log terms given that it is a rate), as non-stationary variables with trends do not fit tvp var models well. b1t,… … . …,bst are (k × k) matrices of time-varying coefficients, , and et ~ n(0: ωt). where ωt is a (k × k) time-varying covariance matrix. an assumption pertaining to a recursive identification is made by the breakdown of ωt i.e. , where at represents a lower-triangular matrix with the diagonal elements equal to 1, and ∑t is a matrix with diagonal elements σ1t, … . . σkt, and off-diagonal elements equal to 0. in this var specification, the coefficients b1t,… … . …,bst, the parameters at and ∑t are all time-varying. to model the process for these time-varying parameters (following primiceri 2005 and nakajima 2011), let βt be a stacked row vector of b1t,… … . …, bst, simultaneous relations be a stacked row vector of the lower-triangular elements in at and with stochastic volatility , for j=1, … ……, k, t = s + 1, … … …, n. the time-varying parameters in equation 2 are assumed to follow a random walk process as follows: equation 3 applies for t = s+1, … … … , n where . since the tvp var model has a number of parameters to estimate, employing the random walk assumption effectively decreases the number of parameters. it is assumed that σβ, σh and σa are diagonal matrices (that govern the variance and covariance structure for the innovations of the time-varying parameters) and that the shocks to the innovations of the time-varying parameters are uncorrelated among the parameters βt, ht, at. the model is specified with two lags as in the constant parameter var model, and the following priors (which provide reasonable identification) are assumed for the ith diagonals of the covariance matrices: , and , implying that rather flat priors are set for the initial state of the time-varying parameter. a much tighter prior is set for the time-varying coefficient (β) compared to the simultaneous relations (a) and the volatility (h) of the structural shock for the variance of the disturbance in their time-varying process. m = 10 000 samples are drawn to compute the posterior estimates after discarding the initial 1000 samples.6 figure 4 and table 1 output the estimation results for selected parameters in the tvp var model specified above. figure 4 illustrates the sample autocorrelation function, the sample paths and the posterior densities for selected parameters. inspecting the figure reveals stable sample paths and stable decaying autocorrelation functions, after discarding the sample in the burn-in period (initial 1000 samples). this implies that uncorrelated samples are efficiently produced by the sampling method. table 1 shows the estimates for posterior means, standard deviations, the 95% credible intervals (describes the uncertainty of the parameters), the geweke (1992) convergence diagnostics (cd) and the inefficiency factors. the geweke cd analyses individual chains by dividing the chain into two ‘windows’ containing a set fraction of the first and last iterations, dropping out the middle iterations. figure 4: sample autocorrelations (a–f), sample paths (g–l) and posterior densities (m–r). table 1: estimation results for selected parameters. the mean of the sampled values in the two windows are then compared. however, there should be a sufficient number of iterations between the two windows to reasonably assume that the two means are approximately independent. this method then produces a cd statistic that is computed as the difference between the two means divided by the asymptotic standard error of the difference.7 as the number of iterations increase, the mcmc sampling converges in distribution to a standard normal (n(0,1)) if its sequence is stationary. the p-value of the cd statistic in table 1 provides evidence of convergence of the sequence of the mcmc sampling to the posterior distribution as the null hypothesis of convergence for the parameters cannot be rejected at the 1% level of significance. the inefficiency factor is computed as the numerical variance of the posterior sample mean divided by the variance of the sample mean from uncorrelated draws.8 geweke (1992) cited in nakajima (2011) states that the relative numerical efficiency is defined as the inverse of the inefficiency factor. the estimation results for the inefficiency factors are quite low for the parameters, with the exception of ∑h1, which nevertheless indicates an overall efficient sampling for the parameters and state variables. even for the parameter ∑h1, the inefficiency factor is about 120, which implies that i obtain m/100 = 100 uncorrelated samples, which is considered to be enough for the posterior inference. empirical results this section presents the quantitative empirical results for the tvp var model analysing the time-varying structure of the macroeconomic dynamics to shocks to epu within a south african context. the south african economy experienced several different periods over the sample period from 1990q1 to 2015q4, from the transition period to democracy to the global financial crisis. employing the tvp var, i investigate the time-varying structure of south african macroeconomic dynamics to shocks to uncertainty, as follows. time-varying volatility figure 5 plots the series for estimated stochastic (time-varying) volatility of the structural shock on the five variables specified, based on the posterior mean (solid line) and 95% credible intervals (dotted line). the time-series plots consist of posterior draws on each date, presenting the dynamics of volatility over time, which differ across variables. stochastic volatility of industrial production (ip) remained low and stable in the period before 1999 before increasing and peaking around the 2008–2009 period of the global financial crisis. the higher volatility of industrial production was mainly as a result of manufacturing production which was hit hard by the global economic crisis, and the industry’s subsequent recovery has been insufficient for the volume of manufacturing production to return to its pre-crisis level. the time-varying volatility of industrial production declined following the crisis period and stabilised at levels above the pre-crisis period, due mainly to the severe social unrest within the mining sector and energy issues. stochastic volatility of inflation (cpi) and the epu (epu) index display moderate movements over the period with inflation volatility showing a very gradual downward trend (specifically following the formal introduction of inflation targeting in february 2000) and the volatility of the uncertainty index remaining fairly flat overall. the reer exhibited a moderate increase in volatility since the emerging markets crisis in 1998 after which successive speculative attacks pushed it to its low of 2001. local factors such as increasing debt, sociopolitical unrest, and energy issues, as well as global events, such as the global financial crisis and eurozone crisis, kept the stochastic volatility of the reer at a slightly elevated level post 2001–2002. stochastic volatility of 10-year government bond yield (yield) was at its highest level around the period 1998 amid the emerging markets crisis, before moderating gradually and remaining fairly stable during the crisis period of 2008–2009 and 2012. figure 5: posterior estimates for stochastic volatility of the structural shock: (a) ip; (b) cpi; (c) yield; (d) reer; (e) epu. overall, stochastic volatility contributes to the var estimation, identifying the structural shock with the appropriate variance of the shock size. in this case, the time-invariant var model estimates would result in biases in the error covariance matrix and the autoregressive coefficients because of misspecification of the dynamics of the parameters. time-varying impulse responses the impulse response analyses for the times series in the tvp var model specified above are provided in figure 6 and figure 7. since the coefficients are time varying, the impulse responses are calculated at each date over the sample period. however, in my study i arbitrarily present the responses of industrial production (ip), inflation (cpi), 10-year government bond yield (yield), and reer (reer) to an unanticipated shock to the uncertainty index (epu) for the dates 1994q4, 1999q4, 2004q4 and 2009q4 (figure 6). these periods inadvertently coincide with the rise of democracy in sa, the period between the east asian financial crisis and the dotcom bubble bursting, the general elections and large capital inflows in sa, and the global financial crisis. figure 7 presents the impulse responses of the macroeconomic variables for 2, 4, 8 and 12 period ahead, following an unanticipated shock to the epu index. considering the comparability over time, the impulse responses (based on parameter estimates of the tvp var model) are computed by setting the shock size for the responses equal to the time-series average of the stochastic volatility for each series over the sample period. figure 6: impulse responses of selected macroeconomic variables to a positive economic policy uncertainty shock: (a) ip; (b) cpi; (c) yield; (d) reer. figure 7: impulse responses of selected macroeconomic variables to a positive economic policy uncertainty shock: (a) ε epu ↑ → ip;(b) ε epu ↑ → cpi;(c) ε epu ↑ → yield; (d) ε epu ↑ → reer. figure 6 shows that the impact of the uncertainty index upon the selected macroeconomic variables seems to exhibit time variation, with the exception of the less pronounced time-varying impact of 10-year government bond yield. the uncertainty shock has a negative effect on industrial production, with the impact being much more pronounced in the 1990s. international sanctions in the early 1990s ensured sa’s isolation from international markets and the period was characterised by one of the longest recessions in the country’s history which lasted from 1989 to 1993, thus demand was restrained in these periods and beyond. the period around 1999q4 represents the typical economic conditions after the east asian economic crisis when countries in east asia experienced substantial currency devaluations but the rand was largely unaffected by turbulence in these markets, resulting in sa’s manufactured exports being less competitive, adversely impacting on industrial production. industrial production responded much more strongly to an increase in uncertainty during 2004q4 than 2009q4. the low interest rates in the west and rising commodity prices (due to chinese industrialisation) supported the rand in the 2004 period, but impacted negatively upon sa’s competitiveness and hence production in the mining and manufacturing sector were restrained. industrial production at the end of 2009 was supported by the collapse of the rand and commodity prices emanating from the global financial crisis. the response of inflation to uncertainty has time variation and the impact of the response is initially negative in 2004q4 (subdued external demand), while demonstrating slight inflationary pressure in the comparative periods. thereafter, inflationary impact turned negative during 2009, amid the subdued domestic and global demand inflicted by the financial crisis, and turned positive by varying magnitudes in the other periods investigated. a 10-year government bond yield does not exhibit much time variation in response to an uncertainty shock, with the magnitude of the positive response of the yield following an unanticipated shock to uncertainty being more or less the same for the comparative periods. a positive shock to uncertainty is associated with an initial decline in the reer in all the comparative periods. however, the magnitude of the response differs across the periods, with the 2009q4 period of the financial crisis displaying a more pronounced decline. thereafter, the reer increases later on in the comparative periods, displaying varying magnitudes, before moderating to equilibrium. overall, the impact of uncertainty shocks on industrial production, the reer and the price level has moderated slightly over time (with the timing of the change in the price level coinciding with the introduction of inflation targeting in the economy), while the impact on the bond yield has remained fairly stable. figure 7 shows that the impact of the uncertainty index upon the selected macroeconomic variables is more pronounced after two quarters following the unanticipated shock. this impact seems to be less pronounced after four quarters, and more or less flattens out after 8 and 12 quarters. the initial response of industrial production and inflation is the same as in figure 6, as following a shock to the uncertainty index, industrial production declines while the cpi index increases. industrial production tends to rebound significantly after the 80th forecast horizon for each of the periods specified. the general price level shows an overall downward trend after around the 40th forecast horizon, remaining below equilibrium for most parts of each period. the direction of impact on the 10-year government bond yield and the reer differs from figure 6. figure 7 shows that following an uncertainty shock, 10-year government bond yield experiences a jump and is quite persistent after two quarters, but declines initially after four and eight quarters, before rebounding after the 40th forecast horizon. the jump in the yield after two quarters could be attributed to the high probability of sovereign credit rating downgrades (hence higher borrowing costs for government), as more political uncertainty plagues the economy. the reer initially increases after two quarters, but remains rather flat for the remainder of the periods, following an anticipated uncertainty shock. the 2 period ahead response of the reer declines and reverts to equilibrium after the 80th forecast horizon. table 2 shows the respective macroeconomic variable elasticities at the 10th period forecast horizon for the 2, 4, 8 and 12 quarters ahead responses, following a 1% shock to the uncertainty index. a 1% unanticipated shock to the uncertainty index in the current period is expected to result in a 0.19% decline in industrial production, 0.5% increase in the general price level, 0.025% increase in the yield on 10-year government bonds, and 1% increase in the reer, after two quarters. this suggests that the responsiveness of the selected macroeconomic variables to an unanticipated uncertainty shock is inelastic, with the exception of the reer which shows an initial unit elastic response. table 2: elasticity of selected macroeconomic variables following a 1% positive economic policy uncertainty shock. the elasticities, especially for the 4, 8 12 period ahead, suggest that the cpi index appears to be more sensitive to uncertainty shocks compared to the other macroeconomic variables analysed. the elasticities of the macroeconomic variables to the 1% unanticipated epu shock diminishes by quarter 12. overall, figure 7 and table 2 show that the impact of uncertainty shocks on the macroeconomic variables declines over time, following an initial epu shock. this result is perhaps intuitive, given that the new information (initial unanticipated shock) is gradually picked up by the media over time, and hence the unanticipated shock will have less of an impact over the long term, as rational agents incorporate the new information into their decision-making. concluding remarks the contribution of my article to emerging market empirical literature is twofold. firstly, it extends the evidence that uncertainty shocks result in drops in real activity in developing countries, in this case the south african economy. secondly, it provides evidence of the time-varying impact of epu shocks on the macroeconomic dynamics of the south african economy, by allowing for both the coefficients and the variance of structural shock to vary over time. the constant parameter var model shows that an unanticipated positive shock to the uncertainty index is associated with a decline in industrial production and reer, while fostering an increase in the general price level and 10-year government bond yield. the tvp var model reports posterior estimates for stochastic volatility of the structural shock, displaying the dynamics of volatility over time, which differ across variables. in this case, the estimates of the constant parameter var model would result in biases in the covariance matrix for the disturbances and at the same time in the autoregressive coefficients because of the misspecification of the dynamics of the parameters. the time-varying impulse responses for the specified dates (1994q4, 1999q4, 2004q4 and 2009q4) show that the impact of uncertainty shocks on industrial production, the reer and the price level has moderated slightly over time (with the timing of the change of the price level coinciding with the introduction of inflation targeting in the economy), while the impact on the bond yield has remained fairly stable. meanwhile, the time-varying impulse responses and associated elasticities of the macroeconomic variables for 2, 4, 8 and 12 period ahead show a diminishing impact over time, following an unanticipated shock to the epu index. this is perhaps intuitive, as the new unanticipated information is gradually picked up by media and incorporated into rational agents’ decision-making. acknowledgements i would like to thank professor nicola viegi for his supervisory support. competing interests the author has declared that no competing interest exist. author’s contributions the author contributed wholly to the acquisition of data, analysis and interpretation of findings. funding information this research received no specific grant from any funding agency in the public, commercial, or not-for-profit sectors. ethical considerations ethical clearance was not required for the study. data availability statement data sharing is not applicable to this article as no new data were created or analysed in this study. disclaimer the views and opinions expressed in this article are those of the authors and do not necessarily reflect the views of the university of pretoria. references alessandri, p. & mumtaz, h., 2014, financial regimes and uncertainty shocks, working paper 729, queen mary university of london, viewed 15 july 2017, from http://www.econ.qmul.ac.uk/media/econ/research/workingpapers/2014/items/wp729.pdf. arellano, c., bai, y. & kehoe, p.j., 2016, financial frictions and fluctuations in volatility, federal reserve bank of minnesota research department staff report, viewed 13 july 2017, from https://www.minneapolisfed.org/research/sr/sr466.pdf. baker, s.r., bloom, n. & davis, s.j., 2016, ‘measuring economic policy uncertainty’, the quarterly journal of economics 131(4), 1593–1636. https://doi.org/10.1093/qje/qjw024 baker, s.r., bloom, n. & davis, s.j., 2013, measuring economic policy uncertainty, viewed 23 february 2017, from 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(no. 509), viewed 23 february 2017, from https://econrsa.org/system/files/publications/working_papers/working_paper_509.pdf. appendix 1 table 1-a1: list of variables used in analysis. table 2-a1: augmented dickey-fuller unit root test on the variables analysed. table 3-a1: lag length criterion test. table 4-a1: vector autoregressive residual serial correlation lm tests. table 5-a1: vector autoregressive residual heteroskedasticity test: no cross terms. table 6-a1: vector autoregressive residual normality tests. figure 1-a1: plot of variables used in analysis: (a) ip; (b) cpi; (c) yield; (d) reer); (e) epu. figure 2-a1: stability test for constant parameter vector autoregressive model. footnotes 1. the epu index constructed by sandile hlatshwayo can be obtained from her website at https://sites.google.com/site/sandile1984hlatshwayo/research. 2. see appendix for list of variables used and their associated sources (table a1.1), as well as graphical representation of the variables used in the analysis (figure a1.1). 3. see appendix for results of augmented dickey fuller unit root test for stationarity of variables (table a1.2), lag length criterion test (table a1.3), residuals diagnostic tests (tables a1.4–a1.6) and stability test (figure a1.2). 4. primiceri (2005) proposed tvp var with stochastic volatility to analyse macroeconomic issues. the assumption of stochastic volatility in the tvp var model avoids misspecification, as not accounting for possible variation of the volatility in disturbances can lead to biased time-varying coefficients. see also nakajima (2011) for an application of this methodology to the japanese economy. 5. see nakajima (2011) for details of bayesian inference and mcmc sampling method. 6. mcmc algorithm sampling the posterior distribution π(β, a, h, ω | z) (where and ω = (σβ, σa, σh,) employed here and the details of the procedure can be found in nakajima (2011). 7. cd statistic computed as , where n0 and n1 represent the first and last draws respectively, is the i-th draw, and is the standard error of for j = 0,1. as in nakajima (2011), mo = 1, m1 = 5001, n0 = 1000, n1 = 5000, 8. the inefficiency factor is used to judge how well the mcmc chain mixes and is computed as , where ρk is the k th autocorrelation of the chain, and bandwidth bm = 500. an inefficiency factor equal to m necessitates one to draw m times as many mcmc sample as uncorrelated samples. 288 business opportunities development ogunlade r davidson sajems ns vol 5 (2002) no 2 and sustainable energy and development research centre, university of cape town abstract the conventional development paradigm appears to have failed the poor regions of the world. it has led to a widening gap between rich and poor, while the world as a whole is getting richer. attempts to integrate social and environmental concerns into the conventional development paradigm have led to the concept of sustainable development. jel 013 introduction since the united nations conference on environment and development held in 1992 in rio de janeiro (the "rio conference", widely known as the "earth summit"), more people have seriously questioned the conventional development paradigm. this paradigm led to a high standard of living for a few countries and a small segment in the vast majority of countries, resulting in a widening gap between the rich and the poor. of more concern is that while the gap continues to widen, the world as a whole is getting richer. this has triggered many issues since earth summit, among them the lack of integration of social and environmental concerns into the conventional development paradigm. this debate only reinforces the call for such integration which was made in the brundtland report of 1987, calling for changing our development path to a more sustainable one by including social and environmental concerns. attempting to integrate these concerns led to the concept of sustainable development. the growing gap between countries and regions, and different groups within countries, as indicated in figurel, has led to even greater concern regarding the future of the world if these trends continue. redressing this situation will call for participation and cooperation by the main stakeholders of development, including the business sector. such participation will require new types of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 289 relationship between the different stakeholders. this issue will be dealt with later. the skewness in incomes as demonstrated in figure i is mainly due to historical circumstances that evolved between nations and the way management of production and consumption of goods and services resulted in a world divided into developed and developing countries. the former now has about a quarter of the world's population but 75 per cent of the world's income, while the remaining 75 per cent of the population receive 25 per cent of the income. the world economic system that emerged strengthened after the second world war only worsened the situation, because the gap got wider, although a few countries emerged with growing economies and increased incomes. this situation forms part of the ensuing discussion. figure 1 world income distribution 100 i i :~ ~--1 182.7 % = 70 '" .g 60 0. "0 50 i ~ 40 ~ 30 l i ~ ~~j !i 0~i~ __ -l~ __ lj2=_3=%~-=1_~=y.=o~=1.=~=~=11.7% 20% 20% 20% 20% 20% segments of global population countries can be classified into three types: first, those with developed production systems and markets, which are benefiting greatly from the gains of globalisation; second, countries with growing production systems and emerging markets, which have started gaining from globalisation; third, the 48 normally referred to as "least developed countries", which are suffering from increasing marginalisation and almost global market exclusion. all these country types have markets for goods and services produced with sustainable development objectives in mind, but the greatest market is in the last group because they are ready to satisfy their urgent developmental needs and are also flexible enough to adjust to a new developmental paradigm. because of their urgent needs, these countries have the opportunity to take off with a development path that reflects the principles of social equity, feasible economy and efficient markets. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 290 sajems ns vol 5 (2002) no 2 the private sector can contribute in this task of developing countries by assisting with market stimulation as this will provide the opportunity of benefiting from early market entry. providing environmentally and socially sound goods and services offers a business opportunity because it not only widens the market, but also provides the means for earning goodwill from consumers. therefore, the challenge for the business sector is to cooperate with other stakeholders in establishing markets in the least developed countries, promoting markets in emerging countries, and maintaining markets in developed countries. maximising this potential will show that sustainable development can also mean good business. rio experience and agenda 21 at the 1992 rio conference, over 100 heads of state signed and agreed to a blueprint for sustainable development, known as agenda 21, and also to two main global conventions, one on biodiversity (cbd) and the other on climate change (unfccc). this was a clear manifestation of willingness to achieve the various components of the agreements arrived at in rio. a feature common to all these agreements was the search for alternative development paths that include social and environmental concerns as well as economic ones, while not sacrificing national and regional development aspirations. in addition, these documents, especially agenda 2 i, address issues of major concern to a wide range of countries including growing poverty and over-consumption, and how these impact on the world's resources. the conventions also deal with poverty, hunger, disease, illiteracy, and the continued deterioration of global and national ecosystems. coping with these challenges will require an increase in many goods and services, using growth paths that depart from past practices. many new and laudable ideas for international cooperation and financing were agreed upon at the earth summit. these include the financial resources required to implement agenda 21 at national level the spirit of consensus and political commitment led to donor countries agreeing to contribute up to 0.7 per cent of their gdp to finance overseas development assistance. further, issues of debt management, and creating a climate for attracting foreign investments in developing countries, were also agreed on. however, events that followed show that this spirit of cooperation did not continue. defining sustainable development sustainable development has attracted several definitions because of various interest groups' different perspectives. in the brundtland report, it is defined as r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 291 "a development that meets the present needs and goals of the population while not compromising the ability of the future generation meeting theirs", and, with some variations, the academic community largely accepts this definition. the business sector, though, has a different definition, because their interests differ significantly from those of academics and community development workers. the international institute for sustainable development defines sustainable development relating to the business sector as "adopting business strategies and activities that meet the needs of the enterprise and its stakeholders today, while protecting, sustaining and enhancing the human and natural resources that will be needed in the future". here, there is clearly a central concerned about shareholder value, in addition to other aspects of sustainable development. changing trends in customer bera your as suggested before, there is a large market for environmentally sound goods and services in all countries that the business sector can take advantage of. benefiting from this market potential will, however, require recognition of the changing trends in all these countries, although there is variation depending on regional and local situations. the following provides some idea, though not exhaustively, about the changing trends in customer behaviour of which businesses should be mindful. there is a growing awareness of environmental hazards, simply because the impacts of local and regional environmental problems are becoming more vivid. also, impacts of climate variability in the form of extreme events, such as droughts and cyclones, are more regular and pervasive. the healthrelated consequences of pollution in rapidly growing cities could easily be seen in many places, while people living in cities that appear to have managed pollution are concerned about maintaining such gains. many people are increasingly accepting that partnership among stakeholders in development is a preferred strategy for achieving future development goals. past strategies that were largely based on "do it alone" or "merging" to take control have largely failed to deliver the expected results and when they succeed, only a few have benefited. there is a growing call for accountability, transparency and consultation in many sectors, including the business sector, as people become increasingly educated and exposed to high quality literature. also, the results of not abiding by these principles are damaging, and awareness of this is becoming widespread. governments worldwide increasingly demand detailed reporting by operating institutions, including the business sector, and suitable mechanisms are being instituted to ensure that it is done. similar demands r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 292 sajems ns vo15 (2002) no 2 are also increasingly coming from civil society, the usual watchdog for such operations, as it becomes more organised. the desire for environmentally sound goods, commonly known as "green products" is growing, especially in rich countries. changing environment in the business sector a major recent change that has taken place outside business institutions is the attitude of governments towards business, seeing it as a partner in development and not as a competitor in providing services. recent events in the global political scene have' led many to believe in the option of joint public/private collaboration as a way forward in promoting development, including areas that were traditionally the domain of the public sector. there is now increasing participation by the private sector in infrastructure investments, including energy and water. in addition, the private sector is now fully involved in social investments (though the results have been mixed), including building roads, operating railways and even in some cases, owning and operating prisons. another change is the development of an organisation within the business sector that promotes sustainable development and environment concerns as business activities: the world business council for sustainable development (wbcsd). this is a coalition of some 120 international companies, covering 35 countries in a wide range of sub-sectors, that share a common commitment to the environment, economic growth and sustainable development. they play an important role in developing closer ties between business, governments and civil society, and promote high standards of environmental management in business organisations. there are signs that this organisation is not only growing in membership and coverage, but is also enjoying increased status especially with governments, as they now hold joint activities such as seminars and workshops with governments. one wbcsd activity of direct relevance to sustainable development is around the principle of "social responsibility". this mainly involves creating sustainable development networks that promote social responsibility among business operations. the membership of this network is steadily growing, which demonstrates commitment to the ideals of sustainable development. in addition to wbcsd, a group of large multi-national companies have entered into a "global compact" with the secretary-general of the united nations, aimed at establishing an official relationship between the business sector and the un for joint activities and other forms of collaboration in their common interests. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 293 integrating sustainable development in business integrating the main objectives of sustainable development, including social and environmental concerns, poses serious challenges to the business sector because of the traditional role of business that is, maximising shareholder value. these challenges can be summarised as follows: the responsibility for protecting social and environmental concerns has been the government's, with assistance from community groups, usually through regulations that have significant implications for business operations. understanding these regulations and their impacts is a challenge, because they are relatively new. most regulations were conceived with a view to protecting the rights of workers and the environment, and present liabilities to a company if they are not observed. a proper understanding of these regulations and identifying their impacts is necessary, as non·adherence can detract from a company's image and may cause loss of goodwill from current and potential clients. different environmental performance standards are being put into place by governments, especially relating to new areas, such as eco·management and eco-monitoring schemes. this is a challenging task. how to identify possible gains and benefits from practising these new ecostandards is relatively poorly understood. developing a balancing strategy to ensure business commitment to corporate social responsibility and maximising shareholder value is a major challenge, because it has yet to be adequately studied. major business initiatives some businesses have made inroads in trying to incorporate sustainable development initiatives into their normal operations, especially members of wbcsd. these initiatives include the following: eco·efficiency implies producing more with less resources and less pollution, and encourages business to be more competitive, more innovative and more environmentally responsible. environmental accounting reflects the environmental costs of trade "and industrial operations in the accounts of business and, consequently, those of countries. improved management practices include waste minimisation and resource optimisation in products and processes; developing sustainable development products, changing manufacturing processes to reflect sustainable development concerns, and environmental and social accounting. business charters and principles mean agreement by big companies to conform to set principles to operate in a socially and environmentally responsible way. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 294 sajems ns vol 5 (2002) no 2 environmental management systems (ems) are internationally agreed standards based on improvement of quality of product and services, and provide valuable assurances for clients. this initiative is particularly important because of its wide use, and requires further discussion. environmental management systems ems emerged from the british standards institution environmental management systems standard, bs 7750. along with this, the wbcsd members developed a range of ems standards that emerged through the international organisation for standardisation (iso), which led to the iso 14000 series. the iso 14000 did not set specify environmental performance levels but used a management system approach similar to the iso 9000 quality standards to promote environmental performance. ems is generally a group of policies, standards, systems and tools that assist the effectiveness of the business in coping with environmental concerns. ems can be very important for good decision~ma.king. in practice, it should be fully integrated in all functions of business operations and ensure that they are consistent with sustainable development principles. the main areas of incorporating ems in business may include siting, construction and operation of the business; employee performance evaluation; product and process design and modification; materials procurement and supplies; information and business management; and internal and external communications. benefits to companies include savings (freedom from liabilities) resulting from complying with regulations; an improved image, leading to increased goodwill among stakeholders; resource conservation and capital savings; and market advantage and increased market confidence. business in developing countries generally, exploiting most of the market potential in developing countries, particularly in the least developed countries, will require overcoming some of the major inadequacies in these countries that are not necessarily conducive to good business operations. in most of these countries, a large proportion of the people are in a poverty trap, and the economic growth of the country is either negative or very low, thus limiting domestic resource mobilisation. official capital flows to these countries are also, therefore, limited. recent trends show that private capital flows hardly go to poor countries. for the past decade or so, for example, about 11 middle-income countries have attracted over 75 per cent of foreign direct investments. since the dwindling overseas development assistance funding generally follows similar paths, poor countries get very little funding either private or official. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 295 many investors fail to invest in poor countries because of perceived risks, including a high degree of vulnerability to external political and economic shocks, weak social infrastructure, the smallness of the market, and a poor business environment. the last of these is particularly important, and demands urgent attention if developing countries are to attract entrepreneurs. creating a business environment a satisfactory business environment is crucial to attract private funding and foreign business, including those that want to develop partnerships with either local businesses or governments in trying to overcome some of the problems outlined above. setting up an institutional, legislative and regulatory framework environment is important, so that business enterprises are fully aware of the mode of operation in a country. in many least developed countries, the institutional base is fragmented and unclear, and functions and functional relationships within institutions are confusing. in a few cases there may be a need for innovative institutions to cope with the demands for an adequate business environment. in forming such an environment, however, the use of indigenous effort should be maximised because this will assist in developing standards and regulations that reflect and are suited to local conditions. lack of capacity has been identified as a major problem in these countries, and formal and informal training schemes for targeted programmes, including needs assessment and business development, can prove extremely useful ensuring retention of trainees is an important aspect of such programmes. businesses should cooperate with local agencies to undertake useful research and development and demonstration programmes that will support business development. in many developing countries, rationalisation of prices is required to foster a business-friendly environment, and this can be done by reducing distortion in the tax system and promoting targeted subsidies for the poor, to address social concerns. information development using all modern electronic systems, especially the development and promotion of business information is important. the lack of institutions providing business services suggests the need for setting up business intermediaries, to help promote business information. where countries in a region are small and fragmented, regional cooperation and coordination are important to maximise the benefits of business. this can be achieved by promoting different networks, harmonisation of standards and promotion of business forums. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 296 sajems ns vol 5 (2002) no 2 changes needed in business operations business enterprises need to change their perspectives to take advantage of the potential outlined earlier. these changes include the following: businesses should view governments as partners of development and not as an avenue for exploiting subsidies. regulations should be considered as setting targets for establishing a framework of operation to ensure environmental protection, and not as dictating operating guidelines. long-term relations with different stakeholders of development should be promoted because they are crucial for achieving long-term benefits of sustainable development. businesses should assist in stimulating market promotion schemes to help poor countries to move away from aid dependency, and towards participation in commercial operations. conclusions there is a large international market for goods and services produced using the principles of sustainable development, but exploiting it will require the business sector to improve its understanding of this new market, especially in developing countries. promoting market development in some countries in the short run requires development of new partnerships and nurturing the local cooperate sector, but long-term gains can be substantial. businesses should realise that becoming involved in sustainable development goes beyond maximising shareholder value, and includes demonstrating heightened responsibilities towards its workers, customers and society. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 644 sajems ns vol 5 (2002) no 3 importance of external environmental labourrelated risk factors for financial investment decision-making j h mostert business initiation unit, absa corporate & merchant bank s j steel department of statistics and actuarial science, university of stellenbosch f j mostert department of business management, university of stellenbosch abstract external environmental labour-related risk factors influence the relationship between management and the work force of an enterprise. it is therefore of prime importance to consider these labour-related risk factors in order to be able to take a comprehensive financial investment decision. the risk factors concerned come from the political, economic, social and technological environments. the views of the participating investment practitioners (who are active in the long-term insurance industry) regarding these aspects are analysed against the background of relevant literature. the responses with reference to these labour-related risks in manual and knowledge worker enterprises are presented simultaneously and significant similarities and differences are highlighted. jel goo, gil 1 introduction financial investment decision-making requires a detailed investigation of the external environmental labour-related risk factors, since these factors influence labour relations within enterprises. the external environmental labour-related risk factors to be considered include the political, economic, social and technological environments relevant to a particular enterprise. after taking relevant literature into consideration, the views of the participating investment practitioners (who are active in the long-term insurance industry) regarding these aspects are analysed. the responses in respect of labour-related risks in r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 645 manual and knowledge worker enterprises are presented simultaneously, and significant similarities and differences of opinion in this regard are examined. 2 objective of the research the objective of this research is the improvement of financial investment decision-making by focusing on the external environmental labour-related risks of investment alternatives. to achieve this objective, cognisance of the relevant literature is essential, followed by an empirical survey that will provide the information needed to assess the importance of external environmental labourrelated risks for financial investment decision-making. the conclusions should be valuable to institutional investors and to various persons employed in investment management. 3 the empirical study method information from the financial services board indicated that 52 long-term insurers were registered on 3 november 1998 (van der lith, 1998). five of the long-term insurers were excluded from the survey due to the following reasons: these insurers (a) did not have any equities in their investment portfolios; (b) mainly invested in fixed property with only a negligible amount invested in unit trusts; or (c) had insignificant exposure to equities. although 47 long-term insurers participated in the survey, fewer interviews were required, because there were cases of the same institution handling the financial investment management of more than one long-term insurer. consequently, 23 interviews were required to cover the financial investment decision-making practices of the 47 participating long-term insurers. a response rate of 100 per cent was therefore achieved. the positions of the officials who were interviewed indicated that the majority of them had already achieved management status. the seniority of those people interviewed not only made a wealth of experience available for the purpose of the survey, but also enabled them to respond with confidence about the assessment of labour-related risks at their organisations. this contributed in more than one way to the reliability of the information which was obtained. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 646 sajems ns vol 5 (2002) no 3 4 empirical results against the background of relevant literature the empirical results regarding the external environmental labounelated risk factors, with reference to the overall importance as well as the importance of the detailed risk factors, are discussed against the· background of relevant literature. 4.1 external environmental labour-related risk factors the overall importance of the external environmental labour-related risk factors appears in the following pivot table: table 1 responses regarding the overall importance of external environmental labour-related risk factors for the purpose of financial investment decision-making importance of external environmental labourrelated risk factors in cases where there are predominantly manual workers in the labour force mnolp,,,,tplu important highly important extremely imllot1rllnt importance of external environmental labour-related risk factors in eases where there are predominantly not little moimporimportant derately tant important extremely important the discussion guideline (applied during the interviews) made use of an ordinal scale ranging from "not important" (denoted by 1), "little important" (denoted by 2), "moderately important" (denoted by 3), "highly important" (denoted by 4) and "extremely important" (denoted by 5) to rate the external environmental labour-related risk factors in order of importance. the numbers on the ordinal scale were used to calculate the statistics in respect of all of these external environmental labour-related risk factors. the mean (as a measure of central tendency) and the range (as a measure of dispersion) are valuable measures to describe the data. differences in opinion r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . samms ns vols (2002) no 3 647 regarding manual and knowledge workers, however, are not adequately highlighted by these measures. in table 1 it can be seen that four of the respondents indicated that external environmental labour-related risk factors are equally important for manual and knowledge worker enterprises (refer to the numbers in the shaded cells which is referred to as the diagonal line). the numbers above the diagonal line (zero in this case) represent those respondents who indicated that external environmental labour-related risk factors are more important for knowledge worker enterprises than for manual worker enterprises. in contrast, the observations below the diagonal line (19 in total) indicate that external environmental labour-related risk factors are more important for manual worker enterprises than for knowledge worker enterprises. this highlights the need for a statistical measure to indicate whether these differences in opinion regarding manual worker and knowledge worker enteiprises are significant. the sign test (sachs, 1984: 316-20) is used for this purpose. the sign test is one of the simplest non-parametric tests and requires that the responses be ordinal-level at least, that is, that the responses can be ranked from low to high. the name "sign test" refers to the fact that only the signs of differences between observations are evaluated. the null hypothesis of the sign test is that the differences of paired observations on average are equal to zero; one expects about half of the differences to be less than zero (negative signs) and the other half to be greater than zero (positive signs). the sign test thus tests the null hypothesis that the distribution of the differences has median equal to zero. the null hypothesis is rejected if the number of differences of one sign is too large or too small, le. if this number falls short of or exceeds the respective confidence bounds which are summarised in a standardised table. the five per cent level was selected as the level of significance. application of the sign test to the data summarised in the above table, where there are no observations above the diagonal line and four on it and 19 observations below the diagonal line, results in rejection of the null hypothesis at both the one per cent and five per cent level of significance. external environmental labour-related risk factors are therefore more important for the purpose of financial investment decisionmaking when enterprises employ manual workers instead of knowledge workers. the views of the respondents regarding the importance of detailed external environmental labour-related risk factors (viz. the political, economic, social and technological environments) are summarised in table 2 and subsequently commented on. the range of opinions will be reported, but only commented on if the difference in the range for manual and knowledge worker enterprises exceeds one. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 648 sajems ns vol5 (2002) no 3 table 2 responses regarding tbe importance of detailed external environmental labour-related risk factors for tbe purpose of financial investment decision-making labour-related risk manual knowledge sign test factor workers workers responses differences in mean mean belowlon! opinion are not above the significant ("ns") or i diagonal significant ("s") i line with reference to the level of sij;(nificance political environment 3.57 2.70 16/3/4 s (1%) political stability 3.74 3.00 15/3/5 s (5%) distribution of political 3.13 2.39 i 16/4/3 i s (1%) power labour market policy 3.70 2.00 20/3/0 i s (1%) economic environment 3.78 2.83 20/3/0 s(i%) ._ business c~le 3.74 2.83 17/51l s(i%) level and trend in 3.65 2.26 18/4/1 s (\%) unemployment ~ation 3.48 2.43 161611 s (10;.,) global business 3.35 3.35 9/816 ns environment social environment 3.22 2.35 18/5/0 s 0%) different cultural values 3.48 1.65 22/110 s (1%) demographic charac3.\3 1.83 1815/0 s (1%) teristics and trends i skills and education of 3.09 4.00 0110113 s (1%) the population i technological 3.57 2.61 16/6/1 s(i%) environment impart ofterhnologic~1 h1 2.'i7 i 19/311 s (1%) change on employment, production processes and the obsolescence of skills extent and manner of co3.48 2.70 13/8/2 s (j%) operation between management and the labour force when they i deal with technological change i r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 649 4.2 political environment the respondents generally were of the opinion that the political environment was more important for manual than for knowledge worker enterprises. the mean of 3.57 (range of 3 with a minimum value of2 and a maximum value of 5) in the case of manual worker enterprises and 2.70 (range of 3 with a minimum value of i and a maximum value of 4) for knowledge worker enterprises provide proof ofthis statement. an investigation of the individual responses brings to light that only four of the respondents regarded the political environment as a more important risk factor for knowledge worker enterprises than for manual worker enterprises, while three of them regarded it as of equal importance. the majority of the respondents (16 of the 23) were of the opinion that the political environment was more important for manual than for knowledge worker enterprises. application of the sign test shows, that the null hypothesis is rejected at the one per cent level of significance, which implies that the respondents regarded the political environment as a more important labour-related risk factor for manual than for knowledge worker enterprises. the same political environment therefore has a significantly different impact on these two types of enterprises. the respondents were of the opinion that the political role players in south africa had much work to do to reduce perceived labour-related risks attached to manual worker enterprises especially. consideration of the views of the respondents on the importance of the components of the political environment is valuable for clarifying which areas were of particular importance to them. it also enables political role players to identify key areas that require their attention to make south african enterprises more attractive to institutional investors. in what follows, the opinions of the respondents regarding the importance of the components of the political environment will be examined by focusing on political stability, the distribution of political power, and the labour market policy (barker, 1999: 25; blum, 1994: 13; campbell, 1994: 188-9). 4.2.1 political stability political stability was regarded as more important for manual than for knowledge worker enterprises. this is reflected by a mean of 3.74 (range of 3 with a minimum value of 2 and a maximum value of 5) for manual worker enterprises compared to a mean of 3.00 (range of 4 with a minimum value of i and a maximum value of 5) in the case of knowledge worker enterprises. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 650 sajems ns vol 5 (2002) no 3 when the emphasis is shifted from the general view to the responses of the individual participants, it is interesting to note that five of the respondents were of the opinion that political stability was a more important risk factor for knowledge than for manual worker enterprises, three regarded it as of the same importance, while 15 emphasised that it was of more importance for manual worker enterprises. the null hypothesis is rejected at the five per cent level of significance and political stability should therefore be regarded as of greater importance for manual than for knowledge worker enterprises. 4.2.2 distribution a/political power the average respondent regarded the distribution of political power as more important for manual than for knowledge worker enterprises. this is reflected by a mean of3.13 (range of 4 with a minimum value of i and a maximum value of 5) for the former type of enterprise and a mean of 2.39 (range of 4 with a minimum value of i anj a maximum value of 5) for knowledge worker enterprises. an analysis of the individual responses shows that only three of the respondents were ofthe opinion that the distribution of political power was a more important risk factor for knowledge worker enterprises than for manual worker enterprises, while 16 of the respondents held an opposing view. four of the respondents indicated that the importance of this risk factor was the same for both types of enterprises. by the rejection of the null hypothesis, the sign test confirms that the difference in opinions regarding these two types of enterprises is significant at the one per cent level of significance, therefore the distribution of political power can be regarded as a more important labour-related risk factor for manual than for knowledge worker enterprises. 4.2.3 labour market policy on average, the respondents were of the opinion that labour market policy was a far more important labour-related risk factor for manual than for knowledge worker enterprises. the mean of 3.70 (range of 3 with a minimum value of 2 arlu a iflall.ilhullj value of 5) ill tltt: t.:ast: uf liiallua} workel elllt:rprises ami die mean of2.00 (range of2 with a minimum value of i and a maximum value of3) when knowledge worker enterprises are the subject of assessment, is a reflection of this fact. the general view on the importance of this component of the political environment also exists on the individual level, as confirmed by the sign test that indicates, by the rejection of the null hypothesis, that the difference in opinions in this regard is significant at the one per cent level. to be more specific, 20 of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 651 the respondents were convinced that labour market policy was a more important labour-related risk for manual than for knowledge worker enterprises, with no views to the contrary, and only three respondents indicating that it was of the same importance for both types of enterprises. the conclusive evidence highlights the perceived role which labour market policy plays in increasing the risk profile of manual worker enterprises. 4.3 economic environment the respondents generally were of the opinion that the economic environment was more important for manual than for knowledge worker enterprises. this is reflected by a mean of 3.78 (range of 3 with a minimum value of 2 and a maximum value of 5) for manual worker enterprises compared to a mean of 2.83 (range of3 with a minimum value of 1 and a maximum value of 4) in the case of knowledge worker enterprises. closer analysis of the responses indicates that 20 of the respondents maintained that the economic environment was a more important labour-related risk factor for manual than for knowledge worker enterprises, three were of the opinion that it was of the same importance, while none of them regarded it as of more importance for knowledge worker enterprises. application of the sign test indicates that these differences are significant at the one per cent level, therefore the conclusion can be reached that the economic environment is regarded as a more important labour-related risk factor for manual than for knowledge worker enterprises. these results make it clear that the participating investors paid close attention to the economic environment when they considered financial investments in manual worker enterprises. scrutiny of the responses in respect of the components of the economic environment is valuable for a better understanding of how the economic environment impacts on financial investment decisionmaking. attention is therefore paid to the business cycle, the level and trend in unemployment, the impact of inflation, as well as the global business environment (branchflower & freeman, 1992: 57; disney, gosling & machin, 1995: 404; gandz, 1990: 74; heenan, 1995: 18; krugman, 1995: 330; mason & bain, 1993: 334; wood, 1995: 57-58). 4.3.1 business cycle the business cycle is generally regarded as more important for manual than for knowledge worker enterprises as reflected by a mean of 3.74 (range of 3 with a minimum value of 2 and a maximum value of 5) for the former type of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 652 sajems ns vol 5 (2002) no 3 enterprise and a mean of 2.83 (range of 4 with a minimum value of 1 and a maximum value of 5) for the latter type of enterprise. the higher importance of the business cycle as a labour-related risk factor for manual than for knowledge worker enterprises was supported by 17 respondents, with one response to the contrary and five who were of the opinion that this aspect was of equal importance for both types of enterprises. by rejecting the null hypothesis, the sign test indicates that these differences are significant at the one per cent level, therefore it can be concluded that the business cycle is a more important labour-related risk factor for manual than for knowledge worker enterprises. 4.3.2 level and trend in unemployment the mean of 3.65 (range of 4 with a minimum value of i and a maximum value of 5) indicates that the level and trend in unemployment are perceived as approaching highly important for manual worker enterprises. in the case of knowledge worker enterprises, it is regarded as slightly more than of little importance, as highlighted by the mean of 2.26 (range of 4 with a minimum value of i and a maximum value of 5). the importance of the level and trend in unemployment also becomes apparent when the opinions of the individual respondents are analysed. eighteen of the respondents were convinced that it was a more important labour-related risk factor for manual than for knowledge worker enterprises, four were of the opinion that it was of similar importance, while only one felt that it was more important for knowledge worker enterprises. according to the sign test that rejected the null hypothesis, these differences are significant at the one per cent level, and it can therefore be concluded that the level and trend in unemployment is of greater importance for manual worker than for knowledge worker enterprises. 4.3.3 inflation inflation is another component of the economic environment that was regarded as more important for manual than for knowledge worker enterprises. the mean of3.48 (range of 4 with a minimum value of i and a maximum value of 5) in the case of manual worker enterprises and 2.43 (range of3 with a minimum value of 1 and a maximum value of 4) for knowledge worker enterprises provide proof of this statement. this result is repeated on the individual level where 16 of the respondents mentioned that manual worker enterprises especially were exposed to this r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 653 labour-related risk factor compared to only one respondent who held an opposing view. six of the respondents indicated that inflation was of similar importance for both types of enterprises. the sign test highlights that these differences are significant at the one per cent level by rejecting the null hypothesis, and therefore sufficient evidence exists to conclude that inflation is regarded as a more important labour-related risk for manual than for knowledge worker enterprises. these resulls rellcct the concern of the respondents when manual workers insist un \\ age increases beyond the ratc of inllation without a matching growth in productivity. the ri:.k in this regard can be substantial, especially if the labour force is in a strong bargaining position and the enterprise is characterised by a low profit margin. 4.3.4 global business environment on average, the respondents were of the opinion that the global business environment as a labour-related risk factor was of the same importance for both manual and knowledge worker enterprises (mean of 3.35 and a range of 3 with a minimum value of2 and a maximum value of5 in both cases). an analysis of the individual responses indicates that nine of the respondents were of the opinion that the global business environment was a more important labour-related risk factor for manual than for knowledge worker enterprises, while six respondents indicated that it was the other way round. eight of the respondents mentioned that it was of equal importance for both types of enterprises. according to the sign test these differences are not significant, therefore the global business environment can be regarded as of equal importance for both manual and knowledge worker enterprises. 4.4 social environment the social environment was regarded as more important for manual than for knowledge worker enterprises. this is reflected by a mean of 3.22 (range of 4 with a minimum value of 1 and a maximum value of 5) for manual worker enterprises compared to a mean of 2.35 (range of 3 with a minimum value of i and a maximum value of 4) in the case of knowledge worker enterprises. the majority of the respondents were convinced that the social environment was a more important labour-related risk factor for manual than for knowledge worker enterprises. eighteen of the responpents indicated that this was the case, while the remaining five mentioned that it was of the same importance for both types of enterprises. application of the sign test confirms, by rejecting the null r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 654 sajems ns vol 5 (2002) no 3 hypothesis, that these differences are significant at the one per cent level of significance. it is therefore realistic to conclude that the social environment is more important for manual than for knowledge worker enterprises. the perceived impact of the social environment, especially on manual worker enterprises, was highlighted in the preceding paragraphs. the respondents were of the opinion that the perceptions which manual workers brought to the workplace and the impact thereof on the employment relationship, was of particular importance when companies were assessed for the purpose of financial investment decision-making. it also indicated a concern among the respondents that the perceptions of manual workers, who were established in their subsocieties, might be in conflict with the values of their employers. the respondents were of the opinion that this was less of a problem in knowledge worker enterprises. with the above-mentioned as background information, it is necessary to focus on the importance that respondents ascribe to the various components of the social environment as labour-related risk factors. the components are the different cultural values, the demographic characteristics and trends, as well as the skills and education of the population (arumugam, 1996: 26; barker, 1995: 34-6; bendix, 1996: 19; douwes dekker, 1993: 15-16; goldstein & leopold, 1990: 87; manrai & manrai, 1995: 115; minnaar, pretorius & wentzel, 1995:33; mosca & pressman, 1995: 163; otting, 1993: 163; sadie & martins, 1994: 19; sugeno, 1994: 519; wooldridge, 1994: 383). 4.4.1 different cultural values the respondents generally regarded different cultural values as much more important for manual than for knowledge worker enterprises. this is reflected by a mean of 3.48 in the case of manual worker enterprises, which is more than moderately important, compared to a mean of 1.65 for knowledge worker enterprises, which is short of being of little importance. the range of opinions in the case of manual worker enterprises (range of 4 with a minimum value of 1 and a maximum value of 5) exceeds the range of opinions regarding knowledge worker enterprises (range of2 with a minimum value of 1 and a maximum value of 3), which indicates that the respondents showed a greater range of opinions with regard to the importance of this labour-related risk factor for manual than for knowledge worker enterprises. an analysis of the responses obtained indicates that none of the respondents regarded this risk factor as of more importance for knowledge than for manual worker enterprises. twenty-two of the respondents were convinced that it was of more importance for manual than for knowledge worker enterprises, whilst one r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 655 of the respondents regarded it as of equal importance for both types of enterprises. application of the sign test indicates that these differences are significant at the one per cent level. different cultural values are therefore perceived as of more importance for manual than for knowledge worker enterprises. 4.4.2 demographic characteristics and trends the mean of 3.13 for manual worker enterprises and of 1.83 in the case of knowledge worker enterprises indicate that demographic characteristics and trends are generally perceived as more important for manual than for knowledge worker enterprises. the range of 4 (minimum value of i and maximum value of 5) in the case of manual worker enterprises and a range of 2 (minimum value of i and maximum value of 3) for knowledge worker enterprises highlight that there was less agreement among the respondents regarding this labour-related risk factor when manual workers are involved than in the case of enterprises employing mainly knowledge workers. an analysis of the individual responses brings to light that 18 of the 23 respondents regarded this aspect as of more importance for manual than for knowledge worker enterprises. not one of the respondents held a contrary view, while five respondents regarded demographic characteristics and trends as of equal importance for both types of enterprises. the sign test indicates that these differences are significant at the one per cent level by rejecting the null hypothesis. it can therefore be concluded that demographic characteristics and trends are perceived to be a more important labour-related risk factor for manual than for knowledge worker enterprises. 4.4.3 skills and education of the population the mean of 4.00 (range of 4 with a minimum value of i and a maximum value of 5) indicates that the skills arid education of the population are regarded as highly important for knowledge worker enterprises. the mean of 3.09 (range of 4 with a minimum value of i and a maximum value of 5) for manual worker enterprises shows that it is regarded as somewhat more than moderately important for these enterprises. thirteen of the respondents stated that this aspect was of more importance for knowledge than for manual worker enterprises, 10 were of the opinion that it was of equal importance, while none of the respondents regarded it as more important for manual than for knowledge worker enterprises. these differences are significant at the one per cent level, and rejecting the null hypothesis, the conclusion can therefore be reached that the skills and education of the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 656 sajems ns vol 5 (2002) no 3 population are a more important labour-related risk factor for knowledge than for manual worker enterprises. these results point to the concern among the respondents that the future supply of skilled workers might be inadequate to meet the demand for skills and education especially in knowledge worker enterprises. shortages in this regard will tend to limit the growth potential of these enterprises and the increasing burden on those with skills might have a negative impact on their motivation and/or lead to excessive remuneration for them. this may tend to increase the risk profile of knowledge worker enterprises, unless they can rely on alternative external sources of skilled employees. 4.5 technological environment the mean of 3.57 (range of 3 with a minimum value of 2 and a maximum value of 5) is an indication that the technological environment is a more important labour-related risk factor for manual worker enterprises than for knowledge worker enterprises (a mean of 2.61 and a range of 4 with a minimum value of i and a maximum value of 5). sixteen of the respondents indicated that the technological environment was a more important labour-related risk factor for manual than for knowledge worker enterprises, while only one had an opposite view. six respondents mentioned that it was of the same importance for both types of enterprises. the sign test indicates that these differences are significant at the one per cent level and the null hypothesis is rejected. the technological environment is therefore regarded as a more important labour-related risk factor for manual than for knowledge worker enterprises. attention is paid to the importance of the components of the technological environment in the following paragraphs. the components are the impact of technological change on employment, production processes and the obsolescence of skills, as well as the extent and manner of co-operation between management and the labour force when they deal with technological change (firoozi, 1994: 301; freeman, soete & efendioglu, 1995: 587; freund, 1992: 3; machin & van reenen, 1998: 1217; shostak, 1993: 33; thomas, 1991: 167; treynor, 1994: 6). 4.5.1 impact o/technological change on employment, production processes and the obsolescence 0/ skills the respondents generally were of the opinion that this labour-related risk factor was more important for manual than for knowledge worker enterprises. this is highlighted by the mean of 3.83 (range of 4 with a minimum value of 1 and a maximum value of 5) for manual worker enterprises and the mean of 2.57 (range r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 657 of 4 with a minimum value of 1 and a maximum value of 5) in the case of knowledge worker enterprises. the particular importance of this labour-related risk for manual worker enterprises was also obvious when the responses were analysed. nineteen of the respondents were convinced that it was more important for manual than for knowledge worker enterprises, while only one had an opposing view, and three mentioned that it was of the same importance for both types of enterprises. application of the sign test points to the significance of these differences by rejecting the null hypothesis and therefore should it be regarded as a more important labour-related risk factor for manual than for knowledge worker enterprises. 4.5.2 extent and manner of co-operation between management and the labour force when they deal with technological change the extent and manner of co-operation between management and the labour force when they deal with technological change is more important for manual than for knowledge worker enterprises. this is reflected by the mean of 3.48 (range of 3 with a minimum value of 2 and a maximum value of 5) for manual worker enterprises and 2.70 (range of 4 with a minimum value of i and a maximum value of 5) in the case of knowledge worker enterprises. the views of each of the respondents regarding the importance of this labourrelated risk factor for the two types of enterprises also point to the significance of this aspect for manual worker enterprises in particular. thirteen of the respondents maintained this view, eight respondents mentioned that it was equally important for both types of enterprises, while only two felt that it was a more important labour-related risk factor for knowledge than for manual worker enterprises. according to the sign test, these differences are significant at the one per cent level and the null hypothesis is rejected. 5 conclusions the overall importance of external environmental labour-related risk factors for the purpose of financial investment decision-making are regarded as of significantly more importance for manual than for knowledge worker enterprises. the respondents are of the opinion that the following detailed external environmental labour-related risk factors are of more importance for manual r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 658 sajems ns vol 5 (2002) no 3 than for knowledge worker enterprises (with the approximate importance in brackets): political environment (respectively highly and moderately important). political stability (respectively highly and moderately important). distribution of political power (respectively moderately and little important). labour market policy (respectively highly and little important). economic environment (respectively highly and moderately important). business cycle (respectively highly and moderately important). level and trend in unemployment (respectively highly and little important). inflation (respectively moderately and little important). social environment (respectively moderately and little important). different culture values (respectively moderately and little important). demographic characteristics and trends (respectively moderately and little important). technological environment (respectively highly and moderately important). impact of technological change on employment, production processes and the obsolescence of skills (respectively highly and moderately important). extent and manner of co·operation between management and the labour force when they deal with technological change (respectively more than and less than moderately important). the skills and education of the population, a component of the social environment, is the only external environmental labour-related risk factor regarded as of more importance for knowledge than for manual worker enterprises (respectively highly and moderately important). the global business environment, being a component of the economic environment, is the only external environmental labour-related risk factor that is regarded as of equal importance for manual and knowledge worker enterprises (both moderately important). 6 implications the conclusions of this study have implications for role players and should be considered to improve financial investment decision-making. the role players are, for example, institutional investors, enterprises listed on the jse securities exchange south africa, and others who are perceived to have an impact on labour-related risks in manual and knowledge worker enterprises. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 659 6.1 implications for institutional investors institutional investors should take the following into account with regard to the perceived overall importance of external environmental labour-related risk factors for manual worker enterprises in particular: care should be taken not to blame manual workers for perceived labourrelated risks when such risks actually originate in the external ellvironment. the 1i.ii':us should 1i0t be 011 risks originating in the external environment ollly. but also 011 ellterprise strategies for dealing with these risks. an example ill this r~garj would be the co-operation of management and the labour force to deal with the impact of technological change. the skills and education of the population, a component of the social environment, is the only external environmental labour-related risk factor that is regarded as of more importance for knowledge worker than for manual worker enterprises. when assessing this labour-related risk factor, institutional investors should not pay attention to education and skills development within south africa only, but also to the mobility of knowledge workers in and out of south africa. strategies of companies to enhance the skills and education of the workforce internally, should also be given due attention by institutional investors. 6.2 implications for enterprises listed on the jse securities exchange south africa the conclusions of the study have important implications for management and employees of enterprises listed on the jse securities exchange south africa. overall. external environmental labour-related risk factors, as well as the majority of the detailed external environmental labour-related risk factors, are perceived as more important in the case of manual worker enterprises than for knowledge worker enterprises. the implications for the management and employees of manual worker enterprises are therefore of particular interest. as far as management is concerned, it is interesting to note the emphasis placed by the respondents on the importance of different cultural values, a component of the social environment, as a labour-related risk factor in the case of manual worker enterprises. this implies that the management in these enterprises should take cognisance of their responsibility to manage different cultures in the enterprise properly and to put it to productive use. the conclusions of the study also have significant implications for the employees of manual worker enterprises. one such implication relates to the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 660 sajems ns vol 5 (2002) no 3 conclusion that the respondents regard the economic environment as a more important labour-related risk factor for manual worker than for knowledge worker enterprises. this implies that the employees in manual worker enterprises should pay particular attention to the stance of the economic environment and refrain from irresponsible behaviour when negotiating with management. 6.3 implications for other role players the conclusions of this study imply that political role players are perceived to have an important role to play in reducing labour-related risks in manual worker enterprises. it is important, furthennore, that political role players and organised labour, who both influence political decisions, bear in mind that government labour market policies are not evaluated in isolation by investment practitioners, but that they may refer to best practices identified in the rest of the world when they make their decisions. the study also has implications for trade unions, as social institutions, to assist at the national and enterprise level in promoting policies that will make it possible to cope with pressures resulting from different cultures in society and at the workplace. references arumugam, s. 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(1995) "who goes there? iuegals in south africa", indicator south africa, 12(3): 33-40. 21 mosca, j.b. & pressman, s. (1995) "unions in the 21 st century", public personnel management, 24(2): 159-66. 22 otting, a. (1993) "international labour standards: a framework for social security", international labour review, 132(2): 163-71. 23 sachs, l. (1984) applied statistics: a handbook of techniques (2nd ed.) new york: springer-verlag. 24 sadie, j.l. & martins, j.h. (1994) projections of the south african labour force, 1991-2011, (research report no 208) pretoria: bureau of market research, university of south afiica. 25 shostak, a.b. (1993) "the nature of work in the twenty-first century: certain uncertaincies", business horizons, 36(6): 30-34. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 662 sajems ns vol 5 (2002) no 3 26 sugeno, k. (1994) "unions as social institutions in democratic market economies", international labour review, 133(4): 511-22. 27 thomas, r.1. (1991) "technological choice and union-management cooperation",lndustrial relations, 30(2): 167-92. 28 treynor, j.l. (1994) "is training a good investment?", financial analysts journal, 50(5): 6-8. 29 van der lith, m. (1998) facsimile from financial services board. 30 wood, a. (1995, summer) "how trade hurt unskilled workers", journal o/economic perspectives, 9(3): 57-80. 31 wooldridge, b. (1994) "changing demographics of the workforce: implications for the use of technology as a productivity improvement strategy", public productivity & management review, 17(4): 371-86. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems 22-1_2019_contents.indd http://www.sajems.org open access table of contents i original research the information technology role in supplier-customer information-sharing in the supply chain management of south african small and medium-sized enterprises kenneth m. mathu south african journal of economic and management sciences | vol 22, no 1 | a2256 | 26 march 2019 original research physical capital, total factor productivity, and economic growth in sub-saharan africa giampaolo garzarelli, yasmina rim limam south african journal of economic and management sciences | vol 22, no 1 | a2309 | 26 march 2019 original research do wine tourists care about the labourer? andrea saayman, melville saayman south african journal of economic and management sciences | vol 22, no 1 | a2477 | 27 march 2019 original research effectiveness of employer branding on staff retention and compensation expectations mark bussin, hugo mouton south african journal of economic and management sciences | vol 22, no 1 | a2412 | 09 april 2019 original research a test taker’s gamble: the effect of average grade to date on guessing behaviour in a multiple choice test with a negative marking rule aylit t. romm, volker schoer, jesal c. kika south african journal of economic and management sciences | vol 22, no 1 | a2542 | 11 april 2019 original research knowledge exchange and ethnic networks of clustered small-scale enterprises in africa: a case study of furniture cluster in tanzania yessica c.y. chung south african journal of economic and management sciences | vol 22, no 1 | a2450 | 16 april 2019 original research an investigation into the output tax consequences of bitcoin transactions for a south african value-added tax vendor cecileen greeff south african journal of economic and management sciences | vol 22, no 1 | a2162 | 25 april 2019 original research the impact of south african real estate investment trust legislation on firm growth and firm value riëtte carstens, nicolene wesson south african journal of economic and management sciences | vol 22, no 1 | a2257 | 25 april 2019 83 91 101 109 117 129 142 151 page i of iii table of contents i book review good capitalism versus bad capitalism: a review petrus d.f. strydom south african journal of economic and management sciences | vol 22, no 1 | a2794 | 22 january 2019 original research pricing of fair value instruments reported under international financial reporting standards 7: south african setting hopewell hlatshwayo, mbalenhle zulu south african journal of economic and management sciences | vol 22, no 1 | a2345 | 15 january 2019 original research using explicit knowledge of groups to enhance firm productivity: a data envelopment analysis application ayodotun s. ibidunni, joachim a. abiodun, oyebisi m. ibidunni, maxwell a. olokundun south african journal of economic and management sciences | vol 22, no 1 | a2159 | 29 january 2019 original research a high unemployment and labour market segmentation: a three-segment macroeconomic model philippe burger, frederick fourie south african journal of economic and management sciences | vol 22, no 1 | a2103 | 25 february 2019 original research the unemployed and the formal and informal sectors in south africa: a macroeconomic analysis philippe burger, frederick fourie south african journal of economic and management sciences | vol 22, no 1 | a2104 | 25 february 2019 original research the effect of work engagement on total quality management practices in a petrochemical organisation dinko h. boikanyo, marita m. heyns south african journal of economic and management sciences | vol 22, no 1 | a2334 | 26 february 2019 original research modelling the link between supply chain risk, flexibility and performance in the public sector khomotso mhelembe, chengedzai mafini south african journal of economic and management sciences | vol 22, no 1 | a2368 | 25 march 2019 original research a motivation for banks in emerging economies to adapt agency ratings when assessing corporate credit tanja verster, riaan de jongh, simon greenberg, erika fourie, dries de wet south african journal of economic and management sciences | vol 22, no 1 | a2818 | 25 march 2019 1 5 14 23 35 47 60 72 vol 22, no 1 (2019) issn: 1015-8812 (print) | issn: 2222-3436 (online)south african journal of economic and management sciences http://www.sajems.org open access table of contents ii original research use of social media in free state tourism small, medium and micro enterprises to widen business networks for competitiveness lentswe mosweunyane, patient rambe, dennis dzansi south african journal of economic and management sciences | vol 22, no 1 | a2780 | 29 april 2019 original research the bidirectional relationship between entrepreneurial intention and entrepreneurial competencies for nascent and existing entrepreneurs melodi botha, amorie taljaard south african journal of economic and management sciences | vol 22, no 1 | a2230 | 29 may 2019 original research estimating trade flows between regions of kwazulu-natal, south africa clive e. coetzee, ewert p.j. kleynhans south african journal of economic and management sciences | vol 22, no 1 | a2390 | 05 june 2019 original research the effect of transformational leadership on intention to quit through perceived organisational support, organisational justice and trust amos engelbrecht, olorunjuwon m. samuel south african journal of economic and management sciences | vol 22, no 1 | a2338 | 12 june 2019 original research access to microand informal loans: evaluating the impact on the quality of life of poor females in south africa talita greyling, stephanié rossouw south african journal of economic and management sciences | vol 22, no 1 | a2944 | 27 june 2019 original research modelling effect of valuable resources on franchise outlet performance: dynamic sensing capability as mediator jilson zimuto, rachel maritz south african journal of economic and management sciences | vol 22, no 1 | a2706 | 09 july 2019 original research tax revenue mobilisation: estimates of south africa’s personal income tax gap chengetai dare, sophia du plessis, ada jansen south african journal of economic and management sciences | vol 22, no 1 | a2817 | 15 july 2019 original research examining intra-african tourism: a trade theory perspective adam h. viljoen, andrea saayman, melville saayman south african journal of economic and management sciences | vol 22, no 1 | a2860 | 22 july 2019 original research a tale of two ships: follower attributions of leadership with reference to team morale in an air traffic control centre lonell coetzee, sanchen henning south african journal of economic and management sciences | vol 22, no 1 | a2109 | 26 august 2019 159 169 181 189 197 211 220 228 238 original research economic impact assessment of a south african university campus: a case for promoting on-campus contact learning david dyason, riaan rossouw, ewert p.j. kleynhans south african journal of economic and management sciences | vol 22, no 1 | a3153 | 29 august 2019 original research re-examining the ability to explain future south african banking share returns: a data envelopment analysis approach chris van heerden, johan coetzee south african journal of economic and management sciences | vol 22, no 1 | a2852 | 16 september 2019 original research public ‘say on pay’ activism in south africa: targets, challengers, themes and impact suzette viviers, nadia mans-kemp, linda kallis, kristen mckenzie south african journal of economic and management sciences | vol 22, no 1 | a3251 | 22 october 2019 original research the preparation, training and support requirements of expatriate trailing spouses emma-louise webber, adolf j. vögel south african journal of economic and management sciences | vol 22, no 1 | a2703 | 27 november 2019 original research assessing the business case for environmental, social and corporate governance practices in south africa ruth johnson, nadia mans-kemp, pierre d. erasmus south african journal of economic and management sciences | vol 22, no 1 | a2727 | 28 november 2019 original research a conceptual framework for inclusive economics arno van niekerk south african journal of economic and management sciences | vol 22, no 1 | a2915 | 29 november 2019 original research subjective well-being impact of old age pension in south africa: a difference in difference analysis across the gender divide umakrishnan kollamparambil, mfongeh n. etinzock south african journal of economic and management sciences | vol 22, no 1 | a2996 | 06 december 2019 original research structure and an unstable business operating environment: revisiting burns and stalker’s organisation-environment theory in zimbabwe’s manufacturing sector ntandoyenkosi sibindi, olorunjuwon m. samuel south african journal of economic and management sciences | vol 22, no 1 | a2113 | 10 december 2019 new perspective the performance of debt and equity markets in anglo american plc and bhp billiton plc in the period 2006 to 2015 through the lens of merton’s structural model leon b. sanderson south african journal of economic and management sciences | vol 22, no 1 | a1854 | 14 february 2019 248 259 277 287 297 310 319 331 343 page ii of iii http://www.sajems.org open access table of contents iii correction corrigendum: the structural validity and measurement invariance across gender of the brief corporate entrepreneurship assessment instrument renier steyn, g.p. de bruin south african journal of economic and management sciences | vol 22, no 1 | a3421 | 05 december 2019 352 reviewer acknowledgement south african journal of economic and management sciences | vol 22, no 1 | a3437 | 12 december 2019 353 page iii of iii abstract introduction data and empirical framework simulations conclusion, policy interventions and recommendation acknowledgements references about the author(s) kambale kavese department of economics, faculty of business and economic science, nelson mandela university, port elizabeth, south africa andrew phiri department of economics, faculty of business and economic science, nelson mandela university, port elizabeth, south africa citation kavese, k. & phiri, a., 2020, ‘micro-simulations of a dynamic supply and use tables economy-wide leontief-based model for the south african economy’, south african journal of economic and management sciences 23(1), a3431. https://doi.org/10.4102/sajems.v23i1.3431 original research micro-simulations of a dynamic supply and use tables economy-wide leontief-based model for the south african economy kambale kavese, andrew phiri received: 19 oct. 2019; accepted: 18 sept. 2020; published: 20 nov. 2020 copyright: © 2020. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: south africa has not fully recovered from the 2008 global recession. the world bank has predicted that south africa will be one of the worst performers in sub-saharan africa in 2020 with tepid growth of 1.3% which is far below the national development plan targets growth of 5.4% required a year to reduce unemployment, create decent jobs and generate enough revenue for social development. aim: we aim to examine whether changes in the components of final demand (changes in government spending, household consumption expenditure, exports, investment spending) have a considerable effect on the sector’s gross value added, job creation and tax revenue generation and whether there were changes in the exogenous final demand in die post-recession period. setting: we focus on building supply and use tables based on 62 different sectors of the south african economy. methods: an economy-wide leontief multiplier-based model calibrated on a supply and use framework and a micro-simulation model is used to assess post-recession trends in macroeconomic, labour and fiscal multipliers for south africa. results: the simulations show that during the post-recession era, the effect of exogenous shock in the economy, like an increase in investment spending, although positive, yields a smaller return in terms of tax revenue, job creation and economic growth. at sector level, the results show that the inter-industry links and industry-consumer links have therefore weakened. conclusion: our findings imply that the persisting low growth trajectory associated with weaker inter-industry linkages could be exacerbated, while the fiscal austerity measures associated with weaker forward and backword tax linkages could be prolonged. we recommend government should follow a priorities-based spending policy that yields optimal socioeconomic returns. keywords: supply and use tables; fiscal multipliers; employment multipliers; micro-simulations; south africa. introduction micro-simulations of dynamic supply and use tables (sut) are a powerful tool for analysing the dynamic effects of fiscal policy on the macroeconomy. unfortunately, econometric models have limitations in that they do not handle economy-wide analysis related to inter-industry and intra-industry, forward and backward linkages in response to changes in the final demand or exogenous shocks. supply and use tables provide a record of economic data in a matrix form-at, which shows how supplies of different kind of goods and services originate from domestic industries and imports, and how these supplies are allocated between various intermediate in-puts and final demand, including exports. the sut structures allow for the analytic uses at microand macro-levels, including economic analyses, impact assessment and policy analyses, sensitivity analyses and the impact of taxation changes, industrial and sectoral analyses, and local government-type investment planning like construction projects, shopping centres, new motorways, rural planning and energy conversion chains (bouwmeester & oosterhaven 2013; eding et al. 1999; heun, owen & brockway 2018; jackson 1998; madsen & jensen-butler 1999; mahajan 2007; merciai & schmidt 2018; nicolardi 2013; piispala 2000; siddiqi & salem 1995; temurshoev et al. 2011; thurlow & dorosh 2013; timmer et al. 2015; zaman, surugiu & surugiu 2010). this differs from the traditional input-output (io) model which does not specify at sector level the linkages between the supply and use of commodities. to date, not a single study using sut leontief multipliers has examined the effect of taxes or fiscal poli-cy on the south african economy. our study not only aims to fill this identified gap by providing forward and backward tax multipliers for the south african economy, but we further address other gaps identified in the literature. for instance, previous studies that applied leontief-based multiplier models to the south african economy, generally focused either on one sector, for example the mining sector (stillwell 1999), real estate (boshoff & seymore 2016), sugar-sweetened beverages (national treasury 2017), or the agricultural sector (phoofolo 2018), or their analysis was static, based on a single year (cloete & rossouw 2014; davies & thurlow 2013; van seventer et al. 2016). kratena and streicher (2017) used the traditional io, a static model, to analyse fiscal policy multipliers and spillovers in a multi-regional macroeconomy. furthermore, previous studies focused only on a few aggre-gated generic multipliers. for example, the study by burrows and botha (2013) focused only on the gross domestic product (gdp) multiplier for south africa, while phoofolo (2018) measured output and gross value-added (gva) multipliers, and income and employment multipliers. in all the aforementioned studies, only one shock in the exogenous variable was performed, which then narrowed policy intervention due to a limited number of multipliers used in the model. the study by van seventer et al. (2016) assessed the structural change in the south african economy using aggregated social accounting matrices (sams) for the period 1993–2013, focusing mainly on the methodology used to build a mini-sam. moreover, there is no previous study for south africa that uses a dynamic sut framework and economy-wide leontief multiplier approach to investigate the post-recession trend effects of fiscal policy. our study builds upon this previous literature in a number of ways. firstly, we extend the model over 62 different economic sectors. secondly, we split our analysis over two distinct periods corresponding to the pre-recession and post-recession periods. thirdly, we provide a full range of 47 endogenous employment multipliers. lastly, we diversify the number of scenarios and simulations from fiscal, labour and macroeconomic perspectives. on this premise, three eminent research questions emerge which this study seeks to address. firstly, how robust are government strategic interventions in yielding high returns on sectoral employment, tax revenue and gdp multipliers? secondly, how has the south african economy responded to changes in the exogenous final demand over the period prior to and post-recession? thirdly, which of the changes in the components of final demand (changes in government spending, household consumption expenditure, exports, investment spending) has high effects have an effect on a sector’s gross value added, job creation and tax revenue generation? in addressing these three research questions our study sets out four empirical objectives: firstly, to provide the performance and trend analysis of labour, economic and fiscal multipliers in south africa. secondly, to compute and analyse both the supply-side tax forward linkages coefficients and the demand-side tax backward linkages coefficients. thirdly, to empirically investigate the impact of a 5% increase in each component of final demand on selected fiscal, labour and other macroeconomic variables. lastly, to provide the impact of government spending on a full range of 43 endogenous employment multipliers. the importance of this study is multidimensional. it has implications for a variety of policy interventions, such as fiscal policy (using tax multipliers), labour policy (using employment multipliers), poverty and development policy (using income multipliers), investment policy (using investment multipliers), trade policy (using export multipliers), growth and industrial policy (output multipliers, gva multipliers, gdp multipliers, and gross operating surplus [gos] multipliers), small, medium and micro-sized enterprises policy (using small business corporation [sbs] instead of tax multipliers), and so on. data and empirical framework data the data used to compile the sut leontief-based model was collected from two main data sources, namely statistics south africa (stats sa) and the south african revenue services (sars). from stats sa, data were collected from the national account statistics and from the labour account statistics. the nine sut from 2007 to 2015 were all collected from the national account statistics. from sars, tax data were collected, including company tax (number of taxpayers and tax assessed in millions of rand), value-added tax (vat) (number of vendors; payments in millions of rand), pay as you earn (paye) tax and small business corporation (sbc) tax (number of taxpayers; tax assessed in millions of rand). layout of a simplified supply and use framework for south africa statistics south africa uses the sut as a coordinating framework for economic statistics, as well as an accounting framework for ensuring the numerical consistency and coherency of data obtained from various sources. south africa’s sut framework is consistent with the recent united nations 2008 system of national accounts (united nations 2009), the revised 2008 european system of accounts (eurostat 2008) and the united nations’ new handbook on the compilation of the sut released in 2017, therefore, international best-practices. following miller and blair (2009), and using the standard notations, the format of the simpli-fied south african sut is presented in figure 1. this format has been used with slight modifications by various authors (bouwmeester & oosterhaven 2013; eding 1996; jackson 1998; madsen & jensen-butler 1998; piispala 2000; siddiqi & salem 1995). the sut comprises two tables: the supply table and the use table. figure 1: layout of a simplified supply and use framework for south africa. the supply table comprises four matrices which provide information about the origin of goods and services in the economy, imports of goods and services, trade and transport margins, and taxes less subsidies on products. it shows that the total supply (dic) for industry (i) and com-modities (c) has two origins, namely domestic (pic) and foreign (mic) (piispala 2000). the use table contains three main matrices. the first matrix is intermediate consumption ex-penditure (yic), which comprises the input cost of goods and services produced within the eco-nomy. the second matrix is the components of final demand (fic), which include household consumption expenditure, government consumption expenditure, fixed capital formation, changes in inventory and exports (xic). lastly, there are the components of value added (wic), which include compensation of employees, taxes on products (excluding import duties), subsi-dies on products, gos and mixed income, and consumption of fixed capital (piispala 2000). following the double entry accounting principles, total supply of goods and services must balance with total demand of goods and services (boomsma & oosterhaven 1992). the process of balancing the sut simultaneously can only be achieved if the following identities for all products (c) and all industries (i) balance: in equation 1: pic = domestic output of commodity c in industry i mic = import of commodity c in industry i ttic = trade and transport margin of commodity c in industry i tsic = taxes and subsidies on products of commodity c in industry i dic = total supply at purchasers’ prices of commodity c in industry i fic = final consumption expenditure of commodity c in industry i yic = intermediate consumption expenditure of commodity c in industry i the first identity in equation 1 comprises the supply and demand of goods and services. from the supply side, equation 1 shows that total supply (dic) of commodity c by industry i equals total domestic supply (pic) plus imports (mic) plus trade and transport margin (ttic) plus taxes less subsidies on products (tsic). from the demand side, the total supply (dic) of commodity c by industry i is also equal to inter-mediate consumption expenditure (yic) plus total final demand (fic) which also includes ex-ports (mic). the second identity in equation 2 shows that the total output of (tic) is equal to the intermedi-ate consumption expenditure (yic) plus components of gross value added (wic). put differently, the gross value added is equal to the output less the cost of production: the third identity in equation 3 contains the components of gross value added, namely com-pensation of employees (ceic), gos (osic), taxes less subsidies on products (tsic) and taxes less subsidies on production (tsic): substituting equation 3 into equation 2 and solving yields: supply and use tables and gross domestic product estimations the sut combines into a single framework the three approaches to estimate gdp according to the production approach (equation 5), the income approach (equation 6) and the expenditure approach (equation 7). the production approach: gdp = output (at basic prices) – intermediate consumption + taxes less subsidies on products: the income approach: gdp = compensation of employees + gos + other taxes less subsidies on production + taxes less subsidies on products: the expenditure approach: gdp = final consumption expenditure + exports – imports: having dealt with the three approaches, it became apparent that each method yields the same estimate of the south african gdp at market prices (see equation 8): this means that irrespective of whether the income, production or expenditure method is used, the value of gdp should be the same and each method should lead to the same value of gdp. inter-industry linkages, forward and backward linkages the way goods and services flow within the economy is an indication that economic agencies do not operate in isolation (leontief 1936). more recently, linkage analysis methods have again attracted increasing attention from policy analysts throughout the world. with regard to the measurement of linkage coefficients, there are two main methods used to examine the interdependency between the production and cost structures of the economy (miller & blair 2009). both methods, that is, the chenery-watanabe method (backward linkage of industries) and the rasmussen meth-od (forward linkage of industries), are applied to south africa’s sut leontief-based model. the chenery-watanabe method is derived from the input coefficient, a demand-driven model that attempts to supply a quantitative evaluation of backward and forward linkages for the economy’s production structure. the backward linkages of an industry j are defined as: the forward linkages of an industry i are defined as: in equation 9 and equation 10: is the backward linkage of sector j for the chenery-watanabe method is the forward linkage of sector j for the chenery-watanabe method aij is the input coefficient matrix bij is the output coefficient matrix xij is the magnitude of industry i’s output used as production input by industry j xj is industry j’s output and aij is the input coefficient of industry j to industry i on the other hand, the rasmussen method is based on the leontief inverse matrix, l = (i–a)−1, and is used to measure inter-industry linkages. the backward linkage is defined as the column sums of the leontief inverse matrix: the backward linkage is defined as the row sums of the inverse matrix: here, gij is the ijth element of the leontief inverse matrix. the backward linkage blj reflects the effect of an increase in final demand of industry j on overall output; in other words, it measures the extent to which a unit change in the demand for the product i of industry j causes production increases in all industries. conversely, the forward linkage flj measures the magnitude of the increase in output in industry i, if the final demand in each industry were to increase by one unit; in other words, it measures the extent to which industry i is affected by an expansion of one unit in all industries. in our analysis we employ both forward and backward multipliers, but in most instances we only report the backward multipliers. it is vital to mention that micro-simulations from the supply and use framework remain a powerful tool of measuring the effect of, say, an additional r1 increase in government spending on households of different income, race, gender, occupation and age groups. the applications of the sut model at sectoral level are designed to achieve these purposes: to identify industries and sectors with high comparative and competitive advantages, to deter-mine inter-industry effects through multipliers, to assess backward and forward linkages and, lastly, to assess the number of jobs sustained by the sector through infrastructure projects (miller & blair 2009). the tool is also useful to simulate the impact of a fiscal expansion through a hypo-thetical 1% increase in government expenditure and its effects on growth, employment, pov-erty reduction, investment and productivity. economy-wide models there are four different but complementing type of economy-wide models: traditional io models (industry by industry matrix under the 1968 sna). sut leontief model (industry by product matrix under the 1993 sna, and recently the 2008 sna). in this study, the sut was preferred over the sam and computable general equilibrium (cge) because the sut allows exhaustive sectoral analysis, while in sam and cge, often the number of sectors is much more aggregated, which would forfeit the objective set in this article. sam-leontief model (a statistical representation of the economic and social structure of a country). cge model which uses the neoclassical theory to analyse the structural and behavioural aspects of the economy. the sut is used as a building block in the construction of a sam (miller & blair 2009), which is used as a building block in the construction of a cge model (lofgren, harris & robinson 2002). the io, sut and sam are partial equilibrium models with fixed prices and fixed coefficients meaning that substitution possibilities in consumption, production, imports and exports are ignored. although the behavioural specifications in partial equilibrium models emphasise important linkages in the economy, these models are demand-driven adhering to keynesian philosophy, best suited for the analysis of structural changes in the economy, but awkward in dealing with issues such as price changes. moving from partial equilibrium models to a general equilibrium (cge) model is achieved by including on the one side the function forms, such as the cobb-douglas production function, the constant elasticity of transformation (cet) and the constant elasticity of substitution (ces), and on the other side by incorporating the behaviour of institutions such as households, government and private firms into the cge model (humphrey 1997). unlike the partial equilibrium models, the cge adheres to neoclassical philosophy, considers the behavioural drivers of change in the economy and allows a much broader analysis of analytical structure and the behavioural aspects of the economy (lofgren et al. 2002). simulations this section focuses on the results and presents key findings of the dynamic sut leontief-based model for south africa. the results are grouped in four sets: the first set of results captures simulation trends over a 9-year period (2007–2015) to reflect changes in post-recession tax multipliers and other generic multipliers such as: income multiplier, output multiplier, gdp multiplier, gva multiplier, gos multiplier, gross fixed capital formation (gfcf) or investment multiplier, fixed capital stock (fcs) multiplier and export multipliers. the second set of results shows the sectors that will generate more tax when there is a shock in the economy. for example, given a hypothetical r1 million increase in final demand, the second set of results pro-vides tax multipliers, including both the tax forward linkage coefficients and the tax backward linkage coefficients for each economic sector in 2007 and in 2015. tax multipliers include: company tax, vat, paye tax and sbc tax multipliers. the third set of results is presented in four different scenarios, assessing what happens to different tax multipliers and other generic multipliers over the period 2007–2015 if: (1) exports increase by 5%, (2) government spending increases by 5%, (3) household consumption expenditure in-creases by 5% and (4) total investment increases by 5%. the last set of findings is static. it exhaustively presents empirical labour results under 43 different employment multipliers depicting the number of jobs to be created when government spending increases by a hypothetical r1 million. employment multipliers are firstly disaggregated to display the effect on economic sectors, skill level, province, occupation, level of education and by expanded public works programmes (epwp). secondly, employment multipliers are further derived and presented in such a way as to distinguish effects between formal and informal employment multipliers, rural and urban employment multipliers, and the youth and adult employment multipliers. model 1: trend analysis of type i and type ii multipliers for south africa (2007–2015) in collectively summarising the findings of the study, it is firstly noted that over the long run (2007–2015), as shown in table 2, the effect of r1 invested in the south african economy had a positive multiplier effect on growth, tax, employment and poverty. however, the most important observation noted in this study is the significant decline in fiscal multipliers, employment multipliers, output and income multipliers over the period 2007–2015. these re-sults imply that the inter-sector multiplier effect has weakened over the post-recession peri-od. this finding justifies the low growth path that has persisted since the economic meltdown in 2008 (national treasury 2018). the effect of the average r1 spent in the south african economy yielded a smaller return in terms of economic effect throughout the economy in 2015 (post-recession) than it did in 2007 (pre-recession). this suggests that the inter-industry links and industry-consumer links weak-ened. the result of this study supports the finding by burrows and botha (2013), who investigated the changing io multipliers in south africa for the 1980–2010 period and found a decline in gdp and output multipliers. contrary to these findings, in the study by bekhet (2011) on output, income and employment multipliers in the malaysian economy over four periods (1983, 1987, 1991 and 2000) and using the malaysian io tables, he found in-creasing output, income and employment multipliers. trend analysis of individual type i and type ii multipliers are presented in table 1. it shows that apart from paye tax multipliers, all other tax multipliers – companies tax, vat and sbs tax – declined during the period under review. this suggests that paye is the most sustain-able tax in the economy. only paye tax multipliers increased, the rest decreased. table 1: overall trend analysis of generic multipliers for south africa (2007–2015). from the first set of simulation results in table 1, it can be inferred that, based on the reference years 2007 and 2015, an additional r1 million worth of exogenous final demand injection into the south african economy through the direct and indirect effect on production would have generated an average of the following values throughout the entire economy, which in this case yield positive but declining results over time. example: fiscal effect on company tax assessed would have been r104 000 in 2007 (r63 000 in 2015); vat payment: r129 000 in 2007 (r104 000 in 2015); paye tax: r81 000 in 2007 (r126 000 in 2015); sbs tax would have fluctuated around r1000 throughout the period under review. labour effect in terms of employment creation suggests that in 2015 there would have been a total of 4.7 jobs created, of which 3.4 would have been in the formal sector and 1.2 in the informal sector. of the 3.4 jobs in the formal sector, 0.8 would have been for high and skilled labour, 1.7 for semi-skilled labour and 0.9 for low or unskilled labour. the effect on employment creation in 2015 would have been lower than that in 2007. total employment in 2007 would have been 9.3 jobs created of which 7.7 jobs would have been in the formal sector and 1.6 jobs in the informal sector. of the 7.7 jobs in the formal sector, 1.8 would have been for high and skilled labour, 3.9 for semi-skilled labour and 3.4 for low or unskilled labour. economic effect on total output would have been r2.9 million in 2007 (r2.7 m in 2015); gross value added: r1.2 million in 2007 (r1.1 m in 2015); income in the form of compensation of employees: r569 000 in 2007 (r564 000 in 2015), but the income to shareholders (gos) would have been r619 000 in 2007 (r532 000 in 2015) and imports r442 000 in 2007 (r431 000 in 2015). these results show that for every r1 injected in the south african economy, the effect was low for compensation of employees pre-recession, at workers’ disadvantage. in 2015, after the recession, the situation has changed, and the impact is now low for gos, at a dis-advantage to the capital owners. model 2: tax forward and backward linkage coefficients the second set of simulation results focuses on supply-side tax forward linkage coefficients and demand-side tax backward linkage coefficients effects for different sectors of the econo-my. given a hypothetical r1 million increase in final demand, which economic sector would have yielded high tax multipliers? simulation results in table 2 reveal that the trade industry had high tax backward linkage coefficients and the finance industry had high forward linkage coefficients both in 2007 and 2015. so domestic wholesale and retail sales together with inter-national trade should be targeted to stimulate tax generation in the south african economy. table 2: comparing tax backward and forward sector tax multipliers in 2007 and 2015. contrary to this study’s findings, the study by zaman et al. (2010) on the propagation effect of taxes in the romanian investigated tax policy effects backward and forward for the years 2000 and 2006. they concluded that the industries with universal vocation, serving all the other industries of the national economy, like electricity, gas, water, education and public administration, were characterised by a strong tax effect. as mentioned earlier, apart from paye tax, most tax multipliers in all sectors were high in 2007 prior to the recession and were low in 2015 after the recession. for example, using backward tax multipliers as in table 2, a hypothetical r1 million increase in final demand would have re-sulted in an economy-wide yield of r70 000 paye tax from the agriculture industry in 2007 compared with r111 000 in 2015. value-added tax payments in agriculture would have a yield of r164 000 in 2007 and 135 000 in 2015. model 3: effect of a 5% increase in exogenous variables on different taxes and other endogenous variables the third set of results presents four different scenarios that assessed, over the period 2007–2015, the effect of a 5% increase in exogenous variables, such as exports (scenario 1), govern-ment spending (scenario 2), household consumption expenditure (scenario 3) and total in-vestment (scenario 4) on endogenous variables (such as taxes, employment, gross domestic fixed investment, compensation of employees gos, taxes less subsidies on products, fixed capital stock, and imports). in all four scenarios, simulation results presented in table 3 are consistently aligned with those shown in the first and second sets of results in terms of declining multipli-ers over the period under review. another finding is that a 5% increase in all exogenous vari-ables has a higher economy-wide effect on imports than it has on other endogenous variables. for instance, in the first scenario, a 5% increase in exports leads to a 5.08% increase in imports. in the second scenario, a 5% increase in household consumption expenditure leads to a 10.03% increase in imports. in the third scenario, a 5% increase in government spending leads to a 1.69% increase in imports. in the last scenario, a 5% increase in investment leads to a 3.78% increase in imports. results of the low effect in the third scenario (5% increase in government spending) are in line with prior expectations, in the sense that the bulk (75%) of government spending (on education, health and social welfare) has little effect on imports. moreover, an increasing demand for goods and services by households (in the second scenario) triggers a high demand for production and intermediate inputs. firms react by importing final goods or inter-mediate inputs to satisfy the demand. table 3: impact of a 5% increase in exogenous variables: the four scenarios. consequently, the second scenario, which dealt with a 5% increase in household expenditure, would ultimately yield a higher multiplier effect than the other three scenarios. for example, when household spending rises by 5%, most taxes (company tax, vat, paye tax and sbc taxes) increase by over 7%, compared to 3% in scenario 1 with a 5% increase in exports, result-ing in a total employment rise of about 6%, more specifically among semi-skilled labour at 6.9%. amazingly, gos rises by 1 percentage point above the compensation of employees, which implies that the increase in household consumption expenditure benefits more shareholders than it does workers. in all four scenarios, a 5% increase in all exogenous variables yielded higher employment mul-tipliers for semi-skilled workers than for skilled workers, low-skilled and unskilled workers, and workers in formal and informal sectors. most semi-skilled workers are in the middle-income class so an initiative that causes a shock in any of the exogenous variables will have a greater effect on the middle class than on the lower and upper classes. finally, investment has an economy-wide multiplying effect on itself. in the fourth scenario, a 5% increase in gross fixed capital investment leads to a 2.4% increase in investment. model 4: a full range of 43 employment multipliers the last set of findings is presented in a static sut model calibrated for the 2015 reference year. table 4 presents empirical labour results exhaustively under 43 different employment multipliers, depicting the number of jobs to be created with a hypothetical r1 million increase in final demand. put differently, this scenario reveals the areas in which jobs will be created in the south african economy given a shock in exogenous variable that increases final demand by r1 million. the economy-wide effect (type ii) on employment multipliers is sum-marised: gender disparity is observed with 5.2 jobs for men against 4.5 jobs for their female counterparts. sluggish youth employment disadvantaged at 3.9 jobs against 5.7 jobs for adults, implying that the pace of fighting youth unemployment will persistently remain slow. the economy will create more jobs for workers with less than secondary (3.2 jobs) and secondary completed (3.0 jobs) than for workers with tertiary education (1.9 jobs). these employment multipliers pose a huge challenge for a knowledge-based economy geared toward the fourth industrial revolution. low employment multipliers amongst workers with tertiary education can affect innovation and development negatively. more jobs are created in the formal economy (6.6 jobs) than in the informal sector (1.6 jobs). this is commendable since employment in the formal sector is more sustainable than in the informal sector. spatial distribution of employment multipliers reflects areas with more economic activities, namely gauteng with 3.1 jobs, kwazulu-natal with 1.6 jobs and the western cape with 1.4 jobs. gauteng has the potential to remain an economic hub of the coun-try. the high employment multiplier in gauteng is one of the main reasons why more people migrate to the province. other reasons may be attributed to the high urbanisa-tion rate. there is a correlation between a high urbanisation rate and employment rate. this is revealed by employment multipliers in urban areas (7.3 jobs) being higher than those in the rural areas (2.3 jobs). since it was established earlier that the south africa economy creates more jobs for people with less than secondary education, this observation implies that more workers will hold low occupations in their working place. thus, employment multipliers by occupa-tion are high for workers in elementary occupations (1.7 jobs), sales and services work-ers (1.4 jobs), domestic workers (1.3 jobs) and clerks (1.0 jobs) compared with workers in managerial positions (0.4 jobs). the study also looked at employment multipliers within the epwp. contrary to earlier findings with a higher employment multiplier among men than among women, the epwp employment multipliers, although negligible (less than one job), are somewhat higher among women than among their male counterparts. however, they remain higher among adults than among the youth. table 4: detailed employment multipliers for south africa (2015). conclusion, policy interventions and recommendation this study went further than the traditional io model by considering the most recent dynamic supply and use framework, and micro-simulation models to measure the impact of exogenous final demand on selected fiscal, labour and macroeconomic variables. it provided the performance and trends analysis of tax multipliers, growth and employment multipliers, and other generic multipliers for south africa for the period 2007 to 2015. the methodology used to develop the sut is in line with the most recent 2008 sna and international best practices. in terms of the research finding, the study had four objective and results were presented in a model per each objective. one of the most im-portant observations from the first model was the significant decline in the tax multipli-ers, gdp and output multipliers, employment multipliers and other generic multipliers over the 2007–2015 period. this finding implies that during the post-recession era, the effect of the average r1 invested in the economy, although positive, yielded a smaller return in terms of tax revenue, job creation and economic growth. at sector level, the results show that the inter-industry links and industry-consumer links have weakened. at policy level, this could exacerbate the low growth that has persisted during the post-recession period. low growth is correlated to low revenue generation and fiscal unsustainability. the second set of results showed that apart from paye tax, all other tax multipliers declined over the period under review. this implies at a policy level that the recent fiscal austerity mea-sures being implemented in south africa may be prolonged for a little while which, if not ad-dressed, could affect service delivery for poor households and delay the quest for all-inclusive, equitable and sustainable economic growth envisaged in the national development plan and south african vision 2030. in terms of backward tax multipliers, simulation results showed that the trade sector had the highest vat multipliers compared with other sectors. the third set of simulations were presented in four different policy scenarios. the results showed that the scenario with policy interventions that seek to stimulate more household consumption expenditure yields high economy-wide growth, employment and tax multipliers than the other three scenarios with strategic policies interventions that seek to stimulate either ex-port, government spending or investment. this result confirms that south africa’s economy is rather more consumption driven than export driven. the fourth set of results quantifies the areas in which jobs will be created given a shock in exogenous variables. it reveals gender disparities, fewer jobs for the youth, compared to adults, fewer jobs in informal than formal sectors, fewer jobs in rural than urban areas. more jobs will be created: (1) for people with less than secondary school education than people with other education levels, (2) for people with elementary occupations than for people in other occupations, (3) for semi-skilled workers than for skilled, low-skilled or unskilled workers, and (4) in gauteng than in other provinces. overall, the findings derived from this study could be used for strategic plans in the country. empirical results are appropriate for policy interventions, such as fiscal policy (using tax multipliers), labour policy (us-ing employment multipliers), poverty and development policy (using income multipliers), in-vestment policy (using investment multipliers), trade policy (using export multipliers), growth and industrial policy (output multipliers, gross value added multipliers, gdp multipliers, and gos multipliers), small, medium and micro-sized enterpri-ses policy (using sbs tax multipliers), and so on. findings from this article could be used to inform south africa’s national development plan, vision 2030 and other national strategic plans. for future work, the model used in this study will be converted into a social accounting matrix which will be used for the construction of a cge model for south africa. acknowledgements competing interests the authors have declared that no competing interest exists. authors’ contributions all authors contributed equally to this work. ethical consideration this article followed all ethical standards for carrying out research. funding information this research received no specific grant from any funding agency in the public, commercial or not-for-profit sectors. data availability statement data sharing is not applicable to this article as no new data were created or analysed in this study. disclaimer the views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of any affiliated agency of the authors. references 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system of national accounts 2008 (sna 2008), united nations, european commission, international monetary fund, organisation for economic co-operation and development & world bank, new york, ny. van seventer, d., hartley, f., gabriel, s. & davies, r., 2016, ‘a 2012 social accounting matrix (sam) for south africa’, wider working paper series 026 (april), united nations university, helsinki. zaman, g., surugiu, m. & surugiu, c., 2010, ‘propagation effects of taxes in romania: an input-output analysis’, romanian journal of economics 30(1), 76–94. sajems ns vol 4 (2001) no 2 332 an affirmative action audit for affirmative change: a management perspective s w tberon and m r viljoen department of human resources management, university of pretoria abstract this paper focuses on management's perception of affinnative action for affinnative change. a questionnaire, developed to measure attitudes towards the implementation of an affinnative action programme, was distributed to managers at all levels of management in a parastatal. results supply evidence of a negative orientation towards affinnative action amongst younger managers. they hold the view that members of disadvantaged groups are favoured at their expense. younger managers also perceive older managers not to have the necessary vision and skills to implement an affinnative action programme successfully. it is recommended that line management encourage communication between the different race groups, and develop positive attitudes and expectations towards the employers, the affinnative action programmes and the various jobs available. introduction transfonnation is the order of the day. the new political dispensation has set new standards and requirements for organisations in south africa. affinnative action, labour legislation, and the reconstruction and development programme (rdp) are some of the large issues at the top of the agenda. the study on which this paper is based was carried out in a parastatal finn which has to adapt to the south african transformation process. it is serious about affinnative action, participative management, and the rdp (viljoen, 1997). human (1993) views affirmative action as temporary intervention designed to achieve equal employment opportunity, without lowering standards and unduly trammelling the career aspirations or expectations of current organisational members competent in their jobs. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 333 sajems ns vol 4 (2001) no 2 the rdp endorses affirmative action to empower communities and individuals from previously disadvantaged groups in society. the affirmative action programme must include mechanisms to make available resources needed to set up enterprises at a number of levels, training and upgrading, and civic education to ensure that groups and individuals recognise and exercise their rights (ane, 1994). affirmative action may raise the blood pressure of an average middleaged white south african, but it is also stressful to black professionals who experience a work environment void of responsibility, doing work at entry level. white colleagues seem to be hostile towards affirmative action appointments, assuming that black people do not have the necessary skills (roberts, 1997: 1822)1. makoena2 as quoted by roberts, op.cit., is adamant that affirmative action is not about putting incompetent people in positions where they cannot cope and doing competent people out of jobs. it is rather about identifying the people with the necessary ability, and training them for positions where they can be productive. the main aim of the study was to determine management's perceptions of affirmative action, especially to: determine by means of an affirmative action audit questionnaire, management's attitude towards affirmative action with special reference to the biographical variables age, race, gender, years of service and management level; determine whether there is any resistance to change and the level of leadership skills and abilities amongst management to facilitate the affirmative action programme and related changes; and make recommendations to enable the company implement affirmative action in an acceptable and efficient way. key concepts of the study it is necessary to define and explain the following concepts used in this study. affirmative action affirmative action means different things to people of different backgrounds. for some it has a positive connotation; for others it is a frightening concept. albie sachs, as quoted by herbert (1994: 2), embraces most of the feeling towards r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2 334 affirmative action in saying "one person's dream of advancement is another person's nightmare." the black management forum set the following objectives in their affirmative action blueprint (1993): affirmative action must help to reverse the prevailing situation of disadvantage of the majority; affirmative action has to create opportunities for education, training and development in the workplace, and these opportunities have to result in the demonstrable economic empowerment of those intended to benefit from them at all levels; and affirmative action must bring about a complete transformation of the racist and sexist attitudes that have been at the core of organisations in the past. the black management forum (bmf) regards an organisation as the primary beneficiary of affirmative action. black men and women are seen as the secondary beneficiaries. the term "black people" refers to all individuals who were politically excluded from a meaningful role within south african society for the reason that they were not white. the bmf recognises that black people comprise three population groups, namely african, indian and coloured, and empowerment should reflect these groups according to their proportionate demographic representation (bmf, 1993)3. affirmative action is closely related to equal employment which implies equal access for all people to participation in the empowerment process and advancement on the basis of merit, ability and potential (luhabe, 1993: 26). the employment equity act (no 97 of 1998) requires organisations/companies to commit themselves to the creation of a diverse workforce broadly representative of all the people in the country. in terms of this act, all organisations/companies will be required to take steps to eliminate unfair discrimination in their employment policies and practices. employment equity goes beyond affirmative action. the employment equity act refers to a policy of fairness, the granting of equal access to all people, whereas in terms of affirmative action, organisations have to ensure access for disadvantaged groups. one of the measures that can accelerate the advancement of disadvantaged groups, is affirmative action (landman, 2000: 187). affirmative change has to be tailored according to the needs of a particular organisation. the integrated vision must be one where the individual in the organisation and the organisation itself are inexorably linked, and which redefines the way that an organisation and its members interact with one another in order to create an environment of affirmative change and opportunity for all (viljoen, 1997). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 335 sajems ns vol 4 (2001) no 2 as regards the preferential treatment of the disadvantaged groups, the question arises what is the price that an organisation pays for this preferential treatment. instead of looking at the price, one should rather look at the return on the investment. there are basically two scenarios, namely a low and a high return on investment. the low return scenario occurs when an organisation implements affirmative action incorrectly and/or ineffectively. this usually happens when an organisation views affirmative action as a political imperative that has to be complied with, and not as a business objective which needs to be sustainable within the framework of the organisational objectives as a whole (bendix, 1996). the revolving-door syndrome of the ineffective implementation of affirmative action occurs when personnel composition has a negative image and management believes that a few black -faces at the right levels will make the organisation appear politically correct (thomas, 1996: 6). low return on investment is embedded in: high recruitment costs; too high and unrealistic salaries paid to affirmative action appointees; and dissatisfaction among the current workforce and experience of affirmative action as reverse discrimination. as regards the high return scenario, the efficient and correct implementation of affirmative action demands the recruitment and selection of persons with known competencies or potential to fill positions worthy of their ability. previously disadvantaged people should be trained and developed to have greater vertical mobility in future. a continuous monitoring system should be implemented as well as the adoption of demographic spread at all levels of the organisation. role of management it is line management who are tasked and held accountable for the implementation of the affirmative action strategy with the human resource department in support (charlton & van niekerk, 1994: iss). kemp (quoted by de witt, 1996: i) agrees that management are responsible for policy implementation. without managerial support and commitment to affirmative action, nothing will change. de witt (1996: 15) is adamant that the success or failure of the implementation of affirmative action lies with management. given that white males constitute the majority of decision-makers and are people of influence within the organisation, it is self-evident that according to the information processing model of perception, the white male manager will have certain perceptions of the company's affirmative action policy, its implementation, and of anyone who has anything to do with it. these managers will eventually, as human (1996: 6) puts it, learn to play the game and learn the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol4 (2001) no 2 336 basic vocabulary of non-discriminatory discourse in the absence of any real change of heart. a change in dialogue will not always reflect a change of heart and basic prejudices and" insecurities remain. much of the reluctance of line management to spend time on and take responsibility for amrmative action is due to their not knowing why this is important, how it will benefit themselves in particular, and how to go about this task (human, 1996). organisations view their middle managers as the stabilisers who make enduring changes possible, linking corporate strategy to action. middle managers are important as agents of change driving the corporate transformation (dauphinais, 1996: 12-13). dauphinais, op.cit., describes the role of middle managers by emphasising four important aspects of their accoutrements, namely creators and implementers, influencers, key sources of stability, and workhorses of continuous transformation. research design a.l'ild method as the principal aim of this study is to ascertain management's attitudes towards amrmative action, the survey method was appropriate. the design was crosssectional as the survey was conducted at one time only. the formulation of a hypothesis is not considered necessary as this is a survey and not a laboratory experiment. measuring instrument a questionnaire compiled by martins (1995: 3-11) which measures the organisation's attitud!! to the implementation of an amrmative action programme was chosen. this questionnaire consists of 80 items and measures seven dimensions, namely skills development, relationships and trust, organisational values, affirmative action programmes, company image, management skills and abilities, and policies and procedures. the affirmative action dimension has three subdimensions, namely training and development, promotions and recruitment, and appointments. in the analysis of data these three dimensions will be separately treated. martins found an overall reliability (cronbach's alpha) of 0.938. viljoen (1997) obtained a split-half reliability coefficient (equal length) with spearman bro\\'11 correction of 0.92. respondents have to respond on a five point likert scale ranging from i (differ strongly) to 5 (agree strongly). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 337 sajems ns vol 4 (2001) no 2 data collection no sampling was done and the questionnaire was distributed to all individuals within the four levels of management, namely top, senior, middle, and junior management. these levels include members of both gender and all race (cultural) groups. a total of 424 questionnaires were distributed of which 182 were returned, resulting in a response rate of 42.9 per cent. data processing data were analysed by means of descriptive and inferential statistics, namely one-way analysis of variance, available on the spssr package: results the mean score fluctuates between 2.37 and 4.5 which indicates that responses vary between differ on the statement to strongly agree with it. the standard error of the mean is generally large which implies that the results of the study cannot be generalised to the total population. also, the distribution is skewed4• a one-way analysis of variances was done with years of service, age, company divisions and management levels as the independent variables5• the results are presented in tables 1 to 4. results of the one-way analysis of variance with regard to years of service are shown in table 1. table 1 one-way analysis of variance years of service variable dimension f-ratio i pro~:~ility organisational values 0.6421 i 0.5274 years of service i training and development 0.6023 0.5487 promotions 4.3203 i 0.0148* ! recruitment and appointments 2.9333 0.0558 i company image 1.8314 i 0.1633 trust 1.0669 0.3464 skills development 0.9868 0.3749 management skills 1.5783 i 0.2093 : policies and procedures 2.0420 0.1329 affirmative action programmes i 1.0005 , 0.3699 (*p ~ 0.05) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2 338 the category ''years of service" was divided into four levels, namely employees with less than four years of service, 4 to 10 years, 11 to 15 years, and more than 15 years of service. table' 1 shows that years of service has only one significant effect (p $ 0.05), namely with regard to the dimension of promotions. post hoc comparisons by means of the scheffe test showed that employees with service of less than four years differ significantly from employees in the ranges of four to 15 years. workers in the category ofless than four years of service have a more positive view of the process of promotions than respondents in the categories four years of service to 15 years and more. results of the one-way analysis of variance with age as the independent variable are shown in table 2. table 2 one-way analysis of variance age variable dimension f-ratio i probability (p) • organisational values 23752 i 0.0960 age training and development 3.1924 0.0435* promotions 3.8990 0.0211* recruitment and appointments 9.5165 0.0001* company irrlage 4.8734 0.0087* trust 3.3625 0.0370* skills development 3.5799 0.0299* management skills 7.5889 0.0007* . '~; .. 5.2937 0.0059* • policies and procedures i affirmative action programmes 53011 0.0059* (*p s: 0.05) the category "age" was divided into three levels, namely 35 years and younger, 36 to 45 years, and 46 years and older. table 2 shows that age has an overall significant effect (p $ 0.05) on all the dimensions except organisational values. post hoc comparisons by means of the scheffe test showed that the three age groups differ significantly with regard to all the abovementioned dimensions except promotions, trust, and skills development. employees in the age group 35 years and younger take the view that there is no comprehensive and effective training at all levels and for all groups, enabling people to have training for their current jobs and also their future positiops. the age group 46 years and older felt more positive in this regard. the age group 35 years and younger differs significantly from both the other two age groups on recruitment and appointments, with the groups 36 to 45 years and 46 years and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 339 sajems ns vol 4 (200 1) no 2 older holding a more positive view than the age group 35 years and younger. as regards company image, the age group 35 years and younger has a more negative view than the group 36 to 45 years of age. as regards management skills, the age groups 36 to 45 years and 46 and older viewed management as having the necessary skills and vision to lead the company successfully. subjects in the age group 35 years and younger did not view management in the same positive light. as regards policies and procedures, age group 35 years and younger perceive the company not to apply policies and procedure equally to the different race and gender groups. the age group 35 years and younger differs significantly from the age group 46 years and older on affirmative action programmes. the younger group was more negatively inclined while the older group was satisfied with affirmative action programmes. results of the one-way analysis of variance with company division as independent variable are presented in table 3. table 3 one-way analysis of variance company division variable i dimension i f-ratio probability (p) • organisational values : 0.2104 0.8105 division i training and development i 1.8487 0.1606 i promotions • 0.6227 0.5377 i recruitment and appointments i 2.8294 0.0617 i company image • 0.9467 0.3900 i trust i 1.4557 0.2362 i skills development 0.8962 0.4100 i mana!tement skills l 2.5025 0.0848 i policies and procedures 0.5344 0.5870 i affirmative action programmes l 1.1404 0.3223 (*p ~ 0.05) it is clear from table 3 that the independent variable, company division, has no significant effect (p > 0.05) on any of the dimensions of the affirmative action audit questionnaire. the results of the one-way analysis of variance with management level as the independent variable are shown in table 4. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (200 i) no 2 340 table 4 one-way analysis of variance management levels variable i dimension f-ratio . probability . (p) i organisational values 3.8698 0.0227* management training and development 1.0534 0.3510 level promotions 0.4423 0.6433 recruitment and appointments 1.2698 0.2834 . company image 2.6619 i 0.0726 • trust 0.8807 0.4164 ! skills development 2.1662 0.1177 management skills ! 2.8360 0.0614 policies and procedures 3.2595 0.0407* affirmative action programmes ! 0.5505 0.5777 (*p:$ 0.05) it is quite evident from table 4 that the three management levels, top, middle, and junior management, differ significantly (p :$ 0.05) on only two dimensions, namely organisational values and policies and procedures. post hoc comparisons by means of the scheffe test showed that top management differ significantly on organisational values from middle management. top management view all the employees in the company as having consensus on organisational values. middle management, on the other hand, do not share this positive view by top management. top and middle management differ significantly on policies and procedures. middle management do not perceive the company as equal in the application of policies and procedures with regard to the different race groups. the human resources policies are also not progressive enough. top management feel comfortable with the equity of policies and procedures. conclusions and recommendations age it is quite conspicuous that managers in the younger age group (35 years and younger) are negatively inclined to the affirmative action programme. they viewed training and development as insufficient and not satisfying their needs of comprehensive training for their current jobs and possible future positions. this may be due to the younger group perceiving their jobs to be precarious and a need to be fit for other positions in future, should the eventuality arise. this group was also negatively inclined towards the company's application of its r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 341 sajems ns vol 4 (2001) no 2 policies and procedures and affirmative action programmes. the two older groups (36 to 45 and 46 years and older) express satisfaction with affirmative action. again the inference can be made that younger employees felt insecure and therefore hostile to affirmative action. they may also view the application of policies and procedures as discrimination against them. years of service as regards years of service, it is again noticeable that employees with less than four years of service differ significantly from employees with four or more years of service, the former revealing a more positive view of the process of promotions. company division the independent variable, company division, had no effect on the dependent variables, thus revealing a uniformity of attitude towards affirmative action. management level as regards management level, top managers are quite comfortable with the application of the affirmative action programme. they are of the opinion that there is consensus among employees on organisational values. they are also quite comfortable with the equity of policies and procedures. middle management felt just the other way round. special attention should be given to the white male and his inclusion in an organisation's workforce with regard to its affirmative action policy. white males, and especially the younger ones, feel that upward mobility is a function of race and not the result of merit and proven competence. they fear unequal treatment in the selection process. it is self-evident that the white male will jump to negative conclusions concerning the affirmative action policy of the company, the implementation thereof, and anyone who has anything to do with it. negative perceptions must however not be allowed to develop. the organisation must affirm equal opportunities for white males by ensuring that they are not discriminated against, and see to it that their right to equal opportunity is entrenched in the organisation's policies and procedures. the organisation should also involve the workforce in the design and implementation of the affirmative action programme. consideration should be given to the conducting of workshops to educate and train employees concerning the achievement of equity for the different groups. during workshops the affirmative action policies and programmes should be clearly communicated to r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2 342 the employees. the exchange of views between workers and management is of great importance. white males should also be sensitised to changing opportunities and demands in the job market, and change their perceptions accordingly. organisations should address this issue in introductory programmes and/or when recruiting potential employees (viljoen, 1997; fischer, 1996: 30-34; norris, 1996: 35-39). as line management is in close contact with the workers, the implementation of affirmative action in the various departments is their responsibility. it is recommended that line management encourage communication between the different race groups and develop positive attitudes and expectations towards the employer, the affirmative action programme, and the various jubs available. in summary, the survey highlights that members of previously disadvantaged groups should not be appointed for the sake of getting the numbers right. implementing affirmative action as window dressing rather than finding the skills and abilities necessary to do the job can be a costly option in the long run. endnotes roberts compiled the views on affirmative action of black professionals and south africa's top business leaders. 2 maja mokoena is on the highest level of management (one level below a directorship) with a large merchant bank. 3 -the bmf also recognises the existence of other forms of discrimination such as handicapped and gay people. 4 it is not considered necessary to present a table of descriptive statistics. 5 in each case a significance level of p ~ 0.05 was found for the tests of homogeneity of variance (cochran's c; bartlett-box f, and maximum variancelminimum variance) indicating an equity of variance and therefore safe to use the one-way analysis of variance. references african national congress (anc) (1994) the reconstruction and development programme, johannesburg, umanyano publishers. 2 bendix, s. (1996) industrial relations in south africa, kenwyn: juta and co, ltd. 3 black managemel\tt forum (bmf) (1993) affirmative action blueprint, johannesburg, bmf policy statement. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 343 sajems ns vol 4 (2001) no 2 4 charlton, g.d. and van niekerk., n. (1994) affirmative action -beyond 1994, kenwyn, juta and co., ltd. 5 de witt, d.e. (1996) "the views of management on affirmative action in telkom sa ltd", university of south africa, pretoria, unpublished mba dissertation. 6 dauphinais, g.w. (1996) "who's minding the middle manager", hr focus. 7 employment equity act, act 97 of 1998, government printers, pretoria. 8 fischer, s. (1996) "affmning equal opportunity for white males", people dynamics, 14(3). 9 herbert, t. (1994) affirmative action in the south african workplace: allowing black eagles to soar, cape town, trevor herbert. 10 human, l. (1993) a practical guide to affirmative action and the development of people, kenwyn, juta and co., ltd. 11 human, l. (1996) "diversity during transformation", human resource management journal, 12(2). 12 landman, c.g. (2000) "a phenomenological analysis of a career planning system within an organisation with a delayered organisational structure", university of pretoria, pretoria, unpublished doctoral thesis. 13 luhabe, w. (1993) "affirmative action: creating the reality", people dynamics, 11(8). 14 martins, n. (1995) "affirmative action: a consensus approach in analysing employee's perceptions", management dynamics, 12(7). 15 norris, b. (1996) "manage diversity or sink", people dynamics, 14(6). 16 roberts, a. (1997) "affirmative action: hell for blacks toot financial mail, 144(2). 17 thomas, d. (1996) beyond affirmative action. managing diversity for competitive advantage in south africa, randburg, knowledge resources. 18 viljoen, m.r. (1997) "an affirmative action audit for affirmative change a management perspective", university of pretoria, pretoria, unpublished master's dissertation. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . microsoft word vol6no3'3.doc sajems ns 6 (2003) no 3 612 the future of the south african retail pharmacy industry in the light of international experience and the changing healthcare market1 ________________________________________________________________ martin wessels business school, university of south africa john luiz wits business school, university of the witwatersrand ________________________________________________________________ abstract the paper evaluates how the changing south african healthcare market is likely to affect the future of retail pharmacy. it examines current developments in retail pharmacy and the impact that these developments will have on the retail pharmacy market. this information is used to create scenarios as to what types of retail pharmacies are likely to thrive in the future. jel i11 1 introduction retail pharmacy has been undergoing dramatic changes over the last decade. these changes seem to be rapidly increasing as more and more pressure is being exerted on retail pharmacy both externally and internally. the effect of these changes can be seen in the reduction in the number of retail pharmacies during the last decade and the change in the types of pharmacy that currently exist. this has left many pharmacy owners in a very precarious position as their businesses become less profitable while having to face increased competition and a dramatically changing environment. for retail pharmacy to survive it has to create value in the market place and it would appear that traditional pharmacies are not adding as much value as they once did. thus the challenge for independent pharmacies is to gain a clear picture of the healthcare market, what it requires and how they can meet its needs. the main purpose of the study is to consider where healthcare is moving in south africa and assess how this is likely to affect the future of retail pharmacy. sajems ns 6 (2003) no 3 613 it examines current developments in retail pharmacy and the impact that these advances will have on this market. 2 overview of the south african healthcare sector south africa has undergone significant social and political changes over the last decade and this has impacted the government�s view of the healthcare market. the vision of the department of health is that all south africans should have access to affordable, good quality healthcare. traditionally the state has been responsible for providing healthcare to the poor who have conventionally been excluded from the private medical aid system mainly due to socio-economic reasons. the public sector has been plagued with a lack of resources, which has lead to poor quality healthcare provision in many areas. the private sector has not been able to participate in the provision of public health on behalf of the state because the state has a closed ordering system that is not suitable for interaction with the private sector. the potential for merging both the private and publics sector in some form has not escaped the attention of the government. recently a commission of inquiry into a comprehensive system of social security released a report that recommends the introduction of a national health insurance (nhi) system that will fund both the public and private sector, over the next few years (wolvaardt, 2002: 10). if implemented these changes could have a dramatic affect on the face of healthcare in south africa (see luiz, 1994). the proposed report aims at dramatically increasing the number of people that belong to medical aids through legislation that will force middle and highincome earners to belong to medical schemes. for this to be practical, medical inflation will have to be brought in line with ordinary inflation. the report proposes to achieve this goal by doing the following (wolvaardt, 2002: 10-11): � controlling the geographical distribution of services � licensing the introduction and distribution of new technology � restricting private hospital beds � removing all perverse incentives � directly controlling the price of goods and services � capping medical scheme administration fees � limiting annual medical schemes premium increases to ordinary inflation � controlling broker fees sajems ns 6 (2003) no 3 614 � making public sector services available to medical schemes on a cost recovery basis � promoting managed healthcare while this report has many positive aspects in that it will draw more people under the healthcare umbrella, it also carries with it many dangers (see luiz & wessels, 2003 for a more detailed discussion). the south african private sector accounts for 54 per cent of the total health care spend in south africa and 3.8 per cent of the total gdp spent in 1998 (undp, 2001: 159). of the total private health care bill of r30.23 billion, r26 billion is spent by medical aids. in 2001 the medical aid membership stood at just over 7 million. thus in the private sector the medical aids have tremendous power in terms of the allocation of spending. however, they also realize that there are approximately 33 million people that are not covered by medical aids (council for medical schemes, 2002: 27). this leaves a tremendous window of opportunity for medical aids to expand if they can create affordable products for this large untapped market. this is verified by a labour survey in 2001 that showed that in the main industries in south africa only 29 per cent of employees contribute to a medical aid (sairr, 2001: 300). the rapid rise in medical inflation has put enormous pressure on medical aids to contain costs and to keep their premiums affordable. medical aids are being forced to look at new ways to contain costs such as pushing for managed health care2. the basis of managed healthcare is that it begins with cost cutting measures such as demanding discounts and proceeds to its most advanced form with a transfer of risk from the medical aid to the health provider, and thus the provider becomes motivated to reduce costs. these challenges facing the medical schemes have, in turn, affected the retail pharmacy industry substantially, which is the topic of the next section. 3 the south african retail pharmacy industry traditionally customers claimed directly from their medical aids and paid their pharmacy account when reimbursed. this resulted in pharmacies having a large number of accounts for customers. however, technological developments have allowed for direct claiming by pharmacies on behalf of their customers. as medicines advanced and their prices increased, pressure was put on the medical aids to contain costs. medical aids began to demand discounts which put pressure on margins. suddenly small pharmacies with low turnovers found they were no longer profitable and had to close. at the same time doctors, also sajems ns 6 (2003) no 3 615 feeling the pressure on their profits, began to dispense which added more competition in the market place. during the 1990s the number of retail pharmacies declined significantly due to changing demographics, increased competition and declining margins. the advent of the big shopping malls drew people to regional centres which created the economies of scale that make the establishment of mega-stores possible. this has led to a huge growth in discount pharmacies that have developed into chains to increase their buying power. these discount pharmacies do not offer accounts and can therefore offer better prices, as their cash business leads to better cash flow. the discount pharmacy chains have aimed at reclaiming areas such as toiletries that had been lost to supermarkets and discount chain stores e.g. clicks. in the process of attacking these other discount groups they have also put more pressure on the many smaller pharmacies that do not have the buying power to compete. many of these smaller retail pharmacies were forced to close under this pressure. more recently there has been a move by independent retail pharmacists to open their pharmacies attached to large doctors� practices. this strategy seems successful because it offers convenience to the customer and allows small pharmacies to buy in bulk those items that the doctor practice prescribes. the only danger is that many medical aids are forming contracts with certain pharmacy groups, which may ultimately leave these independent pharmacies excluded. since these pharmacies rely exclusively on prescription business this could be devastating to their business. south africa currently has 2,693 retail pharmacies. this figure has begun to grow after a long decline. the most probable reason for the increase is the formation of small pharmacies located on the same premises as doctors and the opening of large discount pharmacies. before we can make any judgments about the retail pharmacy industry and those factors that impact on it we need to develop an understanding of the structure of the retail market. porter�s �five forces framework� (discussed in grant, 1998: 55-65) relates the average profitability of participants in an industry to five competitive forces, namely: � the degree of rivalry � the threat of entry � the threat of substitutes. � buyer power. � supplier power the advantage of the five forces model is that it creates a picture of the entire industry and from this vantage point it is then much easier to make an informed decision as to what the industry might look like in the future. a five forces analysis of the retail pharmacy market is presented below. sajems ns 6 (2003) no 3 616 figure 2 the five forces model for the retail pharmacy market suppliers ! wholesalers vs distributors on discount structure ! changed loyalty of existing suppliers to large groups entering the market. ! purchasing volume of large groups ability to put pressure on suppliers. ! distributors ability to reduce discounts given thus reducing margins. ! traditional wholesalers being bought by the large groups limiting choice. wholesalers beginning direct distribution to patients. new entrants ! corporate owners � economies of scale ! medical aids ! supermarkets ! internet ! postal service industry competitors ! postal service ! new corporate entrants ! dispensing doctors ! large discounters ! pharmacy chains ! medical aids ! overseas recruiters ! new pricing structures substitutes ! dispensing doctors ! doctor pharmacy networks postal service pharmacies buyers ! individuals ! medical aids (new pricing structure and demand for larger discounts). large businesses the above diagram attempts to illustrate the various forces that are acting on retail pharmacy and will probably have a big impact on the future of pharmacy. the main factors are discussed below. 3.1 the new pricing structure the pharmaceutical society of south africa (pssa) has been working on a new pricing structure for medicines. the aim of this new pricing structure is to move pharmacists away from the current price plus mark-up system to one where pharmacists charge a professional fee. the idea is that this system would sajems ns 6 (2003) no 3 617 acknowledge the pharmacist�s professional function in supervising medical utilization and disease prevention services for third party payers. this is to replace the current cycle of medical aids pressurizing for greater discounts in order to reduce their medicine costs. the current system encourages pharmacists to sell as much medicine as possible as their profit is directly related to turnover. the new professional fee will allow pharmacists to be paid for carrying out there professional functions and not as a mark-up per product sold. this means that if a pharmacist persuades a patient not to use medicine that may not be inappropriate the pharmacist will still be reimbursed this professional fee. for medical aids this could also bode well as they will be paying a set fee per item. pharmacists will be encouraged to use generics which are more cost effective as this will allow them to reduce the cost of their inventory. this will be a huge plus point for medical aids as generics cost on average a third of the original products price. what makes the new proposed pricing structure so controversial is that doctors will not be able to charge this fee. this means dispensing doctors will have to sell the medicine at cost. for these doctors dispensing has become a major source of their income which they are reluctant to give up. 3.2 corporate ownership the south african pharmacy act no 53 of 1974 section 22a prohibits the ownership of retail pharmacy by non-pharmacists. this means that a retail pharmacy may not even have shareholders that are non-pharmacists. this has led to much debate as to whether this is in the best interest of the public. there is a belief by some that the law has essentially created a cartel and that this has led to higher prices for medicines than larger retailers, with their better distribution and management systems, could provide more affordably to the general public. a change in the law would also allow the medical aids to open their own pharmacies which would allow them to reduce their medicines bill. in recent years much pressure has been put on the government to have the act amended to allow non-pharmacists to own retail pharmacies. pharmacists have defended their right to ownership on the basis that medicines are not an ordinary commodity and that they require professional supervision. they claim that they play a major role in ensuring the correct usage of medicines and checking for possible drug interactions and that large corporates will only be interested in chasing profits to the detriment of patients and the pharmacy profession. the table below hints at the relatively high cost of medicines in south africa with pharmaceuticals making up a third of total health expenditure in the south african private sector which is three times that in the usa private sector. this is partly due to regulatory requirements which require pharmaceutical companies sajems ns 6 (2003) no 3 618 to supply the public sector at low tender rates which they then supplement by charging the private sector higher prices. in addition, it is claimed that the lack of free ownership of pharmacies which may hinder competition is a contributing factor to the cost of drugs. table 1 international comparisons of pharmaceutical expenditure as a proportion of total health expenditure country sector pharmaceutical expenditure as a percentage of total health expenditure uk national health service usa sa private sector sa public sector sa weighted 10.3% 8.% 29% 9.9% 13.4% source: melamet report, 1994 in many industrialised countries legislation was passed years ago which has allowed non-pharmacists to own pharmacies. in the us independent pharmacies have steadily gone down in numbers. between 1985 and 1997, community pharmacies have declined by 14,341 while chain outlets increased to 18,229. by 1996 independent pharmacies were responsible for only 20.6 per cent of dollar prescription sales compared with 27.9 per cent for drug stores (reekie, 1997: 279). with the large capital behind these corporate companies they have been able to form pharmacy chains which has given them large buying power and allows them to be very competitive. this put pressure on independent pharmacies which found it very difficult to compete resulting in a rapid decline in their numbers. those that survived formed associations with other independent pharmacies so that they could compete by raising their volumes. in south africa some of the large retail groups have also expressed interest in opening their own retail chains. the two chains that appear the most active at present are the new clicks and pick �n pay groups. 3.3 one exit price the government is very concerned with the high price of medication. one of their chief objectives is to try and make medicines affordable to the masses. for this reason they have proposed that there should be �one exit price�. the intention is to create a transparent pricing system and thereby cut the fat out of sajems ns 6 (2003) no 3 619 the system. however, this will be very difficult to police and may ultimately not have the desired result. the one exit price may lead to competition actually being stifled in that the larger players will no longer be able to put pressure on manufacturers to provide at reduced prices which can then be passed on to the consumer. the one exit price may ultimately end up protecting the small retail pharmacy by not allowing manufacturers to provide discounts where retailers may provide services that justify it. pharmacists would like to see the end of discriminatory pricing between them and dispensing doctors. with doctors having the power to write prescriptions and therefore the power to influence the sales of prescription drugs they have traditionally been offered better prices in an attempt to lure them to prescribe the manufacturers drugs. this has obviously allowed for higher profit margins which makes prescribing these drugs very lucrative. 3.4 dispensing doctors with the advent of dispensing doctors in the last decade, pharmacists have lost a large proportion of the business that was traditionally theirs. in the early 1980s nearly all private sector sales passed through retail pharmacists. by 1993 this figure had fallen to 41.33 per cent by value with 42.89 per cent being paid out to dispensing doctors (reekie, 1995: 112). this has lead to pharmacists having to offer additional services to generate revenue. these include blood pressure tests, cholesterol tests, and offering various consultations to patients. this has led to a blurring of the distinctions between these two professions. the table below outlines more recent developments in this regard. the table shows that pharmacy�s share have risen to 62 per cent although it could be misleading because part of this increase is due to postal service pharmacies which have taken business away from both retail pharmacies and dispensing doctors. 3.5 managed healthcare retail pharmacy has been affected with the movement of medical aids into managed healthcare. managed healthcare�s aim of reducing the total bill for medicines has led to pharmacies experiencing shrinking turnover of medication on medical aids. they are introducing a host of different managed health tools aimed at reducing medicine utilization. these include evidence-based medicine which means that they will only pay for medicines that have been scientifically proven to be effective; and pharmacy benefit management (pbm) organizations that review chronic utilization against standard protocol and recommend cheaper alternatives where possible. t ab le 2 m ed ic in e ex pe nd it ur e di sa gg re ga te d by s al es pr ov ide r o pe n sa vi ng s r is k po ol r es tr ic te d sa vi ng s r is k p oo l e xe m pt ed sa vi ng s r is k p oo l t ot al p ha rm ac y 58 2, 12 2, 00 0 2, 77 7, 98 1, 00 0 23 9, 51 7, 00 0 1, 61 8, 12 5, 00 0 14 0, 00 0 14 4, 34 1, 00 0 5, 36 2, 22 6, 00 0 d oc to r 20 5, 91 1, 00 0 1, 17 7, 57 6, 00 0 64 ,2 93 ,0 00 36 3, 74 5, 00 0 20 ,0 00 13 7, 91 8, 00 0 1, 94 9, 46 3, 00 0 pu blic 13 9, 00 0 15 ,2 19 ,0 00 12 ,0 00 2, 15 6, 00 0 41 8, 00 0 17 ,9 44 ,0 00 hospital pr iva te 3, 10 4, 00 0 79 1, 46 5, 00 0 92 7, 00 0 41 6, 52 7, 00 0 28 ,0 13 ,0 00 1, 24 0, 03 6, 00 0 t ot al 79 1, 27 6, 00 0 4, 76 2, 24 1, 00 0 30 4, 74 9, 00 0 2, 40 0, 55 3, 00 0 16 0, 00 0 31 0, 69 0, 00 0 8, 56 9, 66 9, 00 0 so ur ce : c ou nc il fo r m ed ic al s ch em es (w w w .m ed ic al sc he m es .c om ) sajems ns 6 (2003) no 3 621 3.6 shortage of pharmacists the world is experiencing a shortage of pharmacists and this has put extreme pressure on south africa to keep its pharmacists. with first world countries being able to offer lucrative packages many pharmacists have left south africa with the associated loss of human capital. in the usa there is such a shortage of pharmacists that graduating pharmacists can make roughly $90,000 a year in new york. this is attributed to the fact that the number of prescriptions in america is growing by 6.5 percent while the number of pharmacists available in the industry is only increasing by about 1 percent per year. the reason is that the baby boomers are ageing and drug companies are advertising more aggressively. this has lead to a pharmacist gap because american law requires prescriptions to be checked by a pharmacist (krulwich, 2002). the increase in the number of pharmacists emigrating is directly related to the number of letters of good standing issued by the south african pharmacy council. these letters are required by overseas registration bodies to ascertain the credibility of the candidate. during 2000, council issued 514 letters of good standing. the number of these letters issued increased by 4 per cent during 1997, by 109 per cent in 1998, and by 86 per cent in 1999 (sapc annual report, 2000: 24). the government has also been experiencing a critical shortage in the rural areas and in government run institutions. to alleviate this problem, a system of community service was instituted in 2001 whereby all graduating pharmacists were required to do a year�s community service before they could become fully registered pharmacists. this has put enormous pressure on the private sector as they have essentially lost one year of newly qualified pharmacists. 3.7 generic substitution the government�s emphasis on making medicines more affordable to the general public has led to much discussion around generic substitution. generics are often priced at less than a third of the price of the original product. the makers of original products claim this is due to the fact that they have no r&d expenses to recoup and that the manufacturing standards are not as stringent. the medicines and related substances control act of 1965 does not allow generic substitution by the pharmacist unless the prescribing doctor grants permission. this has proved very cumbersome to apply in practice as many medical aids will only reimburse the generic price and thus force the patient to pay the difference. the current legislation is not conducive to reducing the price of medicines where generics do exist. to try and rectify this matter the medicines and related substances control amendment act of 1997 proposes sajems ns 6 (2003) no 3 622 that pharmacists be allowed to substitute with generics after consultation with the patient. recently medscheme, which is south africa�s largest medical aid administrator, introduced its own medicines price list (mpl), which sets out the generic alternative it will pay for and how much it is prepared to pay. the reason for this is that in countries like the us, canada and the uk, generic medicines comprise about 40 per cent of the total market while in sa it is only 20 per cent. medscheme believes the failure to move towards generics is one of the reasons why 30 per cent of medical aid payments go to medicines compared with 12 per cent to 15 per cent in the rest of the world. (strong-arm tactics bring pain and gain, 2002: 52). 3.8 access to higher scheduled drugs pharmacists have requested that the medicine control council change the scheduling of certain medications so that they can treat minor illnesses. the idea is that pharmacists undergo extensive lessons in the diagnosis and treatment of common illnesses. this would mean that the general public could be treated without having to consult a doctor. this would be much more affordable for the public. the medical profession has been against such a move as they see it as a threat to their own livelihood. 4 future scenarios of retail pharmacy this section examines how the different forms of retail pharmacy are likely to deal with the changing, increasingly complex and cost focused marketplace. 4.1 the large discount pharmacies these are the large format pharmacies (700m2 and larger) whose main emphasis will be selling fast moving consumables at discount prices. their dispensaries will focus on that sector of the population that is not on medical aid and thus pay cash for their medicines. they will draw people into the store by offering large discounts on medicines and sell fast moving consumables to them at the same time. these stores are very profitable as they generate a high turnover per square meter. the traditional pharmacy, however, relies almost exclusively on their medicines� turnover and has relatively low front shop turnovers. this means that their stock turns are often very low and they therefore have lots of capital tied up in slow moving stock. also the small retailers have smaller turnovers and therefore do not have the buying power to compete on price. unfortunately to open a large discount pharmacy requires a sizeable amount of start-up capital sajems ns 6 (2003) no 3 623 and more than one store to generate the volume buying required to get better prices to attract consumers. the traditional stand alone pharmacy there seems to be little scope for this type of pharmacy in the future unless they find a particular niche area in which to compete. with the likelihood that medical aid contracts to supply medicines will increasingly move to ppos, hmos and postal medicine pharmacies, these pharmacies may find that their access to prescriptions from doctors shrink. medical aids are also becoming more aggressive in demanding larger discounts which will put pressure on their margins and may make marginal pharmacies unprofitable. in addition, the competition from large discount pharmacies offering big discounts on medicines are also having a negative effect on their businesses. these pharmacies do not have the buying power to compete with the prices offered by the large discount pharmacies. their traditional advantage of offering accounts is being eroded as people are no longer prepared to pay a huge premium for credit. those that will survive will need to find or create a niche for themselves. examples would be pharmacies in strategically placed rural areas where no competition exists or those that offer specialist services such as diabetic care or personalized cosmetic treatment. another example would be specializing in homeopathic medicines and offering expert advice. thus traditional pharmacies that want to remain independent and prosper will need to be entrepreneurial to ensure their survival. another option open to independent pharmacies is to get together and form an independent pharmacy association (ipa). the role of the ipa would be to negotiate with medical aids to secure contracts for these pharmacies and to negotiate with suppliers to provide group discounts which would allow them to be competitive. postal service pharmacies postal pharmacies are a new addition to the pharmacy market having only been in existence for about a decade. nevertheless they have had a dramatic effect on the pharmacy environment. they came into existence by offering medical aids larger discount on chronic medication. they could do this because they did not have the high overheads of traditional pharmacies such as prime rental, expensive shop fittings and did not have to pay overtime to provide extended hours. they could also service the whole country and thus could develop volume on prescribed medicines which allowed them to buy in huge volumes and get very good prices. this concept has been extremely successful but has more recently come under pressure. these postal service companies promised medical aids that they would have a saving in chronic medication which is the largest part of the medical aid bill. unfortunately postal delivery has led to sajems ns 6 (2003) no 3 624 people using more medicine. traditionally when people collected medicine at the pharmacy they would only return once the medicine was finished. with postal medication consumers do not want to break the cycle for fear that the medication would not arrive when they really need it and thus receive medication even when they have existing stock. thus chronic medication costs have actually increased and medical aids are becoming aware of this and are now look at pharmacy networks that can still offer them good prices with the advantages of a traditional pharmacy location. the postal companies will have to look for solutions to counteract this problem. added to this is the fact that postal and courier services are very expensive and this also puts pressure on their margins. 4.2 the local chain store this may be a very good option for those pharmacists that still want to maintain ownership of their pharmacies but who feel they need to be part of a larger organization to give them stronger negotiation skills. this seems to be the route that pick �n pay and now clicks are following. this means that each store pays a franchise fee and in return they are marketed under one name and the franchiser negotiates better prices and advertises on a national scale. this could be very important if medical aids start signing exclusive contracts with pharmacy groups. the pharmacists thus retain ownership of the pharmacy and this hopefully will lead to higher standards than one would expect from a manager as the owner has full responsibility and interest in the success of the business. these types of pharmacies will probably be opened in key centres in suburbs which will give convenience for people living in the area. the pharmacy dispensary alongside a doctor�s practice over the past decade many doctors have been dispensing medication to supplement their income. this has been a very profitable practice as the pharmaceutical companies often offered them very lucrative deals as an incentive to prescribe their drugs. added to this, the medical aids discriminated between doctors and pharmacies forcing pharmacies to give larger discounts than the dispensing doctors. this meant that they operated at very high margins. however, as doctors are often very busy consulting patients they did not have the time to effectively administer a pharmacy. whilst margins were very high, inefficiencies in administration could still be tolerated and profits realized. in recent years with the government wanting to introduce legislation to create a one-exit price, doctors no longer get discounts as high as they once did. added to this, the medical aids are moving towards a uniform discount for all providers which has forced dispensing doctors to give bigger discounts. as a result many sajems ns 6 (2003) no 3 625 doctors began to find themselves in financial trouble. pharmacists have been approached to take over the running of their dispensaries. the primary reason is that pharmacists have better claiming technology and administrative skills than the average doctor. also pharmacists are involved full time in the running of the dispensary to ensure proper control of all the business functions. often these pharmacies are run with a profit incentive for doctors so as to ensure that their patients are directed to the pharmacy. this is against the pharmacy act but this is often overcome with rental agreements related to turnover. these types of pharmacies can be very profitable as they do not need to carry the large levels of stock that traditional pharmacies do because only the doctors� preferred drugs need to be stocked. this means that these pharmacies can buy higher volumes of these products and that they can increase there stock turn dramatically. while these pharmacies are very successful, they do face the risks of being excluded from medical aid contracts. nevertheless this pharmacy concept is very practical as it gives great convenience to customers who can see the doctor and receive their medication at the same time. also for pharmacists that want to open their own pharmacy, this is probably the most cost effective way of entering retail pharmacy. the large corporates have not missed this opportunity and companies like medicross have opened doctors� practices that have a pharmacy attached. with their large buying power these dispensaries have become one of medicross�s most profitable areas of business. 5 conclusion we have clearly seen from this study that retail pharmacy is currently going through one of its most challenging times. huge pressure is being put on pharmacies from the medical aids to reduce the cost of medicines. the retail pharmacy industry is also constantly changing and this is being accelerated by the new proposed legislation that will open up ownership of pharmacies. the big players in the retail market have already made their intentions very clear. the government has a big interest in what form the health care market will take and want to see a more inclusive private healthcare market. all these factors mean that it is unlikely that the future retail pharmacy market is going to resemble the status quo. this paper has outlined the probable changes. lastly, whenever there is great change and uncertainty there is also great opportunity. with a good understanding of the latest developments in the healthcare markets entrepreneurial pharmacists can use their skill and expertise to create value in the market place. sajems ns 6 (2003) no 3 626 endnotes 1 this paper is partly based on an mbl dissertation by martin wessels. 2 this can be defined as a system that manages the utilization, costs (including the inflation rate) and quality of services to ensure that a defined population receives appropriate, cost effective and high quality healthcare (chetty 2000: 1). references 1 chetty, m. (2000) introduction to the basics of managed care in south africa, durban: parke-davis. 2 council for medical schemes (2002) www.medicalschemes. com. 3 financial mail (2002) strong arm tactics bring pain and gain, 26th july: 52. 4 grant, m.r. (1998) contemporary strategy analysis, blackwell: oxford. 5 krulwich, r. (2002) prescription for success, abc news, 26th april. 6 sunday times (2002) low cost quality pays off, 16th june 2002: 6. 7 luiz j.m. (1994) �health care in the new south africa: surveying the more radical options�, africa insight, 24(2): 127-32. 8 luiz j.m. & wessels, m. (2003) �private medical care in a changing healthcare environment in south africa�, forthcoming. 9 melamet, da. (1994) commission of enquiry into the method of providing for medical expenses, government printing office: pretoria. 10 reekie, w.d. (1995) health-care options for south africa: lessons from the uk and the usa, free market foundation: sandton. 11 reekie, w.d. (1997) �cartels, spontaneous price discrimination and pharmacy retailing�, international journal of the economics of business, 4(3): 79-285. 12 sairr (south african institute of race relations) (2001) south africa survey 2001/2002, cape town. 13 south african pharmacy council (2000) annual report 2000, pretoria. 14 undp (2001) human development report 2001, united nations: new york. 15 wolvaardt, g. (2002) �the introduction of a national health insurance system � implications for general practice�, gp net insight, july no 6: 10-11. sajems ns vol 4 (2001) no 2254 a systems approach to research inquiry in accounting: a research note carolina koornhof department of accounting and finance, university of pretoria abstract accounting research is strongly influenced by the research methodology and methods adopted in the natural sciences. as a result many researchers in accounting have steered away from non-founal or interpretative methods. from a methodological perspective, accounting research therefore has a narrow base (tomkins and groves, 1983). a solution to expanding the research base may be to search for non-formal, naturalistic research methods in disciplines related to accounting, where they are more established. the purpose of the article is to introduce a research method, employed in management information systems (mitroff, betz, pondy and sagasti, 1974) that may be of value to postgraduate students and accounting researchers engaged in non-founal and naturalistic research. it is hoped that the exposure to this and other research models will contribute towards the broadening of the accounting research base. jel m41 introduction research in accounting has been greatly influenced by the research methodology of the natural sciences. quattrone (2000) confiuns that researchers in accounting, aiming to become "scientific", have adopted the epistemology of the natural sciences, even though they deal with human and not exclusively with non-human issues. one result is that accounting research is still dominated by ontological and epistemological assumptions acceptable within the founal "scientific method". although the realistic, positivistic research approaches have undoubtedly contributed to the growth of knowledge in accounting, they represent but one type of knowledge. morgan (1983) suggests that other research strategies will generate other types of knowledge that have an equally important role to play in the development of accounting research. tomkins and groves (1983) encourage accounting researchers to increasingly explore research approaches beyond the pure "scientific approach" towards more non-formal, naturalistic and interpretive research topics. i r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 255 sajems ns vol 4 (200 i) no 2 at present there is still a limited number of accounting research papers that use more interpretative research methods. this lack of examples of naturalistic research approaches may act as a hindrance to researchers. 2 a solution may be to look for appropriate research approaches or methods in disciplines related to accounting, where a naturalistic research methodology is more established. these research methods may then be introduced to postgraduate students and accounting researchers as feasible research models. the purpose of this article is to introduce a research method in management information systems that may be of value to accounting researchers, especially those engaged in non-formal, naturalistic or qualitative research, where there may be.a paucity of appropriate research methods. in 1974 mitroff, betz, pondy and sagasti developed a model that sought to highlight the processes involved in research inquiry. they used systems theory as a basis to explain the intricate network of relationships in the research process. the model assists the researcher by documenting the various steps in research inquiry and allowing the researcher to identify and follow those steps that are appropriate to hisfher research. although the flexibility of the model's design makes it appropriate to a wide spectrum of research, it is particularly useful in less fonnal, experimental and naturalistic research. the article commences with a discussion of the elements and activities of the mitroff-model. then the use of the model in accounting research and its advantages are identified. the article concludes with some remarks on the future of accounting research and the potential use of the model in accounting. me mitroff·model in developing their model mitroff, betz, pondy and sagasti (1974) aimed to create a programme by which science could be studied from a holistic or systems perspective. they argued that there were aspects of science that could only be studied from a whole systems perspective and that anything less than a holistic view of science would fail to identify some of the essential features of science (mitroff, 1974). the model identifies the different phases of problem solving, and also highlights various research approaches, styles and attitudes towards science. the model for problem solving (mitroff, betz, pandy & sagasti, 1974) represents a systems view of the different varieties of scientific behaviour, illustrated in figure 1. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2. 256 figure 1 a system view of problem solving (narrow sense) 51 validation 6 source: mitroff. 1.1., betz, f., pondy, lr., & sagasti, f. (may, 1974) "on managing science in the systems age: two schemes for the study of science as a whole systems phenomenon", interfaces, vol 4, no 3: 46-58. the systems view of the various kinds of scientific activity in the model results in a circularity, which implies that the diagram has no predefined beginning or end. research does, however, have a beginning and thus a starting point. this starting point, together with the underlying assumptions of the researcher, has far-reaching consequences for the type of research that will be conducted and the subsequent stages of scientific inquiry that will be followed. the model implies that recognised and legitimate research does not have to start or end at a specific point, a view supported by ghurchman and ackoff (l 950). a research project could begin at either of circles i, ii, iii or iv. for example, the inquiry could commence at circle i, with the identification of an existing problem. the first phase of problem solving would then be the performance of activity i, conceptualisation, so as to devise a conceptual model in circle ii. the conceptual model establishes, in broad terms, the definition of the particular problem to be solved. it specifies the field variables that will be used to define r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 257 sajems ns vol 4 (2001) no 2 the nature of the problem and the level at which the variables will be treated (mitroff et al., 1974: 47). for example, a financial problem may be viewed at different levels: from a country perspective (typically a macro perspective), or from an industry, company or individual perspective (increasingly a micro perspective). the next phase may entail the performance of activity 2, namely the formulation or development of a scientific model in circle iii. a scientific model is a set of either qualitative or quantitative logical relationships, which link together the relevant features of the reality with which we, the researchers, are concerned (rivett, 1972: 9). it should be borne in mind that the scientific model represents a simplified version of reality, consequently it is a form of reductionism (hakanson, 1978). the third phase concerns the performance of activity 3 to derive a solution (circle iv) from the scientific model. this function is related to the teleological dimension of social science, which assumes that the practice of science is invariable goal directed. started in simple terms, the aim of social science is to provide a solution to a specified problem. this dimension may act as a constraint on research inquiry, because the problems that are addressed are often limited or restricted to the achievement of specified research goals (mouton & marais, 1996: 15). the implementation of activity 4 entails a feedback of the solution to the original problem or reality. this requires the implementation or utilisation of the solution to the problem area in society. it is apparent that the skills required for the implementation of a proposed solution differ from those required to develop a mathematical model. mitroff et al. (1974: 50) confirm that the elements and activities in the model demand different skills and involve different standards or criteria of performance. for example, individuals who are convergers may excel in modelling while divergers may excel in implementation (hudson, 1966). in validation (activity 6) the degree of correspondence between reality and the scientific model may be evaluated. the comparison between the scientific model and reality may take place repeatedly until the scientific model is refined to reflect the necessary aspects of reality. finally in activity 5, that is, feedback in the narrow sense, problem solving activities (circles ii, iii, iv) are applied when the goal is to derive better scientific solutions. in this activity, continual feedback causes a solution to be refined so that it meets the criteria and field variables specified in the conceptual model. it is typical in this research cycle that no reference is made to reality and implementation does not occur. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2 258 given the simple system of interconnected elements in figure 1, the authors calculated that a total of 3 555 research subsystems could be formed by considering all possible combinations of two, three and four elements (mitroff et ai., 1974). the authors excluded activities that are related to only one element, because a system consists of at least two elements plus a relationship between them. although not included in their total number of possible research subsystems, the authors did not preclude the possibility of subdividing activities i to 6 to incorporate, for example, different ways of performing the modelling or the conceptualisation activities. such subdivision would substantially increase the number of research subsystems. each of the research subsystems represents a different type or form of scientific activity. the model implies that legitimate research need not address all of the activities and elements in the model. mitroff et al. (1974) uses the example of a complex subsystem of scientific inquiry, illustrated in figure 2 to demonstrate the application of the model. figure 2 an application of the model of problem solving 2 6 validati011 in this example, the starting point of research comprises both elements i and ii. the activity of conceptualisation takes place by means of alternate consideration of reality and the problem situation on the one hand and the feasible conceptual models on the other. the outcome of activity 1 serves to influence the direction that will be taken in the modeling and validation activities that follow. in judging performance in a research inquiry such as the one in figure 2, different criteria should be used for each activity. the criteria appropriate to conceptualisation will be based on the ability to identify anomalies, formulate r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 259 sajems ns vol 4 (2001) no 2 new or interesting problems and to identify puzzles or paradoxes. the criteria appropriate to the activity of modelling will be based on the ability to formulate "significant relationships within some formal system of abstract thought" (mitroff et al., 1974). the activity of validation will be assessed on the research design and execution of the validity testing of the scientific model against the problem area or the reflection of reality. the use and benefits of the model in accounting research the mitroff-model guides the researcher through the research inquiry procedures that should be followed in solving a particular problem. the model may be appropriate to use in a wide spectrum of research beyond the realm of systems theory. it may be useful in both scientific and naturalistic research. the model was however, found to be especially useful in accounting areas where well established research methods are lacking, for example where new knowledge is generated or naturalistic and exploratory research are undertaken. the mitroff-model was thus used in an accounting thesis where the new concept of "flexibility" was introduced into the discipline. (koornhof, 1998). the aim of introducing the new construct, was to develop a framework for the identification and measurement of information on flexibility in business organisations. it was posited that this information could then be communicated to users by means of the existing accounting information system (koornhof, 1999). the exploratory and non-formal nature of the research presented the researcher with a problem, particularly as regards to the research approach, the structuring, legitimacy and validity of the research. to address these problems, the researcher selected the mitroff-model proposed in management sciences and used the model to: define the scope of the research; provide guidance in structuring the research; and identify the thought processes and research stages that should be followed in conducting research in accounting. the phenomenon "flexibility" was observed in the behaviour of management in organisations, but no attempt had been made to recognise and measure the multi-dimensional phenomenon in accounting. the research commenced at the activity "conceptualisation" (refer to figure 1) with the purpose of refining "flexibility" into a workable construct. the construct was developed by defining the term, delineating the field of study, categorising flexibility, and by assessing the role of these categories in the organisation. using the activity of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2260 "modelling", a framework consisting of six categories, four aspects and three levels of flexibility was developed. the construct was then introduced into accounting with the view to identifying and measuring information on flexibility and communicating it to users of financial information. the activity of "model solving" resulted in the use the framework to develop indicators of flexibility. suggestions on procedures that management and accountants could use to develop the flexibility indicators for their businesses, were also addressed. the mitroff-model was used in the research design and to divide the thesis into logical chapters. the scope of the research on flexibility in the thesis was confined to circles i, ii, iii and iv and activities 1, 2, 3 and 5 of the model activities 4 (implementation) and 6 (validation) were not included due to the exploratory nature of the research. the application of the mitroff-model in accounting research provided evidence that the model may be useful in disciplines other than management sciences, where it was originally developed. the author found the model to be a valuable tool in accounting research especially in areas where there is a lack of suitable research approaches and methods: its circles and activities were helpful in delineating the scope of research; the circles also assisted the researcher to segment the research project into chapters; the various research activities suggested an appropriate and logical sequence of chapters; it prompted appropriate thought processes at various stages in the research project, for example, lateral thinking during conceptualisation and logical reasoning during modelling; it encouraged a holistic approach to scientific endeavour; it supported a process-related approach, because the model has no specific beginning or end and provides for continuous feedback; it provided legitimacy to an exploratory and non-formal research topic; it dispelled misconceptions about research such as the following: research should cover all activities identified in the model; research must be validated; research must be implemented; and it highlighted alternative research approaches and styles that can be adopted. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 261 sajems ns vol 4 (2001) no 2 concluding remarks from a methodological perspective, accounting research has developed from a narrow base. tomkins and groves (1983) suggest that in the past accounting researchers have generally ignored or been unaware of the existence of more naturalistic and non-formal research approaches, and the adherence to so-called scientific methods has resulted in a very narrow foundation for accounting research. the "scientific approach" has not only dominated research approaches and methods, but also influenced views and opinions as to what constitutes "legitimate" research. researchers in accounting have tended to concentrated on applied research where well established research methods existed, rather than venturing into high risk areas of pur~ and exploratory research where recognised research methods are often lacking. hakanson (1978) contends that because of the formalised approaches by accounting researchers, there has not been major advances in accounting knowledge during recent years. he suggests that the greatest contributions to knowledge in the financial sciences has come from finance rather then accounting. perhaps the growth in accounting research can be stimulated by encouraging pure research, by exploring opportunities requiring naturalistic and non-formal approaches and by developing new research frameworks. the purpose of this article has been to encourage the development of such innovative research approaches. it hopes to introduce postgraduate students and researchers to a research framework from management accounting systems that may be useful to accounting research in more qualitative research areas, where appropriate research methods may not be found. there exists a need to broaden the foundation for accounting research. to realise this aim, accounting researchers should become more "adventurous" in their research by exploring new or different approaches to conducting research. endnotes the terms "scientific" versus "naturalistic" research approaches are defined by abdel-khalik and ajinkya (1983). formal research and nonformal research are defined by churchman (1961). 2 see morgan and willmot (1993) for a list of accounting journals publishing the "new" and "softer" types of accounting research. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol4 (2001) no 2· 262 references abdel·khalik, a.r. & ajinkya, b.b. (1983) "an evaluation of 'the everyday accountant' and researching his reality", accounting organisations and society, 8 (4): 375-84. 2 churchman, c.w. (1961) prediction and optimal decision: philosophical issues of a science of values, prentice hall, new jersey. 3 churchman, c.w. & ackoff, r.l. (1950) methods of inquiry, educational publishers, saint louis. 4 hakinson, n.h. (1978) "where we are in accounting: a review of 'statement on accounting theory and theory acceptance'" the accounting review, liii (3): 717-25. 5 hudson, l. (1966) contrary imaginations, schocken books, new yorlc. 6 koornhof, c. (1998) "accounting information on flexibility", unpublished doctoral thesis, university of pretoria, pretoria. 7 koornhof, c. (1999) "information of flexibility", paper presented at the iaaer conference, japan. 8 mitroff, li. (1974) the subjective side of science: a philosophical inquiry into the psychology of the apollo moon scientists, elsevier. 9 mitroff, 1.1.; betz, f.; pondy, l.r. & sagasti, f. (1974) "on managing science in the systems age: two schemes for the study of science as a whole systems phenomenon", interfaces, 4(3): 46-58. 10 mouton, j. & marais, h.e. (1996) basic concepts in the methodology of the social sciences, human sciences research council, pretoria. 11 morgan, g. & willmot, h. (1993) "the 'new' accounting research: on making accounting more visible", accounting, auditing and accountability journal, vol. 6(4): 3-36. 12 morgan, g. (1983) beyond method: a study of organizational research strategies, sage, beverley hills. 13 quattrone, p. (2000) "constructivism and accounting research: towards a trans-disciplinary perspective", accounting, auditing and accountability journal, 13 (2): 130-55. 14 rivett, z.p. (1972) principles of model building, john wiley, london. 15 tomkins, c. & groves, r. (1983) "the everyday accountant and researching his reality", accounting, organisations and society, 8.(4): 36174. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . f:\ejour\ecoman\index\ecoman_v6_n2.prn.pdf sajems ns vol 6 (2003) no 2 384 an inter-disciplinary perspective on the information privacy issue in a global environment ________________________________________________________________ ac jordaan department of economics, university of pretoria y jordaan department of marketing and communication management, university of pretoria ________________________________________________________________ abstract the world economic system’s transformation from a dominantly massproduction model, to a mass-customisation model is seen as creating a demand for personal information on consumers. this has lead many consumers to feel the need to protect their information because businesses request personal information during commercial transactions. this conceptual paper addresses information privacy as a marketing-related issue with an inter-disciplinary nature and aims to illustrate how marketing and economics can work together in a more cohesive manner. the information privacy issue is presented as striking a fair balance between the privacy interests of consumers, the financial interests of businesses, and the sustainability of an economy in the global environment. the paper concludes that consumer information privacy will always remain an issue of protection for consumers, an ethical issue for marketers, and is fast becoming an issue of social responsibility for government. jel a12, 13, d82 introduction consumer privacy issues are not new and the right to privacy is guaranteed through many official documents on human rights of various countries. however, there is growing consumer concern about personal information used by government and private commercial businesses (turner & varghese, 2002: 11). the internet has contributed, particularly with respect to its use as a tool for communication, entertainment, and marketplace exchange (miyazaki & fernandez, 2001: 28). the consumer privacy issue is taking on greater magnitude as an increasing number of consumers are involved in marketing transactions, and progressively more marketers rely on technology in their daysajems ns vol 6 (2003) no 2 385 to-day operations. businesses rely on the consumer information they gather in daily transactions to participate in an ever-increasingly competitive economic environment. this is in line with the theory of a market economy which is based on profit maximisation, where acquiring consumer information is vital in competing and ensuring a profitable return. in this paper, using an inter-disciplinary approach, some effort is made to address consumer information privacy from a marketing, economic, and global perspective, with reference to south africa as one of the role players in the global environment. the purpose of the paper is to describe how consumers’ perceived threat of the loss of personal privacy and of globalisation forces countries to create national policies that are harmonised with international policy frameworks. this moves the information privacy issue beyond the scope of marketing, turning it into an issue of social responsibility for government and industry. the information privacy issue the right to privacy has become widely recognised all over the world. it is expressly guaranteed in the universal declaration of human rights of 1948, the european convention on human rights of 1950, the international covenant on civil and political rights of 1966, and the american convention on human rights of 1969. it is not explicitly mentioned in the african charter on human and peoples rights of 1981, but is found in most domestic bills of rights, for example the bill of rights in the south african constitution of 1996 (devenish, 1999: 135). one of the first definitions of privacy was documented by warren and brandeis (1890: 193) in the 1800s. they reasoned that the right to life refers to the right to enjoy life, resulting in the right to be let alone. one constant across the history of privacy is the difficulty of defining the concept of privacy. privacy is an elusive, value-laden concept, and it is hard to reach consensus on a universally accepted definition, since this concept means different things to different people at different times (gellman, 2002). academic literature includes contributions from many different disciplines addressing the meaning of privacy. although the purpose of this paper is not to solve the definitional problem of privacy, several definitions are provided to serve as a background for the discussion. in europe, the right to privacy has been defined to consist in “essentially the right to live one’s own life with a minimum of interference” (devenish, 1999: 137). in australia, privacy is defined as “people’s right to the privacy of their own body, private space, privacy of communications, information privacy, and sajems ns vol 6 (2003) no 2 386 freedom from surveillance” (collier, 1995: 44). the royal bank of canada defines information privacy as “the right of customers to have their personal information safeguarded and to determine for themselves how, and to what extent, information about them is collected, used and communicated to others” (jayson, 2002: 3). westin (in agre & rotenberg, 1998: 194) contends that no durable definition of privacy is possible because privacy issues are fundamentally matters of values, interests, and power. privacy itself is an intangible commodity and is often categorised in a negative sense. for example, privacy is ‘invaded’, a confidence is ‘breached’, or a trust is ‘broken’ (pounder & kosten, 1992: 1). violations of privacy can constitute an invasion of a person’s private life or relate to the acquisition and disclosure of personal information. the invasion of privacy has been defined as “an international and wrongful interference with another’s right to seclusion in his or her private life” (devenish, 1999: 145). privacy, but specifically information privacy, is currently on the public agenda of many countries (holvast, madsen & roth, 2001: 14). this paper will focus on consumer privacy, where information privacy is defined as the right of consumers to safeguard information about themselves from the use or control by businesses. many consumers feel the need to protect their information because businesses request personal information during daily commercial transactions. the next section will discuss the concept of information exchange between consumers and businesses. information exhange every exchange requires two or more parties where one party offers something and another party obtains that which is given by offering something in return (kotler, 2000: 12). consumers invest, besides money and other costs, their personal information in an exchange process. exchange may be viewed either from the perspective of economic exchange or of social exchange. in economic exchange models, social interaction is viewed as an exchange of mutually rewarding activities in which the receipt of a needed valuable is contingent on the supply of a favour in return. according to social exchange theory, social relationships are based on each partner’s motivational investment and anticipated social gain (takala & uusitalo, 1996: 47). whatever the reward, it has been suggested that transactions are more likely to be morally defensible if both parties enter them freely and fully informed (kavali, tzokas & saren, 1999: 578). exchange is a value-creating process because it normally leaves both parties better off. this results in a code of conduct to which both parties should subscribe and is described by social contracts. sajems ns vol 6 (2003) no 2 387 a social contract is “that fundamental compact that consists of the rules imposing basic duties, assigning rights, and distributing the benefits of political, social, and economic cooperation, unanimously agreed to by reasonable people in a state of perfect equality and absolute impartiality” (grant, 2000: 19). in a marketing context, a social contract occurs when a customer provides a marketer with personal information at the point of purchase with the intention that the marketer will use this information to serve the customer better (milne, 1997: 299). the belief that information control is a key mediator of consumer privacy concerns has led many to suggest that marketers should view consumers’ exchange of personal information as an implied social contract (culnan 1995: 11; milne, 1997: 299). when marketing is viewed as an implied social contract, consumers provide personal information in exchange for products or services, receiving solicitations and other information, based on an expectation that their personal information will be managed responsibly. according to phelps, nowak & ferrell (2000: 29) the implied social contract is considered breached if consumers are unaware of information being collected, if the marketer discloses the consumer’s personal information to a third party without permission, or if consumers are not given an opportunity to remove their names from lists or otherwise restrict the dissemination of their personal information. as the extensive use of consumer information has become part of the fabric of the modern marketplace, the issue of who owns the consumer’s information is raised (davis, 1997: 35). the control of consumer information has proved a valuable commodity in the marketplace and is therefore a source of power (prabhaker, 2000: 164). information technology is having a major impact in this area by changing the nature of relationships and the balance of power between the parties involved (fletcher & peters, 1996: 147). in practice, consumers and businesses often disagree about who owns the data and what kinds of trade-off are acceptable in different situations (campbell, 1997: 47). several perspectives on ownership have been offered, placing ownership rights either in the hands of consumers or in those of business. one view suggests that businesses that have gathered consumer information through the expenditure of time, effort, and money should be able to control the use and dissemination of the information (davis, 1997: 35). this is supported by taylor, vassar and vaught (1995: 44) who suggest that marketers who have created databases own the information contained in these databases and can therefore use, sell or rent this information to others without consumers’ consent. another view suggests that if personal information can be defined as a property, the original owner should control its use and dis semination. this idea is consistent with those of westin and miller (in davis, 1997: 35) who argued in the late 1960s that property rights should be attached to personal information so that individuals are better able to control its dissemination and safeguard their sajems ns vol 6 (2003) no 2 388 personal privacy. foxman and kilcoyne (in davis, 1997: 34) argue, on ethical grounds, that marketers should recognise consumer ownership rights to personal information, in that consumers perceive these rights to exist and resent their violation. some believe that placing ownership in the hands of consumers could improve consumer targeting and solicitation response rates. this is because consumers who grant permission for contact may be better qualified prospects and more interested in future exchange transactions (davis 1997: 39). it is important to realise that there can be no transaction or exchange without the communication of information (yudelson, 1999: 63). the world economic system’s transformation from a dominantly mass-production model to a masscustomisation model is seen as creating an enormous demand for detailed data on the behaviour of consumers (agre & rotenberg, 1998: 277). at this point, an inter-disciplinary framework for information exchange will be used to explain the dual nature of the information privacy issue. on the one hand, it is concerned with the information exchange between consumers, who have a right to privacy, and businesses, that have a right to a free flow of information. (this will be discussed in the next sectio n from a marketing perspective representing the micro level effects of information privacy). on the other hand, it is concerned with the participation of these role players in a national economy. if market imperfections, such as the lack of information privacy, occur in the market, and industry cannot regulate itself successfully, government may be forced to intervene in terms of data protection actions. (this will be addressed from an economic perspective representing the macro level effects of information privacy). the remainder of the paper will be presented as striking a fair balance between the information privacy interests of consumers, the financial interests of businesses, and the sustainability of an economy in the global environment. micro level effects of information privacy yudelson (1999: 63) conceptualised marketing as “those activities who seek to influence voluntary exchange transactions in a wide range of settings and situations where both parties may look beyond the specific exchange transaction to the development of a mutually beneficial relationship during an extended period of time”. as the relationship between two parties develops over time, consumer-business relationships may well develop along more tightly defined lines, even if this involves introducing more contractual elements into the interaction (peters, 1997: 221). to understand the relationship between the parties involved, one has to understand the objectives and expectations of each party. businesses strive for continuing relationships because it is assumed that these relationships are more profitable (takala & uusitalo, 1996: 48). consumers’ expectations, in turn, extend beyond the provision of the actual sajems ns vol 6 (2003) no 2 389 good or service to the manner in which their information is obtained, stored, and used by businesses (campbell, 1997: 47). let us take a closer look at the effect of information privacy on each party in an exchange relationship. consumers have little or no control over the prospecting efforts of businesses. the sheer volume of direct mail, phone calls and e-mails relates to the physical intrusion of marketing communications into the daily lives of consumers (katzenstein & sachs, 1992: 71; o’malley, patterson & evans, 1999: 442). if consumers could control the extent of marketing solicitations, it would offer advantages as well as disadvantages from a social and economic perspective. one advantage would be the protection that personal information privacy rights provide against unwanted mail and telephone solicitations (davis, 1997: 39). a social disadvantage to information privacy is the situation where consumers cut themselves off from valuable marketing information by failing to provide consent to information use and dissemination (davis, 1997: 39). much of recent attention to privacy issues has focused on the internet. consumers experience a perceived threat to their individual privacy owing to the staggering and increasing power of information-processing technology to collect a vast amount of information about them. this information is often stored, analysed, interpreted, compared and exchanged by businesses on the internet, often without the knowledge or control of consumers. while businesses may claim that they apply tight security and confidentiality controls over the information, these controls are often for the benefit of the business and may provide little protection to consumers (collier, 1995: 41). many consumers will not purchase items on the internet if they fear that their personal information will be misused. some spend time and money solely to evade the consequences of too much information sharing (gellman, 2002). the costs incurred by consumers to protect themselves from unwanted view or intrusion constitute a privacy toll paid in both money and time. the privacy toll includes costs associated with higher prices, stopping junk mail and telemarketing calls, and protecting privacy on the internet (gellman, 2002). as consumers become more comfortable online, they are increasingly open to providing personal informatio n to their favourite websites. but they are stridently demanding that this information be used to enhance their experience and that the information must not be used in ways that abuse a privileged relationship, or even be subject to a perception of abuse. online businesses face a delicate balance between strong consumer demand for privacy protection and a real consumer desire for personalised treatment (mabley, 1999: 1). businesses have good reason to collect information about customers. it enables them to target their most valuable prospects more effectively, tailor their sajems ns vol 6 (2003) no 2 390 offerings to individual needs, improve customer satisfaction and retention, and identify opportunities for new products or services. a generally accepted assumption in any market-oriented economy is that businesses will aim to maximise their profits (mabley, 1999: 4). the profit maximisation principle can have an affect on consumers in that it tends to point towards the selfish motives of businesses. it is important to realise that the forces of competition in the market environment prevent many businesses from being too generous in respect of consumer information privacy protection. sometimes the consequences of pursuing profit maximisation have a detrimental effect on consumers to the extent that it becomes socially undesirable. social responsibility is defined as “doing business in a way that maintains or improves both the customer’s and society’s well-being” (mohr, webb & harris, 2001: 46). most definitions of social responsibility emphasise that a socially responsible business must have concerns beyond short-term profitability. the question here is whether, and in what circumstances, businesses will be willing to forgo profits or other benefits to themselves in order to avoid harm to consumers. it follows that customer relationships lie at the core of marketing and should be developed so that consumer and business objectives are met (grönroos, 1990: 5). while these objectives may or may not in fact be independent, the means of satisfying them are very often interdependent on each other, as well as being dependent on the economic system (peters, 1997: 223). this highlights the importance of the economic environment within which consumer-business relationships are developed. this will be discussed in the next section. macro level effects of information privacy the lack of information privacy experienced by consumers and businesses is an indication that a universal market imperfection is currently evident in many economies. from an economic perspective, this imperfection in the market places the economy in disequilibrium, and one needs to determine the conditions or relationships that have to be satisfied to reach a condition of equilibrium again. in economic models, equilibrium conditions arise from the maximising behaviour of businesses and consumers. suppose an economy operates under perfectly competitive conditions with no market imperfections, no negative externalities in production or consumption, and no public goods. in such a situation, perfect information exists, all resources are privately owned, businesses maximise profit, and consumers maximise utility. finally, markets always clear and there are no adjustment costs or unemployment of resources. in sajems ns vol 6 (2003) no 2 391 this type of economy, the optimal government policy is a laissez-faire approach, and the resulting equilibrium is referred to as a first-best condition. this kind of market condition can be seen as economic paradise since there is no conceivable way of increasing economic efficiency any further (suranovic, 1999). however, real-world economics is unlikely to be so perfect, since market imperfections are part of any economy. as soon as a market imperfection, such as the lack of information privacy, is introduced into an economic paradise environment, the resulting equilibrium is less than optimum, reducing the optimal level of national welfare. this situation is called a second-best equilibrium and is known as ‘the theory of the secondbest’. formulated by richard lipsey and kelvin lancaster (1956), the secondbest equilibria arise whenever all the equilibrium conditions satisfying economic paradise cannot occur simultaneously. the principles of this theory have important implications for the understanding of potential interventions in situations of market imperfection. in this paper, it is assumed that the lack of consumer information privacy is a market imperfection and therefore implies that the economy starts at a secondbest equilibrium. the theory of the second-best posits that when markets have imperfections, it is possible to add another carefully designed ‘imperfection’ (such as a privacy policy) to improve economic efficiency. the reason for this outcome is that the second imperfection (a privacy policy) could correct the inefficiencies of the first imperfection (lack of information privacy) by more than the inefficiencies caused by the second imperfection (suranovic, 1999). in other words, interventions that would reduce national welfare in the absence of imperfections can now improve welfare when there are imperfections present. even though the intervention may not correct the imperfections completely, it may reduce the detrimental effects of the imperfection, and a new and better equilibrium position will be obtained. a general rule to identify first-best equilibrium is to use an intervention method that most directly addresses the market imperfection. self-regulation by industry is one approach available to address market imperfections and is mainly represented by ethical codes. ethics are the moral principles and values that govern the way consumers and businesses conduct their activities (churchill & peter, 1998: 129). to become and remain part of the economic environment, ethical codes have to be accepted by all parties. there will thus be a need for businesses to make the codes explicit, to iterate their doctrine and to make their presence felt. it is clearly in the interest of those who are obeying the codes to enforce them, to call attentions to violations and to use the ethical and social pressures of the society at large. unfortunately, selfregulation has its limitations. first, most consumer groups lodge complaints to sajems ns vol 6 (2003) no 2 392 government agencies instead of to the industry. second, interests of businesses are diverse and one industry solution is hardly possible. third, not all businesses are members of a national controlling body, especially those most apt to act in unethical ways. finally, industry boards have no power to enforce compliance (katzenstein & sachs, 1992: 73). the above-mentioned limitations may lead to a situation where the market cannot correct itself in terms of self-regulation. this can be seen as a market imperfection and warrants government intervention. government should use the most efficient (least costly) method to reduce inefficiencies caused by imperfections. if government were to add information privacy legislation, for example, this would reduce the negative aggregate effects caused by the lack of information privacy and thus raise national welfare. when government intervention corrects the imperfections completely, the economy would revert to economic paradise (rebello, 2002: 14). from the above discussion it is clear that the lack of information privacy is a market imperfection causing the economy to operate at a second-best equilibrium condition. the globalisation of markets has also forced countries to address the market imperfections and to adopt privacy legislation. this can have an effect both on businesses in a market-driven economy, in terms of their principle of profit maximisation, and on a country’s economic growth, in terms of its trading with other countries. the final section of this paper will address information privacy in a global environment. in this section, the focus will also be on south africa as one of the role players in the global environment, and its current position on the information privacy issue with regard to data protection legislation. information privacy in a global environment the reason for government intervention in an economy was explained earlier as a reaction to market imperfections. government can intervene on the basis of the fact that the market is unable to resolve the information privacy problem by means of self-regulation. as the global marketplace continues to expand, businesses face increasingly strict privacy and data protection regulations in a growing number of countries around the world. it is therefore important for countries to take cognisance of the international privacy regulatory environment. a brief overview of the main historical developments with regard to privacy and data protection in the international arena follows. in 1969 the organisation for economic cooperation and development (oecd), an international body of 29 countries, became the first international organisation sajems ns vol 6 (2003) no 2 393 to recognise the privacy implications of trans-border data flows of personal information (holvast, madsen & roth, 2001: 1). the privacy protection act was passed in the united states in 1980 (rotenberg, 2001: 101). in the same year, the oecd issued guidelines for privacy protection in the transfer of personal information across national borders. (rotenberg, 2001: 268). canada passed their privacy act in 1982 (holvast, madsen & roth, 2001: 2). the united kingdom’s data protection act was put in place in 1984, stopping personal information from international transfer if it was considered such information was not adequately protected in the receiving country (collier, 1995: 42). in 1985, the oecd extended their guidelines to cover trans-border data flow, and the council of europe concluded the convention for the protection of individuals with regard to automatic processing of personal data (rotenberg, 2001: 297). in australia, the privacy act of 1988 details information privacy principles based on the oecd guidelines (rotenberg, 2001: 413). in 1995, the european union’s directive on the protection of personal data and on the free movement of such data finally emerged from the european union’s complex and drawn-out legislative process (agre & rotenberg, 1998: 105). the data protection directive has had, and will continue to have, an impact on the data-protection policies of countries (or states) that have not yet passed such legislation, including those outside the european union. the pressure on noneuropean union countries stems principally from the stipulation in article 25 that data transfers to a ‘third country’ may take place only if that country ensures an ‘adequate level of protection’ (agre & rotenberg, 1998: 109). the australian parliament passed the privacy amendment (private sector) bill in december 2000. the new legislation contains amendments to the commonwealth privacy act of 1988 and will regulate the handling of personal information by private sector organisations (rotenberg, 2001: 413). on 21 july 2000, the united states department of commerce, responding to possible restrictions of personal data from europe to the united states as a result of the european union data privacy directive, issued what is known as its ‘safe harbor privacy principles’. the safe harbor programme was agreed to after the united states insisted that a voluntary approach to data privacy was better than a legislative approach (bna, 2002: 191). united states organisations acceding to the ‘safe harbor’ principles are seen by the united states as fulfilling the adequate protection requirement of the european union directive (holvast, madsen & roth, 2001: 14). the personal information protection and electronic documents act of 2000 came into force in canada on 1 january 2001. this act establishes rules that govern the collection, use and disclosure of personal information in the private sector (kirwin, 2002). the latest international development that took effect on 31 july 2002 was the new european union directive on the protection of personal data and privacy in the electronic sajems ns vol 6 (2003) no 2 394 communications sector. this new directive introduces new rules on data retention and unsolicited commercial communications (mason, 2002). given the above, it is evident that protection of personal data transfers varies from nation to nation, as does the regulatory framework governing them. there is also a marked shift in the direction of a global standard for information privacy modelled on the provisions of the european union (rudraswamy & vance, 2001: 133). it is clear that the european union’s 1995 data protection directive constitutes the rules for the increasingly global character of dataprocessing operations. increasing global interdependence has possible consequences for those businesses that rely on the unimpeded flow of personal information and that cannot claim to protect the data of consumers in ways that match the european standard (agre & rotenberg, 1998: 111). in an interdependent world, the policy efforts of the europeans carry externalities that force other countries to pursue policies that they would otherwise oppose or avoid. in addition, the general pressures to conform have increased as more and more countries have joined the ‘data-protection club’. south africa is currently lagging behind in terms of data protection despite the following legislative actions that have been taken. in the bill of rights, chapter 2 of the south african constitution, south african citizens are guaranteed (among other things) the right to privacy and the right to access of information. the promotion of access to information act 2 of 2000 was promulgated to give effect to the constitutional right of access to any information held by the state, as well as any information that is held by another person and that is required for the exercise or protection of any rights. however, this act excluded private section portions and data protection provisions. this led to a request by the minister to form a committee (project 124) to investigate the privacy and data protection issue with the aim of improving existing legislation and adding new legislation in the future. the electronic communications and transactions (ect) bill was tabled before parliament recently and south africa became the first country in africa to join more than 20 countries that have introduced electronic commerce legislation in the past four years (temkin, 2002: 2). using a smart card, a fingerprint and a password, president thabo mbeki signed into law the electronic communications and transactions (ect) bill in july 2002. the ect act makes advanced electronic signatures legal, easing the conclusion of deals and transactions online. despite the advantages of electronic communications and transactions, it also poses renewed threats to information privacy. the most controversial part of the act is chapter 10, which allows for a non-profit organisation to control the ‘.za domain’ (anon, 2002: 2). this organisation’s nine directors will be nominated by the minister, demonstrating a high level of sajems ns vol 6 (2003) no 2 395 regulation by the south african government. considering the south african government’s lack of proper data protection legislation compared to the rest of the world, this act demonstrates excessive control in an area that is not regulated by any other country. south africa has to realise that adequate privacy protection is becoming a necessary condition for being on the global information highway. a lack of proper regulatory frameworks may have far-reaching social and ethical implications, particularly when countries fail to comply with existing global regulations (rudraswamy & vance, 2001: 133). whatever privacy laws the international community adopt, there will be strong and irresistible pressure for south africa to follow suit. conclusion information privacy is not an issue that will be resolved quickly, and it may require a multi-faceted approach involving a combination of self-regulation efforts, privacy policies and legislation. it is therefore vital for consumers, businesses and government to accept the challenge and commit themselves to an enhanced economic environment. all parties will be worse off if the urgency of the matter is not accepted and addressed. countries that neglect to address information privacy concerns will increasingly be confronted to comply with international accepted privacy codes and standards. this is a situation that a country can ill afford within the current competitive global economy. important to all market participants are the inherent transaction factor of mutual gain and the general acceptance of ethical obligations to become and remain part of the economic environment. information privacy is no longer only a consumer-related issue that needs to be addressed by marketers on a micro level; it has become an issue of national concern that needs to be addressed by government on a macro level. consumer information privacy will remain an issue of protection for consumers and an ethical issue for businesses, and it is fast becoming an issue of social responsib ility for government. globalisation is forcing countries to implement relevant privacy legislation to ensure continued 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(1999) “adapting to mccarthy’s four p’s for the twentyfirst century”, journal of marketing education, 21(1): 60-7. abstract introduction the nature of entities being targeted challengers in the ‘say on pay’ movement theoretical link between shareholder activism and executive emolument the effectiveness of shareholder activists as change agents research methods results conclusions and recommendations acknowledgements references about the author(s) suzette viviers department of business management, faculty of economic and management sciences, stellenbosch university, stellenbosch, south africa nadia mans-kemp department of business management, faculty of economic and management sciences, stellenbosch university, stellenbosch, south africa linda kallis department of business management, faculty of economic and management sciences, stellenbosch university, stellenbosch, south africa kristen mckenzie department of business management, faculty of economic and management sciences, stellenbosch university, stellenbosch, south africa citation viviers, s., mans-kemp, n., kallis, l. & mckenzie, k., 2019, ‘public “say on pay” activism in south africa: targets, challengers, themes and impact’, south african journal of economic and management sciences 22(1), a3251. https://doi.org/10.4102/sajems.v22i1.3251 original research public ‘say on pay’ activism in south africa: targets, challengers, themes and impact suzette viviers, nadia mans-kemp, linda kallis, kristen mckenzie received: 05 july 2019; accepted: 20 aug. 2019; published: 22 oct. 2019 copyright: © 2019. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: shareholders and other stakeholders in south africa are increasingly raising their concerns in public about seemingly excessive executive remuneration. most of their criticism is rooted in the large and growing wage gap in the country. aim: the authors investigated the nature of the entities whose executive remuneration policies and practices were publicly criticised, the types of challengers involved in this social movement, key issues raised and the impact that the challengers had on the targeted executives’ remuneration. setting: public activism involving five south african state-owned enterprises and 38 companies listed on the johannesburg stock exchange. methods: executives and entities that were targeted in public were identified from three online financial newspapers published between 01 january 2010 and 31 december 2016. a total of 92 events were recorded involving 65 executives. data on these executives’ emolument and three control variables were sourced from bloomberg. descriptive statistics and mixed-model analysis of variance tests were employed to evaluate the quantitative secondary data. results: in line with the extant literature, most of the targets were large, well-known companies. individual and minority shareholders represented the largest category of challengers, followed by asset managers and trade unions. the vast majority of concerns centred on the size and composition of executives’ packages and insufficient justifications provided by remuneration committees. the total pay, bonuses and other performance-based incentives decreased significantly in the year after the companies were publicly targeted. conclusion: the findings suggest that public ‘say on pay’ activism can be an effective mechanism in addressing seemingly excessive executive emolument. keywords: executive remuneration; public shareholder activism; negative press coverage; total pay; bonuses; performance-based incentives. introduction ‘say on pay’ is an important element of shareholder democracy and has been the topic of a growing body of academic literature in recent years (cai & walkling 2011; conyon & sadler 2010; goranova & ryan 2014). ‘say on pay’ is a legal term that refers to the rights of ordinary shareholders to influence the executive remuneration policies and practices of the companies in which they invest (henceforth called ‘investee companies’) (cai & walkling 2011). evidence in the united states (us) suggests that shareholders had raised their concerns regarding seemingly excessive executive remuneration as far back as 1933 (marens 2002). interest in the topic surged post-2008 as many stakeholders believed that the structure of executives’ emolument packages contributed to the global financial crisis (bhagat & bolton 2014; faulkender et al. 2010). ‘say on pay’ is not only a phenomenon that occurs elsewhere in the world. shareholders in south africa have also joined this social movement which encourages fair and responsible executive remuneration (viviers 2015). although the country celebrates 25 years of democracy in 2019, the sad reality is that economic freedom remains beyond the grasp of many ordinary citizens. according to a 2017 survey published by statistics south africa, poverty levels in the country have risen sharply after the 2010 recession. in 2015, more than half of the population (55.5%) was categorised as ‘poor’ (statistics south africa 2017). south africa also has one of the highest wage gaps in the world (statistics south africa 2017). it reflects the difference between the remuneration received by the highest paid employee in a company, usually the chief executive officer (ceo) and the lowest paid employee. the wage gap of locally listed companies increased from 61.8 times in 2017 to 64.7 times in 2018 (pwc 2018). this large and growing wage differential contributes to south africa having the highest level of income inequality in the world (the world bank in south africa 2018). discontent is subsequently rising among shareholders about remuneration at the highest corporate echelons, notably excessive ceo pay (ertimur, ferri & muslu 2011; kimbro & zu 2016). in addition to social movement theory (reid & toffel 2009), previous scholars have used various other theoretical foundations to address the multidimensional nature of shareholder activism (goranova & ryan 2014). the agency theory is deemed the primary theoretical lens in activism literature (goranova & ryan 2014). this theory is also tied to executive remuneration literature, suggesting that managers should be incentivised to maximise shareholder value (jensen & meckling 1976). some shareholder activists express dissatisfaction with the disconnect between performance and emolument and demand that remuneration policies be amended (goranova & ryan 2014). pay-performance sensitivity is dependent on achieving a so-called ‘optimal contract’ to attract and appropriately incentivise talented executives (bussin 2015a). local companies often justify their generous pay packages to executives by citing the intense competition to attract and retain skilled executives from a limited talent pool (bussin 2018; madlela & cassim 2017). although this claim may be valid in some cases, fundamental questions regarding social justice remain. the wage gap can be addressed from both ends of the pay scale. whereas trade unions can negotiate higher wages for the lowest paid individuals (banning & chiles 2007), shareholders can influence the size and composition of executives’ pay packages (conyon & sadler 2010), albeit through a non-binding vote. the emergent voice among south african shareholders and other stakeholders (collectively called ‘challengers’) might be ascribed to a number of events including the marikana massacre. this tragic incident, which occurred in august 2012, is seen by some as a turning point in south african history. alexander (2013:605) posits that this event initiated a ‘massive wave of strikes which are changing [the] structures that shape people’s lives’. in addition, the surge in civilian and student protests in recent years (bohler-muller et al. 2017) might have emboldened social-minded activists to add their voices to the debate on what constitutes fair and responsible executive remuneration (keke 2017). although protests can highlight pressing issues, they should occur in an organised, controlled manner. ideally, messages should be conveyed with minimal disruption to the economy. a number of public and private voice mechanisms are available to shareholder activists to hold managers accountable and bring about change in investee companies (yocam & choi 2010). private voice mechanisms comprise confidential correspondence and negotiations with investee companies, whereas public voice mechanisms include the filing of shareholder resolutions, voting, asking questions at shareholder meetings and raising concerns in the traditional and social media (viviers 2015). proxy contests and legal proceedings to enforce shareholder rights could also be regarded as formal voice strategies (viviers 2015). most prior studies have investigated the effectiveness of ‘say on pay’ resolutions and voting in the us and the united kingdom (uk) (conyon & sadler 2010; del guercio, seery & woidtke 2008). few studies have been conducted internationally on public opinion and the ‘power of the pen’ in transforming executive remuneration policies and practices (core, guay & larcker 2008; hooghiemstra, kuang & qin 2015; kuhnen & niessen 2012). most of the studies that have been conducted on executive remuneration in south africa have centred on the relationship between ceo compensation and company performance (bussin & blair 2015; bussin & modau 2015; bussin & nel 2015; bradley 2013; deysel & kruger 2015; de wet 2012; scholtz & smit 2012). other scholars have investigated the factors influencing remuneration policies such as pay benchmarking (oberholzer & theunissen 2012) and the retention of talented staff, especially black executives (nzukuma & bussin 2011). limited research has been conducted on the influence that shareholders could have on shaping executive remuneration policies and practices (madlela & cassim 2017; viviers 2015). in light of the research gap, the authors formulated four research objectives, namely to investigate the nature of the south african entities that were publicly criticised for their executive remuneration policies and practices, to identify the main challengers in this social movement, to highlight the key issues they raised, and to determine the impact that challengers had on the targeted entities’ executive remuneration. the study covered five state-owned enterprises (soes) and 38 companies listed on the johannesburg stock exchange (jse) over the period 2010–2016. if shareholders and other stakeholders realise that their actions can democratise executive remuneration in south africa, more of them might be encouraged to speak out in public. in the following section, pertinent literature will be discussed on the nature of the entities that are typically targeted and the challengers who participate in this social movement. attention is also given to the executive remuneration-related issues raised by the challengers and studies outlining the effectiveness of shareholder activists as change agents. next, the methods used to collect and analyse secondary quantitative data are presented. this is followed by the main findings and conclusions along with recommendations for remuneration committees, academics and ‘say on pay’ challengers. the nature of entities being targeted although several international scholars found that large companies and those with poor financial performance are targeted the most (cai & walkling 2011; ertimur et al. 2011; goranova & ryan 2014), no evidence in this regard could be established locally (viviers & smit 2015). companies that were excluded from the ftse/jse responsible investment (ri) index in 2013 attracted significantly more ‘against’ votes than their counterparts that were included. listed south african companies that recorded low environmental, social and governance (esg) disclosure scores, as computed by bloomberg, also received several ‘against’ votes (viviers & smit 2015). barko, cremers and renneboog (2018) likewise established that us companies with low esg ratings were more likely to be targeted. these targets typically had a high market share, enjoyed considerable analyst coverage, had high stock returns and were frequently traded. engagements often resulted in esg rating being adjusted (barko et al. 2018). challengers in the ‘say on pay’ movement as large institutional investors own the majority of listed shares globally, they have a responsibility to monitor corporate behaviour and intervene where deemed necessary (goranova & ryan 2014). these powerful financial intermediaries tend to be better informed, have easier access to investee companies’ boardrooms and have more clout to drive institutional change than individual and minority shareholders (gifford 2010; schnatterly, shaw & jennings 2008). as elsewhere in the world, institutional investors in south africa prefer to engage behind closed doors (yamahaki & frynas 2016). the term ‘institutional investor’ refers to asset owners, such as pension funds and insurance companies, and the asset managers who are appointed to act on their behalf. the authors acknowledge that asset owners could provide debt and equity financing to investee companies. the focus in this article is, however, only on asset owners’ role as shareholders. in large markets, shareholder activists can use an exit (divestment) strategy. if a shareholder sells a significant stake in an investee company and announces this decision publicly, a clear message is sent to management. in addition, a publicly announced divestment can considerably influence the target company’s market valuation (gillan & starks 2000; stathopoulos & voulgaris 2016). an exit strategy might, however, go unnoticed when a shareholder divests without informing the market of the reasons for doing so. as south africa has a relatively small stock market, very few shareholders have used this strategy (viviers & smit 2015). minority shareholders and other challengers, such as trade unions and non-governmental organisations, often find it difficult to secure private meetings with investee companies. as a result, they are limited to asking questions at shareholder meetings and raising their concerns in the press. by ‘airing a company’s dirty laundry’ in public, these challengers often succeed in obtaining swift responses to their questions and transformation requests (viviers, mans-kemp & fawcett 2017). it should be noted that minority shareholders enjoy extensive legal protection in south africa. the companies act (no. 71 of 2008) even enables them to bring a class action suit against an investee company. research conducted by gantchev (2013) and stathopoulos and voulgaris (2016) shows that, as societies are becoming more justice-oriented, more expressions of public discontent are being observed. nowhere is this public discontent more prevalent than in relation to executive remuneration (davids & ntamane 2017). the controversy has even been described as being at ‘the cutting edge of the [us] shareholder spring’ (corkery & medarevic 2013). anecdotal evidence suggests that there has been a notable increase in the number of companies that received a large percentage of ‘no’ votes on their remuneration policies since the publication of the king iv report. compared to earlier versions of the report, king iv introduced more principled guidelines on the structure, approval and disclosure of executive remuneration policies and practices. boards should ensure that executive emolument is fair and responsible in the context of overall employee compensation and are obliged to engage with shareholders should the remuneration policy attract more than 25% opposing votes (institute of directors in southern africa [iodsa] 2016). research shows that few opposing votes were cast at local investee companies in the past (viviers & smit 2015). examples in this regard include mtn group, old mutual and absa group (mchunu 2019). theoretical link between shareholder activism and executive emolument the agency theory is the primary theoretical lens in activism literature (goranova & ryan 2014). there are different views on the agency theory when applied to executive remuneration-related activism. remuneration could arguably be used to align executives’ interests with those of shareholders, by designing contracts that reward superior performance (bussin 2015a; jensen & meckling 1976). carefully structured executive pay packages could provide a potential solution to the agency problem and diminish agency costs (bebchuk & fried 2006; devers et al. 2007). substantial bonuses that are unjustified, however, have the potential to considerably reduce shareholders’ wealth (bebchuk & fried 2006). remuneration committees are criticised for increasing ceo compensation despite poor financial results (bussin 2015a). a prominent driver of shareholder activism is the lack of financial performance at investee companies (goranova & ryan 2014). the perceived misalignment between a company’s financial performance and executive pay furthermore provokes discontent among shareholders, as it represents a lost opportunity to alleviate the agency problem (cai & walkling 2011; ertimur et al. 2011). incentive-based compensation thus necessitates enhanced monitoring by directors and shareholders (goranova & ryan 2014). the need for greater alignment between executive remuneration and company performance gave rise to the optimal contracting theory (bussin 2015a). based on this theory, remuneration committees often defend seemingly excessive executive remuneration packages given the need to attract and retain highly qualified individuals from a limited talent pool (edmans & gabaix 2009). advocates of this theory seek to achieve greater pay-performance sensitivity (bussin 2015a). managerial power is an alternative theory related to the drivers of executive compensation (bussin 2015a). this theory suggests that executives could benefit from large pay packages, as they could partly influence the structure of their packages (bebchuk & fried 2003; edmans & gabaix 2009). given executives’ negotiation power, the remuneration committee could be forced to serve their best interests (bussin 2015a). executives could subsequently receive rewards that are less than optimal from a shareholder’s perspective (bussin 2015b). as managerial power could contribute to the agency problem (bebchuk & fried 2003), shareholder monitoring and engagement are essential (bussin 2015b). most engagements on the topic relate to the misalignment between company performance and executive pay (bussin 2015a; cai & walkling 2011; ferri & sandino 2009). not only did activists question the size of executives’ remuneration packages, but they also requested more information about the metrics that were being used to evaluate and reward these individuals’ performance (conyon & sadler 2010; liu & taylor 2008). scholars attribute the high level of discontent to shareholders observing ‘a lost opportunity to alleviate the agency problem’ (goranova & ryan 2014:1243). other challengers were guided by self-transcendent values (jansson & biel 2011) such as social justice and fairness. executives have also been blamed for excessive risk-taking to optimise their stock option income at the expense of shareholders (burns & kedia 2006; ertimur et al. 2011). the effectiveness of shareholder activists as change agents in one of the first studies on the impact of shareholder activism on executive remuneration, thomas and martin (1999) investigated 168 shareholder proposals submitted to 145 us companies over the period 1993–1997. they noted that boards responded by lowering their ceo pay levels and package composition. challengers tended to target poorly performing companies that exhibited higher levels of executive compensation in comparison to their industry peers. almazan, hartzell and starks (2005) confirmed a negative relationship between total direct compensation and the concentration of active institutional shareholders among us companies in the 1990s. direct compensation included salaries, bonuses, options and stock grants, long-term incentive plans and other sources of compensation. in 2004, shareholder activists targeted more than 150 us companies to adopt fair value accounting for employee stock options. in the cases where shareholders approved these proposals, the level of ceo compensation decreased along with the stock options that were used to reward these ceos (ferri & sandino 2009). in line with previous researchers, ertimur et al. (2011) investigated 1198 shareholder proposals on executive emolument in the us. these authors, however, also assessed the outcomes of 134 ‘just vote no’ campaigns over the period 1997–2007. their findings concurred with those of kimbro and zu (2016) who showed that shareholder activists’ efforts resulted in remuneration committees reducing excessive ceo pay. contrasting findings were reported by conyon and sadler (2010) who investigated ‘just vote no’ campaigns in the uk from 2002 to 2007. they reported little evidence that ceo pay was substantially lower in companies that were previously targeted. this finding could be partly explained by cai, garner and walkling’s (2010) observation that ‘say on pay’ campaigns were often used to focus on large, visible companies and not necessarily on those with excessive ceo pay. instead of analysing voting outcomes, bauer, moers and viehs (2015) studied the extent to which shareholders withdrew their proposals prior to a company’s annual general meeting (agm). their sample included 12 000 shareholder proposals filed to standard & poor’s 1500 companies between 1997 and 2009. proposals were usually withdrawn when shareholders were satisfied with the management’s response to their questions or the commitments made to transform. withdrawn proposals on executive compensation were associated with subsequent amendments to pay practices. whereas the previously mentioned studies focused on shareholder proposals and voting as public voice activism mechanisms, core et al. (2008) investigated the role of the press in shaping executive remuneration in the us. these authors considered more than 11 000 press articles on ceo compensation over the period 1994–2002. they noted that the press coverage was related to company size and large option exercises. however, they found no evidence that negative reporting motivated the considered companies to change their executive compensation practices. in a european context, hooghiemstra et al. (2015) observed that negative press coverage of ceo pay packages predicted shareholder discontent and subsequent ‘say on pay’ votes. their study highlighted the important role of the press in promoting corporate governance, including responsible compensation practices. as indicated earlier, the majority of studies on executive remuneration in south africa have focused on the relationship between executive pay and company performance. as this link is not always clear, shareholders and other challengers have become increasingly critical of local companies’ executive pay policies and practices (viviers 2015). it is essential that shareholders monitor executive pay packages (bussin 2015b), especially as executives have considerable power to influence their own pay (bussin 2015a). in addition to total pay, bussin (2015a) suggested that pertinent attention should be given to the components of executives’ emolument packages. given that the agency theory is the prominent theoretical lens in activism literature (goranova & ryan 2014), the focus of this study was on ‘say on pay’ activism. the authors acknowledge that executive emolument could be an instrument to address the principal-agent problem, but could also be part of the problem (bebchuk & fried 2003). the relationships between public shareholder activism and various executive pay components were thus investigated. given their negotiation power and growing public scrutiny, focus was specifically placed on ceo compensation. in line with core et al. (2008), the following research hypotheses were formulated: h0,1: there is no relationship between public ‘say on pay’ activism and changes in the total pay of targeted executives. h0,2: there is no relationship between public ‘say on pay’ activism and changes in the bonuses and other performance-based incentives of targeted executives. h0,3: public ‘say on pay’ activism does not have a larger effect on the total pay of ceos than non-ceos. h0,4: public ‘say on pay’ activism does not have a larger effect on the bonuses and other performance-based incentives of ceos than non-ceos. research methods this descriptive study firstly focused on the nature of local entities that were publicly criticised for their executive remuneration policies and practices over the period 01 january 2010 to 31 december 2016. focus was also placed on the main challengers in the social movement, the key issues raised and the impact that the challengers had on the targeted entities’ executive remuneration policies and practices. an excel database was created to capture data from relevant online newspaper articles. the required data were hence available in the public domain. keywords and phrases were used to identify articles from three prominent south african finance publications, namely fin24, business day and moneyweb. the keywords and phrases were: shareholder engagement, public shareholder activism, shareholder concern(s), shareholder discontent, proxy voting, wage gap, executive remuneration, cash bonus(es), performance-based incentive(s), agm, shareholder meeting and ordinary resolution. keywords also included the names of well-known local shareholder activists such as theo botha, chris logan, david couldridge and the public investment corporation (pic). as the press cannot be considered a homogeneous information source in predicting shareholders’ ‘say on pay’ voting behaviour (hooghiemstra et al. 2015), a decision was made to exclude articles that appeared in the general press. the following data were captured: the name of the targeted jse-listed company or soe, name of the targeted executive, name of the shareholder activist, name of the newspaper featuring the article, the publishing date of the article and the activist’s specific concerns. only articles featuring activists’ apprehensions about executive remuneration were included, whether raised at a shareholder meeting or during an interview with a journalist. different newspapers often reported the same criticism levelled against a particular executive or company. in such cases, only the most complete article was considered. to ensure the accurate classification of topics, two of the authors compared their individual classifications with each other. a total of 92 events were identified involving 65 executives. most of these individuals were only targeted once or twice during the entire research period. in some articles mention was only made of ‘executives’ without revealing their names. data on the two dependent variables (total pay, and bonuses and other performance-based incentives) were then downloaded for each of the targeted executives in the year when they were criticised and one year later. the latter enabled the authors to determine the impact that the challengers had on changing executive remuneration policies and practices. although core et al. (2008) included stock options in their study, insufficient data were available on share options for south african executives. all values were recorded in south african rand at financial year end. values were adjusted for inflation using south africa’s consumer price index average for each year of the research period. in line with core et al. (2008), the following control variables were considered: company size (log of total assets) and company performance (as reflected by the total revenue and earnings before interest and tax). data on the dependent and control variables were downloaded from bloomberg l.p. (2018) for the 38 jse-listed companies and manually recorded for the five soes based on their published financial statements. data were also captured on the industry in which a listed company operated (using the global industry classification standard) and whether the company was a constituent of the top 100 and ftse/jse ri indices in the year that it was targeted. to test h0,3 and h0,4, a one (1) was allocated for targeted executives who were ceos, and a zero (0) for those who were not. an inductive process was followed to identify the main categories of challengers and remuneration-related concerns that were raised during the research process. this form of content analysis was deemed appropriate as there are, as far as could be ascertained, no previous studies on the phenomenon in the local context (elo & kyngäs 2007). descriptive statistics were computed to evaluate trends in the data, whereas mixed-model analysis of variance (anova) tests were used to examine the research hypotheses. to ensure their anonymity, no names of the targeted companies, soes or executives were reported in this article. ethical considerations stellenbosch university’s research ethics committee (humanities) granted ethical clearance for this project on 18 june 2018 (project and clearance number: rec-2018-6925). as no humans were involved in the study, the ethical risks associated with the project were deemed to be minimal. results the results are discussed according to the four research objectives proposed earlier. the nature of entities being targeted the executive remuneration policies and practices of the following five soes were publicly criticised at some point during the research period: the national electricity provider (eskom), the national broadcaster (sabc), petrosa, transnet and the south african national roads agency (sanral). executives at 38 jse-listed companies were targeted, including those at telkom. although this provider of fixed-line, mobile, data and information technology services is listed on the local bourse, the south african government owns the majority of its issued ordinary shares. most of the listed companies did business in the financial (33.7%) and materials industries (16.3%). labour unrest in the mining industry could be partly blamed on the widening wage gap between mining executives and other employees (bussin 2018; seccombe 2013). a few of the targeted companies (12.5%) had their primary listings on stock exchanges other than the jse, notably in london. this distinction is important as a london-based listing might imply that executives are compensated in pound sterling rather than in south african rand. at an exchange rate fluctuating between r15 and r20 to the pound, these executives’ packages might seem exorbitant in local terms, but they are quite in line with those of their uk peers. the vast majority of the targeted companies (73.68%) ranked among the 100 largest jse-listed companies. this finding is not surprising as previous researchers have also noted that large companies are more likely to be targeted than small ones (core et al. 2008). according to brandes, goranova and hall (2008) and ferri and sandino (2009), activist campaigns involving large companies have a better chance of capturing public and media attention, thus facilitating spillover effects. these authors argue that non-targeted companies tend to address contentious issues to avoid similar, potentially damaging public criticism. half of the targeted companies were constituents of the ftse/jse ri index. the authors expected a smaller percentage of constituents to be targeted, as these companies are supposedly responsible corporate citizens. it was thus anticipated that their executive remuneration policies and practices would be more transparent and socially justifiable. challengers in the ‘say on pay’ movement table 1 provides an overview of the different types of activists who raised their executive remuneration-related concerns in public. table 1: number of ‘say on pay’ events based on activist type. as expected, the largest group of challengers consisted of individual and minority shareholders. these shareholders generally do not have access to corporate decision-makers and are hence forced to ask questions at shareholder meetings or speak to journalists. the most vocal activists in this category were theo botha, chris logan, roy mcalpine and albie cilliers. it is encouraging that more asset managers are articulating their ‘say on pay’ concerns in public. their visible approach might be due to private engagements that were unsuccessful. this claim, however, calls for further investigation. given the nature of the investigated topic, it came as no surprise that trade unions were important challengers. as large asset owners, they have an important monitoring role and responsibility to voice concerns regarding fair emolument on behalf of their members. trade unions have long been regarded as social movements in themselves as they strive to promote fairness in labour markets (masiya 2014; watson 2007). the involvement of challengers who do not have a financial interest in the targeted companies (such as politicians and thought leaders) might be ascribed to their desire to bring about a more just society. the freedom to openly express their views could be construed as a sign of a healthy democracy. prominent executive remuneration-related issues raised by challengers as illustrated in table 2, most of the ‘say on pay’ concerns related to the size of executives’ total pay, bonuses and other performance-based incentives. table 2: categories summarising challengers’ executive remuneration-related concerns. almost 30% of public outcries by challengers related to insufficient or lacking justifications for the size or composition of executives’ emolument packages. challengers were particularly critical of companies that increased their executives’ total pay, bonuses and other performance-based incentives while financial performance stagnated or declined. this finding corroborates prior research in the international context (cai & walkling 2011; core 2008; ferri & sandino 2009). several activists also requested greater clarity on the metrics and time frames that are used to determine (and hence justify) performance-based incentives. the effectiveness of activists as change agents the mixed-model analysis of variance test results for the first two hypotheses are shown in table 3. table 3: mixed-model analysis of variance test results for h0,1 and h0,2. h0,1 could be rejected in light of the significant positive relationship observed between the variables. the average annual total pay of executives decreased from r30 200 583 to r26 545 361 after being publicly targeted. the positive relationship between public ‘say on pay’ activism and change in the bonuses and other performance-based incentives of executives meant that h0,2 could also be rejected. the average annual monetary value of these compensation elements fell from r15 234 711 to r10 580 657 in the year after being targeted. these findings highlight the important monitoring role that shareholders and other challengers play in promoting fair and responsible executive remuneration in south africa. almost two-thirds of the targeted executives (64.45%) were ceos. this finding was expected. other scholars also noted that these individuals experience more public scrutiny, given that they usually earn more than other directors (nordén & strand 2011). the statistics did not reveal that public ‘say on pay’ activism had a larger effect on the total pay (h0,3) or bonuses and other performance-based incentives (h0,4) of ceos compared to non-ceos (ceos: f(2,710) = 0.543; p = 0.583 and non-ceos: f(2,761) = 2.086; p = 0.131). although the majority of ceos earned more than their non-ceo counterparts and were targeted more frequently during the study period, it does not seem as if the remuneration committees differentiated between ceos and non-ceos when adjusting pay packages. challengers might have focused their attention on ceos to make a statement about executive remuneration in general, and not only on the individuals in question. in light of the managerial power theory, it could be argued that although shareholders recognise the considerable power of ceos in influencing remuneration policies and practices, remuneration committees are not as sensitive about the matter. conclusions and recommendations executive remuneration remains a controversial topic and regularly features in newspaper headlines. despite a growing body of literature on shareholder activism and executive remuneration, few studies have considered the intersection between these fields. most local studies focused on the pay-performance link, composition of executive remuneration packages and pay benchmarking. this study is the first of its kind in that it adopts a social movement perspective and offers empirical evidence on the targets, challengers, themes and the impact of public ‘say on pay’ activism in south africa. the first research objective called for the identification of the local entities that were targeted by ‘say on pay’ activists over the research period 2010–2016. a rigorous data collection process revealed that five large soes and 38 jse-listed companies were publicly scrutinised. in line with the extant literature, most of these targets were large, well-known companies. the research furthermore centred on identifying and categorising the key challengers in the local ‘say on pay’ social movement. as expected, individual and minority shareholders represented the largest category of challengers, followed by asset managers and trade unions. as individual and minority shareholders generally do not have access to boardrooms, they have no choice but to raise their concerns in public. it is a pity that only a handful of individual and minority shareholders actively speak out. shareholders of all sizes are encouraged to take a more public stance on executive remuneration as their efforts could just be what is required to promote fair and responsible executive remuneration. the third research objective focused on the key ‘say on pay’ issues raised in the press. the vast majority of concerns centred on the size and composition of executive pay packages. insufficient communication by remuneration committees, especially in cases where companies increased their executives’ pay despite poor company performance, also featured prominently. the empirical evidence in this study showed that some shareholders did not view executive compensation as a means of addressing the agency problem, but rather as a contributing factor. challengers who do not have a direct financial stake in the targeted companies might be raising their concerns on broader social grounds. this argument is bolstered by the finding that most of the targeted executives were ceos. as supported by kidder and buchholtz (2002), these individuals play a major role in creating trust, both within and beyond their organisations. seemingly excessive compensation could thus be detrimental not only to their own reputation, but also to their companies’ reputation. by targeting figureheads, challengers in this study addressed executive pay in general, rather than focusing on specific cases. the authors also investigated the impact that challengers had on the targeted executives’ remuneration. the statistics showed that total pay, and bonuses and other performance-based incentives decreased significantly in the year following negative press coverage. no differences in decreases were observed between ceos and non-ceos. the findings suggest that public ‘say on pay’ activism could be effective in addressing the large and growing wage gap in south africa. the authors acknowledge that private engagement might have a significant impact on the decisions of remuneration committees. given that private correspondence and negotiations between institutional investors and companies are typically confidential, scholars do not have access to data on the nature and effectiveness of these engagements. the empirical evidence could nonetheless encourage shareholders of all sizes to take a stronger public stance on seemingly excessive and poorly justified executive pay packages. the findings contradict claims that requests by individual shareholders, or ‘gadflies’ as they are known in the us, ‘waste managerial time and cost firms millions of dollars’ (gantchev & giannetti 2019:1). the evidence also refutes allegations that these shareholders only seek ‘fame’ by questioning and criticising directors at agms (nordén & strand 2011). a growing number of remuneration committees of local entities might be more attentive to these challengers as they realise the importance of preserving their company’s reputation and subsequent ability to attract capital, consumers and employees in a relatively small market. given the empirical evidence, a number of recommendations are offered. remuneration committees of south african soes and listed companies should take cognisance of the growing ‘say on pay’ movement. they could avoid damaging publicity by improving their reporting, especially pertaining to the metrics they use to determine bonuses and other performance-based incentives. this recommendation is made despite claims that increased disclosure could result in pay benchmarking and an upward spiral in total executive compensation (cadman & carter 2014). shareholders, trade unions and other stakeholders are entitled to more transparent explanations of seemingly excessive remuneration. this recommendation is particularly apt in cases where an entity’s wage gap is far in excess of the industry or national average. in a country plagued by inequality, ‘say on pay’ clearly extends beyond discussions on addressing the agency problem, as it effectively touches on the moral fibre of society. remuneration committees should ideally engage with institutional investors prior to agms to inform them about relevant matters and clarify questions that they might have. scholars could extend this pioneering research by including expression of discontent made via social media. it is expected that a growing number of stakeholders will use this platform in future to convey their discontent. more research is also required on best practices for report details on executive pay policies and practices. challengers should be emboldened by the fact that public ‘say on pay’ activism not only raises awareness of key issues, but that it can effectively reduce the total executive pay, bonuses and other performance-based incentives. shareholders of all sizes and other concerned parties are thus encouraged to make greater use of their democratic right to speak out freely: viva ‘say on pay’ democracy in south africa! acknowledgements the authors would like to thank prof. martin kidd for his assistance with the statistical analysis. a special word of gratitude is also extended to dr ruth albertyn who critically reviewed the manuscript. competing interests the authors have declared that no competing interests exist. authors’ contributions s.v. conceptualised the study and wrote most of the article. l.k. and k.m. sourced relevant literature and constructed the database. n.m.-k. wrote certain sections of the literature review and took responsibility for the technical requirements, including referencing. funding this research received no specific grant from any funding agency in the public, commercial or not-for-profit sectors. data availability statement data sharing is not applicable to this article as no new data were created or analysed in this study. disclaimer the views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of any affiliated agency of the authors. references alexander, p., 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ca. yamahaki, c. & frynas, j.g., 2016, ‘institutional determinants of private shareholder engagement in brazil and south africa: the role of regulation’, corporate governance: an international review 24(5), 509–527. https://doi.org/10.1111/corg.12166 yocam, e. & choi, a., 2010, corporate governance: a board director’s pocket guide: leadership, diligence, and wisdom, iuniverse books, bloomington, in. 190 sajems ns 11 (2008) no 2 evaluating the macroeconomic impacts of imf programmes in latin america, 1975-2004: a gee analysis ilhan ozturk faculty of business and economics, cag university, turkey abstract using panel data for 21 latin american countries over the period 1975–2004, this paper analyses macroeconomic effects of imf programmes by using gee methodology. in line with the results of previous studies, it is shown that these programmes have positive effects on the balance of payments, current account and investment. however, they negatively affect budget deficit, per capita gdp, fdi, inflation and consumption. jel e63, f32, 34, 41, o19 1 introduction the basic conception of the imf’s role, as envisioned at bretton woods in 1944, was to promote exchange rate stability and provide short-term finance to deal with temporary current account deficits in advanced countries. thus, the primary role of the imf is to provide credits to member countries in balance-ofpayments difficulties. however, with the breakdown of the “par adjustable peg system” in 1973, the imf lost its major role as the “guarantor of fixed exchange rates” among advanced countries. nevertheless, the imf did not disappear, and its role expanded instead into many new areas. the imf has now evolved into the “crisis manager” and “development financier” for developing countries1. in its 64 years of existence with 184 member countries (out of 191 independent countries in the world) in 2006, the imf has been criticised because of its institutional structure and lending practices. some argue that the imf is a bureaucratic and nontransparent institution with no accountability for its actions. it has also been suggested that fund-supported stabilisation programmes are ineffective and may create moral hazard. although imf programmes have many different objectives, certain characteristics of fund programmes are linked to its mandate to confront external payment problems. this is the so called “three-pronged approach” (knight & santaella, 1997; mussa & savastano, 2000). the first component of this approach involves securing sustainable external financing, since external financing typically evaporates at the onset of a crisis. the imf assists countries suffering balance-of-payments problems by offering short-term loans through its standby arrangements (sba) and medium-term loans through its extended fund facility (eff). another common element of fund programmes is the adoption of demand-restraining measures consistent with available financing. these first two measures comprise the macroeconomic policies intended to restore a sustainable balance between aggregate expenditure and income in programme countries. the last component of imf programmes requires structural reforms intended to promote growth and adjustment in the medium and long terms. these policies aim to reduce government related distortions and structural problems which result in an inefficient allocation of resources in the economy concerned, thereby hindering growth. sajems ns 11 (2008) no 2 191 the multilateral institutions, the imf and the world bank, play a significant role in determining the policy dynamics in many developing countries. as a result of the economic reform programmes supported by the imf, many crisis-hit countries in the 1990s have temporarily succeeded in achieving macroeconomic stabilisation and the existing studies suggest that imf programmes provide a short-run balance of payments relief to crisis-hit countries2. this effort has, however, been accompanied by temporary deceleration of real growth and prolonged recession in some countries. there is considerable debate over the output and employment effects of imf supported stabilisation programmes. this controversy seems especially heated for countries facing acute balance of payments problems and currency crises, as witnessed in 1997 in korea, indonesia and thailand and elsewhere. despite these strong statements about the value of recent imf programmes, no consensus has emerged regarding the impact of these programmes on the real side of the economy3. most empirical studies using panel data sets and regression techniques find that imf-supported programmes improve the balance of payments and current account (e.g. khan, 1990; conway, 1994; bagci & perraudin, 1997; bordo & schwartz, 2000), but views on the ultimate output and employment effects are much more divergent (haque & khan, 1998). as mentioned by hutchison and noy (2003), latin america is a volatile region with a history of exceptionally high inflation rates, substantial macroeconomic instability, and a record of unsuccessful monetary and fiscal stabilisations. latin american countries are also the most frequent users of imf loans (prolonged users) and associated imf-supported stabilisation programmes. in addition, imf programme failures/cancellations are more frequent in latin america and the output costs of completing a programme, when it does occur, are substantially higher than in other regions. the negative effects of the imf programmes may be entirely explained by the poor performance of latin american countries when they enter into an imf-sponsored stabilisation programme. further, there is little evidence of substantial improvement in the current account when entering into an imf programme once the effects of sharp currency depreciations preceding programme approvals are taken into account. as stated by hausmann and gavin (1996), the inflation in latin america is more than 100 times as volatile (measured in standard deviations) than in the industrial countries, and is higher by far than in any other region of the world; real gdp growth in latin america is about two to three times as volatile as industrial countries, and more volatile than in any region other than africa and the middle east; and while a “typical” recession lasts roughly two years both in latin america and in other regions, it involves an output decline in real gdp of about eight per cent in latin america compared to only about two per cent in industrial economies. fernandez-arias and montiel (2001) also point to especially unfavourable external conditions facing latin america, when explaining low growth in the region. linked with macroeconomic instability, most latin american experiences with stabilization reforms have been disappointing. ivanova et al. (2003) investigate the implementation of imf-supported programmes using measures of programme interruptions, compliance with conditionality, and the share of committed funds disbursed. they find that programme implementation depends primarily on the borrowing countries’ political characteristics. in particular, strong special interests, political instability, inefficient bureaucracies, lack of political cohesion and ethno-linguistic divisions are correlated with low implementation rates. to our knowledge, no study has focused on the detailed macroeconomic effects of imfsupported programmes for latin america over the past two decades. owing to the reasons mentioned above, it will be interesting to investigate the effects of imf programmes in this region. this paper focuses on the effectiveness of fundsupported stabilisation programmes for 21 latin american countries to establish whether the imf achieves its own goals in these programmes. it also provides a discussion of alternative evaluation methods and their weaknesses before considering the selection of the evaluation 192 sajems ns 11 (2008) no 2 method. the method of programme evaluation is based on the observation of relevant variables during pre-programme, programme, and postprogramme years. during the sample period, 21 latin american countries which were provided with any of the four structural adjustment programmes: standby agreement (sba), extended fund facility (eff), structural adjustment facility (saf), and enhanced structural adjustment facility (esaf) were studied4. the organization of the paper is as follows. section 2 reviews the literature on the effects of imf programmes and discusses the evaluation methods. section 3 describes methodology, data and model, while section 4 presents the empirical results. finally, section 5 concludes the paper. 2 literature survey in previous decades, one of the central queries has concerned whether the imf stabilisation programmes have accurately achieved their broad objectives. for this purpose, a number of studies have been conducted to measure the effects of imf stabilisation programmes on beneficiary countries’ main macroeconomic indicators, such as the rate of inflation, the current account, overall balance of payments (bop), and the rate of real economic growth, by means of using different approaches. this section undertakes a review of the existing literature with regards to the effects of imf programmes on macroeconomic indicators. whether the imf indeed influences macroeconomic performance has been subject to a huge number of studies5. in the literature, the most commonly employed approaches to measure the impact of the imf supported macroeconomic stabilisation programmes have consisted of the “before-after approach”, “the with-without approach”, “the actual-versustarget approach”, “comparison of simulations” and “generalised evaluation estimator (gee) approach”6. table 1 depicts a summary of the empirical studies relating to measurement of the effect of imf programmes on macroeconomic variables by using different approaches. with regard to the growth effects of these programmes, the literature is far from reaching consensus. haque and khan (1998) find negative effects on growth over the short run, probably owing to the demand-restraining nature of imf conditions, while over the long run, growth increases. alternatively, bird (2001), goldstein and montiel (1986), and bird and rowlands (2003) find that fund programmes have a negative effect on growth. conway (1994) concludes that imf programmes only lead to favourable growth and investment implications in the long run. recent studies of the macroeconomic effects of imf lending often report adverse growth effects. a large number of studies (barro & lee, 2003; bordo & schwartz, 2000; hutchison, 2001; przeworski & vreeland, 2000; stiglitz, 2000) claim that imf programmes do more harm than good for the recipient countries. however, some other studies are reporting positive growth effects of imf lending (dicks-mireaux et al., 2000; bagci & perraudin, 1997; mercerblackman & unigovskaya, 2004). yet, there is still no consensus about the growth effects of imf lending. these conflicting results may arise from several sources, including differences in the types of imf programmes that are investigated; differences in the groups of countries that are investigated (e.g., impoverished developing versus emerging market economies or transition economies); differences in the methodologies that are employed, and the way in which other factors influencing output growth are taken into account7. the discussion of evaluation methods indicates that all types of programme evaluations are problematic, and a perfect solution to the problems of programme evaluation does not exist. however, the recognition of these problems is important with regard to the selection of the evaluation method and the interpretation of evaluation results. empirical studies analysing the effects of imf programmes have employed a variety of methodologies. as discussed in many studies (barro & lee, 2003; bird, 2001; haque & khan, 1998), some of these methodologies possess important shortcomings. in the literature, five types of approaches for the assessment of the sajems ns 11 (2008) no 2 193 macroeconomic outcomes of fund-supported programmes are found to be very common: • the before-after approach this compares the macroeconomic performance of an economy before and after the adoption of fund supported programmes8. • the with-without approach the macroeconomic outcomes of fundsupported programmes are compared by differentiating the programme and nonprogramme countries9. • the comparison of simulation approach this relies on the simulations of econometric models to infer the hypothetical performance of the policies included in fund supported programmes and alternative policy packages10. • actual versus targeted approach actual outcomes for certain key macroeconomic variables are compared to their respective targets, for the variables specified by the authorities and the fund at the inception of the programme11. • the generalised evaluation estimator approach this compares the macroeconomic performance of the programme and nonprogramme countries, adjusting for the initial differences and condition among the countries and controlling for exogenous influences. the recognition of the inherent biases in the “with-without” and “before-after” approaches led to the creation of the generalised evaluation estimator approach (gee) which modifies the “with-without” approach in two ways. first, it accepts the non-random selection of the countries, and identifies the specific differences between the programme and non-programme countries in the pre-programme period. second, it attempts to capture the effect of policy, exogenous shocks and other variables on the macroeconomic outcomes, taking into account the way in which policies would have evolved in the absence of the programme. the reaction function captures the effect of the policy. this function brings those policies into consideration that might have been adopted in the absence of the programme. the reasoning behind the counterfactual approaches is that either they compare the before and after situation in the economy or compare the sample of the programme countries with the sample of those countries that are not involved in the programme. at the same time the given country cannot be in both situations (programme and nonprogramme). therefore, the reaction function is estimated by taking the difference between the vector of the desired values of target variables and the vector of actual values of the target variables in the last period. then, by regarding the exogenous shock as an explanatory variable in the model, it provides a good measure for analysing their impact on the target variables. its application to the case study also overcomes the two well known limitations, selection of random countries, and the problem of the degree of programme implementation, that is, the willingness of governments to implement certain programmes. second, technically the methodology used in this study overcomes the problems associated with the “with-without”, “before after” and the other above discussed techniques, so that the imf estimator estimated with this technique does not provide biased results. consequently it is known as the comparatively better technique to evaluate the fund-supported programmes. 194 sajems ns 11 (2008) no 2 table 1 literature survey on the macroeconomic effects of imf programs effects on programmes* studies and methods period number of programmes number of countries balance of payments current account inflation growth before-after approach reichman and stillson (1978) 1963-72 79 — 0 — 0 + connors (1979) 1973-77 31 23 0 0 0 0 zulu and nsouli (1985) 1980-81 35 22 — 0 0 0 goldstein and monteil (1986) 1974-81 68 58 – – – – pastor (1987) 1965-81 — 18 + 0 0 0 khan (1990) 1973-88 315 69 0 + 0 0 schadler et al.(1993) 1983-93 55 19 + – – + hutchison (2001) 1975-97 — 67 — — — – evrensel (2002) 1971-97 — 91 – – 0 hardoy (2003) 1970-90 460 69 0 evrensel (2005) 1971-97 — 19 – – + – with-without approach donovan (1981) 1970-76 12 12 — — – + donovan (1982) 1971-80 78 44 + + – – loxley (1984) 1971-82 38 38 0 0 – 0 goldstein and monteil (1986) 1974-81 68 58 – + – + gylfason (1987) 1977-79 32 14 + — 0 0 khan (1990) 1973-88 259 69 + + 0 0 faini et al. (1991) 1978-86 — 93 0 hardoy (2003) 1970-90 460 69 0 hutchison (2004) 1975-97 455 25 0 generalised evaluation estimator (gee) goldstein and monteil (1986) 1974-81 68 58 – – + – khan (1990) 1973-88 259 69 + + – – doroodian (1993) 1977-83 27 43 – – — 0 conway (1994) 1976-86 217 73 — + – – bagci and perraudin (1997) 1973-92 — 68 + + – + dicks-mreaux et al. (2000) 1986-91 88 74 — — 0 + bordo and schwarz (2000) 1973-98 — 24 – przeworski and vreeland (2000) 1970-90 465 135 – sajems ns 11 (2008) no 2 195 hutcison (2003) 1975-97 461 67 – hutchison and noy (2003) 1975-97 764 67 0 – butkiewicz and yanikkaya (2003, 2005) 1970-99 407 100 – nsouli-mourmouras-atoian (2005) 1992-2000 124 92 0 easterly (2005) 1980-99 — 20 0 barro and lee (2005) 1975-99 — 130 0 – dreher (2006) 1970-2000 — 98 – atoian and conway (2006) 1993-2002 181 95 0 comparison of simulations khan and knight (1981) 1968-75 — 29 + + – – actual versus target reichman (1978) 1973-75 21 18 + — + + zulu and nsouli (1985) 1980-81 35 22 — 0 – – * direction of change: (+) indicates positive effect, (–) indicates negative effect, (0) indicates no effect. this technique is capable of serving the objectives set by this study. first, by taking economic growth, current account balance, inflation rate, budget deficit, balance of payments, consumption, foreign direct investment (fdi) and private investment as the target variables, we can estimate the impact of the fundsupported programmes on the macroeconomic performance of latin american countries. second, by including the reaction function in the model it also deals with the difference between the targeted and actual outcomes and furthermore concentrates on the effect of the other policy options that are not included in the programme design by taking the vector of the policies which might have been adopted in the absence of the programmes. third, by including the vector for the exogenous variables, their effect on the target variable is also incorporated. 3 methodology, data and model the choice of the period rests on the availability of data. annually data on macroeconomic v a r i a b l e s a r e o b t a i n e d f r o m t h e wo r l d development indicators (wdi online, world bank), imf international financial statistics (ifs) and penn world data. the analysis covers the time period 1975–2004 for 21 latin american countries12. since some of the data are not available for all countries or periods, the panel data are unbalanced and the number of observations depends on the choice of explanatory variables. the methodology that has been most widely applied was developed by goldstein and montiel (1986) by adapting techniques from the literature on labour training evaluation; it was employed for the evaluation of imf programmes in this study. essentially, this technique, referred to as the general evaluation estimator (gee) or modified control group, involves using policy reaction functions estimated for countries that did not have support from a particular international financial institution (ifi) to approximate the counterfactual for countries that did enjoy ifi backing for their programme13. the gee is a potentially powerful technique, although, as goldstein and montiel (1986) point out, it entails many restrictive assumptions; for example, it must be possible to characterise macroeconomic policy choices in a relatively simple reaction function based on quantifiable data, and it must be credible that the reaction 196 sajems ns 11 (2008) no 2 functions estimated for countries that do not receive ifi support describe the counterfactual for countries that do receive such support. suppose that the target variable is determined according to: y x w dij oj jk ik jh ih j imf i ij= + + + +b b a b f (1) where y ij is the jth target variable (e.g. current account balance, economic growth and inflation rate) in country i; x ik is a k-element vector of policy variables (e.g. the exchange rate, fiscal deficit, domestic credit, inflation rate) that would be observed in country i in the absence of imf support; w ih is an h-element vector of foreign exogenous variables (e.g. the terms of trade, international interest rates) for each ih country i; d i is a dummy variable equal to 1 if an imf programme is in effect during the period in question and zero otherwise; and ijf is a zero mean, fixed variance, serially uncorrelated error. for the jth target variable, jkb and jha are kxl and hxl vectors, respectively, of fixed parameters. the parameter imfb measures the effect of the programme during this period on variable yij . it is important to note that the definition of b means that the x i refers to the policies that would have been adopted in the absence of a programme. the vector x i is therefore directly observable only if there is a fund-supported programme; for a non-programme country x i must be estimated. one way in which x i can be estimated is via the simple reaction function: ( )x y – yi i d i 1= +c hd -7 a (2) where y i is a vector of target variables, y i d is the vector of their desired values, c is an adjustment parameter, ih is a vector of random shocks, and d is first-difference operator. equation (2) basically states that the change in the country’s macroeconomic policy instruments between the current and previous period will be the function of the difference between the desired values of the target variables during this period and their actual values during the last period. the model can be employed to examine the statistical properties of the before–after (ba) and with-without (ww) approaches to an estimation of the programme effects. the before-after estimator bab is: y i pforba ib != d (3) where p denotes the set of programme countries during the current period. the expected value of this estimator, conditional on observed values of the foreign exogenous variables, is: ( \ , ) ( \ , )e i p w w e x i p wba imf i3 2! != + + +b b b b fd d d d d (4) which is equal to the true value of imfb only if: ( \ , )e x i p w – wi2 3!+ =b f bd d d d (5) the before-after estimator is unbiased if one expects that the non-programme determinants of y i would have behaved in such a way as to leave the y i unchanged, on average, between the programme and the non-programme periods. in other words any changes in the external market, innovation in policies, and other unobserved variables cancel each other out. the ww estimator wwb is given by: y – yww ij nj=b d d (6) where ynjd is the average value of the yijd over some set n of non-programme countries. since we can observe xd and ijdf for all i n! , the information set, defined as x, now consists of: , ,x for i n wi ijx != fd d d_ i$ . sajems ns 11 (2008) no 2 197 taking expectations of wwb conditional on i p! and x we have: ( \ , ) ( \ , ) ( )e i p e x i p – xww imf i ij n nj2 2! != + + +b b b f b fx d d x d d (7) the ww estimator will be unbiased if: ( \ , )e x i p xi ij n nj2 2b d df x b d df!+ = + (8) in other words, if it can be expected that in the absence of the programme, the country would have behaved just like the average member of the non-programme reference group, then the estimator will be unbiased. an alternative to the ba and ww approaches can be derived by using equation (2) to substitute out the unobservable policy changes that would occur in the absence of a fund programme (i.e. for x i ) from equation (1). the generalised evaluation estimator is: ( ) ( ) ( ) ( )y – y x w d1ij oij ij j i ’ j j j imf i ij i j1 1 != + + + + + +b c b b a b h bd -l l (9) equation (9) constitutes the basic gee reduced form model as applied in earlier studies. econometric estimation of equation (9) produces an estimate of the imfb that is not subject to the criticism levelled at the ba and the ww estimators. this equation takes care of the estimation of the counterfactual by controlling for the factors that are systematically related to the policies that would have been followed in the country without the programme, which is to include the lag values of the target variables and the policy instruments in the specification (haque and khan, 1998: 21-3). the equation would be estimated by ols estimation. 4 empirical results and discussion the model is nested so as to test the simultaneous effect of: a) the imf programmes, b) policy shocks, and c) foreign exogenous variables. it serves our objective of diagnosing the impact of fund-supported programmes, while taking into account the effect of other policy options that might have been adopted in the absence of the programmes and foreign exogenous variables. the model takes the imf programmes, other policy responses and the foreign exogenous variables as different explanatory variables, which makes it easier to gauge the net effect of the fund-supported programmes on the target variables. the targeted macroeconomic variables used in this study are the current account balance, balance of payments, budget deficit, gdp growth, fdi, inflation rate, private investment and consumption. equation (3) is estimated for all eight-target variables, discussed above. as we deal with panel data, the panel data unit root test is used to check for stationarity. the results suggested that the data is stationary for all the target variables at their levels. the final results find no auto or partial autocorrelation, while the whiteheteroschedasticity test shows no evidence of heteroschedasticity. the statistical parameters for the overall significance are represented in table 2. the values of r2 for the equations of the per capita gdp, balance of payments, budget deficits and current account balances are 0.99, 0.38, 0.36 and 0.28 respectively. however, the r2 is quite low for foreign direct investment, consumption, investment and inflation. the regression results for the current account balance, balance of payments and investment indicate that the effect of the imf programmes is positive. their coefficients have positive signs and the results are statistically significant. however, the results of the inflation, foreign direct investment, budget deficits, consumption and per capita gdp indicate that the imf programmes have negative effects. their coefficients display negative signs and the results are statistically significant. the regression results indicate the positive impact of imf programmes on the balance of 198 sajems ns 11 (2008) no 2 payments, as expected. in other words, imf programmes significantly improve the balance of payments during the programme years. the balance of payments estimator provides the result that imf programmes have contributed to the balance of payments balance. the parameter of the imf (0.60), with positive sign and statistically significant, shows that imf programmes have brought about a considerable decrease in the balance of payments deficit. the inflation estimator provides the result that imf programmes have contributed to the decrease in the rate of inflation. the parameter of the imf (-22.7) shows that imf programmes have caused a considerable decrease in the rate of inflation, which is a chronic disease for the economy. the results of the investment and current account balance indicate that the imf programmes lead to positive effects. therefore, the imf programmes have increased the investments and improved the current account balance of the latin american countries during the programme years. on the other hand, fund-supported programmes cause a deterioration in the growth and budget deficits, reduce foreign direct investment and the level of consumption in programme countries. the fall in consumption and inflation can be explained in terms of the programmes applied by the imf because the imf recommends tight fiscal policy, tight monetary policy and devaluation to the programme countries. table 2 gee model results capita (y) bop ca bd fdi cons inv inf y (-1) 1.003615 0.000909 0.000944 0.000521 0.000223 –0.000991 –0.003785 –0.011426 [224.4535] [4.362005] [5.677215] [3.106647] [3.198829] [-3.241090] [-5.523943] [0.498888] imf(-1) –0.473821 0.608970 0.262611 –0.452817 –0.100979 –0.758756 0.576528 –22.74630 [2.446832] [6.817796] [3.712911] [–5.463841] [–3.113621] [–5.720891] [1.949856] [–2.126083] dc –0.612867 –0.166685 –0.067202 –0.096054 0.006158 –0.014267 0.066640 2.527768 [–2.898299] [-15.61252] [–8.702259] [–11.74708] [1.768933] [–0.989124] [2.065208] [1.930480] c 39.15443 1.839061 –4.083763 –0.315636 0.782028 73.11110 34.43249 45.24279 [1.978338] [1.950304] [–5.523479] [–0.379741] [2.300012] [53.81729] [11.30644] [0.426438] r-squared 0.991775 0.385585 0.285342 0.365158 0.054860 0.128362 0.067355 0.022533 adj. r-squared 0.991718 0.381092 0.280173 0.358528 0.047433 0.122148 0.060752 0.015372 f-statistic 17304.21 85.81931 55.19916 55.07489 7.386154 20.65404 10.20101 3.146614 durbinwatson stat. 1.332262 0.684411 0.643495 0.663633 0.533936 0.433605 0.861045 1.232388 number of observations 579 552 558 388 514 566 570 551 cross section 21 21 21 20 21 21 21 21 see 176.0643 8.016187 6.412259 5.606900 2.578393 11.95425 26.80111 872.8239 note: imf is endogenous, while dc and capita are exogenous policy variables. explanations: capita (yper capita gdp), dc (domestic credit), ca (current account), bop (balance of payments), bd (budget deficit), fdi (foreign direct investment), cons (consumption), inf (inflation), c (constant term). sajems ns 11 (2008) no 2 199 the regression estimates were obtained using an ordinary least squares (ols) procedure. standard errors and t-statistics of coefficients are computed using white’s heteroschedasticityconsistent variance–covariance estimator. 5 conclusion this paper analyses the macroeconomic effects of imf sponsored stabilisation programmes by using the gee methodology. the data used in this study refer to 21 latin american countries that were recipients of imf programmes during the period 1975–2004. four types of balance of payments programmes are considered: standby agreement (sba), extended fund facility (eff), structural adjustment facility (saf), and enhanced structural adjustment facility (esaf). macroeconomic variables used in the empirical analysis include the current account balance, balance of payments, budget deficit, gdp growth, fdi, inflation rate, private investment and consumption. the results of the gee analysis indicate that imf programmes significantly improve current account, balance of payments and investment during the programme years. although stabilisation programmes seem to provide short-term relief in balance of payments, these improvements are not sustained during the post-programme period. however, these programmes exert a negative impact on budget deficit, per capita gdp, fdi, inflation and consumption in programme countries. the study suggests that fund-supported programmes have worsened the budget deficits, per capita gdp, fdi and level of consumption in latin american countries during the programme years. the findings of this study and previous studies in the literature surveyed suggests that imf sponsored stabilisation programmes are unsuccessful, and these results indicate that latin american countries have been implementing inconsistent macroeconomic policies. the empirical results suggest that, when a country begins with a balance of payments crisis and imf involvement enables it to overcome this, the macroeconomic situation deteriorates. the failure of stabilisation programmes and poor performance of latin american countries can be explained by the following factors: the lack of policy credibility, inadequate financial structure, political instability, lack of political cohesion, external shocks combined with poor institutions, inefficient bureaucracies, a history of poor macroeconomic management, low completion of imf programmes, and the nature of imf sponsored stabilisation programmes. considering the revolving nature of the fund support, this result is inconsistent with the effectiveness of stabilisation programmes and may be interpreted as being a signal of moral hazard. endnotes 1 see krueger (1998), and bordo and james (2000) for discussions of the changing role of the imf. 2 see donovan (1982), doroodian (1993), conway (1994), przeworski and vreeland (2000), and evrensel (2002). 3 there is a large literature review regarding the effects of imf-supported stabilisation programmes. see table 1 for these studies. 4 while sbas provide balance of payments support to middle and high-income developing countries, eff, saf, and esaf are designed for low-income developing countries. standbys are provided for a year with a possible extension of up to three years. other programmes last longer and imply longer periods of repayment (5–10 years). see schadler et al. (1993) for more information on these programmes. 5 for a detailed summary of the imf’s effect on economic variables see haque and khan (1998); bird (2001); butkiewicz and yanikkaya (2005); and dreher (2006). 6 see goldstein and monteil (1986); khan (1990); killick et al. (1992). 7 see butkiewicz and yanikkaya (2005) for a detailed review. 8 this is the most popular approach in the early literature of the fund-supported programme. the first study to use this was by reichman and stillson (1978). it compares the macroeconomic performance before and after the adoption of a fund-supported programme, assuming all other factors remain constant. it has the advantage of ease of calculation but whenever the other factors that are assumed constant by this approach affect the macroeconomic position of the economy, it fails. this is because the fund-supported 200 sajems ns 11 (2008) no 2 programme is one of those exogenous shocks that hit the economic variables. hence if there are other factors such as terms of trade, industrial growth, movements in the interest rates etc., along with the fund-supported programme that affect the economic variables of the country, they produce biased results. 9 this is another counterfactual approach, which tried to overcome the drawback of the before-after approach as this takes the panel of the programme and non-programme countries and assumes that both these groups of countries have the same nonprogramme determinants. though it overcomes the problem of the before-after approach, it also leads to a few inherent problems. the assumption of the same non-programme determinants existing between the programme and non-programme countries is quite unrealistic, because the countries selected are not taken randomly; in fact they are selected for having a poor economic performance prior to the programme. this implies that the programme countries had a weaker position prior to the programme than the non-programme countries. thus the macroeconomic determinants between these two groups of countries would not be the same, and in this position the “withwithout” approach would produce biased results. 10 this approach differs from the other two in that it does not consider the actual outcomes of the programme but it relies on the econometric model to incorporate the impacts of the fundsupported programme. khan and knight (1981) and khan and knight (1985) have gauged the macroeconomic impacts of the fund-supported programme. but this approach attracted a famous lucas critique that the actual effects can turn out quite different from the simulated ones. second, due to credibility factors, the effect of the policy can be different when it is implemented inside and outside the fund-supported programme. 11 this is not one of those approaches that are frequently used in the literature of the fundsupported programsme. it compares the targets set by the programmes for certain variables of interest to the actual outcomes of the programme. the drawback of this is that the targets are mostly not available to the public. it is also deficient because targets may be overly ambitious, so that failure to achieve them does not necessarily imply that the adjustment programme was not effective. conversely, the targets could be under ambitious so that exceeding them does not always mean that the programme was effective. 12 country selection is driven by data availability. the countries included in this study are argentina, belize, bolivia, brazil, chile, costa rica, dominica, dominican republic, ecuador, el salvador, guatemala, guyana, haiti, honduras, jamaica, mexico, nicaragua, peru, trinidad and tobago, uruguay and venezuela. 13 applications of the gee can be found in greene (1989), khan (1990), faini et al. 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(1985) “adjustment programs in africa: the recent experience”, imf occasional papers 34, washington, d.c. abstract introduction data and variables econometric methodology results conclusion acknowledgements references appendix 1 footnotes about the author(s) umakrishnan kollamparambil school of economic and business sciences, university of witwatersrand, johannesburg, south africa mfongeh n. etinzock school of economic and business sciences, university of witwatersrand, johannesburg, south africa citation kollamparambil, u. & etinzock, m.n., 2019, ‘subjective well-being impact of old age pension in south africa: a difference in difference analysis across the gender divide’, south african journal of economic and management sciences 22(1), a2996. https://doi.org/10.4102/sajems.v22i1.2996 original research subjective well-being impact of old age pension in south africa: a difference in difference analysis across the gender divide umakrishnan kollamparambil, mfongeh n. etinzock received: 25 jan. 2019; accepted: 03 oct. 2019; published: 06 dec. 2019 copyright: © 2019. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: south africa provides old age pension (oap), a non-contributory means-tested income transfer to persons aged 60 and above. more than two-thirds of the elderly population report receiving the oap. women have historically had a lower pension eligibility age of 60, while the eligibility of men decreased from 65 to 60 between 2008 and 2010. aim: this study analyses the impact of the oap on the subjective well-being of the elderly in south africa. the study aims at understanding the differential impact on the subjective well-being of male and female recipients. methods: the study adopts the difference in difference (did) impact evaluation framework to establish the impact of oap using a sub-sample of data for elderly persons aged between 55 and 64, collected from the first four waves of the national income dynamics study. linear and non-linear did models are estimated as robustness checks given the ordinal nature of the dependent variable. results: the oap variable consistently produced positive and significant estimates for the sample as a whole. further, anticipatory effect of oap was not found to exist. a gender specific analysis indicates that female recipients have a positive and significant change in well-being as a result of oap, while male recipients did not. conclusion: the difference in the well-being impact of oap between male and female recipients can be attributed to the gender difference in the use and meaning of pensions. our findings question the uniform criteria introduced for male and female recipients for oap in south africa. keywords: state transfers; old age pension; difference in difference; south africa, impact evaluation. introduction the south african state provides old age pension1 (oap) which is a non-contributory means-tested income transfer to persons aged 60 years and above. this governmental support was introduced in 1928 for only white citizens and coverage was extended to the rest of the population only in the early 1990s (legido-quigley 2003). women have historically had a lower pension eligibility age of 60 years and above, while the eligibility of men declined from 65 to 60 years between 2008 and 2010 (schatz et al. 2012). the value and coverage of oap has consistently risen since its implementation and stands at r1780 as announced in the 2019 budget. sienaert (2008) and woolard and leibbrandt (2010) argue that the importance of the programme is underscored by the fact that more than two-thirds of the elderly population are pension recipients. the demand for the provision of social pensions is driven by poverty among the elderly as well as the breakdown in living arrangements (multi-generation), wherein younger individuals are either no longer able or willing to provide care for their aging parents (case & deaton 1998). although the desired policy outcome of social grants in south africa – inclusive of the oap – has been to redistribute income to the poor, elderly population and reduce income inequality, its role in life satisfaction has either been equated to or neglected in favour of economic well-being. there are a plethora of studies that have investigated the impact of grants on economic well-being impacts. for example, ranchhod (2006) and sienaert (2008) studied the oap impact on labour supply, while duflo (2000) studied the gender specific effects of pension income on child health; but very few studies have analysed the impact on subjective well-being. given that the oap grant is over three times the value of the food poverty line (r547 in 2018), it represents a sizable source of income for the elderly and is therefore expected to produce positive and significant impacts on life satisfaction. ulloa, moller and sousa-poza (2013) conducted an extensive review of the theoretical literature from economics, psychology and gerontology to provide insights into how subjective well-being evolves across an average lifespan. however, the study concedes that it is difficult to estimate, with certainty, whether the relationship between age and well-being across a lifespan is linear or convex. based on a cross-country analysis shin (2018) analyses the impact of public pension on well-being but does not find a significant relationship. one limitation of this study is that it does not identify a causal impact and further does not differentiate gender. contrary to shin (2018), grogan and summerfield (2019) used a fuzzy regression discontinuity methodology in a russian sample and found pension to positively impact on the well-being of predominantly women. the study used a five-point scale to capture the life-satisfaction spectrum, however, the literature indicates that life satisfaction is ideally measured on a 10-point cantril ladder scale (ortiz-ospina & roser 2019). the only known study, to the best of the authors’ knowledge, that directly relates oap to subjective well-being of recipients in south africa is schatz et al. (2012). the study finds that despite improving financial well-being, the impact of pensions on subjective well-being is gendered and transitory. according to the study, well-being for recently pension-eligible women (aged 60–64 years) was higher compared to women in the pre-pension-eligible category (age 55–59 years), confirming the positive impact of pension on the elderly. schatz et al. (2012)’s study suffers from several methodological issues that may compromise the reliability of the findings. the first of these problems relates to the data used in the study. in the data used, there was no direct measure of pension receipt leading the authors to rely on age eligibility requirement to indicate that the grant was received. this is a problem because the south african oap has age and income thresholds which must be met for an individual to qualify. therefore, attaining the legal age of 60 years does not necessarily imply that the individual qualifies for a grant. consequently, they admit that their results represent intent to treat and not necessarily average treatment on the treated effects. the second problem has to do with the model implemented, wherein the logistic regressions used do not necessarily establish causal effect. further, the study suffers from being regionally constrained as it was conducted in the agincourt sub-district in rural north-east south africa near the border with mozambique and cannot be said to be wholly representative of south africa. in this study we make several improvements to schatz et al. (2012) due to the availability of the national income dynamics study (nids) longitudinal data set which contains more detailed information on actual grant recipients enabling an impact assessment of the oap. we also test for gender differences, based on the arguments made by schatz et al. (2012) that the differences in gender roles and gendered poverty stresses preand post-pension receipt can result in statistically significant differences. further, since men are more likely to have income prior to pension receipt, their pensions do less for household members’ health and well-being compared to women (case & deaton 1998; duflo 2003). we thus also expect the impact of oap to be lower for men than for women. furthermore, we also test for anticipation effect for men and women. the analysis is undertaken within a quasi-experimental setting which produces the causal average treatment on the treated. it is for these reasons that this study makes an original contribution to literature. data and variables data the empirical analysis makes use of data from the nids conducted by the southern africa labour and development research unit (saldru). it is the first national panel study to document the dynamic structure of a sample of household members in south africa (leibbrandt, woolard & de villiers 2009). a total of 29 733 core sample members are tracked over four waves from 2008 to 2015 (chinhema et al. 2016), allowing for analysis of key changes in peoples’ experiences of their incomes, expenditure, assets, access to services, education, health and other dimensions of well-being. the sample for the current study is restricted to an unbalanced panel of 1277 individuals aged between 55 and 64 years over the first four nids waves. the starting point for this quasi-experimental design is the identification of treatment2 and control groups. individuals in the treatment group consists of all elderly persons aged3 between 60 and 64 years who receive pension on turning 60 years. there are two initial periods (prior to turning 60) without grant income proceeded by two post periods with grant income. control group a (treat a) is composed of individuals who are 55–59 years old and earn a monthly income of less than r12 300 which is also the government threshold at which co-residing couples qualify to receive the grant (sassa 2017). the main reason for including this group is to check for the anticipatory effect of the oap. for the purpose of this study, individuals are weighted in accordance with the panel weights correcting for potential over-concentration or under-concentration of observations due to non-responses and attrition in the panel over the four waves (chinhema et al. 2016). in general, the distribution of life satisfaction scores is similar regardless of whether the weights are applied (kannemeyer 2016). given the unbalanced nature of the panel data set (1277 individuals accounting for 2931 observations over the four waves), the panel weight serves the purpose of correcting for this bias. variables the dependent variable in this study is subjective well-being which is measured as the level of satisfaction that an individual currently experiences. within the adult questionnaire of the nids data set, individuals 15 years and above are asked to rate the current level of general life satisfaction on a scale from 1 to 10, where 1 represents ‘very dissatisfied’ and 10 represents ‘very satisfied’. following woolridge (2012), we consider the variable as cardinal in nature given that the number of categories is more than eight. as such, linear estimation techniques are considered appropriate. nevertheless, as a robustness check we collapse the response categories to three to account for measurement bias and apply ordinal regression techniques. in the ordinary least square (ols) regressions and fixed effects (fe) models, the target variable is the binary dummy variable for oap recipient. the nids adult data questionnaire provides alternative indicators of the variable. in one instance respondents are asked to state if they currently receive the oap grant while in another the actual amount of grant received is stated. the preferred approach in capturing the variable is to create a dummy which equals 1 if the elderly person receives oap, and 0 otherwise. based on the poverty alleviation and empowerment effects cited in literature (case & menendez 2007; duflo 2003), we expect the oap variable to have a positive and significant coefficient. due to the multi-determinant nature of the dependent variable, other covariates have been included in the various models in accordance with factors that determine life satisfaction in the literature. income is a key determinant of well-being (herrera, razafindrakoto & roubaud 2006; hinks & gruen 2007; inkeles 1960). the measure of absolute income was constructed as total household monthly income (adjusted for inflation) divided by the household size (per capita income). we also include the square of per capita income to account for the diminishing returns to income that are suggested in the literature (kollamparambil 2019). both per capita income and its square are divided by 1000. it has been recognised that individual utility or welfare functions may be interdependent, and that relative or comparison income may play an important role in determining well-being. subjective well-being is predicted to be diminished by the higher income of others, through feelings of relative deprivation or reduced status (posel & casale 2011). the subjective measure of relative income is directly observable in the nids data. all adults are asked to assess their relative economic rank in south africa by identifying their position on a six-rung ladder from poorest (1) to richest (6). the expected sign for the relative income variable is positive. south african literature (ebrahim, botha & snowball 2013; hinks & gruen 2007; moller 1998) highlights that well-being differs substantially across races, with the black african race group experiencing lowest levels of well-being. as such we include a dummy variable taking the value 1 for the black race and 0 for others. the coefficient is expected to be negative and significant. health status has been noted as one of the most important determinants of subjective well-being and its significance is usually stronger than other variables such as income, education and unemployment (gerdthman & johannesson 2001). kollamparambil (2019) notes that in the south african context health is a critical determinant of well-being. perceived health status is measured subjectively and ranked as excellent (5), very good (4), good (3), fair (2) or poor (1). gender is included in the estimations as a dummy variable, 1 being male and 0 otherwise. studies in other country contexts have observed men to have higher levels of life satisfaction compared with woman (meisenberg & woodley 2015), however, in the south african case this has not come out statistically significant in recent studies (kollamparambil 2019). marital status is obtained from the adult questionnaire where responses were classified as married, living with a partner, widow/widower, divorced/separated and never married. we collapsed these response categories by creating a dummy variable equal to 1 if the individual is currently married or living with partner and 0 otherwise. blanchflower and oswald (2004) and myers (1999) provide evidence that married persons have higher subjective well-being than persons who are either separated, divorced or widowed. botha and booysen (2013) also find married individuals to have higher levels of life satisfaction in the south african context. the study further finds that married women report greater life satisfaction compared to women in other relationship arrangements. there are various ways the education variable could be constructed but to give a simple and clearer measure, the various levels of education are converted into a single continuous variable measuring the total number of years of schooling the individual has obtained. because education has both economic and non-economic benefits, it is assumed years of schooling will result in positive impacts on life satisfaction (knight, song & gunatilaka 2009; ravallion & lokshin 1999; throop 2011). years of schooling is therefore expected to have a positive and significant impact on life satisfaction in south african literature (ebrahim et al. 2013; kollamparambil 2019). evidence on the impact of engaging in religious affiliations has produced consistent positive and significant impacts on life satisfaction (clark & lelkes 2005; hayo 2004). the importance of religious activities in the nids data set is categorised as not important at all, unimportant, important and very important. out of these four categories, a dummy variable is coded as 1 if the individual finds religious activities important or very important and 0 if not important at all or unimportant. based on the south african studies that have highlighted the important role religion plays in the well-being of individuals (kollamparambil 2019), we expect the coefficient to be positive and significant. we also include a variable that measures individuals’ perceived safety in their communities (powdthavee 2005). naturally, if they feel their neighbourhood is unsafe and that crime in their neighbourhoods is high, this is expected to impact negatively on their subjective well-being. the size of the household determines the support structure or responsibility of the elderly and hence is expected to impact on individual well-being (díaz-venegas, sáenz & wong 2017). in south africa and most african countries, it is not unusual to find extended family members living with a breadwinner who supports them financially (malde, scott & vera-hernández 2015). besides the heavy financial burden of extended family, frequent quarrelling and fighting are more prevalent in larger families and these are expected to negatively affect life satisfaction of the individuals in the household. detailed definitions of variables included in the analysis are provided in table 1-a1, in appendix 1. econometric methodology the causal impacts of the old age grant on subjective well-being is established in this article using a quasi-experimental difference-in-difference (did) regression design. particular attention is paid to overcome the differences in unobservable characteristics between programme participants and non-participants through propensity score matching (psm) (wapenaar & kollamparambil 2019). in doing this, the estimation procedure eliminates the problem of sample selection bias – the possibility that those who are eligible or who take up the grant are systematically different from those who do not qualify (white & sabarwal 2014). this framework, along with robustness checks, establishes an argument for causality. various models are estimated, each increasing in sophistication and robustness by improving in capacity to account for potential biases of the treatment estimate generated by confounding factors, endogeneity and non-random self-selection into treatment (mulcahy & kollamparambil 2016). due to the ordinal nature of the life satisfaction variable, the use of linear models that assume the cardinality of subjective well-being scores is brought into question. however, woolridge (2012) suggests that ols may be used with numerically labelled scales that have more points, usually 8 and above. a limitation often mentioned about the cantril ladder measure is that it assumes that the distance between response categories is equal. moreover, there is an inherent subjective element in the association of each category on the ladder with the level of well-being. these two elements result in measurement bias which can be minimised by rearranging the 10-point scale into fewer categories. therefore, as a robustness check we create three categories on subjective well-being and undertake non-linear ordinal did estimations as well. the methodologies employed in this article all take into consideration the panel structure of the data, controlling for individual-specific effects and time invariant unobservable characteristics. these models are presented in the following sections. model 1 to account for the socio-demographic and socio-economic factors that determine life satisfaction, we employ a pooled ordinary least square regression (pols) which is modelled as follows: yi is life satisfaction for individual i, oap is a dummy 1 for receiving pension income and 0 for not receiving pension. xi is a vector of explanatory variables explaining individual i and t is the time trend variable. the panel data structure is ignored for this baseline estimation. model 2 given that within the panel data structure, the same individuals are interviewed in every wave, we expect some year-to-year correlation with a given individual. thus, the model suffers latent person-level effects which this model can more adequately account for. the fe model takes care of this by eliminating the time invariant individual fe. the fe model is specified as: is the demeaned residual, yit is life satisfaction for individual i at time t, xit is a vector of covariates including oap variable for individual i at time t. fixed effects models, however, do not estimate the coefficients of time invariant variables and do not establish causal effects. model 3 the third model employed is the linear did regression approach which attempts to mimic an experimental research design using observational data. as discussed earlier, the sample consists of individuals aged between 55 and 64 years; individuals who begin receiving oap in the third period (when turning 60 years) is defined as the treatment group. they therefore have two initial periods without grant income proceeded by two post periods with grant income. on the other hand, we have the control group that are never exposed to treatment as they do not qualify for oap based on income criteria. based on woolridge (2012), the did model for estimating treatment effects is specified as follows: yit is life satisfaction for individual i at time t. postit is an indicator variable that takes a value of 1 if the measurement of individual i is in the post-programme period (third and fourth periods) or 0 if it is in the baseline period (first and second periods). treat represents an indicator variable that takes the value of 1 if individual i belongs to the treatment group or 0 if the individual i belongs to the control group, while the interaction term postit * treat it measures programme impacts with the simple did estimation. xit is a vector of time varying covariates, μ1represents individual level fixed effect and εit is the error term. the limitation we are still left with regards the self-selection of individuals into the treatment group due to the confounding factors. we account for this bias using a psm method. propensity score matching did (psm-did) (model 3.1) mimics randomisation by creating a sample of units who received the treatment comparable on all observed covariates to a sample of units who did not receive the treatment. this is done by collapsing the different observable covariates into a single balancing score 0 < p (t=1|x) = p(x) < 1 for everyone representing the likelihood of treatment. individual propensity scores are computed with the psmatch2 stata command utilising the logit regression and these are used to weigh the subsequent did regressions. the psm-did estimation hence is considered to be the most robust of all our estimators. nevertheless, we benchmark it against ols, fe and did estimators for purposes of comparison. lastly, the literature suggests there is a possibility that individuals who are a few years away from qualifying for the grant might behave differently in anticipation of this new income source which can possibly bias our estimates (salinas-rodríguez et al. 2014). it is for this reason that we further estimate anticipation effects. treatment group a is composed of individuals who are 55–59 years old having a monthly income of less than r12 300 – the government threshold at or below which couples qualify to receive oap. that is, model 4 replaces treat with treat a to capture anticipatory effects: equations 3 and 4 are also estimated separately for male and female respondents to garner gender differences in the impact of oap. to ensure the internal validity of did results, the parallel trend assumption must be tested. parallelism requires that the conditional pre-treatment trends in the dependent variable should be equivalent for the treatment and control groups (white & sabarwal 2014). this was tested using regression and the results are shown in table 1. table 1: parallel lines assumption result: quasi-experimental sample. the method of testing the parallel trend assumption adopted is developed by pischke (2005:7). the test interacts the treatment variable with time dummies for each period excluding the interaction of the last pre-treatment period. as is evident from table 1, the coefficient of d1 is not statistically significant indicating that the treatment and control groups had similar outcome trends prior to the treatment and that any changes experienced between treatment and control after the treatment period is due to receiving the grant. descriptive statistics the panel weighted means and standard deviations for the variables included in the models are shown in table 2. panel weights are used to address the attrition bias of individuals over the four waves (chinhema et al. 2016). these have been separated into cohorts who receive oap and those that do not. this is done to illustrate observable differences in the covariates between the treatment and control groups. table 2: summary statistics of societal, individual and household characteristics (panel weighted). results the overall significance of all the estimated models are found to be significant at the 1% significance level. within the ols, the variable of interest is oap which has a positive coefficient of 0.375 and is statistically significant in model 1 at the 1% level of significance. accounting for fe in model 2 we experience a reduction of the coefficient to 0.257, statistically significant at the 5% level. these first two results indicate that receiving oap contributes positively to the life satisfaction of the elderly. however, there exists an upward bias in the life satisfaction variable induced by omitted variables associated with time invariant unobservables and self-selection biases that inhibit consistent and efficient estimates (wapenaar & kollamparambil 2019). turning focus to models 3 and 3.1, which are the simple did as well as a did combined with propensity score, the new variable of interest becomes treat*post. these models fare better than the first two models at estimating robust coefficients because they eliminate confounding factors which cause biased estimates. the coefficient of the treat variable in the did model is insignificant confirming that there are no signs of structural differences in outcomes for the treatment and control groups. comparing coefficients from these two models, it is seen that the estimates from both models are almost identical after correction for biases and self-selection into treatment. however, we make use of the did psm estimation for interpretation as it better accounts for the lack of randomisation in selection of individuals into the treated and control groups. the coefficient of interest (treat*post) in the psm-did model is positive and statistically significant at the 95% confidence level indicating that oap increases life satisfaction by an average of 0.478 points on the 10-point life satisfaction scale. among the control variables included, it is clear that black africans have substantially lower life satisfaction compared to other races. regarding the societal variables, the most significant contributor of life satisfaction to the elderly is the income perception of the individual which shows how they rank themselves in relation to others based on income level. the variable is statistically significant at the p < 0.01 level in all models estimated which implies that the life satisfaction of elderly persons is significantly influenced when they compare themselves to others. these results among the older age groups are similar to the existing studies among the south african population as a whole (kollamparmabil 2019; posel & casale 2011). as expected, income tends to increase retirement satisfaction. the did coefficient of income per capita is positive and statistically significant at the 1% level. however, the marginal effects are small with a r1000 increase in per capita household income only contributing 0.032 points increase in life satisfaction on the 10-point scale. the results also show that life satisfaction follows an inverted u-shaped relationship with the income variable. at initial levels of income, life satisfaction increases as income increases, reaching a maximum and then dropping thereafter at higher levels of income. wu and tam (2015) refer to this as the ‘winner’s curse’ where individuals spend more time on activities that increase income but bring less pleasure (e.g. work and commuting) at the cost of activities that enhance happiness (kahneman et al. 2006). as expected, life satisfaction of elderly persons with better health status is also significantly higher. years of schooling and importance of religion also have significant positive effects on life satisfaction in all the estimated models. gender, on the other hand, is not found to be statistically significant in any of the estimates. these results are in keeping with the results of the nationally representative sample analysed by kollamparambil (2019). lastly, household size increases subjective well-being by an average of 0.046 points in the chosen model of psm-did indicating the supportive role of south african households. botha and booysen (2014) did not find a significant association between household size and subjective well-being in their analysis of adults over 16 years of age. clearly, however, our results indicate that the relationship between household size and the older population group is positive and significant. the increase in dependence on family of the elderly possibly explains this significant result. the anticipatory effect of oap is not found to be important as indicated by the insignificant coefficient of treat*post variable in model 4. the gender specific analysis results presented in table 4 and table 5 show clear differences in the impact of oap on men and women. female recipients of oap show positive and significant (at 1% confidence level) increase in their well-being whereas there was no significant effect on male recipients. the preferred psm-did model indicates that oap increases life satisfaction of women by 0.679 points on a scale of 1–10, which is higher than what was found for the whole sample in table 3. the gender difference in the impact of oap is as anticipated as the use and meaning of pensions, as with access to and control over other economic resources, is likely to be gendered (maitra & ray 2003; posel, fairburn & lund 2006). schatz et al. (2012) make the same argument on the grounds of differences in gender roles and gendered stresses and strains preand post-pension receipt. according to the study, pension is a reliable source of income which may allow women to fulfill caregiving and social reproductive roles, thus improving perceptions of overall happiness and satisfaction. since men are more likely to have income prior to pension receipt, and their pensions do less for household members’ health and well-being (case & deaton 1998; duflo 2003), the well-being impact of pension to men is not expected to be as important as for women. even when employed, women often earn lower wages and defer spending decisions to a male in the household, making pension income a new, reliable resource within women’s control (ståhlberg, kruse & sundén 2005). moreover, the pension may ease financial strains and extensive care work that women take on (more than men) related to adult children’s unemployment, aids-related illness and death (munthree & maharaj 2010; ogunmefun, gilbert & schatz 2011; schatz & ogunmefun 2007). table 3: life satisfaction results: whole sample. table 4: life satisfaction results-female sample. table 5: life satisfaction results-male sample. other critical differences emanating from the gender specific analysis is that education is a significant contributor to the well-being of women but not men. religion and relative income, on the other hand, are seen to be important for both sexes contributing positively to life satisfaction. while the impact of relative income is exactly the same for both sexes at 0.649 points, the positive effect of religion is strong for women at 0.425 points compared to 0.25 points for men. being black african, however, is found to contribute negatively to life satisfaction for both sexes, with the effect being more negative for women than men. there is a significant amount of literature (salinas-rodríguez et al. 2014) which suggests that elderly persons who are close in age to meeting the criteria for receiving oap might modify their behaviour in anticipation of the income. this extra source of bias could influence the magnitude of the estimates. to test for anticipatory effects, model 4 estimates the did regression with treatment group (treat a) consisting of individuals who are between the ages of 55 and 59 years who qualify for oap based on the income criteria. if anticipation effects are present in the model, we would expect to have positive and statistically significant coefficient for treat*post in model 4. results are shown in the last column of tables 3–5. the statistically insignificant coefficient for all our samples indicates that there are no changes in behaviour due to an expectation of receiving the gran. robustness checks we further present non-linear ordinal regression did results as robustness check (table 6). in order to undertake the ordinal regression model, the dependent variable is life satisfaction with categories ranging from 1 to 10 which we collapse into three categories. the variable equals 1 (not satisfied) for all life satisfaction responses less than 5, equals 2 (satisfied) for responses 5–7 and equals 3 if the life satisfaction rating is greater than 7. the magnitude of the interaction effect (treat*post) in non-linear models does not equal the marginal effect of the interaction term in linear models (ai & norton 2003). therefore, in order to assess the impact of oap we estimate the contrasting predictive margins following puhani (2008). table 7 represents estimates derived from the ordinal did models. the results are consistent with the linear did estimates in tables 3–5, that while oap is seen to impact positively on the subjective well-being of elderly people as a whole, the impact is seen to be higher and significant for women while it is insignificant for men. table 6: ordinal difference-in-difference regression. table 7: non-linear difference-in-difference regression margins-robustness checks. the results confirm that receiving oap increases subjective well-being for women and not for men. these results support the findings by grogan and summerfield (2019) in the russian context where oap was found to increase the well-being of women, but not men. the gendered results reflect the societal gender stereotypes where the men derive their worth through their workplace related identity. women, on the other hand, are able to derive increased life satisfaction through the oap which gives them an opportunity to increase engagement in household roles of caring for the other family members, especially grandchildren (case & menendez 2007; duflo 2003; moller 1996). conclusion although the desired policy outcome of social grants in south africa – including the oap – has been to redistribute income to the elderly poor and reduce income inequality, its role in life satisfaction has either been equated to or neglected in favour of economic well-being. this article, therefore, investigated the relationship and measured the magnitude of the impact that the oap grant has on subjective well-being of the elderly in south africa. this study employed various models in increasing degrees of sophistication to ascertain the impact of oap. results from these models established that receiving the grant positively and significantly contributes to an individual’s happiness and is critical for these vulnerable groups without which they might not be able to survive. a minimum amount of income contributes significantly to happiness, irrespective of its source. there is no anticipation effect observed and oap does not contribute more to well-being as compared to other sources of income. therefore, for those without other means of income oap is critical in uplifting their well-being. old age pension can therefore be said to be an equaliser of well-being among the elderly. the increased well-being can be attributed to improved consumption and also to empowerment through increased participation of the oap recipient in daily household decision-making and contributing to community development (burns, keswell & leibbrandt 2008; case & menendez 2007). these implied empowerment effects translate into a feeling of worthiness especially relating to children and grandchildren who may still be heavily reliant on them (duflo 2000). a gender specific analysis brings out the differences in impact of oap between men and women. women are seen to improve their well-being substantially as a result of pensions compared to men. our findings support the similar results achieved by grogan and summerfield (2019) in the russian context. the gender difference in the impact of oap is as anticipated as the use and meaning of pensions, as with access to and control over other economic resources, is likely to be gendered (maitra & ray 2003; posel et al. 2006). since men are more likely to have income prior to pension receipt, and their pensions do less for household members’ health and well-being (case & deaton 1998; duflo 2003), the well-being impact of pension to men is not as high as for women. our study shows that both men and women did not record any significant improvement in their well-being due to the anticipatory effect of oap. our findings, together with ranchhod (2006), show that oap significantly reduces labour supply, raises the question whether equalising the qualifying age for oap across genders finalised in 2010 is yielding benefit in terms of improving subjective well-being in south africa. acknowledgements competing interests the authors have declared that no competing interest exist. author’s contributions this study was initiated as the master’s research report of m.n.e. under the supervision of u.k. subsequently for the purpose of journal submission u.k. undertook an extension of analysis and brought in the gender perspective of the study. hence while both authors have contributed in equal measure towards this manuscript, it can be 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notes 10, michigan state university, michigan, usa, viewed 20 november 2018, from https://www.nber.org/wne/lect_10_diffindiffs.pdf. wu, h.f. & tam, t., 2015, ‘economic development and socioeconomic inequality of wellbeing: a cross-sectional time-series analysis of urban china, 2003–2011’, social indicators research 124(2), 401–425. https://doi.org/10.1007/s11205-014-0803-7 appendix 1 table 1-a1: description of explanatory variables. footnotes 1. the oap is one of eight grants in a broader social safety net system of income transfers. other grants are: social relief of distress, grants-in-aid, child support grant, foster care grant, care dependency grant, war veteran’s grant and disability grant. 2. in this study, treatment refers to taking up the oap. 3. ages are separated into 5-year intervals to capture effect of recent grant take-up. abstract introduction brief review of namibia’s export-led growth policy empirical literature methodology: empirical model, estimation technique and data description empirical results conclusion acknowledgements references about the author(s) teboho jeremiah mosikari school of economic science, department of economics, north-west university, mahikeng, south africa joel hinaunye eita school of economics, college of business and economics university of johannesburg, johannesburg, south africa citation mosikari, t.j. & eita, j.h., 2020, ‘modelling asymmetric relationship between exports and growth in a developing economy: evidence from namibia’, south african journal of economic and management sciences 23(1), a2905. https://doi.org/10.4102/sajems.v23i1.2905 original research modelling asymmetric relationship between exports and growth in a developing economy: evidence from namibia teboho jeremiah mosikari, joel hinaunye eita received: 27 nov. 2018; accepted: 09 dec. 2019; published: 25 mar. 2020 copyright: © 2020. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: namibia is an open economy where international trade accounts for a greater proportion of gross domestic product (gdp). openness of the namibian economy for the period 2010 to 2018 has been on average 111% of gdp. the high level of openness of the economy raised an important question on the relationship between export and economic growth in namibia. previous studies investigated the linear relationship between these two variables. the investigation was also done at an aggregate level. this raises important questions on whether the relationship between export and economic growth is asymmetric. it also raises an important question on whether this relationship is sector specific. aim: in order to fill the gap in previous research, this study investigates the asymmetric or non-linear relationship between the main export sectors and economic growth in namibia. a non-linear relationship between the two variables will indicate that negative and positive values of the explanatory variables have different effects on the dependent variable. this analysis is done for the main export sectors of the namibian economy in order to ensure the policy recommendations are sector specific. setting: standard economic theoretical models on the relationship between export and economic growth are used to test the non-linear relationship between the two variables. the study covers the period 2010–2018 and focuses on the three main export sectors (diamonds, manufactured food and live animal products) and growth of the namibian economy. methods: this study uses non-linear autoregressive distributive lag in order to estimate the asymmetric relationship between the main export sectors and economic growth of namibia. the estimation is done for the three main exporters of the namibian economy. results: the results indicate that there is a symmetric relationship between main export sectors and economic growth of the namibian economy. the results show that an increase (positive values) in export of the three main export products will cause economic growth to improve. negative values (decrease in export) will cause economic growth to deteriorate. conclusion: the results suggest that estimating the non-linear relationship for different sectors of the economy (instead of estimating the relationship at aggregate level for total exports) will ensure that economic policies are sector-specific. the results further suggest that when exports are declining, expansionary policies will be the appropriate responses. keywords: economic growth; export; asymmetric modelling; non-linear autoregressive distributive lag; nardl; namibia; unit root; cointegration; breitung; kapetanios, shin, shell; kss. introduction the relationship between export and economic growth has received considerable attention in the literature. this relationship is important in the sense that it addresses central questions of how a country can accelerate economic growth through increase in exports (rangasamy 2009). studies such as salvatore (2011) argued that most countries are subject to weakening strategy of industrialisation. the problem of weakening strategy of industrialisation can be overcome through import substitution. it is important to mention that most economies have been moving away from import substitution to industrialisation strategy that is export-oriented. the keynesian demand side theory postulates that export is very important for economic growth. this postulation has been supported by studies such as helpman and krugman (1985), and aladejare and saidi (2014). according to these studies, export is a key driver to economic growth. countries can expand their domestic market by exporting more products. this will accelerate their economic growth. rangasamy (2009) also supports the role of exports in accelerating economic growth, by stating that increase in export helps developing countries that have smaller and limited domestic markets to gain from economies of scale. this argument is relevant especially for countries that have smaller populations. it is also important to mention that if a country produces and exports products where it has comparative advantage, local industrialisation will be sped up. dritsakis (2006) also argues that developing countries that have more open economies and export more to the rest of the world will have opportunities to absorb the necessary technologies and innovations. these are technologies and innovations that come from advanced economies and can help developing economies to prosper through increase in exports. there are many studies that support an export-led strategy. these studies argue that an outward-oriented export strategy is very important for economic growth and industrialisation (dollar & kraav 2005; world bank 1993). according to these studies, countries that are open to international trade tend to achieve higher economic growth. economies that are less open to international trade experience low economic growth. the views in favour of export-led growth is reinforced by the experience of countries in east asia. these countries adopted an export-led industrialisation strategy and experienced high economic growth. the experience of east asian countries led to many developing countries to adopt export-led growth strategies. namibia is among the developing countries that adopted an export-led growth strategy after attaining its independence in 1990 from south africa’s colonial occupation. namibia has a limited domestic market because of its smaller population which is currently 2.4 million. hence, it adopted an export-led growth strategy in order to expand its limited domestic market and accelerate its economic growth. namibia is richly endowed with natural resources such as gold, diamond, copper, coal, uranium and other rare earth minerals. despite the fact that namibia is endowed with natural resources and world-class infrastructure, its economy is not properly diversified. the country relies on the export of a few products (such as diamonds, manufactured products – processed fish, beverages, meat – food and live animals). namibia is an open economy where trade accounts for a significant proportion of its gross domestic product (gdp). phiri and bhatia (2017) state that the country’s openness (sum of import and export to gdp) increased from 104.6% in 2014 to 111.5% in 2015. data from namibia statistics agency (nsa) show that the main destination of namibia’s exports is south africa. south africa accounted for 24% of namibia’s exports in 2017. other main trading partners are botswana (13% of namibia’s exports) and switzerland (10% of namibia’s exports). countries such as belgium, china and spain accounted for 5% of namibian export. empirical studies on the relationship between exports and economic growth in namibia are limited. however, there are some notable studies such as amavilah (2003), jordaan and eita (2007), and ogbokor and meyer (2016). these studies estimated a linear or symmetric relationship between exports and economic growth. these studies estimated the relationship between economic growth and export and at an aggregate level (total exports). with the exception of amavilah (2003), these studies concluded that there is a positive relationship between export and economic growth in namibia. these studies did not test the non-linear relationship between export and economic growth in namibia. they also did not test the relationship between export and economic growth at sectoral level. that is because estimating the relationship between these variables at an aggregate level may not be appropriate as it may lead to blanket policies for all sectors even though sectors are different. for example, the mineral or diamond sectors may require policies that are different from that of food and live animals. this study will differ from previous studies and contribute in the following ways. it will investigate the asymmetric (non-linear) relationship between export and economic growth using the non-linear autoregressive distributive lag (nardl) estimation technique. it will estimate the relationship between export and economic growth at sectoral level. estimating the relationship between export and economic growth for different sectors ensures that there will be no blanket economic policies; it will ensure that the policies are sector-specific. to the best of our knowledge, this is the first study to test the asymmetric relationship between export and economic growth in namibia. it is also the first study to test the relationship between the two variables for different export sectors. the advantage of an asymmetric relationship between these variables is that it allows for an investigation of the impact of negative and positive effects of exports on economic growth in the long run. that means negative and positive values of exports will have different effects on economic growth. therefore, the following research questions are to be investigated in this study. the first is whether there is an asymmetric relationship between exports and growth in namibia. this will be tested for the main export sectors of the namibian economy. the second question is on the magnitude and size of economic growth due to changes in exports in the long run. this will also be investigated for the main export sectors of the namibian economy. the rest of this article is structured as follows. the following section discusses briefly namibia’s export-led growth policy. this is followed by a presentation of the empirical literature, then a section providing the methodology, empirical model, and estimation technique and data description. next is a section presenting the empirical results and the final section concludes the study. brief review of namibia’s export-led growth policy namibia adopted an outward looking or export-led growth strategy since its independence in 1990. namibia is an open economy and has been historically integrated with south africa through its membership of the southern african customs union (sacu). namibia formally became a member of sacu immediately after its independence from south africa. it also joined the world trade organisation (wto) in 1995. according to the united nations conference on trade and development (unctad 2016), namibia joined the european economic community – cotonou agreement as a matter of priority. this agreement granted namibia access to the european market. this enabled namibia to have access to the export quota of 13 000 tonnes of beef duty free into the european market. a little duty free beef export quota to norway was also granted to namibia. namibia has a limited market size and the government acknowledged that export is important for accelerating economic growth. due to the small market, it was therefore decided that it is important to shift the development strategies of namibia from inward to outward looking. among the outward strategies are the export processing zones (epz) established in 1995, export development strategy of 1998, vision 2030 and national development plans, industrial and competition policies, and trade management act. the epz was established in 1995 and its aim is to attract investment in production for export. transfer of skills to namibians was also another aim of the epz. the epz offers incentives tax exemption, protection from pressures of trade unions and incentives related to training. according to jordaan and eita (2007), firms in epz that manufacture and export products are exempted from paying import duties on intermediate inputs. the epz is still in existence and has assisted namibia in expanding its exports. however, there have been concerns that its contribution to the namibian economy was minimal. it generated less jobs than anticipated. exports from the epz were lower than anticipated. this led to the offshore development company (odc) under the ministry of industrialisation, trade and small and medium-sized enterprises (sme) development to commission a study in 2012 on the performance, cost and benefit of the epz. among others, the commissioned study was expected to cover the epz programme, institutional review and realignment, cost and benefit (of the epz). the study has not yet been made public, but it is expected to be released in 2020. the export development strategy of 1998 prioritised the processing of minerals, mariculture and agriculture. the emphasis of this strategy is to ensure that namibia moves away from exports of primary to processed or secondary products. other sectors such as tourism, which have the potential to generate high income, are also considered as priorities. vision 2030 was adopted in 2004. vision 2030 is an aspirational policy document, which set out namibia’s industrialisation tone and on which the country’s trade policy is hinged. the objective of this document is to attain stability, regional integration and international relations that are democratised. according to vision 2030, manufacturing and the service sectors are expected to account for 80% of namibia’s gdp, and processed products should dominate export. agriculture, tourism, mining, and logistics are identified by vision 2030 as priority sectors. these priority sectors will be strengthened by improved infrastructure such as road, rail, port and telecommunications. these will transform namibia into an industrialised economy that will have gdp per capita equivalent to that of advanced economies. namibia also has medium-term plans called national development plans. the fourth and fifth national development plans consider logistics, agriculture, tourism and manufacturing as keys to industrialising namibia. these priority sectors are complemented by improved education that will enhance the country’s capacity to trade and improve economic development. concerted investment is aimed at creating the pool of expertise to complement namibia’s export and economic development. vision 2030 is an ambitious policy document, but namibia’s exports are still dominated by commodities with limited or basic processed products. however, unctad (2016) statistics from the bank of namibia (bon) indicated that the services sector accounts for a substantial of component of namibia’s gdp. the country has launched namibia’s industrial policy in recent years (unctad 2016). according to namibia’s industrial policy document, industrialisation is important for accelerating inclusive economic growth and development, job creation, wealth and poverty alleviation. this will take place in the context of an open economy that is integrated within its region, compliance with wto and protection of infant industries. market integration, development of infrastructure, fair competition, incentives to manufacturers for export and skills development are considered as key instruments of namibia’s industrial policy document. the namibian government also launched the growth at home strategy in 2015, which is the execution strategy for achieving namibia’s industrialisation as outlined in its industrial policy of 2012. it connects the country’s industrial policy to its socio-economic development. it emphasises an increase in diversified production as very important for regional integration. it focuses on supporting value addition and diversification for growth that is sustainable. it is expected that these will improve the local investment climate and secure market at home and abroad. the expectation is that if this policy is successfully implemented, there will be an increase in value-added export. according to the growth at home strategy, this can only be achieved if the government enhances capacity in priority sectors such as agro-processing, fish processing, manufacturing of steel, fabrication of metals, chemicals and beneficiation of minerals. the plan is to have value-added export growing by 10% per year. it is also expected that valued or processed exports will account for at least 10% of exports. despite that, it is important to mention that it will not be easy for namibia to have its exports dominated by value-added or processed products. that is because namibian export is still dominated by primary products (although there has been an increase in some value-added products). empirical literature the relationship between exports and growth in developing countries has attracted considerable attention in the literature (such as aladejare & saidi 2014; busse & königer 2012). internationally, a cross section study by din (2004) examines the export-led growth hypothesis for the five largest economies of the south asia region. the study used a multivariate time-series framework for the study period 1960–2002. the results show that there is a long-run relationship between exports, imports, and output for bangladesh and pakistan. however, for india, nepal, and sri lanka, no evidence of a long-run relationship was established. furthermore, busse and königer (2012) examine the causal linkage between trade and growth in a group of 108 countries. the study uses the generalised method of moments estimation technique for a sample covering the period 1971–2005. the results provided evidence that the growth of trade through its associated access to additional technologies has a significant impact on income growth. there are also empirical studies in the literature that are country specific. mishra (2011) attempted to investigate the dynamics of the relationship between exports and economic growth for india over the period 1970–2009. the study applied the popular econometric techniques of cointegration and vector error correction estimation techniques. the findings indicate the existence of the cointegration between exports and real gdp in india. shihab and abdul-khaliq (2014) examined the causal relationship between economic growth and exports in jordan. the study used the johansen cointegration test for period covering 2000–2012. the results show that there is evidence of causality between export and economic growth in jordan and the direction of causality runs from economic growth to exports. gurgul and lach (2010) studied the linear and non-linear causalities between international trade and economic growth in the polish economy. the study examined two samples for the period (q1 1996–q3 2009) and the pre-crisis sample (q1 1996–q3 2008). the results of the study indicate that feedback exists between the real growth rate of gdp and the real growth rate of exports. in addition, mtaturu (2016) analysed the relationship between export and economic growth in tanzania using the engle-granger cointegration technique. the study found that there is no indication of cointegration between exports and economic growth in tanzania. aladejare and saidi (2014) examined the impact of the aggregate non-oil sector and its determinant on economic growth of nigeria. the bound test approach was employed to examine the phenomena for the sample period of 1970–2012. the results show a strong support for a long-run relationship between non-oil export and economic growth in nigeria. molapo and damane (2016) empirically examined the relationship between mining exports and economic growth in lesotho. the study tested the export-led growth hypothesis using annual time series data covering the period 1970–2013. it applied the autoregressive distributed lag (ardl) technique and revealed that there is a long-run relationship between mining exports and economic growth. there are few empirical studies on the relationship between export and economic growth in namibia. amavilah (2003) maintained that for namibia, domestic export supply factors are more important to growth than external demand factors. this was followed by jordaan and eita (2007) who studied the relationship between exports and economic growth in namibia for the period 1970–2005. this study used the johansen cointegration technique to investigate the relationship between export and economic growth. the study found that there exists a long-run relationship between exports and economic growth. this was supported by niishinda and ogbokor (2013), who investigated the export and economic growth relationship for namibia. the study applied the johansen cointegration test for the period 1972–2010 to examine the nature of the relationship. the findings show that various measures to increase export can enhance economic growth in namibia. promotion of export has been the catalyst in modern economies to sustain economic growth in most developing nations. simasiku and sheefeni (2014) engaged in a study to determine how changes in terms of trade have an effect on growth in namibia. the results show an indirect relationship between terms of trade and economic growth in namibia. ogbokor (2015) studied the impact of foreign trade on growth in the namibian economy. the study applied two modern econometric time series methods: vector autoregressive (var) and ardl models. the study revealed that the economy of namibia can be expanded potentially by means of foreign trade. simasiku and sheefeni (2017) investigated the nexus between agricultural export and economic growth in namibia for the period 1990–2014. the study confirmed that the cointegration test indicated that there is a long-run relationship between agricultural export and economic growth in namibia. many previous studies on namibia (such as amavilah 2003; jordaan & eita 2007; niishinda & ogbokor 2013; ogbokor & meyer 2016; simasiku & sheefeni 2017) have modelled the relationship between export and economic growth using a linear approach. however, this approach may seem inappropriate especially when the economic variables integrate non-linear characteristics of the business cycle in exports over time. according to hatem and uddin (2012), it is important to allow for an asymmetric or non-linear relationship between the variables of interest in the study. this study further indicated that allowing for an asymmetric relationship is crucial in the sense that the effect of negative shock of exports can be different from the positive shocks of exports on growth. therefore, the main contribution of this study is to explore the asymmetric effect of exports on growth in namibia. the analysis of this study will not be for aggregate export, but will be done for the main export sectors of the namibian economy. to the best of our knowledge, this might be the first study to apply nardl to examine export and growth in namibia. it will also be the first study to investigate the non-linear relationship for the main export sectors of the namibian economy. an investigation of the non-linear relationship between export and growth at sectoral level will ensure that there will be no blanket economic policies for all sectors; the economic policies will be sector-specific. methodology: empirical model, estimation technique and data description empirical model following an extensive review of the empirical literature on exports and economic growth, the long-run relationship between the two variables is specified as follows:
 gdpt is the gdp (representing economic growth), xpott represents disaggregate exports (of manufactured products, diamonds and food and live animals), β1 is the long-run coefficient for disaggregated exports and β0 is the intercept. the variable μt represents the error term. equation 1 will be estimated at disaggregated level. that means that the equation will be estimated for manufactured products, diamonds, and food and live animals. this is contrary to previous studies which estimated the relationship between export and economic growth at aggregate level. estimation technique to capture for asymmetries shin, yu and greenwood-nimmo (2014) developed the nardl model where exports can be decomposed into negative and positive partial sums. then, equation 1 is re-specified in non-linear form as follows: according to equation 2 the long-run relationship between economic growth and disaggregated decrease in exports is measured by . the relationship between economic growth and disaggregated increase in exports is captured by . in the long run both disaggregated increase and decrease in exports are expected to have a positive effect on economic growth. therefore, the long-run relationship between disaggregated exports and economic growth presented in equation 2 reflects asymmetric characteristics. following the presentation of equation 2 in non-linear form, there are some properties which are determined in equation 3 and equation 4 to give the partial sums of positive and negative changes in xpott: equation 2 is augmented with control variables and re-specified (in the nardl form) in equation 5. the variables impt and inft are imports and inflation. other variables are as previously defined: q and p are lag orders, and long-run coefficients are computed as β2 = γ−/β1 and β3 = γ+/β1. in addition, captures the short-run impact of disaggregated increase in exports on economic growth, while captures the short-run impact of disaggregated decrease in exports on economic growth in namibia. to examine the long-run cointegration between disaggregated exports and gdp growth, the article applies the stepwise ordinary least squares model to estimate equation 5 which uses a general-to-specific procedure. after estimating nardl, the study performs a test for long-run cointegration using the bounds testing approach (pesaran, shin & smith 2001). this approach uses the wald f-testing with the null hypothesis, γ1 = ⋯.. = γ6 which implies ‘no cointegration’. finally, the article also uses wald f-test to determine the asymmetric cointegration between disaggregated exports and economic growth in namibia. however, before determining whether there exists a long-run relationship among the variables, the study needs to investigate the non-linearity for each variable. it uses the brock, dechert, scheinkman (bds) test to determine non-linearity. the test was developed by brock et al. (1996). it can be used for testing against a variety of possible deviations from linear and non-linear dependence. following, the study adopts the unconventional non-linear unit root test of kapetanios, shin, shell (kss) by kapetanios, shin and snell (2003) and breitung nonparametric unit root by breitung (2002). data description the article uses quarterly data from the period 2009–2018. data were obtained from the bon and nsa. this period was chosen because of data availability. the main export sectors of the namibian economy were chosen due to consistent data availability. table 1 provides data description for variables that are used in the study. table 1: data description. empirical results the descriptive statistics are presented in table 2. the variable that has lowest mean value is inf at 5.72%. the variable that has the highest mean is gdp with a value n$24 298.68 million. in addition to preliminary analysis the study examined each variable at levels and first difference. the study explored the time series plots of variables in levels and first difference (the letter ‘l’ at the beginning of each variable such lgdp shows that the variable is in logarithm). figure 1 and figure 2, therefore, present all the variables in the analysis in levels and first difference. figure 1 shows that exports and economic growth seem to be moving in the same direction, but the movement seems not to be more linear. the same applies to figure 2 where the variables are in difference form. figure 1: variables in levels: (a) inf; (b) ldext; (c) lfhext; (d) lgdp; (e) limp; (f) lmnext. figure 2: variables in first difference: (a) differenced inf; (b) differenced ldext; (c) differenced lfhext; (d) differenced lgdp; (e) differenced limp; (f) differenced lmnext. table 2: descriptive statistics. to test for the presence of non-linearity in the variables, this article employs the bds test developed by brock et al. (1996). it is conventional for any non-linear analysis to investigate the non-linearity in the variables used in the study. table 3 presents the results of bds test. the results show that the null hypothesis of independently and identically distributed has been rejected. this can be observed by all the t-statistics that are significant for each variable. this confirmed that the null hypothesis on non-linearity cannot be rejected since all the associated probability values are not greater than 1%, 5% and 10% significance levels. these test results imply the non-normal distribution of data which shows the behaviour of non-linearity. the next step is to test the univariate characteristics (unit root) in the variables. the study uses the unconventional test of unit root. these are tests that are suitable for data that depict the non-normality over time. the study used kss and breitung non-linear unit root tests. to apply the kss test, it is important to determine the lag length using akaike information criterion (aic), shwartz information criterion (sic) and hannan quinine (hq). the three criteria selected the optimum lag of 1. therefore, this lag of 1 was used to estimate the t-statistics for kss procedure. the results are presented in table 4. the results in table 4 show that the variables are non-stationary at levels. this is confirmed by comparing the t-statistics in the kss table with kss critical values. this further demonstrates that the null hypothesis of non-stationarity in the presence on non-linearity is present for all the variables. table 3: bds test for non-linearity. table 4: kapetanios, shin, shell test non-linear unit root results. this article also employs the breitung non-linear unit root test. the tests only examine the intercept and the results are presented in table 5. the results confirm that all variables are non-stationary at levels in the presence on non-linearity. it is now appropriate to estimate the nardl cointegration between the main exports sectors and economic growth in namibia. the results are presented in table 6. table 5: breitung non-linear unit root. table 6: non-linear autoregressive distributive lag bound test cointegration results. table 6 presents the results for the nardl cointegration test. as explained earlier, the relationship between export and economic growth (in equation 5) is estimated at disaggregated level. the article has estimated equation 5 in three different variations for the bound test procedure. model i estimates the relationship between manufactured exports and economic growth. model ii estimates the relationship between diamond exports and economic growth. model iii estimates the relationship between food and live animals exports, and economic growth. the critical values in table 7 are extracted from narayan (2005). the results indicate that the computed f-statistics for all the models are greater than the upper bound critical value of 5.544 at 1% significance level. this implies that there is a long-run non-linear relationship between exports (disaggregated products) and economic growth in namibia. table 7: non-linear autoregressive distributive lag long-run estimation results. table 7 presents long-run nardl between export and economic growth. the results in model i indicate that a decrease in exports of manufactured products has a coefficient of −0.164, and it is not statistically significant. in addition, an increase in manufactured products has a coefficient of −0.703 and is statistically significant. therefore, in the long run, a 1% increase in exports of manufactured products will lead to a 0.344% increase in economic growth. however, a 1% decrease in exports of manufactured products will lead to a 0.080% decrease in economic growth of namibia. in the long run, a 1% decrease in imports of machinery and other appliances will lead to a 0.227% decrease in economic growth. however, in the long run a 1% increase in imports of machinery will lead to a 0.104% increase in economic growth. in both cases the parameters for imports of machinery are statistically significant. the last, control variable which is inflation rate has the following impact: a 1% decrease in inflation rate will lead to 0.0003% decrease in economic growth. however, in the long run a 1% increase in inflation will lead to a 0.022% increase in economic growth and it is statistically significant. model ii presents the results of exports of diamonds and economic growth. the results show that a reduction in exports of diamonds will have a coefficient of 0.064, and an increase in exports of diamonds will have a coefficient of 0.134. therefore, in the long run a 1% increase in exports of diamonds will have a 0.098% increase in economic growth and is statistically significant at the 5% level. on other hand, a 1% decrease in exports of diamonds will have a 0.080% increase in economic growth, but this is not statistically significant. the results also show that a 1% decrease in imports of machinery will cause a 0.107% decrease in economic growth. a 1% increase in imports or machineries and appliances will cause economic growth to decrease by 0.069%. in both cases only the parameter for import of machinery is statistically significant at 10%. a 1% decrease in inflation rate will lead to a 0.005% decrease in economic growth. alternatively, a 1% increase in inflation will lead to a 0.006% increase in economic growth, but this coefficient is not statistically significant. model iii presents the results for exports of food and live animals and economic growth. the result indicates that a decrease in exports of food and live animals has a coefficient of −0.138, and it is not statistically significant. in addition, an increase in exports of food and other products has a coefficient of −0.318 and it is statistically significant. therefore, in the long run a 1% increase in exports of food and live animals will lead to a 0.144% increase in economic growth. a 1% decrease in exports of food and live animals will lead to a 0.062% decrease in economic growth. a 1% decrease in imports of machinery, mechanical and electrical appliances will lead to a 0.019% decrease in economic growth. a 1% increase in imports of machinery, mechanical and electrical appliances will cause economic growth to increase by 0.147%. if inflation rate decreases by 1%, economic growth will decrease by 0.007%. however, a 1% increase in inflation will lead to a 0.008% increase in economic growth. the coefficients of both increase and decrease in inflation rates are statistically significant at the 1% level. all the estimated models have an acceptable adjusted r-squared of more than 81%. it is important to test whether there exists asymmetry in the relationship between variables. the presence of asymmetry will simply indicate that the computed ‘positive’ and ‘negative’ series have different effects on the dependent variable. the study makes use of the wald test to determine the asymmetry. the results are presented in table 8. table 8 demonstrates that the null hypothesis of ‘no asymmetry’ is rejected for model i and model iii. table 8: long-run asymmetric test. after estimating the nardl model for equation 5 with its disaggregated exports (models i, ii and ii), diagnostic tests were carried out to assess the validity of the models. the results show that the null hypothesis of normality of residuals cannot be rejected. the model also passed the test for heteroskedasticity and stability (see table 9). table 9: diagnostic test results. conclusion this study investigates the asymmetric (non-linear) relationship between exports and economic growth in namibia. this study differs from previous studies in the sense that it does not just investigate the relationship between the two variables at an aggregate level, but for the main export sectors of the namibian economy. the non-linear relationship between export and economic growth was investigated for exports of manufactured products, diamonds, and food and live animals. these are the main export sectors of the namibian economy and were selected because of availability of consistent time series data. the study used quarterly data and covers the period 2009–2018. the study applied the nardl model to capture the long-run asymmetric relations between disaggregated exports and economic growth. the results show that in the long run there is evidence of an asymmetric relationship between disaggregated exports and economic growth in namibia. the results indicated that a decrease in exports of manufactured products, diamonds, and food and live animal products will significantly cause economic growth to deteriorate. an increase in exports of these products will cause economic growth to improve significantly. the results therefore indicate that increase and decrease in exports of these products will have different effects on economic growth. the main contribution of this study is that it did not just test the non-linear relationship between the two variables (export and economic growth); it investigated the relationship between the two variables for the main export sectors of the namibian economy. this will mean that we do not develop only one economic policy for all sectors; it will ensure that economic policies are sector specific. for example, an economic policy that is good for the diamond sector may not be appropriate for the food and live animal sectors. the study further recommends that when there is a decrease in export, it will be appropriate to pursue expansionary policies in order to improve economic growth. acknowledgements the author would like to thank the national research foundation (nrf) for funding that partially contributed to the finalisation of this research. the authors would also like to thank hilda ampweya (from namibia statistics agency) for her assistance with the data. competing interests the authors have declared that no competing interest exist. 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m.d., 2016, ‘an econometric time-series analysis of the dynamic relationship between foreign trade and economic growth in a developing country: evidence from namibia’, acta universitatis danubius oeconomica 12(4), 153–170. pesaran, m.h., shin, y. & smith, r.j., 2001, ‘bounds testing approaches to the analysis of level relationships’, journal of applied econometrics 16, 289–326. https://doi.org/10.1002/jae.616 phiri, m. & bhatia, a., 2017, african economic outlook 2017, viewed 26 june 2018, from https://www.undp.org/content/dam/rba/docs/reports/african_economic_outlook_2017_en.pdf. rangasamy, l., 2009, ‘exports and economic growth: the case of south africa’, journal of international development 21, 603–617. https://doi.org/10.1002/jid.1501 salvatore, d., 2011, international economics, trade and finance, wiley and sons, singapore. shihab, r.a. & abdul-khaliq, t.s.s., 2014, ‘the causal relationship between exports and economic growth in jordan’, international journal of business and social science 5, 302–308. simasiku, c. & sheefeni, j.p.s., 2014, ‘terms of trade and economic growth in namibia’, international review of research in emerging markets and the global economy (irrem) 1, 90–101. simasiku, c. & sheefeni, j.p.s., 2017, ‘agricultural exports and economic growth in namibia’, european journal of basic and applied sciences 4, 41–50. shin, y., yu, b.c. & greenwood-nimmo, m., 2014, ‘modelling asymmetric cointegration and dynamic multipliers in a nonlinear ardl framework’, in r. sickels & w. horrace (eds.), festschrift in honor of peter schmidt: econometric methods and applications, pp. 281–314, springer, new york. united nations conference on trade and development (unctad), 2016, namibia trade policy framework, united nations, new york. world bank, 1993, the east asian miracle experience: economic growth and public policy, oxford university press, oxford. book review good capitalism versus bad capitalism: a review book title: good capitalism, bad capitalism the role of business in south africa authors: raymond parsons and ali parry isbn: 978-1-4314-2618-8 publisher: jacana media, 2018, r180* *book price at time of review review title: good capitalism versus bad capitalism: a review reviewer: petrus d.f. strydom1 affiliations: 1school of economics, north-west university, south africa corresponding author: petrus strydom, pdfs@icon.co.za how to cite this book review: strydom, p.d.f., 2019, ‘good capitalism versus bad capitalism: a review’, south african journal of economic and management sciences 22(1), a2794. https://doi.org/10.4102/sajems.v22i1.2794 copyright notice: © 2019. the authors. licensee: aosis openjournals. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. introduction effective institutions are not only important in determining the success or failure of economic development but they are significant in shaping economic policy while exerting discipline on government via institutionalised checks and balances to secure a consistent implementation of economic policy measures. this is an important theme in good capitalism, bad capitalism: the role of business i n south africa. the book analyses the role and voice of business in achieving affective policy outcomes in south africa. it covers the past and present role of organised business in achieving such outcomes to secure successful economic development within the context of good capitalism where successful institutions secure widespread participation of the population in an inclusive economy. failure in achieving such outcomes is detrimental to economic development and could be labelled bad capitalism as outlined on pp. 155–156. the history of these successes and failures is analysed within the context of political economy. this particular perspective is an important contribution to the south african political economy literature. although the narrative of good and bad capitalism serves the exposition well, it should, nevertheless, be kept in mind that despite a liberal constitution and market-related economic institutions, our economic system is not a capitalist one. it is a developmental state and one with a poor delivery capacity as implemented by the post-mandela african national congress (anc) governments (see for instance p. 124). in essence, good governance is presented as a critical element in the exposition. the book uncovers the role of organised business in securing or failing in promoting good policy governance. the exposition could be systematised in terms of three themes. firstly, the role of business in resisting the expansion of an authoritarian and oppressive apartheid regime while securing progress towards democracy. secondly, the business contribution towards effective policy governance in a democratic south africa, while hesitantly resisting the failing developmental state. thirdly, the way forward for organised business in securing effective governance in a post-zuma era and the ‘new dawn’ à la president ramaphosa. from repressive authoritarianism to democracy the position of business under the apartheid regime was complicated by many factors. in supporting free enterprise it was obliged to resist the racially discriminatory policies that prevented black south africans from entering business as entrepreneurs or from establishing labour organisations. moreover, business’s success and expansion were adversely affected by particular laws that governed the movement of people and prevented black south africans from entering skilled job categories. numerous efforts by business to oppose these discriminatory laws were without success. instead, the bureaucratic law enforcement machinery became more intolerant towards business. business experienced progression and regression in its efforts to change the behaviour of a regime that did not hesitate to apply violent actions to achieve its goals. these difficult and contradicting situations have been aptly described as follows: the business community was caught between the recognition of the inevitability and desirability of significant political reform and a range of developments which resulted in a great deal of instability and uncertainty (p.35). where direct opposition to the state failed, business was often more successful in staging resistance through entrepreneurial efforts as part of civil society. these efforts were not always structured and in most instances not documented. the result is that they often escape the scrutiny of careful analysis. they, nevertheless, formed part of civil society’s resistance and together with growing media coverage, a new wave of progressive thinking gained momentum. this momentum in intellectual resistance in civil society became too widespread for the regime to control, and political reform was inevitable. it is my assessment that business played an important role in supporting these developments through seminars, research reports, internal company training, public discussions and direct representation to government. apartheid came to an end in 1990 and in the new democratic dispensation that evolved after 1994, business played a prominent role in the evolution of social dialogue and the formation of the national economic development and labour council (nedlac). the council has been the outcome of several developments and the efforts of various institutions that contributed to the ‘building of social capital in south africa’ (p. 67). nedlac was a negotiating organisation that provided the social economic partners ‘an independent space … to develop a common vision on the way forward’ (p. 81). the different partners in nedlac were government, business, labour and civil society. this negotiating forum played an important role in policy formulation and governance, particularly during the early years of the new democracy as is discussed in detail in chapter 4. nedlac suffers from several deficiencies as discussed by the authors and in its present format it has become ineffective in serving good governance. moreover, within the framework of a governmental state, consultation and negotiation are not featuring prominently. more importantly, under the governmental state we have experienced a polarisation of society and increased tension between the nedlac partners that, eventually, revealed a trust deficit. these circumstances encouraged the idea of achieving social cohesion through a social compact. although an effective social dialogue in this country is imperative, the social cohesion has deteriorated. the large trust deficit between social partners that developed under the developmental state regime resulted in ‘many destructive attacks on certain stakeholders, which seem to reflect a visceral hostility towards them’ (pp. 82–83). this does not bode well for achieving a social compact. the national development plan (ndp), although showing sympathy for the idea, formulated the conditions that are required to achieve a social compact successfully. these conditions are unlikely to be met in the present south africa. nevertheless, the authors show some sympathy in favour of a social compact, particularly in reference to the positive assessment by ramaphosa in addressing this subject in 2013 (pp. 168–171). the particular features of a social compact as it originated in ireland and the netherlands – as consensus-based economic policymaking, driven by a tri-party cooperation between government, representatives of employers’ organisations and representatives of labour unions – is somewhat different from the perceptions outlined by ramaphosa in the quoted reference above. european policy negotiation has a long-established well-functioning infrastructure to secure effective negotiations with scientific backing to evaluate the feasibility of competing proposals. south africa has a long way to go towards establishing such an integrated support system. furthermore, the south african envisaged procedures include civil society, or non-governmental organisations, as a participant together with government, business and labour. civil society is likely to complicate a consensus outcome owing to its inability to define mandates. moreover, civil society is not in a position to commit itself to attain certain policy tradeoffs because it lacks leverage in achieving the agreed values of policy parameters. we do not share the optimistic outcome regarding a social compact in this country. democracy and the developmental state the post-1994 period saw far-reaching changes in policymaking and governance. nelson mandela emphasised reconciliation and relied on the mutual spirit of cooperation in business and civil society to promote support for positive nation building. this ‘social capital’ was rapidly spilt by successive anc governments after mandela. the ‘cordial bilateral’ (p. 97) between government and business started slipping and gradually organised business lost its influence in policymaking. owing to difficult economic circumstances and the relatively poor economic performance of small and medium-sized enterprises, organised business polarised. in certain instances the division followed racial and social differences while in others it appeared to be big versus small business. the revival of economic growth became an important priority and the period following mandela was characterised by analyses and growth-enhancing programmes. the most successful was the growth, employment and redistribution strategy (gear) that replaced the reconstruction and development programme (rdp) which merely comprised a wish list without a policy strategy. despite the criticism from the political left against its so-called neoliberal policy stance it, apparently, successfully improved the country’s growth performance. real gross domestic product (gdp) growth exceeded 5% p.a. during the mid-2000s. the alliance partners of the anc government were increasingly uncomfortable with these market-friendly policies of the gear programme. government policies started shifting in favour of a developmental state. the lack of delivery capacity of the developmental state became evident at an early stage owing to the collapse of electricity supply in 2008 by eskom, the governmental-controlled monopolistic electricity supplier. this was a hard blow to the economy as it had already entered a recession in 2007. the situation was aggravated by the great international economic recession of 2008–2009. jacob zuma was elected as president in 2007 and owing to the pressing economic circumstances at the time there was extensive collaboration between government, labour and business to support economic recovery. initially zuma showed preparedness to encourage social dialogue within nedlac (p. 102). this was confirmed by the release of the national planning commission’s ndp. this was an ideology-free policy document with an extensive analysis of the present state of the economy, coupled with policy proposals over a visionary period to 2030. the ndp was accepted as a policy document by government. later on it appeared to be merely an act of tokenism. the ndp was not acceptable to the anc and its alliance partners in government. as opposed to the vision of the ndp, the developmental state became entrenched in policymaking. extensive interventionist policies followed in the areas of employment equity, black economic empowerment (bee) requirements and business charters. certain black business chambers started acting as developmental agents for government (p.104). the developmental state and its transformation agents appeared to be a highway towards corruption and political patronage. this process gained momentum under zuma’s regime and eventually resulted in state capture. these developments were engineered through the destruction of many south african democratic institutions. the processes of checks and balances of a democratic system were eliminated or simply overruled. the destructive effects of the developmental state on the economy and society necessarily alienated business from government. moreover, government created the impression that the developmental state prefers policymaking without consultation. furthermore, some business chambers were accused of being ‘untransformed’ and to be excluded from consultation (p.104). unfortunately, several private sector businesses became linked to state capture through shady deals with government. this sad state of affairs was aggravated by a deterioration in good corporate governance in private companies. the downfall of steinhoff in 2018 was probably the most visible example. it appears that the anc government’s developmental state has failed south africa. the economic performance has deteriorated badly owing to destructive interventionist policies. unemployment is running at an historically high level, poverty has increased while the provision of basic community services is in poor shape as the management in most municipalities is falling apart. the public corporations (state-owned enterprises) are virtually bankrupt and rely heavily on government financial bailouts. the public debt, therefore, escalated and appears to be without bound. south africa is failing international performance criteria (see annexure 4, p. 203). the country has successively been downgraded by international credit rating agencies during recent years. the dysfunctional school education system is wasting the south african youth dividend as it has deteriorated to one of the worst on the african continent. the political elite enriched themselves through state capture while benefitting from lucrative state contracts. furthermore, politically well-connected elites benefitted from interventionist policies such as bee that appeared to be extensions of the developmental state. it is not surprising that the unequal income distribution deteriorated to one of the world’s worst. civil society and the media, particularly through the contribution of investigative journalism have united in the public outcry against the failure of the developmental state and its state capture. in these actions organised business did not feature prominently, owing to particular developments, as explained by the authors and summarised above. this outcome is contrary to the resistance to the apartheid regime where business featured as a prominent participant and in many instances took a leading position in the resistance. my assessment of the evidence is that the ideology-based apartheid regime has failed south africa. resistance from business, civil society and the media, together with international sanctions, contributed towards bringing the regime to an end. the country entered a new democratic era in 1994 with high hopes of an inclusive participation in the economy, reconciliation, poverty reduction, a more equal distribution of wealth while benefitting from international trade in terms of an open economy. these high hopes vanished on the horizon as the anc government opted in favour of an ideology-based socio-economic order namely the developmental state which virtually had no delivery capacity. owing to extensive resistance by civil society and clever political intervention, jacob zuma resigned. the appointment of president ramaphosa is expected to bring new hope to a divisive society. the future the election of president ramaphosa as the new leader of the country is hopefully signaling a ‘new dawn’ for the country, as he himself formulated the new beginning. unfortunately, this new dawn is presently covered by a dark cloud as the anc’s developmental state is preparing a destructive stab at two of our precious democratic institutions. the one is the proposed amendment to the constitution to secure land expropriation without compensation, the other is the proposed nationalisation of the reserve bank with a view to terminate the independence of the bank in financial supervision and the conduct of monetary policy. in 1994 we moved forward by abandoning the ideological-inspired apartheid regime. in 2018 we face a similar choice: abandoning the ideological-based developmental state. the authors do not go that far but they unequivocally argue in favour of substantial change. in this respect proposals are made for the active participation of business in economic policy deliberations. in a similar vein several well-considered proposals for economic reform are made. this confirms the fact that change is not going to be easy. there is no single miraculous solution. one has to do many things simultaneously. this applies equally well to government, labour and organised business. there is, nevertheless, an important barrier in implementing such reforms. as long as south africa is committed to a developmental state there is little scope for an effective and sustainable cooperation between government and organised business. my reading of the authors’ proposals is that business should embrace whatever scope there is to prevent the continuation of the marginalisation of business in policy and planning circles in this country. conclusion the book under review is an important contribution to the political economy literature. it analyses the role of business in the south african struggle for freedom and democracy. the outcome is that it was not always as visible as we would have preferred it to be. business played a prominent role in the resistance to the apartheid regime as part of the revolt in civil society. the high expectations of a new less divisive country, with inclusive institutions that ensure a more equal distribution of wealth under nelson mandela, were harshly destroyed by the anc government’s ideology-based developmental state. owing to particular circumstances, business was less visible in civil society’s revolt against this system that failed south africa. the country is most probably facing the possibility of a new beginning. the authors outlined the challenges of political reform and the conditions for securing sustained economic recovery and the imperative of active participation by organised business in achieving such outcomes. my assessment is that such positive outcomes are only within reach outside the institutional framework of a developmental state. sajems ns vol 4 (2001) no 1 sense of coherence, locus of control, self-efficacy and job satisfaction sroihmann 41 programme in industrial and personnel psychology, potchefttroom university forche abstract job satisfaction is a complex variable and is influenced by situational factors of the job environment as well as dispositional characteristics of the individual. recently there has been renewed interest in the role of dispositional characteristics in predicting work-related outcomes. the aim of this study was to determine the possible relationship between the dispositional factors of sense of coherence, locus of control and self-efficacy on the one hand, and job satisfaction on the other. the study population included 624 employees of 7 organisations. sense of coherence, locus of control and self-efficacy were found to be related constructs, but only sense of coherence and locus of control were significantly related to job satisfaction. sense of coherence, locus of control and self-efficacy predicted 30 per cent of the variance in total job satisfaction. . jelj24 1 introduction information on the job satisfaction of employees and correlates thereof is valuable for organisations. in a literature study, roznowski and hulin (1992) found that job dissatisfaction is related to absenteeism, trade union activities and psychological withdrawal. steel and rentsch (1995) found that job dissatisfaction correlated with absenteeism and employee turnover. according to makin, cooper and cox (1996), employees' satisfaction with aspects of their jobs may influence their motivation. however, iaffaldano and muchinsky (1985) found an estimated correlation of only 0.17 between job satisfaction and job performance. in line with the opinion expressed by bassett (1994), it is not assumed here that a more satisfied employee will be a more productive employee, nor is it assumed that job satisfaction is the result of high job performance. although global job satisfaction is not related to job performance, there are strong relationships between job satisfaction and organisational citizenship r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 42 sajems ns vol 4 (2001) no 1 behaviour (organ & konovsky, 1989). organisational citizenship behaviour is behaviour that goes beyond what is formally required by the organisation. it is behaviour that is intended to assist the smooth running of the organisation (makin et al., 1996). individuals who are satisfied with their jobs are likely to be better ambassadors for the organisation and show more organisational commitment (agho, price & mueller, 1992). job satisfaction is an affective (emotional) reaction to a job, which stems from the incumbent's comparison of actual outcomes with the required outcomes (cranny, smith & stone, 1992). according to weiss, dawis, england and lofquist (1967) employees seek to achieve and maintain correspondence with their environment. correspondence with the environment can be described in terms of the individual fulfilling the requirements of the environment, and the environment fulfilling the requirements of the individual (cook, hepworth, wall & warr, 1981). this means that employees would experience job satisfaction if they feel that their individual capacities, experience and values can be utilised in their work environment and that the work environment offers them opportunities and rewards (dawis, 1992; roberts & roseanne, 1998). interactional explanations of job satisfaction are generally accepted, but the weight attached to dispositional and situational aspects vary. dispositionists (e.g. house, shane & herold, 1996) have contended that work attitudes and behaviour are determined by, or at least directly linked to, individual attributes. situationists (e.g. davis-blake & pfeffer, 1989), on the other hand, have argued that the world of work, job characteristics, organisational situations and economic conditions affect people much more strongly than do individual differences. arvey, carter and buerldey (1991) suggested that dispositional factors account for 10-30 per cent of the variance in job satisfaction, that 40-60 per cent of the variance is associated with situational factors, and that interactive elements account for 10-20 per cent. since staw, bell and clausen (1986) discovered a link between childhood personality and job satisfaction, there has been considerable interest in the relationship between individual dispositions and job satisfaction. dispositional variables can be described as personality characteristics, needs, attitudes, preferences and motives that result in a tendency to react to situations in a predetermined (predisposed) manner (house et al., 1996). in recent years, researchers have begun to explore the psychological processes that might underlie dispositional causes of job satisfaction. weiss and cropanzano (1996) suggested that affective temperament may influence the experience of emotionally significant events at work, which in turn influence job satisfaction. however, house et al. (1996) noted in their review of the dispositional literature that affective disposition is only one of many traits that can and should be r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 43 studied. judge, locke, durham and kluger (1998) explained dispositional detenninants of job satisfaction in tenns of "core evaluations" (incorporating self-esteem, generalised self-efficacy, low neuroticism and locus of control), which can be described as fundamental evaluations that individuals make about themselves. judge et al. (1998) found that individuals with a positive selfevaluation were more likely to assess their job satisfaction at higher levels than individuals with less positive self-evaluations. in this research, the dispositional causes of job satisfaction are studied from a salutogenic paradigm (which focuses on the origins of health) (antonovsky, 1987; strumpfer, 1990) or fortigenic paradigm (which focuses on the origins of strengths) (strumpfer, 1995). strumpfer (1990, 1995) reviewed a number of constructs which have developed independently but which seem part of the fortigenic paradigm, including sense of coherence (antonovsky, 1987), personality hardiness (kobasa, 1982), potency (ben-sira, 1985) and learned resourcefulness (rosenbaum, 1988). constructs such as internal-extemal locus of control (rotter, 1966) and self-efficacy (bandura, 1989) can be regarded as fortigenesis-related this study deals with the relationship between job satisfaction and three dispositional factors, namely sense of coherence, locus of control and self-efficacy. the objectives of this research were to detennine the relationship between psychological strengths (sense of coherence, locus of control and self-efficacy) and job satisfaction of employees and to determine whether these strengths could predict their job satisfaction. research regarding employees' level of psychological strengths (sense of coherence, locus of control and self-efficacy) and the relationships of these with job satisfaction may provide useful infonnation for the implementation of organisational socialisation programmes (such as recruitment, selection, induction and development programmes). 2. theoretical background 2.1 sense of coherence antonovsky (1987, 1991) developed the construct "sense of coherence". sense of coherence can be described as a global orientation that expresses the extent to which one has a pervasive, enduring though dynamic feeling of confidence that one's internal and external environments are predictable and that there is a high probability that things will work out as well as can be reasonably expected. it thus influences an individual's perception of stimuli. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 44 sajems ns vol 4 (2001) no 1 the definition of sense of coherence includes three dimensions which represent the concept, namely comprehensibility, manageability and meaningfulness (antonovsky, 1987). comprehensibility refers to the extent to which one perceives stimuli from the internal and external environment as infonnation that is ordered, structured and consistent. the stimuli are perceived as comprehensible and make sense on a cognitive level. manageability refers to the extent to which individuals experience events in life as situations that are endurable or manageable and can even be seen as new challenges. meaningfulness refers to the extent to which one feels that life is making sense on an emotional and not just a cognitive level. antonovsky (1987) stated that the primary development of the dynamics of sense of coherence takes place in the flrst decade of one's adult life. antonovsky (1987) also said that one's sense of coherence is tried continually, but individuals who developed a strong sense of coherence early in adulthood have the ability to use general resistance resources to restore equilibrium. sense of coherence can thus be viewed as a stable dispositional orientation. a strong sense of coherence is negatively related to measures of negative affectivity, such as anxiety and neuroticism (carmel & bernstein, 1990; flannery & flannery, 1990; frenz, carey & jorgenson, 1993) and work stress (feldt, 1997). a strong sense of coherence is also related to competence and life satisfaction (kalimo & vuori, 1990), general well-being (feldt, 1997), and to emotional stability (mlonzi & strfunpfer, 1998). strfunpfer, danana, gouws and de viuiers (1998) found a moderate correlation (r = 0.47) between sense of coherence and job satisfaction. individuals with a strong sense of coherence should be able to make cognitive sense of the workplace, perceiving its stimulation as clear, ordered, structured, consistent and predictable information. they should experience their work as. consisting of experiences that are bearable, with which they can cope, and as challenges that they can meet by availing themselves of personal resources or resources under the control of legitimate others. lastly, they should be able to make emotional and motivational sense of work demands as welcome challenges, worthy of engaging in and investing their energies in. however, sense of coherence on its own, without the appropriate ability, skills, training and development, would be of no avail (strfunpfer, 199o). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 45 2.2 locus of control the construct of locus of control was developed by rotter (1966) and is described as the extent to which individuals feel that they playa causative role in events in their lives. rotter (1966) defined locus of control as a generalised expectancy of perceived internal or external control of reinforcement. individuals may sbow an internal or an external locus of control. the former means that positive and/or negative outcomes are attributed to own actions and are consequently regarded as being under personal control. an external locus of control means that positive and/or negative outcomes are regarded as unrelated to own behaviour and are therefore beyond personal control. schepers (1995) found that the construct locus of control consists of three independent factors, namely internal control, autonomy and external control. individuals with an internal locus of control will probably feel that they can manage situations in work context, because these are seen as being within their personal control (judge et ai., 1998). compared to individuals with an external locus of control, they will be less inclined to cope with ftustrations in organisations by withdrawing or by reacting aggressively (rahim & psenicka, 1996; spector, 1982). they are also more successful in personal relationships than individuals with an external locus of control (mayer & sutton, 1996). individuals with an external locus of control look at others for direction, while those with an internal locus of control depend on themselves for direction (spector, 1982). spector (1986) found that high levels of perceived control was associated with high levels of job satisfaction, commitment and involvement, and low levels of stress, absenteeism and turnover. the studies of garson and stanwyck (1997), jain, mclaughlin, lall and johnson (1996) and judge et al. (1998) confirmed a relationship between an internal locus of control and job satisfaction. an individual with an internal locus of control is expected to be more satisfied with his or her job because of his or her perceived ability to control situations. 2.3 self-efficacy the concept of self-efficacy, which was developed by bandura (1982, 1989), is described as the judgements of individuals regarding their skills in carrying out the required behaviour performing particular types of actions. wood and bandura (i989: 408) defined self-efficacy as " ... beliefs in one's capabilities to mobilise the motivation, cognitive resources, and courses of action needed to meet given organisational demands." self-efficacy is a belief in the probability . that one can successfully execute some future action or task to achieve some r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 46 sajems ns vol 4 (200 i) no 1 result. in work context, self-efficacious employees believe that they are likely to be successful at most or all of their job duties and responsibilities (gardner & pierce, 1998). according to gardner and pierce (1998) and judge et al. (1998) self-efficacy can be viewed from both a specific and a general angle. task-specific selfefficacy is a state-based expectation or judgement about the likelihood of successful task perfonnance measured immediately before any effort is expended on the task. it is a powerful motivator of behaviour because efficacy expectations at a given point in time detennine the initial decision to perfonn a task. the effort expended and the level of persistence that emerges in the face of adversity. self-efficacy can also be viewed as a general, stable cognition (trait) that individuals hold and carry with them, that reflects the expectation that they possess the ability to perfonn tasks successfully in a variety of achievement situations (eden & zuk, 1995). according to gardner and pierce (1998), self-efficacy gradually emerges through the experiences that the individual accumulates. the cognitive appraisal and integration of the data stemming from these experiences ultimately determine an individual's self-efficacy. frequent situation-specific experiences of personal success across time and situations give rise to generalised selfefficacy. factors that are likely to lead to high generalised self-efficacy include repeated success at a specific task. the accumulation of successful experiences across a wide variety of tasks and feedback from the work environment that the individual is successful (gardner & pierce, 1998). sherer et al. (1982) found that individuals who have developed a generalised view of themselves as efficacious individuals also hold positive images of themselves. stanley and murphy (1997) criticised generalised self-efficacy measures as measuring nothing but self-esteem. according to judge et a1. (1998) it could be expected that generalised self-efficacy would load on the same factor as self-esteem (because self-efficacy and self-worth are the core components of self-esteem). the major consequence of strong specific self-efficacy perceptions is enhanced task perfonnance (sadri & robertson, 1993). general self-efficacy has been hypothesised to be a strong detenninant of specific self-efficacy (eden, 1988). although self-efficacy theory is somewhat silent on possible effects of selfefficacy on employee attitudes, it seems plausible that the higher one's level of self-efficacy in some task, the higher one's positive affect associated with it (lee & bobko, 1994; schwoerer & may, 1996). according to bandura (1989) employees with a low level of self-efficacy doubt their capabilities, shy away from difficult tasks and have low aspirations and weak commitment to the goals they choose to pursue. wood and bandura (1989) suggested that inefficacious thoughts could cause distress and depression, which could then lead to reduced r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no i 47 levels of satisfaction. judge et al. (i998) concluded that self-efficacy indirectly influences job satisfaction in the sense that perceptions of work attributes, which influence job satisfaction. are affected. 2.4 the relationship between sense of coherence, locus of control and selfefficacy the literature provides considerable amounts of research linking self-efficacy and locus of control. sherer et al. (1982) claimed that attributional style is important for general self-efficacy. individuals who have an internal locus of control will attribute past success to themselves, and this tendency will boost their general self-efficacy. shelton (1990) stated that past experiences with success or failure affect an individual's general self-efficacy depending on whether he or she attributes the success or failure to the self. according to lefcourt (1982) and rotter (1966) individuals with an extemal locus of control tend to doubt their personal efficacy. self-efficacy pertains to confidence with respect to actions or behaviour, whereas locus is more concerned with confidence in being able to control outcomes (judge et al., 1998). both self-efficacy and locus of control are cognitive constructs and are about control (rotter, 1966). breed (1997), who found a correlation of 0.37 between locus of control and generalised self-efficacy, stated that both constructs are concerned with the individual's experience of the self in control of his or her own world of experience and available resources. kalimo and vuori (1990) stated that the sense of coherence concept involves some of the issues that can be found in locus of control theory. sense of coherence refers to an internalised sense of control, which also guides orientation towards coming events. sense of coherence helps individuals understand the various facets of control and their consequences through individuals' experience of the environment. it is in this regard that the sense of coherence concept is similar to the concept of locus of control because both lead to anticipatory health.promoting orientations (seeman & seeman, 1983). according to antonovsky (1987). differences exist in the conceptual definitions of sense of coherence and locus of control. sense of coherence also views resources under the control of others as valuable. whereas locus of control views such resources as an external orientation and a failure to take control of their own destiny. similarly, correlation coefficients between 0.38 and 0.44 have been found between sense of coherence and locus of control (antonovsky, 1987). the relationship between self-efficacy and sense of coherence is interesting. because self-efficacy is not primarily conceptualised in the fortigenic paradigm. self-efficacy, like sense of coherence, is concerned with the individual's r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 48 sajems ns vol 4 (2001) no 1 experience of forcefulness in his or her own world (breed, 1997). according to antonovsky (1987) the components of sense of coherence show similarities to the self-efficacy construct. breed (1997) found a correlation of 0.53 between generalised self-efficacy and sense of coherence. 3 research method 3.1 research design a survey design was used to reach the research objectives. the specific design is the cross-sectional design, whereby information is collected from a sample or population at one time (shaughnessy & zechmeister). this design can be used also to assess interrelationships among variables within a population. according to shaughnessy and zechmeister (1997) this design is ideally suited to the descriptive and predictive functions associated with correlational research. correlational research is the method of choice when the goal of the research is prediction. however, there are serious limitations to using the results of this type of research to infer causal relationships. 3.2 study population the study population (n = 624) included samples of the following organisations in south africa: the total population of representatives (n = 55) of a fertiliser marketing company in south africa. approximately 98 per cent of the population consisted of males. the age of the group varied between 20 and 60 years. a stratified random sample (n 98) of the employees of a fmancial institution in south africa (n 500). approximately 51 per cent of the participants were males, 77 per cent below the age of 40 and 15 per cent part of management. a non-probability sample (n = 81) of managers in the dairy industry in south africa (n = 121). a total of 89 per cent of the participants were males. the age of the participants varied between 20 and 60 years. the total population of senior police officers (n = 101) in the north west province in south africa. all the participants were males aged between 26 and 55 years. the total population of supervisory and management personnel (n = 129) of a cigarette manufacturing company in south africa. a total of 97.7 per cent of the participants were males. the age of the participants varied between 24 and 61 years. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no i 49 a stratified random sample (n = 100) of health services workers in a state hospital in the north west province in south africa (n = 300). approximately 86 per cent of the participants were females, 74 per cent below the age of 40 and 32 per cent part of management. a non-probability sample (n = 60) of employees of an estate agency in south africa (n = 130). approximately 63 per cent of the participants were females, 60 per cent below the age of 40 and 20 per cent part of management. 3.3 measuring instruments the minnesota satisfaction questionnaire (msq) (weiss et al., 1967) was used to measure employees' job satisfaction. test-retest reliabilities of 0.70 and 0.80 were found over a span of a week and a year respectively (cook et al., 1981). in this study a cronbach alpha coefficient of 0.96 was found for total job satisfaction (see table 1). the mean inter-item correlation is 0.22, which is acceptable for broad higher order constructs (clark & watson, 1995). the orientation to life questionnaire (olq) (antonovsky, 1987, 1993) was used to measure participants' sense of coherence. antonovsky (1987, 1993) reported cronbach alpha coefficients ranging between 0.84 and 0.93 for the olq. kalimo and vuori (1990) found a test-retest reliability of 0.93 for the olq, while antonovsky (1993) reported test-retest reliability coefficients varying between 0.41 and 0.97. regarding construct validity, it was found that there is an inverted relationship between the olq and stress experienced. the olq correlates negatively with the "state-trait anxiety inventory-trait" and the "beck depression inventory" (frenz, carey & jorgensen, 1993). the locus of control questionnaire (loc) (schepers, 1995) was used to measure locus of control. the loc measures three factors, namely internal control, external control and autonomy. external control measures the extent to which the respondent attributes performance to forces outside his or her control (luck, fate, circumstances or influential people). internal control measures whether the respondent attributes performance to causes within his or her control (abilities, behaviour or personal characteristics). autonomy measures whether the respondent's believes in his or her abilities, acts independently with self-confidence, and decides on and takes action to solve problems. an item analysis of the three scales revealed reliability scores higher that 0.80. research by schepers (1995) established the cronbach alpha coefficients of the three scales of the loc at 0.83 (internal control), 0.84 (external control) and 0.87 (autonomy). schepers (1995) found that external and internal control are not bipolar opposites, but independent constructs. in terms of criterion validity, it r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 50 sajems ns vol 4 (2001) no 1 has been found that the loc correlates with a composite criterion of job success (r = 0.62) (botbma & schepers, 1997). the general self-efficacy questionnaire (gse) (tipton & worthington, 1984) was used to detennme how the individual judges his or her own abilities and regulates the experience of personal efficacy with regard to incidents in his or her life. tipton and worthington reported that they based their gse scale on the concept of faith, especially faith in oneself. marais (1997) and stanley and murphy (1997) obtained cronbach alpha coefficients of 0.71 and 0.83 respectively for the gse scale. 3.4 statistical analysis the statistical analysis was carried out by means of the sas-program (sas institute, 1996). because a non-probability sample was used in this research, effect sizes (rather than inferential statistics) were used. cronbach alpha coefficients were calculated to indicate the internal consistency of the measuring instruments. pearson product-moment correlation coefficients were used to specify the relationships between the variables. a cut-off point of 0.30 (medium effect, cohen, 1988) was set for the practical significance of correlation coefficients. analysis of variance was used to determine the differences between the job satisfaction, sense of coherence, locus of control and self-efficacy of employees of different organisations. the following formula was used to compute the effect sizes (d in table 2) of these differences (steyn, 1999): with ~-mo ~mse ma = mean of the construct in one organisation mb = mean of the construct in another organisation mse = mean square error. a cut-off point of 0.5 (medium effect, cohen, 1988) was set for the practical significance of differences. a stepwise multiple regression analysis was conducted to determine the proportion of variance in the dependent variable (job satisfaction) that is predicted by the independent variables (sense of coherence, locus of control and self-efficacy). the effect size (which indicates practical significance) in the case of multiple regression is given by the following formula (steyn, 1999): /2 = r2 /(1 _ r2). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 51 a cut-off point of 0.35 (large effect, steyn, 1999) was set for the practical significance of/2. 4 results the descriptive statistics and the internal consistency of the measuring instruments for the total population are reported in table 1. table 1 descriptive statistics and alpha coefficients of the measuring instruments item m sd skewness kurtosis a. job satisfaction (n= 624) total 490.60 76.56 0.81 0.99 0.96 sense of coherence (n = 521) olq 140.41 21.89 [-0.22 0.04 0.89 comprehensibility 48.77 8.96 0.00 -0.31 0.74 manageability 48.13 8.42 1-0.25 -0.18 0.75 meaningfulness 43.50 7.98 -0.86 0.58 0.82 locus of control (n = 534) loc: internal 146.81 i 14.87 • -l08 4.94 10.86 loc: external 84.54 20.52 0.07 -0.24 10.80 loc: autonomy 136.65 ·15.92 -0.56 11.74 10.81 self-efficacy (n = 282) gse 74.69 18.34 1.36 14.10 1 0.94 table i shows that the scores on the measuring instruments of job satisfaction and psychological strengths are relatively normally distributed with the loc: internal scores somewhat negatively skew while the gse scores show a positive skewness and kurtosis. the cronbach alpha coefficients of the msq, the olq, the loc and the gse confirm their internal consistency when compared with the norm of 0.80 set by nunnally and bernstein (1994). table 2 shows the differences between the means of the measuring instruments in the different organisations included in this study. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . ~ u. n item msq olq loc: loc: loc: rt gse n external internal autonomy m sd m sd m sd m sd m sd m sd f~~~~ 503.64 63.65 fertiliser 139.71 20.69 79.58 20.49 150.84 11.39 142.40 13.98 73.13 20.75 marketing bl f h company financial 483.39 89.12 139.96 23.31 83.41 22.34 145.04 18.53 135.o? 19.63 75.15 ~ 17.34 institution dairy 506.84 74.34 143.11 21.43 . . . . industry bl d e:~ ;tai .. ~ g ; .... ~ o ~ ;a '" iii ci" 1:1 ~ lli'i iii ~ s· g 1:1 .... '" 1:1" police 483.67 65.28 . . 85.79 19.16 148.91 13.62 141.73 13.10 service h ------i cigarette 511.87 73.23 147.31 18.41 80.19 19.36 145.75 13.03 142.19 12.80 75.00 18.09 manub2 d f h facturing i company health 452.95 76.35 131.20 20.62 93.03 16.79 145.86 16.32 127.08 14.33 i services a c e g institution estate 497.18 69.81 136.68 24.97 83.94 24.17 146.19 13.49 128.34 12.31 agency bl g ~ ei ii '" 0 (il "'" .... ~ 1:1" ~ ei ~ (il ii z = (il :so <: 1:1 fq e. ~ 1:1 =~ 2 0 0 ei -'-" ~ z 1:1 a 0 5' r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 53 a practically significant difference from the organisations where b l (medium effect, d;;:: 0.5) and b2 (large effect, d;;:: 0.8) are indicated c practically significant difference (medium effect, d ;;:: 0.5) from organisations where d is indicated e practically significant difference (medium effect, d ;;:: 0.5) from organisations where f is indicated g practically significant difference (large effect, d ;;:: 0.8) from organisations where h is indicated table 2 shows practically significant differences between the job satisfaction of participants of the health services institution and all the other organisations, except for the police service. these participants also obtained practically significant lower scores on sense of coherence than those of the dairy industry and the cigarette manufacturing company. regarding externa1locus of control, participants of the health institution obtained practically significant higher scores than those of the fertiliser marketing company and the cigarette manufacturing company. participants of the fertiliser marketing company, the police service and the cigarette manufacturing company obtained practically significant higher scores on autonomy, compared with those of the health services institution and the estate agency. the pearson product-moment correlation coefficients between the different constructs are given in table 3. table 3 item total job satisfaction olq: total loc: external loc: internal loc: autonomy pearson product-moment correlation coefficients between total job satisfaction and psycbologicaj strengtbs olq: loc: loc: loc: gse total external internal autonomy 0.50 0.43 0.30 0.37 -0.10 i -0.56 i 0.32 0.47 -0.41 i i -0.17 -0.30 0.25 0.65 -0.25 -0.39 * correlation is practically significant r > 0.30 (medium effect) ** correlation is practically significant r> 0.50 (large effect) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 54 sajems ns vol 4 (200 i) no 1 table 3 shows practically significant correlation coefficients of large effect (r ~ 0.50) regarding the following items: sense of coherence and total job satisfaction, sense of coherence and external locus of control (negative correlation) as well as internal locus of control and autonomy. practically significant relationships of medium effect (r ~ 0.30) exist between sense of coherence and self-efficacy, sense of coherence and autonomy, self-efficacy and internal locus of control, as well as self-efficacy and autonomy. the negative correlation coefficients between generalised self-efficacy and the other constructs could be expected because a low score on the gse is indicative of a positive adaptation. the results in table 3 indicate that all the psychological strengths bad some significant correlation with job satisfaction, except selfefficacy, which showed no practically significant correlation with job satisfaction. next, the correction for attenuation was computed to estimate how high the correlation between job satisfaction and the psychological strengths would be if the variables were made perfectly reliable. the correction for attenuation is computed by using the following formula: where r xy = the correlation between job satisfaction and the specific construct, and rx and ry = the reliabilities of the measures of job satisfaction and the specific construct. table 4 shows the corrected correlation coefficients between job satisfaction and psychological strengths. table 4 item total job satisfaction corrected correlation coefficients between total job satisfaction and psychological strengths olq: loc: loc: loc: gse total external internal autonomy 0.54·' -0.49" 0.33" 0.42" -0.11 ... ...... correlation is practically significant r> 0.30 (medium effect) correlation is practically significant r > 0.50 (large effect) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 55 table 5 shows the homogeneity of the correlation coefficients between psychological strengths (including only sense of coherence and locus of control) and job satisfaction in the different organisations. the method of fisher, who devised a transfonnation from r to a quantity z was used to test the hypothesis that several rs are estimates of the same p (snedecor & cochran, 1980). first each r was converted to z and the term (n 3) was recorded for each z. the test of significance was based on the following fonnula: r l(n-3)z2 -[l(n-3)z]2 l(n-3) the obtained value was compared with the 'x: table to detennine whether the pvalue was significant the cut-off point for the statistical significance of p was set at 0.05. table 5 homogeneity of the correlation coefficients between psychological strengths and total job satisfaction in different organisations study i n ! w=d-3 r z w*z ",*z"2 msqandolq:-l=9.79 p=0.08 pooledz=0.49 pooledr=0.45 fertiliser marketing i 55 52. 0.26 0.27 13.84 3.68 company i financial institution 98 95 ! 0.56"" i 0.63 60.12 38.05 dairy industry 81 78 0.55"" 0.62 48.23 29.83 i cigarette manufacturing i 129 1 126 0.38" 0.40 50.41 20.17 company : i health services institution 100 97 0.36" 0.38 36.56 13.78 i estate agency 60 i 57 . 0.58"" . 0.66 37.76 i 25.01 msq and loc external: 'l = 7.15 p = 0.21 pooled z = -0.42 pooled r 0.40 fertiliser marketing 551 52 1-0.43* -0.46 -23.91 11.00 company financial institution 98 95 -0.46" -0.50 -47.24 23.50 police services 101 i 98 -0.44" -0.47 -46.28 21.85 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 56 sajems ns vol 4 (2001) no i table 5 continued study n w=n-3 r z w*z w*z"'l cigarette manufacturing 129 126 -0.32" -0.33 -41.79 13.86 company health services institution 100 97 -0.26 -0.27 -25.81 6.87 estate agency 60 57 -07s"" -36.91 23.90 0.5t" msq and loc internal: ·l = 9.55 p = 0.09 pooled z = 0.32 pooled r = 0.31 fertiliser marketing 55 i 52 0.26 0.27 13.84 3.68 company financial institution 98 95 0.42" 0.45 42.53 19.04 police services 101 98 0.14 0.14 13.81 1.95 cigarette manufacturing 129 126 0.31" 0.32 40.39 12.95 company health services institution 100 97 0.24 0.24 23.74 5.81 estate agency 60 57 0.53"" 0.59 33.64 19.85 msq and loc autonomy: "i: 8.12 p = 0.15 pooled z = 0.33 pooled r = 0.31 fertiliser marketing 55 52 0.45" 0.49 25.20 company financial institution 98 95 0.49" 0.54 50.93 police services 101 98 0.20 0.20 19.87 cigarette manufacturing 129 126 0.25 0.26 32.18 company health services institution 100 97 0.25 0.26 24.78 estate agency 60 57 0.30" 0.31 17.64 ... ...... correlation is practically significant r > 0.30 (medium effect) correlation is practically significant r > 0.50 (large effect) 12.22 27.30 4.03 8.22 6.33 5.46 table 5 shows that different correlation coefficients were obtained between job satisfaction on the one hand and sense of coherence and locus of control on the other hand. however, the differences between the correlation coefficients are not statistically significant. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 57 next, a regression analysis of the various psychological strengths (as independent variables) and job satisfaction (as measured by the msq) as dependent variable was conducted (see table 6). table 6 regression analysis of olq, loc, gse and msq analysis of variance r=o.55 source of i degrees of i sum of mean square variance freedom squares r2 = 0.30 regression i 5 507720.15 101544.03 residual i 275 1201643.91 4369.61 f=23.24 1/2 = 0.43 i variables in the equation independent b i seofb partial ri f i p variables constant 167.27 65.27 6.57 o.oi olq (soc) 1.03 0.26 0.20 16.34 0.00 loc: external -0.78 0.23 0.03 11.80 0.00 loc: internal 0.64 0.39 0.04 2.60 0.11 loc: autonomy 0.75 0.42 0.01 3.20 0.07 gse 0.68 0.24 0.02 7.91 i 0.00 table 7 demonstrates that sense of coherence, locus of control (external control, internal control and autonomy) and self-efficacy predict a total of 30 per cent of the variance of total job satisfaction (as measured by the msq). the multiple correlation of 0.55 is practically significant (large effect) if 2 = 0.43). these findings indicate that sense of coherence, locus of control and self-efficacy predict approximately 30 per cent of the variance in job satisfaction. 5 discussion the results of the empirical study show that health services employees (who work for the provincial government) are significantly less satisfied with their jobs compared with employees in the other organisations. high demands, money shortages and organisational transformation affect the health services in the province, which may be related to employees' lower job satisfaction. furthermore, the results show that these employees also achieved practically r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . s8 sajems ns vol 4 (2001) no i significant lower scores on sense of coherence and autonomy and higher scores on external locus of control. a practically significant correlation was found between sense of coherence and total job satisfaction. which confirms previous research fmdings (striimpfer et al., 1998). practically significant correlation coefficients were also found between job satisfaction on the one hand and external locus of control, internal locus of control and autonomy on the other hand. locus of control (including internal locus of control, external locus of control and autonomy) correlated significantly with total job satisfaction. an employee who attributes perfonnance to causes within his or her control, believes in his or her ability, acts independently with self-confidence and decides on and takes action to solve problems will experience more job satisfaction than those who do not. this fmding confinns fmdings of other researchers (e.g. garson & stanwyck, 1997; jain et ai., 1996; spector, 1986) that an internal locus of control is related to job satisfaction. employees who perceive that they have the ability to control situations are more satisfied with their jobs. no practically significant correlation was found between self-efficacy and job satisfaction. the absence of significant correlation coefficients is contradictory to the findings of judge et al. (1998) that self-efficacy is a better predictor of job satisfaction than locus of control. the expectation that higher generalised selfefficacy would be related to higher positive affect towards one's job did not realise in this study. however, gardner and pierce (1998) noted that generalised self-efficacy bas not had a strong track record in laboratory experiments and other well-controlled studies. this may be the reason for the low correlation between job satisfaction and generalised self-efficacy. other reasons may be that the measuring instrument is lacking validity. on the other hand, it may also be useful to relate job satisfaction to task-specific self-efficacy rather than generalised self-efficacy (bandura, 1989). the correlation coefficients between job satisfaction on the one hand and sense .. of coherence, locus of control and generalised self-efficacy on the other, show the same tendencies in different organisations. however, in the case of the fertiliser marketing company, a stronger relationship was found between job satisfaction and autonomy in comparison with other organisations, while job satisfaction was not so strongly related to sense of coherence. this fmding may be attributed to the nature of the job of the representative, which requires that he or she should work independently and with self-discipline. in most organisations an external locus of control was significantly negatively related to job satisfaction. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no i 59 sense of coherence is negatively related to an external locus of control, and positively related to an internal locus of control, autonomy and generalised selfefficacy. breed (1997) also found significantly positive relationships between self-efficacy and sense of coherence. (note that a low score on the gse indicates a higher generalised self-efficacy, which explains the negative correlation between sense of coherence and generalised self-efficacy.) employees who experience stimuli from the environment as comprehensible, manageable and meaningful will therefore attribute performance to causes within his or her control (rather than forces outside their control), believe in their abilities, act independently with self-confidence and decide and take action to solve problems and show higher generalised self-efficacy. it was found that an internal locus of control is significantly related to autonomy (r = 0.65), which supports the imdings of schepers (1995). an internal locus of control is also negatively related to an external locus of control (r = -0.30), which suggests that the two scales are somewhat related. the results indicate that an internal locus of control and generalised self-efficacy are significantly related. individuals who believe that they can control their behavioural outcomes could come up with the necessary resources and motivation to cope effectively with challenges and/or tasks at hand. generalised self-efficacy and autonomy are also significantly related. the imdings pertaining to self-efficacy and locus of control in this study are higher than those of breed (1997). the correlation coefficients between sense of coherence, external and internal locus of control, autonomy and generalised self-efficacy could indicate that they measure aspects of the same construct (psychological strengths). the relatively low correlation coefficients between locus of control (internal and external) and generalised self-efficacy may indicate that these constructs measure different aspects of behaviour. this finding is contradictory to the expectation that individuals with an external locus of control tend to doubt their personal efficacy (breed, 1997; lefcourt, 1982; rotter, 1966). it should, however, be taken into account that breed (1997) used rotter's (1966) scale, which is ipsative in nature, to measure locus of control. ipsative scales are not suitable for use in correlative studies. judge et al. (1998) stated that self-efficacy pertains to confidence with respect to actions or behaviour, whereas locus of control is more concerned with confidence in being able to control outcomes. the regression formula for the prediction of job satisfaction could be written as follows: total job satisfaction (msq) = 1.03(olq) 0.78(loc: external) + o.64(loc: internal) + 0.75(loc: autonomy) + 0.68(gse) + 167.27. the three psychological strengths predicted 30 per cent of the variance of total job satisfaction in this study. it seems that sense of coherence explains the largest part of the variance in total job satisfaction. however, the moderate correlation r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 60 sajems ns vol 4 (2001) no 1 coefficients between sense of coherence, locus of control and generalised selfefficacy probably limited the multiple correlation (nunnally & bernstein, 1994). the multiple correlation suggests that if employees have a high sense of coherence, a low external locus of control, a high internal locus of control and a high level of autonomy, they will be more satisfied with their jobs. a limitation of this research is that the research design does not allow one to determine the direction of the relationship between the variables (see kornhauser, 1965). another limitation is that a non-probability sample has been used, which implies that the fmdings cannot be generalised to other settings. 6 recommendations this study generates several application-oriented suggestions. firstly, organisations can select individuals who have a strong sense of coherence, a low external locus of control and a high level of autonomy, depending on the job. however, before organisations begin selecting employees on the basis of these characteristics, more research is required, especially because these characteristics were not studied in a selection context. secondly, organisations can contribute to the development of employees' sense of coherence by giving information in a consistent, structured, ordered and understandable format. employees should further be able to identify their roles within the greater whole and as such the comprehensibility component of sense of coherence will be enhanced. thirdly, by equipping employees with the necessary knowledge, skills, material, instruments and other resources, and by ensuring a balance in the load of tasks to be handled, the employees will increasingly feel that the work expectations are manageable and within their or important other's power. employees should also be given the opportunity to perform work that requires thought and independent judgement. this will also strengthen their task-based self-efficacy.· . training and development programmes that are directed at developing psychological strengths (including sense of coherence, locus of control and generalised self-efficacy) should be investigated. research indicates that dispositional characteristics that relate to coping styles seem to be subject to change (lachman, 1989). fourthly, when a degree of independence and freedom of choice in the performance of employees' tasks is allowed, employees will regard their work as meaningful. participation in decision-making will enhance the employees' feeling of membership and contribute to the meaningfulness component of sense r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 61 of coherence. fifthly, the employee should have the freedom to disagree with his or her supervisor, to discuss what to do with his or her supervisor (rather than to be told what to do) and to act autonomously (without being supervised too closely). the relationship between self-efficacy and job satisfaction should be investigated in other contexts and with larger samples. other instruments, which measure generalised self-efficacy, should also be related to job satisfaction. alternatively, task-specific self-efficacy, rather than generalised self-efficacy, needs to be researched in organisational settings. sense of coherence, selfefficacy and locus of control could be investigated in relation to other work outcomes, such as performance and coping with organisational transfonnation. references agho, a.o.; price, j.l. & mueller.., c.w. 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(1984) "the measurement of generalized self-efficacy: a study of construct validity", journal of personality assessment, 48: 545-8. 66 weiss, dj.; dawis, r.v.; england, g.w. & lofquist, l.h. (1967) manual for the minnesota satisfaction questionnaire, university of minnesota, minneapolis, mn. 67 weiss, h.m. & crop anzano, r. (1996) "affective events theory: a theoretical discussion of the structure, causes, and consequences of affective experiences at work, research in organizational behaviour, 18: 1-74. 68 wood, r.e. & bandura, a. (1989) "impact of conceptions of ability on self-regulatory mechanisms and complex decision-making", journal of personality and social psychology, 56: 407-15. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 3 476 africa and the challenges of globalisation: agenda for action skbasante former principal regional advisor. uneca, ethiopia abstract as we enter the brave new world of the 21st century, a critical analysis of africa's position in the globalising world economy with a view to grasping fully the policy challenges that lie ahead has become increasingly necessary. to this end, the paper addresses not only the challenges which globalisation poses to africa; it also draws attention to the general denunciation, in africa, of the phenomenon of globalisation. it is argued that while africa cannot resist globalisation, it can at least make adjustments in economic policies that will enable the african countries to achieve gains while conceding losses. hence an agenda for action has been provided to highlight a number of key areas on which policy should focus attention. jel 019 i introduction the growing interest in both official and private quarters in the phenomenon of globalisation and its companion, the process of economic liberalisation, as a dominant force in the last decade of the twentieth century, has generated much thinking and analysis about its origin, its impact on economies and societies, and on the pattern of its likely evolution. although much publicity has surrounded some of the analysis, it is clear that these multifaceted phenomena have important implications, which governments, businesses and analysts all over the world must address. much of the analysis and thinking has focused on the more visible aspects of globalisation, notably, the sea changes taking place in the pattern of production, pace of diffusion of knowledge and information and in the convergence of factor markets. less well understood and analysed, however, is the challenge of the phenomenon of marginalisation which globalisation poses to the developing countries, particularly those in africa, which are at the periphery of global processes and have been so over a very long period. marginalisation in this context connotes the decline in the african countries' share of world trade, capital flows and pror ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 477 sajems ns vol 4 (2001) no 3 duction to negligible levels, with severe consequences for their development and living standards. given the importance of trade and foreign direct investment (foi) flows in stimulating and facilitating technological innovations, the implication of this marginalisation is that african countries and the other least developed countries will fall even further behind the rest of the world in terms of their technological capacities. questions such as whether giobalisation will assist their integration in the world economy or whether the new challenges will further weaken their already precarious links are far from academic but are at the centre of the development debate. there is a danger that the fragile economic and social position, which characterises many of the african countries, will deteriorate further unless major efforts are made by them, supported by the international community, to adjust to the challenges of globalisation and liberalisation. this paper attempts to address some of the challenges which globalisation poses to africa. it then outlines the appropriate policies that would be required to meet the challenges. this has become increasingly necessary as, in the absence of appropriate policy responses from the african countries and the international community, globalisation may do little to alleviate the trend towards their marginalisation from the world economy and may even accentuate it. after this introductory section, section ii focuses attention on the globalisation process and its key features, including the causes and forces behind this process, while section iii analyses the position of africa in the global ising world economy. more importantly, the section highlights the challenges which globalisation poses to the african states. in section iv, an agenda for action to meet the challenges of globalisation and consequently facilitate africa' s march towards claiming the 21 st century is provided. section v concludes with a brief highlight on africa's prospects in meeting the challenges posed by globalisation. n the globalisation process globalisation has become an outstanding phenomenon of our times. the term, which is used to describe the shape of the world economy today, has become fashionable but its meaning and implications, particularly for developing countries, are far from clear. it has raised such perplexing questions as: what really is globalisation? why has globalisation occurred? or, what causes globalisation? how, if at au, has globalisation generated social change? what benefits and harms have flowed from globajisation? or, as paul streeten recently put it, is globalisation a threat to humanity, or its salvation (streeten, 1998: 13)? insofar as globalisation can have ill effects, how might they be avoided? r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 3 478 it is not our intention to respond to all these questions, which grip much contemporary political debate. suffice it to say that globalisation as a tenn refers to the growing interaction of countries in world trade, foreign direct investment and capital markets. this phenomenon is shaping a new era of interaction among nations, economies and people. specifically, it is increasing the contacts between people across national boundaries in economy, in technology. in culture, and in governance. briefly stated, globalisation is characterised by four types of changes. first it involves a stretching of social, political, and economic activities across frontiers, regions and continents. second, it is marked by the intensification, or the growing magnitude, of interconnectedness and flows of trade, investment, fmance, migration, and culture. third, it can be linked to a speeding up of global interactions and processes, as the development of worldwide systems of transport and communication increases the velocity of the diffusion of ideas, goods, information, capital, and people. and fourth, the growing extensity. intensity. and velocity of global interactions can be associated with their deepening impact such that the effects of distant events can be highly significant elsewhere and specific local developments can come to have considerable global consequences. in this sense, the boundaries between domestic matters and global affairs become increasingly fluid. globalisation, in short, can be thought of as the widening, intensifying, speeding up, and growing impact of worldwide interconnectedness (held & mcgrew, 2001: 324). the global economy has become more liberalised as almost all countries throughout the world have adopted market-oriented policies entailing the reduction of government intervention and the privatisation of state-owned assets. while liberalisation has contributed to global economic integration by removing barriers to trade and investment, it is also a response to it, as governments' ability to control economic events within their own borders has progressively diminished. globalisation therefore has profound implications for states. everywhere the imperative to liberalise has demanded a shrinking of state involvement in national life, producing a wave of privatisations of public enterprises and, generally,job cuts. and everywhere the opening offmancial markets has limited governments' ability to run deficits requiring them to slash health spending and food subsidies that benefit poor people. thus the comforting illusion that states could exist as islands and successfully manage their economies regardless of the dictates of global markets has been cruelly shattered. another principal issue in debates about globalisation concerns chronology. is the spread of global relations new to contemporary history? or did the trend start several generations, centuries or even millennia ago? or is globalisation a cyclical phenomenon that comes and goes from time to time? what appears certain is that the phenomenon of globalisation is not new since trade and foreign direct investment, the most commonly used indicators of globalisation, grew r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 479 sajems ns vol 4 (2001) no 3 rapidly even in the nineteenth and early twentieth centuries. the geographical dispersion of economic activity has been taking place for decades if not centuries. if globalisation is not a new phenomenon, does the current phase of globalisation differ from the earlier phases? the current phase is no doubt qualitatively different from that of the earlier period, that is, from the mid-i 880s to the end of world war i. a larger part of the world and a larger number of independent countries are participating in it. new technological advances have sharply reduced transportation, telecommunication, and computation costs, greatly increasing the ease with which national markets may be integrated at the global level. economic distances have shrunk and coordination problems have diminished to such an extent that in many cases it has become an efficient method of industrial organisation for a firm to locate different phases of production in different parts of the world. the structure of foreign trade has increasingly become intra-industry and intra-firm, and fdi serves as an important vehicle of globalisation. more and more, countries depend on each other for technology transfer and learn from each other manufacturing methods, modes of organisation, marketing, and product design. the various elements of globalisation trade, direct investment flows, technology transfers have become more closely linked and interconnected, and the world economy is becoming, more and more, the relevant context for economic decisions. although the causes and the forces behind the process of globalisation are well known, three of them, which particularly played a crucial part in giving a momentum to this process, are worth highlighting. one of them is the political change that has taken place recently on the world stage, following the break-up of the communist countries and the end of the bi-polar world. it gave a new ascendancy to the capitalist countries of the west to pursue the policies, the agenda and the goals that they have always believed in. the demise of the communist state and the command economy opened the way for dismantling state control over economic decision-making. it also permitted the resurgence of free market economy policies and deregulation of markets, including liberalisation of international transactions. these policy changes provided further impetus to the free flow of resources within the global economy and across national boundaries. the second factor relates to the role played by many international institutions in creating the framework for the progress of globalisation and liberalisation. a case in point is the role played by the world trade organisation (wto). it not only took the process of opening up markets to new levels, but also introduced and brought into its arnbit a whole new series of issues that had not yet figured in the agenda of international liberalisation, such as negotiations on investment, services, intellectual properties and so on. the bretton woods institutions also contributed to the spread of the globalisation and liberalisation phenomenon, as r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 3 480 evidenced in their introduction of major changes in the economies of the developing countries through what they call structural adjustment programmes, the core of which is encouragement to these countries to allow their economies to be merged with those of the outside world. with this in view they are asked to reduce the barriers to investment and deregulate their economies (gamani, 1999: 15). the third striking development has been the spectacular advances in communications technology, which has brought every part of the globe within easy reach, made it possible for people to come into close and rapid contact with each other, for funds to flow across most borders at a moment's notice, and for investment houses established in different parts of the world to maintain contacts with their head offices. events in one corner of the world are very quickly reported in all other parts, sometimes even as they happen. similarly, their effects are quickly transmitted across national boundaries in a process sometimes referred to as the contagion effect. hence the frequent references to our world today as the global village. it has been argued in recent official reports and studies (unctad, 1996; imf, 1997) that the pressures of globalisation, especially in the past decade or so, have served to accentuate the benefits of good policies and the costs of bad policies. countries that align themselves with the forces of globalisation and embrace the reforms needed to do so, liberalising markets and pursuing disciplined macroeconomic policies, are likely to put themselves on a path of convergence with the advanced economies, following the successful asian newly industrialised economies (nies). these countries may expect to benefit from trade, gain global market share, and be increasingly rewarded with larger private capital flows. countries that do not adopt such policies are likely to face declining shares of world trade and private capital flows, and to find themselves falling behind in relative terms. evidently, therefore, globaiisation is a double-edged sword, with both opportunities and threats. for some countries, globalisation will present unprecedented opportunities for growth and prosperity. for others, globalisation could mean what a recent magazine (african business, 2000: 8) has termed "economic enslavement". where does africa fit into all this? how does the african leadership view the process of globalisation, which, as we enter into the new millennium, will continue to dominate the political and economic landscape, resulting in an unparalleled surge in international trade and financial flows across borders and opening up of the domestic markets of an increasing number of developing countries? r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 481 sajems ns vol 4 (2001) no 3 m africa in the globalising economy virtually from the limpopo river to the nile, africa has been unanimous in its denunciation of globalisation and the challenges it poses to the region. a case in point was the general condemnation of the process of globalisation at the recent southern african international dialogue forum held in the mozambique capital of maputo. at the forum, uganda's president yoweri museveni labelled globalisation as a new form of oppression, stressing that "the new world order is merely the same as old oppression of the developing nations by the west" (african business. 2000: 9). in the same vein, president robert mugabe of zimbabwe stressed that africa did not yet have the capacity to enter the global village, maintaining that the "continent is still grappling to put up basic necessities such as good roads, railways and transportation" (nevin, 2000: 8). in general, african critics have argued that globalisation driven by high technology is just "another form of colonialism", particularly since african economies are so dependent on the prices of raw commodities. africa's bargaining power has evaporated due to the instant availability of alternative supplies from asia, south america and even the developing nations of the ex-soviet empire. it is further stressed that globalisation is spawning a new breed of commercial behemoths and africa is in danger of being dominated by such giants who gain a stranglehold monopoly. the general african denunciation of globalisation was reinforced by president olusegun obasanjo of nigeria at the thirty-fifth ordinary summit of the organisation of african unity (oau) held in algiers, algeria, in july 1999, when he concluded that the "tragedy is that all of us here are witnessing how africa is being bypassed and its marginalisation turning into de-linkage" (aec newsletter, 1999: 5). to many african and third world leaders, therefore, globalisation is nothing short of neo-imperialism. it may well be the defining force in contemporary society, but it looks and smells like good old imperialism in much finer clothes and with a good deal more power, dangling the carrot of imperialism and wielding a bigger stick. as samir amin highlighted at a recent beijing conference, "glohalisation is an ideology that masqueraded as a theory, when in fact it is an expression of the hegemony of the triad, that is, the united states, european union and japan" (inside aisa. 2000: 2). it is a combination of opportunities and challenges: opportunities for those that already have the necessary fmancial and communication infrastructure in place; and challenges for those in africa that are still in the process of re-tooling their economies to meet trade liberalisation requirements. in this regard, south africa's ambiguous attitudes about globatisation are worth noting. in a survey of the attitudes of the south african elite vis-a-vis globalisation, phillip nel argues that the south african policy elite displays ambiguous r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 n03 482 attitudes about whether to accept or resist globalisation. at the heart of this lies the fact that the main partners in the government of national unity have opposing views of desirable macro-economic scenarios in south africa (nel, 1999: 22). it is not surprising, therefore, that south of the limpopo river, south africa finds itself wearing two hats, thus making its stand in this virtual pan-african indictment of the globalisation process disturbingly ambiguous. south africa badly wants its place in the global village, seeing acceptance by western economies as the road to its own financial independence. its problem is to court the well-heeled westerners, while at the same time being seen to share the antiglobalisation indignation of its african kith and kin. south africa finds that a difficult tightrope on which to keep its balance. it is steaming ahead into the information age, becoming a world leader in some sectors. its information technology (it) companies are venturing deeper into africa in an attempt to hasten its information coming of age. while the pan-african denunciation of the globalisation process and the ambiguous position of south africa on the subject are worth noting, the fact remains that africa and, indeed the developing world in general, cannot escape globalisation whether we like it or not, neither can we wish it away. in this regard, the exact position of africa in the globalising world economy is of prime importance in any endeavour to fully grasp the policy challenges that lie ahead as we enter the 21st century. this is particularly necessary as from every point of view, the african state is a peripheral state within the global economy. many african countries are small, poor and land-locked. thirty-four out of forty-eight least developed countries in the world are in africa. out of the 174 countries ranked in the united nations development programme's human development report 1998, the bottom 30 includes 25 african states (undp, 1998: 128-130). although growth and exports have recovered in recent years, per capita incomes are still low. excluding south africa, as a recent illuminating study has highlighted, africa's "average income per capita averaged just $315 in 1997 when converted at market exchange rates". the region's total income is not much more than belgium's, and is divided among 48 countries with median gdp of just over $2 billion about the output of a town of 60,000 in a rich country. "more than 40 per cent of africa's 600 million people live below the internationally recognised poverty line of$l a day, with incomes averaging just $0.65 a day in purchasing power parity terms" (world bank, 2000: 7, 9-10). savings and investment remain equally low while debt and service obligations continue to rise. by the end of 1997 foreign debt represented a burden of more than 80 per cent of gdp in net per cent value terms. high population growth rates have contributed to the erosion of recent gains from higher gdp growth rates. the weakness of africa's global integration, which constitutes a series of challenges r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 483 sajems ns vol 4 (2001) no 3 to the region, is evident in its falling share in the following important sectors, which feature the globalisation process. challenges to africa the challenge of expansion and liberalisation of international trade a major hallmark of globalisation is the liberalisation of trade policies, and the expansion of international merchandise trade. for example, as chinery-hesse notes, the value of world merchandise trade had more than doubled from a little more than us$2 trillion, in 1980, to us$4 trillion in 1994. countries that diversified their exports and opened their economies to imports and investment have grown faster than countries that continue to export only basic commodities and raw materials, or that maintain protectionist policies (chinery-hesse, 1997: 125). the available statistics suggest that africa is in the latter category, as it is visibly stuck at the periphery of the global ising world economy. the region's current position in the global economy is characterised by a small and declining share of world trade, and concentration on the production of primary exports and importation of non-primary products. africa's share of world trade varied from 4.1 per cent to 4.9 per cent from 1960-65, fluctuated around 4.4 per cent during the 1970s and declined to 2-3 per cent in the 1990s. its share of world exports fell from 4.7 per cent in 1975 to 2.0 per cent in 1990; the share of the least developed african countries suffered a more drastic fall, from 0.6 per cent to 0.2 per cent (unido, 1993). against this background, african countries are faced with the challenge of striving to reduce their protectionist measures and reform the trade policies that have been a major factor in africa's declining share in world trade over the past decade. african countries should also reverse the trend of export concentration experienced during the past three decades, through greater efforts at diversifying the agricultural export base and the promotion of processed agricultural products. a closely related challenge is the intensified competition, which the african countries can expect from other producers of manufactured exports and primary commodities, following liberalisation of world trade and increased interdependence of national economies. unless they take appropriate measures, the african countries may continue to lose world-market share to other countries, even in traditional export commodities such as cocoa, palm oil and coffee. given that the diversification of production and exports is a mediumto long-term undertaking, the african countries will have to improve their international competitiveness in traditional exports too. this will require appropriate macro-economic and sector policies namely competitive exchange rates and measures to reduce the domestic costs of production as well as improved competitiveness in nonr ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (200 i) no 3 484 price factors such as more efficient marketing services, and this includes using the information highway. the other challenge facing the african countries in the liberalisation of international trade is related to the phasing out of the preferences under the uruguay round accord. already increased globalisation has seen most african countries suffer under various agreements and treaties, besides the uruguay round, and the june 2000 cotonou partnership agreement between the european union (eu) and the african caribbean and pacific (acp) countries points to many of the problems ahead. in most areas of trade where acp countries had hitherto enjoyed some concessions in the previous lome agreement, these will now be abolished a few years after the members ratify the partnership agreement (otabil,2000). the challenge of investment despite iiberalisation of the investment codes of many countries, africa is confronted with a challenge of marginalisation in terms of fdi flows. the levels of private and public investment have been modest, even in african countries with the most successful reforms. as wangwe and musonda have recently argued, investment as a percentage of gdp declined significantly between the 1970s and the 1990s, from nearly 26 per cent to a little over 16 per cent (wangwe & musonda, 1998: 154). most fdi in africa is concentrated in a small number of countries that are endowed with natural resources, especially oil africa has been largely left outside the fast growing capital markets. since 1980, fdi in africa has remained below us$ i billion, in a period in which fdi in latin america has ranged between us$ 3.5 billion and 14 billion. because of the small size of the domestic market, inadequate infrastructure, falling world prices for private commodities and, in some cases, political instability, sub-saharan africa has failed to attract much fdi. the bulk of external resource flows into the region is accounted for by grants and official loans, with fdi accounting for only 12 per cent of the total in 1993 (unctad, 1995). experience in other regions has shown that investors chose countries with stable political and economic environments. in this regard, africa faces the multiple challenge of deepening or restoring macro-economic stability to help improve the general investment climate. by reducing uncertainty, macro-economic stability allows investment and savings decisions to be made in a manner consistent with underlying economic fundamentals, thereby promoting an efficient allocation of resources. macro-economic stability also boosts confidence, which can encourage domestic investment and the inflow offoreign capital what does not appear to have received much scholarly attention is that not all fdi is equally beneficial historical and empirical evidence suggests that it is r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 485 sajems ns vol 4 (2001) no 3 not so much the quantity of foreign investment that counts, but the nature of the investment and the sorts of linkages that are established with the local economy. in africa, however, fdis are seen as the answer to all developmental problems. this is because both aid and loan financing have proved unsuccessful. the fllst has created dependency and the second crippling and largely unpayable debts. so fdi is now offered as the solution to africa's problems. to be sure, a certain amount of foreign investment is necessary, especially in the form of technology rather than hard cash. but this does not warrant the near religious belief in african countries that only fdis can save them from the developmental crisis. few have looked into the quality of fdi and what it does with the economy. yash tandon has argued that the extent to which fdi can help national development depends on the degree of control the country's government can exercise over the conditions and direction of the entry and operation of fdi. this ability of african and third world countries is whittling away (tandon, 1997: 52). the challenge of information technology one other aspect of the globalising challenge facing africa is in the field of information technology. it has been argued that if africa fails to adjust successfully to the information society of the future, the continent's competitiveness will be severely disadvantaged in the emerging global economy. globalisation has produced a proliferation of applications requiring a diverse range of communication technologies. convergence and cost reduction have created opportunities for leapfrogging. on the other hand, while the new information infrastructure opens up new opportunities, african countries lag far behind countries in asia and latin america in using information technology to spur development. south africa (35th) and egypt (51st) are the only african countries which are "able to absorb new technologies in the information age", according to the world times information imperative index (amoako, 2000: 109). south africa is the sole african country on the economist's indicative list of countries effectively using information technology. as wangwe and musonda conclude, the marginalisation of africa in terms of it has occurred through an inability sufficiently to increase the stock of it hardware in africa; the low capacity to develop appropriate software; the ineffectiveness and unreliability of the telecommunications systems, a situation that is aggravated by their unequal distribution between and within countries, especially between urban and rural areas; and a lack of skill in developing and making effective use ofit (wangwe & musonda, 1998: 157). closely related to this is the challenge posed by the shift towards technology and knowledge-based production. with increasing globalisation, the pattern of production is also shifting away from traditional mass production based on the use r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 3 486 of cheap labour and raw materials, to production based on knowledge and advanced technology.the dawn and advance of information and communication technology have shrunk time and space, and facilitated the conversion of the entire world into one market place. this system of knowledge and technology based production calls for a more skilled and educated labour force. needless to say that as african countries generally lag behind in this invaluable human resources, they face the challenge of losing out in the intensifying global competition. the challenge of regional trading arrangements alongside globalisation and its accompanying effects, a shift towards regionalism is also occurring, posing another kind of challenge to africa. this means that the world has seen at least as much fracturing as merging, as analysed by sideri and fischer in their recent studies (sideri, 1997: 38-82; fischer, 1998: 164-170). despite the multilateral agreements reached under the uruguay round, the growth of regional trading arrangements (rtas) has accelerated, with new rtas being established, the membership of existing rt as expanded, and formal links established between different rtas. african countries are not included in the major rt as, such as the european union (eu) and north american free trade agreement (nafta), which encompass their major exports markets. this has potentially important implications for the african countries. the creation of an rta entails the granting of preferential market access to its own members, and hence discrimination against non-members. africa and other developing countries therefore stand to suffer a relative erosion of the terms of market access in their major export markets as a result of the growth of rt a, covering these markets, with the danger that their exports will lose market shares to exports originating from within the rt a. african countries will be in an especially vulnerable position if competing trade blocs turn inward looking, with each adopting protectionist policies towards non-members. on the whole, the emergence of the eu and other regional economic blocs in north america and the pacific rim is likely to diminish africa's access to export commodity markets by raising the average level of protectionism in the advanced countries, stiffen export competitiveness, cause further substitution for africa's commodity exports and impose losses in terms of trade, higher costs of imports and reduced export earnings from those markets (asante, 1997: 119-125). although african countries are involved in a number of rtas in their own regions (economic community of west african states [ecowas), common market for eastern and southern africa [comesa] and the southern african development community [sadc] being among the largest of these groupings), r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 487 sajems ns vol 4 (2001) no 3 the general experience of these rt as has been disappointing in tenus of the levels of intra-regional trade generated by these arrangements. the exports of the member countries of each of the three major african rt as (comesa, ecowas and sade) to their fellow rta members as a proportion of their total exports to the world declined over 1980-1990. ecow as recorded the largest decline of about 7 percentage points, followed by sadc of almost 3 percentage points, and comesa by 2.5 percentage points (unct ad, 1996: 77). the preceding section has highlighted the series of challenges, which the current course of global economic developments poses to africa. african industries are exposed to stronger competition to which they lack the resources to respond effectively. the markets for their primary commodity exports are being further eroded through increased competition from non-ldc exporters and by the increased use of substitutes for raw materials. the concentration of private capital in rt as, which comprise mostly the developed countries and the more dynamic developing countries, has intensified, with african and other less developed countries facing even greater difficulties in attracting fdi. the long-term opportunities of the uruguay round notwithstanding, some of its agreements pose a number of potential problems for african countries in the short-term, including preference erosion, tariff escalation and higher food import costs. the fact that increased competition in global markets poses dangers for the economies of african countries reflects the very weak supply capacities in these countries. there is a lack of entrepreneurial and managerial skills, technological capacities are very poorly developed, the physical infrastructure is inadequate, the provision of support services, such as fmance and marketing, is often very costly or unavailable, and labour productivity is slow. consequently, africa faces the critical problem of building its competitiveness in an atmosphere of progressive multilateral and regional liberalisation of world trade, increasing giobalisation of production and rapid changes in technology. the continent must therefore develop an effective response to these changes in order to participate in the global trends that are going to shape the future of international economic relations. iv an agenda for action although the specific policy requirements of individual african countries in meeting the challenges of globalisation will differ, it is, however, possible to identify a number of key areas which policy should address in most sub-saharan african countries. in this regard, the following policy responses have been identified. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 3 488 (i) promote trade and investment trade and investment are important vehicles for integrating afiica into the global economy and reaping benefits which accrue from it. a policy framework to promote increased investment in afiica must address issues relating to the political climate; a conducive economic policy framework; increased public savings and investment; increased private savings; attracting foreign investment; and enhanced regional cooperation and integration. the present strategy in many afiican countries of striving to make the local environment attractive, and providing a wide range of incentives to foreign investors, is only part of the question. experience suggests that it will not go very far without substantial improvement in infrastructure, in particular transport and communications, and reliable power supplies. with regard to trade expansion, afiica must embark on a more dynamic course marked by increased participation in world trade and a more purposeful engagement in international exchange of resources. among the key elements to be identified to boost afiica's trade should include: reduction of transactions costs, including efficient physical and service infrastructures; diversification of products and markets; incentive regimes for exporters, including strategies to encourage small producers; institutional capacity-building for improved marketing and export promotion; trade fmancing; access to inputs at world market prices; strengthening negotiating capacities, both at the level of indigenous business as well as for governments' effective participation in the wto multilateral trading system; and strengthening regional and sub-regional cooperation and integration aimed at boosting intra-afiican trade. (ii) explore new opportunities in trade there is the need for afiican countries to actively explore areas where there may be growing opportunities for expanding their exports of goods and services, and take advantage of the opportunities provided by tariff reductions and better market access under the uruguay round on the one hand, and of growing import demand in large scale integration systems derived from their growth prospects on the other. in this connection, export promotion efforts to target the following objectives, among others, would be required: geographical diversification of trade towards rapidly growing markets, including developing countries in south east asia and latin america; exploiting new market opportunities in traditional agricultural sectors as well as processing industries; diversification of industrial exports; and exploiting new opportunities in services. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 489 sajems ns vol 4 (200 i) no 3 (iii) accelerate african integration process while the proliferation of trading blocs is without doubt a global phenomenon, in africa, the trading blocs are particularly important as a measure to contain and mediate competitive global pressures, which national policy resources cannot effectively handle. the rationale is that african countries, acting individually, cannot survive the vicious forces of globalisation in order to access the attendant benefits and minimise its costs. regionalism, particularly in africa, is thus seen as "the human face of globalisation which makes it the only space where liberalisation is suitable economically and politically" (sideri, 1999: 170). new initiatives in the process of african economic cooperation and integration should involve, among others, the following: speeding up the liberalisation provisions of the african economic communities in order to achieve the objectives of complete liberalisation of intra-african trade; promoting new efforts to achieve the harmonisation of macro-economic policies at the subregional level; encouraging strong political commitment of the african governments to advance integration towards common objectives and to give regional economic cooperation and integration a central role in the activities of govemments. (iv) bring information age to africa to be able to benefit most fully from the emerging infonnation age, africa requires an action framework to build information and communications infrastructure at the national level as well as to improve regional inter-connectivity and to provide gateways to international telecommunications networks (amoako, 2000: 99). to this end, there is the need to create enabling environments for an information society by liberalising infonnation and communications technology services and fostering intellectual property protection, privacy, and the free flow of information. (v) adopt selective integration as far as economic development in african countries is concerned, the "first best" policy with respect to liberalisation and globalisation is not to seek rapid and close integration but rather to defme careful policies of selective integration or what has been called strategic integration. although dynamic gains can flow from integration with the world economy, it should be pointed out that these can only be realised by active government policies and if integration is patterned and timed to achieve clearly defmed objectives. put differently, national governr ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 3 490 ments can exercise more discretion when adopting policies of liberalisation. a selective approach to the global market would follow the example of most east asian economies with some time-bound, performance-related protection for potentially viable industries, some industrial intervention and some management of foreign direct investment. (vi) invest in people africa's future economic growth will depend less on its natural resources, which are being depleted and are subject to long-run price declines, and more on its labour skills and its ability to accelerate a demographic transition. to this end, as growth in today's information-based world economy depends on a flexible, educated, and healthy workforce to take advantage of economic openness, policies be adopted to contribute towards:sustaining political commitment to the poor; achieving universal primary education; eliminating gender disparities in education; achieving universal access to reproductive health services. (vi) improve governance as better governance is a development imperative for most african countries, african governments are constrained to initiate policies towards good governance that should aim at achieving what has been described as the "three es": empower citizens to hold governments accountable through participation and decentralisation; enable governments to respond to new demands by building capacity; enforce compliance with the rule of law and greater transparency. effective governance is the foundation for sustainable development and poverty reduction and improved human well-being. this entails a state that., inter alia, respects the rule of law, ensures peace and stability, and enables full participation of citizens. in particular, the importance of transparent and accountable public engagement systems should be underscored. a dialogue on governance in africa will allow the people of africa to share lessons and experiences, identifying capacity needs and best practices. v conclusion: africa's prospects despite the daunting challenges, globalisation does offer a window of opportunity for african states. competition, open market policies and globalisation are a reality in world economy today. even though the benefits are not evenly distributed, african states have not been complete losers. they have enjoyed higher growth through the pursuit of market-oriented policies. competition is also r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 491 sajems ns vol 4 (2001) no 3 gradually exposing african economies to the discipline of the market place. they are moving up the learning curve. the market refonns and structural adjustment policies have brought about rationalisation and increased efficiency of many sectors of african economies. countries, which have been able to undertake and sustain those refonns, have benefited from expanded trade opportunities and growth. more significantly, an african renaissance is unfolding before our eyes. most countries, throughout most of their years of independence, have been ruled by autocratic leaders autocratic because, whether enlightened or not, they stood above the law. today, the rule of law is asserting itself. the sharp rise in political participation opens the way for greater public accountability and pressure from civil society for better management of public resources. today's african leaders are more focused on proper economic management than many of their predecessors, and they have the maturity to address weaknesses of previous policies. these are crucial developments, because the fate of africa in this new century will be determined not by outsiders, but by africans. in this regard, we should welcome the millennium partnership for the african recovery programme (map, 2001) led by presidents mbeki of south africa, obasanjo ofnigeria and boutefilka of algeria, and the omega plan (omega, 2001) proposed by president wade of senegal, which was presented in sirte, libya, in march 2001, to the african heads of state and government. the two major initiatives, which are being rationalised into a single african initiative to be operationalised by the united nations economic commission for africa's compact for african recovery (eca, 2001), would provide an appropriate framework for meeting the challenges of african development. together, these recent initiatives would provide the necessary political vision, momentum and implementation modalities for africa to achieve the necessary conditions for transfonning its prospects. references amoako, k.y. (2000) perspectives on africa's development, united nations publication, united nations, new york. 2 asante, s.k.b. (l997) regionalism and africa's development: expectations, reality and challenges, macmillan press, london. 3 chinery-hesse, m. (1997) "globalisation, african market and the challenges for governance", in proceedings of the african leadership forum international conference on the theme "africa on the eve of the 21st century", maputo, mozambique. 4 economic commission for africa (2001) compact for african recovery, addis ababa. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (200 i) no 3 492 5 fisher, b. (1998) "globalisation and the competitiveness of regional blocs", intereconomics, july/august: 164-1705. 6 gamani, c. (l999) "the challenge of globalisation", in walter fernandes and anupama dutta (eds.), colonialism and globalisation: five centuries after vasco da gama, new delhi, indian social institute. 7 held, d. & mcgrew, a. (2001) "globalisation", in joel krieger (ed.) the oxford companion to politics of the world, oxford university press. 8 nel, p. (1999) "globalisation and south african elite", global dialogue 4:1. 9 nevin, t. (2000) "africa and the globalisation conundrum", africa business: 258. 10 omega plan (200 i) dakar, senegal 11 onitiri, h.m.a. (1995) regionalism and africa's development, unct adiitd/18. 12 otabil, b.a. (2000) "globalisation: which way forward?", west africa, 2-8 october. 13 sideri, s. (1997) "globalisation and regional integration", european journal of development research, 9, 1: 38-82. 14 streeten, p. (1998) "globalisation: threat or salvation?", in a.s. bhalla (ed.) globalisation, growth and marginalisation, macmillan press, london, and st. martin's press, new york. 15 tandon, y. (1997) "africa in the globalisation process", in proceedings of the african leadership international conference on the theme "africa on the eve of the 21st century", maputo, mozambique. 16 the millennium partnership for the african recovery programme (2001) pretoria, south africa. 17 unct ad (l996) the least developed countries 1996 report, tdib142 (2), 11, unct adildc. 18 unctad (1995) trade and development report, geneva, unctad. 19 undp (l998) human development report 1998, new york: oxford university press: 128-130. 20 wangwe, s.m. & musonda, f. (1998) "the impact of glob ali sat ion on africa" in a.s. bhalla (ed.) globalisation, growth and marginalisation london: macmillan press and new york: st. martin's press. 21 world bank (2000) can africa claim the 21st century? washington, d.c.: 7, 9-10 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . is4 sajems ns vols (2002) no 1 personality attributes of successful franchisees in the fast foods sector in south africa b von h kasselmann interaction dynamics, pretoria johannes j de beer and leopold p vermeulen department of human resources management, university of pretoria abstract the aim of the study was to identify the personality traits, emotive responses and attitudinal orientation of franchisees. cattell's 16 personality factor questionnaire, the personal profile analysis of thomas international and boshoff's entrepreneurial attitude questionnaire were used. measurements were obtained in respect of a sample of 80 restaurants belonging to a fast foods franchise. a stepwise discriminant analysis identified statistically significant differences between successful and unsuccessful groups in respect of five factors. successful franchisees were emotionally more stable and sober·minded, exhibited a higher degree of shrewdness, displayed higher self-esteem. and were more compliant. the jack·knife classification was used in devising a classification table to compare the observed and predicted success rates of franchisees. the study found that the identified five factors could be used to predict the potential success rate of franchisees. jelm13 1 introduction recently, the south african government has emphasised the need to develop the small business sector in general. the business format of franchising in particular offers a proven avenue for creating employment. responsibility and wealth. the worldwide phenomena of urbanisation, rising disposable income and expanding consumer markets, coupled with changing work patterns and an increasing number of people looking toward self-employment have provided a sound foundation for the rapid growth of franchising over the last few decades (macmillan, 1996). today the business concept of franchising is well established and has been tried and tested in virtually every domain of business. in south africa the annual growth in franchise systems since 1994 is 32.s per cent (franchise directions, 1999). franchise systems span 12 business r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 155 categories, the largest of these are retail (15.9 per cent), fast foods (15.1 per cent), education and training (ii.5 per cent), automotive products (ll.l per cent) and restaurants (10.6 per cent). the retail turnover of franchise systems has shown an annual average growth of 54.6 per cent since 1994. the total retail turnover in the franchise sector in 1998 was r39, 969 billion and retail franchises provided employment to 266 104 people. retail turnover through franchising contributed 11.5 per cent to annual private consumption for 1998, constituting an increase of 85 per cent since 1995. a total of 147 franchisors out of 358 franchise systems in operation (41 per cent) responded to the survey. judging by these findings, franchising can help south africa to meet the daunting challenges of skills development, job creation and wealth creation. a business franchise is generally defined as the entitlement of a franchisee by a franchisor to trade under the trademark of the franchise and to make use of a package comprising all the elements ne<;essary to establish a business. this involves the development by the franchisor of a blueprint for conducting the business, which eliminates as far as possible the risks inherent in opening a new business by setting out in detail exactly how the business should be run. the pre-established format coupled with the backing of the franchisor's organisation enables a person who has never before owned or operated a business to start a business. the franchise agreement also establishes the format for a comprehensive and continuing relationship in which the initial franchise concept as well as participating franchisees are continually developed (mendelsohn, 1994). the prerequisite for establishing a franchise is that a business must possess definable "know-how" coupled with a distinct way of doing things, which distinguishes it from other businesses (abell, 1992). setting up a franchise involves five distinct stages: the development of a successful business concept that can be replicated elsewhere. the successful implementation of a pilot scheme. the production of a business operations manual, franchise agreement and marketing prospectus. the marketing of the franchise through appropriate channels. the establishment of an appropriate franchise selection system together with arrangements for training of new franchisees. including the provision of pre -opening assistance and continued support. it is generally easier to start a second. third or fourth venture than it is to start a first one, as entrepreneurial expertise increases with time and experience (hisrich & brush, 1986). the franchisor not only provides this entrepreneurial r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 156 sajems ns vols (2002) no 1 expertise but also acts as a role model and mentor, which is one of the most important factors in encouraging entrepreneurship (hisrich, 1990). this supportive role is particularly crucial during the start-up phase, when the franchisor provides information, advice and guidance on such matters as organisational structure, the management control system, the financial resources needed, the location of the business (site), market segmentation and marketing. in view of the relative security that the franchise format offers, it is debatable whether franchisees are required to display entrepreneurial behaviours to any great degree. in fact, they appear to fulfil a distinctly managerial type role in the franchise operation. the roles of entrepreneur and manager suggest different characteristics, competencies and skills. whereas entrepreneurs are expected to be skilled in envisioning possibilities, managers are usually thought of as exercising rational thinking and detail-oriented administrative skills. franchisees appear to be most similar to intrapreneurs who develop profitable businesses within the confines of an existing business entity (pinchot, 1985). intrapreneurship emerged as a hybrid form of entrepreneurship, due in part to the high risks and costs involved in entrepreneurship. intrapreneurs are corporate entrepreneurs who pursue independent and creative business opportunities under the overall supervision of the corporation, expect their performance to be suitably rewarded, yet are prepared to let the corporation decide on the nature and size of the reward (pinchot, 1985). intrapreneurs share the same entrepreneurial spirit as entrepreneurs in terms of taking risks to achieve goals. however, to a large degree, they also behave like managers, because they follow corporate policies and procedures in the process of achieving goals. intrapreneurs appear to fall somewhere between the total involvement of entrepreneurs in all stages of the business venture, and the delegated responsibility of managers who act within an established framework. this is similar to the partnership between franchisor and franchisee in which both have a fmancial stake in the business and take mutual responsibility for maintaining operational standards and achieving financial goals. the main perceived differences/similarities between entrepreneurs, intrapreneurs, franchisees and managers are set out in table i. it appears that franchisees, much like intrapreneurs, exercise a unique blend of entrepreneurial and managerial characteristics by exposing themselves to a moderate degree of risk within a proven and established business framework. franchisees are, on the one hand, like entrepreneurs (and less like intrapreneurs), becanse they risk their own financial security by investing money in a business. on the other hand, they are like managers (and less like intrapreneurs) because they minimise experimentation by managing the business strictly in accordance with the. franchise agreement. in essence, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no i 157 franchising is a partnership. franchisors charge a fixed fee upfront to establish new franchise outlets, but the major share of their income is derived from royalties based on turnover. this makes franchisees the major asset of a franchise (mendelsohn, 1994; franchize directions, 1999). harris (1993) suggests that the most difficult aspect of franchising is getting the recruitment practice right. this was confinned by a survey conducted among exhibitors at the national franchise exhibition held in binningham during 1994, which indicated that the majority of franchisors considered targeting the correct. audience for recruitment purposes as the biggest problem area in establishing a franchise (macmillan, 1996). more than 60 per cent of all franchisors in the survey converted 5 per cent or less of initial enquiries for infonnation into franchise sales. at the same time, as many as 72 per cent of respondents estimated the recruitment cost per franchisee to be between r30 000 to r70 000 expressed in 1993 rand value terms. table 1 trait primary motives risk taking failures and mistakes activity decisions who serves time orientation comparison of entrepreneurs, intrapreneurs, franchisees and managers edtrepreueurs intrapredeurs francbisees managers independeuce, interdependence, interdependence, promotion and creativity and advancement and self-employment corporate money corporate rewards and money rewards moderate to high moderate limit risk control risk deal with hide risky projects minimise try to avoid failures and from view till ready chances offailure failures and mistakes and mistakes mistakes direct direct involvement direct involvedelegate and involvement in more than ment with some supervise, more all aspects of the delegation delegation than direct business involvement follow own try to get others to support the usually agree vision help achieve own vision of the with senior vision franchisor management self and self, customers and self, customers the corporation customers sponsors and franchisor long-term focus depend on urgency long-term focus short-term on survival, of self-imposed and on profits and focus on growth. sales and corporate timereturn on achieving profits tables investment targets and budgets this table is an extensively modified version of a table by hlsnch (1990: 218) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 158 sajems ns vol 5 (2002) no 1 stanworth (1995) argues that conversion rates for becoming a successful franchisee are low, because, while many people desire self-employment, few people really understand what is involved. to most people the main attraction seems to be the grand notion of "doing their own thing with no one looking over their shoulders". the benefit of previous experience of self-employment is that it creates a strong awareness among potential franchisees of the need for a proven business system, which offers more "security", "access to a known tradename" and "business back-up". however, the majority of franchisors believe that the personal qualities of franchisees are very different from the personal qualities of fully self-employed business people. stanworth (1995) asserts that the selection of franchisees is further complicated by a number of additional factors: some franchisors feel that their experience naturally equips them to identify good or bad potential franchisees on an instinctive "gut feel" basis. most developing franchises have only a few staff members who undertake a multitude of tasks and few of them possess expertise in the field of personnel selection. quite often, franchisors fall into the trap of looking for people exactly like themselves, when it would be best to select franchisees who complement rather than duplicate their own abilities and weaknesses. south african franchisors seem to hold essentially the same views on recruitment and selection issues as their international counterparts. a survey conducted by kasselmann (1996) at the south african franchise association and among leading franchisors in the fast foods and restaurant categories indicated that very little, if any, research had been conducted in the south african franchise sector to address selection issues. the single most important selection factor appeared to be whether an applicant could obtain guaranteed financing. in fact, applicants were seldom rejected on the basis of biographical, educational or demographic factors. the majority of those surveyed were quick to emphasise the need for more scientific selection methods. overall, the survey suggested that franchisors were uncertain about how to define the unique blend of entrepreneurial and managerial qualities required of ideal franchisees. kasselmann's (19%) survey highlighted the classic conflict in the industry between encouraging franchisees to use their initiative to develop a successful small business, and exercising strict controls over the products sold and methods employed in terms of the franchise agreement. a key question remains which mix of entrepreneurial and managerial characteristics may predispose a person towards becoming an effective franchisee. how can one identify these r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no i 159 characteristics? there is clearly a need to identify indicators in tenns of personal qualities or characteristics which could be used as reliable and valid predictors in the selection process for the development of appropriate competencies in franchisees. the main aim of the study set out in this article was to identify personality attributes (and an instrument or instruments to measure such attributes) that differentiate between effective and less effective perfonners among franchisees, according to the perfonnance criteria of a franchise company in the fast foods category. 2 identifying· desirable qualities in franchisees as entrepreneurs recently, gordon (1999), managing partner of parker gordon associates (a leading south african consulting company in the franchise sector who conducts regular surveys to monitor the development of franchising), indicated that there has been little or no south african research to investigate the relationship between the personal qwiiities of franchisees and actual work performance in the franchise sector. the little literature that is available does not provide clear and conclusive evidence as to what characteristics are common to franchisees, although there are at least three theoretical and methodological approaches which are generally used to research the characteristics of entrepreneurship (lau, 1992). first, there is the trait approach, which focuses on the personality theory underlying the notion that there is a form of individual behaviour which can be identified as entrepreneurial or non-entrepreneurial (brockhaus & horwitz, 1986; gartner, 1988). the second approach uses demographic information such as age, level of education, and work habits to profile a typical entrepreneur (boshoff, bennett and owusu, 1992; stanworth, 1995). the third approach, which focuses on attitudes, is behaviour-specific rather than characteristic-specific (robinson et ai., 1991). south african studies on demographic variables found significant differences between entrepreneurs and non-entrepreneurs in terms of language, age, place of birth, gender, marital status, race, educational level, religious affiliation and father's occupation (boshoff & van vuuren, 1993; van vuuren & boshoff, 1993). this view is confirmed by schutte, bennett and boshoff (1993), who studied entrepreneurial ventures in a third world setting and found that demographic variables by themselves are moderate predictors of entrepreneurial success. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 160 sajems ns vol 5 (2002) no 1 2.1 the measurement of traits although recognised theorists in the field of psychology, such as carl rogers, gordon allport, erik erikson, george kelly and sigmund freud (hjelle & ziegler, 1986: 6-7), all propose their own definitions of personality, most definitions share a number of features: personality is an abstraction based on inferences derived from behavioural observation. personality reflects the special properties or combination of properties that distinguish one person from another. personality is subject 10 a variety of internal and external influences, including genetic and biological propensities, social experiences, and changing environmental circumstances. aside from these common themes, personality definitions differ substantially and the defmitions depend on the theory of personality chosen (hjelle & ziegler, 1986). many personality theories, for instance allport's (1961: 334), are based on surface traits. often the selection of these traits is strongly influenced by the subjective preferences of the theorist. however, raymond cattell's 19408 choice of 16 "source traits" for the 16pf depends on refined and variable statistical techniques which include mathematical models to describe and assess extensive data bases (stephenson, 1952: 206). cattell was a trait theorist who used multiple abstract variance analysis (mava) to identify clusters of "surface traits", consistent behavioural responses, and "temperament and ability source traits" which are the underlying variables that determine "surface traits" (conn & rieke, 1994: 2). . maas (1989: 11-14) asserts that cattell considered it to be unscientific to formulate a complete defmition of personality, because cattell argued that the precise terms of agreed and ricb significance do not yet exist. at best, cattell was prepared to say that personality is "that which permits a prediction of what a person will do in a given situation". he also advocated that personality be viewed as a holistic and organic entity, but that due consideration be given to the role of source traits in assessing personality. in terms of his definition, source traits are the few unique underlying variables, which influence the manifestation of many surface traits or clusters of observable behavioural events. according to prinsloo (1991: 1-2), cattell applied the technique of factor analysis to a list of 18000 words (eompiled by allport & odbert in 1963) that r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 161 comprehensively describe human behaviour to obtain a set of sixteen primary or first-stratum factors that he accepted as complete and accurate descriptions of personality traits. these 16 factors were seen as a summary of core personality traits, which are universal and stable across all nationalities. cattell used mathematical techniques on a large pool of possible personality descriptions, and asserted that the 16 pf is capable of measuring the true personality constructs present in people in a way that is both reliable and valid. the 16 pf scales measure a person's characteristic style of thinking, perceiving and acting in a wide range of different situations and over a relatively long period. each personality trait is manifested as a set of attitudes, preferences, habits, social and emotional reactions, and is derived from a complicated interaction between inherited disposition and learning from experience. some traits primarily involve internal regulation of defensive or adaptive impulses, while others are maintained as functionally autonomous habits or stylistic responses to the pressures of inner drives. these traits govern practically every facet of a person's overall functioning in the world (cattell, 1989: 2). 2.2 the measurement of emotive responses to the environment the stated origins of the thomas personal profile analysis lie in marston's biosocial theory, fltst formulated during the 1920s, which identified the uniqueness of each person as those feelings and purposeful actions that enable the person to modity and control the effects of the environment. the "painpleasure" principle implies that humans evaluate the environment along a continuum antagonistic at one extreme, and favourable at the other. perceptions of the hostile or favourable nature of the environment normally produce what marston terms "vitalistic forces" or emotions: people try to "avoid pain" in antagonistic environments or "maximise pleasure" in favourable environments. individuals develop a preferred or habitual tendency to confront changes in the environment by emotions that lead to active or passive behaviours. emotions are experienced as part of the total response to the changes (irvine, 1988a), the advent of cross-cultural psychology during the 1960s provided the basis for a more robust calibre of research which defined ecological frameworks for the acquisition of cognitive and social skills. most cross-cultural psychologists (for a convenient overview see irvine and berry, 1983, 1988; berry and irvine, 1986) unwittingly support marston's biosocial proposition that people and the physical and social environment modify each other through constant interaction. ferguson (1954, 1956) was the first cross-cultural psychologist to fonnulate an ecological theory of human development that proposes that groups and their tendencies to thought and action are differentiated by environmental pressures. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 162 sajems ns vol 5 (2002) no i ferguson's law states that society detennines what will be valued for survival in response to different environments and individuals within that society, then people learn patterns of thought and feeling as a natural consequence of these learned values (irvine & berry, 1988). irvine (1988a: 25) asserts that the most relevant contributions to understanding marston's notion of adaptation to holistic and favourable work climates were made by berry (1976, 1986), who expounded the central idea of "cognitive style" to account for habitual fonns of problem-solving and social behaviour used to accommodate the work demands of contrasting environments. berry asserts that some environments are intrinsically antagonistic to survival, in contrast to others which are favourable. consequently, analytical habits of thought, independence and self-reliance are fostered in antagonistic environments, while less analytical modes of perception and thinking, social cohesion and compliance with social rules are encouraged by favourable environments. various modem biosocial approaches to personality conftnn marston's notion that a person's self-concept develops from habitual modification of actions sanctioned by others in the interaction between ecological pressures and dispositional tendencies. according to geier (1979), an early technical manual (the ppa technical manual by thomas hendrickson, undated) asserts that the ppa has a generic resemblance to jung's notion of psychological types and that its initial mode of construction is directly linked to trait psychology, particularly allport's study of trait names. references to allport's work in published material on the ppa are so positive and so pervasive that it is necessary to clarify the nature of his ideas and their contribution to the construction of the ppa. allport defined personality, much as marston did, as an internal, dynamically organised and adaptive response to the environment: which he described as consisting of the external world as well as of an individual's internal understanding of events to create meaning. he emphasised that the fusion in the individual of mental and physiological events produces characteristic modes of thought, feeling and action which exhibit themselves as definable and measurable entities or traits (allport, 1961). allport preferred to seek explanations for motives in contemporary situations and feelings rather than in the surfacing of unconscious needs. in this, allport supports marston's concern with nonnality and consciousness as the mainsprings of human action. it follows that any immediate response to a structured set of stimuli, such as the adjectives that are used as trait descriptions in the ppa, provide insight primarily into the here-and-now responses of the individual in relation to the person's current environmental context. according r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no i 163 to irvine (1988b: 28), the originators of the ppa used allport's unparalleled study of how people actually describe the personality characteristics or traits of others to confirm the four dimensions that are described by marston and that form the basic construct of the pp a. marston's thinking is further confumed by homey (referred to by krech, crutchfield and ballachey, 1962: 105). homey argues that people resolve conflicts by taking actions that could be consistently classified. conflict and accompanying stress are actively resolved by moving against others (aggression and dominance), by moving toward them (compliance), or by moving away from them (detachment). marston postulated four basic adoptive emotional conditions that are used directly as survival strategies from the interaction of antagonistic/favourable environments with the active/passive dispositional reactions of individuals (irvine, i 988a: xx-xxi). marston reasoned that an active reaction in an antagonistic environment would foster qualities of dominance, designed to oppose painful consequences and overcome obstacles by forceful personal actions. at the opposite pole, people with a positive disposition would try to reduce the painful effects of the hostile environment by responding with unwilling but cautious and calculated csompliance. in a favourable environment, an active emotive response would foster a person's attempt at influencing events through persuasion rather than at achieving dominance through confrontation. on the other hand, a habitual passive response in favourable situations would lead to easygoing acceptance of routine and produce steadiness. 2.3 the measurement of attitudes lau (1992) asserts that trait and demographic approaches have reached their limit and are inappropriate as predictors of entrepreneurial behaviour, given the dynamic nature of entrepreneurship. epstein (1984) observed that the trait approach is the most common theoretical and methodological approach used in researching the characteristics of people, but tends to measure general characteristics and is intended for use across a broad spectrum. the main criticism against the trait approach is that its research methodologies are based on personality theory, which was not developed for measuring entrepreneurship, and therefore use information that is not directly applicable (carsrud & johnson, 1989; sexton, 1987). another general criticism of personality measurement instruments is that they do not focus on measuring a specific dimension of a considered concept in a specific context, and this in tum decreases the appropriateness and accuracy of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 164 sajems ns vol 5 (2002) no i such instruments (robinson et ai., 1991). the diffusion of the focus of a measurement instrument across situations also reduces its efficacy in any particular context, primarily due to the addition of error associated with all the situations in which the instrument may be used (ajzen & fishbein, 1977). for example, the measurement of innovation in business cannot really be equated to creativity scales that include artistic qualities such as spatial representation or colour co-ordination (both concepts that do not relate to most business situations). attitude theory offers another alternative for developing an instrument which focuses on measuring a specific dimension of a considered concept in a specific context. attitude is defmed as a person's predisposition to respond in a favourable or unfavourable manner with regard to the object of the attitude, be it a specific person, place, thing, event, activity, mental concept, cognitive orientation, life style or even combinations of these categories (ajzen, 1982; shaver, 1987). because attitudes also exist at the general and specific levels for many objects, attitude specificity needs to be matched by measurement specificity (shaver, 1987: 152; ajzen & fishbein, 1977). matching attitude specificity with measurement specificity not only increases the accuracy of the measurement within the specified domain, but also increases the predictability of the instrument because of this increased accuracy (robinson et al., 1991: 14). attitudes are usually considered less stable than personality traits, in that they change over time, and from situation to situation, through interactive processes with the environment. the rate at which attitudes change may of course vary, depending both on how deep-seated or fundamental the attitude is to the individual's identity and on the intensity of the experiences that influence a particular attitude. this changeability in tum influences the consistency with which behaviours can be predicted from measured attitudes, particularly when attitudes are me~ured in very general ways (chaiken & stanger, 1987). robinson, stimpson, huefner and hunt (1991) attempted to avoid the abovementioned pitfalls in the development of the entrepreneurial attitude questionnaire which measures an interrelated set of attitudes towards entrepreneurship across four constructs. each of the subscales of the questionnaire consists of three components: cognitive (the person's beliefs about and thoughts towards the attitude object); affective (the person's beliefs and thoughts about the object); conative or behavioural (behavioural intentions to behave in a specific way toward the object). the four subscales measure achievement in business, innovation in business, perceived personal control of business outcomes and perceived self-esteem in business. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 165 although boshoff and scholtz (1995) concur that the approach developed by robinson, et al. (1991) must be seen as potentially very useful and consider it to be a major step forward in research in the entrepreneurial field, they conclude that entrepreneurs are not a homogeneous group and that it may be useful to differentiate between types of entrepreneurs. 3 method 3.1 research design one of the most difficult aspects in ex post facto field studies is identifying adequate criteria for what represents success. for a criterion to be valid, it should of course measure important aspects of performance and the criterion measurements themselves should be reliable and valid. once the criteria have been selected, the next problem is to secure dependable measurements, which are then combined and weighted (guiford & fruchter, 1978). in the study discussed in this article, the scales of the 16 personality factor questionnaire ( 16 pf), the personal profile analysis, and the entrepreneurial attitude questionnaire serve as the independent variables and three performance measures (restaurant evaluation, customer satisfaction evaluation and sales growth) were initially used as the dependent criteria variables. later, sales growth was excluded as a variable. 3.2 sample description the target population consisted of the male and female franchisees who manage the fast food restaurants of an established south african franchise operation. franchisees are the owners of the restaurants in terms of the franchise agreement. the sample consisted of approximately 200 restaurants which are geographically dispersed throughout all nine provinces of south africa. in order to maximise the sample size, it was decided to include the total target population in the study. the sample group was selected at random. the 16 pf, personal profile analysis and entrepreneurial attitude questionnaire were completed by 80 franchisees. this constitutes a response rate of 40 per cent. the sample consisted of 75 whites, 3 asians and 2 blacks, and was made up of 64 males and 16 females, of which 37 were englishspeaking and 43 afrikaans-speaking. the minimum educational level of the sample group was standard 10. respondents' experience in a franchise outlet ranged from 1 to 24 years, with an average of 8.19 years. it was found that 22.5 per cent of the respondents have i r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 166 sajems ns vol 5 (2002) no 1 or 2 years experience, 20 per cent have between 3 and 5 years experience, 22.5 per cent have 6 to 10 years experience, and 35 per cent have 11 to 25 years experience. 3.3 measuring instruments 3.3.1 the 16 personality factor questionnaire the 16pf was developed by cattell (cattell et al., 1970) to measure 16 primary source traits. the instrument is generally used for counseling, guidance and selection purposes. since its inception in 1949, the 16pf has become widely recognised as one of the most respected psychometric instruments to measure personality traits. many studies have been conducted to examine the theoretical constructs of the 16pf, to validate its source traits, to evaluate its reliability and validity, and to research its application in various domains (see spangenberg, 1990). split-half reliability coefficients vary between 0.71 and 0.93 and are described as highly satisfactory (cattell et ai., 1970). test-retest reiiabilities vary between 0.74 and 0.90 and are also described as highly satisfactory (prinsloo, 1995). the variables of the 16pf are measured on factor-analytical grounds, which means that face validity is not required (smit, 1991). the sixteen first-order source traits are described as follows: factor a: reserved vs. warmhearted factor b: concrete-thinking vs. abstract-thinking factor c: unstable vs. stable factor e: submissive vs. dominant factor f: desurgent vs. surgent factor g: low superego strength vs. superego strength factor h: restrained vs. adventurous factor 1: tough-minded vs tender-minded factor l: trusting vs. suspicious factor m: practical vs.lmaginitive factor n: nayvite vs. shrewdness factor 0: self-assured vs. apprebensive factor ql: conservatism vs. radicalism factor q2: group-dependent vs. self-sufficient factor q3: uncontrolled vs. controlled • factor q4: relaxed vs. tense the sa-92 form as adapted by the human sciences research council was used, as it is considered culturally fair for south african conditions. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no i 167 3.3.2 the personal profile analysis thomas international conducted various in-house studies to detennine what the ppa actually measures in alternate psychological tenns. the ppa was compared with recognised psychometric instruments which are considered to measure similar psychological properties. all these instruments have been demonstrated to possess sound predictive and construct validity. a comparison between the ppa, cattell's i6pf and saville and holdsworth's occupational personality questiormaire (n==263) yielded correlations that ranged from 0.30 to 0.64 between the four dimensions of the ppa, the sixteen primary factors of the 16 pf and the fifteen dimensions of the opq (irvine, 1988b). kaplan (1982) conducted a comparative study between the ppa and the wechsler adult intelligence scale (w als), the myers-briggs type indicator (mbti), cattell's 16 pf, the mirmesota multiphasic personality inventory (mmpi) and the strong-campbell interest inventory (soil). the study yielded significant correlations exceeding the 5 per cent level of expectation: the similarities between the ppa and the mbti were twelve times more significant than expected. the similarities between the ppa and the i6pf were over eight times the significance expected by chance alone. the pp a and scii similarities were shown to be over four times chance expectancy. the ppa, w als and mmpi similarities were shown to be over four times chance expectancy. the abovementioned results show that the ppa reflects similar personality dynamics and preferences to those revealed 6y the mbti, 16pf, scll and mmpi. the internal consistency of each (of the four) scales ranges between 0.60 and 0.74. test-retest reliabilities vary between 0.52 and 0.78 and are described as extremely high. the pp a is used in 39 culturally different countries and to date no bias has been found with regard to its results in respect of culture, race or gender. research conducted in south africa on pp a profiles assessed since 1995 (n==4240) also indicated no material bias against people from previously disadvantaged groups (van deventer, 1997; van deventer & kruger, 1997). the most recent pp a manual (undated) describes the pp a scales as follows: • dominance drive to accomplishment in the face of opposition . influence influencing others·to react favourably_ . r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 168 sajems ns vol 5 (2002) no i steadiness suitable for performing routine and repetitive work. compliance complying with high work standards to avoid trouble or error. the ppa-plus format was used in this study, as it has been refined to be appropriate for use by the diverse south african working population. 3.3.3 the entrepreneurial attitude questionnaire the entrepreneurial attitude questionnaire (eaq) developed by robinson et al. (1991) is based on attitude theory as an alternative approach to personalitybased psychological models. gasse (1985) confirmed this approach and contended that interrelated attitudes form a comprehensive and orderly pattern which can be taken as an indication of the degree of unity in an individual's orientation toward the object of the attitude. the eaq differentiates between successful and unsuccessful entrepreneurs on the basis of attitudinal orientation. in an empirical study conducted by robinson et al. (1991), the scores of entrepreneurs and non-entrepreneurs were compared and significant differences were tested by means of a manov a. the analysis yielded a significant overall difference between entrepreneurs and non-entrepreneurs on all four subscales of the eaq at the 0.001 level of probability. univariate tests showed a highly significant difference between the entrepreneur and non-entrepreneur groups: the mean for the entrepreneur group was higher than that of the nonentrepreneur group on every subscale. the predictive validity of the four subscales was tested by means of a stepwise discriminant analysis using wilkslambda to predict membership of the entrepreneur and non-entrepreneur groups on the basis of the four subscales. three of the four subscales contributed significantly to the discriminant function, with the exception of achievement, which did not contribute significantly. using classification function coefficients, group membership could be predicted with an accuracy ratio of 77 per cent. test-retest reliabilities achieved for the attitudinal subscales were innovation 0.85; achievement 0.84; personal control 0.71; and self-esteem 0.76. alpha coefficients were regarded as satisfactory at innovation 0.90; achievement 0.84; personal control 0.70; and self-esteem 0.73 (robinson et al., 1991). an empirical study conducted by scholtz (1993) to compare entrepreneurs, engineers and managers (n=299) tested the validity and reliability of the eaq scale under south african conditions and concluded that it is not culture free. consequently, boshoff, scholtz, jacobs and stimpson (1993) revised the eaq for south african conditions. they eliminated all items that obtained corrected r tt values <0.30 in the scholtz study from the questionnaire and they also adjusted the structure of the subscales. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 169 the eaq consists of the following four subscales: achievement in business, referring to concrete results associated with the start-up and growth of a business venture. innovation in business, relating to perceiving and acting upon business activities in new and unique ways. perceived personal control of business outcomes, concerning the individual's perception of control and influence over his or her business. perceived self-esteem in business, pertaining to the self-confidence and perceived competence of an individual related to his or her business affairs. the eaq as revised by boshoff for south african entrepreneurs in the manufacturing and non-manufacturing industries was used in this study. 3.4 performance criteria in terms of the criterion variable franchisee performance or effectiveness, it is noted that performance measures in the franchise sector are generally welldefmed and consistently monitored in terms of the franchise agreement. profitability, which includes assessing the gross and net profit of franchisees, was monitored by 92.3 per cent of the franchisors that participated in the 199811999 annual survey of the south african franchise sector (franchize directions, 1999). franchisors also regularly monitor whether franchise outlets trade under the established trademark and operate according to the operations manual, which sets out the defmed business method. franchisors in the fast foods category often monitor profitability by means of sales growth and conduct restaurant evaluations to monitor whether franchisees operate according to the operations manual. they also regularly evaluate customer satisfaction. franchise and therefore franchisee performance in this study was measured using two of the three performance indicators suggested (and used) by the franchisor, namely: • restaurant evaluation, which is conducted by the franchisor's franchise support managers on at least three occasions per year. this evaluation assesses the achievement of franchise standards in terms of hygiene, maintenance, product management, service, hospitality, uniforms, management and marketing, and is essentially designed to assess the implementation of the franchisor's organisational delivery and control system. a customer satisfaction evaluation, which assesses hospitality, speed of service, restaurant ambience and management support from the customer's point of view. this so-called "mystery shopper" evaluation r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 170 sajems ns vol 5 (2002) no 1 was designed to measure customer response to the particular products and services offered by the delivery and control system and is conducted by an anonymous visitor to the restaurant on at least six occasions per year. sales growth, which measures the annual growth of net sales per restaurant, was excluded from the performance criteria because it is strongly influenced by factors under the direct control of the franchisor. consequently, percentage growth may not be directly attributable to actions taken by the franchisee and is therefore not a true assessment of success. factors outside the franchisee's control include the strength of the trademark or brand, the location (site) and construction of the restaurant, the national distribution of equipment and raw materials, effective marketing and management of the franchise. however, sales growth is contingent on the maintenance of high restaurant and customer standards, which is directly under the control of the franchisee. 3.5 procedure the questionnaires were individually administered to 80 franchisees in an office environment during visits to franchise outlets. the franchisees were given the option to participate or not. franchisee performance as measured by the identified (two) performance measures was assessed by the franchisor over a period of one year for each restaurant. 3.6 statistical analyses franchisees were firstly classified into two groupings according to set performance criteria, namely successful or unsuccessful franchisees. secondly, these two groups were then explored by means of a stepwise discriminant analysis based on linear combinations of the predictor variables (personality traits, emotive responses and attitudinal orientation) to provide the best overall discrimination among the groups. next, the factors common to successful franchisees were identified. lastly, the lack-knife classification (nell, kamfer, van der merwe & venter, 1996) was employed to devise a classification table in order to compare the observed and predicted success rates of franchisees. 4 results 4.1 classification of performance criteria a simple dichotomy was formulated to include the performance criteria for statistical purposes. franchisees were classified into two groups from average r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 171 scores obtained on the restaurant evaluation and mystery shopper reports over the period of one year. the arbitrary averages laid down by the franchisor to separate successful and unsuccessful franchisees were used as cut-off point for restaurant evaluation (91) and mystery shopper (83) scores. consequently, 45 respondents were classified as successful and 35 respondents were classified as unsuccessful. table 2 sets out a description of the two groups. table 2 description of tbe sample in terms of performance criteria group restaurant mystery group % of total evaluation sbopper size group successful franchisees 91 to 100% 83 to 100% 45 56% unsuccessful ot090% oto 82% 35 44% franchisees total 80 100010 the jack-knife classification was used as a method to ascertain whether the two groups were correctly classified in terms of the performance criteria. the classification results are reflected in table 3. from table 3 it is clear that 44 of the successful franchisees were correctly classified, while 1 of the successful franchisees was incorrectly classified. of the unsuccessful franchisees, 34 were correctly classified and i was incorrectly classified. this implies that 97.5 per cent of grouped cases were correctly classified and only 2.5 per cent were incorrectly classified. table 3 predicted group membersbip in terms of performance criteria franchisees number of predicted membership cases successful unsuccessful successful 45 44(97.8%) 1(2.2%) unsuccessful 35 1(2.9%) 34 (97.l%) 4.2 discriminant analysis of personality attrihutes the difference between the successful i unsuccessful franchisees (dependent variable) was further explored by means of a stepwise discriminant analysis (morgan & griego, 1997: 154) using a variety of recognised statistical methods, including the wilks-lambda, canonical discriminant function, structured matrix, and fisher's linear discrimination. the independent (predictor) variables consisted of the sixteen factors of the 16pf, four factors of the ppa, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 172 sajems ns vol 5 (2002) no 1 and four factors of the eaq. the analyses showed that three factors of the 16pf, one factor of the ppa, one factor of the eaq varied significantly between the groups. the results of the fisher's linear discrimination, which is most appropriate for small groups (80 is considered a small sample for statistical purposes), is set out in table 4. the table reflects the weights for the linear combination of variables that discriminate most between successful and unsuccessful franchisees. table 4 discriminant function coefficients of the predictors predictors successful unsuccessful coefficients coefficients emotional stability (factor c 16pf) 0.886629 0.728138 caution (factor f 16pf) 1.644076 1.844949 shrewdness (factor n 16pf) 3.897153 3.543380 compliance (ppa) 2.961377 2.788327 self-esteem (eaq) 2.821686 2.653440 constants -112.7659 -101.3134 the results in table 4 indicate that emotional stability, caution and shrewdness (all 16pf); and then also compliance (ppa) and self-esteem (eaq) are the predictor variables which provide the best discrimination between successful and unsuccessful franchisees. the jack-knife classification was again used to check the effectiveness of the discriminant analysis. the weights of the five predictors (personality attributes), as identified during the stepwise discriminant analysis, were used to predict group membership of the franchisees. the results are reflected in table 5. table s predicted group membership in terms of personality attributes franchisees number of predicted membership cases successful unsuccessful successful 45 31 (68.9%) 14 (31.1%) unsuccessful 35 10 (28.l%) 25 (71.4%) the use of emotional stability, caution, shrewdness, compliance and selfesteem as predictors of performance resulted in the correct prediction of 68.9 per cent of the successful group and 71.4 per cent of the unsuccessful group. overali, 70.15 per cent of the respondents were correctly classified into the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no i 173 appropriate performance groups. the discriminant analysis, however, did better in predicting who would be unsuccessful than it did at predicting who would be successful. 5 discussion the empirical study showed that the personality attributes of successful franchisees differ significantly from those of unsuccessful franchisees with regard to emotional stability, caution, shrewdness, compliance and selfesteem. successful franchisees exercise a higher degree of emotional discipline and display more caution and restraint than unsuccessful franchisees. they also pay significantly greater attention to detail and follow a more calculating and factual approach towards work methods. they display a higher degree of interpersonal insight and also come across as significantly more self-assured and competent. the accuracy ratio of 70.15 per cent in correctly classifying successful and unsuccessful franchisees on the basis of the identified five factors provides a sound basis for the formulation of two equations which can be used to screen potential franchisees in the fast foods category. the prediction formulae can be derived from the results set out in table 4. the prediction formula for successful franchisees is expressed as s i and the prediction formula for unsuccessful franchisees is expressed as ui. sl 2.8217 eq4+ 1.644 i pf5+3.8972 pfii+2.9614 pa4+o.8866 pf3112.7659 ul= 2.6534 eq4+1.8449 pf5+3.5434 pfil+2.7883 pa4+o.728 i pf3101.3134 these two formulae can be used to differentiate between successful and unsuccessful candidates by entering the scores obtained for the five factors into both formulae for each candidate. this means that two scores are computed for each candidate on s i and ul respectively. the greater of these two scores will predict with a 70 per cent accuracy rate whether a candidate has the potential to become a successful or unsuccessful franchisee. of course, these two formulae can only be used once candidates have completed the 16pf, the eaq and the ppa. combined, these three questionnaires measure 24 traits i responses i attitudes, comprising 331 items and take approximately 100 minutes to complete. marking and interpretation of each questionnaire can be done manually. or by means of software packages in the case of the 16pf r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 174 sajems ns vol 5 (2002) no i and pp a. marking and interpreting the questionnaires and computing the formulae, s i and ul takes at least 20 minutes, adding up to a total test time of 120 minutes per candidate. a better alternative would be to identify or construct a questionnaire based on the five factors identified from the research. such a questionnaire should consist of no more than 80 items, it should take approximately 15 minutes to complete and it should be possible to score it in about 10 minutes, which would reduce the total test time when using the 16pf, the ppa and the eaq from approximately 100 minutes to 25 minutes. the questionnaire should also not require sophisticated scoring techniques, but must be designed to be scored either by hand or computer. the research results provide a sound foundation for the identification or construction of a questionnaire that reflects the intrinsic nature of the five factors identified from the 16pf, the eaq and the ppa. once such a questionnaire has been identified or constructed, it should be validated by administering it to a representative group of franchisees in the fast foods sector and their questionnaire results should then be correlated with appropriate performance criteria. it is likely that factor analysis of how franchisees answer each question of the newly constructed questionnaire would enable further refinement to increase the questionnaire's accuracy ratio to above 70 per cent. 6 managerial implications this study has highlighted that successful franchisees appear to display behaviours that reduce risk for example, they exercise emotional discipline, caution and restraint, pay greater attention to detail and follow a calculating and factual approach· towards work methods. indeed, this rmding is not surprising, as the franchise concept is essentially an attempt to reduce the amount of risktaking in setting up, establishing, managing and growing a new business. the results of the present study strongly suggest that franchisees may differ from entrepreneurs in meaningful ways and operate in different contexts. the underlying culture and values conducive to success in a risk-minimised and highly structured business context (the franchise concept) may be quite inappropriate in an entrepreneur's operating context, which is characterised by an increase in risk and less structure. the findings offer support for the view that franchisees are not truly entrepreneurial in nature but instead behave more like intrapreneurs, who want to own and develop their own businesses, but prefer to keep to proven conventional products and services (kao, 1991). this suggests several potentially useful avenues for continued research. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no i 175 the relationships between the three main performance criteria used by the franchisor to determine franchisee effectiveness and success also warrant further investigation. according to the franchisor, the maintenance of franchise standards (as assessed by the restaurant evaluation) forms the basis for the achievement of sound customer service (as assessed by the mystery shopper evaluation). the improvement and maintenance of franchise standards and sound customer service are directly under the direct control of the franchisee. however, it appears that sales growth (which determines the ultimate success of the restaurant) may not be under the direct control of the franchisee, as the franchisor controls many of the factors that influence sales growth, for example, the strength of the trademark or brand, the location (site) and construction of the restaurant, the national distribution of equipment and raw materials, effective marketing and management of the franchise. first, the relationship between restaurant standards and customer satisfaction should be carefully explored to confirm whether the maintenance of franchise (restaurant) standards serve as a basis for customer satisfaction. second, the relationship between restaurant standards and customer satisfaction on the one hand, and fmancial profits on the other hand should be investigated to isolate the factors in the franchise concept that should be under the franchisor's control (in order to maintain the integrity and standards of the franchise) and those factors that should be under the franchisee's control in order to ensure continued growth in the effectiveness and earnings of the franchise. it is also notable that the franchisor generally rates franchisee performance (restaurant evaluation) higher than independent outsiders (customer satisfaction evaluation) do. indeed, a major limitation of the study is the skewness of both the restaurant evaluation and the customer satisfaction evaluation distributions {restaurant evaluation cut-off value: 91 and customer satisfaction evaluation cutoff value: 83 with an upper limit of 100 in both cases. this may mean that the method and frequency of performance assessments need to be re-considered, with a greater emphasis on uniform and consistent training and performance assessments. endnote this article is based on papers delivered at the ninth european congress on work and organizational psychology, 12-15 may 1999, espoo helsinki, 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(1991) norms, means, standard deviations and reality coefficients for the sixteen personality factor questionnaire (forma), pretoria: human sciences research council. 49 prinsloo, c.h. (1995) manualfor the use of the sixteen personality factor questionnaire. south african version (l6pf, sa92), pretoria: human sciences research council. 50 robinson, p.b., stimpson, d.v., huefner, j.c. & hunt, h.k. (1991) an attitudinal approach to the prediction of entrepreneurship, entrepreneurship theory and practice. summer: 13-31. 51 scholtz, c.p.t. (1993) "houdings en voorkeure as metodes om te onderskei tussen entrepreneurs, ingenieurs en bestuurders: suksesvolle en minder suksesvolle entrepreneurs: en tussen entrepreneurs in r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no i 179 verskillende ekonomiese selctore", ongepubliseerde doktorale proefskrif, universiteit van pretoria. 52 schutte, j.l., benneit, f. and boshoff, a.b. (1993) "prediction of success level of entrepreneurial ventures by means of biographical and business variables in a third world setting", proceedings of an international congress on internationalizing entrepreneurship education and training, vienna: 381-95. 53 sexton, d.l. (1987) "advancing small business research: utilizing research from other areas", american journal of small business, i 1(3): 25-30. 54 shaver, k.g. (1987) principles of social psychology, cambridge, ma: winthrop. 55 smit, g.1. (1991) psigometrika, pretoria: haum. 56 spangenberg, h. (1990) assessing managerial competence, cape town: juta. 57 stanworth,1. (1995) developing a diagnostic questionnaire as an aid to franchisee selection, westminister press: international franchise research centre. 58 stephenson, w. (1952) the study of behaviour, o-technique and its methodology etc, chicago press. 59 thomas international. (undated) increasing people effectiveness, pretoria. 60 van deventer, v. & kruger, j. (1997) south african data supports thomas system. pretoria: thomas international. 61 van deventer, v. (1997) thomas international on thomas system research, pretoria: thomas international. 62 van vuuren, 1.1.1. & boshoff, a.b. (1993) "entrepreneurs! are they different? a re-analysis of a south african data set", proceedings of an international congress on internationalizing entrepreneurship education and training, vienna: 397-411. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . f:\ejour\ecoman\ftp\ecoman_v6_n1.prn.pdf sajems ns vol 6 (2003) no 1 178 the impact of economic globalisation on the south african auto industry __________________________________________________________________ oumar bouare, khuli tlabela, jarè struwig and zakes langa human sciences research council, pretoria __________________________________________________________________ abstract this paper assesses the impact of economic globalisation on the south african auto industry. first, a duopoly model of differentiated products is used, which allows the determination of the free trade and protection dividing line. this determines the stay-exit function, which shows the profitability level of the domestic industry. second, to determine the relationship between employment, profitability and export in the auto industry, a log-linear equation is estimated in which the logarithm of employment is expressed as a function of the logarithm of the distance between the stay-exit function and the trade line and the logarithm of export. these estimates suggest that policy makers take measures to either prevent the destruction of the domestic industry and the decrease in employment in the auto industry, or increase its profitability and employment. jel f1, l1 1 introduction economic globalisation was first explicitly used in the literature by modelski (1972). according to him, the term refers to european-led expansion to gain control over other communities and integrate these into one global trading system. in current terms, however, economic globalisation can be defined as the intensification of profit seeking abroad by states or businesses through the widening of world markets, the fast processing of information, the improvement and relocation of production units world wide, and the voluntary participation of countries in the world trading system. and its engines are free trade and government hands-off economic policies. economic globalisation has profound effects on societies in general and industries in particular. like the auto industries of the us and korea, south african auto industry1 faces intense competition from other auto industries because of economic globalisation. however, since its inception in 1920, the south african auto industry has played an important role in the economy of the country as a large sajems ns vol 6 (2003) no 1 179 employer. therefore, if no preventive measure is taken, economic globalisation may sharply reduce the profitability and employment capacity of the south african auto industry. this will worsen unemployment and decrease the national revenue in south africa. this paper, therefore, uses a duopoly model of differentiated products2 to determine the free trade and protection divid ing line on the one hand, and the relationship between the profitability and employment level of the south african auto industry on the other hand. below this dividing line or trade line, the profit of the domestic industry is negative. as a result, the domestic industry can be driven out of business by foreign competitors. above the line the profit of the domestic industry is positive, enabling the possible increase in employment in the auto industry. the determination of the dividing line enables policy makers to implement economic policies that can prevent the destruction of the domestic industry and the decrease in employment capacity in the auto industry. additionally, an empirical estimate of the relationship between the percentage change in employment and profitability enables policy makers to determine the increase or decrease in employment induced by the increase or decrease in profitability respectively. the paper comprises four parts. first, is a review of the literature, followed by an analysis of the impact of globalisation and policy implications of globalisation. third, relevant hypotheses are represented and tested, and the research methodology described. finally, the specification is given for the equations that are estimated. 2 literature review although there is a large literature on free trade and protectionism, there has been little attempt to determine the dividing line between free trade and protectionism. smith (1937) argues that if countries specialise in the production of commodities in which they have an absolute advantage, free trade will be mutually beneficial for the trading partners. ricardo (1911) improves smith's theory by arguing that even if a country does not have an absolute advantage in the production of a commodity, it can still benefit from free trade by specialising in the production of the commodity in which it has a comparative cost advantage. more recently, samuelson (1962) argues that free trade is better than no trade. using a production possibility frontier (ppf) in his 1962 paper, he shows that free trade shifts the ppf outward, making consumers better off. dissenting from these arguments, hamilton (1968) in his report on manufactures stresses the need for protection of the us manufacturing industries. list (1841) also questions smith's "cosmopolitical" viewpoint, arguing that a nation's economic interest can be undermined with free trade, sajems ns vol 6 (2003) no 1 180 particularly if its young manufacturing industries are put at risk by allowing free competition between them and the established manufacturing industries of other countries. he then calls for the protection of young german manufacturing industries. bhagwati (1988), too, argues for some protective measures for developing economies so that they can benefit from trade. bouare (1998) shows that smith’s and ricardo’s theories are inadequate for explaining international trade. he argues that countries are not involved in trade because they have an absolute advantage in the production of a good or can produce a good relatively cheaper as compared to their trading partners, but they are involved in trade because they can make a relative greater profit. bouare introduces a theory of comparative profit advantage in which trade is not always mutually beneficial to two trading partners. perhaps the lack of determination of a dividing line between free trade and protectionism derives from the rift between proponents of smith's critique of mercantilism and proponents of hamilton and list's support for economic protection. state interventions in the south african auto industry since 1920 should be perused against the background of these two opposing approaches. according to duncan (1993), the federated chamber of industries, presided over by harold j. laitte in the 1920s, strongly supported the expansion of industry through tariff protection. in 1934, pirow announced his vision of engine and casting building in south africa, and the complete manufacture of cars and trucks in the country. the ensuing project was a state-driven enterprise, with the government committing itself to purchasing a minimum number of vehicles and holding shares in a south african engine manufacturing company. from 1961 onwards, assemblers were required by the government to include 11 basic local components in their vehicles. the government offered bonuses to assemblers who included more local components in their vehicles. this policy successfully reduced the drain on foreign exchange from r145.6 m (of a total import expenditure of r941.4 m) in 1960, to r110.6 m in 1961 (the total import expenditure that year being r812.0 m). encouraged by tariff protection, by assemblers’ anxiety to buy locally, by increasing vehicle sales and by the government's industrial development corporation, investment in the components sector grew from r15 m in 1961 to r85 m in 1967. by 1967, there were over 200 motor component factories in south africa. in 1970, all manufactured models had to reach a net local content by weight of 50 per cent (excluding tyres and tubes). the government maintained this basic policy of import substitution through the 1970s and 1980s, with steady increases in local content percentages (duncan, 1993: 68-76). for further discussion on this issue, see east (1981), bizos (1985), bell (1989) and ducan (1993). sajems ns vol 6 (2003) no 1 181 but if we judge the success of free trade on its expansion in the world community3, it would seem that the proponents of free trade are winning the contest. however, in spite of these agreements, every country continues to seek to protect its own economic interests by implementing some protective measures4. this suggests that free trade does not seem to be a win-win situation for every country otherwise there would be no need for these agreements or protections. as a result, countries need to set up devices to increase their national revenue and employment, and thereby ensure their economic prosperity. 3 impact of globalisation and policy implications the engines of economic globalisation are free trade and a government hands-off policy, both which foster the expansion of businesses world wide. however, globalisation is not necessarily conducive to an increase in the national revenue of third-world and developing countries, as the recent asian crisis has shown. yet globalisation is strongly advocated throughout the world. developed countries in general and the us in particular are pressurising third-world and developing countries to subscribe to free trade and government hands-off economic policies. the reason is that developed countries have reached a stage of development in the capitalist mode of production in which their respective domestic markets can no longer absorb their production. as a result, the sustainability of their production depends on the existence of outlets. if these countries cannot export the surplus of their output they will face either an economic recession or depression. an important part of american economic growth is derived from american exports. it is therefore not surprising that the us is now a vocal supporter of globalisation, free trade and the opening of foreign markets, whereas in the nineteenth century it erected a wall of protection to secure its economic interests5. what is missing in the globalisation equation is room for third-world and developing countries to secure their industrialisation in order to protect their economic interests as every developed country has actually done6. although developed countries are pressing third-world and developing countries to open their goods and capital markets to international financial capital with which developed countries are well endowed, they close their labour markets through their immigration laws to international labour with which third-world and developing countries are well endowed. if developed countries really believe that globalisation, free trade and government hands-off economic policies are beneficial for all countries, why do they keep at bay the labour of third-world and developing countries? the reason is that the free flow of labour is not beneficial for the economy and standard of living of developed countries. for instance, the free flow of labour will sharply decrease the wage rate in developed countries, create a reserve of cheap labour and lower the standard of living. developed countries will also become overcrowded and economically unmanageable. a sajems ns vol 6 (2003) no 1 182 similar economic difficulty to that of asia will occur in third-world and developing countries if international financial capital is allowed to flow freely. therefore, third-world and developing countries should protect their economic interest and adopt government hands-on economic policies when necessary. economic globalisation increases competitive pressure on the domestic auto industry in south africa because it increases the number of suppliers of automobiles in the domestic market. this results in a decrease in the price of automobiles in south africa, which benefits domestic consumers if the domestic industry is not driven out of business. however, since there is no guarantee that the domestic industry will survive the competitive pressure, it would be illadvised to allow the possibility of the destruction of the domestic industry, which is a large employer in the country. the reason is that not only will foreign producers increase their prices when the domestic industry is destroyed, making domestic consumers worse off, but unemployment will also increase with such magnitude that the country will face acute social tension. therefore, if the point at which the domestic industry may be driven out of business can be determined, some preventive measures can be taken to protect the profitability of the industry and thereby employment in the industry. when the domestic industry is prevented from being driven out of business, the issue then is to determine the relationship between the percentage change in profitability and in employment. however, there is no clear-cut theoretical solution to this. it depends on the demand for automobiles, the wage rate, workers' productivity within the industry, and the bargaining power of the unions, all of which are specific to each country and industry. therefore, to determine this relationship, we will use an empirical estimate of a linear relationship between the percentage change in employment and in profitability over the period under study. 4 hypotheses and research methodology 4.1 hypotheses before setting up any device to ensure the economic prosperity of the south african auto industry, we need to assess the impact of economic globalisation on the industry. to do so we will test the following hypotheses: 1 economic globalisation decreases profitability in the south african auto industry. sajems ns vol 6 (2003) no 1 183 2 economic globalisation increases unemployment in the south african auto industry. 4.2 research methodology to test these hypotheses, we first set up a duopoly model of differentiated products in which foreign and domestic automobiles are sold in the domestic market in order to determine the free trade and protection dividing line. from our model, we determine the price that maximizes the profit of the domestic industry. this price in turn is used to determine what we call the stay-exit function. if the stay-exit function is above the dividing or trade line, the domestic industry's profit is positive; if the stay-exit function is on the line, the profit is equal to zero; and if the stay-exit function is below the line, the profit is negative. thus, free trade can be implemented by policy makers if the stay-exit function is above the dividing line because in this zone the domestic industry stays in business since it is not at risk. however, when the stay-exit function is below the dividing line, some protection measures should be implemented to prevent the domestic industry from exiting business or being driven out of business by foreign competitors. because it may be too late to rescue the domestic industry if the stay-exit function is at or just above the dividing line, we determine a second line above the dividing line, called the gatt or wto line. if the stay-exit function is between the gatt line and the trade line, i.e. in the gatt zone, some agreements should be negotiated with trading partners to prevent the stay-exit function from being pushed below the trade line, i.e. in the protection zone. in other words, managed trade should be implemented in the gatt zone. when the stay-exit function is above the gatt line, i.e. in the free trade zone or banquet zone, the domestic industry is on safe ground because the stay-exit function is far away from the trade line. we call this zone the banquet zone because foreign producers of automobiles produced outside south africa are allowed to freely reap the gain from trade in this zone in the south african domestic market. an estimate of the trade line, the gatt line and the values of the stay-exit function in south africa from 1991 to 1998 will indicate the location of the stayexit function in the free trade zone, the gatt zone or the protection zone. from the beginning to the end of the period under study, the stay-exit function is expected to have a downward sloping trend or to move from the free trade zone to the gatt zone or the protection zone. this will confirm our first hypothesis, i.e. economic globalisation decreases profitability in the south african auto industry. second, we use a linear relationship between the logarithm of employment, the logarithm of the distance between the stay-exit function and the trade line, and sajems ns vol 6 (2003) no 1 184 the logarithm of export to examine the rate of change in employment induced by the rate of change in profitability in the auto industry. in this relationship, the logarithm of employment is the dependent variable, while that of the distance between the stay-exit function and the trade line, and that of exports are the independent variables. an econometric estimate of this linear equation will tell us how much change in employment in the south african auto industry will result from a 1 per cent change in its profitability. from the beginning to the end of the period under study, we expect a relative decrease in employment in the auto industry due to the relative decrease in its profitability. this will confirm our second hypothesis, i.e. economic globalisation increases unemployment in the south african auto industry. from these estimates, we will suggest economic policy measures to pull the stay-exit function into the free trade zone or maintain it there, and thereby increase or maintain profitability and employment in the south african auto industry. 5 empirical study in the recent studies of the us auto industry, toder (1978), bresnahan (1981) and dixit (1988) have used unobserved hedonic prices that are determined from a regression equation where the price is the dependent variable and the physical characteristics of automobiles such as weight, horsepower, automatic transmission, power steering, length, etc. are independent variables. however, there is some uneasiness about this method because not only are hedonic prices not observed prices, but automobile characteristics are also not tractable when new characteristics are introduced through the invention of a new model or a change in the features of an existing model. in these cases, it is difficult to have a set of homogeneous characteristics. instead of hedonic prices, one can use observed prices. but, since automobiles are differentiated products, if one uses observed prices, one faces the problem of homogenising the data. for instance, how can one transform the quantity of trucks into an equivalent quantity of cars? this problem can be solved by transforming the revenue obtained from the sales of trucks into an equivalent revenue of sales of cars. suppose that the revenue obtained from the sales of trucks is: rt = pt.qt, where rt is the revenue obtained from the sales of trucks, pt the price of a truck, and qt the quantity of trucks sold. if the price of one truck can buy for instance k cars, the revenue obtained from the sales of trucks can be written as: sajems ns vol 6 (2003) no 1 185 rt = (pt/k). (k.qt), where (pt/k) is the price of one car and (k.qt) the equivalent quantity of cars bought. thus, the revenue obtained from the sales of trucks is transformed into an equivalent revenue of sales of cars. then, rt can be written as: rt = pc.qc, where pc = (pt/k) is the price of one car and qc = k.qt the equivalent quantity of cars bought. this technique can be used to transform all the annual prices and quantities of every variety of automobiles (small, medium-sized, luxury cars, sport utility van, pickup trucks, trucks) into the corresponding annual prices and quantities of our standard car, which is medium-sized. this homogeneous data will be used to estimate the elasticities of demand for domestically produced cars and imported cars and the elasticity of supply of imported cars in order to determine the annual values of the interaction-elasticity, e0. we also use the homogeneous values of the quantity of domestic and foreign products demanded, i.e. qi and qd, to compute the values of the relative sales of imported automobiles (qi/qd). the market share ß of domestically produced automobiles will be measured by: revenue spent in buying domestically produced automobiles total revenue spent in buying automobiles in south africa . this value will be used to determine the relative market share [ß/(1-ß)] of the south african auto industry. since the marginal cost (mc) is considered constant in our model, its annual value will be the average variable cost because average variable cost = variable cost/total quantity = (mc.q)/q = mc. the sum of payroll and material cost divided by the total quantity of south african automobiles is used as a proxy to measure the marginal cost because the average cost figures are unavailable. we then can estimate the log of the south african price-cost margin equation by ols to determine the elasticity of substitution sid because 1/(sid-1) will be a coefficient in the following regression: ln(pd mcd) = a0 + a1ln( qi ) 1 ln( ß ) + a3ln[1 – ß – (1 – ß) 2. 1 ]. pd qd sid-1 1-ß ß ß e0 sajems ns vol 6 (2003) no 1 186 where pd is the domestic price and the term in bracket the market share elasticityinteraction. the estimates of the elasticities of demand of domestically produced and imported automobiles and the elasticity of supply of the latter will enable us to determine our trade line (tl): ∂qi [ 1 + eis ] ∂pd [∂pi.∂qd.∂qi] [∂pi.∂qd.∂qi] [∂qd ] ∂qi ∂pd ∂pi ∂qi ∂pi ∂pd ∂pd where eis is the elasticity of supply of imported automobiles and pi the price of imported automobiles. let us call s-1/sid-1.e = se the stay or exit function, where s = pdqd/piqi is the terms of sale and e the variable cost curve elasticity. if se < tl, the domestic producer is driven out of business (or exits) because the stay-exit function is below the trade line. that is, the domestic producer will be driven out of business when we have: s-1/ sid-1.e < do. if se ≥ tl, the domestic producer stays in business because the stay-exit function is above the trade line. that is, the domestic producer stays in business when we have: s-1/ sid-1.e ≥ do . 7 let us graph the stay-exit function. the vertical axis represents the values of the stay-exit function, while the horizontal axis represents the values of the terms of sale (figures 1 & 2). the value of the trade line is represented on the vertical axis. figure 1 sid > 1 gatt zone protection zone banquet zone or free trade zone c d a b s1 s0 s se d1 d0 d0 = , sajems ns vol 6 (2003) no 1 187 figure 2 sid < 1 figure 3 sid = 1 the se function intersects the trade line do at point a, corresponding to the critical value of the terms of sale (so), where the domestic producer is driven out of business. because it might be too late to rescue the domestic industry when it reaches its critical value of exit (so), a second critical value s1 is determined, where the domestic industry is still on safe ground. when sid > 1 (figure 1), s1 should be on the left of s0 because the stay-exit function has a hyperbolic shape; while if sid < 1 (figure 2), s1 should be on the right of s0 because the stay-exit function has the shape of the right branch of a parabola. finally, when sid = 1 (figure 3), the stay-exit function is a straight line which runs parallel to the trade line because it equals the variable cost curve elasticity (e) of gatt zone protection zone banquet zone or free trade zone c d a b s1 s0 s d1 d0 gatt zone protection zone free trade zone c a b s d1 d0 h 1 banquet zone or e sajems ns vol 6 (2003) no 1 188 domestic production. in this case, there is no need to determine the intersection s0 of the stay-exit function with the trade line or the second critical value s1. when sid > 1 or sid < 1, the determination of s1 is an empirical matter because it is dependent on each type of industry. as a rule of thumb, s1 = so 50 per cent so when sid > 1 (figure 1); and s1 = s0 + 50 per cent s0 when sid < 1 (figure 2). again, this is simply a matter of convention. alternate values of s1 can be chosen by the domestic industry. when sid > 1 or sid < 1, the vertical line from s1 will intersect the se function at point c corresponding to the value d1 of se which will be called the gatt line. also, the vertical line from s1 will intersect the trade line do at point b, while the vertical line from so will intersect the trade line at point a and the gatt line at d. when sid > 1, the area on the right of s0a, determined by s0a and the trade line d0, will be the protection zone; the area of the rectangle abcd will be the gatt zone; and the area in the north-west of point c will be the free trade zone or banquet zone. we call this area the banquet zone because other countries can freely reap the gain from trade in this zone. when sid < 1, the area on the left of s0a, determined by s0a and the trade line d0, will be the protection zone; the area of the rectangle abcd will be the gatt zone; and the area in the north-east of point c will be the free trade zone or banquet zone. when sid = 1, as a rule of thumb, the gatt line d1 will be equal to d0 + 50 per cent (e d0), which is above the trade line d0 if e > d0. in this case, the terms of sale are such that s = 19. as a result, the protection zone will be the segment ha; the gatt zone will be ab; and the banquet zone [b,c). the estimates of the trade line (d0), the elasticity of the cost curve (e), and the elasticity of substitution (sid) enable us to determine s0 = (d0/e) -(sid -1), which is the value of the terms of sale s = pdqd/piqi, where the stay-exit function intersects the trade line. this allows us to determine the value of the terms of sale (s1 = s0/2) under which the south african auto industry is on safe ground. the value of s1 as well as those of sid and e enable us to determine the gatt line d1 = (s1) -1/ sid-1.e = 21/ sid-1.d0. finally, we determine the values of the stay-exit function se = s-1/ sid-1.e with the estimates of sid, e and the values of the terms of sale s. data will be collected from the publications of the national association of automobiles manufacturers of south africa (naamsa), national productivity sajems ns vol 6 (2003) no 1 189 institute and the department of trade and industry. the study will cover the period 1991-1998, with a structural change in 1994. we started the study in 1991 because the complete set of data was not available before this period. the table below shows the estimates of the price-cost margin equation: table 1 estimation of the log linear price-cost margin (ols) constant -0.27 (3.53) log(import share) -0.21 (2.71) log(sa rel. market share) -1.43 (2.35) log(sa rel. market share el. interaction) 1.61 (2.38) dum 0.03 (4.15) r2 durbin-watson 0.87 2.11 note: the t-statistics are shown in parentheses. the explanatory power of the model or r2 is 87 per cent10. all the variables are statistically significant at the 5 per cent level, including the dummy variable (dum) which account for the structural change in the south african economy in 1994. the coefficient (-1.43) of the log(sa rel. market share) enables us to determine the elasticity of substitution sid = 0.3. this means that south african consumers by and large prefer locally produced automobiles to imported automobiles in terms of price and quality. the computation of the elasticities and cross-elasticities enables us to determine the values of the terms of sale (s), the two critical terms of sale (s0, s1), the trade line (d0), the values of the gatt line (d1) and those of the stay-exit function (se). the estimates of s0, s1, s, se, d0 and d1 are as follows: sajems ns vol 6 (2003) no 1 190 table 2 estimates of variables years s0 s1 s d0 d1 se 1991 1992 1993 1994 1995 1996 1997 1998 0.010725 0.006362 0.009998 0.032168 0.041266 0.024163 0.016794 0.06555 0.0160875 0.009543 0.014997 0.048252 0.061899 0.0362445 0.025191 0.098325 49.41113 23.91816 45.57469 24.35570 43.03306 23.47203 11.48414 12.58096 0.0012700 0.0006022 0.0011488 0.0060991 0.0040526 0.0090203 0.0024100 0.0168620 0.002267 0.001075 0.002267 0.010885 0.007233 0.016098 0.004301 0.030093 217.3978 77.11106 193.6916 79.13406 178.4468 75.06458 27.03536 30.79818 graph 1 trend of profitability of the south african auto industry: 19911998 the graphs of the trade line (d0), the gatt line (d1) and the stay-exit function (se), which are at the bottom, the middle and the top respectively, show that the stay-exit function has a downward sloping trend from 1991 to 1998. this means that economic globalisation decreased profitability in the auto industry. however, the stay-exit function is not in the risky zone because it is located above the gatt line, i.e. in the free trade zone. when the level of profitability decreases, a company usually reduces its variable cost of production, i.e. lays off employees in order to stay in business. this d0 d1 se d0: trade line values d1: gatt line values se: stay -exit values 250 200 150 100 50 0 0.020 0.015 0.010 0.005 0.000 1 2 3 4 5 6 7 8 sajems ns vol 6 (2003) no 1 191 results in an increase in unemployment. in contrast, an increase in employment in a company is due to the increase in the demand for its products, i.e., an increase in its level of profitability. this suggests that the percentage change in employment in a company or industry is a function of the percentage change in their level of profitability. we use the distance between the stay-exit function and the trade line as a proxy for the level of profitability on the domestic market. because some of the profits realised by the auto industry are due to exports, export will be the second independent variable. to determine this relationship, we will use the following equality: ln(e) = a + b.ln(se-d0) + c.ln(exp), where ln(e) is the logarithm of employment in the industry; ln(se-d0) the logarithm of the distance between the stay-exit function and the trade line; ln(exp) the logarithm of exports; a the y-intercept; and b and c the coefficients. the table below shows the estimates of the employment equation: table 3 estimates of the log linear employment equation constant 20.41 (50.49) log(stay-exit – trade line) -0.11 (2.20) log(export) 0.13 (4.56) r2 0.89 durbin-watson 2.02 note: the t-statistics are shown in parentheses the explanatory power of the equation or the r2 is 89 per cent. all the independent variables are statistically significant at the 5 per cent level. the distance between the stay-exit function and the trade line is negatively related to employment. that is, a 1 per cent change in the distance between the stay-exit function and the trade line induced a 0.11 per cent decrease in employment. this means that globalisation increased unemployment in the auto industry. however, the export is positively related to employment. that is, a 1 per cent increase in export induced a 0.13 per cent increase in employment over the period under study. sajems ns vol 6 (2003) no 1 192 6 policy recommendations the state of the south african auto industry calls in general for short-run and long-run policies to prevent the destruction of the domestic industry by foreign competition. 6.1 to stay in business in the short run to stay in business in the short run, i.e. to maintain the stay-exit function in the banquet (free trade) zone, the domestic industry cannot vary the trade line (d0), which is determined by the elasticities of supply and demand, cross-elasticities and the elasticity of substitution (sid) between the domestic and foreign automobiles, which substitution depends on consumers’ preference. however, the domestic industry can increase the elasticity of its cost curve, i.e. decrease its unit cost of production and vary its relative market share or terms of sale (s). if the government does not protect the industry, as is the case in south africa, the domestic industry’s policy should be as follows: given that south african consumers by and large prefer locally produced automobiles, i.e. sid < 1, to increase its terms of sale the domestic industry should increase its revenue by increasing the quantity supplied and the price to the extent that s will be greater than s0. here, the domestic industry need not target consumers loyal to its brand because most of them will buy its products since they are preferred to foreign products. 6.2 to improve business in the long run to improve business in the long run, i.e. to reverse the trend of the stay-exit function in the free trade zone, the domestic industry should improve its technology to reduce its cost of production and make better automobiles so that the elasticity of the cost curve increases. also, given that a 1 per cent change in the distance between the stay-exit function and the trade line induced a 0.11 per cent decrease in employment, to improve business, the domestic industry should isolate its market from foreign competition by further differentiating domestic automobiles from imported automobiles. this can be done by increasing the characteristics of domestic automobiles. this will enable the domestic industry to minimize the negative effect of globalisation. finally, given that a 1 per cent increase in export induced a 0.13 per cent increase in employment, the domestic industry should make better automobiles in terms of sajems ns vol 6 (2003) no 1 193 price and quality to target the export market. this not only will increase employment in the south african auto industry but it will also increase the revenue of the industry because the export market is far larger than the domestic market. this will enable the domestic industry to maximise the positive effect of globalisation. 7 conclusion to assess the impact of economic globalisation on the south african auto industry, we use a duopoly model of differentiated products to determine the free trade and protection dividing line. this enabled us to determine the stay-exit function, which showed the level of profitability of the domestic industry, depending on its location in the free trade zone, the gatt zone or the protection zone. if the stay-exit function moved, for instance, from the free trade zone to the gatt zone or the protectio n zone or had a downward sloping trend, this meant that economic globalisation was decreasing the profitability of the south african auto industry in the south african market. we found that the stay-exit function had a downward sloping trend. however, the domestic industry is not at risk because the stay-exit function has remained in the banquet (free trade) zone. second, to determine the relationship between employment, profitability and export in the auto industry, we estimated a linear equation in which the logarithm of employment was expressed as a function of the logarithm of the distance between the stay-exit function and the trade line, and the logarithm of export. we found that the logarithm of the distance between the stay-exit function and the trade line was negatively related to the logarithm of employment. in other words, globalisation increased unemployment in the auto industry, i.e. a 1 per cent change in the distance between the stay-exit function and the trade line induced a 0.11 per cent decrease in employment. however, a 1 per cent increase in export induced a 0.13 per cent increase in employment. in the light of these estimates, we suggested the implementation of economic policies to improve business in the short and the long run in the south african auto industry. this will reverse the trend of the profitability in the industry and maintain the stay-exit function in the free trade zone. that is, the suggested policies will minimise the negative effect and maximise the positive effect of globalisation. sajems ns vol 6 (2003) no 1 194 endnotes 1 although the automobile plants in south africa are branches of multinationals such as bmw, nissan, toyota, honda, delta and samcor, we call them collectively the south african auto industry because their production takes place on south african soil. 2 by a duopoly model of differentiated products, we mean a situation in which there are two producers or two industries (one domestic and the other foreign) selling two similar products in the domestic market where they compete. see the model and mathematical proofs in the hsrc report, bouare et al. (2001). due to the lack of space in the journal the model and mathematical proofs were removed from the paper. 3 nafta (north american free trade agreement) and the eu (european union). 4 agricultural subsidies in europe and the us, voluntary export restraints on japanese cars in the us and preferential trade agreements for developing countries in the world trade organisation. 5 see hamilton, 1968, pp. 301-314; mathias, 1983, pp. 289-290. 6 see henderson, 1961, pp. 10-11; johnson, 1982; mathias, 1983, pp. 8493; smith, 1976, pp. 405-406. 7 the cut off point should not be seen as a point at which the domestic producer can be driven out of business. indeed, the cut off point is not an indication that the domestic producer will be immediately driven out of business because with a zero or negative profit a domestic industry may not be closed down for a while. instead, the cut off point is a warning sign indicating that if no measure is implemented to rescue the domestic industry, it will be driven out of business. 8 figure 3 is the limit case because in our model sid is different from 1. 9 see hsrc report, bouare et al.(2001). 10 it should be pointed out that the small size of the data reduces the degree of freedom of the regression equation. 11 to avoid correlation, we did not include a dummy variable among the independent variables because the stay-exit function and the trade line values were determined from the previous regression in which the dummy variable was used. references 1 bell, r.t. (1989) "content protection in the motor vehicle industry in the presence of joint ventures", south african journal of economics, 57(2): 103-23. sajems ns vol 6 (2003) no 1 195 2 bhagwati, j. (1988) protectionism, cambridge: massachusetts, m.i.t. press. 3 bizos, a. (1985) "stagnation and crisis in the south african auto industry" (university of sussex m.sc. thesis). 4 bouare, o. (1998) “profit and profit and externalities as a basis for international trade”, economia internazionale, li(3): 315-38. 5 bouare, o. et al. (2001) hsrc report on the impact of economic globalisation on the south african auto industry, pretoria: hsrc. 6 bresnahan, t.f. (1981) “departures from marginal-cost pricing in the american automobile industry: estimates for 1977-1978”, journal of econometrics, 17(2): 201-27. 7 department of trade and industry (1998) current developments in the automotive industry, pretoria: dti publisher. 8 department of trade and industry (1999) current developments in the automotive industry, pretoria: dti publisher. 9 dixit, a. (1988) “optimal trade and industrial policies for the u.s. automobile industry”, in empirical methods for international trade, robert c. feenstra (ed.), cambridge, massachusetts: m.i.t press. 10 ducan, d. (1993) "government policy and the south african motor vehicle industry, 1924-1992", politikon: the south african journal of political studies, 20(1): 66-86. 11 east, h. (1981) "state intervention in the south african motor vehicle manufacturing industry" unpublished hons. thesis, university of cape town. 12 hamilton, a. (1968) "hamilton's report on manufactures", in industrial and commercial correspondence of alexander hamilton, arthur harison cole (ed.) new york: augustus m. kelley publishers. 13 henderson, w.o. (1961) the industrial revolution in europe, 18151914, chicago: quadrangle books, inc. 14 jonhson, chalmers (1982) miti and the japanese miracle, the growth of industrial policy, 1925-1975, stanford: stanford university press. 15 list, f. (1928) the national system of political economy, s.s. lloyd (trans.) new york: longmans. 16 mathias, p. (1983) the first industrial nation, an economic history of britain 1700-1914 (2nd ed) london and new york: methuen & co. ltd. 17 national association of automobile manufacturers (naamsa) (1998) naamsa new commercial vehicles sales statistics, pretoria: naamsa. 18 naamsa (1998) naamsa annual report, pretoria: naamsa publisher. 19 national productivity institute (2000) productivity statistics: south africa, 1991-1998, pretoria: npi. 20 modelski, g. (1972) principles of world politics, new york: free press. sajems ns vol 6 (2003) no 1 196 21 ricardo, david (ed.) (1911) principles of political economy and taxation, m.a., london: g. bell and sons, ltd. 22 samuelson, p.a. (1939)"the gains from international trade", the canadian journal of economics and political science: 195-205. 23 ________(1962) "the gains from international trade once again", the economic journal: 820-29. 24 smith, a. (1976) the wealth of nations, edwin cannan (ed.) new york: modern library. 25 toder, e.j., cordell, n.s. & burton, e. (1978) trade policy and the us automobile industry, praeger publishers. microsoft word vol6no3'3.doc sajems ns 6 (2003) no 3 529 line management�s involvement in people management: a comparison between south africa and australia ________________________________________________________________ leo vermeulen human resources management, university of pretoria ________________________________________________________________ abstract the purpose of this study was to obtain empirical data on expected shifts of people management activities from human resources managers to line managers. the research was done by means of a cross-cultural survey in south africa (n=381) and australia (n=653). the research results clearly indicate that there was a perceived shift of traditional people management functions to line management in both countries. this shift was more prominent in south africa than in australia. the main shift in south africa seemed to be that line managers are increasingly involved in training and development. equal employment opportunity was seen as the second most important area of change, followed by the use of human resources information systems, industrial relations, and occupational health and safety. recruitment and selection were seen as the least important areas of change. jel j50, j59 introduction organisations in south africa are subject to major changes in the way that people are managed. this transformation can be ascribed to the introduction of these organisations in global markets, to socio-political changes, to new legal requirements, to new information systems, to the demand for a more skilled work force, to increasing attention to diversity in the work force, as well as to higher customer and shareholder expectations. successful transformation requires traditional structures and roles to be shed and more flexible practices for managing people in varied and changing conditions to be adopted (noe, hollenbeck, gerhart & wright, 2000). as organisations begin to compete in the challenging business environment of the new millennium, the reason for success increasingly lies in effective human resources management (byars & rue, 2000: 4). human resources management sajems ns 6 (2003) no 3 530 consists of a set of ideas, policies and practices which management adopts in order to achieve a people-management objective (tyson, 1995: 3). in this article, the concepts �human resources management� and �people management� are used interchangeably. according to the latest thinking by prominent and respected human resources experts (gratton, 1997; hunter, 1997; kemske, 1998; laabs, 2000; ulrich, 1998a, 1998b), the human resources function will have to shed its traditional administrative, compliance and service role, and instead will have to adopt a strategic role in developing the organisation and the capabilities of its managers. today�s human resources professionals are administrative experts who set up an efficient system design, and deliver that system. they champion employees and ensure that people�s contributions (their commitment and competence) remain high. they are agents of change who help business through transformation and change (bernardin, 2003; ulrich, 1998a). both within the people management function and in the rest of the organisation, human resources practitioners are seen to fulfil new roles, to take on new responsibilities and to make new contributions to business. the key change for human resources professionals is the requirement that they be facilitators and agents of change, not just practitioners (hardijzer, 1998). in this regard, as early as 1987, gordon (1987) stated that human resources professionals in the 1990s would be likely to focus on increasing the effectiveness of their interaction with line managers and the transfer of some direct human resources management responsibilities to these line managers. subsequently, the human resources manager would act as � a provider � offering expertise to assist line managers in human resources management; � a delegator � assigning personnel roles to managers; � an auditor � evaluating the performance of line managers in implementing personnel policies; � an innovator � upgrading the technical competence and access of managers to information; and � a policy formulator � developing consistent, cost-effective human resources policy (gordon, 1987: 9). organisations are managed and staffed by people. without people, organisations cannot exist. indeed, cascio (2003: 55) claims that the �challenge, the opportunity and also the frustration of creating and managing organisations frequently stems from the people-related problems that arise within them�. as �people issues� become more central to business success, line managers are also compelled to get involved in people management. the reason is that line managers are ultimately responsible for both the processes and the outcomes of sajems ns 6 (2003) no 3 531 the company. they are answerable to shareholders for creating economic value, to customers for creating product or service value and to employees for creating workplace value (ulrich, 1998a). it is line management�s responsibility to define the strategic context, build the organisation, develop staff capabilities and manage performance. to be successful, line management should become directly involved in all human resources management practices. a framework for understanding line managers� involvement in people management functions is provided by gordon (1987: 10-11) and mathis and jackson (1997: 16-18). they have suggested several ways in which line managers and human resources practitioners can share people-related business activities. however, the nature of the line managers� responsibilities may vary for different human resources functions. in general, they include the following: line managers should have primary responsibility and accountability for the implementation of the human resources policies developed by top management and human resources professionals. they should systematically perform each human resources function, in other words, human resources planning and analysis, staffing, training and development, equal employment opportunity compliance, employee and labour relations management and the management of occupational health and safety issues. according to gordon (1987), line managers should continually practice quality, state-of-the-art human resources management. they must be able to use computerized human resources information systems (hris) to obtain information so they can act as diagnosticians and assess the effectiveness of current human resources practices and to ensure the effective and efficient use of human capital (talent) to accomplish organisational goals. the challenge to the human resources staff function in the 21st century will be to enable managers to fulfill this responsibility and pursue continuous improvements in each of the people management areas that are critical to competitive success. managers should integrate people management with business or service priorities and should become human resources champions themselves. sufficient knowledge of functions such as staffing, training and development, equal employment opportunities, occupational health and safety, industrial relations, personnel information systems and compensating employees should strengthen line managers and give them a competitive edge (byars & rue, 2000; lee, 1998). so far only one overseas study has examined whether the expected shifts of people management activities to line managers has indeed occurred. in 1994/95, littler, bramble and dunford (1995) launched a comprehensive research programme on organisational change in australia. their survey of 653 australian organisations provided a comprehensive picture of organisational sajems ns 6 (2003) no 3 532 restructuring and downsizing. these three researchers also gathered data on the involvement of line managers in critical people management activities in the future. this study was duplicated in south africa to provide a comparable data base (vermeulen, littler & wiesner, 1997). south africa was selected for such a study because its industrial mix and history are comparable to those of australia. one major difference is that south africa, after the 1994 elections, has become one of the youngest democratic countries in the world and has embarked on extensive labour reforms and development of its human capital. the purpose of this article is to report on the findings of the cross-cultural research on the expected shifts of people management activities from human resources managers to line managers. the research questions addressed in this study are the following: � to what extent do human resources managers and chief executive officers in south africa and australia perceive that line managers will be involved with people management functions in the future? � is there a statistical difference between the perceived involvement of line managers in people management functions in south africa and australia? method sampling procedure the rationale for the sampling in this study was to obtain a broad cross-section of larger organisations throughout south africa and australia. in defining the sample, it should be noted that the unit of analysis was organisations, not individual employees. in both south africa and australia, the focus was on larger organisations (employing 100 or more people) and the sample is skewed towards those organisations. the sampling frame for the south african survey was derived from the professional register of organisations obtained from the south african board for personnel practice. a sample of 1200 names was randomly picked from the register. this sample represents more organisations than only those noted on the stock exchange. a questionnaire accompanied by a covering letter was mailed to each respondent chosen for the sample. of the 1200, 421 questionnaires were returned, of which 381 were usable. this represented a response rate of 31.08 per cent. sajems ns 6 (2003) no 3 533 the sample for the australian survey was derived from the membership of the australian human resources institute. of the initial 1722 organisations to which the australian questionnaire was sent, there was a sample loss of 30 who indicated that their organisations were too small for the questions to make sense. of the possible 1692 sets of responses, 653 useable questionnaires were returned, a response rate of 38,6 per cent. the response patterns and the characteristics of the respondents of each country are summarised in table 1. table 1 characteristics of participating organisations and respondents variable south africa australia n % n % sector private sector 265 69,7 447 69,8 public sector 115 30,3 193 30,2 number of employees <100 36 9,4 147 22,5 101-1000 102 26,8 275 42,2 >1000 243 63,8 230 35,3 industrial profile agriculture 16 4,2 8 1,2 mining 45 11,8 25 3,8 manufacturing 87 22,8 129 19,8 electricity and gas 27 7,1 9 1,4 construction 8 2,1 11 1,7 trade and catering 31 8,1 41 6,3 transport, storage 20 5,2 18 2,8 communication 13 3,4 28 4,3 financial services 50 13,2 60 9,1 public and community services 73 19,2 82 12,5 other 11 2,9 242 37,1 current work position executive 24 6,3 114 17,5 senior manager 242 63,6 362 56,5 middle manager 115 30,1 164 26,0 functional level human resources management 329 86,4 461 71,6 general management 52 13,6 185 28,4 sajems ns 6 (2003) no 3 534 table 1 continued variable south africa australia n % n % employment period 1-2 years 32 8,4 101 15,4 3-4 years 50 13,1 133 20,4 5-6 years 50 13,1 113 17,3 7 years+ 248 64,9 301 46,1 gender female 58 15,2 153 23,4 male 324 84,8 496 76,0 measuring instrument littler�s organisational change survey questionnaire was used to collect the data. the questionnaire was developed and standardised by littler, bramble and dunford (1995) to measure organisational change in australia. the questionnaire consists of six sections, namely the organisation, staff numbers, structure and the responsibilities of line managers, workforce reduction, delayering, and demographics. for the purposes of this study, only the section of the questionnaire related to the people management responsibilities of line managers is examined in this article. this section assesses whether line managers� responsibilities with regard to people management functions will increase in future, will remain unchanged or will decrease. the respondents made predictions in 1996 for the next two years (1997 and 1998). data analysis a descriptive and comparative research design was followed. descriptive statistics were used to summarise the data (for example, frequencies, percentages and ranking) and inferential statistics were employed to investigate possible differences between groups (morgan & griego, 1998). the choice of the statistical tests was based on the level of measurement achieved in the research (runyon, 1977). in this study an ordinal scale was used as a level of measurement. data measured by either nominal or ordinal scales should be analysed by non-parametric methods (morgan & griego, 1998; runyon, 1977). the mann-whitney u-test was used to determine differences between the two countries (independent variable) regarding line managers� responsibility for people management and human resources functions (dependent variables). this is one of the most powerful of the non-parametric tests and it is a most useful alternative to the parametric t-test when the measurement in the research is sajems ns 6 (2003) no 3 535 weaker than interval scaling. the spss for windows statistical package, release 9, was applied for all statistical procedures (morgan & griego, 1998). results frequencies were calculated for each of the dependent variables (recruitment and selection, training and development, equal employment opportunity, occupational health and safety, industrial relations and human resources information systems) to ascertain whether people management functions have shifted to line management over a two year period. the frequency analysis indicated that the majority of respondents in south africa ( x =76,68 per cent) and australia ( x =58,12 per cent) expected that major shifts in people management functions would take place. according to the results, line managers in both countries would become significantly involved with human resources functions in future. the results are set out in figure 1 and summarised in table 2. table 2 an analysis of the shift of people management activities to line management in south africa and australia: percentage and ranking per country extent human resources functions country n decreased % unchanged % increased % rank south africa 371 13,7 30,2 56,1 6 recruitment and selection australia 632 8,2 43,2 48,6 6 south africa 375 3,5 7,2 89,3 1 training and development australia 627 2,7 24,7 72,6 1 south africa 374 2,4 12,3 85,3 2 equal employment opportunity australia 625 1,6 45,8 52,6 4 south africa 371 2,2 2,8 69,8 5 occupational health and safety australia 627 1,3 38,3 60,4 3 south africa 371 5,1 17,8 77,1 4 industrial relations australia 622 5,6 44,7 49,7 5 south africa 371 2,2 14,6 83,3 3 hr information systems australia 616 1,3 33,9 64,8 2 sajems ns 6 (2003) no 3 536 as is shown in figure 1 and in table 2, the main shifts in south africa seem to be that line managers are increasingly involved in training and development (89,3 per cent), as the most important area of change, followed by equal employment opportunity (85,3 per cent), the use of human resources information systems (83,3 per cent), industrial relations (77,1 per cent), occupational health and safety (69,8 per cent) and recruitment and selection (56,1 per cent). figure 1 line managers involvement with people management functions: a comparison between south africa and australia recruitment and selection equal employment opportunity industrial relations training and development occupational health and safety hr information system south africa australia sajems ns 6 (2003) no 3 537 a proportionally smaller number of respondents in australia indicated an increase in line managers� involvement with human resources management activities. the percentage responses of the australian respondents were lower for all the human resources activities. the highest percentage responses were also allocated to training and development (72,6 per cent), followed by the use of human resources information systems (64,8 per cent), occupational health and safety (60,4 per cent), equal employment opportunity (52,6 per cent), and industrial relations (49,7 per cent), with recruitment and selection (48,6 per cent) as the least important area of change. the mann-whitney u-test was conducted to analyse the difference between south africa and australia (independent variables) with reference to each of the six human resources functions (dependent variables). the results are set out in table 3. table 3 comparison between south african and australian line managers� involvement in people management: mann-whitney u-test human resources functions country n mean rank u-value z sig (2tailed) south africa 371 509,85 recruitment and selection australia 632 490,15 110984,5 -1,1653 0,2439 south africa 375 551,99 training and development australia 627 471,31 98630,5 -6,0162 0,0000* south africa 374 599,22 equal employment opportunity australia 625 440,63 79767,5 -10,1189 0,0000* south africa 371 527,39 occupational health and safety australia 627 483,00 105960,5 -2,8150 0,0049* south africa 371 578,24 industrial relations australia 622 448,54 85240,5 -7,9971 0,0000* south africa 371 549,36 hr information systems australia 616 460,66 93730,5 -6,0522 0,0000* *p<0,01 the outcome of the mann-whitney u-test indicated a statistically significant difference between the respondents in the two countries� perceptions of line managers� involvement with people management in future. the mean ranks of five dependent variables tested significantly differently at the 99 per cent confidence levels, namely training and development, equal employment opportunity, occupational health and safety, industrial relations and human resources information systems. in all of these cases the mean rankings sajems ns 6 (2003) no 3 538 were significantly higher for south africa. from these results, one can infer that the shift of people management activities to line managers was more prominent in south africa than in australia for the period under investigation. discussion the results indicated that the involvement of line managers in human resources management functions is expected to increase considerably in both countries. the south african respondents differ significantly (p<0,01) from the australians in their perception of line managers� involvement in five of the human resources management functions two years hence. recruitment and selection was the only function where there was no difference. the percentage increase expected in people management activities by line managers in south africa was particularly high in training and development, equal employment, occupational health and safety, industrial relations and information systems. reasons for the south african results political, social and industrial democracy in south africa has historically evolved along racial lines, leading to unique but unfair human resource management practices. this situation came to an end with the april 1994 elections. the new south african constitution (act 108/96), government policy and employment laws set the scene for the involvement of ceos and line managers in promoting equity and non-discriminatory practices in all areas of people management. the following acts were instrumental in breaking down the employment disparities of the past, to ensure fair, safe and just human resources practices, and to develop a knowledge-based and skilled workforce (nel, gerber, van dyk, haasbroek, schultz, sono, & werner, 2001). � occupational health and safety act 85/93; � compensation for occupational injuries and diseases act 130/93; � labour relations act 66/95; � unemployment insurance act 30/66; � basic conditions of employment act 75/97; � employment equity act 55/98; � skills development act 97/98. these acts have had and will continue to have a significant impact on employment policies and practices in all sectors of the south african economy. failure to comply with the last two acts in the workplace could result in the imposition of constraints on the organisation or in direct penalties levelled sajems ns 6 (2003) no 3 539 against line managers who do not become directly involved. the result is that ceos and line managers in south africa have become much more directly involved with what was traditionally regarded as the domain of specialist human resources practitioners. according to nel et al. (2001), many organisations in south africa have transformed their human resources departments from specialised stand-alone functions to a broad strategic corporate practice. human resources practitioners and line managers are building partnerships to gain competitive advantage and to achieve their business goals. both south africa and australia are adopting a strategic approach to human resources management. managerial implications in order to meet the challenges of people management under the new dispensation, human resources managers must provide an overall strategy and advice to management. the single biggest challenge for human resources managers is to shift their focus from traditional people management activities to programmes which will address strategic issues as well as managerial and operational areas in future. one of the greatest challenges will be to educate and coach line management about the new paradigm. future human resources management needs to define new relationships with line management and motivate line managers to develop new skills that will contribute to improving the organisation�s people management activities. human resources professionals must educate and encourage line managers to assume responsibility for managing the human side of business. finally, they should educate line managers about their critical role in people management in order to achieve a common vision for the future (gordon, 1987; ulrich, 1998a; bernardin, 2003). several authors (gordon, 1987; howes & foley, 1992; tyson, 1995) are of the opinion that top managers are likely to shoulder primary responsibility for ensuring that human resources management is effective across the organisation. line managers should provide data to top management and human resources professionals about the effectiveness of programmes and practices in their organisations. they should provide data for strategic decisions about human resources in the organisation and regularly assess the effectiveness of human resources management in their unit by evaluating both processes and outcomes. in view of this, bernardin (2003: 4) believes that line managers will spend more than 50 per cent of their time involved in human resources activities. the effectiveness with which line managers perform the human resources management functions with the tools, data and processes provided by the human resources specialists is the key to competitive advantage through people management. sajems ns 6 (2003) no 3 540 references 1 bernardin, j.h. 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(1977) nonparametric statistics: a contemporary approach, addison-wesley publishing company, massachusetts. sajems ns 6 (2003) no 3 541 18 tyson, s. (1995) human resource strategy: towards a general theory of human resource management, pitman publishing: london. 19 ulrich, d. (1998a) �a new mandate of human resources�, harvard business review, january: 125-34. 20 ulrich, d. (1998b) �the future calls for change�, workforce, january, 77(1): 87-91. 21 vermeulen, l.p., littler, c.r. & wiesner, m.s. (1997) �organisational restructuring in south africa and australia: a comparative study�, unpublished report to the human sciences research council: 1-37. sajems ns vol 5 (2002) no i 203 us trade and investment in africa: what are the prospects for the 21 st century? n frank ekanem department of finance. international business & insurance, howard university abstract afiican countries considered in this study face many supply constraints and so lack the capacity to produce. export promotion effort cannot be successful unless such constraints are removed. transparency in governance, improvements in basic infrastructure and economic liberalization are some of the ways to remove such constraints. direct private investment to accelerate economic expansion rather than exchange rate manipulations are needed before export promotion policy can be successful. jel f02 1 introduction prior to the 1980s the us, like many other industrialized countries, invested to develop the largely untapped natural resources in afiica. these countries served as sources of raw materials for the us manufacturing sector. according to the us department of commerce, at the year-end of 1995, the us direct investment in sub-saharan afiica was $4,487 million, $1,269 million of which was in south afiica, $650 million in angola and $595 million in nigeria. there was a large outflow of capital from the united states for new investments, or to expand existing investments in south afiica and nigeria. most of the us trade with afiica is driven by the us investment interest in that region. this acknowledgement by the department of commerce says it all: (i) us direct investment in afiica supports us trade with the region, (2) $684 million of us merchandise exports in 1994 were shipped to us majority-owned affiliates in afiica, including those in north afiica. the major us export markets in subsaharan afiica are south, afiica and nigeria. the united states imports virtually all its manganese, a mineral essential for the production of high grade steel and relies on gabon for about one-third of its needs. because of its heavy reliance on nigeria for its crude oil import, the us invested in oil exploration in that country. these countries together accounted r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 204 sajems ns vol 5 (2002) no 1 for 63 per cent of us exports to the region in 1996. transportation equipment, agricultural products, machinery, electronic products and chemicals were the largest us merchandise exports in 1996. us imports rose to a record high s15.1 billion in 1996. with its investment in the region, the united states was able to obtain one·fifth of its crude oil imports and similarly about 65 per cent of the us vanadium, 44 per cent of antimony, 33 per cent of its platinum group requirement, over 30 per cent of its chromite and its ferro·cbrome, 27 per cent of its gold and to per cent of its manganese imports from south africa. abundant natural resources, pent·up demand for consumer products, capital goods and western technology presented an excellent environment for developing manufacturing and distribution facilities in many african countries. an increased awareness of africa as a market for traded goods and services, rather than merely a source of raw materials characterized the beginning of the i 990s. this was further enhanced by significant positive developments in africa, which created a sense of economic and political renewal throughout the african continent. african countries have also implemented many economic refonns emphasizing growth, private sector development and greater openness to the global economy. this renaissance took place amidst equally dramatic changes in the global political system and significant important opportunities for african nations to deepen their participation in the global economy in numerous and mutually beneficial ways (rogers, 1998). now that an increasing number of african countries are becoming strong candidates as potential trade and investment partners, the united states is once again at the forefront of the industrialized world in pursuit of new opportunities. the passage of african growth and opportunity act is just one step intended to secure a positive and rewarding economic relationship between africa and the united states. although many africans and african american leaders have expressed considerable skepticism, the act contains several provisions which can facilitate african access to american markets and vice versa. 10 particular, the call to eradicate corruption, improve and strengthen infrastructural services and carry out macroand microeconomic reforms are some of the ways to attract direct private investment. as recently as may 1997, a distinguished panel of african scholars, american businessmen and experts called on the clinton administration to develop a new and activist policy toward the continent to sustain development. 10 many ways, sustainable development embraces all of the primary objectives of the preceding decades and represents a better and more integrated understanding of africa's development challenges. the clinton administration was quite aware that failure to fully appreciate the economic aspects of this continent-wide renewal, would represent a lost opportunity for the united states to utilize a positive r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vols (2002) no 1 20s challenge in ways beneficial to the us, african nations and the larger global economy. recent trends in the us trade with africa the us trade with africa since 1980 consisted mainly of machinery and transport equipment, mineral fuels and lubricants, beverages and tobacco, animal and vegetable oil, chemicals and related products. between 1989 and 1992, the us export of mineral fuels and lubricants grew at the rate of 6.9 per cent, machinery and transport equipment grew at 11.1 per cent; miscellaneous manufactured articles grew at 14.4 per cent per annum. most of these exports went to egypt and nigeria. us export of miscellaneous manufactured articles to egypt and to nigeria during the period grew at an annual rate of 21.2 per cent and 8.3 per cent respectively. from 1989 to 1992, the us export of machinery and transport equipment to egypt and nigeria grew annually at 12.5 per cent and 3.3 per cent respectively. these trends were drastically changed between 1993-96. while the us export of mineral fuels and lubricants nearly tripled at 22.3 per cent per annum, exports of manufactured goods nearly doubled at 11.1 per cent per annum. us export of machinery and transport to africa fell drastically from 11.1 per cent to i.s per cent per annum, despite a phenomenal 134 per cent annual growth in these exports to nigeria. export of miscellaneous manufactured articles also fell from 14.4 per cent to 7.1 per cent per annum, in spite of 18.9 per cent per annum increase to south africa, partly because the us export of these products to nigeria fell by 8.9 per cent per annum and exports to egypt remained unchanged. an examination of us imports from africa reveals a very interesting phenomenon. during the period 1989-1992, the growth rate of us imports was dominated by the imports of animal and vegetable oil. us imports of animal and vegetable oil from africa was growing at a rate of 70.3 per cent per annum, beverages and tobacco at about 34.2 per cent per annum, chemicals and related products about 19.3 per cent per annum and miscellaneous manufactured articles at approximately 13.6 per cent of the overall us imports from africa. also, from 1989 to 1992, us imports from africa prominently featured machinery and transport equipment, accounting for approximately 31.6 per cent per annum, animal and vegetable oil (about 2s.0 per cent per annum) and chemicals and related products (about 14.0 per cent per annum). however, during this period, the us imports of food and live animals, crude materials and manufactured goods fell and generally recorded negative growth rates. between 1993 and 1996, the growth rate of us imports began to rise. imports offood and live animals grew at an annual rate of 12.2 per cent. crude materials, which had been declining at an annual rate of 1.6 per cent during the period of 1989r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 206 sajems ns vol 5 (2002) no i 92, now grew at an annual rate of 7.9 per cent; while the us imports of manufactured goods grew at an annual rate of 4.9 per cent. the growth of us imports from africa during this period primarily stemmed from imports of miscellaneous manufactured articles from south africa. this category of imports grew at an annual rate of 55.4 per cent while imports of machinery and transports equipment grew at an annual rate of 32.8 per cent, chemicals and related products at an annual rate of 17.3 per cent and food and live animals at an annual rate of 14.7 per cent. the direction and composition of us trade with africa the us department of commerce acknowledges that us trade and investment in africa are interdependent. most us direct investment in africa has been designed to support us trade in the region and hence the bulk of us merchandise exports was shipped to us majority-owned affiliates in the region. this situation is not dictated by economic theory, but is generally justified and practised by most multinational corporations. nevertheless, us trade with african countries depends on the structure of the african economies, which structure gives rise to countries' inability to export under given circumstances and also determines countries' capacity to import. the capacity to import depends on the income and prices in the african countries, relative to those in the usa. a standard export model partly explains this phenomenon. the standard model emphasizes two main factors: (i) a production function that comprises the stock of capital and labor supply and (ii) environmental factors which emphasize labor productivity, capital productivity and shifts of capital from domestic to the export sector (tyler, 1981; feder, 1982 and esfahani, 1991). this model must be modified to reflect the reality of the african situation, to include important environmental factors that will attract direct private investment and accelerate economic growth. without these modifications, the standard model will be inappropriate. both the ability to export and the capacity to import arguments are explored in this study. based on the department of commerce trade data, the fastest growing us exports to africa consisted of wheat, approximately 17.5 per cent; coal, approximately 12.9 per cent; parts and accessories of motor vehicles, approximately 21.5 per cent; iron and steel tubes, pipes etc, approximately 16.8 per cent; and engineering and motor, non-electrical parts, approximately 11.7 per cent. on the other hand, the fastest growing us imports from africa consisted of cocoa, approximately 17.4 per cent; pig iron, approximately 17.4 per cent; liquefied propane, approximately 17.5 per cent; sugars, molasses and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no i 207 honey, approximately 37.2 per cent; and crude minerals, approximately 29.5 per cent. these are manufactured and agricultural commodities, which the united states and afiican countries either have the technology or comparative advantage to produce more efficiently. the united states has the technology to produce engineering equipment and motor vehicle and parts, as well as the comparative advantage to produce wheat and many other agricultural products. african countries, on the other hand, that have exported to the united states in significant amounts either have comparative advantage in agricultural products, such as. cocoa or are endowed with large reserves of crude minerals, such as coal and petroleum. in this regard, statistics show that between 1993 and 1996 us imports of mineral fuels, lubricants and related materials came from angola and nigeria. during this period, 14.1 per cent and 32.8 per cent of the united states' imports of mineral fuels, lubricants and related materials from africa came from angola and nigeria, respectively. while products, such as civil engineering and contractors' plant and equipment, iron and steel tubes, pipes etc. are required for infrastructural and other development purposes, others are required as industrial inputs. the standard model assumes, for instance, that the united states can export as much as it wishes to african markets, given the stock of capital and labor and the various beneficial environmental factors in the united states, like the efficiency of capital and labor often cited in the literature. these trade statistics show that this is not exactly the case. the united states' exports to africa are limited by of demand constraints and other environmental factors, such as relative price differences in the us and african countries. even when the stock of capital and labor has not changed, us exports to large african countries, such as nigeria, egypt, ethiopia, morocco, kenya or south africa, are constrained and even more so in the case of smaller countries, like sierra leone, the republic of the congo, guineabissau because of demand constraints. recent experience shows that the united states cannot even export as much as it wishes to japan. this is because any country's ability to export is not automatically followed by other counties' ability to import. the case in point is the 1997-98 dip in the us exports to the asian markets. the decline in the us exports to the asian markets was caused by the collapse of the region's financial system, which drastically reduced the region's ability to purchase us exports. during that period, the stock of capital and labor in the united states remained unchanged. between 1989 and 1992, the national economies of the major us trading partners in africa, with the exception of egypt, were experiencing a recession in real terms. real gdp in egypt was growing at an annual rate of 14.9 per cent r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 208 sajems ns vol 5 (2002) no 1 from 1989 and 1992 and over 15 per cent between 1993 and 1996. real gop growth in nigeria during the corresponding periods was 2.61 per cent and 0.7 per cent, respectively. the corresponding growth rates in cote d'ivoire were 2.58 per cent and 2.14 per cent respectively while, in south africa they were1.06 per cent in 1989-1992 and 2.36 per cent in 1993-1996. ~uring these periods, all these countries experienced currency depreciation at the following annual rates: nigeria at 17.55 per cent (1989-92), 1.12 per cent (1993-96); south africa at 4.38 per cent (1989-92), 7.67 per cent (1993-96); egypt at 12.67 per cent (1989-92), 12.34 per cent (1993-96) and cote d'ivoire at 1.21 per cent (1989-92) and 11.55 per cent (1993-96). a recession inhibits these countries' ability to export, while their weak: currencies render imports expensive. it is obvious that such economic conditions can adversely affect not only the countries' ability to export but also their ability to purchase imports. 4 international trade model the us trade with africa can be considered in two parts, namely the direction of trade and the volume of trade. the first part seeks to explain the source and destination of us trade, while the second part seeks to explain the volume of us trade with african countries. statistics show that significant us trade with africa between 1990-1996 was mostly between a few countries, see department of commerce (various years). us exports of manufactured products in excess of $100 million went to algeria, angola, egypt, ghana, morocco, nigeria, south africa and tunisia. us exports of agriculture in excess of $100 million during the same period went to algeria, egypt, morocco, nigeria, south africa and tunisia. us agricultural imports between 1990 and 1996 in excess of $100 million came from algeria and cote d'ivoire. on the other hand, us imports of manufactured products in excess of $100 million were obtained from egypt, ghana mauritius, morocco, south africa and zaire (now the democratic republic of the' congo or orc). the structure of some of these economies between 1980 and 1992 is given in table 1. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 209 table 1 basic indicators and structure of the national economy country 1997 per capita % %agr. % % % pop. gdp growtb indus. mannr. servo mijrate lions '92 '97 '80-1 9065 97 65 97 65 97 6s 97 '90 .• 97 algeria 29.3 1820 1445 2.7 0.8 15 11 34 49 11 9 51 39 cote 14.2 670 716 0.7 3.0 47 27 19 21 11 18 i 55 51 d'ivoire t 60.3 640 380 :¥of 4.0 29 18 27 32 25 1 45 ,2! ethiopia 59tlllo87 4.3 58 55 14 7. 7 ~ ghana 18. 450 247 3. 4.2 44 36 19 26 10 39 kenya 28.6 310 254 4.2 2.1 35 39 18 161 11 16 47 56 morocco ~ 1030 8187 4.2 1.9 1!fim49 51 nigeria 320 544 1.6 2.8 33 20 s. africa 2670 1939 1.2 1.5 10 5 4 23 2 48 57 tunisia 9.2 1720 950 3.3 4.3 22 13 24 29 9 19 54 58 usa 3.0 3.0 3 2 38 27 18 18 59 71 source: world bank: world development indicators (1990,1999) based on 1992 and 1997 population, only four countries have a per capita gdp of over, or close to $1000. this means that these four countries had the capacity to import from the us, not only highly essential imports such as transport equipment and food, items such as aircraft and associated equipment, civil engineering and contractors' plant and equipment, needed for the development of the local economy. the structure of many of these economies has undergone some changes between 1965 and 1997 and in many instances in such a way that per capita gdp actually declined from 1992 to 1997. the structure of many of these economies shows a fairly stable share of services in the gdp but decline and improvements in the share of agriculture, industry and manufacturing appear in many cases. for instance, manufacturing declined in algeria, ethiopia and ghana. the sector improved considerably in cote d'ivoire, kenya. morocco, nigeria and tunisia. statistics show that none of kenya. nigeria, ethiopia, cote d'lvoire and ghana, all of which derive significant share of their gnp from agriculture is able to export up to i per cent of the united states agricultural needs. on the other hand ghana, mauritius and the democratic republic of the congo which exported $100 million or more of manufactured products to the united states during the 1980s, derive the lowest share of their gnp from manufacturing. it is hard to explain these apparent anomalies. where data is available, it is not entirely obvious how the structure of the national economies in africa affects trade with the united states. using the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 210 sajems ns vol 5 (2002) no 1 share of agriculture in the gnp, we can say that, in 1988, algeria with a share of 13 per cent, tunisia with a share of 14 per cent and south africa with a share of 6 per cent were least dependent on agriculture among the african countries on which trade destination data are available. while algeria exported no agricultural products to usa in 1992, tunisia exported $0.62 per capita and south africa exported $1.20 per capita. on the other hand, cote d'ivoire, which derived 36 per cent of its gnp in 1988 from agriculture, exported over $11.00 worth of agricultural products per capita in 1992 to the united states. kenya with 31 per cent of its gnp from agriculture exported over $1.40 per capita, compared to nigeria with a share of 34 per cent which exported a mere $0.29 of agricultural products per capita. however, when over $5,028 million exports of mineral fuels, lubricants and related minerals are included, nigeria's exports to usa rose to over $49.90 per capita in 1992. this means that nigeria's trade expansion policy will have to emphasize the non-oil exports. what role does demand play in africa's trade with the united states? for this purpose, we consider income and population. to answer this question, we limit our analysis to countries with a population of at least 20 million and per capita gnp of at least $600. seven countries were selected on the basis of their size. out of these, only three (or 42.8 per cent) bought combined imports of manufactured and agricultural products from the united states in 1990 in excess of $100 million. similarly, only three (or 30 per cent) of the ten countries which satisfied the minimum per capita gnp requirement bought combined imports of manufactured and agricultural products in excess of $100 million in 1990. out of four countries which satisfied both per capita gnp and population requirements, three countries (or 75 per cent) bought a combination of manufactured and agricultural products in excess of $1646 million from the usa in 1990. in addition, 22 other highand low-income countries for which data are available bought less than $100 million worth of manufactured and agricultural products from the usa in 1992. five of the small, low-income countries bought at least $1.00 manufactured and agricultural products per capita in 1992. seven other small countries also bought at least $1.00 of manufactured and agricultural products from the usa. some of these countries, such as namibia, botswana and mauritania depend more on the usa for their manufactures, while others, such as mozambique rely equally on the usa for their imports of manufactures and agricultural products. this means that for the us corporations to be able to sell significant amounts of their exports in the african market, they will have to target large countries, especially high-income countries, such as algeria, botswana, cameroon, gabon, mauritius, senegal and south africa and large countries such as egypt. how much they can export to small high-income countries, such as botswana, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 211 cameroon, cote d'ivoire, gabon, mauritius, senegal and tunisia, or large lowincome countries, such as kenya and nigeria remains uncertain. other macroeconomic variables, which may be taken into consideration when evaluating the us trade with africa, are domestic inflation and the strength of the local currencies. many african countries are plagued by inflation while their currencies are generally overvalued. five countries, including nigeria, mozambique and guinea have devalued their currencies by over two or three hundred per cent, while ghana and uganda have devalued their currencies at least 1,000 per cent. inflation reduces the purchasing power of the local currency and tends to increase the production cost of local industries. this means that local industries face higher unit cost and become:: non-competitive vis-a-vis their foreign competitors. at the same time, they have no incentive to . produce because of inadequate domestic or foreign demand. table 2 shows inflation and currency depreciation rates, between 1980 and 1990 (annual equivalent) for selected african countries, which normally trade with the united states. it shows that seven of these countries were plagued by hyperinflation between 1980 and 1990, the worst being nigeria, ghana, tanzania. mozambique. zambia and uganda, in order of severity. the countries with the highest rate of currency depreciation, also in order of severity are nigeria, tanzania, mozambique, zambia, guinea, uganda and ghana. when exports of mineral fuels. lubricants and related mineral products are excluded. nigeria, tanzania and uganda are among the countries with medium or large population with less than $1.00 per capita trade with the united states during the 1980s and 1990s. table 1 inflation and currency depreciation rate: annual equivalent (198~90) country inflation rate rate of currency depreciation angola u5 botswana 17.30 8.14 cameroon 12.32 2.66 reoublic ofcon2o 8.28 2.66 cote d'ivoire 6.08 3.20 e2vdt 37.62 21.87 ethiodia 5.38 1.15 ghana 155.02 i 831.67 guinea 71.52 801.16 kenva 20.58 25.47 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 212 sajems ns vol 5 (2002) no i table 2 continued country , inflation rate , rate of currency i depreciation morocco 10.16 10.70 mozambique 170.60 343.56 namibia 23.67 28.35 nigeria 60.42 174.40 senegal 7.64 2.67 south africa 29.08 28.35 tanzania 116.58 258.03 uganda 7,132.86 48,005.00 zambia 406.67 584.00 zimbabwe 22.48 25.74 source: calculated from imf: international fmanclal statistics (1994) exchange rate misalignment is one of the causes of macroeconomic distortion for any economy. overvalued currency stimulates imports for the countries concerned because imports are relatively cheaper. while weak currencies tend to stimulate exports because exports are relatively cheaper. although the world bank encourages prudent currency devaluation as a policy to discourage excessive imports and overdrawn reserves, reckless devaluation as in the case of uganda, ghana, guinea, zambia, mozambique, tanzania and, to some extent, nigeria between 1980 and 1990 is very detrimental to the economy. it is beneficial to discourage excessive consumer importation. however, in many instances, african countries' imports have heavy development and industrial inputs contents. the more expensive these inputs are the costlier and more difficult it is to achieve meaningful development of basic infrastructure and industrialization. a realistic trade model for africa consider the changes in environmental factors demanded in the african growth and opportunity act (agoa), rapid increases in per capita income, exchange rate and labor productivity. such a model must reflect the fact that low income, limited production capacity and exchange rate misalignment can reduce african countries' capacity to export to the us market. two models are specified, respectively for the us imports and exports to selected african countries respectively. these are: log(e...) = ao + a1log(y.) + a21og(l.) + a3iog(er.) ij (i) log(eu.) = po + p,log(y,.il.,) + p2iog(y.il.) + p3iog(er.) + v (2) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 213 e..u represents the african colmtry's export to usa and e..a represents us export to african country. va and la represent the african country's gdp and population, respectively. the variables with subscript u refer to usa. equation (1) assumes that any african country can export as much as it wishes to, provided it has the capacity to produce. however, equation (2) assumes that us exports to any african country may face demand constraints unless per capita income is high and the exchange rate is properly aligned. for meaningful trade to take place, 0.1 and p2 are assumed to be positive and must be at least equal to unity. where constraints exist the coefficients are numerically less than unity, 0< 0.10 p2 < i. 0.3 and p3 may also be positive and numerically less than unity where demand or supply constraints exist. where no such constraints exist, african countries will have the capacity to generate exports and adequate capacity to purchase us imports and therefore can use exchange rate policy to increase exports and reduce the flow of imports. the empirical results however show that, except for nigeria (dominated by the country's petroleum export) and senegal 0.( is generally less than unity. and except for congo, ethiopia, morocco, nigeria and senegal, p2 is less than unity. the estimated constraint elasticity is shown in table 3. the results indicate that there are potential supply and demand constraints in the countries concerned. table 3 elasticity of trade constraint with respect to income and the excbange rate export to usa import from usa 0.1 0.3 bl 6j botswana 0.157 6.601 0.197 3.441 cameroon -0.354 -2.222 -0.222 2.992 congo -1.333 1.444 1.623 -0.459 cote d'ivoire -1.731 0.214 -0.302 2.480 ejoo)t -0.257 1.622 0.433 2.817 ethiopia 4.691 2.886 1.391 3.914 ghana 0.179 0.069 0.745 -0.1l0 morocco 0.690 -1.590 1.042 0.982 nigeria 1.114 1.279 1.732 0.218 senegal 2.724 -2.593 7.323 -5.882 south africa -0.408 2.292 0.791 2.780 tanzania 0.802 2.587 -0.981 3.633 two public policy conclusions can be made on the basis of this study. firstly, some of the countries considered in the study face severe supply constraints and others both supply and demand constraints. these constraints appear to be due to the low per capita gnp and low labor productivity. however some countries, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 214 sajems ns vol 5 (2002) no i like the congo, ethiopia, nigeria and senegal, for some inexplicable reasons appear to have a high propensity to import us goods even though they have low per capita gnp. due to the perceived constraints, it does not appear that currency manipulation can be successfully used to stimulate export expansion or to reduce the flow of imports. in order for the united states to increase exports to the region, per capita income will have to be considerably increased. excessive trade liberalization policy in africa may be more harmful to the african economy and in tum jeopardize the us export promotion policy. excessive external imbalance may be as harmful to the african economy as it may be to the american export sector. if the us wishes to export more to the african market, it will surely be in the us's interest to promote policies to enhance income growth in africa. such policies include debt relief, direct foreign investment and technology transfer. similarly, african countries wishing to export must adopt a wide range ofintemal policies to boost domestic production by accelerating the rate of capital formation, increase efficiency and labor productivity and avoid overvalued currency. they must also be aware that the rampant and widespread corruption and the lack of transparent governance discourage direct private investment and genuine technology transfer and thereby militate against real income growth. statistics show that many african countries are plagued by inflation, which reduces the purchasing power of the local currency. policies to stimulate domestic output will have to include policies to control inflation, enhance efficiency and stabilize currency value. 5 suggested direction for us trade and investment in africa in the 21 st century and beyond the data we have reviewed show that total us exports of manufactured products to africa in 1990 was $5 589 million, $1 569 million of which was shipped to south africa and $7.133 million in 1996, $707 million of which was shipped to egypt. us exports of agricultural products in 1990 were $1 857 million and $2 712 million in 1996. on the other hand, us imports of manufactured products totaled a mere $2 464 million in 1990 and $3 338 million in 1996, while imports of agricultural products were $645 million and $903 million in 1990 and 1996 respectively. table 4 throws more light on the growth and pattern of us trade with selected african countries, which have bought at least $100 million per annum of a combination of manufactured and agricultural products from the united states between 1990 and 1996. based on a 1990 level of trade. algerian and nigerian exports to the us fell in 1996 and imports from algeria and morocco also fell. the table also shows that egypt and south africa play the most significant role r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 215 in the us trade with africa. although the united states corporations export almost as much to egypt in per capita terms as they export to south africa, us corporations import only a paltry $3.84 per capita from egypt in combined manufactures and agricultural products. the lob-sided us trade with south africa is accounted for, in part by per capita gdp in south africa and the us investments in south africa. table 4 country algeria cote d'ivoire egypt morocco nigeria south africa tunisia average usa growth and per capita distribution of us trade to africa 1990-96 1992 total per total per growth in trade pop import capita export capita '90-'96 (mhhon) ($m) import ($m) export import export $ $ (sm) 26.3 1 .04 626 23.80 -500 -326 12.9 165 12.79 83 6.43 197 62 54.7 210 3.84 2,964 54.19 283 904 26.2 108 4.12 433 11.96 130 -19 101.9 46 0.45 982 9.64 -52 265 39.8 1,468 36.88 2,329 58.52 611 '1380 8.4 29 3.45 165 19.64 36 12 12.22 26.31 255.4 2,975 11.65 9369 36.68 source: us department of commerce, 1996 during 1992, the united states imported about s12.oo worth of manufactured and agricultural products from and exported approximately $26.00 worth of manufactured and agricultural products per capita to africa. on the other hand, the distribution of african trade with the usa ranges from a low $.04 of exports per capita from algeria to $36.88 per capita from south africa. in 1992, the usa exported the least in manufactured and agricultural products to cote d'ivoire. that year usa exported $6.43 per capita to cote d'lvoire and $9.64 per capita to nigeria. most us exports went to south africa, about $58.52 per capita, followed by egypt with $54.19 per capita. leaving out algeria and nigeria, this means that the united states imported $12.22 per capita worth of manufactured and agricultural products from every african man, woman and child in 1992 and sold approximately $26.31 per capita worth of manufactured and agricultural products during that year. in the past, the united states corporations have tied their direct investment in africa to their raw material needs. the african growth and opportunity act r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 216 sajems ns vol 5 (2002) no i passed by the us congress and signed into law on may 18, 2000 encouraged african political leaders to hope that there is an intention to broaden the scope of us trade and investment in africa. although there is considerable controversy over the true intents, the act has ostensibly emphasized the need for structural reforms and the eradication of corruption as means of attracting direct foreign investments to africa. american corporations should therefore be encouraged to conduct their trade in such a way as to serve not only the needs of their manufacturing industries, but also to help african-based corporations to effectively use and expand their production potential. in fact, the us government can adopt policies that could encourage us corporations to invest in sectors where available resources show that the benefits of comparative advantage could be exploited. using the per capita imports and exports in table 4 as a planning target for the next ten years, the major us corporations could assist their trading partners in africa to raise their combined exports of manufacturers and agricultural products to between $12.22 and $26.31 per capita. in turn such countries would be able to purchase at least $26.31 per capita worth of manufactured products from the usa, including industrial raw materials and inputs for infrastructural development and agricultural products. international trade theory asserts that by enhancing income growth in the importing country, the exporting country can in turn hope to export even more. if there is a will, the united states corporations have the technology and the resources to invest in selected sectors in africa, to promote their interest and also expand the manufacturing base and enhance income growth in africa. they should not limit their investment interest to the mining and petroleum sectors, but invest in all other sectors where comparative advantage exists and new technologies can be acquired. trade expansion by african countries is not the responsibility of the united states alone. the united states companies have shown interest in importing agricultural products such as cocoa, coffee and sugar from africa. although the us demand for' nigerian cocoa has been declining over the years, the us demand for natural rubber has been increasing. american companies have also shown interest in buying cotton fabrics, furniture and spices from egypt and a broad range of manufactured products from south africa. african countries should do more rather than less in encouraging us corporations to buy their exports by ensuring that they remain competitive in product quality and pricing. with regard to foreign direct investment, african governments must do more to render their countries more attractive for foreign investment if they wish to encourage american companies to invest in their countries. they must do more to eradicate corruption and revamp their inefficient social infrastructures that render many african countries risky and the cost of business too high. rather than being indecisive about the true intent of multinational corporations, they r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no i 217 must realize that the ultimate conducts of the multinational corporations are dictated and encouraged by the conduct of the citizens and businesses in africa. where the laws are enforced, the multinational corporations will obey thern. therefore these corporations should be invited to invest in such sectors as power generating plants and conununications network and other key sectors, a means of reducing the bottlenecks in every sector of the economy. they must also do more to liberalize their economies and remove artificial subsidies that make it difficult to determine the true costs of doing business. references amueoo-dorantes, c. & pozo, s. (1997) "exchange rate volatility and economic growth" (paper presented at the midwest economics association annual meeting: kansas city, march. 2 asheghian, p. & saidl, r (1993) "real exchange rate variability and ldcs exports" (unpublished). 3 eaton, j. & gersovitz, m. (1980) "ldc participation in reply to: international financial markets, debt and reserves", journal of development economics, 7: 3-21. 4 esfahanl, h.s. (1991) "exports, imports and economic growth in semi-industrialized countries", journal of development economics, 35: 93-116. 5 feder, g. (1982) "on exports and economic growth", journal of development economics, 12: 59-73. 6 gyimah-brempong, k. (1991) "export instability and economic growth in sub-saharan africa", economic development and cultural change, 39(4). 7 jiang, r. (1997) "export structures and economic growth" (unpublished). 8 london, e. (1997) "trade liberalization with a fixed exchange rate", the international trade journal, xi, no 2, summer. 9 mathieson, d.j. (1989) "exchange rate arrangements and monetary policy", finance & development, march. 10 onafowora, oa & owoye, o. (1998) "trade liberalization and economic growth nexus: issues and evidence for sub-sahara africa" unpublished. 11 rana, p.b. (1988) "exports, policy changes and economic growth in developing countries after the 1973 oil shock", journal of development economics, 28: 261·264. 12 sheehey, e. (1990) "export and growth: a flawed framework", journal of development economics, 27(1). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 218 sajems ns vol 5 (2002) no 1 13 tyler. g. (1981) "growth and export expansion in developing countries: some empirical evidence", journal of development economics, 9(1). 14 us department of commerce, international trade administration (various years), u.s. foreign trade highlights. 15 us department of commerce (1998) "us direct investment in africa", on line: www.sadc·usa.netltradelustrade/direct96.html. 16 (1998) "get the facts", on line: www.usafica.orglfactlustrade.html 17 us trade task force (1997) "us must not marginalize tradel1nvestment with africa" http://www.usiso israel.org.i1/publish/press/trade.archive.html. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 3 the reaction to globalisation "true believer"? fj scholtz department of economics, university of pretoria a case of the jel b 25 le ciel est vide, fa terre livree a fa puissance sans principles. albert camus in "les deicides" introduction when the editorship started planning this special issue some 18 months ago, there were in excess of 700 titles on the topic of globalisation available on the website of amazon.com. the decision to devote an entire issue of sajems to globalisation did not flow from a need to investigate a new field in the political economy, but was rather intended to contextuaiise the effects of globalisation for the southern african region. and indeed, as work on the issue progressed, international interest in globalisation has heightened rather than waned. it is a near impossible task to present an entirely representative overview of all the divergent opinions on globalisation, or to suggest the solutions to the fundamental shortcomings of the current tide of increased integration. hopefully, a general perspective of the dimensions of globalisation is provided. these dimensions include a general background, the demographical and political dynamics of globalisation, a few trade and financial-flow perspectives, some regional aspects and, finally, the domestic considerations to be taken into account. a new force flouncing this earth globalisation means different things to different people. the term entered common usage in the 1980s, but has increasingly been punted as the golden key to future economic development since the early 1990s, in the period immediately superseding the cold war. as if yet another propaganda blitz, it has swept across the globe and on to the agendas of policy-makers and governments the world over. since then, it seems that nobody was awarded the luxury of a neutral stance on globalisation: it impacts on everyone and everyone r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . ii sajems ns vol 4 (200 i) no 3 seems strongly opinionated about it. one is reminded of the words of shakespeare in julius caesar: there is a tide in the affairs of men which, taken at the flood, leads on to fortune; omitted, all the voyage of their life is bound in shallows and in miseries. on such a full sea we are now afloat, and we must take the current when it serves, or lose our ventures. the effects of globalisation were apparent almost from the onset of increased trade integration. but it has failed to impact by equal measures on all of the nations of the world. the immediacy (and the uneven distributive powers) of globalisation prompted a strongly positive response from those on the receiving end. thus yet another world divide emerged those in favour of globalisation and those vehemently opposed to the concept of "the global village". initially, the consensus bad it that the effects of globalisation were inexorable. the proponents argued that globalisation is a decidedly beneficial process that, through increasing integration of economies around the world by effecting unrestricted trade and financial flows, will enable economies to focus on efficiency, allowing the world to shift economic activity from failing areas to more successful ones. heightened efficiency in global production should, at least in theory, benefit all. others (the dissident voices) argued that globalisation only serves one (or at least then, only a few) master(s). in their view, globalisation feeds on the inherent inequalities in human capacity prevailing amongst different nations, thereby hampering the unfettered diffusion of technology across borders. consequently, this tree of good and evil bears its fruit unevenly, with some nations experiencing unprecedented abundance and with others, who are understandably indignant, caught in the famine of a severe poverty trap. with the us emerging victorious from the cold war, the dissidents claimed that it had used the cold war to race ahead in virtually all fields of applied technology, creating a position of near totalitarian global technological control, or a "technopoly" as termed by the american writer neil postman. also, throughout the nineties we have witnessed a world reeling from the aftermath of the financial crises in russia, south-east asia, mexico, brazil and presently in argentina. these were in most part brought about by the free flow of capital caused by globalisation. south africa too is no stranger to the impact of the fickle global investor sentiment on a freely tradeable currency. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (200 i) no 3 iii hence the growing outcry for "managing" the effects of globalisation, with the core of the present debate seemingly focused on the unequal development brought about by globalisation and especially its effect on the developing world. finally, the once inevitable and irreversible consequences of globalisation are being questioned or, at the very least reconsidered, by both camps alike. "there is nothing new under this sun" globalisation in its simplest form implies ever increasing levels of economic integration. economic integration as such is no new phenomenon. historically, this process usually manifested in some form of regional co-operation. european economic co-operation for instance dates back some 700 years. and whenever there was co-operation of an economic nature, there was a "downside", with dissidents clamouring for protection. the french economist frederic bastiat (himself an ardent believer in the distributive power of undisrupted competition) often derided the voices favouring protection. in his fallacies oj protection from the sophismes economiques (first published in 1845), he used the following satirical analogy for such a purpose. the excerpt is from the candlemakers' petition to government for protection against a very powerful trade rival: we are suffering from the intolerable competition of a foreign rival, placed, it would seem, in a condition far superior to ours for the production of light that he absolutely inundates our national market with it at a price fabulously reduced. the moment he shows himself our trade leaves us all consumers apply to him; and a branch of native industry, having countless ramifications, is all at once completely stagnant. this rival who is no other than the sun, wages war to the knife against us,... (translated by a. goddard, 1964: 60,61). what does make the present debate unique is that it seems, at first glance at least, to have transcended ideological divides. the burial of communism in eastern europe in 1990 and in mother russia shortly thereafter, seemed to have united the world on the virtues of the market system. however, globalisation has developed into a highly pragmatist creature making its own rules as it goes along. a series of incongruous policies attempt to transform the familiar features of the (free) market system. global multinational firms utilise their technical prowess to pinpoint the best spots across the globe for their pursuit of ever-increasing profits. their products are thoroughly globalised; their parts made in factories across the globe. but r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . iv sajems ns vol 4 (2001) no 3 these locations are chosen for mainly two reasons: cheap labour and lax environmental regulations. there is a free flow of tradeable products and capital across nations, in line with the growing allegiance to a global market system. however, the tougher immigration laws imposed by global leaders cause significant restrictions on the unencumbered flow of human resources across national borders. but with every new restrictive legislative measure imposed, these corporate giants and governments alike hone the weapons of the anti-globalisation protesters. the protesters' ultimate target: international organisations like the world economic forum, the world trade organisation, the world bank and the international monetary fund that have come to personify all of the evils associated with globalisation to its critics. what started off as mutterings of dismay amongst the critics of globalisation, had grown to a cacophony of discontent. the dissidents of globalisation had started to mobilise. in an astonishingly brief period, a new force emerged. anti-globalisation protesters staged demonstrations at every meeting of these multinationals. however, these once peaceful demonstrations rapidly mutated into mass displays characterised by increasingly violent tendencies. the movement dubbed themselves "anti-capitalism activists". the first time that the world took notice of such protests were probably in geneva in may 1998, when gatt's 50th anniversary was celebrated by its. successor, the wto. one of the guest speakers at the time was former president nelson mandela. in his address at the united nations' palais des nations, he remarked on globalisation: "it's a process we have to accept and adjust to (business report, may 20 1998). the protesters this time were farmers and development groups who maintained that "the wto and free trade are a plot against the poor" (ibid.). this protest could easily have been written off by the international community as akin to the petition of the candlemakers for protection against "unfair competition". but after geneva, the protests assumed a distinctly different nature. demonstrations became riots. protests were evidently well-organised, concerted in their focus to force the world, by whatever means necessary, to yield to their demands. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 3 v a known ogre with a not so unfamiliar face? protests once again occurred at the beginning of 1999 at the annual meeting of the world economic forum in davos, switzerland. this was met with fully fledged protests by "anti-capitalism activists". resistance by police led to clashes between them and the protesters, leaving several injured. this event was followed by mass disruptions at the meeting of the wto in seattle in december of the same year. another similar disruption occurred in melbourne in august of 2000. to this point, all of the meetings at which the protests were staged, finished on schedule amid heavy protection of delegates by the riot police (the weekly telegraph, october 4-1 0, 2000). in october of 2000 however, the protesters claimed their fir.st victory at the annual meeting of the imf and the world bank in prague. violent street clashes between 12 000 protesters and riot police which, this time, came to within 50 yards of the meeting left 158 injured and led to the assured marring of the proceedings. this time around, the protests triggered an exodus of the imf and world bank delegates, most of them fearing physical hann. similar riots, meanwhile, took place on may day of 2000 and 2001 a day historically associated with distinctly socialist ideologies. these protests united the "anti-capitalist" movements across the globe (weekly telegraph, 10-16 may 200 i; pretoria news, may 2 2001), with the common denominator amongst them being the fight against global capitalism. in 2001, the may day protest rallies swept across cities around the world including london, berlin, frankfurt, zurich, sydney, melbourne, oslo, taipei, hong kong, harare and in south africa in cape town, durban, johannesburg and pretoria (pretoria news, may 22001). henry kissinger reflected in his white house years: "history is not, of course a cookbook offering pretested recipes. it teaches by analogy, not by maxims. it can illuminate the consequences of actions in comparable situations, yet each generation must discover for itself what situations are in fact comparable" (1979: 54). curiously enough, a middle-aged czech woman remarked with disdain when asked about her perceptions of the protesters of october 2000: "the only hardline communists these days are people from wealthy western countries" (the weekly telegraph, 4-10 october 2000). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . vi sajems ns vol 4 (2001) no 3 the "true believer" eric hoffer defined the "true believer" in the preface of a 1951 publication by the same title as " ... tbe man of fanatical faith who is ready to sacrifice his life for a holy cause .. :'. the book deals with the features of mass movements. he continues on mass movements: all mass movements generate in their adherents a readiness to die and a proclivity for united action; all of them irrespective of the doctrine they preach and the program they project, breed fanaticism, enthusiasm, fervent hope, hatred and intolerance; ... (ibid.). the "anti-capitalism" protesters clearly belong to such a mass·movement. one cannot help but to doubt the motives of this movement. it focuses on the "plight of the poor". it proclaims that governments are not powerless against the global capitalism a belief that even the proponents of globalisation are now subscribing to (economist, 23 september 2000: 17). but these protesters are most certainly not peasants. nor are they, ironically enough, greatly impoverished as a consequence of globalisation. they are therefore not from the so-called "smaller, more vulnerable economies". after the events in prague, a lot was written about their true origin. one report remarked that they were loose-knit groups united for the short-teon purpose of discomforting the world's rich and powerful. but they are largely composed of highly educated offspring of the wealthy rejecting the ways and wealth of their parents. in the same report, one of the organisers of the prague protest, a nottingham university graduate, acknowledged that they drew their strength from the middle classes of western europe and north america. in his words: "working people don't have the benefits of and educational system and they are afraid of losing their jobs" (weekly telegraph, 4-10 october 2000:16). they are by own admission "revolutionaries". this bears a disconcerting resemblance to the "professional revolutionaries" referred to by lenin in what is to be done? the longer the protests continue, the more one starts to recognise the face of marxism. however, it is marxism with a make-over. hoffer contends that any revivalist movement is more dangerous than the classical doctrine it is based upon. he argues that every revivalist movement is chiefly driven by the fanaticism of the true believer: "for though ours is a godless age, it is the very opposite of irreligious. the true believer is everywhere on the march, and both by converting and antagonizing, he is shaping the world in his own image" (1951: 10). this brings to mind the quote by albert camus at the beginning: "heaven is empty, the earth given up a to a force without principles". r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 3 vii "communism is dead, long live the communists!" the appeal of classical marxism to the developing nations of the third world has never been surprising, except perhaps to marx himself. marx had thought russia to be one of the most unlikely places to experience a socialist revolution, due to its low level of industrial development at that stage. marx argued that a socialist revolution is an evolutionary process driven by industrial change. on this kissinger remarked that: by one of the ironies of history, marxism has proved attractive to developing nations not because of the economic theory on which it prides itself but because it has supplied an answer to the problem of political legitimacy and authority a formula for social mobilization, a justification for political power, a means of harnessing resentment against western cultural and political dominance (1979: 69). lenin of course proved marx wrong on a socialist revolution in russia by making it happen in the former ussr. in a way, lenin had redesigned classical marxism when implementing its doctrines in the former ussr. as hoffer explained, a revivalist movement always feeds on the fanaticism of its supporters rather than the discipline of the doctrine it subscribes to. marx himself expressed discontent with this characteristic of mass movements, claiming to be his would-be disciples, when he exclaimed towards the end of his life: "as for me, i am no marxist!" (mclellan, 1983: 182). the appeal of socialism to developing nations is seated in its promise to generate greater wealth than capitalism and to spread that wealth in a more equitable fashion. anthony giddens, one of the ardent promoters of a new social democracy, and himself a believer in "managing globalisation", also highlighted this as the possible reason for the appeal of socialism in the third way, published in 1998. the present revivalist movement poses a greater danger to future prosperity than classical marxism. the anti-capitalism activists claim to promote a more fair distribution of resources. john rawls highlights economic freedom, the very freedom being restricted by these protests, as the most important prerequisite for distributive justice in the economic sense in a theory of justice (1971: 273). the real danger of this present revivalist movement insofar as it limits economic freedom, however, lies in its ability to block the effects of technological progress on economic integration, thereby derailing progress that have already been made and its benefits to especially the developing world. innovation (or technological progress) would be hard to force to a halt (though history serves r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . viii sajems ns vol 4 (200 i) no 3 several accounts proving that it is not impossible), but the benefits of technological progress in the form of productive employment opportunities and ultimately higher living standards to the developing world can be blocked more easily. in an article in the economist, the author aptly summarises the true nature of this threat: international economic integration is not an ineluctable process, as many of its most enthusiastic advocates appear to believe. it is only one, the best of many possible futures for the world economy; others may be chosen and are even coming to seem more likely. the protesters are right that governments and companies if only they can be moved by force of argument, or just by force have it within their power to slow or even reverse the economic trends of the past 20 years (economist, 3 september 2000: 17). references i giddens, a. (1998) the third way, london: polity press. 2 hoffer, e. (1951) the true believer, new york: the new american library. 3 kissinger, h. (1979) the white house years, london: 4 lenin, v.i (1975) what is to be done? peking: foreign languages press. 5 mclellan, d. (1983) karl marx: the legacy, london: british broadcasting corporation. 6 marx, k (1888) the communist manifesto, (samuel moore translation), london:hazell watson & viney ltd. 7 the economist (2000) "the case for globaiisation", 356 (8189), september 23: 17-18. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 the role of mining in the south african economy jobannes fedderke and farab pirouz' econometric research southern africa and school of economic and business sciences, university of the witwatersrand abstract this paper examines the contribution of three aggregate mining sectors of the south african economy to output and ~ployment over the 1970-97 period. the fmding of a declining importance of mining in output and employment creation must be sectorally differentiated. gold and uranium mining is the chief source of these declines, while evidence for coal and diamond and other mining is more modulated. we find strong redistribution of output from equity to labour over the course of the 1990s for gold and uranium mining. in mining labour markets, we present developments in employment trends, in real labour cost, and in labour productivity. we examine links between these dimensions in an explanation of changing employment trends. we conclude with a vecm estimation of a labour requirements equation to corroborate our fmdings. jelq30 1 introduction conventional wisdom views the mining sector of the south african economy as its quintessence. as contributor to aggregate output, as foreign exchange earner for the economy, as employer, and as a generator of tax revenues, mining has often been viewed as the locomotive of south africa's economic development historically such a perception certainly carries much validity. in this paper we examine whether this perception of the role of mining in the south african economy remains justified and to what extent the role of mining in the economy has changed. various sources have noted the declining contribution of the mining sector to gross domestic product (gdp) and employment in south africa.2 we focus on output and employment since they have the most immediate and dramatic welfare impact on the south african economy.] the mining industry r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 2 sajems ns vol 5 (2002) no i has been declining both in tenns of its importance as an employer relative to other sectors in the economy, and in tenns of the absolute level of employment that it provides. such job losses have largely affected unskilled workers. we examine possible reasons for the declining importance of mining as an employer. one immediate candidate is the declining level of value added generated by the mining sector that could translate into a declining demand for labour. examination of the evidence suggests that, at best, output levels are a partial explanation of declining employment trends in the mining sectors. the decline in the share of mining in total output of the south african economy has been far more dramatic than the share of mining in the total formal sector employment of the economy. two further possible explanations for employment trends in south africa's mining sectors are therefore examined: real labour cost and real labour productivity. exploratory examination of the evidence suggests that real labour cost for all three mining sectors demonstrates the negative correlation with employment that economic theory would predict. increases in real labour productivity have not been sufficient to warrant the increases in real labour cost observed for the mining sectors, nor have they been justified by an increasing skills mix of the mining sector's labour force. finally, prices are unlikely to feature as explanations of employment trends in these sectors. the role of mining in the economy has thus become more modulated. whereas in a few of its traditionally pivotal roles it remains in much the same position, in most areas it is considerably less important than it used to be. mining in the south african economy has been in a process of profound transformation for a period now spanning well over two decades. such transformation of the role of the mining sector should be seen as a natural process. any economy that considers itself on a developmental trajectory would experience diversification of economic activity over time. the investigation that follows contains two sections. in the first, we examine the contribution of the aggregate mining sector to the total output of the south african economy. in the second, we explore the role of mining in the south african labour market. a final section concludes. whereas aggregate data on the south african mmmg sector was readily available, more detailed data for certain sub-sectors was more difficult to collect. readers should bear in mind that while providing additional information, the use of a range of different data sources is likely to bring about some loss in consistency. details about the data used in the different sections of the document and its description are presented in a summary of data sources in the appendix. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no i 3 2 the contribution of the mining sector to aggregate output of the south african economy this section explores the details of the declining relative and absolute importance of mining in terms of its contribution to aggregate output over the 1970-98 period. the three aggre,ate mining sectors: coal, gold and uranium, and diamond and other mining are analysed in terms of their contribution to total value added in the south african economy, total tax revenue, and export earnings. a final subsection investigates the distribution of output between the factors of production employed by the three mining sectors. 2.1 tbe importance of mining in terms of its contribution to value added in tbe soutb african economy in this section we examine the contribution of the mining sector to south african output in terms of the real value added contributed by the three aggregate south african mining sectors. as such our concern is with the net contribution of the mining sectors to aggregate output in the south african economy, rather than with the aggregate volume of sales of the sector.s over the 1970-98 period, the proportional contribution of the mining sector to total value added in the south african economy has more than halved, declining from 21.3 per cent in 1970, to 9.9 per cent of the private sector's gdp in 1998see the evidence of table 1. the strongest decrease in the proportional contribution of mining to total value added of the economy occurred during the 1970-75 period. while the decrease continued thereafter, it has been at a far slower rate. it is noteworthy that it is the service sector that has increased its proportion of gdp to over 45 per cent after 1995, primarily at the expense of the mining sector. table 1 contribution to private sedor gross domestic product by economic sector 1970 1975 1980 1985 1990 1995 agric, forest and fish 5.4 5.4 5.7 5.4 6.1 5.3 total mining 21.3 13.9 13.3 13.0 11.3 10.5 total manufacturinj:t 27.5 30.1 32.8 29.4 29.6 29.3 electricity, gas and 2.6 3.1 3.6 4.6 5.1 5.6 water building and 5.5 6.3 5.0 4.4 4.0 3.4 construction services 37.8 41.1 39.6 43.2 43.9 45.9 note: figures are m percentages, and may not add up due to roundmg 1998 6.4 9.9 28.3 5.9 3.3 46.3 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 4 sajems ns vol 5 (2002) no 1 in order to obtain a closer understanding of the declining relative importance of mining in the economy, table 2 depicts the proportional contributions to gdp of the three principal mining sub-sectors.6 table 2 contribution of the three principal mining sectors to private sectorgdp 1970 1980 1985 1990 1993 19fcoal 1.1 1.5 2.7 2.0 1.5 1.9 gold and uranium 17.2 8.4 7.1 5.7 7.3 4.1 diamond and other 3.0 3.3 3.3 3.6 3.0 3.1 total 21.3 13.3 13.0 11.3 11.8 9.9 note: figures are percentages, and may not add up due to roundmg what emerges from the evidence is that the declining importance of mining as a proportion of total output in the economy is chiefly attributable to the declining importance of the gold and uranium mining sector. while still contributing 17.2 per cent of the private economy's output in 1970, its proportional contribution to private sector gdp had fallen to 4.1 per cent by 1998. the two other aggregate mining sectors marginally increased their relative share of private sector gdp in the same period to 1998.7 of course, a declining relative importance of mining does not have to entail a declining absolute importance. a falling proportion to total value added in the economy is consistent with rising absolute contributions to value added in the economy. it is therefore important to note that the decline in the importance of gold and uranium mining in the south african economy, is not only one of a declining relative importance but also one of falling absolute output levels in real terms when computed in terms of sectoral deflators (see figure i). second, while the decline in gold and uranium mining bas been dramatic, it has also been relatively unidirectional, with few reversals in the decline of absolute output over time. note that the decline in gold and uranium mining is likely to have been due to structural factors in the sector, rather than changes in the gold price. since the gold price has shown both sharp increases, and sharp decreases in us-dollar terms over the sample period, it is difficult to argue that the monotonically declining value added of the gold mining industry is due to changes in the gold price. figure 2 illustrates. the gold price in rand terms has due to the depreciating exchange rate steadily increased over the period 1970 to 1998, particularly after 1992. hence, the gold price does not serve as a convincing explanation for declining output in gold and uranium mining. the observed r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 5 fall in the rand gold price from 1996 to 1997 by 8.6 per cent may have contributed to the recent dramatic output decreases. figure 1 gold and uranium mining: comparison of real output deflated by sectoral and aggregate gdp deflators ! ,.,., n ; """ l .. j , ... " .... ... figure 2 gold price in us-dollar and south african rand i ~ l..-oii'*i price in u5-ooiiar i .. l.oo-.ii'*i price in rand .. 1970 1m 'if,. 1m 1m 191!jo 1982 1884 1988 1988 1890 1892 '894 ,_ 1_ the preceding analysis is based on real value added produced by the three aggregate mining sectors of the economy, computed on the basis of the sectoral gdp deflator. use of sectoral price deflators does not offer much insight into whether the output of the sector in question has risen in purchasing power r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 6 sajems ns vol 5 (2002) no i relative to other sectors in the economy. in order to establish the sensitivity of our results to the use of sectoral price deflators, we also deflate nominal value added by the three principal mining sectors in tenns of the aggregate (economywide) gdp-deflator. only for the gold and uranium mining sector does a significant difference emerge between the two means of deflating. figure i iiiustrates.s in contrast to the real output series that uses the sectoral gdp deflator for gold and uranium mining, which generates a consistent decline in real output of the sector, the aggregate gdp deflator suggests periods of both expansion and contraction for gold and uranium mining. in terms of the gdp deflator, real output of the sector rose through to the early 1980s, but has declined ever since. the reason for this lies in the gold price bubble of the early 1980s which raised the purchasing power of the sector relative to the rest of the economy. despite this difference the suggested pattern of development in real output obtained from the two gdp deflators through the course of the 1980s and 1990s is much the same, with a consistent decline in real output reported in both series, and with both series reporting very similar levels of real output through the course of the 1990s (the correlation coefficient between the two series is +0.71 over this period). the main source of difference between the two output series for gold and uranium mining is thus that the negative growth rate in real output based on the aggregate gdp deflator since 1980 has been more dramatic than the sectoral gdp deflator would imply, with an associated decrease in the purchasing power of gold output in the economy. use of the alternative deflators does not change the principal fmding of our analysis: that real output of gold and uranium mining has been falling over the 1980-97 period, while that of coal and diamond and other mining has been rising over the same sample period. for the purposes of the analysis to follow we will employ real output as computed by the sectoral deflator. the principal finding to emerge from the analysis is that an understanding of the contribution of the mining sector to south africa's aggregate value added must be sensitive to the differences that arise between the aggregate mining sectors. while the mining sector's contribution to net value added in the economy has declined, this is due to the declining contribution of gold and uranium mining, and not due to developments of the mining sector as a whole!}. on the other hand, the evidence of a declining contribution of the gold and uranium mining sector to absolute output, and a rising contribution of the coal and the diamond and other mining sectors, should be tempered by the fact that the gold sector still dominates the total mining sector output. the contribution of gold and uranium mining to total mining output stood at 80.9 per cent in 1970 and, while having declined to 46.5 per cent by 1997, it still represents the single largest sector in the south african mining industry. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no i 7 2.2 contribution of tbe mining industry to total tax revenue of the south african state in concert with the decline in net output of the mining sector, the contribution to total tax revenues of the mining sector has been declining also. in table 3 we illustrate the contribution of revenue from the three aggregate mining sectors as a proportion of total tax revenue of government. the vast majority of tax revenue to emerge from the mining sector is due to gold mining. however, after peaking in the early 1980s (principally due to the gold price peak in the early 1980s), tax revenue from gold mining has declined sharply, and it now contributes only approximately i per cent of total government tax revenues. table 3 average proportional contribution to total tax revenues by aggregate mining sector, by decade (figures are percentages) 1970sav2 1980sav2 1990sav2 coal 0.29 0.52 n/a gold and uraniwn 10.02 12.51 1.13 diamond and other 1.45 0.56 0.09 2.3 the open economy context the preceding discussion has revealed a declining importance for the mining sector in the aggregate south african economy. in table 4 we report average annual export earnings by the principal (sic two digit) sectors of the south african economy. the most dramatic growth in export earnings attaches to the manufacturing sector, particularly during the course of the 1990s. the mining sector nevertheless remains the largest single exporter of the south african economy on average, even during the course of the 199os.1o r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 8 sajems ns vol 5 (2002) no 1 table 4 average annual export earnings per decade by principal economic sectors agric, forest and fish total mining total manufacturing electricity gas and water building and construction services note: figures are in nominal r millions, since aggregate deflators for exports are not available. percentage contributions in brackets. tables average addual det export earnings per decade by principal economic sectors 1970sav2 1980sav2 1990savg awic forest and fish 410 693 2697 total minin2 2971 18546 38585 total manufacturin2 -2903 -13096 -36857 electricity gas and water 1 35 135 buildin2 and construction -8 -15 -71 services 354 1397 6408 .. note: figures are m r milhons; pos1tive magrutudes mdlcate net exports, negative magnitudes net imports. similarly, an examination of the net export earningsll of the principal economic sectors of the south african economy further demonstrates that mining has consistently been the largest net earner of foreign exchange of the economy. by contrast, south africa has been and remains a large net importer of manufactured goods and services. table 5 illustrates. the evidence thus points to the importance of the mining sector as a net exporter and hence earner of foreign exchange in the south african economy. despite its declining contribution to output in relative and absolute terms mining continues to be a vital component of the economy. nevertheless, the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no i 9 evidence also shows that other sectors, particularly manufacturing, have shown an increasing capacity to generate forex earnings. 2.4 distribution of output strong changes also emerge in tenns of the distribution of the value added produced within the three aggregate mining sectors between the two factors of production employed by the sectors: capital and labour. in order to decompose the value added of the sectors into the earnings of the two factors of production, we graph the real wage bill and net operating surplus (gross operating sutplus minus depreciation) as fractions of real gdp over time. figure 4 reveals a strong upward trend of the wage proportion for the gold and uraniwn mining sector since the mid-1980s. also, for gold and uraniwn mining net operating surplus diminished steadily to a small proportion (4 per cent) of real output in 1997. factor shares for coal mining and diamond and other mining remain relatively constant over time, despite some cyclical fluctuation see figures 3 and 5. only in gold and uraniwn mmmg has organised labour therefore been successful in appropriating a larger share of value added over time. the associated decrease in the share of value added attaching to equity may go some way toward explaining the declining investment propensity in the gold and uraniwn mining sector noted elsewhere,12 and the increased importance of efficiency improvements in the output growth of the mining sector. 13 finally, the increased bargaining power of labour in the gold and uraniwn mining sector and the related real cost increases in labour should serve as a first indicator of likely explanations in employment trends in the sector. we elaborate on this subsequent sections. 14 as will become clear from a subsequent section, the sharp change in the proportion of net value added paid to labour will come to be strongly correlated with changes in the employment trends of the gold and uraniwn mining sector. the proportion of value added that can be explained in terms of the real wage bill and net operating surplus, has declined from over 90 per cent to around 80 per cent for coal and diamond and other mining, and even lower (71 per cent) for gold and uraniwn mining. the remainder is attributable to depreciation expenses on the capital stock. since all three mining sectors have become more capital intensive over the 1970-97 period, depreciation costs have grown over time. the evidence suggests that the south african mining sector bas been subject to strong change over time, particularly the gold and uraniwn mining sector. the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 10 sajems ns vol 5 (2002) no 1 strong change in the distribution of net value added between capital and labour observed in the 1970-97 period pictures mining as a maturing sector in transition. figure 3 coal mining: distribution of output between factors of production o.s ..... 0.7 m 0.1 ° m"n~u~~n~n~~rmm~~m~s~~r~~~.~ figure 4 gold and uranium mining: distribution of output between factors of production 0'&11_ 0.8 0.7 0.6 0.5 0..4 0.3 0.2 0.1 o ronn~hn~nnn~~~~mmm~ufi~~~~~me~ r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 11 figure 5 diamond and other mining: distribution of output between factors of production :ileiiib 07 0.6 •• 0.3 02 o.t o ronnnnnnnnn~~c~mm.~m.~~~~m~mw 2.5 conclusions from tbe exploratory data analysis our descriptive data analysis suggests the following conclusions. first, the declining importance of mining in the economy has been led by the fall in output of mining's single largest aggregate sector, gold and uranium mining. the two other aggregate mining sectors, coal mining and diamond and other mining, have not only increased their shares within the output of the mining sector, but have also marginally expanded their contribution to the aggregate output of the south african economy as a whole. second, the declining importance of gold mining within the economy is allied to maturation of the sector: the distribution of output between the factors of production, capital and labour has been changing strongly over the course of the 1970-1997 period. from earning less than half of net value added produced by the sector, labour now obtains approximately 67 per cent of the net value added produced in the gold and uranium mining sector. third, the gold mining sector in particular and the mining sector in general remains a principal earner of foreign exchange in the economy. these findings suggest that the traditional view of the role of mining in the south african economy is now subject to review. the analyses to be found in some of the standard references to the structure of the south african economy all place emphasis on the significance of mining (see for instance nattrass, 1981: 129ffand lipton, 1986). in the case ofnattrass (1981: 148t), the point is also made that the demise of gold mining has often been predicted prematurely. while we do not make so radical a pronouncement, three decades of data, much of which falls outside the time frame considered by the earlier studies, indicates r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 12 sajems ns vol 5 (2002) no i that the role of mining has permanently altered. it no longer forms the core of the economy. this role has passed to manufacturing and the service sector, though the mining sector continues to generate significant export earnings. the suggestion is thus that south africa is engaged in the process of transition from a primary commodity producer, to a more fully differentiated industrialised economy. in this respect it does not differ substantially from other economies, as demonstrated for instance in grubel and walker (1989). this conforms to the evidence presented in fedderke, henderson, kayemba, mariotti and vaze (2001) and fedderke and mariotti (2002) of a structural change in the south african economy, with manufacturing in particular coming to adjust favourably to the removal of historical distortions in the economy. finally, the evidence suggests that gold and uranium mining in the economy has now matured in the sense that output growth of the sector is unlikely to be substantial in the future (apparently irrespective of gold price changes), and in the sense that such output growth as does materialise will be driven by total factor productivity gains rather than factor input growth. while similar evidence for other mining sectors is weaker, the evidence also suggests that growth prospects in mining are unlikely to be substantial. 3 labour market conditions in the three aggregate mining sectors of the south african economy this section sets out with an examination of trends in labour usage in the three aggregate mining sectors from 1970 to 1997 to provide an initial overview of changes that have occurred in these labour markets. it then turns to possible explanatory factors that might account for the developments in employment levels and concludes with a brief time series (vecm) econometric investigation of the plausibility of such explanations. 3.1 employment by tbe three aggregate mining sectors of the south mrican economy table 6 shows the contribution of south africa's principal (2-digit sic code) economic sectors to private sector employment in the economy over time. again, the service sector's importance as an employer has increased at the expense of the share of primary sectors. the decline in the importance of mining as an employer is not only a relative one. as table 7 illustrates, absolute employment in all three aggregate mining sectors has fallen dramatically, particularly since the late 1980s. the decline has been particularly strong during the latter half of the 19908, and especially so in gold and uranium mining. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 13 it is crucial to note that the decline in the relative and absolute contribution of mining to the output of the economy in the 1970s, from a share of 21.3 per cent to one of 13.3 per cent of private sector gdp in 1980 did not lead to a proportional decline in mining's relative contribution to employment. while the average growth rate in employment across all sectors was 2.2 per cent per annum for this period, mining employment increased by an average 1.9 per cent per annum. as a consequence the relative importance of mining in south africa's labour markets persisted. this relative buoyancy of the mining sector as an employer, in times of a declining aggregate output performance relative to other sectors, provides the first indication that output alone cannot serve to explain the mining sector's labour usage. table 6 contribution to private sector formal employment by economic sector (figures are percentages and may not add up due to rounding) 1970 1975 1980 1985 1990 1995 1998 agric, forest and 19: i 16.8 15.5 13.9 13.3 13.9 14.0 fish total mining 11.9 10.3 12.1 12.2 11.6 9.7 7.4 total manufacturing 19.1 20.9 21.5 21.6 22.5 23.1 23.1 electricity, gas and 0.8 1.0 1.2 1.4 1.4 1.2 1.2 water building and 5.8 7.8 5.7 6.2 6.2 5.8 4.8 construction services 42.8 43.3 44.0 44.8 45.0 46.3 49.5 table 7 absolute employment across the three aggregate mining sectors 1970 1975 1980 1985 1990 1995 1997 coal 73740 76697 93082 101705 89751 63260 55219 gold and 425800 378167 473781 526839 4911oo 382646 241352 uranium diamond 156763 171057 219800 179899 199572 150732 136543 and other buoyancy in mining employment relative to other economic sectors persisted through the 19808 and early 1990s. part of the reason for this is due to the fact that aggregate formal employment in south africa was declining during the course of the 1990s, moderating the decline of mining's contribution relative to total employment only for the 1995-97 period have we seen a particularly r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 14 sajems ns vot5 (2002) no 1 dramatic adjustment in mining's relative contribution to employment: by 1998 the employment share of mining declined to 7.4 per cent. furtber evidence of the partial link between output and employment emerges from the three aggregate mining sectors of the south african economy. employment in gold and uranium mining rose through the 1970s and early 1980s, peaking in 1986, despite the fact that real output for this sector had been declining since 1970: 5 only after 1986 does employment decline steadily and jointly with real output of the sector. once the employment trend in gold and uranium mining turned negative, it has remained consistently negative. even the increase in gold and uranium output levels from 1989 to 1993 was not reflected in a reversal of the decline in employment. thus by 1997 employment in gold and uranium mining had contracted to 60 per cent of the levels attained at its 1986 high point. 16 coal mining historically has shown a relatively strong responsiveness of employment to changes in real output the high point of employment in the coal mining sector corresponded to the peak real output level of 1985. the subsequent decline in real coal output has been accompanied by negative growth in employment. by 1993 real output had fallen by 41 per cent from 1985 (at an average growth rate of -6.14 per cent per annum), employment by 34 per cent (at an average growth rate of -4.82 per cent per annum). this linkage has become somewhat weaker during the course of the 199os. although output has been rising strongly since 1993 employment numbers have responded only weakly, and in 1997, employment had fallen again by 3.7 per cent relative to 1996. the experience of diamond and other mining employment is similar to that of coal mining. it demonstrates a relatively close link to output levels prior to the 1990s, with a much weaker link between output and employment after 1990. thus employment and real output for diamond and other mining both peaked around 1980. when employment reached another high in 1991 it had again followed high output levels in the same period. by contrast, the relatively strong growth in output of the diamond and other mining sector since 1992 was not mirrored by positive employment growth. instead, average employment growth was-l percentperannumfmm 1992-1997. the following section turns to other possible explanations of employment trends in the mining sector's labour market. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no i 15 3.2 links between employment and real labour remuneration the most immediate additional explanatory variable for employment trends in the mining sector offered by economic theory is the real cost of labour. figures 6 through 8 depict employment and real remuneration per labourer over time. 17 we note that with respect to real labour cost, gold and uranium mining is potentially distinct from the other two aggregate mining sectors. it is noticeable that the real cost of labour for the gold and uranium mining sector fell from 1970 through 1986, and rose sharply subsequently. since employment in the gold and uranium mining sector rose steadily until 1986, and declined subsequently, real labour cost therefore represents a plausible explanatory variable for employment trends in this sector. for coal mining, real labour cost has beeu on a steady upward trend over time. employment over the sample period in coal mining has both risen (until 1988), and fallen. sharp increases in real remuneration in 1980-1982 are followed by a levelling off in both real remuneration and employment until 1988. subsequent rises of real remuneration are associated with declining employment. for diamond and other mining real labour cost has been on a slower but nevertheless steady upward trend, while employment has remained essentially static with some cyclical variation. 18 explanations of labour usage patterns are likely to be multivariate in nature, and depend on more than just real labour costs. nevertheless, an association between real labour cost and employment patterns in the coal and diamond and other mining sectors appears at best to be somewhat weaker than is plausible for the gold and uranium mining sector. 19 one possible objection to the evidence presented in the present section is that the patterns observed in the real labour cost variable, for instance for gold and uranium mining do not conform to the conventional wisdom that real wages in the sector rose consistently over the course of the 1970s and the first half of the 1980s. the reason for the discrepancy is readily explained. in computing the real labour cost for the purposes of the present analysis, the nominal wage bill of each of the sectors analysed was deflated by the sectoral gdp deflator. this choice of deflator focuses on the real labour cost to the sector, which makes the appropriate comparison the cost of labour relative to the price of output generated by the sector, rather than the aggregate gdp deflator. while for coal and diamond and other mining use of the sectoral price deflator or the aggregate gdp deflator makes little substantive difference to the estimated real wage cost, 20 for gold and uranium mining there is an important difference, as is clear from figure 9. real wages computed on the aggregate gdp deflator r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 16 sajems ns vol 5 (2002) no i rose over the period through to the mid· i 980s, and stabilised subsequently (with a slight decline through the 199os). however, the aggregate gdp deflator is the appropriate means of deflation only when detennining the purchasing power of wages for workers, since their consumption bundle effectively incorporates the output of the economy as a whole. by contrast, in ordr:r to detennine the real labour cost to an economic sector, the appropriate price adjustment must be made in tenns of the price that attaches to the output of that sector, given that the cost of labour is relative to the price obtained for the output the labour produces. figure 6 coal mining: employment and real cost of labour '20000 loooo 100000 . :1 j , .' aoooo i l iidooo '-1 j ....ao '0000 ••• ~ i1uitibon i _i 20000 ..... ~ figure 7 gold and uranium mining: employment and real cost of labour 250000 .--------------------,-loooo ,," \ :1 " .. ' i '5000 i 10000 ____ '='=' _~ _______ ----,i 5000 i r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 figure 8 diamond and other mining: employment and real cost of labour figure 9 gold and uranium mining: comparative real cost of labour using alternative price deflators ~ ,--------------------------------------, t ~ t-----\--------~~~ ~ & 1~ r---~--7_~~~~~~~?_~~~------~ i i 10000 ~----~----~~~~~~~~----------~ ~ ~ ~~--------------~~~~~~---=~~~i 17 while for the analysis that remains in this section it is thus appropriate to employ the real labour cost series obtained from the sectoral price deflator, the evidence obtained for the gold and uranium mining sector in figure 9 is nevertheless instructive in a number of respects. the strong decline in real labour cost during the course of the 1970s is due to the rise in the gold price over this period. it follows readily that the bargaining power of labour to increase the real purchasing power of their wages was correspondingly enhanced. hence the rise in the real wage observed over this period is not surprising. after 1987 the ability of organised labour to raise the real wage has been considerably more constrained. the rising real labour cost appears to have r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 18 sajems ns vol 5 (2002) no 1 translated not only into labour shedding in the gold and uranium mining sector, but it has also appeared to have lowered the return to capital in the sector (recall earlier discussion), and hence at least potentially its growth prospects. finally, one should bear in mind that examination of bivariate graphical evidence (or simple correlations) in the current context may prove misleading. real labour cost is not the only potential explanatory variable that accounts for labour usage. in the present context a rising real labour cost is consistent with rising employment in the labour market, as long as productivity improvements in labour are such that they justify the increasing real labour remuneration. for this reason, we examine patterns in labour productivity in the following subsection. nevertheless, the exploratory investigation of the present subsection is suggestive of a plausible hypothesis on the mining labour market: that rising real labour cost may have contributed to declining employment in the mining sector. as such, we have a first additional potential explanation besides the declining output trends in the mining sector to account for falling employment in the sector. tables coal gold and uranium diamond and other average percentage changes in real labour cost in the three aggregate mining sectors 1970-75 1975-80 1980-85 1985-90 1990-95 1995-97 3.98 -2.46 21.02 3.57 -0.94 10.91 -8.55 -9.30 6.81 9.31 10.03 -0.59 6.61 -4.88 14.70 3.98 2.17 15.58 3.3 links between labour productivity and real labour cost economic theory would anticipate that perfect labour markets would serve to equalise the marginal product oflabour to the marginal cost oflabour. it follows that one possible explanation besides changes in the real labour cost for changing employment trends are changes in labour productivity. the theory would predict that at any given real wage rate (marginal cost oflabour), a rise in real labour productivity would serve to increase the demand for labour, until the marginal cost marginal productivity equality is re-established. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no i 19 table 9 average percentage changes in labour productivity in tbe three aggregate mining sectors 1970-75 1975-80 1980-85 1985-90 3.19 7.95 11.02 -1.39 gold and -4.47 -4.61 -4.31 -1.22 uranium diamond and 2.40 0.58 5.64 1.19 5.11 8.58 other the implication of the evidence contained in tables 8 and 9 is that for all sectors the real labour cost variable varies positively with real labour productivity. the correlation between the two variables in fact confmns the association: for coal mining +0.75, gold and uranium mining +0.41, diamond and other mining +0.86. however, it is noticeable that the correlation for gold and uranium mining is weaker than in the other two sectors. several explanations are possible for the apparently weaker correlation found for gold and uranium mining. first, higher union pressure might have hindered real wages from falling in the presence of falling productivity or even raised real wages. we have already seen that the proportion of value added allocated to wages in the gold and uranium mining sector declined from 42 per cent in 1970 (with lows of21 per cent) and stabilised at around 35 per cent of the real output value (gdp) until 1986. it increased thereafter to 67 per cent in 1997. by contrast, no corresponding increase in the share of output flowing to labour is evident for the other two aggregate mining sectors. the suggestion might be that for gold and uranium mining real wage pressure was greater than the increases merited by labour productivity improvements. if correct, the consequence of this rmding would be that the declining levels of employment in gold and uranium mining may be due to excessive real wage pressure in the sector, which outstripped real productivity increases. an alternative explanation refers to the nature of subterraneous gold mining itself. the increasing difficulty of gold ore extraction may have led to a falling labour productivity by virtue of the constraints imposed by the mining tasks at hand. as figure 10 illustrates, gold mines increased the ore milled steadi~ after 1978 while kilograms (fine) produced decreased over the same period. i this loss of efficacy is reflected in falling grades in terms of grams per ore milled.22 here the explanation for declining labour usage would lie not in excessive wage pressure, but in the technological requirements of more extreme mining conditions. if correct, this explanation implies a rising output per worker in the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 20 sajems ns vol 5 (2002) no i face of falling employment. however, the correlation between labour productivity and employment numbers while negative is not strong. for coal mining the coefficient is -0.10, for gold and uranium mining -0.42 and for diamond and other mining: -0.19. this suggests that labour shedding has played a limited role in the rise of productivity, except perhaps for the gold and uranium mining sector. figure 10 gold mining: ore milled and production volumes (quarterly) 35,000 ," l' .)0.000 .. i 25.000 12 i 10 .ii j 20.000 t 1 e 15.000 e i ~ 10.000 • i 5.000 0..._ ---0 .f i , , , i there are additional considerations that suggest that excessive wage pressure is associated with falling employment levels in the mining sector. it is possible to identify structural breaks in two of the aggregate mining sectors that illustrate the importance of the growth in real wage costs relative to labour productivity: for coal mining it is possible to identify such a break around 1986. average annual growth in productivity was 6.57 per cent for coal mining from 1970-1986, just above real labour cost growth of 6.4 per cent. from 1987-1997, average real labour cost growth was 4.12 per cent per annum but productivity growth now stood at only 2.91 per cent. the decline in employment in the coal mining sector after 1987 is thus not surprising. real labour productivity ceased to justify the rate of real wage increase of the sector, and demand for labour fell correspondingly. for gold and uranium mining real labour cost decreased on average by 4.05 per cent per annum from 1970 to 1986 and increased by 9.55 per cent per annum form 1987-1997. average productivity growth per annum was negative at -4.93 per cent from 1970-1986 and positive at 3.01 per cent from 1987-1997. the figures manifest an increasing gap between the growth rates of real wages and productivity. if we recall that in this period real output levels were decreasing in the coal and gold and uranium mining sectors,23 and employment levels were at their peak, the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 21 subsequent labour shedding appears inevitable. the rift between real wage increases and increases in real labour productivity constituted a strong disincentive to employ labour post 1986, and demand for labour fell correspondingly.24 by contrast, for diamond and other mining there is much weaker evidence of a structural break in its labour market. average real labour cost growth for diamond and other mining stood at 5.21 per cent from 1970 to 1986 and 5.52 per cent from 1987 to 1997. this steady growth rate is mirrored by average annual productivity increases ofj.21 per cent and 3.67 per cent respectively for the two periods. thus real wage growth consistently outstripped the growth in labour productivity, and changes in employment patterns in this sector is thus difficult to associate with a change in the relation between real wage growth and real labour productivity. we provide one fmal consideration. we have seen that relative changes in real wages and productivity provide a plausible explanation of labour shedding in the south african mining sector. however, one reason for the rising wage bill of the mining sector might be that the labour force of the mining sector has shown dramatically improved skills levels. this would explain rising real wages, while being consistent with either constant or rising levels of employment. we might also expect a changing skills composition to affect the average productivity of labour. data on the skills composition of the labour force is available only for coal mining and gold and uranium mining.25 the data provides information on the number of employees that fall into the categories denoted "skilled" and "unskilled". on the basis of this we defme the skills ratio as the proportion of the labour force that is considered to be skilled. figures ii and 12 display changes in the two aggregate mining sectors' labour force in terms of skills composition. both sectors show an improvement in the skills composition of the labour force from the mid-1980s. however, we note that the rising average skills level in the two mining sectors' work force is not due to a substantial increase in the number of skilled workers. instead, it is due to a shedding of unskilled workers. the evidence of the present section is thus more consistent with an interpretation that suggests that the rising real wage in mining sectors has led to labour shedding, and an effort on the part of mining to increase average labour productivity in order to justify the higher wage structure. it is difficult to suggest that the changing skills composition of the labour force is responsible for the rise in real wages. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 22 sajems ns vol 5 (2002) no 1 figure ii coal mining: skills composition of labour force iloooo 80000 o ~ i 7 i -\ l [j unaidlied employees ~ • skilled employees ~ '" " #~ffl#ltll'#i#iii;iii#'iiii;1 figure 12 gold mining: skills composition of labour force w o..-~ i .skiied~ ~ ---~ ~ looojlo o #~fflllllll#iiiiiiiiii'iiii;1 3.4 conclusions from tbe exploratory data analysis the descriptive analysis above has presented developments in employment trends, in real labour cost, in labour productivity, and examined potential links between these dimensions of the labour market. the most immediate cause of declining employment in mining is declining output of mining, and in gold and uranium mining in particular. however, examination of the evidence suggests that at best output levels of the south african mining sectors are a partial explanation of declining employment trends. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vols (2002) no i 23 two further possible explanations for employment trends in south africa's mining sectors were therefore examined: real labour cost and real labour productivity. exploratory examination of the evidence suggests that real labour cost for all three mining sectors demonstrates the negative correlation with employment that economic theory would predict. moreover, increases in real labour productivity have not been sufficient to warrant the increases in real labour cost observed for the mining sectors, nor have they been justified by increased employment of skilled labour. our findings suggest that output trends, use of capital stock, and real labour cost all contribute toward an explanation of labour usage patterns in the three aggregate mining sectors. what differs between the three sectors is not the explanatory variables, but the responsiveness of labour usage to change particularly in output, and in real labour costs. changes in real labour cost are expected to have the strongest impact on diamond and other mining, followed by gold and uranium and coal mining. diamond and other mining also shows the strongest responsiveness to changes in output levels, followed by coal and gold and uranium mining. the exploratory data analysis presented above cannot be conclusive on its own. in the final part of the labour market discussion, we therefore employ time series estimation in order to examine the relative importance of the alternative explanatory variables identified in the initial exploratory data analysis in accounting for employment trends in the three mining sectors individually. 3.5 an econometric exploration of some reasons for tbe decline in mining employment in what follows we undertake a more detailed econometric exploration of the hypotheses advanced above in explanation of the mining sector's employment patterns. we begin our discussion with a brief introduction to the econometric methodology employed for the study, before moving on to a discussion of the more detailed results obtained. johansen26 techniques of estimation employ a vector error-correction (vecm) framework, for which in the case of a set of k variables, we may have cointegrating relationships denoted r such that os r s k -1. this gives us a kdimensional vector autoregression (v ar): (i) where m denotes lag length, and o'a gaussian error teon. while in general zt may contain 1 (0) elements, as long as non-stationary variables are present as in the present case, we are exclusively restricted to 1 (l) elements. reparametrisation 'provides the vecm specification: r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 24 sajems ns vol 5 (2002) no i '-1 ilz, = :erlilzh + nz,_h + 11+0, m the existence of r cointegrating relationships amounts to the hypothesis that: (2) h1(r):n all (3) where n ispxpand a,'parep x rmatrices of full rank. hj(r)isthusthe hypothesis of reduced rank of n. where r> i, issues of identification arise?' the question we confront in our econometric investigation is whether changing employment patterns in south africa's mining sectors bear any relation to changes in the real wage and changes in the demand for output of the mining sectors. one means of answering this question is to consider a labour requirements equation, derived from the inversion of the production function of each mining sector. assuming that technology is cobb-douglas, logtransforming and inverting a standard production function we obtain: inl = a+ filny + oink + ..iin(~j+e' (4) where y denotes output, k the capital stock, l the labour input into production, 'v other factors influencing output such as technological progress and real factor prices, ~ real per labourer remuneration, and e a standard error term. our particular interest lies in two parameters. we wish to know whether changing output levels impact on the demand for labour by the mining sectors in the economy. specifically, we wish to know whether /1> 0, and hence whether declining output levels in mining explain the labour shedding of these sectors. second, we wish to know whether changing levels of the real wage influences the demand for labour. given the preceding discussion on the labour market for the three mining sectors, we are particularly interested to establish whether ..i<oand hence whether changing real wage patterns in the mining sectors have been a source of the labour-shedding that we have already reported on. lastly, we note that the specification above allows us to establish the impact of changing capital intensity in the mining sector on the demand for labour. the sign of ty allows for a determination of whether the factors of production act as complements or substitutes in the three aggregate mining sectors of the south african economy. for all three aggregate mining sectors, examination of the inverted production function specified by the labour requirements equation confirms the presence of a single cointegrating vector and hence equilibrium relationship. the resulting r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . samms ns vol 5 (2002) no 1 25 coefficients on the explanatory variables in the long run cointegrating relationships are reported in table to. examination of the error correction equation confums that each of the labour requirement equations estimated for the three mining sectors is an equilibrium model, in the sense that the negative and significant error correction term allows for the elimination of any deviation between actual and equilibrium labour usage. the error correction (ecm) parameters, which can be interpreted as the proportion of any error between actual labour usage and the labour usage implied by the equilibrium relationship that would be eliminated in the succeeding time period, are also reported in table 10.28 for coal mining and diamond and other mining, the output coefficients suggest that growth in output is not jobless once other potential explanatory variables of labour usage are controlled for. on the contrary, growth in coal mining output appears to generate an almost proportional increase in the demand for labour, and growth in diamond and other mining appears to generate a strong increase in the demand for labour. for gold and uranium mining the impact of output on labour demand is lower than in the other two aggregate mining sectors in the economy, and proves statistically insignificant. hence, for the one sector in which the exploratory data analysis showed that declining output levels could potentially have accounted for declining labour demand, the statistical evidence fails to corroborate a clear link. we also note that the relative responsiveness of the three sectors to output conforms to the priors to have emerged from our exploratory data analysis. table 10 long-run cointegrating vectors ink 1n w p ecm se coal mining 0.90* -0.19* 0.19 [37.36] 1it35t gold and -0.31 -0.16 0.36 uranium minin [1.74] [2.10j diamond and 2.26· -0.26 -1.45· other mining [9.71] 0.79 l8.2sf note: figures in round brackets denote t-statistics; figures in square brackets denote chi-square statistics at one degree of freedom on overidentifying restrictions on the cointegrating space for significance; * denotes statistical significance. on the other hand, it appears as if capital has displaced the use of labour in both the coal and the diamond and other mining sectors, though the elasticity of labour with respect to capital is relatively modest. by contrast, changing usage r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 26 sajems ns vol 5 (2002) no 1 of capital seems to have had very little impact on labour usage in the gold and uranium mining sector. in all three aggregate mining sectors rising real per labourer remuneration is consistently and strongly related to declining labour usage. each percentage point increase in the real per labourer remuneration of the sector has depressed labour usage by almost half a per cent in coal mining, almost 0.7 per cent in gold and uranium mining and by 1.45 per cent in diamond and other mining. again, diamond and other mining is the most responsive of the three aggregate mining sectors to changes in real labour remuneration. again moreover, the econometric analysis confirms the predicted relative responsiveness to real wage changes that emerged from the exploratory data analysis. 29 the conclusions to have emerged from the exploratory data analysis concerning the negative real wage elasticity is thus confmned.30 4 conclusions the story of the mining sector in south africa over the last three decades of the twentieth century is one of structural change. we saw strong declines in the sector's contribution to value added in the economy, principally due to the decline in the production of gold and uranium mining. the distribution of output of the gold and uranium mining sector shifted substantially away from equity to labour eamings through sharp increases in real wages. the contribution of mining to the net value added produced in the economy has declined sharply since 1970. this decline is attributable primarily to the declining contribution of gold and uranium mining to the total net value added produced in the economy. by contrast, the other two aggregate mining sectors of the economy, coal mining and diamond and other mining have contributed a relatively constant proportion to aggregate net value added. a more disaggregated investigation of output by individual mining sectors confirms the view that a number of sectors demonstrate a growing contribution to output, and that it is chiefly the contribution of gold mining to value added in the economy that has been in decline. the decline in the net value added contributed by mining is mirrored in a declining contribution of mining to total tax revenues of the state. again, it is gold mining whose contribution has been most clearly in decline since the early 1980s. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 27 the mining sector, and gold mining in particular, remains crucial in terms of the foreign exchange earnings of the economy, however. while the manufacturing sector has come to generate greater export sales than mining during the course of the 1990s, as a net exporter the mining sector remains the single most important earner offoreign exchange for the economy. finally, the distribution of the net value added produced by the gold and uranium mining sector of the economy has changed fundamentally over the 1970-97 period. whereas labour earned less than half of the value added in 1970, by the end of the 1990s labour earned approximately 67 per cent of net value added in the sector. as such, the distribution of output within the sector has undergone a fundamental transition, and one that is far more dramatic than in the remaining two aggregate mining sectors of the economy. certainly it points to a mining sector in transition, assuming a different role to its traditional one in contributing to the net output of the south afiican economy. in terms of the contribution of the mining sector to employment in the economy, our fmdings mirror those we obtain for the contribution of mining to net value added in the economy. in particular, mining has contributed a steadily shrinking proportion toward total employment in the economy, and the 1990s have seen a very dramatic absolute fall in employment of particularly unskilled workers. the decline in the importance of mining as an employer is less severe than the decline in its contribution to value added in the economy. and again, the decline is mainly attributable to a massive loss of employment in gold and uranium mining as the largest employer in the mining sector as a whole, although proportionally the employment decrease in coal mining has been equally sharp. the weakest proportional decrease has occurred in diamond and other mining. our analysis explores some of the potential reasons for the decline in employment in the three aggregaie mining sectors. time series (cointegration) data analysis confirms that employment losses in the mining sector is substantially attributable to rising real wage costs. this finding remains robust even where we control for the skills composition of the labour force. south afiica's economic development has been intimately tied to growth in its mining sector. the evidence presented in the present paper has suggested that this trajectory has been subject to structural change with a move away from primary commodities production to manufacturing and service industry as sources of further growth for the economy. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 28 sajems ns vols (2002) no 1 endnotes we thank an anonymous referee for useful comments on an earlier draft of this paper. the trade and industry policy strategies kindly provided some of the data for the present study. responsibility for the contents of the paper rests with us alone. an earlier version of the paper contains a wider discussion of additional data series. the econometric research southern africa policy paper no. 9 version of this paper is available at www.wits.ac.zaieconomicsiersa. 2 see loots (1998), idc (1998), jones and muller (1992). 3 historically the investment rate of the mining sector was of significance to the aggregate economy, with output growth in the sector being driven primarily through capital accumulation. the 1980's and 1990's have seen a steady shift in output growth away from capital accumulation to growth that is driven by growth in total factor productivity (see fedderke. 2002). thus investment by the mining sector has assumed less significance in the economy over time. 4 focus on the three aggregate mining sectors is due to data convenience. it is for these three-digit sic sub-sectors that consistent time series data is available. where more detailed data was available we note any additional infonnation of relevance. s in the discussion that is to follow, we consider the term output to mean value added, rather than gross output or sales. ignoring intennediate inputs of course gives no indication of the magnitude of derived demand associated with mining. consideration of derived demand effects lies beyond the scope of this paper. 6 note that platinum is included in diamond and other mining throughout. 7 the first point to note concerning this evidence is that it proves to be consistent with the evidence that emerges from an examination of the physical volume of output of the eight principal mining industries of the south african economy. gold mining was distinguished from other mining sectors by virtue of its strong and sustained decline in output in volume tenns, while other sectors either increased their volume of output, maintained constant levels of physical output, or where they did report declining output, showed greater cyclical variation. 8 figures for coal and diamond and other mining are available in the econometric research southern africa policy paper no.9 version of this paper. see www.wits.ac.zafeconomicslersa. 9 examination of more disaggregated data provided by the minerals bureau on the perfonnance of the eight principal mining sectors conftnns the point: among these, coal, platinum group metals, iron ore, manganese ore and aggregate and sands and can be characterised as growing. apart from gold, only chromite and copper decline in their r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 29 value of total sales. care should be taken in interpreting these figures. however. total sales at this level of disaggregation are reported in nominal terms, and sectoral price deflators were not available. hence reliable indicators of real output were not available. 10 the manufacturing sector has begun to export more than the mining sector since 1995 in absolute terms. 11 defined as the difference of the exports and imports of the output generated by a sector. thus, the net export measure does not capture the imports of intermediate goods employed by a sector in production. the consequence in the current context will be to bias upward the net export performance of mining, since south africa imports little by way of primary commodities, while they may have a relatively strong reliance on capital and manufactured imports, for instance. unfortunately we were unable to locate the data necessary to establish the net foreign exchange earnings of the mining sectors. 12 see for instance fedderke et al. (2001). 13 see the discussion in fedderke (2002). 14 and see also the discussion in fedderke and mariotti (2002). 15 the returns to production in a sector are properly understood in terms of the price obtained for the output of that sector • hence the use of the sectoral price deflator. once the post·1985 evidence for gold and uranium mining and the evidence from the other two aggregate mining sectors is considered, it is difficult to persist with the notion that output is a principal driver of labour usage in this sector. 16 the gold and uranium mining sector remains the fifth largest employer in the economy in absolute terms, though it also has the fifth lowest employment growth rate amongst all sectors (and is amongst the sectors with the strongest proportional decrease in employment). 17 we define real remuneration per labourer as: real wage bilvemployment. as the nominal wage bill of each of the sectors was deflated by the sectoral gdp deflator to obtain the real wage bill, it is the real cost of labour relative to the price of output generated by the sector that we are discussing with regard to employment patterns. 18 one should take care in interpreting this evidence. closer examination of the two series shows that there is at least some countercyclical variation in employment and the real labour cost. once other explanatory variables are controlled for, we might therefore find that the link between real labour cost and employment for the diamond and other mining sector might increase in strength. 19 correlation coefficients bear out the plausibility of a stronger association between real labour cost and employment in the gold and uranium mining sector than in the remaining two aggregate mining sectors. gold and uranium ore mining exhibits an employment-real labour cost r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 30 sajems ns vol 5 (2002) no i correlation of -0.81, diamond and other mining -0.41 and coal mining0.24. all sectors manifest the negative correlation we would expect. 20 full results are available in are available in the econometric research southern africa policy paper no.9 version of this paper. see www.wits.ac.zaleconomicslersa. 21 see also mainardi (1999). 22 additional evidence on grades is available in the econometric research southern mrica policy paper no.9 version of this paper. see www.wits.ac.zaleconomicslersa. 23 in the diamond and other mining sector the decrease in output set in only after 1989. 24 given the importance of gold and uranium mining as an employer in the economy, this serves as an important insight into the poor employment creation in the economy as a whole over this period. 25 this data is available only for members of the chamber of mines. an important note of caution on the compatibility of data at our disposal has to be made at this stage. we derive our conclusions on the skills ratio in the two sectors above, coal and gold and uranium mining, from data provided by the chamber of mines. the remainder of data used in this section has been drawn from wef a southem africa. the gold mining data by and large corresponds to the aggregate gold and uranium mining sector in the wef a dataset in regard to employment numbers and nominal earnings given. for coal mining we fmd a more substantial discrepancy in the number of employees and therefore in total nominal earnings reported. differences in the nominal earnings are not proportional to the difference in the employment figure. calculations based on the chamber of mines data would lead to a higher average nominal remuneration per employee (skilled and unskilled) for most of the years 1970-1997. 26 see johansen (1991) and johansen and juselius (1990). 27 see wickens (1996), johansen and juselius (1990, 1992), pesaran and shin (1995a, 1995b), pesaran, shin and smith (1996). 28 detailed results on the trace and maximal eigenvalue statistics specifying the reduced rank of the stochastic matrix, and on the full error correction specification are available from the authors. 29 we have already seen that the skills composition of the labour force is unlikely to modify the finding of a negative wage elasticity. this is further confirmed by the fact that when we control for the skills ratio in the labour requirements equation already estimated. we continue to find a unique cointegrating vector, and the real wage elasticity remains negative. where we estimate a labour requirements equation for the skilled and unskilled workforce separately. we again obtain unique cointegrating vectors for the two sections of the workforce for both r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no i 31 mining sectors. for coal mining, the estimated elasticities are quite distinct. for the skilled workforce there is a positive association between skilled labour usage and skilled real per labourer remuneration. by contrast, for unskilled labour, there exists a powerful negative association between unskilled labour usage and unskilled real per labourer remuneration. for gold and uranium mining the estimated elasticities for both the skilled and the unskilled workforce demonstrate a negative association between labour usage and real per labourer remuneration. 30 one concern with the present set of estimations is that the sample size available for the vecm (28 observations) attenuates statistical power. we therefore repeated our estimation using dynamic heterogenous panel estimation on all three panels. all results prove to be consistent with the findings reported here. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 32 sajems ns vol 5 (2002) no 1 appendix section source variables used production volumes minerals total production in the mining sector bureau (diamonds ),production, mass of total sales where production not available the importance of mining wefa gdp, by sector in terms realgdp of its contribution to value wefa london gold price in us-dollar added in the south african (sarb london gold price in zar economy quarterly bulletin) contribution of the mining wefa mining taxation by aggregate mining industry to total tax (css) sector revenue of the south african state aggregate labour market wefa formal employment (number) conditions in the nominal labour remuneration three aggregate mining (current prices) sectors of the south african gdp (constant prices) economy gdp deflator (index 199(}=loo) chamber skilled employees, average no. in of mines service unskilled employees, average no. in service for coal and gold mines members of the chamber of mines links between labour chamber metric tons ore milled production productivity and real of mines total kilograms fme production grade labour cost (grams per metric ton milled) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 33 references fedderke, j.w. (2002) "the contribution of growth in total factor productivity to growth in south africa: 1970-97", forthcoming south african journal of economics, econometric research southern africa policy paper no. 16, university of the witwatersrand. 2 fedderke, j.w., henderson, s., ka yemba, 1., mariotti, m., & v aze, p. (2001) "changing factor market conditions in south africa: the capital market a sectoral description of the period 19701997", development southern africa, 18(4): 493-512, econometric research southern africa policy paper no.7, university of the witwatersrand. 3 fedderke, j.w. & mariotti, m. (2002) "changing factor market conditions in south africa: the labour market a sectoral description of the period 1970-1997", mimeo, and see also econometric research southern africa policy paper no.5, university of the witwatersrand. 4 grubel, h.g. & walker, m.a. (1989) service industry growth: causes and effects, vancouver: the fraser institute. 5 industrial development corpora non and department of trade and industry (1998) sectoral prospects: growth guidelines for south africa's 80 industries 1997-2001. 6 johansen, s. (1991) "estimation and hypothesis testing of co integration vectors in gaussian vector autoregressive models," econometrica,59(6): 1551-80. 7 johansen, s., & juselius, k. (1990) "maximum likelihood estimation and inference on cointegration with applications to the demand for money" oxford bulletin of economics and statistics, 52(2): 169-210. 8 johansen, s., & juselius, k. (1992) "testing structural hypotheses in a multivariate co integrating analysis of the ppp and the vip for uk," journal of econometrics, 53: 211-44. 9 jones, s., & muller, a. (1992) the south african economy 19101990, london: macmillan. 10 lipton, m. (1986) "the interests of mining capital," in: lipton, m., 1986, capitalism and apartheid, south africa 1910-1986, wildwood house, hants. 11 loots, e. (1998) "job creation and economic growth," south african journal of economics, 66(3): 319-36. 12 mainardi, s. (1999) "geological occurrence and economic feasibility in closing decisions by gold mines," south african journal of economic and management sciences, 2(2): 240-57. 13 na ttrass, j. (1981) the south african economy: its growth and change, cape town: oxford university press. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 34 sajems ns vol 5 (2002) no i 14 pesaran, m.h. & shin, y. (1995a) "long run structural modelling" unpublished manuscript, university of cambridge. 15 pesaran, m.h. & shin, y. (l995b) "an autoregressive distributed lag modelling approach to cointegration analysis" dae working paper no. 95j4, department of applied economics, university of cambridge. 16 pesaran, m.h., shin, y. & smitii, rj. (1996) "testing for the existence of a long run relationship" dae working paper no. 9622, department of applied economics, university of cambridge. 17 wickens, m.r (1996) "inrerpreting cointegrating vectors and common stochastic trends" journal o/econometrics, 74: 255-71. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 308 sajems ns vol 5 (2002) no 2 economic policy making for environmental problems as an interactive learning process i mpdewit centre for scientific and industrial research, pretoria abstract the foremost limitation of public policy approaches is that the context of the public policy problem is not taken into account. in the case of complex and dynamic environmental problems, such as global climate change, there is a need for a framework for approaching economic policy that takes account of the complexity and changing realities of such problems. the objective of this paper is to present a framework to approach economic policy making in a case of such complex and dynamic environmental problems. the literature on economic and public policy theories, the need for a systematic policy design process and approaches to complexity and dynamics in policy making is framework available to one where the focus is on the best learning process to facilitate economic policy making on complex and dynamic environmental problems. based on sociological models of experiential learning, a multiple-loop learning framework (mllf) is presented. this model illustrates the importance of orchestrated science-policy interactions through interactive learning. the opportunities and limitations of this model are discussed with reference to the debate on economic policy for global climate change. jel 020, 028, 038 1 introduction the sheer complexity and dynamics of global environmental problems, such as climate change, has opened an intensive debate on the approaches of various economic theories to environmental policy making. it is realized that climate change is also an economic problem as scarce resources are either vulnerable to climate change or have to be allocated to the mitigation of climate change (nordhaus, 1991; cline, 1992; fankhauser, 1995; bruce, lee & haites, 1996; ipcc, 200 i). the question, however, is whether various economic decisionrules are necessary and sufficient to inform economic policy on global climate change, and how this should be done. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 309 the objective of this paper is to answer the question of how economic policy making for complex and dynamic environmental problems can best be approached. in section 2 the underlying positivistic economic philosophy and its implications for approaching policy making is discussed with reference to various economic theories on the environment. in section 3 it is emphasized that a systematic policy design process is needed that can take account of complex and dynamic policy problems. in section 4 the literature on existing approaches to complexity and dynamics in policy making for sustainable development is reviewed which sets the scene for the development of policy learning framework in section 5. in section 6 a few words are said about current economic policy making approaches to climate change and the need for the application of an interactive learning process. section 7 concludes. 2 from economic theory on the environment to policy making the flourishing economic-philosophical argument is that economics is a welldefined science underpinned by realistic assumptions. this positive approach to economic problems is definitive and realism carulot be an independent criterion (see hahn & hollis, 1979: 2). the application of the positive economic approach to policy making was outlined by keynes (1917) in his book the scope and method of political economy. he urged the importance of "recognising a distinct positive science of political economy" (friedman 1953: 3). the stage was set for the further development of economic political theory and, therefore, subsequently economic policy making approaches to issues pertaining to the natural environment. to paraphrase friedman (1953: 4): positive economics is in principle independent of any particular ethical position or nonnative judgements. as keynes says, it deals with "what is ", not with "what ought to be ". its task is to provide a system of generalisations that can be used to make correct predictions about the consequences of any change in circumstances. its peifonnance is to be judged by the precision, scope, and confonnity with experience of the predictions it yields. in short, positive economics is, or can be, an "objective" science, in precisely the same sense as any of the physical sciences. the link between economics and scientific objectivity has been made and translated into the realm of economic approaches to policy through specific welfaristic decision rules such as pareto optimality. such approaches have been standard in approaching economic policy issues ever since. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 310 sajems ns vol 5 (2002) no 2 positivistic economics accepts the scientific objectivity (what is or what might be), or the ethical neutrality, of economics (bromley, 1991: 207). normative economics is perceived as connoting value-laden arguments (what ought to be). according to blaug (1992: 112) one can best think of this as a distinction between scientific economics and practical advice on economic policy. inspired by the philosopher david hume (1711-76), the perception of a watertight distinction between the realm of facts and the realm of values was born and further developed within positivistic economics. the methodology of positive economics, however, has not remained unchallenged in economic thinking. several scholars have asked questions on the nature of and the assumptions underlying positive economics (ha1m & hollis, 1979; blaug, 1992, 1980; boland, 1982; caldwell, 1982; eichner, 1983; bromley, 1991, 2000). blaug (1992, 1980) and caldwell (1982) come to the conclusion that economics cannot claim to be scientifically objective and ethically neutral. ward (1972) argues ''that economics is basically a normative science adorning itself with the fig leaf of hard-headed positivism" (as quoted in blaug, 1992: 238). the distinction between what is and what ought to be in such problems, cannot be separated easily. positivistic economics became divorced from value-judgements and too many values were treated as basic or were simply ignored (sen, 1970). there is no real value-free social science. economy is partly ideology, and a separation of the positive from the normative in developing economic theory is impossible. approaching economic policy to complex and dynamic problems would involve a rethink on keynes' positive science of political economy. the implications of such a statement on policy making are significant (bromley, 1991: 212). the positivistic policy research programme in economics has concentrated on an apparently value-free way of participating in the policy debate. the resulting new welfare economics, with efficiency as evidence of scientific objectivity, however, is controversial. blaug (1980: 147-8) concluded that ''the concept of pareto optimality ... should not be confused with theorems of positive economics .. .immense confusion has been sown on matters of 'efficiency' without committing ourselves to any value judgements". the search in welfare economics for a fixed order for the collective choice process is fiustrated by the complexity of policy making. bromley (1991: 217) describes this search for a fixed order as reductionistic decision rules. according to bromley (1991: 217), the persistent debate on the appropriate welfare criterion and on the boadway paradox, in which the ability of the gainers to compensate the losers does not lead to an unambiguous improvement in social welfare (boadway, 1974), is testimony to this complexity. efficiency on the policy level is a value-laden concept in itself. this change in economic thinking, especially on the level of policy making, forces a recognition of the complexities in the collective choice process. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vo15 (2002) no 2 311 now that the apparent simplistic theory-policy relationship from positivistic economic approaches has been questioned, the next question is what alternative public policy approaches could add to the debate. schneider and ingram (1997: xi) identify four prominent theories that have guided politics and policy during most of the twentieth century: the pluralistic theory, policy sciences, public choice, and critical theories. schneider and ingram (1997: 10-11) conclude that not one of these public policy approaches "have provided an adequate diagnosis, explanation. or prescription for public policy and that their central failures include a narrow knowledge orientation, insufficient attention to policy design, and a failure to recognise the central role social constructions have in determining the characteristics of policy designs". the foremost limitation of these policy approaches is the assumption that the context of the public policy problem is not taken into account, i.e. one design fits all, thereby creating an imbalance in the other values policy must serve (schneider & ingram 1997: 10). the point that public policy, and more specifically environmental policy, is context-specific has also been pointed out by other scholars. according to gunningham and grabosky (1998: 32): "so complex and various are the causes of environmental degradation and the circumstances in which they arise that no single instrument, and indeed no single mix of instruments, could conceivably be successful in addressing all or even most of them. the optimal policy could only be determined on a case-by-case basis". opschoor and turner (1994) state that a priori rules are inferior to case-by-case analysis. sterner (1994: 7) argues that the choice of "[a] policy instrument ... depends crucially on both the institutional setting and on the exact nature of the environmental problem at hand". nevertheless, most economic theories on the environment link most closely with the public choice approach to public policy. in't veld and kraan (1991) present a useful overview of different public choice models, distinguishing between radical public choice, individual moralism, constitutional economics and a hybrid of these three, namely, moderate public choice: in the radical public cboice model, the neoclassical model with a homo economicus is extended to the political process without any adjustments for the realities of the political process. brennan and buchanan (1985: xi) describe this model as one attempting to offer a pure science of politics that is fully analogous to the science of markets. according to them the objective is "to derive testable hypotheses about the effects of specific changes in basic parameters on observed political results". in the model of individual moralism political behaviour is predominantly determined by moral motives, in contrast to the economic behaviour of homo economicus. the task of political theory is to clarify the choices people are making in terms of their belief systems and to improve the contents of these belief systems themselves (in't veld & kraan 1991: 3). empirical work is r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 312 sajems ns vo15 (2002) no 2 directed at description and analysis of prevailing political belief systems. brennan and buchanan (1985: ix) describe this model as being concerned with "analytical esoterica in the modelling of alternative political arrangements". modern welfare theory with its ernphasis on the development of the social welfare function determined by normative criteria such as economic efficiency or sustainability, is an example of this public choice model. the basic claim in the model as developed by buchanan (1991, 1987), namely constitutional economics, is that theoretical analysis should proceed in different ways for different kinds of political decisions. the fundamental distinction is between decisions at the constitutional level of choice and the post-constitutional level of choice. the first type of decision determines the legal-institutiona1-constitutional structure of the polity, while the second type of decision detennines the economic and political process within a given structure (buchanan, 1987). in post-constitutional decision making the model of homo economicus applies. at the level of constitutional choice (choice about institutional rules) decision makers are susceptible to what in't veld and kraan (1991: 4) label normative reasoning. however, individual choice remains dependent on the institutional-constitutional constraints (buchanan, 1989). the overall objective is "to understand the workings of alternative political institutions so that choices among such institutions (or structures of rules) can be more fully infonned" (brennan & buchanan 1985: xi). the model of moderate public cboice is closer to the radical public choice model in that it appreciates the relevance of positive economic analysis for a broader area of economic decision making than constitutional economics tend to do (in't veld & kraan 1991: 5). on the other hand, individual moralism is more accepted in that there is some room for normative reasoning at the post-constitutional level of choice. in some areas of postconstitutional choice, moral motives can be decisive for the behaviour of citizens, politicians and bureaucrats. this model builds on the model of constitutional economics, but pleads for a more realistic mix of positive analysis and nonnative reasoning. the next question is how these public policy theories relate to economic theories on economic-environment interactions. it can be expected that the different economic theories on the environment have different inclinations towards a certain, or more than one, public policy model it is important to link economic theories on the environment to public policy models so as to lose no useful insights into policy design through the ex ante choice of a particular public policy paradigm. in table i an attempt is made to link economic theories on the environment to public policy models. this is an early attempt, as most economic theories on the environment, especially ecological economics, are in early phases of development. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 313 table 1 economic theories on the environment and public policy models public choice pluralism i po~tical critical ! science theories radical individual: constitumoralism tional economics i environmental x. economics x. i ecological x. x. x. economics neo-institutional x. x. x. economics evolutionary x? i approaches i source: de wit (2001: 114) the' focus on optimisation within a particular setting and according to a set of pre-determined normative criteria, such as economic efficiency (in the case of environmental economics) or sustainability (in the case of ecological economics), excludes an unconditional acceptance of the status quo (pluralism) or a total rejection of the status quo (critical theory). the evolutionary approach, however, comes closest to accepting processional realities2 as a foundation for theoretical development, but the reviewed literature does not support the uncritical acceptance of the status quo. the lack of focus on optimisation rules out any connection with public choice models and political science. it can be hypothesised that some elements of critical theory, such as the emphasis on social change, are aligned with evolutionary approaches, but no conclusions can be made at this stage. both environmental economic and neo-institutional approaches are extensions of positivistic neoclassical economic theory. in this approach the theory of homo economicus could be extended to the public policy arena, as in the radical public choice approach. some free marketeers within the environmental economic and neo-institutional approaches follow this approach (anderson & leal, 1991; anderson & hill, 1995). this is the exception rather than the rule, as most environmental economic scholars follow assumptions based on (new) welfare economics. through their emphasis on economic efficiency, these theories are more inclined to follow the welfaristic approach of individual moralism. the difference is that neo-institutional approaches are closely aligned r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 314 sajems ns vols (2002) no 2 with constitutional economics, while environmental economics is not. in constitutional economic theory the co-existence of political and market institutions are accepted by. defmition, which aligns closely to the neoinstitutional notion of a variety in property right structures. none of these institutions is left in its black box, as environmental economists tend to do with the political process (see hahn (1989) for this critique on environmental economic policy making). no literature was found to support the alignment of environmental economics or neo-institutional economics with one of the nontraditional economic approaches to public policy. in summary, environmental economists are clearly linked to public policy by individual moralism, while neo-institutional economists align more closely with a mix of constitutional economics and individual moralism, but with an emphasis on the former. ecological economic approaches take a cautious approach to environmental degradation, distrusting in general the ability of markets to provide a sustainable solution. although a better defined role for both markets and governments is accepted when compared to the environmental economic approach, the realities of the political process itself are not effectively internalised. daly (1992, 1999) suggests a logical sequence of policy tasks: defining scale and distribution in a political process and leaving the allocation of resources, within these constraints, to the market. peet (1992: 220-21) refers to this sequence as a policy hierarchy, since, in his view, "ethical and ecological principles are the true determinants of price". cumberland (1994) brings the concepts of interest group acceptability and political feasibility into the debate and argues that the policy approach depends on the ecological damages in the frrst place. in the case of non-measurable damages, the property-rights approach is sufficient. when damages are measurable, but do not lower the ecosystem productivity, an incentive-based approach (through economic instruments) is applicable. however, when non-sustainable long-term damages are expected to occur, a regulatory approach is followed. for a graphic illustration of this approach, see figure 1. ecological economists follow the precautionary approach arguing a priori that long-term damages are non-sustainable. the property rights and incentive-based approaches can be useful, but only within the boundaries of the politically predefined scale and distributional constraints. the social welfare function, as identified in welfare theory, is still maximised, but subject to different constraints as in environmental economic and neo-institutional economic approaches. ecological economic approaches are therefore closely linked to individual moralism, but this conclusion is not sufficient. a clear role for government intervention is identified, thereby excluding any links with the radical public choice approach. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 figure 1 ecological damage and policy .r:.c')io~;tcoj damage marginal damage non-sustainable long-term damage ~----------~------------~ measurable damage decreasing productivity non-measurable damage property right abatement source: cumberland (1994) incentive 315 although the links have not been made explicitly in the literature, the sequential approach to policy making as promoted by ecological economists such as daly (1999), is similar to the constitutional economic approach of constitutional and post-constitutional choice (buchanan, 1991). politically normative choices on scale and distribution are made on the constitutional level, while the market can allocate resources efficiently within this set of pre-defined constraints_ these approaches also link with the policy science approach of focusing on science and professionalised bureaucracies in improving policy design. an example is the emphasis on the scientific derivation of ecological indicators needed for standard-setting. the general lack of attention on the power relations between different actors, and the desire to change the status quo towards a more sustainable society excludes the pluralistic approach to public policy>. in summary, the ecological economic approach links best to public policy models through individual moralism, constitutional economics and political science. it can also be argued that the strongest link is with individual moralism from welfare theory, but within the boundaries set by constitutional economic and policy science processes. one could debate on the relative contributions of various public policy approaches to the various economic theories on the environment, but for the purpose of this paper it is clear that a focus on one specific economic theory and one specific public policy approach leads to a partial interpretation of reality, resulting in tum in a bias, and possibly increased complexity, in policy recommendations. the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 316 sajems ns vol 5 (2002) no 2 argument also exposes the fact that an ex ante implicit choice of a public policy approach needs to be made, and this reinforces the need for more transparent policy design. 3 the need for a systematic policy design process the public policy approaches discussed so far all view the policy maker as exogenous to a policy support system. following the work of march and simon (1958) and simon (1977), it is assumed that policy making follows a linear and one-dimensional three-stage process of intelligence, design and choice (see checkland & scholes, 1990: 165). in the first stage, problems are identiffed and data collected; the design-phase consists of plaruring for possible alternative solutions; and the choice-phase entails the selection of an alternative and the monitoring of its implementation. based on 12 case histories of policy reform in developing countries, thomas and grindle (1990: 1165) refer to a similar linear process in the implementation of policy reforms, following the stages of agenda setting, decision and implementation. hirschman and lindblom (1972: 358) also critically refer to the linear process of rational decision making in policy making where objectives or values are first clarified, secondly, alternative means of reaching these objectives are surveyed, thirdly, the consequences of each altemative are identified, and fourthly, each set of consequences is evaluated in the light of the objectives. the need for an alternative approach to this linear process of policy making has been raised by various scholars (lindblom, 1959, 1968, 1979; hirschman & lindblom, 1972; thomas & grindle, 1990; de greene, 1993). lindblom (1959) argued against proposals for decision-making tools without an explicit recognition of the realities of the political process itself. this point of departure closely corresponds to the argument that the analysis of the political process itself has to be included in a systems approach to policy making. this approach is, in fact, a recognition of the dynamic, changing nexus of decision-making issues and cognitive issues. as pointed out by hirschman and lindblom (1972: 357), the critique centres around two assumptions implicit in most of the linear approaches to policy making: firstly, that public policy issues can best be understood by attempting to understand them. what does that mean? they cannot be theorised! generalised? secondly, that there exists sufficient agreement to provide adequate criteria for choosing among possible alternative policies. on the first assumption, the public policy making process should be viewed as part of a system characterised by continuous feedback. hirschman and lindblom were r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 317 writing long before the scientific revolution of dynamic, non-linear systems took place\ but the results only seem to confirm their original thesis. it is argued in the literature on dynamic non-linear systems theory that unpredictability and novelty will always be around us, even in the case of deterministic complex systems (stewart, 1990). none of the public policy approaches, as discussed earlier, referred explicitly to the dynamic complexity of the policy making process. as discussed, the foremost limitation of all the public policies evaluated is the assumption that the context of the public policy problem is not taken into account, i.e. one design fits all. unpredictability and novelty do not feature meaningfully in these approaches. the recognition, however, that the policy process itself is continuously changing, emphasises the limitations of the perception that the systems approach can only be seen as a decision support tool to a relatively fixed policy process. the policy process co-evolves with the problem situation (de greene, 1993: 7) and is part of a dynamically interacting systems-field (de greene, 1993: 133). the policy process has also long been debated in the development literature. quarles van ufford (1993), for example, criticised the lack of attention to the process of policy formulation itself. his criticism focuses on an optimised systems approach, in effect, a closed political system one where development is presented as manageable, intellectually simple and explicable to an ignorant audience (van ufford. 1993: 157). his call for a model, that is a better balance between normative (or ideological) and analytical models, is what is understood in an open, systems approach to the policy making process one that explicitly recognises the importance of feedback and continuous learning. on the second point, the linear process of policy making can only take place on the basis that sufficient agreement exists on adequate criteria for choosing among policy alternatives (hirschman & lindblom, 1972: 357). this approach does not advocate either laissez faire or expanded political influence, but is concerned with decision-making and problem-solving activities carried out by the political authorities (hirschman & lindblom, 1972: 364-365). it was already suggested that such agreement is often unlikely as many public policy approaches and different value principles exist with very different implications for policy design, such as economic efficiency and sustainability norms. in view of the above, the design of economic policy for complex and dynamic problems cannot simply be based on theories on the interface between economics and the environment. there are many different theories, such as environmental economics, ecological economics, nec-institutional economics and evolutionary economics, that have different frameworks for the design of policy. none of these theories can make a claim to represent absolute truth values; all of them have to intemalise increasing spatio-temporal scales of environmental problems and in one r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 318 samms ns vol 5 (2002) no 2 way or another, both the static and dynamic aspects of political reality need to be taken into account. public policy approaches are also divided in their approach and based on ideological a priori first principles that are often closely linked to economic or other theories (schneider & ingram, 1997). the design of economic approaches to policy regarding complex and dynamic problems needs to be approached as a process that incorporates feedback and is geared towards continuous learning. it has been pointed out that the systems approach to sustainable development can take account of both increased complexity and the dynamic processes of change (clark, perez-trejo & allen, 1995; de wit, 2001). the question is whether such an approach can be used for policy making as well. the added value of this approach is that dynamic systems approaches are not only used to enhance the presentation of specific problems to policy makers, but to include interest groups in a learning process of policy making. the design of policy is not confined to analysts, but a far broader approach is taken to both the sources of knowledge and participation. there is thus a need for a policy process that intemalises different values within their context, before making a choice on a policy framework. such a process has to be able to include the many aspects of complexity, but also the dynamic character of policy making for sustainable development. the development of such a framework can best be informed by existing literature on the interface between policy making and complexity theory. 4 approaches to complexity and dynamics in policy making for sustainable development the search now extends to identifying approaches to policy making that explicitly takes account of complexity and dynamics in real world environmental problems. the question that needs to be answered is how the complexity in economyenvironment-policy systems and the changing realities of policy design can best be approached. the application of dynamic systems approaches to policy making processes can be informed by various contributions in the literature on systems dynamics, management and organisation (gill, 1996; saeed, 1994; de greene, 1993; rastogi, 1992; gardiner & ford, 1980; murthy, 2000; warfield, 1999, 1994; vennix, 1999, checkland & scholes, 1990; checkland, 1981; senge, 1990; stacey, 1995; kelleher, 1970; busterud, 1977l in addition, and the focus of this paper, a relatively small amount of literature exists on the application of the dynamic systems approach to policy making for environmental problems and/or sustainable development (saeed, 1998; roe, 1998; comfort, 1999; schoot-uiterkamp, 1999; schmoldt & peterson, 1999; wolfenden, 2000; undp, 1999). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 319 saeed (1998) argues that informing policy making for sustainable development is, given its high complexity and uncertainty, an experientialleaming process. the complexity of sustainable development is captured in a system dynamics model that informs policy makers on appropriate actions. such a systems dynamics model is dependent on the learning process followed by the modeller. figure 2 kolb's model of experiential learning concrete experience testing __ a_cti_'v_e ___ pas_s_iv_e -i_i watching i observations implicatiolls '---.----' . • . and reflecllolls :, .. j abstract conceptualisation source: kolb (1984) as quoted in saeed (1998) the core competencies of experiential learning are the learning faculties of watching, thinking, doing and feeling in kolb's model (see figure 2) (saeed, 1998: 407). an important characteristic of these tasks is that they correspond to passivephysical, concrete-cognitive, active-physical and abstract-cognitive domains. such a display takes account of two basic human functions, namely the physical and the cognitive, and integration along two primary dimensions, namely the passiveactive and concrete-abstract dimensions. the important conclusion from such an approach is that an understanding of complexity can be facilitated through a learning model that takes various dimensions of human functioning into account saeed (1998: 407,409) likens system dynamics modelling to an art of balancing between these learning faculties. roe (1998) also argues that complexity has to be taken seriously when formulating policy, but unlike saeed (1998), he does not take a system dynamics modelling r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 320 sajems ns vol 5 (2002) no 2 approach. a central problem of public policy analysis has been to fmd new ways of analysing issues of increasing uncertainty and complexity. roe suggests the method of triangulation using various methods, databases, theories and approaches to converge on the complex issue in question. in this method the same set of questions regarding policy issues are asked from multiple perspectives. in this way facets of the problem are identified that may be omitted by other methods. comfort (1999: 182) welcomes this approach in that it attempts to find appropriate methods that fit the problems, rather than focusing on problems that fit the existing methods. roe applies this method to the issue of sustainable development and makes recommendations on the basis of selected perspectives on the issue. without discussing the recommendations in detail, the important fmding for the pwpose of this paper is, as comfort (1999: 183) puts it: " ... [roe] puts to rest old arguments of politics versus economics in policy debates and demonstrates afresh that both are central elements in designing workable policy, and neither are likely to define the policy issue accurately". and further (1999: 183): ..... implicit in his approach is the recognition that invalid policy analysis contributes to the clamour and confusion in the policy debate. rather than reducing complexity and increasing clarity of understanding on problems to facilitate action, methods of analysis that provide inaccurate or partial views of a complex policy issue seriously inhibit both understanding and action". the united nations development programme (undp, 1999) used roe's method to formulate policy for sustainable livelihoods by starting to recognise that such systems are complex and adaptive and can best be analysed on a landscape level. the undp (1999: 4) distinguished between two types of policy analysis, namely conventional and complex. conventional policy analysis is sequential and cumulative; complex policy analysis is interactive and convergent. the former is only applicable in situations "oflow environmental uncertainty, relative stability in public (including government) objectives, strong institutional memory in the design and implementation agencies, and sufficient resources to tolerate mistakes in trial and error learning relevant to the issue in question" (undp, 1999: 4). complex policy analysis is further applied to the issue of sustainable livelihoods, using the method of triangulation as discussed in the previous paragraph. the main conclusions are that complex policy issues demand analysis on a case-by-case basis. these approaches do take account of complexity in policy design and attempt to deal with this through systems modelling and triangulation approaches. this is a step in the right direction, but the limitation with these approaches, and in fact, with most of the other approaches to understanding complexity (see de wit, 2001: 143-53), is that the policy maker is treated exogenous to the understanding of the policy problem. the focus is on the analyst or scientist to understand and make recommendations on a better understanding of the complexity in the problems at r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 321 hand. although a huge body of literature recognises the need for consultative, participatory or group learning processes, the overall impression is that these only inform policy making, and does not really endogenise the policy design process within the system under evaluation. however, a limited body of literature is available that explicitly attempts to provide a model to handle both complex issues and design a process wherein various actors (such as policy makers themselves) can be involved. checkland and scholes (1990) apply a soft systems methodology (ssm) trying to 'manage' real-world situations; it is system thinking based and is applicable to taking purposeful action to change real situations constructively. in the ssm it is acknowledged that problem solving can be much more complex and dynamic than allowed for in the more traditional linear approach. checkland and scholes (1990: 280-84) distinguish between two modes of ssm. in mode i the key word is intervention. ssm is used to do a particular study it therefore serves as a decision tool for improved management of complex systems. in mode 2, and the one we are interested in, the key word is interaction. the work is done through the use of ssm real-world feedback is included in a management model of continuous learning. 'this does not mean continuous learning about the problem situation per definition, but continuous learning about how to deal with these (new) streams of information in the management process itself. in a model where decision makers are endogenous to the model, mode 2 ssm is more applicable. the important point is that intervention analysis, social system analysis and political system analysis, which are all aspects of the ssm model, inform an understanding of the problem situation and root definitions of the system6• this means that the roles, norms and values of participants are included in the analysis of the system and are subject to continuous learning and revision. the conceptual models are built on the basis of an initial understanding of the system and compared with perceived reality through informal discussions, formal questioning, scenario writing based on operating the models, and attempts to model the real world in the same structure as these conceptual models (checkland, 1981). if there are major differences, this feedback is internalised in a second round of enquiry. the resulting changes that are proposed are subsequently tested for systematically desirable and culturally feasible changes. based on experiences with ssm, such a process can best be attempted through participation and interaction between problem solvers and actors in the system, and not only by a team of independent analysts. in summary, learning about complex systems is facilitated through streams of enquiry and the need for dynamic feedback is recognised. in the same vein, vennix (1999: 391) further argues that an effective way to address messy problems would be to remove barriers to learning through participation in the construction of the model using methods such as group model r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 322 sajems ns vol 5 (2002) no 2 building. a messy problem is defined as a situation in which opinions in a management team differ considerably (polarisation) (vennix, 1999: 370). vennix emphasises the importance of team learning and effective communication to overcome cognitive barriers and accept differences in perceptions that lead to multiple realities. such team learning would need an effective facilitation. the important contribution for this paper is that the process of decision making in messy problems needs to be facilitated carefully through group model building techniques. there are barriers to cognitive learning and communication that would impede the formulation of solutions for these problems. 5 the multiple loop learning framework (mllf) the challenge remains to develop a framework for economic policy on complex and dynamic environmental problems. it is important to think about the meaning of the word framework as this can be interpreted in many different ways. pollard and liebeck (1994: 316) defmes a framework as "the structural basis of an organisation, the structure of a plan, etc". one can therefore describe a framework as something that approximates the best possible solution as closely as possible. the question: what is best?, however, implies reference to pre-determined criteria outside the framework itself (e.g. economic efficiency, equity, sustainability or survival). the discussion of such a framework would either take one or more of these criteria as the point-of-departure, or fall into a discussion of the relative weights of the different criteria. such an approach, however, would defy the argument that uncertainty and novelty are features of complex and dynamic systems, and that learning about these systems are the only available option. in such a case the question on a framework for economic policy making for complex and dynamic environmental problems is rather different. the focus changes from finding the best framework available in the circumstances to one where the focus is on the best learning process to facilitate economic policy making. what aspects have to be in place and what questions have to be asked and at what time/stage to guide the process of learning on economic policy making for complex and dynamic environmental problems? this brings us to the next question: how does one learn? the answer to this question would delimitate some of the issues that need to be included in a learning framework. kolb's model, as discussed in the last section (and referred to in figure 2), is a useful starting point in this regard. one learns both cognitively and physically, but in a circle of continuous feedback. do policy makers also learn in such a way? and, ifnot, why not? dror's (1971) reference to a scbool of rulers accentuates the fact that such questions have been raised before. there is no reason to believe that policy makers themselves are not r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 323 in a continuous cycle of learning, or should be in such a learning process, given the uncertainty and complexity pertaining to policy making issues on complex and dynamic environmental problems. however, the resulting flexible policy making approach could best be guided by a process of learning, in order to reach the best learning process possible. are there situations when the learning process is finalised? the point raised that complexity and novelty will always be around us, suggests that such a process cannot ever be finalised. however, it could be argued that the intensity of learning would differ greatly depending on the problem at hand. based on kolb's model (figure 2), one could define learning on two levels: cognitively focused learning cycle (vertical axis) practically focused learning cycle (horizontal axis). in the first instance, the added value of analytical work, such as applications of economic theories on the environment would prove to be great. the application of economic analysis on environmental problems would provide important inputs to the policy making process. in case of a practically focused learning cycle, the marginal added value of cognitive contributions is declining and added value to the policy making process is gained through practical implementation of policy and attempting to recognise patterns in the responding economies. in the problem at hand, and following the distinction between endogenous and exogenous policy making, one could distinguish between a learning framework for policy makers and a learning process for analysts and system dynamic modellers. the latter is a process focusing on the cognitive content of learning and the former focusing on the practical content of learning. in a sense this is following from the contribution from checkland and scholes (1990) who argue that a mode 2 interactive approach is required to deal with the process of policy design itself. within this meta-level approach one could defme a problem-solving approach that takes more cognisance of case-specific analytical issues, as discussed in checkland & scholes's mode 1 approach. the concept of a learning framework would include a model that facilitates learning itself on different levels. one can refer to the existence of learning cycles within learning cycles, analytical learning cycles within policy process learning cycles, or multiple loop learning cycles, to represent the changing emphasis on cognitive and physical aspects of different learning events for both analysts and policy makers. the issues raised can be clarified in a simple conceptual framework that captures the most important issues in a framework for economic policy in case of complex and dynamic envirol1mental problems. such a multiple loop learning framework (mllf) is illustrated in figure 2. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 324 sajems ns vol 5 (2002) no 2 figure 2 a multiple-loop learning framework (mllf) ~+-~---e--+----'3-----i--'--------jim watching '-----' 4 o source: de wit (2001: 160) the key research question how best to approach economic policy making for complex and dynamic environmental problems can be answered on a conceptual level with the aid of a mllf. the mllf illustrates a number of pertinent issues: economic policy making for complex and dynamic environmental problems is first and foremost a learning process, comprising the learning faculties of watching, thinking, doing and feeling. this learning process has to be facilitated in the best way possible, and the key learning faculties balanced in the right way. this balance would differ with the problem at hand. in loop i (abed), the policy process loop, the focus would be more on the physical and more practical aspects of group processes and facilitation, while loop n (1234), the theoretical learning loop, would be more cognitive, focusing on applications of economic theories on the environment and public policy theories. these loops, however, are not separate but continuously influence each other when policy making is endogenous to problem resolution. without elaborating on the interaction between theoretical learning and policy process loops, which is a process of well-facilitated group participation, the important point is that both these loops have to be facilitated for optimal cross-pollination. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 325 the nearer to the epicentre (the diamond in the centre), the higher the applicability of high precision science. closer to the epicentre of the model is the only area where continuous learning is not required, because of low complexity and low randomness. in such cases the problem is too simple to establish a process of policy and analytical learning. in situations where the problem under observation is too unorganised to attempt a process of learning, short-cut averages could be used to indicate the macro direction of the system, but at the expense of learning about the key levers of control, change and constraints. this conceptual framework illustrates a range of key concepts when dealing with complex and dynamic environmental problems. such types of problems would require continuous learning systems, on both the theoretical and political level and in interaction with each other. in cases of complex and dynamic problems, theoretical studies should be infonned by political variables as well and political learning processes should be facilitated as much as possible to optimise on available theoretical infonnation. a few pertinent questions on especially the economic approach to environmental policy remain. what does the mllf mean for the economic approach to environmental policy? what are the key learning points of the suggested policy learning framework for economic theories on policy making? a few issues are highlighted: to base economic approaches to policy making on positive scientific approaches alone impedes the ability to reach the best solutions for complex and dynamic problems. economic theories on the environment are by definition not scientifically objective. they are based on various different normative premises. the nonnative points of departure of various economic theories on the environment are critically examined in an interactive policy learning framework. economic approaches to environmental policy making are partial representations of reality. the results of such studies are placed in a facilitation process and allocated to the type of problem at hand. studies that, for instance, demonstrate the relative costs and benefits of alternative approaches to environmental policy making have the highest value in settings where uncertainty and polarisation of environmental problems are minimised. solutions to complex and dynamic environmental problems should not be sought in the linear internalisation of external effects alone, but supported and infonned by a process of interactive learning and feedback. the focus on the first instance, shifts from internalisation of external effects inside the system to the internalisation of the policy making process itself in r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 326 sajems ns vol 5 (2002) no 2 addressing complex and dynamic environmental problems. economics and politics are complementary elements in the design of policy for complex and dynamic environmental problems. the opposing policy advices from various theories on economyenvironment interactions are counterproductive. these theories depart from implicit pre-analytical frameworks that do not represent any notion of truth-values by definition. rather than building theoretical power blocks on the basis of different economic approaches to environmental policy, the challenge is to develop and apply the most relevant approaches in the right problem context. in effect, it is a move away from a universal fit of a particular theory on economy-environment interactions to one of contextual design. economic approaches to environmental policy can be leveraged to their highest use when integrated in a well-designed group facilitation process. these processes should at least intemalise the following issues 7 : the normative points of departure of interest groups and different theories (partial interpretation of reality) the wide range of scientific, economic and political theories on addressing such a problem (type of uncertainty) the different interest groups and their values (level of polarisation) the spatio-temporal scale (context) of the problem at hand and the best theoretical fit to these problems (type of complexity). in short, the mllf does not exclude economic approaches to environmental policy, but is a meta-level process that facilitates the application of such economic approaches to their best use. the important learning points for policy making on complex and dynamic environment problems are that policy makers have to recognise that analysis of the problem will be a learning process unless the type of problem is too simple to justify learning. the policy makers' choice is: to slice complex and dynamic environmental problems into simple parts, but at the same time have a well designed policy learning process in place to internalise and facilitate partial analytical results. this choice will be biased towards certain normative criteria (e.g. economic efficiency, sustainability) employed within analytical recommendations, but these are at least placed within the context of a broader model of policy learning. to have an interactive multiple-loop policy learning framework in place that optimises on learning from the cognitively focused analytical learning cycle and the practically focused policy learning cycle. the choice of a policy design process for complex and dynamic environmental problems will have to be measured against the relative transactional costs of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . samms ns vol 5 (2002) no 2 327 such a process. although the benefits of an interactive learning process, as illustrated by the mllf, has been pointed out, the further practical question remains what the costs of alternative systems will be. this is a question for further research. 6 opportunities and limitations of policy design process in the case of climate change the direction of economic policy for global climate change is largely summarised in publications from the ipcc, especially those of the working groups on mitigation options (bruce, lee & haites, 1996; ipcc, 2001). at the time of writing the latest ipcc working group iii (wg iii) contribution to the third assessment report has been accepted, but not approved in detail. nevertheless, the ipcc's line of thought in this document on economic policy issues could be taken as starting point for an evaluation. the evaluation is focused on the issue of policy making and decision making on climate change. the pertinent question used as point-of-departure in this review is: what framework is used for approaching mitigation policy on climate change? this question would inevitably produce an answer that could be compared with the mllf approach, on a conceptual level, as proposed in the previous section. the ipcc wg ill's terms of reference have been to assess the scientific, technical, environmental, economic and social aspects of the mitigation of climate change. although the mandate has been expanded from a disciplinary assessment of the economic and social dimensions of climate change in the second assessment report (sar) to an interdisciplinary assessment of the mitigation options in the third assessment report (tar), this excludes explicit reference to interaction between cognitive analysis of mitigation options and practical policy making processes. the ipcc is very careful to distinguish that it does not make any policy, but only assesses research that is 'policy-relevant'. although research is a political process, the idea is that policy decisions are made in the unfccc cop process, and not by the ipcc8• however, despite possible arguments to broaden the mandate, some useful information in answering the question which approach to economic policy making has been followed, could be found in ipcc wg iii material. the following issues are evaluated more specifically: the nature of the mitigation challenge the implementation of mitigation options supportive decision making r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 328 sajems ns vol 5 (2002) no 2 6.1 the nature of the mitigation cbauenge following the second assessment report (sar) (bruce, lee & haites, 1996), the next !pee wg ui has received the mandate to include equity and sustainability concerns in the assessment. this is a better representation of complexity in the evaluation framework used. however, such an endogenous approach increases the complexity of the system under observation. it has been emphasised in this paper that learning about such complex systems has to be facilitated. this means a well-balanced approach between the practical process of learning and the cognitive content oflearning. however, the ipee wg ui line of thinking is to redefine the nature of the mitigation challenge in terms of its complexity focusing mainly on the content of the problem, but the process of achieving such learning is not elaborated on in detail. in short, the focus in dynamic complex problems is changing from an understanding of the nature of the problem to support policy making towards an interaction with policy makers and other actors in a dynamic policy making process. it is recommended that economic policy makers on climate change evaluate the applicability of results in the science of complexity and its application to policy making processes. the approach to uncertainty and irreversibility taken in ipee wg ui work would largely determine whether one would accept decision analytical tools or more processional approaches to inform mitigation policies for climate change. in any situation where time is treated as asymmetrical, one can talk about some type of implied irreversibility. whether future events are perceived to be predictable depends on this type of irreversibility. unpredictable processes are those where novelty is emerging over time or where there is an unknown end to future activities. the question relevant for the !pee wg ui work is which type of irreversibility should be used for decision analysis of various problems related to mitigation policy. an analysis of some issues at certain spatiotemporal scales might be too uncertain to employ probabilistic outcomes. in such cases, it would be an option to acknowledge complexity and manage the problem-solving process accordingly. when the design of mitigative policies is formulated as an open-ended., soft system, an interactive learning process can provide various inputs for problem solving in the face of uncertainty 'and irreversibility. 6.2 the implementation of mitigation options the assessment of alternative policy instruments in terms of specific criteria is an open-ended debate. the design of optimal policy mixes is, in practice, often still static in orientation and dependent on the chosen normative criteria, such as economic efficiency or sustainability. despite a recognition in !pee wg ui work of the importance of interest groups and policy makers themselves in the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 329 design of policy instrwnents, an analysis of the policy design process that underlies the selection of criteria and the relative weights attached to these criteria in a learning framework, is an omission in this work so far. the increased complexity of policy design for climate change (number of policy instruments, number of criteria, number of actors) raises questions on the analysis of such processes. it is recommended that the option of viewing the problem as an interactive learning process that needs to be facilitated in the best way possible, be evaluated. 6.3 supportive decision making there is no clear, unified, philosophical, theoretical or practical framework that could guide policy making in all aspects of policy design. various decision support tools do exist, but neither on its own would provide a comprehensive overview and recommended action on policies for climate change. ipcc wg iii acknowledges this and makes a sensible, reserved judgement on the usefulness of these tools. however, the challenge remains to develop a systematic policy design process that utilises these tools in the right context answering the right questions at the right time. again, the right balance between the cognitive content of decision-making tools and the practical process wherein these tools are utilised, is one worth exploring. the discussion on decision-making frameworks is limited to providing advice to policy makers that excludes interactive learning processes between cognitive analysis and practical policy making processes. at best, the process of international agreements is analysed in terms of the design of a framework for institutions or to look at procedures of decision making at various levels. although these are important contributions in their own right, a facilitated learning process that makes the most of cognitive inputs and provides inputs for further cognitive development, is an omission in the focus on an analysis of policy options as such. it is recommended that the focus of research on process analysis is broadened from an analysis on the links between policy options and the structure of agreements to one where the parameters for best cognitivepractical interaction are spelt out and implemented. an additional research question would therefore be: how can one best facilitate the interactive process oflearning on mitigation policies for climate change? 7 conclusions in this paper it was attempted to formulate a conceptual framework for economic policy making on complex and dynamic environmental problems. such a framework has been proposed in the form of a multiple-loop learning r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 330 salems ns vol 5 (2002) no 2 framework (mllf). the multiple loops consist of a practical policy making leaming framework, and a theoretical analytical learning framework. these leaming processes influence each other. the processes of learning on both levels need to be facilitated and informed by tools such as group model building and systems dynamics models. an attempt to understand a problem is limited to situations of low complexity and low randomness, such as non-living, engineering systems, consumer choices between a small number of products and the growth of a plant under controlled conditions. an attempt to ex ante understand a dynamic and complex public policy issue, such as economic policy making in the case of climate change, with large nwnbers of interest groups and different value systems, different cognitive frameworks (for example different scientific, economic and public policy theories), different spatio-temporal scales and many possible policy instruments, would underestimate the unpredictability and novelty inherent in complex systems. an evaluation of developments in the approach to economic policy on global climate change reveals that it falls short in approaching as a complex and dynamic environmental problem in the first place, as would be evident through an interactive policy learning process. although the complexities of the problem are more and more intemaiised, there is no real learning process that places these ideas into the right context. the decision analytical tools that are developed are often focused on complex, but closed systems. in addition, normative criteria, such as economic efficiency or sustainability, can play an important role in shaping the debate, but it is evident that the debate on economic policy for global change often resorts to counterproductive theoretical infighting as based on different a priori chosen criteria. the selection of criteria for further analysis, however, should be the result of an interactive learning process, as reality is larger than these theories can comprehend it is therefore recommended that the apphcatiod of interactive learning frameworks to real-world economic policy making for complex and dynamic environmental problems is an area for further research. endnotes this paper is largely based on the author's d.com thesis and funding from the csir is gratefully acknowledged. 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(1999) "twenty laws of complexity: science applicable m organisations", systems research and behavioural science, 16(1); 3-40. 74 wolfenden, j. policy analysis for ecologically sustainable development research outline for ph.d. internet: http://wwwpersonal.une.edu.aul-jwolfendljawsphd.htin. access: 23 august 2000. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . f:\ejour\ecoman\ftp\ecoman_v6_n1.prn.pdf sajems ns vol 6 (2003) no 1 99 strategic supremacy in the hypercompetitive 21st century ________________________________________________________________ j g kotzé potchefstroom business school, potchefstroom university for christian higher education ________________________________________________________________ abstract the dawn of the 21st century has given rise to a new competitive paradigm; brought about by globalisation, information technology and biotechnology developments and the work force revolution. this article identifies the shortcomings of traditional approaches to strategy formulation as measured against the demands of this evolving paradigm. the development of high potential strategic positions, the building and refining of distinctive competencies, the strengthening of strategic fit relationships, the maintenance of balance between the requirements of old and new business and the establishment and maintenance of a strategic thinking and learning culture are building blocks of strategic supremacy in the hypercompetitive 21st century. jel l00 introduction numerous authorities in the field of strategy formulation have noted the rapid escalation of competition, not just in fast-moving, high-tech industries, such as information technology, but in almost all sectors of the global economy (d’aveni, 1995: 54; hamel, 1996: 70; beinhocker, 1999: 96; abell, 1999: 74). this has resulted in the term “hypercompetition” appearing more frequently in the strategy literature (porter, 1996: 61; d’aveni, 1999: 128; abell, 1999: 74). this competitive situation is characterised by intense, vigorous, even savage competition, the near-impossibility of sustaining competitive advantage and a virtual state of business war (d’aveni, 1995: 54); a competitive environment becoming increasingly demanding and unforgiving on a global scale (zahra & o’neill, 1998: 36); disappearing barriers to competition as regulation eases (porter, 1996: 61); the dynamic reinvention of entire industries (hamel, 1996: 69) and a business environment in which the past is not a reliable guide to the future (beinhocker, 1996: 97). sajems ns vol 6 (2003) no 1 100 how should strategy be formulated in such a competitive environment? is sustainable competitive advantage achievable at all in these circumstances? this paper attempts to address these questions and to develop some key guidelines to guide strategy formulation processes at the start of the 21st century. before these issues receive attention, however, the new competitive paradigm which has evolved out of late 20th century trends in globalisation, information technology and biotechnology developments, as well as the work-force revolution, requires closer scrutiny. the new competitive paradigm organisations entering the 21st century obviously face great uncertainty. courtney & kirkland (1997: 68) identify four uncertainty levels, with the highest turbulence and unpredictability being found in levels three and four. the trend in most industries in the new century appears to be a shift towards level 3 and 4 environments (d’aveni, 1995: 55; 1999: 128; zahra & o’neill, 1998: 36; hamel, 1996: 70). another key characteristic of the new business environment is globalisation. according to bolt (2001: 37), technological developments continuously drive convergence which, in turn, is pushing markets toward global commonality. this trend reinforces a global mindset in the 21st century management team. the new paradigm emerging from these developments seems to place great emphasis on the following competitive attributes: • value though organisations are often viewed and described in terms of the products and services they sell, these products and services are actually only purchased for the value they provide. customers worldwide are demanding better quality at lower prices. according to d’aveni (1995: 57) organisations adept in the new paradigm’s evolving requirements, prioritise customers as the most important stakeholder. they continuously attempt to create and maintain the ability, even if only temporarily, to provide better service than that of their competitors. success in these competitive efforts may lead to a powerful new definition and enhancement of the dominant value proposition in the industry (d’aveni, 1999: 127). sajems ns vol 6 (2003) no 1 101 • innovation reinvention is the goal: continuous improvement of products and services, business operations and organisational processes has become the basis for creating greater value for the customer, while also increasing organisational productivity. only those organisations with the ability to adapt timeously and pro-actively to new market challenges, will be able to sustain their competitiveness. d’aveni (1995: 58) identifies, as critical, the ability of the organisation to predict future trends, to exercise some control over the development of key technologies and knowledge that will shape the future and to create self-fulfilling prophecies. hamel (1996: 71) identifies “true strategic innovation” as the cornerstone of a successful strategic quest to redefine the industry, to invent the new by challenging the old. • time and mobility the ability to make decisions quickly, is critical. using customer value as a focal point for action, organisations now increasingly stress swift response to customer demands. this requires shorter design and product/service life cycles. the emphasis is not just on shorter time cycles, but also on correct timing. this requires mobility, speed, surprise and agility from organisations (d’aveni, 1995: 58; zahra & o’neill, 1998: 36). for players in highly competitive environments, the ability to move swiftly from one temporary competitive advantage to the next, may be the only sustainable basis of competitive advantage. • flexibility in a hypercompetitive world, an organisation has to seize the initiative; in order to be successful, it gains business by being light and fast on its feet. the new competitive paradigm downplays the importance of size and scale advantages; it is much more important to be fast and innovative. this enables the organisation to switch competitive positions and stances quickly and effectively as environmental and competitive conditions change. • knowledge and intellectual capital ideas and information are the driving forces of the new economy. in successful organisations, core and distinctive competencies cut across divisional boundaries, allowing management to understand the appropriate strategic paradigms and to compete in vastly different competitive industries. this has become a critical strategic skill in the new century as more industries become knowledge-intensive and globalised (d’aveni, 1999: 129). sajems ns vol 6 (2003) no 1 102 the intellectual capital of the organisation must be enhanced, protected and dynamically redeveloped as industry trends dictate. efforts by industry players or new entrants to change the dominant value proposition, may downgrade or destroy existing competencies. downgrading occurs when the existing key success factors are changed; when the definition of value and quality is redefined; when industry boundaries are blurred by competitive actions destroying entry barriers and forcing industry convergence. a logical concern surfacing at this point is whether established strategy formulation processes can successfully address the issues raised by the new competitive paradigm. traditional strategy formulation processes at the business-unit level, the trends outlined in the preceding sections, have led to the situation where the majority of managers frequently express dissatisfaction with their organisation’s planning processes. strategy formulation has also become problematic at the corporate level (campbell, 1999: 41; collis & montgomery, 1995: 118). a common complaint is that strategic planning is too static and too slow. on the corporate level, strategy frequently destroys rather than enhances the value created by the business divisions. pfeffer and sutton (1999: 50) also point out that the key to strategic success is action translating knowledge, experience and insight into meaningful action, which creates value. many strategic planning processes yield a vast amount of talk, ideas and insights. a disappointingly low percentage of these ideas are finally transformed into effective action. to pinpoint the reasons for this unfortunate state of affairs, a closer look at the established strategy formulation process at the business unit level, is necessary. an effectively formulated and implemented business strategy for the single business (industry) organisation, or for the individual business unit within a multi-business organisation, should ultimately lead to sustainable competitive advantage. in this quest, the typical business strategy formulation process links relevant internal factors in the form of strengths, weaknesses, executive ambitions, values and objectives with relevant external factors in the form of macro-environmental trends, industry-driving forces, antic ipated competitive actions, opportunities and threats, as well as benchmarked best practices of competitors. out of these linkages, a number of strategic action plans are developed and implemented. the objective of this exercise is to position the sajems ns vol 6 (2003) no 1 103 organisation as optimally as possible for the anticipated future, and to work towards sustainable competitive advantage. against the evolving requirements and challenges of the 21st century competitive paradigm identified in the previous section, four major shortcomings of this process can be identified. • not nearly enough emphasis on the intellectual capital, in the form of core and distinctive competencies, of the organisation. in addition, the strategic potential of the learning organisation is overlooked. • a passive approach to strategy formulation. the focus is on the maintenance and future development of existing internal resource capabilities, strengths and skills while waiting for the appearance and realisation of anticipated opportunities, favourable driving forces and opportunistic competitive developments. this approach obviously has severe limitations against a backdrop of continuous and turbulent change. • typically, a mixture of the three generic competitive strategies of cost leadership, differentiation and a focus on niche markets is utilised in the attempt to secure sustainable competitive advantage. unfortunately these strategic initiatives, if successful, may allow the organisation to stay in the industry, but will rarely lead to a leadership position within the dictates of the new competitive paradigm. low prices, high quality, good service and other traditional competitive initiatives are market entry and market maintenance requirements today; they do not confer sustainable competitive advantage. • the process of benchmarking does provide interesting insights during the planning process. it also frequently misleads and distracts, locks the organisation into low ambitions and focuses the management team on operational effectiveness instead of real strategic issues (porter, 1996: 61; campbell, 1991: 41). the conclusion that traditional strategic planning philosophies and processes generally fail to create sustainable competitive advantage leads to a reexamination of this desirable outcome. sustainable competitive advantage in the 21st century the essence of a good strategy has always been, and still is, to develop and exploit insights to create value. sustainable competitive advantage requires management to discover, understand, document and exploit insights into ways of creating more value than that of their competitors (campbell & alexander 2000: 42; porter, 1996: 62). this also contributes significantly to the financial market sajems ns vol 6 (2003) no 1 104 test of investment decisions that lead to greater shareholder wealth (amram & kulatilaka, 1999: 95). market discipline also implies that organisations can sustain a competitive advantage for only that length of time that the products or services they sell have attributes that correspond to the key buying criteria of a large number of customers. “sustained competitive advantage is the result of an enduring value differential between the products or services of one organisation and those of its competitors in the minds of customers” (duncan & ginter, 1998: 8). for some authorities, the essence of sustainable competitive advantage lies in strategic positioning. an organisation identifies one or more attractive industries and positions itself as advantageously as possible within these industries. it then attempts to achieve sustainable advantage by delivering greater value to customers or to create comparable value at lower cost, or to do both (porter, 1996: 62). according to this view, an organisation outperforms competitors if it can establish a difference which it can sustain. it develops a unique strategic position by performing different activities than those of competitors, or by performing similar activities in different ways. other authorities regard strategic positioning as too static for the dynamic markets and changing technologies of the 21st century. for them, sustaining a competitive advantage has become more a matter of movement, mobility, ability to change and speed than that of location or position (duncan & ginter, 1998: 8). the key enabler of sustainable competitive advantage, according to this view, is provided by a solid intellectual capital foundation. this foundation is constructed by acquiring and building resources, abilities and competencies that link closely to the changing requirements of the external environment, are difficult to replicate, are deeply embedded in the organisations culture, thought processes and ways of doing and that are integrated in innovative ways. these resources and competencies are dynamically redeveloped and redeployed as circumstances change and new opportunities arise in other markets and industries. the essence of sustainable competitive advantage in the 21st century is probably found in the creative combination of both of these viewpoints. a unique strategic position, innovatively maintained, will confer short-term advantage. sustaining it over the long term will probably require movement − a dynamic repositioning strategy to create tomorrow’s competitive advantage faster than competitors can copy the one the organisation possesses today. with all of the foregoing trends, issues and challenges as background, the next section will attempt to develop seven guidelines to assist in the formulation of winning strategies in the 21st century. sajems ns vol 6 (2003) no 1 105 formulating winning strategies: guidelines winning organisations of the future will assume leadership positions within the structure of the new competitive paradigm, by being: • fast • friendly • focused, and • flexible (d’aveni, 1999: 133) in pursuing these desirable characteristic s, they will formulate winning business strategies, which • are well suited/appropriate to the future demands and characteristics of the macro, as well as the operating environment of the organisation • contribute to sustainable competitive advantage, and • lead to superior financial results (thompson & strickland, 2002: 68-69). to achieve this, the business strategies of winning organisations will incorporate the following processes, strategic action steps and philosophies: • strategic positioning and repositioning porter (1996: 62) identifies activities as the basic units of competitive advantage. he points out that strategic positioning implies the performing of activities which differ from those of rivals or performing similar activities in different ways. according to this viewpoint, competitive strategy entails the deliberate choice of a different set of activities to deliver a unique mix of value. the choice of activities leads to the creation of a unique and valuable strategic position in the industry. markides (1999: 56) reinforces this view by describing the essence of strategy as the selection of a certain position which a company can claim as its own. “a distinctive strategic position that differs from those of competitors”. day (1997: 96) claims that numerous organisations have enjoyed “protected prosperity” over the years in their unique strategic positions. this has been brought about by isolating mechanisms, which he identifies as competition-deterring market factors, such as protected niches within the industry. afuah (1999: 100) identifies three strategies available to organisations for protecting their strategic positions over time: sajems ns vol 6 (2003) no 1 106 • blocking: the erection and creative maintenance of entry barriers and continual efforts to prevent competitors from imitating innovations and other unique activities; • running: frequent introduction of new products/services and cannibalisation of existing products/services. this strategy corresponds with d'aveni's (1995: 55) creation of industry conditions of constant disequilibrium and change; with hamel’s (1996:71) view of strategy as continuing revolution; with d’aveni’s (1999: 128) continuous redefinition of industry rules establishing a pattern of stability punctuated by disruptions and with beinhocher’s (1999: 97) array of robust adaptive strategies, which are constantly in a state of flux, and allows the organisation to maintain a portfolio of strategic options over time. • collaborative teaming: leveraging of own resources and competencies by teaming up with other organisations to create more stability in its strategic position by, for instance, establishing an industry standard or dominant design. the aligning, re-aligning and fortifying of competitive assets with changing industry characteristics can also be employed to protect existing strategic positions (dewar & frost, 1999: 120). in the hypercompetitive conditions of the 21st century, however, most strategic positions are vulnerable. uniqueness is transitory and new strategic positions are emerging continually (markides, 1999: 58). this author provides a good prescription for a dynamic positioning strategy, under extremely uncertain conditions, which may serve as the first guideline for strategic supremacy: guideline 1 in highly-competitive, 21st century conditions: • identify, exploit and protect a distinctive strategic position in an attractive industry; • continuously search for new strategic positions in established, as well as other industries, on a national as well as an international level; • manage and balance the shifting requirements of both positions simultaneously; • make a well-managed transition to the new strategic position, and then • start the cycle again. sajems ns vol 6 (2003) no 1 107 • exploiting strategic fit relationships a contribution to sustainable competitive advantage in the new competitive paradigm, may be found by means of the improved management of linkages, either internally in the organisation or externally in the industry value chain. the combined strategic focus on network and linkage management, views industry structure and functioning not as a given, but as a variable that can be exploited in the quest for advantage. porter (1996: 70) stresses the importance of fit because discrete activities often affect and complement one another in ways that can create value. competitive advantage results from the unique ways in which activities fit and reinforce one another. sustainability of this advantage comes from locking out imitators by creating an activity chain that is as strong as its strongest link. this author (1996: 71) describes strategy specific fits as adding the most value, due to its ability to enhance a strategic position’s uniqueness. they also substantially reduce cost and increase differentiation. value is also added in the value chain. according to fisher (1997: 108) the critical decisions to be made regarding inventory and capacity concern the position in which they should be placed in the value chain in order to hedge against uncertain 21st century demand. he also stresses that suppliers should not be chosen based on low cost considerations. the new century requires speed and flexibility from suppliers in the value chain. guideline 2: in highly-competitive, 21st century conditions: • search on a continuous basis for linkages and fits between all activities of the organisation. identify better ways of managing these linkages, especially when industry conditions and market requirements change. fit can be exploited to create, contributions to competitive advantage, difficult to imitate. • analyse and evaluate the industry value chain and changes in chain structure, arrangements and functioning. an effective, responsive and flexible value chain is a major contributor to sustainable competitive advantage. • establishment of a strategic thinking culture zahra & o’neill (1998: 39) make the point that emerging problems and issues of the new century require a different mindset. the past does not always reveal sajems ns vol 6 (2003) no 1 108 the solutions to new problems. this poses challenges to the established strategic ways of thinking in the organisation. the ability to think beyond the established paradigm in the industry, and the skill to think in a new and a non-linear way, are required by the challenges of the new competitive paradigm. the cited authors (1998: 43) develop a convincing case that “strategic thinking requires an understanding of the subtle blinders imposed by culture and strategy, and the links between thought, action and reaction”. it should become a habit within the organisation to think and talk about different aspects related to strategy on an ongoing day-by-day basis. strategic thinking is not about establishing correct or optimal solutions, but about understanding complex relationships, ongoing change and uncertain futures. notions of strategic stability have been replaced by an emphasis on strategic change and correspondingly, the notion of the search for the optimal strategy has been overtaken by the concern for a strategy which will work and can be implemented. mintzberg (1987: 66) poses the following challenge for the corporate strategist: “knowing the organisation’s capabilities well enough to think deeply enough about its strategic direction”. strategic thinking is the link between what he describes as a past of corporate capabilities and a future of market opportunities, between thought and action. he also points out that the notion that strategy formulation is something which is done at the highest organisational level, far removed from the day-by-day details and challenges of running the organisation, is misguided. strategy development needs to involve a wide and deep cross-section of managers. what is required throughout the organisation, is to develop a capacity to work together to question, debate and innovate. this requires that managers at all levels be indoctrinated in the art of the strategic conversation. the strategic audit is one of the more effective ways to start the strategic conversation. in conducting a strategic audit of the present strategic situation, the groups of managers think strategically by asking the right questions about their department, division or the entire organisation. gadiesh & gilbert (1998: 141) expand the focus of the strategic conversation by an interesting perspective on the current and future profit pool in the industry. they argue compellingly that an intimate understanding of profit pool dynamics can help guide important decisions about every facet of an organisation’s operation and strategy. it contributes to good strategic thinking by placing that thinking on a solid foundation. christensen’s (1997: 41) research has found that strategic thinking is not a core managerial competence in most organisations. this finding is reinforced by hamel (1996: 70) and further amplified by his contention that the strategy formulation process in most organisations is too elitist, harnessing only a small proportion of creative talent and potential. he argues that the top management level sits atop the pyramid of experience. however, experience is valuable only sajems ns vol 6 (2003) no 1 109 to the extent that the future is the same as the past an unlikely situation in the new century. only a broad and deep engagement of human talent in the organisation will ensure a democracy in strategy formulation, buy-in to the agreed upon strategic direction and unleash true revolutionary and innovative ideas and strategic options. in this way senior management will “supplement the hierarchy of experience with a hierarchy of imagination”. guideline 3: in highly-competitive, 21st century conditio ns: create, maintain and reinforce a strategic thinking culture on as many organisational levels as is practically feasible. the end result should be a manager/supervisor/other employee who thinks about strategic issues, and contributes to strategic value creation on an almost continuous basis. this orientation should become a normal part of everyday business and operations: part of “the way we do things around here”. • development of a learning mindset strategic thinking is closely linked to notions of organisational learning. the concept of the “learning organisation” refers to the creation of circumstances, climates or conditions in organisations which encourage, support and reward the development and learning of its people. organisational learning is strengthened by a culture which tolerates and encourages “new mistakes” and by competition. as organisational members learn to overcome specific competitive challenges, they develop potentially valuable resources and capabilities. zahra & o’neill (1998: 39, 40) raise an interesting point suggesting that homogeneity and stability in organisational teams usually foster less learning. the corollary is that heterogeneity and instability (up to a critical threshold) lead to more learning. they also stress the importance of developing strategic flexibility by preserving, developing and deploying intellectual capital in areas of the organisation’s core competencies. when industry and competitive conditions change, however, a new challenge for the organisation is to develop the ability to abandon traditional core competencies and to replace them, timeously, with new ones. the critical linkage between industry prescience and dynamic, proactive flexibility, is underscored by this point. starkey (1998: 116) identifies knowledge as a key concern of management in the new century. he quotes thurow, who writes that “the dominant competitive weapon of the twenty-first century will be the education and skills of the workforce” and bennis who argues that “the major challenge for leaders in the twenty-first century will be how to release the brainpower of their sajems ns vol 6 (2003) no 1 110 organizations”. hamel & prahalad (in starkey, 1998: 116) identify learning and competence as the fundamental strategic building blocks in the creation of a strategic architecture that links the present with the future. they conclude that competitive advantage will accrue to those organisations that succeed in proactively and speedily building new competencies in new opportunity areas. zack (1999: 125-7) stresses the link between organisational strategy and the management of knowledge. the organisation’s strategic context assists in the identification of knowledge management initiatives which can contribute to competitive advantage. he also identifies knowledge as the most important strategic resource in the 21st century, as it enhances the organisation’s fundamental ability to compete. cummings & worley (2002: 515) discuss the processes of organisational learning, which enhances its ability to acquire and develop new knowledge, and knowledge management, which focuses on how that knowledge can be organised and utilised to improve performance, and be a source of strategic renewal. inkpen (1998: 69) leverages the strategy-enhancing potential of the learning organisation by the unique learning opportunities created by national and international strategic alliances. he (1998: 70) expands on this by describing the requirements for the creation of a successful alliance learning environment. teece (1995: 57-8) stresses the potential of learning and knowledge as a contributor to the sustainability of competitive advantage, as knowledge assets are usually inherently difficult to imitate. he points out that there are increasing returns associated with effective learning and knowledge management. guideline 4: in highly-competitive, 21st century conditions: • acquire, integrate, store, share and apply critical knowledge, especially context-specific, tacit knowledge embedded in the organisation’s operations, processes, routines and activities. • circulate and utilise this knowledge as widely and broadly as possible to capture the increasing returns associated with its utilisation. • recognise and exploit effective, organisational learning and knowledge management as the most important source of sustaining competitive advantage in the new century. sajems ns vol 6 (2003) no 1 111 • balanced management of new as well as old business in line with a preceding guideline which advocated that organisations have to manage a present as well as a desirable future strategic position, managers have to creatively balance the shifting requirements of new, as well as old business. abell (1999: 73-6) argues that excellence in the new economy requires dual strategies from organisations, one for the present and one for the future. furthermore, these are not sequential, but parallel responsibilities. excellence in old business requires a clear, precise definition of the business, a focus on shaping up the business to meet the needs of today’s customers, seeks to achieve close fit in an organisation’s functional activities with the chosen old business definition and requires an organisation structure that mirrors current business opportunities. in contrast, excellence in new business is concerned with the way in which the business should be redefined for the future. reshaping the business to compete effectively in the future may entail major changes from the existing business paradigm and may require significant structural changes to the organisation structure. the above conflicting requirements placed upon the shoulders of each senior manager frequently causes ambiguity, stress and sub-standard performance (usually in terms of new business). the dual focus has to be institutionalised and managed effectively to decrease these negative outcomes. guideline 5: in highly-competitive, 21st century conditions: instill, maintain and reinforce (reward) a dual strategic focus on the appropriate organisational levels to elicit the highest possible performance over time, in both established (old) business (a valuable and profitable present) as well as new business (a prosperous future). • establishing resources and competencies as the cornerstones of strategy resources, capabilities and competencies have been mentioned throughout this article. stalk & evans (1992: 55) identify capabilities-based competition as critical to success in the new economy. they claim that successful competitors focus their managerial attention on the infrastructure that supports hard-toimitate capabilities that consistently provide superior value to the customer. sajems ns vol 6 (2003) no 1 112 these authors (1992: 58) define a capability as a “set of collective and crossfunctional business processes strategically understood, and connected to real customer needs”. collis & montgomery (1995: 119-20) expand on this view by claiming that an organisation will be positioned to succeed if it has the best and most appropriate stocks of resources for its business and strategy. they define resources to include both, tangible and intangible assets including capabilities, competencies, know-how and brand names. they conclude that superior performance will be based on “developing a competitively distinct set of resources and deploying them in a well-conceived strategy”. collis and montgomery’s suggested approach to competing on resources in the new economy, may serve as the sixth guideline for strategic supremacy: guideline 6: in highly-competitive, 21st century conditions: • resources which pass the following five tests must be developed, upgraded and utilised as the basis for an effective, value-adding strategy: inimitability: is the resource difficult to copy? durability: how quickly does the resource depreciate? appropriability: who captures the value that the resource creates? substitutability: can a unique resource be trumped by a different resource? competitive superiority: whose resource is really better? • these valuable resources should form the basis of strategies which should be leveraged into attractive industries, where they can contribute to competitive advantage. • building and refining distinctive competencies during the resource and competence creation process, a significant portion of the strategic team’s time should be devoted to the development of the strategic architecture of the organisation. such architecture consists of the • present core competencies, • potential core competencies, and • required core competencies sajems ns vol 6 (2003) no 1 113 of the organisation. core competencies are the specific collective competencies (skills) of the organisation in the form of • intellectual capacities, • collective experience and skills and • specialised knowledge. that integrate diverse production and service rendering skills and multiple technology streams. this results in products/services that supply demonstrable client value in a unique fashion, and achieves sustainable competitive advantage in a particular segment of one or more industries. to achieve the full potential of core competencies, an organisation requires effective management systems to integrate seamlessly across organisational boundaries. closely tied to the strategic architecture of the organisation is the management and nurturing of its network. it does not have to incur the prohibitive expenses associated with the maintenance and upgrading of a complete inventory of resource capabilities and core competencies. it can focus on the “core business” and source the remaining required competencies, capabilities and support services from its national and international network partners. in this manner, collaboration agreements can be used to leverage internal resources, skills, capabilities and competencies. meyer & semark (1996: 96) claim that core competence is recognised as the competitive advantage gained from a capability which lies behind the products that serve the market. they compellingly argue that “in the boundaryless world of the emerging global economy, and the universal availability of information, competency at individual, organisational and national levels will become the currency of the 21st century” (1996: 102). prahalad & hamel in thomas, pollock & gorman (1999: 72) provide a link between competence and learning by stating that core competencies are the outcome of collective learning in the organisation. they suggest that organisations which successfully identify and cultivate their core competencies can utilise them to obtain a sustainable competitive advantage. according to thomas, pollock & gorman (1999: 72-3), competence-based competition begins at the organisational level and focuses on its distinctive capabilities relative to competitors. collis & montgomery (1995: 123) advocate subjecting the organisation’s core competencies to a harsh external market assessment of what it does better than competitors. any competence passing this test is known as the distinctive competence of the organisation. a distinctive competence is, accordingly, something an organisation does extremely well, relative to competitors. it’s contribution to sustainable competitive advantage is obvious. sajems ns vol 6 (2003) no 1 114 guideline 7: in highly-competitive, 21st century conditions: • the intellectual capital, in the form of core competencies arranged in a strategic architectural framework of the organisation can be deployed and redeployed to contribute to sustainable competitive advantage, as market opportunities dynamically open, close, grow and shrink. • constant efforts should be directed at refining one or more of these core competencies to the point where it leads to the organisation performing the activities flowing from that competence, significantly better than competitors do. this becomes a distinctive competence of the organisation and enables it to build and sustain competitive advantage. conclusion in this article, the highly desirable outcome of strategic supremacy (sustainable competitive advantage) was discussed and analysed. the problems and challenges confronting organisations pursuing this outcome in the very competitive 21st century were identified and discussed. a list of seven guidelines was developed. these guidelines, derived from the newest thinking in the strategic management literature on the topic of competitive advantage in the new economy, should contribute to a 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(1998) “charting the landscape of global competition”, academy of management executive, 12(4): 13, http:// www-sa.ebsco.com. downloaded: 2001-10-23. sajems ns vol 5 (2002) no 3 549 sales call anxiety: investigating the role of fear in a selling situation g g rousseau and l jansingb department of industrial psychology, university of port elizabeth abstract the main objective of this study was to investigate sales call anxiety (sca) amongst insurance sales staff in port elizabeth. the study was based on past research and uses a modified questionnaire developed in previous research. the sample (n=112 sales persons) was drawn using a simple random sampling technique. results confirm four dimensions of sca identified by verbeke and bagozzi (2000), namely negative self-evaluation, negative evaluation from clients, physiological symptoms and protective actions. significant differences in sca between black and white salespeople were further observed. these findings have important implications for training of salespeople. jel j28 introduction sales cali anxiety (sca) can be defined as a fear of being negatively evaluated and rejected by clients, and is accompanied by urges to avoid contact with clients or, when contact is made, to refrain from interacting effectively and asking for a commitment (verbeke & bagozzi, 2000). ray (1995) maintains that sca is prevalent in selling situations and will reach intense levels for up to 40 per cent of salespeople at some point in their careers. some people take the refusal of their products and services personally while others consider themselves failures if they do not make a sale every time (clarke & randall, 1995). cognitive theorists (beck, 1985; powell & enright, 1990) believe that it is not events or problems that cause anxiety but rather the individual's interpretation of these events that may lead to anxiety problems. research conducted by verbeke and bagozzi (2000) indicates that sca consists of four dimensions, namely negative self-evaluations, perceived negative evaluations from clients, physiological responses and protective actions. negative evaluations of one-self may occur during cold calling (canvassing) or closing of a sale. concerns about past failures, negative images of the self, anticipated sales encounters and exaggerated considerations of what can go r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 550 sajems ns vol 5 (2002) no 3 ----------~-.---~---------~-wrong during the sales encounter, are what bring about these negative expectations of the self. with regard to imagined negative evaluation from clients, savitsky, epley and gilovich (2001) report that socially anxious people commonly exaggerate fears of public failure or social mishaps by failing to consider the wider range of situational factors that tend to moderate onlookers' impressions. research by monfries and kafer (1994) and clark and wells (1995) suggest that people, high in social anxiety, tend to set unrealistically high standards for social performance. the third dimension of sca, physiological responses, generally include a pounding heart, perspiration on the palms and face, dry mouth or blushing (rega, 2000). these bodily changes are integral parts of the fight-or-flight system and are the result of the activation of one portion of the autonomic nervous system (kleinknecht, 1991). rapee and lim (1992) have found that socially anxious salespeople tend to overestimate customers' perceptions of them, which leads to amplification of their own physiological symptoms and further increases social anxiety. the final dimension of sca involves urges to perform protective actions such as avoiding eye contact, speaking quickly and fiddling with the hands (verbeke & bagozzi, 2000). extreme protective behaviour such as withdrawal from contact or avoidance of future contact during a sales encounter are usually regarded as dysfunctional. antecedents of sales call anxiety although the focus of the present study is on situational aspects of sca experienced during cold calling and closing of a sale, attention should also be given to antecedents of social anxiety provoking cues, functioning within these settings. one such source of anxiety, arising during cold calling, is when salespeople must initiate contacts with prospects who are of a higher social status. differences in expectations between the client and salesperson may arise as well as uncertainty regarding respect to be shown. another source of anxiety in cold calling situations is the reaction salespeople have to meeting new clients. without prior knowledge of the needs, style and other characteristics of the prospect, the salesperson is asked to face a set of unknowns. these unknowns may severely influence the pressure to create a favourable impression during the initial encounter, adding tremendously to the level of anxiety experienced by the salesperson. a third source of anxiety which may arise during cold calling is when salespeople have to meet a client from a different culture. in this case, anxiety may arise due to unfamiliarity with the clients' culture and therefore limited knowledge regarding his or her needs and wants. body language and gestures during the sales encounter may also cause misunderstandings, adding to stress. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 551 beatty (1998) states that situational factors such as status, dissimilarity and perceived novelty of an audience or customer, contribute greatly to anxiety levels experienced by the person responsible for the presentation or sale. for closing, the strongest source of anxiety is the anticipation of asking for a commitment and being rejected. verbeke and bagozzi. (2000) suggest that anticipatory anxiety can lead to cycles of approach-avoidance, procrastination and strong apprehension. another source of anxiety is the thought of admitting failure to a superior and explaining why the failure occurred. goodwin, mayo and hill (1997) found that when salespeople fail, it negatively affects their feelings of self-esteem. experiencing some anxiety however, is part of everyday life and therefore part of being human (leaman, 1992). when anxiety levels reach heights that are disruptive, though, a person's performance will be negatively influenced leading to emotional disturbance and inability to cope. a further consequence of social anxiety in interpersonal communication, is failure in attention, resulting in a breakdown in communication and lowered performance. results obtained from verbeke and bagozzi's (2000) study indicated that sea, which is believed to occur automatically and unconsciously, differed between cold calling and closing of a sale for negative self-evaluations and imagined negative reactions from clients. anxiety-provoking cues had larger effects on negative self-evaluations and imagined negative evaluations from customers for closing of a sale than for cold calling. in contrast, sea was invariant across the two types of selling situations when physiological responses and protective actions were considered. these findings suggest similar physiological responses and protective actions, as a function of anxiety provoking cues during cold calling and closing. the main objective of the present study was to investigate sales call anxiety amongst insurance sales staff in port elizabeth. the study was based on research carried out by verbeke and bagozzi (2000). the following hypotheses formulated by these researchers were adopted for testing on a multicultural sample: hi sales call anxiety comprises four dimensions: negative self-evaluations, perceived negative evaluation from clients, imagined physiological symptoms and urges to perform protective actions. h2 salespeople undergo sea as a matter of degree that ranges from low to high levels of intensity. two common contexts in which salespeople face sea are cold calling and closing the sale. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 552 sajems ns vol 5 (2002) no 3 h3 sales call anxiety will be provoked to the extent that salespeople are sensitive to difficulties in dealing with new customers, higher status customers, and customers with different cultures than their own, (three/two facets of cold calling). h4 sales call anxiety will be provoked to the extent that salespeople are sensitive to difficulties associated with asking for a commitment and discussing their performance in this regard with their superiors, (three/two facets of closing sales). method a questionnaire was constructed based on items used in a previous study (verbeke & bagozzi, 2000) and was further modified for application in south africa. all items used in the questionnaire related to the four dimensions of sea. the last ten items in the questionnaire focused on the degree to which salespeople experienced sea based on anxiety-provoking cues during cold calling and closing of a sale. a five-point verbal anchored rating scale, suitable for application in developing countries as suggested by malhotra (1999), was used in the study. the question-naire consisted of 30 items and concluded with measures of several demographic variables. sampling procedure a simple random sample (n= 112) was drawn from insurance salespeople employed at various insurance companies in port elizabeth. the sampling frame included all insurance salespeople employed at these companies. a total of 177 questionnaires were e-mailed to insurance salespeople of which 112 useable questionnaires were returned. questionnaires were self-administered. each respondent who received a questionnaire was contacted telephonically beforehand, informing him/her of its arrival data analysis the statistical package spss was used to perform exploratory factor analyses on the 30 items in the questionnaire. the method of principal component analyses was used with oblimin rotation. a separate factor analysis was performed for each dimension of sea as well as for the scale measuring the effect of anxiety provoking cues on sea. results are summarized in table i (a) and (b). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . table l(a) oblique rotated factor analysis matrix for the four dimensions of sca criterion dimension one: neaative self-evaluation 1. i hope i can listen carefully to what the client says. 2. i hope i will not fumble for words. 3. i hope i will not give in to the client. 11. i hope this conversation will not fail. 12. i hope it will not tum out that insurance agents from other firms will be able to convince the client better than i will. 13. i hope that i will not come across as an unfriendly person to the client. percentaae of total variance explained for dimension one cronbachts coefficient alpha for dimension one dimension two: neaative evaluations from cuents 4. the client will think that i have doubts about what i am selling. 5. the client does not like me. 6. i think that the client will tell other people that i am not a competent person. 14. the client will think that i am not professional. 15. the client will think that agents from other insurance firms are better salespersons than me. 16. i think that the client will never do business with me a~ain. percenta!e of total variance explained for dimension two cronbach's coefficient alpha for dimension two -----factor 1 cold callina 0.825 0.856 0.782 51% 0.80 0.747 0.933 0.889 56% 0.85 factor 2 closina 0.771 0.604 0.906 70% 0.73 0.713 0.881 0.841 76% 0.79 vl >~ vl z vl <: e. vi ....... n o o ~ 'l...... vi vi ...... r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . ----_._--_.icriterion ldimension three: imagined physiolo2ical symptoms 7. i am feeling nervous. 8. i can't look the client in his eyes. 17. i am saying too much. 18. my hands are trembling. lpercentage of total variance explained for dimension three icronbach's coefficient alpha for dimension three ldimension four: urges to perform protective actions ~. i cannot talk very persuasively to the client. 10. i dare not argue with the client. 19. i must avoid direct questions like "please will you sign here?" ~o. i will inform the client that he/she does not have to decide to take out an insurance policy now, and that he/she may think it over percentage of total variance explained for dimension four tronbach's coefficient alpha for dimension four sample size n 1i2 factor 1 cold caulne. 42% 0.52 0.839 0.725 36% 0.46 factor 2 closine. 0.743 0.565 0.566 0.700 0.736 0.811 66% 0.34 v> v> .j>. c/l ~ c/l z c/l < g. v> -g t-.) '-' z o w r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . table l(b) oblique rotated factor analysis matrix for anxiety-provoking cues factor 1 criterion cold callil!jl ianxiety-provoking cues 21. i meet with a client who has a higher social status than myself. 0.760 22. i talk to a client who has a higher income than myself. 0.757 123. i prepare for a sales conversation with an unknown "'p£os~ct. 0.754 24. unexpectedly, i have to meet an unknown prospect because my 0.627 colleague is unable to do so. 125. i meet with a client whose culture is different to mine. 0.750 126. i meet with a client whose home language is different to mine. 0.644 127. i have to meet with my manager to talk about my sales results. 128. i have to discuss my sales results with my manager, and it appears i did not achieve my sales goals. 129. the client shows me the offer from a competitor, and i have to respond to this. 130. i ask the client whether helshe will sign the insurance policy. lpercentar;e of total variance explained for anxiety-provoking cues 43% jcronbacb's coefficient alpba for anxiety-provoking cues 0.83 sample size n = 112 factor 2 closink 0.682 0.772 0.877 0.696 57% 0.78 en c: ttl ~ en ~ e: !ji .-.. n 8 n '-' ~ w !ji !ji !ji r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . table 2 descriptive statistics and correlations for cold calling and closing a sale cold calling ~~~~ ---dimensions n mean sd correlations mean sd ofsca 1 2 3 41 negative ~-r---~ ~~-~ self1i2 3.29 0.91 0.290** 0.236*'" 0.437"'· 3.34 1.02 evaluation 2 perceived negative il2 2.12 0.84 0.290** 0.392** 0.304*· 2.00 0.74 evaluation of clients 3 imagined physiological 112 1.96 0.69 0.263** 0.329*'" 0.247** 1.94 0.57 symptoms 4 urges to perfonn 1i2 2.53 0.84 0.437"'* 0.304** 0.247** 2.85 0.84 protective actions closing of sale correlations 1 2 3 0.290** 0.32 0.290** 0.292** 0.032 0.292** 0.135 0.067 0.052 4 0.135 0.067 0.052 vi vi 0\ vl )"ttl 3: vl z vl 2: vi ,....... tv o o tv '-' ~ w r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 557 descriptive statistics such as the mean, standard deviation and pearson product moment correlations were calculated by means of spss. these statistics are reported in tables 2, 3 and 4. spss was subsequently used to perform analysis of variance (anov a) to investigate which of the socio-demographical variables are significantly related to the two factors that have emerged. these results are reported in table 5. in order to explain the relationship between dependent and independent variables regression analysis was performed. eight regressions were run, one for each dimension of sca. three anxiety-provoking cues (dealing with higher status customers, meeting new customers and meeting customers with a different culture than your own) were entered as independent variables for cold calling and two anxiety-provoking cues (asking for commitment and anticipating discussion of performance with a manager) were entered as independent variables for closing sales. table 6 presents the results for the regression analyses. results table i (a) and (b) show the results of the factor analyses performed in the study. the factor analysis produced two factors, namely cold calling and closing of the sale. dimensions one, two and four in table i (a), namely negative self evaluation, perceived negative evaluations from clients and urges to perform protective actions, each loaded on two factors. the scale measuring dimension three, namely imagined physiological symptoms in table i (a), only loaded on one factor. an explanation for the latter is that physiological symptoms reflect reactions that are controlled by the autonomic nervous system and tend to be consistent across different anxiety-provoking cues (i.e. cold calling and closing). the scale measuring anxiety-provoking contextual cues in table l(b) also loaded on the above mentioned two factors. the cronbach's coefficient alphas exceeded the required 0.7 criterion for reliability on three of the five subscales in the tables. on two of the dimensions of sca, physiological symptoms and protective actions, the alphas are marginally below the norm. tables 2 and 3 show descriptive statistics and correlations for the sample. as can be seen from table 2, highly significant positive correlations exist between all four dimensions of sca during cold calling (factor i). for closing (factor 2), highly significant positive correlations occur between 'negative selfevaluation' and 'perceived negative evaluation from clients' as well as between 'perceived negative evaluation from clients' and 'imagined physiological symptoms'. it should be noted that the mean score is highest for 'negative selfevaluation' during both cold calling and closing of a sale. this implies that on r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 558 sajems ns vol 5 (2002) no 3 average, insurance salespeople experience sca fairly intensively during a sales call, due to their insecurity regarding conveying a positive image of themselves to clients. table 3 indicates that there are highly significant positive correlations between the first four anxiety provoking cues of sca, namely meeting (l) new customers, (2) higher status customers, (3) customers with a different culture to the salesperson and (4) asking the customer for a commitment. moderate significant positive correlations exist between cues (4), asking the customer for a commitment, and (5) discussing performance with a manager. the highly significant positive correlations observed between the first four cues may be due to their impact on the general sales conversation with a client. table 3 descriptive statistics and correlations for anxiety-provoking cues correlations anxiety provoking cues n mean s.d. 1 2 . 3 4 5 1 new customers 1i2 2.31 0.95 0.479" 0.426" 0.339" 0.178 ~ higher status 112 2.56 1 1.02 0.479" 0.509** 0.343** 0.164 customers 3 customers of different culture 112 2.23 0.99 0.426** 0.509** 0.409** 0.165 to the salesperson 4 asking for 112 2.53 0.339** 0.343** 0.409** o. commitment 5 discussing performance with a 112 2.62 0.92 0.178 0.164 0.165 0.226* manager table 4 shows descriptive statistics for the factors grouped according to demographic variables obtained from the sample, as well as those factor score differences that are significant. from the table it can be seen that coloured males between the ages of 18 and 25 who have less than 2 years' experience in seiling insurance, and whose highest level of education is a diploma, scored highest on cold calling (factor i). this may be an indication that the younger and less experienced one is at selling insurance, the more anxious one will be during cold calling. generalization would not be wise, however, seeing that the number of respondents in this group was very small. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 559 table 4 descriptive statistics by gender, race, age, education, and service factor 1 factor 2 n mean s.d. mean s.d. gender male 75 2.527 0.559 2.544 0.513 female 37 2.489 0.664 2.592 0.511 lrace white 71 2.4loa 0.609 2.485c 0.550 black 30 2.717b 0.453 2.757d 0.348 coloured 9 2.767 0.707 2.611 0.491 asian 2 2.050 0.212 2.050 0.495 a2e 18 25 yrs 17 2.641 0.548 2.559 0.379 26 35 41 2.568 0.703 2.654 0.548 36 49 41 2.378 0.505 2.446 0.503 50+ 13 2.608 0.499 2.623 0.546 education (highest level) matric 69 2.532g 0.516 2.610 0.462 diploma 26 2.585i 0.686 2.542 0.617 degree 11 2.555 0.780 2.455 0.557 post-graduate degree 6 1.933h 0.413 2.250 0.446 lyears ofservice as an insurance a2ent 02 yrs 31 2.632 0.508 2.655 0.381 3-5 27 2.611 0.644 2.741e 0.448 6 19 50 2.420 0.610 2.416f 0.575 20+ 4 2.125 0.411 2.400 0.548 total sample 112 2.475 0.557 2.523 0.495 significant differences * / observable differences" gender race ab* d* age education gh" i h" iv ears of service as an e f* insurance agent r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 560 sajems ns vol 5 (2002) no 3 with regard to closing of the sale (factor 2), table 4 suggests that black females between 26 and 35 who have matriculated and have 3 to 5 years' experience in selling insurance, scored highest. as with factor i, it can be assumed that these results are due to the fact that salespeople experience high levels of anxiety when they are younger and less experienced in insurance seiling. the reason for black respondents experiencing higher levels of anxiety during closing may also be due to their having less experience when compared to white respondents. this may be a result of black people being previously disadvantaged in terms of access to jobs of such nature. table s analysis of variance to determine relationships between sododemographic variables and factors pender ~ce age feducation years of service as an insurance agent n = 112 significant correlation reportable correlation cold calung df f 1 0.980 3 3.008 3 1.210 3 2.145 3 1.676 *p <0.05 lip < 0.10 p 0.755 0.033* 0.310 0.099" 0.176 closing f p 0.216 0.643 2.826 0.042* 1.209 0.310 1.129 0.341 3.105 0.030* table 5 shows which of the socio-demographic variables are significantly related to the identified factors. from the table it can be seen that race is significantly related to cold calling (factor i) and closing (factor 2). 'years of service as an insurance agent' is significantly related to closing (factor 2). table 5 further suggests that a reportable correlation exists between educational levels and cold calling (factor i). table 4 shows significant differences between white and black respondents in terms of cold calling and closing. table 4 further indicates that respondents with 3 to 5 years' of service as an insurance agent scored significantly higher than those with 6 to 9 years service on closing. table 4 also shows that respondents with a matric or a diploma scored reportedly higher on sca during cold calling than those with a postgraduate degree. these inferences suggest that race, sales experience and education are major role players in sca. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 561 table 6 regression analyses dealing m f meeting dependent ariables with higher ee mg customers 0 new d'ffi status i a 1 erent discussing asking for perf orr% a commitr% mancewith ment customers peop e culture manager 0.257* 0.120 0.287** 0.14 0.002 0.746*** 0.55 0.279* 0.115 0.118 0.06 0.232** 0.405*** 0.25 0.268** 0.166 0.107 0.17 0.337*** 0.034 actions 0.254* 0.070 0.113 0.06 0.115 *** correlation is significant at the 0.001 level ** correlation is significant at the 0.0 i level * correlation is significant at the 0.05 level 0.082 0.10 0.01 table 6 summarizes the fmdings of the regression analyses. the reported r2 values in table 6 indicate extremely low to moderately high proportions of variance in sca. it was found that anxiety-provoking cues relating to closing (factor 2) explained the highest proportion of variance (55 per cent) in dimension one, namely negative self-evaluation. anxiety-provoking cues relating to cold calling (factor i) explained the highest proportion of variance (17 per cent) in dimension three, namely imagined physiological symptoms. the anxiety-provoking cue 'dealing with higher status customers' was found to signilicantly influence all four dimensions of sca during cold calling, with imagined physiological symptoms being affected most. anxiety provoking cue 'meeting new people' was found not to influence any of the dimensions ofsca significantly. this is an interesting finding as one would expect that in meeting customers who are unknown to you, the level of sca should be influenced positively. cue three namely meeting customers of a different culture than oneself, significantly influences only one dimension namely 'negative selfevaluation' . r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 562 sajems ns vol 5 (2002) no 3 with regard to closing the sale 'asking for a commitment' was found to significantly influence dimensions two and three, namely 'negative evaluations from clients' and 'imagined physiological symptoms'. the latter was found to be affected the most by this anxiety-provoking cue. anxiety-provoking cue 'discussing perfonnance with a manager' was found to significantly influence both 'negative self-evaluation' and 'negative evaluation from clients'. the study conducted by verbeke and bagozzi (2000) resulted in the four anxietyprovoking cues, namely dealing with higher status customers, meeting new customers, asking for a commitment and discussing perfonnance with a manager, significantly influenced all four dimensions of sca. in the present study however, the anxiety provoking cues significantly influenced the dimensions ofsca in certain instances only. hypotheses testing with regard to hypothesis one stating that sca comprises four dimensions, namely negative self-evaluation, perceived negative evaluations from clients, imagined physiological symptoms and urges to perfonn protective actions, table l(a) shows that all items satisfactory loaded to these four dimensions. table 2 further shows significant positive correlations between all four dimensions relating to cold calling and significant positive correlations between three of the four dimensions relating to closing a sale. hypothesis one may therefore be accepted. hypothesis two, stating that salespeople undergo sca as a matter of degree, ranging from low to high levels of intensity within two common contexts, cold calling and closing, is upheld. results of the factor analysis presented in table 1 revealed two factors, namely cold calling and closing the sale. furthennore, table 2 shows that during cold calling and closing the sale, many salespeople experience high levels of sca, due to negative self-evaluative thoughts during the sale, and experience low levels of sca, due to imagined physiological symptoms such as shaky hands. hypothesis two may therefore be accepted. hypothesis three stated that sca will be provoked to the extent that salespeople are sensitive to difficulties in dealing with new customers, higher status customers, and customers with different cultures than their own (three/two facets of cold calling). observations from table l(b) show that items 21 to 26 of the scale that measured difficulties in dealing with new, high status or culturally! different customt:rs, were related to cold calling, which is a facet of sca. results from table 6 further show that the anxiety-provoking cues dealing with high status customers and customers of a different culture than one's own, significantly influence certain dimensions of sca. although no statistical evidence exists to prove that 'meeting new customers' does provoke r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 563 sea, the fact that it does relate to sea will be regarded as sufficient evidence to infer its importance as an anxiety-provoking cue. hypothesis three may therefore be accepted. hypothesis four stated that sea will be provoked to the extent that salespeople are sensitive to difficulties associated with asking for a commitment and discussing their performance in this regard with their supervisor (three/two aspects of closing sales). observations from table l(b) show that items 27 to 30 relate to closing the sale. these four items refer to the extent that salespeople are sensitive to difficulties associated with asking for a commitment and discussing their performance in this regard with their supervisor. table 6 indicates that the two anxiety-provoking cues, namely asking for a commitment and discussing performance with a superior, significantly influence certain dimensions of sea during the closing of a sale. hypothesis four may therefore be accepted. conclusion the main objective of this study was to investigate sales call anxiety amongst insurance sales staff in port elizabeth. based on previous research, four hypotheses were formulated and tested. the results of the study revealed two factors emerging from factor analyses, performed for items relating to each dimension of sea, and items relating to anxiety-provoking cues in the questionnaire. the factors were cold calling and closing. this finding supports that of a previous study by verbeke and bagozzi (2000). results featured in table 2 show positive correlations between the four dimensions of sea during cold calling and closing in some cases. table 3 also suggests positive correlations between the five anxiety-provoking cues. on inspection of socio-demographic variables and the factor scores obtained, it could be seen that race was significantly related to both cold calling (factor 1) and closing (factor 2) while years of experience in selling insurance was significantly related to closing the sale. these findings suggest that significant differences in terms of anxiety experienced, exist between black and white salespeople during the sale, and that the less experienced one is at selling insurance, the more anxiety will be experienced during closing of the sale. results of the regression analyses, performed for each dimension of sca, revealed that anxiety-provoking cues create low to moderately high amounts of variance in sca. in summary, the findings of this study demonstrate that sea does in fact consist of four dimensions: negative self-evaluations, perceived negative evaluations r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 564 sajems ns vol 5 (2002) no 3 from clients, imagined physiological symptoms and protective actions. the experience of sca differs between cold calling and closing the sale, and anxiety-provoking cues have a moderate effect on the level of anxiety experienced during a sale. all four the hypotheses could therefore be upheld. despite the limitations of a relatively small sample that is not representative of all the population groups, and some scales not meeting the required 0,70 criterion for reliability, the results of the study do confinn significant correlations between the constructs as predicted by verbeke and bagozzi (2000). therefore nomological validity of the study is suggested. follow-up research in south africa is, however, needed to provide guidelines for sales managers in assisting salespersons to deal with sales call anxiety. sales managers need to learn to detect signs of sca in their salespeople. according to miles and snow (1978), sales managers may notice the effects of anxiety when sales force strategies change or when salespeople change accounts. training and professional treatment can go a long way in preventing negative self-evaluation, imagined negative evaluation from clients, imagined physiological symptoms and urges to perfonn protective actions. one of the best ways to offset the effects of these anxiety provoking cues is to alert trainees of the existence of sca and to teach them how to control it in role playing sessions and behaviour modification. references beatty, m. (1988) "situational and predispositional correlates of public speaking anxiety", communication education, 37 (1): 28-39. 2 beck, a.t. (1976) cognitive therapy and the emotional disorders, new york: international university press. 3 clark, d.m. & wells, a. (1995) "a cognitive model of social phobia", in r.g. heimberg, m. liebowitz, d.a. hope, & f. schneier (eds.) social phobia: diagnosis, assessment and treatment: 69-93, new york: guilford press. 4 clarke, r.d. & randall, i. (1999) "cold calls, cold feet", black enterprise, 29 (8): 125-27. 5 goodwin, c., mayo, m. & hill, r.p. (1997) "sales response to loss of a major account: a qualitative analysis", journal of business research, 40: 167-80. 6 kleinknecht, r.a. (1991) mastering anxiety: the nature and treatment of anxious conditions, new york: plenum press. 7 leaman, t.1. (1992) healing the anxiety diseases, new york: plenum press. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 565 8 malhotra, n.k. (1999) marketing research: an applied orientation, (3rd ed.) new jersey: prentice hall. 9 miles, r.e. & snow, c.c. (1978) organizational strategy, structure, and process, new york: mcgraw-hill. 10 monfries, m.m. & kafer, n.f. (1994) "private self-consciousness and fear of negative evaluation", journal of psychology, 128 (4): 44754. 11 powell, t.j. & enright, s.j. (1990) anxiety and stress management, london: routledge. 12 rapee, r.m. & lim, l. (1992) "discrepancy between selfand observer ratings of performance in social phobics", journal of abnormal psychology, 101: 728-31. 13 ray, d. (1995) "confront call reluctance", personal selling power, (september): 46·51. 14 rega, m.e. (2000) "call and presentation reluctance", american salesman, 45 (3): 10-14. 15 savitsky, k., epley, n. & gilovich, t. (2001) "do others judge us as harshly as we think? overestimating the impact of our failures, shortcomings and mishaps", journal of personality & social psychology, 81 (1): 44·56. 16 verbeke, w. & bagozzi, r.p. (2000) sales call anxiety: exploring what it means when fear rules a sales encounter. journal of marketing, 64 (july), 88·101. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 430 sajems ns vol 5 (2002) no 2 the leaching paradox and return flow management options for sustainable irrigated agriculture r j armour and m f vlljoeo department of agricultural &onomics, university of the free state abstract leaching is necessary to maintain an acceptable salt balance in the root-zone of irrigated crops. this however contributes to point and non-point source water pollution externalities if not managed correctly. the use of a linear programming model, salmod (salinity and leaching model for optimal irrigation development) is demonstrated to determine the feasibility of leaching. artificial drainage, and on-farm storage/evaporation ponds to manage degraded return flows entering the water source and groundwater. results show optimal cropping compositions and management practices to maximise farm returns subject to water quality conditions and return flow constraints. the economic effects of constraining return-flows and of water pricing policy on the volume of return flows are also determined. results show valuable policy information regarding the interactions between artificial drainage subsidisation, return flow restrictions and on-farm storage. jelqoo,q25 1 introddction with sub-saharan africa having by far the highest population growth rate in the world (2.9 per cent per annum), the imminent threat of hiv/aids that's crippling the workforce, weather changes brought about by global climate change and the drastic slump in the regional economy, food shortages in this region loom in the not too distant future. in sub-saharan africa the potential irrigable area is estimated at 33 million hectares. presently only 13 per cent of this irrigable area is utilised for crop production. with the stability of production and increased yields offered by irrigation, tremendous pressure is going to be placed on expanding the potentially irrigated area in sub-saharan africa. this will be at a disastrous cost to the environment and hence on the sustainability of new and existing schemes if the necessary precautions are not taken. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 431 in a study by seckler et al. (1999) titled water scarcity in the twentieth century, south africa is classified under category i: "these countries face 'absolute water scarcity'. they will not be able to meet water needs in the year 2025." water use efficiency in irrigation agriculture will thus also become crucial as per capita demand for water increases (basson et ai., 1997). "there are ( also) clear indications, ... , that the price of water for all uses including irrigation will be adjusted upwards to better reflect the cost of supply or perhaps even its value" (backeberg et ai., 1996: 12). backeberg et al. (1996: 22), further states that "water quality is becoming of increasing concern to irrigation, both from a supply point of view and with respect to the environmental impacts of irrigation." in 1995 in south africa alone about 110 000 hectares of irrigated land were already affected by waterlogging and/or salinisation. currently irrigation in sub-saharan africa is by far the largest user of stored water, using 83 per cent, and in south africa 53 per cent (backeberg et ai., 1996). with total water demand expected to exceed supply before 2020, industry and urban users are going to be competing strongly for this valuable resource. the price-cost squeeze experienced by farmers over the last few decades, the weakening terms of trade, recent drastic fuel price increases and the increasing cost of labour further jeopardise the economic sustainability of irrigation agriculture, an industry so crucial for the economies of many rural areas. a major factor that could possibly further jeopardise the sustainability of irrigated agriculture, but which can be effectively controlled, is the accumulation of minerals salts in irrigated soils, which results in a breakdown of soil structure and accumulate to levels toxic to the crops grown. according to gouws et ai. (1998: 8) the three water quality components that have a financial impact on crop production are the ''lotal salt effect, specific ion toxicity and sodium effect on soil properties". the concentration of dissolved salts, be it from natural or anthropogenic causes, currently poses the greatest threat within the study area. "the rise and fall of a number of past civilizations have been linked to their ability to sustain irrigated agriculture. the inability to control salinisation and degradation of irrigated lands are mostly viewed as the main causes for their decline" (dw af, 1993). no irrigation system is sustainable without sufficient drainage. unless natural drainage till below the root zone is sufficient and water tables are not rising, artificial drainage has to be installed. according to du preez et al. (2000: 154) "results from these estimations (szabolcs model) indicate that all the undrained soils will, due to excessive salt accumulation, become unsuitable for irrigation by approximately the year 2050." to reinforce this, brady and weil (1996: 307) state that "if the irrigation system does not provide good internal drainage, soil r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 432 sajems ns vol 5 (2002) no 2 salinity can increase to intolerable levels, as can the exchangeable sodium level. the latter engenders chemical and physical problems that, if not corrected, will render a soil virtually useless as a habitat for plants." leaching is the process of applying water over and above the requirements of the plants irrigated. it is a management practice used to "flush" a certain amount of accumulated salts out of the root zone to maintain an acceptable salt balance. this practice is often considered by non-specialists as wasteful, especially as irrigation engineers and scientists appear to be in doubt about the required leaching rates and the efficiency of the leaching practice (kijne et al., 1998). to leach effectively, soils should have a good infiltration rate till beyond the root zone. in heavy soils and where waterlogging occurs, artificial drainage is required. the heavier the soils, the more expensive the costs of installing the artificial drainage. thus the benefits of leaching need to be quantified to be able to justify the capital expenses involved. leachate flows back into the river or groundwater carrying high concentrations of salts, further degrading the water source and creating secondary costs through externalities for downstream users. the paradox, however, is that without leaching salts (those inherently found in soil or those deposited by irrigating with poor water quality) out of the soil, salts build up, degrading the soil to levels that can no longer support viable crop production. improper leachate management results in downstream water degradation, rendering it less suitable for other users, and damaging the environment. it may cause watertables to rise and flushes expensive nitrogen applied to the fields, carrying with it other agricultural chemicals. the importance of irrigation has been stressed and leaching is essential for its long-term sustainability. in the past, the government subsidised the installation of artificial drainages. however, subsidising drainage creates an incentive to leach more. the negative externalities created by returnflows thus need to be managed. using salmod, (salinity and leaching model for optimal irrigation development) the economic impact of constraining return-flows is determined. incorporating into the model an option of building an on-farm storage dam to manage return flows, also makes it possible to determine whether or not it is cost effective to build the dam. the main purpose of salmod is to optimise the farm level total gross margin above specified costs (tgmasc) to ensure optimal resource use and to identify the constraints preventing the maximum tgmasc form being attained. this is achieved by calculating with linear programming the optimal crop combination for a farm's specific physical resource endowment, subject to various r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 433 constraints. particularly useful data generated by the salmod, are the dual or shadow values of the constraints. these values indicate how much can be paid for one extra unit of a constraining factor, for example how much can be paid for one extra mmlha on top of the existing quota for inigation water. figure 1 a schematic representation of the positioning of the ovib study area within the regionaj hydrology a schemaric layout ofme hydraulic system impaci1ng on the stijdy area r-----------------------------, 1 aflmoocidl owg .. wiir i < i 3 the study area ~ j'vinj.hoits ~7 '/(911/011 sdi.,.. i legend river ~ canal ~ 0<1'11 0 farmainlef'lleyllld d irrfgafoo s~ '----.' slu~hee bou'looiy douglas, the main town within the study area (see figure i), is a thriving community based entirely on the forward and backward linkages of the irrigation industry. the initial bucklands and atherton inigation plots allocated were part of a government social-economic scheme after the drought and depression of the 1930s (dwaf, 1993: 14). the sustainability of the soils on which these plots were established for inigation agriculture was not a primary factor as they were developed mainly for socio-economic purposes. in 1984 an irrigation board was established to manage water allocations in the demarcated area. currently water is charged for on a per hectare basis and not on a volumetric basis, which distorts incentives for efficiency in inigation water application. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 434 sajems ns vol 5 (2002) no 2 figure 2 salinity fluctuations measured as ec(ms/m) and tds(mgll) at the douglas barrage on tbe vaal river, dw af 1977-1997 vaal river at douglas barage wall 1800,----------========----------,300 1600 +-----------------------j 250 1400 t--------/----------------j ,200 +--------£'-----------------+200 i 1000+----*---~----+_------~--~ ~ s 1501 ~ 800 +--+--~ hl 400 50 200 0 .... '" '" 0 '" '" ;z ." "" ... a> '" 0 ;;; '" .., ~ "' <0 .... .... "" fa> '" a> 00 '" '" a> <xl 00 '" '" '" '" '" '" "" "" "" ~ "" .j. ... .. t ~ .. .. g ... .,. .,. t s .,. t ~ gs ~ (5 0 ~ (5 /5 0 (5 (5 15 (5 ~ 0 (5 0 being right at the bottom of the vaal river system, water usage was usually prioritised for industrial and residential use in johannesburg and for mining purposes in the free state goldfields. during times of drought in the upper catchment, this would lead to water shortages in the study area. a particularly bad drought from 1982 led to the construction of a canal in 1984 to transfer orange river water to the douglas weir. together with the increased water security, farmers noticed a marked improvement in crop yields due to the improvement in water quality. water quality improved dramatically after orange river water was pumped into the system via the canal as can be seen in figure 2 after 1984. the reason for the poor water quality was initially believed to be the result of industry and mining in the upper reaches of the vaal river. it has since been proved by various studies (du plessis, 1982; moolman & quibell, 1995; nell, 1995) that the actual process of irrigation displaces certain salts in the soil and releases sodium, chloride and other salts into the water while at the same time breaking down the physical structure of the soil. this salinity problem together r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 435 with the current "price-cost squeeze" effect has led to the questioning of the long-tenn sustainability of current irrigation practices in the ovib region. the price currently charged for irrigation water in the ovib region is far below that paid by industry and municipal users. farmers are also not accountable for the degraded return flows coming off their lands. the national water act of 1998 however addresses these issues and hence the need for functional models to help guide policy in the right direction, as well as to prepare farmers for the possible impacts of various scenarios. pumping is one of the largest cost items in irrigation due to high energy costs, resulting in farmers being reluctant to intentionally "over-irrigate" to leach out salts that have built up in the soils after years of irrigation. however, with the irrigation quota being based on a volume per hectare water right basis and not a volumetric basis, farmers who over-irrigate are not accountable for it. because the river operates within a closed system, all leachate returns into the system, exacerbating the problem. should the problem persist, the concentration of salts could eventually lead to the total withdrawal of agricultural activity from the area. unless a solution is found, the sustainability of this important food producing area is at stake. the rapid fluctuation in water quality, especially in the lower riet river ann makes crop production highly unpredictable, leading to financial instability in the region. this has resulted in a selection of crops away from crops with the highest returns, towards crops with the most predictable returns. methodology the proposed methodology uses both optimisation and simulation techniques. negahban et al., 1997, define optimisation as "a tool which can sift through the numerous combinations of local choices to pick those which, when combined, will produce an optimum plan which best meets regional goals within the constraints imposed on combinations of activities." the use of both optimisation and simulation is motivated by asce (1990: 530): one approach to select the best management practice is to simulate alternative management policies using crop-water production functions and then choose the best according to some criterion. another approach is to formulate a dynamic optimisation problem and then solve it with the appropriate algorithms. the simulation approach allows construction of a detailed physical chemical and biological processes model but does not optimise beyond simple enumeration or trial and error. dynamic r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 436 sajems ns vol 5 (2002) no 2 optimisation finds the best management practice under specific conditions, but computational considerations usually limit model complexity. the two approaches may be combined for some applications. first, the various options are screened with an optimisation model, and then one or more simulation models are used to evaluate the selected options. salmod is constructed using gams (brook et al., 1997) coding in two sections. contrary to asce (1990: 530), a simulation section precedes an optimisation section. the simulation section determines a range of gross margins and water requirements for all possible combinations of six crops, four soil types, four soil drainage statuses and three irrigation systems, for each of two methodologies. this results in approximately 1700 crop combination activities for salmod to choose from for each of the leaching fraction (lf) and yield percentage (yp) methodologies. for the lf methodology, the electrical conductivity of the irrigation water (eciw) first has to be converted to the electrical conductivity of the saturated soil paste (eee), using the following formula: (1) where: a _ ec _ cwe is the average ec of the crop water, weighted according to monthly volumes demanded at monthly eciw values for each crop (c) and wcf •. ds.(f is the water conversion factor from eciw to ece and is a three dimensional matrix of soil type (.), soil drainage status (ds) and leaching fraction(if)' the key formula of the lf methodology determines the relative yield (ry) percentage over a fixed range of leaching fractions. the r y for each crop (c) is a function of the soil type, drainage status of the soil and leaching fraction implemented. the matrix of ece values is then used in the lf methodology as follows: ry".s.ds./f=((loograd,.) *(ecec.s.ds.lftrsh,.))1100 (2) where: trsh" is the ece limit for each crop (,,) at which no crop yield reductions will be observed as water quality deteriorates as determined by maas and hoffman (1977), and grad" is the gradient for each crop 0, after the threshold has been reached, at which yield declines as ece deteriorates (maas & hoffman, 1977). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 437 the key formula of the yp methodology determines the leaching requirement (lr) percentage over a fixed range of targeted yield percentages, the formula as used in ayres and westcot, (1985: 26) is as follows: (3) where: trshc,yp is a matrix of the ece limits for each crop 0 at which no crop yield reduction will be observed below the specific yield percentage as water quality deteriorates (maas & hoffman, 1977), adapted to be a function of the expected yield percentage. the shortcoming of the yp methodology is that it assumes the eciw to ece conversion factor constant over all soil types, drainage statuses and inigation systems used, this is not the case; and is better captured in the lf methodology, the yp methodology is included in salmod because it calculates the exact leaching fraction required for a specific yield percentage target, while the lf methodology calculates the actual percentage of optimal yield attainable for a specific leaching fraction, results from the lf methodology are shown in this paper, the final step of the simulation section is the setting up of the range of crop/resource combination gross margin above specified costs (gmascc,$,ds,j) to be transferred as the decision variable coefficients (gmi) into the optimisation section of sal mod: gmasce,s,t/s,lj=pricee * meye *rye,$,ds,ljfvce hce ·rye,s,t/s,1j (4) where: pricee is a vector of selling prices for each crop (e), meye is a vector of the maximum expected yield of each crop (e), fvce is a vector of the variable per hectare production costs for each crop (e) excluding the water price and pumping costs, and hce is a vector of the per ton harvesting costs of each crop (e) dependant on the calculated relative yield (ry), the structure of the linear programming problem in its most basic form is as follows: maximise subject to and where: d= .1:'i=lgmj,x; .1:';=1 aij. -xi .;:: s' or = rj x;co d= net returns, (i = 1, 2, '''' n) (j = 1, 2, ... , m) (5) (6) (7) gm;= gross margin for i = i to n activities, x; = the decision variable for the ilb level of activity ( i = 1 to n), r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 438 sajems ns vol 5 (2002) no 2 aij= m x n matrix of constraint coefficients, and rj = the jth constant constraint value g = i to m). the objective function (5) is to maximise fann net return (l7j (or tgmasc) by choosing the optimal level of activity (x) from the range of choice variables x; (i = 1 to n) multiplied by the objective function coefficients gm; (i = 1 to n), which are a set of constants calculated in the simulation section of the model. in equation line 6 the objective function is subject to j (j = 1 to m) constraints. the levels of these constraints, rj are also constants. the coefficients of the choice variables (x;) in the constraints are denoted by aij. since there are m constraints in n variables, the coefficients aij fonn a rectangular matrix with an m x n dimension. equation line 7 is the non-negativity constraint of the choice variables. table i is a schematic layout of the linear programming matrix of salmod in which the soil drainage and inigation system management options are excluded as generated in gamschk by mccarl (1998). results the results generated by salmod shows the following: the maximum attainable fann level total gross margin above specified costs (tgmasc) under various water quality and management scenarios. the optimal combination of leaching fraction and yield reduction management options that would attain the maximum fann level tgmasc over a production year. the identification of the main factors of production constraining attainment of optimal tgmasc. what fanners in the ovib region can indirectly afford to pay for irrigation water of various qualities (salinities) in a free market water system. what the impact of various management scenarios and constraints will be on the dual or shadow value of irrigation water. how the crop composition in each sub-region is expected to change as water quality changes. what the impact of restricting inigation return-flows would be on the tgmasc of the various case-study fanns. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 439 table 1 a schematic representation of the structure of the optimisation (lp) section of the salmod model with a description of the constraints (soil drainage and irrigation system management options excluded) constraint description nr=net revenuer ). y=water fines decision : ' variable, p2a = water transfer. pre-year to after': , ,q i : ; year. x=cropping decision variables. npsd= bd, '~: i,ff:g;:~!~; non-point source discharge counter. ofs=onz>:~:'<jzio! 00 'ct farm sloraf,!e, rhs=rif,!ht hand side (rj) ! objn ;+: +: m ,+: = 0, objective function : land _bal '+ .<= +: land balance : rot at!()n : +' i<"", +1t;;h~~c:-k--::o::'nl°::oy~l -cr-o-p-p-lan-t-e-d-p-er-ha-,.-a-t~an'-ly-tlm-' -e~ : potcons • + ' !<=: + ! max potato constraint ~~otds : +: : ! i 0 i restricting potatoes to well drained soils j potls + i i = i 0 ! no jl()tatoes under flo<><i irrigation systems iwhtmax " : +: :<=: + lml\x' hats of wheat that can be planted !"i:l i gnmax : + '<=: + i max. ha's of groundnuts that can be plan=ted""-_-i ~ ~nsand ! i ~ j ;<=1 0 ! groundnuts only to be planted on loamy~ ;:ll gnds , : ! + j , '<=; 0 i restricting groundrluts to only well drained soils ii; r drip cons ! ! ! ,+! : i = i 0 i limits crops not grown under drip irrigation ~ max_q~ot~~~~=; +. m3?'imum water quota constraint u py quota ! + + :~_, ~,5:= + ! maximum pre-year withdra~a ... ls'--____ 1 : a y _ quota: + j <= + j maximum after-year withdrawals : rfc ~---~'~+:~irrig;tion return flows co~-'-te-r---'--~-----; 'mrf : + i', -'<=, + : maximum return flows;u\owed constrain';-:-s~~ : m ~'i <= gj soil drainage co;;traint -i pcc ! +', ! +' i + '<=' +! production capital constraint ifclc : i i + i <=! + ! fixed capital loan constraint ~-variable type:u' +: +: + i +: +' in == mixed values (+&-), u = free variable (+or-) for all water quality and parameter changed scenario runs, salmod is run with and without fixed capital management options (the latter, no management options, is referred to as "nmo") to show the financial impact of the fixed capital management options as compared to the status quo. the management options tested with salmod in this paper are as follows: model implicit management options that determine the optimal combination of yield percentages and leaching fractions to use to maximise the objective function. model explicit management options that test the impact of constraining the total farm irrigation return-flows allowed, production capital and the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 440 sajems ns vol 5 (2002) no 2 leaching ability of centre pivot irrigation systems on the objective function. fixed capital improvement management options that entail the enhancement of the drainage status of irrigated soils, a possible change in the irrigation systems used to irrigate the crops and the option of constructing on-fann storage if irrigation return-flows were to be constrained. the water quality data set used to display the impact of possible water quality changes is a table comprising 10 per cent interval parametric changes from the actual monthly water quality readings taken by the ovib for 1998. for the purpose of this paper, only the results for a case study fanner from olierivier, a sub-region of the ovm, will be analysed. table 2 olierivier case-study farm basic model input data, 2000 general in~ut data lrrigable area (ha) 200 irrigation rights (ha) ..... i 141 i water cost (r/mmiba) i 0.17 pumping costs (r/mmiba) , 0.56 pre-d.etermined fixed costs (r) , 561000 the general input data required in salmod to defme the olierivier case-study fann are displayed in tables 2 to 4. the fann consists of 200 hectares of irrigable land of which only 141 hectares have an irrigation quota/right. the price of irrigation water for which salmod is run is the 1998 ovm price set for the area, namely ro.l7 per millimetre per hectare (mrn/ha). the pumping cost used however is the average pumping cost determined in the pilot survey conducted in the area. these prices are fixed in all the scenario runs unless specified otherwise. the pre-determined fixed cost for the olierivier case study fanner is r561 000. to determine annual net fann profit/loss, this value is subtracted from the tgmasc value generated by salmod. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 441 table 3 §~ irrig.syst drain.class the division of the olierivier case-study farm irrigable area into soil type, irrigation system used and the drainage status of the soil (ha's), 2000 lms 190 snl 1 10 ; snc 1 0 ! cly 0 --i i -: fis ; 35 i cpi i 165 ! dis 0 i i i nds 100 i ads ! 20 i lds i 70 wlsi 10 the soil type is a function of the clay percentage of the soil. of the 200 hectares irrigable soil, the olierivier case-study farmer has 190 hectares loamy sand (lms: <15 per cent clay), and the remaining 10 hectares are sandy loam (snl: 15-25 per cent clay). there are no hectares sandy clay (snc: 25-45 per cent clay) and clayey soils (cly: >45 per cent clay). 165 hectares are under a centre pivot irrigation system (cpi) while the remaining 35 hectares are flood irrigated (fis) and there is no drip irrigation systems (dis) used. 100 hectares of the irrigable area has sufficient natural drainage (nds), 70 hectares have limited drainage (lds), 20 hectares are artificially drained (ads) and the remaining 10 hectares are waterlogged (wls). table 4 olierivier 1998 monthly average eciw (ms/m) s i oct f nov i dec i 119 i 130 i 113 i 97 source: ovm the monthly average electrical conductivity of the irrigation water (eciw), measured in milli-siemens per meter (ms/m), is depicted in table 4. the annual average of these monthly average eciw values measured by ovm through the year in 1998 (ol98) is 98.25 ms/m and is used in table to set up a range of water qualities incrementally varied at positive and negative intervals of 10 per cent. this range of water qualities is broadened in a forthcoming wrc report on which this paper is based, where salmod is run for a range of predicted water qualities as determined by du preez et al., 2000: 18. tables the annual average eciw varied prametrically from the 1998 ovm reading for olierivier mn3 i md2 mdi ; ol98 pli pu i pl3 i parametric range -30% -20010 "tlo% i ol98 +10% ; +20% +30% ""-~ annual average l i i i i eciw (ms/m) 68.8 78.6 ! 88.4 98.3 108.1 117.9 127.7 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 442 sajems ns vol 5 (2002) no 2 table 6 shows the change in tgmasc, water fine and return-flows over the parametric range of water quality variations. the dual values are zero because return-flows are not constrained. table 6 percentage change in tgmasc (r), total fine (r) & returnflows (mm) from the ovib 1998 eciw results for a parametric run with no management options, olierivier case study farm (2000) parametric mo.=de=l:...:r-=u=n-=fi.=.:or:....:: __________ --l r---------;mn3 : mn2 . mnl: ec98-=---;,_p_l-'-1_-'-pl_2-=--_p-l-'c3----1 total gross i margin i 2.8% ! 2.1 % ' 1.0% l r 908 278=--;-i _-6~-,.-,,-6°,-,%,-,-----=1-:,-4.=2-,-,%,-,-, _--=2-,-7.=2-,-,%'-1 total water fine i o.o%! 0.0%' 0.0% i r 3s 673 i 0.0%. 0.0%: 0.0% return-flows i -3.4%1 10.1%: 10.1%, 13 408 mml 13.0% 167.8%; 173.7% dual i 0%1 o%! 0%, 0 i 0%; 0% table 7 shows the change in optimal crop composition over eciw varied parametrically. wheat replaces maize at ec98 but, interestingly enough, at ec98 + 20% (pl2) maize replaces lucerne resulting in a 167.8 per cent increase in return-flows (table 6) from the ec98 level. using the olierivier case study farmer's own cebs, salmon is set up to choose only between wheat, maize, groundnuts, potato and lucerne. table 7 wheat maize optimal crop composition (hectares) for a parametric run with no management options using ovib 1998 eciw values as basis, olierivier case-study farm (2000) optimal crop composition : mn3 i mn2 i mni ! ec98 ~ pli pl2 pl3 i ; i 40.0 i 43.8 58.2 30.0 ! i 43.0 46.2 46.2 i 1.0 , 21.0 1 ; : groundnut i i potato : 6.0 i i 6.0 6.0 , 6.0 6.0 6.0 6.0 lucerne i 141.0 i 137.8 : 137.8 i 143.0 i 140.2 : 104.8 . 130.4 in table 8 it can clearly be seen how the productive value of irrigation water decreases as the water quality deteriorates. in all water after-year fme rows (wfi-4) the shadow price decreases from left to right. for the pre-year water fine row (wfpy) this is also true except for column pl2 where maize is brought into the optimal crop composition again placing a higher potential value on pre-year water resulting in the deviation at pl2. in table 8 the dual prices r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 443 for extra irrigation water in both the preand after-years change significantly as water quality deteriorates. table 8 change in water fine shadow values (r) from the ovib 1998 eciw results for a parametric run with no management options, olierivier case-study farm, 2000 water fine shadow values mn3 , mn2 mni i ec98 pli pl2 , pl3 , i wfpy 1.83 ; 1.66 i 1.69 , 1.70 0.94 ! 1.58 0.47 ! wfi 2.58 2.41 ; 2.43 2.45 1.69 1.66 1.21 ! , , wf2 , 2.49 ! 2.32 2.35 j 2.36 ; 1.60 [ 1.57 1.13 wf3 2.41 i 2.24 2.26 , 2.28 i 1.52 i 1.49 ! 1.04 wf4 2.32 2.15 2.18 2.19 i 1.43 : 1.40 i 0.96 , , figure 3 tgmasc for the olierivier case-study farm using ovib 1998 eciw readings varied parametrically, with and without returnflows constrained and fixed capital management options implemented, 2000 tg~sc for q!!erlyler case-stu~ f!!m usl!:!g ovib , 11118 !l;ciw varied uarametr1c!lix i-+01. ...... ol~c .:rolrrno --olnmorft i 950 900 ....... ~ 850 ~ 1800 u ~~ i 750 ~~ ~ e 700 "'~ • ... 650 ~ 600 i< 550 mn3 mn2 mn1 ec98 pl1 pl2 pl3 1998 eciwplul (pl) &minul (mn) 10, 20 &30% figure 3 shows the maximum attainable tgmasc for the olierivier case-study farm at the 1998 eciw varied parametrically for various scenarios, if the irrigation water quality were to be improved by 10 to 30 per cent from the 1998 i i i i ! i r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 444 sajems ns vol 5 (2002) no 2 eciw average, constraining return-flows would have no effect as can be seen by the ol and olrfc, and also the olnmo and olnmorfc lines coinciding over mn3, mn2, mn1 and ec98. what this shows, is that if policy is implemented to constrain return-flows, water quality will be improved and prevented from deteriorating further. under these improved water quality conditions, the returnflows from the resulting optimal crop composition will be less than the maximum specified in the constraint, making the return-flows constraint no longer necessary once farmers are using and managing their onfarm storage dams properly. however, farmers have to be convinced to install drainage and to build on-farm storage dams. if water quality were to deteriorate form pll to pl3, tgmasc decreases substantially as can also be seen in table 9. for a water quality deterioration of 30 per cent, table 9 shows a 35 per cent reduction from the attainable tgmasc modelled under 1998 eciw conditions when no management options are implemented and return-flows are constrained (row olnmorfc and column pl3). a 25 per cent reduction in tgmasc is attainable at the same water quality conditions if return-flows are not constrained and management options implemented (row ol and column pl3). the impact of constraining irrigation return-flows only starts to have an effect once water quality deteriorates till below 1998 eciw levels. table 9 tgmasc (rifarm) for parametrically changed 1998 eciw values for the olierivier case-study farmer, 2000 mn3 mn2 mni ec98 pll pl2 pl3 _ ..... ave.annual eciw (~s/m) _68.6 78.4 88.2 98 107.8 117.6 127.4 ol 4.0% 3.5% 2.4% 1.4% -4.8% -12.9% -25.3% qjrfc 4.0% 3.5% 2.4% 1.4% -5.4% -15.5% -33.4% olnmo 2.8% 2.1% 1.0% r908278 -6.6% -14.2% -27.2% -c:::. 2.8% olnmorfc 2.0010 1.0% 0.0% -7.1% -17.2% -35.2% table 10 the impact of fixed capital management options on artificial drainage installation (ha's) brought into the optimal solution for the olierivier case-study farm using 1998 ovid eciw values, 2000 soil trans.wl-ad: lms : snl , snc i cly fis : 0 5 • ____ .9 , 0 r cpi 0 5 ! 0 i 0 i , r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 445 the management options determined by salmod to realise the optimal tgmasc for the 1998 eciw scenario are shown in table 10 salmod calculates that installing artificial drainage to convert 10 hectares of waterlogged sandy-loam soils, 5 of which are flood irrigated and 5 hectares under centre pivot, to fully artificially drained soils will bring about a 1.4 per cent (see table 9, ol-98) increase in tgmasc after the annualised costs of this option are deducted. table 11 water over use volumes, fines (cost) and shadow price (dual) results for the olierivier case-study farm using 1998 ovib eciw data, 2000 stepped tariff i _y!'jume {mm} cost {r} i dual(r) wfi i 14100 3596 2.4473'wf2 1 14100 -t-4794 i 2.3623 --==-=---~-: wf3 i 14100 5993 i 2.2773 wf4 i 14100 ; 7191 , 2.1923 wfpy i 14100 14100 , 1.7023 table 11 indicates that the volume of the irrigation quota is most constraining. at the current water price and stepped water overuse fme structure, all 4 levels of the after-year fine (wf1-4) and the full pre-year fme (wfpy) volumes are fully utilised. this is true for all incremental water quality scenarios that the model was run at for olierivier. this is partially because more inigable land is available (200 ha's) than water rights (141 ha's) to inigate all the land with. the dual of the first after-year fine tier (r2,45) indicates that for every 1 extra millimetre per hectare of water rights available at that specific charge rate (ro.17 + ro.17 x 50 per cent per mmlha), an extra r2,45 /ha would be added to the tgmasc. this indicates that for every 26.5 cents that the farmer currently pays for the 1st tier of water overuse, he makes 244.7 cents, and thus indirectly could afford to pay up to 244.7 cents per millimetre per hectare for that water. as water quality however changes (see table 8) the dual prices for irrigation water change quite markedly. the impact of changing the price of irrigation water for olierivier table 12 shows the change in the water fme rates as the water price is increased from ro.17 per mmlha to r1.70 per mmlha. water fines for overuse in the after-year are directly linked to the water price while in the dry pre-year the water overuse fine is fixed at r1.00 with the ovm 2000 water pricing structure. the analysis in table 13 based on this range of prices, includes the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 446 sajems ns vol 5 (2002) no 2 water fine for the pre-year (wfpy) at the fixed value of rl.00 per mmlha for all water prices. the shadow value of wfpy at the increased rate of r0.34 per mmiha is r1.92 indicating that it would not be feasible to use extra water in the pre-year at r2.00 per mmlha as for each r2.00 spent for each i mmlha extra pre-year water tgmasc will only increase by ri.92. table 13 the water fine tariff structure for the ovib in response to increases in the price of water : water price(r!mmlha) table 13 shows the impact of increasing the price of inigation water on tgmasc, water fine costs, return-flows, the optimal crop composition and the shadow prices of the water fines as the water price is increased from ro.17 per mmlha to ri.70 per mmlha. in table 13 we see that at the full volume of pre-year extra water allowed, subject to the pre-year water fine (wfpy), remains fully utilised as the water price is increased (indicated by positive shadow values) because the pre-year water fine is not linked to the water price, as are the after-year stepped fmes. negative after-year water fine shadow values show the decrease in the fine water price needed before that tier of water can be used profitably on the farm. as water quota costs and water overuse fine costs are included as production costs in salmon, it was found in the farm-level results (not shown in this report) that the increasing cost of water causes production capital to become constraining. increasing the price of irrigation water results in less return-flows, but only after a 6-fold increase in the cost of irrigation water, at which rate all the extra water is no longer viable to use to leach. increasing the price of irrigation water is therefore not a sustainable irrigation policy to reduce the agricultural retumflows as it provides an incentive not to leach that will lead to the building up of salts in the vadose zone. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 447 table 13 the impact of a change in irrigation water prices on tgmasc, total excess water use fine, return-flows, crop composition and water fine shadow values for 1998 ovm eciw data for the olierivier case-study farm, 2000 water price. ' i . l-~mlhal_· ~-j 0.34 : 0.68 · 1.~1.36 1.70 total gross marginj~l 964 272 . 916557 . 815092 727246' 671 133 :630436 total water fine (r) • 35673 : 57246 ; 100392 : 64 437 14100 i 14100 ~~-!lowti...il!!!0!~!l 139 11 139 11 139 , 9729 : 8319 8319 optimal crop composition (ha) ~---~~----~-1 i 25.42 '13.29 0 0 0 0 wheat !-'m=a=iz=e'-------________ :----=9c..::1-=.5---'-4_i, 77.49 34.88 52.59, 87.85 ! 65.34 groundnut 0 ~ , 0 0' 0 ' 0 potato 6.00 : 6.00 6.00 6.00! 6.00 ! 6.00 cotton o 0 0 0 0 0 ~e~~--__ --~~10~2~.4~6~'~i~i~6.~5~1~!~14~6~.9~~1~16~.0~5~_7~5~.5~1'_______,~8~7-=.9~2~ water fine shadow values (r) rwfpy-----·--·------~----::-2--::.0--:-3 -------,'--1,----,.9:'-:c2--'-----';~'1-. 7""8--'--=----;i~i-.5-4-,----1.3-::-0,-------i-.0'--:i6----1 wfi 2.85 i 2.47 ! 1.75 • 0.87 i -0.02 i -0.90 wf2 i , 2.76 i 2.28 . 1.32 0.22 i -0.88 i -1.97 wf3 2.67 i 2.09 ! 0.89 -0.42·---r-------'--1-"-.7-'----3 -: --:i_3--":.0---=-5--l wf4 i 2.57 1.90 0.47 -1.06 -2.59 -4.12 conclusions what the automatic leaching fraction and yield percentage management option results show are that at current water prices, the economic impact of accepting a reduction in yield is greater than the cost of applying extra water to leach accumulated salts from the soil to attain a better yield. at current water prices salmod results indicate that the maximum yield is selected with as much leaching as required subject to the drainage status constraint of the specific soil. the results clearly show that the benefits fonn leaching more as water quality deteriorates, to obtain a 100 per cent yield, outweigh the costs of leaching until return-flows become constraining. it is also clear fonn the results that where irrigation rights exceed irrigable area, irrigation water quantity is generally sufficient and the shadow prices of water overuse fines are generally lower than where irrigable area far exceeds irrigation rights. furthennore, even with the high electricity costs of pumping irrigation water, salmod results show that the productive value of the extra water far exceeds the stepped fmes charged for exceeding water quota allocations. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 448 sajems ns vol 5 (2002) no 2 when conducting the farm level survey, the impression gained was that where the irrigable area far exceeded the irrigation quota, it was a cheaper alternative to move the irrigation system to new land than to remediate old land. jrrigable land without water rights can be purchased for r7000 per hectare while the cost of installing artificial drainage could exceed r 15000 per hectare. the purchase of additional land was however not. an option included in the model. this practice is however unsustainable and very environmentally unfriendly. the subsidisation of the costs of artificial drainage on farms (implemented in salmod by leaving the costs of drainage installation out of the objective function and production capital constraints), results in an increase in the volumes of return flows when return-flow volumes aren't constrained, which could actually further exacerbate the water quality problem. subsidising irrigation drainage thus has to be implemented together with return-flow constraining/effective management policy. by implementing policy constraining return-flows, water quality will be improved and prevented from deteriorating further. under these improved water qualities the return-flows of the resulting optimal crop composition will be less than the maximum specified in the constraint, making the return-flows constraint no longer necessary once farmers are using and managing their onfann storage darns properly, but are initially required to get farmers to install drainage and build on-farm storage dams. the scenario runs also show that when production capital is constraining or limited, the capital will rather be used for production inputs than for implementing long-tenn capital improvements. maize and potato have the same sensitivity and gradient and are the most sensitive crops to salinity of the 6 included in salmod. potatoes being by far the highest value crop are included for all water quality situations and take up the ideal soils leaving little room for maize. maize requires large leaching fractions, so if water quota is constraining and well-leached soil is still available after potatoes have been included, other crops are brought into the optimal crop composition instead of maize. the shadow prices of the stepped water overuse fmes indicate how much a farmer could pay for water if a water market in which water rights could be freely traded existed. for the olierivier farmer for example, only at eight times the current price of irrigation water is it no longer feasible to use extra irrigation water at a stepped fine rate. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 449 further research needs by understanding the full dynamics and interactions between irrigation water quality and the soil salinity status on crop yield over irrigated time, mistakes made in the past by choosing unsustainable irrigation sites can be prevented. furthermore the impact of various natural or artificial (e.g. policy mechanism) scenarios on existing schemes could be more accurately modelled, leading to increased economic efficiency and sustainability of the irrigation industry as a whole. however, current usda salinity laboratory evidence suggests these interactions are far more complex than originally thought. .... rhoades, the doyen of soil/plant/salinity interactions, contends that no one has succeeded in combining all the refinements necessary to overcome the inherent problems of relatively simple salt balance models and geophysical sensors, to address the enormous field variability of infiltration and leaching rates (blackwell et a1., 2000). current literature and research on salinity management in irrigation agriculture also fails to capture the stochastic nature of inter-seasonal irrigation water quality as well as the cumulative economic and sustainability effects of irrigating with stochastic water quality levels. further limitations for setting criteria for salinity include: (i) the need to make assumptions about the relationship between soil saturation extract salinity (for which yield response data is available) and soil solution salinity. (ii) the deviation of the salinity of the soil saturation extract from the mean soil profile salinity, to which crops would respond. (iii) the criteria for crop salt tolerance do not consider differences in crop tolerance during different growth stages (dw af, ]996). endnote this paper is based on preliminary fmdings of a current water research commission (wrc) project due for completion by the end of 200 i. financial support from the wrc to enable this research, and from usaid to attend this conference is hereby acknowledged r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 450 sajems ns vol 5 (2002) no 2 references armour, r.j. & viljoen, m.f. (forthcoming) "the economic impact of changing water quality on irrigated agriculture in the lower vaal and riet rivers", wrc report no. 94711/01, pretoria. 2 asce (1990) agricultural salinity assessment and management, manuals and reports on engineering practice no. 71. tann, k.k. (ed.) american society of civil engineers: ny. 3 ayers, r.s. & westcot, d.w. (1985) water quality for agriculture, fao irrigation and drainage paper 29, rev. 1: rome. 4 backeberg, g.r. bembridge, tj., bennie, a.t.p., groenewald, j.a., hammes, p.s., pullen, r.a. & thompson, h. (1996) policy proposal for irrigated agriculture in south africa. discussion paper july 1996, wrc. report no. kv96/96. beria printers: pretoria. 5 basson, m. s., van niekerk, p.h. & van rooyen, j.a. (1997) overview of the water resources availability and utilisation in south africa. department of water affairs and forestry report p rsaloo/o 197, cape town: ctp book printers. 6 brook, a., kendrick, d., meeraus, a. & raman, r. (1997) gams release 2.25 version 92 language guide. gams development corporation, washington dc. 7 blackwell, j., biswas, t.k., jayawardane, n.s. & townsend, j.t. (2000) irrigation getting the edge. csiro land and water, pmb no 3, griffith, nsw 8 brady, n.c. & well, r.r. (1996) the nature and properties of soils, 11 th ed., prentice hall international editions, new jersey. 9 du plessis, h.m. (1982) "die uitwerking van verswakkende waterkwaliteit op die opbrengs van gewasse langs die benedevaalrivier", department of agriculture. confidential report no. 987/174/82. research institute for soil and irrigation, pretoria. io du preez, c.c., strydom, m.g., le roux, p.a.l., pretorius, j.p., van rensburg. l.d. & bennie, a.t.p. (2000) "effects of water quality on irrigation farming along the lower vaal river: the influence on soils an crops", wrc report no. 74011/00, pretoria. 11 dw af (department of water affairs and forestry) (1993) "south african water quality guidelines" (1st ed.) vol. 4: agricultural use. the government printer: pretoria 12 francois & maas, e.v. (1994) "crop response and management on salt-effected soils" in: m. pessarakli (ed.) handbook of plant and crop stress, marcel dekker, inc.: ny. 13 gouws, j.a., nel, p. & broodryk, s.w. (1998) "quantifying the impact of salinisation of south africa's water resources with special r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 451 reference to economic effects", vol. 3: agricultural sector. draft document for the wrc by urban econ. 14 kljne, 1.w., prathapar, s.a, wopereis, m.c.s. & sahrawat, k.l. (1998) "how to manage salinity in irrigated lands: a selective review with particular reference to irrigation in developing countries", swim paper 2, intemationallrrigation management institute. sri lanka. 15 maas, e.v. & hoffman, gj. (1977) "crop salt tolerance current assessment", asce journal of irrigation and drainage. div.103(ir2): 115-134. 16 mccarl, ba (1998) gamschk version 1.3 developed by dr.bruce mccarl, mccarl@tamu.edu, texas a&m university. 17 moolman, j. & qulbell, g. (1995) "salinity problems at the douglas weir and lower riet river", institute for water quality studies dw af. report number n/c900/291diq1495. 18 negahban, b., moss c.b., jones, j.w., zang, 1., boggess, w.d. & campbell, k.l. (1996) "optimal field management for regional water quality planning", 3rd international conference! workshop on integrating gis and environmental modeling. january 2125, santa fe, new mexico. 19 nel, j.p. (1995) "kriteria vir besproeingswater van gronde in die rietrivier en laer vaalrivier wat deur die oranje-rietkanaal bedien word", instituut vir grond, klimaat en water, verslag nr. gw/a/95/5. 20 rhoades, j.d., kandiah, a. mashali, a.m. (1992) ''the use of saline waters for crop production", fao irrigation and drainage paper 48: rome. 21 seckler, d., barker, r. & amarasinghe, u. (1999) "water scarcity in the twenty-first century", international journal of water resources development vol: 15 no: i page: 29 42. carfax publishers. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2 344 portfolio management practices of investment practitioners active in the long-term insurance industry j h mostert business initiation unit, absa corporate bank, cape town s j steel department of statistics and actuarial science, university of stellenbosch f j mostert deptartment of business management, university of stellenbosch abstract in the long-term insurance industry, sound financial investment decisions depend largely on the portfolio management practices of the investment practitioners concemed. the ability of the investment practitioners to make well-informed decisions, as well as the strategies and policies underlying portfolio management practices, are the main issues of this research. important correlations amongst various aspects of the fmancial investment decisionmaking process, as well as their association with the general information pertaining to the long-term insurers (which were disclosed during the empirical study), emerge in the closing section of this paper. the conclusions should be of prime interest to long-term insurers as well as investment practitioners who are working in that industry. jel g 22 1 introduction this paper analyses the portfolio management practices of investment practitioners (including portfolio managers and investment analysts). these practices are of prime importance to the long-term insurance industry as they provide the basis for financial investment decisions. information about the number of investment practitioners employed, the number of companies that they monitor, the extent to which they conduct independent research or make use of extemally researched investment reports, provide substantial explanation of the ability of these investment practitioners to make well-informed financial investment decisions. information about their portfolio management practices r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 345 sajems ns vo14 (2001) no 2 also indicate whether enterprises are assessed in isolation for financial investment purposes or whether risks are assessed from a portfolio point of view. this type of information is of great value, since it indicates whether an enterprise which in isolation may not appear to be an attractive investment opportunity (due to the risks attached to the enterprise), may still pass the criteria of investment practitioners because of its limited impact on the risk profile of the relevant portfolios. another aspect which receives attention in this research relates to whether the same investment decision-making process is adhered to irrespective of whether long-term insurance assets or funds of other clients are invested. finally, associations amongst various aspects of the financial investment decision-making process as well as their relation to the general ,information disclosed, are analysed. 2 objective of the research a study of the applicable portfolio management practices of investment practitioners active in the long-term insurance industry should help to explain how the related risks are assessed in practice. the objective of this research therefore embodies cognisance of the various aspects related to portfolio management practices, in order to enable institutional investors to assess and possibly improve their practices. to achieve this objective, a synopsis of the components of the financial investment decision-making process is essential, since portfolio management practices are a vital part of it. an empirical survey provides the information needed to assess the nature of the portfolio management practices concerned. the conclusions of this research should be useful to institutional investors, and persons employed in investment management. 3 the financial investment decision-making process of investment practitioners the financial investment decision-making process and the relationships between its various components, appear in figure i. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abilities of .~---~nstit .. l.ltional investors +rational approach to ----, obiective~ decision1 obiectivest---making t information from decision support systems i i i independent investment research hy reports by institutional external investors researchers ------------~~----strategies and policies of portfolio management generation of evaluation of alternatives alternatives soi~tiol.hoj alternative rimplementation l ofthe alternative ." .... ijq c: .., "' .... >-1 c:r "' 1::1 1:1 iii 1:1 t'l .... !!. ei' ~ "' '" .... a "' 1:1 .... q. "' t'l .... '" ($' 1:1 i a iii §ijq "c:i .., c) :;j '" '" izl ~ b!:: izl z izl < £. ~ ,....... n 0 0 ...... '-' z 0 n w ~ 0'1 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 347 sajems ns vol 4 (2001) no 2 a rational (or scientific) approach to financial investment decision-making is the appropriate point of departure in this context (rue & byars, 1989: 145). it is important to realise that some of the investment decisions will be programmed while others are unprogrammed decisions (kroon, 1995: 185). whether investment decisions are programmed or unprogrammed, depends on the extent to which a decision is structured, as well as the contingent factors involved in a particular financial investment decision. the abilities of investment practitioners to make well-informed financial investment decisions, as well as an efficient decision support system are crucial prerequisites for a rational approach to financial investment decision-making (shrivas~va, 1994: 143). table 1 relates to the empirical study and sets out the abilities of the investment practitioners, while table 2 sets out the two sources of available information, namely, the investment practitioners' own research and the investment reports prepared by external researchers. rational approach actually starts with the formulation of the objectives that the investment practitioners pursue. the investment strategies and policies for portfolio management necessary to reach the objectives, are then fonnulated (wheelen & hunger, 1995: 41). the detailed empirical aspects concerning the investment strategies and policies are shown in tables 3, 4, 5 and 6. the generation of investment alternatives needs innovation and creativity, while technology and group techniques are often applied in this regard (lussier, 1997: 112-16). the subsequent steps in financial investment decision-making involve the evaluation of the various investment alternatives and then the selection of the best alternative (rue & byars, 1989: 145). the implementation of the chosen investment alternative is of vital importance (thompson, 1997: 89). timing is very important, as wrong timing can ruin the best of decisions (plunkett & attner, 1997: 196). the final component of the decision-making process is the establishment of a control system (plunkett & attner, 1992: 79-80). comparing the actual results obtained with the objectives, may lead to corrective action of the investment strategies and policies of portfolio management. 4 the empirical study method information obtained from the financial services board indicated that 52 longterm insurers were registered on 3 november 1998 in south africa (van der lith, facsimile, 1998). five of the long-term insurers were excluded from the survey for the following reasons: r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2 348 the insurers did not have any equities in their investment portfolio; mainly invested in fixed property with only a negligible amount in unit trusts; or had insignificant exposure to equities. although 47 long-term insurers participated in the survey, not as many interviews were required, because there were cases where the same institution handled the financial investment management of more than one long-term insurer. in the event, 23 interviews were required (and actually took place) to cover the portfolio management practices of the 47 participating long-term insurers. a response rate of 100 per cent was therefore achieved. it was evident that the majority of the officials interviewed had already achieved management status. the seniority of the people interviewed not only made a wealth of experience avaijable to the survey, but meant that they could respond confidently about portfolio management practices at their organisations. the seniority of the people interviewed therefore contributed in more ways than one to the reliability of the information obtained. 5 empirical results the empirical results first illuminate the ability of the investment practitioners to make well-informed financial investment decisions (section 5.1). the strategies and policies of portfolio management are then discussed (section 5.2). the extent to which the portfolio management practices applicable to long-term insurance funds, are applicable to funds managed on behalf of other clients too, also receive attention (section 5.3). the closing section (5.4) of this research addresses the associations amongst aspects of portfolio management practices, as well as their association with the general information disclosed. 5.1 ability of investment practitioners to make well-informed financial investment decisions the ability of institutional investors to make well-informed financial investment decisions, is in the first place determined by the number of investment practitioners employed by them to perform this task, as well as by the number of companies they are required to monitor. other things being equal, the ability of an institutional investor to make well-informed decisions weakens as the number of companies monitored by each investment practitioner increases. the responses by the participants in the survey are summarised in table i. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 349 sajems ns vol 4 (2001) no 2 table 1 summary of the number of investment practitioners which the participants in the survey employ and the number of enterprises wbich they monitor for tbe purpose of financial investment decision-making i number of investment practitioners employed (a) respondents % of23 i number of companies monitored (b) interviews number of companies monitored byeacb investment practitioner (c) = (b i a) 1 5 (a) 8 34.8 1 120 (b) 6 26.1 1 -15 (c) -7 30.4 i 6-10 (a) 7 30.4 121 240 (b) 10 i 43.5 16 30 (c) 7 30.4 11 15 (a) 5 ! 21.7 241 360 (b) 3 13.0 31-45 (c) 5 i 21.7 16-20 (a) i 1 i 4.3 361 480 (b) 1 4.3 46 60 (c) 3 i 13.0 21-25 (a) 1 1 4.3 481 600 (b) 0 0.0 61 75 (c) 0 0.0 26 30 (a) 1 4.3 601 720 (b) 3 13.0 76-90 (c) i 1 4.3 perusal of the information summarised in table 1 indicates that the majority of the respondents (86.9 per cent) employed not more than 15 investment practitioners to monitor companies for the purpose of financial investment decision-making. to put this into perspective, it is interesting to note that the largest portion of the respondents (43.5 per cent) monitored between 121 and 240 companies, while the vast majority (82.6 per cent) indicated that they monitor a maximum of 360 companies. consequently, in 60.8 per cent of the cases each investment practitioner is responsible for monitoring not more than 30 companies at any stage. this increases to 82.5 per cent if the cut-off is pegged at a maximum of 45 companies per investment practitioner. just on this count alone, it is reasonable to conclude that the majority of investment practitioners responsible for investing the financial assets of long-term insurers, should be able to thoroughly assess each prospect included in their respective target group of companies. this implies that the largest 240 and possibly as many as 360 companies listed on the johannesburg stock exchange, stand a r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol4 (2001) no 2 350 reasonable chance of being subjected to rigorous analysis by the majority of investment practitioners who manage long-term insurance funds. on the other hand, it also implies that about 50 per cent of the 668 companies listed on the johannesburg stock exchange at the time of the survey, received little or no attention from these investors, assuming that all investment practitioners analyse the main companies (jse, 1998: 2). the possibility therefore exists that a significant number of listed companies are not correctly priced to take into account prevailing investment-related risks. the involvement of external researchers reduces the possibility of investmentrelated risks being inadequately or incorrectly priced. it was therefore deemed necessary to determine the extent that respondents made use of investment reports prepared by reputable external researchers. the survey results are summarised in table 2. table 2 summary of responses regarding the practice to do independent research as well as of the extent to which respondents make use of investment reports prepared by reputable external researchers respondents who do independent research (a) number respondents who make use of investment reports prenared bv external researchers (b) not at all (a) 2 (b) 1 once in a while (25% of the time) (a) 4 (b) 3 sometimes (50% of the time) (a) 2 (b) 1 fairly often (75% of the time) (a) 6 (b) 8 always (a) 9 (b) 10 % of23 interviews 8.7 4.3 17.4 13.0 8.7 4.3 26.1 34.8 39.1 43.5 the information summarised in table 2 indicates that it is standard practice for the majority of the respondents (65.2 per cent) to do independent research either fairly often or always. the investment practitioners are therefore not only able to subject the investment prospects to rigorous analysis as pointed out above, they also do so in fact. in addition, 78.3 per cent of the respondents indicated that they make use of investment reports prepared by reputable external researchers, either fairly often or always. the majority of financial investment decisions taken in respect of long-term insurance assets are therefore based on the research r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 351 sajems ns vol 4 (2001) no 2 of more than one institution. this tends to improve the quality of financial investment decision-making and reduces incorrect assessment of risks. based on the findings reported in this section, it can be concluded that the vast majority of respondents should be able to make weli-informed financial investment decisions. this is reflected by the manageable number of companies which the majority of investment practitioners are required to monitor, as well as the high incidence of independent research that is usually supported by investment reports prepared by reputable external researchers. 5.2 strategies and policies for portfolio management practices the portfolio management practices of the respondents disclose important information about the decision-making process as far as long-term insurance assets are concerned. amongst others, they show whether enterprises are assessed in isolation or whether risks are assessed from a portfolio point of view. this type of information is of great value, since it indicates to what extent it is possible for an enterprise, which in isolation may not appear to be an attractive investment opportunity (due to the risks attached to it), to still pass the criteria of investment practitioners because of its limited impact on the risk profile of the relevant investment portfolios. with the above-mentioned in mind, respondents were requested to comment on whether they followed the practice of specifying exposures for the purpose of portfolio management in respect of individual companies. their responses are summarised in table 3. table 3 yes no summary of responses regarding the practice of specifying exposures for the purpose of portfolio management in respect of individual companies response i number i % of 23 i interviews i 21 91.3 i 2 i 8.7 it is evident that the vast majority of respondents (91.3 per cent) do specify exposures in portfolio management of individual companies. this implies that almost all enterprises are not only assessed in isolation, but also with regard to the impact which investment in them has on the investment portfolio. enterprises which are disqualified in isolation for the purpose of financial investment decision-making, as a result of its investment-related risks, may r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . samms ns vol 4 (200 i ) no 2 352 therefore become attractive on account of a weak or even negative correlation of their investment-related risks with that of an existing investment portfolio. on the face of it, this result appears promising, because it can also be justified from a theoretical point of view. it does, however, not imply that the investment portfolios of most respondents are well balanced from the viewpoint of risk. an example would be a diversified portfolio that includes mainly banking, financial services, insurance, technology and media shares. from the industry point of view the portfolio might then appear to be satisfactorily balanced. from the viewpoint of a labour-related risk however, it might be highly unbalanced because it is biased towards knowledge-related workers whose risk profile differs from manual workers. in spite of this, it is promising to notice the awareness among respondents of the importance of portfolio considerations, for though particular risks might not receive the necessary attention directly, the possibility exists that it is taken into account indirectly when portfolios are constructed. respondents were also asked whether portfolio managers were allowed to deviate from the specified exposures of individual companies. the 21 respondents who did specify exposures reacted as follows: table 4 summary of responses as to whether portfolio managers are allowed to deviate from exposures specified in respect of individua] companies response to question whether portfolio number % of21 managers are allowed to deviate from the responses exposures specified in respect of individual companies yes ]2 57.1 no 9 42.9 the summary of these responses indicates that although deviations from the specified exposures of individual companies were allowed in the majority of cases (57.1 per cent), a significant number of respondents (42.9 per cent) said that this was not allowed at their institutions. the former thus implies a larger degree of flexibility than the latter when financial investment decisions are taken. as a result of a flexible approach, certain companies might stand a bigger or smaller chance of being included in the investment portfolio than would have been the case if deviations were not allowed. in other words, if it is fashionable to invest in companies that employ mainly knowledge-related workers, manual worker-related companies stand a lesser chance to be included in the investment portfolio when a flexible approach is followed than if the opposite applies. the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 353 sajems ns vol 4 (2001) no 2 extent of this kind of risk is limited by the practice of respondents to specify boundaries beyond which deviations are not allowed. these boundaries, or maximum deviations, which are allowed from specified exposures, are summarised in table 5. table 5 summary of maximum deviations allowed from exposures specified in respect of individual companies maximum deviation wbicb is allowed from i number 0/00f9 exposures wbich are specified in respect of responses individual companies (expressed as a percentage ofthe specified exposure) i 1%-5% i 4 i 44.4 6%10% 4 i 44.4 11%-15% i 0 0.0 16%-20% i 11.1 note: only nine of the 12 respondents who allow their portfolio managers to deviate from the exposures specified in respect of individual companies (refer to table 4) disclosed the maximum deviation allowed. a vast majority of respondents to this question (88.8 per cent) confirmed that they allowed a maximum deviation of 10 per cent in respect of specified exposures at individual companies. only one respondent did not fall into this group, and mentioned that it allowed a maximum deviation of 20 per cent. it may therefore be concluded that the ability of portfolio managers to deviate from specified exposures in respect of individual companies is fairly limited. those respondents who did allow deviation from exposures were asked to specify the conditions which must be met for this to happen. the responses to this question may be summarised as follows: table 6 summary of the conditions which must be met for portfolio managers to deviate from the exposures specified in respect of individual companies conditions which must be met for portfolio i number %of6 mana2ers to deviate from specified exposures • responses financial services board regulations i 2 33.3 mandate of client : 2 33.3 specified maximum deviation may not be exceeded i 1 16.7 approved investment l'focedure must be adhered to i 1 16.7 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2 354 note: only six of the 12 respondents who allow deviations from the exposures specified in respect of individual companies (refer to table 4) disclosed the conditions which must be met for these deviations to be allowed. the above responses are not mutually exclusive, because although the respondents did not specifically mention it, they apply equally to each of them. in other words, although only two of the respondents mentioned financial services board regulations as a condition which had to be met, the others also had to operate within these constraints, notwithstanding the fact that they did not mention it. this argument can be repeated for each of the four conditions that are listed in table 6. it may therefore be concluded that deviations from specified exposures in respect of individual companies when investment portfolios are constructed, are allowed on condition that portfolio managers adhere to the regulations/guidelines as specified by the financial services board, their clients and employers. 5.3 extent to which the financial investment decision-making process applicable to long-term insurance funds is also applicable to funds managed on behalf of other clients the respondents were asked to indicate to what extent the fmancial investment decision-making process applicable to long-term insurance assets deviates from that pertaining to assets managed on behalf of other clients. all 21 respondents who replied to this question indicated that the same process is followed irrespective of whose assets are managed. the two enterprises that did not respond to this question, stated that the question did not apply to them, because they are long-term insurers who do not manage any funds other than their own. the fact that a similar financial investment decision-making process is followed irrespective of whose funds are managed, adds considerable weight to the findings and conclusions of the empirical study. it is therefore reasonable to conclude that investment-related risks have a similar impact on financial investment decision-making by the respondents irrespective of whether longterm insurance funds or funds of other clients are managed. 5.4 correlations amongst aspects related to the financial investment decision-making process and their correlation with the general information disclosed spearman's rank correlation coefficient (rs) is used as a measure of correlation (mason & lind, 1990: 505-6), this coefficient can assume any value from -1,00 to +1,00 inclusive, with -1,00 indicating perfect negative correlation, +1,00 indicating perfect positive correlation, and 0,00 indicating no relationship at all between two sets of data. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 355 sajems ns vol 4 (200 i) no 2 the significance of rs was also tested in each case. the test of significance was conducted to answer the question whether it was possible for the computed correlation to be due to chance, and that the correlation in the population was really 0,00. the significance of rs was tested by the t-test hypothesis-testing procedure. the null hypothesis and the alternative hypothesis used in each case may be stated as follows: nuil hypothesis (ho): the correlation in the population is zero. alternative hypothesis (hi): the correlation in the population is different from zero. using the five per cent level of significance, the decision rule states that if the computed student t falls in the range between +2.08 and: -2.08 , the null hypothesis cannot be rc;;j;.;cted. the null hypothesis would however be rejected and the alternative hypothesis accepted, if the computed student t falls in the area of rejection, larger than +2.08 and smaller than -2.08. if so, it is highly unlikely that there is no relationship between the two variables in the population. meaningful correlations which are significant at the five per cent level are summarised in table 7. table 7 summary of significant correlations amongst aspects related to the financial investment decision-making process, as well as their correlation with the general information disclosed description i num[spearman's' student i probaber . rank-order t (n-2) bilityi i coefficient level number of investment practitioners 23 0.453 2.330 0.030 employed & number of companies i monitored i number of investment practitioners 23 -0.487 -2.554 i 0.018 employed & number of companies ! i monitored j number of investment practitioners employed number of investment practitioners 23 0.466 2.417 i 0.025 employed & number of respondents who do· , independent research i total investments j number of investment ! 23 0.522 2.803 0.011 practitioners employed & use of investment i i i reports prepared by external researchers total assets i number of investment 23 0.543 2.963 0.007 practitioners employed & use of investment reports prepared by external researchers r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2 356 table 7 highlights the positive correlation between the number of investment practitioners employed who primarily focus on equity investments, and the approximate number of companies that are monitored for the purpose of fmancial investment decision-making (correlation coefficient of 0.453 and pvalue of 0.030). this can be expected, because the ability to monitor a larger number of companies will improve as more investment practitioners are employed. the question arises, whether the rate of increase between these two variables is the same? this may be answered by investigating the correlation between the number of investment practitioners employed and the number of companies monitored by each investment practitioner. as can be seen in table 7, these two variables are negatively correlated (correlation coefficient of -q.487 and p-value of 0.018) which shows that the number of companies which each investment practitioner has to monitor decreases, as the number of investment practitioners increases. joint interpretation of these two correlations indicates that institutions which expand their investment management teams, are also able to increase the number of companies they monitor. perhaps even more important, it reduces the number of companies which each investment practitioner has to monitor. institutions with a relatively large number of investment practitioners, should therefore be able to spend more time on the analysis of each company they monitor than institutions which employ fewer investment practitioners. other things being equal, institutions with a large number of investment practitioners should be able better to assess risks at the companies which they monitor. companies who are of the opinion that their shares are undervalued on the johannesburg stock exchange due to perceived risks, should therefore first approach institutions who employ large numbers of investment practitioners, because these institutions should have more time available to assess detailed information. this is reflected by the positive correlation coefficient of 0.466 (p-value of 0.025) between the number of investment practitioners employed and the practice at those institutions to do independent research. the last two correlations reported in table 7, refer to the practice at institutions to make use of investment reports prepared by reputable external researchers. a positive correlation exists between total investments in respect of each investment practitioner and the practice of making use of investment reports prepared by reputable external researchers (correlation coefficient of 0.522 and p-value of 0.011). this is also the case when total assets in respect of each investment practitioner, is linked to the practice of making use of investment reports (correlation coefficient of 0.543 and p-value of 0.007). the two positive correlations are more or less of the same magnitude, because investments represent the bulk of the total assets of long-term insurers. the positive correlations obtained can be explained by a growing need among investment practitioners to validate their own investment recommendations with those of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 357 sajems ns vol 4 {200l} no 2 reputable external researchers as they are faced with the responsibility of managing larger investment funds. 6 conclusions the present study leads to a number of conclusions that are of prime importance for portfolio management practice in the long-term insurance industry: the majority of investment practitioners who are responsible for the financial investment decisions of long-term insurers, should be able to tll0roughly assess each of the prospects included in their target groups of companies. the majority of investment practitioners either fairly often or always do independent research, and also make use of investment reports prepared by reputable external researchers. the vast majority of investment practitioners follow the practice of specifying exposures in respect of individual companies for the purpose of portfolio management. approximately 57 per cent of the respondents are allowed to deviate from the exposures specified in respect of individual companies. the vast majority of them are allowed a maximum deviation of 10 per cent. conditions which must be met for deviation include that investment practitioners must adhere to the regulations/guidelines specified by the financial services board, their clients and employers. all respondents indicated that the same financial investment decisionmaking process is followed, irrespective of whether long-term insurance assets or assets managed on behalf of other clients are applicable. a positive correlation was found between the number of investment practitioners employed who primarily focus on equity investments, and the approximate number of companies monitored for the purpose of financial investment decision-making. the number of investment practitioners employed was negatively correlated with the number of companies which each investment practitioner has to monitor. a positive correlation was found between the number of investment practitioners employed and the practice at institutions to do independent research. it was found that a positive correlation exists between total investments (and also total assets) in respect of each investment practitioner and the practice to make use of investment reports prepared by reputable external researchers. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2 358 references johannesburg stock exchange (jse) (1998) monthly bulletin, jse, johannesburg. 2 kroon, j. (ed.) (1995) general management (2nd ed.) kagiso tertiary, pretoria. 3 lussier, r.n. (1997) management: concepts. applications. skill development. south-western college publishing, cincinnati, ohio. 4 mason, r.d. & lind, d.a. (1990) statistical techniques in business and economics (7th ed.) richard d. irwin, homewood, illinois. 5 plunkett, w.k & attner, r.f. (1992) introduction to management (4th ed.) pws-kent publishing company, boston, massachusetts. 6 plunkett, w.k & attner, kf. (1997) management: meeting and exceeding customer expectations (6th ed.) south-western college publishing, cincinnati, ohio. 7 rue, l.w. & byars, l.l. (1989) management: theory and application (5 th ed.) richard d. irwin, homewood. i1iinois. 8 shrlv ast a v a, p. (1994) strategic management: concepts and practices, south-western publishing co., cincinnati, ohio. 9 thompson, j.l. {i 997) strategic management: awareness and change (3rd ed.) international thomson business press, london. 10 v an der litii, m. (1998) facsimile from financial services board. 11 wheelen, t.l. & hunger, j.d. (1995) strategic management and business policy (5 th ed.) addison-wesley publishing company, reading, massachusetts. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . microsoft word vol6no3'3.doc sajems ns 6 (2003) no 3 627 measuring the impact of advertising and promotion expenditure at national, industry and company levels in south africa ________________________________________________________________ d h tustin bureau of market research, university of south africa j w strydom department of business management, university of south africa ________________________________________________________________ abstract sound record-keeping of advertising expenditure figures in south africa allows for a relative accurate assessment of the impact of advertising expenditure at national, industry and company level. however, the overall composition of marketing communication expenditure is nowadays affected by the continuous increase of promotion expenditure at the cost of advertising. unfortunately, record-keeping abilities on promotion expenditure figures trails that of advertising. consequently, the study aims to collect data on advertising and promotion expenditure simultaneously. such information is highly valued by marketing practitioners in planning annual advertising and promotional budgets. to add further value to the analysis, some international comparisons are made. jel m37, l60, 70, 80 1 introduction not all marketing communication expenses are formally measured in south africa. at present a relatively accurate enumeration is available of expenditure on above-the-line advertising (television, radio, print, outdoor and cinema advertising) but there is no accurate measurement of expenditure on below-theline promotion (consumer and trade promotions, direct marketing, sponsorship and public relations). the reason for this is probably the traditional domination of the marketing communication industry mainly by above-the-line advertising (hereafter advertising) activities which resulted in the development of formal measurement structures geared to record expenditure figures on these activities. over time, various factors contributed to less of the marketing communication rand being spent on advertising relative to below-the-line promotion (hereafter promotion). from a macro-perspective the transformation from advertising to sajems ns 6 (2003) no 3 628 promotion was largely brought about by recessionary conditions facing the south african economy, increased competition among companies marketing brands, technological developments and greater exposure to international developments engendering additional marketing communication disciplines. more specific factors such as high media inflation (increase in the cost of reaching the same number of viewers, readers or listeners), media proliferation (increase in media categories such as, for example, more television stations) and media fragmentation (increased media categories resulting in more fragmented audiences) is regarded as the main reasons for the growing level of disenchantment with traditional advertising media (adfocus, 1997: 99-101). further factors which exacerbated the shift include the channel captaincy of retailers, the growth in own brands, brand parity (imitation of rival products) and short term profit demands on brand managers (sinclair, 1997: 3). notwithstanding the notable change from advertising to promotion spending, the actual size of promotion spending in particular remains based on speculation. 2 explanation of terminology 2.1 above-the-line advertising (advertising for short) includes advertising in conventional media such as television, radio, cinema, outdoors and print media (sinclair, 1997: 2). it includes marketing in all main (commissionable) advertising media (wilmshurst, 1993: 6). 2.2 below-the-line promotion (promotion for short) includes all other forms of sponsored communication apart from activities traditionally associated with personal selling. below-the-line promotions thus include trade-shows and exhibits, couponing (manufacturer and retailer-based), sampling, premiums, trade allowances, contents, price-off packs, free goods, rebates, bonus packs, point-of-purchase material and different types of direct mail (sinclair, 1997: 64 and strang, 1975: 3). 3 objectives the objective of the study is to investigate the actual size of the marketing communication industry in terms of advertising and promotion expenditure in south africa. this investigation represents one of the first in south africa where advertising and promotion expenditure is studied simultaneously. the study further aims to measure the impact of the total marketing communication sajems ns 6 (2003) no 3 629 expenditure (advertising and promotion) at national, industry and company levels. to allow for international comparisons, the study continuously compares the size of marketing communication expenditure in south africa with the usa and uk. 4 research methodology the study was conducted in two parts. the first part of the study aimed to access the impact of advertising expenditure at national, industry and company level. this step involved the collection of secondary data from various secondary sources. data was collected on advertising expenditure, gross domestic product (gdp) and company sales figures. the clustering of available advertising expenditure figures according to industry, also allowed for a further assessment of the impact of advertising expenditure at industry level. international comparisons on the impact of advertising expenditure further substantiated the findings of the first part of the study. the second part of the study involved the collection of data from a sample of 250 brand owned companies in south africa. data was collected via an e-mail questionnaire sent to brand managers of top brand spending companies in south africa. the main aim of this quantitative survey was to collect data on advertising and promotion simultaneously. further grounds for collecting new data was based on accessing the impact of the total marketing communication industry in terms of advertising and promotion simultaneously. the fist part of the study, which accessed the impact of advertising alone, was used as basis for accessing the overall impact of advertising and promotion at national level. in addition, the survey results provide usable information to access the impact of advertising and promotion at industry and company level. 5 research results the two phases of the study, as explained above, are discussed in the sections below. 5.1 phase one: accessing the impact of advertising expenditure following a chronological approach, phase one of the study starts off with an assessment of the impact of advertising expenditure at national level. hereafter the impact of advertising expenditure is examined at industry and company level. it should be noted that international comparisons of the impact of advertising expenditure are provided at all three levels. sajems ns 6 (2003) no 3 630 5.1.1 the impact of advertising expenditure at national level this step involved the collection of secondary data from adindex (adex) and the south african reserve bank (sarb). adex, a division of acnielsen south africa, records annual advertising expenditure figures while the sarb maintains gross domestic product (gdp) figures. gdp figures measure the size of the all goods and products produced in south africa over a given time period. the following simple ratio formula was used to access the impact of advertising in terms of gdp from 1990 to 2001. advertising expenditure gross domestic product based on the above-mentioned ratio formula, the impact of advertising expenditure on the national economy from 1990 to 2001 is reflected in figure 1. figure 1 sa advertising expenditure as percentage of gdp 1990-2001 0.7 0.7 0.8 0.8 0.8 0.8 0.8 0.9 1.0 1.0 1.0 1.0 0 0.2 0.4 0.6 0.8 1 1.2 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 percentage sources: south african reserve bank (2002) quarterly bulletin (no 223, march) and adex (2002) it is clear from figure 1 that advertising expenditure has increased relative to the national economy since 1990 and now stands at approximately 1,0 per cent of the total economy. sajems ns 6 (2003) no 3 631 in relation to more developed countries such as the united states of america (usa) and european countries, the size of advertising expenditure in south african compares rather poorly. this is particularly evident from table 1, which shows the share of advertising in the national economy of the usa from 1995 to 2000. table 1 usa advertising expenditure, gross domestic product and private consumption expenditure, 1995-2000 adspend as % of: year total advertising expenditure ($bn) gdp ($bn) private consumption expenditure ($bn) gdp c 1995 162,930 7 400,5 5 075,6 2,2 3,2 1996 175,230 7 813,2 5 237,5 2,2 3,3 1997 187,529 8 318,4 5 423,9 2,3 3,4 1998 200,830 8 781,5 5 683,7 2,3 3,5 1999 222,308 9 268,6 5 968,4 2,4 3,7 2000 243,680 9 872,9 6 257,8 2,5 3,9 source: advertising age, 1999b: 126; advertising age, 2001: s12 and bureau of economic analysis, 2002 when considering the 1,0 per cent share which advertising represents of the total economy, it is clear from table 1 that the impact of advertising in the usa economy outstrips that of south africa. even in the uk it is estimated that the advertising accounts for 2,0 per cent of gdp (world advertising research centre, 2001). the substantially larger share of the marketing communication industry in the economies of the usa and uk, compared to south africa, can be ascribed partly to more favourable economic conditions in the usa and uk which, in turn, reflect high corporate profits enabling advertisers to continue spending. higher literacy rates in the usa and uk also probably explains the higher advertising expenditure abroad. in view of the latter, the fact that the share of advertising expenditure in the usa and uk economies is larger compared to that in south africa is actually besides the point. what is more important to note is that, despite the sluggish domestic production in south africa, advertising expenditure remained high and has a notable share in the local economy. sajems ns 6 (2003) no 3 632 5.1.2 impact of advertising expenditure at industry level from the most recent secondary data extracted from adfocus (2000: 44, 2001: 44 & 2002: 40) it is clear that the share in advertising expenditure differs across economic sectors. the most logical explanation for this is the fact that products and services are marketed more vigorously in some economic sectors than in others. to identify industries where brand building is healthiest, the top 100 south african advertising spenders in 1999, 2000 and 2001 were clustered by economic sector according to the standard industrial classification (sic) system in table 2 below. this international numerical system is used to classify economic activities of industries and is better known as the �standard industrial classification of all economic activities�. the sic was adopted in the united nations for the first time in 1948 and was revised several time, the last being in 1990 (potgieter, nänny & van zyl, 1997: 2). this classification system is nowadays used internationally. to further elaborate on the methodology used by sic, potgieter et al. (1997: 2) clearly states that sic is a classification of economic activity and not by ownership, type of enterprise, organizational structure, degrees of mechanization, size of production unit in respect of turnover, capital or labour. the products produced or services rendered determine the economic activity. to allow for cross-industry comparisons, the top 100 brand owned companies were classified according to the sic system in table 2. table 2 magnitude of advertising expenditure of top 100 sa advertisers by economic sector*: 1999-2001 advertising expenditure r�million market share in adspend of top 100 adspenders (%) economic sector 1999 2000 2001 1999 2000 2001 manufacturing 1 490,2 1 800,2 1840.9 39,0 39,8 43,3 retail 745,4 877,4 1102,0 19,5 19,4 25,9 financial and business services 392,7 544,8 664,0 10,3 12,0 15,6 transport, storage and communication 964,5 1 133,8 382,0 25,3 25,1 9,0 community, social and personal services 224,7 168,8 265,0 5,9 3,7 6,2 *sources: adapted from adex in adfocus, 1999: 44; adfocus, 2000: 44 & adfocus, 2001: 40 sajems ns 6 (2003) no 3 633 table 2 shows that the manufacturing and retail trade industries are the market leaders in terms of advertising expenditure in south africa. sub-sectors dominating advertising spend in the manufacturing industry include the food, beverage, chemical (beauty products, detergents, soaps and toiletries) and automotive sectors. in turn, non-specialised and specialised retail stores trading mainly in food, clothing and furniture are the biggest advertising spenders in the retail industry. furthermore, the banking, insurance and assurance sectors top the advertising expenditure list in the financial and business services sector. in the transport and communication industry, air and land transport and the post and telecommunication sectors are the largest advertising spenders. the government, parastatals and the education sector are the biggest advertising spenders in the community, social and personal services sectors. the advertising expenditure of the top three industries listed in table 2, accounted for just below 85 per cent of the total advertising expenditure of the top 100 south african advertisers in 2001. notable form table 2 is the drop in the share of the transport and communication industry from 25,3 per cent in 1999 to 9,0 per cent in 2001. this change emanated from top advertisers like m-net and the sabc moving out off the top 100 advertiser category in 2001. in total, advertising expenditure by the top 100 advertisers in 1999, 2000 and 2001 amounted to r3,8 billion, r4,5 billion and r4,3 billion respectively. this represents about 48 per cent, 54 per cent and 44,0 per cent of the total advertising expenditure in 1999, 2000 and 2001 respectively. the 6,7 per cent drop in advertising expenditure by the top 100 advertisers from 2000 to 2001 is partly indicative of the economic downturn and the ban on tobacco advertising in south africa (adfocus 2002: 95). it may reasonably be assumed that the status of advertising expenditure by economic sector reflected in table 2 provides a relatively accurate picture for south africa as a whole. the information depicted in table 2 reflects trends similar to those in advertising expenditure in the usa. in the usa, for example, most advertising expenditure in 2000 was driven by the retail ($17 304,3 million), automotive ($15 478,3 million), entertainment − movies and media ($6 910,1 million), financial ($5 790,3 million), telecommunications ($4 248,9 million), computers, software and internet ($4 185,5 million), toiletries and cosmetics ($3 669,6 million), restaurants ($3 667,4 million), food non confection ($3 450,1 million), insurance and real estate ($2 543,1 million) and government, politics and organisations ($2 246,5 million) (advertising age 2001: s12). sajems ns 6 (2003) no 3 634 5.1.3 share of south african marketing communication expenditure at company level if disaggregated to company level the sectoral analysis provided in the previous section could be used to determine the share of advertising expenditure in company turnover. the retail sector will be used as framework to ascertain the share of advertising expenditure in company turnover. to avoid any misunderstanding of the meaning of the term �company turnover� it is narrowly defined as equivalent to sales or revenue (the guardian, 1995: 454), including invoiced value goods sold, excluding sales taxes (such as value added tax vat) and other duties (extel, 1997: 11). the share of advertising expenditure in the company turnover of selected retailers from 1996 to 2000 is shown in table 3. the limited list of retailers included in the table is due mainly to a lack of comprehensive secondary data to support similar calculations for other retail companies (only a number of retailers are listed on the jse and no information is therefore available). the table has been constructed by using available advertising expenditure figures of adfocus (1997-2001) and company turnover figures contained in the july to december 1999 stock exchange handbook (see alexander & oldert, 1999) and the financial mails� june 2001 edition of top companies (financial mail, 2001). although combining figures from different secondary sources is not a wholly satisfactory approach, the results at least provide some indication of advertising expenditure as a percentage of company turnover. table 3 share of advertising expenditure in company turnover of selected sa retailers: 1996-2000 above-the-line advertising as percentage of company turnover (%) company 1996 1997 1998 1999 2000 pick �n pay 0,8 0,8 0,9 0,9 0,9 shoprite 0,5 0,6 0,5 0,5 0,5 toyota 0,9 0,8 0,9 0,8 n/a* edgars stores 1,0 1,1 1,0 0,9 n/a* woolworths 0,5 0,4 0,4 0,3 0,5 ellerines n/a* 1,0 1,2 n/a* 1,3 tiger wheels n/a* 2,9 1,5 1,1 n/a* *n/a : advertising or company turnover figures unknown. sajems ns 6 (2003) no 3 635 sources: adfocus. 1997: 36; adfocus. 1998: 46; adfocus. 1999: 44; stock exchange handbook. 1999; adfocus. 2000: 44; adfocus. 2001: 44; mcgregors who owns whom in south africa: the millennium edition. 20th ed. 2000 and financial mail, top companies. (june 2001) it is clear from table 3 that the percentage of advertising expenditure by company remained relatively constant over the four-year period. this probably implies that company turnover figures are used as a guideline when compiling annual advertising budgets. furthermore, the information reflected in the table clearly shows that, on average, approximately one out of every hundred rand of company turnover is allocated to advertising. when compared to companies abroad, south african companies tend to spend less on advertising in relation to company turnover. this is particularly evident from the information reflected in table 4. table 4 shows the size of advertising expenditure in terms of company revenue for a selection of leading usa advertisers operating in the retail industry. table 4 advertising expenditure as percentage of company revenue for selected usa speciality retailers: 2000 retailer advertising expenditure* revenue* advertising expenditure as percentage of company revenue home depot 652 53 553 1,2 grap 450 13 848 3,2 circuit city stores 479 12 959 3,7 office depot 334 11 154 3,0 limited 350 9 363 3,7 *source: advertising age, 2001: 514 & fortune, 2002 it is clear from table 4 that advertising expenditure represents a much higher percentage of company revenue in the usa retail industry compared to south africa. additional comparisons with usa companies operating in the fmcg industry like, for example, pepsico, proctor & gamble and kellogg, also show that these companies spend more than 5 per cent of their company revenue on advertising in 2000 (advertising age, 2001: 514 and fortune, 2002). similar trends are also detected in the uk (curtis, 1997, marketing, 1997: 18-21 & extel, 1997). sajems ns 6 (2003) no 3 636 given the fact that the international figures provided above represent the smaller portion (advertising expenditure) of the total marketing communication budget (which includes both advertising and promotion) they provide additional grounds for the conjecture that south africa trails the usa and uk insofar as marketing communication expenditure is concerned. however, from the information depicted in table 3, local advertising expenditure as a percentage of company turnover seems relatively significant when we take into account, among others, the number of years that south african companies were economically isolated from foreign business and deprived of foreign markets. 5.2 phase two: accessing the impact of promotion and advertising simultaneously 5.2.1 the impact of advertising and promotion expenditure on the national economy as been explained previously, only crude calculations and speculations currently exist on the amount of money being spend on advertising in comparison with what is devoted to promotion. to address this shortcoming, information on advertising and promotion expenditure was collected via e-mail from 250 brand owned companies operating across five different economic sectors in south africa. because the provision of expenditure data was difficult to obtain due to confidentiality, data was collected in ratio format. the outcome of the survey results is shown in figure 2. figure 2 shows that except for the financial and business services sector, more than 50 per cent of marketing communication budgets are devoted to advertising activities. up to 64,5 per cent of the total marketing communication expenditure of brand owned companies who market products and services in the retail industry is on advertising. the remainder (35,5 per cent), is spent on promotion. sajems ns 6 (2003) no 3 637 figure 2 composition of advertising and promotion expenditure in south africa by economic sector 64.5 56.1 49.8 58.4 61.4 58.7 35.5 43.9 50.2 41.6 38.6 41.3 0% 20% 40% 60% 80% 100% retail manufacturing financial & business services community, social & personal service transport & communication services total above-the-line below-the-line important to notice is that the outcome of the survey findings show slightly higher expenditure figures on advertising relative to promotion than speculated. most secondary sources speculate a 50/50 split in the composition of advertising and promotion expenditure (adfocus, 2000: 30). based on the outcome of the survey findings reflected in figure 2, speculations of marketing communication money being equally divided between advertising and promotion activities are slightly misplaced. if a ratio of 59:41 for advertising to promotion expenditure is regarded as more correct (see figure 2), this could mean that the total marketing communication industry accounts for approximately 2,0 per cent of gdp. based on the latter, a crude calculation shows that the total marketing communication industry generates as much as r17 billion. 5.2.2 impact of advertising and promotional expenditure at industry and company level tables 5 and 6 show the size of advertising and promotion expenditure as percentage of company turnover. the information was collected via the quantitative survey. it should be noted that the difference between the results reflected in tables 5 and 6 is due to the recording of responses in percentage terms rather than monetary terms. sajems ns 6 (2003) no 3 638 table 5 size of advertising expenditure as percentage of company turnover by economic sector, 2001 sector % of turnover retail 2,91 manufacturing 1,86 financial and business services 0,92 community, social and personal services 1,30 transport and communication services 1,25 total 1,93 table 6 size of promotional expenditure as percentage of company turnover by economic sector, 2001 sector % of turnover retail 2,85 manufacturing 1,20 financial and business services 1,00 community, social and personal services 0,67 transport and communication services 0,71 total 1,50 tables 5 and 6 show that the impact of advertising expenditure on company turnover is the highest for the brand owned companies who market products and services in the retail industry (2,91 per cent). overall, advertising expenditure represents just below 2,0 per cent of company turnover. this percentage is slightly higher than the 1,5 per cent that promotion expenditure denotes of company turnover. 6 conclusions and recommendations firstly, the study is valued in terms of the measurement of the economic impact of advertising and promotion expenditure simultaneously at nation, industry and company levels. in today�s competitive business environment, information of this nature could guide marketing practitioners across different economic sectors when planning annual marketing communication budgets. taking note of the impact of advertising and promotion simultaneously, further encourages sajems ns 6 (2003) no 3 639 integrated marketing communication budget planning for the future. finally, the study encourages sound record-keeping of advertising and promotion expenditure figures. ultimately, updated information on advertising and promotion expenditure improves prospects for 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(1975) the relationship between advertising and promotion in brand strategy, marketing science institute:cambridge. 78 the guardian (1995) guide to the uk�s top companies, fourth estates: london. 79 the media book (1992) your guide to get the most from media: for marketing, advertising, public relations and media professionals, wth publications: johannesburg. 80 times books (1997) the times 1000. london. 81 wilmshurst, j. (1993) below-the-line promotion, butterworth heineman: oxford. 82 world advertising research centre. (2001) uk adspend breaks £17 billion barrier, oxfordshire. also available on http://www.adassoc.org.uk. 263 sajems ns vol 4 (200 i) no 2 the enforcement of the bcea and waiters: will they gain or lose? l j bothma and k thomas department of economics. university of the free state abstract this study, conducted in bloemfontein, found wide discrepancies between the prescriptions of the basic conditions of employment act and the actual working conditions of waiters. in order to make waiters' situation compliant with the law, several changes will have to be made. however, it was also found that not all changes would necessarily benefit the waiters. policy makers should therefore be cautious in addressing these discrepancies and making a sectoral determination for waiters. introduction in order to restructure the south african labour market, the government has passed several laws. one of these, the basic conditions of employment act (bcea) of 1998, specifies certain new working conditions. domestic workers, as well as farm labourers, who are usually low-wage and often part-time workers, have had very little protection in the past. they are explicitly mentioned in the bcea, but are not the only vulnerable workers in the south african labour market. in march 2000 the department of labour issued its 2000 programme of action and budget. according to this document, the department commits itself to the protection of "vulnerable workers" and states that it would "undertake extensive work on sectoral deterrninations detailing minimum wages and conditions for domestic and farm workers, as well as workers in the retail, hospitality, clothing, civil engineering sectors and for learnerships in the hospitality industry". classified under the hospitality industry are restaurants, which employ waiters, often on a casual basis. many waiters complain about the unpleasant manner in which they have to go about their tasks and how their employers treat them. long working hours, low and unpredictable wages and lack of stability, are r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol4 (2001) no 2264 some of the main issues. in a letter to a newspaper in bloemfontein, a waiter writes about her working experiences in a local restaurant: "one day i worked from 09:00 till 17:00 without a break and i earned ri4,94, from which r3,00 was deducted for breakages for which i was not responsible. another r3,00 was deducted for an order book. we work for 3 per cent commission, but the manager can change that to 2 per cent or even 1 per cent if you make any mistakes. but what can we do about this? a person needs the money" (translated from bloemnuus, 21 january 2000). the above statement is but one example of the many ways in which the bcea is probably transgressed in the restaurant industry. this raises the issue of discrepancies between law and practice. to what extent does the restaurant industry comply with the prescriptions of the bcea? furthermore, if there are indeed discrepancies and these were to be addressed, would the waiters be better off? it seems as if very little, if any, research has so far been done on this topic, which might serve as a guideline to the department of labour. according to statistics south africa, there is no information available on the number of waiters or restaurants in the country, let alone working conditions and remuneration. a pilot study during the latter half of 1998 in bloemfontein, lay the groundwork for an in-depth investigation into the working conditions of waiters in this city. the investigation was done at the beginning of 2000. in the light of the department of labour's endeavours to protect vulnerable workers, the results of this study could assist them in determining minimum wages and basic conditions for waiters. research method sample what makes bloemfontein, a city with approximately 350 000 inhabitants (1996 census report), ideal for this study, is the fact that it houses several tertiary institutions and secondary schools. this is significant, since the assumption has always been that young people, in particular students, make up the largest proportion of waiters. in order to determine the population of waiters and thus the sample size, a list of all the restaurants in bloemfontein was compiled. this was done by making use of the free state white and yellow pages (1999/2000) telephone directory, as r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 265 sajems ns vol 4 (2001) no 2 well as the braby's greater bloemfontein business directory (1999/2000). all restaurants were contacted telephonically between 11 and 14 february 2000 and asked how many waiters they employed. the following restaurants were not included in the investigation: those which • do not serve food and liquor after 17hoo (since this implies no night and double shifts), • did not respond after three attempts were made to contact them, • had changed their telephone numbers or names, or • indicated that they were not willing to be part ofthe investigation. in this way a list of 28 restaurants employing a total of 777 waiters was arrived at. ten per cent of the waiters at each restaurant on the list, and at least one waiter per restaurant, were included in the sample. therefore every restaurant on the final list was drawn into the study. in cases where 10 per cent of the waiters did not produce a whole number (e.g. 10 per cent of 18), the answer was rounded to the nearest whole number (2 waiters). this is why the sample size was 83 instead of 78 (10 per cent of 777). questionnaire information was collected by means of a questionnaire. informal, exploratory interviews and discussions were held with managers and waiters, and a concept questionnaire was then drawn up. this was tested, codified and finalized. the questionnaire was divided into three sections. the first section dealt with age, qualifications, previous experience and present status as a waiter (part-time or full-time). this section was included to describe the general profile of waiters and to find out how many wait on tables as an occupation, not merely a sideline. the second section concerned working conditions, such as working hours, rest periods, deductions, particulars and termination of employment. the last section specifically dealt with remuneration, which consists of three parts in the restaurant industry, namely commission on sales, gratuities or tips by customers, and payments in kind. data collection and processing on 28 february and 1 march 2000, two fieldworkers went to the respective restaurants to collect the data. since this was done during restaurant hours, it was impossible to select the waiters randomly. therefore the method of accidental or availability sampling was used (bless and higson-smith, 1994: 945). waiters, who were not busy serving tables, were thus selected. since the target group was reasonably homogeneous with regard to the tasks they have to r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no:2 266 perform and the training needed to do so, and all restaurants on the final list were included, bias was probably minimized. the waiters completed the questionnaires whilst the fieldworkers remained on the premises, so that the fieldworkers were available for assistance if necessary. they would then collect the questionnaires on completion. this ensured that all 83 questionnaires were completed and returned. results proflle of waiters the ages of the respondents ranged between 16 to 30, the highest frequency being 20 years of age. the average age is 21.5 years. seventy-four respondents had passed grade 12, three indicated that they were still at school, and the remaining six left school without a grade 12 certificate. almost one third of the waiters in the survey had a tertiary qualification. more than half of the respondents (47) indicated that they were full-time waiters. the remainder were either full-time students (19), part-time students (14), or at school (three). working conditions working time there are two shifts in the restaurant industry: a day shift and a night shift. waiters have to decide at the beginning of each week which shifts they would like to work and have the option of working both shifts on the same day (a double shift). the number of shifts they worked per week (single and/or double) was indicated on the questionnaire, as well as the length of each shift. from this information, each waiter's longest working day per week was calculated. as can be seen from figure i, for 48 waiters the longest working day of the week exceeded nine hours. the rest indicated that they never worked more than nine hours per day. they are the waiters who do not work double shifts. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 267 sajems ns vol 4 (2001) no 2 figure 1 waiter's longest working day 14~----------------------------------~ 12+-------------------------~ 10 numberof 8 respondents 6 4 2 o 6 7 8 9 10 11 12 13 14 15 16 number of hours per day the length of each respondent's working week was calculated too, and is illustrated in figure 2. it should be noted that 41 (49.4 per cent) of the respondents worked more than 45 hours per week. figure 2 length of working week 12+----number of 10 +-___ _ respondents 8 6 15 25 35 45 55 65 75 85 95 100 number of hours per week r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2 268 also included under working time are meal breaks. sixty-seven of the respondents said that they did not get any meal breaks during shifts, whilst eight of the sixteen who did get a meal break, said that it was only 10 minutes long. with regard to work on sundays and public holidays, the overwhelming majority of the waiters (76) involved in the study said that these days were regarded as ordinary working days. particulars of employment most of the respondents had not received any written particulars of employment from their employers. only nine had signed some form of service contract sixty-nine waiters said that they had to perform tasks other than their primary duties (serving clients and cleaning tables). these included cleaning the restaurant, taking stock and, in some cases, even assisting the cook. only three waiters said that they were paid for these tasks. termination of employment on the question of notice periods, 53 waiters in the study indicated that their services could be terminated summarily, while 15 had no knowledge of any notice period. the remaining 15 respondents said that they could get anything between one and three warnings before they would be dismissed. however, if these waiters wanted to terminate their services, they were expected to stet a period.. of notice. this period stet from 24 hours to one week, 2 weeks or, in some cases, one month. deductions the respondents were also asked about the consequences when losses occurred (breakages, customers leaving without paying or theft of goods). more than half (46) said that after every shift they have to contribute a fixed amount to a common fund. fourteen said that they have to bear the full cost of the losses themselves, whilst 13 indicated that losses are shared equally amongst all waiters. only ten of the respondents did not have to pay for losses. remuneration almost two-thirds (50) of the respondents said that they received a commission on sales which was either 2 per cent (9 waiters), 3 per cent (9 waiters), 4 per cent (24 waiters) or 5 per cent (13 waiters). the rest of the respondents (28) said r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 269 sajems ns vol 4 (2001) no 2 that their employers pay them no commission at all. they are solely dependent on tips by the restaurant patrons. figure 3 remuneration per week 18 16 14 12 nuinber of 10 respondents 8 6 4 2 o ~ i ~ i ~ d ~ ~ ~ 1~1~1~1~i~moonoo remuneration per week (rands) furthermore, the waiters were asked to approximate their remuneration per shift(commission and/or tips). from this, remuneration per week (income per shift times number of shifts per week) was calculated. as illustrated in figure 3, this ranged from r200 to r2 200 per week. the hourly remuneration of each waiter was then determined (income per week divided by hours per week). the results are illustrated in figure 4, which shows that 62 respondents (75 per cent) earned between r5 and r20 per hour. the average remuneration was r14.52 per hour. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2" figure 4 remuneration per bour 22 20+--18+--16+--14+--number of 12 +--respondents 10 +--6 4 2 o 270 with regard to payments in kind, the majority of the waiters in the survey (66), answered that they either received free meals (to a certain value) or discount on food. eighteen said that they receive no payment in kind. laws vs. rest aurants: discrepancies as seen from the results, it appears that there are wide discrepancies between the stipulations of the bcea and the actual working conditions of restaurant waiters in bloemfontein. these discrepancies are summarized in table 1. the bcea contains a variation clause, which states that basic conditions may be varied, either through collective bargaining, or by the minister of labour. however, the discrepancies summarized in table 1 are not a result of this clause, since waiters in this study indicated that they do not have recourse to collective bargaining. therefore, these discrepancies seem to be blatant transgressions ofthe bcea. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 271 sajems ns vol4 (2001) no 2 table 1 bcea stipulations vs. actual working conditions conditions bcea waiters working time: · ordinary hours/day max. 9 hours 58% work longer, some up to 16 hours · ordinary hours/week max. 45 hours 49% work more, some up to 96 hours • meal intervals 1 hour after 5 consecutive 92% get none hours • night work allowance must be paid no allowance paid, no and transport provided transpo-rt provided · sundays ~ times wage should be no extra commission paid paid particulars of should be in writing and 89% have nothing in employment detailed writing termination of employnotice: 1 week, 2 weeks 64% could be summarily ment or 1 month (depending on dismissed without any length of service) notice deductions only by written 88% are in some or other agreement, and proven way responsible for guilt losses; guilt not proven bcea: will waiters gain or lose? contrary to the general perception that waiters are merely young people who earn pocket money, the results of this study show that this is not necessarily true. more than half of the respondents are full-time waiters making a living from waiting on tables. like domestic and farm workers, they are vulnerable and need protection. however, laws should improve the life experience of those to whom it applies. therefore, the question is: if the bcea is enforced in the restaurant industry, will waiters actually be better off? the answer to this is not a simple yes or no. with regard to particulars and termination of employment, waiters seem to be extremely vulnerable. the overwhelming majority in this study can be summarily dismissed, and have to perform tasks for which they receive no compensation. enforcement of the law would give waiters at least job security and stability. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2 272 the bcea is quite specific about the issues of deductions, night work and sunday work. none of the respondents indicated that they were consulted regarding deductions for losses. no distinction is made between day and night work, and sundays and public holidays are treated as ordinary working days. since the law stipulates that differential rates should be applied, waiters lose income to which they are legally entitled. in this regard, waiters would benefit from the enforcement of the bcea. on the other hand, in the case of working hours, enforcing the law could be to the waiters' detriment. since waiters themselves determine the length of their workday and workweek, they often work more hours than the law allows. more hours implies higher remuneration. therefore, the enforcement of maximum working hours, which would cause a reduction of the hours worked, will lead to lower income. similarly, the enforcement of meal breaks will also cause waiters to lose income. according to this study, waiters would lose an average of r14.52 for every hour they do not work. how much waiters would gain or lose is complicated by the fact that the bcea allows the minister to set minimum wages. there could be a strong case for this, since a considerable percentage of waiters in this study indicated that they in fact receive no remuneration from their employers. they are solely dependent on gratuities or tips, which, though an age-old practice, still depends on the customer's generosity. even those who are paid a commission on sales, would earn nothing per shift if there are no customers to serve. although waiters could gain from a minimum wage in terms of income, one has to consider the impact on employment levels. again, there are no clear-cut answers. theory predicts that, in a competitive market, employment levels will decrease (mcconnell & brue, 1995: 375-7). in the restaurant industry, the opposite seems likely to happen. according to two studies in the usa by katz and krueger (1992) and wessels (business week, 9 june 1997), higher minimum wages caused the employment levels of waiters to rise. concluding remarks this study clearly shows that there are wide discrepancies between the stipulations of the bcea and the actual working conditions of waiters. although the results apply to bloemfontein restaurants only, this may be the case throughout south africa. it is however difficult to conclude whether waiters would actually be better offif the bcea were enforced in the restaurant industry. the application of some of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 273 sajems ns vol 4 (2001) no 2 its stipulations, such as conditions and tennination of employment would make waiters less vulnerable. on the other hand, maximum working hours and meal breaks could reduce waiters' income. a strong case might be made for a minimum wage. although it primarily effects waiters' income and employment levels, either negatively or positively, it could have faheaching implications for both restaurants and waiters. in the united states, where there is a minimum wage for waiters, tips are legally regarded as part of wages and must be declared for tax purposes. because "tip-tax" is difficult to administer, the trend is to do away with tipping and replace it with salary income (nation's restaurant news, 19 may 1997). although being a waiter is a low-wage occupation, it is much more complicated than it seems on the surface. before the department of labour makes any sectoral detenninations in this regard, much more investigation is needed. references 1 basic conditions of employment act (no. 75 of 1997). 2 bloemnuus, 21 january 2000. 3 bless, c. & higson-smith, c. (1995) fundamentals of social research methods, kenwyn: juta and co, ltd. 4 braby's, (1999-2000) greater bloemfontein business directory, pinetown braby's. 5 business week, 6 june 1997. 6 katz, l.f. and krueger, a.b. (1992). the effect of the minimum wage on the fast-food industry, labour relations review, 46 (1): 6-1. 7 mcconnell, c.r. & brue, s.l. (1995) contemporary labour economics. singapore: mcgraw-hill. 8 nation's restaurant news, 19 may 1997. 9 statistics south africa, (1996) census report. 10 telkom, free state white and yellow pages (1999-2000). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 172 samms ns vol 4 (2001) no 1 youth participation in the economy cwmaian department oj information science, university oj pretoria m c breitenbach department oj economics, vista university abstract youth in south africa are persons of the ages 14 to 35 and constitute a large part of the potential labour supply and economically active population. the youth are also one of the central focus areas of government and receive priority in national development policies. very little is known about the role of youth in the economy. the purpose of this article is therefore to explore the position of youth in the south african economy. the survey below will indicate that one of the major problems faced by youth in africa is the inability to establish a sustainable livelihood. youth constitute 40 to 65 per cent of the unemployed in african countries, and this figure is rising. this requires alternative policies, in addition to the economic growth policies within the growth, employment and redistribution framework. it has become essential that the scope be broadened for a larger range of solutions. jele32 1 introduction: young people without a vision for thefuture youth in south africa are persons of the ages 14 to 35 and constitute a large part of the potential labour supply and economically active population. youth are one of the centre focus areas of government and they receive priority in national development policies. as is evident from recent research initiatives, very little is· . known about the role of youth in the economy. the purpose of this article is therefore to explore the position of youth in the south african economy. the survey below will indicate that one of the major problems faced by youth in africa is the inability to establish a sustainable livelihood, with the lack of a steady income as the main reason. youth constitute 40 to 65 per cent of the unemployed in aftican countries, and this figure is rising (iorc, 1997b: 16). although the situation is comparatively better in south africa, unemployment among the youth is still exceptionally high. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 173 economic growth is usually regarded as the ideal solution to high and rising levels of unemployment. however, the structure of the modem economy has changed to such an extent that in the wake of high economic growth rates, economies world-wide experience job losses. breitenbach (1999) describes this as job-destructive economic growth. alternative policies, in addition to the economic growth policies within the growth, employment and redistribution (gear rsa, 1996) framework, are required. it has become essential that the scope be broadened for a larger range of solutions: from a focus on employment to the nature of sustainable livelihoods, from entrepreneurship training to the development of enterprise capabilities, from reliance on government intervention to private and informal sector involvement. for this kind of shift in focus it is imperative that decision makers take cognisance of the views and needs of young women and men. what do they view as the basic needs for a sustainable livelihood; how do they perceive their role in the economy; what are their aspirations for productive participation in society? in this survey, some of these views will be discussed and contextualised within the larger global and african experiences. the survey has to be considered against the background that youth-related development challenges are relatively recent phenomena and tend to be sidelined. 1 youth education and employment the plight of a third of all young men and women without the basic resources and skills to ensure a reasonable future has become one of the greatest concerns for government, parents and other sectors of society. in 1995 a third of the south afiican youth, amounting to 3.5 million, were not studying or in training, or had discontinued studies earlier than they had wished despite a desire to return to some form of study.] only 12 per cent of black youth (as opposed to 58 per cent white youth) had studied as far as they wanted to. young people aged between 14 and 24 have considerably lower levels of education than 26 to 35 year olds. clearly the ideal point of entry for the development of employment skills is the education system. however, the current reality in sub-saharan afiica is that most young men and women leave this system before the age of 12 (hoppers, 1994). in 1995,43 per cent of young south africans were unemployed, and the national youth policy (nyp) document stresses that this represents 29 per cent of the total adult population of south afiica (nyc, 1997: 12).2 there are indications that this situation is still deteriorating. according to statistics south afiica (ssa, 1998), general unemployment was 20 per cent in 1994 and it grew to 22,9 per cent in 1997. in 1997, 35 per cent of people in the age group 15 to 30 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 174 sajems ns vol 4 (2001) no i were unemployed, 19 per cent in the group 31 to 45 and 10 per cent in the group 46 to 65. according to ssa more than 90 per cent of the unemployed people had been without work for a year or longer in 1997. in 1996, south africa's potential labour force (persons aged 15 to 65) was calculated at 24,4 million, 40 per cent of whom were not economically active. the economically active population then counted 14,5 million people, 38 per cent of whom were unemployed. currently the labour force is expanding at a rate of about 3 per cent a year, while employment growth is negative, and analysts estimate that only one in 30 new entrants into the labour market will find a job in the formal sector of the economy (erasmus, 1999). youths and persons with lower skills levels are those most affected by this situation, and an analysis of the situation in south africa reveals that unemployment predominantly occurs in the age group 20 to 44. it is estimated that 72 per cent of the unemployed are younger than 40 years of age and that 41 per cent of all unemployed people 20 years and older can be considered illiterate or severely under-educated (erasmus, 1999). 3 youth's views on their situation and the economy it is difficult, and in some cases impossible, for outsiders to interpret what youth groups in various parts of the country consider to be an acceptable and sustainable livelihood. researchers sometimes are amazed to discover that young respondents appear content to continue living in a relatively comfortable "squatter hut" as long as they can afford "luxuries" such as fashionable clothes and entertainment. research for policy purposes will therefore first of all have to take cognisance of the perceptions, preferences and needs of young people themselves. this section is devoted to such an overview, based on a national survey, before the perceptions will be contextualised in the following sections. the 1998 hsrc nation-wide survey (referred to as the hsrc survey) showed that most young people were unhappy and pessimistic about their living·· circumstances, although they remained fairly optimistic about the future. contemporary views of youth on economic matters, livelihoods, etc., were collected by means of the survey conducted for the hsrc in novemberldecember 19983• since the sample was representative of all population and age groups from 18 years upwards, the youth section of the survey largely reflected the views of the majority group, i.e. black youth between the ages of 18 and 34. because the sample cells of the other youth population groups were proportionally small, it is not feasible to compare their views with those of young black people. however where relevant, comparisons were made between age, gender and income groupings. questions about government's performance r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 175 regarding the economy and the provision of services should also be seen against the background that 53.5 per cent of the youth sample group indicated that they would support the anc at that stage. respondents were asked how the financial situation in their households had changed in the previous year (before novemberldecember 1998). most youth felt that it was a lot worse (25.0 per cent) or a little worse (26.4 per cent) and only 2.6 per cent felt that it was a lot better. that young people were generally dissatisfied with their livelihoods, in particular the financial situation in their households, was indicated by the responses 'dissatisfied' (37.5 per cent) and 'very dissatisfied' (23.1 per cent). most of the group felt that the situation in other households was about the same or a little better. the general economic situation in the country was also perceived to have deteriorated during the previous year to "it got a lot worse" (25.9 per cent) and to "it got a little worse" (26.3 per cent). still, a considerable number of youths felt that the situation had stayed the same or improved a little. youth perceptions were more optimistic than those of the total sample, of whom 31.4 per cent felt that the situation had "got a lot worse". asked whether they were satisfied with the general economic situation in the country, 39.9 per cent the youth answered "dissatisfied" and 21.7 per cent "very dissatisfied". this reflected the general feeling of the total sample. cautious optimism about changes for the better within the near future (the next year) was considerably higher among young people than other age groups. no less than 32.3 per cent of the 18 to 24 year-old respondents felt that the general economic situation in the country would "get a little better" (25.5 per cent of 25 to 34 year-old), as opposed to 16.2 per cent of people over 55 years. these percentages also reflected the perceptions about changes in respondents' own households and the economic situation of people like themselves. youth's optimism about improvement in their livelihoods over the longer term was even more pronounced. most of them felt that the economic situation for people like themselves would improve a little during the next five years (29.4 per cent), or even a lot (20.1 per cent). only 15.9 per cent believed that the situation would get a lot worse. it should be encouraging for the present government that, in spite of the general dissatisfaction with their own financial position, most young women and men felt that the economic situation of people like themselves had actually improved compared with what they were at the time of the april 1994 elections. a third of them (33.8 per cent) felt that the situation was a little better, 7.9 per cent that it was a lot better, and 20.8 per cent that it was about the same. a large group also r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 176 sajems ns vol 4 (2001) no i expressed their feelings about the way south africa was being governed at present as "satisfied" (30.1 per cent) or "very satisfied" (12.4 per cent). still, a substantial section answered "dissatisfied" (28.9 per cent) and "very dissatisfied" (15.3 per cent). the majority expressed trust (37 per cent) or strong trust in the national government as an institution. more young people (51.9 per cent) than the older age groups also felt that government should adopt a more active role in the economy. the same pattern and statistics applied with regard to willingness to pay more taxes if this would allow the government to improve services that were important to the respondents. however this did not mean that youth were uncritical of government policies. no less that 41.2 per cent felt that government policies during the previous year had had a bad effect on the general economic situation in the country, however substantial portions also believed that the policies did not make much difference (33.3 per cent) or had a good effect (17.6 per cent). similar sentiment were expressed regarding government policies' effect on the position of people like the respondents and slightly more positive regarding the fmancial situation in their households. asked about the possible effect of these policies on the general economic situation in the country for the following year, less youth answered "bad" (33.2 per cent) than the older age groups (ranging from 40 to 53 per cent). a large majority of young respondents (82.5 per cent) answered "no" when asked if they had benefited from the government's reconstruction and development programme. with the exception of the provision of electricity and health care, young people felt that the delivery of various services had not improved or improved substantially since the general elections of 1994 in the area where they lived. turning to the employment situation, a solid majority of the total group (55.7 per cent) and slightly fewer youth (51 per cent) felt that government policies for the previous year were to blame for unemployment. they were asked if these policies had had a good or bad effect, or whether they had not made much· . difference to the prospects of people like the respondents getting or keeping a job. on the other hand, some youths felt that the policies were good (14.4 per cent) or that they did not make a difference (29.6 per cent), the same criticism regarding the negative influences of government policies on prices that people like the respondents had to pay was expressed. a large majority of the total sample (65 per cent) answered "bad", with youth slightly less (60.7 per cent). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 177 considerably more young people (62.5 per cent) than the older groups felt that a strong and active labour movement was necessary to defend the economic interests of the majority of south africans. a large majority of youth (65.6 per cent) also agreed with the statement that employers should give preference to people from previously disadvantaged groups when they hire and promote workers. as was stated, the non-black section of the youth sample was not large enough for sound comparisons, however it is clear that the most significant differences can be found between racial groups. whereas 28.9 per cent of the black youth were "dissatisfied" or "very dissatisfied" with the general economic situation in the country, the percentages were considerably higher for whites (41.5 per cent), asians (37.5 per cent) and coloureds (31.8 per cent). only 13.7 per cent of young black people felt that the economic situation of people like themselves were "a little" or "a lot" worse than in april 1994, but negativity was higher among whites (32.4 per cent), asians (24.8 per cent) and coloureds (22.8 per cent). only 10.2 per cent of black youth believed that the economic situation of people like themselves would get "a little" or "a lot" worse during the next five years, while pessimism was high among whites (37.5 per cent) and asians (19.8 per cent), with coloureds (5.5 per cent) even more optimistic that blacks. whereas only 14.0 per cent of blacks felt that their standard of living would worsen during the next 12 months, again whites (37.2 per cent) and asians (42.1 per cent) felt that it would get worse, while coloureds (11.6 per cent) again were the most optimistic. in contrast to the black youth, the other race groups all felt that fighting crime was a more important priority for the government that creating more jobs. generally, youth groups in the lower income brackets (below r830 p.m.) were more satisfied with., and optimistic about, their own standard of living and the economic situation than those in the higher income brackets. the former group was also much more optimistic about the economic circumstances in the next five years. one of the explanations could be that most respondents in the lower income group were still largely financially supported and did not experience economic hardships directly. regarding most of the key issues discussed above, there were few differences between the young female and male respondents. only 31.1 per cent of the females, as opposed to 37.3 per cent of the males, felt that the economic circumstances of people like themselves were "a little better" compared to april 1994, but in other respects the gender groups were equally positive and optimistic about their situation and that of the country. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 178 sajems ns vol 4 (2001) no 1 even if the statistics surveyed here mamly reflect the views of the majority of youth, le. black youth, it should be clear that south african youth as a whole have a strong opinion and remain a force to be reckoned with by decision makers. a survey of 1992 and various analyses (slabbert et ai., 1994) showed that a small but significant component of the youth was highly militant before the political transition. surveys since then have given the impression that this attitude has more or less "softened". in the face of growing unemployment, young women and men are understandably critical and even despondent about their own position and future in the economy, yet they remain optimistic. in spite of their critical stance they remain fairly loyal to the central government as an institution. they expect from the government that they have elected to help secure their future by fighting crime and creating employment. the loyalty of young (black) people to the central government has significant implications for the possibilities of government interventions and programmes aimed at youth. elsewhere in sub--saharan africa youth have lost their confidence in governments and it is widely perceived that these institutions have failed them (mkandawire & chigunta, 1997). still, south african youth's dissatisfaction with their economic situation and livelihoods should be seen as danger signals in a situation where it is highly unlikely that the government will, in the short run, be able to provide jobs, amenities, quality education, rdp services, etc. at this stage it is a particularly good sign that, in spite of the hardships that they experience, youth have not lost their optimism and belief in the future. even during the last years of apartheid (1993 to 1994), the co-operative research programme: south african youth (slabbert et al., 1994) found that the majority of young people were overwhelmingly positive and optimistic about their role in the country's future, and subscribed to community and family values. the same trends were found recently in the hsrc project a community youth development programme for the khayalami metropolitan council (kmc) of 1997 to 1999. this was the most comprehensive investigation into youth·· development to date. it included a survey among 1500 youth of the kmc area (schurink, 1999) and a model for and an evaluation of the empowerment process that led to the establishment of the kbayalami youth council and all its new representative structures (malan, 1999). the survey (schurlnk., 1998) showed that most youth in the entire kmc area were in urgent need of information, training, guidance and other forms of empowerment. in particular they needed training in life skills, which training should address the most serious issues, such as health training and the prevention of crime, as well as economic empowerment and entrepreneurship training. in spite of this, most young people remained optimistic about the future and their own role in society. considerable r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (200 1) no 1 179 numbers of (largely black) youth participated in the empowerment process that led to the establishment of the new regional youth council. 4 factors inhibiting productive participation in society why do youth in one of the richest countries in africa find themselves in a situation where they are generally pessimistic about their livelihood situation and their position in the economy? in this survey a conscious effort will be made to focus not only on the obvious answers, such as the lack of employment opportunities which may be linked to the legacy of apartheid. there is a range of factors inhibiting young women and men from contributing productively to society (listed in nyc, 1997, case, 1997, etc.). these include: • the inability of the economy to absorb even skilled workers while low growth rates persist • the general lack of vocationally oriented education and training for the unemployed. the failure of the formal education system to provide for this group can be seen in persistently high non-literacy and semi-literacy levels. most of the "out-of-school" young women and men are unable to acquire sustainable livelihoods on even the most elementary levels. • the bigh incidence of crime and violence. the national crime prevention strategy (rsa, 1997a) emphasises that, in many instances youth are both the perpetrators and victims of the rampant crime and violence. gangsterism and crime are often perceived as an "easy option" for unemployed youth. in the hsrc survey young respondents (39.3 per cent) considered fighting crime as the most important government priority. it was asked how safe south africa as a country is to live in, and youth respondents were generally negative, indicating "unsafe" (34.6 per cent) or "very unsafe" (14.1 per cent). they were critical of government's control over the crime situation at present, and 45 per cent felt that it had no control at all, while a large percentage (38.3 per cent) felt that it bad control only to a small extent. • health-related issues such as my/aids and substance abuse are claiming thousands of young victims and have a devastating impact on the economy. • the disruption of social and family structures is eroding society and is the cause of an unstable childhood for many young people. values such as a belief and pride in bard work, honesty, respect for authority and the law, etc., are constantly undermined. fundamental changes to traditional patterns of life in both urban and rural areas makes it increasingly difficult for youth to rely on the traditional social support systems (grant & schnurr, 1999). • early school leavers are particularly ill equipped to acquire sustainable livelihoods. they no longer have the benefits of formal education and most r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 180 sajems ns vol 4 (2001) no i resources and attention by far are directed towards the formal educational sector. • where training for groups such as these is available, it is mostly sectoral, ad hoc, aimed at "quick-fixes" and contributes little to a holistic empowerment process based on essential life skills. there certainly are no simple answers to the questions surrounding these problems and simplified solutions might create dangerous expectations. for instance, many role players and apparently even the national youth policy (nyp) maintain that intervention by government, in collaboration with the formal sector, is the only workable solution. certainly, next to fighting crime, youth in the hsrc survey viewed creating more jobs in the next ten years as the most important government priority (34 per cent). government intervention also seems to be the preferred main strategy of the national youth commission (nyc). although the nyp acknowledges the role of innovation and enterprise, its proposed strategy focuses on collective youth programmes and large-scale mobilisation (such as the national youth service and a national youth employment strategy). one may ask whether this emphasis is at the expense of recognising the importance and role of the informal sector and alternatives to mobilisation. one of the main reasons why sceptics will question large-scale government intervention, which is discussed below, is disillusionment of large segments of anglophone african society, particularly youth. for instance, it is no longer believed that central government and its policies could protect the vulnerable. is the situation different for youth in south africa? during the political transition in this country it seemed that young people's position had at last changed considerably. for the first time, a youth policy was introduced and then president nelson mandela and deputy president thabo mbeki, who took charge of policy development, both afforded youth development their personal attention. however, while women as a sector of society have been in the position to considerably strengthen their position in society since 1994 particularly through representation in parliament the opposite is true for youth. although a number of important policy documents concerning youth have been produced, there have been few implementation results. various government departments are addressing some of the most burning issues, but research has indicated that only a systematic and holistic approach to the interrelated problems can produce effective results (slabbert et ai., 1994; case, 1997; jep, 1998). according to various observers (such as jep, 1998) no major national youth organisation has so far managed to produce any significant results in improving r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 181 the plight of the youth. the national youth commission (nyc) remains the only really significant role player within a youth constituency, primarily because it is responsible for the development of the nyp. some youth circles have high hopes for the south african youth council, but many have not. the nyc, which was established in 1996, and its nyp, adopted only in 1998, has so far had little impact on young people's situation. jep (1998:4) notes that the nyc does not have the resources to translate the nyp into tangible implementation strategies and that the government's gear policy (rsa, 1996) has not been able to provide the growth in employment opportunities that was envisaged. the national job summit of october 1998 (rsa, 1998a) explicitly recognised the tremendous marginalisation of youth in the economy. many young men and women therefore feel that their position in society has deteriorated since the transition to democracy. the early schoolleavers whose prospects for sustainable livelihoods are already bleak: as a result of declining economic conditions, have suffered most. there are a number of basic reasons for young people to leave school: the lack of employment opportunities, even for the skilled is demoralising; a lack of even basic school fees and support by parents and other role players; the crises in education; general demoralisation; negative peer pressure; etc. the situation was exacerbated by political promises for job creation, particularly connected to the transitional government's reconstruction and development programme (rdp), of which little materialised. instead, it has become an easy alternative for society to evade its responsibility towards a third of its youth by labelling them as "lazy" or "without moral fibre". it is easy to stereotype those young women and men who cannot productively participate in society as mostly belonging to subcultures and groups such as gangsters and other juvenile delinquents, such as drug addicts, street children or prostitutes.4 5 international recognition of youth and their problems traditionally youth have not been in the position to assert themselves in terms of national policy development, but across the world governments are increasingly aware of young people's position in society. almost 30 per cent of the world's total population, i. e. one and a half billion people are between the ages of 10 and 24. by the year 2025 their numbers are projected to reach nearly 2 billion (cf. population reference bureau, 1996). in africa, more than half of the people are under the age of 25. in spite of the many health and educational problems, the health status of youth is improving internationally, and today's young people r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 182 sajems ns vol 4 (2001) no i are more likely to complete secondary school than any previous generation (valla, 1996). still, across the world, youth are amongst the sectors of society worst affected by problems related to unemployment. unemployment and under-employment are persistent long-term trends, affecting up to 30 per cent of the global work force, amounting to some 820 million men and women (grierson, 1997: i). even though international attention to youth policies is a relatively recent phenomenon, many international organisations have recognised the urgent need for youth empowerment and development. in a number of cases, they have initiated action plans to address these issues. these organisations include the un, unesco, unicef, ilo, and iorc (also with their acacia and aspr programmes in africa). the opening clause of the united nations world programme of action for youth states that (nyc, 1997: 81): every state should provide its young people with opporturubes for obtaining education, for acquiring skills and for participating fully in all aspects of society, with a view to, inter alia, acquiring productive employment and leading self-sufficient lives. the influential united nations conference on environment and development (unced), held in june 1992, paid specific attention to youth's participation in decision-making and their need for creating sustainable livelihoods (unced, 1992): numerous actions and recommendations within the international community have proposed to ensure that youth are provided a secure and healthy future, including an environment of quality, improved standards of living and access to education and employment. among the un escap's major objectives for national youth policies are the encouragement of full participation of youth in the socio-economic development of the country, and to produce good citizens and leaders (un escap, 1997). the international institute for sustainable development (lisd) recognises that communities should be built through the provision of opportunities to earn a livelihood. the approaches of their community adaptation and sustainable livelihoods section will be discussed below. the same principles guided the assessment of social policy reform (aspr) programme of the iorc, which will also be surveyed below. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vo14 (2001) no i 183 6 africa: youth's participation in democratic governance 5 youth participation in the economy and in civil society has benefited considerably from the processes of democratisation in the region. the establishment of youth councils in almost every country in southern africa is in itself a response to the growing numbers of youth organisations, which are a reflection of a liberalised political environment. young men and women from civil society organisations are increasingly being afforded an opportunity to express their political views through the youth council forums. in the past five years their participation has been particularly noticeable in the realm of youth policy development (mwansa, mufune and osei-hwedie, 1994; mkandawire, 1997b). this area has emerged as a conduit for the articulation of their political views, most of which are a direct criticism of government policies. they have expressed concern about issues like youth unemployment, crime and violence, youth health problems and gender inequalities. all these issues mirror the wider societal or national development concerns. youth are clearly beginning to reassert themselves in many countries by forming non-partisan associations whose primary objective is to articulate their interests and needs. undoubtedly, these new youth organisations will increasingly act as pressure groups to compel governments in the region to formulate policies and programmes that reflect the needs of young people. in the case of south africa for instance, the growing concern about youth unemployment resulted in the national youth council convening a national youth job summit in 1997. the subject of youth unemployment is reflected in literally all national youth policies in commonwealth africa. most countries have identified youth unemployment as a problem that needs to be addressed. unfortunately, the resulting national programmes of action on youth are not clear on how the growing levels of youth unemployment will be curbed. there is a rather naive assumption that, since one of the major hurdles to the creation of selfemployment among youth is limited access to credit, what needs to be put in place is a micro-credit programme to promote micro-enterprise development. 7 the economic context in africa the idrc (i 998b ) lists several conditions such as demographics and a low level of gnp that make the plight of youth in africa particularly challenging. the idrc's sustainable livelihoods research was motivated by a growing concem that significant numbers of developing country youth lack a solid institutional context for developing their life and employability skills, leading to r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 184 sajems ns vol 4 (2001) no i unemployment and poverty. one of the commissioned reports notes that ''youths constitute 40 to 65 per cent of the unemployed in african countries, and this figure has been rising. for instance, between 1986 and 1991 the proportion of youth who were unemployed in zambia increased from 19 to 27 per cent. at present youth unemployment in zambia stands at 30 per cent. unemployment is particularly severe in the age group 12 to 19 years ... in africa many children at the age of 12 are forced to enter the labour force as they cannot continue in school for various reasons" (iorc, 1997b: 16). several conditions make the plight of youth in africa particularly challenging. the most important is the juxtaposition between stagnant economic growth and a burgeoning youth population. of 34 countries in sub-sahara africa, mead (1994) notes that gnp per capita declined from 1980 to 91 in 23 countries and was virtually stagnant in three others. the anglophone africa study cites a poverty assessment survey for 1996 that found that "76.6 per cent of those surveyed believed that they were poorer than they had been 5 years before" (iorc, 1997b: 5). according to the 1998 unfpa report on the state of world population, over 50 per cent of the global increase in young people (age 10 to 24) since 1980 occurred in sub-saharan africa. currently, approximately 75 per cent of the population of sub-saharan africa is under the age of 30 and approximately 50 per cent under the age of 15 (unfp a, 1998). africa's total population more than doubled between 1950 and 1980 and is expected to double again after the year 2000. consequently, young people are a large portion of the african population. over half the population is under 25. this increase in young people will eventually increase the numbers of economically active people. for west africa, this increase has been estimated at 2.31 per cent a year from 1980 to 1985,2.57 per cent from 1985 to 1990,2.69 per cent from 1990 to 1995, and 2.84 per cent from 1995 to 2000 (ndongo, 1997: 2). young people have benefited substantially from the processes of democratisation and policy development, including the youth policies surveyed above. when the focus turns to economic conditions and unemployment, a far less optimistic picture emerges. in their study of enterprise and entrepreneurship in african countries, mkandawire and chigunta (1997) describe a backdrop for the development crises which most anglophone african countries have been facing since the mid 1970s and that have over the years induced far reaching economic reforms. designed to improve economic management and performance, the reforms entail undertaking painful economic restructuring. a r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 185 major effect of the reforms is that the formal, largely urban based sector, is losing ground as an important labour sponge, much as the urban areas have deteriorated as a haven for safeguarding survival, especially for the youth. the restructuring of both the public and private sectors in the region has worsened the position of young people through retrenchments, liquidation of companies and labour market freezes and shrinkage. mkandawire and chigunta (1997) appear to believe that the on-going economic reforms in anglophone africa have to a large extent shattered hopes for a better future among the youth. however, seen from the positive side, these reforms present new challenges and opportunities for the youth to enter potentially gainful employment through enterprise and entrepreneurship development. already the urban informal and rura1/agricultural sectors have grown in importance as sources of employment in the region. in their discussion of development problems in the region, the iorc (l998a) indicated that africa presents the opportunity to improve the livelihoods of youth by means of enterprise. to begin with, there is acute and widespread poverty. economies of the region are in the midst of significant structural adjustment, which nevertheless fails to meet the needs of a burgeoning youth population. in this process, masses of young people are moving away from rural, agrarian-based economies to urban centres in the hope of improving their lives. traditionally, it was accepted that formal education and vocational training systems imparted the skills needed for entry into the formal labour market. reforms are now in place to integrate enterprise skills development with vocational training. however, a large majority of young people exits the formal education system before level 7 and is unlikely to be in the position to access the training services offered by these reforms. the decline of formal sector livelihood opportunities has resulted in increased informal sector activity, accounting for up to 80 per cent of gdp in some african countries.6 this is largely due to the vast numbers of young men and women entering the world of work prematurely and coping with poverty by barely scraping together a livelihood in the informal sector. although economic adjustment envisages the possibility of a better policy environment for employment growth and enterprise development, the immediate effect has been to reduce the capacity of the economy to absorb new entrants into the workforce. during this economic adjustment period, most young people are without direction in the sense that traditional socio-economic paths are eroded, yet new paths are not fully developed. with change also comes opportunity. the literature points to the increased demand for skills in certain sectors. for r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 186 sajems ns vol 4 (2001) no i example, tourism services, information and communication technology and environment sectors are increasingly offering livelihood opportunities. moreover, structural adjustment programmes have assigned a significant role to endogenous enterprise and entrepreneurship in economic and social change. 8 livelmood and employment issues in south africa8 there is substantial political commitment by the nyc in south africa to award youth livelihood and self-employment skills development priority. this was prompted by the recognition that after 40 years of bantu education and other apartheid policies, many african communities became underdeveloped, especially in the former homelands. the nyc, which received the legal mandate from government to co-ordinate national youth programmes, has identified the following elements which are intended to guide the national youth livelihood and self-employment initiatives. the establishment of a youth clearing house, that will provide information to unemployed and out of school young men and women on employment and training opportunities. the national youth information service was established in 1998 and is contributing much to the dissemination of information that young people need for self-development. the co-ordination of a series of activities designed to promote the employment of young people and identify and research issues affecting young unemployed men and women. this will include labour market analysis, the design of youth training agreements and programmes and the promotion of specific sectors for youth employment such as science and technology. • the promotion of youth enterprise development, which will involve coordinated skills and activities designed to address the specific needs and opportunities facing young people in the field of self-employment and enterprise development. this will include the preparation of a national youth enterprise policy and the subsequent design of programmes and services that promote self-employment opportunities. the specific barriers and constraints experienced by young people attempting to enter business or by those already in some kind of business, need to be addressed. (nyc, 1998). the nyc has made the important observation that youth employment creation can only be viable when it is integrated with other broader youth employment initiatives. for instance, a micro-credit programme that is not linked to the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 187 provision of marketing information, training of beneficiaries in entrepreneurship, communication and the development of interpersonal relationship skills, among others, is unlikely to create long~term employment prospects for young people. as observed elsewhere (mkandawire and chigunta, 1998), governments in afiica have established a number of micr~credit initiatives to promote micr~enterprise development among young people. one of the major weaknesses of these initiatives however, is that most of the micr~ credit programmes over-emphasise the credit aspect in isolation of other broader employment concerns, such as training in entrepreneurship skills and manufacturing related programmes. micro-credit programmes in africa have as a consequence turned out as a "quick-fix" solution to the youth unemployment problem. most young men and women with no discernible production related skills, or entrepreneurial skills, resort to "quick-fix" money-making ventures, such as vending. a vending youth culture has therefore evolved and is being fuelled by the micro-credit programmes currently being promoted by governments in most afiican countries. notable micro-credit programmes for youth exclusively, have for instance been established in kenya, malawi, zambia and zimbabwe, among other countries. most of these micro-credit schemes were not only established without a careful analysis of the prevailing social, cultural and economic environment where they were supposed to operate, but in many cases they were not linked to other broader youth employment concerns such as markets (mkandawire and chigunta, 1997). it is consequently not surprising that success stories in the delivery of micro-credit programmes as a strategy for creating youth employment in africa are very rare. 9 large-scale programmes vs. the informal sector as mentioned above, many role players, and apparently even the nyp, maintain that intervention by government, in collaboration with the formal sector, is the only workable solution. this also seems to be the preferred strategy of the nyc. although the nyp acknowledges the role of enterprise, its proposed major strategy focuses on collective youth programmes and large-scale mobilisation. the nyp emphasises government responsibility and the role of institutional structures. in the nyp survey of institutions and agencies responsible for youth development (nyc, 1997: 55-63) a considerable number of central, provincial and local institutions (mainly committees) are listed. by contrast, only a few paragraphs are devoted to non-government institutions (mainly the south r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 188 sajems ns vol 4 (2001) no i african youth council [sa ycn while the infonnal sector is not even mentioned. central to the nyc's action plan is the proposed national youth service. the technical task team responsible for the green paper on national youth service (rsa, 1998a) released in october 1998, recommended that pilot programmes begin as early as 1999. the task team is of the view that different categories of youth require different types of services. the green paper identifies four key target groups as beneficiaries of the service: higher education students, further education and training students, unemployed young people and youth in conflict with the law. the urgency to address youth unemployment and the widespread lack of training were also clearly recognised at the national job summit held on 31 october 1998 (rsa, 1998b). all parties were committed to the progressive building of south africa's human capacity at all educational levels. an emphasis on learnerships was important for this project. a leamership is a workbased route of learning, and is one of the initiatives proposed in the skills development bill all parties were also fully committed to leamerships, an example of which is the partnership between business and government in tourism and hospitality to support some 6 000 leamerships. another important decision emerging from the summit, was to initiate special measures to train and support women entrepreneurs. the larger part of the summit's decisions on youth referred to the youth brigade programme. this programme will be established as a means to involve youth in public and community service and to facilitate their access to income generating opportunities. there will be three leading programmes: working for water, the clean and green cities campaign and the community based public worlcs programme. participants in a youth brigade would provide public works and/or community service, receive accredited education and training, as well as an allowance. aids brigades would launch a campaign against illv/aids. in addition to the brigade, government will, through the departments of education . and labour, explore opportunities for community service for students in cooperation with a range of stakeholders. both the nyp and the range of stakeholders present at the job summit therefore emphasised government intervention and were in favour of the overlapping concepts of a youth brigade and youth service. however, the idrc (1998b: 34) questions the nyp reliance on institutional and volunteerism factors: "this document focuses disproportionately on awareness of national identity, volunteerism and institutional capacities. however worthwhile these objectives, they are fundamentally disconnected from the practical problems of employment r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 189 that policy itself documents in some detail. ii the reliance on government intervention. bureaucratic management and collective endeavours might be at the expense of support for individual initiatives and innovation and the strengthening of the informal sector. yet the informal sector has grown from 1,2 million people in 1994 to 1,8 million in 1997, according to ssa (1998). this is in accordance with international trends: the informal sector already accounts for up to 60 per cent of the labour force in the urban areas of many sub-saharan african countries (grierson, 1997: 2). the general lack of recognition of the importance of this sector and of the declining influence of government regarding youth empowerment in anglophone africa is cause for concern. on the other hand it should be pointed out that use of the concept "informal sector" is becoming increasingly controversial, particularly since government restrictions on small businesses have been relaxed everywhere. certainly a formally constituted governmental base responsible for policy formulation and implementation is integral to the success of youth development, as mwansa, mufune and osei-hwedie (1994: 261) conclude in their comparative study of youth policy in botswana, swaziland and zambia. but in this regard, some hard lessons have been learnt in africa. earlier reference was made to the disillusionment of large segments of anglophone african society, particularly youth, and that they no longer believe that central government and its policies could protect the vulnerable. the youth have adopted self-reliance coping strategies in order to survive the devastation brought by the economic crises and the social harshness of the measures implemented to combat it. many youths no longer look up to the state, and have begun adopting practical survival strategies. this has resulted in the rapid growth of the informal sector in the region. south african circumstances show a clear need for an emphasis on technology transfer and entrepreneurship in a national strategy to address unemployment. the white paper on science and technology (rsa, 1997c) specifies six major requirements for promoting competitiveness and job creation, including a strong technology component for creating and sustaining micro-enterprises and small businesses, and development and entrepreneurship. the need for a comprehensive and holistic strategy to address youth employment has been widely recognised since youth policy carne under scrutiny. the co-operative research programme: south african youth drew attention to the low priority accorded to self-employment and entrepreneurship, and called for education and training to inform people of opportunities in these r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 190 sajems ns vol 4 (2001) no i areas (slabbert et ai., 1994: 137). they suggest three specific ways to empower the unemployed: • education should be used to help eliminate the harmful effects of myths and stereotypes apropos the unemployed. • there is a need for direct support services for the unemployed through the family, which currently provides most of the social and moral security for the unemployed in its midst. • the unemployed should be helped to externalise blame for their being without work. solidarity among the unemployed needs to be supported to provide a positive reference group for these people (slabbert et ai., 1994: 136). 10 youth empowerment and participation in society some fonn of employment, including self-employment, is crucial for a sustainable livelihood. however, if research is to identify ways for youth to play a truly productive role in building a prosperous and democratic society, much more than employment should be investigated. international youth development organisations are placing the empowerment of young people in a broader societal context. following this worldwide trend, the joint enrichment project (jep, 1998: i) has since 1994, worked towards an integrated and holistic strategy where government, the corporate sector and ngos work together. their strategy is called an integrated approach to youth development (ia yo). it wants to move away from the traditional focus on training only, and emphasises three areas: skills (technical) training, education support and life skills. an example of an approach that did not work was the short-term training provided by the regional training centres, which often did not equip trainees to move into formal employment. the integrated strategies developed by jep and a number of other ngos (jep, 1998: 6) locate development of the young individual within a network fonned by civil society, government, the community, family structures, youth culture and the media in most approaches such as the ia yo, the emphasis is on personal empowerment, learning as opposed to only training and a comprehensive development process. personal empowerment is learned by discovering that even those labelled as poor or disadvantaged or otherwise socially incapacitated can triumph and improve their own lot. real empowerment is the sense of efficacy that occurs when people realise they can solve the problems they face and have the right to contest unjust conditions. empowerment is the process of gaining control over r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 191 different fonns of social power. it also occurs when people gain skills and feel more confident. development is that process by which the disguised, unexpected, latent characteristics or potential of (young) people are developed, made available, utilised or transfonned for the enhancement of their quality oflife, the stimulation of environmentally sensitive modernisation and the improvement of the social functioning of those people. 11 basic competencies for youth development youth development education programmes and policies will be assessed to determine if they address the five basic competency areas identified by pittman (1991) as essential for success in adulthood: 1. vocational competence understanding and awareness of life planning and career choices, leisure and work options, and steps to act on those choices. 2. personal and social competence skills for understanding self and having self-discipline; working with others, communicating, co-operating, negotiating and building relationships; coping, adapting and being responsible; and finally, making good judgements, evaluating, making decisions and problem-solving. 3. citizenship competence. 4. health and physical competence. 5. cognitive and creative competence. while these five competency areas are an ideal focus for intentional learning experiences for non-fonnal youth development education programmes, they are also central to many school curricula. it is the educational design and delivery system that commonly distinguishes fonnal and non-fonna! education. 12 the livelihood, enterprise and employment cap abilities approach the notion of a livelihood looks beyond the conventional meaning of employment and seeks to understand the fullest range of ways in which young men and women survive. young men and women are often the last to be employed in the fonnal economy. they engage in a number of income generating activities to survive, which draw on their capabilities and resources. underemployment (rather than unemployment) keeps individuals living at a r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 192 sajems ns vol 4 (2001) no i subsistence level and forces them to underutilise their abilities because of a lack of access to resources. the world commission on environment and development introduced the concept of sustainable livelihoods in 1987, to relate to ownership of and access to resources, basic needs and existential security, particularly in rural areas. the united nations conference on environment and development (unced) of 1992 acknowledged the integrative value of the concept in agenda 21 (unced, 1992). it also introduced the concept "sustainable livelihoods for all", making it applicable in developing as well as developed countries. the concept enables decision-makers to integrate decisions on socio-economic and ecological policy issues in a coherent structure, which is pertinent to a development policy_ there is currently much discussion regarding the definition of sustainable livelihoods and its relevance to developing countries. according to the iorc's first phase research fmdings (1998b), the definitions that have the greatest connection to young people in africa are those that reflect an understanding of the realities which influence their decisions. for sustainable livelihoods to be relevant to the target group we have defined, it must take into consideration poverty, the lack of formal employment opportunities, family obligations and the significant gap between their education, their inherent capabilities and the resources available to them. chambers and conway (1992: 5) define sustainable livelihoods in the following manner: (a) livelihood comprises the capabilities, assets (stores, resources, claims and access) and activities required for a means of living; a livelihood is sustainable, can cope with and recover from stress and shocks, maintain or enhance its capabilities and assets, and provide sustainable livelihood opportunities for the local and global levels in the short and long term. sustainable livelihoods have been defmed by singh and titi (1995) as people's capacities to: ... generate and maintain their means of living, enhance their well-being and that of future generations. these capacities are contingent upon the availability of and accessibility to options which are ecological, sociocultural, economic and political, and are predicated on equity, ownership of resources and participatory decision-making." livelihood is therefore a broader category than "having a job" and more in line with the actual manner in which many young men and women in developing countries must organise themselves and their activities in order to survive. the key to generating a sustainable livelihood is adaptability and the utilisation of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 193 what chambers and conway (1992: 6) describe as dynamic livelihood capabilities. chambers considers that, "most livelihoods of the poor will continue to be adaptive performances, improvised and versatile in the face of adverse conditions, shocks and unpredictable change". the undp (1997: 5) believes that sustainable livelihoods should integrate all economic activities currently defined under employment as well as "introduce the social dimensions of sustainability and equity ... " what is proposed is an inclusive, rather than exclusive concept of sustainable livelihood that is potentially applicable to any form of making a living which can be pursued independently, i) without compromising personal security, ii) is reasonably stable across significant periods of time (without of course any guarantee), iii) is mutually beneficial to individuals and their immediate social grouping, as well as to the consumers of their products/services, and iv) does not compromise the physical environment." creating a livelihood is a necessity; making it sustainable is the challenge. sustainable livelihoods always entail more than employment or economic empowerment, crucial as these aspects may be. political, ecological, sociocultural, educational and other factors all are important indicators of a reasonable means of living and well-being. as unesco (1991: 4) points out, there is no direct conflict between employment and unemployment in developing countries, since there are two additional categories underemployment and work in a family environment which are geared more towards subsistence than towards commercial production. the dynamic nature of sustainable livelihoods within different socia-economic contexts is well explained by the international institute for sustainable development (iisd). the interaction between these contexts and sectors as theorised by their community adaptation and sustainable livelihoods (issd/casl, n.d.) is paraphrased in this section. the local economy can be broken down, as can the macro-economy, into a number of sectors or activities. in a pastoral community for example, these might include livestock keeping, cultivation, employment, collecting (including hunting, gathering, fishing) and the informal sector. the relative importance of each sector (percentage contribution to sustainable livelihood) will vary widely from one local economy to another. the concept of sustainable livelihoods is therefore not static. because of both internal and external dynamics, to be sustainable a livelihood requires the capability to respond to change, and to continually renew and develop adaptive r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 194 sajems ns vol 4 (2001) no i strategies. the capacity of households and communities is both reactive in responding to adverse changes in conditions, as well as proactive and dynamically adaptive. capacities and livelihoods, therefore, have a dynamic relationship; capacities enable a livelihood to be gained while livelihoods provide the support, enhancement and the environment for the exercise of capacities. possible indicators of sustainable livelihoods are divided by the iisd (casl, n.d.) into the following sectors: ecology and environment, infrastructure and technology, socio-cultural, political and economy. some of the indicators that touch on most of these categories are the following: diversity of income source, lidi index, access to transport, time spent on water source and accumulation of waste. the notion of dynamic livelihood capabilities dovetails with a broader notion of enterprise and entrepreneurship. chambers and conway (1992) describe dynamic livelihood capabilities as " the ability to perceive, predict, adapt to and exploit changes in the physical, social and economic environment." canada's institute for enterprise education dermes enterprise as the ability to take initiative to achieve a self-determined goal that is part of a future vision, in order to achieve one's own meaning in life, while sharing achievements with others in the community" (lee, 1998). dynamic livelihood capabilities can be thought of as enterprising behaviour in a developing context. by enterprise is meant that set of knowledge, skills and attitudes (referred to here as enterprise skills) that allow a person to adapt to changing circumstances by taking control and initiative. when these skills are applied to business formation and expansion, we call this "entrepreneurism" whereas enterprise skills may be applied to a wide variety of other life circumstances including coping with poverty. the lee (grant and schnurr, 1999) sees the need for enterprise skills as being related to fundamental changes in the global economy that place new demands on the individual to create self-supporting skills. enterprising behaviour can have various manifestations. it can manifest itself in adapting to adversity in the traditional rural sector and in various forms of selfemployment and income generation in the informal sector. a common manifestation of this behaviour is in vending and trading in the urban informal markets, which in many cases is considered an under utilisation of a young person's potential. more productive manifestations of enterprise capabilities may come in the form of a self-employed clothing maker, bricklayer or furniture maker. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 195 entrepreneurship is seen as the application of enterprise skills or dynamic livelihood capabilities in the context of long-tenn business development. according to loucks (1988), "all entrepreneurs are self-employed, but all selfemployed are not entrepreneurs if we interpret entrepreneurship as involving production or sale of a product or service and the person concerned takes a substantial fmandal risk and its success generates further employment". enterprise capabilities allow technical skills to find social and economic expression where fonnal employment opportunities are constrained. many young people naturally work in a dynamic, enterprising marmer despite the barriers that block their access to important resources. much of this enterprising behaviour is actually a manifestation of a failure in the employment market. it can be argued that these conditions predispose a larger number of young men and women to self-employment because they have been exposed to it through the inability of the fonnal market to absorb them. in summary there are clearly defined sub-groups of school leavers who face different challenges and who posses different enterprise capabilities. the assertion is that enterprise approaches to non-fonnal training can help alleviate the market failure by: (1) helping young men and women cope; (2) improving the role of self-employment in the fonn of micro and small enterprise development; and (3) generating more fonnal employment opportunities by expanding the private sector through entrepreneurship development. self-employment will obviously be one of the most important alternatives for early school leavers to be investigated. the self-employed are working owners of unincorporated businesses. these units are also referred to as microenterprises (hoppers, 1994: 5), grierson (1997: 15) has developed a planning and assessment framework that can be used to evaluate vocational training for self-employment. the (a) selection, (b) training and (c) enterprise stages are distinguished, and respectively combined with "raw material", "processing" and "product" phases. interventions in favour of self-employment can focus on any or all of these stages. all case studies used for this model demonstrate the close involvement with local communities and markets, and collaboration with other organisations interested in promoting self-employment (1997: 19). 13 a coherent approach to livelihoods, enterprise and employment capabilities development there are several non-fonnai training programmes in place in, for example, malawi, zambia and south africa. these programmes focus on developing the livelihood, enterprise and employment capabilities of young men and women. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 196 sajems ns vol 4 (200 i) no i the programmes are often developed in isolation of each other, with a lack of a detailed understanding of the livelihood contexts and capabilities of the target group and with few if any links to policy and a broader youth skills development strategy. viewing the situation from a development perspective, there are vast human resources waiting to be tapped the 1998 unfpa report on the world population talks of the bulge in the working age population, largely attributable to the growth in the population of young people (age 15 to 30), as the "demographic bonus", which "offers (developing) countries an opportunity to build human capital and spur long-term development" (unfp a, 1998). complementing this potential is a real demand by the private sector for skilled labour in the form of, for example, self-employed bricklayers, carpenters, computer service technicians and sales representatives (grierson, 1997). finally, the study of micro and small enterprise development has produced an abundance of literature on financial and non-fmancial services for small business development, some of which is relevant to promoting youth enterprise and livelihood skills development (grierson, 1997). the ilo, 9 unicef and the unfpa and a number of international ngos and local community-based organisations have documented experiences on youth life skills development related to self-employment. the lessons learned from these experiences, placed in the context of the livelihood conditions, circumstances and capabilities of young men and women, have the potential to lead to the development of a coherent non-formal training programme framework for the development of youth livelihood, enterprise and employment capabilities. 14 linking non-formal training programmes to education and training policy objectives the ideal point of entry for the development of employment skills is the education system. however, as mentioned earlier, the current reality in subsaharan africa is that most young men and women leave this system before the age of 12. skills development of early schoolleavers, in most cases, falls under the jurisdiction of the ministries of youth, gender and community affairs. in many cases (e.g., south africa and zambia), there are policy objectives for the development of self-employment skills. these objectives are often well articulated and are based on sound reasoning and a good general understanding of the conditions facing young men and women. the problem is that these ministries tend to be understaffed with limited financial resources to implement these policies. a more efficient non-formal training system, with relevant links to policy could provide the means to implement many existing policy objectives. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (200 1) no 1 197 in summary, the institutional challenge is to improve the effectiveness of the non-formal training system. there is a need to develop an institutional mechanism to respond to market failures to mediate the latent potential of young people into productive social and economic activity, while understanding their current livelihood conditions and capabilities. in particular there is a need to: 1) identify the skills and services demanded and by whom; 2) identify the young men and women with the capabilities to fill this demand; 3) develop the targeted training to support the development of these capabilities and link the supply of trainees to the demand for skills and services; 4) link the intent of skills development policy objectives to the range of effective programmes which do exist; and where possible establish links with the formal education system; and 5) identify the appropriate roles for government, civil society and the private sector. 15 support structures in the community research into livelihoods should pay particular attention to the existing support structures at the community level. indeed in the african context, one cannot discuss the concept of a youth livelihood in isolation from the prevailing social, economic and cultural context within which young people find themselves. it will therefore be critical to explore how local communities as well as organisations such as churches or clubs or indeed any other local civil society organisation, support or impinge on sustainable livelihoods for youth. for instance, in many countries in africa some young people have sought political space through volunteering to work with local communities, including church organisations. hence although not fully employed, the political and social space that is provided, enables them to gain some degree of skills including confidence, a sense of belonging and connection to their communities. this provides them with a useful springboard into future employment. social support structures are crucial for empowering young women. it comes as no surprise that sharif (1998) fmds that women entrepreneurs in sub-saharan africa, especially youth, lack equal access to economic resources such as land, improved technology and government services (such as transportation). they also have unequal access to formal education and lack training in management related and technical skills. in south africa, the national job smnmit (rsa, 1998b) fully recognised women's margina1ised position as entrepreneurs and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 198 sajems ns vol 4 (2001) no 1 adopted a range of proposals to remedy the situation. before their situation is improved, however, they will have to rely heavily on community and family networks. 16 conclusion the problems facing the youth are so numerous and complex that only some of the most pressing ones could be surveyed here. valuable lessons can be learned from international and comparative research. in south africa, it remains to be seen if the vision articulated by the nyc in the national youth policy and strategic plan, and also of the national job summit., will be translated into the creation of viable and sustainable livelihood initiatives for the majority of youth. given the approach that the nyc is considering to adopt, one could only hope that mistakes made in the implementation of programmes to create sustainable livelihoods elsewhere, are avoided in south africa by acquiring sufficient data about the current status of young men and women in their various livelihood contexts. notes unless otherwise stated, local statistics regarding youth are based on the 1995 household survey by case (1997), which was also used for the national youth policy (nyp). 2 note that these statistics used for the nyp do not correlate with those of statistics south africa (1998), quoted below, but the survey co-operative research programme: south african youth found in 1993 that 42 per cent of young people between the ages of 15 and 30 were unemployed (slabbert et al., 1994:128). obviously statistics will depend on the definition of "the unemployed" strictly speaking youth undergoing training or education cannot be considered unemployed. 3 the survey involved a countrywide random sample of 2 182 respondents representative of all population groups, provinces and regions (including former tbvc states) of south africa. of these, 838 respondents were in the age group 18 to 34, whose views are discussed here. the survey was conducted for the hsrc by market research africa. multi-stage stratified cluster sampling was employed to draw the sample. questionnaires were completed by means of personal interviews conducted by trained interviewers. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 199 4 tenns used by everatt & sisulu (1992) and everatt & orkin (1993), but disputed by slabbert et a/.(1994) precisely because the negative tenns contribute to stereotyping of youth. 5 this section is largely based on mkandawire (1998b). 6 the survey of the infonnal sector is provided by the idrc (1997a). 7 non-fonnal training refers to skills development programmes that lie outside the fonnal education system. these programmes are commonly managed by non-governmental organisations and community based organisations (e.g. church groups) and funded by the private sector, donors and government. 8 this section was contributed by mkandawire (1998a). 9 the ilo defines life skills as those that "enhance the abilities of trainees to both cope with the changing environment and translate technical skills into employment. life skills empower people to make infonned choices about their future". some of these skills will have been acquired through schooling but equally important will be infonnal and non-fonnal means of acquiring skills. references breitenbach, m.e. (1999) "the new millennium: trends and challenges", paper presented at the annual conference of the development society of south africa, johannesburg. 2 chambers, r. (1995) poverty and livelihoods: whose reality counts? new york: undp. 3 chambers, r. & conway, g.r. (1992) "sustainable rural livelihoods: practical concepts for the 21 sf century", discussion paper 296, institute for development studies, sussex university. 4 community agency for social enquiry (case) (1997) youth and youth development in south africa; the challenge of reconstruction and development, johannesburg: community agency for social enquiry (case). 5 erasmus, j. (1999) the sa labour market: trends & future workforce needs, pretoria: human sciences research council (hsrc). 6 everati, d. & orkin, m. (1993) growing up tough: a national survey of south african youth, johannesburg: community agency for social enquiry (case). 7 everati, d. & sisulu, e. (eds.) (1992) black youth in crisis: facing the future, johannesburg: ravan press. 8 grant, m.& schnurr, j. (1999) "enterprise approaches to youth livelihoods development: an exploration of themes in sub-saharan r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 200 sajems ns vol 4 (2001) no 1 africa", unpublished report: international development research institute (idrc). 9 grierson, j.p. (1997) where there is no job: vocational trainingfor self-employment in developing countries. geneva: swiss centre for development co-operation. 10 hoppers, w. (1994) the promotion of self-employment in education and training institutions: perspectives in east and southern afiica. international labuur organization working paper: 85-86. 11 human sciences research council (hsrc) (1998) "results of the novemberldecember 1998 general survey", unpublished report. pretoria: hsrc. 12 ilo/jaspa (jobs and skills programme for afiica) (1990) africa employment report, addis ababa: international labour organization. i3 international development research institute (idrc) (1997a) "anglophone africa study on youth enterprise and entrepreneurship", nationalldrc study: kenya, october. 14 international development research institute (idrc) (1997b) "youth enterprise and entrepreneurship development. research towards sustainable livelihoods for youth", unpublished report, ldrc. 15 international development research institute (ldrc) (1998a) "sustainable livelihoods for youth. a multi-country proposal for action research and the establisbment of the africa youth livelihoods knowledge network", unpublished proposal, idrc, october. 16 international development research institute (idrc) (1998b) "sustainable livelihoods for youth", draft report of the idrc research findings to date, unpublished report, idrc, october. 17 international institute for sustainable development (iisd) (1994) youth sourcebook on sustainable development, winnipeg, manitoba: iisd. 18 international institute for sustainable development (iisd) n.d. (a) "community adaptation and sustainable livelihoods (casl): sustainable livelihoods", unpublished document, available through url http://iisdl,jisd.ca. 19 international institute for sustainable development (iisd) n.d. (b) "community adaptation and sustainable livelihoods (casl): indicator checklist: possible indicators of sustainable livelihoods", unpublished document, available through url htqrlliisdl iisd.ca 20 joint enrichment project (jep) (1998) "the integrated approach to youth development", unpublished discussion document. johannesburg: jep. 21 loucks, k. (1988) training entrepreneurs for small business creation: lessonsfrom experience, geneva, switzerland: ilo. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 201 22 malan, c. (with v.z. slabbert, h. marais, j. olivier & r riordan) (1995) "south africa's youth. facing the challenges", iriformation update, first term: 11-18. 23 malan, c. (1999) a model for youth development in the khayalami metropolitan council area, pretoria: unpublished hsrc report for the khayalami metropolitan council. 24 mead, d.c. (1994) "the contribution of small enterprises to employment growth in southern and eastern africa", world development 22(12): 1881-94, december. 25 mkandawire, r. (1997a) "the alienated, disillusioned and resilient youth in africa: present and future employment prospects of youth 1997", paper presented at an anc-organised seminar on youth. august, johannesburg, south africa. 26 mkandawire, rm. (1997b) experiences in youth policy and programme development in commonwealth africa, lusaka: commonwealth youth progranune africa centre. 27 mkanda wire, r.m. (l998a) "sustainable livelihoods and selfemployment initiatives research for south africa, with specific reference to the northern province", unpublished planning document. 28 mkanda wire, rm. (i 998b ) "youth's participation in democratic governance", unpublished submission to the hsrc. 29 mkandawire, rm. & chigunta, f. (1997) the regional study on youth enterprise and entrepreneurship in anglophone africa in the jr' century, unpublished report. lusaka: commonwealth youth progranune, africa centre: 30 mkanda wire, rm. & chigunt a, f. (1998) rejuvenating cooperatives for the 21st century: youth participation in co-operatives in zambia and malawi, lusaka: commonwealth youth progranune, africa centre. 31 mwansa, l.k., mufune, p. & osei-hwedie, k. (1994) "youth policy and progranunes in the sadc countries of botswana, swaziland and zambia: a comparative assessment", international social work, vol. 37: 239-63. 32 national youth commission (nyc) (1997) youth policy 2000. national youth policy, pretoria: government of the republic of south africa. 33 national youth commission (nyc) (1998) "strategy plan", (unpublished.) june. 34 ndongo, rn. (1997) potential contribution of enterprise and entrepreneurship to improving youth livelihoods in ivory coast, idrc exploratory study and data collection. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 202 sajems ns vol 4 (2001) no 1 35 pittman, k. (1991) promoting youth development: strengthening the role 0/ youth serving and community organizations, washington d.c.: academy for educational development. 36 population reference bureau. (1996) the world's youth, washington, dc: population reference bureau inc. 37 republic of south africa (rsa) (1996) growth, employment and redistribution: a macroeconomic strategy (gear) pretoria: department of finance. 38 republic of south africa (rsa) (l997a) national crime prevention strategy, pretoria: government printers. 39 republic of south africa (rsa) department of education (1997b) white paper on higher education transformation, pretoria: government printers. 40 republic of south africa (rsa) department of education (1997c) white paper on science and technology, pretoria: government printers. 41 republic of south africa (rsa) (l998a) green paper on a national youth service, pretoria: government printers. 42 republic of south africa (rsa) (l998b) national job summit resolutions summary, press release. 43 schurink, e. (1999) "youth empowerment for the khayalami metropolitan council", report for the kbayalami metropolitan council. pretoria: hsrc. 44 sharif, n.r (1998) "youth livelihood choices and constraints in subsaharan africa: a gender perspective", unpublished iorc report. 45 singh, n. & titi, v. (1995) "empowerment: towards sustainable development, winnipeg, manitoba: international institute for sustainable development (llsd). 46 slabbert, v.z., malan, c., marais, h., olivier, j. & riordan, r (eds.) (1994) youth in the new south africa. towards policy formulation, pretoria: hsrc. 47 standingetal, g. (1996) restructuring the labour market: the south african challenge, statistics south africa. 1998, results of the . 1995 census. press release. 48 united nations development programme (1997) productive employment and poverty eradication: how can livelihoods be more sustainable. new york: undp. 49 unesco. (1991) facing the future: young people and unemployment around the world. paris: orient longman. 50 united nations. (1998) statistical charts and indicators on the situation o/youth: 1980-1995. new york: un. 51 united nations. n.d. perspectives on contemporary youth, new york: united nations publications. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 203 52 united nations conference on environment and development (unced) (1992) proceedings of unced. new york: united nations. 53 united nations escap (1997) review of the youth situation. policies and programmes in asia and the pacific, new york: united nations. 54 united nations, informal sector development in africa. (1996) locating africa's informal sector, new york: united nations. 55 united nations population fund. (1998) the state of the world population, new york: unfpa. 56 valla, v. (1996) audit of a youth development sector, johannesburg: joint education trust (jet). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . f:\ejour\ecoman\index\ecoman_v6_n2.prn.pdf sajems ns vol 6 (2003) no 2 304 a study of corporate travel management in selected south african organisations and a conceptual model for effective corporate travel management ___________________________________________________________________________ berendien lubbe department tourism management, university of pretoria ________________________________________________________________ abstract south african corporations with a substantial travel expenditure of between r1 million and r300 million per annum are faced with two main issues. the first is the management and control of travel expenditure and the second is the management of the travel process to ensure required service levels at an optimum cost-benefit ratio. the corporation depends heavily on numerous interactive relationships to achieve this. in this article the key elements of corporate travel management are identified and the results of a survey conducted on the way in which corporate travel is managed in terms of each of these elements in selected south african organisations is reported. a conceptual model, based on a “soft value management model” which highlights conflicting values of participants and their commitment to goals is proposed as a foundation on which further research can be conducted. jel g30 introduction corporate travel is that segment of the business travel market that can be described as travel undertaken by the employees of a particular organisation that has a substantial travel volume. travel arrangements are generally consolidated into a centralized function that falls under a specific department or in many instances includes the establishment of a separate corporate travel department that oversees the entire travel programme. one of the primary functions of such a department is to consolidate the travel volume to obtain leverage from travel providers such as airlines, hotels and car rental firms in the negotiation of contracts at reduced prices (bell & morey, 1995). it is generally nondiscretionary travel because business travellers have little influence over where, when, how and how long to travel. sajems ns vol 6 (2003) no 2 305 in contrast to corporate travel, travel undertaken by the employees of small to medium size enterprises often lacks the volume of travel business to negotiate preferred rates from travel suppliers. these travellers generally make their travel arrangements through a retail travel agency as independent business travellers, although companies such as south african airways has introduced, through its website www.flysaa.com, a facility for the management of travel for small and medium sized businesses. on the other hand, corporations with substantial travel portfolios generally use the services of one or more contracted travel management companies (tmc) to handle all their travel requirements. thus, the difference between the independent business traveller and the corporate traveller lies in the way they make their travel arrangements. the independent business traveller generally makes his travel arrangements through a retail travel agency, as the leisure traveller would do, while the corporate traveller makes his arrangements via his organisation through a contracted tmc. the tmc is essentially a travel agency that specializes in corporate travel and provides a range of specialized services to the corporate client. in south africa approximately 40 per cent of the total travel market can be considered corporate or business-related (palapies, 2001). it is expected that by 2003 more than half of the travel business in south africa will be driven by corporate travel. corporate travel spending for large organisations in south africa can run from anything between r1 million and r300 million per annum and these costs steadily increase because, in most cases, travel and entertainment expenditure is not incurred by purchasing professionals but by the travellers themselves. the pre-eminent concerns of these travellers are not necessarily the cost involved but their own convenience and esteem while they are travelling (gilbert & morris, 1995; mason & gray, 1995). frequent travellers often consider themselves experts on making travel arrangements and will use their own discretion in the selection of hotels , airlines and car rental companies. as a result organisations often see travel as an uncontrollable expense. with the introduction and proliferation of online corporate booking tools which, according to a survey conducted in the usa, account for signific ant savings on travel costs (http://getthere.com [may 30, 2002]); the increasing rate of adoption of technology by consumers (chircu, kauffman & keskey, 2001); and the introduction of management fees by the travel management companies, the pressure to implement cost-saving strategies in corporate travel is mounting. these changes have also meant that the role of the travel supplier and the travel management company has changed fundamentally with traditional travel servicing making way for partnership agreements with corporate clients. sajems ns vol 6 (2003) no 2 306 in summary, two main issues face the corporate sector. the first is the management and control of travel expenditure and the second is the management of the travel process to ensure required service levels at an optimum cost-benefit ratio. the corporation depends heavily on numerous interactive relationships in facing these issues and achieving their goals (wilkinson, 2001). these include the travellers, top management, travel suppliers and the travel management companies. travellers are expected to comply with travel policies and top management must support the goals of travel management for it to be effective. the travel supplier and travel management company need to understand the issues that face the corporate client so that they can maintain their position as an integral partner in the travel management process. in this article the results of a survey conducted on the way in which corporate travel is managed in selected south african corporations is reported and a conceptual model, based on the interrelationships of the various roleplayers in corporate travel is proposed for its effective management. corporate travel management in contrast to the popular perception that travel expenditure cannot be efficiently controlled, bartholomew (1995) and ravenall (2002) suggests that travel and entertainment is one of the largest controllable expenses after salaries and information technology and that four opportunities exist for organisations to control travel and entertainment expenditure: • before the expense is incurred • when making the reservation and at the point of sale • when the expense item is paid • when expense reports are prepared, audited and processed. the only way to use these opportunities is to implement an effective travel management programme. according to academics such as bell and morey (1997), travel management companies such as american express (bunge, 2001) and consulting specialists such as international corporate travel solutions (ravenall, 2002), four core activities form the cornerstones of such a programme: • the development of a travel policy and procedures of implementation • the consolidation of travel management information • the establishment of an effective payment system through the use of a centralised travel expenditure processing system such as a corporate credit card • the careful selection of a travel management company. sajems ns vol 6 (2003) no 2 307 furthermore wilkinson (2001) stresses the importance of working relationships in effective corporate travel management: “travel management has never been for the faint of heart. it requires staying on top of numerous interactive working relationships. it is designed to reconcile a company’s policies and traveller’s preferences and to process that purchasing dynamic through a series of suppliers.” (wilkinson, 2001: 10). the travel policy the major purpose of the travel policy is to keep the cost of corporate travel within predictable and realistic parameters and to save the organisation money. it also serves a secondary purpose of allowing travellers to understand exactly what the limitations are in terms of choices and alternatives (gilbert & morris, 1995). the travel policy should include three categories of information: the procedure and guidelines for making travel arrangements; reporting procedures for expenses incurred; and the way in which the policy should be distributed to employees for easy reference. ravenall (2002) maintains that a regularly updated and enforceable travel policy is essential for effective travel management. a travel policy highlights the relationship between the company and its travellers. in travel policy compliance or non-compliance, conflicting values and goals can emerge between management and travellers. travel management information an organisation should expect proactive and quality management reporting and access to data. on a practical level a corporate travel reservation may have many components, including everything from the passenger name, routes, duration, fares, rates, frequent flyer numbers and even special meal requirements. computer software programmes can provide reports on who goes where, how much an individual spends, if lower fares were offered and refused and much more (limone, 2000). the consolidation of information on travel patterns and expenditure forms the basis of management reporting and allows the organisation to use the information to negotiate best buys, direct travellers to best buys and identify leaders and ‘laggards’ (bunge, 2001). with current technology capabilities such as the extranet, data can be accessible to the organisation and the travel management companies, and may also include preferred suppliers such as airlines, car rental companies and hotels (buhalis, 2003). typically the breakdown of travel expenditure for a large organisation in south africa would be divided into airline tickets, accommodation, car rental and sundries as shown in figure 1. this division of expenditure is based on gomes-costa and birns (2003) and a summation of figures derived from a number of corporate travel management company sales. sajems ns vol 6 (2003) no 2 308 as the accuracy of the sources of data is of primary concern to management, the management reports enable them to achieve their objectives of greater negotiating power with suppliers and travel policy compliance from travellers. in this the relationship between suppliers, travel agencies/travel management companies, travellers and the organisation is highlighted. figure 1 a typical pattern of corporate travel expenditure airlines 80% car rental 6% accomodation 8% sundries 6% source: costa-gomes and birns (2003) and a summation of selected travel management company sales 2002 travel expenditure processing organisations differ in their approach to processing their travel expenditure. some companies use a central corporate credit card placed in the office of the travel management company for airline tickets. other travel expenditure is either billed back, where agreements with suppliers have been made, or the traveller reclaims upon his return. some companies issue corporate travellers with company credit cards or have them use their personal credit cards and reclaim upon return. however, to enable the company to capture travel data, a central system is required. the corporate card can serve this purpose. the corporate card represents a single payment system whereby the organisation is issued with a business travel credit card from a corporate bank such as diners club or american express. credibility and efficiency of suppliers in this travel expenditure process is paramount to an effective corporate travel management programme. sajems ns vol 6 (2003) no 2 309 the travel management company organisations must consolidate their travel buying with a preferred travel management company, agreeing on the management, transaction or service fee, defining the service specifications and buying requirements and at the same time monitoring performance (bunge, 2001). organisations without an effective travel management programme have generally made their travel arrangements through one or more retail travel agencies. an effective corporate travel management programme requires the services of a travel management company rather than a travel agency. the evolution of retail travel agencies to travel management companies has been swift with retail travel agencies still existing to serve the leisure market and individual business travellers. however, those serving corporations have had to adjust their focus, service and operations. the major shift has been to becoming agents acting on behalf of the client rather than agents acting on behalf of the supplier. in the past (and still today) corporate secretaries contacted the travel agency by telephone and provided the details of the corporate traveller’s itinerary, whereupon the travel agent did the reservations. the travel agency earned 9 per cent on international airfares and 7 per cent on domestic airfares. many travel agencies and particularly those serving the corporate market had agreements in place with preferred suppliers for overriding commissions when pre-set sales levels were achieved by the agencies. travel agencies handling corporate clients with a substantial travel budget were generally travel agencies with branches throughout the country and in-house agencies were established to secure, as far as possible, a corporate travel account. suppliers were the primary source of revenue and agencies were the main channel for suppliers to reach corporate clients. in these circumstances, the relationship between suppliers, travel agencies and corporate clients could be described as linear as depicted in figure 2. figure 2 the relationship between suppliers, travel agencies and corporate clients: a linear relationship more recently, with technological advances such as the internet and commission cutting, where the agent in south africa earns a basic commission of 7 per cent on both international and domestic airline sales, the relationship has had to change. corporate clients have focussed far more on cost management and obtaining value for money, not only in terms of products and services, but also corporate client travel agency supplier sajems ns vol 6 (2003) no 2 310 in demanding added value from the travel agency. the travel agency has had to re-evaluate the nature of its service and move from being an "order-taker" mainly receiving and processing bookings, to also providing value added services such as management information systems on travel patterns and expenditure; travel policy adherence; negotiating client-focussed preferred supplier agreements; cost containment and budgeting. travel agencies have therefore evolved into travel management companies. the revenue structure of this evolving travel management company has also had to change. the focus has shifted from the supplier as the only source of revenue; to the client who, on the basis of the value-added service provided by the travel management company (tmc) negotiates a management fee where the client as well as the tmc can benefit. revenue earned by the tmc is not as simple as that of the retail travel agency earning commission or service fees from independent leisure or business clients. a tmc must negotiate with their corporate client, as part of their partnership agreement, on how they will be paid. the revenue earned can range from commissions paid by suppliers, to a negotiated fixed management fee paid by the organisation or profit sharing between the organisation and the agent based on the savings achieved on travel expenditure. agreements on fees are based on the types of services required by the organisation and are generally negotiated on a contractual basis. in this changing relationship the supplier is seeking the highest possible yield, reducing its distribution costs by cutting commission to the agents and seeking exclusivity in the use of its services by negotiating corporate agreements with corporate clients. the relationship under these circumstances can be described as circular as depicted in figure 3. figure 3 the relationship between suppliers, travel agencies and corporate clients: a circular relationship c o p o r a t e c l i e n t • v a l u e f o r m o n e y • s e r v i c e • p r e f e r r e d s u p p l i e r • c o s t m a n a g e m e n t s u p p l i e r • h i g h e s t y i e l d • s e r v i c e • c o r p o r a t e a g r e e m e n t s • e x c l u s i v i t y t r a v e l a g e n c y • c o m m i s s i o n e a r n e d • o v e r r i d e a g r e e m e n t • p r e f e r r e d s u p p l i e r sajems ns vol 6 (2003) no 2 311 with continuing technological advances in the use of the internet and systems such as mobile technologies travel management companies increasingly have to compete with suppliers who have far greater direct access to the client than ever before. under these conditions the managing director of seekers travel south africa, jonathan gerber, says that the future of travel management lies in a partnership approach (depicted in figure 4) between the tmc and the corporate client on the one hand, where they share a common goal, seek value for money, share in achieving a desired level of service, managing costs and jointly negotiating best deals, and preferred suppliers on the other hand. figure 4 the relationship between suppliers, travel management companies and corporate clients: the partnership approach t r a v e l m a n a g e m e n t c o . c o p o r a t e c l i e n t • c o m m o n g o a l • v a l u e f o r m o n e y • s e r v i c e • p r e f e r r e d s u p p l i e r s u p p l i e r • h i g h e s t y i e l d • c o r p o r a t e a g r e e m e n t • e x c l u s i v i t y in determining to what extent south african organisations implement corporate travel management programmes and their perceived effectiveness, a research project was undertaken. this research covered the four core elements of a corporate travel management programme as identified in the literature: a travel policy; travel data, a travel expenditure processing system; and, a contracted travel management company. the research also covered the use of technology by corporations, which is regarded as central to the entire process of corporate travel management (wilkinson, 2001). research objectives the research project investigated the current status and trends in corporate travel management in south africa by analysing the management and control of travel expenditure in terms of each of the elements identified, with the aim of developing a management model for effective corporate travel management. the following research objectives were identified: sajems ns vol 6 (2003) no 2 312 • to determine the organisation of travel management in south african corporations. • to evaluate travel policy compliance by travellers of the selected south african corporations to highlight possible conflicting values • to identify sources of travel data, the objectives and their accuracy • to determine which travel expenditure processing system is used • to establish the perceptions, concerns and expectations of corporations on value-added services of travel management companies to highlight possible conflicting goals • to introduce a conceptual management model for effective corporate travel management. methodology a quantitative ex post facto survey was undertaken. a questionnaire was sent to the individual concerned with managing the corporate travel function at each of 350 south african corporations registered on the association of corporate and travel executives (acte) south african database. these individuals were either officially designated as corporate travel managers or appointed to manage corporate travel as part of their designated function, which ranged from that of financial director to purchasing or procurement manager. the selected organisations have a substantial travel spend and are spread over diverse industries. this population was selected because membership of and participation in acte forums indicate awareness (and willingness) by these organisations to effectively manage corporate travel. structured qualitative interviews with suppliers and travel companies were conducted, together with an assessment of current and available online booking tools and other electronic channels in preparation for the formulation of the questionnaire. the questionnaire was pre-tested on a small group of companies and then dispatched in electronic form. to ensure the highest possible response rate an incentive prize of two return airline tickets from south africa to switzerland, sponsored by swiss airlines, were given in a lucky draw. follow-up of non-respondents was done telephonically with a second round of questionnaires being dispatched where necessary. data-analysis primarily included the use of descriptive statistics of variables to assess the current state of travel-related activities in the selected south african corporations; the organisational placement of corporate travel; the implementation and compliance of a travel policy; the quality of travel data; the use of travel management companies and their level of service; the billing system; current technology used; and the perceptions, concerns and expectations of corporations with regard to emerging technologies. crosstabulation was used for comparing across size of organisations and current travel sajems ns vol 6 (2003) no 2 313 processes. chi-square tests were done to establish correlation between variables and statistical significance of results, where applicable results the questionnaire was successfully sent to 350 electronic mail addresses and 109 responses were received, with 3 being unusable, this represents a response rate of 30 per cent, which is considered good if the length of the questionnaire is taken into account. for the purposes of this article, and mainly due to length limitations, only certain relevant findings are presented. corporate profile through the use of frequencies it was established slightly more south african owned organisations were surveyed than international organisations with offices in south africa. the two main types of organisations surveyed were public companies and private companies with a small number being parastatals and only a few being government departments. it was found that the organisations were spread over a diverse number of industries with the most being found in the manufacturing and financial services industries. travel expenditure of the organisations ranged from approximately r1 million to as much as r300 million. for purposes of further analysis organisations were categorised into two groups: those with a travel expenditure of less than r10 million and those with a travel expenditure of more than r10 million. this provided two groups of approximately the same size. the corporate travel management function as corporate travel becomes more specialised organisations are increasingly formulating a corporate travel strategy that is implemented through the development of a corporate travel management programme. the four cornerstones of travel management underpin this programme: a travel policy; a travel information system; a travel expense processing system; and a contracted travel management company. the results from the frequency analysis shows that the companies surveyed generally have a corporate travel strategy and centralise the travel function under a specific department. in cross tabulation (as shown in figure 5) it was significant that where organisations have a corporate travel management strategy, they are more likely to centralise the travel function as opposed to those organisations that do not have a strategy in place. sajems ns vol 6 (2003) no 2 314 figure 5 cross tabulation of respondents with a centralised travel management function by the presence of a corporate travel management strategy 82 40 0 20 40 60 80 100 have a corporate travel management strategy do not have a corporate travel management strategy pe rc en ta ge an interesting result from the frequency analysis was that while centralisation does occur and strategies are in place, the time spent by the manager designated to travel management is in most instances not the major part of his task with only 8 per cent indicating that they spend all their time on travel management. organisations that have an increasing travel volume tend to move towards some form of consolidation or centralisation of this function. this consolidation often takes place under an existing department such as procurement or finance. one of the primary functions of such a department is to consolidate the travel volume to obtain leverage from travel providers such as airlines, hotels and car rental firms in the negotiation of contracts at reduced prices, this is generally seen as the domain of the procurement department and thus travel management becomes part of it. on the other hand, the increasing pressure to control travel expenditure makes it a logical choice for management by the finance department. organisations may also consolidate the travel function under a separate corporate travel department. as shown in figure 6 the results from this study indicated the same trend in the placement of the corporate travel function. a separate department for corporate travel was indicated by approximately one quarter of respondents, with slightly more respondents showing travel management as part of procurement and slightly less as part of finance. this confirms that these are the three most logical options for the location of corporate travel. the rest, as shown under others, ranged from no allocation to the marketing department or human resources departments. sajems ns vol 6 (2003) no 2 315 figure 6 organisational placement of corporate travel management 25% 29% 22% 24% corporate travel procurement financial other travel policy the first step in effective travel expense management is to establish a comprehensive travel policy within the organisation that maintains high levels of productivity and morale. the next logical step is to effectively monitor travellers’ compliance with the policy. if travellers do not comply with the policy, reasons should be sought so that the causes can be dealt with. the frequency analysis showed that most policies have been in place for longer than two years, are available in a formal and written format, mostly available online and updated as necessary or continuously. as shown in figure 7, only 22 per cent of organisations reported that travellers comply with the travel policy all the time. while 73 per cent of organisations believe that there is compliance most of the time, this does highlight that problems in compliance do exist. sajems ns vol 6 (2003) no 2 316 figure 7 travel policy compliance 22% 73% 4% 1% all the time most of the time some of the time rarely more than half of the organisations reported that non-compliance was found in the area of meals and entertainment expenditure with approximately equal numbers reporting non-compliance in airline and accommodation expenditure. the two areas where the least number of organisations experienced noncompliance were car rental and travel approval procedures (figure 8). figure 8 areas of non-compliance 51 50 38 57 39 0 10 20 30 40 50 60 airline expenditure accommodation expenditure car rental expenditure meals and entertainment expenditure travel approval procedures percentage (%) as shown in figure 9, most organisations are of the opinion that last minute bookings are a reason for non-compliance with almost the same number agreeing that unknowing infringement by travellers is a reason. the use of personal loyalty cards was also indicated by more than half of respondents as sajems ns vol 6 (2003) no 2 317 being a reason for non-compliance. an interesting result is that of deliberate infringement by travellers (41 per cent), which suggests that policy monitoring is a problem or travellers are unsatisfied with policy content. figure 9 reasons for non-compliance of the travel policy 78 54 69 42 35 0 20 40 60 80 100 l as t m in ut e bo ok in gs b y tr av el le rs p er so na l lo ya lt y ca rd s he ld b y tr av el le rs u nk no w in g in fr in ge m en t b y tr av el le rs d el ib er at e in fr in ge m en t b y tr av el le rs l ac k of t ra ve l po li cy co m m un ic at io n p er ce nt ag e figure 10 shows that a significant difference was indicated between public and private companies with more public companies reporting deliberate infringement as opposed to private companies. figure 10 cross tabulation of deliberate infringement by public and private companies 0% 10% 20% 30% 40% 50% 60% public private sajems ns vol 6 (2003) no 2 318 the question of more public companies experiencing deliberate infringement of the travel policy by travellers raises a number of questions: • is travel policy monitoring less effective in public companies? • are public companies prone to greater abuse of travel benefits by travellers? • are private companies more concerned with controlling travel expenditure? travel management information most respondent organisations indicated that they obtain their travel management information from sources such as travel agency reports, their own financial accounting systems (these proved to be the sources used by the most organisations in this study), corporate card expense reports, dedicated information systems, supplier reports and expense processing systems. organisations may use more than one source of data. as shown in figure 11, the majority of organisations regard their travel data as important mainly to control travel expenditure and increase negotiating power with suppliers. this supports the proposition that these are the two main reasons for formulating a corporate travel management programme. other reasons mentioned are: to understand employee travel; and to redirect travel expenditure to fulfil supplier agreements. figure 11 objectives of travel data 0% 20% 40% 60% 80% 100% to increase negotiating power with suppliers to control travel expenditure to understand employee travel to redirect travel spend to fulfil supplier agreements not important useful important the results show a significant difference in the use of certain sources of data between organisations that have a corporate strategy and those that do not. sajems ns vol 6 (2003) no 2 319 more organisations with a corporate travel strategy make use of travel agency reports, corporate card expense reports and supplier reports as sources of data than do those organisations that have no corporate travel strategy, as shown in figure 12. figure 12 cross tabulation of sources of travel data by corporate travel strategy 0% 20% 40% 60% 80% 100% travel agency reports corporate card expense reports supplier reports strategy no strategy as shown in figure 13, it would appear that the general standard of accuracy of the sources of data is good or acceptable to the majority of respondents, with the highest number of organisations regarding the financial accounting systems as accurate. the question on the accuracy of travel data reports was regarded as essential as it may show some link to problems experienced in controlling travel expenditure and highlight problems with suppliers or travel agencies. this result shows that more respondents regard internal sources of data as accurate than they do the external sources. sajems ns vol 6 (2003) no 2 320 figure 13 accuracy of sources of travel data 0% 20% 40% 60% 80% 100% tra vel ag enc y r epo rts co rpo rate ca rd exp ens e r epo rts fin anc ial acc ou ntin g s yst em s a ded ica ted in for ma tion sy ste m su pp lier re po rts ex pen se pro ces sin g s yst em s accurate acceptable inaccurate travel expenditure processing organisations differ in their approach to centralizing their travel expenditure processing. figure 14 shows that in this study most organisations use the bill back system. some companies use a central corporate credit card placed in the office of the travel management company for airline tickets. some companies issue corporate travellers with company credit cards or have them use their personal credit cards and reclaim upon return. it is evident that organisations use more than one system for travel expenditure processing. the complexity of the various systems may have implications for travel expenditure control and travel policy compliance. sajems ns vol 6 (2003) no 2 321 figure 14 travel expenditure processing 50 51 14 21 36 42 69 0 20 40 60 80 consolidated ravel credit card consolidated c-card for air travel consolidated c-card for acc. consolidated c-card for car hire individual corporate charge cards personal charge card reimbursement bill back system percentage the use of travel management companies currently 89 per cent of organisations use travel agencies/travel management companies (either in-house or outside) for travel arrangements and other travelrelated services (figure 15). of the remaining organisations 2 per cent work through suppliers and 9 per cent work through both travel agencies and suppliers. figure 15 most used distribution channel 5 5 % 2 % 3 4 % 9 % in-house agencies suppliers outside agencies suppliers & agency sajems ns vol 6 (2003) no 2 322 figure 16 indicates how organisations perceive the level of service provided by their travel agencies. the service level of travel reservations is considered to be good or acceptable by most respondents. services such as travel advice, policy development and supplier negotiations show more diversity of opinion. in a number of instances the organisation’s travel agency does not provide the service at all, for example, in summaries of car rental expenditure, policy development, compliance and monitoring and technology support and access. where the service is provided the percentages ranged from good to no service, particularly if a comparison is made between services such as reservations, travel advice and technology support and access. figure 16 service levels of designated travel agency 0% 20% 40% 60% 80% 100% travel reservations travel advice summary on airline exp. summary on acc. expenditure summary on car hire exp. recon. reservations and billing policy development policy compliance monitoring supply and negotiations technology support and access vip services percentage good acceptable unacceptable not provided as far as the revenue agreements with travel agencies, figure 17 shows that there is a significant difference between types of revenue agreements selected and the size of the organisations annual travel expenditure. management fees are selected by a greater number of organisations that have an annual travel spend of more than r10 million. this is also true where two types of sajems ns vol 6 (2003) no 2 323 agreements are used, for example management fees and transaction fees. substantially more organisations with an annual travel spend of less than r10 million have transaction fee agreements in place whereas approximately the same number of organisations from both categories has no agreements in place. figure 17 cross tabulation of revenue agreements with travel agencies by travel expenditure 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 50% < r10m > r10m travel expenditure management fee transaction fees no agreement combination as shown in figure 18, although most organisations believe that the revenue agreement is to the equal benefit of both parties, interestingly a quarter of respondents indicated that they perceive it to be more in favour of the travel agency. this shows clearly that in some organisations there is a value and goal conflict between the participants in the travel management programme. figure 18 benefit of revenue agreements to organisation versus travel management company 71% 25% 4% to the equal benefit of both parties more in favour of the travel agency not one of the above sajems ns vol 6 (2003) no 2 324 critical success factors the final section of the study covered the issue of what respondents believe to be critical to the success of a corporate travel management programme. a list of factors was provided and respondents were asked to respond with a “yes”, it is critical, “no”, it is not or “i don’t know” whether it is or not. in determining what the respondent considered to be critical success factors, almost all agreed on the factors as shown in figure 19. critical success factors where practically all appeared to be in agreement were negotiated agreements with suppliers; travel expenditure control; top management support and comprehensive and accurate travel data. the majority was in agreement on all the other factors and where respondents were asked to provide any further critical success factors, none of any significance was provided. figure 19 critical success factors for effective corporate travel management 89 95 82 98 91 91 89 96 84 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% consolidated/centralisation of corporate travel top management support one designated travel agency negotiated agreements with suppliers accurate travel data comprehensive travel data traveller education on corporate travel travel expenditure control travel education on airfare structures and options yes no don't know in determining the use of technology for travel arrangements, the frequency analysis showed that while approximately half of the respondents use some form of internet-based system (for example supplier websites or online corporate selfbooking systems) only 12 per cent of respondents use the online self-booking systems. as far as critical success factors and technology is concerned, an interesting result found was on the question of whether organisations regard corporate self-booking systems that are linked to suppliers and travel agencies as a critical success factor in effective corporate travel management. while only 32 per cent of all respondents regard this as a critical success factor and 13 per cent indicated that they do not know, a substantial difference of opinion was found sajems ns vol 6 (2003) no 2 325 between the “user” (those organisations that use some form of online system for travel reservations and management) and “non-user” (where respondents either use the internet for enquiries or information only or who use no computer-based system at all). as shown as shown in figure 20 in the “user” category more organisations believe it is a critical success factor while in the “non-user” category only half this number believes it to be so. this suggests a difference in expectations regarding the value and benefits of such a system and may be one of the reasons for “non-users” not actively pursuing changes in technology to become “users”. figure 20 is corporate self-booking system a critical success factor? 0% 10% 20% 30% 40% 50% users non-users synthesis of research findings in summary of the results, this research shows that corporations generally have a corporate travel management strategy and programme in place. an overwhelming number of respondents were in agreement on the critical success factors, which showed that suppliers and travel management companies play a major role in its success and that top management support is essential. corporate travel agencies/travel management companies are still perceived to be the most effective reservations channel although there is some conflict indicated in terms of revenue agreements. there is, however less satisfaction with their ability to offer travel advice, provide travel data, assist with policy development and compliance, conduct supplier negotiations and provide technology support. the research found that the majority of corporations believe that the role of corporate travel agencies should change to that of travel management companies. although only a small percentage of corporations are using corporate self-booking tools and supplier websites, an increase over the previous year was indicated. this, together with the perceived advantages of technology, and efforts to overcome current application and integration sajems ns vol 6 (2003) no 2 326 problems, should serve as warning signals to corporate travel agencies. corporate travel agencies are expected to provide value-added corporate services with the necessary effective technology access and support in order to maintain their position as the preferred channel. with continuing technological advances and systems such as the intranet and mobile technologies, travel management companies increasingly have to compete with suppliers who have far greater direct access to the client than ever before. a conceptual corporate travel management model in conceptualising a management model for corporate travel management, the results from the empirical research was taken into account which highlights some of the problems of conflicting values and goals between internal partners (for example, between management and travellers in policy compliance) as well as external partners (for example between the organisation and the tmc in terms of service levels). the model thus had to take a number of factors into account: • the various role-players and the nature of their relationship with the corporation (internally this means management and travellers and externally, suppliers and travel management companies); • the goals of the travel programme and desired outcomes (travel expenditure control through travel policy compliance and expenditure processing as well as effective supplier negotiations); • the components of the travel programme (policy, data, expenditure, suppliers/travel management companies). a model that appears to fulfil many of the characteristics of corporate travel is the so-called “soft value management model” (liu & leung, 2002) and is proposed as a foundation for further testing and evaluation in ensuing studies. this model was specifically described in the context of project management in the engineering field but the underlying elements of this model are similar to those found in corporate travel management. a brief theoretical overview of this model as depicted in figure 21 states that value management is represented by the input of internal (personal/individual values) and external factors (environmental pressures) that triggers a decision-making process producing decision outcomes. this leads to the definition of project goals. the transformation of values into goals – as a decision-making process – comprises objective setting, objective analysis and alternatives evaluation. the goals being set will initiate required action towards project realisation. goals are underpinned by an individuals value system. what the person attaches value to affects the content specificity of the goals set. when more than one individual is involved in goal setting (as is the case in corporate travel management), value sajems ns vol 6 (2003) no 2 327 conflict may lead to goal conflict. agreement on value standards between individual participants, referred to as “value specificity”, is a prerequisite to agreement of goals, also referred to as “goal specificity”. the nature of the conflict (which may be interand intra-personal) arises from the expected probabilities of alternative actions and possible outcomes. this conflict may be latent or manifested in behaviour patterns and should be brought forth, supporting participative and creative problem-solving and stimulating the desire to transform value specificity to goal specificity. “people are more easily committed to performance with specific goals; vague goals have shown to have a deterrent effect on high performance” (liu & leung, 2002: 345). feedback is part of the goal-action-outcome cycle that guides the individuals’ behaviour (through considerations of options/alternatives) towards goal attainment, and also provides a basis for assessing the project outcome. in determining the success of a project the individ ual considers the utility of its success/failure and the level of his/her satisfaction/dissatisfaction. satisfaction is measured in terms of what the person wants to gain and or keep in the outcome and goal attainment. figure 21 a soft value management model source: adapted from liu and leung (2002: 346) in proposing that this model form the basis for a corporate travel management model, a theoretical discussion on the way in which the elements of corporate travel match the elements of the soft value management model is provided. the overall goal of corporate travel departments is to control travel-related corporate spending (anderson, lewis & parker, 1999). in the pursuit of this goal, the corporate travel department is dependent on the support of individuals in senior management and the co-operation of corporate travellers (this can be regarded as the internal input), and on the support of travel providers and the travel internal input factors external input factors evaluated outcome goal specificity commitment value specificity conflict acti on feedback (options) sajems ns vol 6 (2003) no 2 328 management company (seen as the external input). value conflicts can occur between the corporation, suppliers and travel management company because corporate clients typically want flexibility in their travel arrangements; airlines and other travel suppliers want to maximise yields by optimising revenue and travel management companies want to service client needs at the lowest cost (roodt, 2001). value conflicts also occur: • between management and travellers due to cost containment actions versus traveller comfort and “self-esteem” (gilbert & morris, 1995). • between suppliers, travel management companies and the corporate client in optimising the travel management process, particularly in the area of technology application, where the client often faces both a traditional channel partner and an electronic commerce channel partner. there is often confusion about which channel they should support because it is not clear whether the electronic commerce partner will be successful in the long term or if the traditional channel partner will be able to re-establish itself. according to subramani and walden (2000) having both a traditional and an electronic commerce partner allows the firm to play one off against the other, with the result that the new partner will not have the same level of incentive to invest in the relationship as he would otherwise. • between management and travellers in policy monitoring and compliance (gilbert & morris, 1995). value management through specification and agreement of values and goals for effective corporate travel management leads to commitment by all participants to appropriate action and goal attainment. conclusion and future outlook this article serves as a prelude to the future application and testing of the model. this research was focussed on the needs and objectives of management in terms of corporate travel. future research must include the other two main roleplayers: travellers, their needs and objectives in terms of corporate travel and service providers such as travel management companies and suppliers with their particular needs and objectives. the results of these studies must enable comparison between the three main role-players in corporate travel management in order to specify the values and goals of each. once this is done the applicability of the soft value management model can be tested where all participants are committed to appropriate action and goal attainment for effective corporate travel management. sajems ns vol 6 (2003) no 2 329 to conclude this article a brief look at the future of corporate travel shows that changes that will probably take place in corporate travel from two perspectives: that of the corporate client and that of the corporate travel agency. andersen (1998) says that in the corporate market, there will be a move towards the provision of self-booking tools that allow the corporate travellers to book their own travel by making direct contact with gds or supplier inventory systems. this will be done through corporate intranets accessible via personal computers, personal digital assistants or by telephone, using voice recognition systems. however, there will still be a need for more complex journeys and itineraries to be handled by highly qualified travel consultants. successful travel agents will therefore have to respond by transforming themselves into global travel management companies serving their corporate clients rather than acting as a distributor for the travel provider. in the corporate market, corporate agents (travel management companies) will retain a number of advantages which will guarantee a continued role for them in the travel management process: first, they remain the cheapest and easiest distribution medium for the airlines; secondly, those with a high level of industry expertise can use their skills to secure the best value deals for their clients or more complex international multileg trips; thirdly, they can help clients implement and enforce travel policies; and finally, they are well placed to capture data about their client’s travel patterns and expenditure enabling them to provide management information. in order to maintain their role in the future the travel management company must, according to andersen (1998), underscore the following fundamental principles: • knowing and understanding the individual customer. • focusing on the right customer. • aligning their products and services with those customers. • delivering value through differentiated services. this article covered the theoretical nature of corporate travel management and the role of the corporate travel management company highlighting its partnership relationship with the corporate client and suppliers. the result of a study on the current status of corporate travel in selected south african organisations was presented and finally a conceptual model was proposed for effective corporate travel management. references 1 andersen consulting (1998) “the future of travel distribution”, research report executive summary: 7. sajems ns vol 6 (2003) no 2 330 2 anderson, r.i., lewis, d., & parker, m.e. (1999) “another look at the efficiency of corporate travel management departments”, journal of travel research, 37(3): 267-72. 3 bartholomew, d. (1995) “tracking travel costs”, information week, 538: 92-4. 4 bell, r.a. & morey, r.c. (1995) “increasing the efficiency of corporate travel management through macro benchmarking”, journal of travel research, 33(3): 11-20. 5 bell, r.a. & morey, r.c. (1997) “are you in the book? hotel attributes and corporate travel departments”, cornell hotel and restaurant administration quarterly, april: 55-61. 6 buhalis, d. (2003) etourism, pearson education: essex. 7 bunge, r. (2001) “corporate travel”, presentation to the b com tourism management honours students at the university of pretoria. 8 chircu, a. m., kauffman, r.j. & keskey, d. (2001) ”maximizing the value of internet-based corporate travel reservations systems”, communications of the acm, 44(11): 57-63. 9 gilbert, d.c. & morris, l. (1995) “the relative importance of hotels and airlines to the business traveller”, international journal of contemporary hospitality management, 7(6): 19-23. 10 gomes-costa, i. & birns, h. (2003) “zero commission not set in stone says saa”, tir. 95: 1. 11 limone, j. (2000) “corporate travel firms bring tools, expertise”, travel weekly, 59(77): 31-32. 12 liu, a.m.m. & leung, m. (2002) “developing a soft value management model”, international journal of project management, 20: 341-49. 13 mason, k.j. & gray, r. (1995) short haul business travel in the european union: a segmentation profile”, journal of air transport management, 2(3/4): 197-205. 14 palapies, f. (2001) “mixing business with pleasure is becoming more business than leisure”, tir southern africa, 75: 19. 15 ravenall, c. (2002) “what is travel management? why do we need it?” presentation to the travel management forum of acte. johannesburg 27 march 2002. 16 roodt, a. (2001) “flight plan”, leadership, september 2001: 61-4. 17 subramani, m.r., & walden, e. (2000) “economic returns to firms from business-to-business electronic commerce initiatives: an empirical examination”, proceedings of the 21st international conference on information systems, brisbane, 2000: 229-41. 18 wilkinson, t. (2001) “automating corporate travel management”, travel weekly, 60(34): 10-12. 19 http://getthere.com [may 30, 2002]. sajems ns vol 5 (2002) no 3 663 destination attributes affecting tourists' readiness to recommend lagos state (nigeria) for tourism jcmadu architect and urban and regional planner, vienna snmadu department of psychology, university of the north abstract this is an investigation into tourists' readiness to recommend lagos state of nigeria as a tourist destination and the destination attributes (factors) affecting their readiness. the investigation was conducted through a survey of 378 on-site business, recreational, international and domestic tourists sampled from different tourist attraction sites. results show that the majority of the tourists were ready to recommend the destination. however, more recreational tourists are ready to recommend the destination than the business tourists. more domestic tourists are also ready to recommend the destination than the international tourists. the authors conclude that there is an urgent need for tourism encouraging measures aimed at maximisation of the potentials of hospitality, and minimisation of maintenance of tourist infrastructures and transportation problems; and increased measures to guarantee personal safety in the state. jel introduction in contemporary business development and management, organisations tend to engage in studies that explore the needs and experiences of their customers. this is because improvement of customer satisfaction became one of the major challenges facing business establishments in the 1990s (barsky & labagh, 1992: 32-40). a customer who is dissatisfied with hislher experience with a product or service is likely to be a lost customer for the organisation responsible for the supply (bahia & paulin, 2000: 27-42). one of the crucial issues in this relationship is that the outcome of the experience is mostly extended to the customer's friends and relatives. thereby a dissatisfied consumer communicates hislher aggravation to an average of eleven persons, while a satisfied consumer communicates hislher enthusiasm to an average of three persons (horovitz, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 664 sajems ns vol 5 (2002) no 3 1990). demos (1992: 81-86) added as one of the fundamental 'rules of thumb' in the tourism industry management, that one dissatisfied customer has more influence than ten content ones. this influence is a negative one, however, since dissatisfaction sounds louder than satisfaction. the analysis of tourism is a phenomenon in the modem socio-economic development. the identification of its status and problems, and the study of the factors affecting tourists' readiness to recommend the tourism destination makes it possible to formulate the basic characteristics of future policies for planning of tourism in the respective destinations. however, very few studies have been conducted on various aspects of tourism development in the lagos state of nigeria, and none has been conducted particularly on their readiness to recommend lagos state as a tourism destination to others. hence, the question: what destination attributes affect tourist's readiness to recommend lagos state as a tourism destination to others? according to perterson and wilson (1992: 61-71), more than 15000 academic and trade articles have been published on customer satisfaction until the early 1990s. these studies centre on the elicitation of the needs of the customers and the corresponding supplies in form of goods and services to maximise customer satisfaction. the maximisation of consumer satisfaction also maximises the profitability and market share of an organisation and the customer's readiness to recommend it to others. this is supported by a survey conducted by the juran institute in 1994, whereby 90 per cent of the top managers of america's largest companies who were interviewed agreed on the immense importance of improving customer satisfaction for their companies' success (vavra, 1997). therefore, the quality and success of any service delivery and the likelihood of its being recommended to others, are testified by the satisfaction of the customer and their readiness to recommend it to others (bahia & paulin, 2000: 27-42; brady, & robertson, 2001: 53-61; disney, 1999: 491-8; herrmann & huber, 2000: 77-97; lassar, manolis, & winsor, 2000: 181-200; lee, lee, & yoo, 2000: 217-32; sureshchandar, rajendran, & kamalanabhan, 2001: 111-25; zeithaml, berry, & parasuraman, 1996: 31-46). as barlow and moller (i996) suggested, "a complaint is a gift from the customer to the establishment". these relationships show the extent to which satisfaction or dissatisfaction of a consumer may affect the image of a product, a service or an establishment. this image, in other words, the influence of the information and experiences acquired by the consumers on the supply, extends to both their lifetime and their lifetime values, and also their willingness to recommend the organisation or destination to others {vavra, 1997}. lagos state is the former capital city of nigeria. it is located on the coastal plain of the atlantic ocean stretching 180 kilometres along the bight of benin. the area is 3,577 square kilometres, with a population of 5,685,781 people in 1991. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 665 its state is endowed with tourist attractions and resources that include natural (water based), cultural and historical, and commercial attractions. in spite of these potentials, there are few traces of viable development in the tourism sector. one of the major reasons is that, during the past three decades, lagos state has experienced an unplanned rapid urbanisation, coupled with the effects of the civil war in the late 1960s. these have had a series of negative impacts (for example, safety problems) on the development of the state in general and particularly in the area of tourism. some authors (e.g., ajayi, 1998; balogun, 1986) refer to lagos state as a jungle; a horrible and unhealthy city. this is the result of urban planning and management problems, especiauy in some important areas such as transportation, security, cost ofliving, etc. this situation is worsened by the general economic instability in the country and the associated social problems. smoltczyk (1997) described lagos as the largest city of black africa with no refuse disposal, no public transport and no mayor; there is no law and order, but is controlled by the street gangsters known as the 'area boys'; and it is a jungle governed by the practice of 'survival of the fittest'. although this description seems exaggerated and unreliable, lagos state however seems to emit a feeling of insecurity to its inhabitants. such problems without doubt would negatively influence the experience of the tourists in this destination as well as their readiness to recommend lagos state as a tourism destination to others. moreover, according to odutayo (1986), olukoya (1989), ukpanah (1990), and adepeju (i990), there has been also little recognition of tourism as a positive means of improving the economy of the state and nation, despite the tremendous natural, cultural, and commercial attraction resources in the area. in fact, one of the pressing problems facing the state today is the planning and management of the city. a functional and conducive environment should be created to attract more tourists; this will require that the physical or environmental, social, political, psychological, and cultural qualities of the state in particular, and nigeria in general, are enhanced. there is a need, therefore, to address the tourism situation in view of the need to diversify the nation's income generating source. as part of this, the structural adjustment programme (sap) was introduced by the federal government of nigeria in 1986. this programme aims at improving the nation's economic situation in general (nigerian economic review, 1993). in an attempt to implement the sap by improving tourism, the lagos state government has enacted a tourism policy that proposes land use zones for the development of tourism activities in 1993. the zones include the bar beach resort zone, lekkimaiyegun resort based zone, kuramo water based tourist complex, epe marina cultural tourism and recreational zone, eleko beach, tarqua bay, and badagry marine and cultural zone. however, these have not remarkably contributed to an r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 666 sajems ns vol s (2002) no 3 improvement of recreational tourism in the state. such policies do not generally result in improvements unless they guide efforts towards development and unless they are acted upon. this study hopes to serve as a guideline for tourism planning, and to give direction towards achieving viable and sustainable development in this important economic sector in the state. in fact, proper planning and management based on scientific research can be used to upgrade and revitalise the existing outmoded and under-developed recreational tourism in lagos state. method participants this study involved the participation of 378 tourists, comprising 229 business tourists (whose main purpose for visiting the lagos state was business) and 149 holiday (recreational) tourists. (lagos is a large commercial city in nigeria. thus, most visitors to the state are there for business purposes. among the participants, 223 were domestic tourists and 154 were from abroad. (one tourist failed to indicate where he/she came from). domestic tourists are all the tourists in lagos state who came from within nigeria, but from outside lagos state. tourists from abroad or international tourists are those who came from outside nigeria. 279 were males and 99 were females. 33 (8.7 per cent) were within the age range of 12-20 years, 25s (67.5 per cent) were within the age range of21-40 years, 84 (22.2 per cent) were within the age range of 41-60 years and 6 (1.6 per cent) were above 60 years of age. they were all non-residents of lagos state, nigeria. instrument a questionnaire used for this study enquires about the purpose of visit to lagos (business or recreational), and explores tourists' perceptions of the quality of the following destination attributes: personal safety (safety during the day and at night), transportation problems, hospitality, costs (cost of hotel accommodation, meals, drinks, and transportation), and maintenance of tourist infrastructure. they were also asked whether they would recommend lagos state as a tourist destination to others. response to the above questions were categorical (e.g., safe/not safe, low/high, yes/no). the last part of the questionnaire contains demographic questions, such as age, gender, nationality and place of work or permanent residence. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 667 for the coding of the categorical responses to the destination attributes and the readiness to recommend lagos state as a tourism destination to others, the responses that are negative are coded '0', and those that are positive are coded 'i'. procedure the spatial extent of the study covers lagos mainland and its islands. with the assistance of the lagos state tourism board, the major tourist attractions that statistically represent the 'tourist attraction population' in lagos were selected as sampling locations. thus, all the major recreational attractions (natural, cultuml and historical, and special attractions) were chosen. there were nine recreational attraction sites (lekki beach, bar beach, eleko beach, tarqua bay beach, whispering palm, tinubu square, national museum, apapa amusement park, and badagry slave chain) altogether. these attmctions were chosen owing to their status as key tourist zones. the business attraction sites were excluded, which means that business tourists and holiday tourists were selected at the same recreational attractions, and at the same time. table 1 locations of survey research and sampling features type of attraction no of tourists of no of questlonn. no of 150 sampled filled by questionn. sites used for sam duo i! visitors subjects usable 1. natural lekki beach 19 79 71 bar beach 88 75 69 elekobeach 81 65 61 tarquabay 56 47 43 whispering palm 22 14 12 2. culturallhistorical tinubi square 40 25 21 national museum 54 39 36 badagry slave chain 28 24 21 3. special amusement park 58 49 44 total 518 417 378 results according to the frequency distribution of the tourists' readiness to recommend lagos state as a tourist destination to others, 149 (65.1 per cent) of the business r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 668 sajems ns vol 5 (2002) no 3 tourists were ready to recommend the destination to others, while 77 (33.6 per cent) were not ready to do so; 3 (1.3 per cent) did not respond to the question. in the case of the recreational tourists, 133 (87.9 per cent) of the recreational tourists were ready to recommend the state as a tourism destination to others, while 18 (12.1 per cent) were not. 183 (83.2 per cent) of the domestic tourists were ready to recommend the destination to others, while 37 (16.8 per cent) were not ready to do so; 96 (62.3 per cent of the international tourists were ready to recommend the destination to others, while 58 (37.7 per cent) were not. table 2 shows the mean scores of the perceptions of the tourists, according to the destination attributes. operationally, we define an attribute with a mean score that falls above 0.5 (average) to mean either that the attribute has a high value or that it has a low value depending on the coding scale of the attribute. table 2 the destination attributes, tourists' mean scores and interpretatior business recreainteroadomestic tional tional (n=229) (n=149) (n=ls4) (n=223) destination mean mean mean mean attributes (interpre(interpre(interpreinterpretation) tation) tation) tation safety at day time 0.73 (hi2h) 0.65 (hi2h) 0.67 (hi2h) 0.45 (high) safety at night 0.27 (low) 0.15 (low) 0.24 (high) 0.41 (low) transportation! 0.18 (high) 0.04 (high) o.is (high) 0.31 (high) traffic problems hospitality 0.58 (high) 0.07 (low) 0.58 (hi2h) 0.48 (low) r-0.06 (high) 0.05 (high) 0.09 (high) 0.15 (high) cost of hotel cost of meals 0.06 (high) 0.14 (high) 0.10 (high) 0.28 (high) cost of drinks 0.15 (high) 0.13 (high) 0.17 (hi2h) 0.33 (high) cost of 0.22 (high) 0.21 (high) 0.25 (high) 0.39 (high) transportation maintenance 0.33 (low) 0.35 (low) 0.27 (low) 0.49 (low) the business and the recreational tourists differ significantly on their readiness to recommend the destination (x2 = 91.27, df= 1, p < 0.05). more recreational tourists are ready to recommend the destination than business tourists. the international and the domestic tourists also differ significantly on their readiness to recommend the destination (x 2 = 12.63, df = i, p < 0.05). more domestic tourists are ready to recommend the destination than international tourists. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 669 in order to identify the pattern of correlation between the destination attributes, factor analysis was perfonned as shown in table 3. table 3 factor analysis of the destination attributes final statistics' variable communanty * factor eigenvalue i pet of var cumpct safedl 0.78034 *1 2.73907 i safeni 0.47899 *2 1.49867 transpri 0.17509 *3 1.04603 i edi eni spri hospital c.hoteli c.mealsi c.drinki c.transi attr.mtl note: variables safedi safeni transpri hospital c.hotell c.mealsi c.drlnki c.transi attr.mtl or 1 -0.07479 -0.09133 -0.04144 0.08635 0.76488 0.76998 0.85463 0.76550 -0.20421 label safety at day time safety at night factor 2 -0.01032 0.38417 0.39206 0.77007 -0.10974 0.01042 -0.18303 0.03962 0.77208 transportation and traffic problems how tourist feels attended to in lagos cost of hotel accommodation cost of meals cost of drinks cost of transportation maintenance 30.4 30.4% 16.7 47.1% 11.6 58.7% factor 3 0.88014 0.56839 0.14022 0.10745 0.02753 ·0.19278 0.02237 -0.09711 -0.10081 examination of the correlation among the destination attributes or variables reveals that there are significant overlaps among the variables as shown in table 3. the 'final statistics' in the table shows that 3 factors are extracted, and that, 58.7 per cent of the total variance has been explained. as shown by the 'varimax rotated factor matrix', the factor loadings reveal that 'cost of hotel accommodation', 'cost of meals', 'cost of drinks', and 'cost of transportation' are closely related, with large loadings of 0.76488,0.76998,0.85463, and 0.76550 respectively. they form the 'factor i' that is denominated as 'cost of living'. the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 670 sajems ns vol 5 (2002) no 3 second factor (factor 2) is fonned through a correlation between 'hospitality', 'maintenance' and 'transportation and traffic problems'. hospitality and maintenance have large loadings of 0.77007 and 0.77208 respectively, while, 'transportation and traffic problems' has a loading of 0.39206. this factor is denominated as 'services'. although 'safety at night time' has a smaller loading of 0.38417 in this factor, it is excluded from the factor since 'safety' fonns a separate factor (factor 3); 'safety at day time ., and 'safety at night' fonn the factor 3. they have large loadings of 0.88014 and 0.56839 respectively. this factor is denominated as 'personal safety'. the factor scores are used to represent the standardised values of the factors in each observation. they are used in the subsequent statistical analyses of the destination attributes. in order to test the relationship between the destination attributes (factors 1, 2, and 3) and the business and recreational tourists' readiness to recommend the destination to others, logistic regression analysis was applied as shown in the tables 4a and 4b. table 4a logistic regression of business tourists' readiness for recommendation and the destination attributes (factors 1, 2, and 3) classification table for recommendation predicted 0.0000 1.0000 observed 0 1 percent correct 0.0000 0 49 27 64.471)t( 1.0000 '--_1=---::-'---:-::--=..::13'--_'----=.;;13:...;;1'---+ __ 9:...;;0:.:..:.9:....:.7...:...%=__---1 overall 81.82% variables in the equation; variable b s.e. wald df si factor 1 -0.2142 0.1568 1.8668 1 0.1718 factor2 1.0670 0.1896 31.6738 1 0.0000 factor3 0.5685 0.1653 11.8233 i 0.0006 constant 0.7745 0.1696 20.8581 1 0.0000 note: total number of cases: 229 number of selected cases; 229 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . salems ns vol 5 (2002) no 3 671 table 4b logistic regression of recreational tourists' readiness for recommendation and the destination attributes (factors 1, 2, and 3) classification table for recommendation: predicted 0.0000 1.0000 observed 0 i percent correct 0.0000 i 0 0 18 0.00% 1.0000 i 1 0 126 100.00% overall 87.50% variables in the equation: variable b s.e. wald df si2 r exp(b) factor i -0.3200 0.1938 2.7273 i 0.0986 -0.0819 0.7262 factor2 0.3208 0.2884 1.2372 i 0.2660 o.oooo~ factor3 0.2521 0.2635 0.9150 1 0.3388 0.0000 constant 2.0967 0.2883 52.8741 1 0.0000 note: total number of cases: 149 number of selected cases: 149 according to the logistic regression analysis in table 4a, the analyses indicate that 81.82 per cent of the result has been predicted correctly in the case of the business group. in the case of the recreational group, 87.50 per cent of the result has been predicted correctly (see table 4b). more details of the results are presented below according to each factor. factor 1 (cost of living): as shown in table 4a, the logistic regression coefficient in the case of the business tourists indicates no statistical significance (8 -0.2142, p > 0.05). this means that, the business tourists' perception of the 'cost of living' during their stay in lagos, does not influence their readiness or willingness to recommend this state as a tourist destination. the same also applies to the recreational tourists (see table 4b, b = -0.3200, p > 0.05). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 672 sajems ns vol 5 (2002) no 3 factor 2 (hospitality. maintenance and transportation): as shown in table 41, factor 2 bas a significant relationship with the readiness of the business tomists to recommend the destination to others (b = 1.0670, p < 0.05). this result further indicates that, on the one hand, the business tourists who perceived a high value of factor 2, that is, a high level of hospitality and maintenance, and a low level of transportation and traffic problems, tend to recommend the destination to others (see also table 2). on the other hand, it suuests that those who perceived a low value of factor 2 (a low level of hospitality and maintenance, and a high level of transportation and traffic problems), tend to show no readiness for recommendation. contrarily, factor 2 bas no significant relationship with the recreational tourists' readiness to recommend lagos as a tourist destination (table 4b, b == 0,3208, p > 0,05). factor 3 (personal safety): as shown in table 4a, 'personal safety' bas a significant relationship with the readiness of the business tourists to recommend lagos to others (b == 0.5685, p < 0.05). the results also suggest that those who perceived a high value of personal safety, would recommend the destination to others and those who perceived a low value of personal safety, would not recommend the destination. contrary to that, personal safety bas no significant relationship with the recreational tourists' readiness to recommend lagos as a tourist destination (table 4b, b = 0.2521, p >0.05). in order to test the relationship between the destination attributes (factors 1, 2, and 3) and the internationals and domestic tourists' readiness to recommend the destination to others, logistic regression analysis was applied as shown in table sa and table 5b. table 5a logistic rep-ession of international tourists' readiness for recommendation and the destination attributes (factors 1, 2, and 3) classification table for recommendation: predicted percentage correct observed .0000 1.0000 i .0000 36 22 62.1 i 1.0000 10 83 89.2 overall 78.8 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 variables in the equation: b s.e. wald ifactorl -.078 .154 .252 ifactor2 1.124 .229 24.073 ifactorj .208 .182 1.314 k::onstant .741 .207 12.777 note: total number of cases: 154 number of selected cases: 151 missing cases: 3 673 df sil!. exp(b) 1 .616 .925 i .000 3.078 i .252 1.232 1 .000 2.099 table 5b logistic regression of domestic tourists' readiness for recommendation and the destination attributes (factors 1, 2, and 3) classification table for recommendation: predicted percenta2e correct observed .0000 1.0000 .0000 0 36 .0 1.0000 0 176 100.0 overall 83.0 variables in the equation: b s.e. wald df sig. exp(b) factorl -.283 .179 2.498 i .114 .754 factor2 .471 .209 5.080 1 .024 1.602 factor 3 .539 .196 7.552 1 .006 1.714 constant 1.707 .206 68.624 i .000 5.512 note: total number of cases: 223 number of selected cases: 212 missing cases: ii according to the logistic regression analysis in table sa, the analyses indicate that 78.8 per cent of the result has been predicted correctly in the case of the international tourists. in the case of the domestic tourists, 83.0 per cent of the result has been predicted correctly (see table 5b). more details of the results are presented below according to each factor .. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 674 sajems ns vol 5 (2002) no 3 factor j (cost of living): as shown in tables 5a and 5b, the logistic regression coefficients in both cases of the international and domestic tourists indicate no statistical significance (for international tourists: b = -0.078, p > 0.05; for domestic tourists: b = -0.283, p > 0.05). this means that, both the international and domestic tourists' perceptions of the 'cost of living' during their stay in lagos, do not influence their readiness or willingness to recommend this state as a tourist destination. factor 2 (hospitality. maintenance and transportation): as shown in table 5a, factor 2 has a significant relationship with the readiness of the international tourists to recommend the destination to others (b = 1.124, p < 0.05). this result further indicates that, on the one hand, the international tourists who perceived a high value of factor 2, that is, a high level of hospitality and maintenance, and a low level of transportation and traffic problems, tend to recommend the destination to others. on the other hand, it suggests that those who perceived a low value of factor 2 (a low level of hospitality and maintenance, and a high level of transportation and traffic problems), tend to show no readiness for recommendation. factor 2 has also a significant relationship with the domestic tourists' readiness to recommend lagos as a tourist destination (table 5b, b = 0.471, p < 0.05). therefore, the same thing applies to them as in the case of the international tourists. factor 3 (personal safety): as shown in table 5a, 'personal safety' has no significant relationship with the readiness of the international tourists to recommend lagos to others (b == 0.208, p > 0.05). the results suggest that their value of personal safety do not influence their readiness to recommend the destination to others. contrary to that, personal safety has a significant relationship with the domestic tourists' readiness to recommend lagos as a tourist destination (table 5b, b = 0.539, p < 0.05). the results also suggest that those who perceived a high value of personal safety, would recommend the destination to others and those who perceived a low value of personal safety, would not recommend the destination. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 675 discussion the results of this study show that more recreational tourists are ready to recommend the destination than the business tourists. also, more domestic tourists are ready to recommend the destination than the international tourists. put differently, more business and more international tourists are not ready to recommend lagos state as a tourist destination compared to their recreational and domestic counterparts (respectively). according to horovitz (1990), a dissatisfied consumer communicates his or her dissatisfaction to an average of eleven persons, while a satisfied consumer communicates his or her satisfaction to an average of three persons. demos (1992: 81-86) also holds that one dissatisfied consumer has more influence than the satisfied ones. this implies that the number of participants (in our study) who are not ready to recommend lagos state as a tourism destination (33.6 per cent of the business tourists and 12.1 per cent of the recreational tourists; 16.8 per cent of the domestic tourists and 37.7 per cent of the international tourists), thereby expressing their dissatisfaction, would have a much higher adverse effect on tourism and the economy of the state than initially appears. as balogun (1994) indicated, there is a decline in nigeria's foreign exchange earnings. thus, lagos state needs to embark on extensive tourism awareness and tourism improvement measures to reduce (especially, business and international) tourists' dissatisfaction to the minimum. results also show that hospitality, maintenance of infrastructure and transportation/traffic problems (factor 2) have a significant influence on the business tourists' international as well as domestic readiness to recommend the destination to others. that implies that if the above destination attributes do not meet the expectations of the three types of tourists, they would not recommend the destination to others. thus, urgent measures must be taken by the lagos state government and the tourism industries in the state to reduce the problems in the area of hospitality, maintenance and transport. as inskeep (1991) asserts, hospitality is one of the crucial tourist attractions and is essential for tourism development. in nigeria and west africa as a whole, high levels of hospitality have been one of the major attraction potentials of tourism (burch, 1997: 23-27; olokesusi, 1989; world tourism organisation, 1984). similar to hospitality, transportation is recognised as one of the major infrastructural elements whose functionality is highly needed for successful tourism (blank, 1989; danaher & arweiler, 1997: 89-93; feilmayr, 1996; gunn, 1994; inskeep, 1991; mill & morrison, 1985; steinbach, 1991; steinbach el al., 1983;) but, this infrastructure or service is among the most critical destination problems in tourism planning in the non-industrialised countries (heraty, 1989: r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 676 sajems ns vol 5 (2002) no 3 272-4). as one can see, the above result on lagos state reflects inskeep's opinion on hospitality, as well as heraty's (1989: 272-4) view on transportation. transportation and traffic problems pose obstacles to tourism activities in lagos since transportation often fails to function efficiently as the linkage between the tourists and their attractions. in fact, transportation and traffic problems have been a negative landmark in lagos state. these are among the major daily problems in the lives of everyone in lagos (see balogun, 1993; dickey, 1975). our study has also shown that personal safety (factor 3) influences the business and domestic tourists' readiness to recommend the destination. this supports inskeep's (199 i) view that personal safety has a great impact and plays an important role in creating the image of a tourist destination. this may explain why tourism does not yet flourish in many parts of africa, because of the high frequency of safety problems in this continent. it is then understandable when arnold (1990), boniface and cooper (1989), olekesusi (1989), richter, (1992) and wto (1984, 1997) see personal safety as one of the common problems of tourism in the countries of africa. personal safety problems may be seen as an outcome of political and economic problems and the resultant social problems like ineffective services of the police and other security forces result in disorderliness. these insufficient or ineffective services negatively affect the business and domestic tourists' feeling of safety and their readiness for recommendation of the destinations to others. considering the negative result with respect to safety at night (see table 2), one may conclude that the police and other security forces in lagos state are not efficient in their duties during those hours. inefficiency of the security forces may even be worse in lagos since its federal capital status was transferred to abuja (in 1990). this transfer may mean a reduction of security, law and order especially at night, since the federal government's attention and presence have been partly withdrawn, leaving law and order to the state government. feelings of insecurity at night may also be a result of the socio-economic problems in nigeria as a whole. there is high social instability (especially among the youths, school leavers and graduates) caused by 'scarcity' due to the economic recession in the country as a whole. according to balogun (1994), there is, among others, a decline in nigeria's foreign exchange earnings, accumulation of arrears of trade debts, drastic diminishing of salaried employment and a rapid decline in the gross national product. there are few jobs for millions of applicants and people migrate within and outside the country in search of livelihoods (nigerian economic review, 1993). migration to lagos as the main national metropolitan city therefore increases contributing to crime of various kinds, for example, robbery, fraud and conuption. this social malady of lagos no doubt would r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol5 (2002) no 3 677 prevent many business and domestic tourists from recommending the destination to others. cost of living (factor i) does not have a significant relationship with the readiness of both business, recreational, and domestic tourists to recommend the destination. the case of the business tourists seems to be understandable, since their travel expenses, are usually covered by their firms. the weak nigerian currency (l naira was about 130 us dollars a the time of the research), may have made the international tourists who normally come with harder currencies less sensitive to the high cost of living. with reference to the recreational and domestic tourists, the explanation may also be that the perception of 'high cost' does not necessarily entail having spent 'much'. rather, it may be that the awareness of the high cost of jiving in lagos motivated some tourists to seek alternative ways of avoiding the high cost of living. for example, a recreational or domestic tourist who actually sees lagos as being expensive may organise and stay with a friend or a relative to minimise the expenses. nevertheless, 'cost control measures' should be proposed in concomitance with high quality services in lagos. this is vital, since the targets for destination planning and marketing should be to achieve a high tourist satisfaction in order to win their loyalty as well as their readiness for further recommendation of the destination to the potential tourists. one would expect a significant relationship between factor 2 (hospitality, maintenance and transportation) and the recreational tourists' readiness to recommend the destination as it is the case with the other three types of tourists, but the opposite is the case. however, the negative effects transportation, for example, would be more pronounced on a business (international or domestic) tourist who misses his business appointment than it would be on a recreational tourist. this does not mean that the fulfilment of the recreational tourist's daily activity schedule may not be as important as that of the business tourists; rather, it is assumed that the recreational tourists may be more flexible in this instance. according to the results of the study, personal safety has no influence on the recreational and international tourists' readiness to recommend the destination. this may be because recreational tourists have the free choice of destinations for their recreational activities and therefore, may not willingly choose an unsafe destination site for their holiday. the international tourists may also be better informed on safety measures before travelling to nigeria than the domestic tourists. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 678 sajems ns vol 5 (2002) no 3 limitations of study this study did not investigate beyond the 'on-site experiences' of the tourists. although investigations that may capture the tourists' readiness to recommend lagos state at the time the tourists have gone back home may be very expensive, it may give some insight into the tourists' post-travel-perception of the state and their readiness to recommend. consumers' perception of a service is a continuous process and could be assessed in any phase of the travel experience. thus, further research on tourists' readiness for recommendation of lagos state as a tourist destination to others, based on the last phase of the travel experience, that is, after the visit to lagos, is strongly suggested. the possible effects of age, nationality and 'first time' and 'repeat' visitors on their readiness to recommend lagos state to others have not been investigated. further studies on tourists' impression and readiness to recommend other destinations in nigeria and west africa as a whole are also strongly suggested. the distributions of the sample population (business versus recreational tourists, domestic versus international tourists), as well as that of the respondents in the different sites, are unbalanced. this may have affected the results of the study. conclusion and recommendations stringent measures need to be taken to improve lagos state as a tourist destination, especially in the area of hospitality, maintenance and transportation, and personal safety. therefore, the following are suggested: first, transportation and traffic hindrances (e.g., traffic jams, go-slows, safety lapses, snatching and pickpocketing) should be dealt with in the state. this should be done through the location and concentration of the tourist facilities outside the busy business centres of lagos. for example, a recreational resort centre ('badagry resort') should be planned in badagry in the west wing of lagos state, and another one ('lbeju/lekki resort') in the east wing. these areas are a distance from the congested centre of lagos. direct connection roads should be constructed to link up the recreational resorts with the international airport and other major entry ports to lagos state. transportation should be wholly or partly taken over by the state government. this will entail detailed planning of shuttle bus services to link the holiday resorts with the airport and main lagos, as well as other tourist attractions. regular bus services and prompt arrival of buses at the bus stops involve accurate planning and good execution. taxi services as well as private transport services organised by travel agencies should also be encouraged. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 679 the unique potential of the atlantic ocean and waterways in lagos should be exploited for ferry and boat transportation of the tourists between the resorts in order to minimise transportation problems. pollution due to such transportation should however be avoided in the planning. this transportation should give the tourists the opportunity to have a round trip sightseeing tour over land and sea, and may also serve as one of the major tourist attractions in lagos. second, measures aimed at improving personal safety in the state should be instituted. when transport is organised for tourists and housing designed to guarantee safety, the problem of safety will be solved to some extent. the planned resorts should have functional police stations with staff specially trained on the need and behaviour of the tourists in order to avoid police nuisance. constant police patrol is recommended, particularly at night. hawkers should be cleared from the streets and the quality of the commodities sold in the resort areas should be controlled to prevent the sale of stolen goods. functional banking services should be made available to cope with the needs of tourists. this will avoid the safety hazard of carrying large sums of cash and therefore reduce the risk of being attacked, or even the fear of being attacked. third, people employed in the tourism industry should be well-trained in hospitality. finally, more money should be invested in maintaining tourist infrastructure in the state; a maintenance culture should be developed and maintained in the state. references adepoju, e.a. 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(1989) the community tourism industry imperative: the necessity, the opportunities, it's potential, state college, p a: venture. ii boniface, b.g. & cooper, c.p. (1989) the geography of travel and tourism, london: heinemann. 12 brandy, m.k. & robertson, cj. (2001) "searching for a consensus on the antecedent role of service quality and satisfaction." journal of business research, 51(1): 53-61. 13 burch, b. (1997) "ecotourist's paradise", african business, 225 (october): 23-27. 14 danaher, pj. & arweiler, n. (1997) "consumer satisfaction in the tourism industry: a case study of visitors to new zealand", travel and tourism research, 35 (summer): 89-93. 15 demos, e. (1992) "concern for safety: a potential problem in the tourist industry". journal of travel and tourism marketing, 1 (1): 81-86. 16 dickey, j. (1975) metropolitan transportation planning, washington d.c: scripta book. 17 disney, 1. 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(1989) a study on tourism development at the lagos beaches: a pilot study of tarqua bay, a paper presented at the department of architecture, university of lagos, nigeria. 31 perterson, r. & wilson, w.r. (1992) "measuring customer satisfaction: fact and artefact", journal of the academy of marketing science, 20 (1): 61-71. 32 richter, l.k. (1992) political instability and tourism in the third wor/d, in tourism and the less developed countries. london: belhaven press. 33 smoltczyk, a. (1997) "lagos, ueberleben im moloch von afrika". geo magazine, 3 (march): 54-7l. 34 steinbach, j. (1991) wandel von angebot und nachfrage im fremdenverkehr: neue tendenzen im tourismus, wandeln sich urlaubziele und urlaubsaktivitaeten?, muenchen: geobuch. 35 steinbach, 1., feilma yr w., hang h., & studentische, m. (1983) regionalanalysen im land salzburg. vienna: department of urban and regional research, university of technology vienna. 36 sureshchandar, g. s., rajendran, c., & kamalanabhan, tj. (2001) "customer perceptions of service quality: a critique", total quality management, 12(1): 111-125. 37 ukpanah, sj. (1990) "nigeria's tourism resources and potentials to be harnessed", tourism, 1(1): 12-18. 38 vavra, t.g. (1997) improving your measurement of customer satisfaction: a guide to creating, conducting, analysing, and reporting customer satisfaction measurement programmes. wisconsin: asq quality press. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 682 sajems ns vol 5 (2002) no 3 39 world tourism organisation (1984) regional conference on intra-african tourism co-operation, niamey: world tourism organisation. 40 world tourism organisation (1997) tourism market trendsafrica, madrid: world tourism organisation. 41 zeithaml, v., berry, l. & parasuraman, a. (1996) "the behavioural consequences of service quality", journal of marketing, 60: 31-46. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction literature review data and methodology empirical results conclusion acknowledgements references appendix 1 footnotes about the author(s) celsa m.d.c. machado department of economics, porto accounting and business school (iscap), polytechnic institute of porto (ipp), porto, portugal antónio f.m.g. saraiva department of economics, porto accounting and business school (iscap), polytechnic institute of porto (ipp), porto, portugal paulo d.d. vieira department of economics, porto accounting and business school (iscap), polytechnic institute of porto (ipp), porto, portugal citation machado, c.m.d.c., saraiva, a.f.m.g. & vieira, p.d.d., 2021, ‘finance-growth nexus in sub-saharan africa’, south african journal of economic and management sciences 24(1), a3435. https://doi.org/10.4102/sajems.v24i1.3435 original research finance-growth nexus in sub-saharan africa celsa m.d.c. machado, antónio f.m.g. saraiva, paulo d.d. vieira received: 26 oct. 2019; accepted: 29 oct. 2020; published: 19 feb. 2021 copyright: © 2021. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: there is now significant empirical literature suggesting that finance is good for growth only up to a threshold level of financial development, becoming harmful after that level, in developed and developing countries. aim: this study extends this literature that investigates non-linearities on the finance-growth link, by testing the inverted u-shape hypothesis in sub-saharan african countries, which are among the least developed ones. setting: 36 countries from sub-saharan africa over the period 1980–2015. method: estimation of quadratic dynamic panel data models by system-generalised method of moments. results: empirical results show that there is a hump-shaped relationship between financial development and economic growth in sub-saharan african countries. conclusion: results suggest that the hypothesis of ‘too much finance harms economic growth’ also holds for low-income and less developed countries, but for much lower threshold levels of financial development than those of more developed and higher-income countries. as for policy implications, measures to strengthen finance quality and other growth-enhancing strategies need to be undertaken, rather than increasing finance size. keywords: financial development; economic growth; sub-saharan africa; non-linearity; dynamic panel model. introduction an extensive literature has examined the impact of financial development on economic growth.1 a significant branch found empirical evidence of a positive relationship between financial development and economic growth, suggesting ‘more finance, more growth’ (e.g. beck, levine & loayza 2000; king & levine 1993a, 1993b; levine, loayza & beck 2000). indeed, most arguments rely on the fact that a more developed financial system reduces information, transaction and monitoring costs while improving the allocation of capital and risk-taking across the economy. these gains exert positive effects on economic growth by increasing investment and its quality, through affecting its composition and encouraging innovation. however, the financial sector also competes for physical capital and high-skilled labour with the rest of the economy and that may distort the allocation of resources, draining the more qualified from the productive sectors of the economy. additionally, a malfunctioning financial system may discourage saving, encourage speculation and benefit low-productivity projects, thus decreasing investment and its quality. the subsequent negative effects on economic growth are more likely to dominate when the financial sector is too large, giving support to the hypothesis that ‘too much finance harms economic growth’.2 the global financial and economic crisis of 2007–2008 provides evidence of the negative consequences of a large, high-developed, though malfunctioning, financial sector. therefore, there is now significant empirical literature that assesses the existence of a hump-shaped relationship between financial development and economic growth in developed and developing countries where the financial system is relatively developed (e.g. arcand, berkes & panizza 2015; benczúr, karagiannis & kvedaras 2019; cecchetti & kharroubi 2012; law & singh 2014; samargandi, fidrmuc & ghosh 2015). at large, this literature suggests that finance improves growth only up to a threshold level of financial development and that it becomes harmful beyond that level. the argument that some critical levels of financial and economic development, human capital or political institutions’ quality are required to make economic growth benefit from financial development also echoes in the literature that addresses the presence of non-linearities in the finance-growth nexus. some of this empirical literature suggests that, in less developed and low-income countries, the relationship between financial development and economic growth is not significant, while it becomes positive and significant for relatively more developed and higher-income countries (e.g. deidda & fattouh 2002; rioja & valev 2004b). in the case of african countries, characterised, on average, by low levels of financial development, there is now a growing body of empirical literature that investigates the potential role of financial development in economic growth, by resorting to an array of panel data econometric techniques (e.g. adusei 2013; bist 2018; effiong 2015; ehigiamusoe & lean 2018; ibrahim & alagidede 2018; inoue & hamori 2016; ngongang 2015). however, to the best of our knowledge, only ibrahim and alagidede (2018) assess the existence of a non-linear relationship for a sample of 29 sub-saharan african (ssa) countries during the period 1980–2014. their findings lend support to the hypothesis that financial development has a positive and significant impact on growth, only when initial income, financial development or human capital are sufficiently high. many african countries have recently experienced extensive reforms in the financial sector that made the access to financial services more widespread and increased financial sector depth (demirgüç-kunt & klapper 2012). in consequence of such reforms, access to financial services has grown faster in the ssa countries that were among the countries with the lowest records in this matter (inoue & hamori 2016).3 a larger dissemination of financial services, promoted by the successful adherence to new technologies, such as mobile money, together with the financial deepening of credit, contributed to the development of ssa countries’ financial sectors. despite the development of the financial sector in ssa, important informal methods of saving and borrowing still coexist with formal ones. moreover, demirgüç-kunt and klapper (2012) show that, when compared to other developing economies, high-growth small and medium firms are less likely to use formal financing, suggesting that formal financial systems may not be serving the needs of firms facing growth opportunities. hence, in ssa countries, it may be the case that the relative dimension of the financial sector is underestimated when one uses the typical measures of (formal) financial development. apparently, it may also be the case that the projects benefiting from formal financing funds may not be the most productive and growth-enhancing ones. therefore, relying on the empirical evidence of an inverted u-shaped relationship between financial development and growth for highand middle-income countries, we conjecture that parallel evidence would also hold in low-income countries, such as ssa countries, but certainly for lower threshold levels of financial development. the low levels of physical and human capital and the weak institutional quality that characterise these countries are additional factors that may contribute to a (still) underdeveloped financial sector becoming excessive. in line with these arguments, this article extends recent empirical literature that investigates non-linearities in the link between financial development and economic growth, by testing the inverted u-shaped hypothesis in countries that are among the least developed ones, such as the ssa countries. it contributes to the existing literature in three aspects. firstly, to the best of our knowledge, we present the first attempt to investigate this pattern of non-linearity in this region, by applying the cecchetti and kharroubi (2012) non-linear modelling strategy to a panel of 36 ssa countries, over the period 1980–2015. secondly, as estimation strategy, we use a dynamic panel system-generalised method of moments (sys-gmm) estimator, which allows us to control for potential endogeneity problems. thirdly, we use the lind and mehlum (2010) u-test, which is more appropriate to validate the inverted u-shaped relationship than conventional tests. our results suggest that more finance may be growth-depleting, even for countries with (still) low levels of financial development. to get positive growth effects from ‘more finance’, complementary reforms may be required: institutional quality and economic reforms should be pursued together with those in the financial system. ‘more finance’ needs to be supported by ‘better finance’. the rest of the article is structured as follows. section 2 reviews relevant literature on the finance-growth nexus. section 3 specifies the model, describes the data and the econometric methodology. section 4 presents and discusses empirical results. section 5 provides main conclusions. literature review the services provided by the financial sector might contribute to economic growth by: (1) producing ex-ante information about potential investments, (2) monitoring investment and enhancing corporate governance, (3) facilitating risk management and diversification, (4) mobilising and pooling savings, and (5) easing the exchange of goods and services (levine 2005). essentially, by reducing information, transaction and monitoring costs and improving the allocation of capital and risk across the economy, financial development increases investment and improves its quality, and thus exerts a positive effect on economic growth, suggesting a positive relationship between financial development and economic growth.4 however, there is also the possibility that financial development distorts resource allocation, discourages saving, encourages speculation, and favours unproductive projects, decreasing investment and its quality, and thus exerts a negative effect on economic growth. negative effects are likely to coexist with positive ones and might explain non-linearities on the finance-growth nexus. there is a strand of theoretical literature that identifies the sources of a non-linear relationship between finance and growth relying only on financial development itself, while another strand of the literature, instead, emphasises the role of mediating factors on such non-linearity. in line with the first strand of literature, a first important argument for the non-linearity of the finance-growth nexus is the suboptimal allocation of talents that results from a large financial sector. according to tobin (1984), the private returns of the financial sector are higher than the social ones. bolton, santos and scheinkman (2016) provide a theoretical model where the financial industry extracts excessively high rents from the provision of financial services and these rents attract too much talent. therefore, a larger financial sector, competing for more qualified resources with the rest of the economy, may drain the ‘cream-skimming’ resources from the productive sectors, with negative consequences for economic growth. a second argument relates to financial development, resulting from financial innovation and liberalisation, with the increase of systemic risk which, by exacerbating macroeconomic volatility, impacts negatively on economic growth (see, for instance, arcand et al. 2015; ductor & grechyna 2015; popov 2017). another argument follows from the segmentation of the credit market between investment and consumption credit markets or between firm and household (especially house mortgage) credit. hung and cothren (2002) show that, with credit market imperfections, when screening consumers is cheaper than screening entrepreneurs, financial development initially favours investment and promotes growth. however, when credit markets are further developed, consumers’ borrowing constraints are relaxed and net savings decrease more substantially, and this attenuates the effects of financial development on economic growth. this model predicts that the effects of credit market development on growth are more effective in countries with lower levels of financial development than in those with higher levels of financial development. in turn, hung (2009) develops a more general model, aiming to replicate all the non-linear patterns found by recent empirical literature, of the finance-growth nexus. in his model, financial development facilitates both investment loans and consumption loans with opposite impacts on economic growth. the net effect on economic growth depends on the relative magnitudes of these two channels which hinge on the initial level of financial development. in countries with low levels of financial development, there is uncertainty on which effect dominates and thus the effect of financial development on economic growth is also uncertain. however, in countries with intermediate levels of financial development, the relationship between finance and growth is positive because the effect of investment loans clearly dominates. finally, in countries with high levels of financial development, the effect of consumption loans increases with the level of financial development and once more there is uncertainty about which effect dominates. however, even if the investment loans effect dominates, the positive net effect on economic growth becomes smaller than that for countries with intermediate levels of financial depth. along these theoretical arguments, there is substantial literature that finds empirical evidence of a non-linear relationship between financial development and economic growth. typically, in most empirical studies, measures of banking sector development, such as the ratios of private sector credit or of liquid liabilities to gross domestic product (gdp), are employed as measures of financial development, while the financial sector encompasses other types of financial institutions and markets. at large, this literature suggests that finance is good for growth only up to a threshold level of financial development, becoming harmful beyond that level, giving support to the so-called ‘too much finance’ hypothesis.5 however, this threshold level varies significantly across the different studies. while swamy and dharani (2019) found, using a sample of 24 advanced economies, that more finance hinders growth when the domestic credit to private sector ratio exceeds a level of 142% of gdp, benczúr et al. (2019) found, also in high-income economies, threshold levels ranging from 37% to 46% and 61% to 76%, depending on the group of countries and on how financing is decomposed. for more comprehensive samples of developed and developing countries, arcand et al. (2015), cecchetti and kharroubi (2012) and law and singh (2014) found that credit to the private sector is expected to start having negative effects on output growth when it reaches threshold levels of 100%, 99% and 88% of gdp. in turn, samargandi et al. (2015), in a panel of middle-income countries and using the threshold method, found that, for the whole sample and the upper-middle income subsample, the estimated threshold value of the financial development indicator is around 92% of gdp, while it decreases to 43% for lower middle-income countries. soedarmono, hasan and arsyad (2017), from a panel data set of provinces of indonesia over the period 2000–2009, document inverted u-shaped relationships between total credit, investment credit and, to a lesser extent, consumption credit and the regional economic growth, but with much lower threshold levels. their different measures of financial depth start to hamper regional output growth when they reach threshold levels ranging from 18% to 40%. according to these authors, if the majority of loans are allocated to sectors that contribute less to economic growth, such as wholesale and retail trade sectors in indonesia, then more credit might have adverse consequences on growth and become ‘too much’, even for relatively low levels of financial depth. rioja and valev (2004a), using a panel of 74 developed and developing countries, found a different non-linear pattern in the finance-growth nexus, as predicted by the theoretical model of hung (2009). more specifically, the effect of financial development produced: (1) an uncertain effect on economic growth for countries with low levels of financial development, (2) a significantly positive effect for countries with intermediate levels of financial development and (3) a positive, but small, effect for countries with high levels of financial development. another strand of theoretical and empirical literature asserts the importance of mediating factors to explain non-linearity on the finance-growth relationship. the conditioning effect of political and economic institutions on the finance-growth nexus is emphasised by, for instance, demetriades and law (2006), gazdar and cherif (2015) and slesman, baharumshah and azman-saini (2019), while that of the economic development stage receives empirical support from deidda and fattouh (2002), rioja and valev (2004b) and ibrahim and alagidede (2018), among others.6 for instance, slesman et al. (2019) posit that empirical evidence of a non-linear relationship between finance and growth in developing countries may have missed the contingent role played by political institutions. they found robust evidence that a critical threshold level of political institutions is required for economic growth to benefit from financial development in developing countries, where political institutions are known to be relatively weak and the levels of financial development low. in turn, ibrahim and alagidede (2018) claim that the initial level of income is a key potential threshold variable mediating how finance affects economic growth. for a panel of 29 ssa countries, their results suggest that, in less developed and low-income countries, the relationship between financial development and economic growth is not significant, while it becomes positive and significant for relatively more developed and higher-income countries. more generally, ibrahim and alagidede provide evidence that financial development has a positive and significant impact on growth, only when economies are above some threshold levels of initial income, financial development or human capital; below these threshold levels, there is no significant impact of financial development on growth. data and methodology model specification and data description in line with cecchetti and kharroubi (2012), but within a dynamic model, we assume the following standard quadratic relationship between financial development and economic growth: in equation 1 growthi,t refers to gdp growth rate in the ith country at time t. lnfdi,t is the natural logarithm of the country’s level of financial development, xi,t represents the vector of control variables, αi is the unobserved country-specific effect for country i, θt is the period effect for time t and εi,t is the error term. the control variables used in the model are commonly used in the literature and include initial income, investment, human capital, inflation and an index of institutional quality. our major concern is the magnitude and significance of coefficients β1 and β2. if the finance-growth relationship follows an inverted u-shaped relationship, then β1 is positive and β2 negative. to estimate the model and to test this hypothesis, we use a panel data sample of 36 ssa countries for the period 1980–2015.7 in order to purge business cycle frequencies from the data, the data set is averaged for non-overlapping periods of 5 years, which allows for a maximum of seven observations per country (1981–1985, 1986–1990, 1991–1995, 1996–2000, 2001–2005, 2006–2010, 2011–2015). table 1 describes the variables, and corresponding sources, used in the model. economic growth (growth) is proxied by percentage changes in real gdp per capita. two different variables are used as measures of financial development (fd): the domestic credit to the private sector (dc) and liquid liabilities, commonly referred to as broad money (m3), all expressed as ratios to gdp. domestic credit to the private sector refers to loans given by financial institutions to the private sector, that is, it excludes credits issued to governments or its agencies, public enterprises, as well as credits issued by the central bank. liquid liabilities include currency plus demand and interest-bearing liabilities of banks and non-banking financial intermediaries. both indicators of financial development are commonly used as indicators of financial intermediation and financial depth (e.g. loyaza & rancière 2006), although domestic credit is more directly linked to investment and economic growth than liquid liabilities. table 1: definitions and sources of variables. as for control variables, the ratio of gross capital formation (gcf) to gdp is used to proxy investment and physical capital accumulation, while the index of human capital (hc) is a per worker index based on the average years of schooling and on the rate of return for primary, secondary and tertiary education, as described by feenstra, inklaar and timmer (2015). both variables are expected to have a positive effect on growth. the growth rate of the consumer price index (inflation) is used to proxy macroeconomic instability while initial income (gdp0), the initial gdp per capita (constant price in us$, 2010) for each 5-year sub-period, is used to capture absolute convergence effects. these two variables are expected to negatively impact on growth. finally, we use the freedom house index of political rights and civil liberties (il) to represent institutional quality, as in anwar and cooray (2012). naturally, better institutions are expected to enhance growth. with the exception of growth, inflation and il, all variables are transformed into natural logarithms. methodology model estimation uses the dynamic panel system gmm estimator developed by arellano and bover (1995) and blundell and bond (1998). this estimator, requiring a large number of cross-section units and a small number of time periods, was chosen in order to control: (1) country-specific effects, (2) autocorrelation problems, due to the presence of the lagged dependent variable in the model, and (3) simultaneity bias, caused by potential endogeneity of some of the explanatory variables. unlike the difference gmm estimator, proposed by arellano and bond (1991), this estimator is appropriate when explanatory variables are persistent, as is the case of macroeconomic variables such as financial development, human capital, gdp per capita, investment or inflation, for which corresponding lagged values are seen as weak instruments (see law, lee & singh 2018, for more elaborated arguments). we use the two-step system gmm estimator which is asymptotically more efficient than the one-step estimator. the proliferation of instruments in a sample of small cross-section dimensions, as in the present study, may lead to biased standard errors. therefore, we apply windmeijer (2005) finite-sample correction to reported standard errors in the two-step estimation, to avoid standard errors being severely downward biased. to test for the presence of an inverse u-shaped relationship between financial development and economic growth in a more appropriate way, we use the test provided by lind and mehlum (2010). these authors argue that it is not enough that the first and the second derivatives have opposite signs for having a u-shaped or inverted u-shaped relationship. this criterion will be misleading when the estimated extreme point is close to the end point or to the starting point of the data range. to validate an inverted u-shaped relationship between fd and growth, we test the null hypothesis h0 (equation 2) against the alternative hypothesis h1 (equation 3): lnfdlow and lnfdhigh represent the minimum and maximum values of lnfd. the inverted u-shaped relationship holds, if the null hypothesis is rejected. empirical results descriptive statistics presented in table 2 confirm the small magnitude of the financial sector in these countries: the average domestic credit to the private sector represents only 18.5% of gdp, while the average liquid liabilities represents 26.4% of gdp.8 descriptive statistics further indicate that, on average, these countries are low-income countries, with high average inflation (52.4%) and exhibiting poor institutional quality (the index of political rights and civil liberties averages 0.3 out of 1). records also suggest that countries in the sample are highly heterogeneous. moreover, correlation coefficients between financial development variables and economic growth, reported in table 2, are positive but only statistically significant for liquid liabilities. gross capital formation, human capital and the index of political rights and civil liberties are also positive and statistically significantly correlated with growth during this period, while inflation is negatively correlated. table 2: descriptive statistics and correlation matrix. analysis of estimation results table 3 reports the results from the two-step system gmm estimation of equation 1, in its original form and without the financial development quadratic term, using separately domestic credit to private sector (lndc) and liquid liabilities (lnm3) as proxies for financial development. table 3: two-step system-generalised method of moments estimations. referring to models 1dc and 1m3, which assume a linear relationship between financial development and economic growth, the results indicate that financial development does not have a statistically significant impact on economic growth, in line with the findings of effiong (2015) and ngongang (2015). however, the results of the estimation of a linear relationship are misleading when the true relationship between financial development and economic growth is non-linear, as we hypothesise it to be. the estimation of models 2dc and 2m3 show the existence of a non-linear relationship between both financial development indicators and economic growth. the results are in line with the hypothesis that finance delivers a positive impact on growth only up to a certain threshold and that too much finance becomes harmful. effectively, the coefficients of the linear term of both financial development indicators are positive, while those of quadratic terms are negative (and statistically significant), suggesting the existence of an inverted u-shaped relationship between finance and growth. this relationship is validated by the lind and mehlum (2010) u-test in table 3.9 therefore, as many studies have demonstrated for the case of more developed and higher-income countries, our estimation suggests that the inverted u-shaped relationship between finance and growth also holds for low-income and less developed countries, but on a much lower threshold-level of financial development. according to our point estimate, domestic credit to private sector ratio (%gdp) becomes harmful to economic growth after a threshold level of 6.9%, while liquid liabilities (%gdp) become detrimental after 11.8%. these two values fall below the means for the two financial indicators reported in table 2. figure 1 and figure 2 present the graphical representations of models 2dc and 2m3. they illustrate the inverted u-shaped profile between both indicators of financial development and economic growth and show that most observations fall in the descending part of the fitted lines. this suggests an oversized financial sector, even in countries where its relative dimension is, apparently, too small. such counter-intuitive results may be the consequence of the confluence of many factors: (1) the financial sector’s drainage of the scarce ‘cream-skimming’ resources from productive sectors (e.g. tobin 1994), (2) the dominance of consumption credit over investment credit (e.g. hung 2009), (3) the low quality levels of political, legal and economic institutions (e.g. slesman et al. 2019), (4) unbalanced growth in the financial and real estate (e.g. ductor & grechyna 2015) and (5) a financial structure where informal methods of saving and borrowing compete with the formal financial sector regarding financing high-growth small and medium firms (demirgüç-kunt & klapper 2012). figure 1: domestic private credit to gross domestic product ratio and growth. figure 2: liquid liabilities to gross domestic product ratio and growth. some other empirical studies also have found relatively low threshold levels of financial development: samargandi et al. (2015) in a subsample of lower-middle income countries and soedarmono et al. (2017) for indonesia, using regional-level data, for instance. however, as for african countries, most panel data studies assume a linear finance-growth nexus with blurred evidence of the significance and signal of this relationship. while, for instance, adusei (2013) and ehigiamusoe and lean (2018) find evidence of a significant and positive relationship between finance and growth, ngongang (2015) find no statistical significance and bist (2018) show that private credit has a positive and significant impact on economic growth for 9 out of 16 african countries, no significant impact on four countries and a negative impact on three countries.10 however, these results may lose relevance if the true finance-growth nexus is non-linear. ibrahim and alagidede (2018) add to this empirical literature by estimating a threshold model and allowing for a non-linear relationship between finance and growth. based on data from 29 ssa countries over the period of 1980–2014, they find that financial development only has a significant and positive effect on growth after an initial financial development threshold-level, at odds with our results. concerning control variables, table 3 shows that their coefficients have signs consistent with the theory and that they are statistically significant, except for human capital. as expected, more investment and better institutional quality improve economic growth, while a higher initial income and higher inflation lead to lower economic growth. as for the diagnostic tests, the sargan test does not reject the null hypothesis of over-identification restriction, suggesting that the instruments are valid. furthermore, the serial correlation test fails to reject the null hypothesis of no second-order autocorrelation. overall, both tests suggest that models are relatively well specified. robustness checks in order to examine the sensitivity of the results, we carried out two robustness checks. in the first one, additional explanatory variables are included, namely the ratio of government expenditure to gdp (lng) and trade openness (lnopen).11 table 4 presents estimation results of models 3dc and 3m3, that include lng as an additional control variable, and models 4dc and 4m3 that, instead, include lnopen. the coefficients of these two additional variables are not statistically significant and the results are qualitatively similar to the ones reported in table 3. table 4: two-step system-generalised method of moments estimations with an additional explanatory variable. as a second robustness check, we apply two different estimation methodologies. following soedarmono et al. (2017), we check the robustness of our results, running a static panel data model with gmm instrumental variables estimation. the estimation results presented in table 1-a1, in appendix 1, globally corroborate previous results of an inverted u-shaped relationship between financial development and economic growth. moreover, since our inverted u-shaped relationship result seemed incompatible with the results of ibrahim and alagidede (2018) of the existence of a threshold above (below) with which there is a positive and significant (non-significant) relationship between financial development and growth, we also applied a threshold estimation technique. however, ibrahim and alagidede estimate a static panel threshold model with annual data, while we control for endogeneity and purge business cycle frequencies from the data, estimating a dynamic panel threshold model with 5-year averaged data. we follow the estimation procedure of seo, kim and kim (2019) for a model with a kink in financial development. the threshold modelling strategy is becoming increasingly popular to search for non-linear relationships. as law and singh (2014) argue, the quadratic specification strategy imposes that the effect of finance on growth monotonically and symmetrically increases and decreases with the level of financial development. the threshold model, instead, allows for asymmetric behaviour with positive ranges of the relationship differing, in absolute impact, from that observed over negative ranges. the threshold model allows the relationship between finance and economic growth to be piecewise linear, with the levels of financial development indicators acting as a regime switching trigger. however, the estimation of this model requires a strictly balanced panel sample and, as a consequence, our sample is reduced to 23 countries. therefore, this robustness exercise just seeks to check if the use of a threshold estimation method supports evidence of the non-linear pattern as seen in ibrahim and alagidede’s (2018) results, rather than validate our results for the sample of 36 countries. table 2-a1, in appendix 1, reports the results of the estimation of a dynamic threshold model using a gmm estimator, for a balanced sample of 23 ssa countries and for the period 1980–2015.12 empirical findings show a hump-shaped relationship between financial development and economic growth: financial development has positive effects on growth only until a threshold level of 17%, for the domestic credit to private sector ratio (%gdp), and only up to 15.4% of gdp for liquid liabilities, hurting growth if these threshold levels are surpassed. the threshold levels for financial development indicators are still very small, only slightly higher than those from our quadratic baseline models and large sample. hence, smoothing the business cycle effect and controlling for endogeneity with the estimation of a dynamic threshold model reinforce our findings in the large sample and the alternative estimation method, but do not support ibrahim and alagidede’s (2018) results. conclusion there is now significant empirical literature that documents the existence of a hump-shaped relationship between financial development and economic growth in developed and developing countries where the financial system is relatively developed. in face of the recent expansion of the financial sectors of ssa countries, it may be the case that even underdeveloped financial systems can become relatively oversized. in other words, it is possible that an inverted u-shaped relationship between financial development and economic growth can also be verified in less developed and low-income countries, but on a much lower threshold-level of financial development compared to developed countries. we fill a gap in empirical literature by testing this hypothesis for a panel data in 36 ssa countries for the period 1980–2015. our empirical results suggest that more finance is not always better and may harm economic growth, even in countries with low levels of financial development. moreover, most of the sample observations exceed the low threshold levels of financial development suggesting that further increase of the size of the financial sector may hamper economic growth in ssa countries. therefore, in terms of policy implications, policymakers should focus more on formulating and implementing policies that create a favourable environment for the private sector to grow with the availability of the required finance, rather than just increasing the size of the financial sector. measures to strengthen the quality of finance and other growth-enhancing strategies, namely institutional quality and economic reforms, need to be undertaken. future research could shed more light on the non-linear relationship between finance and growth by examining more profoundly the role of mediating factors such as the quality of political institutions and by deconstructing the credit into consumption and investment credit. investigating this non-linear relationship in the individual ssa countries may be also of interest. acknowledgements we are grateful to three anonymous peer reviewers of this journal for their helpful comments and suggestions. competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in the writing of this research article. authors’ contributions c.m.d.c.m, a.f.m.g.s. and p.d.d.v. contributed equally to this research article. ethical considerations this article followed all ethical standards for research without direct contact with human or animal subjects. funding information this research has been financed by portuguese public funds through fct – fundação para a ciência e a tecnologia, i.p. – in the framework of project uid/eco/04105/2019 (celsa machado). data availability data may be available from the authors on request. disclaimer the views and opinions expressed in this 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from indonesia’, international economics 150, 19–35. https://doi.org/10.1016/j.inteco.2016.11.003 swamy, v. & dharani, m., 2019, ‘the dynamics of finance-growth nexus in advanced economies’, review of economics and finance 64(1), 122–146. https://doi.org/10.1016/j.iref.2019.06.001 tobin, j., 1984, ‘on the efficiency of the financial system’, lloyds bank review 153, 1–15. windmeijer, f., 2005, ‘a finite sample correction for the variance of linear efficient two-step gmm estimators’, journal of econometrics 126(1), 25–51. https://doi.org/10.1016/j.jeconom.2004.02.005 appendix 1 table 1-a1: generalised method of moments instrumental variables estimations. table 2-a1: dynamic panel threshold model estimations. footnotes 1. levine (2005), beck (2011, 2013), pasali (2013), panizza (2014), fernandez and tamayo (2017) and popov (2017), among others, provide comprehensive surveys on this literature. 2. arcand et al. (2015), ductor and grechyna (2015) and popov (2017) systematise some theoretical channels that support this hypothesis. 3. effectively, financial access, proxied by the number of commercial bank branches per 100 000 adults in the period 2004–2012, increased at an average annual rate of 6.7% in ssa countries, compared to only 2% in the world (inoue & hamori 2016). 4. greenwood and jovanovic (1990), bencivenga and smith (1991), pagano (1993) and acemoğlu and zilibotti (1997) are examples of theoretical contributions demonstrating the role of financial development in promoting investment and the improvement of its efficiency. 5. in developed countries, security markets play an increasingly important role in the process of economic development, while the reverse occurs in the services provided by banks (cf. demirgüç-kunt, feyen & levine 2013). arcand et al. (2015) claim that this may provide a rationale for a ‘too much credit’ hypothesis rather than the ‘too much finance’ hypothesis, as it may be the case of a wrong structure of finance with a disproportionate size of banks relative to markets. 6. other mediating factors have been explored in recent empirical literature. dombi and grigoriadis (2020) investigate the role of ancestral institutions and historical legacies in the finance-growth relationship in post-soviet countries, while adusei (2019) investigates the role of the risk premium in the finance-growth link, using data from south africa. 7. we considered 36 out of 46 ssa countries; these are the only ones with data available for the index of human capital. the list of countries is presented in a note to table 2. 8. in the sample of 75 developed and developing countries, for the period 1996–2010, used by law et al. (2018), the mean of the ratio of private sector credit to gdp is 72.9%. 9. the test rejects the null hypothesis of a u-shaped profile and the slope of the lower bound is positive while that of the upper bound is negative, both being significant. this validates the existence of an inverted u-shaped relationship between finance and growth. 10. acaravci, ozturk and acaravci (2009) provide a comprehensive review of empirical literature on ssa. 11. natural logarithm of the ratio of the general government expenditure to gdp (lng); natural logarithm of the ratio of exports plus imports to gdp (lnopen). both indicators were obtained from world bank, world development indicators (wdi). 12. the 23 countries are: burundi, burkina faso, botswana, central african republic, cote d’ivoire, cameroon, democratic republic of the congo, gabon, ghana, gambia, kenya, madagascar, mauritius, malawi, niger, nigeria, rwanda, sudan, senegal, sierra leone, swaziland, togo and south africa. abstract introduction literature review research methodology discussion of the results recommendations conclusion acknowledgements references about the author(s) bongani khonjelwayo national energy regulator of south africa, pretoria, south africa thilivhali nthakheni national energy regulator of south africa, pretoria, south africa citation khonjelwayo, b. & nthakheni, t, 2020, ‘investment in electricity distribution capital infrastructure in south africa: the role of regulation’, south african journal of economic and management sciences 23(1), a3413. https://doi.org/10.4102/sajems.v23i1.3413 original research investment in electricity distribution capital infrastructure in south africa: the role of regulation bongani khonjelwayo, thilivhali nthakheni received: 03 oct. 2019; accepted: 08 apr. 2020; published: 28 july 2020 copyright: © 2020. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the electricity distribution industry in south africa is faced with numerous challenges that include distribution capacity shortages and backlog in investments. aim: this study was carried out to investigate the role of regulation in enabling investment in distribution capital expenditure. setting: the study focusses on the licensed electricity distributors and the energy regulation institution in south africa. methods: primary data for the study was collected through interviews with 16 energy regulator officials responsible for analysing and approving electricity distributor tariff applications. secondary data was collected and analysed through a sample of 112 electricity distributors in south africa. results: it is established that the national energy regulator of south africa has put a number of processes and methods in place to ensure that electricity distributors (eds) are efficient in their operations and that the tariffs they charge customers are not excessive and are aligned to specific benchmarks as approved by the regulator. however, a majority of eds are not performing according to the benchmarks. for instance, they are operating at a negative surplus, which does not allow them to make sufficient investment in infrastructure refurbishment and acquire new infrastructure. the study also discovered that eds are spending the minimum 6% required by regulation on repairs and maintenance. conclusion: the conclusion of the study is that in the absence of a regulatory methodology that allows eds to earn a required return on assets, benchmarks play a big role in ensuring that they are performing at the level required and that through the surpluses they generate, they can invest in the acquisition of new infrastructure for capital gain. however, regulation alone is not sufficient to ensure that capital investment is adequate; government intervention through infrastructure grants is also necessary and a private sector capital injection. keywords: capital expenditure; electricity distributors; infrastructure backlogs; regulation; benchmarks; repairs and maintenance and infrastructure capital. introduction the purpose of this study is to assist the south african electricity supply industry to be sustainable through investment in infrastructure by determining the role of regulation. this section of the study covers the background, aim of the study and research questions. background at the municipal sphere of government, revenue from electricity constitutes a major proportion of municipality’s income, followed by property rates. municipalities that sell electricity generated at least 40% of their revenues from the sale of electricity in 2017 (statistics south africa [stats sa] 2017). the electricity pricing policy (no. 31741) of 2008 states that the electricity distribution industry (edi) in south africa is faced with several challenges that include capacity shortages and backlog in investments. according to eskom (2019), municipalities accounted for 42% of electricity sales in south africa in 2018, while eskom was responsible for the difference. eskom also states that networks are inadequately maintained which results in refurbishment and maintenance backlogs. this has led to a rise in electricity supply disruptions. a 2010 study (reviewed in 2016) conducted by the department of energy (doe) showed that the investment backlog in electricity distribution infrastructure investment stands at r68 billion. de beer (2016) investigated the role of regulation in supporting and ensuring that electricity distributors (eds) generate sufficient revenue to earn a required return to be able to invest in infrastructure and capital expansion to meet the demand from customers. this study revealed several reasons for the failure of electricity distribution systems in south africa, which included the following: lack of planned or preventative maintenance. lack of asset databases, suitable spares and contingency arrangements. a bottom-up planning approach that does not inform maintenance budget. when there are budget deficits, the readjusting maintenance expenditure downwards becomes the easiest option to close the gap. aim of the study the aim of this study is to investigate the role of regulation in enabling investment in distribution capital expenditure by eds to enable sustainable electricity supply in south africa. the objectives of the study the primary objective of the study is to determine the role of regulation in supporting infrastructure investment and monitoring the performance. to achieve these, the following specific objective were developed: to determine the role of regulation in facilitating investment in capital infrastructure acquisition. to determine regulatory mechanisms that are at the disposal of the energy regulator to ensure that there is sufficient investment in the electricity infrastructure by distributors. to determine the correlation between the financial performance measures used by the energy regulator and the ability of municipalities to invest in capital expenditure (capex). to determine electricity tariffs and revenues that are sufficient for electricity distributors to contribute towards capital expenditure. to achieve these objectives the following questions were developed: what is the role of regulation in facilitating investment in capital infrastructure acquisition? what regulatory mechanisms are at the disposal of the energy regulator to ensure that there is sufficient investment in electricity infrastructure by distributors? what is the correlation between the financial performance measures used by the energy regulator and the ability of municipalities to invest in capex? are electricity tariffs and revenues sufficient for electricity distributors to contribute towards capital expenditure? literature review this section discusses various literature concepts, theories and practices that are relevant to the topic under review. literature relating to electricity distribution and investment, challenges to infrastructure regulation and investment were discussed. electricity distribution and capital investment the national government discloses several challenges faced by the distribution sector in south africa. these include backlogs in infrastructure investment in maintenance and expansion, fragmentation in terms of investments, inadequate budgeting and management practices and lack of skills and human capital (palmer et al. 2016). infrastructure investment is the expenditure to purchase, replace or construct fixed assets or facilities that will provide a service for more than a year. these are fixtures such as buildings, land, streetlights and transmission lines (mahabir & mabena 2015). according to the south african local government association (2018), the country’s distribution infrastructure is very old, with some of the assets older than 40 years. the financial and fiscal commission (2013) estimates that investment in electricity infrastructure is insufficient and only 60% of what is required for adequate investment has been invested. this is equivalent to r10 billion in underinvestment per annum since 2011. palmer et al. (2016) put the electricity infrastructure investment backlog at 43% by 2016. this lack of investment has led to increased localised blackouts that impact on economy and livelihoods of many citizens. some of the reasons put forward for insufficient investment were lack of skills and institutional capacity within municipalities to spend the allocated funding on infrastructure projects. the financial and fiscal commission stated that local government was responsible for infrastructure worth r1.2 trillion in 2012, of which electricity infrastructure accounted for r398 billion. the report also estimated the backlog to be between rzar 8 billion and r41 billion per annum. a report by the development bank of southern africa (2012) estimated that between 2013 and 2023, municipalities would require an investment of r176 billion in electricity infrastructure, 15% of which will be channelled towards addressing backlogs, 42% towards catering for the expected growth, and 43% to rehabilitating existing infrastructure (palmer et al. 2016), as shown in table 1. eberhard (2012) estimated the investment backlog in infrastructure to be growing at r2.5 billion per annum. table 1: projected 10-year capital investment in municipal infrastructure. the department of energy (doe 2015) of south africa acknowledged that the demand for electricity has been increasing and capital investment was required to meet the demand from agriculture, commerce and industrial customers. a balance is needed between the construction of a new infrastructure and refurbishment of the existing infrastructure. according to de beer (2016), distribution companies should be investing at a rate of 10% of asset value per year; however, current investment is at 1% – 2%. even though electricity infrastructure budgets have increased, they are not increasing at a pace required to reduce backlogs. most municipalities’ capital budgeting capacity is weak as municipalities’ budget is over the short term instead of long-term planning. the quality of planning is poor, resulting in under expenditure on capex budgets (national treasury 2015). challenges to infrastructure investment in electricity distribution at global level, fewer countries can afford to fund fully public acquisition of energy infrastructure. investing in distribution infrastructure poses several challenges and risks. this is because governments must choose which projects to finance, subject to limited resources. often, they choose to exit the energy sector and surrender it to the private sector and instead focus on projects that are less attractive to private investors (statham 2008). additionally, emerging countries have challenges to attract investment because of perceived risks associated with investing in these countries. stratham (2008) stated that the electricity industry is moderately capital intensive with payback periods of 10–20 years. the points of production and consumption are far apart, creating a geographical imbalance. access to deep rural areas exacerbates the situation and increase the cost of distribution. mahabir and mabena (2015) identified funding constraints to municipal investment and discovered that local economic circumstances and internal municipal planning ability are the primary drivers of the ability of municipalities to make their own contributions towards capital infrastructure investment. municipalities with high unemployment, for example, have a lower contribution of own revenue towards capital infrastructure investment. municipalities that have better management abilities, as measured by the financial audit performance, are more likely to contribute revenue towards capital infrastructure investment. this is because they can prepare budgets, determine their capital costs and be able to design tariffs to fund capital needs. the financial and fiscal commission (2013) stated that municipalities scored less than 50% in asset management in 2012. asset management refers to all the facets of acquisition, maintenance, refurbishment, disposal and replacement of an asset. the main finding of the report was that municipalities were not aware ‘of the assets at their disposal, the value and specifications of those assets, their location, composition, physical attributes, and maintenance needs of the assets’ (financial and fiscal commission 2013:5). the centre for scientific and industrial research (2007) contended that one of the reasons for backlogs in electricity infrastructure refurbishment by municipalities was database deficits for municipal assets. the government has embarked on several initiatives to assist municipalities in addressing the infrastructure-related challenges facing them. these include the establishment of a president’s infrastructure coordinating committee (picc), the establishment of municipal infrastructure support agency (misa), as well as the approach to distribution asset management (adam) programme. the adam is a multiyear initiative intended to assist municipalities with maintenance and refurbishment of key electricity infrastructure. the national government is also assisting with the provision of conditional grants, such as the infrastructure skills development grant (national treasury 2017). there are three main sources of funding for capital expenditure in south africa: municipal taxes and tariffs, intergovernmental fiscal transfers and municipal borrowing. tariffs are considered the best option to fund operating and capital expenditure, including maintenance, metering and connection costs, and a return on investment and profit (mahabir & mabena 2015). the funding for electricity infrastructure has largely been done through municipal infrastructure grants (mig), which are conditional grants from the national government, as well as international organisations such as the european union, the world bank, and united states agency for international development (usaid), and the german development corporation. municipalities still largely depend on government transfers to finance capital expenditure. over the 2015 medium term expenditure framework, r313.7 billion was transferred directly to municipalities, while r31.9 billion was transferred as indirect grants. only 22% of capital budgets for municipalities came from their own revenue (national treasury 2015). eberhard (2012) suggested that one of the ways to address the infrastructure backlog include the need to focus on the municipalities that make the biggest contribution towards the electricity distribution by applying the 80:20 principle. this means focusing on the 20% of municipalities that contribute 80% of the electricity distribution. the study also contended that revenues, accounts and assets from electricity be ring-fenced from other municipal businesses. the role of the regulator should be to establish national norms and standards for minimum electricity infrastructure. the national energy regulator of south africa (nersa) can also recover revenues from municipalities that are not spending on infrastructure upgrades. according to de beer (2016), one of the challenges facing the south african edi is the lack of skills to carry out repairs, maintenance and infrastructure refurbishment projects. this is exacerbated by the prohibitive costs of upgrading and expanding training facilities, severe shortage of qualified technical instructors and shortage of workplace assessors and mentors. (de beer 2016). voss et al. (2018) asserted that the constitution makes provision for municipal electricity reticulation and administration. the white paper on energy (2008) requires that electricity reticulation must be linked to municipalities’ infrastructure investment plan by incorporating it into the electricity master plan, in the municipality’s integrated development plan (idp), and municipal budgeting process. the infrastructure master plan forms the basis for the development of bulk municipal electricity infrastructure. the plan is part of the idp and capital funds are allocated annually in accordance with the approved idp (zietsman 2014). intergovernmental transfers are suitable for the provision of capital assets that spill over into more than one municipal jurisdiction and where costs cannot be assigned to individual users. there are two types of intergovernmental transfers: general purpose (unconditional) and specific purpose (conditional). capital expenditure is normally funded through conditional grant (mahabir & mabena 2015). according to the south african national treasury (2017), municipalities are allocated a share from revenue raised by national government through the division of national revenue act (which is approved every year for the implementation of the annual budget). the purpose of the equitable share for local government is to assist municipalities fill the fiscus gap to provide basic services and perform functions allocated through section 227(1) of the constitution (national treasury 2016). electricity distribution regulation and investment according to stratham (2008), regulation plays a pivotal role in attracting investment to the energy sector. the primary role of regulation is to oversee and define the context around the organisation of the energy sector. regulation also protects and balances the interest of both the investor and the consumer over the short term and long term (stratham 2008). the regulatory mechanism and institution should strive to bring stability and efficiency over the long term. this system should also be transparent, predictable and independent, and ensure that regulation occurs at generation, distribution and transmission levels. some of the mechanisms to ensure this are licensing and putting in place predictable and cost reflective tariffs (doulet 2016). this view was supported by felsmann (2013)’s assertion that a clear and transparent regulatory framework was necessary to support the implementation of tariffs that promote new investment in the electricity distribution sector. according to khan (2018), there are two types of regulatory methodologies: performance based or incentive regulation, which is based on rewards and penalties to induce good performance, and hybrid approach, which uses a cost-plus approach but specifies certain normative parameters such as benchmarks. khan (2018) defined performance-based regulation as regulation that encourages licenses to be efficient by regulating, for instance, quality of service, plant load factors, transmission and distribution losses, operation and maintenance expenses and outages. there are three types of performance regulation: rate of return, price cap and revenue cap regulation. rate of return sets the price level based on a fair return of the cost of capital. price cap regulation uses a formula to determine the maximum allowable price increase for a product or basket of products over a fixed period. revenue cap allows a firm to change prices if the revenue did not exceed cap. doulet (2016) also added another method to regulate tariffs: cost indexation, which links the price of tariffs to specific input costs such as commodities. this method is usually utilised with some other method, creating a hybrid method. according to egert (2009), the regulatory regime that is adopted has an impact on investment decision of firms. it may lead to either underinvestment or overinvestment. this view is supported by cullmann and nieswand (2015) who postulated that empirical studies show that rate of return regulation can lead to overinvestment or underinvestment in certain instances. firms may choose to underinvest if the timing of regulation is too short to allow the recovery of investment costs. firms may also choose not to invest, to delay investment or invest sequentially under conditions of regulatory uncertainty. the use of ex-post rather than ex-ante information in the decisions on the inclusion of assets in the regulator base may also impact on the decision to invest. nezlobin, raja and reichelstein (2012) agreed that rate of return does not allow for the implementation of prices and quantities that are close to the marginal cost pricing, due to the fact that prices are often higher that the welfare maximising price. this is attributable to the fact that fixed historical costs are not aligned to long-run marginal costs. alexander and irwin (1996) stated that price cap regulation was assumed to encourage utilities to be more efficient because businesses are incentivised to lower their costs because they can keep their cost savings; however, they are exposed to more risks should the cost rise dramatically. felsmann (2013) stated that empirical evidence has also shown incentive price regulation was effective in eliminating short-run cost inefficiencies. it may lead to depressed investment if the regulatory cycle is not long enough to break even or if the regulator sets unrealistic targets or revised the targets before the end of the cycle. firms would shift this risk to consumers through higher required rate of return and higher cost of capital. however, if regulation allows opportunities to generate higher profit by investing in cost-reducing technologies, utilities will invest to upgrade existing infrastructure. the non-confidential information on processes and operation of each municipality should become available to consumers and should be monitored by the energy regulator. consumers should have access to information pertaining to the electricity tariff detail, the cost structure of the electricity distribution network, outage performance, backlogs and investment plans (kaziboni, rustomnjee & steuart 2018). eberhard (2006) concurred in that one of the goals of economic regulation is investment and extension of service. it also ensures that infrastructure investment is enabled and ensures that goods and services are provided in a cost-efficient, fair and sustainable manner. tariff setting should improve operational management and private sector investment through transparent decision-making. regulation of the electricity sector in south africa is the responsilility of nersa in respect of the licensing of electricity providers and the regulation of electricity tariffs (palmer et al. 2016). the south african distribution tariff code that was developed by eskom (2014a) and approved by nersa stated that the design of distribution tariffs and connection charges should take into account the need to recover the regulated revenue requirement in the most cost-effective way so that a business is financially viable and customers are provided an acceptable level of service. the code also stated that distribution tariffs should be designed in a way that allows for the recovery of annual interest and depreciation on invested capital employed to provide the existing network, as well as a return on assets. between 2009 and 2012 municipalities increased their surplus on electricity by r7.3 billion, an increase of 68% in real terms. municipal tariffs are regulated by nersa through the annual guideline and benchmarks that are published and used to determine increases applicable to electricity distributors. the guideline increase is determined from eskom’s approved bulk increase to municipalities and an increase to municipalities’ cost structures. the average cost structures and benchmarks are determined from a stratified random sample of municipal information from distribution forms (d-forms) submitted by municipalities every year to nersa (nersa 2018), who determines the average cost structure for eds. the average cost structure shows that municipalities expended 74% of their revenue on bulk purchases, 10% on salaries and wages, 6% on repairs and maintenance (r&m), 5% on capital charges and 5% on other costs. capital charges are expended on debt repayments for municipal repairs and capital infrastructure investments. nersa also determined the financial benchmarks that municipalities must comply with and expects eds to ensure that their costs are aligned to this benchmark. tariff applications are assessed against this benchmark (nersa 2018). table 2 shows the financial benchmarks that nersa uses to assess the performance of eds. electricity distributors are expected to utilise 75% of their revenue for bulk purchases, with an acceptable range of 58% – 78%. they are also expected to generate a surplus of between 10% and 20%, keep losses between 5% and 12% and maintain an average sales price to purchase price ratio of 1:1.58 – 1:1.62. the debt collection rate should be maintained at 95%. table 2: electricity distribution cost benchmarks. nersa also produces tariff benchmarks that are based on the average consumption on five tariff categories: residential, commercial, agricultural, industrial and time of use tariffs. electricity distributors that submit applications that are outside the benchmark must provide a motivation and support why these should be kept higher. table 3 shows an example of a tariff benchmark for a domestic inclining block tariff (ibt). distributors are expected to sell domestic ibt at between 83.82c/kwh and 194.85c/kwh. table 3: domestic inclining block tariff benchmarks. kelly (2016) disapproved of benchmarks because nersa does not provide benchmarks for charges such as service charges, network access charges, seasonal or time of use charges. kelly further argued that municipalities also contend that the use of standard tariffs does not consider the cost base of local authorities and customer base mix, which might require cross-subsidisation to occur. where communities have a higher proportion of residential customers, the cost of supplying them might be higher because it requires a higher number of connections. nair, montgomery-clair and rynan (2014) concurred that larger urban municipalities are in a better position to finance refurbishment of infrastructure through borrowing as they have access to capital. rural municipalities must depend on grants as they have a high proportion of poor customers. the south african distribution code by eskom (2014) requires tariffs to be designed in a way that recovers the revenue requirement and that the cost should be allocated into purchase costs, transmission costs and distribution costs. the distribution costs include recovery of annual interest and depreciation on invested capital employed to provide the existing network, allowed operation and maintenance costs, regulated return on assets, other allowed costs, and technical and non-technical losses. muratovic (2017) stated that to recover all these costs, utilities design several tariffs that may be grouped into four categories: connection charges for customer specific requirements that are not shared by customers. demand and capacity charges to cover a portion of the revenue requirement though a price that measures a customer’s maximum demand for electricity. energy charges based on consumption and covers marginal cost of production. fixed charges to cover customers’ monthly specific costs such as billing, metering and service provision. with these tariff components, licensees can recover their operating and capital costs from different customers, depending on network usage. they can also aggregate these costs among their customers. capacity charges and fixed basic charges are ideal for recovering capital costs of electricity distribution. nersa identifies four tariff components: fixed charges, energy charges, time of use tariffs and capacity charges. the electricity pricing policy requires eds to conduct a cost of supply (cos) study every five years or when the licensee has cost structure changes, for example to customer base. the cos framework is based on a cost-plus methodology that allows an efficient licensee to recover its total cost to supply electricity, plus a reasonable return. it also allows licensees to earn a return on investment and depreciation on assets. licensees must, therefore, keep up-to-date asset registers to earn a depreciation and a return (nersa 2016). nersa requires electricity distributors to conduct a cos study as it will form an objective basis to determine tariff increases. very few municipalities have carried out the cos (kaziboni et al. 2018). amra (2013) noted that the cos has a risk of allowing licensees to either over-recover or under-recover their cost if it is not subjected to independent verification and rigorous testing. kelly (2016) stated that only large municipalities have been able to conduct cos because they have the capacity and resources. nersa relies on eskom’s cost base to determine municipal tariffs; nersa also looks at the investments municipalities make into r&m of distribution infrastructure. these should be funded through electricity tariffs (nair et al. 2014). there is a requirement that if the investment in r&m is not aligned to the benchmark of 6% of a municipality’s value of property plant and equipment, it should be substantiated by an explanation. nersa approves applications for tariff increases above benchmarks for municipalities if they are supported by information that the funds would be used for capital infrastructure programmes. these funds must be ring-fenced for use on the intended capex projects. montgomery-clair and rynan (2014) contended that the biggest role nersa plays in infrastructure investment is by giving municipalities an incentive to invest in distribution infrastructure, as well as skills and resources to carry out infrastructure refurbishment projects. this can be achieved through a stakeholder approach that involves the doe and the national treasury. nersa could also introduce norms and standards such as minimum maintenance levels and measures to penalise municipalities that do not spend allocated capex and maintenance budgets. eskom on the other hand is regulated through the multiyear price determination (mypd) rate of return methodology. this method allows eskom to earn a return on its assets, including distribution assets. this allows eskom to earn a return on its regulatory asset base (rab) to allow it to recoup the investment on capital employed (eberhard 2012). for example, in the 2018/2019 revenue application, eskom was allowed rab value of r702 billion, for property plant and equipment, work under construction and working capital. from this rab eskom was allowed a return on assets of r4.3 billion for its electricity distribution assets, as well as depreciation of r5.9 billion on a weighted average cost of capital (wacc) of 4%. this return and depreciation was allowed after an assessment of efficiency and prudency of its capital expenditure programme by nersa (2019). this approach is different from how municipal eds are regulated where they are allowed to spend 1% on finance charges to repay loans and 6% for repairs and maintenance from their revenue from electricity. as discussed above, some of the advantages with this approach are that it ensures that the utility earns a return on investment and reduces the risk for investors by providing certainty to the market. the method also provides a high level of oversight and ensures transparency and due process. however, utilities could overinvest in non-productive assets or gold plate. it is also difficult to determine a fair rate of return using this method (national ports authority 2017). the literature review highlighted the fact that investment in electricity distribution infrastructure is not sufficient; thus, there has been increase in supply disruptions due to backlogs in investment and insufficient repairs. the regulation of municipal eds is based on benchmarks for costs and tariffs. the expectation is that this will allow these licensees to recover revenues to invest in capital infrastructure development projects and earn a surplus. eskom is regulated through a return of investment approach, which allows it to earn a return on assets as well as the depreciation for future asset replacement. this study emanates from a need to investigate if the regulatory methodology in place is adequate to allow for investment in assets. this study is necessary to establish the regulator methodology role in facilitating adequate investment in distribution infrastructure using empirical data. the following section discusses the results of both secondary and primary data collection. research methodology introduction this section discusses the research method used for the study. the role of regulation in supporting infrastructure investment and monitoring the performance of eds was examined through literature review, secondary data collection of distribution data (d-forms, used by distribution licensees when submitting their annual tariff application for approval), as well as interviews with officials involved in analysis and approval of ed tariffs at nersa. the present study was conducted through both primary and secondary methods of research. primary data were collected through interviews with officials of nersa that are involved in analysing and recommending eds’ tariff applications for approval by the energy regulatory board members. interviews are useful to collect data that explain or describe a phenomenon from the point of view of respondents (alshenqeeti 2015). secondary data of financial and technical information of eds were collected and analysed from the d-forms that are submitted by eds as part of tariff applications. these data are used by nersa to analyse tariff applications and to monitor the performance of electricity distribution licensees. the use of secondary data has a potential to reduce the costs of research and to enhance or refute the conclusions derived from primary data. it also helps to entrench the validity of the research if reliable data sources were used (nicholson & bennett 2008). data collection data were collected using both qualitative and quantitative methods. statistical data were collected from the six metropolitan d-forms and 106 local municipalities and the interviews were conducted with 10 nersa officials. quantitative data were collected through a stratified sample of municipal eds in south africa. nersa’s records stated that there were 168 such municipalities in south africa in 2016/2017. the present study then stratified these municipalities and categorised them based on size of the population within each municipality, as presented in table 4. table 4: population sampling. a municipality was selected from each population group for each province to ensure a representative sample of municipalities. a total of 112 municipalities were selected for this study. south africa also has eight metros; a metro was selected from each province for inclusion into the list based on the population parameters. six metros were selected in total, as depicted in table 5. table 5: sample from the list of metropolitan municipalities. eskom sold 81 000 gwh to municipalities. the municipalities selected, represent 73 000 gwh, 90% of the municipal consumption for 2016/2017. secondary data were collected through interviews with the officials of nersa that are involved in the monitoring of eds and approval of tariffs. these officials are organised into six clusters covering eds throughout south africa. each cluster consists of a senior analyst that is in charge of a cluster and 3–4 analysts within each cluster. a total of 16 respondents participated from all six clusters, representing 67% of all analysts and senior analysts in the clusters. ethical consideration this article followed all ethical standards for carrying out research. discussion of the results introduction this section provides an analysis of primary and secondary data. saunders et al. (2016) stated that quantitative data need to be interpreted and analysed to provide meaningful results to a reader, as unprocessed data give no meaning to the users. in quantitative method there are various analysis approaches including graphs and tables to help in examining relationships and trends of data for better presentation of information. findings and analysis correlation analysis table 6 provides a summary of the revenue from the sale of electricity of the sampled eds. the minimum revenue earned by the smallest ed in 2016/2017 was r20.3 million, and the maximum was r16.03 billion. the average revenue was r79.7 million, as depicted in table 6. table 6: summary of revenue from the sale of electricity. table 7 summarises the financial performance of eds. table 7: financial performance indicators (2016/2017). the average surplus for the eds in the study was −2.5%. nersa’s benchmark requires the surplus to be in a range of 10% – 20% to be acceptable. this means that the eds are not generating enough surplus to invest in capex. this is in spite of the fact that the mark-up they are allowed from electricity tariffs is 57%, slightly below the benchmark range of 58% – 62%. the low surplus can be attributed to the fact that the energy losses are higher than the allowed losses at 18.31%, against a range of 5% – 12%. the surplus amounts of selected eds range from -65% to 40%. the percentage power costs measure how much of the revenue received from customers is spent on electricity purchases in relation to all other costs. if the percentage power cost is within the range, it is an indication that an ed is not subsiding other businesses from revenue from electricity business. this might mean that funds that should be used for infrastructure investment are not redirected to other services. the average power cost was 68% against a benchmark of 58% – 78%. the average selling price was 139c/kwh for 2016/2017. the average sales price to average purchase price ratio is 1:1.58 – 1:1.62. electricity distributors are expected to spend at least 6% of their budget on r&m. the average expenditure on r&m for 2016/2017 was 7.4%. the researcher tried to establish if the financial performance data collected from the sample could be used to perform certain statistical analysis to assess, for instance, if there is any correlation between the variables. the researcher also tried to investigate whether the data set could be used to predict certain trends, by predicting a relationship between variables. as table 8 depicts, there is a strong negative correlation between surplus and energy losses, which means that when losses increase, the surplus decreases. the analysis also established that there is a weak negative correlation between revenues collected and r&m investment, which means that on a small scale eds that collect higher revenues do not necessarily spend more on r&m. lastly, there is a weak negative correlation between revenues and losses, which means that on a small scale eds that have higher revenues just experience lower losses. table 8: pearson’s correlation. primary data collected suggest that there is almost no correlation between the numerous financial benchmarks that are used to assess the performance of eds. for example, there is almost no correlation between energy losses and the revenue size of eds. this means that even though eds with large revenues might be expected to have resources to address losses, this is not necessarily the case, as depicted in table 8. the researcher also tried to test other variables such as surplus and r&m, power purchase costs and r&m, and losses and r&m. the statistical analysis of these variables showed that there is a low correlation between these variables and a relationship between them could not be established. the researcher also conducted a regression analysis to ascertain if any of the financial variables can be used to predict any of dependent variables, for example whether revenues of the ed can be used as a predictor of investment in r&m. none of the results was sufficiently significant to be included in the study. interview analysis in this article, an interview was conducted with nersa officials of different ages, genders and areas of employment (technical and financial employees). interview data were coded and interpreted using descriptive codes that emanated from responses. in vivo descriptive codes come directly from statements of respondents and are based on an analysis of common statements from subjects or are common phrases found in statements being examined (cope 2010). from these common phrases key emerging themes were analysed. these are summarised below. respondents were asked if nersa monitors the investment of eds in capital expenditure. respondents stated that licensees are expected to submit regulatory financial reports as part of their application for annual tariff increases based on bulk purchase increase from eskom. respondents stated that they are aware of the existence of infrastructure backlogs in eds under the cluster as evidenced by the regular power outages and interruptions that occur in some of the eds in their clusters. respondents also stated that the financial benchmarks used by nersa do not provide for licensees to earn a return on assets. they are allowed a mark-up on purchases from eskom thus allowing them to earn a surplus. this is because eds do not have up-to-date regulated asset registers that would allow them to earn a return and depreciation on their assets. respondents were asked if the tariffs are cost reflective and if licensees can use revenue from sale of electricity alone to meet their infrastructure needs. respondents stated that the tariffs that eds charge are not cost reflective in that they do not allow them to cover their costs and earn a return on their assets. this, they state, emanates from the fact that the financial reports of the eds show that they are not enough to cover their costs and generate a surplus. respondents also stated that it is hard to determine that eds are not generating a surplus because they have not concluded the cos studies that are required by nersa. therefore, without these studies, cost reflective tariffs cannot be implemented by eds. respondents stated that tariffs alone are not sufficient to ensure that capital infrastructure is maintained and refurbished. that is why there is a need for government funding in the form of migs to finance the acquisition of capital assets. electricity distributors are also allowed to apply for above average tariff increases to finance capital infrastructure acquisition. once nersa grants this increase, the funds should be ring-fenced for specific asset acquisitions, for example substations, transformers or 11 kv lines. respondents were asked how nersa monitors the information submitted on r&m expenditure. respondents stated that nersa required licenses to report annually on their r&m budget to ensure that they spend a minimum of 6% of their revenue from the sale of electricity on r&m costs, both material and labour. respondents stated that r&m could be of a short-term (operational) or long-term nature (capex). the energy regulator does not the capacity to distinguish between short-term refurbishment and capex in the current regulator reporting methodology. respondents stated that an accurate measure for r&m efficiency is an ed’s ability to reduce energy losses. recommendations it was found that nersa relies on information provided by distributors in making decisions thereby performing its role of regulation in facilitating investment in capital infrastructure acquisition. it is therefore recommended that data that nersa rely on when making decisions that facilitate investment in capital expenditure are accurate and reliable. electricity distributors must develop a cos study to achieve a cost reflective tariff to enable them to invest in infrastructure expansion and refurbishment. electricity tariffs are not sufficient for electricity distributors to contribute towards capex. it was found that tariffs alone are not the only mechanism to ensure that capital infrastructure is maintained and refurbished. it is therefore recommended that other mechanisms such as infrastructure finance grants be considered to facilitate investment in capital infrastructure. it was found that when losses increase, surpluses for distributors decreases. it is recommended that distributors comply with financial performance measures used by nersa to be able to invest in capital investments. conclusion benchmarks determined by nersa assist in ensuring that eds are efficient in their operations so that through the surpluses they generate, they can invest in the acquisition of new capital infrastructure. benchmarks provide a yardstick to measure performance of regulated entities; however, for earning a return on assets, benchmarks alone are not sufficient. the regulator is in the process of implementing cos studies that will allow eds to earn a reasonable return to be able to generate revenues to invest in new assets. electricity distributors also need to address and reduce high-energy losses, as they are an obstacle towards the collection of more revenue to allow for more capital investment. the role of regulation in facilitating capital investment is important to ensure the financial sustainability of electricity distributors and thereby achieve security of supply in south africa. the energy regulator in making its decision needs to rely on credible and accurate information provided by electricity distributors. municipal infrastructure grants need to be considered for infrastructure expansion at municipal level since tariffs alone are not sufficient to enable the capital investment. these grants are conditional in nature and are gazetted based on registered capital projected. this article focused on the role of regulation in investment in electricity distribution capital infrastructure in south africa. further study is suggested to be conducted in the following areas: the role of cos to achieve cost reflective tariffs. impact of non-technical losses on municipal surpluses. impact of technical losses on municipal surpluses. the rise of renewable energy and their impact on the electricity supply in south africa. relevancy and adequacy of an infrastructure grant in financing capital expansion. acknowledgements the national energy regulator of south africa made it possible for this study to be conducted. competing interests the authors have declared that no competing interest exists. authors’ contributions all authors contributed equally to this work. funding information this study did not receive any specific grant from any agency in the public, commercial and not-for profit sectors. data availability statement the data used for this study are available for sharing. disclaimer the views and opinions expressed in this article are those of the authors and 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management, jiangsu university, zhenjiang, china school of business and management studies, bolgatanga technical university, bolgatanga, ghana zhiqiang ma school of management, jiangsu university, zhenjiang, china mingxing li school of management, jiangsu university, zhenjiang, china oswin aganda anaba school of management, jiangsu university, zhenjiang, china school of applied science and arts, bolgatanga technical university, bolgatanga, ghana nelson amowine school of management, jiangsu university, zhenjiang, china weijun hu art college, jilin university, changchun, china citation asunka, b.a., ma, z., li, m., anaba, o.a., amowine, n. & hu, w., 2020, ‘assessing the asymmetric linkages between foreign direct investments and indigenous innovation in developing countries: a non-linear panel auto-regressive distributed lag approach’, south african journal of economic and management sciences 23(1), a3496. https://doi.org/10.4102/sajems.v23i1.3496 research project registration: project number: 7167031130;18glb024 original research assessing the asymmetric linkages between foreign direct investments and indigenous innovation in developing countries: a non-linear panel auto-regressive distributed lag approach benjamin azembila asunka, zhiqiang ma, mingxing li, oswin aganda anaba, nelson amowine, weijun hu received: 17 dec. 2019; accepted: 18 sept. 2020; published: 21 dec. 2020 copyright: © 2020. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the contributions of indigenous innovation and foreign direct investments (fdi) inflows are critical elements of economic growth and hence very important for developing economies. fdi inflows have been recognised as having a direct influence on innovation in host countries. the relationship between these two variables is explored and well documented in literature. however, these studies have focused on linear relationships between fdi and indigenous innovation, ignoring a possible asymmetric relationship between them. aim: the current study aims to analyse the existence of hidden cointegration and asymmetries between the two variables using a non-linear approach. setting: the focus of this study is on developing countries. five countries are selected from the regions of africa, asia, europe and south america. these countries are chosen on the basis of economic status (all countries are developing countries) and data availability. methods: the study employs panel data of 20 developing countries from 1993 to 2017. the study employs the non-linear auto-regressive distributed lag model to test for an asymmetric relationship between the variables. the variables are deconstructed into their negative and positive components to identify possible hidden cointegration and asymmetries that exist between them. this method allows for the detection of long-run asymmetric relationships in a non-linear fashion. results: the empirical findings show that a long-run cointegration and asymmetric relationship exists between the negative and positive components of fdi and indigenous innovation. for the four regions, positive changes in fdi directly influence positive changes in indigenous innovation. negative changes in fdi have no effect on the positive changes in indigenous innovation in the countries under study. however, negative changes in fdi influence negative changes in indigenous innovation across the four regions. conclusion: fdi inflows have a positive and significant effect on indigenous innovation in developing countries, and reduction in fdi can lead to reduction in innovation output in the long term. policy directions in developing countries will be effective if they are centred on non-linear relationships between the investigated variables. keywords: indigenous innovation; fdi; asymmetric cointegration; non-linear panel auto-regressive distributed lag model; developing countries. introduction indigenous innovation, which involves innovation by the domestic firms of a country, is continually advocated as a main driver of the economic growth of developing economies. this phenomenon promotes technological innovation which is identified as a key component of industrialisation (intarakumnerd & goto 2018; rodrigues & da costa 2018). industrialisation driven by indigenous innovation is a major determinant of sustainable economic growth in developing countries. studies on the effect of foreign direct investments (fdi) on innovation were pioneered by caves (1974), and since then several scholars have reported that fdi facilitates innovation in developing countries (awate, larsen & mudambi 2015; howell 2019; maurer 2017; qin & du 2017; shamsub 2014; tan & mathews 2015). one limitation of those studies is that they measure the relationship between fdi and indigenous innovation using linear methods, ignoring the hidden cointegration and asymmetric relationships that may exist between the variables. in an attempt to fill this gap, there is the need to investigate the non-linearities between the two variables, which is the main issue addressed in this study. trade openness is a factor that encourages fdi in many economies (kumari & sharma 2017) and technology transfer that comes with fdi benefits developing countries. fdi is an investment involving a long-term relationship in which a foreign entity (foreign direct investor) has a lasting interest and control of an enterprise resident in a country (foreign affiliate) other than that of the foreign direct investor (unctad 2007). two key words are at play in this definition: lasting interest and control. fdi comes in the forms of private capital and portfolio equity investment. private capital implies investments with long-term prospects, while portfolio equity investment is done mainly in the short term. the concept of control occurs when the foreign investor has a minimum of 10% shareholding in a foreign affiliate. according to moosa (2002), fdi comes in three main forms: (1) the greenfield which is an investment made ‘from scratch’, to create a completely new enterprise. this type of investment helps in creating jobs and, hence, knowledge spillovers. (2) joint ventures are investments made by a foreign entity in conjunction with a domestic entity or public institutions. this form of fdi brings expertise with technical and financial skills that can benefit local enterprises in the long term. (3) mergers and acquisitions involve a change of ownership of the existing enterprise. this involves buying, selling and combining enterprises to form new businesses. the theoretical bases of knowledge spillovers and other benefits of fdi to domestic businesses are founded in the works of several scholars including those of ohlin (1952) and hymer (1976). hymer argued that fdi activities came about as a result of the existence of imperfect market conditions in different countries which facilitated international trade among countries. this argument is based on the concept of factor proportions which distinguishes between factor endowment structures and trade arrangements. these concepts focus on how trade impacts on the income levels of residents in the countries involved. ohlin posited that fdi is promoted where a capital-abundant country exports capital-intensive goods, while a country that abounds in labour will export labour goods. this implies that countries that are less endowed in some resources stand to benefit from foreign investors from countries where such resources abound. these perspectives mean investors will be looking at increasing profitability opportunities, hence investing in countries where they can have access to cheaper capital resources. hymer further stated that foreign investors can be successful if they can compete effectively with domestic companies. the second condition is that the market must be an imperfect one. razin and sadka (2012) argued that foreign investors are motivated to invest in projects where they have comparative intangible skills. with superior managerial skills, foreign investors can occupy top levels of management where their specialised skills are required. these ideas mean that developing economies can benefit from technologies and technical skills that are lacking in the domestic market. from knowledge spillovers and technologies that come with foreign investors, domestic businesses in these economies can generate knowledge that will lead to the production of novel technologies to solve domestic problems and those in foreign countries. kastrati et al. (2016), among other scholars, have made strong arguments that fdi has a positive effect on indigenous innovation. zhao et al. (2019) opined that multinational enterprises (mnes) transfer technical know-how to their host markets by offering training to local employees who then absorb and leverage knowledge to spur innovation in domestic firms that they later get involved in. with this notion, several developing countries have sought to attract more fdi inflows by offering incentives to foreign investors in a bid to attract them into the local market. these incentives vary from tax to non-tax benefits offered to mnes to invest in the host market. knowledge spillovers from mnes benefit local firms in the medium to long term in their innovation efforts. mnes bring with them vertical technology spillovers between local and foreign suppliers that seek to serve the same customers through direct and indirect imports. moreover, many researchers have found a significant and positive effect of fdi on indigenous innovation efforts by developing countries. fu and gong (2011) opined that fdi has been a bedrock for the diffusion of foreign technology from technologically advanced countries into less developed countries. hence, imports into developing countries associated with fdi activities create ‘escape competition’ that leads to indigenous innovation (seenaiah & rath 2018; shu & steinwender 2019; xie & li 2018). medina (2017) posited that import competition could bring about product upgrading opportunities, and local firms will react to changing preference by leveraging existing factors to produce new products (bloom, draca & van reenen 2016). studies show that in the aftermath of trade liberalisation, innovation efforts have been on the increase with foreign goods flooding local markets. this is evident in most studies done in latin america (fernandes & paunov 2013; iacovone 2012; iacovone, keller & rauch 2011). in contrast, some studies found that fdi suppresses indigenous innovation in developing countries. these negative findings were reported by aitken and harrison (1999) for venezuela, hu and jefferson (2002) for china and barasa et al. (2019) for sub-saharan africa. the oecd (2002) reported that domestic firms’ innovation efforts in developing countries may be reduced by competition from foreign subsidiaries. moreover, multinational firms might not open up for local firms to benefit from the technical know-how they possess due to lack of effective links with local firms (seenaiah & rath 2018). tian (2007) argued that foreign firms jeopardise the growth of indigenous innovation due to market-stealing and skill-stealing effects. it has also been argued strongly that developing countries are unable to diffuse new technologies due to lack of skilled human resources (fu, pietrobelli & soete 2011). acemoglu (2002) opined that this negative impact could stem from the fact that foreign technologies largely come from developed countries while domestic businesses lack the capacity to utilise these novel technologies. the above literature shows that findings on the relationship between fdi and innovation have been mixed, leaving the question of asymmetries between the variables unanswered. the aim of this study, therefore, is to bring to the fore the asymmetric linkages between fdi and indigenous innovation in developing economies around the world. this study goes beyond the linear relationship between the two variables by digging out how increasing and decreasing fdi inflows influence innovation output registered by residents of the countries studied. studying asymmetric relationship is essential to finding any cointegration that may be hidden in some components of the variables. the development of this methodology is spurred on by the fact that linear models are restrictive and therefore unable to reveal such hidden relationships. based on this, shin, yu and greenwood-nimmo (2014) proposed a bivariate asymmetric cointegration model in which the variables are decomposed into their negative and positive components. their non-linear dynamic model simultaneously models asymmetries and the underlying long-run relationships in the variables. the model further derives an error correction term associated with the asymmetric cointegration regression, producing the non-linear auto-regressive distributed lag (ardl) model. the relationship between these decomposed components is tested wherever the variables are found not to be cointegrated in a linear form. non-linear methods have been applied in several contexts to study relationships between variables, including energy and economic growth (araç & hasanov 2014; bayramoglu & yildirim 2017; kouton 2019; ndoricimpa 2017), economic production (burke, hsiang & miguel 2015), corporate social responsibility and financial performance (nollet, filis & mitrokostas 2016), oil prices and implied volatilities (lin, liang & tsai 2019), credit ratings announcements and financial market development (li et al. 2019). hence, this study finds the non-linear ardl an appropriate model to test the asymmetric relationships between fdi and indigenous innovation. interestingly, previous studies have focused mainly on the linear relationship between the two variables leaving a vacuum in the potential non-linear relationship that may exist between them. the current study contributes to literature in this area by addressing two main issues: firstly, it tests for hidden cointegration between the two variables to reveal any long-run cointegration between their negative and positive components. secondly, it tests for asymmetric relationships between the variables by analysing the effect of increasing and decreasing levels of fdi on the variations in indigenous innovation. the study is further organised in the following order: an explanation of the methodological approach adopted, results and conclusions. materials and methods to achieve the objective of this study, we use the non-linear panel ardl model to analyse the possible asymmetric relationship between fdi and indigenous innovation. to analyse this model effectively, we first analyse the stationarity of the data using the pesaran (2007) cross-sectional ips (cips) test for the unit root which takes into account cross-sectional dependence (cd) in the data. further, a test for both symmetric and asymmetric cointegration is carried out on the variables, and finally the non-linear panel ardl is estimated for whole panel and separately for each continent. data data for this study are taken from the world development indicators by the world bank group (www.data.worldbank.org/indicator). the data cover 20 countries across the regions of africa, asia, south america and europe for the period between 1993 and 2017. five countries are taken from each region. these countries are chosen on the basis of economic status (all countries are developing countries). the sampled countries are all middle-income countries (both upper and lower middle income). the sample includes five countries from africa (egypt, morocco, algeria, tunisia and south africa), five countries from asia (china, india, pakistan, philippines and sri lanka), five countries from europe (bulgaria, russia, slovenia, ukraine and moldova) and five countries from south america (brazil, argentina, columbia, ecuador and peru). the reasons for capturing both upper and lower middle-income countries is data availability. data on patents registered by residents of developing countries are very scant, hence a major constraint. secondly, the study sought to include countries that are performing very well in innovation in their respective regions following classifications by cornell university, insead (2019). study variables the two main variables used in this study are indigenous innovation and fdi inflows. indigenous innovation is made up of the number of patents and trademarks registered by the residents of each country under study. following several other studies, patents and trademarks are used as a proxy for innovation, and those registered by the residents of a country are used in this study for indigenous innovation. patents have been largely used as a proxy for innovation in extant literature (burhan, singh & jain 2017; clancy et al., 2020; crosby 2000; lv, qi & dong 2020). trademark applications are also increasingly being used as a proxy for product and service innovations in extant literature (block et al. 2014; gotsch & hipp 2012; schautschick & greenhalgh 2016; yoshioka-kobayashi, miyanoshita & kanama 2020). a summary description of the variables and data is captured in table 1. from the descriptive statistics, it can be observed that the combined investments in fdi, as well as indigenous innovation by asian countries are the largest. african countries registered the least amount of fdi inflows and the lowest maximum number of innovations for the period under study, perhaps an indication that fdi inflows do have a positive influence on the innovation efforts of indigenous firms in developing countries. however, selected countries for europe and south america registered almost the same amount of fdi inflows, but the number of innovations churned out by south american countries is higher than that of europe. these dynamics further demonstrate that there could be asymmetries between the two variables that a simple linear analysis will not capture. table 1: summary statistics of data. unit root analysis a check for stationarity of the data is done by conducting a unit root analysis. the rationale for testing data for stationarity is to be sure that there is no form of shock that would throw the series out of its long-term equilibrium. to achieve this, the cips test (pesaran 2007) is used. this method is particularly suited for a study of this nature with heterogeneous panels since it accounts for cd effect within the data. the null hypothesis of this test is the presence of a unit root against the alternative of a stationary series. the cips test is based on the following formula: δyit = yit – yit−1; yit is an ith item observed at time t, αi is the intercept and bi is the parameter of yit-1.υifi represents the cd element where υi is a factor that is common to all cross-sectional units i, and fi is the latent factor, while εit is the error term. negative values for bi are to be expected where there is an absence of the unit root. the test hypothesis is defined as: the outcome of the unit root test will give a clue as to whether the relationship between indigenous innovation and fdi is temporary or permanent. if the variables are stationary, then fdi can be said to have a transitory effect on indigenous innovation, wherever the variables return to their long-term equilibrium after any shock. in the presence of a unit root, there will be indication of a permanent effect between the variables. however, in the presence of a unit root and a subsequent cointegration between the variables, then the effect will be temporary; if there is no cointegration in this case, then any effect will be permanent. cointegration analysis prior to testing for causal relationships between the variables, it is important to first test for cointegration between them in order to determine the nature of the relationship that exists. this study begins the cointegration analysis by first testing for linear cointegration, and proceeds to test non-linear cointegration. the latter test demands that the variables be decomposed into their positive and negative elements for an effective test of non-linear cointegration. like the unit root test, cd in the variables needs to be considered in the test for cointegration, hence the panel cointegration test by westerlund (2007) is adopted for this purpose. this test produces four test statistic results of possible cointegration between the variables. firstly, there are the ga and gt tests which test for cointegration in at least one cross-sectional unit based on the null hypothesis of no cointegration. a rejection of this null hypothesis, therefore, means cointegration exists in at least one of the cross-sections. secondly, there are the pt and pa tests which test for cointegration for the panel as a whole; the null hypothesis is no cointegration, and a rejection of this hypothesis shows there is cointegration between the variables in the whole panel. the cd element is computed using bootstrap replications to produce robust p-values for assessing the null hypothesis. the next step in the test for cointegration is to test for asymmetric cointegration between the panels. this test is conducted on the negative and positive components of the variables to test for the any hidden links between them. hence, this test is referred to as hidden panel cointegration, because it assumes that no cointegration exists between the variables themselves but between their hidden properties. these hidden dynamics would not be obvious in a linear test but do exist in an asymmetric manner. asymmetric cointegration is tested when the series are integrated at order one. hatemi-j (2014) proposes that the variables y and x can be decomposed into their positive and negative components as follows: following hatemi-j (2020), the cointegration equations can be written as: the positive and negative cumulative shocks are integrated if the residuals and are stationary. non-linear panel auto-regressive distributed lag numerous studies have used the ardl model to test relationships among various variables. common among them is the test of the relationship between fdi and other economic variables in various settings. the non-linear ardl which was proposed by shin et al. (2014) has also gained popularity in extant literature that tests the relationship between various macroeconomic variables. this method allows for the detection of long-run asymmetric relationships in a non-linear fashion. the test allows for decomposition of the dependent variable into its negative and positive components, while the variable is simultaneously tested in the same equation in its normal form. this test of dynamic panels has been found to also be appropriate for large t panel data modeling (salisu & isah 2017). the following equation is specified to test the asymmetric relationship between the two variables (kouton 2019). y is the dependent variable (indigenous innovation) and x is the independent variable (fdi). both variables are estimated in their logarithm form: µi and εit represent the country-specific effect and error term, while the lags of the variables are represented by the notations р and q. the long-run asymmetries are captured by and while the short-run asymmetries are captured by and . the asymmetric relationship is then tested by separating the impact of positive shocks from negative shocks (hatemi-j 2020; kouton 2019). hence the non-linear panel ardl model is specified as follows: δy+ and δy− represent the increasing and decreasing amounts of indigenous innovation, while δx+ and δx− represent the increasing and decreasing amounts of fdi. if the negative and positive components of the variables are found to be cointegrated, then an error correction representation is estimated as follows: ξit−1 is the error-correction term that captures the long-run equilibrium in the model, while πi is the speed of adjustment time at which the system returns to equilibrium after a shock. after determining that the cointegration exists in the positive and negative components of the variables, it is appropriate to estimate the relationship using the non-linear panel ardl. the error correction term is estimated alongside this cointegration analysis. to achieve this, the study employs the pooled mean group (pmg) or mean group (mg) estimators to estimate the equations. the advantage of these estimators over other econometric tools is that we are able to estimate both short-run and long-run dynamics. in order to determine the efficient estimator between the pmg and the mg, the hausman test is conducted after estimating each equation. the null hypothesis of this test is that there is no vast difference between the two estimators, hence the pmg is the efficient estimator. therefore, a rejection of the null hypothesis will mean that the mg is the efficient estimator and pmg and mg are effective tools for estimating relationships in heterogeneous panels (kouton 2019). the difference in the two estimators lies in how they treat the pooling coefficients. the pmg combines pooling and averaging coefficients in estimating the relationship. the mg on the other hand handles only the averaging coefficients. testing for asymmetric panel causality firstly, the study checks for causality in a linear framework by conducting the panel causality test using the test proposed by dumitrescu and hurlin (2012). the advantage of this test over time-series tests is that it considers both possible heterogeneity and cd. the null hypothesis of this test is that there is no causality from the independent variable to the dependent variable for all the cross-units in the panel. a rejection of the null hypothesis means there exists causality of the independent variable to the dependent variable. secondly, it goes on to test for panel causality test using the asymmetric causality by hatemi-j (2011). the asymmetric causality test is conducted by first decomposing the variables into their positive and negative components. following this, a panel causality test is conducted using a vector auto-regressive model as follows: the asymmetric causality is tested using the wald test. the test is conducted by pairing the positive and negative components of the variables. ethical consideration this article followed all ethical standards for carrying out research without direct contact with human or animal subjects. results test for unit root for a study that deals with large panels, it is necessary to test for cd before proceeding to do the unit root analysis. a cd test is necessary to determine if variations in the variables of one country affect those of another country under study, particularly because there are similarities among these countries. this test is done based on the pesaran cd test; the null hypothesis is cross-sectional independence against the alternative of cd. results of the cd test in table 2 show a rejection of the null hypothesis for both variables, confirming the presence of cd. the results of cd in both variables could be due to globalisation and international trade which make it easy for a shock in one economy to affect other economies as well (nazlioglu 2011). the presence of cd in the variables is good grounds for the use of the cips test by pesaran (2007). the test is conducted at three levels: firstly the model is tested with a constant, secondly without a constant or trend, and thirdly with a constant and trend. the results of the cips unit root test as shown in table 2 indicate stationarity of the variables at first difference on all three lags selected. table 2: results of cross-sectional dependence and unit root tests. cointegration analysis since the data is proven to be stationary at order 1, we proceed to estimate the cointegration between the variables. in this analysis the westerlund (2007) panel cointegration test is used since it takes into consideration the cross-sectional effect in the data which has been established in this study. the robust p-values are generated using 300 bootstrap replications. the results of the cointegration test as captured in table 3 show an acceptance of the null hypothesis of no cointegration between the variables. this outcome gives the grounds for the decomposition of the variables into their positive and negative components in order to perform a further test for asymmetric cointegration between the variables. descriptions of the decomposed variables are shown in table 4. the test for hidden cointegration is conducted on the residuals of the negative and positive components of indigenous innovation and fdi, and results are reported in table 5. first, the decomposed components are tested for cd using the pesaran cd test, the results of which show a rejection of the null hypothesis of no cd. the presence of cd in the decomposed series means the cips pesaran (2007) unit root test is appropriate for detecting asymmetric cointegration between the variables. the null for cips tests is that the series is i(1). the cips test assumes cd in the form of a single unobserved common factor. only the model with trend has been reported here. the test was done using three lags, but only lag 1 is reported in this analysis. the test shows the stationarity of the decomposed at various levels. this evidence of stationarity means there exists long-run cointegration between the variables (hatemi-j 2020). however, this cointegration is hidden because it is not visible in a linear fashion but in a non-linear manner. this result indicates that estimating the relationship between the two variables in a linear form might mean missing some critical aspects of the relationship that are not obvious between the variables themselves, but which exist in their hidden components. the outcome of this analysis gives an indication that an estimation of the relationship can be done more effectively using a non-linear model. table 3: results panel cointegration test results. table 4: description of decomposed variables. table 5: results of asymmetric cointegration test. model estimation after determining that cointegration exists in the positive and negative components of the variables, it is appropriate to estimate the relationship using the non-linear panel ardl. the error correction term is estimated alongside this cointegration analysis. to achieve this, the pmg and the mg estimation method are used. these tools are particularly suited for this analysis because of their consistency in estimating long-run relationships in the context of dynamic panel data (chudik & pesaran 2019; pesaran & smith 1995). this can give effective results since the data come from different countries with potentially different characteristics and their reaction to fdi inflows. the estimation is based on the relationship between the decomposed components of the dependent variable (indigenous innovation) and the independent variable (fdi). this makes the relationship non-linear since it is not estimated on the variables themselves but on their hidden properties. the study uses columns 1, 2, 3 and 4 which represent equations 9, 10, 11 and 12. the letters ‘a’ and ‘b’ represent pmg and mg estimates. the analysis begins with a concentration on the non-linearities between the variables for the entire sample. the results of this analysis are shown in table 6. the hausman test results show that the pmg is the efficient estimator for columns 1, 2 and 4, while the mg is suitable to estimate column 3. x+ and x−represent the positive and negative shock from fdi inflows, while y+ and y− represent positive and negative shocks in indigenous innovation. the results of the first column show the error correction term and the speed at which the variables return to their long-term equilibrium after any shock. the error correction term shows statistically significant results across all equations, and the negative outcome confirms that long-run relationships exist and that there is long-term convergence after a shock in the system. long-run equilibrium is achieved at a fast rate among all models, albeit varied. the error correction rate is faster from positive shocks at a rate of 52.5% return to equilibrium, while recovery from negative shocks is slowest at a rate of 24.7% where decreases in fdi also lead to a decrease in indigenous innovation output. table 6: results of non-linear auto-regressive distributed lag estimation. the causal analysis of the decomposed variables shows varied results among the positive and negative components of the variables. considering the outcome from column 1, positive changes in fdi generally have a strong causal relationship with positive changes in indigenous innovation in the short term and in the long term. negative changes in fdi inflows shown in column 2 have no causal effects on positive changes in indigenous innovation. however, the results of column 3 show that positive changes in fdi have a causal effect on negative changes in indigenous innovation in the long run. furthermore, negative changes in fdi inflows demonstrated in column 4 do have a significant effect on negative changes in indigenous innovation in the short term. this indicates that reducing levels of fdi inflows will generally have an effect on reducing levels of indigenous innovation. following the theoretical basis of the benefits of fdi inflows to host countries (hymer 1976; ohlin 1952), it is clear that foreign technological expertise that come with fdi are useful in fostering indigenous innovation in developing economies. this is obviously the reason why reducing levels of fdi has a long-term effect on decreasing levels of indigenous innovation in these developing economies. multinational companies are known to be major benefactors of knowledge to local businesses (zhao et al. 2019), hence increased numbers of multinationals in developing economies are major sources of knowledge that can boost indigenous innovation in countries where such expertise is not adequate. rankings by the global innovation index (gii, 2019) shows that most developing countries are still lagging behind their developed counterparts in yearly improvement on innovation output. cheung and ping (2004) point out three benefits that come with fdi. firstly, businesses of the receiving country adopt ideas from foreign counterparts and feed into their innovation efforts. secondly, there is a spillover of knowledge as a result of people working with foreign firms and later working for domestic firms. thirdly, foreign technologies in the domestic markets spur local firms to be more creative in bringing out new products. the integration of new knowledge learned from foreign firms with local knowledge can lead to successful indigenous innovation (cassiman & veugelers 2002). the gii states that hong kong, singapore and luxembourg have had high performance in innovation due to some enabling factors including trade openness. the practice of opening up their economies to international trade has made these states the hubs of trade and investment in their respective regions. learning-by-doing has become an important element in absorbing spillovers from foreign firms operating in the domestic market. the absorption of spillovers has a positive and significant effect on innovation output and performance, especially with firms that have the requisite expertise to absorb and use new technologies (baark 2019). analysis of the asymmetries among the decomposed variables for individual regions is shown in table 7. for countries from the africa region, the results show that increasing amounts of fdi inflows are positively related to increased innovation among domestic enterprises in the long term. no relationship is obvious between decreases in fdi inflows and increases in innovation output, and there is no association between negative changes in fdi and negative changes in innovation output. however, increases in fdi inflows have a causal relationship with decreasing levels of innovation output. evidence from selected countries in the asia region reveal that increasing levels of fdi inflows lead to increases in indigenous innovation in both the long and short term. the dynamics for asia are quite different, in that both positive and negative changes in fdi inflows have causal relations with negative changes in innovation output in the long term. table 7: results of non-linear auto-regressive distributed lag for individual regions. furthermore, as with other regions, results of countries selected from the european region show that positive changes in fdi in the long term and in the short term have significant effects on the positive changes in indigenous innovation. however, countries on the continent can still increase innovation output in the face of long-term decreases in fdi as negative changes in fdi associate with positive changes in innovation output. meanwhile, short term increases in fdi have a significant effect on decreases in indigenous innovation output. results of countries selected from south america also show that positive changes in fdi generally have an effect on the positive changes in indigenous innovation in the countries selected from the region. most importantly the effect of reducing levels of fdi on indigenous innovation is pronounced in this study. the effect of this in the short term is not significant; however, the long-term effect is significant, leading to a reduction in indigenous innovation among the countries in the region. these results show fairly similar results for all the regions. it is evident that increasing fdi inflows’ influence increases indigenous innovation. on the flip side, reducing fdi generally is related to reducing innovation output in these countries. the exception is the european countries: in spite of reducing fdi inflows, innovation output still goes up. panel causality tests panel causality tests analyse the causal relationships between variables. in this section, following hatemi-j (2011), after the variables have been decomposed into their positive and negative components, a linear causality test is done, then the non-linear causalities are also tested. the linear causality test results (in table 8) show there exist linear causalities from fdi to indigenous innovation. the opposite causalities have proven not significant, hence there is no evidence of linear causality from indigenous innovation to fdi. in order to understand further the causal relationship between these variables, a non-linear panel causality test is conducted to investigate the asymmetric causal relations between the decomposed variables. in this study, the hatemi-j test is employed to conduct a non-linear panel causality test between the decomposed components for the full sample. results of this test are captured in table 9. the results show that increasing fdi (x+) is a significant cause of increasing rates of indigenous innovation output (y+). the hypothesis that decreasing fdi (x−) does not granger-cause decreases in innovation output (y−) has been rejected, indicating that when fdi inflows decrease, it causes a reduction in the rate at which indigenous innovations are churned out. however, decreasing fdi does not lead to increasing levels of innovation output, and increasing fdi equally does not lead to decreases in innovation output. table 8: panel causality test. table 9: asymmetric panel causality test between research and development and indigenous innovation. conclusion the main aim of this study is to analyse the asymmetric linkages between fdi and indigenous innovation. following mixed findings on the relationship between the two variables using linear analysis, this study is conducted using the non-linear panel ardl to analyse the asymmetries between them. to achieve this, panel data of 20 developing countries from 1993 to 2017 taken from the world development indicators is employed. within the non-linear ardl model, the variables are decomposed into their negative and positive components in order to establish any long-run cointegration and asymmetric relationship among them. a cd test conducted on the variables resulted in a rejection of the null hypothesis of cross-sectional independence, hence the pesaran (2007) cips was applied to test for stationarity. the westerlund (2007) cointegration was used to test for linear cointegration, then the hatemi-j (2020) asymmetric cointegration test was employed to test for hidden cointegration. estimation of the asymmetric relationship between the variables was done using pooled mg and mg estimation methods. these estimation methods come with an error correction term which determines the speed of adjustment after a shock in the system. the study resulted in the following conclusions. first, the unit root test showed that the variables are stationary at first difference, but the results of the linear test for cointegration showed no cointegration between the variables. however, results of the asymmetric cointegration test showed there is long-run cointegration between the negative and positive components of the variables. this result is an indication that although the variables may not be cointegrated by themselves, there exists a long-run cointegration relationship between their hidden properties. secondly, the error correction term tested in this relationship shows that the variables return to their long-term equilibrium after a shock resulting from increases or decreases in fdi inflows. the significance of the error correction term further affirms the existence of a long-run relationship among the variables analysed. thirdly, a test of the relationship between the decomposed components of the variables based on the non-linear panel ardl shows that positive changes in fdi inflows generally result in positive changes in indigenous innovation output. the results effectively suggest that developing economies benefit from technologies and expertise brought into the domestic markets by foreign investors. increasing fdi inflows leads to increasing levels of innovation output among indigenous firms in developing economies. meanwhile, indigenous innovation takes a downward trend in the short term and in the long term when fdi inflows reduce. however, the selected countries from europe show an upward trend in indigenous innovation output when fdi inflows reduce. this is an indication that such countries can still increase their levels of innovation even when fdi inflows decrease. an asymmetric causality test conducted on the decomposed variables shows strong causalities running from the positive and negative changes in fdi to the positive and negative changes in indigenous innovation. policy decisions regarding fdi inflows to developing countries should consider the non-linear relationships between fdi and indigenous innovation. developing countries should pay more attention to the effect of reducing levels of fdi. while these countries can benefit from increasing fdi inflows, if there is not enough local capacity to absorb and use new technologies, then increasing and decreasing levels of fdi will stifle indigenous innovation. trade policies should encourage multinational corporations from countries with advanced technologies to invest in and partner with local businesses in the domestic markets. moreover, effective policy measures for developing countries to benefit from fdi inflows should be targeted at building the capacity of domestic firms to enable them to diffuse new technologies in the shortest possible time. this will ensure that variations in fdi will not drive down indigenous innovation. the results of this study have brought interesting insights on this subject albeit focusing on developing countries. hidden cointegration and asymmetries between these variables bring out salient issues that are critical for policy decisions and further research. future studies may analyse the asymmetric relationship between fdi and indigenous innovation in developed countries and developing countries in other regions. acknowledgements we are grateful to the institutions that provided funding for this work, and also to the editorial team and reviewers for their various 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study show that the landfill site has a negative effect on new brighton house prices. the average increase in house value is r36.00 per one hundred metres from the landfill site. this increase amounts to 0.44 percent of the value of a house per 100 metres from the landfill. when the change in value is summed for all the properties in the sample area (allowing for variation in value change due to differing distances from the landfill site) the total disamenity effect of the landfill site is approximately r1.4 million. jel q57 1 introduction whether, and to what degree, solid waste landfills have an adverse effect on residential property prices has received a great deal of attention over the years (see, for example, bouvier, halstead, conway & manalo, 2000; havlicek, richardson & davies, 1971; reichert, 1991). it is a well-recognised fact that the establishment and operation of a landfill creates negative externalities, which may include environmental damages, such as the build-up of methane gas and groundwater contamination (lomberg, rosewarne, raymer & devey, 1996; reddy & gardiner, 2003). in addition to these damages, the dumping of solid waste may also give rise to bad odors, vermin and flies, while litter may spread from the landfill if it is not properly policed (bouvier et al., 2000). moreover, covering and compacting the solid waste with soil creates airborne dust. as a result of these negative impacts, it is normal to locate landfills that may have a deleterious aesthetic and health impact on areas remote from residential neighbourhoods, as well as creating buffer zones to prevent further encroachment. the economic impact of a landfill on the value of properties situated in close proximity to it is important for a number of reasons. first, price disparities between like properties, differing only in their distance from a landfill, provide information on the welfare effect on households situated in the vicinity (ready, 2005). second, affected property owners want to know what effect, if any, the presence of a landfill has or will have on the value of their assets. third, in the event of a landfill project being subject to cost-benefit analysis, estimates of property price effects can be incorporated into the cost-benefit profile. numerous studies have been conducted to determine an empirical relationship between residential property prices and proximity to a solid waste landfill site (ready, 2005). the hedonic pricing method, which entails drawing sajems ns 12 (2009) no 2 257 inferences from markets where it is believed preferences for environmental goods are captured, was used in these studies to estimate the abovementioned relationship. most of these studies have found a negative relationship between residential house prices and proximity to a landfill (see, for example, nelson, generoux & generoux, 1992; havlicek, richardson & davies, 1971; havlicek, 1985; adler, cook, ferguson, vickers, anderson & dower, 1982; baker, 1982). more specifically, these studies show that the values of residential properties situated within a four-mile radius of a landfill site rise by between 5 and 7 percent per mile (i.e. 1.6 km) distance away from the site. no negative value effects were found for properties located in excess of four miles from the landfill. however, property values fall more dramatically (i.e. between 21 and 30 percent) the closer (i.e. within a quarter to a half mile radius) the properties are situated to a landfill site. on the other hand, a few studies have found that no statistically significant relationship exists between house prices and proximity to a landfill (see, for example, gamble, downing, shortle & epp, 1982; zeiss & atwater, 1989; bouvier et al., 2000). there is a paucity of south african studies which explore the negative effects of proximity to landfill sites on the value of residential properties. the purpose of this paper is to derive a measure for the reduction in house value in rands due to proximity to a landfill site, by means of an application of the hedonic pricing method. 2 methodology the theory underlying the economic rationale for employing the hedonic pricing method to analyse residential house prices is couched in the work of rosen (1974). the hedonic pricing method relies on the principle that a person’s utility is based on the characteristics of the good consumed. in the context of the housing market, the characteristics theory of consumer choice hypothesises that the purchase price a potential buyer is willing to pay is dependent upon the broad range of characteristics of the house, for example physical characteristics (such as house size, age, number of rooms), location characteristics (such as proximity to amenities like schools and shopping centres), and environmental quality variables (such as the quality of the air, noise pollution, and proximity to a landfill). the application of the hedonic pricing method requires the collection of information on all the factors determining the price of a house. once this has been done, the conventional hedonic pricing method continues in two steps: first, a hedonic (or implicit) price function is estimated; second, a demand curve is estimated for some environmental quality component (hanley & spash, 1993). the derivation of the hedonic price function entails estimating an empirical relationship between the market price of a particular residential property and the levels of its characteristics or attributes. this function portrays the equilibrium collection of property values, given the house-purchasing population and the obtainable housing supply (ready, 2005). formally, the hedonic pricing function can be defined as follows: p h = p(c i , l j , e k ); [i = 1..f, j = 1..g, k = 1..h] (1) where: p represents the house prices in an urban area of interest; c represents the physical characteristics; l represents the location characteristics; and e represents the environmental characteristics (hanley & spash, 1993). equation (1) can be expected to be nonlinear, because consumers are unable to treat individual housing characteristics as discrete components from which they can choose until the required composite of characteristics is found (rosen, 1974). the implicit price of an individual characteristic or amenity can be found by partially differentiating equation (1) with respect to that individual characteristic (hanley & spash, 1993). the conventional way of determining the effect of a solid waste landfill site on house prices is to incorporate a certain continuous 258 sajems ns 12 (2009) no 2 measure of proximity to a landfill site into the hedonic price function. for instance, assuming that e in equation (1) represents solely the proximity to a landfill site, then its implicit price would be: (p h /(e k = (p(c i , l j , e k )/(e k (2) the expression (p h /(e k provides an estimate of a household’s marginal willingness-to-pay for a change in distance from a landfill site. this expression can therefore be viewed as the incremental increase in the value of a house for a one-unit increase in distance from the landfill site, assuming that there is a positive relationship between distance and price (van kooten bulte, 2001). the second stage of the hedonic price model is based on rosen’s (1974) work on implicit markets and requires that the compensated demand curve for the environmental variable in question be estimated. using this demand curve, the consumer surplus can be calculated. the rest of this paper is structured as follows: section 3 describes the data and methods used in the study, section 4 reports the results of the study, section 5 provides a discussion of the results, and section 6 provides a short conclusion. 3 data and methods 3.1 the study area the study area is the new brighton neighbourhood located in the nelson mandela metropole, eastern cape, south africa. the majority of the houses in this area can be classified as low-cost housing. one solid waste landfill site is included in the study, namely the ibhayi landfill site. this site was used as a landfill from 1981 to 2001, and accepted waste mostly from the nelson mandela metropolitan municipality (nmmm). the total amount of solid waste dumped at this site was approximately 20 000 tons per month (horn, 2005). the site is presently under the control of the nmmm. the landfill is not physically isolated from the surrounding formal residential area (i.e. new brighton). formal residential housing is located adjacent to the eastern and northern sides of the landfill border. an informal settlement of shack dwellers is located to the west of the landfill (the shacks are erected on vacant areas and are not registered properties), and no formal housing is found to the south of the landfill border. these areas do not constitute part of the survey. the formal residential area has a high housing density and an equally high population density. more specifically, population density is in excess of 12 000 per square kilometre with an average occupancy of four per household (census, 2001). the mean erf size for the area is 246 square metres (horn, 2005). 3.2 data to compile data on the houses located in the formal residential area (i.e. new brighton) and situated adjacent to the ibhayi landfill site, the gis database was used. the database was supplied to estate agents for the purposes of valuing properties in the nelson mandela metropole. municipal street maps were then used to identify, by means of an erf number, those houses that were situated within two kilometers of the landfill site.1 the rationale for setting a two kilometre limit was that this is the limit of formal housing to the east of the landfill site, at which point it gives way to an industrial area. a total number of 40 000 housing units were identified, from which a representative sample of 496 houses was selected. this sample generates an error of less than 4.5 percent at a 95 percent confidence level. for each house identified in the sample, the following data were collected: the value of the property (at 2005 price levels), the erf size, the building size, and the existence or lack of outbuildings. based on the location of the relevant properties, straight-line distances from the landfill site were calculated. the residences situated adjacent to the landfill site in the township (new brighton) are primarily low-cost units and the property market for this area is not well developed. owing to a paucity of market transaction data, property valuations conducted by municipal officials and independent property evaluators were used as sajems ns 12 (2009) no 2 259 house prices. the differences in these valuations reflect municipal perceptions of the relative market worth of the relevant properties at a given point in time. 3.3 the hedonic pricing model as noted in the discussion of the methodology of the hedonic pricing method (see section 2), to determine the effect on house values, if any, of proximity to a landfill site, it is necessary to develop a statistical function (i.e. the hedonic price function) that accurately reflects the magnitude of the effect that a range of explanatory variables, including the proximity to landfill issue, have on the dependent variable, namely house values. for the purposes of this study the following hedonic price function was specified: value =  0 +  1 (erfsize) +  2 (sizebuild) +  3 (outbuild) +  4 (distance) + u (3) where: value denotes the house price in rands; erf size indicates the size of the erf in m2; sizebuild denotes the size of the main building in m2; outbuild refers to the presence or lack of outbuildings; distance refers to the distance of the property from the landfill; and u represents the error term. a description of the abovementioned variables, their operational definitions, and their hypothesised sign, are provided in table 1 below. table 1 variables included in the hedonic price function dependent variable operational definition hypothesised sign value (rand) continuous variable independent variables operational definition hypothesised sign size of erf (m2) continuous variable positive size of main building (m2) continuous variable positive outbuildings dummy variable positive distance from landfill (m) continuous variable positive 4 results analysis of the house value statistic reveals that, on average, the houses in the study area have table 2 analysis of the house value statistic in the hedonic price function variable mean (rand) std dev (rand) min (rand) median (rand) max (rand) house value r8505.34 r3341.00 r1410.00 r7630.00 r23810.00 a value of r8 505.34. the statistics relating to the house value variable are shown in table 2 below. a statistical analysis of the explanatory variables used in the hedonic price function is provided in table 3 below. 260 sajems ns 12 (2009) no 2 table 3 descriptive statistics of explanatory variables in the hedonic price function variable mean (rand) std dev (rand) min (rand) max (rand) median (rand) erf size 228.85m2 30.94 m2 148.00 m2 405.00 m2 228.00 m2 building size 61.33 m2 23.59 m2 0.00 m2 195.10 m2 53.30 m2 outbuilding 0.455 0.498 0.00 1.00 0.00 distance from landfill 710.16m 658.52m 10.00m 2000.00m 550.00m the results of the estimation of the hedonic price function (equation 3) are shown in table 4 below. table 4 estimation results of the hedonic price function (n = 496) dependent variable: house value (rand) r2 = 0.869 adj. r2 = 0.868 variable estimated coefficient standard error t-statistic p-value intercept –957.25 431.13 –2.22 0.0269 erf size 4.72 2.02 2.34 0.02 building size 125.71 3.60 34.94 0.0000 outbuildings 908.44 111.86 8.12 0.0000 distance from landfill 0.36 0.08 4.26 0.0000 the data set generated an r2 of 0.869 and an adjusted r2 of 0.868, which attests to the model’s predictive power. all the estimated coefficients are statistically highly significant and have the hypothesised sign. when the mean values for all the explanatory variables (except that of the distance from landfill) obtained in the analysis are substituted into the estimated hedonic price function (see equation 3), the following equation results: value = 8246.03 + 0.36(distance) (4) 5 discussion the results obtained above show that the ibhayi landfill site has a negative effect on new brighton house prices. more specifically, the average increase in house value is r36.00 per one hundred metres from the landfill site (see equation 4 above). based on the assumption that the value of a property adjacent to the landfill border is r8 246.03 and that a property located two thousand metres away has a value of r8 966.03, the effect of proximity to the landfill site is to reduce the value of a house by a maximum of r720.00 (two thousand metres is the easterly limit of housing in the new brighton neighbourhood). stated differently, house prices increase by 0.44 percent if the houses are situated 100 metres away instead of adjacent to the landfill border, and by 8.73 percent if they are 2000 metres away instead of adjacent to the site. if the change in value is summed for all the properties in the sample sajems ns 12 (2009) no 2 261 area (allowing for variation in value change due to differing distances from the landfill site) the total disamenity effect of the landfill site is approximately r1.4 million. a number of restrictive assumptions surrounding this type of analysis must, however, be borne in mind. first, the hedonic pricing method only provides accurate estimations of the value of environmental quality if perfect information exists in the market (i.e. all buyers in the housing market have perfect information on the environmental quality variables at every conceivable location). this assumption is, however, not met in reality if people’s awareness of the landfill site is based on inaccurate information or lack of knowledge (bouvier et al., 2000). for example, if a landfill site poses a serious health risk, individuals may not be aware of either its extent or its potential impact on house values. second, the assumption regarding zero transaction costs is also not borne out in reality (bouvier et al., 2000). many individuals who reside in close proximity to a landfill site may be disturbed by the potential health risks it poses, but relocation costs may be prohibitively expensive. this often outweighs the incremental benefits derived from being situated further away from the landfill site. in summary, the results of this study do not permit wide-ranging generalisations regarding the effect of a landfill site on house prices in south africa. the landfill considered in this study has been inoperative since 2001, and the adjacent neighbourhood is one where low-cost housing dominates. 6 conclusion many studies on hedonic pricing have shown that property prices increase with a move away from a landfill site. a few studies have shown that the impact of landfill sites on house values is negligible. there is, however, a paucity of similar studies conducted in south africa. this study applied the hedonic pricing method to estimate the loss, if any, of property value due to the disamenity created by proximity of low-cost housing to a solid waste landfill site (the ibhayi site) located in new brighton, nelson mandela metropole, eastern cape. a regression analysis was performed to obtain a statistical function (i.e. the hedonic price function) that depicts the empirical relationship between property values and distance from the landfill. other housing characteristics were also included in the hedonic price model, such as erf size, house size, and the existence or absence of outbuildings. the results obtained show that the ibhayi landfill site has a negative effect on new brighton house prices. more specifically, the average increase in house value is r36.00 per one hundred metres from the landfill site. stated differently, house prices increase by 0.44 percent per 100 metres from the landfill. when this change in value is summed for all the properties in the sample area (allowing for variation in value change due to differing distances from the landfill site) the total disamenity effect of the landfill site is approximately r1.4 million. the results suggest a need for more considered residential planning, particularly in low-income areas. more specifically, solid waste landfill sites that may have deleterious aesthetic, health and economic impacts should, ideally, be located far from residential neighbourhoods or, at the very least, buffer zones should be created to prevent further encroachment. in the case of the ibhayi landfill, the nmmm should endeavor to keep the disused landfill site as tidy as possible, and monitor it on a regular basis so as to safeguard the values of properties situated adjacent to it. acknowledgements the helpful comments and suggestions made by the anonymous referees are gratefully acknowledged. endnote 1 convention 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� ��������� ���������� ���� ������� �������� ��� ������ �������������� sajems ns vol 3 (2000) no 1 143 employees' perception of service orientationan exploratory study kkgovender department of business management, university of transkei abstract in a matched sample survey of bank employees and customers, it was found that the employees' perception of the service orientation [servor] of the banks, is positively correlated with the customers' perception of their overall service quality [squal]. service firm managers should take note that in the absence of direct control of the service encounter, organizational practices and procedures that treat service as top priority, are also likely to succeed in delivering service of high quality. jel m21 introduction since services are intangible, it is difficult for management, employees and customers to assess service output and service quality. consequently, an organization's overall service orientation is very important in shaping the frontline employees' attitude to the process and outcome of service delivery. although it may be argued that there are certain similarities between the constructs "market orientation", "customer orientation" and "service orientation", it is necessary to stress that service orientation is a perceptual process regarding the whole organization, whereas customer orientation focuses on the individual employee and hislher behaviour towards the customer. furthermore, market orientation is a much broader concept in terms of its antecedents and consequences than service or customer orientation (jaworski and kohli, 1993). however, some researchers, for example kohli and jaworski (1990) and nel and schreuder (1994), do point out that customer orientation is an element of marketing orientation. service orientation (for the purpose of this study) refers to the employees' perception of what is important to the organization regarding the service it provides. the association between the employees' perception of the service orientation of their organization, and the customers' perception of the overall r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 144 sajems ns vol 3 (2000) no 1 service quality is therefore being explored in this paper. brief literature review and hypothesis schneider, gunnarson and niles-jolly (1994) assert that employees observe what happens to them and around them, and draw conclusions about the organization's priorities. some researchers (julian and ramaseshan, 1994) claim that since service organization employees have face-to-face contact with customers, their work seems to result in increased stress and strain because employees try to meet conflicting demands from management and customers. schneider and bowen (1995) contend that management can potentially manage employee stress by establishing an environment in which employees' desires to provide good services are made easier and encouraged. thus the service environment created in an organization, including how the service is delivered, is crucial for the service unit's effectiveness. gronroos (1990) argued that a service orientation enhances the functional quality dimension of customer-perceived quality, and it probably also supports the production of good technical quality. since service quality is in the delivery, it is the interaction between the deliverer and the consumer that determines service quality for the consumer. organizations can only indirectly control the interaction or "service encounter" because of the simultaneous nature of production and consumption. in the absence of direct control of the service encounter, it is therefore posited that the organizational practices and procedures that communicate service as top priority will succeed in delivering high quality service. in order to explore the relationship between service orientation and quality, it is hypothesized that: the service orientation as perceived by the employees is positively correlated with the service quality as perceived by the customers of a firm. research design sample and sampling procedure the survey was conducted among a random sample of 210 front-line employees and 1050 customers of three major commercial banks in south africa. a combination of convenience and judgemental sampling was followed in selecting 210 front-line bank employees who had meaningful encounters with bank customers, to distribute the customer questionnaires. after being briefed r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 145 about the research, branch managers were requested to distribute and collect the employee questionnaires during regular staff meetings. the bank employees were requested to hand the questionnaire together with a covering letter explaining the purpose of the research, as well as stamped and self-addressed envelopes, to every third customer with whom they interacted for at least five minutes. this approach has also been reported in other studies (danaher and mattsson, 1993; naumann and giel, 1995). research instruments to measure the customers' perception of the service orientation, a 22-item, five point likert scale with anchors of (5) strongly agree and (i) strongly disagree was developed based upon an adaptation of kelley's (1987) scales. kelley's (1987) scale in turn was developed around the exploratory research by parasurarnan, zeithaml and berry (1985). since some researchers like babakus and boller (1992), buttle (1996) and nel, pitt and berthon (1997) have uncovered certain deficiencies in the servqual (parasuraman et al., 1988) scale, an alternative scale (named squal), based on the 22 items of the servqual instrument, was used in this study. this scale combines expectations and perceptions into one measure by asking customers whether certain aspects of service quality exceeded or fell short of expectations. this approach has inter alia been recommended by cronin and taylor (1992). service customers were asked to rate each of the twenty-two items on a scale ranging from 1 (worse than expected) to 5 (better than expected). a 5;'point scale was used in this study because the pre-test revealed that respondents could not make fine mental distinctions with respect to the object measurement. this strategy is supported by parasurarnan (1991) who asserts that for accurate measurement, a large number of scale positions are needed when a single-item scale is used, in contrast with a multiple-item scale as was used in this survey. reliability an~ validity of measuring instruments reliability stepwise reliability analysis was perfonned on the various measuring instruments using the computer programme sas proc.corr (sas institute, 1990). in stepwise reliability analysis (sra), individual items are deleted from the various measuring instruments if this improves the overall reliability of a particular measuring instrument as measured by its cronbach's coefficient alpha (cronbach, 951). the process was repeated until all the measuring instruments possessed an acceptable level of reliability. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 146 sajems ns vol 3 (2000) no i due to the fact that the latent variables servor and squal had too many items, it was decided to reduce their number by averaging the individual measurements. the final servor scale which comprised of 13 items was refined as follows: sol = (s03 + s04 + s07)/3; s02 = (s08 + s09 + soi0)/3; s03 = (soli + sol2 + s0l6)/3; s04 = (soi7+ sol8 + s021 + s022)/4. the final squal instrument which comprised of 16 items was refined as follows: sqi = (sq3 + sq6 + sq7 + sq8)/4; sq2 = (sq9 + sqii + sqi2 + sqi3)/4; sq3 = (sqi4 + sqi5 + sqi6 + sqi7)/4; sq4 = (sqi8 + sqi9 + sq20 + sq2i+ sq22)15. the servor scale returned a cronbach alpha of 0.908 and the squal scale was 0.961. since an instrument which produces a coefficient of reliability of at least 0.7 is favoured by most social scientists (bless and higson-smith, 1995), the instruments used in this study were thus fairly reliable. validity after determining the cronbach's coefficients alpha, stepwise exploratory factor analysis (wille, 1996) was performed to ascertain the discriminant and construct validity of the measuring instruments. in each step of the analysis, bmdp4m (frane, lennrich & sampson, 1993) was used to perform a maximum likelihood factor analysis with a direct quartimin rotation (jennrich & sampson, 1966) of the unrolated factor matrix. it is evident from table i that the measuring instruments had acceptable levels of discriminant and construct validity, since they load heavily with loadings above 0.4 (rummel, 1967) on one factor only. table 1 rotated factor loadings items factor 1 factor 2 service quality service orientation sqi 0.907** 0.041 sq2 0.886** 0.022 sq3 0.960** -0.060 sq4 0.910** 0.019 sol -0.085 0.866** s02 0.028 0.740** s03 0.112 0.884** s04 0.070 0.858** ** : a loadmg above 0.4 was considered slgmficant r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no i 147 data analysis the computer programme sas proc.corr (sas institute, 1990) was used to assess the reliability of the research instruments, as well as to perform initial data analysis. the validity of the measurements was determined by use of the computer programme bmdp4m (frane, jennrich & sampson, 1993). to empirically evaluate the hypothesized relationship, the computer programme ramona (brown and mels, 1990) was used. findings, discussion and recommendations the three-month survey yielded 104 employee and 200 customer responses, representing a response rate of 49.5 % for the employees and 19% for the customers. however, only 50 employee responses could be matched with 190 customer responses. in table 2, it appears that the overall mean and standard deviation scores were 4.269 and 0.470 respectively. considering that a five-point scale was used, it may be assumed that the 104 employees perceived their organization as being highly service-oriented. table 2 mean and standard deviation scores for servor item mean standard in==104) deviation sol staff should ensure that customers appreciate the 4.423 0.867 service provided s02 staff should use language which the customer can 4.509 0.750 understand s03 customers should be informed beforehand how 4.413 0.770 much the service will cost s04 it is important to honour promises to customers 4.644 0.520 s05 customers should be informed about what alternate 4.596 0.566 services are available s06 it is important to have convenient operating hours 4.000 0.903 s07 employees should always be polite and friendly to 4.682 0.728 customers s08 it is important to have up to date equipment so as 4.625 0.753 to provide good service r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 148 sajems ns vol 3 (2000) no i table 2 continued item mean standard i [n=104) deviation , s09 it is important to keep the customer's best interest 4.577 0.569 at heart solo the training and preparation of the employees are 4.519 0.995 important soll dependable service performance is important 4.519 0.750 sol2 consistent service performance is important 4.548 ~ so 13 prompt service by staff is stressed 4.317 sol 4 convenient service locations are important 4.327 0.675 s015 the appearance of employees is important 4,519 0.682 s016 employee honesty is stressed 4.567 0.707 s017 a reputation for good service is emphasized 4.606 0.614 sol8 the development of customer confidence in the service is stressed 4.375 0.791 s019 individual customer attention is stressed 4.~8m s020 a nice atmosphere for service is stressed 4.240 s021 customers should feel free to discuss their needs 4.490 0.710 s022 the confidentiality of the service is stressed 4.519 0.750 the proc.corr procedure using the sas computer programme (sas institute, 1990) was also used to determine spearman's correlation coefficient. the resulting correlation coefficient (r = 0.4040) implied that servor is positively correlated with squal. furthermore, as reflected in figure i, the employees' perception of the service orientation of the banks is positively associated with the customers' perception of the overall service quality (0.149; p <0.05). this implies that when employees perceive that the banks are supportive of customer service, this will be reflected in their contact with customers, who then experience service of high quality. thus the data supports the hypothesis. the findings of this exploratory study are supported by gronroos (1990) who argued that a strong service orientation is likely to lead to higher quality in service delivery, which in turn may well lead to higher perceived service quality from the customer's point of view too. schneider and bowen (1995) also maintained that customer service thrives in organizations which are perceived by employees as being service-oriented. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 3 (2000) no 1 149 figure 1 empirical evaluation of hypothesized model schneider et al. (1994) also assert that the service atmosphere does impact on the performance and job satisfaction of employees. thus houston (1994) suggests that there is a need to manage the service environment in order to make the form a pleasant place to work. unlike the earth's atmosphere, the atmosphere of a work situation can be controlled; it can be improved, or worsened, by the actions of a firm's leaders and employees. a service orientation characteristic of a service culture. may well improve the service quality as perceived by customers. in an effort to better manage the organization, service providers need to ask the following questions: how do employees see the organization? are they clear about their role within the organization? are they experiencing any stress from conflicting demands by management and customers? limitations and future research due to the research method used, namely mail survey, the tests of significance involving the matched employee-customer data were limited to 50 employees and 190 customers. given an adequate research budget, customers could be interviewed immediately after their service encounter. however, this method may also not be very successful, because customers who have spent time in the bank queues may not be willing to be interviewed as well. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 150 sajems ns vol 3 (2000) no i from a methodological point of view, the data in this study were obtained from front-line employees and customers. future research may also include backoffice staff. furthermore, to increase the generalizability of the findings, future research might involve the replication of this study in a variety of service settings, industries and organizations. it would also be interesting to ascertain how customers view the service organization and compare this with the views of employees. references babakus, e. and boller, g.w. 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(1995) winning the service game. boston: harvard business school press. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction literature review research design and methodology corporate financial performance measures data analysis results and discussion conclusions, limitations and recommendations acknowledgements references about the author(s) ruth johnson department of business management, faculty of economic and management sciences, stellenbosch university, stellenbosch, south africa nadia mans-kemp department of business management, faculty of economic and management sciences, stellenbosch university, stellenbosch, south africa pierre d. erasmus department of business management, faculty of economic and management sciences, stellenbosch university, stellenbosch, south africa citation johnson, r., mans-kemp, n. & erasmus, p.d., 2019, ‘assessing the business case for environmental, social and corporate governance practices in south africa’, south african journal of economic and management sciences 22(1), a2727. https://doi.org/10.4102/sajems.v22i1.2727 original research assessing the business case for environmental, social and corporate governance practices in south africa ruth johnson, nadia mans-kemp, pierre d. erasmus received: 31 july 2018; accepted: 14 aug. 2019; published: 28 nov. 2019 copyright: © 2019. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: by focusing on sustainable financial and environmental, social and corporate governance (esg) returns, companies and investors can do well by doing good. despite growing interest in sustainable corporate practices, limited esg-related research has been conducted in south africa. previous researchers have mainly focused on corporate governance. all three esg aspects should, however, be addressed to ensure corporate sustainability. it is possible that the consideration of a composite esg measure can conceal varying levels of consistency in the individual aspects. aim: the main objective was to investigate the relationship between esg and corporate financial performance (cfp) measures. setting: firms listed on the johannesburg stock exchange between 2011 and 2016. a total of 66 firms were considered from six sectors. methods: data for the sample (359 firm-year observations) were analysed by conducting panel regressions. in line with international research, esg was considered as the independent variable, while eight measures of cfp were individually considered as the dependent variables. composite and individual esg disclosure scores were obtained from bloomberg. the respective accounting-based, market-based and value-based cfp measures were sourced from iress. results: two main trends emerged from this study. the majority of the significant relationships identified between variables were only observed: (1) once the composite esg disclosure score was disaggregated and (2) when a distinction was made among sectors. conclusion: the empirical evidence suggests that esg aspects are not homogeneous across sectors. firm leaders should hence employ a differentiated approach to address the most important risks relevant to their operating environments. keywords: environmental practices; social considerations; corporate governance; esg; disclosure; corporate financial performance; accounting-based; market-based; value-based. introduction william ford junior (ford motor company 2010) remarked that ‘creating a strong business and building a better world are not conflicting goals; they are both essential ingredients for long-term success’. his quote underlines the importance for managers and directors to consider simultaneously pertinent sustainability issues while striving to build successful businesses. the concept of sustainability is of particular importance to investors who engage in responsible investing (ri) (van der ahee & schulschenk 2013). such investors incorporate environmental (e), social (s) and corporate governance (g) aspects in addition to risk-and-return considerations when assessing investee firms (pasquini-descomps & sahut 2013). the inclusion of non-financial information in addition to corporate financial performance (cfp) broadens the scope of investment analysis and decision making (bassen & kovács 2008; eccles et al. 2007; pasquini-descomps & sahut 2013). responsible investors acknowledge the potential positive and long-term impact of sound esg risk management on cfp (van der ahee & schulschenk 2013). previous research on the relationship between esg and cfp was mainly conducted in the developed market context (balatbat, siew & carmichael 2012; ferrero-ferrero, fernández-izquierdo & muñoz-torres 2016; nollet, filis & mitrokostas 2016; pasquini-descomps & sahut 2013; qiu, shaukat & tharyan 2016; velnampy & pratheepkanth 2013). less research has been carried out on the esg practices of companies doing business in developing and emerging markets (aaltonen 2013; sustainable investment research analyst network 2009). based on a literature review, it was evident that researchers primarily used accounting-based (chetty, naidoo & seetharam 2015; de klerk & de villiers 2012; demetriades & auret 2014; marcia, maroun & callaghan 2015; mutezo 2014) and non-risk-adjusted market-based (breuer & nau 2014; chetty et al. 2015; horn, de klerk & de villiers 2018; nkomani 2013) cfp measures, while ignoring the potential risk-reducing benefits that sound esg practices could hold for emerging market firms. in the current study, cfp was measured by employing accounting-based, market-based and value-based metrics. accounting-based cfp measures focus on a firm’s past performance (cooper 2017; margolis & walsh 2001). critique against accounting-based measures includes the fact that such ratios may be manipulated by managers through changing accounting methods or accruals, that they can be influenced by inflation and that they may be difficult to interpret across sectors (velnampy & pratheepkanth 2013; venanzi 2012). despite these concerns, the return on assets (roa) and earnings per share (eps) ratios are extensively used to measure accounting-based performance (porter & norton 2016). the roa profitability measure reflects how well a firm’s management has used its total assets to generate profit for a given year. the eps ratio reflects the amount of attributable earnings that were earned per ordinary share in a specific year (els, erasmus & viviers 2014). market-based cfp measures are typically based on the value of a company’s ordinary shares. such measures are used to reflect on expectations about future performance (margolis & walsh 2001; martin, petty & wallace 2009). furthermore, market-based measures are less subject to managerial manipulation than accounting-based metrics (gentry & shen 2010). these measures are typically utilised by the potential investors of a firm (masa’deh et al. 2015). market-based methods can be affected by exogenous factors, such as the overall share market performance. the market-based measures that were used in this study are the earnings yield (ey) and total shareholder return (tsr) ratios. the ey ratio is a popular indication of value as it compares the eps to the market price per share. the tsr measure considers the dividend income and the change in the share price over the investment horizon (cooper 2017; megginson, smart & lucey 2010). value-based measures aim to remove the accounting distortions that are evident in a firm’s financial statements and are often regarded as an improvement on the traditional performance measures (erasmus 2008; maditinos, šević & theriou 2006). such methods take the cost of capital into account in an attempt to determine a firm’s potential to create value (erasmus 2008). the return on invested capital (roic), the spread, market value added (mva) and cash return on invested capital (croic) are examples of value-based measures, and are included in this study to assess shareholder wealth creation. the roic measure compares the net operating profit after tax (nopat) generated by a firm to the amount of the net operating capital (noc) employed. the spread is utilised to consider the difference between a firm’s roic and weighted average cost of capital (wacc). if the roic generated by a firm is larger than its wacc, growth is profitable and the firm is adding value (brigham & daves 2010). the difference between the market value of a firm’s shares and the equity capital supplied by investors is referred to as the mva (cooper 2017). in contrast to roic, the croic measure represents the amount of free cash flow (fcf) being generated in a firm in comparison to the noc. none of the considered studies included value-based metrics. this exclusion indicates a gap in the literature, as these measures focus on the long-term sustainable value creation potential of a firm in a socially responsible context. despite the growing interest in sustainable corporate practices in emerging markets, limited esg-related research has been conducted in south africa. the majority of local researchers have focused on corporate governance (mangena & chamisa 2008; mans-kemp, erasmus & viviers 2017; ntim et al. 2012; tshipa et al. 2018; waweru 2014). this tendency could be ascribed to the country’s well-developed corporate governance framework provided by the king reports. the implementation of sound corporate governance practices is therefore often the first level of esg integration for local firms. however, to ensure corporate sustainability, it is important for managers and directors to engage with all three esg aspects (linnenluecke & griffiths 2010). against this background, the authors investigated the business case for the esg practices of selected johannesburg stock exchange (jse) listed companies between 2011 and 2016 by employing an assortment accounting-based, market-based and value-based cfp measures. the results could enhance the understanding of esg and motivate corporate managers and directors to allocate more time and financial resources to the consideration and active management of esg risks. unless more attention is given to sustainable long-term value creation, shareholders run the risk of benefiting over the short run, but experiencing severe negative consequences over the long term (institute of directors in southern africa [iodsa] 2016). the remainder of the article is structured as follows: a critical overview of the theoretical link between various sustainability-related terms is first offered. the local esg context and pertinent esg-related developments are also discussed, followed by an overview of previous research on the topic and the formulation of the hypotheses. thereafter, the collection of quantitative esg and cfp data for 66 jse-listed firms is explained. the resulting panel data set was analysed by means of panel regression analysis. based on the reported results, recommendations are offered to relevant stakeholders. literature review an explanation of several sustainability-related terms is offered which provides the theoretical background for the consideration of esg aspects in south africa. clarification of relevant terms sustainability considers the effect of the current generation’s actions on the ecosystems, societies and environments of the future (ameer & othman 2012). sustainability comprises social (people-related), economic (profit-related), environmental (planet-related) and cultural (diversity-related) components (werbach 2009). a sustainable firm should aim to eliminate any potential negative impact pertaining to all four sustainability components. the challenges faced by firms in the 21st century require a fundamental change in the way businesses function. traditionally, firms and investors aimed to reach the ‘ultimate investment goal’, namely to maximise return given a certain level of risk (iodsa 2011). however, challenges such as climate change, insufficient energy provision and the depletion of natural resources also require attention, since esg aspects can have a considerable impact on the long-term sustainability of firms (quinn & baltes 2007; van der ahee & schulschenk 2013). a paradigm shift is therefore required in the way in which (some) corporate managers and investors make decisions and construct their investment portfolios. in an attempt to address sustainability challenges, firms started to engage in corporate social responsibility (csr) initiatives in the late 1990s (carroll & shabana 2010; nkomani 2013). csr can be defined as: … the social responsibility of a business which encompasses the economic, legal, ethical, and discretionary philanthropic expectations that society has of organisations at a given point in time. (carroll 1999) furthermore, matten and moon (2008) highlighted that csr consists of clearly articulated and communicated policies and programmes that reflect a company’s responsibility for broader societal good. the concepts ri and csr are closely linked. whereas csr focuses on wealth creation from the perspective of firms, ri considers wealth creation from the viewpoint of investors (viviers, krüger & venter 2012). the term socially responsible investment (sri) is essentially underpinned by ethical requirements to shape the market, while the ri concept integrates both esg and financial aspects into mainstream investment decision-making (van der ahee & schulschenk 2013). since the launch of the united nations principles for responsible investment (un pri), more researchers and practitioners have been using the term ‘responsible investing’ rather than ‘socially responsible investing’ (viviers et al. 2012). the csr concept could be considered as a building block for corporate social performance (csp) (carroll 1999). the term csp reflects a comprehensive assessment of a firm’s observable outcomes as it relates to socially responsible behaviour (cooper 2017; simpson & kohers 2002; van der laan, van ees & van wittelosstuijn 2008). the key motivation for firms to engage in csr, while improving their csp, is to contribute to an improved society at large (carroll & shabana 2010). the definitions for both csr and csp focus mainly on environmental and social considerations (carroll & shabana 2010), while omitting corporate governance (dahlsrud 2008). as responsible investors consider all three esg aspects, the scope of their investment analysis is broadened by including corporate governance aspects in addition to csr and csp considerations (eccles et al. 2007; pasquini-descomps & sahut 2013). there are various misconceptions associated with the inclusion of esg aspects in investment analysis and corporate decision-making. some investors believe that the integration of esg aspects would result in a high-risk investment with a low return (eccles et al. 2007). however, this is not necessarily the case. when investing in a responsible manner, investors are encouraged to act as long-term shareholders and less like share traders. active shareholders are expected to engage with investees on various esg concerns (eccles et al. 2007). the proper evaluation of a firm’s esg practices thus facilitates a better understanding of the risks and opportunities relevant to a firm (bassen & kovács 2008; gond et al. 2018). this could lead to improved investment decision-making. losses associated with poor esg performance could be avoided and the risk associated with an investment could be more accurately assessed. environmental, social and corporate governance considerations in south africa environmental aspects that are of particular concern to companies operating in south africa include climate change, a lack of water, the destruction of natural habitats, overfishing and pollution (hebb et al. 2016). climate change will most likely have an even greater effect on firms’ operations, revenues and costs in future (girdwood 2013). an improved understanding of these aspects would enable firms to address the effects thereof more efficiently. responsible investors should also consider these concerns when establishing their environmental screening criteria (hebb et al. 2016). south africa has a legacy of social injustices that have hampered its socio-economic development (herringer, firer & viviers 2009). regulatory measures such as the employment equity act (no. 55 of 1998) and the broad-based black economic empowerment (b-bbee) act (no. 53 of 2003) have aimed at addressing the inequalities brought about by the apartheid system. furthermore, the increasing number of individuals living with hiv and aids still places considerable pressure on the country’s social and economic development. this disease results in several direct and indirect expenditures for companies, including increased absenteeism and decreased productivity as well as escalating healthcare and hiv/aids awareness training costs (hebb et al. 2016). in terms of governance issues, the country has a well-developed corporate governance framework. the latest king report (king iv) centres on value creation in a sustainable manner (iodsa 2016). key concepts highlighted in king iv include ethical leadership, sustainable development, corporate citizenship, stakeholder inclusivity, integrated thinking and integrated reporting (iodsa 2016). there is an enhanced focus on sustainability matters in addition to financial performance. an integrated report entails a combination of the traditional annual report, which focusses mainly on financial performance, and a separate sustainability report. locally, integrated reporting is promoted by the integrated reporting committee (irc) of south africa. one of the main objectives of this committee is to design, distribute and encourage standardised integrated reporting guidelines. an efficient integrated report should reflect the economic, social and environmental dimensions of a firm (irc of south africa 2018). firms are encouraged to publish details related to the six capitals of their business models, including their financial, manufacturing, human, intellectual, natural and social and relationship capital (iodsa 2016). traditionally, financial performance has mainly been the basis on which current and potential investors have conducted investment analysis and decision-making (cooper 2017; iodsa 2011, 2016). sustainability-related risks relating to the other capital sources, however, pose a threat to the long-term value creation capacity of local companies. while south african investors have been slow to engage with the boards of investee firms on esg aspects, they are gradually starting to acknowledge and integrate esg aspects into their investment activities and decision-making (viviers & smit 2015). the increased interest in firms’ esg considerations stems particularly from the institutional investor community (atkins & maroun 2012; pasquini-descomps & sahut 2013; viviers & smit 2015). given that south africa is one of africa’s largest institutional investment markets, institutional investors play a critical role in influencing local corporate behaviour. they can encourage positive esg-related reforms in the investment sector (iodsa 2011). if ri is actively pursued by local investors, positive contributions can be made to socio-economic development in south africa (viviers et al. 2009). after the publication of the king iii report in 2011, a recommendation was made that a separate report should be released, focusing on the expectations of institutional investors (iodsa 2011). the code for responsible investing in south africa (crisa) was released in 2011 to guide institutional investors on how to perform investment analysis and activities effectively. the code highlights that it is no longer appropriate for institutional investors to focus narrowly on the monetary benefits to beneficiaries. attention should also be given to esg aspects which could have an impact on long-term sustainability and value creation (iodsa 2011). institutional investors have a fiduciary duty to act in the best interests of their beneficiaries (hebb et al. 2016). beneficiaries may, however, question whether esg aspects are related to financial performance. researchers differ on whether esg aspects are associated with long-term financial performance and corporate sustainability, as explained next. overview of previous studies and hypotheses development based on a meta-analysis of 52 studies on esg, csr, csp and cfp, orlitzky, schmidt and rynes (2003) concluded that the majority of authors reported positive relationships across industries and study contexts. more than a decade later, friede, busch and bassen (2015) also conducted a meta-analysis of 2 200 studies and reported that approximately 90% indicated a positive or neutral association between esg and cfp. pertaining to abnormal returns, revelli and viviani (2015) reported that the inclusion of csr in share portfolios is regarded as neither a weakness nor a strength compared with conventional investments. they based this observation on a meta-analysis of 85 studies and 190 experiments on the financial performance of sri. the heterogeneous findings could be ascribed to the different thematic approaches, investment horizons and analyses (revelli & viviani 2015). previous researchers employed a variety of accounting, market and value-based metrics, intended to gauge different aspects of cfp. while accounting-based cfp measures focus on a firm’s past performance, market-based metrics could be used to reflect expectations about future performance. value-based measures account for the cost of capital when assessing a firm’s value creation potential (margolis & walsh 2001). the association between environmental, social and corporate governance disclosure and accounting-based corporate financial performance in a seminal study, waddock and graves (1997) considered the link between csp and lagged roa, return on equity (roe) and return on sales (ros) in the united states (us) in 1990. they constructed a csp index by using kld data. they argued that strong financial performance could result in resource allocation to improve csp. as such, a virtuous circle is created where companies ‘do well by doing good’. rodriguez-fernandez (2016) confirmed the existence of such a circle, based on a positive link between csr and profitability for spanish companies. callan and thomas (2009) employed kld csp data and also noted a positive csp-cfp relationship (roa and ros). their findings imply that the benefits associated with investment in socially responsible practices outweigh the costs thereof. in addition, ferrero-ferrero et al. (2016) noted significant positive relationships between esg performance (particularly social and environmental aspects) and the thomson reuters datastream asset4 economic performance score for 15 eu member states. breuer and nau (2014) reported a similar association in the us between thomson reuters datastream asset4 esg scores and roa. michelon, boesso and kumar (2013) concluded that if csr initiatives are linked to stakeholder preferences, they have a larger effect on accounting-based cfp than other initiatives. some international authors also employed bloomberg’s esg disclosure scores. nollet et al. (2016) observed a u-shaped relationship between esg and roa for standard and poor’s 500 companies between 2007 and 2011. they hence argued that expenditure pays off only after a threshold csp has been reached. governance was founded to be the key driver affecting the observed relationship. in addition, qiu et al. (2016) noted a positive relationship between lagged profitability and bloomberg’s social disclosure score in the united kingdom (uk) between 2005 and 2009. they concluded that companies with more economic resources make more extensive social disclosures which yield positive financial benefits compared to those of their less profitable counterparts. several local authors employed the jse sri index as a proxy for csr and sri. nkomani (2013) found that firms not included in the index performed better over the period 2002 to 2011 than constituent companies. he compiled a total return index, including the net profit margin, roa and roe to measure cfp. in addition, mutezo (2014) reported insignificant positive associations between sri and roe and roa, while a significant positive relationship was noted between eps and sri. in contrast, demetriades and auret (2014) reported that there seemed to be no causal relationship between csr and cfp (roa and roe) between 1995 and 2009. du toit and lekoloane (2018) also reported no significant associations between csr and cfp (roe and price earnings) between 2009 and 2014. chetty et al. (2015), however, reported significant links at industry level between csr and eps, roa and roe between 2004 and 2013. the majority of south african authors have focused on csr that narrowly centres on the environmental and social aspects of a firm, but omits corporate governance. given the complex nature of esg, the usage of an aggregated index as a proxy for esg or sri is questionable. for the purpose of this study, bloomberg’s composite esg, as well as the individual esg disclosure scores, were thus employed. given inconclusive evidence on the nature of the relationship between esg and different accounting-based financial performance, two of the most commonly employed accounting-based cfp measures were incorporated for the purpose of this study. the following null hypothesis was formulated: h01: there is no relationship between the esg disclosure scores and the accounting-based cfp of selected jse-listed firms from 2011 to 2016. the link between environmental, social and corporate governance disclosure and market-based corporate financial performance in the international context, callan and thomas (2009) reported a positive link between kld’s csp and tobin’s q. similarly, breuer and nau (2014) noted that thomson reuters datastream asset4 esg scores were positively related to tobin’s q in the us. in contrast, horn et al. (2018) reported no significant association between csr disclosure and tobin’s q for selected south african firms, although a significant negative relationship was noted with firm value. they argued that there is a link between csr assurance and the need to enhance csr reporting credibility. since the relationship between tobin’s q and firm performance is confounded by endogeneity, other local authors excluded this measure (mans-kemp et al. 2017). lins, servaes and tamayo (2017) reported that us firms with high csr intensity had higher share returns than those with low csr during the 2008–2009 global financial crisis. trust that is built between a firm and investors through investments in social capital seemingly paid off when the market suffered this considerable shock. galema, plantinga and scholtens (2008) noted that sri impacted on us share returns by lowering the book-to-market ratio and not by generating positive alphas. they explained that excess demand for the relatively small sri stock universe predicates overpricing thereof. applying vigeo sustainability ratings, van de velde, vermeir and corten (2005) reported no significant outperformance of sustainabilityrated portfolios before the crisis. brammer, brooks and pavelin (2006) noted that so-called ‘socially least desirable shares’ had considerable abnormal returns in the uk. in addition, balatbat et al. (2012) reported that the returns of so-called ‘esg leaders’ in australia were lower than those of ‘esg laggards’. they argued that esg scores possibly ‘do not inform sufficiently about the true sustainability practices that provide a flow-on effect to firm performance’. hörnmark (2015) considered selected us and sub-saharan african companies and reported that esg-integrated portfolios generated significant positive alphas in emerging markets. viviers et al. (2008) considered risk-adjusted returns for local ri funds by employing the sharpe, sortino and upside-potential ratios. their findings showed that local ri funds underperformed relative to their benchmark indices between june 1992 and march 2002, but significantly outperformed their benchmark indices between april 2002 and march 2006. they remarked that sri has been acknowledged as an approach that can be implemented to manage esg risks effectively. several local authors conducted event studies to estimate sri portfolio performance. demetriades and auret (2014) employed the same risk-adjusted measures as viviers et al. (2008) and revealed that none of the event dates under consideration had any influence on jse sri constituents’ share prices. gladysek and chipeta (2012) investigated whether the announcement of sri index constituents (they regarded it as a csr signal for investors) had an impact on share returns between 2004 and 2009. by applying the capital asset pricing model (capm), they reported that the index constituents did not outperform those included in the jse all share index. in contrast, chetty et al. (2015) noted that investors were rewarded in 2004 and 2012 when firms entered the jse sri index. other authors applied the ohlson model in the south african context. de klerk and de villiers (2012) found that jse-listed firms with high levels of corporate responsibility reporting had high share prices. such reporting provides information to shareholders that could affect their valuation of a company. the ohlson model regards the market value of equity as a function of book value, accounting for earnings and other (non-accounting) value-relevant information. marcia et al. (2015) also investigated the value relevance of corporate responsibility reporting of 82 jse firms by applying this model. they reported no significant share price association and remarked that csr disclosure does not per se add value to a firm’s share price. several previous authors investigated the abnormal returns of esg portfolios (proxied by the jse sri index). in contrast, the authors of this study considered the market-based tsr and ey measures and employed bloomberg’s esg disclosure scores. the following null hypothesis was formulated: h02: there is no relationship between the esg disclosure scores and the market-based cfp of selected jse-listed firms from 2011 to 2016. the relationship between environmental, social and corporate governance disclosure and value-based corporate financial performance it is evident that previous international and local authors focused on accounting-based and market-based cfp measures. exceptions include balatbat et al. (2012), who incorporated roic in an australian study, and nollet et al. (2016), who examined the relationship between bloomberg’s esg disclosure scores and return on capital for selected standard & poor’s 500 companies. a significant negative relationship was reported with csp. given the paucity of research on the association between esg disclosure and value-based cfp in corporate south africa, the following null hypothesis was formulated: h03: there is no relationship between the esg disclosure scores and the value-based cfp of selected jse-listed firms from 2011 to 2016. research design and methodology to assess the business case for esg practices in south africa, a positivistic paradigm was adopted, which resulted in the collection and analysis of secondary quantitative data. sample selection the population consisted of all jse-listed firms for the period 2011 to 2016 (the king iii regime). the start of the research period concurred with the advent of integrated reporting locally. a combination of convenience and judgement sampling was used to draw a sample of 66 companies from six jse sectors. the convenience sampling technique was employed based on ease of collecting readily available standardised esg and cfp data. the judgement criteria were as follows: a firm had to be listed on the jse for at least two years (to ensure that there would be sufficient data points for statistical analysis). a firm’s esg disclosure score had to be available on the bloomberg (2017) database. a firm’s cfp data had to be available on the iress (2017) database. esg data were available for 373 firm-year observations, but the required financial data were available for only 359 firm-year observations. firms operating in the consumer goods, consumer services, healthcare, technology, telecommunications and industrials sectors (hereafter referred to as the considered sectors) were examined. firms listed in the basic materials and financials sectors were excluded from the sample as their annual financial statements, the nature of their activities and the level of regulation differ from those of the firms listed in the considered sectors. no companies were listed in the utilities sector during the research period. environmental, social and corporate governance disclosure scores in line with international researchers (such as breuer & nau 2014; ferrero-ferrero et al. 2016; pasquini-descomps & sahut 2013), esg was considered as the independent variable in this study. the bloomberg (2017) database provided standardised composite and individual esg disclosure scores for the considered jse-listed companies. the database gathers esg data from publicly disclosed corporate sources such as csr reports, integrated reports and company websites. in some instances, proprietary surveys are also conducted by bloomberg to request specific information. the bloomberg (2017) esg categories are indicated in table 1. table 1: bloomberg’s environmental, social and corporate governance considerations. corporate financial performance measures table 2 summarises the cfp variables that were used, consisting of accounting-based, market-based and value-based metrics. table 2: measurement of the selected corporate financial performance variables. in line with breuer and nau (2014), ferrero-ferrero et al. (2016), pasquini-descomps and sahut (2013) and balatbat et al. (2012), the authors controlled for firm size and leverage. it is likely that smaller firms will not have the same level of esg consideration as larger firms, mostly because of financial reasons. as firms become larger, it is expected that they will receive more attention from various external stakeholders. in the same way, large firms will have a tendency to respond to diverse stakeholders’ demands (breuer & nau 2014; waddock & graves 1997). market capitalisation data were sourced from iress and used as a proxy for firm size. management’s attitude towards risk could have a direct impact on cfp, resulting from decisions relating to cost management and investment opportunities (breuer & nau 2014; waddock & graves 1997). the debt-to-assets ratio can be utilised as a proxy for management’s risk tolerance (breuer & nau 2014). this leverage ratio was sourced from iress. the researchers also controlled for industry, as companies operating in six jse sectors were considered. data analysis descriptive statistics were computed to evaluate trends in the data set. pooled ordinary least squares (ols) and fixed effects and random effects panel regression analyses were conducted to investigate the relationship between the dependent and the independent variables. to select the appropriate regression models, the f-test for fixed effects and the hausman-test were used. panel regression analyses were conducted on the composite esg, as well as individual esg disclosure scores. specification errors may occur when conducting regression analysis, including heteroskedasticity and multicollinearity. acceptable tolerance values were reported and the results were adjusted for heteroskedasticity where applicable. pertaining to reliability, the reported observations are not generalisable to all jse-listed firms, as some sectors were excluded. the study can be reproduced in future by using a similar methodology. when considering validity, it should be taken into account that the esg scores as reported by bloomberg (2017) were used. firms’ actual esg performance could, however, deviate from their disclosed performance. ethical clearance was granted by the humanities research ethics committee at the researchers’ university. ethical consideration ethical clearance was obtained for this study: su-hsd-004264. results and discussion figure 1 provides a comparison of the trends identified in the mean scores of the composite esg and individual esg disclosure scores. the figure furthermore illustrates how changes in the individual components contributed to the change in the composite esg disclosure score over the study period. figure 1: annual mean values for the composite and individual environmental, social and corporate governance disclosure scores. environmental practices were the least disclosed esg aspect over the research period as depicted in figure 1. resource depletion and the effects of climate change are some of the prominent environmental realities that leaders of jse-listed firms should consider to ensure corporate sustainability (hebb et al. 2016). however, based on the low, almost stagnant environmental disclosure scores (e-scores), it seems as if the considered companies gave limited attention to the disclosure of environmental aspects. in contrast, the social disclosure score (s-score) displayed an increasing trend over the research period. given the socio-economic context of the country, it was expected that social aspects such as b-bbee, poverty and hiv and aids policies would receive considerable attention from jse-listed companies. despite the increase, mean s-scores remained relatively low. in a study conducted by van der ahee and schulschenk (2013), institutional investors were questioned on the level of importance they had placed on esg components. the results revealed that environmental and social aspects were viewed as ‘less important’ than corporate governance aspects. south africa offers a well-developed corporate governance framework to listed companies. the relatively high corporate governance disclosure score (g-score), in comparison to the e-score and s-score in figure 1, could, however, also be partly attributed to the surge in corruption cases in south africa. van der ahee and schulschenk (2013) and the world economic forum (2017) highlighted corruption as a prominent challenge for south african companies. when comparing the individual esg disclosure scores to the composite esg disclosure score, it is evident that the e-scores and s-scores mostly contributed to the increase in the composite esg disclosure score over time. the g-score remained relatively stable over the study period, thus providing a smaller contribution to the overall increasing trend of the composite esg disclosure score. despite the gradual increase, the composite esg disclosures remained below 35 (out of 100). regression analyses results for the sample regression analyses were conducted on the composite esg disclosure score as the independent variable and the respective cfp measures of the sample firms. no significant esg regression coefficients were reported (refer to panel a in table 3). in contrast, ferrero-ferrero et al. (2016) found a significant positive relationship between the level of esg performance and economic performance for selected companies in the european union. according to them, it is possible that a composite esg disclosure score can ‘conceal different levels of uniformity in the esg dimensions’. limkriangkrai, koh and durand (2017) confirmed that firms engage with the individual esg aspects to varying degrees. as such, the relationships between the individual esg disclosure scores and cfp measures were also investigated (see panel b in table 3). table 3: summarised regression results for the sample companies. while no significant relationship was noted between the composite esg disclosure score and accounting-based eps, statistically significant e-score and s-score regression coefficients are reported in panel b of table 3 for eps. these conflicting results highlight the importance of investigating the individual esg aspects, rather than focusing only on the composite esg disclosure score. based on the statistically significant negative association between the escore and accounting-based eps, it can be inferred that firms with high escores reported lower attributable eps in a specific year. the costs required to incorporate sound environmental initiatives could have a negative effect on the earnings realised by a firm, offering a potential explanation for the observed negative relationship. in contrast, firms that disclosed more details on their social considerations generated higher accounting-based earnings. in line with this finding, chetty et al. (2015) also noted a significant positive relationship between csr and eps in south africa. as mentioned in the literature review, csr mainly focuses on the environmental and social dimensions of esg. balatbat et al. (2012) similarly reported a statistically significant positive association between social aspects and economic performance for listed australian firms. a statistically significant negative regression coefficient is reported for the sscore and market-based tsr in panel b of table 3. this result suggests that those firms with higher s-scores generated lower market-based returns for shareholders. according to richardson and welker (2001), a possible explanation for this negative relationship is that socially responsible investments made by firms are consistently negative net present value projects that contribute to overall risk. although proponents of responsible corporate behaviour highlight the potential cost savings and long-term strategic advantages of csr, the market could hold a different view. this negative relationship might therefore be partly ascribed to market participants perceiving the spending on social projects as superfluous. attention was also given to associations between the individual esg disclosure scores and the cfp measures at the sector level. only three of the six considered sectors, namely the consumer goods, consumer services and industrials sectors, had sufficient data to conduct regression analyses. regression analyses results for the considered sectors differentiation in the consideration of esg aspects could be apparent for firms operating in different sectors. for example, a firm might engage in environmentally friendly activities, but could regard social responsibility aspects as less important, given that the firm’s operations rely heavily on preventing environmentally damaging production processes. all sector regression analyses were conducted with the individual esg disclosure scores as the independent variables, and the respective cfp measures as the dependent variable. consumer goods sector the results of the regression analyses conducted for the consumer goods sector are reported in table 4. table 4: regression results for the individual environmental, social and corporate governance disclosure scores for the consumer goods sector. a statistically significant positive relationship is observed between g-score and roa in table 4. this positive association reflects that consumer goods firms with high g-scores also reported high accounting-based roa ratios. as such, better-governed consumer goods firms were more effective over the research period at utilising their assets to generate income than their poorly governed counterparts. similar to the results reported for the overall sample in table 3, a significant negative relationship was observed between e-score and accounting-based eps, while a significant positive relationship was reported between the s-score and accounting-based eps for the consumer goods sector in table 4. therefore, the higher the s-score for a sample firm listed in this sector, the higher the reported accounting-based earnings by the firm. a negative regression coefficient is furthermore observed between the e-score and market-based ey. if an increase in the disclosure of environmental practices has a negative relationship with the eps of a firm, it is likely also to result in a negative association with the ey ratio. in addition, significant positive regression coefficients are observed between the g-score and the value-based roic and mva measures in table 4. based on this finding, it can be deduced that those firms that had sound corporate governance practices in place tended to have higher returns on invested capital and an increased capacity to create aggregated shareholder value, in comparison to their counterparts, which lacked sound corporate governance. consumer services sector the regression analyses results for the consumer services companies are reported in table 5. table 5: regression results for the individual environmental, social and corporate governance disclosure scores for the consumer services sector. similar to the findings reported in table 4 for the consumer goods companies, table 5 shows a statistically significant positive regression coefficient between the s-score and accounting-based eps. in addition, a significant positive market-based ey ratio is also noted. these results suggest that consumer services firms with high s-scores generated high accounting-based earnings and market-based ey. given the nature of this industry, it is understandable that aspects related to, among others, community relations, human rights, diversity and consumer protection would have an important role to play in the manner in which these firms conduct their business and their capacity to generate earnings. a significant positive regression coefficient is furthermore reported between the s-score and the spread in table 5. as such, it can be inferred that the considered consumer services firms that performed better in disclosing their social considerations earned higher returns in excess of their cost of capital. such firms could be benefiting from a lower cost of debt or equity capital. the majority of global banks, including a few south african banks, are signatories to various voluntary principles, such as the equator principles, which require them to assess and manage environmental and social risks in project financing (equator principles 2018; marco 2011). as a result, firms that are effectively disclosing their social considerations might be receiving a lower cost of debt when borrowing funds. similarly, responsible investors are particularly interested in firms that perform well in disclosing social aspects and as such might have a lower required rate of return. based on the significant negative regression coefficients reported between the g-score and value-based roic and croic (table 5), it seems as if the considered consumer services firms with higher g-scores generated lower roic and croic than those firms with lower g-scores over the study period. corporate governance compliance is often costly for firms (mans-kemp et al. 2017). these costs relate to the implementation of corporate governance practices such as costs of compliance, opportunity, disclosure and reputational costs (aguilera et al. 2008). the additional expenses incurred to comply with corporate governance standards could be a possible reason for the negative relationship observed for roic and croic. the higher the costs a firm incurs to implement initiatives and disclose information related to corporate governance practices, the lower the nopat and consequently also the fcf generated by the firm. a decrease in these values, by implication, would result in lower value-based roic and croic values. when investigating the relationship between the individual esg disclosure scores and firms’ ability to create long-term shareholder value (mva), a significant positive regression coefficient is reported for the g-score in both tables 4 and 5. the considered consumer goods and consumer services firms that were better governed therefore appear to have an improved ability to create sustainable shareholder wealth over the lifetime of the firm. industrials sector the regression results for the industrials sector are reported in table 6. table 6: regression results for the individual environmental, social and corporate governance disclosure scores for the industrials sector. table 6 depicts a significant positive regression coefficient between g-score and accounting-based eps. based on this finding, it can be deduced that well-governed industrial firms reported higher accounting-based earnings than those firms characterised by poor corporate governance practices. this outcome is in line with mans-kemp et al. (2017), who found a statistically significant positive association between corporate governance and eps for a sample of jse-listed companies that included several industrial firms for the period 2002 to 2010. a statistically significant negative regression coefficient is reported between the e-score and the value-based croic in table 6. this finding implies that industrial firms with high e-scores yielded low croic values. in contrast, significant positive regression coefficients were reported for the s-score and g-score and croic. it can hence be inferred that industrial firms that provided a detailed disclosure of their social and corporate governance practices had high value-based croic values. according to bauer, guenster and otten (2004), sound corporate governance practices lead to higher investor trust. as investors view well-governed firms as less risky, they may require a lower expected rate of return, resulting in a higher firm value. furthermore, well-governed firms may have high operating performance and therefore high expected future fcfs, which in turn, may lead to higher firm value over the long term (breuer & nau 2014). in table 7, the research hypotheses are linked to the most significant outcomes of the statistical analyses. table 7: summary of the most significant outcomes of the statistical analyses. as can be seen in table 7, the researchers rejected all three of the formulated null hypotheses. when considering the relationship between the composite esg disclosure score and the employed cfp measures, no significant relationships were observed. however, when distinguishing between the individual esg components, significant results were reported for the sampled companies. it therefore seems that the composite esg disclosure score failed to reflect the differences in esg performance. when a further distinction was made between the individual esg components at sector level, several significant results were reported. it is hence essential to consider the individual esg aspects most applicable to a specific sector in addition to a range of cfp measures when considering the relationship between esg and cfp. conclusions, limitations and recommendations sustainability-related challenges will continue to threaten the longevity of firms and society as the competition for resources constantly intensifies. as a result, it has now become more important than ever that firms acknowledge corporate sustainability challenges and actively manage their esg risks. previous authors mainly employed accounting-based and market-based performance measures when they considered the relationship between sustainability-related aspects (mostly csr and sri) and cfp in south africa. the business case for esg practices in south africa was assessed by focusing on a sample of jse-listed firms operating across six different sectors, during a period subsequent to the advent of integrated reporting. this study could be considered novel as the authors included comprehensive composite esg and individual esg disclosure scores. in addition, a variety of cfp measures that also incorporated a set of value-based metrics not only expanded upon previous studies, but also ensured that the complex nature of financial performance is being recognised. the study hence addresses a gap in the existing body of knowledge on esg and cfp in the emerging market context. based on the reported results, it is evident that esg risks are not homogeneous across sectors and, as such, corporate leaders should employ a differentiated approach to address the most important risks relevant to their operating environments. corporate managers need to acknowledge that esg considerations are a combination of diverse aspects. to generate sustainable returns, it is important for corporate managers to embrace a long-term focus when dealing with esg aspects. directors could include esg indicators to assess the competencies of management and the successful implementation of risk management mechanisms. shareholders should furthermore engage more actively with firms on esg concerns. given their scope of influence, institutional investors should deliberately implement the recommendations and guidance provided by crisa and the king iv report when engaging with investee firms. the study’s sample included firms from only six jse sectors. two sectors, namely the basic materials and financials sectors, that are essential in the local economy were omitted, given the nature of their primary activities and reporting. future researchers could investigate the relationship between esg and cfp in these sectors. in addition, it could be argued that investments in esg initiatives by firms realise returns only over a longer term than the considered six-year period. future researchers are hence encouraged to consider a longer study period when investigating relationships between esg and cfp. it should be noted that the considered esg disclosure scores might not necessarily reflect the true esg practices of firms. these scores were primarily based on corporate reporting. even though firms are required to disclose both positive and negative aspects, it is debatable whether they will do so, given the repercussions that this might have on their business. greater effort should thus be made to properly disclose a firm’s actual esg performance. attention should also be given to whether the currently employed measures accurately reflect the different dimensions of esg performance. future researchers should contemplate alternative ways to measure a firm’s actual esg performance. it is essential that stakeholders, such as shareholders, suppliers and customers, should ‘come on board’ by acknowledging that esg aspects should be considered and accounted for over the long run to create value in a sustainable manner. by focusing on sustainable financial and esg returns, companies, and investors, can do well by doing good. acknowledgements thank you to prof. kidd for 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strategy for sustainability: a business manifesto, harvard, boston, ma. world economic forum, 2017, the global competitiveness report 2017–2018, viewed 11 october 2017, from http://www3.weforum.org/docs/gcr2017-2018/05fullreport/theglobalcompetitivenessreport2017%e2%80%932018.pdf. abstract introduction the south african banking industry relative efficiency and the general data envelopment analysis model methodology and data results conclusion and recommendations acknowledgements references appendix 1 about the author(s) chris van heerden school of economics, faculty of economic and management sciences, north-west university, potchefstroom, south africa johan coetzee department of economics and finance, faculty of economic and management sciences, university of the free state, bloemfontein, south africa citation van heerden, c. & coetzee, j., 2019, ‘re-examining the ability to explain future south african banking share returns: a data envelopment analysis approach’, south african journal of economic and management sciences 22(1), a2852. https://doi.org/10.4102/sajems.v22i1.2852 original research re-examining the ability to explain future south african banking share returns: a data envelopment analysis approach chris van heerden, johan coetzee received: 18 oct. 2018; accepted: 03 june 2019; published: 16 sept. 2019 copyright: © 2019. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: using financial ratios is considered to be important when making informed judgments about investment portfolios. however, the ‘ideal’ set of ratios is an elusive notion on which the literature has failed to reach any consensus. aim: this study attempts to identify to what extent so-called ‘non-financial’ measures can outperform ‘traditional’ financial and risk-adjusted performance ratios to explain future share returns for south african banks in a momentum investment strategy. method: a multi-stage data envelopment analysis model was used in the study. results: the results suggest that non-financial measures are able to explain up to 90% of banking shares’ future returns, which is a 30% to 40% improvement on that of traditional financial and risk-adjusted performance ratios. in identifying the ‘ideal’ set of ratios for the south african banking industry, this study also found that pure technical efficiency, the price-to-earnings ratio and the static omega ratio were able to explain up to an average of 83% of future banking share returns. conclusion: the study contributes to the field of portfolio management in that both risk-adjusted performance ratios and non-financial measures can be used as short-term and long-term investment decision-making tools. further to this, the ability to explain future returns to some extent implies that the south african banking industry may be time-varying-information efficient. keywords: banking industry; data envelopment analysis; dea; financial and non-financial measures; risk-adjusted performance ratios; south africa. introduction the capital asset pricing model (capm) has played a significant role in modern portfolio theory for decades. the innovative work of sharpe (1964), lintner (1965), mossin (1966) and black (1972) brought together a model that ‘embodies a theory of what can be inferred about expected returns when markets are in equilibrium, homogeneous expectations prevail and when all investors pursue a mean-variance optimizing objective’ (van rensburg & robertson 2003:7). however, literature has shown that there are several empirical contradictions of the so-called sharpe-lintner-black (slb) model, brought about by the assumptions that expected returns are a positive linear function of market betas and that market betas are sufficient to describe the cross-section of expected returns (fama & french 1992). the most prominent contradiction of the slb model is reported by banz (1981), who found that the size effect contributes to the ability of market betas to explain the cross-section of average returns. another contradiction can be found in the work of bhandari (1988), who reported a positive relationship between average returns and leverage. although the slb model assumes that leverage risk should already be captured by the market beta, bhandari (1988) found that including leverage in a model (which already accounts for market size and beta) improves the explanation of average share returns. further studies also found evidence to support the book-to-market ratio (b/m); the price-to-earnings ratio (p/e); the return-on-equity ratio (roe); the dupont model to overcome the shortcomings of the roe ratio (berzkalne & zelgalve 2014; traub 2001); the dividend yield (dy); the implied dividend growth rate; the cash-flow-to-price ratio; and the price-to-net asset value (nav) ratio as additional ‘blanket’ proxies for unnamed risk factors that can enhance the explanation of average share returns (see, for example, asness, porter & stevens 2000; auret & cline 2011; auret & sinclaire 2006; basiewicz & auret 2010; basu 1983; chan, hamao & lakonishok 1991; fama & french 2017; hoffman 2012; hou, karolyi & kho 2011; johannes, korteweg & polson 2014; lakonishok, shleifer & vishny 1994; litzenberger & ramaswamy 1979; rosenberg, reid & lanstein 1985; soliman 2008; stattman 1980; van rensburg 2001; van rensburg & robertson 2003; zaremba & czapkiewicz 2017). however, the studies of chen and shimerda (1981) and pech, noguera and white (2015) argue that financial ratios tend to comprise overlapping information, which make the suitability of a small representative group of ratios possible, but to establish such an ‘all-inclusive’ group remains an enormous challenge. delen, kuzey and uyar (2013) attempted to address this problem by evaluating the underlying dimensions of several ratios and found that the net profit margin and earnings before tax-to-equity ratio possess the most promise for predicting future performance. the results from surveys conducted by gibson (1987) and matsumoto, shivaswamy and hoban (1995) contradict these findings. they report that security analysts and financial analyst charter-holders consider profitability and valuation ratios to be more insightful. conversely, pech et al. (2015) reported a wider range of ratios, pointing out that the dy, p/e and the roe ratio are some of the ratios that are more frequently used by equity analysts. nevertheless, the study of clark (1997) considers financial ratios as being backward-looking, lacking the ability to reflect long-term and future consequences of managerial actions. this may be due to: their reliability on internal historical data and the sensitivity to manipulation (van heerden & heymans 2013), their being ineffective to represent the many facets of performance in general (avkiran 1997), their inability to capture the interplay amongst the multiple resources and outputs of a company (davenport & sherman 1987), and their failure to explain the reasons for ‘good’ or ‘bad’ performances (avkiran 1997). to overcome these shortcomings, investors could typically consider the use of non-financial ratios as they are less exposed to manipulation, a more reliable source of information on firm failure, and better predictors of long-term performance (ames et al. 2012; kaplan & norton 1996; johnson & kaplan 1987; singleton-green 1993). given this background, the main objective of this study is to determine to what extent bank efficiency, as a non-financial measure, outperforms: (1) financial (or, traditional accounting) and (2) risk-adjusted performance ratios to explain ex-post future share returns for the six largest south african banks from a momentum investment strategy perspective. the study of jegadeesh and titman (1993) found that past ‘winners’ on average continued to outperform past ‘losers’, which implies that there is momentum in share returns, to some extent, which can be exploited as documented by fama (1991). for this study, this implies that the year-end rankings of each ratio at time t is used to determine which of the top six south african banking shares will be more profitable over a one, three, and five year investment horizon. after each consecutive year the rankings of each ratio is compared to the ex-post realised and risk-adjusted banking share returns to determine which of the ratios is more efficient in explaining ex-post future performance and thus more ideal to utilise in a momentum investment strategy. establishing which ratios are more consistent in explaining future performance can enable investors and portfolio managers to make more informed ex-ante decisions, using the more ‘ideal’ set of ratios as identified in this article. the scope of this study will, however, not include a comparative study of alternative momentum investment strategies, as the focus will be directed to determine only the most insightful ratios to use in the south african banking industry as future decision-making tools. also, this study will only consist of an ex-post analysis and will not include any form of forecasting (ex-ante analysis). the modelling flexibility of data envelopment analysis (dea) and its ability to address both quantitative and qualitative data, as well as discretionary and non-discretionary inputs (golany & storbeck 1999), makes it most suitable for this study. the significance of this study is further emphasised by the limited research in this field. only an estimated 1.63% of all dea application papers have been applied in the field of investment management (liu et al. 2013). in this study the goal of the dea model will be twofold. firstly, it is utilised to estimate three different forms of bank efficiency scores from the historical di900 reports that were converted to ba900 reports by the south african reserve bank (sarb 2017a). these efficiency scores incorporate the internal operations of a banks and entail pure technical efficiency, scale efficiency, and total technical efficiency (which is a combination of scale and pure technical efficiency). secondly, the same non-parametric, non-stochastic, mathematical programming approach is used to determine the ability of these bank efficiency scores to explain ex-post future banking share returns, along with that of other selected financial and risk-adjusted performance ratios. the dea model’s ability to acknowledge the interdimensional relationships (cooper, seiford & tone 2007) between the selected ratios and the ex-post future realised share returns for banks further reinforces its applicability as an investment decision-making tool and is therefore deemed appropriate for a study of this nature. the structure of this article is as follows: section two provides a brief overview of the south african banking industry and, specifically, highlights the benefits of this industry as an investment option; section three provides an overview of the concept of relative bank efficiency and the general dea model; section four provides a discussion on the methodology adopted in the study; section five reports the findings; finally, section six provides the conclusion and recommendations. the south african banking industry structure and performance the south african banking industry has changed substantially since especially 2001, when the number of registered banks equalled 41, which has subsequently fallen to 17 by the end of 2016 (sarb 2016). after the september 2001 terrorist attacks in the united states (us), global uncertainty had a particularly profound impact on the south african banking industry, as many smaller banks either lost their licences or merged with larger south african universal banks (stemmet 2016). as such, as of 2017 the south african banking industry was characterised by having four dominant universal bank holding companies, namely barclays africa group ltd (functioning under absa bank), the firstrand group ltd (which includes the banks first national bank – fnb – wesbank and rand merchant bank – rmb), the standard bank group ltd, and the nedbank group ltd. these so-called big four had a combined market share of approximately 83% in 2017 (sarb 2017b). investec bank ltd, which has a dual listing on both the london stock exchange and the johannesburg stock exchange (jse), is a high net worth specialist bank and the fifth largest according to asset size. capitec bank ltd has in recent years entered the retail banking environment and shown tremendous growth. in september 2017, it had surpassed nedbank in size according to market capitalisation and held the second-largest number of retail clients of all south african banks (bonorchis 2017b; businesstech 2017). the growth of capitec bank ltd has seen unprecedented levels since its february 2002 listing on the jse, where it had gained over 50 000% as at august 2017 (bonorchis 2017a). although the south african banking industry is highly concentrated with predominantly four large banks, by no means is the industry as a whole large in global terms. with total assets of approximately r4.9 trillion at the beginning of 2017 (sarb 2017b), the total assets-to-gdp-ratio has exceeded 100% consistently in recent years (stemmet 2016). for banks individually, in 2014 it was estimated that the largest south african bank, the standard bank group, was approximately 20 times smaller than the largest bank in the world (icbc) according to assets, 18 times smaller according to equity, and employed almost ten times fewer the number of personnel (coetzee 2016). although small in global terms, the industry as a whole is, however, well capitalised. for example, due to strict compliance requirements to the basel capital standards, the average total capital adequacy ratio (car) as of january 2017 was 15.9% (sarb 2017b). on an individual bank level, the common equity tier one (cet1) car ratio and the total car ratios are provided in table 1 for the six largest bank holding groups in south africa. the table also provides the most recent basel iii requirements relating to the leverage ratio and the liquidity coverage ratio. table 1: selected regulatory indicators according to basel iii for the top six south african banks for year-end 2016. the cet1 ratios for all six banks are well above the minimum south african requirements of 6.88% for year-end 2016, and the total capital ratios also exceed the minimum requirement of 10.38%. the leverage ratios also exceed the minimum of 4% set by the sarb and the liquidity coverage ratios (lcrs) are above the 2016 requirement of 70%. overall, the south african banking industry is well capitalised and complies with the basel iii requirements driving the international regulatory agenda for banks (sarb 2017b). the regulation and soundness of south african banks the south african banking industry is regarded as one of the best regulated in the world. the world economic forum’s global competitiveness report (gcr), for example, rates the soundness of south african banks as consistently being in the top 10 globally since 2009. table 2 reports the global competitiveness of five selected indicators provided by gcr that relate specifically to the south african banking industry and the jse. clearly, the banking industry is very competitive, and the soundness of banks in particular, suggests well-capitalised banks, that have been shown to be resilient to global systemic shocks, especially since the advent of the global financial crisis. table 2: the global competitiveness of the south africa’s banking industry. as of the end of 2017, south african banks were regulated by the banking supervision department (bsd) at the south african reserve bank (sarb). however, the regulatory and supervisory environment is set to change in the next few years towards the so-called twin peaks framework, which focuses on separating prudential and market conduct regulation and supervision: the former will be governed by the prudential authority (pa) and the latter by the financial sector conduct authority (fsca) (coetzee & de beer 2016). the so-called financial stability oversight committee (fsoc) will also be established to provide systemic oversight in the financial sector at large. these changes have been proposed amid the regulatory challenges post the global financial crisis of 2007–2009 throughout the world. more specifically, twin peaks is ‘intended to provide a streamlined system of licensing, regulating and supervising financial institutions, whilst at the same time providing a new approach to the enforcement of financial regulation, supervision, client complaints (including a revised ombud scheme), client advice and financial (literacy) education’ (coetzee & de beer 2016:74). the financial sector regulation (fsr) bill of 2015 is set to be the legislation used by regulators to enforce the twin peaks framework. the fsr is also set to provide clear guidelines for regulators regarding the systemic risk and financial stability facing south african banks (sarb 2017b). this macro-prudential approach to regulation is at the core of the future regulatory approach adopted by both the pa and the fsca and is aligned to global best practices. twin peaks will therefore provide a total revamp of the regulatory environment for the south african financial sector. overall, the south african banking industry is well regulated and capitalised and is regarded as one of the most sound in the world. these features suggest an environment that encourages future investment into the industry. relative efficiency and the general data envelopment analysis model the literature provides no consensus regarding which method is more appropriate in measuring bank efficiency (titko, stankevičienė & lāce 2014). the traditional approach mostly considered applying traditional financial ratios, but it is considered to provide unreliable results as these ratios are unable to capture the complex financial environment and all the activities of a bank (arshinova 2011; yang 2009). despite that, the study of mester (2003) also argues that efficiency measurement can be thought of as only one aspect of firm performance. nevertheless, to overcome the shortcomings of using traditional financial ratios, frontier approaches were introduced which are able to incorporate multiple inputs and outputs (titko et al. 2014). this new approach of measuring efficiency was initiated by studies like that of debreu (1951), who demonstrated the comprehensive quality of using a resource utilisation coefficient, and koopmans (1951), who introduced the concept of an efficient point. however, the novel work by farrell (1957) demonstrated how to measure efficiency in practice and was the first to recommend that the level of efficiency be measured by means of an equi-proportionate reduction in current inputs to produce predetermined levels of outputs. this can be accomplished by means of either a non-parametric, non-stochastic, mathematical programming framework (charnes, cooper & rhodes 1978), or a parametric, stochastic, statistical framework (aigner, lovell & schmidt 1977; meeusen & van den broeck 1977). the latter includes the stochastic frontier analysis (sfa), which constructs a smooth parametric frontier that considers stochastic noise in the data and allows for hypothesis testing regarding production structures and the degree of inefficiency (hossain et al. 2012; jacobs 2001). however, the need to impose an explicit parametric form for the underlying technology and an explicit distributional assumption for the inefficiency term makes this a less flexible model (sharma, leung & zaleski 1999). to deal with this, charnes et al. (1978) introduced a suitable alternative that entails a non-parametric, non-stochastic, mathematical programming framework called the dea model. this model was originally introduced under a limited constant returns-to-scale (crs) perspective, which generalises ‘the single-output to single-input classical engineering-science ratio definition to multiple outputs and inputs without requiring preassigned weights’ (banker, charnes & cooper 1984:1078). inspired by the work of allen (1939) and shephard (1953; 1970), which considered the possibility of increasing, decreasing or constant returns to scale in multiple input and output scenarios, banker et al. (1984) improved on the crs perspective by introducing a variable returns to scale (vrs) perspective, which accounts for possibilities such as capacity limitations on inputs. under both crs and vrs, the dea model has the ability to solve linear programming (lp) problems that generate a non-parametric, piecewise-linear, convex frontier (färe, grosskopf & lovell 1985). this enables the measurement of relative or comparative efficiency in terms of the inputs and outputs of a decision-making unit (dmu) (or in the case of this study, banks) by benchmarking the non-best practices with best practices in order to determine the extent of inefficiencies (avkiran 1999; jaforullah & whiteman 1999). although the dea model does not address the problem of output assessment, it seeks to combine multiple inputs and outputs in a single, non-arbitrary, non-subjective manner via the criterion of pareto efficiency without requiring specification of any a priori weights (nunamaker 1985). nevertheless, the results derived from the dea model are still sensitive to the selection of inputs and outputs (kumar & singh 2014), emphasising the importance of selecting the correct inputs and outputs. the significance of the dea model can be emphasised by its vast application. for example, in the health care sector (nunamaker 1983; omrani, shafaat & emrouznejad 2018; worthington 2004), in the agricultural sector (iglesias, castellanos & seijas 2010; kuhn et al. 2018), in the transportation sector (azadeh, ghaderi & maghsoudi 2008; barak & dahooei 2018; schefczyk 1993), in the education sector (aparicio et al. 2018; bessent et al. 1982), in the tourism sector (barros & dieke 2008; cheng, lu & chung 2010; van heerden & saayman 2018), in the industrial sector (fang, wu & zeng 2009; sueyoshi, goto & ueno 2010; wang & zhang 2018), in the communication sector (giokas & pentzaropoulos 2008; hu et al. 2018; resende & façanha 2005), in the energy sector (azadeh et al. 2008; shi, bi & wang 2010; zurano-cervelló et al. 2018), in local government (afonso & fernandes 2008; van heerden & rossouw 2014; xia et al. 2018), in the sport industry (boscá et al. 2009; roboredo, aizemberg & meza 2015), in the real estate sector (anderson et al. 2002; isik & topuz 2017; topuz, darrat & shelor 2005), in the construction industry (hu & liu 2018; tsolas 2011; xue et al. 2008), in the manufacturing sector (halim 2010; liu 2008; mahadevan 2002), in the retail sector (kahraman et al. 2018; xavier, moutinho & moreira 2015), in the insurance sector (barros, nektarios & assaf 2010; eling & jia 2018; wanke & barros 2016), and in the banking sector (quaranta, raffoni & visani 2018; sherman & gold 1985; van heerden & van der westhuizen 2008). however, the significance of this study can be emphasised by the limited research in investment management. the only existing literature in this field includes, amongst others, the use of dea as a portfolio selection criterion (dia 2009; edirisinghe & zhang 2008; huang et al. 2015; joro & na 2006; mashayekhi & omrani 2016; pätäri, leivo & honkapuro 2010, 2012), to measure portfolio efficiency in a mean-variance framework (liu et al. 2015), to evaluate fund managers’ efficiency (banker, chen & klumpes 2016), as a mutual fund performance assessor (abad, thore & laffarga 2004; alexakis & tsolas 2011; basso & funari 2016; chen 2008; kuosmanen 2007), to evaluate portfolio risk in the forex spot market (amiri et al. 2010), to evaluate the link between bank efficiency and share performance (beccalli, casu & girardone 2006; sufian & majid 2007), to evaluate the relationship between portfolio diversification and efficiency (choi & min 2017), as a complementary share performance tool to the traditional set of fundamental factors (van heerden & heymans 2013), as an investment tool to predict japanese bank share performance (avkiran & morita 2010), and to evaluate an investment fund’s or portfolio’s performance (lim, oh & zhu 2014; tarim & karan 2001). from the literature it is clear that the popularity of the dea model can be motivated by its flexibility, as it is capable of handling non-commensurate multiple inputs and outputs simultaneously (kirigia, sambo & scheel 2001; nunamaker 1985). its estimators are considered to be consistent, able to converge faster than estimators from other frontier methods, and unbiased, with the assumption of no underlying model or reference technology (grosskopf 1996; kittelsen 1999). the dea model is also able to uncover relationships that are unknown to other methodologies (kumar & singh 2014). furthermore, the efficiency scores generated from the dea model enable the characterisation of resource utilisation (førsund & hjalmarsson 1974), which is grounded on an initial set of objectives (mester 1993). the scope of this study will, however, be limited to focusing on only two elements of x-efficiency, namely technical and scale efficiency. x-inefficiency as a whole implies that banks are either wasting their inputs (that is, they are technically inefficient), or using the wrong combination of inputs (they are allocatively inefficient), or both (mester 2003). the inappropriate usage of the capacity size (too small or too large) can also be a contributing factor to total technical inefficiency. this is commonly referred to as scale inefficiency and can take on two forms, namely increasing returns to scale (irs) or decreasing returns to scale (drs). if the scale of the operation is considered to be too small and must be expanded in order to improve efficiency, the economies of scale are characterised as being irs. however, when the scale of operation is too large and must decrease in order to improve efficiency, it is characterised as being drs (zere et al. 2006). in the estimation process an input-orientated or output-orientated approach can be executed under a crs or a vrs perspective. the input-orientated approach will characterise the production technology of a dmu for producing a given output mix with the minimum inputs, whereas an output-orientated approach will characterise a dmu in pursuit of producing the maximum output bundle with the given inputs mix (coelli, rao & battese 1998). in order to determine the level of efficiency in which ratios explain future share returns, this study will adopt an input-orientated approach. using this approach with a vrs perspective will result in outputs increasing or decreasing disproportionally when the inputs increase; conversely, with a crs perspective, outputs will increase proportionally owing to an increase in inputs (avkiran 1999). however, the crs perspective will not function properly under conditions such as imperfect competition and constraints on finance that limit dmus, and in this case banks, from operating at their optimal scale (coelli et al. 1998). despite this, it is still recommended that the dea model be estimated separately under both the crs and vrs perspectives and then compared in terms of the generated efficiency scores (coelli et al. 1998): the efficiency scores generated from the vrs perspective represent pure technical efficiency that measures efficiency without scale efficiency, whereas the efficiency scores generated from the crs perspective represent technical efficiency that measures the inefficiencies resulting from the size of operations and input-output combinations (avkiran 1999). the difference between the vrs efficiency and crs efficiency scores represents a potential scale inefficiency measurement. to determine the economies of scale, an additional model must be estimated with a non-increasing return to scale (nirs) perspective. by comparing the technical efficiency scores of the nirs perspective with those of the vrs perspective, it can be determined if banks are operating at decreasing or increasing returns to scale (coelli et al. 1998). if these models generate efficiency scores that are the same, it will be an indication that banks are operating at decreasing returns to scale. however, if the efficiency scores of the vrs perspective and of the nirs model differ, increasing returns to scale exist. methodology and data the multi-stage dea model this study utilises the multi-stage dea model, which is estimated using the deafrontier software, a dea add-in for microsoft excel® developed by zhu (2016). in this model, consider k to be the number of inputs and m the number of outputs on each of n banks, where for the ith banks these inputs and outputs are represented by the vectors xi and yi. the m × n output matrix is represented by y, and the k × n input matrix by x. the constant returns to scale, input-orientated, multi-stage dea model can thus be illustrated by the following steps provided by coelli (1998), with minor changes to this approach when applying a variable returns to scale approach: first, conduct a radial lp process with the following form: θ is a scalar and λ denotes a n × 1 vector of constants. this process is continued n times, generating a θ for each of the banks. second, this process is followed by a second-stage lp process in which the sum of any remaining slacks is maximised, illustrated as follows: cxi denotes the input vector of the ith banks, which has been multiplied by θ (being contracted) from step 1; os denotes the m × 1 vector of output slacks; is denotes the k × 1 vectors of input slacks; and k1 and m1 are k × 1 and m × 1 vectors of ones. this process is continued n times, after which all the banks with no slacks and those who have a technical efficiency score of θ= 1 are identified and classed as ‘efficient banks’. this process is also duplicated for all banks with non-zero slack variables, after which they are classified as the ‘banks with slacks’ set. the ‘banks with slacks’ set is then used to estimate a sequence of radial movements based on projected points estimated in step 1 in order to obtain the projected point on the efficient frontier. conversely, the ‘efficient banks’ will be used only as a reference in the lp estimations from this stage forward. third, a sequence of k lps is conducted in order to identify all input dimensions that consist of slacks of the ith banks in the ‘banks with slacks’ set. this step will, however, break down if some inputs are found to be zero. in this process, each lp will allow contractions in only one of the inputs, which will determine the presence of potential slacks within these inputs. the lp for the jth input of the ith bank can be illustrated as follows: cx ji denotes the jth input of the ith bank, which is multiplied by θ (being contracted) that is obtained from step 1, x je denotes the 1 × ne vector of the jth input of all the efficient banks, and cxi≠j denotes the (k – 1) × 1 vector of inputs of the ith bank. this excludes the jth input, which is then contracted by being multiplied by θ, as obtained in equation 1.xe≠jdenotes the (k – 1) × ne matrix of inputs of all the efficient banks, also excluding the jth input, ne denotes the number of efficient banks as already identified in step 2, ye denotes the matrix of outputs of the efficient banks, and λ has a dimension of ne × 1. fourth, an lp is estimated for the ith bank in the ‘banks with slacks’ set, which seeks a radial reduction in all inputs that have already been identified during step 3 as having potential slacks. this estimation can be illustrated as follows: s denotes the subset of inputs that have potential slacks, and ns denotes the remainder of the inputs used. remember that the radial reduction in this specific step starts by applying the projected point (ye, cxi) that has already been estimated during step 1. fifth, it is still possible for some input slacks to remain after the radial reduction in the previous step. to overcome this problem, steps 3 and 4 must be repeated with the projected point (which has already been identified during step 4) until no remaining input slacks are present. finally, a radial expansion is conducted in the output slack dimensions until no output slacks remain. this can be accomplished by taking the projected points of the ith bank (as estimated in step 5) and repeating steps 3 through to 5. the final projected point from this step (which will be invariant to the units of measurements that were chosen) will be on the efficient surface. the slacks can then be estimated by subtracting the final projected point in this step from the projected point that was obtained in step 1. also, the peers of the ith bank can be identified from the λ vector of the final projected point. the benefit of using a multi-stage dea model is that it has the ability and advantage to focus on each bank individually, relative to sample averages or parametric populations. the model can thus adjust for exogenous variables that are beyond the control of dmus and accommodate multiple inputs and outputs without the need for homogeneous measurement units. it also does not require any assumptions of a functional form relating inputs to outputs and can focus on observed best-practice frontiers rather than on central tendency properties of frontiers. furthermore, it provides insight into the input and output quantities that inefficient banks must achieve in order to operate on the efficient frontier and it produces a single efficiency estimate for each bank in terms of its respective input-output relationships (charnes et al. 1978; nunamaker 1985). the multi-stage dea version is therefore appropriate for this study, as it overcomes two main shortcomings of the commonly used two-stage lp process (coelli 1998; lovell & pastor 1995): firstly, the two-stage lp process maximises the sum of slacks, where it should minimise it, and it identifies the furthest efficient point, where it should identify the nearest point; secondly, the two-stage lp process is not invariant to the units of measurement. sampling and data selection the data used for this study included annual financial ratios obtained from the iress inet (2017) database spanning from 2004 to 2016 (see table 3). the implied dividend growth rate and the equally weighted dupont were estimated in microsoft excel®. as the roe fails to account for financial leverage, a dupont index was constructed, where equal weights were assigned to financial leverage, return on assets, and the roe. the implied dividend growth rate was estimated by multiplying the retention rate with the roe, as obtained from the iress inet (2017) database. furthermore, monthly closings prices for barclays africa group ltd (bga), capitec bank holdings ltd (cpi), firstrand ltd (fsr), investec ltd (inl), nedbank group ltd (ned) and standard bank group ltd (sbk) were sourced from the iress inet (2017) database for the period 31 january 2004 to 31 december 2016. this time span was determined by the data availability at the time of the study. the monthly share returns and market capitalisation derived from these closing prices were adjusted for splits and dividends, accordingly, before being converted to an annual average. the monthly returns were estimated as follows: (pricet – pricet–1) ÷ pricet–1. table 3: the financial, non-financial and risk-adjusted performance ratios and measures under evaluation. the jse bank index (j835) was utilised as the market proxy and was also sourced from the iress inet (2017) database. based on the findings and arguments posed by van heerden (2016) and grandes and pinaud (2004), this study uses the 3-month negotiable certificates of deposits (ncds) rate as the risk-free rate proxy and the threshold proxy for the static omega ratio, which was sourced from the sarb website (2017a). owing to the unavailability of data, transaction costs were excluded. a list of the typically most popular risk-adjusted performance ratios and measures used in this study is provided in table 3. jensen’s alpha (jensen 1968) is included to evaluate the predictive ability of the market beta over the time horizon under evaluation. further to this, in order to account for higher moments and correlation in returns, the sharpe ratio is adjusted to account for value-at-risk (var), conditional expectation of loss (cvar), and the implementation of the cornish-fisher expansion (mvar). finally, as with the works of elyasiani and mehdian (1990), kaparakis, miller and noulas (1994) and wheelock and wilson (1995), this study will adopt an intermediation approach (sealey & lindley 1977) in the selection of input and output variables for the estimation of pure technical (vrs), scale, and total technical efficiency (crs). listed in table 4, these input and output variables for the period january 2004 to december 2016 were obtained from the historical di900 reports that were converted to ba900 reports on the sarb website (2017a). the monthly total of each variable (which also forms the main entries in the financial return statements) is used as reported in the ba900 statements (see column 2 in table 4), with the only exception being the deposits, loans and advances output variable which excludes sa group financing (item #111), and was used as an input variable. table 4: selected input and output variables for estimating technical and scale efficiency. results the results on the average ability of each ratio (across all six banks) to explain ex-post future share returns over a one-, threeand five-year investment horizon are depicted in figure 1. on average, pure technical efficiency (vrs) was able to explain 94% (the highest) of the ex-post future share returns over all three investment horizons under evaluation. total technical efficiency (crs) exhibited the second best performance in explaining an average of 91% of ex-post future share returns over the threeand five-year investment horizon. scale efficiency exhibited the second best ability to explain one-year-ahead share returns (92%) and the third best ability to explain ex-post future share returns over the threeand five-year investment horizon (90% on average for both periods). conversely, market capitalisation exhibited the poorest ability to explain ex-post future returns over all three investment horizons under evaluation (34% on average), followed by the equally weighted dupont index (41% on average) and the var-sharpe ratio (43% on average), with their poor ability to explain one-, threeand five-years-ahead share returns (ex-post). the financial ratio that exhibited the best performance over all three investment horizons under evaluation was the p/e ratio (82% on average), which supports the findings of van rensburg and robertson (2003). other top-performing financial ratios include the roe ratio (76% on average), the ey (69% on average), and the implied dividend growth rate (65% on average). figure 1: average ability to explain future returns (across all banks). the results reported in figure 1 (and table 1-a1 in the appendix) contradict the findings of fama and french (2017), muller and ward (2013), and van rensburg and robertson (2003) from a specifically banking industry point of view. more specifically, the ey (69% on average), cash-flow-to-price ratio (64% on average), b/m ratio (60% on average), and the market capitalisation (34% on average) performed relatively poorly and were inconsistent in explaining ex-post future returns over the different investment horizons. it is also interesting to note that the composition of the best performing financial ratios differed amongst the three investment horizons. although the p/e and return-to-equity ratios exhibited the best performance throughout all three investment horizons, the rest of the composition for each investment horizon differed. the other three top-performing ratios over the oneand three-year investment horizon entailed the earnings yield, cash-flow-to-price ratio and the implied dividend growth rate, whereas the implied dividend growth rate, price-to-nav ratio and the earnings yield were the other three top-performing ratios over the five-year investment horizon. these results imply that passive and active portfolio managers may consider different financial ratio compositions. the implication is that the most ‘ideal’ set of ratios will be influenced by the investment horizon, which to some extent may provide some explanation as to why past studies found different results (besides the fact that they might also be sector dependent). this time-dependency phenomenon was, however, not present with the evaluation of the risk-adjusted performance measures. the static omega ratio exhibited the best performance in explaining ex-post future share returns over all three investment horizons under evaluation (71% on average), followed by the treynor ratio (54% on average), the calmar ratio (53% on average), the sharpe ratio (53% on average), and the jensen’s alpha (52% on average). this implies that risk-adjusted performance ratios (including non-financial measures) can be used, to some extent, as a shortand long-term investment decision-making tool. however, the worst performing risk-adjusted performance ratios over the three investment horizons consisted of the sortino ratio (44% on average) and the different modified sharpe ratios, which entailed the mvar-sharpe ratio (45% on average), the cvar-sharpe ratio (43% on average), and the var-sharpe ratio (43% on average). overall, the results suggest that non-financial measures exhibit the highest average ability (92%) to explain ex-post future share returns over all three investment horizons, followed by the financial ratios (61% on average) and risk-adjusted performance ratios (51% on average). nevertheless, there is also consistency found in the top-ranked measures (per category) over all three investment horizons under evaluation. these ratios entailed pure technical efficiency (94% on average), the p/e ratio (82% on average), and the static omega ratio (71% on average), where this group of measures would have enabled an investor to explain 82% (on average) of future returns over all three investment horizons. tables 5–7 further highlight the findings that non-financial measures had the highest success rate in explaining future returns of individual banking shares, over the one-, three-, and five-year investment horizons (83%, 83%, and 67% on average). pure technical efficiency (vrs) exhibited the best performance, followed by scale efficiency and total technical efficiency (crs). the financial ratios outperformed the risk-adjusted performance ratios, with the p/e ratio having the highest success rate followed by the roe and price-to-nav ratios. from the risk-adjusted performance ratios perspective, the static omega ratio exhibited the best success followed by the treynor and the sharpe ratios. of interest to note is that market capitalisation exhibited the worst success rate in explaining the ex-post future share returns of firstrand ltd, standard bank group ltd, and nedbank ltd over all three investment horizons under evaluation, except for nedbank ltd over the five-year investment horizon. the sortino and cvar-sharpe ratios exhibited the poorest success rate in explaining the ex-post future share returns of capitec bank holdings ltd and investec bank ltd, over all three investment horizons (see tables 3–5). the only noteworthy exception was for barclays africa group ltd, where the p/e ratio exhibited the best success rate (as opposed to pure technical efficiency), whereas the equally weighted dupont (over the one-year horizon) and market capitalisation (over the threeand five-year horizons) exhibited the poorest success rate. furthermore, over the five-year investment horizon, there was no significant difference between the different ratios in explaining the ex-post future share returns of capitec bank holdings ltd. also, the price-to-nav ratio exhibited the best success rate in explaining the ex-post future share returns of firstrand ltd over all three investment horizons (see tables 5–7). table 5: average explanatory ability of ratios to explain one year ahead share returns per bank. table 6: average explanatory ability of ratios to explain three years ahead share returns per bank. table 7: average explanatory ability of ratios to explain five years ahead share returns per bank. these findings suggest that the non-financial measures, namely pure technical efficiency (vrs), scale efficiency, and total technical efficiency (crs), outperformed the ability of financial and risk-adjusted performance ratios to explain ex-post future share returns for the six individual south african banking shares. it is also noteworthy to report that the ex-post future returns of capitec bank holdings ltd (90% on average), investec ltd (64% on average) and firstrand ltd (60% on average) are best explained by all the measures over all three investment horizons under evaluation. on the other hand, the ex-post future share returns of standard bank group ltd is the poorest explained by all the measures (56% on average), where the risk-adjusted performance measures explained the least (34% on average). the ability to explain barclays africa group ltd’s ex-post future share returns also ranked second last (58% on average), with risk-adjusted performance ratios being able to explain only 36% (on average) over all investment horizons under evaluation. to conclude the empirical study, until this point pure technical efficiency (vrs), the price-to-earnings ratio and the static omega ratio were identified as the top performing ratios. however, these measures were only credited with being able to explain ex-post future share returns, but not identified as selecting tools in establishing the ranking order of the top performing banking shares. for this reason, it is also useful from a risk-adjusted perspective, to evaluate the ability of these measures to select the top two, three and four banking shares over the three investment horizons under evaluation. this implies that the ranking orders of the different efficiency scores were compared to the ranking orders derived from evaluating the realised risk-adjusted returns (average returns divided by the annualised standard deviation) over the three investment horizons. over the one-year investment horizon, figure 2 reports that pure technical efficiency (vrs) exhibited the greatest success rate, with an average ability to predict 63% of the top two banking shares (on an ex-post basis), followed by the p/e ratio (56% on average) and the static omega ratio (50% on average). however, pure technical efficiency (vrs) and p/e ratio exhibited similar performance in being able to predict the top three and top four banking shares (71% and 72% on average). it is also noteworthy to report that pure technical efficiency (vrs) and the p/e ratio were able to predict 100% of the top two banking shares during 2008, and to predict 83% (vrs) and 67% (p/e ratio) of the top two banking shares over the global financial crisis (estimated from 2008 to 2010). besides the poor ability of the omega ratio to predict 66% (on average, from 2004 to 2011) of the top four banking shares, it exhibited similar performance to pure technical efficiency (vrs) and the p/e ratio in predicting the top three banking shares. furthermore, the static omega ratio outperformed in predicting 100% of the top four banking shares in 2008, and exhibited the greatest ability to predict the top four banking shares (83% on average) over the global financial crisis (estimated from 2008 to 2010). on the other hand, in predicting the top three banking shares over the global financial crisis, all three measures exhibited similar performance (78% on average), and specifically in 2008 where 100% of the top three banking shares could be predicted by all three measures. figure 2: average ability of pure technical efficiency (vrs), the p/e ratio and static omega ratio to select the top performing banking shares: (a) 2004; (b) 2005; (c) 2006; (d) 2007; (e) 2008; (f) 2009; (g) 2010 and (h) 2011. over a three-year investment horizon, figure 2 illustrates that pure technical efficiency (vrs) and the p/e ratio exhibited the greatest ability in predicting the top two and top four banking shares in 2008 (100% and 75%), whereas all three measures exhibited similar performance in being able to predict 67% of the top three banking shares in 2008. however, on average, pure technical efficiency (vrs) outperformed the p/e and static omega ratio in predicting the top two, three and top four banking shares over the global financial crisis and over the entire horizon under evaluation (2004 to 2011). however, over the five year investing horizon the static omega ratio was more dominant in predicting the top three and top four banking shares (71% and 69% on average). the only exception was in predicting the top two banking shares, where pure technical efficiency (vrs) was more dominant (44% on average). nonetheless, the static omega ratio was better at predicting the top two banking shares in 2008 and more dominant at predicting the top two, three and top four banking shares over the global financial crisis (67%, 78% and 75% on average, respectively). there is only one exception to the former, where all three measures exhibited similar performance in predicting the top three and top four banking shares in 2008 (67% and 75% on average). overall, from these results it is more conclusive that non-financial measures may have the tendency to better explain future returns and to select top performing banking shares. although the results from this study may suggest that pure technical efficiency (vrs), the price-to-earnings ratio and the static omega ratio are the more ‘ideal’ set of ratios to consult, it is evident from figure 2 that there may be a tendency for risk-adjusted measures to be a better share selecting tools over a longer investment horizon. conclusion and recommendations from the literature it is clear that there is no consensus on the choice of an ‘all-inclusive’ group of ratios that can be used as a basis to explain future returns. this leaves a gap in the literature to identify the true drivers that will ensure the creation of future portfolio wealth. this study fills this gap by comparing the abilities of financial, non-financial, and risk-adjusted performance ratios to explain ex-post future returns for banks in the south african context for a specifically momentum-based investment strategy over one-, threeand five-year investment horizons. the results find that non-financial measures exhibited the overall highest average ability (92%) to explain ex-post future banking share returns over the three investment horizons, followed by the financial ratios (61% on average) and risk-adjusted performance ratios (51% on average). the most accurate non-financial measure was pure technical efficiency (vrs), because of its ability to incorporate the interdimensional relationships of banking operations and, in so doing, be less vulnerable to data manipulation. the financial and risk-adjusted performance ratios that exhibited the best performance included the p/e and the static omega. however, with the evaluation of the five top-performing measures per investment horizon, evidence suggested that passive and active portfolio managers may consider different financial ratio compositions, as each investment horizon emphasised a different composition of more ‘ideal’ performing ratios. nevertheless, the dominance of non-financial measures was further accentuated by demonstrating pure technical efficiency’s (vrs) ability to predict the top performing banking shares over the oneand three-year investment horizons from a risk-adjusted perspective. the static omega ratio, on the other hand, exhibited greater performance over the five-year investment horizon, in predicting the top three and top four banking shares. this implies that risk-adjusted performance ratios and non-financial measures can be used as a short-, and long-term investment decision-making tool, although the static omega ratio tended to be a better share-selecting tool over a longer investment horizon. this study raises a few opportunities for future research. firstly, additional non-financial measures such as balanced scorecards and the stochastic frontier analysis can also be investigated to determine their ability to explain future share returns as compared to the efficiency ratios used in this study. secondly, future studies can use the approach used in this study and apply it in other industries or sectors. these studies can also use a wider range of financial and risk-adjusted performance ratios. finally, the ability to explain future returns to some extent may imply that the south african banking industry may be time-varying information efficient. future studies can therefore determine whether or not rigorous regulation is a function of better share return predictability. acknowledgements competing interests the authors 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a. & czapkiewicz, a., 2017, ‘digesting anomalies in emerging european markets: a comparison of factor pricing models’, emerging markets review 31(june), 1–15. https://doi.org/10.1016/j.ememar.2016.12.002 zere, e., mbeeli, t., shangula, k., mandlhate, c., mutirua, k., tjivambi, b. et al., 2006, ‘technical efficiency of district hospitals: evidence from namibia using data envelopment analysis’, cost effectiveness and resource allocation 4(1), 1–9. https://doi.org/10.1186/1478-7547-4-5 zhu, j., 2016, ‘deafrontier’, viewed 27 june 2017, from http://www.deafrontier.net/deasupport/index.html. zurano-cervelló, p., pozo, c., mateo-sanz, j.m., jiménez, l. & guillén-gosálbez, g., 2018, ‘electricity mix assessment of the eu member countries using dea and effmixf’, computer aided chemical engineering 43, 445–450. appendix 1 table 1-a1: average ability to explain future returns (across all banks). table 2-a1: average ability of pure technical efficiency (vrs), the p/e ratio and static omega ratio to select the top performing banking shares. 493 sajems ns vol 4 (2001) no 3 global integration of africa versus regional integration in africa i willem naude and waldo krugeu "decision-making and management for economic development", faculty of economic & management sciences, potchefstroom university abstract proposals and schemes for regional integration have abounded in postindependence afiica, often with disappointing results. recently there has been a revival of interest in afiican economic integration. unlike in the past, regional integration is now motivated as a way to open up afiican economies. this paper assesses whether regional integration amongst afiican states is the best way to achieve open economies. the conclusion is that regional integration between afiican states may be of limited value, apart from possibly contributing to better co-ordination of sound macro-economic policies. instead, integration between afiican countries and higher-income regions, such as euroland, may be a preferred strategy. jelf 15 1 introduction according to the united nation's human development index (hdi), 18 of the 20 least developed countries in the world are in afiica. afiica's unsatisfactory economic development experience has in recent years come increasingly under scrutiny. the so-called afiican development "tragedy" is reflected in persistent poverty, low growth and high inequality. during the 1980s, the average growth in gdp per capita in sub-saharan afiica (ssa) was 1.3 per cent. current estimates put per capita income in afiica (in ppp terms) at roughly us$ 1045 more than 10 times lower than that in the average oecd country. the result of low growth and low per capita incomes is that more than 40 per cent of the african population may be living below the accepted poverty line ofus$ 1 per day. taking into account measurement methods, afiica also has the most unequal distribution of income in the world exceeding that of latin america. on a political level, calls have increasingly been made for afiica to reverse this process of economic underdevelopment through "afiican unity". calls for and discussions about an "afiican century", "the afiican renaissance", a "united r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 3 494 states of africa" has all been prominent in recent times. of course, calls for african unity is nothing new the abuja treaty of 1948 having already called for an african economic union by the year 2000. this paper critically assesses, from an economic point of view, the potential of regional economic integration amongst african countries for promoting economic development in africa. it does so by considering the recent explanations for africa's poor economic development and by assessing the african experience with regional integration. the insights from these analyses are then combined with recent theoretical advances in understanding the extent to which economic integration schemes leads to divergence or convergence of per capita incomes amongst members states. the paper concludes, with reference to the recent free trade agreement between south africa and the eu, that integration amongst african states may be sub-optimal to integration between african states and a higher income region (e.g. the eu) and that regional cooperation in terms of economic policy and political stability may be vital in the face of significant neighbourhood effects on economic growth. seen in this way, the contribution of this paper is to call on african states to focus on economic integration with countries outside of africa for expansion of trade and for obtaining technology and investment. in this, the paper sounds a positive note on the advantages of globalisation for african economic development. african countries should furthermore not expect of economic integration agreements amongst themselves to lead necessarily to greater trade. the advantage of regional integration amongst african countries lies rather in its potential to enhance economic policy co-ordination and the adoption of sound macroeconomic policies and governance practices. the economic development case for regional integration between euroland and southern africa can thus be made. the paper is structured as follows. in section two it is showed that there is a great consensus that a major cause of africa's disappointing economic performance is that fact that african economies are amongst the most closed economies in the world to international trade. it is argued that regional integration is called for as a way to ensure trade liberalisation but on a limited scale. in section three africa's experience with regional integration in the past is seen not to have been successful, and that it contributed little to intra-regional trade in africa. in fact, the argument that regional integration can assist to enlarge the markets for african products is shown to be false, as most african countries have similar revealed comparative advantages and trade in the same basic commodities. in section four, some new contributions to the theory of regional integration are set out. these contributions can be applied to the african situation to argue that regional integration may present africa with a lose-lose situation and that integrar ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 495 sajems ns vol 4 (2001) no 3 tion between african economies and a higher-income economy may be preferential. section five concludes. 2 explaining africa's economic development crisis the economic crisis in africa has led scientists and policy makers to use a number of approaches to gather evidence as to the causes of the crisis. these approaches included use of cross-country growth regressions, case studies as well as micro-economic survey evidence on households, markets, firms, labourers and investors. micro-economic longitudinal surveys have been conducted with increasing regularity in african countries since the early 1990s. these include household surveys and so-called living standard measurement surveys that have indicated that macro-economic reforms and greater openness of african economies can lead to improvements in living standards (see e.g. demery). they also include the world bank's regional programme on enterprise development (rped) that surveyed firms in eight african countries. these surveys supported recent policy implications of the endogenous growth literature2 but also supported the macro-economic evidence of the cross-country regressions as far as suggesting the importance of lowering the riskiness of the african environment and of opening up african economies to foreign trade. cross-country growth regressions have been popular in economics since the revival of growth theory and the rise of the so-called endogenous growth theory, see for instance barro (1991) and sala-i-martin (1997). in these regressions, which are typically run using some adaptation of the solow-model, the dummy variable for "africa" as a region was initially consistently significant. a number of authors (e.g. easterly & levine, 1997) expanded the set of variables in order to account for this "african dummy". the found that six broad sets of variables were significant in explaining the african dummy, namely the lack of social capital in african communities coupled with high levels of ethnic diversity; the lack of openness to trade; deficient public services; africa's geography and high riskiness of investment in africa; the lack of financial depth of african economies; and africa's high aid dependence. from the perspective of regional integration, many calls for regional integration amongst african countries in recent years have been motivated by the finding r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 3 496 that african economies need to be more open to international trade. thus, regional integration is seen as a reciprocal way of lowering trade barriers, but without subjecting previously sheltered industries to the full force of international competition. although it will be shown that this policy prescription is wrong, the diagnosis is correct and there is now a significant consensus that one of the most serious causes of africa's slow growth has been its lack of openness to trade. as noted by jenkins and thomas (1999: 4) with reference to the cross-country regressions "almost all of these concerned exclusively with africa find that impediments to trade have been detrimental to growth perfonnance, reducing the annual growth rate by between 0.4 and 1.2 percentage points". in the regressions of sachs and warner (1995) openness to international trade is based on a composite indicator consisting of the size of tariffs, the extent of nontariff barriers, the difference between the black market and official exchange rates, the type of economic system, and the extent of state control over major exports. sachs and warner (1995) fmd that most of the countries in africa were effectively closed to international trade for the 25 years from 1965 to 1990. only botswana and mauritius were "open" for any length of time. the lack of openness was especially negative as far as it contributed to the failure of manufacturing in africa. this is firstly because closed economies meant that the input prices of capital and intennediate inputs were above world market prices. secondly, the closed domestic markets were small, preventing scope for either economies of scale or domestic competition. as a result, african manufacturing !inns remained inefficient, which in turn caused reduced investment and skills fonnation (jenkins & thomas, 1999: 9). the overall impact of this vicious cycle is the low growth rates in africa and the inability of african countries' per capita incomes to convergence to levels of other countries. ng and yeats (1999) found that in africa, countries that adopted less restrictive governance and trade policies were in fact able to achieve significantly higher levels of per capita gdp as well as higher growth rates for exports. many countries have embarked on regional integration as a "reciprocal" manner to liberalise trade as opposed to unilateral trade liberalisation. in this light, it can be understood that from an economic point of view, calls for african regional integration in 2000 are different from the calls that were made for african regional integration in the years immediately after independence. then, the calls were made based on arguments for larger markets, as well as political arguments. today the calls are made to ensure the opening up of african economies (collier & gunning, 1995: 387). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 497 sajems ns vol 4 (2001) no 3 3 regional integration in africa most of the current regional integration groupings in africa have been in existence for over 30 years. the major regional economic integration agreements in africa is summarised in table l. table 1 regional integration agreements in africa regional group name member countries acronymn cepgl economic commuburundi, rwanda, democratic repubnity of the great lic of congo lakes countries eccas economic commui burundi, cameroon, central african nity of central afrirepublic, chad, congo, equatorial can states guinea, gabon, rwanda ecowas economic commubenin, burkina faso, cape verde, nity of west african cote d'ivoire, gambia, ghana, states guinea, guinea-bissau, liberia, mali, . mauritania, niger, nigeria, senegal, i sierra leone, togo mru mano river union guinea, liberia, sierra leone pta preferential trade angola, burundi, comoros, djibouti, agreement eritrea, ethiopia, kenya, lesotho, madagascar, malawi, mauritius, mozambique, namibia, rwanda, seychelles, somalia, sudan, swaziland, uganda, tanzania, zambia, zimbabwe sadc southern african deangola, botswana, lesotho, malawi, velopment commumozambique, namibia, swaziland, nity south africa, tanzania, zambia, zimbabwe udeac · central african cuscameroon, central african republic, i toms and economic chad, congo, equatorial guinea, gaunion bon uemoa west african ecoi benin, burkina faso, cote d'ivoire, · nomic and monetary mali, niger, senegal, togo i union sacu southern african botswana, lesotho, south africa, · customs union swaziland r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 3 498 table i shows that there are currently 9 major regional integration schemes in ssa. in order to assess the feasibility of a 'united states of africa", one must judge the success of these schemes in contributing to the economic development of their member states. a large literature exists on regional integration in africa (see e.g. yeats, 1998). from this literature, it seems fair to draw out the following "stylised facts" of african regional integration. first, despite decades of regional integration agreements, intra-regional trade still comprises only 12 per cent of total african exports. second, in the trade patterns amongst african countries, trade between only 5 countries completely dominates intra-african trade (excluding south africa). these are cote d'ivoire, nigeria, kenya, zimbabwe and ghana. together the trade between these 5 countries account for over 75 per cent of intra-regional trade. third, african intra-regional trade is dominated by four products. none are manufacturing goods; all are commodities namely petroleum, cotton, maize and cocoa. these commodities are responsible for 50 per cent of intra-african trade. fourth, despite decades of regional integration, the percentage of intra-regional trade in africa has not increased significantly. in other words, there is little evidence that regional integration in africa has lead to trade creation. table 2 summarises the percentage share of intra-regional trade in the various regional integration groupings in 1970, 1985 and 1993. table 2 percentage share of intra-regional trade in africa, 1970-1993 regional group 1970 1985 1993 cepgl 0.4% 0.8% 1.1% eccas 2.4% 2.1% 2.5% ecowas 3.0% 5.3% 8.6% mru 0.2% 0.4% 0.0% pta 9.6% 5.5% 7.0% sadc 5.2% 4.7% 5.1% udeac 4.9% 1.9% 2.3% uemoa 6.4% 8.7% 10.4% source of data: yeats, 1998 table 2 indicates that in over 30 years, the movement towards regional integration has done little to contribute to trade amongst african countries. in major groupings such as the pta and sadc, trade has actually declined in percentage r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 499 sajems ns vol 4 n03 tenns. this suggests that african countries' trade with the rest of the world has been increasing must faster that intra-regional trade. other evidence seems to suggest that this integration of africa with the rest of the world (outside africa) is not only a pattern in trade in goods, but also in tenns of capital markets for instance through capital flight from the continent. collier for instance, argues that up to 30 per cent of the wealth of africa could currently be held outside the continent. fifth, if one considers the imports of ssa countries, almost 75 per cent of this consists of capital goods such as machinery and transport equipment. the current economic structure of ssa countries is such that they have very little capacity to meet these needs and many african countries show a revealed comparative advantage (rca) in the same products. in other words, -there seem to be very little motivation for african countries to trade with one another given the lack of complementarity in trade patterns. the above overview of regional integration has shown that regional integration in africa is unlikely to lead to substantial trade between african countries. as supported by yeats (1998: 2) this makes less compelling arguments that regional trade can help overcome problems of small domestic markets in african countries. moreover, if the contributions from the new theory of regional integration are correct, then indeed regional integration may present africa with a lose-lose situation. these will be outlined in the next section. 4 africa and the theory of regional integration the classic contribution towards understanding the economics of regional integration had been made by viner (1950). viner used the terms trade creation and trade diversion to detennine in which instances it would be beneficial for countries to engage in regional integration. baldwin and venables (1995) contain a good overview of the subsequent literature on understanding trade creation and trade diversion. the practical experience of various regional integration agreements has supported the implication in viner's and other's work that the effect of regional integration on the welfare of a participating country may be ambiguous. venables (1999) point to the experience of the eu where regional integration has led to convergence of per capita incomes amongst member states. however, in ecow as and other agreements, regional integration has led to divergence in per capita incomes. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 3 500 to predict who gains and who loses in a regional integration agreement, venables (1999) has recently integrated two strands of research, namely research on the comparative advantage of countries and research on the importance of agglomeration forces. with reference to the former strand of research, venables (1999: ii) concludes: typically, the country in the free trade agreement (fta) that has comparative advantage most different from the world average is most at risk from trade diversion. thus, if a group of low income countries form an ft a, there will be a tendency for the lowest income members to suffer real income loss due to trade diversion. in contrast, if an ft a contains a high income country (relative to other members and to the world average) then lower income members are likely to converge with the high income partner. venables' contribution to incorporate agglomeration forces into the understanding of regional integration is a useful contribution that contains vital insights from the so-called new economic geography. given the great concern in africa about the continent's lack of manufacturing development, it is necessary to provide a more detailed explanation. regional integration may lead to welfare-inducing changes in the agglomeration of economic activities in member countries. this is because regional integration (through for example an ft a) makes it easier to supply consumers from a few locations. this would lead to the relocation of industries in either one of two ways, each with different implications for convergence of divergence of per capita incomes between countries. the first is when the regional integration causes particular sectors to become more spatially concentrated e.g. a certain country experiences an agglomeration on financial services, another of manufacturing enterprises, another of commercial agriculture, etc. in such a case, despite adjustment costs, the net effect of regional integration may not necessarily be greater inequality between countries. ifhowever, regional integration leads to manufacturing as a whole to cluster in a few locations, it may lead to the de-industrialisation of less-favoured regions. this will lead to divergence in per capita incomes amongst member states. as shown by venables (1999: 17) this is more likely to occur if manufacturing as a whole is a small share of the economy as in most african economies. the agglomeration forces descnbed above may interact with competitive advantage forces. specifically, agglomeration may accentuate the competitive advantage force in the direction of divergence in the case of developing countries (venables, 1999: 18). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 501 sajems ns vol 4 (200 i) no 3 the conclusion from the above analysis, when combined with the stylised facts on african regional integration is that regional integration schemes amongst african countries could lead to divergence in incomes due to agglomeration forces, as well as the comparative advantages that will be enjoyed be only a few countries. schiff (1999) extends the theory of regional integration by asking not whether regional integration should be pursued or not, but that if it is pursued, what criteria should be used by countries to decide on a partner country or block. this question is relevant in the present context, since if it is the case that regional integration amongst african countries could lead to divergence in per capita income, and regional integration with higher income countries is preferred, a decision should be made about which country to integrate with. schiff (1999) shows that pre-fta (free trade area) volume of trade is not a useful criterion for selecting a partner bloc. instead, he concludes that: a home country will be better off with a large partner country (or bloc). this is because a large partner country is more likely to satisfy the home country's import demand at world prices. thus, for sade countries, it will be more beneficial to integrate with euroland than with south africa. the ft a as a whole is likely to be better off if each country imports what the other exports (rather than each country importing what the other imports, as was shown in section 3 to be the case in africa). the recommendation from the above is that african countries should pursue unilateral trade liberalisaton on a most favoured nation (mfn) basis as a preferred strategy to regional integration, with a ft a with a higher income region the second option. however, it must be added here that this does not mean that regional integration groupings such as those listed in section 3 should necessarily be abandoned. there is a strong case to be made for the maintenance and expansion of these. this is because there is empirical evidence that significant "neighbourhood" effects exist in africa. easterly and levine (1995) found that there are significant spillovers of growth performance between neighbouring countries in africa. they conclude that if neighbouring countries in africa act together to improve economic policies and political stability, the effects on the growth rates of all are much greater. specifically, the results suggest that the effect of neighbours adopting a policy change (e.g. opening up trade) is 2.2 times greater than if a single country acted alone. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (200 i) no 3 502 5 summary and conclusions this paper critically assessed, from an economic point of view, the potential of regional economic integration amongst african countries for promoting economic development in africa. it did so by considering the recent explanations for africa's poor economic development and by assessing the african experience with regional integration. the insights from this analysis were combined with recent theoretical advances in understanding the extent to which economic integration schemes leads to divergence or convergence of per capita incomes amongst members states. it may be concluded, with reference to the recent free trade agreement between south africa and the eu, that integration amongst african states may be sub-optimal to integration between african states and a higher income region (e.g. the eu). specifically, regional trade agreements between ssa countries could be of limited value and could even lead to trade diversion and a divergence of per capita incomes amongst member states. older arguments for african regional trade integration agreements centred round the lack of market size in individual african countries. however, given the wto's gatt, the lome agreement with the eu and the generalised system of preferences (gsp), few external obstacles to fmding markets for african countries' products still exist. the recommendations following from this paper are therefore that instead of first and foremost promoting regional integration and/or a united states of africa, that african policy-makers focus on the following: the liberalisation of import barriers on a most favoured nation (mfn) basis to increase the openness of their economies; the concluding of a free trade agreement (ft a) with high-income country (-ies) in the form of north-south regional integration. the south african fta with the eu and possibility of extending this agreement to sadc offers a starting point. the use of regional integration agreements not with the primai)' expectation of leading to increased trade or regional convergence, but to achieve mechanisms of co-operation between african countries in terms of macroeconomic policy making and for providing a politically and economically stable environment to facilitate the repatriating of the huge amounts of african wealth currently held outside of the continent. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 503 sajems ns vol4 (2001) no 3 the advantages of the above strategy are that trade creation occurs, which could facilitate convergence between african per capita incomes and that of the rest of the world, that foreign direct investment and technology transfers are raised, that cheaper inputs needed can be sourced and that a lock-in (commitment) mechanism is created for reducing the risk of african countries reneging on trade liberalisation. it also alleviates the problems of negative neighbourhood effects in africa. the call made in this paper is therefore that african states should focus on economic integration with countries outside of africa for expansion of trade and for obtaining technology and investment, and should expect of economic integration agreements amongst themselves not to lead necessarily to greater trade, but to enhance economic policy co-ordination and the adoption and maintenance of sound macro-economic policies and governance practices. endnotes an earlier version of this paper was presented at a graduate seminar, faculty of economic sciences, universitiit paderbom, january 2000. the authors wish to thank the many participants, in particular professor mike gilroy, for their useful comments. financial assistance from the national research foundation, making possible the collaboration with the university of paderbom is gratefully acknowledged. the usual disclaimer applies. 2 these are that four broad avenues of policies could raise economic growth, namely policies that ensure (a) learning by doing (romer,1986), (b) human capital formation (lucas, 1988), (c) research and development (aghion & howitt, 1992) and (d) public infrastructure investment (barro, 1990). references baldwin, r. & venables, aj. (1995) "regional economic integration" (in grossman, g. & rogoff, k. (eds.) handbook of international economics, vol. 3. amsterdam: north holland). 2 barro, r. (1991) "economic growth in a cross-section of countries", quarterly journal of economics, 106(2). 3 collier, p. & gunning, j.w. (1995) "trade policy and regional integration: implications for the relationship between europe and africa" the world economy, 18: 387-410. 4 collier, p. gunning, j.w. (1999) "explaining african economic performance", journal of economic literature, 37. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 3 504 5 easterly, w. & levine, r. (1995) "africa's growth tragedy: a retrospective", policy research working paper no. 1503, washington dc: the world bank. 6 jenkins, c. & thomas, l. (1999) "what drives growth in southern africa?", crefsa quarterly review, 1: 2-11. 7 ng, f. & yeats, a. (1999) "good governance and trade policy: are they the keys to africa's global integration and growth?", policy research working paper no. 2038, washington dc: the world bank. 8 sachs, j. & warner, a. (1995) "economic reform and the process of global integration", in brainard, w. & perry, g. (eds.) brookings papers on economic activity, 1. 9 sachs, j. & warner, a. (1997) "sources of slow growth in african economies", journal of african economies, 6(3). 10 sala-i-martin, x. (1997) "i just ran two million regressions", american economic review, papers and proceedings, 87(2). 11 schiff, m. (1999) "will the real natural trading partner please stand up? "policy research working paper no. 2161, washington dc: the world bank. 12 venables, a. (1999) "regional integration agreements: a force for convergence or divergence?" policy research working paper no. 2260, washington dc: the world bank. 13 viner, j. (1950) the customs union issue, new york. 14 yeats, a.j. (1998) "what can be expected from african regional trade agreements? some empirical evidence", policy research working paper no. 2004, washington dc: the world bank. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . page 1 of 1 reviewer acknowledgement http://www.sajems.org open access acknowledgement to reviewers in an effort to facilitate the selection of appropriate peer reviewers for the south african journal of economic and management sciences, we ask that you take a moment to update your electronic portfolio on https://sajems.org for our files, allowing us better access to your areas of interest and expertise, in order to match reviewers with submitted manuscripts. if you would like to become a reviewer, please visit the journal website and register as a reviewer. to access your details on the website, you will need to follow these steps: 1. log into the online journal at https:// sajems.org 2. in your ‘user home’ 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https://sajems.org/index.php/sajems/user mailto:publishing@aosis.co.za f:\ejour\ecoman\ftp\ecoman_v6_n1.prn.pdf sajems ns vol 6 (2003) no 1 118 value-added tax and its implication for the provision of private health services in botswana ________________________________________________________________ zein kebonang lecturer of law, university of botswana ________________________________________________________________ abstract this paper examines the impact of value added tax on the provision of private health care in botswana and argues that government cannot succeed in the discharge of its social obligations unless the private sector is also taken on board. the introduction of value added taxation has led to an over-whelming demand for and constraint on government health facilities and a decline in the number of patients seeking private health care service. the government’s success in providing health facilities must be complimented by private sector particip ation and this can be achieved by providing certain incentives such as zero rating and exempting the provision of certain health care services. jel h23 introduction botswana has recently introduced a value added tax (vat)1 to replace the sales tax2. vat, unlike sales tax2, which was selective in its application, is a comprehensive tax. absent any exemption, it taxes almost all goods and services. under current vat legislation, the provision of health services has been brought under the act. under the 2nd schedule of the vat act, public health facilities are exempt from vat. certain drugs (particularly hiv-aids related drugs) prescribed under schedules 1, 2 and 3 of the drugs and related substance act3 are also exempt. private health facilities, however, do not benefit from the same exemption. except for certain drugs, the act provides for a uniform tax rate of 10 percent3 that must be paid by patients and collected by medical practitioners in respect of private health services. the same does not apply in respect of government operated or aided hospitals 4. besides the 10 percent vat, patients on medical aid schemes are required to contribute an additional 10 percent of the cost of consultation, and other services such as laboratory services, x-rays sajems ns vol 6 (2003) no 1 119 and other non-invasive examinations like an ultrasound, to mention but a few. vat doubles the financial contribution for all income groups on medical aid. whereas a person with a higher income may have no difficulty in making an almost 20 percent payment on his account, those with incomes in the lower ranges will experience difficulty to cope with the added expense. the escalation in costs confines patients to the following options: either to switch over to government health services or to stop treatment altogether. the cumulative effect is a reduction in life expectancy, an increase in the spreading of disease and ultimately a decrease in the number of people who contribute to the tax base. furthermore, because the value of these health services is taxed, the service provider must identify and value the taxable services, with the result that the correct application of vat becomes problematic. in this regard, vat encourages an imperceptible mitigation of the cost of service by an increase in the cost of drugs that are otherwise exempt from vat. further, the exemptions as they relate to drugs, disregard the fundamental issue that it is not the sale of these prescription drugs that constitutes the core business of medical practitioners; it is the service that is fundamental. experience indicates that, as private health services become expensive and unaffordable, governments adopt the burden of providing such services. this would require increased budgetary allocations, human resource development and expansion of current facilities, which the fiscal may not be in a position to provide5. it is submitted that good health is fundamental for an active and productive life6. the right to good health should therefore not be compromised by one’s ability or inability to pay for it. indeed, the right to good health has now been espoused in international documents on human rights. the international covenant on economic, social and cultural rights commits signatories, including botswana, to recognize ‘the right to enjoyment of the highest attainable standards of physical and mental health’7. the universal declaration states that ‘everyone has the right to a standard of living adequate for the health and well-being of himself and his family, including food, clothing, housing and medical care and necessary social services’8. while zero-rating health services9 will narrow the tax base and reduce revenue, a good balance between government’s economic goals (of raising revenue) and government’s social policy (providing health services) must be struck. the government must recognize that without private sector participation in service delivery, government would not be able to achieve some of its objectives. zerorating medical services will address in one measure the limitations faced by government in providing health services to its citizens. sajems ns vol 6 (2003) no 1 120 the role of the state the role of government in relation to health-care, involves the combination of the following; a) a regulator, b) a funder and c) a provider. the regulation of the activities of doctors has been done through delegation to professional bodies10. with respect to state hospitals, the government has played a strong funding role. government through general revenue finances the public health system. user fees of p2.00 for outpatients and p1.00 per day for inpatients are levied. the introduction of vat now provides an alternative approach to state funding, which is, funding from taxation. the ministry of health the ministry of health is responsible for all health matters, including the development, research, administration and implementation of national health policy 11. through its various departments the objectives of the ministry include the improvement of the health status of all botswana citizens by providing quality affordable and accessible preventive, promotive, rehabilitative and curative health services through community and multi-sectoral participation and involvement by the year 201612. private sector health care most hospitals and clinics in botswana are either state-owned or funded, and every citizen has the right to appropriate health treatment almost free of charge. however, people may opt for private health care, which option is expensive. applying vat to private health facilities while exempting government facilities imposes a financial penalty in the form of tax on the former. patients are expected to pay for exercising their right to appropriate treatment in the form of a 10 percent tax on the health services they have received. medical aid schemes, which are a form of insurance, provide an element of cost sharing between the state and the private sector. a patient must be allowed to make a choice as a consumer. vat constrains the freedom of choice, however, because it increases the cost associated with the exercise of that choice. ultimately, when private services become too expensive, patients must depend on government facilities. government’s budgetary position may not be able to accommodate sajems ns vol 6 (2003) no 1 121 this increased demand. if experiences in other jurisdictions are considered an indication, any attempt to pursue legal avenues to compel government to provide health services would in all probability fail13. botswana’s medical bill has increased over the number of years14. with the hiv-aids pandemic, the cost will continue to escalate. the high and rising health cost imposes an onerous burden on those who pay, namely; the private sector (businesses providing benefits for their employees), the government or individuals either through direct payment as patients or through private insurance premiums. the rising cost of health care places a strain on public finance. a great number of people may not have sufficient resources to afford medical insurance or pay for necessary health care. without private sector participation, government shoulders the entire responsibility. the idea of partnership must be extended to include stakeholders. to keep the cost of health care low, government must also provide necessary incentives. these would include zero-rating medical facilities in respect of private medical services. indeed the national health policy provides that the development of the private health sector shall be supported and in particular the cooperation of such sector with the public sector shall be encouraged. by comparison, certain jurisdictions have zero-rated basic health services: australia, uganda, namibia and the united kingdom have zero-rated some health services. the key objective is to ensure for wider access and affordability. rising cost also places an enormous financial strain on the private sector, with this cost often being passed to the patient. further, medical aid organizations may find that their premiums are rising at a rate that deters many individuals from renewing their subscription. this may result in the latter having to curb the rate of increase by restricting the cover available to policyholders. a reduction in the amounts charged for the provision of medical services is not even an option. health costs are often pushed up by changes to the prices charged by those who supply the medicines and the technology. there are also other ‘suppliers’ of health are sources of increasing cost; for instance, medical staff, whose wages and salaries have to be paid. medical practitioners and medical-aid organizations are not in a position to influence or contract out of these costs. sajems ns vol 6 (2003) no 1 122 medical aid membership statistics in botswana the following table shows the number of people covered by private medical aid schemes and those who personally incur the cost of health care. the rest of the population depends on government health facilities. country’s population 1.7 million number of people covered by medical aid schemes afa schemes 196 842 bomaid 55 330 private patients total 12 500 264 672 fiscal policy v. social policy whilst an argument may be made that the primary function of a tax system is to generate revenue needed to finance public administration and the provision of social and economic infrastructure, this function must be balanced with competing social claims. according to the national development plan 8, the government’s recurrent expenditure on health is expected to slow down and this raises the question of sustainability of the health care system in the long run. government would, in the long term, be limited to providing only services it can afford. this may impact negatively on the attainment of government’s health objectives. if government is to succeed in its objective of improving the quality of health care services offered in botswana, it ought to make certain concessions. also, the vital role and contribution of the private sector should be recognized. the imposition of vat on medical services runs contrary to the spirit of vision 201615, which espouses a claim that all batswana must have access to good quality health facilities16. access does not only mean access to government facilities but to private facilities as well. publicly funded health facilities are funded through taxpayer contributions, whilst private health services are largely funded by private funds. consequently, private patients should therefore not be required to pay vat on private services for a state sector they do not use. sajems ns vol 6 (2003) no 1 123 conclusion the pursuit of a healthy citizenry requires the active involvement of both the state and the private sector. this requires that the state and the private sector should co-operate in partnership to ensure that the provision of health care is not undermined. the provision of health care has over the years become costly. while this rise in cost appears to be absorbed by government and the private sector, it is invariably passed on to the patient through an increase in the price of prescription drugs, subscription fees and an increase in the cost of medical services generally. the fact that certain prescribed drugs in the private sector have been exempted from vat indicates that there is a measure of insight into the negative effect of vat on the users of private health services. taxing health expenditures is indeed an area that deserves a careful approach when it comes to the method of taxation. currently, insurers assume a 90 percent of medical expenses for patients on medical aid schemes with the remaining 10 percent being borne by the patient. vat now makes the individual responsible for almost 20 percent of the account. better coverage needs to be supplied by medical aids. with respect to certain medical aid schemes, for example bpomas, this would require a significant increase in contributions from government and government employees. in the case of the other health coverage plans, the clients and their employers would have to provide the extra funds. employers will need to recover their contributions. to do this they may have to limit the benefits they provide to their employees and in certain instances simply shift the burden of payment to their employees. zero-rating health services will obviate some of these attendant and glaring problems. admittedly good health does not depend purely on direct medical provision. factors such as income, an unpolluted environment, and a safe lifestyle significantly contribute to the attainment and maintenance of good health. the imposition of vat on private medical services fails to recognize the valuable contribution provided by the private sector. while government grapples with different economic and social realities, its solutions and responses to such challenges must be pragmatic. the national health policy explicitly states that the government shall, when planning its activities, put health promotion and care and disease prevention among its priorities, the basic objective of which shall be access by all citizens of botswana to essential health care, whatever their financial resources or place of domicile. in respect of medical services, vat simply places an excessive burden not only on government but also on people it is intended to assist. sajems ns vol 6 (2003) no 1 124 endnotes 1 value added tax act, 2000, act no 1 of 2001. 2 act no 1of 1993. 3 act no 18 of 1992. 3 see section 7 of note 1 supra. 4 see paragraph 1 and 2 of 3rd schedule. 5 in the united kingdom the court in r v secretary of state for social services, ex parte hincks (1979) 123 sol jo 436, held that it was not the function of the court to direct parliament what funds to make available to the health service and how to allocate them. the court could only interfere if the secretary of state acted so as to frustrate the policy of the act or as no reasonable minister could have acted. these views were also expressed in re j (a minor) 1992 (4) all er 614 @ 625. 6 doyal, l & gough, i. (1991) a theory of human needs, london, macmillan, explore the arguments. 7 international covenant on economic, (1976) social and cultural rights article 12. 8 universal declaration of human rights (1948), article 25. 9 countries such as australia, namibia, the united kingdom and kenya have either zero-rated or exempted the provision of certain health services. botswana could thus learn from the experiences of these countries. 10 these include the nurses association, dental association, private medical practitioners association and the nurses council. 11 see the national health policy (1995), which was adopted through presidential directive cab 21 (b)/95 dated 20th july 1995. 12 a more expansive concept of health care would include protection from disease and accidents, protection from adverse environmental factors, the promotion of an environment which would foster improvements in health, and the provision of health care. 13 see r v sheffield ha ex parte seale (1995) 25 bmlr 1 where auld j articulated the position as follows, “it is not arguable…that the health authority is bound, simply because it has undertaken to provide such a service, to provide it on demand to any individual patient for whom it may work, regardless of financial an other constraints upon the authority..” see also r v central birmingham health authority, ex parte collier (1988) unreported, reproduced in part however in kennedy i and grubb a; medical law-text with materials (butterworths, 1994, 2nd ed.) 428, wherein the court observed as follows, ‘difficult and agonizing judgments have to be made as to how a limited budget is best allocated to the maximum advantage of the maximum number of patients. that is not a judgment the court can make’. sajems ns vol 6 (2003) no 1 125 14 in the 2002 budget speech, the ministry of health was allocated an amount of p380 million and the hiv-aids project under which all hivaids activities are consolidated (including the provision of anti-retroviral drugs) being allocated p200 million. it is estimated that as more people die of hiv-aids, the government budgetary allocations will not be sufficient to meet the demand and constraint placed on governmental health facilities. thus the position would require an examination of sharing of responsibility for health between private individuals (for their own health and that of others), the state and those who take on responsibility through their status as employers or health professionals. 15 vision 2016: a long term vision for botswana adopted in 1997. 16 the vision acknowledges that although botswana’s health infrastructure has improved steadily since independence, well-trained staff does not man many of the clinics and health posts across the country nor are they equipped with adequate equipment. sajems ns vol 4 (2001) no 3 412 post-soviet globalisation m peter van der hoek law school, erasmus university, rotterdam, netherlands and academy of economic studies, bucharest, romania abstract in this paper, i will focus on the current situation with regard to globalisation from a historical perspective, while i will also look at possible future developments. the term globalisation appeared in a dictionary for the first time in 1961, but the concept of globalisation is not always clear. according to levitt (1993) a global corporation "operates ( ... ) as if the entire world (or major regions of it) were a single entity; it sells the same things in the same way everywhere". this describes a problem of some of us companies operating in foreign markets rather than to define globalisation meaningfully. globalisation is sometimes viewed as synonymous to internationalisation, increasing international interdependence, or as a development towards relations acquiring relatively distanceless and borderless qualities. i interpret globalisation as economic integration of countries in the world economy on the basis of open markets and free movement of goods, services, workers and capital. jel f 15 p 27 1 introduction the fall of the berlin wall in 1989 and the collapse of the soviet union in 1991 are the most important events of the late 20th century. few observers foresaw these events. as late as in february 1989 fugitives trying to escape eastern germany were shot. in december 1990, when i was in tallinn, estonia, i discussed the situation in the soviet union with someone who had been correspondent in moscow for a swedish newspaper for over ten years. thus, he knew the soviet union very well. yet, he believed that the balties would not be able to secede from the soviet union, certainly not before the turn of the century. only nine months later, however, this was exactly what happened after the failed coup of august 1991. the soviet union collapsed and the baitics regained their independence. this illustrates that predictions are very difficult to make even for those who are well informed i, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 413 sajems ns vol 4 (2001) no 3 in this paper i will not make predictions. however, i will not ignore the future either. i will focus on the current situation with regard to globalisation from a historical perspective, while i will also look at possible future developments. the term globalisation appeared in a dictionary for the first time in 1961, but the concept of globaiisation is not always clear (rodrik, 2001). in the literature concepts of globalisation can be found that sometimes seem fuzzy. according to levitt (1993) a global corporation "operates ( ... ) as if the entire world (or major regions of it) were a single entity; it sells the same things in the same way everywhere". this seems to describe a problem of a number of us companies operating in foreign markets rather than to define the concept of globalisation in a meaningful way. some us companies try to sell products that were developed for the home market in foreign markets. this is a far different approach compared to many japanese companies, which develop products for foreign markets and try to sell them in these markets. an example is the lexus, a car that is widely sold in the us market. emotions sometimes seem more important than facts and rational arguments. when interviewed, demonstrators against globalisation do not always appear able to provide a meaningful defmition. at the g8 meetings in genoa in july 200 i a variety of protest groups marched on the streets to protest against globalisation. protesters also voice their opinions on the intemer. they seem to have some influence on official institutions as well as companies. the next g8 meeting will most likely be held in some remote place. world bank development projects have been abandoned. starbucks has promised to sell "fair trade" coffee beans in its coffee shops. clothing importers in the usa settled after they had been sued over working conditions in the american commonwealth of saipan in the pacific. the internet has proved an important tool in organising protest groups, which seem to have globalised faster than their target enterprises. however, a crucial question is who elected them? the governments they fight are in the end accountable to voters, but who holds the protest groups accountable? globalisation is sometimes used as synonymous to internationalisation, which could be interpreted as increasing international interdependence. globalisation is also defined as a development towards relations acquiring relatively distance less and borderless qualities (schoite, 1997). i interpret globalisation as economic integration of countries in the world economy on the basis of open markets and free movement of goods, services, workers and capital. this implies that products are sold across countries irrespective of distances and borders between the various outlets. global products comprise a wide range of products including food (e.g., kellogg's cereals), beverages (e.g., coca-cola), stimulants (e.g., marlboro cigarettes), clothes (e.g., levi's jeans), pharmaceuticals (e.g., bayer aspirin), music recordings (e.g., madonna), office equipment (e.g., xerox copiers), transport vehicles (e.g., ford), and travel services (e.g., holiday inn). howr ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol4 (200 i) no 3 414 ever, this is a qualitative characterisation rather than a quantitative and precise account of global products. the role of governments is limited with regard to this concept of globalisation. market principles have gained popularity in the last decades of the 20lb century. in western countries this occurred in the 1980s. leading politicians including president reagan in the usa and prime minister thatcher in the uk heavily emphasised the market as the organising principle. privatisation became a key word. in the 1990s, market principles also gained popularity in developing countries and former communist countries. after the collapse of the soviet union and the end of the cold war profound changes occurred in central and eastern european societies. a major shift from principles of planning and control to market principles could be observed. the omnipresent fist of the centrally planned economy was replaced with the invisible hand of the market economy in a relatively short period of time. the economic consequences of these upheavals proved to be very large. in the i 990s, gdp in central and eastern european countries fell dramatically. in 2000, real gdp in the commonwealth of independent states (cis) the former soviet republics except the three baltic states amounted to 55 per cent of its 1989 level. in the former east bloc central and eastern europe, the baltics and the cis this figure amounted to 68 per cent (ebrd, 2000). given the notorious allocative inefficiency of the centrally planned economies in central and eastern europe, however, a fall of real gdp is not identical to a decline in the standard of living. a decrease of the production of weapons and barbed wire does not necessarily reduce the welfare of individuals. nonetheless, the transition from centrally planned to market economies has proved to be painful. 2 globalisation over time over time the world economy has greatly benefited from globalisation. economic theory explains that mutual gains can result from international trade if there are comparative advantages in the production of goods between nations. dutch experience from 1850 to the end of the napoleonic wars provides a dramatic demonstration of the way in which western eur9pe interacted with the world economy in that epoch. in the mid-18 th century britain removed all trade and tariff restrictions unilaterally. in 1860 it had concluded reciprocal treaties for freer trade with france and other european countries, which had mostfavored nation clauses (maddison, 2001). historically, the first half of the 20th century was an interruption of the move towards free trade. world war i shattered the old liberal order and international trade collapsed. this was a result of increasing protectionism during the great depression and the beggar-thyr ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 415 sajems ns vol 4 (2001) no 3 neighbor policies. only after world war ii did the move towards free trade resume, giving rise to a sustained period of high economic growth. table 1 shows annual growth rates of gop for different periods and regions. it reveals interesting developments. first, economic growth was indeed relatively high in 1950-1973 in most regions and thus also in the world. second, in the last two centuries economic growth was typically higher in the usa compared to western europe, but the reverse was true in 1950-1973. third, economic growth in eastern europe was typically in line with that in western europe with the exception of the period 1973-1990, when eastern europe lagged behind. fourth, economic growth in japan was exceptionally high in 1950-1973, when the japanese economy few two times as fast as the economies in the western world. fifth, in the 19 century economic growth in africa exceeded that in asia, but lagged behind with the western world. in the first half of the 20th century, however, economic growth in africa was considerably higher than in western europe and at the same level as in the usa. in 1950-1973 economic growth in africa was comparable to that in the western world. in this period african growth exceeded somewhat economic growth in the usa, while it was only a little bit lower than in europe. sixth, economic growth in asia was the lowest in the world until the mid-20th century. until 1950 the annual growth rate was lower than 1 per cent, but in the post-war period it was over 5 per cent. table i average annual gdp growth rates, 1820-1998 1820-70 1870-1913 1913-50 1950-73 1973-98 western europe 1.65 2.10 1.19 4.81 2.11 eastern europe 1.36 2.31 1.14 4.86 0.73 usa 4.20 3.94 2.84 3.93 2.99 latin america 1.37 3.48 3.43 5.33 3.02 japan 0.41 2.44 2.21 9.29 2.97 asia (excl. japan) 0.03 0.94 0.90 5.18 5.46 africa 0.52 1.40 2.69 4.45 2.74 world 0.93 2.11 1.85 4.91 3.01 source: maddison, 2001 globalisation is not a new phenomenon. on the contrary, it already occurred centuries ago. mussa (2000) points out that the extent of global economic integration through international trade today is, by some key measures, not much greater than it was a century ago. around 1900, however, roughly two-thirds of gop was in the goods producing sector of the typical industrial country. now that situation is reversed, and roughly two-thirds of gop is in the service sector of the typical industrial country. if trade shares are measured as ratios of internar ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 3 416 tional trade of goods to the output of goods production, then those shares are soon to have increased significantly from a century ago. therefore, mussa (2000) stresses that this supports the view that international integration of markets for goods is significantly greater today than a century ago. the globalisation process seems to have stagnated in the first half of the 20th century. table 2 shows that exports decreased relative to gop in the most important industrialised countries (plus the netherlands) in the first half of the 20th century. exports rose in the second half of the 20th century. the increase in the post-war period was much larger, however, than the decrease between the two world wars. in terms of exports the globalisation process thus flourished in the second half of the 20th century after a period of contraction in the first half of that century. given the data in tables i and 2, williamson (1997) seems correct in his characterisation of the different periods. he speaks of the late 19th century belle epoque, the dark middle years between 1914 and 1950, and the late 20th century renaissance. the first and last epochs were characterised by rapid grovl-th; economic convergence as poor countries caught up with rich ones; and globalisation, marked by trade booms, mass migrations, and huge capital flows. the period 1913-1950 is associated with slow growth, a retreat from globalisation, and economic divergence. table 2 exports as a percentage ofgdp, 1913-1998 1913 i 1929 1950 i 1973 1998 usa i 3.7 i 3.6 3.0 i 4.9 10.} japan i 2.4 • 3.5 2.2 i 7.7 13.4 france 7.8 8.6 7.6 i 15.2 28.7 germany i 16.1 i 12.8 6.2 i 23.8 38.9 uk l 17.5 i 13.3 11.3 i 14.0 25.0 netherlands 17.3 17.2 12.2 i 40.7 61.2 world i 7.9 l 9.0 5.5 10.5 17.2 source: maddison, 200 1 history thus offers an unambiguous positive correlation between globalisation and convergence. williamson's detailed analysis of the pre-world war i years leads him to the conclusion that the correlation seems to be causal. he concludes that globalisation was the critical factor promoting economic convergence (williamson, 1996). before the collapse of the soviet union, central and eastern european countries formed an almost closed trading bloc. trade witltin the council for mutual economic assistance (cmea) dominated their international trade relations and only r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 417 sajems ns vol 4 (2001) no 3 a small share of trade was conducted with the rest of the world. in particular, the soviet union was a closed economy with a share of trade with other cmea countries of 90 per cent (ebrd, 1999). exports of eastern europe and the former soviet union were not significant. in 1913, the region's share in world exports was nearly the same as its share in the world population. its share in the world population steadily declined, whereas its share in world exports initially increased. seven years after the collapse of the soviet union, however, its share in world exports was at the same level as in 1913. thus, the relative importance of eastern europe and the former soviet union in terms of exports was equally small at the end and in the beginning of the 20th century. table 3 exports population share of eastern europe's exports and population in world total,1913-1998 1913 1950 1973 1998 4.1 5.0 7.5 4.1 4.4 3.5 2.8 2.0 source: maddison, 200 i seven years after the collapse of the soviet union and the cmea the cis countries were still to a large extent dependent on trade links with other transition countries, in particular russia. yet, the liberalisation of external trade in the early 1990s led to a reallocation of trade flows away from the cmea towards the european union. this holds in particular for estonia, the czech republic and hungary, where exports to the european union stood at some 50 per cent of gdp (ebrd, 2001). trade with the rest of the world also increased, but by much less. therefore, regionalisation seems to reflect developments in central and eastern europe after the collapse of the soviet union more accurately than globalisation. regionalisation seems a growing trend. as of mid-2000 114 regional trade agreements were in effect and virtually all wto-members are partners in at least one regional trade agreement. in the western hemisphere, the north american free trade association links canada, mexico and the usa. in europe, the european union is linked by bilateral free-trade agreements to the countries in central and eastern europe. a number of recent regional trade agreements in europe and central asia concern the integration of countries of the former soviet union as well as with their neighbors. both in central and latin america and in asia the pace of conclusion of regional trade agreements continues to be rapid. also in africa and the middle east regional trade agreements are growing (wto, 2001). this growing trend of regionalisation may give rise to a tripolar view of the world, with the usa, japan and the european union being the three poles. however, trade groupings are not always stable in the long run. the sysr ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 3 418 tern of british commonwealth preferences and the comecon, for example, has collapsed, while some regional trade groupings in africa and the caribbean have collapsed or merged with others (lloyd, 1992). moreover, the european union is the only region where the share of intra-regional merchandise trade exceeds 50 per cent. thus, with a share of intra-regional trade of 69 per cent trade among european union member states, trade within the european union is more important than trade between the european union and the rest of the world. in asia the share of intra-regional trade amounts to 47 per cent and in north america 40 per cent (wto, 2000). asia and north america are thus to a lesser extent closed economies than the european union. 3 scenarios for further globalisa tion one may look into the future without making any predictions by describing future developments. this is the scenario approach. the central planning bureau (1999) has identified four scenarios that address the globalisation process in various ways. for that purpose it has used worldscan, an applied general equilibrium model for the world economy focusing on economic growth in the long run and trade patterns between 12 regions3• the first scenario identified is the schumpeterian world, which is optimistic on economic progress and developing regions. it emphasises globalisation tendencies and market-oriented policies in the world economy. it is based on the idea that when developing countries grow fast the linkages between oecd and nonoecd countries intensify. oecd countries specialise relatively more in goods intensive in high-skilled labor such as capital goods and services, whereas nonoecd countries specialise in consumer goods intensive in low-skilled labor. rapid development outside the oecd area and complete liberalisation of goods and capital markets produce closer economic integration of rich and poor countries. the non-oecd share in world production increases from 23 per cent in 1995 to 42 per cent in 2020, while the ratio of trade to gdp nearly doubles. liberalisation of goods, services and capital allows countries to specialise, exploit economies of scale, and create competition. moreover, open markets encourage dissemination of modem technologies in developing regions. technology is particularly important for transition countries to help restructure their inefficient production processes inherited from the communist past. the second scenario is the malthusian scenario. it assumes that developing regions are unable to pursue marketand outward-oriented policies. the political situation is unstable and leads to an inward-looking attitude. the lack of trade liberalisation and neglect of infrastructure and education hurts economic growth substantially in these regions. in this scenario, people in developing regions tend r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 419 sajems ns vol 4 (2001) no 3 to migrate to the oecd area and the trend towards globalisation is reversed. despite the unfavorable market circumstances in non-oecd countries their growth rates exceed those in the oecd area. this reflects the enormous potential of these countries. however, the non-oecd share in world production shows only a modest increase to 28 per cent in 2020. the trade restrictions imposed by nonoecd countries hamper trade significantly and the ratio of trade to gdp lowers in these countries. japan and western europe reinforce their positions in the production of intermediate goods, while all oecd countries can maintain their position in the production of consumer goods. most developing regions lose the opportunities to export agricultural goods to the oecd. china shifts to the production of consumer goods, because it faces less competition from its asian neighbors. the third scenario that the central planning bureau (1999) identifies is the developing scenario, which is less rosy than the first two scenarios. growth perspectives for oecd countries are bleak, while non-oecd countries grow fast at high environmental costs. the lack of flexibility on the labor and product markets within the oecd keeps unemployment levels high and economic crises inside the oecd strengthen protectionist sentiments. disagreement on free trade issues on agriculture and services between the usa, the european union and japan withholds all globalisation tendencies in the oecd. producers reduce investment, curb research and development, and technological progress slows down. the developing countries do not face these problems and they catch up with the developed countries. their policies are outward oriented and they go further in opening up and strengthening their markets, thereby creating their own trade blocs. they invest in infrastructure and education and rapidly copy technologies from the oecd countries. the non-oecd share in world production doubles to nearly 50 per cent as in the schumpeterian scenario, the transition countries have to rely on technical progress, which pushes up economic growth substantially. the other regions also benefit from the increase in labor productivity by schooling and labor reallocation. the fourth scenario is the ecological scenario, in which producers and consumers value environmental quality and put less emphasis on economic growth. people value the consumption of local products of their own culture. globalisation is thus not important in this respect and there are few incentives to eliminate trade barriers. the main reason for low economic growth is the lack of technological progress. the trade to gdp ratio hardly increases in the oecd area and remains constant in the non-oecd countries. the bulk of production continues to occur in the oecd area and the shift to non-oecd regions is modest. the ecological scenario differs from the other scenarios in that the rise in demand for energy is very modest. as a result, the total emissions of co2 are about 40 per cent lower than in the developing scenario. emissions in the oecd area do r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (200 i) no 3 420 not even increase. the decd and transition countries agree to reduce the emissions according to the kyoto protocol, while the non-decd countries limit the growth of energy demand by energy-efficiency improvements in production and a reduction in consumer demand. curbed demand for energy hurts the energyexporting regions. the share of energy in total exports by the middle east and north africa, sub-saharan africa and the former soviet union declines significantly. they diversify their exports to capital goods, services, and intermediate goods. the traditional exporters of agricultural goods, the usa and the rest of the decd, improve their positions in this sector in response to the partial trade liberalisation. asian regions now dominate the market for consumer goods. they specialise in these goods because of the relatively abundant supply of lowskilled labor. the shift in the export mix is possible due to a shift of low-skilled labor from agriculture to consumer goods. the former soviet union is the biggest loser in this sector and its export share vanishes. the outcomes of the scenarios differ because different assumptions underlie the driving forces. table 4 compares a selection of the exogenous trends and variables that the central planning bureau (1999) has assumed. technical progress is one of the most important driving forces for economic growth. if its pace is high, economies grow fast., like in the schumpeterian and the developing scenarios for the non-deed countries. most scenarios combine economic growth with increased international linkages and, consequently, trade liberalisation. tariff reductions in agriculture and raw materials are limited to 50 per cent at the most, because these levels are very high for some regions and much less progress has so far been made in lowering these barriers. even in the ecological scenario some trade liberalisation occurs because regions are willing to cooperate in the field of environmental policy. since in this scenario they are less interested in globalisation, however, trade liberalisation remains limited. the schumpeterian scenario also features increasing capital market integration, while the extent of competition is assumed to be larger than in the other scenarios. in all scenarios with high economic growth, sustainable production is only possible if energy-efficient technologies are introduced. therefore, decd countries save 0.5 per cent annually on energy per unit of production in the schumpeterian and malthusian scenarios. non-decd countries even save i per cent in the schumpeterian scenario. in the ecological scenario, the environmental awareness of non-deed countries is much higher. as a result, the energy saving amounts to 2 per cent per year with much lower dissemination of technology from the deed countries. decd countries save less in the ecological scenario because technical progress is slow, which makes it more difficult to implement energy-saving technologies. the reduction in energy demand is realised by introducing energy taxes that the decd countries impose according to the kyoto protocol. they even agree to reduce the emissions further by 1 per cent per year after 2010. in the ecological scenario, industrial and transition countries can r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 421 sajems ns vol 4 (2001) no 3 trade in emission rights in order to realise the emission targets. the other nonoecd countries do not participate because the oecd and transition countries are mainly responsible for the abatement. table 4 exogenous trends in the scenarios until 2020 (in %) trade liberalisation in manufacturin and services il'schumpeterian o' na 1.5 2.0 1.2 100 100 100 ecological o n 0.6 0.9 50 50 50 25 25 the use of different exogenous trends used in the various scenarios implies a wide variation in the results. rapid technological progress raises economic growth as is the case in the schumpeterian and the developing scenarios for the non-oecd countries. table 5 shows that in high-growth scenarios gdp growth per capita is about 2 per cent in oecd countries and 6 per cent in non-oecd regions. high economic growth leads to high savings rates. savings rates in the oecd area are generally lower than in non-oecd regions. high gdp growth also changes consumption patterns. consumers in oecd countries spend relatively more on services. the share of food in total consumption in oecd regions is already low in 1995 (10 per cent). therefore, the differences in the shares of food consumption in the different scenarios are small within the oecd area and range from 6.5 to 7.7 per cent. in non-oecd regions, however, these differences are considerably larger. the share of food consumption drastically declines from 26 per cent in 1995 to 12.6 or 16.7 per cent in 2020 depending on gdp growth in the scenarios. the share of consumption of services increases from 54 per cent in 1995 to 64.8 or 70.6 per cent in 2020. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (200 i) no 3 422 table 5 summary of scenario results until 2020 scenario 'schumpeterian i malthusian developing i ecological rerion io' n a .0 n 0 n o n average annual growth between 1995 and 2020 gdp 2.6 6.2 2.6 3.6 1.2 i 5.9 l.2 4.0 gdp per capita 2.2 4.7 l.7 i 2.2 0.8 4.4 0.9 2.5 real producer prices l.5 i 0.3 ! 0.7 0.2 1.6 i -0.1 ! 0.7 0.0 energy i i emissions 0.8 3.6 l.l 2.8 0.3 4.6 i 0.0 1.4 ratios in 2020 labor reallocation as % 19.1 of labor supply savings rate 17.8 23.5 spending on services 77.9 70.6 spending on agriculture • 6.5 ~~ trade to gdp 22.9 a. 0 oecd; n == non-oecd. source: central planning bureau, 1999 i 7.9 [ 17.9 16.6 14.7 77.2 i 65.2 75.7 7.1 17.0 7.6 12.5 22.6 " 15.0 18.1 i 114.5 i 24.4 14.9 ! 18.9 68.6 75.6 164.8 13.4 7.7 i 16.7 25.5 14.624.7 trade only flourishes if all countries reduce their trade barriers. since oecd countries are endowed with high-skilled labor and capital and non-oecd countries are endowed with low-skilled labor, specialisation will increase if trade barriers between these regions are reduced or eliminated. this occurs in the schumpeterian scenario. oecd countries have similar endowments of highskilled labor and capital, while non-oecd countries have similar endowments of low-skilled labor. specialisation within the oecd and non-oecd regions will thus be less pronounced than between oecd and non-oecd countries given the level of aggregation in the model. therefore, the trade to gdp ratios are fairly low in the malthusian and developing and also the ecological scenarios. the high trade to gdp ratio in the schumpeterian scenario depends on trade liberalisation and the degree of international competition. high economic growth harms the environment. in the schumpeterian and malthusian scenarios emissions grow substantially but do not accelerate, due to energy-saving technologies. in the ecological scenario demand for energy is stable due to strict environmental legislation in the oecd area. as a result, the global increase in co2 emissions is about 20 per cent, which seems very modest given the economic development in non-oecd regions. moreover, at the end of the scenario period emissions do not increase at all. in the developing scenario growth of emissions does accelerate due to rapid growth in developing regions, which ignore environmental quality. as a result, emissions double in the scer ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 423 sajems ns vol 4 (2001) no 3 nario period. if energy growth is not allowed for at all, economic growth has to be low as in the ecological scenario or a more strict environmental legislation is necessary. the differences in emission growth in the non-ecological scenarios are not very pronounced. in these scenarios emissions grow substantially. whether this growth is sustainable or not is hard to say. first, the quantitative effects of pollution on the environment are unclear. second, simulation paths of 25 years are relatively short to analyse emission paths. 4 summary globalisation is not a new phenomenon, but already occurred centuries ago. the first half of the 20th i"entury seems an interruption of the move towards free trade. after world war ii, however, the move to free trade resumed and gave rise to a sustained period of high economic growth in most parts of the world. central and eastern europe was an exception because this region formed an almost closed trading bloc. though cis countries are still to a large extent dependent on russia, liberalisation of external trade in the early 1990s led to a reallocation of trade flows away from central and eastern europe towards the european union. the central planning bureau (1999) has explored possible future developments by applying a general equilibrium model for the world economy. it has identified four scenarios: 1 the schumpeterian world, a scenario that is optimistic on economic progress and developing regions emphasising globalisation tendencies and market-oriented policies in the world economy. 2 the malthusian scenario, which assumes that developing regions are unable to pursue marketand outward-oriented policies. 3 the developing scenario assuming bleak growth perspectives for the oecd area, but high growth in non-oecd countries at high environmental costs. 4 the ecological scenario, in which producers and consumers value environmental quality and put less emphasis on economic growth. because of the differences in underlying assumptions the scenarios produce different outcomes. the results are not predictions, but descriptions of possible future developments on the basis of an applied general equilibrium model of the world economy. and various exogenous trends that have been assumed. there seems considerable scope for cis countries to integrate in the world economy. continued globalisation may further economic growth, while high economic growth harms the environment. however, energy-saving technologies and environmental legislation may affect the outcomes. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (200 i) no 3 424 endnotes according to rodrik (2001) economists rank second to astrologers in their predictive abilities. 2 one example is www.destroyimf.org advertising itself as "a web resource for all those mobilising to end the poverty and injustice inflicted by global capitalism". as the spelling suggests the movement seems to be organised by european activists. 3 these regions are the usa, western europe, japan, rest of the oecd, eastern europe, former soviet union, middle east and north africa, sub-saharan africa, latin america, china, south east asia, and south asia & rest. references central planning bureau (1999) globalization, international transport and the global environment: four quantitative scenarios, working paper no. 110, the hague: cpr 2 european bank for reconstruction and development (1999) transition report 1999, london: ebrd. 3 european bank for reconstruction and development (2000) transition report 2000, london: ebrd. 4 european bank for reconstruction and development (2001) transition report update april 2001, london: ebrd. 5 levitf, t. (1993) "the globalization of markets", in: robert z. aliber and reid w. click (eds.), readings in international business: a decision approach, cambridgellondon: the mit press. 6 lloyd, p.l (1992) regionalisation and world trade", oecd economic studies, no. 18: 7-43. 7 maddison, a. (2001) the world economy: a millenial perspective, paris: oecd. 8 mussa, m. (2000) factors driving global economic integration, http://www.imf.orglexternavnp!speeches/2000/082500.htrn. 9 rodrik, d. (2001) "how far will international economic integration go?", journal of economic perspectives, 14(1): 177-186. 10 scholte, la. (1997) globalization: a critical introduction, basingstoke: macmillan. ii williamson, j.g. (1996) "globalization, convergence and history", journal of economic history, 56(2): 277-306. 12 williamson, j.g. (1997) "globalization and inequality, past and present", the world bank research observer, 12(2): 117-135. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 425 sajems ns vo14 (2001) no 3 13 world trade organization (2000) international trade statistics 2000, geneva: wto. 14 world trade organization (2001) annual report, geneva: wto. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction historical context conceptual delineation theoretical framework: inclusive economic theory conclusion acknowledgements references footnotes about the author(s) arno van niekerk department of economics and finance, faculty of economics and management sciences, university of the free state, bloemfontein, south africa citation van niekerk, a., 2019, ‘a conceptual framework for inclusive economics’, south african journal of economic and management sciences 22(1), a2915. https://doi.org/10.4102/sajems.v22i1.2915 original research a conceptual framework for inclusive economics arno van niekerk received: 04 dec. 2018; accepted: 04 oct. 2019; published: 29 nov. 2019 copyright: © 2019. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: in view of growing concerns about global inequality and economic exclusion within and between countries, the theme of ‘inclusive economics’ or ‘economic inclusivity’ is gaining significance. aim: in discovering a more in-depth understanding of inclusive economics, the article develops a conceptual framework to better understand both the interpretation and application of inclusive economics. setting: as an ideal setting, the post-global financial crisis period provides fertile ground to explore alternative economic theories and systems such as inclusive economics. methods: a variety of terms and theories are associated with inclusive economics, hence a conceptual and theoretical analysis, in a descriptive context, is used to clarify the theoretical demarcation of this concept. results: since the concept does pose a challenge to conventional economic frameworks, a key result is that it may become a valuable addition to the range of economic thinking and proposals in solving much-needed 21st century economic challenges. conclusion: the article contributes towards developing a new paradigm for genuine economic progress – in theory and practice. keywords: inclusive economics; well-being economy; sharing economy; conceptual framework. introduction many economies around the world have come to a crossroad: what is the way forward? current economic frameworks are often failing, yet there is also no obvious alternative. a significantly different or new framework needs to be invented or constructed for the 21st century ‘global village’ where globalisation is as much a reality as community level disparities. within society – global and local – there exists a growing ‘silent suffering’ due to inhuman exclusion and in many cases a regression in quality of life (stiglitz 2013). the need for change that is inclusive is increasing. however, economic change must start with a sound theoretical basis. the article begins to develop a conceptual framework for inclusive economic theory. the objective is to start constructing a theoretical underpinning of the new (and often loosely used) concepts of an ‘inclusive economy’, a ‘well-being economy’, a ‘sharing economy’ and ‘social capital’. this exploration is in response to the growing concerns about the current neoliberal capitalist model’s failures globally and the search for a workable alternative, without falling into the traps of existing conventional models’ limitations and weaknesses. a new framework is investigated, reflecting lessons learnt from tried economic paradigms. consumption-driven capitalism (or ‘supercapitalism’) is failing economies and is largely unsustainable (piketty 2014). with inequality (i.e. exclusion) escalating, growth and consumption are reaching saturation, known as ‘secular stagnation’ (fioramonti 2017). expecting to endlessly increase production is imaginary. the limits of growth and capitalism is the concern, especially given the environmental and social costs of contemporary supercapitalism. fundamental inclusive change is needed, but it requires an adequate theoretical framework to enable transition through a gradual and evolutionary process of change. developing alternative models that are purposefully more inclusive, with a strong focus on genuine economic progress, is critical. the article examines such an alternative and signals a beginning to developing a conceptual framework that can be employed in studying and designing new, inclusive economic models and systems. historical context arguably the first documented reference to economics as a concept originates from the 15th century when it was derived from the greek oikonomos (daly & cobb 1990). the meaning then was management (nomos) of the household (oikos), referring to a fair distribution of the resources. over time the same meaning was expanded to the community (micro level) and the economy as a whole (macro level). it is notable that aristotle, from the beginning, contrasted oikonomia with chrematistics – the latter referring to the manipulation of property and wealth to maximise an owner’s short-term monetary exchange value. unlimited accumulation is the goal of the chrematist and aristotle considered it unnatural and a threat to the fair distribution of resources. lauderdale (1819:57) warned against this by drawing a critical distinction between ‘public wealth’ and ‘private riches’. the concern to society was that private riches could expand while public wealth declined due to a manipulation of resource distribution. oikonomos emphasises good judgment and decisions in the management of resources, keeping the well-being of the community as a whole in mind. daly and cobb (1990) highlight three characteristics of oikonomos (i.e. origins of the economy): (1) it takes the long-term rather than the short-term view, (2) it considers costs and benefits to the whole community, not just to the parties to the transaction, and (3) it prioritises restrained accumulation of wealth (economy of enough), rather than the impetus towards unlimited accumulation (economy of more). this ‘economics for community’ involving care and shared responsibility could thus be identified as the true character of the economy. in his theory of moral sentiments (1759) adam smith warned against exploitation of the economy, and to protect its essence. he submitted that the market is a system so dangerous that it presupposes the moral force of shared community values as its necessary restraining context to ensure responsible stewardship of resources in the collective interest. the market tends to deplete moral capital, instead of economising on it, thus requiring the community to renew it. smith pointed out that conscience arises from dynamic and interactive social relationships. hence, accommodating others’ interests in economic decision-making ensures that the market serves as an effective instrument of resource distribution and wealth creation (safeguarding collective well-being), and not the dominant determinant of socio-economic relations. this signifies the classic distinction between development and growth. because of conscience, morality was originally seen as integral to economics as a social science. when morality, conscience and values are divorced from the market, oikonomos turns into chrematistics (greed and exploitation), making it a consumption-driven system with pervasive externalities (daly & cobb 1990). keeping such a balance in the economy in check, similar to an ecosystem, is thus paramount. the contemporary work of amartya sen has re-emphasised the importance of ethics in economic development. his unique concept of (anand & sen 2000): ethical universalism is basically an elementary demand for impartiality – applied within generations and between them. it is, in the present context, the recognition of a shared claim of all to the basic capability to lead worthwhile lives. (p. 2030) learning from history and charting a new way forward, a fundamental question is: what is the purpose of the economy? according to fioramonti (2017), it is to organise society through distributing tasks and resources so that well-being is achieved – the ultimate goal of all systems of social organisation. this involves dividing responsibilities between producers and consumers, organising the distribution of goods and services, and designing a monetary system to manage it. the key is for these channels to be directed towards well-being first, then growth. when collective well-being is prioritised above hedonistic self-interest, the right balance is established. economic policies, regulation and shared principles of economic decision-making in a community, country and global economy ought to be focused on achieving such a balance. a historic example of this is germany after the second world war when it began to develop a ‘social market economy’ in the midst of a severe economic and socio-political crisis. the need was finding a balance between a free market (laissez-faire) economy and a collectivist planned economy, not as a compromise but rather a combination of state provision of social security and protecting individual freedom (glossner & gregosz 2011). the seeds of this were planted during the 1880s when germany implemented the world’s first welfare state and universal healthcare programme. workers received greater security as industry and state worked together in stimulating economic growth (hennock 1998). chancellor otto von bismarck gave workers a corporate status in the legal and political structures of the german empire. to improve productivity, these social security programmes also included sickness insurance, accident and disability insurance, compulsory education and retirement pension – the first in the world. the social market economy of the late 1940s just took it further by emphasising the state’s responsibility to actively improve market conditions and pursuing a social balance by putting social policy on par with economic policy. it was designed to be an adjustable, holistic conception pursuing a complete human-centred societal order as a synthesis of economic freedom and social security (müller-armack 1971). the ‘economic miracle’ of west germany was the result of free and able individuals being included (integrated) in a system that produces optimal economic benefit and social justice for all, a healthy balance between freedom and responsibility. legislation for establishing co-determination in the coal and steel industry were introduced, plus the creation of subsidised housing, child benefits, the system of employee property formation and the agricultural green plan. this social market economy brought about genuine performance-based competition (fair competition and equal opportunity) and independent control of monopolies. it established a socio-economic balance: a market economy with social obligations. from the 1960s onwards western europe pursued this approach. the work of walter eucken, in particular, made a significant contribution to laying the foundation for viewing the concept of the market as a ‘constitutional order’ (eucken 1938). the market is hereby defined by its institutional framework and subject to constitutional choice – either explicitly or implicitly. today, in view of ecological limits, capitalism faces exceptional challenges as the chrematistic side of the economy keeps surging for dominance. the neoliberal growth-driven model, particularly espoused since the 1980s and 1990s by american supercapitalism, led to a series of economic crises and a sharp incline in economic inequality – in and between countries (stiglitz 2013). the global financial crisis (gfc) has had a sobering effect on the world. the post-gfc period is now characterised by a renewed search for more balanced, inclusive, circular economic models. in a sense, economics as a science is in a phase of reinventing itself in the context of its origin (oikonomos), and pursuing sustainability as a major objective, which prefigures the building of a well-being economy. the challenge is to move beyond a solely growth-centred approach to progress. conceptual delineation a number of concepts describe different facets of an ‘inclusive economy’. these relatively new economic concepts will be employed in attempting to encapsulate the inherent (and evolving) meaning of economic inclusivity. each will emphasise some form of ‘inclusion’. for more clarity, they will often be contrasted with conventional economic thinking, that is, contemporary neoliberal capitalism. one aspect they all have in common is underscoring ‘genuine economic progress’.1 the first concept is that of a ‘well-being economy’. for fioramonti (2017:13) it means ‘improving the quality and effectiveness of human-to-human and human-to-ecosystem interactions, supported by appropriate enabling technologies’. economic well-being is seen as a goal that goes further than economic growth. whereas a consumption-based development model is dependent on increased consumption and standardisation, a well-being-based model includes and empowers people to make objective decisions linked to their values and motives. well-being connects self-interest with social benefits. it induces society to the natural human predisposition of optimising individual and collective interests, while embedding us in those ecosystems vital to our existence. the growth-driven economy follows a vertical structure, assuming a trickle-down effect through a separation of production and consumption. increased inequality is often a result, which excludes many from mainstream economic activity. a well-being economy aims to ‘include’ through a more horizontal structure in which participants are empowered in an integrated network of ‘redefined’ roles and functions as they sculpt new forms of productivity and economic utility. consumers, for instance, become ‘co-producers’ through entrepreneurial initiatives (e.g. uber and airbnb) and ‘open-source’ production (e.g. linux and wikipedia). well-being increases when social and natural or ecological capital is strengthened while generating human development and inclusive growth2 (fioramonti 2017). a well-being economy endorses a holistic approach to development and growth, taking both the positive and negative impacts of human activity into account, so as to improve collective well-being. the latter could be seen as the sum, or average, of the well-being levels of individuals who are part of the collective or community. this will determine the state or level of collective well-being. as a way to pursue it, community social capital – and its optimisation – could furthermore serve as a predictor variable for increasing collective well-being (ferguson 2006). since inequality plays a significant role, a distinction should be drawn here between destructive and constructive inequality. the latter is not seen as having a negative impact on collective well-being since it could create positive incentives at the micro level such as income concentration needed for rapid growth and investment, and incentives for individual effort, productivity and innovation (birdsall 2001). however, destructive inequality, which relates to inequality of opportunity, limited social mobility and inhibition of growth, negatively affects collective well-being. the second concept reflecting an inclusive economy is a ‘sharing economy’. here the emphasis is placed on the community and a collectivistic consciousness. as social beings we thrive because of the quality and depth of relations with others and because of our connectedness to the ecosystems within which we live. the economy is the strongest shaper of social organisation, hence the need to create economic value from the basis of the interconnectedness of the human economy (as a productive network of relations) and natural ecosystems, on which it depends. the sharing economy gives preference to low-impact processes of production (drastically reducing waste) and strengthening interrelationships for higher levels of (inclusive) production (senge 2008). fioramonti (2017:38) points out that ‘a technological revolution is advancing a new “sharing economy” model based on collaboration rather than reductive competition’. networks become key. this has, for instance, led to the emergence of ‘smart villages’ in asia and africa, which enable shared renewable energy systems and agro-ecology or organic agriculture in communities. this is increasing productive participation by community members, creating a sense of shared ownership. a variation of the sharing economy is an ‘access economy’. it comprises a fully horizontal process of sharing goods and services that facilitate direct trade, thus replacing the need for a mediating role player or company. open-source platforms are good examples, where users are given full access to ‘co-design’ and continually upgrade a product or system. emphasising flexibility and freedom from obligations, it brings a shift, in that access to goods and services becomes more valuable than owning them (eckhardt & bardhi 2015). inclusive access becomes the basis for trading, not ownership. collaborative networks come into existence through which citizen-users can directly exchange goods and services as collaboration replaces mediation. this reduces the demand for materials and assists in managing waste much better. satell (2015:1) summarised it well: ‘rather than assets managed by centralised organisations we have ecosystems managed by platforms. capabilities are no longer determined by what you own or control but by what you can access’. the third concept strongly related to an inclusive economy is a ‘responsible economy of care’. it values the interdependent reality of being human – both as reciprocal community members (and economic participants) and receiving and sharing resources from nature. productive labour is seen as more than a means of production; it is viewed as an ‘object of care’ (goudzwaard & de lange 1995). the same goes for the environment: if we don’t take care of it, we create a fundamental economic loss. this reintroduces ‘shared ethics’ relating to care and responsibility, for optimal collective economic benefits. having a shared public ethos – not just in reducing crime and violence but also in alleviating suffering and poverty in the community – ideally finds its expression through taking collective responsibility. it also involves ‘an economy of enough’ where limits are respected to prevent overconsumption and over-production (i.e. waste). research conducted in the netherlands showed that an economy of enough would decrease unemployment significantly, compared to export-led growth or consumption-driven growth strategies (nscgp 1983). studying hundreds of persons for 74 years, researchers at harvard medical school found that the key determinants to a happy and healthy life lie in human connections and the quality of the social and natural environment (powell 2012). caring for others, being integrated in local communities and living closely to healthy ecosystems are what truly increases quality of life. to facilitate a transition towards an economy of care, fioramonti (2017:32) underlines the need for ‘a better system of rewards and incentives, underpinned by different values’. families play a central role in such an economy as households become a locus of collaboration rather than of segregation. as the essential suppliers of care and responsibility, families, communities and small businesses become principal drivers in development – even as new forms of productivity, which also include non-market production, are valued in meeting the needs of the community. this opens a pathway for resource recycling and ‘upcycling’3 to be integrated into mainstream business models and the creation of new employment opportunities. making, in this way, care and responsibility a collective priority, more value is generated for the economy through improving human relations and their connection with nature. balmford et al. (2002) showed that investing in nature gives a return of $100 for each dollar invested. this reminds us that the real creators of value are the trees, rivers and forests around us. in a responsible economy of care the ‘convenient dissonance’, where managers make decisions far away from the people living with the consequences of those decisions, is eradicated. it ensures that decisions to dump and pollute are not just abstract econometric considerations, but they become personal moral judgments. it also goes further than companies only fulfilling their social responsibility (as a duty), but builds a culture of involving all stakeholders and caring for all involved in the productive process. a responsible economy of care continually considers ways of increasing the participation of key economic role players. one such area is the fairly new concept of ‘smart redistribution’. for example, many donors and taxpayers are frustrated from not knowing how their contributions are spent, resulting in low commitment. if they were empowered to decide for themselves how to allocate their contributions, and be informed of their progress and impact through a transparent process, it would raise their willingness to give. the combination of a functioning system of public services and enabling donors to steer their decisions creates ‘smart redistribution’ (fioramonti 2017:141). in this way taxpayers become ‘prosumers’4 through, for instance, a crowd-funding mechanism, equipping them to access impacts, monitor progress and even share best practices with beneficiaries. by being co-producers in participatory governance, it reconnects them with tangible results. this builds a sense of ‘community’ (even trust-based relationships) as the distance between contributors and beneficiaries is reduced. when taxpayers become actively involved in the welfare choices of society, they want to invest more in collective well-being, resulting in a heightened sense of responsibility. the state then becomes a ‘manager’ of funding choices offered to taxpayers. a fourth interpretation of inclusive economics is social capital (or ‘conscious capital’). it is a form of capital that produces public goods for a common good. the value of resources – both tangible (public spaces and private property) and intangible (role players and human capital) – are impacted by the interrelationships related to them (adler & kwon 2002). portes (1998) highlights that social capital is that which facilitates individual or collective action, generated by networks of relationships, reciprocity, trust and social norms. it represents a synthesis between the value contained in communitarian approaches and individualism maintained by rational choice theory. viewed as ‘social participation’, social capital can only be generated collectively through collaboration within communities and social networks. in the corporate world the emphasis on social capital brings a shift from creating value only for shareholders to creating value for all stakeholders (partners, employees, customers, supplies, the community and shareholders). stakeholders are all who come into contact with a company’s product or service. the aim is to create an inclusive culture that considers all constituencies and their complexity. o’toole and vogel (2011:60) draw attention to a ‘conscious capitalism’ movement in business where companies distinguish themselves through their commitments to ethical and sustainable business practices. they focus on creating a new model for business behaviour to integrate greater social responsibility into mainstream business practices. they also explore how the power of business can solve social and environmental problems, using the profit motive to create win-win business models. with the wins, according to mackey (2009:103), ‘being what benefits the company, its stakeholders, and the environment/society in general. this is the only way to optimise value’. sustainability then becomes a key driver of innovation, resulting in many companies balancing the needs of their stakeholders and often outperforming those who still follow the ‘classic capitalism’ model (lubin & esty 2010). when focus is placed on behaviour rather than just financial exchange, profit follows, and employees show altruistic behaviour that cannot be bought, sold or traded. unlike other forms of capital, this indicates that use, rather than non-use, increases social capital. the emphasis on building an ‘inclusive economy’ represents a transition in economic thinking, which introduces an altered paradigm for economic progress and success. the most fundamental shift in emphasis is from self-interest to shared interest, signifying a growing consciousness of the collective (social and ecological). this kind of collaborative economy underscores the interdependent reality of ‘i am because i am part of’ (ubuntu). being part of community and the environment means there are relationships that must be respected. inclusion is the natural result when these relationships are valued. the quality of relationships determines the value being created – generating scope for inclusion (fioramonti 2017). as the economy is a system of social relations, this is what gives meaning or substance to the notion of ‘inclusive economics’. theoretical framework: inclusive economic theory in an attempt to fill the void in economic science between what is knowable and what cannot be known about economic behaviour, motivation and outcomes at individual and collective levels, inclusive economic theory brings together different threads of contemporary economic theory. in this integrated framework three complementary paradigms – idealist neoclassical theory, realist neoclassical theory and neo-realist economics – are linked to comprehend prevailing causality. on their own they are incomplete, but combining them under the umbrella of inclusive economic theory, their limitations are reduced and it allows for a broader and more realistic approach to contemporary economic analysis and policymaking. as three unfolding parts, they enable analysts to identify what is true (or truth-like verisimilitude) in interpreting economic realities, solutions and changes. inclusive economic theory probes the limits of neoclassical and neo-realist paradigms to draw valid positive and normative inferences about real economic behaviour to give inclusive guidance on how to proceed when these theorems fail to correspond with observed behaviour in reality. the idea is not to simply elevate the status of social concerns in contemporary economic policymaking or in the economy, but to start developing an integrated body of economic theory as a guiding framework for individual, social and environmental realities in an inclusive economy. neoclassical economic theory: idealist and realist an awakening in economic thought through markets and adam smith’s invisible hand theory introduced the competitive ideal as the main driver of wealth creation. the power of reason translated into a rational pursuit of self-betterment, assuming consumers will always make rational decisions to maximise utility (homo economicus) and producers will maximise profits – all in the context of john locke’s social contract (having proper institutions). rationalism led to increased competition – private, business and government. the utilitarianism that followed created a framework to value and determine the comparative worth of goods and services since utilities could be ordered, ranked, quantified, added and multiplied across individuals. marginal ordinal utility assumed that individual utilitarian experiences can cumulate into better and better states of well-being on condition that physically and mentally healthy people always choose wisely (rosefielde & pfouts 2015). although, since the 19th century, average income levels markedly increased (along with inequality), it also showed the great weakness of neoclassical theory: a predisposed faith in rationality that the invisible hand is always effective. the reality is that real behaviour and policies deviate diversely from the rational competitive utility maximising ideal. many reasons exist: some exert power that benefits the few at the expense of the many; individuals fail to maximise or optimise due to irrational behaviour, being inconsistent and having incomplete information, and also families, communities and governments do not maximise the collective interest as asserted. the neoclassical paradigm serves admirably when core axioms largely hold, but is otherwise incomplete and misleading. only when the assumptions of ideal neoclassical theory fully apply does it provide pareto optimal solutions. neoclassical idealism has its value in igniting economic progress, but is an inadequate scientific substitute for inclusive welfare improving systems. it needs the supplementation of accurate assessments in improving the evaluation of why economic outcomes deviate from ‘rational’ competitive potential. this brought realist neoclassical economics to the fore, advancing the theory of ‘bounded rationality’: the idea that in decision-making, the rationality of individuals is limited by the information they have, their cognitive confines, and the finite time they have to make decisions (gigerenzer & selten 2002). this more pragmatic realist approach provided a foundation for exploring many unique types of economic behaviour excluded in the perfectly competitive framework. while these advances are welcome, realist neoclassical theory remains incomplete as it excludes various omitted psychological variables, satisficing5 and ideocratic behaviour. rosefielde and pfouts (2015) underline that neoclassical theory will always struggle to be comprehensively realistic because it only addresses ‘rational selection’, which ignores the construction of individual preferences. it furthermore disregards the full range of satisficing behaviour and excludes emotionally conflicted choice. capitalism is predominantly characterised by the neoclassical ideal, which schumpeter (1942) describes as an ‘evolutionary process’. it is mainly driven by new consumer products, markets, and technological innovation in production, communication systems and transport. it brings about ‘creative destruction’ in that old economic structures are destroyed by new ones through the competitive intra-market modernisation drive. while innovation is welcomed, the concern is the increasing negative externalities of capitalism’s ‘self-destruction through innovation’. what looked like progress now appears to be a continued net deficit, considering the social and environmental costs of the supercapitalism of neoclassical economics. the limitations of the neoclassical paradigms – idealist and realist – are found in bounded rational vulnerabilities and the market’s deficient self-regulation. this is exacerbated by mankind’s moral imperfectability in the absence of collective accountability. neo-realist economics the broad neoclassical consensus lays a foundation that competitive markets and governments yield decent results based on the premise of sound realist heuristics and that human motives are mostly rational and benevolent. but what if reason fails? given counterclaims of humans often acting irrationally and immorally, faith in reason can be overdrawn. this is where neo-realist economic theory assists in assuring that satisficing yields acceptable results where bounded rationality and sound heuristics fall short. it covers the cases where neoclassical outcomes are insufficiently explained by reason, despite workably competitive price attractors and heuristic substitutes for optimal decision-making. when reason fails, people are unreasonable, often discontented, conflicted, driven by undisciplined desires or coerced by the powerful. neo-realism furthermore helps to explain why people cannot apply reason effectively to evaluate the merit of their preferences. the reality is that cognitive and environmental constraints often compel people to satisfice in a real world that is in many cases not efficient, beneficent and stable. most of neo-realism’s assumptions are subsequently heterogeneous and case specific. the strength of the neo-realist explanation is that it is not confined to the rational individualist, utilitarian and community neutral models of ideal organisation and social control. individuals in both the neoclassical and neo-realist realms contend with the same challenges in similar ways, but generate dissimilar outcomes: one pareto efficient, the other pareto-esque (rosefielde & pfouts 2015). while consumer preferences determine supply in the neoclassical world, disturbed and meticulous consumers or usurpers of power are the dominant role players in the neo-realist world. economies thus involve mixes of ideal, realist and neo-realist forces. societies where norms are more consistently applied are expected to perform better. neo-realist theory moreover includes a variety of welfareand utility-enhancing behaviours overlooked by neoclassical theory, for instance when some shun materialist utility maximising for the greater good by adopting satisficing conventions that restrict or eliminate free choice. the communal culture of the japanese economic system embraces ‘group values’ (in family, community, company and government) where sacrifices are viewed to be enhancing their well-being (aoki 2001). self-seeking and unfettered competition are disdained, yet their collective6 well-being keeps improving in a milieu where institutions foster consensus-building. this communalism model does not reject markets; rather it subordinates them to the higher cause of communal satisficing based on shared values. such well-being enhancing opportunities for individuals and societies are included in the neo-realist paradigm which serves as a substitute for neoclassical economics (which excludes it) and a complement for enhancing pareto welfare. it offers a more realistic picture of economic decision-making and collective progress. inclusive economic theory currently, contemporary economic theory is still fused to enlightenment idealism. having gradually evolved in a realist direction, it still stops well short of an inclusive economic theory. the need for greater realism and broader inclusion in economic theory has become critical. even during the enlightenment period, bentham (1776) analysed the cardinal additivity of interpersonal utility to evaluate the collective merit of individual self-seeking. he realised the need for inclusivity by developing a ‘human happiness calculus’ as a measurement for society’s hedonistic betterment and morally principled state regulation. it was found that societies that maximised collective utility, as distinct from each individual maximising their own utility, were best (rosefielde & pfouts 2015). the idea of increasing the common good of society took root, but it was only since the failures of neoclassical economics became widely evident that priority was given to start reconsidering ideas about collective well-being. work by robert heilbroner (1974) specifically drew attention to the pressure of the human economy on the biosphere as the world population doubled between 1950 and 1986 (from 2.5 billion to 5 billion) and fossil fuel consumption correspondingly quadrupled. in his inquiry into the human prospect he projected a gradually slowing growth economy until it stagnates during the first half of the 21st century. the loss and degradation of the environment is now fully recognised as a threat to human existence. together with environmental destruction, the other side of humanity’s impending catastrophic confrontation is social disintegration as the social costs of crime, drugs, vandalism, and so on increase. accordingly, work by daly and cobb (1990) contributed significantly to a revaluation and reorientation of the dominant neoclassical economy and developed realistic alternatives to capitalism and socialism (both growth economies). they advanced a switch of emphasis in economics from money (chrematistics) to focused real-life resource management (oikonomos), and a revised measure of sustainable economic welfare to include humanity’s most treasured traditional assets in what it values: a supportive local community and a healthy natural environment. the challenge is that conventional models of neoclassical economics have systematically tended to marginalise and exclude these very aspects critical to human existence. conversely, the inclusive economic framework incorporates biocentric ethics and shared community values. as such, inclusive economic theory presents an alternative paradigm that does not replace but reorients neoclassical and neo-realist theories, redeeming the original purpose of the economy (to an extent) and causing a re-think of neoliberal supercapitalism. inclusive economic theory has an appreciation for the linked nature (shared aspects) of the three complementary theories. it functions as an umbrella that provides insight into individual, societal and national well-being. well-being is determined as a composite of individual and societal outcomes, assessed through diverse normative observations, some of which are generic. when ideal neoclassical theory does not provide pareto optimal solutions – that is, when its assumptions do not fully apply – then realist and neo-realist paradigms govern aspects of outcomes, and causalities can be uncovered in full or partially by analysing theory and evidence with critical rationality to identify truth-like verisimilitudes. in this way inclusive economic theory affords deeper insight into causality than neoclassical theory or neo-realist theory alone, and creates the potential for superior policymaking. individual and social behaviour and corresponding policy options are attained best by a combination of the three complementary paradigms. economic theory’s task, especially inclusive economic theory, is to accurately comprehend complexities and devise properly targeted interventions tailored to reality rather than using the lens of only one paradigm to interpret the whole. then some types of behaviours like transcendental awareness and satisficing communality, which offer societies and individuals opportunities for enhancing well-being, are included. ‘inclusive economic theory is more than conjecture, and is capable of providing better predictions than idealist or realist neoclassical theories in most circumstances’, according to rosefielde and pfouts (2015:143). as essentially a synthesis, inclusive economic theory offers a middle ground between anti-scepticism and fallibilism, and can be combined with critical rationality to critique rival interpretative assertions. while it cannot resolve all disputes and paradoxes in economic theory, inclusive economics has significant practical implications for public policy designed to promote well-being. over-reliance on idealist and realist neoclassical microeconomic and macroeconomic theories yield weak results whenever they fail to properly capture irrational or anti-competitive behaviour, as well as prospects for enhancing well-being outside the pareto context. a broader inclusive economic framework combining policies issue by issue with right idealist and realist neoclassical and neo-realist paradigms will bear significantly better results than the current neoliberal myopia. the inclusive economic framework creates space for seemingly opposites to co-exist, but in a balanced format. what would appear to be contradictory components of different economic paradigms need not be mutually exclusive. for instance, growth and competition are vital for economic progress but need to be counterbalanced or complemented by inclusive growth and cooperation; irrational hedonistic behaviour needs collective (altruistic) values, responsibilities and productivity in communities. these are crucial balancing factors that must be included, not at the periphery, but at the core of how the economy functions, how economic policies are formulated and in theoretical frameworks. inclusive economic theory makes collective well-being a central focus, not just growth, and brings the economic model closer to sustainable, genuine economic progress. already, a sharing economy is evolving organically, placing increased emphasis on circular, horizontal and decentralised economic systems in the global village. inclusive economic theory incorporates this in shaping a conceptual framework that balances economic contradictions for the purpose of higher well-being. it reduces the self-centredness of neoclassical theory’s individualism by recognising, for instance, that consumer demand is often co-determined by various endogenous ethical and obligational factors, including family duty and community responsibility. mccloskey’s (2007) ‘virtue ethics’ make it possible for hedonism to be modified, thus stressing ethically constrained optimisation in the context of shared collectivist ideals. as part of the inclusive framework, national economic performance is therefore better assessed with a composite measure of well-being (physical and mental health), economic justice, consciousness, contentment and personal fulfilment. today we have a global village in which humanity shares the world’s resources in a highly interdependent global economy. due to globalisation, systemic risk is a greater global reality in this networked economy than perhaps ever before in human history. hence, the need to re-employ the inclusive principles of shared responsibility, collective well-being and collaborative productivity as building blocks for a truly sustainable economy is increasing. in view of a looming fourth industrial revolution, genuine progress can only come from balancing extremes. hence, the importance of shaping a more inclusive economic order could be seen as simply the next step in the evolutionary process of the economy. the development of inclusive economic theory is central to theoretically grounding such a new economic order. conclusion responsible management of the ‘global household’ requires greater inclusivity (i.e. oikonomos principles): growth should incur benefits for every section of society, and finding ways to involve more people in productive employment is critical for increasing the incomes of poor and excluded groups and raising living standards. both the historical trajectory and theoretical evolution of economics point to the vital element of inclusivity to ensure sustainability. prioritising collective well-being becomes a core balancing factor in the economy. developing a theoretical framework for inclusive economics is therefore essential to understanding the elements required to construct a more balanced approach to the economy. in this way, inclusive economic theory presents an alternative framework in light of current economic failures. as economics as a science becomes more technical, the need for more ‘humanised’ solutions also increases to better understand and manage the social dynamics of economics, which include both individual and collective needs. this will require more sophisticated analysis on how to optimise well-being in a holistic context, generating higher (and wider) levels of satisfaction in the economy. inclusion brings greater equality of conditions (fioramonti 2017). although it is at an emergent stage, the inclusive economic framework incorporates a balance between rigorous theoretical analysis and realistic humane solutions. it also interprets and appreciates the interconnectivity of objective as well as subjective factors, combined with a working economy where shared interests are the leading factor in daily economic decision-making and policymaking, and vital to genuine progress. this is where the article goes further than, for instance, rosefielde and pfouts (2015): it adds value by integrating the practical components of an inclusive economy into inclusive economic theory in developing a better means for interpreting the theory. given the possibility of lower growth expectations due to many economies reaching points of ‘secular stagnation’, moving towards a more sustainable inclusive economy is creating higher potential for genuine economic progress (stiglitz 2013). development focused on collective well-being, where alternative means are also developed to generate wealth based on self-sustainable systems (e.g. circular economy), is creating new economic avenues. economies might then not be growing as much in the traditional sense, but people’s well-being increases as new economic value is created, often outside the confines of the market (e.g. upgrading and upcycling). the accelerated technological innovation of the 21st century inaugurates completely new economic thought and methods to which economic theory has to adjust. thinking is becoming more holistic and integrative, thus necessitating inclusive economic models for a collaborative economy that would generate inclusive growth. the sustainable development goals (sdgs) are illustrative of this new direction in thinking. in constructing a conceptual framework for inclusive economics an umbrella of complementary theories can be identified. inclusive economic theory combines idealist and realist neoclassical theories as well as neo-realism in a suitable way. each of these theories makes a unique contribution, and where one fails, another complements it (fills the gap) in interpreting economic reality. the benefit of such an inclusive economic theory is that it more accurately comprehends complexities and ‘includes’ what is normally excluded by each theory on its own (e.g. non-market well-being opportunities). this helps to eventually interpret a more accurate depiction of reality and make more substantiated predictions. exploring such an admixture of complementary paradigms provides more precise causal characterisations of economic action, and offers a wider range of constructive policy options than a single paradigm. it pairs policies focused on specific issues with the three paradigms in a desired way to generate superior results. thus, for instance, policies that promote growth will be able to include well-being. as such, inclusive economic theory has the ability to create space for balancing opposites, for example collective well-being and individual interest (classic growth model) through inclusive, and competition and cooperation through shared responsibility. by enabling the economy to work with the tension of extremes, it unearths the benefit of ethically constrained optimisation. shifting the emphasis, this conceptual framework of inclusive economics is anchored in the ‘humanness’ of economics as a science, not in its ‘mechanistic’ reductionist analysis. while the latter is crucial in terms of optimising the measurements and techniques for examining economic complexities, it ought to function as a supportive instrument, and not replace the people-centredness of economics as a social science. having started to develop a conceptual framework for inclusive economics in this article, attention is drawn to ‘humane economics’ where both analysis and the industrial functioning of the economy serves people (e.g. ‘prosumers’) in terms of practical solutions and empowerment, not vice versa. as such, inclusive economics brings a realignment in the machinery of the economy in putting human worth and collective well-being at the centre of the growth process. this is the significance of an inclusive economy in a time when new models for genuine economic progress are desperately searched for. in a holistic context, inclusive economic theory provides a start for economic modelling based on shared interest. further research on an inclusive economic framework for both its theoretical underpinning and its practical applications would prove to be vital in enhancing economic sustainability. acknowledgements competing interests the author declares that he has no financial or personal relationships that may have inappropriately influenced him in writing this article. author’s contributions the author declares that he is the sole author of this research article. the contribution is a conceptual and theoretical framework for inclusive economics, which would assist in exploring the measurement and implementation (through policy) of inclusive economic paradigms. ethical considerations ethical clearance number: not applicable since there are no ethical considerations or concerns regarding this research. data availability statement data sharing is not applicable to this article as no new data were created or analysed in this study. disclaimer the views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of any affiliated agency of the authors. references 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1942, capitalism, socialism and democracy, harper & row, new york. senge, p., 2008, the necessary revolution: how individuals and organisations are working together to create a sustainable world, doubleday, new york. smith, a., 1759, the theory of moral sentiments, andrew millar, london. stiglitz, j., 2013, the price of inequality, norton, new york. footnotes 1. genuine economic progress is the net effect of subtracting negative externalities (e.g. social and environmental costs) from growth in gross domestic product (gdp), and adding positive externalities not measured by gdp. 2. inclusive growth stimulates equal opportunities for all economic participants during the growth process. 3. ‘upcycling’ refers to continual improvement (upgrades and repairs) of existing goods, without disposing of them. 4. fioramonti (2017:96) invented the term ‘prosumer’, meaning that as middlemen are increasingly being cut out in the collaborative economy, consumers become producers (co-producers and co-creators), and vice versa. 5. satisficing means seeking a satisfactory solution, not necessarily the optimal one since it might be unrealistic. 6. collective action strives to cooperate for better individual utility outcomes (personal benefit). communal action does not separate private and group utility, and thus operates with a shared consciousness (communal benefit). microsoft word 4 entrepreneurship in emergin luiz & mariotti sajems ns 14 (2011) no 1 47 entrepreneurship in an emerging and culturally diverse economy: a south african survey of perceptions john luiz wits business school, university of the witwatersrand martine mariotti research school of economics, australian national university accepted january 2011 south africa has consistently ranked very poorly in the global entrepreneurship monitor survey in terms of entrepreneurial activity. it is clear that south africa is not producing a sufficiently entrepreneurial economy and this needs to be addressed so as to create employment, expand markets, increase production and revitalize communities. this paper examines the entrepreneurial traits of a diverse group of young adults in south africa. it draws on a sample of 609 university students and looks at their attitudes towards and perceptions of entrepreneurship, entrepreneurial opportunities and the broader economic environment in an attempt to clarify how south africans view entrepreneurship. although the data do not allow the identification of causal relationships, descriptive statistics show that socio-economic elements play a noteworthy role in people’s perceptions of the value of entrepreneurship and thus need to be incorporated in entrepreneurial models. key words: entrepreneurship, entrepreneurial traits and process, global entrepreneurship monitor, employment, socio-economic, demographics, south africa jel: j00, o17, 55, z13 1 introduction the role of entrepreneurship in economic processes is well documented (see naude, 2011 for a more complete discussion). van praag and versloot (2007:352), on an analysis of 57 recent studies, conclude that entrepreneurs have a very specific function in the economy: they create employment and productivity growth, and produce and commercialise high-quality innovations. entrepreneurial firms also create important spill-overs that affect regional employment growth rates in the long term. ayyagari, beck and demirguc-kunt (2007:429) in a study of 76 countries find that on average smes constitute 64 per cent of the economy while the informal economy on average accounts for 26 per cent of gdp in their sample of developed and developing countries. therefore, understanding the drivers of entrepreneurial behaviour at both a macro/institutional level as well as at a micro/individual level is an important area for research within the social sciences. south africa has one of the highest unemployment rates recorded internationally – 25.3 per cent in the third quarter of 2010 (statistics sa, 2010). given this high unemployment rate, kingdon and knight (2004:392) argue that one would expect a large informal sector to absorb this surplus labour, but south africa has a relatively small informal sector. there are a number of possible explanations for this phenomenon (see banerjee, galian, levinsohn, mclaren & woolard, 2008; rodrik, 2008) but a recurring theme is the assertion that south africans lack entrepreneurial spirit. the south african government has implemented various strategies to encourage entrepreneurs and small businesses without much success (see herrington, kew & kew, 2009; urban, 2010 abstract 48 sajems ns 14 (2011) no 1 for a full discussion). south africa performs very poorly in international entrepreneurship surveys and has consistently been ranked near or at the bottom in the global entrepreneurship monitor (gem) (bosma & levie, 2009:21). undoing the legacy of apartheid necessitates bringing more south africans into the economic mainstream but the large corporate sector cannot absorb the surplus labour which means that entrepreneurial activity must be an important cornerstone of any economic strategy. understanding the drivers of entrepreneurship in south africa is thus an important area for research. this paper examines the entrepreneurial traits of a diverse group of young adult university students in south africa drawing on a sample of 609 respondents. it looks at their attitudes towards and perceptions of entrepreneurship, entrepreneurial opportunities and the broader economic environment. the aim of the study is to explore the impact of socio-economic, demographic, cultural and institutional variables on entrepreneurial attitudes of individuals. although the data do not allow the identification of causal relationships, the results suggest that socioeconomic factors play a significant role in entrepreneurial behaviour and thus need to be accounted for in entrepreneurial models. the paper is structured as follows. section 2, the literature survey, explores the concept of entrepreneurship and the explanations for entrepreneurial activity with a particular focus on the south african performance in the latter part of the section. this is followed by an explanation of the methodology employed, in section 3. section 4 presents the results of the survey and an analysis in terms of the socioeconomic, demographic and institutional characteristics of the respondents. section 5 concludes. 2 literature review 2.1 entrepreneurship, culture and individuals the research on entrepreneurship is rich and complex. indeed merely defining entrepreneurship has spawned a mass of literature (see schumpeter, 1934; leff, 1979; morrison, 2000; kuratko & hodgetts, 2001). there are broadly two distinct approaches to defining this concept. the first approach focuses on the entrepreneurial process whilst the second approach emphasises the characteristics of the entrepreneur (see carton, hofer & meeks, 1998). neither of these approaches is particularly satisfactory, because they should not be mutually exclusive. this paper defines the concept using both approaches, that is, a combination of the entrepreneurial process and the characteristics embedded within the entrepreneur and the society. in this vein, ahwireng-obeng (2006) examines three broad theoretical approaches to the supply of entrepreneurship the sociopsychological, the socio-cultural, and the economic approaches: a) the socio-psychological approach most discussions in this area of study usually begin with the work of max weber in his famous exposition of “the protestant ethic and the spirit of capitalism” in which he attempted to establish that the protestant ethic or the ‘minor virtues’ of thrift, hard work, sobriety, honesty and fulfilment of promises contributed to the successes of capitalist institutions in fostering fast economic progress brought about by a new character type. b) the socio-cultural approach this approach views entrepreneurship as an aspect of cultural change comprising the transformation of human agents and the socioeconomic setting in which they operate. it examines present and past political, social and economic institutions, their relationships with current values, motivations and incentives, and their conditioning effect on current role structures. c) the macroeconomic approach in the construction of a macroeconomic model of entrepreneurship, an identification problem emerges regarding the distinction between supply and demand determinants. it is normal practice to make the supply schedule a function of socio-psychological and cultural variables as well as the stock of human capital of the individual. the demand for entresajems ns 14 (2011) no 1 49 preneurship then becomes a function of demand for entrepreneurial goods and services which, in turn, depends on prices of production factors, the stock of existing and transferable technology and consumer incomes among others. the macroeconomic approach, therefore, incorporates both quantifiable and qualitative variables of both economic and non-economic description and is the tool of analysis widely used by development economists. this paper uses an eclectic approach and explores perceptions amongst young south african adults both regarding the process of entrepreneurship and the traits of the entrepreneurially inclined. with regard to the characteristics of the entrepreneurs, it follows the literature which finds the following traits most pervasive: desire to be independent, locus of control, creativity, risk-taking propensity, need for achievement, and credible role models (see carton et al., 1998). the paper analyses responses against individual and socio-cultural criteria such as race, gender, family history and other background information to examine the influence of these on entrepreneurial behaviour. urban (2008:169-170) states that entrepreneurial motivation is likely to be conceptualised as a function of not only culture and personality, but also of the interaction between these, and proposes the following model: e/p = a + bm (c x p) [(ce/s x db/s)] where entrepreneurial performance (e/p) is a function of culture (c) x personality (p), and where both are treated as essential elements of entrepreneurial motivation. most studies examining the link between cultural variables and entrepreneurship are based on country level not individual level intercorrelations. for example, hayton, george and zahra (2002), davidson and wiklund (1997), mueller and thomas (2000) find links between national rates of innovation or entrepreneurial orientation with cultural variables such as individualism and power distance. this study attempts to look at potential variables affecting entrepreneurial attitudes both of an individual and cultural/social/institutional nature. south africa is an interesting case to examine, because of its past structure of institutionalised racial estates which allows the examination of the interplay between the individual and social characteristics. for example, are there differences in attitudes based on race (given the process of racial discrimination in the past) or indeed are there intra-racial differences based on language, religion or parental status? in this respect south africa provides a unique canvass to explore these issues. 2.2 entrepreneurship in south africa the challenges facing south africa are immense: it is a relatively young democratic, highly inegalitarian country, with enormous socio-economic problems. jobs are not being created in the south african labour market at a fast enough rate and there is an expectation from school-leavers that they must find work in the corporate world with scant attention given to creating their own businesses. banerjee et al. (2008:717) sees several reasons why unemployment has remained at such high levels. first, job search appears to be less effective for african job seekers compared to whites, which is likely due to the spatial separation between the business centres and the outlying areas where africans reside. second, while it may be expected that the informal sector will provide employment, especially in these outlying areas, and absorb many who would otherwise be unemployed, it has not. unlike other african countries, the informal sector has grown very little as participation and unemployment rates have risen. they go on to state that crime rates and high start-up costs for small businesses probably impede its growth. small, medium and micro enterprises (smmes) are an important source of employment and economic growth in most countries and south africa is lagging behind on this front. smmes make up 95 per cent of all corporations in asia, employ up to 80 per cent of the labour force and constitute almost 60 per cent of gross domestic product (gdp). in south africa, smmes employ 47 per cent of the economically active population and constitute close to 45 per cent of gdp (dti, 2008). the state of entrepreneurship and small business development in south africa presents 50 sajems ns 14 (2011) no 1 a picture of underperformance relative to other countries at similar levels of development. for example, the 2009 gem research (herrington et al., 2009:59-60) shows the following: • south africa’s tea 1 rate of 5.9 per cent is significantly lower than the average for all efficiency-driven economies (11.2 per cent) as well as the average for all middle to low income countries (14.8 per cent). according to the gem data, a country at south africa’s stage of economic development would be expected to have a tea rate in the order of 13 per cent, more than double south africa’s actual rate. • latin american countries have a significantly favourable attitude towards entrepreneurship and score well above the average for efficiency-driven economies with respect to entrepreneurial attitudes and perceptions. south africa scores below average for these indicators. in terms of perceived capabilities, south africa has the third lowest score. the discrepancy in entrepreneurial attitudes and perceptions between south africa and the efficiency driven latin american economies is likely to contribute to the significant differences between their respective tea rates. • south africa’s nascent entrepreneurship rate of 3.6 per cent is below the gem average of 5.9 per cent as well as the average for efficiency driven economies of 6.1 per cent. in terms of new firm activity south africa ranked 40th out of the 54 countries, with a new business prevalence rate of 2.5 per cent. this is significantly lower than the average of 5.2 per cent for all gem countries and 5.3 per cent for all efficiency-driven countries. • in terms of established business activity south africa ranked last out of the 53 countries, with an established business rate of only 1.4 per cent. the average for all gem countries is 7.7 per cent while that for all efficiency-driven countries is 7.9 per cent almost six times the rate for south africa. banerjee et al. (2008:735) question why south africa has such a small informal and entrepreneurial sector, why the transition between the informal and formal sectors is so rare, and why the spirit of entrepreneurship is poor? this study is an exploratory attempt to understand the more micro foundations of entrepreneurship in south africa by examining attitudes towards and behaviours of entrepreneurship and their association with socio-economic, demographic and institutional factors. 3 methodology a study by simmons (1998) in the united kingdom found that almost 50 per cent of final-year undergraduates think that they may start up their own business in the future. similarly leading business schools report that 40 per cent of their post-graduate students start their own venture within 10 years of graduating. in south africa there is little, if any, comparable research despite the obvious need for this research. burger, mahadea and o’neill (2004) and louw, van eeden, bosch and venter (2003) represent some of the few studies that examine the entrepreneurial traits of south africans. in terms of the factors investigated, these studies are limited and a larger list of criteria is employed in this study. the survey instrument is based upon a similar one to the national science foundation innovation project at several south dakota universities. the structured questionnaire comprised of 40 questions testing respondents’ perceptions towards entrepreneurship using a five point likert scale and 10 questions of a more social or demographic nature. the survey was conducted amongst 609 university students drawn from various parts of south africa. the physical questionnaires were administered to students in their lecture venues at the conclusion of their lectures. participation was voluntary and completely anonymous. students completed the questionnaire in class in approximately 30-45 minutes and the results were then scanned electronically. since the survey is based on existing prior surveys and since the sample is drawn from a diversity of backgrounds with respect to race, gender, family history, and income status, which is discussed below, content validity is maintained. furthermore, to ensure that the sajems ns 14 (2011) no 1 51 wording and instructions of the questionnaire were clear and understandable and that the study was reliable, a pilot study was run thereby maintaining construct validity. the results are based on descriptive statistics derived from the sample. for all 40 questions, the mean response on the likert scale was calculated. comparisons were then made testing for significance in either a category’s mean deviation from neutral, or the difference in the means of two categories with different backgrounds where the backgrounds are taken from the 10 social and demographic questions in the survey. 4 results of the survey table 1 lists the characteristics of the respondents in the survey with regards to gender, race, level of study, parent characteristics and personal money experience. 52 per cent of the sample was male, 48 per cent female. africans made up 54.7 per cent of the sample, followed by whites at 31.4 per cent, asians at 11.3 per cent and coloureds at 2.5 per cent. as one would expect at a tertiary level, 61 per cent of respondents had parents with tertiary education, 16 per cent with matriculation, 13 per cent with some high school, 6 per cent only primary school and 4 per cent with no education 2 . parental income was fairly evenly distributed: a third had monthly income in excess of r20,000; 20 per cent r10,001-r20,000; 15 per cent r5,001r10,000; 13 per cent r2,000-r5,000; and 19 per cent less than r2,000. furthermore, 43 per cent of their parents own their own businesses. 78 per cent of respondents received pocket money whilst at school, 43 per cent had a job whilst at school, and 48 per cent had a job whilst at university. table 1 respondent characteristics demographic variables n % gender male 306 52.4 female 278 47.6 584 race african 324 54.73 white 186 31.42 asian 67 11.32 coloured 15 2.53 592 degree commerce and law 323 54.84 arts, humanities, social science and education 108 18.34 science 58 9.85 engineering 24 4.07 mba 76 12.9 589 parents own business yes 243 42.71 no 326 57.29 569 parents education tertiary education 355 61 52 sajems ns 14 (2011) no 1 matriculation 95 16.32 high school 77 13.23 primary school 33 5.67 no schooling 22 3.78 582 pocket money at school yes 446 77.57 no 129 22.43 575 job while at school yes 247 43.33 no 323 56.67 570 job while at university yes 274 47.82 no 299 52.18 573 study business subjects yes 349 61.55 no 218 38.45 567 parents monthly income less than r2000 106 19.41 r2000-r5000 70 12.82 r5001-r10 000 80 14.65 r10 001 – r20 000 109 19.96 greater than r20 000 181 33.15 546 table 2 presents summary statistics on all the perception questions provided in the survey 3 . respondents were asked to evaluate the perceptions given in the table on a likert-type scale of 1 to 5, where 1 is “strongly agree” and 5 is “strongly disagree”. the analysis focuses on the mean response to each question for each type of respondent and tests whether the mean is statistically significantly different from a value of 3 which represents a response of “neutral” on the likert-type scale at the 5 per cent and 10 per cent levels. in addition, it tests whether the mean of the response for each group is statistically different from the mean response of the other groups for each question. table 2 responses to perception questions – statistical analysis variables strongly agree agree neutral disagree strongly disagree total mean st. dev perceptions 1 190 144 149 93 30 606 2.39* 1.21 2 66 181 133 170 54 604 2.94 1.17 3 33 72 120 234 142 601 3.63* 1.13 4 28 62 118 262 126 596 3.66* 1.07 5 145 166 122 131 35 599 2.57* 1.23 sajems ns 14 (2011) no 1 53 6 112 241 134 93 25 605 2.47* 1.08 7 19 42 160 211 175 607 3.79* 1.03 8 172 191 125 81 37 606 2.38* 1.20 9 260 231 82 24 10 607 1.84* 0.92 10 92 168 136 141 67 604 2.87* 1.25 11 113 112 30 143 207 605 3.36* 1.55 12 22 58 115 214 197 606 3.83* 1.10 13 131 208 166 84 14 603 2.41* 1.05 14 77 152 194 151 31 605 2.85* 1.09 15 257 245 68 21 12 603 1.82* 0.91 16 154 184 105 92 68 603 2.56* 1.32 17 85 158 196 117 48 604 2.81* 1.14 entrepreneurial opportunities 18 127 192 138 114 30 601 2.55* 1.16 19 96 192 152 138 26 604 2.68* 1.12 20 120 209 149 87 36 601 2.52* 1.14 21 33 118 200 188 62 601 3.21* 1.05 22 88 214 178 99 20 599 2.58* 1.03 23 130 210 109 111 43 603 2.55* 1.22 24 71 216 159 132 24 602 2.70* 1.06 25 25 52 125 241 159 602 3.76* 1.07 26 159 242 90 94 20 605 2.30* 1.12 campus entrepreneurship environment 27 41 128 176 186 71 602 3.20* 1.11 28 52 108 81 196 164 601 3.52* 1.29 29 54 153 141 169 79 596 3.11* 1.19 30 42 159 136 176 81 594 3.16* 1.17 31 185 273 89 37 19 603 2.06* 0.99 32 235 274 70 16 9 604 1.82* 0.85 33 218 298 66 16 5 603 1.83* 0.79 34 211 273 96 18 5 603 1.89* 0.83 35 193 233 126 38 7 597 2.05* 0.95 south african entrepreneurship environment 36 207 227 111 44 16 605 2.07* 1.03 37 52 170 242 104 32 600 2.82* 0.99 38 79 174 181 125 38 597 2.78* 1.11 39 45 179 128 186 59 597 3.06 1.14 40 47 157 99 182 109 594 3.25* 1.25 notes: * significant at the 5 per cent level, ! significant at the 10 per cent level. a preliminary review of these tables reveals the following. on the perception side, respondents agree that entrepreneurship is an honourable occupation and that it plays an important schumpeterian role by promoting new innovations, technologies and products. they have a positive attitude towards entrepreneurship and have considered it as a career option. respondents see themselves as risk-takers and perceive entrepreneurship to be a useful way to make money. in contrast and almost in contradiction, respondents seem to think that a large company offers better career prospects. one way of reconciling this is that respondents may think that although being an entrepreneur may yield better income and is a good profession, they feel it may be limiting in terms of future personal growth and 54 sajems ns 14 (2011) no 1 opportunities. they seem to recognise the more immediate benefits, but are not thinking in an holistic way to see how it could develop into something much larger in the future. a worrying aspect is that they argue that entrepreneurs will do anything for profit which implies the willingness to do something illegal if need be, a level of expediency, and ignores the potential for social entrepreneurship. respondents agree that there are many entrepreneurial opportunities in their field. in general, they are positive about their ability to start a business and do not agree that all the good ideas have already been taken. on the contrary, they are on the lookout for business opportunities and have ideas about possible ventures. respondents feel quite strongly that it is necessary to have contacts to start a business. this is a particularly strong feature of the south african economy both under the previous dispensation of white business networks and the current dispensation of black business networks and empowerment (luiz, 2002:56). while they maintain that south africa is a good country in which to start a business, they are neutral as to whether their local community supports the idea. more importantly, they demonstrate that while they are positive about entrepreneurship, they do not have enough information on how to start a business. for example, they are not aware of government programmes supporting small business startups nor do they know how to gain access to assistance. 4.1 perceptions of entrepreneurship broken down by race and gender table 3 breaks down the summary statistics into gender groups and tests whether male and female perceptions are statistically significantly different from each other at the 5 per cent and 10 per cent levels. table 3 perceptions, by gender variable mean male female perceptions 1 2.09 2.74 2 2.93 2.95 3 3.60 3.65 4 3.66 3.68 5 2.50! 2.67! 6 2.46 2.45 7 3.91 3.66 8 2.16 2.61 9 1.79 1.86 10 2.91 2.83 11 3.43 3.30 12 3.93 3.74 13 2.25 2.55 14 2.69 3.00 15 1.81 1.77 16 2.58 2.54 17 2.94 2.68 entrepreneurial opportunities 18 2.28 2.87 19 2.69 2.71 20 2.39 2.66 sajems ns 14 (2011) no 1 55 21 3.18 3.23 22 2.39 2.76 23 2.39 2.67 24 2.50 2.94 25 3.76 3.78 26 2.18 2.42 campus entrepreneurship environment 27 3.22 3.17 28 3.59 3.45 29 3.08 3.16 30 3.26 3.07 31 1.97! 2.13! 32 1.72 1.89 33 1.75! 1.87! 34 1.86 1.92 35 1.95! 2.09! south african entrepreneurship environment 36 1.93 2.18 37 2.85 2.81 38 2.69! 2.86! 39 2.89 3.22 40 3.09 3.41 notes: means in bold denote significance at the 5 per cent level, ! denotes significance at the 10 per cent level. men seem more inclined to want to start their own businesses as soon as possible than women and are more disposed to consider entrepreneurship as a career option. men are less prone to find entrepreneurship risky and are also more likely to consider themselves to be risk-takers. men agree that owning their own business offers great financial potential whilst women are more neutral on the matter. men are less certain than women that working for a large company provides better career opportunities and are a lot more certain that they have many good ideas for possible business ventures. men also perceive more opportunities in their field of study than women and appear more alert to business opportunities. men are slightly more positive than women regarding their access to assistance as well as being aware of programmes that help people start businesses. there is therefore a distinct gender dimension to entrepreneurship with men being more positively inclined than women, although both genders are in favour of entrepreneurship. perceptions can also be broken down by race as shown in table 4 4 . significance is slightly more complicated here as two-way tests are conducted across the four groups. table 4 indicates only if a mean is different to that of other groups at the 5 per cent level. table 4 perceptions, by race variable african mean white asian coloured perceptions 1 2.16 2.60 2.94 2.33 2 2.67 3.33 3.13 3.00 3 3.48 3.89 3.73 3.47 4 3.60 3.68* 4.00* 4.00* 56 sajems ns 14 (2011) no 1 5 2.26 3.02* 2.97! 2.20*! 6 2.39 2.55 2.54 2.47 7 3.92 3.65 3.61 3.67 8 2.39 2.22* 2.72* 2.53 9 1.76 1.83* 2.12* 2.20 10 3.01 2.77 2.64 2.80 11 3.59 3.12 2.82! 3.80! 12 4.02 3.68 3.42 3.73 13 2.19 2.68* 2.66 2.13* 14 2.60 3.15 3.03 3.13 15 1.87 1.63* 1.92* 1.67 16 2.80 2.24 2.40 2.53 17 2.68 3.14* 2.61* 2.53* entrepreneurial opportunities 18 2.39 2.77 2.76 2.67 19 2.50 3.01 2.82 2.67 20 2.36 2.69 2.66 2.73 21 3.06 3.45 3.24 3.00 22 2.61 2.48 2.64 2.53 23 2.56 2.51 2.35 2.60 24 2.68 2.66* 2.95* 2.80 25 3.70 3.87 3.73 3.80 26 2.08 2.44* 2.93*! 2.33! campus entrepreneurship environment 27 3.19 3.15 3.28 3.40 28 3.35 3.87* 3.40* 3.27 29 3.06 3.22 3.04 3.47 30 3.09 3.24 3.22 3.73 31 1.99 2.06 2.30 2.40 32 1.79 1.82 1.94 1.67 33 1.75 1.86 2.01 1.80 34 1.86 1.83 2.18 2.07 35 1.97 2.04* 2.35* 2.27 south african entrepreneurship environment 36 1.99 2.12 2.21 2.33 37 2.86 2.78 2.93 2.93 38 2.81 2.76 2.81 2.60 39 3.04 3.05* 3.01! 3.60*! 40 2.83 3.82 3.59 3.87 notes: a difference between african and white, asian or coloured is shown by numbers highlighted in bold, * indicates a difference between white and asian or coloured and ! indicates a difference between asian and coloured. caution should be used when interpreting statistics involving the coloured group as there are so few observations. the racial results reveal surprising and perhaps counter-intuitive trends. intuitively one may have expected asian respondents to be the most positively inclined towards entrepreneurship and africans the least positively inclined given the fact that the question on parents reveals that asians have the most entrepreneurially active parents and africans the least. yet african respondents think they are more likely to start their own business, followed by coloureds and whites, and asian respondents are least likely. some sajems ns 14 (2011) no 1 57 follow-up interviews revealed that africans aspire towards new african role models – billionaires that have emerged in the postapartheid era of black economic empowerment (bee) programmes. asians had a more hard-nosed attitude having seen how their parents worked long hours and sacrificed to achieve what they had. asians also a more conservative view of risk. coloured and african respondents are more likely to consider themselves to be risk-takers than the other two groups but all groups think they are risk-takers. only african respondents feel that entrepreneurship is an excellent and fast way of generating high incomes. coloured and african respondents are convinced that entrepreneurs will do almost anything to make a profit, whilst the other two groups are neutral on the matter. african respondents believe most strongly that one needs connections in order to start a business, which again, through further probing, reveals perceptions regarding bee and the apartheid favouritism. white respondents are most likely to think that tertiary education is not necessary in order to be a successful entrepreneur; africans are least likely to think that. all races believe that there are many opportunities in their major field of study and african respondents are the most positive about this. african, coloured and asian respondents feel that it is too expensive to start one’s own business. but african respondents are much more aware than whites, coloureds and asians of state programmes that provide assistance to small business starters and they also feel more positive about the investment climate in south africa. 4.2 perceptions of entrepreneurship broken down by degree of study, parental background, and work experience one may consider that students in different degree programmes have differing perceptions of entrepreneurship. to establish whether this is the case the paper breaks down the results into degree of study. table 5 lists the means for the forty variables by degree of study. once again significance is more complicated and is only noted if respondents differ at the 5 per cent level. table 5 perceptions by degree of study variables mean commerce art science engineering mba perceptions of entrepreneurship 1 2.39 2.44 2.57 2.46 2.26 2 2.90 2.75* 3.07 2.83# 3.37*# 3 3.58 3.66 3.52 3.67 3.86 4 3.71 3.55 3.55 3.79 3.75 5 2.43 2.50* 2.71! 2.42# 3.16*!# 6 2.41 2.47 2.66! 2.08!# 2.68# 7 3.75 3.73 3.76 4.04 3.97 8 2.45 2.35* 2.57! 2.67# 1.91*!# 9 1.88 1.94* 1.88! 1.92# 1.53*!# 10 2.83 2.66* 3.02 2.96 3.18* 11 3.41 3.26 3.14 3.50 3.41 12 3.88 3.63 3.84 3.88 3.87 13 2.32 2.46 2.58 2.46 2.59 14 2.81 2.64* 3.00* 2.75 3.17* 15 1.86 1.72 1.95! 1.87 1.64! 16 2.73 2.57* 2.60! 2.25 2.00*! 17 2.71 2.67* 2.64! 2.67# 3.47*!# 58 sajems ns 14 (2011) no 1 entrepreneurial opportunities 18 2.53 2.55 2.70 2.33 2.68 19 2.62 2.63* 2.66! 2.42# 3.14*!# 20 2.39 2.70* 2.81! 2.04*!# 2.74# 21 3.17 3.11* 3.16 3.30 3.50* 22 2.61 2.65 2.36 2.63 2.50 23 2.29 3.07* 3.10! 3.46# 2.14*!# 24 2.78 2.71 2.81! 2.67 2.42! 25 3.68 3.75* 3.86 3.71 4.08* 26 2.31 2.27 2.40 2.33 2.22 south african entrepreneurship environment 36 2.10 2.23* 2.03! 2.25# 1.70*!# 37 2.88 2.78 2.86 2.92 2.68 38 2.84 2.63 2.78 3.00 2.73 39 3.05 3.10 3.28 3.04 2.90 40 3.16 3.13* 3.41 3.46 3.66* notes: a mean in bold indicates a difference between commerce and any of the other four, a * indicates a difference between arts and any of the remaining three, a ! indicates a difference between science and any of the remaining two, and # indicates a difference between engineering and an mba. mba respondents differ markedly from the rest of the respondents. this may have something to do with their age and race as well as the fact that, unlike the majority of undergraduate respondents, mba respondents have already obtained professional work experience. most of the mba respondents are white and considerably older. they seem to have stronger opinions than the undergraduates and are most likely to think that they will start their own businesses followed by commerce respondents. mba respondents are the most open-minded about what constitutes entrepreneurship: they need not be inventors, and businesses can be bought or franchised and still be entrepreneurial. they are also least likely to agree that entrepreneurs will do anything for a profit and this may have something to do with the emphasis placed on ethics, governance and sustainability in mba programmes since the collapse of enron. generally, all respondents were not exposed to entrepreneurship ideas either at high school or at university, with mba respondents having the least exposure at high school and the most exposure at university. for mba respondents, the low exposure to entrepreneurship at school-level may have been due to the curriculum focus, during the period they attended school. high school counsellors may have changed their approach in the more recent past, giving the topic of entrepreneurship more of a focus in the curriculum covered at school. at university level, the nature of the mba degree results in more exposure, as one would expect. the results also compare the perceptions of respondents whose parents own businesses to those who do not, parents who are educated to those who are not, and compared respondents who did and did not earn pocket money while they were in school 5 . respondents whose parents own businesses do not differ greatly from those whose parents do not. both groups are equally likely to start their own businesses, although respondents whose parents own businesses are more likely to have seriously considered the option. as regards parental education, respondents differ significantly on only a few variables. the more educated the parents, the less likely they are to start their own businesses (although, on average, all groups agree that they will do so). respondents whose parents have tertiary education seem more flexible with respect to their definition of entrepreneurship, and are least likely to agree that entrepreneurs are almost always inventors. they are also the least likely to believe that entrepreneurs will do anything to make a profit. there is no consistent difference in student perceptions when analysing responses related to parents’ level of education. although there sajems ns 14 (2011) no 1 59 are significant differences for various questions and groups, there does not appear to be much of a pattern. one is tempted to conclude that parental education may not greatly influence how university students perceive entrepreneurship. respondents who did not receive pocket money are more likely to consider themselves to be risk-takers, perhaps out of necessity. those with pocket money are more inclined to think that entrepreneurship is an honourable profession. table 6 characterises the parents’ incomes in order to determine whether income has an effect on entrepreneurship perceptions. table 6 perceptions by parental income variables mean <r2000 r2001-r5000 r5001r10 000 r10 001 r20 000 >r20 000 perceptions of entrepreneurship 1 2.08 2.43 2.43 2.70# 2.32# 2 2.56 2.62* 2.84! 3.34*! 3.14* 3 3.38 3.43* 3.56! 3.72! 3.80* 4 3.46 3.69 3.74 3.65 3.78 5 2.12 2.04* 2.68* 2.81* 2.83* 6 2.25 2.47 2.35! 2.67! 2.51 7 3.99 3.84 3.68 3.86 3.72 8 2.38 2.66* 2.41 2.53# 2.19*# 9 1.79 1.81 1.71 1.93 1.79 10 3.08 3.06 2.97 2.72 2.82 11 3.98 3.65* 3.13* 3.30 3.12* 12 4.15 4.04* 3.75 3.62* 3.78 13 2.07 2.10* 2.38! 2.69*! 2.56 14 2.49 2.449* 2.90* 3.04* 3.01 15 1.89 1.80 1.95! 1.89# 1.63!# 16 2.89 2.83* 2.65! 2.53 2.28*! 17 2.59 2.60* 2.84 2.78 3.03* entrepreneurial opportunities 18 2.38 2.41 2.56 2.86# 2.50# 19 2.32 2.71 2.45! 2.57# 3.01!# 20 2.18 2.61 2.54 2.55 2.59 21 2.88 2.91* 3.44* 3.22 3.33* 22 2.75 2.72* 2.58 2.55 2.40* 23 2.64 2.43 2.79! 2.53 2.39! 24 2.71 2.61 2.69 2.90# 2.59# 25 3.48 4.10* 3.80 3.69* 3.92 26 1.98 2.30 2.30 2.41 2.34 35 1.95 2.00 2.15 1.97 2.05 south african entrepreneurship environment 36 2.01 2.03 2.13 2.18 1.98 37 2.89 2.73 2.80 2.91 2.72 38 2.75 2.77 2.84 2.73 2.87 39 3.03 2.94* 3.06 3.36*# 2.88# 40 2.84 2.85* 3.32* 3.33* 3.51* 60 sajems ns 14 (2011) no 1 notes: a mean in bold indicates a difference between an income of less than r2000 and any of the other four, * indicates a difference between an income of between r2001 and r5000 and any of the remaining three, ! indicates a difference between an income between r5001 and r10 000 and any of the remaining two, and # indicates a difference between an income between r10 001 and r20 000 and an income greater than r20 000. respondents from both the poorest and richest households are most likely to think that they will start their own businesses. as discussed above, it may be that poorer respondents are thinking about more basic enterprises whilst richer ones are thinking about innovative startups. yet poorer respondents are more inclined to think that business owners will do anything to make a profit while believing that it is not necessarily true that they may earn more money working for a company. respondents in the lowest two income groups are least likely to feel that it is too risky to start their own business and are correspondingly most likely to believe that they are risk-takers. interestingly, respondents in the highest two income groups are least likely to believe that entrepreneurship is a financially viable option while those in the lowest two income groups are most likely to believe this. however, all the respondents, except those in the highest income group would prefer to work for a large company, believing that there would be better career opportunities. only the highest income group disagreed with that statement. this suggests that poorer respondents may see entrepreneurship as a necessity, perhaps indicating some doubt about their ability to find a job working for a business. on the other hand, the richest respondents may have more confidence about finding jobs in large companies and may see entrepreneurship as more of a risky choice. respondents from these differing income groups may have different perceptions about what constitutes owning their own business. richer respondents are thus less likely to believe that owning a franchise or buying a business is not entrepreneurship. the results obtained from breaking down responses by income group are closely related to those broken down by race group when acknowledging that respondents from the wealthiest income groups are likely to be white while those from the poorest group are likely to be black. overall, respondents from the poorest two groups appear to be the most positive about starting their own businesses and also appear to have access to more information. table 7 shows the differences between respondents who had a part-time job whilst at school or at university and those who did not as well as the difference between those who took business related subjects and those who did not. table 7 perceptions by job background and access to business courses variables mean school job university job business subjects yes no yes no yes no perceptions of entrepreneurship 1 2.21 2.57 2.31 2.51 2.47 2.36 2 2.94 2.97 3.09 2.83 2.92 3.01 3 3.73 3.54 3.71 3.55 3.59 3.70 4 3.74 3.60 3.74 3.61 3.67 3.68 5 2.75 2.48 2.76 2.44 2.49 2.71 6 2.40 2.48 2.46 2.46 2.48 2.45 7 3.87 3.73 3.79 3.80 3.76 3.83 8 2.15 2.54 2.25 2.51 2.46 2.31 9 1.79 1.86 1.82 1.86 1.91 1.73 10 3.08 2.70 2.97 2.77 2.83 2.92 11 3.29 3.42 3.26 3.47 3.32 3.44 sajems ns 14 (2011) no 1 61 12 3.91 3.79 3.77 3.87 3.86 3.76 13 2.30 2.49 2.44 2.37 2.36 2.52 14 2.87 2.85 2.92 2.81 2.84 2.88 15 1.61 1.93 1.73 1.83 1.83 1.75 16 2.49 2.63 2.40 2.71 2.71 2.34 17 3.06 2.67 3.02 2.65 2.66 3.06 entrepreneurial opportunities 18 2.37 2.68 2.57 2.55 2.55 2.59 19 2.77 2.63 2.79 2.60 2.58 2.84 20 2.44 2.59 2.60 2.44 2.44 2.60 21 3.28 3.14 3.20 3.20 3.23 3.18 22 2.50 2.59 2.50 2.61 2.60 2.53 23 2.35 2.65 2.47 2.58 2.36 2.77 24 2.55 2.84 2.62 2.79 2.77 2.67 25 3.87 3.70 3.76 3.78 3.67 3.89 26 2.38 2.26 2.23 2.40 2.27 2.32 35 1.95 2.06 1.95 2.09 1.99 2.12 south african entrepreneurship environment 36 1.90 2.16 1.98 2.12 2.09 2.05 37 2.68 2.94 2.70 2.95 2.80 2.87 38 2.77 2.82 2.74 2.86 2.79 2.83 39 2.94 3.13 3.04 3.03 3.02 3.14 40 3.34 3.16 3.30 3.19 3.22 3.31 respondents with early exposure to financial responsibility are more likely to think that they will start their own businesses. they are also more flexible on what constitutes an entrepreneur as well as slightly less inclined to think that entrepreneurs would do anything for a profit. it thus comes as no surprise that these are also the respondents who are more likely to have considered entrepreneurship as a career option and are more likely to consider themselves to be risk-takers. they are more convinced that entrepreneurship is an honourable profession and less likely to believe that their career prospects are better at a large company. they are also more prone to believe that they have many ideas for business ventures. respondents with part-time jobs at university are also generally more positive about entrepreneurship than those without jobs and are less likely to think that a tertiary education is necessary to be an entrepreneur. generally, respondents who did not take any business classes seem more optimistic about entrepreneurship. probing revealed that the perceptions of these respondents had an element of romanticism; many were unaware of what entrepreneurial success and commitment really requires. they also seem less inclined to believe that they would have better career prospects working for another company. the reason may be that business classes bias students away from entre-preneurship given that there is not much focus on entrepreneurial content and tend to train students for the existing labour market that is dominated by larger corporations. 5 conclusion the results extracted from this sample of 609 south african students generally reveal that respondents have a very positive attitude towards entrepreneurship. over 83 per cent of the respondents view entrepreneurship as an honourable profession and respect people who are entrepreneurs. more than half intend starting their own business as soon as possible and see themselves as risk-takers. however, delving further into these results illustrate distinct gender and racial differences with men 62 sajems ns 14 (2011) no 1 generally more positively disposed towards entrepreneurship whilst africans are the most positive and asians the least positive. degree of study, parental income, student work and financial experience all appear to affect perceptions of entrepreneurship. the results reinforce the earlier literature review which emphasised the importance of both individual and social characteristics with regard to entrepreneurial attitudes. given these generally favourable results, the paper is left with the puzzling question as to why south africa performs so poorly on international entrepreneurship rankings? one explanation could be that the sample of university students is automatically more entrepreneurial than less qualified south africans. however, this contradicts available evidence that university students tend to seek employment in the existing corporate sector. it is evident that although respondents believe entrepreneurship to be an honourable occupation and can imagine themselves running their own businesses, they are nonetheless attracted by the employment and financial security available in large corporations. indeed, over 40 per cent of the sample admits that they would prefer to work in large companies because of better career prospects with a further third being neutral, and less than 28 per cent disagreeing with the desire to work for a large company. it could be that currently students have a more idealistic view (as one would expect at that age), but when they enter the ‘real’ world then the realities become enmeshed with risk aversion and overshadow these perceptions, rendering entrepreneurial activities largely defunct. 5.1 limitations and recommendations for future research this paper uses a cross sectional approach to entrepreneurial attitudes and behaviours and as such cannot look at the dynamics of these perceptions nor can it determine any causal influences. a longitudinal study which follows these respondents over time as they leave university and enter the workforce would yield useful insights about how their perceptions change and how their perceptions match up with their actual employment choices. furthermore, there have been great advances in the area of behavioural and experimental economics which would be useful for testing some of these results. an obvious extension would be the analysis of risk aversion through experiments and the use of real world incentives. 5.2 study implications the paper demonstrates that socio-economic, demographic, cultural and institutional variables are associated with the entrepreneurial attitudes of individuals. this has interesting potential implications for the policy realm where the south african government has spent enormous resources in trying to stimulate entrepreneurship with limited success (herrington et al., 2009:15). some of the characteristics which have revealed themselves to be significant include race and gender and these are path dependent which government policy cannot alter, but it can play a role in underwriting risk through various types of affirmative action. for example, the research shows that the level of study and the degree being pursued matters and this does allow for policy intervention. furthermore, the way in which individuals think of themselves and their abilities is itself influenced by institutional factors and these are subject to intervention although it is a slow process (see luiz, 2009:59). a more holistic approach to entrepreneurship and policy is thus warranted. acknowledgement the authors gratefully acknowledge the financial support of ersa. endnotes 1 total early-stage entrepreneurial activity (tea) index indicates the prevalence of business startups (or nascent entrepreneurs) and new firms in the adult (18 to 64 years of age) population – in other words, it captures the level of dynamic entrepreneurial activity in a country. sajems ns 14 (2011) no 1 63 2 students completing the matriculation year obtain a high school completion certificate. tertiary education refers to post school higher education. 3 see appendix a for a list of question numbers and their assigned variables. due to space constraints, these are not included in the tables in this section. 4 given south africa’s history of exclusionary racial estates which also applied to economic and educational opportunities, it makes sense for us to test these perceptions using the official racial classification of white, african/black, asian and coloured. this was the classification employed under apartheid and it is being used by the current government to promote a form of affirmative action. 5 we do not present these results because of space constraints, but the results are available from the author. references ahwireng-obeng, f. 2006. entrepreneurship in africa. in luiz.j (ed.) managing business in africa. cape town: oxford university press. ayyagari, m., beck, t. & demirguc-kunt, a. 2007. small and medium enterprises across the globe. small business economics. 29:415-434. banerjee, a., galian. s., levinsohn, j., mclaren, z. & woolard, i. 2008. why has unemployment risen in the new south africa. economics of transition. 16(4):715-740. bosma, n. & levie, j. 2009. global entrepreneurship monitor: 2009 global report. 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[online] available at: http://www.soton.ac.uk/~infoserv/pubaff/newrep/vol16/no20stud.html. statistics sa. 2010. key indicators. [online] available at: http://www.statssa.gov.za/keyindicators/keyindicators.asp. [accessed 2010-11-29]. urban, b. (ed.) 2008. frontiers in entrepreneurship. johannesburg: heinemann publishers. urban, b. 2010. competitive strategies for technology entrepreneurs: links to environmental dynamism and hostility. international journal of entrepreneurship and innovation. 11(1):69-77. van praag, c.m. versloot, p.h. 2007. what is the value of entrepreneurship? a review of recent research. small business economics. 29:351-382. http://www.soton.ac.uk/~infoserv/pubaff/newrep/vol16/no20stud.html http://www.statssa.gov.za/keyindicators/keyindicators.asp sajems ns 14 (2011) no 1 65 appendix 1: list of question numbers and their assigned variables number variable perceptions of entrepreneurship 1 wants to start own business 2 entrepreneurs are almost always inventors 3 buying a business is not entrepreneurship 4 owning a franchise is not entrepreneurship 5 entrepreneurs will do anything for profit 6 entrepreneurs are largely responsible for new innovations, technologies and products 7 can earn more money working for someone else 8 has seriously considered entrepreneurship as career option 9 academic institutions should encourage students to consider entrepreneurship 10 too busy with classes to consider starting own business 11 parents are entrepreneurs 12 too risky to start own business 13 is a risk-taker 14 entrepreneurship is a good way to make lots of money 15 entrepreneurship is an honourable profession 16 a tertiary education is not necessary to be an entrepreneur 17 prefers to work for a large company, better career prospects entrepreneurial opportunities 18 has many ideas for business ventures 19 too expensive to start own business 20 there are many entrepreneurial opportunities in student’s area of study 21 entrepreneurial ventures are mainly limited to business ideas 22 has good understanding of intellectual property 23 understands equity finance 24 constantly alert to business opportunities 25 all the good ideas have been taken 26 need connections to start a business campus entrepreneurship environment 27 students are encouraged to pursue entrepreneurship ventures 28 high school counsellor mentioned entrepreneurship as career option 29 examples of how science and technology are key to business are included in class examples 30 entrepreneurial or business related examples are included in classes 31 having a mentor would help 32 a small seed grant would encourage entrepreneurship 33 more business sector interaction would encourage entrepreneurship 34 private sector support for student entrepreneurs would result in more university based business start-ups. 35 a programme to defer student loan payments for student entrepreneurs would encourage more students to pursue a business venture after graduation south african entrepreneurship environment 36 south africa is an excellent country to start a business. 37 my local community supports entrepreneurs 38 it would be very difficult to raise the money needed to start a new business in south africa 39 i know how to have access to the assistance i would need to start a new business. 40 i am aware of programmes the state provides to help people start businesses f:\ejour\ecoman\index\ecoman_v6_n2.prn.pdf sajems ns vol 6 (2003) no 2 399 the impact of legislative changes in the tobacco industry on south africans − clearing the air ________________________________________________________________ leon de w fourie department of public management, technikon pretoria johan de jager department of marketing, technikon pretoria ________________________________________________________________ abstract the purpose of this article is to gain insight in the south african tobacco industry, its influence on the community and the role of anti-tobacco campaigns. this is done by conducting an empirical investigation of the attitudes and behaviour of smokers and non-smokers regarding the national government campaigns against tobacco products. consequently, it will contribute in determining the efficiency of the anti-tobacco campaigns as well as the effect of the tobacco products control amendment act, 1999 (act 12 of 1999) on smokers and non-smokers. it is postulated that by applying the principles of marketing (demarketing and remarketing) it could contribute significantly in influencing smoking behaviour amongst south africans. jel k2, d12 1 introduction an international survey conducted by medline in 2001, concluded that tobacco usage not only has a negative affect on the health of those who do smoke, but secondary smoke is also harmful to non-smokers. passive smoking is widespread, and environmental tobacco smoke contains many potent respiratory irritants. data collected from 7882 adults (age 20-48 years) who had never smoked, from 36 centres in 16 countries researched the effect of passive smoking on respiratory symptoms, bronchial responsiveness, and lung function of non-smokers. the study concluded that more than 50 percent of participants showed signs of respiratory diseases from passive smoking. it could be argued that decreasing involuntary exposure to tobacco smoke in the community, especially in workplaces, is likely to improve respiratory health (riley et al., 2000: 1). sajems ns vol 6 (2003) no 2 400 it is common knowledge that tobacco usage is one of the chief preventable causes of death in the world. the world health organisation (who) attributes some 4 million deaths per year to smoking. this figure is expected to rise to 8.4 million deaths per year by 2020 (riley et al., 2000: 1). in another study, bechoo (2001: 1) similarly concluded that by the year 2020 tobacco related deaths are expected to rise to 10 million a year. disconcertingly, it is determined that 70 percent of these deaths will be in developing countries, which does not bode well for south africa. the human sciences research council (hsrc) and medical research council (mrc) in november 1998 estimated that more than 4 million people worldwide die of tobacco related illnesses every year. in south africa alone an estimated 25 000 people die of diseases attributed to cigarette smoking every year. smokers lose an average of 12 years of life expectancy due to the smoking habit. the research statistics conducted by the hsrc and mrc show the following estimated prevalence among south african adults: 41 percent african males; 3 percent african females; 62 percent coloured males; 41 percent coloured females; 47 indian males; 1 percent indian females; 45 percent white males and 28 percent white females. this brings the number of smokers in south africa to almost 25 percent of the population (riley et al., 2000: 1). contrary to popular belief and extensive anti-smoking campaigns by the national government, smoking is on the increase among young people. as a result the south african national government and other stakeholders, such as churches and schools, have called for concerted action against tobacco use in public places, the workplace and smoking by especially young people (riley et al., 2000: 1). in terms of section 24 of the constitution of the republic of south africa, 1996 (act 108 of 1996) every south african has the right to an environment “…that is not harmful to their health or well-being”. this has led to the tobacco products control amendment act, 1999 (act 12 of 1999), prohibiting the advertising and promotion of tobacco products; prohibiting the free distribution of tobacco products; limiting smoking in public places including the workplace and; allowing for the regulation of the nicotine and tar levels of tobacco. according to kotler & levy (1969: 10-15) marketing principles are not only applic able to profit organisations, but are also used by non-profit organisations in order to obtain their objectives. these marketing principles are not only applicable on goods and services, but can be extended to be applied to organisations, places and ideas. idea marketing is better known as social marketing because it deals with the marketing of social affairs. this includes aspects such as road safety campaigns, family planning and anti-tobacco campaigns. sajems ns vol 6 (2003) no 2 401 the purpose of this paper is to gain insight in the tobacco industry, its influence on the community and the role of anti-tobacco campaigns. this is done through conducting an empirical investigation of the attitudes and perceptions of smokers and non-smokers regarding the national government campaigns against tobacco products. consequently, it will contribute in determining the efficiency of the anti-tobacco campaigns as well as the effect of the tobacco products control amendment act, 1999 (act 12 of 1999) on smokers and non-smokers. it is postulated that by applying the principles of marketing it could contribute significantly in influencing smoking behaviour amongst south africans. 2 research objectives tobacco smoking is an addictive habit. people who are addicted have great difficulty in giving up tobacco smoke and the smoking cessation strategies have at best an approximately 20 percent success rate. thus, it is important to ensure that south africans are not exposed to marketing forces that promote smoking behaviour. with this borne in mind the objectives of this research are to investigate the: • perceived success of anti-tobacco groups in limiting smoking; • extent of the tobacco industry’s involvement in smoking; • influence of restrictive measures on tobacco products in south africa; • influence of the tobacco products control amendment act, 1999 (act 12 of 1999) on various stakeholders; • counteractions by the tobacco industry as a result of the tobacco products control amendment act, 1999 (act 12 of 1999); and • success of anti-tobacco campaigns as perceived by inhabitants in the greater pretoria region conducted by means of an empirical survey. 3 method of the study an ontological approach to the study allows the researchers to study the reality of the impact of tobacco products control amendment act, 1999 (act 12 of 1999) on smokers and non-smokers. the research topic lends itself to utilising predominantly a historical and descriptive research technique. historical research will enable the researchers to give rational explanation and reasons why the incidence of tobacco related diseases are inordinately high in south africa. descriptive research will assist the researchers to look beyond mere factual information, by using observation as a means of obtaining information regarding smokers’ behaviour and non-smokers’ reaction to substantiate arguments. sajems ns vol 6 (2003) no 2 402 an ontological approach implies that the researchers will mainly focus on secondary data. in this case secondary data pertains to data that was collected by other researchers concerning the tobacco industry. secondary data is used to get insight on the tobacco industry, its influence on the community and the success of anti-tobacco campaigns. primary data was collected from the attitudes and perceptions of smokers and non-smokers regarding the use of tobacco products, as well as tobacco legislation. this was done to determine the efficiency of the anti-tobacco campaigns as well as the effect of the tobacco products control amendment act, 1999 (act 12 of 1999) on smokers and nonsmokers. this further implies that the research theme was approached from a both quantitative and qualitative research perspective. quantitative research data was obtained by means of the empirical survey conducted in the pretoriaregion; whilst qualitative research data was obtained through the perceived behaviour of smokers leading to discovering novel or unanticipated findings. seven hundred households were selected at random in pretoria, centurion, akasia and mamelodi. these households were issued with two different structured questionnaires, which had to be completed by the head of the household. the stratified sample method was used to ensure that the correct ratio of questionnaires was distributed in each sub-unit. following this procedure, the systematic sample method was used to select the desired sample unit. initially the head of the household was approached to participate to the survey. in the event that the head of the household was unavailable or unable to assist, a substitute of the age of 18 years or older was selected. chi square tests of dependency were used to test relationships on a 5 per cent level of significance. dependencies were tested between the outcomes of the two different studies related to selected smoking related questions. these are appropriately highlighted in the article. 4 health hazards of tobacco smoke environmental tobacco smoke (ets), also known as second-hand smoke, is the smoke given off by the burning tip of a cigarette, cigar, or pipe, and the smoke exhaled by the person who is smoking it. the smoke of tobacco products contain over 4000 chemical compounds, more than 43 of them can cause cancer in humans. in a working life of 40 or more years, exposure to tobacco smoke at work can be considerable. it is a scientific fact that passive smoking causes lung cancer and heart disease in non-smokers. the world health organisation (who) estimates that nearly 700 million, or almost half the world’s children, breathe air polluted by tobacco smoke, particularly at home. children and infants exposed to second hand smoke are vulnerable to diseases such as sudden sajems ns vol 6 (2003) no 2 403 infants death syndrome (sids), higher risk of pneumonia and bronchitis, higher risk of developing asthma and worsened asthma. according to the tobacco action group (tag), the national cancer association, the heart foundation of south africa and the council against smoking, (www. cansa.org.za) tobacco smoke has the following inherent health hazards: • smoking robs a person from energy giving oxygen and replaces it with up to 15 percent carbon monoxide. carbon monoxide is a poisonous chemical and causes amongst other reduced stamina in smokers. • smoking causes the heart to work harder and increases the chance of heart deceases. • nine out of ten smokers present evidence of emphysema, a dismantling disease that causes a painful and slow death. emphysema destroys the air bags in the lungs causing difficulty to breath. • tobacco is responsible for one out of every three cancer mortalities. tobacco smoke does not only cause lung cancer, but is also responsible for other cancers such as mouth, kidney, bladder and cancer of the pancreas. • passive smoking causes cancer amongst non-smokers. inhaling of second hand smoke increases the risk on heart attacks by 30 percent. in the united states of america 53 000 people die annually due to passive smoking (alberts, 1993: 10). in china, this figure is an alarming 500 000 people per annum (anon, 1996: 932). • the medical research council of south africa determined that almost one third of south africans die as a direct result of smoking. taking the abovementioned into consideration it is clear that action groups against the use of tobacco products have significant factual foundations to substantiate their arguments and launch their campaigns. the application of social marketing principles is thus undoubtedly a useful tool in the campaign against smoking. 5 acknowledging tobacco smoke as a health hazard health hazards caused by smoking have not been high on the international health agenda. concern over the health hazards caused by cigarette smoke had gained some attention in the 1950s in the united states of america. however, it was only after the surgeon general’s report in 1964 that public policymakers in sajems ns vol 6 (2003) no 2 404 the united states of americ a began to launch considerable efforts to alter the american public’s smoking behaviour. in 1967 the department of health and human services (dhhs) spent more than 20 million rand in an effort to inform consumers of the health hazards of smoking. dhhs used tactics as bumper stickers that read “smoke, choke, croak” and endorsements from athletic stars such as peggy flemming and bart starr claiming: “ i don’t smoke”. in general, the approach was to depict smokers as distraught coughers, whereas nonsmokers were portrayed as happy and healthy. these promotional efforts had some limited impact on smoking behaviour. it was discovered that cigarette sales fell by 1.3 billion cigarettes annually and that the number of american smokers dropped by a total of 71.5 million to 70 million smokers. however, it was found that rather than a steady decline in cigarette sales or the number of smokers, the major behavioural trend has been toward the purchase of low-tar and low nicotine brands (mowen, 1996: 833). it can therefore be deducted that the american government’s attempts to change smoking behaviour among its citizens was to an extent successful. during the 1990s the negative publicity concerning smoking and the actions of the tobacco industry escalated. in 1994 a national poll was conducted which found that 68 percent of all americans believed that cigarette advertisements influence children and teenagers to smoke. the results also revealed that two thirds of americans, including half of all the smokers, wanted the government to place greater restrictions on cigarette advertising. more than 50 percent of those polled wanted all cigarette advertising banned (mowen, 1996: 833). a survey conducted in 1998 by the xinhua news agency in south africa, similarly indicated that 70 percent of smokers and 90 percent of non-smokers favoured a ban on smoking in public and the workplace. (xinhua news agency, 2000: 15 and white, 2001: 1). to illustrate the extent of tobacco promotion budgets, de jager (1997: 3) reported that the promotion budget for cigarette companies in england in 1996, amounted to 100 million pounds (143 million us dollars), while anti-tobacco campaigns amounted to 150 000 pounds (215 217 us dollars). thus, in monetary terms a clear indication that anti-tobacco campaigns have a lesser impact on smokers than promotions and advertisements offered by the tobacco industry. white (2001: 1) claims that prior to the end of apartheid in 1994, a third of all south africans smoked, excise taxes were low and there were few tobacco control measures. according to the human sciences research council (hsrc) 52 percent of the males in south africa are smokers, placing south african male smokers sixteenth in the world. sajems ns vol 6 (2003) no 2 405 6 legislative measures to control the tobacco industry on 14 august 1998, dr. gonda perez, of the department of health announced that: “government has a responsibility to protect our young people from the dangers of smoking. while we can utilise health warnings on packaging and advertisements to inform the public of the dangers of tobacco, it is not enough. warnings are directed at smokers to encourage them to quit and young people, starting to smoke tend to ignore the health warnings. we therefore need to act against advertising which encourages young people to see smoking as symbol of independence, a way to boost self esteem and self confidence.” the south african government embarked on a plan to discourage people’s smoking habits, especially males (white, 2001: 1). the end of apartheid and democratisation of south african in 1994, was an important step in the government’s shift away from support for the tobacco industry. in the period 1996 to 1998 the south african tobacco industry spent approximately 240 million rand (20.8 million us dollars) a year on advertising and promotions. the tobacco industry claimed that it did not influence anyone to smoke, but were merely competing for market share. (zuma, 1998: 1). the tobacco industry objected to proposed amendments to the tobacco products control act, 1993 (act 83 of 1993), by challenging the then minister of health, dr. nkosazana zuma, in court. despite their plea that the proposed amendments would lead to 15 000 people becoming unemployed, the tobacco industry lost the court case. despite an american ban on television commercials promoting tobacco products, the tobacco industry continues to survive. it could be argued that poor communication strategies by anti-smoking groups were in part to blame, but the root causes are the strong social reward for smoking in some circles (mowen, 1996: 833). the limited success achieved through government regulation is therefore not unique to south africa a five year experiment with an outright ban on cigarette advertising in canada, saw an operating profit of more than double because of the huge cutback in advertising costs greising (2001: 49). the tobacco action group (tag), a coalition consisting of the national council against smoking, the cancer association of south africa, and the heart foundation of south africa, helped raise public awareness about smoking hazards and drove tobacco control to the forefront of the political agenda. as a result, precautions have been in place since 1993 to control the use of tobacco products in public. in terms of section 83 of the tobacco products control act, 1993 (act 12 of 1993), the minister of health is authorised to promulgate regulations to prohibit smoking in official places. this led to the sajems ns vol 6 (2003) no 2 406 implementation of the tobacco products control amendment act, 1999 (act 12 of 1999) prohibiting the advertising and promotion of tobacco products; prohibiting the free distribution of tobacco products; limiting smoking in public places including the workplace and; allowing for the regulation of the nicotine and tar levels of tobacco. in 1994 the act was strengthened, requiring stronger health warnings and restricting smoking in government buildings and in certain types of private businesses (white, 2001: 1). in terms of section 7 of the tobacco products control amendment act, 1999 (act 12 of 1999), a person caught smoking in a non-smoking area will be fined up to r200, while companies which contravenes the regulations face fines up to r200 000. children under the age of 16, in terms of section 5, are not allo wed to purchase tobacco products and retailers can be fined should they be found selling tobacco products to children. the bottom line is that a smoke-free environment will limit the number of tobacco related illnesses that from which the population suffers. the tobacco products control amendment act, 1999 (act 12 of 1999), also stipulates that public places should have smoking and non-smoking areas, and that not more than 25 percent of public places including the workplace, restaurant, pub, shebeen or bar should be allocated for smoking. a concrete wall or solid partition should divide the smoking area form the non-smoking area. the smoking area should have ventilation in a form of a window or an electronic ventilation. if the floor space takes only 32 people no smoking is allowed at all. soolojee quoted in white (2001: 11) denied insinuations that the government is hesitant to place a total ban on smoking, due to a loss of potential income. an outright ban on smoking would result in criminalising smoking and cause them to move underground. however, according to kotler and andreasen (1996: 450), governments are not inclined to place a general embargo on the use of tobacco products. this is due to the fact that government’s, as in the case of south africa, are dependent on the revenue, which results from the tobacco industry. 7 impact of legislative measures on stakeholders the tobacco industry argued that tobacco is vital to the south african economy because it creates jobs and is an important farm crop. however, despite greatly increased consumption of tobacco in south africa, since 1950 the number of tobacco farms and the amount of land cultivated has both steadily declined. the university of cape’s project on the economics of tobacco control studied the sajems ns vol 6 (2003) no 2 407 employment in the tobacco-manufacturing sector in south africa between 1945 and 1995. the studies showed that there was a considerable decrease in employment over the stated period, or an estimated 5.6 percent per year. the tobacco products control amendment act, 1999 (act 12 of 1999) has had an impact on a number of stakeholders. it could be argued that the act negatively impacted on the freedom of speech as stipulated in section 16 of the constitution of the republic of south africa, 1996 (act 108 of 1996). consequently the proposed prohibition of tobacco advertisements made the act a controversial issue in the press and media. on the one hand the use of tobacco products is acceptable; but on the other hand the smoker’s right to be informed is negated. the tobacco products control amendment act, 1999 (act 12 of 1999) has had far reaching consequences for the media. the prohibition of traditional tobacco promotions causes considerate damage to the press. according van deventer, executive head of nasionale koerante, this led to poor service rendering to news agency customers because of the consequent reduction in advertisement income as a result of the prohibition imposed by the act (de jager, 1997: 5). jurgens (1997: 12) is of the opinion that the “…tobacco industry is unlawfully harmed because of all the constraints imposed on the sales of tobacco products”. although excise duty and corporative tax is paid to government, the department of health does not show much interest in negotiations with the tobacco industry. du plessis (2001: 3) confirms that the tobacco industry endeavours to have a constructive relationship with government regarding this issue, but that antitobacco organisations attempt to create a gap between the tobacco industry and the government. in response the tobacco industry make the usual noises when faced with increased regulations, primarily that the laws are too strict and would carry a high economic cost. it is also alleged that the tobacco industry claims that the legislation would harm the tourism industry, and even lobbied the minister of tourism for support. according to white (2001: 1) various pressure groups such as the freedom of commercial speech trust, representing the media and marketing industries; the south african chamber of business; the american chamber of business and the council of south africa banks; lobbied against the proposed advertising bans. furthermore, stakeholders such as the food and allied workers union (representing the tobacco manufacturing workers), international experts and sports and cultural recipients of tobacco sponsorships, were influenced by the tobacco industry to testify against the proposed act. according to white (2001: 4), however, the tobacco industry publicly claimed that although the opportunity for smoking became less they did not expect a drop in tobacco sales. sajems ns vol 6 (2003) no 2 408 the tobacco products control amendment act, 1999 (act 12 of 1999) also had a negative impact on job creation opportunities and economic activity in the tobacco industry, the media, the advertising industry, and the government as well as tobacco action groups. south african soccer lost 10 million rand in revenue in tobacco sponsorship annually with the scrapping of the rothmans cup due to the government’s anti smoking legislation. the result was that the south african football association (safa) had to find new sponsorship. safa, however, joined the anti-smoking lobbyist promoting a healthy lifestyle amongst its players and the public (naidoo, 2001: 1). the most significant question was to determine if the tobacco products control amendment act, 1999 (act 12 of 1999) had the desired effect on the smoking behaviour of south african citizens. the government anticipated that a ban on tobacco advertising would effectively reduce the number of smokers, either aspirant or existing. palmer (1998: 4) points out that statistics from european countries where curbs have been placed on tobacco advertising for sometime, actually showed an increase in tobacco consumption. although in norway, finland, new zealand and france bans on tobacco advertising and promotions resulted in a decrease of between 14 and 37 percent in cigarette sales since the ban in 1996. it could be argued that it is difficult to determine what the impact of tobacco legislation would have on citizens, because it could result in both a decrease or increase in smoking behaviour. 8 novel tobacco marketing ploys it is clear that the tobacco products control amendment act, 1999 (act 12 of 1999) had a significant impact on the marketing strategy of the tobacco industry. in 1998 the tobacco industry spent approximately a quarter of a billion rand (21 739 billion us dollars) on publicity and promotion. the perceived fear that a prohibitio n on advertisements and promotions would lead to a decrease in tobacco sales figures was eminent. interestingly, tobacco companies halted their advertisements three months before they were obliged by law to do so (keenan, 2001: 11). whether it was done in good faith of the government’s anti-smoking campaign or just a clever marketing ploy by the tobacco industry is difficult to determine. it could be argued that this was the inception phase of nontraditional, creative advertising of tobacco products. the tobacco companies had to devise novel ways of reaching its market. the predominant question was how to reach a market that by law could not see nor hear tobacco advertisements, or a market that could not be targeted by means of sajems ns vol 6 (2003) no 2 409 promotions? white (2001: 4) is of the opinion that in the past the tobacco industry circumvented laws, exploiting loopholes in the law and often disregarded it altogether. bednall quoted in keenan (2001: 11) concurs that it is possible, through mass events such as concerts or utilising the internet, web pages and cellular phones, to reach a particular market. this approach is permissible with the proviso that permission has been obtained. however, it remains a fact that tobacco companies can no longer influence non-smokers directly. bednall quoted in keenan (2001: 11) points out that unique cellular phone messages have been developed which could add value to smokers by informing them about aspects that are perceived to be of personal interest for the smokers. in doing so, the smokers’ interests are determined, and it becomes possible for the tobacco companies to focus their marketing strategies on those interests. in other words a client relationship is created. keenan (2001: 11) aptly states that “…cellular phones are the new road to a person’s lungs because cigarette companies are concentrating on lower income groups and third world countries, the same market on which cellular sales are aimed”. greising (1996: 49) agrees with this new creative personal method and argues that the tobacco companies are continuously looking for novel methods to comply with changing legislation. the cellular approach seems promising for the interim, but government and anti-smoking agencies continuously try and foil such manoeuvres. palmer (1998: 4) supports a non-traditional approach to marketing the tobacco industry and proposes alternative ways of promoting tobacco products. nontraditional techniques circumvent the prohibitions in terms of tobacco products control amendment act, 1999 (act 12 of 1999). techniques for example, include advertising on the internet, the motion picture industry, and even direct approaches such as direct mail. these techniques cannot be inhibited because of the right to free speech in terms of section 16 of the constitution of the republic of south africa, 1996 (act 108 of 1996). palmer (1998: 4) argues that the only effective way to curb the smoking habit, is to educate the public. this argument is supported by mason (2001: 1) who points out that there are better ways of curtailing the smoking habit. in this regard he propagates improved scholastic education and the promotion of a healthier life-style through advertising. according to twinn (2001: 1) health warnings are not effective, and a product such as tobacco, even becomes more alluring when a warning is attached to it. according to kotler and clark (1985: 16) demarketing, or otherwise referred to as unselling campaigns, seeks to reduce the overall demand of a product and sajems ns vol 6 (2003) no 2 410 implies such actions as raising prices, and/or reducing promotion, access, or service. in other words, demarketing requires finding ways to discourage demand of a product temporarily or permanently. products considered unwholesome, such as tobacco, alcohol, and drugs, will attract organized efforts to discourage their consumption. the marketing task is to get consumers to quit, or at the very least reduce the use of a harmful product (mowen, 1995: 290291). anti product marketers use the same tools as demarketers, although the former are also more likely to use promotional communication and reduced availability to discourage consumption. in this context demarketing schemes against tobacco usage are aimed at countering the marketing efforts of tobacco companies. demarketing of tobacco products by the south african government would, for example imply a legislative prerequisite for the placement of warning labels on tobacco products. the goal of the warning labels is to influence attitudes by identifying an attribute that results in a negative outcome, for example “smoking causes cancer” or “smoking is harmful to children” and “smoking is hazardous to your health”. an interesting strategy by the south african government to complement their demarketing approach is to place radical tax increases on tobacco products from year to year, otherwise known as “sin tax”. scott (1995: 1) claims that instead of discouraging smoking through demarketing, a remarketing approach should be followed. this implies that instead of deliberately making tobacco use less attractive, another option should be made more attractive, for example promoting a healthier life-style through national health weeks or using opinion formers such as prominent sport personalities. the challenge is to redirect marketing efforts towards discovering, developing, and delivering options that satisfy both tobacco companies and consumers. while legislation and regulatory policies are in place to control the extensive use of tobacco products and the exposure of non smokers to hazardous conditions, demarketing efforts by both the government and non profit organisations may be implemented in addition to discourage the demand for tobacco products. while demarketing efforts in areas such as health care may be questionable and even regarded as unethical, demarketing efforts can be implemented without any doubt in an attempt to control smoking behaviour. marketing is about giving customers a choice. while it is the duty of the government to legislate the use of tobacco products, and it was seen earlier that banning measures might in fact increase consumption, it is suggested that nonprofit attempts such as anti-tobacco campaigns should engage in positive options sajems ns vol 6 (2003) no 2 411 to discourage the use of tobacco products. it should offer and deliver better ways to meet the basic consumers needs that drive demand for unhealthy habits. against this background the research findings of the survey conducted in the pretoria-region, will be discussed. 9 research findings the survey was conducted in january 2002 to determine the attitudes and perceptions of the public in the pretoria-region regarding tobacco smoke. the results of the survey were compared with a similar survey conducted by the researchers in 1997. of the seven hundred households that were surveyed, 55 percent of the respondents were males and 45 percent were females. the majority of the respondents (62 percent) were either xhosa, zulu or sotho speaking; whilst 12 percent were afrikaans speaking, 16 percent english speaking; and 10 percent indicated that they speak a foreign language. notably 66 percent of the respondents indicated that they were in the age category between 16 and 24 years of age. fifty one percent of the respondents have indicated that they were non-smokers, whilst 49 percent were smokers. table 1 smoker/non smoker 1997 2002 smoker n percent n percent yes 180 46 149 49 no 214 54 153 51 there was a marginal increase of 3 percent in the number of smokers in the period 1997 to 2002. it would therefore seem that the tobacco products control amendment act, 1999 (act 12 of 1999), did not have the desired outcome of reducing the smoking behaviour of south africans. thirty six percent of the respondents regarded themselves as heavy smokers, 31 percent as social smokers and 33 percent as light smokers. sajems ns vol 6 (2003) no 2 412 table 2 number of cigarettes smoke per day 1997 2002 per day n percent n percent 1 – 5 43 24 62 42 6 – 10 55 31 38 26 11 – 20 59 33 25 17 20 and more 23 13 24 16 chi square dependency test. p<0.0001. there is a significant dependency between the different studies related to the questions. according to table 2, sixteen percent of the respondents indicated that they smoke more than twenty cigarettes per day. the table shows an increase of 3 percent of persons smoking more than 20 cigarettes per day compared with the 1997 study. however, it seems as if there was a significant shift towards smoking less cigarettes per day compared with the 1997 study. this could indicate that the prohibitions placed on the tobacco industry have had the desired effect of reducing the numbers of people who start to smoke. on the other hand, it could indicate that the health warnings are taken seriously, and that although people do not stop smoking, they at least smoke less. table 3 motive for smoking 1997 2002 motive n percent n percent pleasure 66 37 62 42 29 16 26 18 habit 76 43 54 36 group pressure 5 3 2 1 other 4 2 5 3 forty two percent and 36 percent of the respondents have indicated that they are smoking for pleasure or because of habit respectively. the percentage of persons that have indicated that they smoke for pleasure have increased by 5 percent, while the respondents that have indicated that they are smoking because of habit, has decreased by 7 percent. it is significant the percentage of respondents that smoke out of habit has dropped. this indicates that the reinforcement of habit provided through advertisement and promotions could actually contribute to increase smoking behaviour. in other words, the sajems ns vol 6 (2003) no 2 413 restrictions on advertisements and promotions have caused a drop in habitual smoking behaviour. apart from this, 87 percent of the respondents have indicated that they prefer smoking cigarettes, 7 percent cigars, 2 percent pipe and 4 percent other tobacco products. table 4 influence of compulsory warnings 1997 2002 influence n percent n percent yes 58 32 29 20 no 122 68 99 66 not sure 21 14 twenty percent of the respondents have indicated that the compulsory warnings on tobacco products have influenced their smoking habits, while 14 percent have indicated that they are not sure whether it does or not. although the compulsory warnings have influenced the smoking habits of respondents, it is clear that other strategies would have to be devised to influence smoking behaviour. table 5 attempts to quit smoking 1997 2002 quit n percent n percent yes 116 64 97 65 no 64 36 52 35 sixty five percent of the respondents have indicated that they have tried to quit smoking mainly (77 percent) for health reasons. it seems that the clear majority of respondents acknowledged the health hazards of smoking, but were unable to break the habit. anti-tobacco campaigns were therefore successful in bringing the health hazard message across. it could be argued that future campaigns should contemplate including effective and proven techniques that smokers could utilise to quit smoking. sajems ns vol 6 (2003) no 2 414 table 6 reasons for trying to quit smoking 1997 2002 reason n percent n percent 80 69 76 76.8 economic reasons 31 27 11 11 group pressure 4 3 7 7.1 influence of legislation 1 1 5 5.1 chi square dependency test. p<0.0001. there is a significant dependency between the different studies related to the questions although 56 percent of the respondents indicated that the government should legislate the use of tobacco products, 85 percent felt that tobacco companies should be allowed to sponsor sporting events. it seems that the public cannot make the connection between allowing sponsorships or advertisements and how it impacts on the smoking behaviour of citizens. it could be argued that the public needs to be sensitised about the impact that promotions and advertisements have on human behaviour. the survey produced a number of other noteworthy results: • fifty four percent of the respondents have indicated that smoking should be prohibited in restaurants, while 50 percent have indicated that it should also be prohibited in public places. generally proprietors of businesses and managers of work places have complied with the restrictions on smoking in public places. • eighty three percent of the respondents have indicated that they adhere to the legislation as to where they are allowed to smoke or not. seventeen percent have indicated that they are not bothered with the legislation at all. the restrictions placed on tobacco products are relatively new, and it is understandable that there would be initial rejection of the provisions of the act. the policing of the provisions would in time, lead to a near total compliance of the act. • fifty five percent of the smokers have indicated that their parents did not smoke. it could be argued that parental smoking behaviour is not necessarily indicative of children’s smoking behaviour. this could indicate that other frames of reference, such as peer group behaviour, dictates smoking behaviour. • thirty five percent of the respondents have indicated that they started to smoke at the age of sixteen years of age and younger. it could be argued that the prohibitions of the tobacco products control amendment act, 1999 (act 12 of 1999) relating to advertisements and promotions, would sajems ns vol 6 (2003) no 2 415 lessen the tobacco awareness among children, leading to a decrease in the smoking habit. table 7 main reason for quitting smoking 1997 2002 reason n percent n percent health reasons 60 90 18 44 economic reasons 4 6 6 15 external pressure 3 4 3 7 influence of legislation 0 0 2 5 other 0 0 12 29 it is clear from the graph that respondents who indicated that they have smoked, have quitted smoking predominantly because of health reasons. it is interesting that 15 percent indicated that they stopped smoking because of economic reasons. considering the significant increase in sin taxes in the annual government budget, an average of 9 percent in the period 1999 to 2002, it could be expected that more smokers will kick the habit because of economic reasons. table 8 period since stop smoking 1997 2002 period n percent n percent 0 6 months 10 14 13 32 6 months 1 year 7 9 7 17 1 year 2 years 12 16 7 17 2 years 3 years 9 12 3 7 3 years and more 37 49 11 27 the majority of those who have stopped smoking did so only recently. almost all the respondents who have stopped smoking do not consider smoking again. ninety four percent of the respondents admitted that they knew that smoking causes cancer. almost 70 percent of the respondents felt that smoking is not addictive, whilst 92 percent agreed that smoking could harm those around them. seventy percent of the respondents have indicated they knew that secondary smoke is more harmful than initial inhalation. ninety five percent have sajems ns vol 6 (2003) no 2 416 indicated that they understood that smoking could harm a baby during pregnancy. seventy percent and seventy five percent of the respondents respectively have indicated that it is false that smoking cannot damage a person’s lungs or does not cause heart diseases. fifty five percent were of the opinion that smoking can help to reduce a person’s body weight. almost eighty percent of the respondents have indicated that it is false that smokers generally live longer than non-smokers. sixty five percent of the respondents have indicated that smokers are generally unhealthy, whilst seventy-five of the respondents felt that smokers in general do not respect non-smokers’ right to clear and smoke free air. 10 conclusion significant amounts of money are spent annually by non-profit organisations such as anti-tobacco campaigns, in an attempt to demonstrate the dangers of tobacco smoke to smokers and potential smokers. south africa joined the world health organisation, world bank and the growing number of countries, which have taken strong legislative action against tobacco, in response to the global threat to health posed by smoking. in terms of section 3 of the tobacco products control act, 1993 (act 83 of 1993) warnings have to be printed on every cigarette packet regarding the dangers of smoking, protecting nonsmokers and the vulnerable such as children, pregnant women and their unborn babies. health warnings on packaging of all tobacco products available in south african market are compulsory to ensure that people who purchase cigarettes are ware of the dangers of their habit. legislation was accepted in parliament to restrict advertis ing and the phasing out of existing sponsorship or contractual agreements with tobacco companies. the success of these actions are not always clear and an attempt should be made to measure the effectiveness of anti smoking campaigns as well as to see whether all these efforts are worth while, thus leading to a reduction in smoking. seven hundred households were selected at random in pretoria, centurion, akasia and mamelodi. these households were issued with two different structured questionnaires, whic h had to be completed by the head of the household. the results of the survey were compared with a similar survey conducted by the researcher in 1997. the results provided an indication of the extent to which the tobacco products control amendment act, 1999 (act 12 of 1999), was successful in changing smoking behaviour. in this paper it was determined that marketing principles are undoubtedly applicable to governmental programs, such as anti-tobacco campaigns. insight was gained in the tobacco industry, its influence on the community and the role of anti-tobacco campaigns. an empirical investigation of the attitudes and perceptions of sajems ns vol 6 (2003) no 2 417 smokers and non-smokers regarding the national government campaigns against tobacco products determined the efficiency of the anti-tobacco campaigns as well as the effect of the tobacco products control amendment act, 1999 (act 12 of 1999) on smokers and non-smokers. it was therefore concluded that by applying the principles of marketing it could contribute significantly in influencing smoking behaviour amongst south africans. references 1 anon, (1996) “aanslag op tabakreklame onregverdige oorregulering”. beeld, august 1. 2 baleta, a. (1998) “tough anti-tobacco legislation moves forward in south africa” the lancet, november, 14: 1609. 3 bechoo, i. (2001) “doctors in bid to end smoking”, daily news, march 27. 4 de jager, j.w. (1997) “influence of social marketing on the tobacco industry”, paper presented at the ebm conference in pretoria. 5 greising, d. (1996) “global investing. how cigarette companies aim to beat new laws”, business week, 70 (11): 44-49. 6 mowen, j.c. (1995) consumer behaviour (4th ed.) englewood cliffs: irwin. 7 naidoo, s. (2001) “safa sees upside of losing r10m sponsorship”, www.iol.co.za. 8 keenan, t. (2001) “dis twak dat verbod adverteerders keer”, finansies & tegniek, june, 1: 11-14. 9 keenan, t. (2001) “after government action, tobacco companies’ satisfaction”, finance week, january, 6: 14. 10 kotler, p. & andreasen, a.r. (1996) strategic marketing for non profit organizations (2nd ed.) englewood cliffs: prentice hall. 11 kotler, p. & levy, j. (1969) “broadening the concept of marketing”, journal of marketing: 10-15, january. 12 kotler, p. & clark, r.n. (1985) marketing for health care organizations, englewood cliffs: prentice hall. 13 mason, t. (2001) “alcohol warnings slammed by isba”, marketing, december: 13. 14 mowen, j.c. (1995) consumer behaviour, englewood cliffs: prentice hall. 15 palmer, g. (1998) “today its tobacco … tomorrow?”, the sa journal of marketing and sales, 4(4): 3-4. 16 riley, l., asma, s., eriksen, m.p., green, l., blanton, c., loo, c., batchelor, s. & yach, d. (2000) “tobacco use by youth: a surveillance report from the global youth tobacco survey project”, sajems ns vol 6 (2003) no 2 418 bulletin of the world health organisation, july. 17 scott, m. (1995) “remarketing yes, remarketing health care”, journal of health care marketing, winter 15(4): 57. 18 south africa (1999) tobacco products control amendment act, 1999 (act no. 12). 19 twinn, i. (2001) “alcohol warnings slammed by isba”, marketing, december, 13. 20 white, a. (2001) “the great south african smokeout”, multinational monitor, 22(1&2): 23. 21 zuma, n. (1998) “tough anti-tobacco legislation moves forward in south africa”, the lancet, november, 14: 1609. 22 zinhua news agency. (2001) “south africa sets new deadline for implementation of smoking law”, may, 1. sajems ns vol 5 (2002) no 2 413 baselines for suppressed demand: cdm projects contribution to poverty alleviation harald winkler energy and development research centre, university of cape town steve tbome southsouthnorth project, cape town abstract projects implemented under the clean development mechanism (com) need to establish a baseline. the baselines is a projection of greenhouse gas emissions that would have occurred without the project. establishing baselines that allow for sustainable development through com projects is a key challenge, especially in poor communities. the com rules explicitly allow for baselines that account for emissions "above current levels due to specific circumstances of host parties". this provision lends support to crediting of growth in demand for energy services where it is currently suppressed as a result of poverty and/or lack of infrastructure or suppressed demand. the question is whether the existing level of consumption is the baseline or the future expected level of consumption including "development" advances in provision of energy services and as a result of poverty alleviation is the baseline. or should development be allowed to get dirty before it qualifies to become clean? the paper presents a baseline methodology that provides opportunities for suppressed demand to be predicted and counted. jelq25,q40 1 introduction the united nations framework convention on climate change (unfccc) aims to reduce emissions of greenhouse gases (ghgs) in order to 'prevent dangerous anthropogenic interference with the climate system' and promote sustainable development (unfccc, 1992). the kyoto protocol, which was adopted in 1997 and appears likely to be ratified by 2002 despite the us withdrawing, aims to provide means to achieve this objective (unfccc, 1997). the clean development mechanism (com) is one of three 'flexibility mechanisms' in the protocol, the other two being joint implementation (ji) and emis$ions trading (et). these mechanisms allow flexibility for annex i r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 414 sajems ns vol 5 (2002) no 2 parties (industrialised countries) to achieve reductions by extra-territorial as well as domestic activities. the underjying concept is that trade and transfer of credits will allow emissions reductions at least cost. since the atmosphere is a global, well-mixed system, it does not matter where greenhouse gas emissions are reduced. the com is a project-based mechanism that allows annex i parties to meet part of their emissions reductions targets by investing in developing countries. com projects must also meet the sustainable development objectives of the developing country. further criteria are that parties must participate voluntarily, that emissions reductions are 'real, measurable and long-tenn', and that they are additional to those that would have occurred anyway. the last requirement makes it essential to defme an accurate baseline. the crediting of increases in demand, where it has previously been suppressed, has a basis in the rules of the com negotiated in the unfccc process. paragraph 46 of the marrakech accord states that: "the baseline may include a scenario where future anthropogenic emissions by sources are projected to rise above current levels, due to the specific circumstances of the host party" (unfccc, 200 i: 37. para. 46). this paper argues that suppressed demand is a specific circumstance that justifies baseline scenarios in which future emissions increase. the paper introduces the concepts of baselines and suppressed demand, provides examples of baselines for com projects which would avoid emissions, and suggests lessons for a generic methodology for suppressed demand baselines. 2 what are baselines and their uses? there is a growing literature on baselines for project-based mechanisms (lazarus et al., 1999; bernow et al., 2000; lazarus et al., 2000; meyers, 2000; oeco & iea,2000; winkler et al., 2000; lazarus et al., 2001). put simply, baselines seek to predict what would have happened without the com project. if emissions from the project are lower than in the business-as-usual (bau) case, real emission reductions will be achieved. baselines may be used for two purposes, (i) to determine whether the project is additional to what would have happened anyway, and (ii) to calculate the credits to be transferred between host and investor entities. the first purpose testing additionality occurs before the com project is implemented, while credits must of course be calculated after project implementation. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 415 article 12 (5)(c) of the kyoto protocol requires that emissions reductions be "additional to any that would occur in the absence of the certified project activity" (unfccc, 1997). if a project would have happened anyway, it should not be a cdm project and receive investment through that mechanism . baselines suggest themselves as means of testing additionality (unfccc, 1997; baumert, 1999; meyers, 1999). once a project has qualified for the cdm and been implemented, the emissions reductions need to be calculated. to do so, the difference between the baseline agreed at the start of the project and the project performance needs to be calculated. we focus here on the latter use of baselines, to calculate certified emissions reductions (cers) under cdm projects. like any projection, baselines depend on assumptions about the future. key assumptions include the level of economic growth, energy supply and demand. baselines are counterfactual (lazarus et ai., 2001), in the sense that, due to climate change policy, the baseline will never occur. a judgement is made by the persons calculating the baseline relating to the reference case for example, if the cdm project had not installed compact fluorescent lightbulbs (cfls), incandescents would have been used; if the cdm had not contributed to a wind power park, gas-fired electricity generation would have produced the power instead. in calculating cers, it is usually assumed that the same level of activity applies to both the baseline scenario and the cdm project. for example, the same number of mwb that would have been generated from a coal-fired power station are replaced by a cdm project implementing a cleaner energy technology. in situations of suppressed demand, this constraint may need to be relaxed. before considering calculations of baselines, however, we first explain the importance of suppressed demand. 3 why is suppressed demand important? in poor countries and communities, households demand less services because they cannot afford to buy more. demand is suppressed or remains suppressedl due to a budget constraint or lack of infrastructure. clearly this means that sustainable development is not being achieved, in that basic human needs are not being satisfied. in economic theory, households face a budget constraint. if they allocate their total budget between two goods, they can only consume more of one good by trading off the other (nicholson, 1995: 107-9). so household cannot move to higher levels of utility, due to the income constraint. the suppressed demand r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 416 sajems ns vol 5 (2002) no 2 situation would be where the budget constraint lies below any utility level considered to meet basic needs. introducing energy savings means that household income increases, allowing it to move to higher levels of service (a higher utility curve), suppressed demand also has implications for baselines and the calculation of cers, through the 'take-back' or 'rebound' effecr (greening et ai., 2000). part of the emission reduction in technical efficiency is taken back by a change in consumer behaviour. roy (2000: 433) describes the effect as the way in which ..... the benefits from savings in energy demand arising out of the technical efficiency improvement, and hence reduction in ghg emissions, are going to be taken back through increase in demand", the calculated energy savings (and hence emission reductions) are greater than the actual savings, the degree to which this happens can be defined as (roy, 2000: 435): rebound effect (%) = 100· (calculated savings actual savings)/ calculated savings energy efficiency projects are perhaps the clearest example of the effect. consider an energy efficiency project which reduces the amount of co2 per unit of output. higher efficiency reduces the emissions intensity (kgco~unit output). however, the efficiency gains also results in energy savings. these savings may be invested in additional activity the take-back effect. the additional activity can occur either extending operating hours or increasing capacity. if demand is unsatisfied or suppressed, it is very likely there will be significant take-back to meet the unsatisfied demand. in calculating cers, the baseline methodology must consider how to deal with the increased level of activity represented by the take-back effect. compared to analysis of the cdm project without the take-back effect, the annual emissions will increase. in the extreme case, where a service (e.g. bus transport) was previously completely unavailable, the introduction of a cleaner technology may still result in an increase the absolute levels of ghg emissions, however, compared to a bad development path (without cleaner technologies), the technology introduced through the cdm may be cleaner. in the sa energy sector, for example, the introduction of gas-fired power stations may increase total emissions, but would produce lower emissions than new coal-fired plants. we argue that credit should be given to development paths that 'leap-frog' to cleaner technologies, without first getting dirty. the following sections outline how this might be achieved in calculating cdm project baselines. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 417 4 calculating cers while different methodologies exist for calculating baselines (michaelowa & dutschke, 1999; meyers, 2000; oecd & lea, 2000; lazarus et al., 2001; sathaye, 2001), some generic steps can be identified. for the purpose of calculating cers, these steps may be performed on a periodic (perhaps annual) basis: 1. defme the reference scenario (e.g. the set of power plants to compare against, the form of transport that would otheiwise have been used, the lights installed, etc.); 2. define a set within that scenario comparing against the whole sector, recently-built plants, only best available technologies; 3. calculate emissions intensity of baseline scenario and cdm project (kg co2/ unit output). 4. reduced emissions intensity baseline emissions intensity cdm project emissions intensity; and 5. calculate cers by multiplying by activity level (cers =0 activity level * reduced emissions intensity. in units: cers (kg c02) = activity level (unit output) * reduced emissions intensity (kgc02/unit output. this brief outline of steps makes clear that the activity level is a key factor in determining the numbers of credits eventually transferred. how this plays itself out in a cdm project in a situation with suppressed demand is best illustrated by means of examples. 5 examples of demand baselines 5.1 take-back effect: efficient lighting example a practical example of an efficient lighting project demonstrates the issues around the take-back effect and suppressed demand. cdm projects may replace incandescent lamps with compact fluorescent lightbulbs (cfls) of a much lower wattage. such projects have been initiated in south africa even prior to the cdm, with the costs of the cfls being paid by the programme. eskom has launched an efficient lighting initiative aiming to install some 18 million cfls (eskom, 2000), and economic analyses have been conducted (clark, 1997). for the purposes of this article, we focus on a single household using only electricity for lighting. assume that before the cdm project, the household uses two loow incandescent bulbs. being a low-income household, they cannot afford to run r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 418 sajems ns vol 5 (2002) no 2 more bulbs. assume that the cdm project replaces the incandescents with two cfls of 25 w each. assuming a 75 per cent increase in efficiency from incandescents to cfls, the household receives the same amount of light with less energy consumed. service levels (the amount of light) remain the same in this initial situation. initial situation, before the com: 2 x 100 w x 4 hr/d x 30 dlmth = 24 kwh! month. after the com (without take back): 2 x 25w x 4 hr/d x 30 dlmth = 6 kwh! month. the total capacity used for lighting was decreased from 200w to 50w, and hence the monthly energy use is expected to decrease from 24 kwh to 6 kwh. reduced energy consumption means that the household saves on expenditure for lighting. this saving might be used to buy more lighting, which is likely in a situation where demand is suppressed by poverty. using the energy savings to buy other services is also likely, but is considered part of the sustainable development benefits of the cdm project and is not included in the baseline calculations. in response to this situation, the household may increase its consumption either by increasing the number of operating hours of the bulbs, or by installing more lights. for calculation purposes, the effect on the consumption in kwh! month of installing twice the number of bulbs or running existing bulbs two times as long is the same. in practice, there are significant differences, given the high initial costs of cfl3. we therefore assume that the increased service levels are reflected in a doubling of operating hours. after the com (with take back/increased service): 2 x 25w x 8 hr/d x 30 dlmth = 12·kwh!mth. the development benefits of the project under this scenario are two-fold. firstly, the level of lighting has doubled from the baseline scenario. secondly, the household still saves money on energy for lighting, paying only half the number of kwh per month. accounting for suppressed demand requires that we consider what would have happened without the com project. we assume that bau economic development will lead to increased levels of service, as economic development increases incomes and better infrastructure is graduauy established. over time, doubling service levels with the old technology would have resulted in: bau growth: 2 x 100 w x 8 hr/d x 30 dlmth = 48 kwh!mth. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 419 the various levels of energy for lighting correspond to emissions, since we are only considering electricity for lighting. since the lighting comes from the same grid, less energy used results in a directly proportional reduction of ghg emissions. situations were multiple fuels are used for lighting and replaced by electricity require a separate analysis. three different situations can be considered with the help of rough graphic representations. the effects on consumption and service levels are shown separately in figures i and 2. a businesswas-usual (bau) path of development uses the old technology (incandescent lamps) and service levels grow gradually over time. consumption of lighting services starts at a level where part of the demand remains unsatisfied or suppressed. the cdm project (without the take-back effect, the lowest, shortwdashed line) lowers the consumption level through the increased efficiency of a new technology, in this case cfls. again, we assume that demand grows somewhat over time. service levels are initially the same as in the bau case, and increase at a comparable rate. the solid line shows cdm project with the takewback effect. the new, more efficient technology is used, but service levels increase as the household uses energy savings to purchase more lighting services. the top line shows what development might have occurred if there was no constraint on demand. in determining the level of this line, judgements have to be made on what constitutes 'satisfied demand'. energy consumption would increase to satisfy demand, say at 10 or 12 hours/day. in figure i, the shaded areas a and b together show the difference before and after the project. since energy consumption (and hence ghg emissions) grows over time in each case, the sum of the two areas are kwhs of electrical energy, which if multiplied by an emissions factor, represents the emissions reductions. area b on its own represents the takewback effect, the amount of increased consumption of lighting, which the household pays for out of its energy savings. the increased lighting service is a sustainable development benefit of the project. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 420 sajems ns vol 5 (2002) no 2 figure 1 consumption of lighting services under business as usual, with cdm project, with the take-back effect and under development without constraint 481 i /'-"---"-"-"-"-"--"-'-''-''-''-''-''~':-::':':'~' 42~ i @ i ! ..... ' 36 ii ••••••• ,301l' ....... . sl : t····....: _ .... _._.-6~l ...................... · .. ···· .. ·· .. · .............. ·· .. ·· .. ·· .. o~i------'------r----~------r-----o+ present time (years) t+5 _ ... development without consttllint ._ ... bau development (old tecbnology, increased service levels) _ project with takeback (new technology, increased service levels) ._. cdm project (new technology. bau service levels) figure 2 service levels under business as usual, with cdm project and take-back effect i i .. =: .. _ •. _ •. _ •• _ .. _ •. _ •• _ .. _ •. _ .• _ .. _ •• _ •• _ .. _ .. _ .. _ •• .:r.:=. ii l" .. ~ .. ~··>~,~·>o .•. m •..•. m.o.'.' .. ,.' ..•.•. m ••••• '.' •• ,.0. tlme i _ ... development without cons~~y 1 .. bau development (old technology. i_sed service levelll) -project with lakebaek (new technology. i""""""",, servios _s) ...... com project (new tachnology. bau mnios levels) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 421 the changes in service levels in the four cases are summarised in figure 3. clearly the cdm project with take-back and unconstrained development have higher levels of service than bau development or the cdm project without take-back. what are the implications for calculating cers? referring back to figure 1 we argue that only area a should be counted for cers for the investors, showing the difference before and after the cdm project taking into account the increased consumption. this gives the cdm investors a return on the real emissions reductions, but not the part taken back by the household in response to its energy savings (area b) which is additional emissions attributable to increased service and hence part of the sustainable development benefit. we argue that the difference between the development that would have happened without constraint and bau development (area c) should be credited to the host countries or entities within the host country (e.g. the project owners). the host country might choose to re-invest its cers into the project, in order to promote projects that have a high sustainable development benefit. a practical difficulty that needs to be resolved is how the level of 'satisfied demand' or demand without constraint is determined. 5.2 fuel switching for rural lighting roy (2000: 434-436) gives an example of the take-back effect in relation to rural lighting. the project example cited dates back to surveys undertaken in 1995 and explains fuel switching from subsidised kerosene fuelled lamps to subsidised solar lanterns for lighting. before the introduction of the solar lanterns, kerosene was used for lighting on a household average rate of consumption of 2.5 litres per week. when the lanterns were introduced, kerosene consumption for lighting was expected to be replaced. what did happen was that lighting quality improved (from 10 to 380 lumens) and the level of activity increased from 2 to 4 hours per night to 6 hours per night. part of the quality and quantity of unsatisfied demand are hereby met. initial situation, before the cdm: 2.5litreslweek. after the cdm: 0 litres/week (same level of activity as bal)). the calculated saving therefore was expected to be 2.5 litres per week (except in seasons when there was insufficient sunshine). however, the actual saving was ranged between 1.25 and 0.5 litres per month. the 50 per cent to 80 per cent kerosene take back effect was attributed to saved kerosene being used meet the increased demand for lighting. not included in this take-back is the saved kerosene that was used to meet previously suppressed cooking services (only r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 422 sajems ns vol 5 (2002) no 2 partly met with biomass) and to on-sell kerosene to other members of the community. roy (2000: 435) suggests that if the increase in activity is totalled, the combined take back could be in the region of200 per cent. after the cdm (2): 1.25 to 2litreslweek (with lighting take-back). after the cdm (3): 5 litreslweek (with lighting and cooking take-back). the business-as-usual (bau) scenario assumes a beginning at the point of the project intervention and proceed at an increased growth of kerosene consumption (consistent with the expected growth rate in commercial energy consumption expected in india) at 5.5% per annum. this increase in both lighting and cooking services is the result of, amongst others factors, increasing population and income. in relative terms, the income constraint is relaxed somewhat over time, but demand is still not saturated. business-as-usual growth: 2.5 litres/week * (1 +o.055)/year. development without constraint: levels of activity for service are at a saturated/satisfied level using bau technologies immediately. the example could be explained diagrammatically in figure 3. as in the previous example, the areas a and b in figure 3 show the difference before and after the project. since energy consumption (and hence emissions) . grow over time in each case, the sum of the two areas represents litres of kerosene which, multiplied by an emissions factor provides an indication of the total emissions reductions. however, area b represents emissions avoided by moving to a cleaner development path from business as usual and is the sustainable development benefit. area c provides the amount of kerosene that would be required to meet a kerosene fuelled lighting demand at a satisfied lighting service benchmark of so many lumens being related to x litres per week, less the measured cdm project cers in lighting with the lighting takeback. the cooking takeback can, like area b, be considered a sustainable development benefit, that may have to be counted when leakage is considered in compiling a project development document. though in this case, the leakage is closely linked to the introduction of a second subsidides fuel/energy service which has increased the affordability of kerosene fuelled energy services in part replaced by pv. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 figure 3 consumption of kerosene for lighting for rural lighting ': ~ (-.--.-.. -~--.-.. -.-.. -.. -~:~---:~ . .... 4.5 1 ! ~ :, c ;. 4 -, : :8 ~ ! i i" ~ 3,5 -; i •• ' ~ j 3 j jl , .. _.' .. 0 _ u ~2.5. @. 2 ~ ® .~ .................... .. 1 5 1 l ........... · .. ··· .. ··· .... ·· .. ·· .. ····· .. ·· .. ··· .. ·· .... ···· .. · .. ·· ..... , 1 1 0.5 -i i o~:-------r------.-------.------,-------­ present time (years) i key _ ... lighting servi.:e development wttllcut constraint 1 _. bau development (oldtecllnology. increased 5ervicelevels) project wtth takeback (new tectmoiogy. ;"creased service levels) ...... cdm project (new technology, bau service levels) 1+5 423 the total certified emissions reductions (cers) is area a plus area c multiplied by the emissions factor of kerosene less any emissions associated with the solar lantern. this amount includes the benefits of the efficiency improvements (a) and credits the suppressed lighting demand (c). the cers represented by area a accrue to the investor. the host country might bank credits from c against possible future commitments, project owners might wish to sell them on the market or they could be re-invested in the project to make it more attractive to investors. area b does not receive cers, but results in a development benefit of increased service levels. the increase in the level of activity, is equivalent to a formal contribution to energy poverty alleviation. roy suggests that the pre-efficiency improvement situation is like "a constrained optimum case" where constraint comes from lack of infrastructure (electricity or kerosene) or low-income. she concludes "in such a situation change in the technical efficiency improvement acted like relaxation of constraint." a surprising conclusion is that fuel demand was higher after rather than before the solar lantern introduction. this seems to indicate that the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 424 sajems ns vol 5 (2002) no 2 introduction of cleaner energy technologies can contribute to addressing energy poverty. the current energy consumption in india indicates that indians use 3 per cent of what us citizens use on a per capita basis (roy, 2000). the high growth rate of 6 per cent and the less than unitary elasticity of commercial energy use (0.92) implies a high potential level for growth in emissions at a rate of 5.5 per cent. india is not alone in this predicament. speculation is that "even with aggressive policies to address energy efficiency, developing countries' energy demand is likely to grow fiveto ten-fold over the next 30 to 40 year, resulting in a threefold increase in world energy demand" (roy, 2000). these scenarios add up to a compelling case to design and implement climate-related policy interventions that address this possibility before it becomes a reality. addressing suppressed demand is now one such measure of increasing levels of service while coincidentally decreasing emissions intensity of the new clean technologies. 5.3 starting from minimal service levels: shs example where there is currently minimal (close to zero 4) levels of service, the approach to suppressed demand baselines must be modified. an example of solar home systems (shs) provided by lazarus et al (1999) illustrates this point. the results can differ depending whether a benchmark or project-specific baseline is used. the cdm project introduces shs by reducing initial costs to rural households. as a results, the households run televisions or small refrigerators, services they did not have before the cdm project and were unlikely to acquire in the absence of the cdm project. a similar logic would apply in any off-grid electricity project, or other project categories were there is currently very low or zero levels of service. before the cdm (project-specific approach): 0 kwh/mth, therefore 0 emissions. the com project, therefore, results in activity (le., use of energy services) that is additional to the reference situation without the cdm project. assume that the shs program results in ancillary emissions of 0.1 kg coikwh. and the benchmark baseline for rural electricity is set nationally at 1.0 kg c02ikwb 5 , roughly equivalent to the emissions of small diesel generators (lazarus et al., 1999: box 2.1). before the cdm (benchmark): 1.0 kg c02ikwh. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 425 whether the project generates any cers depends on whether a benchmark or project-specific baseline is used. compared to the national benchmark, emissions are 0.9 kg cozlower for every kwh generated. effectively this does not take into account actual current activity levels. after the com (benchmark): (1.0 kg cozlkwh ·0.1 kg cozlkwh) * activity of shs. the project·specific approach considers both activity and intensity. the shs project would not be credited, since total emissions increase in comparison to the baseline scenario of no energy services. after the com (project·specific): project emissions 0 emissions = no credit. lazarus et al. (1999) argue that the project might still be credited under the project·specific approach because it is impossible to predict the counterfactual situation with any certainty (random error) or because it is difficult to refute the claim that the activity would have occurred anyway (gaming and systematic error) (lazarus et al., 1999). 6 a baseline methodology in situations of suppressed demand how should com project baselines deal with conditions of suppressed demand? as a general approach, we have argued that in conditions of suppressed demand, one cannot assume that activity levels will remain constant. increases in activity levels are allowed in terms of the com rules. credit should be given where a project assists the developing country in moving directly to a cleaner development path, rather than first adopting old ("dirtier") technologies. similar to the fast-track provisions in the com rules, this requires focusing on the greater public benefit and accepting some non·additional emission reductions. this paper has illustrated the approach with selected examples. the examples illustrate three more general groups of projects those with take-back effect, fuel·switching and minimal service levels. where some of the emissions reductions are counter-acted by the take·back effect, we suggest that: the increased service levels of the same energy service using the business as usual technology should form part of the baseline calculations; r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 426 sajems ns vol 5 (2002) no 2 increases in service levels of other energy services should be counted as sustainable development benefits to the host country, but not included in baseline calculations. they are likely to be relatively small; eers accruing to the investor should be calculated as the difference between bau development and the edm project with the take·back effect related to the same energy service; and host country entities should have discretion over credits for the difference between development without constraint and bau development under suppressed demand. where juel switching occurs, take· back would certainly be considered for the same service. whether take-back used for increases in other services should be counted as sustainable development benefits or included in the baseline, requires further study. in situations where there are minimal (close to zero) levels oj z service, sustainable development must mean increasing service levels. the recommendation from the case study is that credit should be given against a benchmark, rather than taking a project-specific approach. 7 conclusion it is apparent that wherever there are opportunities for relaxing activity/demand constraints there are possibilities for edm interventions using a suppressed demand baseline methodology. examples of interventions will therefore exist wherever there is poverty and/or lack of infrastructure. the methodology outlined here could be applied equally to other sectors, including some grid expansion edm projects where currently services are going unmet or met at low levels of service and other situations of suppressed demand. household, transport, small and medium enterprises, small-scale agriculture (water pumping, tilling etc.), greenfields projects providing a new service and energy services are all likely to qualify precisely because the level of activity is constrained and will grow faster once efficient technologies are introduced. the methodology suggested in this paper raises questions that will need to be addressed in practical application to real edm projects. this short paper could not attempt to address all questions that arise. a specific area requiring further investigation is what host country credits might be used for. another is what level of energy services might be considered 'satisfied' and whether this might be an international, regional or local standard. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 427 the unfccc and the cdm both have sustainable development among their objectives. sustainable development will require increased levels of service in many instances, particularly where there is suppressed demand. this needs to be taken into account in baseline calculations. this approach will need to be presented to the cdm executive board to make an in-principle decision, so that it can be applied to projects that will raise the concern. by far the most important outcome of such an approach to baseline methodologies is that it establishes a formal modality for using flexible mechanisms to attract investments that contribute to poverty alleviation and infrastructural underdevelopment. if this is achievable, and it looks as if the text would allow for this, it would strengthen the sustainable development contribution of the cdm. endnotes different terms are used in various aspects of the climate change debatesuppressed demand, avoided emissions, unsatisfied demand and growth baselines. each has its own associations; we use suppressed demand in this paper and explain the concept here 2 both terms are used in the literature; we use take-back effect in this article. 3 an alternative cdm project would be to reduce the price of cfls to a level where this barrier is removed. 4 it is tempting to talk of zero service levels, but even in very poor households, there is some kind of lighting service, even if the levels are appallingly low. public transport might be an example where one can more accurately speak of zero service levels. 5 we follow the factor used by lazarus et al. (1999) for simplicity. a weighted average for planned facilities for electricity generation in sa showed a similar value of 0.83 kgcozlkwh (winkler et aj. 2000) references baumert, k. (1999) "understanding additionality", (ed.) promoting development while limiting greenhouse gas emissions: trends & baselines, new york, world resources institute & united nations development programme: 135-145. 2 bernow, s., karma, s., lazarus, m. & page, t. (2000) cleaner generation, free riders and environmental integrity: clean . development mechanism and the power sector, boston, tellus institute. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 428 sajems ns vol 5 (2002) no 2 3 clark, a. (1997) "economic analysis of eskom's· energy-efficient lighting programme for low-income households", energy & development research centre, university of cape town. 4 eskom (2000) efficient lighting initiative. menlo park, eskom. 5 greening, l.a., greene, d.l. & difiglio, c. (2000) "energy efficiency and consumption the rebound effect a survey", energy policy 28 (6-7): 389-401. 6 lazarus, m., kartha, s. & bernow, s. (2000) key issues in benchmark baselines for the cdm: aggregation, stringency, cohorts and updating, boston, tellus institute. 7 lazarus, m., kartha, s. & bernow, s. (2001) "project baselines and boundaries for project-based ghg emission reduction trading", boston, tellus institute. 8 lazarus, m., kartha, s., ruth, m., bernow, s. & dunmire, c. (1999) evaluation of benchmarking as an approach for establishing clean development mechanism baselines, boston, tellus institute and stratus consulting. 9 meyers, s. (1999) additionality of emissions reductions from clean development mechanism projects: issues and options for project-level assessment, lbnl-43704, berkeley, lawrence berkeley national laboratory . 10 meyers, s. (2000) determining baselines and additionality for the clean development mechanism: are simplified methods viable? berkeley, lawrence berkeley national laboratory. 11 michaelowa, a. & dutschke, m. (1999) "economic and political aspects of baselines in the cdm context. wri and undp" (ed.) promoting development while limiting greenhouse gas emissions: trends & baselines. new york, world resources institute & united nations development programme: 115-134. 12 nicholson, w. (l995) microeconomic theory: basic principles and extensions. fort worth, dryden press. 13 oecd & lea (organisation for economic co-operation and development, international energy agency) (2000) emission baselines. paris. 14 roy, j. (2000) the rebound effect: some empirical evidence from india. energy policy 28 (6-7): 433-438. 15 sathaye,1. (2001) baselines, data needs, and other methodological challenges: technical considerations. sustainable climate change projects: training on host country program development, cape town, us department of energy, us agency for international development & us environmental protection agency. 3-5 april. 16 unfccc (1992) united nations framework convention on climate change. new york, united nations, http://www.unfccc.delresourceiconv/ conv.htm. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 429 17 unfccc (1997) kyoto protocol to the united nations framework convention on climate change, bonn, unfccc secretariat, www.unfccc.de. 18 unfccc (united nations framework convention on climate change) (2001) report of the conference of the parties on its seventh session", held at marrakesh from 29 october-l0 november 2001, fccc/cp/2001!13, marrakesh, cop-7, www.unfccc.int. 19 winkler, h., spalding-fecher, r., afrane-okese, y. & davidson, o. (2000) "potential multi-project baselines in the power sector in south africa", presented at the sixth conference of the parties to the un framework convention on climate change, cape town, energy & development research centre and la'wrence berkeley national laboratory. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . f:\ejour\ecoman\ftp\ecoman_v6_n1.prn.pdf sajems ns vol 6 (2003) no 1 197 agricultural development problems in a newly independent, war-ravaged country: eritrea ________________________________________________________________ abubaker osman and j a groenewald department of agricultural economics, university of the free state ________________________________________________________________ abstract eritrea obtained independence in 1992, after a century of foreign rule and war. the agricultural sector has been unable to produce enough food for eritrea and the situation deteriorated substantially during the war with ethiopia. it has considerable potential for agricultural, including horticultural, production. eritrea should therefore develop an export base built on agriculture. the rural economy should be transformed from a subsistence to a commercial economy. agricultural policy could partially achieve this goal by developing incentives, including (nito alis) changes in land tenure systems, improvement of transport, storage and communications infrastructure, marketing services, and also extension and human capital development. trade policy should focus on gaining access to foreign markets. the government should not attempt to take over entrepreneurial functions, instead it should focus on empowering this sector. jel q10 1 introduction eritrea came under european rule when italy took possession of the country in 1885 and became an italian colony a few years later. in 1936 eritrea was incorporated, together with abyssinia (now called ethiopia), in a larger italian colony of east africa. during the colonial rule, the italian colonisers erected irrigation works and infrastructure to help intensive agriculture by italian colonist farmers. the second world war terminated italian colonial rule, and in 1951 eritrea was incorporated in ethiopia in accordance with a decision by the united nations. during the ethiopian rule, which lasted until 1991, eritrean infrastructure did not develop further, but instead regressed during the revolution regime that followed the deposition of the emperor of ethiopia. a protracted war of insurrection against ethiopian rule, particularly during the late 1980s, led to the establishment of the independent state of eritrea in 1992. as difficult as the sajems ns vol 6 (2003) no 1 198 development of independent eritrea would be to achieve, it was dealt another heavy blow by a border war with ethiopia from 1996 to 1999. economic development, including development of agriculture, presents a great challenge. this article sets out to outline the importance of agriculture to the eritrean economy and its development since 1992. guidelines are suggested for future development policy. very little data is available in terms of quantitative analysis concerning eritrea itself. development policy will therefore have to lean heavily on experience elsewhere. concerted efforts are also needed to generate quantitative data and information within eritrea itself. 2 agriculture and the eritrean economy due to the interdependence between different sectors of an economy, any simplistic assessment of the importance of a sector is bound to be misleading. economic sectors contribute positively or negatively to the output of other sectors in the economy. in order to describe the contributions of agriculture to economic development, brand (1969) advocated a functional classification of the contributions of the sector, involving five functions: the supply of food; contributions to trade balance; employment and labour transfer; capital transfer; and market contributions in the form of forward and backward linkages. the paucity of economic data for eritrea renders a full functional analysis impossible. however, available data will be presented in order to obtain at least some idea of the contributions and problems of eritrean agriculture. 2.1 contribution to gdp the role of agriculture in the economic development of eritrea will remain highly significant for the forseeable future. at present, eighty per cent of the population depends on agriculture for their livelihood. as can be seen from the composition of the gross domestic product (gdp) the agricultural sector’s contribution to gdp is much smaller than its proportion of the population, indicating that rural poverty is a real phenomenon in eritrea. gdp data are shown in table 1. table 1 gross domestic product of eritrea by economic sector, 1993-1999 estimated annual product (millions nacfa) average 1992 1993 1994 1995 1996 1997 1998 1999 % share of gdp annual growth rate (%) agriculture 589.0 510.8 778.0 714.4 693.3 700.5 1412.6 1541.0 20.1 14.7 industry 235.3 399.9 439.9 613.3 847.3 1033.1 999.4 1086.6 15.5 24.4 distribution 722.1 1034.6 1255.4 1393.5 1577.3 1743.0 1583.6 1698.8 32.3 13.0 services 401.7 561.9 886.0 1000.2 1109.8 1240.9 1395.4 1568.1 22.8 21.5 gdp at current factor cost 1957.2 2507.1 3395.4 3721.4 4227.7 4770.5 5390.9 5894.5 90.8 17.0 growth (%) 28.1 35.4 9.6 13.6 12.8 13.0 9.3 growth, agriculture (%) -13.3 52.3 -8.2 -3.0 1.0 101.6 9.1 plus: indirect taxes 233.8 338.3 341.7 375.9 450.4 511.5 464.7 500.0 9.6 11.5 less: subsidies 43.1 54.5 57.3 0.33 15.3 gdp at current market price 2190.9 2845.4 3701.1 4097.3 4678.1 5185.9 5801.2 6337.2 100.0 16.4 source: ministry of finance eritrea, asmara, 1999. data for the year 1999 is preliminary sajems ns vol 6 (2003) no 1 200 according to table 1, gdp at factor cost grew at an average of 17 per cent p.a. during the 1992-1999 period. there were huge fluctuations in the rate of economic growth, from a high of 35.4 per cent to a low of 9.3 per cent. such fluctuations are to be expected in an economy in which agriculture plays a dominant role and which is largely dependent on climatic conditions. the growth of the agricultural contribution to gdp was even more variable, ranging from doubling in 1998, an increase of more than 50 per cent in 1994, to a present negative growth. the mean share of agriculture of gdp was 20 per cent. 2.2 supply of food food security is a serious concern in the less developed world, including eritrea. many low-income countries are not able to meet the nutritional requirements of their people. even in countries that do have enough available food, poorer sections of the population can nevertheless not afford it. famine and starvation are as much functions of income and food distribution systems as of food availability (sen, 1981). sub-saharan africa, which includes eritrea, is the world’s most vulnerable region regarding food security. although its population comprises only 25 per cent of the total of less developed countries, sub-saharan africa, is projected to account for 66 per cent (from 66 countries) of the inadequacy to meet its nutritional needs by 2007 (shapouri & rosen, 1997: 3). even if grain output in eritrea would rise by 2.9 per cent per year, this increase would not be sufficient to fill the country’s nutritional gap by 2007 (shapouri & rosen, 1997: 52). in general, a country’s food sources consist of domestic production and commercial imports. the ability to import food commercially depends on the country’s ability to maintain a trade balance by exporting alternative products. the ability of other sectors in eritrea to generate foreign earnings through exports is rather limited at this stage. food aid, the third component of food for many less developed countries, depends on political decisions and is in any case not sufficient to close food gaps. the ideal is for a country to develop sufficiently in order to be independent of food aid. failure to expand domestic food production at an equal rate to the increase in demand for food, will lead to either a resulting rise in food prices or an increase in food imports (including food aid) to increase domestic food supply, or both. the relative importance of these two sources of supply is assessed by means of the annual physical food balance sheets prepared by the fao. these balance sheets show estimates of total annual food supplies in physical terms. the data sajems ns vol 6 (2003) no 1 201 is used in table 2 to compare domestic production with imports for 1993 to 1999. as reflected in the data, cereals are the principal source of food in eritrea. imports have generally constituted a major source of food supplies during the period under consideration. for instance, from 1993 to 1995, imports on average accounted for 53.8 per cent of the supply of cereals. then, from 1996 to 1997, it increased on average to 76.0 per cent, to decline to 21.23 per cent in 1999. the decline in the late 1990s was due to an increased production of cereals through the introduction of integrated farming systems by the ministry of agriculture and constraints imposed by the border war with ethiopia. sugar is only supplied through imports. vegetable and crop oils and fruit on average, were imported in small quantities. only negligible quantities of the total supply of meat and eggs were imported. although imports of these commodities (vegetable, fruits, meat and eggs) constitute a small percentage of the total new supply, it does not mean that local supply satisfies the demand. these agricultural commodities are very scarce on the market, but the very low income of the majority of the population suppresses the demand for them. imports as a percentage of total consumption, fluctuated from year to year in the cases of cereals, pulses and milk. table 2 source of food supply, eritrea, 1993 1999 in 1000 metric tons new supply from local production and imports year cereals starchy roots sugar pulses vegetable & crop oils meat & eggs vegetables & fruit milk1 total all commodities 1993 203 124 2 27 31 25 28 44 484 1994 522 126 5 58 34 28 39 60 872 1995 269 122 10 60 38 30 34 57 620 1996 329 119 14 59 28 33 33 53 668 1997 419 127 26 60 24 29 36 60 781 1998 762 130 7 64 32 31 41 84 1151 1999 405 127 12 54 31 34 38 76 777 sajems ns vol 6 (2003) no 1 202 table 2 continued imports as percentage of total new supply year cereals starchy roots sugar pulses vegetable & crop oils meat & eggs vegetables & fruits milk total all commodities 1993 57.14 0 100.00 37.04 22.58 0 0 0 27.98 1994 50.38 0 100.00 25.86 11.76 0 0 23.33 34.52 1995 54.28 0 100.00 6.7 5.26 0 2.94 17.54 27.90 1996 74.77 0 100.00 13.56 3.57 0 3.03 0 40.42 1997 77.33 0 100.00 18.33 0.0 0 2.78 3.33 46.61 1998 41.08 0 100.00 6.25 9.38 0 7.32 22.62 30.32 1999 21.23 0 100.00 7.41 12.90 0 13.16 11.84 15.44 1milk all dairy products including fresh milk, cheese, butter, sour milk, etc. converted to milk equivalent tons source: data for production and imports taken from the food balance sheets prepared by fao for the period 1993 1999 cereals constitute the main staple food and the need to import these causes a serious drain on the country’s foreign currency. at the same time, most of the population – like the poor elsewhere in the world – spend a high proportion of their income on survival needs, of which food is the major component. eritrea has therefore been unable to import capital goods and attract foreign investment. in addition, the majority of the population receives inadequate nutrition. this severely affects people’s health and productivity of workers. important nutrition and health are prerequisites for improved productivity. 2.3 agricultural trade as outlined above, the agricultural sector of eritrea, whilst being the livelihood of 80 percent of the population, earns only 20 per cent of the gdp and produces insufficient food for the population. this causes eritrea to spend a large portion of the available funds on food imports. it is safe to state that a large part of the population earns incomes that are insufficient to purchase enough food; this is evident from the widespread malnutrition observed in eritrea. the major agricultural commodities imported include sugar, wheat, teff (which is used as a cereal for human consumption), coffee, wheat flour, maize and sorghum. the main exports are fish (fresh or chilled), vegetables and live animals especially goats. the commodities imported serve basic food needs of the population while the agricultural commodities that are exported earn foreign currency. sajems ns vol 6 (2003) no 1 203 according to table 3 35.7 per cent of imports originate from western europe, whilst originate from the middle east (mainly saudi-arabia, united arab emirates, yemen, jordan and israel). the horn of africa constitutes the next source of imports with an average share of 9.6 per cent which has declined from 14.7 per cent since the late 1990s. imports from central and east asia hail mainly from japan, south korea, singapore, india and china. imports from the united states constitute only 2.8 per cent while the share from latin america and north africa is almost negligible. table 3 origin of imports to eritrea, 1993 1999 (percentage share) year origin 1993 1994 1995 1996 1997 1998 1999 average western europe 31.4 33.0 43.2 33.3 35 38.2 36.4 35.7 central and east asia 2.2 na 6.9 12.6 12.2 12.8 8.0 7.8 middle east 38.2 26.5 29.7 27.3 29.2 32.4 39.2 31.8 horn of africa 12.2 8.6 10.6 14.7 12.7 4.6 3.9 9.6 north africa 0.2 na 0.3 0.6 0.2 0.7 1.5 0.5 usa 1.1 1.8 3.7 2.7 3.1 4.2 2.9 2.8 latin america 0.0 na 0.0 1.1 1.3 1.2 3.7 1.0 others 14.9 30.1 5.6 7.7 6.3 5.7 5.0 10.8 source: customs department of eritrea, asmara the destinations of eritrea’s exports and re-exports of commodities are shown in table 4. from 1993 to 1997 ethiopia was the main destination, usually with a share of over 60 per cent. the war caused exports to ethiopia to drop to zero in 1999. sudan has been the second largest destination, with an average of 19.3 percent. this declined gradually from 1993 to 1996 and started to increase again since then. in the five years from 1993-1997, ethiopia and sudan received a combined share of 77.8 per cent of eritrea’s exports. the decline inexport to ethiopia has, as could be expected, seriously affected the country’s income from foreign trade. italy and saudi-arabia were the two other significant export-trading partners. countries like djibouti, uk, usa, yemen, germany and many other countries constitute the other destinations. between 1993 and 1997, these countries received a combined average share of 14.2 per cent. the decline in exports to ethiopia was associated with increased exports to the aforementioned destinations as eritrea endeavoured to offset the loss of ethiopian markets by seeking other markets. however, the rise of these countries’ share to 57.8 per cent could not offset the negative effects of the collapse of trade with ethiopia. sajems ns vol 6 (2003) no 1 204 table 4 direction of export and re-exports from eritrea, 1993-1999 (percentage share) year country 1993 1994 1995 1996 1997 1998 1999 average ethiopia 62.4 52.3 67.0 65.8 63.4 26.5 0 48.2 sudan 22.3 14.6 14.4 10.1 16.6 27.0 30.3 19.4 italy 2.6 2.6 2.9 4.2 4.9 5.3 4.8 3.9 saudi arabia 1.7 12.7 3.0 3.8 1.9 1.2 7.1 4.5 others 11.0 17.8 12.7 16.1 13.2 40.0 57.8 24 source: customers department of eritrea, asmara table 5 estimates the foreign exchange earnings from agricultural exports and the foreign exchange expenditures for agricultural imports for the seven years: 1993 to 1999. the trade balance is an indication of the country’s ability to pay for its imports with exports and can influence the value of its currency in world markets (kohl’s & uhl, 1998: 120). eritrea had a negative trade balance during this period. table 5 contribution of the agricultural sector to the balance of trade of eritrea (in millions of naafi) 1993 1994 1995 1996 1997 1998 1999 agricultural exports 113.120 259.077 319.281 244.217 221.020 148.283 95.974 imports of agricultural products -244.338 -551.970 -530.110 -737.865 -747.548 -595.295 -933.395 estimated balance -131.218 -292.893 -212.829 -493.648 -526.528 -447.012 -873.421 source: data for export and imports from ministry of agriculture and customs department eritrea, asmara the estimates in table 5 show that agriculture has consistently made a negative contribution to the balance of trade, and the agricultural trade gap has worsened considerably during the years under observation. this is very reasonable when the economic condition of the country is considered. the country became independent in 1991, after 30 years of devastating war. the country’s infrastructure was in a very poor condition. besides this, several other factors (like lack of credit for agriculture, shortage of skilled man power, low soil fertility, shortage of rainfall and traditional farming) contributed to the low productivity of the agricultural sector and its inability to fulfil the local demand. hence, the country had a low level of food security. this resulted in the high sajems ns vol 6 (2003) no 1 205 level of imports of agricultural commodities. the border war with ethiopia has further worsened agricultural productivity because the majority of the working population were involved with the war. this has also contributed to low exports of commodities during the three-year war from 1998 tot 2000. the negative trade balance is becoming a very critical issue that could lead to severe constraints on the eritrean economy. the rates of growth of imports and exports respectively, can be seen in table 6. growth of imports has completely overshadowed export growth. on average, imports grew by 33.12 per cent per year, compared to an average annual growth in exports of 8.51 per cent. during the first two years under discussion, export growth exceeded growth of imports, but declined from 1996 onwards. table 6 the annual growth in percentage of agricultural imports and exports in eritrea from 1993-1999 annual growth in percentage year imports exports 1994 125.90 129.00 1995 -3.59 23.24 1996 38.66 -23.50 1997 1.31 -9.49 1998 -20.36 -32.90 1999 56.79 -35.27 average 33.12 8.51 source: customs department of eritrea, asmara when one considers the relative contribution of agriculture to eritrea’s total export earnings, the gravity of the problem is highlighted by a negative trade balance in agricultural products, mainly food production,. for the period 1993 to 1999, agriculture contributed to more than half of the country’s export earnings in 6 years out of seven as clearly shown in table 7. growth of agricultural production is urgently needed in order to reduce food imports, increase export of agricultural products and to stimulate agriculturally-based industry. sajems ns vol 6 (2003) no 1 206 table 7 percentage share of export earnings from 1993-1999 year percentage share of export earnings agricultural sector non-agricultural sector 1993 54.1 45.9 1994 65.2 34.8 1995 60.3 39.7 1996 46.9 53.1 1997 59.0 41.0 1998 75.2 24.8 1999 58.7 41.3 source: data taken from customs department of eritrea, asmara 2.4 horticultural potential there is historical that eritrea has the potential for horticultural production to supply processing industries and earn foreign exchange. during the italian colonial period and immediately thereafter when eritrea was administrated by great britain (from approximately 1930 to 1950), horticultural products played an important role in the processing industry. although these industries were small-scale, they were very successful in food processing. the horticultural sector earned sizeable amounts foreign exchange during that period. during the war of independence against ethiopia, the contribution of this once flourishing export revenue earner shrank to negligible amounts. the eritrean economy had proven its ability to compete internationally in the export and horticultural products in the years before civil unrest and war. new efforts should focus on the development of the horticultural sector to achieve this outcome once again. eritrea has a locational advantage, being on the main sea route between europe and asia, and is therefore in close proximity to the lucrative markets of both europe and some rapidly growing asian economies. in a recent survey, the ministry of agriculture (1999) reported that horticultural holdings cover approximately 12 000 hectares in various parts of the country. the number of holdings is approximately 34 000. of this area, approximately 72 per cent has been cleared and developed, while the remaining 28 per cent is unutilised. these holdings are distributed over various climatic zones, which makes the production of a variety of fruit and vegetable crops possible. in 1999, five horticultural crops occupied 78 percent of the land used for horticultural production: onions, bananas, potatoes, guavas and tomatoes. yields are sajems ns vol 6 (2003) no 1 207 generally low, leading to high costs of production. there is certainly considerable scope to improve yields. efforts to achieve this must include the provision of high quality services to this sector and the supply of improved quality inputs, mainly in the form of seed and vegetative plant material. technological change in agriculture is typically associated with increased commercialisation and accompanied by increases in the use of purchased inputs, especially seeds and fertilizer (delgado et al., 1988). 2.5 post-harvest problems: an impediment to agricultural growth in many developing countries, post harvest losses of agricultural commodities (including horticultural products) is the main impediment to realising a profit. the most effective method of making more food available is to limit postharvest losses (berck & bigman, 1993). food losses stem from poor postharvest handling and often, in the case of perishable products, from overproduction. in order to avoid wasteful overproduction, post-harvest loss reduction activities of perishables such as fruit and vegetables should begin even before the crop is planted. if access to consumer markets is limited (mainly due to insufficient transport infrastructure), then production of that specific type of crop should be reconsidered. the problem of food production for developing countries is far too often approached in terms of the mere production of sufficient amounts of food. equally important issues relating to preservation and distribution that apply to the particular type of crop in the period between harvest and consumption are frequently neglected or even ignored. postproduction operations in agriculture and horticulture include a wide range of functions which should be taken into consideration in order to supply good quality food, reduce transaction costs, and increase domestic welfare. the main post-harvest constraints in eritrea are marketing services, transportation, storage, prices, diseases and pests, packaging and processing, and also equipment, quality, safety, and shelf life. poor transportation systems are a major marketing problem in africa (delgado et al., 1988; abbot, 1986; mittendorf, 1993). a study conducted by ahmed and rustage (1984) mentioned that agricultural marketing margins in five major african countries are typically twice as high as in four major asian countries; higher transport costs account for 40 per cent of the difference. to large part, this may be due to a paucity of rural roads. poor road conditions often cause truckers to refuse to go into rural areas because costs are too high (mittendorf, 1993). efficient transportation modes and routes are crucial to the success of an agricultural development strategy. transportation costs seriously affect the comparative advantage of any country’s agriculture. high transportation cost reduces comparative advantage of any export crop that eritrea may produce and sajems ns vol 6 (2003) no 1 208 puts the country at a disadvantage for both exports and for competition with imports on local markets. poor storage facilities, the absence of an established food processing industry and poor food preservation technology all contribute to serious post-harvest losses. this exacerbates food shortages for poor consumers and also causes severe losses of revenue to farmers. it has for example been estimated that 31 per cent of banana production is lost due to post-harvest treatment (table 8). a low technological base, high-priced equipment and a lack of finance further worsen these problems. table 8 post-harvest losses of banana production in eritrea, 1999 no causes of losses losses in per cent 1 in farmers field 8 2 transportation loss 10 3 storage 8 4 in retail shop 5 total loss 31 source: ministry of agriculture, preliminary survey on post harvest handling situation of bananas, 1999 the introduction and development of post-harvest technology including selection, preservation, packaging and processing in many countries has contributed to the promotion of agricultural production. farmers’ incomes have improved in due to the rising value of agricultural products. it is also important to develop techniq ues to preserve or maintain the quality, freshness and nutritional value of these agricultural products. 3 priorities for agricultural policy 3.1 general considerations although the agricultural sector should be able to lead any form of economic recovery and growth, given the quantity of the country’s resources and the large proportion of the population involved in agricultural production, it has not happened yet. a host of factors have restricted agricultural development, leading to insufficient productio n to even satisfy an underdeveloped local market. sajems ns vol 6 (2003) no 1 209 because of these conditions, policy should be directed to remove or at least reduce factors impeding production and marketing on both local and foreign markets. this is in line with myint’s (1959) “vent for surplus” model, which in accordance with that of adam smith, regards international trade as the means to overcome the effects of narrow local markets on domestic production. according to myint, it is necessary in the early growth stages in less-developed economies to achieve a transfer of labour efforts from subsistence to commercial production, thus from a subsistence to a monetary-based economy. an increase in working hours in relation to leisure is a second prerequisite, and an expansion of the amount of land under cultivation is a third condition for successful development. however, as shown by hayami & ruttan (1985, chapter 4), such development should include the development of effective technology suited to local natural and economic conditions. such technology is the basis for further development. expansion of production occurs only if producers have the incentive to do so. this involves a positive marginal value product relative to their inputs of labour, land and capital, to the extent that it is more than their marginal resource cost. increased returns to farmers are achieved by increased production and increased financial returns per unit produced. the latter means higher net product prices, which can largely be obtained by reduced marketing costs, reduced post harvest losses and reduced transaction costs. a fourth possibility is market expansion, which involves international trade. agricultural policy for eritrea should include the considerations mentioned in the previous paragraph, and should be aimed at the elimination of any factors impeding the attainment of these objectives. it is beyond the scope of this article to cover policy action in depth. some general principles, based on experience elsewhere, will however be briefly outlined. 3.2 land tenure eritrea has mixed systems of land tenure. the distribution of all land is not known at present. according to a recent horticultural survey, land under horticulture is divided as follows (ministry of agriculture, 1999): communal land: 42 per cent lease and concession: 28 per cent private: 23 per cent other: 7 per cent sajems ns vol 6 (2003) no 1 210 security of tenure in most areas is uncertain. the communal system as practised in eritrea, involves redistribution of land by villagers approximately every seven years. this obviously impedes investment in improvements and the establishment of perennial crops. land tenure reform is needed in eritrea. it should be noted that internationally, land tenure reform has had two objectives – equity, while maintaining productivity. in eritrea, where such a large part of the population is dependent on subsistence, it is however still important not to neglect the productivity objective. tenurial arrangements must enable land to achieve the following (groenewald, 1998: 112-3): • the land should foster agricultural production on a sustainable basis; tenure must contribute to conservation. • land must be able to provide increasing yield over time. • tenure must therefore provide incentives for investing capital on land. land should be able to attract capital. the tenure system must also accommodate and provide incentives for new technology; the person who makes such investments or introduces such technology should be able to reap the benefits. • the tenure system must stimulate the optimal use of the land. • land must be able to provide an attractive place to live to those who utilise it. • land and its tenure should be such that high calibre people are attracted to agricultural production. the main requirements for successful land tenure are that it should provide incentives for people to produce and increase their production. this will have to be kept in mind in future tenure policy while ensuring that tenure changes do not lead to social upheaval. there is much literature available today covering more and less successful attempts of land reform. the experience of others should guide eritrea in its tenure reform efforts. 3.3 transportation and storage inadequate transportation facilities limit the possibilities of many producers to gain access to markets. it also makes access to inputs more difficult and costly, and lowers producers’ returns. the absence of storage facilities aggravates seasonal market fluctuations and the level of post-harvest losses. in the light of critical food shortages, more attention should be given to this situation which causes a monetary loss of valuable products and nutritional loss of essential nutrients. poor transport networks complicate problems where storage facilities are insufficient and thus influence prices of foodstuff (spio, 1997). sajems ns vol 6 (2003) no 1 211 rapid improvements in infrastructure are essential. this includes farm-tomarket roads, regional packing points, rail and port facilities, refrigeration facilities, access to modern telecommunication and accurate and timely product and price information. the support mechanisms of private and public sector and urgently need to be developed and ways to facilitate private sector investment need to be expanded. in the planning of a road network, it is essential to consider maintenance costs. the whole range of potential costs, fixed and variable, need to be evaluated against benefits. over-investment in particular areas should be avoided; one-third of the value of road networks in sub-saharan africa has been lost through neglect, with government having been financially unable to perform maintenance (world bank, 1987). better roads and lower transportation costs will enable the poor to reach markets to sell products and improve their chances to benefit from trade liberalisation. eritrea’s inadequate infrastructure has hampered economic development and is an obstacle to economic integration, export growth, and the realisation of greater economic potential in general. in this regard in order to alleviate this problem, there should be more focus on the following: (1) road maintenance and rehabilitation; (2) encouraging the development of local road construction and maintenance contracting capability; (3) privatising state construction companies; (4) helping develop the private sector construction industry; (5) minimising the role of government in industry; (6) reducing the capital requirements for registration of contractors and (7) encouraging joint ventures with foreign contractors. by doing so, the government’s primary role should be to guide development through appropriate policies, and its intervention is only justified where private sector involvement may not be practical or may be in conflict with national goals. experience in many industries and countries have proven that privatisation improves efficiency, provided that ample competition is ensured (groenewald, 1998). 3.4 marketing services marketing involves all transactions and actions between the farmer and final consumer and also between the producer of inputs and the farmer. it involves all marketing functions and marketing institutions. the importance of marketing was perhaps best described by peter drucker (1976): “in every ‘underdeveloped’ country i know of, marketing is the most underdeveloped or least developed part of the economy……marketing would make the producers capable of producing marketable products by providing them with standards, with quality demands, and with specifications for their product. it would make the product capable of being brought to markets instead of perishing on the way. sajems ns vol 6 (2003) no 1 212 and it would make the consumer capable of discrimination, that is of obtaining the greatest value of this very limited purchasing power”. government should try not to perform most of the marketing functions itself. international experience has clearly shown the inefficiencies of nationalised industries on a global scale. the major role of government should be the creation of an enabling environment, including a well-defined system of commercial law and the control of crime. control of industry concentration should be part of the commercial law component. in a developing country such as eritrea, government also has a task of empowerment. without improved communication and information, marketing cannot be expected to develop optimally. experience has shown that whilst some of these services can be provided efficiently by the private sector in developed economies, in developing economies the state should provide information networks. in general the private sector runs marketing most effectively. the public sector’s role must be to enable the private sector to operate efficiently. to enable the private sector to develop an effective marketing strategy, the following policy areas need to be considered: (1) focus on stronger participation of the private and co-operative trade to encourage the private sector to take greater initiative in the development and maintenance of marketing infrastructure; this requires a flexible government agricultural pricing policy; (2) the establishment of viable village banks, the mobilisation of personal savings, flexible interest rates, efforts to reduce financial transaction costs and developing sounder credit and investment policies; (3) decentralisation of government services and programmes and the promotion of self-help projects and (4) greater emphasis on the development of financial instruments to promote medium and long term investments in marketing infrastructures. it is essential that the government plays an active and facilitative role to encourage the private sector to support the agriculture sector (van rooyen & bembridge, 1998). 3.5 human capital development it is generally accepted that there is always a need for human capital development for economic growth and human development. priority should be given to policies aimed at satisfying the most basic human needs and improvements in the quality of life, particularly of the most vulnerable groups. this requires a clear commitment in areas such as health, food and education. training, which also plays a critical role in the development of human resources, should be directed towards teaching creative skills, specialisation and selfreliance, in such a way that everyone is given an equal opportunity to participate in the economic development process. therefore general literacy and numeracy sajems ns vol 6 (2003) no 1 213 education, agricultural training and health education must be regarded as the essential prerequisite for agricultural development. increased agricultural productivity is needed for economic growth in eritrea. this implies a wider spread use of more modern technology in many areas involving better seeding, fertilization, plant pest control, animal health and animal breeding, etc. the ability and desire to do so will largely be due to incentives provided by the markets and of the knowledge base. this emphasises the role of agricultural knowledge extension –importing knowledge on technical, economic and managerial aspects of modern farming. research elsewhere has led to developments in for example, improved seed varieties and related technologies that greatly benefit developing countries. the adoption of these innovations by large numbers of farmers however, depends on their knowledge (zaman & bose, 1974). appropriate models of knowledge extension should be selected and implemented by well-trained personnel. tertiary training is very important for human capital development. the eritrean government has started to address this need, given the support to the university of asmara and the large number of eritrean graduate students presently enrolled at south african universities with eritrean government scholarships. 3.6 trade policy eritrean trade policy must be aimed at improving local producers' access to foreign markets while simultaneously enabling those who achieve a desired level of efficiency, to compete on domestic markets. the main thrust must be widening of market access. it is also necessary to facilitate the importation of important agricultural and industrial inputs such as machinery, fertilizers and other chemicals at prices low enough to promote local competitiveness. tariff policy is one of the most important tools of foreign trade policy. tariffs allow the country that levies them to influence the pattern and volume of its trade with the outside world. tariffs have become the main tool through which a government can control the openness of the agricultural playing field (van schalkwyk et al., 1995). eritrea should apply tariffs that will level the playing field between lo cal and subsidised overseas producers, for instance the eu. eritrea should attempt to benefit from wto rules which exempt developing countries from obligations to reduce tariffs. tariffs on necessities for local production – e.g. machinery needed in agriculture and industry, should be kept low. sajems ns vol 6 (2003) no 1 214 it is also imperative for eritrea to focus on access to foreign markets. the policy makers and planners should strive to allow the country to benefit from the opportunities provided by the us african growth and opportunity act and also the eu lomé convention. trade connections with african neighbours and also the arab world – eritrea's other close neighbours – should be strengthened. eritrea must strive to derive benefits from her membership of comesa and igad, and also from nepad. a shift in industrial strategy is needed to change the high import dependence of eritrean industries to more domestic resource-based manufacturing. value adding of eritrean-based raw materials should be encouraged for both local use and exports. the success of trade as well as industrial policy, will ultimately depend on the soundness of eritrea's macro-economic policies. agriculture, trade, industry and other economic activities are irrevocably linked to a total economy which must be managed well by the authorities. 4 conclusion the problem of stimulating agricultural and other development in eritrea does not have easy, simple solutions. as elsewhere in africa, “the development will need to overcome a number of structural constraints arising from history and geography, and that goes beyond the very necessary but insufficient-bythemselves market reforms of the late 1980s and early 1990s”. (delgado, 1995 and 1999; eicher, 1992). the great need is for smallholding farmers to become increasingly involved in production-for-sale of higher value per weight and more value added products in which eritrea may have a comparative advantage. there must be development of commercial and manufacturing services to support this and create non-agricultural employment and income. the infrastructure must be created to enable this process and more importantly, to reduce transaction costs. farmers, traders and processor/manufactures alike need access to assets, information, services and remunerative markets (delgado, 1999). the eritrean government must resist the temptation to achieve this on their own. parastatal enterprises have generally had a poor record for bringing about largescale transformation in developing countries. furthermore, there is evidence that parastatals in africa have brought about higher marketing margins than in developing countries elsewhere (koester, 1992). an analysis identified four reasons for this phenomenon (ntangse, 1992): (1) the use of parastatals for sajems ns vol 6 (2003) no 1 215 political patronage; (2) their contributions to public financial crises, partially due to their need of large subsidies; (3) the burden to the economy caused by their high indebtedness and poor debt servicing performance; and (4) their high cost structures, coupled to the monopolistic conditions spawned by them. the eritrean government must furthermore realise the importance of agriculture and avoid the temptation to discriminate against the agricultural sector by limiting services to them or depriving their access to inputs at reasonable prices, or to profitable markets. such policies have impeded economic development in many countries, including nigeria (ilorah, 2000), china (lin, 1994) and india (srinivasan, 1994). references 1 abbot, j.l. (1986) “building food marketing infrastructure for economic development”, in kaynek, e (ed.) world food marketing systems, butterworths, london. 2 ahmed, r. & rustage, n. (1984) agricultural marketing and price incentives: a comparative study of african and asian countries. international food policy research institute, washington dc. 3 berck, p. & bigman, d. (1993) “the multiple dimensions of the world food problem”, in berck, p. & bigman, d. (eds.) food security and food inventories in developing countries, cab international, london. 4 brand, s.s. (1969) “the contributions of agriculture to the economic development of south africa since 1910”, b.sc. (agric) thesis, university of pretoria. 5 delgade, c.l. (1995) “africa’s changing agricultural development strategies: past and present paradigms as a guide to the future”, international food policy research institute, washington dc, environment discussion paper, no. 3. 6 delgade, c.l. (1999) “sources of growth in smallholder agriculture in sub-saharan africa: the role of vertical integration of smallholders with processors and marketers of high value-added items”, agrekon, 38 (special issue) 165-89. 7 delgado, c.l., mellor, j.w, & blackie, m.j. (1988) “strategic issues in food production in sub-saharan africa”, in mellor, j.w. delgado, c.l. & blackie, m.j. (eds.) accelerating food production in sub-saharan africa, johns hopkins university press, baltimore. 8 drucker, p.f. (1976) “marketing and economic development”, in enis, b.m. & cox, k.k. (eds.) marketing classics (4th ed.) grid, columbus. sajems ns vol 6 (2003) no 1 216 9 eicher, c.k. (1992) “african agricultural development strategies”, in lall, f. & wangwe, s. (eds.) alternative development strategies in subsaharan africa, macmillan, london. 10 enki, m. belay, k. & dadi, l. (2001) “determinants of adoption of physical soil conservation measuring in central highlands of ethiopia: the case of three districts of north shewa”, agrekon, 40: 293-315. 11 futur, w. (1993) “importance of trade and industrial policy for socio economic development: reflections on the eritrean economy”, in tesfagiorgis, g.h. (ed.) emergent eritrea: challenges of economic development, the red sea press, trenton, new jersey. 12 groenewald, j.a., (1998) “marketing and trade issues” in van rooyen, j., groenewald, j., ngqangweni, s & fenyes, t. (eds.) agricultural policy reform in south africa, aipa/francolin publishers, cape town. 13 hayami, y, & ruttan, v.w. (1995) agricultural development: an international perspective, johns hopkins university press, baltimore. 14 ilorah, r. (2000) “a classification of different phases of development in the export sector of nigerian agriculture”, south african journal of economic and management farmers, ns3: 234-272. 15 koester, u. (1992) “the efficiency of agricultural markets in directing agricultural develo pment”, in peters, g.h., stanton, b.h. & tyler, g.j. (eds.) sustainable agricultural development: the role of international co-operation, dartmouth, aldershot. 16 kohls, r.l. & uhl, j.n. (1998) marketing of agricultural products. (8th ed.) prentice-hall, upper saddle river, nj07458. 17 lin, j.y. (1994) “chinese agriculture: institutional changes and performance”, in srinivasan, t.n. (ed.) agriculture and trade in china and india, ics press, san francisco. 18 ministry of agriculture (1997) agricultural brochure 19921996, ministry of agriculture, asmara. 19 ministry of agriculture (1999) eritrean horticulture survey, ministry of agriculture, asmara, tcp/er1/6714. 20 ministry of finance (1999) data on financial affairs, ministry of finance, asmara. 21 mittendorf, h.j. (1993) “improving physical marketing infrastructure in africa through more self-help”, in abbott, j.c. (ed.) agricultural and food marketing in developing countries. selected readings, cab international, wallingford. 22 myint, h. (1959) “the classical theory of international trade and the underdevelopment countries”, economic journal, 68: 317-37. 23 ntangsi, j. (1992) “agricultural policy and structural adjustment in cameroon”, in peters, g.h. stanton, b.f. & tyler, g.j. (eds.) sustainsajems ns vol 6 (2003) no 1 217 able agricultural development: the role of international co-operation. dartmouth, aldershot. 24 ruttan, v.w. (1983) agricultural research policy, university of minnesota press, minneapolis. 25 sen, a. (1981) poverty and famines, clarendon press, london. 26 shapouri, s. & rosen, s. (1997) food security assessment. united states department of agricultural, economic research service, washington, report gfa-9. 27 spio, k. (1997) “the law food input farming sector in sub-saharan africa: lessons and experience”, agrekon, 36: 231-50. 28 srinivasan, t.n. (1994) “indian agriculture: policies and performance”, in srinivasan, t.n. (ed.) agriculture and trade in china and india, ics press, san francisco. 29 van rooyen, c.j. & bembridge, t.j. (1998) “challenges for the restructuring of small farmer support services”, in van rooyen, j., groenewald, j., ngqwangwani, s. & fenyes, t. (eds.) agricultural policy reform in south africa, aipa/francolin publishers, cape town. 30 van schalkwyk, h.d., van zyl, j. & jooste, a. (1995) “the effect of the exchange rate and international factors on the competitive position of south african wheat producers”, agrekon 34 : 250-53. 31 world bank (1987) road deterioration in developing countries. 32 zaman, m.r. & bose, s.r. (1974) “extension service, education and agricultural development, with special reference to bangladesh”, in islam, n. (ed.) agricultural policy in developing countries, macmillan press, london. microsoft word 3 portmann & mlambo sajems 16(3) 2013.doc 258 sajems ns 16 (2013) no 3:258-278 private equity and venture capital in south africa: a comparison of project financing decisions david portmann and chipo mlambo uct graduate school of business accepted: january 2013 this paper investigates the manner in which private equity and venture capital firms in south africa assess investment opportunities. the analysis was facilitated using a survey containing both likert-scale and openended questions. the key findings show that both private equity and venture capital firms rate the entrepreneur or management team higher than any other criterion or consideration. private equity firms, however, emphasise financial criteria more than venture capitalists do. there is also an observable shift in the investment activities away from start-up funding, towards later-stage deals. risk appetite has also declined post the financial crisis. key words: private equity, venture capital, investment criteria, south africa jel: g24, g34, n27 1 introduction besides the limited access to start-up capital as an inhibitor to entrepreneurship in south africa, many other factors have emerged in entrepreneurial surveys. in a survey by herrington, kew and kew (2009), 81 per cent of respondents cited shortage of capital as the greatest challenge in their businesses. however other challenges cited relate to business planning (68 per cent), insufficient information knowledge (75 per cent), the quality of employees (57 per cent), and issues around the marketing of products/services (57 per cent). in this regard, private equity (pe) becomes an important source of financing for such businesses. this is because pe firms do not just provide funding but also bring a wealth of experience, knowledge, expertise, networks, alliances and new customers to the businesses they fund. they provide capital to high-risk businesses that other capital providers would not fund. these include businesses without track records, rapidly growing businesses in constant need of external funding and distressed or troubled companies. private equity refers broadly to two forms of investments; venture capital (vc) and buyouts (smolarski, 2007). while pe is commonly used to refer to the buyouts of laterstage businesses, vc provides seed or start-up capital to early-stage and high-growth businesses, mostly innovation-based. with the declining trend in pe and vc investments in south africa from r26.1 billion in 2007 to only r7.0 billion in 2009 (kpmg & savca1, 2010), seed capital by venture capitalists has been the most affected. deloitte and savca (2009) reported that whereas approximately 40 per cent of the respondents (vc investors) were interested in seed or startup capital and early-stage investments in 2005, this figure had dropped to approximately 23 per cent by 2008 and to less than 5 per cent by the third quarter of 2009. this was corroborated in a subsequent study by kpmg and savca (2010) who reported that seed or start-up capital and early-stage investments declined from r1.134 billion in 2008 to only r280 million in 2009. consequently, seed capital is provided by friends and family with the so-called “angel investors” often filling the funding gap between friends and family and vc investors (wainwright & groeninger, 2005)2. numerous authors have argued that the presence of an active pe and vc market abstract sajems ns 16 (2013) no 3:258-278 259 encourages the efficient allocation of capital (banerjee, 2008; chan, 1983; sahlman, 1988; wright, gilligan & amess, 2009). pe directs capital flows to where they are most effective resulting in an optimal reward per given level of risk. however, given the general lack of transparency and the shortage of information flows in the industry, it is not clear whether or not such efficient allocation does indeed take place. according to hege, palomino and schwienbacher (2003) the higher internal rate of return (irr) in the us than in europe is due to the more advanced screening skills of us venture capital investors. it is in the arena of pe investment screening and decision-making that this research is concerned. with pe funds receiving hundreds of proposals by prospective business owners every day, it is essential to know what they are looking for in such proposals. this research attempts to make a contribution by evaluating the investment criteria used by pe and vc firms in south africa when making their investment decisions. these and other questions will be addressed: 1) what is it that south african pe and vc firms look for in an investment? do they use the same investment criteria that are used by pe and vc firms elsewhere? 2) are investment criteria used by pe firms that focus on later-stage investments and buyouts significantly different from those used by vc firms that focus on early-stage deals and if so where do the differences lie? 3) considering the declining trend in pe and vc investments in south africa between 2007 and 2009 as reported in the kpmg and savca (2010) report, have vc firms in south africa tightened or revised their investment criteria post the financial crisis and if so, what has changed? the study proceeds as follows. the literature review (section 2) is presented in three parts. the first part describes the emergence of pe and vc markets and the typical manner in which they function. the second part reviews pe and vc activities in south africa. the third part ends the section by describing investment screening and decision-making criteria on both south africa and internationally as documented in the literature. these criteria are used in designing the likert-scale questionnaire that is used in the data collection as described in section 3. section 4 presents the research results and section 5 concludes. 2 review of related literature 2.1 the functionality of private equity and venture capital markets wright et al. (2009:2) describe pe as “an increasingly important mechanism to rapidly and radically restructure organisations worldwide.” in this context, it is becoming ever more important for the pe market to function effectively in order to best provide alternative funding and encourage economic growth (zider, 1998). in an attempt to determine how the success of the us venture capital market can be replicated in other countries, gilson (2003: 1069) expounds on three factors that are crucial, namely, “capital, specialised financial intermediaries, and entrepreneurs.” gilson (2003) explains that the availability of capital and the support of effective financial intermediaries will lead to the promotion and facilitation of entrepreneurial activity. this model, described by gilson (2003), offers a clear and succinct perspective of vc market development. another useful model was advanced first by tyebjee and bruno (1984). this model has five distinct steps, that is, deal origination, screening, evaluation, deal structuring, and post investment activities. whereas the screening phase in the tyebjee and bruno (1984) model is only a firm-specific screen, in a subsequent article, fried and hisrich (1994) suggested that there are in fact two screening phases, one firm-specific and the other generic. the screening phase in tyebjee and bruno (1984) only takes into account basic criteria such as deal size, geographical location and stage of financing. it does not take into account pre-evaluation factors such as the quality of the business plan or relevant proposal-specific knowledge held by the venture capitalists. these are accounted for in the fried and hisrich (1994) version. a further difference in the tyebjee and bruno (1984) and fried and hisrich (1994) 260 sajems ns 16 (2013) no 3:258-278 models is the inclusion of an additional evaluation phase by the later authors. this phase relates to the vc evaluation activity post the pricing settlement. in isolation, the vc process model has limited applicability. however, as a lens through which to understand vc activity, and by extension pe activity, it is useful for two reasons. first, it provides a clear perspective of the investment process and allows one to contextualise how and when vc firms apply their investment decision criteria. second, it is useful in understanding the vc cycle model created by gompers and lerner (2000) described as one of sustainable and self-renewing growth. it explains the development of a vc market as a product life cycle that begins with the raising of funds from investors, continues with the investment in companies, the monitoring of and value addition to these companies, and ends with the successful exit from the investment and the returning of capital to investors. the cycle then renews itself with the raising of new funds (gompers & lerner, 2000). a final consideration in the functionality of pe markets is the phenomenon of syndication, the process whereby two or more investment firms partake in an investment opportunity. lockett & wright (2001) suggested three rationales for syndication, that is, the sharing of financial risk, the pooling of resources to specific target levels, and the boosting of deal flow through reciprocity with other pe firms. according to hege et al. (2003), a mature market, like the us, benefits considerably more from syndication than does a younger market, like the european market. consistent with the findings of hege et al. (2003), bent, williams and gilbert (2004) found that while syndicated investments appear to outperform stand-alone investments, only a relatively small proportion of around 13 per cent of previous pe investments had been syndicated in south africa, compared to an equivalent figure of 60 per cent in the us. 2.2 private equity and venture capital in south africa previous studies have questioned the effectiveness of adapting the us vc model to other countries like brazil (de lima ribeiro & de carvalho, 2008) and south africa (lingelbach, murray & gilbert, 2008). in their findings, lingelbach et al. (2008) indicate that the traditional simultaneity and vc cycle models, proposed by gilson (2003) and gompers & lerner (2000), respectively, do not satisfactorily explain vc development in emerging economies like south africa. lingelbach et al. (2008) proposed an alternative model which introduces the concept of coproduction3 as a third necessary process in the formulation of a successful vc market. this model was tested by lingelbach and gilbert (2009) in a study on botswana. in south africa, black economic empowerment (bee) is a necessary and important driver of pe activity. according to missankov, van dyk, va biljon, hayes and van der veen (2006:56), bee dominates the south african pe industry and is promoted either through the ownership and management structure of pe managers or through the funding sources used for the pe transactions. it is estimated that more than 90 per cent of total pe transactions in south africa and 100 per cent of buyout transactions have a bee element (missankov et al., 2006:56). with such an obvious state-induced influence over the pe industry in south africa, it is, therefore, not surprising that lingelbach et al. (2008) lay part of the blame for vc stagnation in the country on bee. it can thus be deduced that bee acts as a catalyst in laterstage pe investments (missankov et al., 2006), on one hand, and as an inhibitor in early-stage vc investments (lingelbach et al., 2008) on the other. another feature of the south african pe market is its skewness towards later-stage investment activity. internationally, the pe industry has shown considerable growth over the last 10 years, and south africa is no exception to this (van niekerk & krige, 2009). however, a significant component of this growth is accounted for by the later-stage buyout end of the market (wright et al., 2009). while markets such as the us and asia (pintado, de lima & van auken, 2007) still maintain a strong focus on early-stage vc investments, other markets, such as europe (pintado et al., 2007), brazil (de lima ribeiro & de carvalho, 2008), australia (hudson & sajems ns 16 (2013) no 3:258-278 261 evans, 2005), and south africa (jones, 2009; lingelbach et al., 2008; roodt, 2007; stillman, sunderland, heyl & swart, 1999) are investing more in later-stage projects. given this, it seems incongruent that the majority of published literature has tended to focus on addressing issues relating to early-stage vc activity. the investment decision criteria so far documented relate more to vc firms that invest in early-stage projects than to pe. 2.2.1 the south african regulatory environment for pe/vc firms like any company, the establishment of pe and vc firms in south africa is governed by the new companies act no. 71 of 2008 which came into effect on 1 may 2011, replacing the companies act no. 61 of 1973. the legal form of entreprise often taken by pe and vc firms is the en commandite partnership, which has two categories of partners – the general (disclosed) partners and the limited (undisclosed) partners. pe/vc firms can also take the ‘company’ legal form. under the companies act, the memorandum of incorporation (moi) overrides any shareholder agreements in case of contradictions. the only problematic legal structure, especially for pension funds as investors in pe/vc funds, is a trust. unless it is a bewind trust whereby the trustees simply administer or control the invested assets, it may mean transferring the ownership of the invested assets to the fund trustees. this is not allowed under section 5 of the pension funds act no. 24 of 1956. while regulation 28 of the pension fund act previously did not stipulate the allocation that pension funds can make to pe investments, the amended regulation 28 which came into effect on 1 july 2011 limits investments by south african pension funds to 10 per cent of their assets in pe funds, with a 2.5 per cent limit per individual fund and a 5 per cent limit to a fund of funds. this regulation also requires a pension fund, its advisors and trustees to perform reasonable due diligence in its investment and disinvestment activities by taking into account relevant risks – the solvency, liquidity and reasonableness test. public-to-private buyout transactions, prevalent among pe firms, are regulated under the companies act of 2008, the takeover code, jse listing requirements, the securities services act of 2004 and the competition act of 1998 (bellew, hutton & dennehy, 2011). in addition, pe fund managers and advisors are required to be licensed under the financial advisory and intermediary services (fais) act of 2003. the south african income tax act of 1962, as amended, regulates the tax relief entitlement of headquarter companies that meet the act’s definition. with the partnership legal structure, pe fund partners are taxed in their personal capacities on their portion of interest attributed. foreign partners are taxed only on income generated within the republic and are required to pay capital gains tax on the proceeds from the disposal of their south african interests, assets and immovable property. they are also subject to exchange control approval by the financial surveillance department (fsd) of the south african reserve bank (sarb) under the exchange control regulatory order rules of 1961. the taxation laws amendment bill of 2011 provides for the taxation of restructuring, mergers and acquisitions and pe transactions, whether these are in the form of amalgamations (section 44), intra-group (section 45), or liquidations (section 47). interest on debt used to finance these transactions is no longer automatically deductible but is subject to approval by the south african revenue service (sars) following application by the acquitting company as defined in sections 45(1) or 47(1) of the income tax act.4 any interest that is considered excessive is treated as declared dividends under the thin capitalisation restrictions of the income tax act. investment by individuals in a sarsapproved vc company is tax deductible up to r750 000 per vc investment or r2.25 million aggregate lifetime limit. with the relaxation of exchange controls, pe funds are no longer required to seek sarb approval on a deal-by-deal basis when investing outside the common monetary area of south africa, namibia, lesotho and swaziland. they only need to acquire approval for all foreign investments, renewable every 3 years. in addition, amendments to the tax laws have been instrumental in avoiding local taxation on international investors. funds no 262 sajems ns 16 (2013) no 3:258-278 longer need to have dual structures (local and foreign), thus eliminating unnecessary administrative and legal costs that comes with the dualism (bellew et al., 2011). foreign fund managers with deals on the continent can also set base in the country with ease if it is essential for them to do so (bellew et al., 2011). therefore, given this regulatory background, the question that remains is what else do pe/vc firms in south africa consider in making their investment decisions. 2.3 evaluation criteria in private equity and venture capital although quindlen (2000:169) describes the process of valuing an early-stage investment as “much more an art than a science”, the most common methods used by vc firms include the discounted cash flow (dcf) method, the earnings multiple approach, the net asset value (nav) approach, and the subjective vc method (ge, mahoney & mahoney, 2005). manigart, waele, wright, robbie, debrieres, sapienza and beekman (2000) found considerable differences between the valuation techniques used across the countries they studied. they attributed this primarily to differences in maturity levels of the markets. smolarski (2007) asserts that differences “are not as large as previously and that the pre-investment stage is relatively homogenous across countries.” while the above concerns relate to the valuation of new ventures undertaken by vc firms, similar concerns can be inferred for later-stage pe investments. diller & kaserer (2009:648) state that when compared with the relatively efficient public exchanges, the lack of a continuous market for pe investments result in information asymmetries in the market. of more importance in pe than in publicly traded funds are the management skills of the fund-holders (wright & robbie, 1998; rogers, holland & haas, 2002; diller & kaserer, 2009). this concept of information asymmetry further reiterates the importance of sound evaluation processes in pe investments. the first published studies on the subject of investment decision criteria were done by tyebjee & bruno (1984), macmillan, siegel & subba narasimha (1985), and macmillan, zemann & subba narasimha (1987), each of whom sought to provide useful rankings of the relative importance of various investment criteria. interestingly, the results of these studies generally point to the importance of the entrepreneur or management team when evaluating new projects. pointing out similar research done in the mid-1990s by fried and hisrich (1994), wright and robbie (1998) suggested that concern has shifted towards market acceptance of the product. this possibly indicates the developing sophistication of the us vc market at the time. findings in the us (kakati, 2003) and contemporary research, albeit in a european vc context, for example spain (pintado et al., 2007) and central and eastern europe (farag, hommel, witt & wright, 2004), and in south african (van deventer & mlambo, 2009), support the assertion that the entrepreneur and/or management team are an important decision criterion. according to pintado et al. (2007:85), the “characteristics of the entrepreneur, manager background, and management team experience were consistently more important evaluation criteria than market and product characteristics.” sander and koomagi (2007) add further contemporary support, in their study of estonian pe and vc firms, by indicating that non-financial criteria, in general, and the strengths of the management team, in particular, play an important role in the evaluation process. clearly there appears to be considerable consensus on the topic of the importance of management or entrepreneur-related criteria when evaluating new investments. however, one ought to look at a range of factors that influence the performance of new ventures since limiting the number of criteria in survey questionnaires may result in important facets of the process being overlooked (kakati, 2003). in this respect, van deventer and mlambo (2009) incorporated 54 possible decision criteria in their questionnaire. wright & robbie (1998) criticise the fact that the majority of the relevant literature relates to investment criteria employed by early-stage vc firms, with little attention to differences in evaluation criteria according to investee growth stage. this is a view supported by shepherd (1999:629) who acknowledges the “potential differences in a vc’s decision sajems ns 16 (2013) no 3:258-278 263 policy for businesses in different stages of development.” while the above authors realised the need for such research in the late 1990s, very little has been written about the effects of the investment stage on the decision criteria used, other than attempts by farag et al. (2004) and pintado et al. (2007). these two studies focused on developed countries. however, it is expected that the criteria differ not only according to investee growth stage, but also between developed and emerging markets. this study tries to close this gap by investigating the investment decision criteria employed by early-stage vc versus later-stage pe firms in an emerging market context, namely, south africa. 3 data and methods a sample of south african pe and vc firms was surveyed using criteria identified by van deventer & mlambo (2009). a statistical analysis was then conducted to allow the comparison of results to those achieved by van deventer and mlambo (2009). the inclusion of both pe and vc firms in the sample also enables comparison of the two fund types. open-ended questions regarding respondents’ perceptions of changing firm and industryspecific conditions post the international financial crisis were added to the survey instrument. this facilitates a descriptive analysis to substantiate the findings of the criteria ranking analysis. for sampling purposes, the population was defined as all vc and pe firms that are listed as members of savca. this list was considered to be sufficiently representative of the pe and vc firms in south africa. this population was refined by eliminating nonrelevant firm types such as legal, advisory and consulting firms leaving 56 firms in total. of the 56 firms, 41 are active in the pe space and 12 in vc, while three firms are active in both. a self-completion survey, developed by van deventer and mlambo (2009) with only minor modifications, was sent electronically to all the 56 firms and 26 responded, which translate to a 46 per cent response rate. of the 26 firms that responded, 15 are pe firms, 10 are vc firms and one is a holding company active in both vc and pe. it was necessary to use van deventer and mlambo (2009)’s survey instrument in comparing vc investment criteria preand postthe global financial crisis.5 the original questionnaire consisted of likert-scale questions, determined through a literature analysis of criteria used by overseas venture capitalists. in extending the survey to pe firms, a few questions were slightly reworded, in line with the language commonly used in pe circles. for the most part, the rewording involved replacing the term “entrepreneur” with “management” in the pe survey instrument. the questions were constructed so that respondents could rate the investment decision criteria in order of importance on a scale of 1 (not important), to 5 (very important). the research is limited by the low response rate of only 46 per cent, thus small sample size, and the tendency of the likert-scale method to oversimplify the responses (leedy & ormrod, 2010). although a high response rate is preferable, it is not uncommon in economic surveys to have a low response rate. out of 249 managers and entrepreneurs, gratchev and bobina (2001) received 64 responses, translating to a response rate of 26 per cent, while brau and fawcett (2006)’s response rate was only 19 per cent. one of the lowest response rates is by bernile, cumming and lyandres (2007) who received responses from 42 funds out of 8000 funds, translating to a response rate of 0.5 per cent. however, in these studies, even though the response rates were low, they reached the ‘more than 30’ observations rule of thumb for statistical analysis. in south africa, the population of pe and vc funds is low, such that a low response rate impacts on the choice of statistical and econometrics analysis that can be done. in addition, one can only generalise results with a grain of salt. while having one respondent per firm may result in responses not reflective of the view of the whole firm’s executive team, it is important to note that the effect is minimal since pe and vc firms typically have small executive teams. in addition, to avoid the order effect bias that normally comes with the use of questionnaires, the questions were ordered randomly within each category. the order 264 sajems ns 16 (2013) no 3:258-278 effect bias means that the “relative position of an item in an inventory of questions or stimuli may uniquely influence the way in which a respondent reacts to the item” (perreault, 1975: 544). 4 research analysis and findings 4.1 analysis of group or category rankings a nonparametric, friedman two-way analysis of variance (anova) test was used to determine whether there were any significant differences in the rankings of the four categories of criteria, namely, management, product, financial, and market considerations as ranked by pe firms and by vc firms. the test results are reported in table 1 at the 1 per cent, 5 per cent and 10 per cent levels of significance. significant differences in the rankings of the four categories by both pe firms and vc firms are observed. in the case of pe firms, the observed friedman statistic of 17.325 is significant at the 1 per cent level, suggesting that at least two of the four categories differ. the management considerations category has the highest mean rank of 3.375 (as shown in table 1), implying that it is the most important of the four categories. in the survey, 63 per cent of pe firms ranked management considerations as the top most important criteria group, compared with 25 per cent for the financial considerations, 13 per cent for product considerations and 0 per cent for marketing considerations. regarding vc firms, it is observed that while no significant differences exist in the rankings of the four categories at the 5 per cent level of significance, they are found to exist at the 10 per cent level of significance with a reported friedman test statistic of 7.737. the mean ranking of management considerations was also found to be the highest of the four categories with a mean rank of 3.2. whereas the lowest mean ranking for pe firms is observed for market considerations with a mean rank of 1.5, the lowest mean rank for vc firms is observed for the financial considerations category with a mean rank of 1.8. looking at the kendall coefficients of concordance and the average rank correlation coefficient, there also appears to be a relatively higher level of agreement in the rankings of the four categories by pe firms than by vc firms. t a b l e 1 friedman and mann-whitney u test results: private equity and venture capital firms 2010 variable friedman test mann-whitney u test private equity venture capital private equity vs. venture capital mean rank std. dev. mean rank std. dev. adjusted z statistic p-value management considerations 3.375 0.957 3.200 1.101 0.649 0.516 product consideration 2.438 0.892 2.850 0.823 -0.870 0.384 financial considerations 2.688 1.138 1.800 0.789 2.006** 0.045 market considerations 1.500 0.632 2.150 1.101 -1.377 0.168 friedman anova chi sqr. 17.325*** 7.737* p-value 0.001 0.052 kendall coeff. of concordance 0.361 0.258 aver. rank r 0.318 0.175 source: analysis of survey data done using statistica *** implies significance at the 1% level ** implies significance at the 5% level * implies significance at the 10% level, std. dev. = standard deviation in order to undertake a direct comparison of the results of the pe and vc surveys as they pertain to the four respective categories, a pairwise comparison using the mann-whitney sajems ns 16 (2013) no 3:258-278 265 u test was carried out. whereas no statistically significant differences are observed between pe and vc firms in their rankings of management, product and market considerations, significant differences are observed in the way the two fund types rank financial considerations. a mann-whitney z-statistic of 2.006 is observed for financial considerations, implying a statistical significance at the 5 per cent level. this suggests that there are differences in the way in which pe and vc firms assess financial considerations, a finding that is also observed in the responses to the open-ended questions. further to this, the sign test was employed to determine the significance of the differences in the mean rankings between the most important and the least important criteria groups, that is between management and market considerations for pe firms and between management and financial considerations for vc firms. however, in both cases, results are reported for both management versus market considerations and management versus financial considerations. the results, as given in table 2, suggest that south african pe firms recognise management considerations to be more important than market considerations, and this result is statistically significant at the 1 per cent level of significance with a sign test z-statistic of 3.25. on the other hand, when it comes to vc firms, management considerations are found to be significantly more important than financial. this result is observed at the 5 per cent level of significance with a z-statistic of 2.214 (table 2). t a b l e 2 sign test results: private equity and venture capital firms 2010 pair of variables private equity venture capital sign test z stat. p-value sign test z stat. p-value management & market considerations 3.250*** 0.001 0.949 0.343 management & financial considerations 1.250 0.211 2.214** 0.027 source: analysis of survey data done using statistica *** implies significance at the 1% level ** implies significance at the 5% level * implies significance at the 10% level these findings are consistent with the literature where, among others, sander and koomagi, (2007) and wright and robbie (1998) point out the inherent difficulties in valuing start-up enterprises. within this context of low valuation accuracy of start-ups, farag et al. (2004), ge et al. (2005), hege et al. (2003), hill & power (2001), kakati (2003), and mishra (2004) have found that, in response to the valuation difficulty, vc firms tend to look more closely at management considerations. indeed muzyka, birley & leleux (1996) found that venture capitalists, when tested on the trade-offs made in assessing new ventures, tend to favour opportunities that display management fundamentals even if the deal does not meet overall fund requirements. in the responses to the open-ended questions, a number of the respondents indicated a general lack of willingness among pe firms to fund start-ups owing to the high levels of uncertainty involved. the fact that no significant differences are observed between management and market considerations, as ranked by vc firms, is in contrast with the results reported by van deventer and mlambo (2009). this anomaly would appear to have two possible explanations. firstly, it may indicate a change in the functionality of south african vc firms since the survey by van deventer and mlambo (2009) was conducted in 2007 in that some venture capitalists may now be operating in the pe space. this might possibly signify the maturation of the south african vc market, in line with the findings by fried & hisrich (1994) on the us market. it is also important to note that two of the firms in this study categorised by van deventer and mlambo (2009) as vc firms, were pe firms, as they attested to the fact that since 2007 their activities have shifted away from typical earlystage vc investments towards later-stage pe investments. 266 sajems ns 16 (2013) no 3:258-278 4.2 investment criteria rankings by private equity versus venture capital firms to enable comparison with the study by van deventer and mlambo (2009), an examination of the most and least important criteria is carried out and the mean rankings and standard deviations for the top ten and bottom ten criteria reported in tables 3 and 4, respectively6. respondents were also given the opportunity to list and rate the importance of any additional criteria that were not mentioned in the questionnaire but which they felt should have been included. these additional criteria and their rankings are presented separately in appendix table a1. 4.2.1 ten most important criteria as ranked by private equity versus venture capital firms the data (table 3) indicate a strong bias towards management criteria, especially for pe firms, with five of the top ten criteria falling into this category, compared with one for market and one for financial considerations. with vc firms, although four of the top ten criteria are product considerations, the top three criteria all relate to management considerations and none of the criteria in the top ten relate to financial considerations. for both pe firms and vc firms, the honesty and integrity of the management team or the entrepreneur top the list as the highest rated criterion. this finding is consistent with other findings by macmillan et al. (1985), fried & hisrich (1994) and pintado et al. (2007). macmillan et al. (1985), for example, reported in their findings that five of the top 10 most important criteria had something to do with the entrepreneur’s experience or personality. a further interesting observation is that while a high irr is ranked as the fourth most important criterion by pe firms with a mean rank of 4.6 and a low standard deviation of 0.51, a high irr does not appear in the top ten most important criteria for vc firms7. this further compounds the view that later-stage investments are easier to value than early-stage investments. while wright and robbie (1998: 526) seem to suggest that there is less focus on financial criteria at the early-stage, the findings by pintado et al. (2007: 86) appear to be to the contrary. in their examination of the spanish vc market they found evaluation factors affecting the required rate of return to be ranked as generally more important for earlystage than for late-stage deals. 4.2.2 ten least important criteria as ranked by private equity and venture capital firms the ten least important criteria as ranked by the pe and vc firms are detailed in table 4. while the results are generally similar for both firm types, for pe firms, five of the ten least important criteria relate to financial considerations, compared to four for vc firms. for both pe and vc firms, two of the ten least important criteria both relate to market and product considerations and one is a general criterion relating to the bee status of the prospective business. interestingly, in line with the findings thus far, and in line with the majority of available literature, none of the management criteria for pe firms, and only one for vc firms, appear in the ten least important criteria list. the least important criterion as ranked by pe respondents is whether the product or service in question makes use of an emerging or innovative technology. this criterion scored a mean rank of 2.0, compared with 3.8 obtained from the vc rankings. conversely, in the case of vc firms, the least important criterion is the venture’s bee status with a mean rank of 1.88. this supports the assertion by lingelbach et al. (2008) that bee is, in fact, an inhibitor of early-stage vc activity in south africa. contrary to the supposition by missankov et al. (2006) and van niekerk & krige (2009) that bee acts as a significant incentive in the pe space, the “bee status” criterion in this study is ranked as the fourth least important criterion by pe firms with a low mean rank of 2.4, and as the least important by vc firms as aforementioned. sajems ns 16 (2013) no 3:258-278 267 t a b l e 3 ten most important criteria as ranked by private equity firms vs. venture capital firms 2010 top 10 criteria as ranked by private equity firms top 10 criteria as ranked by venture capital firms criterion mean std. dev. category* criterion mean std. dev. category* the management team is honest and has integrity 4.73 0.59 mgt the entrepreneur is honest and has integrity 4.82 0.42 mgt the management team has excellent skills/experience 4.73 0.46 mgt the entrepreneur has good knowledge of the sector 4.82 0.42 mgt the product or service has a good market acceptance 4.60 0.51 pdt the entrepreneur has a great desire for success 4.80 0.42 mgt the investment will provide a high internal rate of return (irr) 4.60 0.51 fin the size of the market (big market for the product/service) 4.79 0.42 mkt the management team has a good track record 4.53 0.64 mgt the product/service has a competitive advantage over competing products 4.75 0.48 pdt the management team has a great desire for success 4.53 0.74 mgt the product/service is unique and/or patentable 4.64 0.52 pdt the management team has good knowledge of the sector 4.47 0.64 mgt there is a market need for the product or service 4.59 0.52 mkt the product/service has a competitive advantage over competing products 4.47 0.64 pdt there is potential for market growth 4.57 0.52 mkt the investment has a developed product 4.47 0.64 pdt a good market acceptance for the product or service is expected 4.54 0.53 pdt there is potential for market growth 4.47 0.64 mkt the venture has a developed product or working prototype 4.53 0.71 pdt source: own calculations from survey responses * key to columns 4 and 8: abbreviation notation used to conserve space: mgt = management; pdt = product; mkt = marketing; fin = financial; and “other” refer to any other category apart from the first four. t a b l e 4 ten least important criteria as ranked by private equity firms vs. venture capital firms 2010 bottom 10 criteria as ranked by pe firms bottom 10 criteria as ranked by venture capital firms criterion mean std. dev. category criterion mean std. dev. category the product/service make use of an emerging or innovative technology 2.00 0.85 pdt the venture has bee status 1.88 0.88 other there will be a tax benefit in financing the investment 2.33 0.72 fin the venture will require low monitoring and administration costs 2.18 0.79 fin the business will create a new market 2.33 0.82 mkt the venture has production capabilities in place 2.29 0.82 pdt the business has bee status 2.40 0.99 other the venture will operate in a non-competitive industry 2.32 0.67 mkt there will be no follow up investment required 2.47 1.19 fin there will be a tax benefit in financing the venture 2.39 1.07 fin the investment will require low marketing and production costs 2.47 0.99 fin the venture will require low marketing and production costs 2.42 0.70 fin the investment will require low monitoring and administration costs 2.53 0.92 fin product/service is in an early-stage of life cycle 2.52 0.85 pdt there should be an early exit opportunity 2.67 1.18 fin there will be no follow up investment required 2.68 1.06 fin there are no high barriers to new entrants in this market 2.80 1.61 mkt the entrepreneur has many years of work experience 2.80 0.42 mgt the product/service is unique and/or patentable 2.93 1.22 pdt there are no high barriers to new entrants in this market 3.00 0.82 mkt source: own calculations from survey responses * key to columns 4 and 8: mgt = management; pdt = product; mkt = marketing; fin = financial; and “other” refer to any other category apart from these four. 268 sajems ns 16 (2013) no 3:258-278 the importance of high barriers to entry into the market for pe firms was the most polarising with a standard deviation of 1.61. although it achieved the ninth lowest mean rank of 2.8, two of the respondents opted to include it as an additional important criterion in the survey. shepherd (1999) highlights the importance of high barriers when providing a new venture with a period of monopoly as a first entrant. high barriers can be considered more important for early-stage vc investments. in this study, high barriers to entry appear as the tenth least important criterion for vc firms, although they achieved a higher average rank of 3.04, compared with 2.8 for pe firms. the very high standard deviation for this criterion, in the case of the pe survey results, is likely to have occurred because certain of the firms’ investment activities cover a wide spectrum of opportunities from early-stage to later-stage investments and a high degree of variance is likely to be observed in the importance placed on competitive barriers. 4.3 criteria rankings by venture capitalists: 2010 vs. 2007 surveys in a similar study, van deventer and mlambo (2009) report results from a survey of 12 vc firms conducted in 2007. the mean rankings from this 2007 survey, as reported by van deventer and mlambo (2009), are compared with mean rankings by vc firms in the 2010 survey. the most important and least important criteria from the two surveys are reported in tables 5 and 6, respectively. 4.3.1 the most important criteria as ranked by venture capitalists: 2010 vs. 2007 although in 2007, a high irr was considered jointly with the entrepreneur’s honesty and integrity and a good market acceptance for the product or service, to be one of the most important criteria with a mean rank of 4.91, its importance in the 2010 survey dropped significantly to an average rank of 4.02. other criteria that have shown significant changes in ranking include the existence of an opportunity for an early exit, the merger or acquisition potential of the venture, the uniqueness and/or patentability of the product or service, how articulate the entrepreneur is about the venture, and the presence of a developed product or working prototype for the venture. these criteria have significantly increased in importance with the mean rankings improving by 1.10, 0.87, 0.82, 0.79 and 0.62 points, respectively. the first two criteria are closely related and they each have something to do with the efficient capitalisation of the investment. their increased importance can in part be explained by the shift in focus by vc firms from early-stage towards later-stage investments since 2007. respondents to the open-ended questions indicated a general move away from investing in start-up ventures, where the opportunity for numerous rounds of financing is important8, towards more mature later-stage deals, where the ability to efficiently and profitably exit an investment is critical. this may well be in response to the recent financial crisis and the increased risk aversion by the vc firms that followed. firms that had taken on too much risk are the ones that suffered the most during the financial crisis. indeed, three of the vc firms that responded to the open-ended questions indicated that they have shifted focus to later-stage deals owing to increased uncertainty. another respondent pointed out that exit opportunities have become more difficult in a post-financial crisis environment. the full responses to the open-ended questions are reported in appendix table a3 for pe funds and appendix table a4 for vc funds. 4.3.2 the least important criteria as ranked by venture capitalists: 2010 vs. 2007 regarding the least important criteria, the data reveals that apart from the importance of the criterion “no follow up investment required”, the presence of a tax benefit in financing a venture has also improved in importance from a mean ranking of 1.91 in 2007 to 2.39 in 2010, albeit with a higher standard deviation, increasing from 0.70 to 1.07. with the current lack of deal flows, it may be that vc fund managers have become more creative in their investment decision motivations including exploiting the tax benefits of certain investment opportunities. this argument is contrary to tyebjee & bruno’s (1984) finding that most venture capitalists focus their efforts on capital gains for their investors rather than acting on the tax shield. in addition, no explanation for this item was provided in the open-ended questions. sajems ns 16 (2013) no 3:258-278 269 t a b l e 5 most important criteria as ranked by venture capital firms: 2010 vs. 2007 mean ranks criterion 2010 mean 2007 mean difference the entrepreneur is honest and has integrity 4.82 4.91 -0.09 the entrepreneur has good knowledge of the sector 4.82 4.18 0.64 the entrepreneur has a great desire for success 4.80 4.73 0.07 the size of the market (there is a big market for the product or service) 4.79 4.45 0.34 the product/service has a competitive advantage over competing products 4.75 4.73 0.02 the product/service is unique and/or patentable 4.64 3.82 0.82 there is a market need for the product or service 4.59 4.82 -0.23 there is potential for market growth 4.57 4.73 -0.16 a good market acceptance for the product or service is expected 4.54 4.91 -0.37 the venture has a developed product or working prototype 4.53 3.91 0.62 the entrepreneur has excellent management skills/experience 4.45 4.55 -0.10 the entrepreneur is articulate about the venture 4.43 3.64 0.79 the entrepreneur is hardworking and flexible 4.32 4.55 -0.23 the entrepreneur has good leadership ability 4.31 4.45 -0.14 the managers must be realistic 4.29 3.82 0.47 the entrepreneur has a good track record 4.24 4.27 -0.03 the venture has merger/acquisition potential 4.23 3.36 0.87 the references of the entrepreneur are reputable 4.14 4.09 0.05 there should be an early exit opportunity 4.10 3.00 1.10 the entrepreneur is capable of intense, sustained effort 4.04 4.18 -0.14 the venture will provide a high internal rate of return (irr) 4.02 4.91 -0.89 source: own calculations from survey responses. the criteria are presented in the table using the 2010 survey rankings another interesting change is the decreased importance attached to the venture’s bee status, with a decline in mean ranking from 2.36 to 1.88. since many, if not all, bee deals are leveraged buyouts, and thus highly geared, the sharp decline in leveraged transactions post the financial crisis must have made these deals less prominent. t a b l e 6 least important criteria as ranked by venture capital firms: 2010 vs. 2007 mean ranks criterion 2010 mean 2007 mean difference the venture has bee status 1.88 2.36 -0.48 the venture will require low monitoring and administration costs 2.18 2.09 0.09 the venture has production capabilities in place 2.29 2.82 -0.53 the venture will operate in a non-competitive industry 2.32 2.45 -0.13 there will be a tax benefit in financing the venture 2.39 1.91 0.48 the venture will require low marketing and production costs 2.42 2.64 -0.22 product/service is in an early-stage of life cycle 2.52 2.72 -0.20 there will be no follow up investment required 2.68 2.09 0.59 the entrepreneur has many years of work experience 2.80 3.09 -0.29 source: own calculations from survey responses. the criteria are presented in the table using the 2010 survey rankings 4.4 statistical significance of differences in the responses in order to test the statistical significances of the differences in the decision criteria rankings between pe and vc firms and between the vc firms in the 2007 and 2010 surveys, t-tests for matched pairs were performed on the mean rankings of the 54 criteria used. for the pe 270 sajems ns 16 (2013) no 3:258-278 versus vc comparisons, a t-statistic of -1.455 was observed indicating no statistically significant differences in the rankings by the two firm types, even at the 10 per cent level of significance. this could be owing to the closing gap between pe and vc in south africa with investments becoming more concentrated for firms in the expansion and development phases. farag et al. (2004), pintado et al. (2007), shepherd (1999), and wright & robbie (1998) have attempted to test the differences between the two ends of the pe spectrum, that is, the early-stage and late-stage funds, but not between their investment criteria rankings. t a b l e 7 t-tests – private equity vs. venture capital firms 2010, and venture capitalists 2010 vs. 2007 pairs of comparison obs. a mean diff. std. dev. diff. t-statb df c p-value pe 2010 vs. vc 2010 54 -0.132 0.667 -1.455 53 0.152 vc 2010 vs. vc 2007 54 -0.021 0.459 -0.340 53 0.735 source: analysis of survey data using statistica. a obs. = observations. there were 54 items that were ranked in the questionnaire thus corresponding to 54 observations. note that the values used for each firm type are the mean ranks as opposed to the raw data. b t-stat = t-statistics. the t-test used is for dependent samples c df = degrees of freedom. similarly, the comparison between the mean rankings in the 2010 and 2007 vc surveys yielded no significant differences. a t-statistics of -0.340 was observed, which is not significant at any of the three significance levels. therefore, while there is a shift in the ranking of categories and certain selected criteria, the general ranking of criteria has not changed. in order to assess ranking consistency and to discern any changes, the responses by five vc representatives who completed both the 2007 and 2010 surveys were analysed and any differences assessed using the sign test. the results are presented in table 8. t a b l e 8 criteria rankings by the same venture capital: 2010 vs. 2007 pair of variables no. of non-ties percent v < v sign test z stat. p-value respondent a 2007 & respondent a 2010 31 22.581 2.874*** 0.004 respondent b 2007 & respondent b 2010 36 50.000 -0.167 0.868 respondent c 2007 & respondent c 2010 21 57.143 0.436 0.663 respondent d 2007 & respondent d 2010 29 51.724 0.000 1.000 respondent e 2007 & respondent e 2010 36 30.556 2.167** 0.030 *** implies significance at the 1% level ** implies significance at the 5% level * implies significance at the 10% level in table 8, it can be seen that there were no significant changes in the rankings by three of the five respondents. the only significant differences were observed for respondents a and e. when looking at the actual rankings given by respondents a and e in 2007 vis-àvis 2010, both respondents revised their ranking of financial criteria downwards attaching them lower importance. this could be reflective of the post-financial crisis environment where greater levels of uncertainty have resulted in a diminished emphasis on valuation tools, which is substantiated by respondent a’s answers to the open-ended questions. according to respondent a, there is now greater skepticism about projections and forecasts in the face of uncertainty. the other the downward revisions in rankings by the two respondents were in respect of market considerations. respondent e changed the ranking of “high barriers to entry for competitors” from a five (very important) in 2007 to a one (not important) in 2010 and “the length of the venture’s lead time sajems ns 16 (2013) no 3:258-278 271 over competitors” from a four in 2007 to a one in 2010. because these criteria are expected to be important in early-stage deals, this may confirm the assertion that there is a shift in south africa from early-stage vc deals to later-stage pe investments. in general, improved criteria rankings of more than two points by all five respondents pertains to the negative effects of uncertainty. these include the proposed venture’s resistance to economic cycles and whether the venture operates in a non-competitive industry and already has a working prototype. a number of the respondents maintained that an increasing amount of caution is now evident in the face of greater uncertainty. 4.5 risk and return in order to understand the importance that pe and vc firms place on return projections in evaluating projects for investment, four questions were included in the questionnaire, specifically on returns and valuations. looking at the mean ranks of these four criteria (table 9), it is interesting to observe that although returns and valuations are still considered important by both pe and vc firms in their investment decision-making (with mean ranks above 3), they are not as important as they were in 2007. in 2007, the mean ranks for vcs for the same four criteria were all above 4, with the highest for irr of 4.91. in order to determine whether the differences are significant, a comparison test was done using the mann-whitney test. there are no statistically significant differences in the rankings of these four criteria by pe and vc firms in 2010. however, there are statistically significant differences at the 5 per cent level in the ranking of two of the criteria by vc firms in 2010 vis-à-vis 2007. less importance is attached to high valuation projections and high irr in 2010 compared to 2007, with mannwhitney z-statistics for the two criteria of 2.547 and -2.080, respectively. t a b l e 9 the importance attached to financial criteria that focus on return and valuations decision criterion mean ranks pe 2010 vs. vc 2010 vc 2010 vs. vc 2007 pe 2010 vc 2010 vc 2007 mann-w z p-value mann-w z p-value high profit margin projections 3.63 3.80 4.27 -0.473 0.636 -1.041 0.298 high valuation projections 3.56 3.90 4.73 -1.114 0.265 -2.457 0.014 high internal rate of return (irr) 4.50 4.00 4.91 0.759 0.448 -2.080 0.038 high absolute return (large investment with sufficient monetary returns) 4.31 3.70 4.18 1.698 0.089 -1.483 0.138 mann-whitney analysis done using statistica software no explicit risk-specific criteria were included in the survey for ranking. however, two pe respondents added criteria on risk but under the management category (see appendix table a1). nonetheless, in both cases, it seems they attach high importance to a manager who is not afraid to take risk, presumably implying high returns. in the open-ended questions, the indication is that risk appetite has generally declined post the financial crisis. in addition, the fact that firms with good managers survived the financial crisis, and not necessarily those that had promised high returns, may explain why high importance is now attached mostly to management criteria than to financial criteria. 5 conclusions and recommendations it is documented in the literature, internationally, that pe/vc is an important and growing contributor to economic growth. vc deals, although difficult to quantify, have become an increasingly important source of start-up funding (kpmg & savca, 2008 & 2010; herrington et al., 2010). thus the declining trend of pe/vc investments in south africa should be a cause for concern. research on pe/vc especially in the south african context is distinctly lacking. this study sets out to investigate the key criteria employed by pe and vc firms in 272 sajems ns 16 (2013) no 3:258-278 evaluating new investment opportunities, and how these criteria differ between the two firm or fund types. it also examined how the investment criteria used by vc firms have shifted in importance since 2007 and how the pe/vc industry, in general, has changed in south africa, in response to the recent global financial crisis. data was gathered by means of an industry survey of pe and vc firms. the survey consisted predominantly of a likertscale questionnaire, to allow for the ranking of criteria, as well as a number of open-ended questions that enabled respondents to provide qualitative information to substantiate their rankings. the survey results for 2007 were requested and obtained from van deventer and mlambo (2009). this enabled the analysis of any possible shifts in the rankings by vc firms. it is found that criteria relating to the quality of management or the entrepreneur are the most important, from both the pe and vc perspective, and in line with previous findings elsewhere. differences in rankings by the pe and vc firms relate to criteria such as the importance of bee status and the relevance of the irr performance measure – a financial criterion. while no statistically significant differences are observed between pe and vc firms using the t-test, there are significant differences in the rankings of financial considerations by the two fund types. pe firms are evidently more concerned with financial considerations than their vc counterparts. regarding the rankings of criteria by the vc firms in 2007 as compared with those in 2010, no significant differences are observed. a pairwise comparison of the rankings by the five repeat vc survey participants indicates a shift in certain rankings, with significant differences for two of the five participants. a closer look at the results indicates a decreased emphasis on financial criteria and a greater emphasis on risk aversion. in addition, there is an increased emphasis on criteria relating to the venture’s merger and/or acquisition potential and the opportunity for early exit, indicating a bias towards late stage pe investments. 5.1 limitations and delimitations of the study the study only reports the importance of criteria as reported by respondents. however, what is reported may not necessarily be what is implemented in practice. therefore, our results suffer from self-reporting bias. an accurate assessment is only possible by analysing the proposals that have been presented to pe and vc firms and grouping those that have been funded and those that have been rejected and through a comparative analysis to determine why a project would be funded and why it would be rejected. unfortunately, there is no database for such proposals to enable this kind of analysis. in addition, due to the small sample size, generalising the results to south africa could be a problem. 5.2 future study there is need to further study the changing nature of the pe/vc industry with respect to the allocation of funds between early-stage and later-stage deals. given the importance of early-stage or start-up funding in enterprise development and economic growth, the observed shift in investment activities by vc funds towards late-stage deals in south africa is a cause for concern and warrants further investigation. the case for the development of south africa’s emerging (or stagnating) vc market should be contextualized accordingly so that appropriate policy solutions can be identified. in addition, the decreasing importance placed on financial valuation tools by both pe and vc firms, and the wider impact of the recent financial crisis on the industry should be explored. research should also focus on developing theory that can be used to understand the industry better, now and in the future. endnotes 1 south african venture capital & private equity association 2 http://www.money-zine.com/investing/investing/angel-investors/. http://sbinfocanada.about.com/cs/financing/g/angel.htm. http://www.noobpreneur.com/2012/08/17/where-to-look-for-angel-investors/; etc. 3 this is a “distributed-production arrangement in which different firms (often located in different countries) produce different parts of the same end product. it may involve the transfer of technology as well as of key personnel, especially in the earlystages of the agreement.” (http://www.businessdictionary.com/definition/coproduction.html). sajems ns 16 (2013) no 3:258-278 273 4 http://www.bowman.co.za/news-blog/blog/privateequity-significant-regulatory-developments 5 van deventer and mlambo did their survey in 2007. 6 note that in van deventer and mlambo (2009), criteria with mean rankings of 4 and above were reported as the most important criteria and those with mean rankings of 2 and below were reported as the least important criteria. we only report the top ten and bottom ten to keep the tables to manageable sizes. 7 for venture capital firms, a high irr was ranked at number 21 with a mean rank of 4.02 and a standard deviation of 1.33. 8 this assertion is also supported by the improved importance attached to the criterion “there will be no follow up investment required”, from a mean rank of 2.09 to a mean rank of 2.68. acknowledgements the development of this work for publication was supported by funding from the national research foundation (nrf). any opinion, findings and conclusions or recommendations expressed in this material are those of the authors and not of the nrf. the nrf accept no liability in this regard thereto. we also acknowledge the useful comments of two anonymous referees. any errors and omissions remain ours. references banerjee, a. 2008. private equity in developing nations. journal of asset management, 9:158-170. bellew, j., hutton, s. & dennehy, b. 2011. a q&a guide to private equity law in south africa. available at: http://incentives.practicallaw.com/4-376-4687 [accessed 2012-10-11]. bent, n., williams, k. & gilbert, e. 2004. the syndication of private 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incentive structures management 5 preparedness to take a significant financial risk management 4 a proven track record of success in the space management 5 manager/s personally known by us or our network management 4 risk capital in the business management 5 management are properly incentivized management 5 the management team is open for discussions and strategy meetings management 5 the ability to think strategically and operationally management 5 barriers to entry for competitors product 4 brand, ability to price lead product 5 product distribution network product 5 product barriers to entry product 5 reasonable entry pricing financial 5 investment used for growth capital financial 5 sustainable earnings financial 5 good history of predictable cash generation financial 5 history of good profits financial 5 flexible cost structure financial 4 established, stable market market 5 well-developed controls and financial disciplines other 5 added by venture capital respondents energetic management 5 realistic valuation expectation management 5 financially committed management 4 investment is not highly leveraged financial 4 esg plan in action, principles and practices other 4 governance and policy plans/reports other 4 276 sajems ns 16 (2013) no 3:258-278 appendix table a2 brief profiles of pe and vc firms that participated in the survey company fund names fund size min investment max investment start-up investment excluded industries aureos capital aureos africa health (2009) us$ 105 million us$ 1 million us$ 5 million no gambling, alcohol (excluding beer and wine), tobacco, and armaments aureos africa fund (2008) us$ 381 million us$ 5 million us$ 38 million (10% of fund) aureos southern africa fund (2003) us$ 50 million capitalworks investment partners (pty) ltd capitalworks private equity i r1,5 billion r70 million r450 million no oil and gas exploration capricorn capital partners (pty) ltd capricorn capital partners r600 million r10 million r150 million no mining coast2coast investments coast2coast r350 million r30 million (annual profit over r10 million) r300 million no niming, agriculture, technology collins private equity holdings p/l collins private equity r150 million nil r25 million no none remgro ltd kingdon zephyr pan-african investment part ners (paip) i us$ 123 million $ 10 million $50 million no defense, liquor, tobacco and gambling paip ii us$ 200 million lereko metier capital growth fund managers (pty) ltd lereko metier capital growth fund r3,5 billion r50 million r750 million no spirits and gambling rmb corvest rmb corvest open ended r4,44 billion (r2,19 billion in bee deals) r10 million r500 million no mining, agriculture and property vantage risk capital vantage mezzanine fund i r1 billion (with fund manager's coinvestment) r60 million r350 million (with coinvestment) yes primary agricultural, low margin trading business, businesses selling arms, loss making operational turnaround opportunities, junior mining businesses vantage captial mezzanine fund ii r1,85 billion trinitas private equity trinitas private equity fund r600 million r40 million r150 million no direct resources and property rmb private equity rmb private equity open ended r5,2 billion no rmb ventures open ended (in excess of r1 billion invested) r50 million r750 million mining, agriculture and property nedbank capital private equity nedbank capital private equity r1,2 billion r30 million r120 million no real estate, primary agriculture actis actis africa fund 1 us$ 396 million us$ 50 million us$ 200 / 250 million no military and gambling actis africa fund 2 and canada investment fund for africa (cifa) us$ 566 million actis africa fund 3 us$ 910 million actis africa empowerment fund us$ 50 million across africa acorn private equity acorn general fund one r60 million (first close) r 5 million r 50 million no property and mining general private equity (llp) r51 million acorn venture technology fund r 18 million (first close) no limit no limit yes technology (llp) r 9 million standard bank private equity (sbpe) private equity captive fund more than us$ 1 billion us$ 10 million us$50 million no financial services, real estate resources glenhove fund managers women private equity fund1 (wpef) r128 million r 5 million not more than 15% of committed capital in one investment no mining, real estate and gambling the fund is fully invested and is closed to new investment opportunities. sajems ns 16 (2013) no 3:258-278 277 vertical capital partners undisclosed undisclosed undisclosed undisclosed undisclosed biotech venture partners bioventures biotechnology and life sciences venture capital r 76 million r 2 million r 12 million yes all except biotechnology and life sciences bioventures undisclosed undisclosed undisclosed undisclosed undisclosed undisclosed cape venture partners undisclosed undisclosed undisclosed undisclosed undisclosed undisclosed invenfin invenfin fund i undisclosed none none yes property, gambling, franchise, licensee hasso plattner ventures africa hasso plattner ventures africa fund r 380 million r 5 million r 35 million yes property, mining and agriculture poweredbyvc (pty) ltd hbd venture capital r 138 million r 10 million r 25 million yes agriculture, armaments, alcohol, financial services, gambling, insurance, mining, real estate, tobacco as well as morally objectionable industries mecene investment mecene investment company us$ 50 million us$ 500 000 us$ 5 million yes non financial services treacle treacle fund ii r 463 million r 10 million r 92 million yes primary agriculture, real estate and resources source: profile information compiled from the savca matrix reports 2005-2012 and company websites appendix table a3 pe responses to open-ended questions with respective to the financial crisis question 1: with reference to any of the above categories or criteria, please describe any general changes that have taken place in the private equity industry over the last few years. in particular these should refer to changes pertaining to the recent financial crisis. question 2: with reference to any of the above categories or criteria, please describe any changes that have taken place in your firm over the last few years. in particular these should refer to changes pertaining to the recent financial crisis. question 3: in your personal view what are the major challenges facing the industry that have emerged from the financial crisis? 1 1. good leadership and experienced management teams were able to come through the downturns a lot better. therefore the importance of management quality has increased. 2. companies and investments are not seeking the same amount of leverage as before. lbo type deals have dried up. 1. more interaction with portfolio company management. 2. lower security of potential investments 1. finding the investment that has the potential for growth in their industry and that has the right structures in place to be a market leader. 2. confidence in alternative asset type financing needs to be rebuilt and more focus must be put on growing companies as opposed to using high levels of gearing in an attempt to gain returns through financial structuring as opposed to tangible growth. 2 pe has moved more towards the fundamentals on which it developed as an asset class with a greater trend towards growth investment as opposed to the buyout model. the ability to successfully partner management teams and add value beyond the capital invested has become more relevant. no change – [firm] established 2006 obviously the ability to pursue highly leveraged transactions has been affected. in addition, many potential investors have lowered their alternative asset allocations. the industry has been classed with a bad name as a result of some of the highly leveraged transactions that took place immediately prior to the crisis – this does result in opportunity however. 3 focus on cyclicality. focus on defensive sectors obviously high irrs with less leverage. difficulty in raising funds 4 a lot more opportunities have arisen in all sectors due to the down turn in the economy, allowing private equity to buy up more market share in varying sectors. there are a lot more opportunities to invest in but borrowing from the retail banks has become harder, so structuring of deals has become even more important with deferred payments, warranties etc. the major challenges are lack of debt funding, the competition commission and government regulation of more and more markets making it harder to get critical mass in any one sector. 5 the only impact we have felt from the financial crisis is that debt funding is harder to obtain and more expensive, limiting our ability to do heavily leveraged deals. none bank funding 6 as a minority equity investor that generally does not look to structured finance in its transactions, and focussing on africa, north of south africa, where very little credit is used (in general), the main changes we’ve seen over the last 3 years are valuation expectations by vendors. in 2008/2009, these were high compared with 2006/2007 years. often vendors and pe shops couldn’t get to as middle ground due to focussed on building a stronger team that has improved portfolio management capacity, as some investments require a lot of focus in an economic downturn. also revised the deal and team structure to get significant “eyes on a deal” to mitigate risk. in africa, more money chasing the same, or fewer deals, as growth metrics can be quite attractive relative to other emerging markets that had more credit facilities. e.g. south africa, central & easter europe. lp’s also becoming more demanding with regard to portfolio management and performance. the financial crisis has in some cases 278 sajems ns 16 (2013) no 3:258-278 unrealistic expectations. also, as pure equity provider, we have had access to opportunities that in more upbeat economic times would have gone to other funding sources (e.g. institutions/ipos/debt etc.) highlighted weaknesses in certain firms, which were previously hidden behind a bullish market. 7 there is general acceptance now that leverage alone should not be sufficient to generate private equity returns. the fund manager must add value to the business fundamentals and returns should be generated by growth and multiple expansion, not just by yield and leverage there is an increasing realisation that banks should lend and not make risky and/or illiquid proprietary investments. this has changed our prospective investor base and our competitive landscape as private equity is inherently illiquid, how do investors with liabilities, member choice or strategy changes justify continued investment in the asset class? the flight to liquidity must adversely affect long term equity risk taking 8 businesses are funded through more equity then debt than what was historically the case. sustainable earnings are now in question. need to look at different funding structures in comparison to the historical high leverage model. cost base of most companies too high for current level of activity. gearing levels need to reduce further. 9 sharp reduction in deals being completed due to increased difficulty in arguing a growth model for a business in difficult economic environment (rather than due to insufficient "dry powder") increased focus on tight covenant structures achievement of target returns (irr and x money) after significant losses on portfolios. underperformance of pe funds makes future fund-raisings more difficult. 10 deals are fewer due to continued buyer/vendor valuation gap, lower amounts of debt available to fund deals, increased equity commitments to make deals a reality. reduction in the absolute size of the portfolio as a form of risk mitigation. a new jerk reaction of regulators with various new regulatory proposals up for discussion. 11 no different from those changes impacting on the broader financial services/investment industries as previous as previous not everyone responded to the open-ended questions appendix table a4: vc responses to open-ended questions with respect to the financial crisis question 1: with reference to any of the above categories or criteria, please describe any general changes that have taken place in the venture capital industry over the last few years. in particular these should refer to changes pertaining to the recent financial crisis. question 2: with reference to any of the above categories or criteria, please describe any changes that have taken place in your firm over the last few years. in particular these should refer to changes pertaining to the recent financial crisis. question 3: in your personal view what are the major challenges facing the industry that have emerged from the financial crisis? 1 less appetite for risk. greater scepticism of projections and forecasts no longer interested in start-ups or early-stage. businesses must have critical mass and sufficient depth of management capital raising difficult, investors have greater need for liquidity. very difficult to forecast in face of uncertainty 2 there is no vc to speak of in sa. invenfin, with a small fund is the only one. hp is itc only. idc is "soft strategic". government and tia is not working and crowding out private sector. they need to stop taking equity. going slow none 3 there is increased risk averseness thus fewer early-stage deals will be funded. we have seen investors default and this has driven away many investors from the vc and private equity funds. we have gone from managing a vc fund to now managing a private equity fund. how do you fund start-ups? as most funds move to later-stages who will fund the early-stage? in particular who will fund high tech early-stage as these companies need the hand holding that vc provides. the other major challenge is finding investors! 4 the m&a market and the vc market outside sa has become more restricted and therefore offer less opportunities no changes were made more difficult exit opportunities 5 as the banks and other traditional finance providers became more conservative with their lending policies, entrepreneurs turn to alternative sources of finance, adding to an influx of vc deal flow. however, the number of south african vc transactions, as well as transaction values, decreased significantly over the past two years as vcs conserved capital by assisting portfolio companies to maintain a low cash burn rate (planning, cost cutting etc). it is also more difficult for sa entrepreneurs to obtain seed or start-up capital today as vc investors moved up the ladder towards laterstage developmentand expansion-type deals as a result of the recession. more conservative on doing new deals. more focus on steering the existing portfolio through the crisis. taking more risks at doing earlier stage deals. not everyone responded to the open-ended questions   204 sajems ns vol 4 (2001) no 1 is the south mrican business cycle time dependent? ashley g frank regent college. university of luton. united kingdom abstract this study is concerned with the south african business cycle and makes use of the hazard function to detennine the importance of duration for its analysis. this function gives the conditional probability that a state sustained through a previous period will end in the current one. the study estimates this probability for both economic downturn and expansion. at the 95 per cent confidence level, there is no statistical underpinning found for conventional ideas about the likelihood of an upturn or downturn in the economy over time. the duration of a business cycle does not help predict the turning point jele32 introduction thirteen times in the past fifty-three years, south african business has passed through a crisis. the list of crisis years [1947, 1950, 1953, 1956, 1959, 1961, 1965, 1967, 1972, 1977, 1983, 1986, 1993] (sarb, 1999) shows that the periods between successive crises have varied considerably in length. further, no two crises have been precisely alike and the differences between some crises have been more conspicuous than their similarities. it is not surprising then, that business long thought of crises as abnormal events brought on by some foolish blunder made by the public or the government (mitchell, 1923). longer experience, wider knowledge of business in other countries and better statistical data have gradually discredited the view that the crises are abnormal events, each due to a special cause. the modern view is that crises are but one aspect of recurrent business cycles. business cycles refer to short-run fluctuations in general prices which are characterized by business prosperity, recession, depression and recovery (james, 1958). statistically the term means two things (schumpeter, 1935): o that fluctuations of values of economic quantities in historic time, do not display haphazard increase or decrease, but rather recurrence of either these values themselves or values related to them, and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . samms ns vol 4 (2001) no 1 205 o that these fluctuations do not occur independently in every such time series, but always display their immediate or lagged association with each other. objective of the study this study seeks to answer the question as to whether the termination probabilities of a business expansion or contraction increase with age. market views such as "since the economy is bad this year, it will probably be better next year", tacitly imply that duration is a factor in judging the likely course of the economy. this paper investigates whether the assumption is valid for south africa. the concept of duration dependence may be illustrated quite simply. consider first a lottery: a person purchases a lottery ticket every month but has never won the first prize. is it more likely that he will do so next time, since he has been unlucky for so long? that is, does the probability he will get the frrst prize increase the longer he has been unlucky? obviously not, since each lottery is an independent event and the probability of winning the first prize is the same across the number of players (assuming one ticket per player), even though some may be frrst-time buyers and others regular players. thus the chances of winning at the lottery show no duration dependence. now consider a bingo game: there are 75 balls in a box. each ball bears a number, from 1 to 75. one ball is drawn every minute. after 25 balls have been drawn, ball number five is required for a call of "bingo". the probability that ball number five is drawn in the 26th draw, given that it has not appeared in the last 25 trials (minutes) is two per cent. the probability of a change in a players state from being unable to call "bingo" to winning in the 26 trial after 25 minutes is similarly two per cent. in the same way, the probability that ball number five is drawn in the 36th trial, given that it has not appeared in the last 35 trials, rises to 2.5 per cent. this probability rises to 3.33 per cent in the 46th trial, given it has not appeared in the last 45 trials. in this example. the probability that ball number five will be drawn increases the longer it fails to come up. this is an example of an event with positive duration dependence. several authors have recently modelled the business cycle as the outcome of a mitchell process that switches between two discrete states, with one of the states representing expansions and the other representing recessions. however, very different specifications have been adopted for the transition probability governing the movement of the economy between these two states. for example, neftci (1982) assumed that the transition probabilities were duration dependent; in particular, he contended that the longer the economy remained in one state, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 206 sajems ns vol 4 (2001) no i the more likely it was to change to the other. in contrast hamilton (1989) assumed that the state transition probabilities were duration independent so that, for example, after a long expansion (i.e., a long time in the expansion state), the economy was no more likely to switch to the recession state than after a short expansion. this is also the fmding of diebold and rudebusch (1989). to resolve the question of duration dependence of expansions and contractions in south africa, this study investigates the nature of the probability process that generates their length. of interest, of course, is the significance of the tendency of business fluctuations to maintain a fixed cyclical length. early on, irving fisher (1925) argued that business cycles had no such tendency, but rather resembled "monte carlo cycles", the phantom cycles of luck perceived by gamblers at a casino. similarly, to a casual observer of a repeated coin toss, runs of consecutive heads or tails may appear more likely to end as they grow longer, but the termination probability of a run actually remains constant as fisher (1925) would argue, "one may tabulate the number of consecutive heads in repeated trials and may fmd the average length of these runs, but there is no intrinsic clustering of run lengths or periodicity, in the process". it is precisely this interpretation of weak business cycle periodicity that this study tests as its hypothesis. bow business cycles are identified the south african reserve bank has identified the turning points of south africa's business cycle since 1946. these upper and lower turning points (or peaks and troughs) have generally been regarded as the reference turning points in the south african business cycle. pretorius et al. (1999) describe the combination of methods used in determining reference turning points: o first, the composite leading and lagging indicators are calculated (cf burns & mitchell, 1946). the composite leading indicator is calculated as a· weighted average of a selected number of individual economic indicators that have historically anteceded changes in general economic activity. similarly, the coincident indicator combines a selected number of economic indicators that have historically coincided with the business cycle (see table i). o second, a comprehensive composite index [called the current diffusion index) (cf broida, 1955) is compiled from the actual month to month percentage changes in each of 251 seasonally adjusted economic time series. these series cover economic processes such as production, demand, employment and income in different industries or sectors of the economy. the sectoral contributions are weighted according to their respective r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 207 contributions to aggregate value added. as these weights may change over time, the weight assigned to a particular sector is determined as the average of the relative contribution that sector makes to the total value of production for different sub-periods. o third, the same 251 series are used in calculating a historical difussion index, defmed as a measure of dispersion of the changes in a number of time series during any period (smit & van der walt, 1970). the sectoral weighting scheme is identical to the weighting structure of the current diffusion index. the turning point of the cyclical component of each series is determined. the value of the historical diffusion index is obtained by expressing the number of series which increase during any particular period as a percentage of the total number of series considered. q fourth, use is made of both survey techniques and a production function. in practice it has been found that surveys of business confidence in trade, manufacturing and mining; order volume in manufacturing; as well as of stocks in relation to demand in manufacturing and trade, produce series that lead the cycle (boyd & blatt, 1988). a production function tests the utilization of productive capacity in manufacturing and this has been found to produce coincident series (christiano, 1981). o finally, as the identification of a turning point is never a purely mechanical exercise, important economic events and developments occurring near a possible turning point are appraised to determine its exact date. gabisch and lorenz (1989) provide a comprehensive summary of methods used internationally. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 208 sajems ns vol 4 (200 i) no 1 table 1 composite business cycle indicators leading business cycle indicators overtime hours as a percentage of ordinary hours worked in manufacturing. physical volume of gold ore mined. opinion survey of business confidence: manufacturing, construction and trade. physical volume of mining production, excluding gold. opinion survey of volume of orders in maufacturing. number of new motorcars sold international business cycle indicator: industrial production. value of merchandise exports, excluding gold and agriculture. number of residential building plans passed. net number of new companies registered. number of real estate transactions. opinion surveys of stocks in relation to demand: manufacturing and trade. prices of all classes of shares. london gold price in rand company profits, after tax. coineldent business cycle indicators employment in manufacturing, mining and the construction sector. gross domestic product at constant prices, excluding agriculture. physical volume of manufacturing production: non-durable goods. physical volume of manufacturing production: durable goods. utilization of production capacity in manufacturing. value of wholesale, retail and motorcar sales at constant prices. value of imports at constant prices, excluding mineral products. lagging business cycle indicators employment in non-agricultural sectors. total number of hours worked by production workers in the construction industry. physical volume of mining production of building materials. value of unfilled orders as percentage of sales in manufacturing. commodity prices: percentage change value of fixed investment in machinery and equipment. over twelve months. ratio of output prices to unit labour costs in manufacturing. real mi money supply: percentage change over twelve months. net gold and other foreign reserves. . consumer credit at constant prices. 1tender treasury bill discount rate. source: van der walt and pretorius (1994) value of non-residential buildings completed. value of industrial and commercial inventories at constant prices. labour costs per unit of physical volume of manufacturing production. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no i 209 method a large statistical and econometric literature has addressed the interpretation of duration data, with wlemployment spell length receiving much of that focus (devine & kiefer, 1987). the papers by lancaster (1979) and nickell (1979) use the hazard function to develop behavioural models based on job search arguments. being reduced form results, they can serve to rule out a few potential scenarios but cannot distinguish between others, and hence there is dissent (atkinson & micklewright, 1985). more recently sichel (1991) used the technique to analyze post war us business cycles while diebold el al. (1994) focused on pre-war data. the central concept in these methods is not the wlconditional probability of an individual becoming wlemployed. but rather its conditional probability. that is, the probability of an individual leaving wlemployment in the tenth week, having been wlemployed for nine. of course, conditional and wlconditional probabilities are related, making the mathematical description the same in either case (kiefer, 1988). it is the conceptual difference rather, that is of importance in the business modelling of duration data. the special methods of duration analysis are useful and convenient ways of organizing, summarizing and interpreting data for which representation in terms of conditional probabilities is appealing (cox & oakes, 1985). the functions a(/) are hazard functions for random variables such as contraction or expansion in the business cycle, conveniently presenting a continuous-time version of a sequence of conditional probabilities. simply, a(t) is the rate at which spells will be completed at duration i, given that they last wltil t. a simple generalization of the exponential distribution, obtained by setting a = i, results in a two parameter distribution (y > 0, a > 0) with a hazard function, called the weibull hazard: a (t) = y a t a. i (1) matsuoka (1998), due to a limited number of observation points, made use of this approach in discussing sequential probability recursion of japanese business cycle data. the weibull can be conceptualized as an exponential distribution on a rescaled time axis. it provides a transformation of duration that is both exponentially distributed but dependent on more than just the value of y. the function is increasing in duration if a > i, decreasing if a < i and constant if a = i. alpha thus shows whether business cycles exhibit positive duration on time, with gamma being the starting value of the hazard function at time i for any given series. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 210 sajems ns vol 4 (2001) no 1 the lengths of expansions and contractions are as designated by the reserve bank business cycle turning dates. these durations (in months) are given in table 2 and provide the raw data for analysis. the table shows that on average expansions have lasted longer than downturns, but not markedly so. the difference in duration is only 1.4 fold compared with 2.1 fold for japan and 3.6 fold for the united states (matsuoka, 1999). the asterisked duration is ongoing to july 1999. the average duration excluded this observation. table 2 turning points and durations of business cycles in south africa trough peak trou2h expansion downturn 07/46 04147 9 04/47 11148 02/50 19 15 02/50 i 12151 03/53 22 15 03/53 i 04155 09/56 25 17 09156 i 01158 03/59 16 14 03/59 04160 61 13 16 08161 04/65 12/65 44 8 12/65 05167 12/67 17 7 12/67 12170 08172 36 20 08172 08174 12177 24 40 12177 08/81 44 19 03/83 06/84 03/86 is 21 03/86 02189 05/93 35 51 05/93 11196 ? 42 32 average duration 27 19 adapted from sarb (1999) in the weibull hazard, the density of a duration of length i may be written as 1(1,9). if an observation pool of n completed spells is available and each individual's spell is independent of the others, the likelihood function is: n l" (9) = n 1 (t;, 9) i=l (2) as usual. simply stated, the likelihood function is the joint probability distribution of the sample as a function of parameter 9. when a spell is censored, at duration tj for example, the only information available is that the duration was at least ij. thus the contribution to likelihood from that observation is the value of the survivor function, s(lj, 9), the probability that the duration is r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 211 longer than tt. let lit = 1 if the ktb spell is uncensored, lit = 0 if censored. then the likelihood function l(e) lnl· (e) is: n n l(a) = l d; inf(t;. a) + l (l-di) 1ns(ti. 9) (3) i =1 i =1 which has completed spells contributing to the density term f(ti, 9). using the fact that the density function is the product of the hazard and the survivor function, f(t, 9) a(t, e) s(t.9), and the fact that the log of the survivor function is minus the integrated hazard ins(t, 9) = (t, a), the log-likelihood function can now be expressed as in terms of the hazard function: n n l(9) = l d; in a{ti,e) l 1\ (t;, 9) (4) i =1 i =1 in practice it is usual to estimate the parameters by maximum likelihood. when the weibull hazard function expressed above is substituted in this equation, then the log-likelihood function for expansions in south africa (all spells complete) can be obtained using: n n n n lc(y,a.) = l iny + l ina. + (a.-i) l int; y l t{j. (s) i =1 i =1 i =1 i =1 the downturn since november 1996 in south africa is considered an incomplete spell (censored observation) hence its contribution to likelihood is the survivor and not the density function. the log likelihood function for downturns can be written as: n-l n-l n-l n ld(y, a.) = l lny + l ina. + (a.-i) l inti y l tt (6) i =1 i =1 i =1 i =1 for south africa, n=13 for post war expansion and n=14 for contraction. the parameters a. and y may be obtained through grid search. the negative inverses of the second derivatives of the log-likelihood function can be used as the asymptotic variances of a. and y. for downturns we get: ql=n:.l +n-1ind;-y n [ind;(dio)] (7) roa. l l r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 212 ~=-n:.l -y n [(in di dja ] 00. 2 a 2 l var (a") = {ifld / oa2 ia"y"r) var (y") = {&ld / ai i a"y"r) sajems ns vo14 (2001) no 1 (8) (9) (10) where a" and y" are the maximum likelihood estimates of a and y. in case of expansions in which we do not have censored observations (all durations are complete), the terms involving n-l are replaced with n. analysis and discussion table 3 summarizes results of the weibull hazard estimates obtained from maximum likelihood for both expansions and contractions. the most important parameter in the table is alpha, the slope of the hazard. for south africa's expansion, a is 1.2701 (with a standard error of 0.2292). the 95 per cent confidence interval ranges between 0.821 and 1.715. because this range includes 1, the likelihood of a > 1 and a < 1 can both be rejected. on this basis the probability of an expansion ending in south africa does not rise the longer the expansion lasts. similarly for downturns the likelihood of a > 1 or a < 1 can also be rejected. at the 95 per cent confidence level, alpha ranges between 0.714 and 1.554 and thus still includes 1. this suggests that in south africa, the probability of a recession ending does not rise the longer the recession lasts. table 3 estimated parameters in weibuu function alpha gamma expansion downturn expansion downturn maximum 1.2701 1.1338 0.02908 0.04341 likelihood standard 0.2292 0.2143 0.0081 0.0120 error table 4 summarizes a series of hazard function values for different month durations, that is, the conditional probability that a turning point has arrived this month given it had not arrived by the previous month. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no i 213 table 4 hazard function conditional probabilities months 10 20 30 40 so 60 70 80 90 100 ex0.069 0.083 0.093 0.1 0.106 0.112 0.116 0.121 0.125 0.128 pand prob. conti 0.067 i 0.073 0.078 0.081 0.083 0.085 0.087 0.088 0.090 ! 0.091 ract i prob. manipulating the table above by interpolation shows that the hazard function for upturns in the 27th month is nine per cent, although this has been the historic average duration. comparing this to the hazard function for, say, the 50th month shows that there is only a 1.3 percentage difference or hardly any change in probability, this as a = 1.2701 is extremely close to 1. while the table does suggest that the hazard rises slowly to the right with time, as the confidence interval is extremely wide, it is not possible to conclude that a > l. similarly, the hazard function for contractions in the 19th month results in a probability of only 6.7 per cent, although this has also been the historic average duration. comparing this to the hazard function for the 50th month shows only a 1.6 percentage difference, being an extremely small change in probability over a rather considerable change in duration. again the hazard function does slope gradually to the right but this is not statistically significant. implications for further research if it is postulated that government and the reserve bank have the power of counter-cyclical macroeconomic policy, which aims at smoothing out business fluctuations, the result of this intervention should be longer periods of expansion and shorter periods of recession. if such a policy was effective the alpha for expansion would be smaller and that for recession larger, meaning that expansions lengthen in time. the hazard function would show greater time independence (posting results closer to a 1). similarly as recessions would end in a shorter time, the hazard function should show an increasingly positive duration dependence (a > i). in south africa a greater alpha value for expansions rather than contractions suggests that this has not been the case. george (1998) described the two purposes of central banks, monetary and financial stability, as being "inextricably bound up with each other". is it possible that the unexpected hazard function values arrived at, point to a more structural weakness on the part of the reserve bank, such as its historic r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 214 sajems ns vol 4 (2001) no i preoccupation with defending the currency at the expense of sustainable growth? further research into this question would be welcome. references atkinson, a.b. & mlcklewright, j. (1985) unemployment benefits and unemployment duration: a study of men in the united kingdom in the 1970s, london school of economics and political science: suntory-toyota international centre for economics and related disciplines. 2 boyd, i., & blatt, j.m. (1988) investment confidence and business cycles, new york: springer. 3 broida, a.l. (1955) "diffusion indexes", the american statistician, 9: 7-16. 4 burns, a.f. & mitchell, w.c. (1946) measuring business cycles, national bureau of economic research: studies in business cycles no 2. cambridge, mass.: nber 5 chrlstiano, l.j. (1981) a survey of measures of capacity utilization, imp staff papers, 28: 144-98. 6 cox. d.r & oakes, d. (1985) analysis of survival data, london & new york: chapman & hall. 7 devine, t.j. and kiefer, n.m. (1987) empirical labor economics in the search framework, manuscript, cornell: cornell university. 8 diebold, f.x. & rudebusch, g.d. (1989) "scoring the leading indicators", journal of business, 62: 369-91. 9 diebold, f.x., glenn, d. & sichel, d.e. (1994) "further evidence on business-cycle duration dependence in stock", j.h. & watson, m.w. (005.) business cycles, indicators and forecasting, chicago: university of chicago press. 10 fisher, i. (1925) "our unstable dollar and the so-called business cycle", journal of the american statistical association, 20: 179-202. ii gabisch g. and lorenz, h.w. (1989) business cycle theory: a .. survey of methods and concepts (2nd ed.), berlin: springer-verlag. 12 george, e.a.j. (1998) "maintaining financial stability", south african journal of economic and management sciences, i: 192-203. 13 hamilton, j.d. (1989) "a new approach to the economic analysis of non-stationary time series and the business cycle", econometrica, 57: 357-84. 14 james, c.l. (1958) principles of economics, new york: barnes & noble. 15 kiefer, n. m. (1988) "economic duration data and hazard function" journal of economic literature, 26: 646-79. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 215 16 lancaster., t. (1979) "econometric methods for the duration of unemployment", econometrica, 47: 939-56. 17 matsuoka, m. (1998) "prediction of business cycle turning points: an application of sequential probability recursion", simulation, 13: 3-13. 18 matsuoka, m. (1999) time alone won't heal the economy, economics research, japan, tokyo: jardine fleming. 19 mitchell, w.e. (1923) business cycles and unemployment, cambridge, ma.: national bureau of economic research. 20 neftci, s.n. (1982) "optimal prediction of cyclical downturns", journal of economic dynamics and control. 4: 225-41. 21 nickell, sj. (1979) "estimating the probability of leaving unemployment", econometrica. 47: 1249-66. 22 pretorius, w.s., venter., j.e. & weiderman, p.j. (1999) "business cycles in south africa during the period 1993-1997", quarterly bulletin, march, south african reserve bank: pretoria. 23 sarb {south african reserve bank] (1999) business cycle data, pretoria: sarb. 24 schumpeter., j.a. (1935) "the analysis of economic change", the review of economic statistics, 17: 2-10. 25 sichel, d.e. (1991) "business cycle duration dependence: a parametric approach", review of economics and statistics, 71: 254-60. 26 smit, d.j. and van der walt, b.e. (1970) "business cycles in south africa during the post-war period. 1946 to 1968", quarterly bulletin. september, south african reserve bank: pretoria. 27 van der walt, b.e. and pretorius, w.s. (1994) ''notes on the revision of the composite business cycle indicators", quarterly bulletin. september. south african reserve bank: pretoria. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vo14 (2001) no 2274 consumer socialization agents for young children: an exploratory study ernest north and brenda poggio department of marketing and communication management, university of pretoria abstract although marketers in south africa are beginning to realise that the youth market is a segment that cannot be ignored, only a limited number of studies have thus far been conducted to examine the consumer behaviour of children. the relevance of this topic to south african marketers suggests the need for research in this field. the purpose of this article is to report the findings of an exploratory study conducted to determine the role or influence of consumer socialization agents in the buying behaviour of primary school children, 9-11 years of age. a broad overview of the nature and processes of consumer socialization is provided, as well as of research conducted in this field over the past few decades. some important marketing implications are also suggested. jel 329 'much consumer behaviour is performed under the influence of others. the very foundation of human behaviour is learning from others. james mcneal, 1973. introduction scholarly research examining the consumer behaviour of children dates back to the 1950s. although much has been said and written about the development of children as consumers, not all of this material is based on solid research. the lack of systematic research that examines factors such as children's preferences, spending patterns and how they influence family decision-making, can be ascribed to the fact that marketers may think that it is inappropiate to regard children as a "market" (mcneal in stipp, 1988); or that people do not consider children to be important enough to warrant expensive research. children are difficult to study, and empirical findings on those in the elementary school phase, 6-12 years of age, in particular are scarce. they are unreliable reporters r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 275 sajems ns vol 4 (2001) no 2 of their behaviour and feelings, find it difficult to understand abstract questions and have poor recall (stipp, 1988). mcgee (1997: 53) is of the opinion that research with children is ..... an even newer idea than selling things to them." today's children live in a mpidly changing technological world, and have different perspectives on things. a different approach and new kinds of qualitative research must therefore be employed to understand the consumer behaviour of children, and to ascertain the reasons why they feel and act the way they do. in the south african context, a limited number of studies have thus far investigated the consumer behaviour of children. these studies include focus groups .with children to determine, inter alia, the influence'of advertising on their consumer socialization (north, 1987) and their understanding of television advertisements and the influence thereof on their buying decisions (cardwellgardner & bennett, 1999). the advancement of a better life and future for children in south africa is a matter of great concern for the present government. the question arises whether marketers are taking cognisance of this change in the social environment, and whether it is reflected in their marketing strategies. the dramatic changes that have recently taken place in south africa have generated many new marketing opportunities. the redistribution of income and mpid westernization of black south africans is of special interest to south african marketers. they, like their counterparts in other countries, are beginning to realise that the youth market is a segment that cannot be ignored. furthermore, the changing social climate also reveals the relationship between advertising strategy and the environment. marketers in south africa are being challenged to adapt their marketing and advertising strategies to fit in with the new environment created by post-apartheid changes. the limited number of studies of the consumer behaviour of children and the relevance of this topic to south african marketers suggest the need for further research. the purpose of this article is to report the fmdings of an exploratory study conducted to investigate the role or influence of consumer socialization agents in the buying behaviour of primary school children, 9-11 years of age. a broad overview will be provided of the nature and processes of consumer socialization and the research conducted in this field during the past few decades. a number of important marketing implications will also be discussed. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2 276 background and historical overview consumer socialization children move through various cognitive and social phases on their journey from birth to adolescence and adulthood. consumer socialization (which is only a part of a child's general socialization) is described as "the processes by which young people acquire skills, knowledge, and attitudes relevant to their functioning as consumers in the marketplace" (ward, 1974: 2). although mcneal (1993) sometimes refers to it as "consumer education" or "consumer development", ward's description of the concept can be regarded as a universally accepted definition (john, 1999; carlson & grossbart, 1994). john (1999) views consumer socialization as a process that occurs in the context of social and cognitive development as children move through three stages of consumer socialization, namely the perceptual stage (3-7 years), the analytical stage (7-11 years), and the reflective stage (11-16 years). children partcipate in many activities during the process whereby they acquire basic consumer skills. according to mcneal (1993), children pass through the following five-stage learning process in their consumer development: stage i: observing. this first stage is the child's initial interaction with the marketplace. mothers usually take their infants to shopping malls and stores where they make sensory contact with the shopping environment. mcneal's (1993) studies show that the median age here was two months, but answers ranged from one to 33 months. stage 2: making requests. during this phase, children make requests (by pointing, gesturing and even making statements) to parents that they see something they want. these requests are made mainly when they are in the presence of store objects. in the latter part of this phase they make requests for objects at home, probably because of the stimulation by television advertisements. stage 3: making selections. when children start walking (3-4 years of age), they experience their first physical contact as consumers by choosing an article and taking it from the shelf. they sometimes wander through the store by themselves. factors such as the layout of the store, displays and even packaging are becoming important at this stage. slage 4: assisted purchases. almost from birth, children regularly witness their parents and other shoppers giving money in exchange for goods. these scenes give meaning to the money children receive from their parents or grandparents. this contributes to the child's understanding that the store owns the goods and money is the medium of exchange. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 277 sajems ns vol 4 (2001) no 2 stage 5: making independent purchases. the fifth and final step in the development of consumer behaviour is performing independent purchases without parental assistance. there is usually a significant time lag between a child's first purchase with parents and an independent purchase without them (mcneal & yeh, 1993). it is not until the age of eight that children begin to make purchases on their own. according to sheth, mittal and newman (1999: 587), consumer socialization occurs when one or more of the following are learned or acquired by children: "... preferences among alternative brands and products; knowledge about product features and the functioning of the marketplace; and skills in making 'smart ~ecisions' ... ". the theory and published literature fo\:us largely on the consumer socialization of children. engel, blackwell and miniard (1995), however, state that it should be recognized as a lifelong process. consumer socialization agents the learning of consumer behaviour patterns (consumer socialization) by children has been of interest to researchers since the end of world war 2. prevey (in mcneal, herndon & yeh, 1993) reported that children who receive financial training from their parents are better able to use financial resources later in life. in the 1950s and 1960s, other pioneers such as guest, mcneal, berey and pollay (in john, 1999) started to examine factors related to the consumer behaviour of children. the topics investigated include children's understanding of marketing and retail functions, brand loyalty and the influence of children in family decision-making. specific studies on the influence of consumer socialization agents in children's buying behaviour were apparently missing in these early years of research. according to moschis (1987), socialization agents are the persons and organizations involved in the orientation and education as consumers such as family members, peers, mass media, schools and retailers. the stage was thus set for more widespread research on children, specifically the consumer socialization process of children. john (1999) states that research in this field blossomed and gained momentum in the mid-1970s. scott ward's (1974) article entitled "consumer socialization" which was published in the journal of consumer research, forcefully argued for studying children and their socialization into the consumer role. this gave focus to a new generation of researchers and an emerging field of research in the field of consumer socialization and the role of socialization agents in children's development as consumers. ward's work opened up a stream of research in this field, including topics such as children's knowledge of products, advertising, pricing, and decision-making strategies. of particular importance to this review are the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2 278 studies that focused on children's knowledge about and influence of the family and retail shopping experiences (as socialization agents) on children's development as consumers. excluded here are research by economists and psychologists pertaining to children's knowledge of money values and their consumption of products such as cigarettes and alcohol (john, 1999). the family can be regarded as the primary source (agent) of consumer socialization. hawkins, best and coney (1998: 203) state that parents teach their children consumer skills both deliberately and casually through instrumental training, modelling and mediation. instrumental training occurs, for example, when a parent tries to teach a child to eat a certain snack because it has nutritional value. modelling occurs when a child learns appropriate (or inappropriate) consumption behaviours by observing others (for example parents who smoke). mediation occurs when a parent alters a child's initial interpretation of or response to a marketing stimulus (for example an advertisement depicting a situation in which a child will be rewarded with a snack for good behaviour). a study by mcneal (1993) revealed that children's consumer socialization is greatly enhanced by retailers who act as socialization agents. they learn many consumer skills while visiting shops, supermarkets and shopping malls. the supermarket is normally the first shop children visit. in many cases this is also where they make their first purchase requests and self-selection of a product. children soon perceive a shop as "child-friendly" and these shops help to form impressions that guide them in their future shopping behaviour. table. i lists examples of studies conducted in the past three decades on the family and retailers as consumer socialization agents (john, 1999). cross-cultural marketing research has recently grown in popularity. it is interesting to note that this kind of research also features in studies on the consumer socialization of children. recent studies by mcneal, herndon and yeh (1993), mcneal and ji (1999), and lee and marshall (1998) are worth noting. findings of the mcneal studies indicate that hong kong children's patterns of consumer behaviour are becoming increasingly similar to those of us children. chinese children utilise their parents and retail outlets as important agents for socialization, especially to gain information in order to learn more about new products. mcneal and ji (1999) report that chinese children from the age of nine upwards make two or more shopping visits to two or more stores a week, and consequently develop store preferences. the lee and marshall study found that new zealand children exert more influence on family decisionmaking than singaporean children. new zealand families are also more democratic in their decision-making than singaporean families. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 279 sajems ns vol4 (2001) no 2 table 1 studies on socialization agents 1970-1993 author(s) atkin, c.k. belch, g., belch, m. & ceresino, g. bums, a. & gillett, p. carlson, 1. & grossbart, s. haynes, j., burls, d., duke, a. & cloud, r. hempel, 1. isler, 1., popper, e. & ward, s. mcneal,j. moschis, g. & moore, 1. popper, e. topic observation of parent-child interaction in supermarket decision-making. parental and teenage influences in family decision-making. antecedents and outcomes of the family purchase socialization process for a child's toys and games. parental style and consumer socialization of children. year 1978 1985 1987 1988 consumer socialization of pre-schoolers 1993 and kindergarteners as related to clothing consumption. family buying decisions: a cross1974 cultural perspective. children's purchase requests and 1987 parental responses. children's perceptions of retail stores. 1981 family communication and consumer 1979 socialization. mother's mediation of children's 1979 purchase requests. the literature study revealed that very little research has been done on the role of the school as a socialization agent. however, one south african study focused on the school's role in educating young children as consumers (north, 1998). the aim of this curriculum development project was to introduce a new subject into the school curriculum. a draft core syllabus for this "new subject" (economic education) was compiled, and some of the objectives explicitly stated that pupils need to gain knowledge and skills in order to become skilful consumers. they also need to manage their own money matters responsibly. method sampling in order to gather information on the role of the family and retail shopping experiences as consumer socialization agents for children in the foundation school phase, three focus group interviews were conducted with 18 children (six r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2 280 per group). a list of all primary schools in the pretoria region served as the basis for the sampling procedure. a non-probability convenience sample resulted in the selection of a primary school in the eastern suburbs of pretoria. the specific school was selected because it represented a balanced blend of language, gender and ethnic diversity. the teachers were asked to select children between the ages of nine and ten. the children in the sample were old enough to fonn particular opinions about family decision-making, and children of that age have the potential to provide data because they are still shopping with their mothers (mcneal, 1993: 34). the focus groups were conducted at school because it was the easiest way to reach the children, and they were also in a familiar environment. personal interviews were also conducted with ten mothers of children in the above-mentioned age group. the researcher made sure that this convenience sample did not include mothers of the 18 children who constituted the focus groups. the reason for this decision was that a degree of bias may be present if only the mothers of some of the children who were interviewed, were also interviewed. the reason for including mothers in the study is that children spend a lot of time in shops with their mothers who play a primary role in the consumer socialization of their children. data couection the researcher and an experienced moderator conducted the focus group interviews with the children in an isolated classroom, a discussion list or interview guide containing relevant topics guided the interviews. great care was taken in compiling the list to ensure that the research questions or objectives were met. the interview guide contained the following topics that supplied the basis from which questions were asked: introduction of the topic (family decision-making and shopping) general questions on advertising, money and shopping habits the influence of the family (parents and siblings) on product and outlet selection and joint decision-making guidance or teaching by parents relating to shopping and consumer education shopping centres, shops (kinds, preferences, shopping experiences and children's proposals for improvements to shops and shopping malls) the value or influence of retailers on consumer education an audiotape recorder was used to record the participants' feelings and ideas, and later transcribed for closer evaluation and analysis. the discussion list contained open-ended fonnat questions, the moderator was also free to explore r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 281 sajems ns vol 4 (2001) no 2 comments and issues raised by members of the group. challenges faced during the sessions were to encourage the shy children to speak up and prevent the "know-it-all" from dominating the group. all of the children were given an equal chance to respond, thus ensuring even participation of the whole group. the moderator, who had the necessary knowledge and experience to deal with small children, helped the group to work together well, despite the level of immaturity and impatience of the children. described as "a conversation with a purpose" (marshall & rossman, 1995: 80), the personal interviews with mothers were the second of the three methods employed in this study. the researcher conducted the interviews in an informal manner with the mothers in the comfort of their homes. the discussion list used in the interviews with children served as a framework for the interviews with the mothers. in order to make the assumptions in this study more objective, the interview data obtained from the children and the mothers were triangulated with the data gathered by means of a third method, namely the technique of picture drawing. according to mcneal (1992: 216), obtaining information from children through drawings has been standard practice among psychologists for a century. it is now becoming standard practice among marketing researchers as well. valuable insights can be gained through this technique because children sometimes have limited language abilities, or struggle to transmit what is on their minds. when children draw a picture, it reflects their non-verbal information on a particular topic that is stored in their minds. this could give marketing researchers reasons why a child likes and selects certain products, stores or shopping centres. sometimes children have the tendency to become bored quickly, thus making the moderator's task of gathering information difficult. however, they respond eagerly and positively when asked to draw a picture. the 18 children who participated in the focus groups were asked to "draw what comes to your mind when you go shopping". findings notes taken during the sessions by the moderator and the researcher, as well as the transcribed audio tapes, were studied, interpreted and systematically categorized in order to arrive at meaningful and valid research results. the pictures drawn by the children were also carefully scrutinized and discussed by the researcher and the moderator. the main findings that contribute to the achievement of the research objectives are summarized below. the findings r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2 282 presented correlate with the topics listed in the interview guide discussed previously. introduction: all the children were exited about discussing the topic of shopping and family decision-making, because they love shopping and it is something they are involved in regularly. remarks made by the mothers and the colourful drawings confirmed this finding. one mother, however, did not like shopping at all. general questions: children tend to watch a lot of television. however, it was noted that they are beginning to replace tv watching with computer playing. a few mothers were concerned about the possible negative influence of computer games and children surfing the net. most children have their own money and a few even save some of it in a bank. they could not answer the question why they save money. it is assumed that they do so because their parents make suggestions in this regard. parents allow their children to spend money on sweets, toys, and books or comics. children understand the role of advertising. two of the boys thought that most advertisements lie (probably because they heard this from their father or an older sibling). fami(v decision-making: in the majority of cases, mothers select the shopping centre, especially if they have more than one child to accommodate. sometimes mothers with one child will allow the child to select a shopping centre, especially where the child has to buy something he or she needs for a school project. a degree of conflict occurs only when children insist on buying a specific item in a shop, normally as a result of peer pressure. the value of consumer socialization (education) in these cases was highlighted by the mothers who saw this as an opportunity to teach children consumer skills, for example looking at quality and price before buying. girls exert a greater influence than boys when it comes to selecting clothes. an interesting fact was that not one of the respondents in the two samples considered or referred to the fact that older brothers or sisters play a significant role in the consumer socialization of younger children. future research in this area may be of value to marketers. consumer education by parents: the children consider the role of the parents "to teach them important stuff about buying" in the same light as "telling us to brush our teeth before going to bed at night." the mothers who were interviewed, however, had different views on this matter. some said that fathers should also be involved, others expect the school to do the job, while others again (the majority) felt that it is a joint effort of both parents and the school. this part of the discussion revealed clearly that different family types (husband-dominant, wife-dominant, joint/syncretic, individualized, or child-dominant), and even the size, age and family life cycle are factors that have an influence on the consumer socialization of children (hawkins, best & coney, 1998). the mothers agreed that they r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 283 sajems ns vol 4 (2001) no 2 should teach their children not to spend money on "rubbish" and not to become "shopaholics". shopping experiences: the analysis of the pictures drawn by the children revealed some interesting facts about their feelings and experiences as shoppers. the following points were clearly highlighted by the children in their drawings: they appear to be happy, enjoying themselves, have big smiles and are content with themselves. the mothers were depicted in most of the cases, and trolleys were present in almost all the drawings. the products most commonly shown were toys, books, sweets, and clothes. one girl's picture included a sign saying "sale". children like to go shopping where they can see new things. during the personal interviews a fe:w mothers mentioned that their children do not like to go shopping where it is hot or too crowded. when asked what extra features should be added to our shopping malls, the children suggested a gym, swimming pool, mini amusement parks and even learning centres. it should be noted that these suggestions were made mainly by children who had visited overseas shopping malls. one mother mentioned that she was prepared to pay for it if shopping malls had a nursery where children could be looked after. role of retailers in consumer socialization: the participants in the two samples did not respond satisfactorily when questions were asked or discussions introduced by the interviewers about the role of retailers in the consumer education of children. none of the pictures drawn by the children depicted anything that showed children or their mothers interacting or communicating with store personnel. the reason for this is not clear, and is a possible topic for further investigation. discussion and conclusions the execution and results of this exploratory study confirm that it is a challenging task to research children. marketers and researchers who wish to get "inside childrens' heads" should note that today's children are completely different from children, say, ten years ago. according to liebeck (1998) children are now more knowledgeable they have increased access to information and a greater knowledge and understanding of today's issues. they are truly the internet generation; and get their news and information primarily from television. today's children also have disposable cash and visit multiple store formats every month. they understand the marketing and advertising campaigns presented to them. they are, however, rooted to home their family is still their most important social group. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2 284 the sample of only 10 mothers who participated in the personal interviews as well as the diverse answers and opinions given by them on certain topics, indicate that far more research needs to be done in this field. unfortunately both the samples in this study included only white respondents. the transformation taking place in south africa at present, stresses the need for a more multicultural research approach. conducting research with children is possibly also hampered by the fact that some segments of society see children as vulnerable and in need of protection from marketing research. in this particular study, not all parents gave permission for their children to participate in the focus groups. out of 26 pupils in one class, only 16 were allowed to participate. mcneal (1993: 39) is of the opinion that a " ... lifetime customer may be worth 1 00 000 dollars to a retailer. it is well worth to understand and anticipate the needs and desires of even the smallest consumers." little evidence could be found in this study to show that mothers and children consider the role of the retailer important in the socialization of children. this underlines the need for further research in this regard. mcneal (1999) reported that 68 per cent of a sample of retail chains attempt to target children as consumers with shopping facilitators, consumer education and promotion, and also train store personnel to serve children. marketers and researchers are therefore compelled to use different methods to glean information about the feelings, attitudes and perceptions of children, relating to marketing activities. mcgee (1997) mentions alternative ways to gather information from these special consumers, for example observational research, telephone and online focus groups and consumer panels. references cardwell-gardner, t. & be1\'nett, j.a. (1999) "television advertising to young children: an exploratory study", paper presented at the 1999 imm marketing educators conference, september: 22-4. 2 carlson, l. & grossbart, s. (1994) "family communication patterns and marketplace motivations, attitudes, and behaviours of children and mothers", journal of consumer affairs, 28( 1): 25-54. 3 engel, j., blackwell, r. & miniard, p.w (1995) consumer behavior (8 th ed.) harcourt brace college publishers, florida. 4 hawkins, d.l., best, r. & coney, k.a. (1998) consumer behaviour. building marketing strategy (7th ed.) mcgraw-hill, boston. 5 john, dr (1999) "consumer socialization of children: a retrospective look at 25 years of research", journal of consumer research, 26(3): 183-237. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 285 sajems ns vol 4 (2001) no 2 6 lee, c.k. & marshall, r. (1998) "measuring influence in the family decisionmaking process using an observational method", qualitative market research: an international journal, 1(2): 88-98. 7 liebeck, l. (1998) "the customer connection: children under 13", discount store news, october: 55-7. 8 marshall, c. & rossman, g. (1995) designing qualitative research (2nd ed.) sage publications, london. 9 mcgee, t. (1997) "getting inside kids' heads", american demographics, 19(1): 53-7. 10 mcneal, j.u. (1973) an introduction to consumer behaviour, wiley, new york. 11 mcneal, j.u. (1992) kids as customers, lexington books, new york. 12 mcneal, j.u. (1993) "born to shop. (children's shopping patterns)", american demographics, 15(6): 34-9. 13 mcneal, j.u., herndo, n. & yeh, c. (1993) "a study of children's consumer socialization over a five-year period: income, spending and saving", asia pacific journal of marketing and logistics, 5(4): 48-62. 14 mcneal, j.u. & yeh, c. (1993) ita cross-cultural study of children's consumer socialization in hong kong, new zealand, taiwan, and the united nations", asia pacific journal of marketing and logistics, 5(3): 56-69. 15 mcneal, j.u. & ji, m. (1999) "chinese children as consumers: an analysis of their product information sources", journal of consumer marketing, 16(4): 345-64. 16 moschis, g. (1987) consumer socialization: a life style perspective, lexington books, ma. 17 north, ej. (1987) multistapnavorsing oor kinders in reklame, unpublished dcom dissertation, university of south africa. 18 north, ej. (1998) "catch 'em young: developing a culture of entrepreneurship among children", paper presented at the 1998 saesba conference, may 27-29. 19 stipp, h. (1988) "children as consumers", american demographics, 10(2): 26-33. 20 sheth, j., mittal, b. & newman, b. (1999) customer behavior: consumer behavior and beyond. dryden press, new york. 21 ward, s. (1974) "consumer socialization", journal of consumer research l(september): 1-14. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract context and significance of the study research question literature review the international accounting standards board’s international financial reporting standards 3 post-implementation project methods results conclusion acknowledgements references appendix 1 appendix 2 appendix 3 footnotes about the author(s) gary k. marques school of accountancy, faculty of commerce, law and management, university of the witwatersrand, johannesburg, south africa warren maroun school of accountancy, faculty of commerce, law and management, university of the witwatersrand, johannesburg, south africa robert garnett school of accountancy, faculty of commerce, law and management, university of the witwatersrand, johannesburg, south africa citation marques, g.k., maroun, w. & garnett, r., 2020, ‘challenging the accounting for goodwill in the context of a business combination’, south african journal of economic and management sciences 23(1), a3255. https://doi.org/10.4102/sajems.v23i1.3255 original research challenging the accounting for goodwill in the context of a business combination gary k. marques, warren maroun, robert garnett received: 10 july 2019; accepted: 17 feb. 2020; published: 28 may 2020 copyright: © 2020. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the accounting for goodwill under the international financial reporting standard 3 has become generally accepted as a basis for providing useful information to users of financial statements. however, the international accounting standards board has conducted a review of the international financial reporting standard 3, the focus of which is on the revision of the accounting for goodwill. aim: this article adds to the discussion on the accounting for goodwill by examining its characteristics and considering how these can be used to inform changes to its recognition and measurement. setting: the principles of neoliberalism and stewardship, widely regarded as key drivers of developments in financial reporting, are used to frame the accounting for goodwill. method: the research method makes use of correspondence analysis which is a method used to explain complex relationships in a simple diagrammatic manner. in the case of this article, the correspondence analysis is used to show how characteristics of goodwill interact with principles of neoliberalism and stewardship to reveal different perspectives on the accounting for goodwill. the sample selected was 55 chartered accountants, chartered financial analysts and business owners. the chartered accountants are in practice and academia. the reason for this is to give both an academic and practical perspective on the appropriateness of the accounting for goodwill. the reason for the inclusion of the financial analysts and business owners was to enrich the opinions received. results: the research finds that the accounting for goodwill needs revision. conclusion: a hybrid accounting model is revealed that proposes that goodwill be recognised as an asset in its own right (neoliberalism) and that it be amortised and the recognition of the effect of inefficient negotiation of the purchase price be recognised in profit or loss (stewardship). keywords: accountability; correspondence analysis; goodwill; neoliberalism; stewardship. context and significance of the study international financial reporting standard 3: business combinations (ifrs 3) requires goodwill arising in a business combination1 to be recognised as an asset (ifrs 3 2009). the goodwill is not amortised but is tested for impairment at least annually. any impairments are recognised in profit or loss and cannot be reversed (ifrs 3 2009). while this accounting treatment has become the generally accepted basis for providing useful information to users, it is not without criticism. there are a number of examples that challenge the assumption that goodwill is an asset or question inconsistencies in the initial and subsequent measurement of goodwill and other types of assets (baldi & trigeorgis 2009; ellis 2001; eloff & de villiers 2015; negash 2003). a fairly large body of work has also considered if goodwill is value relevant (al jifri & citron 2009; lee, kim & yoon 2013), the appropriateness of the models used to identify and measure subsequent impairments (see huikku, mouritsen & silvola 2017; lee 2011) and whether or not goodwill should be amortised, contrary to the requirements of ifrs 3 (martínez & rubio 2018). in addition to the accounting treatment being challenged by researchers and academics, in may 2016, the international accounting standards board (iasb) met to discuss the post-implementation findings on ifrs 3. the major finding that was highlighted was with regard to goodwill and its impairment (iasb discussion paper 2016). the iasb collected data from preparers of financial statements who raised concerns around three key areas, namely the complexity of the impairment requirements, amortising goodwill to solve communication issues to users and identifying other intangible assets from goodwill. these will be discussed in more detail later in the article (iasb discussion paper 2016). in this study, we turn to the core principle of accounting for transactions and balances to reflect economic substance. our aim is to identify the essential features or characteristics of goodwill arising in a business combination and consider how these should inform the recognition and measurement of goodwill. this is done using stewardship or neoliberalism as theoretical frameworks to form an opinion on how goodwill could be accounted by examining it directly rather than following the more commonly used approach of drawing inferences about goodwill based on its value relevance or how it is subsequently tested for impairment (see lee 2011; kim, lee & wook yoon 2013; ramanna & watts 2012). the choice of theoretical framework is informed by the fact that tensions between accountability and neoliberalism have been identified as a defining feature of the development and application of contemporary accounting standards (see, for example, murphy, o’connell & ó’hógartaigh 2013; ram, maroun & garnett 2016; ravenscroft & williams 2009). examples include: changes to the conceptual framework issued by the iasb (whittington 2008) and the proliferation and application of fair value measurment (durocher & gendron 2014; zhang & andrew 2014). nevertheless, to the researchers’ knowledge, examples on how an alignment with either an accountability or a neoliberal agenda influences accounting treatments at the level of individual classes of assets or liabilities are rare (see murphy et al. 2013). consequently, an examination of the accounting for goodwill and how this accounting might change depending on the whether or not an accountability or neoliberal framework is applied offers an excellent opportunity for illustrating how theory can be used to inform normative reccomemdations for accounting for a specific type of asset. this should be relevant for both the academic and practitioner community especially because of the article’s chosen method. research question the research question that arises is whether the current accounting for goodwill, in the context of a business combination,2 achieves relevance and faithful representation. the reason for this is that there is a large body of published literature that challenges the current accounting practice. in addition, the iasb is in the process of developing revised accounting practices for goodwill. in this context, the researchers find it relevant to research whether preparers, academics and auditors are of the opinion that goodwill achieves relevance and faithful representation. literature review in this section, the prior literature, dealing mainly with the definition and measurement of goodwill, is examined to identify characteristics of goodwill. these serve as row headings (labelled ‘r’) in the correspondence analysis (see appendix 1). the theoretical framework is presented in the ‘accounting policies’ section. principles of stewardship (also referred to as accountability) and neoliberalism are used to derive accounting policies for goodwill which serve as column headings (labelled ‘c’) in the correspondence analysis.3 the interaction between the elements of goodwill (row headings) and possible accounting treatments (column headings) is used to examine alternate views on how goodwill should be recognised and measured in financial statements. characteristics of goodwill the katz commission concluded that goodwill lacks physical substance (steenekamp 1996). in addition, ifrs 3 defines goodwill as ‘unidentifiable items purchased in a business combination’ (ifrs 3 2009; appendix 1). in this context the following characteristics are included in the correspondence analysis: r1: goodwill is intangible. r2: goodwill is unidentifiable items purchased in a business combination. when goodwill works in combination with other assets it is often assumed to enhance the productivity of those assets. these synergistic benefits are realised in the form of superior operating performance and earnings (jahmani et al. 2010; ma & hopkins 1988). in this context the following characteristic has been included in the correspondence analysis: r3: goodwill represents synergies that are expected to arise as a result of a business combination. baldi and trigeorgis (2009) define two approaches to the assessment of the goodwill transaction. the first is the ‘residual approach’ in terms of which: goodwill is measured as the difference between the purchase price and the fair market value of an acquired company’s net tangible and identifiable intangible assets. it is thus a residual amount that cannot be directly identified. (baldi & trigeorgis 2009:115). the second is the ‘excess profits approach’ in terms of which: goodwill is the value of the combined company’s profits that exceed normal earnings for a similar business. it is the present value of projected future excess earnings. (baldi & trigeorgis 2009:115). the excess profits approach is not followed by the iasb and financial accounting standards board (fasb) although the fact that goodwill is associated with excess profits (qasim, haddad & abughazaleh 2013) or economic value added (ifrs 3 2009, bc 326, b239) has been acknowledged by both standard setters. in terms of the excess profit approach, goodwill is the aggregation of multiple features of corporate activities that can increase a company’s earning power (baldi & trigeorgis 2009) or result in the generation of ‘super profits’ (qasim et al. 2013). goodwill can also be viewed as the networks built up by an acquired company’s managers including, for example, relationships with suppliers, distributors and customers (sinclair 2007). the acquiree could have established systems, new products, trained staff and innovative ways of managing its operations, all of which optimise profitability. internal business efficiencies are defined as the reengineering of structures and processes to ensure more timely and reliable information for decision-making purposes (savčuk 2007). a business combination can lead to the development of such internal efficiencies by way of the acquirer combining their internal structures with those of the acquiree. sinclair (2007) and ifrs 3 go on to identify that goodwill can represent such internal efficiencies (ifrs 3 2009, bc 313 2009; sinclair 2007) and in this context the following characteristic has been identified: r4: goodwill represents internal efficiencies or entity-specific benefits. ellis and martin (2001) find that goodwill is also the control premium paid over the current operating value of the target firm taking into account the ability of the acquiring firm to benefit from or realise this value (ellis 2001). in this context, the following characteristic has been derived: r5: goodwill arising on acquisition represents a payment made by the acquirer in anticipation of future economic benefits. while the amount, timing and certainty of the future cash flows inherent in goodwill may be questionable (eloff & de villiers 2015), the economic benefits represented by the goodwill balance can be attributed to the reporting entity which, by virtue of the fact that it controls the acquiree, could prevent the realisation of those benefits by other parties.4 in this context, the following characteristic has been derived: r6: the economic benefits inherent in goodwill are restricted and cannot be realised by other parties. the fasb released a report in 1998 on whether goodwill is an asset or an expense (johnson & petrone 1998). this report noted that the iasb5 expensed goodwill. the iasb’s argument for doing so was that, firstly, goodwill was not identifiable. by its very nature, it is an unidentifiable component of a business combination. secondly, goodwill is not separable. it cannot be separated from a business and sold6 (see also ias v38). consequently, goodwill cannot be seen as a resource controlled by the reporting entity and should, therefore, be expensed (johnson & petrone 1998). gore and zimmerman (2010) present a similar argument. synergy, which is the most common explanation for the existence of goodwill, is not something that has an independent existence and should not be reported on the statement of financial position. in this context, the following characteristics have been derived: r7: goodwill is not identifiable and separable. r8: goodwill is not a resource controlled by the reporting entity. in the absence of earnings management, ifrs 3 states that the purchase price paid by the acquirer to obtain control over an acquiree represents a genuine outflow of economic resources which forms part of the cost of the business combination (ifrs 3 2009). in this context, the following characteristic has been derived: r9: goodwill is the result of an outflow of economic resources of the acquirer. su and wells (2014) discuss how goodwill represents the present value of expected post-acquisition performance and changes in performance (su & wells 2014) which, in essence, capture the going concern element of the acquiree’s business. in this context, the following characteristic has been derived: r10: goodwill is the going concern element of the acquiree’s existing business. the conceptual framework (iasb 2010) defines an asset as a ‘present economic resource controlled by the entity as a result of past events’. ifrs 3 requires goodwill to be recognised as an asset (ifrs 3 2004b). the rationale for this accounting treatment is found in the basis for conclusions on ifrs 3 which states: the fasb also considered evidence about the relevance of goodwill provided by a number of research studies that empirically examined the relationship between goodwill and the market value of business entities. those studies generally found a positive relationship between reported goodwill of entities and their market values, thereby indicating that investors in the markets behave as if they view goodwill as an asset. (ifrs 3 2004b, bc327) ellis and martin (2001) define goodwill as the difference between a company’s net assets at book value and market value. in other words, goodwill is seen as the difference between a company’s equity as reflected in the financial statements and the market value listed on a securities exchange (ellis 2001). in addition, negash (2003) and eloff and de villiers (2015) found that there is an association between intangible assets, including goodwill, and the market value of the company to which it relates (eloff & de villiers 2015; negash 2003). as a result, the usefulness of financial statements is undermined by the gap between the book and market value of a firm (negash 2003), something that can be partially addressed by recognising goodwill arising on a business combination (eloff & de villiers 2015). in this context the following characteristic is included in the correspondence analysis: r11: there is a relationship between the market value of a business and goodwill. linked to the point that goodwill is unidentifiable, shalev, zhang and zhang (2013) discuss how goodwill has the characteristics of a ‘dumping ground’ for other identifiable assets arising as a result of the acquisition of the acquiree. this is because goodwill is not amortised in the same way as other intangible assets creating an incentive to incorporate these intangible assets as part of goodwill (shalev et al. 2013). in this context, the following characteristic has been derived: r12: goodwill may incorporate identifiable unrecognised assets or recognised under-valued assets, as part of an earnings management exercise. gore and zimmerman (2010) and bugeja and gallery (2006) question the accounting for goodwill as an asset in terms of existing accounting standards. they identified that goodwill which is more than two years old is no longer value relevant to market participants (bugeja & gallery 2006). this is because the benefits of an acquisition are increasingly reflected in normal operations and any additional value is captured in earnings rather than goodwill (bugeja & gallery 2006). this links with the excess profits approach. as explained earlier, this describes goodwill as being the present value of excess earnings measured with reference to a benchmark entity (baldi & trigeorgis 2009). over a period of time, the excess earnings will begin to reflect as normal earnings. in addition, competitors will enter the market to share in excess returns leading to a reduction in earnings. therefore, the excess profits reduce and the value of goodwill tends to zero (baldi & trigeorgis 2009). in this context, the following characteristic has been derived: r13: the economic benefits inherent in goodwill are realised within a short period after acquisition. ma and hopkins (1988) and jahmani et al. (2010) explain that goodwill can be seen as a type of ‘earnings reserve’ which represents the future cash flow potential of the business combination either due to an increase in cash inflows or cost savings as synergistic benefits are realised (jahmani et al. 2010; ma & hopkins 1988). in this context, the following characteristic has been derived: r14: goodwill has the ability or potential to contribute, directly or indirectly, to future cash flows. this premium is paid to obtain access to the acquiree’s systems, know-how and processes and to generate economic benefits. alternatively, it is paid to control the flow of products or services from a competitor, restrict access to a market or protect a particular line of business (ellis 2001). in this context, the following characteristic has been derived: r15: goodwill is a form of a defensive intangible asset. the characteristics discussed in the preceding paragraphs form the basis of the row headings (r1 – r15) in the correspondence analysis (goodwill matrix) in appendix 1. accounting policies history of the accounting for goodwill over time, different accounting policies for goodwill have emerged. ding et al. (2008) summarise these differences into four stages (ding et al. 2008). the four stages in ding’s model are the ‘static’, ‘weakened static’, ‘dynamic’ and ‘actuarial’. the static phase saw the balance sheet as a representation of the liquidity of a business. as a result, all assets were measured at a liquidation value (ding et al. 2008). goodwill was not seen as having value that could be realised directly and it was, therefore, expensed. this stage ended during the early 1900s with the start of the weakened static phase. this emphasised the going concern assumption and accounted for goodwill as a direct debit to equity. around the mid-1970s to the early 1980s the dynamic phase saw goodwill capitalised as an asset based on the view that it represented economic benefits expected to be realised in the future rather than a reduction to reserves (equity). goodwill was amortised over a ‘random useful life’ which varied from 10 to 40 years.7 the fourth stage, which characterises current accounting practice, is the actuarial phase (ding et al. 2008). the move to the actuarial phase was due to the fasb taking the position that the amortisation of goodwill over a random useful life was not conceptually sound (sfas 142 2001; ding et al. 2008). the fasb concluded that goodwill arises due to integrated activities between two or more companies. by amortising goodwill over a useful life, this fact is ignored as only one of the companies (the acquiree or the acquirer) is considered when making the useful life assessment rather than all of the companies involved in the business combination (sfas 2001, 142). to correct this, the fasb resolved that goodwill has an indefinite useful life and is assessed for impairment annually and when any indicators of impairment arise (sfas 2001, 142). to avoid the revaluation of goodwill and, indirectly, the capitalisation of internally generated goodwill, an impairment of goodwill cannot be reversed (baldi & trigeorgis 2009; sfas 2001, 142). the iasb followed a comparable approach when replacing ias 22 with ifrs 3 (eloff & de villiers 2015). the iasb also removed the accounting requirements for goodwill in ias 38 because goodwill does not meet the separability and identifiability criteria required to meet the definition of an intangible asset (eloff & de villiers 2015). current accounting for goodwill in terms of ifrs 3 goodwill is defined as: an asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognised. (ifrs 3 2009, a148) subsequently goodwill is not amortised but assessed, at least annually, for impairment (ifrs 3 2009). this is consistent with the actuarial phase described in (ding et al. 2008). stewardship and neoliberalism are used as theoretical frameworks to evaluate this accounting policy in more detail and derive alternate perspectives on accounting for goodwill. stewardship accounting has its genesis in the need to ‘keep account’ in order to hold individuals accountable. this function continues to be relevant in contemporary organisations (hopwood 1987; ravenscroft & williams 2009). murphy et al. (2013), for example, analyse the accounting landscape in relation to social jurisprudence. they identify a ‘living law’ rooted firmly in the principles of accountability and stewardship which, in turn, influences the development of accounting systems. from a classic agency perspective, the information asymmetry between management and shareholders can also be seen as requiring an accounting function to ensure monitoring and control (watts & zimmerman 1979; young 1998). as explained by gjesdal (1981) and ding et al. (2008) financial statements are not used primarily for internal management by the owner-manager but by a separate body of shareholders concerned with evaluating managers’ performance and overall corporate stewardship. ravenscroft and williams (2009) confirm this view, arguing that, while accounting assists an organisation by presenting facts that can be used internally, it provides the primary basis for gauging management’s performance. the accountability agenda leads to a clear focus on objective measures of financial position and performance and an emphasis on determination and allocation of costs (gjesdal 1981; ravenscroft & williams 2009; whittington 2008). the allocation of the cost of a business combination giving rise to goodwill informs users about what has been purchased. this is consistent with a residual approach to accounting for goodwill which conceptualises goodwill as the purchase consideration paid for obtaining control over the different elements of the acquiree rather than something that can be identified and measured directly (baldi & trigeorgis 2009). the current accounting under ifrs 3 reflects elements of this residual framing of goodwill in the sense that goodwill is defined as the difference between the fair value of the consideration paid to obtain control over the acquiree and the fair value of the acquiree’s net identifiable assets (see ifrs 3 2009). in addition, goodwill is defined as the other assets acquired in a business combination that are not individually identified and separately recognised (ifrs 3 2009). from a stewardship perspective, these benefits cannot be specifically identified and realised and, as a result, should be measured indirectly. c1: goodwill is recognised initially and measured indirectly as the difference between fair value of the consideration paid and the net asset value of the acquiree. more conservatively, it can be argued that the synergistic benefits represented by goodwill should be expensed. they represent an over-payment for the identifiable component of a business for which management should be held accountable (ravenscroft & williams 2009; whittington 2008): c2: the difference between the purchase price and net assets should be accounted for as an expense. in terms of an accountability paradigm, cost is a relevant measurement basis. it provides a value for evaluating measures of financial performance in order to determine how managers have generated returns from the capital made available by shareholders without the effect of market forces (or other factors) over which managers have no direct control (maroun & garnett 2014). in essence, cost precludes changes in fair value being recognised as unrealised gains in income. this is an example of the application of prudence (whittington 2008). with regard to business combinations, it would be prudent to measure the transaction at its cost and allocate the cost to goodwill and the other assets acquired. prudence would then imply that, if the cost of the combination is assessed subsequently and is overstated, an impairment should be recognised to adjust the cost accordingly. the principle of prudence is a key concept of stewardship, and can ameliorate the reliability of financial reporting (whittington 2008). in this context, the following accounting policy themes are used in the correspondence analysis: c6: recognising post-acquisition increases in goodwill is imprudent. c7: goodwill should be tested for impairment. as explained by ding et al. (2008), there have been a number of different accounting policies for goodwill. johnson and petrone (1998) also discuss this fact in their commentary on whether goodwill is an asset. they discuss that the definition of an asset cannot be applied to goodwill and that much further debate is required. this debate arises due to the fact that for an economic resource to be controlled by an entity from which economic benefits are expected to flow, such asset must be separable and identifiable (ciprian et al. 2012). goodwill, by its definition, is those assets that are not separately identifiable (ifrs 3 2009). the inference from the context of johnson and petrone’s argument is that goodwill can be expensed (johnson and petrone 1998). this accounting treatment is in line with the static phase. subsequently, the accounting standard setting bodies, such as the iasb and fasb, published standards related to the accounting for goodwill. an example would be frs 10: goodwill and intangible assets, which introduced the concept that goodwill be amortised over a period of no longer than 10 years8 (iasb 1997). more recently, the iasb published ifrs for smes which allows for the amortisation of goodwill over a useful life of also no more than 10 years (iasb 2015). these two accounting policies are consistent with the random useful life phase and suggest that: c9: goodwill should be amortised over a fixed maximum period. neoliberalism from the start of the 21st century, financial reporting has experienced a fundamental shift characterised by a neoliberal paradigm (murphy et al. 2013; ravenscroft & williams 2009; zhang & andrew 2014). at the heart of neoliberal accounting is the ‘information metaphor’ which sees the primary purpose of financial reporting as the provision of useful information to users (ravenscroft & williams 2009; whittington 2008). in addition, neoliberalism places emphasis on the amount, timing and certainty of future cash flows rather than the relevance of past transactions. as a result, prudence and cost give way to financial relevance and the use of fair values (whittington 2008). in the context of a business combination, neoliberals would require all assets and liabilities to be measured directly at fair value. in keeping with this view, goodwill should be measured initially at fair value as an asset in its own right rather than as a residual value (consider ravenscroft & williams 2009; whittington 2008; zhang & andrew 2014). this may require the use of complex estimation techniques, even though the measure of goodwill is less reliable: c5: goodwill should be measured at fair value as an element in its own right. from a neoliberal perspective, carrying goodwill at its fair value provides the most relevant information to current and future providers of financial capital. any difference between the direct measure of goodwill at fair value and the indirect measure proposed under an accountability regime represents overperformance or underperformance relative to a market-based measure and is, as a result, recognised immediately as a gain or loss: c10: differences between fair value of goodwill (measured directly) and the amount determined using ifrs 3 (an indirect measure) should be recognised in profit or loss at acquisition date. changes in the market or fair values of assets and liabilities are important for understanding an organisation’s ability to generate future cash flows (baldi & trigeorgis 2009; beatty & weber 2006; chambers 2007; ravenscroft & williams 2009; whittington 2008; zhang & andrew 2014). this means that changes in value should be accounted for even if these are unrealised or can only be estimated: c8: changes in the value of goodwill after initial recognition should be accounted for. changes in the fair value of goodwill are, in essence, part of comprehensive income and essential for providing a more complete measure of financial performance for the period under review (see whittington 2008). comprehensive income is the variation in a company’s net assets from non-owner sources during a specific period (iasb 2007, ias 1). the reason why comprehensive income would be used is because changes in the fair value of goodwill would be a variation in the net assets. the source of such change would be due to changes in the market value of the company’s share price, which is a non-owner source. the reason for this is that such changes would be outside the control of management of the entity. this is the case even if there is significant volatility in the fair value measure (ram et al. 2016). stewardship would preclude volatility due to the ‘noise’ it creates in the financial statements, as well as the fact that changes in the fair value are not under management’s control (ravenscroft & williams 2009). from a neoliberal perspective, changes in the quantum of realised and unrealised gains are important because they help predict an organisation’s ability to generate future cash flows. in this context, the following accounting policy themes are used in the correspondence analysis: c3: volatility in market and asset prices should not preclude recognition of goodwill. c4: volatility in market and asset prices should not preclude measurement of goodwill. the accounting policies form the basis of the column headings (c1 – c10) in the correspondence analysis (goodwill matrix) in appendix 1. balancing neoliberalism and accountability rather than seeing neoliberalism and stewardship as opposing forces, these theoretical perspectives can be meaningfully employed to shed light on how transactions and events can be ‘portrayed’ in financial statements. more specifically, the two paradigms are used to propose different accounting policies for goodwill and compare the resulting accounting to the characteristics of goodwill. in turn, this will assist in evaluating the appropriateness of the current accounting for goodwill. the international accounting standards board’s international financial reporting standards 3 post-implementation project as discussed above, the iasb met in may 2016 to discuss post-implementation findings from the implementation of ifrs 3. data were collected from preparers of financial statements who raised concerns around three key areas, namely (iasb discussion paper 2016): the complexity of the impairment requirements. proposal to amortise goodwill to solve communication issues to users. identifying other intangible assets from goodwill. the reason for the second key issue is due to the first key issue (iasb discussion paper 2016). the preparers of the financial statements have expressed that the impairment of goodwill calculation is complex and leads to errors being made. this is supported by prior research which has indicated that this calculation contains a number of subjective estimates and can be manipulated or purely have errors (iasb discussion paper 2016). instances have arisen where goodwill should have been impaired, and was not, which reduces the usefulness of the financial statements (beatty & weber 2006; jahmani et al. 2010; jordan & clark 2004). the preparers of financial statements have provided feedback to the iasb that to eliminate the risk of impairments not being recognised timeously, goodwill should be amortised. therefore the second key issue addresses the first key issue. c9 above is consistent with the views of these preparers as c9 specifies that goodwill should be amortised over a fixed period. the third issue raised by the iasb is that previously unrecognised assets and liabilities that are identifiable at acquisition are not being recognised. this results in these values being capitalised to goodwill, thus misstating the goodwill balance (iasb discussion paper 2016). in the case of identifiable intangible assets, these assets are not amortised over a useful life (iasb discussion paper 2016). instead they form part of goodwill and are not amortised but only assessed annually for impairment. this supports r12 and shalev et al.’s (2013) research that goodwill becomes a ‘dumping ground’ for other intangible assets as part of an earnings management exercise. the amortisation of these intangible is not reflected in profit and loss and so profit and loss is manipulated. methods inductive thematic analysis in the first phase, an inductive thematic analysis was carried out. research papers, technical papers on goodwill and current and previous accounting standards pertaining to goodwill were purposefully selected by the lead researcher and analysed for key themes. as the intention is not to quantify or generalise results, a random sampling technique was unnecessary. instead, validity and reliability were ensured by the sampling relevant academic and professional literature from reputable databases such as jstor, social science research network and wiley until saturation was achieved. in total 90 indexed journals and 5 professional accounting repositories were identified. structured searches were conducted for all of the sources to identify articles, technical papers or professional reports that referred to goodwill in their title, key words, abstract or html files (when available). each source was then examined in detail by the lead researcher to identify characteristics of goodwill, views on how to account for goodwill and any criticisms of the accounting standards applicable at the time. in total 118 pieces were reviewed with journal articles constituting the majority (approximately 85%). each article or report was coded by the lead researcher. in essence, each publication was analysed for similarities which were then aggregated into recurring themes or open codes (guest et al. 2013; leedy & ormrod 2014). themes relating to the characteristics of goodwill identified during the coding process are discussed in ‘characteristics of goodwill’ section and themes dealing with the possible approaches for accounting for goodwill are discussed in the ‘accounting policies’ section. the lead researcher assumed responsibility for the coding process to ensure consistent data analysis. the coding was, however, reviewed by the support researchers who independently examined the coding of the prior literature and identification of row and column headings to ensure accuracy and consistency. in total, 15 row and 10 column headings were identified resulting in a 10 × 15 matrix presented in appendix 1 (table 1 a-1). the orders of the entries in the correspondence table and assigned symbols have no specific meaning. it should be noted that the coding was inherently subjective. this is not, however, seen as a validity concern because of the exploratory nature of the study. scientific text analysis offered a more objective method but an interpretive coding exercise, informed by the prior literature on goodwill and a clearly defined theoretical framework, avoided data reduction and loss of exploratory potential (guest et al. 2013; saunders, lewis & thornhill 2009). correspondence analysis in the next phase, a correspondence analysis was carried out with 55 accounting experts. these included auditors, practitioners and standard setters. the practitioners included chartered accountants and direct investors or shareholders.9 the intention in canvassing a broad range of respondents was to add to the robustness of the study by ensuring that varied perspectives were included in the final analysis. as the aim of this study is not to determine an optimal result, a smaller sample size is justifiable and consistent with those used in comparable studies (kudlats, money & hair 2014; maroun 2015; ram et al. 2016). the article also deals with a technical analysis of goodwill and its accounting rather than how a broad group of stakeholders understand goodwill. for this reason, only individuals with a detailed understanding of financial reporting were engaged. choice of method the use of correspondence analysis is appropriate as this technique is becoming increasingly popular as an exploratory tool, rather than as a means of pure statistical analysis (beh 2004). the research in this article is exploratory and uses a correspondence analysis to ‘map’ possible approaches to accouting for goodwill. correspondence analysis has been used successfully in marketing (bendixen 1996; hoffman & franke 1986), psychology (doey & kurta 2011) and tourism (chen 2001) to explain otherwise complex relationships in a simple diagrammatic manner. in the case of this research, the correspondence analysis is used to show how characteristics of goodwill interact with principles of neoliberalism and accountability to reveal different perspectives on the accounting for goodwill. this is done using an easy-to-interpret correspondence plot which generates findings that can be readily understood by both academics and practising accountants (consider broadbent & unerman 2011). this method’s ability to summarise the interaction among variables (included in row and column headings in a correspondence matrix) and reveal relationships that may not be obvious from a correlation test or regression model is why it has been used. data collection and analysis the researcher contacted respondents directly and informed them of the purpose and nature of the research. they were provided with a brief explanation of the technique and the final correspondence table (appendix 1). as an added quality safeguard, the correspondence table was piloted with accounting academics to ascertain its validity. the participants were asked to mark with an ‘x’ cells where they felt that the characteristics of the goodwill (rows) correspond positively with the accounting policies (columns). each cell did not need to be marked and could be left blank depending on participants’ opinions. each response and non-response was assigned a value of 1 or 0 so that the data was standardised for analysis. the results were then compiled into a single frequency table. the completed frequency table was used to construct a correspondence plot (kudlats et al. 2014). firstly, the masses of the rows and columns were determined, including the column and row profiles (habib et al. 2012). next, these values were used to determine the inertia of each point in the table (maroun, turner & sartorius 2011; ram et al. 2016). each data point in the analysis has a set of coordinates, assigning it a location in a visual map. these points are a certain distance away from the average of all the data points or the centroid (kudlats et al. 2014). the maximum number of dimensions is given by the degrees of freedom. for ease of interpretation, only two dimensions are used for the analysis (kudlats et al. 2014). principal component analysis was used to ascertain the coordinates of each data point. summary statistics and a correspondence plot were generated and interpreted by the researchers (doey & kurta 2011; habib et al. 2012; kudlats et al. 2014). this involved a visual inspection of the plot to determine the relationship between the characteristics and accounting policies focusing only on significant row and column points (kudlats et al. 2014). in order to determine the significance of the goodwill characteristics and accounting policy themes, the total inertia is allocated equally but separately to the characteristics and themes to determine the average inertia per characteristic and theme (kudlats et al. 2014; maroun 2015; ram et al. 2016). a characteristic or theme is significant where its inertial contribution exceeds the average inertia per characteristic or theme (kudlats et al. 2014; maroun 2015; ram et al. 2016). once the significant accounting policy themes were identified, the coordinates of these accounting themes were then explored in greater detail. based on whether the accounting policy theme was significant in dimension 1 or dimension 2, the accounting policy themes were assigned to a dimension. significance in dimension 1 indicated that the respective data point lay on the x-axis and significance in dimension 2 indicated that it lay on the y-axis. the sign (positive or negative) of the coordinate indicated whether it was on the positive or negative side of the applicable axis. the axes were labelled by the lead researcher according to the accounting policy themes that provided the best explanation of the respective dimensions.10 the loading of goodwill characteristics on each axis (taking into account the strength of correlations and inertial contribution) provides an interpretive perspective of how the characteristics of goodwill influence the selection of accounting polices (adapted from kudlats et al. 2014; maroun et al. 2011; ram et al. 2016). ethical consideration wits university granted the ethics clearance for the authors to contact the samples from which the data were collected. wits university has a well-established governance structure and ethics committee. ethical clearance number: caccn/1122, 15 july 2018. results descriptive statistics summary descriptive statistics are presented in table 1. table 1: descriptive statistics. at 126 degrees of freedom, the chi-squared statistic of 250.45 is in excess of the critical value (at a 1% level) providing evidence to suggest that there is a statistically significant dependence between the rows and columns. the total inertia is explained by nine dimensions. table 1 also shows that the first two dimensions (which are the x-axis and y-axis in the final correspondence plot) account for 81% of the total inertia and for most of the exploratory potential of the graphical plot. this confirms the appropriateness of using only two dimensions for the analysis.11 while the inclusion of more dimensions will increase the percentage of the inertia explained, the result would be difficult to interpret (hair et al. 1998) with only a marginal increase in exploratory detail. only those characteristics and accounting themes that make an above average inertial contribution are included in the correspondence plot (figure 1) to ensure ease of interpretation. appendix 2 and appendix 3 provide test statistics for the goodwill characteristics (rows) (see appendix 2 table a-2) and accounting policy themes (columns) used to identify the statistically significant elements. in this regard, the characteristics of goodwill (rs) with a contribution exceeding 7%12 and accounting themes (cs) (see appendix 3 table a-3) with a contribution exceeding 10%13 have been included in the correspondence plot.14 figure 1: correspondence plot. analysis naming the axis taking into account the sign of each accounting policy theme (column headings), its correlation coefficient and inertial contribution (refer to appendix 2 and appendix 3), the x-axis and y-axis are named. this is done by examining and analysing the similarities in each of the grouped accounting policy themes. the positive x-axis is named ‘neoliberalist basis of measurement’. this is because c5 is the accounting policy theme that loads on that axis, which requires goodwill to be recognised as an asset in its own right and measured at fair value in line with a neoliberal framing. the negative x-axis is named ‘stewardship basis of measurement’. this is because c2 and c10 load on this axis. the former requires that goodwill be expensed. in essence, it represents an over-payment for the net assets of the acquiree which will not necessarily be recovered in the future. to hold management accountable, the amount is included as profit or loss to show a reduction in total performance for the current period (consider baldi & trigeorgis 2009; eloff & de villiers 2015; ravenscroft & williams 2009; whittington 2008). similarly, c10 is concerned with accounting for differences between a direct and an indirect measure of goodwill as a gain or loss in order to provide a measure of management’s performance when executing the business combination (see maroun & garnett 2014). the positive y-axis is named ‘subsequent measurement’. this is because c6, c7 and c9 load on this axis. c6 states that recognising post-acquisition increases in goodwill is imprudent and is consistent with the existing provisions in ifrs 3 which does not permit increases in the value of goodwill to be accounted for after the acquisition date (ding et al. 2008; ifrs 3 2004b; whittington 2008). similarly, c7 is aligned with the stewardship view and provisions of ias 36 which state that goodwill should be tested for impairment annually and whenever there are indicators to suggest that the asset may be impaired (iasb 2004a, ias 36). c9 is derived from frs 10 which required goodwill to be amortised over some form of a useful life (iasb 1997). this is consistent with the stewardship-based approach of allocating the cost of an asset over an expected useful life in order to match revenues and expenses (ding et al. 2008; whittington 2008). the aim is to include a measure of the cost of goodwill ‘consumed’ in each period which can be contrasted with the revenues generated and provide a basis for gauging how well managers have deployed the resources entrusted to them in order to generate returns. the negative y-axis is named ‘volatility in initial recognition and measurement’. this is because c3 loads on this axis. c3 states that the recognition of goodwill should not be precluded because of volatility in asset and market prices. as explained in the ‘characteristics of goodwill’ section, this is in keeping with the neoliberal position that the inclusion of volatile changes in fair value in comprehensive income enhances users’ understanding of the nature of expected cash flows rather than undermining the usefulness of financial statements (ram et al. 2016; whittington 2008). volatility in subsequent measurement should also not preclude the recognition of an asset (barth 2006). detailed analysis of the axes each row-point’s sign, correlation coefficient and chi-squared value-variance are then used to position the points (characteristics) on the positive or negative x-axis and y-axis (bendixen 1996; maroun et al. 2011). the sign of any point is only indicative of its positioning relative to the axes and does not, in or of itself, indicate a favourable or unfavourable finding (see appendix 2 and appendix 3). figure 1 represents the correspondence plot based only on statistically significant relationships (contributions in excess of the average inertia). the results were stratified into four quadrants based on the coordinates in each dimension (see the ‘accounting policies’ section). for example, r11 was statistically significant in dimension 1 (contribution of 8.7% exceeded the average of 7%) and the coordinate was positive meaning that it lies on the positive x-axis. the y-axis r9 and r11 are loaded on the negative y-axis. r9 deals with the fact that goodwill represents an outflow of economic resources of the acquirer. r11 defined the relationship between the market value of a business and the calculated goodwill. the correlations suggest that the volatility in the value of goodwill after a business combination does not detract from the fact that there has been an initial outflow of economic resources which should be accounted for upon initial recognition. this points to a neoliberal leaning in the sense that uncertainty inherent in future cash flows affects the measurement of the transaction rather than assessment of whether or not the conceptual framework’s recognition criteria have been satisfied (see barth 2006). r1 and r13 load predominately on the positive y-axis. r13 deals with the fact that the economic benefits inherent in goodwill are consumed within a short period of time (baldi & trigeorgis 2009; bugeja & gallery 2006; gore & zimmerman 2010). the correlation between r13 and c6, c7 and c9 suggests that the economic benefits inherent in goodwill are temporary; goodwill does not have perpetual earning power with the result that it is necessary to account for the ‘consumption’ of the benefits associated with the business combination as these are realised. this also supports the iasb’s findings from their post-implementation review of goodwill that goodwill should be amortised. r1 defines the goodwill transaction as giving rise to an intangible asset (steenekamp 1996). the fact that goodwill is unidentifiable and inseparable reaffirms the view that economic benefits inherent in the asset are probably enjoyed over a short period of time. in addition, because goodwill is similar to other intangible assets, respondents appear to be of the view that it should be treated in the same way as the majority of intangibles that ias 38 requires to be amortised to a nil residual value. the x-axis r7, r8 and r9 load on the negative x-axis. the fact that goodwill is not identifiable or separable (r7) and not necessarily a resource that is directly controlled and managed by the reporting entity (r8) suggest that it should be expensed on initial recognition (johnson & petrone 1998). this is reaffirmed by the fact that there has been an outflow of economic resources (r9) which, as discussed earlier, may not necessarily result in an increase in future cash flows as the benefits of the business combination are realised. this points to a relatively prudent assessment of the ability of goodwill to contribute to improved financial returns in the long term and is in line with an accountability-based view which would preclude the recognition of an asset under conditions of uncertainty (gjesdal 1981; johnson & petrone 1998; whittington 2008). r11 and r14 load on the x-axis. this accounting is seen as appropriate because of an established relationship between goodwill and the market value of the acquiree (r11) as suggested by the prior research (see ellis 2001; eloff & de villiers 2015; negash 2003) and the basis for conclusions accompanying ifrs 3 (iasb 2004b, bc 327). the fact that goodwill has a non-zero value means that it is more than some form of speculative element. it is grounded in an economically rational assessment of the value of the underlying business being acquired (shalev et al. 2013) and may be viewed by investors as if it were a directly observable asset (ifrs 3 2004b). this is true, irrespective of whether the contribution made by goodwill to an organisation’s future cash flows are direct or indirect (r14). any uncertainty in the amount and timing of future cash flows associated with the goodwill would be taken into account in the market-based measure rather than the decision to recognise goodwill (barth 2006; jahmani et al. 2010; ma & hopkins 1988) in keeping with a neoliberal stance (ravenscroft & williams 2009; whittington 2008). conclusion possible accounting treatments are summarised in figure 2 based on the results discussed in the ‘results’ section. figure 2: summary of accounting policies. figure 2 indicates that goodwill can either be expensed or capitalised. in the case of expensing goodwill, stewardship is the applicable framework. stewardship holds management responsible for inconsistencies in the bargaining process. expensing differentials between the value and the purchase price of the acquired business is a method of recording the cost of inefficient acquisitions where the amount paid for the business exceeds the net expected cash flows from identifiable net assets (ding et al. 2008; gjesdal 1981; whittington 2008). in recognising goodwill as an asset, elements of neoliberalism are evident at initial recognition. in particular, volatility in asset values should not preclude the recognition of goodwill (ram et al. 2016; whittington 2008). in addition, at initial recognition, goodwill should be measured as an asset in its own right at fair value and not as a residual. this is in contrast to the approach prescribed by ifrs 3 and in favour of a type of excess profit methodology for assigning a value to goodwill directly (see baldi & trigeorgis 2008). any difference between a direct and residual measure of goodwill is accounted for in profit or loss. this draws on principles of stewardship. management should be accountable for potential inefficiency when negotiating the business combination or favourable bargaining techniques, something which may be captured by the direct and residual value differential (gjesdal 1981; watts & zimmerman 1978; whittington 2008). for the purpose of subsequent measurement, accounting for post-acquisition changes in fair value was seen as imprudent. goodwill should also be amortised and subject to regular impairment testing in keeping with a stewardship framework and approach suggested by ifrs 3. it appears that, after the business combination has been completed, the primary objective of the accounting system is to communicate the manner in which management has managed the resources entrusted to them and attribute the cost of any assets to profit and loss over time (ding et al. 2008; gjesdal 1981; whittington 2008). the findings make an important contribution to the academic literature and have a number of implications. firstly, the article challenges the current accounting practice for recognising and measuring goodwill. the initial recognition of goodwill per ifrs 3 is seldom questioned by practitioners and the possibility of accounting for the difference between direct and indirect measures of goodwill has not been addressed in either the academic or professional literature (eloff & de villiers 2015). secondly, the study raises an interesting perspective on how assets are conceptualised by proponents of neoliberal and stewardship paradigms. in terms of ifrs, an asset must result in an inflow of future economic benefits to the reporting entity (iasb 2010). this is interpreted broadly by neoliberalists. they view goodwill as an asset because it is capable of generating synergistic benefits in perpetuity. uncertainty in the measurement of these benefits is accounted for by incorporating volatility in fair value measures in the income statement (see barth 2006; whittington 2008). in contrast, stewardship embraces a narrow temporal focus. where goodwill is expected to result in synergistic benefits, an asset is recognised. an inherently conservative approach is applied which sees the income-earning potential of goodwill decreasing over time. this erosion of future economic benefits is accounted for by amortising goodwill over a finite period and regularly accounting for impairments. uncertainty in expected future cash flows is not seen as a measurement problem but as an indication that initial recognition of those cash flows is inappropriate (see whittington 2008). at an extreme, goodwill may need to be expensed at initial recognition if cash flows are so uncertain that the difference between the purchase price and the value of net identifiable assets is indicative of inefficient bargaining by management, rather than anticipated future synergistic benefits. thirdly, rather than seeing neoliberalism and stewardship as opposing paradigms, it may be appropriate to incorporate features of these frameworks in a hybrid accounting model. goodwill is initially recognised as an asset and measured using the excess profits approach. the difference between the direct measure and the indirect measure required by ifrs 3 is interpreted as a gain or loss and indicates how effectively management has negotiated the acquisition price. subsequently, the amount initially recognised as an asset is amortised over the period in which management expects reasonably to benefit from the synergistic benefits of the business combination. limitations and areas for further research the proposed accounting model is a normative one which is not consistent with ifrs 3. as a result, it cannot be applied by practitioners. the proposed accounting is, however, useful for framing an alternate approach to accounting for goodwill which can be considered by the iasb and fasb when revising existing accounting standards. this will require additional research. for example, additional guidance will be required on how to interpret and apply fair value models for goodwill. it is unlikely that a single market price for goodwill can be observed directly, with the result that level 2 and level 3 inputs will need be used (ifrs 2011, 13). the relevant calculations will be subjective and complex, leading to possible understatement or overstatements of goodwill, opportunities for earnings management and a need for additional testing by auditors. each of these aspects can be considered in more detail by researchers interested in evaluating the application of accounting policies in a real-world setting. related closely to this, this article deals only with goodwill in the context of a wholly owned subsidiary. it does not deal with goodwill acquired as part of the purchase of a business that is not also a subsidiary or goodwill arising in partly owned subsidiaries. presentation and disclosure requirements are also outside the scope of this article. these present areas for further research which can yield additional perspectives on the proposed normative accounting policies or the current ifrs 3 treatment. finally, this article uses a correspondence analysis informed by the opinions of a group of experts whose focus is on the financial performance of the organisation. future researchers can examine how differences in the accounting for goodwill vary among stakeholders in order to gain a better understanding of how financial reporting is interpreted by multiple stakeholders with different information needs. this can be complemented by an expanded study dealing with the accounting for other balances and transactions and in different jurisdictions to take into account variations in underlying economic and cultural heuristics. acknowledgements competing interests the authors have declared that no competing interests exist. authors’ contributions all 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matrix) table 1-a1: data collection instrument. appendix 2 statistics for goodwill characteristics table 1-a2 represents the statistics relating to the characteristics of the goodwill (rows) in the correspondence table. each characteristic has a coordinate in both dimension 1 and dimension 2, with the contribution (‘contrib’) showing the relative strength of the characteristics in the overall relationship. a higher contribution indicates a greater strength and, therefore, increasing statistical significance. table 1-a2: statistics for characteristics of goodwill. appendix 3 statistics for goodwill accounting themes table 1-a3 represents the statistics relating to the accounting policy themes (columns) in the correspondence table. each accounting policy has a coordinate in both dimension 1 and dimension 2, with the contribution (‘contrib’) showing the relative strength of the accounting policy to the overall relationship. a higher contribution indicates a greater strength and, therefore, increasing statistical significance. table 1-a3: statistics for accounting policy themes. footnotes 1. ifrs 3 defines a business combination as ‘a transaction or other event in which an acquirer obtains control of one or more businesses. transactions sometimes referred to as “true mergers” or “mergers of equals” are also business combinations as that term is used in this ifrs’ (ifrs 3; a148 2009). 2. for ease of analysis, the readers’ attention is drawn to the fact that the research deals only with the accounting for goodwill arising in a business combination where a parent company acquires a 100% interest in a subsidiary. accounting for other types of business combinations, step-up transactions or partial acquisitions is deferred for future research. 3. the order in which row and column headings are presented in the literature review has no specific meaning. 4. example 2 in the ias 38 illustrative examples, discusses a patent that protects the technology used by the entity and does not allow other entities to make use of the same technology. this is an example of the way in which an asset restricts access by others (iasb 2008). 5. the iasb was the accounting standard setting body in the united kingdom. 6. this consistent with the approach of ias 38: intangible assets (iasb 2008). international accounting standards board [iasb] 2008. ias 38: intangible assets. london. 7. ifrs for small and medium enterprises still amortises goodwill over a maximum useful life of 10 years (iasb 2015). 8. in certain circumstances frs 10 allows for the useful life to be extended to 20 years (iasb 1997). 9. respondent types are equally represented. an un-tabulated series of chi-squared tests of association revealed no differences in pattern of responses between the types of respondents. this is probably due to the fact that all of the respondents have a detailed understanding of the nature of goodwill and existing financial reporting standards. 10. this introduces a degree of subjectivity which is in keeping with an interpretive research design. the labelling of the axes was, however, reviewed by the support researchers and presented at two accounting conferences to ensure reasonability. 11. this is consistent with the approach followed in other exploratory studies (bendixen 1996; doey & kurta 2011; hoffman & franke 1986; kudlats et al. 2014) 12. 100% divided by the 15 characteristics to determine the average inertia for characteristics. 13. 100% divided by the 10 accounting policy themes to determine the average inertia for the accounting policy themes. 14. all such items are denoted with a ‘*’. microsoft word vol6no3'3.doc sajems ns 6 (2003) no 3 542 sharing business information with employees ________________________________________________________________ r van der walt department of industrial psychology, vista university ________________________________________________________________ abstract the adoption of legislation such as the labour relations act no 66 of 1995 and the promotion of access to information act no 2 of 2000 has brought about radical change in the process of disclosure of information in south african organisations. the article reviews developments in respect of information disclosure in south africa and other countries and discusses the effects of the lra in regard to disclosure of information to trade unions and workplace forums. it then describes a study conducted by the author and discusses the findings. it concludes with pointing out certain shortcomings in the disclosure process and urges managements and the trade unions to work together to improve this important tool for achieving success in organisations and enhancing industrial democracy. jel j50, j59 1. introduction many changes have taken place since the first democratic elections were held in south africa in april 1994. an important objective of the new government was to disseminate democratic values throughout south african society. one of the first areas of society earmarked for transformation was the workplace. amongst other means this was done through legislation such as the labour relations act no 66 of 1995 (lra 66 of 1995) which was radically different from its predecessor. this paper examines the new democratic values and the effects of information sharing and disclosure which resulted from these new democratic values. democracy is undoubtedly one of the major political models in the world. in a true democracy the entire population participates in the government through its elected representatives. on a social level all members of society may share in the benefits of that society but they also have a responsibility to act in the interests of that society. all members may also freely take part in economic activities, provided these are not harmful to the larger society. if democracy is also applied to the world of work, it would mean that employees are entitled to participate in sajems ns 6 (2003) no 3 543 decision-making especially in those decisions that have a bearing on them. productive participation by employees would require that relevant information is shared and disclosed to them for joint decision-making. information disclosure is, in fact, an essential element in joint decision-making and in labour relations processes such as dispute resolution, collective bargaining and consultation. the sharing and disclosure of work-related information are means through which industrial democracy can find expression in the workplace. however, not all information which may be disclosed would be of interest to employees, but on the other hand, effective worker participation in decision-making without disclosure of the relevant business information would be impossible. streek (1994: 90) believes constructive involvement of workers is only possible if they are familiar with the employer�s plans and decisions i.e. information is shared between the workers and the employer. legislation and judicial rulings dealing with information disclosure emerged at different times in different countries. in the united states it dates back as far as 1936 when the national labour relations board (nlrb) (similar to commission for conciliation mediation and arbitration (the ccma) in south africa) recognised that information disclosure was important for collective bargaining purposes. in the united kingdom legislation was introduced in 1971 that compelled employers, when requested, to provide trade unions with the kind of information without which collective bargaining would be impeded. most european countries have a works council system with statutory provisions for disclosure. in sweden after the second world war, the disclosure of information was regulated by a voluntary national agreement between the swedish confederation of employers� organisations (saf) and the confederation of trade unions (lo). this arrangement was replaced by the joint regulation of working life act in 1977 which provides for wide-ranging statutory rights to information (ballace & gospel, 1983). on an international level organisations such as the international labour organisation (ilo), the organisation for economic co-operation and development (oecd), the united nations commission on transformational corporations and the european community/union have all contributed to a greater awareness of the importance of disclosure of information to the representatives of the workers (roberts & liebhaberg, 1977). trade unions view information disclosure as a means of furthering their objectives by extending negotiations and joint regulation into areas that were previously the exclusive domain of management. european unions also regard disclosure of information as a means of broadening industrial democracy (ballace & gospel, 1983). on the other hand some employers regard statutory sajems ns 6 (2003) no 3 544 obligation to disclosure to trade unions as a threat to their management prerogative. their objections are based on the need for commercial secrecy and confidentiality and fear that effective decision-making will be impeded. other more progressive employers welcome greater disclosure as a channel of communication with their employees. 2 sharing and disclosure of information in south africa since 1994 the south african government has actively attempted to foster a culture of transparency and accountability in public and private bodies by giving effect to the right of access to information. section 8 of the constitution �provides for the horizontal application of the rights in the bill of rights to juristic persons to the extent required by the nature of the rights and the nature of those juristic persons� as quoted in the promotion of access to information act no 2 of 2000. furthermore section 32(1) (a) of the constitution provides for everyone to have the right of access to information held by the state and section 32(1) (b) � provides for the horizontal application of the right of access to any information held by another person to everyone when that information is required for the exercise or protection of any rights�. section 32(1)(b) means that employees and trade unions now have constitutional support when they demand information from their employers in order to exercise or protect their rights. the constitution requires the government to enact national legislation to give effect to the rights in section 32 of the constitution and this has taken the form of the promotion of access to information act of 2000. landman (1996: 22) is of the opinion that the rationale for disclosure of information can be divided into two aims: the employee-centred aim and the company-centred aim. he writes �parliament believes that employees and their agents will be able to perform their monitoring functions, exert influence on managerial discretion and make decisions on a higher and more informed perhaps even rational basis if they are provided by employers with relevant knowledge and information.� based on his research grosett (1997: 37) provides the following reasons for business information disclosure and writes that �employee-centred aims are based on more �ethical� considerations such as the organisation�s responsibility to keep its employees informed and the desirability of employees� representatives to be given information to support the role of joint consultation and other forms of participation in decision-making �. in dealing with their employers, employees today regard access to business information as essential in order for them to gauge the employer�s financial position, as well as the employer�s ability to meet their demands. some sajems ns 6 (2003) no 3 545 employers in turn regard the disclosure of business information as a further opportunity to increase their influence and control of the workplace. in this regard grosett (1997: 37) writes that the aim with information disclosure is to �reinforce management�s influence and control of the organization .... achieved by increasing employee involvement and identification with the interests of the organization�. however, not all employers view disclosure of information as an opportunity − some see this as a definite threat to their �management prerogative� and fear that it could lead to an escalation in demands from employees. grosett�s (1997: 38) research of south african organisations found the following benefits of information disclosure as indicated by employers. employers believe that information disclosure leads to improved employee cooperation because information enhances the employees� understanding of the organisation and decisions made within it. employers were also of the opinion that shared information leads to improved collective bargaining and reduced conflict. employers also reported increased employee involvement in decisionmaking because employees had access to relevant information. a further reported benefit was increased levels of job satisfaction. the disclosure of information in collective bargaining and the consultation process has long found acceptance in other countries as pointed out briefly above. brand and cassim (1980: 250) write �the progress of collective bargaining in the united states and europe has been characterised by the move away from uninformed and irrational bargaining towards sophisticated and intelligent bargaining. in the usa this process has been facilitated by a recognition that, integral to the duty to bargain, is the requirement that an employer furnish relevant information in its possession to the union. the purpose of this is to enable the union to bargain intelligently, to understand and discuss issues raised by the employer�s opposition to the union�s demands and administer a contract.� jordaan (1996: 1-2) quoting a report issued by the advisory, conciliation and arbitration services in the uk writes that a lack of information has been shown to handicap the ignorant party when it comes to the bargaining and consultation process. automatic disclosure of information to works councils in germany and the netherlands is common practice. the international labour organisation(ilo) also recommends that disclosure of information should be part of the collective bargaining process. the ilo�s collective bargaining standards recommendation 163 (1981) reads �measures adapted to national conditions should be taken, if necessary, so that parties have access to information required by meaningful negotiation�. sajems ns 6 (2003) no 3 546 the need for the development of a culture of information disclosure in south africa must be seen against the background of a system of government which prevailed for decades and over time resulted in a secretive and unresponsive culture in public and private bodies and which in turn led to abuse of power and even to human rights abuses. the provisions for information disclosure contained in the labour relation act no 66 of 1995; the doctrine of discovery in law practice, i.e. the obligation on opposing sides to disclose documents that they may have in their possession and the constitution of the rsa have all contributed to the development of a culture of information disclosure. johannessen (1995: 45) identified the following reasons for access to information under section 23 of the constitution of the republic of south africa act 200 of 1993 (the interim constitution): access to information is a right identified in the chapter on fundamental human rights in the constitution. allowing citizens to obtain information is an essential part of democratic participation and the free flow of information supports the participatory form of democracy. access to information encourages accountability in a democracy and also encourages better administrative decisions. the reasons for gaining access to information mentioned above, reflect the importance of information disclosure in any constitutional democracy. this right to access to information is of such importance that it is specified in the final constitution. section 32 of the constitution of south africa act no 108 of 1996 deals specifically with this very important right. in his commentary on section 32, devenish (1998: 80) writes �its inclusion endorses the pervasive theme of accountability and transparency of government and administration that runs like a golden thread through the entire constitution and forms part of a new political morality�. it follows that without disclosure, employees would find it impossible to hold employers accountable for actions that are detrimental to employee interests. in south african labour law the right to disclosure of information was in the past advanced through the principle of good faith bargaining and the industrial court decisions regarding retrenchment. under the lra 28 of 1956 the unfair labour practice jurisdiction of the industrial court was utilised to induce parties to the bargaining process to engage in meaningful bargaining. in addition, the industrial court was able to order access to an employer�s premises and the disclosure of relevant information. some years ago in the atlantis diesel engines v numsa case (1995) the labour appeal court dealt with the matter of good faith bargaining and disclosure of information to the trade union when retrenchments were considered. kahn-freund (1997b: 21) has written that �negotiation does not deserve its name if one of the negotiating parties is kept in sajems ns 6 (2003) no 3 547 the dark about matters within the exclusive knowledge of the other which are relevant for agreement.� 3 the lra no 66 of 1995 and its effects on sharing and disclosure of information disclosure of information is provided for in section 16 in order for the lra to achieve its objectives of promoting collective bargaining and employee participation. section 16(1) specifies that disclosure of information can only be claimed by a majority union. minority unions may however act together to achieve a majority and then exercise their right to disclosure. section16(2) requires that the employer must disclose to a trade union all relevant information. du toit et al. (2000: 176 and 1998: 114) under the heading �disclosure of information�, write that �once a union has acquired this right, the onus is on the employer to disclose the required information, even in the absence of any request from the union.� in this context, �this right� means the trade union concerned achieving representative status. the �required information� refers to disclosure of relevant information to the union that will allow its representatives to effectively perform their functions and enable it to engage effectively in consultation and collective bargaining in terms of the relevant sections of the lra. the spontaneous disclosure of information by employers during collective bargaining and participation by employees in decision-making may be the action that is required to improve and strengthen the trust relationship between employers and trade unions in south africa, successful consultation and joint decision-making processes depend largely on the knowledge the parties have about the issues being discussed. it is for this reason that the legislature has granted workplace forums (wpfs) the right to information in terms of section 89 of the lra. the employer must disclose to the workplace forums all relevant information that will allow the workplace forums to accomplish effective consultation and joint decision-making. disclosure of information is mandatory and therefore the workplace forums need not first have to request the information specified in the relevant sections of the act. according to section 89(1) the disclosure is intended to allow the workplace forums to take part effectively in consultation and decision-making. it therefore seems logical that such information should be made available before these processes begin in order to allow parties time to prepare. sajems ns 6 (2003) no 3 548 an employer with a functioning workplace forum has to disclose all relevant information. the relevance is determined by reference to the matters listed for consultation in section 84 and for joint decision-making in section 86. the workplace forums may request further disclosure except in respect of information that is legally privileged and information that cannot be disclosed as such disclosure would contravene the law or an order of the court. disclosure of information that may cause substantial harm to an employee or employer and private and personal information is also excluded. 3.1 relevance of information everingham (1991: 217) suggests that, in general, the following information should be disclosed: information on the financial status of the organisation; information on absenteeism, industrial relations and productivity; and lastly, information on the employees� contribution to the planning of the organisation�s future. this suggestion includes the typical information found in annual reports of companies. it is doubtful whether disclosure of this type of information which is designed to meet the requirements of the shareholders will contribute to more constructive collective bargaining and greater employee participation in decision-making . based on the research of information disclosure to employees, grosett (1997: 39-40) lists the following items of information for disclosure: productivity information; information on morale; information on wages and benefits; safety information; information on company performance; information on wealth sharing and information on the organisation�s future. in regard to disclosure to representative trade unions under section 16 of the lra, the question of whether or not information is relevant is determined with reference to the circumstances of each case. furthermore the relevance of information must be determined by the purpose for which it is sought and it must be pertinent to the issues under discussion. according to section 16(2) the information must be relevant to the duties to be performed by a trade union representative or a shop steward which include such duties as representing employees in grievance and disciplinary hearings; monitoring the employer�s compliance with provisions of the act and collective agreements and reporting alleged contravention of workplace-related provisions of the former; and to perform any other functions agreed to between the trade union representative(s) and the employer. section 16(3) provides for the disclosure of information so as to allow the trade union to engage effectively in consultation or collective bargaining. sajems ns 6 (2003) no 3 549 it is clear that from the preceding review that disclosure and sharing of information play a crucial role in industrial relations in most industrialized countries. as a developing and newly industrialized country, south africa has securely anchored democratic ideals in its constitution as well as in its labour legislation such as the labour relations act. in order to obtain some idea of the extent to which these ideals have found practical application the writer conducted a study in a number of organisations to establish this. the findings are discussed in the next section. 4 research method and results 4.1 research method miles and huberman�s (1984; 1994) approach to qualitative analysis is the approach employed in the current study. this approach views data analysis as concurrent flows of activity: data collection, data reduction, data display and conclusion drawing/verification. as a result of the interactive nature of the model data reduction and data display could take place concurrently. 4.1.1 data collection a number of data collection methods were employed in the research referred to, namely, a literature study, a survey questionnaire and in-depth interviews within the qualitative research tradition. an extensive investigation was undertaken in order to obtain background information for the execution of the research. the second source for data collection was the seven cases which eventually agreed to participate in the study. these cases are members of the agricultural research (case a), the tertiary education (case b), the private security (case c), the manufacturing (case d), the research and development (case e), the private hospital (case f) and the armaments (case g) sectors of the economy. all seven of these cases were located within the gauteng province. to meet one of the criteria of good qualitative research, namely generalizability triangulation of multiple sources of data was applied, as suggested by lincoln and guba (1985: 20). each organisation that indicated its willingness to participate in the study, was requested to have two questionnaires completed, one by management representatives and one by worker representatives. all the management respondents were requested to give the view of management and the shop stewards/worker representatives the views of the workers in their respective organisations. in other words, multiple views were obtained in each sajems ns 6 (2003) no 3 550 case as well as multiple views across different cases in various sectors of the economy. where possible available agendas, minutes of meetings and any other documents related to inter-action between management and workers were also obtained. further data for analysis were obtained from in-depth interviews with respondents who were amenable to requests for explanatory data. 4.1.2 data reduction this component of the qualitative analysis process refers to selecting and transforming the �raw� data that appear in written field notes or sources of data that could be utilised for research purposes. data reduction occurs continuously throughout the duration of any qualitative oriented project. in the qualitative analysis process this often starts when a researcher decides which conceptual framework, which sites, which research questions and which data collection approaches to utilize. data reduction further entails such activities as making summaries, coding, eliciting themes, making data clusters, partitioning data and writing memoranda. data is further reduced through focussing and bounding the research and generally consists of building a conceptual framework, formulating research questions, sampling and instrumentation (miles & huberman, 1984: 36). a conceptual framework explains either graphically or in a narrative form, the main dimensions to be studied − the key factors or variables and the presumed relationships. a framework can be rudimentary or elaborate, theory driven or commonsensical, descriptive or causal. using the method suggested by (miles & huberman, 1984: 28; 1994: 18) a conceptual framework was developed for the study. from the literature studied and current labour relations practice in south africa, four very specific areas of industrial democracy were chosen as focus areas of which disclosure of business information is one. disclosure of business information served as the research question of the study, with several subquestions which formed part of the survey questionnaire. the qualitative researcher encounters the same dilemma as the quantitative researcher in that not all facets of an important problem or social phenomenon can be studied. the answer to deciding which parameters to include in a study is derived from the nature of the study itself. sampling in the qualitative research paradigm may involve decisions about which people to observe or interview as well as those sajems ns 6 (2003) no 3 551 settings, events and social processes that to should be included in the study. the conceptual framework and research questions dictate the foci and boundaries within which samples are selected. in the case of the current study the sampling activity commenced with reference to a report of the commission for conciliation, mediation and arbitration (ccma) which is the institution created by the lra of 1995 inter alia to facilitate the establishment of workplace forums (wpfs). wpfs are the vehicle of choice to institutionalise industrial democracy in south african workplaces, with advancement of industrial democracy being one of the primary objectives of the lra of 1995. in terms of chapter v of the lra, all trade union organisations that wish to establish a wpf have to apply the ccma. unfortunately, not all applicants have thus far fulfilled all the statutory requirements for registration and consequently failed in establishing statutorily recognised wpfs. wood and mahabir (2001: 241) have also pointed out the sparsity of workplace forums. all the applications received are registered by the ccma according to the nine provinces and are given corresponding case numbers. for purposes of the current study, the gauteng province was chosen as the setting of the investigation as it is the province with the greatest economic activity. in the ccma report available at the time, seventeen cases where registered for the gauteng province. one of the cases registered had incomplete organisation and contact details which rendered that particular case unusable for research purposes. of the original sixteen cases that were registered with ccma only two organisations agreed to participate in the study. reasons for the nonparticipation of the sixteen original cases range from some organisations were no longer in business, committed to other research to not interested in participating in the study. as it was felt that two cases were too few for even a qualitative study it was decided to approach other organisations that were subsequently placed on the ccma�s register or met the requirements for registration but decided not to apply for registration for various reasons. this second attempt added another five cases to the study. in the current study the data from the questionnaires was reduced through the following steps. the data from each questionnaire was analysed and summarised to build one worksheet with responses of the management and the trade union/worker representatives for each organisation. relevant additional information from agendas, minutes of meetings, memoranda etc. were also sajems ns 6 (2003) no 3 552 recorded on the worksheets. from the worksheets the data was transferred to displays such the various tables and lists used in the study. 4.1.3 data display the first step to display the data in the current study was build a cross-case compilation of the management and the worker views on the four selected aspects of industrial democracy. miles and huberman (1994: 178) refer to these cross case displays as meta-matrixes. they are master charts that gather descriptive data from each of several cases in a standard format. table 1 illustrates the result of this step. having completed the meta-matrixes each question�s data was displayed in either a list or in a table format. this was done for both management representatives� and worker representatives� responses. (see question 1 and question 2). as result of a restriction on space only one example of each display format is given. 4.1.4 data analysis: conclusion drawing/verification in regard to drawing and verifying conclusions miles and huberman (1994: 245) note that �people are meaning-finders; they can very quickly make sense of the most chaotic events�. of the utmost importance is whether the meanings the researcher finds in qualitative data are valid, repeatable and right. the abovementioned authors have suggested a number of tactics for confirming, avoiding bias and assuming the quality of conclusions of qualitative data: noting patterns, themes; seeing plausibility; clustering; making metaphors; making contrasts/comparisons; partitioning variables; subsuming particulars into the general; factoring; noting relations between variables; finding intervening variables; building a logical chain of evidence and making conceptual/ theoretical coherence. where applicable some of these tactics were used in the discussion of results and the drawing of conclusions in the current study. 4.2 analysis of data and results once the questionnaires were completed and the relevant documents were received, the responses of the two groups of representatives were summarised and tabulated. in a number of cases it was necessary to conduct follow-up interviews to clarify certain responses. the responses to each of the survey questions and sub-questions on the selected aspects of industrial democracy were recorded and tabulated prior to analysis. sajems ns 6 (2003) no 3 553 table 1 compilation of all management representatives� responses on disclosure of information a b c d 1. view of s16 of lra. open to idea. enhances consultation agrees with s16 as long as focuses on relevant info only disclosed if necessary to assist our employees disclose what tus/employees want if reasons are justified 2. who makes requests for doi. tu reps or employees tus, staff members wpf reps. tus, staff members wpf reps. requested via internal forum and supported by real need for info. 3. tu limited to info on members only yes, limited tu members only no, should have clear picture of organisation�s ability to participate responsibly yes, nonmembers have right to confidentiality of their info. no, would not be sufficient. a thoroughly thought-out approach implemented uniformly is required 4. improved cb and conflict resolution? yes, positive influences on cb and conflict resolution yes, better understanding of organisation�s limitations no, explanation by management usually sufficient not really, honesty and transparency not appreciated by tus 5. effect on employee participation? yes, positive influences on employee participation positively, better understanding and problemsolving not sure if disclosure has had effect once info is received by tu that is normally the end of request due co�s honesty 6. type of info disclosed all relevant info. salary, budget strategies, all management info at appropriate time vacancies, company notices non-sensitive : marketing, finance , production, co. performance etc 7. stage/ when disclosure takes place when requested/ deemed necessary by management when they ask or when we think it can assist the process only if the majority of employees are in agreement that info is needed by employees need to know basis. by delaying disclosure it appears as if info becomes more important to tus sajems ns 6 (2003) no 3 554 table 1 continued a b c d 8. disputes re disclosure of info. no disputes so far not really. handled in-house no disputes yes, info verified by ca under auspices of ccma 9. resolve disputes? process used n/a negotiation between employer and tu n/a. arbitration of ccma e f g 1. view of s16of lra in terms of agreement between tus and employer communication means conveying and disclosure of info at the earliest possible time before acting agree with principle expressed in s16 we share business processes and financial information 2. who makes requests for doi chairperson of wpf employees and/or union representatives the union and people needing information 3. tu limited to info on members only yes, personal info limited to tu members. remuneration info disclosed during wage negotiations yes, info must be limited to tu members only yes, we apply this principle. the union is not entitled to info. re non-members 4. improved cb and conflict resolution? yes, lra is silent on info sharing by tu to enable employer to bargain/consult effectively yes, more info is available and therefore better cb and conflict resolution not at first, later it improved the collective bargaining process 5. effect on employee participati on? yes, forms part of collective agreement between tus and employer yes, employees are more involved due to more info available to them no effect. unions bargained regardless of info. available 6. type of info disclosed all relevant info for effective functioning: closing/ erection of plants, org. restructuring, promotion of employees financial info during wage negotiation organisational restructuring specific marketing, financial situation, monthly sales estimates, employment equity sajems ns 6 (2003) no 3 555 table 1 (continued) e f g 7. stage/when disclosure takes place usually during wage negotiations during wage negotiations or when requested on a continuous basis or when requested 8. disputes re disclosure of info no disputes yes, about financial info no disputes to date 9. resolve disputes? process used n/a conciliation and mediation at ccma n/a question 1. �respondents� views of section 16 of the lra providing for disclosure of information.� cases (managements representatives� views) a. open to idea enhances consultation b. agrees with s16 as long as focus is on relevant information c. only disclosed if necessary to assist our employees d. disclose what trade union (tu)/employees want if reasons are justified e. in terms of agreement between tus and employer communication means conveying and disclosure of info at earliest possible time before acting f. agree with principle expressed in s16 of lra g. we share business processes and financial information cases (tu/worker representatives� views) 1. in line with lra. means of solving disputes 2. taken note and have made arrangements for disclosure of certain info. not info on remuneration of senior management 3. good idea gives workers more insight 4. it gives the tu the right to information 5. makes protecting interests of tu members much easier 6. very important as it allows tu reps to perform functions 7. gives tu more information than before from an examination of the management representatives� views on section 16 of the lra of 1995 it is clear that all seven respondents agree with the principle of disclosure of information. however, the application of the principle differs and appears to range from an open approach of sharing information to a narrow approach of disclosing only some information and only when requested by the trade union or workers as is indicated in cases c and d. sajems ns 6 (2003) no 3 556 judging from the responses, the worker representatives are in favour of the disclosure of information. this is to be expected as the workers and their representatives now have more information available than ever before, making their job of protecting the interests of worker so much easier. case b indicated that certain information is excluded from disclosure. this theme of reluctance to disclose certain information is repeated amongst the responses to question seven of this section. question 2. �who should make such requests for disclosure of information?� table 2 management representatives� responses a b c d e f g trade union (tu) x x x employees x x x x tu and employees x workplace forum x x other representative body x the responses of the management representatives to the question of who should make the request is presented in table 2. no clear pattern emerges from the responses plotted in the table, but it appears that the management representatives favour the trade union and employees (or a combination of the two) in making requests for the disclosure of information. table 3 tu/worker representatives� responses a b c d e f g tu officials x x x x elected representatives x x x x councillors x individual employees x x x wpf representatives x outside parties x from the responses in table 3 it appears that worker representatives prefer that the elected or trade union representatives as well as individual employees make the requests for disclosure of information. it is interesting to note that there is sajems ns 6 (2003) no 3 557 strong agreement on this point between both management and worker representatives in spite of the fact that they serve different constituencies. the responses to question 3, �should trade unions be limited to information concerning their members only?� gave the following results: the majority of management representatives held the view that information disclosed to the unions should be restricted to information concerning their members. however, there was also a view that information should not be so restricted. a management representative was of the opinion that worker representatives �should have a clear picture of the organisation�s ability to participate responsibly�. such a view may be described as mature and progressive on the role of trade unions because it recognises their particular function in healthy labour relations. as could be expected the workers representatives, almost without exception, believed that disclosure should not be limited to information concerning members only. this was hardly surprising as more available information could strengthen their union�s bargaining position. one worker representative had reservations about unrestricted access to information. this concern related to possible abuse of confidential information. question 4 asked �has disclosure of information improved collective bargaining and conflict resolution processes in your organisation?� the responses of the management representatives presented a mixed picture � four reported improvement in collective bargaining and conflict resolution in their organisations and this was confirmed by the worker representatives in three of the same organisations. the remaining three management representatives (cases c, d and e) reported that disclosure of information had not contributed to improvement in collective bargaining and conflict resolution in their organisations. this view was confirmed by four of the worker representatives, including those of organisations c, d and e. these four based their views on reasons such as that the information disclosed was too selective and too limited to be of much use. employee participation in decision-making is a key element of industrial democracy and question 5 therefore asked �has disclosure of information affected employee participation in your organisation?� four management representatives gave an outright positive response tot the question. this finding corresponds with that of grosett (1997: 38) who found that one of the benefits of disclosure of information listed by employers was sajems ns 6 (2003) no 3 558 increased employee involvement. five of the worker representatives also reported that the disclosure of information definitely improved employee participation in their organisations. the responses from management and the worker representatives to question 6 �what type of information is disclosed?� indicated a wide range of categories. most frequently requested and furnished were financial information or budgetary information. disclosure of information on organisational changes and restructuring was second most frequent. the lra does nor specifically indicate when information should be disclosed to a trade union or worker representatives. however, section 16(3) provides that whenever an employer is consulting or bargaining with a representative union, he must disclose all relevant information that will allow the union to engage effectively in consultation or collective bargaining. there is a similar provision in section 89(1) in respect of the functioning of workplace forums. the responses to question 7 �at what stage/when will your organisation disclose information to a trade union?� also demonstrated a wide variety of practices. the most common practice reported by management and by worker representatives was disclosure during wage negotiations. other responses by management included �when deemed necessary by management�, �on a need to know basis� and �when compelled by law� and �only after salary negotiations have been concluded�. ngobo and howard (1999: 9) refer to the reluctance of employers to disclose information as �minimal compliance�. this reluctance to disclose information has the potential to cause disputes and this was probed by question 8 which asked �has your organisation had a dispute relating to disclosure of information?� one of the worker representative stated that these disputes were �on-going � every year we experience the same kind of problems to obtain information�. in contrast only two management representatives reported disputes about disclosure of information � in both cases involving financial information. a possible explanation of this dichotomy is that worker representatives experience greater frustration from management while the latter have yet to come to terms with disclosure of information as now required by the lra. to question 9 �how were disputes resolved? what process was followed?� the representatives of both sides reported making use of the conciliation and/or mediation or arbitration services of the ccma or resolving the disputes by internal negotiations between the employer and the trade union. however, the same response was given in only two cases, which is an indication of how differently matters are viewed by management and worker representatives. sajems ns 6 (2003) no 3 559 5 conclusions bearing mind south africa�s past in which secrecy rather than disclosure of information was the norm, the strides made with the new openness regarding access to information for south african citizens can be described as quite remarkable. in the work environment, in particular, the lra of 1995 for the first time provides for disclosure of information by employers to employees. however, there are still reluctance and resistance to providing types of information which were previously considered as belonging to the domain of management. it is believed that it will take some considerable time for the human environment to change to such an extent that it sincerely supports a culture of openness and sharing. the study described here indicated that there is universal support amongst the participants for the principle of disclosure of information. differences between the parties occur about the type of information to be disclosed and the timing of such disclosure. the employer side is concerned about erosion of management prerogatives and commercial confidentiality while the employee side wants information disclosure because it enhances their negotiating capacity and their ability to jointly regulate the workplace. the fact that many disputes between management and workers emanate from problems in regard to disclosure of information indicates that both sides need to work hard on developing a spirit of trust and cooperation with the other side. in view of our long history of adversarial relations this is likely to take a long time to evolve. the study shows agreement by the parties that request for information should be made by worker representatives. from this it appears that employees are not making efficient use of section 16 and section 89 of the lra which, respectively, provide that an employer must disclose all relevant information to a representative trade union or to a workplace forum to enable them to perform their functions. it is a weakness of the lra that it is not more specific and prescriptive of when the information must be provided. the spontaneous disclosure and sharing of information by employers prior to and during collective bargaining and participation by employees in decision-making is what is required to improve and consolidate a trust relationship between employers and trade unions/employees. grosett (1997) found that employers reported that information disclosure were conducive to improved collective bargaining, to increased employee involvement in decision-making and to reduced conflict in their organisations. the current study produced similar responses but a significant variation is that in this instance the responses came from employer as well as employee representatives. however, worker representatives were of the view that sajems ns 6 (2003) no 3 560 insufficient information was being disclosed. this is certainly an aspect of disclosure and sharing which needs to be attended to. it appears to be imperative for the enhancement of industrial democracy in south african organisations that a mutually acceptable procedure be developed between the national representatives of business and labour on all aspects of disclosure of information which have given or are likely in future to give rise to disputes. greater clarity is needed, for example, on the timing of disclosure of information; on its relevance and sufficiency and on what can reasonably be expected from employers to share with their employees. south african organisations will only achieve success and growth if suspicion and mistrust between management and labour are eradicated. one of the most powerful means of accomplishing this and then reaching mutual understanding and common objectives is the sharing of information and knowledge. it is therefor of the utmost importance that management and trade unions give urgent attention to this vital aspect of industrial relations. references 1 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(1985) naturalistic inquiry, ca: sage: beverly hills. 15 miles, m.b. & huberman, a.m. (1984) qualitative data analysis: a source book of new methods, sage publications: london. 16 miles, m.b. & huberman, a.m. (1994) qualitative data analysis: a source book of new methods, sage publications: london. 17 ngcobo, h. & howard, h. (1999) "disclosure of information", south african labour bulletin, 23(6): 6-11. 18 ottervanger, t.r. (1996) "employee participation in corporate decision making: the dutch model" international lawyer: 42-64. 19 roberts, b.c. & liebhaberg, b. (1977) "international regulation of multi-national enterprises: trade union and management concerns", british journal of industrial relations, xv(3). 20 streek, w. (1994) "co-determination and trade unions", south african labour bulletin, 18(5): 87-95. 21 wood, g. & mahabir, p. (2001) "south africa�s workplace forum system: a stillborn experiment in the democratisation of work", industrial relations journal. 32(2): 230-43. acts 22 constitution of the republic of south africa act no 108 of 1996. 23 labour relations act no 66 of 1995. 24 employment protection act of 1975, legislative series, 1975-uk 2. 25 promotion of access to information act no of 2000. cases 26 atlantis diesel engines (pty) ltd v numsa (1993) butterworths law reports. abstract introduction literature overview empirical analysis conclusions and policy recommendations acknowledgements references footnotes about the author(s) carli bezuidenhout school of economics, north-west university, potchefstroom, south africa marianne matthee gordon institute of business science, university of pretoria, johannesburg, south africa neil rankin department of economics, stellenbosch university, stellenbosch, south africa citation bezuidenhout, c., matthee, m. & rankin, n., 2020, ‘inclusive growth and wage inequality: the case of south african manufacturing exporters’, south african journal of economic and management sciences 23(1), a3014. https://doi.org/10.4102/sajems.v23i1.3014 note: additional supporting information may be found in the online version of this article: online appendix 1: https://doi.org/10.4102/sajems.v23i1.3014-1 original research inclusive growth and wage inequality: the case of south african manufacturing exporters carli bezuidenhout, marianne matthee, neil rankin received: 04 feb. 2019; accepted: 17 apr. 2020; published: 27 july 2020 copyright: © 2020. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: exporting poses a challenge to the achievement of inclusive growth because there is a discernible wage inequality between exporting and non-exporting firms. the literature shows that exporting firms pay a wage premium relative to non-exporting firms, with the resultant wage gaps having widened over the years in line with expanding global trade. aim: limited research has been done on the distribution of wages within manufacturing exporting firms relative to non-exporting firms in south africa and how wage differentials might contribute to wage inequality. this article disentangles these wage differentials using administrative firm-level panel data. setting: exporting and non-exporting firms in the south african manufacturing sector. methods: by determining the wage differential in a firm at various percentiles, it is found that all employees (across the wage distribution) in an exporting firm earned a wage premium. this premium seemed to increase in magnitude towards the upper tail of the distribution, indicating that the wage differential did contribute to wage inequality. results: much of the wage inequality could be explained by the size and labour productivity of a firm. this implies that larger, more productive firms are more likely to be exporters, whereas there was little evidence that wage inequality is driven by either the type of destination country or the quality of export products. conclusion: the findings suggest that the resultant wage inequality is related to the process of exporting or simply a firm being in the export market. alternatively, wage inequality could be attributable to a specific type of firm (employing a specific type of person with sought-after skills) that had this (unequal) wage distribution before it started to export. keywords: exporters; firm-level administrative data; wage premium; wage inequality; wage distribution; south africa; inclusive growth. introduction although exports have been identified as an engine for inclusive growth, they also pose challenges as far as such growth is concerned, since they create a type of wage inequality that can be discerned between exporting and non-exporting firms. this is because the most productive firms (where wage inequality is most acute) are more likely to be exporters. exporting firms have been shown in the literature to pay a wage premium relative to non-exporting firms. moreover, this wage differential between exporting and non-exporting firms has contributed to an increase in wage inequality in developed and developing countries alike (krugman 2008). moreover, this wage gap (between the wages of exporters and non-exporters) has been widening as global trade has expanded over the last few decades (klein, moser & urban 2013), which calls into question the ability of exports to foster inclusive economic growth, especially in developing countries like south africa. south africa’s reintegration into the world economy and trade liberalisation process since the 1990s (edwards 2001) constitute an interesting case study, as they have taken place during a period in which income inequality has been steadily increasing – so much so that south africa is one of the world’s most consistently unequal countries, with an income gini coefficient ranging between 0.66 and 0.7 (world bank 2017). van der berg (2011) decomposed south africa’s income inequality by income source and found wage income to be the primary component in income inequality. therefore, a large part of the unequal gini coefficient relates to an uneven distribution of wages, indicating wage inequality. in the light of the above, this article investigates how south africa’s participation in the global market (more specifically, the country’s export participation from 2010 to 2014) affects the wage distribution within the manufacturing sector. south africa experienced an average overall export growth of 14% for the period 2010–2014 (trademap 2020). during this period south african manufacturing exporters’ behaviour is similar to the stylised findings in the international literature (i.e. exporting firms employ more people and pay higher wages than non-exporters). however, only limited work has been done on how these higher wages are distributed within manufacturing exporting firms, relative to non-exporting firms (e.g. do all employees earn a wage premium or only some of them?) and how this wage differential contributes to wage inequality. the international trade literature reveals that wage inequality is usually studied in terms of the skills premium (which relates to the wages of skilled and unskilled labour being higher in an exporting firm than in a non-exporting firm) (bernard & jensen 1997; brambilla, lederman & porto 2012; klein et al. 2013). the firm-level data used in this study do not contain variables on education or skills level. however, the data allowed for the calculation of the average wage within a firm at the 5th, 25th, 50th, 75th and 95th percentiles (i.e. the within-firm wage distribution). therefore, instead of comparing the average or median wages of exporting versus non-exporting firms, one can compare how wages are distributed within an exporting firm, relative to a non-exporting firm. wage inequality can therefore be illustrated through this within-firm wage distribution, where a more unequal distribution of wages thoughout the percentiles shows higher wage inequality. this article contributes to the limited literature by firstly disentangling the wage differentials between non-exporters and exporters, as well as within exporters (which includes a consideration of exporter dynamics and destinations served). in short, it studies within-firm wage distributions and wage inequality. there are only a limited number of international studies that have considered the within-firm wage distribution phenomenon (see, for example, bernini, guillou & treibich 2015). secondly, the article examines possible sources of wage inequality by analysing firm characteristics, the type of product exported and the type of destination served. the article uses detailed longitudinal tax administrative data (made available by the south african revenue service [sars]) to do a precise evaluation of the link between a firm’s export status, its within-firm wage distribution and wage inequality. a panel data set from 2010 to 2014 was created by linking three sets of administrative data, namely the company’s income tax (cit) data, employee data (irp5) and customs data.1 literature overview empirical literature overview the wage differential between exporting and non-exporting firms is one of the sources of the increase in wage inequality within countries (krugman 2008). moreover, this gap (between the wages of exporters and non-exporters) widens as global trade expands (klein et al. 2013). this implies that the wage inequality between exporters and non-exporters grows as international trade increases. the link between (the rising) wage dispersion and trade has been examined in numerous countries, for example germany (klein et al. 2013), the united states (us; bernard & jensen 1997), mexico (verhoogen 2008) china (fu & wu 2013) and france (bernini et al. 2015). a study by bernard and jensen (1997) investigated the increase in wage inequality among exporting and non-exporting firms. they found that a large part of the rise in wage inequality in the us manufacturing sector (in the 1980s) was due to exporting firms’ increased demand for skilled labour. therefore, relative to non-exporting firms, exporting firms needed to pay these ‘skilled workers’ higher wages (which is also known as a ‘skills premium’). bacchetta et al. (2017) also discussed the skills premium and its link to wage inequality. in a paper on investing in skills for inclusive trade, they explained that the demand for and supply of skills in the context of trade can affect the wage distribution (and thus wage inequality). if the skills supply is inadequate for the demand (i.e. there is a skills mismatch), then the price of skilled jobs increases and there is an increase in inequality. there is risk of further polarisation of the wage distribution if the demand for middle-paid jobs decreases in relation to high-paid, as well as low-paid jobs. on the other hand, if the skills supply meets the increased demand, then there is a less discernible link between trade and wage inequality, and overall labour market outcomes improve. similar to bernard and jensen (1997) and bacchetta et al. (2017), klein et al. (2013) also considered the skills premium, but used german manufacturing employer-employee level data to compare the wages of different skills groups employed by exporters. they found that significant export wage dispersion existed among highly skilled workers (earning a ‘wage premium’) and low-skilled workers (earning a ‘wage discount’). moreover, 30% of wage inequality (within and between skills groups) could be ascribed to exporting firms. in a similar study in mexico, verhoogen (2008) found that the devaluation of the peso (during the peso crisis of 1994) led to within-industry wage dispersion. moreover, the more productive exporting firms in mexico were able to withstand the crisis and increased their exports (both in terms of quality and wages), while the less productive firms were unable to do so, which resulted in within-industry wage dispersion. it is important to consider not only the difference in the average wages of firms (using ordinary least squares [ols] regressions) but also the wage differences at different quantiles or percentiles of the wage distribution (using either quantile regressions or ols regressions at different percentiles). as stated by fu and wu (2013): … if more talented and high-ability workers would tend to be hired by exporting firms, the average wage of exporting firms would be driven up and the export wage premia would be overestimated. (p. 185) recently, the availability of more detailed data has allowed for the consideration of the wage differential (across the wage distribution) on both a firm level (i.e. the firm’s distribution of wages – see bernini et al. 2015) and a job level (i.e. the overall wage distribution in a sector – see fu &wu 2013). a noteworthy study by bernini et al. (2015) focused on the within-firm wage distribution (firm level) of exporters versus non-exporters. their results showed a wage premium right across the distribution (from the 10th to the 90th percentiles). this premium seemed to increase towards the top end of the distribution. furthermore, they showed that this premium increased with the export intensity of the firm. bernini et al. (2015) considered not only the firm-level distribution of wages (to compare firms) but also the job level (employee level) distribution of wages in order to study the distribution of wages for all employees. they found that, across the wage distribution, the wages of those working in exporting firms were predominantly higher than those working in non-exporting firms. fu and wu (2013) also considered the overall wage distribution (at the job level) of the chinese manufacturing sector in 2004. they found an export wage premium (specifically among firms defined as state-owned enterprises originating from countries in the organisation for economic cooperation and development [oecd]) across the entire wage distribution. this wage premium seemed to decrease as one moved from the lower tail to the upper tail of the distribution (while controlling for firm characteristics, e.g. labour productivity, size, age and capital intensity, female share of total employees, workers with graduate degrees, college degrees or highschool certificates, industry and province). even though workers in exporting firms earn higher wages (across the distribution), this is not to say that all exporting firms are the same (and pay the same premium). exporters themselves are heterogeneous in nature. this can be seen in terms of the location of the firm (fu & wu 2013), productivity levels (bas 2012; bernard, jensen & schott 2009), number of products exported, number of destinations served (bernard et al. 2009), type of destination served and product quality (brambilla et al. 2012; brambilla & porto 2016; verhoogen 2008). exporter heterogeneity in terms of firms’ location influences the wages they pay. in their study on chinese manufacturing exporters, fu and wu (2013) showed that the wages of chinese exporters differed depending on the firm’s location. firms that were situated along the coast paid higher wages than those that were located inland. exporters are also heterogeneous in terms of their level of productivity. a plant level study on the productivity of chilean manufacturing exporters revealed a difference between the upper range exporters and lower range exporters within the productivity distribution (bas 2012). the exporters in the upper range used high technology and were more skill-intensive, and therefore paid higher wages than the lower range exporters. another study considering the productivity levels of exporters (specifically us manufacturing exporters) showed that the more productive firms (that paid higher wages) were the ones that exported multiple products (i.e. they were multi-product exporters) to multiple destinations (multi-destination exporters) (bernard et al. 2009). furthermore, the more products exported and destinations served, the higher the wage and employment levels were (bernard et al. 2009). it is not only the number of destinations that influences an exporting firm’s wages, but also the ‘type’ of destination. there is a link between the type of destination country (high, middle or low income), the product quality required, the type of worker who can manufacture it and the worker’s wages (brambilla et al. 2012; brambilla & porto 2016; verhoogen 2008). verhoogen (2008) studied mexican manufacturing exporters for the periods 1993–2001 and 1984–2001. his results showed that when firms exported to high-income countries, their products needed a quality upgrade, which required more skilled workers. in a similar vein, in a study conducted by brambilla et al. (2012) there was a so-called ‘skills bias’ in export destinations for argentinian manufacturers. this ‘skills bias’ was evident in the fact that exports to high-income countries (relative to middle-income countries or their domestic market) necessitated higher worker skills levels, which in turn implied higher wages (brambilla et al. 2012). a more recent study by brambilla and porto (2016) confirmed this. in their study of 82 countries they showed that high-income countries demanded higher-quality goods (and firms exporting to these destinations subsequently paid higher wages). the following section focuses on the south african literature on the wage differential between exporting and non-exporting firms. south african literature overview the south african literature on the within-firm wage distribution of exporting and non-exporting firms is very limited. however, the literature does reveal a wage differential between exporting and non-exporting firms (bhorat et al. 2017; edwards, sanfilippo & sundaram 2016; matthee et al. 2016; rankin 2001, 2013; rankin & schoër 2013). this wage differential seems to vary by type of exporter. by using newly available administrative data on south african manufacturing firms, bhorat et al. (2017) measured the contribution of firm and individual level characteristics to south africa’s wage formulation. they found that approximately 61% of wage variance is due to individual effects, while at least 13% is due to firm-level effect. it is typically firms that are profitable, older, more capital-intensive, more productive and involved in international trade that pay higher wages, on average. a paper by bhorat et al. (2017) shed some light on the theoretical underpinnings of why wages differ within firms. it is clear that wage differences within firms are strongly related to basic measures of productivity. furthermore, bhorat et al. (2017) illustrate that there is a direct relationship between wages and capital intensity. moreover, they show that the less important labour costs are to capital costs, the greater the possibility of workers extracting rents (bhorat et al. 2017). a high capital to labour ratio may be indicative of high fixed costs and barriers to entry and hence product market power. these product market power rents may be shared between workers and may be asymmetrical across the wage distribution. edwards et al. (2016) identified a wage premium among firms involved in international trade. they further distinguished between the wages of three types of traders, namely exporter only, importer only and two-way trader. they showed that the wage premium was the highest for two-way traders, followed by importers only and then exporters only. by using the same data as edwards et al. (2016), matthee et al. (2016) confirmed the export wage premium in south africa, showing that exporters paid 31% higher wages than non-exporters (even after controlling for firm size). they further distinguished between different types of exporter in terms of the number of products they exported (multiple-product versus single-product exporters), the number of destinations they served (multiple-destination versus single-destination exporters) and the market they served (africa or non-africa). their results showed that multiple-destination exporters paid higher wages than single-destination exporters. the same was true for multiple-product exporters (paying higher wages than single-product exporters). furthermore, they showed that exporting firms serving only the african market paid higher wages than domestic firms, but it was the exporters serving both african and non-african countries that had the highest export wage premium (matthee et al. 2016). in a similar vein, rankin (2001; 2013) and rankin and schoër (2013) classified south african exporters into two groups, namely those who serve regional (lower-income) markets and those who serve international (high-income) markets. rankin (2001) showed that firms exporting to countries outside of the southern african development community region pay the highest wages. in a later study, rankin (2013) confirmed these findings by also grouping south african exporters into two markets served, namely those who export to high-income markets (europe and north america) and those who export to lower-income markets (africa). the firms exporting to high-income markets pay higher wages than those exporting to lower-income markets (which pay even less than non-exporters). another study by rankin and schoër (2013) related this phenomenon to product quality and worker quality. moreover, the high-income destinations require higher-quality products, which are manufactured by more skilled (high-quality) workers who are paid a skills premium (rankin & schoër 2013). the link between trade and skills was also investigated by edwards (2001). he found that trade liberalisation had resulted in a skills bias. edwards (2001) analysed the impact of trade and structural change on employment in south africa from 1984 to 1997. even though the study was not on a firm level, the results showed that technological change had brought about a rise in demand for high-skilled employment and a decrease in the demand for ‘elementary-skilled employment’ (edwards 2001:54). furthermore, edwards (2001) showed that there was also a skills bias in the manufacturing export sector. therefore, growth in trade will more likely create skilled jobs which are paid a skills premium, adding to wage inequality. even though south african exporters are heterogeneous in terms of the number of products they export, the number of destinations they serve and the types of destination they serve, it is clear that these exporting firms pay higher wages. however, limited research has been conducted on how these higher wages are distributed within the exporting firm (e.g. do all employees earn a wage premium or only some of them?) and how the wage gap contributes to wage inequality. this article therefore set out to evaluate the link between export participation and the within-firm wage distribution. empirical analysis data the availability of detailed, longitudinal administrative data in the international literature has recently cleared the way for a more precise evaluation to be done of the link between wages (more specifically the within-firm wage distribution) and export status (bernini et al. 2015). this article made use of south african tax administrative data (from sars) with a view to investigating the link between a firm’s export status, wage distribution and wage inequality. in order to do this, a panel data set was created by linking three sets of data, namely the cit data, employee data (irp5) and customs data. the first data set (i.e. the cit data) contained the balance sheets and income statements of firms. from the cit, the following variables describing firm characteristics were obtained: property, plant and equipment (which measure capital intensity), gross income (which measures sales and output) and the profit code classifier or main industry code (which identifies the sector in which a firm operates). the profit code classifier was condensed to the four-digit international standard industrial classification (isic) used by sars to select the firms in the manufacturing sector (isic four-digit codes 1010–1033). it is important to note that the form that firms use to complete their income tax return changed in may 2013. the it14 was replaced by the itr14. with the transition from the it14 to the itr14, it became evident that some firms completed the it14 and others completed the itr14; therefore, these two forms were merged to form a panel of data. the second data set used in this article (the irp5 data) contained the irp5 certificates of employees completed by or on their behalf by their employers. hence, the data are reported per job (a unique employer [firm]–employee [individual] combination). the irp5 contains information on the period that an individual worked in a specific job (in days), their income and their birth date. the raw irp5 data was adjusted to remove duplicate certificates, multiple job spells and invalid periods worked (see table 1-a1 in online appendix 1). two variables were created from the irp5 data, namely the number of employees per firm and the within-firm distribution of wages. firstly, the weighted number of employees per firm was created by calculating the length of employment (in days) for each worker within a year, arriving at a total within the firm and dividing by 365. the aim was essentially to generate the stock of worker inputs into production per firm for the whole year. secondly, the within-firm distribution of wages was created in two steps. step one involved generating the weighted monthly wages per worker by taking the income and dividing it by the number of days worked (to get the daily wage equivalent), and then multiplying this by 30 to get the monthly equivalent of wages. step two involved taking the weighted monthly wages per person for each firm and measuring the distribution of wages within the firm (i.e. measuring the average wage in the firm at the 5th, 25th, 50th, 75th and 95th percentiles). the third and final data set used in the article (the customs transaction data) reported the export transactions of south african firms on a monthly basis. from this database, the following variables were obtained: trader identifier (firm identifier), tariff code (product code on hs6-digit level), country of destination (market), country of origin (south africa), customs value of the transaction (south african rand) and the statistical value (number of units). two adjustments were made to the raw customs data. firstly, duplicate transactions were removed and, secondly, only exporters trading more than r10 000 per year were kept in the data set (which, however, still covered 99% of export data). in the empirical analysis sections of this article, the customs data were utilised on two different levels (on firm level and on transaction level). for the within-firm wage distribution and inequality section, the customs data were used to create the following firm-level variables: dummy variables to indicate if a firm was an exporter (or not), the destination to which it exported (south african customs union2 only, africa only or international), exporter dynamics (if a firm entered,3 exited4 or continued5 in the export market), the number of products (on hs6-digit level) a firm exported and the number of destinations served. when considering the possible sources of wage inequality (namely the type of product exported and destination served), transaction level data were used, which allows one to control for the type of product being exported (hs6-digit product code), its price and the gross domestic product (gdp) per capita6 of the destination country. the product price per firm was calculated in two steps: step 1: step 2: step one involved taking the customs value per transaction and dividing by its statistical quantity (to get the hs6 price). step two involved determining the difference between the hs6 price and the average price of all products with the same hs6 code (this provides the price as a measure of the deviation from the average price per product). to create a panel containing all three data sets, a conjunction table (provided by sars) was used to link the various data sets through different firm identifiers. as all three data sets worked on different reporting years or periods, the dates of the data sets were aligned. after these adjustments were made, the panel data set on south african manufacturing firms, spanning the period 2010–2014, was completed. descriptive statistics on manufacturing exporters and their characteristics an overview of the data is provided in the form of an illustration of the average number of firms in the manufacturing sector from 2010 to 2014 and these firms’ export status. from figure 1 it is clear that, on average, 21% of all manufacturing firms export. these exporters are heterogeneous in the markets they serve, as 5% of these firms export only to sacu, 7% export only to other african countries (i.e. excluding sacu exporters) and 9% export to international markets (these firms export to both african and non-african countries). figure 1: the average number of manufacturing non-exporters and exporters (serving different destinations) from 2010 to 2014. exporters differ not only in terms of the markets they serve, but also in terms of their export dynamics (i.e. a firm can enter into, continue in or exit the export market). figure 2 illustrates the average number of manufacturing exporters in each export dynamic group per export destination. it is clear that, on average, 64% of firms continue to export year on year. furthermore, an average of 29% of firms enter into the export market each year and only 7% exit. figure 2: exporter dynamics per destination (average number of firms from 2010 to 2014). it is interesting to note that across all the dynamic groups, the number of firms exporting to african countries only is larger than the number of firms exporting to the international market (exporting to both african and non-african countries). a possible reason for the larger number of firms in the african market is the size, competitiveness and proportion of output exported by these firms (i.e. there are large numbers of small, less competitive firms exporting a small proportion of their output to africa). moreover, the literature suggests that a large share of south african firms export, but only a few firms specialise in exporting (the top 5% south african exporters export 85% of the total export value) (naughtin & rankin 2014). the firms exporting to africa most likely form part of the remaining firms that export only a small amount of their output and are no more productive than domestic firms (rankin 2001). table 1 confirms that it is the smaller firms (in terms of number of employees) that export to the african market only (relative to the firms exporting to the international market). this suggests that the threshold for entering the africa-only market is lower, and consequently a larger number of (smaller) firms are able to enter and remain in this market. table 1: characteristics of different firms (serving domestic, african and non-african countries). table 1 provides more detail on the characteristics (number of employees, capital per worker and output per worker) of firms entering, continuing in or exiting the international or african markets. relative to non-exporters and african exporters, continuing and entering international exporters are larger (in terms of number of employees and capital per worker) and more productive (in terms of output per worker). even though smaller than international exporters, all (continuing, entering or exiting) african exporters have a larger number of employees, more capital per worker and larger output per worker than non-exporting firms. it is also important to take note of the wages (per person) paid to workers in the different types of exporting firms, as well as to consider the within-firm wage distribution (i.e. consider the average monthly wages per person paid at the 5th, 25th, 50th, 75th and 95th percentiles of a firm’s wage distribution). figure 3 provides a visual representation of the within-firm wage7 distribution. from figure 3 it is clear that the average wages from the 5th to 95th percentiles increase with the distance of the markets that these exporters serve (first serving the domestic market, followed by exporting to sacu countries only, then exporting to african countries only and finally also exporting to international markets). the hierarchy appears to be across all parts of the distribution and is larger at the top end. this, together with the increase in the interquartile range (at the right-hand side of the graph), suggests that the wage inequality within firms increases as the market served gets further away. figure 3: wage distribution: non-exporters versus exporters (serving african and non-african countries) average from 2010 to 2014. the next section analyses the wage distribution within these heterogeneous firms and investigates possible sources of wage inequality. regressions on within-firm wage distribution and possible sources of wage inequality from figure 3 it is apparent that there is a wage differential and wage inequality between firms that serve different markets (first serving the domestic market, followed by exporting to sacu countries only, then exporting to african countries only, and finally also exporting to international markets). however, as figure 3 simply represents wage levels, the observed inequality should be investigated further by means of regressions with various control variables. to this end, the following sections consider the within-firm wage distribution to which different controls (in terms of firm characteristics) are added, with a view to shedding light on the possible sources of the wage differential and wage inequality, and the characteristics of the destination economy (proxied by gdp per capita) and quality of exports (proxied by the price of the manufactured export product) as other possible explanations for the wage inequality. within-firm wage distribution and inequality estimation strategy: within-firm wage distribution and inequality the wage differential and wage inequality between exporters (serving different destinations) and non-exporters observed in figure 3 could be due to exporters just being different types of firms (for example, larger and more capital-intensive firms serving different industries). one way to compare ‘like-for-like’ is to estimate regressions with control variables. consequently, to examine the within-firm wage distribution of exporters (with different dynamics and destinations) relative to non-exporters (with control variables), this article followed the methodology of bernard and jensen (1997) in measuring the export premia (in terms of monthly wages). this was done by estimating regressions of the general form: in equation 1, ln (x)it is the logarithm of monthly wages earned by workers at each percentile of the firm’s wage distribution (5th percentile, 25th percentile, 75th percentile and 95th percentile), as well as the standard deviation and interquartile range of these wages per firm. the ‘expoteri’ is a dummy variable indicating the export status of a firm. the export status can vary between a non-exporter and an exporter exporting to africa, sacu or the international market. furthermore, export status can also indicate a firm’s dynamics (enter, exit or continue). the number of destinations (no.destit) to which a firm exports and the number of products (no.prodit) it exports are also accounted for (in the case of non-exporting firms this variable is simply a zero). real capital per worker (lklit) is also included in the equation. equation 1 further adds two control dummies. the first is for the industry (industryit) in which the firm operates (classified according to the four-digit isic code) and the second is for the years (2010–2014) in the panel (yeari). finally, the export premia (of the wages) are represented by (βit), as well as the error term (µit) (also see table 3-a1 of online appendix 1 for a detailed description on the regression variables). even though equation 1 takes into account the capital per worker (lklit) in a firm (in real terms), other firm characteristics could influence the wages that a firm pays to workers in different parts of its wage distribution. equation 2 expands on the model (equation 1) by adding firm characteristics that measure firm size and labour productivity: in equation 2 (llit) is the natural log of the number of employees which measures firm size, whereas (lklit) is the natural log of the output per worker (in real terms) which serves as a measure of labour productivity. by adding these two controls, it is possible to determine the impact of firm size and labour productivity on wages (and the wage distribution in a firm) when equation 1 and equation 2 are compared. results: within-firm wage distribution and inequality table 2 shows the distribution of wages between exporting firms serving different destinations relative to non-exporters (by estimating equation 1, i.e. controlling for the number of destinations, number of products, capital per worker, industry and year). right across the distribution (from the 5th to the 95th percentiles) there is a hierarchy in the wage premium for firms, the further away the destination is (i.e. sacu-only exporters’ wages are lower than africa-only exporters’ wages, which are in turn lower than international exporters’ wages). for example, at the 25th percentile the wage premium for sacu-only exporters is 9.23% lower than that for africa-only exporters, which is in turn 6.8% lower than that for international exporters. therefore, a job at an international firm pays higher wages, but what about the wage inequality in these firms? table 2: wage distribution: firms serving domestic, african and non-african countries. the wage inequality can be seen by considering the standard deviation and interquartile range in the last two columns of table 2. it is clear that (similar to the wage premium) the standard deviation and interquartile range also increase as the export destination becomes more distant. therefore, a job at an international firm pays better (are better jobs), but there is higher wage inequality within these firms. when considering the number of products a firm exports and the number of destinations to which they export, it is clear that both the number of destinations and the number of products are more significant and have a bigger quantitative effect, as one moves from the lower tail to the upper tail of the distribution (from the 5th to the 95th percentiles). for example, exporting to one more destination increases the 95th percentile (2.0%) by more than it increases the 5th percentile (0.6%). it is also important to note that, with destinations, the wage effect of adding a destination is the largest at the 95th percentile while, with products, the wage effect is almost equal at each percentile. one of the arguments put forward in the literature as to why exporters pay more, is that they need more sophisticated management. for example, they may be exporting multiple products to multiple destinations which is a complex process that requires quality upgrades and the enhancement of operational services and skills. exporters therefore need more sophisticated staff on the factory floor, but also greater management or technical expertise found in higher-skilled workers (which are seen at the upper tail of the distribution) (brambilla, chauvin & porto 2015). figure 4 provides an illustration of the estimation of both equation 1 (also see table 2) and equation 2. therefore, figure 4 plots the coefficient of the wage premium from the regressions on a line graph to illustrate the wage distribution within a firm. the difference between the two equations is that equation 1 (represented by the solid lines) only controls for capital intensity (capital per worker) whereas equation 2 (represented by the dotted lines) also controls for firm size (in terms of number of employees) and labour productivity (in terms of output per worker). the solid lines (results of equation 1) show the within-firm wage distribution of international, african and sacu exporters relative to non-exporters. here, the export wage premium is very clear. this observed premium also increases in magnitude towards the upper tail (75th and 95th percentiles) of the within-firm wage distribution (which indicates wage inequality). when more firm characteristics are added (by estimating equation 2), the distribution changes shape (which is represented by the dotted lines). essentially, this shows that the wage inequality observed from the solid lines is mostly due to firm characteristics (i.e. different types of firms export internationally, compared to those that export regionally). figure 4: distribution of the coefficients of the wage premium: firms serving domestic, african and non-african countries, with different controls. as seen in the descriptive statistics, exporters do not only differ in terms of the markets that they serve, but also in terms of their export dynamics (i.e. a firm can enter, continue or exit the export market). table 4-a1 and table 5-a1 and figure 5 focus on the wage distribution between exporters with different dynamics. figure 5: distribution of the coefficients of the wage premium: exporter dynamics (enter, exit and continue), with different controls. comparing firms that enter the export market with those that continue to export or exit the export market, provides an indication of what happens to an exporting firm’s wage distribution over time. table 4-a1 and table 5-a1 present the results of estimating equation 1 (with and without controls for the number of products and destinations). when controlling for the number of products and the number of destinations, table 5-a1 shows that the distribution of wages within a firm is higher for entering firms than for continuing firms (from the 5th to the 75th percentile). without the control (see table 4-a1 in appendix 1), the continuing firm’s wage distribution is higher (wider). therefore, as firms continue exporting, they grow in terms of the number of products exported and the destinations served. table 5-a1 also shows that when a firm enters the export market, the bottom 5th percentile, on average, earns 1.7% more than continuing firms (exporting the same number of products to the same number of destinations). however, when a firm enters the export market, the top 95th percentile on average earns 6.5% less than continuing firms. therefore, relative to entering firms, continuing firms pay more as one moves to the upper tail of the distribution. however, there is not a big difference between entering and continuing firms. overall, table 4-a1 and table 5-a1 suggest that actually prior to or within the first year of entry, firms already pay higher wages and have higher wage inequality right through the distribution. figure 5 provides a graphical illustration of estimating equation 1 and equation 2 (also see table 2) for firms with different exporter dynamics. equation 1 (represented by the solid lines) only controls for one firm characteristic, namely capital intensity (capital per worker), whereas equation 2 also controls for firm size (in terms of number of employees) and labour productivity (in terms of output per worker). from the results of equation 1 (represented by the solid lines) in figure 5, it is clear that, relative to non-exporters, the wage premium for firms in the export market increases in magnitude towards the top end of the distribution. however, when controlling for more firm characteristics (estimating equation 2), the distribution changes shape and the large wage inequality at the 75th and 95th percentiles drops (see dotted lines). therefore, the observed wage inequality can mostly be explained by firm characteristics (i.e. firm size and worker productivity). table 4-a1 and table 5-a1 and figure 5 illustrate how the wage distribution differs between exporters with different dynamics (enter, exit or continue). the next point to consider is the destination or market that these exporters enter, continue in or exit. figure 6 and figure 7 add destination categories, showing the wage distribution of exporters that enter, continue in or exit from different destinations (using different controls). figure 6: distribution of the coefficients of the wage premium: exporter dynamics (to african and non-african countries). figure 7: wage inequality in terms of exporter status. figure 6 combines the exporter dynamics with the destination served. similar to figure 4 and figure 5, this figure is a visual representation of estimating equation 1 and equation 2 (for which the regression results are available on request). the difference between the equations is that equation 1 only controls for one type of firm characteristic (namely capital per worker) whereas equation 2 controls for two more firm characteristics (namely firm size and worker productivity). the results of equation 1 are presented as the full bars (upper and lower end of each bar) and equation 2’s results are presented as the lower (darker coloured) end of each bar. overall, from the results of equation 1 and equation 2, there is a clear export premium across the wage distribution. when distinguishing between exports to african and international markets, the premium is larger for exporters serving international markets. this is true across all export dynamic groups. furthermore, the shape of the distribution of continuing and entering exporters is relatively similar. the results of equation 1 (represented by each full bar) show that there is an export premium across the wage distribution. relative to non-exporters, higher wages are paid by exporters throughout the distribution. this premium increases in magnitude towards the top end of the distribution. exporters, relative to non-exporters, pay much higher wages at the top end than at the bottom end. in figure 6, the darker coloured, lower end of each bar represents the premium when firm characteristics (number of employees and output per worker) are controlled for, while the lighter coloured, upper end is the additional premium without the controls. overall, this indicates that the wage inequality is driven by the distribution of firm size (measured by the number of employees) and labour productivity (which is output per worker) within exporters compared to non-exporters (see table 1), with much of the observed wage inequality being because larger, more productive firms are more likely to be exporters. in addition to figure 6, figure 7 shows the standard deviation of each of these groups before (estimating equation 1 – see bars on the left-hand side) and after (estimating equation 2 – see bars on the right-hand side) controls for firm size and labour productivity are added. on the left-hand side, it is evident that there is a wide dispersion of wages within exporters (particularly within international exporters). however, almost all that dispersion (particularly within continuing exporters) is explained by labour productivity and the size of these firms (see bars on the right-hand side). this suggests that there is a large degree of dispersion of these variables (namely number of employees and output per worker) for these firm groups (represented by each bar) relative to non-exporters. even though the standard deviation (figure 7) is substantially smaller after controlling for firm size and output per worker, there is still a difference in the within-firm wage distribution of exporters relative to non-exporters, as well as within exporters. from the literature it is clear that skills do have an influence on wage inequality. as there are no variables available on skills, an indirect way to take skills into account is by considering the gdp of the destination country and the quality of the product. verhoogen (2008), brambilla et al. (2012), brambilla and porto (2016), as well as rankin and schoër (2013) allude to the fact that the type of product (high quality versus low quality) exported or the type of destination (high or low income per capita) exported to, could influence workers’ wages. this is due to higher-quality goods being manufactured by more skilled workers who get paid a skills premium (brambilla & porto 2016; rankin & schoër 2013). also, high-income countries have been shown to demand higher-quality goods, and firms exporting to these destinations subsequently pay higher wages (brambilla & porto 2016). these factors (type of destination country and type of product) could, therefore, influence the wage distribution and, therefore, wage inequality between exporters and non-exporters (as well as within exporters). the following section investigates these factors as possible sources of wage inequality.8 possible sources of wage inequality estimation strategy: possible sources of wage inequality to be able to consider the impact of the type of export product and destination on within-firm wage distribution, the transaction-level customs data is used as it reports on the product being exported (hs6-digit), the export price and the country of destination. the panel data (dated from 2010 to 2014) used in this section were constructed using the customs transaction data as the base and merging firm characteristics (obtained from the cit and irp5 data sets) onto it. the starting point for this analysis is estimating the following regression of the general form: in equation 3: xijk,t – within-firm distribution of monthly wages (measured at the 5th, 25th, 50th, 75th and 95th percentiles) exporterijk,t – dummy variable of export status (sacu, africa, international, enter, continue) no.destijk,t – control dummy (number of destinations exported to by firm) no.prodijk,t – control dummy (number of products exported by firm) industryijk,t – control dummy (four-digit isic classification) to account for heterogeneity firmjk,t – control for firm characteristics (natural logs of capital per worker, number of employees and output per worker) yearijk – control dummy for the years 2010–2014 priceik,t – control for type of product (price is in real terms) gdpij,t – control for type of destination prod fe – product-fixed effects (at hs6-digit level) uijk,t – error term the results of estimating equation 3 are presented in the following section. figure 6 shows that wage inequality is higher among international exporters than within african exporters and the same is true for entering versus continuing exporters. figure 8 represents the distributions to african and non-african countries, figure 9 represents exporter dynamics and figure 10 represents a combination of destinations and dynamics. figure 8: distribution of the coefficients of the wage premium (inequality): firms exporting to african and non-african countries. figure 9: distribution of the coefficients of the wage premium (inequality): exporter dynamics. figure 10: distribution of the coefficients of the wage premium (inequality): exporter dynamics (to african and non-african countries). results: possible sources of wage inequality figure 8 provides an illustration of the distribution of the coefficients of the wage premium for african exporters relative to international exporters (the base). similar to figure 4, figure 8 shows that international firms (the base) have higher wage premia across the distribution. furthermore, each line in figure 8 represents different combinations of equation 3. firstly, the africa-only line illustrates the results of estimating equation 3 without any type of product or destination controls. this provides a base (reference point) for the wage distribution and inequality. when adding product price, the distribution shifts slightly down (shifts in the mean) but does not change shape. therefore, the wage inequality does not seem to be due to product quality. by adding gdp per capita of the destination country, the distribution also shows a slight downward shift but does not flatten out (does not change shape). thus, the destination country does not seem to influence the wage distribution. finally, when adding product-fixed effects in combination with type of product and destination controls, the distribution’s shape stays similar. thus, the wage inequality is not due to a specific product type or within-product type. for example, the fact that an exporter pays higher wages or has an unequal distribution of wages is not due to a specific product (e.g. car) being exported. hence, the observed wage inequality has little to do with the destination country (high or low income per capita), the quality of the product (high-quality versus low-quality product) or the type of product being exported. not only is the wage inequality higher among international exporters, but figure 6 shows that firms entering the export market have higher wage inequality than those continuing in the export market. the next section considers the wage inequality of exporters with different dynamics. it also investigates if the unequal distribution of wages changes shape when controls for product quality, gdp and fixed effects are added. figure 9 shows the wage distribution of entering firms relative to continuing firms.9 similar to figure 5, figure 9 demonstrates that there is a wage premium for firms entering the export market. as in figure 8, the distribution does not change shape when adding a control for product price, a gdp control or product-fixed effects. this confirms that, with entrants, wage inequality is not caused by the type of product or destination. from figure 8 and figure 9 it is clear that the wage inequality is higher within international exporters (who form the base), than within african exporters, with the same being true for entering versus continuing exporters. the next section combines these two figures by considering the wage inequality of firms that enter and continue to export to african and non-african countries. figure 10 shows the wage distribution of firms entering the international market, entering the african market and continuing in the african market relative to firms continuing in the international market. this figure confirms two of the findings from figure 6. firstly that, relative to firms continuing in the international market (the base), continuing or entering firms in africa do not have a wage premium, but firms entering the international market do. the within-firm wage distributions of entering (africa only) and continuing (africa only) exporters are very similar. secondly, figure 10 adds to figure 6 by considering if the type of product (high-quality versus low-quality product) exported or the type of destination (high or low income per capita) exported to could have an effect on the within-firm wage distribution. the results show that the within-firm wage distribution of firms entering the international export market (represented by the four top solid lines), relative to continuing international exporting firms (the base), do not change shape (flatten out) as product control, destination gdp control or product-fixed effects are added. therefore, the wage inequality seems to have little to do with the destination country, the quality of the product or the type of product. it might suggest that it has something to do with the process of exporting or simply being in the export market (a firm’s export status). another possible explanation is that the remaining wage inequality is due to a specific type of firm which has this (unequal) wage distribution even before it starts to participate in the export market. in such a case it is most likely that the firm is willing (and able) to pay a premium for a specific skill or skill set that is high in demand, but scarce. as explained by bacchetta et al. (2017), if the supply of skills is inadequate for the demand, the price of skilled jobs increases and there is an increase in inequality. conclusions and policy recommendations the aim of this article was to more fully understand the wage differences between non-exporters and exporters and within exporters (by considering exporter dynamics and destinations served). in short, it investigated within-firm wage distributions and inequality among south african manufacturing firms, with a focus on exporting firms. twenty one per cent of all south african manufacturing firms export and these firms employ on average 19 workers, whereas firms that do not export employ on average 7 workers. therefore, the impact of exporting firms’ wage inequality may have a significant impact on overall wage inequality in south africa. the results firstly showed that, right across the within-firm wage distribution (from the 5th to the 95th percentiles), there is a hierarchy in the wage premium for firms the further away a destination is located (i.e. sacu-only exporters’ wages are lower than africa-only exporters’ wages, which are in turn lower than international exporters’ wages). secondly, the results showed that the wage premium increases in magnitude towards the upper tail (75th and 95th percentiles) of the within-firm wage distribution (which illustrates wage inequality). therefore, exporters (specifically international exporters) seem to pay higher wages (and thus provide better jobs), although there is a higher degree of wage inequality within these firms. to arrive at potential explanations for this apparent wage inequality, the article considered the effect of firm characteristics (capital per worker, firm size and labour productivity). when firm size and labour productivity are controlled for, the wage distribution changes shape. this suggests that the wage inequality is largely driven by the size (number of employees) and labour productivity (output per worker) of exporters relative to non-exporters. most of the observed wage inequality is because larger, more productive firms are more likely to be exporters. in other words, wage inquality may be accentuated by further trade liberalisation because it leads to a re-allocation of resources from less productive to more productive firms (as explained in melitz 2003). even though the observed wage inequality is substantially smaller after controlling for firm size and output per worker, there is still a difference in the within-firm wage distribution of exporters relative to non-exporters, as well as within exporters. from the literature it emerged that there are two other possible sources of wage inequality – which relate to the skills levels required to manufacture goods – namely the characteristics of the destination economy (proxied by gdp per capita) and the quality of exports (proxied by price relative to the average price). when the characteristics of the destination economy and quality of exports are controlled for, the results show little evidence of wage inequality being driven by these. therefore, the observed wage inequality has little to do with the destination country (high or low income per capita), the quality of the product (high-quality versus low-quality product) or the type of product being exported. another possible explanation is that the remaining wage inequality is due to a specific type of firm (employing a specific type of person) that has this (unequal) wage distribution even before it enters the export market. in such a case it is most likely that the exporting firm is willing (and able) to pay a premium for a specific skill or skill set that is scarce but very valuable to the industry in question (e.g. highly effective marketers, technology experts or ceos). clearly, policymakers cannot simply look to increased exports as a way of achieving more inclusive growth. policies need to support specific types of exporting firms (the firms that have the potential to become the larger, more productive exporters). specific interventions might include: providing financial support and market information (using tools such as the trade decision support model) so that firms are better equipped to take advantage of available export opportunities, targeting investment in sectors with strong export growth potential, adapting trade and investment policy to allow cost-effective sourcing from abroad and to stimulate knowledge and technology transfer, and encouraging more competition in the local market. however, at a more fundamental level, if the wage gap between exporting and non-exporting companies is to be narrowed (and indeed wage inequality within firms is to be addressed), much more serious attention needs to be paid at the policy level to improving education and skills development in the country. this would involve driving high-quality teaching and learning by building capacity and accountability in schools and other education and training institutions (oecd 2016), reducing government red tape in the education and training sectors to encourage greater participation by providers and quicker and better results, and providing greater (including financial) incentive to firms to engage in staff training and development. another policy imperative should be to open up the education and training sector to more foreign participation, and promoting the regional exchange of expertise and cross-recognition of qualifications to encourage a more mobile workforce in southern africa. furthermore, accentuated within-firm wage inequality (as a result of trade liberalisation) might be addressed by ensuring that low-skilled individuals participate in life-long learning opportunities, thereby creating a more skilled cohort of workers and prompting a more inclusive approach to productivity enhancement. ultimately, through these various measures, the supply of skilled workers would increase, thereby reducing the premium paid to scarce skilled workers and spreading the workload and commercial benefits more evenly throughout society. in conclusion, there is much scope for further research to be done in the field covered by the study, which will further enhance people’s understanding of the labour dynamics of exporting firms in south africa. this in turn will help to give greater impetus to south africa’s currently troubled export and job creation efforts. acknowledgements all the authors would like to thank the united nations university world institute for development economics research and national treasury for funding support. also, they would like to thank the south african revenue service for the data. competing interests the authors have declared that no competing interest exists. authors’ contributions this article is based on a chapter c.b.’s phd thesis and c.b. constructed the article. m.m. and n.r. were her supervisors, and assisted with the conceptual construction of the study (and article). ethical consideration north-west university research committee meeting (trade), ethical clearance number ems/15/09/15-04-01, 27 february 2017. funding information this works received support from united nations university world institute for development economics research and national treasury. m.m. also acknowledges support from the national research foundation (nrf) of south africa (grant no. 127652). data availability statement the data is held by the national treasury. disclaimer the views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of any affiliated agency of the authors. any opinion, finding and conclusion or recommendation expressed in this material is that of the authors and the nrf does not accept any liability in this regard. references bacchetta, m., gregg, c., rubínová, s. & klok, b.t., 2017, investing in skills for inclusive trade, world trade organization (wto) and international labour office (ilo), geneva, viewed 29 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super-exporters: are they different and what does this mean for policy?, viewed 14 february 2017, from http://www.tips.org.za/research-archive/manufacturing-conference-2014/item/2798-south-african-super-exporters-are-they-different-and-what-does-this-mean-for-policy oecd, 2016, the productivity-inclusiveness nexus, viewed 05 september 2017, from https://www.oecd.org/global-forum-productivity/library/the-productivity-inclusiveness-nexus-preliminary.pdf. rankin, n., 2001, ‘the export behaviour of south african manufacturing firms’, munich personal repec archive paper no 16904, viewed 14 february 2017, from https://mpra.ub.uni-muenchen.de/16904/1/mpra_paper_16904.pdf. rankin, n., 2013, exporting and export dynamics among south african firms, occasional paper no 149, june 2013, south african institute of international affairs, johannesburg. rankin, n. & schöer, v., 2013, ‘export destination, product quality and wages in a middle-income country, the case of south africa’, review of development economics 17(1), 64–73. stolper, w.f. & samuelson, p.a., 1941, ‘protection and real wages’, the review of economic studies 9(1), 58–73. trademap, 2020, trade statistics for international business development, viewed 10 february 2020, from https://www.trademap.org. unu-wider (united nations university, world institute for development economics research), 2017, regional growth and development in southern africa, viewed 20 february 2017, from https://www.wider.unu.edu/project/regional-growth-and-development-southern-africa. van der berg, s., 2011, ‘current poverty and income distribution in the context of south african history’, economic history of developing regions 26(1), 120–140. verhoogen, e.a., 2008, ‘trade, quality upgrading and wage inequality in the mexican manufacturing sector’, quarterly journal of economics 123(2), 489–530. https://doi.org/10.1162/qjec.2008.123.2.489 world bank, 2016, world development indicators, viewed 10 march 2016, from http://databank.worldbank.org/data/reports.aspx?source=2&series=ny.gdp.pcap.pp.cd&country world bank, 2017, world bank county overview, viewed 23 march 2017, from http://www.worldbank.org/en/country/southafrica/overview. footnotes 1. a part of this article was incorporated into a unu-wider working paper (2017/11) titled ‘labour demand and the distribution of wages in south african manufacturing exporters’ (matthee, rankin & bezuidenhout 2017). 2. sacu is a customs union between botswana, lesotho, namibia, swaziland and south africa. 3. entering firms are defined as firms that did not export in year t–1, but exported in year t. 4. exiting firms are firms that exported in year t–1, but not in year t. 5. continuing firms are firms that exported in both year t–1 and year t. 6. the gdp per capita was obtained from the world bank (2016). 7. the wage distribution is the average figures (in wage per person) per quantile for descriptive purposes. 8. a recommendation for further research is to better measure the sources of inequality by using the theil index. the theil index allows one to determine the sources of inequality (domestic versus external factors) as the index can be decomposed into inequality within and between different defined subgroups. 9. there are no exiting firms because they do not trade and therefore would not be included in the customs transaction data. 180 sajems ns vol 5 (2002) no 1 the benefits of hiv / aids intervention in the workplace: a case studyl fie r booysen department of economics. university of the free state j molelekoa department of economics, vista university welkom abstract over the next ten years, as the aids epidemic takes its toll on the economically active population, employers will incur considerable costs. however, relatively inexpensive interventions, if implemented now, can yield substantial returns and save business considerable amounts of money. thus, social responsibility can be argued to make economic sense. worrying, though, is that there also appears to be a general apathy on the part of business, especially amongst small and medium-sized enterprises. a lot needs to be done to change the attitude of business and get business actively involved in the fight against hiv/aids. the private sector can and need to do its share in an integrated, coordinated response to hiv/aids, thus contributing to the initiatives on which the government, ngos and communities have already embarked. jelj50 1 background the hiv/aids epidemic poses a great threat to the economies of developing countries and diose on the african continent in particular. south africa is no exception and is being affected fundamentally by the epidemic. by the end of 1997, some 2.8 million people were estimated to be living with hiv/aids in south africa (ilo, 2000: 7). the estimated prevalence of hiv/aids among the country's adult population (11.8 per cent) is amongst the highest in the world. south africa also has the largest number of people living with hiv/aids of all countries (unaids, 2000). according to the metropolitandoyle model, the number of south african living with hiv/aids will increase from 160 000 to almost one million between 2000 and 20 i o. the annual number of aids deaths is estimated to increase from 120000 to between 545 and 635 thousand between 2000 and 20 i 0 (abt associates, 2000: 8-9). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no i 181 the epidemic has the potential to completely erode economic gains made in past decades. as the disease takes its toll on the economically active population, production and demand are expected to decline, which will slow down economic growth and development. studies on the macroeconomic impact of the disease have estimated that the differential in the economic growth rate will be 2010 amount to between 0.4 and 2.6 percentage points (arndt & lewis, 2000; ing barings, 2000: 2). the epidemic will also have serious budgetary implications in terms of increased government expenditure on health care and social security, which will be aggravated by the decline in government revenue due to declining economic activity (barnett & whiteside, 1998; ilo, 2000). employers will also incur considerable costs as the disease takes its toll on the economically active population. these costs result from increased absenteeism, direct and indirect medical costs, increased labor turnover, decreased productivity, and employee benefits payable to employees living with and dying from hiv/aids (bollinger & stover, 1999; whiteside & sunter, 2000: 11012). the degree of impact depends on (i) how many people are infected, (ii) the role of the infected persons in the company, (iii) the nature of the production process, (iv) the nature of the employee benefits provided by the company, and (v) the impact on the business environment in general following from the impact of hiv i aids on other companies and on government (loewenson & whiteside, 1997: 25). case studies conducted in south africa and other african countries present some information on the nature of this impact. so, for example, the cost of hiv/aids per employee has been estimated at between us$49 and us$300 (whiteside et al., 1999: 5). in a sugar mill in kwazulunatal the total annual cost per worker was estimated at r8464 (morris et al., 2000: 940). hiv/aids-related costs to business have been estimated as ranging between 0.8 and 8.6 per cent of the total wage bill (aventin & huard, 2000: 172; thea et ai., 2000) and between 3.4 and 20 per cent of profits (guinness & alban, 2000: 9). metropolitan has put the increase in the wage bill as a result of hiv/aids at respectively 25 and 45 per cent by 2005 and 2010 (ing barings, 2000: 12). according to the results of these studies, the major components of hiv i aids-related costs are absenteeism, employee benefits and health care. the mining, transport and storage, construction, and catering and accommodation sectors are amongst those most vulnerable to the impact of hiv i aids (ing barings, 2000: 29). although a number of large companies in south africa have conducted studies on the impact ofhiv/alds on their costs, little if any research has been conducted that will present a picture of how business in general will be affected. hence the cost to business of future aids deaths and the value of benefits from intervening so as to extend the working lives of hiv-positive employees and prevent the spread of hiv/aids remain largely unknown. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 182 sajems ns vol 5 (2002) no 1 2 aims and objectives in a recent article, rosen et al. (2000) present some calculations of the future benefits to firms of getting involved in combating hn/aids. the assumptions, though, on which their calculations are based are derived from studies conducted in other countries (i.e. malawi and botswana) or from case studies of select south african companies. these assumptions are not necessarily equally applicable to businesses operating in the free state province. in order to put a more accurate value to the benefits for business of extending the working lives of hiv -positive employees and of combating the spread of hn/alds, certain information related to the economic impact of hiv/aids were collected from businesses in bloemfontein and welkom. based on the assumptions derived from this data and results presented in other studies, the future costs of aids to business are estimated. these costs are then compared with the cost of now intervening in the workplace so as to extend the working lives of my-positive employees and combat the spread of the epidemic. michael (2000: 8) emphasizes the importance of such case studies in expanding the limited information on the costs of hiv / aids to business in south africa that is in the public domain. 3 data and method in certain case studies of individual companies employees are actually subjected to hn -testing, which is conducted in an anonymous and random manner. the resulting estimates of hn prevalence in the workplace are used to project future changes in the workforce, which is required for costing the impact of hn/aids in the particular setting (morris et ai., 2000). this approach was not followed in this study. the researchers simply did not have the resources or time to obtain approval from such a large number of businesses to conduct hn/aids tesfuig and the procedure prescribed by law, e.g. the provision of preand post-counselling. the project was aimed at doing a quick study that will inform the members of the chambers of business in bloemfontein and welkom about the likely impact of hn/aids. hence, the focus is on integrating primary and secondary data from a variety of sources, e.g. information obtained from companies themselves and published findings available from the literature, to estimate the cost of hn / aids for businesses in the two selected sites. hopefully, this work will encourage individual companies to avail researehers the opportunity to conduct more in-depth studies in specific settings, which will contribute much to the rather sparse literature on the impact of hn i aids on the private sector that is in the public domain. such research is also crucial for improving the assumptions made in studies of this nature. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 183 the need for adequate data was balanced with the need for an acceptable response rate in designing the self-administered questionnaire used for the purposes of data collection amongst business organizations. the questionnaire, amongst other things, collected infonnation on the type of industry, the number of employees, the composition of the workforce by age, gender, race and skill level, the average annual wage/salary bill, and average annual turnover. data were also collected on the nature of pension and employee benefits accruing to employees that are medically retired or pass away whilst in the service of the employer, sick leave, funeral leave and expenses, in-house health care services, and recruitment and training of new employees. this represents the background financial and human resource data required to estimate the impact ofhn/aids on business. information was also collected on the extent to'which businesses have implemented or intend implementing hivi aids programs in the workplace. businesses were also asked to indicate the amounts they are willing to pay to avert aids deaths amongst certain categories of employees. questionnaires were distributed among more than 200 randomly selected businesses in bloemfontein and welkom between december 2000 and january 2001. by march 200 i completed questionnaires were received from a total of twenty fmns, ten each in bloemfontein and welkom. admittedly, this response rate is relatively poor. however, self-administered questionnaires in general have a very low response rate. in addition, the lack of resources to do regular follow-ups so as to improve the response rate also contributes to the problem. yet, the information still provides some indication of the manner in which businesses in these two towns are dealing with the aids crisis. in terms of the standard international industrial classification (sic), nine of the twenty finns were from wholesale and retail trade, maintenance and repair services. two businesses each were from the construction and the real estate, renting and business activities industries respectively. the remaining seven businesses represent each of the following industries: (a) agriculture, hunting and forestry, (b) manufacturing, (c) hotels and restaurants, (d) fmandal intennediation, (e) education, (f) health and social work, and (g) other community, social and personal services. the twenty businesses in total employed 1600 employees. the average number of employees per business ranged from 2 to 1000 with an average of 80. three quarters of the businesses employed twenty or less workers. the average annual turnover of these businesses over the last five years amounted to ril.6 million, ranging from r70000 to rloo million. given these particulars, these businesses can mainly be described as smail to mediumsized enterprises. this lends a unique perspective to this particular case study. companies involved in other case studies were mostly subsidiaries of large national or multinational business corporations. the ilo (2000: 30), furthermore, emphasizes the need to expand the available knowledge on the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 184 sajems ns vol 5 (2002) no 1 impact of hiv i aids on smaller enterprises, which employs the majority of workers. the data collected from these businesses is combined with 1996 census data and estimates from other studies of the economic impact of hiv i aids on business to estimate the cost of aids to business. due to constraints of space, combined results are here presented for bloemfontein and welkom rather than distinguishing between these two individual towns in the free state province. 4 cost of aids to business in order to estimate the cost of aids to business one ftrst requires an estimate of the number of aids deaths. !ng barings (2000: 8) reports estimates of the number of aids deaths per 100 workers, based on projections made with the aid of the assa600 model. a distinction is made between highly skilled, skilled, and semiand unskilled workers2• the model makes certain restrictive assumptions about risk behavior and changes in behavior. the estimates of the number of aids deaths may look rather different when these assumptions are changed. however, this model remains the only readily available source of projections of the estimated number of future aids deaths. the number of aids deaths for 2001-2010 is estimated by multiplying the former ratio with the number of employed persons in bloemfontein and welkom aged is-59. the 1996 census data is used for this purposel . this represents the only data source that reports a relatively recent estimate of the number of employed persons in these two free state towns. this calculation of the number of aids deaths is based on the explicit assumption that the workforce remains stable over the next ten years and that workers that do die as a result of aids are replaced with newly recruited employees. the predicted niunber of aids deaths is reported in table i. evident from table i is that the largest share of deaths will occur amongst semiand unskilled employees, given that the prevalence of hiv amongst these employees is assumed to be relatively high. however, no employees are exempt from the epidemic. employees dying from aids also include a considerable number of highly skilled and skilled employees. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 table 1 predicted number of aids deaths in bloemfontein and welkom (2001~2010) 6.000 5.000 .. ... ii 4.000 t----~ ...... ----==_-.. ." '" = :;;: 3,000 t-------... co l e 2.000 .. :z; 1.000 2001 2002 2003 2004 2005 2006 2001 2008 2009 2010 id un/semiskilled employees q skilled employees • highly skilled employees 185 the specific costs resulting from these aids deaths need to be identified and quantified in a specific manner. certain costs pertain to individual infected employees, e.g. absenteeism and employee benefits. other costs resulting from the impact of hiv/aids concern all employees, e.g. rising medical aid premiums and funeral attendance. the cost to business of individual aids deaths is assumed to accrue in the last two years before the infected employee dies (rosen et al., 2000: 302). values for 2001 are inflated by five per cent per annum to determine the value of these aids~related costs in each of the subsequent years. an average annual inflation rate of five per cent is considered justified insofar as this represents the upper limit of the inflation targets recently announced by the south african reserve bank. the predicted inflation rate employed in the macroeconomic forecasts for the next three fmancial years also falls within this range (national treasury, 2001: 38). the individual components of aids costs are treated in the following manner in calculating the cost of future aids deaths to business in bloemfontein and welkom. the calculations employed in estimating the number of aids deaths, each of the cost components, and the average cost of aids per employee and per aids death are described in an appendix to this paper. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 186 sajems ns vol 5 (2002) no 1 4.1 recruitment and training costs aids-related deaths of employees require that businesses replace these workers, which involves expenses regarding recruitment and training. businesses that participated in the survey were asked to indicate the number of new employees recruited over the past five years and the average annual amount spent on recruiting and training these new employees. the twenty firms that returned completed questionnaires on average spent r6804 per new recruit. this amount is substantially lower than the estimate of r8405 employed by rosen et al. (2000: 302) and which was obtained from a study of five companies conducted in botswana. given that these relatively small or medium-sized businesses in bloemfontein and welkom utilize less expensive recruitment channels and agents than large business corporations, this assumption may be justified. the aids-related cost pertaining to recruitment and training is calculated by multiplying the number of aids deaths for each year by r6804 after adjusting for the effect of inflation. 4.2 cost of employee benefits businesses also need to pay employee benefits to workers that die whilst in their service or who are retired on medical grounds as a result of aids. the majority of the businesses consulted during the survey indicated that they do provide pension benefits to employees. the reported value of these benefits range from one to four times annual salary. however, seventeen of the twenty firms indicated that they do not offer any such benefits when employees opt for medical retirement. in other studies an assumption is sometimes made about the proportion ofhiv-positive employees that die whilst in service and that are boarded medically (thea et al., 2000). for simplicity, it is assumed that infected employees do not accept medical retirement and that these benefits are paid to their dependents as a pension. the cost of these employee benefits is estimated at three times the average annual salary of the deceased worker. rosen et al. (2000: 302) employed a similar assumption. the total value of employee benefits related to aids deaths is calculated by multiplying by three the average annual salary of highly skilled. skilled. and semiand unskilled workers, as calculated from the data collected during the business survey. to obtain the total cost, this figure is multiplied with the annual predicted number of aids deaths in each of the three skill categories (table i). 4.3 sick leave a third major cost of aids results from the increased absenteeism of infected workers due to illness and due to funeral attendance. the majority of the firms consulted in the business survey indicated that they offer employees the ten r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no i 187 days of paid sick leave per annum stipulated in the act on basic conditions of employment. businesses were not asked about actual trends in absenteeism, because it is impossible to distinguish aids-related absenteeism from nonaids-related absenteeism without knowing the identity of infected workers. moreover, infected employees are likely to in the last two years of their illness be absent for considerably longer than ten days. a study by ing barings (1999) has estimated that total absenteeism could amount to as much as 250 productive days per infected employee over the course of the illness. given that the data collected from the business survey does not allow the number of days infected employs will be absent from work to be estimated directly, the relatively conservative assumption that rosen et al. (2000: 302) employ for this purpose is used here. they assume that absenteeism reslliting from aids amounts to 55.5 days sick leave per infected employee; spread equally over the two years before the death of the infected employee. the cost of absenteeism is calculated by multiplying the average number of days of sick leave by double the daily salary, which is calculated from average salary levels. this is considered a conservative but acceptable approach to putting a value to the direct and indirect cost of absenteeism. businesses not only have to pay workers a salary while they are absent from work, but may also have to hire replacements and/or take into account that the absence of these workers results in productivity losses. 4.4 funeral attendance the aids epidemic will also have an impact on the leave that employees take to attend funerals. one would expect the number of person days lost due to funeral attendance to increase as the aids epidemic intensifies, i.e. as an increasing number of co-workers and family members of employees die as a result of aids. this particular cost applies to all employees and not only ones infected with hn, thus emphasizing the point that all people are ultimately affected by the aids epidemic. as in the case of sick leave, the business survey only collected information on the number of days of funeral leave offered to employees. again the majority of businesses indicated that they offer the three days per annum stipulated by the act on basic conditions of employment. furthermore, it is not possible to distinguish between funeral attendance related to aids deaths and other causes of death. hence, this particular cost component is quantified only in relation to the number of aids deaths amongst employees. it is assumed that for each worker that dies of aids, one highly skilled employee, one skilled employee, and one semior unskilled employee will each take two days funeral leave. as in the case of absenteeism, the cost of funeral leave is calculated by multiplying the two days of funeral leave by double the daily salary of the employees that are assumed to take such leave. this number is multiplied by the number of aids deaths to r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 188 sajems ns vol 5 (2002) no 1 obtain the total cost to business of funeral attendance. although this assumption is very conservative, it should present an acceptable proxy of the additional working days lost as a result of funeral attendance resulting from aids deaths. 4.s funeral expenses in the case of funeral expenses, only one of the twenty businesses consulted during the survey indicated that they contribute to the burial costs of employees that die whilst in their service. for this sample of businesses, therefore, this particular cost of aids remains the responsibility of the kin of the deceased rather than their employer. consequently, this cost component is excluded from this analysis. 4.6 cost of health care services certain businesses provide their employees with in-house medical or health care services. in the face of the aids epidemic these direct medical costs to business of aids deaths should increase substantially. however, the majority of the businesses consulted during the survey do not provide such services. where the particular question was answered in the affirmative, it simply related to emergency medical care provided in the case of occupational injuries. consequently, this particular component of aids costs is excluded from this analysis. none of the twenty businesses indicated that they are currently spending money on hiv / aids programs, which also removes this element of the direct cost of aids from the analysis. 4.7 medical aid premiums lastly, there is the fact that medical aid premiums will increase as insurers come under increasing pressure and pay--outs to hn -positive patients increase. as in the case of funeral leave, this particular cost applies to all employees with access to such benefits and not only to employees dying from aids. a quarter of the businesses participating in the survey indicated that they do offer their employees medical aid benefits. the contribution of these businesses to their employees' medical aid funds ranged between five and ten per cent of the person's salary. the contribution in most cases was shared equally between the employer and employee. on closer inspection of the data it was found that the majority of employees in the service of businesses offering these benefits are highly skilled employees. in turn businesses not offering these benefits mostly employ skilled, semi-skilled and unskilled workers. hence aids costs related to increased medical aid premiums are only calculated for highly skilled employees. the average medical aid premium paid· by the employer is r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 189 calculated as 7.5 per cent of the average salary of highly skilled employees. this premium is escalated by 9.4 per cent per annum, which represent the average increase in medical aid premiums reported by thea et al. (2000). the aids-related increase in premiums was then determined by multiplying the number of highly skilled employees by the annual difference between the normal and escalated medical aid contribution per employee. 4.8 total cost of aids to business in order to estimate the total cost to business of aids the value of each of the above cost components was first estimated. the total annual cost was then obtained by adding up each of the five cost components. a d.istinction is made between aids costs pertaining to highly skilled, skilled, and semiand unskilled employees. these values, like those presented elsewhere in these pages, are present values. present values are calculated by discounting the future cost of aids at ten percent per annum, which approximates the difference between the interest rate and inflation rate (i.e. the so-called real interest rate). this adjustment is necessary so that the cost of current interventions can be compared to the savings to be gained from extending the working lives of my -positive employees or of preventing one infection and therefore one future aids death. table 2 total annual cost of aids to business in bloemfontein and welkom (2001-2010) j50.000.000-r------------------..,. ... : ho.ooo.ooo+------!. .. .! 20 •• 000.000+-----=:--. .. • : .. .. .. j 00,000,000 50,000.00' a va/scm i~ : .killed ! employeea i a.killed : employee • i biably , -,till.4 ! . employees , i the total cost of aids to business in bloemfontein and welkom is substantial (table 2). the average annual present value of the cost amounts to nearly r236 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 190 sajems ns vo15 (2002) no 1 million, while the total present value of these annual costs adds up to close to r2,4 billion over the period often years. annual costs continue to increase and peak in 2009 when the aids epidemic is assumed to reach its turning point. table 3 reports on the distribution of the total annual cost of aids by level of skill. table 3 distribution of total annual costs of aids to business in bloemfontein and welkom by level ofskill (2001-2010) i----~---------------------~ 2001 2002 2003 2004 200' 2006 2007 2008 2009 2010 m:~:~iemployees c skilled employeu highly • skilled emolovees because .the number of aids deaths amongst semiand unskilled workers exceeds that amongst highly skilled and skilled workers (table 1), the largest share of the aggregate cost of aids can be attributed to deaths amongst semiand unskilled employees. on average just more than half of the total cost of aids accrues to semiand unskilled workers over the period of ten years. skilled and highly skilled workers on average share respectively twenty-nine and twenty per cent of the total cost of aids over the period. cohen (2000) reports a similar trend in the distribution of the cost of aids between employees of different levels of skill. 4.9 limitations oftbe study the above estimates and those presented elsewhere in these pages represent a relatively conservative estimate of the cost to business of hiv i aids. in fact, the estimates for a variety of reasons most likely present an underestimation of these costs; for example, the labor force was assumed to remain constant over r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 191 the next ten years. it was also assumed that employees that die as a result of aids are replaced. different assumptions about this, e.g. that the workforce increases as the economy grows or that not all infected employees are replaced once they die, would have seen costs either increase or decrease, depending on the specific nature of these assumptions. this study only quantifies a relatively small number of the cost components of aids. the analysis does not attempt to put a value to the so-called systemic costs of aids, e.g. the impact of a loss of workplace cohesion and workforce experience or the external impact resulting from changes in demand and the introduction of legislation goveming mv / aids in the workplace. nor are indirect costs such as those resulting from reduced productivity and an increased management burden quantified here (whiteside & sunter, 2000: 110-12). these costs can only be estimated following an in-depth study of specific rums, which falls outside the scope of the business survey conducted for the purposes of this analysis. furthermore, a proportion of skilled employees also has access to medical aid benefits, which will further increase the aids-related cost to business of escalating medical aid premiums. the assumption made about time lost to funeral attendance is relatively conservative and more man-days are likely to be lost through increases in funeral attendance. the major costs following from an aids is assumed to accrue in the last two years before the infected employee's death. yet, earlier episodes of illness will also lead to increased absenteeism, with a corresponding increase in the estimated costs of the impact of hiv / aids. also, national estimates of the predicted number of aids deaths were used to calculate these cost estimates for bloemfontein and welkom. in terms of recent sera-prevalence data, the free state province faces a more severe and faster growing aids epidemic than many of the other provinces in south africa (cohen, 2000). hence the number of aids deaths may be underestimated, which in tum implies that the total cost of aids to businesses in bloemfontein and welkom is also underestimated. in terms of the comparison of these costs to the cost of current interventions to determine the benefit to business of intervening now, the estimated return on current interventions will also be underestimated. this means that the message to business that current interventions are worthwhile becomes of even greater importance. this, in combination with the fact that this study relies on information obtained from a relatively small sample of businesses (20), means that the extent to which the findings can be generalized to all businesses in these two towns and in the free state province as such may be problematic. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 192 sajems ns vol 5 (2002) no i figure 1 composition of cost of aids to business in bloemfontein and welkom (2001-2010) recruitment and training 4.10 composition of cost of aids the composition of the total cost of aids is also of interest in studies of this nature. figure i represents the percentage share of each of the five cost components in the total cost of aids. these results are not directly comparable to findings from other studies, which may employ different assumptions and include different cost components in estimating these costs. however, the results broadly correspond to findings presented in other studies. employee benefits and absenteeism here represent the major components of aids costs, respectively contributing fifty-three and twenty-four percent to total costs. in other studies these two cost components consistently feature amongst the largest cost components. so, for example, thea et 01. (2000) report pensions to make up between forty and seventy per cent of total cost, while aventin and huard (2000; 167) put this at twenty-four per cent. a ventin and huard (2000; 167) estimate that absenteeism contributes between eighteen and thirty-one per cent to total aids costs. whiteside and sunter (2000: 10 i) report an estimate of fifty-two per cent for absenteeism from a study conducted across a number of countries. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 193 4.11 average cost per employee and per aids death estimates of aids costs can also be presented as the average aids cost per employee (table 4) and the average cost per aids death (table 5). the respective estimates are calculated by dividing the total cost of aids by the total number of aids deaths and the total number of employees. averages are reported for all employees as well as for each of the three different categories of employees, i.e. highly skilled, skilled, and semiand unskilled workers. these estimates present a better indication to business of the relative cost of aids than estimates of aggregate costs. it also presents important proxies to be employed in determining the value of implementing hiv/aids interventions in the workplace. table 4 average cost of aids per employee (2001-2010) soo.oo 1000.00 rands (preseilt value) 1500.00 highly skilled ri8\3.33 2000.00 as expected, the average cost per employee increases as the level of skill increases. there are two reasons for this. first, cost depends on salary, which means that costs increase as the average salary increases. second, the cost of increased medical aid premiums was assumed to accrue only to highly skilled employees. as in the case of the composition of aids costs, these estimates cannot be directly compared to results reported in other studies. broadly speaking, though, the results again confer with other fmdings. whiteside et al. (1999: 5), for example, report a range of estimates of the annual cost of aids per employee of between us$49 and uss300. the above estimates, when translated into us dollars using the current exchange rate (r7.84 per ussl), equate to between us$231 (highly skilled employees) and us$136 (semiand unskilled employees). these values fan well within the range of estimates reported by whiteside et al. (1999). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 194 sajems ns vo15 (2002) no i tables average cost per aids death (200)·20)0) as in the case of the aids cost per employee, the average cost per aids death increases as the level of skills increases. although a different methodology is employed here to estimate the cost of aids, the estimates correspond closely to those estimated by rosen et al. (2000) rosen et at. (2000; 303) estimated the cost per aids death respectively as ri81222 (highly skilled employee), r92767 (skilled employee), and r48540 (semior unskilled employee). the average cost per aids death reported in table 5 respectively represents 2.5 times (highly skilled), 1.27 times (skilled), and 1.35 times (semiand unskilled) the average annual salary of these classes of employees. these estimates correspond relatively well with some of the fmdings reported elsewhere, but are also substantially lower than other estimates. michael (2000; 8), for example, puts the cost per aids death at between three and four times the annual salary of the infected. employee. cohen (2000) though, reports estimates of respectively 6.8, 5.1 and 5.2 times the annual salary of highly skilled, skilled and unskilled employees. as argued elsewhere, these differences can be attributed to differences in the particular methodology employed in estimating the cost of aids. 5 benefits to business of current interventions the most important parameter of the cost of aids with which to compare the cost of current interventions is the present value of the cost per aids death. these estimates were reported in table 5 and can be compared to the cost of current interventions in one of two ways. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no i 195 first, there is the option of extending the working life of infected employees. this will allow businesses to keep infected employees in productive service for longer, implying less interruption in production and reduced labor turnover. if business can manage to extend the working life of an hiv -positive employee by one year or more it also means that the current value of the future cost per aids death will be discounted over a longer period of time. this will reduce the current value of the cost per aids death. assume, for example, that the working life of all hiv -positive employees can be extended by one year. this means that the cost per aids death will be discounted over a period of eleven rather than ten years. the difference between the average cost per aids death discounted over eleven as opposed to ten years amounts to r5491.18. table 6 reports the average savings per infected employee for highly skilled, skilled, and semiand unskilled employees. savings are also calculated across all employees. savings as percentage of the baseline cost per aids death (table 5) increase from nine to thirty-eight per cent as the working life of the infected employee is extended with one to five years. tabled average savings per infected employee of extending tbe working life of mv -positive employees in bloemfontein and welkom (2001-2010) 10 000.00 -,--__ ~ .. ______________ _ :: 70000.00 +----------------lilm--.~__1 ,-----, .. ~ ; 6000 •. ('o~----------_m~-: %: a : 4000.(w~----~--~~~ ---j~1----~-~ • '. ~ 1 •••• ,('o~----_rn,r----~~----~i,r_----~--~ = 200 •• (w~----,--~~----~---~ . '" i •• o.,o~hm----ei ~~1~~ employeel akillcd • employee. q ::~i~·~ cmdlovces ii :~pktycea r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 196 sajems ns yol5 (2002) no 1 according to rosen et a/. (2000: 303) there are relatively inexpensive ways to extend the working lives of hiv -positive employees. they elaborate on three specific examples. a study in spain found that a single twelve-month course of tuberculosis prophylaxis (isionazid), which costs approximately r40.00 per annwn, on average increased the median survival time of my-positive adults by three years. in a study conducted in the ivory coast it was found that a daily dose of prophylactic cotrimoxazole administered to hiy-positive adults from discovery of infection until death reduced the rate of severe events leading to hospitalization or death with forty-three per cent. this drug costs approximately r90.00 per annwn, while the discounted cost of ten years of therapy amounts to nearly rsoo per patient. counseling and other psychosocial interventions can be equally useful in extending the working life of infected employees. in the united states, for example, a study found that such interventions reduced the probability of developing aids at 5.5 years after infection by two to three times among adult men (rosen et al., 2000: 303). although no details are available about the likely cost of such interventions, these costs may be relatively modest compared to the substantial savings per aids death reported in table 6. no information is available on the cost of hiv i aids interventions in south africa and more work is required in this regard. the cost of the first two interventions described here (i.e. isionazid and cotrimoxazole) is relatively low compared to the benefit to be gained from extending the working life of infected employees. the combined cost of these two drugs make up less than ten per cent of the average savings per aids death of extending the working life of hiv -positive employees by just one year. this represents a tenfold return on such investment. these costs are also much lower than the amounts that surveyed businesses indicated they are willing to pay to avert a single aids death or that they are willing to allocate to such programs in future budgets. thus, relatively inexpensive interventions, if launched now, can yield substantial returns and save business considerable amounts of money. furthermore, particularly in terms of counseling and psychosocial interventions, interventions need not require additional resources to be channeled toward such initiatives. it may, for example, be possible to assign such responsibilities to the hwnan resources and/or occupational health functions of management without incurring additional costs. the above results gain even greater significance when considering that none of the businesses consulted during the survey currently have any hiv/aids program running in the workplace. alternatively, the benefit to business of managing to avert one future aids death through current interventions would equal the cost per aids death minus the cost of the particular intervention. this issue can be best analyzed with reference to the information obtained from a business survey. businesses were asked what they are willing to allocate toward implementing hiv/aids programs in the workplace and what they are willing to pay to avert a single r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vols (2002) no 1 197 aids death amongst certain groups of employees. only five of the twenty firms indicated that they are willing to allocate money toward hiyi aids programs in future budgets. these moneys amount to an average of r120 per employee, ranging from r2.13 to r1333 per employee. in the case of the question on willingness-to-pay, seven of the twenty businesses indicated that they are willing to spend some money to avert an aids death. these amounts range from rloo to rsoooo, while the average amount the said firms were willing to pay to avert one aids death amount to r6884. when taking the education or skill level of employees into account, the average amount ranges from r7412 (highly skilled employee) to r6294 (unskilled employees). these amounts are relatively modest compared to the benefits of managing to avert one aids death. assume, for example, that a business spends somewhere between r6884 and r9600 this year to implement an hiv i aids program in the workplace. the former estimate represents the average willingness-to-pay to avert a single aids death, while the latter represents an annual hiv i aids budget of r120 per employee, given an average labor force of eighty. if the said program is successful in preventing just one employee from becoming infected and dying ten years from now, the investment will yield a 4.5 to 6.s fold return relative to the average cost per aids death of rs2 883 for 2010. therefore, relatively modest investments in current interventions can yield considerable returns, given of course that such programs are effective. employees attach considerable weight to information received in the workplace, which highlights the importance of the workplace as a site for information and education programs (farnham, 1991: 663). 6 conclusions and policy implications over the next ten years, as the aids epidemic takes its toll on the economically active population, employers will incur considerable costs. however, relatively inexpensive interventions, if launched now, can yield substantial returns and save business considerable amounts of money, given that such programs are implemented effectively and efficiently. both interventions aimed at extending the working life of currently infected employees and interventions aimed at preventing future aids deaths are economically feasible. worrying, though, is the fact that a large proportion of businesses consulted during the survey indicated that they are not willing to spend money on hiv i aids programs or pay to avert aids deaths. given that the survey mostly included small and medium-sized firms, this may simply reflect the inability of firms with a relatively low turnover and a small budget to allocate money to hiv/aids programs at a time when the national economy is still reeling from the recent recession. yet, there does appear to be a general apathy on the part of many managers. two quotes from the survey strikingly illustrate this negative r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 198 sajems ns vol 5 (2002) no i sentiment on the part of certain managers. one business indicated that there are 'so many other people to replace the dead (and that) only people with degrees might be a problem'. another business volunteered that 'we use people from the middle and even upper class who know (hopefully) everything about aids. (we) do not see the necessity of such a program. everyone has a television and reads newspapers where the matter is discussed on a daily basis. i am not aware of any problem amongst my staff, and do not see why i must spend money on something which the firm will not benefit from'. this problem appears to not be unique to bloemfontein and welkom or the free state province for that matter. farnham (1991: 663) reports that a study conducted in 1987 amongst 623 us companies found that seventy-one per cent of these companies at the time neither had, nor planned to implement an aids policy in the workplace. a study conducted amongst local employers in north nottinghamshire found that only twenty per cent of the eighty-six respondents had a policy on hiv/aids, with'local businesses particularly, that are not subsidiaries of national or regional corporations, failing to implement such policies (whelan et al., 1994: 101). in the case of asia, kimball and myo (1996: 1) emphasize the lack of access to information and education in the workplace and failure of efforts to gain cooperation of business and industry in the fight against hiv/aids. hence much needs to be done to change these attitudes of business, not only in south africa but also elsewhere. moreover, the current policy environment, seems supportive of this increased role of business in the fight against hiv/aids. for example, the code of oood conduct on key aspects of hiv/aids and employment issued in december 2000 emphasizes the role of employers in 'developing strategies to assess and reduce the impact of the epidemic upon the workplace' and 'supporting those individuals who are infected or affected by hiv/aids so that they may continue to work productively for as long as possible' (department of labour, 2000: 5). to this end companies should, according to smart (2000: 14) establish so-called care task teams thai will develop a care strategy that describes (i) who will have access to care, (ii) what the care will consist of, and (iii) who will cover that costs. components of such care strategy may include establishing support groups and networks of people living with hiv, supporting home-based care initiatives, and providing health services (smart, 2000: 14). in south africa, as in other countries (!lo, 2000: 27), employers have also formed a business coalition on hiv/aids (sabcoaha) in order to pool resources and improve their response to the crisis. the private sector, government and noos should also consider initiatives that can support smaller fum.s in offering their employees training and counseling on hiv / aids. an example is the development of care and prevention programs fmanced via mutual health funds established for small enterprises (ilo, 2000: 30). lastly, as whiteside (2000: 5) emphasizes, the involvement of business in partnership initiatives in fighting r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 199 hniaids and mitigating its impact should be based on a give-and-take relationship in which the benefits to business are clearly illustrated. it is hoped that this paper may contribute to this process of education and may encourage business involvement in an integrated, coordinated fight against hn i aids by government, ngos and communities. endnotes an earlier version of this paper was presented at the international aids in context conference, 4-7 april 2001, university of the witwatersrand, johannesburg, south africa. 2 the survey did not distinguish between highly skilled, skilled, and semiand unskilled employees, which is the classification of employee!! used here to estimate the cost of aids. instead a distinction was drawn between employees with different levels of education. consequently, employees with degrees were assigned to highly skilled category, ones with a certificate or diploma to the skilled category, and those with matric or less to the semiand unskilled category. 3 the census results are reported in terms of the standard intemational classification of occupations. this classification does not allow for a distinction to be drawn between highly skilled, skilled, and semiand unskilled employees, which is the classification of employees used here to estimate the cost of aids. consequently, employed persons were assigned employed persons to the three skill categories for which aids death ratios are available using this classification. highly skilled employees comprise of legislators, senior officials, managers and professionals. skilled employees include technicians and associated professionals, clerks, skilled agricultural and fishery workers, and plant and machine operators and assemblers. semiand unskilled employees consist of service workers, shop and market sales workers, craft and related trades workers, and elementary occupations. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 200 sajems ns vol 5 (2002) no i appendix the estimates of the cost of aids to businesses in bloemfontein and welkom that are reported in these pages were calculated as follows: (i) number of aids deaths per skills category = [(number of workers per skill category)lloo] x estimated number of aids deaths per 100 workers per skills category. (ii) total number of aids deaths = l number of aids deaths per skill category. (iii) cost of recruitment and training = number of aids deaths x r6804. (iv) cost of sick leave = number of aids deaths per skill category x (55.5 days x 2 x average daily salary per skill category). (v) cost of funeral leave = number of aids deaths (ii) x [(2 days x 2 x average daily salary of unskilled employee) +(2 days x 2 x average daily salary of skilled employee) + (2 days x 2 x average daily salary of highly skilled employee)]. (vi) cost of increased medial aid premiums = number of highly skilled employees x [(7.5 per cent x average annual salary) x 9.4 per cent]. in calculating the results for each subsequent year (i.e. 2002 to 2010), the particular cost components (i.e. cost of recruiting one new employee, average daily salary and cost of medical aid premiums) were inflated at five percent per annum. the number of aids deaths in each of these years, was calculated based on the estimated number of deaths per 100 workers reported for 200 i to 20 i 0 by ing barings (2000: 8). (vii) average annual total cost of aids deaths = l [(iii) + (iv) + (v) + (vi)] x {l/l.lo)d for each of the years 2001 to 2010, where n represents the number of years between the current year (200 i) and each of the outer years (i.e. 2002 to 2010); calculated for all employees and per skills category. (viii) average cost per employee = (vii)/number of employees; calculated for all employees and per skills category. (ix) average cost per aids death := (vii)/number of aids deaths; calculated for all employees and per skills category. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 201 references abt assocla tes (2000) the impending catastrophe: a resource book on the emerging hlvlaids epidemic in south africa, johannesburg: henry j. kaiser family foundation. 2 arndt, c. & lewis, j.d. (2000) "macro implications of mv/aids in south africa: a preliminary assessment", south african journal of economics, 68(5): 856-87. 3 a ventin, l. & huard, p. (2000) "cost of aids to three manufacturing finns in cote d'ivoire", journal of african economies, 9(2): 161-88. 4 barnett, t. & whiteside, a. (1998) guidelines for preparation and execution of studies of the social and economic impact of hlviaids. geneva: unaids. 5 bollinger, l. & stover, j. (1999) the economic impact of aids. glastonbury, ct: futures group international. 6 cohen, n.p. (2000) economic impact of hlvlaids on south africa. mimeo of presentation in pretoria on may 25. 7 department of labour (2000) "code of good practice: key aspects of hiv/aids and employment", government gazette, no. 21815: 3-17. 8 farnham, p.g. (1991) ''knowledge, attitudes, beliefs, and behaviors of the business community relative to hiv/aids", public health reports, 106(6): 663-66. 9 guinness, l. & alban, a. (2000) economic impact of aids in africa: a review of the literature, unaids background paper for african development forum 2000. 10 ing barings (1999) demographic impact of hiviaids on the south african economy, johannesburg: ing barings. ii ing barings (2000) economic impact of aids in south africa: a dark cloud on the horizon, johannesburg: ing barings. 12 international labour organlsa non (2000) hiviaids: a threat to decent work, productivity and development, document for discussion at the special high-level meeting on hiv/aids and the world of work, geneva, 8 june. 13 kimball, a.m. & myo, t. (1996) "role for business in hiv prevention in asia", lancet, 347(9016): 1670-72. 14 loewenson, r & whiteside, a. (1997) social and economic issues of hi vi aids in southern africa, harare: safaids. 15 michael, k. (2000) "unbelievable: aids reporting in the business press", aids analysis africa, 10(4): 1-8. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 202 saiems ns vol 5 (2002) no 1 16 morris, c.n., burdge, d.r., cheevers, e.j. (2000) "economic impact of hn infection in a cohort of male sugar mill workers in south africa", south african journal of economics 68(5): 933-46. 17 national treasury (2001) budget review joo} , pretoria: national treasury. 18 rosen, s., simon, j.l., thea, d.m. & vincent, j.r. (2000) "care and treatment to extend the working lives ofhiv-positive employees: calculating the benefits to business", south african journal of science, 96: 300-304. 19 smart, r. (2000) "aids care: why and how should industry respond", aids analysis africa, 10(5): 13-14. 20 thea, d.m., rosen, s., vincent, j.r., singh, g. & simon, 1. (2000) economic impact of hiviaids in company a's workforce, mimeo. 21 whelan, s., mousley, a.a. & wight, j.p. (1994) "survey of employers' policies on hn and aids in north nottinghamshire", journal of public health medicine, 16(1): 101-4. 22 whiteside, a., (2000) "aids and the private sector", aids analysis africa, 10(5): 1-6. 23 whiteside, a., o'grady, m. & alban, a. (1999) how will aids impact on your business? 1998 southern africa economic summit, update session, 4 july. 24 whiteside, a. & sunter, c. (2000) aids: the challenge for south africa. cape town: human & rousseau tafelberg. 25 unaids (2000) report on the global fuviaids epidemic, available: http://www .unaids.orgl epidemic _ updatelreportlindex.html. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . journal 10.p65 ��� ������ � � �� �� � � ������������������ ��� � ������� ��������� ����� ���������� ���� ��� �� ��� ����� ��� ������ �� �� � ���� ��� �� � �������� ������������ ��� �� � �� ��� � ��� � ����� � �� � �� ��� � � � ���� �� ������ � � � �� ��� � �� ����� � � �� ����� ��� ���� �� ���� ������ � ���� � ��� �� ���� ��� � ������ � � ������ � ��� � ��� �� � ������ �� �� ������ �� � � � ���� �� �� ���� � � ���� �� � �� ����� ������ �� ��� �� � � � �� ��������� ����������� �� ���� ����� � �� ����� �� � � � ��� ��� � � �� � ������� �������� ���� ��� � ��� �� � ��� ����� � �� ������� � �� � � � ���� �� �� ���� � � ���� �� � �� ����� ������ �� ���� ��� �������� �� �� 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no 1 an empirical capital market rate function for south africa elna pretorius and charlotte du toit department of economics. university of pretoria abstract the aim of this paper is to explain the detenninants of the south african longtenn interest rate. a market-related approach is followed which explains interest rate detennination on the basis of the relationships between the capital maricet and other domestic and international markets. some implications for monetary policy are derived. jel g 12 1 introduction interest rates are the key detenninants in the flow of funds from the financial sector to particular real investments in the real sector of the economy. if the markets operate efficiently, funds flow to the most economically attractive real investment opportunities, where attractiveness is detennined by the interest rate offered and the probability of being repaid. in practice, money flows in large amounts from lenders to different borrowers on the basis of fairly small changes in interest rates. relatively small changes in interest rates can therefore cause huge flows of money from one sector to another. these flows, in tum, can be a major detenninant of the amount of real economic activity that takes place and in what sectors growth occurs. even a percentage point increase can have a huge impact on the present discounted value of future revenues, and thus on investment decisions, output and jobs (smith & spudeck, 1993: 14). interest rates are therefore a vital part of the economy, and knowledge of the role of interest rates and the reasons underlying their movements is crucial to an understanding of financial developments and economic po hcy. monetary authorities are particularly interested in the detennination of the longtenn interest rate and wish to understand to what extent they can influence it. in south africa the reserve bank plays a vital role in detennining the level of short-term interest rates since these are closely related to the repo rate, which is the interest rate at which the reserve bank lends money to commercial banks. however, monetary authorities do not know .whether, and to what extent, they r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 67 can influence the long-tenn interest rate. the aim of this paper is to determine the factors underlying changes in the long-term interest rates in south africa, with specific reference to the implications for monetary policy. apart from analysing the univariate characteristics of the data and empirically estimating the factors that influence the interest rate and the magnitudes of these influences, the estimated function is subjected to rigorous diagnostic and stability testing. the estimated function can be used to forecast the long-run level of south african interest rates, and will form the linkage between the real and fmancial sectors in the macroeconometric model of the department of economics, university of pretoria. 2 the socio-political environment in south africa the course of south african interest rates could be influenced by the different phases of monetary policy and the dramatic socio-political changes in the country. since the empirical function will be estimated for the period 1960 to 1998, the discussion will also be confined to this period. during the 1960s, the south african reserve bank attempted to slow down an excessive expansion of liquidity in the banking sector by introducing a required liquid asset ratio in the banks act of 1965. after the promulgation of the banks act, there were years of brisk economic activity, increasing inflationary pressures and a rapidly expanding liquidity base of the banking system. during his tenure, dr de jongb (reserve bank governor from 1967 to 1980) implemented a series of additional direct controls such as a ceiling on advances, deposit rate controls, exchange control, import deposits and some direct consumer credit controls in an effort to contain the persistent increases in money supply and the inflationary tendency. the results were encouraging, and the country enjoyed higb levels of real growth. the controls of the 1960s and 1970s gave way in the 1980s to a general recognition of the need to abolish as many restrictions as possible in a shift to market-oriented policy. this was in line with the international thinking of the time. during the 1980s, there was a definite shift across the globe in favour of market-oriented policy measures. this shift in policy was further encouraged by the liberalisation of international financial markets. south africa likewise followed this pattern, and under dr de kock (reserve bank governor from 1981 to 1989), the reserve bank became more willing to align its policies to market developments, rather than to try to force markets in a certain direction. this was the most difficult decade in the history of the reserve bank, operating as it did in the face of widespread international hostility and growing resistance r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 68 sajems ns vol 4 (2001) no 1 to the consequences of the economic and racial policies of the government at the time. after president pw botha's so-called rubicon speech, international sanctions and a debt boycott were introduced against south africa. and huge amounts of capital flowed out of the country almost immediately. this period of international isolation was characterised by high interest rates that attempted to prevent capital outflow and attract foreign capital. (botha, 1997; fourie et al., 1999: 314). although monetary policy did not change much in the 1990s the stals era some most dramatic changes in the socio--political situation occurred during this period. after the first democratic election in 1994, political barriers were removed and south africa became more exposed to world financial market movements, as a result of the abolition of sanctions and the scrapping of exchange controls on foreigners. since 1994 in particular, south africa has adopted a clearly defined policy of actively participating in the process of fmancial globalisation and implemented a number of economic policies to facilitate its participation in globalisation (stals, 1999). financial globalisation caused revolutionary and irreversible changes in capital markets. international capital transactions have accelerated and international financial interdependence increased substantially. innovation and deregulation have changed financial market structures. more instruments and markets have developed, and technological change has made portfolios comprising international assets universal. as a consequence of these transformations, financial markets have become more efficient, but also more volatile and subject to speculation. some countries benefit greatly from the opportunity to attract unprecedented inflows of capital. however, international markets tend to shun countries that are not performing well. it is therefore not surprising that subsaharan africa. the region with the world's poorest growth record, is now a net exporter of capital. furthermore, capital flight is increasingly prevalent in countries that are perceived not to provide competitive investment opportunities. the international environment has simply become much more averse to countries that do not foster competitive economies (handley & mills, 1996: 74). in broad, monetary policy in south africa since the 1960s can thus be divided into the pre-1985 and post-1985 periods, with a shift from the use of direct monetary instruments to more market-oriented monetary policy. this dramatic policy shift implies that monetary variables such as interest rates will contain a structural break, which should be reflected in the empirical estimation of such a variable. the most significant socio-political events that impacted on the course of south african interest rates, international sanctions and the process of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no i 69 financial globalisation, also have to be reflected in the empirical estimation of interest rates. 3 the south african capital market the capital market constitutes the long-term component of the financial system, and can be regarded as the complex structure of institutions and mechanisms involved in the trade of long-term securities (with maturity longer than one year) (fourie, falkena & kok, 1999: 183). it is not a physical market, but only the abstract concept that includes all trade in long-term securities in the same way that the money market includes all trade in short-term securities (stapelberg, 1981: 23). the capital market can be broadly divided into two parts, namely the primary and the secondary market new securities are issued in the primary market, while previously issued securities are traded in the secondary market 3.1 the primary capital market securities are issued in the primary market by institutions wishing to borrow money. securities are issued in south africa by the treasury, public corporations (e.g. eskom), public utilities (e.g. telkom and transnet), local authorities and private sector companies when they need to finance their activities. the demand for the securities issued in the primary capital market is generally by banks, building societies, insurance companies, pension funds, mining houses, stockbrokers, and the public investment commissioners (fourie eta!., 1992: 121). the securities issued in the primary market can be either fixedor variableinterest-bearing securities. fixed-interest-bearing securities such as government bonds, annuities and debentures are characterised by a stipulated maturity date and value (the nominal or face value) and contractually guaranteed interest payments. these interest payments are based on a fixed and predetermined rate (the coupon rate) paid on the nominal value of the bond (fourie et ai., 1999: 172). if the security is issued at nominal value, its yield will be equal to this rate of interest, since the interest payment will be the only income received from this investment. however, if the security is issued at a price below the nominal value, the yield to maturity will be higher than this rate of interest since the yield will not only include the interest receipts but also a capital gain. the interest rates on variable-interest securities (e.g. long-term loans), shares and negotiable documents fluctuate sharply, particularly when the inflation rate changes frequently. in south africa, a variable-interest loan normally remains a contract solely between the lender and the borrower. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 70 sajems ns vol 4 (200 i) no i the way in which secunties are issued depends on the type of security. government bonds are sold on a tap or tender basis. in the case of a tap issue, the reserve bank buys stock from the treasury at a rate at which the bank can sell a fairly large volume to the market, and then resell it to the public. in the case of a tender issue, the date of the issue and amount of stock available are announced to the public, and sold to the highest bidders. other fixed-interest securities as well as all variable-interest securities are either sold by the issuer or by an underwriter, usually a merchant bank, acting on behalf of the issuer. the issue may either be by way of a public issue where the terms and conditions are announced to the public at large, or by way of a private issue where it is offered only to selected investors (fourie et al., 1999: 185; fabozzi, 1992: 523). 3.2 the secondary capital market the securities issued in the primary market are traded in the secondary market. the financial intermediary sector is the principal supplier of funds to the secondary capital market, in particular insurers, pension funds and building societies, which simply channel surplus funds of the household sector into appropriate invesnnents. other banking institutions, the public invesnnent commissioners, and other financial intermediaries such as participation mortgage bond schemes and the national housing commission are also lenders in the capital market (fourie et al., 1992: 41). the main traders of securities in the secondary capital market are divided into five categories, namely fmancial intermediaries, the government, corporate business enterprises, households and the foreign sector. foreign participants, in other words foreign households, businesses, institutional investors and governments, act in the south african capital market in the same way as domestic households, businesses, investors and the government. however, technological development and the process of globalisation have dramatically increased the importance and role of foreign participants in the domestic capital and other fmancial markets. globalisation bas resulted in the acceleration of international capital transactions, and international fmancial interdependence has increased substantially. in consequence, fmancial markets have become more efficient, but also more volatile and subject to speculation practices. advances in computer technology, coupled with advanced telecommunication systems, link market participants throughout the world and allow the transmission of real-time information on security prices and other key information to many participants in many places. this enables many investors to monitor global markets and simultaneously assess how this information will impact on the risk/reward profile of their portfolios (fabozzi, 1995: is). the securities that are issued in the primary market are traded in the secondary market. the number of new securities issued in the primary market bas a r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no i 71 considerable influence on the demand for and price of securities in the secondary market. the secondary market serves as a barometer of changes in the markets and reflects these changes in the prices and volumes of traded securities. this gives the issuers in the primary market a good idea of the correct price and interest rate at which they should issue new securities which is vital to a successful issue. the secondary market also guarantees investors that they will be able to resell their securities and adjust their portfolios, provides an indication of the general availability of funds and enables the reserve bank to buy and sell securities in order to influence the liquidity of financial markets (fourie, 1999:13; faure et al .• 1991: 10). there are active markets in many of the securities issued in the primary market, but they differ in terms of so-called "breadth" and "depth". mainly fixedinterest-bearing securities are traded in the secondary market, while there is virtually no secondary market for variable-interest securities because of the uncertainty of their variable pattern of income which makes it difficult to discount their future earnings. institutions trade in the secondary market in the attempt to maximise their expected portfolio returns while bearing minimum risk. investment is therefore a risk-return trade-off. the nominal rate of return (r) on a security is not the absolute rand return, but is r sl so + d d . f th . calculated as = , where so an s} are the pnce 0 e secunty at so the beginning and the end of the investment and d, any dividends or interest payments in the interim (kobold, 1986: 67). since the rate of return is uncertain, the investor has to take into account the risk that the expected return may not be realised. risk is the variation of actual return from expected return and may be caused by broad economic forces such as recession, unemployment and inflation, or attributable to causes that are peculiar to the specific security or issuing company. there are several risks associated with investing in bonds. interest-rate risk is the risk that if an investor has to sell a bond prior to the maturity date, an increase in interest rates will mean a capital loss (f abozzi & modigliani, 1996: 5). reinvestment risk is the variability in the reinvestment rate of a given strategy because of changes in market interest rates (fabozzi & modigliani, 1996: 5). default or credit risk is the risk that the issuer of a bond may default, in other words be unable to make timely principal and interest payments on the issue. inflation or purchasing power risk arises as a result of the variation in the value of cash flows from a security because of inflation, as measured in terms of purchasing power of money (fabozzi & modigliani, 1996: 7). the risk that the currency in which the flows are paid will depreciate relative to the rand, is the exchange rate or currency risk (fabozzi & modigliani, 1996: 7). liquidity or marketability risk depends on the ease with which an issue can r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 72 sajems ns vol 4 (2001) no 1 be sold at or near its value, usually measured by the size of the spread between the bid price and the ask price quoted by a dealer (fabozzi & modigliani, 1996: 7). risk and return are always the criteria for investment, but investors can choose between the efficient market hypothesis (emh), markowitz's portfolio choice theory and the capital asset pricing model (capm) (dobbins, witt & fielding, 1994: 18). security prices conform to the law of demand and the law of supply like any other price. since the demand and supply of a security are determined by the behaviour of investors, their behaviour will also influence security prices and therefore interest rates. 4 an empirical functionimodel for the long-term interest rate in this section the determinants of the long-term interest rate are empirically estimated by means of annual data. although the yield on the r150 long-term government bond is the leading long-term interest rate in south africa, it was issued in 1987 and expires in 2004, which means that only a minute sample of 12 observations is currently available. the rl50 yield is also extremely volatile, which makes empirical estimation rather difficult hence in this study the yield on the eskom 168 (ei68) security is used instead to proxy the general level of long-run interest rates in south africa (see figure i). the e 168 is a security issued by eskom. it has biannual interest payments fixed at ii per cent on the nominal value. and it matures on i june 2008. unlike the ri50 and other government bonds, the government does not guarantee eskorn securities. the guarantee of eskorn securities lies in the size of eskom. the fifth largest utility in the world, and the nature of its business, namely the provision of electricity to southern africa (http://www.eskom.co.za). hence eskom securities, like government bonds, are not subject to default risk. since the ei68 long-term eskom security has no default risk, is actively traded in the south· . african capital market and a relatively large sample is available, it may be used to proxy long-term interest rates in south africa. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no i 73 figure 1 the eskom rate 20 18 16 14 12 10 8 6 4 60 65 70 75 80 85 90 95 4.1 the theoretical model the process of globalisation dramatically changed the way in which small open economies, such as south africa, function. they no longer function in an isolated environment, for their financial markets are driven by developments in international markets. the market approach (see gayed 1990 and murphy 1991) is therefore regarded as the most appropriate analytical method in a small open economy where the interaction between the various domestic and international markets predominantly determines interest rates. studies on interest rate determination in small open economies, such as harmse and du toit (1999) and hodgson, kremmer and lee (1998), are therefore based on the market approach, which explains interest rate determination on the basis of the relationship between the various domestic and international markets. on the other hand, interest rates in large economies are mainly determined by the traditional demand and supply factors. studies such as tran and sawbney (1998), mehra (1995) and mehra (1994) on interest rate determination in industrialised countries are thus based on the economic approach which explains interest rate determination by the demand and supply of money or loanable funds. this study will however follow the market approach, since south africa has a small open economy where interest rates are determined by movements in international and domestic markets. a priori theory suggests the following about the relevant variables and their coefficients: (i) the long-term interest rate should be positively related to international interest rates. as the south african fmancial markets become more r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 74 sajems ns vol 4 (2001) no i integrated with the international fmancial system, the relationship between domestic and international interest rates becomes increasingly important. domestic interest rates that are too low will eventually be reflected in a weak currency, and also cause further depreciation of the rand. conversely, interest rates that are too high will encourage speculative short-term foreign capital that will cause undesirable appreciation of the currency and/or an unhealthy expansion of domestic liquidity (sarb, 1999). various studies such as that of pain and thomas (1997), hodgson, kremmer and lee (1998) and awad and goodwin, have shown that the us long-bond rate is the most influential in the world and can be regarded as the leading rate. it is also used in most studies of small open economies such as harmse and du toit (1999) and hodgson, kremmer and lee (1998) to represent the international level of interest rates. hence in this study, the us long-bond rate is also used to represent the level of international interest rates. (n) the short-term interest rates are determined in the money market. if the long-term interest rate does not rise when the short-term interest rates rise, investors will substitute their long-term bonds for money market securities. an increase in the short-term rate should therefore cause an increase in the long-term rate. (iii) according to the fisher effect, the rate of inflation causes the nominal interest rate to change so that the real rate is unaffected by the rate of inflation. an increase in expected inflation should therefore result in a proportional increase in the nominal interest rate. this results in the following specification for the interest rate function (see appendix 2 for an explanation of the pneumonic variables): rl = £{us, e(infl), rs) (+ + +) 4.2 thedata all the data were obtained from the quarterly bulletin of the south african reserve bank, except the us interest rate which was obtained from the international financial statistics of the international monetary fund. all the variables were transformed into the naturallogaritbmic form. annual data from 1960 to 1998 were used. the yield on the e 168 eskom bond was used as the representative long-term interest rate in south africa. the three-month banker's acceptance rate is r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (200 i) no 1 75 considered to be the representative short-tenn interest rate and the yield on 30year us government bonds is used as the long-tenn interest rate of the usa. kalman filter predictions of the expected one-period-ahead inflation rate were used as inflationary expectations. the specification, including the lagged inflation rate, interest rate and exchange rate, was based on the specification of koekemoer (2000) for kalman filter predictions of the expected one-periodahead price expectations. in the specification the rand-dollar exchange rate was used as the exchange rate, and the eskom rate as the interest rate. a dummy variable was created to represent the years 1985 to 1990 during which there were international sanctions and disinvestment actions against south afiica. during this period, interest rates were kept at a high level in an attempt to prevent capital outflow and to attract foreign capital. models that contain potentially non-stationary variables can result in a spurious regression, indicating statistically significant relationships where there are none. the statistical significance obtained from standard regression techniques with non-stationary variables is picking up is the existence of contemporaneous correlation in the variables due to their trending over time, rather than a meaningful causal relationship between them. it is therefore vital to detennine the order of integration of all the variables used in the econometric analysis, since this will detennine the correct estimation technique to use. in this study, the augmented dickey fuller (adf) (1979) and phillips-perron (pp) (1988) tests were used in conjunction with data plots to establish the order of integration of the variables. the adf test assumes that the errors are statistically independent and have a constant variance, while the pp test allows the disturbances to be weakly dependent and heterogeneously distributed (enders, 1995: 239). the pp test also has greater power to reject the false null hypothesis of a unit root, except when the errors have a moving average (ma) structure, in which case this test tends to reject the null hypothesis whether it is true or false. since the structure of the error terms is usually unknown, it is preferable to use both tests. hence both the augmented dickey fuller (adf) and the phillipsperron (pp) tests were used in this study to establish the order of integration of the variables. when there are structural breaks, however, the adf and pp test statistics are biased towards the non-rejection of a unit root, and the perron (1989) test for unit roots in the presence of a structural break should be used instead (enders, 1995: 261; charernza & deadman, 1997: 119). appendix 3 summarises the results of the unit root tests. a priori theory suggests a possible structural break in south afiican long-tenn interest rate in 1985 when monetary policy changed dramatically from direct to market-oriented monetary instruments. the graph of the long-tenn interest rate series (see figure i) confinns that a possible structural break occurred in 1985. the results of the adf and pp test are invalidated by the occurrence of a r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 76 sajems ns vol 4 (2001) no 1 structural break hence the perron test for testing unit roots in the presence of a structural break was used to test the stationarity of the eskom series. the results, which are summarised in appendix 3, confirm that the long-term interest rate is trend-stationary with a structural break in 1985. visual inspection of the graph of the long-term us interest rate (see appendix 1) suggests a possible structural break. the perron test for a unit root in the presence of a structural break confirms that the us long-term interest rate is in fact trend-stationary with a structural break (see appendix 3). the adf and pp tests rejected the null hypothesis of a unit root against the alternative of trend stationarity for the short-term interest rate. therefore, if a trend is included in the regression, the short-term interest rate can be directly included in the ols-regression. in contrast to a priori expectations, both the adf and pp tests could not reject the null hypothesis of a unit root for the inflationary expectations in levels (e(lnfl)). however, if there is a structural break in the inflation rate and inflationary expectations as suggested by the graphs, it invalidates the results of the adf and pp tests. the results of the perron test for unit roots in the presence of a structural break render expected inflation trend-stationary with a structural break in 1985. inflationary expectations are therefore regarded as integrated of order zero. 4.3 empirical estimation of tbe long-term interest rate function for south africa the dependent variable tested trend-stationary with a structural break in 1985, which implies that ordinary least squares (ols) is the appropriate technique to use, with a trend dummy (time) and a dummy allowing for the new trend (dt) included. with the trend and the new trend dummies included, the south african short-term and us long-term interest rates can be regarded as stationary and therefore included without any transformation. both the long-run equilibrium equation and the short-run dynamics or deviations from equilibrium are simultaneously included when ols is used in other words an ecm structure such as that of mehra (1994), mehra (1995) and harmse and du toit (1999) is considered to be inappropriate in this context. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 77 table 1 estimation results of ols-regression, dependent variable: sa long-term interest rate coefficient standard t-value p-values variable error us 0.225712 0.084908 2.658324 0.0125 rs 0.241269 0.047219 5.109571 0.0000 time 0.000491 0.036744 3.752138 0.0000 dt 0.020408 0.005954 3.427301 0.0018 e(infl) 0.984009 5.35e-05 9.177556 0.0557 dum0.165878 0.494351 1.990508 0.0004 sanct rs(-2) 0.138707 0.041299 4.016492 i 0.0008 sample period (adjusted): 1964 to 1998 ip =0.9578 dw= 1.9696 s.e. = 0.0756 f == 136.9639 with the natural logarithmic form, coefficients may be interpreted as elasticities. the coefficient of each explanatory variable can be interpreted as follows: i) us long-term interest rate (us). a one per cent increase in the long-term interest rate of the us results in a 0.225712 per cent increase in the domestic (sa) long-term interest rate. ii) short-term interest rate (rs). a one per cent increase in the short-term interest rate results in a 0.241269 per cent increase in the long-term interest rate. apart from this contemporaneous effect, a one per cent increase in the short-term interest rate two years ago will also cause a 0.138707 per cent increase in the current long-term interest rate. the short-term rate one period ago was insignificant. iii) inflationary expectations «e(infl». a one per cent increase in the oneperiod-ahead inflationary expectations results in a 0.984009 per cent increase in the long-term interest rate. when the null hypothesis that the coefficient is not equal to one was tested against the alternative hypothesis that it is equal to one, it was rejected. the coefficient is therefore assumed to be one, which conforms to the a priori expectation. iv) sanctions (dum-sanct). during the period of sanctions against south africa, interest rates were on average 0.165878 percentage points above the equilibrium path. this implies that south africa was extremely sensitive to international sentiment at that time. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 78 samms ns vol 4 (200 i) no i v) time trend (time). the coefficient of the trend in the equation is 0.000491 which means that the long-tenn interest rate grows on average by 0.000491 per cent every year. vi) new trend (dt). the coefficient of the variable that measures the new trend after 1985 is 0.020408, which means that the interest rate grows on average 0.020408 per cent faster than before. 5 evaluation of the results 5.1 economic evaluation of the estimated function except for the coefficient of inflationary expectations that should be one, economic theory provides only a priori information on the sign of the coefficients and not on the size of the coefficients. as explained in section 4.1, the long-term us interest rate, the domestic short-term interest rate, inflationary expectations and sanctions should have a positive effect on the long-tenn interest rate. the results in table 1 indicate that the influence of all the variables conforms to the requirements of economic theory. it can therefore be concluded that this function is an acceptable representation of the long-tenn interest rate of south africa. 5.2 statistical evaluation of the estimated function since all the variables in the regression are stationary, the assumptions of classical regression analysis are fulfilled. consequently standard diagnostic and other statistical tests can be used to evaluate this function statistically. the adjusted r-squared (ip) of 0.957736 indicates that 95.7736 per cent of the variation in the long-term interest rate is explained by the variation in the dependent variables, which is evidence of a very good fit. the f-statistic of 136.9639 indicates that the dependent variables are jointly significant in .. explaining the long-tenn interest rate. the durban-watson (ow) statistic of 1.969636 fails to reject the null hypothesis of no serial correlation. the tstatistics testing the significance of the individual coefficients indicate that all the coefficients are significantly different from zero, and should therefore be included in the function. table 2 summarizes the results of the diagnostic tests performed on the function. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (200 i) no 1 79 table 2 diagnostic test results test performed test test-statistic probability for normality jarque-bera 0.367785 0.832025 heteroscedasticity arch 0.005304 0.941945 white 8.983760 0.774169 serial correlation breuch-godfrey 2.424835 0.297477 lm specification ramsey reset 1.648535 0.210456 parameter cusum stable stability cusum 2 stable these diagnostic tests proved that i) the error terms are normally distributed ii) there is no heteroscedasticity present in the error terms iii) there is no serial correlation in the error terms iv) no variables have been omitted, and the specification of the functional form is correct v) the parameters are stable 5.3 dynamic simulation to obtain an indication of the goodness of fit of the model, an initial dynamic simulation was performed. a graphical representation of the actual and simulated values for the derived equation provides a good indication whether the function is a good representation of the true data-generating process. the close correlation between the actual and simulated values of the long-term interest rate (see figure 2) suggests that the function is a good representation of the true datagenerating process. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 80 sajems ns vol 4 (2001) no 1 figure 2 actual and simulated values of tbe long-term interest rate 20~--------------------------~ 18 16 14 12 10 8 6 65 70 75 80 85 90 95 the model was subsequently subjected to two different types of shocks. in the first place the sensitivity of the model was tested by increasing the explanatory variables by 10 per cent. if the model is stable, these shocks should result in consistent long-run elasticity effects. this means that the simulated value must increase by 10 per cent of the original coefficient when one of the long-run explanatory variables is shocked by 10 per cent. when one of the short-term explanatory variables is increased, there should be an initial movement away from the long-run equilibrium path, but eventually the model should return to the original equilibrium path. the dynamics of the model are driven by the short-term interest rate and the sanction dummy, and they are the only variables giving dynamic feedback. in the second place, the stability of the model was tested by shocking each of the variables only in one period to test how long the system takes to return to equilibrium. the effect of the sensitivity and stability shocks on the us rate are illustrated in figures 3 and 4. although now shown here, similar shocks were performed on all the other explanatory variables, and .. all of them illustrated that the function is stable. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 81 figure 3 difference between sbocked and original simulated interest rates wben a stability test is performed on tbe us interest rate 0.025...-----------------, 0.020 0.015 0.010 0.005 as may be seen from the graph, the difference between the initial and shocked simulations disappears almost immediately. this means that the effect of a shock will not persist, and that the model is therefore extremely stable. a typical sensitivity test shocks the explanatory variables in the model, one at a time, by increasing them by 10 per cent. the shocks in the long-run variables must result in a convergence of the dependent variable on 10 per cent of the estimated coefficient of the shocked variable in other words 10 per cent of the elasticity effect. a shock in the short-run variables, however, must result in an initial shock, after which the dependent variable must converge on the original equilibrium path. the first shock was performed on the us long-tenn rate, by increasing it by 10 per cent from 1967. the difference between the original and shocked simulations is illustrated in figure 4. the shock results in an immediate movement away from the long-run equilibrium path to a new equilibrium path. the difference between the original and shocked simulations is 10 per cent of the coefficient of the us interest rate, which is consistent with the elasticity effect. although not shown here, similar shocks were perfonned on all the other explanatory variables, and they all indicated that the function is stable. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 82 sajems ns vol 4 (2001) no 1 figure 4 difference between shocked and original simulated interest rates when a sensitivity test is performed on the us long-term interest rate 0.025,-------------------, 0.020 0.015 0.010 0.005 0.000+r-,...,....,.,.+~..,.......,........,....".~,...,....,~.,.."~.,...,,...,....,...,....,...,....,....1 60 65 70 75 80 85 90 95 the function has passed economic and statistical evaluation and can therefore be regarded as a true representation of the determination of the south african longterm interest rate. the results showed that the long-term interest rate is mainly determined by inflationary expectations, but that the us long-term rate and the domestic short-term rate also have important influences on the long-term rate. interest rates increased significantly during the sanction era, which shows that south africa is extremely vulnerable to international sentiment. these results have important policy implications, which are discussed in the next section. 6 the effect on monetary policy monetary policy makers want to know whether and to what extent they are able to influence long-term interest rates, and which instruments they should use. the results of the empirical estimation indicate that the south african long-term' interest rate reacts mainly to changes in international interest rates, the shortterm interest rate and inflationary expectations. this has several important policy implications. the south african reserve bank plays a vital role in determining the level of short-term interest rates, because they are closely related to the rates at which the bank lends money to private sector banks (sarb, 1999). since the empirical results showed that the long-term interest rate reacts to changes in the short-term interest rate, monetary authorities can influence the long-term rate by r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no i 83 changing the short-term rate. however, the influence of the reserve bank on the long-term interest rate through changes in the short-term interest rate is limited. owing to fmancial globalisation, the monetary authorities in a small open economy such as that of south africa cannot force interest rates, especially long-term interest rates, in a direction other than that dictated by the markets. if the monetary authorities try to do that, investors and borrowers simply go to other countries with competitive opportunities. the influence of the us rate is almost as great as the influence of the domestic short-term rate. this means that, as in other small open economies, the south african long-term rate is extremely sensitive to movements in international markets. this emphasises the fact that the south african capital market is not a price leader but a price follower, and that the authorities cannot force domestic interest rates in a direction other than that dictated by the markets. the upward pressure on interest rates during the sanctions era also emphasises the sensitivity of south african interest rates to international sentiment. the empirical results indicated that the influence of inflationary expectations is far greater than that of the short-term or foreign interest rates. this shows that the monetary authorities can have a greater effect on the long-term interest rate if they can influence inflationary expectations. as part of a new approach to monetary policy and price stabilisation, the government and the reserve bank announced an inflation target band in february 2000. the inflation-targeting framework does not require significant changes in monetary policy, but the aim is to reduce the inflationary expectations of consumers, producers, employers and workers (rsa, 2000: 3). the experiences of other countries that adopted inflation targets show that this increases stability in nominal interest rates. the results of this study show that nominal interest rates in south africa will also be stabilised if the monetary authorities can convince the public that the inflation target will be reached. the monetary authorities can influence the long-term interest rate by changing the short-term interest rate and inflationary expectations. the influence of inflationary expectations on the long-term interest rate is greater than that of the short-term interest rate, and therefore the recently introduced inflation-targeting framework can have a significant impact on the long-term interest rate if it reduces inflationary expectations. as in other small open economies, the south african interest rate is sensitive to changes in international interest rates and therefore the monetary authorities cannot force interest rates in a direction other than that which the markets dictate. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 84 sajems ns vol 4 (2001) no 1 7 conclusion a market-related approach was followed in this study to explain the detennination of long-term interest rate in south africa. apart from the theoretical factors, the political and economic environment in which interest rates are determined plays a key role in the process of interest rate detennination. broadly put, since the 1960s south african monetary policy may be divided into the pre-1985 and post-1985 periods with the shift from the use of direct monetary instruments to market-oriented monetary policy. this shift was in line with the global shift in the 1980s to market-oriented policy, and was encouraged by the liberalisation of international fmancial markets. the most significant socio-political events that impacted on the course of south african interest rates were the international sanctions during the 1980s, and the process of fmancial globalisation during the 1990s. the sanctions period was characterised by high interest rates in the attempt to prevent capital outflow and attract foreign capital. owing to fmancial globalisation, international fmandal interdependence has increased substantially, and also become more volatile and subject to speculation. the factors that influence the south african long-term interest rate and the magnitudes of these influences were empirically estimated on the basis of a market-related approach, with annual data from 1960 to 1998. the results indicated that there was a structural break in the long-term interest rate in 1985 when monetary policy in south africa changed, in line with the rest of the world, from direct to market-oriented policy. the long-term interest rate is detennined by the us long-term rate, the domestic short-term rate and inflationary expectations, of which inflationary expectations have the greatest influence. this means that the monetary authorities can affect long-term interest rates by either changing short-term interest rates or influencing inflationary expectations. but they cannot force interest rates in a direction other than that indicated by the markets because domestic rates are sensitive to changes in international markets. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 85 appendixl graphical representation of data series employed in estimations 20 25 18 20 16 14 15 12 10 10 8 5 6 4 0 00 65 70 75 80 65 00 95 00 65 70 75 80 65 00 95 saiong-ierm_rliijii sa shcrt-term interest rliijii 14 600 12 600 10 400 8 !l(lo 6 200 4 100 2 0 00 65 70 75 80 00 95 70 75 80 us ialg-term i_ rate r-i ...:ilenge rliijii 25 20 20 15 15 10 10 5 5 65 70 75 80 65 00 95 75 80 65 00 95 e>peded inflaticn -lniiailcn r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 86 sajems ns vol 4 (2001) no 1 appendix 1 list ofvariables series description rl nominal sa long-tenn interest rate (eskom rate) us nominal rate of us long-tenn government bonds rs nominal sa short-tenn interest rate (3-month banker's acceptance rate) dum-sanct dummy created to represent years of sanctions and disinvestment actions against south africa e(infl) kalman filter prediction of expected one-period-ahead • consumer price level dt dummy for the new trend since structural break in 1985 time trend appendix 3 order of integration table a augmented dickey-fuller and phillips-perron tests for nonstationarity, levels, 1960-1998 (all data series in natural logaritbmic form) series model lagsl rs * ** *** trend 1 constant 4 none 4 slgmficant at a 10% level significant at a 5% level significant at a 1 % level 'tn 'tl1• 't ~~ ppz -4.196** 5.98*** -3.190* -1.76 3.166 -1.540 1.23 2.57 0.4968 tabled augmented dickey-fuller and pbillips-perron tests for nonstationarity, first differenced, 1960-1998 (au series in natural· logaritbmic form) series model lags e(infl) trend 3 * ** *** constant 0 none 0 significant at a 10% level significant at a 5% level significant at a i % level 't" 'tu,'t ~'.1 ipp 0.4366 2.11 -0.606 -1.66 i 2.78 -1.570 -0.427 -0.316 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 1 87 table c perron tesf for non-stationarity in the presence of a structural break4, levels, 1960-1998 (all data series in naturallogaritbmic form) series tb i.. k ~ ~ y as tr(a-l) (t,j (t~) (tt) (ta ) rl 1985 0.64 0 -84.899 0.04416 -0.0475 0.21614 ! -30.57* (-18.14) (18.63) (-7.028) (-4.85**) i us 1985° 0.7 3 -85.663 0.04439 -0.1069 0.27123 -32.79* (-18.66) (19.07) (-13.69) (-3.93*) e 0 -12.419 0.00633 -0.0129 0.17428 -32.20* (infl) 1985 10.64 (-14.42) (14.52) (-ld.71) (-4.78**) '" "'''' slgdlficant at a 5% level significant at a 1 % level endnotes the number of lags used in the estimated equations was determined according to the method suggested by said and dickey (1984), which means starting with ti/3 lags and using sequential t-tests to exclude the last lag if insignificant. 2 the number of truncation lags used in the banlett kernel was detennined as suggested by newey-west. for this sample size newey-west suggested 3. 3 the version that tests ho:yt=j.it+yt-i+(jl2-jli)dut+et against ha: yt=jl+l3lt+(i3z-131)dtt·+et, where dut=1 if t>tb and 0 otherwise and dtt·=t ift>tb and 0 otherwise, was used. 4 the parameters given are from the model: k yt ii + f1 + jdt· t +yt ;yt = ayt-l + .l ci~yt-i + &t 1=1 5 phillips and ouliaris (1990) showed that t ratio procedures diverge under that alternative at a slower rate than direct coefficient tests, which means that direct coefficient tests should have superior power properties over t ratio tests. therefore the t{ a-i) test might have higher power than the a test and therefore both are reported. however, in this study they gave the same results. 6 visual inspection of the data suggests a possible structural break in 1981, and the perron test confirmed this by rejecting the null hypothesis of a unit root against the alternative of trend stationarity with a structural break in 1981. however, to keep the specification parsimonious, the perron test was also conducted to test the null of a unit root against the alternative of r ep ro du 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(1993) interest rates principles and applications, harcourt brace jovanovich: the dryden press. 27 south african reserve bank (sarb) (1999) fact sheet no.8: interest rates and how they work, pretoria: south african reserve bank. 28 st als, c. (1999) the influence of international financial crises on the south african economy, address at the 5200 congress of the south african nurserymen's association on 17 may 2000. 29 stapelberg, n.h. (1981) die finansiele stroktuur van suid-afrika. pretoria: n.h.s. uitgewers. 30 tran, d.t. & sa whney, b.l., (1988) "government deficits, capital flows and interest rates" applied economics, 20: 753-65. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . f:\ejour\ecoman\index\ecoman_v6_n2.prn.pdf sajems ns vol 6 (2003) no 2 331 solving daniel bernoulli’s st petersburg paradox: the paradox which is not and never was1 ________________________________________________________________ robert w vivian school of economic and business sciences, university of the witwatersrand ___________________________________________________________________________ abstract it has been accepted for over 270 years that the expected monetary value (emv) of the st petersburg game is infinite. accepting this leads to a paradox; no reasonable person is prepared to pay the predicted large sum to play the game but will only pay, comparatively speaking, a very moderate amount. this paradox was ‘solved’ using cardinal utility. this article demonstrates that the emv of the st petersburg game is a function of the number of games played and is infinite only when an infinite number of games is played. generally, the emv is a very moderate amount, even when a large number of games is played. it is of the same order as people are prepared to offer to play the game. there is thus no paradox. cardinal utility is not required to explain the behaviour of the reasonable person offering to play the game. jel d81 samuelson (1977: 24) pointed out that ‘the veritable who’s who2 in probability and the social sciences’ have been connected with bernoulli’s (1954/1738) st petersburg paradox3. indeed, few would dispute the correctness of bernstein’s (1998,100) observation that bernoulli’s ‘...paper is one of the most profound documents ever written’. besides those who specifically considered the paradox, the utility solution to the paradox is implicitly accepted by those who apply cardinal utility notions to problems of decision making under conditions of risk and uncertainty. this has produced a formidable body of literature4. the st petersburg paradox has thus been enormously influential. the purpose of this article is to demonstrate that contrary to the accepted view, the st petersburg game does not lead to a paradox at all. the st petersburg game the background to the st petersburg game5 is now6 well-known and it is not sajems ns vol 6 (2003) no 2 332 necessary to repeat it here in any detail. for ease of reference only a brief overview is given. attempts have been made for a long time to develop decision criteria to assist in the decision making process or to find theories7 explaining why people make the decisions they do when facing conditions of risk and uncertainty. the earliest and most well-known criterion is the expected monetary value (emv) criterion8, the formulation of which is credited9 to pierre de fermat (1601-1665) and blaise pascal (1623-1662). according to this criterion a person faced with this kind of decision would or should choose the path involving uncertainty, if it has the most advantageous emv. daniel bernoulli (1738) attempted to demonstrate that this criterion did not in fact explain the behaviour of a reasonable person10 under these circumstances. he used a number of problems including the poor fellow problem and the st petersburg game11 to support his hypothesis. he then went on to suggest an alternative theory. his new theory was based on the notion of marginal decreasing value of wealth12. this today, in its developed form is the expected utility value (euv) criterion or expected utility value hypothesis. the st petersburg game goes like this. peter offers paul an opportunity to take part in a game of chance where a coin is flipped and if a head appears (with an a priori probability of 1/2), paul receives $1 (ie $20)13. if it does not appear, the game continues. if the head appears after the second flip (with an a priori probability of 1/2 2 ), paul receives $2 (ie $21) and if not, the game continues in this fashion, until such time as a head appears (if ever) whereupon the game terminates and paul can take his winnings. it is conceptually possible for any game to continue to infinity. the probability of the game terminating at the ith flip of the coin is 1/2i with a corresponding payout of $2i-1. the simple question to be answered is how much should, a reasonable person, the proverbial paul be prepared to pay to play the game? as a rule-of-thumb, the answer should be of the same order as the emv of the game14. from bernoulli (1738) to aase (2001) it has been accepted that the emv of the game is infinite. in other words accepting the emv as a rule-of-thumb guide, a reasonable man should be prepared to pay an exceptionally large sum to play the game. the traditional derivation is as follows. the game can have any payout from the following infinite range of payouts (c i expressed in dollars); sajems ns vol 6 (2003) no 2 333 2 0, 2 1, 2 2, 2 3, ... 2 i -1 … (1) each with a corresponding a priori probability (p i) associated with it, indicated as follows: 2 -1, 2 -2, 2 -3, 2 -4 ... 2 -i … (2) and since (3) it follows from series (1), (2) and equation (3) that, expressed in dollars, the emv is determined as shown in table 1 table 1 traditional solution of the st petersburg game term t1 t2 t3 t4 ... ti ... t8 totals payout (c i) 2 0 2 1 2 2 2 3 ... 2 i 1 ... 8 na probability (p i) 2 -1 2 –2 2 -3 2 -4 ... 2 -i ... 0 1 contribution to emv (pi x ci) 2 -1 2 –1 2 -1 2 -1 2 -1 2 -1 2 -1 ... emv = ? pixc i = 8 or the emv = 8 . a number of points about the traditional solution of the emv should be noted. the emv is infinite because the series consists of an infinite number of terms each of constant value, in this example $½. the sum of this infinite series of finite numbers is infinite an infinite amount can be an issue for another reason. as the game continues, the payouts become increasing large, tending to infinity. it is possible to confuse the infinity which comes from the sum of the series and infinity of a very large payout. these two infinities are more often than not confused. the paradox concerns paul’s decision vis-à-vis the emv = 8 , not paul’s decision vis-à-vis final large payout. even for very large payouts, according to the traditional derivation15, the contribution of each of payouts to the emv is still the same constant16. emv p ci i i i = = =∞ ∑ 1 sajems ns vol 6 (2003) no 2 334 concluding that the emv of the game is infinite, empirical evidence indicates that no reasonable person in the position of paul will risk a substantial amount (let alone an infinite amount) to play the game. numerous empirical17 tests indicate that in general people will not risk more than $12 $13 to play the game, and in the vast majority of cases a sum much less than this. therein lies the paradox. the emv predicts that a reasonable person should be prepared to risk a very large amount to play the game, and generally no fault can be found with the emv decision criterion which is still the most widely used decision criterion and no-one can fault the reasonable person for not being prepared to risk a large amount to play the game. both are seemingly correct and no completely satisfactory18 explanation has been found to reconcile these contradictory conclusions hence the apparent paradox. 2 determining the emv the st petersburg game it will now be shown that the traditional determination of the emv is only correct as a special case where the game is played an infinite number of times. 2.1 a single game first, the position of a single game19 is considered. it seems to me the source of the paradox stems from the irrational assumption that the emv can be applied equally when a large number of games are played or when a single game is played. this irrational assumption ignores the law of large numbers. since the emv by definition, is concerned with the average payouts of a number of games, the emv is of little assistance when a single game is played20. if the game is played only once, there will be one outcome (?) taken from the following series of possible outcomes, shown with their respective probabilities of occurring: ? = [(2 0; 1/2 1 ) or (2 1; 1/2 2) or (2 2; 1/2 3) or ...or (2 i ; 1/2 i-1) ... (8 ; 0)] this is an infinite series of mutually exclusive outcomes 1, 2, 4, 8 ... with corresponding probabilities of 0,5; 0,25; 0,125; 0,0625 ...). to accept the traditional view that the emv of a single game is infinite or a large number is to ignore the possibility of any of the lower, high probability outcomes. this is a very unrealistic assumption. when a single game is played, the emv is of little use and an alternative sajems ns vol 6 (2003) no 2 335 approach is needed. it must be decided how much should paul be prepared to pay to play this single game with this range of outcomes and probabilities? although the emv may not, where a single game is played be of much assistance to paul, arrow (1974,415) correctly points out that probabilities are relevant, even when a single game is played. he wrote, ‘[w]hile it may seem hard to give justification for using probability statements when the event occurs only once ... the contrary position [that probability statements are irrelevant] also seems difficult to defend.’ it is not the emv which is important when playing a single game but the probability of the outcome. the choice facing paul can be likened to paul placing his hand in a very large barrel filled with millions of small, marked balls and he can select only one. fifty percent of the balls are marked t1 (paying $1) , twenty-five percent are marked t2 (paying $2), twelve and a half per cent are marked t3 (paying $4), and so forth. thus 93,75 per cent of the balls will pay an amount of $8 or less. the question then becomes, which single ball does he think he will draw and how much should he be prepared to pay for the right to draw this single ball? paul as noted is the proverbial reasonable man. he is not the most pessimistic nor most optimistic; not the wisest nor the most foolish. based on probabilities it is suggested that he will not wager much in excess of $8 to play this single game. in general he does not expect to win more than this by playing a single game. if this is so, he should not be prepared to loose more than this. at $8 there is a 93.75 percent possibility that he will win $8 or less and a 6.25 per cent that he will win in excess of $8. he would be an optimist to pay an amount in excess of $8. if a range indicating what people generally will wager to play a single game, rather than a single figure of $8 is selected, the range is between $4 to $32. this range is in line with the collective wisdom of history21. 2.2 the emv of m games as indicated it is doubtful if the emv is meaningful when only a single game is played so, multiple games are now considered. multiple games must be considered for another reason. the issue is not only what is paul prepared to pay for his ticket, but also what should peter be prepared to accept to allow paul to take part in the game. logically if paul is asked how much would he be prepared to pay to play the game, his answer will be, ‘as little as possible preferably nothing.22’ it is peter after all who carries the risk. if peter accepts $8 for the ticket, then paul knows the extent of his possible loss, $8. it is peter who does not know the extent of his liability until the game or all the games have ended. although paul has only one ticket, seen from peter’s perspective, if for example he is a casino owner, prepared to accept wagers on the st petersburg game there may, over a period of time be millions of other tickets about which he must be concerned. so peter needs to know what is likely to sajems ns vol 6 (2003) no 2 336 happen if he accepts $8 per game and m games are played. assume then that m games are played. this assumption carries with it a number of implications which may not be obvious. firstly, if m games are played there are only m outcomes, not an infinite number of outcomes. each game can have only one outcome. conceptually one of these could continue to infinity23. secondly the mere statement that m games will be played implies that all games do in fact terminate, ie that one of the m games does not continue to infinity. this accords with reality24 and theory25. the fact that a game may go to infinity does not mean that a game does go to infinity. what is not known is where each or any of the m games end. thirdly despite the fact that all the games end, no limit is placed on any single game. particularly no limit is placed on the length of time that any game may last26 or on the magnitude of the payout. if a game happens to go to infinity, peter must live with that risk. once it is accepted that the games are played a multiple number of times, the mathematical nature of the problem becomes clear. peter must find a way of determining the emv of a series of terminating games, but the point of termination is not known beforehand. if peter is prepared to accept $8 per game, millions of pauls may be prepared to play games for that amount. will peter be able to pay the millions of pauls out of the $8 per game he is prepared to accept? once the problem is correctly stated, it is not difficult to solve. assume the game is played m = 2 k times. if this generalised approach is adopted then m (or k) can be varied from 1 to infinity. in this manner all possible numbers of games are catered for, including m = ∞ . the methodology for solving the problem was suggested by bernoulli (1954/1738, 32) himself. the solution setout in this paper could have been arrived at in 1738. bernoulli pointed out that the number of games (ni) which terminate at the first flip of the coin (first term) is ½ of the total number of games played,27 and ¼ terminate at the second term and so on. in general if m games are played then the number terminating at term t1, t2, t3, ...ti ... is ni = pi.m. this number is then multiplied by the payout c i for that term and divided by the total number of games played, m. in this way the contribution of each individual term to the emv is established. the various contributions are then summed to arrive at the emv. if the game is played 2 k times, the number28 of (n1) games which terminate after the first flip of the coin is ½ x 2 k or 2k 1. the payout for the first term (t1) is $2 0. the number of (n2) games which terminates after the second flip, (t2) is 1/22 x 2 k or 2 k-2 with a payout of $2 1 and so the pattern continues until 2 0 is reached. the results are shown in table 2. sajems ns vol 6 (2003) no 2 337 table 2 the emv of the st petersburg game played 2k times term t1 t2 ... tk sub total tk+1 tk+2 tk+3 ... totals (emv) payout (c i) 2 0 2 1 ... 2 k-1 ... 2 k 2 k+1 2 k+2 ... n i 2 k-1 2k-2 ... 2 0 2 k -1 0 or 1 0 or 1 0 or 1 0 or 1 2 k contribution to emv (n i.c i/2 k) 2 -1 2 -1 2 -1 2 -1 k.2 – 1 0 or 20 0 or 2 1 0 or 2 2 ... k/2+ (0 or 1) + (0 or 2) + (0 or 4) + ... probability of games terminating at specific term 0 0 0 0 ... 2 – 1 2 2 2 – 3 ... 1 at the k th term (tk) the game has been played 2 k 1 + 2 k 2 + 2 k 3 ... 1 times. this is a geometric progression the sum of which is 2 k 1. in other words all games have terminated by the kth term, except one29, which had already30 terminated at some point beyond the tk term by the time m games had been played. if this solitary game ended at t(k+1) the payout is $2 k and the contribution to the emv is ($2 k . 2 k)=$1. since all the 2 k games have now terminated all other terms in the series equals zero, all the way to infinity. if the remaining game terminated at t(k+2) then the payout for this game is $2 k + 1 and the contribution to the emv from this game is ($2 k + 1 . 2 -k ) = $2. in this event the contribution from t(k+1) term is 0 as are all the other terms to infinity. thus although terms beyond the kth term have both payouts31 and a priori probabilities pi, the contribution from all of these except one, equals zero, since all games had ended. the contribution of this final game, to the emv depends on its position after the kth term. thus using a priori32 probabilities when the st petersburg game is played 2k times it produces, with certainty a series consisting of not more than k+1 terms, with the series terminating beyond the kth term. if played a finite number of times, a finite, not infinite series is produced. the probability of there being less than k terms is thus zero. after the tk term the series can terminate at any term to infinity. however each term beyond tk requires an additional flip of the coin, with a probability of ½. the probability thus of the term ending after the tk term, decreases at the rate ½. in other words the probability of terminating at tk+1 is 1/2 at tk+2 is 1/4, at tk+3 is 1/8, at or beyond the k+4 is 1/16, adding 1, 2, sajems ns vol 6 (2003) no 2 338 4, 8 ... to the emv arrived at by summing the contributions to the emv up to the tk term. it is clear that the series beyond the tk term is once again the same series as for a single game. as indicated above a reasonable man would value this at an amount of approximately $8. the emv of the st petersburg game, played 2 k times and which pays $1 if a head appears on the first flip of the coin can now be stated. emv (2 k) = k/2 + [(1;1/2) or (2;1/4) or (2 2;1/8) or (2 3;1/16) or ... 8 ; 0] and if ? = [(1;1/2) or (2:1/4) or (2 2;1/8) or (2 3;1/16) ... ] then: ( ) λ+= 2 2 k emv k with the lowest value of the emv being k/2 + 1. or for all practical purposes: ( ) 8 2 2 +≈ k emv k at a 93.7 per cent confidence level. the st petersburg game thus does not have a single a priori value for the emv. it has a series of possible emvs starting at k/2 + 1 and continuing to infinity with decreasing probabilities. of course for any specified number of games, the empirical emv will have only one value determined by the above equation. the traditional solution emv = ∞ is correct but only where the st petersburg game is played an infinite number of times. many people may, subconsciously if nothing els e, hold the view that the emv, is the aggregate of the payouts divided by the number of games played (m), in the limit, when m approaches infinity. in terms of this view there is only one emv and that is the value derived when the numbers of games tend to infinity. those who hold this view will then hold that the traditional solution to the st petersburg game that the emv is infinity is correct by definition. there is no problem with this view but it still does not produce a paradox. one must compare apples with apples. if the assumption is that the game is played an infinite number of times, then it must be accepted that paul can play the game an infinite number of times. in other words the question is ‘paul plays the st petersburg game an infinite number of times, how much should he be prepared to wager per game to do so?’ the answer to this question is quite correctly an infinite amount. sajems ns vol 6 (2003) no 2 339 one cannot compare apples with pears. it clear that the traditional question is irrational if stated as, ‘paul plays the game a finite number of times (m), why does he not wager a substantial amount to play the game?’ the answer is of course because he is only playing the game a finite number of times. in the traditional formulation of the paradox, the assumption is that paul plays the game only once but then uses the emv of an infinite number of games. it is not comparing apples with apples. returning to the above example. assume paul decides he will play one game for $8. should peter accept the wager? peter needs to know how many other games will be played at his casino33. assume he accepts the $8 from all the pauls and estimates that during the next financial year his casino will play 220 (i.e. 1 048 576) games. the question now is, will he face a loss at the end of the year from all of these games? the emv of these games34 is $10+($1 or $2 or $4 or $8) ie within realistic confidence limits from $11 to $18. the first point to note is that whatever figure is chosen it is a modest amount, nowhere near the say $10m or more required by the traditional solution to the st petersburg game. the second point is using a priori probabilities peter faces certainty that the emv will not be less than $11. in other words if he accepted $8 from all the pauls he would have lost not less than $3 per game or a total certain loss of not less than $3 146 328 pa. what peter should have charged was not less than k/2 + ? or $18 to be 93.75 per cent confident that he would not suffer a loss. 3 conclusion so it is easy to answer the question, ‘how much should the reasonable man, paul, be prepared to pay to play the st petersburg game?’ paul would simply respond, ‘how many times am i allowed to play the game?’ if the answer is twice he would answer, ‘an amount in the order of $1/1 + $8 = $9.’ if the answer is that he can play the game 2 18 times he would answer, ‘an amount in the order of $9 + $8 = $17.’ it will be noted that although the number of games increase substantially, the size of paul’s wager does not. in all cases the amount the emv, once correctly determined, predicts that his wager is moderate and this is in accordance with common experience. if the answer is that he can play an infinite number of games, his answer would be that he would wager an infinite amount. the correct determination of the emv does not thus expect paul to wager an infinite amount to play a finite number of games, nor would a reasonable person do so. the emv once correctly derived for the st petersburg game does not lead to a paradox at all − it never did. the application of the emv criterion gives an answer that is consistent with the behaviour of the reasonable man. sajems ns vol 6 (2003) no 2 340 traditionally the incorrect value of the emv was used. utility (cardinal or ordinal) is not required to explain the behaviour of paul – he has during all these centuries been quite rational after all. endnotes 1 earlier drafts of this paper were presented at a business economics research group of the university of the witwatersrand and at the 12th annual conference of the south african institute for management scientists 31st october-2nd november 2000. the paper has benefited from comments and advice from a number of academics from various parts of the world. the usual disclaimers apply. 2 for a history, including the treatment of the paradox by mathematicians of the previous centuries see samuelson (1977). some of the more recent writers who accept that the emv of the st petersburg game is infinite or the utility solution to the paradox include todhunter (1949/1865: 220); marshall (1920: 134); keynes (1973/1921: 350); von neumann and morgenstern (1953); friedman and savage (1948: 281 and note 5); stigler (1950: 374); arrow (1951: 407); menger (1954, note 9) published in bernoulli (1954/1738); samuelson (1960); borch (1968,15); savage (1972: 93); arrow (1974: 63); brito (1975: 123); sennetti (1976); shapley (1977: 439); epps (1978); hagen published in allais and hagen (1979: 14); gorovitz (1979: 259); allias (1979: 498); székely (1987: 28); bassett (1987: 517); cowen and high (1988: 199); machina (1987: 50); russon and chang (1992: 8); schmeidler and wakker (1996); starmer (2000); aase (2001). 3 bernoulli’s paper was presented in 1731 but only published in 1738 however the st petersburg game was formulated in 1728. 4 von neumann and morgenstern’s (1953) book sparked off the renaissance in cardinal utility theory. the literature on cardinal utility is immense but fortunately for purposes of this paper it is not necessary to discuss cardinal utility since it is the thesis of this paper that the st petersburg paradox can be resolved without resorting to utility theory. for a review of the current position see schoemaker (1982), machina (1987) and starmer (2000). 5 a number of explanations have been given as to why the game is called the st petersburg game. samuelson (1977: 36 note 1) suggests it is because bernoulli's article appeared in st petersburg. savage (1972: 93) ascribes the name to the journal in which bernoulli’s paper was first published. slight variations in the name are encountered. some writers such as keynes (1973/1921: 349) refer to the paradox as the petersburg paradox. 6 i say now because until samuelson (1977) set-out its history this had not sajems ns vol 6 (2003) no 2 341 really been done or as samuelson put it '... i found to my surprise that no one seems to have provided anything like a complete survey of the subject.' earlier writers in particular todhunter (1865) provided at least an outline of the subject. 7 the theory could have more than one emphasis. it can for example attempt to explain the behaviour of people when faced with decisions involving uncertainty or be a management tool to assist in making an appropriate decision. 8 the emv is derived as follows. if a game of chance is played m times and has a range of possible outcomes c1, c2, c3 ... cm then the i mi i m c m emv ∑ = = = 1 1 1 . where the outcomes fall into categories and the number of times that an outcome appears in each category is n1, n2 , n3, …nj, then the emv n m cm i i i j i= = = ∑ 1 . . where m is large, the corresponding probabilities become p1, p2, p3, ... pj then the i ji i icpemv ∑ = = =∞ 1 . implicit in the idea of the emv is that m is large, indeed the emv is often defined as the value when m tends to infinity ie ( ) ( ) dxxcxpemv ⋅⋅= ∫ +∞ ∞− ∞ for continuous distribution. 9 samuelson (1977: 37 n4) points out that crediting pascal and de fermat underplays the rôle of earlier contributors. 10 i have used the term reasonable person, the same term used by daniel bernoulli, to avoid a debate if this reasonable person is rational or risk averse or risk neutral or risk seeking. it can of course be argued, as bernoulli did, that no gambler is rational. 11 bernoulli did not claim to be the originator of the game. nicolas bernoulli appears to have first suggested the game. 12 marshall (1920: 134 et seq) preferred using income rather than wealth as a measure of utility. income is not however in issue when it comes to investment decisions where “something” is risked. it is capital (what marshall referred to as stock of wealth) not income, which is risked when undertaking risky projects. see also friedman and savage (1948) for the use of income instead of wealth. 13 the original currency was the ducat, which bernstein (1998: 106) equates to about $40 today. in principle the type of currency is irrelevant. this paper uses dollars. 14 it is accepted that the typical gambler would be prepared to pay an amount in excess of the mathematical expectation of a game of chance. 15 there is a further problem with the traditional solution. in the limit as the payouts tend to infinity and the probability of these large payout tends to sajems ns vol 6 (2003) no 2 342 zero and the contributions from this point onwards, strictly speaking become which is 1/2 n-1 . 2 n or 0.4 which is indeterminate and not a constant. 16 assume for example the game continues to a payout of 2100 an enormous amount. the probability of this happening is 2-101 and hence, according to the traditional view the contribution of this term is still only ½. the size of the final payout is irrelevant in the determination of the emv. 17 i have often explained the game to students and asked them to indicate the amount they would be prepared to risk to play the game. no student is ever prepared to risk more than a few dollars to play the game. despite going to great lengths to explain the game i doubt if every student understood the explanation since some students indicate that zero is a reasonable amount to play the game. since the lowest amount to be won is $1, it is clear that those students did not comprehend the game. 18 utility solutions do not, of course, try to reconcile the emv criterion and the paradox. they do the very opposite and look for an alternative solution to the paradox, accepting that the emv cannot explain the paradox. cardinal utility solutions to decisions under uncertainty are increasingly coming under attack, see starmer (2000); rabin and thaler (2001). 19 for a discussion of a single game of the st petersburg game consult allais (1979: 501 et seq). 20 allais (1979: 502) concludes that ‘the rule of mathematical expectation cannot be a rational principle for decision taking in the case of a single game.’ he concludes that $33 dollars would be the amount a syndicate would offer to play a single came if the banker’s (casino owner) wealth is $10bn. 21 the various writers arrived at their conclusion for different reasons. daniel bernoulli (1954/1738: 32) accepted an amount of 2 ducats if paul had no initial wealth, nicolas bernoulli, his cousin (or uncle) accepted an amount of less than 20 ducats. gabriel cramer, in 1728 accepted an amount of less than 20 ducats. arrow (1974, 407) accepts that paul will not pay the predicted large amount. sennetti (1976: 960) accepts an amount of less than $10. allais (1979: 502) postulates an amount less than $33 where a single game is played. 22 this is almost invariably the answer i get from at least one student when i ask a class of students the question, ‘how much would you be prepared to pay to play one round of the st petersburg game?’ 23 i say only one because if it goes to infinity it never ends and thus the next game in the series will never be played. 24 i simulated st petersburg games millions upon millions of times; all ended. an academic commenting on an earlier draft of this paper simulated the game a billion times; all ended. in practice the games end. sajems ns vol 6 (2003) no 2 343 25 see in particular see footnotes 29 and 30. 26 many writers think that time is a factor which limits the game. it is not clear why they believe that time is an issue. in order to win $2100, only 98 tails in a row would be required, even if played manually this game would take less than five minutes to complete. 27 bernoulli confused matters slightly by saying an infinite number of games are played. this being so karl menger, in footnote 10 in bernoulli’s (1954/1738) paper correctly pointed out that it is not possible to divide infinity by ½ or a ¼ etc. 28 strictly speaking, ni is the ‘… probable number of times that the game terminates…' 29 the implications of this statement must be understood. if the game is played 2 k times it is certain that there will be 2k-1 games all of which terminate by the kth term. in other words the idea that the st petersburg game continues to infinity is not only wrong in practice it is wrong in theory. only one game can continue beyond the kth term. 30 the game which terminates beyond the tk term could be any one of the m games. by the time the last game is played, the game which survives beyond the tk term is almost certain to have long already have ended. the idea that the last game which is played will also somehow be the game which continues to infinity can be dismissed as a statistical improbability. 31 the fact that all terms have a payout is relevant to menger's superparadoxes (see samuelson (1977)). it does not matter what values are assigned to the payouts if n i is zero. neither the a priori probabilities nor payouts matter if all games have ended. 32 it is possible to simulate the games in which event ni will only approximate pi .m. in this case it is possible to get more or less than one game terminating beyond tk. 33 it is not unusual that the two parties to a transaction involving risk are in a different position. a person seeking insurance for his house faces a low frequency of the destruction of his house, say 1/10 000 per annum. most insureds will not in their lifetime experience a total loss. the insurer on the other hand which insures say 1 000 000 houses, faces a virtual certainty that at least more than one insured house will be destroyed each year and more likely than not 100 houses a year will be destroyed. 34 derived from the formula developed in this paper. references 1 aase, k.k. (2001) “on the st petersburg paradox”, scandinavian actuarial journal: 69-78. 2 allais, m. (1979) “the allais 1952 theory of choice with sajems ns vol 6 (2003) no 2 344 uncertainty” in expected utility hypotheses and the allais paradox, m allais and o hagen (eds.) dordrecht, d reidel publishing company. 3 allais, m. & hagen, o. (1979) (eds.) expected utility hypotheses and the allais paradox, dordrecht, d reidel publishing company. 4 arrow, k.j. (1951) “alternative approaches to the theory of choice in risk-taking situations”, econometrica, 19: 404-37. 5 arrow, k.j. (1974) essays in the theory of risk-bearing, northholland (2nd printing). 6 bassett, g.w. (1984) “the st petersburg paradox and bounded utility”, history of political economy, 19(4): 517-23. 7 bernoulli, d. (1954/1738) “exposition of a new theory on the measurement of risk” econometrica, 22(1): 23-36. 8 bernstein, p.l. (1998) against the gods the remarkable story of risk, john wiley & sons 9 borch, k.h. (1972/1968) the economics of uncertainty, princeton: princeton university press [1968] 1972 reprinting. 10 brito, d.l. (1975) “becker’s theory of the allocation of time and the st petersburg paradox” journal of economic theory, 10(1): 123-6. 11 cowen, t. & high, j. (1988) “time, bounded utility, and the st petersburg paradox”, theory and decision, 10: 219-23. 12 epps, t.w. (1978) “financial risk and the st petersburg paradox: comment” journal of finance, 33: 1455-56. 13 friedman, m. & savage, l. (1948) “the utility analysis of choice involving risk”, the journal of political economy, 56: 279-304. 14 gorovitz, s. (1979) “the st petersburg puzzle” in expected utility hypotheses and the allais paradox, m allais and o hagen (eds.) dordrecht, d reidel publishing company. 15 keynes, j.m. (1973/1921) a treatise on probability, london: macmillan press ltd, the royal economic society edition [1921]. 16 machina, m.j. (1987) “choice under uncertainty: problems solved and unsolved” journal of economic perspectives, 1: 121-54. 17 marshall, a (1920) principles of economics (8th ed.) macmillan & co, london 1947 reprint. 18 menger, k. (1954) in bernoulli, daniel. (1954/1738) “exposition of a new theory on the measurement of risk”, econometrica, 22: 23-36. 19 rabin, m. & thaler, r.h. (2001) “anomalies: risk aversion”, the journal of economic perspectives, 15: 219-32. 20 russon, m.g. & chang, s.j. (1992) “risk aversion and practical expected value: a simulation of the st petersburg game”, simulation & gaming, 23: 6-19. 21 samuelson, p.a. (1960) “the st petersburg paradox as a divergent double limit”, international economic review, 1: 31-7. 22 samuelson, p.a. (1977) “st petersburg paradoxes: defanged, sajems ns vol 6 (2003) no 2 345 dissected and historically described”, journal of economic literature, 15: 24-55. 23 savage, l.j. (1972) the foundations of statistics, (2nd ed.) new york, dover publications inc. (rev. ed.) 24 sennetti, j. (1976) “on bernoulli, sharpe, financial risk and the st petersburg paradox”, the journal of finance, 31: 960-62. 25 schmeidler, d. & wakker, p. (1996) “expected utility and mathematical expectation”, the new palgrave − a dictionary of economics, macmillan press: 229. 26 schoemaker, p.j.h. (1982) “the expected utility model: its variants, purposes, evidence and limitations”, journal of economic literature, 20: 529-36. 27 shapley, l.s. (1977) “the st petersburg paradox: a con game”, journal of economic theory, 10: 439-42. 28 starmer, c. (2000) “developments in non-expected utility theory: the hunt for a descriptive theory of choice under risk”, journal of economic literature, 38(2): 332-82. 29 stigler, g.j. (1950) “the development of utility theory ii”, the journal of political economy, 58: 373-96. 30 székely, g.j. (1986) paradoxes in probability theory and mathematical statistics, dordrecht, d reidel publishing company. 31 todhunter, i. (1949/1865) a history of the mathematical theory of probability − from the time of pascal to that of laplace, new york: cambridge university press 1865. reprint. new york: chelsea publishing company. 32 von neumann, j. & morgenstern, o. (1953) the theory of games and economic behaviour (3rd ed.) princeton. princeton university press. 452 samms ns vol 5 (2002) no 2 economic analysis of the eradication and management of invasive alien vegetation in the mhlatuze river catchment (kwazulu-natal, south africa) jennifer cooper and jessica schroenn school of business, university of natal, pietermaritzburg nevil quinn centre for environment and development, university of natal, pietermaritzburg abstract alien invasive vegetation threatens the functioning and existence of natural ecosystems in south africa because many of these plants have no predators or competitors, allowing them to dominate the ecosystem which they inhabit. the rapid proliferation of this alien vegetation, ascribed to the increase in afforestation and changes in land use, has had significant adverse impacts on water resources, biodiversity and the stability as well as integrity of these ecosystems. although eradicating alien invasive vegetation gives rise to a number of different benefits, this process entails enormous costs. consequently, in order to establish the economic viability of alien plant eradication it is essential to analyse these costs as well as the benefits associated with eradication. jelq20 1 introduction the mhlatuze river catchment, which is considered the most severely affected tertiary catchment in kwazulu-natal in terms of alien vegetation infestation, was selected as the focus of this study. although the cost-benefit analysis (cba) was conducted in a small area, its fmdings can be extended to regional, national or even global situations. at the very least, this analysis offers insight into the feasibility of alien plant eradication and ascertains whether or not this eradication is beneficial to both landowners and the broader society. this paper reviews the literature pertaining to alien invasive vegetation and outlines the methods selected for valuing the impacts of its eradication. based r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 453 on the analysis of data generated by the study, the economic efficiency of the clearing process was established, and future actions required to manage invasive alien vegetation identified. 2 theoretical framework the prevalent attitude towards eradicating alien invasive vegetation among timber producers is one of apathy; most producers undertake sporadic clearing, rather than the rigorous removal and sustained management of alien plants. in order to uncover the economic rationale for these attitudes, it is helpful to consider the economic theory underlying project appraisals as well as sources of inefficiency which lead to market failure. the hicks-kaldor criterion (i.e. accept any project which results in a potential pareto improvement) is central to the theoretical justification of cba in welfare economics and provides the rationale for selecting projects whose benefits outweigh their costs (perkins, 1994: 50). cba is purely concerned with the economic efficiency of a project and whether or not this increases social welfare. equity effects are thus ignored: the project decision does not depend on to whom the benefits and costs accrue, or on whether society considers the prevailing distribution of income to be desirable. some cba frameworks, for example that proposed by the world bank, address this issue by advocating the use of distributional weights. in the idealised world of perfect competition, the interaction of many profitmaximising producers and utility-maximising consumers gives rise to a paretooptimal situation, which is efficient. under these circumstances, prices reflect marginal economic costs and the private and social optimums coincide (munasinghe, 1993: 1732). the existence of prices means that scarcity can be gauged through the market forces of demand and supply, which ensures the efficient allocation of society's scarce resources (perkins, 1994: 95). in the real world, however, distortions ascribed to monopoly practices, external economies and diseconomies, or interventions in the market process culminate in market (or financial) prices for goods and services that do not fully reflect the marginal benefit of their consumption to society and which may diverge substantially from their true economic values or shadow prices (munasinghe, 1993: 1732). the failure of the market to price resources efficiently inevitably leads to their over-exploitation and/or inefficient utilisation. consequently, an argument can be developed for government intervention. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 454 sajems ns vol 5 (2002) no 2 an externality exists where the action of one economic agent affects the utility or production possibilities of another in way that is not reflected in the marketplace (just et al., 1982: 269). externalities are particularly relevant to this study, since those individuals not currently engaging in alien plant eradication produce more output than the socially optimal level and adversely affect the welfare of downstream users, who as a result of this inactivity produce less output than the social optimum. in practice, the correction of such distortions is difficult, since many environmental effects (e.g. increased biodiversity) display public good aspects (le. non-rivalry and non-exclusiveness in consumption), and fail to be recorded by market price movements. this explains why environmental effects are often excluded from analyses. for purposes of this study, environmental goods and services are relevant both in carrying out the cba of eradicating invasive alien plants as well as the resulting decision on project choice (hanley & spash, 1993: 10). thus, it is imperative to ensure that such effects are included and, where possible, quantified. 3 impacts associated with alien invasive vegetation the invasion of natural ecosystems by alien plants is a serious environmental problem that threatens the sustainable use of benefits derived from such ecosystems (van wilgen et al., forthcoming: 2). although alien invasive vegetation may have benefits, for example it may provide food for human consumption (e.g. guavas) or may have aesthetic beauty, substantial costs are associated with this vegetation. adverse impacts include: streamflow reduction; loss of biodiversity (as well as ecosystem resilience); increased costs of fire protection and damage in wildfires; loss of potentially productive land and loss of grazing potential and livestock production (ow af, 2000: 16) .. 4 characteristics of the mhlatuze catchment the study area comprises a total of 48 633 hectares, of which approximately eight per cent (3 767 hectares) is densely infested with invasive alien vegetation. this heavy infestation is ascribed to the establishment of plantations of alien species as well as changes in land use. the area is dominated by the agricultural, forestry and industrial sectors, all of which are important in terms r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 455 of their contribution to the local economy and/or their employment of local people. the mhlatuze catchment has been classified as 'water stressed', since more water has been allocated to users than is actually available (versveld et ai., 2000: v). it is anticipated that this sceq.ario will deteriorate in the future, due to increased demand as a result of population and economic growth as well as the launching of the richards bay sdi. furthermore, this catchment is characterised by high levels of unemployment, with most people in the rural areas engaged in a subsistence lifestyle. 5 methodology a multidisciplinary approach was adopted to document the findings of this study due to the wide range of biological, economic and social implications associated with the eradication of invasive alien vegetation. data were gleaned from an array of sources, which included books, journals, reports and government as well as policy documents. the research area was visited on a number of occasions and formal in-depth interviews were conducted with experts, major stakeholders and wfw employees. the purpose of these interviews was to identify the most significant impacts and capture salient information concerning the actual costs and benefits associated with the eradication process. a total of thirteen stakeholders located in the study area and five experts were interviewed. in addition, thirty working for water (wfw) employees residing and working in the study area were interviewed in order to evaluate the social effects of alien plant eradication, and to establish the benefits received from the wfw programme. based on the responses elicited and on the literature survey conducted, those impacts with the highest relative importance were identified. the impact parameters selected include: harvesting of alien vegetation, streamflow amount, biodiversity and fire control. where possible, the values of impact parameters connected with the eradication process were quantified. an the data generated from this process were used to compile the results section of the report, and based on the findings, suitable recommendations were formulated. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 456 sajems ns vol 5 (2002) no 2 6 results and discussion analysis of the results indicates that all the private farmers and other major stakeholders in the study region are engaged in some form of alien plant control. however, this clearing has been more rigorous on private farmland. 6.1 costs associated with alien invasive plant eradication alien plant eradication costs are dependent on the control method adopted (mechanical, chemical or biological control), as well as on the stage and frequency of clearing. individuals in the study area use mechanical as well as chemical control methods, and are responsible for the full costs connected with alien plant eradication, except where the wfw programme is operating on the individual's land. the costs associated with these control methods include capital, operating and maintenance costs as well as the costs of follow-up operations. rehabilitation costs are excluded from this analysis, since it was evident from stakeholder responses that no individual had been engaged in such a process. the total costs of eradicating alien invasive vegetation depend on the degree of infestation (the density of alien plant cover), the type and age of the invasive species, and ease of access to the area (hosking & du preez, 1999: 445). the total costs associated with clearing alien plants over a ten-year period were elicited from stakeholders. it was estimated that on average 65 per cent of the total costs pertained to labour, whilst 25 and 10 per cent were correlated to herbicide and other costs like hired equipment and transport respectively. the average costs associated with the various phases of alien plant removal (refer to table 1) are based on the above categorisation and on the following assumptions: the average weighted daily wage rate for labourers was fixed at r25 per person. all stakeholders adopted the same control methods. garlon was the only herbicide considered in this analysis, since it was found that over 85 per cent of stakeholders in the area used garlon. the cost of garlon is r142 per litre (ppri, 2000: 20). four follow-up operations were required to ensure alien plant density declines to less than 10 per cent cover (goodall pers comm.). each stage of eradication is initiated annually in order of sequence (refer to table 1). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 457 table 1 total costs associated with eradicating alien invasive vegetation for different phases stages of eradilabour cost herbicide cost! otber costs total cost cation (randslhectare) (randsl (rands! (randsl bectare) • hectare) hectare) initial eradication i 1,300 500 200 2,000 first fouow-up 494 190 76 760 second follow-up 280 107 43 430 tbird follow-up 156 60 24 240 fourth follow-up • 123 48 19 190 maintenance 104 40 16 160 this table highlights that so long as regular (that is, at least annual) alien plant eradication is carried out, total costs associated with clearing will decline with each successive year up until the maintenance phase, where costs will stabilise. using the total invaded area of 3 767ha in the study region and the costs referred to in the table above, it is instructive to depict the change in total costs associated with alien plant eradication over the ten-year lifespan of the project (refer to figure 1). it must be noted that the total costs will only follow this given trend if each and every eradication phase is properly and effectively implemented. figure 1 total costs associated with eradication in the study area rb.ooo r 7,000 c .. r6,ooo ::.~ '8;;. r5,ooo ~ 'g r4.ooo co :: e ::i r 3,000 ~ ~ r2,ooo r 1,000 ro ~ \ \ \ \ "" ........ 2345" 8 9 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 458 sajems ns vol 5 (2002) no 2 6.2 benefit now of alien vegetation eradication it is necessary to distinguish between private and social benefits in this analysis, to establish the positive impacts of alien plant eradication and to highlight the distribution of these benefits. the ignorance of social benefits has given rise to the misallocation of resources in the past, and their inclusion in this analysis is thus a significant aspect of the study. 6.2.1 private benefits private benefits are those accruing entirely to the proprietor, for example, income derived from the harvesting of alien vegetation and reduced fire management costs. monetary values for such benefits are generally easy to derive from markets. a) utilisation of alien vegetation the harvesting of alien vegetation is a consumptive use value that is dependent on the species eradicated, the relative age and the extent of infestation. from interviews conducted, it was apparent that the only alien invasive vegetation harvested were commercial timber species (eucalyptus, pinus and acacia mixed species). stakeholders estimated that on average, 20 tonnes of timber per densely invaded hectare were likely to be extracted in the initial phase of eradication. further, they confirmed that there would be market demand for this additional timber at current prices. thus to derive a monetary value for this vegetation, the extraction rate was multiplied by the profit per tonne (i.e. the market price less transport and processing costs) derived from the different timber species used for paper and pulp purposes, and summed (refer to table 2). table 2 total value (august 2001 values) of commercial forestry species located in invaded areas of study area commercial size of area 1 tonnes of timber average profit total value forestry species (hectares) to be extradedl pertonne3 (rands) per bectare (rands) eucalyptus spp. 68 20 r200 r272,ooo pinus spp. 26 20 ri30 r67,600 acacia mixed spp. 1921 20 r290 r 11,141 800 total 2015 r 11,481,400 area occupied by harvestable commercial forestry species wlthm the densely invaded area of the study region (i.e. 3767 hectares). 2 this is with reference to the initial eradication phase only. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 459 3 average profit (i.e. net of costs) for specified commercial timber, which was derived from stakeholders in the study area (august 200 i). the value of harvesting alien vegetation in the initial phase of eradication in the study region amounts to rii 481 400 (refer to table 2). the largest proportion of this potential income will accrue from the harvesting and sale of acacia species, which occupy 51 per cent of the total invaded area. this is based on the assumption that the entire invaded area is cleared in the first year. b) costs associated with burning from questionnaires administered, it was estimated that the average cost of burning open grassland per hectare is r46/ha per annum. the presence of alien invasive vegetation increases this average cost to r 7 4/ha per annum. consequently, ceteris paribus, alien plant eradication would reduce fire hazard or management costs by the same proportion, that is r28/ha per annum or 60 per cent. in order to establish the annual reductions in fire management costs associated with alien plant eradication over the ten-year project period it was essential to examine the rate of recovery over time (i.e. establishment of indigenous vegetation). the following assumption was made: the expected rate of recovery over time will give rise to reductions in fire management costs of: 100 per cent in the initial year, 95 per cent, 90 per cent, 85 per cent, 70 per cent, 60 per cent, 50 per cent and 45 per cent in each successive year thereafter subsequent to alien plant eradication. therefore, the maximum reduction in fire management costs occurs in year one, followed by small increments in costs up to the point where costs reach 55 per cent of their pre-eradication levels (i.e. a sustainable saving of 45 per cent of the base year costs). based on this assumption, the annual reduction in fire management costs in the study region was calculated. in the first year, provided that all alien vegetation is eradicated, these costs will decline by 100 per cent or ri05 476. as indigenous vegetation establishes in cleared areas, the reduction in costs declines somewhat, as shown in figure 2. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 460 sajems ns vol 5 (2002) no 2 figure 2 annual reduction in fire management costs associated witb the different stages of alien plant eradication for tbe ten-year project .. r 120.000 ,--------------------, e ~ t ;: :. r 100.000 +-=~="""4'--==----.. --------____1 .5 c ~ ~ :5 ';" r 80.000 +---------= ............ :::......:-::-------------' ~\i ~ :0 8 r 60.000 +-----------" ....... ~--------t ie i ________________ ~_=~~~~ ii ~ r 40,000 +§ ~ r 20,000 +-----------------·--jl « c e ro+-~ __ -~-_-r_--~-_-_~ 2 3 4 5 6 7 8 9 10 year 6.2.2 social benefits the social benefits flowing from alien plant eradication are those which accrue to society as a whole and include increased streamflow, increased biodiversity as well as employment benefits. it is important to incorporate these impacts into the analysis, and where possible quantify them, in order to prevent the misallocation of resources stemming from incorrect pricing information. a) streamflow increase from previous studies, it is evident that streamflow reduction is positively related to vegetation biomass and age. based on expert opinion, it was established that medium trees (which includes young acacia and eucajyptus species) dominate the invaded area of the study region, occupying over 70 per cent of the total invaded area (refer to appendix i). using the data contained in appendix i, streamflow reduction associated with the alien plants was calculated for riparian and non-riparian zones. the findings suggest that alien invasive vegetation in the study area reduces total streamflow by approximately 4.6 million m3 per annum. consequently, the eradication of this vegetation is expected to increase streamflow by the same amount. it is anticipated that only a portion of this increased streamflow will be reliably captured and extracted given existing infrastructure (wood pers comm.). based on catchment characteristics, experts predict that a minimum of 50 per cent of the increase in streamflow (about 2.3 million m3 per annum) will be available r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 461 for downstream use. in order to provide a more prudent appraisal, this conservative estimate was employed. using estimates of current water allocation in the catchment as well as the prices each sector is required to pay (refer to table 3), the total monetary value associated with increased streamflow per annum was calculated. it is estimated that if all alien vegetation were removed from the study area in the first year, the monetary value of increased streamflow would amount to r422 584 (refer to figure 4). this initial amount would be expected to decline somewhat over time, as indigenous vegetation reclaims the cleared areas. table 3 current allocation of water and differential water tariffs sustained by sectors located in the mhlatuze catchment (van der merwe pers comm.) ~ectors of water use current auocation of current water price i available water (%) cents/m3) rrigation sector 60 2.08 pomestic sector 14 42.34 ndustrial sector 26 .42.34 pnce mcludes infrastructure and catchment management charge increased streamflow arising from eradicating alien invasive vegetation accrues to those individuals situated downstream from this clearing activity, which for purposes of this study includes rural communities, private farmers as well as industries. increased streamflow is an example of a positive externality, in that it enhances society's welfare and downstream users are able to produce at their socially optimal output level. because of the social nature of this benefit, private individuals generally fail to take it into account when allocating resources. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 462 sajems ns vol 5 (2002) no 2 figure 4 annual value of tbe anticipated increase in streamflow over tbe project life span ~ r 500,000 ~---------------------; 'e ~ r400,000 .j----.:="",.~-------------_____j • 'i : i r300,ooo f 0:: u .. .e ii: r 200 000 -f---------------::li-_==-=.-! '0 ' ~ ~ r 100,000 +-----------------_____j 'ii " 0:: 0:: <t 2 b) increased biodiversity 3 4 6 9 10 project 1it....(yean;) biodiversity is an important benefit flowing from the eradication of alien invasive vegetation. however, due to the complexity of critical ecosystem services and the public good aspects which biodiversity displays, it is difficult to measure and value. techniques such as the contingent valuation method (cvm) have been developed to assign monetary values to such goods. the cvm uses surveys of expressed preferences to establish willingness to pay for (and thus, demand) the good in question. this method was employed in the present study in an effort to derive the demand for biodiversity. eighty-five per cent of the stakeholders in the study area asserted that biodiversity was important and was a benefit associated with alien plant eradication. however, when these stakeholders were questioned directly about their willingness to pay (wtp) for an increase in biodiversity, all respondents stated zero wtp, which apparently contradicts their earlier responses. there are several probable explanations for this atypical behaviour. first, such a non-compensatory stance can be viewed as evidence of a lexicographic preference. individuals may express no wtp for increased biodiversity as a protest against the implication that it could be traded for other goods or money. secondly, individuals may have experienced difficulty in comprehending the concept of biodiversity and/or the benefits that would accrue from an increase in biodiversity. thirdly, individuals may be uncertain as to whether eradicating alien plants will give rise to increased biodiversity, since a change in the biodiversity level is often difficult to assess and/or demonstrate. (it is possible r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vols (2002) no 2 463 that the latter two problems may have persisted, despite efforts made during the interviewing process to ensure that respondents understood and accepted the concept of increased biodiversity.) finally, biodiversity has public good characteristics and thus individuals may attempt to 'free ride', expressing no wtp for the good and concealing their true preferences in the expectation that others will sustain the cost. given the inherent uncertainties regarding the increase in biodiversity, rather than attempting to assign a monetary value to this benefit, it was considered more prudent to assert only that all biodiversity is valuable as a resource, and any increase therein as a result of alien plant removal would be socially desirable. c) employment benefits although the employment of individuals is essentially a cost associated with alien plant eradication, when such employment enhances the welfare of society through reduced poverty and crime levels it may also be regarded as a social benefit. it has been established that the mhlatuze catchment is characterised by high levels of poverty and unemployment, which have contributed to the escalation of crime and violence. job creation arising from alien plant removal in the catchment is likely to enhance living standards and social stability in the area, and is thus of paramount importance. external social benefits of employment were not quantitatively defmed in this analysis, but are highlighted here as an important additional benefit. the magnitude of this employment benefit is contingent upon the number of labourers employed, which in tum depends on the form of alien plant control adopted. where mechanical and chemical control methods are used, employment benefits are large e.g. between 4 and 60 labour days are prescribed for the initial eradication of one hectare of densely invaded land (de wit & crookes, 2000: 41). bio-control methods do not compare favourably in terms of employment benefits. finally, it is noted that wfw programmes could potentially provide additional benefits, such as extensive skills training. however, in the study area such benefits were not recorded. 6.2.3 cost-benefit analysis the cost and benefit flows identified above occur at different stages of alien plant eradication as well as in different years. in order to compare these flows it was essential to convert them into common units such as present values r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 464 sajems ns vol 5 (2002) no 2 determined by the discounting process. the average real interest rate on longterm bonds in south africa over the last ten years was used to define an appropriate discount rate for this project, which was five per cent. using this discount rate, the eradication of alien vegetation in the study area would realize a net present value (npv) ofr4 047 703 over ten years (refer to table 4). table 4 year cost and benefit flows associated with alien plant eradication in the study area total final cost net benefit npv npv npv benefits (in rands) or cost (in discount discount discount (in rands) randsl rate 0% rate 5% rate 10% 0 12009460 7534000 4475460 i 501 657 2862920 -2361 263 2 475,254 1,619810 -i 144 556 3 448851 904080 -455229 4 369642 715730 -346088 5 316836 602720 -285884 6 264 030 602720 -338690 7 237627 602720 -365093 8 237627 602720 -365093 9 237627 602720 -365093 total r-1551529 r4 047 703 r4250973 in order to test the sensitivity of the npv result obtained to the discount rate, rates of 0 and 10 per cent (i.e. one standard deviation on either side of the discount rate selected) were also applied. from table 4 it is apparent that the npv is very sensitive to the choice of discount rate. when the discount rate is 0 per cent, which means that future cost and benefit flows are not actually discounted, the npv amounts to -rl 551 529 over ten years. under these circumstances alien plant eradication would be undesirable and rejected. however, a 5 per cent increment in the discount rate from 0 to 5 per cent, is accompanied by a r5 599 232 increase in the npv. in contrast, when the discount rate is increased from 5 to 10 per cent, npv increases by only r203 270, to r4 250 973. the cause of these changes can be investigated by examining the cost and benefit flows associated with alien plant eradication over the ten-year period. although the total costs associated with the eradication of alien plants decrease with time, these are still substantial over the ten-year lifespan of the project when compared with the benefits. for au years except the current year (in which the eradication effort is assumed to be initiated), the costs of eradication outweigh the benefits. in other words, sizeable net costs (i.e. negative net r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 465 benefits) are recorded for years i to 9. the higher the discount rate employed, the lower the importance of more distant cost and benefit flows today. thus, large net costs that stretch into the future will be substantially reduced when a high discount rate is employed, making the alien plant eradication process more desirable. on the other hand, the largest of the quantified benefits of eradication are realised in the base year, and are not subject to discounting (because the immediate benefits from timber sales, the initial streamflow increase and reduced fire management costs are experienced as soon as clearing is undertaken). the use of a higher discount rate therefore does not affect the benefits to the same extent as the costs associated with alien plant clearing. this explains the high npv obtained when a positive discount rate is used. a sensitivity analysis was also performed on those variables with low confidence estimates to ascertain the effects of these on the npv outcome. estimates of confidence levels were based on the researcher's and expert opinion. those assumptions with the lowest confidence estimates include increased water availability, and the water prices different sectors will be required to pay in the future. an increase in the available streamflow from 2.3 million m3 to 3.7 million m3 per year was investigated. furthermore, an increase in the water tariff charged to the irrigation sector was postulated. the effects of both of these on the npv outcome were found to be largely insignificant, and it can be concluded that the fmal npv is relatively insensitive to changes in these variables. examination of the fmdings presented above indicates that the npv outcome is dominated by the revenue obtained from harvesting alien vegetation, and the eradication costs. it is surmised that the fmal outcome will be sensitive to substantial changes in these components. all other impacts play a relatively minor role. in summary, the cba indicates that removing alien plants in the study area is economically viable as well as socially desirable when a discount rate of five per cent is employed. further enhancing the argument in favour of extirpation, is recognition that the cba undertaken for purposes of this study only examined some of the benefits associated with this project, and hence represents a minimum estimate of the benefits. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 466 sajems ns vol 5 (2002) no 2 6.2.4 distribution of costs and benefits cost-benefit analysis per se is only concerned with the economic efficiency of a project and hence, assumes that everyone has the same marginal utility of income. essentially this means that gains and losses, to whomsoever they accrue, are given an equal ranking in the evaluation process. this provides the rationale for selecting projects whose benefits outweigh the costs, even if those individuals who gain from a project are not the same as those who pay for it (perkins, 1994: 55). this may result in accepting projects that are inequitable. since policy decisions concerning alien plant eradication are the preserve of the politician, it is necessary to examine the distribution of costs and benefits, because a project which is efficient may nevertheless be undesirable if this distribution is highly skewed. the costs and benefits associated with eradication in the study area are not proportionally distributed. in the absence of the wfw programme and/or biological control, those individuals engaged in alien plant eradication sustain the full costs associated with this process. although these individuals do obtain some fmancial gain from the commercial alien vegetation harvested and the curtailment of fire management costs, many of the benefits affiliated to eradication accrue to society in general. for example, downstream individuals can obtain monetary gain from utilising the increased water availability to augment production and furthermore, can enjoy positive effects such as increased biodiversity accruing from alien plant eradication. consequently, there is a definite conflict of interests which prevails, as those individuals engaged in alien plant eradication must sustain the total costs associated with clearing, whilst all groups of society can essentially benefit from this clearing. profit-maximising individuals typically make decisions based on market prices and only consider the private costs and benefits related to a particular project when allocating resources. consequently, such individuals are likely to engage in alien plant eradication for the initial year only, because private benefits exceed the private costs incurred in that year only (refer to table 4). thereafter this outcome is reversed and private costs outweigh private benefits for all subsequent years. this leads to the prediction that individuals will discontinue alien plant eradication until such time as there is a monetary incentive to continue. such a prediction is substantiated by sporadic alien plant eradication patterns recorded at a national scale. sporadic clearing is inefficient in the long run, since alien vegetation is never under 'proper' control and hence alien plant density is never reduced. thus, so long as individuals do not embark on regular clearing of alien plants, they will repeatedly have to face the initial, high costs associated with clearing alien plants. in order to encourage individuals to clear r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . samms ns vol 5 (2002) no 2 467 invasive alien plants from their properties, government policy intervention is required. 7 conclusions and recommendations the issue is not whether to undertake control operations to remove alien invasive plants, but rather how to plan and execute sustainable control operations to ensure that the resources allocated to this activity are used as effectively as possible. greater policy emphasis on and funds for curtailing widespread invasion by alien plants in south africa are required in order to correct for the inefficiency associated with sporadic clearing. 7.1 removal of externalities the lack of alien plant eradication is an example of a negative externality which imposes costs on downstream users and is a result of the marginal private costs (mpc) consistently falling short of the marginal social costs (msc) borne by society. in order to ensure the efficient allocation of resources it is necessary to close the gap between mpc and msc. there are two appropriate strategies which may be adopted by government to internalise these costs namely, the introduction of a tax or a subsidy. before these two measures are discussed it is essential to consider the socially optimal level of alien invasive plants. 7.u definition of the optimal alien plant level eradication of alien plants is economically worthwhile as long as the costs of clearing are outweighed by the (total) benefits. thus, although this study has posited the complete eradication of alien plants in the study area, as a general point it should be noted that the optimal level of infestation in any given area is not necessarily zero. rather, the socially optimal level of alien invasive plants is site-specific as well as species dependent, since site and species characteristics will impact on both costs and benefits of clearing. policy-makers would need to take this into consideration in trying to defme an appropriate level of a tax or subsidy to correct for the prevailing distortion in output levels. 7.1.2 levying of a tax government can either levy a tax on individuals who are currently not engaged in alien plant clearing or alternatively, on those individuals engaged in sporadic clearing. it is important to ensure that the tax imposed for non-eradication exceeds the mpc of clearing, since only in this event will such a charge be effective in inducing individuals to remove alien plants in the long-term. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 468 sajems ns vol 5 (2002) no 2 furthermore, the tax levied must be site-specific and charged per dense hectare of invaded alien plants. 7.1.3 introduction of a subsidy government can subsidise those individuals that have been engaged in alien plant clearing on their properties. subsidisation of those individuals currently engaged in clearing can be in the form of either monetary incentives or subsidising of certain costs (besides labour) incurred in clearing (e.g. herbicides). the subsidy, like the tax, should be site-specific and paid per dense hectare of invaded alien plants cleared. subsidisation of costs or monetary measures require on-going monitoring by government officials to ensure that the resources provided are being used for the appropriate purposes. 7.2 supplementary measures 7.2.1 fire insurance premiums the fire insurance premium is one measure which could be used to encourage private individuals and companies to engage in regular alien invasive plant clearing. where individuals have removed or are in the process of removing alien plants from their land, their fire insurance premiums should be reduced because the spread of fire is much easier to control. similarly, fire insurance premiums should be augmented where individuals have not attempted to eradicate alien invasive plants from their properties. the change in fire insurance premiums proposed will act as an incentive for individuals to engage in alien invasive plant clearing. 7 .2.2 formulation of a weed management plan all those individuals owning large areas of natural land which are prone to alien plant invasion should be encouraged by government to fonnulate a weed management plan. this plan would entail the establishment of benchmarks which can be used to measure trends and progress towards achieving some reduced level of alien plant infestation. such a plan is an important means of communicating infonnation about progress towards goals set. the formulation of this plan might be encouraged by only offering subsidies to those individuals who have fonnulated weed management plans. 7.2.3 improvements of alien plant clearing programmes programmes such as the wfw programme are to be encouraged due to their potential for creating employment and thus alleviating crime and poverty, which r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 469 is an extremely important aspect in a cash-strapped country facing massive unemployment. based on criticisms raised by stakeholders in the study area, the following improvements to the current programme are proposed: to prevent animosity between stakeholders in the mhlatuze river catchment, it is recommended that the wfw programme be confmed to state land in the future. stricter control of the current wfw programme is required to reduce the number of conflicts between farm and wfw employees. employment created by the wfw programme per se is not a sustainable solution to the unemployment situation and it is therefore essential that wfw employees are taught skills which they can apply in other activities subsequent to the termination of the wfw programme. 7.3 further research required 7.3.1 impact of alien vegetation on water more research into the impact of alien invasive vegetation on the total available water is required. this will assist in ascertaining the actual volume of water which could in future be reliably captured and extracted for direct use, subsequent to clearing alien invasive plants. in addition, it is necessary to compare the costs of alien plant eradication to alternative schemes (e.g. dam construction) which will augment water resources in the mhlatuze catchment this is important to ascertain and will indicate which are the most cost-effective in the long-term. 7.3.2 formulation ofbio-control agents continued research into the formulation of bio-control agents is required. this is important, especially since their development is likely to substantially reduce the future costs that individuals will have to sustain to effectively control alien infestations. 7.4 concluding remarks the major conclusion of this research is that there are many reasons why the eradication of alien plants is economically and socially desirable, both in terms of the efficiency and equity criteria that are generally accepted desiderata in progressive societies. the cost-benefit data for the mhlatuze catchment certainly suggest that alien plant eradication should be promoted in this area. it should, however, be noted that the costs and benefits presented in this study are site-specific and dependent on the type and density of alien vegetation, and that caution should be exercised in extending these conclusions to other areas. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 470 sajems ns vol 5 (2002) no 2 furthennore, the strategic planning of alien plant clearing initiatives is critically important, given the cost of such an exercise, and thus should also be promoted by government. it follows, therefore that policy-makers should identify policies or management options that are efficient and flexible, and hence can be applied to different areas where different characteristics pertain. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems'ns vol 5 (2002) no 2 471 appendix i average areas and age class of the alien vegetation located wltidn and outside riparian zones in the study area the total dense area of invasive alien vegetation (i.e. 3 767ha) was divided into riparian zones (i.e. 80 per cent or 3 014 ha) and other zones (i.e. 20 per cent or 753 ha). table 1 area and average age class of alien vegetation in riparian zones w12a i wi2b w12c average (w12 a,b&c) area under class i (tall alien 11% 39% 34% 28% shrubs) area under class 2 (medium 89% 56% 66% 70% trees) area under class 3 (tall alien 5% 2% trees) r= age class i (tall alien 2 years 2 years 2 years 2 years s) average age class 2 (medium 5 years 5 years 5 years 5 years trees) average age class 3 (tall alien 15 years 15 years trees) table 2 area and average age class of alien vegetation outside riparian zones w12a w12b w12c average (w12 a,b&c 3% 24% 20% 15% under class 2 (medium 97% 69% 80% 82% under class 3 (tall alien 7% 3% 2 years 2 years 2 years 2 years 6 years 6 years 6 years 6 years 15 years 15 years r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 472 sajems ns vol 5 (2002) no 2 references: de wit, m.p. & crookes, d.l. (2000) "the costs and benefits of black wattle in south africa", prepared for international development research centre (idrc) and department of water affairs and forestry (dwaf), working for water programme. csir report env-p-c2000023, august 2 dw af (2000) the environmental impacts of invading alien plants in south africa, distributed by dw af, pretoria. 3 hanley, n. & spash, c.l. (1993) cost-benefit analysis and the environment, edward elgar publishing company, u.k. 4 hosking, s. & du preez, m. (1999) "a cost-benefit analysis of removing alien trees in the tsitsikamma mountain catchment", south ajricanjoumal of science, 95: 44248. 5 just, r.e., hueth, d.l. & schmitz, a. (1982) applied welfare economics and public policy, prentice-hall inc, usa. 6 munasinghe, m. (1993) "environmental issues and economic decisions in developing countries", world development, 21(11): 172948. 7 p anayotou, t. (1992) "the economics of environmental degradation: problems, causes and responses", in markandya, a and richardson, j (eds.), the earthscan reader in environmental economics, earthscan publications, london. 8 perkins, f. (1994) practical cost-benefit analysis, basic concepts and applications, macmillan, sydney. 9 ppri (2000) herbicide guide for the control of american bramble. bugweed, eucalyptus and wattle, unpublished document. 10 van wilgen, b.w., richardson, d.m., le maitre, d.c., marais, c. & magadlela, d. (forthcoming): the economic consequences of alien plant invasions: examples of impacts and approaches to sustainable management in south africa. 11 versveld, d.b., steyl, i. & nelson, pj. (2000) strategic environmental assessment for water use, mhlatuze catchment, kzn, department of water affairs and forestry, pretoria. personal communications: goodall, j. (1411 112000), project manager, plant protection research institute. wood, j. (11109/2001), private consultant, pietennaritzburg. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 499 memory properties of the forward premium: a study on south african exchange rates h boraine and pj van staden department o/statistics, university 0/ pretoria abstract the forward rate unbiasedness hypothesis states that the current forward rate should be an unbiased forecaster of the future spot rate. inference has always been done under the assumption that the forward premium is a stationary short memory series. recent empirical results have indicated that this assumption is not valid. standard unit root tests performed on the forward premium often indicate infinite long memory. however, in recent literature fractionally integrated models have been applied for the forward premium. empirical analysis is usually performed on exchange rates of developed economies. in this article, the south african rand-dollar exchange rate is considered and the focus is therefore on a developing country. a bootstrap method for determining standard errors and confidence limits is described and implemented. jel clo, f31, gl4 introduction the forward rate unbiasedness hypothesis is a logical starting point for the analysis of spot and forward exchange rates. the hypothesis states that the current forward rate should be an unbiased forecaster of the future spot rate. in terms of a regression model this is expressed as: (1) where s t+l is the logarithm of the spot rate at time 1+ k, f,). is the logarithm of the forward rate at time land k is the length of the forward contract (for example, if monthly data are used and a one-month forward contract is considered, the value of k will be one). i following fama (1984) a regression model in returns is often used instead of (1): r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 500 sajems ns vol 5 (2002) no 3 (2) where sl+k -s, is the spot return and !,.k -s, is the forward premium. the null hypothesis of unbiasedness in this regression is that a' = 0 and fj' = 1. inference in (2) has always been done under the assumption that the forward premium is a stationary short memory series. in effect, it is assumed that the forward premium is integrated to order zero, denoted v,.k -s,)1(0). recent empirical results have indicated that this assumption is not valid. for instance, using unit root tests, crowder (1994) fails to reject the null hypothesis of non-stationarity in several forward premia series. furthermore, he rejects the null hypothesis of stationarity for these series by using the kpss test of kwiatkowski et al. (1992). crowder's empirical results therefore indicate that the forward premium has a unit root, so that v,.k s,)1(1) . as pointed out by baillie and bollerslev (1994), the problem with unit root tests as well as the kpss test is that these tests force a choice between an 1(0) and an 1(1) process. they consider fractionally integrated processes that are i(d) with o < d < 1 and find evidence of fractional integration for the forward premia series. most empirical analysis is performed on exchange rates of developed ecoqomies. we consider the south african rand-dollar exchange rate and our focus is therefore on a developing country. in this article basic results regarding fractional integration and long memory are given. different methods for the estimation of d are cited. a bootstrap method for determining standard errors and confidence limits is described and implemented. the importance of standard errors and confidence limits in the interpretation of results cannot be over emphasized. if, for instance, a 95% confidence interval for d includes both the values 0 and 1, it is impossible to draw any conclusions regarding the memory properties of such a series. even though it is almost always possible to estimate d, some time series simply do not contain enough information to estimate d accurately. it is standard practice to provide standard errors with the estimates. confidence limits are typically calculated under the assumption of a symmetric bell-shaped distribution. this assumption is not necessarily valid. the advantage of the bootstrap is that it does not rely on any distributional form. it is used to estimate the probability distribution of an estimator, together with confidence limits. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 a model for time series with long memory consider the simple autoregressive model for a discrete time series x, x, =¢t"h +~ 501 (3) where the &,' s are white noise innovations with mean 0 and variance u 2 • if ii 1, x, is integrated to order one, denoted 1(1), and has infinite long memory. that is, the effect of the innovations &, is permanent. in contrast, if ii < i, then x, is 1(0) and has short memory so that the effect of the innovations disappear geometrically. the problem with the autoregressive model is that a choice must be made between these two extremes. arma models are not designed to describe time series with long memory, where the effect of innovations is not permanent, but still may take relatively long to die out. a more suitable model for time series with long memory is the fractionally integrated model, which was developed independently by granger (1980), granger and joyeux (1980) and hosking (1981) and is given by (4) where i" is the mean of x" u, is a covariance stationary series, l is the backshift operator and d is the so-called fractional differencing parameter. for d ={}, x, has short memory (corresponding to 11<1 in the autoregressive model), while for d=l, x, has infinite long memory (corresponding to 11=1). for o<d<l, x, is said to be fractionally integrated and has long memory with the effect of the innovations disappearing at a slow hyperbolic rate. in particular, x, is stationary and mean reverting for 0 < d < m, while for m < d <i, x, is non-stationary but still mean reverting (a series is mean reverting for d < 1). if ", is a white noise series, (4) is referred to as a fractional white noise model. by substituting u, =¢(lr1fj(l)&, into (4), an autoregressive fractionally integrated moving average or arflma(p,d,q)model is obtained: ¢(l)(1l)d (x, 1") = fj(l)~ (5) using a taylor series expansion, it can be shown that the fractional difference operator can be written as r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 502 sajems ns vol 5 (2002) no 3 (6) . k d-j with iro = i , ir\ = -d and irt = --k-irt-\. see baillie (1996) for a summary of long memory processes and fractional integration as well as the other important properties of the models described above. estimation methods a comprehensive discussion of estimation methods for fractionally integrated models is given by chung and baillie (1993). these methods include a semiparametric estimator in the frequency domain by geweke and porter-hudak (1983), a minimum conditional sum of squares (css) estimator, originally suggested by hosking (1984), an approximate maximum likelihood procedure in the frequency domain by fox and taqqu (1986) and a full maximum likelihood estimator under the assumption of normally distributed innovations by sowell (1992). for our application the css method is used. the conditional sum of squares function is given by: t s(l) = f loga2 + 2~ ~>,2 ,=1 (7) where &, is obtained from (5) and a.=(d.'pt •...• ;,pa, ... ,oq.cr2 ) is the vector of parameters that must be estimated. an iterative optimization algorithm is employed to minimize (7). css is an approximate maximum likelihood method with the advantage that it is not as computationally intensive as sowell's full maximum likelihood. it is not based on any distributional assumptions and can be extended to estimate models with garch components. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 503 standard errors and confidence limits the bootstrap is a method that is used to detennine the standard error of an estimator and to construct confidence limits for the true parameter value see swanepoel (1990) for a review. in order to assess the precision of an estimate, it is of vital importance to calculate standard errors and confidence limits. if the estimate for d has a large standard error, it is not stable and the confidence interval will consequently be wide and may include a range of values that imply stationarity (d < x), non-stationarity and mean reversion (~< d < i), and nonstationarity without mean reversion d ~ i. on the other hand, if the standard error of the estimate of d is small, the confidence interval will be narrow and it will be possible to draw accurate conclusions regarding the order of differencing from the estimate of d. the bootstrap is often applied in situations where no closed fonn expression for the standard error of an estimator exists, or when it is difficult to derive such an expression. in the case of arfima models the parameters are estimated by minimizing a function that is non-linear in the parameters. conditional sum of . squares is used in this study to estimate the parameters of arfima models. closed fonn expressions for the estimators are not available, let alone expressions for their standard errors. an advantage of the bootstrap is that it does not rely on any distributional assumptions. although it is a computationally intensive method, that is not regarded to be a serious drawback in this age of ever increasing computer power. the bootstrap was originally proposed for cross sectional or non-time series data by efron (1979). the idea is to draw random samples (with replacement) from the observed data. these samples are called bootstrap samples and they me regarded as independent samples from the population. the statistic is calculated for every sample. the value of the statistic will vary from sample to sample and the distribution of values is an estimate of the sampling distribution of the statistic. the standard deviation of the estimated distribution can in many cases be shown to be a consistent estimator for the standard error of the statistic under consideration. the basic assumption is that the observed data set is representative of the population. in the case of time series data special care has to be taken to preserve the dependence structure of the time series. one of the methods applicable to dependent data is to resample from the residuals of the fitted model see chatteljee (1986). in a study on autoregressive processes, de koster (1999) found that this method perfonns better than other methods for dependent data. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 504 sajems ns vol 5 (2002) no 3 in our application, an arflma model is fitted to the observed time series. the residuals of this fit are assumed to be representative of the error terms of the arflma model. a large number of time series are generated using the fitted model as well as the residual terms. these time series are called bootstrap time series. residuals are drawn randomly with replacement from the set of residual terms. for every time series an arfima model of the same order as the original model is fitted. the estimates will vary from one series to the next. the standard deviations of the parameter estimates are then used as estimators for the standard errors of the estimates. care should be taken to fit an appropriate model in the first place. the model may not fit well for several reasons. if the error terms have a relatively large variance, the bootstrap time series will also have large error variances and the estimates will vary relatively more across the different time series, resulting in relatively large standard errors and wide confidence intervals. in other words, if the model does not fit well in the first place, it will also be reflected by the standard errors of the parameter estimates and by the length of the confidence intervals. in order to calculate confidence limits, it is recommended to generate at least 1000 bootstrap time series. we use the method of percentiles to calculate confidence limits. the 1000 estimates for a particular parameter are ordered and the 2.5th and 97.5 th percentiles are used as a 95% confidence interval see for example swanepoel (1990). application to south african exchange rates we study the daily rand-dollar spot and thirty-day forward exchange rates for the period from 3 january 1995 to 5 march 200 i, a time series of 1524 observations. the forward premium is calculated as the difference between the (logarithm of the) thirty-day forward rate and (the logarithm of the) spot rate (figure i). table i presents the results of unit root (phillips-perron) tests and the kpss test for determining the order of integration of the forward premium. first consider the kpss test, which tests h 0 : 1(0) against hi: l(l). the null hypothesis is rejected at a i % significance level so that it is clear that the forward premium is not a stationary short memory series. ho : l(l) is tested against hi : 1(0) with the phillips-perron test. since the null cannot be rejected, the indication is that the forward premium is a non-stationary infinite long memory series. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 505 figure 1 the forward premium: rand-dollar exchange rate 0.018 0.016 0.014 0.012 0.010 0.008 0.006 0.004 0.002 0.000 ql ql i '" '" i ti " t c: t c: c: ii ~ ii ii cd ii .., le .., le (/) .., however, it is known that unit root tests have very low power against fractionally integrated alternatives see diebold and rudebusch (1991) for the dickey-fuller test and hassler and wolters (1994) for the phillips-perron test. in contrast, lee and schmidt (1993) note that the kpss test is quite powerful against fractionally integrated alternatives. given this, the forward premium may be a long memory series that is fractionally integrated. table 1 testing the order of integration of the forward premium ho : 1(0) phillipsho : [(1) kpss test lja lj6 perron z(ta ) z(t6 ) 5.448 3.32" test -1.98 -2.48 notes i lja and lj" are the kpss test statistics based on residuals from rcgrcssions with only an intercept and an intercept and time trend rcspccli\'cly see kwiatkowski et al. (1992). the 0.01 and 0.05 critical values for lja are 0.74 and 0.46 respectively. similarly the 0.01 and 0.05 critical values for lj" are 0.22 and 0.15. 2 z(t a ) and z(t,,) are the phillips-perron adjusted test statistics of the lagged dependent variable in regressions with only an intercept and an intercept and time trend respectively see phillips (1987) and phillips and perron (1988). the 0.01 and 0.05 critical values for z(ta) are3.44 and -2.86 respectively. similarly the 0.0 i and 0.05 critical values for z(t,,) are -3.97 and -3.42. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 506 sajems ns vols (2002) no 3 3 results from other unit root tests (dickey-fuller) were similar to those from the phillips-perron test and are hence not given. 4 for both the phillips-perron tests and the kpss tests the number of lags were truncated at lag 7 following newey and west (1987). 5 • significant at i % level. b significant at 5% level. the correlogram of the forward premium gives more evidence of possible fractional integration. the first 200 autocorrelations of the spot rate, the forward premium and the spot return are shown in figure 2. the spot rate is a random walk and hence has infinite long memory. the autocorrelations of the spot rate will therefore decrease at a very slow rate. since the spot rate is 1(1), the spot return is 1(0) and uncorrelated at higher lags. the spot return therefore has short memory. the autocorrelations of the forward premium are persistent, but considerably less so than those of the spot rate. this is consistent with long memory behavior (the autocorrelations of a long memory series decrease at a slow hyperbolic rate). figure 2 first 200 autocorrelations 1.0 --spot rate --forward premium 0.6 spot retum 0.6 0.4 0.2 0.0 ;';';;'~i"'"'~w,fi:'i::~~f.p-..,..".~i..;:"":;"":;'~'~':""'*:'-""';"-+'<,fh"'+ 60 .. ; 80 100 • 120' 140" '160 180 200 -0.2 lag given the above discussion, the fractional differencing parameter d of the forward premium is estimated. ess is used to estimate low-order arfima(p,d,q) models for the forward premium with p$2 and q'5.2. since none of \ the estimated autoregressive or moving average parameters is significant, they are eliminated from the final model, giving a fractional white noise model. thus, only d and (]'2 are estimated. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 507 the empirical estimation results are given in table 2. the estimate of d is approximately 0.8 so that the forward premium is 1(0.8) and has long memory. a tota1 of 1000 bootstrap time series are used to determine the sampling distribution of d from which the standard error and confidence limits are obtained. figure 3 shows the histogram of this distribution. the distribution is nearly symmetrical (slightly positively skewed) but not normal. because the lower boundary of the 95% confidence interval is larger than ~, the forward premium is non-stationary. however, the forward premium is mean reverting since the upper boundary of the interval is less than 1. table 2 empirical estimation results observations parameter estimate used all 1524 d (1'2 first 800 d (1'2 last 724 d (1'2 0.18 e-06 figure 3 sampling distribution of d 200r---------------~~----------------------_, 180 160 140 j :: 110 40 20 o .f==jiit;~~~p:z. 0.74 0.75 0.711 0.77 0.78 0.79 0.8 0.81 0.82 0.83 0.84 0.85 0.88 0.87 0.88 0.89 d there was a large depreciation in the rand against the dollar in june 1998 followed by a period of high volatility. this is illustrated in figure 4. because of the depreciation, there was a sharp incre,ase in the forward premium in june 1998 as can be seen in figure 1. the question is what the effect of this shock on the forward premium series will be. theoretically, since the estimate of d is less r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 508 sajems ns vol 5 (2002) no 3 than i, the effect should not be pennanent. that is, the forward premium should revert back to the mean. to analyze this problem further, and to confinn our estimation results for d, we divided the time series in two subsets. we took the first 800 observations from 3 january 1995 to 31 march 1998 and the last 724 observations from i april 1998 to 5 march 2001. for both these subsets we again estimated d. as can be seen in table 2, the estimates as well as the confidence intervals correspond well with those of the complete dataset. the forward premium is therefore indeed mean reverting and we conclude that the forward premium is /(0.8). figure 4 the daily rand-dollar spot and 30-day forward rates in 1998 7.00 1-------------;:=:::::::=::::::;, 6.50 6.00 j 5.50 4.50 +-~f___+--+--+_~f--_+-_+_-+---i-_+-_+_.....i jan-ini mar-9a may-9a jul-98 sap-ini nov-98 conclusion recent empirical estimation results indicate that the widely accepted assumption of a short memory forward premium is invalid (for example crowder, 1994). the evidence from unit root tests is that the forward premium has infinite long memory. however, baillie and bollerslev (i994) consider fractionally integrated models and conclude that the forward premium has long memory. all the above studies concentrate on exchange rates from developed economies. we consider the rand-dollar exchange rate and hence focus on a developing economy (south africa). using css estimation we also find evidence of long memory for the south african data. therefore, although the forward premium is non-stationary and has infinite variance, it is still mean reverting. the long memory of the forward premium has implications for the analysis and modeling of exchange rates and is also one of the causes of the forward r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 509 premium anomaly. this anomaly refers to the fact that empirical estimates of fl' in the regression model in returns (2) are often negative. the null hypothesis of unbiasedness is then rejected (since the empirical estimate of fl' is less than unity). as explained in detail by baillie and bollerslev (2000), the rejection of unbiasedness is due to the persistent autocorrelations of the long memory forward premium. in fact, the long memory of the forward premium is in itselfa rejection of unbiased ness. references baillie, r.t. (1996) "long memory processes and fractional integration in econometrics", journal of econometrics: 73, 5-59. 2 baillie, r.t. & bollerslev, t. (1994) "the long memory of the forward premium", journal of international money and finance, 13: 565-71. 3 baillie, r.t. & bollerslev, t. (2000) "the forward premium anomaly is not as bad as you think", journal of international money and finance, 19: 471-88. 4 chatterjee, s. (1986) "bootstrapping arma models: some simulations", ieee transactions on systems, man and cybernetics, smc-16: 294-99. 5 chung, c.-f. & baillie, r.t. (1993) "small sample bias in conditional sum-of-squares estimators of fractionally integrated arma models", empirical economics, 18: 791-806. 6 crowder. w.j. (1994) "foreign exchange market efficiency and common stochastic trends", journal of international money and finance, 13: 551-64. 7 de koster. f.h. (1999) "the bootstrap approach to autoregressive time series analysis", unpublished m.sc dissertation, university of pretoria. 8 diebold, f.x. & rude busch, g.d. (1991) "on the power of dickey-fuller tests against fractional alternatives", economics letters, 35: 155-60. 9 efron, b. (1979) "bootstrap methods: another look at the jackknife", annals of statistics, 7: 1-26. 10 fama, e. (1984) "forward and spot exchange rates", journal of monetary economics, 14: 319-38. 11 fox, r. & taqqu, m.s. (1986) "large sample properties ofpararneter estimates for strongly dependent stationary gaussian time series", annals of statistics, 14: 517-32. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 510 sajems ns vol 5 (2002) no 3 12 geweke, j. & porter·hudak, s. (1983) "the estimation and application of long memory time series models", journal of time series analysis, 4: 221·38. 13 granger, c.w.j. (1980) "long memory relationships and the aggregation of dynamic models", journal of econometrics, 14: 227-38. 14 granger, c.w.j. & joyeux, r. (1980) "an introduction to long memory time series models and fractional differencing", journal of time series analysis, 1: 15-39. 15 hassler, u. & wolters, i (1994) "on the power of unit roots against fractionally integrated alternatives", economics letters, 45: 1-5. 16 hosking, j.r.m. (1981) "fractional differencing", biometrika, 68: 165-76. 17 hosking, ir.m. (1984) "modeling persistence in hydrological time series models using fractional differencing", water resources research, 20: 1898-1908. 18 kwiatkowski, d., phillips, p.c.b., schmidt, p. & shin, y. (1992) "testing the null hypothesis of stationarity against the alternative of a unit root: how sure are we that economic time series have a unit root?", journal of econometrics, 54: 159-78. 19 lee, d. & schmidt, p. (1996) "on the power of the kpss test of stationarity against fractionally.integrated alternatives", journal of econometrics, 73: 285-302. 20 newey, w.k. & west, k.d. (1987) "a simple positive semi-definite heteroskedasticity and autocorrelation consistent covariance matrix", econometrica, 55: 703-08. 21 phillips, p.c.b. (1987) "time series regression with a unit root", econometrica, 55: 277-301. 22 phillips, p.c.b & perron, p. (1988) "testing for a unit root in time series regression", biometrika, 75: 335-46. 23 sowell, f. (1992) "maximum likelihood estimation of stationary univariate fractionally integrated time series models", journal of econometrics, 53: 165-88. 24 swanepoel, j.w.h. (1990) "a review of bootstrap methods", south african statistical journal, 24: 1-34. 25 van staden, p.i (2001) "fractional integration and co-integration", unpublished m.com dissertation, university of pretoria. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (200 i) no 2 the learning organisation: a facilitating training for change african organisations f w struwig and e e smith 380 means of in south department of business management, vista university, port elizabeth dj l venter institute for statistical consultation and methodology, university of port elizabeth abstract this article considers the nature and role of the learning organisation as a means of implementing change through training in south african organisations. the paper is based on theoretical study and empirical research, including 365 training and organisational development specialists in south africa. five nullhypotheses were empirically tested in order to establish relationships between the learning organisation and certain independent variables (classification data and training). advanced statistical methods, such as analysis of variance and correlation coefficients were used to test these hypotheses. the learning orgaqisation facilitates learning by all its members and has the capacity to adapt and change continuously. if learning is an organisational priority, training programmes should be designed to promote initiatives to change the organisation. emphasis should be placed on both learning (acquiring knowledge and skills) and doing (practical application). jelm 14 1 introduction this article focuses on the nature and role of the learning organisation as a means of facilitating training for change in south african organisations. mabey and salaman (1995: 315) are of the opinion that the idea of the learning organisation has flourished as one way of "summing up the sorts of organisational qualities called for and valued in today's changing environment". hendry, johnson and newton, (1994: 229) and lessem (1991: 17) concur that the learning organisation is heralded as the organisation of the future which calls for a new management order, because of the onset of unprecedented rates of change. althougb mcsween (1995: 6) is of the opinion that creating the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 381 sajems ns vol 4 (2001) no 2 learning organisation is simple, solomon (1994: 56) argues that "an organisation never becomes a learning organisation, because by defmition it means always evolving, always being in flux, always learning". the learning organisation is therefore a philosophy that alters the wayan organisation thinks about learning and decision-making. noer (1997: 176) also postulates that organisations of the future will not survive without becoming communities of learning, and that the learning organisation "is no academic fad or consultants' buzz word". the way in which the organisation learns can be the key to innovation, profitability and competitiveness. this article first gives a theoretical overview of the role of the learning organisation in facilitating change in the organisation through training. this is followed by a brief outline of the research method. the main survey results and conclusions, and managerial implications of the study are then provided. 2 a theoretical overview according to senge (1997: 14), the learning organisation can be described as an organisation "that is continually expanding its capacity to create its future". swieringa and wierdsma (1992: 71) contend that the learning organisation has, on the one hand, mastered the art of adapting quickly and, on the other hand, preserved its direction and identity. the learning organisation can therefore be considered as the involvement of all employees in the organisation in identifying and solving problems, which enables the organisation continuously to experiment and improve its capacity to deliver new products and services to customers (hellriegel & slocum, 1996: 680). it appears, therefore, that the learning organisation facilitates the process of learning by all its members and has the capacity to adapt change continuously. marx (1997: 1), however, stresses that a learning organisation is not just a programme to be implemented, but a philosophy aimed at creating, mastering and transferring knowledge. having identified what the learning organisation is, it is necessary to clarify the concept of "organisational learning." both argyris (1994: 123) and dawson (1992: 230) assert that an organisation learns through individuals acting as agents of the organisation and is usually associated with notions of radical change. as individuals learn new ways of behaviour and develop new values, organisations, being collections of people, can also learn and develop new assumptions, values and behaviour. it is, therefore, the individuals in the organisation who enable it to learn ways that facilitate organisational change. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2382 2.1 nature of organisational learning according to beardwell and holden (1994: 278), it is important to understand the process and nature of learning in order to facilitate the learning and development of individual employees and, ultimately, the organisation itself. the process of learning knows no boundaries. people bring the results of this naturally occurring and continuous process to the workplace, and thus have the potential to contribute to skills, attitudes and creative thinking which organisations need to survive in a changing world. hendry et ai., (1994: 230) argue that, at the broadest level, organisational learning is how organisations change. this, however, does not imply that organisational learning is simply about the management of change, but rather about elements and processes by which organisations develop and grow. organisational learning is built on three key precepts: organisations learn through individuals, organisational learning is greater than the sum of individual learning, and it is a process of change in behaviour, beliefs, systems and structures. both argyris (1994: 8) and dawson (1992: 230) advocate two approaches to organisational learning: single-loop and double-loop learning. single-loop learning occurs when errors are corrected, using past routines and present policies. it involves improving organisational capacity to achieve known objectives, and the organisation is learning without significant change in basic values and assumptions (robbins, 1996: 734). double-loop learning means that the learning organisation corrects errors by modifying its objectives, policies and routines. this type of learning involves changing the organisation's culture (luthans, 1995: 41). it correlates with senge's (1997: 14) classification of adaptive learning (single-loop learning) and generative learning (double-loop learning). for the learning organisation, adaptive learning must be joined with generative learning (the capacity to create). marquardt (1997: 2) postulates that organisational learning must equal or exceed the rate of change in the macro-environment, otherwise the organisation will die. organisational learning shows the following common characteristics: * * * * it enhances intellectual and productive capacity gained by organisationwide learning. it builds on shared values, memory and knowledge. it functions like an orchestra. it applies system-wide learning. gordon (1996: 45), on the other hand, highlights some managerial implications of organisational learning. managers must ensure that appropriate conditions for learning exist and must reinforce desired learning-based behaviour. the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . i 383 sajems ns vol4 (2001) no 2 provision of environmental cues which encourage learning, and a physical and an emotional climate supportive of learning, is essential. solomon (1994: 56) emphasises that organisational learning provides an opportunity for human resources to exceed the limits of training and to move further into the organisation. the learning organisation requires organisational learning in addition to traditional training. 2.2 characteristics of the learning organisation mabey and iles (1994: 24) maintain that although each organisation is unique and has its own identity, the learning organisation is an idealised state (a state of being, ~ot just of doing). learning and working become synonymous. as a central activity, the process of transformation enables the organisation to search for new ideas, problem-solving techniques and opportunities of learning inside and outside the organisation. figure 1 depicts some of the basic characteristics of a learning organisation. figure 1 characteristics of a learning organisation leadership: organisation design: • shared risk-taking • employee i • teams empowerment i • no boundaries • few "bosses" culture: environment: sense of community the open and interactive • learning • • caring for workers organisation • advanced technology • trust • participative • learning climate information strategy: sharing: focus on customers • • open • creation of new markets • timely • investment in emerging • accurate opportunities source: hellriegel and slocum (1996: 681) in addition to these basic characteristics, mabey and iles (1994: 25) and pedler, burgoyne and boydell (1991: 18) characterise the learning organisation as one which implements the following: r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2• learning strategies participative policy-making • infonnation technology to empower people internal exchange reward flexibility enabling structures • frontline workers as environmental scanners • inter-organisational learning a learning climate • self-development for all. 384 it is, however, important to note that implementation of all these actions does not necessarily mean that an organisation is a learning organisation. learning must be at the core of all operations. table i illustrates the difference between a traditional versus a learning organisation. table 1 traditional versus learning organisations function traditional organisations learning organisations detennine overall vision provided by top shared vision emerges from direction ! management various places fonnulation and top management decides takes place at all levels implementation of what must be done and the rest within the organisation ideas of the organisation follows confli\::t resolution i through power and collaborative learning and hierarchical influence integration of diverse vie~oints leadership and leader establishes vision, leader builds shared vision, motivation i provides rewards and empowers personnel, encoupunishments and maintains rages effective decisionmai overall control king and inspires commitment through charismatic i leadership source: adapted from luthans (1995: 45) from table i it appears that the learning organisation is a remedy for the fundamental problems inherent in traditional organisations. robbins (1996: 735) attests to the fact that no organisation has, or probably ever will, successfully achieve all the characteristics described above. organisations should strive towards these ideals, rather than see them as a realistic description of structural activities. several specific organisational characteristics serve as r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 385 sajems ns vol 4 (2001) no 2 variables in this study. these include: size of the organisation as measured by the number of employees, the existence of a fully developed training department and type of environment in which the organisation operates. from the aforementioned, the following three hypotheses are formulated: hol the number of employees (size of organisation) is not related to the learning organisation. h02 there is no relationship between an organisation that has a fully developed training department and the learning organisation. h03 there is no relationship between the environment in which an organisation operates and the learning organisat~on. 2.3 creating a learning organisation pedler et al., (1991: 49) and fisher and torbert (1995: 108) stress that although building a learning organisation is a challenge and that there is no single, guaranteed way of becoming a learning organisation, there are, however, some guidelines and directives to be followed at the beginning of this journey. tobin (1993: 178) argues that to effectively bring the learning organisation to life, a series of nine action steps is required: • study learning organisations and decide if this is the direction that the organisation wishes to follow. determine the readiness for starting a learning organisation assess the current status in terms of leadership, basic skills and teamwork. prepare for the "birth" of the learning organisation develop plans to build it. • conception with the plans in place, it is time to announce the new direction and to inform all employees throughout the organisation. provide sufficient training in each identified area of skill allow workers to practice those new skills and to learn from mistakes. • "kick-start" the programme management must be clearly committed to demonstrate the seriousness of the new approach. • institute a series of learning practices inculcate employees' thinking with the values of the learning organisation. encourage and reinforce learning newly-learned skills and information should be applied to the job situation and employees should be given responsibility for mastering the new skills. be open to new emerging ideas allow employees freedom to learn and share ideas. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2386 such stepwise action indicates a long road to success in creating a learning organisation. establishing a strong sense of urgency and shared commitment about becoming a learning organisation is of the utmost importance. wick and leon (1993: 126) devised a formula for creating a learning organisation, which is presented in figure 2. figure 2 formula for creating a learning organisation learning organisation = leader with vision + planimetrics + information + inventiveness + implementation source: wick and leon (1993: 127) employing this basic formula will create a unique learning organisation. if one element is missing, the organisation will either learn the wrong lessons or do so at a rate less than its full potential. a leader with a clearly defined vision, detailed and measurable plans of action, rapid information-sharing, inventiveness and the ability to implement the plan, is the agent who creates a learning organisation. according to swieringa and wierdsma (1992: 80), there are two basic approaches to becoming a learning organisation. the "tourist model" first establishes the precise direction the organisation should follow and how to reach its de~tination, and only then sets out (think fust, act later). the "trekker model" again suggests that the organisation, though not knowing exactly where it is heading, chooses a certain direction and then sets forth. organisational change takes place in the form of a common, collective learning process. using the "trekker model" implies that change takes place faster and that there is little time to establish its precise direction and destination. mabey and salaman (1995: 349) highlight five development phases of the learning organisation (refer to figure 3). figure 3 development phases of a learning organisation transformation ~ transfiguration ~ learning organisation foundation ~ formation ~ continuation ~ organisational learning i source: adapted from mabey and salaman (1995: 349) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 387 sajems ns vol 4 (200 i) no 2 the three lower parts of figure 3 represent the initial phases of organisational learning. the foundation phase concerns basic skills development and enthusing learners to learn more. the formation phase encourages and develops skills of self-learning and development (individual begins to learn about the organisation as a whole and its purpose). in the continuation phase, the learner and organisation become more independent, innovative and confident. the two parts in the upper section of the model are evidence of a transition from organisational learning to the learning organisation. transformation illustrates a complete change in the form, appearance and character of the organisation. idealisation is the focal point during the transfiguration phase of the learning organisation. the organisation represents a way of life to be cherished because of its v~lues. an organisation can thus progressively develop into a learning organisation. 2.4 lifelong learning authors like beardwell and holden (1994: 280) and morton (1994: 126) advocate the inculcation of a lifelong learning culture in the organisation, to meet a continuous need for learning. longworth and davies (1997: 22) defme lifelong learning as lithe development of human potential through a continuous, supportive process which stimulates and empowers individuals to acquire all the knowledge, values, skills and understanding they will require throughout their lifetimes and to apply these with confidence, creativity and enjoyment to all roles, circumstances and environments." people continue learning throughout life, which implies continuous adaptation. senge (1997: 4) maintains that learning organisations are possible because all people are learners. learning is a basic characteristic of human nature and people enjoy it. increased knowledge and improved skills enlarge the individual's capacity to adapt to the environment and to change it, if possible. managers and agents of change must therefore cultivate a learning culture in the organisation, which implies that the individual learns throughout its life in the organisation. 2.5 the role of training in the learning organisation greenberg and baron (1997: 92) argue that training is a systematic approach to incorporating learning in the organisation. training can be used to prepare employees to meet the challenges and changes in the workplace and to upgrade and refine skills. the best training programmes often use many different approaches, thus ensuring that several learning principles are incorporated into training. in order to accomplish this, harrison (1998: 33) states that trainers need a paradigm shift to introduce a new framework for coping with rapid organisational change. learning cannot be made a purely individual responsibility. it is a corporate process involving organisation, team and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2388 individual table 2 highlights the evolution of training in a learning organisation. table 2 evolution of training in a learning organisation traditional training i organisational learning employees receive skills training and , all employees receive learning support executives development training. ' lifelong development. training goals are based on requests by learning goals are based on corporate users. strategy and users' needs. training primarily addresses immediate • learning focuses on ~ore competencies. needs. training is conducted locally or in an education takes place at the workplace, job offsite classroom. site or elsewhere. delivery of training is scheduled on a delivery of education is on time, upon i periodic basis. request. training is instructor-driven. . education is self-directed. training approach is that of delivering education approach is to design learning knowledge. experiences or workplace interventions. content is generalised and developed by • content is specific and applied, and training specialists. developed jointly with trainees. trainers develop and deliver content, educators facilitate the process and coach trainees are recipients. learners learners are joint developers. needs assessments are carried out by a needs assessments are carried out jointly training group or managers. by individuals, managers and training groups . . source: adapted from solomon (1994: 64) table 2 shows that the learning organisation requires organisational learning in addition to traditional training. mabey and salarnan (1995: 320) state that one of the elements of the learning organisation profile is training programmes designed to support the change strategies and values held by top management. if learning is an organisational priority, training programmes should be designed to emphasise both learning (acquiring knowledge and skills) and doing (practical application). bencivenga (1995: 69) states that through learning and training in the organisation, employees' capacity to act and organisations' ability to adapt quickly, are enhanced. dobson and tosh (1998: 66) also point out the benefits of training an organisation to become a learning organisation. the stress should be on training which seeks organisational objectives to be cascaded to departmental objectives and then transformed into training objectives. according to jones and mann (1992: 207), training should contribute to the development of the innovative capacity of the learning organisation. changing r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 389 sajems ns vol 4 (2001) no 2 times are forcing trainers to reconsider their role in the organisation. initially, training within organisations largely focussed on specific, well-defined skills which employees needed to improve job perfonnance. although this type of training remains important in the learning organisation, additional types of training are needed in order to empower employees and seek their participation. based on this reasoning and background, the following two hypotheses are fonnulated: h04 there is no relationship between the facilitating role of training and the learning organisation. h05 there is no relationship between the role of training in managing organisational change and the learning organisation. in the learning organisation, where employees are expected to invent their own procedures and empowered to try new ways of operation, the "old" training technology seems inappropriate. the following are four common approaches to the changing role of training in the learning organisation: • open training the creation of a flexible and accessible range of good quality courses. obstacles which impede participation in training courses must be removed. self-study, and the use of new technologies and requisites of the learning environment need to be arranged. • responsive training directed towards the creation of an environment in which learners are stimulated to find their own approach to key problems. managers and personnel should support each other in developing methods of handling critical tasks. • on-site learning this involves the dismantling of barriers between working and learning, by adding an educational dimension to functions, regulations and systems. • collective competence this implies the enhancement of individual and group competence by providing adequate working aids and facilities. the main concern is perfonnance and not learning (jones & mann, 1992: 209). 3 research method 3.1 sampling for the purpose of this research project, the target population was chosen from south african organisations. all organisations with a training department or section, headed by a training practitioner or director, were regarded as the target population. the sample selected for this study consists of 374 training r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2390 practitioners registered with the south african board for personnel practices. it was felt that these training specialists would be able to provide objective and expert opinion with regard to implementing change through training in south african organisations. only south african organisations were included and, therefore, nine foreign practitioners were excluded from the sample. it was felt that conditions in foreign organisations and the perceptions of their training practitioners may differ from their south african counterparts. the total sample size is therefore 365. 3.2 survey design based on the size of the sample (365), a mail survey by questionnaire was considered best suited to this study. the questionnaire consists of the following three sections: section a: the learning organisation section b: training in the organisation • section c: classification data (demographic proflles of respondents) the type of ordinal scale used in section a and b of the questionnaire is a fivepoint likert-type scale. section c contains a nominal scale of measurement. because this questionnaire had not been used in any previous research project, a pilot survey among 40 local organisations was conducted. wherever possible, it was sent to human resources managers and training specialists for completion. the questionnaire was also sent to academics in the field of management, trainiflg, industrial psychology and statistics in order to identify problem areas and obtain suggestions. a total of 365 covering letters, questionnaires and return-paid envelopes were sent, with a reminder postcard following a week later. questionnaires received from respondents were inspected, edited, coded and transferred for storage. the response rate for this survey is 54.25 per cent (l98 questionnaires from a possible 365 included in the sample). the effective response rate (usable questionnaires) is 49.86 per cent (182 responses from a possible 365). 4 survey results 4.1 descriptive statistics figure 4 shows frequency distribution results of the research data for the learning organisation. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 391 sajems ns vol 4 (2001) no 2 figure 4 histogram of tbe frequency distribution results of section a of tbe questionnaire: tbe jearning organisation s 16 ~4 c 32 <: fib i:( 25 c <: ell 15 2 22 1 5 0 5 10 15 20 25 30 35 % of respondents i figure 4 illustrates the frequency distribution percentages for the five points on the likert-type scale of the questionnaire. it is shown that 27 per cent (5 per cent + 22 per cent) of respondents tend to disagree with the statements regarding the learning organisation. twenty-five per cent of respondents neither agree nor disagree with the variables concerning the learning organisation. forty-eight per cent (32 per cent + 16 per cent) of respondents indicate agreement with the aspects on the learning organisation. it therefore appears that the majority of respondents agree with the variables regarding the learning organisation. in terms of the degree of asymmetry or skewness, the distribution of results seems to be negatively skewed (the tail of the distribution is to the left among the lower values of the variables). kurtosis, which is a measure of the peakedness of the distribution, shows that the distribution is thicker and more peaked in the tail and can be classified as leptokurtic. 4.2 reliability of tbe variables the bmdp statistical software package (programme 4m) was used to perform the factor analysis. factors were extracted using principle component analysis with direct quartimin oblique rotation to allow for intercorrelations between factors. to confirm that all iterns load on the single factor, cronbach's alpha was calculated. the reliability coefficient of cronbach's alpha is 0.95 (cronbach's alpha should be above 0.7 to indicate internal reliability). it can therefore be concluded that all factors are internally reliable (cronbach's alpha> 0.7). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2392 4.3 anova inferential statistics were used to make conclusions about the population using sample data and decisions about various hypotheses. an analysis of variance was conducted, which investigated the relationship between the following variables: organisational development (dependent variables) and training and classification data (independent variables). the anova results, which indicate the relationship between the independent variables (classification data) and the learning organisation, are shown in table 3. table 3 analysis of variance results to investigate the relationship between the independent variables and the learning organisation variable sum of i degrees mean i f-test ! squares of square ! freedom • number of 1.53527 2 0.76764 i 1.39 i employees p-value 0.2508 training department 6.66008 1 6.66008 12.10 ! 0.0006** environment 15.86708 2 7.93354 14.41 0.0000** error 94.13925 171 i 0.55052 i from table 3, it can be deduced what is the relationship between the independent variables and the learning organisation. it is clearly shown that hoi cannot be rejected, f (1.171) = 1.39; p > .05. the number of employees (size of organisation) is not related to the leaming organisation. there is a highly significant relationship between the existence of a training department and the learning organisation, f(l. 171) = 12.10; p < .05. the null hypothesis (ho2) can therefore be rejected (p < .01) and the alternative hypothesis (hd be accepted. there is thus a relationship between an organisation which has a fully developed training department and the learning organisation. the third null hypothesis (h03) can also be rejected, f (2. 171) 14.41; p < .01. it appears that there is a highly significant relationship between the environment in which an organisation operates and the learning organisation (accepting haj)' the anoy a results, which indicate the positive relationship between the independent variables (training) and the learning organisation, are presented in table 4. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 393 sajems ns vol 4 (2001) no 2 table 4 analysis of variance results to investigate tbe relationsbip between tbe independent variables and tbe learning organisation independent sum of • degrees of mean ! f-test p-value variables squares i freedom square • bi 50.5434 2.179 25.2717 i 57.83 0.0000** b2 • 37.1508 2.179 18.5754 i 36.29 0.0000** from table 4 it can be deduced what the relationship is between the learning organisation and the independent variables. it is clearly shown that the null hypothesis (h04) can be rejected, f (2.179) == 57.83; p < .01. the alternative hypothesis (haa ) can therefore be accepted: the facilitating role of training is related to the learning organisation. the null hypothesis, hos, falls within the rejection region, f (2.179) = 36.29; p < .0 i and suggests that has can be accepted. there is a relationship between the role of training in managing organisational change and the learning organisation. 4.4 correlations table 5 highlights the correlation matrix of the variables or factors used in the study. table 5 pearson product-moment correlation coefficients: section a and b of tbe questionnaire variable/factor i al i bi ! b2 al 1.0000 • bi i 0.6867 1.0000 i b2 i 0.6733 i 0.8394 i 1.0000 al = the learnmg orgamsatlon b i = the facilitating role of training in the application of the learning organisation b2 == the role of training in managing organisational change in analysing the r-values of the correlation matrix in table 5, the critical value used to interpret these r-values is: r == 0.1720; p = 0.01; n == 182. all the calculated values of r are greater than the critical value (r > 0.1720) which indicates that the relationship between the variables is statistically highly significant. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2 394 s conclusions and recommendations the importance of the learning organisation is emphasized by the fact that organisations of the future will not survive without becoming communities of learning. they have the capacity to facilitate the learning of all their members and to adapt and change continuously. it is important to understand the process and nature of learning in order to facilitate the learning and development of individual employees and, ultimately, the organisation itself. organisational learning must equal or exceed the rate of change, otherwise the organisation will not survive. training programmes should maximise the balance between learning and doing, and contribute to the development of the innovative capacity of the learning organisation. analysis of the results investigating the relationship between the learning organisation and the independent variables (classification data) produced the following conclusions: • it appears that the size of an organisation, based on employment size, has no direct relationship with the learning organisation (hm not rejected). organisations of different employment sizes do not differ with regard to the facilitation of the learning organisation concept. there is a highly significant relationship between an organisation that has a fully developed training department and the learning organisation (h02 rejected). organisations that have a fully developed training department differ from those in which training activities fall under another function or department (regarding the learning organisation). the type of environment in which an organisation operates is related to the learning organisation (h03 rejected). organisations operating in a dynamic environment (more inclined to learn and adapt to change) differ significantly from those operating in a moderate or static environment (as far as the learning organisation is concerned). the following conclusions can be drawn from the relationship between the learning organisation and training (independent variables): the facilitating role of training is related to the learning organisation (h04 rejected). training can therefore be used to facilitate the implementation of the learning organisation concept. there is a highly significant relationship between the role of training in managing organisational change and the learning organisation (h05 rejected). in using training to manage organisational change, the learning organisation concept can therefore be implemented. action should be taken to ensure that organisations become communities of learning, because the way in which an organisation learns can be the key to r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 395 sajems ns vol 4 (2001) no 2 innovation, profitability and competitiveness. a philosophy should be developed which is aimed at creating, mastering and transferring knowledge in the organisation in order to adapt and to change. it is important to understand the process and nature of learning in order to facilitate the learning and development of employees and the organisation itself. management should establish appropriate conditions for learning, reinforce desired learned behaviour, provide environmental cues which encourage learning and a physical and emotional climate supportive of learning. the leader should empower employees, encourage effective decision-making and inspire commitlnent through charismatic leadership. a learning organis~tion could be created by a leader who has vision, weft-developed plans, a sense of inventiveness and is able to share information and implement all plans and strategies. it is vital to inculcate a culture of lifelong learning in the organisation to meet a continuous need for learning. it is important to note that a fully developed training department, and the environment in which an organisation operates are related to the learning organisation. attention should be given to the role of the training department and the environment of the organisation, and how the learning organisation could facilitate organisational change. the present survey revealed highly significant relationships between training and the learning organisation. action should be taken to use training in bringing about organisational change through the learning organisation. the following are general guidelines and recommendations for building the learning organisation, as a means of facilitating training for change in an organisation: • • • • • provide learning strategies to improve knowledge and skills. use participative policy-making practices. implement flexible reward structures. use front-line members as environmental scanners. create a lifelong learning climate in the organisation. develop a shared vision which emerges at all levels in the organisation. promote self-development for all members. resolve conflict through collaborative learning and/or integration of diverse viewpoints. formulate and implement ideas on all levels. facilitate learning for all members of the organisation. continually expand the innovative capacity of the organisation to create its own future. continually experiment and improve the capacity of the organisation to deliver new goods and services to customers. learn at a faster rate than that at which the organisation is changing. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2 396 regard learning as part of working. facilitate the process of transfonnation which enables the organisation to search for new ideas and/or opportunities. references argyrls, e. (1994) on organizational learning, blackwell business, oxford. 2 beardwell, 1. & holden, l. (1994) human resources management: a contemporary perspective, pitman publishing, london. 3 bencivenga, d. (1995) "leaming organizations evolve in new directions", hr magazine, 40(10): 69-73. 4 da wson, s. (1992) analysing organisations, the macmillan press, ltd., hampshire. 5. dobson, p.e. & tosh, m. (1998) "creating a learning organization: training and development in british steel's universal beam mill", total quality management, 9(4/5): 66-70. 6 fisher, d. & torbert, w.r. (1995) personal and organisational transformations, mcgraw-hili co., london. 7 gordon, j.r. (1996) organizational behavior: a diagnostic approach, prentice-hall, inc., new jersey. 8 greenberg, j. & baron, r.a. (1997) behaviour in organizations, prentice-hall, inc., new jersey. 9 harrison, r. (1998) "move the goal posts", people management, 4(2): 33. 10 .hellriegel, d. & slocum, j.w. (1996) management, south western college publishing. ohio. 11 hendry, j., johnson, g. & newton, 1. (1994) strategic thinking: leadership and the management of change, john wiley & sons, chichester. 12 jones, m. & mann, p. (1992) human resource development: international perspectives on development and learning, kumarian press, inc., west hartford. 13 lessem, r. (1991) total quality learning: building a learning organisation, basil blackwell, oxford. 14 longworth, n. & davies, w.k. (1997) life long learning, kogan page, london. 15 luthans, f. (1995) organizational behaviour, mcgraw-hill, inc., new york. 16 mabey, e. & iles, p. (1994) managing learning, routledge, london. 17 mabey, c. & salaman, g. (1995) strategic human resource management, blackwell business, oxford. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 397 sajems ns vol 4 (2001) no 2 18 marquardt, m. (1997) building the learning organisation, seminar conducted at vista university, port elizabeth, 4 september 1997. 19 marx, a.e. (1997) the suggestion system as a useful instrument in a learning organisation, paper delivered at national productivity institute conference, pretoria technikon, november 1997. 20 mcsween, d. (1995) "the learning organization? it's child's play", management review, 84(9): 6. 21 morton, c. (1994) becoming world class, macmillan press, ltd., hampshire. 22 noer, d.m. (1997) breaking free: a prescription for personal and orgnizational change, jossey-bass publishers, san fransisco. 23 pedler, m., burgoyne, j. & boydell, t. (1991) the learning company: a strategy for sustainable development, mcgraw-hill book company, london. 24 robbins, s.p. (1996) organizational behavior, prentice-hall, inc., new jersey. 25 senge, p.m. (1997) the fifth discipline: the art and practice of the learning organization, century business, london. 26 solomon, c.m. (1994) "hr facilitates the learning organization concept", personnel journal, 73(11): 56-64. 27 swieringa, j. & wierdsma, a. (1992) becoming a learning organisation: beyond the learning curve, addison-wesley publishing company, england. 28 tobin, d.r. (1993) re-educating the corporation, oliver wight publications, inc., essex junction. 29 wick, c.w. & leon, l.s. (1993) the learning edge: how smart managers and smart companies stay ahead, mcgraw-hill, inc., new york. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 566 sajems ns vol 5 (2002) no 3 tax revenue as an automatic fiscal stabiliser a south african perspective a s swanepoel south african reserve bank n jscboeman department of economics, university of pretoria abstract the many practical economic and political difficulties encountered in discretionary fiscal stabilisation policy highlight the potential benefits of allowing automatic fiscal stabilisers to operate over the cycle. this article investigates the relevance of tax revenue as an automatic fiscal stabiliser in the south african economy by an empirical analysis of its role and impact since the i 970s. the study finds that cyclical changes in tax revenue are relatively small and provide no significant evidence of automatic stabilisation; however, the potential of this tool as an effective automatic fiscal stabiliser in south africa cannot be overlooked as results show a high correlation between the output gap and automatic stabiliser estimates. automatic fiscal stabilisers were employed symmetrically over the cycle and results showed that automatic fiscal stabilisers became increasingly important towards the end of the sample period. jel clo, e32, e63, h29 1 introduction and background the way in which the government allocates its spending, collects its taxes and finances its deficit has important implications for the economy. since 1984, consolidated general government expenditure in south africa accounts for more than 30 per cent of the gross domestic product (gdp), while the average ratio of general government employment to total non-agricultural employment for the preceding nine fiscal years also exceeded the 30 per cent mark. the south african government is therefore a key economic player that can influence total economic activity and employment by changes in government spending and/or influence the amount of money individuals and firms have to spend on consumption and investment by changing the level of taxation. consequently, increased spending or lower taxes tend to boost the economy, while decreased spending and higher taxes tend to have the opposite effect in true keynesian tradition. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 567 this article highlights the fiscal policies pursued by the south african government since the 1970s with specific reference to the role of taxes in stabilisation policy. the main focus is on the magnitude and composition of general government tax revenue and its role and potential as an automatic fiscal stabiliser in south africa. no attempt is made to assess the efficiency of fiscal actions. the scope of this paper also does not extend to an evaluation of monetary policy or the linkages between monetary policy and fiscal policy. section 2 discusses fiscal stabilisation policy with reference to discretionary and non-discretionary fiscal policy. the many practical economic and political difficulties encountered in discretionary fiscal stabilisation policy highlight the importance and benefits of automatic fiscal stabilisers. section 3 documents the main factors that influence the size of automatic fiscal stabilisers. some aspects of south african fiscal policy are discussed in section 4 while section 5 evaluates the role of general government tax revenue as an automatic fiscal stabiliser in south africa since the 1970s. section 6 concludes and draws policy implications. 2 fiscal stabilisation policy the use of fiscal policy as a stabilisation tool is difficult. there are many factors that contribute to the frequent divergence of fiscal and economic outcomes of government plans. these factors include, for example: the uncertainty regarding the impact of fiscal measures; the uncertainty as to the present and anticipated economic conditions; the lag between fiscal decisions and their implementation; the possibility of conflict between political and fiscal policy objectives; and the complexity of intergovernmental financial relations. fiscal instruments have behavioral and structural consequences and their use for stabilisation purposes may conflict with tax-smoothing and efficiency objectives. the government's budget has many purposes besides stabilisation and much of government spending is committed years or even decades in advance. expanding or contracting government expenditure rapidly for macroeconomic stabilisation purposes is therefore difficult without either spending wastefully or compromising other fiscal policy goals. the same applies to taxes. taxes are somewhat easier to change, but the tax laws also have many different goals. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 568 sajems ns vol 5 (2002) no 3 the main difference between discretionary and non·discretionary fiscal policy is that non·discretionary fiscal policy does not involve any deliberate government action, while discretionary fiscal policy can be defined as a deliberate attempt by government to obtain a certain objective. automatic (or built-in) stabilisers are types of automatic fiscal policies that do not require new legislation, because economic conditions cause government revenue and expenditure to change without any deliberate government action. 2.1 problems with discretionary fiscal policy there are many practical economic and political difficulties encountered in discretionary fiscal stabilisation policy. governments find it easier to increase spending in times of low growth than to reduce expenditure and tighten fiscal policy during economic upturns. according to the european central bank (2002: 36), this induces a tendency for continuous increases in deficits and the tax burden. furthermore, it is difficult to determine the appropriate size of the annual deficit, while fiscal adjustments and their effects are also subject to variable and unpredictable time lags. as a result, governments' well-intended efforts to stabilise the economy often end up destabilising it, "booming the boom" or "depressing the depression". proper timing of discretionary policy is both extremely difficult to achieve and extremely crucial if it is to help the economy. there is also the growing realisation that high budget deficits could directly or indirectly crowd out relatively more productive private sector activity such as investment. moreover, discretionary policy presents a dilemma when low levels of economic activity coincide with high inflation and balance of payments deficits such as the case in south africa during the latter half of the 1970s (heyns, 1999: 70). according to the european commission (1997: 109), the efforts to support the economy during downturns in eu countries have often been made through expenditure commitments that have subsequently proven de facto irreversible. this resulted in an upward "ratchet" effect on the size of the public sector in the economy, on both the tax and the expenditure side. the attempts of discretionary fiscal policy to stabilise the economy therefore run into some technical problems. the ability to measure and analyse the economy is imperfect; gauging how far the economy is from full employment at any particular time is difficult. furthermore, the amount that output will increase in response '0 a fiscal expansion is not known exactly, making it difficult to assess how much of a fiscal change is needed to restore full employment. because macroeconomic policies take time to implement and more time to affect the economy, their optimal use requires knowledge of where the economy will be in six or twelve months from now. such knowledge is, at best, very imprecise. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 569 against this background, most economists have become highly sceptical about the potential benefits of "fine tuning" the economy. while there is generally broad agreement on the usefulness of allowing automatic stabilisers to operate over the cycle, there is a large literature dealing with the pros and cons of attempting stabilisation through discretionary measures. the combined problems of lags, crowding out effects, political constraints, inflexibility and practical problems in measuring and forecasting the state of the economy and determining how much fiscal stimulus is needed at any particular point in time all present very serious challenges for discretionary fiscal policy to have the desired effect on stabilisation. 2.2 taxes as tools for stabilisation automatic fiscal stabilisers get around these problems because economic conditions cause government expenditure and revenue to change without any deliberate government action, ensuring that they can act in a much quicker and timelier fashion compared to the use of discretionary measures. tax receipts weaken and social transfers increase, for example, during recessions and show reversed movements during expansions. these changes in the budget balance that are induced by cyclical fluctuations, in tum have a stabilising influence on economic activity. these budgetary automatic stabilisers contribute to a stimulation of the economy in a period of recession and exert a dampening effect in periods of overheating, and should therefore be automatically selfcorrecting. governments have the option to either let these automatic stabilisers work or to reinforce or restrain their effect via discretionary budgetary policy. during a recession, governments might prefer not to let the budget deficit deteriorate due to the operation of the automatic stabilisers and will therefore decide to conduct a procyclical budgetary policy, or they might choose to actively undertake a counter-cyclical budgetary policy which will further increase the deficit. taxes are used for stabilisation purposes either by way of discretionary tax rate changes or via their built-in stabilisation properties. fluctuations in revenue usually account for a much larger share of automatic stabilisers than fluctuations in expenditure. according to the oecd (1993: 44), tax-based automatic stabilisers have the advantage that they are rule-based because they respond immediately to changes in activity and generate expectations of future reversals that may limit the impact of greater public borrowing on long-term interest rates. if the economy goes into recession because of a sudden drop in autonomous consumption, for example, the progressive taxes drop even faster than income, and this decrease in taxes has a multiplier effect, partly offsetting the drop in autonomous consumption, so that equilibrium income does not drop as far or as fast as it possibly could. according to abel and bernanke (2001: 572), this r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 570 sajems ns vol 5 (2002) no 3 automatic tax cut helps cushion the drop in disposable income and prevents aggregate demand from falling during recessions, making fiscal policy automatically more expansionary. on the other hand, when people's income rise during a boom, the government collects more income tax revenue, which helps restrain the increase in aggregate demand. in summary, automatic stabilisers help to smooth out fluctuations in the business cycle by automatically moving the budget toward a deficit during recession and toward a surplus during an expansion. automatic fiscal stabilisers like the income-based tax system can playa prominent role in converting some periods of likely recession into periods of normal growth as well as in boosting growth in the first year following recession troughs. by preventing sharp economic fluctuations, fiscal stabilisers may enhance long-term economic performance and avoid frequent changes in spending or tax rates (van den noord, 2000: 2). 3 factors influencing the size of automatic fiscal stabilisers according to the european commission (1997: 95), the magnitude of budgetary automatic stabilisers is quite important for most of the eu member states and varies substantially across countries and over time. the size of automatic fiscal stabilisers is important for budget planning and for the assessment of progress towards fiscal targets throughout the cycle. 3.1 size of government the size of automatic fiscal stabilisers varies with the importance of the government sector in the economy. the higher the share of tax revenue in the economy, the greater is the sensitivity of government income to fluctuations in gdp. the oecd (1993: 37) argues that the size of the public sector relative to gdp is the most important element in determining the extent of the automatic stabilisers. 3.2 tax structure and the sensitivity of tax revenues to the cycle the size of automatic fiscal stabilisers also depends on the budget's sensitivity to the cycle (oecd, 1999: 138). the sensitivity of budget receipts to cyclical fluctuations differs depending on the revenue category. for example, corporate taxes paid by the business sector vary most with the cycle due to the sensitivity of profits to cyclical fluctuations, while social contributions vary less with the cycle due to the regressive nature of this tax. the cyclical sensitivity of personal income taxes and indirect taxes is situated between these two extremes. based r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 571 simply on the relative size of its fluctuations, the corporate income tax can be a potentially important source of automatic stabilisation (auerbach & feenberg, 2000: 18). according to the oecd (l993: 44), the extent of the cyclical fluctuation in government revenue depends on two factors: i) the size of the initial level of taxation (the average tax rate); and ii) the elasticity of taxation with respect to changes in output (the marginal tax rate). furthermore, the cyclical behaviour of tax yields may be changing over time due to reforms of tax systems. for example, reform initiatives that flatten personal tax rate structures reduce the automatic stabilising properties of tax systems. the response of tax bases to changes in activity may also depend on the nature of the economic shock(s) that produced the boom or recession. cohen and follette (2000: 40) maintain that higher income tax rates represent stronger automatic stabilisers. the progressivity of the tax system is an important factor in determining the size of automatic stabilisers (van den noord, 2000: 4). government revenue fluctuates with slightly greater amplitude than fluctuations in output. in part, this stems from the difference between the average and the marginal rates of taxation on labour income. such a difference means that when average income per person employed falls during a recession, either through a fall in overtime work or through a fall in wages, the drop in government revenue is more rapid than that of average incomes. the oeed (1993: 37) maintains that the structure of the tax system has a significant impact on the size of automatic stabilisers. the higher the average tax rate on income from a cyclically sensitive source, the larger will be the automatic stabiliser. for example, taxation is lost when an employee is made redundant. in this case, the amount of stabilisation depends on the average tax rate on labour income (defined as wage income plus social security contributions). van den noord (2000: 7) also argues that the tax structure has a significant impact on the size of automatic stabilisers. the higher the taxation of cyclically sensitive tax bases, the more the tax take will vary with the business cycle and hence the greater will be the cyclical sensitivity of the fiscal position. apart from differences in tax rates and tax structures, the distribution of income also influences the size of automatic fiscal stabilisers. according to auerbach and feenberg (2000: 12), severai authors have estimated that the income of lower-income individuals is more cyclically sensitive to macroeconomic conditions, as measured by fluctuations in aggregate income or the unemployment rate. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 572 sajems ns vol 5 (2002) no 3 3.3 the effectiveness of stabilisation efforts in relation to the openness and structure ofthe economy the dampening effect of automatic stabilisers on output fluctuations differs significantly across countries. it depends among others on the degree of openness of the economy and on the structure of tax and expenditure systems. according to barrell and pina (2000: 23), openness often inversely related to economic size counters the effectiveness of budgetary stabilisers. the european commission (1997: 99) argues that in the open economies of the smaller eu member states, the impact of the automatic stabilisers on output fluctuations can be expected to be relatively modest because of the importance of the trade leakages, which reduce the domestic effectiveness of fiscal policy. in the more closed economies of the larger eu member states, the dampening effect of the operation of the automatic stabilisers should be more significant. the more open countries therefore need, ceteris paribus, comparatively larger budgetary fluctuations in order to achieve the same degree of output smoothing as obtained in the more closed economies, which have automatic stabilisers of a smaller size. the effect of automatic stabilisers on activity can be significant or almost nonexistent depending on the structure of the economy (oecd, 1993: 42). the degree of stabilisation provided depends on the same factors that influence tax and expenditure multipliers following discretionary changes in fiscal policy: trade flows, savings reactions and the degree of flexibility in labour and product markets. 3.4 fiscal restraints eichengreen (1997: 94) states that there is empirical as well as counterfactual evidence that governments operating under maastricht-type restrictions engage in significantly less automatic stabilisation. governments with relatively strict restrictions on deficits and debt are found to stabilise the least. governments operating under relatively stringent fiscal restrictions carry out significantly less fiscal stabilisation due to reductions in the cyclical sensitivity of their spending. 3.5 the relationship between automatic and discretionary stabilisation the overall degree of fiscal stabilisation reflects both the operation of the stabilisers themselves and their influence on, and interaction with, discretionary policies (oecd, 1999: 141). thus, if automatic stabilisers are overridden by discretionary adjustments, their impact will be neutralised. on the other hand, if they are reinforced by discretionary adjustments, the overall fiscal impulse will be stronger. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 573 it is important to note that larger automatic stabilisers are not necessarily preferable. large automatic fiscal stabilisers may indicate high tax burdens, highly distorting tax rates or overly generous benefit systems fraught with potentially large deadweight costs that can delay adjustment to a changing economic environment (tam & kirkham, 2001: 5 and european central bank, 2002: 35). 4 fiscal policy in south afrlca 4.1 some aspects of fiscal policy in south africa fiscal policy in south africa during the 1970s and early 1980s centered around demand management, including frequent variations in the size of the national budget deficit in the interest of macroeconomic stability in the relationship between growth, inflation and the balance of payments (heyns, 1999: 69). according to heyns (1999: 70), official stabilisation policy in south africa during the 1970s was premised on the keynesian requirement of flexibility and the assumption that government could and should influence the level of economic activity through short-term fiscal adjustments in spending and taxes. heyns (1999: 73) states that the automatic response of tax yields on economic activity was an important ingredient of the national budget's total influence on the national economy. the government used discretionary policy action during the 1970s mainly to smooth out automatic fluctuations in government deficits (heyns, 1999: 74). heyns (1995: 309) argues that since the 1980s, the focus of south african budgetary policy has increasingly shifted from the earlier keynesian emphasis on short-term stabilisation to the longer-term implications of the budget. after several years of consolidation, bringing the national government budget deficit down to 1.5 per cent of gdp in the fiscal year 200112002, fiscal policy in south africa is now decidedly growth-orientated. the 2001 budget paved the \\ ay for a growth-orientated fiscal policy stance of improved spending, ~i!!lllljcant increases in infrastnlcture allocations and ongoing tax reform, within thl: sound framework of fiscal management established over the last six years (sollth african national treasury, budget review, 2001: i), the 2001 budget had a renewed focus on microeconomic and structural reforms. the belief was that the series of growth-orientated microeconomic reforms would complement and sharpen the broader structural changes that have taken place through the economy. the 2002 budget reinforces the growth-orientated stance of the previous budget (south african national treasury, budget review, 2002: i). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 574 sajems ns vol 5 (2002) no 3 the south african government's medium-tenn fiscal programme, adopted in 1994, operates within the parameters of the government's strategy on growth, employment and redistribution (gear). the government presented gear in 1996, as a non-negotiable policy document confinning that the country had embarked on an outward orientated economic growth and development path that shows strong correspondence with good international practice. the belief was that sustained growth on a higher plane requires a transfonnation towards a competitive outward-orientated economy. the gear strategy maintains that the main goal of fiscal policy since 1993, has been to achieve an annual reduction in the budget deficit of about 0.5 per cent of gop, together with a reduction in government consumption expenditure and avoidance of penn anent increases in the tax burden. it is also envisaged that there should be an increase in public sector investment spending. gear emphasised a systematic reduction of the budget deficit to reduce government dissaving as a means towards higher economic growth. it is clear from table 1 that the south african government succeeded in reducing the government deficit as a ratio of gop since the publication of the gear document. as a result, government dissaving as a ratio of gop also decreased from 6.1 per cent in fiscal 1992/93 to 0.4 per cent in fiscal 1999/2000. table 1 deficit projected actual projected and actual fascal deficit as a ratio of gdp. 1996-2000 (per cent) 1996 1997 1998 1999 2000 average 5.1 4.0 3.5 3.0 3.0 3.7 5.1 5.0 3.7 2.8 2.3 3.8 source: gear and south african reserve bank with discretionary fiscal policy embedded in the philosophy of the gear document, the objectives were stated as a drive towards international competitiveness and minimising the distorting effects of taxation on economic behaviour, while preserving the fundamental progressiveness of the overall tax structure. the objective for the ratio of tax to gop is set at about 25 per cent. the gear document argues that the combined effect of recent tax refonns has probably been roughly neutral with respect to the overall burden. several measures have had a favourable impact on the distortionary effects of the tax system, while the overall tax incidence has remained progressive. on the expenditure side of the budget it should be remembered that south africa is a developing country with huge disparities in income and standards of living in general. instead of stabilising the business cycle, expenditure is dedicated r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 575 . ----.--------------towards addressing these social disparities. with regard to income tax (the largest tax component), average and marginal rates are highly progressive and there is much more room for automatic stabilisation. over the past few years, there has been a strong focus on improving the capacity of the tax authorities and the establishment of a more independent revenue service was an important step. section 3.5 of the gear document states that an improvement in economic growth, together with improved tax administration, should lead to a strong increase in tax revenue relative to gdp. improved tax administration did in fact contribute significantly to higher tax revenue (south african reserve bank annual economic report, 2000: 84). but how much did other factors, including automatic fiscal stabilisers, contribute towards this achievement? this question will be addressed in section 5. 4.2 trends in general government tax revenue in south africa data on the consolidated general government tax revenue was obtained from the south african reserve bank's database. the south african reserve bank classifies government finances in its quarterly bulletin according to the imf's a manual on government finance statistics (1986). south africa's consolidated general government comprises three levels of government, namely the consolidated central government, i provincial government and local authorities. taxes on income and profits and domestic taxes on goods and services are the most important categories of direct and indirect tax revenue respectively. from table 2 it is clear that direct taxes are the main source of south african revenue, averaging 54.4 per cent of total tax revenue over the sample period. indirect tax as a ratio of total tax revenue, reached a maximum of 51.9 per cent in fiscal 1993/94 before declining to 47.0 per cent in fiscal 2000/01. as a ratio of gross domestic product, the highest value of 12.9 per cent was recorded in fiscal 1989/90. this was the result of stronger collections from taxes on goods and services. the improvement in the ratios of direct tax revenue and total tax revenue to gross domestic product during the last three fiscal years can partly be ascribed to better management and the implementation of more efficient practices and procedures by the south african revenue service. table 3 indicates that taxes on net income and profits are the main source of consolidated general government revenue. during fiscal 1974175, more than half of total revenue could be ascribed to taxes on income and profits. this ratio decreased slightly to the lowest value of 41.2 per cent in fiscal 1993/94 before increasing again to 47.0 per cent in fisca12000/0l r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 576 sajems ns vol 5 (2002) no 3 table 2 components of consolidated general government tax revenue fiscal. direct tax indirect tax total tax years rbillions % total % gdpr billions % total %gdp r billions "/"gdp 1974/75 3.2 66.7 12.8 1.6 33.3 6.3 4.8 19.2 1979/80 5.8 57.1 • 11.5 4.4 42.9 8.7 i 10.2 20.2 1984/85 14.0 54.2 12.2 11.8 45.8 10.3 25.8 i 22.5 1989/90 34.3 50.5 13.2 33.7 49.5 12.9 i 68.0 26.1 1993/94 51.1 48.1 11.6 55.2 51.9 12.5 i 106.4 24.1 1999/00 116.8 52.9 14.2 104.0 47.1 12.7 220.8 i 26.9 2000/01 127.6 53.0 14.0 113.1 47.0 12.4 240.7 26.4 source: south afncan reserve bank over time, the tax burden has shifted away from mines and corporations towards individuals. the share of taxes on goods and services increased noticeably from below 20 per cent at the beginning of the sample period to 30.6 per cent at the end of the sample period. taxes on international trade and transactions increased in nominal terms after south africa's reintroduction to international markets. social security contributions also increased noticeably since the latter half of the sample period. as illustrated in figure i, tax revenue became increasingly important towards the end of the sample period, while the opposite holds for non-tax revenue. according to blanchard (2000: 71), an increasing share of taxes and transfers in gdp suggests an increase in automatic stabilisers. the next section will explore this issue, and more particularly the role of tax revenue as an automatic fiscal stabiliser in south africa. table 3 consolidated general government tax revenue, share of total revenue (per cent) i i i taxes on! taxes i tax fiscal . taxes on taxes . taxes on itt d . other social . • n. ra e. sec.contri-~etincom on i goods and! & trans-! taxes on i reveyears & profits property. services· cf butlons payroll. nue a ions 1974175 50.6 5.9 13.5 4.2 3.1 l.l 0.3 l78.5 1984/85 43.6 4.9 27.2 2.1 2.5 1.0 0.2 181.4 1993/94 41.2 i 6.2 31.6 3.8 1.6 1.7 0.0 l86.0 2000/01 47.0 5.2 30.6 2.7 2.2 1.6 0.5 189.7 source: south african reserve bank r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 577 figure 1 consolidated general government tax and non-tax revenue as a ratio of gross domestic product 30.0 ~er cent 25.0~~ 20.0 15.0 10.0 5.0 0.0 "" vl t'" m vl t'" t: t: ~ ~ 00 ~ 00 ~ ~ n .... <:; n ~ >c ttttoo 00 00 00 00 '" :::: '" :::: '" '" :::: :::: :::: fiscal years "" g: g: 0 n 8( '" '" vl tg: $ ~ 8( percent 6.0 5.0 4.0 3.0 2.0 1.0 5 the role of tax revenue as an automatic fiscal st abiliser in south africa the cyclical component of general government tax revenue is calculated by subtracting the estimated structural component from its actual level. structural tax revenue is calculated from actual tax revenue, adjusted proportionately, according to the ratio of potential output to actual output and corresponding elasticity assumptions (see giorno et ai., 1995: 191). this can be illustrated as: r: = (.cja. r; y where: t;· structural tax revenue for the jth category of tax ti = actual tax revenue for the jth category of tax y = level of actual output y* = level of potential output ui = elasticity of the ith tax category with respect to output. potential output was estimated by the gdp smoothing approach using a hodrick-prescott (hp) filter (lambda = 100).2 according to cerra and saxena (2000: 4), trend output (y*) derived using the hp filter is obtained by r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 578 sajems ns vol 5 (2002) no 3 minimising a combination of the gap between actual output (y) and trend output and the rate of change in trend output for the whole sample of observations (t): t n 1 min2:(y, y;y + ..l2:[(y;.1 y;)-(y; y;-i)j 2 1 ... 0 ,-2 where the detrending parameter a. determines the degree of smoothness of the trend. the sensitivity of tax revenue categories with respect to gop (clj) is captured in the form of an elasticity and these elasticities were assumed to remain constant over the cycle. elasticities were calculated using a simple regression of each tax category (tj ) on output (y) (in current prices).3 the results of this approach, estimated using data from fiscal i 969no to 1999/2000 are shown in table 4. table 4 tax elasticity estimates tax catel(ory elasticl~ taxes on net income and profits 1.04 taxes on property 1.02 taxes on goods and services 1.24 taxes on international trade and transactions 0.94 other taxes 0.84 social security contributions 1.24 employer's payroll and manpower taxes 0.45 total tax revenue l08 direct tax 1.03 indirect tax 1.14 most of the coefficients reported in table 4 are unitary or larger, meaning that some increase proportionally with gop while others increase more than proportionally with gop. this reflects the built-in elasticity of the south african tax structure that can generate an increasing tax effort if no discretionary tax measure is used to offset this effect. the marginal sensitivity of budgetary receipts to gop can be obtained by multiplying the overall revenue elasticity by the tax to gop ratio (european commission 1997: 97). the average marginal sensitivity of general government revenue estimated at 0.2 for south africa, indicate that each widening of a negative output gap by 1 percentage point reduces general government revenue in south africa by 0.2 percentage points of gop. figure 2 illustrates south african real gop, the trend in real gop derived using the hodrick-prescott filter, and the gop gap measured as the percentage deviation of observed real gop from trend real gop. over the years, economic r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 579 activity was volatile in terms of large and persistent deviations from trend as measured by the output gap. figure 2 actual real gdp, trend real gdp and the output gap percent rmillions ,-----------------------------~7~oo 6 4 2 o -2 ·4-~~~~ __ ~~~~~~~~~~~ 6~00 500000 -400000 300000 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 100 tables size and volatility of the output gap and the cyclical component of general government tax revenue volatility lowest negative highest positive stand. dev. component component (% points of value (as % year value (as % year gdp1_ ofgdp) ofgdp} cyclical 0< .0.9 1993 0.5 1989 component output gap 2.1 -3.9 1993 5.1 1981 the standard deviation of the cyclical component of tax revenue may be useful a" a rough indicator of how sensitively it responds to the business cycle. (icnt'ral go\emmcnt tax revenue show icss marked deviations than the business cyclc as a whole. table 5 shows that the cyclical component and the output gap on avcrage varies with around 0.3 and 2.1 percentage points of gdp respectively in either direction around their means. the lowest negative values for the cyclical component and the output gap were recorded in 1993, while the highest positive values for the output gap and the cyclical component were recorded in 1981 and 1989 respectively. the actual, structural and cyclical part of general government tax revenue (as a ratio of trend gdp) is shown in figure 3. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 580 sajems ns vol 5 (2002) no 3 figure 3 comparison of actual, structural and cyclical tax revenue as a ratio of trend gdp per cent per cent r-----------------------------------~40 20 0.5 10 o 0.0 -0.5 -1.0 -h--..-.,.....,....,......,..--,-.....-r-r-""t"""1-,-.,..-,--.-...-r-r-1--..-,......,...,.....,....,.-,.-........... -i 70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 100 figure 4 cyclical tax revenue and the output gap per cent per cent 70 72 74 76 78 80 82 84 86 ss 90 92 94 96 98 100 the high correlation between the output gap and the cyclical component of general government tax revenue is clear from figure 4. tax revenue responds more or less in line with changes in the output gap and it seems as if the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 581 automatic fiscal stabilisers associated with the tax system in south africa were allowed to operate in both the up and down sides of the cycle. the results also illustrate a more prominent role of automatic fiscal stabiiisers during the latter half of the sample period. figure 5 sensitivity of cyclical tax revenue with respect to alternative tax elasticities per cent 1.0.----~~~~~~~----~~~~------~~_, 0.5 0.0 -0.5 -1.0 the sensitivity of automatic stabiliser estimates to assumptions determines their usefulness in policy making (tam & kirkham, 2001: 11). alternative assumptions change the level of estimated stabilisers making it difficult to accurately assess what the state of government finances is at a given point in time. however, a consistent trend makes it possible to state whether the structural position is improving or deteriorating. a sensitivity analysis with respect to the automatic fiscal stabiliser estimates was carried out by means of alternative assumptions of the elasticity of tax revenue, adjusted 50 per cent either way from the current estimate. figure 5 shows that the calculation of automatic fiscal stabilisers associated with general government tax revenue in south africa is relatively robust with respect to alternative assumptions of tax elasticities. the maximum or minimum value for the alternative assumptions resulted in a maximum difference 0[0.5 per cent ofgdp. taylor (2000: 33) provides estimates of the responses of the total budget balance, and its structural and cyclical components to the output gap. using the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 582 sajems ns vol 5 (2002) no 3 same methodology for south africa, table 6 shows estimates from bivariate regressions using the output gap as the independent variable and structural, cyclical and actual tax revenue, one at a time, as the dependent variable. the impact of the output gap on discretionary fiscal policy (measured by structural general government tax revenue) and automatic fiscal stabilisers (measured by cyclical general government tax revenue) varies significantly according to the chosen sample period. the role of automatic stabilisers was much smaller than that of discretionary fiscal policy over the sample period. regressions over two sub samples (1970-1985 and 1986-2000) indicate that automatic fiscal stabilisers were stronger in the latter half of the sample period. estimated effects of variations in the output gap on total tax revenue and structural tax revenue are not significant in any of the reported time periods. table 6 estimated response of tax revenue to the output gap sample period structural cyclical actual com onent 1970-2000 -1.14 1.81 1970-1985 0.36 0041 1986-2000 -2.35 3.39 1970-1979 -0.56 1980-1989 1.39 0.90 1990-2000 -4.27 4.55 note: standard errors in parentheses the regression results for the period 1970-1979 supports the findings of heyns (1999) that the government relied strongly on discretionary policy action during the 1970s in an attempt to smooth out automatic fluctuations in government deficits. this possibly explains the smaller automatic stabiliser estimates in the first half of the sample period illustrated in figure 4. the larger coefficient of 0.22 of the cyclical component for the last decade (1990-2000) confirms the argument of section 3.5 of gear that improvements in economic growth, apart from improved tax administration, should lead to a strong increase in tax revenue. therefore, strong growth in tax revenue over the last few years can be ascribed to the working of automatic fiscal stabilisers in addition to better management and the implementation of more efficient procedures and practices r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 583 by the south african revenue service. thus, both these factors were an important force behind the success of the south african government in reducing the budget deficit over the past few years. figure 6 compares south africa's output gap and cyclical tax revenue with six other developing countries, namely: chile, india, indonesia, mauritius, mexico and romania. 4 the size of south africa's output gap is broadly similar to that of india, but smaller compared to the other countries. south africa, india and romania recorded their largest negative values in their output gaps in the early 1990s. except for indonesia, mexico and romania, the trend in cyclical tax revenue for each country is broadly similar to their respective output gaps. with the exception of indonesia, there are not any major differences in the size of cyclical tax revenue between the various countries. cyclical tax revenue in south africa, india, mexico and romania reached their largest negative values in the early i990s. table 7 a comparison of tax elasticities and tax to gdp ratios elasticity tax to gdp ratio .. _-_. . average maximum minimum chile 1.02 17.9 22.5 11.3 india 1.01 9.8 11.0 8.0 indonesia . 3 15.6 19.4 10.9 mauritius 5 6.7 10.3 2.0 mexico 1.03 12.7 15.4 8.1 romania 1.23 14.9 33.0 5.1 south 1.09 21.9 26.6 16.5 africa source: international monetary fund, government fmance statistics cd-rom (august 2001) and weo database (october 2001); own calculations the tax elasticity and tax to gdp ratio of each country are reported in table 7. south africa has the highest average tax to gdp ratio, followed by chile and indonesia. the south african minimum tax to gdp ratio is also the highest among the reported countries. mauritius has the smallest average tax to gdp ratio and the lowest minimum. the highest maximum value of 33,0 per cent was recorded by romania in 1992. mauritius has the largest tax elasticity, followed by romania and south africa. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 584 sajems ns vol 5 (2002) no 3 figure 6 a comparison of output gaps and cyclical tax revenues output gop, mexico.l 'i1$ 1il10 '111!5 i.e ,. cyclical tb revenue: "o"ico. i source: international monetary fund, government finance statistics cd-rom (august 2001) and weo database (october 200]); own calculations r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 585 6 conclusion south africa must adopt an appropriate fiscal policy stance, taking the country's particular circumstances into account. both fiscal discipline and flexibility are important. in fact, fiscal discipline and flexibility are complementary and interdependent features of budgetary behaviour. fiscal discipline will allow the credibility of monetary policy to strengthen, while fiscal flexibility is required to deal with country-specific and other shocks. since fiscal discipline is more or less confined in the south african government's gear strategy, it is in the latter case where automatic fiscal stabilisers can play an important role. this article identified several factors that influence the size of automatic fiscal stabilisers. the main determinants of the size of automatic fiscal stabilisers associated with the tax system include the importance of the government sector in the economy, the tax structure, the progressivity of the tax system, the sensitivity of individual tax bases to the cycle, reforms in tax rates and structures and the distribution of income across individuals. most of these factors are favourable in the south african context to allow automatic stabilisers to operate. the average tax to gop ratio over the sample period was 23 per cent and the elasticity of general government tax revenue to gop is 1.08. the marginal sensitivity of budgetary receipts was estimated at 0.2. the south african government's strategy on growth, employment and redistribution (gear) is committed to preserve the fundamental progressiveness of the overall tax structure and states that the overall tax incidence of recent tax reforms has remained progressive. a graphical representation of tax revenue to gop illustrated how south african tax revenue had grown in importance over the years. increased tax revenue contributed to the annual reduction in the deficit and private dissaving over the past few years. over the last three decades, tax revenue was not affected much by variations in the output gap and the effects of cyclical responses to the output gap were relatively weak. the results show a small positive response of the automatic fiscal stabilisers to the output gap. regressions over sub samples indicated the prominent role played by discretionary policy with deliberate attempts to smooth out automatic fluctuations during certain periods. systematic and predictable responses through automatic stabilisers, with discretionary fiscal policy to be aimed at explicitly longer-term issues, requiring less frequent changes, can still be very important in the south african context. the automatic fiscal stabilisers became increasingly important since the 1990s. the results also show that automatic stabilisers in south africa were employed symmetrically over the cycle, i.e. automatic fiscal stabilisers associated with the tax system operated in both the up and down phases of the cycle. tax revenue responds more or less in line with changes in the output gap and the estimated automatic fiscal stabilisers r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 586 sajems ns vol 5 (2002) no 3 also proofed to be relatively robust with respect to alternative assumptions of tax elasticities. the article compared south africa's cyclical tax revenue with six other developing countries, namely: chile, india, indonesia, mauritius, mexico and romania. the size of south africa's cyclical tax revenue is more or less in line with five of the six countries and the trend in cyclical tax revenue for most of the countries (including south africa) is broadly similar to their respective output gaps. south africa has the largest average tax to gdp ratio and a tax elasticity equal to the seven-country average. it is important to note that automatic fiscal stabilisers are difficult to use in a policy framework as empirical estimates of the cyclical budget balance vary significantly. different point-in-time output gap and elasticity estimates produce different point-in-time estimates of automatic stabilisers. thus, relying on automatic stabiliser estimates for budgeting and decision-making purposes is difficult as a given budget deficit may be entirely cyclical (remedial action is not required) or entirely structural (remedial action required), depending on the assumptions. also, the need to establish sufficient room for manoeuvre to allow automatic stabilisers to work is an important concern in setting medium-term targets. for positive gains to be realised, the tax system needs to be structured appropriately and questions such as whether the south african economy would benefit from adjustments in taxes to bring about stronger stabilisation must be addressed. all the difficulties mentioned in section 2 related to "fine tuning" the economy could be eliminated by properly functioning automatic fiscal stabilisers. however, before a proper assessment of the significance of automatic fiscal stabilisers in south africa can be made, it is necessary to evaluate the automatic fiscal stabilisers on the expenditure side of the budget as well moreover, apart from the traditional path of stabilisation through aggregate demand, other stabilisation paths such as stabilisation effects on labour supply should also be invcstigatcd. endnotes comprising the national government, extra-budgetary institutions and social security funds. 2 this article does not attempt to evaluate the strengths and weaknesses of different techniques to calculate potential output or to compare results for different sets of potential output and output gap estimates. in order to overcome the drawback of the poor reliability of the end of sample r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 587 estimates associated with the hp filter, the gdp series was extended by forecasts based on gdp growth assumptions taken from the national treasury's budget review 2002. 3 note that these regressions show the average elasticity over the whole sample period and embody policy changes in addition to automatic effects. a correct measure of tax elasticities captures changes in tax revenue arising exclusively from changes in the tax base. since no attempt was made to control for the impact of discretionary changes in the tax structure, the values reported should be interpreted as buoyancy coefficients rather than elasticities. 4· data on tax revenue refer to the consolidated central government of each country. 5 as a ratio oftrend gdp. references abel, a.b. & bernanke, b.s. (2001) macroeconomics, (4th ed.) boston: addison wesley longman. 2 auerbach, a.j. & feenberg, d. (2000) "the significance of federal taxes as automatic stabilizers", nber working paper no 7662. 3 barrell, r. & pin a, a.m. (2000) "how important are automatic stabilizers in europe? a stochastic simulation assessment", eui working paper eco no 2000/2. 4 blanchard, o. (2000) "commentary on cohen and follette", federal reserve bank of new york economic policy review, 6( i) 69-74. 5 cerra, v. and saxena, s.c. (2000) "alternative methods of estimating potential output and the output gap: an application to sweden", imf working paper no 59. 6 cohen, d. & follette, g. (2000) "the automatic fiscal stabilizers: quietly doing their thing", federal reserve bank of new york economic policy review, 6(1) 35-68. 7 eichengreen, b. (1997) "saving europe's automatic stabilisers", national institute economic review no 159. 8 european central bank (2002) "the operation of automatic fiscal stabilisers in the euro area", monthly bulletin, april, 33-46. 9 european commission (1997) economic papers, no 125. 10 giorno, c., richardson, p., roseveare, d. & van den noord, p. (1995) "potential output, output gaps and structural budget balances", oeed economic studies, no 24, 1995(1) 167-202. ii heyns, jvds. (1999) "fiscal policy in south africa during the 1970s", south african journal of economic history, vol. 14(1&2), september. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 588 sajems ns vol 5 (2002) no 3 12 heyns, jvds. (1995) "the dimension of government saving in south african fiscal policy", south african journal of economics, september. 13 organization for economic co-operation and development (1993) automatic stabilisers: their extent and role, oecd economic outlook, no 53, 37-44. 14 organization for economic co-operation and development (1999) the size and role of automatic fiscal stabilisers, oecd economic outlook, no 66,137-149. 15 south africa budget review, various issues. pretoria. national treasury. 16 south africa (1996) growth, employment and redistribution: a macro-economic strategy. pretoria: department of finance. 17 south african reserve bank quarterly bulletin, various issues. 18 south african reserve bank (2000) annual economic report. 19 tam, 1. & kirkham, h. (2001) "automatic fiscal stabilisers: implications for new zealand", new zealand treasury working paper no 10. wellington, new zealand. 20 taylor, 1.b. (2000) "reassessing discretionary fiscal policy", journal of economic perspectives, 14(3) 21-36. 21 van den noord, p. (2000) "the size and role of automatic fiscal stabilizers in the 1990s and beyond", deed economic department working paper no 230. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . f:\ejour\ecoman\index\ecoman_v6_n2.prn.pdf sajems ns vol 6 (2003) no 2 218 globalisation and economic growth in south africa: do we benefit from trade and financial liberalisation?1 ___________________________________________________________________________ elsabe loots department of economics, rand afrikaans university ________________________________________________________________ abstract this article investigates whether the process of globalisation, through trade and financial liberalisation, benefits economic growth in emerging market economies in general and in south africa in particular. the analysis of trade openness and liberalisation in emerging market economies reveals that trade volume has a relative small impact on gdp per capita, while trade liberalisation led to an approximate 50 per cent increase on gdp per capita. the analysis of the financial dimension showed that capital account openness is associated with a 34 per cent increase in real gdp per capita growth over the period, while financial liberalisation seems to have a dramatic impact of approximately 136 per cent. in south africa approximately 98 per cent of the current growth performance in the country can be explained by the forces of globalisation. jel f40, 43 1 introduction the process of globalisation has influenced most developing countries. while the opportunities and benefits of the opening of economies are emphasised by proponents and supporters of globalisation, disillusionment is growing among many policy-makers and economists about the costs and risks involved in the globalisation of natio nal economies as well as the impact of it on future growth prospects. there is a general consensus (see rodrik, 1997; frankel, 2000; hemmer, 2001) that the driving forces behind economic globalisation are a reduction in transport and communication costs in the private sector, reduced policy barriers to trade and investment by the public sector, an increase in the availability of and access to information and technology, and the speed with which information and technology can be transmitted across national boundaries. the most important aspects of economic globalisation therefore include the breaking down of sajems ns vol 6 (2003) no 2 219 national economic boundaries, the liberalisation of international trade, finance and production activities and the growing power of transnational corporations (tncs) and international financial institutions (khor, 2000: 3). economic globalisation therefore manifests itself in various forms such as an increase in international trade, financial flows and foreign direct investment (fdi). among the group of developing countries are the emerging market economies 2, a group of countries that are generally seen as the economic leaders in the developing world. emerging market economies have since the early 1990s played a more important role in the world economy. during the 1980s and 1990s these economies achieved higher economic growth rates than did developed and developing countries. emerging market economies averaged real economic growth rates of 4 per cent and 4.1 per cent respectively during the 1980s and 1990s, in comparison with average rates of 3.4 per cent and 3.3 per cent for developing countries and 3.2 per cent and 2.5 per cent on average for the world economy. emerging economies’ exports contribute 23 per cent to world exports and 92 per cent of exports from developing countries. apart from the fact that emerging markets are highly active on the international trade scene, they are also the recipients of 92 per cent of all fdi inflows to developing countries. almost all the portfolio flows to developing countries are also directed at emerging economies since their financial markets are more developed than those of the remaining developing countries 3. these flows are very volatile and subject to emerging market crises, as has been seen in the mexican peso crisis, the east asian meltdown, and to a lesser extent the russian, turkish and argentinean defaults. south africa re-entered the international economy in the early 1990s at a time when the process of globalisation was beginning to gain momentum. policy choices were made that led to rapid liberalisation of finance, trade and investment. the question can be raised to what extent did south africa benefit from this process? economic globalisation can be analysed within two distinct dimensions. the trade dimension focuses on the impact of trade openness and liberalisation on economic growth and development. the other dimension is financial or capital account openness and liberalisation. although literature on a comprehensive measure of globalisation is still lacking, research has been done on the trade and financial dimensions of globalisation, respectively. the aim of this article is firstly to discuss the recent literature on the fields, to establish to what extent globalisation, seen from the perspective of these two dimensions, contributes to economic growth and development in emerging market economies and to test the robustness of the results. the second part of this article will focus on the sajems ns vol 6 (2003) no 2 220 relationship between globalisation and economic growth in south africa. the article concludes with policy implications and recommendations for the country. 2 trade openness and liberalisation in emerging market economies 2.1 literature overview traditional economic theory views trade as the engine of growth. since the early 1980s economists have recommended market-oriented reforms that included as a fundamental component the reduction of trade barriers and the opening of international trade to foreign competition (edwards, 1993: 1359). the rapidly growing east asian economies are an excellent example of the economic growth benefits of more open and outward-oriented economies. multilateral institutions such as the imf, the world bank and the oecd also urged developing countries to embark on trade liberalisation and to open their trade as a precondition for receiving financial assistance. rodrigues and rodrik (1999: 1) refer to prominent economists such as krueger and stiglitz who agree on the positive benefits of outward-oriented trade strategies and external openness for per capita income growth. a large number of comparative studies on the benefits of liberal trade policies on the growth and economic performance of various countries have been done since the 1970s. prominent economists such as bela balassa, anne krueger and jagdish bhagwati, to name a few, were involved in these different studies. edwards (1993: 1365) concluded that the literature on the subject has not always been successful in dealing with precise definitions of trade regimes and trade orientation. to address this issue, the world bank (1987) constructed an index of trade liberalisation. the index has values of between 1 – in cases of a highly oppressed external sector − and 20 in case of fully liberalised trade. however, most of the cross-country studies during the 1970s and 1980s were plagued by empirical and conceptual shortcomings (edwards, 1993: 1389). they also focussed mostly on whether inward or outward trade policies are beneficial for economic growth and development, which were naturally the issues of the time. during the late 1980s the emergence of the theory of endogenous economic growth by romer and lucas (see barro, 1998: 5) provided new evidence on the long-run equilibrium relationship between openness and economic growth, although empirical evidence was still lacking. during the 1990s a new generation of research developed that focussed on whether countries with lower trade barriers grow faster, once other relevant country growth variables are controlled for. two opposing schools of thought sajems ns vol 6 (2003) no 2 221 developed – the trade liberalisation optimists and the trade liberalisation sceptics. the optimists (see edwards, 1998:383) include romer (1992), grossman and helpman (1991) and barro and sala-i-martin (1995), who argued that countries that are more open have a greater ability to absorb technological advances generated in developed countries. the sceptics (see edwards, 1998:383) include krugmann (1994), rodrik (1995) and rodriguez and rodrik (1999), who argued that the effect of openness of trade on growth is doubtful. the most widely cited study of the 1990s is the paper by dollar (1992). he constructed two separate indices, namely an index of real exchange rate distortion and an index of real exchange rate variability. these indices are meant to capture two dimensions of outward orientation and each is negatively correlated with growth over the 1976-1985 period in a sample of 95 developing countries. rodriques and rodrik (1999: 15), who tested the results, concluded that the variability index is robust, but that the distortion coefficient is not statistically significant. this study was followed by the construction of a composite openness index by sachs and warner (1995), known as the sachs-warner openness indicator. this indicator is a zero-one dummy. the value of zero indicated a closed economy according to any one of the following criteria: if the average tariff rate exceeds 40 per cent, if non-tariff barriers covered more than 40 per cent of imports, if the country has a socialist economy or a state monopoly on exports, and lastly, if the black market premium exceeded 20 per cent during the 1970s and 1980s. if the sachs-warner dummy is used, the coefficients seem to be robust in growth regressions. however, when the individual components were tested, it emerged that the dummy’s strength mainly derives from the combination of the black market premium and the state monopoly of exports. both of these variables are less direct measures of trade policy such as tariffs and non-tariff barriers. rodriques and rodrik (1999: 24) concluded that “the sachs-warner measure is so correlated with plausible groupings of alternative explanatory variables ….. that it is risky to draw strong inferences about the effect of openness on growth based on its coefficient in a growth regression.” sebastian edwards (1998) went on to analyse the robustness of the opennessgrowth relationship by using the following already existing nine indicators of openness: the sachs-warner openness index, the world bank integration index, the edward leamer openness index (based on the basis of the average residuals from regression of trade flows), the average black market premium, the average import tariff as developed by barro and lee (1994), the average coverage of non-tariff barriers (also barro & lee), the heritage foundation index of distortions in international trade, the ratio of total revenues on trade taxes to total trade, and lastly, the regression index of holger wolf on import distortions. sajems ns vol 6 (2003) no 2 222 edwards (1998: 386) concluded that “in spite of significant efforts and ingenuity, there has not been too much progress in this area.” the vast majority of indices continue to be subject to limitations. the most recent published study in this field is by romain wacziarg (2001). he investigated the links between trade policy and economic growth by using a sample of 57 countries for the years 1970 and 1989. he developed a new measure of trade policy openness based on the policy components of trade shares, using a simultaneous equation system to identify the effect of trade policy on several determinants of growth. the indicators used include the average import rate, the non-tariff barrier coverage rate and the sachs-warner index. the results suggested a positive impact of openness on economic growth. wacziarg (2001: 422) also concluded that trade openness affects growth mainly by raising the ratio of domestic investment to gdp. the criticism from rodriques and rodrik (1999: 38) on an earlier version of this analysis focussed on the deficiencies of the sachs-warner index. they also question whether the results will hold up when averages of over a decade are used instead of the fiveyear averages that were used in the model. 2.2 the trade openness and liberalisation effect in a classic growth regression from the early 1990s the emerging market economies became more prominent players in the world economy. at that stage fast-growing countries like singapore, korea and malaysia had already expanded their export base. neighbouring countries in asia like indonesia, the philippines, thailand and china started to benefit from the spill over benefits of the region. during the late 1980s countries in latin america changed their inward trade strategies to become more outward-oriented and had settled most of their debt problems of the 1980s. countries in eastern europe entered the world economy in the early 1990s after the abolition of socialist rule. south africa was also able to extend the range of its trade ties after the abolition of apartheid in 1990. since the process of globalisation for emerging market economies started to gain momentum in the early 1990s (see loots, 2002 for a detailed analysis), it is imperative to analyse this process for the period 1990 to 2000. although most of the emerging market economies have been included in some of the earlier studies, they have not been analysed as a group as such and during the period covering the 1990s. this study will use a cross-sectional data set for 22 emerging market economies for the period 1990 to 2000. the countries included in the data set are argentina, brazil, chile, china, colombia, czech republic, egypt, hungary, india, indonesia, israel, republic of korea, malaysia, mexico, peru, philippines, poland, singapore, south africa, thailand, turkey and sajems ns vol 6 (2003) no 2 223 venezuela. due to data limitations, the russian federation and hong kong have been excluded from this analysis. the classic growth regression equation to be used in the analysis is as follows: gdpgro = α + β1govex + β2 log gdp80 + β3log lifeex + β4 secenrol + β5 popgro + et where gdpgro = average real per capita gdp growth for the period 1990-2000 govex = government expenditure as percentage of gdp gdp80 = real gdp per capita in 1980 lifeex = average life expectancy at birth secenrol = average secondary school enrolment popgro = average population growth rate et = residual term the regression results are reported in table 1. the results are broadly consistent with the current growth literature. the 1980 gdp per capita – representative of the initial gdp level – has a significant negative coefficient, indicating that low initial gdp levels imply higher growth rates, conditional upon the other variables included. this is known as the conditional convergence result (gylfason, 1999: 76; bekaert et al., 2001: 12). life expectancy has a positive coefficient indicating that long life expectancy is associated with higher economic growth. the secondary school enrolment variable is also positive and significant suggesting that countries with high levels of human development will achieve higher economic growth. the significantly negative coefficient of government expenditure indicates that countries with large government sectors have lower economic growth rates. in this regression the coefficient of population growth is positive, but insignificant at a 95 per cent confidence level. a possible explanation for this may be that the population growth rate in this group of countries is below the world average and does not therefore serve as a deterrent to growth. table i classic growth regression results variable coefficient t-statistic c -35.0880 -1.7691 govex -0.1129 -3.5165 loggdp80 -1.3643 -3.8868 loglifeex 12.5246 2.6629 secenrol 0.4143 1.9655 popgrow 0.5425 1.4254 sajems ns vol 6 (2003) no 2 224 notes: dependent variable is the average real gdp per capita for the period 1990-2000. data for the independent variables covers the same period. r2 = 0.7168 the question that can be raised is whether trade policy or trade volume or both affect economic performance. to test the significance of trade volume on growth, the trade variable was introduced in the classic growth regression. this caused major changes in the significance of the coefficients. the regression equation was transformed as follows: gdpgro = α + β1 trade + β2 log gdp80 + β3log lifeex + β4 secenrol + et where gdpgro = average real per capita gdp growth trade = import plus exports as percentage of gdp gdp80 = real gdp per capita in 1980 lifeex = average life expectancy at birth secenrol = average secondary school enrolment the regression results are reported in table ii. the results of the controls are broadly consistent with those reported in the empirical growth literature. life expectancy and secondary school enrolment both have positive coefficients. the trade volume coefficient is positive and significant suggesting that, once growth variables are controlled for, countries with higher levels of trade will benefit from higher growth rates. the trade volume coefficient of 0.0086 suggests that, on average, it is associated with approximately one per cent increase in real per capita gdp growth over the period. stronger evidence of conditional convergence occurs when controlled for trade volume. table 2 trade volume and growth variable coefficient t-statistic c -51.8040 -2.2481 trade 0.0086 1.5202 loggdp80 -1.5771 -3.8232 loglifeex 15.2341 2.6759 secenrol 0.0211 0.8972 notes: the dependent variable is the average real gdp per capita for the period 1990-2000. data for the independent variables covers the same period. r2 = 0.5274 sajems ns vol 6 (2003) no 2 225 the level of trade policy or the extent to which countries have liberalised their trade, is controversial. as has been indicated in the various studies discussed, no conclusive measure exists. insignificant results are obtained when the average tariff rate (imports plus exports) is included in a regression specification. even when the import and export tariff rates are entered individually, no significant coefficients are obtained. the black market premium 4 also proved to be insignificant, either in the form of the black market premium index or as a 0/1 dummy. to address these problems, a new trade liberalisation indicator (tradelib) with a 0/1 value was constructed. a country is classified as having a liberalised economy with a one dummy value if the average export tariff rate for the 1990s is less than one per cent, the average import tariff rate is less than 10 per cent and if the average black market premium index is less than 10 per cent. the introduction of this new liberalisation indicator in the classic growth regression does not significantly change the coefficients of the growth variables – see table 3. the liberalisation indicator is positive, but not significant at the 95 per cent confidence level. however, it is still significant at the 75 per cent confidence level. this result suggests that countries that embarked on more liberalised trade regimes will benefit from higher growth rates. it can also be inferred that countries with more liberalised trade regimes have performed better than countries that have isolated themselves. the trade liberalisation coefficient of 0.4987 also suggests that trade liberalisation appears to increase growth by approximately 50 per cent on average during the 11-year period. the evidence on conditional convergence, once controlled for trade liberalisation and other growth variables, also indicates that convergence is quite rapid. table 3 trade liberalisation and growth variable coefficient t-statistic c -40.1881 -1.8752 loggdp80 -1.4964 -3.7090 secenrol 0.0425 1.9785 tradelib 0.4987 0.7008 govex -0.1022 -2.8416 loglifeex 13.6589 2.7065 popgro 0.6638 1.5665 notes: the dependent variable is the average real gdp per capita for the period 1990-2000. data for the independent variables covers the same period. r2 = 0.7258 sajems ns vol 6 (2003) no 2 226 2.3 robustness the evidence presented above suggests that trade volume appears to increase growth by only 1 per cent, while trade liberalisation will lead to a 50 per cent increase in growth over the 11-year period. how robust are these results? the robustness exercise will focus on the various regions among the group of emerging market economies, namely the east asian countries, latin america, eastern europe and the group that includes the remaining countries (india, egypt, israel, south africa and turkey). when regional dummies for all the respective regions are stepwise included in the regression, the coefficients for the asian and other group of countries are significantly positive, while the coefficients for the remaining two regions are negative (see table 4). this evidence suggests that the benefits of growth through large trade volumes are largely driven by the east asian emerging markets and to a lesser extent by the other mixed group of emerging economies. latin american and eastern european economies are currently not benefiting by increases in trade volumes. table 4 trade volume regression results with regional dummies region coefficient ladum -0.1735 asiadum 1.6044 eudum -2.4555 otherdum 0.2781 regarding the impact of the trade liberalisation indicator on growth, the introduction of regional dummies also proves to be controversial. in contrast with the trade volume evidence, the coefficients for the regional dummies for latin america and the mixed group are positive, while those for the asian and eastern european regions are negative – see table 5. the significantly positive impact of trade liberalisation seems to be largely driven by countries in latin america and the mixed group of economies countries that are classified as the more recent liberalisers. table 5 trade liberalisation regression results with regional dummies region coefficient ladum 0.6274 asiadum -0.6712 eudum -3.3963 otherdum 0.9246 sajems ns vol 6 (2003) no 2 227 3 capital account openness and financial liberalisation in emerging market economies 3.1 literature overview in contrast with studies on trade openness and liberalisation that date back to the early 1970s, a comprehensive analysis on the impact of capital account openness and financial liberalisation is still lacking. one reason is that different theoretical perspectives have different implications for the desirability of liberalising capital flows. another reason is that empirical analysis so far is very limited and has failed to yield conclusive results (eichengreen, 2001: 341, edwards, 2001: 1). although research on the impact of openness on inward fdi indicates that it is positively associated with growth, studies on the effect of financial capital flows are less conclusive. some academics also argued that the free mobility of capital during the 1990s – promulgated by the globalisation optimists – was behind the succession of crises that emerging markets experienced during the decade (edwards, 2001: 1). the crucial question is if domestic financial markets can be counted on to deliver an efficient allocation of resources, why can’t international financial markets? various studies on financial liberalisation and/or capital account openness, all with differences in emphasis, have been done over the past number of years. some of these studies will be discussed before an attempt will be made to quantify the phenomenon for the 22 emerging market economies. a leading study on capital account liberalisation, published in the political science field by quinn (1997), is widely used by economists. he constructed the quinn index on current and capital account restrictions for 66 countries for 1973 and 1988. the index on capital account restrictions has values between one and four, with increments of 0.5. a higher value of this index denotes a higher degree of capital mobility. for the period 1960-1989 he reports a positive correlation between the change in his capital account openness indicator and growth. since capital flows during quinn’s period of analysis mostly took place in developed economies, the positive correlation can be ascribed to capital mobility in these countries. the most widely-cited study on the correlation between capital account liberalisation and growth is by rodrik (1998, see arteta et al., 2001: 4). he did a cross-country study on approximately 100 countries for the period 1975-1989. the binary indicator constructed by the imf’s exchange arrangements and exchange restrictions was used. a 0/1 dummy was generated for each country. if a country has no capital controls, the dummy has a value of one. controlling for various growth determinants, he found no statistically significant association sajems ns vol 6 (2003) no 2 228 between capital account liberalisation and gdp per capita growth and questions whether capital flows enhance economic efficiency. kraay and swank (see eichengreen, 2001: 345) did independent studies in 1998 by using both actual capital inflows and outflows as percentage of gdp as a measure of freedom of capital movements. although this measure cannot be seen to be an informative indicator of the capital account regime and does not indicate restrictions on capital flows, it may be useful as an indicator of the level of openness. klein and olivei (1999) did a cross-sectional analysis of approximately 92 developed and developing countries for the period 1986 to 1995. as regards the quantification of capital account liberalisation, the authors mention the fact that no single quantitative measure exists to determine capital account openness, especially when studying a widely heterogeneous set of countries. they used two measures: the first of these was the imf binary indicator, also used by rodrik. this variable again proves to be statistically insignificant in the model. second, they calculated the variable share, which represents the portion of years between 1986 and 1995 in which the country had unrestricted capital mobility. even if share was replaced by all, a dummy variable equal to one if a country had no restrictions on the capital account over the whole period, no difference in results was found. they concluded that countries with open capital accounts enjoyed a significantly greater increase in financial depth than countries with continuing capital account restrictions, and that they also enjoyed greater economic growth. however, this positive relationship is only evident in oecd countries. klein and olivei (1999: 22) observed that policy reforms in developing countries should require capital account liberalisation only when adequate institutions and sound macroeconomic policies are already in place. they also warn that this policy prescription requires a better understanding of the manner in which openness alters the performance of an economy. sebastian edwards (2001) investigated the effects of capital mobility on economic growth during the period 1981 to 1990 in 61 countries. he used quinn’s index (only available for 1973 and 1988) to measure the degree of capital mobility in different countries. (he also used the imf-based indicator, but the coefficients become statistically insignificant when included in the model.) his results suggested that, once controlled for other variables, countries that are more integrated into global financial markets have performed better than countries that have isolated themselves. there is also evidence suggesting that an open capital account positively affects growth only after the country has achieved a certain degree of economic development and has achieved a somewhat advanced domestic market, and that this therefore limits the benefits to high-income countries. sajems ns vol 6 (2003) no 2 229 bakaert, harvey and lundblad (2001) did a comprehensive cross-sectional country analysis on whether financial liberalisation spurs growth. the study covers four different data samples. samples i and ii include 95 and 75 countries, respectively, and samples iii and iv include 50 and 28 countries, respectively. they also constructed an official financial liberalisation indicator based on official liberalisation dates in countries. this is based on the dates of regulatory changes when foreigners could access the local market, normally when a sharp upward movement in equity capital flows is evident. the official liberalisation indicator takes a value of one when the equity market is liberalised and zero otherwise. they conclude that, once controlled for determinants suggested by the empirical growth literature, liberalisation appears to increase the real per capita gdp growth rate by an average of 1.13 per cent over a five-year period. differentiating across liberalising countries, a large secondary school enrolment, a small government sector and an anglo -saxon legal system tend to enhance the liberalisation effect. they also proved that the conditional convergence effect is larger once financial liberalisation is accounted for. arteta, eichengreen and wyplosz (2001) did a more cautious analysis on a sample of 61 countries. they re-tested the results obtained by the edwards analysis by using the quinn index. they also tested the interaction between capital account openness and the black market premium. while they find indications of a positive association between capital account liberalisation and growth, their evidence indicates that the effects vary with time, with how capital account liberalisation is measured and with how the relationship is estimated. they also find evidence indicating the need to eliminate major macroeconomic imbalances before opening the capital account. all these studies have difficulties in measuring the “true” degree of capital mobility and/or liberalisation. most studies measure capital controls by constructing a dummy variable for the presence or absence of controls. through this measure they are actually ignoring the intensity of controls or whether gradual relaxation of restrictions took place. the studies also differ in results due to aspects like the choice of the liberalisation variable, the number of countries included in the cross-country empirical analysis, the period covered (for instance during the 1980s capital flows to developing countries were nonexistent due to the debt crises) and the extent to which developed, developing and low-income economies are included. what seem to be important conclusions from these studies is the sequencing of reforms. eichengreen (2001: 353) concluded that countries that first complete the process of macroeconomic stabilisation, allowing them to remove exchange controls and other current account distortions, experience stronger growth effects through capital account openness. sajems ns vol 6 (2003) no 2 230 3.2 the capital account openness and financial liberalisation effect in a classic growth regression capital account openness and financial liberalisation can generally been seen as two related processes. in the preceding part the difficulty in the quantification of these processes was discussed. for the purpose of this study, various variables were considered. the existence of a black market premium in the market for foreign exchange, either in the index format or as a dummy, was tested, but seems insignificant. the standard and poor investor credit ratings for countries, used in the dummy variable format, did not provide a significant fit. enough evidence exists on the insignificant fit of the imf-based indicator. the imf only started to publish data on capital controls in 1996, and the absence of comparable data for earlier years means that its indicator cannot be used here. the quinn index, which is widely used in analysis done on the period of the 1980s, is only available for the 1970s and 1980s. for the purpose of this study, the following two measures will be used: first, the inflow and outflow of capital, as percentage of gdp, will be used to measure the free flow of capital or capital account openness. second, a financial liberalisation dummy for the individual countries will be constructed by using the bekeart and harvey (see bekeart et al., 2001:appendix table a1) official liberalisation dates of countries. countries that were liberalised before 1992 will have a value of one and those after 1992 a value of zero. since most developing countries in general experience an outflow of funds immediately after liberalisation, it can be assumed that the benefits of liberalisatio n for growth are not immediate, as is the case in developed countries. the inclusion of these two variables will be tested in the already specified standard growth regression. the regression equation representing capital account openness is as follows: gdpgro = α + β1capinf + β2 log gdp80 + β3 log lifeex + β4 secenrol + β5 popgro + et where gdpgro = average real per capita gdp growth for the period 1990-2000 capinf = gross fdi and portfolio investment as percentage of gdp gdp80 = real gdp per capita in 1980 lifeex = average life expectancy at birth secenrol = average secondary school enrolment popgro = average population growth rate sajems ns vol 6 (2003) no 2 231 table 6 capital account openness and growth variable coefficient t-statistic c -50.3974 -1.9777 capinf 0.2316 1.3283 loggdp80 -1.8242 -3.9857 loglifeex 14.8320 2.3885 secenrol 0.0355 1.3398 popgro 0.5006 1.0396 notes: the dependent variable is the average real gdp per capita for the period 1990-2000. data for the independent variables covers the same period. r2 = 0.5478 the regression results are summarised in table 6. the introduction of the capital openness indicator does not significantly change the coefficients, with the exception of the coefficient on government expenditure, which was subsequently omitted from the regression. however, the capital openness indicator is positive and significant with a coefficient of 0.2316. this suggests that capital account openness is associated with a 23.1 per cent increase in real gdp per capita over the 11-year period. strong evidence on conditional convergence is also present once controlled for capital account openness. when the financial liberalisation variable is introduced, the regression equation is as follows: gdpgro = α + β1finlib + β2 log gdp80 + β3log lifeex + β4 secenrol + β5 popgro + et where finlib = financial liberalisation variable the regression results are summarised in table 7. the regression results do not change significantly with the introduction of the financial liberalisation variable. the liberalisation indicator is positive and significant with a coefficient of 1.3590. this suggests that countries that liberalised before 1992 experienced an average increase of 135.9 per cent over the 11-year period in their respective gdp per capita growth rates. these results suggest that, once controlled for other growth variables, countries that are more integrated into financial markets have performed better than countries that isolated themselves. this evidence is in line with the conclusions by edwards (2001: 13). sajems ns vol 6 (2003) no 2 232 table 7 financial liberalisation and growth variable coefficient t-statistic c -77.6544 -3.2869 finlib 1.3590 1.3846 loggdp80 -1.8835 -4.0146 loglifeex 21.0961 3.6385 secenrol 0.0560 1.8103 popgro 0.4282 0.8832 notes: the dependent variable is the average real gdp per capita for the period 1990-2000. data for the independent variables covers the same period. r2 = 0.5517 3.3 robustness the evidence cited above suggests that capital account openness appears to increase growth by 23 per cent over the period, while countries that introduced financial liberalisation in the early 1990s experienced an approximate 136 per cent increase in growth over the 11-year period. how robust are these results? the robustness of these results can be analysed by incorporating regional dummy variables into the respective regression equations. tables 8 and 9 represent the coefficients of the regional dummy variables for latin america, east asia, eastern europe and the rest of the countries (india, egypt, israel, south africa and turkey). for the east asian economies the capital account openness and financial liberalisation effect is positive and significant. although the mixed group of countries also have a positive coefficient, it is not highly significant. the statistical and economic impact is the strongest in the east asian region. the coefficients for the latin american countries and those for eastern europe are significantly negative. the results on capital account openness and financial liberalisation are therefore strongly driven by the emerging east asian economies. these countries introduced major changes in their respective financial sector policies during the 1980s and early 1990s (see beim & calomiris, 2001: 139-141 for a detailed analysis). these policy reforms include the liberalisation of fdi regimes, the removal of credit controls, interest rate deregulation, the lifting of restrictions on foreign and local banks, the privatisation of state banks and stock exchanges and the relaxation of measures curbing international capital flows. this could explain the large coefficients obtained for capital account openness and especially the excessively high financial liberalisation coefficient. sajems ns vol 6 (2003) no 2 233 table 8 capital account openness regression results with regional dummies region coefficient ladum -0.6983 asiadum 1.3831 eudum -4.0182 otherdum 0.2711* * statistically insignificant table 9 financial liberalisation regression with regional dummies region coefficient ladum -0.8141 asiadum 1.3569 eudum -2.9678 otherdum 0.1281* * statistically insignificant 4 concluding remarks on emerging market economies economic theory creates strong presumptions that trade and financial liberalisation has favourable effects on economic growth. this paper investigates these phenomena by discussing the recent literature on the field, analysing it for the 22 emerging market economies in a classic growth regression and testing the robustness for the different regions. the trade dimension focused on the impact of trade openness and liberalisation on growth. the evidence suggests that trade volume seems to have a relatively small impact on real gdp per capita over the 11-year period. it is also mainly driven by the emerging economies in the east asian region. the fact that this group of countries has been the drivers of the trade volume process can serve as an explanation on why the impact is relatively small because most of the countries in this region embarked on trade promotion and received the growth benefits in earlier decades. in contrast, countries that embarked on liberal trade regimes over the past decade experienced an approximate 50 per cent increase in growth over the period. the large positive impact seems to be driven mainly by countries in latin america and the mixed group of economies. again the relatively large impact during the past decade is due to the relatively recent (late 1980s and early 1990s) trade liberalisation initiatives in latin american countries. sajems ns vol 6 (2003) no 2 234 the financial dimension focused on capital account openness and financial liberalisation. the evidence on capital account openness suggests that it is associated with a 34 per cent increase in real gdp per capita growth over the period. financial liberalisation seems to have a dramatic impact of approximately 136 per cent over the 11-year period. the results on both the financial liberalisation variables indicate that it is strongly driven by the emerging east asian region and can be ascribed to the dramatic turnabout in the financial sector policies during the late 1980s and early 1990s. these countries have experienced significantly large increases in fdi flows since the early 1990s. regarding financial liberalisation, the change in policy reforms allowed a more active role for private sector involvement on financial markets for the first time. 5 globalisation and the south african economy from the cross-sectional empirical analysis on trade and financial openness and liberalisation, respectively, it is evident that not all countries/regio ns benefited to the same extent. it is therefore imperative to establish what the impact of globalisation is on the south african economy. south africa extended its trade ties in the international economic arena in the early 1990s when the forces of globalisation became more prominent. a general analysis indicates that the expansion in the south african economy only started to take off in 1994. the trade pattern since 1990 is shown in figure 1. from the figure it is evident that, after a period of stagnation during the early 1990s, international trade started to increase from the latter part of 1994. financial flows in the form of fdi, portfolio and other investment flows made a dramatic turn-around from dominantly negative flows to mostly positive inflows from the third quarter in 1994 (see figure 2). in contrast with the long-term upward trend in trade since 1994, the investment flows are still extremely volatile. the volatility can be explained, firstly, by the fact that south african companies and individuals – due to exchange rate restrictions and international sanctions – did not have the opportunity to invest abroad. since 1994 a large number of south african companies expanded to become trans-national companies. the gradual relaxation of exchange control also permitted companies and individuals to invest abroad. a second explanation for the volatility in capital flows is the relative openness of the capital market for foreign speculative attacks against the rand. sajems ns vol 6 (2003) no 2 235 figure 1 trade as percentage of gdp 0 10 20 30 40 50 60 1q 19 90 3q 19 90 1q 19 91 3q 19 91 1q 19 92 3q 19 92 1q 19 93 3q 19 93 1q 19 94 3q 19 94 1q 19 95 3q 19 95 1q 19 96 3q 19 96 1q 19 97 3q 19 97 1q 19 98 3q 19 98 1q 19 99 3q 19 99 1q 20 00 3q 20 00 1q 20 01 3q 20 01 quarters % source: south african reserve bank, quarterly bulletin figure 2 total investment to gdp -3.00 -2.00 -1.00 0.00 1.00 2.00 3.00 1q 19 90 4q 19 90 3q 19 91 2q 19 92 1q 19 93 4q 19 93 3q 19 94 2q 19 95 1q 19 96 4q 19 96 3q 19 97 2q 19 98 1q 19 99 4q 19 99 3q 20 00 2q 20 01 quarters % source: south african reserve bank, quarterly bulletin since economic globalisation includes both the trade and financial dimensions, the simultaneous effect on the south african economy will be tested for the period 1990 to 2001 on a quarterly basis. the proxies for globalisation to be used in the model are as follows: 1. trade openness will be represented by the total value of imports plus exports, as percentage of gdp. data from the south african reserve bank quarterly bulletin will be used. 2. the proxy for trade liberalisation is more contentious. in the case of emerging market economies, the total taxes received by government on sajems ns vol 6 (2003) no 2 236 international trade transactions, as percentage of total imports and exports, respectively, were used. this figure is substantially lower than the average tariff rates being used in the sachs-warner openness index, where the average nominal tariff rate is used. for the south african exercise it was decided to use the import weighted average tariff rate, which is a more accurate reflection of the extent or level of trade restrictions. the latter rate also seems to be more in line with the rate suggested in the sachs-warner openness index. the other two variables included in the latter index, namely the black market premium on foreign exchange and the socialist economy/state monopoly on exports, are not relevant factors to be taken into account for the south african economy. the data source for the south african data is based on independent research done by the industrial development corporation. 3. capital account openness will be represented by the total inflow plus outflow of investment (fdi, portfolio investment and other investment), as percentage of gdp. the data source is the south african reserve bank quarterly bulletin. 4. the proxy for financial liberalisation is slightly more complex. in most international studies a dummy variable is used with 0/1 values. such dummy variables simply indicate the presence or absence of controls and cannot include the gradual relaxation of exchange and other capital controls, which is the case in the south african economy. to compensate for the gradual relaxation of controls, a financial liberalisation variable is constructed according to the six most prominent dates of exchange control relaxation measures in south africa. the dates have been chosen based on research by botha (1999) and the announcements in various budget speeches (see national treasury). the six most prominent announcements for the period 1990-2001 are in march 1995, when the financial rand was abolished; july 1995, when local insurance companies, pension funds and unit trusts were allowed for the first time to undertake foreign investment through the so-called asset swap arrangements; march 1997, when the minister of finance announced that most controls on current account transactions would be abolished, travel allowances for individuals were increased and corporations could invest more abroad and raise foreign funds; march 1998, when the minister announced the further relaxation of exchange controls for individuals and corporations; march 2000, when it was announced that companies would be allowed to use local cash holdings to finance new foreign finance and repay foreign debt, corporate asset swaps may be used to finance new foreign investments, unit trusts would be able to invest 20 per cent of total assets through asset swaps, certain currency transfers by pension funds, insurers and unit trusts would be allowed and a further increase in travel allowances; march 2001, when the minister announced that although the sajems ns vol 6 (2003) no 2 237 asset swap mechanism pertaining to institutions is terminated, south african firms are allowed to increase the limit on their new investments abroad from r50 million to r750 million in africa and r500 million in the rest of the world. the value of the financial liberalisation variable for the period 1990-1995 would be zero, with increments of 0.5 for each additional capital account relaxation, starting with the march 1995 abolition of the financial rand. the dependent variable to be used in the regressions is the real gdp and not per capita income growth as is used in the classical growth regressions. since the latter is only available on an annual basis and would only provide a very limited time series, it was decided to rather test the impact of globalisation on a quarterly basis since 1990 by using the real gdp at annualised rates. the regression equation is as follows: log gdp = α + β1 imexgdp + β2 avimtar + β3 totingdp + β4 gradfinlib + et where gdp = real gdp imexgdp = total value of imports plus exports, as percentage of gdp. avimtar = import weighted average tariff rate totingdp = total inflow plus outflow of investment, as percentage of gdp gradfinlib = financial liberalisation variable the regression results are shown in table x. all the coefficients prove to be statistically significant. the coefficient for gradfinlib is 0.0204, indicating that the gradual relaxation of capital account controls leads to, ceteris paribus, an approximate 2 per cent increase in real gdp. the imexgdp and totingdp coefficients of 0.0053 and 0.0042, respectively, indicate in each case a positive, but relatively small (less than one per cent) impact on gdp. the coefficient of avimtar is −0.0039, indicating that a one per cent decrease in the average tariff rate will, ceteris paribus, increase economic growth by approximately 0.3 per cent. the adjusted r2 of 0.9798 indicates that approximately 98 per cent of the future change in economic growth can be explained by globalisation, which is a fairly strong fit. sajems ns vol 6 (2003) no 2 238 table 10 globalisation regression variable coefficient t-statistic c 13.0334 380.3946 imexgdp 0.0053 7.0830 avimtar -0.0039 -3.9088 totingdp 0.0042 2.2281 gradfinlib 0.0204 3.6193 notes: the dependent variable is the log of the real gdp. r2 = 0.9798 the standardised beta coefficients of the independent variables can be used to determine the greatest substantive significance or the strongest relationship in the globalisation model (see table 11). the standardised beta coefficients indicate that trade volume (xexim) has the largest impact on growth with a contribution of 48.7 per cent to the change in real gdp. however, this can only be classified as a moderate positive relationship. the second largest contribution is from the financial liberalisation variable (xfinlib) with a positive but weak value of 27.5 per cent. this is followed by a weak negative relationship between gdp and trade liberalisation (xavimtar). the smallest contribution is from total investment flows (xinv) with a mere 5.5 per cent contribution, indicating that the benefit for the south african economy through capital account openness is negligible. this could be attributed to various factors. a large number of south african companies expanded to become tncs after 1994 and expanded their activities abroad. the gradual relaxation of capital controls also contributed to individuals and companies investing abroad. the volatility of portfolio flows due to various emerging market crises can naturally not be ignored. table 11 standardised beta coefficients variable coefficient t-statistic xinv 0.0547 2.2350 xavimtar -0.2462 -3.9755 xfinlib 0.2749 3.6568 xexim 0.4868 7.1601 it can be concluded that economic globalisation has a definite positive impact on the south african economy. the adjusted r2 indicates that approximately 98 per cent of the change in the real gdp is explained by globalisation. the south african economy is also less sensitive to trade variations than it is to the gradual liberalisation of capital controls. the fact that trade has been liberalised, also has a positive impact on the economy. the strongest impact on the real gdp is sajems ns vol 6 (2003) no 2 239 coming from trade, followed by a weaker, but still significant, influence from the financial and trade liberalisation variables, respectively. total investment has a negligible but still significant influence in the model, due to the volatility in these flows. 6 policy implications and recommendations the globalisation process in emerging market economies, including south africa, proved to have mixed results – some positive and others negative. in general, what seems to be important is the timing and sequencing of policy changes. from a trade perspective, the benefits of trade volumes in growth seem to be fairly small in the 1990s. the trade liberalisation impact is much larger, especially in the case of latin american countries, where liberalised trade policies had an immediate impact on growth. the financial liberalisation side is more complex. in this regard the liberalisation of fdi regimes on other restrictive flows and ownership on capital in east asia had an immediate and excessively strong impact on growth. the south african economy is more complex. south africa re-entered the international economy from isolation at a time when the forces of globalisation – especially for developing countries – seemed to gain momentum. although the economic growth pattern is lower than acceptable norms in other emerging economies, the forces of globalisation seems to be stronger than expected. approximately 98 per cent of the current growth performance in the country can be explained by the forces of globalisation. the regression results also indicate that the south african economy is benefiting from the gradual relaxation of exchange controls. the relative small impact of trade volume on economic growth is in line with the conclusions in international literature in this regard. sceptics like krugmann and rodrik (see edwards, 1998: 383) state that the effect of trade openness on growth “is, at best, very tenuous, and at worst, doubtful”. the volatility in investment flows also has a relatively weak impact on the gdp. the benefits of the decrease in the nominal average import tariff indicate that, on average, import tariffs are at a competitive level. the variables that have the greater substantive significance in the model are the proxy for trade volume, followed by the financial liberalisation variable, the trade liberalisation variable and, lastly, the negligible capital account openness variable. to conclude, according to the analysis the gradual financial and trade liberalisation did not distort the economy and contributed positively to growth. the trade impact is still moderate and could have a larger impact when exports are increased. the variable that demands greatest attention by policy makers is sajems ns vol 6 (2003) no 2 240 that which relates to total investment flows to the country. less volatility can be created by sustainable long-term fdi inflows, which will create a more stable environment and curb volatile portfolio flows. endnotes 1 based on a paper presented at the tips forum 2002, 9 september 2002, johannesburg. 2 the economist’s classification of emerging market economies has been used. this group of countries includes argentina, brazil, chile, china, colombia, czech republic, egypt, hong kong, hungary, india, indonesia, israel, korea (rep), malaysia, mexico, peru, philippines, poland, russian federation, singapore, south africa, thailand, turkey and venezuela. 3 see loots, 2002 for a detailed analysis on the globalisation trends in emerging market economies. 4 the black market premium represents the black market premium index, a measure of the extent of rationing in the market for foreign currency and therefore a measure of exchange rate policy. the theoretical reasoning for including the black market premium is that, under certain conditions, foreign exchange restrictions act as a trade barrier. references 1 arteta, c., eichengreen, b. & wyplosz, c. (2001) “when does capital account liberalisation help more than it hurts?”, national bureau of economic research, working paper, w8414, august, cambridge ma. 2 barro, r.j. (1998) determinants of economic growth. a cross-county empirical study, mit press, cambridge ma. 3 barro, r.j. & lee, j. (1994) “sources of economic growth”, carnegierochester conference series on public policy, june. 4 barro, r.j. & sali-i-martin, x. (1995) economic growth, mcgraw-hill, new york. 5 beim, d.o. & calomiris, c.w. (2001) emerging financial markets, mcgraw-hill, boston. 6 bekeart, g., campbell, r.h. & lundblad, c. (2001) “does financial liberalisation spur growth?”, national bureau of economic research, working paper, w8245, april, cambridge ma. 7 botha, z.c. (1999) “the exchange rate system in south africa – some aspects of past, present and future management policies”, paper presented at the annual ebm research conference, port elizabeth, november. sajems ns vol 6 (2003) no 2 241 8 dollar, d. (1992) “outward-oriented developing economies really do grow more rapidly: evidence from 95 ldcs, 1976-85”, economic development and cultural change, april. 9 edwards, s. (1993) “openness, trade liberalization, and growth in developing countries”, journal of economic literature, 31, september. 10 edwards, s. (1998) “openness, productivity and growth: what do we really know?”, the economic journal, 108, march. 11 edwards, s. (2001) “capital mobility and economic performance: are emerging market economies different?”, national bureau of economic research, working paper, w8076, january, cambridge ma. 12 eichengreen, b. (2001) “capital account liberalisation: what do cross-country studies tell us?”, the world bank economic review, 15(3), oxford university press. 13 frankel, j.a. (2000) “globalisation of the economy”, national bureau of economic research, working paper, w7858, august, cambridge ma. 14 grossman, g. & helpman, e. (1991) innovation and growth in the global economy, mit press, cambridge ma. 15 gylfason, t. (1999) principles of economic growth, oxford university press, new york. 16 hemmer, h.r. (2001) “developing countries – victims or beneficiaries of globalisation?”, paper presented at the konrad adenauer foundation workshop, johannesburg, 19 june. 17 holden, m. (2000) “openness, the terms of trade and trade policy in natural resource economies”, south african journal of economics, 68(2), pretoria. 18 khor, m. (2000) “globalisation and the south: some critical issues”, unctad, discussion papers, 147, april. 19 klein, m. & olivei, g. (1999) “capital account liberalization, financial depth and economic growth”, national bureau of economic research, working paper, w7384, october, cambridge ma. 20 loots, e. (2002) “globalisation, emerging markets and the south african economy”, the south african journal of economics, 70(2), march, pretoria. 21 national treasury (1997-2001) budget speeches, web page: www.treasury.gov.za 22 quinn, d (1997) “the correlates of change in international financial regulation”, american political science review, 91(3), september. 23 rodrik, d. (1997) “trade, social insurance and the limits to globalisation”, national bureau of economic research, working paper, w5905, january, cambridge ma. 24 rodrik, d. (1998) “who needs capital-account convertibility?”, essays in international finance, 207, may, princeton. 25 rodriques, f. & rodrik, d. (1999) “trade policy and economic sajems ns vol 6 (2003) no 2 242 growth”, national bureau of economic research, working paper, w7081, april, cambridge ma. 26 sachs, w. & warner, a. (1995) “economic reform and the process of global integration”, brookings papers on economic activity, washington dc. 27 south african reserve bank quarterly bulletin, various issues, pretoria. 28 wacziarg, r. (2001) “measuring the dynamic gains from trade”, the world bank economic review, 15(3), oxford university press. 29 world bank (2002) world development indicators, cd rom, world bank: washington dc. sajems ns vol 5 (2002) no i sense of coherence, coping and burnout of pharmacists m basson human resources department, s. buys pharmacy group, carletonville s rotbmann programme in industrial psychology, potchefstroom university for che abstract 35 people in almost any occupation could develop burnout. the objective of this research was to detennine the relationship between sense of coherence, coping and burnout in a corporate phannacy group. a cross-sectional survey design was used. the study population consisted of 67 pharmacists. the maslach burnout inventory, orientation to life questionnaire and cope were administered. the results showed that sense of coherence is significantly related to emotional exhaustion, depersonalisation and personal accomplishment. regarding coping strategies, mental disengagement was positively related to emotional exhaustion and depersonalisation, while positive reinterpretation and restraint coping were positively related to personal accomplishment. sense of coherence and coping strategies explained 44 per cent, 35 per cent and 41 per cent of the variance in emotional exhaustion, depersonalisation and personal accomplishment respectively. jeljoo 1 introduction the environment in which pharmacists currently function demands more of them than during any previous period. pharmacists have to cope with the demands that arise from fulfilling various roles, as well as with increased pressures such as managed health care and primary health care (davidson, 1998). it is therefore of great importance to track and address their effectiveness in coping with new demands (gupchup, singhal, dole & lively, 1998). one area that should be researched in this regard is burnout. burnout as a phenomenon was originally observed primarily among people helpers such as nurses, social workers and police workers. however, today it is acknowledged that people in almost any occupation could develop burnout (dubrin, 1990). burnout is a syndrome of emotional exhaustion and cynicism r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 36 sajems ns vol 5 (2002) no i that occurs frequently among individuals who do "people-work" of some kind (maslach, 1982b). it is accompanied by an array of helplessness and hopelessness, disillusionment, negative self-concept, negative attitudes toward work, people and life itself (maslach & jackson, 1986). the consequences of burnout are potentially serious for staff, clients, and the larger institutions in which they interact. maslach and jackson (1986) suggested that burnout could lead to deterioration in the quality of care or service that is provided by the staff. it appears to be a factor in job turnover, absenteeism, and low morale. furthermore, it correlates with various self-reported indices of personal dysfunction, increased use of alcohol and drugs, and marital and family problems (maslach & jackson, 1986). managers suffering from burnout could hurt the organisation because they spread it to their subordinates (dubrin, 1990). golembiewski, boudreau, munzenrider and luo (1996) summarised more than 60 north american studies that included almost 25 000 participants ranging from accountants and managers, through nurses, clerks and production workers, to students of police academies and mba-programmes. overall, 20 per cent are categorised in the most severe phase of burnout, with percentages ranging from study to study between 0 per cent and 35 per cent. they concluded that the estimates of burnout in various occupations are "far too high for anyone's comfort" (op. cit.: 165). golembiewski et al. (1996) also listed more than 20 studies that were performed outside north america where it was found that burnout rates were even higher in most of the samples. according to gupchup et al. (1998), burnout among pharmacists can have severe adverse implications, including reduced quality of care, absenteeism, low organisational commitment, turnover and job dissatisfaction. it was found pharmacists experience a moderate level of burnout. m611er, rothmann, coetzer and rothmann (2000) expressed concern that a pattern of introversion, neuroticism, a practical approach and inflexibility, combined with situational demands, role overload and pharmacists' responsibility for management and care, may result in burnout and eventually impairment. therefore, research regarding the burnout levels of pharmacists in a corporate pharmacy environment and correlates thereof seems relevant and necessary. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 37 2 theoretical background 2.1 burnout schaufeli and enzmann (1998: 36) define burnout as ita persistent, negative, work-related state of mind in 'normal' individuals that is primarily chamcterised by exhaustion, which is accompanied by distress, a sense of reduced effectiveness, decreased motivation, and the development of dysfunctional attitudes and behaviours at work. this psychological condition develops gmdually but may remain unnoticed for a long time by the individual involved. it results from a misfit between intentions and reality in the job. often burnout is self-perpetuating because of inadequate coping strategies that are associated with the syndrome". stress should not be confused with burnout. according to schaufeli and enzmann (1998), burnout can be considered as a particular kind of prolonged job stress. an individual experiences job stress when the demands of the workplace exceed his of her adaptive responses. burnout is a particular, multidimensional, chronic stress reaction that goes beyond the experience of mere exhaustion. burnout is seen as the final step in a progression of unsuccessful attempts to cope with a variety of negative stress conditions. burnout also differs from depression. burnout occurs in a context of anger mther than guilt and is situation-specific mther than pervasive. depression is characterised by a genemlisation of an individual's symptoms across all situations and spheres of life, whereas burnout is regarded as job-related. individuals who are burned-out at work may function normally in respect of their private life. although the emotional exhaustion component of burnout is related to depression, the relationship of depression with other burnout components is less strong (schaufeli & enzmann, 1998). burnout is conceptualised by maslach (1982b) as a syndrome consisting of three interrelated but conceptually distinct characteristics, namely emotional exhaustion, depersonalisation and low personal accomplishment: emotional exhaustion describes a reduction in the emotional resources of an individual. when asked how they feel, burned-out employees typically answer that they feel drained or used up and physically fatigued. depersonalisation refers to an increase in negative, cynical and insensitive attitudes towards colleagues, clients and/or patients. low personal accompushment refers to a feeling of being unable to meet clients' needs and to satisfy essential elements of job performance. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 38 sajems ns vol 5 (2002) no i schaufeli and enzmann (1998) analysed 73 studies and found that the levels of emotional exhaustion for six occupational fields were significantly higher than the cut-off points provided by maslach, jackson and leiter (1996). this tendency is attributed to the increase in overall job demands during the past decade. in the field of medicine, physicians and nurses experience about the same level of emotional exhaustion, but physicians have much higher scores on depersonalisation, whereas nurses experience a strongly reduced sense of personal accomplishment (schauf eli & enzmann, 1998). furthermore, teachers experience high levels of emotional exhaustion, while physicians and police officers experience high levels of depersonalisation. the symptoms of a burnout sufferer can be categorised as follows (dubrin, 1990; schaufeli & enzmann, 1998): affective symptoms. individuals who suffer from burnout show a tearful and depressed mode. the individual's emotional resources are exhausted because too much energy has been used for too long a time. his or her emotional control might be decreased which can lead to undefmed fears, anxiety and nervous tension. burned-out individuals can be irritable and oversensitive, but also cool and unemotional. bursts of angers may occur and their job satisfaction is low. cognitive symptoms. the burned-out individual feels helpless, hopeless and powerless. work loses its meaning and a sense of failure is experienced. the individual may not be able to concentrate for a long period, is forgetful and makes all kind of minor mistakes. thinking becomes rigid, while emotional and personal issues and problems are intellectualised. decision-making becomes more difficult and the individual may run away from reality by daydreaming and fantasising. at interpersonal level there is a decreased involvement with recipients, which is evident in negativism, pessimism, hostility, suspicion, lessened empathy and stereotyping. physical symptoms. three categories of physical symptoms are observed in burned-out individuals. firstly, all kinds of indefmite physical distress complaints are observed, for example headaches, nausea, dizziness, restlessness, muscle pains, hyperventilation, sexual problems, sleep disturbances, sudden loss or gains of weight and chronic fatigue. secondly, psychosomatic disorders like ulcers, gastric-intestinal disorders, coronary heart disease, prolonged colds and flu and susceptibility to viral infections are observed. thirdly, a number of physiological reactions are observed, for example increased heart rate and respiration rate, hypertension and high levels of serum cholesterol. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vols (2002) no 1 39 behavioural symptoms. the burned-out individual tends to be hyperactive, but does not know what to do or where to go. he or she acts impulsively without carefully considering alternative options. on the other hand, procrastination, doubt and decisiveness are also observed. the consumption of stimulants, like coffee and tobacco increases, as may the use of alcohol, tranquillisers, barbiturates or drugs. overand undereating and accident proneness are also observed. at interpersonal level, the individual tends to be aggressive or tends to social isolation and withdrawal. at organisational level, burnout is characterised by reduced effectiveness, poor work performance and minimal productivity. motivational symptoms. the bumed-out individual's intrinsic motivation vanishes: enthusiasm, interest and idealism are lost. by contrast, disillusionment, disappointment and resignation set in. at an interpersonal level the motivational crisis is expressed by a loss of genuine interest in recipients, indifference and discouragement. work motivation is poor, there is a strong resistance to go to work and the individual's initiative is dampened. possible causes of burnout can be classified into personality characteristics, work-related attitudes, and work and organisational characteristics. organisational factors which contribute to burnout are work overload (corrigan et al., 1994; landsbergis, 1988), poor collegial support (golembiewski & munzenrider, 1988), role conflict and role ambiguity (miller, ellis, zook & lyles, 1990) and lack of feedback (participation in decision making and autonomy). regarding work related attitudes, high (unrealistic) expectations are related to burnout (scbaufeli & enzmann, 1998). burnout is observed more often among younger employees compared with those older than 30 or 40 years. furthermore, burnout is negatively related to work experience. kunzel and schulte (1986) interpret the greater incidence of burnout in younger and less experienced employees in terms of reality shock:, while cherniss (1980a) regards it as an indicator of an identity crisis due to unsuccessful occupational socialisation. maslach et al. ( 1996) show that burnout symptoms decline with growing age or work experience. however, scbaufeli and enzmann (1998) wam that a selection effect ("survival" bias) might explain the decline of bum out symptoms: " ... those who bum out early in their careers are likely to quit their jobs, leaving behind the survivors who exhibit low levels of bum out". women tend to score higher on emotional exhaustion, whereas men score higher on depersonalisation. according to schaufeli and enzmann (1998), this can partly be explained by sex role-dependent stereotypes. for example, men r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 40 sajems ns vol 5 (2002) no 1 hold instrumental attitudes, whereas women are more emotionally responsive and seem to disclose emotions and health problems more easily. furthermore, due to additional responsibilities at home, working women experience higher workloads compared with men. workload, in turn, is positively related to burnout, particularly to emotional exhaustion. unmarried people (especially men) seem to be more prone to burnout compared with those who are married. however, it is possible that age or psychosocial problems may influence this proneness (schaufeli & enzmann, 1998). cash (1988) found that individuals with a higher level of education were more prone to burnout than less educated employees. this could be attributed to the higher expectations of the more educated individuals. another explanation might be that the more highly educated individuals (compared with less educated individuals) more often gain positions with more responsibility (schauf eli & enzmann, 1998). according to schaufeli and enzmann (1998), personality characteristics of employees are related to burnout. personality hardiness, a confrontational coping style, self-esteem, and extroversion are negatively related to burnout, while an external control orientation, type a behaviour and neuroticism are positively related to burnout. the tendency to perceive events and circumstances as stressful, ways of coping with them and how failure in coping is dealt with, depend in part on the dispositional characteristics of a person. these characteristics involve one's beliefs about the world and possibilities of dealing with it (semmer, 1996), and include constructs such as sense of coherence (antonovsky, 1987), personality hardiness (kobasa, 1982) and locus of control (rotter, 1966). for the purposes of this research, the focus is on employees' sense of coherence and coping and the possible relationship thereof with burnout. 2.2 sense of coherence sense of coherence is a construct from a salutogenic (antonovsky, 1987) or fortigenic (strilmpfer, 1995) paradigm. the salutogenic paradigm focuses on the origins of health in terms of an ease/disease continuum, while the fortigenic paradigm focuses on the strengths of individuals. these paradigms are in contrast with a pathogenic approach, which focuses on the origins of illness. sense of coherence is defmed as "a global orientation that expresses the extent to which one has a pervasive, enduring though dynamic, feeling of confidence that one's internal and external environments are predictable and that there is a. high probability that things will work out as well as can reasonably be expected" (antonovsky, 1987: xiii). the definition of sense of coherence r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 41 includes three dimensions which represent the concept, that is comprehensibility, manageability and meaningfulness (antonovsky, 1987). comprehensibility refers to the extent to which one perceives stimuli from the internal and external environment as information that is ordered, structured and consistent. the stimuli are perceived as comprehensible and make sense on a cognitive level. manageability refers to the extent to which individuals experience events in life as situations that are endurable or manageable and can even be seen as new challenges. meaningfulness refers to the extent to which one feels that life is making sense on an emotional and not just a cognitive level. according to antonovsky (1987) there is good theoretical reason and empirical evidence for expecting the three components to be inextricably intertwined. antonovsky (1987) mentions that one's sense of coherence is tried continually but individuals who developed a strong sense of coherence early in adulthood have the ability to use general resistance resources to restore equilibrium. sense of coherence can thus be viewed as a stable dispositional orientation. a strong sense of coherence is negatively related to measures of negative affectivity, such as anxiety and neuroticism (flannery & flannery, 1990; frenz, carey & jorgenson, 1993) and work stress (feldt, 1997). a strong sense of coherence is also related to competence and life satisfaction (kalimo & vuori, 1990), general well-being (feldt, 1997), emotional stability (mlonzi & strl.impfer, 1998) and successful coping with life stress (flannery, perry, penk & flannery, 1994; mcsherry & holm, 1994). according to antonovsky (1987), a high level of sense of coherence should enable a person to apply a wide range of coping strategies flexibly. tyler and cushway (1998) found that more stressed workers make more use of all types of coping strategies. levert, lucas and ortlepp (2000) reported significant correlation coefficients between two components of burnout (emotional exhaustion and depersonalisation) and sense of coherence in a group of psychiatric nurses in south africa. their results showed that whether psychiatric nursing staff believed they had the resources available to meet the demands of their environment, the extent to which these demands were seen as challenges worthy of engagement, and the degree to which the environment was regarded as structured and predictable related to whether they will experience emotional exhaustion and depersonalisation components of burnout. gilbar (1998) found significant correlation coefficients between social workers' sense of coherence and emotional exhaustion (r = -0.30) as well as sense of coherence and personal accomplishment (r = -0.34), r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 42 sajems ns vol 5 (2002) no i an individual with a strong sense of coherence will be more inclined to understand the nature and dimensions of an acute or chronic stressor and will define it as something that he or she can cope with. he or she will regard it as manageable by using resources within his or her own or others' control rather than becoming helpless. however, sense of coherence on its own, without the appropriate ability, skills, training and development, would be of no avail (striimpfer, 1990). 2.3 coping kleinke (1991: 3) defines coping as "the; efforts we make to manage situations we have appraised as potentially harmful or stressful if. coping refers to perceptual, cognitive or behavioural responses that are used to manage, avoid or control situations that could be regarded as difficult (folkman & lazarus, 1984; moos, 1994; zeidner & endler, 1996). the term "coping" could be used to refer to either strategies or results (fleishman, 1984). as a strategy, coping refers to the different methods that a person may apply to manage his or her circumstances. as a result, coping refers to the eventual outcomes of this strategy for the person. for the purposes of this research, the focus is on coping as a strategy. callan (1993) defmes non-coping as failed efforts to cope, accompanied by various physical and psycho-social disturbances, which result in higher stress. non-copers experience that things do not make sense and they lose perspective on issues. carver, scheier and weintraub (1989) mention that non-coping results in higher levels of depression and anxiety. these characteristics are negatively related to sense of coherence (mlonzi & strumpfer, 1998). amirkhan (1994), callan (1993) and folkman and lazarus (1980) distinguish between problem-focused and emotion-focused coping. problem-focused coping is directed at eliminating an unpleasant experience or reducing the effects thereof. emotion-focused coping is directed at reducing the effects of stressful feelings caused by an unpleasant experience through relaxation, the use of alcohol and drugs, social activities and/or defence mechanisms. carver et al. (1989) distinguish between five variations of problem-focused coping, namely: active coping (taking active steps to remove stressors or to reduce their effects). planning (thinking about various strategies which could be used to solve a problem). • suppressing competing activities (moving other projects temporarily to the background). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no i 43 restraint coping (waiting for the right opportunity to solve a problem rather than acting impulsively). seeking social support for instrumental reasons (looking for advice, support or information). furthennore, carver et al. (1989) distinguish between the following five variations of emotion-focused coping: seeking social support for emotional reasons (reaching out to others for moral support, sympathy and understanding). positive reinterpretation (managing stress emotions rather than the stressors by reinterpretation). denial (experiencing stressors as unreal). acceptance (accepting stressors as a reality). turning to religion (focusing on religion to facilitate emotional support, positive reinterpretation as well as active coping). carver et al. (1989) distinguish the following coping strategies that are used less: focus on and venting of emotions (focusing on a stressful situation and expressing feelings about it). behavioural disengagement (ignoring and avoiding stressors and becoming more helpless and powerless). mental disengagement (excessive sleeping or daydreaming to get away from stressors). alcohol-drug disengagement (using alcohol or drugs to manage stress). in the literature high levels of burnout are associated with ineffective (rowe, 1997) or withdrawal coping strategies and low degrees of burnout with constructive coping strategies (maslach & jackson, 1982). rowe (1997) also demonstrated the importance of teaching individuals with limited coping skills to alter the way in which they address problems. alsoofi, ai-heeti and alwashli (2000) found a significant correlation between ways of coping and burnout. individuals who are burned-out cope with stressful events in a rather passive, defensive way, whereas individuals who use confronting coping strategies experience less burnout (schauf eli & enzmann, 1998). both confronting and avoiding coping share about 5-10 per cent of the variance of emotional exhaustion and depersonalisation. with respect to personal accomplishment, confronting coping explains 15 per cent of variance, whereas the relationship with avoiding coping is weaker. the use of a problem-focused strategy may trigger feelings of personal accomplishment, which could explain the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 44 sajems ns vol 5 (2002) no i relationship of confronting coping with personal accomplishment (lee & ashforth, 1996). the objective of this research was to establish the relationship between burnout, sense of coherence and coping in a corporate pharmacy group. if a relationship between burnout, sense of coherence and coping of pharmacists in the corporate environment could be found, it may have implications for their recruitment, induction, selection, training, development and performance management. 3 method 3.t research design a survey design was used to reach the research objectives. the specific design is the cross-sectional design, whereby a sample is drawn from a population at a specific time (shaughnessy & zechmeister, 1997). 3.2 participants the study population consisted of all retail, hospital and executive pharmacists (n = 67) in a corporate pharmacy group. a total of 56.72 per cent are married, while 25.37 per cent have been working for the company for longer than two years. 3.3 measuring battery the maslach burnout inventory (mbi) (maslach & jackson, 1986) was used to determine participants' level of burnout. the mbi consists of three sub-scales, namely emotional exhaustion, depersonalisation and personal accomplishment (maslach & jackson, 1981, 1986). the three sub-scales of the mbi were dealt with separately in this study, based on considerable factor-analytical support for their separation (maslach & jackson, 1986; schaufeli & janczur, 1994). maslach and jackson (1981, 1986) and lahoz and mason (1989) reported cronbach alpha coefficients varying from 0.71 to 0.90 for the three sub-scales of the mbi. test-retest reliability varied from 0.60 to 0.82 and 0.54 to 0.60 (applied after one year). external validation of the mbi comes from analyses of its convergence with peer ratings, job dimensions associated with burnout, and stress outcomes (maslach & jackson, 1984). the orientation to life questionnaire (olq) (antonovsky, 1987) was used to measure participants' sense of coherence. the olq consists of 29 items. antonovsky (1993) reported alpha coefficients of the olq in 29 research r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 45 studies varying between 0.85 and 0.91. test-retest reliability studies found coefficients between 0.41 and 0.97 (antonovsky, 1993). rothmann (2000) reported an alpha coefficient of 0.89 for the olq, which may be regarded as acceptable (nunnally & bernstein, 1994). regarding the construct validity of the olq, it was found that there is a negative relationship between the olq and experienced stress and that the olq correlates negatively with the "statetrait anxiety inventory-trait" and the "beck depression inventory" (frenz et al., 1993). the cope questionnaire (cope) (carver et al., 1989) was used to measure participants' coping strategies. the cope is a multidimensional 53-item coping questionnaire that indicates the different ways in which people cope in different circumstances (carver et al., 1989). it measures 13 different coping strategies. five sub-scales (four items each) measure different aspects of problem-focused coping: active coping, planning, suppressing of competing activities, restraint coping and seeking social support for instrwnental reasons. five sub-scales (four items each) measure aspects of emotion-focused coping: seeking social support for emotional reasons, positive reinterpretation and growth, acceptance, denial and turning to religion. four sub-scales indicate coping responses that are used less: focus on and venting of emotions, behavioural disengagement, mental disengagement and alcohol-drug disengagement (carver et al., 1989). carver et al. (1989) reported cronbach alpha coefficients varying from 0.45 to 0.92. all the sub-scales have sufficient levels of reliability except for mental disengagement, which measures lower than 0.60. test-retest reliability varies from 0.46 to 0.86 and 0.42 to 0.89 (applied after two weeks). 3.4 statistical analysis the statistical analysis was carried out with the help of the sas-program (sas institute, 1996). cronbach alpha coefficients, inter-item correlation coefficients and confirmatory factor analysis were used to assess the reliability and validity of the measuring instrwnents (clark & watson, 1995). descriptive statistics (e.g. means, standard deviations, skewness and kurtosis) were used to analyse the data. because a non-probability sample was used in this research, effect sizes (rather than inferential statistics) were used to decide on the significance of the fmdings. pearson product-moment correlation coefficients were used to specify the relationships between the variables. a cut-off point of 0.30 (medium etrect) (cohen, 1988) was set for the practical significance of correlation coefficients. a stepwise multiple regression analysis was conducted to determine the percentage of the variance in the dependent variables (coping and burnout) that r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 46 sajems ns vol 5 (2002) no i effect size (which indicates practical significance) in the case of multiple regression is given by the following formula (steyn, 1999): a cut-off point of 0.35 (large effect) (steyn, 1999) was set for the practical significance of/2. 4 results table i shows the descriptive statistics, the cronbach alpha coefficients and the average inter-item correlation coefficients of the mbi, olq and cope. table 1 descriptive statistics, alpha coefficients and inter-item correlation coefficients of the mbl, olq and cope item mean sd range skewkurtor a ness sis (mean) mbi emotional 14.69 9.91 41.00 0.68 -0.19 0.51 0.89 exhaustion depersonalisation 5.21 4.90 19.00 1.10 0.56 0.31 0.67 personal 38.89 5.96 26.00 0.86 0.31 0.26 0.73 accomplishment i olq comprehensibility 51.37 7.90 34.00 -0.12 -0.40 0.20 0.73 . manageability 52.76 8.38 34.00-053 -0.58 0.33 0.83 ingfulness 47.07 5.74 23.00 -0.48 -056 0.42 0.85 total 151.2 19.53 81.00 -0.37 -0.62 i 1 cope active coping 12.42 2.10 10.00 -0.23 0.22 0.25 0.56 planning 13.63 2.23 11.00 -1.16 2.30 0.41 0.73 suppressing 10.45 2.20 12.00 -0.22 0.33 0.26 0.58 competition i restraint coping 11.03 2.59 12.00 -0.14 0.09 0.36 0.68 table 1 continued r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 47 table 1 continued item i mean sd range skewkurtor a ness sis (mean) cope seeking social 11.72 2.89 12.00 . -0.53 -0.32 i 0.57 0.84 support-ir seeking social 10.88 3.49 12.00 -0.06 -u2 0.64 0.88 support-er positive 13.54 1.90 8.00 -0.43 -0.30 0.35 0.67 reinterpretation acceptance 11.55 2.22 10.00 0.08 0.03 0.32 0.64 turning to 13.87 2.75 12.00 -1.61 2.35 0.63 0.86 religion focus on i venting 8.60 2.94 12.00 0.84 0.38 0.52 0.81 emotions denial 5.60 1.94 11.00 2.01 7.08 0.27 0.56 behavioural 5.70 1.61 5.00 0.80 -0.47 0.16 0.42 disengagement mental 8.19 2.08 7.00 0.24 -0.56 0.13 0.36 disengagement alcohol-drug 1.09 0.34 2.00 4.09 17.72 disengagement .1 note low personal accomplishment scores imply high burnout levels; emotional exhaustion scores ~ 16 are 'low'; 17-26 are 'average'; and scores ~ 27 are 'high'; depersonalisation scores ~ 6 are 'jow'; 7-12 are 'average'; and scores ~ 13 are 'high'; personal accomplishment scores ~ 31 are 'high'; 32-38 are 'average'; and scores ~ 39 are 'low'. table 1 shows cronbach alpha coefficients varying from 0.67 to 0.89 for the mbl although the alpha coefficient of depersonalisation is somewhat lower than the cut-off point recommended by nunnally and bernstein (1994), the coefficients are acceptable. the average inter-correlation between the items is also acceptable (0.15 ~ r ~ 0.50; clark & watson, 1 994). factor analysis confinned the factor structure of the mbi. compared with the norms provided by maslach and jackson (i986), the scores of pharmacists are low to average. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 48 sajems ns vol 5 (2002) no i the scores on the mbi are relatively normally distributed, with low skewness and kurtosis. a classification of the levels of burnout (high, moderate or low) ofphannacists as measured by the three scales of the mbi is given in table 2. table 2 classification of pharmacists' mbi scores item frequency percentage emotional exhaustion high 9 13.43 moderate 17 25.37 low 41 61.19 depersonalisation high 7 10.45 moderate 12 17.91 low 48 71.64 personal accomplisbment high 43 64.18 moderate 15 22.39 low 9 13.43 table 2 indicates that 13.43 per cent of the pharmacists show high levels of emotional exhaustion. a total of 25.37 per cent of the pharmacists show moderate levels of emotional exhaustion. regarding depersonalisation, table 2 shows that 10.45 per cent of the pharmacists show high levels of depersonalisation. furthermore, 17.91 per cent of the pharmacists show moderate levels of depersonalisation. table 2 further shows that 13.43 per cent of the pharmacists show low levels of accomplishment. a total of 22.39 per cent of the pharmacists show moderate levels of personal accomplishment. it is clear from table 2 that most of the pharmacists experience relatively low levels of emotional exhaustion and depersonalisation and high levels of personal accomplishment. the product~moment correlation coefficients between the olq and the cope are reported in table 3. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no i 49 table 3 product-moment correlation coefficients between the olq and the cope item socsocsoc i soccomprehen managemeaningful• total -sibiuty ability ness active coping 0.24 0.330.24 0.31" planning 0.30' 0.32' 0.23 0.33' suppressing 0.18 0.21 0.18 0.22 competition restraint coping 0.39' 0.50" 0.29 0.46* seeking social -0.03 -0.07 -0.06 -0.06 support-ir seeking social -0.05 -0.02 -0.05 -0.04 support-er positive 0.29 0.44* 0.50" 0.46' reinterpretation acceptance 0.24 0.07 0.12 ~ tuming to religion 0.05 0.17 0.13 0.13 focus on i venting -0.34" -0.26 -0.16 -0.30· emotions denial -0.10 -0.09 -0.11 -0.12 behavioural -0.06 -0.26 -0.22 -0.20 disengagement mental -0.29 -0.12 -0.13 -0.21 disengagement alcohol-drug -0.01 -0.15 -0.16 -0.14 disengagement ** practically significant correlation (large effect): d ~ 0.50 * practically significant correlation (medium effect): d ~ 0.30 table 3 shows that sense of coherence (total) is positively related to active coping, planning, restraint coping, positive reinterpretation (all medium effects). sense of coherence (total) is also negatively related to focus on and venting of emotions (medium effect). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 50 sajems ns vol 5 (2002) no i the product-moment correlation coefficients between the olq and the mbl are given in table 4. table 4 product-moment correlation coefficients between tbe olq and tbembi item emotional depersonalipersonal exhaustion sation accomplishment soc-0.45' -0.32" 0.29 comprehensibility soc-0.56" -0.38' 0.48' manageability soc-0.41' -0.38' 0.55" meaningfulness soc-total -0.56" -0.41' 0.48' "'''' practically significant correlation (large effect): d;;:: 0.50 '" practically significant correlation (medium effect): d;;:: 0.30 table 4 shows that emotional exhaustion is negatively related to individuals' sense of coherence (total score; large effect). emotional exhaustion is also negatively related to the components of sense of coherence, including manageability (large effect), comprehensibility (medium effect) and meaningfulness (medium effect). furthermore, it seems from table 4 that depersonalisation is negatively related to sense of coherence (total score) as well as. its components, namely comprehensibility, manageability and meaningfulness (all medium effects). lastly, table 4 shows that personal accomplishment is related to sense of coherence (total score; medium effect) as well as manageability (medium effect) and meaningfulness (large effect). table 5 shows the product-moment correlation coefficients between the cope and the mbi. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no i 51 tables product-moment correlation coemcients between the cope and thembi item emotional depersonapersonal exhaustion accomplishment active coping -0.23 -0.09 0.19 planning -0.20 -0.17 0.17 suppressing -0.08 0.02 0.18 competition restraint coping -0.25 -0.19 0.39seeking social 0.21 0.12 -0.04 support lr seeking social 0.24 0.16 -0.10 support-er positive -0.29 -0.21 0.54-reinterpretation acceptance -0.05 -0.07 0.10 tuming to religion -0.20 -0.27 0.18 focus on i venting 0.29 0.16 -0.14 emotions denial -0.12 -0.11 -0.07 behavioural 0.18 0.01 .0.33disengagement mental 0.380.34om disengagement alcohol-drug 0.08 0.29 -0.03 disengagement ** practically significant correlation (large effect): d ;;::: 0.50 * practically significant correlation (medium effect): d;;::: 0.30 table 5 shows that the emotional exhaustion and depersonalisation sub-scales correlate positively with mental disengagement (medium effects). the personal accomplishment sub-scale correlates positively with positive reinterpretation (large effect) as well as restraint coping (medium effect). the personal accomplishment sub-scale also correlates negatively but significantly with behavioural disengagement. no other practically significant correlation coefficients were found between bumout and coping strategies. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 52 sajems ns vol 5 (2002) no i the results of a stepwise regression analysis with the sense of coherence and coping strategies as independent variables and emotional exhaustion (as measured by the mbi) are shown in table 6. table 6 regression analysis of sense of coherence and coping as independent variables and emotional exbaustion as dependent variable analysis of variance k=o.44 source of degrees of sum of squares mean square variance freedom r=0.66 regression 3 2837.69 945.90 f= 16.381/2 0.79residual 63 3638.73 57.76 variables in tbe equation independent variables parameter standard f p error intercept 49.59 14.65 27.58 0.0001 sense of coherence -0.27 0.05 29.14 0.0001 denial -1.21 0.49 6.09 0.0163 mental disengagement 1.46 0.47 9.92 0.0025 ... practically significant:/2 ~ 0.35 (large effect) table 6 demonstrates that the independent variables (including sense of coherence and coping strategies) predict a total of 44 per cent of the variance in emotional exhaustion of pharmacists (as measured by the mbi). the multiple correlation of 0.66 is practically significant (large effect) if2 = 0.79). the results of a stepwise regression analysis with sense of coherence and coping strategies as independent variables and depersonalisation (as measured by the mbi) as dependent variable are shown in table 7. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no i 53 table 7 regression analysis of sense of coherence and coping as independent variables and depersonalisation as dependent variable analysis of variance r2= 0.35 source of degrees of sum of squares mean square variance freedom r=0.59 regression 5 559.82 111.96 f = 6.661 j2 = 0.54" residual 61 1025.25 16.81 variables in the equation independent variables parameter standard t p error intercept 17.64 5.56 10.06 0.0024 sense of coherence -0.08 0.03 9,21 o. tuming to religion -0.36 0.19 3.71 0.057 -0.56 0.27 4.36 0.0410 mental disengagement 0.59 0.26 5.00 0.0290 alcohol-drug 2.96 1.62 3.33 0.0728 disengagement * practically significantj2;::: 0.35 (large effect) table 7 demonstrates that the independent variables (including sense of coherence and coping strategies) predict a total of 35 per cent of the variance in depersonalisation of pharmacists (as measured by the mbi). the multiple correlation of 0.59 is practically significant (large effect) (j2 0.54). the results of a stepwise regression analysis with the sense of coherence and coping strategies as independent variables and personal accomplishment (as measured by the mbi) as dependent variable are shown in table 8. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 54 sajems ns vol 5 (2002) no 1 table 8 regression analysis of sense of coherence and coping strategies as independent variables and personal accomphshment as dependent variable analysis of variance if 0.41 source of degrees of sum of squares mean square variance freedom r=o.64 regression 3 958.90 319.63 f= 14.491/2 0.70· residual 63 1389.37 22.05 variables in the equation independent variables parameter standard f p error intercept 14.46 6.07 5.68 0.0202 sense of coherence 0.08 0.03 5.93 0.0177 positive reinterpretation and 1.21 0.34 12.43 0.0008 growth behavioural disengagement -0.76 0.37 4.16 ,0.0456 * practically significant:j2 ~ 0.35 (large effect) table 8 demonstrates that the independent variables (including sense of coherence and coping strategies) predict a total of 41 per cent of the variance of personal accomplishment of pharmacists (as measured by the mbi). the multiple correlation of 0.64 is practically significant (large effect) ([2 0.79). s discussion based on the standardised categorisation of burnout levels for sub-scale scores proposed by maslach and jacksoo (1986), the pharmacists in this sample experience low to moderate levels of burnout on the emotiooal exhaustion and depersonalisation sub-scales. however, it seems that approximately 39 per cent of the phannacists experience moderate to high levels of emotional exhaustion. this implies a reduction in the emotional resources of an individual, which is accompanied by a feeling of being drained as well as being physically fatigued. a total of 28 per cent of the phannacists experience moderate to high levels of depersonalisation. this implies negative, cynical and insensitive attitudes towards colleagues, clients and/or patients. the results of pbannacists in this study confirm the fmdings of gupchup et al. (1998) that phannacists experience r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no i 55 a moderate level of burnout. daily demands of the job and dealing with patients, the professional role, counter prescribing and time pressures may contribute to emotional exhaustion and depersonalisation. . pharmacists experience a relatively high level of personal accomplishment, with only 36 per cent who experience low to moderate levels of personal accomplishment. in general, they feel that they are able to meet clients' needs and to satisfy essential elements of job performance. gupchup et al. (1998) also found that on the personal accomplishment sub-scale, pharmacists' scores indicated a low level of burnout. the evidence of high personal accomplishment levels seems to correlate with satisfaction reported by pharmacists working in the corporate pharmacy group (rothmann, rothmann, van rensburg & malan, 2000). the sense of coherence of the current sample was found to be above average compared to other samples analysed by rothmann (2000). a strong sense of coherence is promoted by life experiences which are the results of generalised resistance resources (antonovsky, 1987). regarding coping strategies, the current sample was found to score the highest on planning, active coping, positive reinterpretation and turning to religion. they scored the lowest on alcohol-drug disengagement, denial and behavioural disengagement. pharmacists with a strong sense of coherence will experience less burnout. this is so because the stronger the sense of coherence, the greater the tendency to identify the nature of the stressor confronted and select the appropriate resources for the given situation. more specifically, the findings indicate that a weak sense of coherence (and especially manageability) is strongly related to emotional exhaustion. pharmacists who do not experience events in life as manageable, who do not perceive stimuli from the environment as ordered and structured and do not feel that life is making sense tend to experience a reduction in their emotional resources and feel emotionally drained. these components are also related to negative, cynical and insensitive attitudes towards colleagues, clients and/or patients. meaningfulness is most strongly related to personal accomplishment (i.e. a feeling of being able to meet clients' needs and satisfy essential elements of job performance), although total sense of coherence and manageability are also related to personal accomplishment. it is interesting to note that the pharmacists with a strong sense of meaningfulness believe that the professional demands encountered are challenges worthy of investment and management and consequently will feel more accomplishment and less burnout. the results show that a strong sense of coherence is related to constructive coping. it seems that a strong se,nse of coherence is related to the use of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 56 sajems ns vol 5 (2002) no i problem-focused coping strategies such as active coping (taking direct steps to solve problems), planning (thinking about steps to handle stressors) and restraint coping (waiting for the optimal opportunity which will reward appropriate action). a strong sense is positively related to one emotion-focused coping strategy, namely positive reinterpretation. therefore, pharmacists with a strong sense of coherence will tend to accept the reality and manage stress emotions by positive reinterpretation. however, pharmacists with a strong sense of coherence will be less inclined to cope by just expressing their feelings about stressful situations. pharmacists who cope by mentally disengaging themselves from situations experience more emotional exhaustion and depersonalisation. mental disengagement implies that they engage in activities such as excessive sleeping and daydreaming, which divert their attention from stressors. however, by denying the reality of situations, it becomes more difficult to cope with them later on (carver et al., 1989). although other problem-focused coping strategies (e.g. active coping, planning and restraint coping) are negatively related to emotional exhaustion, the obtained effect sizes were small. it is clear that pharmacists who are burned-out cope with stressful events through mental disengagement, but no clear support was found for previous findings (maslacb & jackson, 1982; rowe, 1997; schaufeli & enzmann, 1998) that individuals who use confronting coping strategies experience less burnout. pharmacists who measure high on restraint coping (wait for the optimal opportunity that will reward appropriate action) and positive reinterpretation (accept the reality and manage stress emotions), and low on behavioural disengagement (avoiding problems, losing courage and reacting), tend to experience higher levels of personal accomplishment. they feel able to meet clients' needs and to satisfy essential elements of job performance. these fmdings confinn the results of rowe (1997) that withdrawal coping strategies are related to burnout. the use of a problem-focused strategy may trigger feelings of personal accomplishment, which could explain the relationship of confronting coping with personal accomplishment (lee & ashforth, 1996). the regression formula for predicting emotional exhaustion could be written as follows: emotional exhaustion :: 49.59 o.27(sense of coherence) 1.2 i (denial) + l46(mental disengagement). these variables predict 44 per cent of the variance in emotional exhaustion. the regression formula for predicting depersonalisation could be written as follows: depersonalisation = 17.64 o.08(sense of coherence) 0.36(tuming to religion) o.s6(denial) + o.59(mental disengagement) + 2.96(alcoholr ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 57 drug disengagement). these variables predict 35 per cent of the variance in depersonalisation. the regression formula for predicting personal accomplishment could be written as follows: personal accomplishment = 14.46 + 0.08(sense of coherence) + 1.2 i (positive reinterpretation and growth) 0.76(behavioural disengage-ment). these variables predict 41 per cent of the variance in personal accomplishment. the relationship between coping and burnout should be interpreted carefully for two reasons. firstly, folkman and lazarus (1984) have argued that coping is a state (le. situation specific response) rather than a personality trait that is stable across situations. therefore, correlations between ways of coping and burnout would indicate that burnout is related to particular situations that are perceived as being stressful, which in turn, stimulate. a person to cope in a particular way. secondly, withdrawal from work: or from clients which closely resembles avoidance coping has been regarded as a core symptom of burnout (cherniss, 1980a). depersonalisation is also characterised by behaviour that include mental or behavioural withdrawal (maslach, i 982a ). accordingly, avoidance coping and burnout overlap conceptually. a limitation of this research is that the research design does not allow one to determine the direction of the relationship between the variables. another limitation is that a non-probability sample has been used, which implies that the findings cannot be generalised to other settings. the sample size was also relatively small. also, only self-report measures were used, which may affect the validity of the results. 6 recommendations this study generates several application-oriented suggestions. firstly, the pharmacy group can select individuals who have a strong sense of coherence and constructive coping strategies. however, before the pharmacy group begins selecting pharmacists on the basis of these characteristics, more research is required, especially because these characteristics were not studied in a selection context. secondly, the pharmacy group can contribute to the development of pharmacists' sense of coherence by giving information in a consistent, structured, ordered and understandable format. pharmacists should further be able to identify their roles within the greater whole and as such the comprehensibility component of sense of coherence will be enhanced. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 58 sajems ns vol 5 (2002) no 1 thirdly, by equlppmg pbarmacists with the necessary knowledge, skills, material, instruments and other resources, and by ensuring a balance in the load of tasks to be handled, they will increasingly feel that the work expectations are manageable and within their or important others' power. research indicates that dispositional characteristics that relate to coping styles seem to be subject to change (lachman, 1989). therefore, training and development programmes that are directed at developing sense of coherence and coping with stress should be compiled and evaluated. future research should focus on individual and organisational factors related to the emotional exhaustion, depersonalisation and lack of personal accomplishment of pharmacists in pharmacy groups. research is also needed regarding burnout and its possible correlates in other organisational contexts, such as retail pharmacies and public and private hospitals. in future research, objective measures such as performance appraisals and registered absenteeism 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(1996) handbook of coping: theory, research, applications, new york: wiley. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction literature review data and methods results discussion conclusion acknowledgements references footnotes about the author(s) adam h. viljoen tourism research in economics, environs and society, north-west university, potchefstroom, south africa andrea saayman school of economics, north-west university, potchefstroom, south africa melville saayman tourism research in economics, environs and society, north-west university, potchefstroom, south africa citation viljoen, a.h., saayman, a. & saayman, m., 2019, ‘examining intra-african tourism: a trade theory perspective’, south african journal of economic and management sciences 22(1), a2860. https://doi.org/10.4102/sajems.v22i1.2860 original research examining intra-african tourism: a trade theory perspective adam h. viljoen, andrea saayman, melville saayman received: 26 oct. 2018; accepted: 22 may 2019; published: 22 july 2019 copyright: © 2019. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: around the world, domestic and regional travel is considered the backbone of the tourism industry, with as much as 80% of international visitors within the same region, however, various factors permit or deter tourists to move around freely. the arguments of tourism promoting trade and vice versa, are both valid. since trade can promote tourism in africa it implies that regional integration is necessary to foster regional tourism. aim: this article seeks to determine whether trade theory is able to explain intra-african tourism. this was done by applying four theoretical models of international trade to bilateral african tourism flows. method: using panel data from 25 african countries over a 10-year period, this research shows that intra-african tourism flows can best be explained by the gravity theory. results: cultural and geographic proximity, as well as the development of the destination country, dictates intra-african tourism. additionally, african countries that already have an advantage in worldwide tourism receipts also benefit from intra-african tourism. conclusion: this research contributes to a greater understanding of the determinants that attract african travellers to other african countries, which holds important implications for both policymakers and destination managers. keywords: intra-african tourism; trade theory; heckscher-ohlin model; comparative advantage theory; linder’s hypothesis; gravity model. introduction tourism has long been advocated as an alternative strategy for economic development and social reconstruction, especially in less developed countries (briedenhann & wickens 2004). it has also been identified as a catalyst by the united nations conference of trade and development (unctad 2013), to improve trade and development within regions which, within the african context, can contribute to the african union’s vision of ‘an integrated, prosperous and peaceful africa, driven by its citizens and representing a dynamic force in global arena [sic]’ (african union 2013). africa’s trade pattern is strongly influenced by its past, with the european union (eu25) and the united states (us) being the continent’s main trade partners. the african development bank group (afdb 2016) states that, during 2014, the combined imports from the us and eu25 (54.3%) and exports (46.7%) to the us and eu25 still represented the majority of trade for africa, while intra-african trade (exports plus imports) constituted only 18% of total trade. this is in sharp contrast with the dominant role that intra-regional trade plays in other parts of the world, for example in europe (69%), asia (52%) and north america (50%), as estimated by the world economic forum (wef 2016). the following reasons were identified as impacting negatively on intra-regional trade in africa: high transaction costs, complicated immigration procedures, the limited capacity of border officials, costly import and export policy procedures and a lack of investment in trade associations. these factors not only have a negative effect on regional trade, but also influence regional tourism. africa’s traditional trade partners, usually ex-colonial powers, are being replaced by emerging trade partners like china. in recent times, china has made significant investments into africa by means of trade, specifically imports. it is estimated that imports from china to south africa (brics) are now exceeding us$15 billion or 19%, followed by germany (12%) and a mere 6.7% from the usa (trading economics 2019). contrary to trade between african countries, tourism flows between african countries dominate african outbound tourism. the international air travel association (iata 2014) accounts for 3% of the global air service market, with intra-african tourism, which refers to the tourism activity between various african countries, constituting 70% of total african air service. the united nations world tourism organization (unwto 2013) supports this by stating that 3% of outbound african markets travel internationally. the main recipients of african tourists by air include: south africa, nigeria, namibia, kenya and angola (iata 2014). a review of the literature reveals that there is a growing body of research on african tourism, which necessitates an investigation into the drivers of intra-african tourism – the main destination of african travellers. in 2005, naudé & saayman investigated inbound tourism to africa from various continents using a demand specification and panel data. in 2008, kareem also used a panel data approach to estimate the determinants of aggregate demand for africa as a destination, also using a demand-driven specification. in 2012, du toit and fourie investigated which african countries have a comparative advantage in tourism and the sources of the advantage. fourie and santana-gallego (2013) investigated tourism to africa using a gravity model specification, while more recently viljoen, saayman and saayman (2018) investigated inbound tourism to different african regions. most of the available research only focuses on arrivals to africa, excluding african arrivals, with the research by naudé and saayman (2005) and fourie and santana-gallego (2013) the only exceptions, and no research to date explores the determinants of intra-african tourism comprehensively. research by saayman and saayman (2012) leads one to believe that there might be other reasons why africans travel to other african countries. they show that african tourism to south africa is driven by shopping tourism, which indicates that the traditional pull factors (sun, sea and sand) may not necessarily apply to intra-african travel and fourie and santana-gallego (2013) confirm this. another approach is therefore required and research by santana-gallego et al. (2010), keum (2010), du toit and fourie (2012) signalled an alternative. all these authors applied the principles of trade theory in explaining tourism flows, with santana-gallego et al. (2010) using the gravity model, keum (2010) applying both the gravity model and linder’s hypothesis and du toit and fourie (2012) exploring which african countries have a revealed comparative advantage in tourism and why. the authors mentioned have pioneered the work to use trade theory as a means to explain tourism flows. the aim of this article is therefore to determine whether trade theory is able to explain intra-african tourism patterns. this evaluation is important not only for tourism development on the continent, but also for regional trade facilitation within an intra-regional context (njoloma 2010:17). in addition, projections indicate that improved cross-border policies could eradicate africa’s 400 million unemployed youth (15 to 35 years of age), while increasing global competitiveness and decreasing reliance on western economies (world bank 2012). the remainder of this article is structured as follows: the next section explores the underlying trade theory on which the analysis of intra-african tourism is based. this is followed by a discussion of the data and methods used in the article, before the results of the analysis are presented. thereafter, the results will be discussed before the article concludes. literature review one of the earliest trade theories, the ricardian comparative advantage theory, is based on the differences in labour productivity, while the heckscher-ohlin model (h-o) describes the differences based on factor endowments. both these theories therefore focus on the competitiveness of a country, but from different perspectives. the h-o theory primarily relies on differences in country endowments to explain the international pattern of trade and production (debaere & demiroglu 2003). the most commonly used analogy includes the ratio between capital and labour. when a country is more capital abundant, it will export capital abundant products, while labour abundant countries will export labour abundant products. the h-o model has been applied to many scenarios related to trade, such as demand for skills (michaels 2008), unemployment reduction (dutt, mitra & ranjan 2009) and per capita income (markusen 2013). using both these views in tourism competitiveness implies an analysis of the comparative advantage of destinations, as well as the factor endowments. the balassa index (balassa 1965) computes the revealed comparative advantage as: xij represents exports of sector i from country j (du toit, fourie & trew 2010). however, according to du toit et al. (2010), more precise and consistent comparisons across time, countries and commodities can be made when another method of measurement is used, that is, the normalised revealed comparative advantage (nrca), which is computed as: to test the theory for travel service exports, du toit et al. (2010) hypothesised cross-country differences to reveal comparative advantage as a function of relative resource endowments following the h-o hypothesis. for example, for country i, the comparative advantage in good j is determined by capital (ki), labour (li), natural environment (ni) and a collection of other possible sources (ri), such that: africa is well known for its natural beauty as a drawcard for international tourists. therefore, the natural resource endowments (ni), including aspects such as natural and cultural heritage sites (du toit & fourie 2012), may be the most pertinent for the possible application of the augmented h-o theory in tourism. following the earlier theories of trade, which focused mainly on the production or supply side of the economy, more recent trade theories turned to evaluating trade from a demand perspective. linder’s country similarity model (1961) is driven by two assumptions. firstly, countries will export products that are popular in the domestic market, as manufacturers introduce new products to serve the domestic market so that economies of scale are reached and costs are reduced. secondly, the exported product will be marketed to countries with similar tastes and income levels. linder (1961) states that the framework for the theory is based on understanding which forces contribute to international or inter-regional specialisation and trade patterns. linder (1961) indicates that, due to real-world trade, the patterns of trade could be: (1) to some extent accidental, (2) not particularly unstable and (3) gradually changing over time. the theory provides insight into potential trade as many variables have an influence on actual trade such as the distance factor, transport costs and human-made obstacles (tariffs) that are trade-braking forces (linder 1961). linder (1961) continues that potential trade between countries with similar demand structures (income per capita) would be most intensive. the basic assumption of the gravity model is that a country will experience a higher degree of trade with another country sharing common characteristics. a shorter distance, both geographically and culturally, based on similar language, currency, colonial connections and political history enhances trade. moreover, if the country is rich in resources, as well as being geographically large, enhanced trade will occur compared to countries that do not share the same characteristics (ciuriak & kinjo 2006). the popularity is due to the opportunity to project bilateral trade (egger 2002). the model was developed using newton’s gravitational force theory by walter isard in 1954 and introduced by tinbergen in 1962. the model is based on the following equation (fry 2015): t represents trade flow between two countries (i and j), while y represents the economic mass of two countries, d represents the distance, and a is a constant. therefore, the gravitational force between two countries can be calculated if the object mass (yi yj) and the distance (dij) are known. the application of the model has been widely used in testing international trade patterns, currency unions and border effects (see burger, van oort & linders 2009; carrère 2006; westerlund & wilhelmsson 2011). the gravity model has also been applied to tourism scenarios such as transport infrastructure (khadaroo & seetanah 2008), tourism flows (keum 2010), tourism demand (hanafiah & harun 2010; hanafiah, harun & jamaluddin 2010; leitão 2010; morley, rosselló & santana-gallego 2014), tourism competitiveness (chang & lai 2011; fourie & santana-gallego 2013; fourie, rosselló & santana-gallego 2015; muhammad & andrews 2008; seetanah, durbarry & ragodoo 2010) and tourism and regional integration (saayman, figini & cassella 2016). it is therefore the most widely applied trade theoretical model in the tourism literature and will therefore also form the basis for our modelling approach. data and methods the discussion of the method used in this study focuses on (1) the estimating equation and data used, and (2) the estimation methods. estimating equations and data the baseline estimating equation used in this study follows a typical gravity model specification that has been applied by gil-pareja, llorca-vivero and martínez-serrano (2007), priego, rosselló & santana-gallego (2015), and santana-gallego, ledesma-rodríguez and pérez-rodríguez (2016) within the tourism context: arrivalsijt refers to the number of tourist arrivals from origin country j, to destination country i in year t (sourced from the unwto, available on request only from the unwto), and ln indicates that natural logarithms of the data are used to ensure linearity of the estimated β’s. included in this equation are two measures for mass, namely the gross domestic product (gdp) per capita of the origin and destination countries in constant us dollars as well as the population size of the origin and destination countries sourced from the world bank development indicators (wbdi). furthermore, the distance between the countries is sourced from the centre d’etudes prospectives et d’informations internationales (cepii, available online: http://www.cepii.fr/cepii/en/bdd_modele/bdd.asp) as well as the relative price differences between the destination and origin countries defined as the relative cpi ratio (sourced from the wbdi, available online: https://datacatalog.worldbank.org/dataset/world-development-indicators). cultural proximity between the origin and destination country is controlled by using two variables, namely common coloniser and common language (both from cepii). the former is a dummy variable that takes the value of unity when the countries in question had a common coloniser. the second is also a dummy variable that controls for common ethnic languages spoken in both the origin and the destination country. these variables are associated with stronger social ties between countries, and the expected effect is therefore positive on tourism arrivals between the two countries (saayman et al. 2016). similarly, the typical gravity model controls for common borders, with a dummy variable that takes the value of one when countries share a common border (obtained from cepii). to control for unobserved heterogeneity, country-specific and year-specific fixed effects are included in the estimation, denoted by gi, ƹj and λt. finally, εijt represents a well-behaved error term. this model is referred to as the least-square dummy variable (lsdv) model and is a special case of the panel fixed effect model. the model includes destination and origin dummy variables separately, and therefore it does not control for factors that are common in both countries. the exclusion of bilateral factors that may influence the model is referred to as omitted variable bias. in gravity models, three alternative methods are available in dealing with omitted variable bias, namely: (1) country-pair fixed effects, (2) country-year fixed effects or (3) a multilateral resistance term (gil-pareja et al. 2014). in this research, the multilateral resistance term (mrt), introduced by anderson and van wincoop (2003), is included to control for omitted variable bias. it is a bilateral trade cost measure that is unique to each country and is compiled as follows (saayman et al. 2016): the baseline model is therefore expanded to include the mrt: this specification of the model, therefore, tests the gravity theory and it is expected that the variables measuring mass, that is, population and gdp per capita, will all have positive signs, while the distance variable and the mrt will have negative signs. the gravity specification above was also expanded to test for (1) linder’s hypothesis, (2) ricardian comparative advantage theory and (3) the heckscher-ohlin resource endowment theory. for linder’s hypothesis, the research by keum (2010) and lorde, li and airey (2015) was followed in compiling a linder variable. according to these authors, linder’s hypothesis can be modelled in two ways: (1) the absolute value of the difference between the two countries’ gdp per capita (called linder 1) and (2) the absolute value compiled in (1), but as a ratio of the sum of the gdp per capita of the origin and destination countries (linder 2): the data was obtained from the wbdi. within the african context, it may be argued that gdp per capita is not the only variable to consider when country similarities in taste and preferences are evaluated. therefore, this research also considered differences in the urbanisation rate between african countries as a possible variable that may indicate similarities in taste and preferences between countries. these variables were compiled similarly to the linder variables above, using the urbanisation rate (also available from the wbdi) rather than gdp per capita: in all instances, the sign was expected to be negative, since a smaller difference in gdp per capita or urbanisation rates had been associated with increased tourism between the two countries in question. apart from the inclusion of the linder variables, the gravity model was also expanded to include ricardian comparative advantages. the revealed comparative advantage (rca) and normalised rca (nrca) variables were constructed as indicated in equations 1 and 2. both of these were also included separately into the gravity specification to test for significance to explain tourism flows in africa. in general, these terms were expected to relate positively to tourist arrivals. finally, the heckscher-ohlin theory was tested through the construction of factor endowment differences between countries. firstly, since tourism is a labour-intensive sector, the ratio between the destination and origin population was considered (referred to as pop_difference in the models). secondly, differences in natural resource endowment, on which tourism depends, were considered through the calculation of two proxies, namely the ratio of marine protected areas between the destination and origin country (marine_difference in models), and the ratio of terrestrial protected areas between the destination and the origin countries (terra_difference in models). data for these variables was obtained from the wbdi. it was expected that a larger ratio of endowments would lead to increased tourism flow and therefore a positive sign was expected. the data is summarised in table 1. table 1: results of the gravity model. the data set consists of 251 african countries’ bilateral tourism flows for a period of 10 years (from 2001 to 2010). this provided a panel of 6000 observations. however, tourist arrivals data is not always captured for all countries, given that only the main origin countries are listed separately in the arrivals statistics. the remaining arrivals are often categorised as ‘other african countries’. this created some zeros in the arrivals data, which may indicate either zero arrivals, or very low arrival numbers (not significant enough to list separately). altogether, 3500 of the arrivals data was zero in the panel, which significantly reduces the panel when estimation methods that do not control for missing observations were used. estimating methods the gravity model is estimated using the lsdv method (which is similar to the fixed effect method) that allows the constant or intercept to differ for each cross-section by introducing a dummy variable for each country. this differs from random effects, which assume that differences between cross-sections are not fixed, but random. with random effects, the intercept is estimated as a constant together with a random variable (asteriou & hall 2016). to ensure that the correct specification is used, the hausman test was conducted. the chi-square statistic was 36.91, and the null hypothesis can be rejected with 99% certainty (χ2 = 36.91, p = 0.0013). therefore, the null hypothesis, stating that random effects are consistent and efficient, was rejected, and the remainder of the models were estimated by applying fixed effects (or the lsdv estimator). the occurrence of zero tourism flows presents problems for log-linear estimations, and it is recommended that procedures such as the heckman two-step estimation and the poisson pseudo-maximum likelihood (ppml) estimation should be used to deal with the zero trade matrix to achieve unbiased and consistent estimations (cipollina & salvatici 2010). the ppml method was applied in this research as it addressed the two broad dimensions of problems with gravity model estimation. the first dimension is concerned with the error term, while the second focuses on the degree of model structure. the ppml method is preferred for its robustness in identifying patterns of heteroscedasticity (first dimension errors) and measurement errors (second dimension errors) (fally 2015:76). the ppml estimator therefore provides consistent estimations of the original non-linear model with various beneficial properties, for instance: (1) consistency in the presence of fixed effects (entered as dummy variables in ols), (2) inclusion of observable tourism values that are zero (which is dropped from log-linear ols models), (3) interpretation is closely related to ols; however, the dependent variables in ppml are specified in levels rather than logarithms, while the independent variables are still considered as elasticities (united nations economic and social commission for asia and the pacific 2013). silva and tenreyro (2006) show that the distance coefficient is smaller when estimating gravity models by applying ppml compared to the lsdv approach. in this research study, all estimations were done using stata 14 (statacorp, 2016). ethical consideration this article followed all ethical standards for carrying out research without direct contact with human or animal subjects. results the results of the trade models – that is, the gravity model, linder’s model, rcas, and h-o model – are subsequently discussed. gravity model results the gravity model, as specified in equation 5, was estimated by applying the lsdv approach as well as ppml. with the lsdv approach, the regression was estimated by means of ols, but included both country fixed effects and year fixed effects. the ‘robust’ estimation option was also chosen for more robust standard errors. therefore, the lsdv estimates included all the variables involved in the fixed effect estimation, but also other dummy variables that cannot be estimated through fixed effects. these variables included the cultural and physical proximity dummies specified in equation 5. the results are indicated in column 1 of table 1. furthermore, the robustness of the lsdv estimation was also tested using the ppml estimator (country and year dummy variables were also included in the ppml estimations to control for country differences and business cycle effects). the results are indicated in column 2 of table 1. it is evident from table 1 that the r-squared was very high with more than 85% of the variance explained, as is typical of gravity models. it is also noteworthy that the lsdv estimator uses fewer observations (n) due to the zeros in the tourist arrivals data. this is corrected in the ppml estimations (compare 2280 to 5300 observations), which control for zero observations. because the ppml estimates include the zeros in the estimation, the results differ slightly from those of the lsdv approach. however, it is encouraging to see that although the parameter estimates differ slightly, the nature of the relationship (positive or negative) is not influenced by the estimation method. in general, the results of the gravity model are in line with theory, that is, the mass variables, gdp per capita and total population are positive although only the destination variables are significant. the distance variable is negative and significant in all the estimated results. this confirms the gravity model in explaining tourism flows within the african continent. the results were quite robust and did not change significantly when more dummy variables were added2 or when the ppml estimator was utilised. concerning the other variables, it is evident that the relative price variable is negative in all specifications, but insignificant. the mrt is also very small and insignificant in explaining tourism flows. the dummy variables indicate that sharing a common border has a strong positive and significant influence on tourism between the origin and destination country. likewise, cultural proximity is clearly a significant determinant of tourism, with common ethnic language being positive and significant in the lsdv estimation. the influence of colonisation is also very clear with countries that used to be colonised by the same country experiencing enhanced tourism flows between one another. the results compare well with findings by keum (2010:555), who states that the distance and the economic size between origin and destination are the most important variables for the gravity model. this is confirmed by lorde et al. (2015:8) specifying that destination and origin income, destination population and substitute prices are important variables. this also confirms that the gravity model does well in explaining intra-africa tourism flows. it shows that larger economies in population size, as well as richer economies (in gdp per capita) attract more tourists than smaller and poorer economies do. distance plays a key role, and african tourists tend to travel more to neighbouring countries, countries that were colonised by the same country and where the ethnic language is similar to their own. linder’s hypothesis results to test whether linder’s hypothesis can be used to explain intra-africa tourism, the same gravity model, specified in equation 5, was used and the various linder variables (specified in equations 8–11) were included separately. the results are indicated in table 2. the first four columns (1 to 4) of table 2 indicate the results of the lsdv estimations and the last four columns (5 to 8) the ppml estimations. table 2: results of the linder hypothesis. in general, the results of the models in table 2 echo those of table 1, with destination gdp per capita being positive and significant, and distance negative and significant in all estimations. the dummy variables – common border, common ethnic language and common coloniser – are also still significant in explaining intra-african tourism flows. these variables indicate a reduction in cultural distance, which is associated with increased tourism arrivals (santa-gallego et al. 2016). concerning the linder variables, it is evident that all the linder variables are insignificant, except for the ppml estimation with the ratio of the difference between the urbanisation rates relative to the sum of the urbanisation rate between the origin and destination country. in this instance, the variable is positive and significant at a 5% level. this is contrary to linder’s theory, which predicts that countries with similar characteristics (smaller linder variables) will trade more with one another (travel more to one another). moreover, lorde et al. (2015) also found that the linder variable had an inverse effect on the level of tourism flow relating to per capita consumption and income levels in caribbean countries. however, the similarity between the origin countries’ income and the income of the caribbean region shows a convergence, which might have had an influence on the results. this cannot, however, be used as an explanation within the african context. since linder 1 and linder 2 are positive, it indicates that large differences exist between countries’ demand characteristics and tourism arrivals (keum 2010). this is also supported by the positive and significant linder 4, which addresses the absolute value of urbanisation as a ratio of the sum of urbanisation rate. it indicates that less urbanised countries tend to travel to more urbanised countries, and vice versa. both keum (2010) and lorde et al. (2015) revealed that linder’s hypothesis does not explain tourism flows, and this study confirms the same results for africa. revealed comparative advantage results the rca and nrca for every african country were calculated according to equation 1 and equation 2. the calculation involved using tourism receipts and export data from the wbdi database. it therefore represents not only african receipts from tourism, but total tourism receipts from all international tourist arrivals. table 3 presents the results for the gravity model specification augmented with the rca and the nrca separately. table 3: revealed comparative advantage results. the results in table 3 confirm the results of the previous models in terms of the gravity specification, with destination gdp per capita and population variables as positive and significant determinants of tourism arrivals. the distance result is again negatively related to tourism arrivals, while the common country characteristics were positive and significant, similar to the previous modelling results. the rca is positive, as expected, but insignificant, while the nrca is positive and significant for both least-square dummy variable (ldsv) and ppml estimations. the rca results imply that countries that show an rca for worldwide tourism receipts also benefit most from african tourism. however, the nrca results indicate that the combination of capital, labour, natural resources and other resources has a positive and significant influence on arrivals, especially when the model is estimated using lsdv. this implies that countries endowed with more natural resources will increase the relative or comparative advantage in exporting tourism services, because nrca is a function of capital, labour, natural environment and a collection of vectors of other possible sources (du toit et al. 2010:8). to explore this in more detail, the next set of results reports the h-o variables. the heckscher-ohlin results the h-o variables are calculated using the factor endowment differences between countries. for every destination and origin country population difference (as a proxy for available labour work force), pop_difference, is determined. for the differences in natural resource endowments between destination and origin country, both the terrestrial protected area and marine protected area between the two countries, specified as terra_difference and marine_difference, are used. these variables were included in the basic gravity specification and the results are shown in table 4. table 4: heckscher-ohlin results. the results in table 4 show that the basic gravity variables are still significant, especially with regard to gdp per capita, population, distance and common characteristics. the inclusion of the h-o variables therefore does not influence the main gravity results, indicating robustness. differences in factor endowments, expressed as population differences (pop_difference), ratio of marine protected areas (marine_difference) and ratio of terrestrial protected areas (terra_difference) were included separately in the estimations. a larger difference implies large differences in endowments and therefore a positive sign was expected, which would signify increased tourism flows. the results indicate that terra_difference in the lsdv estimation is positive, but not significant, and negative in the ppml estimation. the remaining variables (pop_difference and marine_difference) are both negative, but pop_difference is significant in lsdv, and marine_difference is significant in both estimations. the results are contrary to expectations and indicate that tourism resource endowment may not be a driver for intra-african tourism. this confirms the notion that african tourists’ travel patterns are less reliant on natural tourism resources of other african countries, and by preference more dependent on cultural and geographical proximity as well as the development of the destination country. discussion does trade theory explain intra-african tourism patterns? the results from the analyses do indeed suggest that tourism flows in africa follow the predictions of trade theoretical models. more specifically, intra-african tourism is consistent with the predictions of the gravity model and there is also some support for specialisation in tourism, as indicated by the revealed comparative advantage theory. the following findings and implications are based on the research results: firstly, the gravity model offers a robust explanation for tourism patterns in africa. the results show that larger and more developed african destinations (measured by total population and gdp per capita) benefit most from african tourism. this result can be explained when the research by saayman and saayman (2012) on african tourism to south africa is considered, which indicates that a large portion of african travel is for shopping purposes. larger, more developed countries offer access to goods and services that cannot be found in the african traveller’s home country. the gravity model results also show that distance between countries plays a key role, with african tourists preferring to travel to destinations closer to their own country. this result is also evident in the significance of the common border dummy variable in all the specifications. the reasons african travellers choose closer destinations may be influenced by (1) travel cost in africa and (2) accessibility of african countries for african travellers; for example, two-thirds of africans travelling within africa are obligated to apply for visas (afdb 2014:10). the third finding from the gravity model results is that decreased cultural distance between countries, as measured by the common ethnic language and common coloniser dummy variables, contributed to increased arrivals. regional economic integration could possibly lead to enhanced competitiveness, prevent conflicts and consolidate economic and social reforms. this is especially true for countries that share common ethnic languages, a common coloniser or common borders, as the cultural distance is not a deterrent. the higher degree of integration makes it possible for trade and tourism to flourish, and subsequently leads to enhanced economic activity and growth for the region. linder’s hypothesis implies that countries with similar demand structures will trade more with and travel more to one another. however, the results for intra-african tourism do not confirm this notion. they indicate that countries with different demand structures experience increased tourism flows. larger african economies that are better developed and more urbanised attract more african arrivals. this result again confirms the notion by saayman and saayman (2012) that african tourists travel predominantly for shopping purposes. the insignificance of most of the linder variables also confirms research by keum (2010), who found that linder’s model also does not explain asian travel patterns. the results of the rca and nrca indicate that countries that have a rca in tourism, that is, ratio of tourism export receipts compared to total export receipts, are not only benefiting from international tourism, but are also more popular destinations for african tourists. these tourism-oriented countries are successful due to the existing tourism infrastructure, which shows the importance of a clear focus on tourism development. however, while du toit and fourie (2010) found that the rca is mainly because of the natural and cultural heritage of various african countries, the h-o results in this study show that resource endowment differences (terra_difference and marine_difference) between african countries do not dictate african tourism flows. in fact, tourism flows are greater for countries with similar tourism resources. this again highlights that a large portion of african travel is not driven by typical tourism attractions, such as sightseeing, sun, sea, sand or safaris. conclusion intra-african travel has, to date, received little empirical investigation, although the majority of african outbound travel is to other african countries. the continent is therefore the main destination for african tourists. since african tourism does not seem to follow the same trends as international travel does, the aim of this article was to determine whether trade theory is able to explain intra-african tourism patterns. using bilateral tourism flows from 25 african countries over a 10-year period, this research shows that african tourism flows are consistent with the gravity theory. this implies that distance is a key determinant of african tourism, as well as the size and level of development of the destination and the cultural proximity of the origin and destination countries. little support could be found for the statistical significance of the other trade theories in explaining african travel patterns. this research contributes to a greater understanding of the determinants that attract african travellers to other african countries. it is clear that the reasons international tourists travel to africa – for safari, culture, sun, sea and sand – are not the main driving forces of intra-african tourism. the results rather indicate that african tourists travel more to larger, developed african countries that are close to their country (in the geographical as well as the cultural sense) and therefore the notion that a large portion of african travel is for shopping purposes is supported. this holds important implications for policymakers as well as tourism destination managers. policies to promote inter-regional travel and movement of goods (i.e. regional economic integration) would therefore facilitate tourism growth. this implies improved accessibility in terms of lower visa restrictions as well as better transport infrastructure. it is also important for tourism destination managers to recognise that african tourists travelling to their countries are from countries with similar tourism resources (protected and marine areas) and would therefore not necessarily be interested in these tourism products. the preference might therefore be for more urban tourism products. while the research explored intra-african tourism, future research should expand the model to include a more comprehensive set of countries, including non-african countries, and to distinguish between different reasons for travel, such as visiting friends and family, business or holiday. furthermore, it would be worthwhile to determine the effect that different types of trade agreements in africa have on bilateral tourism flows. acknowledgements the authors would like to thank the united nations world tourism organization for granting access to the travel data used in this article. competing interests the authors have declared that no competing interest exist. author’s contributions a.h.v. was responsible for overall article layout, 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gravity model without gravity using panel data’, applied economics 43(6), 641–649. https://doi.org/10.1080/00036840802599784 world bank, 2012, let africa trade with africa, viewed 05 may 2016, from http://www.worldbank.org/en/news/video/2012/02/01/let-africa-trade-with-africa. world economic forum, 2016, africa needs to trade with itself – here’s how, viewed 18 november 2016, from https://www.weforum.org/agenda/2016/04/africa-needs-to-trade-with-itself/. footnotes 1. algeria; egypt; morocco; tunisia; burundi; ethiopia; kenya; mauritius; seychelles; tanzania; uganda; benin; the gambia; niger; nigeria; sierra leone; angola; central african republic; zambia; south africa; lesotho; madagascar; malawi; mozambique; namibia. 2. more detailed results available from the authors on request abstract introduction literature review method results discussion conclusion acknowledgements references about the author(s) xander van lill department of industrial psychology and people management, university of johannesburg, johannesburg, south africa gerhard roodt department of industrial psychology and people management, university of johannesburg, johannesburg, south africa gideon p. de bruin department of industrial psychology, stellenbosch university, stellenbosch, south africa citation van lill, x., roodt, g. & de bruin, g.p., 2020, ‘the relationship between managers’ goal-setting styles and subordinates’ goal commitment’, south african journal of economic and management sciences 23(1), a3601. https://doi.org/10.4102/sajems.v23i1.3601 original research the relationship between managers’ goal-setting styles and subordinates’ goal commitment xander van lill, gerhard roodt, gideon p. de bruin received: 07 mar. 2020; accepted: 19 sept. 2020; published: 02 nov. 2020 copyright: © 2020. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: convincing employees to set aside their self-interests and commit to collective goals is essential for the effective functioning of organisations. it is critical that the impact of different managerial goal-setting styles, and the associated impressions of fair interpersonal treatment in the workplace, is understood from subordinates’ perspective. this might clarify the psychological mechanisms involved in motivating subordinates to commit to organisational goals. aim: the primary aim of this article is to determine the relationship between managers’ goal-setting styles and subordinates’ goal commitment. the secondary aim is to determine whether this relationship is mediated by interactional justice. setting: a total of 451 working adults completed an online or paper-and-pen survey. methods: a mediator model was conducted in structural equation modelling with maximum likelihood estimation and bollen-stine bootstrapping, with 5000 bootstrap resamples, to test the hypotheses. results: the perception that managers are deliberative had the greatest positive direct relationship with subordinates’ goal commitment, followed by the directive style. subordinates’ perception of managers as complaisant, in turn, were unrelated to goal commitment (amotivational), whereas the perception of managers as hostile had a negative relationship with goal commitment. informational justice, not interpersonal justice, emerged as the only mediating variable. conclusion: managers should be encouraged to actively seek feedback from subordinates on their goal-setting styles. managers can accordingly adapt their behaviour to effectively motivate subordinates to commit to organisational goals. keywords: work motivation; goal-setting styles; supervisor-focused interactional justice; goal commitment. introduction a motivated workforce is central to the performance and, therefore, the competitiveness of any organisation in the global economy (campbell & wiernik 2015; van iddekinge et al. 2018). although motivation is strongly related to work performance (schmidt, beck & gillespie 2013; van iddekinge et al. 2018), a study conducted by gallup (2017) indicated that only 15% of employees in 155 countries were highly involved in and enthusiastic about their work. continued research into cognitive factors that motivate employees to make constructive contributions is critical to achieving success in the present-day workplace. the study under discussion attempts to create a framework that highlights the importance of subordinates’ social perceptions of managers’ styles during goal setting on subordinates’ commitment to goals. the term social perception refers to the cognitive schemas employees instinctively use when making sense of and reacting to behaviours of others in the workplace (cuddy, glick & beninger 2011; fiske 1993). goal setting, in the study under discussion, is defined as the social exchanges between managers and subordinates when determining the aim of their collective actions (locke & latham 2013). managers were defined as persons in positions of authority who, in part, must motivate subordinates to set aside self-interests and commit to collective goals (hogan & sherman 2020). if managers can motivate subordinates to commit to goals, employees’ collective actions can be directed towards important and practically relevant organisational outcomes with greater intensity and persistence (meyer 2014; meyer, becker & vandenberghe 2004). subordinates’ commitment to goals is, therefore, instrumental to organisational performance (locke & latham 2013; piccolo & buengeler 2013), but, to date, limited attention has been paid to the impact of subordinates’ social perceptions of managers’ styles on their goal commitment. the primary aim of the present study was to investigate the relationship between subordinates’ perceptions of managers’ goal-setting styles and subordinates’ goal commitment. the secondary aim of the present study was to determine whether an additional layer of social perception, namely supervisor-focused interactional justice, mediates the relationship between subordinates’ initial impressions of managers’ goal-setting styles and subordinates’ subsequent goal commitment. literature review the central aim of the current study was to determine the relationship between managers’ goal-setting styles and subordinates’ goal commitment. goal commitment can be viewed as an important benchmark against which the effectiveness of managers’ attempts to motivate subordinates through goal setting is measured (piccolo & buengler 2013). an orientation to conceptualise goal commitment will follow. subordinates’ goal commitment even though consensus exists among scholars about the importance of a committed workforce for the performance of an organisation, there is disagreement about its conceptualisation (klein, molloy & brinsfield 2012; meyer 2014). roodt (2004) argues that the lack of conceptual clarity could be attributed to the haphazard way in which research on commitment evolved. disagreement exists as to whether the experience of commitment can be described as cognitive (positive expectations of goals’ attractiveness and attainability), affective (positive emotions such as satisfaction with goals), volitional (wilful dedication to goals), conative (intentions to work hard to implement goals), or inclusive of all four psychological constructs (klein et al. 2012; roodt 2004). a study conducted by van lill, roodt and de bruin (2020) provides evidence that goal commitment could be viewed as a hierarchical model with a strong unidimensional factor, which consists of cognitive, emotional, volitional and conative dimensions. the general factor of commitment is theorised to be an intrinsically motivated bond with a goal (klein et al. 2012), which influences the direction, intensity and persistence of subordinates’ efforts at work (meyer 2014). following prior studies, goal commitment was used as the benchmark in the present study to investigate the effectiveness with which different goal-setting styles motivate subordinates to pursue and implement goals (piccolo & buengler 2013). however, in contrast to prior studies, goal commitment was measured as a hierarchical factor which is inclusive of a cognitive, affective, volitional and conative factor. managers’ goal-setting styles house and mitchell’s (1975) path-goal theory is the only framework that explicitly addresses the different styles that managers adopt during goal setting to motivate subordinates to pursue goals (piccolo & buengler 2013). few, if any, alternative frameworks of managers’ goal-setting styles, with the necessary empirical support, since 1975 could be identified. an alternative framework that accounts for key evidence in the preceding 50 years of goal-setting literature might provide a new perspective and advance scientific literature (locke & latham 2019). two constructs measured by latham, erez and locke (1988), namely participative goal setting and goal rationales, provide axes around which an alternative and coherent theory of managers’ goal-setting styles can be formulated. however, as portrayed in figure 1, the constructs are reformulated in the present study to reflect universal dimensions on which subordinates form social impressions of managers (cuddy et al. 2011; rosenberg, nelson & vivekananthan 1968). subsequently, goal rationale is reformulated as intellectual competence, which reflects managers’ ability to persuade others to pursue collective goals by using convincing rationales in support of the importance and practicality of the proposed goals (cuddy et al. 2011; latham et al. 1988; rosenberg et al. 1968; yukl, kim & chavez 1999). participative goal setting, in turn, is reformulated as warmth, which refers to the degree to which managers are concerned about others’ well-being and their respectfulness towards alternative views or concerns raised while setting goals (falbe & yukl 1992; house & mitchell 1975; latham et al. 1988; rooney & gottlieb 2007). intellectual carelessness and coldness anchor the intellectual competence and warmth dimensions on the opposite ends of the axes. intellectual carelessness occurs when managers set goals impulsively, with little thought given to the importance or practical implications of goals (de vries 2018; shaw, erickson & harvey 2011). a perception of coldness is created by managers who are overly critical and discourage others from participating in goal setting (de vries 2018; rooney & gottlieb 2007). figure 1: taxonomy of managers’ goal-setting styles. four goal-setting styles are inferred from the two theoretical axes, which are argued to have weak or strong relationships with intellectual competence, warmth, intellectual carelessness and coldness depending on the constructs’ relative locations in figure 1. the four styles inferred from the two axes are: deliberative, directive, complaisant and hostile. deliberative managers are perceived as persons in positions of authority who encourage democratic forms of goal setting, by thoughtfully engaging subordinates in critical discussions, to set goals that are meaningful and practical (gastil 1994; van lill, roodt & de bruin 2019). the view that managers are intellectually competent could emerge when managers provide new insight about the meaningfulness or practical relevance of goals when deliberating with subordinates (schneiderhan & khan 2008; van lill et al. 2019). the impression that deliberative managers exchange relevant information, and invite and carefully consider alternative views, could simultaneously increase the sense that managers are warm (redeker et al. 2014; schneiderhan & khan 2008; van lill et al. 2019). directive managers are perceived by subordinates as forceful persons in positions of authority who set goals with assertiveness, conviction and a determination to achieve set standards and follow procedures (redeker et al. 2014; schriesheim & kerr 1974). anderson and kilduff (2009) posit that dominance is strongly associated with indicators of intellectual competence, such as the ability to persuade others. however, subordinates who perceive their managers as decisive and unbending in convictions about assigned goals might also believe that subordinates’ views and concerns are disregarded (gagné & deci 2005; rooney & gottlieb 2007), reducing managers’ perceived warmth (cuddy et al. 2011; redeker et al. 2014). subordinates who perceive managers as complaisant might believe that managers are willing to compromise organisational goals to accommodate subordinates (einarsen, aasland & skogstad 2007) and, consequently, the style is associated with greater warmth (cuddy et al. 2011; redeker et al. 2014). a perception of managers as complaisant might, however, be associated with an ineffectiveness to rise above individual concerns and set broader strategic goals (einarsen et al. 2007). the perception that managers are less attentive to broader strategic matters might lead subordinates to believe that managers are intellectually careless (einarsen et al. 2007; van lill et al. 2019). hostile managers are, in subordinates’ view, destructive persons in positions of authority who actively undermine subordinates’ attempts to reason and misrepresent facts to support assigned goals (duffy, ganster & pagon 2002; rooney & gottlieb 2007; shaw et al. 2011). perception of managers as individuals who ridicule subordinates’ views while misrepresenting facts to persuade others might cause subordinates to believe that these managers are higher in intellectual carelessness and coldness (cuddy et al. 2011; de vries 2018; rooney & gottlieb 2007). relationships between goal-setting styles and goal commitment each goal-setting style is hypothesised to have a different relationship with goal commitment depending on its relative location in figure 1. however, this relationship is argued to be dependent on an additional social layer of interpretation that subordinates use to make sense of their exchanges with managers when setting goals (cropanzano et al. 2017), namely supervisor-focused interactional justice. supervisor-focused interactional justice refers to the perceived fairness of interpersonal treatment received from managers (bies 2015), which in the current study is argued to be influenced by subordinates’ perceptions of managers’ relative standing on intellectual competence and warmth during goal setting. greenberg (2009) differentiates between two concepts of interactional justice, namely interpersonal and informational justice. when managers provide clear rationales for goals (intellectual competence), subordinates are theorised to experience a deeper sense of being treated with sincerity and honesty and, therefore, attribute supervisor-focused informational justice to the goal-setting style (bies 2015; greenberg 2009). when managers are perceived to be considerate of alternative views or concerns about goals (warmth), subordinates are theorised to experience a greater sense of being treated with dignity and respect (bies 2015; greenberg 2009) and, therefore, attribute supervisor-focused interpersonal justice to the goal-setting style. relationship between the deliberative style and goal commitment managers who insightfully engage in critical discussions about the meaningfulness and practicality of goals are theorised to increase subordinates’ positive expectancies, intentions to implement and, therefore, commitment to goals (van lill et al. 2019; vroom 1964; yukl et al. 1999). subordinates’ impression that managers exchange relevant information, and invite and carefully consider alternative views (warmth) could further increase subordinates’ sense of self-determination, positive emotions about, internal dedication and, therefore, commitment to goals (deci, olafson & ryan 2017; gagné & deci 2005; redeker et al. 2014; van lill et al. 2019). considering the deliberative styles’ higher standing on both intellectual competence and warmth, it is hypothesised that: h1a: the deliberative style has the strongest positive relationship with goal commitment. the mediation of the relationship between a deliberative style and goal commitment by informational and interpersonal justice subordinates are likely to experience a greater sense of honesty and dignity when managers share relevant information and thoughtfully engage subordinates in discussions about the meaningfulness and practicality of goals (cropanzano et al. 2017). an increase in the experience of honesty (informational justice) and dignity (interpersonal justice) is, in turn, argued to increase subordinates’ willingness to reciprocate managers’ fair interpersonal treatment by committing to goals (colquitt et al. 2013; cropanzano et al. 2017). against this background, it is hypothesised that: h1b: supervisor-focused informational and interpersonal justice will mediate the positive relationship between the deliberative style and goal commitment. relationship between the directive style and goal commitment subordinates might associate the dominant characteristics of a directive style with greater competence, which could increase subordinates’ positive expectancies of, intentions to implement and, therefore, commitment to goals (anderson & kilduff 2009; van lill et al. 2019). however, subordinates might also experience managers’ unbending conviction about assigned goals as a disregard for others’ views (coldness). this disregard could decrease subordinates’ sense of self-determination, positive emotions about and internal dedication to goals, and, therefore, reduce the intensity of subordinates’ commitment to goals (deci et al. 2017; gagné & deci 2005; van lill et al. 2019). considering this background, it is hypothesised that: h2a: the directive style has a positive relationship with goal commitment, albeit with a weaker relationship than the deliberative style. the mediation of the relationship between a directive style and goal commitment by informational and interpersonal justice managers who are decisive, confident and clear about their expectations might be viewed as honest and thorough in their explanations of goals. subordinates could, as a result, commit to goals as a social exchange for what is perceived to be supervisor-focused informational justice (colquitt et al. 2013; cropanzano et al. 2017). however, subordinates are less likely to attribute interpersonal justice to directive managers because of disregard for alternative views and concerns about goals. on that premise, it is hypothesised that: h2b: supervisor-focused informational justice, but not interpersonal justice, will mediate the positive relationship between the directive style and goal commitment. relationship between the complaisant style and goal commitment a perception of managers as complaisant might be associated with an ineffectiveness to rise above individual concerns and set broader strategic goals and, therefore, reduce positive expectancies of and the intention to implement goals (einarsen et al. 2007). even if managers’ complaisance is perceived to be a sincere attempt to maintain warm relationships and allow any person to take control of the goal-setting process (cuddy et al. 2011; redeker et al. 2012), the perception that managers are less attentive to broader strategic matters might render subordinates emotionally unaffected, undedicated (deci et al. 2017; gagné & deci 2005; redeker et al. 2012; van lill et al. 2019) and more attuned to other role players who are perceived to be more deliberate when setting goals (einarsen et al. 2007; latham et al. 1988; van lill et al. 2019). it is accordingly hypothesised that: h3a: a complaisant style has a negligible relationship with goal commitment. the mediation of the relationship between a complaisant style and goal commitment by informational and interpersonal justice managers who are perceived as easily manipulated might also be viewed as less capable of maintaining subordinates’ dignity or upholding the truth when it is socially inconvenient to do so (einarsen et al. 2007; van lill et al. 2019). when managers are viewed as ineffectual in upholding interpersonal and informational justice, subordinates might also be unmotivated to commit to goals. against this background, it is hypothesised that: h3b: neither supervisor-focused informational nor interpersonal justice will mediate the relationship between a complaisant style and goal commitment. relationship between the hostile style and goal commitment the belief that hostile managers are intellectually careless is theorised to erode subordinates’ positive expectancies of, intentions to implement, and, therefore, increase the likelihood to withhold commitment to goals (van lill et al. 2019; vroom 1964; yukl et al. 1999). the view that hostile managers are disregardful could further increase a sense of external tyranny that might erode positive emotions about, increase an internal opposition to and also enhance the likelihood that subordinates will withhold goal commitment (gagné & deci 2005; redeker et al. 2014; van lill et al. 2019). it is accordingly hypothesised that: h4a: the hostile style has the strongest negative relationship with goal commitment. the mediation of the relationship between a hostile style and goal commitment by informational and interpersonal justice subordinates are less likely to attribute informational justice (honesty and thoroughness) to managers who misrepresent facts (or display dishonesty) to motivate others to pursue assigned goals. managers who further undermine subordinates’ ability to reason during goal setting are also likely to decrease subordinates’ perceptions of being treated with dignity and respect (tepper 2000). subordinates might withhold their commitment to goals as a psychological form of retribution to restore a psychological imbalance caused by supervisor-focused informational and interpersonal injustice (colquitt et al. 2013; colquitt & zipay 2015; cropanzano et al. 2017). it is accordingly hypothesised that: h4b: supervisor-focused informational and interpersonal justice will mediate the negative relationship between a hostile style and goal commitment. method subordinates’ cognitive schema of their managers’ goal-setting styles, as well as their willingness to commit to goals, were central to this study, which could not be investigated from other stakeholders’ points of view (spector 2019). furthermore, a measurement of subordinates’ cognitive schemas at different time intervals might have introduced extraneous variables into the design (spector 2019). a cross-sectional design was selected to explore the multifaceted nature of the subjective ways in which subordinates make sense of and react to their managers’ goal-setting styles at one point in time (pierce & aguinis 2003; spector 2019). setting the respondents were 451 working adults aged 18 and older who had at least a grade 12 education, a satisfactory english reading ability and who reported to a manager in their work setting. to achieve generalisability of results, 17 organisations across various sectors and industries were targeted for participation in an online or paper-based survey. respondents were drawn from six participating organisations that represented the industries of agriculture, finance, manufacturing, science, human health and transport. a total of 77% of the respondents were non-managerial employees, while 23% were managers; 36% had a university qualification and 64% held grade 12 (matric) or a diploma. instruments a five-point intensity rating scale was employed for all the items (zikmund et al. 2010). verbal anchors were used to define extreme points at both ends of the scale (zikmund et al. 2010). goal-setting styles the deliberative scale (e.g. ‘how keen is your manager to clarify uncertainties, regarding proposed goals, through mutual reasoning?’), directive scale (e.g. ‘how assertively does your manager communicate his/her expectations for assigned goals?’) and hostile scale (e.g. ‘how prone is your manager to undermine subordinates’ attempts to reason about assigned goals?’) each consisted of six items. the complaisant scale (e.g. ‘how willing is your manager to sacrifice organisational requirements to promote subordinates’ interests when setting proposed goals?’) consisted of four items. the internal consistency reliabilities of all the goal-setting style scales were satisfactory (cronbach’s alpha and mcdonald’s omega ≥ 0.71). social perception the intellectual competence scale (e.g. ‘how clearly does your manager explain why proposed goals are necessary?’), warmth scale (e.g. ‘how concerned is your manager with the impact that proposed goals may have on subordinates’ welfare?’), intellectual carelessness scale (e.g. ‘how impulsively (irrationally) does your manager set goals?’) and coldness scale (e.g. ‘how disregardful is your manager about the impact, whether positive or negative, of assigned goals on subordinates?’) each consisted of six items. the internal consistency reliabilities of all the social perception scales were satisfactory (cronbach’s alpha and mcdonald’s omega ≥ 0.93). supervisor-focused interactional justice an adapted version of colquitt and rodell’s (2015) justice measure, with the supervisor as focus, was administered. respondents had to rate their perceptions of managers’ fairness on the interpersonal justice scale (e.g. ‘how politely does your manager treat you?’) and the informational justice scale (e.g. ‘how honest is your manager when communicating?’). the interpersonal and informational justice scales consist of four and five items respectively. the internal consistency reliabilities of all the supervisor-focused justice scales were satisfactory (cronbach’s alpha and mcdonald’s omega ≥ 0.93). goal commitment three items were developed for each of the scales measuring the first-order factors of goal commitment: cognitive commitment (e.g. ‘how reachable are goals set by your manager?’), affective commitment (e.g. ‘how satisfied are you with goals set by your manager?’), volitional commitment (e.g. ‘how dedicated are you to goals set by your manager?’) and commitment intentions (e.g. ‘how willing are you to put forth a great deal of effort, beyond what normally is required, to achieve goals set by your manager?’). the internal consistency reliabilities of all the goal commitment scales were satisfactory (cronbach’s alpha and mcdonald’s omega ≥ 0.95). procedure access to organisations in gauteng was obtained by approaching executives or human resource practitioners within the organisations. the questionnaires were administered using an online platform or a paper-and-pencil version of the survey. to prevent non-responses, which posed a threat to the external validity of the survey administrated using the online platform, frequent reminders were sent to encourage participation. to prevent missing responses, which posed a threat to the external validity of the paper-and-pencil survey, respondents’ questionnaires were inspected upon submission. ethical consideration the study was low in risk, but precautions were taken to ensure that participation was voluntary and anonymous, that no harm was caused, that the questions were completed truthfully and that informed consent had been given to use the results for purposes of research. ethical approval for the research project was obtained from the research ethics committee, college of business and economics, university of johannesburg. fom2016-ippm02, 14 april 2016. analysis as a preliminary step in investigating each research hypothesis, the multivariate skewness and kurtosis, inter-factor correlations, factor regressions, mean, standard deviation and inter-item reliabilities of each scale were inspected. inter-factor correlations and factor regressions were inspected by conducting structural equation modelling (sem) with robust maximum likelihood estimation (mlm) (li 2016). fit, based on absolute indices, was considered suitable if the root mean square error of approximation (rmsea) and standardised root mean residual (srmr) were 0.08 or lower (brown 2006; browne & cudeck 1992). fit, based on comparative indices, was considered suitable if the comparative fit index (cfi) and tucker–lewis index (tli) were 0.90 or higher (brown 2006; hu & bentler 1999). a parallel multiple mediation model was inspected by conducting sem using version 0.6-4 of the lavaan package in r (rosseel 2012; rosseel & jorgensen 2018) to examine h1a, h2a, h3a, h4a, h1b, h2b, h3b and h4b. model parameters were obtained by conducting sem with ml and bollen-stine bootstrapping with 5000 bootstrap resamples (bollen & stine 1992; finney & distefano 2006; hayes 2018). hayes’s (2018) guidelines were followed to specify the paths between the latent variables, and to calculate the direct, indirect, indirect total and total effects. as recommended by baron and kenny (1986), the products of paths relevant to h1b to h4b (a*b) were calculated to inspect the hypothesised multiple mediator model. the indirect effects were interpreted in line with the squared values in cohen’s (1988) guidelines (kenny 2018; shrout & bolger 2002). an effect size of 0.01 to 0.09 was interpreted as small, 0.09 to 0.25 was interpreted as moderate, and 0.25 to 1 was interpreted as large (cohen 1988; kenny 2018; shrout & bolger 2002). results descriptive statistics mardia’s multivariate skewness and kurtosis coefficients for the entire set of 72 items (manifest variables) were 99 332.88 (p < 0.05) and 117.73 (p < 0.05), which provided justification for the use of more robust estimation techniques. the standardised inter-factor correlations are reported in table 1, with the mean, standard deviation and internal consistency reliability of each variable in the last four rows. the models specified to determine the inter-factor correlations yielded satisfactory fit (χ2 [df] = 1567.44 [835]; cfi = 0.94; tli = 0.94; srmr = 0.06; rmsea = 0.05). table 1: inter-factor correlations of the goal-setting scales. the internal consistency reliability of each of the scales in table 1 was satisfactory (α and ω ≥ 0.71). the size of the correlations between the factors pointed towards the order in which the styles were expected to be related to informational justice, interpersonal justice and goal commitment. the deliberative style had the highest positive correlation with informational justice, interpersonal justice and goal commitment. the directive style also had a positive relationship with informational justice, interpersonal justice and goal commitment, albeit smaller than the deliberative style. even though the complaisant style had positive relationships with informational justice, interpersonal justice and goal commitment, the size of these relationships was small. per the predictive hypotheses, the hostile style had negative relationships with informational justice, interpersonal justice and goal commitment. the inter-factor correlations merited a further investigation into the predictive validity of different goal-setting styles for goal commitment. relationship between goal-setting styles and social perceptions the central aim of the current study is to investigate the relationship between managers’ goal-setting styles and subordinates’ goal commitment. evidence in support of the cognitive schema that subordinates use to make sense of different goal-setting styles, as proposed in figure 1, assists in validating the framework used to explain the relationships between goal-setting styles and goal commitment. the relative standing of goal-setting styles was tested by regressing the four goal-setting styles on four different social perceptions, namely intellectual competence, warmth, intellectual carelessness and coldness, simultaneously. the standardised factor regressions are reported in table 2, with the mean and standard deviation of the social perceptions in the last two rows. the model specified to determine the factor regressions (χ2 [df] = 1602.29 [961]; cfi = 0.96; tli = 0.95; srmr = 0.05; rmsea = 0.05) yielded satisfactory fit. the internal consistency reliability coefficients of the social perception scales are also provided in the last two rows of table 2. table 2: factor regressions of goal-setting styles scales on social perception scales. the internal consistency reliability of each of the scales in table 2 was satisfactory (α and ω ≥ 0.93). the factor regressions indicate that the deliberative style had the strongest positive relationship with intellectual competence and warmth. the directive style had a small positive relationship with intellectual competence but was not positively related to coldness. evidence, at this juncture, suggests that directive managers might simply be unsuccessful at increasing perceptions of warmth among subordinates. a small positive relationship was found between the complaisant style and intellectual carelessness and warmth. the hostile style had a positive relationship with intellectual carelessness and coldness. most of the styles’ associations with social perceptions, apart from the directive style’s relationship with coldness, confirmed the relative location of goal-setting styles in figure 1. given the evidence in support of the location of goal-setting styles in figure 1, the next step was to test the predictive hypotheses. parallel multiple mediator model before the relationships in h1 to h4 could be inspected, the fit statistics of the parallel multiple mediator model had to be evaluated. the fit statistics for the model (χ2 [df] = 2252.66 [836]; cfi = 0.92; tli = 0.92; srmr = 0.07; rmsea = 0.06) were satisfactory. two alternative models to figure 2 were specified, to inspect the viability of other explanations for the relationship between the observed and latent variables. firstly, due to the high inter-factor correlations between the deliberative style, the directive style, interpersonal justice and informational justice (see table 1), the measurement variables of all the factors were loaded on a unidimensional factor called the constructive approach to goal setting. the direct relationship between the constructive approach, hostile style, as well as the complaisant style, and goal commitment was, in turn, determined. however, the fit statistics for the model (χ2 [df] = 4508.16 [850]; cfi = 0.80; tli = 0.79; srmr = 0.08; rmsea = 0.10) were unsatisfactory. secondly, the mediation of interactional justice (a unidimensional factor containing items from both informational and interpersonal justice) on the relationship between goal-setting styles and goal commitment was specified. this model also did not yield satisfactory fit with the observed data (χ2 [df] = 3015.43 [841]; cfi = 0.88; tli = 0.87; srmr = 0.07; rmsea = 0.08). after establishing model fit, path coefficients were inspected to obtain a detailed understanding of the coefficients on which direct and indirect relationships between goal-setting styles and goal commitment were calculated, which are reported in figure 2. figure 2: the direct and indirect relationships between goal-setting styles and goal commitment. direct relationships between goal-setting styles and goal commitment as reflected in figure 2, the deliberative style had the strongest positive direct relationship (c1: 0.50*) with goal commitment, unadjusted for the mediation of informational and interpersonal justice, followed by the directive style (c2: 0.26*), which supported h1a and h2a. the complaisant style had a non-significant direct relationship with goal commitment (c3: 0.02), unadjusted for the mediation of informational and interpersonal justice, which supported h3a. the hostile style had a negative direct relationship with goal commitment (c4: -0.21*), unadjusted for the mediation of informational and interpersonal justice, which supported h4a. after the direct relationships have been established, the dependence of the primary relationship on a third and fourth variable, namely informational and interpersonal justice, could be investigated. mediation of the relationship between goal-setting styles and goal commitment by informational and interactional justice the coefficients for the hypothesised mediation of informational and interpersonal justice, after controlling for all the other relationships, are reported in table 3. table 3: mediation of the relationship between goal-setting styles and goal commitment by informational and interpersonal justice. in partial support of h1b, informational justice (effect 2: 0.24*), but not interpersonal justice (effect 1: 0.01), mediates the positive relationship between the deliberative style and goal commitment. the direct positive relationship between the deliberative style and goal commitment decreased (from c1: 0.50* to c’1: 0.24* in figure 2) when the mediation of informational and interpersonal justice was controlled for. the positive relationship between the directive style and goal commitment is mediated by informational justice (effect 4: 0.15*), but not interpersonal justice (effect 3: 0.01), which supports h2b. the direct positive relationship between the directive style and goal commitment decreased (from c2: 0.26* to c’2: 0.11* in figure 2) when the mediation of informational and interpersonal justice was controlled for. neither informational (effect 6: 0.03) nor interpersonal justice (effect 5: < 0.01) mediated the relationship between the complaisant style and goal commitment, which supports h3b. the negative relationship between the hostile style and goal commitment was mediated by informational justice (effect 8: -0.18*), but not interpersonal justice (effect 7: -0.03), which provides partial support for h4b. the relationship between the hostile style and goal commitment decreased (from c4: -0.21* to c’4: -0.01) after controlling for the mediation of informational and interpersonal justice. unexpectedly, interpersonal justice appears to play a limited role in mediating either the relationship between the deliberative style and goal commitment, or the relationship between the hostile style and goal commitment. the assumption of full mediation, as with the non-significant adjusted direct effect of the hostile style, should be viewed with caution, as the calculation of mediators has a power advantage over the calculation of direct effects (kenny & judd 2014; shrout & bolger 2002). subsequently, the coefficients of the hypothesised indirect effects (see table 3) were of primary concern, irrespective of whether zero could be ruled out as a value for the direct effects. discussion to date, limited attention has been paid to the relationship between subordinates’ social perceptions of managers’ goal-setting styles and subordinates’ goal commitment as mediated by supervisor-focused informational and interpersonal justice. the central aim of the study under discussion was to determine the impact of a greater range of subordinates’ perceptions of managers’ behaviours during goal setting on subordinates’ goal commitment. the hypotheses that goal-setting styles would have different relationships with goal commitment, based on the styles’ relative location to intellectual competence, warmth, intellectual carelessness and coldness in figure 1, received preliminary support. firstly, the perception of managers as deliberative had the strongest positive relationship with goal commitment (h1a). the finding is, in part, attributed to an increase in positive expectancies of and intentions to implement goals set when managers afford insights about the meaningfulness and practicality of goals while deliberating with subordinates (intellectual competence). deliberative managers are also likely to increase subordinates’ sense of self-determination, positive emotions about and internal dedication to goals when thoughtfully considering alternative views (warmth). secondly, perceptions of managers as directive had a smaller positive relationship with goal commitment relative to a deliberative style (h2a). it is theorised that a perception of managers’ unbending conviction about assigned goals could leave subordinates ambivalent about managers’ warmth or coldness. this ambivalence might reduce positive emotions about and an internal dedication to goals. thirdly, subordinates’ perception of managers as complaisant had an amotivational relationship with goal commitment (h3a) due to a strategic ineffectiveness to increase positive expectations about, intentions to implement and dedication to goals. instead, subordinates might be more dedicated to the goals of other strategic role players who are perceived as more deliberate. finally, the evidence supports the notion that subordinates’ perception of managers as hostile provokes subordinates to withhold their commitment from goals (h4a). the finding is, in part, attributed to doubt brought about by subordinates’ perception that hostile managers withhold information or misrepresent facts, thereby reducing positive expectations of and subsequent intentions to implement assigned goals. hostile managers’ undermining of subordinates’ attempts to reason about goals might further be interpreted as a form of external tyranny that erodes positive emotions about and increases the will to oppose goals set. informational justice (h1b, h2b, h4b), relative to interpersonal justice (h1b and h4b), appears to be a more important interpersonal criterion used by subordinates to determine whether they should reciprocate goal-setting styles by bonding with or withholding their commitment from goals. the sincerity and truthfulness with which managers communicate information may be foundational to effective deliberation, since its absence could jeopardise the impact of democratic leadership by distorting discussions, thereby obstructing the goal-setting process from following the intended course (gastil 1993). the growing need for sharing information is amplified by the complexity of the business environment, which emphasises the increasing need for managers to create networks in organisations through the effective sharing of information (uhl-bien & arena 2018). theoretical implications the results of the study suggest that subordinates’ commitment to goals is influenced by their unique social perceptions of their managers, based on two dimensions of social cognition, namely the degree of warmth (increasing self-determination, positive emotions about and an internal dedication to goals) and intellectual competence (increasing positive expectations and intentions to implement goals) associated with managers’ goal-setting styles (cuddy et al. 2011; van lill et al. 2019). as a result, each style’s relationship with goal commitment depends on its relative location to intellectual competence, warmth, intellectual carelessness and coldness in figure 1. new insights on the social dynamics between managers and subordinates when setting goals is, therefore, obtained by integrating the theory of goal setting with workplace deliberative democracy and social cognition. the present study further provides evidence that perceptions of managers’ styles as informationally fair, more so than interpersonally fair, has important implications for subordinates’ commitment to goals. the findings shed a unique light on an additional social perceptual layer that could be incorporated into future studies to make sense of democratic goal setting, namely supervisor-focused informational justice. managerial implications the dimensions outlined in this section could be used by managers to actively seek structured feedback from subordinates about their goal-setting styles. if managers can identify early signs of the negative impact of their goal-setting styles by asking subordinates what they think of and feel about goals set, including taking note of expressions of subordinates’ dedication to and intentions to implement goals, managers could engage their teams by using more effective goal-setting styles that are likely to ensure subordinates’ sustained effort on important and practically relevant collective goals. however, managers should also be cognisant that subordinates evaluate managers’ goal-setting styles through the lenses of supervisor-focused informational justice in the workplace. goal-setting styles that are more strongly associated with the rules of informational justice (honesty and thoroughness) may have a greater motivational impact on subordinates’ commitment to goals set. conclusion limitations and future directions a self-report survey was administered to respondents, to ensure an efficient measure of the relationships between subjective variables at a given time, which may be perceived as a weakness in terms of common method variance (spector 2019). however, given the centrality of subordinates’ social perceptions in the present study, it would not have made sense to infer their social cognition from other stakeholders’ (managers, peers, subordinates or clients) points of view (podsakoff et al. 2012; spector 2019). furthermore, a measurement of subordinates’ impressions of managers’ goal-setting styles and goal commitment at different time intervals might have introduced extraneous variables into the design (spector 2019). to reduce method bias in the study under discussion, apprehension was reduced by protecting respondents’ anonymity (cf. podsakoff et al. 2003). the ambiguity of items was further investigated by conducting an item-sort exercise with subject matter experts (cf. podsakoff et al. 2012; van lill 2019). items with low substantive validity were subsequently adjusted or removed from the measures (howard & melloy 2016; van lill 2019). an investigation of the consistency of the effects of goal-setting styles on goal commitment across goal conditions might provide invaluable information about situational variables that could influence the relationships reported. for example, the sem could be nested in different types of goals (i.e. learning or performance goals) or managerial levels. learning goals might elicit more interest and enjoyment than performance goals from subordinates and, as a result, lead to greater goal commitment, irrespective of managers’ goal-setting styles. the importance of goals set at higher levels of management might accentuate the need for greater deliberation to get commitment when compared to lower levels of management. to investigate the effects of situational variables, a multilevel sem model that nests the effects in different goal conditions could be investigated (rabehesketh, skrondal & zheng 2012). according to stone-romero and rosopa (2008), erroneous inferences can be made about causal effects based on non-experimental research. the study under discussion relied on theory, as well as the inspection of alternative sem models, to determine if supervisor-focused informational and interpersonal justice mediate the relationship between goal-setting styles and goal commitment. however, it is strongly recommended that future experimental studies be designed to determine whether the findings of this study are replicable. acknowledgements competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. author’s contributions x.v.l. and g.r. developed the conceptual framework. g.p.d.b. contributed to the research method. funding information this research received no specific grant from any funding agency in the public, commercial or not-for-profit sectors. data availability statement the data that support the findings of this study are available from the corresponding author, 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2020, ‘on the mandate, ownership and independence of the south african reserve bank’, south african journal of economic and management sciences 23(1), a3416. https://doi.org/10.4102/sajems.v23i1.3416 research note on the mandate, ownership and independence of the south african reserve bank cobus vermeulen received: 07 oct. 2019; accepted: 05 may 2020; published: 24 aug. 2020 copyright: © 2020. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract it has been suggested that the south african reserve bank (sarb) is not doing enough to support economic growth and employment creation. there is confusion in the public debate, however, as three distinct concepts – the sarb’s mandate, ownership and independence – are often inaccurately lumped together and misinterpreted. this clouds the debate, and hinders progress. this article attempts to focus and stimulate the academic debate by distinguishing between these three distinct, yet interrelated, concepts, and to clarify misunderstandings and misinterpretation. it also suggests some avenues through which each could be investigated further, and how different dimensions to the problem could be considered independently. keywords: central bank; mandate; independence; nationalisation; private shareholders. introduction against the backdrop of a poorly performing economy, high unemployment and pervasive poverty, as well as a growing international discontent with the conduct and approach of central banks, the role of the south african reserve bank (sarb) in the south african economic policy debate has been questioned. the sarb’s main policy instrument1 is the repo rate, which is the interest rate at which the sarb lends to commercial banks, and which anchors domestic interest rates, including the prime lending rate, as well as longer-term rates. the repo rate is therefore the main determinant of the cost of credit, and thereby the sarb’s main tool in combating inflation: by increasing the cost of credit, it can cool down an overheating economy, slowing down inflation. a higher repo rate makes it more expensive to borrow, which would have the effect of slowing down consumption and investment spending, and ultimately aggregate demand and economic growth. it is for this reason that a tight monetary policy stance – that is a ‘too high’ repo rate – is often criticised as harming economic growth. for example, padayachee (2015) suggests that, in order to suppress inflationary expectations, the sarb has too often raised the repo rate in response to mainly exogenous price pressure (rising petrol, energy and food prices) under conditions of slow and low domestic economic growth. this has had ‘negative consequences for consumption itself as well as investment, growth, small business development and employment’ (2015:7). among others, rochon and rossi (2006) question the perceived superiority of inflation targeting above prioritising economic growth and employment, while epstein (2008) argues for an ‘employment targeting’ monetary policy framework for south africa. at the core of the criticism lies the belief that the sarb’s insistence on maintaining price stability constrains economic growth and job creation, and that it simply does not support the government’s broader economic strategy and goals. in perhaps the highest profile criticism to date, the public protector (pp) in a 2017 report suggested that the sarb’s activities, which ‘involves vast amounts of public money does not improve the socio-economic conditions of ordinary citizens’ (public protector [pp] 2017:5.3.23). the report further suggested that: once the state takes control of creating money and credit, numerous benefits aimed at alleviating economic ails of ordinary economically disadvantaged people may be achieved, unlike our current purely commercial transaction system which only seeks to improve a particular financial sector. (pp 2017:5.3.25). the report then concluded with the instruction that the constitution be amended and the sarb’s mandate changed to include the protection of ‘socio-economic well-being of the citizens’, and that the sarb should ensure the achievement of ‘meaningful socio-economic transformation’ (pp 2017:7.2.1). the pp suggested, in short, that the independence of the sarb should be curtailed and its mandate expanded, as its current approach favours only the financial sector and does not sufficiently address developmental goals. this evoked a backlash from several analysts, academic and private economists, and the sarb itself, by way of legal proceedings instigated by both the sarb and national treasury (treasury 2017). in 2018, the high court ruled in favour of the sarb, and the pp’s report was set aside. nonetheless, the controversy around this report ignited the debate on not only the mandate of the sarb, but also its ownership and independent operation. the pp’s report, which suggests that the sarb favours the financial sector, has given rise to a narrative that the sarb’s private shareholders are manipulating monetary policy to their own narrow advances. the fact that the vast majority of central banks around the world are not owned by private individuals, but rather by their respective national governments, makes the sarb an anomaly, and adds fuel to this fire. politicians and analysts are falling over themselves to make statements and pronunciations, or to contradict and contest statements made by others.2 in the meantime, south african debt has been downgraded to sub-investment grade by two of the three notable international ratings agencies – standard and poor’s and fitch. the third – moody’s – was instead optimistically waiting for signs of economic policy certainty and an improved economic outlook. disconcertingly, the conflicting utterances by politicians create an atmosphere of policy uncertainty, which is certainly not conducive to the south african economy escaping the quagmire. moody’s eventually also downgraded south african debt to sub-investment grade in march 2020. however, given stubbornly high unemployment, slow growth and pervasive poverty, the essence of the question remains important: is the sarb failing ‘ordinary citizens’? this question begets several deeper questions: is the sarb’s mandate appropriate, given the south african socio-economic structure? is the sarb too independent, and therefore indifferent to socio-economic issues? can the sarb play a more active role in boosting growth and employment? would nationalising the sarb solve these problems? these are loaded questions, and the purpose of this article is not to exhaustively address them all. instead, this article aims to disentangle the debate by clarifying misconceptions about three key concepts, which are often misinterpreted and conflated in the greater debate, namely the sarb’s mandate, its ownership and its independence. it has been suggested that the sarb is compromised by its private shareholders’ nefarious intentions, whereas, if it was owned by the state (i.e. nationalised), these concerns would disappear. others are concerned that a nationalised sarb would lose its independence and consequently see its inflation-combating ability curtailed, that nationalisation is but a step towards interfering with the mandate, and that expanding the mandate to explicitly include economic growth and employment creation could in itself be inflationary and ultimately ineffective. careful consideration and understanding of these key concepts – distinct, yet interrelated – is imperative to driving the debate and research in the field forward. this article is organised as follows: section 2 considers the legal framework which governs the sarb and its current inflation targeting strategy. section 3 separates the three key concepts highlighted earlier, namely the sarb’s mandate, ownership and independence, in an attempt to eliminate ambiguity around these issues. this section further investigates possible overlaps between these three concepts. section 4 considers some of the burning questions in the debate, and suggests areas for further research within each subject. section 5 concludes. a brief history of the south african reserve bank establishment of the south african reserve bank the sarb was established in 1921 through the currency and banking act (no. 31 of 1920). some of the early functions of the sarb were to act as sole issuer of banknotes, hold reserves of commercial banks, discount short-term paper, and make advances against said paper, gold or government securities (gelb 1989). at the time, virtually all central banks around the world were privately owned. in south africa ‘commercial banks were required by law to subscribe … a part of the capital of the central bank’ (de kock 1974:306) to contribute to its establishment. specifically, any bank that did business in south africa was required ‘to hold stock of the reserve bank to a nominal value of not less than 5 per cent of its own paid-up capital’ (de kock 1954:24), although this requirement was subsequently dropped, as is explained below. the sarb issued share capital of £1 million3, represented by 2 million shares. only £280 420 was subscribed by commercial banks, and the remaining £719 580 was offered to the public (de kock 1954:48). the share capital was fully subscribed by 06 march 1922 (rossouw 2018). the sarb was therefore established with stockholders (as they were called at the time), consisting of commercial banks and private individuals. contemporary legal framework the sarb is ultimately governed by the south african constitution, which reads: the primary object of the south african reserve bank is to protect the value of the currency in the interest of balanced and sustainable economic growth in the republic. (rsa 1996:224[1]) this is the sarb’s mandate. ‘protecting the value of the currency’ is interpreted as maintaining price stability, ‘quantified by the setting of an inflation target by government that serves as a yardstick against which price stability is measured’ (sarb n.d.a). growth and employment objectives are therefore not explicitly part of the sarb’s mandate, while price stability – protecting the value of the currency – is. the independence of the sarb is also enshrined in the constitution: the south african reserve bank, in pursuit of its primary object, must perform its functions independently and without fear, favour or prejudice, but there must be regular consultation between the bank and the cabinet member responsible for national financial matters. (rsa 1996:224[2]) reading these two paragraphs in conjunction, ‘an independent sarb would be constitutionally bound to consult the finance minister in conducting monetary policy, and … the bank should act in support of the general economic policy of government’ (padayachee 2015:5). indeed, the sarb governor regularly meets with the minister of finance, as well as provides briefings to parliament. this sets up the relationship between the sarb and the government as the sarb simply an arm or functionary of government, under the umbrella of the ministry of finance (national treasury). moreover, the sarb is not narrowly focused on the inflation target only, but also considers economic growth and broader goals when setting policy.4 the sarb is further governed by the south african reserve bank act (no. 90 of 1989), which has since been amended by, among others, the south african reserve bank act (no. 39 of 1997) and the south african reserve bank amendment acts (no. 10 of 1993, no. 2 of 1996, no. 57 of 2000 and no. 4 of 2010). the final mention of the sarb in the constitution refers to its functions: the powers and functions of the south african reserve bank are those customarily exercised and performed by central banks, which powers and functions must be determined by an act of parliament and must be exercised or performed subject to the conditions prescribed in terms of that act. (rsa 1996:225) the sarb formulates and implements monetary policy, acts as a banker for the government, manages and supports the national payment system, acts as the custodian for south africa’s gold and foreign exchange reserves, and oversees several aspects of financial stability and macroand micro-prudential regulation, among others (sarb 2007). however, since the debate around the role of the sarb is mostly concerned with the monetary policy stance, through the sarb’s control over the policy (repo) interest rate, the remainder of the article considers only the sarb’s monetary policy role. these constitutional clauses – indeed the constitution in its entirety – were the result of the convention for a democratic south africa (codesa) and multiparty negotiating forum (mpnf) negotiations during the early 1990s. at the time, south africa had just emerged from years of oppressive minority rule under the apartheid government and strict economic sanctions imposed on them during the 1980s which led to disinvestment, debt crises and a crippled economy. the negotiators and decision-makers at the time were faced with a difficult decision: the juxtaposition of the ‘world-wide accepted increase in the importance of central bank independence’ against the dominant ‘political grouping (the african national congress [anc]) with an initial inclination towards socialism … also involving many jobless and disadvantaged stakeholders’ (wessels 2004:132). ultimately, the decision was taken that the sarb should be empowered through independence to protect the value of the currency. while the choice at the time was not between choosing either employment or price stability, the expectation was presumably that an independent central bank would be first and foremost concerned with price stability, which would hopefully foster balanced and sustainable economic growth in the long run, leading to employment creation. it is quite likely that the fragile state of the economy at the time, and resultant urgent desire to attract foreign investment5 and reintegrate in global markets, inspired these sections of the constitution to be drafted in such a manner as would ensure access to the increasingly integrated world financial markets. inflation targeting the government, through the minister of finance, announced the adoption of a formal inflation targeting framework in 2000 (treasury 2000). this framework involves maintaining inflation – as measured by the consumer price index (cpix),6 excluding interest costs, within a target band of 3% – 6%. this target was chosen in consultation between the national treasury and the sarb (treasury 2000) and became the benchmark by which the sarb exercises its mandate of the achievement of price stability. the importance attached to price stability (i.e. low and stable inflation) is twofold: firstly, inflation reduces purchasing power, and erodes living standards. some individuals are able to hedge or protect themselves against inflation: salaries can adjust in line with inflation, while growth in savings or investments could outperform inflation, thus protecting purchasing power. however, the poor and unemployed are unable to protect themselves against inflation. these citizens are often reliant upon nominal earnings, such as social grants or daily or seasonal wages, if they earn anything at all. they are more vulnerable to price increases, and their incomes are too small to even consider investing in inflation-hedging products. easterly and fischer (2001:161) find that ‘inflation reduces the relative income of the poor’, while statssa (2016) suggests that ‘volatile inflation hurts the poorest’. secondly, treasury reasoned that ‘stability in the value of money … enhances growth prospects’ (treasury 2000:6). the setting of an inflation target is suggested to anchor inflation expectations while creating ‘certainty and transparency with regard to the bank’s policy intentions’ (wessels 2004:144). anchored expectations, in turn, make it easier for a central bank to manage and combat inflation. this creates an environment conducive to sustainable long-term economic growth. the government thus prioritised price stability specifically to ‘counter the erosion of people’s incomes and living standards that comes with rising prices and to remove the fear of future inflation that undermines investment and savings decisions’ (treasury 2000:5). demarcating the debate the preceding section presented the legal framework and relationship to the government within which the sarb operates, while highlighting the importance the government and decision-makers of the time attached to price stability. this provides the context within which the sarb’s mandate, ownership and independence can be examined further. mandate the sarb’s mandate is given by p.224 of the constitution as to protect the value of the currency in the interest of balanced and sustainable economic growth in the republic. to protect the value of the currency is interpreted as maintaining price stability, in the form of maintaining inflation within the 3% – 6% target band. however, the sarb’s mandate was not always this well defined. during the second half of the 1980s, monetary policy objectives were stated as ‘promoting economic growth, price level stability, balance of payments equilibrium, and enhancing employment’ (wessels 2004). in practice, however, ‘different monetary policy objectives got prioritised at different times’ (wessels 2004:137). wessels (2004:135), however, argues that it is ‘imperative for a central bank to have a clear, single or primary objective’, as the setting of multiple objectives might ‘compromise the bank and invite political interference’. a single and clearly defined objective also enhances transparency and accountability. wessels (2004) further argues that the sarb was strongly influenced by political matters in the mid-1980s, due to, among others, disastrous international sanctions imposed on south africa. this pressure, including the primrose prime incident of 1984,7 ‘resulted in the non-attainment of price stability, due to a more accommodating policy stance than was warranted’ (2004:138). during the early 1990s, as south africa was transitioning to a democratic state, the central bank’s mandate needed to be reconsidered. a clear single mandate for the sarb was adopted, in line with international best practice of the time. however, just over 25 years later, the sarb’s mandate is back in the spotlight. while the attainment of relative price stability during the 1990s and 2000s is praiseworthy, economic growth and especially employment creation has lagged behind. inflation has been reigned in from around 15% to under 6%, but growth has been lethargic and the unemployment rate has steadily increased. the price stability mandate, which did not translate into the employment creation envisaged, is therefore being questioned. the ruling african national congress (anc), at its 54th national conference, consequently revisited the mandate of the sarb, and concluded that: without sacrificing price stability, monetary policy should also take account of other objectives such as employment creation and economic growth. (anc 2017:32) price stability was affirmed again to be the primary object of the sarb, despite the fact that price stability has not resulted in satisfactory employment creation. some analysts believe that the bleak employment numbers are the result of other factors which are not sensitive to monetary policy, while others suggest that these numbers are proof that the government’s faith in price stability is misguided. the controversial pp’s report, alluded to earlier, instructed that section 224 of the constitution, pertaining to the mandate of the sarb, be changed to read: the primary object of the south african reserve bank is to promote balanced and sustainable economic growth. (pp 2017:7.2.1) this order was met with outrage, no less than from the sarb itself, who challenged the authority of the pp to order changes to the constitution. the pp’s report was set aside by the high court in 2018 (high court of south africa 2018), thus leaving the sarb’s mandate unchanged for the time being. in actual fact, the sarb’s mandate can only be changed by parliament through a constitutional amendment bill to amend section 224, with such a bill requiring the support of at least two-thirds (267 out of 400) of the members of the national assembly (rsa 1996:74[3]). ownership and nationalisation origin of the south african reserve bank’s private shareholders by the early 20th century most central banks were quasi-governmental bodies, despite the fact that at that time ‘only a tiny number of central banks … were state-owned institutions. the majority had total or majority or significant private shareholders’ (padayachee 2015:11), including the sarb. indeed, at the time ‘it was exceptional for central banks not to have private shareholders’ (rossouw & rossouw 2017:6). sarb stock (as the shares was known until 1989, with shareholders known as stockholders) was originally owned by both commercial banks and private individuals. this changed when banks were ‘relieved8 of the obligation to hold a certain amount of reserve bank stock’ (de kock 1974:306). some of the stock in the hands of banks was subsequently sold to the public with some south african banks at the same time retaining some of their stock (currently known as shares). ownership structures of central banks started changing after 1936 and gained momentum after the second world war (wwii) (rossouw & breytenbach 2011). in contrast to the early central banks, central banks established during and after wwii had no private shareholders, and ‘were founded as state institutions’ (de kock 1974:304), by way of national governments subscribing the new central banks’ full capital. the majority of older central banks were also nationalised during this time, with governments effectively buying out shareholders. for example, the bank of england was owned by private shareholders from its inception in 1694, until it was nationalised in 1946 by way of the bank’s capital stock wholly transferred to the treasury (boe 1946). as of 2019, there are only nine remaining central banks with private shareholders in the narrow sense of the word, namely: belgium, greece, italy, japan, san marino, south africa, switzerland and turkey. the federal reserve banks in the united states have banks in their regions as ‘shareholders’ in the overall federal reserve system, but this shareholding is akin to reserve holding deposits with central banks in other countries. current shareholders and shareholder rights the question of who the sarb’s shareholders are, and what interests they represent, is often raised. the sarb currently has about 750 private shareholders who own the 2 million shares issued (sarb n.d.c). no associated shareholders are allowed to own more than 10 000 shares,9 while shareholders have one vote for every 200 shares held. the objective of capping the voting rights of shareholders gives effect to par. 224(2) of the constitution to not allow prejudice or undue influence over the sarb by its shareholders, although this was in existence long before the adoption of the constitution. dividends are statutorily limited to 10c per share (sarb n.d.c) and are subject to dividend withholding tax. surpluses after payment of tax and allocation to reserves are transferred to government, which indicates that the sarb’s operations are not driven by a profit motive. the sarb’s board of directors can consist of up to 15 directors. eight directors, including the governor and three deputy governors, are appointed by the president of south africa, after consultation with the minister of finance and the board. the sarb’s shareholders can elect a maximum of seven non-executive directors from a list of candidates approved by a panel chaired by the governor (rsa 2010:2). such candidates shall be deemed ‘a fit and proper person with appropriate skills and experience’ in fields such as commerce or finance, agriculture, industry, labour and mining (rsa 2010:2(e)–(f)). non-executive directors serve terms of three years. the four executive directors – the governor and three deputy governors – are appointed for initial terms of five-year terms, while reappointment for second and consecutive terms can be for any period up to five years. the powers and functions of the board are spelled out in the sarb amendment act (no. 4 of 2010) (rsa 2010:4a), and comprise various aspects of corporate governance of the bank. the act also explicitly states that ‘all other powers and duties of the bank under this act shall vest in and be exercised by the governor and deputy governors’ (rsa 2010:4a). the power of shareholders is thus strictly limited to decisions impacting on governance decisions, such as the election of non-executive directors and the appointment of auditors. this governance structure is argued to ‘enhance the independence, transparency and accountability’ of the central bank (rossouw 2018:7). independence walsh (2010:21) defines central bank independence as ‘the freedom of monetary policymakers from direct political or governmental influence in the conduct of policy’. the importance of independence stems from the argument that ‘the power to spend money should in some way be separated from the power to create money’ (mboweni 2000:1). governments and politicians naturally carry an inflationary bias, as they can be tempted to spend money to ‘create favourable economic and political environments just before elections’ (wessels 2004:133). a government concerned with its immediate popularity might strive for short-term gains from lower interest rates, even at the risk of promoting somewhat higher inflation further down the road (mboweni 2000). an independent central bank would, in contrast, theoretically be free from political interference and have greater commitment to long-term objectives such as promoting a more stable price level (polillo & guillen 2005:1770). an independent central bank can pursue policies that are in the interest of the public, even if they might be politically unpopular.10 the motivation for independence to be granted to central banks is thus exactly to shield or insulate them from short-term political influence or partisan political goals, and allow them to fulfil their mandate of long-term price stability as part of the country’s overall economic strategy. another consideration is the danger of fiscal dominance. in emerging-market economies, there will always be added pressure for greater social expenditure that is funded via government spending, but against a narrower tax base (kahn 2008:131). under such conditions, the central bank could be forced – or at least expected – to create money to finance fiscal deficits or service the government’s debts, which could ultimately enable a government to spend with reckless abandon. even well-meaning governments can be tempted to simply create their own money through the central bank in order to finance deficit spending.11 however, the inflationary impact of such behaviour has often been disastrous. indeed, ‘there is ample historical evidence of countries experiencing runaway inflation stemming from the malpractice of central banks being pressurised by governments into financing their fiscal deficits’ (wessels 2004:153), evident recently right on our doorstep in the case of zimbabwean hyperinflation. printing money to finance government spending has the effect of lowering the value – and therefore purchasing power – of existing money, leading to the need to print even more money to finance the same level of real spending, further eroding purchasing power, and so forth in a vicious cycle. it is for this exact reason that governments choose to delegate the functions of monetary policy and money creation to an independent, technocratic institution concerned first and foremost with price stability. this is also why the pp’s suggestion that the state should directly take ‘control of creating money and credit’ (pp 2017:5.3.25) was met with outrage and consternation from several directions. independence is desirable for a central bank focused on price stability. an independent central bank is less vulnerable to the time-inconsistency problem (kydland & prescott 1977), where a policymaker might be tempted to pursue short-term gains at the expense of its long-term objectives. moreover, a central bank that successfully pursues its mandate will have its credibility enhanced. this sets in motion a virtuous cycle, where higher credibility further anchors inflation expectations, ultimately improving the central bank’s ability to meet its objectives. credibility thus results in more effective combating of inflation. this is supported by many empirical studies which found that lower inflation is often realised in economies with more independent central banks (see e.g. bodea & hicks 2015; walsh 2003). finally, and perhaps most importantly an independent central bank is better equipped to withstand fiscal dominance. there are also arguments against central bank independence. forder (2005:854) questions central banks’ motives by arguing that they are ‘organisations with a very clear political interest, namely the enhancement or protection of their own position’, while disputing ‘the presumption of economists’ moral superiority and the superiority of policy making by economists over politicians and democratic policy’ (2005:856).12 an independent central bank could also result in poor coordination of monetary and fiscal policies (maxfield 1997).13 caruana (2013) warns against ‘financial dominance’, arguing that central banks should be insulated not only against political pressures (fiscal dominance), but also against financial market pressures.14 the political argument is that turning over control of monetary policy, which affects every person in the country, ‘to a body of unelected officials, is simply “undemocratic”’ (mboweni 2000:3). such independent officials could have limited accountability, and be insensitive to the broader goals of government and society. forder (2005:852) argues that ‘unrestrained authority cannot be presumed to serve the public interest’. walsh (2010:25) warns against the ‘danger that a central bank that is independent will not be accountable’. maxfield (1997:16) concedes that ‘central banks are accountable to voters only indirectly’, through their accountability to the government. notwithstanding these criticisms, the global trend has seen the autonomy of central banks gradually increasing since the 1980s (padayachee 2015). independence insulates central banks from the time-inconsistency problem and partisan political pressures, which improves the central bank’s credibility. specifically: if the public believes that the central bank is free from interference … it will also lower inflationary expectations, leading to price stability above and beyond the control of the money supply. (bodea & hicks 2015:54) however, unrestrained independence is also not desirable, with the ideal scenario seeing ‘a role for the elected government in establishing the goals of policy and in monitoring the central bank’s performance in achieving these goals’ (walsh 2010:25). relationship between these concepts independence and mandate the sarb receives its price stability mandate – the inflation target – from the government. this means that the sarb does not have the freedom to select its own goals or objectives, and it is therefore nothing more than an agent or representative of the government tasked with a certain set of delegated goals. however, the government does not dictate to the sarb how it should go about to achieve said goals. instead, the ‘setting of monetary policy instrument values … is entirely up to the reserve bank’ (mboweni 2000:4–5). therefore, the sarb is viewed as goal dependent but functionally or instrument independent. that is, the sarb can autonomously utilise any tools it deems necessary to achieve its government-directed goals, and it enjoys ‘full independence to apply its range or mix of policy instruments to pursue the target in an unconstrained way’ (wessels 2004:155). the sarb thus falls within walsh (2010)’s standard, where government sets the goals of policy and monitors the sarb’s performance in achieving these goals. ownership and mandate normally, shareholders have a substantial say in a company’s strategic objectives such as profit maximisation, maximising shareholder value through dividends or the appointment of executives. however, current legislation prevents shareholders from exercising the same influence over the sarb. the sarb is not a profit-maximising corporation, surplus earnings are transferred to the government and dividends are capped by law. while shareholders can appoint non-executive directors, executive directors are appointed only by the government. therefore, the sarb’s shareholders cannot set the sarb’s goals or objectives, nor can they flaunt or change the sarb’s constitutional mandate. just as private shareholding of the sarb does not give private individuals the power to dictate the sarb’s mandate, so government ownership of the sarb will not give government or treasury – who would be the new sole shareholder if the sarb was nationalised – or the ruling party the power to simply change the mandate. the mandate can only be changed through a constitutional amendment bill, as was described earlier. independence and ownership there are suggestions that the independence of the sarb is supported by the presumed more effective governance instilled by its private shareholders (rossouw 2018), as well as the expertise they bring to the board. however, the fact that several independently operating central banks around the world are fully owned by their respective governments, suggests that private ownership is not a prerequisite for a credible and independent central bank. a nationalised central bank can also be independent in this context. independence simply means that the central bank has the autonomy to pursue its goals, without its notional ‘owners’ (be they private individuals, the government or some combination) dictating how it should go about things. focusing the debate having separated these concepts, key questions or areas of debate can now be teased out, and each addressed within its own paradigm. this allows the debate to be broken down into manageable research agendas. could, and should, the south african reserve bank’s mandate be changed? the sarb’s mandate is determined by the constitution, and it can only be changed through parliament by a constitutional amendment act (see section 1). the anc reaffirmed that the mandate of the sarb should be the maintenance of price stability, while also calling for the nationalisation of the sarb (see section 3). price stability therefore remains the primary object. nationalisation, or full state ownership, of the sarb, however, does not in and of itself broaden the sarb’s mandate to explicitly include growth or employment creation. therefore, nationalising the sarb would not translate to a change in its mandate.15 however, there are still calls from various directions that the mandate should be formally changed to include growth and employment. but to what extent can monetary policy affect growth and employment? what does existing empirical evidence suggest? for the purpose of the current national conversation, it is important to acknowledge the influence of monetary factors on the economy, and the role that monetary policy can – and cannot – play.16 during the 1950s and 1960s, the dominant academic view, supported by empirical evidence from various countries, was that there existed a trade-off between inflation and unemployment. this relationship was known as the phillips curve, after phillips’s (1958) seminal paper, which detected a negative relationship between wage inflation and the uk unemployment rate and gave rise to the ultimately misconstrued idea that monetary policy could essentially ‘buy’ lower unemployment by tolerating higher inflation.17 however, the relationship broke down in the 1970s, with the result that ‘monetary policy was [is] no longer an effective tool for determining national employment levels’ (maxfield 1997:7). vermeulen (2017) recently confirmed that such a long-term phillips curve trade-off has not existed for south africa since at least 2000. empirical evidence further suggests that domestic economic growth and employment creation are relatively unresponsive to changes in interest rates and inflation (hodge 2002; vermeulen 2017). in fact, hodge (2006:30) finds that ‘inflation drags down growth in south africa over the longer term’. the sarb’s own models suggest that the growth effect of an interest rate reduction is quite small: a 100-basis-point rate cut would lead to a 0.5 percentage point increase in growth (kganyago 2019). tolerating more inflation for the sake of higher aggregate demand, through a looser policy stance, could potentially boost growth in the short term, but this boost would be quite small. however, this would raise inflation expectations and core inflation in the longer term, growth will slow down again, and there will be ‘no permanent increase in output’ (kganyago 2019:10). in addition, permanently higher interest rates would be required to combat the higher inflation (kganyago 2019), which is likely to further erode any gains made in the first place. this view is consistent with the main criticism of the phillips curve hypothesis in the academic literature, which states that ‘expansionary monetary policy would eventually raise expected inflation, resulting in higher inflation with no output stimulus’ (erceg 2010:176, own emphasis). moreover, the brunt of the higher inflation will be felt by the poor and unemployed (easterly & fischer 2001). therefore, striving for a short-term growth boost through rate cuts is likely to perversely slow growth in the long term, while imparting unnecessary inflationary pressure. there are, of course, studies that make the opposite case. these include epstein (2008) and rochon and rossi (2006), who argue that the opportunity cost of maintaining price stability is lost growth and employment. stiglitz (2008:3) contends that inflation targeting leads to a ‘weaker economy and higher unemployment’. there is also a strand of literature that suggests that mildly high inflation would not adversely affect output. for example, pollin and zhu (2006:593) find that ‘higher inflation is associated with moderate gains in gross domestic product growth’ across a sample of middle-income and low-income countries. in such an environment, a looser monetary policy stance could potentially be pursued to attempt to boost economic growth. as there seems to exist a fundamental disagreement over the degree to which monetary variables could influence real variables, this area warrants further empirical research in the south african context. considering the two sides though, it is unclear how changing the sarb’s mandate could contribute to growth and employment creation. as it stands, the evidence favours the conclusion that monetary policy cannot permanently support economic growth. if a looser policy stance, due to chasing growth and employment, causes higher inflation, growth would surely be harmed in the long run. would the small short-term gains then be worthwhile? what about the impact of higher inflation on the poor? this debate is likely to rage on, as there are different motives and ideologies at play. but clearly, these questions need to be unequivocally answered first, before improper responsibilities and expectations are foisted upon the sarb. empirical evidence suggests that looser monetary policy would have a very small impact on real variables, and could cause the sarb to lose its grip on inflation. higher inflation would erode the living standards of all, especially our 9.4 million unemployed and discouraged work-seekers (statssa 2019), while its expansionary effect would be limited. therefore, the current price stability mandate is arguably the mandate which best protects the socio-economic well-being of citizens. are the south african reserve bank’s private shareholders exerting undue influence over monetary policy? the governance of the sarb rests in the hands of its board of directors. the shareholders can elect up to seven (a strict minority) non-executive directors to the board, but – crucially – these directors have ‘no power over monetary policy decisions or implementation’ (rossouw 2018:11). the remaining four non-executive directors and the four executive directors are appointed by the president. the monetary policy stance (i.e. the level of the repo rate) is not determined by the sarb’s directors, board or shareholders, but by the monetary policy committee (mpc).18 the mpc consists of the governor, three deputy governors, and up to three senior officials (sarb n.d.b). the mpc is thus clearly a separate entity from the board, with only the four executive directors present on both panels. shareholders are therefore not represented on the mpc. moreover, ‘at no time have private shareholders [been able] to affect the conduct of monetary policy’ (padayachee 2015:12). in addition: the governor of the bank has a deciding vote on the board, giving control of the bank to those appointed by the president. shareholders cannot remove the governor or the other members of the board and have very little power over the bank. (de vos 2010:1). finally, the reserve bank act makes provision for the minister of finance to make regulations regarding, among others, the election of directors by shareholders and shareholders’ meetings in general (rsa 1989:s36). this reveals the ‘considerable influence government has on the appointment of these officials’ (wessels 2004:146). even though the sarb is not notionally ‘owned’ by the government, its key executive officers are appointed by the president. these executive officers currently occupy four out of the five seats on the mpc, while no director elected by the shareholders is present on the mpc. control of the bank – and indeed over monetary policy – therefore effectively rests mainly with the government through the appointment of the executive directors. shareholders’ influence is limited to matters of corporate governance, and they are unable to dictate the monetary policy stance: ownership is therefore completely removed from control of the sarb and its policy objectives. should the south african reserve bank be nationalised? the ruling anc recently resolved that the sarb should be nationalised, that is ‘100% owned by the state’ (anc 2017:32). this would be consistent with the global standard where shares in the majority of central banks are, in fact, owned by their respective governments. this creates the expectation – and implication – that the government should buy out private shareholders, thus taking the sarb into national ownership. the political pressure to act on this resolution, as well as widespread disagreement over the sarb’s mandate and independence, has, however, created a volatile situation. owning sarb shares is not particularly profitable; however, selling the shares could potentially be lucrative. a government instructed by its ruling party to buy out these shareholders could potentially be forced to pay an exorbitant price in order to enact this resolution. indeed, it would be in the interest of current shareholders to value their shares as high as possible, in the hope that the political pressure would force treasury to meet their valuation when determining the price per share. as there is currently no mechanism in place to force shareholders to relinquish their shares, the predicament is thus that some current shareholders could simply refuse to sell their shares if the government is not willing to meet their valuation. this impasse creates the impression of the tail wagging the dog, and is likely contributing to the polarisation of the debate. recently, sarb shares have been separately valued at r1.55 and r1.38 per share (rossouw & rossouw 2017). the shares have also been argued to be worth an exorbitant r470019 each (mail & guardian 2017), suggesting that some shareholders are indeed trying to profit from the political situation. however, the anc also resolved that full public ownership of the sarb must be ensured ‘in a manner that does not benefit private shareholder speculators’ (anc 2017:32). so the question of how the shares should be valued, to ensure that a just and equitable price can be reached, remains a potential area for further research. however, given that ownership of the sarb is so far removed from control over policy, nationalisation would really just change the name on the door, with precious little effect on policy. is the south african reserve bank ‘too’ independent? the sarb receives its price stability goal from the government, and is free to pursue this utilising any tools it deems appropriate. however, the mpc also takes account of economic growth and other macro-economic considerations, and not just inflation, when choosing the policy stance, as a cursory reading of many mpc statements would confirm. sarb officials report to, and are held accountable by, the government, both in terms of the governance of the central bank, as well as the conduct of monetary policy within the framework of government’s broader economic policy. indeed: … even the most autonomous central bank has to report in some form or another to the legislature, which in any case also has the ultimate power to change the laws governing the central bank (mboweni 2000:3). central banks are ultimately ‘creations of their respective governments and can therefore never function in complete isolation from parliament’ (wessels 2004:151). independence does not imply a relentless focus on inflation at the expense of growth. according to maxfield (1997), a weak empirical relationship between independence and employment and growth is observed for organisation for economic co-operation and development countries, which ‘suggests that fears that central bank independence will strangle social democracy may be misplaced for the present’ (p. 17). however, the fact that very little evidence on this relationship is available – particularly for developing economies – suggests a need for further empirical investigation. conclusion it has been suggested that the sarb’s mandate should be expanded to formally include economic growth and employment. to some, the sarb’s ‘soft’ stance on these factors is unacceptable: growth and employment should not be subordinate to price stability. on the other hand, the orthodox academic view, shared by many central bankers around the world, is that price stability is an important precondition for sustainable long-term economic growth, and that employment creation should follow from such growth. higher inflation, resulting from the rejection of the price stability goal and a subsequent looser policy stance, would harm growth and stifle employment creation. moreover, higher inflation erodes the purchasing power and living standards of everyone, especially the poor and unemployed. reckless and populist monetary policy could easily result in hyperinflation, the debilitating effects of which are currently visible in zimbabwe and venezuela. short-termism by politicians cannot be reconciled with the long view central bankers hold. thus, to protect themselves from temptation, governments around the world have generally delegated monetary policy matters to an independent central bank, while legally or politically empowering central banks to pursue such matters at their own discretion. nonetheless, the central bank is only one pillar of broader economic policy, and ‘monetary policy … accordingly has to serve the overriding objective of macroeconomic policy’ (wessels 2004:141). however, the cost of a central bank artificially boosting demand by lowering interest rates, increasing the money supply, or generously monetising government debt is likely to outweigh any potential short-term gains. by taking the long view and focusing on price stability, the central bank creates ‘a financial environment conducive to economic growth’ (wessels 2004:142), thus ensuring fertile soil for sustainable and inclusive long-term economic growth. while the central bank ‘has the machinery and the expertise to carry out the monetary policy’ (de kock 1974:318), it remains but an agent of the government which dictates the overall direction of policy. the government therefore has the full right to change the direction of policy, and thereby the directive of the central bank, if it deems necessary. nationalising the sarb would eliminate perceived conflicts of interest between the private shareholders and the government’s policy goals. however, given that monetary policy is already fully insulated from shareholder interests, such an approach would be largely symbolic. this would not change the way the sarb operates, nor change its mandate or priorities, all at an added cost to an already-stretched fiscus. independence does not make the sarb unaccountable or insensitive to growth and employment. the sarb reports to parliament, and is held accountable by the minister of finance. moreover, according to padayachee (2015:2), ‘most independent central banks are also state-owned entities’. there is thus no reason for a nationalised sarb to be any less independent than it is under its current private ownership. fears that a nationalised sarb would lose its independence and credibility are perhaps misplaced. in conclusion, the debate about nationalising the sarb is much ado about semantics. the ‘owners’ of the central bank have no say in matters of monetary policy. moreover, given current legislation, changing the name on the door will make no difference to the sarb’s mandate, nor to growth or employment creation. in the words of governor kganyago, ‘the growth problem in south africa is mainly structural, … beyond the reach of monetary policy alone’ (2019:2). we should stop pretending that ‘if the sarb could just cut rates … all will be well’ (kganyago 2019:13). in short, the nationalising debate is the wrong debate to have. instead of foisting unrealistic expectations on the sarb, we would be better served to let the central bank get on with what it is designed to do: maintain price stability. on the balance of current evidence, monetary policy is unfortunately not the silver bullet that would cure our growth and employment problems. acknowledgements competing interests the author has declared that no competing interests exist. author’s contributions i declare that i am the sole author of this research article. ethical consideration this article followed all ethical standards for carrying out research. funding information this research received no specific grant from any funding agency in the public, commercial, or not-for-profit sectors. data availability statement data sharing is not applicable to this article as no new data were created or analysed in this study. disclaimer the view and opinions expressed in this article are those of the author and do not necessarily reflect the official policy or position of any affiliated agency of the author. references african national congress (anc), 2017, 54th national conference: report and resolutions, viewed 04 october 2019, from 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journal of economic history 19(1–2), 132–157. https://doi.org/10.1080/10113430409511173 footnotes 1. the operational approach to monetary policy and the sarb’s accommodation system are explained in sarb (2007). 2. see, for example, fin24 (2019b). 3. the share capital was converted to r2 million at decimalisation in 1961 (rossouw 2018). 4. the sarb applies a ‘flexible’ inflation targeting framework (kahn & de jager 2011), favouring a pragmatic, instead of draconian, approach to interest rate setting. this should prevent a knee-jerk reaction in response to exogenous price shocks. 5. according to maxfield (1997:4), governments hoping to attract foreign investment ‘use central bank independence to try to signal their nation’s creditworthiness to potential investors’. 6. the cpix was replaced by the re-weighted cpi in january 2009. 7. in 1984, the sarb dropped interest rates shortly before an important by-election in the primrose constituency. this ‘placed in serious jeopardy the ability of the bank to conduct autonomous monetary policy’ (rossouw & padayachee 2008:17). 8. the currency and banking act amendment act (no. 22 of 1923) allowed banks to ‘dispose of the whole or part of their holding of reserve bank stocks’ (de kock 1954:61). 9. a small handful of current shareholders opposed this limit, and legal action against delinquent shareholders was instituted by the sarb (rossouw & rossouw 2017). 10. an independent central bank can be a convenient scapegoat for failure of economic policy (kane 1980). governments cede monetary policy to a central bank since ‘politicians want to be able to deny responsibility for unpopular monetary policy’ (maxfield 1997:12). kganyago (2019)’s conviction that this ‘obsession’ with the sarb is a distraction from the real, hard economic questions that need to be asked perhaps gives credence to the scapegoating theory. 11. it should be noted that the reserve bank act does make allowance for a limited amount of government stock to be held by the sarb. the sarb cannot, however, make ‘excessive direct purchases of government stock’ (mboweni 2000:6). this does not rule out the central bank granting credit to the government, but it does restrict the direct financing of government deficits by the central bank. 12. it is this perceived arrogance and disconnect of economists and technocrats to think themselves more equipped than the elected government to act in the public interest which grates. the misunderstanding is, however, that they are arguably simply performing the tasks delegated to them by democratically elected politicians. 13. however, maxfield (1997:15) argues that ‘lack of policy coordination can stem from a variety of factors other than central bank independence’. 14. interestingly, the sarb’s first board of directors included three representatives of the commercial banks of the time. however, the currency and banking act amendment act (no. 22 of 1923) excluded these banking representatives from the board, specifically to increase its independence from the banking sector (de kock, 1954). 15. this point has also been made and emphasised by president ramaphosa (fin24 2019a). 16. the literature on the impact of monetary variables (money supply and interest rates) on real variables (employment, economic growth and development) is immense. an exhaustive treatment of this topic falls beyond the scope of this article, but the debate can be traced back as far as keynes and hayek in the 1930s. 17. a significant empirical literature also interprets the phillips curve as the relationship between inflation and output. in this view, higher output could be achieved by tolerating higher inflation. 18. interestingly, ‘during the pre-democratisation era monetary policy decisions were made predominantly by the person of the governor of the bank’ (wessels 2004:149). the mpc was only created in 1999. 19. there seems to exist a misconception that the sarb’s shareholders have access to gold and foreign exchange reserves held by the central bank on behalf of the government. crucially, however, the sarb is not the owner of the country’s gold and foreign exchange reserves, but merely the custodian. gold and foreign exchange belongs to the government, while the sarb is only responsible for the management thereof. therefore, no sarb shareholder can lay claim to a share of the country’s gold or foreign exchange reserves, as these assets do not belong to the sarb and, by extension, also not to its shareholders. abstract introduction review of literature method results discussion acknowledgements references about the author(s) liana fourie work well research unit, north-west university, potchefstroom, south africa crizelle els work well research unit, north-west university, potchefstroom, south africa leon t. de beer work well research unit, north-west university, potchefstroom, south africa citation fourie, l., els, c. & de beer, l.t., 2020, ‘a play-at-work intervention: what are the benefits?’, south african journal of economic and management sciences 23(1), a2815. https://doi.org/10.4102/sajems.v23i1.2815 note: this article is partially based on the first author’s mini-dissertation submitted in partial fulfilment of the requirements for the degree master’s of commerce in industrial psychology at north-west university, south africa, with supervisor dr c.e. and co-supervisor, prof. l.t.d.b., received may 2018, available from: https://repository.nwu.ac.za/bitstream/handle/10394/30974/fourie_l.pdf?isallowed=y&sequence=1. original research a play-at-work intervention: what are the benefits? liana fourie, crizelle els, leon t. de beer received: 17 sept. 2018; accepted: 12 feb. 2020; published: 27 may 2020 copyright: © 2020. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: organisations are investing time and resources in implementing play at work. however, the possible effect of play at work as an organisational intervention is largely unknown. aim: this study aimed to determine the effect of a play-at-work intervention on psychological detachment, work enjoyment, employee performance, and workplace boredom of work teams. setting: the sample consisted of 26 telemarketing employees in the northwest province, south africa. methods: a longitudinal, three-wave intervention study design was followed. the sample consisted of two work teams from a telesales company divided into the experimental group (n = 9) and the control group (n = 17). a play-atwork intervention consisting of different single-player and multi-player games was developed. surveys were used to collect data prior to introducing the intervention, after one week of play, and again after the second week of the intervention. results: the results indicated that the play-at-work intervention positively influenced employees’ psychological detachment during their lunch break. team performance also increased when the play-at-work intervention was introduced. conclusion: employees who participates in play during their breaks will be more likely to psychologically detach compared to other employees. also, organisations who implement play will have higher team performance compared to others. keywords: play-at-work intervention; psychological detachment; work enjoyment; team performance; workplace boredom. introduction traditionally, play and work were seen as opposites, but in the modern workplace, play seems to be intertwined with work (butler et al. 2011; west 2015). many organisations have reformed to a fun and playful work environment. west (2015) describes play as a behavioural approach that is characterised by play being voluntary, fun, frivolous, imaginative, and bound by structure or rules in some way. a playful work environment does not directly meet any organisational outcomes, but it can be a pleasurable mood booster as joy is emotionally contagious, resulting in employees learning from one other, improved team cohesion, social relationships, creativity, trust, commitment and productivity (han, kim & jeong 2016; sukovic, litting & england 2011; tews, michel & noe 2017; verenikina & hasan 2010; west 2015). literature has indicated that younger employees may welcome play at work, while the majority of the senior workforce may not enjoy it (belkin 2007). research has also proved that fun working environments are more customary in less formal organisations (bolton & plester 2009). although the benefits of a playful work environment are confirmed in the literature above, the majority of studies found in the literature study the gamification of work, rather than playing at work. gamification refers to the application of characteristics from games into non-gaming contexts (perryer et al. 2016); in other words, gamification suggests that you modify the employees’ work into the form of a game. although this type of work design has proven to have a positive impact on the workplace (kapp 2012; perryer et al. 2016), others have revealed that employees do not enjoy being forced by management to play as fun and laughter are spontaneous and not a package with the promise of results (bolton & houlihan 2009). similarly, west (2015) suggests that play should be done just for fun and for no other reason. play at work, rather than the gamification of work, refers to employees playing games just for fun, to enable them to psychologically detach from work and replenish their resources (hülsheger 2016), before they commence working again. therefore, for the purpose of this study, play at work was used as a term to describe fun activities or games in the workplace separate from work. research has shown that playing while at work creates a break in the workday, which may benefit employees’ motivation, involvement, relationships and physical and mental fitness (sørensen & spoelstra 2012). despite fascinating findings regarding play, empirical research regarding the relationship between play and work is scarce, and consequently the effects of play on organisational outcomes are still relatively unknown (perryer et al. 2016; sørensen & spoelstra 2012). therefore, it is against this background that the current study aims to investigate the effect of play as organisational intervention on different workplace constructs. review of literature play at work and psychological detachment one of the main recovery experiences is psychological detachment which refers to employees refraining from work-related thoughts and activities during non-work time, thereby disengaging psychologically from work (sonnentag & fritz 2015). it forms part of the conservation of resources (cor) theory and the effort-recovery (e-r) model that emphasise that employees need to recover to restore lost resources (hülsheger 2016; sonnentag & fritz 2007). previous studies have been in agreement that it is important for employees’ well-being to psychologically detach from work during non-work time as it helps employees to restore energetic and affective resources (sonnentag & fritz 2015; sonnentag & kühnel 2016; zijlstra, cropley & rydstedt 2014). play promotes openness and humour, and helps employees to temporarily relax and forget about objectives (west 2015). a study conducted by oerlemans, bakker and demerouti (2014) revealed that happiness during physical and social activities enhances recovery among employees. similarly, trougakos and hideg (2009) affirm that enjoyable activities help employees to restore their affective resources. however, previous research shows that employees who experience workplace fun had lower levels of emotional exhaustion and emotional conflict (karl, peluchette & harland 2007). additionally, employees psychologically detach more when they are fully engaged or absorbed by the off-job activities (feuerhahn, sonnentag & woll 2014; hahn, binnewies & haun 2012). therefore, the assumption could be made that play at work may help employees to psychologically detach from work as it can be an enjoyable activity that is not completely undemanding. against this background this hypothesis is formulated: h1: a play-at-work intervention will be effective in increasing the psychological detachment of an experimental group, compared to the psychological detachment of a control group. psychological detachment was at first only measured away from work, but sonnentag and fritz (2015) argue that employees can psychologically detach from work during their breaks; however, research regarding this is lacking. therefore, there is a gap in the literature regarding psychological detachment during break times at work, which this study aimed to investigate. furthermore, another study also identified that employees felt most fatigued before their lunch break than any other part of the day (hülsheger 2016). play at work and work enjoyment the workforce of today has changed from the previous years: employees now expect their work to be fun and enjoyable (romero & pescosolido 2008; west 2015). research has proved that the workplace can have a large impact on employees’ happiness and well-being (rodríguez-muñoz & sanz-vergel 2013) thereby highlighting the importance to investigate employee’s work enjoyment. work enjoyment refers to the extent that employees perceive their work as pleasurable or enjoyable (graves et al. 2012). peters et al. (2014) explain that work enjoyment is how employees evaluate the quality of their lives at work. the antecedents of work enjoyment include employee characteristics, the employees’ work itself and the work environment (bakker 2008), and therefore this study argues that a play-at-work intervention will influence the work environment, thereby influencing work enjoyment levels: h2: a play-at-work intervention will be effective in increasing the work enjoyment of an experimental group, compared to the work enjoyment of a control group. for employees to be happy at work, they need to experience more pleasure (bakker & daniels 2013; xanthopoulou, bakker & ilies 2012). positive events such as the play-at-work intervention can lead to employees experiencing positive emotions (trougakos & hideg 2009). according to the broaden-and-build theory, when employees experience positive emotions, it can increase a variety of personal resources (fredrickson et al. 2008). consequently, a study by demerouti et al. (2012) identified that work enjoyment results in lower exhaustion levels and higher vigour levels. the authors also identified that employees who psychologically detach during off time and who had high levels of work enjoyment also showed higher levels of vigour. therefore, it is no surprise that research has proved that happy employees can lead to an organisation’s competitive advantage (kasper-brauer & leischnig 2016). this is supported by other studies that proved that work enjoyment can lead to improved work performance (engeser & rheinberg 2008; graves et al. 2012; hsiao et al. 2015). play at work and performance if an organisation wants to have the competitive edge, it need to ensure that it employs the best persons for the job; however, it seems that the new career enterers value fun at work. thus it is understandable that many organisations are creating a fun work environment since it has an influence on not only the well-being of their employees, but also the reputation of the company, as well as employee performance (karl et al. 2007). performance is important for any organisation as it directly influences the profitability of an organisation (maiga, nilsson & ax 2015). performance is defined as ‘those actions and behaviours that are under the control of the individual and contribute to the goals of the organisation’ (rotundo & sackett 2002:66). tews, michel and stafford (2013) argue that fun at work may allow employees to take a break from work, resulting in employees being more engaged when they start working again, thereby improving performance. karl et al. (2007) identified that fun at work can increase employee satisfaction and performance. similarly, fluegge-woolf (2014) found that fun at work is directly and positively related to citizenship behaviour and indirectly and positively related to employee performance. butler et al. (2011) add that the less the office is perceived as dull and dreary, the more value will be added to the bottom line. therefore, the assumption could be made that the play-at-work intervention will increase employee performance: h3: a play-at-work intervention will be effective in increasing the team performance of an experimental group, compared to the team performance of a control group. play at work and workplace boredom workplace boredom refers to the experience of boredom within the domain of work (van wyk et al. 2016). workplace boredom is described by schaufeli and salanova (2014) as ‘an unpleasant state of relatively low arousal and dissatisfaction, which is attributed to an inadequately stimulating work situation’ (p. 298). when an employee’s ability exceeds task complexity, workplace boredom is more likely to be experienced (schaufeli & salanova 2014; van wyk et al. 2016). cummings, gao and thornburg (2016) also mentioned that workplace boredom is experienced when employees feel their work is too simple and easy or when they have too little to do. therefore, workplace boredom has also been linked to employees doing short repetitive work (schaufeli & salanova 2014). consequently, it is clear that the work environment and job characteristics are seen as main sources of workplace boredom (loukidou, loan-clarke & daniels 2009). according to the mood management theory, employees seek entertainment when they experience workplace boredom (perryer et al. 2016). the authors further explain that, according to the mood management theory, play at work can satisfy hedonic needs of employees and assist in regulating arousal by reducing the experience of boredom. jackson and carter (2011) also argue that employees use boredom to generate the need to do something pleasurable, for instance play at work. butler et al. (2011) explain that work has an intrinsic relation to the experience of workplace boredom and play represents the employees’ desire to escape from it. therefore, according to the authors, it is understandable that employees implement play in the workplace to cover up the boredom experienced by employees: h4: a play-at-work intervention will be effective in reducing the workplace boredom of an experimental group, compared to the workplace boredom of a control group. although theory suggests that play can reduce workplace boredom, more research is needed to identify the direct influence of play on workplace boredom (spraggon & bodolica 2014). method research design a longitudinal, three-wave, pre-test–post-test randomised experimental design was followed. in longitudinal studies, researchers collect data from the same subjects at more than one point in time. a pre-test was administered to the experimental and the control group before a play-at-work intervention was introduced. one post-test was done after one week of implementing the intervention and again after the second week of implementing the intervention. paper-based questionnaires were used to collect the data. research participants the sample consisted of employees working at a telesales company in the north west province of south africa. a non-probability purposive sampling strategy was followed. the telesales environment may tend to be repetitive, creating an ideal environment for evaluating the intervention developed in this study. the telesales department of the organisation consisted mainly of two work teams and these two teams were randomly assigned to the experimental and the control group. therefore, both of the teams had an equal chance of being the experimental or the control group (boot et al. 2013; reid 2013). the biographical characteristics of the participants are presented in table 1. table 1: biographical characteristics of participants. the sample consisted of two very small groups of employees; all the employees in the department were invited to participate in the study and 26 participants (n = 26) completed all three waves of data. the experimental group consisted of 9 participants (n = 9) and the control group consisted of 17 participants (n = 17). the majority of the experimental group sample were female (n = 6; 66.67%) and 88.89% (n = 8) of the participants were between the ages of 20 and 29. the control group consisted mostly of men (n = 11; 64.71%) and 88.24% (n = 15) of the sample were between the ages of 20 and 29. measuring instruments psychological detachment psychological detachment was measured by adapting the psychological detachment dimension of the recovery experience questionnaire (req) of sonnentag and fritz (2007). the four psychological detachment items were adjusted to measure psychological detachment during the employees’ lunch break when they participated in the play-at-work intervention (e.g. ‘during my break time i do not think about work at all’). work enjoyment work enjoyment was measured with the work pleasure scale, a section of the dutch questionnaire on the experiences and evaluation of work (van veldhoven et al. 1997). this scale has nine items (e.g. ‘i enjoy my work’) and has been proven to be reliable with a cronbach’s alpha coefficient of 0.80 (kompier, taris & van veldhoven 2012). team performance team performance was measured with objective performance data provided by the participating organisation. the team performance was calculated with the added total of all team members’ number of sales and number of upgrades. the team performance during the two weeks of the intervention (first two weeks of july 2017) was compared to: (1) the team performance in the month preceding the intervention (i.e. first two weeks of june 2017) and (2) team performance by the teams at the same time during the previous year (i.e. first two weeks of july 2016). the experimental group’s team performance was also compared to that of the control group. workplace boredom workplace boredom was measured with the one-dimensional dutch boredom scale (dubs) developed by reijseger et al. (2013). this scale has six items (e.g. ‘i tend to do other things during my work’) and has reported a cronbach’s alpha coefficient of 0.78 within the south african context (van wyk et al. 2016). all the items were measured on a six-point likert scale: 1 (strongly disagree), 2 (disagree), 3 (slightly disagree), 4 (slightly agree), 5 (agree), 6 (strongly agree). feedback on the experiences and choices of games for the intervention was also included in the survey. specifically, the open-ended questions that were asked included: ‘please indicate the dates on which you have played this week. also indicate the length of time you played each day’, ‘please indicate which games you have played in this week. also indicate the approximate time spent on each game’, and ‘what was your overall experience of this opportunity to play during your lunch break?’ play-at-work intervention for the purpose of this study a play-at-work intervention was developed. as employees might not share the same interest in games, the intervention consisted of different single-player and multi-player games and the games catered for individuals who enjoy sport-like, creative, thinking, board-based and puzzle games. employees were free to choose which games they wanted to play during the intervention (perryer et al. 2016). the 13 games that were implemented were chosen after consulting with experts in the field of industrial psychology. table 2 provides a brief description of the games that were included in the intervention. table 2: intervention games. research procedure the first survey (pre-test) was administered to both the experimental and the control group prior to introducing the intervention. during the first week of introducing the intervention, only the experimental group had the opportunity to play during their lunch break for one hour. after the first week of introducing the play-at-work intervention, both the experimental and the control groups completed the first post-test. to also allow the control group to have the opportunity to play, both the experimental and control group had the opportunity to play during the second week of the intervention. after the second week of play, both the experimental and the control group completed the second post-test. figure 1 illustrates the implementation of the play-at-work intervention and the research procedure followed to collect the data. figure 1: research procedure. all the questionnaires were distributed by hand and participants anonymously deposited their completed surveys in a sealed box provided. a unique code was generated by each of the participants that consisted of the first three letters of the employee’s mother’s name, followed by the first three letters of their father’s name. the unique code protected the identity of the participants and also assisted in identifying the employees who completed surveys on more than one occasion. statistical analysis the statistical package for the social sciences (spss) version 24 (ibm corp. 2017) was used to perform statistical analyses. descriptive statistics provided a summary of the data: measures of central tendency were calculated with the mean and median scores; measures of dispersion were calculated with variance, standard deviation, range, and skewness and kurtosis scores (struwig & stead 2013). statistical significance was set at the 0.05 level (i.e. p < 0.05). the independent sample t-test was used to test for statistical differences between mean scores of the two groups (elliott & woodward 2007). the spss program includes levene’s test to investigate for the homogeneity of variances. the mean scores of psychological detachment, work enjoyment and workplace boredom were compared within and between the groups to ascertain if there were any significant differences between the scores on the variables over time. the three different waves of data from the experimental group were compared (within groups) and the three different waves of data from the control group were also compared (within groups). the mean scores of the experimental group were also compared to the mean scores of the control group (between groups). to determine whether the intervention had the same impact on both groups during their first week of play, the mean scores of the second wave of data of the experimental group were also compared to the mean scores of the third wave of data from the control group. when the independent sample t-test indicated statistically significant differences in mean scores, an effect size was calculated (i.e. cohen’s d value). cohen’s d value represented the standardised mean differences between groups with small effects (d = 0.20), medium effects (d = 0.50) and large effects (d = 0.80) (ellis 2010). ethical consideration ethical clearance has been obtained from the economic and management sciences research ethics committee (ems-rec), north-west university (ethics no. nwu-00439-17-a4) prior to conducting the study. results the distribution of scores is presented in table 3. table 3: data distribution. the data set was normally distributed since the skewness and kurtosis scores were between 1 and −1, as can be seen in table 3 (reid 2013). all the requirements for an independent sample t-test were met as levene’s test supported homogeneity of variances. this analysis indicated that all the results had equal variances assumed, as none of levene’s tests for equality of variances’ results proved to be statistically significant (p < 0.05). when comparing the mean scores, as seen in table 4, the mean score for psychological detachment is noticeably lower at survey 1 for the experimental group when compared to the other surveys and the control group, with a standard deviation of 3.28. furthermore, it can be seen that the mean score for psychological detachment of the control group increased considerably from survey 2 to survey 3 after the introduction of play. the results showed that the mean scores for work enjoyment and workplace boredom stayed relatively unchanged across the three surveys. table 4: group mean scores and standard deviations. as seen in table 5, when comparing the pre-test (survey 1) and the post-test (survey 2) of the experimental group, statistically significant differences were indicated for psychological detachment (p < 0.001). cohen’s d value (d = 2.207) indicated a large practical effect between these mean scores. there were no statistical differences for work enjoyment and workplace boredom. table 5: independent sample t-test results. the mean scores of the pre-test (survey 1) were compared with the second post-test (survey 3) of the experimental group and the results indicate statistically significant differences (p < 0.001) for psychological detachment with cohen’s d value indicating a large practical effect size difference (d = 2.771). however, no statistical differences were indicated for work enjoyment and workplace boredom. also, no statistical differences were found when comparing the first (survey 2) and the second post-test (survey 3) of the experimental group. as seen in table 5 no statistically significant differences were indicated when comparing the pre-test of the experimental group to the pre-test of the control group. when comparing the results of the second survey of the experimental group to those of the control group, statistically significant results were found at psychological detachment (p = 0.025), with cohen’s d value indicating a large practical effect (d = 1.054). again, no statistical differences were indicated for work enjoyment and workplace boredom. finally, table 5 indicates that no statistically significant differences were indicated when comparing the third survey of the experimental group to that of the control group. when comparing the results of the first week of play of both groups (survey 2 of the experimental group and survey 3 of the control group), no statistically significant differences were indicated. no statistically significant differences were identified when comparing the control group’s mean scores of the pre-test (survey 1) to the first post-test (survey 2). there were statistical differences (p < 0.001) indicated at psychological detachment when comparing the pre-test (survey 1) to the second post-test (survey 3) of the control group, and cohen’s d value indicated a large practical effect (d = 1.853). when comparing survey 1 and survey 3 of the control group, again no statistical differences were found for work enjoyment and workplace boredom. to assess team performance, the number of sales and upgrades made per team were calculated during the intervention (i.e. first two weeks of july 2017), one month prior to the intervention (i.e. first two weeks of june 2016) and one year prior to the intervention (i.e. first two weeks of july 2016). firstly, the team performance of the experimental group for july 2017 was compared to the same team’s performance for july 2016. the results indicate that the team’s performance was higher during the intervention in july 2017 when compared to july 2016. when comparing the control group’s performance for july 2017 with the previous year, july 2016, the results indicate that the control group also performed better when participating in the intervention. furthermore, the results suggest that the experimental group’s performance during the intervention was higher than their performance the previous month, june 2017, as seen in figure 2. the experimental group’s team performance during the first week of the intervention was also compared to their performance during the second week of the intervention. the results revealed that more sales were made during the second week of introducing the intervention than the first week of the intervention. comparison of the control group’s results to that of the month before the intervention was implemented (june 2017) indicated that the control group performed better while participating in the intervention, as seen in figure 2. figure 2: comparison of team performance in the experimental and control groups: (a) july 2016 and july 2017; (b) june 2017 and july 2017. additional data was also gathered in the second and third survey to document the number of participants interested in each game, the total amount of time spent on each game, as well as the experiences of the employees playing these games. table 6 illustrates the number of participants who played each of the games per week, and the total time (in minutes) each team spent playing each game per week. both the experimental and control groups seemed to have enjoyed the foosball, darts, neon-paint doodling, 30 seconds, fingerboard and playing cards. less play time was spent on adult colouring, heads up, scrabble, jenga, crossword puzzles, sudoku and dominoes. table 6: collective minutes played per team, per week. discussion this study aimed to determine the effect of a play-at-work intervention on organisational outcomes of work teams by specifically investigating psychological detachment, work enjoyment, team performance and workplace boredom. this study sought to address the gap in the literature, as previous research regarding the application of play to the workplace context is sparse and as psychological detachment during employees’ lunch break has not been fully investigated (perryer et al. 2016; sonnentag & fritz 2015; west 2015). to this end, a play-at-work intervention was implemented in a telesales organisation in south africa for two weeks. hypothesis 1 stated that a play-at-work intervention will be effective in increasing the psychological detachment of an experimental group, compared to the psychological detachment of a control group. the results support this hypothesis as the second survey indicated that the experimental group experienced higher levels of psychological detachment during their lunch break when participating in the play-at-work intervention compared to the control group who at this stage did not participate in the intervention. the results of comparing survey 1 and survey 2 of the experimental group also confirmed that employees psychologically detached more while participating in the intervention. this hypothesis was again supported when comparing survey 1 and survey 3 of the experimental group and survey 1 and survey 3 of the control group. these results support the arguments that employees can psychologically detach during their lunch break and that leisure activities that are enjoyable, positive and not completely undemanding help employees to psychologically detach (sonnentag & fritz 2015; trougakos & hideg 2009; tucker et al. 2008). these findings suggest that a play-at-work intervention has the potential to allow employees to psychologically detach from their work. this finding is important, as the benefits of psychological detachment for both the individual and the organisation has been noted in previous research, indicating its impact. for example, a study by moreno-jiménez et al. (2009) found that psychological detachment moderates the relationship between workplace bullying and psychological strain. previous research also suggests that psychological detachment from work alleviated the negative relationship between relationship conflicts at work and well-being (sonnentag, unger & nägel 2013). it was also found that psychological detachment moderated the relationship between role conflict and anxiety (moreno-jiménez et al. 2012). sonnentag, binnewies and mojza (2010) identified in a longitudinal study that psychological detachment from work has an impact on emotional exhaustion and buffers the relationship between job demands and psychosomatic complaints. the authors also identified that psychological detachment moderates the relationship between job demands and work engagement. hypothesis 2 of this study stated that a play-at-work intervention will be effective in increasing the work enjoyment of an experimental group, compared to the work enjoyment of the control group. this hypothesis was rejected as the results suggested that both the experimental group and control group’s work enjoyment levels were relatively unaffected by the intervention. a possible reason for the lack of significant increase in work enjoyment may be because the play-at-work intervention took place during the employees’ lunch break and therefore did not have anything to do with the employees’ work itself. sanz-vergel and muñoz (2013) also explained that work enjoyment refers to employees feeling happy while working. research regarding the gamification of work may possibly yield more significant results when trying to establish a relationship between play and the work itself, since gamification entails the application of game characteristics into non-gaming contexts (perryer et al. 2016), meaning that you transform the employees’ work into the form of a game. hypothesis 3 stated that a play-at-work intervention will be effective in increasing the team performance of an experimental group, compared to the team performance of the control group. the results from this study did indeed indicate that a play-at-work intervention has the potential to increase employee performance. it was found that the performance of the experimental group slightly increased during the duration of the intervention compared to the team’s performance one month prior to the intervention, and also during the same time of the previous year. however, the control group’s results also indicated that the team performance improved when participating in the play-at-work intervention. therefore, according to the results, the play-at-work intervention seemed to improve the team performance of the experimental and the control group, thereby supporting hypothesis 3. these results are in line with sørensen and spoelstra (2012) who stated that play in an organisation is productive for work. verenikina and hasan (2010) also argued that play at work is an influence on the emotional climate and performance of an organisation. previous research also indicated that recovery among employees predicts improved performance (binnewies, sonnentag & mojza 2010; halbesleben, wheeler & paustian-underdahl 2013; volman, bakker & xanthopoulou 2013). this may also explain the increase in the team performance in this study. hypothesis 4 suggested that a play-at-work intervention will be effective in reducing the workplace boredom of an experimental group, compared to the workplace boredom of a control group, which was not confirmed by the results. there were no statistically significant differences indicated in workplace boredom when the groups were compared, thereby indicating that the levels of workplace boredom experienced by the employees did not change during the play-at-work intervention. therefore, the hypothesis is rejected. these results are in contrast to the suggestion made by butler et al. (2011) that work and play have a relationship with boredom experienced by employees. these results also do not support that games in the workplace can help to restore a deficit such as boredom, as explained by the mood management theory (perryer et al. 2016). research has proved that when employees’ abilities exceed their task complexity, and when they have too little to do, they are more prone to experiencing workplace boredom (cummings et al. 2016; schaufeli & salanova 2014; van wyk et al. 2016). the lack of decline in workplace boredom experienced in our study may be explained by the fact that the play-at-work intervention may have given employees the opportunity to do something else when they experience workplace boredom, but it did not change the employee’s task complexity. another reason for the rejection of the hypothesis may be due to the short duration of the play-at-work intervention. the question can be raised whether two weeks of intervention allows sufficient time to recover from boredom at work. previous studies identified that employees under the age of 30 are more prone to enjoy fun in the workplace (belkin 2007; tews, michel & bartlett 2012). the participants in this study were all almost younger than 30: 88.89% of the experimental group were younger than 30, and 88.24% of the control group were also younger than 30. for this reason, the age of the majority of the sample could have had an impact on the results. as employees older than 30 are not inclined to participate in fun at work, an older workforce may not have participated in the play-at-work intervention, which could have resulted in no statistically significant findings. the results also suggest that the participants showed interest in different games. this is in line with perryer et al. (2016) who stated that all employees will not be interested in the same games, as well as with karl et al. (2007) who identified that fun may be welcomed by some employees and not by others. both teams seemed to enjoy the neon-paint doodling, foosball, darts, 30 seconds, fingerboard and playing cards; interestingly, all of these games are group based, except for the neon-paint doodling. employees showed little to no interest in the individual games, for example adult colouring and crossword puzzles. furthermore, the participants’ positive experiences indicated that the play-at-work intervention was relaxing for the employees and it helped them to forget about work for a moment. participants also reported that they got to know their colleagues in a new way. participants reported that they also felt more focused and positive after playing in their lunch breaks. these findings support trougakos and hideg (2009) who identified that the experience of positive events also enhances the experience of positive emotions. this also builds on the broaden-and-build theory that conceives when employees experience positive emotions, it helps them to increase personal resources (fredrickson et al. 2008). practical implications in this study, it was found that play at work can increase the psychological detachment of employees. psychological detachment can be greatly beneficial for the individual and the organisation. research has shown that psychological detachment plays a moderating role in the relationships between some important organisational variables, including the relationship between workplace relationship conflicts and well-being (sonnentag et al. 2013); it also moderates the relationship between anxiety and role conflict in organisations (moreno-jiménez et al. 2012) and psychological detachment moderates the relation between job demands and work engagement (sonnentag et al. 2010). therefore, based on this study’s results, it can be recommended that organisations should invest in implementing play at work to help employees to psychologically detach from work as it can benefit an organisation in the long run. furthermore, it can be suggested that when organisations invest time and resources to introduce playing at work, it may increase their bottom line, as play at work improves team performance, and performance has been proven to directly influence the profitability of an organisation (maiga et al. 2015). despite the positive consequences playing at work may have on employees and their performance, organisations should remember before implementing play in the workplace that some employees may welcome play in the workplace, while others may not (karl et al. 2007). for organisations to benefit from playing in the workplace, it is therefore important to match play with the employees. furthermore, all employees differ and as a result they will not be interested in the same type of games (perryer et al. 2016), and consequently it is also important to match the type of games with the employees in the organisation. research has shown that younger employees (belkin 2007) and more informal organisations (bolton & plester 2009) are more inclined to enjoy fun in the workplace. however, this does not mean that older employees or employees in more formal work settings may not benefit from playing at work. in the case of these employees, the organisation might need to convince the employees of the possible benefits of playing at work in order to win their buy-in. it can also be recommended that these employees are given the opportunity to express their preferences of the types of games they are interested in. limitations and recommendations this study is not without limitations. firstly, the duration of this study was only two weeks. consequently, the long-term effect of the intervention is still unknown. one could have done a final survey one or two months after the intervention to determine whether the inclines in psychological detachment and performance were prolonged effects or only short-term results. furthermore, it can be argued that two weeks might not have been enough time to influence levels of work enjoyment and workplace boredom. it is therefore suggested that future research should explore the possibility of a prolonged play-at-work intervention and the influence of such a longer duration on employee outcomes. secondly, the intervention was implemented in a telesales organisation in the north west province of south africa. the participating organisation is described by its management as informal. previous research has indicated that informal types of organisations are more inclined to participate in play at work (bolton & plester 2009), and therefore this type of intervention may not have the same effect in a more formal organisation as employees may not participate in the play-at-work intervention and therefore the intervention may not have the same results. for this reason, these results cannot be generalised to all organisations within the south african context. furthermore, this sample only had 9 participants in the experimental group and 17 participants in the control group. as estimates in small samples can be incorrect (schönbrodt & perugini 2013), no reliability or correlations could be calculated. it can therefore be suggested that future research should utilise a larger sample to address this limitation. acknowledgements competing interests the authors have declared that no competing interests exist. authors’ contributions l.f. fulfilled the role of the primary researcher, and this study formed part of her master’s research. she was responsible for the conceptualisation of the article, collecting of the data, the interpretation of the research results, and the writing of the article. c.e. acted as supervisor and l.t.d.b. as co-supervisor to this study, and thus played an advisory role in this study and assisted in the conceptualisation of the study and the writing of the research article. l.t.d.b. also conducted the statistical analyses. funding information this study was in part funded 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stress & health: journal of the international society for the investigation of stress 30(3), 244–252. https://doi.org/10.1002/smi.2604 abstract introduction market orientation and non-technical innovation research methods and procedures data interpretation and results discussion and implementation conclusion and recommendations acknowledgements references about the author(s) chen wang department of construction management, huaqiao university, xiamen, china yee lin lee faculty of built environment, university of malaya, kuala lumpur, malaysia jeffrey boon hui yap department of surveying, lee kong chian faculty of engineering and science, universiti tunku abdul rahman (utar), petaling jaya, malaysia lincoln c. wood department of business and management, university of otago, dunedin, new zealand hamzah abdul-rahman faculty of built environment, university of malaya, kuala lumpur, malaysia citation wang, c., lee, y.l., yap, j.b.h., wood, l.c. & abdul-rahman, h., 2020, ‘non-technical innovation and entrepreneurship in project-based small service firms’, south african journal of economic and management sciences 23(1), a3498. https://doi.org/10.4102/sajems.v23i1.3498 original research non-technical innovation and entrepreneurship in project-based small service firms chen wang, yee lin lee, jeffrey boon hui yap, lincoln c. wood, hamzah abdul-rahman received: 18 dec. 2019; accepted: 29 may 2020; published: 27 aug. 2020 copyright: © 2020. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: because of doubts about the sufficiency of convention indicators to continually gauge innovative outcomes at the firm level, a burgeoning stream of scholars has shifted their empirical efforts to the theoretical development of non-technical innovations. aim: this study investigates the contribution of non-technical, innovative, entrepreneurial and marketing endeavours to the development of superior entrepreneurship through two types of firm capabilities. setting: over several stages, a structured questionnaire form was formulated. firstly, an extensive review of previous similar research was performed to identify the adoptable scale items. after adjusting the scales based on the feedback from the pre-testers, the final questionnaire comprised 55 items measured on a five-point likert-type scale. methods: a total of 155 valid questionnaires, with the inclusion of late-responses, were obtained and this represented a response rate of 22%. particularly, a conceptual model connecting market orientation, organisational learning, non-technical innovation and entrepreneurship was tested using partial least square path modelling. results: in considering the criticality of innovation as the fulcrum of service-based delivery, our model advances the existing empirical approaches with a more intangible dimensionality of innovative efforts. overall, the model distinguishes that small service firms engaging in dual modes of non-technical innovation strategically nurture intangible capabilities, which in turn provides them with enduring performance outcomes in outperforming competitors. conclusion: the findings could assist small firms in accomplishing new value creation via non-technical innovations. keywords: entrepreneurship; non-technological innovation; organisational learning; innovation; small-sized firms; sme. introduction for many years, research on innovation has tended to endorse a technical-centred advancement (davies, manning & söderlund 2018; drejer 2004; slaughter 2000). due to doubts about the sufficiency of these convention indicators to continually gauge the innovative outcomes at the firm level, a burgeoning stream of scholars has shifted their empirical efforts to the theoretical developing of non-technical innovations (armbruster et al. 2006; camison & villar-lopez 2014; caroli & van reenen 2001; evangelista & vezzani 2010; gallego & rubalcaba 2012; greenan 2003; hamel 2006; mol & birkinshaw 2009; naidoo 2010; oecd 2005; shergill & nargundkar 2005). these findings reported that non-technical innovation, which suggests advantage within organisational or managerial and marketing innovations, can harness the extant research stream with an enhanced understanding of the innovative dynamism and the performance consequences of engagement (iliescu & ciocan 2017; martínez-román, tamayo & gamero 2017; nyström, nilsson & lind 2016). the inclusion of non-technical metrics is anecdotally meritorious in terms of their complementing role in new technical deliveries (aravind, damanpour & devece 2014; evangelista & vezzani 2010; gallego & rubalcaba 2012; weerawardena, o’cass & julian 2006). in spite of the myriad arguments, the question of how non-technical innovation fundamentally pullulates in its own right remains tangential in discussion (turk 2016; xue et al. 2018). this study extends the previous line of reasoning on three fronts. firstly, centred on the non-technical innovation, camison and villar-lopez (2011) encourage research on its capabilities-based antecedents and performance consequences. to date, reports identifying the effects of firm capabilities, such as market-oriented competence (baker & sinkula 1999; im & workman 2004; salavou 2002; zhang & duan 2010) and learning capacity (alegre & chiva 2008; pesamaa et al. 2013), were subject to fragmentation as seen in the biased preference towards technical innovative offerings. although the central importance of market-oriented and learning-based capabilities has been long attested in the literature, understanding of their integrative impact on entrepreneurship, first directly and second via the mediated effect of non-technical innovation, is as yet nearly non-existent. this issue is especially crucial given that non-technical innovative activities are essential sources of superior entrepreneurship (mol & birkinshaw 2009; naidoo 2010; shergill & nargundkar 2005). extending the original reasoning, the present study moulds the antecedents and consequence of organisational and marketing innovations together in a single model. secondly, beyond the ubiquitous manufacturing orthodoxies (camison & villar-lopez 2011, 2014; weerawardena 2003), this study explicates the empirical value of a service-centred approach in analysing non-technical innovation. innovation modes are relatively heterogeneous; in fact, there is considerable variation between firms with product-centric market settings and those engaging with service-based value creation (kindstrom, kowalkowski & sandberg 2013). in this respect, service firms that based their business deliveries upon projects have been identified as ideal for the conceptualisation of service-based innovation (salunke, weerawardena & mccoll-kennedy 2011). given their distinct features, such as co-creation of outputs around one-off projects, temporary coalition with varying business actors and business deliveries within complex in-situ sites (manley 2008), project-based service firms reflect characteristics differentially unique to the services regime. in the project-based context, this study addresses the need for greater evidence in conceptualising innovation within the services setting (hauser, tellis & griffin 2006; o’cass et al. 2013). thirdly, the growing literature on non-technical innovation pays scant attention to the implications for small firms as compared to larger organisations (pereira & romero 2013; turk 2016; xue et al. 2018; zubizarreta et al. 2017). this is detrimental for small businesses, for they do not always engage in value-creating changes via research and development (acs & audretsch 1988). despite the innate scarcity of resources, small firms have demonstrated an innovation pattern conceivably different from that of their larger counterparts (gallego & rubalcaba 2012). this study attempts to capture the essence of non-technical measures in connection with resource-poor firms. aware of the aforementioned inconsistencies, this study conjectures that innovative firms would purposefully develop certain capabilities for which superior performance have been found. theorising non-technical innovation as the likely mediator, a conceptual framework is formulated to distinguishing the interplay effect of market orientation (mo) and organisational learning (ol) on entrepreneurship within a sample of small malaysian contracting service firms. the article starts with a review of related literature and a description of the conceptual framework with its hypotheses. the design of the study with empirical analysis from 155 project-based small innovative firms is then presented. market orientation and non-technical innovation market orientation has long been addressed as a central tenet of organisational strategy that rests profit maximisation on the continuous deciphering of volatile market demands (fernandez, roy & chiambaretto 2018; lettice, tschida & forstenlechner 2014). as part of the cornerstone of organisation culture (narver & slater 1990), mo leads to specific behavioural traits that translate into organisational competitive performance (han, kim & srivastava 1998; matear et al. 2002). facing rapidly changing consumer preferences, the proficiency to integrate a market-oriented attitude with innovation focus would furnish small businesses with superior service advantages (iliescu & ciocan 2017; raju, lonial & crum 2011; salavou 2002; turk 2016). even in times of economic crisis, firms with a stronger market focus indicate a greater ability to withstand adverse turbulence than those exhibiting a weaker market focus (lettice et al. 2014). in an empirical sense, the mo scales have gained prominent validation in services-specific contexts, such as hotel services (sin et al. 2005), software services (akman & cengiz 2008), chartered surveying services (tay & morgan 2002) and food services (dibrell, craig & hansen 2011). alternatively, the scholarly efforts view mo as a long established three-dimensional construct that includes customer orientation, competitor orientation and inter-functional coordination (narver & slater 1990) or intelligence generation, intelligence dissemination and organisation-wide responsiveness (kohli & jaworski 1990). despite some variation around the alternate use or adoption of the two frameworks, it is worth noting that mo is an important contributor to long-term business performance throughout the services domain (lettice et al. 2014; matear et al. 2002; sin et al. 2005; tay & morgan 2002; tsiotsou 2010). building on prior studies, this study infers that mo is particularly relevant to project-based business provisioning (martínez-román et al. 2017; nyström et al. 2016). in essence, firms with close connections with customers, clients and value chain partners of diverse functions and professions are endowed with a higher relationship-building competency to better respond to site-based uncertainties in relation to successful outcomes of innovative project deliveries (manley 2008; preeker & giovanni 2018). also, project-based firms are inherently competitor-oriented in their strategic establishment of pricing and bidding strategies for winning project tenders (coskun, erdis & demirci 2013). where the propensity towards mo is generally stronger in small firms in contrast with larger firms (pelham 1999; raju et al. 2011), this study makes a clear analysis of the role of market-oriented posture in complementing a business’s project-based nature: h1: market orientation is positively related to entrepreneurship market orientation and organisational learning mo, however, evolves as a function of organisational core competency only when it is amalgamated with a learning climate (slater & narver 1995). proposed as antecedent of mo, organisational learning, in its basic sense, refers to (jerez-gómez, cespedes-lorente & valle-cabrera 2005): … the capability of an organization to process knowledge – in other words, to create, acquire, transfer and integrate knowledge – and to modify its behaviour to reflect new cognitive situations with a view to improving its performance. (p. 716) such learning norms strengthen market-driven firms with a better sensing of new information in the marketplace (sinkula 1994; slater & narver 1995) and being more flexible and responsive in value creation than the competitors (day 1994). put differently, a high degree of learning within an organisation constitutes critical sources for long-term superior performance (alegre & chiva 2008; baker & sinkula 1999; hurley & hult 1998; jimenez-jimenez & sanz-valle 2011). any organisation, overtly, might eventually end with dysfunction without the relentless pursuit of learning (dibella 1995). mere aspiration to transform into a learning organisation is inadequate and, additionally, firms must attempt to turn their learning into capabilities (hamel & prahalad 1994): ‘creating a market orientation is only a start’ (slater & narver 1995:63). inspired by these implicative assertions, various scholars have exposed that much of the firm’s competitive capability hinges on the managerial coordination to realise the synergistic effect of mo and organisational learning to result in the aforementioned capability (baker & sinkula 1999; farrell & oczkowski 2002; hult, hurley & knight 2004; hurley & hult 1998; keskin 2006; lertpachin, wingwon & noithonglek 2013; sinkula 1994; sinkula, baker & noordeweir 1997). echoing the importance of the combinative view, however, the prior findings did not examine in particular whether specific antecedents, such as organisational learning, would nurture small firms’ market-oriented competence across their routine business activities (raju et al. 2011). addressing this need, it is postulated that: h2: organisational learning is positively related to entrepreneurship. h3: market orientation is positively related to organisational learning. non-technical innovation in evaluating the preceding research, it is uncovered that innovation mostly goes along with the aim of achieving some sort of competitive advantage to outperforms rivals (salunke et al. 2011). while the conventional conceptualisation of innovation dominates over product or production means (drejer 2004; slaughter 2000), such a tangible approach has increasingly attracted criticism for the risk of disintegrating other relevant metrics (xue et al. 2018). joining this debate, recent scholarly efforts reform the dynamism of innovation in the role of non-technical innovation (brochner 2010; hipp & grupp 2005; oecd 2005) that is suggested as one of the pivotal pillars of organisational competitiveness (evangelista & vezzani 2010; greenan 2003; mol & birkinshaw 2009). tracked through the extant literature, theoretically and empirically, non-technical advancements are depicted to entail organisational (or managerial) and marketing innovations (camison & villar-lopez 2011; oecd 2005). structurally, organisational innovation includes changes in responsibilities or the information flow and divisional structure of a firm; procedurally, organisational innovation involves the new implemented routines, processes and operations within firm (armbruster et al. 2006). in project business, new business practices would enable firms to acquire a greater competitive advantage (seaden et al. 2003), and enhance problem-solving and profitability (pellicer et al. 2012). firms pursuing advanced practices in management could better manage projects over a range of related activities, resources and business linkages (hakansson & ingemansson 2013). marketing innovation, on the other hand, relates to new marketing methods that manifest significant changes in design or packaging, placement, promotion and pricing (oecd 2005). from a practical standpoint, innovative marketing efforts are especially important for project-based companies in aiding business development (dikmen, birgonul & ozcenk 2005). a recent study has also demonstrated that construction organisations that carefully and systematically integrated their pricing and promotion strategies with their firm’s specific resources had a higher chance of successful tender bidding (coskun et al. 2013). to sum up, both organisational and marketing innovations have a substantial impact on business success. potentially, non-technical innovation produces similar beneficial effects as those depicted in cost-reducing process enhancements or customer value-generating product developments (evangelista & vezzani 2010). to date, how non-technical measures enable firms of a project-based nature to seize greater market positional advantage is underexplored (brochner 2010). using a small firm as the focal point, this study accordingly advances an analysis of non-technical innovation to appropriately capture its impact on businesses that focus on project-based provisioning. market orientation and non-technical innovation innovation is essentially an outcome of strong market-oriented culture (hurley & hult 1998). underlined as one of the ‘core-value creating capabilities’ (slater & narver 1994), mo enables access to valuable inputs required for innovation such as accumulated knowledge from customers, rivals and technologies (deshpande, farley & webster 1993). in this connection, innovative decision-makers rely on customer input to secure improved outcomes through the strategic alignment of customer-oriented needs with organisational innovation efforts (alam 2002). not only does market-oriented culture foster an optimal environment for continuous value creation (han et al. 1998), it also allows firms to capitalise on market-based success through customising the benefits of novel offerings for customers (baker & sinkula 1999; matear et al. 2002; tsiotsou 2010). accordingly, knowledge sources relating to clients or competitors can essentially inspire new organisational practices (birkinshaw & mol 2006). to better accommodate customer needs, both intra-organisational and inter-organisational innovation could support firms with greater efficiency, effectiveness and flexibility in their service deliveries (armbruster et al. 2006). therefore, the present study conjectures that firms integrate both marketing and organisational innovation into their quest to better accommodate market demands: h4: market orientation is positively related to organisational innovation. h5: market orientation is positively related to marketing innovation. organisational learning and non-technical innovation literature has long acknowledged the role of knowledge-based capabilities in driving the discovery of value-creating opportunities in the form of innovation (alegre & chiva 2008; hurley & hult 1998; jimenez-jimenez & sanz-valle 2011; pesamaa et al. 2013). nonetheless, rarely are these recognised in the domain of non-technical innovation (nyström et al. 2016; zubizarreta et al. 2017). exceptionally, a recent empirical analysis conducted on industrial firms views both organisational memory and learning capabilities as the key to discover novel organisational and marketing practices (camison & villar-lopez 2011). likewise, some studies suggest that different forms of learning, such as market-focused, internally focused and relationally focused learning, exert different impacts on the development of innovative managerial practices and marketing instruments (weerawardena 2003; weerawardena et al. 2006). even in high-tech industries, new aspects of organisational practice are essential in nurturing an optimum learning culture that fosters firms’ competitiveness (lee, tan & chiu 2008). these empirical investigations were in consensus about the value derived from both organisational learning and non-technical advancement to achieve positive organisational outcomes (camison & villar-lopez 2011; lee et al. 2008; weerawardena 2003; weerawardena et al. 2006). in relation to innovation, the importance of learning has also been discussed in project-based business literature (drejer & vinding 2006; gann & salter 2000; salunke et al. 2011). along with the impedance of knowledge loss between various firms associated with boundary-crossing projects, gann and salter (2000) suggest that firms fail to coherently integrate their on-off project experience into the repetitive business routine to achieve sustained innovative opportunities. also, drejer and vinding (2006) accentuate that innovative initiatives are anchored through firms’ continuous efforts to collect, diffuse and assimilate project-specific knowledge at the firm level. interestingly, manley (2008) argues that the known liabilities of smallness could turn into positive features of small firms, where the knowledge transposal processes are relatively easier and therefore promote the generation of new ideas despite the resource-poor environment. in multiple case studies, salunke et al. (2011) decipher the dynamic mode of different learning activities in connection with the occurrence of project-oriented innovation. however, it is important to note that these studies are exclusive to the conceptualisation of innovation over non-technical means. given that project-based firms innovate technically and non-technically (brochner 2010), the likely impact of organisational learning on non-technical measures is posited as follows: h6: organisational learning is positively related to organisational innovation. h7: organisational learning is positively related to marketing innovation. non-technical innovation and entrepreneurship the extant research offering evidence of the practical relevance of non-technical innovation in regard to entrepreneurship is inconclusive. while some researchers echo the strong positive impact that non-technical innovation has on performance (caroli & van reenen 2001; evangelista & vezzani 2010; greenan 2003; hamel 2006; mazzanti, pini & tortia 2006; mol & birkinshaw 2009; shergill & nargundkar 2005), others present contradictory conclusions to the empirical relationship (cappelli & neumark 2001; staw & epstein 2000; walker, damanpour & devece 2010). furthermore, the incongruous findings are complicated by varying metrics of organisational outcomes, such as brand performance (weerawardena et al. 2006), improvement in future productivity (mol & birkinshaw 2009), reputational advantage (staw & epstein 2000), organisational effectiveness (jimenez-jimenez & sanz-valle 2011) and others. positing non-technical innovation as a predictor of positive entrepreneurship, which has been argued to be better measured from both financial and market perspectives (cheng & krumwiede 2012; matear et al. 2002; shergill & nargundkar 2005), the present study proposed the following hypotheses: h8: the greater the organisational innovation, the greater the entrepreneurship. h9: the greater the marketing innovation, the greater the entrepreneurship. the research framework of this study is presented in figure 1. figure 1: research framework. research methods and procedures over several stages, a structured questionnaire was formulated. firstly, an extensive review of previous similar research was performed to identify the adoptable scale items. these items were pre-tested using a sample of 30 senior managers with working experience in small project-based service firms. after adjusting the scales based on the feedback from the pre-testers, the final questionnaire comprised 55 items measured on a five-point likert-type scale. an initial sample was then assembled from key construction firms listed in the malaysian small-and-medium-enterprises corporation and the malaysian construction industry development board listings. following spanos and lioukas (2001), the sampling frame was refined by firms having 10–49 full-time employees (i.e. small firms) and a final sample of 700 firms was yielded. as it has been corroborated that members of the executive level in a firm (e.g. owner, managing director, ceo) are the ‘single most knowledgeable and valid information sources’ (lechner, dowling & welpe 2006:525), these people were selected as the key informants. after three weeks from the first wave of primary distribution, reminder letters were sent out to the non-response firms. a total of 155 valid questionnaires, with the inclusion of late responses, were obtained and this represented a response rate of 22%. the sample varied between firms that based business upon main contracting (56%) and specialist contracting (43%) projects delivery. on average, firms were aged around 15 years old and the respondents attributed to the firms had approximately 8 years of business experience. in terms of market size, the vast majority (95%) of the firms operate in domestic markets whereas a small minority (5%) operate overseas. to assess the potential presence of non-response bias (armstrong & overton 1977), the early and late responding groups were compared in terms of the mean of all variables. the t-test methodology detected no systematic differences between the two groups. all measures used in the current research were drawn from previously similar studies. market orientation this study follows nasution and mavondo’s (2008) work to operationalise mo as four dimensions: customer orientation, competitor orientation, inter-functional coordination and latent need fulfilment. the additional dimension of latent need fulfilment is a crucial focus on customers’ unexpressed needs in order to discern and anticipate potential market-based opportunities by proactive means. in consideration of previous works (day 1994; slater & narver 1995) that omitted the component of inter-functional coordination, the final mo scale consists of customer orientation (4 items), competitor orientation (4 items) and latent need fulfilment (4 items), structured on a five-point likert-type scale (anchored by ‘strongly disagree’ and ‘strongly agree’). organisational learning this study adopts the scale developed by jerez-gómez et al. (2005) in interpreting the observed ol across four dimensions: managerial commitment (5 items), systems perspective (3 items), openness and experimentation (4 items) and knowledge transfer (4 items). like mo, ol is assessed using a five-point likert-type scale (anchored by ‘strongly disagree’ and ‘strongly agree’). non-technical innovation this study adapted the scales previously developed by dikmen et al. (2005) and oecd (2005). two dimensions, organisational innovation (4 items) and marketing innovation (4 items), were self-assessed by respondents on a five-point likert-type scale (anchored by ‘never practice’ and ‘always practice’). all eight items are self-reported by respondents to conquer the difficulties in requesting sensitive information pertaining to organisations (im & workman 2004). finally, age of the firm was viewed as the extraneous variable given its documented effect on innovation-related performances (jimenez-jimenez & sanz-valle 2011; sinkula 1994). data interpretation and results a combination of spss 22 and smart-pls 2.0 software packages were used for data visualisation. validation of measures some preliminary analyses were performed in the first place. primarily, in assessing the univariate skewness and kurtosis for each construct, an acceptable level of data distribution was detected. the reliability of each construct, as indicated by the cronbach’s alpha values, was well above the threshold value of 0.7 (nunnally 1978). further, both the kaiser–meyer–olkin (kmo) index and bartlett’s test of sphericity were computed to determine the sufficiency of the data set for exploratory factor analysis (efa) (chu & murrmann 2006). the result, with a kmo index of 0.885 and bartlett’s sphericity test of high significance (p < 0.001), indicated the appropriateness of efa in the subsequent analysis. in this regard, a principal component method with oblique rotation was performed for all the measures to examine their respective factor structures. regardless of the theoretical underpinning, hair et al. (2006) suggested the removal of an item if: (1) its factor loading is less than 0.5, (2) it cross-loads in two different groups at a time or (3) it loads in a group that it does not belongs to. accordingly, two items from mo constructs and three items from ol constructs were dropped. while the ol construct was restructured into two new related groups, the remaining indicators (i.e. three components of mo, two non-technical innovation types and two metrics of entrepreneurship) have loaded on their respective latent construct as expected. in the next step, all the multi-item constructs were assessed by confirmatory factor analysis (cfa) using partial least square (pls) path modelling. measurement model analysis the fitting index of measurement for each construct was computed via cfa. to assess the composite reliability, the factor loadings of each item should be above the suggested threshold of 0.708 (hair et al. 2014). accordingly, one item in the construct of mo and three items in the construct of ol were dropped due to low and insignificant factor loadings. as recommended by nunnally (1978), all the multi-item constructs should fit a minimum value of 0.8 for the demonstration of construct reliability. ranging from 0.86 to 0.90 (table 1), the result indicated good reliabilities across the measures. meanwhile, the average variance extract (ave) values of the key constructs were higher than 0.5 (fornell & larcker 1981) and therefore in support of convergent validity. finally, the discriminant validity was determined by the value of the key construct in its square root of ave (sqrt ave) to be greater than its correlation with any other factors in the framework (hair et al. 2006). the result, diagonal from 0.71 to 0.84, showed adequate discriminant validity for each construct. table 1 presented the specification of the adequacy of the measurement model in all cases. table 1: measurement model results (n = 155). structural model analysis rather than goodness-of-fit indices (henseler & sarstedt 2013), the robustness of a structural model is computed via its explanatory power on the hypothesised paths (hair et al. 2014). both mo and ol are the exogenous constructs, with organisational and marketing innovation as the intermediate endogenous constructs, and entrepreneurship as the endogenous outcome. as indicated in figure 2, the square multiple correlations (r2) value of the structural model revealed a very satisfactory level of predictability for the framework. the respective r2 value for the intermediate endogenous constructs (i.e. organisational innovation = 0.65; marketing innovation = 0.48) and the endogenous latent constructs (i.e. entrepreneurship = 0.52) largely exceeded the 0.1 threshold value (falk & miller 1992). figure 2: partial least squares structural equation modelling framework of innovation for small-size project-based service firms. next, each standardised path coefficient (β) and the associated t-values of each latent construct were examined (as indicated in table 2). accordingly, mo has a moderate significant positive effect on entrepreneurship (β = 0.25, t = 2.644), supporting h1. a strong and significant positive effect exists between mo and ol (β = 0.76, t = 19.708), supporting h3. the significant effect of mo on organisational innovation (β = 0.21, t = 2.435) and marketing innovation (β = 0.45, t = 4.756) supports h4 and h5. organisational learning has a significant positive effect on organisational innovation (β = 0.33, t = 4.937) and marketing innovation (β = 0.29, t = 3.181), supporting h6 and h7. the effects of organisational innovation (β = 0.21, t = 2.482) and marketing innovation (β = 0.23, t = 3.171) on entrepreneurship are also significant, giving support to h8 and h9. contrary to prediction, however, no support is indicated for the hypothesised path of ol and entrepreneurship (h2). the control variable of firm age was significant as well. nevertheless, an interesting significant effect is detected between marketing innovation and organisational innovation (β = 0.38, t = 5.013). table 2: structural equation model results. beyond the direct hypothesised paths, the present study disentangled the indirect paths to understand the mediating function of non-technical innovation in its causal relationships with its antecedents and consequences. consistent with cheng and krumwiede’s (2012) recommended component-wise procedure, we dismantle each of the key constructs into their respective components to better scrutinise the specific mediated effects of the mediators. the significance of each path was computed using the sobel test (preacher & hayes 2008) assisted with bootstrapping procedure. as indicated in table 3, both the first-order and second-order analysis of structural models offered support for the existence of a mediation effect in the proposed framework. for instance, in observing the second-order structural model, the path of market orientation to entrepreneurship significantly indicated a direct effect (β = 0.25, p < 0.01) and an indirect effect (β = 0.18, p < 0.05). similarly in the path of organisational learning to entrepreneurship, the direct effect (β = 0.17, p < 0.05) and indirect effect (β = 0.16, p < 0.05) are statistically significant. further to this line of assessment, the variance accounted for (vaf) in the proposed model was computed to determine the mediating strength of the mediator. the respective variances of less than 20%, between 20% and 80%, or more than 80% equate to no mediation, partial mediation and full mediation (hair et al. 2014). as such, non-technical innovation was observed to exert a partial mediating effect in both mo to entrepreneurship (vaf = 42%) and ol to entrepreneurship (vaf = 41%) paths. table 3: direct, indirect and total effect of the first-order and second-order constructs of market orientation, organisational learning, non-technical innovation and entrepreneurship. figure 2 presents the developed structural model of innovation based on the quantitative strand. through the use of pls structural equation modelling, the structural model indicated the factors that significantly relate to innovation practices of the firms. these included organisational capabilities (all except human resource practice construct), innovations (include both technological and organisational innovation activities) and entrepreneurship. importantly, it depicted that firms affiliated with certain capabilities could competently pursue the undertaking of innovations across projects and within the firm to acquire higher performance. moving a step further into the first-order structural model, several interesting findings were suggested (table 3). under the mo construct, customer orientation was insignificantly associated with both financial performance (β = 0.03) and market performance (β = 0.02), suggesting no mediation in the paths. meanwhile, competitor orientation was significantly and positively related to financial performance (β = 0.13, p < 0.05) and market performance (β = 0.15, p < 0.05), both of which, in turn, imply partial mediated effects in the paths. likewise, the indirect effects of latent needs fulfilment regarding financial performance (β = 0.14, p < 0.05) and market performance (β = 0.11, p < 0.05) were significant, suggesting partial mediation as well. under the ol construct, managerial commitment and openness were significantly related to financial performance (β = 0.13, p < 0.05) and market performance (β = 0.12, p < 0.05), suggesting partial mediated effects in the paths. additionally, knowledge transfer and integration had a significant indirect effect on financial performance (β = 0.17, p < 0.05) but a non-significant effect on market performance (β = 0.04). figure 3 presents the structural equation model. figure 3: structural equation model of non-technical innovation, market orientation and organisational learning with managerial performance in small-size project-based service firms. full model of innovation the optimum number of extracted components for each key construct was determined. traditional methods included a latent root test (that identified all factors to have eigenvalues > 1) a scree test (that examines the cut-off point in the curve graph). a syntax named ‘tsplot’ was conducted for parallel analysis, which was a plot with horizontal lines crossing the main line of the eigenvalue. the number of factors lying above the crossing lines determining the appropriate number of extracted factors. the parallel analysis was used to determine the appropriate number of extracted factors for all eight the constructs, including: integrated market orientation (imo), organisational learning (ol), human resource practice (hrp), entrepreneurship (eo), inter-organisational network (in), technological innovation (ti), organisational innovation (oi) and entrepreneurship (fp). as depicted in figure 4, only factors lying above the extraction line were considered. the y-axis denotes the eigenvalue while the x-axis denotes the number of variables. appendix g showed o’connor’s syntax and the steps of conducting parallel analysis. figure 4: tsplot for constructs in parallel analysis. via the pls technique, the full model was depicted by connecting all constructs according to the conceptual model. all manifest variables were assigned to their latent constructs based on the results of analyses in the previous sections. as shown in figure 5, the full model comprised both measurement and structural models. the measurements models displayed the relationship between the constructs (i.e. circles) and the indicator variables (i.e. rectangles) while the structural model displayed the relationship (or paths) between the constructs (e.g. ol and ti; ti and fp, etc.). the current study used the following criteria to run the algorithm in pls to obtain the results of the full model: weighting scheme: path weighting scheme data metric: mean 0, var 1 (the default in the program, to ensure normality) maximum iterations: 300 (the default in the program) abort criterion: 1.0e-5 (the default in the program) initial weight: 1 (the default in the program) figure 5: full model of innovation (extending the manifest variables). discussion and implementation overall, the survey results of 155 service firms engaging in project delivery were in support of the proposed conceptual framework. for project-based firms with size-based vulnerability, non-technical innovation provides firms with beneficial value in performance terms. specifically, the internally established capabilities of market orientation and organisational learning were both pivotal antecedents in favour of entrepreneurship through varying mediators of non-technical innovation. by means of a non-technical approach, the present study suggested some motivational implications to both the theorists and practitioners. theoretically implication this study has informed several new insights to academic research. firstly, unlike previous studies that predominantly anchored on the technical sense of innovation, this study examines the offerings of non-technical innovation by specifically drawing their relation with the firm’s capabilities. based on the empirical results, capabilities are important determinants of non-technical innovation. both market-oriented and learning postures, as disclosed in their mutually complementary effects (β = 0.76, t = 19.709), synergistically spur on the coupled development of non-technical innovation. remarkably, the leverage of market-oriented efforts within the learning perspective not only favours the growth of technical innovation (hurley & hult 1998; lertpachin et al. 2013; nasution & mavondo 2008), but also constitutes impetus for new organisational and marketing practices. these findings have unlocked interesting extensions to previous works (camison & villar-lopez 2011; weerawardena, 2003; weerawardena et al. 2006) that advocate the antecedent role of the firm’s capabilities in exploiting the novel value creation within the framework of non-technical initiatives. secondly, this study advances the inconclusive empirical findings that have sought to model non-technical innovation in affiliation with the preponderance of business performance. as noted earlier, the innovation literature frequently interweaves entrepreneurship with diverse types of outcome metrics. featuring entrepreneurship in both financial and market forms, as depicted in the major stream of empirical research (cheng & krumwiede 2012; matear et al. 2002; shergill & nargundkar 2005), the result reveals the nearly significant positive effect between the two varying non-technical innovation dimensions with regard to entrepreneurship. specifically, organisational innovation (β = 0.21, t = 2.486) and marketing innovation (β = 0.23, t = 3.171) play a favouring role in engendering beneficial sources of opportunities that directly impact on business performance. in addition to this line of evidence, both innovative approaches unravel their interdependent linkage (β = 0.38, t = 5.013) in further establishing the performance breadth. as stressed by gambatese and hallowell (2011), some innovations have intangibly occurred throughout routine business activities although they are more difficult to recognise in contrast to tangible product-based innovations. our study represents a supporting response to the call of brochner (2010) for the inclusion of non-technical innovation in a setting that captures small firms’ pursuit of innovation-based performance. thirdly, this study specifically scrutinised the potential mediating impact of non-technical innovation in the capabilities-performance linkage. in particular, the findings were in contrast to earlier studies that ued customers’ explicit thoughts as the basis of innovative capability among small and medium enterprises (akman & cengiz 2008). in contrast, non-technical innovative offerings were observed to substantiate beneficial entrepreneurship through firms’ efforts to adapt to implicit customer expectations and integrate knowledge linkages across peer competitors. similar results were found in prior studies that captured organisational business advantage in affiliation with the appropriate input of latent needs of customers (nasution & mavondo 2008) and competitor orientation (cheng & krumwiede 2012). likewise, the favouring role of non-technical innovation is found to partially intertwine with both the components of managerial commitment and openness, as well as knowledge transfer and integration in relation to entrepreneurship. in this regard, the sturdier the integral trait of project-centred learning at the firm level, the greater the performance value sustained in firms (manley 2008; salunke et al. 2011). the current study presents more refined findings in discerning the impact of innovative offerings upon their antecedents and consequences. managerial implication notably, the findings offer valuable implications for small service firms. to secure new service offerings, managers should pay special attention to the role of non-technical innovation in connection with both organisational and marketing dimensions. specifically, given the constrained resources and uncertain site-based operations, firms affiliated with certain strategic capabilities could competently pursue the undertaking of non-technical innovation. managerial emphasis should therefore persistently deploy to seize new marketplace opportunities in alignment with various active learning-based practices. accordingly, both mo and ol need to be considered, interdependently, in enabling the non-technical feasibility of innovation delivery. in addition, non-technical innovation has emerged as a favourable source for the overall success of business performance. even with finite resources, managers should strive to capitalise the two distinctive types of innovation while concatenating them into routine business operation and project activities, without which superior firm success is difficult to underpin. our thorough empirical analysis should enlighten practitioners that new service offerings should not be based solely on a product and process viewpoint, but organisational and marketing prospects should be included in strategic innovation. conclusion and recommendations in conclusion, this research provides worthy insights for both scholars and practitioners. in considering the criticality of innovation as the fulcrum of service-based delivery, our model advances the existing empirical approaches with a more intangible dimensionality of innovative efforts. overall, the model distinguishes that small service firms engaging in dual modes of non-technical innovation strategically nurture intangible capabilities which in turn provides them with enduring performance outcomes in outperforming competitors. nonetheless, it presents several limitations and holds great opportunities for future research. firstly, the design of the cross-sectional analysis in the present study impedes a full consideration of the causality between constructs. future research should apply longitudinal analysis to enable higher accuracy in examining the causal nature of the relationships. secondly, the findings are derived within project-based contexts, which demands caution in generalising our findings as with assessing their applicability to other service sectors. replication of this research in other countries should help to verify the applicability of the results of this study for other parts of the world. also, how does non-technical innovation complement the higher degree of technical innovative practices across portfolios of projects? how do large and small organisations vary in their central routine activities in seeking a different range of innovative endeavours? further research should test these questions to better understand the existing non-technical offerings and the potential benefits of adding non-technical services to actual offerings. acknowledgements competing interests the authors have declared that no competing interests exist. authors’ contributions all authors contributed equally to this work. funding information this research was funded by huaqiao university, grant number 17bs201, quanzhou city government, grant number 600005-z17x0234, and quanzhou science and technology bureau, grant number 2018z010. ethical consideration this article followed all ethical standards for carrying out research without direct contact with human or animal subjects. data availability statement data sharing is not applicable to this article as no new data were created or analysed in this study. disclaimer the views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of any affiliated agency of the authors. references acs, z.j. & audretsch, d.b., 1988, 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h. & orbe, a., 2017, ‘innovation evaluation model for macro-construction sector companies: a study in spain’, evaluation and program planning 61(1), 22–37. https://doi.org/10.1016/j.evalprogplan.2016.10.014 abstract introduction literature review and hypotheses methodology data analysis and results discussion and conclusion conclusion acknowledgements references appendix 1 about the author(s) alassane d. yeo school of economics and trade, hunan university, changsha, china aimin deng school of economics and trade, hunan university, changsha, china citation yeo, a.d. & deng, a., 2020, ‘logistics performance as a mediator of the relationship between trade facilitation and international trade: a mediation analysis’, south african journal of economic and management sciences 23(1), a3453. https://doi.org/10.4102/sajems.v23i1.3453 original research logistics performance as a mediator of the relationship between trade facilitation and international trade: a mediation analysis alassane d. yeo, aimin deng received: 08 nov. 2019; accepted: 08 sept. 2020; published: 08 dec. 2020 copyright: © 2020. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the development of services, infrastructure and logistics has contributed in reducing costs and delays in exchanges between countries, leading to a significant increase in global trade. aims: to provide empirical evidence of the relationship between trade facilitation and international trade through logistics performance. settings: we collected data every 2 years – 2010, 2012, 2014, 2016 and 2018 – over 8 years from 62 countries, including 33 lower-middle-income countries and 29 upper-middle-income countries. methods: structural equation modelling is used to analyse the structural relationships between measured variables and latent constructs. results: using mediation analysis, the results reveal a positive and statistically significant relationship between trade facilitation and international trade through logistics performance. conclusion: the results draw the attention of policy makers that improved logistics performance facilitates the movement of goods and services between countries for both importers and exporters. lower middle-income countries should encourage cooperation between the public and private sectors and focus their efforts on all aspects of the development of transport infrastructure services to improve the efficiency of international trade. keywords: trade facilitation; international trade; logistics performance; mediation; analysis. introduction the growing volume of international trade, the disappearance of borders between countries and the expansion of the concept of globalisation have recently made the logistics sector more important in world trade. today, logistics has emerged as one of the largest and most dynamic activities in the world. unfortunately, the logistics gap between rich and poor countries persists. according to the logistics performance index (lpi), high-income countries dominate the logistics ranking, while the worst performers are underdeveloped economies that are often landlocked countries, small island states or post-conflict countries. however, logistics performance is not merely determined by the level of per capita income, as many countries perform better than others in different income groups. when talking about logistics performance, gani (2017) refers to the processes necessary for the safe and secure transport of goods from one country to another. underdeveloped and developing countries, therefore, need practical trade logistics measures to facilitate trade in order to change import and export processes and optimise the supply chain without having to commit to significant additional human and financial resources. trade facilitation refers to the transparency and efficiency of international trade procedures aimed at reducing the time and cost of international trade transactions (portugal-perez & wilson 2012). it is a broad concept that can be applied to the entire supply chain as a whole and, in particular, to the logistics. previously considered a highly technical field, specifically for customs specialists at the border, trade facilitation is now a central element of trade and development strategies. this change in perception is seen in recent studies which have shown that the costs associated with trade in goods – border procedures, documentary requirements, delays and logistical costs – are likely to increase considerably (ariekot 2018; hausman, lee & subramanian 2013) the relationships between trade facilitation, logistics performance and international trade are many and varied. international trade involves the movement of capital, commodities and services between countries (paruzel 2018). countries specialise in exporting those products and services that they can produce most efficiently and import those in which they are less efficient. logistics is about managing the activities along in a supply chain, from procuring materials to delivering finished goods that satisfy customer orders (pagel 1999). adequate logistics and supply chain management (scm) are, therefore, the key enablers of international trade. efficient infrastructure services lower transaction costs, raises added value and increase performance while strengthening connections with global supply chains and distribution channels for producers (pérard 2009). logistics services play a crucial role, and the challenges of efficient logistics are increasing as countries move towards higher value-added manufacturing and production processes become increasingly sophisticated and complex. there are several studies on applying mediation models to examine the relationships among variables in various fields. meyer and catherine (2000) applied structural equation modelling (sem) analyses to examine the mechanisms involved in observed relations between human resource management (hrm) practices and employee commitment. alfes et al. (2013) also developed and tested a moderated mediation model linking perceived hrm practices to organisational citizenship behaviour and turnover intentions. fairchild and mackinnon (2009) present a general model that simultaneously estimates the effects of mediation and moderation, and describe methods for testing the effects of mediation and moderation in a data set, both together and separately. cromley and azevedo (2007) tested the fit of the model and three variants of the model to data from 175 grade 9 students and discussed the direct and indirect effects of these five predictors on reading comprehension. indeed, the model hypothesises the relationships between background knowledge, inferences, reading comprehension strategies, vocabulary and word reading. this study aims to provide empirical evidence of the relationships between trade facilitation on international trade through logistics performance. to do so, firstly, sem conceptualises a theoretical causal model consisting of a set of predicted covariances between variables and tests whether it is plausible when compared to the observed data (jöreskog 1970). then, the mediation analysis is used to obtain the indirect analysis of trade facilitation on international trade through logistics performance and test whether it is statistically significant or not. figure 1 describes the hypothetical model for the study. figure 1: conceptual framework. the rest of the article is structured as follows: the next section reviews the literature and hypotheses development, the third section describes the research methodology and the following section provides the results of different tests. then we discuss implications and limitations, which is followed by the conclusion. research questions this research attempts to address the following questions: does trade facilitation have a significant relationship with international trade? does trade facilitation have a significant relationship with logistics performance? does logistics performance have a significant relationship with international trade? does logistics performance mediate the relationship between trade facilitation and international trade? literature review and hypotheses trade facilitation and international trade trade facilitation focuses on simplifying and harmonising trade procedures through reduced transport costs (behar & venables 2011), efficient customs procedures (messerlin & zarrouk 2000), transparent and harmonised regulations (wilson & otsuki 2003) and improved information technology infrastructure (stone & strutt 2010). in recent years, the notion of trade costs has been widely discussed in the literature on international trade. milner, morrissey and zgovu (2008) identify the types of trade facilitation reforms that could address transport, distribution and communication issues and produce results in terms of improving the efficiency of revenue collection, reducing trade costs and promoting greater regional cooperation in the areas of customs and transport costs. pomfret and sourdin (2010) identified, apart from distance-related transport costs, port efficiency and regulatory charges, the difference between cost, insurance and freight (cif), and free on board (fob) as the best aggregate measure of trade costs, which unfortunately suffers from a lack of data consistency. the main target of trade facilitation is to increase international trade. clark, dollar and micco (2004) studied the determinants of shipping costs to the united states using an extensive database of more than 300 000 observations per year on shipments of products aggregated at the six-digit harmonized system level from various ports around the world. they found that a reduction in inefficiencies in transport costs can result in an increase in bilateral trade of countries to the united states. iwanow and kirkpatrick (2007) identified that a 10% improvement in trade facilitation would lead to an increase in exports of about 5%. their findings suggest that while trade facilitation can contribute to improving export performance, improving the quality of the regulatory environment, basic transport and communications infrastructure are also essential in facilitating export growth. wilson, mann and otsuki (2005) constructed four indicators to a larger set of countries and used econometric estimates from a gravity model to show that improved trade facilitation in a sample of 75 countries could increase trade by 10%, or $377 billion. martinez-zarzoso and márquez-ramos (2008) used an augmented gravity equation to estimate data collected from the world bank’s doing business database of 13 exporters and 167 importers using several estimation techniques, namely ordinary least squares, personalized print markup language and the harvey model. the results indicate that the reduction in transport costs and the number of days required for import and export would lead to an increase in the volume of trade flows. based on previous studies, we hypothesised that: h1: trade facilitation has a positive and significant relationship with international trade trade facilitation and logistics performance assessment of logistics performance, including customs and border controls, are key elements of trade facilitation. lakshmanan (2011) suggests that investment in port infrastructure can improve a country’s logistics performance. as a result, the port offer has a positive effect on demand, and the added value of the port-related activity can have a positive impact on the development of the regional economy (gonçalves & assumpção 2016). they believe that better technology and modern equipment to ensure higher reliability, less damage, the ability to track and trace shipments would contribute to improving a country’s logistics performance. weerahewa (2009) uses gravity models of the exports of five product categories, that is, all food and agriculture, live animals, vegetables, processed food and manufactured products, to show that significant trade gains can be achieved by reducing border inefficiencies in south asia. these gains for trade have been further demonstrated by portugal-perez and wilson (2009), who argue that african exporters who reduce their trade costs midway through mauritius have a greater effect on trade flows than a substantial reduction in tariff barriers. raballand et al. (2012) have highlighted the long duration of goods in different ports. the impact of downtime on trade has recently been identified as a major obstacle to the development of low-income countries. they also indicate that ports in sub-saharan africa have an average of more than 2 weeks of downtime, adding that this not only affects the efficiency but also aggravates the congestion situation with its cost implications for the economy. also, yang and chang (2019) identified transport capacity, external risks, information integration, logistics infrastructure, logistic capacity of local agents and national laws and policies as the determining factors for logistics operations in landlocked african countries. hence the following hypothesis: h2: logistics performance has a positive and significant relationship with trade facilitation logistics performance and international trade the global enabling trade report (2014) suggested that improving logistics key components can result in an increase of up to 4.7% in gross domestic product (gdp) and 14.5% in global trade. this argument is supported by banister and berechman (2001), who have indicated that better logistics stimulates growth, competitiveness and investment. puertas, martí and garcía (2014), in their work on the importance of logistics performance in the european union exports during the period 2005–2010, have identified the important role that logistics plays in competitiveness. korinek and sourdin (2011) estimate the effect of the various proxies for trade logistics quality on bilateral trade to quantify how logistics quality influences trade flows using the logistics proxies outlined above for 2008, after controlling for other trade cost measures and determinants of bilateral trade. this article investigates the role that trade logistics plays in the volume and value of international trade and the extent to which poor-quality logistics constitute a barrier to trade. itakura (2014) identified three key components affecting international trade: the reduction of tariffs on goods, the reduction of trade barriers in services and the saving on time costs. although liberalisation through reducing trade barriers has a significantly positive impact on economic welfare, logistics is indeed essential in determining the trade flows of goods (bensassi et al. 2015). so, the present hypothesis is: h3: logistics performance has a positive and significant relationship with international trade trade facilitation, logistics performance and international trade simultaneous research on the relationship between trade facilitation, logistics performance and international trade remains limited as most of the work includes logistics performance as an integral part of trade facilitation. in her work, mann (2012) identified trade facilitation as the policy analysis of impediments to global sourcing and multinational supply chains. research on trade facilitation provides a macroeconomic overview of how policymakers should change the business environment to promote international trade and economic growth. in contrast, logistics provides the microeconomic perspective of the supply chain and examines how a company should organise its operations in light of the policy environment. trade facilitation and logistical support are two effective ways to facilitate the flow of goods and services between importers and exporters. wilson et al. (2005) measured and estimated the relationship between trade facilitation and trade flows, considering four important categories: port infrastructure (air and maritime), customs environment, regulatory environments and e-business infrastructure. the results suggest that reform and capacity building in trade facilitation could significantly increase trade and exports. njinkeu, wilson and fosso (2008) also analysed the impact trade facilitation has on export by constructing four indicators to which are included the performance logistics indicators: port efficiency, customs environment, regulatory environment and service infrastructure. these same indicators have also been constructed for logistics performance in other studies, for example, martí, puertas and garcía (2014) used the lpi to analyse differences between countries in terms of customs procedures, logistics costs and the quality of the infrastructure for overland and maritime transport. the results show that improvements in one of the components of lpi can lead to a significant growth in trade flows in many countries in africa, south america and eastern europe. the quality and efficiency of logistics services can be a major advantage for international trade, in the same way as weak logistics infrastructure and operational processes can be a major obstacle to global trade integration (devlin & yee 2005). otherwise, improved trade-related logistics, combined with a liberalised economic environment, can increase trade volume and economies of scale and scope in distribution and production activities (lakshmanan et al. 2001). given the above, the idea of logistics as a mediator between trade facilitation and international trade could be verified. so, the fourth hypothesis is as follows: h4: trade facilitation has a positive and significant relationship with international trade mediated through logistics performance. methodology data this study adopted the sem method widely used when it is a question of constructing the latent variable. we collected data from 62 countries, including 33 lower-middle-income and 29 upper-middle-income countries (appendix 1). to meet the criterion that a sample size for complex should be more than 100 (kline 2005), we pooled the data over five time periods, namely 2010, 2012, 2014, 2016 and 2018, and therefore obtained 310 observations necessary and sufficient for our analysis as predicted (hoogland & boomsma 1998; muthén & muthén 2002; tinsley & tinsley 1987). the summary of demographics is outlined in table 1. the majority of the countries in our database (57.1%) have a gdp under $100 billion. most of them have an estimated population of under 50 million (71.4%). the frequency distribution also shows that 9.7% of the countries present have a gdp below $10 billion and above $1 trillion, and 48.4% have a gdp between $10 billion and $100 billion. four continents are represented in our database: africa 24.4%, asia 31.7%, america 27.4% and europe 16.1%. table 1: summary of demographics. dependent variable the importance of international trade in the global market was revealed earlier by political economists such as ricardo (1817) and smith (1776). international trade, therefore, enables consumers and countries to access goods and services that are either not available to them or are not in sufficient quantities at the local level. two variables – export and import – measure international trade. the remaining dependent variables were all obtained from the world bank database. export is the selling of goods and services from the country of origin to a foreign country. at the same time, import refers to the purchase of foreign products and then bringing them to the country. nations have specific resources and capacities; for example, some countries are rich in natural reserves, others in technology and human capital. the needs of countries to import and export are, therefore, essential to the functioning and growth of nations. the shares of trade, exports and imports in gdp are widely used in the literature and are found to be significantly and positively correlated with growth (kali, méndez & reyes 2007; yanikkaya 2003). mediating variables logistics performance is considered as a component indicator of trade facilitation (martí et al. 2014). many studies consider logistics performance to be the new leader in scm, for example bolumole (2001) indicates that the role of service providers in the logistics strategy and the logistics process facilitates supply chain solutions. in our case, logistics performance is measured by the six indicators given by the world bank lpi. these include the following: the efficiency of the clearance process or customs (speed, simplicity and predictability of formalities), quality of trade and transport-related infrastructure (ports, railroads, roads and airports), ease of arranging competitively priced shipments, competence and quality of logistics services (transport operators, customs brokers), ability to track and trace consignments, and timeliness of shipments in reaching the destination within the scheduled or expected delivery time. all measurements were captured in the world bank database on a scale of 1 (low) to 5 (high) initially and rescaled on a scale of 0 to 1. independent variables four variables were constructed following those elaborated by portugal-perez and wilson (2012) to measure the concept of trade facilitation. physical infrastructure refers to the physical network necessary for the functioning of the modern industry. it includes roads, railways, ports and airports. information and communication technology is the set of technologies used to manage telecommunications, broadcast media, intelligent building management systems, broadcasting processing and transmission systems, and network control and monitoring functions. the efficiency of borders and transport is controlled from export time (the time required to comply with all procedures required to export goods), export documentation (a number of documents that must be prepared by the exporter in order to organise the export of his shipments) and cost to export (cost measures the duties collected on a 20-foot container in us dollars). the institutions are based on data available from the world economic forum global competitiveness index. the institution’s measure is government regulation, irregular payments and bribes, the prevalence of bribes, the prevalence of commercial bribes and the transparency of government policymaking. data analysis and results statistical method we use exploratory factor analysis (efa) and confirmation analysis (cfa) to conduct reliability, validity and descriptive analysis. the sem technique was used to test the hypothesis; ibm spss amos software version 22 was used to conduct data analysis. data measurement model we conducted several tests to verify the validity and reliability of the variables. first, we used kaiser meyer-olkin (kmo) and bartlett to indicate the proportion of variance in our variables that could be caused by underlying factors. the results presented in table 2. show that the kmo of the sampling adequacy is 0.886, which is less than 0.90; therefore, it is barely acceptable (kaiser 1974). bartlett’s sphericity test with a value of 0.000 (less than 0.05) attests that the correlation matrix is an identity matrix. moreover, factor analysis can be useful with the data. in table 2, the correlation coefficient indicates the strength of the relationships between all the latent variables, which means that there is a positive and significant positive correlation between the variables. exports have a positive and significant correlation with imports (r = 0.996, p < 0.05). the two variables are extremely strongly related, while many of the other variables are weakly related. table 2: kaiser meyer-olkin and bartlett’s test. table 3 presents the results of the evaluation of the measurement model; as indicated by drolet and morrison (2001), high reliability is generally desirable. common criteria for measuring the reliability of construction variables such as cronbach’s alpha and composite reliability (cr) have values between 0 and 1, and should be as high as possible to indicate excellent reliability. the result obtained showed that the cr of the latent variable on logistics performance, trade facilitation and international trade was 0.928, 0.802 and 0.900, and the cronbach’s alpha coefficients were 0.933, 0.921 and 0.998, which is desirable because it indicates almost perfect reliability of the measurements. considering that the saturation coefficient was higher than the accepted threshold of 0.7 (cronbach 1951) and that the average variance extracted (ave) was higher than the threshold of 0.5 (bagozzi & phillips 1991), we then validated our latent measurements. table 3: reliability, validity, correlation and description statistics of the variables. hypothesis testing the sem analysis approach will be used to provide model fit information that provides information about the consistency of the hypothesised mediational model to the data. it also eliminates the measurement error in estimating the relationships between variables. the chi-square of 248.727, degree of freedom of 51 and p value of 0.00 indicate that the model fits the data according to sample size. the goodness of fit index (gfi = 0.934) and the root-mean-square error approximation (rmsea = 0.096) confirmed a good fit (see table 4). table 4: results of the goodness of fit indices for the measurement model. a series of hypotheses were used to test the relationships between latent construction. the results and their significance are presented in table 5. the first hypothesis revealed a negative and insignificant relationship between trade facilitation and international trade (β = −0.048; p = 0.481), indicating that better trade facilitation leads to a reduced volume of international trade. the second hypothesis revealed a significant relationship between trade facilitation and logistics performance (β = 0.609; p < 0.001), indicating that better trade facilitation is associated with better logistics performance. the same result was obtained for the third hypothesis, meaning that logistics performance has a positive and significant effect on international trade (β = 0.524; p < 0.001). the final hypothesis showed the positive and significant effect of trade facilitation on international trade through logistics performance (β = 0.240 p < 0.001), indicating that trade logistics performance mediated the effects of trade facilitation on international trade. thus, h2, h3 and h4 are supported, and h1 is not supported. table 5: hypotheses testing summary. figure 2: measurement model. mediating effect of logistics performance we analyse mediation following baron and kenny’s (1986) steps and test the significance through sobel’s (1990) test and bootstrapping. the basic steps in mediation analysis suggested by baron and kenny are as follows. the mediation analysis is conducted using three regression sets: x → y, x → m and x + m → y. in examining a mediational hypothesis, the relationship between an independent variable and a dependent variable is decomposed into two causal paths (alwin & hauser 1975). one of these paths links the independent variable (x) to the dependent variable (y) directly (the direct effect), and the other links the independent variable to the dependent variable through a mediator (m) (the indirect effect). an indirect or mediated effect implies that the independent variable causes the mediator, which, in turn, causes the dependent variable (sobel 1990). to examine the mediation effects of logistics performance on international trade. we consider logistics performance as the mediator (m), trade facilitation as the independent variable (x) and international trade as the dependent variable (y): a = raw regression coefficient for the association between x and m (unstandardised). sa = standard error of a. b = raw regression coefficient for the association between m and the y (when the x is also a predictor of the y). sb = standard error of b. the results presented in table 6 show the existence of a strong causal indirect relationship between trade facilitation and international trade. to support the idea of a mediator effect, testing mediation using the bootstrapping has been done. we found a significant indirect effect that varies from 0.0325 to 0.1543, with an estimated effect of 0.0935 over a 95% confidence interval. the remaining direct, indirect and total effects are presented in table 7. the direct effect is −0.043 (the path coefficient from trade facilitation to international trade). the indirect effect is derived from the product of the path coefficient resulting from trade facilitation to logistic performance and the path coefficient from logistic performance to international trade: (0.833) (0.112) = 0.0935. the total effect represents the sum of the direct effect and the indirect effect: (0.0935) + (−0.0428) = 0.0507. figure 3: standardised β-coefficient in logistics performance partially mediated pathway from trade facilitation to international trade. table 6: mediation analysis through sobel’s t. table 7: direct, indirect and total effects of trade facilitation on international trade mediated by logistics performance. discussion and conclusion theoretical implications in this study, we focused on the relationship between trade facilitation and international trade through logistics performance. the main finding suggests that logistics performance mediates the relationship between trade facilitation and international trade. in other words, the relationship between trade facilitation and international trade is found to be positive and statistically significant when it is associated with logistics performance. so far, psychology remains the field that has more research taking into account the mediated effects (baron & kenny 1986; mussel 2019). relationship quality mediates the association between cultural intelligence and institutional success. mediation analysis also helps managers to develop strategies to enhance their international market orientations in order to increase performance (nakos, dimitratos & elbanna 2019). in the field of trade, few studies have been carried out on this issue. munim and schramm (2018) focused on the plausible contribution of seaborne trade, from a partial infrastructure quality and logistics performance perspective. indeed, efficient logistics helps trade facilitation to achieve its objectives, which is to increase trade through the reduction of all kinds of additional costs. the logistics performance is found to be an important enabler to trade (tang & abosedra 2019). this study is unique in dealing with logistics as the mediator between trade facilitation and international trade, given the absence of studies that highlight logistics performance in the context of trade at the national and international levels. according to baron and kenny (1986), the reason why the relationship between trade facilitation and international trade is considered non-significant is because the first step doesn’t reveal anything to mediate. this statement has been criticised by several researchers, mainly by shrout and bolger (2002), who suggested moving to the next step if there is a thorough theoretical background about their relationship even if there is no significant association between x and y. the other steps, therefore, indicate the indirect effect of trade facilitation on international trade through logistics performance. another important implication of our study is what mackinnon et al. (2007) call an inconsistent mediation since the sign of the direct effect (c’) is opposed to the sign of the indirect effect (a × b). indeed, the failure to meet step 1 and the existence of mediation means that the mediating variable (lp) acts as a suppressive variable. likewise, hoyle and kenny (1999) perceive this mediation as proximal mediation, given that a = 0.833 is greater than b = 0.112 (effects of normalisation). our result is more similar to the example of the relationship between stress and mood as mediated by coping. in principle, the direct effect is negative: the more trade facilitation, the worse international trade. however, the fact that the effect of trade facilitation on logistics performance is positive (more trade facilitation, more logistics performance) and the effect of logistics performance on international trade is positive (better logistics performance, better international trade), means that the indirect effect is positive. the total effect of trade facilitation on international trade is then likely to be very small because the direct and indirect effects will attempt to neutralise each other. managerial implications this study reminds policymakers and logistics service providers of the need for regulatory reforms in the logistics sector as a bridge to connecting small businesses to international markets. the management of international flows of goods, as well as related documentation and payments, aims to reduce direct and indirect logistics costs through the simplification and harmonisation of procedures and documentation. otherwise, the limited availability of these services leads to a reduction in the volume of trade flows. for these reasons, this study encourages policymakers in developing and least developed countries to improve their domestic trade competitiveness by promoting positive policy reforms in the logistics and transport sectors. in a context of competition, the interaction between public and private actors, and strengthening trade and investment support institutions can truly make a significant difference. policymakers and managers can take advantage of these results, since logistics has been shown to have a crucial role in scm, and recent studies have also revealed that the improvement of the logistics sector enables increasing the volume of trade. this study also confirmed that through quality logistics, trade tends to increase considerably more than without quality logistics. this suggests that trade performance measures need to be taken into consideration by countries, particularly middle-income countries, to develop the import and export process and optimise the supply chain in order to increase trade more efficiently and effectively. limitations as no other study so far has addressed the mediating role of the logistics performance between trade facilitation and international trade, it remains challenging to conclude from the previous literature. therefore, we encourage researchers to take an interest in this question and to guide future research on the role that scm could have on international trade due to its very secure connection with logistics. additionally, the data for this research come mainly from lower-middle-income and upper-middle-income countries. future research can extend on a large database by adding low-income and high-income countries. moreover, the variables were constructed from the data we collected from different sources; those unobserved, hidden or latent cannot be directly measured in the research. to remedy this problem, we carried out several tests in order to validate the data. however, future research should use variables that can be observed and directly measured. the mediation analysis is not only restricted to linear regression. it is also conducted using logistic regression or polynomial regression, and more. besides, several other variables and relationships can be added, for example moderated mediation or mediated moderation. future research can extend by testing the effects of two or multiple mediators, for example indirect effects for m1 (scm) and m2 (trade barriers) on international trade. conclusion this study attempted to analyse the role of logistics performance in the relationship between trade facilitation and international trade. firstly, we used sem to assess unobservable latent constructs. following baron and kenny’s (1986) four steps, we applied sobel’s (1990) test and bootstrapping to see if the effect of mediation is statistically significant or not. the sobel test was chosen because it was widely used before, and bootstrapping because its use was strongly recommended in recent years. larson et al. (2012) have argued that logistics, including transport, has a direct effect on prices and trade in local markets as it determines the performance and adaptability of supply chains, particularly in african and middle eastern countries that are highly dependent on food imports. in developing countries, especially poor and landlocked countries, transport and logistics account for 20% – 60% of the price of products at the point of delivery and constitute 48% of the cost of maize imported from the united states by nicaragua (arvis, marteau & raballand 2010). our research results show that the empirical evidence does not support the conclusion that there are direct links between trade facilitation and international trade. in contrast, it provides evidence of indirect links between trade facilitation and the international trade with which logistics performance is associated. in sum, logistics performance mediates the relationship between trade facilitation and international trade. however, logistics performance acts as a suppressive variable, and this mediation is qualified as incoherent and proximal mediation. lower-middle income countries should follow the example of upper-middle income countries by encouraging cooperation between the public and private sectors and focus their efforts on all aspects of the development of transport and infrastructure services capable of improving logistics performance in order to enhance and facilitate the flow of international trade. nevertheless, this finding needs to be reassessed by other methods, and additional data sets should be collected in the future. acknowledgements first, i thank the founder and director of the institute of transport and logistics and all members of the institute of transport and logistics of hunan university for their help, support and sympathy. competing interests the authors declare that they have no competing interest in this publication. authors’ contributions a.d.y. is the main author of the manuscript; he undertook the literature review, developed the theoretical framework, collected and analysed the data from the different sources. a.d. is the co-author of this manuscript; she approved the research idea, supported the empirical data analysis, gave suggestions and comments. both authors read and approved the final manuscript. ethical consideration this article followed all ethical standards for carrying out research. funding information this research was financially supported by the project of the national social science fund of china (no. 18bjy168). data availability statement data sharing is not applicable to this article as no new data were created or analysed in this study. disclaimer the views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of any affiliated agency of the authors. references alfes, k., shantz, a.d., truss, c. & soane, e.c., 2013, ‘the link between perceived human resource 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factors influencing international logistics operations for african landlocked countries – a case study of burkina faso’, maritime policy & management 46(8), 939–956. https://doi.org/10.1080/03088839.2019.1606464 yanikkaya, h., 2003, ‘trade openness and economic growth: a cross-country empirical investigation’, journal of development economics 72(1), 57–89. https://doi.org/10.1016/s0304-3878(03)00068-3 appendix 1 table 1-a1: list of countries. f:\ejour\ecoman\ftp\ecoman_v6_n1.prn.pdf sajems ns vol 6 (2003) no 1 126 a new approach to managing community participation and stakeholder negotiation in south african local government ________________________________________________________________ enslin j van rooyen school of public management and administration, university of pretoria ________________________________________________________________ abstract community participation currently forms an important element of the south african government’s policy on integrated development planning in local government. community participation and stakeholder negotiation involve a process of comprehensive engagement, as divergent opinions, needs and expectations normally exist. it is therefore important to correctly identify legitimate stakeholders, to know the different types of partnerships that form stakeholder units within municipalities, and where final decision-making responsibility and accountability are located in local government affairs. this paper reflects on the need for a culture of community participation and most importantly, stakeholder negotiation to be established and institutionalized to the extent that it will be viewed not as an event but rather a continuous process in local government. this approach defines a new era for public management in south african local government. jel d73, h70 introduction traditionally, south africa does not have a culture of actively engaging communities in local government development affairs. democracy brought new emphasis to transparency in government activities, greater public accountability and the notion of respect for human rights. this approach significantly differs from the old -style paternalistic approach to managing development where community information and consultation was limited. integrated municipal development planning, local economic development-projects, various forms of municipal partnerships, municipal taxation and services rating issues all require effective community participation processes. at this point in south africa’s development, such a culture therefore, needs to be actively inculcated. sajems ns vol 6 (2003) no 1 127 the question may be posed as to why stakeholder negotiation is emphasized where generally reference is only made to community participation. normally, the concept community participation is employed to reflect the interactive processes of informing and consultation with communities. however, on the way to achieving true community participation in the management of local government affairs, processes of stakeholder negotiation, rather than mere information and consultation, are involved as well. often, some form of negotiation needs to be entered into between different stakeholders to formulate appropriate policies and settle differences. following is a reflection on community participation and stakeholder negotiation and the role thereof in achieving particular desired outcomes for south african local government in the future. this paper calls for the entrenchment of a culture of community participation and most importantly, that stakeholder negotiation should be institutionalized to the extent that it will be viewed not as an event but rather a continuous process in local government. as municipal managers are consequently required to participate in such negotiations, they should ensure that they are well skilled in this regard. this approach defines a new dimension for public management in south african local government. stakeholder negotiation as part of community participation while municipal integrated development planning-processes are unfolding and local economic development-projects are being launched, local communities should be afforded the opportunity to participate in processes to articulate their expectations and to prioritize their needs. this would in effect necessitate a process of comprehensive engagement with local stakeholders and where divergent opinions, needs and expectations exist, some form of negotiation should be entered into. it is not implied that in absolutely all cases actual negotiations, as one would expect in a bargaining forum-context, would be undertaken. this may become cumbersome and render municipalities ineffective. what, however, is necessary, is a process where communities are informed and made aware of – and even educated (van der walt & knipe, 1998: 143 and coetzee, graaf, hendricks & wood (eds.), 2001: 473) – on the basics of what developmental local government could afford them; that they are stakeholders in municipal affairs in one way or the other; and the fact that in reality resource constraints are prevailing and therefore in most cases, projects and resources allocation are approved on the basis of priority. sajems ns vol 6 (2003) no 1 128 interaction with stakeholders is currently an activity that is regarded as imperative for the successful planning, management and evaluation of development projects in the south african private and public sectors. in most university classes that examine entities’ relationship with society, stakeholders and stakeholder management are among the first concepts introduced. stakeholders are typically defined as “ individuals and groups that have an involvement or an investment in the company’s decisions and in its social and economic exchanges.” (beckenstein, long, arnold & gladwin, 1996: 2). mersham, rensburg and skinner (1995: 57) concur with this view and emphasize that in terms of public relations and development communication in south africa, communities and stakeholders are regarded as key communicators in communication and should therefore be actively be involved in the process. communities and stakeholders should not merely be the passive recipients of information: interactivity and proper dialogue is required. in a public management context, fox and meyer (1995: 122) define a stakeholder as “a person or group of people, such as shareholders, employees, customers, creditors, suppliers, trade unions, government and the community, who have an interest in the operation and outcomes of the organization.” van der walt and knipe (1998: 143) quote paul (1987: 2) in defining community participation as “an active process in which the clients, or those who will benefit, influence the direction and implementation of a development project aimed at improving the welfare of people in terms of income, personal growth, independence and other values regarded as valuable”. it can therefore be deduced that stakeholders may be regarded as those individuals or groupings whose existence may somehow be impacted upon by decisions and actions taken by particular organizations or institutions and who, in turn, may through their actions impact on the functioning of such organizations or institutions or the achievement of their goals. the above definitions clearly establish that stakeholders are those important roleplayers who participate in community affairs to achieve particular objectives. in a local government context, these objectives may be to formulate a budget or achieve certain developmental ideals, such as the establishment of a training facility. in the south african municipal systems act (act 32 of 2000), the term stakeholder is not employed to refer to the above individuals or groupings. the act merely mentions the word community, and refers to community participation to encapsulate the spirit of involving individuals and groupings within a community in the activities of local government and governance. however, it should be noted that merely practicing superficial community participation might not be sufficient to attain the objectives of developmental local government, especially from a sustainability point of view. beckenstein, long, arnold and gladwin (1996: 3) argue that mere community participation/ sajems ns vol 6 (2003) no 1 129 consultation – also referred to as regulatory processes − in developmental projects may form but an element of a bureaucratic structure that is often viewed, negatively, as impeding decision-making. it may well be that this is part of a “going through the motions”-process to legitimize the actions of any particular entity which does not embrace the true spirit of partnership and cooperation. in other words, it is a de facto retaining of the paternalistic approach towards development. in this regard the batho pele-principles, as contained in the white paper on transforming public service delivery (1997), eight service delivery principles apply: consultation, access, information, redress, service standards, courtesy, openness and transparency and value for money. however, to ensure that these principles are adhered to, communities should be awarded the opportunity to express their opinion in this regard, which in turn, necessitates intensive and thorough community participation in government affairs (du toit, knipe, van niekerk, van der walt & doyle, 2001: 108). van der walt and knipe (1999: 144) view community participation as a very involved process and specifically mention the problem-solving nature thereof. however, van der walt and knipe (1999: 144) note that practically community participation may present some daunting problems, inter alia: (a) the processes associated with managing projects where certain community members and groups may frustrate progress; (b) pressure on personnel as the process of participation and consultation requires additional human resources capacity; and (c) the unpredictability associated with dealing with community groups. tsenoli in reddy (ed.) (1995: 34) sounds a warning that democratic local government and sustainable development could only be realized if facilities, resources and technical skills are provided to ensure that all development is truly people driven. swanepoel and de beer (1996: 16) confirm that development “is about people participating in decision-making and implementation that will affect their position and their future”. the community as stakeholders in democratic local government should therefore actively become involved in all planning, implementation and monitoring processes. such processes should also be supported by sufficient administrative capacity to ensure effectiveness. according to beckenstein et al. (1996: 3) the stakeholder concept is critical to sustainable development. it is emphasized that dialogue and negotiation among stakeholders are the vehicles through which the principles for sustainable behaviour are established, implemented and monitored. this form of community consultation is far removed from the more traditional regulatory processes that claim to include community participation when government institutions merely invite comment from stakeholders. typically the inputs are then reviewed and incorporated into a programme that balances legislative intent with the concerns of the stakeholders (beckenstein et al., 1996: 3). sajems ns vol 6 (2003) no 1 130 concerning the concept of negotiation, spoelstra and pienaar (1996: 3) define it as “a process of interaction between parties directed towards reaching some form of agreement that will hold and which is based upon common interests, with the purpose of resolving conflict, despite widely dividing differences”. swanepoel and de beer (1996: 16) mention that there are essentially three possible causes of conflict whilst managing community development projects: (a) clashing interests: (b) clashing personalities; and (c) misunderstanding. each of these should be managed through a process of negotiation and by focussing on the causes of the conflict. spoelstra and pienaar (1996: 12) continue to classify the types of negotiation, two of which are important for local government stakeholder negotiations: firstly, co-operative negotiation. in this type of negotiation win or lose is irrelevant. conflicting views are discussed and converted into co-operation. secondly, continuous negotiation, involves entering into an on-going relationship between the parties. this relationship is maintained throughout the negotiations and into the future. spoelstra and pienaar (1996: 3) emphasize the nature of negotiations as being that of a process and not an event. an element of continuity therefore forms its basis. in addition, it is also important in this regard to note that negotiation involves an element of information exchange. from the point of view of local government, information dissemination could have the advantage that it assists in attaining the objective of transparency and greater accountability and that it may result in educating some communities in aspects related to their environment. policy on stakeholder negotiations and the role of management in policy-making stakeholder definition may become quite complex. as a process of stakeholder consultation is entered into, it is necessary to identify the affected parties (stakeholders) and to determine legitimate representation of these parties on the relevant structures. the constitution of the republic of south africa (act 108 of 1996) places an emphasis on the aspect of involving communities in decision-making (e.g. section 152) as well as on the need for sound intergovernmental relations and co-operative governance in local government. however, community involvement and representation on relevant structures should be balanced by the need to manage the process effectively (beckenstein et al., 1996: 2). in local government one of the current debates center on the integrated development planning process and the associated stakeholder consultation process that should form an integral part of the structuring of the plans. the municipal systems act (act 32 of 2000) dedicates chapter 4 to community participation in local government. it states that local sajems ns vol 6 (2003) no 1 131 government should develop a culture of community participation and municipal governance that complements formal representative government and should encourage and create conditions for local communities to participate in the affairs of the municipality in inter alia: (a) the preparation and implementation and review of its integrated development plan; (b) the establishment, implementation and review of its performance management system; (c) the preparation of its budget; and (d) strategic decisions relating to the provision of municipal services. the municipal systems act (act 32 of 2000) specifies that in each municipality mechanisms, procedures and processes for community participation should be put in place. stipulations pertain to persons who are unable to submit their comments concerning any local government-related issue because of their disability or disadvantaged disposition or if they are unable to write are made in the act. it is also stated (in section 22) that the minister responsible for local government may regulate or issue guidelines pertaining to community participation in municipal affairs. so far, the minister, however, had not regulated on this matter. municipal managers, specifically, are required in terms of the integrated development planning guidelines issued by the department of provincial and local government, to be instrumental in structuring different community participation forums to facilitate a process of consultation for integrated development planning. the question arises as to how to proceed in entering into effective stakeholder consultation and consequently negotiations in local government. as has been stated before, there are some concerns related to the aspect of setting a policy for effective stakeholder negotiations: first, defining a stakeholder in a particular municipality; second, ascertaining the legitimacy of the representation of stakeholders on forums to conduct consultations and negotiations; and third, how much negotiations and consultation is sufficient to ensure a just reflection of community needs in planning and implementation management, without frustrating administrative processes. concerning the first two issues, coetzee, graaf, hendricks and wood (eds.) (2001: 478) mention that in constituting forums where negotiations are entered into with stakeholders, the following could serve as guidelines: • establish who are the significant decision-makers and influential people in a particular area. • ascertain whose interests these influential decision-makers serve. • find out how those members of the community generally excluded from the decision-making process hold these decision-makers in check and exert their own influence on the political process. • establish to what extent do present structures affect local participation in decision-making. sajems ns vol 6 (2003) no 1 132 concerning the third issue, it should be noted that not all aspects of the day-today management of a project could be subjected to a comprehensive consultation process before decisions are taken. van der walt and knipe (1988: 137) indicate a number of important responsibilities of public managers i.e. financial, political, legal and ethical. although local governments need to regularly enter into consultation with their communities, municipal managers and the community each do play roles that are complementary but not identical. the essential difference is found in the responsibility and accountability aspects associated with the tasks of a municipal manager as the chief executive officer of a municipality. steering committees and forums, on which representatives of communities serve, should not substitute the accountability (van der walt & knipe, 1998: 134) that should be borne by the local authority and specifically the municipal manager as the accountable officer. in the guidelines set by the national department of provincial and local government pertaining to the integrated development planning process, some policy principles on community participation are presented. the idp guide pack (guide 1: 39) refers to the emphasis placed on public participation by the white paper on local government (1998). according to the idp guide pack the primary objective of community participation is the promotion of local democracy. local government is not only expected to find its own way in structuring stakeholder participation (idp guide pack guide 1: 39) (because of the fact that national or provincial policy cannot prescribe detail requirements for local particularities) but it is expected to actively encourage and promote participation, especially in the case of marginalised groups and women (white paper on local government, 1998, sec. 3.3) and (municipal systems act, 2000, sec. 17). the white paper on local government (1998) proposes active community participation in local government by defining the four levels through which citizens and community groups may participate and influence municipal functioning. on the first level voters have the opportunity to participate in a democratic process to elect candidates to represent them in local government affairs. voters should be ensured of the maximum democratic accountability of the elected political leadership for the policies they are empowered to promote. secondly, citizens should have the opportunity to express, through different stakeholder associations and groupings, their views before, during and after policy formulation processes to ensure that those policies address community needs as accurately as possible. on the third level consumers and end-users should be the recipients of value for money services and courteous and responsive service. on the fourth level, community members may participate in local government sajems ns vol 6 (2003) no 1 133 affairs as organized partners involved in the mobilization of resources for development via businesses, non-governmental organizations and communitybased organizations (infra). to achieve some of the above-mentioned ideals of community participation, both the idp guide pack and the white paper on local government (1998) require extended community participation processes and structures in municipalities by proposing the following: 1. the establishment of forums of organized formations (especially in the fields of visioning and on issue-specific policies). 2. structured stakeholder participation in council committees (especially ad hoc issue-related committees). 3. participatory action research, with specific focus groups (for in-depth information on specific issues). 4. forming associations (especially for people in marginalised areas). the above exposition indicates that participation should be a continuous and structured process and it should focus on certain specific processes with particular outcomes in mind. the decisions on how to structure and manage the particular mechanisms, processes and procedures to attain effective public participation are left to the individual municipalities. this allows for relevance and appropriateness to accommodate local peculiarities and avoids imposing isomorphic models of stakeholder participation. however, the idp guide pack (guide 1: 40) to an extent, seems to question the wisdom of leaving the decision on ways and means of public participation to each municipality. the fear seems to exist that some municipalities may not be able to effectively engage in a process of community participation. in some cases, the previous integrated development planning processes undertaken by south african municipalities did not adhere to the basic requirements to ensure effective community participation, as set in the municipal systems act (act 32 of 2000) and the white paper on local government (1998). some reasons forwarded as to why a more pronounced policy leadership is required to ensure stakeholder participation in the integrated development planning process are as follows: completely different styles of democracy with highly diverging combinations of formal representative and participatory governance are established. in different municipalities different structures and systems, as allowed by legislation, are in operation. community participation and stakeholder negotiations necessarily differ in form and intensity between well-resourced metropolitan municipalities with a large contingent of sophisticated stakeholders and poor rural sajems ns vol 6 (2003) no 1 134 municipalities that may consist of a largely unemployed and illiterate stakeholder contingent. in some cases residents were denied the right to actively particip ate in local government affairs since no minimum requirements were set in this regard. lacking policy directives on community participation relating to establishing structures and setting procedures create helplessness and confusion on the side of most municipalities since they find it difficult to determine appropriate procedures of their own. the policy paper on integrated development planning (october 2000: 30) concurs that various south african municipalities have experienced problems related to the above in the past, but cautions that policy documents prescribing detailed ways in which stakeholder participation should be managed, will not address these problems. municipalities should rather ensure compliance with the general requirements set for community participation in the municipal systems act (act 32 of 2000) but should “apply their own minds in developing contextually appropriate, and perhaps unique, ways of involving all segments of the municipality, and in building partnerships.” as general guide towards effective participation, municipalities should take the following into account (policy paper on integrated development planning, 2000: 30): 1. mass meetings are not the most effective way to acquire information from the community. 2. many different creative techniques exist (e.g. focus groups) that may be useful in attaining effective community participation. 3. information technology may be of use to interact with communities and stakeholders. it should be borne in mind though, that access to these technologies is limited in some communities. 4. participation should be carefully structured, as it may become time consuming and costly. this may particularly be the case in newly demarcated areas that are of large physical size and/or have a large and highly differentiated population. each municipality should find ways to establish a practical working relationship with all stakeholders. such practical working relationships should adhere to the following principles: (a) it should move beyond mere “demands” associated with protest politics and which incorporates a more involved and participatory role; (b) it should take into account the particularities of local politics in south africa − especially in the rural areas; and (c) it should recognize that communities often reflect division and competing interests and not often harmony and common purpose (coetzee, graaf, hendricks & wood (eds.) 2001: 478). in addition to the above, coetzee, graaf, hendricks and wood (eds.) (2001: 479) mention that power structures and relationships is becoming increasingly sajems ns vol 6 (2003) no 1 135 important in municipalities. achieving true community participation is difficult. local stakeholders tend to monopolize power and are often hostile toward comprehensive participation. it is therefore necessary that a negotiated working relationship should be established between all stakeholders in local government. local government managers should accept that stakeholder negotiation is an ambiguous process where no one party is in charge. individual stakeholders should be willing to note each other’s interests and accept that traditional decision-making practice should be changed to accommodate these interests. managers should be willing to support initiatives that may pose uncertain outcomes although they may find it safer and easier to operate within a regulated environment where the way forward is set. stakeholder negotiation in local government is not only reserved for local community members or community based organizations. stakeholder negotiation may occur between other stakeholders as well: between business and local government, between the local and the district municipalities or between different spheres of government (e.g. district municipalities and provincial authorities). other forms of stakeholder negotiations are to be found on an intrainstitutional level where different local government departments in the same council may find themselves competing and therefore eventually negotiating for the same resources. only in this way will true municipal partnerships develop and could the principle of co-operative governance (on an interand an intrainstitutional context) really emanate. municipal-community partnerships as community participation processes become increasingly institutionalized, practical municipal-community partnership ventures will become more prevalent. however, questions could be raised as to how such initiatives may be managed to ensure their effectivity. to address such concerns the south african department of constitutional development commissioned a study on the status of municipal-community partnerships in 1999. the study involved 22 municipalities, 29 civil society organizations and 25 case study surveys. emanating from the study was a report that reflected some insightful results. the findings generally indicate the limited or ineffective nature of the community consultation or participation approach generally prevalent in south africa. local governments generally confuse municipal community partnerships with community participation and employment programmes (cranko & khan, 1999: 2). the true spirit of partnership and the intensive involvement of the community in the activities of the local government are not yet well cemented. the research has indicated that municipalities’ primary motivation for the establishment of municipal community partnerships is to supplement capacity or sajems ns vol 6 (2003) no 1 136 enhance the cost-effectiveness of services. some interest exists among municipalities to establish municipal community partnerships to enhance job creation and economic empowerment. community contact and improved services, as such, were not indicated as being the primary reasons why municipalities enter into municipal-community services (cranko & khan, 1999: 3). municipalities experience a number of constraints regarding the establishment of effective municipal community partnerships and cite inter alia the following: • the political divisions and conflicts within communities. • a lack in capacity to manage the processes of planning implementation and monitoring of development outputs. • local government capacity to engage in true partnerships is ascribed to limited skills, expertise and commitment among its officials. • local government experiences a general of lack of adequate administrative and financial resources to support municipal-community partnerships. • differences between the organizational and operational ethos of partners are sometimes difficult to reconcile. this state of affairs causes of many misunderstandings, divis ions and mistrust in interactions and exchanges between local governments and their stakeholders. • the ad hoc nature of community partnerships tends to “projectise” development, which results in a breakdown of the engagement once the projects are finalized. non-governmental organizations are primarily motivated by the benefits of pooling resources and the need for increased financial sustainability. an important aspect that motivates non-governmental organizations is the potential that community partnerships carry in empowering communities (cranko & khan, 1999: 3). non-governmental organizations identify the following barriers in the establishment of community partnerships: • local government in many areas lack the appropriate technical and managerial capacity to deal with municipal-community partnerships and do not have the ability to identify, design and manage and monitor the outputs of partnerships. • non-governmental organizations and municipalities differ in their organizational ethos. municipalities are perceived as being overly bureaucratic, their responsiveness to community proposals is lengthy and many staff members are not committed to engaging with service providers on alternative delivery strategies in a sustained way. • politicians and municip al officials are not sensitive to the complex social and economic processes prevailing within communities. sajems ns vol 6 (2003) no 1 137 • officials often neglect to fully engage with communities and community representatives and thereby forfeiting the opportunity to build true partnerships. • municipal departments operate in a non-integrated manner that results in unsustainable development. it is evident from the above findings that the situation in south african local government generally does not reflect the municipal-community partnership ideal that it should provide mechanisms for more effective communication and the resolution of development deadlocks. co-operation should be improved and a new understanding about roles, responsibilities, duties and obligations in service provision should be created. current thought on the true nature of partnerships is that it should be underpinned by policies of decentralization. this recognizes the role of lower levels (spheres) of government to steer developmental initiatives and to ensure effective and efficient service provision (cranko & khan, 1999: 20). in addition to the legislation quoted (supra) concerning the south african government’s policy on community participation, the following table indicates a comprehensive policy framework for engagement in partnerships. the policy framework originates from the recognition of the south african government that it faces constraints in terms of human, financial and technical capacity to deliver sustainable development and that a comprehensive set of policies are needed to guide the process. the policies cited are currently in various stages of development or implementation. south african policy framework for engagement in partnerships • macro-economic reform the growth, employment and redistribution strategy (gear) makes provision for a social compact (wage, price and productivity agreement) and emphasizes partnerships as a vehicle for service delivery and economic growth. both of these impact on the way local government organizes its activities and discharges its duties. • reconstruction and development the reconstruction and development programme (rdp) places the empowerment of institutions of civil society as a fundamental aim of government’s development approach. structured consultation processes at all levels of government will be introduced to ensure participation in policymaking, planning and project implementation. in this way, government will draw on the creative energy of communities. sajems ns vol 6 (2003) no 1 138 • competition policy a competition policy makes provision for the removal of barriers to entry in an accountable and transparent way through a public forum and an independent tribunal. the decisions of the competition board impacts on local government’s local economic development programmes and the type of support provided by community service organizations. • community based public works programme the community based public works programme regards non-governmental organizations and local governments as implementing agencies being responsible for project management. in this regard, municipal-community partnerships are important in public works programmes. • a national infrastructure plan the consolidated municipal infrastructure programme provides grants to local authorities for the provision of infrastructure to poor households. each municipality should, in consultation with the beneficiaries (stakeholders), determine the package and level of services required. it is envisaged that through the consolidated municipal infrastructure programme partnerships between municipalities and civil society will become more structured and dynamic. • restructuring of state assets participation by organized labour and employees of relevant enterprises in restructuring public enterprises and service delivery is guided by the principles of inter alia batho pele. these partnerships range from building institutions, removing boundaries and shifting the balance between state and the market (from internal reform to privatization). • non-profit organizations act the non-profit organizations act, which establishes the national development agency, promotes a co-operative relationship between civil society and government. the objectives of the national development agency is to contribute towards poverty eradicatio n, to assist in capacity building to improve service delivery and to promote dialogue between relevant government spheres and stakeholders. • municipal service partnerships policy the municipal services partnership policy framework envisages partnerships and the type of contractual arrangements that are informed by the aims and objectives of integrated development plans made compulsory in local government by legislation (municipal systems act, 2000). this ensures that developmental objectives are duly negotiated between the relevant stakeholders. cranko and khan, 1999: 23-26 sajems ns vol 6 (2003) no 1 139 business-municipal-community partnerships the global trend of reduced spending by governments has resulted in businesses to become increasingly involved in playing active roles in development. in this regard the current trend is to engage in public -private partnerships (ppps) in an attempt to improve service delivery to specific communities. in the local government sphere, various public -private partnerships are initiated to address service delivery gaps in for instance the sectors of water, transport, waste management, parks and recreation and emergency services. public -private partnerships comprise not only business (in its various forms e.g. multinational companies and small, medium and micro enterprises) but also non-governmental organizations and community based organizations (van niekerk, van der walt & jonker, 2001: 256). according to van niekerk et al. (2001: 256) ppps can assist in empowering local communities and encourage lo cal economic development. furthermore, a partnership can be viewed as a continuous relationship and a definite process. such partnerships involve active interactivity and are based on the following principles: particular skills; cost effectiveness and service efficiency; effective public participation; continued government responsibility; a proper contractual relationship, monitoring process and regulatory framework; and a good working relationship between the government authority and the service delivery agent. in view of the aforementioned, it is important to note badshah’s comments in the city development strategies–publication (1999: 27) that a tension exists between governments, businesses and civil society concerning their respective roles in the community. the tension is unlikely to abate and unless interaction and partnership among the different above-mentioned sectors are established (city development strategies, 1999: 27). according to city development strategies (1999: 28) a number of lessons could be learned from international “best practice” cases with regards to partnerships between business, local government and the community: first, for partnerships between business, the community and local government to be effective, the way in which cities are managed should be altered. what is needed is increased transparency and accountability. decision-making processes should allow stakeholders a direct say in what a particular outcome may bring. all government institutions should be redirected towards institutionalizing partnership engagements. short-term commitment towards engaging in partnerships with business stakeholders will not prevail because of the tendency of the political landscape to change frequently. the culture of management in government should therefore change comprehensively in order to create a continuum of stakeholder negotiations in this regard. sajems ns vol 6 (2003) no 1 140 second, partnerships fail because of a lack of trust between the stakeholders. a result of this may be that there is a lack of commitment on behalf of all parties to see the process through and achieve the desired results. third, there is an element of capacity building and education involved from business’ side in that it should assist non-governmental organizations and community organizations to develop as entities so that they, in turn, can become the cohesive factor in these partnership arrangements. this calls for a true commitment from within local government, business and the community, which cannot be enforced from any outside agency. fourth, local governments should open up the process of decision-making to include participation of all the stakeholders (city development strategies, 1999: 28). in brief, the above lessons teach that a new approach towards managing cities should be adopted wherein constant negotiation takes place between the stakeholders, where all concerned parties are involved in decision-making. in addition, improved consultation and decision-making will be achieved if community organizations are capacitated to play their roles effectively with the assistance of business and local government. conclusion in the preceding discussion it became apparent that south african local governments should re-assess their roles in their areas of municip al jurisdiction. management in local government should adapt to new approaches concerning how to best improve municipal service rendering and how to achieve developmental objectives on the basis of sustainability. community participation and stakeholder negotiations challenge traditional views on decision-making and responsibility in the municipal environment. resourceconstrained public institutions working in close collaboration community stakeholders and the private sector will present municipalities with challenges that are different from traditional local government affairs. democratic, transparent and accountable practices are highly regarded traits where local governments strive towards legitimacy in view of their communities and where investment in development projects is sought. an effective way of meeting local government objectives could therefore be to establish and institutionalize community participation and most importantly, stakeholder negotiation to the extent that it will be viewed not as an ad hoc event but rather a continuous process. out of necessity, the divergent views and needs would require frequent negotiation and supportive resources should be made available to prove local sajems ns vol 6 (2003) no 1 141 government’s commitment towards engaging in partnerships with stakeholders. the ideal is to form true partnerships with municipal stakeholders through a process of consistent involvement in decision-making. this could support the entrenchment of a culture of stakeholder negotiations in all matters that impact on the parties concerned. finally, the trust-building dynamics among different stakeholders and within different municipalities motivate the need for other spheres of government to abstain from overregulating community participation and stakeholder negotiation processes other than by creating a broad policy environment to allow the stakeholders to facilitate this process themselves. municipalities should in this regard rather be supported through offering appropriate mechanisms, resources and advice. much applied research is still needed in this area. the south african local government system is still evolving and it is dependent on the processes of community participation and stakeholder negotiation to ensure its ultimate effectiveness. references 1 beckenstein, a.r. long, f.j. arnold, m.b. & gladwin, t.n. (1996) stakeholder negotiations. exercises in sustainable development, chicago: irwin. 2 city development strategies (1999) “business citizenship: new approaches to social investment in cities”, city development strategies initiative, issue no 1 (october). 3 coetzee, j.k. graaff, j. hendricks, f. & wood, g. (eds.) (2001) development. theory, policy, and practice, cape town: oxford university press southern africa. 4 cranko, p. & khan, f. (1999) municipal community partnerships, department of constitutional development. 5 du toit, d., knipe, a., van niekerk, d., van der walt, g. & doyle m. (2001) service excellence in governance, sandown: heinemann publishers (pty) ltd. 6 department of provincial and local government (2000) research compiled by: oranje, m. harrison, p. meyer, e. van huyssteen, e. october, a policy paper on integrated development planning. 7 department of provincial and local government idp guide pack, guide 1. 8 fox, w. & meyer, i.h. (1995) public administration dictionary, kenwyn: juta & co ltd. sajems ns vol 6 (2003) no 1 142 9 mersham, g.m., rensburg, r.s. & skinner, j.c. (1995) public relations, development and social investment: a southern african perspective, pretoria: j.l. van schaik. 10 reddy, p.s. (1996) (ed.) perspectives on local government management and development in africa, durban, south africa: department of public administration, university of durban-westville. 11 spoelstra, m. & pienaar, w. (1996) negotiation. theories, strategies & skills, kenwyn: juta & co. ltd. 12 south africa, republic (1996) the constitution of the republic of south africa, act 108 of 1996. pretoria: government printer. 13 south africa, republic (2000) municipal systems act, act 32 of 2000, pretoria: government printer. 14 south africa, republic (1997) white paper on transforming public service delivery, pretoria: government printer. 15 south africa, republic (1998) white paper on local government. pretoria: government printer. 16 swanepoel, h. & de beer, f. (1996) communication for development. a guide for fieldworkers, johannesburg: international thompson publishing (southern africa) (pty) ltd. 17 van der walt, g. & knipe, a. (1998) project management for strategic change and upliftment, johannesburg: international thompson publishing (southern africa) (pty) ltd. 18 van niekerk, d., van der walt, g. & jonker, a. (2001) governance, politics, and policy in south africa, goodwood, cape town: oxford southern africa. microsoft word vol6no3'3.doc sajems ns 6 (2003) no 3 439 a panel data analysis of crime in south africa ________________________________________________________________ f l e blackmore department of economics, university of pretoria ________________________________________________________________ abstract this study analyses the determinants of crime in south africa using economic, social and demographic variables. the model is estimated using an unbalanced panel of 1044 observations for 15 crimes across the 9 provinces of south africa over 8 years. a comprehensive analysis of the crime situation is achieved using this data, since it combines the benefits of macroeconomic time series with microeconomic cross sectional series. the statistical results identify significant effects for the income per capita, drug use, ratio of woman to men, the economically active population, degree of urbanisation, unemployment rate and age structure variables. only one third of all crimes are sensitive to changes in quantity of expenditure on total protection services. education and change in gross domestic product variables yielded insignificant results. jel c10, d14, e24, j1 1 introduction south africa, with its population of 44 million, 39 percent of whom are under the age of fifteen, has undergone tumultuous change over the past few years as the authorities came to terms with existing inequalities, generations of neglect, and a developmental backlog created as a result of years of disruption and student unrest during the struggle against apartheid. south africa is characterised by tightly controlled input markets which together with the social and economic implications of the past political regime have resulted in an unemployment rate of 30 percent. in addition the reintroduction of south africa to the international stage brought about a tremendous increase in incidence of drug trafficking, vehicle theft, and hijacking, many of which can be linked to organised crime syndicates that have been found operating within the country (brown, 2001). loopholes in the border control system exist and the relatively easy trafficking of contraband across south africa�s borders is notoriously well known (saps, 1996). currently south africa is crippled by crime which seems unlikely to abate within the near future. private security has become one of the most profitable industries sajems ns 6 (2003) no 3 440 employing well over 450 000 people (brown, 2001). many suburban south africans live in jail-like homes guarded by vicious dogs, razor wire, and armed security guards summoned by panic buttons. region-specific and demographically representative monitoring of crime only began after the democratically elected government came to power in 1994. the introduction of these statistics has made it apparent that something had to be done to control crime in south africa. in 1994 interpol ranked south africa as the second most dangerous country in the world with more than 60 murders per day compared to the rate of 9 in the united states and an international average of 5.5. it was also ranked as second in the world with respect to sex related crimes and had the highest number of rape cases reported (141 cases per day) (builta, 1995). the study of the crime rate in south africa is relevant from a national and international perspective. within south africa basic elements of human rights such as freedom of movement, personal security, the preservation of human dignity and in the final instance the very right to life, have been continually jeopardised by the effects of violent crimes and have traumatised the majority of the population. in fact the results of a survey indicate that as many as 25 percent of south african households have experienced some form of crime directly (brown, 2001). this has created a sense of anxiety and apprehension within the population. it is clear that the crime rate has also contributed to the loss of professionally skilled people if one accepts the official reasons that have been provided for emigration. the cost of crime to the insurance industry amounts to approximately 35 per cent of all insurance claims paid out. these costs mentioned represent only some of the direct financial costs associated with crime, they do not include the indirect costs associated with crime. indirect crime related costs such as those costs associated with the criminal justice process, medical costs, and loss of working hours are not included (saps, 1996). internationally the crime rate has a negative influence on investor confidence and consequently south africa has been unable to attract the quantities of foreign direct investment it requires to attain the growth rate to enable it to address the inequities of the past, secure sustainable developmental programmes and focus on new national issues affecting the country such as managing the aids pandemic. the long-term survival of the economy relies on south africa being able to take a position equal to its peers in the global economic environment as a stable and reliable trade partner. apart from the government and private investment required in order to help alleviate the backlog of social problems extensive long-term foreign direct investment is also essential (abedian & cronje, 1995). sajems ns 6 (2003) no 3 441 a need therefore exists for an intensive study into the nature and causes of the crime rate in south africa so that the correct policies can be put into place in order to control this serious socio-economic problem and barrier to long term economic growth and prosperity. the aim of this study will be to determine the significance and magnitude of the impact of the social, economic and demographic variables that have been identified in the literature as possible determinants of crime in south africa. 2 theoretical background woman and girls in south africa are increasingly victims of physical, sexual and psychological abuse irrespective of age, status, income, creed, colour or culture. unemployed individuals accounted for 49 percent of the offenders of such crimes. violent crimes (murder and attempted murder), which cannot be separated from the business dealings associated with organised crime, and crimes related to the social fabric of south african society (both categories of assault and rape), tend to have higher incidence in (saps, 1996b): (i) areas experiencing a high rate of urbanisation with concomitant social problems like urban unemployment, informal settlements which are difficult to police, high levels of relative deprivation and expectations and the displacement of rural support and value structures by peer group pressure (e.g. the phenomenon of gangs). international and interregional migration further increases the problem of urban unemployment. it is estimated that around 1000 people migrate to johannesburg every month looking for work. they usually become squatters and then apply for lowcost public housing which is very difficult to get (builta, 1995). (ii) property-related crimes that are associated with organised crime (syndicates involved in crimes like vehicle theft, commercial crime, and robbery with aggravating circumstances � including bank robberies, robbery of cash in transit and hijacking) seem to be more prevalent in johannesburg and the areas surrounding it in the gauteng province. (iii) rural areas historically associated with the phenomenon of alcohol abuse. the south african government has made only infrequent mention of the crime problem and often seems to underplay its severity more often shifting the blame to the media for over-dramatising the crime situation. the modest real overall increase in government spending on the criminal justice system means that in order to increase the state�s ability to come to grips with crime, reliance is, one hopes, being placed on better management and better-trained personnel than on sajems ns 6 (2003) no 3 442 frivolous spending. expenditure by the three crime-related departments (safety and security, justice, and correctional services) has increased from r12.047 billion in 1994/95 to r27.792 in 2000/01 � a nominal increase of 11 per cent per year over this time period. the need to provide for south africa�s rapidly increasing prison population has been accepted by the government, and thus the department of correctional services stands to benefit most. more reliance seems also to be placed on improving skills and support systems than on increasing personnel numbers, which may be a step in the right direction (gastrow, 1998). the cause of the high crime rate has been difficult to pinpoint. past analyses have indicated that crime generally has multiple attributing elements such as, economic recessions, poverty and unemployment, the inefficient level of crime expenditure, the age structure of the population, and even social and moral degradation (fajnzylber, lederman & loayza, 2002). the demographics of the south african population are changing the age structure of criminals and according to hess (1997) there has been a boom in the number of child convicts. crime perpetrated by individual criminals such as burglary of residential and business premises, common robbery, shoplifting, other theft and stock-theft, have been found to occur evenly around the country. the explanation for the broader, and even rural, prevalence of these crimes is that the single criminal tends more often to be motivated by need than by greed (or economic profits), whereas in the case of organised crime economic profits, and not need, seems to be the predominant motivating factor (saps, 1996abc). it is therefore implied that unfavourable socio-economic circumstances, especially urban unemployment resulting from rapid urbanisation, may contribute to a continued increase in crimes often motivated by individual need, whereas organised crime may be more inelastic to both the economic and political climate and thus cannot be expected to react significantly if economic and political inadequacies alone are addressed. it has also been suggested that other reasons for the high levels of crime include; government inaction to the crime situation, the lack of sufficient police presence, inadequate police training, a corrupt police force, a faulty justice system, ending capital punishment, and even the police and prisons civil rights union. (smith, 1997). there has been a widespread belief that government expenditure on total protection services has not been adequate given the current crime situation in south africa. this line of thought is however based on the assumption that increased expenditure on total protection has a deterrent effect and is thus an important avenue for combating crime. sajems ns 6 (2003) no 3 443 3 methodology the study of crime in south africa can be approached from many angles because of the widespread influence of crime on different spheres of society and everyday life. the economic model of crime focuses on the costs and benefits of crime, treating it as an alternative career or way of earning a living, in other words as a consumption model. this methodology assumes that rational choices are being made by rational individuals in order to calculate and compare the costs and benefits of illegal activities with non-criminal alternatives of earning a living. the expected benefits from crime tend to be the difference between the windfall and the opportunity cost of the crime, while the costs are given by the penalties imposed on apprehended criminals (fajnzylber, lederman & loayza, 2002). usually such models would include both supply and demand variables which enter implicitly into an individual�s decision making process. an improvement to the economic model of crime involves an interdisciplinary approach which can include social, political, economic and law enforcement variables in its design. the focus of such an interdisciplinary model is broader than the economic model and includes other crime causation variables which may contain important information on the causes of crime. variables normally included in the interdisciplinary model are the following (brown, 2001): (i) clearance rate: given a fixed manpower resource, the proportion of crimes that are cleared (the probability of apprehension) would be expected to be inversely related to the volume, and thus, to the rate of crime (fox, 1978). (ii) conviction rate: the number of people charged of a crime who are convicted for that crime would be expected to be negatively related to the crime rate (avio & clark, 1976). (iii) average sentence received: this can be seen as a deterrent to crime if sentences are severe and should thus have a negative effect on crime (avio & clark, 1976). (iv) value of stolen/damaged property or a proxy thereof: can be seen as the payment for crimes such as theft. one would expect a positive relation with the crime rate (becker, 1968). (v) standard of living variable such as income per capita: this represents the opportunity costs of crime. consequently, a negative relation to crime would be expected for this variable (fajnzylber, lederman & loayza, 2002). (vi) unemployment rate: a macroeconomic variable associated with the general health of the economy and would be predicted to have a positive relation to crime. (vii) education level would be expected to be negatively related to crime (fajnzylber, lederman & loayza, 2002). sajems ns 6 (2003) no 3 444 (viii) demographic indicators such as age distribution, and in particular the participation rate of those persons who are between the ages of 15 and 34, and a gender dummy variable would both also be related to the crime rate (shapiro & ahlburg, 1986). (ix) other social, demographic, and economic indicators such as the number of citizens per police officer, racial group, number of people per household, home language, occupation, geographic location, consumer price index and gross domestic product could also be included in such a model and be expected to contribute to the crime rate (schmidt & witte, 1984). data on these variables are usually used in a time series model in order to assess their relation to and effect on the crime rate. models following the economic model tend to explain around 90 percent of the variation in the crime rate indicating that a significant proportion of the crime rate can be explained by such a model. a problem with the economic model of crime is its focus on the operation of the criminal justice system, which is severely limited with respect to crime causation theory (brown, 2001). a further problem with models of this nature is that in order for them to work properly and yield significant results large time series of data are required. in general the conclusion derived from this approach are that crimes will be committed whenever the benefits of committing crimes exceed the possible costs associated with being apprehended, convicted, and punished for such crimes, and thus policy prescriptions usually focus on increasing the cost associated with criminal activity. one of the pioneering studies on crime by becker (1968), using the economic model of crime, indicates that increasing the probability of being punished is the most effective way to reduce the crime rate. with only 8 years of complete crime data available for south africa, a reliable time-series regression model cannot be estimated due to insignificant degrees of freedom. however, these data are available for all nine provinces as well as for many of the socio-economic variables and thus a cross-provincial panel data model has been chosen for this analysis. the longitudinal or panel data set follows fifteen crime types over time and thus provides many observations on each crime type in the sample. panel data sets for economic research have the following advantages over both cross-sectional and time series data sets (hsiao, 1999): (i) they contain a larger number of observations since they have both a crosssectional and time series component. this results in greater degrees of freedom and thus improves the efficiency of econometric estimates (fourtin, keil & symons, 2001). sajems ns 6 (2003) no 3 445 (ii) panel data sets allow the researcher to analyse more complicated behavioural models than either pure cross-sectional or pure time series data sets. micro-dynamic and macro-dynamic effects cannot be estimated using cross-sectional data, while time series data cannot provide accurate estimates of dynamic coefficients. (iii) one is better able to control for the effects of omitted variables by using information given by both the intertemporal dynamic and the individuality of the entities being investigated. the fixed effects and random effects panel model specifications involve some form of aggregation and the assumption that the explanatory variables have identical impacts across crime types, and thus suffer from statistically biased results (cherry & list, 2002). the importance of the different explanatory variables tends to vary across different crimes because of the different �skills� that are required for perpetrating different crimes. for example, to commit fraud, offenders are per definition employed, usually older than other criminals and also tend to be better educated and have higher incomes. in contrast, the effects of income, education, and age differ for those who are likely to commit malicious damage to property. this type of crime tends to be committed by offenders who are younger and for whom income represents a low opportunity cost because of their juvenile status (foot & stoffman, 1998). it is assumed that due to the different �skills� required for each crime type the resultant coefficients would be significantly different so that pooling data in any form would be inappropriate in this case. consequently the appropriate estimation model to be used in this study is a seemingly unrelated regression (sur) model in which a different set of crime equations are estimated with different coefficients for each of the equations. this technique captures estimation efficiency due to the correlation of errors across the different equations. 4 data analysis the statistics on the 15 crime types (fraud, forgery and misappropriations, malicious damage to property, arson, common assault, rape and attempted rape, common robbery, attempted murder, murder, theft out of motor vehicles, theft of motor vehicles, shoplifting, stock theft, burglary from residential premises, bank robbery and carjacking) were collected for the months of january to september for the years 1994 to 2001 for all nine south african provinces (northern cape, eastern cape, western cape, free state, gauteng, kwazulu-natal, mpumalunga, north west and limpopo) and include the total number of transgressions over this period as well as the respective crime ratios calculated per 100 000 of the population. sajems ns 6 (2003) no 3 446 the decision to use provincial data was based on data availability, as there was not enough national time series data available to construct a national time series model of crime. taking data for the nine provinces added significant degrees of freedom to the model and a substantial amount of additional variance in variables that are specific to a particular province and are thought to influence the crime rate. consequently, by using provincial data, there is scope for improving estimation efficiency and the power of statistical tests significantly. data on 15 crime types were collected over an 8-year period resulting in a data set of 120 observations for each of the 9 provinces. the 9 provincial data sets were then stacked to provide the final data set defined across the 15 crime types and over 72 observations (9 provinces for 8 years), resulting in a panel that should contain 1080 elements. however for two of the crime types (carjacking and bank robbery) data for 1994 and 1995 is unavailable, and thus 36 elements (2 years for 2 crime types for 9 provinces) have been excluded from this data set, hence the classification of the model as an unbalanced panel data model. the final data set therefore contains a total of 1044 observations. this stacked specification of the data was possible due to the fact that since all variables are ratios the data used is assumed stationary, and only stationary data can be pooled in this manner. another advantage of employing ratios is that the growth rate of the population figures are neutralised. by using ratios artificial increases in the crime rate due to population growth, and not to a real increase in the incidence of crime, are avoided. ratios also enable one to compare the incidence of crime among different provinces or countries, notwithstanding differences pertaining to the size of populations. furthermore, comparisons involving ratios are also more appropriate than comparisons involving frequencies, as ratios generally indicate: (i) the probability of becoming a victim of a specific crime. (ii) the presence of those factors, or combinations of factors, conducive to the incidence of specific crimes and which have to be addressed in order to combat these crimes effectively. the data was converted to logarithmic form in order to be able to interpret the resulting coefficients as elasticities. the expenditure on total protection services as a percent of gross domestic product variable and the proportion of the population that is male and between the ages of 15 and 34 years variable are both national variables and were collected from the budget review and census report respectively. data on the remaining explanatory variables was collected from various issues of the october household survey and the labour force survey. these variables are all specific to a particular province. sajems ns 6 (2003) no 3 447 the fact that crime in south africa is on the increase, or at best stable at a very high level, cannot be debated; however, the rate at which some crimes seems to have been growing can be brought into question. there are two reasons why there may be errors in these data. firstly, accurate and region-specific (the nine new provinces) monitoring of crime only began after the democratically elected government came to power in 1994. up until that point in time crime statistics were available largely for minority areas only, whereas the crimes committed to the majority of the population were left, either unreported, badly documented and generally ignored by the government of the day. secondly, in traditionally black communities where crime rates are higher than in other areas, there is still a distrust of the police and vigilante justice is still common. however, initiatives have been set in place to encourage crime reporting such as implementing a crime prevention campaign which calls on people to report crime, increasing awareness of crime and improving police availability. these have both resulted in a significant increase in the number of crimes reported, without crimes themselves necessarily having increased. we need to take a closer look at all the variables included in this model, by classifying them into economic, demographic and socio-economic variables. 4.1 economic variables (i) income per capita: if crimes are motivated by need as opposed to greed, one would expect that there would be some relation between income per capita and the crime rate. generally one would expect a negative relation since greater income per capita represents a higher opportunity cost of committing crime, and consequently one would expect a lower crime rate (brown, 2001). however, the income per capita variable does not take account of the distribution of income. it may be that the income of small proportion of the population increase by amounts large enough to affect overall income per capita leaving the income of the majority of people unchanged or even lower than before. a study by fajnzylber et al. (2002) found that income inequality was a robust determinant of violent crimes. in this case one could even expect a positive relation between crime and income, since an increase in income per capita represents a larger possible reward to criminal activity. (ii) unemployment rate: generally there are two main ways of securing an income, either through legal job markets or illegal activities. the bulk of the literature suggests that if the official unemployment rate is high then there is a certain incentive to switch to illegal activities to earn a living, and thus it is to be expected that there is a positive relationship between the level of unemployment and the crime rate. sajems ns 6 (2003) no 3 448 (iii) expenditure on total protection services: total protection services consist of three main national expenditure items; safety and security, justice and correctional services. theory suggests that increased expenditure on these three items would generally increase the probability that perpetrators of crimes are caught, successfully sentenced, and finally punished. this increases the risk of criminal behaviour and thus requires an equal increase in return, which if not forthcoming make criminal activities less attractive relative to legal means of earning an income. it is thus expected that increasing expenditure on total protection services would lead to a subsequent decline in the crime rate. other law enforcement variables, as given by the economic model of crime, are not available and thus expenditure on law enforcement was taken as a proxy for these variables. (iv) growth rate of gdp: this variable would take the phase of the business cycle into account. it is expected that a growing economy, and thus a positive growth in gdp value, would be associated with a decrease in the crime rate, since in an expanding economy the opportunity cost of crime increases. 4.2 demographic variables (i) degree of urbanisation: urbanization is generally related to higher levels of criminal activity and thus in this study a positive relation is expected between urbanization and the crime rate. urbanization concentrates large numbers of people and wealth in a relatively small area thus providing increased opportunities for criminal activity. (ii) proportion of the population that is male and aged 15 to 34 years of age: from studies such as avio and clark (1976), and more recently foot and stoffman (1998), one can conclude that the majority of crimes are committed by males aged between 15 and 34 years of age. this implies that the larger the size of this cohort is in any given population, the higher the crime rate should be. in other words a positive relationship is expected between this cohort size and the crime rate. this variable is believed to decrease the moral cost of committing crime and increase the net earnings from illegitimate activities, resulting in a higher crime rate (brown, 2001). (iii) economically active proportion of the population: the economically active portion of the population is defined as all those people between the ages of 16 and 65 years of age who are able to work. the sign of this variable is generally expected to be negative if it is assumed that there are enough jobs available to absorb these economically active people and that there will be ample legitimate employment opportunities available. if, however, there are not enough jobs available to accommodate the economically active portion of the population then criminal or illegal sajems ns 6 (2003) no 3 449 alternatives of making money may be pursued and a positive coefficient can be expected. 4.3 social factors (i) ratio of woman to men: it is assumed that men commit the majority of crimes. the larger the ratio of woman to men in any community would thus be expected to reduce the relative crime rate in that community since the proportion of those committing crime is relatively reduced. this variable may also capture some positive ethical or moral effects introduced through the presence of a larger ratio of woman to men in any community. this variable is assumed to increase the moral cost of committing cri-me and should thus lead to a lower crime rate. (ii) number of drug possession offences: this variable measures the effects that drugs and alcohol have on the crime rate. it is expected that an increased consumption of alcohol and drugs are related to higher crime rates since use of these substances impairs the correct assessment of the risks and rewards associated with committing a crime and may also introduce a temporary departure from the assumption that criminals are rational when deciding on committing crimes. (iii) education. this variable is measured by the proportion of all learners that pass the senior certificate examination. it is expected that this variable would be negatively related to the crime rate since greater educational levels create more legitimate income earning opportunities. 5 empirical estimation we estimate a crime equation of the following form ititiiitc εβα ++= x with 1044 observations on the 15 crime types, across the 9 provinces for the 8 year period of 1994 to 2001. there are a total of 9 regressors: the constant and 8 explanatory variables included in xit. the eight explanatory variables are those discussed in the previous section of this paper. 5.1 econometric results the r-square value for the interdisciplinary sur model has a value of 0.953, which indicates that over 95 per cent of the variation of the overall crime dependent variable can be explained by the variation of the eight independent variables. this confirms that the estimated model fits the data well. we will now take a more detailed statistical and economical look at the results achieved for each of the eight independent variables as explanatory variables of the fifteen sajems ns 6 (2003) no 3 450 individual crime types. both the education and change in gdp variables yielded insignificant results and were excluded from the final model design. educational attainment was also found to be insignificant in the study by fajnzylber, lederman and loayza (2002). 5.2 interpretation of results 5.2.1 economic variables (i) income per capita: according to the results in table 1 the income per capita variable was found to be statistically significant for all crime types. for twelve of the crime types the null hypothesis of an insignificant coefficient was rejected at the 1 per cent level of significance, while for the remaining three crime types this hypothesis was rejected at the 10 per cent level of significance. this means that income per capita is an important explanatory variable for all crime types and should therefore be included in the crime model. income per capita has a positive impact on the majority of crimes. this can be explained by the fact that criminal activity is a substitute for legitimate employment especially in the case where there is an unequal distribution of income. thus, even though income per capita shows an increasing trend over time it is possible that this results as a consequence of large increases in income for a wealthy minority, while the incomes of the majority of people remain constant or even decrease. in this case an increase in income per capita would represent a larger reward for criminal activity and thus the amount of such activity could be expected to increase. stock theft, rape and attempted rape, and common assault all have negative coefficients suggesting that an increase in income would lead to decrease in these crime rates. the negative coefficient for stock theft can be easily explained but the case for rape and common assault initially appear less convincing. in the case of common assault, there are two possible explanations for the negative coefficient. firstly, higher income may reduce the levels of social tension and stress making people less likely to commit acts of assault or, alternatively, that there is not a great incentive to report such crimes and thus the data series may be unreliable. t ab le 1 e st im at ed c ri m e eq ua ti on s fo r fi ft ee n cr im e ty pe s, s ou th a fr ic a, 1 99 420 01 c ri m e t yp es c on st an t in co m e pe r ca pi ta d ru g re la te d cr im e ra te r at io o f w om an to m en e co no m ica lly a ct iv e pr op or ti on of p op ula ti on d eg re e of ur ba ni sa ti on u ne m pl oy m en t r at e p ro po rt io n of p op ula ti on a ge d 15 to 3 4 ye ar s e xp en di tu re o n to t. pr ot ec ti on se rv ic es a s a % o f g d p m ur de r -4 8. 29 0. 79 8* ** (0 .1 78 ) 0. 46 ** * (0 .0 73 ) 3. 49 ** * (0 .8 65 ) -0 .8 62 ** * (0 .2 83 ) 0. 86 ** * (0 .2 77 ) 0. 75 ** * (0 .1 81 ) 7. 89 5* ** (1 .4 02 ) 1. 92 5* ** (0 .7 1) c om m on as sa ul t 40 .2 0 0. 67 2* ** (0 .1 32 ) 0. 26 2* ** (0 .0 54 ) -2 .6 97 ** * (0 .6 4) -1 .2 79 ** * (0 .2 17 ) 1. 29 4* ** (0 .2 05 ) -0 .5 19 ** * (0 .1 35 ) -5 .1 31 ** * (1 .0 58 ) -2 .3 17 ** * (0 .5 31 ) st oc k th ef t -8 .8 46 2. 14 2* ** (0 .4 21 ) 1. 69 9* ** (0 .1 74 ) -1 1. 96 ** * (2 .0 6) 3. 48 7* ** (0 .6 72 ) -3 .4 29 ** * (0 .6 63 ) 1. 00 6* * (0 .4 26 ) 7. 36 9* * (3 .2 49 ) 3. 92 3* * (1 .6 74 ) t he ft of m ot or ve hi cl es -4 4. 40 2. 04 ** * (0 .3 5) -0 .2 43 * (0 .1 42 ) 3. 31 1* * (1 .6 79 ) -1 .5 82 ** * (0 .5 46 ) 1. 58 7* ** (0 .5 37 ) 1. 00 6* ** (0 .3 59 ) 5. 23 8* (2 .8 35 ) 1. 18 3 (1 .3 99 ) sh op lif tin g -1 0. 68 0. 59 6* ** (0 .1 29 ) 0. 40 6* ** (0 .0 53 ) 1. 94 9* ** (0 .6 28 ) -0 .6 87 ** * (0 .2 04 ) 0. 68 7* ** (0 .2 01 ) 0. 22 6* (0 .1 3) 1. 21 (1 .0 05 ) -0 .1 25 (0 .5 12 ) a rs on -2 7. 28 0. 23 6* (0 .1 26 ) 0. 21 7* ** (0 .0 52 ) 1. 56 3* * (0 .6 18 ) -0 .2 49 (0 .2 22 ) 0. 21 9 (0 .1 98 ) 0. 48 1* ** (0 .1 28 ) 5. 17 2* ** (0 .9 76 ) 1. 31 3* ** (0 .5 06 ) t he ft ou t of m ot or ve hi cl es -1 3. 88 1. 37 7* ** (0 .1 44 ) 0. 26 5* ** (0 .0 59 ) 3. 97 4* ** (0 .7 04 ) -0 .9 72 ** * (0 .2 3) 0. 95 7* ** (0 .2 26 ) 0. 11 7 (0 .1 47 ) 0. 10 9 (1 .1 32 ) 0. 13 9 (0 .5 76 ) m al ic io us da m ag e to pr op er ty 4. 34 5 0. 15 3* (0 .0 89 ) 0. 32 ** * (0 .0 36 ) -1 .1 92 ** * (0 .4 3) -0 .7 04 ** * (0 .1 72 ) 0. 76 5* ** (0 .1 37 ) -0 .0 29 (0 .0 9) -0 .0 13 (0 .6 92 ) -0 .4 2 (0 .3 57 ) sajems ns 6 (2003) no 3 451 t ab le 1 c on ti nu ed c ri m e t yp es c on st an t in co m e pe r ca pi ta d ru g re la te d cr im e ra te r at io o f w om an to m en e co no m ica lly a ct iv e pr op or ti on of p op ula ti on d eg re e of ur ba ni sa ti on u ne m pl oy m en t r at e p ro po rt io n of p op ula ti on a ge d 15 to 3 4 ye ar s e xp en di tu re o n to t. pr ot ec ti on se rv ic es a s a % o f g d p r ap e an d at te m pt ed ra pe 6. 21 0 -0 .1 36 * (0 .0 69 ) 0. 16 6* ** (0 .0 28 ) -2 .9 79 ** * (0 .3 4) -0 .3 17 ** * (0 .1 14 ) 0. 31 1* ** (0 .1 09 ) -0 .0 01 (0 .0 7) 0. 40 6 (0 .5 35 ) 0. 23 4 (0 .2 77 ) a tte m pt ed m ur de r -3 1. 04 1. 30 3* ** (0 .1 89 ) 0. 06 1 (0 .0 78 ) 4. 71 9* ** (0 .9 23 ) -0 .3 67 (0 .3 05 ) 0. 27 9 (0 .2 96 ) 0. 4* * (0 .1 93 ) 3. 20 6* * (1 .4 87 ) 1. 98 ** * (0 .7 57 ) b ur gl ar y fr om re si de nt ia l pr em is es 7. 40 0 0. 67 4* ** (0 .0 94 ) 0. 15 2* ** (0 .0 39 ) 0. 23 8 (0 .4 59 ) -0 .5 57 ** * (0 .1 49 ) 0. 56 ** * (0 .1 47 ) 0. 03 6 (0 .0 95 ) -2 .0 27 ** * (0 .7 37 ) -0 .0 08 (0 .3 75 ) fr au d, fo rg er y, m is ap pr opr ia tio ns -1 4. 69 0. 67 3* ** (0 .1 ) 0. 05 2 (0 .0 38 ) 0. 69 1 (0 .4 35 ) -1 .3 13 ** * (0 .2 76 ) 1. 62 8* ** (0 .1 38 ) 0. 28 3* ** (0 .0 91 ) 2. 59 6* ** (0 .7 09 ) -0 .4 95 (0 .3 69 ) c om m on ro bb er y 37 .4 4 0. 42 3* ** (0 .1 56 ) -0 .0 08 (0 .0 65 ) -0 .1 24 (0 .7 68 ) -1 .6 35 ** * (0 .2 56 ) 1. 53 2* ** (0 .2 47 ) -0 .1 68 (0 .1 58 ) -8 .4 ** * (1 .2 08 ) 0. 13 6 (0 .6 25 ) b an k ro bb er y -5 7. 59 1. 53 6* ** (0 .4 3) -0 .4 27 ** (0 .1 72 ) -0 .3 31 (1 .8 19 ) -0 .9 68 (1 .6 65 ) 0. 35 5 (0 .6 4) 0. 71 6* (0 .4 13 ) 10 .4 5* ** (3 .0 75 ) -2 .4 83 (2 .1 65 ) c ar ja ck in g -8 4. 62 3. 69 1* ** (0 .8 86 ) -0 .9 53 ** * (0 .3 54 ) 6. 98 3* (3 .8 12 ) -2 .6 75 (3 .1 78 ) 1. 29 (1 .3 16 ) 1. 88 8* * (0 .8 6) 8. 56 9 (6 .5 13 ) 5. 77 2 (4 .3 10 ) t he n um be rs in p ar en th es es b el ow th e es tim at ed c oe ff ic ie nt s ar e th ei r as so ci at ed s ta nd ar d er ro rs . st ar s in di ca te r ej ec tio n of t he h yp ot he si s of a n in si gn if ic an t co ef fi ci en t at t he 1 0 pe r ce nt ( *) , 5 p er c en t (* *) a nd 1 p er c en t (* ** ) si gn if ic an ce le ve ls re sp ec tiv el y. so ur ce : a ut ho rs � c al cu la tio ns sajems ns 6 (2003) no 3 452 sajems ns 6 (2003) no 3 453 a possible explanation of the negative coefficient for rape may be the fact that often rape goes hand in hand with other crime types that are perpetrated in order to gain materially, such as burglary of residences and common robbery. consequently any increases in income is likely to decreases the need for committing materially motivated crimes and thus incidence of rape may decrease too. (ii) unemployment rate: the coefficients of ten crime types reject the hypothesis of an insignificant coefficient at various levels of statistical significance, indicating that the unemployment rate should be included as an explanatory variable in these cases. in general one would expect a positive relationship between the unemployment rate and the crime rate since higher levels of unemployment indicate that there are fewer legal opportunities of employment available, and thus the unemployed may have to turn to illegal or criminal means of earning income. from table 1 one can see that this is in fact so for nine of the ten crimes for which unemployment is a significant explanatory variable. however, for the case of common assault the coefficient has a negative sign indicating that increases in unemployment are related to a decrease in incidence of common assault. again a possible explanation for this could be that because of the lack of any material reward such crimes are not consistently reported and this could lead to the data giving spurious results. (iii) expenditure on total protection services: for only five crime types could the hypothesis of an insignificant coefficient be rejected, in four of these cases at a 1 per cent level of significance and in the fifth case at the 5 per cent level of significance. in other words for the remaining ten crime types the hypothesis that the coefficients are insignificant could not be rejected indicating that for these crimes this variable is not a significant explanatory variable for the variation on the dependent variable. the disappointing results obtained for this variable could possibly be explained by the fact that national figures were used as a proxy for the expenditure across all provinces and was thus not defined on a provincial basis. it is common knowledge, however, that expenditure on the three components of total protection services differs vastly across the nine provinces and this variation is not included in this variable. theory dictates that there should be a negative relationship between expenditure on protection and the crime rate since the probabilities of being caught, tried and punished generally increase, and with it the risk of committing crimes also increases. the incidents of criminal activities will then decrease if it is assumed that the rewards from committing these sajems ns 6 (2003) no 3 454 crimes remains constant or even increases, but at a lower rate than the risks thereof. this appears to hold true for only one of the crime types, common assault. for the other crimes, a significant positive relation exists indicating that increases in protection expenditure result in higher incidence of crime. a possible explanation for this positive relationship is that there may exist a threshold level of protection expenditure above which the negative relation holds, but below which may have any sign. south africa may not have reached this threshold level of expenditure yet and thus increases in expenditure have no deterrent effect on the crime rate. it may also be the case that the level of expenditure actually adjusts to the crime rate in which case a higher crime rate would cause expenditure on protection to increase, hence the positive sign for many of these coefficients. corruption and possible government inefficiencies may also add to the conflicting results associated with the results of the coefficients of this variable. 5.2.2 demographic variables (i) degree of urbanisation: for eleven of the fifteen crime types this variable is highly significant and the hypothesis of insignificant coefficients is rejected at a 1 per cent level of significance in all of these cases indicating that this variable is a good explanatory variable for the variation of the dependent variable. as mentioned earlier, a positive relationship is expected between this variable and the crime rate. this is so because as relatively more people move to urban areas there is a resultant increase in both the concentration of people and wealth within a relatively confined area. at the same time the large numbers of people have to compete against one another for employment and costs generally tend to be higher than rural areas, which increase the amount of income required for sustainability. there is consequently a large incentive to earn income from illegal means. crimes that are generally not committed for material gain also tend to be higher in urban areas due to the increased levels of social pressure and the large diversity of people living in urban areas. from the model output it is clear that for all crime types, except for stock theft, this positive relationship is in fact upheld as is expected. stock theft tends to occur mainly in less populated rural areas and thus the negative coefficient for this variable is also justified by the fact that relatively more people living in urban areas implies that relatively fewer people are living in rural areas, and thus incidence of stock theft would be expected to increase, given that the probability of being caught is reduced together with the rural population. sajems ns 6 (2003) no 3 455 (ii) proportion of the population that is male and aged 15 to 34 years of age: for ten of the crime types the parameter nullity hypothesis can be rejected. for ten crime types this variable has a significant impact at least at a 10 per cent level of significance. since the majority of crimes are perpetrated by young men aged between 15 and 34 years of age one would expect that an increase in the size of this cohort would lead to an increase in the crime rate. from the results of the model one can see that there is in fact a positive relationship for seven of the crime types as expected. the remaining coefficients have a negative sign indicating an inverse relation between this variable and the crime rate. again common assault has an unexpected sign, and again the explanation for this is that the data for this crime type may be incomplete or corrupt due to the low incentive to report incidence of such crimes. burglary from residential property and common robbery also exhibit inverse relationships between this variable and their crime rates. possible explanations for this negative relation is that perpetrators of such crimes are actually outside of this demographic cohort, since younger people generally have a size advantage over older people which gives them a comparative advantage when compared to older and larger people. evidence of the very young cohort (younger than 15 years of age) being involved in crime is provided in brown (2001). it may also be the case that much of the theft from residences may be committed by, or with the help of domestic employees, which also may fall out of the top end of this demographic. (iii) economically active proportion of the population: eleven of the coefficients were found to be highly significant with the insignificant coefficient hypothesis being rejected at the 1 per cent level of significance for all of these cases. ten of these coefficients have a negative sign suggesting that the larger the economically active proportion of the population, the lower the crime rate. again the exception to this is stock theft where a positive sign for the coefficient is observed. this can be explained by the fact that economically active people would generally be pulled away from rural areas where employment opportunities are relatively scarce, to urban areas where employment opportunities are more promising. 5.2.3 social factors (i) ratio of woman to men: for eleven of the crime types the insignificant coefficient hypothesis could be rejected in favour of the alternative hypothesis indicating that this variable is a statistically significant variable and thus should be included in the model of crime. a negative relationship is expected for the coefficient of this variable since the more sajems ns 6 (2003) no 3 456 women relative to men generally can be expected to lead to lower crime rates for most crime types. in four cases this is in fact so, however for the remaining seven crime types a positive relation was found to exist between this variable and the crime rate. there are a few possible reasons for this positive relationship. firstly, it may be that for certain crime types such as shoplifting, women are as guilty of committing these crimes as men in which case a positive relationship would be justified. the second possible explanation for the positive relationship is that women generally make soft targets for many crime types and thus any areas where there are relatively more women then men one could expect more crimes against or involving women. (ii) number of drug possession offences: for twelve of the fifteen crimes this variable was found to be a statistical significant and the hypothesis of insignificant coefficients could be rejected generally at the 1 per cent level of significance. one would expect that this variable be positively related to incidence of crime and for nine of the crime types this is the case. for the remaining three crimes: bank robbery, carjacking and theft of motor vehicles a negative coefficient was found. this can be explained by the fact that generally these three crimes require a higher level of cognitive functioning and may have been planned in great detail prior to the crime actually being committed. any use of alcohol or drugs will impair the cognitive functioning and thus the probability of success in executing their crimes. 6 conclusion the panel data study of crime across the provinces of south africa provides strong evidence in favour of an interdisciplinary model of criminal behaviour that emphasizes the role of economic, social and demographic variables in its design. the crime rate in south africa has a far broader range of causes than those specified in the economic model of crime, and therefore emphasis on this model alone may only be able to explain a limited share of the crime problem. the most significant explanatory variables of the crime rate are income per capita, unemployment rate, degree of urbanisation, ratio of woman to men and drug possession offences respectively. these variables indicate that the main motive for criminal behaviour in south africa is need and not economic profit. this result suggests that the long term management and reduction in the crime rate is primarily associated with the economic and social environment within the country since increases in these variables tend to raise the opportunity cost of sajems ns 6 (2003) no 3 457 criminal activities thus decreasing the returns to such activities and encouraging more legitimate behaviour. according to the results obtained the expenditure on total protection tends to be the least important determinant of the crime rate. there are a number of possible explanations for this result. firstly, the relationship may be non linear with a positive relation between the variables being found up to some critical or threshold level of expenditure and after which any further increases in expenditure would yield a negative relationship to crime. secondly, since national expenditure data were used for this variable the data may contain spurious information resulting from aggregation bias. provincial specific data may yield more robust results. finally, this may not be a significant determinant variable of the crime rate in south africa due to the fact that although expenditure increases over time law enforcement personnel may be inefficient due to the lack of adequate training and thus actual crime prevention may be minimally impacted. focus on this variable should thus be on the improvement in the quality of the law enforcement and policing personnel and not only on the quantity thereof. it can therefore be concluded that responsibility for combating crime lies not only in the hands of the department of justice and its focus on the criminal justice system, but also with most other governmental departments whose responsibilities include the reduction of unemployment and the improvement of economic and social conditions for more south africans. according to the finding of this study the crime rate will be most efficiently controlled by addressing those issues that have the greatest impact on the choices available to the majority of south africans in terms of employment and income earning opportunities. these choices are increased with greater education and employment opportunities, as well as with improvements in the basic developmental necessities required to attain a simple yet dignified standard of living. references 1 abedian, i. & cronje, a. (1995) �government foreign borrowing in south africa�, the south african journal of economics, 63(2): 132-47. 2 avio, k.l. & clark, c.s. (1976) property crime in canada: an econometric study, ontario economic council: toronto. 3 becker, g.s. (1968) �crime and punishment: an economic approach�, journal of political economy, 76: 169-217. 4 brown, k.v. (2001) �the determinants of crime in south africa�, the south african journal of economics, 69: 2. sajems ns 6 (2003) no 3 458 5 builta, j. (1995) south africa: crime is on the increase. on-line at the office of international criminal justice: http//www.acsp.uic.edu/oicj/ pubs/cje/060101.htm. 6 cherry, t.l. & list, j.a. (2002) �aggregation bias in the economic model of crime�, economic letters, 75: 81-86. 7 fajnzylber, p., lederman, d. & loayza, n. (2002) �what causes violent crime?� european economic review, 46. 8 foot, d.k. & stoffman, d. (1998) boom, bust & echo 2000: profiting from the demographic shift in the new millennium, macfarlane, walter and ross: toronto. 9 fortin, p., keil, m. & symons, j. (2001) �the sources of unemployment in canada, 1967-91: evidence from a panel of regions and demographic groups�, oxford economic papers, 53. 10 fox, j.a. (1978) forecasting crime data, lexington books: toronto. 11 gastrow, p. (1998) parliament and crime issues: recent events. online at: http://www.iss.co.za. 12 hess, s. (1997) �boom in child convicts�, electronic mail & gardian, july 4, on-line at http://www.mg.co.za.mg/news/97jul1/4. 13 hsiao, c. (1999) �analysis of panel data�, econometric society monographs no.11, cambridge university press. 14 october household survey p0317 (various editions) statistics south africa. 15 schapiro, m.o. & ahlburg, d.a. (1986) �why crime is down�, american demographics, october, 8(10): 56-59. 16 schmidt, p. & witte, a.d. (1984) an economic analysis of crime and justice: theory, methods, and applications, academic press, inc.: toronto. 17 smith, n. (1997) �a state of emergency won�t end crime�, electronic mail & guardian, may 21, on-line at http://www.mg.co.za.mg/news/ 97may2/21. 18 south african labour force survey p0210 (2001) february 2001, statistics south africa. 19 south african police services crime statistics on-line at: http://www.saps.co.za/8_crimeinfo/398/table_of_contents.html saps (1996a) hijacking of passenger vehicles. saps (1996b) the national serious crime picture. saps (1996c) rape. sajems ns vol 2 (1999) no 2 176 international financial stability how can it be restored and maintained?" andrew croekett general manager, bank/or international settlements invited lecture jel f 30 i am greatly honoured to be invited to give the] 999 gerhard de kock memorial lecture. gerhard de kock was a distinguished central banker, whose reputation and influence, like that of his father, another prominent governor of the reserve bank, spread far beyond his native south africa. in his long service to the reserve bank, de kock never wavered in his conviction that a strong and stable financial system was the best basis for economic and social progress. in these times of turbulence in the international economy, his legacy is an inspiration to those who seek a better-functioning international monetary system. it is a privilege to pay tribute to his memory. for me it is a special pleasure to make my first visit to south africa; to honour the contributions of chris stals as he prepares to take his retirement, and to welcome tito mboweni to the community of central bankers. the transition in governorship that is taking place at the reserve bank mirrors what is happening elsewhere in your country. it is the unique achievement of the current political leadership in south africa to have charted a new course for the country's economic and social development that is not afraid to build on the strengths of the past, even as it sets new goals for the future. in the field of finance, this means harnessing the skills and experience of financial institutions and markets to meet changing social needs. to be effective, however, development goals have to work with the grain of underlying economic forces. when market disciplines are ignored, instability can too easily result. and financial instability is, as we have seen, a powerful obstacle to social progress. in my remarks today, i want to consider some of the forces that have contributed to financial instability at the global level. why have so many countries been victims of volatile capital flows and currency instability? and what can be done to prevent it? • gerhard de kock memorial lecture, pretoria. 23 march 1999. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 177 sajems ns vol2 (1999) no 2 driving forces for financial change first, however, it is necessary to understand the underlying developments that have been taking place in the financial sector. the financial system has undergone a remarkable transformation in the past two or three decades. many of these changes have their origin in deep-seated, technological and social forces. such forces cannot simply be resisted or repealed because some of their consequences are unwelcome. financial systems will have to adapt to the new environment, not vice versa. one of the principal driving forces has been the revolution in communication and information processing technology. this has transformed economic processes in many sectors, but in few more fundamentally than in finance. it has greatly increased the information available to economic agents, and led to an enormous reduction in the cost of making transactions across borders. it has made many traditional structures and methods of providing financial services obsolete. and it has facilitated the development of complex new financial instruments. these have provided innovative ways of hedging against risks and taking positions across markets and geographic boundaries. in short, the ability to make tinancial judgements and act on them has been enormously enlarged. a related development has been liberalisation in financial markets. related, because technological innovation has rendered ineffective many of the administrative restrictions and controls that used to characterise the tinancial system. but liberalisation also reflects a deep-seated change in economic and social philosophy. in the political arena, it is reflected in the growing support for democracy and open societies. the economic counterpart is a greater willingness to let market forces play their role in the allocation of economic resources: in international trade, in domestic competition and in the economic role of the state. this should not be mistaken for "market fundamentalism", the notion that unrestrained markets are always right. far from it. but it is a recognition that, with proper safeguards, the signals free markets can give are the practical basis for better resource allocation and faster growth. another major factor underpinning financial transformation has been rising levels of income and wealth. as societies have become richer, individuals have become better able to provide for the future, both tor themselves and their families. they have sought additional ways of insuring against risk and providing for retirement. this has led to an increasing demand for financial assets, in forms that meet a diversity of individual needs. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 178 an important aspect of these driving forces of change in the financial system is that they are largely irreversible. the genie of technology cannot be put back into the bottle. financial markets are now so open and innovative that it would be almost impossible to roll back the tide of liberalisation, even if it were judged to be desirable. and rising levels of income and wealth are a key objective of economic policy in all societies. financial implications of economic change the major consequences of the underlying forces shaping the financial environment can be grouped, for convenience, under four headings: globalisation, securitisation, competition and complexity. let me say a few words about each. globalisation is a term that is widely used, but defies precise definition. i take it to mean a process in which geographic and market barriers are being rapidly eroded. economic agents are now able to make financial transactions with little hindrance in all major markets of the world. not only this, they can switch with increasing ease between different types of intermediation, each of which is in increasingly close competition with the others. perhaps the most obvious manifestation of globalisation is the huge upsurge in cross-border financial transactions. in 1975, cross-border purchases of bonds and equities in the g-7 major industrial countries were approximately 4% of the annual gnp of these countries. by 1985, the comparable figure was around 30%. by 1995 it was close to 200%. and by now there are several large countries where cross-border securities transactions are several times larger than national gnp. in the field of foreign exchange, the latest triennial survey of the bank for international settlements (bis) reveals daily turnover in the foreign exchange market of some $1.85 trillion. this means that daily foreign exchange turnover in private markets is greater than the entire reserve holdings of the world's central banks. annual turnover is somewhere in the region of twenty times world output. all this represents a huge change in the degree of integration in the world's capital markets. securitisation refers to the process by which financial intermediation is shifted away from direct lending by institutions towards finance raised through the issue of marketable securities. this does not necessarily eliminate the role of intermediaries, since ultimate borrowers and lenders stili often need financial expertise to access markets efficiently. the floating of equity or marketable r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 179 sajems ns vol 2 (1999) no 2 debt by an industrial company requires underwriting and marketing services. and tinancial institutions are the ones that design products by which individual credits (mortgages, for example) can be bundled together and sold as a marketable security. securitisation has been encouraged by technological developments that provide market participants with better information about the market and credit characteristics of the underlying assets. more information both allows a reduction in the information-providing contribution of intermediaries, and facilitates the attribution of different risks (credit, interest, exchange rate, and so on) to those most willing and able to bear them. its consequence is that a greater proportion of financial intermediation than previously is responsive to changing market conditions. a third consequence of a changing financial environment is increased competition. before innovation and financial liberalisation, many intermediaries enjoyed a protected franchise, the result of administrative controls, lack of intormation, and the market power of established institutions. banks and other tinancial firms were generally disinclined to jeopardise their franchise value by taking unnecessary risks. with the removal of controls, however, and the breakdown of barriers between market segments, this comfortable situation changed rapidly. new entrants to the industry could offer similar services at lower cost, sometimes by "unbundling" existing financial products and eliminating hidden crosssubsidisation. an obvious example of this trend was the advent of moneymarket tunds, offering the money-management services of traditional banks, without the costly additional features entailed in widespread branch networks. other changes involved the separation of account-management, money transmission, credit origination, liquidity provision, custody, and so on into specialised intermediaries where service charges could be more accurately aligned with costs. with increased competition, rates of return on capital began to fall for those institutions unable or unwilling to adapt. one response was to maintain protitability by reducing cross-subsidisation and cutting costs. in addition, many institutions sought higher yields from their portfolios, often by being willing to accept greater risk. such a strategy could only be successful, however, where risk-management capabilities were up to the tasks of managing the new vulnerabilities. fourth and last, mention should be made of the sophistication and increased complexity of financial intermediation. a wide variety of new instruments r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . salems ns vol 2 (1999) no 2 180 enable market participants to hedge risks and take positions more etliciently than before. this is a reflection both of innovation in the design of tinancial products, and the need of institutions to hedge efficiently the risks they have taken on to enhance yield. many of the new instruments are custom-<lesigned and traded over-the-counter. they can have pay-off characteristics that are related in non-linear ways to the value of underlying assets. this makes it more difficult for counterparties to accurately judge the risk-appetite and vulnerability of the institutions which whom they deal. it also means that market participants cannot easily judge what strains may occur in asset markets. risks in the new environment it is now time to consider how these changes in the financial landscape have contributed to the instability that has characterised international tinancial markets in recent years. before doing so, however, it is worth pointing out that the globalisation of capital markets, increased competition and the development of new financial instruments have had many beneficial consequences. capital flows have enabled emerging markets to tap into a larger pool of savings to augment the resources available for development. foreign investment has acted as a vehicle for the transfer of technical and managerial know-how, speeding the growth of productivity. and openness has been a spur to better domestic policies, as market disciplines have more quickly curtailed unsustainable policy developments. it is hard to imagine the asian miracle having been as remarkable as it was without the contribution of international capital. competition, too, has had largely beneficial results. the cost of financial intermediation, that is the margin between the interest rates paid by users of funds and the returns received by savers, has been significantly reduced in the major financial centres. moreover, new products have enabled firms and households to protect themselves against a wider range of financial risk. all this has increased the productivity of resource use and enhanced the rate of growth of output. yet it would be foolish to deny that the growing size, sophistication and complexity of the financial system have led to greater costs when crises occur. in the year following the outbreak of the mexican crisis, the output of the mexican economy fell by 6.2%. previously, it had been growing by 3-4% per annum. argentine economic growth also dropped about 10% below trend in the same period. output losses by the five economies most affected by the east asian crisis were even greater. they went from an average rate of growth of 7% r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 181 sajems ns vol 2 (1999) no 2 in the year before the crisis, to a decline in output of about the same magnitude the fol.lowing year. all this is dramatic enough. but the impact on domestic absorption and living standards was even greater, because of the drying up of capital inflows and the enforced turnaround in the current-account of the balance of payments. on average, capital inflows were adding 6% to the spending power of these economies before the crisis hit. afterwards capital outflows were taking always as much as 9.5%. i will focus on three types of instability that have been particularly troubling in recent years. the first is volatility in capital flows: the tendency for financial resources to flow into countries in excessive amounts, and then to be reversed suddenly and massively when confidence is lost. the second is contagion: the phenomenon by which a crisis in one country is transmitted to others which were previously performing satisfactorily. and the third is internal financial fragility: the capacity of domestic banking and financial systems to develop deep-seated weaknesses, that are suddenly reflected in a costly crisis. of course, there are important interactions between the three types of instability. indeed, one of the most troubling aspects of what has occurred in the emerging markets in recent years is the simultaneous occurrence of all three. a currency crisis broke out in thailand, then quickly spread to other countries, even those whose broad policy stance had previously been endorsed by the international monetary fund (imf). then, in numerous economies, devaluation exposed weaknesses in the financial system and led to a vicious circle of further depreciation and intensified financial distress. even though the countries originajiy hit by the crisis, thailand and south korea, are now showing signs of recovery, developments in russia and brazil remind us that its continuing consequences are severe. but even though financial crises usually reflect a cont1uence of several elements, it is helpful in analysis to separate their individual contributions. the volatility of capital flows results from a combination of macro-economic policy weaknesses in borrowing countries and herd behaviour by lenders, exacerbated by inadequate information. in cases where economies have been performing well for several years, lenders have uncritically extrapolated the continuance of good times. they have been too ready to accept inflated collateral values, the sustainability of a policy of fixed exchange rates, and ill-thought out investment projects. then, when economic conditions deteriorated, there has been a scramble for the exits. investors suddenly realise that, however promising the longer terms future, a country may not be able to satisfy all its short-term obligations on time. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 182 a second source of instability is domestic financial fragility in borrowing countries. this has some of the same causes as volatility in capital flows. banks and other financial institutions have built up portfolios of loans and other claims that are predicated on the continuation of strong economic performance. among the most glaring weaknesses of domestic financial systems have been: political interference in lending decisions; excessive lending to connected enterprises; currency and maturity mismatches; dependence on co lateral with inflated values; the absence of effective bankruptcy legislation; inadequate capitalisation; and weaknesses in internal controls, facilitated by lax or inexperienced supervision. contagion is a more complex phenomenon. it is not quite true that economic disturbances are transmitted indiscriminately: it is usually the weaker economies and financial systems that are hit hardest. countries with sound macroeconomic policies and strong financial systems generally weather disturbances quite well. nevertheless, there has been a disturbing trend for countries that have had reasonably good domestic policies to find their implementation threatened by factors beyond their control. south africa is an example of this kind. part of the reason lies in the tendency of certain categories of investors to lump countries into the same asset class, even where there are differences in objective circumstances. they may simply lack the time or resources to be more thorough. or they may realise that it is what the market in general thinks that determines price movements in the short term. there is no profit in being "right" about fundamental economics, if you are "wrong" about how markets will move in the short term. the name of the game in the short term is to correctly anticipate the reactions of others, irrespective of whether these are well-informed or not. the behaviour of financial markets recalls keynes' famous dictum about the long run. this can make economies unnecessarily vulnerable. strengthening the financial system a unifying characteristic about these various sources of financial instability is that they all have their roots in market failures. in the presence of market failure, policy makers have a fundamental choice: either to correct the source of the failure, or to control or offset its consequences. the second course, controlling market outcomes through intervention, may occasionally be necessary, but carries considerable risks. it implies that the authorities can improve outcomes by frustrating market forces they believe to be r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 183 sajems ns vol 2 (1999) no 2 undesirable. the risk, of course, is that they inadvertently delay desirable, or unavoidable, outcomes. this is the case when governments try to fix an exchange rate as economic competitiveness deteriorates. it is the case when regulators try to control which categories of assets financial institutions can invest in. and it is the case when administrative restrictions are placed on certain categories of capital flow, while other channels remain open. for all these reasons, it is better, where possible, to try to correct the underlying sources of market failure: to remove the policy inconsistencies that lead to unstable exchange rates; to give private financial institutions the incentive to make prudent investment decisions; and to provide the necessary information for well-informed judgements to be made about cross-border financial flows. all this sounds fine in the abstract. but exactly how can the sources of market failure in the financial system be identified and corrected? to answer this question, it is necessary to analyse the financial system in somewhat more detail. the financial system can be thought of as having three pillars. the first is the set of institutions that are the principal intermediaries: banks, securities firms, insurance companies, and fund managers. the second is the markets in which tinancial claims are traded: equities, foreign exchange, fixed interest securities, as well as the various derivative instruments based on them. and the third is the infrastructure within which institutions and markets interact. this infrastructure includes payment and settlement systems, the framework of accounting conventions, the nature of corporate governnance, the structure of contract law, including bankruptcy provisions, and so on. each of the three pillars displayed significant weaknesses in recent years. financial institutions have got into difficulties, leading to a contagious loss of contidence, and in some cases to widespread failures. bail-out costs have been high. financial markets have displayed a degree of instability that cannot easily be related to underlying economic fundamentals. and accounting and legal shortcomings have aggravated financial difficulties in economies as widely different as japan and mexico, russia and indonesia. strengthening the international financial system requires measures to address all these sources of weakness. for jinancial institutions, what is needed is an improved culture of risk management and a capital cushion that is sufficient to absorb unavoidable fluctuations in economic fortunes. banks and other financial intermediaries should only be licensed to conduct business when they meet strict professional and prudential standards. their credit-granting activities should conform to rigorous requirements of risk measurement, pricing and control. internal r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (l999) no 2 184 systems must be up to the task of containing the risks of modern financial techniques. and banks' activities need to be restricted whenever they fail to meet these requirements or when their capital falls to unacceptably low levels. the main responsibility for prudent operation falls on the owners and managers of financial institutions themselves. they can be encouraged in this by minimum capital standards (which increases their incentive to protect their investment), by disclosure and transparancy, and by effective supervision. in the banking sector, the basle committee on banking supervision a year and a half ago issued a set of "core principles for effective banking supervision a "year and a half ago. other regulatory groupings are following the same path. supervision of financial institutions is, however, an extremely complex task, which cannot be reduced to a limited number of quantified rules. it will require a sustained effort of leadership, training and monitoring over a number of years. this is one reason why the bis recently established the bis financial stability institute under the chairmanship of john heimann, an experienced regulator with knowledge of the industry from the practitioners' side also. for financial markets, there are at least three requirements to improve their current funcitoning. the first is macro-economic stability, so that markets are not subject to sudden changes in the external environment. currency crises generally have their origins in unsustainable macro-economic policies. often excessive fiscal deficits or exchange rates that remain fixed in the face of a deteriorating external position. it is therefore important that countries commit to stable fiscal and monetary policies and an exchange rate regime that is consistent with their ability and willingness to adjust domestic policies. a second requirement is greater transparency, so that all market agents have access to information that is relevant for price determination. markets do not function well when key information is withheld or distorted. examples of this are the nature of the indebtedness of the public sector in mexico in 1994, and the underlying level of foreign exchange reserves in thailand and south korea in 1997. similarly, when economic agents are unaware of the exposures of other players, and their possible reactions to changes in market conditions, they may withdraw from the market, causing liquidity to dry up. this happened following the russian moratorium in 1998, and led to the near-collapse of a major hedge fund. the third requirement for effective market functioning is an appropriate set of incentives, so that market participants are appropriately rewarded or penalised for the quality of their judgements. a problem in recent years has been that decision-makers have faced a distorted incentive structure. they may be highly r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 185 sajems ns vol 2 (1999) no 2 rewarded for positive outcomes, but only lightly penalised for negative ones. this encourages excessive risk-taking. the incentive structure may also encourage herd behaviour. financial decision-makers find the penalties for being wrong in company with the rest of the market are much less than those for being wrong alone. in the area of market irifrastructure, the needed reforms are rather clear. countries with underdeveloped legal codes need to quickly develop a robust system of contract law, and law enforcement. those that have such a system have to make sure it works quickly enough. justice delayed is justice denied. accounting standards have to be clarified and strengthened, so that the accounts of financial firms can be readily interpreted by their counterparties. payment and settlement systems have to be made robust. and dependence on external technologies, from information processing to communications to public utilities, has to be constantly reviewed. the year 2000 problem is only the most prominent of the threats to financial stability posed by external events. the process of reform i have argued that a strengthened international monetary system will have to be based on efforts to improve the functioning of the market mechanisms on which the current system is based. but how, in more concrete terms, can this be achieved? specifically, how can the three pillars of the tinancial system institutions, markets and infrastructure all be made more robust? the key is to realise that in a decentralised system of many players and many markets, a centralised approach to reform is unlikely to work well. moreover, in a market-based system, regulations that run counter to market forces are probably doomed to failure. it is simply too easy with modern technology to find ways around burdensome controls. and the incentives to do so are too great. is this a counsel of despair? i do not think so. market practitioners have a strong interest in sound standards and market stability. working together, i believe regulators and market practitioners should be able to come up with codes of best practice and industry minimum standards that will enhance market functioning while strengthening stability. of course, otlicial supervision and regulation will be needed. it is rarely possible for the private sector to agree completely on best practice. and some enforcement mechanism to prevent free riders is necessary. moreover, the social and private costs of financial instability are not the same, so that official intervention is often required to ensure the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 2 (1999) no 2 186 optimal social outcome. but within these parameters there is no reason why the process of developing best-practice codes should not be a market-friendly one. there are four main stages to the process. first comes the identification of sources of market failure. second comes the design of standards. third comes the monitoring of observance in individual countries. and fourth comes technical assistance to meet standards that are not observed. allow me to say a little more about each of these four aspects in tum. the identification of sources of market failure is a task for the official sector, working internationally in such forums as the imf's interim committee, and other groupings such as the g-7 and g-22. specialised groups, such as bank, securities and insurance regulators, as well as other committees that meet at the bis can also play a role in this process. the job to be done is to analyse the weaknesses that have led to crises in the international tinancial system, and to identify areas where improved standards would help deal with them. the second task is to draw up standards that will help contain risks and remove sources of market failure. drawing up standards should mainly be the responsibility of groups of specialised experts drawn from national authorities. the reason for this is twofold. the necessary expertise is largely at the national level, rather than in the international organisations. and the acceptability of codes is likely to be greater if those affected by them feel they have had a hand in their development. when it comes to tinancial supervision, accountancy practices, legal codes, market practices and payment and settlement systems, there is no substitute for the detailed knowledge that can be found only among regulators and practitioners at national level. these have the additional advantage of direct and continuous contact with the industry they represent or supervise. the bis hosts and supports a number of grouping of such experts, amongst the best known of which is undoubtedly the basle committee on banking supervision. it is a different matter when it comes to the third task, that of monitoring and surveillance. strengthened codes of prudential behaviour are of no use if they are not implemented effectively. the international community has a strong interest in ensuring effective implementation. one means to this end will be to create market incentives for countries to adopt best practices. but the organisation best placed to oversee the process of implementation is the imf. the imf has regular annual consultations with virtually all its 182 member countries. it is uniquely well paced to assess the interactions between appropriate pressure to bear in those cases where non-compliance with best practice has systemic stability implications. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 187 sajems ns vol 2 (1999) no 2 fourth, and last, many countries will need help, perhaps over prolonged periods to strengthen their financial systems to a point where they do not pose a systemic threat. such technical assistance can come from many sources, but clearly the world bank has a central role to play. the world bank and the regional development banks have longer-term structural retorm as a central part of their mission. they also have the financial and human resources to devote to what is bound to be an expensive and time consuming task. the bis will also contribute to this task through its recently established financial stability institute, the initial focus of which will be to support the implementation of the core principles for effective banking supervision. you will have noticed that i mentioned a number of institutions and groupings as being well placed to take primary responsibility tor each of the tour stages towards a strengthened financial system. but it is important to recognise that all of these stages are closely inter-related. so, there tore, are the tasks of the various institutions that the international financial community has created to oversee and implement measures to strengthen the system. one key issue in the new international financial architecture will be to ensure that co-operation and co-ordination among these institutions is as efficient as it can be. this is the purpose of the financial stability forum, which was proposed by president tietmeyer and has been accepted by the 0-7. i have the honour of having been invited to chair this torum, which will hold its tirst meeting next month. the goal of the forum is to exchange intormation, promote improved standards, and identify incipient vulnerabilities in the international financial system. the forum will comprise all the main international organisations, regulatory associations and expert groups, as well as national authorities from the 0-7 and, eventually, other countries. its success, however, depends on its collective willingness to act together in the fields i have been discussing in this lecture. concluding remarks let me conclude. strengthening the global financial system is one of the most urgent items on the agenda of the international community. it does not call tor grand new institutional designs. rather it requires the more mundane and painstaking task of identifying present sources of weakness in market functioning and correcting them. fortunately, the broad lines of what needs to be done are reasonably clear. what is now required is the will to get on with it. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . f:\ejour\ecoman\index\ecoman_v6_n2.prn.pdf sajems ns vol 6 (2003) no 2 419 hiv/aids and poverty: evidence from the free state province1 ________________________________________________________________ f le r booysen department of economics & centre for health systems research & development, university of the free state ________________________________________________________________ abstract poverty is likely to deepen as the aids epidemic takes its course, with households being caught up in a vicious cycle of poverty and hiv/aids. this paper shows that affected households are poorer than non-affected households, regardless of whether income is measured at the household, per capita or adult equivalent level and regardless of the poverty line or poverty measure employed in measuring poverty. the incidence, depth and severity of poverty are worse amongst affected households, particularly amongst affected households that have experienced illness or death. the evidence underscores the importance in the longer term of economic policies focused on job creation and education in mitigating the impact of hiv/aids, with poverty alleviation through an enhanced social safety net being important in the short to medium-term. jel i0-* 1 introduction the hiv/aids epidemic poses a severe threat to the economies of developing countries, and those on the african continent in particular. south africa, which is being affected fundamentally by the epidemic, is no exception. by the end of 1997, an estimated 2.8 million adults in south africa were living with hiv/aids. by 2001, this figure had increased to 4.7 million. the estimated prevalence of hiv/aids among the country's adult population (20.1 per cent) is amongst the highest in the world (ilo, 2000; unaids, 2002). according to the metropolitan-doyle model, the annual number of aids deaths is estimated to increase from 120 000 to between 545 and 635 thousand between 2000 and 2010. the number of children younger than fifteen years orphaned by aids has been estimated to be 800 000 by 2005, rising to more than 1.95 million by 2010 (abt associates, 2000: 8-11). sajems ns vol 6 (2003) no 2 420 these infected individuals and affected children all belong to individual households (meaning that an even larger number of people are affected by the epidemic in some way) and their deaths will have a significant impact on their families. poverty, moreover, is likely to deepen as the epidemic takes its course. the socio -economic impact of hiv/aids combine to create a vicious cycle of poverty and hiv/aids in which affected households are caught up. as adult members of the household become ill and are forced to give up their jobs, household income will fall. to cope with the change in income and the need to spend more on health care, children are often taken from school to assist in caring for the sick or to work so as to contribute to household income. because expenditure on food comes under pressures, malnutrition often results, while access to other basic needs such as health care, housing and sanitation also comes under threat. consequently, the opportunities for children for their physical and mental development are impaired. this acts to further reduce the resistance of household members and children (particularly those that may also be infected) to opportunistic infections, given lower levels of immunity and knowledge, which in turn leads to increased mortality (world bank, 1998; bonnel, 2000: 5-6; wekesa, 2000). households headed by aids widows are also particularly vulnerable, because women have limited economic opportunities and traditional norms and customs may see them severed from their extended family and denied access to an inheritance (undp, 1998). worrying, more, is that firms are increasingly using contract labor rather than appointing employees on a permanent basis, which increasingly shifts the burden of hiv/aids onto households and government (rosen & simon, 2002). this also means that hiv/aids-affected households (and in particular infected persons) may find it increasingly difficult to find employment and remain in employment, which is crucial for ensuring some kind of economic security at the household level. in many third world situations, therefore, hiv/aids exposes already vulnerable, resource-poor households to further shocks. these are all ways in which hiv/aids can cause poverty to increase. whiteside (2001/02) describes the above linkages between hiv/aids and poverty in considerably more detail, but then goes on to point out that poverty can also result in increased vulnerability to hiv/aids, which in turn can aid the spread of the disease. poverty, apart from being associated with poor nutrition and a breakdown of immune systems, also stand to increase the vulnerability of people to hiv/aids by resulting amongst others in unsafe sexual practices as a result of lack of knowledge and lack of access to means of protection, due to women’s inability to negotiate about condom use with sexual partners as a result of entrenched gender roles and power relations, and because of violence and coercion (whiteside, 2001/02). in fact, both desmond (2001) and whiteside (2002) emphasize how complex the relationship between poverty and hiv/aids actually is and how many facets it has, e.g. how labor migration sajems ns vol 6 (2003) no 2 421 induced by rural poverty can contribute to the spread of the disease and how poor, single mothers may be forced to become occasional sex workers in order to survive (desmond, 2001: 56; poku, 2001: 195). gillies et al. (1996) and nyamathi et al. (1996), moreover, highlight the importance of homelessness, urban/rural migratio n patterns, migrant labor practices and the breakdown of social support networks in communities with limited access to social service delivery and in developing countries in increasing the vulnerability of poor people to hiv/aids. this paper deals primarily with the question of the extent to which hiv/aids (via increased morbidity and mortality, as well as other hiv/aids-related impacts) can cause poverty to increase. 2 data and method the impact of hiv/aids on households was assessed by means of a cohort study of households affected by the disease, and compared with a control group of households not currently affected by the disease. the survey was conducted in two local communities in the free state province, one urban (welkom) and one rural (qwaqwa), in which the hiv/aids epidemic is particularly rife. affected households were sampled purposively via ngos and other organizations involved in aids counseling and care and include at least one person known to be hiv-positive or known to have died from aids in the past six months. informed consent was obtained from the infected individual(s) or their caregivers (in the case of minors). non-affected households represent households living in close proximity to these affected households, but which did not at the time of the first interview include persons suffering from chronic hiv/aids-related diseases such as tuberculosis or pneumonia. affected and non-affected households are compared, whilst the analysis also distinguishes between households that have experienced illness or death and those that have not experienced illness or death. due to the nature of the disease (i.e. hiv only develops into aids over a relatively long incubation period), the sample includes a number of affected households that as yet has not experienced any illness or death. households were defined in terms of the standard definition employed by statistics south africa in the october household survey, i.e. "a person or a group of persons who live together at least four nights a week at the same address, eat together and share resources". a survey on the quality of life and household economics was conducted. interviews were conducted with one key respondent only, namely the "person responsible for the daily organization of the household, including household finances". the results reported in this paper are based an analysis of the data for the 387 households that were interviewed in sajems ns vol 6 (2003) no 2 422 both wave i and in ii of this study. the two waves of data collection were respectively completed in may/june and november/december 2001. although the sample population in certain instances closely reflects the socioeconomic profile of the national population (e.g. male/female distribution), it in most cases differs distinctly from the general south african population (booysen et al., 2002). the profile of the sample of households included in this study can largely be attributed to the sampling design. given that affected households were sampled from networks and/or organizations involved in counseling, home-based care and public health care and mainly in poorer communities, the sample does not include affected households that mainly utilize private health care services. moreover, the study was conducted in one specific province (free state) and in two selected sites only. however, the fact that south africa's poor, predominantly african population face relatively high hiv prevalence rates and are particularly vulnerable to the epidemic and therefore dependent on support from the public service sphere, means that the findings and policy recommendations put forward in this paper are especially relevant to informing government's responses to hiv/aids. 3 discussion 3.1 measurement of standard of living poverty (or standard of living) is measured at the household rather than the individual level, given that the focus here is on the household impact of hiv/aids. poverty is here interpreted in terms of the command over commodities that resources afford people via income and consumption (lipton & ravallion, 1995: 2553-67). the concern, therefore, is with 'poverty proper' (i.e. resource adequacy) and not with the physiological, sociological or political dimensions of poverty (kgarimetsa, 1992: 8; woolard & leibbrandt, 1999: 3). generally, a single monetary indicator, such as income or consumption, is employed in assessing the extent of poverty and inequality (ravallion, 1996: 1328-34). income is argued to reflect consumption opportunities and is therefore a popular measure of poverty (hagenaars, 1991: 135-46). during the survey, data were collected from one informant regarding the employment income, nonemployment income and receipts of remittances for the members of the particular household. an estimate of total monthly household income was derived from these figures by adding up the various component items. consumption represents an alternative resource base for measuring poverty and inequality (lipton, 1997: 1003). during the survey, fieldworkers collected expenditure-related data from the household member in charge of household sajems ns vol 6 (2003) no 2 423 finances in each of these households. this include estimates of household expenditure on specific items such as food, education, health care, transport, monthly repayments of debt, and clothing, as well as remittances made to persons not living with the household. as in the case of income, an estimate of total monthly household expenditure was calculated by adding these items together. income, however, in a certain sense represents an inadequate measure of poverty. so, for example, it is generally assumed that household income is employed in a manner that benefits the whole family. yet, this may not necessarily be the case, given inequalities and inequities in the intra-household allocation of resources (woolley & marshall, 1994: 422-9). furthermore, levels of income and consumption often differ as a result of consumption smoothing. consumption also represents a better proxy of current living standards and longterm average well being than income for other reasons. consumption bridges the observed disparity between income and expenditure levels. expenditure also reveals information about both past and future incomes, because it includes consumption financed from savings (lipton & ravallion, 1995: 2573). the income-based estimates of household welfare in the case of this study exceed the expenditure-based estimates. normally, one would expect the opposite, with expenditure-based estimates exceeding income-based estimates of household welfare. this may be because the one informant that was interviewed (i.e. the person in charge of household finances) generally has a better idea of the employment status and average earnings of other members of the household (in fact, the person during the interview often verified this information with other household members). this person, moreover, is unlikely to be knowledgeable about the manner in which each member of the household spends their income. in fact, individuals and/or households have been found to rarely record expenditure data in detail (woolard & leibbrandt, 1999: 23-24). expenditure, therefore, in this case most likely reflects only that amount of resources of household members that is spent on communal household needs. the literature, moreover, suggests that hiv/aids can impact on household income and expenditure in different ways. on the one hand, the changes in the supply of household labor caused by aids morbidity and mortality are likely to be accompanied by a drop in household income. on the other hand, household expenditure may increase initially following illness or death, given that households need to spend more on medical care and funerals. in the kagera study, for example, the total level of expenditure was 25 percent higher in households suffering an adult death than in household where no adult death occurred (lundberg & over, 2000). in the case of rural thailand, though, per capita expenditure in households affected by an adult death on average dropped sajems ns vol 6 (2003) no 2 424 by 43.5 percent (kongsin et al., 2000, as quoted in parker et al., 2000: 44). as a result, the income-based estimates are likely to represent a more reliable measure of the standard of living of these households and are likely to be a better proxy of the impact of hiv/aids on household welfare, which means that this paper employs household income as proxy of standard of living rather than household expenditure. households with the same level of income do not necessarily enjoy the same level of welfare. the larger the household, the lower the level of welfare at similar levels of household income. measures of equivalent income are employed to allow for these differences in standard of living related to household characteristics (lipton & ravallion, 1995: 2574; burkhauser et al., 1997: 154-61). estimates of household income were here adjusted for differences in household size by dividing total monthly income by nα, where n represents the number of household members and α an adjustment for household economies of scale (filmer & pritchett, 1998: 13). according to lanjouw & ravallion (1995) and drèze & sen (1997), a α coefficient of 0.6 represents an adequately robust and reliable adjustment for household economies of scale. 3.2 comparisons of levels of household income table 1 report on the average adult equivalent per capita household income of affected and non-affected households. a distinction is also made between affected households that have experienced illness (i.e. a member of the household has been chronically ill in the thirty days preceding the interview) or death (i.e. a member of the household has died in the six months preceding the first interview or in the time elapsed following the first interview) and those that has not been affected by morbidity or mortality. table 1 average monthly adult equivalent per capita income for affected and non-affected households (rand) total sample affected households nonaffected households affected households suffering illness/death affected households suffering no illness/ death nonaffected households suffering illness/ death nonaffected households suffering no illness/ death wave i 716 510 916 449 799 695 972 sample (n) 375 185 190 153 32 38 152 wave ii 624 471 773 411 767 660 799 sample (n) 373 184 189 120 64 32 157 sajems ns vol 6 (2003) no 2 425 note: the reported sample sizes reflect those of the total 387 households interviewed in both waves that actually reported an income. the loss of labor supply brought about by aids will cause household income to decline (topouzis, 2000). consequently, affected households (and in particular ones affected by morbidity or mortality) should be poorer than non-affected households. this fact is born out in the results presented in table 1 and figure 1. adult equivalent per capita income in affected households represents only between 50 per cent and 60 per cent of the levels of income in non-affected households (table 1), as is the case with total household income and per capita household income (figure 1). the comparison of the two groups of affected households (these households all include someone known to be hiv/aids positive) presents even clearer evidence of the likely effect of hiv/aids on household welfare. the adult equivalent per capita income of affected households that has experienced illness or death is substantially lower than is the case in affected households that has not suffered illness or death (table 1). this is also the case where non-affected households that have experienced illness or death are compared with ones that have not, thus illustrating how illness and death in general impacts on household welfare even where it is not necessarily related to hiv/aids (i.e. testing was not conducted and non-affected households were only screened for the presence of certain chronic illnesses in wave i). also evident from table 1 is that income has declined between the two waves, both in the case of affected and non-affected households as well as in the total sample. these differences in some cases are relatively small, but may be pointing towards a general decline in levels of income. however, it is felt that more panels are required to determine real trends in household income and therefore to substantiate the findings reported here, particularly insofar as income is measured off a relatively low base (i.e. the study population generally is quite poor), which makes it difficult to distinguish between real trends and small differences in income, particularly in the context of problems of measurement error. sajems ns vol 6 (2003) no 2 426 figure 1 average household income in wave i and ii 40 540 1,040 1,540 2,040 2,540 total affected wave i (n=185) total affected wave ii (n=184) total non-affected wave i (n=190) total non-affected wave ii (n=189) r an d average monthly household income average monthly per capita household income average monthly adult equivalent income note: the reported sample sizes reflect those of the total 387 households interviewed in both waves that actually reported an income the available evidence from other household impact studies supports the above findings, i.e. that households affected by hiv/aids generally are poorer than non-affected households. only one study reports on the impact of aids morbidity on household income. households living in rural chanyanya in the kafue district in zambia that were affected by chronic illness had an annual income 46 per cent lower than households in the same area that were not affected by chronic illness (mutangadura & webb, 1999, as quoted in topouzis, 2000: 18). a number of studies have reported on the effect of aids mortality on household income. so, for example, households in zambia that have suffered a paternal death have experienced a drop in monthly disposable income in excess of 80 percent (nampanya-serpell, 2000). households in rural thailand affected by an adult death saw household income drop by 70.7 per cent, while total per capita income dropped by 68.4 percent (kongsin et al., 2000, as quoted in parker et al., 2000: 44). a study in the ivory coast, which fails to indicate whether the focus in on aids morbidity or mortality, reported that the household income of affected families was found to be half that of total average household income (bechu, 1998, as quoted in desmond et al., 2000: 5). 3.3 comparisons of incidence, depth and severity of poverty apart from describing differences between affected and non-affected households in terms of general levels of welfare (or household income in this case), one would also want to determine how poverty differs between affected and nonaffected households. to estimate poverty one requires a poverty line, i.e. a level sajems ns vol 6 (2003) no 2 427 of income below which people are considered poor. poverty lines provide a yardstick with which to compare the circumstances of individual households. aggregate measures of poverty cannot be estimated without a poverty line. armed with the estimate of household income and the poverty line estimate, one can aggregate this information into a variety of descriptive measures of poverty and inequality (grootaert, 1983: 3-10). the following specific measures of poverty and inequality are employed in this analysis 2. the gini coefficient (g) represents the average ratio between the proportion of total income actually earned by a specific household and the proportion of income the household would have earned had income been distributed equally. g = 0 denotes total equality and g = 1 total inequality (paukert, 1973). because inequality is an important determinant of poverty, an analysis of the extent of income inequality can provide an important pointer to determining whether poverty is more severe amongst affected than non-affected households. if inequality is more pronounced amongst affected households, one would expect that more affected households fall below the poverty line. this in turn will mean that poverty is more prevalent amongst affected households, which can be determined by comparing the estimates of the following poverty indices across affected and non-affected households. the headcount poverty index (h) is a measure of the prevalence or incidence of poverty, i.e. the percentage of the population with a level of income below the poverty line (z). the poverty gap index (pg) is a measure of the intensity or depth of poverty that allows for how far the poor fall below the poverty line. the squared poverty gap index (spg) represents a measure of the severity of poverty that allows for the extent of inequality amongst the poor. the spg attaches more weight to those gains furthest from the poverty line. the headcount, poverty gap and squared poverty gap indices are special cases of the foster-greer-thorbecke (fgt) class of poverty measures. pα= 1/nς[z-yi /z] α, where z represents the poverty line and yi the actual income or consumption level of each person or household. the three fgt measures each focus on a different conventional poverty measure. p0, p1 and p2 respectively are derivatives of the headcount (h), poverty gap (pg) and squared poverty gap (spg) indices (greer & thorbecke, 1986). as explained above, these poverty measures become more sensitive to the well-being of the poorest person as the value of α increases (woolard & leibbrandt, 1999: 28). sajems ns vol 6 (2003) no 2 428 table 2 estimates of the headcount poverty index (h), poverty gap measure (pg), squared poverty gap index (spg) and gini coefficient for affected and non-affected households total sample affected households nonaffected households affected house-holds suffering illness/death affected house-holds suffering no illness/death nonaffected house-holds suffering illness/death nonaffected households suffering no illness/death a. wave i h 36.99 44.74 29.55 48.85 26.11 34.44 27.98 pg 16.32 19.75 13.14 20.93 15.71 15.56 12.44 spg 9.20 11.21 7.55 11.44 13.27 9.16 7.15 gini 59.90 56.50 59.60 54.44 60.08 57.91 59.35 sample (n) 375 185 190 153 132 38 152 b. wave ii h 51.03 57.27 44.37 55.63 41.72 46.38 43.24 pg 24.24 27.22 20.67 24.34 20.13 20.02 20.34 spg 14.55 16.39 12.28 13.82 12.59 11.08 12.23 gini 69.85 65.33 71.36 58.11 70.25 68.25 71.56 sample (n) 373 184 189 120 64 32 157 note: the reported sample sizes reflect those of the total 387 households interviewed in both waves that actually reported an income the gini coefficients and poverty indices calculated for each of the groups of affected and non-affected households are reported in table 2. the results are here reported only for the poverty line of r250 adult equivalent per capita income, which was employed in the most recent poverty estimates published by statistics south africa (2000: 11), albeit not in adult equivalent form. evident from the results in table 2 is that the degree of inequality is slightly higher amongst non-affected households than amongst affected households. these differences in the extent of income inequality are even more pronounced in the case of the comparison between the two groups of affected households, i.e. those having experienced illness or death and those not having experienced illness or death, while it also holds for the comparison across the two groups of nonaffected households. this may be the result of households experiencing illness or death being more likely to have a lower income, which translates into relatively lower levels of income and relatively less variation in income (at least across the higher ranges), which in turn means that the extent of income sajems ns vol 6 (2003) no 2 429 inequality is likely to be less pronounced. in the case of non-affected households, variation in household income is more pronounced, translating into higher levels of income inequality. interesting, furthermore, is that inequality has increased between wave i and wave ii of the study, this being the case in all subgroups of affected and non-affected households, as well as in the total sample population. as explained elsewhere, more panels are required to determine real trends in income and therefore in the extent of income inequality. according to the results presented in table 2, the incidence, depth and severity of poverty are worse amongst affected households than amongst non-affected households. this is also the case when comparing the estimates of the incidence and depth of poverty across affected and non-affected household that have experienced illness or death as opposed to affected and non-affected households that have as yet not experienced illness or death. according to these estimates, poor, affected households will have to boost their income by nearly twenty (wave i) and twenty-eight per cent (wave ii) to reach the poverty line. nonaffected households in turn only have to boost their income by approximately thirteen (wave i) and twenty-one per cent (wave ii) to reach the same poverty line. thus, poverty does appear to be significantly worse amongst affected households. the comparison of poverty estimates across the two rounds of interviews also seems to suggest that the incidence, depth and severity of poverty are on the increase, albeit the case for both affected and non-affected households. in fact, poverty is relatively pronounced in both these communities, with a relatively high proportion of both affected and non-affected households being classified as poor (e.g. the headcount index respectively amounts to 37 and 51 percent in wave i and wave ii). according to statistics south africa (2000), the headcount poverty ratio in the magisterial districts of welkom and witsieshoek (which lies within the boundaries of the former qwaqwa) respectively are 0.34 (this is likely to be much higher in the african communities in which this survey was conducted) and 0.69, while the estimate of average monthly household expenditure respectively amounts to r2364 (again likely to be much lower for the residents of the african and colored townships where the survey was conducted) and r807. again, caution is required insofar as data from more panels are required to validate such claim and to establish trends in poverty. one may therefore tentatively conclude that poverty indeed is worse amongst affected than amongst non-affected households. 3.4 robustness of poverty comparisons in order to further substantiate such argument, one needs to perform a number of poverty comparisons. the main purpose with a poverty comparison is to determine whether the results of such comparison are robust and consistent. the sajems ns vol 6 (2003) no 2 430 conclusion drawn from a poverty comparison, i.e. whether affected households are poorer than non-affected households or not, should not be dependent on the choice of a particular standard of living indicator, poverty line, or poverty measure (ravallion & bidani, 1994: 76; ravallion, 1994b: 44-51). the robustness of a poverty comparison is determined by comparing the headcount, poverty gap and squared poverty gap index across a critical range of poverty lines. arbitrariness is practically unavoidable in setting poverty lines, primarily because of the multitude of methods that are employed for this purpose (kgarimetsa, 1992: 9; alcock, 1993: 60-62; johnson, 1996: 110-12). hence, the standard practice has become one of testing the robustness of poverty lines by simultaneously employing more than one such estimate in poverty analysis. ravallion (1994b: 43) refers to this as the use of dual poverty lines. results are compared across poverty line estimates based on different methodologies and/or alternative assumptions made using similar methods (lipton & ravallion, 1995: 2577; lipton, 1997: 1003). a similar approach is followed here. the range of poverty lines used for this purpose varies from r100 to r600 in adult equivalent per capita terms, which covers all the currently available poverty line estimates for south africa, even when allowing for the effect of inflation (klasen, 1997: 56; woolard & leibbrandt, 1999: 14; booysen, 2001: 680). partial poverty orderings or poverty value curves are used for the purposes of presenting the results (ravallion, 1994b: 1-3; woolard & leibbrandt, 1999: 12). to obtain these curves, estimates of the headcount, poverty gap and squared poverty gap indices for the subgroups of households are plotted for the critical range of poverty lines. the values of the poverty measure are plotted on the vertical axis and the cumulative values of the poverty line are plotted on the horizontal axis. a comparison is robust and consistent if the poverty value curve for one subgroup dominates and/or matches that of another subgroup across the entire range of poverty line estimates. this means that one subgroup is poorer than another subgroup regardless of the poverty line used for comparative purposes. only the poverty incidence dominance curves for each of the four main clusters of households are reported here (figures 2 to 5). according to ravallion & sen (1996: 776), the conditions for dominance are likely to hold for the poverty gap and squared poverty gap measures if it hold s for the headcount index. evident from figures 2 and 3, is that levels of poverty are generally higher amongst affected households, regardless of the choice of poverty line. the poverty incidence curve for affected households dominates that for non-affected households across the entire range of poverty lines. poverty, therefore, does seem to be worse amongst affected households. sajems ns vol 6 (2003) no 2 431 figure 2: incidence of poverty in affected and non-affected households (wave i) 0 10 20 30 40 50 60 70 80 90 100 150 200 250 300 350 400 450 500 550 600 poverty line (rand per adult equivalent) h ea d co u n t p ov er ty i n d ex ( % ) total sample affected households non-affected households figure 3: incidence of poverty in affected and non-affected households (wave ii) 0 10 20 30 40 50 60 70 80 90 100 100 150 200 250 300 350 400 450 500 550 600 poverty line (rand per adult equivalent) h ea d co u n t p ov er ty i n d ex ( % ) total sample affected households non-affected households sajems ns vol 6 (2003) no 2 432 the fact that the socio -economic impact of aids is indeed worse in poorer households has been confirmed by nampanya-serpell (2000), while much of the analysis following from the kagera household study has argued that household wealth and access to public services are very important in protecting households from the impact of hiv/aids. impact was found to only be significantly worse in households affected by adult deaths compared to ones with no adult deaths when controlling for differences in socio -economic status (ainsworth et al., 2000; ainsworth & dayton, 2000; lundberg & over, 2000). another test of the robustness of the findings presented here is the extent to which poverty is consistently worse amongst households that have directly experienced illness and/or death. figures 4 and 5 represent the poverty incidence curves for affected and non-affected households by incidence of illness and/or death. figure 4 incidence of poverty in affected and non-affected households by incidence of illness and/or death (wave i) 0 10 20 30 40 50 60 70 80 90 100 150 200 250 300 350 400 450 500 550 600 poverty line (rand per adult equivalent) h ea d co u n t p ov er ty i n d ex ( % ) affected households suffering illness/death affected households not suffering illness/death non-affected households suffering illness/death non-affected households suffering no illness/death in the case of affected households (i.e. households including at least one person known to be hiv-positive), the incidence of poverty indeed is higher amongst affected households that have experienced illness and/or death than in affected households where this is not the case, regardless of the poverty line employed in quantifying the extent of poverty. again, therefore, the evidence seems to suggest that hiv/aids is likely to result in poverty. in the case of non-affected households, however, the comparison is not consistently robust, with the poverty sajems ns vol 6 (2003) no 2 433 incidence curves crossing at the bottom end of the range of poverty lines in wave ii (figure 5), although being robust in wave i (figure 4). this could be the result of these households being in a better position than affected households to cope with the resulting loss of supply of labor and household income, e.g. having access to medical aid and having other household members in employment. yet, it may also be because of the relatively small number of nonaffected households that have experienced illness and/or death (n<40), which makes meaningful comparisons difficult. in addition, the fact that the two waves of data collection were conducted during different times of the year may means that trends in seasonal income could have influenced the results. here, as is the case with other analysis, data from subsequent follow-ups of households during this longitudinal study will allow one to elucidate these unexplained differences. figure 5 incidence of poverty in affected and non-affected households by incidence of illness and/or death (wave ii) 0 10 20 30 40 50 60 70 80 90 100 100 150 200 250 300 350 400 450 500 550 600 poverty line (rand per adult equivalent) h ea d co u n t p ov er ty i n d ex ( % ) affected households suffering illness/death affected households not suffering illness/death non-affected households suffering illness/death non-affected households suffering no illness/death 3.5 poverty shares the above analysis does not take into account how many affected households there are in comparison to non-affected households. hence, the analysis fails to highlight the extent to which affected and non-affected households share the burden of poverty. such analysis requires poverty measures that are additively decomposable. additive decomposability means that overall inequality can be portioned into inequality between subgroups and within subgroups. sajems ns vol 6 (2003) no 2 434 decomposition across space requires measures of the type pα = napαa + nbpαb, where a and b represent two subgroups and na and nb the population shares of the two groups that the poverty estimate pα for each group is weighted by (lipton & ravallion, 1995: 2580-81). the fgt class of poverty measures is additively decomposable. this feature of the three measures of poverty employed in this analysis makes it possible to determine the share of affected and non-affected households in the poverty burden. poverty shares were calculated separately for affected and non-affected households, as well as for affected households that have and have not experienced illness and/or death in the recent past. poverty shares were calculated with reference to the r250 adult equivalent per capita poverty line. the evidence suggests that there is not such a great difference between the share of poverty shouldered by affected and nonaffected households, although affected households bear a larger share of the total burden of poverty, perhaps because of the fact that the two samples are almost equal in size. affected households have born 53.1 (wave i) and 59.9 percent (wave ii) of the burden of poverty, compared to the 46.9 (wave i) and 40.1 percent (wave ii) born by non-affected households. however, when the poverty shares are calculated across the sub-sample of affected households only, the results underscore the extent to which affected households that have experienced illness and/or death bear the brunt of poverty compared to affected households not yet affected by illness or death. households that have experienced illness and/or death respectively have born 71.3 (wave i) and 90 percent (wave ii) of the burden of poverty on affected households. as a result, policies aimed at poverty alleviation can be argued to be particularly crucial in sustaining the livelihoods of affected households that have actually experienced illness and/or death. 4 conclusion affected households are poorer than non-affected households, regardless of whether income is measured at the household or individual level or in adult equivalent terms and regardless of the poverty line and poverty measure employed in measuring poverty. these poverty comparisons are relatively robust, particularly so in the case of the comparison of affected households that have experienced illness or death (and who also bear the major share of the burden of poverty) with affected households that have not experienced illness or death. in other words, the incidence, depth and severity of poverty are relatively worse among affected households and especially among affected households that have suffered illness or death in the recent past. there is also evidence that the extent of income inequality and the incidence, depth and severity of poverty within this relatively small sample of households may be on the increase, albeit sajems ns vol 6 (2003) no 2 435 the case in both the affected and non-affected group of households. the findings therefore suggest that the introduction of a broad-based social security system offering minimal benefits or of specifically targeted welfare programs may in the short and medium term be important in mitigating certain aspects of the impact of the epidemic, e.g. ensuring food security, making sure that children attend school and mitigating the burden of funeral costs, particularly in the case of households that have directly experiences illness or death. in the longer run, however, continued efforts at poverty reduction through improved education opportunities and job creation are likely to remain important. it also means that efforts aimed at ensuring hiv-infected persons equitable access to the labor market will remain crucial in keeping these households from slipping further into poverty. subsequent follow-up of these households will provide further information on trends in health and socioeconomic status, thus elucidating these complex relationships. endnotes 1 this research paper is sponsored by usaid and administered by the joint center for political and economic studies inc. under a subcontract agreement from nathan associates inc. these findings were included in a more extensive research paper presented in johannesburg at the annual conference of the development policy research unit (dpru) from 2426 october 2002. 2 the estimates of the measures of poverty and inequality that are presented in these pages were calculated with the aid of the povcal program developed by the world bank. povcal is an easy to use and reliable tool for routine poverty assessment work. it uses sound and accurate methods for calculating poverty and inequality measures with only a basic pc and any of the various types of grouped distribution data typically available, often in published form. povcal estimates a general quadratic lorenz curve and beta lorenz curve for each data set and then performs a range of tests to assess the validity of each of the lorenz curves. the measures of poverty and inequality reported in these pages are based on the general quadratic lorenz curves estimated from the tabulated data. the general quadratic lorenz curves were invalid only in select cases and then only at the upper extremes of the income distribution, whereas the beta curves were invalid in most cases. the sum of the squared standard errors over these lorenz curve were generally extremely small. sajems ns vol 6 (2003) no 2 436 references 1 abt associates (2000) the impending catastrophe: a resource book on the emerging hiv/aids epidemic in south africa, johannesburg: henry 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(1994) “measuring inequality within the household”, review of income and wealth, 40(4): 415-31. 47 world bank (1998) confronting aids, washington, dc: world bank. abstract introduction related literature empirical strategy data and descriptive analyses estimation results conclusion acknowledgements references appendix 1 footnotes about the author(s) tobechi f. agbanike department of economics and development studies, faculty of management and social sciences, alex ekwueme federal university, ndufu-alike, nigeria george a. agwu department of economics and development studies, faculty of management and social sciences, alex ekwueme federal university, ndufu-alike, nigeria uwazie i. uwazie department of economics, michael okpara university of agriculture, umudike, nigeria kevin o. onwuka department of economics and development studies, faculty of management and social sciences, alex ekwueme federal university, ndufu-alike, nigeria lasbrey i. anochiwa department of economics and development studies, faculty of management and social sciences, alex ekwueme federal university, ndufu-alike, nigeria michael o. enyoghasim department of economics and development studies, faculty of management and social sciences, alex ekwueme federal university, ndufu-alike, nigeria anayochukwu basil chukwu department of economics and development studies, faculty of management and social sciences, alex ekwueme federal university, ndufu-alike, nigeria kalu e. uma department of economics and development studies, faculty of management and social sciences, alex ekwueme federal university, ndufu-alike, nigeria citation agbanike, t.f., agwu, g.a., uwazie, u.i, onwuka, k.o., anochiwa, l.i., enyoghasim, m.o. et al., 2020, ‘how does bribery affect the wage performance of formal firms? instrumental variables and matching evidence from nigeria’, south african journal of economic and management sciences 23(1), a3123. https://doi.org/10.4102/sajems.v23i1.3123 original research how does bribery affect the wage performance of formal firms? instrumental variables and matching evidence from nigeria tobechi f. agbanike, george a. agwu, uwazie i. uwazie, kevin o. onwuka, lasbrey i. anochiwa, michael o. enyoghasim, anayochukwu basil chukwu, kalu e. uma received: 13 apr. 2018; accepted: 22 oct. 2019; published: 19 mar. 2020 copyright: © 2020. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: there is an ongoing debate about the effects of bribery on economic performance, where strong arguments are made on the opposing sides. this article investigates the relationship between bribery and the level of workers’ wages. the study is a variant of investigations into firms’ compression of wages to pay for staff management mutually beneficial business practices. aim: the aim of this study is to estimate the impact of bribery on the wage performance of formal firms. setting: the empirical assessment uses a unique firm-level data set comprising 1141 nigerian manufacturing firms, some of whom paid bribes to corrupt bureaucrats. methods: the study utilised a standard ordinary least-squares estimation technique. to address the potential endogeneity and measurement error bias arising from bribery, we used industry-location average bribe rate as instrument. results: we find a significant negative effect of bribery on wages to the extent that a one percentage point increase in the rate of bribery reduces the level of wages paid to the workers by about 230 000 naira per worker per annum. a robustness check using the counterfactual evaluation framework of propensity score matching, supports the ordinary least-squares estimation. conclusion: this study lends support to the firm level-based hypothesis that bribery has a detrimental long-term effect on firm performance. in particular, that employers using their monopsony power shift the burden of bribery to the workers through compressing wages. in addition, our results justify the enormous attention of the international community in combating bribery and corruption in nigeria and other developing countries. keywords: bribery; wage performance; formal firms; instrumental variables; propensity score matching; nigeria. introduction bribery is a tax on firms, but the proceeds usually do not go to the government. the literature on bribery has classically focused on the administration of bribes or gaining private advantage by abusing public officials (achim, borlea & anghelina 2018). more recently, however, the debate about the effects of bribery on economic performance has taken the front seat. the two sides of the argument are both convincing.1 the fact that governments do not receive the proceeds from bribery as tax is already a damage to the economy. the ‘efficient grease hypothesis’ suggests that bribery facilitates transaction where otherwise bureaucratic holdups could have stalled exchange (see for instance barasa 2018). the second-best theory of corruption holds that bribery is efficient in allocating licenses and contract through willingness to pay (see méon & weill 2010; xu & yano 2017). so, is bribery more efficient than formal taxation? firm-level theories of corruption argue that bribery may cause more damage than taxation because of the associated higher transaction costs, uncertainty and necessary secrecy, which among other things makes corruption contracts not enforceable in courts (see e.g. rose-ackerman & palifka 2016). however, to the extent that there are inefficiencies in the provision of regulations and public goods, firms offering bribes to corrupt bureaucrats may indeed achieve greater productivity and be in a position to better compensate labour than firms that do not offer bribes (nguyen et al. 2016). whereas literature documents that standard firm sponsored practices such as workers training improve productivity, it also finds that the firms often shift the real costs to the employees through wage compression (neirotti & paolucci 2013). similarly, if bribery increases firm productivity, it is imperative to ascertain, as in the case of employer-provided training, how much of the benefits accrue to the workers in the form of wages. the objective of this article is to ascertain if the giving of bribes to bureaucrats by firms results in lower wages for the workers. whether bribery increases productivity or not, it is unlikely to be neutral to wages because either wages are compressed to recoup bribery expenditures or bribery is undertaken in the first place to reduce regulation costs which may include regulated wage level. finally, that bribes are often coded as informal gifts in surveys may suggest that they are free-will donations or that they are too insignificant to affect the firm’s performance. however, if firms deny their workers necessary compensation as a result of having to meet bribery ‘obligations’, this means that bribery originates from substantial bureaucratic holdups, and the associated opportunity costs may be detrimental to long-run firm growth. nigeria is an appropriate case for this type of study. transparency international ranked nigeria 144 out of 180 countries in the 2018 corruption survey (transparency international 2018) and in the periodic world bank enterprise surveys, an average of 40% of small and medium firms in nigeria report giving informal gifts as a condition of accessing public services (giuseppe, mousley & radwan 2009). nigeria also scores very low in the indices of business freedom and government integrity, both of which suggest a poor business climate that extorts businesses. thus, using a unique data set containing information on the estimated cost of labour (wages and salaries) and bribe payments of firms operating in nigeria, this article estimates a naïve and identified relationship between bribery and the compensation of labour. the naïve estimation ignores potential endogeneity of the bribery variable and leads to the conclusion that there is a moderate negative effect of bribes on the amount of labour compensation. the identified model is based on the use of an instrumental variable in a two-stage regression to overcome the potential problems of endogeneity and measurement error. using the industry-location average bribe as instrument, the negative effect of bribery on wages becomes considerably higher. further, we support the evidence using a counterfactual evaluation framework of propensity score matching and confirm that workers in bribing firms are significantly less compensated than their peers in non-bribing firms. to the best of our knowledge, this is the first article to relate firm’s bribery tendency to workers’ welfare even though bribery is fast becoming standard practice among firms especially in developing countries like nigeria. the article is organised as follows: section 1 introduces the study, a review of related literature is presented in section 2, empirical strategy is described in section 3, section 4 describes the data and performs basic descriptive analysis, while results and conclusion are presented in sections 5 and 6. related literature the theories of bribery as an economic phenomenon are mainly shaped by moral standpoints which perceive bribery as detrimental to the economy. country level studies have largely confirmed this standpoint by showing that economic growth and development have inverse relationships with the level of bribery and corruption (see dimant & tosato 2018). evidence at the firm level about the relationship between bribery and firm performance is still emerging. however, one can distinguish two opposing perspectives from the empirical estimates: on one hand, the position of the moral theorisation is confirmed and bribery or corruption is found to harm firm performance (donadelli, fasan & magnanelli 2014; nguyen et al. 2016). on the other hand, bribery is theorised as greasing the wheels of business and thus enhancing firm performance (dreher & gassebner 2013). a number of firm-level studies have confirmed the harmful effects of bribery on firm performance ranging from one to three percentage point difference. in africa in particular, fisman and svensson (2007) find that a one percentage point increase in bribery rate is associated with a reduction of firm growth of three percentage points. a persisting concern, however, is how the bribe variable is treated in the estimations; as faruq and webb (2013) show, productivity may be the cause and, at the same time, the effect of bribery. this, in addition to the fact that bribe may be measured with error given its clandestine nature, suggests that the traditional ordinary least-squares (ols) estimation of the bribe variable may be biased. athanasouli, goujard and sklias (2012) analysed firm-level data from greece using the instrumental variable method and found that there is a strong negative association between bribery and sales growth. gaviria (2002) found similar results for the case of latin american countries, but assumed that the bribe variable is exogenous. on the other hand, the grease hypothesis emphasises that bribery promotes rather than harms growth by enhancing firms’ performance. from this perspective, bribes help circumvent the distortions caused by inefficient bureaucracy in a second-best situation (dreher & gassebner 2013). the study shows that even if the firm is new in the market or small, bribes may be used to secure ‘good’ relationships with bureaucrats to reduce the risk of failure. another strong argument in line with this perspective is that bribery enhances productivity because it compensates for defective public institutions. however, only few studies have empirically confirmed this perspective; ayaydin and hayaloglu (2014) studied manufacturing firms in turkey and found that bribery helps firms grow faster because bribes enable the firms to bypass bureaucratic holdups. a panel analysis by vial and hanoteau (2010) based on manufacturing firms in indonesia also find a positive relationship between firm bribery, output and labour productivity. williams and shahid (2016) found a strong positive impact of bribery in a cross-country study involving 132 developing countries. nevertheless, none of these opposing perspectives is well established in theory. in the canonical labour markets, firms are wage takers, whereas, in a regulated system where wages are fixed, bribery may enable firms to circumvent regulations in the labour market and obtain freedom to influence wages (see smith et al. 2012). productivity is the main determinant of wages as long as the labour markets operate without friction; otherwise, regulation may supplement productivity in determining the level of worker compensation (de vaal & ebben 2011). in line with this, giuseppe et al. (2009) suggest that for nigeria, the regulated wage in the formal sector outweighs the average product of labour, which implies that employers have incentive to reduce applicable wages by bribing bureaucrats who enforce the regulations. at the same time, by ‘greasing the wheels’ of production, bribing bureaucrats could also increase firm productivity per worker through discriminatory access to public goods (mendoza, lim & lopez 2015). in labour markets without friction, the price of labour is determined by productivity, but as we hypothesise that corruption may promote productivity by clearing regulatory burden in a second-best situation, it is not clear who actually pays the bribe nor whether the benefits lead to higher wages for the workers instead of being completely appropriated by the employer. hence, the issue of whether bribery increases or decreases wages is primarily an empirical question, and one that has not previously been answered. it is evident from country-level studies that corruption hurts growth; cross-country studies with gross domestic product as outcome of interest usually report negative effects of corruption on growth. however, these cross-country studies have a significant chance of being biased by unobserved heterogeneity across data points. in addition, the use of corruption perception indices by these studies expose the estimated effects to perception bias. furthermore, the cross-country evidence is not easily generalisable to firm-level situation and may not be used to make inferences concerning workers’ welfare. the negative effect of corruption on growth measured at the country level could arise from the inefficient provision of public goods, which could easily yield the prediction that corruption damages growth. additionally, the cross-country studies and indeed other studies relating bribery to firm performance do not accommodate worker incentives for abating corruption; corrupt transactions are secretly completed between the firm and the bureaucrats, but the average worker is aware of the transactions. if the welfare of the worker is hurt directly or indirectly by bribery, it immediately suggests incentives compatibility between firm workers and anti-graft agencies. given that grafts may be more visible to firm workers than the graft agencies, anticipated workers-agency cooperation could lead to effective anti-graft policies. furthermore, the evidence presented here illustrates another aspect of the impact of corruption on long-run economic growth. in summary, the investigation into the relationship between bribery and firm performance is not yet conclusive. there are two main opposing theories that are equally generating empirical confirmations, although a few studies report findings that are neutral to the debate. for example, lavallée and roubaud (2011) find no association between bribery and firm output. therefore, more empirical evidence is needed to confirm the theories. moreover, previous studies focus on different dimensions of firm performance and none had studied the wage performance of firms. our focus on the firm wage performance is informed by the fact that bribery has similar motivation as firms’ provision of general worker training, which has been shown to lead to compressed wages. our basic assumption is that just like firms providing general worker training, graft-paying firms do so in order to increase productivity. the theoretical predictions reveal that in non-competitive labour markets and for the sake of raising productivity, firms provide general worker training and bribe bureaucrats (acemoglu & verdier 2000; acemoglu & pischke 1998). in that situation, the monopsony power of the employer guarantees recovery of the training and bribery expenditure through the payment of wages below the worker’s productivity. empirical strategy estimating the effects of bribery on the wage performance of firms in this study presents two main estimation challenges: (1) both wages and bribery are likely to be simultaneously determined and (2) bribes may be measured with error. we report on the practical steps taken to resolve these challenges below. bribery is unlikely to be random; bureaucrats with substantial discretionary powers are likely to assess firms and request bribes according to the firms’ ability to pay (see seker & yang 2012). consider that the measure of ability to pay, monitored by the bureaucrats, may have to do with the unobserved firms’ efficiency level which in turn determines profit, and we have no way of determining the profits made by the firms on the basis of the current data. thus, the unobserved profitability associated with the firm’s products could be a source of endogeneity. the mechanism for selecting the target firm by the corrupt bureaucrats is illustrated by fisman and svensson (2007). the essence is that the optimal incentive of the bureaucrats is to extract as high a bribe as possible, limited only to the willingness of the firms to pay and not exit or snitch on the contract. logically, the bureaucrats extract larger bribes from firms producing goods with higher profitability because they are most likely to be more willing to pay, and vice versa. svensson (1999) argues that current and future expected profitability explain a large part of the variations in bribes among graft-paying firms. hence, if profitability also influences the firm’s willingness to offer higher wages, then, with reference to the two firms, a positive relationship between bribe payments and wages should be observed. the second econometric issue that we wish to address is the ‘noisy’ nature of micro-data; in particular, due to the secretive nature of bribery transactions, the reported bribery level may be subject to measurement error. these estimation difficulties will tend to attenuate any direct negative effect that corruption has on wages. to mitigate these problems, we find suitable instruments for the bribe variable. our identification strategy can be laid out formally following fisman and svensson (2007): let the relationship between firm wage offering (ωij) and bribery (bij) be represented by the equation: in the equation 1, the subscripts denote firm i in sector j; θij is a firm-specific (unobservable) factor that may impact both bribery rates and wage rates, pij is a variable capturing the firm’s propensity to remunerate workers. this remunerative potential can be decomposed into two parts: x’ij is a vector of observable characteristics and ηij is a zero-mean error term. linearising the model yields: going by our previous discussion, the omitted variable θij is correlated with both wage rates (β ≠ 0) and bribery (corr(b, θ)≠ 0) in line with the discussion in the introduction, we assume that β0 > 0 and (corr(b, θ)> 0). for example, we can think of the shifts in demand described above that are likely to influence both the ‘required’ bribe and wage rates. assuming, for simplicity, that θ is essentially uncorrelated with x, this leads to the usual omitted variable bias; given our assumptions, the bias will be towards θ, resulting in an underestimate of the effects of bribery. based on this, our identification assumption to deal with this problem is that bij can be decomposed into two terms, one, industry-specific, and the other, particular to the firm: in equation 4, βj denotes the (average) amount of bribes common to industry-location j, which in turn is a function of the underlying characteristics inherent in that particular industry-location, determining to what extent bureaucrats can extract bribes, while βij denotes the idiosyncratic component. importantly, we assume that the industry-specific part of bribery is determined by the firm’s local corruption environment, which depends not only on the location of the firm, but also on the industry in which the firm operates. thus, we assume that this component is exogenous to the firm, and uncorrelated with θ. for example, such industry-specific factors might include import and export orientation of the product market, and degree of dependence on publicly provided infrastructural services. likewise, we expect rent extraction through bribery to differ across locations simply because some bureaucrats may be more effective at extracting bribes than others. if this assumption is valid, we may use βj to instrument for βij, since corr(βij, θ) = 0. in such a specification, using industry-location averages as an instrument for firm-level bribery gets rid of the bias resulting from unobservables that are correlated with bribery at the firm, but not industry-location level. secondly, the risk of measurement error is high in cross-sectional settings. presently, we are particularly concerned about the bribery variable given the underground environment under which bribery transactions take place and the fact that some managers may feel that reporting high amounts of bribery would paint the firm in a bad light before the public. this sort of endogeneity is usually handled through two-stage estimations where grouped averages are used as instruments for the endogenous variables.2 adopting a similar approach in this study and using industry-location average bribery level as the instrument, we assume that the measurement errors are largely idiosyncratic to the firm, and hence uncorrelated with the average bribery values. one of the pieces of support for this assumption is that the coding of the variable as gifts rather than explicitly as bribes in the survey would undermine the underground nature of the transaction and subject the reporting to relatively idiosyncratic perceptions of the managers. in the meantime, the chosen instrument must fulfil the validity test including a sound theoretical justification. we make the assumption that corr(βj, θ) = 0; the strength of this assumption lies in bribe and wage being randomly determined at the industry-location level. in a similar study, fisman and svensson (2007) made two identification points that are equally applicable to the current study: the first relates to the nature of the estimation data, which draws from a pool of small and medium-sized firms across a spectrum of the non-agricultural industrial categories and regions in nigeria. it is known that these types of firms are not likely to capture the state. even if they are likely to capture the state, this tendency is not likely to be systematically related at the industry-location level. secondly, if some processes at the industry-location level drive simultaneous determination of bribe and wages, its effects on the results are most likely idiosyncratic. suppose that bureaucrats are able to systematically increase both the regulatory burden and demands for bribes for some selected firms at the industry-locations, this could drive the instrumental variable procedure to overestimate the negative effect of bribe payments. on the other hand, if corrupt bureaucrats systematically target particular firms with higher levels of bribery at industry locations with high remunerative potential, this would attenuate the effect of the instrument. in table 1-a1 (appendix 1), we report the results of the first stage regressions obtaining support for the relevance of our instruments in predicting the instrumented bribe variable. these in addition to the reported instrument tests in table 5 provide support that our instruments are valid. data and descriptive analyses for all the empirical analyses in this study, we use the wave of the nigerian enterprise survey recently published in 2014. the main objective of the enterprise surveys is to monitor developments in the business environments of developing countries. the world bank and its partners in the countries conduct the surveys focusing on small and medium enterprises. the surveys achieve representativeness of non-agricultural manufacturing, services firms and excludes firms with major government control. rich qualitative and quantitative information about the firms are collected through face-to-face interviews with firm managers and owners including various aspects of productivity. the nigerian sample covers 2676 firms, but we focus only on the 1141 manufacturing firms. based on this data, we generated all of the variables that are part of our estimations. importantly, we make use of labour productivity generated as sales per full-time worker. although capital productivity would have been an important control in the estimations, we could not generate this variable due to substantial missing values with respect to firm physical assets. the dependent variable is the amount spent per capita on the compensation of labour by the firm per annum. apart from its natural form, the dependent variable was also operationalised as the natural logarithm of the total costs of labour compensation divided by the number of full-time employees. the variable of interest in the article is bribery that is generated as a dummy variable capturing whether the firm offered any amount in informal gifts to bureaucrats in exchange for access to services such as water or electricity connection. in the main estimations, control variables include characteristics identified in literature as affecting firm wage performance including productivity, size, age and workers’ education. further details about the variables and their construction are presented in table 1 and the descriptive statistics presented in table 2. large firms (number of employees > 99) and firms in which governments have stakes are eliminated from the sample. theoretically, bribery can have smaller distortionary effects for large and politically powerful firms because such firms can easily capture the regulatory process. table 1: variables description. table 2: summary statistics. comparing wage, productivity and age distributions by bribe status in order to examine the interrelation of bribery and the wage performance of the firms, we begin our investigation by comparing distributions of main variables using a semi-parametric test for the samples of firms defined by the bribe status. for this purpose, all firms included in the pooled sample are categorised into two broad categories: bribe and non-bribe firms. we conduct the non-parametric kolmogorov–smirnov test (ks test) to determine if there is any significant difference in the wage, labour productivity and age distributions for the two groups. more precisely, the procedure adopted in the study for testing the difference between the distributions functions basically relies on the concept of first-order stochastic dominance and allows us to establish a ranking for the compared distributions. the idea of selecting productivity and age for the test stems from their influence on the propensity of firms to offer higher wages as documented in the literature (brown & medoff 2003; heyman 2005). we summarise the basic concept of the test as follows: if, for instance, given two random samples assumed to be independently distributed, the one sample φ1,…φn comes from a distribution function ω1 and the second sample φ1+1,…φn comes from a distinct distribution function ω2. we are interested in testing the hypothesis; ω1(φ) –, ω2(φ)≤ 0, ∀ φ ℛ. the stochastic dominance of ω1 over ω2 is obtained under the conditions that this hypothesis holds and there is strict inequality for at least some φ ∈ ℛ. this is precisely the examination of the cumulative distribution functions of variables in both samples and determining if one lies entirely to the right of the other. this procedure is used to conduct the two-tailed ks test of stochastic dominance, which identifies the independence of the distributions. the stochastic dominance evaluated based on two related null hypotheses as follows: the test is based on the rejection of the null hypothesis of distributions equality: the two-sided ks test is based on the theory of asymptotic distribution and the test statistics are derived by kolmogorov (1941) and smirnov (1939). a comparison of bribing versus non-bribing firms using the ks test is reported in table 3. column 2 of the table tests the hypothesis which suggests that the non-bribing firms’ outcome distributions contain smaller values than the distributions for bribe firms, while the hypothesis under test in column 3 suggests the opposite. the results strongly reveal that firms who offer bribes have smaller distributions of wages and productivity than firms that do not offer bribes. the results are statistically significant at 1% and 5% levels. there is no significant difference in age across the group of firms. the combined ks test results (column 4) mirrors the results in columns 2 and 3, as the difference in outcome variables between non-bribing and bribing firms is found to be statistically different from 0, except in the case of age of the firms. to interrogate the data further, the generalised lorenz curve framework was used to ascertain dominance between the distributions of wages for the two samples. table 3: kolmogorov–smirnov tests of stochastic dominance. figure 1 clearly shows that the wage distribution for non-bribing firms (bribe = 0) dominates the wage distribution for the bribing firms (bribe = 1) under the framework of generalised lorenz (gl) curve. the wage distribution for the non-bribing firms is less unequal than the wage distribution for the bribing firms, and is quantitatively preferable from a welfare perspective. it can be concluded that the distribution of wages in the sample of non-bribing firms is superior to that of bribing firms. however, productivity distribution in the sample of non-bribing firms also outweighs that of bribing firms (see table 3). therefore, to isolate the effect of bribe on wages, the effects of labour productivity and other determinants of wages must be controlled. figure 1: stochastic dominance of non-bribing firms’ wage distribution over that of bribing firms. estimation results main estimations first, we report a set of regressions run with the naïve model where endogeneity of the bribe variable is not controlled. the results in their different specifications are listed in table 4. in the table, all the specifications show negative effects of bribery on wages. however, the estimated effects are generally moderate. in all the specifications, the standard errors are clustered by the industry location which allows the tendency for the errors across firms in a given industry location to be similar. without controlling for firm provision of worker training which relates to another form of wage compression, the negative effect of bribery was stronger and characteristics of firm such as age and average education of the workers exert positive influence on wages. however, as soon as the training indicator was introduced, the negative influence of bribery reduced but remained significant, while age and average education became insignificant. table 4: effect of bribery on wage payment, basic estimation. the identified model addresses the possible endogeneity and measurement error problems in this relationship. in view of this, we instrument for bribery in the next estimations relying on the exogeneity of industry-location average bribe and industry-location regulation burden.3 clearly, the results reported in columns 1–5 of table 5 support the hypothesis that wages are compressed in bribing firms. more precisely, the coefficient on bribery takes on values from –2.3 to –2.6. this implies that an increase of one percentage point in the rate of bribery payments will reduce the per capita wage paid to the workers by about 230 000 naira per annum. thus, results align with evidence of the use of monopsony power by firms to compress wages and the theoretical framework of corruption as an obstacle to growth. this set of results is unaffected even when firm provision of worker training and firm involvement in international trade are controlled. in columns 1–3 of table 1-a1, we ran the just-identified models where industry-location average bribery is used as instrument whereas in column 5 the model is over-identified using average industry-location regulation burden in addition to the industry-location average bribe rate as instruments. we introduced additional variables of training and trade in columns 2 and 3 to gauge the robustness of the bribe coefficient to the introduction of additional wage enhancing variables. our choice of variables is informed mainly by the mincerian specification of the wage function (see mincer 1974). table 5: effect of bribery on wage payment, instrumental variable estimation. robustness check using propensity score matching in general, estimations based on cross-sectional data has limitations. a particular concern in this case is that some bribing and non-bribing firms used in the estimation may fall outside the area of common support. there is a non-trivial chance that the ‘required’ amount of bribery and other firm characteristics, particularly wages, are determined in a system. moreover, the traditional wage models are based on individual wages as a function of individual characteristics, whereas we model per capita wage as a function of firm characteristics. this means that not all risks of misspecification bias are ruled out in the previous estimations. furthermore, in studying the elasticity of wages with respect to bribes, it matters how bribery payment is scaled. this is why the bribe variable in this study is measured as percentage of sales; however, this does not guarantee the elimination of all risks of misreporting of either sales or bribe values. matching estimations overcome these challenges: in the first instance, matching does not assume correct measurement of the bribe variable, but rather whether any amount of bribery was given or not. secondly, matching does not require specifying the functional form of the outcome equations and therefore is not susceptible to misspecification bias in that respect. the propensity score matching reduces sample selection bias by creating carefully matched treatment and control groups. mallick and yang (2013) noted that this property is particularly useful where selection bias arises from endogeneity, which is applicable in this case since bribery and wages are likely codetermined. as table 1 indicates, we utilised as many covariates as possible in estimating the propensity score in order to ensure that the outcome is indeed conditionally independent of the treatment. this contributed to the common support property of the matched samples as can be seen in figure 2. figure 2: common support between the he bribing and non-bribing samples. analysing the data the second time, using the propensity score matching technique, is to serve as a robustness check to the results reported in the previous section. the central feature of the matching analysis is to measure the relationship between a treatment variable and an outcome variable. presently, the treatment variable is bribe (0 or 1) and the outcome is wages offered by the firm in log and standard forms. simply comparing a sample of firms offering bribes and another sample of firms not offering bribes would almost certainly produce biased results unless the treated and control groups closely resemble each other in all relevant attributes other than the treatment. the matching approach seeks to replicate the process of experimental random sampling, using non-experimental observed data. nevertheless, in this study, we restrict the matching procedure to robustness check only because matching can compute the treatment impact, but does not easily lend itself to the computation of marginal impacts of the covariates. so, we prefer the instrumental variable procedure 2sls over the matching method, mainly because it allows us to compute the marginal impacts and elasticities that are clearly desired from a policy standpoint. table 6 reports the average treatment effect on the treated (att) generated, using different algorithms of the propensity score matching (psm). the results support the earlier results generated based on the instrumental variables approach. the psm atts suggest that, on average, the treatment group – that is firms that usually bribe bureaucrats – spend about 180 000 naira less than the control group in wage compensation per worker per annum. table 6: propensity score estimates. conclusion the contribution of this article is in estimating a very significant and robust negative effect of bribery on the wages paid to workers by the nigerian firms. we used standard ols, instrumental variables and counter-factual evaluation approaches to arrive at this conclusion. the preferred instrumental variables approach shows that a one percentage point increase in the rate of bribery reduces the amount of wages paid to the workers by 230 000 naira per worker per annum. our matching estimation shows that the average treatment effect of bribery on the treated att is –180 000. this means that annual per capita wage paid by bribing firms is 180 000 naira less than the amount by non-bribing firms. based on these, this study lends support to the firm level-based hypothesis that bribery has a detrimental long-term effect on firm performance. in particular, that firm management using their monopsony power shifts the burden of bribery to the workers through compressing wages. we also find a high negative effect of training provision by firms on the workers’ wages. the implication of this is that both practices skills training and bribery are results of the same motivation, which is that firms care about productivity, but in the end, instead of benefitting from the improved productivity, workers are indirectly made to pay for it using their wages. in a country like nigeria, where high unemployment rate puts workers’ unions in check, bureaucratic regulation of wages is the only safety net for workers. this result thus emphasises that even this mechanism is compromised through corruption. however, the scenario creates a significant stake for the ordinary workers in the fight against corruption. nigeria faces a huge challenge in the fight against corruption, one of which is that the corrupt activities are clandestine. given this result, incentives are compatible for workers to alleviate the knowledge limitations of the anti-graft agencies who are usually less informed than the workers about the clandestine bribery practices. this means that anti-graft measures such as the whistle-blowers’ policy is likely to yield results because the workers are privately motivated to report observed corrupt practices in their enterprises. as the international community continues to provide support in the alleviation of corruption in the developing countries, our results provide empirical justification for this effort. in addition, our article creates room for further research in the direction of linking corruption to workers’ welfare. we expect future studies to focus on other work-related welfare measures such as health insurance that are more latent than wages and may be compressed by firms without raising suspicion. acknowledgements the authors would like to thank the anonymous reviewers for their time and suggestions which were most helpful in refining and improving this article. competing interests the authors declare that they have no competing interests. authors’ contributions t.f.a. was involved in the conceptualisation of the study, data analysis and interpretation of results and drafting of the manuscript. g.a.a. was involved in data cleaning, analysis and interpretation of data and drafting of the manuscript. u.i.u. was involved in the conceptualisation of the study and critically revised the manuscript for important intellectual content. k.o.o. was involved in data cleaning, analysis and interpretation of data. l.i.a. contributed to the design of the study and handled the review of relevant literature. m.o.e. contributed to the design of the study and data cleaning. a.b.c. contributed to interpretation of results and drafting of the manuscript. k.e.u. was involved in the critical revision of the manuscript for important intellectual content. all the authors read and approved the manuscript before its submission. funding information this research received no specific grant from any funding agency in the public, commercial or not-for-profit sectors. ethical considerations ethical clearance was not required for the study. data availability statement data sharing is not applicable to this article as no new data were created or analysed in this study. disclaimer the views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of any affiliated agency of the authors. references acemoglu, d. & pischke, j., 1998, ‘why do firms train? theory and evidence’, the quarterly journal of economics 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neirotti, p. & paolucci, e., 2013, ‘why do firms train? empirical evidence on the relationship between training and technological and organizational change’, international journal of training and development 17(2), 93–115. https://doi.org/10.1111/ijtd.12003 nguyen, n.a., doan, q.h., nguyen, n.m. & tran-nam, b., 2016, ‘the impact of petty corruption on firm innovation in vietnam’, crime, law and social change 65(4–5), 377–394. https://doi.org/10.1007/s10611-016-9610-1 rose-ackerman, s. & palifka, b.j., 2016, corruption and government: causes, consequences, and reform, cambridge university press, cambridge. seker, m. & yang, j.s., 2012, how bribery distorts firm growth: differences by firm attributes, the world bank, washington, dc. smirnov, n.v., 1939, ‘on the estimation of the discrepancy between empirical curves of distribution for two independent samples’, bulletin mathematique de i’universite de moscou 2(2), 3–14. smith, j., obidzinski, k., subarudi, s. & suramenggala, i., 2012, ‘illegal logging, collusive corruption and fragmented governments in kalimantan, indonesia’, in l. tacconi (ed.), illegal logging, pp. 107–125, routledge, abingdon. svensson, j., 1999, who must pay bribes and how much? evidence from a cross-section of firms, the world bank, washington, dc. transparency international, 2018, global corruption report 2018: corruption and the private sector, , issn: 1749–3161, isbn: 978-0-521-13240-4. vial, v. & hanoteau, j., 2010, ‘corruption, manufacturing plant growth, and the asian paradox: indonesian evidence’, world development 38(5), 693–705. https://doi.org/10.1016/j.worlddev.2009.11.022 wald, a., 1940, ‘the fitting of straight lines if both variables are subject to error’, the annals of mathematical statistics 11(3), 284–300. https://doi.org/10.1214/aoms/1177731868 williams, c.c. & shahid, m.s., 2016, ‘informal entrepreneurship and institutional theory: explaining the varying degrees of in formalization of entrepreneurs in pakistan’, entrepreneurship & regional development 28(1–2), 1–25. https://doi.org/10.1080/08985626.2014.963889 world bank, 2014, nigeria enterprise survey, 2014, ref. nga_2014_es_v01_m, the world bank, washington, dc. xu, g. & yano, g., 2017, ‘how does anti-corruption affect corporate innovation? evidence from recent anti-corruption efforts in china’, journal of comparative economics 45(3), 498–519. https://doi.org/10.1016/j.jce.2016.10.001 appendix 1 table 1-a1: first stage regressions. footnotes 1. see williams and shahid (2016) for a summary. 2. justification for the use of this approach can be found in wald (1940), angrist and krueger (2001) and fisman and svensson (2007). 3. we use the time firm managers spend in fulfilling and responding to regulations as a proxy for regulation burden. sajems ns vol 5 (2002) no 3 683 transfer pricing as strategic planning tool for multinational enterprises in a post-isolation south africa petri schutte po/chefstroom business school, po/chefs/room university for christian higher education jozua loots tax services, kpmg abstract political and trade liberalisation leads to irrevocable change, exposing south africa to the demands of the dynamic global market, driven by a deluge of competitive forces, demanding world-class, global competitiveness. the challenge facing south african organisations is to successfully transform in an economy undergoing structural change, moving away from import substitution to global competitiveness. historically, stringent exchange controls prevented profits to emigrate from south africa. trade iberalization necessitates the introduction of transfer pricing legislation to protect the national tax base. application of transfer pricing in practice is complex, information constraints compel the use of foreign comparables in determining a reward consistent with the arm's length standard, challenging objectiveness and risk adjustment. strategic opportunities exist if transfer pricing is not entrenched in national regulation compliance. jelf23,m40 introduction sanctions and trade embargos effectively isolated the south atrican economy from international markets. south africa's economy prior to democratisation and trade iiberalisation was predominantly geared towards import substitution. south africa's re-entry into the international market must be seen within the context of expansion in international trade and commerce manifesting in wideranging changes in trade volume and complexity. the latest unct ad! world investment report (2000: i) reports that transnational corporations (tncs) totals 63 000 parent firms with 690 000 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 684 samms ns vol 5 (2002) no 3 foreign affiliates. these tncs are involved in transactions that extend across virtually all countries impacting on all the economies they come into conflict with. the volume and mobility of international financial capital force governments of developing countries to adopt a conservative stance; economic policies are more restrictive with monetary and fiscal policy decision making at the core of achieving diminishing budget deficits along with single figure inflation targets. utmost care must be taken not to embark on a fiscal route that might ,ead to a decrease in investment in health. education. housing and infrastructure if measured in real terms. funding such investment, governments must prevent erosion of their tax. base. south africa had stringent exchange controls that effectively prevented profits to emigrate. trade liberalisation and relaxation of exchange controls forced the south african . government to protect the south african tax. base with transfer pricing and thin capitalisation provisions with the introduction in 1995 of section 31 of the income tax act. application of transfer pricing in practice is complex; infonnation constraints necessitate the use of foreign com parables in determining a reward consistent with the arm's length principle. use of foreign comparables challenge objectiveness and practical application relating to risk adjustment. strategic opportunities exist if multinationals look beyond transfer pricing compliance and national regulations. international trade and south africa in isolation since south africa's return to active participation in global trade, structural policy adjustment, economic growth and development strategies were embarked on in an attempt to increase global competitiveness of south african organisations. world organisations established since the second world war and the influence they have had on international trade as well as the trade policies they enforced, played a major role in south africa's exclusion from international trade. international economies' increased integration in terms of banking and international finance drew national economies closer, resulting in the evolution of trade blocs during the late eighties and early nineties. economic sanctions, as south africa experienced prior to 1994, have a major effect on the domestic economy. south africa emerged from sanctions with r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 685 artificially high domestic prices; an international trade vacuum existed and domestic manufacturing was geared towards import substitution. the south african reaction to sanctions was domestic protection. balassa (1972: 66) indicates that based on research done in developing countries2, protection tends to increase from lower to higher stages uf fabrication. it seems that protection regimes follow the value chain of production. south africa used tariffs and subsidies to substitute domestic production for imports and to balance domestic production and demand as far as possible. since 1994 and under international agreements, tariff reduction in line with wto bindings continues on route to lowering tariffs, following a tendency3 similar to the one reported by balassa (1972: 71). post-isolation challenges and competitiveness the reconstruction and development programme (rdp) the south african government embarked on since 1994 aims to create a better life for all and forms the central objective of economic policies. the minister of finance first presented the government's macro-economic strategy growth employment and redistribution programme (gear) during the course of the finance budget vote on 14th june 1996. macroeconomic strategy the objectives of the gear strategy were to move towards a competitive, outward-orientated economy. the following core element s were to facilitate this: export led growth expansion of private sector capital formation accelerated private sector investment increased infrastructure development and improved labour intensive production. although the scenario projections gave a clear indication of expectations, it would have been prudent if cognisance was taken of the tollowmg realities: growth of at best 3 per cent per annum is expected. with an optimistic economic growth rate, substantially higher spending on social services than was possible in the past is unlikely, given the reduction in the deficit of the budget. exchange rate volatility as experienced since february 1996 and the inherent danger of capital inand outflows, add to the risk of a potential balancc of payments crisis. short-term adjustment in an event of rapid capital outflows must rest on monetary policy so that economic r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 686 sajems ns vol 5 (2002) no 3 contraction and the resulting decline in import demand can be effectively managed. the gear strategy does have flaws and with hindsight gear proved to be of value, providing a clear message of strategic intent. industrial strategy historically south africa was characterised by an industrial policy best described as import~substituting industrialisation. import protection combined with import~substituting industrialisation led to a skewed concentration of economic ownership. protectionist policies were increasingly associated with inefficiencies (balassa, 1972: 22), which led to stagnant economies, whose employment was threatened by lower cost producers in the global economy. continuation of protectionist policies would have led to further stagnation and the persistence of inefficient production with diminishing formal employment. the south african government made a deliberate attempt to move away from import-substituting industrialisation and sought to liberalise imports through encouraging exports and a shift from demand-side measures4 to supply~side measures5 to stimulate the south african economy, in line with the gear strategy. a formal programme of phased tariff reductions and tariff harmonisation commenced in 1995 in terms of the offer presented at the world trade organisation (wto) in 1993. although the tariff offer was based on consultation between business, labour and government, the reality was that average tariffs, maximum tariffs and the number of tariff lines decreased significantly. the free trade agreement (fta) between south africa (sa) and the european union (eu) became effective in 1999. unfortunately, a multiplicity of supply-side programmes were introduced over a very short period of time, resulting in ineffective implementation due to a lack of coherence and vision. the full potential economic benefits of these policies therefore never materialised in south african. globalisation and competitiveness from an economic policy perspective, arguably the most significant development in recent times is the global extension of markets. technology changes and global economic policies reduced barriers to the flows of goods and capital into africa, which flows reached the $10 billion6 mark in 1999, on the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 687 back of african governments actively seeking fdi through business friendly economic policies. in 1999, the clinton administration re-launched the africa growth and opportunity act, now titled the africa trade and development act. at the africa-european union (eu) summit held in cairo during april 2000, emphasis was placed on integrating africa into the world economy with africa and the eu expressing a need to develop a strategic partnership: ... any serious reflection on the future of the world economy and therefore the living standards of the billions who inhabit our world, will show that a strategic shift towards a significantly larger world economy can only be achieved as a result of raising living standards in the countries of the south, and therefore the radical expansion of the world markets for capital, goods and services (mbeki, 2000). joshi (1996: 1) describes competitiveness as "the ability ofa country to achieve sustained high rates of growth in the gdp per capita". joshi also identifies identifies investment and saving as vital prerequisites, based on the premise that economic growth is driven by investment. investment should be expanded to incorporate investment in the skills of people, acknowledging that people are the most important resource in the creation of wealth. lambert (1997: 25) takes this argument further stating that training works, provided objectives are clearly set, learners know exactly what is expected from them and management understands how what is learned, will help achieving goals. not enough can be done to increase south africa's skills base, although the skills development levy may go some way to address the current skill shortage. sunter (1997: ii) states that to be a world-class company "you need to pass a written as well as an oral examination", with the written examination based on "financial statistics, growing real earnings per share (eps) by five per cent per annum for ten years as well as offering the shareholders a total real return of at least ten percent for ten years, the so-called 5xloxlo rule". schutte (1999: 1) defines competitiveness within the south african paradigm as the "ten golden rules of a competitive society": create a stable and predictable legislative environment. work on a flexible and resilient economic structure. invest in trade and technological infrastructure. promote private savings and domestic investment. develop aggressiveness on international markets as well as attractiveness for foreign value added industries. focus on quality and speed in the conduct of administration and reforms. maintain a relationship between wage levels, productivity and taxation r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 688 sajems ns vol 5 (2002) no 3 preserve the social fabric by reducing wage disparity and strengthening the middle class. invest in education, especially at secondary level and in the life long training and improvement of the workforce. balance the economy of globality and proximity to ensure wealth generation, maintain social cohesion and the value system." multinational enterprises literature (douglas & craig, 1989: 373, hout et al., 1982:106, levitt, 1983: 57 & salvatore, 1987: 307) suggests that the existence of multinational enterprises is initially driven by the competitive advantage provided by a global network of production and distribution. this is called a "multi domestic competitor" (hout et ai., 1982: 98) which later becomes a global organisation (douglas & craig, 1989: 371, hout et ai., 1982: 106 and levitt, 1983: 65). levitt (1983: 65) identifies two vectors that shape the world within this context, namely technology, a determinant of human preference and globalisation, an economic reality. given the fact that commerce and business at large is about profit and wealth maximisation, the global company according to levitt will "shape the vectors of technology and globalisation, pushing it towards convergence," which then become tangible as high quality, standardised products at an optimum price. douglas and craig (l989: 384) state that initially, domestic competition and core competencies are extended internationally. however, they conclude that the ultimate goal is "maximal efficiencies in allocating of resources", confirming levitt's view. the multinational enterprise generates approximately $9.5 trillion of global sales through foreign affiliates (unctad, 1998: i) with global exports by foreign affiliates at $2 trillion. gross product (unctad, 2000: i) associated with international production and foreign affiliate sales worldwide, increased faster than the total international production with sales reaching $14 trillion towards the turn of the century, compared to $3 trillion in 1980. levitt (1983: 53) predicted that that the globalisation of markets is at hand with the end of the multinational as he sees it in an article titled "how global companies win out" (hout et al., 1982: 98) it is submitted that competition is changing in many industries, forcin¥ international companies to change from being a "multi domestic competitor" to a global company. in this context, the global company attempts to exert leverage it might have, which ranges from r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 689 cross national production scale economies to foreign competitors' cash flow resources through price competition. national transfer pricing legislation might restrict price cuts insofar as it does not conform to the arm's length standard. in terms of south africa's current regulations (south africa, 1999: 12), these price cuts might be attributed to business strategies8 and as such the multinational might not be regarded as being involved in tax avoidance through transfer price manipulation. national regulation should prevent intemationalisation of cross border transactions to the extent that these transactions bypass national controls and scrutiny with proactive transfer pricing practices. multinationals can use transfer pricing mechanisms based on connected party transactions to minimise tax exposure, depriving home or host economies from tax revenues. nations worldwide have instituted regulatory changes to attract investment as measured by fdi, in an attempt to reap the benefits from fdi investment cross border merger and acquisition activity is driven by companies' survival strategies in response to globalisation. the annual growth rate of mergers and acquisitions (m & a) of 35.4 per cent in 1999, indicates corporate strategy (unctad, 2000: 14) recognising the effect of technological change, and changes in capital markets and regulatory environment (of which transfer pricing is one aspect). with mergers and acquisitions, corporations respond with strategies designed to expand current markets and explore new markets, increase market presence and consolidate market dominance, access to assets and proprietary assets and core competencies, financial opportunities and integration and diversification of risk. over the short term, mergers and acquisitions might have small benefits for a developing country. the effect of mergers and acquisitions on the national economy is best described by the following: insofar investment capital inflow is not adding value to the current capital stock, it replaces only some existing capital and as such no additional capital is ploughed into the economy. it is unlikely that new technologies will be transferred to developing economies on the back of a merger or acquisition. vernon (1979: 199) and lindert (1992: 107) indicate that when new technology is not crucial to comparative advantage of the corporation, it would migrate to countries that might have comparative advantage in other inputs such as labour. it is unlikely that mergers and acquisitions will lead to job creation. the functions of the newly acquired member of the multinational might be extended, although certain functions might be performed centrally to eliminate duplication. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 690 sajems ns vol 5 (2002) no 3 multinational enterprises and transfer pricing salvatore (1987: 306) and practice note 7 (south africa, 1999: 39) identify managerial expertise, technology, goods, parts and marketing intangibles as some of the goods and services that are transferred between the holding company and its foreign affiliate and on which the holding company expects a return. within the transfer pricing paradigm, the return should be commensurate with the functions performed, assets used and the risk assumed by the various members of the multinational (south africa, 1999: 34). exchange controls have historically provided some protection against the more significant manipulation of transfer prices to transfer profits to lower tax jurisdictions. in anticipation of the relaxation of exchange controls and the envisaged adverse effect on the south african tax base, section 31 was introduced into the act in 1995. section 3 i enables the commissioner to adjust the consideration in respect of a supply or acquisition of goods or services in terms of an international agreement between connected persons. transfer pricing the term transfer pricing describes the process by which entities set the prices at which they transfer goods or services between each other. the transfer prices adopted by a multinational have a direct bearing on the proportional profit it makes in each country it operates. if a non-market value9 is paid for the transfer of goods or services, the income attributed to each of the members of a multinational will be inconsistent with their relative economic contributions. this distortion will impact on the tax revenues and or tax liabilities in the relevant tax jurisdictions in which they operate. the concept of transfer pricing does not imply anything complex; it is in essence a simple concept. however, the determination of transfer prices in practice can be very complex and measurement problems may arise, mainly due to information constraints relating to a south african comparable. practice note 7 and the oecd guidelines on the other hand, provide practical guidelines to taxpayers for determining arm's length transfer prices. although no statutory requirement has been placed on the south african taxpayer to document their respective transfer pricing practices, the need for documentation is evident from the approach the commissioner will follow if such documentation does not exist. in view of the above, the taxpayer should make conscientious efforts to establish transfer prices that comply with the arm's length principle and prepare documentation \() to evidence such compliance. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 691 transfer pricing methodologies when selecting an ann's length transfer pricing methodology, taxpayers choose from those endorsed by sars in practice note 7. accordingly, the most appropriate method will be the one that produces the highest level of comparability based on facts and circumstances at hand, availability of data on which to base a comparability analysis and the nature and extent of any assumptions made in the study. the most appropriate method is selected by testing comparability. the challenge is to obtain the most reliable measure of ann's length results. practice note 7(south africa, 1999: 10)" states that the assessment of comparability can be affected by the characteristics of goods or services, relative importance of functions perfonned, tenns and conditions of relevant agreements, relative risks assumed by the taxpayer, economic and market conditions and business strategies. the standard transfer pricing methods recognised by practice note 7 (south africa, 1999: 17) are the comparable uncontrolled price method (cup method), the resale price method (rp method), the cost plus method (cp method), the transactional net margin method (tnmm) and the profit split method. section 31 of the act does not impose a hierarchy of transfer pricing methods. however, in effect a hierarchy exists in that certain methods might provide a more reliable result. although the commissioner acknowledges (south africa 1999: 14) that the use of a particular method will depend on the facts on hand and that the most reliable method will be the method that requires the least adjustments to enhance comparability. testing the application of the various methodologies empirically, made apparent that methodology application is driven by the lack of comparable infonnation publicly available in south africa. the cup method is hardly used at all, the resale price and cost plus methods are used if the transfer pricing practitioners have access to international databases such as compustat. the transactional net margin method and the profit split methods are used, although the latter is used with a degree of subjectivity. in tenns of reliability, comparability and ease of application, to test if connected parties' dealings are at ann's length, it should be attempted to test as high as possible in the income statement. the potential negative effect operating expenses might have on comparability is limited to a large extent. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 692 sajems ns vols (2002) no 3 figure 1 transfer pricing methodologies comparison mcup ii resale price [lcolt plus mtnmm clprofit sput s point scale reliability comparabuity application the cup method is the most reliable and the method that requires the highest level of comparability, whereas the tnmm method's application is relatively easy compared to the cup method. transfer pricing practice in practice, the traditional methods such as the cup, resale price and cost plus might prove almost impossible to apply, due to information constraints. the lack of comparable uncontrolled transactions and published gross margins data, make it necessary to resort to the transactional profits methods such as the transactional net margin and profit split methods. the availability of data will probably determine methodology selection as south africa is a relatively small economy and under certain circumstances reliable comparables may prove difficult, if not impossible to find. applying a transfer pricing method to multiple comparable data after thorough consideration to the functions performed, assets used and risk assumed by the tested party should arrive at a result consistent with an arm's length outcome. criteria for the selection of comparable finns from independent databases are based on functional similarity; that is, the extent to which the functions undertaken are similar to the functions being investigated. databases used to perform comparability research classify companies by standard industrial classification (sic) codes and allow a keyword search to be perfonned. in the study, the march 2001 version of standard & poor's research insight (compustat) (north american and canadian) database was used. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 693 comparability searches provide profit level information of comparable companies operating in different economies, in this instance, the us and canada. comparability would be negatively affected if knowledge of prevalent risk in the market was disregarded. conceptual ising national or sovereign risk within the transfer pricing context is not difficult. however, quantifying the difference in risk and making risk adjustments to the comparable dataset to enhance direct comparability, is complicated and requires a degree of subjective judgement. risk adjustment various companies might be accepted on the basis of comparability. profitability of comparable us companies should be adjusted by a country risk premium to enhance comparability. using profitability level indicators of unadjusted us companies would be naive and determining the arm's length range without due consideution of the perceived risks associated with investing capital in south africa would certainly not enhance comparability. the difference in risk between the us market and the south african market is considered the country risk premium. the profitability of the comparable us companies in addition to the country risk premium will provide a reliable measure of arm's-length result for companies conducting their operations in these countries. determining a risk adjustment premium is one aspect that complicates transfer pricing. differences between inflation, short term interest rates and bond yields must be considered to provide for the market risk element within national economies. multinationals' operations are diverse, functional activities stretch across industries, sectors and product ranges, and an approach must be found that accurately measures the risk-return trade-off and the effect diversification has on the actual rate of return. the risk-return relation is often seen within the context of high returns associated with high risk. alternative theories have been documented with the bowman paradox (kim et al., 1993: 275) postulating that companies with high returns can have low risk. global market diversification provided companies with strategic options and opportunities (kim et al., 1993: 276) beyond domestic companies and might explain the high return low risk profile. the approach followed in the study was based on testing the risk-return trade off on a stand-alone basis, extending the research to incorporate diversification across industry sectors and applying the stand-alone test of risk and diversification to a hypothetical south african company. the aim is to r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 694 sajems ns vol 5 (2002) no 3 investigate the link between diversification strategies of the comparable datasets as identified during a multinational functional comparability analysis, as part of a transfer pricing study and their risk-return performance. following accepted practice in diversification research, company risk was measured by the standard deviation ofroa over the study period, 1995 to 2000. the methodology used in determining the hypothetical risk adjustment is as follows: i. determine sic codes applicable to identified functions to set parameters for comparable industry research. ii. query data sources (compustat database used in this study) based on identified sic codes to determine potential comparable companies to be used in the study. iii. select comparables based on independence, market level comparability and product similarities. iv. calculate roa as comparable profit level (return) indicator. v. calculate industry risk as the standard deviation of roa over the period under investigation. if this approach does not suffice, alternatives will be explored. vi. calculate weighted industry return of comparable companies based on the ratio of actual sales to total sales as determined by data analysis. vii. calculate the weighted industry risk by making use of the standard deviation based on roa of the comparables for the period under investigation. according to kim et al. (1993: 275) the weighted industry risk is an appropriate measure of risk. brigham et al. (1999: 172) state that in the determination ofthe risk in a portfolio context, the standard deviation of the portfolio, as a measure of portfolio risk, is generally not the weighted average of the standard deviation of the individual assets in the portfolio. the portfolio's standard deviation is generally smaller than the weighted average of the asset's standard deviation. research results the sic codes used in the analysis were major groups 50 and 65 to test the diversity risk trade-off assumption. both functions being tested are not assetintensive with plant, property and equipment ratio to sales less than 20 per cent. undertaking the comparability search, 25 and 54 potentially comparable companies were identified. screening measures to ensure comparability were based on independence, functional and product similarity. from the roa summary, there is a distinct difference in realised return between the two industry sectors. this difference (amount of spread) in realised returns r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 695 within, as well as between the sectors, would be a good measure of the inherent risk within these industry sectors. industry risk can be measured on a standalone basis by using the standard deviation ofroa within the industry sectors. table 1 standard deviation roa 1998 1999 '""'-'--'---t--'-'-'--'--+2000 10.62% 11.84% 10.87% % 16.06% 6.11% 13.00% although the one industry sector is not discernably riskier than the other according to the standard deviation, on average major group 65 has the lower standard deviation and could be regarded not as risky as major group 50. the rate of return within portfolio context, is merely the weighted average rate of return for the specific year on the individual functions performed and assets used in terms of the portfolio. however, the risk of this hypothetical portfolio is not the weighted average of the standard deviation of the individual functions being performed in the portfolio. the portfolio's standard deviation will probably be smaller than the weighted average standard deviation of the assets in the portfolio. functions' rate of return might move counter cyclically to each other. measuring this tendency of functions' return could be achieved by making use of the correlation coefficient r. in reality, whilst performing various functions, it would be unlikely that the different functions would be perfectly positively correlated. however, positive correlation exists and on average, combining positively correlated functions in a portfolio sense, would reduce risk but would certainly not eliminate it. it can be deduced that some risk remains even with diversification, but the risk might be smaller than it would be if the functions were seen in isolation. an amount of risk can be eliminated; the diversifiable risk can be managed. however, the remaining portion of risk, market risk, stems from factors that influence all participants in the economy including war, recessions, inflation and interest rates. it is apparent that investors demand a premium for assuming risk. within the context of transfer pricing, risk should not be regarded functionally on a standalone basis, but rather within the wider context of operations where the company performs various functions, each exposed to a different level of risk. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 696 sajems ns vol 5 (2002) no 3 two industry sectors were identified; returns and industry risk were tested for each. major group 65 realised lower returns and was exposed to lower industry risk measured by the standard deviation on a stand-alone basis. this illustrates the risk-return assumption on a stand-alone basis. making use of a weighting scale based on functional sales' contribution to total sales of the two functions performed by the business units in different industry sectors would allow for an analysis of the risk-return and industry diversification. a similar approach to the one followed testing the risk-return relationship in a stand-alone basis will be followed to determine a hypothetical risk adjustment factor. first, the weighted industry return of a company that diversified into industry sectors 50 and 65 was tested and second, the weighted industry risk is measured to get a better understanding of the diversification effect across industry on risk. table 2 weighted industry roa and standard deviation 1995 1996 1997 1998 1999 2000 diversified roaunadu 0.171747 0.146965 0.175535 0.144309 0.107208 0.109946 diversified st<l dev roa 0.086190 0.017524 0.015518 0.016278 0.027360 0.029241 major group 50 roa 0.194052 0.147440 0.143167 0.126420 0.092178 0.091886 major group 65 roa 0.078244 0.144983 0.243721 0.187101 0.145362 0.162296 major group 50 sui dev roa 0.074754 0.079222 0.108122 0.106243 0.1 18376 0.10869 major group 65 stu dev roa 0.049445 0.077236 0.295725 0.160551 0.061135 0.129973 from the summary in table 2 it seems as if the assumption that overall risk can be diminished compared to stand-alone risk of the industry when diversifying across industries, is founded. the study does not explore the extent to which this is true. in 1997 risk was reduced considerably in a weighted industry perspective compared to the stand-alone risk as measured by the standard deviation of major group 50 of 10.81 per cent and 29.5 per cent of major group 65 respectively. application in practice it can be assumed that a relationship exists between risk and return and by diversifying across industry sectors and potentially national markets, risk can be minimised leaving the company exposed to market risk, which the company cannot diversify from and is completely out of its control. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 697 for the purpose of this study it is essential to detennine a single measure of risk that can be used in adjusting returns to enhance comparability from a transfer pricing perspective. the approach being followed is in essence based on the determination of a return premium to compensate for the risk assumed. to achieve the objective of detennining a single measure of risk-adjusted return, an approach that incorporates a return premium based on a unit of risk was followed. table 3 ri!ik adju!itment premium i{i!ok adju!ilmcnt 1995 1996 1997 1998 1999 2000 c'omparable set 0.09902 0.13005 0.16707 0.13443 0.08865 0.09725 roaweiornted 0.171747 0.146965 0.175535 0.144309 0.107208 0.109946 sid dev roa wei.hled 0.08619 0.017524 0.015518 0.016278 0.02736 0.029241 jroasamdle mean 0.147729 0.146211 0.188874 0.154003 0.11877 0.127091 ikrisk free 0.075 0,075 0.075 0.075 0.055 0.075 mean sid dev roa sarndi. 0.08619 0.073772 0.208768 0.130225 0.09402 0.120002 return premium 0.072729 0.071211 0.113874 0.079003 0.06377 0.052091 return premium per unit risk 0.843817 0.965284 0.545455 0.60666 0.678258 0.434084 a single risk premium adjustment factor was calculated between a hypothetical south african company with subsidiaries perfonning functions comparable to companies operating in major industry sectors, major groups 50 and 65. the risk premiums are calculated between the hypothetical south african company and the comparable companies operating in the us as substantially different, driven predominantly by government bond yield rates, risk free. another approach to measure a risk premium, is to extend the current approach by making use of the capital asset pricing model (capm), a tool for analysing the risk return relationship. the capm model from a transfer pricing perspective is based on the premise that the relevant riskiness of an individual function, is its contribution to the risk of a well-diversified portfolio of functions being perfonned. perfonning a specific function in isolation might be regarded as very risky; however, some of the risk could be eliminated by diversification so that the function's relevant risk is much smaller than its stand-alone risk being evaluated in isolation (contribution to functional portfolio risk). it is clear that the risk remaining after diversification is market risk, which could be measured by the degree to which a function's return tends to follow the movement of the market in which the· function is being perfonned. the tendency of a share (an asset) to move up and down with the market is reflected r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 698 sajems ns vol 5 (2002) no 3 in its beta coefficient, ~. beta is central to the capm model as used to analyse the relationship between risk and rates of return (measured by the beta coefficient). a function exposed to average risk, using assets, is the one whose rate of return or return on investment, tends to move up or down in line with the general market or industry in which it may perform, the general market's returns being a measured by an index. the index will by definition have a beta value of 1.0. within a transfer pricing context, comparable companies are selected because they are functionally similar to the tested party. the companies selected are companies passing qualitative and quantitative measures where independence and sufficient sales information are usually prerequisites. under the capm theory beta is an appropriate measure of an asset's relevant risk. the rate of return, the compensation for the investor for assuming this risk at a specific beta value, must be in line with the investment risk, this premium being the market risk premium. the beta coefficients calculated for the two industry sectors are a reflection of the relative risk return relationship and are shown in table 4. table 4 beta coefficients beta coefficient 1995 1996 1997 1998 1999 ~ooo major group 50 beta ~.8970181 1.017362 1.064128 1.066771 \.049574 1.059386 major group 65 beta kl.3998324 0.625096 0.799103 0.689205 0.966438 0.954\02 ldeta ~rtfolio kl.801260 0.941459 0.978816 0.955464 \.02608 1.032381 ~tandard deviation ~aior group 50 sid dey roa 0.074754 0.079222 0.108122 0.106243 0.118376 0.108690 major group 65 sid dey roa 0.049445 0.077236 0.295725 0.160551 0.061135 0.129973 standard dey, portfolic context, fonnula 11 0.0580954 0.10518 0.245198 0.140413 0.060441 0.119674 from this table major group 50 has greater total risk except in 1997, 1998 and 2000. however, using the calculated beta coefficients, another picture emerges. major group 65 may have greater total risk in some years, le. 1997, but over the period under investigation, it was exposed to considerably less systematic or market risk than major group 50 (beta coefficient was lower than that of major group 50), since total risk is the sum of market and diversifiable risk, major group 50 must have a higher risk premium and greater rate of return despite the fact that sometimes it might have less total risk. factoring risk into rate of return implies that the rate of return should be equal to risk free return and the risk premium. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 699 the risk premium adjustment calculated, is in essence hypothetical and considerable research must be done to find a methodology that can be applied to accurately capture the differences in comparability when undertaking a transfer pricing analysis. information constraints in developing economies complicate the determination of an arm's length price or profit level indicator to derive a result that is consistent with the arm's length standard. factors driving transfer pricing policy there are no statutory requirements in south africa that compel local enterprises to document or even conduct a transfer pricing study. however, in responding to questions on the it 14 tax return, the public officer must be cautious not to omit material facts relating to transfer pricing that might be construed as non-disclosure of material facts. transfer pricing and strategic planning transnational life cycle hypothesis and technology diffusion the transnational life cycle hypothesis is primarily based on the international product life cycle theory of vernon (1966: 195) and the product cycle hypothesis in a new international environment (vernon, 1979: 261). functions that multinationals or their subsidiaries perform can be broadly classified as exportation, distribution, manufacturing, global operations and market exit. based on these broad categories, transfer pricing is seen within the transnational life cycle hypothesis model. the transnational life cycle hypothesis on which the study is based might incorrectly give the impression that it predicts the transnationality behaviour of companies. it must be noted that the transnational life cycle hypothesis does not imply that companies progress from left to right on the life cycle. various factors would determine the relative position of a company on the life cycle curve. certain functional activities might be suspended or outsourced; others might be included in the business portfolio, making it naive to construe that companies will start exporting, then distribute, manufacture, etc. this phenomenon of company movement between different stages of the life cycle, may be attributed to technology diffusion, technology being one factor that drives companies' relative positioning on the life cycle model. cross border merger and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 700 sajems ns vol 5 (2002) no 3 acquisition statistics indicate that technology is one of the drivers of global environment changes. technology will give a company a comparative advantage as long as the technology is an integral part of the company's core competency. vernon (1966: 196) expressed the view that once a product became more standardised it became less apparent that it should be produced in the country where the comparative advantage initially existed. bringing this dimension of technology diffusion into the transnational life cycle hypothesis model makes it clear that technology diffusion would to a certain extent drive functionality within the transfer pricing context. figure 2 transnational life cycle hypothesis model revenue functional stages qualified .. jlfatcsic response, to global g 'obal environm en cbange technology legend; !ii wi .. llhc;lliligi .. j -.. t) . ". .", "./ ..... .<' ""'-<--....... . ...... technology luge i innovalion, juder "ountryexport .. technolosy ailso'il tcchnojos, dirrutes. follower. export time net hn porta ........................................ tccbnololy ilasc iii teehaojosy ilishun, leu developed countriel export tecnnoloiy auder, owner of intellectual proputy t c:cbnojoiy d ,frusca. fouo w en uport. huns ins and or contract min u faclurins tc:cnnojoiy it'goltn, eommodity pricin •• leu dnetoped countriu expon tunuatios'iillire cycle source: adapted from vernon 1966: 199 at to the technology leader would export new products based on this new technology. the other technology-advanced nations would import the product, design and develop similar technologies and products, even through subsidiaries of the original inventor. the technology leader would typically export, and distribute through its own network of subsidiaries and permanent establishments or branches. at technology stage ii, the technology is not sufficient to maintain its comparative advantage; technology would most probably be licensed to contract manufacturers in developed industrial countries. the technology would diffuse r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 701 further with developing countries obtaining the rights to the technology and its products. this confmns the trends identified if fdi flows as published by unctad are seen within this hypothetical model. fdi flows are predominantly between developed countries with the developing economies being involved predominantly in asset swaps. discussion and research relating to international strategies tend to focus on the initial stages of entry into international markets (douglas et al., 1989: 367). however, within this study and the transfer pricing paradigm, the focus would be on strategies extending beyond mere initial international market entrance. global strategic dynamics in the determination of the potential direction of future growth, cost of expansion into new national economies, should be seen within the context of globalisation, diminishing international trade barriers and world competitiveness. strategic issues and imperatives would naturally to a large extent depend on the magnitude of corporate learning as well as the nature of current operations in international markets. propositions of vernon and the hechscher-ohlin theory in essence identify phases in the internalisation or globalisation process based on production location and production factor endowment. surely, more than this must be driving globalisation. douglas (1989: 368) proposes that strategy formulation is driven by the internationalisation phase the company finds itself in. within the context of the transnational life cycle model, this proposition of douglas surely seems to be the foundation of strategic intent. explicit strategy formulation within the global market is crucial. first, it would establish objectives regarding the level of activity or operational presence to a specific market. second, the level of involvement in a specific market would be indicative of the degree of risk the company is prepared to assume with careful consideration of the risk-return trade-off and diversification across national boundaries and industry sectors. this approach would encompass systematic evaluation of strategic opportunities globally. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 702 sajems ns vols (2002) no 3 figure 3 dynamics of global strategy development external forces or triggers i 1 ~ new pooltion currellt exploit international if export preposltloll 011 tb. slr.tegic competitive viou.ly. now life cyde model advantages dislribulion. if · export ~l~ distribution, now · distribution manufacture, etc. · manufacture the inverse is also · operations develop establish iru. if new lech-nologies do not · exil ~ new ~ key f+ outprovide sustajn~ slralegic slralegic come able eompelitive direclion decisions advantage t ~ f ii inlernal forces or triggers the dynamics of global strategic development is based on the various phases as identified in the transnational life cycle hypothesis model. external and internal forces act as triggers that would prompt development into a new stage or phase. this then generates new strategic direction, feeding into key strategic decisions that have a specific outcome, which in tum will be influenced by external and internal forces. combined, these forces will define investment and resource allocation priorities depending on the stage in which the company is, i.e. distribution or manufacturing; each would have its own priorities within the broader framework. essentially, key strategic decisions and expected outcomes will be driven by the various internal and external factors within each functionality stage. external triggers would include environmental factors, industry trends and prevalent industry competitive forces whereas internal triggers might be declining sales volumes and profitability. no specific research was undertaken to determine what these triggers might be although experience in undertaking transfer pricing analysis on a functionality basis confirms the abovementioned assumptions. compliance and strategy transfer pricing compliance preparation of documentation in response to a sars query is the main focus and priority of transfer pricing. performance and management bonuses as well as planning to maximise value chain operations are not very significant. the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 703 status quo might be attributed to the fact that most participants are subsidiaries of transnational organisations with the strategic planning being done offshore. transfer pricing activity is predominantly driven by compliance. this is in accordance with the transnational life cycle hypothesis model, which indicates that a subsidiary that predominantly performs agency, distribution and to a limited extend manufacturing on behalf of their international principal focuses 011 icgislati\ e compliance. regulawry acii\ity is currently focused on information gathering. information is predmninantly suurced from taxpayers by making use of questionnaires. the questionnaires cover a range of transactions with the pricing of intangible property not being directly investigated. international tax issues over and above transfer pricing being regarded as important confirm the current compliance focus. customs duties and value added taxation (v at) were highlighted as current issues and the perception prevails that customs duties would remain an important issue in future. there is a relation between compliance and strategic opportunities. the transnational life cycle hypothesis model draws a comparison between the product life cycle and technology diffusion, with the transnational company's life cycle being determined functionally and by technology maturity. within this proposition, the transnational must comply with national legislation and subsequent to compliance, strategic responses result in strategic opportunities as illustrated. within the framework of the following model, the south african subsidiary is predominantly concerned with compliance. however, from a transnational perspective, there is clearly a compliance strategic planning continuum. initially compliance would be the main force driving strategic planning, but with the transnational organisation being forced by global change driven by technology, capital market reform and national regulatory change, strategic responses must follow the global market stimuli. if a company fails to respond, it would fall prey to merger and acquisition or being threatened by market exit. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 704 figure 4 revenue functional stages qualified as strategic espouses sajems ns vol 5 (2002) no 3 strategic planning and compliance iv 'v jgiobalislitlon,s global ! exit effect on trade operations 1 balance based i _ on techno~ logical change /~ /' i o global environment changes ...... i i i:!"'----i------i:''----'i"..----+--:-''---' --=.:..' """ _........,i.;:i ::-_-.~et exports lr) / '1', •• 'rime global environment cbange technology ... / x ~ ...... . net imports ·-.111 .•..................... technology stage i innovation, leader country exports technology stage ii technology diffuses, followers export technology stage 1il technology stagnates, less developed country export relative importance legend: compliance strategic planning trade-off continuum time technology leader, owner of intellectual property technology diffuses, followers export, licensing and or contract manufacturing technology stagnates, commodity pricing, less developed countries export tnmsnationallife cycle within this context, an industry's strategic responses to changes in the global environment were investigated, responses will differ from industry to industry; however, looking at the responses on a generic level would indicate a general direction it would follow and cannot be regarded as industry specific. strategic responses strategic responses of the chemical industry were investigated in broad teltils, on an industry-specific basis some of the major trends that are impacting on and driving global competitiveness in the industry are: r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 705 slower growth can trigger a change of strategic direction and focus with cross industry diversification becoming attractive options. global production is expected to grow by only 4.3 per cent by 2003. the chemical industry is shifting from its concentrated dependence on tonnage petrochemicals and inorganics, to new business based on performance and service. more than 90 per cent of all chemicals bought are for use in other industries. environmental and toxological regulatory changes are having a major impact on the industry at large. the regulatory issues include the basel convention on the control of transboundary movements of hazardous wastes and their disposal (1989); the montreal protocol on substances that deplete the ozone layer (1987), the 1992 rio de janeiro united nations conference on environment and development and the koyoto protocol on the emission of greenhouse gasses (1997). in response to these broad trends, strategic responses of chemical companies are a result of: internationalisation and globalisation of markets, which topics are covered in the study. consolidation of mature businesses and merger and acquisition activity that increased from 75 deals in 1999 to 83 in 2000, valued at more than us$ 25 million. ensuring a realistic balance between capital, r&d, production and functions. relocating offshore from a strong home base as suggested by vernon (1966: 199) as technology matures. diversification in "downstream" businesses. building large enterprises from diverse niche businesses in line with globalisation trends to become true transnational organisations as proposed by the transnational life cycle hypothesis model. developing strategies for each niche. a shift towards decentralised niche type organisation structures. strategic opportunities closely associated with participation in global markets and broader industry diversification are based on: global market diversification provides for potential benefits associated with economies of scale and scope (levitt, 1983: 57) over and above the potential of mere product diversification. different nations have different factor endowments and as such in the absence of efficient markets the difference in factor costs (lindert, 1991: 594) would provide cost advantages for global, diversified companies by configuring their value added chain. the value added chain can be r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 706 sajems ns vol 5 (2002) no 3 configured per country to the extent of utilising the most overall cost efficient production advantage. in essence, global market diversification creates opportunities to increase potential returns by spreading activities across multiple global markets without necessarily committing resources to potentially higher risk activities. competitive retaliation (hout et al., 1982: 98) that could come from various national bases, might effectively limit domestic competitors' strategic options. it would be unlikely that domestic competitors would be able to effectively erode the multinational's competitive position. operations in multiple markets minimise adverse economic shocks on profitability that might be driven by specific national economic circumstances. production and or value adding activities can be shifted around the world. multinational operations are not as vulnerable to national supply and demand conditions prevalent in specific national economies as would be the case if it were operating solely from a domestic base (stand-alone basis). in effect, the supply and demand risk is greatly diminished. transfer pricing in essence tests functions performed to obtain a result consistent with the arm's length principle, taking into account the assets used and risk assumed in performing such functions. within this context the importance of strategic planning based on risk diversification is of immense value. conclusion from the study it is apparent that countries benefit from international trade. south africa came from isolation with relatively high domestic prices and stringent exchange controls that effectively prevented any international profits from leaving the country. with south africa's integration into world markets, rapid trade liberalisation followed with dire consequences for south african organisations that were not as competitive as their international competitors. the south african government made brave attempts to alleviate the consequences of the structural adjustments the south african economy was exposed to. although intent from government's intent was to enhance south african competitiveness, execution of the various policies and programmes was uncoordinated and lacked vision. the regulatory framework changed dramatically with transfer pricing being incorporated in the tax act in 1995 to prevent erosion of the south african tax r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 707 base to erode by transferring profits out of south africa. since 1995 and until 1999 when practice note 7 was released, enforcement of the legislation was not priority. currently the approach has changed, companies are requested to provide details about their transfer~pricing practices and to document their dealings with related parties offshore. documenting transfer~pricing practices in accordance with the transfer~pricing guidelines presents a new challenge. information that could be used in transfer~ pricing analysis relating to south african companies is inadequate. this lack of information prompts the use of foreign comparables in transfer pricing studies while creating its own problems, like comparability and objectiveness, whilst undertaking a transfer~pricing study. time will tell what the sars would accept as current practice in determining transfer prices that are consistent with the arm's length standard, especially comparability issues like risk adjustment, that may enhance comparability if foreign comparables are being used. south african companies in general see transfer pncmg as a regulatory compliance exercise. however, as south african companies are becoming global players in the true sense, transfer~pricing practices may prove to become a gauge and a tool for global strategic pricing opportunities. endnotes 1 united nations conference on trade and development. 2 research was done in brazil, chile, mexico, malaysia, pakistan, norway and the philippines. 3 tariffs for certain steel coil is at 5 per cent whereas tariffs for certain electronic components can be as high as 20 per cent with further reductions in tariffs in the foreseeable future. 4 policies such as import controls, tariffs, subsidies and general export incentive scheme (gels). 5 policies to stimulate the economy on the supply side, aimed at reducing costs and the efficient use of inputs. 6 unctad press release; tad/inf/2857. 7 multidomestic competitors within the text are regarded as a competitor that allows individual subsidiaries to compete independently in different domestic markets. 8 practice note 7 paragraph 8.5. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 708 sajems ns vol 5 (2002) no 3 9 inadequate or excessive consideration, based on economic analysis which detennines an ann's length reward based on the functions perfonned, assets used and risk assumed. 10 sections 69, 74, 74a, 74b, 74c, 740 and 75 of the income tax act 1962 deals with sars' right to documentation for the pmposes of administering the act and these provisions are applicable to transfer pricing. ii practice note 7, paragraph 8.2.1. references balassa, b. 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(1982) "how global companies win out", harvard business review 60(5): 98-108. 7 joshi, s.k. (1996) "international competitiveness revisited" eko-info, 4(6). 8 lambert, t. (1997) "global competitiveness: advantage comes with people development" hrm yearbook: 24-25. 9 lambkin, m. & day, g.s. (1989) "evolutionary processes in competitive markets: beyond the product life cycle", in enis, b.m., cox, k.k., mokwa, m.p. marketing classics. a selection of influential articles, (8th ed.) upper saddle, new jersey: prentice-hall: 447-67. 10 levitt, t. (1983) "the globalization of markets", in enis, b.m., cox, k.k., mokwa, m.p., marketing classics. a selection of influential articles, (81h ed.) upper saddle, new jersey: prentice-hall: 53-65. ii lindert, p.h. (1991) international economics, (9th ed.) burr ridge, illinois: irwin: 682. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 709 12 mbeki, t. 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(1966) "international investment and international trade in the product cycle", quarterlylournal of economics, 80(2): 199-207. 26 vernon, r.g. (1979) "the product cycle hypothesis in a new international environment", oxford bulletin of economics and statistics, no. 41: 255-67 november. 27 west, r.l. (i975) "economic dependence and policy in developing countries", in bergsten, c.f., tyler, w.g. leading issues in international economic policy, lexington, massachusetts: lexington books: 157-84. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction theoretical framework and hypotheses development research design and methodology findings and discussion conclusion, limitations and recommendations acknowledgements references about the author(s) nadia mans-kemp department of business management, faculty of economic and management sciences, stellenbosch university, stellenbosch, south africa cornelis t. van der lugt university of stellenbosch business school, faculty of economic and management sciences, stellenbosch university, cape town, south africa citation mans-kemp, n. & van der lugt, c.t., 2020, ‘linking integrated reporting quality with sustainability performance and financial performance in south africa’, south african journal of economic and management sciences 23(1), a3572. https://doi.org/10.4102/sajems.v23i1.3572 original research linking integrated reporting quality with sustainability performance and financial performance in south africa nadia mans-kemp, cornelis t. van der lugt received: 13 feb. 2020; accepted: 05 may 2020; published: 20 aug. 2020 copyright: © 2020. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: ten years have elapsed since the launch of the international integrated reporting council. stakeholders increasingly question whether integrated reporting (ir) meets the objectives of decision-usefulness and accountability. aim: the primary objective of this study was to assess the usefulness of ir by examining the interrelations between the integrated reporting quality (irq), sustainability performance and financial performance of listed companies in south africa. setting: the study is conducted in the country where integrated reporting is most established. the links between the irq of the top 100 companies listed on the johannesburg stock exchange and their environmental, social and corporate governance (esg) scores and multiple financial indicators are investigated over the period 2013–2018. methods: the ey excellence in integrated reporting awards was used as a metric to determine the sample companies’ irq. these awards were ranked according to four categories, namely ‘progress to be made’, ‘average’, ‘good’ and ‘excellent’. sustainability (esg scores), as well as financial performance data (accounting-based and market-based variables) were sourced from bloomberg. the panel data set was analysed by conducting a mixed-model analysis of variance and panel regressions. results: a high level of irq was found to be significantly associated with high levels of esg performance, as well as high earnings per share and high leverage. conclusion: it appears that ir strengthens managerial efficiency and legitimacy in the eyes of debt capital providers in south africa, while equity capital providers do not provide a clear signal of approval. keywords: integrated reporting; sustainability performance; financial performance; legitimacy theory; stakeholder theory. introduction several accounting scandals and the global financial crisis during the 2000s contributed to the growing criticism of siloed annual financial and sustainability reporting (garcía-benau, sierra-garcia & zorio 2013; jennings 2003). siloed reporting arguably does not provide a holistic picture of a company’s sustainability and financial performance (slack & campbell 2016), resulting in questions being raised about the reporting narrative of listed companies. reporting fragmentation makes it furthermore challenging for investors to discern the true drivers of value creation (klasa 2018). as the digital revolution demands more sophisticated corporate communication on material topics, a new reporting model was required, covering strategic content that reflects the interrelation between businesses, society, the economy and ecology (klasa 2018; slack & campbell 2016). the international integrated reporting council (iirc 2013) has been aiming to embed integrated thinking in mainstream business practice since 2010. their vision was facilitated by introducing a set of integrated reporting (ir) principles as the corporate reporting norm. by 2019, close to 2000 organisations, predominantly listed companies, in over 70 countries, including south africa, were applying these principles (iirc 2019). however, some thought leaders and researchers are critical about the evolution of corporate reporting, especially as ir is only well established in a limited number of countries (adams 2015; de villiers & sharma 2017). it could be argued that ir still has to prove whether it truly offers quality information that enhances decision-usefulness, in line with a key objective of the iirc’s framework (iirc 2013). the accountability for a broad base of capitals should furthermore not only enable the prediction of cash flows, but should also cover sustainable value creation and the responsible use of diverse resources (iirc 2013). based on its democratic transition in the 1990s, south africa is seen as a pioneer in both modern-day corporate governance standards (armstrong, segal & davis 2005) and ir (simnett & huggins 2015). the king reports on corporate governance have tracked the evolution of non-financial reporting and progressively recommended that south african companies should produce sustainability (king ii) and integrated reports (king iii and iv). the target audience of ir is the providers of financial capital, namely investors and lenders (iirc 2013). complex issues such as externalities and intangible assets that are not reflected in conventional financial statements can be addressed in integrated reports (iirc 2013). since 2010, companies listed on the johannesburg stock exchange (jse) are expected to publish integrated reports. initial reaction from the local investor community signalled their approval, especially as valuable information is provided, which can enhance decision-making (atkins & maroun 2015). in a recent international comparison of the integrated reporting quality (irq) of ten g20 countries, south africa received the top ranking (eccles, krzus & solano 2019). furthermore, there is a growing body of research on ir in south africa. although previous researchers have compared companies’ annual reports, sustainability reports and their integrated reports (du toit, van zyl & schutte 2017; setia et al. 2015; solomon & maroun 2012), the links between reporting quality, sustainability indicators and financial indicators (including leverage) and irq have not consistently been assessed. as creditors are likely to request more transparent information from more leveraged companies (dilling & caykoylu 2019), the inclusion of financial leverage (henceforth referred to as leverage) might have a significant impact on ir studies. leverage denotes the percentage debt that is used to fund total assets (chang 2016). it should be taken into account that debt usage can have a considerable impact on the variability in both profitability and earnings per share (eps) (chang 2016). previous scholars mainly assessed irq by applying the iirc framework and by employing the ey excellence in integrated reporting awards (barth et al. 2017; de villiers, venter & hsiao 2017b). given the identified gap in the literature, the authors examined the linkages between irq and the sustainability and financial performance of the jse top 100 companies over the period 2013–2018. the objectives were twofold, namely to investigate differences in the irq of the considered companies, and to explore the links between the companies’ irq and various sustainability and financial considerations. the categorised ey excellence in integrated reporting awards was used to assess the companies’ irq. the usage of these rankings enabled the authors to consider so-called ‘reference reporters’, namely those that received recognition through an award scheme (lopes & coelho 2018). accounting and market-based financial and sustainability data – environmental, social and corporate governance (esg) scores – were sourced from bloomberg (2019). mixed-model analysis of variance (anova) tests were conducted to investigate significant differences across the ey reporting categories (‘progress to be made’, ‘average’, ‘good’ and ‘excellent’), while panel regressions were employed to assess the links between the considered companies’ irq and sustainability and financial considerations. the results revealed that a high level of irq was significantly related to a high level of esg performance, as well as high eps and leverage. companies that had good esg performance scores were arguably in a better position to produce high-quality ir than those with poor sustainability performance. the companies with better financial performance seemed to receive more market recognition. the theoretical framework is presented next, accompanied by an overview of relevant studies that were considered in developing the hypotheses. thereafter, the data collection and analysis are discussed, followed by the findings. conclusions and recommendations are offered for practitioners, investors and researchers. theoretical framework and hypotheses development the literature review indicates that research on corporate reporting typically either pursues legitimacy or economic viewpoints. alrazi, de villiers and van staden (2015) argued that legitimacy is conditional on public evaluation of company performance and reporting. legitimacy theory could be used to offer a societal perspective, or to reflect different stakeholders’ views, industry standards or institutional norms (deegan & unerman 2011) that are linked to reporting a company’s licence to operate (burlea-schiopoiu & popa 2013; demuijnck & fasterling 2016). this theory has been employed by several authors who investigated ir (adams et al. 2016; ahmed haji & anifowose, 2017; de villiers, hsiao & maroun 2017a; setia et al. 2015; van bommel 2014). a company could arguably use ir to justify its existence through legitimising actions (burlea-schiopoiu & popa 2013) in an attempt to boost its reputation (higgins, stubbs & love 2014). companies that have a considerable negative external impact are likely to provide more detailed integrated reports to legitimise their business than those with minor environmental implications (buitendag, fortuin & de laan 2017). disclosure could thus be used to communicate corporate behavioural changes in an attempt to ‘repair’ poor legitimacy (suchman 1995). the question arises whether external communication reflects internal adjustments as part of a proactive legitimacy strategy (alrazi et al. 2015; lindblom 2010), or whether it is a symbolic presentation that confirms a ‘greenwashing view’ of legitimacy theory (mahoney et al. 2013). as managers influence the external perceptions of their companies through communication strategies, concerns have been raised that voluntary reporting is often used as a mere symbolic ‘legitimation practice’ (lai, melloni & stacchezzini 2016). malola and maroun (2019) reported that most disclosures by south african companies are still symbolic rather than substantive. the iirc (2013) envisioned that ir could improve managerial efficiency by providing reliable information that is relevant for long-term value creation. some authors therefore argued that the development of a business case for ir is essential to enhance its wider uptake (adams 2015; burke & clark 2016; simnett & huggins 2015). de villiers, rinaldi and unerman (2014), however, cautioned against a dominant focus on economic value creation at the cost of non-financial resources. it is thus essential to investigate the links between multiple capital resources and irq. sustainability disclosure, depending on multiple tangible and intangible organisational features, might be a substantive legitimacy tool (cho & patten 2007; mahoney et al. 2013; stolowy & paugam 2018). the combination of legitimacy theory and market efficiency paves the way for an assessment of organisational features (including sustainability and financial performance) as determinants of irq (de villiers et al. 2017a). whereas most ir studies have centred on normative arguments, more research is required on ir practices (cheng et al. 2014; dumay et al. 2016). sustainability and financial performance as determinants of irq highlight the prospect of ir being used as an instrument to address a company’s poor performance in an attempt to restore legitimacy. in the international context, melloni, caglio and perego (2017) found that the integrated reports of companies with inadequate social and financial performance tended to be significantly longer and less balanced. another essential financial consideration is leverage, as lenders are demanding more transparent disclosure from highly leveraged companies (lai et al. 2016). companies in need of external funding will arguably be more likely to disclose information than those with sufficient internal funds (dilling & caykoylu 2019). lopes and coelho (2018) suggested that companies with a high level of irq tend to be large, profitable and less leveraged. responsible investors are furthermore interested in whether ir is associated with better esg management. de villiers et al. (2017b) thus suggested that the relationship between ir and corporate value should be assessed, while controlling for esg. churet and eccles (2014) found a positive relationship between the effective management of esg issues and ir. they argued that the quality of esg management will eventually reflect in the company’s financial performance. several authors focused on the economic consequences of ir in south africa, given the country’s front-runner status pertaining to ir. a summary of the findings of authors who applied the iirc framework as a normative checklist for the quality of corporate reporting in south africa is provided in table 1. table 1: summary of studies on corporate reporting in south africa. perusal of table 1 highlights several key points. after 10 years of experimenting with the iirc framework, the content analysis of integrated reports still needs to move beyond considering the quantity of disclosure and compliance with core content elements towards closer examination of reporting quality and applying the iirc’s (2013) principles (including strategic focus, materiality and conciseness). contrasting results were reported on the link between financial performance and irq. some authors reported a positive association between irq and firm value (barth et al. 2017; lee & yeo 2016), lower cost of equity capital (zhou et al. 2017), higher return on assets (roa) and sales growth (lee & yeo 2016). other authors highlighted a lack of significant evidence that links irq with firm value (buitendag et al. 2017; horn et al. 2018; marcia et al. 2015) and with profitability (buitendag et al. 2017). in light of these contradictory findings, as well as the identified gap to account for a company’s esg performance and leverage, the following hypotheses were formulated: ha,1: there is a positive relationship between the sustainability performance and the irq of the considered jse-listed companies over the period 2013–2018. ha,2: there is a positive relationship between the financial performance and the irq of the considered jse-listed companies over the period 2013–2018. ha,3: there is a positive relationship between leverage and the irq of the considered jse-listed companies over the period 2013–2018. it should be noted that a high level of sustainability performance does not automatically translate into a high level of irq. a company might obtain high esg scores for its sustainability performance and publish a good-quality sustainability report, yet fail at integrated thinking and publishing a high-quality integrated report. as a result, the association between sustainability performance and irq (the first hypothesis) was assessed. given the interrelation between financial performance and managerial decision-making on leverage (jermias 2008), the second and third hypotheses tested the considered companies’ external efficiency (recognition for financial performance) and internal managerial efficiency (capturing and communicating decision-useful information by displaying accountability to capital providers). research design and methodology the ey excellence in integrated reporting awards that were allocated to the jse top 100 companies was used as a measure of irq over the period 2013–2018. the considered companies accounted for approximately 95% of the bourse’s market capitalisation (eygm ltd. 2017). the majority of the awardees did business in the financial and the basic materials sectors. the ey scoring system is based on the iirc framework’s content elements and guiding principles, as well as its fundamental concepts (i.e. value creation and the six capitals) (eygm ltd. 2017). the ey award categories were coded as follows for the purpose of this study: ‘progress to be made’, henceforth ‘progress’ (1), ‘average’ (2), ‘good’ (3) and ‘excellent’ (4). over the study period, 119 progress, 113 average, 176 good and 172 excellent awardees were considered. an advantage of using an external source to assess irq is that the evaluators are independent (de villiers et al. 2017b). weaknesses, however, include that a limited number of large companies are evaluated by ey, possible subjectivity of the evaluators, differences in their interpretations of the iirc framework and a lack of clarity concerning cut-off points between different evaluation categories (de villiers et al. 2017b). although the limitations of ey’s methodology were acknowledged in this study, the use of an established rating scheme contributed to the reliability and validity of the findings. the financial variables (table 2) were sourced from bloomberg (2019) for the corresponding financial year on which the ey awards were based. several of these variables were suggested by previous authors (see table 1). both the individual and composite esg scores computed by bloomberg (2019) were used as proxies for sustainability performance. these scores reflect analysts’ evaluation of the companies’ esg disclosure and served as a measure of the companies’ management engagement towards sustainability (eccles, serafeim & krzus 2011). table 2: measurement of the sustainability and financial variables. a descriptive analysis was conducted to determine trends based on the four irq rankings. a mixed-model anova analysis was then employed to test for significant differences between rankings over the research period. the restricted maximum likelihood method was used to estimate variance components. the fisher’s least significant difference (lsd) test was used to test pair-wise comparisons to determine where the differences occurred. given the panel nature of the dataset, the f-test and the hausman test were used to determine whether a fixed or random effects regression model was most suitable for the respective regression analyses. an unbalanced panel design was used, as the compilation of the top 100 companies differed on an annual basis depending on their market capitalisation. the following fixed effects regression model was applied to test ha,1: note that a dummy variable was included for each time period. the following fixed effects regression model was applied to test ha,2: note that a dummy variable was included for each time period. the following random effects regression model was used to test ha,3: the breusch-pagan lagrange multiplier was used to test for heteroskedasticity and the results were adjusted where applicable. given that only publicly available data were used, the research ethics committee of the authors’ affiliated university exempted the study from an ethics review. pertaining to multicollinearity, acceptable variance inflation factor values (5 or below) were determined for the financial variables. given the stated bloomberg (2019) methodology (refer to table 2) to compile both the composite and the individual esg scores, these scores were highly correlated. as the composite esg score might not reflect the true extent of the companies’ individual esg performance, the individual scores were also incorporated in separate regression analyses. ethical consideration this project (number onb-2019-10138) was exempted from ethics review and clearance by the research ethics committee (rec), stellenbosch university, on 17 june 2019. findings and discussion in this section, the descriptive results are discussed for the financial indicators and the esg scores of the companies ranked according to the four ey categories. this discussion is followed by the presentation of the inferential findings. descriptive results table 3 provides the descriptive results. table 3: descriptive statistics. as shown in table 3, the companies in the highest two irq categories had the highest composite esg scores. the companies that were more sustainable than their peers were better sustainability reporters and were familiar with the gri’s reporting guidelines. as a result, they were arguably in a better position to apply the iirc’s (2013) guidelines including improved connectivity between sustainability and financial performance. the average composite esg scores were, however, relatively low (below 50 out of 100 for all four irq categories). this low level of compliance led to the question whether a company’s sustainability could be deemed a mediating factor in determining the effectiveness of ir, as suggested by bernardi and stark (2018). as composite esg scores could conceal differing degrees of disclosure on specific sustainability aspects, the individual esg scores were also considered. the comparatively higher governance scores could be ascribed to south africa’s advanced corporate governance system. before the advent of ir, asset managers highlighted inadequate environmental disclosure by south african companies (giamporcaro, pretorius & visser 2010). the low mean environmental scores (in all four irq categories) suggest that the majority of the jse top 100 companies still experience difficulty to explain their impact and dependence on natural capital. according to buitendag et al. (2017), environmentally sensitive companies tend to have higher levels of irq in comparison to companies with a limited negative environmental impact. the 10 companies that most consistently appeared in the top (excellent) irq category for the overall six-year review period included three mining companies, a petrochemical company and four financial services companies. the high irq of financial institutions, specifically banks, could be ascribed to the pressure from consumers to step up their accountability (van zijl, wöstmann & maroun 2017). pertaining to financial performance, companies rated in the progress category were more profitable (mean roa) than those companies in the excellent category (see table 3). in contrast, companies in the excellent irq category had the highest mean eps and dividends per share (dps). companies with the highest level of irq therefore rewarded their shareholders with higher dividends, despite the companies’ comparably lower profitability. a possible explanation is that some companies that produced a quality integrated report arguably spent more money over the short term to address externalities, resulting in lower profitability, in an attempt to enhance sustainable value creation over the long term. the mean market-based total share return (tsr) of those companies in the excellent irq category was the highest across the considered categories. in contrast, the average tobin’s q value for companies in the progress irq category was higher than those in the excellent category. as tobin’s q reflects growth opportunities, high values could encourage companies to invest more (müller 2013). since companies in the excellent irq category arguably had a better understanding of and disclosure on their asset values (including related opportunities and externalities), they seemed to pay a price for being more transparent about the replacement costs of their assets, resulting in comparatively lower tobin’s q values. the main differences between the market-to-book ratio and tobin’s q included that the former only incorporated the market and book values of equity, while the latter accounted for a company’s total market and replacement values (see table 2). it can be challenging to accurately determine replacement costs, specifically for companies with high levels of intangible assets. despite the growing importance of intangible assets to obtain a competitive advantage, they are often not adequately disclosed (pucci et al. 2014). in their analysis of reporting by jse-listed companies before and after the release of king iii (which introduced ir), baboukardos and rimmel (2016) noted a decline in the value relevance of the companies’ net assets over time. the authors attributed their finding to the so-called ‘unbooked’ liabilities that were revealed or measured more reliably after the introduction of ir. in line with the findings of lee and yeo (2016), the considered companies in the current study with the highest level of irq also had the highest leverage. these companies probably disclosed more relevant information in view of their higher liabilities. accounting for differences in integrated reporting quality given the considerable differences in the reported means of the esg and financial variables as shown in table 3, mixed-model anova and fisher’s lsd analyses were performed to investigate the significance of the observed trends. year and ranking were considered as fixed effects, whereas the ticker codes were used as the random effect. the kenward-rogers degrees of freedom were applicable. the anova results are reported in table 4. table 4: mixed-model analysis of variance results. inspection of table 4 indicates significant differences between the irq ranking categories and the composite esg score and the individual esg scores over the review period. the fisher lsd results furthermore showed significant differences between the lowest irq ranking (progress, average) and the highest ranking (good, excellent) sustainability aspects (proxied by esg) therefore played a considerable role in the observed fluctuations in the irq ranking categories. in contrast, by using a self-constructed irq measure, malola and maroun (2019) reported that environmental and social impact did not influence irq in south africa. they added that external factors had contributed less to irq, whereas internal processes were becoming more relevant when reflecting on quantitative and qualitative considerations. pertaining to the financial indicators, significant differences occurred over the review period for all variables except eps and leverage. however, significant ranking differences were only noted for leverage and weighted average cost of capital. the fisher’s lsd results revealed significant differences between the progress category and the other categories. dilling and caykoylu (2019) argued that companies in need of debt funding are more likely to disclose detailed information, possibly resulting in a higher irq. consequently, capital usage played a considerable role in the observed fluctuations in irq. these results, however, warrant further investigation. panel regression results the regression results for irq and esg performance are shown in table 5. table 5: regression analysis results for integrated reporting quality and environmental, social and corporate governance scores. while significant positive relationships are noted between the individual esg scores and irq in table 5, the combined esg score is significantly negatively related to irq. it is possible that the composite esg score played a more important role for companies that were still making progress in improving their integrated reports, compared to those that already published high-quality integrated reports. it should be noted that the esg scores only accounted for some of the six capitals of the iirc’s (2013) framework. in an attempt to enhance the legitimacy of integrated reports (i.e. positive recognition by shareholders and other stakeholders), companies might report more extensively on a specific resource. bernardi and stark (2018) regarded the level of esg disclosure as a mediating variable when determining the effectiveness of ir. their results were largely ascribed to environmental and governance disclosures, instead of composite esg scores. in addition, buitendag et al. (2017) noted that companies with a more significant negative environmental impact focused more on environmental sensitivities in their integrated reports. south african companies are under considerable pressure to improve their actions and disclosures pertaining to social and environmental considerations. the results of this study, as can be seen in table 5, highlight the importance of accounting for esg aspects. to account for multicollinearity, separate regression analyses were computed for irq and the composite esg and irq and the individual esg scores while controlling for company size (market capitalisation). a positive, but insignificant relationship was reported between irq and esg (t: 1.624; p: 0.11). positive associations were also noted between irq and the individual environmental (t: 0.102; p: 0.92), s (t: 1.576; p: 0.12) and governance (t: 0.430; p: 0.67) scores. given that sustainability concerns differ across industries, separate regression analyses were also conducted for the combined basic materials and financials sectors (as most of the considered companies operated in these sectors) and the other combined sectors (industrials, consumer goods, technology, consumer services, telecommunications and healthcare; henceforth called ‘other sectors’). the results revealed a significant positive relationship between irq and esg (t: 4.583***; p: 0.00) and irq and the social score (t: 3.174***; p: 0.00) for the basic materials and financial sectors. significant positive links were also reported between irq and esg (t: 1.631*; p: 0.10) and irq and the social score (t: 2.087**; p: 0.04) for the other sectors. based on the reported results, ha,1 (eqn 1) was rejected for the composite esg score for the entire sample. significant positive links were, however, noted for the esg composite score on industry level and irq and the individual esg scores. the regression results for the financial indicators for ha,2 (eqn 2) and ha,3 (eqn 3) are shown in table 6 and table 7. table 6: regression analysis results for integrated reporting quality and financial performance. table 7: regression analysis results for integrated reporting quality and leverage. table 6 reveals that the tsr was negatively related to irq. instances of negative market sentiment possibly occurred during the period under review. this result was, however, not significant after adjusting for heteroskedasticity. marcia et al. (2015) likewise reported that csr disclosures of jse-listed companies did not have a significant link with their share prices. in contrast, the sample companies with a high level of irq tended to have high eps values. as managerial stewardship includes the protection and efficient application of resources on behalf of shareholders, the eps ratio is deemed a key investor consideration (mohon 1999). in contrast to the findings of lee and yeo (2016) and barth et al. (2017), table 6 shows no significant association between tobin’s q and irq. while an insignificant roa result was reported for the considered companies, buitendag et al. (2017) noted a significant negative relationship between profitability and irq, considering only the ey progress and excellent categories over a shorter time frame. given the differences in the accounting determination of roa on a sector level, this financial performance variable was omitted and the regression analysis was repeated. after adjusting for heteroskedasticity, the observed negative link between irq and tsr remained significant (t: ‒1.929**; p: 0.05). as indicated in table 7, a positive relationship emerged between the considered companies’ level of irq and their leverage. zhou et al. (2017) and lee and yeo (2016) also found that companies with better integrated reports used more debt capital. these results suggest that lenders have greater trust in companies with reliable credit histories and transparent disclosure (lee & yeo 2016; zhou et al. 2017). companies with a high level of irq arguably experience pressure from lenders to enhance their disclosure given the considerable risks associated with high debt usage. based on the results reported in table 6 and table 7, ha,2 (eqn 2) and ha,3 (eqn 3) were accepted. additional regression analyses were conducted to account for differences on industry level. the two largest sectors in this study (basic materials and financials) were again compared to the other sectors. after adjusting the results for heteroskedasticity, a significant link was detected between irq and leverage for the other sectors (t: – 2.312**; p: 0.02). conclusion, limitations and recommendations the interrelations between irq, sustainability and financial performance of listed companies increasingly draw attention from scholars, practitioners, shareholders and other stakeholders. following the arrival of ir as defined by the iirc a decade ago, south africa offers a suitable research context to investigate the extent to which this hybrid form of reporting succeeds in concretising relationships between irq, sustainability performance and financial performance. the authors of this study argue that integrated reports should prove their decision-usefulness by offering material esg and financial information to capital providers. the ey excellence in integrated reporting awards was employed as a proxy for irq. the sample comprised the largest companies listed on the jse over the period 2013–2018 that were annually scored by ey. composite and individual esg scores were sourced from bloomberg (2019). various financial indicators were also incorporated to assess the hypothesised relationships. in addition to the governance scores, the panel regression results indicated significant positive relationships between a higher level of irq and higher environmental and social scores, which are vital considerations in the south african context. significant positive links were also detected on industry level. the descriptive statistics showed that low-quality (progress) reporters displayed higher levels of roa and tobin’s q than companies with a high level of irq. in contrast, high-quality (excellent) reporters had higher eps, dps, tsr and debt usage in comparison to those ranked in the progress category. the question then arises whether ir truly convinces the providers of equity and debt capital of large locally listed companies’ financial performance. panel regression analyses were consequently conducted. insignificant results were reported between the level of irq and all the considered financial variables except eps and tsr (on industry level). the findings thus suggest that those companies with a high irq, and by implication their capital providers, were not per se rewarded in financial terms. the best integrated reporters made greater use of borrowed capital than progress reporters. high irq could imply that more decision-useful and accountable information was offered to the providers of debt capital to locally listed companies. companies that provide excellent integrated reports are likely to have a more reliable credit history, present a lower risk to lenders and arguably be strategically better positioned to decide on an optimal capital structure. the lack of a significant relation between irq and tobin’s q raises questions about the reliability of the reported asset values. as a result, companies are urged to offer greater clarity on the value of human capital and other intangible aspects in their integrated reports. when investigating the impact of irq, previous researchers considered different components of the iirc framework, including its content elements, principles and fundamental concepts. the apparent lack of recognition by investors may relate to how irq is defined (e.g. by the ey awards scheme) and the possibility that even companies with a high level of irq still fail to effectively link sustainability performance with financial performance. companies need to ensure that information related to the interconnectedness of their capitals is properly explained to gain substantive legitimacy. confusion about target audience might result in a low irq. south african companies should ensure that they offer relevant information to their capital providers. in line with de villiers et al.’s (2017a) observation that legitimacy is a consequence of ir, whereas organisational features are determinants of irq, investors are encouraged to adopt a long-term investment focus. they should pressurise companies to enhance their transparency, decision-usefulness and accountability pertaining to the six capitals, instead of merely focusing on financial capital. institutional investors need to engage more actively with companies to ensure that they deliver on expectations. educators furthermore have an important role to ensure that future corporate leaders and investors are sufficiently informed of the interconnections between capitals and the relevance of sustainable value creation. with respect to the study’s limitations, the narrow focus on the jse top 100 companies and possible subjectivity of the ey assessors are acknowledged. it should also be noted that bloomberg (2019)’s composite and individual esg scores that were employed as proxies for sustainability performance were reflective of disclosure, but they did not necessarily reflect actual esg performance. investors are relying on various sources of information in their decision-making today. future researchers could therefore adopt a broader approach to assess the role of irq by also scrutinising financial and sustainability reports, investor briefings, press releases and related online material. they can consider ir as an ‘umbrella report for an organisation’s broad suite of reports and communications’ (international federation of accountants 2017) to offer a strategic entry point to gain insight into each company’s specific context. more focus could be placed on sector-specific analyses by accounting for differences in the esg practices and organisational complexity of companies. the role of intangible assets and human capital management warrants pertinent consideration. future researchers could focus on banks and other financial companies in the advent of the fourth industrial revolution. acknowledgements prof. martin kidd for his assistance with the statistical analysis. competing interests the authors have declared that no competing interest exists. authors’ contributions n.m-k. conceptualised the article, wrote the results section and contributed to the literature review. c.t.v.d.l. contributed to the conceptualisation of the article, literature review and finalisation of 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https://doi.org/10.1108/aaaj-04-2013-1309 van zijl, w., wöstmann, c. & maroun, w., 2017, ‘ strategy disclosures by listed financial services companies: signalling theory, legitimacy theory and south african integrated reporting practices’, south african journal of business management 48(3), 73–85. https://doi.org/10.4102/sajbm.v48i3.37 zhou, s., simnett, r. & green, w., 2017, ‘does integrated reporting matter to the capital market?’, abacus 53(1), 94–132. https://doi.org/10.1111/abac.12104 505 sajems ns vol 4 (200 1) no 3 globalisation, economic policy and the new dualism in the south african economy gavin maasdorp emeritus professor, department of economics, university of natal, durban abstract economic dualism in south africa has mutated from the original modem vs. traditional sector conception to one of poverty vs. non-poverty. globalisation provides opportunities to reduce poverty, but government policies determine the outcome. the south african government's sound macroeconomic policies have not been matched on the micro side. the labour market has not been liberalised, employers are loath to increase staff numbers, and foreign investment in labourintensive industries is not being attracted. the policy choice is one of lower real wages and more jobs or higher real wages and fewer jobs. the unemployed and those in absolute poverty would opt for the former, unionised labour for the latter. policy reforms will be politically difficult, but without them the dual economy will persist. tel f 41 introduction this is a discursive paper, exploring, at the request of the editors, the implications of globalisation for economic dualism in south africa. the paper argues that the nature of the dual economy has changed over the years, that openness and economic growth are necessary for poverty reduction, that it is government policies which determine whether or not a country and its people are able to use globalisation to improve their welfare, and that south africa could have done better than it bas to take advantage of the opportunities for faster growth and poverty reduction. economic dualism tbeconeept the notion of economic dualism was introduced into economic development literature by boeke (1953). he divided economic activity into two types: that carr ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (200 i) no 3 506 his was a sociological explanation, emphasising institutional differences. traditional institutions would continue to persist, and western institutions would never completely absorb the traditional sector. the concept oftechnological dualism was introduced by hirschman (1958) and higgins (1968) who referred to foreign enclaves of capital-intensive activities (mining and plantation economies) which do not transform the entire economy. the modern sector has fixed technical coefficients of production, and further technological advances favour capital-intensive methods. in the traditional sector technical coefficients are variable, enabling production to become increasingly labour intensive until all available land is cultivated and the marginal productivity of labour falls below zero. this results in disguised unemployment. thus, the gap between the two sectors widens progressively. lewis talks of a "capitalistic" and a "subsistence" sector. the former is "that part of the economy which uses reproducible capital and pays capitalists for the use thereof' (1954: 146); the latter is "all that part of the economy which is not using reproducible capital" (1954: 147). these two sectors exhibit a striking contrast in economic and social organisation. this type of dualism is marked by underemployment, disguised unemployment and a labour-surplus economy. lewis (1954) developed a model of such an economy, as did fei and ranis (1964). the subsistence sector is agricultural in nature, relatively large and slow-growing, and wage rates are determined by institutional forces. by contrast, the modern (commercial and industrial) sector, although relatively small, is rapidly growing, wage rates being determined by competitive forces. in the labour-surplus economy, labour is abundant and capital scarce. the expanding modern sector draws labour from the traditional sector. in practice, this interaction has not been robust enough to prevent growing urban unemployment. this is explained by higher-than-anticipated rates of population growth and the resultant high rates of rural-urban migration. in a celebrated model developed by todaro (1971), migrants move to urban areas on the mere expectation of obtaining wage employment. in reality, what has happened is that urban unemployment and underemployment have grown, and so has the informal sector a concept popularised by an ilo (1972) report on kenya, and which continues to received considerable attention in the literature. the informal sector consists of unregistered and unrecorded activities whereas the formal sector consists of recorded activities in the wage economy. the original, neat distinction between traditional and modern sectors has been fudged by these trends, and today problems of open unemployment, underemployment, inadequate incomes and low productivity are found in urban as well as rural areas. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 507 sajems ns vol 4 (2001) no 3 its relevance today horwood (1964, 1965) attempted to apply the concept of dualism to the south african economy. he found that the subsistence sector appeared to be expanding, and that it had not been reduced as a result of industrialisation. he felt that a subsistence element might eventually tend to creep into the modern sector. that is indeed what occurred with rapid rural-urban migration and the rise of the infonnal sector (maasdorp & humphreys, 1975), exacerbated by relative economic stagnation from 1975 onwards. in fact, the concept of a dual economy, with watertight compartments, has become increasingly inadequate as a tool of analysis not only in south africa but also in neighbouring countries. for example, in swaziland the majority of the population have been exposed to the modern industrial and commercial economy since the late-1800s, and "there is scarcely a household even in the remotest rural area that does not have (or has not had) some linkage with that economy" (maasdorp 1991: 212). while working on rural projects in the pongola flood plain and east griqualand, the writer has encountered a similar situation. if the tenn economic dualism is to be used today, it would best be applied to a distinction between those in poverty and those not in poverty. but how does one calculate the cut-offbetween poverty and non-poverty? the traditional way in south africa was through measures such as the poverty datum line (pol) which calculated the amount required to meet the minimum subsistence needs of an individual household, and then compared it to the monthly income of that household (ellison et al., 1975). as such, the pol was taken to be a measure of absolute poverty, meaning that a household below the pol was unable to satisfy its bare subsistence needs. however, poverty is also a relative concept, referring to the extent ofa household's resources in comparison to what other individuals or households in the society have. relative poverty is assessed in relation to income distribution in the particular society: all those who fall below some arbitrary cut-off point, such as the lowest quintile, are then defined as poor. this method avoids the paternalism of subsistence measures which are calculated in money items, and demonstrates the income inequality rather than the economic survival aspects of poverty. its main disadvantage relates to the reliability of income distribution data which are particularly suspect in countries with large rural subsistence or urban infonnal sectors. clearly, though, it is the elimination of absolute rather than relative poverty which should be the priority of economic and social policy as that it is where the real heart of grinding poverty is found. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 3 508 globalisa tion definition and driving forces the term "globalisation" is essentially a product of the 1990s. collier (1998: 1) defmes it as "the process of integration in product markets and financial markets". calitz (2000: 564) offers a broader definition of economic globalisation, namely, as "the accelerated integration of economies throughout the world through trade, fmancial flows, the exchange of technology, information and ideas, and the movement of people". in the last 30 years the growth of world trade has outpaced that of world gdp, partly as a result of policy changes and trade iiberalisation which lowered trade barriers, and partly due to a technological revolution based on electronics which has led to falling communications costs. together, these have changed the organisation of business worldwide, allowing the growth of transnational companies which account for about one-third of world output and two-thirds of world trade. approximately one-third of world trade takes place within transnational corporations, i.e., between subsidiaries of the same corporation based in different countries. the link with poverty reduction in a white paper (hmso, 2000) on globalisation, the british government states that it creates unprecedented opportunities for sustainable development and poverty reduction. yet, globalisation has its enemies who regard it as a source of exploitation, poverty and inequality. the outcome depends on the policy choices adopted by governments, international institutions, the private sector and civil society: if the new wealth being created by globalisation is managed wisely, it could lift millions of the world's poorest people out of their poverty; if it is managed badly, it could lead to marginalisation and impoverishment. africa's experience appears to substantiate this argument. because of preferential access to eu and us markets, most of sub-saharan africa does not face the same trade barriers for its exports as do many other parts of the developing world, yet its share of total world trade has declined. collier (1998) attributes africa's current relative poverty mainly to its anti-trade policies: its economic policy environment has been hostile to foreign direct investment (fdi) in manufacturing industry which has been the most rapidly growing component of international trade. collier fits africa into the heckscher-ohlin model: this posits that countries with abundant labour and scarce capital would have a comparative advantage in r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 509 sajems ns vol 4 (200 i) no 3 labour-intensive products. thus, africa should export labour-intensive goods, thereby increasing the demand for its labour and raising labour incomes. its other options are labour emigration and an influx of capital. all these mechanisms should operate simultaneously and be poverty-reducing. however, transnational corporations, in shifting those production processes which do not require high levels of skilled labour to developing countries which have an abundance of unskilled labour, have bypassed africa largely because of its poor policy environment. he contends that public expenditure has been directed more towards redistribution rather than infrastructure, whereas private capital prefers countries in which infrastructure is the priority for governments. we return to this point in relation to south africa in section 3. the white paper (hmso, 2000: 17-18,65-67) makes a number of important points: (i) there is no evidence of a systematic relationship between openness and inequality, either between countries or within a country. it is policies of governments which determine whether inequality rises or falls. the poor sometimes gain more from trade, and sometimes less, than the average person. (ii) there is no developed country which has a closed economy. those poor countries which have successfully developed in recent decades the east asian newly industrialising economies (nies) used open world markets to build strong export sectors and attract fdi. they invested massively in education, and the proportion of their populations living in poverty has fallen from 40 per cent to under 15 per cent in 40 years. (iii) trade liberalisation has been associated with more rapid economic growth, and has brought real benefits to consumers, including the poor. it has beneficial effects on productivity, the adoption and use of technology, and investment. the extent to which it contributes to poverty reduction, however, depends on broader economic and social circumstances as well as policies: trade openness is a necessary but not a sufficient condition for poverty reduction. (iv) by contrast, the protectionist policies of the 1950s and 1960s in developing countries, following import-substituting industrialisation, were often associated with quite rapid growth, but unequally distributed gains. often the poor were hurt by the urban bias against agriculture. (v) there is also no systematic relationship between economic growth and inequality. inequality has risen in some countries and fallen in others, no matter whether they have been fastor slow-growing economies. (vi) economic growth is necessary for poverty reduction: the decline in the proportion of the population living in poverty has been largely the result of economic growth. in relation to (v) above, although the rich may gain more than the poor, the numbers in absolute poverty may fall. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 3 510 (vii) however, pro-poor development requires growth and equity, and poverty reduction is most rapid where growth is combined with declining inequality. there has been increasingly strident criticism of globalisation from the late1990s onwards. the wto and bretton woods institutions have come under fire for trade liberalisation and structural adjustment programmes which, it is claimed, have led to macroeconomic instability, unemployment and poverty. the international currency crisis of 1997-98 lent impetus to these criticisms. in response, the bretton woods institutions and other aid agencies have revised their development programmes, realising that policy-making needs to include a pro-poor component in order to ensure that globalisation benefits poor people, especially in the longer term. effective government and efficient markets are essential to attract fdi which will flow to where the climate for business is most favourable and least risky. sound legal, institutional and regulatory frameworks, and the provision of key public and social services, are state responsibilities. programmes now include the strengthening of public revenue and expenditure planning and management, and public expenditure programmes which target the poor through the satisfaction of basic needs. a consequence of all this is that aid agencies are building pro-poor programmes into their project funding. moreover, international development targets endorsed by the bretton woods institutions and the un millennium summit in 1999 include a reduction by one-half in the proportion of people living in extreme poverty by 2015, i.e., they focus on absolute poverty. what has happened in south africa? south africa's rapid economic growth between 1946-74 was also one of growing government intervention in the economy a tendency which continued until into the 1980s. the south african government took a very different path from that of the east asian nies, for example, korea. whereas in 1960 the two countries had roughly equal gdps, by 2000 south africa's was only one-third the size of korea's gdp. korea adopted open policies, but south africa opted for import-substituting industrialisation behind high tariff barriers, delaying economic liberalisation until the early-1980s when some cautious moves on deracialisation of the economy and deregulation of sectors such as transport occurred. however, strict controls on capital movements were retained, and concerted tariff adjustments, centred around the uruguay round offer to gait, were only implemented from 1995 onwards. the government from 1994 onwards relaxed but has not yet abolished exchange control, and has generally continued with liberal macroeconomic reforms. south africa has always manr ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 511 sajems ns vol 4 (2001) no 3 aged to be well integrated into the latest international telecommunications and infonnation technology networks, and since 1994 its global trade network has expanded. political change, with the lifting of sanctions and disinvestment pressures, meant an opening up of south africa's trade far beyond its traditional partners, although these continue to be the major markets for exports and sources of supply for imports. economic dualism from the early 1970s began increasingly to revolve around wage employment. those without it were found in the urban infonnal as well as in the rural subsistence sectors. bhorat (200 i: 5) shows that fonnal employment fell between 1993-98 from about 7.8 million to 7.4 million. it increased only in the wholesale and retail trade and in financial and business services. most of the losses occurred in the mining and construction industries, while manufacturing industry shed 50,000 jobs. the phase-down of tariffs from 1995 onwards under the wto resulted in greater competitive pressures on manufacturing industry, output and investment levels in the sector falling. trade liberalisation was accompanied by the increased adoption of new technologies, often in order to raise efficiency levels and to become more competitive, and capital-labour ratios rose. in public enterprises, job losses were the result of the restructuring programme, especially in the transport and telecommunications sectors. bhorat points to another trend noted above in relation to transnational corporations. whereas the demand for skilled and highly skilled workers increased significantly, that for unskilled workers fell substantially. thus, there is a new fonn of dualism in the labour market a shortage of workers at the top end of the occupational ladder, and rising joblessness among unskilled workers. although the fall in wage employment has been offset in part by the gain of 100,000 jobs in the infonnal sector, there are some 230,000 new entrants to the labour market each year (2000: 15). official figures show a consistent decline in the index of non-agricultural employment since 1989. there are now two official estimates of unemployment: under the narrow definition the rate was 25.8 per cent in september 2000 whereas under the expanded defmition (which includes discouraged job seekers) it was 35.9 per cent. there is conflicting evidence about trends in inequality in south africa. one study (bmr. 2000: 54) calculates that the disparities between rich and poor narrowed by one-half between 1991-96: the ratio of income of the richest 10 per cent and poorest 20 per cent of all households fell from 45:1 in 1991 to 22: l. however, south african inequality remains one of the highest in the world the gini coefficient was 0.63 (when 0 indicates complete equality and i extreme inequality). the narrowing in the gap between rich and poor was attributed by the bmr to a combination of affinnative action, the increased employment of africans in the public service, and the equalising of welfare and pension payr ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 3 512 ments. by contrast, a survey (statistics south africa, 2000) found that inequality between the richest and poorest on the basis of pay increased between 1994-99. this was attributed to rising levels of unemployment. the survey by statistics south africa (2000) found that 28.5 per cent of households were below the household poverty line of r800 per month. the very poor, defined as those spending below r600 per month, accounted for 16.5 per cent of all households, while the comparable figure for those defined as poor (who spent between r600-1000 per month) was 24.8 per cent. thus, 41.3 per cent of all households were poor or very poor. because of a lack of time-series data, the study did not show poverty trends. south africa can globalisation be blamed? the focus of economic policy we have noted in section 2.2 that the general economic climate and government economic policies are powerful determinants of the results of globalisation. economic policy itself invariably has social and political determinants. is collier (1998) correct when he argues that it is possible that in south africa "the composition of public expenditure may be sufficiently capital-hostile because of the political and social need for redistribution that it causes a capital exodus"? in south africa the government introduced its growth, employment and redistribution (gear) strategy. this was basically an output-orientated approach with sound macroeconomic policies matched by redistribution policies. calitz and siebrits (2001: 2), in analysing the 2001102 budget, show that fiscal policy in the 1990s emphasised macroeconomic stabilisation and redistribution at the cost of economic growth and job creation. since 2000, however, the budgets have focused directly on economic growth without abandoning the previous objectives. the size of government has been halted, and public spending on education and health is higher in south africa than in other developing countries; as a percentage of gdp it exceeds that of the lower-middle-income group of countries (calitz, 2000: 588). trade liberalisation has resulted in declining income from trade taxes (5.3 per cent of total government income in 1993/94 as against 3.2 per cent in 1999/oo) for the central government, but this might of course be reversed in due course depending on price elasticities of demand which will determine the rate of growth of imports at the lower tariffs. this decreased reliance on trade taxes was offset by greater dependence on individual company taxes as well as valueadded tax. according to calitz (2000: 598) the income tax burden on individur ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 513 sajems ns vol 4 (2001) no 3 als is much higher than in other developing countries, and signifies a tax pressure on skilled individuals who have international mobility. this is a worrying aspect for south africa. he suggests a move away from income tax toward consumption taxes; these, of course, are regressive although not as much as is usually supposed when lifetime earnings are taken into account. calitz is concerned about the introduction of residence-based taxation, made in order to respond to the globalisation of economic activity, arguing that this is likely to make south africans (both individuals and companies) less competitive than their counterparts in other countries which have lower tax rates. calitz and siebrits (200 i: 18) refer to a study by the department of finance in 1999 which found that the system was broadly progressive, the lowest decile of income earners paying ii per cent, and the richest decile 30 per cent, of their incomes on these taxes, and that between 1993-97 there was a significant shift in social spending patterns from the higherto the lower-income groups. what is important, though, is whether this change in social spending actually attains its goals by reaching the poorest groups. this will depend on whether it is absorbed in civil service salaries and wasted on inefficient execution of delivery because of a lack of managerial capacity. for example, since 1995 there has been a substantial real shift in the budgetary allocation towards social services, but this increase in spending has not been matched by a similar improvement in service levels. much of the increase in provincial education and health spending was the result of salary increases for teachers and health staff. thus, less was available for teaching materials in the schools and medical supplies at hospitals and clinics. the fmancial performance of the provinces varies considerably, but as a group they now record an overall surplus. some provinces, however, are still in a poor fmancial position, and the same is true of many municipalities. in such instances the standard of services provided has declined. it remains to be seen whether the restructuring of local government and the reduction in the number of municipalities will improve the overall delivery of services. this is something which could significantly affect the poorest households. microecodomic issues a growth rate of 5-6 per cent per annum, sustained over a long period and properly managed to produce adequate social services as well as efficient markets, is required if unemployment and poverty are to be reduced substantially. as hofmeyr (1996) pointed out, in the period 1946-75 rapid sustained economic growth eventually led to substantial vertical mobility on the part of disadvantaged groups and a marked improvement in their economic welfare. south africa's low growth rate since 1975 has effectively meant that over a quarter of a century has been lost; even economic performance since 1994 has been poor. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (200 i) no 3 514 although the government has won universal praise for its macroeconomic management, it has fallen down on the micro level, particularly with regard to the failure to: curb the rise in crime and corruption; proceed purposefully with privatisation; revise labour legislation in order to increase labour market flexibility; and adopt a large-scale public works programme in order to provide jobs and incomes both in urban and rural areas (nomvete et al., 1997). the rigid labour market is consistently shown to be one of the major concerns of foreign investors. in the same view, the proposed minimum wage legislation for domestic service and farm workers generally considered to be two of the poorest groups is likely to be counter-productive, leading to increased unemployment and hardship. market-clearing wages should have been allowed to work, and public works programmes should have been developed on a large scale to mop up unemployment and provide badly needed infrastructure (maasdorp et ai., 1994). a high rate of economic growth would have meant that a policy of affinnative action would have been far less urgent since there would have been rapid vertical mobility, repeating the 1965-74 experience examined by hofineyr (1996). instead, this policy has led to an enonnous loss of scarce human resources through early retirement or emigration which has been encouraged by the perceived discrimination in employment, especially in the public service but also in large corporations. emigration and early retirement since 1994 have seriously depleted the country's skills base, especially in the public sector. self-declared emigration is generally regarded as a significant underestimate of the situation. in the context of serious skill shortages this is a trend which the country cannot afford: an efficient economy demands the most efficient management possible. the brain drain covers all race groups and, all told, it is a serious constraint to economic growth: between 15-20 per cent of resignations in 2000 were due to emigration i. other well-documented concerns of investors relate to crime, taxation and social policies, which are all areas in which the government could introduce refonns. however, it is also clear that continued high levels of inequality are worrying to investors, and that these levels need to be reduced if fdi is to be attracted. the government has recognised that the private sector is the prime force for economic growth as well as for wealth and employment, creation. this process would be enhanced were the government to focus more directly on economic growth as the top priority, allow the private sector to concentrate on business expansion without constant changes to labour and taxation legislation, and then regulate the proceeds of economic growth so as to influence social welfare. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 515 sajems ns vol 4 (2001) no 3 expanded investment in education and the maintenance of a sound system are basic to a high rate of economic growth for south africa. unfortunately, the government has attempted to introduce dubious reforms far too quickly, in the process losing thousands of experienced teachers especially in science and mathematics. the same has happened throughout the civil service, and the entire legal system as well as other important economic institutions have become increasingly inefficient (cde, 2001: 20). an unexpected development since 1994 has been the adoption of a seriously flawed policy towards gambling. provision has been made for the granting of up to 40 casino licences nationwide, and this is much more than the economy can sustain. in recent months there have been an increasing number of press reports pointing to the adverse effects on poor households of expenditure on gambling (particularly on lotteries and casinos). incomes of poor households have been put under increasing pressure as this expenditure is diverted from basic items such as foodstuffs, clothing and footwear. the rural poverty problem who are the real poor in south africa? in general they do not include those in the wage economy, and certainly do not include members of trade unions. neither do they include everyone in the informal sector: by definition, as the unrecorded sector, this contains such lucrative illegal activities as drug lordism and car-theft syndicates. some people in the informal sector, in fact, are quite wealthy. nevertheless, one would expect that much of the poverty at the urban end is found among the openly unemployed as well as individuals in marginal activities in the informal sector, street children and the like, while in rural areas it would consist of households in districts with poor resource endowments, environmental degradation, and low agricultural yields. an hsrc researcher, o'donovan, argues that poverty is being sustained by a chanrng job market and the unintended consequences of development initiatives. he talks of a geographical " trap" within which poverty is entrenched. the trap is created by the interaction of three factors: the changing employment proftie, government spending and reduced migration. the professional, technical and managerial categories are the ones for which there is increased demand, but employment prospects are declining for unskilled and semi-skilled labour which faces a falling demand. thus, poorly trained individuals will increasingly become peripheral to the formal economy as will regions that act as reservoirs of unskilled labour. these areas coincide with the former homelands. this appears to be borne out by bhorat (2001: 22) who found that urban employment increased by approximately the same number as rural employment der ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 3 516 creased. thus, jobs were redistributed away from rural towards urban areas. this might be in part because of the withdrawal of industrial decentralisation incentives but also in part to trade liberalisation which forced marginal rural firms either to close or to relocate in order to remain competitive. however, it might also have been due to drought and other causes of rural-urban migration. whereas a high economic growth rate could have countered impoverishment, the only avenues left for alleviating the situation in these areas are migration and government redistributive spending. however, o'donovan3 fmds that rates of migration from the homelands appear low, and that state spending by way of the reconstruction and development programme (rdp) has resulted in an urban bias (well known in development economics) whereby the urban poor receive more than those in rural areas. this is a direct contradiction of their relative needs: the rural population has the greatest need for improved services because its level of deprivation is higher than that in the metropolitan and urban areas. however, rdp expenditure benefits the poor in the developed rather than in rural areas, especially the former homelands where a high proportion of the population is accounted for by poorly educated people and females. 0' donovan argues that there appears to be a change in the basis for rdp spending away from greatest need to an emphasis on positive rates of return on the investment. in view of the arguments of o'donovan and bhorat, it is instructive to refer to a study (antrobus et al., 1999) in the maluti district of the eastern cape. according to this study, the economics of commercial agriculture suggests that the real development opportunities are not to be found in this sector. rather, there is a need for a new path for economic development and rural resource reconstruction. eco-tourism offers a more promising alternative, while other new stimuli would be derived from road construction projects (labour intensive where possible) and public works programmes focused on the eradication of exotic species and the combating of soil erosion. in former commercial areas which had been bought out many years ago by the transkei government and redistributed to local residents, arable lands had not been cultivated for some time. in another area which previously produced large volumes of wheat and maize as well as being important in the dairying and beef industries, the decline of output is attributable mainly to the fact that the former commercial farms are being held on leasehold. thus, the farmers are reluctant to invest in improvements. the decision by the then government to lease out the farms was good neither for securing collateral for bank loans nor for inculcating a commitment to commercial production. many of the lessees were affluent traders or bus owners with good political connections for whom a farm would be a mere sideline on which a few cattle could be kept. while the lessees were meant to have been carefully selected, not all were screened, there was an eler ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 517 sajems ns vol 4 (2001) no 3 ment of political patronage, and some are not serious about farming. however, most did not have sufficient capital anyway to start commercial farming operations, and are in deep financial trouble. the communal areas contain some of the best land for maize production in eastgriqualand, but are underutilised. it is very difficult for small farmers to establish themselves because of the small margins. yet, new dwellings are very evident in the communal areas of the district, but they have been constructed with funds received from household members employed in the towns and from pensions, not from farming income. agriculture does not appear to be a highly esteemed occupation, and the population consequently is not geared to commercial production. it is difficult to generate the equivalent of a monthly pension from a small piece of land, and residents would rather devote their expenditure to other items than to farm inputs. because food is relatively cheap, it is not worth the labour time and effort to grow crops. in many parts of the transkei, therefore, agriculture is non-existent, and maize is grown more for cultural than for subsistence reasons. agricultural land is largely unused; land is valued not for its title but for its security (social security and cheap housing), and consequently it is treated as a free good. the area is a rural dormitory for those dependent on income transfers from the urban areas. the economics of agriculture, therefore, militates against development of this sector. all efforts on the part of non-governmental organisations and development agencies tend to peter out after a while because the time inputs necessary from farmers are not commensurate with the benefits derived. the development challenge is how to get people off the land or else encourage them to use it productively. a land tax and economic incentives could be appropriate policy instruments, but a focus on agriculture would prove of only limited usefulness in an environmentally sustainable resource development programme in the maluti district. consequently, the potential of other economic sectors must be investigated. the entire stretch of the drakensberg in the district remains to be exploited for eco-tourism development which could act as a trigger not only for rural resource reconstruction but for improving the quality of life for local communities. given this untapped potential, linkages need to be made between agriculture and tourism. agriculture needs to move away from the traditional focus on maize towards the development of small-scale production to supply niche foods such as fresh, organically grown vegetables and hormone-free meat to tourist accommodation establishments which need to be built in the area. moreover, export markets arising from changing global consumer tastes could be supplied: there is a growing trend towards the use of altemative health products in the rich countries of the northem hemisphere. this is manifested in increased consumpr ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 n03 518 tion of organically produced foodstuffs, hormone-free meat and natural medicines. in all these lines there is potential for an imaginative approach to the transformation of agriculture. tunnel farming is labour-intensive, and current moves in south africa to involve rural communities in some former homeland areas in organic agriculture and floriculture hold out some hope for helping them out of the poverty trap. policy cboices south africa has an open economy, measured by merchandise exports and imports together as a proportion of gdp. the figure was 47.6 per cent in 1998 (world bank, 2000: 252-3; 2001, 312-3), which puts south africa in the same category as britain, kenya, nigeria, new zealand, germany, france and spain. thus, as fields (2000: 5) points out, south africa does not have a choice: if it is to prosper, it must export more. it cannot become prosperous by selling to itself. if south africa is to attract fdi, foreign enterprises must have an incentive to employ south african labour. the country must make itself attractive to manufacturing investment, and can do so through high productivity, good labour relations, and high rates of return on the investments. conversely, its efforts will be impeded by "excessively restrictive labour practices, the labour hassle factor and unsafe living environment for business executives and their families" (fields, 2000: 5). fields (2000: 4) points out that no study has found zero elasticity of employment; most have found a wage elasticity of demand for labour of -0.5 to -0.7, meaning that for each percentage point increase in wages there is roughly a onehalf point reduction in employment. thus, the policy choice for south africa in reducing absolute poverty is to raise the earnings of the employed or to raise employment by holding down the growth of real wages, i.e., between lower real wages but more jobs, or higher real wages but fewer jobs. wood (2000:9) also points to hard policy choices which need to be made between increased wage inequality and increased unemployment. surely, however, for those in absolute poverty and without jobs, the choice is clear: lower real wages but more jobs. the policy choice is indeed hard for the government since it was political pressure which gave rise to the economically ill-conceived labour legislation of the last few years. this has offered trade union members employment conditions superior to those in other countries with similar labour market conditions and at similar levels of economic development, as well as wages far in excess of market-clearing levels. by making it extremely difficult to dismiss or retrench workers, it has discouraged firms small and large from taking on more staff. for foreign companies there is no intrinsic reason to invest in south africa when flexible labour markets are operating in developing countries (including r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 519 sajems ns vol 4 (2001) no 3 neighbouring states in the region). it is largely for this reason that asian companies are locating apparel and textile industries in lesotho and namibia rather than south africa. labour market rigidity has meant that a key factor market is unfree at a time when the other factor market capital has been liberalised through general macroeconomic reforms. yet, liberalisation of the one without the other would not achieve the desired goals of stimulating investment, creating employment, and helping to reduce the income gap and raise the standard of living of the poorest. labour market policy is antithetical to the interests of the unemployed masses, for whom there has been a negligible economic trickle-down effect from political change and globalisation. the fact that the market mechanism is prevented from operating allows trade union membership, although accounting for only 20 per cent of the total economically active population, to provide guaranteed entry into a club of urban insiders protected against competition in the labour market from outsiders (nomvete et al., 1997: 27-32). a new dualism, then, can be said to have emerged between union members and the mass of the labour force who are unorganised. the prime interest of the labour force as a whole, including those who are unemployed and underemployed, is for job expansion. conversely, the interest of the unionised workforce is to protect itself by eliminating competition in an open labour market. a standard bank report (2000) has pointed out that there have been important structural changes in the economy in recent years. first, the relative share in gdp of the primary and secondary sectors has declined while that of the tertiary sector has grown. secondly, restructuring and technological change have led to an increased demand for skilled and a declining demand for unskilled labour. employer demand for skills exceeds supply, creating a constraint to economic development. the report (standard ban.k. 2000) finds that trade generated 60, 436 net jobs between 1993-97 but that these structural changes mean that the continued ability of trade to generate employment is weakening. however, both the weakening of trade as an employment-generating factor and the growing skills gap are influenced by south africa having effectively pricing itself out of the market for labour-intensive industry. perhaps south africa would not be able to compete with the very low-wage countries of china and south-east asia, but after 1994 foreign companies were clearly interested in investing in the country. were it not for negative perceptions about the general labour envirorunent, there is little doubt that the country could have attracted fdi into manufacturing industry at both the capital-intensive and labourintensive ends. the skilled and highly skilled as a proportion of the labour force r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 3 520 increased from 38 per cent in 1970 to 57 per cent in 1997/98, while the share of unskilled workers declined from 62 per cent to 43 per cent over the same period (abedian & antonie, 2001). even though there is a skills shortage, this skills mix implies that south africa is better placed than other countries in africa to attract capital intensive indusliy, while at the same time the excess supply of unskilled labour is favourable for the attraction oflabour-intensive indusliy. for the urban unemployed the equivalent to introducing innovative thinking into transkei agriculture would be to open up the labour market in order to attract investment at the lower end and create a climate in which firms, in all sectors of the economy, are willing to take on additional staff. for the unemployed and underemployed, both rural and urban, it is government policy, not globalisation, that limits their opportunities for escaping from poverty. conclusion the governor of the south african reserve bank recently stated that "even the staunchest critics must agree that globalisation is inevitable and that it can be a strident force for generating wealth and reducing poverty''''. he also stated that south africa's responses to globalisation needed to be managed, pointing to the grouping of countries into economic and political blocs in order improve their bargaining power in world fora. south africa is part of the african group of countries which have been cooperating in formulating a negotiating position in the next round of wto negotiations. the policy of governments should be to improve the present world trading system under the wto in order to ensure that it works for the poor. inequities in the existing international trading system need to be corrected. in particular, protectionism and subsidies, especially in agriculture, in developed countries need to be abolished. these barriers are most damaging in areas of key importance for poverty reduction in developing countries, namely, agriculture, textiles, and clothing. it is along these lines that south africa ought to concentrate its arguments. the alternative is a situation in which richer countries dominate the rest or else make bilateral trade deals among themselves which exclude poor countries. a retreat into trade protectionism would hit the world's poorest countries, and jettisoning the system is not the answer. as the economist (ii december 1999) points out, trade is about greater competition. thus, it weakens the power of vested interests, creates greater opportunities for the masses rather than privileges for the few, and allows more countries to join the east asian nies which have been the ones which have closed the gap on the west and raised the standards of living of their populations. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 521 sajems ns vol4 (2001) no 3 for south africa to close the gap, it will need to overcome its weak points in the global competition ratings. there is a dichotomy between its sound macroeconomic policies and some of its micro policies. failure to address the issues would bear out collier's (1998) interpretation, namely, that socio-political factors conceivably are the real driving forces and that south africa is one of two african economies in which redistributionist policies might cause public expenditure to be capital-hostile and repel private capital. this would mean that south africa would not attract the fdi it needs in order to achieve robust economic growth and shrink absolute poverty. the best redistributive medicine, though, would be through higher economic and employment growth, and these require fdi. without them, the dual economy contrasting those in poverty and those who are not would persist. endnotes a survey by poe corporate services quoted in sake-rapport, 25 march 2001. 2 m. o'donovan in a leader page article in business day, 29 march 2000. 3 ibid. 4 business report, 15 august 2001. references 1 abedlan, i. & antonie, f. (2001) "contemporary challenges facing south african business in a globalising economy", paper delivered to the 4th annual conference, centre for the study of african economies, oxford. 2 antrobus, g.; maasdorp, g.; mander, m.; mowat, s. & myers, g. (1999) "flight of the ducks: environmentally sustainable economic development in the matatiele area", pretoria: department of environmental affairs and tourism. 3 bhorat, h. (2001) "employment trends in south africa", occasional paper no.2. johannesburg: friedrich ebert stiftung. 4 bmr (2000) "the south african provinces: population and economic welfare levels, 2000", research report no. 276, pretoria: bureau of market research, university of south africa. 5 calitz, e. (2000) "fiscal implications of the economic globalisation of south africa", south african journal of economics, 68(4), 564-606. 6 calitz, e. & siebrlts, k. (2001) "after the pain the gain? an assessment of the 200112002 budget", absa economic perspective, special edition, april. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (200 i) no 3 522 7 cde (2001) "why is south africa failing to get the growth and jobs that it needs?" johannesburg: centre for development and enterprise. 8 collier. p. (1998) "globalisation: implications for african economic management", draft paper. washington, d.c.: world bank. 9 ellison, p.a., pillay, p.n. & maasdorp, g.g. (1975) "the poverty datum line debate in south afiica: an appraisal", occasional paper no.4. durban: department of economics, university of nata!. 10 fei, j.c.h. & ranis, g. (1964) development of the labour surplus economy homewood, ill.: richard d. irwin, inc. ii fields, g. (2000) "the employment problem in south africa", trade and industry monitor, 16,3-6. 12 higgins, b. (1968) economic development, london: constable and co. ltd. 13 hirschman, a.o. (1958) the strategy of economic development, new haven: yale university press. 14 hmso (2000) "eliminating world poverty: making globalisation work for the poor", white paper on international development. london: the stationery office ltd. 15 hofmeyr, j. (1996) "the south african labour market: historical trends" in innes, d. (ed.), the south african labour market: an analysis of trends. challenges and policy implications. unpublished paper. cape town: afiica institute for policy analysis. 16 horwood, o.p.f. (1964) 'the social framework of economic development in a dual society. the case of south africa" in holleman, j.f. (ed.), problems of transition, pietermaritzburg: natal university press. 1'7 horwood, o.p.f. (1965) "economic balance, dualism and growth, with applications for the south african economy", south african journal of economics, 33(3), 171-192. 18 ilo (1972) employment. incomes and equality: a strategy for increasing productive employment in kenya, geneva: international labour office. 19 lewis, w.a. (1954) "economic development with unlimited supplies of labour", the manchester school of economic and social studies, may, 139-191. 20 maasdorp, g. (1991) "the landlocked countries: swaziland" in konczacki, z.a.; parpart, j.l. and shaw, t.m. (eds.), studies in the economic history of south africa. volume two: south africa, lesotho and swaziland, london: frank cass & co. ltd. 21 maasdorp, g & humphreys, a.s.b. (eds.) (1975) from shantytown to township, cape town: juta. 22 maasdorp, g.,l hofmeyr. n. wilkins, 1. abedlan, b. sta.'1d1sh & donaldson, a. (1994) "special employment projects in south africa". report prepared for the urban foundation. durban: economic research unit, university of~atal. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 523 sajems ns vol 4 (2001) no 3 23 meier, g,m. (1989) leading issues in economic development, new york: oxford university press. 24 nomvete, b.d., maasdorp, g.g. & thomas, d, (1997) growth with equity, cape town: africa institute for policy analysis. 25 standard bank (2000) "the impact of the structural change of the south african economy on labour" editors' brief, september. johannesburg: economics division, standard bank. 26 standard bank (2001) "accelerating growth in south africa". editors' brief, q i. johannesburg: economics division, standard bank. 27 statistics south africa (2000) measuring poverty in south af rica pretoria: statistics south africa. 28 todaro, m.p. (1971) "income expectations, rural-urban migration and employment in africa", international labour review, 104 (5), 39195,411-13. 29 wood, a. (2000) "when and why does globalisation increase rather than reduce labour market inequalities in developing countries?" trade and industry monitor, 16, 7-9. 30 world bank (2000) entering the 21st century: world development report 1999/2000, new york: oxford university press, 31 world bank (2001) attacking poverty: world development report 2000/2001, new york: oxford university press. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . microsoft word vol6no3'3.doc sajems ns 6 (2003) no 3 562 contagion: does it really exist or is it simply pseudo systemic risk? ________________________________________________________________ ashley g frank graduate school of business, university of durban-westville ________________________________________________________________ abstract financial market participants seem to have already accepted the phenomena of speculative currency attacks being temporarily correlated, with crises passing �contagiously� from one country to another. yet doubt still exists about whether speculative attacks on a currency are due to its country�s fundamentals or irrespective of them. more conservative economic opinion is that countries with deep mismanagement of national balance sheets and exchange rate policy as well as political irresponsibility, give rise to weaker external positions, from where they suffer higher negative spillover effects. sadly, despite the possibility of contagious currency crises, being an important policy issue, this paper finds little support by way of systematic empirical analysis. so much so, that the choice is between opting to be a dissident, and, leaving the question unanswered. it chooses the latter. jel g10, 15 1 introduction in delivering the 1998 david finch lecture at the university of melbourne, the international monetary fund�s stanley fischer offered two main reasons for why there is such growing assent on the view that the international financial system should be reformed (fischer, 1999), or to put it a bit more crudely why there is such agreement on the need for a new financial architecture (eichengreen, 1999). the first, as the 1998 east asian crisis showed us, international capital flows to emerging markets are too volatile, subjecting recipient countries to shocks and crises that are excessively frequent and large. the second, is that there is just too much contagion in the system, a point though advanced during the east asian crisis that became uncontestable after the russian devaluation and unilateral debt restructuring spread the crisis across latin america. it is this second aspect and in particular the question of how it is known that the contagion is excessive, that is difficult to establish. this is particularly because when contagion strikes there is method in the madness, hitting weaker economies harder than stronger ones, so that there it is always sajems ns 6 (2003) no 3 563 possible to argue that those countries most affected by contagion �deserved it� more than those that were less affected. indeed, many economists often argue after a crisis that there was no contagion per se since those countries most badly affected already had major policy or structural weaknesses. in the wake of the mexican meltdown, the ability for currency crises to spill contagiously has been hotly debated. indeed the us$50 billion of assistance the imf, the united states and other g-7 governments provided in early 1995 has often been justified by arguing that if the effects of the mexican crisis were allowed to play itself out, it would have not only been limited to mexico but would have had serious repercussions for other emerging markets as well. multilateral intervention was needed because the mexican authorities had little incentive to internalize such externalities. supporting this view are the reserve loses, interest-rate increases, and, exchange rate weakening, countries like argentina and thailand experienced during the first weeks of 1995. of course the contrary view would be simply that investors were discriminating in the countries they attacked. currencies other than the mexican peso came under very little pressure, with the effect being felt only in those countries with large current account deficits, over-valued real rates and other weak fundamentals. the implication being that the mexican bailout, to the extent that it was fuelled by fears of contagion was uncalled for. the 1992/3 crises in the european monetary system (ems) was subject to a similar controversy, when it was claimed that the french franc and the irish punt came under attack as a result of the earlier crises of the british pound and the italian lira. in 1993 it was argued that the attack on the french franc threatened to spill over to other european currencies, the implication being that foreign support for the franc was essential to prevent chaos from spreading contagiously throughout the ems. instead, only those european countries with fundamental weaknesses were subject to speculative attacks. the netherlands for instance, that appropriately aligned its economic policies to the maintenance of its currency pegs, remained relatively immune. the proposition then became that if contagion did in fact exist, only those countries with particular economic and political circumstances were susceptible, a statement that turns the very definition of contagion on its head. certainly such a proposition also highlights the role policy may play. ascertaining whether contagion exists in foreign exchange markets and under what conditions it would inspire currency crises should thus be a high priority for research in open-economy macroeconomics. the purpose of this paper is to examine the theoretical and empirical literature on crises in foreign exchange markets with an eye towards the prevalence of contagion. contagion being defined as the co-movement of asset markets not caused by a common movement of fundamentals (wolf, 1998). several of the contagion studies that have been conducted are either wholly descriptive of a sajems ns 6 (2003) no 3 564 crisis event or use simple correlation coefficients to draw conclusions about transmission effect. some also control for fundamentals and look at the correlation matrix of the residuals, this as comparing correlation calculations with different sub-samples is an accepted way of studying links among variables. principal component analysis has also been used. a finding of high correlation has often been advanced as evidence of contagion. still, as there is no universally accepted definition of the term, different interpretations of this finding have been offered. high cross-country correlation coefficients may be due to similar fundamentals or to common external shocks, as one would expect in a wide variety of models. bordo et al. (1995) for instance, found high correlation among stock prices in emerging markets over 1984 to 1995, but were able to attribute the bulk of it to fundamentals, either through a correlation of in-country fundamentals or a sharing of external fundamentals. they contend that such phenomena should be termed �pseudo systemic risk�. conversely, work by authors such as calvo (1995) who demonstrated the tequila effect of herding behaviour, suggests that high cross-country correlations are due to investors leaving all emerging markets when a shock hits one of them. many economists are of the opinion that it is only such simultaneous speculative attacks [or in the language of the market such �bubble-burstings�] that describe true contagion. thus a suitable research question must be: given the theoretical insights that have been gained, as well as the empirical evidence gathered from the various foreign exchange crisis episodes that have occurred, is it possible to conclude that contagion does actually exist? this paper, which deals specifically with speculative attacks in foreign exchange markets, is arranged as follows: section 2 reviews krugman�s (1979) early work on this subject with a view to determining what lessons may be gleaned from his theoretical model building. section 3 examines the more recent work on multiple equilibria in an attempt to deduce how this phenomenon could help explain speculative bubbles and sun-spot equilibria. based on this theoretical work section 4 examines the transmission mechanisms for how foreign exchange crises might spread contagiously. while section 5 critiques the empirical studies that have been conduced on speculative attacks, to show why the research question remains unanswered. section 6 concludes by pointing out the way further research should take in order to advance the debate. 2 krugman�s model the seminal work by krugman (1979) showed how inconsistencies between domestic economic conditions and an exchange rate commitment inevitably sajems ns 6 (2003) no 3 565 leads to the collapse of currency pegs. in his model, the overly expansionary stance of domestic policy caused domestic absorption to exceed production. the difference then spilt over into a balance-of-payments deficit, which the central bank financed by expending reserves. eventually reserves become so depleted that they fall to a critical threshold that encourages a speculative attack, which in turn depletes the remaining foreign assets. such reserve depletion necessitates abandonment of the exchange rate peg and following the more expansionary stance of domestic as opposed to foreign policy, the currency depreciates secularly over time. this balance-of-payments crisis theory produced four classes of insights. first, it helped to identify the relevant fundamentals. obviously these include the macroeconomic determinants of the exchange rate and the balance of payments, as described by both aggregate models of exchange rate determination as well as the monetary approach to the balance of payments. given the forward-looking nature of these models, the list of determinants should include the expected values of the relevant series. indeed, the possibility of multiple equilibria arises because expected future fundamentals can themselves depend on whether a speculative attack occurs. within this context meese and rogoff (1983), obstfeld and rogoff (1995) as well as obstfeld (1995) have pointed to the poor empirical performance of krugman models, giving concern about the success with which speculative-attack models built on such foundations can be empirically validated. second, the krugman model showed how crises can erupt before official reserves, which decline over time, are actually depleted. currency speculation occurs through the buying and selling of domestic currency for foreign assets. these transactions come about as traders, wishing to equalize rates of return and balance their portfolios in terms of risk-return trade-offs exchange assets among themselves. when the market is not willing to acquire domestic currency at the prevailing pegged price, a crisis is provoked, leaving the central bank as the counter-party caught short. an incentive thus exits for speculators to liquidate domestic currency holdings despite the central bank having sufficient funds to absorb the volume of sales. the timing of the attack is planned such that its magnitude is just sufficient to eliminate the central bank�s reserve stock. the third implication arising from the model is that a central bank can only maintain a currency peg so long as it has adequate foreign exchange reserves. once these have been lost in an attack, the peg must be abandoned, there is no other alternative. in the standard model the crisis results in a transition to floating, reserves stocks are then reconstituted and the exchange rate re-pegged. this implication also necessitates an understanding of reserve adequacy. in order that the peg be defended, the central bank must be able to purchase all of sajems ns 6 (2003) no 3 566 its liabilities other participants want to redeem. the standard model assumed the volume of such sales would be small, corresponding to the decline in monetary base needed to ratify the fall in money demand that higher interest rates, which follow the shift from pegged to depreciating, bring about. since domestic residents who require the currency for transaction purposes should continue to hold a significant proportion of that base, such an assumption appeared logical at first. however, as inter alia edwards (1989) have pointed out, in today�s highly dollarized economies transaction demand for domestic currency may indeed be small, making the share of the monetary base subject to liquidation in a crisis quite significant. on top of that, is the added concern that monetary authorities may also be required to purchase other domestic liabilities (e.g., m2) should the currency crisis initiate a banking crisis as well. the fourth implication from the krugman model is that authorities are quite defenseless, having little chance of fending off an attack. even if the volume of speculative sales of domestic currency was less than the monetary base, the base would still exceed the central bank�s net foreign reserve stock (except in the quite uncommon case of a fully backed currency board). theoretically, the authorities could augment their gross reserves through foreign borrowing, even to the point where reserves exceed the base. unfortunately if borrowed reserves are used to finance sterilized intervention, the monetary base would increase pari passu with there being no level of gross reserves sufficient to repel an attack. of course, the attack can be repelled by authorities choosing not to sterilize, but this comes at the cost of a shrinking base and rising interest rates. in that case should a sizable proportion of the base be involved, the resulting interest rate hikes may be so large that, what started as an exchange rate crisis, then leads to a banking crisis. averting this, forces the central bank into the sterilization it had originally opted against, further undermining its capacity to defend a peg. 3 multiple equilibria and self-fulfilling attacks generic to theoretical rational-expectations macroeconomic models is that they have multiple solutions. standard practice was therefore to assume away divergent solutions by imposing transversality conditions, since most of the solution paths did not converge to a steady state. recently, however this nonuniqueness property, that allows for multiple equilibria, has become the basis for a body of work on speculative bubbles and sup-spot equilibria. following a suggestion by flood and garber (1984), obstfeld (1986; 1995), has provided examples of multiple eqilibria and self-fulfilling attacks in foreign exchange markets. these offer an entirely new dimension to thinking about currency crises. sajems ns 6 (2003) no 3 567 the possibility of multiple equilibria come about when participants, irrespective of whether current policy is compatible with an indefinite maintenance of a currency peg or not, anticipate that a successful attack will alter policy. in this case it is expected future fundamentals, conditional and absent an attack, rather than current fundamentals, that are incompatible with the peg. thus two equilibria exist: the first featuring no attack, with no change in fundamentals and indefinite maintenance of the peg. the second, features a speculative attack followed by a change in fundamentals so that the exchange rate-change speculators expected, occurs ex post. obstfeld (1986) set pre and post crisis policies arbitrarily if the attack is successful, the government simply adopts a more expansionary policy. it was this arbitrary contingent policy process that was the obvious limitation to his model. in later papers bensaid and jeanne (1993), ozkan and sutherland (1995) and obstfeld himself (1995) proposed models of optimizing governments who find it in their self-interest to follow the kind of contingent policy processes that would give rise to multiple equilibria and self-fulfilling attacks. these analyses build on exchange rate escape clauses, where it is optimal for the currency peg to be maintained under certain conditions and abandoned otherwise (c.f., obstfeld, 1991; de kock & grilli, 1993; drazen & masson, 1994). the behaviour of governments in these models still derives from special utility functions, the literature on multiple equilibria and self-fulfilling attacks being simply examples and special cases. krugman (1996) emphasizes this point establishing two further results. the first being that multiple equilibria are ironically less likely when the fundamentals are wrong. this is because when fundamentals are clearly inconsistent with the prevailing currency peg, investors have little doubt that a crisis, as a selfcorrecting device, will occur, hence the model quickly converges to equilibrium as the currency is attacked and devalued. however, when fundamentals are good, multiple equilibria about whether a crisis will eventually result, exist. the second result is that if the authorities preferences are not publicly known the market may test to see its reaction. thus attacks, that although they are unsuccessful, will result just so that information on authority preferences will be revealed. models of self-fulfilling attacks imply that good fundamentals may not be enough to avert currency crises. to prevent an attack unjustified by fundamentals, the central bank�s credibility must be such that the markets estimate that a relaxation of monetary policy once the peg is abandoned is improbable. obstfeld (1986) provides such an example, where the risk of a selffulfilling attack is actually eliminated because the central bank reacts to a crisis by implementing a policy that implies exchange rate appreciation. sajems ns 6 (2003) no 3 568 4 how crises may spread contagiously as was stated earlier, very little theoretical work analyzing the conditions under which currency crises spread contagiously has been conducted. gerlach and smets (1995) provided the first systematic theoretical treatment of this question. inspired by the links between the fall of the finnish markka in 1992 and the subsequent attack on the swedish krona, they considered a two-country model linked together by trade in merchandise and financial assets. in their model, a successful attack on one exchange rate led to its real depreciation, thus enhancing the competitiveness of that country�s merchandise exports. this produced a trade deficit in the second country, a gradual decline in its central bank�s international reserves and thus ultimately an attack on its currency. the second channel for contagious transmission is the impact of the crisis and depreciation in the first country on the import prices and overall price level in the second. post-crisis real depreciation in the first reduces import prices in the second. this, in turn, reduces its consumer price index and money demand by its residents. the foreign reserves of the central bank are subsequently depleted by their efforts to swap domestic currency for foreign exchange. by doing this the second country is shifted from a no-attack equilibrium, where, because it has reserves more than sufficient to absorb the volume of prospective sales no grounds exist for a speculative attack, to a second equilibrium where an attack will succeed, giving speculators the incentive to launch it. andersen (1994) developed a similar argument building on an escape-clause model of exchange rate policy. in his model, a shock from outside the currency market causes the government to abandon its currency peg. following barro and gordon (1983) an exogenous deterioration in domestic competitiveness which increases domestic investment may provide authorities with an incentive to opt for a more expansionary policy in order that unemployment is reduced due to surprise inflation. andersen uses this reasoning to provide a plausible description of exchange rate policy in northern europe in 1991-1992 when the collapse of soviet trade with the nordic countries first aggravated unemployment in finland, leading that government to a more expansionary policy that involved abandoning its peg, subsequently spilling over to the exchange rates of scandanavia. buiter et al. (1996) used an escape-clause model of exchange rate policy to analyse the spread of currency crises in a system of n + 1 countries, n of which (called the �periphery�) peg to the remaining country (the �centre�). the centre is assumed to be more risk averse than the others and hence unwilling to pursue a cooperative monetary policy designed to stabilize exchange rates. a negative shock to the centre leads it to raise interest rates thus inducing the members of the periphery to reconsider their currency-pegging policy. if the members of the periphery cooperate, they may find it in their collective interests to leave the sajems ns 6 (2003) no 3 569 system, which would be considered an extreme case of contagion. more commonly, it would be some subset of peripheral countries, primarily those with the least tolerance for high interest rates, who would find it optimal to leave the system under these conditions, thereby limiting the contagion to this subset. as a spin-off their decision to leave actually stabilizes the currency pegs of the remaining members of the system. this comes about because monetary expansion and currency depreciation by some members of the periphery provides the centre country, which would, by then, have an overvalued currency, with the incentive to relax its monetary stance and in so doing relieves the pressure on the remaining members of the periphery. under this second scenario, contagion is selective: the shock to the centre spilt over negatively to some members of the periphery but positively to others. goldfajn and valdès (1995) focused on the role of illiquidity in financial markets. an important feature of their model was the introduction of financial intermediaries. these authors demonstrated that, in the presence of such intermediaries, small disturbances could provoke large-scale currency runs. this is because intermediaries supply liquid assets to foreigners unwilling to commit to long-term investments; that is, they provide maturity-transformation services. the volume of capital inflow is augmented by their offering attractive terms on liquid deposits. however, when, due to exogenous factors, investors withdraw their deposits, intermediaries unable to costlessly liquidate their assets face the risk of failure. thus a bank run can produce a self-fulfilling banking crisis (c.f., diamond & dibvig, 1983), just like a currency run can provoke a self fulfilling exchange rate crisis. further, the run on intermediaries can spill over into a run on the currency as foreign investors withdraw their deposits and convert them into foreign exchange. as investors who experience liquidity problems in one country typically respond by liquidating their positions in other countries, these crises can spread contagiously. on the subject of information, though not primarily concerned with foreign exchange contagion, shiller (1995) provides a model in which financial market participants share access to much of the same information (e.g., what appears on reuters screens) but interpret and process it differently. what they make of the information depends on their own experience, which has been shaped by the local conditions that they faced uniquely. thus, one market�s reaction to a piece of new information may provide a signal about its global implications. it could suggest to traders in other markets how they to should react. the fact that a particular market draws dramatic conclusions from some information may overcome local culture in other markets leading to a revision of expectations (an �information cascade�). applying this reasoning to speculative attacks, one can see how this effect could lead to an attack on one exchange rate that would prompt traders in other currency markets to attack those exchange rates as well. sajems ns 6 (2003) no 3 570 caplin and leahy (1994) further this analysis with market participants expecting a crisis but having different priors about its timing. it is costly for traders to take a position in advance of a crisis by moving too early. each is unsure whether others share his/her belief that the crisis will eventually occur. whilst they may exchange �cheap talk� amongst themselves they only draw inferences from actual positions taken in the market. the result is �business as usual� with market conditions being normal without a hint of crisis until it suddenly erupts. however, as soon as it occurs, market participants all claim that they had anticipated the crisis and indeed had readied themselves for the eventuality, displaying wisdom after the fact. the utility of this analysis is that it shows how contagion, arising as a crisis in one part of the world, validates individually held suspicions in other markets. applying this model to the ems crisis of 19921993 begins by recognizing that there was a widespread belief at the time, that the ems could not sustain its operations without realignment. yet because it was extraordinarily stable since january 1987, traders were led to accept the official view that the system could function without further realignments. the political difficulties of ratifying the maastricht treaty then trigged the crisis, culminating in the devaluation of the italian lira, confirming the belief and revealing to all traders that what they had believed all along about realignments still being necessary, was true. 5 empirical studies of speculative attacks although the literature on crises in foreign exchange markets is full of models suggesting motives for and dynamics of how speculative attacks occur, the process of systematically testing these predictions has barely started. while there may be many convincing studies of currency crises assembled from biased samples of episodes, there is very little that could be termed systematic analysis. there are two main limitations to the studies currently available. it is not only that they consider a selective sample of episodes in which currency pegs collapsed without confirming that the collapses are representative of the underlying population. rather, and more importantly, most of the episodes where currency pegs were abandoned are themselves inherently unrepresentative of the speculative attack population. pegs may have been abandoned without a speculative attack; others may even have been repelled. hence studies like dornbusch et al. (1995) and krugman (1996) although being quite informative about the characteristics of the actual episodes they analyse, do not provide a representative characterization of speculative attacks. the first systematic analysis of currency crises must be eichengreen et al. (1995) where a measure of speculative attacks was constructed. that measure excluded devaluations and flotations that occurred away from climates of crises sajems ns 6 (2003) no 3 571 as well as included unsuccessful attacks. these were then compared with actual devaluations and other exchange rate arrangement changes. the measure of crises was a weighted average of changes in the exchange rate, changes in international reserves available to pay out in response to speculative pressures, as well as changes in the interest rate differential, since interest rates are often used to fend of an attack. these authors findings on the causes and consequences of devaluations and revaluations were all consistent with the predictions of mainstream models. countries that devalue experience problems of external balance in the period prior to the event. their trade deficits and reserve loses are associated with relatively expansionary monetary policies. moreover, the period leading up to devaluation is characterized by problems of internal balance, which show up as high levels of unemployment. and in fact, the expansionary monetary stance of these countries could well have been chosen (at least partly) in response to these domestic concerns. broadly speaking, revaluations were mirror images of devaluations. in contrast, other foreign exchange market events resisted generalization. for instance, transitions between exchange rate regimes (such as movement from fixed to floating) were found to be largely unpredictable. countries whose governments had pursued accommodating monetary policies leading to high inflation and reserve loses, generally in response to deteriorating conditions on the employment front, were more susceptible to crises. the current account moves initially into deficit and the capital account worsens as the crisis nears. countries that respond quickly by reducing the rate of monetary growth do sometimes succeed in defending the rate. those retrenching less dramatically may still have to recapitulate but often are able to do so without provoking a major crisis. however, those countries that rely on sterilized intervention to the exclusion of more fundamental policy adjustments are generally unable to avoid a full-blown currency crisis. other studies, moreno (1995) for example, has also followed this approach. he analysed crises in the pacific basin economies from 1980 through 1994 and found that periods of speculative pressure tend to be associated with large budget deficits and rapid domestic credit growth rates. he also presented evidence that when slow growth and relatively high inflation make it difficult for authorities to maintain a stable exchange rate, this enhances speculative pressure. however, there was no evidence that external balance indicators differed between crisis and tranquil periods. kaminsky and reinhart (1996) considered speculative attacks on currencies and banking crises, analysing the relationship between the two. they focused on 20 countries in asia, europe, latin america and the middle east that experienced banking difficulties between 1970-1995. their index of currency crises was sajems ns 6 (2003) no 3 572 constructed as a weighted average of exchange rate changes and reserve changes (as relevant interest rate data was lacking for some countries). in their sample crises tended to be preceded by declining economic activity, weakening export sectors, falling stock markets and high real interest rates. moreover, crises were also preceded by accelerating money growth and rapid banking system liability growth rates. while banking crises were leading indicators of currency crises, there were few instances where currency crises predicted banking crises. as stated earlier empirical analysis of contagion is sparse. mainly the studies that do exist provide informal comparisons of small groups of countries. burki and edwards (1995) for instance contrast the experiences of argentina, chile and columbia following the mexican crisis with those of chile and columbia, holding that while contagion was present it was nevertheless selective. calvo (1996) compares mexico with other countries in an effort to ascertain why some countries were more susceptible than others to the tequila effect. the econometric model calvo and reinhart (1995) built, reported evidence of contagion where capital flows to four small latin american countries depend not only on the standard determinants but also on a contagion proxy, that being capital flows to four large latin american countries. as capital flows to neighboring countries are a less-than-ideal proxy and the sample was not randomly selected their results can be questioned. schmukler and frankel (1996) modeled contagion using data on closed-end country funds. their dependent variable, stock price level, differed from that employed by eichengreen et al. (1996) who used an indicator variable that took on a value of unity for a speculative attack or zero otherwise, the two are linked in that a rise in domestic interest rates needed to fend off a currency attack should depress equity prices. the schmukler and frankel study found evidence that suggested investors differentiated among countries to a greater extent after the 1994 mexican crisis than after its 1982 predecessor. in the short run a drop in mexican prices tended to induce sell-offs in other markets motivated by the desire to raise cash. interestingly, while evidence of contagion in latin america in the long run was present as well, the long-run effect of a mexican sell-off on asian markets was positive. in the eichengreen et al. (1996) paper, contagion was thought of as an increase in the probability of a speculative attack on a domestic currency that does not arise from domestic fundamentals such as money or output but from the existence of a (not necessarily successful) speculative attack elsewhere in the world. a panel of quarterly macroeconomic data from twenty industrial countries was analysed from 1959 to 1993. their measure of speculative pressure was a weighted average of exchange rate changes, reserve changes and interest rate changes. they made use of a binary probit model linking their sajems ns 6 (2003) no 3 573 dependent variable to controls with maximum likelihood, including additional regressors to capture the effects of macroeconomic and political influences which affect crisis incidence. their net was cast quite widely and included the presence of capital controls, electroral victory or defeat of the government, domestic credit growth, inflation, output growth, employment growth, the unemployment rate, the central government surplus/deficit (as a percentage of gdp) and, the current account surplus/deficit (again as a percentage of gdp). germany was used as the central country. they found that �a speculative attack elsewhere in the world increases the probability of a domestic currency crisis by around 8 percentage points� (emphasis added). the impact of the other regressors was not dramatic, though a few observations are worth noting. for instance, higher inflation and unemployment are associated with increases in the odds of an attack. still, the absence of robust partial correlations provides grounds for caution against over-interpreting the results. despite the fact that the authors employed a battery of empirical specifications that failed to reject, at quite high levels of significance, their hypothesis of contagion, their study was unable to distinguish the effects of crises in neighbouring countries from the effects of global shocks. a limitation they acknowledge themselves. 6 conclusion this study set out to answer the question of whether it is possible to conclude that contagion does actually exist. although the possibility of contagious currency crises is an important issue for policy makers and global investors alike, the question goes right to the heart of the limitations of the existing research. thus while both theoretical and empirical studies on foreign exchange market crises were appraised and the literature does provide many theoretical models which highlight motives for and dynamics of speculative attacks on pegged currencies as well as the potential channels of transmission, sadly it has found that empirical work lags far behind. while case studies of contagion are available, there seems to be little in the way of systematic empirical analysis. certainly, not enough to demonstrate convincingly that contagion does really exist. epidemiologists would find this situation quite familiar, where they must decided whether the spread of a virus reflects the contagious nature of the germ or the disease-conducive nature of the environment. [south africans have already had much exposure to this kind of dilemma in the: does hiv cause aids debate?]. due to the high stakes at risk this paper recommends that the phenomena of weak domestic fundamentals should not be allowed to obscure the existence of contagion. just because a medical epidemic is more likely to strike those with weaker health, makes it nonetheless an epidemic. and after all, sajems ns 6 (2003) no 3 574 history does have a habit, ex post, of looking inevitable. epidemiologists normally deal with their situations by placing additional structures on the problem. similarly, further work in this area might be to ask whether countries with close macroeconomic and trade ties are more susceptible to contagion. currency crises in neighbouring countries could then be weighted by measures of such economic proximity. this approach might better distinguish between what the financial community is already labeling contagion, from what more conservative economists regard simply, as the effects of common unobservable shocks. till then the question must, at best, remain unanswered. references 1 andersen, t. (1994) �shocks and the viability of a fixed exchange rate commitment�, centre for economic policy research discussion paper 969: london. 2 barro, r. & gordon, d. (1983) �rules, discretion and reputation in a model of monetary policy�, journal of monetary economics, 12: 101122. 3 bensaid, b. & jeanne, o. (1993) the instability of fixed exchange rate systems when raising the nominal interest rate is costly, unpublished manuscript, enpc-caras: paris. 4 bordo, m.d., mizrach, b. & schwartz, a.j. (1995) �real versus pseudo-international systemic risk: some lessons from history�, national bureau for economic research working paper, 5371, cambridge, mass. 5 buiter, w., corsetti, g. & pesenti, p. (1996) financial markets and international monetary cooperation, cambridge university press: cambridge. 6 burki, s. & edwards, s. (1995) latin america after mexico: quickening the pace, unpublished manuscript, world bank: washington, d.c. 7 calvo, g. (1995) �varieties of capital market crises�, centre for international economics working paper, 16, university of maryland, college park. 8 calvo, g. & reinhart, c. (1995) capital inflows to latin america: is there evidence of contagion effects, unpublished manuscript, world bank & international monetary fund: washington d.c. 9 calvo, g. (1996) capital flows and macroeconomic management: tequila lessons, unpublished manuscript, university of maryland � college park: maryland. 10 caplin, a. & leahy, j. (1994) �business as usual, market crashes and wisdom after the fact�, american economic review, 84: 548-65. sajems ns 6 (2003) no 3 575 11 de kock, g. & grilli, v. (1993) �fiscal policies and the choice of exchange rate regime�, the economic journal, 103: 347-56. 12 diamond, d. & dibvig, p. (1983) �bank runs, deposit insurance and liquidity�, journal of political economy, 91: 401-19. 13 dornbusch, r., goldfajn, i. & valdes, r. (1995) �currency crises and collapses�, brookings papers on economic activity, 2: 219-95. 14 drazen, a. & masson, p.r. (1994) �credibility of policy versus credibility of policymakers�, quarterly journal of economics, 1: 109: 735-54. 15 edwards, s. (1989) real exchange rates, devaluation and adjustment: exchange rate policies in developing countries, mit press: cambridge, mass. 16 eichengreen, b., rose, a.j., & wyplosz, c. (1995) �exchange market mayhem: the antecedents and aftermath of speculative attacks�, economic policy, 21: 249-312. 17 eichengreen, b., rose, a. & wyplosz, c. (1996) �contagious currency crises: first tests�, scandanavian journal of economics, 98: 463-84. 18 eichengreen, b. (1999) toward a new international financial architecture, institute for international economics: washington, d.c. 19 fischer, s. (1999) �reforming the international financial system�, the economic journal, 109: f557-f567. 20 flood, r. & garber, p. (1984) �collapsing exchange rate regimes: some linear examples�, journal of international economics, 17: 1-13. 21 gerlach, s. & smets, f. (1995) �contagious speculative attacks�, european journal of political economy, 11: 45-63. 22 goldfajn, i. & valdès, r. (1995) balance of payments crises and capital flows: the role of liquidity, unpublished manuscript, michigan: mit. 23 kaminsky, g. & reinhart, c. (1996) the twin crises: the causes of banking and balance-of-payments problems, unpublished manuscript, federal reserve board and international monetary fund: washington, d.c. 24 krugman, p. (1979) �a model of balance of payments crises�, journal of money, credit and banking, 11: 311-25. 25 krugman, p. (1996) �are currency crises self-fulfilling?� in: nber macroeconomic annual, national bureau for economic research: cambridge, mass. 26 meese, r. & rogoff, k. (1983) �empirical exchange rate models of the 1970s: do they fit out of sample?�, journal of international economics, 14: 3-24. 27 moreno, r. (1995) �macroeconomic behavior during periods of speculative pressure or realignment: evidence from the pacific basic sajems ns 6 (2003) no 3 576 economies�, economic review of the federal reserve bank of san francisco, 3: 3-16. 28 obstfeld, m. (1986) �rational and self-fulfilling balance of payments crises�, american economic review, 76: 72-81. 29 obstfeld, m. (1991) �destabilizing effects of exchange rate escape clauses�, national bureau for economic research, working paper, 2603: cambridge, mass. 30 obstfeld, m. (1995) �international currency experience: new lessons and lessons relearned�, brookings papers on economic activity, 2: 119220. 31 obstfeld, m. & rogoff k. (1995) �the intertemporal approach to the current account�, in grossman, k. & rogoff, k. (eds.) handbook of international economics, 3, amsterdam: north-holland. 32 ozkan, g. & sutherland, a. (1995) �policy measures to avoid a currency crisis�, the economic journal, 105: 510-19. 33 schumukler, s. & frankel, j. (1996) crisis, contagion and country funds, unpublished manuscript, university of californiaberkeley, california. 34 shiller, r. (1995) �conversation, information and herd behavior�, american economic review � papers and proceedings, 85: 181-85. 35 wolf, h.c. (1998) �determinants of emerging market correlations� in: levich, r. (ed.) emerging market capital flows, kluwer academic publishers: london. sajems ns vol 4 n03 426 the demography of globalisation j l sadie department of economics, university of stellenbosch abstract demographic globalisation, as the counterpart of economic globalisation, is interpreted as the movement towards a state depicted as the "global village" where there are no official impediments to the cross-border movement of people. such movement is posited as the outcome of inter-country disequilibria which determine the levels of the propensity to migrate. relevant problems are addressed such as whether the international trade in goods and services can serve as substitute for migration of labour (accompanied or unacompanied by dependents); demographic complementarity between more and less developed countries; the type of labour demanded by countries of immigration; demographically perverse migratory flows; the socio-economic problems ensuing from the formation of numerically strong ethnic minorities in host countries; and what the outlook is for the realisation, in demographic terms, of a global village mode. 1 the substance of globalisation globalisation is interpreted to depict the process of which the end result is the global village where national boundaries will have no significance for the movement of four of the five factors of production (the fifth being natural resources which are locality bound), and their outputs (goods and services), as well as human beings not subsumed under labour and entrepreneurship. that is, their movement will be unfettered by non-market forces as designed and enforced by national governments; which does not mean that there could not be legislation (such as labour laws) which does not discriminate between foreigners and natives, but which can nevertheless militate against the economic accommodation of the former. in the year 2001 the process is by no means complete, neither in its economic nor in its demographic (movement of people) connotation. when the governments of affluent communities, for example, raised their agricultural subsidies from $250 billion in 1999 to $330 billion in 2000 (de lange, 2000) they did not comply with the spirit of the rules negotiated in the uruguay round which led to the establishment of the world trade organisation. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 427 sajems ns vol 4 (2001) no 3 and there is hardly a country which does not pursue a restrictive immigration policy. however, even if the demonstrations in seattle and prague could be seen as harbingers that the heady days of (economic) globalisation are over, it would seem to remain the driving force in the world economy (international business week 2000: 136). and the authors of the age of migration believe that the globalisation l , the acceleration, the differentiation, the feminisation and politicisation of migration are going to playa major role during the two decades to come (castles & miller, 1998: 8-9). "there can be few areas today which are not profoundly affected by the growing global migratory flows" (ibid: 103). an analysis by the international labour office is reported to have revealed that between 1970 and 1990 the number of countries classified as major destinations of labour migrants rose from 39 to 67, at the same time as the number of countries identified as major international suppliers of labour increased from 29 to 55 (world of work, 2000: 7). by 1996 there would have been in excess of 100 million people living outside their country of birth (un, 1997), rising from 75 million in 1965 to more than 120 million in the year 2000 (world of work, 2000: 7). and as far as involuntary movement across national boundaries is concerned we have the pronouncement that "mass forced migration is a child of the global era, and promises to be a prominent feature of world affairs" (kiely & marfleet (eds.), 1998: 85). leaving out of consideration the small minority of persons who move internationally to avoid taxes or escape harsh winters, migrants can be classified into two categories in terms of the push/pull paradigm: (i) economic migrants, permanent or temporary, legal and illegal, accompanied or followed or not by their families and distant relatives; and (li) refugees, whose movement does not result from a considered choice, and is driven by the necessity to flee their countries by reason of hostilities or oppression which put their lives in jeopardy. those referred to in the literature as eeo-refugees appertain to the first rather than the second category. the pull is the dominant force in respect of the first category, while the push element predominates in the second, though rarely does anyone operate in isolation. migratory movement can be considered to originate in a situation captured in the disequilibrium: in which the 0 and d subscripts indicate countries of origin and destination respectively, w stands for wage or income level, p for the probability of securing a livelihood and s for the social or socio-political environment, with the values r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vo14 n03 428 of p and s varying from 0 to 1. in the case of refugees the value of so will be zero, while for economic migrants the perceived value of sd is likely to be lower than so, but wd or wdpd will compensate for that. in the global village state there will, of course, be no difference in the treatment meted out to the two categories. illegal immigration will no longer exist, while the refugee and the economic migrant will have the same status in the recipient countries. since the need for clandestine entry into countries of destination will disappear, the trade in human cargo, which often claim lives, should end. "tighter borders" wrote the economist "encourage dangerous smuggling of people by criminal gangs who pack hapless travellers into rusty ships, airtight lorries and even beside the wheels of the paris-london eurostar" (2001, march 31: 11). asylum-seekers have suffocated or starved to death in airtight trucks and containers and hundreds who had attempted to land on the mediterranean coastline, drowned (kiely & marfleet, 1998: 83). still, after constraints imposed by government policies have been removed, some others will remain, such as the problem of the economics of distance and inadequate knowledge about prospects in foreign countries. the former has, over the years, lost some of its inhibiting effects as a result of the expansion of the transport systems and the phenomenal drop in the cost of air transport and telephone conversations (y.iorld of work, 2000: 4-7). the latter is being attenuated by recruitment agents, historical links (such as those emanating from onetime colonialism), feedback from preceding emigrants, and other support networks, which means that the process of cumulative causation is likely to continue its reinforcing effect to boost the migratory flows. but, whether voluntary or involuntary, planned or unplanned, the breadwinners among those moving across national borders expect to become members of the labour force of the recipient countries, while the un secretariat, population division, has called labour migration "the most inclusive category of population movement" (1992: 1). also, asylum seeking is a phenomenon which cannot be subj ected to the kind of stochastic analysis permitted by deliberate choice migration. at the beginning of the 1990s there were some 17 million refugees most of whom found asylum in the lesser developed regions (shah, 1998: 220), (quite likely because of the latter's proximity to the areas of origin). accordingly, the movement of the factor of production, labour, shall be regarded as a proxy for migration, which factor can then be considered in juxtaposition with the other four: entrepreneurship, capital, technology and natural resources. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 429 sajems ns vol4 (2001) no 3 2 international trade as substitute for international migration the question can then be posed whether the international movements of the outputs produced by the combination of those factors cannot act as substitute for the migration of labour; that is, whether economic globalisation cannot serve the purposes of demographic globalisation, thus obviating the necessity for the latter. for this to materialise, international trade would have to raise the marginal product onabour, and its remuneration, in the countries of emigration (e) to that of the areas of destination (i), to remove the incentive to migrate. the simplest exercise involves contrasting less developed, low income, regions (ldrs) with youthful fast-growing populations and labour forces, and more developed, high income, regions (mdrs) with slow-growing populations which had already undergone a considerable degree of aging. the former would, ceteris paribus, be the potential source of emigration to the latter because of a desire to improve life chances associated with the higher remuneration oflabour in the latter. if, now, countries were to apply the endo\vment of their factors of production in accordance with their relative scarcity or abundance, the ldrs would produce and export labour-intensive goods and services to the mdrs, while importing from the ldrs capital-intensive products. in the former labour becomes less abundant with a consequential rise in its price, while capital is rendered less scarce. the reverse occurs in the latter. the gap, between the two, in the remuneration of labour is narrowed or closed, and the intensity of the inducement to translocate is reduced or rendered inoperative. the outcome is in line with the heckscher-ohlin model. its realisation will, however, depend upon the real world compliance with certain conditions: each of the factors of production has to be of similar quality in the e and i countries; factor intensities differ unchangingly from one product to the next; the production function of a tradeable is identical in the two categories of countries; competition prevails which allows the supply of production factors to influence their remuneration; trade reversals do not occur because of changes in domestic demand stemming from population growth, for example; trade does not induce complete specialisation, the ldrs and mdrs producing some of all the products traded. in real life these conditions are seldom, if ever, satisfied. arguably the most basic of all inhibiting factors and constituting a barrier that cannot be surmounted by international trade, or which pre-empts the realisation of the required volume and composition of such trade, is the difference in the economic quality of the respective populations as represented by the human capital and enterprising content of the labour forces. of the two human factors of production comprised in the labour price labour and entrepreneurship it is the disparity in the endowment of the latter which is of cardinal importance. the i countries' paramountcy in this regard is of the order of 6+ to i (sadie, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 3 430 2000: 188). emigrants, regardless of whether they might become employees or self-employed in their host country would be attracted to those destinations where supplies of entrepreneurship produce the required or perceived economic opportunities as reflected in the size and growth of the gdp, per capita, or in toto. the arrearage of e countries in respect of this fans et origo of economic growth and development spells an insufficiency of enterprise to produce the tradeable goods and services required, or to create job opportunities adequate to prevent large scale unemployment and/or underemployment and poverty. an inducement to trans locate is forever present. the inducement is likely to be strengthened by economic globalisation since its rules are calculated to eliminate the protection which the infant entrepreneur a characterisation which applies particularly to those in the ldrs might otherwise have enjoyed. the emergence of more of those potential generators of employment will be inhibited, and more members of the labour force will need to seek accommodation in mdrs. if e countries have well-educated and -trained labour, whose potential comparative advantage is not negated by wage levels not related to volume of supplies, they may attract entrepreneurs from i countries whose employment creation will reduce the inducement and the outward movement. this may not find favour with the seattle demonstrators who believe that multinationals exploit third world workers and pollute the environment (steyn, 2000: 9). another source of attraction of entrepreneurship and, with it, capital and technology, is the discovery of a rich natural resource, such as oil or one that has become exploitable with profit because of a rise in world prices which can change a labour exporting country into a labour importing one. but this may only effect a change in the direction of the flow of migrants rather than ending or reducing it. the gulf states, for example, became a labour scarce region dependent upon the immigration of egyptians, yemenites, palestinians, jordanians, lebanese, indonesians and others (shah, 1998: 209; un, 1998: 383-91, castles & miller: 116118). saudi-arabia's dependence on foreign labour was estimated at 27 percent of its labour force in 1970, rising to 53 percent in 1980 and to 79 percent by 1985 (un 1998: 209). in the massive flow of migrants, during at least part of the 1840-1930 period from the then developed countries to the less developed world (us report to the president, 1978: 31), we have a demonstration of the attraction of natural resources: wide, open spaces (real and perceived) and/or mineral resources in the united states, new zealand, australia, canada, australia and south africa. in the context of the discussion above the fmdings of two organisations are relevant. the us commission for the study of international migration and cooperative economic development found that in the short run economic development (in e countries) tends to stimulate migration by raising people's expectar ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 431 sajems ns vol4 (2001) no 3 tions and enhancing their ability to migrate. it may take many years, perhaps generations, for development to result in low migration (muus, 1998: 205). the ilo (in workers without frontiers: the impact of globalisation on international migration, 2000) concluded that economic globalisation, for from reducing the international flow of people, is due to intensify migration pressures in the years ahead. "flows of goods and capital between rich and poor countries will not be large enough to effect the need for employment in poorer countries. instead, social disruption caused by economic structuring is likely to shake more people lose from their communities and encourage them to look abroad for work" (world of work, 2000: 4). again, the south tends to perceive the benefits and costs arising from economic globalisation to be favouring the more economically powerful, industrialised north (nel, 2000: 3; leuvenink, 2000: 5). they have been disillusioned about the performance of the world trade organisation. "developing countries that hoped for substantially enhanced market access have been disappointed by slow or no progress when it comes to vital sectors like textiles and agriculture" (mead, 2000: 29). if the north will not relent, it may have to offer freer access oflabour from the south to its labour market, as a quid pro quo. it would seem that, with or without significant economic growth and development in the e countries, prospective migrants would continue to strain at the leash. this applies equally to migration between i countries which offer higher rewards for jobs for which the domestic supply of labour has become inadequate by reason ofa rapid development in a segment of the economy, such as the electronic industry. to judge by south africa's experience, activated demographic globalisation is likely to lead to an increase in temporary migration. professionals who desire to gain some international experience and, at the same time, earn hard currency incomes which are of average level in the host country but, when translated into rand, are much higher than salaries in south africa, accept jobs overseas, for two to three years before returning home. 3 migration promoting demographic complementarity to discover whether there are demographic bases for an expectation or projection of an increased international movement of people, we can investigate the age structures, fertility and mortality of individual or groups of countries. as before, the comparison is between the two categories of communities or regions, ldrs and mdrs. to confine the exercise to an investigation of purely demographic forces, the 15-64 age interval shall be defined as the manpower age group and, accordingly, the potential manpower (which for statistical purposes, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 n03 432 without prejudice, shall refer to males) thus leaving out of consideration labour force participation rates (which reduce manpower to labour force levels). accessions to potential manpower consist of those reaching the age of 15, while separations are made up of deaths among those 15 to 64 years of age, and retirements occurring by virtue of attaining the age of 65. the computations are based on the population projections for 2000 and 2005 by the united nations secretariat in world population prospects volumes i, ii, iii (1999, 2000). the results relating to the mdrs, the ldrs and sub-saharan africa (ssa) are summarised in tables 1 and 2. table 1a age structures mdrs ldrs i ssa a2e i 2000 ! 2005 2000 2005 2000 2005 0-14 i 19,2 i 17,8 32,9 ! 30,7 i 44,7 43,1 15-64 69,1 69,5 62,5 64,4 i 52,7 54,3 65+ i 11,7 i 12,7 4,6 i 4,9 2,6 2,6 ! 100,0 i 100,0 100,0 ! 100,0 i 100,0 100,0 table 1b age structure of age group 15-64, year 2000 mdrs ldrs ssa 15-29 31,3 i 438 52,6 30-49 44,5 i 41,3 35,5 50-64 24,2 14,9 11,9 100,0 i 100,0 100,0 tfr 2000-2005 1,56 i 2,80 5,05 r rate of natural increase 0,12% 1,55% 2,57% sources: adapted from united nanons, 1999,2000; volumes 1, 11, iii it is seen that the mdrs and ldrs have contrasting demographic attributes. at 1,56, the tfr (total f ertility rate) of the mdrs which is below replacement rate is almost half of that of the ldrs. during the three years 1997 to 1999 that of the european union has been 1,45 (sardon, 2000: 730), and the populations of its member countries are either diminishing in number, or are due to decline if they are not supplemented by immigrants. concomitantly, the mdrs have relatively few children and large numbers of elderly people, while the youthful ldrs have large components of children and small numbers of people 65 years and older. the age structure of the manpower age groups themselves reflect the youthfulness of the latter compared to that of the former, with rei ar ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 433 sajems ns vol 4 (2001) no 3 tively large numbers in the age of accession (15-29) and small numbers in the mature age group (50-64). in all these aspects the attributes of the ssa (subsaharan africa) are even more pronounced than those of the ldrs as a whole (and accordingly, of the other members of the ldr category). the above magnitudes can be translated into the components of manpower dynamics by applying coale and demeny's (l966) survival ratios as follows: model north, level 23 for the mdrs, model south level 20 for the ldrs and model south level 13 for the ssa. the results, as represented by the changes between 2000 and 2005, are summarised in table 2. table 2 manpower dynamics: percentage change per annum regions accesse arations co-efficient sions deaths retirement total of replacement mdrs 2,02 -0,48 -1,30 -1,78 113 ldrs 3,44 -0,48 ·0,70 -1,18 291 ssa 4,80 ·0,88 -0,49 -1,37 351 as a result of the relatively low rate of accessions and the high rate of retirement in the mdrs, the rate ofrenewal (or growth rate) of potential manpower is less than one-tenth of that of the ldrs. their co-efficient of replacement =: [ _a_cc_es_s_io_ns_xlooj at 113, is only 39 percent of the ldrs'. whereas the former separations have to generate only 13 extra jobs to accommodate the growth in manpower after filling the vacancies left by death and retirement, the latter have to create 191. in a stationary job market i.e. in which only those replacing the separations will be employed the probability of procuring employment would be 0,88 in the mdrs and 0,34 in the ldrs (all figures are, of course, averages). in ssa countries it will be only 0,28. all the above results reflect a high degree of demographic complementarity between groups of nations which should be conducive to an international movement of labour (accompanied or not by dependants) on a large scale. the conditions for its realisation is that there is to be not only complementarity in respect of skills, but also in regard to demand for them in the respective regions or countries. the first condition represents little or no problem: there are large surpluses oflow-skilled workers in the ldrs compared to the short supply of them in the mdrs. the skills complementarity are in large measure due to the differential population growth: economic resources spent on quantity reduce the amount available for the enhancement of the quality of human resources. in the mdrs there are large supplies of skilled workers whose marginal social product r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 3 434 would be in excess of their marginal private product if they were employed in the ldrs, while within the mdrs the two products would probably be equal. the data in table 3 would appear to bear testimony to the influence exerted, since the 1970s, by the complementarity, in tandem with the liberalisation of admission policies (muus, 1998: 1989). table 3 estimated maximum net migration, annual averages ,1§q=§4 1 965-69 1 970-74 1 975-79 1 980-84 1 985-891 990/9 from mdrs to mdrs 706923 1669144 l572 153 1 171013 i 171324 1 490511 i 180579 from ldrs to mdrs 230 oj 7 1391 850 1654 658 1 762 950 1 890064 939616 . 614887 source: zlotnik, 1994: 362 up to the beginning of the 1970s migration was predominantly between developed countries, but since then the flow from ldrs to mdrs accounted for the major proportion. asylum-seekers, most of whom originated in the ldrs, would have made some contribution, though they tended to move to equally poor neighbouring countries in the first place. the un high commission for refugees estimated that their numbers rose from two million in total during the late fifties to 27 million by 1995 (kiely & marfleet: 70). skills differentials would function in harmony with demographic complementarity if the rising per capita income of the mdrs continue to lead to increasing demand for immigrants who are prepared to accept the arduous and menial jobs at low rates of remuneration which indigenous workers if the receiving countries are increasingly reluctant to consider. rising affluence changes life styles, inducing more leisure to be bought, and leading to a revival of the demand for domestic servants (and entertainers) which favours the immigration of females, eliciting the characterisation of the feminisation of international migration. this has been promoted, it has been argued, by the inferiority ascribed to women in patriarchal societies in countries of departure, which rendered them more docile as workers than men and would be paid lesser wages (phizaklea, 1983: 5). it has been maintained that the usa, for example, is far more attractive to poorer and less privileged mexicans than it is for the mexican middle class (castles & miller, 1998: 90). in germany's reconstruction after the second world war the mass production methods required large numbers oflow-skilled workers, the so-called gastarbeiter. lately, however, demand for labour in countries of destination has become a force functioning perversely to demographic complementarity. the technological revolution, and lt. in particular, has been responsible for not only the burgeoning of the "new" or knowledge economy, but has profoundly affected the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 435 sajems ns vol 4 (2001) no 3 "old" economy as well. brainpower rather than manual dexterity in manipulative operations is the essential input (islam, 2000: 20). germany and the united kingdom, for example, have schemes in operation to attract high-tech labour. the uk, according to the economist (2000, sept: 49) now admits foreign entrepreneurs who have nothing to declare but a good business plan previously they had to bring in £200 000 with them and this policy is attributed to the declining fertility and mortality. and the usa immigration act of 1990 was aimed at increasing the flow of highly skilled foreigners. it has been estimated that in germany over a period of little more than a generation, some two million jobs for unskilled workers can be dispensed with while 3,4 million new skilled jobs can be generated (castles & miller, 1998: 168). while in south africa the employment of skilled workers is steadily increasing the numbers of lesser skilled labourers employed are forever diminishing (statistics sa, 1998). the resulting movement of people is not only between highly developed economies, but involves also an outflow of high level manpower from the ldrs to the mdrs: the so-called brain drain. the population component in scarce supply is rendered still scarcer. the human capital which costs the ldrs millions to generate is, in effect, being offered as a gift to the mdrs. in britain, for instance, public hospitals are heavily dependent upon nurses and doctors from africa and india. the un has estimated that africa had lost 60 000 doctors, engineers and other professionals between 1985 and 1990, succeeded by an annual outflow of 2000 ever since (population today, 2000: 5). globalisation is, at a minimum, unlikely to reverse the movement. the flow of migrants (preponderantly illegal) to south africa from neighboring states appears to be in contradiction to the demographic circumstances. though the tfr and growth of its population are lower than those in the rest of the ssa, it is stili fairly youthful with a large contingent of unskilled workers who are unemployed. this, evidently, does not deter large numbers of unskilled foreign africans from entering the country. to them the value of wdpdsd is obviously sufficiently in excess of woposo to act as an inducement. to its neighbours west, east and north south africa, with its comparatively abundant entrepreneurial endowment, must have the semblance of an affluent country whose gdp per capita is 9,0 times and its aggregate gdp 3,2 times those of its 10 neighbours put together (imf, 2000; s.a. institute of race relations, june 2001: 6). if they cannot secure paid employment, the alternatives such as street hawking, peddling and other services still offer relatively attractive perceived opportunities. demographic globalisation is likely to tum this flow into a flood. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 3 436 4 replacement immigration the population division of the un secretariat undertook a study to detennine how much replacement in immigration would be required to offset the demographic effects of below-replacement fertility and of aging in a number of developed countries over the period 2000-2050. in three scenarios the following objectives were posited: i constant total population; ii constant age group 1564; and ill constant potential support ratio (n 15-t>jn65+). table 4 required replacement migration to satisfy three objectives (annual average 2000-2050) country i 11 111 france 29000 109000 1792 000 gennany 344 000 487000 3630000 italy 251000 372 000 2268000 japan 343000 i 647000 10471 000 republic of korea 30000 ! 129000 10256 russian federation 498000 715000 5068000 united kingdom 53000 125000 1 194000 united states 128000 359000 11 851 000 total 1676000 2943000 138837000 source: un secretanat, june 2000: 3 it will be seen that the demands upon immigration increase as the objective shifts from i to ii and to iii: to keep the population size constant 1 676 000 immigrants per annum would be sufficient to compensate for a projected decline in numbers arising from inadequate natural increase, and should not present an insurmountable problem. the number is almost doubled when the manpower age group has to be maintained in numerical strength, and when the psr has to be kept constant the required number of immigrants rises by a factor of 47. the latter entails "vastly more immigration than occurred in the past ... [and] seems out of reach ... " (un 2000 secretariat, 2000: 5). however, the psr could also be maintained in the absence of migration were the upper limit of the manpower age group to be raised from 65 to 75. this cannot, of course, guarantee that the size of it labour force would increase proportionally. given the propensity to emigrate and assuming demographic globalisation to be implemented, while the value of so is not very high and of sd not inhibitingly low, ldr and mdr demographic complementary as such should allow the realisation of objectives i and ii, and meet some of the migratory demands of objective iii. according to our exercise whose results were summarised in tables i r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 437 sajems ns vol 4 (2001) no 3 and 2, the manpower age group of the ldrs would be expanding at a rate of 34 892 000 p.a. during 2000-2005, adding millions to the unemployed/underemployed (males), compared to 949 000 p.a. for the mdrs. the total number of migrants involved in the movement of members of the manpower group would, of course, be boosted by a factor of two or more arising from the accompaniment of families and other relatives. however, in the last resort, demographic complementarity is not a sufficient condition for the attainment of the above, or similar, objectives. the propensity to migrate has to be appropriate, and an assumption of unlimited international mobility of people would be flawed. except in the case of asylum-seekers (a zero value for so) the lower value of sd compared to so, and the economics of distance would hold the propensity in check. migratory flows under conditions defined by the global village state will facilitate the estimation of its level(s). in 1998 the southern africa migration project attempted to collect some information about the phenomenon among a sample of skilled workers in south africa. four questions were asked ranging from the most general to the most pertinent ones relating to the desire or propensity to emigrate: 1. the degree of thought given to leaving the country: more than two-thirds responded positively and 38 per cent declared that they had given it a great deal of thought; 2. a strong desire to leave for a period of two years or more: 28 per cent; 3. how likely is the wish to be translated into reality? 3 per cent said they would leave within six months, 5 per cent within the ensuing two years while 13 per cent asserted that they were "very likely" to leave within 5 years; 4. how many had already started to prepare for emigration? 6 per cent had applied for work permits overseas, 6 per cent had applied for permanent residence in a foreign country while 3 per cent had put in applications for foreign citizenship (mattes & richmond, 2000: 10-20). such a variety of probing questions and of responses leaves us with a great deal of uncertainty about the intensity of the intentions to emigrate. since it is a function of knowledge of prospects abroad, there is also likely to be a difference in this regard between skilled and unskilled workers. uncertainty is heightened when regard is had to the disparity in numbers of south africans registered as emigrants by statistics sa and the numbers who have settled overseas as reported by the five recipient countries: united kingdom, usa, canada, new r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (200 i) no 3 438 zealand and australia. the respective figures for the period 1989-1997 are 82 811 and 233609 (brown et ai., 2000: 41-47). looked at from the point of view of the ldrs, in light of the above magnitudes, and taking into account the probable propensity to emigrate, the moot question is whether demographic globaiisation is likely to make a significant difference to the pressure of population or overpopulation ~ at given levels of economic development of these regions. the disparity between the two categories of regions is so vast that the answer must be in the negative. the un has estimated that the estimated 9,9 million (net) migrants to the more developed regions during 1995-2000 would have accounted for 61 percent of population growth in that part of the world, but would have reduced it in the rest of the world by no more than 2,6 per cent (2000, vol i i 1: 128). the only effective remedy appears to be economic development in the ldrs coupled with a curbing of fertility. poverty is likely to endure. 5 socio-economic accommodation in recipient countries the kind of socio-economic accommodation of immigrants in the recipient countries seems to be a function of their occupational status. the buzz words in this connection are the "wired" and the "unwired", the former referring to the intelligent and well-educated migrants and the latter to the lesser skilled who do not participate employment-wise in the technological revolution. globalisation is particularly beneficial to the former, the majority of whom are likely to hail from countries of a western orientation and to be going to countries with a similar culture. they are assimilated with facility, most of them disappearing into the middle class multitudes of the host communities. the movement of the lesser skilled would involve, for the most part, a trek from the south to the towns and cities of the north. they would have been nurtured in cultures different from those of the recipient countries, would be operating in a segmented labour market, would have a different skin pigmentation; therefore conspicious and, accordingly, easily recognisable. (while it is not true of african immigrants in south africa, they are obviously still readily identified by black south africans as foreigners and as a potential, or actual, threat to their livelihood). they would tend to cluster together in specific areas to contend with social disadvantage, to enjoy the benefits of similarity of culture or language, of mutual support, and of the opportunities offered by the economics of ethnic conglomeration to mobilise, among their compatriots, custom for informal business enterprises. such clustering can also provide some security against attacks from the natives of the host country who might see in the growing numr ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 439 sajems ns vol4 (2001) no 3 bers in these ethnic enclaves a threat to their national identity and cultural dominance, which culminates in the phenomenon of xenophobia or racism. when globalisation leads to increases in the size of these ethnic groups to meaningful proportions, while the fertility of the host communities continues to fall, or do not rise above 2,1, and projections to show that native populations may become minorities in due time, the perceived threat would undoubtedly loom large. xenophobia would be intensified and increasingly become an issue in politics. the growth of third world populations in europe has prompted the emergence of populist right wing movements (cohen & joly, 1989). the establishment of such cultural and residential enclaves militates against an assimilation approach towards immigrants and favours multiculturalism. adversative relationships are exacerbated. 6 the limits to globalisa tion arising from the above considerations the moot question is whether immigration is likely to be given the free rein as assumed under globalisation. the response has to be: hardly likely. it has already been noted that the demand for labour in i countries is, for the most part not compatible (or at least no longer) with the supplies emanating from the e countries. what the former desire most can be inferred from the type of person they recruit and/or accord preference to, and they are the highly skilled workers who are needed in the technological age. to the extent that the ldrs do indeed supply the mdrs some of this type of manpower, international migration is operating perversely: the former are subsidising the latter and at the same time since this manpower is a prerequisite for the creation of employment to those lower down in the skill hierarchy they are leaving behind a greater need, for the lesser skilled, of opportunities to migrate to countries where they are not needed or desired. some of the latter would no doubt want to repatriate unemployed immigrants since they are hard put to find jobs for native born low-skilled workers if they had not been apprehensive of standing accused of being devoid of compassion. these unemployed remain a burden on the public purse by way of their entitlement to every kind of public service (transport, housing, education, health and welfare services, etc.). when southeast asia experienced their financial crisis, the governments of the ailing economies planned to repatriate millions of foreign workers, among them 2,5 million from malaysia and thailand (cumming-bruce, 1998: 17). "a wave of anti-immigrant sentiment is washing across the continent" wrote the economist (may 2000: 21-25). "these new anivals are popularly perceived as welfare scavengers, jobs-snatchers and threats to stability". europeans blame their 16 million legal immigrants and large numbers of illegals for stealing jobs, raising crime rates and straining welfare budgets. the incidence of crime r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 3 440 among immigrants is three times higher than among native europeans (echikson, 2000: 20-24). in france unemployment among immigrants is 2\--2 times higher than among the rest of the population (castles & miller, 1998: 162; schott, 2000: 10). anti-immigrant political movements have been springing up across europe, and attracted a good deal of support from electorates. and when the aims and political orientation of immigrant communities in a democratic country are basically anti-democratic, the host faces a serious dilemma. in south africa xenophobia seemed to have reared its head when xhosa-speakers chased refugees, who hailed from burundi, angola, nigeria and namibia accused of competing for the limited number of jobs from their homes in milnerton (near cape town) (cruywagen, 2001: 6). it was probably with the above types of situation in mind that the 1994 world conference on population recommended that "policies and development initiatives should be encouraged that would make the option of remaining in one's country a viable one for all people" (un secretariat, 1997: 2). the european union's actions would qualify as such initiatives when they subsidised economic development in the poorer member countries before allowing freer movement of labour from them (smith, 2000: 34), and when it provided funding for the infrastructure of north african states as a quid pro quo to the latter for controlling emigration to europe (balibar, 1991: 188). consonantly, it has been maintained that "planned and controlled entries are conducive to acceptable social conditions for migrants as well as to relative social peace between migrants and local people" (castles & miller: 285). the limits to demographic globalisation have been best spelled out as follows: "the rules of modern migration are clear. desirable migrants with skills, education and capital are let in, undesirables, illiterates, poor people from different cultures, religions and "races" are filtered out: globalisation is a process of social exclusion" (king, 1995: 26). in other words, even while some persons might, in the new age of migration, be accorded greater freedom of movement internationally, it is not going to assume the dimensions of a demographic globalisation on a par with economic globalisation. demographically speaking, the global village mode is an unlikely outcome. endnotes it could be that the use of the word here refers to no more than the involvement of ever increasing numbers of countries in migration flows, which can be, but need not be, a result of globalisation as interpreted by the present author. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 441 sajems ns vol 4 (200 1) no 3 references ballbar, f., (1991) "es gibt keinen staat in europa: racism and politics in europe today", new left review as quoted in kiely & marfleet, globalisation and the third world. 2 bothma, p. 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(ed.) beyond the numbers, a reader on population, consumption and the environment, island press, washington, cited in u.n. 1998: 198. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction literature review regional trade theories africa’s integration and competitiveness record studies investigating the impact of the tripartite free trade agreement research method determining consistently large and growing import demand determining consistently competitive export supply evaluating the current exploitation of the identified trade opportunities results conclusion and recommendations acknowledgements references footnotes about the author(s) lorainne ferreira school of economic sciences, faculty of economic and management sciences, north-west university, potchefstroom, south africa ermie a. steenkamp school of economic sciences, faculty of economic and management sciences, north-west university, potchefstroom, south africa citation ferreira, l. & steenkamp, e.a., 2020, ‘identifying regional trade potential between selected countries in the african tripartite free trade area’, south african journal of economic and management sciences 23(1), a2936. https://doi.org/10.4102/sajems.v23i1.2936 original research identifying regional trade potential between selected countries in the african tripartite free trade area lorainne ferreira, ermie a. steenkamp received: 12 dec. 2018; accepted: 21 nov. 2019; published: 19 feb. 2020 copyright: © 2020. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: one of the most compelling arguments for regional trade and integration in africa is that the african market is the most fragmented in the world, with only 16% of trade being within the continent. furthermore, with 14 regional economic communities (recs), the scale of integrated trading compared to the magnitude of trade is cause for concern. africa could soon witness an important milestone on its path towards increased regional trade and improved integration with the implementation of the tripartite free trade agreement (tfta) involving 26 countries. however, addressing overlapping memberships of the recs and streamlining regulations, customs and border procedures can be a lengthy process. aim: in the meantime, this study aims to identify specific intra-regional trade opportunities among african countries to inform a more targeted approach to regional trade. methods: this article uses a unique approach based on the decision support model (dsm) to identify intra-regional trade opportunities between the tfta countries, taking into account each country’s import demand and export supply. results: we determined 334 such opportunities among the 26 countries, of which 232 (almost 70%) are newly recognised as not being exploited. conclusion: this economic potential calls for policymakers to take a more proactive approach in their actions and recommendations by targeting these trade opportunities. keywords: tripartite free trade agreement; intra-regional trade; free trade; africa; decision support model. introduction african countries are separated by more than 100 bilateral borders, which constrain trade and economic integration among these states. however, african governments have offered much support for regional trade and integration, embracing it as an important component of their development strategies (hartzenberg 2011). as a result, africa has 141 regional economic communities (recs), of which several have notable overlapping memberships. this has created a complex entanglement of political commitments and institutional requirements within the continent that has undermined regional integration. moreover, it has complicated the coordination and harmonisation among african states in different recs, causing counterproductive competition among them, with few success stories (ndomo 2009). only about 16% of africa’s total exports is intra-regional, compared to 68% in europe, 59% in asia and 55% in america (unctad 2019). africa could nevertheless soon witness an important milestone on its path towards increased trade integration with the implementation of the tripartite free trade agreement (tfta). covering 26 countries, representing almost half the population of the continent and a total gross domestic product (gdp) of approximately $1.3 trillion, the tfta has the potential to be an initiative with the broadest regional economic impact globally (united nations conference on trade and development [unctad] 2017). the tfta will merge three of africa’s existing recs: the common market for eastern and southern africa (comesa), the east african community (eac) and the southern african development community (sadc). the main objective of the comesa–eac–sadc tripartite agreement is to strengthen and deepen economic integration in southern and eastern africa by improving terms of trade, boosting infrastructure development and industrial growth, and addressing overlapping memberships among the recs (luke & mabuza 2015). however, realising an ambitious free trade agreement (fta), like the tfta, is a multidimensional challenge. building new infrastructure, confronting issues associated with overlapping memberships and streamlining regulations, customs and border procedures can be a lengthy process. nonetheless, something needs to be done in the meantime to drive intra-african trade. as outlined in the literature review, previous studies on the tfta focused mostly on the impact and significance of the agreement for its member countries on a macroeconomic and sectoral level. this article however identifies, on a disaggregated product level, unexploited intra-regional trade opportunities that serve as low-hanging fruit for exporters and trade promotion entities to start exploring. this can potentially help policymakers to adopt a more practical approach in promoting intra-regional trade in africa. this article reports these intra-regional trade opportunities on an importer–product–exporter level in the tfta region. we first outline the main elements of regional trade theory, the motivations for deeper integration and the status of economic partnerships and competitiveness in africa. we then discuss our method in which filter 2 of the decision support model (dsm) (cuyvers, steenkamp & viviers 2012) is used, a market selection tool, applied for five consecutive years to identify consistently large and growing import demand potential in different tfta countries. the export supply side is added to the model by evaluating the export capacity of the different countries, also over a five-year period. the import demand and export supply are then matched to arrive at export country–product–import country combinations (referred to as matches) with regional trade potential. the use of this regional trade potential then is evaluated by considering actual exports between the identified importing and exporting counties over the period 2010–2014. we identified a total of 334 matches among the 26 tfta countries, from which 232 (70%) were newly recognised matched opportunities that are not being exploited at all. the top three product categories identified in these matches include foodstuffs, vegetable products and metals. this analytical approach is unique for this purpose as it is applied within a regional context where 26 countries’ import demand and export supply are considered and clearly demonstrates the opportunities for increased intra-regional trade within africa. literature review a brief review of the literature establishes the theoretical foundation of this article and consists of regional trade theories and the motivation for closer integration in africa. regional trade theories although africa’s integration path has not been easy, there has been a series of initiatives and political decision-making to try and drive africa’s regional trade and integration efforts. this is embedded in the theoretical literature, with the biggest benefits expected to be gained from enlarged markets (united nations economic commission for africa [uneca] 2012). this section provides an overview of the regional trade theories as a perspective on the potential gains from the proposed tfta. the literature on regional economic integration dates back to 1950 when viner (1950) suggested that the effects of regional trade could be classified as static or dynamic; static effects can be either trade creating or trade diverting. trade creation occurs when countries give up the production of goods and services that their partner countries can produce more efficiently and cost-effectively. integration will therefore stimulate new trade flows that will replace high-cost domestic production with lower-cost production in a partner country. this results in enhanced global and regional welfare. according to robson (1994), trade creation is more likely if there are a large number of member countries, reduced tariffs and non-tariff barriers (ntbs) and the countries involved in the integration have similar levels of development and competitiveness. the trade diversion effect, in contrast, reduces the welfare effect and is seen as a cost to the region. trade is said to be diverted when imports shift away from more efficient, lower-cost products and services towards more inefficient and expensive goods and services from regional partners. trade diversion could lead to a loss of consumer surplus and make markets uncompetitive and inefficient (uneca 2012). if africa’s ftas focused solely on lowering the barriers to intra-african trade, there is a danger that the costs of trade diversion would outweigh the benefits of trade creation. through a liberal–regionalism approach of having a regional economic culture that respects the views and opinions of the member countries, african countries could be able to minimise the scope of trade diversion and maximise the benefits of trade creation (keane 2016). in contrast, dynamic effects focus on the impact of the regional trade agreement (rta) on the rate of output growth of countries in the medium to long term. these effects are often the result of economies of scale because of enlarged markets, efficiency gains to more competitive markets, the removal of trade barriers and increased investments (uneca 2012). de melo, panagariya and rodrik (1993) argue that the most important economic gains are those that result from more affordable unit costs prompted by economic cooperation and policy coordination. in addition, de melo et al. (1993) further argue that where regional groupings result in specialisation in accordance with comparative advantage and economies of scale, costs are reduced and welfare is improved. according to maruping (2005), an expanded market is one of the most general outcomes of an rta with increased access to the markets of member countries. these expanded market opportunities allow firms to specialise in the production of goods and services that were not viable before the integration. moreover, perdikis (2007) avers that an enlarged market creates greater competition between producers in member countries. increased competition drives down prices and encourages firms to reduce expenses and use inputs more efficiently. various studies (burfisher, robinson & thierfelder 2004; lawrence 1997; sheer 1981; unctad 2007) have referred to the static effects of viner’s theory as old regionalism, while the dynamic effects present the new regionalism. new regional integration theories have developed with changing economic conditions and are based on the idea that one cannot isolate trade from the rest of society. according to lawrence (1997), the forces that drove earlier integration have changed drastically over the years. old regionalism had a narrow focus on ftas, with government as the pre-eminent actor, mainly focusing on extending import substitution and industrialisation strategies. new regionalism on the other hand is geared towards structural reforms to assist in making economies more open to implement export-orientated policies, market driven, competitive and democratic. table 1 summarises the main differences in the driving forces of old and new regionalism. table 1: lawrence’s comparison of old and new regionalism. numerous studies have suggested that the emphasis should be on dynamic rather than on static effects when evaluating the appeal of integration among developing countries (abdel 1971; sakamoto 1969). in addition, rueda-junquera (2006) argues that the static effects of integration have little scope in benefits for developing countries and that the basic rationale for economic integration among developing countries should be a dynamic one. furthermore, demas (1965) and abdel (1971) claim that traditional economic integration theory relies strongly on neoclassical assumptions of perfect competition, full employment and constant returns to scale and, therefore, is limited to static effects of integration. in addition, mikesell (1963) concludes that dynamic effects of integration are far more important than static effects because dynamic effects may lead to the exploitation of unused economic capacities and higher growth. according to uneca (2012), the dynamic effects of ftas in africa could provide a better environment for industrial diversification and regional integration than each country could do on its own. unfortunately, africa’s current intra-regional trade is still modest – the continent trades mostly with the world’s most advanced economies like the united states, united kingdom and china. african countries will not be able to exploit the full benefits to be expected from the tfta until policymakers address the barriers that prohibit the movement of goods within their own borders. africa’s integration and competitiveness record africa’s integration agenda, laid down in documents such as the abuja treaty and the african union’s agenda for 2063, has been very ambitious. african leaders have been clear about their aspirations to build a continent where goods and services could be traded freely across borders, world-class infrastructure would connect countries and policies would be harmonised. however, turning this vision into a reality has proved particularly challenging. the concept of a fta and its role in refining regional trade integration originated from the abuja treaty which seeks to use recs as building blocks of regional integration and economic development in africa. commesa, eac and sadc will bring together 26 southern and eastern african countries, which will form the tfta. these include angola, botswana, burundi, comoros, djibouti, democratic republic of the congo, egypt, eritrea, ethiopia, kenya, lesotho, libya, madagascar, malawi, mauritius, mozambique, namibia, rwanda, seychelles, south africa, sudan, swaziland, tanzania, uganda, zambia and zimbabwe. however, there is a consensus that the existing recs have had little success in driving intra-african growth. consequently, one of the main challenges that policymakers will face to make the envisioned tfta work better than the existing trade regimes is how to address the obstacles to intra-african trade. these include restrictive ntbs, rules of origin, high transport costs, border inefficiencies and behind-the-border costs, to name but a few (world bank 2015). although some of africa’s recs have made progress in some areas of integration, many still lag behind. to elaborate further on the continent’s efforts at integration, the african regional integration index report compiled by the african union commission (auc), the african development bank (afdb) and the economic commission for africa (eca) (uneca 2016) measures recs’ level of regional integration and their progress towards implementing their commitment under their respective integration frameworks. the index shows results for eight of africa’s biggest recs, namely cen-sad, comesa, eac, eccas, ecowas, igad, sadc and the arab maghreb union (uma). for the purpose of this study, only the results of comesa, eac and sadc are considered. the index is made up of five key socio-economic categories (dimensions) – regional infrastructure, trade integration, productive integration, free movement of people, and financial and macroeconomic integration – that are crucial to africa’s integration agenda. each dimension has its respective sub-components as illustrated in figure 1. these dimensions are based on the operational framework of the abuja treaty. figure 1: african regional integration index: the five dimensions. table 2 summarises the scores that each of the recs in the tfta obtained under the different dimensions. scores are calculated on a scale of 0 (low) to 1 (high), with the overall average score for regional integration in africa standing at 0.470. table 2: summary of the african regional integration index report scores for common market for eastern and southern africa, the east african community and the southern african development community. on a country level, in comesa, egypt was the top contributor to wealth creation in the region (with a source of 35% of comesa’s gdp), but was ranked fourth on regional integration. sudan and libya are the second and third contributors to wealth creation in comesa, although they are not top performers with respect to integration. in the eac, kenya and uganda are the top contributors to wealth creation (39% and 21% of regional gdp). the eac is the region with the best performance in the trade integration dimension. finally, in sadc, south africa represents 61% of regional gdp and ranks first in the overall integration index. the eac is the top performing rec in terms of trade integration (0.78), followed by comesa (0.572). it is important, however, to keep in mind that the scope and development of the integration process in the three recs are different. each rec implements separate regional trade programmes, infrastructure development and economic development programmes. streamlining these programmes should therefore be a priority in realising the objectives of the tfta. furthermore, most of the countries in the tfta belong to more than one of the recs. of comesa’s 19 members, eight are also members of sadc and four are members of the eac. the eac has five members, one of which is a member of sadc and four are members of comesa. in sadc, 8 of the 15 members are also members of comesa and one is a member of eac. these overlapping memberships have contributed to the difficulty of fully implementing trade agreements. furthermore, africa’s share of intra-regional trade compares unfavourably with other regions of the world. only about 16% of africa’s total trade is with other african countries, whereas the corresponding figures for europe, asia and america are 68%, 59% and 55% (unctad 2019). also, africa’s recs have a low share of intra-group trade relative to other regional groups in the world. the top 14 worldwide regional groupings have an average of 42% intra-group trade compared to africa’s 10% (unctad 2017). the tfta, if properly implemented, could have a substantial impact on the current low levels of intra-regional trade. studies investigating the impact of the tripartite free trade agreement a number of studies have investigated whether, and to what extent, the establishment of the tfta specifically can be expected to create new opportunities for its member countries. inama and crivelli (2014) explored whether the tfta can deliver effective and real trade liberalisation for economic growth. their findings showed a substantial increase in trade creation, despite low levels of export diversification, the small number of traded products and the low share of trade in manufactured products. garlinska-bielawska (2016) investigated the potential economic benefits of the tfta for the three regional formations – comesa, eac and sadc – and found that, in theory, economic gains are expected; however, whether it will be realised depends on factors such as complementarity between member countries, infrastructure and willingness to pursue integration opportunities. in addition, babatunde and odularu (2017) focused on lessons and policy directions for the tfta, stating that the three recs will need to focus their efforts on key areas such as competition policy, technical barriers, electronic commerce, rules of origin and dispute settlement. numerous studies have also modelled the potential impact of the tfta on the participating countries and found substantial increase in trade among member countries, increased industrial production, employment and welfare gains (mold & mukwaya 2017; willenbockel 2013; walters, bohlmann & clance 2016). however, none of these studies has considered a product-level demand–supply approach for identifying specific untapped potential trade opportunities within the region. to summarise, despite the potential benefits of regional trade, there are many obstacles and challenges to intra-african trade threatening the success of the tfta. addressing these challenges can be a lengthy process. for example, building new infrastructure, disentangling overlapping rec memberships and renegotiating in the face of political agendas and increasing tendency towards protectionism all take time. in the meantime, this article addresses the issue of low intra-regional trade by identifying potential trade opportunities among the tfta countries. this product-level supply-and-demand approach highlights low-hanging fruit for exporters and trade promotion entities to investigate and pursue – it provides a shorter-term, interim, proactive approach to start addressing the problem of low intra-regional trade. the next section describes the research method applied in this study to identify specific importer–product–exporter combinations (referred to as matches) with intra-regional trade potential within the 26 tfta countries. this contributes what we believe is useful information on how to promote intra-regional trade among these countries, providing a product-level intra-regional trade opportunity analysis. research method the research method includes a process in which, firstly, the import demand for different products was evaluated within all 26 tfta countries. secondly, the export supply for all possible product and country combinations was assessed. these analyses enable the matching of consistently large and growing import demand and competitive export supply within the tfta countries. each match that was identified formed an intra-regional trade opportunity. finally, the exploitation of these intra-regional trade opportunities was evaluated. determining consistently large and growing import demand filter 2 of the dsm, developed by cuyvers, de pelsmacker, rayp and roozen (1995), cuyvers (1997) and cuyvers et al. (2012), was applied in this article to evaluate the import demand within the tfta region on the international harmonised system (hs) six-digit level. the dsm uses a focused approach to export promotion by identifying and prioritising export opportunities. it is currently the only market selection tool found in the literature that uses a filtering process that sifts through an extensive range of country and product data to identify product–country combinations, or export opportunities for trade. to determine in which products the tfta countries showed sufficient short-term and long-term growth, as well as sufficient import market size, import data per product–country combination at an hs six-digit level were used. the trade data (import and export) were obtained from the cepii baci2 database for 2010–2014. it is important to note that the cepii baci data are audited, meaning that the import value is equal to the export value for the same importer, exporter and product.3 however, cepii reports the trade in the southern african customs union (sacu) as one combined value in its baci database; it therefore does not report trade data for south africa, botswana, lesotho, namibia and swaziland separately. in this study, however, it is important to work with the individual country values. the cepii baci import total for the sacu was therefore split between the member countries in the proportions of the reported import values in the un comtrade data4, in which trade data are reported separately for the five sacu member countries.5 short-term growth was calculated by measuring the growth in imports from 2013 to 2014. the long-term growth rate was calculated as the compounded annual percentage growth in the imports over the five-year period from 2010 to 2014. the import value indicates the size of import demand in each market. to determine which product–country combinations showed satisfactory size and growth, cut-off criteria had to be set. in defining cut-off values for import size and growth, cuyvers et al. (1995), cuyvers (2004) and cuyvers et al. (2012) first calculated a scaling factor (sj) to take into account the degree of specialisation of the exporting country in each product j. the model defines the scaling factor as follows (balassa 1965; cuyvers et al. 1995): where xn, j: exports of country n of product j; xw, j: worldwide exports of product j; xn,tot: total exports of country n; xw,tot: worldwide exports of all product categories. cuyvers (2004) considers a market sufficient in import growth if: where gij is the import growth rate of product j by importing country i; and the cut-off value gj is defined as: where gw,j is the average world import growth rate for product j. the dsm is normally applied from a specific exporting country’s point of view. however, in the case of this study, there are 26 tfta countries that needed consideration. because we consider only products in which the exporting country has a revealed competitive advantage (rca) greater than or equal to 1, an rca value of 1 was used in the calculation of the scaling factor for all products and countries under consideration. a scaling factor of 1.000852 was therefore used throughout. this implies that if a particular country’s import growth for a product is equal to or greater than the average world import growth rate for the product, it can be considered a market with sufficient import growth. cuyvers (2004) considers the import market of country i for product j large enough if: where mi, j is the importing country i for product category j; and the cut-off value sj is defined as: where mw,j is the total world import value for product j. because we consider only products and country combinations for which the exporter has an rca greater than or equal to 1, a particular country’s import size for a product is considered sufficiently large if this import value is equal to or greater than 2% of the total world imports of the product. the dsm considers the import data for each product in the 26 tfta countries to determine whether the countries showed sufficient short-term and long-term growth and import market size. only country–product combinations that passed the criteria for short-term import growth, long-term import growth, as well as import market size for five consecutive years were considered as markets with consistently large and growing import demand in this study. the traditional dsm applications consider import size and growth at only one point in time (cuyvers et al. 2017; mhonyera, steenkamp & matthee 2018); however, this study repeated filter 2 of the dsm for five consecutive years. determining consistently competitive export supply the export supply was added to the dsm by evaluating the export capacity of the different countries over the period 2010–2014. the rca of balassa (1965) was used to determine the export capacity of the different tfta product–country combinations under consideration. the rca represents the relative specialisation of a country in the production of a specific product by dividing the product’s export share of the country’s total exports by its share in world exports (jessen & vignoles 2004). thus, it indicates whether a country has the ability to produce and export a particular product competitively. this article uses the rca to indicate the supply capacity of the different tfta countries. the supply country also had to meet the criteria of an rca greater than or equal to 1 for each year of the five-year period 2010–2014 in order to be selected as a consistent exporter of a product. note that a similar calculation was performed on the sacu export data as for the import data, to separate out the values for each of the member countries from the cepii baci data in the proportions calculated from the un comtrade data as explained in the previous section. the import demand and export supply were then matched to arrive at importer–product–exporter combinations (referred to as matches) with regional trade potential. this is a unique approach as this study does not only consider one exporting country’s point of view. the exploitation of this regional trade potential was then evaluated by considering actual exports over the same period. evaluating the current exploitation of the identified trade opportunities to arrive at the export country–product–import country combinations6 with regional trade potential, the import demand and export supply were matched. in order to distinguish between existing and new matches, the intra-regional trade opportunities were classified into four categories: increase, decline, extinct (now abandoned) and zero. this was done by calculating how the values of existing exports changed between 2010 and 2014. the un comtrade data were used to determine these trends in existing trade flows. this is because it is not possible to derive bilateral trade among sacu members on a detailed product level from the cepii baci data. however, to compare and verify the trend in the un comtrade data for each sacu and non-sacu match, an export value was calculated from the cepii baci data in a similar way as explained in the previous section. also, the trend in the un comtrade mirror data was used to further verify the corresponding trend. results potential export opportunity matches among the tripartite free trade agreement countries the proposed tfta has clearly set high goals and expectations for regional trade integration. however, africa’s slow trade integration shows that the process has thus far not produced the results policymakers were hoping for. this article has identified specific trade opportunities among the 26 tfta countries, which can be seen as priorities and starting points for increasing intra-regional trade. table 4 indicates the importer–product–exporter combinations identified according to hs2 level product categories. a total of 334 matches were identified among the 26 tfta countries. from these, only 74 (22%) indicated a bilateral trade relationship that already exists and has increased over time. seventeen matches (5%) showed a decline in trade and 11 (3%) have become extinct. this left a substantial number of 232 (70%) newly recognised matched opportunities between tfta countries that are not being exploited at all. thus, 78% of the matched intra-regional trade opportunities are underexploited or unexploited. the top five product categories for the 334 intra-regional trade opportunities identified among the tfta countries are: (1) vegetable products (mostly primary food and beverages including beans, fresh fruit, maize flour, wheat flour and soya bean oil), (2) foodstuffs (mostly processed food and beverages including cereals, sausages, preserved fruit and vegetables), (3) metals (mostly processed industrial supplies including steel, iron and copper pipes, bars, rods, tubes, wire, sheeting, sanitary ware and drilling tools), (4) textiles (including clothes, kitchen linen, sacks and bags) and (5) animal and animal products (including mostly processed products such as frozen fish and cheese). in comparison, the top five product categories for the 232 newly matched opportunities include: (1) vegetable products, (2) textiles, (3) foodstuffs, (4) metals and (5) stone and glass (including processed industrial supplies such as ceramic tiles, sinks, basins, baths and imitation jewellery). table 3: categories of utilisation. table 4: number of matches identified according to product categories. figure 2 distinguishes the trade corresponding to the matches derived in terms of the categories of utilisation (see table 5). although some of the opportunities are being exploited, it is clear that most are underexploited or unexploited. the figure also summarises the results of the opportunities identified according to hs2 level product categories, with the greatest demand being for vegetable products, foodstuffs, textiles and metals. figure 2: tripartite free trade agreement intra-regional trade opportunities: product category analysis. table 5: top 20 importer–product–exporter matches with an increase in trade: 2010–2014. tables 5–8 illustrate the specific intra-regional trade opportunities between the tfta countries on an importer–product–exporter level. these tables show the top matches ranked according to weighted import demand divided into the four categories of utilisation listed in table 5. each year (in the period 2010–2014) was assigned a weight to calculate the weighted average7 and these measures determined the relative importance of the trade values reported in each year, giving an indication of the size of the total import demand in each market. a larger weight was assigned to more recent trade figures to place more emphasis on the latest trade (cuyvers et al. 2017). table 6: importer–product–exporter matches where trade has declined (2010–2014). table 7: importer–product–exporter matches where trade has become extinct (2010–2014). table 8: top 20 importer–product–exporter matches with zero trade (new intra-regional trade opportunities) 2010–2014. table 5 shows the top 20 matches (a selection of the total of 74 opportunities for illustrative purposes) that are being exploited, which indicates an increase in trade between 2010 and 2014. considering the number of opportunities in importing countries, angola has the most opportunities (13), followed by mozambique (9), zambia (9) and zimbabwe (8). on the supply side, south africa and egypt are the biggest suppliers among the 74 matches with an increase in trade, supplying more than half of the goods demanded. according to the harmonised commodity description and coding systems (hs), these goods include mainly vegetable products and metals. in terms of the broad economic categories (becs),8 32% are primary products, whereas 68% are processed products. most of the regional trade opportunities identified with an increase in actual trade are between countries representing comesa and sadc. table 6 illustrates all 17 matches that showed a decline in trade between 2010 and 2014, meaning that there is consistently large and growing import demand that can be satisfied with a consistently competitive export supply. however, actual trade has declined over this period. the greatest declines were in the machinery, electrical, metals and transportation sectors. only one of the opportunities identified was for a primary product (namely seeds); the rest are categorised in the becs as processed goods. according to unctad (2007), african countries have been experiencing significant deindustrialisation since the 1990s, resulting in a decline in both intra-regional and global trade over the past two decades. table 7 shows the 11 matches where there is no longer any trade. according to the becs, only two of the opportunities that became extinct are in primary goods (namely spices and cobalt ores). the others involve some form of processing. it is worth noting that the importing countries have a large and growing import demand for the products listed and that exporting countries can supply them as reflected in their export data for the product, yet trade between these tfta countries for the products listed has stopped. further investigation into the reasons for this is necessary. table 8 shows the top 20 matched trade opportunities (a selection from the 232 matches for illustration) within the tfta that are not being utilised. this implies that even though the importing country has a consistently large and growing import demand for the corresponding product and the exporting country is a specialist exporter of these goods, there has been no trade between the countries involved for these particular products over the period 2010–2014. the importing country, therefore, is sourcing this product from other suppliers, whereas they could have received it from within the region. considering all 232 unexploited matched trade opportunities on a country level, angola has 60 unexploited trade opportunities, followed by mozambique with 28 opportunities and egypt with 23. the supplying countries with the largest number of unexploited potential for their products include botswana (45), egypt (37), lesotho (37) and mauritius (31). to integrate the results presented in tables 5–8, the following examples from the results for angola are presented. there are 76 opportunities in total in angola of which 13 (17%) are utilised, three show a decline in actual trade and 60 (79%) are totally unexploited by other tfta countries. although egypt utilises (at least to some extent) the export potential in angola for wheat flour, toilet paper, preserved potatoes, lemons and limes, and articles of nickel, it loses out on fresh fruit, soya bean oil, cereals, undenatured ethyl alcohol, men’s clothing, table linen, as well as sacks and bags. also, namibia utilises (increased exports) the export potential in angola in frozen fish other than fillets (liver or roes) and processed meat of bovines, but loses out on engine parts and frozen fish fillets (decrease in exports). although south africa utilises the export potential in angola for maize meal, fresh fruit and flat-rolled stainless steel products, it loses out on dried fish (zero exports) and hair straightening or waving products (decrease in exports). coming back to the results for the 232 unexploited regional trade opportunities between the tfta countries, the goods demanded include mostly vegetable products, foodstuffs, metals and textiles. according to the becs, approximately 30% of the identified opportunities are in primary goods and 70% in processed goods, of which 56% are in household and consumer goods (see figure 3). figure 3: categorisation of the number of unexploited regional trade opportunities: percentage of unexploited trade by value. figure 3 illustrates the classification of the different types of goods identified as unexploited opportunities. we see that most of the opportunities are in household and consumer goods. food and beverages for primary household consumption include beans, dried fish and other cod, plums and sloes (fresh), strawberries (fresh) and spices. consumer goods include primarily freezers, carpets, clothing, hair products and table linen. food and beverages processed for household consumption include unroasted cereal, prepared or preserved potatoes, mixtures of juices, soya bean oil, mixtures of vegetables, homogenised composite food preparations and preserved olives. with africa being home to more than 1.1 billion people and with more and more africans entering the consumer class as their economic conditions and purchasing power improve, the demands for household and consumer goods are growing. these unexploited intra-regional trade opportunities are a proof of this consumer-driven potential for regional trade. also the processed industrial supplies are worth mentioning, making up 20% of the unexploited trade opportunities within the region. processed industrial supplies include flat-rolled products of iron or non-alloy steel, ceramic flooring blocks, unglazed ceramic tiles, organic surface-active agents and copper tubes and pipes. this illustrates that african countries have intra-regional trade potential in more processed, industrial goods, which could potentially be a step in the right direction for further industrialisation. conclusion and recommendations africa’s intra-regional trade is the lowest in the world and its attempts at achieving regional economic integration are possibly some of the most complex. regional trade and integration in africa means creating new networking interactions between countries, expanding possibilities of intra-regional trade and giving access to new markets. if successful, economic theory predicts that increased regional trade will also provide the countries involved with the opportunity to address constraints to export competitiveness, improve infrastructure and help to facilitate trade with both itself and the rest of the world. moreover, a larger market and the pooling of economies through regional integration should create economies of scale. however, history shows that progress in this regard has been limited and significant structural and policy challenges need to be overcome. it is undeniable that the complex issues of overlapping memberships and conflicting terms of the agreement need to be resolved among member states to allow successful implementation of the tfta. although these are real and relevant issues that need to be addressed, it is likely to be a lengthy process. meanwhile, it is important to determine where opportunities for trade exist in order to address the prevailing low level of intra-regional trade. the objective of this article is to show that african countries have a unique opportunity to trade with a relatively untapped market: itself. for this reason, the article identifies specific underexploited and unexploited intra-regional opportunities to increase trade on an importer–product–exporter level in the tfta region. a total of 334 matched opportunities were identified between the 26 countries (between 2010 and 2014). however, only 74 of the 334 opportunities (22%) show an increase in actual trade in this period, whereas 17 show a decline and 11 have become extinct. of the unexploited opportunities, a total of 232 new matches (70%) were identified mainly in vegetable products, foodstuffs, textiles and metals. this means that 78% of the matched trade opportunities are underexploited or unexploited. these opportunities imply that regardless of the consistently large and growing import demand for the product that can be matched with competitive export supply within the region, there has been declining or no actual trade in the specified period. this means that the import demands in the region are being supplied by countries outside the region. further research is needed to identify the reasons why these intra-regional trade opportunities have not been exploited. these reasons may include strong existing trade relationships with countries outside the region, price competitiveness, quality and quantity requirements, trade barriers such as tariff or non-tariff measures, poor infrastructure, timely border and customs procedures, documentation requirements and high transportation costs. it might also be that these importing and exporting countries are not aware of the opportunity to trade within the region (wto & oecd 2015). this study reveals regional trade opportunities in processed products, implying that selected countries in the tfta specialise in the production and export of not only primary commodities but also more processed goods. even though africa’s production base is lowto medium-skilled and consists of resource-based manufacturing, exploiting the newly recognised intra-regional trade opportunities in processed goods, especially in africa’s growing consumer market, could potentially be a first step to increased competitiveness and even expanded industrialisation. furthermore, with the continental free trade agreement (cfta) negotiations under way, this study can be expanded by including all african countries. this would help to identify possible trade opportunities between all african countries that are not being utilised and could potentially increase intra-regional trade in africa. it would be unfortunate if the tfta was simply a merger of the existing three trade regimes. the literature indicates consensus that the current economic communities have not yet been successful in making intra-regional trade in africa a powerful driver of economic growth and development. thus, the main challenge faced by the tripartite policymakers is how to make the envisaged fta work better than the existing recs. it is important to be realistic about the ambitious goals set in the tfta, taking into account what is feasible in the medium to long run, while acknowledging the complex entanglements of combining three recs. in the short run, these newly revealed trade opportunities can take the integration efforts of policymakers forward. we believe, therefore, that this study contributes valuable information for the promotion of intra-regional trade in africa. acknowledgements the authors acknowledge the financial assistance of the world trade organization (wto) towards this research. competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions this article forms part of a phd study of the trade and development (trade) research focus area of the north-west university by l.f. with e.a.s. as the supervisor and also assisted with the conceptual construction of the study. ethical consideration this article followed all ethical standards for research without direct contact with human or animal subjects. funding information this research was financially supported by the world trade organization (wto). opinions expressed and conclusions arrived at in this article are those of the authors and should not necessarily be attributed to the wto. data availability statement data sharing is not applicable to this article as no new data were created or analysed in this study. disclaimer this manuscript has not been published and is not under consideration for publication elsewhere. we also have no conflicts of interest to disclose. all authors have approved the manuscript and agree with its submission to the south african journal of economic and management sciences. references abdel j.t., 1971, ‘a review article: the relevance of traditional integration theory to less developed countries’, journal of common market studies 9(3), 254–267. https://doi.org/10.1111/j.1468-5965.1971.tb01001.x african development bank (afdb), african union commission (auc) & united nations economic commission for africa (eca), 2016, the africa regional integration index: 2016 report, 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https://unctad.org/en/publicationslibrary/aldcafrica2019_en.pdf walters, l., bohlmann, h.r. & clance, m.w., 2016, ‘the impact of the comesa-eac-sadc tripartite free trade agreement on the south african economy’, ersa working paper, no. 635, september 2016. willenbockel, d., 2013, general equilibrium assessment of the comesa-eac-sadc tfta fta, viewed 18 june 2017, from https://mpra.ub.uni-muenchen.de/51501/. mpra paper no. 51501. world bank, 2015, deepening african integration: intra-africa trade for development and poverty reduction, viewed 08 may 2017, from https://www.worldbank.org/en/news/speech/2015/12/14/deepening-african-integration-intra-africa-trade-for-development-and-poverty-reduction. footnotes 1. only eight of the 14 recs are recognised by the african union (au): common market for eastern and southern africa (comesa), community of sahel-saharan states (cen-sad), east african community (eac), economic community of central african states (eccas), economic community of west african states (ecowas), intergovernmental authority on development (igad), southern african development community (sadc) and arab maghreb union (uma). 2. baci is a trade database, developed by the centre d’études prospectives et d’informations internationales (cepii) which is a french institute doing research into international economics, providing bilateral trade flows for more than 5000 products and 200 countries. the database is built from data reported to the united nations statistical division (un comtrade) and reconciles the trade values reported by exporters and importers (cepii, 2020). 3. exports are reported free on board (fob) and imports cost, insurance and freight (cif). this is why the import and export values for the same exporter–importer–product combination differ in the un comtrade data set. 4. un comtrade is the pseudonym for united nations international trade statistics database. 5. cepii baci sacu import total for product 10 190 (live horses other than pure-bred breeding animals) is usd 4 670 684. in the un comtrade data set, botswana imports usd 354 450, lesotho usd 1 527 948, namibia usd 992 933, south africa usd 1 644 088 and swaziland usd 0. the proportions are, therefore, botswana = 7.589%, namibia = 21.259%, lesotho = 32.714 and south africa = 35.2%. these proportions are multiplied by the baci sacu total to arrive at a comparable value per sacu country. 6. interchangeably referred to as intra-regional trade opportunities, or matches, in this study. 7. weighted average import value = (2014 import value × 1) + (2013 import value × 0.5) + (2012 import value × 0.25) + (2011 import value × 0.125) + (2010 import value × 0.0625) / 1.9375. 8. the broad economic categories (becs) were created by the united nations department of economic and social affairs. the becs are defined in terms of the divisions, groups, subgroups and basic headings of the standard international trade classification that was issued in 1971; it has since been revised three times; united nations, classification by broad economic categories, https://unstats.un.org/unsd/cr/registry/regdnld.asp?lg=1. sajems ns vol 5 (2002) no 1 219 the public finance management act as a reform measure to capacitate public officials djfourie school for public management and administration, university of pretoria abstract the urgent need to develop south africa's human resources in the public service has been conceptualized in many policy documents. the underlying objective of efforts to strengthen the human resources in the public sector, is the delivery of effective services to the people of south africa. in line with the white paper on the transformation of the public service, 1995, the effective mobilization, development and utilization of human resources are stressed as important factors in the transformation of the public service because of their contribution to individual and institutional capacity to ensure effective governance. financial resources are important in order to develop and sustain the skills of the public servants; however, there is a tendency to cut the budget for human resource development programmes. alternative methods should be developed to obtain additional sources of income. jelhoo,h70 1 introducfion the training programmes for public servants inherited from the former regime, lacked a proper strategic, needs~based and outcomes-based focus. in order to address the shortcomings in terms of training in the public service, a number of policy documents have been developed, aimed at addressing human resource development of the public service. the policy documents underpin a strategy that coordinates the broader process of transformation and institution building, with human resource development in the public service and emphasize that education and training should be strategically planned and effectively resourced. with reference to financial resources, the white paper on public service training and education (wppste), determines that a specific percentage of the annual budget of public service departments be allocated towards training and development of human resources. however, this percentage is not sufficient to address the backlog that has developed over the years. the situation is worsened by the cut backs on departmental budgets which impact directly on training budgets. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 220 sajems ns vol 5 (2002) no i alternative funding is required to finance training programmes. the public finance management act, 1999, creates an opportunity to generate additional sources of income for public service departments. 2 status of human resource development in the soum african public service the human resources development (hrd) programme as inherited from the former regime was fragmented and poorly coordinated. human resource development was characterized mainly by a lack of strategic, needs-based and outcomes-based focus, as well as by the inappropriate nature of the training and education provided by the various in-service and extemal providers (white paper on public service training and education, 1998). given the urgent need to overcome some of the problems mentioned above and to build individual and institutional capacity for the new public service, the white paper on the transformation of the public service (24 november 1995) regards the development of south africa's human resources as one of the five key programmes of the reconstruction and development programme (rdp) (september 1994). this can be ascribed to the fact that the development of the country's human resources is central to the process of obtaining the strategic objectives set out in the rdp. in order to have a clear understanding of the need for human resource management, the table indicates the distribution of race and skills the public service according to race and skills level. table i shows clearly that there is a need for human resource development, allowing public servants with lower skills levels to be promoted from one level to the next, more highly skilled level. as a result, a strategic framework for effective human resource development has been developed. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no i 221 table 1 distribution oftbe public service according to race and skills level,l999 african asian coloured wbite percenta~e lower skilled 88 2 9 2 skilled 74 4 9 13 hililily skilled production 66 4 9 21 hi~ly skilled supervision 42 6 6 47 mana~ement 28 5 6 61 senior manar;ement 47 7 9 37 proportion of population 77 3 9 11 .. source: department ofpubltc servlce and admmlstratlon, 1999/2000: 13 the following are some of the elements of the strategic framework (presidential review commission, 1998: 146): (i) human resources should be strategically linked to the broader process of transfonuation, institution building and human resources development in the public service; (ii) adherence to the national qualifications framework (nqf) and the south african qualifications authority (saqa) frameworks, including the proposals regarding the department of labour's new skills development strategy; (iii) education and training should be strategically planned and effectively resourced; (iv) the elevation of the importance and status of training and trainers; and (v) human resource development should be effectively organized, coordinated and accredited in ways that promote and enhance quality, accountability, transparency and cost-effectiveness. in tenus of the white paper on public service training and education, the main objective is to enable departments to design and implement training programmes and education that are linked to the strategic priorities of the departments. therefore, it is required that certain key aspects and organizational structures be formalized in order to provide training and education in a meaningful and effective manner (presidential review commission, 1998: 147). it is envisaged that the white paper on public service training and education will contribute to the materialization of the comprehensive hrd strategy and programme, which white paper provides the following: r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 222 sajems ns vol 5 (2002) no 1 (0 the government has adopted a policy whereby centralized nonns and standards are set, but in a decentralized manner with both state and nonstate providers, in a competitive framework. it is therefore argued that the delivery of training and education programmes will combine creativity and flexibility without undermining the need to build a unified public service with a common culture and value system. (ii) in addition to the centralized norms, the white paper on public service training and education provides for the review of statutory and other regulatory instruments and frameworks in order to facilitate efficiency and accountability in hrd in the public service. this means that individual departments will be able to integrate human resource development planning and implementation with new approaches to the overall management of resources. this process is relevant, as it will allow individual departments to specify and implement linkages between skills development, grading and acceleration in the areas of critical skills shortages. (iii) the white paper on public service training and education specifies a formula prescribing a percentage of departments' payroll that should be allocated to training and education. in this regard, it is stated in the budget review (2000: 50) that expenditure on education and training has to be at least 0.5 per cent of the payroll in 2000/01 and i per 'cent in 2001102 and beyond (see table 2). this means that departments have to reflect the strategic importance of training and development in the allocation of resources, taking into consideration the medium term expenditure framework. it should be noted that the budget for hrd is small compared to international standards. in this regard the presidential review commission's report (1998: 150) states that in the departments surveyed, the ratio of hrd budgets to the overall departmental budget ranged from 0.02 per cent (national department of housing) to 0.3 per cent (d~ent of home affairs), table 1 expenditure on sldus development, 1999/00-1001/03 government training 1999100 1000/01 1001/01 1001103 expenditure (r million) national departments 427 464 287 300 provinces (9) 335 704 740 source: south africa, department of fmance, budget review, 2000: 50 table 2 clearly shows that the expenditure on skills development is not sufficient to support an effective training strategy. national departments employ 306 312 public officials (department of public' service and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 223 administration, 1999/2000: 12). the amount available for training per official is on average ri 394 per official for the fmancial year 2000/01. for the year 2001/02 this average declines to r936.95 per official. this allocation is a mere drop compared to what is required to meet training priorities. the training budget for provincial departments, 759 689 officials (department of public service and administration, 1999/2000: 12) was a mere r440 per official for the 200012001 financial year. for the fmancial year 200112 the amount available per official is r926.69 and for the 2002/03 fmancial year the amount is increased to r974.08 per official. one can assume that the increase in the expenditure on skills development especially on provincial level, is to strengthen the provincial services that are actively responsible for the provision the social services such as health, welfare and education. the allocation for the promotion of hrd on provincial level is inadequate to address the provincial development needs. with the current hrd in the south african public service in mind and in particular the three issues regarding the development of the hrd strategies and programmes, it is necessary to focus briefly on the institutions responsible for training and education in the public service. 3 institutions responsmle for public service training a number of institutions are responsible for the facilitation and enhancement of hrd in the public service, the roles of which will be briefly highlighted. 3.1 pubhc sedor education and training authority (pset a) the pseta has been established by the government to play a part in the design, delivery and evaluation of public service training and development. the functions of the pseta are broad and varied, therefore the establishment of sectoral education and training authorities (setas). these authorities play an important role to co-ordinate professional and vocational education and training throughout the respective economic sectors (white paper on public service training and education, 1998). in principle the government should provide seed money for training in accordance with the identified training needs. thereafter, it must be the responsibility of each seta to find ways and means to generate income to sustain its existence. this may take the foiul of charging trainees a nominal fee to break even with the cost of uaining. simultaneou9ly, this exercise will r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 224 sajems ns vol 5 (2002) no 1 generate income to ensure that the institution continues with its mandate of training public servants. furthennore, the pressure of finding resources to sustain itself will compel the institution to deliver high quality training programmes. 3.2 association of attredited training and education providers (aatep) the association of accredited training and education providers was established by government to promote planning and coordination of the work of the south african management development institute (samdi), provincial training bodies and external training providers. the association also has the function of encouraging and facilitating peer review, mutual support and the development of the teaching and learning profession amongst accredited training and education providers. it should be noted that membership of this association is voluntary (white paper on public service training and education, 1998: 56 and 58). in order to allow the association to continue its function of coordination and planning, its members must pay annual subscription fees. since education and training providers vary in size in tenns of student enrolment, members' fees are detennined according to student numbers. furthermore, to strengthen its financial base, this association may provide services to other institutions and thereby generate additional income. 3.3 south african management development institute the south african management development institute (samdi) operates as a separate entity under the political authority of the minister for public service and administration. samdi is responsible for the provision of public service education and training to the different government departments. to ensure selfsufficiency, samdi should recover its direct training expenses from departments and other users. the mandate of samdi includes· as main objective, targeting of resources, provision, publication and monitoring of plans and targets for training of the different government departments. furthennore, samdi focuses its attention on the priority area public management training (department of finance, 2000: 73). in order to provide the training samdi has a staff component of 63 officials (samdi, annual report 199912000: 9) and a total budget ofr13.9 million for the financial year 199912000. in addition to the budget allocated by parliament, samdi received r26.7 million from the european union during the financial year 199912000 as part of the public service management development r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . samms ns vol 5 (2002) no 1 225 programme. by the end of february 2000 only 65 per cent of the total budget of r40.6 million was spent (samdi, 1999/2000: 12). between march 1999 and march 2000, samdi managed to train 9 500 public servants (fraser-moleketi, 2000). percentage wise, this means that only 0.89 per cent public servants out of 1 065999 million public servants have been trained at a total cost ofr2 789 per official. 3.4 public service institutions government departments offer in-service training programmes. these in-service training programmes take various forms, including training of trainers and mentorship programmes. this form of training focuses on the, improvement in the functioning of a department. furthermore, departments utilize the formal education courses at educational institutions such as universities and technikons. this form of training and developmei,lt is supported by the individual department's bursary arrangements managed by the human resources or personnel component of the specific department. 3.5 institutions of bigber learning the tertiary institutions (there are 22 universities and 15 technikons) wili make important contributions in all sectors of education and training. tertiary institutions fulfili a pivotal role in the revision of more long-term, formative training and learning programmes. such programmes provide continuous, ali round skills which normally is possible or feasible within short-term training programmes (white paper on public service training and education, 1998: 6667 cf. also department of finance, 2000: 108). 3.6 community-based and non-government organizations community-based and don-government organizations possess knowledge, practical experience and expertise that should be utilized directly and continuously as a resource base for public service training. with the assistance of these organizations, public servants will be able to expand their knowledge regarding the increasingly diverse and complex needs of local communities. public servants may also gain knowledge regarding negotiation and consulting skills, participatory learning and teaching, as well as human rights and civic consciousness. as mentioned earlier, external institutions are important in the development of human resources in the public service. this implies that, apart from the national institutions, government will also from time to time, and according to need, seek to encourage cooperation between training and development organizations r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 226 sajems ns vol 5 (2002) no 1 inside' south africa and those outside the country (white paper on the transfonnation of the public selvice, 1995: 67). the institutions mentioned above will have both a direct and indirect influence on budgets of public institutions. it should also be mentioned that there is a failure in general on the side of government departments to make adequate provision in terms of fmancial and human resources for training within their organizational structures. as indicated in table 2 and the analysis of the skills development budget, a relatively small amount of the total budget is devoted to training and education in the public sejvice. therefore, alternative ways and means of generating additional fmancial resources should be found to fund hrd programmes. 4 alternatives for generating training funds as mentioned earlier, education and training can be regarded as essential components in the development of the skills of the public service workforce. it also promotes economic development, reduces unemployment and enhances social development despite government's intentions to provide training to its employees, it is often faced with budgetary constraints and it should be mentioned that the current primary budget deficit amounts to r19.7 billion (department of finance, 2000: 9). in the process of balancing the budget of a department, it is customary to cut the budget of the training division. therefore, the training division of a department should fmd alternative sources to generate additional income. in this regard, the public finance management act, 1999 (act 1 of 1999), could play an important role as the act adopts an approach to financial management which focuses on outcomes and responsibilities instead of the rule-driven approach of the out-dated and old exchequer acts. 4.1 regulatory framework the introduction of new legislation and regulations provided a significant step towards the generation of additional resources. in this regard the new public finance management act of 1999 as amended and implemented on 1 april 2000, represents one of the most important refonn measures undertaken by government to improve fmancial management in the public sector and as a mechanism to improve the generation of additional income. previous financial legislation, e.g. the exchequer act, 1975 (act 66 of 1975) did not allow for autonomous fmancial creativity. the public finance management act of 1999 as amended. assigns greater responsibilities and allows greater powers to accounting officers, and provides the means by which the latter can be held accountable for exercising their managerial prerogatives. the public finance r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no i 227 management act of 1999 is designed to enable managers to manage more effectively and to empower them to reallocate resources. the treasury regulations for departments and constitutional institutions as issued in terms of the public finance management act of 1999 play an important supportive role in the effort towards effective and efficient fmancial management. treasury regulation 7.1 could be mentioned as an example. this regulation deals with revenue management more specifically, with the identification, collection, recording and safeguarding of all revenues for which an institution is responsible. the old treasury instructions were strictly procedural and did not allow the accounting officer to manage revenue management in a creative and effective manner. the new regulations provide room for innovative and creative revenue management. treasury regulation 7.2 states that the accounting officer of an institution must manage the revenue collected efficiently and effectively. therefore, appropriate processes that would allow for the identification, collection, safeguarding, recording and reconciliation of information regarding revenue (also revenue obtained for the purposes of training) must be developed and implemented. 4.2 business enterprises training divisions in the various departments need to determine their actual needs and develop proposals, which should then be submitted to local businesses for support. there are various ways in which the business sector can assist training divisions of departments. businesses can contribute by donating funds to a particular institution or it can adopt a training project. for example, the management training programmes of the south african police service are supported financially by business against crime. in 2000, business against crime supported the delivery of the police station management programme offered by the joint universities public management education trust, for 26 participants with a budget of r260 000 (purkis, 2000). as an incentive, the financial contributions to such programmes are within the prescribed tax· deductible limits (department of finance, 2000: 82·84). 4.3 creation of a non-profit organization the purpose of a section 21 company established in terms of the non·profit organizations act (act 71 of 1997) is to operate loan and bursary schemes for public servants who want to pursue their formal education, but lack the financial means. funds for bursaries and loans can be raised from local and international donors. the umsobomvu fund (r855 million), for instance, invests in young people to develop skills and knowledge (department of finance, 2000: 46). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 228 sajems ns vol 5 (2002) no 1 in the case of loans, a system to enforce repayment should be established. the repayment of loans may present some practical problems as in the case of tertiary institutions departments should take note of these. 4.4 joint-venture projects joint-venture projects are currently an untapped source of funding for training programmes. institutions in need of particular skins that public servants may have, cannot in al1 circumstances meet the needs on their own. arrangements could be made between the training division of a department and those companies who require the skills transfer. a training fee should be payable to the training division of the department to enable it to provide the required training. a practical example of this is the training provided by staff at academic hospitals that possess particular skills to staff at private hospitals who require those skills. in the past, this tra.i.ning was done free of charge whilst the academic hospital carried the cost of the staff member not involved with their core responsibility for that particular day (hospital strategy report, module 3.l, 1996). 4.5 creation of partnerships government is implementing a strategic framework for delivering some public services through innovative public-private partnerships. this could improve service delivery to the public whilst at the same time transferring the risks to private contractors who are sometimes in a better position to manage the delivery of services. innovative projects in the field of training will benefit from this arrangement. a contractual agreement can generate additional income for the training divisions by way of annual registration fees of the private companies wishing to be included in the training division's data base. this implies that a private sector company will have access to information regarding the offering of' training programmes. it also allows the public sector the opportunity to regulate and monitor training standards and performances by training institutions. 4.6 donations and fund raising previous legislation through the exchequer act (act 66 of 1975), and the previous treasury instructions did not allow for government departments, in particular a training division, to raise funds other than the allocated budget for training programmes. the new legislative framework allows for creativity and innovation in the management of public funds and thus allows for fund raising (van der linde, 2000). this means that the training division can now actively be involved in the raising of funds through partnerships, donor organizations, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no i 229 and private sector companies. an official may be contracted to actively raise funds. however, an incentive scheme should be in place to motivate the assigned official to raise funds effectively. 4.7 protecting of intellectual copyright training officials are required to develop training material to meet the specific needs of the public service department. in some cases, the material is a sought after commodity as it could enhance the skills and experience of persons in the industry. training manuals are seen as public goods which industry uses and often profits in doing so. to ensure that the development cost is covered, the training material can be made available to other institutions at·a fee sufficient to cover these costs. 4.8 providing of equipment and facuities to other users training equipment and facilities should be utilized optimally and training divisions can make the equipment and facilities available to other institutions at a market-related charge. this will not only be a source of income but also ensure proper utilization of the equipment or facilities. funds generated in this way can be used to replace old and outdated training equipment, rather than having to depend on a departmental budget, which budget is awarded low priority in the budgeting process. in conclusion. governments are faced with budget deficits and innovative and creative ways should be launched to find additional sources of income. to achieve this. training divisions should hold strategic sessions to identify not only their weak and strong points. but also to identify the opportunities that are available to generate additional income. this will hopefully ensure a commitment from the personnel of the training division who will then pursue these opportunities. also, there should be a clear departmental policy that the income thus generated will be allocated to the training division. in the absence of such a policy, the danger exists that the head of the department may allocate the additional funds generated by the training division to a different project or division in the department. 5 requirements for effective financial management to ensure that the training division operates efficiently. particular requirements for fmancial management should be met, e.g., r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 230 samms ns vol 5 (2002) no i (i) the appointment of a highly skilled financial manager in the training division; (ii) the delegation of greater financial authority to training managers which are linked to: • performance agreements that create accountability for meeting specified training objectives; • accurate and reliable systems for reporting and audit; • a change in management culture so that managers at the different levels assume responsibility and accountability for the use of resources under their control to meet specific objectives; (iii) the restructuring of the training division to allow for cost/profit centre accounting; (iv) the creation of an effective budgeting process to generate realistic budgets based on projected activities and known costs rather than historical budgets; (v) the discretion to apply virement between budget items to allow managers to adopt fmancial provisions to meet changing service needs; (vi) the retention of a portion of the revenue generated to encourage income generation by the training division, bearing in mind that: • the training division should retain a negotiated percentage of income generated by user fees; • income accruing from the sale of training equipment or assets should be retained to a maximum negotiated amount between the training division and the department; • in all other income generating schemes such as donations or the letting of vacant training space, the training division should retain a full 100 per cent of the income generated; and (vii) the establishment of trading accounts implying that the training division manages the negotiated portion of revenue instead of returning it to the revenue a~count a department. the requirements for effective financial management as listed above are of critical importance. the assigned public official is responsible for the effective and efficient utilization of public money and has to achieve value for money in meeting the objectives of the government in delivering of services to the public. 6 critical issues for consideration the generation of additional income has moral implications. in this particular case, the is: who really benefits from the generation of additional income and how does it facilitate the human development of the total population and the overall well-being of the people? . r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 231 in view of the above, government should be cautious and be aware that its primary obligation is to all its people, and not to pursue the profit-making concept to such an extend that it affects society negatively. therefore, the notion of generating additional income to facilitate a reduced tax burden through the application of some private sector concepts, while still delivering goods and services fairly and equitably, is indeed a complex one. however, this is a task that must be dealt with constructively and diligently, since both issues are important and relevant to the overall development of a nation. it is critical that government and other key role-players find a way to integrate these two different viewpoints in order to achieve a balance between them for sustainable growth. this delicate balance has to be maintained or the moral and ethical obligation to its people, especially the poor, will be undennined. it will also impact negatively on growth and development. thus government, in its effort to generate additional income, should always consider the short and long-term effects of their decisions and actions on society in general. this will allow government to be ethically and morally conscious of every process from policy formulation to policy implementation to ensure that the needs of every community, rich or poor, are protected and development fairly and equitably distributed. 7 conclusion the government of the day fulfils an important role in the development of the skills of public officials. the acquiring of skills can be regarded as an important determinant of the delivery of services to people of south africa. in order to develop and maintain skills of public servants, resources should be available. however, due to budget constraints the resources available to the training division in public departments are insufficient to cater for the training needs. this means that innovative ways of fmding additional sources of funding for training should be found. previous legislation such as the exchequer act of 1975, and the outdated treasury regulations did not allow for the generation of additional fmancial resources for departments. the introduction of the public finance management act of 1999, paved the way for managers to be creative in the management of their departments. the new legislation allows for a department to generate additional income. the additional funds could then be used by for the training division to build and maintain the skills of public officials. however, it is important to avoid the misuse of the funds and a mechanism should be put in place to ensure effective utilisation of the resources. appointing highly skilled fmancial managers, delegation of financial authority and the establishment of a departmental policy r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 232 salems ns vol 5 (2002) no 1 to ensure that the sources generated are earmarked for the training division could ensure that the funds will be utilized effectively. references fraser-moleketi, g. (2000) minister of public service and administration. budget vote speech, 13 april. 2 presidential review commission (1998) "developing a culture of good governance", report of the presidential review commission on the refonn and transfonnation of the public service in south africa. 3 purkis, c. (2000) project administrator joint universities public management education trust, 29 september, interview. 4 republic of south africa, department of finance (2000) budget review. 5 republic of south africa (2000) department of finance, national expenditure survey. 6 republic of south africa (1999) department of public service and administration, public service review report, 1999/2000. 7 republic of south africa (1999) south african management development institute, annual report, 1999/2000. 8 republic of south africa (2000) treasury regulations for departments and constitutional institutions, regulation gazette no. 6822, 31 may. 9 republic of south africa (1999) public finance management act, act 1 of 1999, as amended by act 29 of 1999. 10 republic of south africa (1998) department of public service and administration, white paper on public service training and education, 1998. 11 republic of south africa (1997) nonprofit organisations act, act 71 ofl997. 12 republic of south africa (1996) department of health, hospital strategy report. 13 republic of south africa (1995) department of public service and administration, white paper on the transformation of the public service. 14 republic of south africa (1975) exchequer act, act 66 of 1975. 15 van der linde, g. (2000) fonner accountant-general, department of state expenditure, 29 september, interview. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 336 sajems ns vol 5 (2002) no 2 trade, environment and sustainable development: what changed in doha jessica wilson environmental monitoring group abstract agenda 21, the blueprint for sustainable development, adopted at the earth summit in rio de janeiro in 1992, does not have a chapter dedicated to trade. yet since 1992, trade has become increasingly important to democracy, human rights, women's rights, economic development, employment and the environment. "trade and environment" has been identified by many governments and civil society organisations as an important policy issue in preparations for the world summit on sustainable development. at the same time, environment has become a highly politicised word in the world inhabited by trade negotiators. the aim of this paper is to examine whether or not the inclusion of wto environmental negotiations, as outlined in the doha ministerial declaration, advances or retards sustainable development. jel 013, 019, q32 introduction agenda 21, the blueprint for sustainable development, adopted at the earth summit in rio de janeiro in 1992, does not have a chapter dedicated to trade. yet since 1992, trade who trades, how they trade, what they trade and how much they trade has become increasingly important to democracy, human rights, women's rights, economic development, employment and the environment. "trade and environment" has been identified by many governments and civil society organisations as an important policy issue in preparations for the world summit on sustainable development. at the same time, environment has become a highly politicised word in the world inhabited by trade negotiators. in november 2001, negotiations on trade and environment in the world trade organisation (wto) were agreed to by trade ministers in doha, qatar. the aim of this paper is to examine whether or not the inclusion of environmental considerations in trade agreements advances or retards r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 337 sustainable development. is the environment simply a new way of protecting northern markets? or can it be used to advance equity and social justice within and between countries? the specific question that this paper addresses is whether or not including environment in the world trade organisation, as outlined in the doha declaration, will make it easier or more difficult to achieve development that is sustainable. the paper provides an analytical framework for the debate that outlines clear sustainable development parameters for trade and outlines elements of the ecological and economic crises that need to be addressed. it provides a brief history of how environmental issues have been interpreted in the wto, culminating with the launch of environmental negotiations in doha. it evaluates these prescribed negotiations against sustainable development imperatives and examines their implications for other international processes. finally, it offers some suggestions as to how south africa should use the environment and trade negotiations to promote sustainable development more effectively. in this paper, development is used to mean that all people are able to have better lives be that greater access to health care, more food, better jobs, more able to express themselves creatively, living in confidence instead of fear, etc. sustainable is used to mean that development can continue and will not be constrained by the earth's natural resources, stock market crashes or conflict; that no person's development happens at the expense of another's whether or not they are born. framework for analysis one thing that has become apparent this century is that the earth's ecosystems are under enormous pressure and are starting to show significant signs of stress. this is due the pollution that the world population emits, the forests that are cut down, the fish that is harvested, all in excess of the earth's ability to replenish them. a key driver in this behaviour is the way in which nations run their economies. world production is rising, and the firm belief is that this creates jobs and wealth that will contribute to human growth and development. yet, in producing goods, destruction also takes place, often without the knowledge of the producers. conventional economic systems provide very poor feedback on their environmental impact. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 338 sajems ns vols (2002) no 2 the world trade organisation (wto) one of the key institutions that manages the economy globally, is the world trade organisation (wto). its name is misleading; the wto's agenda is far more comprehensive than just trade rights, intellectual property, international investment flows, government procurement and competition policy are some of the other aspects on which the wto has developed treaties and which are integral to the global economic system. being an important regulator in the global economy, the wto has an impact in many domains peoples' livelihoods, nature of work, type of education, living environments, etc. because of this far reaching impact, the question is how the negative aspects of the wto may be mitigated. the wto is not a neutral forum. it has an ideological bias it is built on the premise that trade liberalisation is inherendy good; and an economic bias it is dominated by a group of economic giants known as the quad (usa, ciii13da, eu, japan). thus the nature of trade liberalisation is highly uneven. it is not "free" trade, but selective free trade. developed countries have maintained strong protection on their key (vulnerable) sectors, where developing countries have a comparative advantage. despite its rhetoric, the wto is not an organisation that aims to promote human development or greater wealth for poor people. and it certainly has no mechanisms to evaluate whether or not the world's economy is operating within the earth's ability to regenerate itself. in this, it reflects the national economic policy of most countries that the environment can be cleaned up once sufficient wealth has been created. there are mechanisms within the wto to deal with environment and development issues. they are dealt with separately through the committee on trade and environment (cte) and the trade and development committee. these committees do not have a negotiating mandate. they seek to clarify and make recommendations on various aspects of trade, environment and sustainable development. south africa has not been an active member of the cte, which it sees as low priority, having made very little progress since its inception (crompton, 2(01). a third important structure within the wto, is the dispute settlement body, which has the sole authority to establish panels to resolve disputes, which normally comprise three members who are senior officials or experts in trade law (pgd, 1998). this mechanism has been strongly criticised by ngos and developing country governments as being untransparent and undemocratic. yet the strength of the wto in enforcing dispute settlement has been one reason why certain groups have demanded the inclusion of labour and enviromnent clauses within the wto. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 339 trade aspects of sustainable development there is growing recognition amongst social movements internationally that there are some fundamental contradictions between globalisation, as it has been advanced through institutions such as the wto, and sustainable development whereas globalisation has led to increased inequalities, the commodification of previously untraded goods and the alienation of people from their communities and environments; sustainable development is premised on an economic system that is able to provide for people's needs, whether or not this is done through a market mechanism. it includes considerations of equity, justice, empowerment and environmental integrity. within the trade regime, there are four key aspects that we need to "get right" ifwe are to advance sustainable de~elopment: share the benefits of trade between countries so that terms of trade become equal; bring people back into trade in order to build meaningful economies; incorporate environmental considerations so that trade has a future; and sustainable consumption, thereby orienting production to meet people's needs. these aspects are seldom considered in current trade policy and practice. questioning the dominant trade paradigm trade policy in south africa as in most other countries, is based on an assumption that there is a direct, causal relationship between trade liberalisation, economic growth, development and sustainable development. the first is a necessary (but not sufficient) condition for the second, which is i> necessary (but not sufficient) condition for the third, and so on. but a conceptual and operational understanding of sustainable development remains weak in national economic ministries and in international economic institutions. trade policy is not conceived within the framework of sustainable development in south africa (nor internationally). the nature of the relationship between these components is complex and far from agreed upon. scoring top marks in the first three (le. achieving high levels of trade liberalisation. economic growth and development) does not tell us very much about the fourth component, i.e. whether or not development is sustainable. likewise economic growth and trade liberalisation do not tell us very much about development. furthermore, even the link between trade liberalisation and economic growth is starting to be questioned (halle, 200 i). a study produced by the centre for economic and policy research, found that globally, growth was considerably slower during the 1980-2000 period of rapid globalisation. than between 1960-1980 (weisbrot et al., 2000). on average, per capita output r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 340 sajems ns vols (2002) no 2 fell from an 83 per cent growth rate in the earlier period to only 33 per cent growth over the last twenty years. in sub-saharan africa, gdp grew by 36 per cent between 1960 and 1980, whereas it fell by 15 per cent between 1980 and 2000. ecological destruction and failing economies: mirrors of the same crisis there is a strong correlation between some of the environmental concerns and some of the problems in the global economy. arguments for environmental justice and economic justice stem from a similar analysis of the disjuncture between globalisation and sustainable development. overproduction, the crisis of capitalism, international competitiveness and decreasing rates of growth have profound implications for how economies are run and how the environment is managed. towards the end of the 1960s, rising unemployment, inflation and falling profits indicated that capitalism was in crisis (lehulere, 2000). at the same time the depth of the ecological crisis was starting to be recognised. there was an awareness that the life-supporting systems were changing fundamentally, in ways that could be devastating and irreversible. for example, human induced climate changes impacts on where plants can grow and humans can live; ozone layer depletion brings the risk of harmful radiation; destruction of marine resources and pollution of freshwater has devastating effects on people who are dependent on them, and so on. overproduction, a common feature of capitalism, is a problem both for the economy and the environment. from a market perspective, new consumers must be found to purchase excess produce. overproduction in industrial countries has led to an aggressive search for new markets in the south. from an environmental perspective, production should be limited to the ability of natural systems to replenish themselves and process waste. overproduction tends to result in unnecessary pollution (often toxic or eternal) and excessive use of scarce natural resources, such as wood, water and energy. both the ecological and economic crises have resulted in a move towards efficiency and growth in the service sector. these aims appear laudable fewer resources are used to make the same product or provide the same service. but there are problems with this approach. for example, labour is a key resource that we should not be looking to minimise. in south africa, production should be labour intensive if we are to have any hope of meeting our reconstruction and development targets. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 341 environmentalists have long argued that there are limits to growth. this has been observed in decreasing rates of growth over the past 20 years. yet the underlying assumption of the wto is that growth will continue, wealth will increase and will eventually trickle down to poor people who are currently excluded from the economy, and to fixing up environmental damage caused in the pursuit of wealth. this is not what has been observed. smaller growth rates inevitably lead to greater conflict between capital and labour (lehulere, 2000). the high concentratoin of wealth among a minority of people indicates that capital is in fact gaining while the poor are being further marginalised, while environmental destruction continues. this twinning of environmental and economic problems indicates that we should seek an integrated solution. analysis how is "environment" perceived in the wto? within the wto, different constituencies are taking up environmental issues differently. the following table illustrates very broadly the different issues raised by various interest groups during the wto 3rd ministerial meeting in seattle in november 1999. these are the same issues that have been pushed over the past two years and which were important in shaping the trade and environment negotiations launched in doha, qatar, at the wto 4th ministerial meeting in november 2001. endangered species was probably the most visible environmental issue in seattle. hundreds of people dressed up as turtles or butterflies, held banners and placards proclaiming that the wto threatens wildlife. it is probably also the environmental issue most likely to distinguish north from south. in a more nuanced way, northern ngos are also promoting sustainable consumption, which stems from the understanding that our consumptive lifestyles are one of the biggest threats to environmental integrity. it also acknowledges that people in the north consume much more (and hence impact much more) than people in the south. one of the reasons for reducing consumption in the north, is to allow the south to consume more, resulting in a more equal per capita consumption that remains within the limits of the earth's ability to regenerate natural resources and absorb waste. where southern ngos have articulated environmental concerns, they have pushed for environmental justice, based on the understanding that environmental degradation is disproportionately borne by people who are poor and disempowered. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 342 sajems ns vol 5 (2002) no 2 table 1 environmental concerns and position at seattle primary position secondary position other positions northern endangered sustainable fair trade; ngos species consumption questioning expansion of trade northern environmental 'multiprecautionary governconcerns functionality' of principle ments equivalent to agriculture market protection southern no strong voice component of questioning exportngos on environment sustainable led growth development; vision of environmental justice southern no to pro-active on . article xx (general governenvironmental i trips i exceptions) sufficient ments ! issues south premature to broad african include 'development' round i government environment northern governments' interpretation of their environmental constituency is through a very protectionist lens. for example, the usa proposed to liberalise environmental services even though technology transfer obligations are not currently met under the multilateral environmental agreements, which are much more appropriate instruments to deal with genuine environmental concerns, but which the usa have generally not even ratified. multifunctionality can easily be interpreted as a new way to protect european agriculture. certain subsidies and support to agriculture will be justified on the basis that agriculture has multiple functions, for example conserving the landscape. southern governments are very cautious about bringing the environment into the wto because it would be easy to use it to justify protectionist behaviour. one exception is on trips, where african countries are arguing for it to be amended, so that i) no life forms can be patented, and ii) there is proper protection of indigenous knowledge. the south african government has been a strong advocate of a broad development round. from an environmental perspective, this contains some flawed assumptions, namely that i) growth is desirable and can mitigate hidden costs such as toxic waste or over-fishing and later, ii) the south can achieve the same standard of living as the north (which unrealistically requires a sixteen-fold increase in resource use and pollution over the next five decades). ! r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 343 the inclusion of environment into the wto would link it to the trade agreements so that if there is an environmental infringement, the wto's dispute settlement mechanism could be invoked. there are a couple of problems with this. the first is an intuitive caution the countries that are pushing for the inclusion of "environment" do not have a particularly good history of managing it and are certainly consuming more than their fair share of the world's resources. the european union is particularly strong in pressurising other countries to support its call to make the environment part of wto agreements. the usa favours the liberalisation of environmental services even though it has not ratified any of the key multilateral environmental agreements. the second concern is that bringing non·trade issues into the wto would be to introduce them to a forum that is highly biased against small or weak economies; it brings them into a playing field which is dominated by the quad a group of four countries comprised of the eu, the usa, canada and japan. this would allow economic giants to dictate what is good environmental practice and to sanction those that failed to comply. these different issues were pushed for different reasons; it is interesting to see how they manifested in the subsequent wto ministerial meeting. what bappened in doha, qatar despite strong opposition to the inclusion of negotiations on trade and environment, the wto 4th ministerial held in doha, qatar from 19·14 november, 200 i stated: "3 l with a view to enhancing the mutual supportiveness of trade and environment, we agree to negotiations, without prejudging their outcome, on: i) the relationship between existing wto rules and specific trade obligations set out in multilateral environmental agreements (meas). the negotiations shall be limited in scope to the applicability of such existing wto rules as among parties to the mea in question. the negotiations shall not prejudice the wto rights of any member that is not a party to the mea in question. ii) procedures for regular information exchange between mea secretariats and the relevant wto committees, and the criteria for the granting of observer status; iii) the reduction or, as appropriate, elimination of tariff and non-tariff barriers to environmental goods and services." negotiation on fisheries subsidies are agreed to in a separate paragraph, which states: "participants shall also aim to clarify and improve wto disciplines on fisheries subsidies, taking into account the importance of this sector to developing countries." r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 344 sajems ns vol 5 (2002) no 2 in addition there are some suggestions for pre-negotiations through the committee on trade and environment (cte) "to give particular attention to: i) the effect of environmental measures on market access, especially in relation to developing countries, in particular the least-developed among them, and those situations in which the elimination or reduction of trade restrictions and distortions would benefit trade, the environment and development ii) the relevant provisions of the agreement on trade-related aspects of intellectual property rights; and iii) labelling requirements for environmental purposes." evaluation environmental negotiations against sustainable development imperatives this section examines how the negotiations and pre-negotiations agreed to in doha might contribute to sustainable development, bearing in mind the four key aspects of sustainable development that needs to be addressed in the trade regime: share the benefits of trade between countries so that terms of trade become equal; bring people back into trade in order to build meaningful economies; incorporate environmental considerations so that trade has a future; and sustainable consumption, thereby orienting production to meet people's needs table 2 provides a summary of the discussion presented below. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . samms ns vol 5 (2002) no 2 345 table 2 contribution of environmental negotiations to sustainable development equ.using trade • people-eentred environ~mental sustainable terms i economies considerations consnmption neaotiations ialldcbed in doha. november 2001 mea trade possible if rules no the wto is possible although ob6gations are developed and an inappropriate there is a major agreed to, it could forum to discuss loo~hole in that discourage human wellcountries who do unilateral action being. the talks not sign meas are in the name of will be technical. exempt (this , envirorunental provides an management' . incentive not to i ratify meas) wto-mea difficult to tlssess infonnation exchange appears neutral, but could have information implications for sustainable development, depending on what actions arise excbange from the infonnation exchange. these implications could be negative or positive. environ~ no developed ! no there is no possible possible there mental countries have i indication that envirorunental might be goods & comparative envirorunentaj technologies could efficiency services advantage in services are lead to more gains per unit envirorunental inherently more efficient use of of production, goods and people-focussed resources, such as but it is services. could than any other energy and water, unlikely to undermine traded sector. but liberajisation address overall technology will need to be consumption. transfer under the i allowing willer linked to regulating meas. to be included as overall a service could be consumption. disastrous. allowing water to be included as a service could be disastrous. fisberies i no an agreement no there is no no an agreement no the , to reduce fisheries indication that to reduce fisheries vagueness of subsidies would negotiations will subsidies would commitment benefit deveconsider the benefit marine indicates that loping countries, needs of people resources (by there is no if it is not linked dependent on reducing total serious desire to other trade marine resources catch) but such an to put fisheries agreements. this for their agreement is not ona path positive scenario livelihoods. likely and was not where they are is unlikely to mandated in doha. harvested and transpire and was ' consumed in a not mandated in i sustainable doha. manner. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 346 sajems ns vol 5 (2002) no 2 table 2 continued equalising trade people-eentred environmental ! sustainable terms eeonomies consideratiods consumption pre-" ....... lis (discllssion til the committee on trade tmd environment market no talks are no see previous perhaps if talks no increased seeess aimed at box. mar:lret move into trade is the identifying when access talks will negotiations and stated environmental need to look at there is objective, measures affect impacts on smallidentification of which in many market access. scale producers. instances where instances they are not reduced trade undermines negotiations, so restrictions benefit sustainable there is no environment and consumption. guarantee that development. negative impacts fisheries are an on market access obvious example of will be remedied. the potential for this, yet they are not included under this paragraph. trips no if there was serious commitment to amending article 27(3)b to reduce patent protection and strengthen indigenous rights then tenns of trade could improve, people could be given a more central place, the environment could be managed bener at a local level and production better oriented towards meeting people's needs. this is so very unlikely to happen, particularly within thecte. labelling no likely to posslbleecopossible shifting possible exacerbate labels that take market demand qualitative unequal terms of into account local away from products aspects of trade because of conditions could that are consumption high cost of improve environmentally can be implementing environmental, damaging is addressed certification health and safety possible through through ecosystems. conditions for eco-labelling. e.g. it labels, if they certification workers. could reduce the have integrity standards likely to production of blood and are be biased towards diamonds and relevant to the the north because tropical timber. locale in which they are more they are powerful in wto applied. negotiations. share the benefits of trade between countries so that terms of trade become equal it is unlikely that the negotiations and pre-negotiations outlined in the doha declaration will belp to move the balance of trade in the favour of developing countries. negotiations on environmental goods and services are particularly r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 347 problematic and are likely to exacerbate unequal terms of trade. south aftica might benefit because it has technological capacity and is by far the most dominant economy in the region. its gdp accounts for 80 per cent of the total gdp of the southern aftican development community, sadc (visser, 2000). liberalisation of environmental services will favour those who own or can develop the environmental technologies and skills. 'ibis could undermine technology transfer commitments under the meas in that countries will argue that the market is best placed to deliver technology to developing countries. this is problematic because it will not be aimed at reducing the gap between north and south. fisheries have long been the target of developing countries' claims of unfair practices, yet it is clear from doha that these practices are unlikely to change. parties commit to "clarify and improve wto disciplines on fisheries subsidies", which does not imply any commitment to reduction of subsidies or reduced pressure by developed countries for access to southern fisheries. furthermore, fisheries agreements are required under the sa-eu trade, development co-operation agreement (idca) and under the cotonou agreement (which replaced lome as the european union (eu) aftican, caribbean and pacific (acp) agreement). these agreements are "aimed at mutually satisfactory conditions for fishing activities in the acp states" and state that "the acp states shall not discriminate against the community" (cotonou, 2001). thus positive steps on fisheries in the wto could be undermined by bi-iateral and pluri-iateral agreements that are tied to preferential market access. the prescribed pre-negotiations are equally problematic in sharing the benefits of trade. labelling tends to be biased against small-producers and against countries that do not have the systems in place to monitor and evaluate production. thus farmers who use no synthetic pesticides and fertilisers because they can not afford them, will not be considered "organic" because they are unlikely to be able to afford to prove that their production methods are worthy of certification. market access should theoretically allow poorer countries greater benefits, although the wording does not imply any compensation for reduced access, merely an identification of its effect. bring people back into trade in order to build meaningful economies the wto does not deal very well with human or environment issues because issues of its conviction that the market mechanisms will provide all solutions. aggregate growth (the ostensible aim of trade liberalisation) is a poor indicator r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 348 sajems ns vol 5 (2002) no 2 of wealth distribution within countries and of who is gaining from economic adjustments. negotiating issues in an ad hoc manner such as outlined in the doha declaration is hardly meaningful; what is required is a holistic overhaul of the system. fisheries is an area where trade has really worked against small-scale producers and communities dependent on marine resources for their livelihood. the doha declaration fails to resolve or address this. overcapacity of the european fishing industry is largely responsible for pressure on fisheries in southern countries, which has often led to the exclusion of artisinal fishers. yet there is no commitment in the wto to reduce eu subsidies, which would go some way towards reducing overcapacity. there is grave concern about one aspect of the services clause of the negotiations; that is, about what constitutes an environmental service or good. several countries, including the usa and canada are pushing strongly to include provision of freshwater as a service (barlow, 2001). this, together with trends towards privatisation, is likely to have devastating effects on the poor by further excluding them from access to basic services. it would also limit the ability of governments at national and local levels to manage water in a sustainable manner. the africa group have strongly objected to article 27(3)b of the trips agreement, which allows for the patenting of life forms. their grounds for concern "do not arise merely from the detrimental consequences, such as for further research (patents over research material in this area may restrict further research), from the concept of patentability (that discoveries do not amount to inventions), the rocketing cost of medicines and the targeting of research towards products for the affiuent rather than general public health, or from the doubts over the safety of genetically modified products. they do arise equally from deeply held intuitive values. and if any abuse is to be regulated, excluding their patentability is the point to begin" (africa group, 2000). the doha declaration is vague about which provisions of trips are relevant to discuss in the cte, but presumably this article 27(3)b will be the cornerstone of those discussions. allowing for the patenting of genetic resources takes control over resources away from local communities and from people who have been using them (and often protecting them) for generations. incorporate environmental considerations so that trade has a future the inclusion of negotiations on trade aspects of multilateral environmental agreements (meas) within the wto could be problematic. unlike wto agreements, which form part of a single undertaking, countries can choose r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 349 which meas to sign and which to ignore. likewise with labour conventions. including negotiations on meas that "shall not prejudice the wto rights of any member that is not a party to the mea in question" provides an incentive for countries not to ratify meas. this includes countries such as the usa, which has yet to sign any of the meas arising from the 1992 united nations conference on environment and development (unced). liberalising environmental goods and services could benefit the environment through more efficient use of natural resources such as water and energy, as well as use of clean technologies that are less polluting. yet some of this is already mandated under technology transfer clauses within agenda 21 and specific meas. agenda 21 states that "when discussing transfer of technologies, the human resource development and local capacity-building aspects of technology choices, including gender-relevant aspects, should also be addressed. environmentally sound technologies should be compatible with nationally determined environmental priorities." this key aspect of local relevance and people-centred technology could be threatened by shifting the onus to a market based solution that cannot possibly allow for such critical nuances. pre-negotiations on labelling need to be carefully conducted, if they are to achieve environment protection, rather than economic protectionism. the costs of certification systems are extremely high (both financially and institutionally) and are therefore biased against developing countries and against small-scale producers. the relationship between eco-iabels and sound environmental management is not a given. eco-labels can provide very useful information to consumers, but this depends on the integrity of the label, the relevance of its standards to local conditions etc. sustainable consumption, thereby orienting production to meet people's needs the wto and its agreements are not oriented towards sustainable consumption nor sustainable production. on the contrary, the whole rationale behind trade liberalisation is to increase economic production, with very little regard for the type of production. consumption is not considered overtly the underlying assumption being that consumption must also increase to match production. this is not a sound premise from which to direct production towards meeting people's needs. of all the aspects of environment proposed in the doha ministerial, those relating to environmental goods and services and labelling have the greatest potential to contribute to sustainable consumption. but they could also be r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 350 sajems ns vol 5 (2002) no 2 problematic and the degree to which they are positive will depend largely on the exact tenns of their negotiation and the ability of countries to manage them nationally. although this table 2 gives a breakdown of where and how environmental negotiations could contribute to .sustainable development, it paints an . incomplete picture. possible benefits are unlikely to be realised unless there are fundamental changes in the way that the wto operates, i.e. unless it becomes democratic and not biased towards rich countries. currently benefits are likely to accrue to the powerful countries within the wto and their interests will dominate. developing countries only have a limited number of people and resources they can deploy for negotiations. for them to assert their interests seriously in environmental negotiations, they will have to give up other areas of negotiation that are more important to them. these include implementation and assessment of the true impacts of the previous (uruguay) round of trade negotiations. thus more equal terms of trade, bringing people back into economies and sustainable consumption are unlikely to be realised. even the environment will probably not benefit as the negotiators are drawn from the economic ministries and have little concept of how to manage the environment. it will be hard to distinguish genuine environmental concerns from those that are used for protectionism. moving trade towards sustainable development will only be possible if the voice of all sectors of society are incorporated: government, women, youth, environmental ngos, labour, business, faith-based organisations, etc. implications for other international processes it is a strange turn of events that the doha ministerial declaration is being presented as a breakthrough for sustainable development and developing countries. the processes leading to the world summit on sustainable development (wssd) and the international conference on financing for development have both articulated the need to implement the outcome of doha (un monterrey consensus; un chairman's paper). this is cause for some alarm given that even the environmental negotiations are unlikely to contribute to sustainable development, as discussed above. it is an indication that political space is being taken from the united nations and given to the world trade organisation, with its exclusive membership and ideological and economic biases, to define critical elements of our path to sustainable development. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 351 recommendations for proactive engagement the trade model promoted by the wto does not (and can not) take environmental considerations into account, in a manner that would support sustainable development. although the wto preamble pays lip-service to sustainable development, if that were to be reflected in the treaties, it would have led to a very different economic model. the international institute for sustainable development (llsd) argues that setting clear goals for the wto will provide the necessary framework for a shift towards sustainable development (i1sd, 2001). perhaps, but it is likely to require more than this. a fundamental change in the relationship between different international institutions is required. the wto needs to fall undet a revised and democratised united nations system, where checks and balances are in place to ensure that all institutions work towards (and not against) the international declaration of human rights and the myriad of other agreements that have been signed to bring peace, stability, dignity and sustainable development to all people the wto and its agreements must take their place with other international institutions and agreements, fitting into a broader system of democratic global governance that needs to be in place to manage the global commons and the increasing interaction between people across the world. it is alarming to realise that although developing countries are the least destructive of the global environment, they are paying the most for its protection. this is likely to be exacerbated as more and more things are brought into the market system biodiversity, indigenous culture, traditional knowledge, etc. south africa and other developing countries should take a strong stance against expanding the list of what is considered an environmental service in the wto. water should not be included. instead, meas should be used to give proper (non-monetary) value to southern resources that are globally significant (clean air, forests, water, etc.). this value should be used to benefit the poor who are highly dependent on those resources. recognition of the relationship between people and their environment is critical if we are to move towards more people-centred economies. this would lead to a person's right to choose and have control over their local resources. commodification of resources is likely to undermine this, as local people will be competing with far bigger interests for resource use and management. it is therefore important that governments do not give up their responsibility to local development by placing more and more goods and services into the domain of the unregulated global economy. sustainable consumption is one of the most critical objectives to come out of agenda 21. yet it will not be achieved if trade liberalisation remains a goal in r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 352 sajems ns vol 5 (2002) no 2 itself. clear national objectives need to be set for trade to reorientate it as a tool for sustainable development. this is likely to mean that there will be less trade and that economies will shift towards greater local production and consumption. conclusion bringing environment into the wto is risky for four reasons. firstly, there is an uneven playing field, which disadvantages developing countries. secondly, trade is not designed to promote sustainable development. thirdly, there are numerous processes happening outside the wto that could be compromised if environment becomes a focus of trade negotiations within the wto. and fourthly (as developing countries continue to point out), there are huge opportunity costs in engaging in environmental negotiations, before issues that are critical to developing countries have been addressed. these include implementation and the assessment of the true impact of the uruguay round. the way in which environment has been included in the wto provides greater advantage for developed than developing countries. the agenda for negotiations on trade and environment outlined in the doha declaration is biased against developing country interests. there is some room for small gains, but taking a pro-active stance needs to be weighed up against the opportunity cost of reducing focus on other key aspects of wto negotiations. one example would be for developing countries to be pro-active in identifying where the elimination of trade restrictions and distortions would benefit trade, the environment and development. this could become the basis of their negotiating position and a prerequisite to discussions on issues that are less beneficial, such as ecolabelling. developing countries need to stand firm about not expanding environmental negotiations to areas which would be detrimental to poor people. this includes keeping water out of negotiations on services and insisting that life-forms are not patented. the doha ministerial declaration entrenches the wto's commitment to export-led growth outside a framework of sustainable development. it takes political space away from the united nations and has infiltrated important international processes with its unsustainable model of economic development. yet, because rapid globalisation goes fundamentally against sustainable development and people's values, it will continue to hit barriers and be opposed by people for economic, environment, social and human rights reasons. the question of "trade and environment" is not going to go away, but needs to be dealt with outside of the wto. within south africa we need to have a much better understanding of what it means and how to deal with it. this will require enhancing public debate through active engagement between government, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 353 business, labour and non-profit civil society organisations. references africa group, (2000) draft submission on article 27.3b to the trips council, september. 2 cotonou agreement (2000). 3 crompton, s. (2001) interview with the author as part of the deat review of agenda 21. 4 fgd (1998) "understanding the wto: implications and possibilities for the south", fgd occasional paper, no. 13. 5 iisd (2001) "what's it all for? setting clear goals for the world trade organisation" (wto), lisd viewpoint, august. 6 lehulere, o. (2000) "the evolution of south africa's economic policy", presented at aidc-emg mobilisation against globalisation workshop, 29-31 may 2000, johannesburg. 7 halle, m. (2001) "international institute for sustainable development", discussion at a iisdffralac seminar on trade and sustainable development, august, stellenbosch. 8 united nations (2002) "monterrey consensus", draft outcome of the international conference on financing for development, 30 january, ajac.2571l.13, new york. 9 united nations (2002) "chairman's paper", second session of the preparatory committee for the world summit on sustainable development, 8 february, new york. 10 weisbrot, m., robert, n. & joyce, k. (2000) "the emperor has no growth: declining economic growth rates in the era of globalisation", centre for economic policy research paper, www.cepr.net 11 wilson, j. (2001) "trade, environment and sustainable development", chapter for the south african department of environmental affairs and tourism national review of agenda 21. 12 world trade organisation (2001) ministerial declaration, wtimin(ol)/dec/w/i, 14 november, doha. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . microsoft word 4-harris & vdmerwe sajems 15(3) 2012.doc 282 sajems ns 15 (2012) no 3 the scope for mobilising public opinion against corruption: the attitudes of kwazulu-natal university students geoff harris department of public management & economics, durban university of technology alexander dawid van der merwe department of economics durban university of technology accepted: november 2011 the aim of this study is to ascertain perceptions of public sector corruption that university students, as potentially influential members of society, hold. the study is based on a purposive sample of 509 firstand second-year university students. descriptive and non-parametric bivariate analysis suggests that students overwhelmingly regard public sector corruption as an important issue. in addition, there appear to be remarkable degrees of consensus as to what actions are perceived as corrupt even if there is evidence of mismatches between students’ beliefs and likely actions. at least some of this dissonance may be explained by the finding that respondents' corruption perceptions are biased by gender and ethnicity. these are challenges that programmes aimed at inspiring mass public opinion to join the fight against corruption may have to address. key words: corruption, graft, public sector corruption, anti-corruption measures jel: h00, z00 1 introduction there is increasing awareness of the costs of corruption as documented in a growing international literature. the country corruption assessment report (ccar) (anon., 2003) identifies the following evils of corruption: it hamstrings economic development, interferes with good governance, erodes stability of – and trust in – government’, damages the ethos of democratic government and has considerable social and economic costs. anti-corruption initiatives are a common, and politically expedient, response to perceptions of high and rising levels of corruption. the latest corruptions perceptions index (anon., 2010a) ranks south africa at number 54 out of 178 countries, where 1 is the least corrupt country. south africa’s corruption rating in terms of transparency international’s corruption perceptions index (cpi) has deteriorated consistently from 5.1 in 2007 to 4.5 in 2010 (anon., 2010a). van der merwe (2006) finds that corruption is perceived by public servants to be widespread throughout kwazulu-natal provincial and national government departments. official concern about corruption levels in south africa and how to tackle it gained momentum in 1999 with the launch of the national anti-corruption initiative and the creation of the national anti-corruption forum in 2001 (baqwa, 1999). following the implementation of these and, subsequently, a host of other measures aimed at reducing corruption the question must be asked: how effective are they if south africa has become a more corrupt country in recent years? a heightened national sensitivity towards corruption is evident in the national planning commission’s (2011a) diagnostic report in which it identifies corruption as one of nine major challenges facing the country. this paper explores, on a case study basis, the attitudes of university students in kwazulunatal to aspects of public sector corruption and abstract sajems ns 15 (2012) no 3 283 also discusses the possible implications of the corruption perceptions of young citizens for the local fight against corruption. it proposes that south africa’s general anticorruption approach, which is essentially founded on a mix of principal-agent theory and institutional perspectives, is flawed in at least three respects. firstly, the principal-agent model depends on the principal for implementing reforms and this is a weakness if one considers that there may be several principals each with incoherent objectives and diverse interests (andvig, fjelstad, amundsen, sissener & soreide, 2000). secondly, the principal-agent notion that it is invariably the principal’s objective to reduce corruption, and that the principal is therefore not corrupt, may not always be the case. finally, anticorruption measures can have no significant effect, may find no traction, if there is no real belief in the imperative of acting ethically and morally. there can be no effective monitoring of corruption if society does not perceive certain actions as corrupt or discounts their true cost (olken, 2007). this article probes the possibility that the notions university students, as potential community leaders, have of what constitutes ethical and moral behaviour may be highly variable so as to confound efforts to harness mass public opinion in the local fight against graft. the discussion brings to the fore the issue of integrity and ethics education in south african schools and institutions of higher learning as a vital, although evidently neglected, component of local corruption control. the notion of introducing formal ethics education at school and university level is not without precedent (van der merwe, 2004). however, such programmes would need to be sensitive to society's perceptions of corruption. the study considers the following questions: 1. how serious do university students perceive the problem of public sector corruption to be? 2. what actions do students believe constitute corrupt behaviour? 3. are students’ perceptions of what constitutes corruption influenced by factors such as gender, ethnicity and religious beliefs? the answers to these questions may shed more light on the bigger question of how best to mobilise public opinion in the fight against local public sector corruption. section 2 reviews some of the literature on corruption; section 3 explains the study’s methodology, section 4 discusses the analysis and results and section 5 concludes. 2 review of the literature 2.1 defining corruption the many possible varieties of corruption render it a difficult-to-define and complex phenomenon so that it becomes problematic to distinguish corruption from other forms of social exchange. for the purposes of this discussion corruption is regarded to be: -…behaviour which deviates from the formal duties of a public role because of private-regarding (personal, close family, private clique) pecuniary or status gains; or violates rules against the exercise of certain types of private regarding influence. this includes behaviour such as bribery (use of a reward to pervert the judgment of a person in a position of trust); nepotism (bestowal of patronage by reason of ascriptive relationship rather than merit); and misappropriation (illegal use of public resources for private gain). (nye, 1967:419). 2.2 corruption: predisposing factors the international literature suggests that, historically, corrupt behaviour may be influenced by a range of variables: natural resource availability, culture/ethnicity, masculinity, uncertainty, religion, power distance, inequity, the quality of public institutions, size of government, level of development, market regulation, the market system and economic conditions. thus some evidence has been reported that population size and natural resource wealth appear to be positively correlated with the incidence of bribery (cartier-bresson, 2000; andvig et al., 2000). other studies report that corruption appears to be influenced by attitudes, paradigms and values deeply rooted in the culture of certain populations (husted, 1999; getz & volkema, 2001). several studies record that males are more likely than women 284 sajems ns 15 (2012) no 3 to act corruptly (lambsdorff, 1999; getz & volkema, 2001; bowman & gilligan, 2008). paldam (2001) found that certain religions may be more tolerant of corruption and that religious diversity reduces the incidence of corruption. husted (1999) proposed that corruption is tolerated more readily in high power distance (paternalistic) cultures than in low power distance cultures. the quality of public institutions such as government offices, the judiciary and the media have been associated with corruption levels (cartier-bresson, 2000). lambsdorff (1999) notes that corruption levels have been shown to increase when government regulation imposes a heavy burden on business competitiveness. corruption is more likely to be exposed in developed countries precisely because their public institutions such as the press and other media tend to be more established. this is apart from the consideration that economic development increases the spread of education, literacy and depersonalized relationships, all of which act to constrain graft (andvig et al., 2000). there seems to be some consensus that the prospect of economic adversity heightens the appeal of corruption (getz & volkema, 2001; razafrindrakoto & roubaud, 2003). 2.3 nuances of corruption in south africa the values and norms of a particular society can be expected to inform its attitudes to corruption. south africa has a complex politico-economic history and this affects the genesis and character of local corruption. spencer (2001) suggests that south africans seem to have difficulty distinguishing between legality and morality. he proposes that morality is concerned with objective principles such as duty, obligation and fairness which should be universally desirable. thus legality deals with what one can get away with while morality deals with what one should not attempt to avoid. bauer (2000) asserts that the aspect of racial entitlement enshrined in the philosophy of apartheid contributed to the development of a culture of corruption. within this system, some officials had become disillusioned in their efforts to serve the apartheid policy of mass removals and resettlements of people. such officials would thus help themselves to the large amounts of funds allocated to these projects which, in many instances, held no appeal for them and were probably considered in any case to be wasteful expenditure. apartheid thus perverted not only the morals of its mandarins but also those on whom it was inflicted. kaunda (2001) proposes that apartheid left behind a legacy of a serious breakdown of morals in south african society. she suggests that the results of this collapse can be seen in, among other instances, diminishing parental control of children, a lack of respect for authority and the rule of law and high and rising levels of crime and corruption. mthombothi (2000) agrees that apartheid fostered moral depravity and that all south africans have been corrupted by it. he proposes that south african society, generally, is tolerant of dishonest and corrupt conduct, that cheating is ubiquitous whether in the form of tax evasion, illegal transfers of money out of the country or dubious business practices. indeed it seems that the spectre of corruption lingers on in the post-apartheid era. makhanya (2003) confirms that south african society is apparently becoming increasingly apathetic about the phenomenon of graft in seeming to accept that this is inevitable in government. in south africa’s new political dispensation corruption appears to have some subtly unique characteristics. a common thread linking many of the transactions that have been labelled as corrupt after the advent of democracy in 1994 is that they have drawn openly on the privilege of political office or connections in government (van der merwe, 2004; lund, 2010). considerable evidence has been cited of corrupt transactions between government and favoured groups or cliques (haffejee, 2001; ayoob, 2003). hogg (2011) notes that many appear to regard this “reciprocity” between government and select beneficiaries as due reward for loyal support. he observes, furthermore, that the arrangement may enjoy currency as a tool of economic empowerment. transactions concluded by some public officials verge on blatant criminality. it is common cause that south africa has a high crime rate which fact rautenbach (2000) sajems ns 15 (2012) no 3 285 proposes is a characteristic of a nonconformist society. nonconformist societies are typically heterogeneous and display large social cleavages in terms of language, ethnicity, religion, education levels and income. such societies south africa being a good example in rautenbach’s estimation tend to have high levels of disorder, indiscipline and disregard for the law. it is not inconceivable that, in such an environment, there might be a nexus between crime and corruption. the capacity to corrupt public processes provides significant regulatory advantages by protecting criminal enterprise (shaw, 1998; baqwa, 1999). thus crime and corruption thrive in a symbiotic relationship. this is an intuitively appealing notion if one considers, for instance, the corruption charges that were brought against south africa’s erstwhile police commissioner (anon., 2008) and the criminal charges against the wife of south africa’s state security minister (anon., 2010b). organized crime within the country is reported to be rife (irish, 2003; hartley, 2009) and it appears that corruption in commerce, law enforcement and in other government departments perpetuates this situation (irish, 2003). indeed, president zuma (2009, 2010) has, in two consecutive state-of-the-nation addresses felt it necessary to pledge greater efforts and resources to combating corruption in the public sector. survey results suggest that a decline in ethics and morals is the most commonly cited cause of corruption in south african society in general (camerer, 2001; van der merwe 2006). the country corruption assessment report (anon., 2003) claims evidence of a decay in moral values in general within society. landman (2000) argues that south africa is undergoing a moral and ethical crisis as a result of centuries of social engineering of the worst kind. he suggests that this circumstance has been compounded by the country’s sudden political changes commencing in 1994 with all its attendant insecurities and new institutions, unemployment and other factors such as hiv and aids. greed and moral dislocation, symptoms of distorted values, have also been identified as major causes of local crime and corruption (camerer, 2001; rauch, 2005; van der merwe, 2006). 2.4 a note on south africa’s general anticorruption approach the character of corruption and its likely causes should inform efforts to combat it historically, there appear to be three distinct approaches to controlling corruption (doig & riley, 1998): those based on economic analyses, those founded on mass public opinion or civic culture perspectives and those informed by institutional viewpoints. the institutional approach to corruption control emphasizes the strengthening of institutions such as anti-corruption agencies or functions and procedures within organisations such as registers of interest and codes to delineate the expectations the public has of officials. mass public opinion perspectives examine the social or cultural context of corruption and suggest mass attitudinal change or civic awareness anti-corruption strategies. economic analyses of corruption generally mostly prioritize the principal-agent approach which is rooted in neoclassical economic theory and has been used extensively by the world bank. the debate on the effectiveness of anticorruption strategies has changed markedly since the 1980s. the development agenda of the 1990s focused on developing market economies and liberal democratic systems (riley, 1998). within this agenda, the new context of corruption was conditioned by two assumptions. the first is that public sector corruption will be reduced if the size of the state is reduced. the second is that a move to liberal pluralist politics, a freer press and the creation of other independent institutions (the judiciary for instance) will reduce corruption by making it vulnerable to exposure. riley noted that the policy agenda of the 1990s assumed a limited, legitimate and honest state which in fact may not be the case when the state sector is swollen, corrupt and inefficient and individual and group interests have priority over the public good. modern corruption control techniques appear to be strongly informed by principal-agent/ incentive theory. according to this philosophy, the principal is assumed to be honest while the agent/official and client are motivated by selfinterest. thus any decision by the agent and client to behave dishonestly is based on calculations of potential personal gains and 286 sajems ns 15 (2012) no 3 losses that may result from these actions. accordingly, measures designed to constrain corruption include reducing opportunities for exacting economic rents and the exercising of monopoly power by means of deregulation and privatization. furthermore, administrative reform may be aimed at reducing officials’ discretion and also demanding greater accountability from public servants. the building up of institutions such as auditing and accounting units, legal reforms and encouraging public oversight through parliament and a more vibrant civil society are also core components of modern corruption control. van der merwe (2004) notes that south africa has in place most of the constituent elements of a sound anticorruption system. this includes a comprehensive and practical legislative framework as well as various anticorruption and law enforcement agencies. mechanisms to report corruption are in place as well as strong frameworks for financial, procurement risk and human resource management. van der merwe finds, in spite of this, that local anticorruption initiatives have evidently had no significant impact on kwazulu-natal public sector corruption levels. he argues that this state of affairs can be blamed on, amongst other things, a failure to implement existing measures and strategies due to a lack of resources and political will. thus the institutions charged with keeping corruption in check (institutional approach to corruption control) lack the capacity to do so effectively. woods (2011) argues that this failure of government organisations to properly apply systems creates opportunities for would-be perpetrators of corruption. the reality of corrupt principals, whose activities will be further shrouded by a veil of state-sanctioned secrecy if the mooted protection of information bill is passed in undiluted form, suggests that the principal-agent approach to corruption control can enjoy only limited success. the ccar (anon., 2003) identifies the following causes of corruption within south africa’s private and public sectors: inefficient control mechanisms, insufficient anticorruption training, greed, poverty and the decay of moral societal values. its anticorruption recommendations are correspondingly set out under five headings: enhancing institutional capacity to fight corruption, improving management policies and practices in the public service, slicker reporting of corruption, creating partnerships in the fight against corruption and promoting ethics and civic awareness. this study is particularly interested in the prospects that the last three recommendations hold for corruption control insofar as they hint at the need to mobilise mass public opinion more effectively in the fight against corruption. 3 research method this study employed a purposive sampling design in that it is based on a survey of first and second-year students enrolled in particular economics and business/administration classes at both the durban university of technology (dut, pietermaritzburg) and university of kwazulu-natal (ukzn, durban) in 2010. the choice of sample was influenced by the consideration that university students are likely to become leaders and opinion makers (anon., 2011), citizens who are most likely to demand accountability in respect of curbing corruption. the relatively large sample size (n = 509) offers a measure of confidence that the sample is reasonably representative of the population from which it was drawn. the mainly nominal and ordinal nature of the survey data, dictated the employment of non-parametric inferential analytical techniques together with some descriptive statistical analysis. the survey instrument employed to gather the data comprises a short biographical section with four questions relating to respondents’ gender, age, ethnicity and religious beliefs. the literature generally confirms that gender (bowman & gilligan, 2008), ethnicity (getz & volkema, 2001) and religion (paldam, 2001) have all been implicated in the corruption perceptions that individuals hold. the balance of the questionnaire (totalling sixteen rating scale items) solicits the views, perceptions and attitudes of respondents to aspects of public sector corruption. the study, in seeking to construct meaning and knowledge from respondents’ perceptions, draws on the qualitative approach to research design. within sajems ns 15 (2012) no 3 287 this framework research outcomes are neither totally objective nor unquestionably certain (henning, van rensburg & smit, 2004). the survey instrument was duly piloted and refined before it was administered. practical considerations dictated a survey technique in which accessible firstand second-year economics/administration classes, with the permission of lecturers, were subsequently surveyed at both campuses during scheduled lectures. respondents were generally able to complete the questionnaire, on average, in about 10-15 minutes. 4 analysis and discussion the first part of the research collected demographic data from the respondents and asked five questions about their attitudes towards corruption in south africa. 4.1 sample characteristics of the 509 respondents, 53.8 per cent are females and 46.2 per cent are males. their mean age was 20.2 years, with 79 per cent aged 19 to 21 years. in terms of ethnicity, 318 of the respondents (62.4 per cent) are black and 168 (33.0 per cent) are indian, with small numbers of whites (12) and coloureds (11). as to the importance of their religious beliefs, 95 per cent said that these were at least important (62.2 per cent = very important and 32.8 per cent = important) to them; the pilot survey indicated that asking respondents for their particular religion or denomination was problematic and so these were not sought in the main survey. 4.2 perceptions of the seriousness of local public sector corruption respondents were asked ‘how serious an issue do you think corruption is in south africa these days?’ almost all respondents regarded it as either very serious (73.7 per cent) or serious (23.4 per cent). in response to a question asking them to compare levels of corruption now compared with three years ago, almost half (47.2 per cent) thought it was much worse and 31.8 per cent that it was a bit worse. this result would seem to corroborate the trend of perceived worsening corruption in the three years leading up 2010 highlighted by transparency international's cpi. three questions were asked about perceptions of corruption among public servants, politicians and by the president on a scale ranging from 10 (extremely corrupt) to 0 (not at all corrupt). public servants were given a mean score of 8.0, somewhat less than that given to politicians (8.6). both are towards the very corrupt end of the scale. the president was better regarded, with a mean score of 6.8. it was intended to cross tabulate these and later responses by gender, age, ethnicity and importance of religion. however, the narrow age range and the importance of their religious beliefs to almost all respondents meant that these two variables could not be used for cross tabulation purposes. the small numbers of whites and coloureds in the sample meant that ethnic comparisons had to be restricted to those between blacks and indians. there were no significant gender differences concerning respondents’ ratings of the seriousness of corruption, whether corruption had become more of a problem and their ratings of the corruptness of politicians, public servants and the president. it is notable, though, that indian respondents were significantly more likely than black respondents to regard corruption as very serious and to have become much worse. a strong majority of both groups, it should be noted, regarded it as very serious and becoming much worse. indian respondents perceived higher corruption among politicians and public servants than did black respondents and rated the president at 8.1 on the corruption scale compared with 5.9 by black respondents. these apparent ethnic differences will be examined further. 4.3 what is perceived as ’corrupt’ behavior? individuals’ perceptions of the extent of corruption must logically be informed by what they regard to be corrupt behavior. the uniformity, or otherwise, of corruption perceptions has implications for monitoring and policing corrupt actions (olken, 2007). thus, if behavior is overwhelmingly considered to be corrupt, it may be easier to detect and the policing of such actions is likely to enjoy popular support. such a development, on the 288 sajems ns 15 (2012) no 3 back of galvanized mass public opinion, could be expected to strengthen south africa’s fight against public sector graft. the second part of the research involved posing 10 short scenarios (these are listed in the left hand column of table 1) and asking two questions of each: first, whether the respondent regarded the behaviour described as corrupt, with four options running from “very corrupt” to “not at all corrupt”, plus a category for those who were unsure; and second, whether the student would engage in the activity, with responses running from “definitely not” to “definitely yes”, with a “don’t know” category. the results are reported in tables 1 and 2 respectively. many of the scenarios drew on cases of possible corruption reported in the south african media during 2009 and the early part of 2010. prominent among these were reports of tendering irregularities, of inflated claims for travel expenses by politicians, of public servants engaging in private business work during office hours and of close relations between politicians and public servants on the one hand and business people on the other. it is likely that students had some knowledge of these examples and of the explicit or implicit messages in the media about them but this does not, in our view, lead to any concerns about our scenarios. these were intended to uncover student attitudes towards such behaviours and their possible future involvement in them. at the same time, while we have no way of knowing that students answered honestly, we see little reason for them to lie. t a b l e 1 perceptions of the degree of corruption involved in the 10 scenarios (per cent) scenario very corrupt fairly corrupt a little bit corrupt not at all corrupt unsure 1. a businessman pays r1.2 million to a politician to encourage the politician to award a major government contract to him 86.1 10.6 1.6 0.4 1.4 2. correct tender processes for a local government road building project are not followed; rather, the contract is simply given to a company, with no particular experience, owned by friends of the most powerful councillors 79.3 14.8 2.2 1.0 2.8 3. a government official arranges for his sister to get a job (for which she is qualified) in his department without having to go through the normal application and selection procedures 42.5 34.2 19.0 3.5 0.8 4. a politician makes sure that a lot of public works are carried out in his own community area, which means that other communities are neglected. 47.9 30.3 15.5 3.5 2.7 5. a public servant who travels a lot as part of her work submits claims for reimbursements which are far above the real cost to her 44.4 33.1 13.8 2.9 5.7 6. a public servant spends a number of hours of his work time each week running his private business activities 38.2 32.4 18.7 7.2 3.6 7. a traffic policeman asks a motorist for r100 in order for the motorist not to be fined for a traffic offence 73.4 20.0 5.2 1.1 0.2 8. a cleaner for a university earns r1000 per month from her job. she takes home cleaning fluid and other small items which she sells to supplement her income – by about r30 per month 25.8 31.9 33.3 7.9 1.1 9. most teachers in a rural school do not come to work on fridays 56.1 21.8 10.6 4.5 6.9 10. a business firm makes a substantial donation to the ruling political party each year. the firm doesn’t have particular plans but hopes that they will be regarded well by the government in the future 30.3 26.8 15.7 18.1 9.1 sajems ns 15 (2012) no 3 289 table 1 indicates that all 10 scenarios were judged to be corrupt or fairly corrupt by half or more of the respondents. the responses can be classified into three groups. 1. scenarios 1, 2 and 7 were rated as very corrupt or fairly corrupt by over 90 per cent of respondents 2. scenarios 3, 4, 5, 6 and 9 were so rated by 70-79 per cent of respondents 3. scenarios 8 and 10 were so rated by 57 per cent of respondents. the first group, comprising direct monetary bribes and illegal tender decisions, represents classic corrupt behaviour whereas there is more to consider in the scenarios of the second group. scenario 3, for example, involves a possible conflict between interfering with a job selection process and helping a relative. it is possible that respondents found the two scenarios in the last group difficult to categorise. one is theft, albeit of a low level, while the last concerns the relationship between government and business and the responses may involve judgements about the appropriateness of this relationship rather than corruption as such. the second question – whether the respondent would engage in the activity – was asked to determine whether respondents’ anticipated behaviour matched their opinion concerning the corruptness of that behaviour. the term “dissonance” is used to describe a disconnection between beliefs and behaviour. the results are presented in table 2. t a b l e 2 willingness to engage in the activity involved in the 10 scenarios (per cent) your possible response in such a situation definitely not probably not probably yes definitely yes don’t know 1. would you pay a politician? 51.4 21.5 15.7 3.3 8.1 2. would you agree to irregular tendering practices? 72.2 19.4 4.3 1.4 2.7 3. would you get your sister a job without going through the normal procedures? 36.0 27.0 27.2 4.7 5.1 4. would you favour your own community? 45.1 23.9 19.0 3.4 8.6 5. would you inflate your travel claims? 42.0 30.0 17.2 3.4 7.4 6. would you run your private business from work? 38.1 32.2 19.9 3.8 6.1 7. would you ask for a bribe? 66.5 18.7 9.2 3.1 2.5 8. would you take small items from work? 32.0 28.0 29.0 6.3 4.7 9. would you stay away from school on fridays? 56.1 21.8 10.6 4.5 6.9 10. would you donate to a political party? 34.9 27.4 20.5 7.3 9.8 table 1 shows that the average proportion of respondents who rated a scenario as very or fairly corrupt was 78.7 per cent while table 2 shows that an average of 72.4 per cent said that they definitely or probably would not perform the relevant action themselves. this mismatch indicates the possibility of some dissonance and the importance of disaggregating the responses. notwithstanding this, it appears that respondents' judgements of the actions of others are strongly correlated with their own likely actions in similar circumstances. indeed, spearman’s bivariate correlation coefficients in all cases are positive and significant (p = 0.000<0.01, 2-tailed). this overall consistency suggests a firm foundation on which to base ethics and integrity training. 4.4 are corruption perceptions influenced by demographic characteristics? it would be helpful for the purposes of harnessing mass public opinion into the anticorruption fight to know what factors may influence individuals’ views as to what they perceive to be corrupt behavior. as far as demographic characteristics are concerned females were significantly more likely than males to regard scenarios 4 (favouring your own community) and 6 (running a private 290 sajems ns 15 (2012) no 3 business from work) as corrupt behaviour. they were also significantly less likely to say that they would probably or definitely engage in the behaviour outlined in six of the scenarios – 1, 4, 5, 6, 7 and 10 (table 3). indians were more likely than africans to regard scenarios 3, 5, 6 and 9 as corruption. african students were significantly more likely than indian students to say that they would probably or definitely engage in the behaviours outlined in five of the scenarios: 1 and 3-6 (table 4). t a b l e 3 perception of activity being corrupt and being willing to engage, by gender (rounded to the nearest per cent) hypothetical scenario corrupt engage male female male female 1. pay a politician 99 97 27 13** 2. irregular tendering practices 96 97 7 5 3. get your sister a job 97 94 36 28 4. favour your own community 89 97** 28 17** 5. inflate your travel claims 90 92 26 16** 6. run business from work 84 93** 27 21** 7. ask for a bribe 99 99 17 8* 8. take small items from work 89 93 41 31 9. stay away from school on fridays 85 92 8 8 10. donate to political party 69 76 33 23** * p< 0.05, **p< 0.01 note: chi-square test results are available from the authors on request. t a b l e 4 perception of activity being corrupt and being willing to engage, by ethnic group (rounded to the nearest per cent) hypothetical scenario corrupt engage african indian african indian 1. pay a politician 97 100 25 11** 2. irregular tendering practices 94 100 9 1* 3. get your sister a job 94 98** 37 25** 4. favour your own community 92 98 25 17* 5. inflate your travel claims 89 95** 20 22** 6. run business from work 89 90** 25 20* 7. ask for a bribe 98 99 14 11 8. take small items from work 90 93 40 29 9. stay away from school on fridays 90 85** 9 7 10. donate to political party 72 74 29 27 * p< 0.05, **p< 0.01 both tables 3 and 4 reveal apparent anomalies indicative of dissonance. thus males are at least as likely as females to report paying a politician as corruption but are more likely to engage in it. similarly africans are more likely than indians to regard absenteeism from work as corruption but are at least as likely to do it. this evident lack of accord between beliefs and actions may seem puzzling at first sight but similar results have been found elsewhere. for example, miller’s (2006) study in four post-communist european countries found that the vast majority of citizens and public officials condemned bribery. at the same time, significant minorities (and majorities in some contexts) admitted asking for bribes and to paying bribes. that is, external pressures outweighed inner values, leading officials to sajems ns 15 (2012) no 3 291 respond to temptation and citizens to extortion. miller interprets this to mean that people are best viewed as corruptible rather than as corrupt. 4.5 implications of the study’s findings for south african anti-corruption measures south africa’s present anti-corruption approach relies, ostensibly, on a partnership between government, business and civil society (ramsingh & dobie, 2006). olken (2007) argues that accurate citizen perceptions of corruption are essential for the political process to restrain corrupt activity effectively. he notes that if individuals’ beliefs about corruption inform their decisions about how actively to monitor public officials then biases in these beliefs may affect their monitoring behaviour. individuals’ beliefs may thus, indirectly, impact on corruption control. any programme aimed at mobilising mass public opinion, whether formal or informal, must be sensitive to factors that may condition popular corruption perceptions. this study’s findings that virtually all (97.1 per cent) respondents consider corruption to be at least a serious domestic issue, and that 79 per cent of respondents believe that corruption levels increased since 2007, suggest that important sections of society are sensitive to the issue and may thus be receptive to being more actively engaged in resisting it. these findings suggest that the national planning commission’s call to place greater emphasis on preventing corruption through public education drives (2011b) may prove fruitful. indeed, the recent withdrawal (if only temporary) of the proposed protection of information bill (underhill & donnelly, 2011) and the decision to reopen the investigation into the country’s controversial arms deal (bauer, 2011) signal important victories forced by civil society. the findings of this study also indicate that there appears to be broad consensus as to what constitutes corrupt behaviour although certain acts may be regarded as more corrupt than others. it seems, furthermore, that respondents, despite evidence of some dissonance, are generally willing to be judged by their own standards. at least some of the lack of agreement between respondents’ beliefs and likely actions may be accounted for by the influences of gender and ethnicity. the study offers evidence that males, even though they may recognise corrupt behaviour, are more likely than females to engage in such acts. similarly, different race groups are evidently more likely to risk particular types of questionable behaviour even if they recognise it as such. these are challenges that appeals to civil society to join in the fight against corruption, whether formally through training programmes or informally, will have to address. 5 limitations of the study the case approach employed in this study suggests that its findings are not generalisable with any degree of confidence beyond the 2010 population of first and second-year economics and business students registered at the dut (pietermaritzburg) and ukzn (durban) campuses. future studies could examine aspects of local public sector corrupttion using larger samples at, or across, higher education institutions. such studies could also explore, more minutely, the prospects of incorporating ethics and anticorruption modules into credit bearing courses. 6 conclusion this study set out to gauge the perceptions that first and second-year economics and business/ administration durban university of technology and ukzn students have of aspects of local public sector corruption and to assess the implications of these perceptions for the local fight against graft. the study was inspired by the proposition that south africa’s present anti-corruption approach (informed primarily by a mix of principal-agent theory and institutional perspectives) needs to be reinforced with comprehensive civic awareness initiatives as recommended in the ccar. the study’s findings that respondents, overwhelmingly, considered corruption to be a serious problem suggests that potentially influential sections of society may be willing partners in the fight against local public sector 292 sajems ns 15 (2012) no 3 graft. it seems, furthermore, that the notions that respondents regardless of gender, ethnicity and religious beliefs have of what constitutes ethical and moral behaviour are in fact not highly variable so that initiatives to build on society's common ethical core should yield some return. indeed, evidence of some mismatch between respondents' beliefs and actions suggests a need to align these, possibly by means of formal ethics and integrity schooling programmes. since individuals’ views and opinions are significantly influenced by schooling it may be worth considering the prospects of introducing ethics and anticorruption education at all 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(deon) de bruin centre for work performance, university of johannesburg, johannesburg, south africa citation steyn, r. & de bruin, g.p., 2019, ‘corrigendum: the structural validity and measurement invariance across gender of the brief corporate entrepreneurship assessment instrument’, south african journal of economic and management sciences 22(1), a3421. https://doi.org/10.4102/sajems.v22i1.3421 note: doi of original article: https://doi.org/10.4102/sajems.v21i1.1965 corrigendum corrigendum: the structural validity and measurement invariance across gender of the brief corporate entrepreneurship assessment instrument renier steyn, g.p. (deon) de bruin published: 05 dec. 2019 copyright: © 2019. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. in the initial version of this article published earlier, the first author’s affiliation was incorrect. the affiliation and acknowledgement sections are hereby corrected as follows: authors: renier steyn1,2 g.p. (deon) de bruin1 affiliations: 1centre for work performance, university of johannesburg, johannesburg, south africa 2graduate school of business leadership, university of south africa, midrand, south africa acknowledgement this article stems from renier steyn’s thesis, entitled ‘antecedents of innovation in organisations: a gender perspective’ presented in partial fulfilment of the requirements for the phd degree at the university of johannesburg, johannesburg, south africa. this correction does not alter the study’s findings of significance or the overall interpretation of the study results. the author apologises for any inconvenience caused. sajems ns 11 (2008) no 1 85 export intensity and the competitive intelligence of exporting companies: evidence from south africa1 ludo cuyvers and michel dumont department international trade, university of antwerp wilma viviers school of economics, north-west university patrick de pelsmacker business school, university of antwerp marié-luce muller ibis business and information systems marc jegers department of economics, free university brussels andrea saayman school of economics, north-west university abstract the present paper investigates the relationship between competitive intelligence (ci) factors, characteristics, information sources, needs, requirements and the export intensity of exporting companies in south africa. we establish whether there are significant differences between firms, grouped according to export intensity with respect to awareness, use, information sources and attitude towards ci activities. a questionnaire was developed and sent to exporting firms, resulting in a usable sample of 309 south african respondents. these firms are grouped according to export intensity, and ci practices between groups are compared. the results show that export intensive firms appear to be more aware and supportive of ci activities than less export intensive firms. jel l86, o32 1 introduction competitive intelligence (ci) is the component of business intelligence aimed at gaining strategic advantage (porter, 1980). therefore, it includes competitor intelligence as well as intelligence collected on customers, suppliers, technologies, environments, or potential business relationships (guyton, 1962; fair, 1966; grabowski, 1987; gilad, 1989). a review of the literature related to competitive intelligence suggests that competitive intelligence is a marketing research discipline focused on gathering information on the competition (schollhammer, 1994; agarwal, 1993). however, a broader examination shows that intelligence is not only about monitoring competition but rather monitoring the entire business environment to capture all of the multiple functions within the competitive process. gilad (1996) stated that the objective of intelligence is “being able to predict competitors’ m o v e s , c u s t o m e r s ’ m o v e s , g o v e r n m e n t moves and so forth.” in the broadest sense, intelligence (including the collection, analysis, and dissemination of knowledge) is the process of reducing managerial decision uncertainty. 86 sajems ns 11 (2008) no 1 companies that are active as exporters in the international market evidently have other information and ci needs than local firms. the business environment (e.g. nature of competition, the distribution systems) differs from country to country, which must have an impact on the information system and ci requirements. in addition, the degree of export reliance of companies – or the degree of international commitment in the export business of the company – can be expected to influence the intensity of use that is made of internal and external information, the structure of the company’s information system, and the nature of the ci practices. quite evidently, the frequency and efficiency of the use that is made of information sources and ci, the characteristics of the evolving ci systems, the learning processes involved, etc. will influence the success in the international market and therefore the export intensity of the company’s activities (johanson & vahlne, 1977; walters & samiee, 1990; toften & olsen, 2003; leonidou & theodosiou, 2004). the relationship between the degree of export orientation of companies and the various characteristics of their information systems and ci practices and needs is therefore likely to be one of mutual causation. since the mid-1970s, a good deal of research has focused on the development of firms’ exporting activities. two main streams of research concerning the export development process are readily apparent. the dominant stream posits a “stages” model of export development, ranging from “uninterested in exporting” to “full commitment” to international markets, using a range of differing criteria. firms are conceptualised as growing incrementally along a learning curve, moving from one export stage to the next on their way to becoming fullyfledged, committed exporters. it is generally assumed that the process is evolutionary in nature (bilkey & tesar, 1977; chisnall, 1977; wiedersheim-paul, olson & welch, 1978; cavusgil, 1980). the second stream of research differs in one important facet. unlike the stages models, where greater involvement in exporting is viewed as an evolutionary and incremental process, this work does not assume incremental development (samiee & walters, 1991; rao & naidu, 1992; katsikeas & dalgic, 1995). a central theme in this conceptualisation is that firms do not necessarily incrementally evolve into more committed exporters over time. some firms have a proactive attitude toward international markets right from their inception due to a range of factors that include the background, training and experience of key personnel. other firms follow the incremental path and progress to regular export involvement more gradually. sporadic exporters, on the other hand, exhibit less interest in exporting, maintaining a steady state of low-level export activity for long periods. this reflects that priorities and circumstances of exporting firms often do not change much over time. as a result, there is no inherent momentum for export development. most scholars agree that the internationalisation process of companies evolves gradually (chisnall, 1977; cavusgil, 1980; wiedersheimpaul, olson & welch, 1978) and that as they gain international experience, their management may develop higher expectations, evolve and adopt better suited internationalisation policies and strategies, and adapt organisational structures and procedures. one of these structures is the company ci system. in this paper, we will statistically explore the relationship between ci factors and characteristics, as well as information sources, needs and requirements, on the one hand, and the export intensity of exporting companies in south africa, on the other hand. in the next section, the empirical literature is reviewed. this review will not deal with the literature on information needs and practices of exporting companies (mcauley, 1993), but fully concentrate on whether these needs and practices differ among the exporting companies categorised according to four export intensity levels (defined as the share of exports in company sales). in the third section the data collection phase of the present research is briefly outlined, after which the results of the empirical analysis are discussed. conclusions, implications and suggestions for further research are provided in the final section. sajems ns 11 (2008) no 1 87 2 review of the literature in spite of the fact that many standard international marketing research textbooks provide suggestions and even prescriptions as to the type of marketing research information needed, the issue that is relatively under-covered is whether exporting companies are using this information, or whether the types of information needed tend to change in line with the degree of internationalisation of the companies. research has revealed that exporters conduct a more intensive search for information than non-exporters, attach more importance to market knowledge, and are more likely to conduct their own market research (burton & schlegelmilch, 1987), but the issue we deal with in this paper is rather whether information factors and ci systems differ according to the export intensity of exporters. cavusgil distinguished three categories of exporting firms (experimental, active, committed) and then endeavoured to show, based on statistical analysis, differences between these categories. his data set related to exporting manufacturers from wisconsin and illinois. one of the many aspects he investigated is differences between the three groups of exporters and their foreign market research practices. it is shown that as companies progress through their internationalisation process, they will commit more financial and managerial resources to market research, reflecting the need for a more thorough analysis and assessment of potential in foreign markets. also the nature of the information and data sources required and used will change from general market information for the experimental exporters, to industry/business publications and trade show contacts for both the experimental and active exporters. when exporters become committed, they will find it necessary to develop an internal information system for market research (cavusgil, 1984a). in another study, cavusgil found that more internationalised companies are using a wider variety of data sources, without, however, offering a specific definition of information type (cavusgil, 1984b). in another pioneering study, koh, chow and smittivate (1993) looked into the practices of international marketing research of thai exporters in two industrial sectors (canned food and electronics, electrical appliances and parts). again, one of the aspects researched is the degree of internationalisation of the companies and international marketing research practices. the authors found no significant differences between export experience or export intensity (measured by the percentage of export sales to total sales, i.e. less than 50 per cent and 50 per cent or more, respectively) and the perceived usefulness of conducting international marketing research. a similar absence of relationship is reported between export experience and the frequency of conducting such research, but export intensity seems to have an impact on the frequency of focusing on issues such as socio-cultural factors, the estimation of market size, competition, pricing, product features and consumer preferences (koh, chow & smittivate, 1993). the results obtained by hart, webb and jones (1994) on british small and medium sized enterprises, showed no statistically significant differences in the type of information, the market research activities and the use of market research, between companies exporting less than 12 years and these with more than 12 years experience. they, however, state that it is possible that 12 years’ export experience is not enough to discriminate marketing research activities. using survey data from three ohio industry groups (non-electrical machinery, electrical and electronic machinery, and measuring, analysing and controlling instruments), lim, sharkey and kim (1996) found a number of significant differences between high-involvement exporters and low-involvement exporters, particularly related to the way information was gathered from primary and secondary sources, and the extent to which they conduct marketing research. statistical differences were also found relating to the monitoring of competitors’ performance and their export intentions. a multiple regression analysis resulted in a positive relationship between export intensity (they used the term “export success”) and four variables: information 88 sajems ns 11 (2008) no 1 gathering from secondary sources, conducting market research, information gathering about competitors’ involvement in exporting, and information on product changes. in another study, leonidou (1997) calculated whether high and low export intensities (more or less than 50 per cent share of exports in sales), as well as export experience, of exporters in cyprus coincide with differences in some factors relating to information. only three information factors showed a statistically significant positive relationship with export intensity: information on foreign market preferences, the company’s market position and issues pertaining to promotional activity abroad. the impact of export experience on information type preferences was minimal. in their review of 27 studies on the export marketing information system, leonidou and theodosiou (2004) conclude that current research too is a-theoretic, fragmented and inconsistent. they distinguish four aspects of export information behaviour: determination, acquisition, dissemination and utilisation. none of the studies considered, appear to examine all four dimensions of export information behaviour and as a result do not provide a comprehensive analysis of the characteristics, sources, needs and phases/constructs of competitive intelligence. most empirical work is restricted to exporters of a given country/industry and many studies are based on small samples (less than 150 firms). moreover, as a number of these studies use non-probabilistic sampling designs, leonidou and theodosiou (2004) question their representativeness. with respect to antecedent factors (company size, industry, export experience, expansion strategy and distance) empirical work does not seem to provide unambiguous conclusions, though smaller firms seem to use less expensive, easily accessible and more informal information sources than large firms. leonidou and theodosiou (2004) found six studies in which export experience is used as a potential discriminator of export information behaviour. they conclude that overall these studies failed to find substantial differences in information requirements between new and established exporters although in the earliest study by ursic and czintoka (1984) newer exporters are found to be more aggressive in seeking export information, and mcauley (1993) found that the more experienced exporting firms use fewer information providers. studies examining the export information behaviour of exporters versus non-exporters found that although exporters more actively search for information, differences between exporters and non-exporters were not significant with respect to most dimensions. leonidou and theodosiou (2004) point out that studies in which the information requested is linked to export intensity (i.e. proportion of export sales to total sales) reveal few significant results. in addition to the aforementioned studies by koh, chow and smittivate (1993) and leonidou (1997), they refer to walters (1983) who found that export intensive firms made more use of export agents, statistical agencies, departments of commerce and company executives, and to benito, solberg and welch (1993) who report greater use of formal procedures and service people, but less use of international journals (newspapers), management consultants and sales representatives by firms that were intensifying their export strategy. l eonidou and theodosiou (2004) concluded their review of the literature on export information by stating that research could be improved by e.g. a cross-cultural approach, more representative samples and a more comprehensive operationalisation and measurement of constructs. by considering all dimensions of the ci process and the link with antecedent factors (with a focus on export intensity), using relatively large firm sample we believe to provide some contribution to the existing literature. 3 data collection the data used in this paper come from a survey, on competitive intelligence practices, that was sent to exporting firms in south africa. starting from earlier descriptive research (calof & breakspear, 1999; viviers, saayman, muller & calof, 2002) a questionnaire was developed and pre-tested. it sajems ns 11 (2008) no 1 89 contained, among others, 39 ci-related questions, to be answered on a 5-point likert scale. the likert scale questions were divided into two sections. in the first section (questions 4 to 20), the respondents had to indicate to which degree they agreed or disagreed with the statement (1 strongly disagree and 5 strongly agree). in the second part (questions 21 to 42) the respondents had to indicate to what extent (never or always) they implement a certain action. in this section, 1 equals never and 5 equals always. additionally, a limited number of general questions pertaining to the firm were asked (activity, size, percentage of sales exported). the questionnaire was structured to test all theoretical competitive intelligence dimensions: planning and focus; collection; analysis; communication; process and structure; and awareness and culture. based on the data collected through the survey, saayman et al. (2004) performed an explanatory and confirmatory factor analysis to identify (and test the validity of) factors related to different aspects of competitive intelligence as derived from previous theoretical work. five dimensions of ci were identified empirically: 1. process and structure 2. planning, focus and collection 3. data analysis and quality control 4. culture and awareness 5. skills development in addition the survey contained questions with regard to the number of years of ci experience the firm has, the number of employees (full and part-time) performing ci tasks, the time devoted to different ci activities, whether the firm has a separate ci department or not and who holds the main responsibility for ci within the firm, and the company’s information needs and sources.2 the data of exporting companies was gathered from two sources, namely (i) the kompass southern african database (from reed business southern africa) and (ii) the directors/ceo’s of the respective export council (supported by trade and industry southern africa). a total of 321 responses was received, representing a response rate of 8.11 per cent. all companies that did not complete at least 70 per cent of the questions were removed from the analysis. this left us with a useful sample of 309 south african companies. although no argumentation can be put forward against potential non-response bias, as there is no south african database of exporters according to size, sector or export intensity, it can be stated that at least some characteristics of the economy are reflected in the sample. the exporters surveyed are mainly in the manufacturing sector, which is consistent with the main export sector of south africa, while the low export intensity of south african exporters is typical of the broader export population as is evident in a study by viviers and calof (1995). traditionally, two measures of export performance, i.e. export proportion of sales (“export intensity”) and average size of export transactions are used to assess export development and performance. in a previous study, four stages were used: no export sales, export intensity 1–24 per cent, intensity of 25–49 per cent and intensity greater than 50 per cent (viviers, kroon & calof, 1996). due to an insufficient number of observations with export intensity above 75 per cent they were not able to use a finer categorisation. in the present research exporters were asked the share of exports in the company sales based on the following four groups: • 1–24% (g 1) • 25–49% (g 2) • 50–74% (g 3) • 75–100% (g 4) the reason for not including the “no export sales” group is that the population of companies in the present research only consists of exporting companies. we expect that export intensity is having an impact on both the time devoted to ci, and the content of the ci activities, i.e., exporting companies with a higher share of exports in their sales figure, will devote more time to ci, and we also expect the type of ci that is most relevant to change with export intensity. however, the distance for south african exporters to the major markets that are dispersed worldwide, and therefore, the relative ease of organising the exporting company’s ci can be expected to influence this expected impact. 90 sajems ns 11 (2008) no 1 4 export intensity and competitive intelligence 4.1 export intensity as stated earlier, using the answers of the competitive intelligence survey for exporters of south africa, four categories of export table 1 frequencies of export intensity for the south african sample export intensity south africa 1–24 % 43 % 25–49 % 17 % 50–74 % 18 % 75–100 % 22 % n 303 intensity (exports/ sales) can be distinguished. in table 1 we report the frequencies of the four groups of export intensity in the south african sample. it is evident that almost 40 per cent of south african exporters in the sample have an export intensity of more than 50 per cent, with most firms falling into the low export intensity group (1–24 per cent). 4.2 ci experience figure 1 shows the share of firms in each of the four export intensity groups with 0 years, 1–5 years, 5–10 years and more than 10 years of experience in ci activities. south african firms with export intensity between 25 per cent and 74 per cent have more ci experience than firms with less than 25 per cent export intensity, and more surprisingly also more experience than firms with more than 75 per cent export intensity. moreover, a chi-square test indicates that these differences are significant. figure 2 shows the share of firms in each of the four export intensity groups with 0, 1, 2 or more than 2, respectively full-time and parttime employees engaged in ci activities. there is apparently no clear-cut relationship between export intensity and the number of employees performing ci tasks. none of the differences in terms of the number of employees engaged in ci activities is found to be significant (chisquare test). figure 1 number of years ci experience broken down by export intensity sajems ns 11 (2008) no 1 91 figure 2 number of full-time and part-time ci employees we will now assess whether significant differences exist between the four groups of respondents with regard to competitive intelligence activities. 4.3 ci dimensions table 2 shows the five constructs that were previously identified (saayman et al., 2004), reflecting different dimensions of ci, as well as the questions of the questionnaire to which they refer. for each factor the average score over the variables loaded onto them has been considered to assess differences between the four export intensity groups. table 2 items in the five-factor model factor items process & structure our intelligence findings are widely distributed within the firm (q13) we maintain a comprehensive map or inventory of internal information and knowledge (q14) there is a central co-ordination point for receiving information (q15) our firm maintains a central record of reliable sources of information (q20) planning, focus & collection our firm produces assessments that address several possible outcomes of our competitors’ actions that might be threats or opportunities for our firm (q26) we meet with executives to identify their intelligence needs (q31) we train/prepare our employees before they go to trade shows, exhibitions, conventions, etc. about what information they should look for (q37) results of exit interviews/job interviews are used in our intelligence system (q38) data analysis & quality control our company develops profiles on emerging technologies to better understand their characteristics, potential application and market advantages (q33) key decision-makers are surveyed/interviewed to verify that the intelligence products produced for them satisfy their needs (q35) all information is checked for accuracy and validated by at least one source (q36) we evaluate the reliability of our sources of information (e.g. persons, publications, internet) (q41) 92 sajems ns 11 (2008) no 1 culture & awareness our firm recognises competitive intelligence as a legitimate and necessary activity for business (q5) senior management supports intelligence findings (q8) competitive intelligence can be used to create a competitive advantage (q9) skills development most employees understand what competitive intelligence is (q7) our firm has incentives to encourage employees to report their competitive observations and information (q10) we make competitive intelligence training (e.g. collection and analysis techniques) available to our employees (q16) source: saayman et al. (2004) figure 3 shows the average response regarding the five factors for the four respective export intensity groups in the sample of south african firms. using visual evaluation, the differences appear to not be substantial. figure 3 average scores ci dimensions for a statistical assessment of the differences between the four groups, we performed an analysis of variance (anova) in spss, which permits to test the statistical significance of differences in average responses between groups. the results of the anova are reported in table 3. the f value tests the null hypothesis that all group means are equal, i.e. rejection implies that the means differ significantly. the brown-forsythe statistic also tests the hypothesis that means do not differ. this statistic however, does not depend on the assumption that variances are equal. results of a levene statistic3 show that for some factors the null hypothesis of equal variances is rejected. for the south african firms grouped according to export intensity, there is no factor for which the average responses appear to differ significantly. sajems ns 11 (2008) no 1 93 table 3 results anova sums (df) f bf f1 between within total 5.1 (3) 301.0 (292) 306.2 (295) 1.66 (0.177) 1.57 (0.199) f2 between within total 2.7 (3) 249.0 (289) 251.6 (292) 1.03 (0.378) 1.07 (0.364) f3 between within total 3.8 (3) 288.9 (292) 292.7 (295) 1.27 (0.285) 1.26 (0.290) f4 between within total 4.9 (3) 279.8 (295) 284.8 (298) 1.73 (0.161) 1.67 (0.198) f5 between within total 3.4 (3) 241.0 (292) 244.4 (295) 1.36 (0.254) 1.24 (0.295) note: sums (df) – sum of squares (degrees of freedom), f – f statistic (p-value in brackets), bfbrown – forsythe statistic. *: p< 0.10, **: p< 0.05 and ***: p< 0.01. to check whether the results of the analysis of variance are not merely reflecting differences in company size or economic sectors, we performed the same analysis selecting different sectors and company size groups as far as the number of observations made this possible. overall the previous results seem robust although in some cases differences in response between the four export intensity groups are found to be significant for more factors. in this sample of south african firms with more than 200 employees, differences between the four groups are now significant for all five factors. the results of these analyses are not reported but available upon request. 4.4 ci activities respondents were also asked to rate the importance of different types of ci activities. in table 4 the statistically significant differences – between the four groups of export intensity – in the share of time devoted to five aspects of ci are reported. firms of group g 2 devote more time to data collection than firms with export intensity exceeding 50 per cent (g 3 and g 4), whereas group g 4, the group of most export intensive firms, devotes significantly more time to analysis, interpretation and evaluation than group g 2. table 4 share of time (% of total time) devoted to specific ci activities south africa data collection analysis and interpretation evaluation recommendations g2 (58.00) > g3 (39.23)* g2 (58.00) > g4 (31.92)** g4 (27.69) > g2 (17.67)* g4 (15.00) > g2 (8.39)* note: **significant at 5%, *significant at 10% level. 94 sajems ns 11 (2008) no 1 4.5 information sources for a number of information sources the respondents had to indicate whether they found them unimportant, important or very important. in table 5 the differences in percentage of firms that consider a given type of ci information as very important are reported for the four groups. it is found that the most export intensive firms consider information on how to penetrate world markets to be significantly more important, than less export intensive firms. table 5 percentage of firms per export intensity category that consider a type of ci information to be very important (top 3 of important types shaded) 1–24% 25–49% 50–74% 75–100% how to penetrate on world markets 60.0%* 29.4%* 66.7%* 89.3%* profiles of potential customers 54.3% 43.8% 63.2% 71.4% opportunities in new markets 80.6% 81.3% 84.2% 89.3% reputation and activities of competitors 37.1%° 37.5%° 63.2%° 60.7%° potential partners or agents 77.1% 81.3% 84.2% 82.1% distribution channels 51.3% 56.3% 78.9% 60.7% culture 17.1%* 18.8%* 52.6%* 64.3%* political situation 31.4%+ 18.8%+ 52.6%+ 57.1%+ statistical information about markets 42.9%° 31.3%° 36.8%° 71.4%° regulations, barriers 38.9%* 31.3%* 42.1%* 70.4%* trade fairs 26.5%° 56.3%° 57.9%° 64.3%° exchange regulations 34.3%° 25.0%° 55.6%° 66.7%° note: level of statistical significance of differences between the four groups – °: p<0.10, +: p<0.05 and *: p<0.01. table 5 shows that there are significant differences between south african firms with various export intensities. the share of south african export intensive firms that regard information on culture, the political situation, and regulations and barriers as very important, significantly exceeds the share of less export intensive firms. this supports the notion that export-intensity has an impact on the frequency of focusing on issues such as socio-cultural factors, as suggested by koh, chow and smittivate (1993). information on opportunities in new markets and potential partners or agents tops the list of important types of ci information for all firms, irrespective of their export intensity. this supports the finding of leonidou (1997) as well of hart, webb and jones (1994) that export experience has a minimal impact on information type preferences. yet, there are no significant differences regarding export intensity amongst the four groups as to the importance of different information sources (e.g. information of company staff, published information, internet, government organisations). this finding contrasts somewhat with mcauley (1993) who found that more experienced exporters use fewer information providers, and with benito, solberg and welch (1993), who found that more intensive exporters make less use of published (secondary) sources of information. sajems ns 11 (2008) no 1 95 5 conclusions, implications and suggestions for further research using data from a competitive intelligence survey sent to south african exporting firms, we have tried to establish whether there are significant differences between firms, grouped according to export intensity, with respect to the awareness, use, information sources and attitude towards ci activities. to our knowledge, the present study is the first one to link the constructs of ci, the number of years in exports, the number of staff in ci, time devoted to ci activities as well as information needed for ci to export intensity. following the five constructs of ci that have been identified previously, we find that for south african exporting firms the average responses of the four groups do not seem do differ for any of the five factors that have been identified and verified as constructs of ci activities. our results have significant managerial implications for exporters of more and less export intensity alike. recognising the value of ci as a strategic management instrument could enhance an exporter’s competitiveness for various reasons: it gives management a more comprehensive and accurate picture of the competitive environment in the various markets the exporter is playing in. it could forewarn the exporter of impending threats and emerging opportunities such a new product opportunities. it can assist in strategic, long-term decision-making and it could be used for tactical, immediate decision-making. as far as the relationship between ci factors and characteristics, information sources and information needs on the one hand and export intensity on the other hand is concerned, the research results show that export intensive companies value the importance of ci planning, ci structures and focusing on and collecting the right information as important. the extent of ci activities seem to relate to the export intensity of firms in that the more export intensive firms are more experienced in ci. this is possibly explained by the increased and sustained need for better, faster and more accurate strategic and tactical decisions and the recognition that an effective ci capability could enhance such decisions. it was interesting to note that the most export intensive firms devoted most of their ci time on analysis, interpretation and evaluation. this is possibly due to the fact that there is an abundance of information available but that the real meaning of that information for a particular exporter is not easily discernable. south african exporters are also geographically and culturally further removed from their markets and this probably leads to less knowledge about the different export markets hence the increased need for ci. in terms of ci sources, no significant differences are found between the various groups of export intensity. abundant relevant information is available from various sources and the use (or not) of a variety of sources may not be directly related to the export intensity of companies. the competitive environment with its changing players, consumer preferences and changing regulatory and technological factors to name a few variables, is volatile. sources of information and what they yield in terms of information, also change continuously and therefore it could be argued that export intensity and the importance of different information sources need not be directly related. the extent to which exporters practice ci is related to their export intensity in many ways. ci could yield better knowledge of the market, better understanding of competitive factors, better understanding of where the exporter wants to go, measure of performance, products and services, existing customer base versus potential customer base and in general benchmarking against the best in the market. better knowledge by means of continuous and focused ci activities could pave the way for increased export intensity. further research is however required in order to develop a thorough understanding of the use and benefits of ci relative to the export intensity of exporting companies and to clarify the ambiguities that arise from this research. by and large, the results for south africa confirm our hypothesis that both the quantity (time devoted to) and quality of the ci activities 96 sajems ns 11 (2008) no 1 is larger/different for exporting companies with a higher export intensity (except for the group of companies with the highest export intensity). however, our results should be treated with the necessary caution, taking into account the relatively low response rate. endnotes 1 this paper stems from a research project financed under the bilateral agreement on scientific and technological cooperation between the republic of south africa and the flemish community (belgium). global insight south africa is acknowledged for providing the service to enable us the electronic distribution and collection of the questionnaire in south africa. 2 for full details on the questionnaire see saayman et al. 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(1978) “pre-export activity: the first step in internationalization”, journal of international business studies, 9: 47-58. f:\ejour\ecoman\index\ecoman_v6_n2.prn.pdf sajems ns vol 6 (2003) no 2 346 institutional quality, openness, and investment in africa1 ___________________________________________________________________________ tonia kandiero department of economics, university of pretoria satish wadhawan department of economics, howard university ________________________________________________________________ abstract this study supports the conventional wisdom that openness to trade is good for investment and economic growth. whether this conclusion leaves space for institutional quality as a complimentary policy to determine the success of trade liberalization in africa is the objective of this paper. the theoretical model and empirical analysis show how the behavior of government bureaucrats can be used to explain the impact on investment of the interaction between increased openness to trade and the quality of institutions. empirical work is conducted using panel data observed over three periods: 1985-1990, 1990-1995, and 19952000. jel 017, f1, e22 1 introduction the discussion on the impact of openness to trade and institutional quality on economic performance is increasingly becoming an important topic. as countries present their modalities in the new trade agenda, complimentary policies such as institutional quality should also be taken into great consideration. on one hand, the body of literature on trade, grossman and helpman (1991), edwards (1992), ades and glaeser (1999), ades and di tella (1997a), sachs and warner (1995), kruger (1974), has established that openness to trade is good for economic performance. on the other hand, a number of existing literature on institutions including north (1990), shleifer and vishny (1993), mauro (1995), knack and keefer (1995), nelson (1997), hall and jones (1999), kandiero (2001) conclude that better institutional structure is vital for economic progress. the presence of less corruption, good property rights, and rule of law encourages innovation and investment. this study supports the general framework that openness to trade is associated with positive economic performance. whether this conclusion leaves space for sajems ns vol 6 (2003) no 2 347 institutional quality as a complimentary policy to determine the success of trade liberalization in africa is the objective of this paper. the theoretical model and empirical analysis indicate how the behavior of government bureaucrats can be used to explain the impact on investment of the interaction between increased openness to trade and the quality of institutions. the empirical work is conducted using cross-country data observed over three periods: 1985-1990, 1990-1995, and 1995-2000. the results show that the quality of institutions has a significant impact on the success of increased openness. controlling for variables, such as initial gdp, education levels, inflation, population growth, among others, the total impact of increased openness on investment has a positive coefficient, 2.92, while the direct impact is approximately 4 times more. a one standard deviation improvement in the interaction between institution quality and increased openness would lead to an increase in investment by 6.69 percent as opposed to 4.74 percent from openness alone. similar results are derived when different institutional quality variables are used. the structure of this paper is as follows: section 2 presents measurement issues regarding openness to trade and institutional quality; section 3 adopts the model by shleifer and vishny (1993) to explain the link between openness, institutional quality, and investment; section 4 discusses data on openness and institutional quality; section 5 explains the econometric methodology; section 6 presents scattered plots to depict a simple relationship between openness and investment, as well as the model specification and regression results; and section 7 concludes. 2 openness to trade and the issue of measurement existing studies on openness use different measures of openness. the most common yardsticks are trade shares of gdp, measures of price distortions, and indices of trade barriers. the use of different measures of openness has caused major concerns in regards to the validity of the empirical findings on this issue of openness. studies dealing with the issue of openness have presented different measures as proxies for openness to trade. for this reason, this discussion pertaining to openness has remained very controversial. balassa (1982) applies trade dependency ratio and rate of export growth as proxies for measuring openness to trade. according to edwards (1998), these types of indicators have limitations because a country can have trade distortion, and still have a high trade dependency ratio. sachs and warner (1997) present a series of trade indicators, such as tariffs, quotas coverage, black market premium, social organization, and the existence of export marketing boards as a proxy for measuring openness to sajems ns vol 6 (2003) no 2 348 trade. this measure was seen as a good attempt to improve the previous proxies for openness. the flaw with the approach is that it only shows whether a country is closed or open. as a result, countries with different types of trade intervention policies are perceived as open. pritchett (1991), anderson and neary (1994) and ingco (1997) have used more observable variable, such as average tariff, average coverage of quantitative restrictions (qrs) and collected tariff ratios (ctr), which are defined as ratios of tariff revenues to imports. pritchett and sethi (1994) find that ctr underestimates protection. in addition, the study concludes that there is no linear relationship between official tariff rate and ctr. dollar and kraay (2001) explain that even for the most direct openness measures, average tariff rates or non-tariff barrier coverage ratios, they have obvious shortcomings. in the case of simple averages of tariff rates, it is possible to give inordinate weight to categories of goods that are viewed as relatively not important for a country. if one averages weighting by imports, then the effects of prohibitive tariffs on imports are lost. pertaining to non-tariff barriers, the best available data simply report the number of tariff lines on which one of a small number of easily identifiable ntbs is in place. this type of data again does not provide information on how binding the ntbs are, and obviously excludes other less-easily quantifiable barriers to trade, such as local procurement requirements. and for all measures, there are important gaps between statutory rates and actually collected tariffs, due to both legal exemptions, poor enforcement of tariffs, or corruption in the customs administration. dollar (1992) is one of the most cited papers in the area of openness. the author constructs two indices: an index of real exchange distortion (distortion) and an index of real exchange rate variability (variability). these indices are said to capture the distortions and variability of “outward orientation”. the author concludes that each of the indices is negatively associated with growth over the period 1976-85. one of the issues with the distortion index is that it may not capture trade policy but rather exchange rate and monetary policies. variability also captures movement of domestic prices in relation to world prices, and the distortions do not separate tradable and non-tradable goods. therefore, these two indicators may in fact not represent the best indicators to measure openness to trade. using cross-country studies, ades and di tella (1997a) and other recent studies have used the share of imports in gdp as a proxy of openness. the only concern with this measure is that it may not capture the openness entirely. sajems ns vol 6 (2003) no 2 349 it is clear that measurement issues are potentially a problem for all variables, but it is especially acute for openness variables. since it still appears to be difficult to find reliable systematic data on trade policies across countries, many papers, including dollar and kraay (2001), have instead simply included trade volumes (exports plus imports as a share of gdp) as one of the explanatory variables in a cross-country regression. for this particular purpose of looking at the effects of the interaction between trade and institution on growth, this imperfect proxy for openness, certainly is sufficient. as mentioned earlier, countries under investigation are divided into two groups. countries with openness greater than the mean are assigned a dummy variable of 1 and countries with openness less than the mean are assigned the value 0. the main reason for dividing the countries into two categories is to make the strong argument that benefits from increased openness could be reduced by the quality of institutions. 3 conceptual framework the framework presents a single bureaucratic problem by utilizing a simple model presented by shleifer and vishny (1993). the model assumes that the government manufactures a homogeneous good, y, such as an export license or import license. the quantity of the sales of the good is a function of price the bureaucrat charges (1) y = f(p) (2) dy/dp < 0 and expressing price as a function of quantity (3) p = g(y) (4) where dp/dy < 0 the demand function is assumed to be negatively sloping. as the price increases, the quantity demanded by the private sector decreases. the demand function of the license or public good is assumed to be affected by increase in trade. an increase in trade in this respect is said to affect the demand for the public good. the bureaucrats are in charge of selling this public good, and they can determine how much they can sell. the bureaucrats can choose to delay the process of obtaining the good in order to receive a bribe from the private agent2. the model assumes that the bureaucrats operate in an environment where they can choose not to supply the good without the risk of getting a penalty. essentially, the corrupt bureaucrats have very little or no chance of facing a punishment3. again, the model depends on the assumption that informal sajems ns vol 6 (2003) no 2 350 sanctions associated with religious dictates or moral norms constrain agents from too much opportunism. another assumptions in this theoretical framework is that government corruption occurs without theft. even though the market is competitive, the bureaucrats are assumed to act as a monopoly because they have the power to set the price of the good. in this regard, the public official sets the price of the good as follows: (5) p = p + φ where p is the total price of the good, p is the price charged by the government, and φ is the bribe that the bureaucrats add on the initial price. in this respect, the bribe inflates the price of the good, which entails an increase in the transaction cost. the public official is not concerned with the cost of producing the public good since the government incurs the cost. to find the marginal cost in the case of corruption without theft, the public official gives the government the initial or the official price, p, and keeps the bribe. therefore, the marginal cost of providing the export or import license is equal to the official price (6) mc = p, where mc is marginal cost and p is the price offered by the government. as a result of this restrictive assumption, the mc line is a horizontal line. the bureaucrat’s total revenue, (r) is (7) r = py, and, the marginal revenue, mr, is derived by differentiating equation (7) with respect to good, y. (8) mr = dr/dy = p + y(dp/dy). since dp/dy < 0, marginal revenue, mr is said to be less than price. the bureaucrat as a monopoly is assumed not to engage in price discrimination. therefore, profit for the bureaucrat point is as follows: (9) π = tr – tc. the profit maximization for the bureaucrat is the difference between marginal cost and marginal revenue sajems ns vol 6 (2003) no 2 351 (10) π max = dπ/dy = mr – mc = 0 the second order condition of the maximization problem is (11) d2π/dy2 < 0. the demand for the good in the face of a bribe is able to hold because the market structure does not allow bureaucrats to compete for bribes. competition by bureaucrats would force the bribe to be reduced (ades & di tella (1997b)). figure 1 is the graphic al presentation of the problem. the destructive nature of transaction cost after opening the economy depends on how much the aggregate demand curve shifts and the elasticity of demand. if the shift is small, then the price plus the transaction cost would be below (p + bribe) [see appendix 1]. also, if the demand curve was more elastic (more horizontal), then the total cost after the bribe would be below p + bribe. nevertheless, the transaction cost in the presence of rents is still higher than the price charged by the government. figure 1 corruption and openness to trade sajems ns vol 6 (2003) no 2 352 increased openness in the presence of poor institutional quality as characterized by corruption, weak rule of law, red tape and poor contract enforcement policies may encourage more rent-seeking behavior by the bureaucrats. the consequence would be a diversion of resources from productive resources to the rent-seeking sector. therefore, the moral of the story is that, even though the agent does not steal from the government, the increase in the transaction cost through bribes increases transaction costs for the private agents, leading to lower investment. this theoretical argument is confirmed empirically. the findings indicate that full benefits of increased openness on investment can be reduced by the quality of institutions. this case can be improved if corrupt bureaucrats are penalized for engaging in rent-seeking activities. according to shleifer and vishny (1993), if the expected penalty imposed by the government increases with the level of bribe, the public agent may reduce the bribe. in addition, in the case where the public officials compete for rents, an increase in openness may result in a reduction of bribes making openness more favorable for economic performance (becker & stigler, 1974; rose-ackerman, 1978; ades & di tella, 1997b). 4 openness to trade and institutional quality data the principal idea of this section is to show that underdeveloped institutions can reduce potential benefits from increased openness to trade. as mentioned earlier, the dummy variable 1 represents all the countries with openness to trade more than the mean, while 0 captures all the countries considered less open. table 1 shows that a little less than half of the countries in the sample have the openness variable above the mean, while the rest of the countries fall below the mean. table 1 openness to trade dummy variables dummy = 1 dummy = 0 angola algeria botswana bukina faso congo drc cameroon gabon congo republic the gambia egypt ghana ethiopia cote d’ivoire guinea madagascar kenya malawi mali sajems ns vol 6 (2003) no 2 353 table 1 continued dummy = 1 dummy = 0 mozambique morocco nigeria namibia sierra leone niger south africa senegal tunisia sudan uganda tanzania zimbabwe togo zambia some of the relatively open countries include south africa, botswana, ghana, malawi, cote d’ivoire, just to mention a few. most of the countries in north africa, for example, egypt, algeria, and morocco, are considered relatively less open. institutional quality data: an aggregate of corruption index, bureaucratic quality, rule of law, and investment profile variables are used as a proxy for institutional quality. the data is from the international country risk guide (icrg), a monthly publication by the political risk services5. corruption: this variable represents the degree of corruption in government. corruption is defined as demands for special payments and bribes in connection with import and export licenses, exchange controls, tax assessment, or loans. data range is from 0 to 6 with 0 being highest corruption and 6 lowest corruption. bureaucracy quality (bq): this variable measures autonomy from political pressure and strength and expertise to govern without any drastic changes in policy or interruptions in government services. data range is from 0 to 4, with 0 being lowest bq and 4 highest bq data. law and order: this represents the rule of law variable. this variable reflects the degree to which citizens are willing to accept the established institutions to make and implement laws and adjudicate disputes. data range is from 0 to 6 with 0 being weak court system and 6 strong court system. bureaucratic quality index (bqi): this variable represents the average of three variables: corruption, bureaucracy quality and law and order, with 0 being the lowest quality and 6 the highest quality. according to mauro (1995) and others, the aggregate of the three variables may yield a better proxy for institutional quality. sajems ns vol 6 (2003) no 2 354 investment profile: factors affecting the risk to investment. these factors include contract viability/expropriation, profit repatriation, and payment delays. 0 represents high risk and 12 is low risk. expropriation risk: the risk of foreign firms being confiscated or nationalized. repudiation of contracts by government: reflects the credibility of government in the enforcement of contracts. 5 econometric methodology the study adopts the econometric methodology followed by many cross-country studies, such as barro (1991), mauro (1995), and others. the empirical work is applied to a panel of countries in african countries observed over three periods: 1985-90, 1990-1995, and 1995-2000. the use of panel data makes it possible for meaningful empirical research to be carried out even in a case of data limitations in terms of time frame and missing data. in addition, the advantage of dividing the data into sub-periods is to smooth out business cycle effects. furthermore, the time-dimension of the panel is fairly small in comparison to the number of countries, which helps to avoid some of the complications that may arise in time series data. the regression analysis mainly uses the generalized least square (gls) method to estimate the equations. however, ols combined with the white heteroskedasticity consistent covariance methods are also used in some instances as a robustness test6. gls is assumed to yield better results compared to ols considering the complications in the use of panel data. gls results are consistent, unbiased, and the estimator has minimum variance. in addition, stacking the data into three sub-periods and applying gls also corrects another problem faced by panel data namely, serial correlation where endogenous variables are instrumented by their lagged values. by dealing with serial correlation, gls partially solves the endogeneity, which is another shortcoming in cross-country analysis (caselli, esquivel & leffort (1996)). 6 empirical results 6.1 openness, institutional quality, and investment: a simple relationship openness and investment figure 2 presents a scattered diagram of a simple relationship between trade openness and the investment to gdp ratio. a correlation coefficient of 0.5 shows that there is a positive correlation between openness and investment in the period 1980-2000 for the african countries. the correlation is much stronger in mineral rich countries, for example botswana and namibia. sajems ns vol 6 (2003) no 2 355 figure 2 scattered plots of openness and investment 5 10 15 20 25 30 20 40 60 80 100 120 trade openness in ve st m en t t o g d p this insight supports the studies by grossman and helpman (1991) and edwards (1992, 1998), among others. these studies provide the intellectual argument that openness could be positively associated with economic performance. one of the contrib utors in the economic performance of countries in east asia, such as korea, malaysia, and thailand has been attributed to increase in the volume of trade. with the development of the export sector in the last two decades, east asia was able to achieve impressive capital accumulation figures. the same explanation also holds for a number of countries in latin america, such as mexico, brazil, venezuela, and argentina. this study supports the argument that openness to trade is good for investment. however, the task at hand is to exercise a caution that increasing openness to trade combined with underdeveloped or malfunctioning institutions can be detrimental to investment. the next section gives a simple empirical analysis of how this can occur. 6.2 model specification and regression results model specification the model specification follows the cross-country studies by mauro (1995), ades and di tella (1997a) and many others. ades and di tella (1997a) use a similar technique (using interaction terms) to test the impact of industrial policy on investment, in the presence of corruption. this section presents the results of sajems ns vol 6 (2003) no 2 356 the direct and indirect impact of increased openness and institutional quality on investment. (12) γit = α1 + α2 inst + α3dopeness + α4 inst*dopeness + α5πit+ eit where γit = investment to gdp ratio in ith country at time t inst = institutional quality variable dopeness = a dummy variable with a value of 1 if the value of openness is greater than the mean. this represents countries which are more open to trade πit = control variables (initial gdp per capita ppp adjusted, secondary and tertiary education, population growth, inflation rate, and government consumption). eit = random error from equation 1 the marginal effect of increased openness on investment is (13) ∂ (γit )/ ∂ dopenness = α3 + α4 inst we assign the mean for institutional quality index as the value for inst. the model specification in equation (12) is estimated using generalized least square (gls). the main reasons for using this methodology are to correct for some level of serial correlation and heteroscedasticity. the next section presents regression results of the impact on investment of the interaction between institutions and increased openness. regression results the goal of this section is to examine if the pattern of data in the sample of african countries shows that institutional quality may affect the impact of increased openness on investment. table 2 presents the results from the regression analysis using the general specification in equation (1). the results show that increased openness has a significantly positive direct impact on investment and an indirect impact through institutions. the total effect of openness on investment is reduced when the interaction variable is introduced. sajems ns vol 6 (2003) no 2 357 this shows that even though openness is good for investment, the total benefits can be reduced by the quality of institutions. the regression results in models 1 and 2 presents results for only investment, openness, and institutions without introducing control variables. in both models increased openness to trade has a significantly positive impact on investment, with estimated coefficients, 12.000(1.336) in the first model and 9.967 (3.083). one standard deviation increase in openness improves investment by 6 percent and about 5 percent in models 1 and 2, respectively. institutional quality also has a significantly positive impact on investment. a one standard deviation increase in institutional quality variable results in an increase in investment by 1.59 percent and 1.79 percent in models 1 and 2. the marginal impact of increased openness on investment (equation 2) is also positive. however, the coefficient reduced substantially, with coefficients, 4.52 in model 1 and 4.73 in model 2. clearly, the total benefits of increased openness in the two cases have declined significantly due to the institutional quality. as indicated by the goodness of fit, the study considers gls results to be more accurate than those of ols. also, gls results are consistent, unbiased, and the estimator has minimum variance. in addition, stacking the data into three subperiods and applying gls also corrects the issue of serial correlation. dealing with serial correlation, gls partially solves the endogeneity, which is another shortcoming in cross-country analysis. model 3 introduces control variables, initial gdp, secondary school education, tertiary education, inflation rate, population growth, and government expenditure. the total impact of increased openness on investment has a positive coefficient, 2.92, which amounts to approximately 4 times below the direct impact of increased openness on investment. one standard deviation improvement in the interaction between institutional quality and increased openness leads to an increase in investment by 6.69 percent as opposed to 4.74 percent from the openness only. model 4 includes sub-saharan africa to the control variables in model 3. the direct and the indirect impact of openness on investment has a coefficient, 3.83, an estimate also significantly lower than the direct increased openness coefficient, 9.56. the difference between models 3 and 4 is that, education variables become statistically insignific ant when countries in north africa (egypt, morocco, tunisia, and algeria) are removed from the sample. model 5 omits south africa from the total sample. the overall impact of increased trade on investment is still lower than that the case without the impact of institutions, with a coefficient, 3.58. the only variable that changes is tertiary education, which moves from being insignificant in model 4 to significant in model 5. table 2 regressions for investment, openness, and institutional quality dependent variable: investment to gdp ratio independent variable model 1 (ols)1 model 2 (gls) model 3 (gls) model 4 (gls) model 5 (gls) model 6 (gls) model 7 (gls) constant 13.377* (2.793) 14.496* (1.180) 10.220* (2.790) 13.820* (3.150) 7.450 ** (3.397) 16.206* (2.925) 10.155 * (2.870) trade openness 12.000* (4.391) 9.967* (3.083) 9.550* (2.980) 9.560 * (3.070) 9.656* (3.021) 8.749* (2.830) 13.518* (3.578) institutional quality 2.120* (0.834) 1.811* (0.329) 1.250 * (0.390) 0.880* (0.390) 1.302* (0.409) openness*institutional quality -2.336*** (1.336) -(1.636)*** (0.846) -2.070* (0.810) -1.790* (0.830) -1.899** (0.832) initial gdp 0.990* (0.340) 1.310* (0.360) 0.930 ** (0.345) 0.992* (0.333) 1.153* (0.317) secondary education 0.070** (0.030) 0.004 (0.040) 0.055 (0.0361) 0.049 (0.035) 0.074* (0.033) tertiary education -0.130** (0.050) -0.044 (0.055) -0.102 *** (0.057) -0.160* (0.058) -0.178* (0.056) inflation rate -0.001*** (0.000) -0.001*** (0.000) -0.001*** (0.000) -0.002*** (0.001) -0.001*** (0.000) population growth -1.070** (0.510) -1.553* (0.536) -1.340 ** (0.553) -2.005* ( 0.544) -1.468 * (0.518) government expenditure 0.020 (0.090) 0.143 (0.094) 0.022 (0.085) 0.026 (0.076) -0.040 (0.0834) table 2 continued independent variable model 1 (ols)1 model 2 (gls) model 3 (gls) model 4 (gls) model 5 (gls) model 6 (gls) model 7 (gls) sub-saharan africa -3.97* (0.415) sub-saharan africa (without south africa) 3.912 *** (2.512) corruption 0.587 (0.561) corruption*trade -1.699* (0.084) corruption investment profile 1.259* (0.390) corruption investment profile * trade -2.361* (0.7114) ? 3 + ? 4 inst 4.525 4.732 2.926 3.832 3.579 3.492 3.205 adjusted rsquared .17 .96 .93 .96 .92 .94 .94 number of observations 98 98 80 80 80 78 80 note: 1 ols with white heteroskedasticity consistent covariance * 1 percent confidence level ** 5 percent confidence level *** 10 confidence level sajems ns vol 6 (2003) no 2 360 models 6 and 7 include other measures of institutional quality variables such as corruption and investment profile to test if the results are robust. in the case of corruption (model 6), the total impact has a coefficient, 3.49. the estimate is not too far from the estimates in the previous columns. intuitively, the coefficient is smaller because the variable captures only a small aspect of institutional quality as compared to the more comprehensive institutional quality index. model 7 has the largest direct and the lowest indirect impact of openness to trade on investment compared with the previous columns. institutional quality in this case is represented by an average between corruption and investment profile. the direct impact estimate is 13.56 and the total effect has the coefficient, 3.20. this increase in magnitude means that increased openness is much more effective when countries have less corruption, as well as conditions where there is no risk of foreign firms being confiscated or nationalized and credibility of government in the enforcement of contracts. one standard deviation increase in openness would lead to an increase in investment by only 6.70 percent, and the inclusion of the institutional variables by 10.43 percent. overall, the 7 models have demonstrated that for trade openness to be more successful, the quality of institutions plays an important role. in the case of this sample of african countries, the quality of institution appears to cause a reduction in the overall benefits from trade. in order to show that using the dummy variables present a much stronger case for increased openness than using the actual variable (trade to gdp ratio), an extra regression was run. the results presented in appendix 1, table 1 indicate that the statistically significant coefficients on openness (0.145(0.388)) and interaction terms openness*institutional quality (-0.047(0.011)) are much smaller than the coefficients in model 3. this also shows that restrictive model (model with an openness dummy) yields more compelling results. overall, the 7 models in table 2 have demonstrated that for trade openness to be more successful, the quality of institutions plays an important role. in the case of this sample of african countries, the quality of institution appears to cause a reduction in the overall benefits from trade. 7 conclusion the regression results have provided an important insight in the discussion on openness to trade. the analysis supports the argument that markets that are more open are likely to create significant economic welfare gains through more efficient allocation of resources (static gains). with efficient use of resources, dynamic gains are expected in the longer term with enhanced productivity and investments. openness to trade in this study has a significantly positive direct sajems ns vol 6 (2003) no 2 361 and indirect impact on investment. however, the total impact of openness to trade on investment is reduced by the indirect impact which is through the quality of institutions. controlling for variables such as initial gdp, education levels, inflation, population growth, among others, the total impact of increased openness has a positive coefficient approximately 4 times below the direct impact of increased openness on investment. improving the interaction between the quality of institutions and increased openness by one standard deviation would lead to an increase in investment by 6.69 percent as opposed to 4.74 percent from openness directly. using the combination of corruption and investment as proxies for institutional quality, one standard deviation increase in openness alone would lead to an increase in investment by only 6.70 percent, while openness indirectly through institution by 10.43 percent. intuitively, the message of this study is that, openness to trade will yield optimal benefits if the quality of institutions is improved substantially. less corruption, better investment profile, less delays, and better rule of law have the potential to contribute to increased gains from openness to trade. therefore, even though the issues dealing with market access, domestic support, competition, and other trade liberalization policies are very important, other development issues such as institutional quality should be taken into consideration for liberalization to yield fruitful results in africa. sajems ns vol 6 (2003) no 2 362 appendix 1 figure 1 corruption and openness to trade sajems ns vol 6 (2003) no 2 363 table 1 regressions for investment, openness, and institutional quality dependent variable: investment independent variable model 1 (gls) model 2 constant 10.220* (2.790) 3.223 trade openness(dummy) 9.550* (2.980) trade openness (trade/gdp) 0.145 (0.038)* institutional quality 1.250 * (0.390) 3.600* (0.039) openness*institutional quality -2.070* (0.810) -0.011* (-4.067) initial gdp 0.990* (0.340) 0.785 (2.781)* secondary education 0.070** (0.030) 0.088 (0.032)* tertiary education -0.130** (0.050) -0156* (0.057) inflation rate -0.001*** (0.000) -0.001 (0.001)*** population growth -1.070** (0.510) -1.212* (0.398) government expenditure 0.020 (0.090) 0.141 (0.067) adjusted r-squared .93 .97 number of observations 80 80 note: 1 ols with white heteroskedasticity consistent covariance * 1 percent confidence level ** 5 percent confidence level *** 10 confidence level sajems ns vol 6 (2003) no 2 364 appendix 2 other variables investment (gross capital formation) outlays on additions to the fixed assets (land improvements; plant, machinery, and equipment purchases; and construction of roads, railways, and buildings) of the economy plus net changes in the level of inventories (stocks of goods held by firms). inflation (consumer prices (annual percentage)) inflation as measured by the consumer price index reflects the annual percentage change in the cost to the average consumer of acquiring a fixed basket of goods and services that may be fixed or changed at specified intervals, such as yearly. gross domestic product (gdp) purchasing power parity (ppp) adjusted the sum of the gross value added by all resident and nonresident producers in the economy plus any taxes and minus any subsidies not included in the value of the products. gdp is calculated without making deductions for depreciation of fabricated assets or for depletion and degradation of natural resources. value added is the net output of a sector after adding up all outputs. the industrial origin of value added is determined by the international standard industrial classification (isic). the gross domestic product is converted to international dollars using the purchasing power parity rates. gdp per capita is gross domestic product divided by midyear population. growth rates are calculated as annual averages and represented as percentages. openness to trade (trade/ ppp gdp) the sum of merchandise exports and imports in current u.s. dollars divided by the value of gdp converted to international u.s. dollars using purchasing power parity conversion factors. this variable represents volume of trade as a share of ppp gdp. population total population of an economy includes all residents regardless of legal status or citizenship except for refugees not permanently settled in the country of asylum, who are generally considered part of the population of their country of origin. annual population growth rate is the exponential change for the indicated sajems ns vol 6 (2003) no 2 365 time period. the exponential growth rate is the growth between two periods and is calculated as follows: growth rate = ln (pn/p1)/n where pn and p1 are the last and first observations in the period, n is the number of years in the period, and in is the natural logarithm operator. the growth rate is based on the model of continuous, exponential growth between two points in time. gross enrolment ratio is the rate of total enrolment, regardless of age, to the population of the age group that officially corresponds to the level of education specified. secondary school provides specialized instruction at middle secondary, or high schools, teacher training schools; this level of education is based on at least four years of instruction at the primary level. tertiary education, whether or not to an advanced research qualification, normally requires, as a minimum condition of admission, the successful completion of education at the secondary level. the enrollment ratios are important indicators of the size and capacity of a country's education system and may be useful measures of education outcomes. the world bank obtained the enrollment ratios for the united nations educational, scientific, and cultural organization's (unesco) statistical yearbook 1997. government consumption (government expenditure/gdp) government expenditure includes non repayable current and capital expenditure as a share of gdp. it does not include government lending or repayments to the government or government acquisitions of equity for public policy purposes. the world bank obtained the data from the international monetary fund's (imf) government finance statistics yearbook 1996. each country's accounts are reported by using a system of common definitions and classifications found in the imf's manual on government finance statistics (1996). sajems ns vol 6 (2003) no 2 366 endnotes 1 we would like to thank the referees, arsene aka, roberta hollader, lieffu huang, merlinda ingco, ransford palmer and the participants at the 2002 annual conference on econometric modelling for africa for their helpful comments and suggestions. 2 delays in the process of obtaining public goods, such as licenses in known as red tape. 3 this environment is characterized as having a very weak rule of law. 4 for more information on the government corruption index, bureaucratic index, and the contract enforcement variables see knack and keefer (1995) or keefer and knack (1997). 5 for more information on the government corruption index, bureaucratic index, and the contract enforcement variables see knack and keefer (1995) or keefer and knack (1997). 6 heteroskedasticity is a common problem in panel data. in these crosscountry studies, the scale of dependent variable and independent variables tend to vary across observations. in other words, the disturbance terms have different variances. references 1 ades, a.f. & glaeser, e.l. 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(1995) “institutions and economic performance: cross country tests using alternative institutional measures”, economics and politics, 7: 207-27. 29 knack, s. & keefer, p. (1997) “why don’t poor countries catch up?”, economic inquiry, 1115: 590-602. 30 krugman, p. (1999) the return of depression economics, new york: w.w. norton & company. 31 mankiw, g., romer, d. & weil, d. (1992) “a contribution to empirics to economic growth”, quarterly journal of economics 107: 407437. 32 mauro, p. (1995) “corruption and growth”, quarterly journal of economics, 3: 681-712. 33 murphy, k.m., shleifer, a. & vishny, r.w. (1993) “why is rent seeking so costly to growth?” aea papers and proceedings, 83: 409-15. 34 nelson, r. (1997) “how new is new growth theory?” challenge, 40: 29-58. 35 north, d. (1990) institutions, institutional change and economic performance, cambridge, ma: cambridge university press. 36 pritchett, l. (1991) “measuring outward orientation in developing countries: can it be done”, world bank policy research working paper (washington: world bank). 37 pritchett, l. & sethi, g. (1994) “tariff rates, tariff revenue, and tariff reform: some new facts”, world bank economic review, 8: 1-16. 38 romer, p. (1986) “increasing returns and long run growth”, journal of political economy, 94: 1002-37. 39 rose-ackerman, s. (1978) corruption: a study in political economy, new york: academic press. 40 sachs, j.d. & warner, a. (1995) “economic reform and the process of global integration”, brookings papers on economic activity, 1: 1-118. 41 sachs, j. d. & warner, a. (1997) “sources of slow growth in african economies”, journal of african economies 6: 335-76. 42 sala-i-martin, x. (1994) “cross sectional regression and the empirics of economic growth”, european economic review, 38: 739-47. 43 shleifer, a. (1996) government in transition. cambridge, ma: harvard university press. 44 shleifer, a. & vishny, r. w. (1993) “corruption”, quarterly journal of economics 3: 599-617. 45 ____ (1994) “politicians and firms,” quarterly journal of economics 4: 995-1026. microsoft word 2 coldwell & callaghan sajmes 16(3) 2013.doc 244 sajems ns 16 (2013) no 3: 244-257 the role of internal and external factors on management students’ subject choices david al coldwell and chris w callaghan school of economic and business sciences, university of the witwatersrand accepted: march 2013 the aim of the study is to investigate undergraduates’ perceptions of the comparative worth/utility of studying business science disciplines at a prominent south african university in terms of: (i) internal factors comprising aptitudes, values and interests; and (ii) external factors comprising job attractiveness (job prospects, earning potential, non-salary benefits and work-life balance), and (iii) university and discipline academic reputations. the study utilises a specifically designed instrument to measure internal and external factors impinging on career choice. a purposive non-random sample, consisting of 130 second and third year students in human resource management (hrm) and management, is used. findings suggest that, while perceptions of aspects of careers, such as job and career prospects generally dominate the choice of major subjects, students studying hrm majors hold community orientated values that distinguish them from their peers. many students are found to make choices primarily on the basis of their perceptions of ‘external factors’, rather than their interests. the findings are discussed in terms of extant theory and potential practical outcomes. key words: schein, gottfredson, student perceptions, major subject choice, business science, education jel: m210 1 introduction the human resources management career literature indicates that changes in the structure of organisations have implications for the individuals’ career development and career choices (super, 1980; brousseau, driver, eneroth & larsson, 1996; king, 2004; schein, 1996). the increasing importance of knowledge work requires further research on the development knowledge workers’ careers (van staden & du toit, 2011) and the conceptions of careers have expanded to encompass both work and non-work related factors (king, 2004). furthermore, “careers have a personal as well as a vocational meaning for many people; a complete picture of career selfmanagement needs to consider people’s aspirations for their lives outside work” (king, 2004:117). knowledge of student perceptions of the learning process in contemporary tertiary education is an increasingly important area of research (beckman & rayner, 2011; henige, 2011; keller, parker & chen, 2011) as it can contribute to improvements in both teaching and learning (henige, 2011; tudor, penlington & mcdowell, 2010). intrinsic factors specific to the individual, such as selfesteem, can: “influence employability attributes significantly” (potgieter, 2012:13). this body of career literature reveals the increasing importance of individual perceptions and goals in career choice. 2 purpose and objectives of the study although a voluminous literature now exists within human resources management on the burgeoning new development of career management as a separate discipline in its own right, the current study returns to some of the founding fathers of the career management discipline to gain a clearer insight into the fundamentals of career selection. gottfredson (1981) suggests that individuals perceive career barriers and on the basis of specific perceptions of these barriers compromise occurs. however, swanson and tokar (1991) abstract sajems ns 16 (2013) no 3: 244-257 245 question gottfredson (1981) and argue that although barriers might be perceived as insurmountable by some, others may regard them as merely challenging. thus, a tension exists between these conceptions. gottfredson (1981) suggests that if goals and goalassociated behaviour are adjusted on the basis of perceptions of real life aspects of a career, clearer relationships would be expected between such perceptions and the choice of a major subject at university. gottfredson (1981) maintains that individual career aspirations develop through a process of ‘circumscription’ in which an increasingly refined understanding about oneself and the world of work points to specific careers and occupations. similarly, schein (1996) suggests that an individual, at some point of the career /selfmanagement process, will typically begin to make choices related to the pursuit of particular careers. schein (1996) suggests that the tension between the ‘external career’ and the ‘internal career’ brings about certain fundamental shifts in the nature of career choice and development. career decisions made prior to entry into a career are considered to be particularly important. the major subject or subjects taken at a higher education level in preparation for employment, can be regarded as indicative of the individual’s choice prior to their entry into a career. the ‘internal career’ “involves a subjective sense of where one is going in one’s work life, in contrast to the ‘external career,’ or the formal stages and roles defined by organisational policies and societal concepts of what an individual can expect in the occupational structure” (schein, 1996:80). an individual’s self-concept is the basis of a ‘career anchor’, that maintains consistency in a career (schein, 1996). “a person’s career anchor is his or her self-concept, consisting of: 1) self-perceived talents and abilities, 2) basic values, and, most importantly, 3) the evolved sense of motives and needs as they pertain to the career” (schein, 1996:80). a further differentiation is stressed regarding the core interests of individuals that underpin their career anchors. these core interest anchors are: financial or remuneration interest, job interest and service or community contribution. to the authors’ knowledge, no research has been conducted into the relationship between the individual’s perceptions of schein’s (1996) career anchors and subject choices in the south african higher education context. it is maintained that knowledge about the interface between perceptions and career choices is especially salient at certain stages of an individual’s career and unrealistic career expectations can result in employee dissatisfaction (granrose & portwood, 1987). the stage at which an individual first decides to take a specific major subject at university impacts significantly on an individual’s subsequent career trajectory. however, a challenge exists with regard to subjective career choices at this point of an individual’s development. “most of us are not aware of our career anchors until we are forced to make choices pertaining to self-development, family or career” yet it is “important to become aware of them so that we can choose wisely when choices have to be made”, (schein, 1996:80). the paper also interrogates gottfredson’s (1981) theory of ‘circumscription’ by investigating second and third year business science undergraduate students’ perceptions of market, personal and institutional factors, and aims to contribute to the literature by testing the conflicting theoretical conceptions of swanson and tokar (1991) on the one hand and gottfredson’s (1981) on the other. in a nutshell, the overriding objective of the research is to investigate the career related perceptions of students and how these perceptions influence the choice of major subjects in an academic context. this is achieved by obtaining insight into student perceptions of business science majors and the resulting career aligned choices in terms of attractiveness (soutar & turner, 2002), personal factors (gottfredson, 1981; harvey-beavis & robinson, 2000) and institutional factors (baldwin, 1994). 3 problem investigated if individual career choices are made based on perceptions of ‘external’ or job related factors rather than the ‘internal’ factors of aptitudes, interests and values, a misalignment of students’ career aspirations may occur. this 246 sajems ns 16 (2013) no 3: 244-257 misalignment could prove wasteful for the country and could generate poorly job fitted individuals with low job satisfaction and productivity. the current research attempts to investigate the nature of the relationship between such ‘external’ and ‘internal’ factors in academic major subject choice. the following research questions are posed: • to what extent are self-perceptions of aptitudes, values and interests, or ‘internal’ factors, part of an individual’s core career anchor and choice of a specific major subject? • what specific self-perceptions of ‘external’ job related factors are associated with the choice of particular career majors? individual perceptions that influence major subject choices are usually related to an individual’s specific set of interests and values. according to schwartz (2007), an individual’s values are derived from a motivational infrastructure that draws from physiological, psychological and social needs. an individual’s specific values endowment is associated with behaviour consistent with those values (schwartz, 2007). an individual’s interests are therefore expected to reflect core individual values. perceptions are framed by an individual’s subjective experience of the world. thus, a further research question is posed: • what career perceptions are associated with specific job interest anchors? development of the hypotheses the hypotheses are generated in accordance with the ‘internal’ and ‘external’ factor dimensions mentioned above. however, before stating these formally, a brief explanation is warranted of how they were derived from the literature. a career is “the evolving sequence of a person’s work experience over time” and career theory is “the body of all generalisable theory attempts to explain career phenomena” (arthur, hall & lawrence, 1989:8/9). arthur et al. (1989) stress the multidisciplinary nature of career theory. career theory has traditionally been dominated by the perspective that career outcomes, for both organisations and individuals, are best achieved through an alignment between the “individual’s characteristics and the demands, requirements, and rewards of the organisational environment” (betz, fitzgerald & hill, 1989: 26). theory and research findings associated with this perspective have focussed on individual trait differences in relation to career selection (betz et al., 1989). one aspect of trait-factor theory concerns individual abilities, such as verbal, numerical, and spacial abilities (betz et al., 1989). swanson and tokar (1991) found common factors to be associated with student concerns about career barriers, such as those related to their ability and job market availability. on the basis of a review of the career literature, betz et al. (1989) point to research findings that indicate that five to fifteen percent of the variance in performance is explained by ability. thus, it seems reasonable to expect that individuals include perceptions of aptitudes in their career decisions. the following hypothesis (shown in the form of its null hypothesis) is generated to test this ‘internal’ factor aspect: hoa: there is a significant difference between perceptions of aptitude by major academic field subject choice. evidence supports the link between individual interests and job satisfaction and tenure in careers (betz et al., 1989). needs, values and preferences relate to intrinsic or extrinsic outcomes associated with a career choice (betz et al., 1989). mismatches between the individual and the characteristics of a job associated with a particular career are related to dissatisfaction and turnover (betz et al., 1989). betz et al. (1989) argue that the theory of work adjustment is the most comprehensive of the trait-factor theories. a central tenet of this theory is that work adjustment on the job is a function of two employee characteristics: satisfactoriness and satisfaction in an interactional relationship with the work environment (betz et al., 1989). satisfactoriness, or the successful performance of job responsibilities, is a function of an individual’s abilities and the ability requirements of the job (betz et al., 1989). satisfaction is a function of the alignment between an individual’s vocational needs and values with the work environment (betz et al., 1989). abilities and aptitudes are significant aspects of career theory, but also sajems ns 16 (2013) no 3: 244-257 247 salient are an individual’s vocational needs and values. an individual often makes career choices based on interests and values, which are typically underpinned by motivations (schwartz, 1992; 2007). three potential career anchor dimensions are investigated in this paper: financial interest orientation, job related interest orientation and service interest orientation. the following ‘internal’ factor hypothesis is derived from the current body of literature available on the subject: hob: there is a significant difference between career anchor interests by major academic field subject choice. further support for the inclusion of the dimensions of these interests is offered by holland’s (1973) theory. according to holland (1973), vocational satisfaction, stability and achievement are dependent upon an alignment between an individual’s personality and the working environment. congruence between an individual’s personality and the work environment will lead to increased tenure, and the environment isl also expected to exert an influence upon the individual towards congruence (betz et al., 1989). career barriers have typically been considered to fall into two types: external, such as wages or discrimination and internal, such as motivation or psychological aspects (swanson & tokar, 1991). swanson and tokar (1991:96) investigated student perceptions of career barriers, and categorised these as: 1) social/interpersonal barriers or “barriers regarding one’s family of origin and future marriage and children”; 2) attitudinal barriers defined as “self-concept, interests, and attitudes toward work”; and 3) interactional barriers which are related to demographic characteristics, education, experience and the working environment. an interaction between these internal factors and perceived careerrelated obstacles in the socio-economic environment is expected to influence career decisions (gottfredson, 1981). as career barriers are experienced, individuals compromise their goals (gottfredson, 1981). for gottfredson (1981) the weaker self concepts face modification before deeper rooted self-concepts, such as gender, are affected. an individual recognises and responds to different career barriers in the interaction between self-concept and environment (gottfredson, 1981). thus, goal adjustment will occur on the basis of an individual’s perception of self and the socio-economic environment. differences between career and major subject choice will be expected to be associated with differences in underlying career related perceptions. job prospect perceptions, specific career prospects, specific non-salary work benefits, career specific work-life balance, academic field and programme factors are considered ‘external factors’. to test these aspects, the following hypotheses are generated. each is shown in the form of the null hypothesis. h0c: there is no significant difference between perceptions of external career factors and major academic field subject choice. h0d: there is no significant difference between perceptions of the relative merit of the academic programme and major academic field subject choice. h0e: there is no significant association between perceptions of ‘external’ career perceptions and ‘internal’ career job interest career anchors. the latter hypothesis is included in order to better understand the relationship between ‘external’ and ‘internal’ factors tested. 5 research methodology the study utilises an exploratory quantitative (numerical) cross sectional (i.e. measurements are taken at one point in time) research design and is ‘causal’ in so far as it tests specific hypotheses, and the problem is structured (ghauri & gronhaug, 2002). 5.1 sample the sampling procedure consists of a nonrandom purposive sample aimed at involving all second and third year students studying hrm and management in the school of economic and business sciences willing to participate in the study. participation was voluntary and confidential. second and third year students in hrm and management were 248 sajems ns 16 (2013) no 3: 244-257 considered, of which130 out of 355 possible students comprised the sample. over a third of the students completed the questionnaire. the study incorporates a specially developed questionnaire that uses both ten-point semantic differential items and items arranged on a five point likert-type scale. likert-type scales ranging from ‘strongly agree’ to ‘strongly disagree’, were developed and taken to represent interval data and differences were scaled with equal increments (stevens, 1946). a tenpoint semantic differential scale ranging from ‘very poor’ to ‘excellent’ was used for perceptions of personal aptitudes and aspects of university programmes. the questionnaire incorporates five sections: biographical information, perceptions of market demand, personal work interests and values, perceptions of aptitudes and perceptions of academic programs. 5.1.1 details of the respondents fifty-seven percent were female. the proportions and numbers of students with information systems, marketing, finance, management, insurance and risk and hrm majors are reported in table 1. t a b l e 1 respondent characteristics mean standard deviation number percentage gender male 56 43 female 74 57 major type i/s 20 15 marketing 38 29 finance 49 38 management 61 47 i/r 16 12 hrm 34 26 age 22.5 5.1 abbreviations: i/s information systems; i/r insurance and risk students were typically registered for between one and three majors. three majors were reported by 10.4 percent of the students. older students are found to choose hrm and psychology and younger students economics as major subjects and certain commonalities were found in subject choice combinations. 5.2 statistical analyses the statistical analyses involve descriptive and inferential techniques including: reliability analysis, factor analysis, frequencies and calculations of central tendency, correlations and tests of differences by groups. the ibm spss statistics 20 package, together with sas statistical software, was used throughout the research analysis. a univariate analysis gave insight into the central tendency and the dispersion characteristics of the data. histogram plots were checked for normality. the research included both parametric and non parametric tests. where non normality in the data was identified non parametric measures were used. anova and t-test procedures were included as part of the initial research process and a univariate analysis was undertaken to check their appropriateness. distribution plots, such as the probability-probability (p-p) and quantile-quantile (q-q) plots, were visually checked. outliers from the lines generated were noted, and shape differences subjected to further univariate numerical analysis. descriptive tests for skewness and kurtosis were applied. data that reflected skewness values that differed from zero, either to the right or to the left, and kurtosis values different from the value of three were investigated further. skewness and kurtosis statistics for the entire set of variables were obtained. the shapiro and wilk test w statistic was used for each of the non binary variables. data with values away from one or closer to zero were sajems ns 16 (2013) no 3: 244-257 249 identified for further analysis in terms of normality. the sample size of the study (n=130) fell into the range considered appropriate for the shapiro-wilk test, that being between 7-2000 data points. tests of central tendency: the mean, median and mode values were calculated. in the case of a disagreement between the shapiro-wilk and the kolmogorov significance results, the former were accepted. the kolmogorovsmirnov (ks) test of the d statistic was also applied. the sas procedures also offered the cramer-von mises and anderson-darling tests. if the ks test results conflicted with these latter tests, this discrepancy is identified and reported. however, in none of the tests was such a discrepancy evident. sas was used for the descriptive statistics reporting and the p-p and q-q plots. all the tested variables showed variation from the p-p and the q-q plot lines to some extent, except for the variables entitled ‘work life balance for marketing’, ‘work life balance for finance’, ‘financial interest orientation’ and ’ job interest orientation’. the interquartile ranges of the variables were also inspected. on the basis of the univariate testing, relatively few of the items were found to have an underlying distribution approaching acceptable levels of normality. on the basis of this evidence, non parametric alternative tests were used. appropriate measures were used for analysing nominal data (stevens, 1946). kendall’s tau b measures were used for this purpose. parametric tests were excluded on the basis of the univariate evidence which indicated that many of the variables obtained non–normal distributions. thus, hypotheses a to d are tested using the mann whitney test and hypothesis e is tested with kendall tau correlations. 5.3 measuring instrument: reliability and validity 5.3.1 reliability of the external and internal factors’ measuring instruments several ‘rules of thumb’ for cronbach alpha coefficients have been put forward by various authors. george and mallery (2003:231) state that coefficient sizes range from > .9 (excellent) to >.8 (good), and from >.7 (acceptable) to >.6 (questionable); with >.5 (poor) to <.4 (unacceptable). nunnally (1967:226) however, suggests a minimum internal consistency score of .5 as rule of thumb convention for exploratory studies. the cronbach alpha value for the four job interest scale items was .54. the alpha value for the four financial interest items was .70. the alpha value for the four ‘contribution to society’ items was .814. these internal consistency coefficients are considered acceptable for an exploratory study. 5.3.2 validity of the internal factor ‘interest’ measuring instrument responses associated with the twelve core interest anchor items were subjected to a factor analysis using a principle components analysis. the assumptions underlying the exploratory factor analysis were checked. scatterplots were run to check the assumption of linearity. however, it was not possible to ascertain a clear linear pattern in many of the plots. pearson correlations revealed the presence of inter-item correlations between these items, with these correlations being >.5. the antiimage correlation matrix diagonals reported values of well over .5. in terms of further tests of measures of sampling adequacy (msa), the kaiser-meyer-olkin (kmo) value was found to be .792, which was greater than the required level of .5, and bartlett’s test of sphericity was found to return an approximate chi-square value of 364.191 at 66 degrees of freedom. the bartlett’s test statistic was found to be significant. on the basis of these tests, sampling adequacy was accepted and the analysis was taken to meet the requirements of factorability. a varimax rotation with kaiser normalisation was used. these tests were performed using spss. the factor solution for the spss analysis is shown in table 2. the ideal typical ratio of 20:1 for cases per item was not met, as 12 items were used with 130 cases. the ratio of cases to items was 10.83:1. this ratio exceeds the reasonable cut-off level for exploratory factor analysis of about 5:1. the rotated three factor solution is shown in table 2. this table reports the component loadings together with the communalities (h2) and the total variance, percentage of variance explained and cumulative percentage of variance 250 sajems ns 16 (2013) no 3: 244-257 explained in the components. the scale items loaded in a manner consistent with the original conceptualisations and the interpreted simple structure achieved in the factor loadings. t a b l e 2 factor analysis rotated component matrix of the career interest orientations component 1 component 2 component 3 communalities (h2) squared multiple correlation communalities (h2) extraction total variance explained 3.4 2.1 1.2 percentage of variance explained 28.1 17.8 10 cumulative percentage of variance explained 28.1 45.9 55.9 interest: job itself .209 -.264 .364 1.0 .246 interest: salary -.063 .652 .182 1.0 .462 interest: societal contribution .817 -.154 .138 1.0 .710 interest: good money -.225 .599 -.040 1.0 .411 interest: make a difference in peoples’ lives .715 -.145 .316 1.0 .633 interest: interesting job .285 .164 .534 1.0 .393 satisfaction from job itself .056 -.197 .770 1.0 .635 kind of work is most important .097 .271 .750 1.0 .646 success defined by salary .003 .818 -.114 1.0 .682 education to benefit society .812 -.058 -.044 1.0 .664 happiness is good salary -.068 .752 .014 1.0 .570 enhance the community .761 -.072 .268 1.0 .657 component 1: contribution to society interest orientation; component 2: financial interest orientation; component 3: job itself interest orientation. table 2 indicates that factor 1 comprised all of the ‘contribution to society’ items. factor 2 comprised all of the ‘financial interest’ orientation items and all the items of the ‘job itself’ interest orientation loaded on factor 3. table 2 shows that over half the variance (55.9 per cent) is explained by the first three components (these component’s eigenvalues are >1). each of the five hypotheses (a to e) is described in detail in relation to the findings in section 6. for hypotheses a to d, aptitude endowments; internal career anchor interests; external career factors such as job prospects, earnings potential, career prospects, non salary benefits and work life benefits; and qualification component are tested for differences by groups. groups comprised of students with each major in specific combinations. hypothesis e, which relates to the relationships between internal career anchor interests and external career factors, is tested using an associative measure. 6 discussion of the findings in relation to the hypotheses the results are discussed in relation to the ‘internal’ and ‘external’ factor hypotheses. the ‘internal’ factor hypotheses are discussed first, followed by the external hypotheses. 6.1 discussion of the findings in relation to the ‘internal’ hypotheses h0a: there is no significant difference between perceptions of aptitude by major academic field subject choice. table 3 presents significant mann-whitney u test associations between perceptions of aptitude endowments and interest anchors on major subject choice sajems ns 16 (2013) no 3: 244-257 251 t a b l e 3 mann-whitney u test statistics: differences between self-perception internal factors of; financial interest career anchor, interest in the job itself career anchor, in contribution to society career anchor, numerical aptitude, verbal aptitude and spacial aptitude by major subject choice is mktng fin mgt ir hrm financial interest anchor interest in job itself anchor 1549** interest in contribution society 1950* aptitudenumerical -1339* 2599** aptitudeverbal 2003* aptitudespacial notes: significance p<0.10^; p<0.05*; p<0.01**; p<0.001***. abbreviations used for this and other tables: information systems (is); marketing (mktng); finance (fin); management (mgt); insurance and risk (ir); human resources management (hrm). with regard to hypothesis h0a the mannwhitney tests indicate that individuals choosing marketing as a major subject have relatively lower self-perceptions of numerical aptitude (table 3). the reverse is found for finance and economics. and hrm majors hold higher self-perceptions of verbal aptitude. these results are unsurprising given the more quantitative focus of the finance and economics curricula and the verbal focus of the hrm curriculum. self-perceptions of spacial aptitude are not significantly associated with any major subject choice. gottfredson’s (1991) argument supports these findings since career choices are adjusted on self-assessments of fit between aptitudes and specific career demands. on the basis of the ‘minimum criterion’, the null hypothesis is rejected and the alternative hypothesis is accepted. hob: there is a significant difference between career anchor interests by major academic field subject choice. table 3 indicates that no significant association was found between financial orientation and choice of major subject. this was surprising, as extrinsic (financial) motivation was expected to influence career choice. it may be that a security/stability aspect to students studying business science majors is more evident than purely financial because the current high levels of unemployment emphasise security and stability of employment rather than pure financial reward. this is taken to support gottfredson’s (1981) basic idea of career negotiation in response to changing circumstances. schein’s (1996) argument that an individual’s goals, underpinned by an individual’s core career anchor, will become the strongest influence upon his/her career decisions, and over time may also be evident as many current students appear to look to degree qualifications as a ticket out of their impoverished socioeconomic backgrounds. the only significant association between job-related interest and the choice of a major subject is found to be with is (table 3). this indicates that interest in is may be a fundamental driver of this particular career choice. the absence of significance between interests and the other major subject choices suggests that such choices are not primarily made on the basis of job interest. these findings seem to indicate, in line with gottfredson (1981) that perceptions of core career related differences are more strongly associated with academic major subject choice than with job interest per se. table 3 also indicates that community interest (contribution to society) is associated with hrm as a major subject, which supports schein’s (1996) sense of service or dedication to a cause career anchor. thus, although most evidence appears to support gottfredson’s (1981) notion of gradual adjustment and negotiation of appropriate careers over time, for hrm majors there seems to be an underlying career anchor guiding individuals to select this specialisation. on the basis of the ‘minimum criterion’, the null hypothesis is rejected and the alternative hypothesis is accepted. 6.2 discussion of the findings in relation to the ‘external’ hypotheses h0c: there is no significant difference between 252 sajems ns 16 (2013) no 3: 244-257 perceptions of external career factors by major academic field subject choice. table 4 indicates hypothesis h0c, which is discussed in terms of the ‘external’ dimensions of: job prospects, future earning potential, career prospects. non-salary benefits and work-life balance aspects of this hypothesis are discussed in relation to the mann-whitney test findings displayed in table 5. t a b l e 4 mann-whitney u test statistics: differences between external factors of: perceived job prospects; earning potential and career prospects by major subject choice notes: significance p<0.10^; p<0.05*; p<0.01**; p<0.001*** job prospects mann-whitney test results, as indicated in table 4, suggest a general correspondence between the external factor component perceptions of job prospects and the choice of each major subject, except management and insurance & risk management. the latter were, however, found to indicate higher perceptions of job prospects for finance. economics as a major subject was included in certain of the analyses in order to gain further insight into extant relationships. marketing students perceived insurance & risk to offer fewer job prospects. students with economics as a major were found to perceive that is and hrm offer less in terms of job prospects. thus, the statistically significant associations between the perceptions students have of job prospects and their major subject choices appear to support gottfredson’s (1981) theory. all business science major students, with the exception of management, exhibit a statistically significant association between perceptions of job prospects in their field and their choice of a major subject associated with such a field. a possible reason for this exception, is that management is a more generic skill that does not qualify an individual for a specific professional role. future earnings potential the perceptions of students with economics and psychology as major subjects were included for completeness. individuals with economics majors perceived is, marketing and hrm to have relatively low earning potential. is, marketing and hrm majors perceived their career streams to offer relatively high earning potential. however, finance, management and ir majors were not significantly associated with perceptions of higher relative career earning potential. psychology majors also perceived hrm as a high earning potential career stream. these results are taken to give general support to variables is mktng fin mgt ir hr job prospects (jp) jp information systems. 1467** jp marketing 2272*** jp finance 2332* jp management -1457* jp human resources .341*** jp insurance & risk -1166* earnings potential (ep) ep information systems 1355* ep marketing 2310*** ep human resources 2017** career prospects (cp) cp information sys. 1552*** cp marketing 2335*** -1347* cp management 2411* cp human resources 2015** sajems ns 16 (2013) no 3: 244-257 253 gottfredson’s (1981) hypothesis; that the process of confronting career perceptions leads to adjustments in career choices. career prospects career prospects typically relate to a broader range of work opportunities than do job prospects. it is expected that the core career anchor of an individual will emerge more strongly over time (schein, 1996). certain major subjects maybe perceived to provide more long-term opportunities for certain students. mann-whitney test results (table 4) show that is, marketing, management, and hrm majors each perceived their career prospects to be relatively high. gottfredson’s (1981) hypothesis seems to be supported in these findings as the majority of subject majors are significantly associated with perceptions of specific career prospects. table 5 indicates the findings relating to non-salary benefits and work/life balance external factors pertaining to hypothesis h0c. t a b l e 5 mann-whitney u test statistics: differences in external factors of nonsalary benefits and work life balance by major subject choice. is mktng fin mgt ir hr non salary benefits (nsb) nsb information systems 1442** nsb marketing 1185* -2031* nsb finance -1050* nsb hr .1860* work life balance (wlb) wlb marketing -1039* notes: significance p<0.10^; p<0.05*; p<0.01**; p<0.001*** non salary work benefits individuals with is, marketing and hrm are found to have perceptions of high non-salary benefits associated with their career streams (table 5). of the non business science students, economics majors perceived marketing to have relatively lower levels of non-salary benefits. these significant associations are also taken to support gottfredson’s (1981) hypothesis. work-life balance hrm majors perceive lower levels of work life balance to be associated with a career in marketing (table 5). there is little evidence suggesting that students adjust their goals and choose subject majors on the basis of work-life balance (gottfredson, 1981). on the basis of these significant associations, the null hypothesis is rejected and gottfredson’s (1981) hypothesis of dynamic career adjustment is supported. h0d: there is no significant difference between perceptions of the relative merit of the academic programme by major academic field subject choice. table 6 shows the findings of mann-whitney tests relating to hypothesis h0d t a b l e 6 mann-whitney u test statistics: differences between perceptions of the relative merit of the academic programme by major subject choice. is mktng fin mgt ir hr hrm curriculum -714** 1537*** hr qualification status -716** 1406** school status -764* notes: significance p<0.10^; p<0.05*; p<0.01**; p<0.001*** 254 sajems ns 16 (2013) no 3: 244-257 table 6 indicates that hrm majors perceived the status of the university’s hrm qualifycation and curriculum content positively. management majors, however, perceived the opposite. economics majors perceived the hrm curriculum negatively while psychology majors perceived it positively. is majors had lower perceptions of the school’s status as a whole. thus the null hypothesis is rejected. h0e: there is no significant association between perceptions of ‘external’ career perceptions and ‘internal’ career job interest career anchors. this hypothesis was derived from the third research question: what career perceptions are associated with specific job interest anchors? it relates to both internal and external factor dimensions. table 7 indicates the findings relating to this hypothesis. t a b l e 7 kendall’s tau correlations: associations between career interest orientation anchors and job prospects, earning potential and qualification status variables financial/salary job itself community/service job prospects (jp) jp information systems .158* .164* earning potential (ep) ep information systems .175* ep human resources management .212* ep insurance and risk -.140* career prospects (cp) cp information systems -.151* .200** cp marketing cp management cp human resources management .244*** .142* cp insurance and risk -.151* interest in job itself .310*** interest in financials .132* hrm qualification status .190* notes: significance p<0.10^; p<0.05*; p<0.01**; p<0.001*** table 7 shows that students with a financial job interest have lower perceptions of the earning potential of ir and the career potential of is and ir. a financial job interest is not found to be associated with any particular aptitude, nor any positive perception of careermajor associations. an interest with the job itself is positively related to perceptions of higher job prospects in is and a higher earning potential as well as career prospects in hrm. community service orientation is associated with perceptions of higher job, career and earning prospects for is, and higher career prospects for hrm. a community service orientation was found to be positively associated with an interest in the job itself and the hrm, and negatively associated with a financial interest orientation. the central concern of individuals with a financial job interest seems to be framed negatively with regard to the earning prospects and career prospects of other fields. this may reflect some aspect of the associations between career perceptions and value orientation (schwartz, 1992). individuals with a job interest and community service orientation are positively and primarily focused on is and hrm respectively. this suggests a congruency of values between these majors and the values of service and job interest as career anchors. congruence between individual needs or interests and job characteristics is expected to result in greater job involvement (govender & perumasur, 2010). in general, gottfredson’s (1981) thesis is supported by these findings. on the basis of these results the null hypothesis is rejected and the alternative hypothesis is accepted. sajems ns 16 (2013) no 3: 244-257 255 on the basis of the results of the tested hypotheses, students’ perceptions of career prospects and earning potential appear to dominate the underlying interest in the job itself and of specific major-career associations. 7 conclusion the findings tentatively suggest that consonance in the scores of tests to establish the perceptions of real job aspects of careers by majors across the board support gottfredson’s (1981) hypothesis of progressively negotiated career anchors. the almost total absence of dissonance between perceived aptitudes and major subjecst chosen contests swanson and tokar’s (1991) notion of choosing a career as a ‘challenge’ rather than as a dynamic and negotiated adjustment over time. students who chose hrm as a major, in particular appear to have career aspirations most aligned with internal personal factors relating to self perceptions of aptitudes, values and interests. finance majors perceived the career prospects of other majors negatively. job interest and service were found to frame perceptions positively among is and hrm majors. in terms of external factors, the findings suggest that self perceptions of aptitudes underpinning particular academic major choices are broadly consonant with the perceptions of job prospects, earning potential, career prospects, non salary work benefits, and work life balance perceptions of specific careers. and, perceptions of aptitudes appear to be particularly important in major/career selection. in general, the evidence supports gottfredson’s (1981) hypothesis that self-perceptions generate adjustments in the selection of particular careers. schein’s (1996) evolutionary perspective of a process of negotiation and discovery of core career anchors is thus vicariously supported by the findings. in very general terms, the findings suggest that students select majors that underpin particular business careers on the basis of perceived aptitudes; perceived job, earning and career prospects and,; more tentatively, the career anchors of security/stability (finance, economics, insurance & risk management, marketing), technical/functional competence (is and management), entrepreneurial creativity (management) and service/dedication to a cause (hrm). students selecting finance, as well as economics and insurance & risk management appear to have security and stability anchors, possibly arising from specific socio-economic circumstances and the prevailing high unemployment rate in south africa. these potentially financially rewarding specialisations are chosen by students to find a way out of the precarious socio-economic conditions many of them currently face. this is an overriding goal that may subordinate personal interest in the job itself. those with lesser numerical and/or verbal aptitudes perhaps see their career objectives more in terms of interest in the job itself (is) and service/dedication to a cause. in an exploratory study of this type, there are bound to be limitations in the research process. in this case, perhaps the most prominent is that the study is limited to an investigation of business science majors at one university. the sample is also quite small and is not selected randomly from the population of business science students (although given its proportionate size, it seems reasonable to consider it representative of that population). the study is cross sectional and is thus limited to perceptions of students at one point in time. a longitudinal cohort analysis of student career aspirations on the basis of particular selfperceptions and changing market and/or institutional factors would present more powerful empirical evidence for testing gottfredson’s (1981) theory of circumscription. the study is restricted to the use of exploratory type statistical procedures involving exploratory factor and item analyses to test the validity and reliability of the measuring instruments. the empirical data analysis also adopts statistical techniques that aim to expose underlying associations between the selected variables defined by the hypotheses, thus necessitating a number of exploratory initial hypotheses. the establishment of the particular associations discovered in the analyses enhance the possibility of generating a model that has an empirically verified structure defined by more refined statistical techniques, such as those provided by structural equation modeling. 256 sajems ns 16 (2013) no 3: 244-257 the exploratory findings also suggest that further research could fruitfully be applied to an analysis of the mechanisms of nascent career choice by university students selecting particular business science and other majors at other universities. this may best be conducted using a structural equation statistical analysis built from the basic model provided in the current exploratory analysis. moreover, a longitudinal rather than a cross sectional analysis could be used to plot students’ career negotiation processes as they unfold. possible outcomes of such research would include aiding students in selecting appropriate careers by studying majors more in line with internal personal interests and attributes than external market and/or institutional factors; 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accepted: 16 sept. 2020; published: 09 dec. 2020 copyright: © 2020. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: a review of the literature revealed that the demanding and often challenging nature of work increases the turnover intention of employees. this trend is especially evident within the south african financial services industry. aim: the research goal was to explore and empirically test a theoretical model identifying the most salient causes of turnover intention among sales employees employed by financial organisations operating in the south african financial service industry. setting: the study was conducted on employees operating within the financial service industry in south africa. methods: the current study collected quantitative data from 102 employees of insurance or banking or investment companies, using a web-based compilation of standardised questionnaires. this followed a previous study by the research group that collected quantitative and qualitative data from 122 employees operating in an insurance environment, using a combination of an open-ended questionnaire and standardised instruments. results: the results of the current study confirmed the significance of the paths between turnover intention and employee engagement, time wasted on non-core activities, perceived career development opportunities, and perceived supervisor support, mediated by perceived employee engagement. conclusion: a replication of this study using a longitudinal research design is recommended in order to overcome the methodological limitations of the current study. the conceptual model developed in this study identified relationships that could be used as guidelines to effectively manage the retention of personal financial advisors in the financial service industry in south africa keywords: intention to quit; personal resources; job resources; personal financial advisors; south africa. introduction the financial services industry is one of the most important sectors in the world, as it contributes positively to society and the economy through the improvement of economic development. economic development results in and drives economic growth, which contributes to several economic and social benefits. these benefits include, among others, lower unemployment, higher levels of income, higher standard of living, less poverty, less inequality, more business confidence, and improved public services (sutton & jenkins 2007). it is, however, also evident that the financial sector faces several challenges, of which one is the ability to retain successful personal financial advisors (pfas)1 – the key players in this sector (compdata surveys 2014). adding to this problem is the phenomenon that not enough new sales professionals are entering the financial sector to replace those pfas that have left (van tonder 2011). the decision to leave the employment of an organisation is not the outcome of some random event. rather employees’ decision to resign from their current employment is determined by a complex nomological network of latent variables characterising the employee and the environment in which they operate. in order to proactively and reactively deal with these challenges, organisations need to understand what the factors are that influence successful pfas’ intention to quit (firth et al. 2004; martin 2011), as well as discourage potentially successful pfas from entering the sector. intention to quit, according to basak et al. (2013), can be defined as a conscious and deliberate wilfulness to leave the organisation. this means that intention to quit is the process preceding the actual quitting. according to the theory of reasoned action (ajzen 2012), people’s actions are determined by their intention to act in a specific way. this implies that before an individual does something, they go through a process of thinking about it first. thus, in order to influence people’s behaviour, one needs to understand what influences their intention to express that specific behaviour (basak et al. 2013). according to van der westhuizen (2014), previous studies have placed strong emphasis on the role of organisational factors (i.e., characteristics of the employee’s job) as factors that influence the employees’ level of internal motivation, satisfaction, performance and turnover intention. job characteristics consistently linked to turnover intention are referred to as job demands and job resources. moreover, factors intrinsic to the employee that may influence their intention to quit were also identified. these factors are known as the employee’s personal resources, which include, among others, self-efficacy, resilience, hope and optimism. (basak et al. 2013; firth et al. 2004; martin 2011; van der westhuizen 2014). to address the challenge of high levels of turnover among pfas, managers, especially human resource (hr) managers, need to examine their employees’ intention to quit and the factors that influence it. this should empower organisations to launch a proactive preventative retention strategy, based on their findings, that may reduce the intention to quit among successful pfas and increase organisational success over the long term. rationale for the current study this study was thus focused on investigating the causes of turnover intention among sales employees employed by organisations operating in the south african financial industry. the current study follows a previous study by van tonder (2011) wherein a composite questionnaire consisting of a compilation of open-ended questions, a self-generated questionnaire, as well as five existing psychometric instruments, was sent out to a convenience sample of 608 pfas from one insurance sales organisation. one hundred and twenty-two (122) respondents completed and returned their questionnaires. the focus of the study was on identifying the non-remuneration predictors of burnout and intention to quit. the selected constructs of interest that were theoretically inferred from literature and informed by informal personal feedback were emotional labour, self-efficacy, time wasted on non-sales activities, supervisor support, and their relationship with burnout and intention to quit. the psychometric instruments used were the emotional labour scale (brotheridge & lee 2003), the 12-item version of the general self-efficacy scale (woodruff & cashman 1993), a self-generated questionnaire to assess time wasted on non-sales activities (van tonder 2011), an adapted version of the survey of perceived organisational support (eisenberger et al. 1986), the copenhagen burnout inventory (kristensen et al. 2005), and the intention to quit questionnaire by deconnick and stillwell (2004). the results indicated that the psychometric properties of the instruments utilised to measure the constructs of interest were satisfactory. the goodness of fit of the structural model was found to be outstanding and the lisrel path coefficients indicated that the paths between self-efficacy and burnout, supervisor support and time wasted, burnout and intention to quit, and time wasted and burnout were significant. these results were supported by a subsequent partial least squares (pls) path analysis, with the following significant path coefficients: self-efficacy and burnout −0.32; supervisor support and time wasted −0.22; burnout and intention to quit 0.50; time wasted and burnout −0.31. the amount of variance explained in intention to quit was, however, only 25 %, which left quite a lot of variance unexplained. these findings were further explicated by best-subsets multiple regression analyses that identified time wasted and self-efficacy (effort) as the strongest predictors of work burnout (subscale of burnout). self-efficacy (effort) refers to the willingness to expend effort in completing the behaviour (van tonder 2011). contrary to expectations, effort had a negative relationship with work burnout. the same pattern emerged in the case of client burnout. when intention to quit was used as the dependent variable, the four strongest predictors were time wasted, supervisor support, self-efficacy (initiative) and self-efficacy (effort). self-efficacy (initiative) refers to the willingness to initiate behaviour (van tonder 2011). the relationships between both supervisor support and self-efficacy (effort) and intention to quit were notably negative. supervisor support can therefore be interpreted as a deterrent of intention to quit, while the willingness to expend effort towards the completion of the task at hand was also negatively related to intention to quit. the findings of the qualitative questionnaire about the factors that the pfas regarded as predictive of the intention to quit among their peers are summarised in table 1. table 1: factors that the personal financial advisors regarded as predictive of the intention to quit among their peers. research objectives it is against this background that the research question for the current study was formulated as: what are the causes of turnover intention among sales employees of financial organisations operating in the south african financial service industry? the following objectives were formulated: to propose an explanatory model of variables influencing intention to quit. to empirically determine the relationships between the identified variables and intention to quit. to make recommendations to human resources and senior management about how they can shape their human resource policies and practices to retain employees and reduce intention to quit among sales employees of financial organisations operating in the south african financial service industry. literature review this literature review was informed by the earlier research of van tonder (2011) and focused on the role of selected factors influencing employees’ intention to quit, namely job demands, job resources and personal resources, as these factors have been found to relate to intention to quit (de cuyper et al. 2011; schaufeli & taris 2014; schreurs et al. 2011; van der westhuizen 2014; van tonder 2011; xanthopoulou et al. 2007). research has also indicated that the relationship between job demands, job resources, and intention to quit tends to be indirect in nature and thus mediated by various factors. employee engagement is a specific job attitude that will be of interest in this study as it has been found to act as a mediating factor between job demands, job resources and intention to quit (saks 2006; shuck, reio & rocco 2011; van der westhuizen 2014). employee engagement in the current study employee engagement and burnout were treated as opposite poles of two continua, labelled energy (vigour-exhaustion) and identification (dedication-cynicism) (du plooy & roodt 2010). engagement was defined as ‘a high level of energy and strong identification with one’s work’ characterising the employee’s mindset with vigour (high levels of energy and mental resilience while working) and dedication (high levels of involvement in one’s work, and experiencing a sense of significance in one’s work), while burnout was defined as the opposite: ‘a low level of energy combined with poor identification with one’s work’ where the employee’s mindset is characterised by exhaustion (high level of tiredness) and cynicism (an attitude of pessimism and disillusionment) (du plooy & roodt 2010; schaufeli & bakker 2003:5). according to research, engagement is negatively related to intention to quit, which means that when employees are engaged, they are less likely to experience turnover intentions and ultimately less likely to engage in actual turnover behaviour. (berry 2010; coetzer & rothmann 2005; du plooy & roodt 2010; halbesleben 2010). it can therefore be proposed that: proposition 1: employee engagement has a negative impact on turnover intention. the current researchers further hypothesise that employee engagement serves as a mediator between the respective job demands, job resources and intention to quit, as the level of job demands or availability of job resources can influence the extent to which employees’ experience an attachment to, identification with, involvement in and dedication to their work. in the following sections the influence of engagement on job demands, job resources and intention to quit will be discussed. in addition, the role of personal resources will also be discussed in terms of how it influences intention to quit as a moderator. job demands job demands, also referred to as role stressors, can be defined as those physical, psychological, social or organisational aspects of a job that require sustained physical or psychological effort (bakker, demerouti & schaufeli 2003). job demands are thus known as those work-related tasks that require effort to ensure that one performs these work tasks effectively (bakker & geurts 2004; rothmann, mostert & strydom 2006; van der westhuizen 2014). in this study, the job demands of interest are emotional labour and time wasted on non-core activities, as it has been found to influence service-related employees’ (such as sales employees) turnover intention (chau et al. 2009; halbesleben & wheeler 2008; jaramillo, mulki & locander 2006). time wasted on non-core activities in an insurance sales environment was also found to be a significant predictor of intention to quit in the van tonder (2011) study. emotional labour and intention to quit emotional labour (el) can be referred to as the regulation of feelings and expressions at work (chau et al. 2009; grandey 2000; halbesleben & wheeler 2008). emotional labour has been described as a form of emotional management and can be conceptualised in terms of two emotional management strategies. the first strategy is known as surface acting, according to which an employee temporarily suppresses or masks a job-incongruent ‘true’ emotion (i.e. an employee is angry at a demanding client) and express a job-congruent emotion (i.e. smiling at, or talking calmly to the demanding client). the second strategy is known as deep acting, where an employee modifies emotions to match that which is required by the organisation. researchers have empirically shown that surface acting is commonly associated with negative outcomes, such as personal inauthenticity, lower ratings of effective delivery, depersonalisation, emotional exhaustion and dissatisfaction, since it is solely focused on modifying the emotional response rather than the ‘true’ internal emotions. in contrast, deep acting, aiming to modify truly felt internal feelings, has been found to result in positive outcomes, such as personal authenticity, personal accomplishment, lower likelihood of revealing negative emotions and enhanced job satisfaction and performance (brotheridge & grandey 2002; brotheridge & lee 2002; gosserand 2003; grandey 2000, 2003; grandey et al. 2005; grandey, fisk & steiner 2005; totterdell & holman 2003). available evidence indicates that there exists a relationship between el, burnout and intention to quit (kleemann & matuschek 2002; van der westhuizen 2014; van tonder 2011; visser & rothmann 2009). the current researchers hypothesise that when employees engage in el and are required to act in a certain way that prevents them from being their ‘true’ selves, they could find it difficult to identify with the job, as the job requires them to act and be different from what and who they truly are. this could then result in a loss of interest in and dedication towards the job (bakker et al. 2008; schaufeli & bakker 2003). it can therefore be proposed that: proposition 2: surface acting has a positive impact on turnover intention. proposition 3: surface acting has a negative impact on employee engagement. proposition 4: the relationship between surface acting and turnover intention is mediated by engagement. however, deep acting, on the other hand, has been found to be positively related to employee engagement as it is focused on changing the ‘true’ emotions, rather than modifying the emotional response. research suggests that changing one’s ‘true’ emotions, rather than modifying the emotional response, can reduce job strain, as it assists one in expressing what you truly feel in a manner that is aligned with organisational expectations (de villiers 2015). under these circumstances, employees would most likely be motivated to engage in adaptive work behaviour, such as engagement (saks 2006). it could therefore be proposed that: proposition 5: deep acting has a negative impact on turnover intention. proposition 6: deep acting has a positive impact on employee engagement. proposition 7: the relationship between deep acting and turnover intention is mediated by engagement. time wasted on non-core activities and intention to quit non-core activities among sales employees include all duties that are not related to sales performance (van tonder 2011). time wasted is a concept that refers to the employee’s perception about the time and effort they spend on self-perceived fruitless tasks that do not contribute to how effective and successful the employee is in performing their job (jaramillo et al. 2006). according to van tonder (2011) activities that have been frequently identified as time-wasting activities include preparing paperwork and reports, engaging in non-sales-related tasks and attending meetings. according to low et al. (2001), and narayanan, menon and spector (1999), sales employees who perceive their time and efforts as wasted on non-core activities, that do not involve sale duties, are more likely to experience turnover intentions compared to those sales employees that primarily perform sales duties. the rationale behind this argument is that they may feel that their time and effort is spent on futile tasks that prevent them from effectively performing in their required jobs. (allen, shore & griffeth 2003; halbesleben 2010; koyuncu, burke & fiksenbaum 2006; saks 2006; wefald et al. 2008). it can therefore be proposed that: proposition 8: time wasted on non-core tasks has a positive impact on turnover intention. proposition 9: time wasted on non-core tasks has a negative impact on employee engagement. proposition 10: the relationship between time wasted on non-core tasks and turnover intention is mediated by engagement. job resources job resources refer to the ‘physical, psychological, social or organisational aspects of the work context that: (1) can reduce the health-impairing impact of job demands, (2) are functional in achieving work goals and (3) stimulate personal growth, development and learning’ (van den broeck et al. 2008:278). in a substantial number of research studies three specific job resources that have been found to influence service-related employees’ (such as sales employees) turnover intention are perceived career development opportunities, supervisor support and satisfaction with pay (basak et al. 2013; carraher 2011; maertz et al. 2007; newman, tanacoody & hui 2012; rhoades & eisenberger 2002; van tonder 2011). perceived career development opportunities and intention to quit career development is a structured and formalised act to achieve equivalence between an employee’s career needs and the organisational requirements for the workforce (lips-wiersma & hall 2007). the aim of career development interventions is to assist employees in their career growth, development and learning in a manner that will benefit both the employee and the organisation. employees who perceive their organisation as providing them with career growth opportunities are likely to feel that the organisation cares for and values the development of its employees (riketta 2002; wayne, shore & liden 1997). in accordance with the social exchange theory, the current researchers believe that these perceptions create a sense of obligation or normative commitment to stay with the organisation, to care about the organisation’s future goals, and to extend self-effort in achieving these goals (foong-ming 2008). it can therefore be proposed that: proposition 11: perceived career development opportunities has a negative impact on turnover intention. proposition 12: perceived career development opportunities has a positive impact on employee engagement. proposition 13: the relationship between perceived career development opportunities and turnover intention is mediated by engagement. perceived supervisor support and intention to quit perceived supervisor support can be defined as employees’ overall beliefs about the extent to which the supervisor cares about their well-being and socio-emotional needs and values their contributions (basak et al. 2013; van tonder 2011). supervisor support helps employees to be effective in their job because it can assist employees to: (1) reduce the negative consequences associated with job demands, (2) achieve their work goals and (3) facilitate learning, growth and development, which contribute to the employee’s overall effectiveness. research found that when employees experience a sense of supervisor support, they will display a strong sense of belonging to the organisation and are less likely to experience feelings of entrapment in the organisation. as a result, employees will experience a sense of obligation or normative commitment to care for the well-being and development of the organisation, which will likely result in the employee exhibiting a higher sense of attachment to, identification with, involvement in and dedication to the organisation (basak et al. 2013; gentry et al. 2007; newman et al. 2012). as a consequence, these employees will also be less prone to develop turnover intentions, as they believe the organisation cares about their well-being and values their contributions (allen et al. 2003; halbesleben 2010; koyuncu et al. 2006; saks 2006; wefald et al. 2008). in the van tonder (2011) study perceived supervisor support was also identified as a significant negative antecedent of intention to quit. it can therefore be proposed that: proposition 14: perceived supervisor support has a negative impact on turnover intention. proposition 15: perceived supervisor support has a positive impact on employee engagement. proposition 16: the relationship between perceived supervisor support and turnover intention is mediated by engagement. satisfaction with pay and intention to quit satisfaction with one’s pay refers to the degree to which one is satisfied with the process and level of direct or indirect monetary rewards received for the work and the effort that one exhibits (currall et al. 2005; summers & hendrix 1991; westlunds & hannan 2008; williams, mcdaniel & nguyen 2006). in other words, pay satisfaction may be defined as the ‘amount of overall positive affect (or feelings) employees have toward pay’ (faulk 2002:1). the current researchers hypothesise that when employees are satisfied with the process and level of direct or indirect monetary rewards received, it can be anticipated that these employees will feel valued by the company, feel more engaged in their job and as a result tend to be discouraged from developing turnover intentions (currall et al. 2005; williams et al. 2006). these employees can be expected to develop a sense of attachment to, involvement in and dedication to the organisation as a result of their inferences about being valued and appreciated, and could be described as engaged (bakker et al. 2008; schaufeli & bakker 2003, 2004). such employees would typically be less prone to develop turnover intentions and thus less prone to engage in actual turnover behaviour (saks 2006; van der westhuizen 2014). although satisfaction with remuneration and benefits was not investigated empirically in the van tonder (2011) study, it was identified as an important antecedent of the intention to quit among pfas in 35% of the responses in the qualitative part of the study. therefore, the following can be proposed: proposition 17: satisfaction with pay has a negative impact on turnover intention. proposition 18: satisfaction with pay has a positive impact on employee engagement. proposition 19: the relationship between satisfaction with pay and turnover intention is mediated by engagement. personal resources the construct ‘personal resources’ has been defined as the ‘psychological characteristics or aspects of the self that are commonly associated with resiliency and that refer to the ability to control and impact one’s environment successfully’ (schaufeli & taris 2014:49). according to research, personal resources, like job resources, can assist employees to: (1) reduce the negative consequences associated with job demands, (2) achieve their work goals and (3) facilitate learning, growth and development, which contribute to employees’ overall effectiveness. this implies that personal resources have the potential to alleviate the negative effects of job demands on burnout and increase the positive effects of job resources on engagement (van den broeck et al. 2011). personal resources that have been explored are self-efficacy, optimism, hope and resilience. in previous research these four personal resources have been clustered to serve as a composite construct, which is commonly referred to as psychological capital (psycap). psycap is defined as: … an individual’s positive psychological state of development and is characterised by: (1) having confidence to take on and put in the necessary effort to succeed at challenging tasks (self-efficacy) – thus believing in one’s ability to succeed in a given task; (2) making a positive attribution about succeeding now and in the future (optimism); (3) persevering toward goals and, when necessary, redirecting paths to goals in order to succeed (hope); and (4) when beset by problems and adversity, sustaining and bouncing back and even beyond to attain success (resilience). (luthans, youssef & avolio 2007:3) psycap has been found to: ‘(1) reduce the health-impairing impact of job demands, (2) are functional in achieving work goals and (3) stimulate personal growth, development and learning’ (van den broeck et al. 2008:278). various authors have also reported a strong relationship between psycap and engagement (simons & buitendach 2013; youssef & luthans 2007). the following could therefore be proposed: proposition 20: psycap has a positive impact on employee engagement. according to the current researchers, the negative effect of the job demands of emotional labour and time wasted on engagement is less pronounced when psycap is high than when psycap is low. employees who possess high levels of psycap but have to engage with job demands, will remain engaged in their job as they have the necessary personal resources to perform the job successfully. it can thus be proposed that: proposition 21: the relationship between surface acting and employee engagement is moderated by psycap. proposition 22: the relationship between deep acting and employee engagement is moderated by psycap proposition 23: the relationship between time wasted on non-core activities and employee engagement is moderated by psycap. brenninkmeijer et al. (2010) has produced evidence in a longitudinal study that personal resources enhance the positive effect of job resources on employee engagement. it can thus be proposed that: proposition 24: the relationship between perceived career development opportunities and employee engagement is moderated by psycap. proposition 25: the relationship between perceived supervisor support and employee engagement is moderated by psycap. proposition 26: the relationship between satisfaction with pay and employee engagement is moderated by psycap. the literature review presented an overview of the relevant literature and integrated it with the current researchers’ logical reasoning about the antecedents of variance in turnover intention. the extended job-demands resources model served as the guiding framework to understand and identify the antecedents of turnover intention among sales employees employed by financial organisations operating in the south african financial services industry. this section also presented the various research propositions highlighting the interrelationships between latent variables of interest (job demands – emotional labour and time wasted on non-core activities; job resources – perceived career development opportunities, perceived supervisor support and satisfaction with pay; personal resources – psycap; turnover intention). the next section will present the methodology that was used to evaluate these propositions. research methodology in the current study, an ex post facto correlational design was used to test the formulated propositions. quantitative data were collected from 102 employees employed by financial firms operating in the south african financial services industry. a self-administered web-based questionnaire was distributed electronically to the participants. participation was voluntary and the data collected were strictly confidential and anonymous. the questionnaire comprised eight sections. the questionnaire included a cover letter, the consent form and a biographic information section. subsequent sections measured specific latent variables using valid and reliable measuring instruments. pay satisfaction was measured by means of the pay satisfaction scale (18 items) (heneman & schwab 1985), psycap by the psychological capital scale (24 items) (luthans et al. 2007), engagement by the utrecht work engagement scale (9 items) (richardsen, burke & martinussen 2006), perceived career development opportunities by an adapted scale (15 items) combining the advancement and growth opportunities subscales of the job demands-resources scale (rothmann & jordaan 2006), time wasted on non-core activities by the bern illegitimate tasks scale (8 items) (semmer et al. 2015), surface acting and deep acting by the appropriate subscales of the emotional labour scale (3 items each) (brotheridge & lee 2003), perceived supervisor support by the survey of perceived supervisor support (8 items) (eisenberger et al. 1986), and intention to quit by the intention to quit scale (4 items) (oehley 2007). the data were subjected to a range of statistical analyses, which included item analysis and pls-structural equation modelling (pls-sem) analyses of the outer (measurement) and inner (structural) models. pls-sem analysis is a variance-based non-parametric structural equation technique that explains the variance in dependent variables and is primarily used to test theories in exploratory research (hair et al. 2014). it is predominantly used to predict target constructs, or identify driver constructs, in complex models with small sample sizes (hair et al. 2014). ethical consideration this study was granted ethical clearance by the stellenbosch university research ethics committee: human research (humanities), with ethical clearance number: su-hsd-001192, dated 26 october 2015. discussion the demographic characteristics of the sample of respondents, such as age, gender, education level and length of service, are presented in table 2. the total sample consisted of 102 pfas. table 2: demographic characteristics of respondents. the sample was thus predominantly younger, male respondents with matric as their educational level, and with 1 to 3 years of employment. item analysis an item analysis was performed to provide insight into the functioning of each of the latent variable scales included in the self-administered web-based survey, and to establish the psychometric integrity of the indicator variables assigned to represent the latent variables. the results of the item analysis provided sufficient evidence to support the instruments listed in the research methodology section. each latent variable scale was found to be internally consistent and reliable. the different alpha coefficients were exceptionally high, while all the item-total correlations exceeded the criterion value for satisfactory item-total correlations of 0.40 (murphy & davidshofer 2005). the average variance extracted (ave) scores in table 3 also provide support for the convergent validity of the constructs, as they all explain more than 50% of the variance in the indicators (hair et al. 2014). the results are presented in table 3. table 3: reliability and average variance extracted scores for the outer (measurement) model. evaluation of the path coefficients in the inner (structural) model the pls output, in the form of the variance inflation factors, indicated that there was no multicollinearity between the variables. the path coefficients indicate the strength, significance and direction of the relationships proposed in figure 1. statistically significant path coefficients (with zero not falling within the 95% confidence interval) were observed between engagement and intention to quit (pls path coefficient = −0.37), time wasted on non-core activities and intention to quit (0.27), perceived career development opportunities and intention to quit (−0.20), perceived career development opportunities and engagement (0.33), perceived supervisor support and engagement (0.31), and psycap and engagement (0.30). figure 1: inner (structural) model with path coefficients. the moderation propositions were evaluated by creating interaction terms involving the antecedent and the moderator and evaluating the resulting path coefficient between the interaction term and intention to quit. the finding that the path between time wasted on non-core activities and engagement was moderated by psycap (0.22), indicating that when employees who possess a higher level of psycap are faced with high job demands, like a significant amount of time spent on futile tasks, they remain engaged in their job as they have the necessary personal resources to perform the job successfully. the mediating effect of engagement on the relationship between career development opportunities and intention to quit (proposition 13) was not fully supported, as only a partial mediation was found, because the direct path between career development opportunities and intention to quit was also statistically significant. the mediation of the relationship between supervisor support and intention to quit was found to be fully mediated by engagement (proposition 16). figure 1 provides a graphic summary of the statistical results. the values shown on the lines between the latent variables are the path coefficients. the scores within the circles representing the endogenous variables display the r-squared values, which explain how much variance is explained in the endogenous variable by the exogenous variables impacting upon it. it should be noted that the exogenous variables explained 68% of the variance in engagement and 65% in intention to quit, both of which are quite high in terms of social science research. managerial implications the literature review indicated that employees employed by financial organisations operating in the south african financial service industry display an elevated level of turnover intention. it is therefore incumbent upon south african industrial psychologists and managers to develop and implement interventions concentrating on the reduction of turnover intention or to prevent it from occurring. the following discussion will highlight those proposed relationships that have been empirically supported to launch interventions aimed at managing employee turnover intentions. employee engagement in terms of the job demands-resources model, both job demands and job resources can initiate employee engagement. thus, managers might consider providing employees with enough job resources and an optimal level of job demands to stimulate employee engagement (van der westhuizen 2014). managers should ensure that employees are provided with role clarity, autonomy in their job, continuous feedback about their performance, as well as with challenging tasks that create opportunities for learning, as this will foster employee engagement (bakker & demerouti 2007). van tonder (2011) has commented that relatively large-scale organisation development interventions aimed at combatting burnout, by improving the work circumstances of pfas and attending to their well-being, will reduce the intention to quit. she advocates focusing on the employee’s relationship with their job by changing their work patterns, developing coping skills and utilising their social resources for social support. secondly, she advocates fostering a healthy lifestyle, promoting self-knowledge and developing the employee’s resilience in order to overcome obstacles. time wasted on non-core tasks research suggests that managers should enhance sales employees’ belief that they engage in valuable and fruitful tasks that are not unnecessary and unreasonable. managers should ensure that most of the work sales employees engage in makes sense and is directly related to their role as sales employees (van tonder 2011). research also suggests that managers create opportunities for sales employees to redesign and craft their jobs to ensure they can organise their time around core activities (bakker & demerouti 2014). perceived career development opportunities bakker and demerouti (2014) argue that training interventions is a proactive strategy by management to ensure that employees are provided with opportunities to advance and grow within the organisation and within their profession. supervisors also play a critical role as they serve as a key party in influencing rewards, appraisals and career development practices in an organisation (foong-ming 2008; van tonder 2011). perceived supervisor support perceived supervisory support may alleviate the influence of a heavy workload and psychological strain since the supervisor’s appreciation and support can put demands in a different perspective, assist employees in coping with the job demands, and act as a facilitator of performance and engagement (väänänen et al. 2003). managers or supervisors should value the contribution of their employees and the impact of their work on the overall organisational well-being, by recognising their hard work and reinforcing work well done through both monetary (i.e. bonuses) and non-monetary rewards (i.e. a simple thank you as a sign of appreciation and promotions). lastly, it is also recommended that supervisors build a close working relationship with employees within which employees feel valued and cared for with regard to their development, well-being and socio-emotional needs (foong-ming 2008; van tonder 2011). psychological capital managers should consider determining the psycap status of applicants as a further criterion to ensure that the selected shortlist of potentially successful applicants is narrowed to those candidates that could be viewed as a safe investment in terms of the likelihood of a longer-term contractual engagement. it is also suggested that organisations invest in enhancing the personal resources of their employees. luthans et al. (2007) developed micro-interventions targeted at developing the psycap elements, namely hope, self-efficacy, resilience and optimism. they found that the interventions not only improved the employees’ psycap, but also had a positive impact on financial metrics, and a high return on investment. these micro-interventions are discussed briefly: hope: it is emphasised that employees need to set: (1) measurable goals and (2) sub-goals in order to identify small ‘wins’ on the way to achieving bigger goals. thereafter, individuals are tasked to develop several pathways to achieve their set goals based on the available resources and possible obstacles, and then to discard unrealistic pathways. by following this process people can be shown how to be accountable and responsible for their own gaols and contingency plans, even in the face of obstacles (luthans et al. 2007). self-efficacy: during the training, participants are given exercises that concentrate on modelling accomplishments and success, group role playing, producing positive emotions, and building participant confidence to produce and implement goals. the current researchers advise that managers of sales employees get involved in this training course in order to gain insight into how to facilitate the development of the self-efficacy of their subordinates (luthans et al. 2007). resilience: in this intervention employees are tasked to recognise recent personal setbacks within the workplace and then to reflect on their immediate reactions. employees are specifically led through a process of ideal resiliency in which they are tasked to think of factors that are both under and not under their control and possible actions that could have been taken regarding past incidences (luthans et al. 2007). optimism: this intervention generally focuses on the above-mentioned elements where facilitators prepare a ‘worst-case scenario’ exercise in which individuals are tasked to: (1) identify the worst possible outcome of a situation, (2) develop plans to take proactive action, (3) reinforce positive self-talk, and (4) develop realistic, yet optimistic, expectations about the future in order to counteract pessimism (luthans et al. 2007). limitations and suggestions for future research this study does have several limitations, although these limitations do not seem to detract significantly from the research findings discussed in the results section. the limitations and recommendations for future research are outlined here to ensure that further fruitful research is conducted in the field of industrial psychology in south africa. to begin with, although the researchers exhausted all options to ensure fruitful data collection, the limited size of the sample may cause some concern when considering generalisability, as well as the validity of the inferences made about pfas operating in the south african financial sector as a population. the sample size and the complexity of the theoretical model also limited the use of lisrel to test the structural model. the absence of significant relationships between some of the constructs, which proved to have significant relationships in other studies, could be due to the small sample size. it therefore is recommended that future studies attempt to procure a larger sample from a variety of financial firms. the second limitation of this study involved the self-report data collected by the measurement instruments. method bias is a weakness associated with self-report questionnaires. participants are able, to some extent, to respond in a way that would create a more positive and favourable impression of themselves. the exclusive use of self-report questionnaires in a study can artificially inflate the correlations between predictors (avey 2014). it would be advisable for future researchers to consider using objective measures for some latent variables. the researchers did take reasonable action to restrict the negative impact associated with self-report questionnaires. firstly, data collection was anonymous. secondly, to encourage authentic participation, none of the questions included in the self-administered web-based had a ‘right’ or ‘wrong’ answer. thirdly, item analysis was conducted to establish the psychometric integrity of the indicator variables assigned to represent the latent variables. the perceived confidentiality of the self-administered web-based survey could, however, be regarded as a further potential limitation of this study. even though individual participants were assured of confidentiality, it is possible that they mistrusted the confidentiality clause outlined in the informed consent document. as a result, this could have had a negative impact on the authenticity of their responses. thirdly, the questionnaire was provided only in english. some of the afrikaans-speaking and xhosa-speaking employees might have found some of the items difficult to understand, especially words such as ‘immersed’ and ‘resilient’ in the uwes-9. this could lead to random responding. although the scales showed good reliability, further development and validation of the scales measuring these constructs could be considered within a south african context, especially with respect to the psycap questionnaire. lastly, this study took a ‘snapshot’ of the studied phenomenon (cross-sectional research study), which prevents the researcher from drawing causal conclusions (taris & kompier 2007). to enhance the accuracy and consistency of the reported research findings, it might be desirable to conduct a longitudinal study with multiple time waves or a diary design. not only would this enable the researcher to draw more definitive causal conclusions, but it also would be possible to identify recurring behavioural patterns among sales employees employed by south african financial firms, as well as changes over time. acknowledgements this article is partially based on the theses of the first (b.v.d.m.) and third (rb) authors for the degree of master of commerce (industrial psychology) at stellenbosch university, south africa, with supervisor prof. j. malan, received december 2016 and december 2011 respectively, and available at: http://hdl.handle.net/10019.1/100330 and http://hdl.handle.net/10019.1/17911. the cooperation of the participating companies and their staff who completed the required instruments is gratefully acknowledged. competing interests the authors have declared that no competing interest exists. authors’ contributions the article is based on the theses of two of the authors and their contribution to the final article is reflected by the sequence in the naming of the authors. funding information the research received no specific grant from any funding agency in the public, commercial or not-for-profit sectors. data availability statement the authors confirm that the data supporting the findings of this study are available within the article. disclaimer the views and opinions expressed in this 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https://doi.org/10.2466/pr0.1993.72.2.423 xanthopoulou, d., bakker, a.b., demerouti, e. & schaufeli, w.b., 2007, ‘the role of personal resources in the job demands-resources model’, international journal of stress management 14(2), 121. https://doi.org/10.1037/1072-5245.14.2.121 youssef, c.m. & luthans, f., 2007, ‘positive organizational behavior in the workplace: the impact of hope, optimism, and resilience’, journal of management 33(5), 774–800. https://doi.org/10.1177/0149206307305562 footnote 1. the primary responsibility of pfas is to find clients and sell their products and services to these clients. they are also responsible to present their organisation in a positive light by providing quality services through sales interaction. this means that the success of the organisation within the financial sector is largely dependent on how well pfas perform (van tonder 2011). abstract introduction rationale for regulating financial markets supervisory objectives in other jurisdictions the south african retirement fund market south african supervisory objectives recommendations further research concluding comments acknowledgements references about the author(s) rob rusconi department of actuarial science, faculty of natural and agricultural sciences, university of pretoria, pretoria, south africa citation rusconi, r., 2021, ‘regulating south africa’s retirement funds: the case for clearer objectives’, south african journal of economic and management sciences 24(1), a3943. https://doi.org/10.4102/sajems.v24i1.3943 research note regulating south africa’s retirement funds: the case for clearer objectives rob rusconi received: 04 dec. 2020; accepted: 19 july 2021; published: 30 nov. 2021 copyright: © 2021. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract the rationale for the regulation of participants in financial markets, like retirement funds, is sound. it would be strengthened, however, by a clear statement of the objectives of such regulation. in this article the position is taken that the objectives underpinning the regulation of south african privately-managed retirement funds should be enhanced. it presents this argument with reference to international principles concerning systems of old-age provision, and to the examples of regulations in other jurisdictions. it recommends a set of practical regulatory objectives in the pursuit of efficiency, sustainability, coverage, adequacy and security of provision for old age. keywords: retirement funds; financial markets; regulatory objectives; social protection; government policy. introduction while the rationale for the regulation of financial markets is well-established (llewellyn 1999; ntsa 2011a; organisation for economic cooperation and development publishing, or oecd 2010), the effectiveness of these regulations could be improved, were regulators to publish the objectives of such regulation and monitor the extent to which the objectives are being achieved (baldwin & black 2016; black 2012). explicitly stated objectives enhance accountability (sarkar 2009), provide the means to track progress (knot 2014) and enhance the rationale for regulatory intervention (oecd 2010). these motives are all particularly pertinent to south africa. in this paper it is argued that more could be done by south africa’s regulator of retirement funds, the financial sector conduct authority (fsca), to make clear its objectives. in the next section, the rationale for the regulation of financial markets and participants such as retirement funds is reviewed. in the following section, the objectives stated by the regulators of other retirement-saving markets are summarised. thereafter, south africa’s market for retirement saving is described and consideration is given to the extent to which regulatory objectives are clearly stated. a number of recommendations follow and the paper closes with consideration of possibilities for further research. rationale for regulating financial markets financial markets play an enormously important part in supporting the interactions of participants in economies of all sizes, from remote communities to the global village (oecd 2010). the interactions between these participants are numerous, widespread, diverse and increasingly complex (erskine 2014). as critical as they are to the global economy and all of its component parts, financial markets exhibit remarkable fragility. the operations of these markets are subject to failures of various kinds, such as information inequality (healy & palepu 2001), market-power imbalances (khwaja & mian 2011), principal–agent conflict (laffont & martimort 2002) and contagion (brunnermeier et al. 2009), with sometimes catastrophic consequences, such as the global financial crisis of 2008–2009. this propensity for distortions in financial markets and the potentially damaging impacts of widespread failure are typically utilised as the basis for the regulation of these markets (oecd 2010). the rationale for regulating financial markets thus rests on the combination of their importance to society and their considerable complexity. regulation itself, however, may contribute to the potential for market failure (bisias et al. 2012); while regulation aims to mitigate the risks of market failure, the activities of regulators impact the operation of markets and can exacerbate exactly the risk that it seeks to address, by altering competitive pricing dynamics, for example. retirement funds, privately or publicly managed, form a critical part of the system of old-age provision, itself an element of any country’s system of social protection. they both participate in and utilise financial markets to an enormous extent, as very large investors of assets. despite falling in value over the course of the year, global assets in retirement funds at the end of 2018 amounted to well over usd 40 000 billion in value (oecd 2019). the existence of these funds generates income for a substantial community of providers, operating both within and alongside the financial markets. their allocation of assets to available opportunities can make a substantial difference to the nature of the economies within which they are located. retirement funds play a substantial role in many economies (holzmann 1999; holzmann et al. 2005; james 1995; willmore 2000; world bank 1994). they provide a vital contribution to government policy on social protection. they typically attract a considerable share of government expenditure (in this case, income foregone) in the form of tax incentives of various kinds. retirement fund membership often includes a high proportion of the working and elderly residents of a country; though, across countries, levels of coverage vary significantly. they play a significant role in labour dynamics and employment practices, representing deferred income to workers, typically more effectively and efficiently provided than would be possible by the workers on their own. supervisory objectives in other jurisdictions in the discussion that follows, the publicly-stated objectives of the respective regulatory authorities overseeing retirement funds in five countries are presented. seven countries were assessed, three advanced retirement funding markets in developed countries (australia, the netherlands and the united kingdom), two emerging latin american systems (chile and mexico) and two african markets (kenya and nigeria). these countries were selected with their diversity in mind and in the expectation of regulatory objectives. no such objectives were found for the netherlands and mexico. retirement funds in australia are overseen by the australian prudential regulation authority (apra), which expresses its regulatory goals in a publication dedicated to the purpose (apra 2019a). the australian prudential regulation authority states its key objectives as the financial security of the entities under its remit and the stability of the financial system as a whole. it recognises four second-tier considerations: efficiency, competition, contestability and competitive neutrality, which typically reinforce each other but sometimes come into conflict with one another (apra 2019a). the australian prudential regulation authority expands on its objectives by preparing and releasing, every year, a corporate plan that extends four years into the future (apra 2019b). this identifies focal areas for the near future and establishes a number of performance measures through which it seeks to achieve its objectives. each year, it reports progress in meeting its strategic objectives within the constraints of these measures (apra 2019c). the pensions regulator (tpr) is responsible for overseeing privately-managed retirement arrangements in the united kingdom (tpr 2019b). the pensions regulator works under six statutory objectives, which it expands into four outcomes and eight outcome indicators. every year it reviews its plans, resolving six corporate priorities and 18 key performance indicators (tpr 2019a), three indicators to each priority. the annual report of the tpr sets out a thorough assessment of progress against its performance indicators (tpr 2019b). the pensions regulator prominently discloses five areas of responsibility (thepensionsregulator.gov.uk, accessed 15 june 2020) and backs this up with the six priorities for the period 2019–2022, which it describes in more detail in its corporate plan (tpr 2019a). chile runs an individual retirement account system, to which workers must make contributions. the pension’s superintendent (la superintendencia de pensiones, sp) has been responsible for overseeing the (relatively few) entities registered to manage pension savings under the individual account system since 2008, when it replaced the original superintendent (spensiones.cl, accessed 15 june 2020). the sp describes its mission in terms of four strategic objectives. it publishes a formal description of priorities to its line ministry (spc 2019a). it also provides a summary of strategic intent for the period 2019–2022. in addition, the sp publishes annual summaries, written for broader public consumption (spc 2019b). all funded arrangements in kenya (iops 2012) are regulated by the retirement benefits authority (rba). the rba describes its mandate in broad terms and discloses clear objectives in its strategic plan for the period 2019–2024 (rba 2019). it sets out three strategic themes and translates these into a set of strategic objectives. the rba strategic plan also includes: (1) descriptions of the stakeholders of the rba, (2) the key risks that it faces and its appetite for each of these risks, and (3) the monitoring and evaluation framework of the authority. yet to be seen is how transparently it reports its progress against these goals. nigeria’s individual account system is overseen by a dedicated regulator, the national pension commission (pencom). the pencom statement of mission focuses on the benefits of sound regulation to workers covered under the system, but the vision states the aspiration, by 2020, for 20 million contributors and a measurable impact on the nigerian economy (pencom.gov.ng, accessed 17 june 2020). it builds on this through its statement of five objectives, presenting a mix of high-level aspiration concerning the size of the scheme and a determination to address pressing operational challenges. the annual report (npcn 2018) does not reiterate these objectives or provide any information on progress against them. while, a systematic analysis of the similarities and differences between the objectives in other jurisdictions was not utilised, a number of observations follow from this brief study of the approaches taken by the authorities in these countries. firstly, different approaches are evident, meticulous in the united kingdom and australia, ambitious and wide-ranging in kenya and nigeria, clear but somewhat understated in chile. secondly, having a dedicated pension supervisor appears to be helpful to the definition of goals, because such a person represents the entire ambition of that organisation. thirdly, though an improved knowledge of the respective political economies would assist in the understanding, policy support appears to matter. finally, in practice, few hindrances appear to exist to any supervisory authority, with the support of policymakers and within the constraints of its legal mandate, from adopting a strong and transparent set of objectives supported by a measurable set of outcomes. the south african retirement fund market the retirement fund industry in this country is large. the most recent report of the financial services board (fsb 2018) cites total assets across all fund types as r4262 bn. this amounts to 89.3% of the end-2017 value of the gross domestic product of r4772 bn (south african reserve bank, sarb, resbank.co.za, viewed 08 june 2020). an oecd (2019) assessment puts south african privately-managed retirement assets in 2016 among developing countries at second in dollar terms, and first as a percentage of gdp. membership of these funds is more difficult to determine with certainty. the fsb (2018) reports total membership of all funds as 16.9 million at the end of 2017, against an end-2017 labour force of 22.1 million and total employment of 16.2 million (statssa.gov.za, viewed 08 june 2020). in fact, only 11.2 million of the members are reported by the fsb as contributing to their retirement funds. some 950 000 are pensioner members. approximately 4.5 million, some of them potentially also pensioners, are eligible for unclaimed benefits. furthermore, it is reasonable to assume significant double-counting of these 11.2 million contributing members. until recently, south africa regulated its banks from the sarb and all other financial-market participants through the non-bank regulator, the fsb. following the patterns established by a number of other countries, australia and new zealand for example, regulation of all financial-market entities has been split between two specialist organisations. prudential regulation now falls to the newly established prudential authority (pa), which is located at the sarb. market-conduct regulation is the responsibility of the fsca, based at the offices of the defunct fsb. retirement funds fall into a special category of entities whose prudential oversight is the responsibility of the fsca, but the pa has indicated that it is expected to take responsibility for the prudential oversight of retirement funds from 01 april 2021 (pasa 2020). policy context while current assets in retirement funds are high, household saving levels are not. gross nominal household saving amounted to 1.3% of gdp throughout 2019 (seasonally adjusted, sarb 2020). this is marginally higher than over the previous decade, but low by international standards. the oecd cites south africa’s household saving rate at 0.26% of household disposable income in 2017, the first year since 2005 with a positive value, in position 27 out of 34 jurisdictions included, mostly industrialised countries (data.oecd.org, viewed 09 june 2020). south africa’s privately managed retirement system is large by international standards, because, rare among developed or upper-middle-income developing countries, it offers no national-level retirement savings vehicle, publicly or privately run, to which contributions are mandatory. this is inconsistent with both the world bank multi-pillar model, which emphasises a shared approach to old-age provision across a number of variables, and the corresponding framework of the international labour organisation that focuses on the role of the state as primary provider of social protection (ilo 2017; world bank 1994). retirement saving, supported by tax incentives, is thus directed to these privately managed vehicles, increasing the importance of sound regulatory objectives over such entities. while south africa does provide near-universal old-age income to a large proportion of its elderly citizens, this is not designed to meet the needs of its low-income workers, many of whom are effectively excluded from the system of retirement saving. south africa’s unusual approach to social protection for the elderly has been acknowledged and discussed by policymakers for some time (committee of inquiry 2002; dsd 2006; npcsa 2012; ntsa 2004, 2007, 2015). it is widely agreed that the system of private provision for retirement in south africa suffers major flaws and does not, by and large, achieve its primary objective of providing effectively for the retirement needs of workers. preserving retirement savings is not compulsory, notwithstanding broad agreement on the principle and repeated efforts by policymakers to render it so. the outflow from retirement funds significantly exceeds the corresponding inflow. the membership of retirement funds appears to be broadly healthy, but it is, in fact, very poor in some industry sectors and income bands (ntsa 2013). the durability of accumulated saving after retirement is also being brought into question, given the investment risks carried by members in their defined contribution arrangements and evidence of high rates of drawdown in retirement in preference to purchasing an annuity guaranteed for life (ntsa 2012). the primary concerns of those representing the working poor and the unemployed are that the system does not work effectively to mitigate the retirement risks of those with low income or interrupted work, and that the redistribution to the poor, implicit in the system of social grants, is inadequate. policymakers have, until now, appeared not to be able to agree on priorities for social protection and the potential path of reform. it is not clear where this leaves south africa’s retirement funds, or the regulator overseeing them. the challenges of retirement fund regulation if they are to be effective, the objectives that the regulatory authority establishes must recognise the flaws in the market under consideration and the steps that may be taken to mitigate these flaws. before turning to examining the manner in which the fsca establishes its priorities, consideration is given to the challenges of regulating retirement funds. these entities are marked by complexity of various forms. this complexity makes it more difficult to identify and mitigate potential market failures through regulation. the financial management of defined benefit funds, which provide guarantees of exceptional duration, calls for careful attention, skill and experience (clark & monk 2006a, 2006b; cowling et al. 2019; franzen 2010). less obvious, but perhaps more dangerous, is the risk borne by members of defined contribution funds and the challenge that these members are largely not able to manage this risk (randle & rudolph 2014; stewart & yermo 2008). these funds now dominate provision by private-sector workers in south africa. operations are complex. optimising the investment of assets is not straightforward. perhaps the most intractable problem to the regulatory authority, however, is the complexity inherent to the system of governance and the deep dependence of retirement-fund members on the effectiveness of such governance in practice. in south africa, as in many countries, the legal framework establishing oversight of retirement funds concentrates substantial responsibility in the hands of a few. the exercise of this responsibility is inadequately scrutinised by the ultimate stakeholders of these funds, the members and beneficiaries, who generally do not have the skill to exercise such scrutiny. the resulting outcomes are widely regarded as inadequate (dsd 2006; npcsa 2012; ntsa 2004, 2007, 2013). south africa, in addition, employs a limited approach to enforcing minimum standards of expertise and experience of these few. the management board of a retirement fund represents the interests of the fund and all of its stakeholders. quite how it balances the respective interest of the fund and its members has been the subject of vigorous debate. consider the complex dynamics of the principal–agent relationship. the trustees play the role of agent for the principals, ultimately the members and beneficiaries. typically, though, the trustees do not have the expertise to invest the assets of the fund themselves. bearing in mind the nature and extent of their responsibilities, they engage asset managers and advisors of various types to facilitate this. in this engagement, however, they act as principals over a range of agents, many of whom are experts in their fields and have considerable information advantages over their clients. even simple interactions between principals and agents introduce the possibility of far-reaching conflicts of interest and distorted incentives. with the stakes as high as they are in retirement funds, the regulatory task to minimise the potential for market distortions and their consequences is formidable. a special case in point is the set of multi-employer funds, typically referred to as umbrella funds in south africa. they appear to be the preferred vehicle of the regulator for addressing operational inefficiency by consolidating smaller funds. these entities present a pertinent challenge in the management of conflicts of interest, however. umbrella funds are, in nearly all cases, established and controlled by a for-profit entity, which seeks a return on its investment. this fundamentally distorts the operation of a fund that, in law at least, is supposed to operate in the interests of its members and beneficiaries. efforts to address this, forcing options to allocate assets elsewhere, for example, or ensuring that at least half of the trustees are independent, cannot overturn the underlying commercial conflict. finally, it is not clear how retirement funds contribute to policy objectives. consider the five criteria commonly stated in international circles for a retirement system. these are: efficiency, sustainability, coverage, adequacy and security (price, ashcroft & hafeman 2016). the extent to which privately managed retirement funds are able to contribute to all of these goals, is questionable. these funds have no influence on the extent to which coverage objectives might be met, for example. they are legally established as not-for-profit entities that do not actively seek new members. defined contribution arrangements cannot deliver on the goal of adequacy unless the contributions paid by employers and members are adequate. these constraints typically leave the regulator focusing on operational efficiency and integrity and on the role of governance in supporting the security of member claims on the fund (randle & rudolph 2014). this is only a small part of delivering on the promise of retirement funding: these issues provide a taste of the intractable challenges facing the regulator of retirement funds in south africa. the funds have enormous investing potential and substantial responsibility to millions of members. they are typically overseen by trustees, often with inadequate skill who, in delicate positions, have to manage as best they can in the face of the substantial power and interests of information-rich providers of service. the power imbalances and conflicts of interest that characterise this market appear to introduce intractable market distortions. under these circumstances, clearly stated regulatory objectives are surely a minimum requirement. south african supervisory objectives in the discussion that follows, the stated objectives of a number of south africa’s financial-market regulators are considered, ending with the goals of the retirement fund unit of the fsca. this assessment starts by considering whether, in its responsibility to regulate other parts of the financial markets, south africa’s policymakers and regulators generally have taken care to express their regulatory objectives and determine progress against these objectives. at legislative level, objectives are consistently defined with clarity. the objectives of the pa, for example, that are expressed in the financial regulation act, 2017, are consistent with the high-level goals set out in the paper that established the way forward for the financial sector (ntsa 2011b). the legislation continues with a description of the functions required by the pa to meet its objectives and of the power to put in place further functions in order to achieve the objective established for it. the market-conduct regulator is similarly authorised to act in pursuit of its objectives. law sets out high-level objectives. these need to be translated by regulators into a more tangible set of outputs if they are to be useful. the pa has expressed its objectives, the five priorities that it intends to focus on in pursuit of these objectives and, for each of these, the outcomes that it regards as defining adequate progress towards achieving such priorities (pasa 2018). the first annual report of the pa (pasa 2019) indicates its progress to date, albeit not directly against the goals and outcomes set out in its strategy. under the terms of the financial sector regulation act (2017), the fsca is required (section 70) to develop and adopt a regulatory strategy, which must set the regulatory and supervisory priorities for the next three years and describe the principles under which it is to perform its functions. it must also review its strategy no less frequently than annually. the fsca strategy paper (2018) sets out priorities for the fsca as a whole, among them ‘a robust regulatory framework that provides fair customer treatment, informed financial customers [and] strengthening the efficiency and integrity of our financial markets’ (fsca 2018:5). it does not define objectives specific to its mandate to oversee retirement funds. under the draft terms of the conduct of financial institutions bill (2018), which was issued in december 2018 and by june 2020 had passed through the first draft of consultation, the fsca is furthermore mandated to promote the objectives of the law, which are set out in the bill itself. it also makes reference to the objectives of the fsca, as defined in the financial sector regulation act (see paragraph 5.2) and sets high standards for the fsca to assess the success with which any provisions that it makes under the bill, achieve its stated objectives. the fsca, in other words, has the power to establish its regulatory objectives and the mandate to report on the success with which it achieves them. more widely, south africa’s financial-sector policymakers have a good track record of explaining the reasons for proposed reforms to the regulatory framework. among regulators, the sarb is particularly transparent in its statement of objectives and the extent to which it is making progress towards these goals (sarb 2017). a look back at the practices of the fsb are helpful. the supervisory authority had a sound history of stating its goals and expanding its mission and vision into a number of parts. it expressed its mission: to promote fair treatment of consumers of financial services and products, financial soundness of financial institutions, systemic stability of financial services industries, integrity of financial markets and institutions and consumer financial education. (fsb 2017:13) the fsb also defined objectives and performance indicators. it stated progress against these indicators, in broad terms. in its last few annual reports (fsb 2017, for example), it described progress against a number of performance indicators. retirement funds are represented in a dedicated part of the fsb annual reports. that section includes descriptions of the responsibilities of key departments within the retirement-funds unit, a discussion of significant industry-related issues and a range of statistics regarding the retirement industry (fsb 2017). objectives are not included, but the mission of the retirement fund unit is set out as follows: to promote a safe and stable environment for members of retirement funds so that obligations of all stakeholders are met when due through our commitment, professionalism and teamwork. (fsb 2017:32) the most recent available report covering retirement funds at the time of drafting appears to be the final report of registrar of pension funds (fsb 2018), issued in december 2018 and covering the calendar year 2017. this paper describes the activities of the unit and extensive statistics on retirement funds, but does not report on progress against regulatory objectives. the fsca, since its inception, does not appear to have published a report covering retirement funds. to date, in conclusion, the fsca has not formulated a set of objectives for retirement fund regulation in significant depth or breadth. while the criteria governing the success of a retirement system may be described as efficiency, sustainability, coverage, adequacy and security, the retirement funds unit at the fsca has focused its objectives on safety and stability for the members of retirement funds. in mitigation, it may be suggested that its objectives include elements of efficiency and adequacy. evidence for the first exists in the market-conduct framework of which it forms a part, in statements regarding the need for industry consolidation and in its concern over the communication to members of projected retirement benefits. regarding the second, the release of draft rules covering the calculation underpinning the description of projected retirement benefits (fsca 2020) is an example of the customer-centric approach of the fsca. south africa’s retirement funds regulator operates in the context of considerable policy uncertainty. this paper includes a number of references to the start-stop nature of the development of this policy over many years. opaque policy regarding the role of retirement funds may make it more difficult for the regulator to set its objectives. recently, however, with the powers granted to the fsca to develop regulation (primarily by the financial sector regulation act 2017), the status of the overseeing entity was effectively raised from the position of supervisor to regulator. this gives the fsca the authority to amend its regulatory strategy at any time, subject to appropriate consultation. recommendations in the discussion that follows the options available to the fsca to clarify its regulatory objectives concerning retirement funds are considered. this calls for a systematic approach to the retirement funding system, the risks of market failure and actions that may be taken by regulators to overcome these risks. the approach that follows, considers – for each of the primary goals of a framework for old age provision, efficiency, sustainability, coverage, adequacy and security – what role the retirement fund unit at the fsca might play to develop and meet its regulatory objectives. considering regulatory priorities along the lines of these primary goals, provides a sound foundation and a better chance of completeness than an alternative method. efficiency defined contribution retirement funds are effectively owned by their members. the trustees of these funds should be doing everything they can to ensure that they utilise member resources as effectively as possible, taking into account the costs and corresponding benefits of alternative actions. the market-conduct framework of the fsca facilitates oversight of the extent to which funds manage their expenses in the pursuit of the most appropriate outcome for their members. a number of approaches might be used by the fsca to track fund expenses and influence trustees to operate with appropriate efficiency. setting limits is not recommended as it runs the risk of distorting the operation of markets (bar-gill 2015; loube 1995), but requiring funds to report expenditure electronically and gathering comparative information across the industry, could lead to the development of benchmarks that might influence behaviour appropriately. perhaps more important, however, and more closely in line with the market-conduct philosophy of the fsca, is that retirement funds demonstrate their focus on efficiency through their commitment to sound and effective governance. boards of trustees themselves ought to acknowledge the impacts that their decisions have on the welfare of their members and make every effort to manage fund expenditure accordingly. requiring the demonstrable implementation of effective governance and risk management by retirement funds would assist in building this responsibility. effective governance helps to overcome the potential for the pursuit of low costs at the expense of effective delivery. efficiency can only be gauged in terms of the effectiveness with which outcomes are delivered, which must take both costs and benefits into account. regulatory objectives should be expressed in such terms. sustainability issues of sustainability appear to fall outside the brief of the retirement funds regulator. sustainability is concerned with whether the value of contributions payable is sufficient, in the very long run, for the benefits provided. old-age funding systems that are not sustainable are typically those that promise benefits without pre-funding and suffer the impacts of changes to the balance of contributors and beneficiaries (world bank 1994). defined contribution arrangements do not suffer from this problem, but if contributions are insufficient or members withdraw savings prior to retirement, then the sustainability of the system is without question inadequate as well. south africa surely suffers this problem. much can still be done, at the level of the retirement fund, to improve sustainability. this should be reflected in regulatory objectives. good governance, along with disciplined record-keeping, financial management and regular actuarial reviews all contribute to the financial viability of a retirement fund and ultimately to the sustainability of the system as a whole by ensuring that the risks that members bear are managed as effectively as possible. a strong focus by the regulator on these disciplines, ultimately on the effectiveness with which members are supported in their risk-management challenge, would represent a sound contribution to sustainability at system level. coverage coverage also seems to fall outside the remit of the regulator, which does not have the power to require employers to make available to their workers a retirement fund or an efficient alternative individual arrangement. the fsca accepts its responsibility, however, to deliver financial education to south africans. highlighting the importance of saving for retirement should form part of this, not just in the environment of the workshop but through efforts to grow public awareness. furthermore, contributing to efforts to identify more accurately how many south africans are preparing financially for old age and how effectively they are doing so, would also be helpful. finally, the fsca has a significant role to play in contributing actively to the development of sound government policy regarding provision for old age. all of these might be reflected in its objectives. adequacy south africa faces enormous challenges regarding the adequacy of provision for old age. this is particularly acute among low-income workers who do not have access to a retirement fund and workers at all income levels who choose not to preserve their accumulated retirement saving when they leave employment, or switch from one job to another. the fsca has access to the data needed to bring these concerns to light. gathering sound information and reporting it through appropriate channels would contribute meaningfully to the development of sound policy. adequacy is also of critical importance at the level of the fund. defined benefit funds typically provide for income in old age at a relatively generous rate, though they should take care to explain to members both the nature of this promise and the consequences of leaving the arrangement prior to retirement. for members of defined contribution funds, the situation is a great deal more difficult. these members bear the risk that, at retirement, they have not accumulated sufficient assets in their fund, along with other arrangements that they have made. they also take investment risk in the fund, a risk that these members typically do not have the skills to manage. a number of retirement funds undertake good work to communicate to their members the importance of planning ahead for old age by projecting to the date of retirement the income expected from savings accumulated to date, along with future contributions and investment returns. under the responsibilities imposed on these funds by the market-conduct framework, the standards covering communication to members of the risks to which they are exposed, and the means for mitigating these risks, should be high. the fsca could assist in this process of communication, perhaps by issuing regular information leaflets using a variety of media that are designed for consumption by fund members. under its market-conduct mandate, furthermore, the fsca could establish minimum standards of communication to members by trustees. overall, however, it is not clear that sufficient work is undertaken to test the effectiveness of communication to members. communication that is either not understood or is not converted into appropriate action is wasted. the fsca should frame regulatory objectives with this in mind. security the security of retirement savings is the goal that lends itself most closely to the current regulatory model. it would be helpful as a start for the fsca to explain what it means by ‘safe and stable’ and to identify the actions that it takes to achieve these ends. since the objectives underpinning regulation typically identify potential market failures and the steps required to address these, the fsca could take this approach to defining its role as part of the ongoing process of establishing its regulatory mandate, taking into account the approaches utilised elsewhere. as a result, it might require trustees to adopt and follow strategic plans, consider issues of market competition, identify ways to improve management or aim to ensure that retirement funds overcome tendencies to view investment performance through a conservative short-term lens to the potential detriment of long-term success. under the powers now available to the fsca to ensure an effective framework of market-conduct regulation, the regulator is well able to require all retirement funds to meet minimum requirements of governance and risk management and to demonstrate that they do so in the interests of all members. this could be supported by minimum standards of disclosure to members and a summarised version of this disclosure for public consumption, facilitating comparison across funds. it is not clear how commercially established multi-employer arrangements would be able to demonstrate a best-practice approach to governance that is sufficiently strong to overcome the natural bias resulting from the commercial relationship of the fund with one financial service provider. one possibility for consideration by the regulator is to recognise that, by virtue of the inseparable relationship between the not-for-profit fund and the commercial entity that established it, additional regulatory requirements may need to be placed on these entities. these may help to address the limits to investment choice, the potential for compromises to the effectiveness of governance and the distortions to competitive dynamics between these entities and their stand-alone counterparts. while price controls are particularly dangerous to the effective operations of markets and are not recommended, an alternative might be minimum levels of public transparency of these entities concerning the fees that they charge and the range of services that they offer. finally, it is difficult for groups of members to leave multi-employer arrangements, again impacting competitive dynamics. minimum standards in this regard may be helpful. lessons might be learned from the fsca’s latin american counterparts, which utilise intense and intrusive approaches to manage the regulation of the few powerful commercial entities under their jurisdiction. concluding comments the fsca has been established with a strong mandate and supporting powers, and with few limitations on its scope, to exercise a lasting effect on the market: a strong market conduct policy framework should support the delivery of desired policy outcomes in the financial sector, enable the monitoring of the extent to which those outcomes are being achieved, ensure preventative action is taken to mitigate the risk of poor outcomes, and ensure remedial action is taken when poor outcomes are in fact produced. (ntsa n.d.:11) it is precisely the development of those outcomes that this paper encourages. the trustees of a retirement fund take enormous ethical and technical responsibility for the well-being of their members. they should be required to demonstrate how they meet minimum standards of governance, disclosure and risk management, failing which firm action should be taken by the regulator to improve these standards. improving the seriousness with which retirement funds meet the needs of their members would go a long way to meeting the fundamental purpose of the fsca and to clarifying the contribution of these funds to the social protection framework of the country. further research research is critical in support of fsca goals to improve the effectiveness of market operation to the advantage of the ultimate beneficiaries of these markets. a wide range of research has been carried out, internationally and locally, into the dynamics of choice faced by the members of retirement funds. consideration of the five policy objectives for old-age provision suggests a number of possibilities for further research in south africa. coverage and adequacy of retirement savings represent burning ships that need urgent attention. not enough is understood about the quality of retirement fund coverage in south africa and the split between those, with the benefit of tax incentives, who are saving for an income in retirement and those, members of provident funds, most likely on lower incomes, who will receive a lump sum and may well then draw an old-age grant. little is also known about the nature of old-age income security, given the poor rates at which retirement proceeds are converted into lifetime annuities. furthermore, the extent to which accumulated saving is preserved until retirement is not well understood, though it appears to be low. all of these provide an excellent reason for systematic information gathering and analysis, in all likelihood combining a number of sources. the fsca itself may be in a strong position to coordinate this activity. efficiency considerations should also be high on the fsca agenda, given its focus on sound market conduct. analysis of the overall expenditure of retirement funds, on a year-by-year basis, suitably normalised to allow for asset and membership differences, should give to external commentators and to the funds themselves (not to mention their members) an opportunity to assess differences in the efficiency of these vehicles. the fsca probably has better access to information than most and could carry out and publish this analysis itself. industry bodies should have an interest in promoting transparency of this nature. in the interests of industry transparency, multi-employer funds and entities designed for individual take-up should also be publishing appropriately calculated and soundly balanced assessments of efficiency, supported by the association for savings and investment south africa. if they are not, the fsca has a role to play in encouraging or mandating such publication. perhaps the most challenging area for scrutiny is that of the security of retirement saving. high-quality, detailed, reliable data is a necessary condition for effective research, but it is not sufficient. market failure presents itself in a number of ways. many of these channels of market distortion adversely impact member security because they affect the extent to which customers are able to act fairly in their own interest. it is not sufficient, for example, to note that administrative services or risk benefits are priced competitively, but not asset management, as appears anecdotally to be the case, if this is not supported by a careful understanding of why this may be the case and what might be done to address it. high-quality research would be useful in a number of further areas, for example: the decisions that members of defined contribution funds take regarding the allocation of accounts to asset classes, both before and after retirement; the effectiveness of communication to members in terms of improved understanding and appropriate conversion of thoughts into action; the potential for goals-based arrangements and other methods from the disciplines of behavioural finance to improve retirement outcomes; the quality of governance and risk management at retirement funds, and the consequences of this quality on the performance of the funds and outcomes for members; the impacts, positive and negative, of the constrained models of governance that characterise funds that fall exclusively under the operational oversight of a commercial entity, multi-employer funds and those aimed at individuals; the impacts on the overall outcome for members of pricing investment management services as a percentage of assets under management rather than on an alternative basis such as a fee for service; the potential for inappropriate incentives to asset managers arising from performance-based investment fees; and the costs and benefits of directing resources to the management of operational risk in retirement funds. the fsca is surely the party most directly interested in an effectively operating retirement-funding market. it probably also has the best access to fund-level information. it should play a critical role in coordinating research into the market and its participants. concluding comments like many retirement funding markets, south africa’s ecosystem for private-sector old-age provision is large, complex and very important to a wide range of players. it is also characterised by deep challenges, particularly with regard to the alignment of incentives between principals and their agents. this ecosystem requires sound, effective oversight. the fsca has been granted the power to exercise this oversight. to do so effectively, however, it needs to establish a set of regulatory objectives that are clearly stated and are translated into measurable outcomes. progress against these outcomes should be reported upon regularly. in the context of opaque government policy regarding the role that privately managed retirement funds are to play in the social protection framework, this is difficult. it is, nevertheless, critical. acknowledgements the research reported in this article is intended to contribute to completion of a phd degree at the university of pretoria. some of the work was carried out as part of an msc thesis completed in 2019 at the university of pretoria. i am grateful for the guidance provided by supervisors prof conrad beyers and prof corlia van heerden. i acknowledge as well comments received from delegates to the 2020 convention of the actuarial society of south africa, to which this paper was presented, and from pre-presentation reviewer, costa economou. competing interests i declare that i have no financial or personal relationships that may have inappropriately influenced me in writing this article. author’s contributions i declare that i am the sole author of this research article. ethical considerations this article followed all ethical standards for research without direct contact with human or animal subjects. funding information financial support for open-source publication is gratefully acknowledged from the university of pretoria. data availability data sharing is not applicable to the article, as no new data were created or analysed in this study. disclaimer responsibility for all errors remains mine: the views expressed in this article are my own and are not an official position of the university of pretoria. references apra, 2019a, apra’s objectives: information paper, australian prudential regulation authority, sydney, australia, https://www.apra.gov.au/contact-us apra, 2019b, corporate plan 2019–2023, august, sydney, australia, https://www.apra.gov.au/contact-us apra, 2019c, annual report 18/19, september, https://www.apra.gov.au/contact-us baldwin, r. & black, j., 2016, ‘driving priorities in risk-based regulation: 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countries: an analysis with particular reference to bangladesh’, international journal of public administration 32(13), 1101–1123. https://doi.org/10.1080/01900690903188826 spc, 2019a, balance de gestión integral año 2018, management strategy, superintendency of chile, superintendencia de pensiones, ministerio del trabajo y previsión social, chile. spc, 2019b, cuenta pública, gestión 2018, superintendencia de pensiones, annual report of the superintendency of chile for public participation, santiago, https://www.spensiones.cl/portal/institucional/594/w3-propertyvalue-9969.html stewart, f. & yermo, j., 2008, pension fund governance: challenges and potential solutions, working paper on insurance and private pensions no. 18, oecd, paris, https://www.oecd.org/finance/private-pensions/41013956.pdf tpr, 2019a, corporate plan: 2019–2022, the pensions regulator, birmingham, https://www.thepensionsregulator.gov.uk/en/document-library/corporate-information/corporate-plans/corporate-plan-2019-2022 tpr, 2019b, annual report and accounts, 2018–2019, the pension regulator, birmingham, https://pmg.org.za/page/ar2018-2019 willmore, l., 2000, three pillars of pensions? a proposal to end mandatory contributions, desa discussion paper no. 13, economic & social affairs, united nations, new york, https://www.un.org/esa/desa/papers/2000/esa00dp13.pdf world bank, 1994, averting the old age crisis: policies to protect the old and promote growth, world bank, washington, dc. 359 sajems ns vol 4 (2001) no 2 some recommendations towards reducing electricity consumption in the south african manufacturing sector in blignaut and t de wet i department of economics, university of pretoria abstract this paper investigates the means of reducing electricity consumption in the south african manufacturing sector. it concludes that neither the price of electricity, nor taxes, subsidies or legislation are likely to bring about the required change. a change in the production structure using relatively more labour and less capital is also unlikely in the immediate future, given the socioeconomic and legislative milieu currently prevailing in south africa. the only feasible solution that seems likely is a change in technology, which includes the more efficient use of electricity. given the possible international agreement regarding global climate change commitments and procedures, clean development mechanisms may therefore yet provide the answer. jeln67 1 introduction and problem statement few would deny the importance of electricity or of a strong manufacturing sector in the economic development of a country. within the context of global climate change and the negative environmental impact of the externalities associated with the generation of electricity, it is increasingly important to reduce the levels of electricity consumption without jeopardising the manufacturing base of the economy. it is therefore valid to ask what measures are necessary to reduce electricity consumption by the manufacturing sector. in an attempt to answer the question, this paper starts by giving an overview of the consumption and production of electricity in south africa, followed by a discussion of the research method used. then the price elasticity of electricity demand is investigated. this, in turn, is followed by a discussion of the production structure of manufacturing, and the correlation between the use of capital and electricity. finally, some concluding remarks are made. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2 360 2 consumption and production of electricity in south africa: an overview 2.1 demand for electricity electricity is an essential input in any economy, particularly in a developing country, since without it little development is possible. it is therefore not surprising that the reconstruction and development programme (rdp) stresses the importance of an increased provision of electricity in the following terms (anc, 1994: 108): "the benefits of cheap electricity presently enjoyed by large corporations must be extended to all parts of the economy." from this statement it follows that, from the outset, it was the aim of the anc to continue to supply cheap electricity and to extend its consumption to as many people as possible. there is no question that this objective has enjoyed high priority and that considerable progress has been made in pursuit of it (ner annual report, 1998). this is supported by the fact that the average annual growth in electricity consumption is highest in the residential sector, namely 4 per cent (see table 1). from table 1 it is also clear that manufacturing is the largest single consumer of electricity (comprising approximately 41 per cent of total demand). furthermore, the rate at which electricity consumption is growing in this sector is faster than the national average of 1,8 per cent a year over the period 19891995, namely 2,1 per cent. since manufacturing is such a major consumer of electricity, this paper focuses on this sector only. table 1 electricity consumption in south africa: 1989-1995 (gwb) consumer 1989 1)/1) of 1992 %of 1995 i % of annual total total total growth rate mining 34963 ~33359 23.49 33612 • 21.59 -0.7% transnet ltd. 4915 3 4347 3.06 i 4036 2.59 -3.2% . domestic use 211 5.07 23834 16.78 26663 i 17.13 4.0% manufacturing 561 0.07 54474 38.35 63801 ! 40.99 2.1% commerce, con14282 10.19 15715 11.06 17513 11.25 3.5% struction, and other. business i other purpose 8721 6.22 1 7.25 10034 i 6.45 2.4% total 140169 100 142031 100 155661 ! 100 1.8% source: stats sa, census of electricity, gas and steam 1995. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 361 sajems ns vol 4 (2001) no 2 2.2 supply of electricity eskom is by far the largest single producer of electricity in south africa, and is currently the fifth largest electricity utility in the world in tenus of both sales and capacity (eskom annual report, 1999). not only is it such a large producer of electricity, its share in domestic production has also increased considerably since 1960. as is indicated in table 2, eskom produced 62.3 per cent of the total electricity in 1960, and 98.3 per cent in 1999, mainly through its coal-based fire stations. in 1960, all of the electricity produced was coal-based, but due to other technologies such as nuclear power, coal's contribution has declined slightly to approximately 93 per cent in 1999. consequently, eskom is the largest single consumer of coal in south africa, absorbing approximately 40 per cent of the total coal production in 1999. its consumption of coal increased more than seven fold over the period under consideration from 12.5 million tonne to 88.5 million tonne. for comparative purposes, this consumption of coal should be seen in the light of the fact that total coal exports comprised 29.5 per cent of the market in the same year. (south africa is the world's second largest exporter of coal with australia being first and america third). table 2 selected energy add electricity statistics in south africa: 19601999 coal coal coni coal contotal eskom's electricity production sumption sumption by electricity contribution supply: coal for elect. eskom generated to local fired (million generation (million (gwh) electricity eskom todnes) (million tonnes) supply pwr pint tonnes) i (gwh) (gwht 1960 i 38.1 16.4 i 12.5 25840 16094 17306 1965 47.6 22.1 16.7 34490 23143 24583 1970 i 53.1 29.5 i 21.6 50791 34890 37321 1975 69.1 39.1 34.2 74894 i 57869 60400 1980 113.1 55.0 46.8 98951 87539 82342 1985 i 172.0 67.4 59.5 141384 112305 113941 1990 184.1 76.2 70.9 165516 i 144440 134744 1992 176.1 i 78.0 75.9 166260 146392 i 136830 1995 212.5 i 87.6 79.4 . 174571 161848 i 151730 1997 224.5 93.6 90.2 190700 181372 j 170464 1999 220.74 i 93.4 88.5 191734 177934 i 165665 sources: dme, south african energy statistics no.2, 1995. dme, south africa's mineral industry 1998/99, 1999. eskom, annual report, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2 362 various issues. ner, annual reports, various issues. stats sa, census o/electricity, gas and steam 1995, 1995. chamber of mines, mining statistics in brie/1999, 2000. 2.3 electricity prices eskom has committed itself to be one of the producers of electricity at the lowest cost in the world (eskom annual report, 1999). eskom's tariffs are much lower than those of many developed nations with electricity utilities of comparable size, for example japan, germany, the united kingdom and the united states (van horen, 1996: 8). according to doppegieter (1999: 52) south africa has the second cheapest electricity in the world, beaten only by new zealand. in the national context, electricity prices have declined in real terms since eskom announced its price compact in 1991. in announcing and motivating the price compact, eskom was convinced that cheap electricity is essential for rapid economic growth (van horen, 1996: 9). in terms of this price compact, eskom undertook to decrease the real price of electricity substantially over the period 1992-2000. the achieved price reductions over the period 1970-1999, are shown in table 3. from this table it emerges that the real price of electricity (1995 100) for all economic sectors declined by 7.8 per cent, and that for the manufacturing sector by 21.1 per cent over the whole period. since 1990, the price of electricity for all sectors declined by 29.5 per cent and that for manufacturing by 35.6 per cent. table 3 real electricity prices in south africa: 1970-1999 (c/kwb) -4.71 -5.57 -3.95 2.84 -1.03 17.30 -7.84 33.12 -7.81 4.76 ! -6.97 1979 14.46 -6.16 i 1980 , 13.54. -6.36 i r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 363 sajems ns vol 4 (2001) no 2 table 3 continued ave: all sectors manucacturin2 ave: all sectors manucacturin2 real % real % real % reaj % price chan~e price i change price change price change 1981 13.24 -2.22 13.25 -2.21 1996 10.53 -5.56 9.41 -9.52 1982 14.19 7.18 14.30 i 7.92 1997 10.17 -3.42 9.25 -1.70 1983 i 15.17 6.91 • 15.24 i 6.57 1998 9.86 -3.05 8.84 -4.43 1984 14.49 -4.48 14.53 -4.66 1999 i 9.49 -3.75 8.05 -8.94 . over -7.77 over -21.08 i i period· period source: dme, south african national energy prices. 200~0: 70. the low and declining price of electricity encouraged the consumption of electricity to grow at the average annual rate of 5.4 per cent from 1960 to 1999. from 1990 to 1999, the average annual growth rate of electricity consumption was 1.9 per cent, which is marginally higher than the increase in the real gross domestic product of 1.6 per cent over the same period. however, according to doppegieter (1998: 3-59) such figures are misleading. electricity is consumed wastefully in south africa and much electricity can be saved. the inefficient use of electricity is attributed to a number of reasons, amongst others the low coal and electricity prices and large coal reserves. one of the major factors contributing to the low electricity price is the relative cheap coal that eskom buys. in 1998, eskom paid an average price of r41.31/tonne, compared to the r54.55/tonne sasol paid, and the r156.36/tonne the metallurgic industries paid. these price differences can be attributed to different contract arrangements, entitlements and differences in the quality of coal (dme, 1999). 2.4 the social and environmental cost of electricity generation the increase in the consumption of both coal and electricity contributes not just to economic growth, but also to the increase in negative social and environmental externalities. from table 4 is it clear that eskom is a dominant polluter of greenhouse gases in south africa, contributing to more that 45 per cent of domestic emissions. these emissions are mainly derived from the coalbased plants ofeskom. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (200 i) no 2 364 table 4 carbon dioxide, sulphur dioxide and nitrogen emissions in south africa: 1990, 1994 and 1995 co2 (million tonnes) , s02 (thousand tonnes) ! eskom sa eskom % of sa % of sa 45.2 1088.32j 1760.0 61.8 45.0 1166.80 48.1 1198.17 345. -. nox {thousand tonnes eskom 913.8 961.2 sa ,eskomi ! % of sa 2268· 40.3 sources: doppegieter, 1998: 3-69 & 3-80. van der merwe & scholes, 1999. unfccc, 2000. viewed from an international perspective, south africa was the 15th highest emitter of carbon dioxide in 1995 and 1997 in absolute terms (doppegieter, 1998: 3-69 & unfccc, 2000). south africa was hence the 10th highest nonannex i (cf developing country) polluter of carbon dioxide per capita in both 1995 and 1997, or 28th overall (including the developed economies) (doppegieter, 1998: 3-69 & unfccc, 2000). these rankings do not reflect the country's economic strength and are clearly disproportionate. chronic exposure to emissions of this magnitude has serious mortality and morbidity implications, such as chronic bronchitis and other respiratory diseases. acid deposition in water bodies also severely impacts on the quality of surface and even ground water. this health hazard is further magnified by the fact tliat there is sufficient evidence to believe that global climate change is mainly due to anthropocentric (economic) activities (houghton et al., 1996). in the light of these environmental and social costs due to the externality associated with coal-based electricity generation (see also van horen, 1996 & 1997), there is a need to reduce the generation of electricity from this source. this can be achieved in one of two ways, or a combination of both. eskom can change its production technology, that is divert from coal to alternative energy sources, or there should be a decline in the consumption of coal-based electricity. a possible change in the production technology of eskom and its associated cost will, however, not be discussed here. the remainder of this paper will focus on the demand for electricity by the largest single consumer of electricity, the manufacturing sector, and an appropriate policy required to bring about a reduction in the consumption of electricity. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 365 sajems ns vol 4 (2001) no 2 3 method and data in the attempt to find an appropriate policy to reduce the consumption of electricity in the manufacturing sector, this study investigates the effect of a change in the price of electricity on the consumption of energy by calculating the price elasticity of electricity demand. because of data limitations, a static approach had to be used and elasticity was calculated on the ceteris paribus assumption, that all other factors that might influence electricity demand remain constant. this exercise produced some surprising results, which caused the authors to investigate the production structure in manufacturing by means of a cobb-douglas production function, estimated for each year in the sample period .. these estimates indicate that the production structure in south african manufacturing has changed rather drastically and that this change has socioeconomic as well as environmental consequences. based on these results, the effect of the change in production structure on electricity consumption in south africa was tested and some policy proposals for the reduction of electricity consumption in manufacturing were made. the data used in the empirical tests was obtained from statistics south africa's census of manufacturing and the department of mineral and energy affairs' yearbooks. the sample years included in the study are 1972, 1976, 1979, 1982, 1985, 1988, 1991, 1993 and 1996. the manufacturing sector has been disaggregated into 27 subsectors. this implies a cross-sectional data set for nine years across 27 subsectors. the data for estimating the price elasticities are the price of electricity measured in rimwh and the total consumption of electricity measured in mwh for the 27 sub sectors. the data used for estimating production functions for the manufacturing industry, and in calculating the effect of structural change in production on electricity use, are net production (i.e. turnover less consumption of fixed capital), the value of fixed capital stock and the cost of electricity. these aggregates are expressed in constant 1995 prices. each of these three variables is then expressed as a ratio of the number of labourers employed. all variables are published in nominal terms only, and the gdp deflator was used to deflate fixed capital stock whilst the cpi was used to deflate the other variables. 4 price elasticity of electricity demand in the south african manufacturing sector there exists, at least theoretically, a negative correlation between the volume consumed of any commodity and its price, ceteris paribus. one of the easiest, and generally accepted, methods to measure the quantity to which electricity r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2 366 consumption will change with a change in price is, by calculating the price elasticity of electricity demand2• the calculated price elasticity of demand for electricity is reported in table 5: table 5 price elasticity of demand for electricity in 27 manufactnring subsectors in the south african economy: 1976-1996 1197611979 1982 1985 . 1988 1991 1993 11996 ave. over period food 0.743 0.074 0.659 ~0.281 0.300 -2.179 4.406 -0.674 0.156 beveraj!;e industries : 1.203 0.231 . 0.385 ~0.031 0.654 -2.877 2.763 -0.503 . 0.105 tabacco products • 1.007 0.405 . 0.187 0.243 • 0.882 -0.406 1.220 1.367 0.720 textiles 0.540 ,,0.052 -0.013 0.023 f.4.486 5.043 -1.550 0.709 -0.047 wearing apparel, 0.707 0.019 0.384 0.040 i 0.673 . -1.816 8.752 -0.143 0.451 except footware leather and leather : 0.712 ~0.318 0.181 ro.142 .0.860 -2.3361 3.305 : 1.082 0.172 products footwear 0.536 0.160 0.345 0.040 10.615 -0.775 2.584 i -0.669 0.232 wood and wood and 0.745 0.255 : 0.884 0.019 0.806 1 -2.194 1 5.467 ! 0.287 0.389 cork products, except i furniture furniture and fixtures, 0.615 0.056 0.986 0.260 1.080 i -2.367 9.345 • -2.130 0.316 except primarily of metal paper and paper 0.620 0.182 ! -0.522 1.524 1 0.319 -2.157! -1.490 1.313 0.255 products ! printing, publishing 1.214 1 0.641 0.495 0.295 0.778 i -2.217 1 5.403: -0.643 0.299 and alfied industries industrial chemicals 1.60 0.512 0.439 0.222 1.085 -1.018 6.227 5 0.831 ~!:~~~emical 0.248 i 0.170 ! 0.251 1.883 0.658 -1.180 1-17.946 : 1.692 -0.250 rubber products 2.498 ~0.208 0.090 0.313 0.146 -1.040 1 4.186. 0.330 0.760 plastic products, not 1.122 ! 0.202 1.020 0.342 0.661 : -1.236 3.811 1.557 0.793 elsewhere classified pottery, china and 0.552 10.150 ! 0.781 0.058 0.414 : -1.173 3.746 1.046 0.302 earthenware glass and glass 0.564 lo.504 0.527 0.099 0.716 -2.715 i 1.546 0.274 -0.099 products i other non-metallic oa17 1..0.250 oa85 0.722. 1.841 . -1.635 -1.077 • 0.494 -0.306 products i iron and steel basic 0.597 i 0.666 ! 0.119 0.252 • 1.224 -1.974 3.460 0.805 0.571 industries non-ferrous metal 0.580 i 0.402 ! 0.137 0.567 1.085 ! -2.509 6.172 • 2.921 0.708 basic industries . r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 367 sajems ns vol 4 (2001) no 2 table 5 continued 1976 1979 1982 11985 19881 1991 1993 11996 ave. over period fabricated metal 10.825 0.020· 0.790 0.507 0.352 i -1.298 . 2.409· 0.103 i 0.292 products, except i i • i machinery and i i i ! equipment l machinery, except 10.678 0.109. 0.846 0.286 • 0.203 i -1.882 3.242 -1.994 0.q30 i ! • electrical machinery i electrical machinery, i 1.1161 0.242 0.262 0.161 0.741 -1.653 6.329 -0.607. 0.485 apparatus, appliances i i and supplies i motor vehicles, parts 1 0.547 0.054. 0.852 l 0.278 0.450 -1.567 6.720 0.167 i 0.428 land accessories· . transport equipment, 0.564 : 0.106 0.950 0.652 0.39 -2.500 -7.425 5.264 0.209 except motor vehicles, i parts and accessories i professional and .0.134 1°.214 i -0.220 1.586 0.171 -2.355 7.066 -2.825 i -0.111 scientific, measuring i and controlling ! ! i equipment, i photographic and [optical goods i other manufacturing 0.502 0.115 0.869 0.236 0.258 -1.182 2.243 3.042 0.517 industries source: own analysis. two things are evident from table 5. firstly, in most subsectors an increase in the price of electricity has not resulted in a decrease in the use of (i.e. quantity demanded of) electricity. one might at least have expected that in the majority of cases price elasticity of demand would have a negative sign, but this is not the case. secondly, the price elasticities are small and lie between 1 and -1, indicating that electricity consumption is price inelastic. one may therefore conclude that the manufacturing sector is not sensitive to the price of electricity in its decision-making. this outcome is in line with earlier results (van horen, 1997: 66). as mentioned above, electricity is cheap in south africa and its price declining. this has resulted in the cost of electricity as a percentage of total cost for almost all subsectors and in ali the years being less than 10 per cent, with an average of 4.5 per cent over all the years and subsectors. this can be seen in table 6. these results indicate that there should be other, non-price, factors causing electricity consumption to change in the south african manufacturing sector. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol4 (2001) no 2 368 these results reiterate that the price of electricity is a very weak instrument to bring about a change in electricity consumption in south african manufacturing. the following section examines the change in production technology in the south african manufacturing sector since 1972, to determine what does in fact cause electricity consumption to change. table 6 electricity cost as percentage of total cost in 27 manufacturing subsectors in south africa: 1972-1996 industry: 1972 1976 1979 1982 1985 1988 1991 1993 1996 ave. description food 6.624 8.687 10.189 11.632 9.138 9.136 3.632 4.481 1.043 3.082 beverage industries 4.649 11.765 10.581 10.547 9.905 8.045 2.301 2.574 0.658 2.209 tabacco products 1.635 3.303 4.074 8.981 7.631 4.203 3.440 3.267 1.051 2.108 textiles 5.272 7.453 9.563 8.445 8.111 0.921 4.167 4.515 1.773 3.389 wearing apparel, 1.j90 1.724 2.448 2.217 2.062 2.884 j.l85 1.794 0.631 1.195 except footware leather and leather 3.390 4.515 5.249 5.253 5.349 6.366 2.353 2.714 0.687 1.751 products footwear 1.467 1.848 2.182 1.931 2.061 2.419 1.328 1.611 0.598 1.205 wood and wood and 5.660 7.189 7.935 9.207 8.493 10.678 4.365 6.530 1.796 4.004 cork products, except furniture furniture and 2.069 3.263 1 4.465 4.414 3.893 5.309 1.858 3.868 0.931 2.214 fixtures, except ljjrimarilv of metal paper and paper 9.254 9.196 19.376 11.675 15.361 16.988 6.451 5.579 1.916 4.985 [products printing, publishing 1.326 2.527 2.440 2.427 2.369 3.090 1.260 1.750 0.607 1.312 and allied industries industrial chemicals 8.968 14.685 19.051 18.620 16.282 33.086 14.148 11.038 3.941 7.806 other chemical 6.575 5.539 7.129 7.146 7.636 9.871 5.215 1.947 0.827 3.482 ~oducts rubber products 1.542 7.960 8.882 6.850 7.307 6.490 3.731 4.784 1.932 3.660 plastic products, not 3.181 4.892 6.248. 7.393 6.960 7.277 3.645 4.262 1.779 3.144 elsewhere classified pottery, china and 10.531 14.093 18.643 16.216 16.882 13.876 7.493 10.498 2.844 6.282 earthenware glass and glass 16.910 23.100 23.531 20.112 23.829 22.790 7.138 9.796 3.421 8.689 iproducts other non-metallic 16.995 20.295 23.892 26.052 32.903 16.515 8.115 8.115 3.313 9.415 'products iron and steel basic 13.349 13.913 24.010 23.719 28.248 49.209 2j.l44 29.991 9.028 17.876 industries non-ferrous metal 25.672 31.471 41.959 44.116 40.261 60.832 19.289 34.814 i j.l76 19.404 basic industries r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 369 sajems ns vol 4 (2001) no 2 table 6 continued industry: . 1972 1976 1979 1982 1985 1 1988 1991 11993 1996 ave. description fabricated metal 3.147 4.262 5.505 5.736 5.211 6.322 3.256 4.004 1.2791 2.825 products, except machinery and lequipment ~achtnery,except electrical machinery electrical machinery, apparatus, appliances and supplies 2.649 3.121 i 4.324 3.955 4.428 5.202, 2.013 2.902 0.658 1.994 1 ' 2.106! 3.100 4.85114387i4.l79i 4.960 2.339 3.451 0.9l9 2.131 ~otor vehicles, parts i 2.848. 3.185 4.423 4.847 3.496 4.507 1.945 2.915 0.560! 1.372 and accessories ' transport equip11.8251. 2.4231 3.413 1 4.270 3.789 3.007 1.406 1.136 1 1.450 1.993 ment, except motor i ,. i i vehicles, parts and. 1 ii accessories ; professional and 2.992 3.351 3.998 2.515 3.330 3.363 1.563 1.741 0.372 1.229 scientific, measuring and controlling equipment, photographic and optical goods • i i other manufacturing industries 2.092 2.8181 3.093 4.125 3.808 4.38611.7581 2.326 1 0.889 1.567 source: own analysis. 5 production functions for the south african manufacturing sector to calculate the change in production technology in the south african manufacturing sector since 1972, cobb-douglas production functions have been estimated for each of the sample years over the 27 subsectors. the function estimated for each year is given by: qi = eli a c/, ii, with qi = production in subsector i lj = number of labourers employed in subsector i cj ;: capital employed in subsector i ej = error tenn a. elasticity of labour !) ;: elasticity of capital r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2 370 the results of this estimation are reported in table 7. table 7 results of estimation of cobb-douglas production functions for the south african manufacturing sector: 1972-1996 date a ! b a+b c 1972 0.669556 0.276535 0.946091 3.619703 (7.813961) (4.155798) (5.133022) 1976 0.562570 0.366546 0.929116 3.514579 (7.189039) (6.210758) (6.298416) 1979 0.515375 0.425608 0.940983 3.173307 (7.179832) (7.818833) (5.776759) 1982 0.562756 0.398406 0.961162 3.153122 (9.790596) (9.570515) (7.280743) 1985 0.500285 0.382278 0.882563 4.037432 (6.153849) (7.093315) (6.752536) 1988 0.458135 0.423226 0.881361 3.963550 (6.727693) (9.085144) (7.676274) 1991 0.415977 0.480410 0.896387 3.624855 (5.576698) (9.034326) (6.771560) 1993 0.492383 0.392499 0.884882 4.076646 (6.696717) (7.811565) (6.712788) 1996 0.462675 0.451166 0.913841 6.592393 (4.804403) (6.854599) (8.855874) source: own analysis. from table 7 one may conclude that the south african manufacturing sector is producing at constant returns to scale. this is indicated by the sum of the two elasticities (a + 13) which remained approximately 0.9 from 1972 to 1996, and is not statistically significantly different from 1. the most interesting result that emerges from these estimations, however, is that the elasticity of labour decreased significantly from 1972 to 1996. in 1972 the elasticity of labour was 0.66 and it decreased by approximately 30 per cent to 0.46 in 1996. in contrast to this, the elasticity of capital increased by approximately 67 per cent from 0.27 in 1972 to 0.45 in 1996. this indicates that capital's share as input in the production process increased considerably while that of labour decreased. it also implies that labour has been substituted by capital. if the increase in the use of capital results in an increase in the use of electricity, the substitution of capital for labour has an effect on the natural environment through an increase in emissions. this relationship between capital r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 371 sajems ns vol 4 (2001) no 2 as input in the manufacturing sector and the use of electricity in manufacturing will be investigated next. 6 capital and electricity use in the south african manufacturing sector firstly, the correlation coefficients between capital and electricity use from 1972 to 1996, within each subsector, were calculated to test whether a relationship exists between the use of capital in the manufacturing sector and electricity. the results from this estimation are reported in table 8. table 8 correlation coefficients between capital input and energy input in 27 subsectors in the manufacturing sector of south africa: 1972-1996 industry: description i correlation coefficient i between capital input and electricity input food -0.100 beverage industries -0.133 tabacco products i -0.770 textiles ! 0.289 wearing apparel, except footware 0.629 leather and leather products -0.257 footwear -0.207 wood and wood and cork products, except furniture 0.030 furniture and fixtures, except primarily of metal 0.428 paper and paper products 0.688 printing, publishing and allied industries -0.007 ~;. industrial chemicals 0.833 other chemical products 0.707 rubber p.ioducts 0.101 plastic products, not elsewhere classified i 0.817 pottery, china and earthenware i 0.230 glass and glass products 0.217 other non-metallic products 0.774 iron and steel basic industries -0.564 non-ferrous metal basic industries 0.774 fabricated metal products, except machinery and 0.761 equipment r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2372 table 8 continued industry: description correlation coefficient between capital input and electricltv indut machinery, except electrical machinery 0.738 electrical machinery, apparatus, appliances and supplies 0.630 motor vehicles, parts and accessories. -0.031 transport equipment, except motor vehicles, parts and 0.315 accessories professional and scientific, measuring and controlling 0.580 equipment, photographic and optical goods other manufacturing industries 0.360 source: own analysis. these results indicate a positive correlation between capital and electricity input in 19 of the 27 sub sectors. this positive correlation indicates that an increase in capital will result in an increase in electricity input and vice versa. using another form of analysis, the results from the correlation coefficient calculation are confirmed by cross-sectional ordinary least squares estimation of the simple function, e, = a, + rk, + e: • with ej ki ei o'i =: electricity input for subsector i capital input for subsector i error term constant this has been done for all the sample years. the estimated coefficients are reported in table 9, and confirm that an increase in capital does indeed result in an increase in energy input for each of the sample years. in each cross-sectional estimation the coefficient on capital is highly significant as indicated by the tvalues. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 373 sajems ns vol4 (2001) no 2 table 9 results from cross-sectional ordinary least squares estimation of capital on energy input constant i coefficient (t-value adj. rz (t-value in parenthesis) . in parenthesis) 92168.75 0.587700 0.848850 1972 (0.633830) (11.89110) 458800.3 0.407422 0.850220 1976 (2.569611 ) (12.18968) i -6209.79 0.662099 0.917549 1979 (-.242557) (16.70959) 645645.7 0.407459 0.591870 1982 (1.449727) (6.103691) 932277.2 0.342793 0.410409 1985 (1.600755) 4.370171 620388.1 0.713901 0.385599 1988 (0.701271) (4.161447) -5677.44 0.514078 0.601022 1991 (-.1 048) (6.337707) 581618.6 0.457981 0.444243 1993 (0.969181 ) (4.667230) 303616.9 0.615572 0.518659 1996 (0.443322) (5.386630) source: own analysis. the increase in the use of capital over time and across the 27 subsectors thus resulted in an increase in electricity consumption by manufacturing. this conclusion has been reached from the calculation of the correlation coefficients between capital and energy within each subsector over the time period and the estimation of the simple regression of energy on capital across all the subsectors. 7 reduction of electricity consumption in the south african manufacturing sector: some policy options it has been established that the low electricity prices (based on low coal prices) contribute to the high and increasing, but often inefficient, consumption of electricity. this consumption of electricity contributes significantly to the emission of greenhouse gases and other negative social and environmental externalities. since 1970 the production structure in the manufacturing sector, the single most important consumer of electricity with the highest energy r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2· 374 intensity3 of all economic sectors (doppegieter, 1999: 67), has changed dramatically in favour of capital at the expense of labour. the increased use of capital has also contributed to the increased use of electricity as a productive input. furthermore, the price of electricity is a weak policy instrument to manage the consumption of electricity. diesendorf (1996) concludes also that correct pricing of electricity is not sufficient for efficient electricity consumption. since electricity consumption is not sensitive with respect to price, it is likely that a tax on electricity consumption would have little, if any, impact as well. the probable outcome of such a tax is that it would be viewed as an additional cost item and passed on to the fmal consumer, depending on lhe price elasticity of the final product. in such a scenario, there will be high social welfare loss. o'connor (1999: 96) supports this view, arguing that a tax on electricity is only effective if price elasticity is high and substitutes cause less pollution. whalley (1999: 123) is concerned that environmental tax policy may become so complex, that it would be of little use given its difficulty of implementation. another policy option is to prescribe maximum levels of electricity intensity per industrial subsector by legislation. this would mean a cap on electricity consumption per unit of production. such legislation however implies high transaction costs on account of the policing and implementation of such a system, and is open to abuse. the required institutions to implement and manage such environmental legislation in developing countries tend to be weak and ineffective. this further adds to the high transaction cost of this policy option {see also da motta, huber & ruitenbeek, 1999: 184). in principle, a subsidy is an inefficient policy instrument since it causes social welfare losses (rosen, 1998: 295-97). under some circumstances, one could convincingly argue that a subsidy is a temporary measure to facilitate the change between two different policy and operational regimes. such regimes might include a change in technology to bring about a reduction in pollution. in this regard, however, da motta, huber and ruitenbeek (1999: 186) view subsidies for abatement investments as having a limited impact, stating: subsidies for abatement investments have, however, been of limited impact since environmental enforcement has not been effective enough to increase firms' demand for these expenditures. moreover frrms are using these incentives inadequately because of the lack of proper follow-up procedures, in fiscal and environmental terms to monitor their investments. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 375 sajems ns vol 4 (2001) no 2 from the above discussion it follows that conventional policy measures to bring about a change in electricity consumption behaviour of firms are likely to have a negligible effect. this is so, because these policy measures address the symptom of the problem, the electricity consumption and the ensuing emissions, and not the cause, which is an inappropriate production method and high capital intensity of the production structure. murthy, panda and parikh (1997) and pimentel et al. (1994) are convinced that electricity conservation is possible only through a change in technology and the more efficient use of electricity, brought about by a change in the production structure (i.e. capital and labour input) and method. which technological changes. are then required to bring about the desired reduction in electricity consumption? table 10 highlights the main procedures to reduce co2 emissions in manufacturing. these measures are in addition to those offered by doppegieter (1998: 4-66 4-74), van der merwe and scholes (1999), halnaes, callaway and meyer (1999) and the world bank (1998). table 10 selected mechanisms for reducing co2 emissions in manufacturing co2 reduction i application . reduction i need for new mechanisms i i potential . technolo2)' energy intensity i housekeeping (maintei low i low reduction i nance) conservation high medium i fundamental process high high changes energy source • coal/oil to natural gas high low switching fossil fuels to electricity high high co-generation high medium fossil fuels to biomass low i medium flow changes materials recycling high i high i materials substitution i high i high process integration high high source: international energy agency, 1994: 132. from table 10 it may be concluded that technology options for reducing electricity consumption are in fact available. one major objection to the introduction of these technologies would be the additional cost burden that it would imply. this is, however, not necessarily true. south african industry may greatly benefit from international trade using the flexible mechanisms (cj clean development mechanisms (cdm» considered under the banner of global climate change policies within the kyoto protocol framework (see zhang, 2000). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2. 376 south africa acceded to the kyoto protocol on 13 june 200 i. many studies have indicated that developing countries, such as south africa, have a lot to gain from cdm projects (world bank, 2000; oecd, 1999 & kpmg, 2000). pending international agreement on the cdm process and mechanisms, a way does exist of gaining superior, clean, technology without having to pay the full bill 8 conclusion electricity intensity in the south african manufacturing sector is particularly high. this in itself may not be a problem, but it contributes greatly to the generation of electricity, which in turn significantly contributes to the emission of greenhouse gases and other pollutants. these negative externalities have very high social and environmental costs. it is therefore important to reduce the electricity consumption of the manufacturing sector. electricity consumption in the manufacturing industry is, however, not price sensitive. to use price as a policy tool to reduce the consumption of electricity will therefore not contribute much. therefore, to reduce consumption one of three options is available. apply conventional policy mechanisms, use electricity more efficiently through a change in technology or substitute labour for capital. from this study it seems that none of the conventional policy mechanisms, that is, taxes, legislation or subsidies, would achieve the objective of a cost-effective permanent reduction in electricity consumption. the substitution of labour for capital in south africa, however laudable, is likely to be restricted by numerous socio-political factors. the global climate change debate, in terms of the kyoto protocol, and especially the flexible instruments such as clean development mechanisms (cdm) proposed by the protocol, has brought a unique opportunity for south african firms. south african firms can exchange their old technology for a better one, gain in foreign direct investment and contribute to a cleaner environment. this seems an effort well worth investigating. endnotes the authors would like to thank all those who have contributed to this paper, but are solely responsible for all remaining errors and the views expressed here are those of the authors and do not reflect those of the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 377 sajems ns vol 4 (2001) no 2 authors and do not reflect those of any institution that they may be involved with. 2 the price elasticity of electricity demand is calculated as the percentage change in the demand for electricity divided by the percentage change in the price for electricity. this implies that the change in demand is solely due to a change in price. 3 calculated by dividing the real gdp at factor costs by final energy use. references anc (1994) the reconstruction and development programme. johannesburg: umanyano publications. 2 chamber of mines (2000) mining statistics in brief 1999. johannesburg: chamber of mines. 3 da motta, r.s., huber, r.m. & ruitenbeek, r.j. (1999) "market based instruments for environmental policymaking in latin america and the caribbean: lessons from eleven countries", environment and development economics, 4: 177-201. 4 department of minerals and energy (dme) (1995) south african energy statistics no.2. pretoria: department of minerals and energy. 5 department of minerals and energy (dme) (1999) south africa's mineral1ndustry 1998199, pretoria: department of minerals and energy. 6 department of minerals and energy (dme) (2000) south african national energy prices, june 2000, pretoria: department of minerals and energy. 7 dlesendorf, m. (1996) "how can a "competitive" market for electricity be made compatible with the reduction of greenhouse gas emissions?" ecological economics, 17: 33-48. 8 doppegieter, j.1., du toit, j. & liebenberg, j. (1998) energy futures 1998199, stellenbosch: institute for futures research. 9 doppegieter, j.j., du toit, 1. & liebenberg, j. (1999) energy indicators 1999/2000, stellenbosch: institute for futures research. 10 eskom annual report, various issues, johannesburg. 11 halnaes, k., callaway, lm. & meyer, h.l. (1999) economics of greenhouse gas limitations, riso, denmark: unep. 12 houghton, j.j., meiro filho, l.g., callander, b.a., harris, n., ka ttenberg, a.. & maskell, k. (1996) climate change 1995, "the science of climate change. contribution of working group i to the second assessment report (sar) of the intergovernmental r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 2378 panel on climate change (ipcc), cambridge: cambridge university press. 13 international energy agency (1994) energy and environmental technologies to respond. to global climate change concerns, paris: ienoecd. 14 kpmg (2000) south african national strategy study on cdm. unpublished report to the national climate change committee, cape town:kpmg. 15 murthy, n.s., panda, m. & parikh, j. (1997) "economic growth, energy demand and carbon dioxide emissions in india: 1990-2020, environment and development economics, 2: 173-93. 16 national electricity regulator (ner) (t998) lighting up south africa: 199711998, johannesburg: ner. 17 national electricity regulator (ner) various issues. electricity supply statistics, johannesburg: ner 18 o'connor, d. (1999) "applying economic instruments in developing countries: from theory to implementation, environment and development economics, 4: 91-110. 19 organisation for economic co-operation and development (oecd) (1999) implementing domestic tradable permits for environmental protection, paris: oecd. 20 pimentel, d., herdendorf, m., eisenfeld, s., olander, l., carroquino, m., corson, c., mcdade, j., chung, y., cannon, w., roberts, j., bluman, l. & gregg, j. (1994) "achieving a secure energy future: environmental and economic -issues", ecological economics, 9: 201-19. 21 rosen, h.s. (1998) public finance, new york: mcgraw-hill. 22 statistics south africa (stats sa) (1995) census of electricity, gas and steam 1995, pretoria: statistics south africa. 23 statistics south africa (stats sa) various issues, census of manufacturing, pretoria: statistics south africa. 24 united nations framework convention on climate change (unfccc) (2000) the hague 2000: sixth session of the conference of parties un framework convention on climate change. press kit, http://cop6.unfccc.intlpdf/presskc6e2.pdf. 25 van der merwe, m.r & scholes, r.i. (eds.) (1999) sa greenhouse gas inventory, department of environment affairs and tourism: unpublished report. 26 v an horen, c. (1996) counting the social costs: electricity and externalities in south africa. cape town: elan press and uct press. 27 van horen, c. (1997) "cheap energy at v,,'hat cost?" in bethlehem, l. and goldblatt, m. the bottom line, cape town: university of cape town press. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 379 sajems ns vol 4 (2001) no 2 28 whalley, j. (1999) "environmental considerations in tax policy design", environment and development economics, 4: 111-24. 29 world bank. (1998) pollution prevention and abatement handbook 1998, washington, d.c.: world bank. 30 world bank (2000) taxes and tradable permits as instruments for controlling pollution: theory and practice, report no. wp/001l3. washington, d.c.: world bank. 31 zhang, z.x. (2000) "estimating the size of the potential market for the kyoto flexibility mechanisms, weltwirtschaftliches archiv review of world economics, 136(3); 491-521. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 589 -_ ... _-----------------------the effect of organisational leadership on value congruence and effectiveness: an integrated model a s engelbrecht department of industrial psychology, university of stellenbosch abstract the study explores the influence of transactional and transformational leadership on value congruence and leader effectiveness. despite the relevance of a leadership-value congruence relationship, a good theoretical framework is lacking. after a review of literature on each of these areas, an integrated model of the relationships between leadership, value congruence and outcomes, is presented. drawing on previous research, it is proposed that the relationship between leadership and effectiveness be mediated by the efficacy expectancies of followers. it is argued that leader-follower altruistic value congruence would moderate the relationship between transformational leadership and effectiveness. by contrast, leader-follower trading value congruence would moderate the relationship between transactional leadership and effectiveness. based on the leadership-value congruence model, several research propositions are presented for future empirical verification. jel j20, j50, mi2 introduction the ultimate point of studying leadership is to identity good leadership leaders that are both morally and technically good (ciulla, 1998). this research goal is in line with the increasing leadership focus on ethical initiatives and programmes in the business sector (bass, 1998; ciulla, 1998; howell & avolio, 1993; kanungo & mendonca, 1996). it reaffirms the management philosophy that the real role of leadership is to manage the values of an organisation (peters and waterman, 1982). tichy and devanna (1986) found that transformational leaders could articulate a set of core values and exhibit leader behaviour that was congruent with their value system. differences in value systems may explain differences in leadership styles, decisions, goals and behaviour (bass, 1985; bums in ciulla, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 590 sajems ns vol 5 (2002) no 3 1998; yukl, 1998). bass and bums argue that transfonnational and transactional leaders reflect different beliefs, attitudes and behaviours. accordingly, there may be core values that characterise transformational leaders and which, if identified, would distinguish transformational leadership from other leadership styles. it would seem, then, that different leadership styles reflect different value systems. according to house and shamir (1993), followers of transformational leaders are assumed to be motivated by deeply held values and the recognition that these values are shared with their leaders. a high level of value congruence in organisations has long been thought to be a source of job satisfaction, commitment, job proficiency, and long tenure for employees (connor and becker, 1979; meglino, ravlin & adkins, 1989; murry, 1993; o'reilly, chatman & caldwell, 1991; weiss, 1978; yuki, 1998). connor and becker (1979) postulated that the degree of convergence between the values of the leader and the follower is directly related to leadership effectiveness and it is important to link this value congruence with leadership style and job satisfaction. weiss (1978) asserts that people align their values with the values of their leaders if they perceive their leader to be considerate, competent and successful. consequently, the relevance of analysing the work values of organisational leaders is based on the assumption that positive outcomes will result when a leader's values are congruent with those of hislher followers. despite the apparent logic of a leadership-value congruence-leader effectiveness relationship, there is a surprising absence of research on the conceptual and empirical link between value congruence and leadership styles. thus, the interactions between work values and leadership raise a basic research problem to be addressed in this study: does leadership style have such a profound impact on the congruence between a leader and hislher followers on important workrelated values that the level of congruence will enhance or diminish leader effectiveness? both the leadership literature and the work values literature lack a good theoretical framework as to how these two very important areas should be combined. therefore, the aim of this study was to develop a conceptual model of the relationships between leadership styles, value congruence and outcomes upon which researchers can embark on the important empirical verification of the propositions resulted from the model. the first issue, then, to analyse was leadership styles. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 591 transactional and transformational leadership during the past two decades, a paradigm shift in the study of leadership has taken place. house & podsakoff (1994) identified three versions of exemplary leadership, namely charismatic leadership theory (conger & kanungo, 1994; house, 1995), visionary leadership theory (bennis & nanus, 1985; sashkin, 1988), and transformational leadership theory (bass, 1985; bums, 1978; tichy & devanna, 1986). the present study focuses on bass's (1985) theory of transformational leadership, which builds on the earlier ideas of bums (1978). more recently, bass and avolio (1994) have presented a more refined model for a full range of leadership styles. this latter model includes different leadership styles expressed in terms of both transformational leadership (i.e. individualised consideration, intellectual stimulation, inspirational motivation and idealised influence) and transactional leadership orientations (i.e. management-byexception and contingent reward). bums (1978) introduced a model of leadership behaviour that includes transformational and transactional leadership styles to illustrate the two fundamentally different patterns of interaction between leaders and their followers that may occur. according to bums, transactional leadership "occurs when one person takes the initiative in making contact with others for the purpose of an exchange of valued things" (bums, 1978: 20). that means that both leader and follower experience their interaction as simply a transaction in the most instrumental sense of the word (conger & kanungo, 1994). the parties in this relationship have no enduring purpose that holds them together other than the transaction itself (bums, 1978: 20). for bass and avolio (1994), transactional leadership expresses the exchange or transaction that is based on the leader discussing their role requirements with subordinates and specifying the rewards they will receive if they fulfil those requirements. by contrast, a transformational leader engages "with others in such a way that leaders and followers raise one another to higher levels of motivation and morality" (bums, 1978: 20). transformational leadership is an expansion of transactional leadership (bass & avolio, 1994). transformational leadership is based on more than the compliance of followers or the establishment of agreements; it involves shifts in followers' beliefs, values, needs and capacities. transformational leaders inspire and motivate followers to do more than they originally intended and often even more than they thought possible (bass & avolio, 1994). these leaders therefore are capable of eliciting extra-role behaviours from their followers, such as organisational citizenship behaviours (pillai et al., 1999). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 592 sajems ns vol 5 (2002) no 3 transformational leaders stimulate more challenging expectations and typically achieve higher performances than transactional leaders (bass & avolio, 1994; howell & avolio, 1993; yammarino, spangler, & bass, 1993). transformationalleaders will augment transactional leadership by increasing a follower's confidence, elevating the value of outcomes, focusing on satisfying the selfactualisation needs of followers, or focusing on a transcendent interest (bass & avolio, 1994). every leader displays both transformational and transactional leadership to some degree (bass & avolio, 1994). thus, transformational and transactional leadership are conceptually independent dimensions of leadership. however, an optimally performing leader's profile would reveal infrequent displays of laissez-faire leader behaviour with increasing frequencies of transactional leader behaviour, but, most frequently, transformational leader behaviour. the present study attempts to extend previous work on organisational leadership and its relationship with job outcomes, and to integrate research on work motivation and value congruence. we do this by presenting a model of the impact of transformational and transactional leadership on leader effectiveness through follower expectancies and perceptions of value congruence. next, we focus on the underlying value schemes of transformational and transactional leaders. altruistic and trading values in recent years, a substantial amount of research has been devoted to operationally defining and classifying work-related values (chatman, 1991; engelbrecht, 2001; engelbrecht & murry, 1995; schwartz & sagiv, 1995; stackman, pinder & connor, 2000; super & sverko, 1995). super and sverko (1995: 54) define work values as objectives which people seek in satisfying their work needs. likewise, schwartz and sagiv (1995) define personal values as desirable goals, varying in importance, that serve as guiding principles in jlcorle's lives. thus. work values can be thought of as internalised normative bclicf..:; that guide work behaviour. we analysed the typologies of value theorists that claim considerable evidence of construct validity (chatman, 1991; elizur, 1994; ronen, 1994; schwartz & sagiv, 1995; super & sverko, 1995; whitely & england, 1980), and used these as a basis for identifying the underlying value schemes of transformational and transactional leaders. in classifying the values that we have examined in this study, blau's (1964) concept of social exchange, which refers to relationships that involve unspecified future obligations, was found to be very useful. social exchange provides a different basis for casting relationships from economic or r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol5 (2002) no 3 593 transactional exchanges in which the obligations are clearly specified and are more short-term in orientation (pillai et al., 1999). social exchange, like psychological contracts, goes beyond economic exchange and strictly transactional contracts. social exchange explains why subordinates become obligated to their supervisors, and contribute in ways that transcend the requirements of the formal employment contract. bass (1985) clearly identifies transactional leadership as being based on material or economic exchange and transformational leadership as being based on social exchange. while transactional leaders are more inclined to develop economic exchanges with their followers, pillai et al. (1999) also argue that transformational leaders will tend to develop social exchanges with their followers. it is believed that economic exchanges between leaders and followers are mainly guided by trading values (e.g. economic rewards, prestige, results orientation) and social exchanges mainly directed by altruistic values (e.g. collectivism, trust, integrity) (engelbrecht, 2001). we therefore postulate that: proposition 1: transactional leadership is directed more by trading values than altruistic values and transformational leadership more by altruistic values than trading values. figure 1 presents the theoretical model that was developed to integrate the literature and which guides this research. the next section provides an explication of each component of the model and reviews appropriate supporting theory and research. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . figure 1 model of the influence of leadership on value congruence and leader effectiveness • transformational leader-follower ~ altruistic values i'-leadership i== congruence followeroutcomes: organization efficacy ,,. ---. follower cultural i+~ expectancies of " performance values followers and satisfaction congruence ..... ------_ .......... rleader-follower transactional ~ trading values ileadership congruence vi 'i. 00 ~ ttl :: 00 z 00 -< g, vi ,-. n § z o w r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 595 leadersidp. value congruence and leader effectiveness the first part of our theoretical model includes one relationship that has largely been left unexamined: the relationship of transformational and transactional leadership to value congruence. leadership and value congruence apart from the direct impact of values on worker perceptions, attitudes, and behaviours (whitely & england, 1980), another means of influence is through the mechanism of value congruence. value congruence is the tendency for individuals to express greater positive attitudes when they encounter others who exhibit values similar to their own (meglino et al., 1989). leaders become role models that help define the values, beliefs and behaviours that are good and legitimate for the followers to develop (house & podsakoff, 1994). to persuade followers to accept and implement organisational goals, leaders engage in intemalisation or frame alignment. frame alignment refers to the linkage of individual and leader interpretative orientations, to such a degree that some values and beliefs of followers become congruent with and complementary to the leader's goals, values and ideology (house & podsakoff, 1994). typically, frame alignment will occur over time, because of the enduring quality of values (rokeach, 1973). this frame alignment will probably become more clear as the followers have closer interactions with their leaders, and have more exposure to the organisational cultural values. yet, the values shared among employees, especially among senior managerial leaders, form the basis of an organisation's culture (schein, 1992). in this regard, schein (1992) noted the importance of the leader in the transmission of critical organisational values to subordinates over time. bass (1985) suggests that transactional leaders operate by clarifying instrumentalities for their subordinates. thus, the role of the transactional leader is to make rewards (and punishments) clearly contingent on performance and specify the outcomes that the individual can expect in exchange for good performance. we expect that transactional leadership will have a stronger effect on the trading values of followers. our theoretical model therefore shows transactional leadership as positively related to leader-follower trading value congruence. we believe that the transformational leader actively aligns particularly the altruistic values of hislher followers with hislher own through hislher specific r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 596 sajems ns vol 5 (2002) no 3 behaviours. the increasing altruistic value congruence further leads to higher levels of trust based relationships between leaders and followers (engelbrecht and cloete, 2000). transformational leaders may enhance individual perceptions of altruistic value congruence through an emphasis on group solidarity and on the collective mission. this may influence trust in the leader over the long term and followers' tendency to engage in self-sacrificial behaviour. self-sacrificial behaviour is likely to take the form of organisational citizenship behaviours (pillai et al., 1999). trust is more likely to result when a social bond has been created between a subordinate and his or her supervisor (le., in a transformational relationship), than in the case where instrumental judgements, such as outcome favourability, are more salient (i.e., in a transactional relationship) (pillai et ai., 1999). if the trust between a leader and follower is violated, the follower may be more likely to recast the relationship in economic exchange terms. in order to gain trust, build commitment to hislher goals, and elicit extraordinary levels of performance, a transformational leader must be perceived as sharing altruistic values. our model, therefore, shows transformational leadership to be positively related to leader-follower altruistic value congruence. thus, both transactional and transformational leaders may be able to strengthen the value congruence with their followers, but the emphasis may be on different values. we therefore propose that: proposition 2: while transformational leadership has a stronger influence on leader-follower altruistic value congruence, transactional leadership has a stronger effect on leader-follower trading value congruence. value congruence as a moderator between leadership and effectiveness subsequently, the causal relationships between leadership style, leader-follower value congruence, and outcomes or leader effectiveness will be addressed. for this purpose, leader effectiveness is defined in terms of the influence of leader behaviour on follower performance and job satisfaction, particularly satisfaction with the leader. rather than being a substitute, leader-follower value congruence may actually be complementary or additive (chatman, 1991) to leadership style as a determinant of leader effectiveness. conversely, a high level of value incongruence can function as a potential leadership neutraliser (howell, dorfman & kerr, 1986), making it difficult for leaders to influence followers' performance with their style alone. a high level of value congruence in organisations may have a positive impact on job satisfaction, commitment, job performance, and long tenure for employees r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 597 (connor and becker, 1979; meglino, ravlin & adkins, 1989; murry, 1993; o'reilly, chatman & caldwell, 1991; weiss, 1978; yuki, 1998). for meglino and his colleagues, values are shared by leaders and followers through interaction and this sharing is thought to foster commonalities in thinking, communication, and decision-making crucial to the success of the interaction process. weiss (1978) examined the direct effects of value similarity on the superior-subordinate relationship and found value similarity was significantly related to leader consideration, and ratings of leader success and competence. furthermore, murry (1993) found that work value congruence significantly predicted job satisfaction; that is, satisfaction was higher when leaders' values were closer to those of their subordinates. we postulate that the impact of leadership style on outcomes wil1 be moderated by the relationship between the leader and follower based on their level of value congruence. through the process of frame alignment, leaders will transform the value systems of their followers to eventually match their own and the core values of the organisation. this increasing value congruence will have a larger positive effect on leader effectiveness than the direct effect of leadership alone. conversely, low leader-follower value congruence wilt diminish the positive effect of leaders on follower satisfaction and performance. studies have consistently demonstrated an augmenting effect of transformational over transactional leadership on leader outcomes (bass & avolio, 1994). we believe that this augmenting effect can be explained by the ability of transformational leaders to also achieve altruistic value congruence and trust relationships with their followers apart from only trading value congruence. this leads to the following propositions: proposition 3: leader-follower altruistic value congruence will moderate the relationship between transformational leadership and leader effectiveness. proposition 4: leader-follower trading value congruence will moderate the relationship between transactional leadership and leader effectiveness. proposition 5: transformational leaders will have a stronger effect on leader effectiveness than transactional leaders, due to their ability to achieve altruistic value congruence and resulting trust-based relationships with their followers. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 598 sajems ns vol 5 (2002) no 3 expectancies as a mediator between leadership and effectiveness so far, it has been suggested that value congruence may moderate the relationship between leadership and performance. a possibility that we have not considered is that leader behaviours may influence follower expectancies directly as a mediating variable. consequently, the total effects of leadership on follower performance and satisfaction may be the result of a combination of moderated (through value congruence) and mediated (through follower expectancies) effects (see figure i). efficacy expectations determine how much effort followers will expend and how long they will persist in the face of obstacles and aversive experiences (bandura in kanungo & mendonca, 1996). a follower will only have a high degree of task motivation when he or she perceives that efforts to improve performance are likely to be successful and will lead in tum to desirable outcomes (house. 1995; kanungo & mendonca, 1996). thus, the effect of leadership style on follower performance and satisfaction will be influenced by the intervening variable of follower efficacy expectations. specific behaviours of transactional leaders, such as clarifying role expectations, recognising accomplishments, and giving contingent rewards (yuki, 1998), will increase the efficacy expectations of followers that their efforts will lead to the attainment of work goals and desirable rewards (e.g. higher pay, recognition, promotion, sense of achievement). transactional leaders will try to influence the efficacy expectations of followers by primarily using specific influence tactics like exchange, legitimating tactics, and instrumental compliance (yuki, 1998) to motivate followers to higher performance levels. the basic psychological dynamics that seem to operate in the transformational influence process also relate to the enhancement of the followers' self-efficacy beliefs that is, the belief that their efforts to realise the leader's vision will lead to the expected beneficial outcomes (e.g. respect, trust, development). the empowerment strategies of transformational leaders contribute to transforming ihe. self-efficacy beliefs of the followers (kanungo & mendonca, 1996). through these strategies, followers are enabled to perform well beyond the organisalion's expectations (bass, 1985). transformational leaders truly believe that their followers are capable of high performance and therefore have a pygmalion effect on their behaviour (pinder, 1998). transformational leaders act in ways that instil confidence in followers and that result in high performance. accordingly, transformational leaders can create a climate in which followers become engaged in upward efficacy spirals successful performance of a task fuels higher beliefs of self-efficacy that, in r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 599 tum, raise a person's confidence and facilitate further successful performance (pinder, 1998). therefore, transformational leaders will try to influence the efficacy expectations of followers by primarily using influence tactics such as inspirational appeals, rational persuasion, and consultation (yuki, 1998) to strive for excellence and create a high quality work environment. apart from increasing the individual self-efficacy of followers, transformational leaders will also increase the collective self-efficacy (shamir, house & arthur, 1993) of followers to collaborate toward achieving their collective mission. the major premise of bass's (1985) theory of transformational leadership is that follower motivation is enhanced more by transformational leadership than by transactional leadership. thus, our model posits follower expectancies as a mediator of transformational and transactional leadership and effectiveness. consequently, it can be postulated that: proposition 6: transactional leadership enhances the efficacy expectations of followers to strive towards the accomplishment of desirable goal-related rewards, that is the increasing of effort-goal-reward expectancies of followers. proposition 7: transformational leadership enhances the efficacy expectations of followers to strive towards the achievement of desirable vision-related rewards, that is the increasing of effort-vision-reward expectancies of followers. feedback effects of leadership outcomes the outcomes of the leadership process in terms of the degree of follower satisfaction and performance will influence the leader's choice of the appropriate style to use in future. it will determine the manners in which the leader must act to both improve followers' efficacy expectancies and followers' value congruence, to ensure increased performance. thus, our model depicts a feedback loop between leader outcomes and leadership styles. it can be postulated that: proposition 8: outcomes of the leadership process will lead to adjusting transformational leadership relative to transactional leadership. leadership and follower-organization value congruence meglino, i ravlin & adkins (1992) define organisational culture in terms of values, and the concept of strong culture in terms of value congruence among organisational members. o'reilly et al. (1991) propose that congruency between an individual's values and those of an organisation may be the crux of person-culture fit. value congruence is a significant form of person-organisation r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 600 sajems ns vol 5 (2002) no 3 fit, because values are fundamental and relatively enduring and are the components of organisational culture that guide employees' behaviours (chatman, 1991; schein, 1992). guided by schneider's (kristof, 1996) attraction-selection-attrition (asa) framework, individuals' value congruence with organisational leaders and peers can also be used to operationalise person-organisation fit. the asa framework is based on the premise that similar people are attracted to and selected by organisations whose values are similar to their own. the most powerful leaders in organisations can influence the goals and policies of their organisations in directions that are consistent with their own values and needs (stackman et al., 2000). by using the influence process of social identification (shamir et al., 1993), the key leaders can strengthen the shared values among followers and also align the values of their followers with the values of the organisation. thus, the core values of the key leaders in organisations collectively form the core values ofthe organisation. therefore it is proposed that: proposition 9: while transformational leadership has a stronger influence on follower-organisationaj altruistic value congruence, transactional leadership has a stronger effect on follower-organisational trading value congruence. implications and conclusions the aim of the study was to develop a model linking transformational and transactional leadership with value congruence and leader effectiveness by synthesising three main streams of organisational research, namely organisational leadership, work values and work motivation. based on the conceptual model, the study explored the relationships between transactional and transformational leadership, altruistic and trading values, leaders' and followers' value congruence, leadership and motivation of followers, core values of transactional and transformational leaders, leader values and organisational values, leadership and ethics, as well as leadership and leader effectiveness. this study submits that transformational leadership, from an exchange and relational perspective, would have a stronger influence on the altruistic values of their foilowers. conversely, transactional leaders would have a stronger impact on the trading values of their followers. it is believed that transformational leaders influence leader-follower value congruence directly through aligning the altruistic values of foilowers with that of their own. it is further asserted that transactional leadership effects leader-follower value congruence through the aligning of trading values. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 601 the strongest implication of this study is that transfonnational leadership influences leader effectiveness through perceptions of altruistic value congruence. thus, this study found that transfonnational leaders, more than transactional leaders, facilitate perceptions of congruence in altruistic values that build trust in the leader. through these variables, they elicit perfonnance beyond the call of duty (i.e. organisational citizenship behaviours). thus, if leaders want to ensure sustained superior perfonnance among their followers, they should work at improving perceptions of altruistic value congruence. according to kanungo and mendonca (1996), leadership is more likely to be ethical when leaders adopt the transfonnational influence process mode. rather than being unethical, true transfonnational leaders identify the core values and unifying purposes of the organisation and its members, liberate their human potential, and foster plural leadership and effective, satisfied followers (hickman in ciulla, 1998). therefore the argument is put forward that in order to foster moral and ethical transfonnational leader behaviour, altruistic values (e.g. collectivism, benevolence and equity) must extend trading values (e.g. economic security, achievement and advancement). it is further believed that the underlying core values of transfonnational leaders, in particular self-transcendence, developmental orientation, team rewards orientation, empowennent, and interactional justice, would direct socialised and ethical leader behaviour, rather than personalised and unethical behaviour (engelbrecht, 2001). in the present paper, it is recognised that leadership style can have an indirect effect on leader effectiveness either through the process of value congruence or the efficacy expectancies of followers. drawing on previous research, it is asserted that the relationship between leadership and leader effectiveness is mediated by the efficacy expectancies of followers. it is also argued that leaderfollower altruistic value congruence would moderate the relationship between the transfonnational leadership style and leader effectiveness. over time, transfonnational leaders will be able to influence leader-follower value congruence towards the core work values of transfonnational leaders, namely self-transcendence, empowennent, visionary orientation, openness to change, developmental orientation, team rewards orientation, and interactional justice (engelbrecht, 200 i). it is further asserted that leader-follower trading value congruence would moderate the relationship between the transactional leadership style and leader effectiveness. thus, the higher the leader-follower value congruence on selfenhancement, authority, objective orientation, conservation, training orientation, individual reward orientation, and distributive justice (engelbrecht, 2001), the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 602 sajems ns vol 5 (2002) no 3 higher would be the satisfaction and performance of transactional leaders' followers. eventually, the increasing leader-follower value congruence would augment and complement the positive effects of transformational and transactional leader behaviour on follower satisfaction and performance through increasing efficacy expectancies of followers. however, because of the distinctive leadership skills and core values of transformational leaders, they will have a stronger effect than transactional leaders on the efficacy expectancies of followers. altruistic values will also have a stronger inspirational influence than trading values on the performance of followers. consequently, we expect that altruistic value congruence would have a stronger augmentation effect than trading value congruence on leader effectiveness. if there were a maximum value congruency on trading core values, an upper limit would be placed on the influence of transactional leader behaviour on follower satisfaction and performance. in order to break through this upper barrier or ceiling of performance, transactional leaders must be changed to transformational leaders by means of appropriate socialisation practices of the organisation (chatman, 1991; meglino et al., 1992; o'reilly et al., 1991), or through formal training programmes in transformational leadership (bass & avolio, 1994). a question revolves around the extent to which high levels of leader-followers value congruence are good for organisations and workers (chatman, 1991). although it is understood that the core work values of empowerment, openness to change and developmental orientation would somewhat counteract the inclinations to groupthink (janis & mann, 1977), it is evident that there is a need for a maximum level of an ideal value congruency in organisations. the positive outcomes for organisations of a maximum level of ideal value congruence make the effective management of groupthink imperative (hambrick & brandon, 1988; yuki, 1998). in this regard, some value theorists have suggested that the management teams in an organisation should have similar core values but dissimilar cognitive experiences and expertise (hambrick & brandon, 1988). however, empirical research is needed to get to know the circumstances under which homogeneous team values foster or harm organisational performance. in conclusion, the model presented in this paper suggests a number of testable propositions, which, if confirmed, may lend greater insight into the effects of leader behaviour on value congruence and, consequently, on follower satisfaction and performance. the model is intended to be a tentative explanation of the effects of leadership on leader-follower value congruence and r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 603 leader effectiveness only, and does not attempt to include all of the moderating variables that may be relevant. to be effective, the leader should carefully examine the situation, including the competencies and values of the followers, as well as the organisational culture and external environment, and act in ways that will increase the followers' expectancies that effort will lead to highly valued outcomes. references bass, b.m. 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(1998) leadership in organizations. upper saddle river, nj: prentice hall. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . f:\ejour\ecoman\index\ecoman_v6_n2.prn.pdf sajems ns vol 6 (2003) no 2 243 the implementation of performance management in the cape town municipality: 19962000 ________________________________________________________________ robert cameron department of political studies, university of cape town bill sewell performance improvement consultant, partners in change, cape town ________________________________________________________________ abstract the aim of this article is to describe, interpret and critically analyse the political and managerial processes which the newly constituted cape town municipality (ctm) followed in initiating and implementing its performance management approach from 1996-2000. the following research questions were posed: (i) how clearly were the political-administrative vision and values of the ctm formulated and developed? (ii) how was achievement of strategic performance objectives facilitated through management effectiveness and efficiency? (iii) how effectively was a normative framework of international best practice implemented by the ctm? (iv) what was the impact of political and union attitudes and actions on performance management principles and practice? (v) what issues of co-ordination and co-operation were evident in the process? jel j50 introduction the notion of performance management (pm) is a relatively new one in south africa, especially in the public sector. it developed internationally in the past 30 years from its origin in the management by objectives (mbo) approach first enunciated by management writers such as drucker (1954), odiorne (1965) and reddin (1970). in the past decade, mbo has evolved into a more holistic, participative managerial approach, now generally known as ‘ performance management’. performance management has its roots in the private sector. in recent years attempts have been made to transplant it to the public sector, albeit with mixed success (hughes, 1998: 181-7). sajems ns vol 6 (2003) no 2 244 the aim of this article is to describe, interpret and critically analyse the political and managerial processes which the newly constituted ctm followed in initiating and implementing its performance management approach from 19962000. performance management – definitions armstrong (1994: 23) defines performance management as a method of establishing shared understanding about what is to be achieved, and an approach to managing and developing people in a way that increases the probability that defined outputs will be achieved in both the short and longer terms. the overall goal of performance management is to establish an organisational culture in which individuals and teams take responsibility for the continuous improvement of the organisation, and of their own skills and contributions to desired results. williams (1991: 7) states that: ‘the setting of objectives and measurements is the performance management activity which ensures that all employees know what results they need to achieve, to maximise their contribution to the overall business plan. in essence it enables employees to know what is required of them and on what basis their performance contribution will be assessed.’ williams also emphasises (1991: 9) that performance indicators should: • be agreed jointly in advance between the manager and the individual as both realistic and challenging and, as such, they are ‘owned’ • measure the actual level of achievement so that the basis on which performance is assessed can be clearly understood in advance. • support the overall business strategies and values of the organisation so that the performance objectives taken together are mutually supportive and consistent throughout the organisation. the selection of which key performance areas (kpas) and key performance indicators (kpis) are to be used by the organisation is one of the most important strategic decisions that need to be made by the organisation. this decision, and the relative weightings of such indicators will largely determine the shortand long-term strategic focus of the organisation, its management culture, and the performance information systems required (bacal, 1999: 18-19). sajems ns vol 6 (2003) no 2 245 constitutional and policy context chapter 7 of the 1996 constitution of the republic of south africa (rsa, 1996) sets out the objectives and developmental duties of local government. section 152 deals with the objectives of local government, as follows. objectives of local government 152(1) the objectives of lo cal government are: (a) to provide democratic and accountable government for local communities; (b) to ensure the provision of services to communities in a sustainable manner; (c) to promote social and economic development; (d) to promote a safe and healthy environment; and (e) to encourage the involvement of communities and community organisations in the matter of local government. 152(2) a municipality must strive, within its financial and administrative capacity, to achieve the objectives set out in subsection (1). development duties of local government 153 a municipality must: (a) structure and manage its administration and budgeting and planning processes to give priority to the basic needs of the community; and (b) participate in national and provincial development programmes. the white paper on local government (department of provincial affairs and constitutional development, 1998) emphasised the impact which developmental local governments can have on the lives of typical south african communities such as: • provision of housing infrastructure and services • creation of liveable integrated cities, towns and rural areas • local economic development • community empowerment and resource redistribution. amongst the ‘tools’ and ‘approaches’ for developmental local government, the white paper identified significant changes required in the way local government sajems ns vol 6 (2003) no 2 246 works in south africa. three approaches were identified to assist municipalities to become more developmental and effective (p. 26), namely: • integrated development planning and budgeting • performance management • working together with local citizens and partners. flowing out of the white paper was the local government: municipal systems act (rsa: 2000). this act requires municipalities to establish a performance management system that is in line with the objectives, indicators and targets in its integrated development plan to enable it to administer its affairs in an economical, effective, efficient and accountable manner. it needs to be noted that this legislation was not in place when the ctm introduced its pm system. however, the city was influenced by national thinking which was moving towards setting up a pm system. the ctm’s view was that it wanted to be the cutting edge of such pm reform. the new city of cape town 1996-2000 the move towards performance measurement after the cape metropolitan area (cma) local government ‘interim phase’ elections in 1996, the african national congress (anc) emerged as the governing party in the ctm. the ctm was the best resourced of the seven councils (1 metropolitan council and 6 metropolitan local councils) within the cma. the national party (np) had won control of the other 5 metropolitan local councils and of the cape metropolitan council in the greater cape town region (see cameron, 1999). the ctm was the only metropolitan local council in the cma to appoint its chief executive and all executive directors on performance-based contracts with the potential of performance bonuses, rather than on traditional permanent tenure appointments (sewell, 2000: 113). the 1996 municipal election marked the end of racially segregated local government in south africa. in particular, it brought severely disadvantaged african areas under the control of formerly white local government structures. the ctm also faced the enormous challenge of the historical legacy of apartheid, characterised by unequal distribution of services. in some areas of the city infrastructure and basic services were non-existent. this included sanitation, water supply, electricity, street lighting and other infrastructure, as well as municipal amenities such as libraries, community halls and clinics. there was also a severe housing crisis, worsened by high levels of poverty and unemployment (city of cape town: 1999a: 3). sajems ns vol 6 (2003) no 2 247 the ctm had defined its macro organisational design in terms of five executive directorates or departmental ‘clusters’: corporate finances, municipal services, planning and economic development, community development and institutional transformation. these five strategic executives would be led and co-ordinated by a chief executive, forming the executive management team (emt). the chief executive and line executive directors were appointed on a five year performance based contract, while the institutional transformation executive director was appointed with a three year performance related contract, on the assumption that the transformation and organisation development goals would be achieved within a three year period. the new city manager, and the executive directors (eds) were appointed in early 1997 and by the middle of the year their contracts had been finalised, with fairly broad performance related objectives and a commitment to annual performance review and reward. these broad objectives were to strive to ensure that cape town becomes: • a leading city of the world • a prosperous city with a thriving economy • an integrated city, with equal access to facilities and opportunities • a harmonious, safe, orderly and secure city with an attractive natural and built environment • a city in which all of its peoples are able to ensure an optimum quality of life (sewell, 2000: 113-6). the performance contracts also had more specific objectives. for example, the ed for planning and economic developments director’s contract stated that he had to: • plan and ensure the implementation of the city of cape town’s economic development strategy; • plan and ensure the implementation of spatial integration and the management of urbanisation strategies; • plan and ensure the implementation of strategies for the integrated management of built environments; • build and promote the effective use of coalitions for growth and development, through facilitating the establishment of community networks and public -private sector partnerships which facilitate the achievement of the city’s strategies, programmes and budgets; • on an ongoing basis to review, monitor and appraise progress and performance in achieving the fulfilment of agreed plans and budgets and taking appropriate corrective action; • participate in the activities of the executive management team and such other teams as convened from time to time, to conceptualise, plan, integrate, cosajems ns vol 6 (2003) no 2 248 ordinate, implement and monitor corporate policies and strategies (sewell, 2000: 116). comparative perspectives the ctm commissioned a comprehensive international study of successes and failures in public sector and parastatal performance management programmes. a complete analysis of the international lessons learned survey by the ctm is beyond the scope of this paper. what was deduced was that the following components were necessary for an effective and sustainable public sector pm normative framework: • meaningful consultation with community stakeholders in defining priority outcomes and in agreeing performance objectives or indicators • clear definition of ‘customer’ related outputs and outcomes, which the institution can realistically measure and achieve, within its resources • visible political and management commitment and pro-active leadership of the pm process • clear linkages between the organisational performance objectives and individual performance indicators of the appropriate political, strategic and operational management levels • a developmental, rather than a punitive approach • credible achievement measurement criteria • accurate, timeous performance evaluation data and feedback • prompt and commensurate consequences, whether positive or negative • simplicity and flexibility in operation, yet with consistency in measurement standards and consequences. initiation of the performance management system while there had been a thorough international review of comparative best practice of performance management systems, the implementation thereof in the ctm turned out to be rather problematic. as pointed out, the ctm had introduced a pm system before there was any national framework. while local experimentations are not necessarily a problem, the absence of a national framework did in fact mean that the introduction of the cape town pm system was a process of trial and experimentation which contributed to some crucial errors that were made, in the “interim” transformation period of local government, 1996-2000. throughout this period, the pressure and confusion of the ongoing transfer of staff, files, equipment and premises to and from the new ctm and the other newly constituted municipalities made the effective marshalling of resources to sajems ns vol 6 (2003) no 2 249 begin implementing any specific vision or pm system a near impossibility (interview with ctm exco chairperson, july 1997 and sewell, 2000). this lack of focus on pm was reflected in the media reports on the first performance review, carried out in 1998. the eds and city manager were evaluated by the ctm executive committee (exco) on their personal performance and the effective operation of their departments. the city manager is said to have exceeded expectations, receiving a 85 per cent rating from exco. other eds ratings were 85 per cent, 65 per cent and 70 per cent although the ed for planning and economic development was given a performance rating of only 55 per cent. the latter ed challenged this, saying that the process was flawed: his department did not have the necessary resources and did not have enough support in dealing with a ‘difficult’ public. after taking legal advice, exco retracted, publishing a public apology in the local press, acknowledging that the process of performance evaluation was incomplete and a number of serious objections were being considered. exco stated that while it was fully committed to evaluations of the performance of staff to ensure delivery, it had unanimously decided to declare this particular process null and void. it appeared that exco had adopted a subjective set of impressions of achievement, rather than using objective agreed performance criteria indicators. this was a significant setback for the embryonic pm approach and as a result, no performance bonuses were paid to city emt members for 1997/98 (sewell, 2000: 122-3). the ctm then returned to the drawing board and began working on a comprehensive performance management system. each of the 16 directorates were required for the first time to draw up operational business plans within the agreed budget, with performance related objectives and performance indicators. exco also decided to put in place a review process which would entail monitoring and evaluating corporate performance on business plans by means of regular performance review, moving as soon as practical to an individual director level. this review process was necessary in order to track the performance results of individual directors and managers within the framework of their organisational business plans (sewell, 2000: 124-7). the pm programme was ready to be launched and the tender for external consultants to facilitate the process was awarded to ibm’s consulting division; which then seconded a consultant to head the ctm’s transformation staff. as the former ed for institutional transformation had departed, a project team consisting of senior politicians and officials was set up to lead the performance management project. sajems ns vol 6 (2003) no 2 250 deadline dates were agreed, with a view to gaining exco approval for the framework of a performance management programme by march 1999. however, the pm project plan soon began to show cracks. firstly, the ed for institutional transformation had resigned and a former anc councillor (in fact the former ‘political sponsor’ of the pm project) was appointed to the post. this had a number of adverse effects. firstly, the new ed was seen by several officials as a political appointment to promote governing party policy and accordingly did not get management buy-in for the pm process. secondly, the human resources department (hrd) and organisation development and transformation (od&t) department, formerly co-ordinated by the departed ed, began operating autonomously, and strategy and personality differences began to emerge, negatively influencing coherent pm implementation. thirdly, the corporate relationship with ibm consultants began to sour, apparently because of their perceived distance from the practical needs of the council in moving the project forward. fourthly, the level of commitment and ownership required from the executive management team was not always top of their priority list. this was possibly because of the disputed performance rating of the ed which was leaked to the press, and resulted in considerable embarrassment for exco and non-payment of any bonuses to all the emt members. furthermore, 2 eds who had previously been on the permanent staff of the former cape town city council had refused to sign their new performance contracts until they received a written assurance that they would not be financially disadvantaged in terms of their length of service and the benefits to which they were entitled. this was only resolved in 2001. a key element of best practice, namely line management accountability and “ownership” of the pm process, was accordingly absent. this was reflected in an audit of performance management attitudes within the city where only 11 out of 63 directors and branch managers indicated that they would support the introduction of a formalised corporate performance monitoring system (sewell, 2000: 127-30). development of performance management thrust the increasing thrust for a performance management approach developed from the seven strategic political objectives adopted by the cape town city council in 1998, widely publicised as the “commitment to cape town” (sewell, 2000: 118-20): • a framework for the integration of the city: “a common vision for a divided city” • equity and redistribution: “a commitment to fairness for all” • poverty and social disintegration: “helping areas most in need” sajems ns vol 6 (2003) no 2 251 • housing and homelessness: “new solutions for public housing projects” • economic development and job creation: “working for growth and opportunity” • promoting community safety: “teaming up to fight crime” • special high impact projects: “from planning to action” this “commitment to cape town” document was adopted by council as a corporate business plan, emphasising that the seven strategic priorities must be integrated into a coherent plan, driven by three management strategies: • a financial strategy: including new budgeting and reporting processes • a transformation strategy: including human resource development, performance management and change management; • a communications strategy: aimed at internal and external stakeholders. in her budget speech for the “people’s budget” of 1998/1999, the exco chairperson emphasised that the integrated development planning process for the city of cape town was developed within this framework of seven strategic priorities, and pointed out that because of the reduced subsidies from national and provincial government, capital expenditure had to be budgeted at an overall reduction of 10.9 per cent compared with the previous year, and also that council’s personnel budget was under severe pressure. the overall tone of the budget speech underlined the determination of exco to “do more with less”, challenging councillors and management to focus their resources, energies and skills on the services and projects that would deliver most effective and sustainable results, within the framework of the seven strategic objectives. each of the 16 directorates was required to draw up operational business plans within their agreed budgets; with performance objectives and performance indicators for each objective. this was a significant move in the direction of creating a framework for the performance management approach within council’s organisation, because “performance indicators” had seldom been part of the culture of any council department in past years. a “strategic scorecard” for council, exco and emt agendas, was adopted – based on the balanced scorecard approach1. most significantly, in terms of the launching of a formal performance management programme within ctm, was the exco decision to put in place a regular performance review process. this would monitor and evaluate corporate performance on the business plans by means of regular performance reviews at executive management team level … moving “as soon as possible” to an individual management level, in order to track the contributions of individual directors and managers within the framework of their business plans. now came the creation of a powerful and innovative aspect of the ctm business planning and performance improvement process: the concept of sajems ns vol 6 (2003) no 2 252 identifying mission – critical business plan highlights (bph) in each of the business plans, which were politically and operationally vital and which could be resourced and motivated by a “carrot and stick method”. in implementing the 1999/2000 budgets, the focus on key result areas was underscored by reducing all operational budgets by 5 per cent, thus creating a pool of funding which could be used as an extra incentive to directors and branch managers who performed “on track” with their business plan highlights quarterly, and would then be allocated additional funding based on their demonstrated ability to perform. although the total value of the 17 business plan highlights was less than 20 per cent of council’s operational budget, this was regarded as an acceptable proportion in keeping with the pareto or 80/20 principle, familiar to many effective business managers who manage the 20 per cent key deliverables within their businesses, in order to achieve the 80 per cent most significant results. during the ensuring financial year, the system of focussing on and resourcing business plan highlight achievements proved successful and motivational at emt and director level: during a subsequent performance audit, several directors made comments such as “business plan highlighting is a master stroke – it has broken us away from the old incremental budgeting”; and “it’s a hell of an improvement; we are now much more focused and we ask many more questions about cost, service standards and deadlines”. the increased paper work and centralised controls inherent in the ctm system, however, caused some resentment from middle management: “we are gatvol (fed up); we spend too much time regurgitating information … we are being paralysed by paper and process … and it stops us from getting on with our work”. 1999-2000: new budget benchmarks and accelerated performance management as cape town’s 1999/2000 budget was prepared and presented, the seven strategic objectives were clearly defined again as the council’s agenda for equitable service delivery and integrated development. further valuable performance-related research was commissioned in order to provide a more solid basis for understanding community needs and defining performance indicators in the strategic areas, including (sewell, 2000: 132-6): • a 100 page comprehensive and definitive report on “poverty indicators” and the 7 strategic priorities of the city of cape town (isandla institute, 1999) • an extensive residents satisfaction study (nielsen, 1999) which highlighted opinions from civic, community and business organisations throughout the city in terms of their classification of services as “essential”, “necessary”, and “nice to have”. the satisfaction study also enabled community stakeholders to rate council communications, customer service standards and citizens’ willingness to pay for improved services. sajems ns vol 6 (2003) no 2 253 using this data, the business plan highlights were redefined in several cases, and the ctm’s human resource management department was able to begin a skills audit with a view to preparing a comprehensive document entitled “business plan highlights – training strategies”, incorporating a skills development plan process linked to council’s employment equity plan to redress former apartheid job discrimination. a major project was launched to focus on the core competencies required by council management and key staff, as a possible basis for equitable selection, internal promotion and staff development programmes. as the year 2000 progressed, however, increasing political pressure (doubtless in the light of the looming municipal elections) was evident; and the city manager commissioned an independent performance audit team to verify the latest business plan highlights and capital project reports submitted in january 2000, so that the emt and exco could be assured that valid performance measurement information was in fact flowing through to them. the report of the independent performance audit, however, was not at all reassuring to emt and exco leadership; neither in terms of the verification of figures and key performance area objectives, nor in terms of the achievement of required performance indicators for the various business plan highlights and capital programmes. the main findings of the performance audit to emt were as follows: • business plan expenditure and projected results were “suspect”, as approximately 95 per cent of the sample of branches audited indicated that 100 per cent of their budgets would be spent by year end, despite an average of only 15 per cent actual expenditure reflected for the six month period under review. “it was highly unlikely, therefore, that such a large backlog could be recovered in the second six months of the financial year”. • the business plan highlight scorecards were not always completed in a standardised manner and “the expenditure reflected and projections made could therefore not be used as an effective performance measuring tool for future decision making” • with regard to the specific performance indicators on the various business plan highlights, the review form given to directors and managers did not ask for any indicator information, and so “it was therefore not possible to verify their achievement or otherwise”. as a direct consequence of this performance audit report, the processes of monitoring, tracking and reviewing the organisational performance indicators had to be further refined and simplified, seeking to achieve the full benefits of the performance management thrust; and also to maintain an acceptable level of credibility, motivation and implementation by directors and managers. sajems ns vol 6 (2003) no 2 254 the exco chairperson made a telling point in his remarks to a subsequent exco/emt bosberaad (strategic review workshop) that unlike politicians, who will “soon undergo the ultimate performance audit – an election”, senior management in the ctm had not yet had their performance appraised. ironically, he did not reflect that this was in fact the employer’s responsibility in terms of the emt contracts. flowing from this bosberaad, a further refinement to the business plan highlights was prepared for the coming year, and revised performance indicators and objectives were set for the preparation of the 2000/2001 council budget. decisions were also made to prepare performance reviews for the city manager and each executive director; and to prepare practical training sessions for all branch managers in the philosophy and practical application of performance management for implementation in their branches. this planned roll out during 2000 was destined not to happen, however – for a combination of reasons, as it later emerged in the study: increasing pre-election pressure to deliver left little time for reviewing results and training middle management in the essential interactive skills of performance improvement in their branches; and a growing reluctance to discuss actual achievements was evident, in the light of the fact that few specific performance objectives had actually been agreed between exco and emt members, against which they could equitably be assessed. given that the two eds formerly on permanent staff had still not signed their 1997 performance agreements, it was apparently decided not to pursue the performance reviews, and the process of assessing actual performance, reviewing skills development needs and resource deployment ultimately took second place to the public promotion of council achievements, as the unicity election programme began to take centre stage in the minds of politicians and professional managers alike. as one of the eds put it: “why should i expose myself to a performance review at this stage? with elections just around the corner, and the possib ility of a new council employer – that could be a career limiting event!” evaluation of ctm’s performance management system how effectively and efficiently did the ctm initiate and implement its performance management system? this analysis is based on the perusal of primary documents and a set of qualitative interviews held with senior ctm officials and managers. 1. how clearly were the political-administrative vision and values of the cape town municipality formulated and developed? on the balance of the evidence it can be suggested that the ctm’s political vision, core values and strategic priorities were carefully formulated, sajems ns vol 6 (2003) no 2 255 consistently communicated to the stakeholders and reviewed regularly with senior management and communities as the basis of cape town’s public commitment to performance. 2. how was the achievement of strategic performance objectives facilitated through management effectiveness and efficiency? possibly because of their inexperience in the design and implementation of performance management processes, political leadership and executive management did not adequately build in fundamental pm processes. they allowed a very complex set of organisational performance indicators, framework and centralised reviews to be brought into being which led to long emt and exco meetings, some of which time could have been used more productively in devolving accountability to, and developing operational pm skills at director and branch manager levels. the ctm’s political/administrative management was neither optimally effective nor efficient in achieving its planned strategic implementation of transformation and performance management objectives. indications of why there was underachievement are discussed hereunder. 3. how effectively was a normative framework of international best practice implemented by cape town? within the framework of international best practice research, and the components identified by several exco and emt performance improvement workshops, the following conclusions can be reached on how effectively the ctm implemented its stated pm approach: (i) meaningful consultation with community stakeholders in defining priority outcomes and in agreeing performance objectives and indicators. there was generally much consultation and ongoing annual public information campaigns, including pre-budget consultation meetings which were held on a large scale as part of the ‘commitment to cape town’ theme of the pm programme. civic organisations indicated that the flow of information generated was unprecedented and provided much meaningful feedback to council’s exco and emt for performance planning and review. the data does, however, suggest that municipal trade unions were seldom consulted for their inputs on performance priorities and indicators. sajems ns vol 6 (2003) no 2 256 (ii) clear definition of ‘customer-related’ outputs and outcomes which the institution can realistically measure and achieve, within its resources. this component was generally positive. for example, the 2000/2001 business plan manual (city council of cape town, 1999b) for the first time defined departmental outputs and medium-term outcomes for almost every council function, not always readily measurable at the time, but indicating the future information database necessary for measurement. (iii) visible political and management commitment and pro-active leadership of the pm process. exco and emt commitment to the pm process was evident from the conceptual origins of the pm programme in early 1997, when the new emt was appointed on the basis of broad performance competencies and contractual criteria. the pro-active emt management leadership lost momentum from late 1998, however, after the public retraction of ed performance reviews, which had still not been systematically undertaken by 2000. this lack of meaningful consequences of performance, and the reluctance of two eds to sign their performance contracts until the resolution of their questions regarding their former service conditions, undoubtedly diminished ‘ownership’, motivation and commitment of senior management to the pm process and products. (iv) clear linkages between the organisational performance objectives and individual performance indicators at the appropriate political, strategic and operational management level. one major shortcoming was that no direct linkage was established between cape town’s institutional and individual performance agreements, below ed level. the ed individual “performance scorecards” were not consummated after the october 1998 objections and apology; and were not further implemented, pending resolution of legal queries on two ed performance contracts. the process of developing a “performance management culture” was not extended to the next levels of management, by re-focussing their job descriptions on outputs linked to the organisational business plans. (v) a developmental rather than a punitive approach the conceptual process of effective pm encourages continuous performance feedback, improvement and development. observations, however, showed that senior ctm managers had a punitive culture i.e. ‘to performance manage’ was typically understood to connote ‘taking disciplinary or punitive action’, rather than coaching, developing or supporting performance improvement. sajems ns vol 6 (2003) no 2 257 (vi) credible, achievable measurement criteria the issue of identifying and effectively using credible performance indicators or management criteria for council’s strategic priority outcomes and business plan objectives proved to be difficult. firstly, the ctm strategic priorities related largely to long-term outcomes which were measured through specifically commissioned surveys and national census data, which was not necessarily available by local municipal areas. secondly, the lack of previous experience in defining performance indicators and negotiating realistic targets for council’s wide range of services led to many hours of heated debates at political and managerial workshops, regarding the relevance, validity and achievability of alternative performance criteria. a further concern was that the 17 business plan highlights which together with the capital development projects, formed the main pm thrust for cape town, represented only 20 per cent of total city expenditure and did not involve all branches in the pm process. (vii) accurate, timeous performance evaluation data and feedback one of the most essential components of the pm conceptual model is the existence and use of accurate and timeous evaluation data, so that recognition, reinforcement or corrective action can contribute to performance management. this component was not often evident in cape town’s pioneering pm programme. probably, the most serious gap was the archaic financial reporting system, which was never less than two months in arrears, thus making prompt reaction to financial performance data out of the question. (viii) prompt, commensurate consequences, whether positive or negative the lack of meaningful consequences to reinforce team or individual achievement and behaviour was recognised by most officials interviewed as a serious shortcoming in the cape town pm pilot process. for example, at emt level, the exco failure to resolve disputes regarding the two eds’ performance contracts and to implement individual ed performance contracts, meant that there were no performance bonuses paid out in terms of their contracts to the city manager and the eds. this was described by these senior officials as a very demotivating situation, given that they had foregone the usual guaranteed thirteenth cheque ‘bonus’ in accepting the challenge of a fixed-period performance-based contract (sewell, 2000: 188-204). sajems ns vol 6 (2003) no 2 258 there was a serious lack of co-ordination, co-operation and trust between the hrd and the od&t departments. this led to significant dysfunctionality and lack of effective integration between the desired thrust of pm, and the existing personnel management processes which needed to be linked in to pm, several of which (such as job descriptions, competence definitions, skills development, career management, recruitment and selection and employment equity) were located in the human resource function (sewell, 2000: 188-206). (ix) simplicity and flexibility in operation, yet with consistency in measurement standards and consequences. central to the ctm performance management programme was a series of corporately identified business improvement projects, aimed at simplifying and streamlining customer service and administrative efficiency. all senior management respondents interviewed (may/june 2000) who had been involved in id entifying and implementing these projects, confirmed their value in terms of saving time, money and facilitating improved staff motivation and service delivery levels. almost all of these senior officials, however, commented on the perceived complexity of the organisational pm tracking and review processes, indicating a high level of frustration with the ‘huge volume of paper produced by the planning and reporting’ and the ‘chopping and changing of objectives and systems’. (4) what was the impact of political and union attitudes and actions on performance management principles and practice? proactive political leadership from exco was always a positive factor in the direction of the ctm organisational performance management. exco worked closely with the executive management team in promoting the cape town mission, vision and seven strategic priorities. the political-administrative interactions of the ctm standing committees, however, were not similarly proactive or productive. the perception was expressed by several senior managers and union leaders that a ‘punitive approach’ was too frequently observed in the interactions between politicians and management. the phrase ‘we must performance manage him’ was heard at various meetings with the connotation of disciplining or taking strong corrective action against an unco-operative staff member. several senior managers also expressed concern at the blurring of the politicaladministrative roles through the appointment of a former politician as the project sajems ns vol 6 (2003) no 2 259 leader in charge of performance management. several directors and managers found this blurring to be problematic, because the person concerned was perceived to be participating actively in political caucuses, influencing the opinions of politicians about officials’ performance, competence and commitment. union support for the performance management process (as reflected in interviews in may/june 2000, towards the end of the research period) was at best lukewarm; confined to broad support for organisational goal setting and productivity improvement, but firmly against translating organisational objectives into ‘subjective’ measurable individual accountability, which might affect union members’ career scope. conclusion based on the foregoing discussion, the following conclusions can be made regarding the processes adopted by the cape town municipality to implement their pm system from 1996 until 2000. • the performance management concepts, approaches and tools used by the ctm were politically and theoretically appropriate at organisational level, though not effectively operationalised to achieve real management ownership, accountability, motivation and commitment. • the development of the city’s vision, mission and strategic priorities as a platform for integrated development planning was done with considerable community consultation by political leadership and executive management. a high level of awareness of these strategic priorities was achieved, certainly at senior management level and possibly amongst the majority of the council managerial staff. it refocused the energies and resource allocation of ctm management on defined outputs and outcomes, rather than on mere administrative effort. • the planned cascading of performance indicators from organisational business plans to team and individual managers accountable for performance outputs did not happen. it is likely that little more will be done at individual pm level until the specifics of the process are agreed with the trade unions. • ctm political exco and emt officials have initiated and participated in community and sectoral progress reviews with a range of stakeholder groups. • it is difficult to assess accurately (without comprehensive staff attitude surveys) whether the ctm organisational culture has become more performance-aware or results-driven from branch manager level down. although the focus on bphs and capital projects has contributed to a higher sajems ns vol 6 (2003) no 2 260 level of performance awareness and accountability for results, this is only evident in these branches where these pm processes were implemented. • without clear definition of relevant, measurable indicators and benchmarks to monitor and motivate performance, no municipal pm approach can achieve the desired sustainable results. a great deal of thorough research and experienced thought at organisation level went into the selection of kpis for the bphs. a significant problem was that the archaic municipal information systems did not facilitate timeous, accurate reporting on many of these performance indicators. this was mitigated by the fact that several senior managers instituted their own manual kpi information monitoring and reporting systems. this made meaningful follow-up, diagnosis and corrective action possible in those branches. • acceptable methods have yet to be worked out for the conversion of permanent career appointments to fixed-period performance-based contracts; as shown by the legal complexity of the non-resolution of two cape town eds’ unsigned contracts. non-payment of ed performance bonuses and lack of agreed specific performance criteria and consequences by the council as employer unfortunately became a disincentive; and led to diminished management support for the effective implementation of performance management, despite all the enthusiasm and drive of political leadership in the city council. endnotes 1 the balance scorecard is a performance measurement approach which enables organisations to define their strategic focus in terms of four key “perspectives”, (or “strategic themes”) whic h need to be “balanced” for sustainable performance, namely: financial, customer, internal business processes and staff learning and growth perspectives. the alignment of organisational with individual scorecard objectives, and identification of linkages between various functions or departments, are essential for the balanced allocation of resources and co-ordination of potentially conflicting strategies, in a complex organisation. 2 initially designed for application to the for-profit (private) sector, where the emphasis on financial profitability objectives is paramount, the authors subsequently developed a modified version of the balanced scorecard tool for not-for-profit and public sector organisations, notably pioneered by the city of charlotte, usa (kaplan, 1999). sajems ns vol 6 (2003) no 2 261 references 1 armstrong, m. (1994) performance management, london: kogan page. 2 bacal, r. (1999) performance management, new york: mcgraw-hill. 3 cameron, r.g. (1999) democratisation of south african local government. a tale of three cities, pretoria: j.l. van schaik. 4 city of cape town (1999a) mid term review: a city in transition, cape town. 5 city of cape town (1999b) city of cape town: business plan manual 2000/2001, cape town: city council of cape town, city manager’s office. 6 druker, p. (1954) the practice of management, maidenhead: mcgraw-hill. 7 hughes, o. (1998) public administration and management. an introduction (2nd ed.) basingstoke: macmillan. 8 isandla institute (1999) key performance indicators: poverty indicators and the seven strategic priorities of the city of cape town, report prepared for the organisational development and transformation unit, cape town: cape town city council. 9 kaplan, r. (1999) the balanced scorecard for public-sector organisations, boston: harvard school press. 10 nielson, c. (1999) resident satisfaction study for the city of cape town, cape town: nielsen company. 11 odiorne, g. (1965) management by objectives, new york: pitman. 12 provincial affairs and constitutional development (1998) the white paper on local government, pretoria: government printer. 13 reddin, w.j. (1970) effective management by objectives, new york: mcgraw-hill. 14 republic of south africa (1996) the constitution of the republic of south africa, act no. 108 of 1996, cape town: government printers. 15 sewell, w.j. (2000) “performance management in the cape town municipality, 1996-2000: transformation towards effectiveness, efficiency and equity”, unpublished masters of public administration thesis, university of cape town. 16 williams, s. (1991) ‘strategy and objectives’ in neale, f. (ed.) the handbook of performance management, london: institute of personnel management. abstract introduction literature review method results discussion, conclusion and areas for future research acknowledgements references appendix 1 footnotes about the author(s) marianne kok school of accountancy, faculty commerce, law and management, university of the witwatersrand, johannesburg, south africa warren maroun school of accountancy, faculty commerce, law and management, university of the witwatersrand, johannesburg, south africa citation kok, m. & maroun, w., 2021, ‘not all experts are equal in the eyes of the international auditing and assurance standards board: on the application of isa510 and isa620 by south african registered auditors’, south african journal of economic and management sciences 24(1), a3784. https://doi.org/10.4102/sajems.v24i1.3784 original research not all experts are equal in the eyes of the international auditing and assurance standards board: on the application of isa510 and isa620 by south african registered auditors marianne kok, warren maroun received: 28 july 2020; accepted: 30 nov. 2020; published: 18 mar. 2021 copyright: © 2021. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the article focuses on inconsistencies in audit approaches when auditors place reliance on the work performed by others. it examines differences in the approach followed by auditors when relying on the work of a predecessor versus the work of an auditor’s expert. setting: the study contributes to the limited body of auditing research focusing on the technical application of international auditing standards and the functioning of actual audit practice in a south african context. it outlines how auditors apply their professional judgement when using technical auditing standards when comparing the work of a similarly trained expert in the field of accounting and auditing (per isa510) versus the work of an expert in a field other than accounting and auditing (per isa620). aim: the purpose of this article is to examine and identify inconsistencies in the interpretation and application of isa510 and isa620 by a purposefully selected number of registered auditors in south africa. it considers how inconsistencies in the approach followed when an auditor places reliance on the work of another auditor or an auditor’s expert points to underlying efforts to seek legitimacy and manage legal liability. method: detailed interviews are used to explore auditors’ experiences and challenges with the application of these two isas. results: audit quality is not necessarily a function of compliance with professional standards. while isa510 and isa620 deal with a situation where an auditor places reliance on the work of a third party, they are interpreted and applied very differently. conclusion: the application of isa510 is part of a rules-based approach to auditing aimed at reducing an auditor’s legal liability rather than enhancing audit quality. the same logic applies to isa620 except that auditors perceive that their risk exposure is lower because the standard is limited to a single transaction or balance rather than to the entire audit engagement. the application of isa620 is also useful for convincing internal reviewers, external regulators or audit committees that sufficient appropriate evidence for a complex line item has been obtained. the need to ensure a more robust process for testing complex balances and transactions is not, however, the primary consideration. regulators and standard setters should not assume that compliance with auditing standards results in better quality audits. at the operational level, the need to manage legal liability and to signal the credibility of test procedures may be more relevant for the execution of audits than ensuring that audit opinions are supported by sufficient appropriate audit evidence. as only two standards, applied in a single jurisdiction, are used to illustrate this point, additional research will be required to determine the extent of inconsistency in the application of auditing standards and how this can result in lower levels of audit quality. keywords: auditor’s expert; audit quality; international auditing and assurance standards board; iaasb; predecessor auditor. introduction users, auditors, regulators and general society have different views on audit quality. users think that high audit quality means the absence of any misstatements in financial information. regulators tend to view high audit quality as compliance with professional standards (christensen et al. 2016; defond & zhang 2014; knechel et al. 2012). the auditor may define high audit quality according to their internally developed audit approaches or methodologies. these evolve as society’s information needs change, amendments to regulatory requirements are introduced and clients’ value creation processes mature (peecher, schwartz & solomon 2007). key for defining and evaluating audit quality are the provisions of the applicable auditing standards. considerable time and effort are invested in the development and improvement of technical guidelines (burns & fogarty 2010; byington & sutton 1991; humphrey, loft & woods 2009). while these have not been able to prevent every corporate failure, the codification of acceptable audit practice has been important for ensuring consistent execution of audit engagements, monitoring and review of audit practice and minimum levels of audit quality (see also humphrey et al. 2011; maroun & solomon 2014; power 2003a). an example is the framework on audit quality issued by the international auditing and assurance standards board (iaasb). the objectives of the framework are to raise awareness about the key elements of audit quality, encourage ways to improve audit quality and facilitate dialogue among key stakeholders (iaasb 2014). the framework is complemented by international standards on quality control (isqc1) – which deals with the development and maintenance of quality designed to provide a governance schematic for audit firms – and quality control for audit of financial statements (isa220), which guides quality control at the engagement level (bedard et al. 2008). collectively, these standards are designed to address each ‘element’ of the audit quality paradigm. exactly how standards impact audit practice has not been considered in detail. we know very little about how audit firms interpret and apply professional standards to ensure high-quality audit engagements. the majority of international research focuses on inputs or variables that may affect audit quality such as the size of the audit firm (deangelo 1981; lawrence, minutti-meza & zhang 2011), length of audit tenure (geiger & raghunandan 2002; jackson, moldrich & roebuck 2008), legislation (kleinman, lin & palmon 2014) and different skills of engagement leaders (martinov-bennie & pflugrath 2009; nelson 2009; simnett, carson & vanstraelen 2016). the outputs of the audit process have also been tested extensively. for example, there is a large body of work that deals with the effect of external audit on earnings quality (becker et al. 1998; piot & janin 2007), the accuracy of going concern reports (carson et al. 2012; geiger & rama 2006) and recommendations for changes in the content and structure of different audit reports (mock et al. 2012; turner et al. 2010). technical analysis of audit processes appears to have been overlooked (maroun & jonker 2014). with the above points in mind, the objectives of the current article are twofold. the first is to present the interpretation and application of isa510 and isa620 by registered auditors (ras). the second is to explore inconsistencies in approaches followed when applying the two standards. the study focuses specifically on isa510 and isa620 because of curious differences in the approach that is followed when an auditor places reliance on the work of another auditor or an auditor’s expert. in substance, the standards deal with a similar situation: an auditor is placing reliance on the work of a third party to collect sufficient appropriate audit evidence. nevertheless, as discussed below, it appears that relying on the work of an auditor’s expert is less onerous than placing reliance on the work of another auditor. this is despite the fact that a fellow auditor would be subject to the same technical training, professional development and regulatory oversight as the incumbent. in this context, differences in the two standards, coupled with variations in how they are interpreted and applied in practice, can reveal factors (other than the technical requirements in auditing standards) that affect the audit process. the researchers acknowledge that other standards, notably isa610, also involve an auditor placing reliance on the work of others. these standards are not specially considered in this article because, at the time of writing, the use of isa510 and isa620 was more common following the south african regulator’s decision to introduce mandatory firm rotation (effective in south africa from 2023). as with any research of this type, delimitations are also required to retain focus. a more detailed review of inconsistencies in the isas and differences between the isas and other assurance standards is deferred for future research. despite the above delimitation, the article makes an important contribution. it provides empirical evidence on how auditing standards are being interpreted and applied by ras in a real-world setting, adding to the limited body of interpretive research on auditing (power 2003b) especially from a south african perspective (maroun & jonker 2014). the research also identifies key considerations for the application of two commonly used auditing standards (including key risk areas), challenges encountered and technical inconsistencies. these findings will be useful for auditors seeking to improve audit quality and for standard setters who need to ensure internal consistency of audit practice. the remainder of this article is organised as follows: a review of the applicable academic and professional literature, and a summary of the method followed and the rationale for using an exploratory research design. then the findings are discussed followed by the conclusion and ideas for further research. literature review to obtain reasonable assurance, the auditor must gain an understanding of the client, its business environment and relevant internal controls (bentley, omer & sharp 2013; iaasb 2013, 2019). this will entail performing risk assessment procedures in the audit planning phase to assess the risks of material misstatement at the overall and assertion level (iaasb 2019), following which the auditor designs suitable test procedures to reduce audit risk to an acceptably low level (hogan & wilkins 2008; iaasb 2009f). audit risk is the risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated. as audit risk is a function of the risk of material misstatement and detection risk (iaasb 2009b:para 5) it is important to gather sufficient appropriate audit evidence to ultimately support the auditor’s opinion (iaasb 2009g). of interest for this research is the application of isa510 and isa620 as part of the process of reducing audit risk. isa510 – initial audit engagements isa510 deals with three areas: opening balances, consistency of accounting policies and relevant information in the predecessor auditor’s report (iaasb 2009h:para 5,7–9). the standard should be read with isa300 which refers to quality control for an audit of financial statements and communicating with the predecessor auditor when there has been a change of auditors (iaasb 2009e:para 13). procedures for evaluating opening balances include: (1) the review of the predecessor auditor’s workpapers to obtain evidence regarding the opening balances, (2) evaluating whether or not audit procedures performed in the current period provide evidence relevant to opening balances or (3) performing specific audit procedures to obtain evidence regarding opening balances (iaasb 2009h:para 6(c)(i)–(iii)). the review of the predecessor auditor’s workpapers is influenced by the professional competence and independence of the predecessor auditor (iaasb 2009h:para 4; ifac 2008). the requirement to consider the independence and competence of the predecessor auditor appears similar to the guidance provided in isa600. however, the iaasb asserts that an incoming auditor is not to place reliance on the work of a predecessor auditor while, in isa600, an auditor may place reliance on the work of a component auditor (international federation of accountants [ifac] 2008). in evaluating the work of the predecessor auditor, the auditor applies professional judgement and professional scepticism. the former stems from the application of rigorous formal training, knowledge and experience (jones, massey & thorne 2003; nelson 2009). both the incoming and predecessor auditor’s ethical standards affect the application of professional judgement. finally, if the incoming auditor could not obtain sufficient appropriate audit evidence regarding opening balances, the auditor will modify the audit opinion (iaasb 2009h:para 10). isa620 – using the work of an auditor’s expert if an auditor has limited expert knowledge to obtain sufficient appropriate audit evidence, the assistance of an auditor’s expert will be considered. the application of isa620 is summarised as follows: firstly, the auditor is required to assess whether expertise in fields other than accounting or auditing is required. if so, the auditor will determine whether or not to use the work of an auditor’s expert (iaasb 2009i:para 7). secondly, when an auditor’s expert is used, the nature, timing and extent of audit procedures should consider factors such as the nature of the matter to which that expert’s work relates, the associated risks of material misstatement and the significance of that expert’s work (iaasb 2009i:para 8(a)–(e)). thirdly, the auditor will evaluate if the auditor’s expert has the necessary competence, capabilities and objectivity for the auditor’s purposes. in the case of an auditor’s external expert, an evaluation of objectivity will include inquiry regarding interests and relationships that may create a threat to that expert’s objectivity (iaasb 2009i:para 9). fourthly, the auditor will obtain a sufficient understanding of the field of expertise of the auditor’s expert to enable the auditor to determine the nature, scope and objectives of that expert’s work and evaluate the adequacy of work performed (iaasb 2009i:para 10(a)–(b)). finally, the auditor will agree in writing on relevant matters with the auditor’s expert. these include, for example, the nature, scope and objectives of that expert’s work (iaasb 2009i:para 11(a)–(d)). the auditor must evaluate the adequacy of the auditor’s expert’s work (iaasb 2009i:para 13, a38–a39). if the auditor determines that the work of the auditor’s expert is inadequate for the auditor’s purposes, the auditor will agree with that expert on the nature and extent of further work to be performed by that expert or perform additional audit procedures (iaasb 2009i:para 13). the auditor will not usually refer to the work of an auditor’s expert in an auditor’s report containing an unmodified opinion unless required by law or regulation to do so (iaasb 2009i:para 15, a42). comparison of isa510 and isa620 table 1 shows a comparison of isa510 and isa620 in terms of audit activity and process. table 1: comparison of isa510 and isa620. the difference in the application of audit standards from an agency theory perspective, external audits play a key role in addressing information asymmetry (watts & zimmerman 1983). it follows that, as the risk that financial statements are misstated increases, the auditor must perform more rigorous and extensive testing to avoid issuing an incorrect audit opinion (iaasb 2009a) and ensure that agency-related costs are mitigated (watts & zimmerman 1983). for example, an increase in risks of material misstatement might be addressed by relying on more substantive tests, in addition to tests of controls, which are designed to collect audit evidence over extended periods based on larger sample sizes (iaasb 2009f, 2009g, 2013). similarly, the decision to engage an expert to test complex balances and transactions and the work performed by the auditor to corroborate the expert’s findings should be informed by the assessed level of audit risk (iaasb 2009h, 2013, 2018). the same logic should apply when it comes to the nature and extent of the work performed by an incoming auditor to support conclusions on opening balances tested by the predecessor auditor (iaasb 2009h). as a result, variations in the process followed by an auditor before deciding to rely on the work of either an expert or another auditor should reflect the differences in the risks of material misstatements going undetected. an audit of financial statements is not only a technical function designed to reduce agency costs. as explained by power (1991, 1994, 1995) and humphrey and moizer (1990), an audit can only confer legitimacy on financial reporting if the audit itself is accepted as legitimate. as a result, the ‘rituals of verification’ may be more important than the technical operation of the audit process itself (power 2003b; unerman & o’dwyer 2004). this is especially true when considering that the users of the audit report are unable to observe exactly how an audit has been executed. they must rely on the good-faith assumption that, because an audit was conducted by an independent expert exercising due care and skill, that audit results in more reliable financial reporting (power 2003b; unerman & o’dwyer 2004). consequently, the application of auditing standards may have more to do with demonstrable displays of compliance with the respective standards to reassure the user of an audit report than with the substantive reduction of audit risk (power 2003b; unerman & o’dwyer 2004). managing legal liability is a key part of this ceremonial process. legal disputes with clients and third parties can result in direct and material financial losses for an auditor. claims of negligence or professional misconduct are also a powerful signal of poor audit quality (palmrose 1988, 1997). they can have adverse implications for professional reputation and the confidence that users of an audit report and non-experts vest in the practitioner. as a result, the implementation of auditing standards, including those dealing with the use of experts and the work of other auditors, will be influenced by the need to mitigate legal liability in addition to reducing audit risk for technical purposes (botez 2008). before exploring this possibility in more detail the following section outlines the approach followed to collect and analyse data. method as explained by o’dwyer et al. (2011:38), a qualitative approach is most appropriate when examining seldom studied issues.1 qualitative research designs are well suited to exploring processes, techniques and practices where relationships cannot be defined and measured in a positivist sense. an interpretive approach to collecting and analysing data allows the researchers to highlight how the technical requirements of isa510 and isa620 are understood and operationalised in different practical contexts and reveal any inconsistencies in their application (see brennan & solomon 2008; maroun 2012; o’dwyer et al. 2011; thomas 2006). the intention is not to generalise or extrapolate results but to explore auditors’ views on two important but seldom studied professional standards and how these standards influence audit practice in a real-world setting (see brennan & solomon 2008; o’dwyer et al 2011; rowley 2012). data collection purposeful sampling was used to select respondents. all respondents are ras. their experience and the sectors that they audit are summarised in appendix 1. the sample consisted of audit partners from the big 4 (8 respondents), second-tier firms (6 respondents) and small firms (6 respondents).2 the aim was to ensure that findings were not influenced by the type of audit firm or industry specialisation. it should, however, be noted that the intention is not to consider if specific industry experience, type of audit firm or other variables (such as cultural background) are associated with different views on the technical provisions of isas. the number of interviews was informed by the point at which ‘saturation’ was reached. this occurred after 14 interviews were completed (adapted from leedy & ormrod 2015). all interviews were semi-structured to ensure a thorough examination of the subject matter while retaining focus on the research question (holland & campbell 2005; leedy & ormrod 2015; o’dwyer, owen & unerman 2011; rowley 2012). interviews were conducted in johannesburg and pretoria from november 2014 and march 2015 and lasted between 40 and 70 min. questions dealing with the technical provisions and execution of the requirements in isa510 and isa620 were included in the interview agenda followed by open-ended questions dealing with the interviewees’ views on the similarities and differences of these two standards (rowley 2012; ryan, scapens & theobald 2002). the interview agenda was reviewed by two researchers at the authors’ host institution. it was also piloted with a ra at one of the big 4 to ensure that it covered the relevant provisions of isa510 and isa620, is accurate and focuses on the research questions. the pilot interview resulted in no significant adjustments to the interview questions. interviewees were provided with an overview of the nature and purpose of the research and invited to participate in the study. interviews were conducted in person with the exception of one telephonic interview (r5). data analysis the researchers focused on how the requirements of isas were explained by the respondents and how these provisions were being applied. no detailed coding was done at this stage as the aim was to gain a general sense of how respondents were operationalising the professional standards. the second step focused on the development of categories or emerging themes in the data (open codes). examples included reasons for changing auditors, technical disagreements among auditors, different views on the technical requirements of the standards and procedures performed when accepting new clients or using the work of experts (adapted from leedy & ormrod 2015; rowley 2012). the open coding process required each transcript to be read several times. the coding was also an iterative exercise with transcripts being recoded as additional interviews were conducted. no new open codes were noted after the 14th interview. after all of the transcripts were coded, the open codes were aggregated under axial codes. these were guided primarily by isqc1 and isa220 and included: competency of the auditor or auditor’s expert, the importance of independence, staffing considerations and difference in audit strategy or approach. any quotations that may result in the identification of respondents have been paraphrased or amended with changes indicated. participants were interviewed at their choice of location. interviewees could also discontinue the interview at any time. finally, as interviews can be classified as moral enquiry, the required ethics clearance was obtained from the authors’ university. results interviewees’ understanding of the application of isa510 and isa620 are presented below. differences in the use and interpretation of the two standards are outlined thereafter. isa510 respondents discussed several instances where isa510 is relevant. each is discussed below. risk assessment – review of financial statements the risk assessment for listed entities differs from privately owned entities as the needs of the stakeholders are different (r1, r3, r8, r9). for example, consideration is given to what management may attempt to overstate or understate and potential fraud areas (r1). a common departure point for performing the risk assessment is a review of the most recent financial statements to determine the materiality and potential future impact of each financial statement line item (r1, r2, r3, r4). basic analytical review of the previous year’s financial statements is used to ‘understand the numbers’, the ‘history of movement in account balances’ and ‘types of audit reports issued’ (r13). in addition, the status of the previous audit report and the presence of any possible reportable irregularity are considered (r11, r20). compliance with the international financial reporting standards the review of financial statements involves evaluating whether there are complex balances and transactions. the aim is to assess the risk of a disagreement between the incoming auditor and the client because of differences in the interpretation of accounting standards. one expert explained as follows: ‘the last thing you want to identify is the previous auditor had a disagreement on a technical matter that the client is shopping around to get the right opinion and that you then accept the client and challenged with a similar view.’ (r2, former auditor and audit committee chair, financial services) review of the financial statements provides a sense of whether the accounting framework and selected accounting policies have been complied with or not (r16, r17). r1 and r2 commented explicitly on the difference in interpretation of the application of ias39 and ifrs9 among the big 4 relating to areas of judgement. areas of possible restatement due to a difference in interpretation of the international financial reporting standards (ifrs) need to be raised early in the new client-auditor relationship (r1, r2, r3, r4). review of predecessor auditor’s workpapers compliance with selected accounting policies is validated when reviewing the predecessor auditor’s workpapers. analytical review of financial performance is key, with special attention given to areas where management judgement is present and how these areas have been disclosed in the financial statements (r2, r4, r5). attention is given to previous year’s issues reported by the external auditor to management and the schedule of unadjusted audit differences (r5). the accounting framework adopted and the application of certain ifrss are considered, specifically where there may be a difference in interpretation among the audit firms. where the opening balances have not been subjected to an audit in the prior year, the opening balances will be subjected to a full audit to ensure that they do not have a material impact on the current year’s results (r4). access to the predecessor auditor’s workpapers is a key consideration. this is usually ‘dependent on who the predecessor audit partner was and not so much the firm’ (r5). all of the respondents felt that, where access to workpapers was restricted, this was a potential indicator of deficient audit practice or a breakdown in the relationship between the predecessor auditor and client. in both instances, the assessed risks of misstatement are seen as higher and more rigorous testing of the opening balances will be required. finally, more reliance or comfort is gained when the predecessor auditor is a firm with international alliances (r5). this may be because of the international brand as a type of collateral for the quality of the outgoing auditor’s work (r4; r19). nature, timing and extent of procedures by the incoming auditor: in some instances, a verbal discussion with the predecessor auditor is sufficient to conclude on opening balances if the initial risk assessment is low. the big 4 seldom obtain clients from smaller audit firms while there is some client movement between the big 4 and the second-tier firms (r1, r2, r3). for a listed entity, the initial review will be performed by a partner and, for smaller entities, by a competent manager with monitoring and review by the partner (r1, r2, r3 and r4). for other firms, a senior manager with some partner supervision will take place (r5, r6, r9 and r10). as touched on earlier, examining the predecessor auditor’s workpapers is the preferred approach for evaluating opening balances. the main objective is to understand the predecessor auditor’s assessment of materiality and errors found. if available, the schedule of adjusted and unadjusted audit differences will be reviewed or discussed with the predecessor auditor (r1, r2, r3, r4). the schedule of unadjusted differences assists with ‘the identification of a possible trend for misstatements’ (r4). management letters about audit findings from the prior year, if made available, will also be scrutinised to establish the risks of misstatement in opening balances. if possible, a review of the main assertions will be helpful to understand the scope of the prior year’s work (r3). the discussion or meeting with the predecessor partner provides further information about the opening balances. the aim is to identify areas of concern noted by the previous auditor and gain a sense of skill and competency of the previous audit team. this can consider, not only the work done at the current client, but also the outgoing partners’ portfolio and how long the partner has been in practice: ‘you ask: “what other clients are you doing?” “how long have you been the auditor of this one” and “how long have you been an auditor?” those basic things – to understand independence and to understand competency – are an integral part of the nature, timing and extent of the procedures carried out under isa510.’ (r3, audit partner, consumer goods and services) if access to the workpapers of a predecessor auditor is restricted, alternate procedures on opening balances are performed. examples include walkthrough procedures or tests of detail (r14). the application of accounting policies is also reviewed. for example, the approach for determining if debtor balances are impaired and the application of ifrs9’s expected loss model are evaluated (r1). planned rotation of audit partners (within the same firm) is different from a change in audit firm. in most cases, the incoming auditor will shadow the exiting auditor (r2, r3). a ‘roll-forward of balances and a conversation will take place’ between the outgoing and incoming audit partners (r3, r4, r5). the competence of the previous engagement leader will still be considered (r3, r4). for the big 4 firms and the second-tier firms, the prior year’s audit files would have been subjected to internal quality reviews providing a basis for assessing the rigour of procedures performed on the prior period’s balances and transactions (r3). the audit team and, in most instances, the audit manager are still allocated to the audit client (r1, r2, r3, r4, r5). the rationale for isa510: respondents had different views on the inclusion of specific procedures in isa510. the most commonly held view was that these procedures are part of the big 4 and second-tier firms’ risk management processes which, over time, have become a generally accepted basis for testing opening balances and have, therefore, been codified (r1; r15; r17). the standard stipulates minimum procedures but, based on the risk associated with the audit client, ‘the depth of the audit work will vary’ (r4, r5). a slightly different interpretation of isa510 is that its prescribed procedures are not necessarily about enhancing audit quality directly but rather about lowering the auditor’s risk of legal liability. as a result, there was a sense that isa510 developed in response to specific facts or circumstances encountered in practice. performing a specific set of procedures becomes a taken-for-granted part of the audit firm’s policies for managing its business risks (r1; r12). respondents agreed that there were no laws or regulations that directly mandated the application of the procedures in isa510. nevertheless, they felt that they were expected to comply with all the procedures. for example, irrespective of differences in facts or circumstances, all respondents indicated that they will review any available financial information to determine what was included in the prior period’s financial statements. this includes a review of management’s accounting policy choices. concerns that the audit firm may have with the auditee’s industry are also taken into consideration (r2). similarly, while auditors may be able to justify excluding clearly immaterial balances from the scope of isa510 testing: ‘[t]here are certain minimums … [isa510] is one of the standards that you can’t bypass so you can’t say, “well, there is no risk in opening balances: i am doing nothing”.’ (r4, audit partner, consumer goods and services) respondents justified the strict adherence to isa510 on the grounds that access to the previous auditor’s workpapers may not be available. in these cases, isa510 provides a practical solution for concluding on opening balances. similarly, the procedures prescribed by isa510 are useful if the previous auditor has not divulged all the relevant information relating to the opening balances. in this instance, isa510 is useful for providing a basis for reaching a conclusion on opening balances and demonstrating that the incoming auditor has obtained sufficient appropriate evidence over the opening balances (r5). in addition: ‘if the opening balances are wrong you are going to get a wrong end result. it also provides you with an opportunity to gain knowledge of the client’s business and it enables you to get some indication of how the client operates especially with small businesses.’ (r8, audit partner, financial servies) there was also a view that having too much discretion to determine the nature, timing and extent of procedures for opening balances would lower audit quality. this is predicated on the view that, given the increased focus on external regulation of the profession, specific audit procedures should also become more prescriptive: ‘the auditing profession is fairly regulated and risk-focused. auditors have an accustomed mind set to pre-engagement activities as part of planning. i think the problem with standards is that they become too vague so that you allow for too much judgement which means that there is potentially too much room for error.’ (r3, audit partner, consumer goods and services [author’s own emphasis]) importantly, the quality of the audit evidence provided by prescriptive procedures was not discussed. in addition, respondents could not give examples of exactly how the use of prescriptive procedures improved audit quality. it is sufficient for practitioners to conclude that the nature, timing and extent of their approach for testing opening balances is sufficient because it covers each of the recommended procedures in isa510 (r1, r4). other isa standards contain a fair amount of professional judgement in the sense that: ‘… you assess a risk and respond to it.’ (r4, audit partner, financial services). the auditor’s response to the level of risk is based on knowledge, experience and competencies. when dealing with opening balances, the incoming auditor is not privy to information relating to the prior period. as a result, respondents feel that isa510 ‘forces the auditor by mandating procedures to ensure that the incoming auditor is covering something’ (r4, audit partner, financial services). respondents felt that the detailed procedures listed in isa510: ‘… make logical sense without considering access to the predecessor auditor.’ (r4, audit partner, financial services). this finding can probably be attributed to the appearance of a quasi-scientific approach to testing opening balances which, on the surface, appears to be objective and rigorous (see humphrey et al. 2011). isa510 defines specific procedures that need to be performed to demonstrate that sufficient appropriate evidence has been collected. there is little judgement being applied when determining which of these procedures need to be applied and the extent to which they are being relied on. the procedures are also applied without having to place significant reliance on judgements by the predecessor auditor. as a result, respondents suggest that isa510 is a useful risk management tool because it creates a clear distinction between audit work performed by the predecessor and incoming auditor. because the incoming auditor has ‘objectively’ tested opening balances, any errors or omissions of the predecessor auditor are, in essence, ‘quarantined’ (r3, r4). ironically, while the user of the audit report can rely on the opinion of the predecessor auditor, the same is not the case for one auditor seeking to rely on the work of another auditor (r10). in other words, non-expert users can place reliance on claims to professional expertise and independence of the predecessor auditor but, within the profession, professional appearance alone is not enough. this is because the credibility of work performed is being defined based on adherence to formalised test procedures in isa510 and not the good-faith assumption that all auditors are equally competent (r10): ‘auditors are just human beings, an honest mistake can be made or a deliberate mistake can be made. not all auditors are professional.’ (r9, associate director, mining and industrials) in this context, normative pressures to perform procedures required by isa510 have encouraged the development of internal or firm-level policies that take a procedural approach to testing opening balances. for individual members of the firm, the result is a drive to comply with internal policy and, by default, isa510. for example, respondents explained that electronic workpapers are utilised by the big 4. their audit software is designed to generate predetermined procedures based on the isas and other regulatory requirements (r1, r2, r3, r4). these procedures can be mandatory and the individual auditor cannot proceed to the next workpaper or online screen unless the procedure has been considered. alternately, approval from senior partners or representatives from technical departments is required if an auditor attempts to ignore one of the isa510 procedures. this is designed to ensure that, at minimum, risk areas and materiality relative to the current year financial statements have been addressed and that the firm can claim compliance with the isas (r1, r2, r3, r4). isa620 – auditor’s expert respondents outlined two broad instances when isa620 is applicable: when the audit team does not have sufficient skills to test a balance or transaction and when the use of an expert provides complementary audit evidence. as clients’ business models become more complex, multidisciplinary skills become essential for understanding audit risks and designing audit procedures to obtain sufficient appropriate audit evidence (r1, r2, r5). isa620 is applicable when required skills are clearly outside the scope of the professional accountant’s expertise (r12). there were also instances where experts were being used to complement the audit team’s skills. these typically involved the use of actuaries or qualified valuators to assist with complex mathematical models needed for valuing assets and liabilities such as defined benefit obligations, pension plan assets, credit loss models under ifrs9 and sensitivity analyses under ifrs7 (r2, r3). in most instances, these experts were engaged when the applicable accounting standards required the use of a fair value measurement or disclosure. respondents confirmed that most cost-based accounting standards (such as ias2, ias16 and ias38) seldom require the use of an expert. in contrast, accountants and auditors appeared to be less comfortable with the methods used to determine fair values in terms of ifrs13 and the assumptions of different valuation models. in these cases, an expert is used to provide the necessary assistance, even though, on strict reading of isa620, the auditor should be in a position to test these fair values without having to rely on an expert (r8, r9, r10). audit clients frequently rely on experts to assist with the measurement of different assets and liabilities. respondents pointed out that, when a client makes use of a management expert, the auditor will typically use his or her expert to verify the work performed by the management expert (r1, r3, r7). this was justified because the use of an auditor’s expert is the most efficient and appropriate approach for confirming complex judgements and estimates made by the audit client’s expert (r1, r2, r5). as a result, a primary objective of isa620 is to distinguish between the sufficiency and appropriateness of evidence provided by a client’s and an auditor’s expert. while these experts may be similar in most respects, the former may lack the same level of independence and objectivity of the audit expert due to a close working relationship with the client (r1, r3, r4, r6). as a result, an auditor cannot rely exclusively on the work of a management expert (see also isa500). additional audit procedures are required to confirm that key assumptions, chosen methods and the scope of any work performed are sufficient to address the relevant audit risk and to support a conclusion on the respective balance or transaction (r1, r3, r4, r7). even in cases when a management expert is not used, some respondents felt that an audit expert could be used to complement procedures performed by the audit team on different balances or transactions, especially when these have the potential to become material in future periods (r4). for these respondents, isa620 provided a framework for using a form of third-party verification usually to provide confirmatory evidence of the results of the auditor’s test procedures. nature, timing and extent of procedures the nature, timing and extent of audit procedures consist of an assessment of an auditor’s expert’s competence, communication of scope of work, agreeing to the format of deliverables and testing the auditor’s expert’s findings (iaasb 2009i:para 9, 11–12). the assessment of competence, where the auditor’s expert is not employed by an audit firm, is based on the person’s qualification and experience (r3). scope of work to be performed, due date and the format of the deliverable are agreed in writing with the auditor’s expert (r1, r2, r3, r4). where an auditor’s expert is already in the employment of an audit firm, the scope of work is also communicated with the auditor’s expert. however, the format of the deliverable is known to the auditor’s expert who would have been informed of the firm’s audit methodology (r1, r2, r3, r4). in this case, the auditor’s expert is seen as another member of the audit team and is familiar with the audit firm’s quality control policies and procedures (r3, r4). once the deliverable is received from the audit expert, detailed testing of the report or findings takes place. this involves the testing of assumptions or estimates applied. assumptions or estimates are tested or verified, usually by the audit supervisor or manager. any input data (for example, interest rates or statistical data) are verified against available market data. if a certain methodology was used, this will be tested against other available models and approaches as a reasonability check (r3, r6). rationale for isa620 the two primary reasons for the application of isa620 were the lack of skills by the engagement team to test certain balances and transactions or the need to obtain complementary audit evidence. in addition to these technical justifications for using isa620, respondents suggested that the standard can be used (in some cases) to limit the auditor’s legal liability. respondents feel that the audit evidence provided by isa620 may be more persuasive than the result of test procedures completed by an audit team. this is because the work has been prepared by an individual with specialised skills or experience and was less likely to be questioned by a third party. consequently, using an auditor’s expert was a useful approach for testing a balance or transaction associated with a high level of legal liability risk (r1, r7, r8). there were, however, instances of auditors applying isa620 by default. instead of considering the nature of the respective balances and transactions, including inherent risk, some respondents automatically concluded that an expert would be required to provide sufficient appropriate audit evidence for material balances (r6, r7, r10). one respondent provided an example concerning a non-monetary asset that was valued by an expert in prior years. even though the state of the asset and the applicable market had not changed, the asset was re-assessed each year by an independent expert (r7). similarly, even in instances where fair value measures were being computed under ifrs13, experts were engaged to support the work of the audit team because this had become standard firm procedure (r10). as the use of an expert becomes more common on audit engagements, the application of isa620 becomes a basis for demonstrating that sufficiently rigorous procedures have been applied to support an opinion on complex balances and transactions. in other words, the standard is not being used as part of a rational response to assessed risks of misstatement but as part of a symbolic demonstration that the approach followed for the current audit engagement is consistent with that used in prior periods or by other professional firms (r7, r10). under isa620, the individual engaged to assist the auditor must be a recognised subject expert. the standard also refers to the importance of formal training and membership of recognised professional bodies (iaasb 2009i:para a9, a15). this is complemented by an assessment of the appropriateness of the methods applied by the expert, any assumptions used and the scope of the work performed (iaasb 2009i:para a33). similarly, the confidence that non-expert users place in the audit opinion is based on the codification of audit methodology, the appearance of rational technical audit procedures and the competency of the independent practitioner. in this way, isa620 does more than articulate technical processes that are followed when an auditor engages an expert to assist with testing balances and transactions. it provides the discourse for articulating the features of expertise that the layman values in the auditor and that, by analogy, the auditor identifies in the duly appointed expert. similarities and tensions between isa510 and isa620 table 2 summarises the differences in the application of isa510 and isa620 discussed by the interviewees. table 2: similarities and tensions between isa510 and isa620. discussion, conclusion and areas for future research all of the respondents agreed that isa510 and isa620 provide important guidance on assessing the risks of misstatement applicable to the respective balances and transactions and inform the approach that needs to be followed to reduce that risk to an acceptably low level. as a result, the application of these standards almost always requires the involvement of the audit manager and partner. the importance of professional judgement and scepticism when applying both standards also makes them a focal point for a quality review partner or internal peer review under isqc1. differences in the way in which isa510 and isa620 are applied reflect the fact that the standards deal with different circumstances. most notably, the former is applicable for evaluating all the opening balances (and accumulated prior transactions) while the latter is usually limited to testing a select number of financial statement line items. variations in how the requirements of the two standards are operationalised also reflect auditors’ personal beliefs about the rationale for the standards rather than the express objectives for each standard as outlined by the iaasb. isa510 is intended to provide a framework for ensuring that opening balances are tested in sufficient detail to ensure that the incoming auditor provides an appropriate opinion on a new client’s financial statements (ifac 2008). in practice, the standard is seen primarily as a means for reducing the auditor’s risk of legal liability. auditors acknowledge that, while isa510 does not mandate the execution of every specified procedure, practically, all the standard’s listed procedures are applied irrespective of whether or not this is beneficial for the integrity of the audit. the reason: by executing audit procedure on a client’s opening balances, the work of the predecessor auditor, including any omissions or errors, can be separated from testing carried out by the incoming practitioner. with risk management – rather than the technical rigour of the audit engagement – being the primary consideration, isa510 is applied legalistically rather than as part of the normal risk-based audit model. isa620 is applicable where the auditor requires specialised knowledge or expertise. at the technical level, respondents agree that, as a client’s business models become more complex, multidisciplinary skills become essential for understanding audit risks and designing audit procedures to obtain sufficient appropriate audit evidence. the use of an expert is also desirable when the transaction or financial statement line item is associated with a high level of legal liability. more relevant than limiting legal exposure is the value of isa620 for legitimising the test of a material balance or transaction. the layman places reliance on the auditor’s opinion on a client’s financial statement without a detailed understanding of exactly how the financial statements have been tested. as explained by power (2003a, 2003b), the rituals of verification matter more than the mechanics of the audit process itself for the audit opinion to be accepted as legitimate. the same applies at the level of the auditor testing a specific balance or transaction. using the work of an expert is an efficient and easy-to-apply technique for convincing internal reviewers, external regulators or audit committees that sufficient appropriate evidence for a complex line item has been obtained. an expert can also be used to bolster the auditor’s confidence and lower any risks to personal reputation by providing corroborating conclusions on different ‘elements’ of the financial statements. these findings have several important implications. firstly, they explain variations in the application of technical auditing standards. when the aim is to create a type of firewall and limit legal liability, standards are applied legalistically. the number of audit procedures performed is increased and the scope of the testing is broad in the sense that multiple balances and transactions must be addressed. when the objective is to corroborate findings and legitimise audit work, additional testing can be focused on the specific balance or transactions. legitimacy is not secured by performing additional procedures, expanding sample sizes or focusing on multiple financial statement line items but by engaging an expert to test the most complex balance or transaction. secondly, audit quality is not necessarily a function of compliance with professional standards. if guidance in particular standards is applied only for symbolic purposes or for limiting legal liability, the fact that audit procedures outlined by the iaasb have been executed does not guarantee a rigorous audit approach. as a result, this article’s findings are important for standard setters and regulators interested in driving higher levels of audit quality. rather than focusing exclusively on the technical detail of different standards, the impact that legal liability and auditor’s own need to manage impressions may have on how engagements are executed must be carefully considered. like any study of this type, there are inherent limitations and areas for future research. most notably, the operationalisation of only two standards is dealt with. the findings are generated from a single jurisdiction and a relatively small group of respondents. other standards, such as those dealing with risk assessment, the audit of estimates and documentation need to be examined. more nuanced findings can also be generated by considering how differences in an auditor’s age, level of experience and cultural background affects their views on legal exposure and the need to seek legitimacy for their audit work. this can be complemented by considering how recent external regulatory measures interact with individuals’ interpretation of professional standards. prior research has largely neglected the practical dimension of an external audit with the result that this is an area where academics can make a significant contribution to both theory and practice. acknowledgements competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this research article. authors’ contributions m.k. conceived the idea for the study. data were collected by m.k. and w.m., who also wrote the manuscript. ethical consideration this article followed all ethical standards for carrying out research. funding information this research received funding from the national research foundation: grant #118525. data availability the data in this article derives from interviews and are not made available due to ethical restrictions. disclaimer the views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of any affiliated agency of the authors. the views and opinions expressed by respondents quoted in this article 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application of auditing standards are not publicly available for quantitative analysis. 2. the big 4 include, in alphabetical order, deloitte, ey, kpmg and pwc. the researchers distinguished between second-tier and small firms based on revenue. abstract introduction background to the problem and purpose of the study literature review research methods findings discussion and implications conclusion acknowledgements references footnotes about the author(s) johan coetzee department of economics and finance, university of the free state, bloemfontein, south africa brownhilder neneh department of business management, faculty of economic and management sciences, university of the free state, bloemfontein, south africa karlien stemmet department of economics and finance, university of the free state, bloemfontein, south africa jana lamprecht school of accountancy, faculty of economic and management sciences, university of the free state, bloemfontein, south africa constance motsitsi department of public administration and management, faculty of economic and management sciences, university of the free state, bloemfontein, south africa winnie sereeco department of business management, faculty of economic and management sciences, university of the free state, bloemfontein, south africa citation coetzee, j., neneh, b., stemmet, k., lamprecht, j., motsitsi, c. & sereeco, w., 2021, ‘south african universities in a time of increasing disruption’, south african journal of economic and management sciences 24(1), a3739. https://doi.org/10.4102/sajems.v24i1.3739 original research south african universities in a time of increasing disruption johan coetzee, brownhilder neneh, karlien stemmet, jana lamprecht, constance motsitsi, winnie sereeco received: 17 june 2020; accepted: 30 nov. 2020; published: 26 apr. 2021 copyright: © 2021. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the fourth industrial revolution (4ir) and the coronavirus disease 2019 (covid-19) have disrupted the higher education environment in unprecedented ways. aim: this article identifies the impact of increasing disruption driven by the 4ir and covid-19 on the content and curriculum design of degree programmes in economic and management sciences offered by south african universities. setting: six south african and five top-tier us and uk universities. methods: the study used a non-positivist qualitative research design and specifically the case-study approach. a document analysis of the information in university yearbooks and prospectuses was conducted, using a purposive sampling design. results: an online presence will become more important due to increased disruption, and will not only ensure an additional revenue stream, but also promote continuity in operations and mitigate threats from competitors. covid-19 has accelerated the extent of this disruption and expedited the migration to online teaching and learning platforms. conclusion: since science, technology, engineering and mathematics are integral to the majority of 4ir-related modules, south african universities must not shy away from degree programmes that ignore interand multi-disciplinary curriculum designs. coupled with the challenges facing the majority of south african students to access electronic devices, data and the internet, covid-19 has thrust this challenge to the forefront in the south african higher education landscape. by comparing the developments in south african universities with those in trendsetting, top-tier, global universities, management can assess the extent to which they are internationally competitive and adapting to the demands of the 4ir. keywords: fourth industrial revolution; south africa; massive open online courses; mooc; university; covid-19. introduction universities face a very real threat of becoming archaic institutions that offer irrelevant programmes to the graduate of tomorrow, if they do not adapt to the so-called fourth industrial revolution (4ir). the 4ir will usher in a business environment that embeds the use of technology to disrupt and challenge conventional thinking and practices, forcing new business models that utilise different skill sets. it is therefore expected to cause major changes in society, and equipping graduates from institutions of higher learning to meet these demands will require a fundamental rethink of how curricula are designed to meet this challenge. the covid-19 (coronavirus disease 2019) pandemic will accelerate these changes at a rate that was not anticipated even a few months before the spread of the virus to south africa in early 2020. thus, this article considers developments in curricula from selected top-tier universities vis-à-vis the 4ir, while also considering how the teaching and learning environment is set to change in a post-covid-19 world. the findings will inform management within south african universities. background to the problem and purpose of the study the pace of technological change is faster today than ever before in human history and this is reflected in the education sector. the world economic forum (wef) (2016) estimates that nearly 50% of subject knowledge acquired during the first year of a four-year technical degree will be outdated by the time the student graduates. they further state (2016:3) that ‘65% of children entering primary school today will ultimately end up working in completely new job types that don’t yet exist’. drivers such as a more flexible working environment, mobile internet, cloud computing, big data, the internet of things (iot), a sharing economy, robotics, artificial intelligence, and automation will revolutionise the working environment of the future (wef 2016). the change will potentially be, as bhalla et al. (2017) state, ‘a tidal wave of change … that will soon make the way we work almost unrecognisable to today’s business leaders’. effectively, they argue, dramatic change will become the norm: ‘in an age of rapidly evolving technologies, business models, demographics, and even workplace attitudes … change is not only constant but also exponential in its pace and scope’. universities must be responsive to this. in particular, the curricula they offer would need to be increasingly more dynamic and adaptable, almost, it can be argued, simultaneous to the demand for new skills dictated by the 4ir. a speedy response is, therefore, crucial in an increasingly innovative environment, but is a concern in the south african higher education environment (rodney-gumede 2019) where only 11 out of 26 universities have introduced modules and degree programmes responding to the skills demand of the 4ir (pandor 2019). moreover, given that the so-called stem1 (science, technology, engineering and mathematics) disciplines are sure to dominate 4ir-related content, for south african universities this is particularly concerning because schools are not providing them with entrants that have the requisite stem skills to enter programmes dealing with 4ir-related content. considering that 78% of grade 4 learners cannot read for meaning (howie et al. 2016) and 79% of grade 6 mathematics teachers have subject-content knowledge level lower than that of the grade 6 learners they teach (venkat & spaull 2015), the quality of mathematics and science in south african public schools rank as being of the worst in the world (wef 2017). this is exacerbated by the fact that south african universities only accept entrants into the sciences with a pass mark of above 50% in mathematics, whereas the number of matriculants achieving above 40% in their final examinations fell almost 11% from 2018 to 2019 and reflected just over 41% of total bachelor passes in 2019 (dhet 2020). with only 29.1% and 28.7% of all university graduates eventually qualifying in the fields of science, engineering and technology in 2016 and 2018 (dhet 2018, 2019), there are clear indications of an education system with major structural concerns at the secondary schooling level. the president of south africa has realised this and appointed a task team to focus on upskilling school learners. in the 2019 state of the nation (the presidency 2019c) address, he announced that a number of subjects related to technology would be introduced into the school curriculum in coming years (the presidency 2019a). so too the department of basic education (dbe) has indicated that teachers would be trained in computer skills and coding, with the latter being piloted in 1000 schools in five provinces as from 2020 (businesstech 2019). the dbe further confirmed that robotics would be offered as a subject from grade 9 onwards. as stated by the minister of the dbe (businesstech 2019): this [the introduction of robotics in curricula] will not only develop stem skills, but also contribute to effectively developing children’s creativity, critical-thinking, design-thinking, and digital skills [that will] ensure that south africa develops learners who are makers and inventors who will contribute to building an innovative culture in south africa. (n.p.) to further support this, the president announced the merger of the departments of higher education and training with science and innovation (the presidency 2019b). whether or not these proposed initiatives will achieve the desired effect, given the dire state of the quality of mathematics and science teaching at school level remains to be seen. besides considering the practical challenges facing the south african higher education sector, the devastating effects of the covid-19 pandemic in 2020 have challenged universities all over the world to change the way they operate. with over 80% of the world’s student population affected as a result of imposed lockdowns (sahu 2020), especially those at universities that offer a face-to-face teaching and learning environment, the use of technology has become more pervasive than ever before. this has forced universities around the world to recognise the need to adapt to technology as the only practical approach to saving the 2020 academic year (mohamedbhai 2020). by implication, the expedited move towards a digital-based online teaching and learning environment has transpired without prior warning, and preparation and implementation has been on a largely ad hoc basis. in africa this unplanned sudden move to digital is a particularly large problem. tamrat and teferra (2020) indicate that ‘only 24% of the african population has reliable access to the internet’, which inadvertently raises concerns regarding the quality of the teaching and learning experience (mohamedbhai 2020). the internet penetration rate of south africa is substantially higher than fellow african countries at 62% and, although lower than counterparts in the developed world such as north america (88%), western europe (92%), northern europe (95%) and southern europe (83%), it compares favourably with emerging economic blocks such as central america (66%), caribbean (60%), eastern asia (63%) and south east asia (66%) (datareportal 2020). needless to say, improving access to the internet is a priority for the south african government (the presidency 2019b). although covid-19 has identified major structural concerns for universities, there is the potential to use it to implement long-term strategies that will digitalise their online teaching and learning environment in the future (khagram 2020), and in particular to align themselves to developments in the 4ir. universities will therefore not only have to speedily adapt to the challenges of equipping graduates for the rigours of the 4ir, but also skilling entrants from a public schooling system with structural weaknesses (mouton, louw & strydom 2013). for the former, the ability of universities to incorporate new modules into curricula at a rate commensurate to the ever-evolving work environment is key to sending graduates into the workplace to meet the demands of the 4ir; for the latter, the added pressure on them to commit resources to upskill or even reskill, in particular, the stem knowledge of incoming students from the school system. covid-19 has at the very least provided the platform to accelerate these processes. based on these arguments, this study focuses on the former – that is, it considers what top-tier universities are incorporating into their curricula to address the rigours of the 4ir and the developments in the technology-driven space that directly affect the modus operandi of south african universities. more specifically, the article investigates the developments in curricula focusing specifically on economic and management sciences (or in a broader sense, commerce) for south african and a selected group of international universities, in order to assess what content they are incorporating to address developments within the 4ir. by comparing the developments in the south african situation with trendsetters (top-tier global universities), as well as technology-related developments, a judgement can be made as to what extent south african universities are adapting to a time of disruption that is unprecedented, especially with regard to the effect that covid-19 has had on higher education globally. the following structure is used: in the article the typical skill sets expected from graduates entering the 4ir, are first considered, and then the effect of covid-19 on the high education sector. following this, the content of curricula in leading universities is investigated in: (1) south africa, (2) the developed world (top-tier universities in the united states and the united kingdom) and (3) online offerings such as massive open online courses (moocs) to ascertain what content they include to equip graduates for the 4ir. in conclusion, the article identifies the major findings and makes recommendations for south african university management vis-à-vis developments in curricula in the broader field of commerce in an increasingly disrupted world. literature review the fourth industrial revolution and developments in skills the 4ir is currently one of the most commonly discussed topics among academics, researchers, practitioners and policymakers across the globe. the term ‘fourth industrial revolution’ was initially coined during the hannover fair in 2011 and officially announced in 2013 as part of a german high-tech strategic initiative to take a leading role in industries that were transforming the manufacturing sector (mosconi 2015). while its origin is not doubted, its definition remains debateable (bauer et al. 2014). in general, extant literature identifies four typical features (hermann, pentek & otto 2016; jabbour et al. 2018; knudsen & kaivo-oja 2018; lu 2017; ning & liu 2015; xu et al. 2018): firstly, cyber physical systems (connections between the real and virtual world), secondly, the internet of things (iot), thirdly, the internet of services (ios) and fourthly, the smart factory. a further study by lorenz et al. (2015) identified nine technological pillars of the 4ir, namely systems integration, big data and analytics, simulation and virtualisation, the iot, the cloud, cybersecurity, autonomous robots, augmented reality and additive manufacturing. the 4ir is therefore a broad reference to developments in technology and its integration into everyday life. more specifically, it is ‘characterized by a fusion of technologies that is blurring the lines between the physical, digital, and biological spheres’ (schwab 2016). an important consideration is the extent of the integration – it is pervasive to such an extent that it alters, and even threatens, the traditional modus operandi in the work and personal context for humans (bawa 2017). this suggests that the skill sets required by the future worker, and thus future university graduate, will be different to those required in the past. rodney-gumede (2019) emphasises that the skills and experiences that were important only three years ago, will continue to shift from being industry-specific to being transformable and centred on what he refers to as the 4cs: collaboration, communication, creativity and critical thinking. gray (2016:1) further argues that ‘35% of the skills considered important today will change as the 4ir will have brought us advanced technologies’. skill sets will therefore not only expand, but also becoming increasingly more complex and integrated with each other, typically including complex problem solving, critical thinking, creativity, people management, coordination with others, emotional intelligence, judgement and decision-making, service orientation, negotiation, cognitive flexibility, and the management of information (botha 2017; rodney-gumede 2019). skill sets therefore play directly into the education that future entrants into the labour force will require. menon and castrillion (2019) argue that university graduates must not merely receive training all-round with skills and knowledge, irrespective of the field they specialise in. rather, due to disciplinary boundaries becoming increasingly blurred, flexibility in the curricula of qualifications would offer students ‘rapid knowledge silos’ and prepare them for a multifaceted and multi-disciplinary future. this, they argue, requires a holistic approach to curricula development and teaching that will empower graduates with the ‘ability and agility’ to adapt to the challenges of the 4ir. the proliferation of new knowledge and the respective skills attached to it, is significant. in addition to the estimates that up to 50% of current technical curricula will be outdated by the time a student graduates, a study conducted by the wef found that more than one-third of the respondents regarded the core skill sets of workers in 2020 to be those not considered to be important in 2016 (wef 2016). complex problem-solving in particular was considered to be the most important skill leading into the 4ir, followed by skills related to social, process and systems (wef 2016). by implication, the skill set of the future requires a fusion between both traditional ‘hard’ skills (those associated with technical expertise) and ‘soft’ skills (those associated with emotive, abstract and social dynamics). universities therefore need to adapt modules and programmes that promise to ensure their graduates are ready and qualified for both of these (wef 2018). given these escalating demands placed on universities, what would the implications be on curriculum design? curriculum design in a changing workplace suskie (2018) states that effective curriculum design focuses on the learning goals, and not necessarily only the content. this is an important consideration vis-à-vis the 4ir, as it places focus on not only the curriculum per se, but also the outcome of the curriculum and suggests an approach that is adaptive to changing societal outcomes. two approaches typify this approach: backwards and competency-based curriculum design. for the former, the curriculum is designed with the skills and knowledge that the students should acquire by the time they graduate in mind; for the latter course credits are replaced with competencies. the importance of this is that curriculum design must shift from being the traditional discipline-based kind – in which knowledge forms the core of the curriculum – to being more constructivist or learning-centred – in which case the focus is on the development of the learner in changing times (cullen, harris & hill 2018). moreover, transforming the education system through curricula redesign will increasingly be measured against how educational outcomes meet the requirements of stakeholders in the workplace (halili 2019; panikar, dev & washinton 2015). this, however, is a challenging task for educational systems (shahroom & hussin 2018) that will require a re-articulation of curricula within higher education (penprase 2018). it is further exacerbated by the fact that both the nature of work and the job market are changing and will continue to change at an increasing pace (xing & marwala 2017). the way curricula disseminate information, as well as how students are expected to apply the information, suggests that even those studying in a field such as the humanities where the technical skills attached to, say, technology are not as prevalent, need to ensure that they at the very least understand the founding principles (if not the ethical principles) of new developments in technology (butler-adam 2018). by implication, penprase (2018) suggests that education strategies must prioritise human skills to maximise the development and empowerment of graduates in an all-rounded manner, focusing specifically on cultural, socio-economic and interpersonal skills. in essence, curriculum development must equip graduates with the capabilities and skills that technology is not able to replace (shahroom & hussin 2018) and be designed in such a way to not only teach and develop new skills, but also to also do this as the demand for skills evolves (hussin 2018). in doing this, not only will universities train graduates to have a mindset aimed at lifelong learning, but reposition themselves to remain relevant as long as they themselves evolve amid new developments ushered in by the 4ir (halili 2019). this evolution will be driven by an integrated approach to curricula development (xing & marwala 2017) that focuses on developing the capacity of students to comprehend the impact of technological advances on humans (bawa 2017). a more interand multi-disciplinary mindset will be required in which lifelong learning becomes central to developments in the job market (hong 2017; horowitz & white-burke 2018). although the 4ir, in and by itself, is the driving force behind the disruption facing universities, the rate at which it is set to occur has been expedited due to the covid-19 pandemic. disruption amid covid-19 the novel covid-19 pandemic, which by all accounts started in the chinese city of wuhan in late 2019, has rapidly spread across many countries around the world. in response, many have introduced both local and international travel restrictions and imposed strict lockdown regulations. as of the end of march 2020, over 150 countries had closed down schools and universities affecting over 80% of the world’s student population (sahu 2020). this has created a host of unexpected challenges from both the university’s and the student’s perspective. many universities have been forced to rapidly transition from traditional face-to-face teaching to different forms of online delivery modes (gewin 2020), resulting in unplanned expenditures. also, while online teaching is not necessarily a new mode of delivery for the majority of universities, many staff members were found wanting technologically savvy and had to acquire the skills of online learning platforms without the requisite training (the 2020). many academic staff members also do not have the experience of designing learning material for the online environment (bao 2020). the added pressure of working from home, while in many instances also being required to homeschool children, has added further pressure due to not necessarily having a work environment conducive to productivity (gorlick 2020). assessments in the online environment have created further challenges. for example, assessments developed for a face-to-face environment had to be transformed to online assessments, which have raised concerns regarding not only their quality, but also the likelihood of encouraging cheating in the online environment (watson & sottile 2010). two recent examples include online cheating at the georgia institute of technology and boston university where students used the help of the education technology company chegg to complete online assessments (flaherty 2020). the aforesaid has thus disrupted universities in ways unimaginable before the onset of covid-19. moreover, the majority of students in south africa are reliant on the computer labs, wi-fi connections and libraries available on the campuses of universities. due to many not having access to any of these at home, covid-19 has forced them to rely on data plans provided by universities and their smartphones to attend and complete online classes and assessments (mathiba 2020). students who, therefore, lack access to digital devices are at a clear disadvantage, which has implications on both the grades they receive and the likelihood to defer their studies (alruwais, wills & wald 2018). furthermore, students used to the face-to-face environment require a heightened sense of self-discipline and a learning attitude conducive to online learning (bao 2020). the speed at which students have been forced to adapt, places them under immense pressure and raises concerns regarding the value for money they get while paying for tuition that presupposes the full ambit of a traditional face-to-face teaching and learning environment (burki 2020). with most accounts suggesting that a vaccine is expected in 2021, the reality is that universities and students will have to endure the online environment into late 2021 and, most likely, later (le et al. 2020). research methods this study adopts a non-positivist qualitative research design and specifically the case-study approach, which aims to ‘build a holistic, largely narrative, description to inform the researcher’s understanding of a social or cultural phenomenon … [emerging] organically from the research context’ (astalin 2013:118). although qualitative research, and by implication a case study, adopts an ‘interpretative paradigm’ that may be construed as being subjective from the perspective of the researcher (starman 2013:30), the suggested bias has been argued to be misguided as case studies, in particular, explore real-world situations ‘as they unfold in practice’ (flyvbjerg 2011:309). to ensure this, and specifically scientific rigour, the results need to be unbiased, trustworthy, credible and confirmable (guba & lincoln 1982; morse, olson & spiers 2002). as such, a documentary analysis was conducted from those available in the public domain on the websites of the chosen universities – more specifically, a ‘documents as commentary approach’ according to which ‘insight into individual and collective … practices and structures that are not otherwise observable’ was adopted (atchan, davis & foureur 2017:56). yearbooks or prospectuses from the faculties of economic, management and business sciences (or broadly speaking, commerce) were identified after which critical probing into the content (atchan et al. 2017) allowed the content, and specifically modules within curricula, to be identified through the ‘orientation of qualitative description’ (oczkowskia et al. 2018:59). the study, therefore, follows an inductive approach, typical of qualitative research designs and allows ‘research findings to emerge from the frequent, dominant, or significant themes inherent in raw data, without the restraints imposed by structured methodologies’ (thomas 2006:238). the study used a non-probability sampling design and more specifically purposive sampling. the sampling frame comprised south african and top-tier united states and united kingdom universities. the overarching criterion used for selection was the availability of information regarding the modules in curricula focusing on degrees in commerce. based on this, six south african universities were selected and five of the top six global universities according to the qs university rankings. table 1 provides the list of these universities. table 1: selected universities used for the study. at the risk of merely providing a summary of the modules in university curricula, we need to explain what is meant by ‘4ir-related content’. for purposes of the study, this refers specifically to modules that deal with topics within the curricula of qualifications in the field of commerce that, in the broadest sense, are expected to deal with those relating to the 4ir. generally speaking, this includes, but is not necessarily limited to, data science, business analytics and fintech in a specifically commerce-related degree programme. more specifically this includes modules focusing on technology, the management, analysis and dissemination of information and data – including coding, programming and the like, simulation, digitalisation, machine learning, robotics, big data, blockchain, iot, artificial intelligence and so on. a caveat on this is in order: although the yearbooks (or prospectuses) providing information on the respective modules are informative as to the name of the respective modules, and they usually provide a list of the expected outcomes, detail of the content is typically sparse. for this reason, the study does not specifically consider the content within modules themselves, but rather identifies modules that, through their names, describe content linked to topics associated with the 4ir. ethical considerations this article followed all ethical standards for research without direct contact with human or animal subjects. findings south african universities south african universities offer traditional commerce degrees, but have introduced 4ir-related modules as either electives or as part of the core modules. for example, at the university of cape town (uct) students studying towards a bcom can specialise in ‘traditional’ areas including accounting, actuarial sciences, economics and management, whereas students studying towards a bbussc can specialise in 12 areas (uct 2018a), including analytics and information systems, dealing specifically with analytical methods pertinent to advances in the 4ir or modules more interdisciplinary by nature, such as cognitive neuroscience. at stellenbosch university (su) a bcom is offered in mathematical statistics with a focus on data science, focusing specifically on requiring students to gather, store, transform and graphically represent data (us 2019). in the field of business management at the university of pretoria (up), there have been substantial changes with the introduction of modules, such as design thinking and business innovation, business analytics (including topics such as data mining, big data and data stream analysis), and responsible leadership (up 2019). universities also acknowledge the roles of both interand multi-disciplinary degrees with a 4ir flavour. at both uct and the university of the witwatersrand (wits) (2019), degrees specialising in philosophy, politics and economics (ppe) follow the practice of prestigious top-tier universities such as the london school of economics and political science,2 the university of pennsylvania3 and the university of oxford.4 with a slight tweak, the university of johannesburg (uj) introduced a bachelor of arts (ba) degree in 2019 specialising in politics, economics and technology with the specific purpose of equipping students for the 4ir, relying heavily on the expertise from different faculties, including the college of business and economics (cbe) and the faculties of humanity and science (uj 2019). the university of the free state (ufs) in 2020 introduced a bcom specialising in business and financial analytics focusing specifically on addressing the potential 4ir skills of the future graduate, with modules focusing on integrating traditional banking and finance topics with those typical of data analytics, such as programming and problem solving, databases and database management systems, and data analytics for business (ufs 2020). in general, south african universities understand the important role of data and information management in their commerce degrees. wits offers a bcom information systems, uct and su offer modules focusing on information systems as core in the first year of study and up a bcom informatics information systems, dealing with the management of information systems, manipulation of data and computer programming. at uj, the school of consumer intelligence and information systems integrates it and computer sciences in the field of commerce to enable students to develop software, manage information systems and program. in addition to traditional departments within commerce faculties, certain business schools also offer a host of modules on topics pertinent to the 4ir. for example, at wits the graduate school of business administration offers a master of management in the field of digital business, which includes modules such as systems thinking in the digital economy, applied big data and analytics, cybersecurity and risk management, digital financial services, digital government, digital commerce, business strategy for a digital world, marketing for digital business, digitalising operations, innovation and entrepreneurship in digital business, digital transformation and change management and digital technology (wits 2019). the gordon institute of business science (gibs) of the up offers a senior executive programme with the harvard business school with 4ir modules such as competing in the age of digital platforms, competing on business analytics and big data, driving digital strategy and leading an agile workforce transformation.5 the provision of 4ir content is therefore not limited to traditional departments within the faculties of commerce, but extends to the offerings of business schools in certain instances. ensuring that graduates are well versed in the principles of ethical behaviour in the workplace is required by several professional qualifications, typically offered by different departments within the faculties of commerce. for example, when graduates qualify as chartered accountants in south africa, they have to adhere to the ethical requirements prescribed by the south african institute of chartered accountants;6 when graduates in finance pursue qualifications such as the chartered banker,7 chartered financial analyst or financial risk manager, they have to adhere to the ethical requirements of the chartered banker institute, chartered financial analyst institute8 and the global association of risk professionals;9 when industrial psychologists qualify as such, they have to adhere to the professional conduct and ethical standards of the health professions council of south africa.10 although all of the universities under investigation are either affiliated or accredited by some of these bodies, particularly in their postgraduate degree programmes, the inclusion of courses focusing on ethics is not necessarily a requirement for undergraduate study. top-tier universities in the united states and the united kingdom the composition of the bachelor’s degrees offered by the top-tier universities in the united states and the united kingdom are unique. for instance, the us curricula are more flexible, orientated towards being inter-disciplinary, and emphasise a broad approach to subject content. harvard and stanford curricula, for example, maintain a major-minor system which allows students the opportunity to select subjects outside of their major areas of specialisation. in contrast, oxford and cambridge offer curricula that are more rigid and orientated towards in-depth specialisation (also called majors, concentrations or triposes) in various fields. an interesting dimension of the curricula of harvard, stanford and the massachusetts institute of technology (mit) is the so-called general educational requirement (or general institutional requirement at mit) that needs to be completed by all students irrespective of their area of specialisation. the aim of this requirement is to develop a set of essential intellectual competencies and social skills to broaden the exposure of students to a plethora of different disciplines – it is therefore multi-disciplinary at its core. for example, the content is not only spread among courses in the traditional sciences, humanities, arts, social sciences, and technology, but also covers exposure to soft skills associated with improving writing and speaking, planning, reasoning, culture, diversity, foreign languages and cultures, ethics, and belief systems to name only a few (harvard university 2019a; mit 2019b; stanford university 2019c). at mit there is even a ‘physical education requirement’ which entails a minimum of four physical education courses and the requirement to pass a 100-yard swimming test – the rationale being that both the body and mind need to be healthy and are not independent of one another (mit 2019b). the top-tier universities offer students substantial choices in the composition of their curricula. for example, although mit awards only one undergraduate bsc degree, a major (or specialisation) is selected out of a possible 54 fields (mit 2019a). in turn, stanford university offers students ba, a bsc or a ba&sc with a major from a possible 65 fields, constituting at least one-third (but not more than two-thirds) of a student’s programme (stanford university 2019a). harvard offers more than 3700 courses in 50 undergraduate fields of studies, albeit not offering a business concentration to undergraduate students (harvard university 2019b). furthermore, at the university of cambridge an undergraduate ba (hons) degree with more than 65 subjects is offered (cambridge university 2019). therefore, although top-tier universities offer students considerable flexibility, balance is sought between the depth of knowledge acquired when specialising in a specific major and the breadth of knowledge acquired through broader exploration of multiple disciplines (stanford university 2019b). specialist undergraduate programmes that speak directly to the principles of 4ir content are further reflected in interdisciplinary curricula. with a bsc in computer science, economics and data science at mit, subjects include, among others, fundamentals of programming, introduction to algorithms, design and analysis of algorithms, econometric data science, communicating with data, networks and optimization methods in business analytics, networks, economics and e-commerce, and data analysis for the social scientist (mit 2019d). moreover, the department of economics at stanford offers students courses in social and economic networks and the future of finance, which directly address the pressing issues in the current landscape of global financial markets such fintech, regtech, artificial intelligence, crowd financing, blockchain, machine learning and robotics, iot, cybersecurity, financial warfare, cryptocurrency risks, etfs, new instruments and payment platforms, robo-advising, and big data and algorithmic trading (stanford university 2019d). students majoring in economics are offered electives from outside departments, including mathematics, statistics, computer science and overseas studies. electives include, among others, design and analysis of algorithms, artificial intelligence: principles and techniques, machine learning and general game playing (stanford university 2019e). furthermore, postgraduate studies are typically offered by the business schools of the respective universities. at mit, modules that have a distinct 4ir flavour include: information, entropy and computation econometrics for managers: correlation and causality in the big data world, statistical thinking and data analysis, introduction to machine learning, introduction to applied probability, data mining: models and predication that create value, the analytics edge, artificial intelligence, predictive data analytics and statistical modelling, negotiation analysis and algorithmic trading and quantitative investment strategies (mit 2019c). stanford requires mba students to complete compulsory core modules in the mba, such as ethics in management, optimization and simulation modelling, data analysis and decision making, and information management, with over 100 modules in the second year of the mba programme, including but not limited to cryptocurrencies, the evolution of finance, digital marketing, and data science for platforms (stanford university 2019f). at harvard, commerce subjects are presented by both the faculty of arts and sciences and the harvard business school. the mba offers a specialised module called tech ethics: ai, biotech, and the future of human nature, which explores the moral, social and political implications of new technologies (harvard university 2019b). harvard business school also offers the courses economics of networks and using big data to solve economic and social problems (harvard university 2019b). the mba at the saïd business school at oxford university further offers specialised modules such as digital and social media strategy, fintech: present and future, and the digital transformation of marketing, media, and advertising (oxford university 2019a, 2019b). massive open online courses, short courses and micromasters® in recent years universities have aggressively pursued the use of technology in the provision of specialised and shorter online-based programmes. top-tier universities in particular have focused on offering moocs which provide free courses through partners such as edx, coursera and udemy. edx, for example, was formed in 2012 when harvard joined mit to allow an open-source online learning platform to distribute course content and other academic material of over 2 400 courses, collaborating with top-tier universities across the world.11 as an extension of edx, mooc.org provides a database on all the available moocs with a substantial number of courses focusing on 4ir-related content such as artificial intelligence, big data, blockchain, computer science, cybersecurity, data science, machine learning, python, r programming, and robotics.12 for a nominal fee, top-tier universities offer online short courses focusing on industry-relevant content, and especially those related to the 4ir. usually marketed as online certificate courses in either ‘executive’ or ‘professional education’, these courses are typically presented in collaboration with an it collaborator such as emeritus, getsmarter or greater learning which facilitate the entire online process, running for periods averaging 6–12 weeks. in south africa, universities such as uct and su offer similar featured online certificates on topics such as data science and fintech.13 a further development in recent years has been the so-called micromaster® programmes, the logic of which is to enable prospective students the opportunity to do smaller, more manageable, postgraduate courses in topics that will ultimately count for recognition (credit) in full master’s degrees at the respective university. offered by top-tier universities, they are more expensive than short online certificate courses, but cheaper than full master’s programmes, and typically run for periods of 6 months to usually not longer than 1 year.14 programmes related to the 4ir are particularly prevalent, with examples including micromaster® certificates in ‘statistics and data science’ from mit, ‘marketing analytics’ from the university of california at berkeley, ‘integrated digital media’ from new york university, ‘data science’ from the university of california at san diego, ‘artificial intelligence’ by columbia university, and ‘marketing in a digital world’ offered by curtin university to name only a few. discussion and implications discussion of the findings the 4ir requires a different way of thinking and will blur the boundaries between content on its own and the application of the content where integration in an interand multi-disciplinary setting will increasingly become the norm. south african universities incorporating subjects such as economics, politics, technology and philosophy, similar to that of top-tier international universities, are examples of this and reflect the more integrated approach to curricula attempting to upskill graduates entering the 4ir. this is particularly important amid concerns about skills constraints inhibiting economic growth in south africa (burger 2018). the south african universities investigated in this study acknowledge that 4ir-related content is important in commerce degrees. in most part there does not seem to be a mass overhaul of curricula, but rather that core modules tend to remain largely the same and are supplemented by additional modules addressing topics related to the 4ir. furthermore, business schools seem to play an important role in the presentation of modules related to the 4ir. this is probably due to their role to stay current and adaptable to market trends, although the criticism is that content is not always as dynamic as it should be (denning 2018). needless to say, ‘authentic engagement’ between the relevant stakeholders to ensure meaningful curriculum changes, requires ‘ongoing conversations’ as the process becomes increasingly more dynamic amid the 4ir (uct 2018b). in turn, top-tier universities offer degrees that are fundamentally multi-disciplinary and offer a wide and extensive range of modules in undergraduate programmes. students are therefore encouraged to select from various disciplines. at postgraduate level, business schools, as opposed to discipline-specific departments, offer coursework and the range of specialised modules focusing on 4ir is extensive. covid-19 has set the scene to rapidly change the teaching and learning environment for south african universities. for universities to remain sustainable post-covid-19, they have to change their business models as the traditional face-to-face mode of teaching and learning will no longer be the only feasible approach. blended online learning approaches such as hyflex may be considered in which students are given the option to attend classes either in person or in an online setting. by implication, besides adapting curricula to developments in the 4ir, universities need to start thinking differently about how they train students by strengthening their active learning abilities outside of the traditional face-to-face context. managerial implications six managerial implications for the management of south african universities are posited. an online presence will become increasingly important for revenue and continuity reasons although face-to-face learning is the main mode of teaching at the majority of south african universities, having an online presence is becoming increasingly important, especially amid the covid-19 pandemic. there are main drivers for the move towards a more integrated online presence in the teaching and learning environment for universities: firstly, south african universities need to become more competitive, compared to international universities, by focusing on south africa-specific content; secondly, assuming the labour and physical resources are available, an online presence ensures an additional revenue stream in a higher education environment where the state is shifting the financial burden increasingly to students to fund their tuition (czerniewicz, trotter & haupt 2019); thirdly, and arguably most importantly, an online presence will contribute to ensuring continuity in teaching and learning due to an increasingly disrupted higher education environment. the latter two reasons in particular support moving content to the virtual space as it provides some sort of continuity in the delivery of classes during times of strikes, protests and disruptions on campus such as those seen during the #feesmustfall movement in 2015 and 2016, the unpaid national student financial aid scheme allowances in 2020, and the covid-19 pandemic, which will continue into at least 2021 (mafolo et al. 2020; mbolekwa 2020; geduld & sathorar 2016). given the highly politicised higher education environment in south africa, adopting a hybrid (or blended) approach to class delivery may become the status quo in the future, despite the challenge of not all students having access to electronic devices or the internet due to coming from poor and working-class households (brodie & harding 2020). the integration of science, technology, engineering and mathematics skills is integral to curriculum design the 4ir will revolutionise the way society operates and stem subjects will be the foundation of this. the focus on equipping future graduates with the requisite skills to meet the demands of the 4ir, must, however, not overshadow the realities facing the quality of education received by the majority of students prior to entering south african universities. the poor performance of the vast majority of south african school-leavers in stem subjects is a concern for universities, reiterating the structural challenges in specifically the spheres of mathematics and science education. this is also exacerbated by the fact that the so-called millennials and generation z require a different mindset as to how knowledge is disseminated. the use of technology in the classroom is central to this and shorter attention spans and the pervasive use of technology require educators to present classes in far more interesting and stimulating ways than in the past (giunta 2017). although one study suggests that the attention span for generation z’s is 8 s (elmore 2014), universities must adapt curricula, taking into account the changing behavioural and technological habits of students as well, yet at the same time being sensitive to the challenges many south african students have regarding access to digital devices. covid-19 and any such disruptive event in the future, has arguably made this more relevant than ever before. a mass overhaul of curricula is not required although a few specialised degrees have been established, the general trend seems to be that universities are supplementing existing degree curricula with additional modules pertinent to the 4ir. with the exception of specialised degrees, especially at top-tier universities, degrees seem to be quite ‘fluid’, as the focus is rather to complement core modules, related to the traditional area of specialisation, with those expected from the 4ir. this feature is considered favourable for south african universities as it ‘facilitate[s] the creation of new work fields at the intersection of knowledge domains’ (bawa 2017). universities should therefore not necessarily be lulled into a mindset that they need to ‘provide everything to everyone’ through a mass overhaul of curricula, but maybe consider building in more flexibility in module selection within degree programmes. top-tier universities in particular have adopted a very explicit interand multi-disciplinary approach to their curricula, with several south african universities having recently followed suit. due to the pervasiveness of online content, the reputation of universities to provide formal and reputable qualifications will be pivotal to their success already moocs and platforms such as youtube threaten the dissemination of information offered by institutions of higher learning, especially those not offering the former. by implication, if information is so pervasive and cheaper alternatives to disseminate it in the public domain potentially threaten the existence of universities, what would motivate a student to pay for a formal education at a university rather than through (1) cheaper online-based programmes from reputable top-tier universities or (2) free online content such as moocs? the threat this poses to universities with a dominantly face-to-face teaching and learning environment, is exacerbated as their tuition fees are higher than universities that offer an exclusively online environment. the forced sudden reaction of universities to covid-19 has exposed this reality and threatens to result in students switching to universities which have the technological infrastructure to deal with online teaching and learning. needless to say, the answer to the question arguably lies in the reputational benefits of qualifying from a university of repute. for a south african university, this suggests competing with the best universities in the world, and it poses a potential threat to the competitiveness of south african qualifications if these universities are able to scale their online content and offer competitive teaching to potential south african students. as the migration to a digital teaching and learning environment due to covid-19 has shown, the challenge will be to ensure that south african students have the necessary technology and data at their disposal to facilitate online education. universities must require all students to take a course in ethics, specifically focusing on topics relevant to the fourth industrial revolution top-tier universities in particular have modules focusing on the ethical dimensions of the 4ir, given that it presupposes the integration of technology in everyday human life (schwab 2016). although technology has resulted in huge progress made in both the medical and business environment, concerns related to, for example, cybersecurity and the confidentiality of data raise ethical concerns with regard to privacy and the intrusive nature of data management. the question therefore becomes: can a university afford to send graduates into the workplace with no exposure to what ethics are, or how to handle unethical situations and, if so, what sort of message does it send out to the business community? although south african business schools in particular grapple with these questions (businesstech 2017), it is not as pervasive in curricula in general. and, as indicated above, although several professional qualifications require graduates to adhere to conduct and ethical-related standards as part of either curricula of professional affiliation in the fields of commerce, there is no reason why offering a compulsory module on ethics should not be applicable to every graduate in commerce, not to mention any student studying at a university who does not specialise in one of the above-mentioned career paths. clearly, therefore, there is an acknowledgment by industry that ethics and the associated conduct in unethical situations in the workplace cannot be separated from what students need to learn at university. curricula must differentiate the skills of graduates to keep them competitive in the workplace universities need to ensure that they are driven by two overarching principles leading into the 4ir: (1) students must be provided with the requisite knowledge and skills to be part of the 4ir, and (2) the knowledge students acquire must differentiate them from the ‘robots’ (read: artificial intelligence, machine learning, mechanisation, automation, etc.) by focusing on their abilities to problem-solve, think critically, behave with empathy, be creative, question and dream (marr 2018). by implication, graduates must not leave university having merely acquired the skills that technology will be able to do in the future, anyway. given the rapid rate of change that technology brings to the fore, graduates will also need to adopt a mindset that encapsulates a lifelong learning approach. the covid-19 pandemic has no doubt reinforced this and as long as a disrupted environment is the norm of the day, lifelong learning will be part and parcel of the mindset that the graduate of the future is expected to engender. university studies will thus be a means to an end: on-the-job experience, coupled with the skills and knowledge acquired at university, will count for more in terms of being competitive in the workplace. finally, although the impact on students is without question, university staff also need to be mentioned, especially while covid-19 prevents them from attending the physical workplace. universities must implement human resource policies that are increasingly more flexible and integrated with a performance-based culture that considers homebound work pressures. with covid-19 likely to be part of the landscape until at least 2021, any developments in curriculum design are ultimately articulated and implemented by academic staff. without the necessary institutional support to facilitate this, the ability of university, to capitalise on developments in the 4ir will be a futile exercise. conclusion as the custodians of disseminating knowledge, universities need to be at the forefront of equipping societies for the developments leading into the 4ir. this challenge has undoubtedly been escalated to unprecedented levels due to the covid-19 pandemic and accelerated the rate of adoption. given the socio-economic imbalances inherent to the south african economy, failure to do this will have severe implications on the well-being of the people and exacerbate the problem from being one of being unemployed to one of becoming unemployable. if south african universities do not adapt and do so quickly, they run the risk of losing relevance in the broader higher education environment due to the competition from especially international universities which have a strong presence in the online environment. the solution is integrating the skills of the 4ir to address south africa-specific problems and consequently not compete directly with top-tier international universities. rather, they must become more relevant to south african problems using the tools and skills inherent to the 4ir. this will differentiate the offerings of south african universities from those of universities in the rest of the world. as such, covid-19 has in many ways provided the platform for universities to ‘reset’ their business model and use technology as the fundamental tool to provide education in a time of disruption, arguably never seen before in higher education across the globe. acknowledgements this manuscript was the result of work conducted by a task team focusing on developments in curricula due to the 4ir appointed by the faculty of economic and management sciences at the university of the free state. competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this research article. authors’ contributions j.c. was the lead researcher for the design and writing up of the final manuscript. b.n., k.s, j.l., c.m. and w.s. contributed to certain sections of the manuscript. funding information this research received no specific grant from any funding agency in the public, commercial or not-for-profit sectors. data availability data sharing is not applicable to this article as no new data were created or analysed in this study. disclaimer the views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of any affiliated agency of the authors. references alruwais, n., wills, g. & wald, m., 2018, ‘advantages and challenges of using eassessment’, international journal of information and education 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included to incorporate, in particular, the liberal arts. 2. see http://www.lse.ac.uk/study-at-lse/undergraduate/degree-programmes-2020/bsc-philosophy-politics-and-economics. 3. see https://ppe.sas.upenn.edu/. 4. see http://www.ox.ac.uk/admissions/undergraduate/courses-listing/philosophy-politics-and-economics. 5. see https://www.gibs.co.za/programmes/open-programmes/pages/harvard-business-school-senior-executive-program.aspx. 6. see https://www.saica.co.za/. 7. see https://www.charteredbanker.com/. 8. see https://www.cfainstitute.org/. 9. see https://www.garp.org/. 10. https://www.hpcsa.co.za/. 11. see www.edx.org. 12. see www.mooc.org. 13. see https://www.getsmarter.com/universities/university-of-cape-town?&ef_id=c:326879540764_d:c_n:g_ti:kwd-364334305164_p:_k:uct%20online%20courses_m:e_a:60368263834&gclid=eaiaiqobchmirlcgnp_i4wivfplrch18ggk4eaayasaaegj-3_d_bwe; https://masterstart.com/courses?utm_source=google&utm_medium=cpc&utm_campaign=allcourses&keyword=on%20line%20courses&matchtype=p&device=c&gclid=eaiaiqobchmirlcgnp_i4wivfplrch18ggk4eaayaiaaegik2_d_bwe 14. see https://www.edx.org/micromasters. sajems ns vol 5 (2002) no 2 473 greenhouse gas mitigation options in the industrial sector a trikam energy research institute, department 0/ mechanical engineering, university o/cape town abstract this report identifies the major opportunities for climate change mitigation through industrial energy efficiency and fuel switching in south africa. the potential for greenhouse gas reduction (outlining areas of possible resultant cdm investment) in local industry, a co2 mitigation cost curve and accounting of emissions reductions in existing and future industrial plants, will provide the basis for realising these opportunities. greenhouse gas mitigation in the industrial sector is closely linked with 2 groups: energy efficiency improvements and fuel switching; and these options are outlined in more detail in this report. jelq40 1 introduction this paper quantifies the potential for ghg reduction in south african industry in the form of a co2 mitigation cost curve, which shows the cost versus carbon savings potential for each mitigation option. other key results from this study include fuel consumption per sub-sector under a business as usual 'baseline' scenario. 1.1 background the bulk of the potential for greenhouse gas mitigation in the industrial sector is linked with energy efficiency improvements and fuel switching options. a national industrial energy efficiency program, 'the 3e strategy' (energy efficiency earnings), showed that energy and therefore co2, could be saved in south african industry. three industries, anglogold, sappi kraft and south african breweries, with a record of active energy management were invited to be a part of this program. a summary of the results from implementing (additional) short '3e strategies' follows: r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 474 sajems ns vol 5 (2002) no 2 table 1 results of '3e strategy' case studies costs ('high cost' estimates r 1180000 r 1290000 r3220000 8 months 7 months about 60 per cent of these savings were without significant investments in new capital furthermore, none of the energy saving projects above had an investment payback period of over one year. this clearly indicates the potential co:! abatement. based on an energy efficiency case study, a carbon mitigation case study for vw uitenhage is also described here, a further pmctical indication of the potential for emissions reductions possible in industry. 1.2 scope of study owing to the complexity of the industrial sector and some generic assumptions are necessary that limit the detail of the work due to the poor availability of energy consumption data. key differences between south african and international economies, such as fuel prices and specific processes and technologies, make the correct selection of appropriate mitigation technologies and options for the south african economy essential. this selection is done on an industrial sub-sector by sub-sector basis determined by the assumptions made to accommodate the availability of data. a 30 year period was modelled, from 1995 to 2025. the 1995 base year comprises an extensive data set. this data was then projected using various economic and other drivers to create a credible baseline. given the options applicable and having determined the potential fuel consumption for each sub-sector for the baseline, an estimate for the reduction of energy demand and greenhouse gas emissions with the costs associated can be compiled for mitigation. the long-range energy alternatives planning system (leap2000) and microsoft excel were the tools used for modelling the energy system and compiling emissions and associated costs for the generation of a mitigation cost curve. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 475 2 methodology the following methodology was used to determine a greenhouse gas emissions baseline from 1995 to 2025, the period modelled in leap2000: l estimate industrial sector activity and fuel activity shares from energy consumption data. 2. calculate the annual energy consumption by fuel using energy intensities and energy balances. 3. estimate emission coefficients for each type of fuel for co2, c~ and n02 (ipcc tier i default emission factors). 4. multiply emission coefficients by fuel use to get total greenhouse gas emissions by type of fuel. population of a database and simulation and modelling of south african industry energy demand was done in leap2000 with some calculations on excel spreadsheets. 2.1 definition of industrial sector activity table 2 shows subsector energy consumption for the base year, 1995, defined through: production (activity level), energy intensity, and percentage input fuel shares in each of the respective subsectors. 2.2 data collection energy data for the base year was taken from department of minerals and energy's sectoral energy balances compiled by cooper (1997), south african energy balance for 1995, unless otherwise indicated. 1999 figures were not used due to poor availability of comprehensive data. changes made to the base year data include: biomass demand from the pulp and paper industry, and the sugar industry, which were derived from a bottom-up analysis. coal demand for non-ferrous metals, the pulp and paper industry, the food and tobacco industry, and households was taken from kenny (1999) as no data was given by cooper. electricity consumption by the pulp and paper industry and the food and tobacco industry was estimated from kenny (1999). diesel demand by coal mining was estimated, and moved from mining demand to coal mining transformation. electricity supply statistics were taken from eskom (1995) and the national electricity regulator (1995). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 476 sajems ns vol 5 (2002) no 2 3 energy consumption the baseline data for the model is dependent on current (the base year 1995) and future energy consumption (projections to 2025). the major assumptions for the baseline energy consumption are detailed here beginning with a general point of view in terms of the national aggregated consumption and then on a sub-sector-by-sub-sector industrial division basis. future projections (detailed as per the base year data set), which provide a basis for the data that was modelled are outlined below. due to the direct link between greenhouse gasses and energy consumption via emission factors, it follows that the quantification of emissions reductions (mitigation options) depends on energy savings. 3.1 basic industrial energy consumption data the industry sector in this report includes mining, manufacturing, construction and all processing, excluding the processing of energy from one form to another. in 1996, the south african industrial sector constituted 39 per cent of south africa's total final energy consumption (1057 pi out of 2555 pi) and 57 per cent of her electricity (306 pi out of535 pi) (kenny, 1998: 4). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . gold other iron & chemicals nonnonpulp & food & other .., 00 • ~ ~ ;" :s: n 00 mining industry steel & petroferrous metallic paper beverages mining chemicals metals minerals totalsuhs24t nla 8741000t 7'7oooollt lsl8000t 1 6700000t 3000000t nla 68000000t z 00 s's' <: !!.=g. ." c: sector production energy 160tjit nla 32.04gjit lj.03gjit 24.jgjit 4.246gjit 34.13gjit nla o.784gjit intens~ energy 83.84pj 102.10pj 280.06pj 100.33pj 36.89pj 70.90pj 102.39pj 109.86pj 53.31pj consumption ~~ ~~~~~~~~~~~~~~~~~~ ~~~~~~~~~~~~~~~ ~ ~ ~ ~ ~ ~,~ ~ ~ ~ ~ ~ ~ ~ ~ ~ percentage split of energy consumption by fuel across sub-sectors electricity 95.3 18.5 24.8 50.9 93.81 26.2 16.9 18.5 58.8 • coal 2.9 45.8 33.9 42.5 4.0 61.2 49.5 39.6 25.9 diesel 1.2 11.0 12.6 12.6 i h2 rich gas 0.5 3.1 2.8 1.3 2.2 8.3 0.7 0.9 i lpg 3.8 0.2 0.2 ' paraffin 3.5 0.5 ~ 0.5 fuel 011 _0.1 4.2 2.5 0.6 4.4 1.0 1.1 coke oven 6.8 27.4 ~e petrol 0.2 vl ,-,=. t"" ::!. -n !:'!l. :5 ~= n = '-' .... ". z ::8." 0 (il~ n =s 1111 "i .... ." ~. i "g "i n til a • ~ ~ c-. :ii. 4 ch4 rich gas 3.1 1.3 0.4 i bagasse 40.1 reonerygas 3.4 ." =-• ~ '" coke oven gas 8.6 ~ ~ wood 33.2 totals too 100 too 100 too too 100 100 100 ;. ij ." = .... r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 478 sajems ns vol 5 (2002) no 2 table 3 1996 energy consumption ocindustrial divisions energy (pj] %of electricity %of iodustrial (pj] lodustrial consumption electricity iron & steel 227 21 56 18 chemical & 263 25 9.5 3.1 petrochemicals non-ferrous metals 48 4.6 47 15 non-metallic 43 4.1 4.1 1 minerals transport 0.2 i 1.89 0.03 0 equipment mining & quarrying i 159 16 125 41 food & tobacco 109 10.2 20.4 6.7 paper, pulp & print 106 10.0 20.1.4 5.7 wood & wood • 2.4 0.2 2.1 0.7 products construction 14 1.4 0.06 0 textile & leather 1.9 0.2 1.8 0.6 non-specified 79 7.5 18.3 6.0 total for industry 1057 100 306 100 table 3 shows the energy consumption of the various divisions within the industrial sector in 1996. the table shows the largest user was the chemical and petrochemical division which used 25 per cent of industrial energy although only 3 per cent of its electricity. this does not include the refining of crude oil to petroleum and other products nor the conversion of coal to liquid fuels. the second largest user was the iron and steel division, which uses 21 per cent of industrial energy and 18 per cent of its electricity. in previous years, iron and steel had been the largest user (see figure i below). the third largest user was mining and quarrying with 17 per cent of industrial energy; this was however the largest user of industrial electricity with 41 per cent of the total. the food and beverages division follows, with 10 per cent of energy and 7 per cent of electricity, and paper, pulp and print with 10 per cent of energy and 7 per cent of electricity. non-ferrous metals and non-metallic minerals each use 5 per cent of total industrial energy. the largest energy user in non-ferrous metals is in the electricity intensive aluminium-smelting industry. the largest in non-metallic minerals is the manufacture of cement. the large division "non-specified" which consumes 7 per cent of the total energy of the industrial sector, takes the wide range of small consumers into account (kenny, 1998: 5). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 n02 479 figure i below shows the historical trends in total energy use by the main industrial divisions, excluding food and tobacco and paper, pulp and print, from 1992 to 1997. figure 1 industrial energy demand by main divisions from 92 to 971 300.0r---------------------------------------~ .-250.0 200.0 il? :::: f-.. -. -.. -.-.. ~."'-' .. ~.~ .. ~.~. ~'_'_'_*""_-~.jl-:-.,..,.,.,..-:-: .. :-:-.~. ::-::.~: .:-:.-:-. :-:"-=-.:-:: .-=-.:-: .. 11 i ~~'i 5:.: t. ===~====!===~~~=~~===i='99! 7 i::: i 1992 1993 1994 1995 1996 3.2 future industrial energy consumption projections future energy demand in south african industry depends on a number of factors including economic growth, the changing structure of the economy, and the volumes and nature of our exports. it also depends on policy decisions: decisions by parastatals such as eskom on investing, costing and subsidy; decisions by the south african government on tariffs and support, and on environmental legislation; and decisions by the international community on environmental issues such as greenhouse gases. 3.2.1 natural gas the introduction of natural gas into the country via various gas fields discovered would change the balance of the types of energy in south africa. industry is well suited to use natural gas as it is a large user of energy and has an anchor market in big plants, unlike the residential sector. natural gas is cleaner and easier to use than coal or oil and releases less carbon dioxide per unit of energy. piped sasol gas (both methane-rich and hydrogen-rich gas), is already supplying some industry. the hydrogen rich gas from sasol i at secunda is piped to the gauteng region and also supplies the steel-making r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 480 sajems ns vol 5 (2002) no 2 plants. it has a calorific value of about 18 to 20 mj i cubic metre. the methane rich gas comes from sasol2 and 3 at secunda and has a calorific value of 33 to 36 mj i cubic metre. utilisation of the kudu gas field could be effectively be established between 2004 and 2007, and the feasibility of building a gas pipe down to cape town is currently being studied (keny, 1998: 25). 3.2.2 other fuel trends following electricity trends seen in other countries, it is likely that south africa will also follow these trends of electricity taking up an increasing fraction of industrial energy. coal use will probably increase absolutely for another ten to twenty years and then steady out or decline due to electricity being mostly generated by coal-fired power stations. the use of coke from coking ovens will probably decline further, given south africa's poor reserves of coking coal. liquid fuels are likely to be increasingly expensive in real terms in about ten to twenty years time and this can already be seen by the recent rises in crude price. 3.2.3 mining for the mining sector a 3 per cent (approx. 1.3 per cent up to 2004 thereafter 0.8 per cent/per annum) yearly increase in energy demand was assumed due to demand for minerals. this would give a total energy demand of 354 pj, consisting mainly of electricity with some liquid fuel and a bit of coal and natural gas (op cit.: 26). gold, production is likely to decline but with increasing depths and poorer ores, the amount of energy required will increase. ultra-deep mining, to depths down to 5000 m, could extract again almost as much gold as has been mined in the past, but is only likely to happen with a large and sustained increase in the price of gold with the increased working of mine dumps offering a limited counteraction (minerals bureau bulletin, 1998: 2). energy consumption in platinum mines is expected to show significant growth in the medium term with platinum consumption levelling off due recovery, and the less material needed for catalysis reactions. some projections from other mining include (prinsloo, 200 1): a number of new platinum mines and a new smelter at pietersburg have been proposed. coal mining in south africa is expected to show moderate growth. iscor is presently building an iron and titanium mine in empangeni. the future expansion of anglo-american namaqua sands is expected over the medium term. zinc mining is expected to get a boost from future zinc plants such as gamsberg. the expansion of the premier diamond mine near cullinan is expected to occur in the medium term. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 481 a feasibility study is underway looking at a large-scale expansion of the a vrninlnkomati nickel mine in mpumalanga at a capital expenditure of around rl.6bn. there are also plans to deepen and extend the life of the black mountain mine which produces mainly lead and zinc. over the longer term, the proposed haib copper mine, immediately north of the south africainamibia border indicates some potential for copper mining. 3.2.4 iron and steel conventional iron and steel production in south africa is not expected to show any significant growth in the future as the demand for carbon steel has actually levelled off. the future growth of south africa steel depends on the local market, which has been weak for nearly three decades, and the world market, which has been better but still sluggish. the sa department of mineral and energy affairs (dme) in 1992 gave the following three projections for steel production until 2015: (i) "survival" at 1.5 per cent growth per annum (ii) "moderate" at 2.7 per cent, and (iii) "fast growth" at 5.0 per cent granville, (stanko & freeman, 1992: 103). 3.2.5 chemicals and petrochemicals future energy consumption in the chemical and petrochemical division in south africa is difficult to assess because of the uncertain prospects for coal, the biggest energy and feedstock source now. the products of this division are likely to have an expanding market especially in exports. sasol chemical industries at sasolburg will within the near future be using natural gas instead of coal, with natural gas used as a compliment for any expansions at secunda. south africa has estimated coal bed methane reserves of about 90 billion cubic metres (3300pj), with the most promising field being at waterberg. sasol and african explosives and chemicals industries (aeci) both wish to move towards higher value, smaller volume products which will require less energy per unit of production. given these considerations, the maximum likely energy requirement for 2025 is a doubling of the present requirement, which would require 526 pj in 2025 (kenny, 1998: 30). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 482 sajems ns vol 5 (2002) no 2 3.2.6 non-forrous metals for aluminium, only two more smelters are predicted to be built, pushing aluminium production up from 660 000 tons now to 1 660 000 tons by 2025, a 2.5 fold increase (op cit.: 32). for titanium an estimate of 1860 tons was assumed as richards bay minerals and namakwa sands are both expanding their operations and iscor has proposed projects to mine titanium ore in the northern province and at richards bay. the non-ferrous industry is projected to have a maximum energy demand of 130pi by 2025 consisting mostly of electricity. 3.2.7 non-metallic minerals cement making and brick-making dominate this division, which is almost entirely for domestic consumption. thus, growth in energy demand depends on gdp, which is assumed to be at a 4 per cent rate between now and 2025 giving a demand of 122 pi by 2025 (op cit: 32). 3.2.8 pulp and paper due to over-capacity and low prices in the pulp and paper industry, the chances of new mills being built look low. thus, no significant growth is assumed with almost no improvement or limited improvement in energy efficiency expected for the baseline, and an expected demand of 158 pi by the year 2025 (op cit.: 33). 3.2.9 food and beverages growth in the food and beverages division is likely to follow growth in gdp and exports. a growth rate of 4 per cent for gdp and exports was assumed, if the sugar industry, which is the dominant energy user, is able to produce increasing quantities and also assuming no improvement in energy efficiency, for the baseline, this gives a maximum energy demand of 340 mi by 2025 (op cit.: 33). 3.2.10 other industry the rest of industry is also assumed to grow by 4 per cent per annum to give a total demand of243 pi by 2025 (op cit.: 33). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 483 4 modelling and simulation the long·range energy alternatives planning system (leap, 2000) was the simulation software package used to model, simulate and quantify energy and greenhouse gas emissions for south african industry. this software was chosen due to the flexibility and ease of us.e for structural changes, and integrated emissions factors for carbon accounting. a baseline model was first built using an existing database of south african data with extensive revision and changes. some structural changes (further disaggregating the demand sector structure) were made to accommodate the modelling of energy efficiency programs (mitigation options) in terms of energy demand. these changes involved the disaggregation of a subsector into two separate categories. one of the categories having a share of activities that the use only electricity (except process heating), the other the remainder of the energy consumed in the sector by all the other fuels, inclusive of electrical process heating. this allowed the modelling of energy efficiency of electrical activities (hv ac, motors) and fuel switching (electrical process heating vs gas). costs, quantified in terms of the reduction in energy demand and subsequent emissions for power generation, were then applied to each of these mitigating options. the respective ipcc emissions factors applied to the power stations for electrical energy efficiency savings and to combustible fuels in the industrial demand subsectors for fuel switching enabled the collation of the actual greenhouse gas emissions reductions. the desired result, a mitigation cost curve of emissions versus costs. 5 results a summary of final energy consumption (demand) can be seen in figure 2, which forms the basis for the emissions baseline. the total emissions from the industrial sector for the baseline can be seen summarised in the figure 3 below (with actual figures shown alongside on the right of every entry. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 4000 3500 3000 j 2500 " .. iii' a 2000 ~ ::ie 1500 1000 500 o 1995 2000 final energy demand for industry for 1995-2025 2005 2010 years 2015 2020 ""m l clwood .refinery gas ii paraffin clpetrol cl natural gas • methane rich gas .lpg cl hydrogn rich gas .fueloil • electricity .oiesel clcoke oven gas ii coal commercial a coal coking ii bagasse 2025 oo,:j ... ijq =: ri n = iii .., l!. ... = (i) ::i = !!. (i) = (i) ?3 q. (i) a iii = q. a' ., 5i' q. =: .., ... .:! a' ., ... ~ • n e:n (.ii j» ~ (i) ~ (i) z (i) 8: vi ~ 8 ~ ~ tv r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 60.000 50_odd 40.000 30.000 20.000 10.000 0.000 1995 2000 industrial emissions by subsector 1995-2025 2005 2010 v.an 2014 .. __ .. _-_ .. _2020 & paper -other mining ~other indu slly iii:nonmetal. min. l:inonferrous met. iiilron & steel .gold minlng iiifood & beverages ~chemical 2025 ..., c/) a'q' ~ = '"'l t'!> a:: w c/) z c/) = -< = '" !?-. i!.. vi s' n t'!> s' 0 0 =n = '-" '" z .... :3. 0 = n t'!> ~, '" '" e;' 1:1 '" r::j' '< '" = r::j' '" t'!> i':> .... 1:1 .., (;' '"'l ,... \c:o \c:o til i n <:> n til i +>00 vi r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 486 sajems ns vol 5 (2002) no 2 6 mitigation options for credibility and reference, it was particularly important that the options presented should be applicable to the south african industrial sector especially for the short to medium term. this principle was used as a guideline to determine the mitigation options chosen and the extent to which they could be implemented in the longer term. thus out of the three groups of mitigation options: process switching, fuel switching and energy efficiency; only the two groups, fuel switching and energy efficiency were considered. 6.1. fuel switchidg a basis for fuel switching is established through estimates of the ratio of conversion from fmal to useful energy for different fuels and equipment. the following efficiencies have been assumed for the equipment (mostly boilers) considered. it was assumed that steam systems were 80 per cent efficient. table 4 efficiency assumptions for technologies fue) technology overall efficiency including steam system losses electrical process heating 75 coal fired boilers 60 oil fired boilers 65 wood fired boilers 60 gas fired boilers 70 electricity can also be fuel switched, as no emissions are given off at the point of use, but coal is inefficiently transformed in power stations (compared to direct use), and it is here where the emissions are accounted. 6.1. ] oil and coal fired boilers to natural gas assumptions for switching from oil and coal to natural gas are that: in the baseline, natural gas becomes available in 2006 and by 2025 supplies 9 per cent of useful thermal energy to industry. in the mitigation option, the natural gas share was assumed to increase to 25 per cent., displacing coal and oil (14 per cent of industries consumption of fuel). the cost of implementing the actual mitigation option only was negligible (de villiers, 2000) relative to the fuel cost, which takes the difference in fuel costs (of coal and oil compared to natural gas) into account. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 487 6.1.2 electrode boilers to natural gas assumptions for switching from electrical systems to natural gas are that: the cost of adapting a system would cost of the order of r20 000 per 1000kglhr (op cit.). industrial boilers operate all day for i 1 months of the year. 10 per cent of electrical heating could be replaced by gas over the period. the penetration rate of natural gas over the base case is low, and that issues of reserves and distribution may limit its use as a fuel. as natural gas will likely be imported, increased use will result in a negative effect on the balance of payments. this will be offset slightly by the oil displaced, which has low quantities compared to coal 6.2 efficiency improvements the following thermal efficiency improvements for each boiler type is given below, relative to a business as usual scenario: table 5 boiler thermal efficiency improvements boiler type • assumed assumed overau potential boiler losses recoverable savings used for • (recoverable) steam system this study losses coal 20% (5-8%) 20% 20% oil 15% (3-6%) 20% 18% gas 10% (2-4%) 20% 16% electrode 5% (1-2%) 20% 15% the cost savings data is determined by the relative costs of fuel and potential efficiency improvement. it is also assumed that the potential savings are only fully realised at the end of the scenario period. 6.2.1 compressed air for compressed air systems it was assumed that a 20 per cent improvement was possible by 2025. this is consistent with estimates from several studies (kenny & howells, anglogold, sab & sappi mandini, 2000). it was assumed that, functionally, up to 40 per cent (fawes, van es, khumalo & howells, 2001) of compressed air could be saved in south african industry by better management. a well-managed compressed air system will have a leak rate of less than 10 per r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 488 sajems ns vol 5 (2002) no 2 cent (trikam, howells & drummond, 2000). these savings were assumed to have a payback of one month (fawkes et al., 2001) and ten percent of the cost saving per year can be dedicated to maintaining these savings. this option lowers electricity consumption, thus pollution from electricity generation should be reduced. 6.2.2 variable speed drives (for fans) variable speed drives in some applications can reduce electrical demand by closely matching demand during times of low output, and thus draw less electricity and therefore less greenhouse gas emissions associated with electrical generation. it is reported that for fans savings can amount to 30 per cent (de villiers, 2000), which was felt to be optimistic, and reduced to 25 per cent saving. it was assumed that only 25 per cent of existing fans in industry would be eligible for replacement vsds. the application of vsds for pumping, hv ac and other motors was in applications such as mining was not considered, due to the extra control requirements, which would need to integrated into the system. potential in gold mining, for example, does exist for complete automation and vsd control as part of an integrated approach, consequently, vsds have not found extensive application in gold mining2• 6.2.3 electrical motors for electrical motors mitigation option, high efficiency motors (hems) with efficiency improvements of 1-5 per cent (geldenhuis, 2001) over the period modelled (1995-2025), are probably realisable in the south african context. other potential savings options include: motor downsizing, minimising load, cutting the power supply during no load times and the further application of variable speed drives. the following assumptions were made for the motor stock in south africa: a modest 1 per cent improvement could be realised per motor over the base case over 25 years, the average life of the motor was 10 years, the increased capital cost per motor was $7.3 per kw3 the average load factor was assumed to be 70 per cent the systems that would be affected by introducing high efficiency motors include: fans, hv ac, pumping and motors. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 489 6.2.4 lighting using higher efficiency lamps, switching them off when not needed and in sunny areas making use of skylights present a significant opportunity for electricity and therefore greenhouse gas saving. much of the lighting energy is used on the factory floor. the assumptions are taken from the vw case study4. the assumptions used for this mitigation option are as follows: a saving of 30 per cent of electrical lighting energy for 30 per cent of installations over the base case by 2025 5• 6.2.5 efficient hvac systems various measures can be taken to help improve the efficient operation of heating ventilation and cooling systems (hv ac). these include, amongst other things (kenny, trikam, howells & drummond, 2000): ensuring minimum hours of operation proper maintenance of heat exchanger surfaces waste heat utilisation high efficiency motors and vsds (this has been captured in another section, and not included here.) it was assumed that 50 per cent of hv ac systems could have their efficiency improved by about 20 per cent. a recent report suggested that 37-25 per cent of energy consumption could be reduced in south african installations (de villiers, 2000) over the baseline for old and new systems respectively. the measures were anticipated to have a three-year payback with ten percent of fuel cost savings dedicated to maintaining savings. similar studies in local industry show one-year paybacks (kenny & howells, 2000) all with conservative costs. 7 evaluation and discussion this section describes the effects of some of the options outlined above, with table 6 showing a summary and evaluation of mitigation options according to selected criteria set out by the south african country study process and then the presentation of the mitigation cost curve derived from leap2000. in table 6, each option was quantified and assessed as either positive, negative or have no effect. the criteria considered include: local environmental issues, macro economic effects and social impacts and was used as a basic standard of comparison with the country study. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 490 sajems ns yol 5 (2002) no 2 7.1 effects of electricity based options the effect of compressed air, ysds, hems and lighting mitigation options is to lower electricity consumption, and therefore generation. this has the effect of delaying the construction of new plant, which helps optimise the electricity resource system. pollution from the generation of electricity versus the base case should be reduced. there may be a negative impact in terms of a loss of jobs associated with reduced coal mining and new power plant activity. this however should be counterbalanced against a possible improved export markets for cleaner goods, and the extension of the life of the coal industry. the money saved would also increase economic performance, increase taxable revenue, and likely be re-invested in other sector offsetting initial job losses 7.2 effects of boiler efficiencies 7.2.1 coal fired boilers the effect of improving coal fired boiler efficiencies extends the life of local reserves, and reduces local pollutants. there may be some negative employment effects due to reduced coal production. this however should be counterbalanced against a possible improved export markets for cleaner goods, and the extension of the life of the coal industry. the money saved would also increase economic performance, increase taxable revenue, and likely be reinvested in the economy offsetting initial job losses. the same comments are applicable for saving steam produced from coal-fired boilers. 7.2.2 oilfired boilers the effect of improving oil fired boiler efficiencies reduces oil consumption, and therefore crude imports and reduce local pollutants. as a result, the effect on the balance of payments would be positive. other effects may include improved export markets for cleaner goods. the money saved would also increase economic performance, increase taxable revenue, and likely be reinvested in the economy. the same comments are applicable for saving steam produced from oil-fired boilers. 7.2.3 gas fired boilers the effect of improving gas fired boiler efficiencies reduces gas consumption, and therefore for lpg, crude imports; for natural gas, gas imports; and for synthetic gas lower local outputs. this measure will also have the effect of lowering local pollutants. in the case of lpg and natural gas the effect on the balance of payments would be positive due to a reduction of imports. other r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 n02 491 effects may include improved export markets for cleaner goods. the money saved would also increase economic performance, increase taxable revenue, and likely be re-invested in the economy. the same comments are applicable for saving steam produced from gas-fired boilers. the negative impact on the trade balance of the electricity to natural gas option is due to the importing of natural gas compared to the local electricity generation. due to the positive cost per ton of the coal and oil to natural gas option, there is a negative impact on the trade balance and on international competitiveness. 7.3 mitigation cost curve by dividing the life cycle cost (using a discount rate of 11 per cent) of the mitigation option for the period considered by the number of tons of carbon dioxide equivalent saved for the period, together with the total number of tons a mitigated 'cost curve' can be constructed. this cost curve gives an indication of the quantities of co2 equivalent that can be mitigated and the cost effectiveness of the measure. in the calculation of the total costs, all capital costs, operating and maintenance costs and fuel costs have been taken into account. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . reduccost tionln ghg local environmental impact effecmacro economic effects social impacts emissions tlveness >-3 i~ ii> =-li' e-. soil ... _-~-.... ... ---~-------------------ghg million water air quality impact on impact on social conserleakinternational equity and job mitigation tonnes of vation and resources and (non-ghg (riton) the trade competipoverty creation measure col biodiverbiodiversity emissions) age balance tiveness . alleviation sity efficient oil heating 2 zero zero positive zero .48.4 positive positive zero positive efficient zero-mildly electrical 19 zero positive zero -32.s zero positive zero positive healing positive compressed 76 zero zero-mildly positive zero -28.9 zero positive zero positive air systems positive -------electricity to 42 zero zero-mildly positive zero -11.4 negative positive zero zero ~lls .. _... positive ---------efficient 129 zero zero positive zero -11.1 zero positive zero positive coal heating efficient zero-mildly ------~----.... -------motors s zero positive positive zero -3.8 zero positive zero zero variable 33 zero zero-mildly positive zero -2.7 zero positive zero zero speed drives positive ----------efficient i zero zero-mildly positive zero ·1.81 zero positive zero positive hvac positive efficient gas 4 zero zero-mildly positive zero -1.7 positive positive zero positive heating positive 00 = a a ii> ~ ii> ;:i q. "' < !. = ii> ::1 q ;:i q .... e. vl ::1 ~ a: .... :s' e::: ;:i vl .g z ::1 vl q 9: == "" vi ------------lighting 13 zero zero-mildly positive zero ·0.78 zero positive zero zero ilositiv~_ ......... t-.j 8 coal and oil t-.j '-' to natural 91 zero zero positive zero i gas s1.9 negative negative zero zero ~ -. .. . . t-.j r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . ""'l <ia" .: ~ .... ~ 8: ijci • -5" = n q ~ n .: ~ fi> s" ., (j') q .: ~ ~ rr • =:i s· q. .: iii -~ cil > ....... ~ cil z cil <: 2v. ,-... iv 8 iv '-' z 0 iv ""'" \c) w r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 494 sajems ns vol 5 n02 8 ghg case study vw uitenhage 8.1 general background this section is based on an energy efficiency case study and an energy consumption monitoring and verification study conducted for the volkswagen sa (vw) uitenhage plant a. it should be stressed here that this report is intended as an illustration of greenhouse gas emissions that can be saved because of energy efficiency measures undertaken. for further information or detail on the study, please see the full reports. 8.1.1 energy forms and use in the plant electrical energy is used for operating much of the process-related equipment (conveyors, robot welders, hand welders), for air conditioning in offices, for lighting, for workplace fans, water chilling fans, water chiller units, fluid pumping (water and thermic oil) and for compressing air. heavy fuel oil (hfo) is used to heat thermic oil in boilers. thermic oil is then pumped to ovens in the paint shop. liquid petroleum gas (lpg) is used for air heating. it is used to control the temperature of air for the spray areas and for heating ovens in the paint shop. paraffm is used as a solvent and for heating wax polish to a workable temperature. 8.1.2 current energy conservation and waste minimization practices some significant energy and cost saving measures implemented include the following: high efficiency lighting (high pressure sodium) has been installed in the receiving and container warehouses (approximately 40 per cent of existing lamps). lights in the press shop were turned off during the daytime. outside air has been ducted to intake ports of the main compressors allowing them to operate efficiently. sections of old dirty fibreglass skylight panels have been replaced with clear or translucent polycarbonate in some areas of the plant thereby allowing a jot more natural light to enter the plant during the day (particularly the press shop and the receiving warehouse). a number of sources of wastage (compressed air, effluent, power factor) had already been identified by the engineers at plant a. investigations by consultants had been carried out and recommendations been made. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 495 in response to investigations into compressed air wastage, vw engineers have acquired airflow monitoring equipment and they are in the process of installing the sensor mountings and setting up data-logging equipment. 8.2 energy and carbon accounting greenhouse gas emissions that are the result of energy usage can be accounted for through energy accounting via the use of the appropriate emission factors. the tracing of energy usage and costs in a plant can assist in the identification of possible areas of cost effective, greenhouse gas, emission reductions. some common practices include: energy management electric bill sample calculation summary of energy usage and costs the avoided cost of energy 8.3 abatement mitigation options from on-site investigations and information gained from collected data, the following abatement mitigation options (amo) were identified and their respective energy savings, emissions reductions, costs and payback periods shown below: amo 1 repair compressed air leaks and faulty blow-down valves amo 2 a void and discourage misuse of compressed air amo 3 switch off er compressors and main cooling towers during nonproduction time. amo 4 isolate areas of the plant or individual machines that do not require compressed air during non-production time amo 5 use waste heat from refrigerant condenser to pre-heat phosphate bath amo 6 install high-efficiency lighting amo 7 install skylights and photo-sensor light controls amo 8 turn offbay lights during non-production hours additional items considered (aic) identify and switch off equipment that is not essential during non-production time. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 496 sajems ns vol 5 (2002) no 2 table 7 vw mitigation options summary energy total cost implemenpayback conservation co2 savings tation cost period emissions reduced amoi 2222639 mj/yr 607.280t r1859860/yr r60000 2 weeks am02 207981.5 mj/yr 56.826t r173840/yr r 30 000 2 months am03 167580mj/yr 45.787t r108459/yr none immediate am04 387334 mj/yr 105.829t r250686/yr r40000 2 months amos 185185 mj/yr 29.802t r190000/yr r300000 19 months am06 69512 mj/yr 182.927t r239473/yr r 726 936 3yrs am07 223549 mj/yr 61.079t r303314/yr $2,844,900 5+yrs amos 742404 mj/yr 202.843t r446190/yr none immediate alc 1633333 mj/yr 446.267t r1057106/)'l not estimated not estimated 8.4 monitoring and verification the monitoring and verification of the abatement options is considered very crucial as it verifies that the projected savings to be realised and what quantities need to be monitored in order to realise these savings. energy and cost saving measures are only likely to be effective and sustainable where these measures form part of staff performance reviews. ideally, where the cost of full instrumentation is possible, performance reviews could include defmed monetary targets. it is recognized that review systems may not generally be in place and, consequently, any energy management recommendations rely on the diligence of departmental managers and their staff as a minimum. the overall site electricity consumption data collection systems should remain. it is assumed that data collection would be undertaken centrally, possibly in the finance department. disaggregated data must be sent to departmental heads for inclusion in their existing reports. clearly, actual consumption data should be compared with target values and any variance, quoted in both energy and monetary terms, must be accompanied by an explanation. strong consideration should be given to including energy consumption figures in departmental budgets. for more effective energy management it is recommended that a dedicated energy manager be employed within the finance department with overall r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 n02 497 responsibility for achieving economical operation of the whole site and coordinator for energy conservation measures. some of the abatement options have clear guidelines for monitoring and verification application, but all should consider the following: i. quantities to be monitored 11. metering equipment and costs iii. energy management required. 8.s total cost of m& v plan the estimated total cost of all the monitoring is r270 000, including a rio 000 allowance for commissioning and training. the estimated total cost of all the energy cost saving measures is r12 825 098, which makes the m & v approximately 2 per cent of this value. in addition, an energy manager would cost the company a further r150 000 per year. these costs include measures not shown above. 9 conclusions and recommendations all mitigation options, apart from moving from fossil fuel to gas, can be considered financially feasible mitigation options in the industrial sector. it can be seen from the mitigation cost curve that the only option that has a positive cost in r/ton of c02 equivalent is switching from fossil fuel to gas. coal heating efficiency improvements provide the largest carbon dioxide equivalent emission reduction, while oil heating efficiency improvements provides most costeffective mitigation option. it is recommended that better data collection and iterations of the modelling process should be made to refine the quantification of the emissions reductions from the various options for each of the sub-sectors. endnotes cooper c. s a balances 1992-1997. institute of energy studies. rand afrikaans university. this figure does not contain biomass data. 2 based on comments from the control room staff at anglogold mine elandsrand in carltonville, 2000. 3 'motor master' software of the us department of energy's motor challenge programme. assuming a 75hp motor. 4 of the options investigated (skylights, turning lights off during nonproductive hours and high efficiency lighting upgrade) high efficiency r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 498 sajems ns vol 5 n02 upgrades were chosen, as this represents an easily measured option. it also does not represent the full spectrum of savings, and therefore probably understates the potential savings and at a higher cost. this is consistent with the philosophy of the report, which seeks to identify realisable mitigation options. 5 table showing comparison of mercury vapour to metal halide lights. references de villiers, 'greenhouse gas baseline and mitigation options for the commercial sector', energy and development research centre, january 2000. 2 fawkes h., van es d., khumalo s. & howells m., 'vw uitenhague energy assessment' energy research institute, university of cape town, draft, november 2001. 3 geldenhuis, a. (2001) eskom isep office, email. 4 granville, a, stanko j.s., & freeman, m. (1992) " review and nalysis of energy use in the metal industries", report number ed 9101. august. department of mineral & energy affairs. pretoria: 103. 5 kenny a r. (1998) "'sustainable energy for south africa, energy demand: the industrial sector", energy research institute, university of cape town, december: 4. 6 kenny, ar. & howells, m.i. (2000) "management summary, energy audit: anglogold" pp 6, prepared for the european commission, netherlands ministry of economic affairs, october. 7 kenny, a.r., trikam, aj., howells, m.i. & drummond, r.s.h. (2000) "how to save energy and money: refrigeration", prepared for the european commission, netherlands ministry of economic affairs, october. 8 minerals bureau bulletin (1998) september, 11(2): 2. 9 conversation with johann prinsioo, chief engineer, isep, eskom, august 2001. 10 trikam, aj., howells, mj. and drummond, r.s.h. (2000) "how to save energy and money: compressed air systems" compiled by kenny ar., pp 53, prepared for the european commission, netherlands ministry of economic affairs, october. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . f:\ejour\ecoman\ftp\ecoman_v6_n1.prn.pdf sajems ns vol 6 (2003) no 1 143 the controllable elements of the total retail experience: a study of clothing shoppers ________________________________________________________________ n s terblanche department of business management, university of stellenbosch c boshoff department of business management, university of port elizabeth ________________________________________________________________ abstract retail clothing stores continually have to adapt to marketplace demands to remain competitive. customer retention has become a major objective for many clothing retailers. this study combines the management of a number of the controllable personal and non-personal elements that a customer are exposed to and interacts within a retail store, as part of the shopping experience. the data analysis procedures closely followed the guidelines for scale development suggested by churchill (1979). the empirical results suggest that there are five dimensions considered important by consumers when assessing their satisfaction with a total retail experience in a clothing store. these are: merchandise value, internal store environment, personal interaction with staff, merchandise variety and complaint handling. jel m30 1 introduction more sophisticated and demanding customers, domestic and foreign competition and the expanding range of choices available to customers make it increasingly difficult to retain customers over the long term. loyal customers are increasingly regarded as the backbone of any businesses and authors such as singh and sirdeshmukh (2000: 150) describe loyal customers as “the emerging market-place currency for the twenty-first century”. two of the more popular alternatives that retailers utilise to differentiate themselves from competitors are customer loyalty schemes and the delivering of exceptional service quality as part of their retailing strategy (egan, 1999: 11; berry, 1986; hummel & savitt, 1988; reichheld & sasser, 1990). egan (1999: 11) has, however, cited the mixed success of loyalty schemes in retail sectors such as the fast moving consumer goods (fmcg) sector. he suggests that low acquis ition and switching costs in the fmcg sector impact negatively on the sajems ns vol 6 (2003) no 1 144 success and viability of loyalty schemes. in other words, because competitors could easily copy them, loyalty schemes have yielded only limited success as a sustainable differential advantage. service quality and especially servqual, the instrument developed to measure service quality, received a considerable amount of attention in the marketing literature published the past decade. the majority of the studies using or assessing the servqual instrument were executed in fairly "pure" services settings such as banking, airline reservations and credit card services. the typical retail store experience includes activities such as browsing, price comparisons, looking for merchandise, evaluating product variety and quality and interaction with store personnel – dimensions not captured by the servqual instrument. in other words, servqual in its original form has proved unsuitable to capture the unique blend of merchandise and service that typically make up a retailing experience. if loyalty schemes and/or other individual approaches such as the management of service quality are unsatisfactory to retain customers, it might be worthwhile to consider an approach that combines the management of a number of the personal and non-personal elements that a customer are exposed to and interact with in a retail store. this so-called shopping experience is defined by kerin, jain & howard (1992) as the outcome of a customer’s interaction with a store’s physical surroundings, personal interaction with employees and customerrelated policies and practices. in other words, managing the retail experience optimally presents a further alternative to retailers as a differentiating variable. 2 the total retail experience total retail experience (tre) has been defined as all the elements that encourage or inhibit consumers during their contact with a retailer (berman & evans, 2001: 18). tre is influenced by two groups of components, namely noncontrollable and controllable components. the non-controllable components consists of aspects such as the adequacy of street parking and the timing of deliveries from suppliers and taxes, all of which are either uncontrollable or a retailer can exert only limited control. the controllable components, on the other hand, comprise of a variety of elements that the retailer can control to a varying degree, such as the number and quality of salespeople on the shopping floor, the variety of brands on offer and the volume of stock on hand. the controllable elements of the tre form the focus of this study. the retail literature suggests that the dimensions of the controllable components may be described as (hummel & savitt, 1988; mazursky & jacoby; 1985; kerin, jain & howard, sajems ns vol 6 (2003) no 1 145 1992; westbrook, 1981; baker, grewal & parasuraman, 1994; sirohi, mclaughlin & wittink, 1998): • service quality • merchandise quality • merchandise variety and assortment • internal store environment • product prices • store policies the six dimensions mentioned above have been adequately described elsewhere (terblanche & boshoff, 2000(a): 99-117; terblanche & boshoff, 2000(b): 3541) and are briefly attended to here. service quality consists of the five dimensions of responsiveness, reliability, empathy, assurance and tangibles and is measured with the servqual instrument. merchandise quality refers to customers’ perception of the quality of the products on offer. merchandise variety and assortment refer to the width and depth of the merchandise offered. internal store environment includes all those elements that contribute towards a pleasant shopping atmosphere and include elements such as shop layout, aisles that make it easy to shop, store cleanliness, well-spaced product displays and attractive décor. product prices as a dimension aims to establish customers’ perception that product prices represent good value. store policies are those elements that are influenced by a shop's responsiveness to the customer's needs and include elements such as the return or exchange of purchases, shopping hours, payment options available and a system or process to deal with customer enquiries and/or complaints. two dimensions that some want to include in tre, namely store image and store location, are not extensively dealt with in this study. retailing literature also suggests that a favourable store image leads to store loyalty (hirschman, 1981). store image, in turn, has been described as consisting of the following three general factors: merchandise-related aspects, service-related aspects and pleasantness of shopping at a store (mazursky & jacoby, 1985). all three of these factors are captured comprehensively in tre (figure 1) and that loyalty is an outcome of a positive total retail experience (tre) rather than an underlying dimension. although store location is normally one of the important reasons for customers frequenting a particular shop, it is not addressed in this study because in many cases, a retailer does not have complete control over store location, irrespective of whether the retailer locates in a shopping centre or a separate shopping area. for instance, over time a favourable location may deteriorate in value due to changes in road patterns, traffic congestion, the opening of competitive shops and changing demands for parking. sajems ns vol 6 (2003) no 1 146 the theoretical structure of the tre is illustrated in figure 1. the shaded dimensions in figure 1 are the ones included in the first empirical survey. these are dealt with in paragraph 5. figure 1 schematic presentation of the theoretical structure of the total retail experience* total retail experience n o n-controllable elements controllable elements merchandise variety & assortment merchandise quality service quality product prices internal store environment store policies responsiveness empathy assurance reliability tangibles * shaded areas indicate the controllable elements assessed in the first phase of the research 3 some comments on the typical behaviour and expectations of clothing shoppers in a recent study on the importance of clothing store image attributes amongst black females, the dimensions of physical facilities, salespeople service, merchandise requests and store layout were considered as important by all the clusters of black female shoppers identified (kleinhans, visser, van aardt & du preez, 1998: 14-15). de klerk, velleman and malherbe (1998: 15-24) also found that the appearance of and interaction with salespeople are important determinants of whether a female customer will take advice from and return for further purchases. a study amongst male consumers found the following five store attributes as most important (in order of most important to less important) to male shoppers when they shop for clothing (torres, summers & belleau, 2001: 207). • price of merchandise • quality of merchandise sajems ns vol 6 (2003) no 1 147 • selection of merchandise • brand carried in the store • friendly personnel in earlier studies the quality and knowledge of sales personnel were also found to be very important store attributes for clothing shoppers (mahoney & sternquist, 1989: 101-11; thorpe & avery, 1983: 35-41). in a study of speciality store customers, thorpe and avery (1983) found that customers were willing to travel longer distances and pay higher prices in order to be served by knowledgeable sales personnel. westbrook (1981: 68-85) found that the most influential components of retail satisfaction were satisfaction with stores’ sales personnel, special store sales, products/services purchased at the store, store environment and value-priced relationship offered by the store. the abovementioned findings offer some explanation as to why middle and higher price clothing shops, in their attempts to entice shoppers to browse and spend time in the shop, use a free-flowing or boutique layout pattern because it creates a friendly atmosphere in which unplanned or impulse purchases are enhanced (berman & evans, 2001: 613). all of the above-mentioned attributes of clothing shops that have been found to be important to consumers, are included in or covered by the dimensions of tre. 4 the objectives of this study the main objective of this study is to develop a multi-item instrument to measure customer satisfaction with the controllable components of the total retail experience. this article reports on the first two phases of a long-term study attending to the controllable elements of the total retail experience for shoppers and deals specifically with the findings of the second phase in respect of clothing shoppers. based on the disconfirmation paradigm (oliver, 1980), the first two phases of this three-phase process is to identify the dimensions of importance to consumers when assessing their satisfaction with a total retail experience. only once these dimensions have been identified and empirically confirmed, can there be proceeded to the development of a valid and reliable instrument to measure customer satisfaction with the total retail experience at retailer or shop level. 5 methodology and sample of the first phase the first phase of the empirical research was undertaken to assess which dimensions are of importance to retail shoppers when assessing their customer satisfaction at shop level. based on the theory, the three dimensions of tre sajems ns vol 6 (2003) no 1 148 shaded in figure 1 (service quality, merchandise quality and merchandise variety and assortment) were investigated during this first phase of the study. because of the size of the complete tre model and the large number of items measuring the three dimensions, as well as the distinct possibility of respondent fatigue, it was decided to include only three of the dimensions in the first empirical phase of the project. all 22 items of servqual were used to measure service quality. the merchandise quality dimension was measured with three merchandise quality items suggested by finn & kayandé (1997) as well as two self-generated items. merchandise variety and assortment was measured with a self-generated five-item instrument. all items were linked to a 7-point likert-type scale. the sampling procedure used in the first phase was a combination of judgement, convenience and random sampling. four retail industries, namely fast food, clothing, supermarkets, and hardware stores were selected for the sample. these industries were studied because they offer a combination of both servic e and physical products and their market offer cannot be described as a “pure” service or independent of any service component. two organisations in each industry were then selected on a convenience basis and requested to participate in the study. individual respondents (customers) to be interviewed were selected on a random basis. personal interviews, using a structured questionnaire, were conducted with customers of firms in these four industries on the retailer’s premises following a shopping visit. every fourth customer leaving a shop was approached to take part in the survey. a total of 2 063 questionnaires were completed. in the scale purification process that followed, a maximum likelihood exploratory factor analysis was conducted specifying a direct quartimin oblique rotation (jennrich & sampson, 1966) of the original factor matrix using the computer programme bmdp (jennrich & sampson, 1966). this was followed by an assessment of the internal consistency of each dimension as suggested by churchill (1979). 6 results of the first empirical survey several different factor solutions were considered during the scale purification process. the most interpretable factor structure (factor loading exceeding 0.4 and no cross-loadings) to emerge, was a 3-factor solution. all the factors in the 3-factor solution had eigen values above 1.00 and a sufficient number of items loading on them to a significant (0.40) extent (hair, anderson, tatham & black, 1998). the three factors that emerged were named personal interaction (measured by 3 assurance, 4 empathy, 2 reliability and 3 responsiveness items of servqual), physical cues (measured by 1 reliability and 2 tangibles items of servqual and 4 merchandise quality items) and variety (represented by 5 sajems ns vol 6 (2003) no 1 149 variety items). the items that did load to a significant extent or did not demonstrate sufficient discriminant validity were deleted. the remaining 24 items were then subjected to a reliability analysis to assess the internal consistency of the instrument. all three factors, as well as the overall instrument returned cronbach alpha coefficients above the 0.7 level suggested by peterson (1994). the three remaining empirical factors and their associated items are listed in table 1. the outcome of the first survey was that figure 1 had to be re-configured slightly as shown in figure 2 to reflect the results of the scale purification process (table 1). table 1 empirical factor structure: survey 1 empirical dimension items measuring the tre dimensions personal interaction (α = 0.937) employees of xyz should always be willing to help me xyz employees should give me personal attention employees of xyz should provide me with prompt service employees of xyz should be consistently courteous xyz should give me individual attention employees of xyz should never be too busy to respond to my requests when i have a problem, xyz should shows sincere interest in solving it i should have confidence in xyzs employees employees of xyz should understand my specific needs employees of xyz should have the knowledge to answer my questions xyz should have my best interests at heart xyz should provide its services at the time it promises to do so physical cues (α = 0.863) the products available at xyz should be of good quality xyzs should offer products of good quality xyz should be known for good quality products materials associated with xyzs service (such as shopping bags, till slips or catalogues) should look good sajems ns vol 6 (2003) no 1 150 table 1 continued empirical dimension items measuring the tre dimensions xyzs products should not have defects xyzs physical facilities should look good xyz should provide error-free sales transaction records (till slips, credit card slips, accounts) merchandise variety and assortment (α = 0.857) xyz should offer me a satisfactory choice of products xyz should have all the products that i want to buy xyz should offer a wide variety of products the products of xyz should cater for a wide range of preferences xyz should make products available in a variety of sizes 7 the second survey a second empirical survey was then conducted as suggested by churchill (1979). the six items with the highest factor loadings that measured personal interaction were retained for the second empirical survey. three of the items used to measure physical cues measured product quality and it was decided to retain only one of these three items as one item was enough to measure product quality. the following item was added to measure physical cues: “products that function the way they are supposed to”. two new items, apart from the five that were used to measure merchandise variety and assortment in the first survey, were added for the second empirical survey. these two items were: “a choice of different brand names” and “a good selection of well-known brands”. a total of sixteen items remaining from the scale purification process of phase 1 as well the three new items (in total nineteen items measuring personal interaction, physical cues and merchandise variety and assortment) were combined with items to measure the three remaining (then untested) dimensions of tre, namely internal store environment (9 items), product prices (5 items) and store policies (7 items). figure 2 is a schematic presentation of the dimensions of tre that were subjected to empirical assessment during the second survey. sajems ns vol 6 (2003) no 1 151 figure 2 schematic presentation of the dimensions of the tre tested in the second phase of the study total retail experience non-controllable elements controllable elements merchandise variety & assortment physical cues personal interaction product prices internal store environment store policies 8 sample and data collection: second survey the sampling procedure used in the second survey was a combination of convenience and random sampling. respondents were visitors to two regional shopping centres. individual respondents (visitors) to be interviewed were selected on a simple random basis. personal interviews, using a structured questionnaire, were conducted with visitors to the shopping centre after they had finished their shopping. the interviews were conducted over a period of two days to include all the different types of visitors that usually frequent these shopping centres. respondents were asked to rate the importance of the various components of tre on a 7-point scale where a 7 meant that the aspect under consideration is “extremely important” and a 1 meant that it is “not important”. a total of 1307 questionnaires were completed. 9 empirical results: second survey the second survey data analysis procedures again closely followed the guidelines for scale development suggested by churchill (1979). to assess the discriminant validity of the instrument a maximum likelihood exploratory factor analysis was again conducted specifying a direct quartimin oblique rotation (jennrich & sampson, 1966) of the original factor matrix. although it was expected that a six-factor solution would emerge (in line with figure 2) several different factor solutions were considered. the most interpretable factor structure (factor loading exceeding 0.4 and no crossloadings) to emerge, was a 5-factor solution (table 2). four of the five factors in sajems ns vol 6 (2003) no 1 152 table 2 had eigen values above 1,00 and a sufficient number of items loading on them to a significant (0.40) extent (hair, anderson, tatham & black, 1998). two of the three factors retained from the first survey (personal interaction and product variety and assortment) remained stable during the second survey. of the “new” dimensions added for the second survey internal store environment and store policies emerged as separate factors as expected. some of the items expected to measure physical and product prices, however, loaded on a common factor that was labeled merchandise value (table 2) whilst the internal store environment items that remained, all measured complaint handling and the dimension was subsequently called complaint handling. table 2 rotated factor loadings factor 1 factor 2 factor 3 factor 4 factor 5 items merchandise variety merchandise value personal interaction complaint handling internal store environment var7 0.742 0.036 0.019 -0.040 0.012 var3 0.701 -0.063 0.057 -0.102 -0.005 var6 0.682 0.109 -0.043 0.094 -0.040 var4 0.595 0.133 0.007 0.045 -0.045 var5 0.564 0.054 0.026 0.133 0.026 env8 0.523 -0.121 0.026 0.073 0.202 phys1 -0.079 0.631 0.026 0.021 0.010 price1 0.013 0.585 0.074 -0.018 0.056 phys2 0.038 0.546 0.042 0.080 0.086 price2 0.139 0.532 0.039 0.175 -0.035 var1 0.149 0.484 -0.006 -0.124 0.172 phys3 0.025 0.470 -0.014 0.182 -0.019 price3 0.172 0.463 0.173 0.181 -0.118 pers3 0.100 -0.173 0.663 -0.002 0.027 pers2 -0.105 0.201 0.636 -0.014 0.015 pers4 0.089 0.004 0.583 0.139 0.023 pers6 0.140 -0.021 0.523 0.272 -0.011 pers1 0.006 0.156 0.440 -0.070 0.037 pers5 -0.031 0.018 0.423 0.288 0.119 pol6 0.033 0.021 0.040 0.731 0.097 pol7 0.064 0.070 0.087 0.660 0.053 pol5 0.036 0.129 0.044 0.620 -0.006 env1 -0.032 0.099 0.042 0.037 0.773 env7 0.250 0.012 0.091 0.224 0.400 eigenvalues 8.18 2.03 1.60 1.21 0.96 cronbach alpha 0.83 0.81 0.81 0.82 0.65 sajems ns vol 6 (2003) no 1 153 9.1 reliability assessment the assessment of the proposed instrument’s discriminant validity by means of an exploratory factor analysis was followed by an assessment of the internal consistency of each dimension as suggested by churchill (1979). as indicated at the bottom of table 2, four of the five factors/dimensions returned cronbach alpha values above the customary cut-off of 0.7 (peterson, 1994). the cronbach alpha value for the whole instrument was 0.914 9.2 convergent validity any measuring instrument should be both reliable and valid (churchill, 1979). a variety of different types of validity should be considered before any claims of validity can be made (tull & hawkins, 1993). to test the convergent validity of the tre instrument the total tre score (mean 151.45, sd18.43) was correlated with scores that was expected to measure perceptions of adequacy of parking facilities (park), satisfaction with the special in-store promotions (spec) and the image of the company (image). it was expected that consumer perceptions of these three retail issues would be positively associated with satisfaction with the total retail experience (tre). the empirical results reported in table 3 confirm this contention. the pearson correlation coefficients shown in table 3 reveal a consistent pattern of significant positive correlations with the total tre scores, namely perceptions of adequacy of parking facilities (park, mean 6.24, sd 1.23), satisfaction with special in-store promotions (spec, mean 5.33, sd 1.52) and the image of the company (image, mean 5.72, sd 1.40), confirming the convergent validity of the tre instrument. table 3 correlation matrix tre park spec image tre 1.00000 0.0 park 0.43859 0.0001 1.0000 0.0 spec 0.50349 0.0001 0.26448 0.0001 1.00000 0.0 image 0.46983 0.0001 0.3506 0.0001 0.49265 0.0001 1.0000.0 sajems ns vol 6 (2003) no 1 154 9.3 construct validity to assess the construct validity of the instrument a confirmatory factor analysis was conducted using lisrel 8.30 (jöreskog & sörbom, 2000). the results summarised in table 4 and figure 3 suggest a close fit of the model to the data (χ2 = 1113.9; df = 242; rmsea = 0.057; gfi = 0.925; agfi = 0.907; and ecvi = 1.07). the close fit of the model to the data provides additional evidence of the construct validity of the proposed instrument for clothing shoppers. figure 3 empirical results of survey 2: clothing total retail experience non-controllable elements controllable elements internal store environment merchandise value personal interaction complaint handling merchandise variety table 4 model fit indices chi-square 1113.9 df 242 rmsea 0.057 ecvi 1.07 normed fit index (nfi) 0.901 comparative fit index (cfi) 0.92 standardised rmr 0.047 gfi 0.925 agfi 0.907 pgfi 0.746 sajems ns vol 6 (2003) no 1 155 10 findings this study attempted to develop a generic instrument that could be used to measure customer satisfaction with the controllable elements of the in-store shopping experience of clothing shoppers. the final questionnaire consists of 23 items measuring 5 dimensions of the in-store shopping experience that adequately tap the in-store retail experience of clothing shoppers, compared to customer expectations. these five dimensions are merchandise value, internal store environment, personal interaction with staff, merchandise variety and complaint handling. clothing retailers who whish to enhance the customer satisfaction of their shoppers will have to perform at exceptional levels on these dimensions to improve their customer satisfaction ratings and to differentiate themselves from competing clothing retailers. 11 conclusion this study reports on two phases of a long-term study on the controllable elements of the total retail experience. the eventual outcome of this stream of research is to develop a reliable and valid instrument to measure customer satisfaction with the controllable components of the total retail experience at store level. closely following the guidelines for multi-item scale development suggested by churchill (1979) and based on the result of two empirical surveys we conclude that there are five dimensions of importance to clothing shoppers when assessing their satisfaction with a total retail experience. these dimensions are merchandise value, internal store environment, personal interaction with staff, merchandise variety and complaint handling. these five dimensions and thus the total retail experience, are measured by means of 23 items (see appendix a). the proposed 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(1983) “a demographic and psychographic assessment of a specialty store’s customers and non customers”, clothing and textiles research journal, 2: 35-41. 24 torres, i.m.; summers, t.a. & belleau, b.d. (2001) “men’s shopping satisfaction and store preferences”, journal of retailing and consumer services, 8(4): 205-12. 25 tull, d.s. & hawkins, d.i. (1993) marketing research: measurement and method (6th ed.) new york: macmillan. 26 westbrook, r. (1981) “sources of consumer satisfaction with retail outlets”, journal of retailing, 57(fall): 68-85. sajems ns vol 6 (2003) no 1 158 appendix a items to measure the total retail experience of customers merchandise variety varos1 a good selection of well-known brands varos2 a choice of different brand names varos3 a wide variety of products varos4 a variety of brand names that are available in many different sizes varos5 products that cater for a wide range of preferences merchandise value meval1 products that function the way they are supposed to meval2 reasonable prices meval3 products of good quality meval4 prices that offer value for money meval5 a satisfactory choice of products meval6 products that are free from defects and flaws meval7 products at prices that represent good value personal interaction persin1 staff that give me personal attention persin2 staff are always willing to help me persin3 staff that provide me with prompt service persin4 staff that are never too busy to assist me persin5 staff that understand my specific needs persin6 staff that are courteous complaint handling cohan1 an effective means of dealing with customer enquiries cohan2 staff that efficiently deal with customer complaints cohan3 a fair system for the handling of complaints internal store environment stenv1 a pleasant shopping atmosphere stenv2 a convenient shopping environment sajems ns vol 5 (2002) no 3 franchisors on the financing and other problems of prospective franchisees amsmit 711 po/chefs/room business school, po/chefs/room university for chris/ian higher education abstract the current high unemployment rate and the need to develop the sme sector in south africa, has highlighted the franchise sector as a possible generator of employment and wealth. certain problems in the sme sector, for example the lack of financing, were identified and investigated from the viewpoint of the franchisor. this study attempts to analyse the general problems that prospective franchisees are confronted with and then focuses on the more specific problems regarding financing as experienced by the prospective franchisees. jel background and motivation for the research the development of the small business sector is one of the critical areas in the economy of south africa. the small business sector plays an important part in the economic and social development of the country and can contribute substantially to job creation. a lively small business sector is regarded as a prerequisite for fast growth and economic development in south africa (thomas, 1995: 13). the development of the small business sector is also regarded as a mechanism allowing formerly disadvantaged groups access to economic opportunities. it may thus contribute to the redistribution of income and wealth. in order to achieve success regarding the goals, as expounded in part 4 of the smme white paper, twelve aspects identified in the white paper deserve attention. one of the most important aspects, which is directly relevant for this survey, is the accessibility of financing for the small business sector. the general feeling of entrepreneurs and other institutions supporting the small business sector is that access to financing at affordable interest rates is one of the deciding factors for the success of the small business enterprise (thomas, 1995: 21). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 712 sajems ns vol 5 (2002) no 3 several studies have been undertaken to determine the reasons for failure of small business enterprises. amongst the most important reasons pointed out are the lack of managerial capabilities such as planning and decision making and experience of the entrepreneur (gaskill, van auken et al., 1993: 25). many other reasons for the failure of the small business enterprises arise from this, for example: lack of market research; choice of location is wrong; ineffective layout of the enterprise (floor design); lack of a long-term business plan; ineffective control over cash flow; high interest rates; lack of knowledge in terms of price strategy; and bad relationship with suppliers. a kind of enterprise containing some of the elements to address abovementioned deficiencies is the franchise enterprise. franchising is also considered a good option for south africa to create work and establish new enterprises (holmes, 1994: 27). in view of tendencies in the south african economy, it seems as if small business enterprises and especially the franchise trade can playa part in creating entrepreneurs. it can also result in the creation of work opportunities, which in tum can contribute to economic growth. the international success record of the franchise trade makes research on this relatively young form of business not only topical but also essential. american statistics show a 90 per cent success rate of all franchise businesses that are established (african business, 1993: 24), while 80 per cent of other types of small business enterprises fails. franchising presently grows at a rate of 10 per cent per year and represents 5.6 per cent of the trade activities in the world economy. in the us, the franchise business was already labeled the success story of the nineties, with more than 600 000 franchise enterprises providing an annual turnover of$758 milliard (de villiers, 1994: 53). since 1994, the number of franchised systems in south africa has increased threefold. between 1994 and 1998 growth was exponential; the growth has slowed somewhat over 1999 and 2000. this can be attributed to high interest rates and a shift in consumption patterns. as a result, the nature and type of businesses, which usually expand on a franchise basis, are changing (gordon, 2000: 2). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 713 given the above statistics, the growth in the franchise trade worldwide and the need for growth and development in the south african economy, a study on the aspects which can foster the trade locally is of importance to south africa. problem-setting in 1994, parker gordon associates undertook the first formal investigation of the franchise business in south africa (parker gordon assoc., 1995: i). in the survey, it was determined that 41.8 per cent of the franchise holders confirmed that their prospective franchisees experienced difficulty obtaining financing. in their study, the problems that the prospective franchisee experienced in terms of fmancing were the following: lack of capital for collateral; insufficient own capital; banks and other financial institutions do not understand the concept of franchising; apart from commercial banks there are inadequate other financing sources accessible to the prospective franchisee. this study investigates and analyses financing constraints experienced by a prospective franchisee in view of the above-mentioned aspects. purpose of the study the main purpose of this study is to identify fmancing constraints and thus to facilitate fmancing for prospective franchisees. this can stimulate growth in the small business sector, enhance job creation and result in general economic progress. research methodology the study is constructed as follows: a literature review is conducted, which review concentrates on certain aspects of financing and more specific the financing of small business enterprises. the empirical study focuses on the present financing practice of the small business enterprises with special reference to franchises. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 714 sajems ns vol 5 (2002) no 3 the analytical units of the population on which the research is based consist of all the franchisors registered with the franchise association of southern africa (f asa). according to the franchise book of southern africa of 1998, there were 358 franchised systems in operation in south africa (stone, 2000: 46). according to louw, the executive director of fasa, about 70 to 75 i':r cent of all franchisors in southern africa are registered with f asa. the top 100 franchisors were selected on account of their turnover and the number of outlets. according to gorden (2000: 4) the average number of outlets or business units per franchised system is 49. the data was collected by means of questionnaires sent by post and/or fax. there were 43 responses and the response rate was 43 percent. results the problems experienced by the franchise trade in terms of financing and otherwise the first part of the questionnaire deals with the general problems experienced by the small business sector. specific financing problems and the contribution that can be made by the trade to economic progress are also addressed. general problems experienced by tbe small business sector studies in other developed and developing countries suggest that the small business sector can contribute to the advancement of the economy and job creation (ruiters, 1996: 8). despite this, there is still scope for extensive development in this sector in south africa and some problems persist. in question 1 of the questionnaire, a list of possible problems is submitted to the respondents to which items could be added and then evaluated on a scale from i to 4. a scale mark of 4 indicates a problem generally experienced and i a problem that never occurs. the results are presented in table i. the problems indicated by the respondents as problems experienced generally and often are focused on next. the first problem singled out is the lack of knowledge and managing experience. here, 11.6 per cent of the respondents indicated it as a general problem and 39.5 per cent a problem occurring often; the arithmetic mean is 2.56. 14 per cent indicated inaccessibility of financing as a problem occurring always and 39.5 per cent as a problem occurring often; the arithmetic mean is 2.53. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 715 among the other problems added to the list, lack of training is a problem occurring often, according to 4.7 per cent of the respondents. table 1 problems experienced by the small business sector never sometimes orten generally arithm. i 2 3 4 mean f %: r 0/0 r 0/0 r % i.jd. "iiiiiiijii\c '--1~.-16~3 25 58.1 8 18.6 3 7.0 2.16 l..ii;~ 01 ~nll\\ kjl!c jiii.l +.. '--r --,----17 39.5 • 5 11.6 2.56 3 i 7.0. 1m 41.9 the market is saturated 16 37.2 19 44.2 lack of market 6 14.0 21 48.8 research inaccessibility to 6 14.0 14 32.6 financin other 40 93.0 2.3 the lack of knowledge and managing experience and the inaccessibility of financing are the most prominent problems of the small business sector. the franchising concept offers the advantage that the entrepreneur is not left to its own devices but can rely on the support of the franchisor. part of the franchise package is the supply of trade manuals and training by the franchisor. the problem indicated above as a lack of knowledge and managing experience can be obviated by the franchising concept. problems experienced by the prospective franchisee the purpose of question 2, is to identify which problems prospective franchisees experience in establishing an enterprise and then to rate it on a scale from 1 to 4. the results are shown in table 2. the first part of the column shows the frequency, which is then expressed and a percentage in the second part of the column. 14 per cent of the respondents indicated financing as a problem occurring a/ways, while 41.9 per cent mentioned that financing problems occur often. the next problem often encountered, is the lack of managing experience. 14 per cent also indicated that financing problems are never experienced. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 716 sajems ns vol 5 (2002) no 3 table 2 problems experienced by tbe prospective francbisee ! no problem little/seldom often i always a 1 2 3 problem 4 f % f 0/. f 0/. f % lack of managing 6 14.0 22 51.2 14 32.6 1 2.3 experience locality of the enterprise 16 37.2 16 37.2 9 20.9 2 4.7 crime 19 44.2 17 39.5 4 9.3 3 7.0 financing problems 6 14.0 13 30.2 18 14.9 6 14.0 other 39 90.7 i 2.3 3 7.0 problems indicated under 'other' are difficulties in convincing the financier of the viability of the project and the lack of sufficient collateral. however, both these problems bear relation to financing. from the results it is clear that, although other problems such as crime and the location of the business are also mentioned as problems, these are not of the same magnitude as lack of managing experience and difficulties obtaining financing. in question 3 the franchisor was asked to indicate whether some of his franchisees experience problems obtaining financing. the results are shown in table 3. table 3 financing problems yes no f °/. f % 28 65.1 15 34.9 65.1 per cent of the respondents indicated that their franchisees encounter problems in obtaining financing. financing related difficulties are among the gravest problems experienced by prospective entrepreneurs. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 717 the contribution of the franchise trade to the economic progress of the country in question 4 the respondents were asked to indicate whether the franchise trade can contribute to the economic progress of the country. the results are reflected in table 4. table 4 the contribution of the franchise trade yes no f % f % 42 97.7 1 2.3 from the results above it would appear that 97.7 per cent of the respondents confirm that the franchise trade can contribute to economic progress. the franchise concept, and particularly the business format and method involved, contains inherent qualities that may surmount the weaknesses, giving rise to failures. this trade has great potential and is still under utilised. parker & gordon (1995: 6) predict that franchising will increasingly be used in south africa to furnish large markets with commodities. feinstein, an authority on small business enterprises and franchises, also expresses the view that the possibilities offered by franchises are not fully exploited in south africa (feinstein, 1993: 1). in question 5, the respondents were asked to give their opinion with regard to the contribution the franchise trade could make to the uplifiment of less privileged groups. the results are presented in table 5. table 5 the contribution of the franchise trade to groups previously underprivileged yes no f % f % 40 93.0 3 7.0 according to the results in table 5, 93 per cent of the respondents are of the opinion that the franchise trade can encourage economic activity of less privileged groups. a project to support prospective entrepreneurs in south africa, the black integrated commercial support network (bicsn) sponsored r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 718 sajems ns vol 5 (2002) no 3 by the us agency of international development (us aid) is currently in operation. franchising is regarded as one of the methods of supporting black people effectively in establishing businesses (anon., 1993: 24). problems regarding financing as experienced by prospective franchisees in question 6, a list of problems experienced by prospective franchisees in tenns of financing is submitted to respondents requesting them to identify how often these and other problems are experienced and to add infonnation, if necessary. a scale mark of 4 indicates a problem occurring continuously and 1 a problem never experienced. inadequate own capital is singled out as a problem experienced always by 18.6 per cent of the respondents and by 58.1 per cent as a problem experienced often. the arithmetic mean is 2.93. insufficient collateral is indicated as a problem always experienced by 27.9 per cent of the respondents. 34.9 per cent indicated lack of collateral as a problem often occurring. the arithmetic mean is 2.84. table 6 problems regarding financing as experienced by prospective franchisees never sometimes often always! ! aritbm. 1 2 3 cons!antly i mean f 'yo r % r % r °/ .. lack of collateral 3 7.0 13 30.2 15 34.9 12 27.9 2.84 too little own capital i 2.3 9 i 20.9 25 ! 58.1 8 18.6 2.93 banks and other 10 23.3 15 34.9 12 27.9 6 14.0 2.33 financial institutions do not understand the i franchise concept too little sources of 7 16.3 17 39.5 14 32.6 5 11.6 2.40 financing other 97.7 1 2.3 regarding other problems, 14 per cent of the respondents are of opinion that banks and other financial institutions always fail to understand the franchise concept, while 27.6 per cent feel that the concept is often not understood. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vols (2002) no 3 719 furthermore, 32.6 per cent indicated that sufficient financing sources are often not available to the prospective franchisee. the most prominent problems are inadequate own capital and collateral. these two problems are closely related; entrepreneurs have insufficient capital or other assets at his disposal to hedge against risks. the greatest part of the population has insufficient collateral at their disposal. in order to stimulate entrepreneurship, the establishment of own businesses and the small business sector in general, banks may consider a more compliant stand regarding the provision of collateral when evaluating an application for financing. 6 conclusions the lack of practical knowledge and managing experience, with an arithmetic mean of 2.s6, and the inaccessibility of financing, with an arithmetic mean of 2.53 out of 4, are considered as the most important problems experienced in the small business sector (table 1). in a next section, with regard to the same problems, the respondents were requested to single out the general problems experienced by prospective franchisees. in table 2 the general problems the prospective franchisee experiences are reported. on an interval scale 14 per cent of the respondents indicated financing problems as a problem always occurring. an additional 41.9 per cent indicated that financing problems occur often. lack of knowledge and managing experience is the problem appearing in the second place, as indicated. interesting conclusions may be drawn from a comparison of the above information. in the case of general problems experienced by the small business sector, lack of practical knowledge and managing experience appears prominent. in the case where the question was applicable to franchisees, a shift in emphasis is noticeable. inaccessibility of fmancing was then shown to be the most prominent problem, followed by the lack of business knowledge and managing experience. the above shift in emphasis can be explained as follows: it confirms one of the advantages of the franchise concept, namely that management skills and experience are transmitted from franchisor to franchisee. the franchising concept thus alleviates the problem of inadequate business skills and managing experience. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 720 sajems ns vol 5 (2002) no 3 it is in many instances more expensive to buy a franchise busin(;;ss; consequently there is a greater need of financing and therefore greater prominence is given to the financing problem. having singled out the financing problem, the problem was further investigated by identifying which specific problems are experienced with regard to financing. table 6 shows the results of the franchisers' responses. inadequate own capital and a lack of collateral, with an arithmetic mean of respectively 2.93 and 2.84, are identified by the franchisors as the most important problems. in the third position insufficient financing sources, with an arithmetic mean of 2.40, is designated. quite close to the previous result, with an arithmetic mean of 2.33, is the difficulty that banks and financial institutions fail to understand the franchising concept. the conclusion is that that there are fundamental problems in respect of financing. the lack of sufficient financing sources was confirmed; also very few prospective entrepreneurs would not experience the problem of insufficient own capital. only a few could generate capital on their own, have inherited large sums of money or received a substantial retirement endowment. the problem regarding inadequate collateral also appears to be widespread. banks and financial institutions set stringent requirements concerning collateral. they are risk averse and it is known practice that banks are more conservative in granting credit to new businesses than in the case of already established enterprises. the foregoing response confirms the statement of government that a lack of access to financing is a significant constraint in the way of new and expanding small business enterprises. references anon. (1993) "why franchising could be the best option", african business and chamber of commerce review. 2 baucus, d.a., baucus, m.s. & human, s.e. (1993) "choosing a franchise: how base fees and royalties relate to the value of the franchise", journal of small business management, 31(2): 91·104. 3 castro giovanni, g.i., justis, r.t. & julian, s.d. (1993) "franchise failure rates: an assessment of magnitude and influencing factors", journal of small business management, 31 (2): 105-15. 4 de villiers, t. (1994) "fokus op bedryfsreg", finansies en tegniek, 46(21); 49-58. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 721 5 gaskill, l.r., van auken, h.e. & manning, r.a. (1993) "a factor analytic study of perceived causes of small business failure", journal of small business management, 31(4): 18-31. 6 gordon, b. (2000) "the franchise factor 1999/2000": fourth survey on the franchise sector in south africa, franchise directions: johannesburg. 7 holmes, m. (1994) "spreading your wings", financial mail, 133(10). supplement: independent business opportunity: 27-30. 8 ntoula, r. (1993) ''the franchising highroad", african business and chamber of commerce review. 9 parker, e. & gordon, b. (1995) the franchise factor: first formal franchise survey in south africa, johannesburg: perskor. 10 ruiters, a. (1996) "government strategies to promote the development of small business in south africa, accountancy and finance update, 1(2): 8-10. 11 thomas, w. (1995) "the smme white paper beginning of a new era?" southern african and small journal for entrepreneurship business, 7(1): 12-28. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems 21-1_2019_contents.indd http://www.sajems.org open access table of contents i original research corporate social responsibility and earnings management of south african companies lauren a. jordaan, marna de klerk, charl j. de villiers south african journal of economic and management sciences | vol 21, no 1 | a1849 | 29 march 2018 original research flexi work, financial well-being, work–life balance and their effects on subjective experiences of productivity and job satisfaction of females in an institution of higher learning leon t.b. jackson, edwina i. fransman south african journal of economic and management sciences | vol 21, no 1 | a1487 | 29 march 2018 original research a review of biodiversity reporting by the south african seafood industry kieran usher, warren maroun south african journal of economic and management sciences | vol 21, no 1 | a1959 | 03 april 2018 original research bibliometric analysis of organisational culture using citespace yi cui, yanping liu, jian mou south african journal of economic and management sciences | vol 21, no 1 | a2030 | 03 april 2018 original research the impact of fiscal policies on corruption: a panel analysis monica v. achim, sorin n. borlea, andrei m. anghelina south african journal of economic and management sciences | vol 21, no 1 | a1970 | 04 april 2018 original research does the baltic dry index predict economic activity in south africa? a review from 1985 to 2016 kurt sartorius, benn sartorius, dino zuccollo south african journal of economic and management sciences | vol 21, no 1 | a1457 | 05 april 2018 original research ethical practices of small and medium-sized enterprises in developing countries: literature analysis peter k. turyakira south african journal of economic and management sciences | vol 21, no 1 | a1756 | 05 april 2018 original research quantitative efficiency assessment based on the dynamic slack-based network data envelopment analysis for commercial banks in ghana zhixiang zhou, nelson amowine, dechun huang south african journal of economic and management sciences | vol 21, no 1 | a1717 | 09 april 2018 99 112 125 137 149 158 167 174 page i of v table of contents i original research does the national innovation system spur economic growth in brazil, russia, india, china and south africa economies? evidence from panel data brima sesay, zhao yulin, fang wang south african journal of economic and management sciences | vol 21, no 1 | a1647 | 22 january 2018 original research internet access and its relationship to subjective well-being in a developing region talita greyling south african journal of economic and management sciences | vol 21, no 1 | a1841 | 28 february 2018 original research a regression and comparative study of united states and south african yield curves using principal component analysis kavir patel, ashfaaq mohamed, gary w. van vuuren south african journal of economic and management sciences | vol 21, no 1 | a1626 | 26 march 2018 original research empirical analysis of inbound open innovation and smes performance: evidence from oil and gas industry yusuf o. akinwale south african journal of economic and management sciences | vol 21, no 1 | a1608 | 27 march 2018 original research density forecasting for long-term electricity demand in south africa using quantile regression paul mokilane, jacky galpin, v.s. sarma yadavalli, provesh debba, renee koen, siphamandla sibiya south african journal of economic and management sciences | vol 21, no 1 | a1757 | 27 march 2018 original research new perspectives on the role of customer satisfaction and commitment in promoting customer citizenship behaviours estelle van tonder, leon t. de beer south african journal of economic and management sciences | vol 21, no 1 | a1894 | 28 march 2018 original research supervisory trust to be earned: the role of ethical leadership mediated by person-organisational fit anton grobler, maggie m.e. holtzhausen south african journal of economic and management sciences | vol 21, no 1 | a1920 | 28 march 2018 original research private hospital expenditure and relation to utilisation: observations from the data marine erasmus, helen kean south african journal of economic and management sciences | vol 21, no 1 | a1658 | 29 march 2018 1 13 25 40 49 63 74 85 vol 21, no 1 (2018) issn: 1015-8812 (print) | issn: 2222-3436 (online)south african journal of economic and management sciences http://www.sajems.org open access table of contents ii original research the impact of food prices on the welfare of households in south africa roscoe b. van wyk, cliff s. dlamini south african journal of economic and management sciences | vol 21, no 1 | a1979 | 09 april 2018 original research the impact of gainsharing in the automotive parts manufacturing industry of south africa robert w.d. zondo south african journal of economic and management sciences | vol 21, no 1 | a1773 | 10 april 2018 original research assessing the financial implications of quality management system accreditation on small training providers in kwazulu-natal robert w.d. zondo south african journal of economic and management sciences | vol 21, no 1 | a1728 | 10 april 2018 original research the role of tax incentives in encouraging energy efficiency in the largest listed south african businesses mareli dippenaar south african journal of economic and management sciences | vol 21, no 1 | a1723 | 11 april 2018 original research what are the indicators of a successful business rescue in south africa? ask the business rescue practitioners shaneen conradie, christiaan lamprecht south african journal of economic and management sciences | vol 21, no 1 | a1726 | 11 april 2018 original research business rescue decision-making: post-mortem evaluation of an ‘orgy’ marius pretorius south african journal of economic and management sciences | vol 21, no 1 | a1622 | 11 april 2018 original research competencies for the effective management of legislated business rehabilitations rajendra rajaram, anesh m. singh south african journal of economic and management sciences | vol 21, no 1 | a1978 | 12 april 2018 original research the link between internet investor relations and information asymmetry george f. nel, eon smit, leon m. brummer south african journal of economic and management sciences | vol 21, no 1 | a1966 | 12 april 2018 original research filter selection for countercyclical capital buffers dirk visser, gary van vuuren south african journal of economic and management sciences | vol 21, no 1 | a1744 | 12 april 2018 185 194 202 210 222 234 248 257 267 original research determinants of urban consumers’ participation in informal vegetable markets: evidence from mahikeng, north west province, south africa, and implications for policy olebogeng marumo, majola l. mabuza south african journal of economic and management sciences | vol 21, no 1 | a1743 | 12 april 2018 original research exploring the south african tax consequences of a residential property lottery silke de lange, danielle van wyk south african journal of economic and management sciences | vol 21, no 1 | a1951 | 12 april 2018 original research a lean six sigma framework to enhance the competitiveness in selected automotive component manufacturing organisations raveen rathilall, shalini singh south african journal of economic and management sciences | vol 21, no 1 | a1852 | 17 april 2018 original research determinants of pricing objectives and price flexibility policies of pork-based agro-businesses in mashonaland central province, zimbabwe saul ngarava, abbyssinia mushunje south african journal of economic and management sciences | vol 21, no 1 | a2029 | 18 april 2018 original research the effect of industry nuances on the relationship between corporate governance and financial performance: evidence from south african listed companies jonty tshipa, leon m. brummer, hendrik wolmarans, elda du toit south african journal of economic and management sciences | vol 21, no 1 | a1964 | 18 april 2018 original research assessing fiscal sustainability in swaziland welcome n. nxumalo, nomvuyo f. hlophe south african journal of economic and management sciences | vol 21, no 1 | a1821 | 19 april 2018 original research repatriation turnover revisited: a focus on south african multinational enterprises christiaan j. naude, a. johan vögel south african journal of economic and management sciences | vol 21, no 1 | a1680 | 19 april 2018 original research the relationship between strategic thinking and leadership effectiveness in kenyan indigenous banks samuel m. muriithi, lynette louw, sarah e. radloff south african journal of economic and management sciences | vol 21, no 1 | a1741 | 19 april 2018 281 290 300 313 324 342 354 366 page ii of v http://www.sajems.org open access table of contents iii original research informal financial transactions and monetary policy in low-income countries: interpolated informal credit and interest rates in malawi harold ngalawa south african journal of economic and management sciences | vol 21, no 1 | a1531 | 23 april 2018 original research psychological capital: convergent and discriminant validity of a reconfigured measure anton grobler, yvonne t. joubert south african journal of economic and management sciences | vol 21, no 1 | a1715 | 23 april 2018 original research impact of gender on small and medium-sized entities’ access to venture capital in south africa herring shava south african journal of economic and management sciences | vol 21, no 1 | a1738 | 24 april 2018 original research the relationship between remuneration and financial performance for companies listed on the johannesburg stock exchange elize kirsten, elda du toit south african journal of economic and management 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envelopment analysis for commercial banks in ghana zhixiang zhou, nelson amowine, dechun huang south african journal of economic and management sciences | vol 21, no 1 | a2689 | 10 december 2018 reviewer acknowledgement south african journal of economic and management sciences | vol 21, no 1 | a2880 | 26 november 2018 858 871 880 891 892 page v of v microsoft word vol6no3'3.doc sajems ns 6 (2003) no 3 577 employees' perceptions of performance evaluation in the manufacturing industry ________________________________________________________________ h e brand and o j pretorius department of human resources management, university of pretoria ________________________________________________________________ abstract this study determines the management effectiveness of a performance evaluation system in a national manufacturing organisation. this organisation has developed and implemented a new performance evaluation system. after 3 years since implementation, the effectiveness of the system is determined. a questionnaire was used to obtain data from a systematic sample of both employees and supervisors of the organisation. the results show that the organisation should improve certain aspects of its performance evaluation system, like the documentation of information, training of supervisors and communication of strategy and objectives. jel l 60, m 51 introduction organisations today compare well with one another in terms of the utilisation of technology and the resources to obtain this technology. strategic advantage is therefore not so much found in equipment and technology, but rather in new, innovative strategies, methods and resources (kaplan & norton, 1996). organisations increasingly seem to focus on their workforce in their search for these strategies, methods and resources. to stay competitive, organisations focus their attention on human resource development in order to develop a workforce which is motivated, skillful and competitive (williams, 1998). performance evaluation plays a decisive role in the development and motivation of employees, and still is management's most effective tool for improving productivity (english, 1991). the management and evaluation of employees' performance is a critical success factor in the future of any organisation. without a skillful and dedicated work force, no competitive advantage can be obtained (de waal, 2001). the importance of performance evaluation can be explained by the following aspects: sajems ns 6 (2003) no 3 578 performance evaluation as a method to execute strategy strategic planning and objectives play an important role in determining the success of an organisation. these objectives must be reached through the actions and behaviour of all employees of the organisation. performance evaluation is necessary to determine how well or how poor employees reach these objectives, and it also serves as a development aid to employees to help improve their performance (cascio, 1991). improved performance thus can be directly linked to an improvement in strategic effectiveness of the organisation. performance evaluation and teamwork according to meyer (in shaw, scheier & baird, 1995), performance evaluation systems should be devised to adapt to the basic operational principles supporting it. the aim of performance evaluation systems should be to provide teams with meaningful information to be utilised in decision making. the focus is thus on the process under control of the team, rather than on the measurement of results. performance evaluation and motivation performance evaluation goes hand in hand with the setting of performance standards and objectives. according to latham and locke (in steers & porter, 1991), research indicated that the setting of specific, challenging objectives through participation leads to better performance than when general objectives are set. the correct application of performance evaluation and its accompanying objective-setting process, should lead to improved performance in an organisation. performance evaluation and other organisational processes performance evaluation should not be seen as a process on its own. it must form an integral part of the greater human resource management system and it has a definite effect on other processes in this system. performance evaluation and legal implications according to malos (in armstrong, 1998), the human resource practitioner should accept that any performance evaluation system will, from time to time, go through a process of legal scrutiny. most legal disputes around performance evaluation relate to various forms of discrimination inherent in such a system. malos (in armstrong, 1998) provides the following suggestions in order to strengthen the legality of a performance evaluation system: sajems ns 6 (2003) no 3 579 � procedures must be standardized and uniform for all employees within a specific job group. � procedures must be formally communicated to all stakeholders. � procedures must provide the necessary information to employees regarding deviations in performance, as well as opportunities to correct such deviations. � evaluations must be accessible to employees, so that it can be revised. � performance evaluation must make provision for a formal appeal procedure. � performance evaluation must make provision for written instructions and training for evaluators. the performance evaluation process must provide a system to identify and eliminate potential discriminating procedures and results. the results of legal actions due to the performance evaluation process can cause great harm to the organisation's image, as well as efforts to recruit potential employees. legal costs alone should prompt the organisation to devise a legally safe and defendable system of performance evaluation, also taking into account all developments in the field of labour legislation. as was already mentioned, performance evaluation cannot be seen as a secondary process in the organisation, but it must be well managed as a primary process in order to ensure organisational success. in this management process, certain concepts or practices are of critical importance. these concepts are the following: coaching coaching all activities relating to the development and improvement of individual performance. it is thus important for each supervisor and manager to be able to execute this activity in order to provide to employees the necessary guidance, and to empower them to improve their performance. effective coaching skills and methods should be part of the training of performance evaluators (williams, 2002). feedback romanoff (1989) accentuated the importance of training supervisors and managers to effectively provide feedback in the process of performance evaluation. feedback is used to focus employees' attention on obtaining or reaching certain desired results. feedback should always be clear, descriptive and constructive. it is also important to provide both positive and negative sajems ns 6 (2003) no 3 580 feedback, and to connect negative feedback with coaching activities in order to improve performance. objectives and strategic management williams (1998) indicated that performance evaluation should be closely related to the objectives of the organisation. organisations should also distinguish between training objectives, needs, business objectives and challenges. according to kaplan and norton (1996), the organisation should strive to divide its vision into smaller tasks which should be executed in order to realise this vision. the vision should be rolled down to the lowest levels in the organisation in order to attain alignment among all activities in the organisation. this process influences the way employees are evaluated, as well as how objectives are implemented and reached. remuneration according to english (1991), many organisations keep performance evaluation systems and remuneration systems apart from one another, due to the fact that they do not have the ability to successfully connect these two activities. english (1991) also points to the fact that the manner in which performance is linked to remuneration has an important effect on individual work motivation. weiss (1997) indicated that recent developments in the national qualifications framework in south africa are forcing organisations to investigate the manner in which employees are remunerated for performance and participation. the relationship between performance and remuneration should be clear and decisions should be made about how performance evaluation can influence the remuneration system and vice versa. performance evaluation and the criteria used for such evaluation can have a significant impact on the remuneration system of an organisation (de waal, 2001). training performance evaluation has a logical impact on training and staff development (bacal, 1999). training and development can only be optimally executed in situations where it can de directly related to development opportunities and/or behaviour deficiencies. performance evaluation serves as an effective way to determine employees' abilities to perform certain duties successfully and to identify training needs. the performance evaluation interview can, for example, be used as an opportunity to compile an individual development plan for each employee. sajems ns 6 (2003) no 3 581 labour relations few organisations realise the impact of performance evaluation on labour relations. according to romanoff (1989), the employer obtains employee support and devotion by involving employees in the development process of a performance evaluation system. performance evaluation systems also contain criteria which could relate closely to labour relations. organisations often do not really comprehend the impact of poor labour relations on employee performance. the quality of labour relations could have either a positive or negative influence on performance and hence on performance evaluation. cooperation between management and employees during the development of a performance evaluation system provides management with the opportunity to explain and clarify expectations and values. this leads to a better understanding of all organisational activities and should also improve labour relations. human resource planning this concept or practice relates closely to performance evaluation, as the latter is also used for employee development. by co-ordinating such development with human resource planning, opportunities for promotion of employees can be created. the organisation also creates the opportunity to determine future human resource needs and how these needs will be met (bacal, 1999). it is clear that performance evaluation has a definite influence on individual and team motivation, as well as all organisational processes. it is a critical important instrument in employee motivation and serves as a key instrument in the management of human resources in the organisation. the management of every organisation, in co-operation with all employees, should be responsible for the creation of a system wherein activities such as the planning, communication, feedback and control of performance evaluation can take place. the management of performance evaluation should thus be an integral part of the strategic management system of the organisation, indicating that a performance evaluation system should be continually evaluated and maintained (wade, 2000). research method respondents the respondents in this study consisted of all employees (n = 1205) in the organisation evaluated by the specific performance evaluation system, as well as all supervisors involved in the performance evaluation process (n = 380). a sajems ns 6 (2003) no 3 582 randomized sample was drawn from these respondents, resulting in a total of 720 respondents, consisting of 530 employees and 190 supervisors. department and number of individual performance evaluations done, were utilised as biographical variables. departments or sections primarily involved in the production side of the organisation formed 35 per cent of the research group, the rest consisting of departments more on the administrative side. the majority of the research group is male (91 per cent). 35 per cent of the research group was evaluated four times (or more), 28 per cent three times, 27 per cent two times and 10 per cent once. procedure a total of 720 questionnaires were sent out (530 to employees and 190 to supervisors). in an accompanying letter, all participants were assured that the information would be handled confidentially and that the research is done with the approval of management and union representatives. a total of 88 completed questionnaires (46 per cent) were received from supervisors and 214 (40 per cent) from employees. measuring instrument questionnaire: profile of your ideal performance management programme. this questionnaire consists of four sections, each focussing on an important area of performance evaluation management. the first section focuses on the implementation of strategy in the organisation, referring to the utilisation of the setting of objectives in the organisation (questions 1-4). the second section focuses on the continuity of, participation in and judicial basis of the performance evaluation system (questions 5-10). the third section focuses on management's involvement in and commitment to the implementation and appliance of the system (questions 11-19). the fourth section focuses on training provided in the field of performance evaluation in the organisation (questions 20-29). question statements are answered according to a 7-point scale, ranging from 1 (do not agree at all) to 7 (agree to a great deal). the reliability of the questionnaire was determined by using the spearmanbrown method, obtaining a coefficient of 0.92. a cronbach's alpha of 0.93 was also obtained. sajems ns 6 (2003) no 3 583 statistical analysis this analysis was done by means of the spss for windows computer programme. the data derived from the questionnaires were analysed by means of descriptive and inferential statistics of the mentioned computer programme. although various statistical methods were used to evaluate the data, only the results of the descriptive statistics and one way analysis of variance will be reported in this article. results of the study the descriptive statistics of the questionnaire are depicted in table 1. the results of the one-way analysis of variance are depicted in tables 2 and 3. table 1 descriptive statistics of the questionnaire: profile of your actual/ideal performance management programme sections & items mean sd skewness se of the mean kurtosis variance 1 4.695 2.332 -0.242 0.088 -0.534 1.527 2 4.801 2.286 -0.240 0.087 -0.817 1.512 3 5.606 1.841 -0.904 0.078 0.387 1.357 implemen -tation of strategy 4 4.851 2.473 -0.386 0.090 -0.709 1.572 5 4.596 2.188 -0.235 0.085 -0.568 1.479 6 4.447 2.613 -0.175 0.093 -0.762 1.617 7 4.414 2.516 -0.138 0.091 -0.778 1.586 8 4.404 2.580 -0.101 0.092 -0.791 1.606 9 4.821 2.559 -0.318 0.092 -0.866 1.600 the performance evaluation system 10 4.755 2.431 -0.317 0.090 -0.656 1.559 11 4.861 2.446 -0.366 0.090 -0.723 1.564 12 4.841 2.234 -0.459 0.086 -0.309 1.495 13 4.841 2.639 -0.406 0.093 -0.652 1.625 14 4.417 2.948 -0.154 0.099 -0.898 1.717 15 4.606 2.173 -0.200 0.085 -0.482 1.474 16 5.298 1.931 -0.650 0.080 -0.080 1.390 17 4.123 3.317 -0.050 0.105 -1.087 1.821 18 4.394 2.685 -0.171 0.094 -0.861 1.639 management's involvement and commitment 19 4.583 3.214 -0.246 0.103 -1.077 1.793 20 4.732 2.509 -0.208 0.091 -0.799 1.584 21 4.785 2.535 -0.309 0.092 -0.750 1.592 training in perform. eval. 22 4.901 2.249 -0.496 0.086 -0.435 1.500 sajems ns 6 (2003) no 3 584 table 1 continued sections & items mean sd skewness se of the mean kurtosis variance 23 4.556 2.540 -0.230 0.092 -0.614 1.594 24 4.884 2.222 -0.394 0.086 -0.440 1.491 25 4.705 2.474 -0.360 0.091 -0.595 1.573 26 4.444 2.680 -0.119 0.094 -0.788 1.637 27 4.623 2.515 -0.294 0.091 -0.618 1.586 28 4.411 2.416 -0.172 0.089 -0.708 1.554 training in perform. evaluation 29 4.523 2.456 -0.184 0.090 -0.689 1.567 as is evident from table 1, the mean scores vary between 4 to 5, indicating that the respondents agree to an extent with the statements made in the questionnaire. it is also clear that the distribution is not normal, as the kurtosis is platicurtic. the values are all smaller than 0,263. the skewness coefficient is generally smaller than zero (0). however, the values of the standard error of mean is quite large, indicating that the results cannot be generalised to the population. as regards inferential statistics, an one-way analysis of variance was done to determine significant differences, if any, between the organisation departments on the 29 questions of the questionnaire. the results are presented in table 2. table 2 one-way analysis of variance results for the independent variable: department variable f-relation significance question 1 1.2313 0.2943 question 2 4.6800 0.0004* question 3 1.4008 0.2238 question 4 2.1211 0.0629 question 5 1.6248 0.1532 question 6 0.9537 0.4466 question 7 2.0293 0.0745 question 8 3.8752 0.0020* question 9 1.7158 0.1308 question 10 0.7961 0.5532 question 11 1.4793 0.1964 question 12 0.9533 0.4469 question 13 2.1944 0.0549 question 14 2.6449 0.0234* question 15 3.1230 0.0092* sajems ns 6 (2003) no 3 585 table 2 continued variable f-relation significance question 16 2.4315 0.0351* question 17 1.5572 0.1721 question 18 1.9227 0.0904 question 19 5.2119 0. 001* question 20 1.4227 0.2159 question 21 1.9605 0.0844 question 22 1.7552 0.1220 question 23 1.5936 0.1617 question 24 1.2390 0.2908 question 25 2.0610 0.0703 question 26 1.5211 0.1830 question 27 1.6777 0.1398 question 28 2.1371 0.0611 question 29 3.4095 0.0052* p ≤ 0.05 it is clear from table 2 that the independent variable "department" has a significant effect on questions 2, 8, 14, 15, 16, 19 and 29. question two (2) refers to the organisation's encouragement of managers to regularly communicate senior management's vision and objectives throughout the organisation. it is clear that different departments also differ on the performance management system's inclusion of extensive orientation and training for all (question 8). the various departments also differ with regards to the employees' involvement in the successful implementation of the performance appraisal system (question 14). question 15 relates to the link between strategic business planning and the performance management system. this system and its integration with other key systems, for example quality improvement, productivity improvement and succession planning, was also perceived significantly different by the various departments. question 19, another factor of significant differences, refers to the appraisal results and its utilisation in determining training needs. the training provided in support of performance evaluation systems, which includes ways of measuring the effective utilisation of skills in the job context (question 29), was another bone of contention between the various departments. post hoc comparisons were done by means of the scheffe test to determine which groups differ significantly from one another. sajems ns 6 (2003) no 3 586 � as regards communication of organization objectives and vision, departmental group 6 (human resources & services; financial) seems to differ significantly from group 4 (technology and logistics) and group 5 (engineering works; support services). � as regards orientation and training, departmental group 6 (human resources & services; financial) seems to differ significantly from group 5 (engineering works; support services). � as regards employees' dedication to the implementation of performance evaluation, departmental group 6 (human resources & services; financial) again seems to differ significantly from group 5 (engineering works; support services). � as regards the relation between strategic planning and performance evaluation, departmental group 5 (engineering works; support services) seems to differ significantly from group 6 (human resources & services; financial). � as regards the extent to which evaluation results are utilized in the process of training planning, departmental group 5 (engineering works; support services) seems to differ significantly from group 1 (raw materials & steelworks), group 2 (roller works), group 3 (cold products), group 4 (plate technology; logistics) and group 6 (human resources & services; financial). � as regards the extent to which the application of skills in the workplace is evaluated, departmental groups 5 (engineering works; support services) and 6 (human resources & services; financial) seem to differ significantly. the results of the one-way analysis of variance regarding the number of times respondents were evaluated by the performance evaluation system are depicted in table 3. table 3 one-way analysis of variance results for the independent variable: number of times evaluated variable frelation significance question 1 0.0204 0.9798 question 2 0.2332 0.7922 question 3 0.1110 0.8950 question 4 0.2946 0.7450 question 5 0.1991 0.8196 question 6 0.1983 0.8202 question 7 0.7851 0.4570 question 8 0.3753 0.6874 question 9 0.7058 0.4945 sajems ns 6 (2003) no 3 587 variable frelation significance question 10 0.2737 0.7608 question 11 1.0195 0.3620 question 12 1.2652 0.2837 question 13 0.0087 0.9914 question 14 1.3261 0.2671 question 15 1.5843 0.2068 question 16 1.2535 0.2870 question 17 1.5727 0.2092 question 18 1.1141 0.3296 question 19 0.5260 0.5915 question 20 1.4388 0.2389 question 21 1.1195 0.3278 question 22 2.4342 0.0894 question 23 0.5831 0.5588 question 24 0.4788 0.6200 question 25 0.3291 0.7198 question 26 0.0532 0.9482 question 27 0.2367 0.7894 question 28 0.6709 0.5120 question 29 1.2885 0.2772 p ≤ 0.05 it is evident from table 3 that the independent variable "number of times evaluated" does not have any significant effect on any one of the dimensions of the questionnaire. discussion this study and the literature study done on performance evaluation, indicate that the effectiveness of performance evaluation can be adequately evaluated according to four aspects, namely the relation between performance evaluation and organisation strategy, the participation of all stakeholders in the development process of an evaluation system, the participation and commitment of all stakeholders in the process of implementation and execution of the process and the training involved in the application of the system (armstrong, 1998; de waal, 2001; wade, 2000; williams, 2002). this study focussed on a specific organisation and its employees' and supervisors' perceptions relating to the stated four aspects. the following conclusions can be drawn from the study : sajems ns 6 (2003) no 3 588 the questionnaire used (profile of your actual/ideal performance management system) seems to be reliable for the evaluation of the effectiveness of a performance evaluation system. the standard error, however, is significantly large, indicating that the results cannot be generalised to the population from which the sample was drawn. there seems to be no significant differences between employees' and supervisors' perceptions regarding the effectiveness of the performance evaluation system. there seems to be a strong relation between employees' perceptions regarding the following aspects: � the extent to which management communicates with employees regarding the organisation's vision and objectives, and employees' perception of their involvement in organisation decision making. � the extent to which training in the organisation empower employees to effectively define jobs and performance standards. � the extent to which training assist supervisors to provide the right feedback on performance areas that need improvement and perceptions of management's commitment to and involvement in the successful implementation of the performance evaluation system. � the extent to which training enable supervisors to address performance problems and how well supervisors utilise the system of performance evaluation as an aid to development in the organisation. � the extent to which supervisors, during training, are given the opportunity to exercise their skills and their perceived ability to address performance problems. � the extent to which supervisors, during training, are given the opportunity to exercise their skills and employees' perceptions of the extent to which supervisors learn to determine how well they (employees) apply their skills in the workplace. from the study it also seems as if the department or section to which a respondent belong, could have an influence on the respondent's perception of the training, the extent to which strategy is related to performance evaluation, participation in the system, and involvement of all stakeholders in the system. departments or sections appear to differ significantly on these aspects. these findings to al large extent also correspond with findings by latham and wexley (1994), matheson et al. (1995) and williams (1998). the number of times respondents were evaluated with the performance evaluation system do not appear to have a significant influence on their perceptions regarding involvement, participation, training and strategy. sajems ns 6 (2003) no 3 589 the one-way analysis of variance done with regard to the various departments/sections of the organisation, seems to indicate that respondents in the different departments do differ significantly in their responses to certain questions. the post hoc comparisons done to determine which groups differ significantly from one another, seem to indicate significant differences on certain dimensions of the questionnaire. in conclusion, the results of the study seem to indicate that an improvement in training regarding performance evaluation in the organisation is necessary, due to the following reasons : � training has an influence on the assessor's ability to determine performance standards. � training improves the measure of objectivity in the performance evaluation system. employees' perceptions regarding management's dedication are influenced by the latter party's ability to evaluate correctly and to provide accurate feedback. the better assessors are equipped to identify performance problems, the better the system can be utilised as a development aid. training does not include enough opportunities for assessors to practice their skills before returning to the workplace. references 1 anderson, g.c. (1993) managing performance appraisal systems, blackwell: oxford. 2 armstrong, m. (1998) performance management: the new realities, institute of personnel and development: london. 3 bacal, r. (1999) performance management. new york: mcgraw-hill. 4 cascio, w.f. (1991) applied psychology in personnel management (4th ed.) englewood cliffs, prentice-hall: new jersey. 5 de waal, a. (2001) power of performance management: how leading companies create sustained value, wiley: new york. 6 english, g. (1991) �tuning up for performance management�, training and development journal, 10(9): 56-60. 7 kaplan, r.s. & norton, d.p. (1996) �using the balanced scorecard as a strategic management system�, harvard business review, 9(3): 7585. 8 latham, g.p. & wexley, k.n. (1994) increasing productivity through performance appraisal, addison-wesley: reading, mass. 9 matheson, w., van dyk, c. & millar, k. (1995) performance evaluation in the human services, haworth: new york. sajems ns 6 (2003) no 3 590 10 romanoff, k.e. (1989) �the ten commandments of performance management�, personnel, 61 (3): 24-8. 11 shaw, d.g., scheier, b. & baird, c. (1995) performance measurement, management and appraisal sourcebook, human resource development press: amherst. 12 steers, r.m. & porter, l.w. (1991) motivation and work behaviour (5th ed.) mcgraw-hill, inc: singapore. 13 wade, d. (2000) corporate performance management: how to build a better organization through measurement-driven strategic alignment, butterworth-heinemann: boston. 14 weiss, t.b. (1997) reengineering performance management: breakthroughs in achieving strategy through people, lucie press: boca raton, fla. 15 williams, r.s. (2002) managing employee performance: design and implementation in organisations, thomson learning: london. 16 williams, r.s. (1998) performance management: perspectives on employee performance, international thomson business press: boston. microsoft word vol6no3'3.doc sajems ns 6 (2003) no 3 459 the potential for monopoly rents from etosha national park, namibia ________________________________________________________________ janet ågren, carita nyyssölä and jesper stage department of economics, umeå university, sweden ________________________________________________________________ abstract this paper reports on a survey carried out among visitors to etosha, namibia, in may 2002. we use the contingent valuation method to estimate foreign tourists� willingness to pay for visiting the park. we find that the namibian government could raise park fees substantially and increase profits from foreign tourists by approximately n$ 2,3 million per year. if fees were raised in collusion with other governments, in order to avoid competition between countries in the region, profits could presumably be increased even further. however, the survey used to collect data on tourists� willingness to pay also indicated dissatisfaction with current management of in-park resorts, and improved management of these resorts would probably be crucial for the success of any new tariff scheme. jel h21, h42, l12, l83, q21 introduction african wildlife in its natural habitats is a resource which is unique to the african continent and, largely, to the national parks on this continent. this means that african wildlife tourism is a market with natural barriers to entry and, hence, with potential monopoly rents to be earned by governments through suitable pricing or taxation policies. international wildlife tourism accounts for considerable fractions of foreign exchange earnings, and of gdp, in many african countries (see, for instance, bird, 1992, or cleverdon, 2002). however, the issue of optimal pricing and taxation arrangements for international tourism has still not been properly analysed in many countries. prices are frequently set at rates that are intended to be �competitive� in comparison to other tourist destinations, in order to maximise the number of tourists. this sometimes entails explicit or implicit support to the tourism industry in the shape of subsidies or tax breaks. even where this is not the case, price policies frequently only aim at recovering the financial costs associated with operating the parks. sajems ns 6 (2003) no 3 460 however, when the customers of a monopolistic industry are mainly foreigners, financial cost recovery should not be seen as the appropriate goal. rather, the government�s goal should be to maximise the monopoly rents earned from the industry. this paper studies the opportunities for increasing profits to namibian society from the etosha national park. etosha is one of the largest national parks in southern africa with a unique diversity of flora and fauna, and has approximately 150 000 visitors annually, most of whom are foreign tourists. the park fee for foreign visitors is currently less than a percent of the visitors� total cost for visiting the park, so that a large part of their willingness to pay for park visits is, in all likelihood, either appropriated by other agents or accruing to the tourists themselves in the form of increased consumer surplus. there are several options available for increasing government profits from etosha. the obvious option would of course be to raise fees generally. a further option could be to use price discrimination between different tourist groups; this is already used to some extent, in that namibian visitors pay only half the fees that foreign visitors do, but if foreign tourist groups of different origin have different willingness to pay one might also envisage setting different fees for different groups on the basis of origin. since there is a risk that higher fees can lead to a loss of visitors to other parks in the region, an additional option might be to increase park fees in collusion with other governments, i.e. form a cartel in order to increase overall revenue from parks. this paper therefore studies tourists� willingness to pay for visiting etosha and the potential for increased profits through higher fees. a stated preference (cvm) approach is used to determine what the profit maximising fees would be if fees were set separately for two different groups, visitors from other african countries and visitors from non-african countries. other subdivisions could have been made, but this categorisation would be relatively easy to enforce, and if agreements on tariff setting were to be made with other african countries it is likely that this would include lower tariffs for residents of the countries involved in the agreement. it is therefore of interest to study non-african tourists, who would not be included in a pricing agreement, separately from the tourists from african countries. tourism in etosha etosha is the oldest and most visited national park in namibia. the park lies in the north of namibia with a size of 22 270 square kilometres. in 1907 governor von lindequist established the park with the aim of preserving and protecting sajems ns 6 (2003) no 3 461 wild animals. when the park was first established it covered approximately 100 000 square kilometres, running all the way to the atlantic ocean. in 1964, the park obtained its present size, and by 1973 a fence had been placed around etosha in order to stop migration patterns and disease spreading among the animals. etosha is namibia�s main tourist attraction with visitors coming from all over the world. the tourists arrive either at the andersson gate in the south or at the von lindequist gate in the east. when arriving at the gate the tourists have to register in order to get their park permit. the daily fee is currently n$ 15 for namibian residents while foreigners pay n$ 30 (namibia is part of the cma zone and 1 n$ = 1 zar). in addition to this, a vehicle fee of n$ 10 must be paid once per entry. the main attraction in etosha is the diversity and large populations of animals. the 1995 aerial census found that the park was home to more than 40 000 big animals (auer, 1998) and more than 114 different mammal species, of which the most famous are lions and elephants. other animals that can be spotted in the park include black rhino, zebra, springbok, impalas, cheetah, and leopards. waterholes have been set up near the tourist roads, to make it easier for tourists to spot animals. another reason for the park�s popularity is the varied landscape. the vegetation changes from savannah to steppe and into the dry pan. etosha means �great white place�, a name which refers to the big salt pan in the east of the park; this salt pan covers over 5 000 square kilometres and is partially filled with water in the rainy season. the park is host to more than 340 bird species and during the rainy season many migratory birds, such as flamingos, come here to breed. there are three rest camps in etosha: okaukuejo, halali and namutoni. okaukuejo is the oldest and most popular, with a water hole that can be visited during the day, and also at night when it is floodlit. namutoni rest camp is situated in the northeast and the main building, and accommodation, is the rebuilt fort namutoni. halali is the smallest rest camp and is located between okaukuejo and namutoni. tourists who do not wish to spend the night in the park have other options just outside the park, where several private lodges can be found. the ministry of environment and tourism (met) formerly managed the rest camps in etosha. however, in 1999 the management of the park was divided between the met and the government owned company: namibian wildlife resorts (nwr). nwr now administers the tourism facilities and the accommodation, whilst met handles the maintenance and management of the park as well as wildlife supervision. nwr is intended to function as a normal sajems ns 6 (2003) no 3 462 firm but has received repeated grants and subsidies from the government; although some of this could be seen as covering the cost of reduced accommodation fees for namibian residents (which is more appropriately paid by the government than by a firm) these grants effectively entail giving government subsidies to foreign tourists, and the intent is that these subsidies will disappear as nwr becomes more fully operational. in namibia, part of the tax on petrol and diesel is earmarked for road maintenance and the revenue from this tax goes to the roads authority, an independent government entity which is responsible for the country�s roads. however, maintenance of tourist roads within etosha, which should in principle also be funded through this tax, is still handled by met as part of general government operation costs for the park. despite the considerable tourist traffic on the park roads, they are therefore still gravel only and the lack of general government funds for park maintenance have led to insufficient road maintenance, so that the roads have deteriorated. visitor numbers have increased substantially from 1990 onwards, putting increased pressure on facilities as well as, potentially, increased pressure on the ecosystems of the park. however, a study recently commissioned by the met (tarr et al., 2000) found no evidence of ecosystem damage arising from tourism, indicating that there is still room for increasing tourist numbers without damaging the environment of the park. theory when setting park fees for national parks, several factors must be taken into consideration. it is important to take into account, not only financial, but also social and economic considerations. when setting fees for domestic tourists, not only government profits from park fees should be considered, but also the consumer surplus for the tourists, since this will be part of the overall social welfare generated by the park. however, when setting park fees for foreign tourists, issues of consumer surplus can be ignored, since any consumer surplus will in any case accrue to (usually very affluent) foreign tourists rather than to members of namibian society. this implies that the pricing between foreigners and domestic residents should differ, perhaps substantially. the government should try to maximise its profit from the foreigners like an ordinary monopolistic firm; in other words, set fees so that the marginal cost equals the marginal revenue rather than the fee. for domestic tourists, on the other hand, fees should be set equal to the marginal cost. if monopoly prices were to be used for domestic visitors, a dead weight sajems ns 6 (2003) no 3 463 loss for the domestic consumers would be created since their consumer surplus would be lower. hence, the optimal park fee for the country residents is where marginal cost equals the demand for country residents to visit the park (carlton & perloff, 1999). price discrimination, for instance between different tourist groups, is one possible course of action to make parks more profitable. the fees that should be charged are decided by the price elasticities for the different groups. if demand from a group is inelastic, a high fee can be charged, and vice versa if the demand is elastic. this implies that a tourist group with a high elasticity should be charged a lower fee than a group with an inelastic demand. fees for a specific group should be set so that the marginal revenue from that group is equal to the marginal cost caused by visitors belonging to that group. if there exist social or environmental costs in addition to the financial costs, economic marginal costs are higher than the financial marginal costs, and the park fees (both for foreigners and domestic tourists) should be set higher than if there were no additional social costs. the most common tourist related externalities in national parks are congestion, eco-damage and wildlife disturbance. the first problem implies that when too many tourists are visiting the park, tourists� enjoyment, and hence their willingness to pay, may decrease. congestion can also disturb the wildlife; this may reduce tourists� enjoyment of their visit further (shah, 1995). eco-damage is present in etosha and the main source of damage is the tourist roads, which have a negative effect on flora and fauna. the gravel roads create a lot of dust when people are using them. this, combined with limited maintenance of the roads, increases the dust generation and worsens the situation for the vegetation and animals close to the roads. it is difficult to calculate the exact economic cost of this damage. however, since the revenue from the petrol taxes paid by the tourists would be enough to pay for tar roads, it is reasonable to assume that this cost is already internalised and that the main problem is that revenue from this tax is currently not going to the agency responsible for the park roads. it is also difficult to value wildlife disturbance in the park. many tourists drive off the roads or drive too fast, which in some cases can lead to road kills. however, there are no available data on the number of road kills that occur every year. again, this cost could be reduced by road bumps and by other traffic obstacles making it more difficult to leave the roads, and this could in principle also be paid for through the petrol tax revenue generated by the tourists. sajems ns 6 (2003) no 3 464 data in order to provide data for the study, a survey was carried out at the andersson gate during three weeks in may 2002. during the survey period most tourists arrived through this gate. a total of 500 questionnaires were distributed to the incoming tourists. the questionnaires were handed to tourists when they were entering the park, and these questionnaires could then be handed in either at the tourist centre in okaukuejo camp or at one of the gates when leaving. distributing the questionnaires was fairly straightforward since the tourists had to register at the gate both when entering and leaving the park. 275 questionnaires were completed, giving a response rate of 55 percent. in general, the respondents did not neglect to answer any of the questions and often gave very detailed comments. hence, the data provided a good basis for analysis. the costs of operating the park are mainly divided between the management and maintenance departments. in 2001 the management department spent approximately n$ 3,9 million in order to perform its duties. the department�s main expenditures consist of salaries, including overtime and vehicle costs. maintenance has four major costs: construction, water supply, fencing and tourist roads. this sums up to approximately n$ 5,3 million. the total cost in year 2001 was thus approximately n$ 9,2 million. however, the cost of maintaining tourist roads should not be included in the total cost used to determine park fees, since costs for road maintenance are in principle already paid for through the petrol tax. although this cost is part of the park budget, it should therefore be considered as being internalised through other taxes and not as one of the costs which need to be financed through the park fees. excluding road maintenance from the operational costs leaves a total cost of n$ 8,1 million. as noted, the operation of the park resorts is now in the hands of a government company which, presumably, attempts to maximise its profits by setting appropriate prices. this simplifies the analysis, since most of the costs which vary with the tourist numbers are now the responsibility of the nwr. thus, the met expenses for the park can be seen as more or less fixed, giving a financial marginal cost approximately equal to zero. there is no congestion in etosha, and the eco-damage costs are in principle already internalised through petrol taxes (although allocated to the wrong government agency). this means that there is no need to internalise social and environmental marginal costs through the park fees. consequently, when calculating optimal fees and tourist numbers, it has been assumed that the marginal cost of an additional tourist is approximately equivalent to zero. sajems ns 6 (2003) no 3 465 tourist characteristics table 1 tourist profile parameter value namibia 30,5 percent other africans 17,2 percent overseas 52,3 percent mean age 44,1 years sex: male 63,1 percent mean group size 3,83 persons mean trip days 16,96 days mean days spent in etosha 3,19 days mode of transport: car 91,3 percent type of accommodation: bungalow 54,6 percent camping 28,9 percent mean income: namibia n$13 000 other africans n$20 000 overseas n$40 000 in table 1 the general features of the respondents are illustrated. respondents from 16 different countries were included; 30,5 percent were namibian residents. the two largest foreign tourist groups were from germany (28,2 percent) and south africa (16,9 percent). in total, more than half of the tourists (52,3 percent) answering the survey were from non-african countries. the average respondent was a 44,1 year old male. during the visit in etosha 54,6 percent of the respondents stayed in bungalows, 28,9 percent were camping, 14,3 percent stayed in lodges outside the park and 2,2 percent stayed in other accommodation, for example luxury suites. the overall experience for the respondents was mostly described as very good or good (84,3 percent) despite the fact that 62,9 percent did not see all the animals that they had hoped to see. when asked about the tourist and vehicle numbers most respondents felt that the numbers were just right. most tourists, 93,6 percent, found environmental issues to be very important and a total of 97,4 percent considered it to be very important to preserve endangered species. one frequent problem in surveys is that respondents are often reluctant to answer questions about income, but the response rate for this question proved to be over 85 percent. the mean income for namibian residents was approximately n$ 13 000 per month. for other african residents the average monthly income sajems ns 6 (2003) no 3 466 was slightly higher: n$ 20 000, while the overseas tourists had a substantially higher average monthly income: n$ 40 000 per month. the respondents had the opportunity to comment on the questionnaire and to express their opinion about their experience in the park. in one of the questions they were asked to state why they chose to visit etosha. the most common replies were that the park hosted a unique diversity of animals and nature in its natural habitat. other reasons were: its size, as it is one of the largest game parks in namibia, its reputation, and the location of the park. in other words, it was quite important for the tourists that the park was easily accessible and that it was well known. other factors that were of importance was the tranquillity in the park and camps, and that the park visit was considered rather inexpensive. many remarks were made about the camps, especially about the maintenance of the accommodation and the facilities, which were in a poor condition and in need of improvement. there were also comments about the inadequate assortment and service received in the shops, restaurants and tourist information centre. moreover, responses to a question about waiting time indicated that the tourists mainly had to wait at the rest camps and not at the gates. another issue was the loud noise made at the waterholes, and from the staff quarters that the tourists perceived as disturbing. furthermore, a common complaint was that most drivers were travelling too fast in the park and that the roads were in need of attention. several suggestions for improvements were made, for instance, information boards about the waterholes, animals, and warning signs for jackals. it was also desirable to have professional guides and night drives. despite many complaints made about the state of the camps, a number of tourists were satisfied with the present camping facilities and accommodation. numerous positive comments were made of the park and the roads. some people were very impressed with the beautiful views and accessible waterholes. finally, many respondents considered the park personnel and rangers to be very friendly and helpful. questions about the vehicle and tourist numbers were included in the questionnaire to examine if there is any crowding in etosha. most respondents, 87,7 percent, considered the tourist number to be just right. very few (only 9,7 percent) believed there were too many tourists in the park. the same question was asked about the vehicle numbers, which gave similar replies. 89,1 percent of the respondents felt that the number of vehicles were just right, while few (8,3 percent) thought there were too many. consequently, it is reasonable to assume that congestion is not perceived as a problem by most tourists, confirming the earlier findings made by tarr et al. (2000). sajems ns 6 (2003) no 3 467 70,8 percent of the respondents stated that there were no substitutes to the park, and an additional 15,7 percent of the respondents were not aware of any alternatives. the tourists who considered there to be substitutes to etosha were only 13,5 percent. the alternative destinations suggested by these tourists were rather diverse and they did not always refer to a meaningful alternative, which may be because the respondents did not fully understand the question. the suggested alternatives were, for instance, a private lodge outside the park or nearby towns. these destinations cannot be referred to as substitutes to etosha as they are not able to offer the same experience. in order to estimate demand curves for different groups, several questions were used in the questionnaire that considered the respondents� maximum willingness to pay. in one of the questions, the respondents had to answer how they felt about the present park fees. on average, both african and non-african tourists found the park fee to be appropriate at its present level. african residents� average willingness to pay was given as n$ 40 with a median of n$ 30, which is the present level. the non-african tourists� willingness to pay was, as might perhaps have been expected, higher than this; the mean value was n$ 74 and the median was n$ 50. the mean wtp for tourists staying in lodges outside the park was n$ 76, compared to n$ 54 for the tourists staying within the park, but since only 33 respondents were staying in lodges this group was too small to draw any definite conclusions. almost all respondents, 91,4 percent, thought that the trip was worth the money that they had spent. a follow up question was asked, where the respondents had to specify a park fee that would prevent them from returning. the mean level stated was 1,5 times the present level for other africans and 3 for non-africans, which was fairly close to the results from the other wtp questions. finally, the respondents were asked if they would recommend a visit to the park to other people in their home country, and 98,7 percent answered that they would. this suggests that the tourists were generally satisfied with their trip to etosha and that their willingness to pay is higher than what they are presently paying. there is a risk that those answering were the most keen about nature conservation (and thus with the highest wtp) and that they were not representative for the entire group. nevertheless, the response rate for the survey was quite high, 55 percent, and consequently the results for the study are believed to be accurate. there is also a risk that since the survey was carried out in may 2002, in the middle of a worldwide recession, visitors may have been more cost conscious than usual and stated lower wtps than they would have done under more favourable economic conditions. the wtp values used in the analysis could thus, potentially, be understated. if this is the case the true sajems ns 6 (2003) no 3 468 demand curves (and, hence, the profit maximising tariffs) for the two groups will be higher than suggested by our analysis. results restricted least squares were used to determine the demand functions for the two groups of foreign tourists, with the willingness to pay as the dependent variable, with the response rates for the different willingness to pay levels as the predictor, and with the visitor number constrained to the current level at the present park fee level. the visitor number for 2000 has been produced from the entrance books for etosha, where tourists need to register on entry. however, data were not available for three months and for these three months the average monthly visitor number was used to add up to a full year. the visitor number used for 2000 is therefore not entirely correct, but can nonetheless give a reasonable approximation. table 2 results of estimating a constrained log-log demand function for tourists from african countries coeff. std. err. t ln (q) -.7729676 .12488 -6.190 const. 11.13068 1.2488 8.913 table 3 results of estimating a constrained semilog demand function for tourists from african countries coeff. std. err. t q -.0000542 7.13e-06 -7.606 const. 5.185569 .2346277 22.101 table 4 results of estimating a constrained linear demand function for tourists from african countries coeff. std. err. t q -.0028635 .0004749 -6.030 const. 124.2162 15.62466 7.950 for residents of african countries, three econometric specifications were estimated � linear, semi-log and log-log, with the constraint that at the fee of sajems ns 6 (2003) no 3 469 n$30 the visitor number should equal the current level of 32 902 (tables 2 through 4). the linear model had the least satisfactory adjusted r2 of 74,2 percent, while the log-log model had an adjusted r2 of 79,2 percent. the best fit for african residents was the log-linear demand function with an adjusted r2 of 85,2 percent. the demand function estimated was 051042,5 185569,5 −× − = np qaf l , where qaf is the number of visitors from african countries and p is the park fee to the park. based on this demand function, the marginal revenue mraf can be calculated as )1042,51( 051042,5185569,5 05 af q af qemr af −×− ×−= − . the profit maximising park fee for african residents is n$ 66, given the assumption that the marginal cost equals zero. at this park fee there would be 18 375 visitors from other african countries, as compared with the present number of 32 902, but generating a total revenue of n$ 4,5 million (4,3 million in park fees and 200,000 in vehicle fees) rather than the present level of n$ 3,8 million (3,5 million + 300 000), provided that the average number of days spent in etosha by african tourists remained at 3,54. table 5 results of estimating a constrained log-log demand function for tourists from non-african countries coeff. std. err. t ln (q) -.6103584 .0359202 -16.992 const. 10.27667 .40464 25.397 table 6 results of estimating a constrained semilog demand function for tourists from non-african countries coeff. std. err. t q -.0000237 1.22e-06 -19.455 const. 5.247447 .0949082 55.290 table 7 results of estimating a constrained linear demand function for tourists from non-african countries coeff. std. err. t q -.0019584 .0002405 -8.142 const. 182.8317 18.77033 9.740 for non-africans the same three specifications (linear, semi-log and log-log) were estimated using restricted linear squares, with the constraint that at the fee of sajems ns 6 (2003) no 3 470 n$30 the visitor number should equal 78 040 (tables 5 through 7). the best fit was given by the log-linear specification, with an adjusted r2 of 90,7. (the linear model produced an adjusted r2 of only 32,7, while the log-log model had a higher adjusted r2 of 88 percent.) the estimated demand function was thus 051037,2 247447,5 −× − = np qnaf l , where qnaf is the number of visitors from non-african countries and p the park fee paid by these tourists. the marginal revenue function given by this demand function can be written as )1037,21( 051037,2247447,5 05 naf q naf qemr naf −×− ×−= − . the profit maximising tariff for non-african tourists, n$ 70, is only slightly higher than for african tourists. the visitor number at this tariff level is estimated as 42 150 visitors from overseas, compared to the current number of 78 040. assuming that the mean average of days spent in etosha by nonafricans remained at 3,23, this would increase the total revenue from nonafrican tourists from the present level of n$ 8,3 million (7,5 million in park fees and 800,000 in vehicle fees) to 9,9 million (9,5 million in park fees and 400,000 in vehicle fees). conclusion this study suggests that it could be beneficial for the namibian government to modify the present park-pricing scheme for etosha national park. the results imply that increasing the park fee to n$ 66 for visitors from other african countries and n$ 70 for non-africans would increase total profits from foreign tourists from n$ 12,1 million to 14,4 million. the difference between the profit maximising park fees for african and non-african visitors is small, and as long as there is no agreement on tariff setting with other african governments the administrative problems associated with having two different fees may be enough to warrant maintaining a joint fee for the two groups. using higher fees to generate more revenue for the government would enable numerous opportunities. for instance, more funding could be invested in conservation of endangered species and the protection of the environment. it would also be possible to improve the conditions in the park. this should increase long-term demand for visiting the park, and in turn increase revenue further. higher park fees in etosha would presumably induce at least some foreign tourists to go elsewhere for their wildlife viewing. it would therefore be desirable for governments in the region to cooperate in exchanging experiences sajems ns 6 (2003) no 3 471 from tariff setting and, preferably, setting tariffs jointly in order to reduce competition and increase overall profits from foreign tourism. most of the environmental costs caused by tourists are already internalised through the petrol tax, but the revenue from this tax is not currently used for park maintenance. it would therefore be desirable either to use petrol tax revenue to finance the road maintenance part of the park budget or to transfer responsibility for park roads to the government agency responsible for maintenance of other namibian roads; this would provide a closer link between the costs being internalised and the tax used to internalise them, and would make it easier to finance tar roads (which would decrease the ecosystem pressure substantially). in any case, the pressure on the park ecosystems, and any other social costs associated with park tourism, would be reduced by the tariffs suggested here, since the visitation rate for the foreign tourists would almost be reduced by half. if additional social or environmental costs are identified by future research this would imply that the tariffs should be set even higher than advocated here; our figures, which are substantially higher than the present day fees, should therefore be seen as lower rather than upper bounds for the tariffs. many tourists remarked on the condition of the nwr rest camps, and their main concern was that the camps were in need of improvement. it is important for the government that both met and nwr operations in the park function smoothly. if the nwr management does not function well, this is likely to decrease the chance of success of a new tariff regime. if the park fees were to be increased without improvements in nwr management there is a risk of declining demand, which would affect both met and nwr. on the other hand, if nwr management were to be improved, the revenue generated might be even higher than estimated in this study, and visitor numbers might increase beyond the estimated numbers. etosha national park is a great resource and has the potential of generating more income for the namibian government. by managing the park resorts better, creating closer links between environmental costs and the taxes used to offset these costs, and setting more appropriate park fees, there is an opportunity that both the namibian government and namibian society as a whole can benefit even more than is presently the case. sajems ns 6 (2003) no 3 472 acknowledgments financial support from the swedish international development co-operation agency (sida) is gratefully acknowledged. the authors are indebted to jon barnes, ben beytell, shayne kötting, as well as many others at the ministry of environment and tourism in namibia for help with the study. we are also grateful to åsa linder and mia wikström at the department of economics, umeå university, as well as to an anonymous referee, for constructive comments on earlier versions of this paper. all responsibility for any errors is of course ours only. the conclusions and suggestions in this paper should be seen as our personal conclusions and suggestions only, and not as those of the abovementioned individuals or organisations. references 1 auer, c. (1998) �water availability and chemical water quality as important factors for sustainable wildlife management in the etosha national park and for domestic stock in farming areas of namibia�, research discussion paper no 26. directorate of environmental affairs, ministry of environment and tourism, windhoek. 2 bird, r.m. (1992) �taxing tourism in developing countries�, world development, 20(8): 1145-58. 3 carlton, d.w. & perloff, j.m. (1999) modern industrial organization (3rd ed.) ma: addison-wesley longman: reading. 4 cleverdon, r.g. (2002) �tourism development in the sadc region: the opportunities and challenges�, development southern africa, 19(1): 7-28. 5 shah, a. (1995) the economics of third world national parks: issues of tourism and environmental management, edward elgar: aldershot, uk. 6 tarr, p., nakanuku, l., nghitila, t., berry, h. & hipondoka, m. (2000) �an assessment of the negative impacts of tourism in etosha and sossusvlei/sesriem�, mimeo, ministry of environment and tourism, windhoek, namibia. abstract introduction study area: potchefstroom literature review methodology conclusion acknowledgements references about the author(s) david dyason school of economic sciences, trade research entity, north-west university, potchefstroom, south africa riaan rossouw school of economic sciences, trade research entity, north-west university, potchefstroom, south africa ewert p.j. kleynhans school of economic sciences, trade research entity, north-west university, potchefstroom, south africa citation dyason, d., rossouw, r. & kleynhans, e.p.j., 2019, ‘economic impact assessment of a south african university campus: a case for promoting on-campus contact learning’, south african journal of economic and management sciences 22(1), a3153. https://doi.org/10.4102/sajems.v22i1.3153 original research economic impact assessment of a south african university campus: a case for promoting on-campus contact learning david dyason, riaan rossouw, ewert p.j. kleynhans received: 30 apr. 2019; accepted: 27 june 2019; published: 29 aug. 2019 copyright: © 2019. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: public universities in south africa play an extremely important role in preparing students for productive and fulfilling careers. universities also, directly and indirectly, benefit the economy through high levels of operational and capital expenditure and by providing employment to both academic and administrative staff. aim: the aim of this article is to quantify the economic benefits of one of south africa’s largest universities, and to determine what strategic view the university should take to maximise the benefit for the economy. setting: the potchefstroom campus of the north-west university in south africa is used for the analysis. methods: the primary method to determine is a social accounting matrix of the north west province, while data collected through a staff and student survey are used to refine and apply the analysis for the university campus. results: the economic benefits of a university are much more significant than might initially be assumed. among the findings is that north-west university should absorb relatively higher numbers of contact, rather than distance learning, students if it is to make a sustainable contribution to the provincial economy. conclusion: student spending has a direct and significant impact on the economy and helps to promote national income and employment creation within the province. the results of the study provide valuable insights for cities and provinces that have established new public universities. keywords: social accounting matrix; economic impact; university; consumer expenditure; higher education. introduction universities are currently attracting a great deal of attention in south africa, particularly in connection with accessibility and affordability of tertiary education. as recently as 2014, two new public universities were established with a view to addressing the growing demand for higher education. in addition, in december 2017 the south african government announced a policy of free higher education for families with an annual household income below r350 000. this enables deserving candidates from such families to receive full bursaries for their studies (at least in 2018) where previously they might not have been able to attend university because of financial constraints (national treasury 2018:14). the funding of free education has necessitated changes to the fiscal framework – notably new tax measures to increase revenue and a reduction in expenditure amounting to r85 billion (national treasury 2018:10). this could potentially lead to higher numbers of students attending university which in turn might lead to an increase in operational and capital expenditure (dyason & kleynhans 2017:13). with more students having the chance to study, the economies of the host towns or cities of universities could theoretically benefit. in light of these developments, this article sets out to estimate the impact of a south african university campus on the provincial economy. there are some references in the literature to the economic contribution made by universities in south africa. for example, kleinsmith and horn (2015) attempted to highlight the potential benefits of universities for host cities but lacked evidence of a quantitative assessment. furthermore, no economic impact assessments have been carried out, either of the new universities or the more established ones in the country. this article addresses this gap, using a particular south african university campus – the potchefstroom campus of the north-west university (nwu) – as an example to measure the economic impact of a university on the provincial economy. the aim of the study that gave rise to this article was twofold: firstly, to illustrate the economy-wide impact of the potchefstroom campus of the nwu on the provincial economy using a social accounting matrix (sam) and, secondly, to determine the effect on the provincial economy of various modelled scenarios relating to the spending patterns of first-year students. the rest of the article is structured as follows: section 2 describes the potchefstroom study area, while section 3 provides an overview of the literature and identifies best practice modelling techniques from existing theoretical and empirical work on the topic. section 4 explains the methodology used to quantify the economic impact, with the research results being presented in section 5. section 6 concludes. study area: potchefstroom a tertiary institution, especially a university or college, offers a number of benefits to the local community, particularly in an economic sense. universities are large, economically active organisations that have spin-off effects throughout the economy (from local to national). thus, an increase in a university’s expenditure (operational or capital) could potentially have a transformative effect on the economy (love & mcnicoll 1990). in this regard, an economic impact assessment provides an economy-wide picture of the contribution that a university makes. the potchefstroom campus has significant purchasing power. in 2006 the campus spent approximately r659 million on operational and capital expenses, which had increased to r1.75 billion by 2015 (nwu 2016). between 2006 and 2015, the total number of students increased from 16 079 to 21 320 (nwu 2018). figure 1 illustrates the increase in expenditure and staff and student numbers on the campus during this period. figure 1: expenditure, staff and student numbers, 2006‒2015. figure 1 shows that while there has been an increase in staff and student numbers on the campus, the university’s total expenditure has also increased. for many years the local economy (i.e. tlokwe municipal area) has been increasing its economic contribution to the provincial economy, rising from 5.2% in 1993 to 5.9% in 2016 (quantec 2018). the economic contribution of the potchefstroom campus of the nwu has most likely played a role in this result, and the impact assessment would most likely indicate if this was indeed the case. literature review ways of measuring the economic impact of a university campus have evolved since their initial appearance in the 1960s, prompting a growing number of studies (see brown & heaney 1997; stewart et al. 1989). early studies mainly quantified the direct economic impact and neglected the indirect and induced impacts (bonner 1968:339). although the direct impact is often the greatest, the indirect and induced impacts highlight the significance of universities’ operations for the economy as a whole, which extends beyond the initial benefit. bonner (1968) and later caffrey and isaacs (1972) introduced methods to broaden the level of aggregation that measured the economic impact to include the entire economy. their findings revealed that a university has a much wider influence than merely the direct economic benefits and, as a result, the majority of university economic impact studies have since incorporated multipliers, sourced from input-output analyses. the method used to estimate the economic impact has not changed significantly over time. input-output (io) tables and sams are mostly used. the io model is a linear model that illustrates the sale and purchase relationship between producers and consumers in an economy, in matrix form (oecd 2018). the consuming industry (demand) is shown in the columns while the supplying industry is shown in the rows. this infers that for each industry or product, input must equal output; hence, total supply must equal total demand (statssa 2017). the sam is a natural extension of the io model and shows the circular flow of income, representing all transactions involving production activities, factors of production, households, the government, the corporate sector and the rest of the world. a benefit of the sam is that the structure of the matrix makes it possible to analyse the effect of disruptions or shocks within the economy (polo & valle 2012). this makes it possible to incorporate and quantify the economic impact – of, for example, the potchefstroom campus of the nwu – in the north west (nw) province, using existing sam data. a further benefit of the sam is that multipliers can be extracted from the matrix. a multiplier quantifies the effect of income injected into one part of the economy and shows the impact of this injection on the rest of the economy (round 2003:14–2). multipliers extracted from a sam quantify the direct, indirect and induced impacts, while the io matrix can only extract the direct and indirect multipliers. in this respect, the sam and sam-based multiplier analysis were the preferred data set and methodology when setting out to quantify, analyse and evaluate the economic impact of the potchefstroom campus. the underlying reasons for quantifying the economic impact vary. the majority of studies aim to quantify the economic benefit of a university for a specific geographical area. sen (2011) estimated the employment and local income benefit of the izmir university of economics on the izmir metropolitan area in turkey. tavoletti (2007) evaluated the regional and local economic impact of the university of cardiff in wales, while carroll and smith (2006) estimated the economic injection of the bowling green state university into ohio’s economy. smith and bissonnette (1989), in turn, showed the impact on the economy of west virginia, with particular attention given to the impact of students who hail from outside west virginia but opt to study at tertiary institutions within the state. these analyses all highlight how students’ spending constitutes a valuable financial injection into the economy. it is also possible to illustrate the differences in economic impact between universities in metropolitan areas and rural areas. beck et al. (1995:250) explain how the delineation of the area surrounding a university, and whether a campus is situated in a metropolitan area or a rural area, can significantly affect the value of the economic contribution to the surrounding area. studies are also sometimes directed at motivating additional government grants for tertiary education institutions (love & mcnicoll 1990). studies estimating the economic value of a university often describe the benefit for the local economy in qualitative terms, ignoring the capital and operational expenses associated with the university (booth & jarrett 1976). with the advent of economic modelling, though, politicians and academics have realised that quantifying this impact can greatly support the development and expansion of such institutions (brown & heaney 1997:229). results are typically based on multipliers, which illustrate the amount by which one dollar or rand spent by the university will benefit the economy through the multiplier process. the majority of studies tend to consider the impact for a particular year; however, future estimates are also possible. for example, in 1968 bonner (1968:341) forecasted the economic impact of the university of colorado in the year 1980 based on the predicted number of students. the study revealed that every dollar spent by the university stimulated us$1.37 of production and that its annual expenditure of $47 million in 1968 resulted in $64 million worth of sales in the surrounding geographical area. an alternative to the economic base approach with multipliers is a skill-based approach. this approach, which was developed by bluestone (1993), argues that a university produces higher-skilled workers who in turn earn higher wages compared with those without an education. this then leads to higher incomes earned and higher taxes paid to the government (brown & heaney 1997). consequently, the skill-based approach quantifies the economic impact at a higher yield than the economic-based approach. brown and heaney (1997) question whether the skill-based approach is indeed more realistic than the economic-based approach, asserting that there is substantial overestimating when the skill-based approach is used. methodology the model a sam was used to measure the economic impact of the potchefstroom campus of the nwu on the provincial economy. the sam provides a detailed framework of the economy in a matrix form, showing the interdependencies within the regional economy in a given year (round 2003:14–2). it is a tool used by economists to, inter alia, illustrate the structure of the economy, determine the effect of changes in production and quantify economic injections or shocks in an effort to explain the impact on the economy (polo & valle 2012:227). the sam is not a model in itself; however, the relationship between production and income in particular signals a relationship that is illustrated through coefficients or multipliers and is used to evaluate changes in the economy (round 2003:14–5). the advantage of using a sam analysis is that it allows for the modelling of various scenarios. a sam is flexible in its application due to disaggregation and the emphasis that can be placed on different elements of the economic system to measure the impact of various scenarios (round 2003:14–1). the benefits of using a sam in this context were twofold: firstly, it allowed the economic significance of the campus within the provincial context to be quantified and, secondly, it allowed an economic analysis of shocks within the economy. figure 2 shows how an incident in the economy can change the economic value over time. figure 2: social accounting matrix as an impact-quantifying tool. figure 2 illustrates the impact of a shock on the economy, resulting in a benefit or a cost, or no substantial change in the economy. the suite of models usually applied for the current type of analysis includes computable general equilibrium (cge), partial equilibrium and (input-output or sam-based) multiplier models. according to dixon et al. (1992), cge models are the dominant framework among these models. however, because cge models are mainly used to conduct an ex-ante analysis of the potential impact of a policy change (see, e.g., bellù 2011), and because this article aims to quantify the economic contribution of a south african university campus, a cge model will not be appropriate. preferably, a simpler fixed-price model, such as a sam multiplier model, will provide a better indication of the contribution of the university campus within its current locality. the 2006 nw provincial sam, commissioned by the development bank of south africa (dbsa) and developed by conningarth economists, was used for analysis. this was the most recent and lowest level of aggregation available for a sam in south africa. the sam was adjusted, and the potchefstroom campus activity was extracted from the original sam and included as an individual entity in the sam that transacted with the rest of the economy. the economic value of the campus was extracted from the community, social and personal services sector which was the sector to which the educational component of the provincial sam had been allocated. the values obtained were based on the operational and capital expenditure of the campus. once this was done, the adjusted sam was complete, and the economic analysis could be conducted. lastly, it is essential to bear in mind that the justification of sam-based economic multipliers as a methodology for the current study rests on the appropriate interpretation of the results. thus, the critical assumption of fixed relative prices and perfectly elastic supply of economic multipliers must be kept in mind when interpreting the results. moreover, the data reflects a snapshot of the provincial economy during 2006; that is, the provincial multipliers are calculated for 2006 constant south african rand. we assume that the structure of the provincial economy has remained the same and, therefore, use the sam as is to calculate the required multipliers. the sam was adopted to suit the particular research needs of this study. table 1 shows the nw sam framework. each account is represented twice, in a row and in a column. the row represents the income received (from supplying the product) and the column represents the expenditure incurred (in response to demand for the product) from the corresponding account (round 2003:14–3). table 1: north west social accounting matrix framework. the corresponding totals of the rows and columns should be equal to one another, as the total income received should be equal to the total expenditure incurred. this framework represents the basic structure used for the economic analysis. the data university operational and expenditure data, as well as survey data, were used to quantify the economic impact. the survey data considered the spending patterns of first-year students to determine the effect of government’s new financial support model on the economy of the nw province. the analysis considered only first-year students to try and highlight the initial additional injection by students that were granted access to the university after the announcement of free higher education. the university expenditure data were sourced from the university’s finance department and included a detailed breakdown of expenditure on various goods and services. operational expenditure and capital expenditure were provided separately and also integrated into the sam to determine the economic impact. the values of university expenditure from 2006 to 2015 were provided. the 2006 expenditure values were used to adjust and develop the sam with a focus on the potchefstroom campus and its contribution to the nw provincial economy. the standard industrial classification (sic) and the nw sam report (2006) were used to classify the value of expenditure within sectors. this ensured that the allocation of expenditure for the province and the campus were aligned. in some instances, the provincial sam did not have values for specific commodities and activities. in these cases, the values were apportioned to similar activities to ensure that equilibrium was still achieved within the matrix. the economic impact assessment of the campus was carried out using the latest available expenditure data from the university, which in this case was 2015. the 2015 campus expenditure is illustrated in table 2. table 2: campus expenditure (r/millions), 2015. the campus expenditure values represented the direct impact from university expenditure with the impact of this spending within the provincial economy being quantified through the sam. survey data were used to measure the impact of a stimulus (shock) on the economy. student spending represents an exogenous demand stimulus. to determine the value of this stimulus, student surveys were conducted during september 2016. the survey obtained expenditure data based on monthly spending on goods and services typically undertaken by students studying at the potchefstroom campus. a total of 497 surveys were completed of which 110 were completed by first-year students. only full-time contact students were surveyed. the student spending values were then reclassified in terms of sector spending, integrating the results with the sam to determine how student spending stimulates the provincial economy. ethical consideration based on approval by the ethics committee of the faculty of economic and management sciences (ec-ems) on 30/08/2016, the north-west university institutional research ethics regulatory committee (nwu-irerc) approved this project. ethics number: nwu-00224-16-a4. simulation results the economic contribution of the campus extends beyond the expenditure values emanating from the campus. the economic value or impact is threefold, namely direct, indirect and induced impacts. the direct impact refers to the value that is transferred to the nwu’s direct suppliers, such as payment to a firm that provides a service to the campus. the indirect impact refers to the value that is transferred to a supplier’s suppliers. lastly, the induced impact refers to the money spent by suppliers and their employers within the economy as part of their living expenses – also referred to as the income effect (econex 2017:2). two analyses were conducted. firstly, the economic impact of operational and capital expenses associated with the potchefstroom campus of the nwu was presented for 2015. this was to quantify the economic impact of the campus on the provincial economy. secondly, various scenarios pertaining to first-year student expenditure were modelled to identify the specific implications for the provincial economy. the impact of university expenditure the economic benefits of a university are much more significant than might initially be assumed. to understand the impact, it is appropriate to quantify it in terms of monetary value. in a provincial context, such value is illustrated using the contribution to the gross domestic product, employment, production and labour income. the sam provides a detailed analysis of the above indicators, which is summarised in the following sections. impact on production and gross domestic product the impact on production is revealed in those activities that benefit from the university’s expenditure. this is indicative of the inputs used by the university to function. figure 3 shows the value associated with the direct, indirect and induced impacts as a result of the campus spending r1753 million on capital and operational expenditure during 2015. the figure illustrates the activities (or sectors) that benefit due to the indirect and induced effects from university expenditure, with the total impact value or the economy-wide value illustrated in the last right-hand bar. figure 3: economy-wide impact on production (r/millions), 2015 values. the economy-wide impact totalled r3167 million. spending by the university, which is mainly in tertiary sectors (see table 1), also benefits production in primary sectors (agriculture and mining). the implication is that the spending of r1 by the university has a multiplier effect (or creates additional production) of r1.81 in the economy. the implication for the provincial gross domestic product (gdp) is illustrated in figure 4. figure 4: economy-wide impact on gross domestic product (r/millions), 2015 values. the impact of the campus’s operations on the gdp shows a total economy-wide impact of r1791 million for 2015. this represents a 0.37% contribution to the provincial gdp for the corresponding year. impact on employment south africa had an unemployment rate of 26.7% during the fourth quarter of 2017 (statssa 2018). providing employment is one of the most critical impacts that an institution can make in south africa. the university represents an economic entity that relies on human capital to function appropriately and plays an essential role as an employer. the employment provided by the campus itself and the employment created by the university’s purchasing activities are illustrated in figure 5. figure 5: economy-wide impact on total employment numbers, 2015. in 2015 a total of 8 565 jobs were created throughout the economy. the largest component of employment opportunities was the result of the induced impact (income effect) which generated a total of 3452 jobs. every r1 million of spending by the campus created an additional four jobs throughout the economy. this equated to 1.1% of total formal employment within the nw province. the sectors that benefited the most from this employment are shown in figure 6. figure 6: economy-wide impact on total employment per sector (number), 2015. apart from the direct employment provided by the nwu, the sectors that benefited most in 2015 included retail, business services, agriculture and manufacturing. figure 7 shows the employment that was created according to skill level and gender throughout the economy. figure 7: economy-wide impact on (a) skill level and (b) gender, 2015. impact on labour income figure 8 illustrates the impact on household income by the salaries and wages paid by the campus to its employees. the figure illustrates the remuneration paid to university employees by the campus and by the university’s suppliers and their suppliers. figure 8: economy-wide impact on household income (r/millions), 2015. the potchefstroom campus’s total remuneration bill in 2015 was r1.06 billion (direct impact) while the economy-wide impact amounted to r1.8 billion. the income benefit that accrued to labour is illustrated in figure 9. the figure shows the labour income generated by expenditure on-campus activities or, in other words, the labour income associated with the value of production in figure 3. the figure shows labour remuneration (r/millions) for various income levels, from lower-income households (p1 to p4) to middle-income households (p5 to p9) to higher-income households (p10 to p12). figure 9: economy-wide impact on labour income (r/millions), 2015. the direct impact on labour remuneration by a university campus mostly benefits high-income households, which might be attributed to the strong link between university expenditure and the services sector. the impact of student expenditure most universities have capacity constraints, which limit indefinite growth in the student population. the result is that not all students who want to attend university are able to do so. the study considered three possible scenarios for the potchefstroom campus over the next five years (up to 2022), with recent developments in the tertiary education sector influencing the growth trajectory of the campus. among these developments are the recent announcement of free education for disadvantaged first-year students in 2018 and the growth in numbers of online student in recent years. the first scenario examined the impact of first-year student spending on the economy where future enrolment trends are similar to those at present, that is, assuming that the status quo is maintained. the second scenario considered the impact of free higher education on student spending in the host city of the university, that is, potchefstroom. the third scenario estimated the economic impact of a move away from full-time contact study on campus towards online learning. in all three scenarios, the direct, indirect and induced impacts were assessed. the findings from the analysis (which took the form of student surveys) showed that students spend locally, that is, in the host city of potchefstroom, with the result that the direct impact is largely felt in the economy of potchefstroom. the indirect and induced impacts, on the other hand, extend further afield into the surrounding region. scenario 1: status quo this scenario assumes that the status quo in terms of growth in student numbers will continue until 2022. the average annual growth in first-year admissions on the campus between 2010 and 2017 was 195 students. this has resulted in an increase in first-year admissions from 3480 in 2010 to 4842 in 2017. the same rate of growth up to 2022 will result in approximately 5815 first-year students. it is assumed that student spending patterns will remain in line with the student survey results from 2016. the market size of first-year student spending by 2022 will be approximately r46.9 million. the economy-wide impact of spending by 5815 first-year students in 2022 is illustrated in table 3 column a and b. the table shows the gdp and employment benefits per sector. table 3: first-year student spending patterns, 2016. scenario 2: free education in 2018, first-year students are allowed to study for free if their household income is below r350 000 per annum (approximately r29 000 per month). there was a realistic chance that this announcement would result in additional demand from students who fall within this segment of the market. this scenario estimated the economic impact on the economy of changed spending patterns by students as well as a proportional shift in the number of students towards an increase in qualifying students from lower-income households. the 2016 student survey captured the average monthly spend of first-year students, who totalled 4726 that year. table 3 illustrates the average monthly spending by students who fell within the 25th, 50th and 75th percentiles. the average spend value per month for students within the 50th percentile amounted to r3574. this is also the segment that is expected to benefit from the free education announcement. the impact assessment accepted that the total number of first-year students would continue to increase by 195 each year until 2022, while there would be a proportional increase (out of total new enrolments) of 5% per year in the number of students that benefit. figure 10 illustrates the changes in the composition of first-year students who are forecast to enrol at the campus between 2018 and 2022. figure 10: composition and monthly spending of first-year students, 2018‒2022. the number of first-year students is expected to increase from 5037 in 2018 to 5815 in 2022, which represents the same increase as in scenario 1 (195 per year), the only difference being a proportional change in the number of students who tend to have a lower spending value per month. the market size of first-year student spending is estimated to be r44.2 million by 2022. table 3 column c and d illustrate the economic impact of this scenario. scenario 3: distance education the third scenario considered a move to more distance-oriented education instead of full-time contact studies on campus. this scenario implied that the campus would attract a smaller number of first-year students annually as online study becomes more popular. the spending value of first-year students in this scenario, and its impact on the economy, is illustrated in table 4, column e and f. table 4: economic impact of first-year student spending, 2022. the three scenarios provided an initial indication of what the impact on the economy would be in the wake of changing student spending. the direct impact in all three scenarios would mostly be felt in potchefstroom, the host city of the campus. as expected, more spending on the part of students would be beneficial for the host economy, with the local and provincial economies likely to experience stronger benefits than the university itself. the results of the study indicated that the continued increase in the number of full-time first-year (contact) students would deliver the most significant economic benefit to the local and provincial economy. the nwu attracts a large number of students who reside outside of the province and their spending within the host city of potchefstroom is beneficial for the local economy. the implementation of the free education policy could be positive for the economy if it enables more people to attend the university as full-time contact students. in contrast, a move to online learning is the least favourable scenario for the local and provincial economies. conclusion given their high levels of expenditure on salaries, goods and services, universities in south africa have the potential to stimulate local and provincial economies. the purpose of this article was to highlight the economic significance of a south african university campus to the surrounding region and to quantify the impact of first-year student spending on the economy. the methodology used in the underlying study comprised surveys and impact modelling using sam analysis. a sam provides for the assessment of stimuli in the economy to quantify the direct, indirect and induced impacts. the potchefstroom campus of the nwu was used as an example. over the past decade, the potchefstroom campus has experienced growing numbers of full-time contact students, and the university’s expenditure has correspondingly increased during this period. this continued rise in both student enrolments and university expenditure has led to a positive financial injection for the host city and province, especially since a significant proportion of students at the university reside outside the province. among the results of the assessment was that for every r1 million spent by the university, a total of r1.81 million is added to production and four jobs are created throughout the provincial economy. campus expenditure has a major direct economic impact on its suppliers, which is expected to benefit the local economy. it is proposed that further research be conducted to determine if the direct impact is on the host city’s economy or more on the regional economy. student spending has a direct and significant impact on the economy and helps to boost gdp and employment creation within the province. the modelling exercise involving three different scenarios for student spending revealed that an expanding full-time (contact) student population is beneficial for the economy and should be encouraged at the nwu as many students come from outside the province to study at the potchefstroom campus. their spending is of major benefit to the provincial and local economy. if faced with a choice of how to help fuel the provincial economy, the university would much rather increase the number of students who qualify for free education than actively promote online tertiary learning as a contact learning substitute. the results of the study provide valuable insights for cities and provinces that have established new public universities. the establishment of the sol plaatjie university in kimberley and the university of mpumalanga in mbombela is expected to be an essential driver of the northern cape and mpumalanga provinces. as time goes by, as these universities expand their curricula and enrol more full-time students, the benefits will expand accordingly. in the face of a fast-changing higher education landscape in south africa, more in-depth research (of a quantitative nature) into the relationship between universities’ operations and local and regional economic development should be prioritised. this article has taken an important step in demonstrating that the value of higher education should be seen not only in terms of preparing young people for the workforce; it is also an important vehicle for economic growth and development at a local and regional level – an aspect that is not given sufficient attention by university administrations and municipal and regional governments. acknowledgements the authors acknowledge the support from the world trade organization and the national research foundation. opinions expressed and conclusions arrived at in the article are those of the authors and should not necessarily be attributed to these institutions. competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. author’s contributions d.d. formulated the main concept and did the original research. he conducted most of the research and wrote the original manuscript. he is an expert on the topic, and was a lecturer and doctoral fellow at north-west university (south africa). e.p.j.k. assisted in the development of the concept, interpretation of some of the empirical findings and the development of the manuscript. e.p.j.k. assisted in the writing and the finalisation of the article for publication. r.r. assisted with the sam modelling and interpretation of the results. funding the authors acknowledge the support from the world trade organization and the national research foundation. data availability statement data may be available from the authors on request. disclaimer the views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of any affiliated agency of the authors. references beck, r., elliott, d., meisel, j. & 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south africa), 2017, economic analysis: input-output tables, statssa, pretoria. statssa (statistics south africa), 2018, quarterly labour force survey. quarter 4:2017, statssa, pretoria. stewart t.j., prinzinger, j.m., dias, j.k., bowden, j.t., salley, j.k. & smith, a.e., 1989, ‘the economic impact of a historically black college upon its local community’, journal of negro education 58(2), 232–242. tavoletti e., 2007, ‘assessing the regional economic impact of higher education institutions: an application to the university of cardiff’, transition studies review 14(3), 507–522. https://doi.org/10.1007/s11300-007-0157-9 sajems ns vol 5 (2002) no 1 63 examining the crises in the food sector of nigerian agriculture richard i10rah school of economics and management, university of the north abstract food output in nigeria has deteriorated since the 1970s, whereas the population continues to grow. consequently, the country experiences a fall in per capita food production. grouping the country's food producers under four categories, this paper argues that production has remained a predominantly peasant affair, characterized by subsistency, inefficiency and low productivity. for a way forward out of the food crises, we introduce a theoretical model of the impact of policy mechanisms on agricultural output. we also look at the target group of the policy mechanisms. the paper concludes that to tackle the food crises, the country needs a radical approach to the problem, with emphasis on a total departure from its hitherto subsistence farming to a modem commercial farming. jelqis 1 introduction categories of staple food in nigeria range from root tubers (yam, cocoyam, potato and cassava) to grains (maize, millet, soyabeans, cowpeas, sorghum, wheat and rice). the above list is not exhaustive, though, as there are other staples such as beans, plantains, etc. the tubers as well as rice are produced mainly in the southern thick forest region of the country characterized by heavy rainfall, a long wet season and high humidity.the grains are produced in the northern savannah region that experiences low rainfall, a short wet season and low humidity. accurate measure of subsistence output (export and domestic commodities) in the country is very difficult, particularly in the case of domestic food commodities. in some cases where data does exist, it is recognized to be very unreliable. among the reasons for lack of reliable data on food output is the fact that the marketing of food is not as officially organized as is the marketing of cash crops (primary export commodities). data on food output is therefore based mainly on a national agriculture sample census that gives aggregate estimates based on rural household inquiries and on population r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 64 sajems ns vol 5 (2002) no 1 data which is also unreliable. interpretations of food crops output levels in nigeria should therefore be done with great caution. early studies on nigeria suggested that the annual growth rate of food output during the decades before the 1970s was generally higher than the rate of population growth. for example, during the period 1950-1957, food output grew at an estimated average annual rate of 6.7 per cent, whereas the annual growth rate of population was estimated at 2.5 per cent (olayide et at., 1982: 87). the annual growth rates of food output during the periods 1960-1967 and 1960/61·1970nl were estimated at 4 per cent and 3.1 per cent, respectively. the drop during the later period was presumably the result of the nigerian civil war during the period 1967-1969no (sano, 1983). the major imported food products were not close substitutes for domestically produced food products. in 1957, for example, among the major food imports were sugar, salt, wheaten flour and milk powder, all of which accounted for about 82 per cent of total food imports (teal 1983, olayide et al., 1982: 87). by the mid-1960s, the situation still remained more or less the same. imported food items (excluding sugar) constituted just about 3.1 per cent of the value added of domestic food production (lewis, 1967: ii). th.: imported food products during those years were considered as luxuries. their imports therefore did not reflect food shortages in the country. in other words, the imported food products were not necessarily the staples consumed by most nigerians. real stagnation in the output of food started in the 1970s. output declined at an estimated average annual rate of 4.3 per cent during the ftrst half of the decade. estimates by the world bank (1999: 25) revealed that during the period 19651997, agricultural value added (net output) grew at an average annual rate of 1.5 per cent,' and the total population at a rate of 2.9 per cent. even though in nigeria agricultural production includes not only food but also non-edible agricultural products (like cotton and rubber), both categories are produced by the same farmers using the same farming techniques and facilities. all indications are that nigerians, on the whole, were no better off in terms of per capita availability of food than they were in terms of per capita availability of non-edible agricultural products (todaro, 1994, chapter 9). in fact, the poor agricultural performance in the 19708 and through the 19808 and the 19908 would mean that the sector never really recovered from its decline during the nigerian civil war of the second half of the 1960s. while output of food declined, imports grew. the annual rate of growth of imports stood at about 14.8 per cent during the 1 970s. the imported food products were no longer just the so-called luxuries, but included even the basic food items such as yam, maize, rice, wheat and fats, all of which were formerly produced locally and in sufficient quantity for the local population. during the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 65 period 1970-1980, the import of food items such as rice and maize grew at an estimated average annual rate of about 50 per cent, with the growth rate in the second half of that decade having mostly accounted for the high estimate (fao trade yearbooks, various issues). a continuous food import, though, could not be sustained by the country's dwindling foreign exchange reserves. as oil (petroleum) revenue declined appreciably, so arguments for self-sufficiency and import bans gained upper hand. a ban on the imports of maize and rice was declared late in 1985 followed by more bans on the imports of wheat, stockfish, vegetable oils and day-old chicks (forest, 1993: 186). it became apparent that nigeria had descended into a food crisis, as both imports and the locally produced food decreased. the causes of the shortages were officially claimed to be drought related, among others. this paper examines the root causes of the ongoing food crises in nigeria. first, we look at the country's food production in terms of its characteristics and the categories of producers. we argue that food production by all categories is best classified as inefficient and that the country's food sector, in general, is a low productivity one. we argue further that with the continuously increasing population, and the decreasing output of food (a combination which reflects a fall in per capita food production), a more suitable policy should have to be developed to reverse the food output trend. we proceed to discuss policy interventions in agriculture, looking into issues such as why governments in some developing countries intervene in agricultural production. we also introduce a theoretical model of the impact of policy mechanisms on agricultural output. we also look at the issue of the target group of the policy mechanisms. we proceed to discuss the steps taken so far by the nigerian authorities to solve food shortages in the country. finally, we make a few recommendations in our concluding remarks. 2 food production in nigeria 2.1 main characteristics food production in nigeria is a predominantly peasant affair, the participation by government and some members of the utban elite in recent years notwithstanding. output development as from the 1970s onward has shown that agriculture in the country has not outgrown the type that is characterised as inefficient and of a low productivity that can barely sustain the farm population, let alone the burgeoning utban population. farming method is old fashioned and primitive. the main farming tools are hoes and cutlasses and, to a lesser degree, animals such as donkeys. the use of donkeys is most common in the northern r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 66 samms ns vol 5 (2002) no i part of the country where they assist in the tedious task of ploughing and tilling the soil. land is more or less fixed, labour being the only variable input. production is labour intensive. the use of machines such as tractors is rare for the main reason that the predominantly peasant farmers lack the resources to acquire them. the few non-peasant farmers who do use machines lack the knowledge for proper utilization of such capital machinery. these comprise rich businessmen, retired army officers and government officials, most of whom have taken up farming merely as a hobby or simply as a way of enhancing their position in the society. often, these farmers do not use the machines on large tracts of land and, as a result, such capital equipment is grossly underutilized. the use of fertilizers is also low compared to other countries with relatively developed agriculture. table i below compares nigeria to selected countries with respect to their use of agricultural inputs and their attained productivity levels. nigeria clearly stands out as the country that applies the least modern farming techniques in the form of machinery and fertilizer usage. its low level of agricultural productivity (also shown in table i) reflects the country's poor farming techniques and actually provides some insight into the economics of subsistence agriculture. farming characteristics in nigeria. in general, provide an economic rationale for the generally observed low agricultural productivity in most developing countries similar to nigeria where the sector is usually dominated by several fragmented small family farms (todaro, 1994: 305). table 1 agricultural inputs and labour produdivities in selected countries (1) (2) (3) country fertilizer agricultural agricultural consumption machinery productivity (hundreds of (tractors per logo (agricultural grams per hectare agricultural value-added per of arable land) workers) 1994worker) 19951995-1997 1996 1997 antentina 254 190 13833 japan 4168 593 28665 malaysia 6375 23 6267 nigeria 68 i 541 usa i 134 1452 34727 notes: (i) fertilizer consumption measures the quantity of plant nutrients used per unit of arable land. fertilizer products cover nitrogenous potash and phosphate fertilizers. (2) agricultural machinery refers to wheel and crawler tractors (excluding garden tractors) in use in agriculture at the end of the calender year specified or during the first quarter of the following year. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 67 (3) agricultural productivity refers to the ratio of agricultural value-added, measured in constant 1995 us dollars, to the number of workers in agriculture. source: the world bank (1999, world development indicators 28-32,124-31. 2.2 categories of producers producers of food in nigeria can be grouped under four categories. family members working in family-owned farms come under the fll'st category. in the christian/pagan south, farm labour under this fll'st category comprises male and female family members, but predominantly male family members in the muslim north. under the second category are part-time farmers who also work as hired labourers comprising mainly young men and, to a lesser degree, women. these farmers sell their services during peak seasons of ploughing the fields and harvesting the crops, when production requires far more labour than the average farmer-family could supply. food producers under the third category are the socalled self-proclaimed farmers comprising of urban businessmen, retired military officers and government officials. producers under this category claim to practise mechanized farming despite their lack of training for the task. these producers have access to credit and do actually acquire the necessary machines and other sophisticated equipment for mechanized farming. government-recruited farmers come under the fourth category of food producers in nigeria. these farmers receive wages to produce food in government-managed farms such as the farm settlements and plantations that are scattered all over the country. usually, the government farms receive priority over other farms during the allocation of the agricultural share of federal budgets. all categories of farmers in nigeria have a common feature: their progress and sustainability are marred by low productivity. table 2 below shows the situation of agricultural labour force and output for selected years, 1960-1998. the table reveals that in spite of the fact that the agricultural sector accounts for most of the employment in nigeria, at least, until 1985, it accounts for a much lower share of the output long before 1985. such a trend reflects a relatively low level of agricultural labour productivity, which is common among many less developed countries (todaro, 1994: 283-4). the table also reveals a sudden increase in the sector's labour force in 1985. a severe drought in the country in 1983 and the subsequent food shortage as the aftermath forced many people back to the fanns. government-financed irrigation facilities were also rejuvenated during the period. as is revealed in the table, agricultural share of output during the period still reflected a low labour productivity though, despite the sudden attention to the sector. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 68 sajems ns vol 5 (2002) no 1 studies have also revealed that in tenns of land productivity, measured as tons of grain harvested per hectare of agricultural land, the nigerian situation is dismal compared to those of countries like japan and the usa, both of which practise mechanized fanning. back in 1985, when nigeria was supposed to be reaping the gains from its several rejuvenated irrigation facilities and other agricultural development projects, the japanese and usa land productivities were about 725 per cent and 600 per cent, respectively, that of nigerian land productivity (ibid: 289). the situation has remained dismal in nigeria even in recent years. during the period 1995-1997, the land productivity, measured as kilograms of grain per hectare, was 1191 compared to 1269 during an earlier period 1989-1991. that was clearly a decrease of 6.1 per cent in the later period (world bank, 1999: 129). table 2 output and employment in nigerian agriculture, 1960-1998 year percentage of labour output of agriculture force in a2riculture as percentaee of gdp 1960 80.1 65.1 1965 78.1 50.0 1970 75.2 41.0 1975 64.2 40.3 1980 60.2 29.9 1985 68.6 32.9 1990 43.0 36.0 1995 48.5 28.0 1998 47.3 31.7 source: undp, human development report (vanous issues); the world bank, 1999, world development indicators: 28-31; federal office of statistics (fos), national accounts of nigeria (various issues); oyejide, 1986: 37 nigeria has a vast amount of cultivable land estimated to about 72 million hectares, out of which about 34 million hectares were cultivated in the early 1980s (oyejide, 1986: 15, borah, 2000b). of the 34 million hectares cultivated, about 6.5 million hectares were devoted to grain production. about a decade and half later in 1995/97, the amount of land devoted to grain production has increased to about 18.1 million hectares (world bank, 1999: 125). despite this increase in land, the output of grain fell by about 6 per cent, and therefore exacerbated the food crises in the midst of a growing population. the poor output level reflects the retrogressive nature of the land under cultivation as a result of poor maintenance and under-utilization of production factors. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no i 69 farmers in the category of family-owned farms lack not only capital but also the necessary expertise required for modem agriculture. these farmers also lack other support services such as good roads and reliable transport services for easy access to the farms as well as to the marketing centres where their products are sold. their common mode of transport, at best, are bicycles and, in some areas, donkeys. at worst, they walk to the market centres carrying with them heavy loads of farm products. the whole exercise of bearing heavy loads and walking to the marketing centres affects the farmers' health, particularly since the trips are often long (up to twenty kilometres in certain areas) and tiresome. farmers' total work time (excluding leisure time) is therefore divided between actual working time (time spent working in the farms as well as selling fann products), and the time wasted because of sickness. poor health consumes time that should otherwise be spent working in the fanns. wasted work time impacts negatively on labour productivity (linder in king, 1980). physical health, it is argued, most clearly reveals the close linkage that exists between low levels of income and low levels of productivity in developing countries, since a worker's poor health can adversely influence his or her attitude toward the job and the people at work (todaro, 1994: 47). a worker has to be both physically and emotionally active in order to withstand the daily pressures of competitive work, or low productivity sets in. farmers in the hiied-iabour category lack motivation and the joy in fanning. they only engage in farming, albeit part-time, because of lack of alternative employments. underutilization of labour manifests visibly among farmers in this category. many of these farmers work much less than they should do. their participation in farm work is seasonal. they lack of alternative non-farm employment during off-peak seasons. yet, as late as 1978, of the total farmers in nigeria, only slightly above 50 per cent worked as full-time farmers. the rest worked either as part-time farmers or as farm labourers (fos, 1979: 11). these farmers' lack of motivation in subsistence farming became apparent during the oil boom years of the 1970s in nigeria, when they very quickly abandoned agriculture in search of urban jobs. when the boom phased out, many of them were reluctant to return to farming partly because of self-pride aggravated by their loathing for the farming profession, and also because many of them bad been absorbed into the country's expansive urban informal sector (comprising activities such as petty trading, carpentry, motor mechanics, bicycle repairs, etc). the nigerian urban informal sector is generally characterized by low productivity. reduction in hours put into several informal sector work by this group would most probably have a negligible impact on total output, since a great majority of them idle around city centres in disorganized fashion searching for potential customers. they could go for days and weeks without work, which is why occasionally, some of them rush back to the farms during peak seasons to sell their services for quick money. generally, food producers under the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 70 sajems ns vol 5 (2002) no i hired-labour category choose an in-and-out pattern of fanning rather than sticking to the profession as steady work. their attitude results from the fact that subsistence fanning is unattractive because of low standards of living that manifest in the form of poor health, low incomes and general poverty. other undesirable factors such as lack of credit facilities and the necessary support services also add to the disincentives. these fanners therefore would rather stay away from agriculture in favour of other activities including leisure; they are wary of being "trapped" like the full-time producers, many of whom are considered to have constant health problems. the self-proclaimed fanners in the urban elite category are neither trained as farmers nor is farming, in the real sense, a genuine passion to them. it is not a secret in nigeria that members in this group are proud of being called farmers, but they dislike farming. branded as "overnight" fanners by collier (1983: 212), these producers use farming as a camouflage to wash clean their ill-gotten money acquired through corruption and financial malpractices. in some sense, farming accords members in this group an illusive status in the society for "condescending" to food production that is a supposedly a peasant affair. most important of all is the access to land ownership which fanning guarantees them in their claim to produce not only food crops but primary export crops as well (i1orah, 2000a). according to the nigerian land tenure system, a local government has the power to grant customary rights of occupancy to any person or organization who intends to use the land for agriculture, residential and other purposes such as grazing (fabiyi, 1979). even with the easy access to facilities for modem farming enjoyed by the elite farmers, it is not uncommon to fmd that small fanners, particularly those in the group of family-owned farms who have little or no access to facilities, are relatively more efficient producers of most agricultural commodities in the country in terms of total factor productivity. the small fanners produce relatively more output quantity per hectare of cultivated land and at relatively lower costs. a normal situation according. to todaro (1994: 293), would be that large farms are lower cost producers than small farms since the large farms can take advantage of economies of scale, being exposed to farm tractors and combine harvesters as well as large tracts of land. in nigeria, the poor performance of farms run by the elite fanners reflects the poor utilization of productive fann resources. it also validates a popular belief that elite fanners value their modem agricultural facilities and the associated privileges not for their potential contributions to national agricultural output but rather for the considerable power and prestige that they bring. any significant contribution to food output made by this category of fanners is yet to be seen, despite their relatively easy access to land and credit facilities both from government sources and from private banks. compared to the small fanners, many of who lack access to credit facilities, because of lack of collateral r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vots (2002) no i 71 securities (ilorah, 2000a), the elite farmers have enjoyed credit facilities at very low interest rates. for example, it was not uncommon that they obtained credits at rates of usually not more than s per cent (collier, 1983: 212), which by nigerian standards is considered very low. the government-recruited farmers in the final category of farmers work in government-directed food farms and livestock units. these farmers receive wages above their marginal labour productivities, due to government subsidies. their overrated wages constitute high labour costs (a deterrent to factor productivity), not just to their employers, the government, but most detrimentally to peasant farmer-families who have to compete for hired labour during peak seasons. in view of the poor productivity of all categories of food producers in nigeria, coupled with the country's population, that grows above the natural rate, recording an average annual growth rate of 3 per cent during the period 19801997 (world bank, 1999: 43), the authorities should have embarked on a more viable agricultural policy to combat food shortages, particularly in the longrun. for example, they should have revived the agricultural potentials in the country by not only seriously looking into the plight of the country's devoted farmers in terms of their needs, but also by implementing adopted policies to satisfy the needs, such as: making credit facilities accessible, providing rural infrastructure (roads, transport system, water and health care services). providing safety and security in the farming communities, etc. they should also have stopped government's direct involvement in production since such involvement has mainly driven up production costs through inflated wages. most of these policies were adopted but were never implemented successfully. poor implementation of viable policies meant that the authorities rather resorted to short-run solutions for the food crises. they encouraged imports to fill the output gap between the burgeoning demand for food and the insufficient domestic supply. it turned out that imports became more of a long-run solution. the value of food imports peaked in 1983 when it accounted for about 20 per cent of total import value (forest, 1993: 187). even though a severe drought was recorded in the country in 1983, the share offood imports for that year was a staggering one compared to an estimated figure of about 8 per cent in the post civil war year, 1970, that also witnessed an increase in food import. among the increased imported food items that accounted for the increased expenditure on total food imports, were rice and maize both of which were formerly produced locally and in sufficient quantities for domestic consumption. for example, about 347 000 metric tons of maize and 543 000 metric tons of rice were imported in 1982 and 1983, respectively, compared to their import figures of 2000 metric tons for rice and 9000 metric tons for maize in 1970 (ibid.). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 72 sajems ns vols (2002) no i several other factors, apart from poor productivity, lack of proper implementation of policy and explosive population growth, contributed to food shortages and subsequently to the increase in food imports. first, at the end of the nigerian civil war in 1970, a great number of youths from the rural fanning sector, particularly those that had served in the military, abandoned farming. many of these youths who could not secure alternative non-farm jobs resorted to crimes, harassing and stealing from those who went back to farming, as well as from those that had continued farming even during the war. such criminal acts against farmers resulted in increased risk in farming, increased production cost, and in decreased incentives and output. second, having emerged from the civil war, the country, particularly the war tom eastern region (biafra), received generous quantities of foreign brands of food stuffs. for example, there were foreign brands of wheat, wheaten flour, non-fat milk, rice, frozen fish and meat, etc. these were donated by international bodies such as caritas international, red cross, and other international aid agencies. these food stuffs were meant to rehabilitate victims in the civil war affected areas. later imports of the same food items followed the ones donated by the international bodies. it became apparent that many nigerians had changed their tastes from the local staples to foreign ones. for example, imported rice, such as uncle ben's brands, was preferred to the locally produced ones. to make things worse for local food producers, the imported food items sold at relatively low prices compared to the locally produced ones. considering the high labour costs faced by local food producers, it was difficult for their products to compete with the imported food stuffs in terms of profitability. low food prices that were promoted by imported food also meant that the domestic price ratio between food and manufactured goods turned against farmers as prices of the manufactured goods were not equally low. incentives for serious farm work were therefore eroded for many farmers, and that encouraged further increases in food imports. apparently, the price of imported food did not remain low in the long run, particularly when the burden on foreign exchange reserves became overwhelming, placing strain on the balance of payments, and the country sunk deeper in debt crises. a third factor that contributed to food shortage were the droughts of 1973-1974 and a more severe one later in 1983. the drought incidents were the official version of the authorities to explain the food shortage and justity increased imports. with that kind of explanation, the government also attempted to justity expenditures on several of its projects, the majority of which have failed because of the involvement of and intrusions by its inefficient managers. an example was the expenditure on government irrigation projects, which were prioritized over all other agricultural-related expenditures, receiving over 47 per cent of federal expenditure on agriculture, under the revised third national development plan 1975-1980 (forest, 1980). the government irrigation projects are yet to bear fruits. the fact that droughtr ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 73 related incidence dictates, to a large extent, the perfounance of the country's agriculture demonstrates the overly precarious nature of that sector. fourth, the period 1973-1982/83 coincided with the oil boom when the international price of petroleum and related products soared to unprecedented levels. nigeria, being an oil producer, and therefore enjoying increases in international demand for its oil, experienced a tremendous influx of foreign exchange into the country. the local currency, naira, appreciated and encouraged more food imports. the naira recorded an appreciation of about 17 per cent during the period 1973-1980 (oyejide, 1986: 27; 1i0rah, 1999). the effect of exchange rate appreciation on the volume of food import was mostly felt during the period 1978-1982/3, when the import volume recorded an average growth rate of over 100 per cent compared to its level a decade earlier (f ao trade yearbooks, various issues). a more serious effect of the exchange rate appreciation was the decline in output and employment in the country's exports (particularly primary crops) and import-competing (food and manufacturing) sectors. the authorities resisted any devaluation of the local currency, naira, (ibrd, 1986:72), their main argument being that the naira exchange rate should adequately reflect the country's balance of payment position (oyejide, 1986: 27; 1i0rah, 1999). the fact was that the authorities had embarked on several excessively ambitious industrialisation programs, encouraged by the oil boom-related capital inflow and the overvalued naira, and had overlooked the consequences on the agricultural sector. apparently, the overvalued naira led to economic curruption, gross misallocation of resources, and widespread inefficiencies. a fifth factor that contributed to food shortage was the fact that the oil boom also gave rise to a general increase in the level of economic activity in the country, particularly in the services sector. founal sector wages, including those paid to workers in the government-managed farms, were adjusted upward. the most significant upward adjustment of wages during the oil boom-dominated years was ,the udoji award in 1975176, which granted workers wage increases of between 30 per cent and 131 per cent (imf, 1975: 319; norah, 1999). the response from the peasantry was to flee the rural sector and farming and head for the cities in search of better paid jobs. to meet the food demand of the increasing urban population, food imports were encouraged. the policy of encouraging food imports was sustained as long as the oil boom (the influx of foreign exchange) lasted. by the mid-1980s, a decline in the exchange earnings of the oil sector was beginning to be felt. the strong local currency, the naira, was also beginning to weaken against the us dollar and other major currencies, following successive exchange devaluations that intensified during the middle 1980s and afterwards, after much pressure on the nigerian authorities. the decrease in foreign exchange earnings coupled with the weakening naira meant that a change in policy over food imports (and imports in general) was inevitable. the authorities turned to a more protective r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 74 sajems ns vol 5 (2002) no i stance towards domestic food production. several reforms were introduced in the context of a structural adjustment program aimed at promoting market forces and private enterprise. for example, the federal and state governments were to completely withdraw their involvement in agricultural production. in practice though, they continued with their involvement indirectly through their officials who form part of the elite farmers. privatization of agricultural parastatals was launched, and agricultural input subsidies reduced. there was also an initiative to improve rurai infrastructure through the directorate of foods, roads and rural infrastructure. these efforts were merely initiatives that were never followed through and therefore never yielded positive results. no wonder the quantity of food output in the country has continued to fall short of local demand. 3 government policy interventions in agriculture 3.1 reasons for government intervention governments intervene in the affairs of their domestic agriculture for reasons that may vary from country to country. in some countries, government intervention is aimed at increasing and boosting the standard of living of the agricultural population. such intervention is not limited to developing countries, but occurs even in developed countries (deed, 1961). it is assumed that farm incomes fail to keep up with rising income in the non-agricultural sectors. the low levels of farm incomes, particularly in developing countries, manifest quantitatively and qualitatively in the form of inadequate housing, poor health, limited or no education, high infant mortality, low life and work expectancy, and a general sense of hopelessness (todaro, 1994: 38). it is also generally believed that agriculture is considered the financial responsibility of most less developed countries' governments and, hence, the intervention by those governments. such intervention is most visible in the marketing of export crops by government authorities who, by law, set the prices received by farmers, rather than let market forces of demand and supply determine producer prices (ilorah, 2000b). governments also intervene in an attempt to increase the degree of agricultural self-sufficiency, either replacing imports or adding to exports (ritson, 1978: 352). whether governments intervention in agriculture is aimed at income support for farmers, raising funds for the governments, or promoting self-sufficiency, the results of interventions should be seen as the ultimate criteria upon which the policy measures should be judged. unfortunately, most devices used by governments to raise farm incomes or to attain the other goals are, in fact, not r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 75 capable of meeting those objectives. not only are most of the policies unsuitable, but there is a chronic lack of devices for implementation even when the policies are suitable. policy devices are unlikely to fulfill the commonest subsidiary goals if there is no improvement in productivity and income distribution. 3.2 the impact of policy mechanisms a theoretical model we introduce a partial equilibrium model of agricultural trade based on ritson (1978). the model analyzes the impact of a policy mechanism that seeks to raise farm output in the form of increased domestic supply. it is assumed that an increase in output will increase farm revenue that will in tum boost incentives for more production. the model has some important limitations. it is concerned with the impact of government policies on the domestic market it does not show the corresponding adjustments in the world market. it is also strictly limited to the case where the country's exports or imports are insignificant in world terms, having no perceptible influence upon the world price of the product or products. we assume an open economy where the government regulates neither exports nor imports. we consider the product at a farm-gate stage in the production process. we therefore derive the demand curve from fmal consumer demand through the marketing process. see figure 1 as illustration. figure 1 the impact of policy mechanism on farm output price o q. quantity r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 76 sajems ns vol 5 (2002) no 1 the world price p w at the port of entry is directly competitive with the farm gate price of supplies from domestic sources. the horizontal line sf represents an infinitely elastic free-trade foreign supply curve of the food commodity. sb and db are domestic supply and demand curves, respectively. oqh of food is produced domestically, while obqe is imported. domestic producers receive the amount opwaob as revenue from the sale of their food product. the amount spent on imports, in tenns of domestic currency, is qhabqe. a good policy could shift the supply curve rightward to sn resulting in the following: a positive production effect, implying an expansion of domestic production from oqh to oqn; a positive revenue effect, implying an increase in domestic producers' aggregate revenue from op waqh to op wcq 0; a positive trade effect, implying a decline in resources spent on imports from abqeob to cbqeqn; and a positive consumption effect, implying an increase in consumption of domestically produced food. the decline in import qhqn is replaced by locally produced food product, and should be considered a positive effect, particularly if the locally produced food is of a better quality than the imported ones. in fact, we should expect a positive consumption effect as long as the locally produced food stuff fulfils the condition of a normal good. a steady increase in aggregate revenue of domestic producers will boost producer incentives and therefore promote a steady increase in local food production. with time, the country will attain self-sufficiency. the policy will be regarded as nationally worthwhile if, in the short-run, a valuation of the extra output, in the frrst instance obqd' exceeds a valuation of the extra resources spent on agriculture to shift the supply curve rightward. with a continuous improvement in production and an ultimate attainment of economies of scale, promoted by a sustainable good agricultural policy, the supply curve will continue its rightward shift to si, intersecting with domestic demand curve db at point b. at this stage the country attains self~sufficiency. the policy will be regarded worthwhile if a valuation of the entire output that replaces imports exceeds a valuation of the entire resources spent in order to attain a fmal equilibrium at point b. policies most likely to shift the supply curve in figure 1 rightwards are those directed towards improving agricultural productivity. prioritised areas to improve productivity should include the following: (a) proper agricultural research institutes that target the improvement of quality and quantity of local staples that thrive excellently in the local climate with respect to the soil texture and weather conditions, (b) promotion of large scale commercial food farms that emphasize the cultivation of specific crops on specific pieces of land. (c) proper land management through good maintenance. (d) promotion of the use of agricultural machinery (tractors, combine harvesters, etc.) and a proper training of potential users. (e) improved roads and motor transport to facilitate trips to r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no i 77 the farms as well as the market centres. (1) availability of water facilities, particularly in those areas most suitable for food production. (g) extensive campaign to encourage a more nutritious eating culture, particularly among the younger members of the population. (h) availability of credit facilities that are more easily accessible (in terms of location and collateral requirements) to all farmers. (i) subsidies on farm inputs such as improved food seedlings, fertilizers, etc. g) establishment of food producers' information centres. the information could come from farmers themselves concerning new discoveries in the production process which they may want to share with fellow farmers, or it may come from the authorities concerning new policies aimed at improving production. farmers are therefore kept well informed about new technologies, new improved seeds, market conditions, threatening diseases and parasites and methods of avoiding them, etc. a successful implementation of these policies will serve as an incentive and, with time, high and sustainable productivity will be achieved. 3.3 the target group of the policy mechanisms the main target group of the government support policy is more likely to comprise the few more prosperous farmers that are not very risk-averse. these farmers could easily respond to new farming techniques that are usually most favourable for large scale production. the primary goal of agricultural support policy is to raise farm incomes. from our theoretical analysis, farm income is a product of agricultural output and price. at constant output (product) prices, and with input prices that may be rising, partly as a result of the expenditure on research, and also as a result of expenditure on several other areas of infrastructure, small farmers, who actually make up the majority of total farmers, may not benefit from the project. not only do small farmers lack the willpower and the fmancial resources to respond to high risk new technological packages, but the new packages may result in serious income problems for the farmers, particularly if farm costs are forced up by the increase in output by large farms that enjoy economies of scale. large fanns that enjoy economies of scale, can more comfortably replenish their production factors even at increasing factor prices. channelling public funds directly to small farmers as a form of income support may not prove a better option in view of the fact that such a direct form of support may allow them to enjoy only a tolerable existence rather than being fully exposed to market forces. in other words, a direct form of income support may give false expectations concerning the long-run viability of small farms. survival' of small farms may therefore not be guaranteed by reliance on measures that improve productivity. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 78 sajems ns vol 5 (2002) no 1 4 government food promotion programs in nigeria the earliest significant food promotion program by the authorities in nigeria was the so--called national accelerated food production program (nafpp) in the late 1960s and the early 1970s. the program was encouraged by the world bank as part of its drive to promote integrated rural development in the developing countries (forest, 1980). the program aimed to raise productivity of farmers by introducing to them new technology and intensive project management. the introduced technology was in the form of fertilizers, insecticides, seeds, sprayers and tractor units, all of which were to be administered through the network of farm service centres. the farm service centres, which were under the control of several government ministries, were also to administer the necessary credit, marketing and extension services. the nafpp failed because it later turned out that very stringent conditions were required for obtaining the credits, and those conditions were very difficult, if not impossible, for most poor farmers to satisfy. the few elite farmers, who could produce the required collateral securities to obtain credit, were said to have employed the credit to secure for themselves large stocks of grains during harvests and thereafter large profits from seasonal price movements (ibid). in other words, the elite farmers paid less attention to using the credit for producing food crops. they rather bought already produced crops immediately after harvests at very low prices from numerous small poor farmers, who must sell to meet taxes, debt repayments, and expenditure on non-agricultural consumption goods. later, during off-harvesting seasons (for example, planting seasons) when market supply of crops was generally scarce, they released their accumulated stocks and made huge profits. the nafpp therefore failed mainly because the small farmers who were primarily responsible for production could not obtain credit, while the few elite farmers, who did obtain credit, used it for speculative purposes rather than for production. the official version claimed that the program failed because it lacked practical incentives to motivate farmers. government-owned food fanos and livestock units also performed very poorly, even though they had equal access to credit. most of them ended up sustaining heavy financial losses. a typical example of such government-owned farms were the cross river state model fanos, which were started in 1972. by 1977, the farms had acquired about 12 198 acres of land and developed about 3 167 acres. later, it was reported that because of excessive central control from the cabinet office, coupled with the inefficiency of undisciplined managers, the farms ran up a loss of over n850 000 in just a three quarter period in 1977 (ibid). the next food promotion program pursued by the authorities was operation feed the nation (ofn). the ofn was launched already in 1976 when the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 79 failure of nafpp had become obvious. officially, the ofn was to promote self-sufficiency in food production through labour mobilization and the supply of subsidized inputs such as fertilizers, seeds and pesticides. students were encouraged to start their first off-school jobs in government-owned farms. critics of the project condemned it as a publicity investment for the military government in power. they argued that the authorities mainly sought support from urban groups and students. the result was that while productivity was low, wages were high. according to sano (1983), the ofn failed not as a public relation enterprise but rather as a development strategy. apparently, the ofn was a government and students affair as far as peasant farmers were concerned. even the authorities later acknowledged in their official report (the green revolution, 1982: 8) that among the main causes of the failure of the program was that it was not geared to meeting the needs of small farmers. with the failure of the ofn, the authorities introduced yet another food promotion program called the green revolution. the green revolution aimed to achieve self sufficiency for the nigerian population by 1985. to that end, the agricultural share of government allocated resources was increased tremendously. sadly though, investments in government owned and managed projects (irrigation facilities, agricultural banks, food farms, roots and grain producing establishments, etc.) continued to be prioritized in government agricultural budget allocations. in other words, the government continued with its full involvement in production, implying that despite the disastrous results of their previous involvements, the responsible authorities refused to learn from their mistakes. funds provided for the green revolution were later, when the program had failed, officially conceded to have been appropriated, in excess of their absorptive capacity, to wealthy businessmen who pretended to be practising large-scale mechanized farming. the green revolution therefore failed because apart from being heavily politicized, and thus largely mired in political conflict, the resources were mischannelled. as soon as it became obvious that the green revolution has failed, the government introduced a number of reforms in 1986 under the context of a structural adjustment program (sap), with its emphasis on market forces and private enterprise. loans were granted by the world bank under stringent conditions which (in agreement with nigerian authorities) included that: federal and state governments withdrew completely from agricultural production; agricultural parastatals be privatized; subsidies on inputs be stopped; fertilizer procurement and marketing be commercialized; rural infrastructure be improved; agricultural development projects (adps) be promoted and given priority over exististing wasteful giant and difficult-tomanage projects such as the so-called river basin development authorities and large-scale irrigation projects. did the sap improve the production of food in r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 80 sajems ns vol 5 (2002) no 1 the country? the answer to that question requires a closer look at an important arm of sap, namely the adps, and at the contributions they had made. originated in the mid-i 970s, the adps were started as pilot projects to promote food production to a commercial level in the agricultural potentially rich parts of northern nigeria such as gombe, gusau and funtua. the period coincided with the oil boom in the country. the local currency was relatively strong and the country could conveniently afford surplus food imports. nigerians weu nourished at the time, albeit from imported food stuffs. a serious implication of running projects during the boom years in nigeria was that even weak projects were misinterpreted to be high performers simply because the oil-inspired booming economy with its spill-over effects protected most local establishments. poor performances by several projects went unnoticed. the adps were no exception and were disguised as a success story, at least for as long as the boom lasted. the misleading interpretation of the actual situation led to some financial support from the world bank that even encouraged the activities of the adps to be extended country-wide. their activities included input deliveries (particularly fertilizers at heavily subsidized rates), partnerships with chemical producing companies, development of improved breeds of seeds that could lead to large scale harvests, and provision of infrastructure and extension services. as soon as the oil boom and its associated spill-over effects had phased out, poor performances by the adps became more obvious, considering that the food crises resurged in the economy. a follow-up on the adps in the 1980s was based on strong tendencies for self-perpetuation, since the projects had created strong administrative, intellectual and material vested interests. there was no doubt among observers that the adps failed. according to forest (1993: 189), the reports on the gombe and funtua projects showed disappointing results. at best, the total grain in crop production, for example, in gornbe area, was only 35 per cent of what was anticipated. at the worst, there was no net increase in production generally. the failure of the projects was attributed to the fact that they neglected some of the core crops in the agricultural regions. the projects encouraged sole cropping even in the areas that have traditionally practised mixed cropping. in the process, production of crops such as maize and sorghum was promoted in gombe and funtua areas, respectively, while an important crop such as millet was neglected. unfortunately, even the promoted ones, particulaly sorghum, proved a total failure. critics of the projects concluded that their failure was due to the fact that farmers favoured mixed-cropping over sole-cropping that was promoted by the projects (forest, 1993: 189). the few beneficiaries of the adps were the so-called elite farmers that were recruited from urban businessmen, retired military officers and state officials, all of whom had access r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 81 to state and federal government credit. the losers were small farmers and the country's consumers in general. 5 concluding remarks considering the number of programs that have been introduced by the nigerian authorities to solve the country's food crises and the subsequent failures of each and every one of them, a radical departure from the old measures becomes necessary. the present mode of farming in the country makes the sector a very risky one. output performance is dependent on uncertainties such as the highly variable rainfall and a generally demotivated labour. in order to utilize its surplus cultivable land at full capacity, attain self-sufficiency as well as export quantity, the presently practised subsistence farming has to be replaced with a modem commercial farming. past government programmes to revive food production have failed mainly because of faulty implementation instruments. obviously, the choice is not between support for several small farmers who not only lack modem farming facilities but have consistently refused to abandon the old subsistence method, and support for few relatively large farms that are managed by few elites who are non-farmers by training. any support to either of the two is bound to lead to inefficient resource allocation, as was evident in the country. problems of food production in nigeria should be solved through a more radical approach that aims at totally restructuring agricultural policy. specifically, there should be measures directed towards reducing the number of farms and farmers, and increasing farm sizes. such measures will guarantee an increase in income, since the aggregate income of the sector is distributed among few individuals. increases in income will promote incentives among farmers to maintain a good standard of output in terms of quality and quantity. as a deterrent against possible unnecessary influx of youths into food production, the authorities should encourage an adequate and broadly based educational system. this is to be followed by incentives for firms to invest in agricultural regions so as to provide wider job opportunities for young people in the rural areas. the existing farmers with limited or no skills outside agriculture, and who are left outside the general provisions of social security and old age pensions, can continue to live on their farms, providing at least a minimum amount of food for their own needs, and often receiving support from their descendants. for a smooth transition from subsistence farming to specialized commercial farming, it is inevitable that the two shoul~ initially coexist. nevertheless, as soon as commercial profit becomes the criterion of success and survival, since farms should be encouraged to rely on economies of scale to reduce unit labour costs, subsistence farming disappears and specialized commercial farming takes r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 82 sajems ns vols (2002) no i over the full control of food production. in other words, fanners in the subsistence category are ultimately phased out. left behind will be professionally trained fanners to manage the fanns, using modern commercial fanning techniques. in the structural process, the government should implement pricing policies that reflect market conditions. the government should also tone down their involvement in direct production of agricultural commodities. this will lessen the risk of corrupt fanners, particularly the so-called ovemight fanners recruited from urban business people and other members of the elite. modern commercial farming requires three important factors, namely, cultivable land, capital and expertise. as we have mentioned earlier in a previous section, cultivable land is in abundant supply in nigeria. over the years, though, and following a continuous population growth, the land under cultivation has become severely fragmented. the result is that landholdings per family member has shrunk even from their original low levels. expansion of agricultural land to new virgin areas should therefore be promoted and fanners be encouraged to take risks. fanners should be encouraged to abandon, albeit gradually, the traditional technologies and crop patterns that are concentrated on small parcels of land. they should rather move to new technologies that promise higher yields on large land areas. for land under usage to achieve its full output potential, through efficient resource allocation, it is important that economics rather than politics be the driving force behind land tenure in general. agriculture as an academic discipline should be strengthened in the country's institutions of higher learning. awareness of the importance of commercial fanning, particularly food production, should be instilled in the minds of youths taking courses in agriculture. after successful completion of their programmes, the emerging fanners should be given fmancial assistance by banks to enable them to start their own farms. banks should be user friendly to emerging farmers, applying less stringent conditions when giving loans, branching out to the farming communities, and encouraging aggressive farming and output diversification. with time, discipline and perseverance, a good agricultural policy that is successfully implemented will bear fruit, and the country will not only attain self-sufficiency in food production, but will also have enough export quantity to complement the oil sector as a foreign exchange earner. references 1 coluer, p. (1983) "oil and inequality in rural nigeria", in ghai, d. and radwan, s. (cds.) agrarian policies and rural poverty in africa, international labour office, geneva. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 83 2 fabiyi, y.l. (1979) "land tenure reform in nigeria: implications of the land use decree for agricultural development", the jounal of agriculture, 1: 235-57. 3 f ao, un, trade yearbooks (various issues). 4 fos (federal office of statistics), (1979) nigeria rural economic survey 1978179 (consolidated results of rural household enquiries 197811979), lagos. 5 fos, national accounts of nigeria (various issues). 6 forest, t.g. (1980) "agricultural policies in nigeria, 1900-1978", in heyer, j., roberts, p. & williams, g. (eds.) rural development in tropical africa. macmillan, london. 7 forest, t. (1993) politics and economic development in nigeria, westview press, oxford. 8 green revolution (insurance against hunger) (1982) federal department of information, lagos. 9 ilorah, r. (1999) "petroleum and its consequences for prices, employment and wages in nigeria", south african journal of economic and management sciences, 2(1): 143-56. to ilorah, r. (2oooa) "a classification of different phases of development in the export sector of nigerian agriculture", south african journal of economic and management sciences, 3 (2): 245-72. ii ilorah, r. (2ooob) "explaining de-agriculturalisation in nigeria: theory and evidence", the south african journal of economics, 68 (2): 307-23. 12 ibrd (1986) trade and pricing policies in world agriculture, (world development report, part ii), the john hopkins press, baltimore. 13 imf report (1975) survey of african economies: nigeria, 6, washington d.c. 14 king, j.e. (1980) readings in labour economics, (edited readings with commentaries by j.e. king), oxford university press. 15 lewis, w.a. (1967) reflections on nigeria's economic growth, development centre, oecd, paris. 16 linder, s.b. (1980) "the increasing scarcity of time", in king, j.e. (oo.) readings in labour economics, oxford university press. 17 olayide, s.o., olatobusun, d. & essang, s.m. (1982) nigeria's foreign trade and economic growth, 1948-1964. nigerian institute of social and economic research, university press, ibadan. 18 oyejide, t.a. (1986) the effects of trade and exchange rate policies on agriculrure in nigeria, research report 55, international food policy research institute. 19 oecd (1961) trends in agricultural policies since 1955, development centre, paris. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 84 sajems ns vol 5 (2002) no i 20 ritson, c. (1978) agricultural economics (principles and policy), granada publishing, london. 21 sano, h-o. (1983) the political economy of food in nigeria, 19601982, scandinavian institute of african studies, uppsala. 22 teal, f. (1983) "the supply of agricultural output in nigeria, 19501974",journal of development studies, 19: 191-206. 23 todaro, m.p. (1994) economic development. longman, new york and london. 24 undp, human development report, (various issues). 25 world bank (1999) world development indicators, washington, d.c. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems 23-1_2020_contents.indd http://www.sajems.org open access table of contents original research modelling asymmetric relationship between exports and growth in a developing economy: evidence from namibia teboho jeremiah mosikari, joel hinaunye eita south african journal of economic and management sciences | vol 23, no 1 | a2905 | 25 march 2020 original research auditor independence and professional scepticism in south africa: is regulatory reform needed? michael harber, ben marx south african journal of economic and management sciences | vol 23, no 1 | a2912 | 26 march 2020 original research the limits of laws: traffic law enforcement in south africa sophia du plessis, ada jansen, krige 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research macroeconomic implications of uncertainty in south africa theshne kisten south african journal of economic and management sciences | vol 23, no 1 | a3350 | 18 february 2020 original research identifying regional trade potential between selected countries in the african tripartite free trade area lorainne ferreira, ermie a. steenkamp south african journal of economic and management sciences | vol 23, no 1 | a2936 | 19 february 2020 original research a systematic literature review of the implementation and evaluation of the jobs programme: a suggested framework for south africa rachéle paver, hans de witte, sebastiaan rothmann, anja van den broeck, roland blonk south african journal of economic and management sciences | vol 23, no 1 | a3049 | 25 february 2020 original research dimensions and indicators of non-profit financial condition: evidence from south african public universities mark bunting south african journal of economic and management sciences | vol 23, no 1 | a2974 | 11 march 2020 original research the influence of employee engagement on labour productivity in an automotive assembly organisation in south africa robert w.d. zondo south african journal of economic and management sciences | vol 23, no 1 | a3043 | 17 march 2020 original research how does bribery affect the wage performance of formal firms? instrumental variables and matching evidence from nigeria tobechi f. agbanike, george a. agwu, uwazie i. uwazie, kevin o. onwuka, lasbrey i. anochiwa, michael o. enyoghasim, anayochukwu basil chukwu, kalu e. uma south african journal of economic and management sciences | vol 23, no 1 | a3123 | 19 march 2020 1 12 20 35 48 61 78 87 vol 23, no 1 (2020) issn: 1015-8812 (print) | issn: 2222-3436 (online)south african journal of economic and management sciences http://www.sajems.org open access table of contents original research trust and perceptions of compliance, fairness and good faith in primary labour relationships lukas i. ehlers south african journal of economic and management sciences | vol 23, no 1 | a3353 | 22 june 2020 original research inclusive growth and wage inequality: the case of south african manufacturing exporters carli bezuidenhout, marianne matthee, neil rankin south african journal of economic and management sciences | vol 23, no 1 | a3014 | 27 july 2020 original research a critical analysis of the foreign services reportable arrangement provision of the tax administration act of south africa marlene oosthuizen, cara thiart south african journal of economic and management sciences | vol 23, no 1 | a3248 | 27 july 2020 original research investment in electricity distribution capital infrastructure in south africa: the role of regulation bongani khonjelwayo, thilivhali nthakheni south african journal of economic and management sciences | vol 23, no 1 | a3413 | 28 july 2020 original research the significance of performance appraisal for innovation, in selected south african organisations navin g. matookchund, renier steyn south african journal of economic and management sciences | vol 23, no 1 | a3272 | 12 august 2020 original research linking integrated reporting quality with sustainability performance and financial performance in south africa nadia mans-kemp, cornelis t. van der lugt south african journal of economic and management sciences | vol 23, no 1 | a3572 | 20 august 2020 original research online reputation, virtual experience and tourists’ revisit intentions. the case of vilakazi street tourism corridor in soweto freddy m. mgiba, norman chiliya south african journal of economic and management sciences | vol 23, no 1 | a3533 | 25 august 2020 original research non-technical innovation and entrepreneurship in project-based small service firms chen wang, yee lin lee, jeffrey boon hui yap, lincoln c. wood, hamzah abdul-rahman south african journal of economic and management sciences | vol 23, no 1 | a3498 | 27 august 2020 original research establishing the risk denominator in a sharpe ratio framework for share selection from a momentum investment strategy approach chris van heerden south african journal of economic and management sciences | vol 23, no 1 | a3467 | 31 august 2020 190 199 213 226 236 247 258 269 282 original research influence of moral intelligence, principled leadership and trust on organisational citizenship behaviour amos engelbrecht, karen hendrikz south african journal of economic and management sciences | vol 23, no 1 | a3429 | 21 september 2020 original research work-life balance, job satisfaction and retention: turnover intentions of professionals in part-time study judite adriano, chris w. callaghan south african journal of economic and management sciences | vol 23, no 1 | a3028 | 28 september 2020 original research the anticipatory psychological contract of management graduates: validating a psychological contract expectations questionnaire werner g. gresse, barend j. linde south african journal of economic and management sciences | vol 23, no 1 | a3285 | 26 october 2020 original research the influence of cognitive dimensions on memorable experiences within a marine tourism context altouise g. jonas, laetitia radder, marlé van eyk south african journal of economic and management sciences | vol 23, no 1 | a3579 | 27 october 2020 original research the relationship between managers’ goal-setting styles and subordinates’ goal commitment xander van lill, gerhard roodt, gideon p. de bruin south african journal of economic and management sciences | vol 23, no 1 | a3601 | 02 november 2020 original research micro-simulations of a dynamic supply and use tables economy wide leontief-based model for the south african economy kambale kavese, andrew phiri south african journal of economic and management sciences | vol 23, no 1 | a3431 | 20 november 2020 original research long-run performance of corporate spin-offs and sell-offs: evidence from the jse limited mitteran e. nkongho, daniel makina south african journal of economic and management sciences | vol 23, no 1 | a3683 | 07 december 2020 original research logistics performance as a mediator of the relationship between trade facilitation and international trade: a mediation analysis alassane d. yeo, aimin deng south african journal of economic and management sciences | vol 23, no 1 | a3453 | 08 december 2020 original research intention to quit in the financial services industry: antecedents and managerial implications bahia van der merwe, johan malan, ronel bruwer south african journal of economic and management sciences | vol 23, no 1 | a3710 | 09 december 2020 301 310 322 334 348 359 372 382 393 page ii of iii http://www.sajems.org open access table of contents original research assessing the asymmetric linkages between foreign direct investments and indigenous innovation in developing countries: a non-linear panel auto-regressive distributed lag approach benjamin azembila asunka, zhiqiang ma, mingxing li, oswin aganda anaba, nelson amowine, weijun hu south african journal of economic and management sciences | vol 23, no 1 | a3496 | 21 december 2020 research note on the mandate, ownership and independence of the south african reserve bank cobus vermeulen south african journal of economic and management sciences | vol 23, no 1 | a3416 | 24 august 2020 405 416 reviewer acknowledgement south african journal of economic and management sciences | vol 23, no 1 | a3933 | 20 december 2020 427 page iii of iii 112 sajems ns 11 (2008) no 1 viewpoints, perspectives or letters to the editor introduction to section in line with international trends, the sajems editorial board decided to introduce a section in the journal called: viewpoints, perspectives or letters to the editor. we solicit submissions to this section that comprise novel concepts, ideas, or even a dialogue with either the editor or an author of an earlier paper either in sajems or elsewhere. controversial perspectives are even welcome, as long as they are presented in a constructive manner. submissions to this section are likely to be shorter than a conventional manuscript, varying from 1 page to approximately 2 500 words. submissions, though not necessarily qualifying in terms of all the rigorous requirements of a fully fledged scientific contribution, will nonetheless have to be robust and well motivated, and should be of relevance to scientific discourse and humanity. we therefore see this section as an opportunity for senior scholars to provide insight into specific issues or ideas that are unlikely, or not ready, to take the form of a full scientific manuscript. we also see this as an opportunity for students and young scholars to share their research results from a less daunting (and belligerent) platform. also, as is the case in this issue, we would like to see interesting information and research results, which could spark further discussions, based on a small sample survey. i would therefore wish to extend an invitation to all our readers to submit shorter, focused, robust and well-articulated views, perspectives, comments, letters or papers to this new section. yours truly, steve koch editor: sajems sajems ns 11 (2008) no 1 113 rethinking asgisa and the rand exchange rate willem h boshoff department of economics, university of stellenbosch abstract the asgisa policy document identifies the exchange rate as one of the factors constraining accelerated growth in south africa. this note argues that currency developments do not translate into business cycle movements in the aggregate economy, and that a weaker exchange rate is less likely to boost either foreign investment or export performance in the face of regulatory uncertainty. the south african government has recently launched the accelerated and shared growth initiative (asgisa) aimed at raising the long-term growth path of the economy. the plan identifies several so-called “binding constraints” that are considered to be inhibiting the economy from rising to more elevated levels of economic growth. one such “constraint”, according to the asgisa policy document, is the “volatility and level of the currency” (republic of south africa, 2006). by including this issue, policymakers have signalled that fluctuations in the rand are considered significant to broader economic fluctuations in south africa. this research note questions such a conviction by offering evidence that currency fluctuations are not mirrored in the south african business cycle. nonetheless, proponents may argue that a weaker rand will stimulate particular sectors, mostly those that are export-oriented, while it will boost foreign direct investment (fdi). however, this note argues further that a weaker rand is less likely to generate sustainable improvement in either export-oriented industries or fdi in the absence of other reforms. the following sections consider these two issues in sequence. jel e32, f31, n17 1 there is no general co-movement between the sa economy and the rand proponents of the view that the currency is a “binding constraint” on growth rely on the effects of the 2001 rand depreciation, which fuelled exports and, perhaps more importantly, the subsequent deterioration in export performance as the rand appreciation gained momentum. however, this observation is not an adequate reflection of the larger body of empirical evidence. theoretically, currency developments should play an important role in south african industrial production as far as it affects exporters. research on the relationship between south african financial variables and the business cycle broadly confirm this. using a turning point cycle framework, similar to the one employed by the south african reserve bank (sarb) when dating the business cycle, boshoff (2005; 2006) illustrates the relationship between the exchange rate cycle and the industrial production cycle. table 1 reports the so-called concordance index (which can be interpreted as a correlation statistic) between these cycles for the period 1986–2004 (see boshoff (2005; 2006) for details). the table contains results for cycles in both the levels and the twelvemonth growth rate of industrial production, and considers a lagged concordance of either six or twelve months between the exchange rate and industrial production cycles: 114 sajems ns 11 (2008) no 1 table 1 concordance of south african exchange rates and industrial production concordance of industrial production with 6-month lagged exchange rate concordance of industrial production with 12-month lagged exchange rate exchange rate cycle industrial production (levels) industrial production (growth) industrial production (levels) industrial production (growth) real effective rand (growth) –0.22* –0.11 –0.11* 0.20 real rand-dollar (growth) 0.48** 0.09* 0.16* –0.18* * significant at 25% ** significant at 15% *** significant at 5% source: boshoff (2006) the table confirms that, for the sample period, there is a statistically significant lagged comovement between cycles in the exchange rate and the industrial production cycle. the evidence is particularly strong when the real rand/dollar exchange rate is used. appreciation phases in the currency therefore appear to have been followed by contraction phases in industrial production, while depreciation phases have resulted in expansions in industrial production. nevertheless, it is important to note here that, while there appears to be a consistent empirical relationship, the direction of causality is not necessarily clear. for example, if exports are invoiced in foreign currency, then exchange rate depreciation will not necessarily improve exports. the causality issue is not pursued further here (see du toit et al., 2002) and macdonald and ricci (2004) for a discussion of plausible causal linkages). how do these results compare when, instead of one output component such as industrial production, the aggregate south african business cycle is taken into consideration? table 2 reports the results when both the official sarb business cycle and the gdp growth rate cycle are used. table 2 concordance of south african exchange rates and the business cycle concordance of business cycle with 6-month lagged exchange rate concordance of business cycle with 12-month lagged exchange rate exchange rate cycle official sarb cycle gdp growth official sarb cycle gdp growth real effective rand (growth) –0.02 0.01 0.04 0.01 real rand-dollar (growth) 0.35 0.27 0.16 0.12 * significant at 25% ** significant at 15% *** significant at 5% source: boshoff (2006: 111) none of the results are statistically significant (even at very generous 25 per cent levels). this is not due to the specific lag order (six or twelve months), as the results are unaltered for alternative choices of lag order ranging from zero months to eighteen months (boshoff, 2006). also, the results are not different for cycles in the levels (instead of the twelve-month growth rate) of the exchange rate. the same conclusions are reached when the nominal sajems ns 11 (2008) no 1 115 rand-dollar exchange rate is analysed. figure 1 illustrates the lack of a consistent relationship by juxtaposing periods of acceleration and deceleration in gdp growth and similar upward and downward phases in the real rand/dollar exchange rate since 1995 (darker parts indicate upward movements). clearly, there is no strong correspondence between upward phases in the exchange rate (i.e. depreciation phases) and acceleration phases in gdp growth. national gdp growth does not respond to the long depreciation phase starting at the turn of the century, and accelerates only from 2002, when the depreciation phase culminated in a rand crisis at the end of 2001. furthermore, national gdp growth resumes acceleration towards the end of 2003, in the midst of a prolonged period of currency appreciation. figure 1 upswing and downswing phases in the real rand/dollar and gdp growth rate cycles, 1995-2004 source: adapted from boshoff (2006) all in all, there is evidence for arguing that, while the exchange rate is of great importance for certain sectors of the south african economy, currency developments do not translate consistently into lagged cyclical movements in the aggregate economy. this evidence is supported by more extensive research on the prediction power of various south african financial variables. the general conclusion is that other financial variables, including the yield curve, fare better than the exchange rate in predicting business cycle developments in south africa (moolman, 2003). these results are not unexpected. south africa is an increasingly services-based economy, with the services sector accounting for 78 per cent of real gdp growth since 1994. the entire manufacturing sector, in contrast, has contributed approximately only 16 per cent of growth since 1994, while the sector’s share of the total economy has continued to decline (du plessis & smit, 2006: 4). it seems misguided to argue that the exchange rate, a famously difficult monetary policy target, could be used to permanently raise south african economic growth. policy-makers should not be concerned about the performance of individual sectors, but should focus on overall economic performance. such a policy focus would prevent special interest groups from influencing policy-makers towards pursuing policies that do not reflect the realities governing the economic system (and such captured policy focus may even undermine the productivity of that system (see north, 2006 for a discussion). 116 sajems ns 11 (2008) no 1 2 a weaker rand is not a panacea – and exchange rate targeting is difficult the previous section argued that, historically, gyrations in the rand have not translated into concomitant fluctuations in the national economy. nonetheless, it could be argued that a weaker currency is important to export performance and may also boost fdi. the asgisa policy document implies that the rand has had a negative effect on investment: “[the currency is] overvalued in the sense that economic resources are diverted into narrow areas of investment, laying an unsteady foundation for the future” (republic of south africa, 2006: 4-5). this proposition is questionable. the above quotation supposedly refers to the lower levels of fdi, compared with portfolio investment flows. however, the conclusion in the literature (although tentative) is that exchange rate fluctuations play a much more pronounced role in the case of portfolio investments, while fdi flows depend more on the underlying structural parameters of the economy (du plessis & smit, 2006). more generally, the hypothesis that the rand is misaligning south african financial markets is less plausible. kantor and barr (2006) show that the overall impact of exchange rate fluctuations on the performance of the south african share market is “moderate”, noting that economic fundamentals drive returns in the long run. it is therefore not clear exactly which misalignment policy-makers are seeking to redress. the south african mining industry offers a useful example to illustrate that the exchange rate is not the true “constraint”, even in an export-oriented industry. the mining industry’s relatively disappointing performance over the recent upswing in the commodity cycle is only partially attributable to exchange rate fluctuations. instead, regulatory uncertainty and its significant costs appear to be the main sources of poor performance in the south african mining industry (the economist, 2006: 66). regulatory problems undermine the integrity of the institutional matrix of the economy, raising systemic risk and contributing to reduced investment. consequently, if it is the government’s aim to raise fdi or to boost export performance, it is the regulatory environment, and not necessarily the rand, that requires policy attention. furthermore, insofar as the rand does have a role to play, it is informative to consider the conclusions of du toit et al. (2002) who show that, at least since 1995, political risk factors appear to have offered at least a partial explanation for currency developments in south africa. for this reason, if policymakers are really concerned about the volatility of the currency, it is essential to reduce policy uncertainty. it is important to note that the inclusion of the exchange rate issue in the asgisa document implies that a “remedial” policy is being planned. however, there are two problems here. firstly, a policy response aimed at targeting the exchange rate is blind to south africa’s own historical experience, in particular, the sarb’s failure to manage the rand during the early and mid-nineties. du toit et al (2002) show that previous attempts at using exchange controls to stabilise the currency have failed. in fact, these authors argue that attempts to manipulate the currency increased financial market uncertainty and may have had adverse long-term consequences, resulting in an exchange rate that deviates even further from the level preferred by policy-makers. worse, when making statements about the value of the rand, policy-makers assume that they “know” the equilibrium value of the exchange rate. however, the latter continues to be a source of substantial disagreement among macroeconometricians (see macdonald & ricci, 2004: du plessis, 2005; macdonald & ricci, 2005, for a discussion in the south african context). in fact, frenkel (2007) provides econometric evidence that the recent appreciation of the rand is consistent with its past behaviour, noting that the evidence is not “in favor of the proposition that the rand was overvalued (as of early 2007) when judged by its own past relationship to economic fundamentals”. secondly, even if it is argued that policymakers should aim to reduce the volatility of the rand (kumo, 2006), such a policy response ignores the fact that the sarb has increased its sajems ns 11 (2008) no 1 117 involvement in the foreign exchange market in recent years. the sarb has been accumulating substantial foreign exchange reserves at a consistent pace since mid-2003, acquiring as much as $817 million in reserves in december 2006 alone (steyn, 2007). these purchases of dollar assets have continued despite the depreciation phase in 2006, indicating that the sarb may also favour a weaker currency. consequently, the empirical evidence does not support the assertion that the sarb is not concerned about the exchange rate or is unable to influence its evolution. it is not clear why policy measures are sought (and the current monetary policy framework questioned) when monetary policy, in its current inflation targeting form, allows ample room for the sarb to influence the foreign exchange market. in fact, given that the exchange rate has a strong lagged correlation with the inflation rate, the external value of the rand is an important variable when the sarb is forecasting the path of inflation and contemplating monetary policy reaction. 3 conclusion if asgisa is “a work-in-progress”, as parsons (2006) argues, it may be useful for future redrafts to exclude the rand as a “binding constraint”. the rand is an important variable in exportoriented sectors, but there are other policy variables that are of much greater importance to both the economy in general and exporters in particular, such as regulatory certainty and its associated costs, which reduce investment and growth prospects. in addition, it is highly probable that attempts to target the exchange rate will fail, as the monetary policy history of south africa and other countries suggest. it is encouraging that the asgisa policy document does identify the regulatory environment as another “binding constraint” (republic of south africa, 2006: 5). however, a future re-draft of asgisa should shift even more emphasis onto regulatory problems, issues that, arguably, represent the ultimate “binding constraints” on growth. references 1 boshoff, w.h. (2005) “the properties of cycles in south african financial variables and their relation to the business cycle”, the south african journal of economics, 73(4): 694-709. 2 boshoff, w.h. (2006) “the properties of cycles in south african financial variables and their relation to the business cycle,” department of economics. stellenbosch: university of stellenbosch. 3 du plessis, s.a. (2005) “exogeneity in a recent exchange rate model: a response to macdonald and ricci,” the south african journal of economics, 73(4): 741-746. 4 du plessis, s.a. & smit, b.w. (2006) “economic growth in south africa since 1994,” working paper 1/2006, stellenbosch, department of economics: university of stellenbosch. 5 du toit, c.b.; blackmore, f.; brink, s.m.; de wet, w.a.; harmse, c.; jordaan, j.j.; moolman, h.c.; schoeman, n.j. & steyn, f.g. (2002) “south african exchange rate policy dilemmas,” focus on economics issues, pretoria: university of pretoria. 6 frenkel, j. (2007) “on the rand: determinants of the south african exchange rate,” the south african journal of economics, 75(3): 425-441. 7 kantor, b.s. & barr, g.d.i. (2006) “the impact of the rand on the value of the johannesburg stock exchange,” journal of studies in economics and econometrics, 29(2): 77-96. 8 kumo, w.l. (2006) “macroeconomic uncertainty and aggregate private investment in south africa,” the south african journal of economics, 74(2): 190-204. 9 macdonald, r. & ricci, l.a. (2004) “estimation of the equilibrium real exchange rate for south africa,” the south african journal of economics, 72(2): 282-304. 10 macdonald, r. & ricci, l.a. (2005) “exogeneity in a recent exchange rate model: a reply,” the south african journal of economics, 73(4): 747-753. 11 moolman, e. (2003) “predicting turning points in the south african economy,” south african journal of economic and management sciences, 6(2): 289-303. 12 north, d.c. (2006) understanding the process of economic change, oxford, princeton university press. 13 parsons, r. (2006) “the accelerated and shared growth initiative for sa – will it make a big difference to economic policy and economic 118 sajems ns 11 (2008) no 1 performance?”address to the university of stellenbosch, 27 march 2006. stellenbosch. 14 republic of south africa (2006) “accelerated and shared growth initiative south africa,” pretoria. 15 steyn, g. (2007) “die rand: wensdenkery,” finweek, 18 january 2007 ed. 16 the economist (2006) “undermined: mining in south africa,” the economist. 18 november 2006 (ed.). sajems ns 11 (2008) no 1 119 call for papers: sa journal of economic and management studies (sajems)1 special issue: new frontiers in strategy guest editor johan hough (jhough@sun.ac.za) university of stellenbosch co-editors ernst neuland (mwneulnd@mweb.co.za) institute for business innovation marius pretorius (marius.pretorius@up.ac.za) university of pretoria paul sulcas (psulcas@gsb.uct.ac.za) university of cape town submission deadline: september 15, 2008 a central focus of strategic management research and practice has been the development of concepts, models and tools to guide effective market-based, competitive strategies. today, however, strategists face mounting external pressures from increasingly mobile, influential, new media savvy and demanding stakeholders. these increasingly diverse and changing groups of stakeholders are having a greater impact on competitive and corporate level strategies and on the practices of strategic management. these influences no longer are localized in their impact. they are felt on national, regional and global levels. consequently, on-market strategies are being employed in an ever widening circle of market settings: agriculture, airlines, autos, bio-tech, chemicals, food processing, e-commerce, entertainment, natural resources, pharmaceuticals, retail, etc. trends of globalization of capital flows are increasingly expanding the influence of non-financial stakeholders (e.g., political, social, regulatory, legal) over company policy. these stakeholders also affect and shape performance expectations. in large public corporations, strategic plans are increasingly developed for consumption by non-market forces where the strategy discourse reflects non-market considerations. the time is ripe for an open and critical debate about the impact of strategies on strategic actions, competitiveness and performance. types of papers for this sajems special issue this special issue aims at providing an opportunity for debate on the above-mentioned and related topics. we invite papers, including case studies, with different theoretical concepts, frameworks and methodologies, both empirical and theory-building. as this topic lies at the intersection of several subject domains, papers can draw from several fields, such as strategy, innovation, international business, and technology. aspects of the phenomenon can also encompass other areas such as entrepreneurship, operations research, marketing, finance, hr and organisational behaviour. examples of sub topics that may be included in this sajems special issue this special issue seeks to explore themes such as the ones shown below. the list below is not meant to be exhaustive, and authors are welcome to contribute papers with other perspectives as well. • how can operational performance and benchmarking add to strategy implementation and competitiveness? • how to implement blue ocean strategies through effective leadership and teamwork 1 sajems is an isi accredited journal 120 sajems ns 11 (2008) no 1 • how can companies create and capture new markets by using strategic maps and other implementation tools? • why are companies considering the off-shoring and/or outsourcing of core functions that comprise a firm’s competitive advantage? • what role do emerging markets like south africa, india, brazil, china, etc and/or emerging market firms play in the global outsourcing/off-shoring phenomenon? • what precautionary mechanisms are being put into place to protect proprietary knowledge and capabilities of the firm to prevent the loss of future competitiveness? • what is the role of global mergers and acquisitions and strategic alliances to ensure sustainable competitiveness? • business ethics and corporate governance as part of organisational strategy • strategic planning in knowledge-based industries and ventures • ownership, management and operational issues in family businesses • issues of particular significance to the future of south africa including bbbee, hiv/aids, sme’s, triple bottom line guidelines and timeline for this sajems special issue all manuscripts should be prepared according to sajems “instructions to authors” appearing after the contents in a typical issue. please submit manuscripts (not under review elsewhere) in electronic msword format to sajems@up.ac.za. deadline for papers for this sajems special issue: september 15, 2008 decision on acceptances for this sajems special issue: march 15, 2009 abstract introduction theoretical context data and descriptive statistics econometric models results discussion conclusion acknowledgements references appendix 1 about the author(s) gracious nyoni school of economics and finance, faculty of commerce, law and management, university of the witwatersrand, johannesburg, south africa umakrishnan kollamparambil school of economics and finance, faculty of commerce, law and management, university of the witwatersrand, johannesburg, south africa citation nyoni, g. & kollamparambi, u., 2022, ‘rural-urban migration and the well-being of the migrant-sending households: an impact evaluation study’, south african journal of economic and management sciences 25(1), a4120. https://doi.org/10.4102/sajems.v25i1.4120 original research rural-urban migration and the well-being of the migrant-sending households: an impact evaluation study gracious nyoni, umakrishnan kollamparambil received: 12 apr. 2021; accepted: 11 nov. 2021; published: 29 apr. 2022 copyright: © 2022. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: rural-urban migration is largely depicted as a household survival strategy, yet rigorous quantitative studies to uncover its impact on the sending households is rare. aim: the study aims to assess the causal impacts of rural-urban migration on sending households’ economic and subjective well-being (swb). setting: the context of the analysis is south african rural-urban migration using the national income dynamics study panel data. methods: a range of methods are used to increase the consistency and precision of estimates, namely: ordinary least squares, fixed effects, difference in differences, difference in differences with propensity score matching and difference in differences with instrumental variables, controlling for pertinent issues such as fixed effects, self-selection and endogeneity. results: our econometric analysis reveals a positive correlation between migration and the swb of the sending household. this effect can be attributed to a range of factors discussed in the study, one of which is the positive association observed between the migration of a household member and the origin household’s economic well-being. this upswing in economic well-being is captured by increasing the sending household’s monthly income per capita and increased remittance inflows. conclusion: from our analysis, we can infer that the improvement in economic well-being offsets the psychological effects of separation, thus leading to the enhanced swb of the migrant-sending households in south africa. keywords: rural-urban migration; impact evaluation; internal migration; subjective well-being; remittances; south africa. introduction it is well accepted that rural-urban migration has formed part of south african households’ survival strategies (lehohla 2006), with an annual rate of urbanisation estimated at 2.1% (world bank 2019). despite removing the apartheid era movement restrictions (bouare 2001), rural-urban migration has remained circulatory due to many migrants preferring to retain ties with their households of origin (collinson et al. 2003; posel 2004, 2010). the nature and patterns of rural-urban migration in south africa is a relatively well-researched issue (kok & collinson 2006). however, studies on the consequences of this rapidly increasing migration are more limited in south african literature, and these studies focus on the impact of migration on the migrant itself. mbatha and roodt (2014) explored the labour market outcomes and found that migration improves the probability of employment. mulcahy and kollamparambil (2016) found that rural-urban migration in south africa decreased the subjective well-being (swb) of the migrant by 8.3%, possibly due to false expectations, increased feelings of isolation, and adapting to a new environment. as much as this is the only published study investigating the effects of rural-urban migration on swb in south africa, the sole focus of mulcahy and kollamparambil (2016) is on the migrant’s well-being. the decision to migrate is usually seen as a household survival strategy (lehohla 2006), and thus, focusing on the migrant alone does not provide a complete picture of the consequences of rural-urban migration. there is a gap in the literature that looks at the effects of rural-urban migration on the well-being of the sending households. the most documented channel in global literature, through which rural-urban migration affects the sending household, is remittances (brown 2006). there is a vast literature on remittances and how they possibly affect the sending communities in different country contexts (adepoju 2018; ajaero & onokala 2013; hefti 2003; nguyen, raabe & grote 2015; rempel & lobdell 1978). however, these studies are concerned with the impact of remittances on rural inequality and development and do not explore the impact of migration on the migrant-sending households themselves. nevertheless, some studies in various country contexts have shown that remittances play a significant role in migrant households’ economic well-being, with remittances used for daily transactions, purchasing land, sending children to school, and improving living conditions (semyonov & gorodzeisky 2008). in addition to improving the household’s economic well-being, remittances can also provide health benefits through better food habits and improved nutritional status (hadi 1999). however, both of the above studies investigating the effect of remittances are in the context of international migration instead of internal rural-urban migration (russell 1992; giuliano & ruiz-arranz 2009). in contrast, some studies show that reliance on remittances can have a negative impact on the well-being of the remaining households. kothari (2002:16) argued that the remaining households might become ‘vulnerable through lack of regular and sufficient remittances and other forms of support from those upon whom they are dependent in various ways but have moved away’. further, several migrants finance their migration through debt, leaving the sending household members under much financial strain due to the increased debt burden (dwiyanto & kebor 1997). rural-urban migration and receipt of remittances can also affect the well-being of the sending household through a residual psychological channel (nguyen, yeoh & toyota 2006). the knowledge of having a household member residing in the city could elevate the status of the household in the rural community, thus increasing swb. further, rural-urban migration’s psychological and social costs as family disruption and prolonged separation usually follow in the wake of migration is equally pertinent (byerlee 1974; lu 2012). depending on the social dynamics of the rural area, family life and gender roles are also shifted by migration (chant 1998). this shift adds to the household’s emotional and physical burden due to added responsibilities and diminished labour supply (taylor et al. 1996). this is more apparent in areas where agriculture is the main source of livelihood, and the left-behind families are left with additional agricultural & household responsibilities after the migration of family members (de haas & van rooij 2010). these studies make a valuable contribution to our understanding of the left-behind members of migrant households. however, they are not without limitations in terms of addressing serious methodological issues such as selection bias and endogeneity. moreover, the economic well-being perspective overlooks the psychosocial costs of rural-urban migration as migration often involves family disruption, reconstruction of household roles and prolonged separation (budlender & lund 2011; hall & budlender 2013; lu 2012). in a more recent study, ivlevs, nicolova and grahams (2019) investigate the effect of international emigration on the swb of the left-behind. however, the econometric methodology employed does not take into account issues of endogeneity. this paper aims to fill that gap by investigating the impact of rural-urban migration on migrant-sending households’ economic and swb. the contribution of this paper is two-fold. firstly, our focus is on the effects of rural-urban migration on the swb, household income per capita and remittances received by the rural migrant-sending household and secondly, we try to establish a causal effect through a quasi-experimental impact evaluation study design (gertler et al. 2016). the methodologies employed to root out fixed household-specific characteristics that might bias the results create a counterfactual against which the treated group can be compared and account for endogeneity and selection bias. for these reasons, this study is not only a significant contributor to south african literature, but through its methodological innovation and robustness, it improves upon the existing global literature on rural-urban migration and the sending households. theoretical context in the context of rapid urbanisation in africa despite high urban unemployment rates, todaro (1997) highlighted the role of expected income in driving household income strategy. remittance is the key channel through which the migrant continues to contribute to household income. various theories have been put forth to explain the motivations behind remittances (rapoport & docquier 2005). while altruistic motivation is put forth as one such theory, the circular migration observed in south africa (collinson et al. 2003; posel 2004, 2010) is testimony to the continued relationship of the migrant with the household of origin and therefore indicate contractual motivations such as exchange, insurance and investment as another strategic rationale for remittance. while it is acknowledged that economic factors fundamentally drive migration decisions in africa, byerlee (1974) has presented a theoretical framework that extended decision drivers beyond economic factors. apart from the economic costs and returns, he included ‘psychic’ costs and returns of migration in the schematic framework for analysing the migration decision in africa. the psychic costs, according to byerlee (1974), emanated from the ‘risks’ and ‘social adjustment’ arising from migration. while byerlee (1974) highlighted the ‘psychic’ effects of migration, his framework did not separate the ‘psychic’ effect on the migrant individual from that of the rural household. the current study argues that the swb effect of migration on the household of origin can vary from that of the migrant considering that there is less disruption to the social networks for the household as a whole, compared to the risks borne and social disruption experienced by the migrant individual. therefore, the household’s net swb returns from migration are likely to be higher than for the migrant. the contribution of this study is in attempting to quantify the net returns and test the postulation regarding the net swb returns to the migrant-sending household. the empirical literature has focussed on the economic benefits of migration and employment outcome for the migrant, and to a lesser extent, on the non-economic effects on the migrant in terms of mental/physical health and swb (mulcahy & kollamparambil 2016). the empirical explorations on the effects of migration on the rural household have focussed on the income effect through remittances. the current study extends the effect of migration on the swb of the migrant-sending household. data and descriptive statistics this study utilises the national income dynamics survey data, the only nationally representative individual-level panel dataset in south africa. the dataset contains numerous variables pertaining to migration, income, remittances and well-being in south africa. it is a sample of over 28 000 individuals in 7300 households (brophy et al. 2018). the survey has been conducted approximately every 2 years, starting from 2008, by the southern african labour & development research unit (saldru) at the university of cape town (brophy et al. 2018) and tracks individuals over time. we used all five waves in this study and restricted the age of sample members to those above 15 years. for the analysis, we restructured the dataset into a panel of households. in order to do this, we implemented a method developed by harris, collinson and wittenberg (2017) and harris (2016). they use a rule-based approach to define: [w]hen a given household may be identified as the same observational unit across any two consecutive periods when a given household can be identified to have dissolved after a given period, or when a given household can be identified to be newly formed, i.e. formed between the previous period and current period. (harris 2016:7) following wittenberg and collinson (2020), harris (2016) and harris et al. (2017), the study identified the same household across waves using two criteria: same dwelling unit across waves. there must be an overlap of residents. in order to track and allocate unique identifiers to households in the dataset, we needed to figure out when new households form and when existing households dissolve. with the help of a national income dynamics survey (nids) variable that indicates whether a sample member is a mover or stayer in the current wave, we identified individuals moving in and out of households. to identify dissolved households, variables were generated that identified ‘future movers’individuals whose status in the next wave is ‘mover’. individuals who stayed in the household after the current wave was identified and termed ‘future stayers’. these movers and stayers were counted in every household, and the figures therein were recorded. in the next wave, households that did not comprise at least one ‘future stayer’ were identified as dissolved households. the process for identifying newly formed households followed the same process. using the nids variable, ‘stayer’, we were able to identify individuals that had moved in the previous wave. we termed these ‘past movers’. individuals that did not move since the last wave were labelled ‘past stayers’. households that were comprised entirely of movers and new respondents were identified as newly formed households. households that were not comprised entirely of movers and new respondents (i.e. had at least one resident stayer) were tagged as continuing/surviving households. after successfully categorising households in the sample as continuing, newly formed or dissolved households, unique household identifiers were then constructed for each household depending on which category it fell into. continuing households were allocated their first-wave household id as their panel id. newly formed households took on the household id of the wave in which they were formed, for example, if a household were formed in the second wave, then its panel id would be its second wave household id. all migrants were then dropped from the sample to only remain with household members from the migrant’s origin rural-based households. this rule-based approach was then used to reconstruct the nids individual panel dataset into a household panel. using the newly constructed household panel, the households were divided into a treatment group and a control group containing migrant households and non-migrant households, respectively. survey participants were asked to answer the question, ‘all things considered, how satisfied are you with your life?’ respondents then ranked their well-being with a value between 1 and 10. these are the values used to compute the average swb of every household, which was used as one of the dependent variables. the second dependent variable, economic well-being, was denoted by deflated values of household income per capita. the ‘remittance’ variable was measured by the total remittances received by the sending household. based on dolan, peasgood and white (2008), variables with information about race, gender, marital status, health, employment, income, relative income, safety and remittance are included as control variables. variables about sanitation conditions are also included as control variables, as these are contributors to the swb of people (kollamparambil 2021). details about how these variables were defined are included in appendix 1. we defined a migrant as an individual who has not moved in the first three waves but has moved from a rural to an urban area between the 2nd and 3rd wave (i.e. has a nids migration status of ‘stayer’ for the first two waves and migration status of ‘mover’ for the 3rd wave). a non-migrant is an individual who has not moved at all in all five waves. consequently, this means that our treatment group was comprised of households where at least one member migrated from a rural to an urban area between waves 2&3, whilst the control group was made up of households in which no members migrated from a rural to an urban area in all five waves. since the research question is on the effect of rural-urban migration on the well-being of the sending households, urban inhabitants were dropped from the sample to focus on rural dwellers. individuals who engaged in all other forms of internal migration, namely rural-rural, urban-rural and urban-urban, were also dropped to isolate rural-urban migration. a glance at table 1 tells us that migrant households report lower average swb levels than non-migrant households before and after migration. the average household monthly income per capita for the non-migrant households is also consistently higher than that of the migrant households in both periods. this could indicate self-selection in our sample, where migrants from relatively lower-income and lower swb households choose to migrate in search of a better life in the city. this further highlights the importance of our econometric analysis that roots out these statistical issues. table 1: comparison of outcome variables across waves (panel sample). the average swb of the migrant households increases in the post-treatment periods. however, it seems that the swb of the non-migrant households also follows a similar trend, that is, an increase in the post-treatment period. this provides motivation for the use of econometric methodologies to specifically single out the effect of the migration of a household member on the swb of the left-behind. we also discover the same pattern in the change in monthly household income for both groups. both household types experience an increase in monthly household income per capita. however, there is a significant difference in the magnitude of these increases. the household income of the migrant households increases by 35.89% more than that of the non-migrant households. the migration of a household member does, therefore, result in a higher monthly household income of the migrant households. additionally, we note that even though, in our study, the non-migrant households are classified as households that do not have a household member who participated in rural migration, they still receive remittances from migration that happened prior to our study period. from table 2, we find that there are slightly more female migrants than there are male migrants. black africans also engage in rural-urban migration more than the other race groups. statistical analysis is still needed to uncover an unbiased effect of migration on monthly household income from remittances. table 2: characteristics of migrants. table 3 goes on to track the changes in education and employment of the migrant throughout the waves. in line with expectations, by 2017 (wave 5), 55.77% of migrants were employed. this is a significant improvement from the 30.67% of migrants that were employed prior to migration. it is also worth noting that in the second wave, the period before migration, the number of employed individuals in the treatment group had declined by 12.5%, perhaps indicating an economic shock that would later spur them to migrate to the cities in wave 3. table 3: changes in employment and education statistics of migrants throughout the waves. nevertheless, the number of the economically inactive migrant population is relatively high, even after migration. prior to migration, the economically inactive population was at 38.38%. by 2017, there was a slight decrease to 32.69%. these statistics support our view that the migration pool does not only consist of individuals seeking employment, but a significant portion of individuals are also migrating to the cities for educational purposes or other reasons unrelated to employment (kollamparambil 2017). table 3 also illustrates a continuous change in the educational outcomes of the migrant. in 2008, 10.19% of migrants reported that they had never had any schooling. by 2017, that number had halved to 5.79%. the number of migrants reporting high school education as their highest form of education also increases slightly over the years. the most significant change, however, can be seen in higher education statistics. by 2017, there was over a 20% increase in the number of migrants who reported having received some form of higher education, compared to the pre-migration period. the slight decrease in the number of migrants with only primary school education makes sense if interpreted together with the subsequent increases in secondary and higher educationas this suggests that some migrants are progressing through the educational levels. this also highlights that education is one of the primary motivators of migration in our sample. these discoveries have implications for how the sending household fares after the migrant’s departure. econometric models the effect of rural-urban migration on the sending households’ well-being is estimated using five methodologies; ordinary least squares (ols), linear fixed effects (fe) and difference in difference (did), difference in differences with propensity score matching (did-psm), and lastly, difference-in-differences with instrumental variables (iv-did). ordinary least squares ordinary least squares regression is a basic statistical method commonly used to estimate linear relationships between two variables (gujarati 2003). it is a naïve approach to impact evaluation, but it is included for comparison. our model took the following form: where y is the outcome variable (swb, monthly household income per capita, monthly household income from remittances) for household i. ‘rural-urban migrant’ is a dummy variable denoting whether a household has a migrant or not. the estimates produced by this model have to be interpreted with caution; not only does the model ignore the panel nature of the data, but it also does not consider the unobserved heterogeneity that might be present in the sample. furthermore, it does not accurately estimate a causal effect due to its inability to construct a counterfactual group. since our panel data follows a group of households over time, household fixed effects and time effects are present and might potentially bias the results. ordinary least squares alone cannot root out these effects. therefore a more robust approach is required. fixed effects the fixed-effects model roots out the household-specific effects that might be present in panel data. time invariant effects are eliminated in the fixed effects estimation. the model took the form: although fixed effects improves on the ols method, the model suffers from the same limitation: the absence of a counterfactual against which our hypothesis can be compared. another disadvantage is that the fixed effects model cannot estimate coefficients for time-invariant variables such as gender, which may be essential in determining well-being. as is the problem with many estimators, unobserved heterogeneity is also not accounted for. difference in differences an ideal experiment would be a randomised experiment. however, the closest we can get to that standard is using experimental data to emulate a randomised experiment. the difference-in-difference regression on the nids panel data is used to achieve that. as mentioned, the sample of households was divided into two groups, a treatment and a control group. the treatment group contained migrant households, and the control group contained non-migrant households. a dummy variable, ‘treat’, was constructed where a value of 1 denotes households in the treatment group, whilst a value of 0 denotes control group households. a variable, ‘post’, indicating treatment periods is also included, where a value of 1 is given to waves 4&5 (post-treatment periods), and a value of 0 is given to wave 3 (pre-treatment period). waves 1 and 2 were excluded in order to avoid averaging out the pre-treatment effects. the model took the following form: where y is the outcome variable; ‘treat’ indicates whether an individual is in a treatment or a control group, and ‘post’ indicates whether a wave falls in the pre-treatment or post-treatment phase. the value of the coefficient of the interaction term reflects the impact of rural-urban migration on well-being. difference in difference estimation helps us use the observational data to emulate a randomised experiment, thus reducing selection bias. however, for our did results to be meaningful, the parallel trends assumption needs to hold. in this context, this means that in the absence of rural-urban migration, the material and swb of both the treatment and control groups needs to follow the same path. table 4 shows that the assumption holds for all three of our outcome variables. the insignificant pre-treatment coefficients capture this. table 4: parallel trends test results. difference in differences with propensity score matching propensity score matching is a statistical method that aims to reduce bias by balancing covariates between the treatment and control group and aids us in creating treatment and control groups whose characteristics are as similar as possible. propensity scores for each household were created through logistic regression. this logistic regression estimated the conditional probability of a household being a migrant-sending household given a set of covariates (household size, the gender of household head, employment status, household income, average age, race, religion). upon creating propensity scores, observations were matched using the kernel matching algorithm. by utilising psm, we ensured that the pre-treatment characteristics of both groups were as similar as possible, thus reducing selection bias. any differences noticed between the two groups after successfully matching were then purely by chance and not systematic. this similarity in characteristics also means that these two groups will most likely follow parallel trends in the absence of rural-urban migration, thus fulfilling the assumption. after the successful matching, a did regression was run. difference in differences with instrumental variables endogeneity bias through simultaneity/self-selection is a serious concern when investigating the effects of rural-urban migration. lower subjective or economic well-being scores of the migrant’s origin household might have spurred a migrant’s decision to migrate. confounding factors might also bias our results and produce spurious results. other sources of endogeneity, such as measurement error and omitted variable bias, are likely to be present and need to be controlled for. neither of the models we have listed above sufficiently address this issue. as much as did and did-psm construct a counterfactual group, they also fail to deal with the critical issue of endogeneity and do not deal with the effects of unobserved heterogeneity. for this reason, we set out to utilise did with iv. the iv regression is a statistical method that allows us to get consistent estimates even in the presence of omitted variables. these consistent estimates can only be observed in the presence of appropriate ivs. good ivs satisfy two properties: instrument relevance: a good instrument should be correlated with the outcome variable. instrument validity/ exclusion restriction: it should not be correlated with any other determinants of the dependent variable. using these guidelines, we chose municipal gross domestic product (gdp) per capita as one of the instruments for the migration of a family member when investigating the impact of rural-urban migration on swb. the migration literature has well documented (hare 1999; parkins 2010) that migration decisions are often caused by push and pull factors in the origin and destination places, respectively. if a municipality has a low gdp per capita, this speaks to potentially low economic activity in that region, which might push residents to migrate to places where their economic well-being is secure. our second iv is the average yearly rainfall per municipality. weather shocks have been proven in international migration literature to be correlated with the decision to migrate (warner et al. 2012). in migration literature, worldwide, people tend to migrate from drier areas to areas with more favourable conditions (gray 2010; warner et al. 2012). rainfall is, therefore, a suitable iv for migration in our study as it is strictly exogenous and not correlated with any determinants of migration that we did not control for. it is only correlated with either subjective or economic well-being through the decision to migrate. furthermore, the first stage regression displays a strong positive and significant link between the migration of a household member and the quantity of municipal rainfall. therefore, this makes us confident in the use of average rainfall as an instrument for rural-urban migration. two-stage least squares were utilised in the iv regression. the first stage regression was run to estimate the impact of the ivs on the endogenous independent variable. the equation took the form: where ‘treatment’ is binary and refers to the migration of a household member and ‘instruments’ is municipal gdp per capita and municipal yearly rainfall. as our endogenous treatment variable is binary, instead of ols being utilised in the first stage regression, we use maximum likelihood logit estimation. the probability of treatment was then predicted from the first stage regression. in the second stage of regression, the predicted values of the probability of treatment is used as the treatment variable, as illustrated in the model below: results subjective well-being we first assess the results of the impact of migration on swb. the first three models displayed in table 5 depict the impact of migration to be consistently insignificant. however, after controlling for self-selection and applying a comparison group using did with psm, the relationship between the origin household’s swb and the migration of a household member is revealed to be positive and significant (treathh*post). this corroborates the descriptive statistics displayed in table 1. according to the did-psm model, the migration of a household member leads to a 0.32 increase in the sending household’s average swb. after controlling for endogeneity and confounding factors using did with ivs, the migration of a household member is seen to lead to a 0.59 increase in the origin household’s swb. evidently, in our previous models, simultaneity, measurement error, and omitted variable bias/ confounding factors were crowding out the effect of migration on the sending household’s swb. table 5: impact of migration on household’s subjective well-being. the increase in swb can be attributed to a variety of factors and channels. nguyen et al. (2006) argues that knowledge of having a household member residing in the city can lead to an increase in the origin household’s swb through a residual psychological channel. the presence of a city-dwelling household member might lead to an elevation of the sending household’s status in the community. as discussed in the literature review, family life and gender roles could experience a shift due to migration (chant 1998). this reconstruction of gender roles is likely to benefit the ‘left-behind’ women (yabiku, agadjanian & sevoya 2010). parreñas (2008) and yabiku et al. (2010) suggest that this may be caused by the women’s increased decision-making power and newly found autonomy due to their husbands’ absence. similar to the evidence provided by (cummins 2000), our regression results in table 5 consistently show a positive and significant association between income and swb. the positive and significant coefficient of the treathh*post variable in the iv-did model indicates a net positive swb benefit from migration on the migrant-sending household. as expected from the literature (kollamparambil 2021), our results show that being a black african household negatively correlates with swb. variables that have been proven in the literature to affect well-being are also shown to be consistently significant in our models. predictably, there is a positive correlation between health and swb. being religious is also significant and positive in four models, endorsing the numerous findings that depict a positive relationship between religious involvement and life satisfaction levels (ellison 1989; witter et al. 1985). an increase in household size also leads to an increase in well-being across all models consistently. this may be due to a more extensive support system for each household member, putting them in a position where they can better cope with the emotional effect of the migration of a household member (figley 1983). the result that the presence of streetlight electricity and a flush toilet is also positively correlated to an increase in swb is in line with existing studies (bookwalter & dalenberg 2004; kollamparambil 2021). income table 6 reports the impact of migration on household per capita income. while ols, fe, and basic did, estimations did not report a significant correlation between a household member’s migration and the sending household’s income per capita, the more robust did estimation after matching on observable covariates using psm and accounting for endogeneity yields a positive and significant relationship. this is indicative of the self-selection of migrants/migrant households into the treatment group and the presence of endogeneity through reverse causality. table 6: impact of migration on the sending household income per capita (log). a household member’s migration increases the household’s income by 11%, according to the psm-did, but the iv-did estimation indicates that the impact is lower at a 5% increase in the household’s income per capita. the positive effect of migration on income is heavily supported by research investigating the same relationship in other parts of the world (taylor & lopez-feldman 2010). there could, however, be two channels through which the per capita income of sending family increases. the main channel cited in the literature, through which the left behind’s household income increases, is remittances (byerlee 1974; todaro 1997). nonetheless, the household’s income, independent of remittances, can also increase due to the reduction in the household size (datta & meerman 1980). if the migrant was not the primary breadwinner of the house, his departure might increase the household’s income, seeing as there are fewer people to survive on a fixed income. as we have deciphered from the descriptive statistics displayed in table 3, 70% of migrants reported being unemployed or economically inactive in the period prior to migration. logically, the migration of individuals that fall within these brackets, unemployed and inactive in the labour market (afsar 2002; tsegai 2007), would leave the sending household economically better off, as there are fewer individuals to support on a fixed household income. once the migrant is settled in the city, the cash inflows from remittances would lead to further improvement in the sending household’s economic well-being. remittances next, we attempt to understand the impact of migration on the receipt of remittances by the sending household (table 7). ordinary least squares reports that the outmigration of a household member is significantly associated with a 0.5% increase in the value of the remittances received by the origin household. after controlling for household fixed effects by running the fixed effects regression, this figure shoots up to 1.23%. the did regression, which creates a comparison group, downsizes this increase to 0.75%. after controlling for self-selection using psm did, however, we get an insignificant result. controlling for endogeneity reaffirms the positive impact of migration on remittance receipt, highlighting that confounding factors confirm the results from the first three modelsthe rural-urban migration of a household member is correlated with an increase in the value of the remittances received by the sending household at 0.39%. table 7: impact of migration on the value of remittances received by the sending household. the increase in remittance inflows is not a surprising result, as the prospect of remitting is often a key element in the decision to migrate. hagen-zanker (2015) showed that the more integrated migrants are in the labour system, the more likely they are to remit. as we have deciphered from table 3, only 30% of migrants reported being involved in some type of employment in the period prior to migration, but by 2018 after migration, this number had increased to 56%, further improving the migrant’s chances of remitting. furthermore, (niimi, pham & reilly 2009) also provided evidence that illustrated how, among other things, the vulnerability of a migrant’s life at the destination, their link to relatives back home, and the time spent at the destination affect remittances. this evidence combined with the temporary migration pattern in south africa adds weight to the theory that migrants act as risk-averse economic agents and send remittances back to the household of origin as part of an insurance exercise in the face of economic uncertainty (niimi et al. 2009). discussion this study set out to investigate the association between the rural-urban migration of a household member and the subjective & economic well-being of the origin household. in a country where urbanisation is rapidly on the rise, it is of utmost importance that we understand how this inevitable process affects the population. as much as the south african literature on rural-urban migration is emerging, it often focuses on the migrant and ignores the migrant’s origin household (mbatha & roodt 2014; mulcahy & kollamparambil 2016). however, the research is often also conducted at an individual level. in global literature, there is a need for an empirically sound analysis on the effects of rural-urban migration on the sending households, which is what this study has successfully achieved. the results are based on five estimation techniques that increase precision and robustness and account for pertinent issues such as reverse causality and fixed effects. from the results laid out in the preceding section, we confidently conclude that rural-urban migration has a significantly positive effect on the swb of the left-behind household. this is in contrast to the migrant’s declining swb reported in mulcahy and kollamparambil (2016). a plausible explanation for improving the households’ economic well-being is increased monthly household income per capita and remittance inflows. our descriptive statistics reveal that most migrants in our sample migrate from their origin household to the city in search of either work or education. this suggests another channel, in addition to remittances, through which the sending household’s monthly income per capita increases. if the school-going, unemployed and non-labour participant household member migrates, then this would lead to an increase in household income per capita in the sending household. the household income that was previously used to cater to a relatively larger group would now be distributed amongst a smaller group, thus increasing the household income per capita. the increase in remittance inflows could result from the migrants’ integration into the labour market, as depicted by the descriptive statistics. there is also evidence that temporary migrants are more likely to remit as a form of insurance against economic uncertainty (niimi et al. 2009). this could be one of the reasons for the increase in remittances observed in our study, as south africa’s migration patterns have since been discovered to be temporary (posel 2004). conclusion the study has shown that the net swb returns to migration for the sending-household are positive, despite the negative swb effect on the migrant (mulcahy & kollamparambil 2016). by providing an in-depth econometric household-level analysis of the effects of rural out-migration on the sending household, we hope to have provided a much-needed viewpoint on the effects of rural-urban migration on the rural population. acknowledgements competing interests the authors have declared that no competing interest exist. authors’ 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well-being: average subjective well-being of all the household members, scale 1–10 household income per capita: log of household income divided by the number of members, deflated using 2012 values remittance: log of money received by household as remittance, deflated using 2012 values covariates treathh: 1 – if the household has an individual that has migrated from a rural area to an urban area between waves 2&3, 0 – if not post: 1 – if the wave is 3,4, or 5 and 0 – if the wave is 1 or 2 migration-1-household after migration of its member, 0 – otherwise female: 1 – female, 0 – male, household head marital status: 1 if the household head is married or cohabiting, 0 otherwise religious: 1 – if religion is of importance to the household head, 0 – otherwise health: 1 – if the perceived health status of household head ranges from excellent to fair,0 – otherwise employment: 1 – if the household head is employed, 0 – otherwise education: 1 – if the household head received at least matric level schooling, 0 – otherwise age: 1: 0–17 years, 2: 18–20 years, 3: 21–29 years, 4: 30–45 years, 5: 60 years and above for household head housing type: 1 – if the house is formal, 0 – if the dwelling is informal for variables; street light, refuse removal, electricity, flush toilet, and piped water: if the facility is present, 0 – otherwise safety: 1 – if the respondent reported feeling safe, 0 – otherwise abstract introduction literature review method discussion conclusion acknowledgements references about the author(s) anton grobler department of leadership and organisational behaviour, graduate school of business leadership, university of south africa, midrand, south africa yvonne t. joubert department of human resource management, faculty of the college of economic and management sciences (cems), university of south africa, pretoria, south africa citation grobler, a. & joubert, y.t., 2020, ‘the relationship between hope and optimism, ethical leadership and person-organisation fit’, south african journal of economic and management sciences 23(1), a2872. https://doi.org/10.4102/sajems.v23i1.2872 research project registration: project number: 001 of 2016 original research the relationship between hope and optimism, ethical leadership and person-organisation fit anton grobler, yvonne t. joubert received: 07 nov. 2018; accepted: 10 oct. 2019; published: 04 may 2020 copyright: © 2020. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: ethical leadership is viewed as a challenge globally, with person-organisation fit, as well as hope and optimism, being regarded as an essential element of employee well-being and, ultimately, productivity. aim: the aim of this study is to examine the relationship between the employees’ perceived ethical leadership in the organisation and the employees’ person-organisation fit, hope and optimism. setting: employees of 30 organisations in south africa were sampled and there were 1663 respondents. methods: a typical positivist methodology – based on an empirical approach, using a cross-sectional design and the quantitative analysis of the data obtained from the surveys – was utilised in this study. results: it was found that there is a strong, positive relationship between ethical leadership and hope and optimism (as a composite construct). it was further found that person-organisation fit mediates this relationship. conclusion: recommendations were made to enhance hope and optimism from an institutional (including human resources) as well as leadership level. recommendations were also made for further research. keywords: ethical leadership; hope; micro, meso, macro levels; optimism; person-organisation fit. introduction avey (2014) identified a gap in the psychological capital research (with hope and optimism being two of the four basic components), as he believes that there is a lack of research in terms of antecedents of psychological capital. positive organisational behaviour variables, like psychological capital dimensions (including hope and optimism), are often studied from an independent variable position; in other words, by studying their impact on other variables. avey (2014) identifies a need to study organisational as well as individual processes that contribute to psychological capital. by the adoption of the meso framework as conceptual framework, hope and optimism is studied as the dependent variable, with the impact of ethical leadership and person-organisation fit (and these in combination) as antecedents. the rationale for this approach is based on the notion that hope and optimism is regarded a state-like variable, which can be developed, and it is susceptible to environmental influences. not only does research on the antecedents of hope and optimism contribute to the academic body of knowledge, but it can also be used to develop strategies and actions to enhance hope and optimism in the workplace. consequently, the aim of this study is to examine the relationship between the employees’ perceived ethical leadership in the organisation and the employees’ person-organisation fit, hope and optimism. hope and optimism in the workplace (collectively referred to positive work expectations) is studied as a composite variable, based on the work of grobler and joubert (2018). they found that hope and optimism (originally two separate dimensions of psychological capital) loaded onto one factor, referred to as hope and optimism in this article. it is acknowledged that there are theoretical differences between the two constructs, and these will be discussed shortly, but the communality between them seems to resort in their expectancy of goal attainment. it is for this reason that the line of argument of this study is moved to hope and optimism as positive work expectations, instead of as separate and distinct constructs. this study is approached from a positively focused organisational perspective which is intended to foster the development of a holistic understanding of employee and organisational functioning (dawkins 2014), with specific reference to positive work expectations. it can be approached from the perspectives of two broad and distinct schools, namely positive organisational scholarship and positive organisational behaviour. positive organisational scholarship focuses on positive dynamics, processes and patterns that lead to organisational effectiveness (cameron, dutton & quinn 2003), and is thus on the macro level of an organisation. positive organisational behaviour, on the other hand, is the study and application of employees’ psychological strengths and capabilities that can be measured, managed and developed for enhanced performance in the workplace (luthans 2002). it thus represents variables on the micro (or individual) level of an organisation. the interaction and interrelatedness of the variables under investigation is conceptualised in terms of the macro, meso and micro hierarchical levels, in accordance with the so-called meso framework. ethical leadership, person-organisation fit, and hope and optimism are represented on the macro, meso and micro hierarchical levels. this study is thus based on multiple levels in terms of the interrelated conceptualisation, although the level of analysis is employee perceptions, with the level of measurement being the perceptions of the constructs on the three levels. the value contribution of this study is in terms of the model that is presented, indicating the role of ethical leadership and person-organisation fit in hope and optimism. this study can contribute on a practical level to identify and confirm variables that impact on hope and optimism, and to make practical recommendations to enhance hope and optimism (as it can be developed). this is important as hope and optimism has been found to be a predictor of employee wellness, productivity and satisfaction and so on, all contributing to organisational positivity and, from an interrelated meso approach, integrating the two schools of thought, namely positive organisational behaviour and positive organisational scholarship. literature review in these turbulent geopolitical and economic times, all countries around the globe find themselves teetering between fear and despair on the one hand, and hope and opportunity on the other. why is south africa a good example of this? the country experienced a turning point in its history more than 20 years ago – significant not only because it resulted in the first democratic election of a black majority government and because it marked the end of apartheid, but also because it initiated a paradigm shift for organisational leadership. in the intervening years, however, south africa has reached a state of crisis brought about largely by a shortage of good leaders, something that has become painfully evident since the 2017 cabinet rearrangement. added to this, recent incidents (within both the private and the public sectors) of leaders being involved in tax evasion, cadre deployment, money laundering, falsifying qualifications, and financial manipulation, to name just a few, have had a serious negative impact on organisational as well as individual well-being (grobler 2017). this runs directly counter to south africa’s need for ethical leaders who will render good service and to give the nation hope, rather than focusing on self-enrichment and power (reddy 2017). to illustrate the seriousness of the situation, it is noted that 22% of chief executives in south africa, compared to only 14% globally, are concerned about possible ethical scandals (city press 2018). in terms of hope and optimism within an organisational context, it was found in a study (involving 28 participating countries) that a total of 76% of the respondents are of the view that 2018 will be a better year than 2017. south africa is one of the most optimistic countries with 85% of the respondents expecting a good year. this could be due to the recent change in the country’s leadership and the promise of better economic prospects (lindeque 2018). hope (and optimism) is generally associated with the quality of leadership, according to shade (2001), while helland and winston (2005) comment that positive forms of leadership (including ethical leadership) inspire hope. the last mentioned are of the view that hope (and optimism), as a result of effective and ethical leadership, positively contributes towards the achievement of organisational goals, because they regard effective leadership as awakening hopeful thinking. ethical leadership is thought to be uniquely important because of the impact leaders may have on the conduct of (others in) the organisation (de hoogh & den hartog 2008). we argue that ethical leadership behaviour will contribute to employees’ optimism about their organisation and is mediated by their perceptions of fit within the organisation. to our knowledge, this has not yet been tested. we further believe that ethical leadership points organisational members towards mutual goals and objectives and guides them on this path, something that can only benefit the organisation, its members, stakeholders and society (de hoogh & den hartog 2008). moreover, through ethical behaviour, leaders reap the loyalty and confidence of their followers and this, in turn, leads to employees being more hopeful, optimistic and positive about their work and organisation. when leaders are unethical, and their moral integrity is in doubt, their followers will most likely not work towards achieving organisational goals. ethical leaders attempt to create just work environments, they care about their followers’ feelings and they strive to make fair choices. their followers are, therefore, expected to be optimistic and positive about their work situation and the organisation. positive and engaged employees with high levels of hope are needed in today’s extremely turbulent environment. organisations tend to be characterised by downsizing, relentlessly advancing technology, mergers, bankruptcies and an uncertain global economy (luthans & jensen 2002). luthans and jensen (2002) continue by saying that hopeful employees can cope and thrive in unprecedented environments and are effective performers in organisations. yet, despite this knowledge, limited attention has been paid to hope within leadership studies (helland & winston 2005). hope, like leadership, arises in relationships with others and involves dialogue regarding ultimate outcomes and future orientation and it is action directed to achieve goals (helland & winston 2005). leaders may have an impact on their followers’ optimism. it is argued that followers learn optimism from their leaders’ behaviour. the leader’s behaviour carries positive, consistent (and ethical) information and directs followers to develop a positive outlook on the future, which results in perceptions of optimism (lu, xie & guo 2018). people with an optimistic view believe that they will have a favourable and prosperous future (perera & mcilveen 2014) and such people will be engaged in achieving organisational goals (tuckey, bakker & dollard 2012). optimistic employees also experience workplace satisfaction, which means that they reach a state of work fulfilment and are able to cope with job demands (lu et al. 2018). however, according to peterson and seligman (2003), as well as luthans, youssef and avolio (2007), the role that leadership plays in building positive behaviour, such as optimism in the workplace, has been neglected in research. this study includes three variables, namely ethical leadership (on the macro level), hope and optimism (as part of psychological capital) (on the micro level) and person-organisation fit (on the meso level), which are discussed below. micro-meso-macro framework on organisational behaviour research before the variables are discussed, it is deemed necessary to provide a short introduction to the micro-meso-macro framework that is proposed as a conceptual framework to analyse and explain the interrelatedness of the variables. the discussion is focused specifically on the hierarchical nature of the interaction of the variables. the micro-meso-macro framework is based on the work of dopfer, foster and potts (2004) and elaborated on by dopfer (2005) and dopfer and potts (2008). they define three distinct levels of analytical structure which comprise the knowledge base of any economic (or organisational) system. connections can be established through the integration of the three levels (jeurissen 1997). house, rousseau and thomas-hunt (1995) regard this framework to be universal and applicable across disciplines and phenomena. it can therefore be utilised within the broad domain of organisational behaviour and is thus deemed appropriate for this study. the interrelatedness manifests itself in that the macro-organisational phenomena are influenced by individuals and groups, as individuals enact environments, and vice versa. conventional macro-organisational components (archetypally related to organisational behaviour) are organisational culture and climate, including leadership. the meso level (interactional) is concerned with at least two levels of analysis simultaneously, with one or more levels concerning individual or group behavioural processes, as well as one or more organisational processes, and the linking or bridging of the respective processes (house et al. 1995). it is aimed at synthesising the micro-organisational and macro-organisational processes. the micro level, within the organisational behaviour context and according to kyriakidou and özbilgin (2006), is all about individuals as the elementary unit of analysis, assuming fixed identities, interests, goals and preferences. it therefore represents individuals as self-subsistent entities. positive work expectations – hope and optimism (as micro level variable) two concepts that are arguably the most widely researched within positive psychology are hope (snyder 2002) and optimism (scheier & carver 1985). according to rand, martin and shea (2011), a person’s physical and psychological adjustment is influenced by the extent to which goals are attained, and it is for this reason that hope and optimism are considered as important elements of well-being in general. snyder (2002) depicts two notions for hope: firstly that hope is obtained when goals are met and, secondly, that hope is influenced by the perceived availability of successful ways to achieve goals. scheier and carver (1985), on the other hand, based optimism on the expectancy-value model of motivation. even tough expectancy varies from different goals. scheier and carver (1985) are of the view that people have a more diffuse sense of expectancy (also called optimism) about goals in their lives. therefore, optimism affects the situation-specific opinions people have when they are working towards a goal. optimistic people are inclined to expect a positive outcome no matter what the goal, whereas pessimistic people are inclined to expect a negative outcome. according to luthans, van wyk and walumbwa (2004), optimistic people are more satisfied, are motivated to work harder, persevere in the face of difficulties, have high levels of positive aspiration, see their setbacks as temporary, and analyse their personal failures. the basic difference between optimism and hope is that optimism includes expectancies about the outcome of a situation through forces and people outside oneself, whereas hope lies within the individual (snyder 2002). luthans and jensen (2002) continue by saying that, although optimism and hope share common perspectives regarding the importance of expectancies, and that both are goal-directed behaviour, the two concepts differ in expectancy. optimistic people believe that good things will happen, but they may lack the vital ways of thinking, such as generating the new alternative ways needed to overcome hurdles and to attain the goal. according to jahanara (2017) the differences between hope and optimism are that hope involves thoughts about an individual’s own ability to attain goals, as well as ways and motivation to use this ability to reach these goals. optimism, on the other hand, involves expectancies for outcomes in the future without the individual having control over the achieving of those outcomes. despite the differences, there are also similarities between hope and optimism. hope and optimism share a common element, namely the belief that goals will be attained (rand et al. 2011). these two concepts are traits that affect cognition about goals, positive and negative emotions, coping behaviours, well-being and goal attainment (jahanara 2017). both concepts emphasise the importance of goals and outcomes and assume that a person’s behaviour is motivated by goals. therefore, optimism is a goal-orientated belief that a positive outcome will be achieved for now and in the future, whereas hope closely resembles optimism in that it is a goal-directed cognitive belief based on ways to attain goals (luthans et al. 2007). in other words, an optimistic person has the willpower component of hope, but not necessarily the so-called ‘way power’ dimension of hope (luthans & jensen 2002). regarding the influence of the external environment (from macro and meso variables) on hope and optimism, seligman (2011) is of the view that individuals grow optimistic through learning from the environment. snyder (2002) further hypothesised that hope includes endurance and is based on continuous traits such as self-referential appraisals, as well as on situation-specific thought processes about a person’s ability to attain goals. meaning of ethical leadership people often ask ‘what is leadership?’ or ‘what characteristics does a good leader have?’. good leaders are not only competent, but also ethical in their actions (ciulla 1995). different authors outline characteristics and attributes that pertain to good leaders (toor & ofori 2009), such as integrity, trustworthiness, encouragement, character, altruism, honesty, collective motivation and justice (holder 2019; palanski & yammarino 2007; resick et al. 2006; toor & ogunlana 2008). however, studies have shown that there is more to leadership than merely attributes (toor & ofori 2009). kodish (2006) is of the view that leadership is a skill and not only the knowledge of theories. he continues by saying that it is the ability to act ethically and purposively in situations, based on experience, intuition, perception and the knowledge of universals. but what is ethical leadership? an interesting observation from kanungo (2001) is that ethical leaders refrain from behaviours that will cause any harm to others and are engaged in behaviours that benefit others. according to trevino and brown (2004), ethical leadership is the promotion of ethical conduct by consciously managing and practising ethics and holding every employee accountable for it. in this research study, we accept the definition of ethical leadership by brown, trevino and harrison (2005) who define ethical leadership as the demonstration of appropriate normative conduct through interpersonal relationships and personal actions, combined with toor and ofori’s (2009) promotion of such appropriate conduct to followers through decision-making, reinforcement and two-way communication. meaning of person-organisation fit previously, literature on person-organisation (po) fit focused more on outcomes in an organisation – such as the organisation’s culture, effectiveness and structure (schneider, smith & paul 2001). more recently, however, the focus has turned to outcomes for an employee, for example employee behaviour (arthur et al. 2006). person-organisation fit can be defined as the compatibility between employees and organisations that occurs when: (1) one entity provides what the other one needs, (2) similar fundament characteristics are shared or (3) both (grobler 2016; kristof-brown 2000). liu, liu and hu (2010) continue by saying that po fit is the similarity between the characteristics of the organisation and the employees’ personalities, compatibility of goals between the organisation and its employees and, lastly, the consistency between the organisation’s culture and its employees (grobler 2016). research has found that po value fit has an effect on the employees’ commitment, performance and satisfaction in an organisation (li 2006). pervin and rubin (1967) are of the opinion that employees who do not fit in their organisation experience feelings of anxiety and incompetence, while those who fit have fewer negative and more positive effects. posner (1992), on the other hand, found that po value fit relates to positive work attitudes. relationship between ethical leadership and psychological capital very little research was found where ethical leadership and psychological capital were studied. considerable research has been done specifically on authentic leadership and psychological capital. authenticity, viewed from an ethical perspective, means being true to oneself and keeping one’s word. being true to one’s word, especially when dealing with others, is an example of behavioural integrity (leroy, palanski & simons 2012). luthans and avolio (2003) consider authentic leadership as a construct that incorporates ethical and transformational leadership. the focus in this section is on the relationship between authentic leaders (which is closely related to ethical leadership) and psychological capital, due to the availability and relevance of such research. owens (2017) concluded from a study that there is a positive relationship between psychological capital and authentic leadership (r = 0.38). resilience, an element of psychological capital, had a non-significant but moderate-sized relationship with self-awareness, an element of authentic leadership (r = 0.31). there was a non-significant but moderate-sized relationship between the total scale of psychological capital and relational transparency, another element of authentic leadership (r = 0.33). hope, another element of psychological capital, had a non-significant but moderate-sized relationship with the total score of authentic leadership (r = 0.30). in a study done by du plessis (2014), it was found that there is a low correlation between the total scores of psychological capital and authentic leadership, with a common variance of 11.5%. she further found that there is a low correlation between the dimensions of authentic leadership and the dimensions of psychological capital. the relationship between optimism, an element of psychological capital, and the dimensions of authentic leadership, ranges from r = 0.13 to r = 0.16, which indicates a slight relationship between the two concepts. relationship between ethical leadership and psychological capital no previous research was found that studied the direct relationship between ethical leadership and psychological capital. related to psychological capital, it was found that there is a positive association between perceptions of ethical leadership and psychological well-being (bedi, alpaslan & green 2015). another study, conducted by yang (2013), concluded that ethical leadership indirectly influences an employee’s life satisfaction as well as their well-being. relationship between ethical leadership and person-organisation fit similarly to the previous section, very little research was found that describes the relationship between ethical leadership and po fit. related to ethical leadership, ambrose, arnaud and schminke (2007) examined whether the congruence between ethical values, a specific subset of values of the organisation and the values of the employee is associated with attitudinal outcomes. in this study it was found that the fit between an employee’s moral development and the organisation’s ethical climate relates to higher job satisfaction. it was further found that the fit between an employee’s moral development and the organisation’s ethical climate relates to greater organisational commitment. further, it was found that the fit between an employee’s moral development and the organisation’s ethical climate relates to lower employee turnover. valentine, godkin and lucero (2002) conducted a study on the relationship between ethical context, organisational commitment and po fit, using a sample of 304 employees. they concluded in their study that the corporate ethical values construct positively relates to po fit (p < 0.001). from the discussion about the relationship between the variables used in this study, it is clear that many untapped research opportunities exist, with specific reference to psychological capital as dependent variable. for instance, the need for future collective psychological capital research to consider not only the presence of various levels of analysis, but also the interaction across these levels has been identified (youssef & luthans 2011) and greater variance can be explained in dependent variables when psychological capital components are analysed individually (rego et al. 2010). multilevel research allows for consideration of the consequences of behaviours crossing organisational levels (for instance across levels). thus, a richer understanding of social phenomena, including collective psychological capital, can be developed by going beyond a single level of analysis. the model in figure 1 assumes a three-variable system, with two causal paths feeding into the outcome variable: the direct impact of the independent variable (path c) and the impact of the mediator (path b). there is also a path from the independent variable to the mediator (path a). figure 1: the model studies: the role of ethical leadership in hope and optimism, mediated by person-organisation fit. method research design a typical positivist methodology, based on an empirical approach and using a cross-sectional design and the quantitative analysis of the data obtained from the surveys, was utilised in this study. sample employees of 30 organisations in south africa were sampled, with 16 of the organisations being from the private sector, including the medical, engineering, retail, construction, financial, telecommunication, pharmaceutical and information technology industries. the public sector is slightly less represented with 14 organisations, consisting of national and provincial departments, as well as local government. in each organisation, 60 employees were randomly selected to participate in the study. there were thus, potentially, 1800 individual participants. the fieldwork was done by 30 co-researchers working on a larger project in the same industry and ethical clearance was granted by the university of south africa. there were 1663 valid responses (after deleting all missing values case wise), thus 92.38% of the potential sample. the mean age of the respondents was 38.51 years (sd = 9.39), and the mean tenure in the specific organisation 8.85 years (sd = 7.65). the assumption can thus be made that the sample is well representative of the general work force and that the participants, in terms of age and tenure, would be able to provide an accurate assessment of their perceptions of the constructs being measured. measuring instruments the respondents were requested to rate their executives’ perceived levels of ethical leadership and their own levels of po fit and hope and optimism. the three-factor ethical leadership questionnaire (elq) developed by de hoogh and den hartog (2008) was used to measure ethical leadership, the independent variable in this study. the first items relate to morality and fairness and one of the items reads ‘the leaders in my organisation deserves trust, can be believed and relied upon to keep their word’. role clarification leadership is the second factor and one of the items reads ‘the leaders in my organisation communicate their performance expectations for group members’. power sharing leadership, the third factor, is made up of items such as ‘the leaders in my organisation will reconsider decisions on the basis of recommendations by those who report to them’. this instrument was designed to elicit respondents’ reports of behaviour of leaders and uses a seven-point likert scale. de hoogh and den hartog (2008) reported cronbach’s alpha coefficients of 0.81, 0.88 and 0.78 for the respective factors in their study conducted in the netherlands. grobler (2017) validated the instrument for use in the south african context through three independent studies, and his results support the original conceptualisation and factorial composition, except for one item that loaded on another factor compared to the original model. he also reported cronbach’s alpha coefficients ranging from 0.82 to 0.95. grobler and joubert (2018) further reported that a second-order model with all 17 items loading directly on their respective factors (i.e. morality and fairness, role clarification leadership and power sharing leadership), which then contributes to a higher or secondary factor, namely ethical leadership, is the best-fitting model (χ2/df (409) = 5.11, cfi = 0.99, rmsea = 0.033). his study further yielded acceptable levels of convergent and discriminant validity of the instrument. person-organisation fit was measured using an instrument developed by cable and judge (1996). the initial instrument was multidimensional and consisted of three factors, with three items on each of the factors. however, grobler (2016) developed a reconfigured two-factor structure, still with all nine items. the first factor, supplementary fit (organisation fit as values congruence), consists of three items, with one of the items reading ‘my personal values match my organisation’s values and culture’. the second factor, called complementary fit (which includes needs–supplies fit, as well as demands–abilities fit), consists of six items. two of the items, by way of example, read ‘the attributes that i look for in a job are fulfilled very well by my present job’ (needs–supplies fit) and ‘my personal abilities and education provide a good match with the demands that my job places on me’ (demands–abilities fit). the instrument uses a five-point likert scale. grobler (2016) reported acceptable cronbach’s alpha coefficients (0.92 for supplementary fit and 0.89 for complementary fit) within the south african context. hope and optimism (as a composite variable) was measured with the psychological capital instrument developed by luthans et al. (2007) and validated by grobler and joubert (2018) for the south african context. in their study, hope and optimism manifested as a combined factor (consisting of seven items) within the overall three-factor structural configuration. this composite factor hope and optimism showed good psychometric properties (cronbach’s alpha coefficient of 0.85). typical items under hope and optimism read ‘i always look on the bright side of things regarding my job’ and ‘at the present time, i am energetically pursuing my work goals’. the instrument uses a six-point likert scale. statistical analysis the statistical package for the social sciences (spss version 25), supported by analysis of a moment structures (amos version 25), was used to analyse the data. the information regarding the distribution of the data was analysed by means of basic descriptive statistics, specifically the mean score as the precise centre of the amalgamated values and the standard deviation as the measure of variability. skewness and kurtosis were also calculated to investigate the distribution of the data. the critical values for these two statistics are 2 and 7 (west, finch & curran 1995). the cronbach’s alpha coefficient (α) was calculated to test the proportional variance error and the internal consistency of the instrument. a score of α = 0.70 or higher, is generally regarded as acceptable (clark & watson 1995). convergent validity was assessed by the composite reliability (cr) and the average variance extracted (ave), with critical values of 0.70 or higher and 0.50 or lower. the discriminant validity was determined by comparing the ave with the maximum shared variance (msv). discriminant validity would be confirmed when msv is less than ave and where the average shared variance (asv) is less than the ave (hair et al. 2010). due to the fact that the three variables used in this study are based on a common method, harmon’s single factor was used to assess the common method variance. it is one of the most widely-used techniques employed by researchers to assess common method variance (podsakoff et al. 2003). nevertheless, despite its popularity, podsakoff et al. (2003) are of the opinion that it is not the best solution to resolving common method variance. the harmon’s single factor technique makes use of an exploratory factor analysis that loads variables onto a single factor, which is constrained so that there is no rotation (eichhorn 2014). this new factor that has been created is not part of the final model and is developed for analysis purposes only. thus, once it has been assessed, it may be discarded (eichhorn 2014). after conducting a harman’s single factor test, a single factor should emerge from the factor analysis and, if it represents more than 50% of the variance, this may indicate that common method variance may be present (eichhorn 2014). correlations between the constructs were calculated by means of pearson’s product moment correlations. stepwise multiple regression analysis was used to determine the amount of variance explained by the ethical leadership construct in psychological capital when po fit is added to the analysis. the rationale for the inclusion of po fit is to determine whether it improves the model or not. the multiple regression was further utilised to determine the relative strength of the two independent variables in the prediction of the dependent variable, by studying the beta (β) values. the tolerance, as well as variance inflation factor (vif) values, were calculated to test for possible multicollinearity. tolerance is an indicator of the amount of variance not explained by the other independent variable in the model and should preferably be larger than 0.10. the vif, on the other hand, is the inverse of tolerance, and values should be below 10 (pallant 2013). it was further decided to use structural equations analysis (by means of structural equation modelling [sem]) in addition to the multiple regressions, as it presents some advantages over traditional multivariate techniques, according to haenlein and kaplan (2004). to analyse the model from a theoretical perspective, amos was used to perform the sem. to clarify the meaning of mediation, a path diagram was introduced as a model for depicting a causal chain. the basic causal chain involved in mediation is diagrammed in figure 1. to assess the model fit, several fit indexes were used, including the comparative fit index (cfi), the root mean square error of approximation (rmsea), chi-square (χ2) and the ratio of the differences in chi-square to the differences in degrees of freedom (χ2/df). given that there is no one acceptable cut-off value of what constitutes adequate fit, it was elected to evaluate each model and to recommend the model closest to the cfi value of 0.90, an rmsea value of 0.05 (byrne 2010). an analysis to determine whether the independent variable affects the dependent variable through a mediating variable (zhao, lynch & chen 2010:205) was conducted. mediation was assessed by focusing on the indirect effect of el on hope and optimism, by means of bootstrapping of the confidence interval (95% interval) as recommended by hayes and rockwood (2017). this procedure (as calculated by spss process) determined the indirect effect of ethical leadership on hope and optimism. the determination was made through the mediator (po fit) which quantifies the estimated difference in hope and optimism – which is caused by a one-unit change in ethical leadership – and where ethical leadership affects po fit and where po fit in turn affects hope and optimism (hayes & rockwood 2017). findings the descriptive statistics and the psychometric properties of the instruments are reported in table 1. table 1: descriptive statistics, cronbach’s alpha coefficients and the results of the convergent and discriminant validity analysis of the instruments. the descriptive statistics in table 1 show that the skewness and kurtosis values of the factors do not exceed the critical values of 2.00 and 7.00, which is an indication that the data is normally distributed. most of the values of the ethical leadership, person-organisation fit and hope and optimism constructs and sub-factors on the skewness scale were negative, which is an indication that the distribution has relatively few small values and tails off to the left. the cronbach’s alpha coefficients of the factors are acceptable if the guideline of α > 0.70 is applied. it would thus appear that the factors possess acceptable levels of internal consistency. all the factors met the conditions of convergent validity, with all cr values higher than 0.70 and the ave value greater than 0.50, with the exception of hope and optimism which reported a slightly lower ave value. evidence of discriminant validity was also found as all the ave values are larger than the msv values. in addition, and in support of the notion of discriminant validity, the asv values are also less than the ave. to investigate the relationship between ethical leadership, person-organisation fit and hope and optimism, a correlational analysis and a stepwise multiple regression analysis were performed. the strength and the direction of the linear relationship between the factors (and total score) of ethical leadership, person-organisation fit and hope and optimism are reported in table 2. table 2: correlation matrix of the factors and total scores of ethical leadership, person-organisation fit and hope and optimism (all correlations are significant at p ≤ 0.001). all the correlation coefficients reported in table 2 indicate a positive and statistically significant (p ≤ 0.001) relationship between the sub-factors of ethical leadership, person-organisation fit and hope and optimism. the purpose of this study is, however, to determine the relationship between main constructs and it is this relationship that will form the essence of the interpretation. hope and optimism correlates with ethical leadership with r = 0.39 and with person-organisation fit with r = 0.44 (p ≤ 0.001, medium effect). there is thus a medium strength, positive relationship or association between hope and optimism and both ethical leadership and person-organisation fit. to analyse these relationships further, a stepwise multiple regression analysis was performed. the results are reported in table 3 and table 4. table 3: results of stepwise multiple regression analysis with hope and optimism as dependent variable and the ethical leadership and person-organisation fit constructs as independent variables. table 4: the relative predictive strength of the ethical leadership and person-organisation fit (in terms of the beta values) on and hope and optimism, well as multicollinearity between them, by means of a stepwise multiple regression analysis. the stepwise multiple regression analysis yielded statistically significant results, with ethical leadership explaining 15% of the variance in hope and optimism (f(1, 1661) = 286.44, p < 0.001). with the addition of person-organisation fit, the model improves by 8% (total variance explained is 23%), with f(1, 1660) = 250.74 (p < 0.001). the results of the stepwise multiple regression thus support the research purpose as they show that ethical leadership and person-organisation fit combined explain a significant amount of the variance in hope and optimism. subsequently, to determine the relative strength of the independent variables (ethical leadership and person-organisation fit) in the prediction of hope and optimism, the beta coefficients (β) were determined. the results are reported in table 4. the tolerance value is 0.79 and the vif value is 1.27, indicating non-multicollinearity between the two independent variables, in this instance ethical leadership and person-organisation fit. thus, although ethical leadership and person-organisation fit are correlated (see table 2), they can still be used independently of each other with a substantial degree of accuracy. it was found that the best predictor of hope and optimism is ethical leadership (β = 0.23, p ≤ 0.001) with person-organisation fit (β = 0.33, p ≤ 0.001). one of the objectives of this study was to determine the possible mediating effect of person-organisation fit on the relationship between ethical leadership and hope and optimism. table 5 presents a summary of the mediation analysis. table 5: summary of mediation analysis with a bootstrap confidence interval of 95.00%, per sample of 1663. there was a significant indirect effect of ethical leadership on hope and optimism through person-organisation fit, ab = 0.10, ci [0.08; 0.21]. the mediator could account for roughly 38% of the total effect, pm = 0.38. finally, to confirm the model (as depicted in figure 1), a sem was conducted. the results indicated a good fit (χ2 = 1980, df = 446, χ2/df = 4.44, p < 0.001, ifi = 0.96, tli = 0.95, cfi = 0.96, rmsea= 0.046). this result supports the purpose of the research, as it was found that person-organisation fit causes mediation in hope and optimism and ethical leadership. person-organisation fit thus partially explains the relationship between the hope and optimism and ethical leadership and can be regarded as an intervening variable. ethical consideration ethical approval was obtained from the graduate school of business leadership, university of south africa, with ethical clearance number: 2016_sbl_001_ca, 2016. discussion ethical leadership is globally regarded as lacking, resulting in a plethora of negative outcomes, including feelings of hopelessness and pessimism. this study examines the relationship between the opposites of such shortcomings, namely the perception of ethical leadership (as macro variable) and optimism and hope (as micro or outcome variables). the study further aims to determine the mediating effect of po fit as meso or intervening variable. the decision to undertake this specific study and the variables selected was based on the premise that, through a positive perception of ethical leadership, employees will be loyal and will have confidence in their leaders, which will lead to such employees being more hopeful, optimistic and positive about their work and organisation. this study was approached from a multilevel perspective, more specifically from the micro-meso-macro framework. this supports the notion of dawkins (2014) who postulates that studies need to focus on the alignment between theory, conceptualisation and operationalisation of psychological capital (which consists of four general dimensions, including hope and optimism), through the utilisation of a multilevel approach. very little research was found that describes the relationship between the variables, although some were found in terms of related variables. examples are studies that reported a positive relationship between authentic leadership (which has an ethical component) and psychological capital and its dimensions. ethical leadership was found to have a positive relationship with psychological well-being and life satisfaction, which is related to psychological capital. ethical climate (which is related to ethical leadership) was reported to have a positive relationship with employees’ moral development fit and organisational commitment, and a lower employee turnover intention. ethical leadership, person-organisation fit and hope and optimism were measured with the elq (de hoogh & den hartog 2008), the po fit questionnaire (cable & judge 1996) and a section of the psychological capital questionnaire (luthans et al. 2007). ethical leadership consisted of morality and fairness, role clarification leadership and power sharing leadership, while person-organisation fit consisted of two dimensions, namely supplementary fit and complementary fit. the results of the correlational analysis indicated that a positive and statistically significant (p ≤ 0.001) relationship exists between ethical leadership (and its sub-factors), person-organisation fit and hope and optimism (medium effect). the multiple regression, with hope and optimism as dependent variable and the ethical leadership and person-organisation fit constructs as independent variables, yielded statistically significant (p < 0.001) results. it was found that the best predictor of hope and optimism is ethical leadership (β = 0.23) with person-organisation fit, β = 0.33 (both with p ≤ 0.001). ethical leadership explained 15% of the variance in hope and optimism and the model improved by 8% – 23% with the addition of person-organisation fit. the mediation analysis also yielded statistically significant results, accounting for a mediating effect of roughly 38%, thus the indirect effect of ethical leadership on hope and optimism through person-organisation fit. the model was further assessed by means of sem, resulting in a confirmation that person-organisation fit mediates the relationship between ethical leadership and hope and optimism. the value and contribution of this study is in terms of the model that was developed and confirmed. practically, this study contributes in terms of the identification and confirmation of variables that impact on hope and optimism in the workplace. these results could be used to make practical recommendations to enhance hope and optimism, which is regarded to be an important element of employee wellness, satisfaction, and so on. conclusion recommendations practical recommendations are formulated in accordance with the constructs’ measures, specifically ethical leadership and person-organisation fit (and its sub-factors), and the work of luthans and jensen (2002), luthans et al. (2004) and avey (2014). in line with the notion of role clarification leadership, and the nature of hope and optimism, organisational and personal goals should be clear, specific and challenging, with measurable targets. planning should be done in a participative manner, sharing ideas and ensuring that contingency plans or alternative pathways are in place as part of planning for ‘what if’ scenarios. continuous feedback should also be provided so as to ensure that employees see their role in and contribution towards the attainment of the goal. finally, opportunities should be created for rethinking the goals and plans and for the planning of alternative pathways. in terms of the institutional functions, interventions can be developed by the human resource development function on individual (employees, leaders, etc.) or team level, as well as at organisation level. general training of leaders and employees that is focused on the enhancement of employee psychological capital (and specifically hope and optimism) will improve not only leadership effectiveness, but also employee well-being, employee productivity and, ultimately, according to literature and various scholars, organisational performance. recommendations for leaders are to allow employees to participate in decision-making and goal setting, and to stimulate and encourage self-reflection. leaders can ensure that they obtain the necessary exposure (for instance through training, as well as coaching) in terms of different models of hopeful thoughts, and thereby build their capacity and ability to establish and institutionalise alternative ways. it is further recommended that additional research be conducted in terms of the determination of the relationship that other leadership styles and mediators have on hope and optimism, and also on psychological capital in general. it is recommended too that different methodologies be applied, for instance longitudinal and more qualitative research designs to study the causality of these relationships. limitations the limitations of this study are mainly in relation to the methodology used. the measures were based on self-reporting, which might contribute to common method bias. the harman single factor procedure was used to determine common method bias, but it does have limitations. this may be a reality, even with the assurance provided to participants during the briefing regarding anonymity and confidentiality. social desirability and subsequent response bias will always remain a concern and a limitation in studies such as this one, while self-reporting may be seen as a one-sided report from the respondents’ side. a further limitation of this study is the drawback of having used a cross-sectional design which might have artificially increased the relationship between the three components. acknowledgements competing interests the authors have declared that no competing interests exist. authors’ contributions both authors contributed equally to 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& m.f. steger (eds.), designing positive psychology: taking stock and moving forward, pp. 351–364, oxford university press, new york. zhao, x., lynch, j.g. & chen, q., 2010, ‘reconsidering baron and kenny: myths and truths about mediation analysis’, the journal of consumer research 37(2), 197–206. https://doi.org/10.1086/651257 abstract introduction literature review research methodology discussion of findings limitations and recommendations concluding remarks acknowledgements references about the author(s) lukas i. ehlers gordon institute of business science, university of pretoria, johannesburg, south africa citation ehlers, l.i., 2020, ‘trust and perceptions of compliance, fairness and good faith in primary labour relationships’, south african journal of economic and management sciences 23(1), a3353. https://doi.org/10.4102/sajems.v23i1.3353 original research trust and perceptions of compliance, fairness and good faith in primary labour relationships lukas i. ehlers received: 20 aug. 2019; accepted: 20 apr. 2020; published: 22 june 2020 copyright: © 2020. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: primary labour relationships (plrs) occur within supervisory relationships. previous studies confirmed that compliance, fairness, good faith and trust were interrelated facilitators of positive perceptions of primary labour relationship quality. many researchers regard trust as a primary requirement for effective implementation of formal and psychological employment contracts. aim: this study investigated the nature and direction of relationships between subordinate employee perceptions of the levels of compliance, fairness and good faith in plrs and levels of trust in plrs. setting: two interviewers adopted snowball sampling approaches to conduct structured interviews with 68 subordinate employees residing in gauteng, south africa. methods: the researcher adopted a mixed-method research methodology that included a thorough literature review, development of a structured interview, interviewing 68 voluntary participants and statistical analysis of data. results: confident conclusions were drawn and discussed, and related limitations were explained. specific recommendations for further research into the relationships and dynamics of trust-related phenomena in plrs were made. conclusion: it was confidently concluded that literature and empirical findings, jointly and separately, provided ample evidence of positive relationships between subordinate employee perceptions of the levels of trust and their perceptions of the levels of compliance, fairness and good faith in plrs. accordingly, it can be confidently expected that lower levels of trust will be related to lower levels of perceived compliance, fairness and good faith in plrs, and higher levels of trust will be related to higher levels of perceived compliance, fairness and good faith in plrs. causality was not investigated in this study. keywords: primary; labour; relationship; supervision; compliance; fairness; good faith. introduction background trust can simply be defined as the willingness of a relationship stakeholder (trustor) to rely on another relationship stakeholder (trustee) to behave in an agreed or expected manner. perceptions of trustworthiness can influence the trust relationship between trustors and trustees. a trustor will typically not expect exploitation by a trustworthy trustee, but will expect exploitation by an untrustworthy trustee (krot & lewicka 2012). trust is a fundamental requirement for effective human interaction, and has been described as the basic essence of social relations by firmansyah et al. (2019). these definitions and assumptions are generally applicable in most types of social relationships, including labour relationships (flanagan & runde 2009; grogan 2017; virues, velez & sanchez 2019). labour relationship trust is a complex and dynamic social phenomenon that entails far more than mere compliance with laws and formalised work regulations (searle & skinner 2011). perceptions of the levels of labour relationship trust are normally subjective and are thus related to a plethora of employer and employee expectations (williams 2007). these expectations are unique and typically informed by the trustor or trustee’s unique experience of societal variables that affect them (bendix 2015; randy 2010). numerous researchers have recommended further research into various aspects of trust in organisational and labour relationships (cropanzano, bowen & gilliland 2007; fawcett, fawcett & jin 2017; krot & lewicka 2012). a recent study confirmed that subordinate employee perceptions of the levels of trust, compliance, fairness and good faith in supervisory relationships are interrelated. it was concluded that these perceptions are strongly related to subordinate employee perceptions of the levels of relationship quality in plrs (ehlers 2017). unfortunately, the aforementioned study did not investigate the significance of differences between perceived levels of compliance, fairness and good faith in plrs with lower and higher levels of trust. no results of studies that specifically deal with relationships between subordinate perceptions of the levels of compliance, fairness and good faith and perceived trust levels in plrs, or supervisory relationships, have been published recently. there is thus a knowledge gap in this regard. research objectives this article aims to investigate the relationship between perceived levels of trust and perceptions of compliance, fairness and good faith in plrs. the researcher subsequently investigated the validity of the following research propositions, and related hypotheses: proposition 1: there is a positive relationship between subordinate perceptions of the levels of compliance and trust in plrs: h0: there are no positive relationships or significant differences as hypothesised. h1: there are positive relationships between subordinate perceptions of compliance and trust levels in plrs. h2: there are significant differences between subordinate perceptions of compliance levels in plrs with lower trust levels, and plrs with higher trust levels. proposition 2: there is a positive relationship between subordinate perceptions of the levels of fairness and trust in plrs: h0: there are no positive relationships or significant differences as hypothesised. h3: there are positive relationships between subordinate perceptions of fairness and trust levels in plrs. h4: there are significant differences between subordinate perceptions of fairness levels in plrs with lower trust levels, and plrs with higher trust levels. proposition 3: there is a positive relationship between subordinate perceptions of the levels of good faith and trust in plrs: h0: there are no positive relationships or significant differences as hypothesised. h5: there are positive relationships between subordinate perceptions of good faith and trust levels in plrs. h6: there are significant differences between subordinate perceptions of good faith levels in plrs with lower trust levels, and plrs with higher trust levels. definitions the following definitions were accepted for purposes of this article: labour relationship trust can be defined as the willingness of a labour relationship stakeholder to rely on another relationship stakeholder to behave in an agreed upon or expected manner (searle & skinner 2011). compliance refers to compliance with explicitly defined laws, contracts, objectives, policies and procedures that regulate labour relationship conduct (ehlers 2017; grogan 2014). fairness refers to even-handed exchanges in labour relationships. such treatment includes awareness, objectivity, equity, consistency and reciprocity (bendix 2015; ehlers 2017; venter & levy 2014). good faith refers to displays of interest, sincerity, respect, consideration and constructivity aimed at the creation of maximum labour relationship benefits for all (ehlers 2017; heap 2009; riley 2009; shimanskaya 2010). positive relationship means that an upward change in one variable is related to an upward change in another variable, irrespective of the causes of such changes. likewise, a downward change in one variable will be related to a downward change in another variable (cozby & bates 2015; cresswell 2014). perception refers to the process that individuals or groups of people use to organise and interpret their unique sensory impressions to give meaning to their social and physical environments (robbins & judge 2017). subordinate refers to an individual who performs work under instruction of another individual who is believed to be his or her immediate superior in some or other labour relationship (lian et al. 2014). overview the remainder of this article contains a literature review, a discussion of the mixed-method research methodology that was adopted in this study, a discussion of findings and an overview of limitations and recommendations of the study. specific findings are described in the concluding section of the article. literature review trust in labour relationships there are no laws that specifically require high levels of trust in labour relationships, even though trust is regarded as the foundation of labour relationships (williams 2007). labour relationship trust refers to the willingness of a vulnerable labour relationship stakeholder (trustor – very often an employee) to rely on a more powerful relationship stakeholder (trustee – very often an employer or employer representative) to behave in an agreed upon or expected manner (cropanzano et al. 2007; ehlers 2017). an employee will not typically anticipate exploitation by an employer when labour relationship trust levels are perceived to be high, and vice versa (flanagan & runde 2009; krot & lewicka 2012; linde, schalk & linde 2008; searle & skinner 2011). numerous environmental variables that reside in the formal and psychological dimensions of labour relationships can influence trust levels in plrs (cropanzano et al. 2007). trustworthiness perceptions of subordinates lay foundations for trust in plrs. mayer, schoorman and davis (2007) believe that such perceptions are strongly influenced by subordinate perceptions of the ability (skills, competencies means), benevolence (willingness to create benefits for subordinate) and integrity (predictability and reliability) of their supervisors. ehlers (2017) found that interrelated subordinate perceptions of the levels of trust, compliance, fairness and good faith in supervisory levels are strongly related to their perceptions of relationship quality in plrs. subordinate expectations, experiences and outcomes of previous trust exchanges will typically result in revised positive or negative perceptions of supervisor trustworthiness. these revised perceptions will then influence a subordinate’s willingness to trust a supervisor in future trust exchanges. subordinates of trustworthy supervisors are less likely to anticipate exploitation and could therefore be more willing to increase their trust in their supervisors. accordingly, subordinates of untrustworthy supervisors are more likely to anticipate exploitation and could therefore be less willing to increase their trust in their supervisors and may even have distrust in their supervisors (starnes, truhon & mccarthy 2016). coyle-shapiro and shore (2008) found that employees who are involved in organisational relationships with higher trust levels are more likely to put greater effort into their work and cooperate with their colleagues. they will also be less prone to displaying deviant workplace behaviours. joint development of procedures, transparency in decision-making processes, responsiveness and the equitable distribution of benefits and risks are typical characteristics of work relationships in which higher levels of trust reside (stern & coleman 2015). these characteristics are also closely related to certain behaviour forms that contribute to positive subordinate perceptions of the levels of trust, compliance, fairness, good faith and relationship quality in plrs (ehlers 2017). a climate of trust facilitates an open and constructive relationship interaction and can prevent minor differences from evolving into dysfunctional labour relationship conflicts. higher trust levels can also promote humane interpersonal relations in workplaces, and facilitate the effective prevention of inhumane, opportunistic and exploitative relationship behaviours (flanagan & runde 2009; williams 2007; kleptsova et al. 2018). employees who have low levels of trust in their organisations will typically put less effort into their work and will also interact less effectively with their colleagues. such employees will also be more likely to display deviant or undesirable workplace behaviours (coyle-shapiro & shore 2008; lian et al. 2014). at least five behaviour forms can be regarded as typical characteristics of labour relationships in which higher trust levels are evident. the absence of one or more of these characteristics will typically be related to less positive perceptions of trust in such relationships (ehlers 2017). the five key characteristics of trust in plrs are summarised in table 1. table 1: criteria for trust in labour relationships. compliance in labour relationships employers and employees are legally obliged to comply with all employment-related provisions of the constitution, common law and statutory employment laws. these sources of labour law, and related case law, promote and regulate legal compliance, fair employment practices, good faith, fair discrimination and the equitable distribution of benefits in employment relationships, among numerous other objectives. unreciprocated and charitable benevolence is, however, not an obligation of employers or employees under south african labour law (grogan 2014; viviers & smit 2014). additional formal guidelines, or control mechanisms, are typically introduced in labour relationships to ensure the effective and harmonious achievement of relationship objectives, and to reduce the risk of misinterpretation and labour conflict. such guidelines include labour relations vision and mission statements, objectives, strategies, policies and procedures (greenwood 2006; searle & skinner 2011; viviers & smit 2014). the various laws, contracts, policies and procedures that apply in labour relations establish clearly defined boundaries for relationship expectations and trust in such relationships, and should therefore be complied with by all relationship partners (nel et al. 2016; searle & skinner 2011; venter & levy 2014). lower levels of trust are typical of labour relationships where employees perceive the implementation or nature of rules and procedures of their employers as unjustified or invalid (linde et al. 2008; williams 2007). however, ongoing compliance with valid and justifiable work procedures can result in positive levels of trust, commitment, job performance and customer satisfaction, and subsequently reduce the risk of labour relationship tension, conflicts and grievances. compliance is strongly related to employee perceptions of procedural justice in their organisations, their identification with an organisation and their perceived sense of self-worth and job satisfaction. there is a strong relationship between positive employee perceptions of procedural justice, or compliance, and positive perceptions of organisational trust levels (cropanzano et al. 2007; holtz & harold 2009; patel, budwhar & varma 2012; seppälä 2012). positive employee perceptions of compliance are also significantly related to positive perceptions of primary labour relationship quality (ehlers 2017). in contrast, non-compliance with any source of labour law is a characteristic cause of perceived breaches of formal employment contracting expectations that typically result in numerous forms of relationship tensions, conflicts, grievances or disputes (grogan 2014; searle & skinner 2011; venter & levy 2014). positive perceptions of compliance in labour relationships result from active and justified compliance with numerous labour laws, contracts, policies and procedures. negative compliance perceptions may result from non-compliance with such formal directives (ehlers 2017). compliance can be assumed to be demonstrated in a labour relationship exchange when at least five interrelated compliance criteria are met. failure to satisfy any one or more of these criteria during relationship exchanges will strongly suggest that the behaviour was non-compliant, non-compliance will typically have a negative effect on compliance perceptions in plrs (ehlers 2017). the five criteria for assessing compliance in plrs are summarised in table 2. table 2: criteria for assessing compliance in labour relationships. fairness in labour relationships fairness is perceived through the eyes of the beholders. most assessments of fairness are therefore subjective and context dependent. employers and employees can subsequently have different expectations or perceptions of fairness in work relationships. these differences often result in tension or relationship conflict (robbins & judge 2017). fairness can simply be defined as even-handed treatment in social relationships. vulnerable societal members will be at risk of exploitation by more powerful societal members if fairness is not valued in a society (viviers & smit 2014). fair employment discrimination practices, fair labour practices, fair disciplinary or dismissal practices, fair employee representation practices and fair dispute resolution practices are subsequently explicitly and implicitly prescribed in numerous south african labour laws and related codes of good conduct (grogan 2014; venter & levy 2014). patel et al. (2012) highlight the need for fairness, equity and reciprocity in labour relationships. such behaviours may reduce the likelihood of undesirable workplace behaviours, such as tension, grievances, absenteeism and social loafing. other researchers agree that employees who believe that they are fairly treated in their employment relationships will be more likely to exceed their minimum job requirements or perform additional job duties. such employees will also typically refrain from misconduct and other forms of undesirable work behaviour (kickul, gundry & posig 2005). employees can also be confidently expected to be less sensitive to issues of fairness and equity in employment relationships with higher levels of trust (dimatteo, bird & colquitt 2011). however, subordinate employee perceptions of unfair treatment can lead to lower levels of relationship trust and a variety of undesirable organisational outcomes. some employees may resort to deliberately restricting their work output or sabotage work processes if they believe that they are unfairly treated or harassed in their work relationships (commission for conciliation mediation and arbitration [ccma] 2011). many employees are more likely to retaliate or litigate when they perceive a termination of their employment as procedurally and substantively unfair. such retaliation typically results from the broken trust relationship (dimatteo et al. 2011; kickul et al. 2005; southey 2010). fairness can be assumed to be demonstrated in plrs when at least five interrelated behaviour criteria are met. failure to satisfy any one or more of these criteria during relationship exchanges will strongly suggest that an exchange was unfair and will typically result in negative perceptions of fairness in plrs (ehlers 2017). the five criteria for assessing fairness in plrs are summarised in table 3. table 3: criteria for assessing fairness in labour relationships. good faith in labour relationships goodwill towards relationship partners and genuine concern for their well-being and interests are generally regarded as typical characteristics of good faith (dietz & hartog 2015; hakanen 2017). good faith can simply be defined as displaying honest and sincere intentions to create mutual benefits for all partners in labour relationships (ehlers 2017; heap 2009; riley 2009; shimanskaya 2010). individual perceptions of good faith in the behaviour and decisions of superiors, as well as numerous other organisational behaviours, are believed to be strongly related to employee perceptions of trust levels in organisational relationships (searle & skinner 2011). positive perceptions of good faith are related to higher levels of trust in organisational relationships, and organisational trust is positively related to several positive organisational behaviour outcomes. conversely, negative perceptions of good faith, or displays of bad faith, are generally believed to be related to lower levels of trust in such relationships (botha & moalusi 2010; guest 2004). positive perceptions of good faith have also been found to be strongly related to positive subordinate perceptions of relationship quality in plrs (ehlers 2017). samadi et al. (2015) believe that frequent and convincing displays of good faith will promote gradual positive transformation and change in organisations and society and thereby decrease the need for the strict implementation of laws regulating unfair discrimination and affirmative action in workplaces. the ccma (2011) has identified numerous forms of workplace harassment that are typical examples of unfair workplace discrimination that relate to the absence of good faith in labour relationships. some examples are mental bullying of subordinates, ridiculing subordinates in front of others, promoting less deserving employees, blocking employee progress, victimising employees, allowing special privileges to selected employees or intentionally blocking promotion of employees. bad faith will thus become evident when one or more relationship partner acts in dishonest, insincere, rude, insulting, victimising, exploiting, abusing, harassing or intentionally disruptive manners in labour relationship exchanges (bendix 2015; grogan 2014). as in the case of fairness, most assessments of good faith are also subjective and context dependent. rights and obligations of employers and employees regarding good faith are not readily and clearly defined in labour laws, which makes it difficult to assess the legitimacy of differing expectations and perceptions of labour relations partners. subsequently, diverging employer and employee expectations and perceptions of good faith often result in labour relationship tension and conflict, which in turn influence trust perceptions and levels in such relationships (heap 2009; robbins & judge 2017; shimanskaya 2010). good faith can be assumed to be demonstrated in a labour relationship exchange when at least five interrelated behaviour criteria are met. failure to satisfy any one or more of these criteria during relationship exchanges will strongly suggest that good faith was not displayed during the exchange and will often have a negative effect on good faith perceptions in plrs (ehlers 2017). the five criteria for assessing good faith in plrs are summarised in table 4. table 4: criteria for assessing good faith in labour relationships. research methodology mixed methodologies allow researchers to make confident research assumptions despite unique research challenges, such as relatively small samples. in addition, mixed-method research studies can yield trustworthy findings that provide foundations for further development of theory, and a deeper understanding of the nature of phenomena under investigation, despite relatively small sample sizes (cooper & schindler 2014; cozby & bates 2015; cresswell 2014; fusch & ness 2015; kumar 2011; trotsuk 2016). the mixed research methodology that was devised for this study required a thorough literature review, identification of an appropriate sampling methodology, development of a valid and reliable research interview, definition of an appropriate sample, structured research interviews, capture and analysis of data and final integration of literature and data analysis findings. the following specific steps were followed in the study that preceded this article: a thorough literature review was undertaken on the nature of trust, compliance, fairness and good faith in plrs, and a customised research interview was developed. interview questions were selected after considering the objectives of the study, data required to test propositions and hypotheses, research interview guidelines, potential respondent characteristics and typical knowledge of concepts, language barriers and response options (cozby & bates 2015; cresswell 2014; edwards & holland 2013; kumar 2011). the draft structured interview contained three biographical questions relating to age, gender and years of employment, as well as 12 questions relating to perceptions of trust, compliance, fairness and good faith in plrs. all interview questions were closed-ended and linked to specific quantified response options (cozby & bates 2015; kumar 2011; trotsuk 2016). interview question validity was deemed to be higher than adequate, considering the very narrow alignment between questions and the respective hypotheses that were to be tested in this study (edwards & holland 2013; trotsuk 2016). furthermore, the researcher developed a concise fact sheet that contained simplified definitions of trust, compliance, fairness and good faith. this fact sheet was explained to all interviewees before the start of interviews, and they could refer to a copy of the sheet at any time during the interview to ensure conceptual clarity. ten voluntary respondents participated in mock research interviews and provided positive feedback on their structured interview experience. a cronbach’s alpha coefficient of 0.79 confirmed that the interview questions were more than adequately consistent (cresswell 2014; salkind 2014; trotsuk 2016). the type of data that was obtained from interviews was also found to be appropriate for purposes of judging research propositions and related hypotheses. two skilled interviewers then adopted snowball sampling approaches to conduct 68 structured interviews with voluntary research participants. all interviewees were employed in the larger pretoria and ekurhuleni areas of gauteng, south africa. the sample size of 68 far exceeded the generally recommended minimum sample size of 30 for qualitative research studies (baker & edwards 2012; dalphin et al. 2007; depaulo 2000; fusch & ness 2015; guest, bunce & johnson 2006; mason 2010), as well as the generally recommended minimum sample size of 30 for effective application of inferential statistics in quantitative research studies (cresswell 2014; salkind 2014). research data were captured, and descriptive and non-parametric inferential statistical analysis procedures were applied to judge the validity of the respective research propositions and related hypotheses. salkind (2014) provide descriptions of the spearman’s rho correlation test, wilcoxon signed ranks test for two dependent samples and the mann-whitney u test for testing the significance of differences in means between two independent samples. discussion of findings the following section contains discussions of the validity of the respective propositions and hypotheses that were investigated in this study. figure 1 reflects mean scores of interviewee perceptions of the levels of compliance, fairness and good faith in plrs with lower, average and higher trust levels. figure 1: levels of compliance, fairness and good faith at different trust levels in primary labour relationships. proposition 1: relationship between compliance and trust in primary labour relationships it can confidently be assumed that there is a positive relationship between subordinate perceptions of the levels of compliance and trust in plrs. this assumption is strongly supported by reports in related literature (cropanzano et al. 2007; ehlers 2017; grogan 2014; holtz & harold 2009; linde et al. 2008; patel et al. 2012; searle & skinner 2011; viviers & smit 2014), and the following findings from this study: the perceived levels of compliance in plrs with lower trust levels were average (x = 0.99; s = 0.72), and slightly higher than average in plrs with average trust levels (x = 1.22; s = 0.64). however, compliance levels were perceived to be higher in plrs with higher trust levels (x = 1.65; s = 0.57). figure 1 illustrates the positive relationship between perceived levels of compliance and trust in plrs. h0 was rejected in favour of h1. the results of a spearman’s rho correlation test confirmed that there is a statistically significant relationship between subordinate perceptions of compliance and trust levels in plrs (r = 0.39, p < 0.00). h0 was rejected in favour of h2. the results of a wilcoxon signed ranks test confirmed that there is a statistically significant difference (z = -6.94; p < 0.00) between related subordinate perceptions of the levels of compliance in plrs with lower and higher trust levels. proposition 2: relationship between fairness and trust in primary labour relationships it can confidently be assumed that there is a positive relationship between subordinate perceptions of the levels of fairness and trust in plrs. this assumption is strongly supported by reports in related literature (botha & moalusi 2010; dietz & hartog 2015; dimatteo et al. 2011; ehlers 2017; hakanen 2017; patel et al. 2012; robbins & judge 2017; searle & skinner 2011; stern & coleman 2015), and the following findings from this study: the perceived levels of fairness in plrs with lower trust levels were average (x = 1.04; s = 0.68), and slightly higher than average in plrs with average trust levels (x = 1.15; s = 0.58). however, fairness levels were perceived to be higher in plrs with higher trust levels (x = 1.60; s = 0.55). figure 1 illustrates the positive relationship between perceived levels of fairness and trust in plrs. h0 was rejected in favour of h3. the results of a spearman’s rho correlation test confirmed that there is a statistically significant relationship between subordinate perceptions of fairness and trust levels in plrs (r = 0.35, p < 0.00). h0 was rejected in favour of h4. the results of a wilcoxon signed ranks test confirmed that there is a statistically significant difference (z = −6.78; p < 0.00) between related subordinate perceptions of the levels of fairness in plrs with lower and higher trust levels. proposition 3: relationship between good faith and trust in primary labour relationships it can confidently be assumed that there is a positive relationship between subordinate perceptions of the levels of good faith and trust in plrs. this assumption is strongly supported by reports in related literature (botha & moalusi 2010; dietz & hartog 2015; ehlers 2017; samadi et al. 2015; searle & skinner 2011; stern & coleman 2015), and the following findings from this study: the perceived levels of good faith in plrs with lower trust levels were average (x = 0.97; s = 0.83), and slightly higher than average in plrs with average trust levels (x = 1.12; s = 0.64). however, good faith levels were perceived to be higher in plrs with higher trust levels (x = 1.59; s = 0.58). figure 1 illustrates the positive relationship between perceived levels of good faith and trust in plrs. h0 was rejected in favour of h5. the results of a spearman’s rho correlation test confirmed that there is a statistically significant relationship between subordinate perceptions of good faith and trust levels in plrs (r = 0.33, p < 0.00). h0 was rejected in favour of h6. the results of a wilcoxon signed ranks test confirmed that there is a statistically significant difference (z = −6.89; p < 0.00) between related subordinate perceptions of good faith levels in plrs with lower and higher trust levels. below average levels of compliance, fairness and good faith it was noted that the perceived levels of compliance, fairness and good faith in plrs with lower levels of trust were all very close to the average score of one (0.97, 0.99, 1.04). these average levels gradually increased in plrs with average (1.22, 1.15, 1.12) and higher than average (1.65, 1.6, 1.59) trust levels (see figure 1). this trend suggests that levels of compliance, fairness and good faith could expectedly be perceived as below, or far below, average when trust levels are very low in plrs. mcknight and chervany (2014) believe that trust and distrust are not opposite ends of a continuum but two phenomena that exist alongside each other in social relationships. increases in relationship trust are often related to, or even caused by, decreases in distrust, and vice versa. distrust levels can therefore also be confidently expected to be higher when the levels of trust in plrs are below average. low levels of compliance, fairness and good faith, as well as non-compliance, unfairness and bad faith in organisational relationships are known to be related to higher levels of distrust and numerous related undesirable organisational relationship behaviours and outcomes (flanagan & runde 2009; kleptsova et al. 2018). damage to trust relationships, or increased distrust will typically arise when employers or employees fail to demonstrate legally or socially expected levels of compliance, fairness or good faith in plrs. such failures can also be perceived as breaches of written employment contracts or the regulations, policies and procedures that apply to plrs in terms of such contracts. perceived breaches of formal employment contracts can typically result in employee grievances, disciplinary action and labour disputes. irreparable breaches of trust or intolerable levels of distrust in plrs typically result in the termination of an employment contract by employers or employees (bendix 2014; grogan 2014). breaches of subjective unwritten psychological contracts occur when subordinate employees perceive unfairness or bad faith in plrs. such perceptions may give rise to decreased levels of trust, and increased levels of distrust in plrs. perceived breaches of psychological contracts can also result in undesirable labour relationship tension, unresolved conflict, deviant workplace behaviours, stress, rumouring and numerous other undesirable relationship behaviours (botha & molausi 2010; dimatteo et al. 2011; guest 2004). the above-mentioned views in literature and findings from this study very strongly suggest that below, or far below, average levels of compliance, fairness and good faith could be typical of plrs in which very low levels of trust or higher levels of distrust reside. consistency of perceptions of different sample groups the sample size of 68 was adequate for mixed-method research studies but too small to make generalisable findings resulting from statistical analysis of data. nonetheless, an investigation of the statistical significance of differences between the means of perceptions of different sample groups was undertaken to obtain some indication of differences between such perceptions. a non-parametric mann-whitney u test was applied to determine if there were statistically significant differences between the mean scores of two independent sample groups, and yielded the following results (salkind 2014): there are no statistically significant differences between male (n = 35) and female (n = 33) interviewee perceptions of levels of compliance, fairness or good faith in plrs with different trust levels. there are no statistically significant differences between younger (0–35 years, n = 34) and older (36 years and older, n = 34) interviewee perceptions of the levels of compliance, fairness or good faith in plrs with different trust levels. there are no statistically significant differences between less experienced (0–10 years, n = 39) and more experienced (11 years or more, n = 29) interviewee perceptions of levels of compliance, fairness or good faith in plrs with different trust levels. limitations and recommendations the relatively small sample and snowball sampling approach precluded this study from classification as a true quantitative research study, and findings from this study were subsequently interpreted from a mixed-method research perspective. nonetheless, findings from a literature review and statistical analysis of research data confirmed that the research propositions and hypotheses under investigation were mostly true (cozby & bates 2015; cresswell 2014; edwards & holland 2013; trotsuk 2016). there were no statistically significant differences between different sample group perceptions of the levels of good faith compliance, fairness and good faith at different trust levels in plrs. similar studies of related perceptions of employees in south african provinces other than gauteng could facilitate further investigation of differences in perceptions and re-assessment of the validity of the propositions and hypotheses of this study (cresswell 2014; salkind 2014). the perceived levels of compliance, fairness and good faith in plrs with lower and average trust levels were all relatively close to average (1) and noticeably higher in plrs with higher levels of trust. accordingly, it can be expected that very low levels of trust, or higher levels of distrust, in plrs may be related to perceptions of below average levels of compliance, fairness and good faith in plrs. the views of mcknight and chervany (2014) may serve as foundations for further investigation into the relationships between distrust and trust levels in plrs. this study confirmed that there are positive relationships between perceived levels of compliance, fairness and good faith and trust levels in plrs, but no findings on causality or the sequential development of compliance, fairness and good faith were made. further research into causality and the sequence in which compliance, trust and fairness develop in plrs could fill this knowledge gap. it could be worthwhile to conduct a thorough investigation into potential associations between underlying patterns in the situational leadership theory of hersey and blanchard, maslow’s hierarchy of needs and theories on labour relationship trust and quality perceptions plrs (ehlers 2017; robbins & judge 2017). concluding remarks this article reported on a study that was undertaken to investigate the relationship between perceived levels of trust and perceptions of compliance, fairness and good faith in plrs. findings from a literature review and statistical analysis of data were reviewed and integrated to arrive at the following conclusions: positive subordinate employee perceptions of the levels of compliance, fairness and good faith are typically related to higher levels of trust in plrs, and negative employee perceptions of the levels of compliance, fairness and good faith are typically related to lower levels of trust in plrs. these assumptions were strongly supported in literature and empirical findings in this study. increased displays of compliance, fairness or good faith by superiors in plrs can be confidently expected to result in more positive subordinate perceptions of the levels of trust in plrs. in contrast, inadequate or reduced displays of compliance, fairness or good faith by superiors in plrs can confidently be expected to result in less positive subordinate perceptions of the levels of trust in plrs. literature and empirical findings from this study strongly suggest that it can confidently be expected that higher levels of distrust and very low levels of trust in plrs will typically be related to far below average levels of compliance, fairness and good faith in plrs. correspondingly, it can confidently be expected that perceived levels of distrust in plrs will increase in relation to increases in perceived levels of non-compliance, unfairness and bad faith in plrs. it can thus be confidently assumed that there are positive relationships between subordinate perceptions of the levels of trust and their perceptions of the levels of compliance, fairness and good faith in plrs. furthermore, there are significant differences between subordinate employee perceptions of the levels of compliance, fairness and good faith in plrs with lower levels of trust and plrs with higher levels of trust. findings strongly suggest that levels of distrust in plrs can confidently be expected to increase when subordinates perceive below average levels of compliance, fairness and good faith in such relationships. higher levels of trust in plrs are related to numerous desirable labour relationship behaviours, outcomes and benefits for all stakeholders in such relationships. all stakeholders in all forms of plrs should subsequently be continuously encouraged to actively establish, protect and promote compliance, fairness, good faith and, accordingly, higher levels of trust in such relationships. acknowledgements the author would like to thank martine van der walt-ehlers for editing and athenkosi mbuma for data collection. competing interests the author has declared that no competing interests exist. authors’ contributions the author declares that he is the sole author of this research article. ethical consideration ethical clearance to conduct the study for purposes of this article was obtained from the gordon institute of business science of the university of pretoria during august 2018. funding information the research received no specific grant from any funding agency in the public, commercial, or not-for-profit sectors. data availability statement data sharing is not applicable to this article. disclaimer the views and opinions expressed in this article are those of the author and do not necessarily reflect the official policy or position of any affiliated agency or authors. references baker, s.e. & edwards, r., 2012, how many qualitative interviews is enough? expert voices and early career 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accepted: 07 july 2020; published: 21 sept. 2020 copyright: © 2020. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: organisational citizenship behaviour (ocb) plays a substantial role in individual and organisational performance. aim: the aim of the study was to investigate how moral intelligence and principled leadership can influence trust in the leader and ocb. setting: data were collected from 300 employees from various organisations in south africa. purposive, non-probability sampling was used. methods: a theoretical model and hypotheses were developed to explain the structural relationships among the latent variables. data were analysed by means of item analysis and confirmatory factor analysis conducted via structural equation modelling (sem). results: high levels of reliability were found for the measurement scales. good model fit was demonstrated for the measurement and structural models. empirical support was found for the significant mediating effects of principled leadership and trust in leaders in the indirect relationship between moral intelligence and ocb. the principled leadership scale (pls) could be used in the selection or development of principled leaders to develop an ethical culture to combat the high levels of corruption that many organisations face. principled leaders play a key role in creating an ethical and trusting work climate conducive for ocb. conclusion: this study is the first to analyse the joint relationships among the specific latent variables in the structural model. furthermore, the study provided the first supporting evidence for the concurrent validity of the newly developed pls. keywords: ethical leadership; moral intelligence; principled leadership; leader trust; organisational citizenship behaviour. introduction several benefits of organisational citizenship behaviour (ocb) to organisations and employees have been cited in the literature, including: an increase in organisational efficiency and productivity through the freeing up and more effective allocation of human resources, better job performance in that colleagues and managers are more efficient at planning, scheduling and problem solving, higher quality of service delivery through positive employee attitudes, higher job satisfaction and organisational commitment, and retention of high-quality people because organisations gain a reputation for being good places to work at (luthans 2011; newman et al. 2014; zhu et al. 2013). understanding how ocb can be fostered in organisations is thus clearly advantageous and important. the literature provides evidence that trust in the leader is a key antecedent to ocb (chen et al. 2008; dirks & ferrin 2002; engelbrecht & chamberlain 2005; newman et al. 2014). when followers perceive their leader to be trustworthy, they will be willing to voluntarily take on extra-role responsibilities. various prior studies provide evidence of a positive relationship between trust in the leader and value-based leadership, such as transformational (dirks & ferrin 2002; hemsworth, muterera & baregheh 2013), authentic (hassan & ahmed 2011; walumbwa et al. 2008), servant (joseph & winston 2005; miao et al. 2014; sendjaya & pekerti 2010) and ethical leadership (engelbrecht, heine & mahembe 2017; lu 2014; newman et al. 2014). value-based leaders build mutual trust with their followers by displaying compassion, openness, integrity, empathy, fairness and moral role modelling. furthermore, when leaders extend trust to followers, mutual trust is developed through social exchange mechanisms (liden et al. 2014). value-based leader behaviour is driven by integrity and well-developed moral intelligence (beheshtifar esmaeli & moghadam 2011; engelbrecht, kemp & mahembe 2018; wickham & o’donohue 2012). the greater the moral intelligence of leaders, the more successful they will be at moral and ethical decision-making. aim of the study in context of the above, the problem to be investigated in this study was: what are the key antecedents of ocb? the aim of the study then was to explore ocb as an asset to organisations, and to establish what the antecedents of ocb might be. trust in leaders, value-based (principled) leadership and moral intelligence were proposed as such antecedents. furthermore, the researchers sought to validate their assumptions through structural equation modelling (sem) within a structural model of the relationships among these latent variables. the purpose of the study was thus to clarify strategies for the enhancement of ocb. theoretical background and hypotheses organisational citizenship behaviour organisational citizenship behaviour has been defined as ‘individual behaviour that is discretionary, not directly or explicitly recognised by the formal reward system, and that in the aggregate promotes the effective functioning of the organisation’ (organ, podsakoff & mackenzie 2006). ocb can be described as discretionary, contextual or extra-role performance (asgari et al. 2008). according to organ et al. (2006), ocb consists of five dimensions, namely: (1) altruism (e.g. providing voluntary assistance to other employees with a heavy workload), (2) courtesy (e.g. displaying behaviour that maintains good work relationships such as empathy and understanding, even when provoked), (3) civic virtue (e.g. taking part in volunteer projects that promote the good reputation of the organisation), (4) sportsmanship (e.g. not complaining about little inconveniences in the workplace) and (5) conscientiousness (e.g. working late to finish a project even though there is no direct financial reward). trust in the leader and organisational citizenship behaviour as relational constructs, trust and ocb play a critical role in the social exchange context (engelbrecht & chamberlain 2005; rubin, bommer & bachrach 2010). in a trust relationship, parties to the relationship are prepared to be vulnerable to one another’s actions because of the expectation that when either party acts in a way that influences the other, the rights and interests of the other will not be violated (hassan & ahmed 2011; joseph & winston 2005). trusting the leader to not violate the rights and interests of the follower is important because leaders are in a position where they make decisions and take actions, which directly affect followers. trust is established through inferences that followers make about the nature of their relationship with the leader, based on the actions and character of the leader (dirks & ferrin 2002). mutual trust develops over time as employees and their leader engage in the exchange of socio-emotional benefits through the display of concern, respect and care for each other (zhu et al. 2013). this should in turn strengthen the emotional bond between followers and their leader. when followers perceive their leader to be capable, benevolent and to have integrity, they will be more willing to reciprocate with desirable behaviours like ocb (dirks & ferrin 2002; organ et al. 2006; rubin et al. 2010; zhu et al. 2013). a trusting relationship between employees and their leader should also enhance group cohesion, which can lead to a greater willingness of employees to go above and beyond their job role to help others and support their organisation on a voluntary basis (zhu et al. 2013). in contrast, when the leader is perceived to be untrustworthy, followers will divert energy to protecting themselves, instead of focussing on their work performance (dirks & ferrin 2002). several researchers have found a positive relationship between trust in leadership and ocb (asgari et al. 2008; chen et al. 2008; dirks & ferris 2002; engelbrecht & chamberlain 2005; newman et al. 2014; rubin et al. 2010; shahzad et al. 2013). employees are more likely to demonstrate ocb when they trust their leader and when they experience an exchange of socio-emotional benefits in their relationship with the leader. this leads to the formulation of the first research hypothesis: h1: trust in the leader has a significant, positive influence on ocb. value-based leadership as an antecedent of trust if the trust relationship between leader and follower is dependent largely on the character and actions of the leader, what character and actions should a leader display to foster the trust relationship? from the above it would seem that behaviours such as trustworthiness, integrity, benevolence, compassion and honesty are important. these types of behaviours are typical of what the researchers have grouped as value-based leader behaviours, that is, leader behaviours that are based on the ‘golden rule’ of do unto others as you would have them do unto you (kinnier, kernes & dautheribes 2000; lennick & kiel 2008). when examining the most prominent leadership theories, those that align most closely to these behaviours are transformational, servant, authentic and ethical leadership. ample studies have been conducted that provide proof of the positive relationship between each of these theories and trust in the leader. transformational leaders were found to build trust through individualised concern for followers, which led to care for and development of the follower and strong emotional bonds between follower and leader (asgari et al. 2008; dirks & ferrin 2002; hemsworth et al. 2013; zhu et al. 2013). relational transparency and self-awareness were found to be key ingredients to building trust between authentic leaders and their followers. relational transparency leads to openness and the expression of true thoughts and feelings about issues and a forthrightness of communication, while self-awareness leads the leader to be honest about their strengths and weaknesses and how these affect others (hassan & ahmed 2011; joseph & winston 2005; walumbwa et al. 2008). servant leaders build trust through their insight, empathy, concern for the welfare of their followers, as well as the ethical example they set for followers (joseph & winston 2005; miao et al. 2014; sendjaya & pekerti 2010). ethical leaders seem to enhance mutual trust by behaviour that is typically marked by the care, equity, fairness and respect they show towards their followers (engelbrecht et al. 2017; hassan & ahmed 2011; hemsworth et al. 2013; keck et al. 2018; miao et al. 2014; newman et al. 2014; sendjaya & pekerti 2010; zhu et al. 2013). principled leadership and trust in analysing the behaviours of value-based leaders, the researchers found that there was a great deal of overlap in the behaviours inherent to the four value-based leadership theories mentioned above. while each placed an emphasis on specific moral values, they all essentially measure moral leadership (xu, caldwell & anderson 2016). to measure the underlying behaviours of transformational, servant, authentic and ethical leadership, hendrikz and engelbrecht (2019) developed principled leadership as a holistic, value-based leadership construct, defining principled leadership as follows: principled leaders inspire and motivate others with a sense of purpose that goes beyond their own needs and desires; they are trustworthy and act as role models of universally accepted moral behaviour, by mastering their behaviour and interactions with others through humility, openness and vulnerability, by focussing on the empowerment of others and by taking accountability for their own actions and holding others to account for theirs. trust is an essential component of the social exchange theory (sendjaya & pekerti 2010). social exchange is the voluntary actions of employees who are motivated by an expectation of support and benefits from their leader (blau 1964). principled leaders may thus influence follower trust in leaders through social exchange. furthermore, principled leaders may gain follower trust through role modelling, a phenomenon that can be understood using social learning theory (brown & treviño 2006). according to this theory, individuals learn by observing the behaviour of role models chosen, based on their attractiveness and credibility. principled leaders are particularly likely to become role models, because their behaviours, specifically integrity, concern for others and strong ethics, may enhance their attractiveness and trustworthiness, resulting in greater credibility (brown & treviño 2006; liden et al. 2014; walumbwa et al. 2008). such leadership behaviours provide a psychologically secure environment in which employees can develop high levels of trust in the leader (lu 2014). consequently, the following hypothesis can be postulated: h2: principled leader behaviour has a significant, positive influence on trust in the leader. moral intelligence as an antecedent of principled leadership the discussion to this point has highlighted several behaviours that would be expected from principled leaders. however, not all leaders behave in a principled manner. the enron debacle of 2001 and more recently the scandals involving volkswagen, fifa, steinhoff, bosasa and the alleged state capture of the south african government indicate that immoral leader behaviour is alive and well. a question that begs answering in this regard is why some people are more inclined to act morally than others? to explore this question, the researchers investigated the concept of moral intelligence, which has been defined as follows: ‘moral intelligence is the mental capacity to determine how universal human principles should be applied to our values, goals and actions’ (lennick & kiel 2008:7). the understanding of moral intelligence requires a brief discussion of research relating to the origins of morality. the origins of moral intelligence in plato’s opinion, the development of the ability to reason brought about morality, which in turn controlled the wayward emotions of humankind (narvaez 2010). plato’s pupil, aristotle, alleged that humans possess within themselves the emotional and rational abilities necessary to achieve moral excellence, which can be developed through proper guidance by society and family (dow 1998). the theologian augustine argued that, essentially, man desires happiness and peace. however, when his will is directed towards selfish desires instead of towards god, he will act immorally (wogaman 2011). to counteract this inherent selfishness, morality must be developed through training of good habits (narvaez 2010). similarly, confucius in china, and buddha in india, held the view that people within themselves want to be just, self-controlled, and temperate as this is critical for their well-being and happiness (hass 1998). in addition to the philosophical viewpoints stated above, empirical science has begun to prove that an innate propensity to be moral is part of the physical make-up of all human beings (lennick & kiel 2008; narvaez 2010). as suggested by the ancient philosophers and modern psychology, nurturing, training and development of this inborn morality is, however, necessary for humans to function effectively in terms of their morality (lennick & kiel 2008). benefits of moral intelligence for leadership the most defining benefit of moral intelligence is that it is viewed as the ‘central intelligence’, which provides an anchor for the cognitive, emotional and social intelligences, ensuring that the right thing is done, rather than acting in possible destructive ways (beheshtifar et al. 2011; lennick & kiel 2008). liden et al. (2014) analysed moral maturity and moral conation, which are related concepts to moral intelligence. leaders who possess moral maturity are likely to behave in a way that is consistent with their personal ethical norms (i.e., their moral identity). moral conation is the capacity to believe one is morally responsible and act in a moral way, even in the face of obstacles. liden et al. (2014) view moral maturity and moral conation as antecedents of the ethical behaviours of servant leaders. furthermore, leaders’ cognitive moral development has been found to be positively linked to ethical decision-making (ashkanasy, windsor & treviño 2006). in today’s world of work, leaders will inevitably be faced with ethical decisions and the more adept they are at handling these, the more successful they will be (beheshtifar et al. 2011; liden et al. 2014). morally intelligent leaders thus have an edge on those who have an underdeveloped inner moral compass (beheshtifar et al. 2011; engelbrecht et al. 2018). this led to the postulation of the following hypothesis: h3: moral intelligence has a significant, positive influence on principled leader behaviour. conceptual model based on the analysis of the above-mentioned literature a conceptual model of the relationships among moral intelligence, principled leadership, trust in the leader and ocb was developed (see figure 1). figure 1: relationships among moral intelligence, principled leadership, trust and organisational citizenship behaviour. research method sample selection and data collection purposive, non-probability sampling was used to select participants from various companies in south africa. the participating organisations included software development and consulting services (80%), retail (6%), wine making (5%), construction (5%) and public service (4%). the population can be defined as middle to top management in organisations. the sample of 300 respondents consisted of employees who reported to managers in such positions. of the respondents, 58% were working in non-managerial positions, 31% in lower to mid-level management and 11% in senior to top management level positions. the average age of participants was 33 years. electronic or paper-based questionnaires were sent either to a contact person at the organisation for further distribution, or directly to participants. in the covering letter, the purpose of the research was clearly explained to participants; confidentiality and anonymity were guaranteed and feedback would be provided in aggregate format only. furthermore, electronic data was directly sent to the statistical centre of the university. measuring instruments the researchers utilised the following scales to measure the four components of the structural model: moral intelligence the moral competency inventory (mci) measures the four moral intelligence principles of integrity, responsibility, compassion and forgiveness (lennick & kiel 2008). an adapted 29-item mci (amci) was used to measure moral intelligence in this study. research participants were required to evaluate the moral intelligence of their line manager. this required the researchers to change the original self-rating scale to an other-rating scale. in doing so, it was necessary to remove 11 items, as it would not be possible for a subordinate to rate the extent to which their manager displays these behaviours (i.e., items 2, 9, 10, 11, 19, 20, 29, 30, 31, 39 and 40). the removed items primarily refer to the principle of forgiveness. principled leadership the new 58-item principled leadership scale (pls) developed by hendrikz and engelbrecht (2019) was utilised to measure principled leadership. four subscales were developed for the pls, namely trustworthiness, self-mastery, empowerment and accountability. participants rated the principled behaviour of their line manager. trust in the leader trust in the leader was measured using the 13-item leader trust scale (lts) developed by engelbrecht et al. (2017). participants assessed the level of trust they had in their line manager. the item analysis of the lts achieved a good cronbach’s alpha value (α = 0.97) (engelbrecht et al. 2017; nunnally 1978). a confirmatory factor analysis showed close fit (p > 0.05) of the lts measurement model with the empirical data (rmsea = 0.067; standardised root mean residual [srmr] = 0.03; normed fit index [nfi] = 0.98) (engelbrecht et al. 2017). organisational citizenship behaviour organisational citizenship behaviour was measured using engelbrecht and chamberlain’s (2005) modification of podsakoff and mackenzie’s 24-item organisational citizenship behaviour scale (ocbs). this modified scale allows for self-reporting and ensures that the wording of questions is relevant for the south african context (engelbrecht & chamberlain 2005). research participants evaluated their own organisational citizenship behaviour. the adapted ocbs achieved an acceptable level of internal consistency for the total scale (α = 0.78) (engelbrecht & chamberlain 2005). ethical consideration the research ethics committee of stellenbosch university granted ethical clearance for the study: su-hsd-000617. furthermore, informed consent was sought from participating employers and respondents. results descriptive statistics and reliability analysis table 1 presents the means, standard deviations, reliability coefficients (α values) and pearson correlation coefficients for all four measures included in the study. table 1: descriptive statistics and pearson correlations (n = 300). reliability analysis was also conducted on each of the dimensions of the scales comprising the structural model. all the cronbach’s alpha values were above the acceptable cut-off value of 0.70 (nunnally 1978) except for the subscale civic virtue of the ocbs, for which a value of 0.66 was obtained. as per nunnally (1978) this deems the dimension to have low but acceptable reliability. in addition, the corrected item-total correlations were satisfactory (> 0.30) for all subscales (pallant 2013) (see table 2). table 2: reliability results of the four scales. evaluation of the fit of the measurement models the fit of the measurement models was investigated by performing confirmatory factor analysis (cfa) to determine whether the theorised models were supported by the data collected. adapted moral competency inventory the amci measurement model achieved a reasonable fit with the data indicated by the rmsea and srmr indices (see table 3). however, the goodness-of-fit (gfi) showed poor fit and the index of close fit (p < 0.05) did not support the close fit hypothesis. the nfi and comparative fit index (cfi) values indicated good fit (hooper, coughlan & mullen 2008). furthermore, the factor loadings of the items on their dimensions were significant and greater than the desired 0.50 (mackenzie, podsakoff & podsakoff 2011), ranging from 0.63 to 0.87. on balance, the measurement model of the amci was regarded as showing reasonable fit. table 3: goodness-of-fit indices. principled leadership scale a confirmatory bi-factor analysis provided close fit (p > 0.05) of the pls measurement model with the empirical data (hendrikz & engelbrecht 2019) (see table 3). the gfi produced a poor model fit (< 0.90), but the rmsea, srmr and relative fit indices indicated good model fit (hooper et al. 2008). overall, the bi-factor measurement model showed good fit. leader trust scale good fit was indicated by all fit indices except the gfi, which narrowly missed the 0.90 cut-off point (see table 3). the p-value for close fit (> 0.05) also supported the close fit hypothesis. in addition, all the factor loadings in the completely standardised lambda-x matrix were significant and greater than 0.50 (mackenzie et al. 2011), ranging from 0.72 to 0.89. overall, the researchers deemed the lts to have good fit. organisational citizenship behavioural scale the ocbs’s p-value for close fit met the criterion necessary to support the close fit hypothesis (see table 3). the srmr and nfi showed acceptable fit while the other fit indices indicating good fit. the factor loadings were above 0.50 (mackenzie et al. 2011) for all items except for ocb6 and ocb17. the factor loading range for the remaining items was between 0.52 and 0.79. in the unstandardised lambda-x matrix, the z-value for both these items was however greater than│1.64│, indicating significant (p < 0.05) factor loadings (z = 6.38 for ocb6 and z = 7.28 for ocb17). the researchers thus concluded that the measurement model for the ocbs showed good fit. overall measurement model underlying the structural model all fit indices of the overall measurement model underlying the structural model indicated good fit. in addition, the p-value for close fit supported the close fit hypothesis (see table 3). structural model fit the structural model also showed good fit. this was supported by all the fit indices. support was also found for the close fit hypothesis (see table 3). discussion of results statistical analysis of the links between the variables of the structural model was necessary to determine whether the data supported the relationships between these variables, as originally conceptualised. the relationship between trust in the leader and organisational citizenship behaviour hypothesis 1 postulated a positive relationship between trust in the leader (ŋ2) and ocb (ŋ3). this was confirmed by this study (β = 0.50; p < 0.05) (see table 4). this corroborates the results of prior studies in which a positive, significant relationship between trust in leadership and ocb was found (asgari et al. 2008; chen et al. 2008; engelbrecht & chamberlain 2005; newman et al. 2014; rubin et al. 2010; shahzad et al. 2013). thus, if employees believe their leaders to be highly trustworthy, they will in turn display greater levels of ocb. table 4: gamma and beta matrix of the structural model’s path coefficients. the relationship between principled leadership and trust in the leader the study supported hypothesis 2, which proposed that a positive, significant relationship exists between principled leadership (ŋ1) and trust in the leader (ŋ2) (β = 0.92; p < 0.05) (see table 4). this confirms prior findings of a positive relationship between value-based or principled leadership and trust in leaders (engelbrecht et al. 2017; hassan & ahmed 2011; hemsworth et al. 2013; keck et al. 2018; miao et al. 2014; newman et al. 2014; sendjaya & pekerti 2010; zhu et al. 2013). principled leaders will therefore create high levels of trust between subordinates and their leaders. the relationship between moral intelligence and principled leadership support was found for hypothesis 3, which suggested that a positive, significant relationship exists between moral intelligence (ξ1) and principled leadership (ŋ1) (β = 0.98; p < 0.05) (see table 4). this supports the positive relationship established between integrity, as well as cognitive moral development and value-based or principled leadership (ashkanasy et al. 2006; beheshtifar et al. 2011; engelbrecht et al. 2018; lennick & kiel 2008; liden et al. 2014). consequently, leaders with a high level of moral intelligence will exhibit strong principled leadership. the mediating effects of principled leadership and trust in the leader based on the results of the direct relationships, two ad hoc analyses were conducted to test mediator effects formally. firstly, the significance of the mediation effect of trust in the leader in the principled leadership–ocb relationship was tested (as both hypothesis 1, the effect of trust in the leader on ocb, and hypothesis 2, the effect of principled leadership on trust in the leader, were supported). the results of the sobel test (preacher & hayes 2004) revealed that trust in the leader significantly mediated the relationship between principled leadership and ocb (z = 2.88; p < 0.01). secondly, as both hypothesis 2 and hypothesis 3 (the effect of moral intelligence on principled leadership) were supported, principled leadership as a mediator in the moral intelligence–trust in the leader relationship was formally tested. the results (z = 5.21; p < 0.01) confirmed this mediation effect. modification indices analysis of the modification indices did not show any other significant, positive paths that could be considered within the structural model, other than those postulated as part of the study. limitations of the study and suggestions for future research the study had certain limitations and revealed areas for future research, which should be considered. the study was based on self-report questionnaires. common method bias stemming from data collection by means of self-report measures has been shown to inflate the strength of observed relationships (williams & mcgonagle 2016). it would be useful if future research could replicate the findings in the current study by using approaches such as the hybrid method variables model to control for common method bias (williams & mcgonagle 2016). the four scales utilised in the study were related with their respective antecedents and outcomes as a whole, rather than by dimensions. it may be useful to know to which extent the dimensions of moral intelligence affect the separate dimensions of principled leadership, and which of the leadership dimensions bear most weight in affecting trust in the leader. this would assist with knowing which behaviours to focus on developing to positively influence ocb. a more detailed study on the item and factor structure of the adapted mci may increase the reliability of the third dimension, compassion, as well as the fit of the measurement model. this study analysed the reliability and factor structure of the amci by loading the items onto three moral intelligence principles. the researchers suggest that further analysis of the mci is conducted in a model where the items load on their related moral intelligence competencies, which in turn load on the four moral intelligence principles as postulated by lennick and kiel (2008). this study provided preliminary evidence of the reliability and concurrent validity of the pls within a nomological network of specific latent variables. future studies should identify other correlates of principled leadership (e.g. organisational justice, empowerment, employee wellness, ethical climate, leader effectiveness) to further determine the construct validity of the pls in a more elaborate structural model of principled leadership. finally, a longitudinal study would be valuable to substantiate the causal relationships postulated in the structural model. managerial implications the aim of the study was to determine what precedes ocb in the work context. the literature and this study provided support for the hypothesis that trust in the leader has a positive influence on ocb. by implication, organisations should thus aim to increase the level of trust between managers and subordinates to increase ocb and ultimately positive organisational results such as job satisfaction, the ability to attract and maintain a good workforce, and greater efficiency and productivity (luthans 2011; newman et al. 2014; zhu et al. 2013). the study proves that principled leadership has a positive influence on trust in leaders. principled managers can utilise various strategies that may enhance a social exchange relationship with their subordinates, which, in turn, will help develop managers’ trustworthiness. these strategies might include empowering subordinates, benevolence and caring for subordinates, accountability, displaying a high consistency between moral intentions and actions, being self-aware and displaying authenticity in relationships (dirks & ferrin 2002; zhu et al. 2013). the strong links between principled leadership and trust in the leader in this study emphasise the importance of developing principled behaviour in managers to increase the level of trust between them and their subordinates. finally, the positive relationship between moral intelligence and principled leadership emphasises an important link between these two constructs. lennick and kiel (2008) argue that when managers have a high propensity to display behaviours linked to integrity, responsibility, compassion and forgiveness, they can be regarded as being morally intelligent. moral intelligence in managers is important because it forms the moral compass, which directs the optimal utilisation of managers’ other intelligences (e.g. emotional intelligence) (beheshtifar et al. 2011). the behaviours identified in moral intelligence are effectively a prerequisite to principled leader behaviour. without the innate ability to behave with integrity, responsibility, compassion and forgiveness, managers will struggle to display behaviour aligned with universally accepted moral values and to stand their ground about what is ethical. it will be difficult for such a manager to take on the responsibility of devising a strategy that is focussed wider than the bottom line of profits, or to build an organisation that is financially sustainable in the long term, without using the planet or people as means to build that sustainability. such managers will not have the service attitude necessary to be able to put the development needs of subordinates at the forefront of their responsibilities, nor will they have the necessary humility to question their thinking and be open to the ideas of others. essentially, a manager who is not morally intelligent will also not be principled. conclusion in conclusion, this study provides some evidence for the concurrent validity of the newly developed pls through the positive mediating effect of trust in the leader on the indirect impact of principled leadership on ocb, as well as the positive mediating effect of principled leadership on the indirect influence of moral intelligence on trust in the leader. moreover, this study promotes the argument that if employee behaviour, specifically ocb, is an asset to an organisation, the leaders of the organisation should focus on developing their moral intelligence and principled behaviour to increase mutual trust and ocb, and ultimately the organisational benefits brought about through ocb. acknowledgements competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions both a.e. and k.h. were responsible for the conceptualisation of the study, the interpretation of the findings and writing of the article. k.h. was also responsible for the data collection and statistical analyses. funding information this research received no specific grant from any funding agency in the public, commercial, or not-for-profit sectors. data availability statement data supporting the findings of this study are available within the article. disclaimer the views and opinions expressed in this 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acknowledgements references about the author(s) nicholas ngepah school of economics, college of business and economics, university of johannesburg, johannesburg, south africa charles s. saba school of economics, college of business and economics, university of johannesburg, johannesburg, south africa ntombomzi g. mabindisa school of economics, college of business and economics, university of johannesburg, johannesburg, south africa citation ngepah, n., saba, c.s. & mabindisa, n.g., 2021, ‘human capital and economic growth in south africa: a cross-municipality panel data analysis’, south african journal of economic and management sciences 24(1), a3577. https://doi.org/10.4102/sajems.v24i1.3577 original research human capital and economic growth in south africa: a cross-municipality panel data analysis nicholas ngepah, charles s. saba, ntombomzi g. mabindisa received: 18 feb. 2020; accepted: 30 nov. 2020; published: 19 mar. 2021 copyright: © 2021. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: in the literature, human capital has been identified as a key economic variable that is needed to promote growth; hence this study explores the components of human capital, that is, different skill levels in order to capture the real effect of the employed labour on economic output across the municipalities of south africa. aim: this study investigates the effect of human capital of employed labour on economic output and growth in south africa. setting: the study focuses on the balanced panel of 269 south african municipalities for the period 1993 to 2016. methods: the study utilises panel causality test and the generalised method of moments estimation techniques. results: a panel causality test confirms bidirectional causality between human capital and total output, as well as between total employment and total output. the resultant aggregate findings suggest that human capital has a positive and a significant impact both on total output and economic growth. the disaggregated proxy of human capital shows that higher levels of skilled employment is associated with higher total output and economic growth. conclusion: the findings of the effect of skilled employment on economic growth are in line with theoretical literature and therefore the study concludes that human capital in the form of skilled labour has a positive effect on both economic output and growth in south africa. this informs policy to prioritise the upskilling of the labour force in order to contribute positively towards value-generating economic activities in south africa. keywords: human capital; economic growth; panel causality; south africa. introduction this study focuses on investigating the effect of human capital on economic growth in south africa, making use of a balanced panel of 269 south african municipalities for the period 1993 to 2016. the approach used in this study differs from previous studies because it examines the skills component of human capital and its impact on economic growth. economic growth literature highlights three mechanisms that show a causal relationship between the education component of human capital and economic growth. firstly, education is a key instrument that shapes the human capital fibre, equipping the labour force for higher productivity levels (mankiw, romer & weil 1992). secondly, education increases the innovative capacity of the economy and brings knowledge of new technologies, products and processes which then promote efficient production activities that boost economic growth. this view is supported by theories of endogenous growth developed by lucas (1988), howitt and aghion (1998) and romer (1990). lastly, education facilitates the diffusion and transmission of knowledge needed to understand and process new information, as well as successfully implement new technologies to promote economic growth (benhabib & spiegel 1994; nelson & phelps 1966). acemoglu (2009) notes that in the case of farming, educated farmers accept and adapt easily to the utilisation of new technology or seeds in order to increase productivity and income levels. the south african economic landscape has been characterised by different levels of economic growth from the democratic transition period which saw a lifting of sanctions, the ushering in of open trade and increased levels of foreign direct investments (fdi). the political shift accelerated the country’s position as a gateway to the african continent by diversifying the economy beyond the mining and agricultural sectors to expand the financial services, retail and manufacturing sectors. a commodity boom period between 2004 and 2007 also affirmed the country’s global standing in trade (frankel, smit & sturzenegger 2008). however, the global financial crisis of 2008–2009 resulted in a significant decline in south africa’s exports and jobs (south african reserve bank 2009). as south africa continues to experience poverty, inequality and unemployment, the government developed a national document – national development plan (ndp) – to mitigate their effect on the economy. the ndp regards investment in human capital as a critical instrument that will reduce inequality levels and prepare people to participate in income-generating economic activities (national planning commission 2011). an educated, skilled and healthy workforce is an important factor in realising higher levels of total output. according to the world bank (2015), developing economies have been reported as having steady economic growth post the 2008 to 2009 economic crises. the performance of the south african economy was reported as lagging behind other middle-income countries like brazil, india and china. the post-apartheid south african economy has been characterised by high levels of unemployment, inequality and poverty. this is despite impressive economic growth rates recorded between 2005 and 2008. data from statistics south africa (stats sa) show that employment growth has not reflected similar improvements (mahadea & simson 2010). contrary to the gross domestic product (gdp) growth trend of developing countries where labour-intensive industries in the primary and secondary sectors are the main contributors, the south african gdp growth is led by the tertiary sector (stats sa 2016:q42016). imbs (2013) considers this structural shift as ‘premature de-industrialisation’. south africa’s large pool of low-skilled and semi-skilled labour is likely to be rendered redundant in some of the employment opportunities offered by the tertiary sector. this is similar to witherick’s (1999) view of the negative impact of rising service sector jobs on low-skilled and semi-skilled people of the united kingdom in the 1980s. an inadequately educated workforce has been highlighted as one of the problematic factors of doing business in south africa (schwab 2017). this deficiency has the potential of containing fdi and capital inflows. in this regard, gross domestic investment as a percentage of gdp also decreased from 28% to 19% between 1980 and 2016 (south african reserve bank 2018). borensztein, gregorio and lee (1998) inform that the effect of the flow of advanced technology through fdi is determined by the absorptive capability of the hosting economy or country. denison (1985) confirmed that an extended number of years in school between the years 1929 and 1982 explained about 25% of income per capita growth in the united states. however, the quality of tertiary education in south africa has been reported as less capable of adequately preparing people for effective participation in the labour sector (fedderke, de kadt & luiz 2003). the alignment of the basic education policy with industry requirements would give basic skills to secondary school learners to meet entrance requirements of the labour sector. secondly, the increasing growth momentum of the tertiary sector (services) requires matching skills from the labour force. lastly, increasing mechanisation and technological advancement of production processes require specialised skills. it is therefore important that the set of skills provided by south african education institutions is in line with the demand for labour required by key economic sectors. therefore, a study to determine the effect of human capital on south africa’s economic growth is important to inform policy. some empirical studies (barro et al. 1993; bassanini & scarpetta 2002) use education levels, school enrolment, education attainment and number of years in school as proxies for human capital. this study will use the skill levels (skilled, semi-skilled and low-skilled) in order to capture the real effect of the employed labour on economic output across the municipalities of south africa. the skills proxy is also used by hanushek, schwerdt and wiederhold (2015) in investigating the returns associated with different measures of cognitive skills (human capital). measuring human capital by different skill levels includes those with school attainment, individual ability and labour market experience (hanushek et al. 2015). this is in line with the assumption that education boosts labour productivity and equips people for ease of technological adaptation (verspoor 1990). to the best of our knowledge, little or no attention has been given to how human capital in the form of skills has an impact on economic output and economic growth across the 269 south african municipalities for the period 1993 to 2016. therefore, this study contributes to filling this gap in the literature. the objective of this study is to investigate the effect of the human capital in employed labour on economic output and growth in south africa, with a balanced panel of 269 south african municipalities for the period 1993 to 2016. this study contributes to the empirical literature in three important ways. firstly, the direction of causality between skilled employment and total output, as well as between skilled employment and total employment, is investigated. secondly, the dynamic panel generalised method of moments (gmm) estimation technique is introduced to investigate whether human capital in the form of skills has an impact on economic output and economic growth. thirdly, it aims to recommend policies that will align the labour force to skill levels that have a high contribution to total output. the remainder of the article is organised as follows: literature review, research methodology, empirical results and discussion, and, finally, the conclusion. literature review classical economic thinking on the sources of economic growth, beginning with solow’s (1957), considers labour productivity as an exogenous factor, depending on the ratio of capital and labour, and technical progress, with no regard to the role of education and skills. however, the main source of technological change on economic growth was not explored extensively until the 1990s, with mankiw et al. (1992) adding human capital as a factor of production. solow (1956), nelson and phelps (1966) and lucas (1988) concur that human capital is an important factor for economic growth. however, these and other authors use different frameworks to explain the effect that human capital has on economic growth. nelson and phelps explain that human capital is a catalyst that accelerates productivity levels through innovation and ease of adaptation to new technological ways of manufacturing, concluding that higher endowment of human capital results in increased levels of innovation. engelbrecht (2003) highlights the dynamic role played by human capital both as an input in the aggregate production function and as a catalyst for innovation and technological progress. becker, murphy and tamura (1990) find a negative correlation between human capital and population growth. this is further reiterated by rosenzweig’s (1990) view that developed countries are characterised by low population growth and high levels of human capital in terms of education, education attainment, on-the-job training and vocational skills. for the case of south africa, bhorat, cassim and tseng (2016) investigate the impact of education cohorts of the south african labour market on economic growth. they used the two-stage regression on a modified cobb–douglas production education function. they further disaggregated the labour component by education to determine the effect of each educational group on economic growth. the results of the study suggest a positive relation between growth and tertiary education. their findings were similar to an assertion made by van der berg et al. (2011) that ‘poverty can perpetuate itself via low educational attainment and low-quality education, resulting in dire labour market prospects, creating a vicious cycle that impedes social mobility’. a positive relationship is also reported for those with a matric certificate while the further education and training qualification holders recorded a negative relationship with growth. a number of studies that have investigated the impact of human capital on economic growth have used different proxies, with a majority opting for the education variable as a proxy for human capital (awad, halid & yussof 2013; barro et al. 1993). the endogenous growth model argues that a certain level of education advances technological innovation and contributes favourably towards economic growth. however, a better education resulting in higher innovation is, on its own, a function of high economic growth, thereby suggesting reverse causality (bayraktar-sağlam 2016; blundell & bond 1998). bils and klenow (2000) argue that there is a high correlation between education investments and economic growth owing to a reverse causality, where higher economic growth levels result in increased investment in education. barro (2001) informs that there is a strong correlation between school enrolment, and long-run economic growth. similarly, bassanini and scarpetta (2002) conclude that one additional year in schooling years translates into a rise in gdp per capita of 6%. blundell et al. (1999) also report on the positive contribution of manpower qualifications and skills to productivity and competitiveness. however, murphy, shleifer and vishny (1991) find that the effect of human capital differs according to a selected proxy, with the use of engineers as proxy cited as having a higher effect on economic growth compared to legal professionals. furthermore, easterly (2001) argues that the combination of quality education, economic institutions and capital has a muting effect on growth in countries where facilitating factors like functioning markets and legal systems are not established. this shows that the value-generating effect of human capital may be limited by the absence of enabling factors. the mismatch of allocating cognitive skills to socially unproductive activities may render human capital unfruitful to economic growth (pritchett 2001). the lack of a universally aligned proxy for human capital has led to a debate as to whether human capital should be treated as an ordinary input to the aggregate production function. the use of different proxies like school enrolment rates, educational attainment, and completion of primary, secondary or tertiary education has often led to different conclusions with respect to the impact of human capital on economic growth. furthermore, the relationship between the two variables is compromised by proxies used such as the ‘average years of school attendance’ in which each extra year in education, whether at primary, secondary or tertiary level, is considered to yield an equal additional benefit to total output. other empirical studies (abbas 2001; borojo & jiang 2016; petrakis & stamatakis 2002) disaggregate the education proxy into different levels – primary, secondary and tertiary – in order to detect the impact of each level on economic growth. results from these studies suggest that education at primary level has a positive contribution to economic growth of least developed countries while tertiary education has a significant contribution to developed countries where innovation and adoption of technology is critical. a similar outcome was reported by gyimah-brempong, paddison and mitiku (2006). this study follows a similar pattern in which a proxy for human capital (skills) will be divided into three categories of skilled, semi-skilled and low-skilled employment. however, this study proxy for human capital is measured from the labour market in terms of various socio-professions and the number of years of education required to attain such. research methodology in order to achieve the objective of this study, three processes were used, which include: a panel granger causality test and the gmm estimation techniques. this study applies the recently developed dumitrescu and hurlin (2012) panel causality test to investigate the direction causality between the variables of interest. this causality test was used because it takes into account the heterogeneous nature of the panel data. the study further estimated gmm and system gmm (interested readers are referred to arellano & bond 1991; arellano & bover 1995; blundell & bond 1998 for more details). this method was used because according to baum, schaffer and stillman (2003), gmm estimator is more efficient than the simple instrumental variable techniques. besides, the gmm panel estimator exploits the time-series variation in the data, accounts for unobserved country-specific effects, reduces finite sample biases and controls for endogeneity of all the explanatory variables. functional form and model specification theoretical research on the determinants of economic growth has highlighted the importance of human capital (solow 1956; nelson & phelps 1966; lucas 1988). endogenous growth models such as the augmented solow growth model presented human capital as a critical factor of economic growth. in order to estimate the impact of human capital on economic output and growth, the study will use a theoretical framework of the cobb–douglas production function. according to solow’s neoclassical aggregate production function, total output (y) is a function of capital (k) and labour (l) inputs shown as: neoclassical economists like mankiw et al. (1992) have shown the flexibility of this framework to allow the inclusion of different economic variables like technology (a) and human capital (h) as shown below: for the purpose of this study, the cobb–douglas production function will be adjusted to include three different skill levels (skilled, semi-skilled and low-skilled) as proxies for human capital. three methods of analysis will be utilised. the first method is a widely utilised ordinary least squares (ols), with equations for total output at level and log transformed presented as: equation 3 and equation 4 show logarithms of all variables, with l.output showing a logarithm of total output. β0 is a constant term while β1l.si,t shows a logarithm of skilled employment, β2l.ssi,t represents a logarithm of semi-skilled employment and β3l.lsi,t depicts a logarithm of low-skilled employment – all these variables are proxies for human capital at different skill levels. the variable β4l.capitali,t is a logarithm of gross fixed capital formation and ε is a random error term. borojo and jiang (2016) argue that there is a possibility of endogeneity when dealing with economic growth due to its dynamic phenomenon. the existence of endogeneity will be evaluated by a granger causality test. for the purpose of this study, the dumitrescu-hurlin test for granger non-causality will be done between economic output and human capital (skilled employment). an equation depicting causality from economic output to human capital is presented as: in equation 5, output is a proxy for economic growth, s is skilled employment (a proxy for human capital), γ and b are the slope coefficients, i represents each municipality in a panel, t is the year in the panel, k is the number of lag length, α is the intercept of the equation and ε is an error term. similarly, the equation showing causality from human capital to economic output is presented as: these equations will test the direction of causality between the two variables (human capital and total output). another causality test is between total output and total employment and between total employment and total output. equations are shown below. also, an assumption is that lag orders of k are identical for all cross-section units of the panel. k represents the number of lags. in equation 7 and equation 8, empl_t represents total employment. it is expected that the granger causality test will suggest whether there is endogeneity between total output and human capital, as well between the total output and total employment. as discussed above, in the likely presence of endogeneity, a dynamic system gmm model is a preferred estimator as it is able to correct endogeneity. the system gmm model is characterised by the presence of a lagged dependent variable (δl.outputi,t–1) on the right-hand side of the equation. therefore, equation 9 shows the ability of the system gmm model to remove unobserved individual specific effects by first differencing (δ)the growth equation: furthermore, functional forms for estimating the impact of the different shares of skill levels (of total employment) on total economic output are presented as: in equation 10, sh_si,t, sh_ssi,t and sh_lsi,t are shares of skilled, semi-skilled and low-skilled employment. as with models estimated for the impact of human capital on economic output, the estimation of the impact of human capital on economic growth will follow the same method. the estimation equation presented below is for the system gmm: the variable g represents economic growth and gi,t–1 depicts a lagged dependent variable of economic growth. equation 12 will estimate the impact of the three different shares of skill levels (of total employment) on economic growth: the study uses municipal data across six key economic sectors – agriculture, forestry and fishing; mining and quarrying; manufacturing; wholesale and retail trade; catering and accommodation; transport, storage and communication; finance, insurance, real estate and business services – for 24 years (1993–2016) of observations. all data is extracted from quantec database – a south african based consultancy, providing an online database for macro and regional economic, industry and international trade data. variable names and descriptions and sources are depicted in table 2. the list of the municipalities is not included in this study in order to save space but it is available upon request. definition of skills this study defines skills by profession (see table 1). this approach is better than defining skills by educational level. it may attenuate the education quality issue and also capture elements of workplace skills accumulation. for instance, there may be people of a certain educational level who are unemployed. table 1: skills classification according to profession in south africa. table 2: variables, description and data sources. empirical results and discussion the summary statistics presented in table 3 show the data for the dependent variable at level (output) with an average of r941 million and varies between 0 and r42 073 million. the output growth (g) averages 0.028% and varies between -0.6% and 1%. the minimum of growth rates indicates that some of the values are negative suggesting that if a need to take the logarithm of the variables arises, the logarithm of the growth rate will result in missing values for the negative values. the human capital proxies show that semi-skilled (ss) employment has the highest mean of 2445 employees, followed by low-skilled (ls) at 1061 employees and lastly the skilled (s) employees averaging 902 employees. a similar trend is reported for the standard deviation, suggesting high volatility within the semi-skilled employed labour. physical capital has an average of r187 million and varies between 0 and r9.8 billion for the determined period. table 3: summary statistics. table 4 presents the correlation matrix of the variables used. statistically significant association is reported among a majority of the variables with a positive correlation between total output and capital recording a notable 90.4%. the total output is positively related with all skill levels of the employed (human capital proxies), recording correlation coefficients of 78% with skilled labour, 85% with semi-skilled labour and 59.2% with low-skilled labour. this suggests that the semi-skilled labour cohort has a significantly high correlation with total output in south africa followed by the skilled and to a lesser extent the low-skilled of the employed labour. table 4: correlation matrix for total output. similarly, a correlation matrix with output growth (g) as a dependent variable shows a positive correlation between skilled employment and economic growth while reporting a negative correlation between low-skilled employment and economic growth. the weak correlation between physical capital and growth was unexpected and is not in line with borojo and jiang’s (2015) emphasis on physical capital as a critical input for economic growth. the results of the pairwise correlation with the growth rate of output as the dependent variable are shown in table 5. table 5: correlation matrix for output growth. the structure of the labour force is presented by the different skill shares of the employed people in the formal sector as defined in table 2. the correlation between output and shares is in line with theoretical expectation as a share of skilled employment (sh_s) is strongly positive at 31%, followed by a share of semi-skilled (sh_ss) at 5% while a share of low-skilled (sh_ls) is negatively correlated with output (table 4). similar results were reported in the correlation between output growth (g) and the shares in table 5. these results are in line with arguments made by diebolt and hippe (2016) that educated labour is an enabling agent to economic growth. the positive sign between total output and total employment, as well as capital is in line with mnif’s (2016) argument that capital accumulation and labour productivity bode well for total output. these economic agents (capital and labour) are also recognised by eicher (2000) as crucial for economic output. this study focuses on the quality embedded in labour, and the contribution of skilled, semi-skilled and low-skilled employees to economic output. the variation of the coefficients (in the different models) will inform the contribution of each of the proxies of human capital to total economic output. table 6 presents overall results of the panel causality test between total output and human capital (s) from lag 1 to 4 across 269 municipalities of south africa. the study applies the hypothesis of dumitrescu and hurlin (2012). the proxy of skilled labour (s) is considered to be highly embedded with an educational element (compared to semi-skilled and low-skilled labour). with the panel results showing that the p-values of the z-bar and z-bar tilde statistics are significant at 1%. table 6: causality between economic output and human capital. the results indicate that the null hypothesis of no granger causality will be rejected as all coefficients are different from zero. the alternative hypothesis is accepted, implying that there is bidirectional causality between economic output and human capital for all panels at all four lags. similarly, the results presented in table 6 indicate bidirectional causality between economic output and total employment (empl_t) for all panels of the four lags. the p-values of the z-bar and z-bar tilde statistics are statistically significant at 1% level. this led to the rejection of the null hypothesis of no granger causality running from output to empl_t. the null hypothesis of no granger causality running from empl_t to output is also rejected. the results confirm that total output is a causal effect for employment and that employment also propels economic output. results from the panel causality test informed that higher levels of economic output could possibly predict a demand for skilled employment, indicating that as the economy grows, the need for skilled employees to facilitate the adoption of new technologies will increase. also, an increased number of skilled employed bodes well for total output and total employment. the results from table 6 confirm a bidirectional causal relationship between total output and human capital in the formal employment sector. this suggests that a change in total output predicts a change in the skilled cohort of formal employment and also a change in the skilled cohort of formal employment will cause a change in total output. similarly, table 6 shows that on average a change in total output predicts a change in total employment while a change in total employment is an indicator of a change in total output in south africa’s 269 municipalities between 1993 and 2016. the results are suggestive of endogeneity between the key variables. from the above results of the causality test, the presence of possible endogeneity led to the reliance and use of a system gmm estimation technique. a system gmm is best suited to deal with heterogeneity, heteroscedasticity and potential endogeneity issues. each estimator has two regression results, for human capital variables at level and the different shares of skills of total employment. this section further discusses the estimations of total output and output growth in level terms in which the skill quality embedded in the labour force is used as a proxy for human capital in this study. in this regard, the formal employment sector has been divided into three constituent elements (skilled, semi-skilled and low-skilled) in order to clearly determine the contribution of each skill level to the economy. table 7 presents the estimation of the two-step system gmm results in which total output is the dependent variable. the data is in logarithm form for both actual values and shares of each of the human capital proxies. for this study, the variables of interest are the total output, proxies of human capital (s, ss and ls), as well as shares of each skill level in formal employment (sh_s, sh_ss and sh_ls). table 7: system generalised method of moments results. the overall performance of the models displayed in table 7 is largely satisfactory with most of the signs of the coefficients in harmony with theoretical expectation of the catalytic influence of human capital on economic output and growth (lucas 1990; mankiw et al. 1992). the results from the dumitrescu and hurlin (2012) panel causality test confirmed the existence of bidirectional causality a possibility of endogeneity. in this regard, yakovlev (2007) commends a system gmm application as a more robust and efficient estimator. system gmm also introduces instrumental variables to deal with endogeneity. furthermore, nayan, kadir and abdullah (2013) concur that for robust estimation, system gmm is the superior estimator. the lagged dependent (output_l1) coefficient in table 7 is positive and statistically significant at 1% level showing the dynamic nature of total output. this suggests that municipalities record positive total output despite the different levels. however, the lagged dependent (g_l1) coefficient of output growth in table 7 is statistically significant at 1% level and negative (indicating that the growth path of municipalities is moving in the same trajectory). table 7 shows that all p-values of the three different skill levels (s, ss, ls) are statistically significant below 0.05. therefore, all the three null hypotheses will be rejected and alternative hypotheses accepted. this shows that all three the different skill levels have an impact on economic output. however, the coefficients of the three different skill levels will inform if each of the skill levels has a negative or positive impact on economic output. in line with theory, the system gmm model shows the coefficient for skilled employment as statistically significant at 1% level and with an overall positive effect on the total output. holding other variables constant, a 1% increase in skilled employment (s) will boost total output by 0.055%. this implies that municipalities that employ skilled labour will record a higher total output. this confirms that the employment of high-quality skills bodes well for total output (bayraktar-sağlam 2016). in contrast, semi-skilled and low-skilled employment have a negative contribution to total output even as they are statistically significant. this shows that a 1% increase in semi-skilled and low-skilled employment will reduce total output by 0.059% and 0.002%. similarly, table 7 shows that at the level, skilled employment has the highest contribution to economic growth (g), compared to a negative effect of semi-skilled employment. a 1% increase in skilled employment will increase output growth by 0.043 units, ceteris paribus. however, low-skilled employment begins to show a positive effect on growth over time as a 1% increase contributes 0.033 units to output growth, a notable improvement from a reduction (-0.002) reported in table 7. this shows that the effect of low-skilled employment is realised on the growth rate of output rather than on level production (total output). on the structure of employment, table 7 shows that the skilled share of employment is reported as statistically significant at 1% level. a 1% increase in the skilled share of employment, ceteris paribus, will propel total output by 0.046%. similarly, in growth terms (in table 7) a 1% rise in the skilled share of employment will increase output growth by 0.035% when all other things remain constant. the contribution of the semi-skilled share of employment to total output and output growth is not consistent. a 1% increase in the semi-skilled share of employment will increase total output by 0.019% but reduce output growth by 0.034% if all other things remain constant. the low-skilled share of employment has a positive contribution to both total output (0.024%) and output growth (0.058%). this suggests that while additional low-skilled employment has an immediate muting effect on the level of production (total output), the increase of the low-skilled share of employment will increase output growth over time. the results show that labour-intensive sectors that easily attract low-skilled employees are likely to record low production levels but over time the share of low-skilled employment will have a positive contribution to economic growth. system gmm results largely show a positive and statistically significant relationship between the total output and skilled employment. skilled employment contributes 0.055% to total output, while a share of skilled employment is reported to contribute 0.046% to total output. semi-skilled and low-skilled employment are reported to have a negative impact on total output. the negative sign for semi-skilled employment indicating a negative contribution to total output was not in line with the pairwise correlation outcome. this suggests that semi-skilled employment is not adequately equipped to have a value-generating effect on total output. a similar contribution is reported for employment shares. overall, the results suggest that investment in high-end skill programmes to fully equip labour would bode well for the total output and output growth across municipalities in south africa. conclusion this study investigates the effect of human capital of employed labour on economic output and growth in south africa, with a balanced panel of 269 south african municipalities for the period 1993 to 2016. this study utilises a panel causality test and the gmm estimation techniques. empirical literature informed that educated labour tends to have a high contribution to economic output. human capital was proxied by different skill levels of formal employment. for the purpose of this study, human capital was defined as elements embodied in human beings that boost the quality of labour provided by the workforce through their skills and knowledge (kleynhans 2006). the panel causality results confirm the bidirectional causality between economic output and human capital, as well between economic output and total employment. the findings show that skilled employees have a positive effect on both economic output and economic growth. these results concur with empirical findings by pegkas and tsamadias (2014) that education (investment embodied in human beings) increases labour productivity and therefore has a positive effect on economic output both at level and growth rate. the results show that on average, skilled employment in different economic sectors across municipalities in south africa yields a higher value than semi-skilled and low-skilled employment. these findings confirm the positive effect of human capital in the form of skilled employment on economic output and economic growth. empirical findings from this study inform that skilled labour has the highest contribution to total output (even though with fewer employees) compared to semi-skilled and low-skilled labour. in line with this, ghalandarzehi and safdarie (2012) argue that a positive relationship between human capital and economic growth is mainly witnessed when the economic structure of the country is able to attract, employ or absorb and retain skilled labour. for policy direction, it is recommended that the government implement skills development policies (training scarce competitive skills to their work force) in order to upwardly shift a significant share of the semi-skilled and low-skilled employees to the highly skilled cohort. the initiative by government to revitalise technical and vocational education and training colleges is applauded if the quality of training meets the requirements of potential employers in different industries. this will ensure the realisation of one of the identified strategic interventions (improving skills and human capital formation) to develop a more competitive and diversified economy (ndp 2011). following the progress on the millennium development goal 2 of universal primary education, it is recommended that the government should also target education spending on medium and high skills to ensure progression beyond primary education. the implementation of free higher education to deserving beneficiaries is welcome as an increased number of people will progress beyond primary education. in this study, the authors investigated only employed labour and not the entire labour force. another area of research may be to include the unemployed skilled labour in order to appreciate forgone economic value. as a result of limited data prior to 1993, the study could not assess if the effect of skills on economic growth was the same prior to the democratic government. acknowledgements competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this research article. authors’ contributions n.n., c.s.s. and n.g.m. contributed equally to this article. ethical considerations this article followed all ethical standards for research without direct contact with human or animal subjects. funding information this research received no specific grant from any funding agency in the public, commercial or not-for-profit sectors. data availability data sharing is not applicable to this article as no new data were created or analysed in this study. disclaimer the views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of any affiliated agency of the authors. references abbas, q., 2001, ‘endogenous growth and human capital: a comparative study of pakistan and sri lanka’, the pakistan development review 40(4), 987–1007. https://doi.org/10.30541/v40i4iipp.987-1007 acemoglu, d., 2009, introduction to modern economic growth, 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african reserve bank college abstract 524 there is no "silver bullet" for reducing the external imbalances facing south africa, and for coping with the ebb and flow of foreign capital movements. nevertheless, various policy measures can be identified which would most probably reduce the incidence of external shocks which can plague south africa's capital account of the balance of payments. sound macro-economic policies, and in particular the creation of an environment incorporating greater monetary stability are perceived to be crucially important. the position on the capital account needs to be altered such that greater inflows of foreign direct equity capital take place, and in this respect it is concluded that a reduction in the corporate tax rate offers one of the few options open to the authorities at this stage. this offers greater potential than a system of special tax incentives, the effectiveness of the latter in attracting greater foreign investments being open to question. jel f 21 1 introduction the world economy is now fundamentally different from that which existed from 1946 to 1973 under the bretton woods system of fixed but adjustable exchange rates. the leading currencies now float in the foreign exchange markets, while the mobility of capital in the global arena has escalated substantially. the external economic environment facing south africa has accordingly changed dramatically, even though the country retains a modicum of exchange controls. a well known result of open economy macroeconomics is that countries cannot simultaneously maintain independent monetary policies, fixed exchange rates, and a liberalised capital account of the balance of payments. in the case of south africa monetary policy autonomy is now the chosen route along with a measure of capital mobility, but this has meant that it has to accept a floating exchange rate regime, and the latter has been characterized at times by instability in recent years. this article focuses attention upon the position of the rand against the background of the inherently uncertain position where south africa's capital account of the balance of payments is concerned, given this new global r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 525 sajems ns vol 4 (200 i) no 3 environment. despite the alleged undervaluation of the currency based on purchasing power parity considerations, the south african rand has experienced sharp falls in its external value both in 1996 and 1998, and to a lesser extent also in 2000. this has accordingly raised questions concerning the appropriate mix of economic policies which should be adopted to discourage periodic large outflows on the capital account of the balance of payments, while encouraging inflows of foreign capital. in this article the exact nature of the problem relating to the country's capital account of the balance of payments is outlined. thereafter, several recommendations are put forward pertaining to appropriate economic and monetary policies, which it is believed would be conducive to reducing the danger of future large outflows of capital from south africa. since roughly the middle of 1994 the stance of foreign investors towards investments in south africa improved. in particular, foreign investments in quoted south african shares changed with net buying on balance becoming the order of the day. the johannesburg stock exchange in effect took its place as one of the emerging equity markets, which was attracting attention from international investors. the character of foreign inflows of capital to south africa changed in line with mutations in global capital flows. the rise of the "equity culture" in the international sphere led to a surge in cross border equity flows into emerging markets including south africa. this supplemented a situation where foreigners had been net buyers of south african bonds on balance since 1985, some indication of this trend being shown in the following table: table 1 transactions by non-residents on the jse (r millions) 1991 1992 1993 1994 1995 1996 1997 1998 1999 i 2000 net pur-4110 -471 2809 185 4812 5254 26201 42291 40604 17421 chases of shares net pur2023 784 1521 1103 1871 3383 14778 -9765 142591-20181 chases of i bonds source: south african reserve bank quarterly bulletm, vanous issues. investment in the share and bond markets of developing countries by foreign investors has represented one of those important shifts in investment patterns that emerge from time to time, and which could prove to be still in its infancy. despite the greater risks attaching to such equity and bond investments, as shown by the economic crisis in south east asia in 1997 and 1998 and brazil in early 1999, these emerging markets had been proving in general to be attractive, because developing countries as a group had been growing much faster economir ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol4 (2001) no 3 526 cally than their industrialized counterparts. many of them have been embracing new policies aimed at instituting free market principles, lowering inflation rates, reducing budget deficits, privatising state industries and encouraging foreign investment. such considerations to some extent explained the increase in foreign portfolio investments in south africa from 1994 onwards. unfortunately, these investments and more especially foreign investments in south african quoted government bonds have proved to be fickle. after steady increases for a number of years such bond investments suddenly turned negative in february 1996, accompanied by other outflows of foreign capital including leads and lags influences. these developments were largely due to a widening deficit on the current account of the balance of payments, doubts about the speed of economic reforms in south africa, and adverse local political developments. between february and october 1996 the rand accordingly fell by roughly 25 per cent against the dollar. thereafter, the position stabilised, and subsequently during 1997 the buying of local bonds and equities by foreigners escalated dramatically as indicated in the previous table, despite the onset of economic turmoil in south east asia in the second half of 1997. moreover, the buying accelerated further in the first few months of 1998, the net buying of equities by foreigners reaching r19 billion in roughly the first four months, while net purchases of local bonds by foreigners amounted to around r16 billion in the same period. unfortunately, the danger all along had been that this buying of south african quoted securities would not continue unabated. south africa became more prone to volatile capital movements in and out of the country following the abolition of the financial rand system in march 1995, and its vulnerability in this regard was aggravated by its relatively low level of foreign reserves. for much of the time in recent years the foreign reserves of the south african reserve bank have been well below the level of three months of imports. this vulnerability is further exacerbated by the historical volatility of the short term capital account of the balance of payments due to the incidence of leads and lags influences. foreign capital flows are totally unsentimental in nature, and an internal and/or external development posed the risk that sentiment towards south africa could suddenly deteriorate, and this is exactly what happened starting in the wake of renewed turmoil in emerging markets around the world in may 1998. in part currency contagion struck south africa at that time as currency weakness in other emerging market economies spread to the republic. from the beginning of may 1998 up to early july 1998 alone the nominal effective value of the rand exchange rate dropped by more than 20 per cent. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 527 sajems ns vol 4 (200 i) no 3 this significant fall in the external value of the rand was linked to heavy selling of local quoted government securities by foreign investors. by late 1998, however, the position had stabilised, and during 1999 net inflows of funds to buy such securities supplemented the on-going buying of equities by foreigners. the situation, unfortunately, was reversed again in 2000 with foreigners disposing of the great bulk of their holdings of south african gilts and semi-gilts, net sales by foreigners amounting to r20,7 billion. whereas some emerging market economies are plagued by unstable flows of international bank finance, in the case of south afiica the element of international capital flows which has proved to be unstable in recent years has been flows of international bond finance. moreover, whereas some emerging market economies have suffered instability in foreign capital flows due in part to the domestic fragility of financial institutions, especially banks, this kind of instability has not been present in south africa. portfolio investment in south african bonds has proved to be highly volatile even though the fiscal position of the government has improved since 1994. lower budget deficits as a percentage of gross domestic product have been recorded which would suggest that foreign investors could have become more positive about bond investments in south africa, because the pressure to raise taxes was thereby reduced, as well as the danger that the government might seek to monetize the deficits, and thereby fan inflation. fragile balance of payments position there is a structural weakness in the south african economy. this takes the form of a low level of investment to gross domestic product which is around 17 per cent, and an even lower savings rate of roughly 13 per cent, which seemingly limits the potential for economic growth to a maximum of around 3 per cent at the best of times. at the same time the excess of domestic investments spending over gross domestic savings can show up in current account deficits on the balance of payments at virtually all stages of the business cycle. when they occur these deficits are being financed in part by volatile portfolio capital inflows and particularly investments in quoted bonds as already indicated, a situation which renders the rand highly vulnerable to mutations in the sentiment of foreign investors, mutations which in tum can precipitate adverse leads and lags influences. it only requires net capital inflows to fall to levels below the prevailing deficits on the current account for the rand to start coming under pressure. this vulnerable balance of payments position could partly explain why south africa is one of the few countries in the world where the central bank relies heavily upon private foreign credit lines extended by foreign banks. these credit lines have been drawn upon substantially in recent years when the rand has corne under pressure, although the major motive for such drawings may r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 3 528 have been an attempt to bolster the gross foreign reserves of the bank, and enhance its credit status. 2 impact of international capital flows south africa is to some extent a hostage to developments in international capital markets. the international economy is increasingly dominated by huge capital movements. every day around $1,85 trillion of funds move through the foreign exchange markets of the world at the speed of light with major effects on national economies around the world including south africa. (andrew crockett, 1995: 178). the growth in international financial transactions has been particularly prominent in the case of portfolio investments, some indication of this being furnished in the following table: table 2 cross-border transactions in bonds and equities (as a percentage ofgdp)(a) 1 1975 1980 1985 1990 1997 united states 2,8 4,2 9,3 36,4 92,5 213 japan 1,5 7,0 60,5 118,6 96 germany 3,3 5,1 7,5 33,9 57,5 253 i france 8,5 21,4 53,3 313 italy 0,9 1,1 4,0 26,7 672 united kingdom 367,5 690,1 canada 5,7 3,3 9,6 26,7 63,8 358 (aj gross purchases and sales of securities between residents and non-residents source: bank for international settlements annual reports 1992: 193 and 1998: 100 the figures revealed in this table refer to foreign portfolio investment in industrial countries. however, as previously indicated globalisation now extends to emerging market countries in the sense that investors in industrial countries now invest substantial amounts at times in the equities and bonds of developing countries as well as undertaking direct foreign investments in these countries. from 1990 to 1996 net private capital flows to developing countries (including countries in transition from planned economies) more than quintupled, rising from about $44 billion to $244 billion a year (world bank, 1997: 5). largely unrestrained capital flows in the international arena are able to exploit the international inconsistencies of national economic policies. with no restrictions on international capital flows in place the global capital markets will continue to flourish, capital flows changing direction quickly against a background r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 529 sajems ns vol 4 (2001) no 3 in which there are no coordinated monetary policies among the major central banks in the industrial countries. huge swings in international capital flows and gyrations in exchange rates that often result, can create substantial problems for even the most highly developed economies. for developing countries like south africa, which require foreign capital to supplement domestic savings and to stimulate economic growth, the impact of capital flows is even greater, because of the crises which can afflict emerging markets from time to time. there is a strong school of thought which argues that the historical pattern of boom-and-bust cycles in international capital flows to emerging markets are likely to persist. this school asserts that fundamental failures in policy in the emerging market economies, and financial linkage across these markets help to explain why boom-and-bust cycles take place in foreign capital flows to these markets in an environment where exchange controls on capital flows are being progressively phased out. as a result it is argued that the time will come again when a number of emerging market countries will face severe external financing difficulties. the reforms to the international monetary system which have recently been introduced, moreover, will not necessarily lessen these problems. contingent credit lines of imf in an effort to reduce the impact of disruptive capital flows on emerging market countries, the imf in april 1999 introduced a new facility which in effect is a contingent credit line. under this new facility the imf offers large, preapproved lines of credit to shield prudent developing countries from panic on the part of foreign investors. these lines of credit are supposed to be for countries with fundamentally strong economic policies, but which are in danger of suffering from disruptive capital outflows emanating from problems afflicting emerging markets in general. however, by september 1999 no country had applied for such a contingent credit line. some countries do not want to adopt the strict economic reforms that the imf would demand, but the main reason seems to be rooted in a dilemma attached to the contingent credit line idea. the credit line facilities are supposed to be an imf seal of approval on a country's economic policies, and a sign that industrialized countries and the lending institutions (such as the imf) which they control are prepared to place money behind that endorsement if the need arises. in theory, investors around the world should find the imf's promise so reassuring that they would keep their investments in the country concerned, even if there is turmoil elsewhere in the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 3 530 emerging markets league. ideally; the country would not have to draw on an imf loan. in reality, however, developing countries are not sure whether foreign investors will see the contingent credit line as a sign of strength, or as a big banner that blares in essence that the country has economic problems that investors are not aware of. if the markets reach this latter conclusion such a credit line could precipitate even bigger capital outflows from the country. some commentators have mentioned south africa as a potential recipient of a contingent credit line from the imf in the future, but this is open to serious doubt, especially if no other country applies for such a credit. uncertainties about the manner in which the markets react could be a strong inhibiting factor. from the perspective of reducing the incidence of capital outflows from south africa, internal policy changes may hold far more promise. 3 capital flows and gold unrestrained capital mobility in the international arena is probably here to stay, partly because such free movement of capital permits a more efficient allocation of global savings, and directs resources towards their most efficient use. at the height of the crisis afflicting emerging markets in 1998 some critics argued for the imposition of exchange controls, and the closing of emerging market economies to the outside world. however, in confronting the crisis, virtually all policy makers in emerging markets rejected these calls, thereby signalling their belief that integration with the world economy is in their interests. nevertheless, south africa still has to come to terms with this phenomenon of unchecked capital mobility. there are some gold bugs who still claim that part of these huge international capital flows, far from continuing periodically to disrupt . south africa's capital account of the balance of payments, will at some juncture be redirected to the gold markets with dramatic positive implications for the price of the yellow metal, and south africa's gold export earnings. any such eventuality, however, should be deemed to be very doubtful under prevailing circumstances. the enormous increase in international capital flows has been accompanied by the liberalisation of financial markets, and a wide array of new investment products. gold has many more competitors for investment funds compared with a couple of decades ago, and in this respect the emergence of greatly enhanced international capital flows has been negative for south africa. the scrapping of exchange controls in various countries has also furnished new investment opportunities for investors who are keen to move out of their domestic currencies. new alternatives to gold have again emerged from r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 531 sajems ns vol 4 (2001) no 3 this process. moreover, inflationary pressures around the world in general remain subdued, and the globalised financial markets can quickly punish nations which get out of line in this regard through the capital outflows which can be generated. 4 capital flows and south african exchange controls during and after the financial crisis afflicting asia in 1997 and 1998, attitudes towards the free movement of capital between countries hardened somewhat. it was asserted in some quarters that india and china two asian countries with exchange controls escaped the crisis precisely because they maintained exchange controls. the asian crisis is now over, but the debate on exchange controls rages on, one lesson of the asian crisis seemingly being that countries with exchange controls in place should take their time in liberalising their capital accounts of the balance of payments. in certain quarters, moreover, it is anticipated that the global trend towards the elimination of exchange controls will receive a major jolt from future developments in europe. the pronounced weakness of the single european currency the euro since its launch at the beginning of 1999, and the expectation in some quarters that this weakness will persist, has convinced certain observers that exchange controls could eventually be re-introduced in the european union (international currency review, 2000 and 2001: 6). nevertheless, the south african authorities have indicated that they intend moving in the same direction as many other countries in the sense of abolishing the remaining exchange controls on residents now that those on non-residents have been removed. in other words, they want to liberalise the local foreign exchange market, and fully join the global capital market network. much progress in this direction has indeed already been achieved, and each step towards further liberalisation means that capital flows become larger relative to current account transactions on the balance of payments. however, the removal of the remaining exchange controls in south africa is being complicated by the existence of these liberalised capital markets in the international sphere, and the vast opportunities for foreign investment which they offer to residents of countries including those of south africa. roughly rl,5 billion a year now flows out of south africa which is undertaken by individual residents taking advantage of foreign investment facilities now made available under the exchange control regulations. it should also be noted that capital outflows from south africa in recent years have been facilitated in part by the libr ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 n03 532 eralisation of financial markets in overseas centres reflected for instance in the growth of numerous offshore financial centres where taxes are minimal or nonexistent. from the perspective of strengthening the capital account of the balance of payments, reducing the incidence of disruptive capital flows and scrapping exchange controls, there are grounds for arguing that income taxes on investment incomes accruing to south african residents should be reduced, especially since this could boost personal savings which are low at around i per cent of personal disposable incomes. creating a more favourable environment for private savings in south africa would promote a desirable structural adjustment in the economy. the objective of removing the remaining exchange controls is in part influenced by the desire not to be left behind by other countries which are progressively eliminating such controls, as well as the desire to make south africa more "investor friendly", and therefore better able to tap some of these huge flows of international capital. these considerations mean that the authorities are most unlikely to consider the re-introduction of the financial rand system, which would be an exchange control method of limiting the impact of sudden reversals in capital inflows. this is the case even though there is some evidence that the financial rand system did insulate to some extent the commercial rand exchange rate from volatility in non-resident inflows of portfolio capital during the period from 1985 to 1995 (farrell, 2001). however, this aim of removing the exchange controls is being made more difficult by today's financial climate in which many of these capital flows seek currencies which are expected to appreciate. the south african currency is not perceived to be a strong one, partly because of its relatively high rate of inflation, which raises the issue of the appropriate monetary policies to be pursued by south africa in the face of its vulnerable position on the capital account of the balance of payments. 5 implications for south african monetary policies the argument is commonly put forward that the liberalisation and international integration of financial services around the world as well as growing international trade links make it imperative for south africa to bring domestic inflation in step with that of its major trading partners. these growing financial links also render it important that the country maintains sound and efficient financial institutions and markets. if the rate of inflation is not brought down to a level in line with that of its major trading partners, the rand will continue to depreciate over time against other major currencies, and the incentive of foreigners to invest in the country will be blunted. in addition, monetary stability is also of primary importance in south africa because it imparts credibility to the central bank. a credible central bank, in tum, offers some defence against weaknesses on the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 533 sajems ns vol 4 (200 i) no 3 capital account of the balance of payments. the thrust of monetary policy should therefore be to establish monetary stability, partly because this would aid the capital account of the balance of payments. the benefits of monetary stability stretch even further. such stability creates an environment which is conducive to greater economic growth, which in turn could attract greater amounts of long term foreign capital. monetary stability potentially promotes economic growth because it improves the workings of the pricing mechanism and economic decision making, minimises the inflation risk premium in long term interest rates, reduce the incentive to hedge against inflation, and facilitates investment decision making. a much more stable rand stemming from a lower inflation rate is not guaranteed. south africa's fundamental balance of payments problems will not be eliminated simply by eradicating the inflation rate differential which currently exists. during the past few years south africa's export base has been steadily eroded by the fall in the international price of gold, and the decline in domestic gold production. nevertheless, such a monetary environment would be conducive to greater stability on the capital account of the balance of payments and in the rand, and prudent fiscal policies would further aid this outcome. indeed, some analysts argue that the benefits on the capital account which can flow from the implementation of such policies can precipitate a new set of problems. the degree of integration of an emerging market economy with the rest of the world is crucially affected by the economic policies which it pursues. prudent macro-economic policies accompanied by strong central bank credibility, may instill such confidence in the country in the eyes of foreign investors that large capital inflows may raise questions as to whether chilean type controls on inflows of short term foreign capital are desirable. monetary stability should be accompanied by financial stability. south africa needs a strong well regulated financial system, something which it fortunately possesses. in asia, circumstances varied from country to country, but the crises of 1997 and 1998 reflected to an important extent weaknesses in the financial systems of certain countries. while crises may occur even when the fmancial system is sound, as in brazil in january 1999, the extent of crises can be significantly affected by the strength of the financial system. in this regard, because south africa's banking system is sound and well regulated, it was able to withstand the shocks from the large increase in interest rates, and the substantial depreciation in the currency during the time of the crisis in 1998. in view of its strong banking system the country was better able to raise interest rates in an effort to discourage capital outflows and encourage inflows of foreign capital. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 3 534 some commentators argue that in view of the shocks which can suddenly disrupt the capital accounts of the balance of payments of developing countries, interest rates in such countries need to be more flexible over the ups and downs of the economic cycle. a prompt response to shocks may prevent the need for larger subsequent movements in rates. however, such a forward looking approach to monetary policy and interest rate setting came into being in south africa with the introduction of a new accommodation system in march 1998 involving more frequent changes in interest rates in response to movements in the rand. this new system unfortunately did not prevent a crisis emerging in the middle of 1998, even though the scale of capital outflows was no doubt moderated by the sharp increase in interest rates at that stage. 6 moves towards a more freely floating rand in general countries have found it increasingly difficult to maintain fixed exchange rate regimes due in part to the huge increases in capital flows across borders during the past two decades or so. in today's environment where massive amounts of capital can move in a relatively short period of time as previously explained, the potential for shocks has become much greater. this in turn has prompted more and more countries to move towards more flexible exchange rate regimes that render it easier to accommodate substantial shifts in capital flows. in 1975, 87 per cent developing countries had some type of pegged exchange rate; by the mid 19908 most countries had adopted floating exchange rate arrangements (lmf survey, 1997: 356). in south africa this quest for flexibility resulted in mutations in exchange rate policy in august 1998, which took the form of adopting a more hands off approach towards management of the floating rand. this move could lead to a more volatile rand exchange rate. at the time of the change the south african reserve bank claimed that in a world of volatile capital movements and widely fluctuating exchange rates, an asymmetrical exchange rate policy that allowed for depreciation in the rand from time to time, but never permitted any meaningful appreciation of the currency, could no longer be defended, and represented a structural weakness in the economy. for good reason the reserve bank in the past had been quick to absorb any oversupply of foreign exchange in times of balance of payments surpluses, but had been reluctant to sell foreign exchange in times of deficits on the balance of payments. the exchange rate of the rand therefore seldom appreciated, and often depreciated quite sharply. the reserve bank believed that under current conditions of financial globalisation, this policy furnished an open invitation to currency speculators who were offered a one-way bet in the south african market. the bank had come to r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 535 sajems ns vol 4 n03 the conclusion that like all other prices, the exchange rate of the rand must be allowed at times to decline, and at other times to rise. the new intervention policy was motivated by the desire to curb speculation by operators in the foreign exchange market when the rand is weak. by introducing a new element of uncertainty it was no doubt hoped that the policy would discourage some speculators such as hedge funds from taking short positions in the rand, hedge funds having allegedly operated extensively in the local market at times during 1998. it remained to be seen, however, whether a more hands off approach to management of the rand exchange rate would deter hedge funds from speculating in the rand/dollar market, and thereby affect the short term capital account of the balance of payments. indeed, the new intervention policy could have led to greater speculation in the foreign exchange market since the rand could be expected to be more volatile. leads and lags operations, for instance, could easily have become more prominent. speculators thrive on such volatility. moreover, allowing the exchange rate to appreciate might have encouraged inflows of foreign purchases of south african bonds, investments which could have been reversed as soon as these investors perceive that the cycle of appreciation is ending. any appreciation in the rand would also have created other problems of its own if the strength was based on volatile capital inflows rather than economic competitiveness, which could have been the case. this would have created problems for export industries, and sown the seeds of a deterioration in the current account of the balance of payments, which would eventually have caused the currency to weaken, which in tum would have generated speculative pressures against the rand, and adversely affect the capital account. it could have been strongly argued that any appreciation of the rand exchange rate would only have been desirable if the capital inflows pushing up the rand were associated with a sustainable increase in the international competitiveness of the economy. faced with these types of problems the policy proved to be short lived. in the second half of 1999 the bank shifted to a policy in which it intervened in the foreign exchange market to acquire dollars when meaningful surpluses appeared in the market, these dollars then being employed to run down the commitments of the bank on its forward exchange account. at the same time the bank indicated that in future it would not support the rand at times of weakness in the currency by selling dollars from the foreign reserves, a decision most probably influenced by the events of 1998 when large scale intervention by the bank failed to prevent a sharp fall in the external value of the rand. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 3 536 7 competition for foreign direct equity capital quite apart from tinkering with exchange rate arrangements, developing countries are aggressively seeking to strengthen their long term capital accounts of the balance of payments. this is being done in particular by seeking to attract long term direct foreign equity capital rather than simply foreign portfolio capital to help finance their economic growth while simultaneously strengthening their balance of payments positions. developing countries in the 1980s and early 1990s had been led to believe that foreign investment in equities and bonds traded on local markets was more long term in nature than the foreign bank lending they attracted in the 1970s. however, the huge flight of capital from the emerging markets at times in recent years has exploded that myth. inflows of direct foreign equity capital can be crucial from the perspective of creating jobs. multinational companies have been an important source of new high wage employment in numerous countries over the years. out of 8 million jobs created globally by multinational companies between 1985 and 1994, 5 million were created in developing countries. moreover, such equity capital is long term nature, posing little or no danger that it will quickly flow out of the country where it has been invested, and brings with it technology transfers, more efficient business practices, and hopefully increased international competitiveness. many developing countries are therefore concluding that direct equity investment in their economies by foreign companies is a safer way of attracting capital than relying too much on the financial markets for foreign portfolio investment. this helps to explain why many of these countries are creating a tax environment which encourages foreigners to establish production facilities within their territories. one can therefore anticipate that the competition which already exists between developing countries (and developed ones) to reduce their corporate tax rates could well intensify. globalisation is leading to greater tax competition in this area, even though governments can offset the loss of tax revenues to some extent by broadening the defmition of taxable profits. the desire to attract such foreign capital also helps to explain why privatisation of state assets is sweeping through some of these countries. these developments have significant implications for south africa. the country can attract large net purchases of bonds and equities by foreigners at certain times, but it has been seen that such investments and especially bond investments can be quickly liquidated precipitating downward pressures on the rand. there is a large imbalance between foreign portfolio investments and direct foreign investments which are attracted into the country as indicated in the following table: r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 537 sajems ns vol 4 (2001) no 3 table 3 direct and portfolio investment flows into south africa 1991 1992 1993 1994 1995 1996 1997 1998 direct foreign 685 -11 56 1334 3940 3411 11297 1887 investment in private nonbanking sector foreign portfolio invest1740 5227 2427 10298 10651 17983 51563 50452 ments source: south african reserve bank quarterly bulletin, june 1999 this imbalance is supplemented by another weakness on the capital account. according to reserve bank statistics total foreign direct investments in south africa in 1998 at r3, 16 were lower than foreign direct investments made abroad by south africa totalling r9,6 billion in the same year. this imbalance, moreover, was recorded despite the existence of tight exchange controls in south africa. the most important prize for south africa would be an upsurge in foreign direct equity investments rather than simply portfolio investments. the factor that precipitated the foreign debt crisis in august 1985 was not disinvestment by foreign firms, but rather the pressures for the repayment of foreign loans. throughout south africa's economic history it was this kind of foreign capital that was often instrumental in promoting periods of fast economic growth. the industrialisation of the south african economy in the interwar period before 1939 was associated with a wave of investments by foreign manufacturing firms. the competition faced by the country in attracting long term foreign direct equity capital is probably going to become more fierce at a time when its ability to compete in this area is already under a cloud due to various factors, one of which is the limited size of the domestic market. direct equity capital at this stage constitutes a very small proportion of the total foreign capital flowing into the republic as already indicated. even so, in a global context the propensity of foreign investors to invest in this way is strong. between 1990 and 1997 such foreign direct investment rose at an annual rate in real terms of 14 per cent. inward foreign direct investments into oecd countries reached a record of $465 billion in 1998, representing a 71 per cent increase over 1997, while outflows of such investments also reached an unprecedented $566 billion. (oecd, 1999: 111). the problem is that south africa is largely failing to attract such investments to its shores. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 (2001) no 3 538 pressures will therefore probably be exerted on the south african authorities to continue with a programme of privatisation of state assets since this will create the opportunity for selling such assets to foreign investors, and thereby attract foreign direct equity investments such as those already tied up through selling 20 per cent of telkom and south african airways to foreign investors. this programme is potentially set to accelerate starting in the fourth quarter of 2001 with the possible listing of telkom on the johannesburg securities exchange. numerous obstacles stand in the way of this programme since the environment for emerging market investments at this juncture is not particularly promising. moreover, the government's plans involve the state in keeping majority stakes in the corporations which are due to be partially sold off, which may not appeal to some foreign investors. nevertheless, the authorities could be keen to launch the programme in view of the potential benefits. in addition, pressures will exist for a reduction to be made in the burden of corporate taxation. at this stage additional tax burdens on the corporate sector could be highly inappropriate in view of the pending intensification of the global competitive struggle to attract foreign direct equity capital. ireland, which has been exceptionally successful in attracting foreign direct equity capital during the past decade or more, has a corporate tax rate of just 12 per cent. increasing international capital mobility is partially eroding the base for taxation of capital, and corporate profits in south africa. it is these considerations which explain the decision of the south african government to reduce company tax from 35 per cent to 30 per cent in the february 1999 budget. further reductions in the corporate tax rate are complicated by the fiscal implications at a time when the treasury is bent on further reducing the budget deficits as a percentage of the gross domestic product. what is more, tax arbitrage is already being encouraged by the wide margin between the top marginal tax rate of 42 per cent and the company tax rate of 30 per cent. in other words, individuals are already provided with incentives to convert personal incomes into corporate incomes to reduce their tax liabilities. corporate tax rates, moreover, constitute only one of a variety of influences which playa role in determining inflows offoreign direct equity capital into any specific country. foreign investors may be more attracted by sound economic fundamentals and relatively low risks than by tax incentives which may be perceived to be temporary in nature. the relatively low growth rate of the economy is an obvious impediment to foreign direct investment in south africa. the encouragement of direct foreign investment can also raise concerns about foreign ownership and control, and any reduction in company tax would boost retained profits of the corporate sector in south africa. this in turn could lead to new pressures from the business sector for further relaxations in the exchange controls to facilitate foreign investment. nevertheless, further moves in this direction could be appropriate since the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 539 sajems ns vol 4 (200 i) no 3 competition to reduce corporate tax rates is intense even in southern africa alone, as indicated by the recent decision of lesotho to introduce a 15 per cent rate. it is sometimes argued that south africa should avoid engaging in competition with other countries by means of offering fmancial incentives for foreign direct investment in such forms as reductions in corporate tax rates, because this may prove to be counterproductive. in other words, if south africa cuts its corporate tax rate this may encourage other countries, especially in the southern african region, to do likewise, and the end result is that the country does not acquire a competitive advantage. this argument, however, ignores current realities in which other countries are lowering their corporate tax rates irrespective of whether south africa does likewise. hence, if south africa keeps its tax regime unchanged, it will risk becoming steadily less competitive from a corporate tax perspective. moves to reduce the corporate tax rate in south africa would simultaneously encourage greater amounts of foreign portfolio equity capital onto the johannesburg stock exchange, and in this regard it should be noted that such portfolio equity capital is superior to quoted bond investments by foreigners. foreign buyers of south african equities typically have a longer term perspective than is the case with foreign investors in local fixed interest stocks. a great proportion of the buying by foreigners is now concentrated on local industrial shares, whereas in previous times the orientation was much more directed towards gold mining shares, which are much more volatile in nature with foreign investors often buying them for short term speculative purposes. a weak rand is clearly negative for bonds, because of the boost to inflation which this imparts, and the consequent danger of a fall in bond prices in terms of rands, as well as the reduced external value of the bonds stemming from a weak rand in the foreign exchange market. in contrast, many foreign investors hold south african shares with significant rand hedge qualities attaching to them, and such counters offer some protection against a falling rand. in the face of disturbances to the capital account of the balance of payments in 1996, and more especially in 1998, the policy of the authorities in south africa was to raise domestic interest rates in an effort to discourage outflows and encourage inflows. this policy worked to some extent, but it is worth noting that keeping interest rates at very high levels partly attracts short term foreign capital in the form of foreign investment in local bonds, which is at the expense of long term direct equity capital. there is a trade off between attracting portfolio foreign investment in the form of quoted bond investments, and foreign direct investment. equity capital from abroad in direct form is discouraged by high real interest rates and recessionary conditions in the economy. the same applies to r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 4 n03 540 portfolio equity capital from abroad to some extent. in sum the country needs to attract more long term direct equity capital, which should be facilitated by lower corporate tax rates, even though other negative factors such as crime, low economic growth, the zimbabwe factor and the tortuous system for granting work and residence permits for foreigners will most probably remain deterrents to such investments. rising levels of international mobility of capital are not only progressively eroding the base for taxation of company profits; they are also putting pressure on countries to reduce personal income tax rates. lower corporate taxes mean that the top marginal rates of income tax tend to come down in order to prevent "tax arbitrage" between the corporate and personal sectors. in addition, the high mobility of capital is encouraging countries such as the united states to cut income taxes, which in tum exerts pressure on other countries to move in the same direction, and this includes south africa. 8 taxincentfves one of the important features of the globajisation process is the competition between different countries to attract foreign direct investment of a long term nature, and this competition in tum has spawned a wave of specific economic incentives in developing countries in particular to encourage such investment. in the case of south africa, the country has a relatively low rating (number 33 out of 49 countries in the 1999 world competitiveness yearbook), and one keenly debated issue is that of tax incentives. tax incentives may be defmed as those provisions in the tax code that afford preferential treatment to certain activities over others such as tax holidays and credits for investment in manufacturing industries. tax incentives also include preferential treatment for certain kinds of assets in the form of accelerated depreciation for specified assets, and preferential treatment for certain types of organisation, such as lower tax rates for small rather than for large businesses. while granting tax incentives to promote investment is common, available evidence suggests that their effectiveness in attracting additional investments is often questionable. what is more, the loss in tax revenues can be high, because tax incentives can be abused by existing enterprises disguised as new ones through nominal reorganisation. the primary target of most tax incentives is foreign investors, and their decision to enter a country will normally be influenced by a series of factors, with the tax incentives possibly being of little importance. in particular, if a country's tax system is internationally competitive to start with tax incentives may be of marginal influence. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 541 sajems ns vol 4 (2001) no 3 tax incentives can also be of questionable value to a foreign investors because the true beneficiary of the incentives may not be the investor concerned, but rather the treasury of his home country. this arises because any income that is spared from taxation by the host country can be taxed by the tax authorities in the investor's home country if the latter's tax system is based on the residence principle, unless a tax sparing clause is introduced in bilateral double taxation treaties. tax incentives to encourage foreign investment therefore have virtually no influence in the absence of tax sparing agreements between the home and host country, and this is especially relevant in south africa's case because the latter has very few tax sparing agreements in force, and those which exist are very restrictive in nature involving countries with very limited propensities to export capital. from south africa's perspective tax concessions in the form of reductions in corporate taxes appear to offer more potential gain than specific tax incentives, especially since numerous other countries are competing aggressively in this tax area (vito tanzi & howell h. zee, 2000: 24-29). references crockett, a. (1999) "international financial stability how can it be restored and maintained", south african journal of economic and management sciences, 2(3): 178. 2 farrell, g.n. (2001) "capital controls and the volatility of south african exchange rates", south african reserve bank working paper. 3 imf survey (1997) november 12th: 356. 4 international currency review, winter 2000-2001, 26(4): 6, london. 5 oecd (l999) "recent trends in foreign direct investment", financial markets funds, june: ill. 6 tanzi, v. & zee, h.h. (2000) "imf working paper", imf, march: 2429, washington. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction literature review methodology study results summary of results: statistical tests and box plots for determining whether the normality and homogeneity of variances have been met discussion implications of results for policy and practice study limitations conclusion acknowledgements references about the author(s) robert w.d. zondo department of entrepreneurial studies and management, faculty of management sciences, durban university of technology, durban, south africa citation zondo, r.w.d., 2020, ‘influence of a shop floor management system on labour productivity in an automotive parts manufacturing organisation in south africa’, south african journal of economic and management sciences 23(1), a3269. https://doi.org/10.4102/sajems.v23i1.3269 original research influence of a shop floor management system on labour productivity in an automotive parts manufacturing organisation in south africa robert w.d. zondo received: 16 july 2019; accepted: 06 nov. 2019; published: 18 feb. 2020 copyright: © 2020. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: south africa’s labour productivity at the shop floor remains an issue of central concern for business. it plays a role in the life of every person and the performance of every business, thus requiring the business to solve problems at the shop floor level. this sentiment underpins the concept of a shop floor management (sfm) system. an sfm system refers to the extent of control exercised at the shop floor level for commitment and involvement of shop floor employees aimed at improving productivity. it is a process that facilitates employee engagement. aim: this study examines the influence of an sfm system for productivity improvement in automotive parts manufacturing companies in south africa. productivity in the south african’s manufacturing sector is low compared to its counterpart industries in the asian and western countries. this sector experiences the lack in short to medium term growth in productivity. setting: the automotive parts manufacturing company that has adopted an sfm strategy for productivity improvement participated in the study. methods: the study objectives were achieved by examining the production and related experiences in the company. the collection of data was carried out in two phases. this includes the collection of results pre and post-sfm implementation from company records for spoilage, absenteeism and housekeeping rates. the pre-sfm results were quarterly data reflecting the company’s performance over the three-year period prior to the implementation of the sfm. this company operates in the ethekwini district municipality in kwazulu-natal. results: the study established that housekeeping and sfm have no relation to labour productivity. however, it revealed the relationship of both absenteeism and spoilage rates with labour productivity. conclusion: sfm is an employee engagement process that creates a working environment that encourage worker participation and commitment. contribution: the original value of this paper is its approach in uncovering strengths and weaknesses of sfm for productivity in south africa. keywords: automotive parts manufacturing organisation; employee shop floor engagement; employee motivation; labour productivity; shop floor management. introduction south africa’s labour productivity, in the manufacturing sector, is low when compared to korea, the united states of america (usa), taiwan, japan, france and the united kingdom (uk) (klein 2012). it lacks both shortand long-term growth in productivity (unido 2013). the south african manufacturing industry only achieved 36% of the usa productivity level in 2014 (conference board 2015). hence, this study investigates whether the shop floor management (sfm) strategy has the ability to improve productivity in the selected automotive parts manufacturing company. scholars have described the sfm system in different ways. hanenkamp (2013) defined it as a process designed to empower the workforce so that they make decisions and solve problems appropriate to their level in the organisation. the logic is that the people closest to a problem or opportunity are in the best position to make decisions for improvement if they have control of the improvement process. according to suzaki (1993) (a japanese employee engagement philosopher), sfm is a practice of three reals (that is, genba, genbutsu and genjitsu). genba refers to the real place or the location where the value is created, while genbutsu refers to all those associated to understand the nature of all problems. genjitsu is the third real that draws a connection between the current problems and the root causes. thus, suzaki (1993) defines sfm as a closed loop process that helps observe problems on site and eliminate the root causes of such problems. in return, this will have a positive impact on productivity. a slightly different approach sees peters (2003) explaining sfm as the focus on the lower levels (namely the shop floor operators) to react quickly to process failures. hanenkamp (2013) justifies the above explanation by stating that the empowered shop floor teams with profound understanding of shop floor standards and targets sustain the business’s attempt to remain competitive and profitable. womack (2008) indicates that sfm is not literally mentioned in the earlier versions of the toyota house of lean principles. however, there are several connections between the toyota lean principles and sfm, which include developing and managing shop floor operations and workers. according to hertle et al. (2016), sfm is one of the major management approaches in lean production. through activating the potentials of employees, sfm aims to improve the business processes by developing the competencies of the employees (hertle et al. 2016). hence, this study examines the influence of sfm on labour productivity in automotive parts manufacturing businesses. larteb, benhadou, haddout and nahla (2016), who referred to sfm as shop floor control (sfc), indicate that the key to lean performance is through the implementation of a daily sfc system. they mention that sfc enhances process improvement in all sectors of the industrial economy. in order for companies to succeed and enhance their productivity, daily contact with the shop floor is vital. hence, this study is guided by the following two research questions (rq): rq1: is sfm an appropriate system for productivity improvement? rq2: does control at shop floor level improve employee commitment for productivity increase? for an organisation to evolve, people working within it have to be involved in processes that improve the organisation’s productivity (business victoria 2016). the people-involving initiative of sfm is employee engagement. thus, shop floor employee engagement is a psychological and physical demonstration of what the employee understands of their role in the organisation, and the commitment of stewardship that manifests in high productivity levels in their work (geldenhuys, laba & venter 2014). employees that engage with their organisations and those that feel a sense of belonging remain loyal and concern themselves with productivity in their roles (guest 2014). despite the acknowledgement of its importance in business, low levels of shop floor employee engagement are reported globally. the percentage of highly-engaged shop floor employees is reported to be 13%. however, 26% are reported to be disengaged (illing 2012). bersin (2015) lists the elements that negatively affect shop floor employee engagement as an absence of meaningful work, a less inclusive workplace and a disregard for opportunities for growth. employees should be recognised as a company’s most important resource and a driver for changing processes within the production area (röhrle 2009). therefore, the employee potentials should be utilised and appropriately developed (grundnig & meitinger 2013). this process will lead to the shift of decision rights from supervisors to employees. managers will then act as coaches to train employees in methodical aspects of their work. subsequently, this enhances productivity at the shop floor level. various studies show a positive correlation between high levels of shop floor employee engagement and productivity (gallup 2016; guest 2014). however, previous studies (dobre 2013; illing 2011; polster 2013) have not shown the effectiveness of an sfm system as an intervening variable for productivity in the automotive manufacturing industry in south africa. the next section discusses the theoretical framework of the study. it elaborates on an overview of sfm, as well as the effects of shop floor processes through housekeeping. a discussion of sfm and labour productivity concludes the literature review of the study. the research methodology exploring the research design, data collection, as well as the measurement and data analysis discusses the approach employed in the study. study results, followed by the related discussion, implications of results for policy and practice, study limitations and future studies required, conclude the article. literature review this section discusses an overview of sfm. it discusses the effects of shop floor processes through housekeeping. the section elaborates on sfm and labour productivity, and presents sfm as a process for employee engagement. exploration of employee motivation and teamwork as sfm tools concludes the section. overview of shop floor management shop floor management has been described as a system that provides a bottom-up information flow in production with the use of key performance indicators, action plans and regular short meetings at the shop floor. according to hanenkamp (2013), the objective of sfm includes the development of empowered shop floor teams. each team consists of operators and the team leader of that specific work area. hertle et al. (2016) indicate that the process starts with grouping the workforce into teams and allowing the team to track their contribution to the organisation’s key performance indicators (kpis). during this process, shop floor employees express themselves physically, cognitively and emotionally during role performance (gems 2015). dobre (2013) defined sfm’s engagement process as a positive, fulfilling, work-related state of mind that is characterised by vigour, dedication and absorption. hence, cherry (2016) defined it as the level of commitment and the involvement an employee has towards their organisation and its values. hoxsey (2010) studied the relationship between employee engagement within the sfm system, the organisational commitment and absenteeism. he indicates that, by looking at employees’ absenteeism records, an organisation could pinpoint which employees may not be committed in their current job. when a member of staff is unexpectedly absent from work, it raises immediate cause for concern with regard to the likelihood of missing deadlines, disruption to the quality and continuity of service delivery, the loss of productivity and efficiency, as well as a drop in motivation. consequently, this study assesses the influence of sfm on absenteeism for labour productivity. mann (2009) explains that the process of sfm is comprised of core shop floor elements. these include the use of visual controls in which visual aids in the form of process performance charts illustrate the department’s performance. it involves the initiation of daily team meetings to provide feedback to the department using visual aids, as well as the standard accountability processes. hence, team leaders should be trained with skills necessary for the management of shop floor employees (hanenkamp 2013). illing (2011) adds that sfm empowers companies to implement a sustainable continuous improvement process, complements it with the integrated production systems in order to bring executives closer to their daily business, creates transparency, and focuses on responsibilities. similarly, illing (2012) indicates that sfm has a positive influence on labour productivity. it provides the workforce with clear direction and goals, unites the organisation in one direction, initiates feedback forums which focus on the current problems and seeks solutions to resolve these problems, promotes involvement from management with shop floor employees, and fosters an environment for mutual trust and respect. hertle et al. (2016) stress that the entire sfm process depends heavily on employee engagement philosophy. thus, employee engagement is a positive attitude held by the employee towards the organisation and its value (mann 2009). an engaged employee is aware of business context and works with colleagues to improve performance within the job for the benefit of the organisation. as a driver of an sfm system, wranx (2016) adds that employee engagement is a positive, fulfilling, work-related state of mind that is characterised by vigour, dedication and absorption. the effects of shop floor processes through housekeeping two significant challenges in business, such as competitiveness and efficiency, have impelled a number of manufacturing organisations to implement innovative management strategies (zahraee et al. 2014). this includes housekeeping strategies like 5s. the 5s (or good housekeeping) involves the principle of waste elimination through workplace organisation (dobre 2013). it applies standard housekeeping practices in the workplace through the five principles of sort, set in order, clean, standardise and sustain (harino 1996). for sfm to be effective, the 5s approach must guide shop employees towards their work and help improve communication among various business functions and departments. a well-organised workplace provides a safe and efficient production environment, which boosts shop floor employee morale, promoting the feeling of ownership, pride and ownership of their responsibilities. many researchers (bicheno 1998; hirano 1996; ho 1997; o’heocha 2000) believe that the successful implementation of 5s in the sfm environment significantly improved quality, productivity, time delivery, safety and shop floor employee morale values. shop floor management and labour productivity an engaged employee is able to offer a sustained effort to their organisation (cook 2008). the benefits of shop floor employee engagement include improved labour productivity and greater passion for commitment to vision, strategy and goals of the organisation. consequently, dobre (2013) adds that sfm (as a primary process for employee engagement) is an approach that ensures the effective utilisation of people and processes. employee engagement through sfm team meetings is key to achieving labour productivity targets outlined by the business. the business needs to foster a shop floor culture that encourages the workforce to perform their responsibilities to meet customer expectations, thus positively influencing labour productivity (dobre 2013). according to hanenkamp (2013), for employees to perform optimally they should understand their work standards, receive adequate training and be provided with timely feedback regarding their performance (dobre 2013). wranx (2016) adds that employees operating in an sfm environment must be engaged in order to yield greater labour productivity. for labour productivity to be realised, hanenkamp (2013) presents the links between sfm and employee motivation and teamwork. employee motivation the motivational functions in performance feedback stipulate that management hold regular meetings to provide feedback regarding employee progress towards targets (mann 2009). in this case, the feedback is used as an opportunity to appraise the employee for the purpose of increased efficiency, productivity and morale. hence, the feedback process brings the opportunity to focus on work activities and targets. it encourages and motivates employees to perform better (nyaoga, simeon & magutu 2010). teamwork a team is a collection of individuals who are interdependent in their tasks and share the responsibility for outcomes (cohen & bailey 1997). brown (1995) adds that teamwork can influence performance results and organisational objectives. it enhances effectiveness and productivity of a company, which leads to an organisation becoming more profitable (jiang 2010). hanenkamp (2013) indicates that empowered shop floor teams are important factors for successful sfm. the influence of teamwork is evident when employees come together during their daily team meetings (quddus & nazmul 2014). the team is able to detect deviations, analyse and solve them in accordance with defined improvement measures. the implementation of the improvement measures is discussed in the structured meetings at the shop floor level (illing 2011). however, liker (2012) indicates that the problem and the implementation of the improvement measures can be escalated to the next level, upwards, depending on the complexity of the problem. nonetheless, high performance work teams operate with little or no supervision (bhuvanaiah & raya 2014). hence, illing (2012) indicates that sfm creates a platform in which team members are encouraged to share workloads and help each other. while sfm supports lean principles, the system improves the operational performance of a company. therefore, a quantitative goal of sfm is the systematic control and improvement of operational kpis (peters 2003). these include quality, efficiency, and reliability of order fulfilment (riegger 2011). hence, this study investigates whether sfm has the ability to improve labour productivity in the automotive parts manufacturing sector. it explores the suitability of sfm as an appropriate tool for productivity improvement. hypothesis: the study is based on the following assumptions: h1: the implementation of sfm leads to labour productivity improvement in automotive parts manufacturing companies. h10: the implementation of sfm does not lead to labour productivity improvement in automotive parts manufacturing companies. the following are sub-hypotheses: h2: an increase in the absenteeism rate increases labour productivity in automotive parts manufacturing companies. h20: an increase in the absenteeism rate decreases labour productivity in automotive parts manufacturing companies. h3: an increase in spoilage rate increases labour productivity in automotive parts manufacturing companies. h30: an increase in spoilage rate decreases labour productivity in automotive parts manufacturing companies. h4: an increase in the rate of housekeeping increases labour productivity in automotive parts manufacturing companies. h40: an increase in the rate of housekeeping decreases labour productivity in automotive parts manufacturing companies. methodology the method for this research will be discussed under the following headings: research design and approach, company that participated in the study, data collection, as well as measurement and data analysis. research design and approach this study was quantitative in nature. it examines the relationship of labour productivity as a dependent variable with absenteeism, spoilage, and housekeeping as well as a post-sfm dummy. bryman and bell (2007) explain that the quantitative approach involves the use of statistical procedures to analyse the data collected. consequently, after the measurements of the relevant variables, the scores were transformed using statistical methods. the study was also conclusive in design. conclusive studies are meant to provide information that is useful in decision-making (yin 2008). company that participated in the study a convenience sample from one large automotive parts manufacturing organisation situated within the ethekwini district municipality in the province of kwazulu-natal in south africa was used. the company had adopted an sfm strategy and agreed to participate in the study. it is labour intensive and, prior to sfm implementation, disturbances were reported in the production process, resulting in the production targets not being met. the shop floor employees did not show commitment in their work activities. consequently, the company had to implement sfm in order to improve supervision and give employees the platform to raise concerns they come across in their workplace. hence, the sfm system was used on the company’s blue-collar employees whose jobs require manual labour. the company had 1307 employees and operates a three-shift system. table 1 presents a percentage breakdown of employees in terms of their level of activities. table 1: percentage breakdown of employees in terms of their level of activities. data collection the collection of data from the company that participated in the study was carried out in two phases. this involved the collection of pre-and post-sfm results from company records for absenteeism, spoilage, housekeeping and labour productivity. the pre-sfm results were quarterly data reflecting the company’s performance over the four-year period prior to sfm implementation. this includes data from the first quarter of 2009 to the final quarter of 2012. the post-sfm data reflect the company’s performance for four years after sfm was implemented. this includes data from the first quarter of 2014 to the final quarter of 2017. note that the year 2013 was the sfm implementation period. its data was excluded from the study. measurement and data analysis the company’s quarterly time series data on absenteeism, spoilage and housekeeping rates were used. the measurements were based on a total of 96 observations. a dummy variable, which assumed the value of 0 and 1 to represent the periods preand post-sfm, was introduced into the ordinary least squares (ols) model. the aim was to isolate productivity effects resulting from an introduction of sfm. consequently, if sfm proved to be a useful strategy in raising productivity levels, this would result in a statistically significant coefficient on the dummy variable. the ols model used was as follows: labour productivity = b0 + b1absenteeism + b2spoilage + b3housekeeping + b4pre/post dummy. the above model identifies labour productivity as a function of absenteeism, the spoilage and housekeeping rates, as well as the sfm system. for this study to achieve its objectives, the normality test was conducted using kolmogorov-smirnov and shapiro-wilk for the overall score of the constructs. table 2 presents results for normality tests for labour productivity, absenteeism and spoilage rates, as well as the housekeeping rate. table 2: normality tests for absenteeism, spoilage and housekeeping rates. the statistical tests in table 2 show that the data were not normally distributed (p > 0.05). hence, the results were analysed using a parametric test, that is, the t-tests. study results this section presents results for the preand post-sfm means comparison, as well as labour productivity. preand post-shop floor management means comparison table 3 compare the means (in percentages) for absenteeism, spoilage and housekeeping. table 3: preand post-shop floor management percentage means comparison. table 3 indicates that the percentage mean data for the pre-sfm period for absenteeism, spoilage and housekeeping are 2.51, 2.04 and 73.75%. however, the percentage mean data for the post-sfm period for absenteeism, spoilage and housekeeping are 4.11, 0.70 and 65.04%. the table shows mixed results of mean values on the three variables (that is, the absenteeism, spoilage and housekeeping from pre-sfm mean data to post-sfm mean data). hence, the next section assesses labour productivity results as a consequence of sfm implementation. labour productivity results table 4 presents the results for labour productivity as a dependent variable to absenteeism, spoilage, housekeeping, as well as post-sfm dummy. table 4: results for labour productivity as a dependent variable to absenteeism, spoilage, housekeeping, as well as post-shop floor management dummy. labour productivity as a dependent variable to spoilage rate the results in table 4 show that spoilage rate has a statistically significant relationship with labour productivity as shown by its t-value of –4.555. it is above the critical absolute t-value of 1.960 at the 5% level of significance (curwin & slater 2002). the negative relationship indicates that any decrease in spoilage rate would result in an increase in labour productivity. labour productivity as a dependent variable to absenteeism rate results as illustrated in table 4 show that absenteeism rate has a statistically significant relationship with labour productivity. this is determined by its t-value of 2.504, which is above the critical absolute t-value of 1.960 at the 5% level of significance. labour productivity as a dependent variable to housekeeping table 4 show that housekeeping has no relationship with labour productivity. this is determined by its t-value of 0.839, which is below the critical absolute t-value of 1.960 at the 5% level of significance. labour productivity as a dependent variable to shop floor management dummy variable results show that sfm has no relationship with labour productivity. this is determined by its t-value of -0.885 and is below the critical absolute t-value of 1.960 at the 5% level of significance, thus accepting the null hypothesis of no relationship between the two variables. it has the adjusted r2 of 0.868. however, the serial correlation is high at 1.914 when compared to the standard value of 1.72 at the 5% level of significance (curwin & slater 2002). summary of results: statistical tests and box plots for determining whether the normality and homogeneity of variances have been met this section analyses data using factorial designs. it incorporates box plots to determine whether the factorial anova assumptions of normality and homogeneity of variance have been met. porkess (2005) explains that the populations represented should be normally distributed (that is, the normality), making the mean an appropriate measure of central tendency. however, the homogeneity of variance indicates that the population from which the data are sampled should have the same variance. the bartlett’s test was used to verify whether the variances were equal for all the samples (curwin & slater 2002). figure 1 shows the summary of the results from bartlett’s test for homogeneity of variances. figure 1: bartlett’s test for homogeneity of variances. table 5 presents detailed results of bartlett’s test for homogeneity of variances for labour productivity, spoilage rate, absenteeism rate as well as housekeeping. table 5: bartlett’s test for homogeneity of variances (p = 7.520). the p-value in the bartlett’s test (at p > 0.05) shows that the homogeneity of variance is violated. the p-value at 7.520 is above the significant level of 0.05. therefore, the variances are not equal, given the amount of variability in the variances that can naturally occur in the data. this is confirmed by levene’s test of equality, shown in table 6. table 6: levene’s test of equality of error variances. porkess (2005) defines levene’s tests of equality as an inferential statistic used to assess the equality of variance on different samples. in levene’s test of equality, the statistical procedure assumes that variances of the populations from which different samples are drawn are equal. however, the results in table 6 show that the obtained similarities between the variances in the samples between the pre and post data sets at p-value 0.604 did not occur. they are above the statistically significant value of 0.05. the associated plots in figure 2 confirm the results. figure 2: box plots determining the normality and homogeneity of variance. figure 2 shows the mode of change from preto post-sfm system periods are homogeneous. however, the box plots indicate that the variances for spoilage, absenteeism and housekeeping rates are not equal. this was confirmed by both bartlett’s and levene’s tests results. discussion this study investigates the influence of the sfm system on the improvement of labour productivity in an automotive parts manufacturing company in south africa. it examined the production and related experience of the parts manufacturing company that has adopted an sfm strategy for its employees. quarterly time series data on absenteeism, spoilage and housekeeping were used to analyse data. results indicate that housekeeping and sfm have no relation to labour productivity. however, it revealed that the both the absenteeism and spoilage rates have a relationship with labour productivity. this is supported by bhuvanaiah and raya (2014) who indicate that, during the process of the sfm system, employees become self-motivated, driven and energised to perform to the organisation’s expectations. furthermore, riegger (2011) adds that an engaged shop floor employee is aware of business context and works with colleagues to improve performance within the job for the benefit of the organisation. implications of results for policy and practice organisations in south africa should revise their performance management systems and develop sfm strategies, policies and practices that help to achieve new business goals and support organisational and cultural change (wranx 2016). this must be based on an understanding of the economic factors affecting employee engagement and motivation, and the significance of the psychological meaningfulness of work that influences shop floor employee engagement for productivity improvement. besides the achievement of study objectives, the following conclusions can be made on the sfm philosophy: it is an extent of control that is exercised at the shop floor level for employee engagement aimed at achieving organisational values. hence, sfm is a process for employee engagement gearing for organisational success through productivity. it empowers shop floor employees to make decisions and solve problems appropriate to their level in the organisation. it is a system that improves absenteeism and reduces spoilage rates for labour productivity. in order to maximise performance, a comprehensive performance policy must be developed, which aligns employee engagement to productivity (farouk 2014). study limitations the study was limited to an automotive parts manufacturing company within the ethekwini district municipality. the investigation was conducted in a single company that has adopted the sfm system. as there are 378 registered automotive parts manufacturing organisations in south africa (sainfo 2008), the results cannot be extrapolated to other companies within the sector. secondly, it did not examine the process followed during the sfm implementation including (among others) the individuals that participated in the implementation process. it only used quarterly time series data to determine the preand post-labour productivity effects resulting from the sfm strategy. lastly, the econometrics model used was of the ols variety, solely due to data constraints. future studies ought to use the more advanced johansen var methodology or panel data analysis, both of which rely on large data sets. conclusion sfm is an appropriate employee engagement process that creates a working environment that encourages worker participation and commitment. properly implemented and managed, the system results in employee performance improvement. psychological meaningfulness and motivation play a role in shop floor employee engagement (geldenhuys et al. 2014). consequently, the study revealed the relationship between both absenteeism and spoilage rates and labour productivity in the selected automotive parts manufacturing company. it is an approach that takes advantage of a focused organisational strategy to combine employee communication, decision-making and participation. the system can be used for developing employee capability in the organisations. hence, the employees will have the capabilities to solve organisational problems (alazzaz & whyte 2015). future research required during the course of this study, issues relating to the long-term survival of an sfm strategy after implementation were not covered. this includes the applicability of sfm to a wider sector of the economic activity, including the public sector. the nature of this research did not allow these areas to be covered in depth. it is recommended that future research should examine the following issues in greater depth: when to use and when not to use the sfm system. the applicability of an sfm approach to other industrial sectors. the process followed during the implementation of an sfm system. a more comprehensive investigation should be carried out using a randomised sample of the registered automotive manufacturers that use an sfm strategy, to see if the results can be generalised. acknowledgements competing interests the author declares that he has no financial or personal relationships that may have inappropriately influenced him in writing this article. author’s contributions the author, r.w.d.z., declares that he is the sole author of this research article. he administrated the questionnaire, worked on the literature review, analysed the raw data, aligned and consolidated the article into a final manuscript. ethical consideration this article followed all ethical 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footnote about the author(s) rudie nel school of accountancy, faculty of economic and management sciences, stellenbosch university, stellenbosch, south africa nicolene wesson stellenbosch university business school, faculty of economic and management sciences, stellenbosch university, bellville, south africa lee-ann steenkamp stellenbosch university business school, faculty of economic and management sciences, stellenbosch university, bellville, south africa citation nel, r., wesson, n. & steenkamp, l-a., 2022, ‘the relationship between investor tax preferences and the payout methods of jse listed companies’, south african journal of economic and management sciences 25(1), a4534. https://doi.org/10.4102/sajems.v25i1.4534 original research the relationship between investor tax preferences and the payout methods of jse listed companies rudie nel, nicolene wesson, lee-ann steenkamp received: 26 jan. 2022; accepted: 16 june 2022; published: 31 aug. 2022 copyright: © 2022. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: investor tax preference parameters have been included as an explanatory variable for changes in payout methods in developed countries. there is, however, a lack of research in this area in developing countries. tax reform in south africa – comprising a change in the tax regime and successive increases in tax rates – offers a unique setting to examine investor tax preference parameters as a contribution to literature. aim: this study investigated the relationship between investor tax preference parameters (of individuals, corporates, and institutions) and payout methods (namely dividends, capital distributions, additional shares, and share repurchases). setting: the study used data collected in respect of companies listed on the johannesburg stock exchange (jse) in south africa for the financial reporting periods ranging from 2012 to 2019. method: a regression analysis of panel data was employed to relate the changes in payout methods to changes in profits, investor tax preference parameters, the lagged levels of variables, and ownership concentration dummy variables. findings: the empirical evidence of this study revealed that investor tax preferences affected dividends as a payout method. this accordingly suggests that the tax differential of dividends and capital gains affect the supply of dividends in south africa. conclusion: the study contributes empirical evidence in support of the taxes and tax clienteles theory from a developing country perspective. this could suggest that tax reform in a developing country, in this case, south africa, has a more pronounced effect on payout methods than in developed countries. keywords: dividends; payout methods; tax preference; investor tax preference; tax preference parameters; taxes and tax clienteles. introduction payout policy is central to corporate finance as it dictates the amount and method elected for distribution and could affect valuation, investment decisions and the taxes investors would pay (farre-mensa, michaely & schmalz 2014). the lack of consensus on the motivations for paying dividends, described as the dividend puzzle, remains unresolved despite much research and extensive debate (al-najjar & kilincarslan 2019). empirical evidence in respect of taxes and tax clienteles theory as an explanation for dividend relevance provides mixed support and is characterised by sparse research from emerging markets (baker & jabbouri 2016). further research is also warranted on whether the differential taxation of dividends versus capital gains affects the supply of dividends (farre-mensa et al. 2014). the term ‘investor tax preference parameters’ refers to the preference for dividends relative to capital gains and incorporates the shareholding of different categories of investors in a company (geiler & renneboog 2015; poterba 2004). south africa, an emerging market and developing country, provides a unique setting to incorporate investor tax preference parameters in empirical research due to tax reform. tax reform in south africa has been extensive owing to a change in the tax regime from a company-level secondary tax to an investor-level dividends tax during 2012, which was followed by successive increases in tax rates. the change in tax regime during 2012 resulted in the possibility of dividend tax arbitrage arising for the first time in south africa, as only certain investors are exempt from dividends tax (marcus & toerien 2014). payout methods other than dividends (namely capital distributions, additional shares, and share repurchases) could result in capital gains tax, dividends tax, or a combination of both. conflicting tax preferences of investors for different payout methods are further pronounced in south africa as a result of the differential tax rate on dividends and capital gains tax (nel & wesson 2021). descriptive evidence suggests that, since the introduction of dividends tax in south africa, corporate investors would prefer dividends and individual investors would prefer capital gains when tax is the only consideration (toerien & marcus 2014). explanatory evidence based on the dividend growth during 2012 and 2013 has also been submitted that jse-listed companies with higher corporate shareholding grew dividends significantly faster than other companies (badenhorst 2017). subsequent to these south african studies, further increases in the applicable tax rates occurred, which further pronounce the differential of taxation on dividends and capital gains, and afford an opportunity to incorporate investor tax preference parameters in south african literature. a literature review did not reveal any evidence of prior studies on the effect of investor-level tax reform on the payout policies of jse-listed companies with reference to the tax preference of investors for different payout methods. empirical evidence in respect of the effect of investor-level tax reform on payout policies would, in turn, contribute to the debate regarding the dividend puzzle by investigating tax as an explanation for payout methods elected by companies. the objective of the present study is to investigate the relationship between changes in payout methods and changes in investor tax preference parameters since the introduction of dividends tax in south africa during 2012. accordingly, this study will investigate how companies respond when faced with the conflicting tax preferences of investors – which could be of interest to researchers, investors and those charged with fiscal responsibility (badenhorst 2017). an understanding of investors’ preferences and corporate payout behaviour is further submitted as a prerequisite to efficient policy formulation (chazi, theodossiou & zantout 2018). this study is, to the researchers’ knowledge, the first to investigate the effect of investor tax preference parameters on payout methods in south africa since the introduction of dividends tax in 2012. the findings of the present study make four novel contributions to the extant body of knowledge. firstly, empirical evidence from south africa, an emerging market and developing country, could enable a comparison to be made with other developing countries (aivazian, booth & cleary 2003; mollah 2011). findings could further contribute to the limited empirical research concerning the dividend puzzle in sub-saharan africa (arko et al. 2014). secondly, the data collected in respect of investor tax preference parameters are not available in a commercial financial database and could serve as the basis for further research. thirdly, the distinction between registered and beneficial shareholding applied in the data analysis of the present study may provide additional insights as these types of shareholding differ in nature. fourthly, the study also incorporates ownership concentration as a determinant for changes in payout methods – an aspect that has not previously been considered in a south african context. literature review this study is grounded in the traditional theories of dividend relevance, in which taxes represent a major market imperfection and support payout policies as relevant in determining a company’s value. in finance literature, dividend relevance theories have been extensively researched within major theories and explanations, such as the bird-in-the-hand (i.e. that investors would prefer the certainty of dividend payments to the possibility of substantially higher future capital gains), taxes and tax clienteles, signalling, agency costs, behavioural explanations, company life-cycle theory and catering theories (baker & weigand 2015). the taxes and tax clienteles theory centres on the notion that the after-tax return of payout shapes investors’ payout preference and, in turn, investors select a company that pursues their preferred payout policy (baker, kapoor & jabbouri 2018). the literature review commences with an overview of the definitions and findings of previous studies in respect of dividend tax preference parameters and investor tax preference parameters and concludes with an overview of the literature in respect of ownership concentration. dividend tax preference parameters and investor tax preference parameters when considering the tax position of each investor type, both the taxes on dividends and capital gains should be considered (geiler & renneboog 2015; lie & lie 1999). tax preference parameters consist of dividend tax preference parameters (based solely on tax rates) and investor tax preference parameters (a function of tax rates and shareholding). dividend tax preference parameters are defined by poterba (2004) as: where τdiv is the marginal tax rate on dividends and τcg is the marginal tax rate on capital gains. dividend tax preference parameters depict the preference for dividends relative to capital gains based solely on tax rates. investor tax preference parameters expand on dividend tax preference parameters by including the shareholding of companies, based on the data of each company. investor tax preference parameters at time t are consequently depicted as θt and defined by poterba (2004) as follows: where wh,t refers to the percentage shareholding of investor h at time t. investor tax preference parameters consequently express the relative tax burden of dividends versus capital gains for different categories of investors in a company. poterba (2004) considered federal data for the period 1929 to 2003 (74 years) in respect of households and funds in the united states of america (usa). corporate investors were excluded from the specification as corporate investors could invest for strategic reasons, resulting in a dividend policy that is, at best, expected to be a second-order consideration (desai & jin 2011). short-run changes in tax preference parameters were, however, found by poterba (2004) to have a small and statistically insignificant effect on aggregate dividends. poterba (2004) used aggregate data to study how a change in the weighted-average tax preference parameter affects aggregate dividend payments (desai & jin 2011). consequently, poterba’s (2004) evidence was at the macro level, whereas subsequent studies (desai & jin 2011; geiler & renneboog 2015) provided evidence by calculating tax preference parameters based on the data of each company, not at a macro level. desai and jin (2011) in their study in the usa for the period 1980 to 1997 (17 years) classified institutional shareholding, based on the clients that the institutions serve, as dividend-averse and non-dividend-averse. the analysis of desai and jin (2011) provided direct evidence of the presence of dividend tax clienteles based on the heterogeneity, across companies, in payout policies and classification of institutional shareholding. geiler and renneboog (2015) considered the payout data of companies listed in the united kingdom (uk) for the period 1997 to 2007 (10 years). geiler and renneboog (2015) included three different tax preference parameters (for individuals, pension funds, and corporate investors). three studies from developed countries have accordingly considered the effect of investor tax preference parameters on dividends (desai & jin 2011; geiler & renneboog 2015; poterba 2004). two of these studies (geiler & renneboog 2015; poterba 2004) concluded that short-run changes in tax preference parameters have a limited effect on the aggregate dividend payout methods. ownership concentration this study will include dummy variables in respect of ownership concentration, which was not included in the model estimated by geiler and renneboog (2015). an analysis of the relationship between large shareholders, indicative of ownership concentration, and dividend policy is submitted as important to better understand dividend policy (truong & heaney 2007). the tax preference of investors, in turn, has been recognised as relevant when considering ownership concentration (booth & zhou 2017; peyer & vermaelen 2016). the inclusion of ownership concentration in the model of geiler and renneboog (2015) would therefore expand the investigation on the relationship between investor tax preferences and changes in payout methods. in empirical studies relating to dividend policy, ownership concentration is measured in terms of the herfindahl ownership concentration index (hoci), which is based on the shareholding of the top five shareholders in companies (gonzalez et al. 2017; harada & nguyen 2011), as well as the top shareholder category in a company (truong & heaney 2007). high ownership concentration companies are those whose herfindahl index is above the median value of the index for all companies (arora & srivastava 2019). previous south african studies have considered ownership concentration in relation to capital structure, corporate performance and agency costs (dube 2018; qopana 2018), with only a limited focus on dividend policy under the previous tax regime prior to the introduction of dividends tax in 2012 (abor & fiador 2013; arko et al. 2014). this study aims to extend the literature by investigating the effect of ownership concentration on payout methods under the dividends tax regime in south africa. research methodology and design an empirical study, which is explanatory in nature, was pursued in which quantitative data were analysed. a regression analysis of panel data was conducted to relate the annual changes in payout methods to annual changes in corporate profits, changes in investor tax preference parameters, the lagged levels of the explanatory variables, and ownership concentration dummy variables. the regression model is based on poterba (2004) but originally dates back to lintner’s partial adjustment models (geiler & renneboog 2015). the regression model was refined by geiler and renneboog (2015) for an investigation based on the data of each company. in the present study the model specified by geiler and renneboog (2015) was further refined in the following respects: the present study employs a variation of the model to also investigate changes in payout methods other than dividends (the aggregate of capital distributions, additional shares, and share repurchases). payout methods other than dividends could serve as a substitute for dividends and warrant further investigation of the effect of investor tax parameters on payout methods other than dividends. the study includes a distinction between registered and beneficial shareholding. a distinction between registered (or overall) and beneficial shareholding was made in recognition of the two different sources of information (the data sources are elaborated on under the data collection section). the study included the tax preference parameters of institutions that are not limited to pension funds. institutional investors in south africa could be grouped based on the flow-through principle for tax purposes (in which beneficiaries are taxed rather than the institutions investing on behalf of the beneficiaries). the study included ownership concentration dummy variables. investigating the relationship between ownership concentration and dividend payout could contribute to an understanding of the effect of taxes on dividend payout methods. the regression model estimated in this study is: where δ ln payout methodsit represents the natural log of changes in payout methods (ordinary dividends and payout methods other than dividends) as the dependent variable for each company-year observation. the natural log of current changes in corporate profits with a return on assets (roa) as proxy and represented by δ ln roait. calculated investor tax preference parameters are depicted by θ (equation 2) and the natural log of changes in current investor tax preference parameters is represented by δ ln θindividuals,it, δ ln θcorporates,it, and δ ln θinstitutions,it. the lagged levels of variables are represented by ln payout methodsit-1, ln roait-1, ln θindividuals,it-1, ln θcorporates,it-1 and ln θinstitutions,it-1. ownership concentration dummy variables include the hoci and the top shareholder category in a company (being either an individual, corporate or institution). all regression variables were transformed to natural log and first differencing was applied in line with studies of geiler and renneboog (2015) and poterba (2004). panel data sets have been argued to be most useful when controlling for time-constant unobserved features which might be correlated with the explanatory variables in a model (wooldridge 2013). pooled ordinary least squares (ols), first differencing, fixed effects and random effects are the different estimation methods for unobserved effects in a panel data model (wooldridge 2013). first differencing was applied in the present study to control for unobserved effects in line with geiler and renneboog (2015). first differencing enables the use of standard ols analysis on the differences (wooldridge 2013). regression results were analysed based on the sign and the significance levels of coefficients rather than inference based on the size of coefficients. the only inference based on the comparison of coefficients was to evaluate the importance of each investor tax preference parameter, relative to each other, in explaining changes in payout methods. the significance of variables was evaluated using t-statistics and the calculated probability (p-value). the significance of the results was interpreted at the 90, 95 and 99 per cent confidence intervals. this study focused on the interpretation of the short-run effect (or short-run elasticity) of a change in tax preference on a change in dividends which is captured, in line with poterba (2004) and geiler and renneboog (2015), by the coefficients of current investor tax preference parameters, being β2, β3, and β4 in equation 3. the long-run effect (or long-run elasticity) of a change in tax preference on a change in dividends is captured, in line with poterba (2004) and geiler and renneboog (2015), by the negative lagged levels of tax preference parameters divided by the lagged levels of dividends. the long-run effect of a change in tax preference on a change in dividends depicts the sensitivity of payout methods towards tax changes over the long term. the long-run effect of a change in tax preference on a change in dividends was only considered for comparison with the findings of geiler and renneboog (2015) to allow for a comparison between a developing country (south africa) and a developed country (the united kingdom). target population and sample the target population comprised jse-listed companies with reporting periods from 2012 to 2019. companies were selected according to the following criteria: (i) companies with listed ordinary and/or n-class shares; (ii) companies with their primary listing on the jse; (iii) companies listed on the jse main board and not in the basic resources and finance sectors; and (iv) companies listed for the full duration of the period 2009–2015. companies listed in the basic resources and finance sectors were excluded owing to unique accounting policies regarding capital investments and financing (wesson et al. 2018). companies listed from 2009 to 2015 were included to focus on companies listed at least three years before and after the introduction of dividends tax in 2012. companies that delisted after 2015 were included to eliminate potential survivorship bias (mans-kemp & viviers 2015). in total, 116 companies were included in the population comprising 33 large companies, 43 medium-sized companies, and 40 small companies based on market capitalisation during 2012. the company size classifications (small, medium, and large) of the jse during 2012 were applied, namely, large companies represented by companies with a market capitalisation exceeding r10 bn; medium size companies with a market capitalisation exceeding r1 bn but not exceeding r10 bn; and small companies with a market capitalisation of r1 bn or less (sa shares 2019). purposive non-probability sampling was applied based on four aspects: (i) the exclusion of observations with a negative roa; (ii) the availability of shareholding data; (iii) observations with no change in payout methods other than dividends; and (iv) observations during the 2019 financial years of companies affected by the covid-19 pandemic. to resolve the issue of negative earnings in a log-log specification, observations with a negative roa were excluded in line with the study of geiler and renneboog (2015) and poterba (2004). if the required shareholding data were not available in respect of a company for more than one year, such company-year observations were excluded. for shareholding data that were only unavailable for one year, missing data for that one year were added by replacing the missing year with half of the movement in shareholding from the preceding year to the subsequent year. missing data were added for a total of 10 company-year observations based on registered shareholding1. owing to the infrequent nature of payout methods other than dividends, this study included only company-year observations with changes in payout methods other than dividends (namely capital distributions, additional shares, and share repurchases) for purposes of data analysis, resulting in all company-year observations with no change in payout methods other than dividends, being excluded. lastly, for two companies the data in respect of the 2019 financial years were excluded due to dividend payout which was cancelled or reduced as a result of the covid-19 pandemic in terms of relief afforded to jse-companies (jse 2020a, 2020b). in conclusion, the initial population comprised 928 company-year observations (116 companies), from which only certain company-year observations were included based on the sampling applied. in respect of dividends, 482 company-year observations based on registered shareholding (70 companies) and 739 company-year observations based on beneficial shareholding (104 companies) were included in the final sample. in respect of payout methods other than dividends, there were 482 company-year observations in total based on registered shareholding, of which only 233 observations (35 companies) had changes in other payout methods (resulting in the exclusion of 249 observations with no change in other payout methods). in respect of beneficial shareholding, there were 739 company-year observations in total, of which only 356 observations (51 companies) were identified as having changes in other payout methods (resulting in the exclusion of 383 observations with no change in other payout methods). data collection payout methods data payout methods data in this study comprised of ordinary dividends and payout methods other than dividends (the aggregate of capital distributions, additional shares, and share repurchases). payout methods data compiled by nel and wesson (2021) were employed and expanded on by the inclusion of the 2019 financial years of selected companies. payout methods data were accordingly compiled based on the consolidation of an existing dividend database (nyere & wesson 2019) and a share repurchase database (steenkamp & wesson 2020). following the data collection method described in the previous studies (nel & wesson 2021; nyere & wesson 2019; steenkamp & wesson 2020), data were collected from disclosed annual financial statements and announcements via the security exchange news service (sens) of the jse. the annual financial statements used to capture payout methods data were retrieved from the iress financial database. return on assets ratios the return on assets ratios, which serve as a proxy for profitability, were obtained from the iress expert financial database. investor tax preference parameters the calculation of investor tax preference parameters (equation 2) is a function of dividend tax preference parameters (equation 1) and shareholding. dividend tax preference parameters are based solely on tax rates which were obtained from tax pocket guides published by the south african revenue service (sars n.d.) in respect of each tax year of assessment. shareholding data included overall shareholding (registered shareholding), shareholding reported as beneficial (beneficial shareholding), top five shareholding, and the top shareholder for each company-year observation, as illustrated in figure 1. the registered shareholding information disclosed by jse-listed companies represents the overall shareholding of which only a portion is required to be reported as beneficial shareholding. to promote transparency between the company and shareholders, registered shareholders are obligated, in terms of section 56 of the companies act 71 of 2008 (republic of south africa 2009), to disclose to a company where a person other than the shareholder has a ‘beneficial interest’ in shares held by the registered shareholder (norton rose fulbright 2017). accordingly, not all registered shareholders are obligated to report beneficial shareholding, as reporting is only required for shareholding exceeding certain thresholds (three per cent or five per cent). in this study, a distinction between registered and beneficial shareholding was made in recognition of the two different sources of information – registered shareholding maintained by share trading transactions totally electronic (strate) and beneficial shareholding data disclosed by registered shareholders. figure 1: levels of shareholding data representing data sources used in the study. in respect of registered shareholding, jse-listed companies disclose an analysis of shareholding (which includes a shareholder spread and a distribution of shareholders) in their annual financial statements. the disclosure of a distribution of shareholders (or shareholders analysis) could extend to disclosure of different categories, including banks, brokers, custodians, close corporations, endowment funds, individuals, retail investors, private investors, directors, empowerment, insurance companies, mutual funds, other corporations, private companies, public companies, retirement funds, share trusts, trusts, nominees, and other trusts. in this study the different categories of registered shareholding disclosed by companies in the distribution of shareholders were grouped into individuals, corporates, and institutions: individuals are considered to be natural person shareholders. retail shareholders of a company could include individual shareholders, companies, and family trusts (johnston 2019). as the disclosure of the distribution of shareholders includes the declaration of companies as a separate category, retail shareholders were classified as individual shareholders. family trusts were also categorised as individual shareholders as such a trust would be for the benefit of individual beneficiaries. ‘empowerment’ as a category in the distribution of shareholders could include a share trust or share scheme. a typical example of a share trust is one established for the benefit of employees as a share incentive initiative (fouché 2012). share incentive plans are submitted to encourage employees to take ownership of their company and increase their performance by aligning the interest of individuals with that of shareholders (hunt 2014). any share trust (or empowerment trust) and share scheme were therefore submitted to be for the benefit of individuals and were categorised as individual shareholders. corporates are considered as public companies, private companies, and close corporations, as disclosed in the distribution of shareholders analysis. close corporations were categorised as corporate shareholders, since a close corporation is included as a company, as defined in section 1 of the income tax act 58 of 1962 (republic of south africa 2020) for tax purposes. furthermore, it was investigated whether a company or close corporation represented the empowerment category to be classified as a corporate shareholder. institutional shareholders include asset owners (typically pension funds and insurance companies) and asset managers (who traditionally manage pooled share portfolios on behalf of clients and asset owners) (johnston 2019). desai and jin (2011) in their study in the usa utilised data on institutional shareholders combined with data on the tax preferences of the clients those institutional investors serve. south african institutions are also required to disaggregate holdings, which are then reported to the financial surveillance department (finsurv) of the south african reserve bank; however, such data are not publicly available (thomas 2017). owing to data availability, the present study did not attempt to infer the tax position of institutions based on the tax position of the clients they serve. all investor categories, apart from those included as individual shareholders and corporate shareholders, were classified as institutional shareholders and were calculated as the remaining percentage of shareholding (i.e. 100 per cent less individuals shareholding less corporates shareholding). beneficial shareholding data were collected from shareholder history reports, as compiled by refinitiv eikon (previously thomson reuters) from the filings of shareholders and with only investments of beneficial shareholders being processed (thomson reuters 2016). the shareholder history reports include the classification of shareholder type and sub-type and enabled the following classification of investors as individuals, corporates, and institutions: individuals were represented by the ‘individual investor’ sub-type. in this study, the beneficial holding of a share trust, share scheme, or family trust was seen as benefiting individual beneficiaries and was therefore categorised as individual shareholding. it was noted – in data collected from refinitiv eikon – that share trusts and schemes are classified as corporation or holding company in the shareholder history reports. this classification of a share trust or share scheme as a corporation or holding company was reclassified to individual investor for this study. corporates were represented by the ‘corporation’ sub-type. institutions comprised the remaining beneficial shareholding (i.e. beneficial shareholding not categorised as individuals or corporates). beneficial shareholding cannot exceed registered shareholding as only holdings exceeding the reporting threshold are required to be reported as beneficial. shareholding data collected confirmed the mean percentage of beneficial shareholding for each category (13.52% for individuals, 20.23% for corporates, and 35.23% for institutions) as lower than the mean percentage of registered shareholding for each category (19.97% for individuals, 23.58% for corporates, and 56.47% for institutions). institutional shareholders have also been noted as accounting for most of the overall volume of shareholding on the jse in south africa (jse 2016). shareholding data collected confirmed the mean registered shareholding of institutions as the majority of registered shareholding (being 56.47% of total registered shareholding). ownership concentration dummy variables for each company-year observation, the hoci was calculated per company as the square of percentage shareholding held by the top five shareholders (figure 1) and high (low) ownership was identified on the basis of the median hoci (harada & nguyen 2011). a binary variable of ‘1’ was applied to indicate company-year observations with high ownership concentration and ‘0’ as low ownership concentration. data collected in respect of the top shareholder included the category of top shareholder (individual, corporate, or institution) in terms of the description of categories under the shareholding data collection method. a binary variable of ‘1’ was applied to indicate company-year observations with a top individual, corporate, or institution shareholder. a binary variable of ‘0’ was similarly applied when the top shareholder was not an individual, corporate, or institution. formulating expected relationships a summary of explanatory variables and expected relationships is provided in table 1. the first explanatory variable was the change in the natural logarithm of profit (δ ln roait). more profitable companies, based on roa, were found to consistently pay higher dividends (badenhorst 2017; nyere & wesson 2019) and high accounting profit was also submitted as a prerequisite for payout earnings by different payout channels (geiler & renneboog 2015). a positive relationship between changes in profit and changes in payout methods was expected. table 1: variables description and expected relationships. the second category of explanatory variables referred to the change in the natural logarithm of investor tax preference parameters, depicted as δ ln θindividuals,it, δ ln θcorporates,it, and δ ln θinstitutions,it. the expected relationship between changes in payout methods and changes in investor tax preference parameters was informed by the tax rate on dividends and capital gains tax. for this study, the dividend tax preference parameters (equation 1) were calculated based on south african tax rates for individuals, corporates, and institutions (as illustrated in figure 2). individuals are represented by higher-rate individuals (individuals taxed at the highest marginal normal tax rate for each year of assessment) to demonstrate the maximum differential of tax between dividends and capital gains tax for individuals. institutions are represented by funds, as funds are the majority institutional investor type on the jse based on holdings (thomas 2017). based on dividend tax preference parameters displayed in figure 2, the expected relationship between each of the categories of investor tax preference parameters and payout methods (dividends and payout methods other than dividends) was as follows: individual investors taxed at the highest normal tax rates only had a marginal dividend tax preference during 2017, with a marginal preference for capital gains tax above dividends tax noted for other years since the introduction of dividends tax in 2012. the bird-in-the-hand theory posits that investors could prefer the certainty of dividend payments to the possibility of substantially higher future capital gains (baker & weigand 2015). individual investors could, in terms of the bird-in-the-hand theory, prefer dividends despite the marginal differences between dividends tax and capital gains tax rates. furthermore, shares held by employees (individual investors) could also affect the likelihood that dividends will be paid, because executive compensation could be increased by allowing dividends to be paid on unvested restricted shares awarded (minnick & rosenthal 2014). the expectation is that tax preference parameters of individuals (δln θindividuals,it) would have a positive relationship with changes in dividends (and a negative relationship with changes in payout methods other than dividends) despite the marginal tax preference for capital gains tax observed in figure 2. corporate investors had the highest dividend tax preference parameters (figure 2) as a result of an exemption from dividends tax afforded and the increases in the effective rate of capital gains tax. the expectation is that corporate investor tax preference parameters (δ ln θcorporates,it) would have a positive relationship with changes in dividends (and a negative relationship with changes in payout methods other than dividends) and, based on having the highest dividend tax preference parameters, are most likely to affect changes in dividends. institutional investors (represented by the tax position of funds) were tax-neutral since 2012 owing to an exemption from dividends tax and capital gains tax being afforded. where institutional investors were the majority investors, a tax explanation for a positive relationship between dividend distribution and ownership concentration based on dividend preference has been reported (short, zhang & keasey 2002). institutional investors could also increase large companies’ propensity to pay dividends (jacob & lukose 2018). the tax preference parameters of institutions could accordingly still be positively related to dividend payout despite the tax-neutral position since the introduction of dividends tax (as illustrated by a uniform dividend tax preference in figure 2). the expectation is that institutional tax preference parameters (δ ln θinstitutions,it) would have a positive relationship with changes in dividends (and a negative relationship with payout methods other than dividends) despite a tax-neutral position. figure 2: dividend tax preference parameters per investor type. the third category of explanatory variables pertained to the lagged levels of variables. the lagged levels of dividends were found to be highly predictive but negatively related to aggregate dividend payout (geiler & renneboog 2015; poterba 2004), based on which a negative relationship with changes in payout methods is expected. the lagged levels of profits (ln roait-1) indicate past profitability which could also inform current changes in payout methods to the extent that past profits are not distributed but retained for future expansions or dividends, based on which a positive relationship with changes in payout methods is expected. the lagged levels of investor tax preference parameters (ln θindividuals,it-1, ln θcorporates,it-1, and ln θinstitutions,it-1), unlike past profitability, is not expected to affect current changes in payout methods, based on which no specific relationship with changes in payout is expected. the final category of explanatory variables related to ownership concentration dummy variables and the category of top shareholders. this study explored whether high ownership concentration was a significant explanatory variable or not, without any expectation on the direction of relationships. the category of the top shareholder was also considered and the expected relationship differed depending on the category of shareholders. a top individual shareholder is expected to have a negative relationship in respect of changes in dividends (and a positive relationship in respect of payout methods other than dividends) owing to lower tax preferences for dividends if tax is the only consideration (figure 2) and the sole aim is to maximise after-tax receipts and not the immediate cash receipts in terms of the bird-in-the-hand theory. a top corporate and institutional shareholder is expected to have a positive relationship in respect of changes in dividends (and a negative relationship in respect of payout methods other than dividends) owing to tax preferences for dividends, based on the applicable tax rates (figure 2). in summary, a positive relationship between changes in dividends and the majority of explanatory variables is expected. a negative relationship between changes in payout methods and the lagged levels of payout methods is expected, whereas a positive relationship between changes in payout methods and corporate profits (and the lagged levels of corporate profits) is expected. a negative relationship is expected between changes in dividends (and a positive relationship is expected between changes in payout methods other than dividends) and top individual shareholders. multivariate statistics when testing the assumptions of the regression analysis, normal probability plots were inspected to assess the normality of data by considering the distribution of residuals. the models estimated in the present study also applied log transformation to all variables, in line with previous studies, which would aid in addressing the normality assumption. the breusch-pagan test was performed in respect of heteroscedasticity with the results found to be significant for registered shareholding (p-value of 0.04) and beneficial shareholding (p-value of 0.01), which indicated the need to adapt regression results for heteroscedasticity using white’s robust covariance matrix. the durbin-watson statistics approximated two for registered shareholding (d-value of 1.83) and beneficial shareholding (d-value of 1.86) submitted as evidence of no autocorrelation of variables. the variance inflation factor for variables other than a top institutional shareholder ranged from 1.09 to 3.27 and indicated no multicollinearity between independent variables. the variance inflation factor of top institution was found to be collinear and top institution was therefore excluded for purposes of data analysis. in respect of outliers, the grubbs test for outliers was performed on all variables. each variable containing entries that were identified as outliers was winsorised by replacing the upper (lower) outlying entries with the value of the maximum (minimum) of the non-outlying observations plus 10% of the non-outlying interquartile range. the regression results estimated for equation 3 using ols are provided in table 2. table 2: regression results – payout methods and investor tax preference parameters. changes in profitability (δ ln roait) and past profitability (ln roait-1) were found to have a statistically significant positive relationship with changes in dividends, in line with expectation and previous literature (geiler & renneboog 2015). only past profitability (ln roait-1) was found to have a statistically significant positive relationship with changes in other payout methods, which suggests the retention of past profits (ln roait-1) as a more important determinant than changes in current profits (δ ln roait). previous payout methods (ln payout methodsit-1) were found to have a statistically significant negative relationship with changes in dividends and other payout methods, in line with expectation and previous literature (badenhorst 2017; geiler & renneboog 2015; poterba 2004). these findings confirm the importance of profitability as well as past payout methods in explaining changes in payout methods. different insights were obtained in this study based on registered shareholding and beneficial shareholding in respect of investor tax preference parameters. changes in investor tax preference parameters were found to have a statistically significant positive relationship with changes in dividends based on registered shareholding only. the level of significance relating to corporate tax preference parameters (δ ln θcorporates,it) was found to be higher than the other investor tax preference parameters considered. the standardised beta coefficient of corporate tax preference parameters (δ ln θcorporates,it) was also observed as higher than the standardised beta coefficients of other investor tax preference parameters considered in relation to ordinary dividends based on registered shareholding (table 3). the higher standardised beta coefficients in respect of corporates (δ ln θcorporates,it) suggests that corporate tax preference parameters explained changes in dividends more than other investor tax preference parameters considered. the finding in respect of corporate investors supports the findings of badenhorst (2017), which suggested that corporates could be more successful in lobbying for beneficial dividend changes than other investor types. investor tax preference parameters based on beneficial shareholding were only found to be significant in one instance, being for individuals (δ ln θindividuals,it) at the 10 per cent level of significance in respect of ordinary dividends. this finding could suggest that beneficial shareholders could invest for strategic reasons, such as obtaining control, rather than maximising their after-tax receipt, which could result in tax preferences being less important. table 3: standardised beta coefficients and errors of investor tax preferences parameters. in respect of ordinary dividends and based on registered shareholding (table 2), the estimated coefficients implied a long-run effect on changes in dividends for investor tax preference parameters of 1.08 for individuals (−0.026/−0.024), 0.167 for corporates (−0.004/−0.024), and 3.08 for institutions (−0.074/−0.024). geiler and renneboog (2015) concluded that there was a long-run effect on changes in dividends with respect to investor tax preference parameters of 0.03 for individuals, −0.042 for corporates, and −1.58 for pension funds. the long-run effects on changes in dividends reported in the present study were higher than those noted by geiler and renneboog (2015), which suggested that, over the long term, dividend payout in south africa seemed to be more sensitive to investor tax preference parameters than dividend payout in the uk. changes in investor tax preference parameters (δ ln θindividuals,it, δ ln θcorporates,it, and δ ln θinstitutions,it) were found not to have a statistically significant relationship with changes in payout methods other than dividends. contrary to the findings in respect of dividends, the short-run changes of investor tax preference parameters were not found to have a significant effect on the aggregate changes in payout methods other than dividends. this finding suggests that tax is not a significant determinant of payout methods other than dividends. payout methods other than dividends could be explained by other determinants. in respect of share repurchases (i.e. the main payout method other than dividends), shareholder heterogeneity, the size of the distribution, the level of company undervaluation, agency cost, and history of dividend payment have all been found to be significant determinants in the choice between share repurchases and dividend payments (wesson et al. 2018). in respect of ownership concentration, this study considered hoci and top shareholders (as corporate or individual), however, none of the ownership concentration dummy variables was noted as statistically significant. a possible explanation could be that top shareholders invest for strategic reasons, which could result in tax not being a first-order determinant. conclusions and recommendations prior empirical evidence offers mixed support for taxes and tax clienteles theory as an explanation for dividend relevance (baker & weigand 2015). the present study contributes in respect of the theory of taxes and tax clienteles from a developing country perspective by exploiting data not previously included in south african literature. this study investigated the relationship between changes in investor tax preference parameters (of individuals, corporates, and institutions) and changes in payout methods (namely dividends, capital distributions, additional shares, and share repurchases). corporate investors had the highest tax preference for dividends of all categories of investors considered since the introduction of dividends tax in 2012 in south africa due to an exemption from dividends tax being afforded and increases in the effective rate of capital gains tax. regression results confirmed changes in corporate investor tax preference parameters as the most statistically significant in explaining changes in dividends, of all investor tax preference parameters considered. this finding contributed to literature in three respects. firstly, short-run changes in corporate investor tax preference parameters were found to be statistically significant in explaining aggregate changes in dividends, contrary to previous studies from developed countries (geiler & renneboog 2015; poterba 2004). this could suggest that tax reform in a developing country, south africa, has a more pronounced effect on payout methods than in developed countries. secondly, this finding provides empirical evidence that the tax differential of dividends and capital gains, as depicted by investor tax preference parameters in this study, affect the supply of dividends (farre-mensa et al. 2014). thirdly, this finding expands on previous findings that suggest that corporate shareholders in south africa could have greater success in lobbying for beneficial dividend changes than individuals (badenhorst 2017). in conclusion, the empirical evidence of the present study suggests an effect of investor tax preferences on dividend payout methods. the findings on how companies respond when faced with the conflicting tax preferences of investors could be of interest to researchers, investors, and those charged with fiscal responsibility (badenhorst 2017). this evidence could also enable a comparison with other developing countries (aivazian et al. 2003; mollah 2011) in future research. the data collected in respect of investor tax preference parameters are not available in a commercial financial database and could serve as the basis for further research. the collection of ordinary dividend data and shareholding data, however, relied on annual financial statements and two financial databases (iress and refinitiv eikon) and a focus of future research could be to consider alternative data sources. acknowledgements prof. daan nel (centre for statistical consultation, stellenbosch university) for the statistical analyses performed in respect of this study. competing interests the authors have declared that no competing interest exists. authors’ contributions r.n. was the primary researcher as part of his phd study and n.w. and l.s. supervised the research project in their capacity as phd supervisors. ethical considerations the departmental ethics screening committee of the university of stellenbosch business school (usb desc) confirmed that the research is exempt from ethical 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https://doi.org/10.1016/j.qref.2007.09.002 wesson, n., smit, e., kidd, m. & hamman, w.d., 2018, ‘determinants of the choice between share repurchases and dividend payments’, research in international business and finance 45, 180–196. https://doi.org/10.1016/j.ribaf.2017.07.150 wooldridge, j.m., 2013, introductory econometrics: a modern approach, 5th edn., cengage learning, boston, ma. footnote 1. as a robustness test the influence of the observations for which values were imputed/added was considered. the regression analyses were reperformed and the observations for which values were imputed/added were excluded it was confirmed that the main findings of the present study were not affected by the exclusion of the observations for which values were imputed/added. f:\ejour\ecoman\index\ecoman_v6_n2.prn.pdf sajems ns vol 6 (2003) no 2 369 south african pharmaceutical prices: an international price comparison __________________________________________________________________________________ george g djolov1 school of economic and business sciences, university of the witwatersrand ________________________________________________________________ abstract a major presumption underlying the current debate on pharmaceutical prices in south africa is that south african medicines are priced at levels out of line with comparable products in other countries. this paper presents some empirical evidence in an attempt to ascertain the validity of these presumptions. the results provide little support for the view that south african prices are in need of controls over and above those already existing through competition. the evidence reveals that recent calls and public policy proposals for parallel importation and its variant reference pricing are misplaced. to put forward such proposals without taking account of existing empirical knowledge for policy (or legislative) making purposes is a less than optimal approach. jel c 130, i 180 1 introduction a major presumption underlying the current debate on pharmaceutical prices in south africa is that south african medicines are priced at levels out of line with comparable products in other countries. to contain medicine costs act 90 of 1997 (§15c and §22g) proposes the use of parallel importation or its variant reference pricing. parallel importation refers to the policy of allowing the importation of the same drugs as those available in south africa if they can be obtained cheaper, i.e. at a lower price, elsewhere. a variant of parallel trade is reference pricing, which is the policy where the price set for a drug in a given country is the average of the lowest prices of the same drug in other countries. this paper presents some empirical evidence in an attempt to ascertain the validity of the presumptions guiding these public policy proposals. first, some thoughts are presented about the intrinsic difficulties of carrying out price comparisons between countries. second, the results of two pricing studies, one for the private sector and the other for the public sector are presented. here it may be instructive to note that the south african healthcare market splits into sajems ns vol 6 (2003) no 2 370 two separate sectors or markets, i.e. the private and the public. the private sector caters for those with income and medical cover and the public sector, which is administered by the state, caters for the poor (or indigent). the state purchases drugs for the public sector using the comed tender system. the manufacturer able to meet a tender at the lowest or specified price is awarded the tender for the supply of a particular medicine or medicines. the study for the private sector presents a comparison between prices in south africa and seven other countries. the study for the public sector presents a comparison between tender prices in south africa and those obtainable through international competitive bidding, i.e. international tendering. 2 international price comparison caveats the discussion here is based on a synthesis of that offered by danzon (2000: 5659), nesbitt (2000: 14-25 of chapter 2), and reekie (1997: 20-26). international price comparisons of pharmaceuticals are subject to a number of difficulties. indeed the number and nature of the reservations imply that they should only be used with extreme care. many would argue they should not be used at all. first, identical or analogous products must be compared. most countries have several hundred, even thousands of drugs on sale. many are not available elsewhere. the products selected for comparison must not only be available to compare but they should be important in their respective markets. this is not necessarily easy to achieve since not all products are available in every country. further, the mix of leading products varies by disease incidence, medical convention and legal framework. these impact on product usage and even on the presentation of the product (e.g. vaccines and tablets may differ in usage between countries and hence so too, may the relative prices). not only must the compared products all be of similar commercial importance on the demand side, that condition should also exist on the supply side. if products vary in importance to the marketing firm, then price patterns may differ. similarly, if the marketing firm is a licensee, this also impacts on pricing behaviour, as does the nature of any (unknown) royalty agreement. moreover, questions must be asked as to the level in the distribution chain at which the prices are compared. are the prices affected by the nature of that institutional arrangement? manufacturer prices are the basis from which final consumer prices derive, but intermediaries vary in importance country-by-country in the costs they impose or save on any transaction. some intermediaries are passive; others are active buyers seeking out best prices. this in turn raises the issue of whether list prices or transaction prices are used. most data sources use list prices, and surveys, which use transaction prices –which are more meaningful−,are high cost tasks (and neither buyer nor seller may be willing to sajems ns vol 6 (2003) no 2 371 divulge the information). should the price be at pack level? (most products are sold in several alternative pack sizes). if so, which pack? should it be at unit level? and if so, which unit? (units vary for the same product, e.g. 125 mg or 375 mg). which form should be compared, oral solid or injectable, or some other? should it rather be at cost per daily treatment, or cost per prescription (covering several days)? after all different drugs require different quantities to be consumed daily, or have different numbers of days’ treatment in a regimen. to select any one criterion, of course, implies selection from a “most commonly adopted” criterion in country a, which may be inappropriate in country b. in a world of exchange rate movements, at what date is the comparison to be made? a 10 per cent movement in a currency immediately alters any computed results by that amount. if non-branded (generic 2) drugs are excluded from a study, but they have a significant market share in any given country, then their exclusion will bias comparisons. the bias could make the drug bill in the country with a small generic share appear to be relatively lower than it is in reality. the country with the high generic share would have its price level over-stated (since generics are generally cheaper than branded products). one further reservation is that in any study prices of drugs sold for ambulatory care should not be compared with those of drugs sold to bulk-buying institutions such as hospitals. in the case of south africa, this reservation must be extended to the exclusion of the entire state sector where drugs are purchased in bulk and by tender. the relevant comparison in our first study is the prices of drugs in the south african private sector. before proceeding with the results and the methodology of the study a note is in order concerning the type of price studies whose methodology may centre on comparing a basket of high selling (by value) products in one country with the same products in another country irrespective of the selling status of these products there. precaution must be exercised with such studies given their methodology is highly likely to produce biased results. this can be explained with reference to the construction of the demand curve. if the products are highselling items in the one country (country a) but are low-selling items in the other (country b), prices in the former instance would be low, whereas in the latter instance they would be high. thus if one is to construct price ratios (weighted by volumetric market share) the choice of the country which assumes the numerator determines which country appears cheaper. accordingly if country a is placed in the numerator, the resulting price ratio would reflect it as more expensive than country b, or put differently country b would appear cheaper. sajems ns vol 6 (2003) no 2 372 3 methodology and results for private sector assessment with the above reservations in mind we now report on two studies that examined prices in south africa in relation to seven other countries in 1998 and 2001. these studies use the same data source and build on an identical methodology to that of a study first done by reekie (1997: 20-6). there have been no updates of this latter study since it was first done, and what is presented here is the second of its kind. without further ado we now proceed with discussing the research carried out but beforehand we describe the sample at hand. the sample of countries compared was south africa, usa, uk, germany, denmark, the netherlands, australia, and brazil. to ensure that the price comparisons are on a like-for-like basis the choice in countries should satisfy three important criteria, namely: (i) the countries chosen should have relatively liberal drug pricing systems; i.e. price controls on products (particularly on new product introductions) are either absent or exist in limited form, and if the comparisons involve prices of drugs sold for ambulatory care (as is the case here) than these should not be compared with those of drugs sold to bulk-buying institutions or ones with monopsony purchase power. australia, brazil and some southern european states fail on this count in their comparison with the south african private sector. in brazil, mendonca (1999) has noted that since the abolition of the pharmaceutical price control system there in 1992 the country’s price regime on pharmaceutical products is one of “monitored freedom” where prices are still controlled through voluntary arrangements between the government and the pharmaceutical industry. in australia the majority of prescriptions are written for medications that are subsidised under the taxpayer funded pbs (pharmaceutical benefits scheme), which grants the australian government a monopsony purchasing power (oecd, 2001). the prices of all products listed on the pbs are determined and reviewed by the pharmaceutical benefits pricing authority, which either resorts to reference pricing to infer if a given drug’s price is “fair” or includes products in the pbs on the basis of the lowest price or cost (from products falling in the same therapeutic sub-groups). (ii) research and development should play an important part in the market for pharmaceuticals. the oecd (1981) has noted that the south african pharmaceutical industry has a major research and development component and that the country is among the preferred locations of choice for the clinical trial activities of the multination pharmaceutical firms. reinforcing the strong role of research and development in the industry sajems ns vol 6 (2003) no 2 373 has been the continual or long-standing presence of a strong patent system. all this has been absent from brazil, which only recently (i.e. as of 1996) placed a formal system in place for the protection of intellectual property rights for pharmaceuticals (rozek, 2000). how strong is the enforcement of these rights is questionable. in 1999 a generic law was approved by the brazilian legislature, which makes it mandatory for the generic name to be included in addition to the trade mark name on all product packs of the original product (mendonca, 1999). (iii) the countries should share a corresponding income per capita. in the south african private market, as table 1 shows, income per capita is in line with that of the high-income category of the world bank. thus comparisons with countries, whose income per capita is considerably below that of the south african private sector, as is the case with brazil or some southern european states, would be inappropriate. table 1 estimated income per capita for the private sector, 2000 country income per capita (in purchasing power parity), us$ usa uk germany denmark netherlands australia brazil south africa1 34100 23550 24920 27250 24970 25850 7300 36288 high-income group 2 eu high-income oecd countries 3 27770 23600 24874 sources: (1) world development report 2002 – world bank, oxford university press. (2) registrar of medical schemes annual report 2000 – council for medical schemes (pretoria). notes: 1 the world bank’s development report for 2002 recorded the south african populatio n at 43 million people in 2000 and the south african gross national income (in purchasing power parity terms) at us$ 392 billion in 2000. the annual report for 2000 by the registrar for medical schemes records the size of the south african private sector, sajems ns vol 6 (2003) no 2 374 i.e. those with medical aid/insurance, at 7 million in 2000. as per the world bank’s development report for 2002 which provides a breakdown of the income share of each income quintile it was assumed that the 7 million people forming the private sector constitute the highest paid 20 per cent of the population, which accounts for 64.8 per cent of the total south african income. the south african figure is an over-estimate. first not all 7 million people are likely to be part of the highest paid 20 per cent of the population, i.e. the possibility of middle income has to be accepted. accordingly those paying for medical cover may account for less of the total south african income. second the income per capita calculation assumes the denominator is 7 million people. this is an understatement. people without medical aid/insurance cover also attend private sector health care facilities (e.g. hospitals, doctors, pharmacies) via out-of-pocket expenditure. 2 this group comprises the eu, the high-income oecd countries, and the high-income non-oecd countries. the income per capita for the high-income group is the average for the aforementioned groupings. the income per capita for the eu is also the average for the eu member states. by analogy the same applies for the high-income oecd countries. 3 income per capita calculation based on data for 21 of the 23 highincome oecd member states. from the sample selection criteria the following should be taken cognisance of. although the comparisons with australia and brazil (or for that matter these involving some southern european states like spain) would not live up to fulfil the sample selection criteria in turn making them questionable, their inclusion for reasons to be detailed later highlights the importance of pricing freedom and strong intellectual property protection. let us now see what the studies entailed. the private sector studies looked at how much a basket of some of the best selling products in south africa would cost in the other seven countries. the list prices of the products, which were in the currencies of each country, are ex-factory prices for ethical, i.e. prescriptionbased, products dispensed through pharmacies. the source of the raw data for these prices (and the corresponding product volumes) is the market research house ims. prices were compared in rands at the year-end exchange rate for 1998 and 2001. the sample was restricted (owing to data availability) to the top 80 products in south africa in 1998 and 2001, ranked according to sales value. of the 80 products, on the average, 23 products were actually found in common to be important sellers in the other countries in 2001 and 18 in 1998. the sajems ns vol 6 (2003) no 2 375 remaining products were either produced only by south african pharmaceutical companies or were products that had ceased to be major sellers in the foreign markets. the prices of the common products, weighted by market share determined from their volumes traded in south africa, were aggregated to derive a weighted average in order to find out how much the hypothetical basket (of comparable products) would cost in south africa vis -à-vis the other countries studied. it was assumed when making the calculations that the market shares that the top selling products had in south africa in 1998 and 2001 would be the same in the other countries as well. simply put to address the question of how much south african consumers might pay (at ex-factory prices) if they faced foreign prices but maintained south african consumption patterns, prices were weighted according to the volume of purchases by south african consumers. mathematically the calculations were carried out as per the standard formula for weighted average expenditure (wae) given below: wae = s(piq sa i)/sq sa i [1] where s is the summation sign over the basket of the common products, pi the price for the ith product, and qsai its quantity consumed in south africa. expression [1] was applied once to take account of the south african prices and a second time to take account of the non-south african prices, with the resulting values used to form the ratios in table 2. table 2 eight country comparison -top 80 products 1998 2001 pairwise comparison rsa/usa rsa/uk rsa/germany rsa/denmark rsa/netherlands rsa/australia rsa/brazil n 21 22 11 13 21 21 14 price ratio 1.00:4.58 1.00:1.16 1.00:1.06 1.00:1.12 1.00:1.14 1.00:0.83 1.00:1.17 pairwise comparison rsa/usa rsa/uk rsa/germany rsa/denmark rsa/netherlands rsa/australia rsa/brazil n 27 27 20 20 27 26 16 price ratio 1.00:3.20 1.00:1.40 1.00:1.19 1.00:1.24 1.00:1.29 1.00:0.79 1.00:1.15 note: n = number of comparable products a note on interpreting the ratios is in order. the south african value would always be equal to 1, while the value for the foreign country would be variable. if the foreign country value is greater than 1, this means that country has higher prices than south africa for the same basket of goods. the reverse would apply if the foreign country value were below 1. for example, for 2001 the ratio in the sajems ns vol 6 (2003) no 2 376 pairwise comparison rsa/netherlands is 1.29. this means that ex-factory prices in the netherlands are 29 per cent higher than in south africa (at a point in time) for the same basket of goods available in south africa and the netherlands. 4 analysis of private sector results there is little to suggest from the studies reported on above that south african private sector prices for pharmaceuticals are far out of line from those of countries with similar degrees of regulation, importance of research and development, and roughly similar income levels. we come to that conclusion, however, in the light of the reservations expressed earlier. what adds credibility and some confidence to the findings here is that they confirm the systematic inability of the evidence to show that the prices of pharmaceuticals in the south african private sector are high in relation to comparable markets. for instance the findings here reinforce (or support) those of the earlier study by reekie (1997: 25) reported in table 3 below. it would be recalled that this study is based on the same methodology as the one applied here. the difference is that the top 50 rather than the top 80 products were looked at (also using ims exfactory list prices data as it applies to ethical drugs dispensed through pharmacies). table 3 six country comparison top 50 products (1995) pairwise country comparison number of comparable products price ratio rsa : usa 20 1.00 : 1.57 rsa : uk 21 1.00 : 0.75 rsa : germany 15 1.00 : 1.59 rsa : denmark 19 1.00 : 1.00 rsa : netherlands 22 1.00 : 1.16 source: reekie (1997: 25) it should be noted that direct comparison of the price ratios between table 2 and table 3 (and within table 2 itself) is not possible since the products between the periods are not the same, i.e. new products are introduced and old ones are discontinued over time. all that can be inferred is that at any point in time the comparable basket of important sellers across the comparable countries examined costs less in south africa than elsewhere. for instance in 2001, for directly comparable products, relative to south african prices us prices were 220 per cent higher, uk prices were 40 per cent higher, german prices 19 per cent higher, danish prices 24 per cent higher, and for the netherlands 29 per sajems ns vol 6 (2003) no 2 377 cent higher. in the sample of comparable markets (countries) considered in table 2 (and table 3) south africa consistently appears to be the second cheapest country whilst the usa was always the most expensive. although direct price comparisons with australia and brazil may not be possible, their comparison to the south african private sector highlights two important points, namely: (a) where intellectual property protection is perverted relative to en environment where it is not prices of pharmaceutical products are higher. in this case they were 15 per cent higher in 2001 and at least this much in 1998; and (b) free markets produce prices, which are as low, and very likely lower compared to ones arrived at by government control or intervention. in cases where such controls or interventions exist the cost(s) they come with must also be examined. although australian prices may be around 20 per cent lower than south african ones (whether in 1998 or 2001), 84 per cent of the total cost of the pbs is subsidised by government (oecd, 2001: 155). the evidence suggests that letting freedom of choice in the selection of products exist and allowing manufacturers to exercise discretion in the pricing of their products, subject to their assessment of the conditions of demand and supply, produces the results that legislative proposals in the name of the public interest, like parallel trade, promise to attain. a detailed report by the boston consulting group, which studied the impact of price controls on pharmaceuticals, came to a conclusion not dissimilar to the one expressed above. in particular the report (1999: 36) noted that “the diffusion of innovation seems to bear out a simple economic truth: where pharmaceutical companies have an economic incentive to ensure that more people get treated, and are given the freedom to price and market accordingly in response to market competition, more people will get appropriately treated. where these incentives and freedoms are reduced, treatment levels reflect the policies put in place by the government officials who define pharmaceutical industrial policy”. at this point we move to the pricing study for the public sector. 5 methodology and results for public sector study following various allegations of excessive pricing in south africa compared to international sources, as described in report 6 of 1997 by the public protector, an analysis was undertaken of prices in the south african state sector. the sajems ns vol 6 (2003) no 2 378 government bases its purchases on pharmaceuticals on nine tenders. out of the nine tenders, information pertaining to only eight of these could be obtained. in all cases the price comparisons were based on the weighted volumes of the quantities (in packs) called for on the comed tenders. the intention is to show what the total purchase value would be on a weighted basis as opposed to price alone. simply put to maintain consistency with the methodology followed on the private sector studies, inter alia, use is made of expression [1] in the case of the public sector too. here to address the question of how much the south african state might pay if it faced foreign prices but maintained its consumption patterns, prices were weighted according to the volume of purchases the state makes. the public sector price comparison involves (a) low levels of income (see table 4) and (b) the same kind of pharmaceuticals, i.e. generics. table 4 estimated income per capita for the public sector, 2000 country income per capita (in purchasing power parity), us$ south africa1 low-income countries 316 1980 sources: (1) world development report 2002 – world bank, oxford university press. (2) registrar of medical schemes annual report 2000 – council for medical schemes (pretoria). note: 1 the world bank’s development report for 2002 recorded the south african population at 43 million people in 2000 and the south african gross national income (in purchasing power parity terms) at us$ 392 billion in 2000. the annual report for 2000 by the registrar for medical schemes records the size of the south african private sector, i.e. those with medical aid/insurance, at 7 million in 2000. thus it was assumed the public sector takes care of 36 million people. as per the world bank’s development report for 2002 which provides a breakdown of the income share of each income quintile it was assumed that the 36 million people forming the public sector constitute the lowest paid 20 per cent of the population, which accounts for 2.9 per cent of the total south african income. the south african public sector figure is an under-estimate. first not all 36 million people are likely to be part of the lowest paid 20 per cent of the population, i.e. the possibility of middle income has to be accepted. accordingly those using public sector health facilities may account for more of the total south african income. second the income per capita calculation assumes the denominator is 36 sajems ns vol 6 (2003) no 2 379 million people. this is an overstatement. people without medical aid/insurance cover also attend private sector health care facilities (e.g. hospitals, doctors, pharmacies) via out-of-pocket expenditure. the public sector comparison was conducted using the international drug price indicator guide (idpig) jointly developed by the world health organisation and management sciences for health (a non-profit organisation). the guide is an indicator of the international price norm of generics. it is appealing to use because it provides the actual international tender prices through international competitive bidding (icb) for the supply of generic drugs by procurement agencies and vendors to poor or low-income countries. in summary the international price comparison for the public sector refers to prices that are (a) obtained through a tender based process, (b) are aimed at the same income level and (c) involve the same kind of drugs. the data comprises list prices. the comparison is with reference to available data for the year 2000. to ensure the comparison is on a like-for-like basis the international and comed tender prices refer to products common to the south african essential drug list, the comed tenders, and the listing of products obtainable through international competitive bidding. in total 79 comparable products were identified. of the 79 products considered information on 71 was available. the products came from the various tenders as depicted in table 5. table 5 composition of public sector price comparison sample tenders tender origin of products (%) rt 280 – drops, aerosols, inhalers and inhalants 4 rt 281 – semi-solids and powders 4 rt 285 – biological preparations 1 rt 289 – solid dosage forms 56 rt 297 – small volume parenterals and insulin administration devices 21 rt 299 – large volume parenterals and accessories 1 rt 300 – liquids 4 rt 301 – antibiotics 9 total 100 source: office of the state tender board – tender contracts data from the products considered reveals that in the case of the comed tenders 71 per cent of products are supplied in patient-ready packs and 29 per sajems ns vol 6 (2003) no 2 380 cent in bulk packs. in short under the comed tenders the prices for products apply to packs. by contrast the prices for products obtainable through international competitive bidding are exclusive of packaging and recorded in comparable dosage unit (e.g. tablets or millilitres). like the comed tender prices the international tender prices are delivery or cif (cost, insurance, and freight) inclusive. in contrast to the comed tender prices the international tender prices are not vat inclusive. to make the comparison in the same currency the year-end rand-dollar exchange rate for 2000 was applied (given international tender prices are recorded in us dollars). in addition to account for the difference in packaging and vat the international tender prices in each instance (prior to calculating the expenditures) were loaded by: (a) the size of the pack required under the comed tender. (b) 10 per cent to reflect the cost of packaging (on the premise, following a study by the npi (1989, p 53-64), that packaging costs for south african pharmaceutical manufactures amount to 10 per cent of total manufacturing costs, and that these costs are the same for the international suppliers); and (c) 14 per cent to reflect the presence of vat. in all cases the price comparisons were based on the estimated quantities (in packs) called for on the comed tenders. table 6 presents the price comparison result (with expression [1] being applied on the one occasion to take account of the south african prices and on the other of the non-south african prices, with the values so formed used to obtain the ratios in the table. the interpretation of the ratios is the same as that for table 2. for instance in 2000, for directly comparable products, relative to comed prices, idpig prices were 53 per cent higher. put another way relative to the idpig international tender prices, prices obtained under the comed tender system yield the state a 53 per cent saving in its drug expenditure (for comparable products). table 6 comed-idpig comparison for 71 common products, 2000 price ratio for comed tenders at comed prices 1.00 for comed tenders at international (idpig) tender prices 1.53 savings 53% note: the information is based on 8 out of 9 tenders in total sajems ns vol 6 (2003) no 2 381 6 analysis of public sector results there is little to suggest from the above study that the south african public sector prices for pharmaceuticals, the state secures through the comed tender system, are higher than the international tender prices the state would face if it were to participate in international competitive bidding for the same drugs. relative to the idpig international tender prices, prices obtained under the comed tender system yield the state a 53 per cent saving in its drug expenditure (for comparable products). in short it appears that the competitionfor-the-market the comed tender system creates in the supply of drugs for the public sector is very intense compared to the icb norm. what adds credibility and some confidence to the findings here is that they join a list of studies that systematically fail to show that the prices of pharmaceuticals in the south african public sector are high when compared with the idpig norm. the previous studies (pma, 2001: 28), which are based on comparisons involving the average of idpig supplier rather than tender prices, have established that the savings in expenditure achieved by the state with the use of comed (relative to the idpig) could be deemed to be 30 per cent on the average. in the present study it should be accepted that the saving is likely to be lower than estimated. first as presented above there are historical reasons for supposing so. in addition in the case of the public sector study assumptions were made in order to balance off the packaging difference between the comed and international tender prices. if the packaging cost for the international suppliers is lower than the one assumed than the reported savings would also be lower. it should also be noted that quantity estimates rather than actual consumption figures were available for the calculation of the expenditure figures. any discrepancies between the estimates and the actual figures (which must be assumed exist) would also mean that we have to content with accepting a level of savings lower than is reported in table 6. 7 conclusion on the basis of the findings the conclusion drawn is simple. the results provide little support for the view that south african prices are in need of controls over and above those already existing through competition, i.e. recall that in the private sector companies are free to price their products and that in the public sector competition is encouraged by means of tendering. the evidence reveals that any calls or public policy proposals for parallel importation and its variant reference pricing are misplaced. to put forward such proposals without taking account of existing empirical knowledge for policy (or legislative) making sajems ns vol 6 (2003) no 2 382 purposes is a less than optimal approach and one that the south african legislature ought to steer away from. endnotes 1 i would like to thank the head office of a pma member company, without whose help it would not have been possible to gain access to the proprietary ims raw data on which the private sector studies are based. i would also like to thank ms marita van rooyen from the pharmaceutical management cluster of the department of health for providing the proprietary comed data pertaining to the quantity estimates for the public sector without which conducting the public sector study would not have been possible. thanks are due to prof. wd reekie for spending time to elaborate on his pricing studies on the pharmaceutical industry. the assistance of ms christine schoeman during the data processing stages of the studies reported in here is acknowledged. the views expressed by the author (in this article) do not represent those of the pharmaceutical manufacturers’ association of south africa. 2 generic medicine is the one with the same chemical composition or active ingredient as the original medicine. references 1 boston consulting group (1999) ensuring cost-effective access to innovative pharmaceuticals – do market interventions work?, boston, usa. 2 danzon, p.m. (2000) “making sense of drug prices”, regulation, 23(1): 56-63. 3 mendonca, t. (1999) “report on the brazilian pharmaceutical industry” report by the u.s. foreign commercial service and u.s. department of state, washington, usa. 4 management sciences for health (2001) international drug price indicator guide 2000, arlington (va), usa. 5 nesbitt, e.r. (2000) “pricing of prescription drugs” report by the u.s. international trade commission, washington, usa. 6 national productivity institute (1989) productivity study of the pharmaceutical manufacturing industry in south africa, pretoria, south africa. 7 organisation for economic co-operation and development (1981) multinational enterprises, governments and technology: the pharmaceutical industry, paris, france. sajems ns vol 6 (2003) no 2 383 8 _____ (2001) competition and regulation issues in the pharmaceutical industry, paris, france. 9 pharmaceutical manufacturers’ association (2001) annual report 2001, johannesburg, south africa. 10 public protector (1997) report 6: report on the propriety of the conduct of members of the ministry and department of health relating to statements in connection with the prices of medicines and utilisation of generic medicines in south africa, pretoria, south africa. 11 reekie, w.d. (1984) “drug prices in the uk, usa, europe and australia”, australian economic papers, 23(2): 71-78. 12 _____ (1997) “the pprs: regulations without a cause?”, in: green, d.g. (ed.) should pharmaceutical prices be regulated?, iea health and welfare unit, london, uk. 13 rozek, r.p. (2000) “the effects of compulsory licensing on innovation and access to healthcare” report by national economic research associates (nera), washington, usa. 14 south africa (1997) “medicines and related substances control amendment act” act 90, government gazette no 18505, government printers, pretoria. f:\ejour\ecoman\index\ecoman_v6_n2.prn.pdf sajems ns vol 6 (2003) no 2 262 historical analysis of african women workers in south africa during the period 1900 to 2000 ________________________________________________________________ pinky lalthapersad department of economics, unisa ________________________________________________________________ abstract the article is a detailed exposition of the history of the incorporation of african women into paid work in the south african labour market. the interlocking effects of racism, classism and sexism exposed african women to income and job insecurity. historically, access of african women to the labour market was shaped by the gendered nature of the migrant labour system and by legal measures that restricted women’s entry into urban areas and waged work. when african women were allowed into the formal labour market, they were only allowed to undertake the low-skilled, low-paying, menial jobs, were excluded from union benefits and forced to work under exploitative conditions. jel j16 introduction this article analyses the passage of entry of african women into paid work. the proletarianisation of african women in south africa assumed a unique character in that it was forged by the government’s policies of institutionalised segregation and inequality. any attempt to trace the path of the incorporation of african women into paid work and the anomalies that existed in the labour market must entail an analysis of previous statutory obligations on the utilization of african labour, and the conditions of work itself. african women were trapped in hardship and poverty by a tightly meshed web of restrictions on education, training, housing, work and pay. the subordination of afric an women was threefold, being premised on race, class and gender. in a highly stratified society and labour market, african women occupied the lowest positions in both arenas. the experience of african women in south africa is unique to that of white women within the country, and of women in other countries. whilst other women could rely on male earnings and were privileged in that they could sajems ns vol 6 (2003) no 2 263 retreat to the household if so desired, african women did not have the luxury of choosing whether or not to work. their restricted access to urban areas meant that they could not refuse jobs, as they were confronted with a limited range of jobs. their dire economic circumstances meant that they could not afford to leave work for childbearing or marriage. women endured the cumulative burden of low wages for themselves and their spouses, male migration, live-in domestic jobs, customary law, traditionalism and state regulation (berger & robertson, 1992: 13). the impact of influx control on african women policies of racial segregation in south africa unleashed a battery of artificial restrictions such as blocked urbanization, influx control and job reservation, which affected the utilization of african labour. the migrant labour system and pass laws served the dual purposes of restricting the movement of people and securing a cheap supply of labour. the exploitative nature of the migrant labour system was such that it forced african women to subsist in the reserves, and prevented them moving to the urban areas, thereby stifling the emergence of an african urban population (bernstein, 1985: 9). the african women that remained in the reserves fulfilled an important reproductive task in caring for the young, the old and the sick. prior to 1950, there were many localized measures aimed at controlling african female urbanization, for example, single female work seekers entering town were housed in labour depots, subject to their finding work. also, local authorities were given the right to deport women who lacked accommodation. under section 10 rights of 1945, african women were allowed into urban areas if they were the wife or unmarried daughters of men who had obtained section 10 rights (i.e. a person that legally qualified to live in an urban area) (simons, 1968: 281). in 1952 a system of influx control applied to both african men and african women. thus in 1952, the state viewed african women as separate entities within households, who forthwith had to qualify in their own right to be in urban areas. the enactment of the pass laws was an acknowledgment by the state of the collapse of patriarchal control over women (gwagwa, 1989). pass laws surfaced at an inopportune time for women, as new avenues of employment were opening up in the formal labour market (wells, 1993: 8). in 1959 it was compulsory for women to have their service contracts registered at the pass office. this requirement impinged further on women's access to the formal labour market. women were placed in a predicament in that even if they sajems ns vol 6 (2003) no 2 264 were able to secure jobs, their service contracts could not be registered if they lacked the appropriate permission from the pass office (yawitch, 1983: 5). in 1964 the special right of admission granted to wives and daughters was discarded. a wife could be allowed to enter an urban area but could only remain there for no more than 72 hours without permission. also, in 1964 women had to provide proof of satisfactory accommodation to the labour officer (yawitch, 1983: 8). this stipulation was grossly vindictive as housing was not available to african women. the bantu labour regulations act of 1973, made employers requisition african labour through the bureaux. african workers were not permitted to go to the cities in search of work. the bureaux issued temporary contracts of six to ninemonth’s duration. there were seventeen categories of occupations that were open to african males. only the category of domestic service applied to african women (kraak, 1993: 10-11). because registration with the bureaux was voluntary, it disguised the extent of african female unemployment (yawitch, 1983: 9). african women who were living lawfully in an urban area could only obtain work through the municipal or district labour officer who was charged with the task of issuing work permits. labour officers wielded extensive control over women. a permit could be refused for a specific job, women and their dependents could be forced to leave an area or an existing labour contract could be cancelled (bernstein, 1985: 41). women who worked illegally in urban areas endured many hardships. firstly, they risked being arrested and deported back to the reserves. secondly, they were exploited by employers who gained by remunerating them low wages. thirdly, their illegal status meant that they could not challenge low wages or bad working conditions and could be summarily dismissed. fourthly, they were denied the right to acquire a work profile (barrett et al., 1985: 13). the government utilized its policy of influx control to paralyse the entry of african women into urban areas. it weighed more heavily on women than on men, because when women entered the urban areas, they had to contend with low paid jobs of a domestic nature (walker, 1991: 21). the migrant labour system produced the rural/urban divide that profoundly affected african woman’s future role in the formal labour market. apartheid legislation resulted in a splintered labour market that afforded different groups, different degrees of security (standing et al., 1996: 11-13). sajems ns vol 6 (2003) no 2 265 the effect of influx control on family relations and work patterns influx control dislocated family relationships in that african women were denied the right to live with their husbands and lead a normal family life. according to yawitch (1984: 9) the ultimate effect of section 10 rights is that it tied african women's urban status to men, and thereby influenced both women's choice of residential abode and their lifestyle. if women divorced, they also risked losing their accommodation. african women had to contend with a capacious quantity of grossly vindictive laws. 'offences' such as cohabiting with husbands in employer-provided quarters, or sharing accommodation with men that lacked section 10 rights, constituted grounds for arrest (barrett et al, 1985: 19). domestic workers were also prevented from being transferred with employers (cock, 1980: 246). unemployed african women were especially vulnerable, as they fell within the definition of 'idle bantu' and could be asked to vacate the area (cock, 1980: 241). the prospect of being removed from an urban area, coupled with a loss of income was indeed, a very real threat confronting african women. a brief analysis of the employment trends of african women: 1900-1985 according to boserup (1970) the 'feminization' of occupations is a corollary of economic development, that is, as economic development occurs, women enter adjacent occupations, causing these new occupations to be 'feminized' (boserup, 1970: 217). in south africa, this development assumed a racial character in that, white women moved into jobs that were previously closed to them, like clerical and administrative work, leaving african women to occupy factory jobs (bernstein, 1985: 69). the ideology of female domesticity in the labour market was evident in the reservation of appropriate jobs for women. the state by only making the category of domestic work applicable to african women, coerced african women into domestic services (kraak, 1993: 10-11). live-in domestic work obliterated any reasonable family life. the slum clearance movement of the 1930s, and the relocation of africans from the cities to the townships, also made part-time domestic work difficult, and 'washing jobs' impractical due to time and cost factors (berger, 1980: 134). in this way afric an women were dealt another blow. sajems ns vol 6 (2003) no 2 266 in 1944, secondary industries experienced rapid growth and underwent increased mechanization, which necessitated a larger skilled workforce. since 1946 there was a movement of african women away from agriculture and domestic service into industry. the number of african women employed in manufacturing rose from 1 per cent in 1946 to over 20 per cent in 1979 (bernstein, 1985: 63). among the professional occupations, african women flocked into nursing and teaching because they comprised the better-paid options open to african women (budlender, 1991: 26). african women dominated service sector jobs which comprised of cleaning office blocks and shops, laundry work, cooking, waitressing, tea and kitchen work and messenger services (budlender, 1991: 26). in 1980, four sectors, namely, agriculture, manufacturing, commerce and services, employed over 97 per cent of african women workers (pillay, 1985: 23). in 1981, nine times as many women as men were employed in service jobs (kraak, 1993: 84). in 1985, african women made up 88 per cent of domestic workers, cleaners or chars. thus, the south african labour market was stratified in terms of both sex and race. women, employment and conditions at work working conditions confronting african women in industry was usually harsh and inflexible. time was so tightly regulated that a timekeeper was usually employed to check on the time women reported, in and the time spent away from their work stations (bernstein, 1985: 69). in some industries women were expected to clock in and out when availing themselves of the bathroom (berger & robertson, 1986: 222). in many instances african women also worked in employers' kitchens, performing domestic chores. they were employed in labour-intensive sectors, where work was strenuous and involved standing for long hours. whilst white women were excluded from heavy, physical work, african women were the only group of women that undertook such jobs (berger, 1992: 70). women worked in conditions that posed a hazard to their health. expectant mothers worked in refrigeration rooms and endured ailments such as rheumatism and arthritis (mashinini, 1989: 115). women employed in bakeries had to endure extreme heat and the associated negative health problems in terms of high blood pressure, skin diseases and dizziness (gwagwa, 1989). sajems ns vol 6 (2003) no 2 267 african women had to contend with severe authoritianism. in some circumstances, pay was deducted for arriving late at work, even though the dismal transport system was to blame. women could also be fired for missing a day of work. complaining of low pay or demanding better wages, carried the risk of dismissal and a ultimate loss of income. another trend was to replace women in their late thirties and forties with younger women, claiming they were too old to work. many african women were forced to accept temporary employment, thereby forfeiting benefits and the ability to acquire an employment history and service card (yawitch, 1984: 24). supervisors checked for signs of pregnancy. in one engineering factory in 1920, african women were forced to take the contraceptive pill, under nurses’ supervision. in some companies, factory doctors were instructed to watch for signs of pregnancy (berger, 1992: 226). to keep their jobs, women attempted to prevent and conceal pregnancy at all costs (barrett et al., 1985: 143). there were other petty and humiliating regulations in the textile and clothing industries. company policy restricted the excessive use of toilet paper. searching of african women in some stores and workplaces meant that african women employees were stripped naked, even during menstruation. possession of trade union material found during these searches, were grounds for dismissal (mashinini, 1989: 113). also, in the textile and garment industry, management utilized patriarchal principles to obtain control and discipline over workers. male supervisors were able to dispense permission to go to the bathroom or take a rest in exchange for sexual favours from workers (berger & robertson, 1986: 229). in the clothing factories, there was a readiness to fire women without prior notification and it was not unusual for ten people to be dismissed in the course of a day (budlender, 1991: 18 -21). at most firms workers were offered no tea or coffee and were only allowed a ten minute tea break. time constraints meant that lunch had to be hastily consumed, sparing little time for relaxation (mashinini, 1989: 6). industrial work often carried the penalty of a postponement of childbirth. in the industrial council agreement of 1983 covering sick leave, no provision was made for maternity leave for female workers, nor special sick leave in the case of women who suffered miscarriages. the majority of african women workers were forced to work until the final stages of pregnancy. many women received no maternity benefits at all. although the industrial council agreement of 1983 stipulated twelve weeks maternity leave, it did not compel employers to hold the job for returnees. if on the other hand women were rehired, their maternity leave constituted broken service and workers received a drop in salary (bernstein, 1985: 70). sajems ns vol 6 (2003) no 2 268 from 1970 onwards, textile industries in durban resorted to hiring african female migrants rather locals as migrants tended to work for lower wages. female migrants were housed in single-sex hostels and had to sleep two to a bed. women were limited to the confines of the hostel which was fenced in, and permanently guarded. they were subject to many petty rules which included expulsion for refusing to pick litter, being forbidden from smoking and drinking in rooms, and bringing children into rooms. controls were imposed on women even during their free time (berger & robertson, 1986: 230). mashinini points out that the association of white skin with preferential treatment in the labour market was so well established, that african women resorted to using skin lighteners in the hope of inducing favourable treatment (mashinini, 1989: 8). in jobs involving night work, women worked eight hour shifts each night, cleaning office blocks, shops and supermarkets. women employed in the textile industries in the border region worked night shifts. shifts were twelve hours long and lasted seven days a week, with two shifts off per fortnight. most spinners and weavers spent the entire shift on their feet (mashinini, 1989: 57). many african women employed in factories in menial work were excluded from the grading system. such exclusion separated women from the rest of the workforce and deprived them of union gains (mashinini, 1989: 84). the african female labour force in the 1990s in 1991, the occupational structure of the south african female labour force displayed three glaring disparities in terms of the distribution of african workers. firstly, african women comprised a negligible portion of managerial and administrative staff (2.5 per cent) compared to women of other racial groups (20 per cent). secondly, there was a high proportion of women in service occupations (namely, 34 per cent). thirdly, 46 per cent of african women practised occupations that were classified as ‘unspecified’. the large numbers of african women workers comprising the ‘unspecified’ category points to their preponderance to undertake work in the informal sector. furthermore, african women constituted the lowest percentage of professional and technical workers (6 per cent) compared to women of other race groups (52 per cent). they also comprised a mere 1 per cent of artisans (ssa, 1993). a more recent account of the occupational stratification is shown in tables 1 and 2 which are based on the october household survey for 1995, 1997, 1998 and 1999. although the data is not comparable across the years due to differences in sajems ns vol 6 (2003) no 2 269 sample sizes, they do convey succinct details on the employment trends of african women. according to table 1, african women comprised two-thirds of the total female workers and white women a fifth of the total. a common pattern across all five years is the fact that african women predominate in five industries, namely, agriculture, manufacturing, wholesale trade, community and social services and private households. a peculiar feature of these industries is that they tend to be low-paying, are typically involved in women’s work, possess unpleasant working conditions and few fringe benefits. there are also very few white women in these industries. whilst white women consistently make up more than 50per cent of those in finance and insurance, african women are sparsely located in this industry, an industry that actually contains more lucrative jobs. table 1 distribution of african and white female workers per industry industry 1995 1997 1998 1999 %af %wf %af %wf %af %wf %af %wf total female workers 60 39 62 21 61 22 63 20 agriculture 71 6 63 5 76 na 76 5 manufacturing 54 17 55 17 54 19 55 16 wholesale trade 55 27 64 18 64 19 65 18 transport 45 62 38 44 30 57 39 45 finance & insurance 21 66 25 55 27 56 29 54 community & social 71 17 57 29 57 28 59 27 private households na na 89 1 85 1 87 na own analysis based on 1995, 1997, 1998 & 1999 ohs: ssa table 2 highlights the skewed distribution of african and white women workers occupationally. african women were in the main located in the following occupational categories, namely: • technicians; • service workers; • skilled agriculture; • craft workers; sajems ns vol 6 (2003) no 2 270 • plant operators; • elementary occupations; and • domestic work. also evident from table 2 is the fact that white women featured prominently in the following categories, namely: • legislators; • professionals; and • clerks. the occupations into which african women are clustered in are essentially secondary sector jobs which offer very little training and avenues for mobility. furthermore, they are either peripheral activities in a job or an extension of women’s caring responsibilities. the occupations that white women dominate can be classified as better-paying, more challenging, occupations that offer opportunity for advancement, acceptable wages and have pleasant working conditions. the above analysis reflects the nature of the south african labour market where african women workers are crowded into certain occupations and industries. a palpable reason for this clustering is due to low levels of human capital and lack of formal labour market experience, a factor that is both reinforcing and limiting. it distinctly reflects the unique labour market status of african women workers who are disadvantaged by both income and work insecurity. they have little chance of securing a regular job that is adequately paying. african women are highly marginalized in the labour market as they are the least likely of all workers to be in formal employment. when employed they tend to be located in jobs that are poorly paid and exploitative, such as domestic work and informal sector work. the proportion of african women undertaking elementary occupations is indicative of the monopolization of african women of informal sector work. informal sector work mostly entails survivalist activities that pay a low income that is very erratic. an intricate aspect of labour markets, is joblessness and african woman, bore the brunt of unemployment. african women have the highest rate of unemployment which makes them the most vulnerable of all groups in south africa. in 1993 over 70 per cent of african women aged between 16 to 24 were unemployed according to the expanded definition (that is, job search excluded). in 1997 the unemployment rate for african women was 34.6 per cent according to the official definition and over 50 per cent based on the expanded definition (ssa: 1998). sajems ns vol 6 (2003) no 2 271 table 2 distribution of african and white female workers per occupation occupation 1995 1997 1998 1999 %af % wf % af %wf %af %wf %af %wf total female workers 60 39 62 21 61 22 63 20 legislators 35 56 32 51 32 51 23 62 professionals 42 47 54 32 34 50 38 51 technicians 58 32 46 38 51 33 57 30 clerks 30 54 34 44 30 49 35 43 service workers 58 21 61 19 69 17 62 19 skilled agriculture 55 33 79 na 94 na 83 5 craft workers 63 16 68 9 75 9 71 13 plant operators 61 4 60 na 54 8 58 6 elementary 83 0 75 3 81 na 82 2 domestic na na 89 1 88 na 87 0 own analysis based on 1995, 1997, 1998 & 1999 ohs: ssa conclusion the state exerted rigorous control over the lives of african families. laws governed the physical movement of african people, access to the cities, the right to housing and above all, access to the job market. the pass laws of the 1950s severely restricted the movement of african women. the migration of women to towns was dictated by employer needs rather than family considerations. when african women did come to the urban areas, they faced a number of constraints on their employment and occupational choice, that is, a rigid sexual and racial stereotyping, which excluded them from jobs in the formal industrial sector. they were targeted for domestic work and even when allowed into formal industry, were given the menial and lowest paid jobs. in many industries, african women worked under hazardous and unhealthy conditions. their private lives were controlled by employers who, handed contraceptives, monitored signs of pregnancy and summarily dismissed workers. african women spent long, tedious hours travelling to work, earning salaries sajems ns vol 6 (2003) no 2 272 that were extremely low, with the threat of job loss and removal from urban areas, ever present. the south african labour market has inherited structural rigidities and inequalities from the apartheid era. african women were found only in a few industries and occupations. african women’s marginality in the south african labour market is evident in the kinds of jobs they undertake, that is, there is a very small number of them in managerial positions. african women have to be provided with education and training to enable them to filter into higher-paying jobs and become more representative in the formal labour market. business and government have to make a concerted effort to this end. trade unions have begun to address the issue of casualisation of work in the loom of globalisation that is beginning to grip the south african economy. in this regard, three key pieces of legislation that have been introduced are crucial. firstly, the employees standards act of 1999 is a measure that aims to protect full-time, part-time and contract workers. such a measure will offer employment and work security to these groups that tend to be overwhelmingly female. secondly, the employment equity act of 1998 seeks to remove unfair discrimination in hiring, promotion, training, pay benefits and retrenchments. it will amongst other things, compel employers to accommodate the needs of women and disabled people and achieve a more representative workforce. thirdly, the skills development act of 1998 which seeks to equip workers with skills to enable them to improve their quality of life, employability and productivity. such process bodes well for the future, especially if women are to make a meaningful contribution to the economy. references 1 barrett, j., dawbar, a., klugman, b., obery, i., schindler, j. & yawitch, j. (1985) vukani makhosikazi: south african women speak, london : catholic institute for international relations. 2 berger, i. & robertson, c. (1986) women and class in africa. new york: africana publishing company. 3 berger, i. (1992) threads of solidarity women in sa industry 19001980, indianapolis: indiana university press. 4 bernstein, h. (1985) for their triumphs and for their tears: women in apartheid south africa. london: international defence and aid fund for southern africa. 5 boserup, e. (1970) women's role in economic development, new york: st martin’s press. sajems ns vol 6 (2003) no 2 273 6 budlender, d. (1991) women and the economy, johannesburg: case offices. 7 cobbett, w. & nakedi, b. (1987) “behind the 'curtain' at botshabelo: redefining the urban labour market in south africa”, review of african political economy, 40: 32-46. 8 cock, j. (1980) maids and madams a study in the politics of exploitation, johannesburg: ravan press. 9 gwagwa, n.n. (1989) “the family and women's emancipation in south africa”, paper read at the malibongwe conference, amsterdam. 10 kraak, g. (1993) breaking the chains labour in south africa in the 1970s and 1980s, london: pluto press. 11 kuzwayo, e. (1960) “the role of the african women in towns”, journal of the south african institute of race relations, 22: 40-48. 12 mager, a. (1989) “moving the fence: gender in the ciskei and border textile industry, 1945-1986”, social dynamics, 15(2): 46-62. 13 mashinini, e. (1989) strikes have followed me all my life: a south african autobiography, london: the women's press. 14 pillay, p. (1985) “women in employment in south africa: some important trends and issues”, social dynamics, 11(12): 203-37. 15 standing, g., sender, j. & weeks, j. (1996) restructuring the south african labour market: the south african challenge, geneva:ilo office. 16 simons, h.j. (1968) african women: their legal status in south africa, united kingdom: northwestern university press. 17 statistics south africa (ssa) (1996) census in brief, pretoria. 18 ssa (1993) south african labour statistics, pretoria. 19 ssa (1995) october household survey, pretoria. 20 ssa (1997) october household survey, pretoria. 21 ssa (1998) october houshold survey, pretoria. 22 ssa (1999) october household survey, pretoria. 23 van onselen, c. (1982) studies in the social and economic history of the witwatersrand 1886-1914. vol 1. johannesburg: ravan press. 24 walker, j.c. (1991) women and resistance in south africa: cape town: david philip. 25 wells, j.c. (1993) we now demand a history of women's resistance to the pass laws in south africa, johannesburg: wits university press. 26 yawitch, j. (1983) “the incorporation of african women into wage labour 1950-1980”, south african labour bulletin 9(3): 10-24. 27 yawitch, j. (1984) “tightening the noose: african women and influx control in south africa 1950-1980”, carnegie conference paper no 82. second carnegie inquiry into poverty and development in south africa. cape town. microsoft word 4 douglas et al sajems 16(3) 2013.docx sajems ns 16 (2013) no 3:279-297 279 travel or technology? business factors influencing management decisions anneli douglas and berendien lubbe department of tourism management, university of pretoria inger fabris-rotelli department of statistics, university of pretoria accepted: march 2013 there is an on-going debate on the use of technology as an alternative to business travel, with industry and academia differing in their views on such substitution. this study investigates the trend towards substitution and identifies the factors and barriers that play a role in either supporting or limiting such substitution. the results provide management with an evaluation of the benefits of replacing business trips with videoconferencing and other alternatives, against the potential disadvantages of using these alternatives. key words: business travel; corporate travel management; videoconferencing; teleconferencing; web conferencing jel: l96 1 introduction business travel is a significant sector in the overall tourism market accounting for about 15 per cent of all tourist arrivals (unwto, 2008). although organisations are increasingly facing the need to interact with distant partners (aguilera, 2008), this does not necessarily require physical travel. according to cramton (2001) the way in which groups are organised and their means of communication to support their work are changing. communication and collaborative technologies have developed to such an extent that it has now become feasible for groups to work together even though their members are physically dispersed. cramton (2001:346) describes geographically dispersed teams as ‘groups of people with a common purpose who carry out interdependent tasks across locations and time, using technology to communicate much more than they use faceto-face meetings.’ many relationships can be built and maintained through mediated communications such as telephones, emails and videoconferences. in fact, according to wang and law (2007) information and communications technologies (icts) offer people a substitute for face-to-face contact and thus have the ability to replace physical travel. today, some companies even make it compulsory for an employee to motivate their need to travel rather than using their company’s implemented videoconferencing system (brightcom, n.d.). at the same time constraints exist because technology is not yet optimal as a substitution for face-to-face meetings or could be too costly to implement. according to cramton (2001) research relating to the sharing of information amongst groups and the effect that media might have on those groups poses questions about the possibility of success under dispersed and technologymediated settings. denstadli (2004) and mason (2002) found that technologies such as videoconferencing had not had a significant influence on the number of business trips undertaken, although in 2002 mason predicted that icts would advance sufficiently to permit some substitution in the future (mason, 2002). a further consideration is the growing concern for the environment and the impact of travel on the environment, which suggests that more studies should be conducted to determine the abstract 280 sajems ns 16 (2013) no 3:279-297 extent of substitution and the circumstances under which such substitution can take place. the overall purpose of this paper is to gain a greater understanding of the factors that influence organisations in their choice between physical travel undertaken for face-to-face meetings and the use of technology such as videoor teleconferencing as a substitution. the paper focuses on the so-called businessdriven factors that may have an influence on management decisions, for example the cost of travel, decreasing the carbon footprint of the business, and ensuring the safety of business travellers. the paper does not cover personal motivations for business travel (for example the desire for a business traveller to experience new cultures, meet new people or break away from normal work routine). more specifically, the paper identifies the type of business interaction that is appropriate to the use of technology as a substitution for face-to-face meetings and would overcome the problems inherent in the communication of geographically dispersed teams, the constraints that affect the use of technology as an alternative to business travel, and finally the extent to which technologies are currently being used as an alternative to business travel. in this study south africa was chosen as the research setting. research from both industry and academia suggests that there is increasing use of technology as an alternative to business travel in europe and the usa (american express, 2003; face-to-face meetings still beat web teleconferencing, 2006; robart, 2008; wainhouse, 2004). as far back as 1995, burger estimated that videoconferencing alone could reduce the need for business travel by as much as 40 per cent, depending on trip distance and purpose (roy & filiatrault, 1998), while more recently researchers predicted that video meeting applications will substitute 2.1 million airline seats yearly by 2012, costing the travel and hospitality industry us$3.5 billion per annum (alves, 2009). the videoconferencing market has grown considerably in the past 20 years, growing fivefold in the period from 1991 through to 2006 (denstadli & gripsrud, 2010) to a total value of $1.06 billion (denstadli, julsrud & hjorthol 2012: 70). a number of factors set south africa apart from other countries. firstly, telecommunication costs in south africa are still very high, and this might be a barrier to the implementation of ict alternatives. furthermore, it seems that some south african companies are convinced that face-to-face meetings are still superior to virtual ones and that these companies are travelling more than ever before (hurley, 2011; muller, 2011). it was thus necessary to determine whether south africa is following the rest of the world in terms of technology usage to replace business trips, or whether these distinguishing factors are causing south africa to lag behind in terms of technology adoption. the paper begins by providing an overview of the main types of travel alternatives available in the market and their viability in achieving the objectives of business meetings. thereafter the factors influencing the use of technology as an alternative to business meetings are identified from a theoretical perspective. the importance of these factors is tested empirically by selecting managers with travel portfolio responsibilities in corporations, travel management companies and travel suppliers in south africa. the methodology section covers the sampling and data analysis techniques used. finally the results of the research study are explained and the paper concludes with a discussion of these results and the potential for future research on this topic. 2 types of technology available as a substitute for business meetings teleconferencing, web conferencing and videoconferencing appear to be the most viable alternatives to travel (wainhouse research, 2004). according to enbysk (2008) teleconferences are the ideal communication tool for sharing straightforward information and making simple decisions that need no visual presentation. but they are not the appropriate way to discuss more complex matters, which could be presented more appropriately via web conferencing. teleconferencing is also not a desirable way to start or even advance a vital business relationship. another tool that is becoming increasingly important as a substitute for business travel is web sajems ns 16 (2013) no 3:279-297 281 conferencing, which, according to the economist grew by 40 per cent in 2003 (business: being there; virtual meetings, 2004). according to enbysk (2008) web conferencing can be explained as videoconferencing without the video – or alternatively – teleconferencing but adding the web for interactive presentations by using powerpoint, excel or other documents. still, web conferencing cannot compete with face-to-face meetings since, unlike videoconferencing, the audience’s facial expressions and body language cannot be observed. however, for simple business plan reviews, sales meetings and software demonstrations web conferencing remains a viable alternative to travel (enbysk, 2008). videoconferencing can be summarised as an interactive application of video, computing and communication technologies to permit people, either one-on-one or in groups of up to 12 people, in two or more localities, to convene without actually being together (enbysk, 2008). the ability of the media to facilitate several information cues at the same time, provide speedy response and establish a personal focus is referred to as the “richness of the media” and is a determining factor in the type of content that the media can be used for. although media with low richness can be used to facilitate routine activities, richer media is more suitable for non-routine activities and ambiguous communication. communication failure happens when the medium is not rich enough for the content. videoconferencing is often seen as a rich medium, although not as rich as face-to-face interaction, since it can facilitate visual cues and provide instant response (denstadli et al., 2012). the newest addition to travel alternatives is telepresence, and mckenzie (2008:7) describes this technology as “a form of videoconferencing that uses advanced technology to integrate the sights and sounds of remote meeting participants into a local setting, such as a corporate boardroom”. more specifically, davis and kelly (2008:2) explains telepresence as solutions that ‘use video and audio conferencing components as well as other “arts and sciences” to create a two-way immersive communications experience that simulates an in-person, interactive encounter’. it has been established by authors such as dennis and valacich (1999); veinott, olson, olson and fu (1999); kraut, fussel and siegel (2003) and kraut, gergle and fussel (2002) that some media, such as email and the internet, are better able to distribute information called “conveyance” while other media such as video conferencing or telepresence are better at producing a common understanding, or “convergence”. convergence media, especially telepresence technology, has the ability to “accurately simulate face-to-face contact”. it should be kept in mind that media that might be better able to handle one type of process may not automatically be as well equipped to handle the others and so the use of several types of media may be the ideal (rhoads, 2010:115). according to malhotra and majchrzak (2005:11) “email and conference calls, have until recently, formed the backbone of communications support for virtual groups but these rudimentary technologies have been found to encourage miscommunication and the loss of crucial contextual information”. what is more, teams making use of email and audioconferencing often do not succeed in providing vital information regarding the underlying context of a message, for example why information has to be shared, a person’s reason for not responding, the context behind decisions made or alternative perspectives on a matter (malhotra & majchrzak, 2005). consequently, virtual team members relying exclusively on email and audioconferencing find it difficult to create the “common ground” needed for grasping each other’s communications (clark, 1996). 3 factors influencing the use of technology as a substitute for business meetings the factors that influence the use of technology as a substitute for business meetings can be seen from the perspective of the advantages inherent in their use, the disadvantages of using icts as alternatives and the constraints on their adoption. a number of studies agree that the most important reason for the increase in the use of audio/video conferencing tools is that it is a 282 sajems ns 16 (2013) no 3:279-297 way to reduce travel expenses (arnfalk & kogg, 2003; business: being there; virtual meetings, 2004; the conference board of canada & association of corporate travel executives, 2007) which come in the form of direct cost savings such as flights, hotels, car services and food as well as indirect cost savings, for example the cost of saved employee time (meyer, 2009). it is estimated that video conferencing systems could save a company approximately 50 per cent of their original travel cost in the second year of implementation, and 38 per cent of their original travel cost during a five year period (brightcom, n.d.). the time saving factor appeals to many business travellers since technology could be utilised as an alternative to gain lost travel time while enhancing productivity and business performance, as well as the quality of business level decisionmaking (brightcom, n.d.; eyefortravel, 2002; is your journey really necessary?, 2006). other research showed that converting inperson meetings to meetings conducted via technology would permit business travellers to travel less, spend more time with family and friends and cultivate better relationships with co-workers, customers and partners (wainhouse research, 2004). meyer (2009) asserts that one of the most essential benefits of videoconferencing is its ability to enhance employees’ quality of life. he mentions that the use of videoconferences could lead to higher job satisfaction and loyalty to employers as well as less stress and improved work-family balance. another advantage of using technology instead of face-to-face meetings is that it allows the attendees of a meeting to archive sessions and view them again later on. organisations’ concerns about saving costs may be encouraging them to implement green alternatives to business travel. web conferencing has been gaining in popularity over the past year, and is named as one of the main sustainable business strategies (sustainable life media, 2009). videoconferencing can help lessen an organisation’s carbon footprint (arnfalk & kogg, 2003) since organisations are beginning to give consideration to the carbon-based effect of their policies, and are reducing air travel as a way to deal with climate change (mackenzie, 2008), while at the same time improving their corporate social responsibility (meyer, 2009). mcquail (2000) is of the opinion that computer-mediated communication has some advantages over face-to-face communication and mentions the fact that it can balance hierarchies among participants by reducing status, as an example. rhoads (2010:112) adds that computer-mediated communication can “increase opportunities for participation since the more vocal have fewer means to dominate the setting than they do in face-to-face encounters”. on the other hand, some of the disadvantages of travel alternatives are preventing organisations from using these technologies. sole and edmondson (2002:20) define situated knowledge as “knowledge embedded in the work practices of a particular organizational site.” members of geographically dispersed teams situated at different sites thus do not share situated knowledge even when their responsibilities are alike. cramton (2001) emphasises the creation of “mutual knowledge” as a problem when geographically dispersed teams collaborate. kraus and fussell (in cramton, 2001) describe mutual knowledge as knowledge that parties who communicate with each other share, while being aware of the fact that they share this knowledge, and describe three mechanisms by which mutual knowledge could be established: direct knowledge, interactional dynamics and category membership. when dispersed team members try to achieve mutual knowledge through interaction, information must be shared and receipt and understanding of information acknowledged (cramton, 2001). electronic mediation creates obstacles not only to the distribution of information but also acknowledgement thereof. according to quest (in mill & morrison, 2006), in the uk, corporate travellers are travelling less because of technology – particularly through the use of remote access and virtual private networking (vpn) but not many travellers believe that such technology is more valuable than face-to-face meetings. first, the practical problems linked with videoconferencing have restricted its use as it has never been completely stable (is your journey really necessary?, 2006). second, de lind van wijngaarden, erman, matthews, sharp and sutter (2010) believe that travel sajems ns 16 (2013) no 3:279-297 283 alternatives are either too costly, need dedicated equipment and infrastructure, or are too complex to implement on an individual location basis for extensive use. less expensive options typically do not offer the wanted level of interaction or the consistent quality required for corporate communications. thirdly, armstrong (2007) adds that technology often adds an impersonal feeling, while de lind van wijngaarden et al. (2010) mention the limited level of interaction between the participants as a disadvantage of travel alternatives. arnfalk and kogg (2003) believe that meeting someone in person allows the individual meeting participants to build personal networks and build deeper personal relations, something that virtual meetings do not permit. mason (2002:65) agrees by saying that ‘there is no substitute to meeting people face-to-face’. according to arnfalk and kogg (2003), face-to-face meetings are often preferred when meetings are held with persons outside the firm, even if such meetings could have been conducted via icts. physical presence can be regarded as a sign of interest and users of virtual meetings sometimes perceive these meetings as less significant, or second class meetings. thus, using icts to conduct meetings could create perceptions of a client being less important. another disadvantage of travel alternatives is that the security of information cannot be guaranteed when using these technologies. apart from the disadvantages of travel alternatives, certain barriers prevent organisations from implementing these technologies in their organisations. the high telecommunication costs in some countries might deter companies from implementing travel alternatives (gabara, 2009). since those services are usually bought on a per-minute or simultaneous user basis, access and usage is often limited to less than 20 per cent of employees in an organisation to prevent escalating subscription costs. gillam and oppenheim (2006) also feel that there might not be enough knowledge within an organisation to permit implementation of travel alternatives. table 1 summarises the advantages and disadvantages of using technology as an alternative to travelling to business meetings, and barriers to organisations investing in such technology. strong arguments for face-to-face meetings have been presented in the preceding section and therefore physical travel is expected to remain the most vital tool for maintaining relationships, because of the unique strengths of such face-to-face interaction. however, it is also argued that the communication method used, either icts or face-to-face meetings requiring physical travel, is determined by the nature of the business interaction or the purpose thereof, as well as the type of organisation making the decision. 4 types of business interaction suited to videoconferencing and other alternatives aguilera (2008) argues that the chosen communication method will depend on the nature of the knowledge to be exchanged in any interaction. she distinguishes between two types of knowledge, namely ‘codified’ knowledge and ‘tacit’ knowledge. codified knowledge is explicit knowledge and relates to facts (know what) and to principles and laws (know why), and can usually be communicated through icts because of its direct nature. tacit knowledge, in contrast, cannot be conveyed by icts, but rather needs face-to-face contact. it relates to competence as well as skills (knowhow) along with information regarding who knows what and who knows how to do what (know-who) (lundvall & johnson, 1994). the relationship between the type of interaction and the use of computer-mediated communication also depends on the number of cues that need to be transmitted simultaneously. rhoads (2010:115) mentions the media richness theory, which postulates that face-to-face contact is the richest of the communication media since participants can transmit a number of cues at the same time. in terms of richness, face-to-face contact is followed by video communication, then telephone, and the lowest on the continuum is electronic communication, for example email and computer documents. lu and peeta (2009) also found that the context within which a meeting is conducted has a significant influence on the communication mode selection, with meeting contexts that do not particularly 284 sajems ns 16 (2013) no 3:279-297 need face-to-face contact being likely to promote increased videoconferencing usage. furthermore, they contend that meetings that necessitate face-to-face contact, such as business discussions, negotiations, marketing demonstrations, and event participation, stimulate business air travel while videoconferencing is sufficient for information exchange, management meetings, training, and consulting. enbysk (2008) says that face-to-face meetings are warranted under the following circumstances: when meeting a new client, when introducing new people to a continuing business relationship, when concluding a sale or signing a contract, when delivering a product demonstration, when resolving a problem or discussing confidential information, when convening with a lawyer, when asking for money from an investor and lastly when making sales or training presentations. however, there are situations where videoconferencing and other alternatives can actually be more effective, for example as a second meeting tool after the first introductory meeting (business: being there; virtual meetings, 2004). the challenge is to be able to identify these situations and assign resources accordingly (lehman & niles, 2001). table 1 factors affecting the use of technology as a substitute for business meetings factor related factors advantages reduce travel expenses save time enhance productivity better decision-making cultivate relationships higher job satisfaction enhance employees’ quality of life improve work/family balance reduce carbon footprint archive sessions and to view them later disadvantages access and use is limited technology is not yet ready practical problems with technology not human contact no relationship building and establishing of contacts technology is costly security might be compromised no opportunity for sharing knowledge and best practice creates perceptions of a client being less important barriers to implementation telecommunication costs are too high not enough knowledge in organisation no need for it resist change not a worthwhile financial investment the cultural environment within which business is conducted may determine the suitability of travel alternatives (hall, 2009). when travelling to asia, for example, it is generally accepted that it will not be possible to start or even continue business relationships without direct face-to-face contact. on the other hand in australia and north america organisations believe that business can be maintained through other media once direct contact has been made. nevertheless, hall (2009) maintains that face-to-face interaction is regarded as essential when developing trust in business relationships. evidence suggests that the organisational profile may also influence the adoption of technology as an alternative to travel. lethiais and aguiléra’s (cited in aguilera, 2008:1112) studied companies in brittany, france and determined that there is an association between the sector or size of a company and the frequency with which business travel takes place. miyoshi and mason (2009) further asserted that certain industries travel more than others, and it is thus safe to assume that the bigger the volume of travel within the organisation, the greater the need for ict alternatives might be. according to hall (2009) smaller firms would like to sajems ns 16 (2013) no 3:279-297 285 utilise travel-alternative technologies but they do not see it as a worthwhile financial investment. arnfalk and kogg (2003) further believe that organisational culture will have an effect on the decision to increase the use of travel alternatives or not. in essence, it seems that the types of business interaction that would be suited to the use of travel alternatives are those where the inherent problems of dispersed collaborations have been overcome. one of the problems of dispersed collaboration already mentioned in this paper is in creating ‘mutual knowledge’, defined by krauss and fussel (in cramton, 2001) as ‘knowledge that the communicating parties share in common and know they share’. when considering internal meetings, for example, it is obvious that the communicating parties have shared knowledge in common. in contrast, during negotiations, shared knowledge might be absent, and so travel alternatives will not be suitable. cramton (2001) further believes that electronic mediation presents some obstacles to information sharing as well as confirmation, since computers do not usually give efficient back-channel feedback, something that is vital during the negotiation process. in summary, table 2 summarises the types of meetings and the nature of the organisation in terms of its size, location and culture, that would be suited to the use of technology as a substitute for business trips. table 2 types of business interaction and organisational profile influencing the use of technology as a substitute for business meetings types of business interaction suited to the use of travel alternatives internal meetings urgent meetings status meetings client interaction attending a conference collecting information before approaching a client second-meeting tool not suited to travel alternatives negotiations disciplinary and performance hearings sharing confidential information organisational profile size location of offices local/international organisational culture type of industry using the identified factors as the theoretical foundation, this study aims to assess the importance of the advantages, disadvantages and barriers to the use of technology as an alternative to business travel, and to show the type of business interaction that is appropriate for the use of technology. the study also ascertains whether the type of organisation has an influence on the use of technology; and finally establishes the extent to which technology are currently being used to replace business travel in south africa. 5 methodology a quantitative, ex post facto study was conducted using a web-based questionnaire which was designed based on the factors identified through the literature study and depicted in tables 1 and 2. three corporate travel managers were approached to verify the terminology used in the questionnaire and confirm the questionnaire items; in these interviews no new knowledge on the topic was generated. furthermore, the questionnaire was then pretested amongst a group of five corporate travel managers to verify readability and correctness of the constructs and variables. thereafter the questionnaire was distributed to the management of corporations, travel management companies and travel suppliers in south africa derived from the 2009 register of all listed jse (johannesburg stock exchange) companies, and a number of other business and industry specific databases. this resulted in a 286 sajems ns 16 (2013) no 3:279-297 total of 440 organisations being approached via web-based questionnaires on a nonprobability basis, with a total number of 80 useable responses being received out of the 440. where travel management companies and travel suppliers were approached, they were asked to complete the questionnaire as a travel buyer, in other words, as a company who also has to travel for business purposes, and having the need to replace business trips with appropriate technologies. web-based questionnaires were chosen since these surveys are fast becoming desirable alternatives to traditional survey methods, ameliorating some of the disadvantages of selfadministered questionnaires. email and webbased data collection techniques have become popular amongst researchers because of their low costs and fast response rates (ilieva, baron & healey, 2002). the anonymity that webbased surveys offer to the respondents provides a level of comfort that cannot be attained with other conventional techniques, for example, mail, telephone and mallintercept surveys. thus, web-based surveys are expected to represent more honest responses than other types of surveys (rubin in hudson & ritchie, 2006). conversely, there are also a number of disadvantages linked with web-based surveys, of which the most frequently mentioned are sample frame and non-response bias (manfreda in fleming & bowden, 2009). sample frame bias refers to the non-random omission of individuals from the sample frame, due to the lasting social and spatial divide in access and utilisation of the internet in the majority of populations, which can cause sample biases to any online research. sample frame bias had no influence on this research study as the entire sample had access to the internet at their places of employment. nonresponse bias occurs when respondents within the sample frame have very dissimilar attitudes or demographic characteristics to those who do not respond. the purposive nature of the sampling in selecting ‘typical’ respondents should limit this type of non-response bias. non-response bias increases when potential respondents display different levels of technical ability, and it becomes a particular predicament when response rates are low (fleming & bowden, 2009). it was assumed that management-level players within the corporate travel industry responding to the web-based questionnaire would have a certain degree of technical ability that would enable them to complete the questionnaire, and this prevented non-response bias from influencing the study. a further possible disadvantage of web-based surveying is the fact that the researcher often has no way of knowing if there are a number of respondents at one computer address, or if one respondent is completing a questionnaire from a selection of computers (marta-pedroso, freitas & domingos, 2007). in our study, the use of cookies and server log files addressed these concerns. 6 data analysis and results 6.1 descriptive statistics first the descriptive analyses findings are provided to illustrate the extent to which technology is currently being used to replace travel, as well as how different factors affect the use of technology as travel alternatives. the organisational profile in terms of ownership, type of company and travel expenditure is shown in table 3. table 3 shows that the majority of respondents were employed by companies that were mainly south african owned. approximately half of the companies were private and half public (listed on the stock exchange). as shown in table 3 travel expenditure ranged between less than r10 million to more than r50 million per annum. in answer to the question on their propensity to use technology as an alternative to business travel, seventy two percent of respondents affirmed that they are currently using technology to replace a portion of their travel, with teleand videoconferencing being the most popular applications to use. in terms of the percentage of company trips being replaced by technology almost eighty percent (77 per cent) of respondents said that 5-10 per cent of their travel is being replaced by technology, while 13 per cent said between eleven and twenty percent of their travel is sajems ns 16 (2013) no 3:279-297 287 being replaced. only eight percent of respondents said that more than 50 per cent of their business trips are being replaced by technology. table 4 indicates the results on the advantages and disadvantages associated with a company’s use of travel alternatives to replace business trips, the barriers to implementing travel alternatives, and the types of meetings that are most suited to using travel alternatives. the question regarding the advantages of travel alternatives asked respondents to rate how important they think the listed advantages of travel alternatives were on a scale of 1-4 where 1 was very important and 4 was unimportant. categories were combined, for example, ‘strongly disagree’ and ‘disagree’ were combined to form ‘disagree’ and the arithmetic means were calculated to rank the items. it should be highlighted that while the mean scores cannot strictly be used as a ranking tool under these circumstances of discrete data, the mode and median scores do support this. from the mean scores it was evident that the advantages that were the most important were that travel alternatives lead to more efficient use of employees’ working hours, it improved an employee’s productivity and it reduced an organisation’s travel expenditure. the question on disadvantages asked respondents to rate the extent to which they agreed/disagreed with the listed disadvantages of travel alternatives. the disadvantages that were ranked the highest were that travel alternatives made it difficult to build relationships, they did not allow for human contact and that one could pick up on body language when using travel alternatives to conduct a meeting. when asked about the barriers to the implementation of travel alternatives, respondents ranked the following factors as the biggest barriers: organisations might resist change, practical problems experienced with equipment and incompatible equipment. regarding the types of interaction most suited to the use of travel alternatives, respondents felt that internal, urgent and status meetings were the most suited for travel alternatives, whereas in the cases where first contact needed to be established, new contracts negotiated and disciplinary hearings held, travel alternatives were least suited. table 3 organisational profile ownership of organisation type of company average total expenditure number of respondents mainly south african 52 (75.36%) public company 24 (34.78%) less than r10mil 8 (11.6%) between r10mil and r50mil 8 (11.6%) more than r50mil 8 (11.6%) private company 21 (30.43%) less than r10mil 14 (20.29%) between r10mil and r50mil 5 (7.25%) more than r50mil 2 (2.9%) parastatal 5 (7.25%) between r10mil and r50mil 1 (1.45%) more than r50mil 4 (5.8%) government organisation 2 (2.9%) between r10mil and r50mil 1 (1.45%) more than r50mil 1 (1.45%) mainly international 17 (24.64%) public company 5 (7.25%) between r10mil and r50mil 2 (2.9%) more than r50mil 3 (4.35%) private company 12 (17.39%) less than r10mil 9 (13.04%) between r10mil and r50mil 1 (1.45%) more than r50mil 2 (2.9%) when asked whether travel alternatives offered an adequate substitute for face-to-face meetings, the majority (71 per cent) of respondents said that in many cases they did, 15 per cent said no, while only 6 per cent gave a definitive yes, the rest (8 per cent) were unsure. despite the fact that the majority of respondents agreed that travel alternatives did offer an adequate substitute for face-to-face travel to some extent, 72 per cent of respondents still admitted that their travel policy did not outline choices between travel 288 sajems ns 16 (2013) no 3:279-297 and technology alternatives, while 85 per cent said their organisations did not have a process to decide when to travel and when to use alternatives. table 4 factors affecting the use of travel alternatives rank mean median mode advantages more efficient use of employee’s working hours 1 1.37 1 1 improving an employee’s productivity 2 1.39 1 1 reducing an organisation’s travel expenditure 2 1.42 1 1 making faster decisions 3 1.51 1 1 making better decisions 4 1.52 1 1 reducing an organisation’s carbon footprint 5 1.63 2 1 avoiding the safety-related hazard of travelling 6 1.93 2 2 allowing an employee more free time 7 2.16 2 2 disadvantages difficult to build relationships 1 1.76 2 2 cannot pick up on body language 2 1.91 2 2 no human contact 3 1.81 2 1 security of information might be compromised 4 2.27 2 2 creating a perception of a client being less important 4 2.34 2 2 it is too expensive 5 2.60 3 3 barriers organisations might resist change 1 2 2 2 practical problems experienced with equipment 2 2.12 2 2 incompatible equipment 3 2.27 2 2 the capital layout is too expensive 3 2.25 2 2 not enough knowledge to implement 4 2.35 2 2 telecommunication costs in sa are too high 5 2.27 2 2 there is no need for it 6 2.97 3 3 types of interaction internal interaction status meetings 3 1.92 2 2 internal meetings 1 1.74 2 1 urgent meetings 2 1.85 2 2 disciplinary hearings 11 3.24 3 3 solve problems 5 2.3 2 2 to share confidential information 8 2.75 3 3 new interaction to collect information before approaching a client 4 1.96 2 2 establish first contact 9 2.91 3 2 established interaction negotiating new contracts 10 3.11 3 3 sales calls 7 2.71 3 3 attending a conference 6 2.52 2 2 6.2 multiway tables a number of variables were cross-tabulated to determine the relationships between travel alternatives usage (yes or no) and determinants affecting their use. chi-squared tests were used to assess whether any significant interaction between usage and the determinants was present. a number of relationships, presented sajems ns 16 (2013) no 3:279-297 289 below, were found to be significant. one of the questions in the survey asked respondents whether they are currently using technology to replace any portion of their companies’ travel. the results of this question were cross tabulated with the results of a number of other questions. only those tests that proved significant, with p < 0.01 providing convincing evidence, p < 0.05 providing strong evidence, and p < 0.10 providing moderate evidence of significance are shown in the figures below. where cells had low counts, categories were combined: for example, ‘strongly disagree’ and ‘disagree’ were combined to form ‘disagree’. figure 1 indicates that the greater the respondent perceived the risk that icts might compromise the security of information, the less likely his/her organisation was to make use of icts. the chi-squared test provided convincing evidence of significance, with p < 0.013. figure 1 usage of icts vs. security of information figure 2 usage of icts vs technology being too expensive 98 87 2 13 0 10 20 30 40 50 60 70 80 90 100 currently using icts not currently using icts % usage of icts vs reducing travel expenditure important unimportant 28 60 72 40 0 20 40 60 80 100 currently using icts not currently using icts % usage of icts vs technology too expensive agree disagree 290 sajems ns 16 (2013) no 3:279-297 from figure 2 it is evident that when a respondent disagreed with the statement that ict technologies were too expensive, his/her organisation was likely to make use of these technologies. similarly, when a respondent agreed that ict technologies were too expensive, his/her organisation was less likely to make use of these technologies. this relationship provided convincing evidence of significance, with p < 0.026. figure 3 usage of icts vs no need for technology not surprisingly, figure 3 shows that when a respondent agreed that there was no need for ict technologies in their organisation, the organisation was not likely to make use of these technologies. the chi-squared test once again provided convincing evidence of significance, with p < 0.027. next, all the disadvantages associated with ict technologies were grouped together and a chi-squared test was used to establish whether a significant relationship existed between the disadvantages associated with icts and the usage of icts. the results in figure 4 showed that the greater the perceived disadvantages of travel alternatives, the lower the usage of travel alternatives will be (p < 0.027). figure 4 usage of icts vs disadvantages of icts 17 47 83 53 0 10 20 30 40 50 60 70 80 90 currently using icts not currently using icts % usage of icts vs no need for technology agree disagree 64 76 36 24 0 10 20 30 40 50 60 70 80 90 100 currently using icts not currently using icts % usage of icts vs disadvantages of icts agree disagree sajems ns 16 (2013) no 3:279-297 291 all the barriers to the implementation of travel alternatives were also grouped together to ascertain whether a significant relationship existed between these barriers and travel alternatives usage. from figure 5 it is evident that the greater the perceived barriers to the implementation of travel alternatives are, the lower the usage of travel alternatives will be (p < 0.001). from the results of the chi-squared tests, we can ascertain that the disadvantages and barriers to using travel alternatives are the greatest influencers in the decision to use travel alternatives or not. figure 5 usage of icts vs barriers to implementation table 5 provides an indication of the current usage of icts across the company profiles. table 5 the effect of the organisational profile on the use of icts 56 73 44 27 0 20 40 60 80 100 currently using icts not currently using icts % usage of icts vs barriers to implementation agree disagree ownership of organisation type of company average total expenditure number of respondents currently using icts to replace a portion of company travel yes no not sure mainly south african 52 (75.36%) public company 24 (34.78%) less than r10mil 8 (11.6%) 4 3 1 between r10mil and r50mil 8 (11.6%) 5 3 . more than r50mil 8 (11.6%) 7 1 . private company 21 (30.43%) less than r10mil 14 (20.29%) 9 4 1 between r10mil and r50mil 5 (7.25%) 4 . 1 more than r50mil 2 (2.9%) 1 1 . parastatal 5 (7.25%) between r10mil and r50mil 1 (1.45%) 1 . . more than r50mil 4 (5.8%) 3 1 . government organisation 2 (2.9%) between r10mil and r50mil 1 (1.45%) 1 . . more than r50mil 1 (1.45%) 1 . . mainly international 17 (24.64%) public company 5 (7.25%) between r10mil and r50mil 2 (2.9%) 2 . . more than r50mil 3 (4.35%) 2 1 . private company 12 (17.39%) less than r10mil 9 (13.04%) 8 1 . between r10mil and r50mil 1 (1.45%) . 1 . more than r50mil 2 (2.9%) 1 1 . 49 (71.01%) 17 (24.64%) 3 (4.35%) 292 sajems ns 16 (2013) no 3:279-297 in order to investigate the effect of the organisational profile on the use of icts, a logistic regression model was used, with ict use as the dependent variable; the independent variables were these factors: ownership of company, type of company, expenditure (all as shown in table 5); industry (mining, financial, manufacturing, telecommunication, information technology or engineering), the number of branches the company has, and the number of employees the company has. none of these factors were significant, with a smallest pvalue of 0.311, indicating the usage of icts is unaffected by a company’s organisational profile. a logistic regression was also fitted with usage of icts as the dependent variable for the factors given in table 4. among the disadvantages of ict use, only three factors were significant: the security of information possibly being compromised (p-value of 0.05), difficulty in building relationships (p-value of 0.073), and icts being too expensive (p-value of 0.01). the final model is given as 321 016.2732.1711.1259.2 xxxy ++−= where 1x is the response for security of information being compromised, 2x is the response for the difficulty in building relationships, and 3x is the response for icts being too expensive. this is an interesting result as it indicates that the disadvantages have a more profound effect than the advantages on whether an organisation will implement icts. 7 discussion the latest research reports predict that telepresence and videoconferencing sales will reach $2.7b by 2015 (brightcom, 2010a), gaining further impetus through the 2010 eruptions of iceland’s volcano. during this time 17,000 flights were disrupted and millions of people stranded by the volcanic ash cloud covering most of northern europe. the value of telepresence and videoconferencing was proven as a backup plan for businesses with delayed communication and productivity (brightcom, 2010a). business meetings can be conducted on a person-to-person basis or via certain technologies such as tele-, weband videoconferencing. person-to-person meetings require physical travel to the meeting site while technology allows for meetings to be conducted virtually. the decision on which method to use for meetings is driven by two types of factors, personal or business. personal factors generally relate to the factors that influence the individual traveller to either conduct a meeting in-person or virtually, such as the desire of a business traveller to discover new cultures or to meet new people, or the need of a traveller not to be away from home too often. these factors do not form part of this study. business driven factors can be divided into a number of categories on which management base their decisions, including the type of meeting, the advantages and disadvantages associated with the usage of technology alternatives, barriers that might prevent the successful implementation of the technologies and the organisational profile of the company wanting to invest in technology alternatives. in 2004, lian and denstadli’s survey found that the business sector’s use of videoconferencing technologies was rather undeveloped, with only a limited number of users and for a restricted variety of purposes. the use of video and other communication technologies to replace business trips has definitely increased, even in south africa, with this survey indicating that the majority of respondents are currently using icts to replace a portion of their organisations’ business trips, with tele and videoconferencing the most popular applications to use. this study substantiates the findings of denstadli (2004) who reported the “time saving” factor as the leading motive for implementing videoconferencing equipment with nearly all their respondents, indicating that they were concerned with efficiency gains to be made from videoconferencing. in the current study the most appealing advantages of travel alternatives were found to be that the use of travel alternatives instead of travel afforded employees more efficient use of their working hours, it improved their productivity, and it reduced an organisations’ travel expenditure. although organisations implement telepresence and videoconferencing technologies at first to overcome the geographical distance between their facilities and employees, they soon realise that by integrating these technologies into their daily operations they could also use them in sajems ns 16 (2013) no 3:279-297 293 product development, sales training and even as customer profit centres, enabling the organisation to achieve a larger return on investment and a larger potential for this technology (brightcom, 2010b). in 2004 lian and denstadli predicted that intra-company travel would be the travel segment most likely to be substituted by telecommunication alternatives. this was confirmed with our results showing internal meetings to be best suited to the use of travel alternatives. charlot and duranton (2006) are of the opinion that the improvement in ict applications can mean that face-to-face interaction will be required for only the most complex interactions. their point of view gained support with the results of this research showing that where first contact needed to be established, new contracts negotiated and disciplinary hearings held, travel alternatives appeared to be the least suited. the results also showed that the disadvantages of using travel alternatives and the barriers to the implementation of travel alternatives significantly influence whether travel alternatives will actually be used to replace a portion of a company’s travel. this research study confirms arnfalk and kogg’s findings (2003) in that different methods of communication can be seen to be complementary and not substitutes for one another. the fact that most businesses still consider technology alternatives only as a supplement to personal meetings (lian & denstadli, 2004) has not changed, with respondents still arguing that ict alternatives do offer an adequate substitute for face-to-face travel, in many cases but not all. denstadli (2004) also asserted that personal relationships are complicated to create over a distance, and even though new technologies can produce ‘virtual rooms’ that give participants a feeling of co-presence, videoconferencing rarely substitutes the real reason for personal meetings: the in-person contact. a number of researchers (urry, 2007; mok, carrasco & wellman, 2009; rettie, 2010) have highlighted the value of relationships and individual social networks in increasing the need for business travel. in their research denstadli et al. (2012:70) confirmed a number of prior studies on social capital development that emphasized the importance of personal relationships (adler & kwon, 2002; cohen & prusak, 2001; lin, 2001; nahapiet & sumantra, 1998). denstadli et al. (2012:70) concluded that “the use of vc will be moderated by a growing need for modern professionals to build personal relationships and networks with other professionals in their field”. even though the environmental debate and other greening issues are gaining increasing importance on a global scale, it seems that these matters are not yet of great importance in south africa. the ability of technology applications to reduce an organisation’s carbon footprint was not seen as an important advantage of the applications. brightcom (2010c) asserts that the environment not only benefits from a reduction in carbon emissions from business travel but also from the amount of paper, cardboard and other business materials that are being saved by the use of videoconferencing systems. this might indeed put south african companies at a disadvantage globally as the aberdeen group (2011) reports that being seen as a green company holds various branding and differentiation benefits. companies investing in videoconferencing solutions usually focus on the need to decrease travel as an important business pressure. this has however changed over the past years, as the aberdeen group (2011) reports that organisations are increasingly using videoconferencing to support real-time collaboration among geographically dispersed employees. in their research 55 per cent of organisations indicated this as a core pressure motivating the need for videoconferencing technologies while only 41 per cent stated the need to decrease travel costs. even though travel expenses will always be part of the return on investment for videoconferencing solutions, corporate users have progressed to the value-added advantages related to videoconferencing (aberdeen group, 2011). a question that many organisations are asking is how to increase the adoption of videoconferencing in their organisations. although this paper did not investigate this matter, industry publications suggest the following: the aberdeen group (2011) encourages organisations to appoint an executive champion for video collaboration. this champion should 294 sajems ns 16 (2013) no 3:279-297 assist in their organisation’s ability to reduce travel, increase revenue and achieve greater return on investment. furthermore, the champion should provide vision on the need for videoconferencing applications in their organisation, serve as an example of curtailed travel and increased collaboration through the personal use of videoconferencing and support best practices to enforce policies and foster dialogue throughout the organisation. denstadli et al. (2012:69) are of the opinion that media choice is influenced more by social norms and customs than by what is being communicated and the bandwidth of the technology. they use the social influence model (fulk, schmidtz, & steinfield, 1990) to substantiate their view, and this model suggests that an organisation’s media choice is not only dependant on the media features, but also on a person’s previous experiences with the media as well as the influence of others. denstadli et al. (2012) conclude that the use of videoconferencing is strongly influenced by the users’ norms and attitudes rather than its technical abilities. a further strategy of organisations to increase their usage of videoconferencing technologies is to increase employees’ access to the technologies (aberdeen group, 2011). like all studies, this paper is not without limitations. perhaps the biggest limitation relates to the use of a non-probability sampling method. this means that the results of this study only apply to the selected respondents, and cannot be generalised to the broader corporate travel industry population. secondly, the number of responses added another limitation as it allowed for only a limited range of analyses to be done. should more responses have been attained, other results may have proven significant. the results of the study are also limited to the responses received in south africa. as mentioned earlier, the decision on which method to use for meetings is driven by two types of factors, personal or business. this study investigated the business factors influencing the method to use for meetings, but a future study could focus on identifying the personal factors that have an effect on the use of technology alternatives. seeing that the results showed that the biggest barrier to the implementation of travel alternatives is the fact that organisations might resist change, future research could perhaps investigate the attitudes of business travellers towards travel alternatives. in conclusion it seems fair to say that south africa is indeed following the rest of the world in terms of technology usage to replace business trips, and the factors that set south africa apart from other technology using countries are not causing them to lag behind in terms of technology adoption. ‘thus, rather than one replacing the other, the two modes of meetings will probably coexist within and across today’s postbureaucratic organisations and serve different communication 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[accessed 2009-06-15]. wang, d. & law, f.y.t. 2007. impacts of information and communication technologies (ict) on time use and travel behavior: a structural equations analysis. transportation, 34(4):513-527. abstract introduction the evolution of the sharpe ratio and the admissible risk measure method and data results conclusion and recommendations acknowledgements references about the author(s) chris van heerden department of economic sciences, faculty of economic and management sciences, north-west university, potchesfstroom, south africa citation van heerden, c., 2020, ‘establishing the risk denominator in a sharpe ratio framework for share selection from a momentum investment strategy approach’, southern african journal of entrepreneurship and small business management 23(1), a3467. https://doi.org/10.4102/sajems.v23i1.3467 original research establishing the risk denominator in a sharpe ratio framework for share selection from a momentum investment strategy approach chris van heerden received: 18 nov. 2019; accepted: 12 may 2020; published: 31 aug. 2020 copyright: © 2020. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: based on the static mean-variance portfolio optimisation theory, investors will choose the portfolio with the highest sharpe ratio to achieve a higher expected utility. however, the traditional sharpe ratio only accounts for the first two moments of return distributions, which can lead to false portfolio performance diagnostics with the presence of asymmetric, highly skewed returns. aim: with many criticising the standard deviation’s applicability and with no consensus on the ascendency of which other risk denominator to consult, this study contributes to the literature by validating the importance of consulting value-at-risk as the more commendable risk denominators for the johannesburg stock exchange. method: these results were derived from a novel index approach that produces a comprehensive risk-adjusted performance evaluation score. results: of the 24 sharpe ratio variations under evaluation, this study identified the value-at-risk sharpe ratio as the better variation, which led to more profitable share selections for long-only portfolios from a one-year and five-year momentum investment strategy perspective. however, the attributes of adjusting for skewness and kurtosis exhibited more promise from a three-year momentum investment strategy perspective. conclusion: the results highlighted the ability to outperform the market, which further emphasised the importance of active portfolio management. however, the results also confirmed that active and more passive equity portfolio managers will have to consult different sharpe ratio variations to enhance the ability to outperform the market and a buy-and-hold strategy. keywords: admissible risk denominator; jse; momentum investment strategy; risk-adjusted performance; shares; sharpe ratio; south africa. introduction common practice in selecting suitable portfolio compositions comprises the characterising of the different assets under consideration, where the desired properties in terms of reward and risk are evaluated (markowitz 1952). based on modern portfolio theory, these properties are generally identified with the mean and variance of returns. however, roy (1952) considered the implications of minimising the upper bound of the chance of losses, if information is confined to only the first and second order moments. this implies that investors tend to be more protective of portfolio wealth against the possibility of making losses and not necessarily interested in how share prices deviate around a profitable mean. from this argument markowitz (1959) was inspired to introduce the downside risk measure, named semi-variance, thus replacing the ordinary variance to include a downside risk measure for the first time in portfolio selection. also, as investors’ attitude towards risk can vary considerably, this led some studies to consider different nth moments of downside to suit different preferences, thus leading to the introduction of the lower partial moment (lpm) of the downside (bawa 1975; fishburn 1977). nonetheless, the theory of portfolio analysis was still assumed to be essentially normative by many, which led some studies to continue measuring risk on the basis of variance, through the application of the standard deviation as the denominator of the sharpe ratio (sharpe 1966). over time many criticised this denominator, as it measures only the dispersion of returns around its historical average and penalises positive and negative deviations from the historical average in a similar manner, leading thus to a misperception of actual risk (e.g. harlow 1991; lhabitant 2004). this implies that the standard deviation does not differentiate between downside and upside risk (de wet et al. 2008; harding 2002), especially if the divergence from normality becomes more apparent when the higher moments (skewness and kurtosis) of the return distributions are taken into account (kat 2003). this can pose a problem when investing in emerging markets, such as the johannesburg stock exchange (jse), where the presence of higher moments has been established (bekaert et al. 1998; van heerden 2015). these findings, therefore, imply that the traditional sharpe ratio will find it difficult to rank volatile returns (lo 2002), due to its risk denominator, and will thus fail to capture downside surprises (lamm 2003). with this outcome rendering the creditability of the traditional sharpe ratio inconsequential, it opens the field of performance measurement to establish solutions to overcome the limitations posed by the standard deviation. the presence of higher moments can be considered as an eminent hurdle that has hindered the field of performance measurement for decades. the study of mandelbrot (1963) was one of the first to suggest that asset return distributions can be ‘fat-tailed’, implying that outliers will be more numerous than would be expected from a gaussian distribution. fama (1965a) accentuated this argument when he directed the focus to stable paretian distributions, which led other studies (e.g. fama 1965b) to advocate the mean absolute deviation as the more preferred risk measure to adopt. however, findings from wise (1966) and sharpe (1971) suggest otherwise, emphasising that the choice of the appropriate risk measure might be far from obvious. later studies by sinn (1983) and meyer (1987) argue that investment funds’ returns are equal in distribution to one another, with the exception of the location and scale (ls) property. however, schuhmacher and eling (2011) are in disagreement with this argument, reporting that several distribution types can have the tendency to satisfy the ls property. this explains the possibility of high-ranking correlations between different risk-adjusted performance measures, where different risk measures are adopted (eling et al. 2010; schuhmacher & eling 2012). overall, the findings above raise the question as to whether it matters which risk denominator can be considered admissible for the sharpe ratio framework (where the latter refers to the following equation: excess returns ÷ risk denominator) and to what extent portfolio performance can be influenced by this choice. the literature argues that admissible risk measures should satisfy positive homogeneity and that adding a positive constant (risk-free rate) to an investment fund’s random excess returns should not increase the investment fund’s risk. nevertheless, regarding the latter, the presence of heightened risk levels has been acknowledged with the adding of risk-free rate proxies (schuhmacher & eling 2012), especially from a south african perspective (e.g. grandes & pinaud 2004). although this still remains a limitation in the literature, this study attempted to address the issue by including a risk-free rate proxy that has exhibited the lowest return volatility (see van heerden 2016). furthermore, it is argued that the combination of investment funds and risk-free rates can still satisfy the ls property, but not necessarily when combining different investment funds (meyer & rasche 1992), where stronger conditions on distributions are required (e.g. chen et al. 2011). however, for distributions to satisfy the ls property the third and fourth normalised order moment should be identical, except under the generalised ls property (e.g. meyer & rasche 1992). this is, however, not the case for emerging market returns (van heerden 2015), which can lead to very different portfolio allocations when comparing the traditional mean-variance framework to more advanced performance measures (e.g. fung & hsieh 1999; terhaar et al. 2003). the study of gilli and schumann (2011) further argues that alternative, non-gaussian specifications, such as conditional and partial moments, quantiles and drawdowns may be more applicable in these instances. the literature, however, still fails to produce a risk denominator that can also account for risks, such as callable risk, liquidity risk or discounting factors, such as tax implications and other opportunity costs. essentially, as the traditional sharpe ratio is only valid for gaussian distributions or quadratic preferences (ziemba 2005), the findings cited above provide a decision-theoretic foundation for evaluating the application of already established risk denominator alternatives for the standard deviation, such as the tracking error, maximum drawdown, lpms, downside potential and value-at-risk (var) based risk measures, to name a few. the inability of the literature to reach a consensus on which risk denominator is more commendable to incorporate in the sharpe ratio framework provided the inspiration for this study. the selection of 24 sharpe ratio variations were based on the unique perspective each provided by means of its risk denominator or the adjustment feature it offered. the approach of this article was also motivated by the study of jegadeesh and titman (1993), who argued that past ‘winners’ on average tend to outperform past ‘losers’, which implies that there is momentum in share returns, to some extent, which can be exploited as documented by fama (1991). this led this study to adopt a novel approach of applying risk-adjusted ratios as a forecasting tool to select shares, and to identify the ratio with the ability to identify portfolio compositions that will yield the highest future risk-adjusted performance. for this study this implies that the year-end rankings of each of the 24 sharpe ratio variations under evaluation at time t will be used to determine the share selections for each representing portfolio over one, three and five years (ex post, in-sample), whereafter the portfolios will be rebalanced according to a new set of rankings. these portfolios will be compiled from an investment universe of 583 listed and 357 delisted south african shares. each equally weighted, long-only equity portfolio will comprise 40 shares that exhibited fairly low volatility (standard deviation), ranging between 0% and 1.68% over the different portfolios and investment horizons under evaluation. after each consecutive rebalancing year (time t + 1, t + 3 and t + 5) the sharpe ratio variation that led to the best-performing portfolio (based on in-sample, ex post performance) will be identified. each equity portfolio’s ability to outperform a buy-and-hold strategy on the equity, bond and money market will also be evaluated. two equity market proxies (jse top 40 and jse all share indices), two bond index proxies (1–3-year and 3–7-year bond indices) and one money market index proxy (12-month jibar yield rate) will be utilised. the overall outperformance evaluation will be conducted through an index ranking approach. two sets of index rankings will be consulted to derive a final conclusion. the first ranking set (equally weighted) will assign the same weight to seven categories, which will entail geometric returns, upside potential, downside potential, standard deviation, maximum downturn, upside risk, and downside risk. the second ranking set (50:50 weighting) will assign 25% to geometric returns and upside potential and will divide the remaining 50% evenly between the risk measures, namely downside potential, standard deviation, maximum downturn, upside risk and downside risk. the motive for this index ranking approach is to introduce an innovative risk-adjusted performance method that can be used to evaluate equity portfolios more comprehensively, especially if selected shares exhibit both normal and non-normal return distributions. the scope of this study will, however, not include a comparison study of alternative momentum investment strategies, as it will only focus on renewing the creditability of the sharpe ratio (or variations thereof) as a future share selecting tool from a momentum investment strategy perspective. also, the rebalancing approach of this study will not adopt any unique mean-variance optimisation approach, as rebalancing was only based on the new set of rankings provided by the 24 sharpe ratio variations, every one, three and five years. this study will also exclude short-selling and the use of derivatives. moreover, the effects of transaction costs and taxes will be ignored, although the share returns were adjusted for splits and dividends. to achieve this goal this study commences by elaborating on the evolution of the sharpe ratio and the admissible risk measure, which will be followed by an overview of the method and data utilised. the empirical results are then reported, followed by concluding remarks and recommendations. the evolution of the sharpe ratio and the admissible risk measure to understand the origins of the traditional sharpe ratio, it is important to acknowledge the link between the standard expected utility theory framework, the mean-variance optimisation framework, and the reasoning behind the formation of the traditional sharpe ratio. suppose an investor desires to allocate his wealth between a risky and risk-free asset, where the returns on these assets over time interval ∆t can be illustrated as follows (zakamouline & koekebakker 2009): in equation 1, μ denotes the mean and s the standard deviation of the risky asset returns per unit of time; ε denotes a normalised stochastic variable, such that e[ε] = 0 and var[ε] = 1. in equation 2, r denotes the risk-free rate per unit of time. furthermore, assume that the investor possesses the wealth of w and decides to invests a in the risky assets and (w − a) in the risk-free assets. this implies that the investor’s wealth and expected utility over time interval ∆t can be illustrated as follows (zakamouline & koekebakker 2009): for a given utility function u(·), and by assuming it increases concave and is a differential function, the investor’s objective to maximise his expected utility by investing in a can be illustrated as follows (zakamouline & koekebakker 2009): however, if the investor decides to invest in several different risky assets, the mean-variance framework must be implemented to derive the most efficient portfolio that optimises the expected utility. in this instance, suppose the amounts a0,t, a1,t,…,an,t are invested at time t in the different assets i = 0,1,…,n, where 0 denotes the risk-free asset. if the value of the portfolio at time t is wt = a0,t +…+ an,t, then its future value is equal to , where rt is the risk-free rate at horizon one and pi,t is the unitary price at time t of asset i. with the selection of the portfolio allocation, the investor must solve the following optimisation problem from the mean-variance framework (darolles & gourieroux 2010): in equation 6, a denotes the individual (absolute) risk aversion, et denotes the expectation and vt denotes the variance, given the available information utilised by the investor at time t. by solving the budget constraint, the quantity invested in the risk-free asset can be obtained as . by substitution, the unconstrained quadratic optimisation problem is deduced to be the following (darolles & gourieroux 2010): in equation 7, yi,t+1 = (pi,t+1 − pi,t)/pi,t − rt. the optimal allocation in the risky assets, , can then be illustrated by (markowitz 1952): in equation 8, mt is the expectation of the vector of excess returns yt+1 = (y1,t+1,…,yn,t+1. furthermore, the optimal value of the objection function is equal to (darolles & gourieroux 2010): evidently, it depends on the risk-free rate, the initial budget, the risk-aversion coefficient and quantity, , which summarises the stochastic properties of the risky asset returns (treynor 1965; sharpe 1966). the above mentioned quantity is called the sharpe performance of the set of assets 1,…,n at time t, which also depends on the information utilised by the investor to compute the variances, covariances and means. to simplify the sharpe performance illustration, consider only a portfolio that includes a single risky asset j and a risk-free asset (darolles & gourieroux 2010): in equation 10, is the expected excess returns between the risky asset j and the risk-free asset, and denotes the variance of risky asset j. this sharpe performance measure can take on any positive value; however, it can also be computed by taking the sign of the expected excess returns into account, as st:j = mj,t/σj,t (e.g. mcleod & van vuuren 2004). nonetheless, in a scenario where the investor has to choose between two competing portfolios – where the first portfolio includes a risk-free asset and the risky asset j, and the second portfolio includes a risk-free asset and the risky asset b – the portfolio with the highest sharpe performance will always be chosen, as it implies a higher risk-adjusted return. by redefining this performance measure as and by annualising the expected excess returns and volatility, this measure also corresponds to the renowned sharpe ratio or the reward-to-variability ratio, as originally published (sharpe 1966). the sharpe ratio was introduced as an extension of treynor’s (1965) work. the reward-to-volatility ratio or treynor ratio (treynor 1965) makes use of systematic risk (beta) as the risk denominator (adapted from treynor 1965): in equation 11, rp denotes the return of a security, rf denotes the risk-free rate and β denotes market risk. unfortunately, the literature has reported several empirical failures of beta. for example, the market proxy used in the estimation of beta must be as comprehensive as possible in representing the entire market under evaluation. other factors such as beta instability, its failure to explain share return behaviour, regression biasness and thin-trading (e.g. blume 1975; bradfield 2015; fama & french 1992) also caused many to criticise its viability. another critical flaw of the treynor ratio is that it assumes portfolios are already completely diversified (treynor 1965), thus ignoring company-specific risk (unsystematic risk). this limitation led to the development of the sharpe ratio, which utilises total risk (the standard deviation) that will penalise the lack of diversification. although the sharpe ratio was initially intended to serve as an ex ante performance measure, it is generally utilised in an ex post manner. even so, sharpe (1994) argues that historical results are assumed to have some predictive ability, but he acknowledges the fact that the use of ex post sharpe ratios as substitutes for unbiased predictions of ex ante ratios is still subject to future deliberations. it is also further argued that both the ex ante and ex post sharpe ratios fail to account for the correlation of a fund or strategy, rendering it lacking and demanding augmentation in certain instances (sharpe 1994). the study of dowd (1999, 2000) attempted to address some of these issues, proposing a generalised rule that can overcome the problem of correlation with the standard application of the sharpe ratio. he argues that the choice of incorporating an additional asset in an existing portfolio can be evaluated by computing a sharpe ratio for both the existing (srold) and the new portfolio (srnew), where the new portfolio includes the additional asset. as the comparison between the two sharpe ratios already accounts for the correlation present, the final choice only resides on whether the new asset will raise the sharpe ratio of the existing portfolio. thus, the inclusion of the new asset will only be considered if srold is less than srnew. in addition, dowd (1999, 2000) also recommends the substitution of the standard deviation with the var measure (see equation 12), which offers the sharpe ratio the ability to limit the distortion in investment decision-making as correlation in returns escalates: in equation 12, rp denotes the annualised return of the share under evaluation, rf denotes the annualised risk-free rate, (rp − rf) denotes the excess returns and var = rp + zc × σ, with zc as the critical value for probability (1 − α) = −2.326, for α = 99% probability in this study, and σ is the annualised standard deviation of the returns. however, a major downfall of the var approach is that it is still based on the mean-variance framework, thus assuming the presence of a gaussian distribution, and unable to account for higher moments. the var, therefore, fails to provide any information on the shape of the distribution’s tail and on the expected size of loss beyond the decided confidence level, which is referred to as tail risk (cgfs 1999, 2000). moreover, the studies of goetzmann et al. (2002) and agarwal and naik (2004) acknowledge the presence of significant left-tail risk with hedge funds, which exhibit non-normal pay-offs due to the application of options and option-like dynamic trading strategies. this implies that the traditional sharpe ratio may be open to manipulation, which encouraged goetzmann et al. to derive general conditions and dynamic and static rules in order to maximise the expected sharpe ratio with the utilisation of derivative instruments. however, earlier studies by artzner et al. (1997, 1999) propose the use of the expected shortfall, which is the conditional expectation of loss (cvar). substituting the standard deviation with the cvar enables the sharpe ratio to account for the possible loss beyond the normal var level (e.g. esfahanipour & mousavi 2011): in equation 13, rp denotes the annualised return of the share under evaluation, rf denotes the annualised risk-free rate, , with zc as the critical value for probability (1 − α) = −2.326, for α = 99% probability in this study, and σ is the annualised standard deviation of the returns. this admissible risk alternative demonstrated attractive properties for portfolio decision-making (e.g. agarwal & naik 2004; esfahanipour & mousavi 2011; tasche 2002), but due to its dependency on sample size (e.g. yamai & yoshiba 2002), inability to generate more stable statistical estimates compared to the normal var and relative poor out-of-sample performance if tails are not modelled correctly (sarykalin et al. 2008), other studies sought to identify alternative risk denominators. one proposal entailed the implementation of the cornish-fisher expansion (e.g. favre & galeano 2002) to adjust the normal var to account for higher moments, which led to the development of the modified var (mvar) that can be utilised as an alternative risk denominator for the sharpe ratio as follows (e.g. gregoriou & gueyie 2003): in equation 14, rp denotes the annualised return of the share under evaluation, rf denotes the annualised risk-free rate, with zc as the critical value for probability (1 − α) = −2.326, for α = 99% probability in this study, σ2 is the annualised variance of the returns, s is the skewness and k denotes the kurtosis. in addition to the recommendation of utilising a var-based risk denominator to eliminate correlation, as discussed above, the study of lo (2002) presented an alternative approach. he derived explicit expressions for the statistical distribution of the sharpe ratio by applying standard asymptotic theory, in an attempt to improve the accuracy of the traditional sharpe ratio. in the process, lo (2002) proved that monthly sharpe ratios cannot be annualised by multiplying by , except under certain circumstances. he further proposed an alternative method for the conversion of stationary returns, where the sharpe ratio can be adjusted for serial correlation (sc) as follows (lo 2002): in equation 15, sr denotes the traditional sharpe ratio estimate on a monthly basis, q = 12 and ρk is the kth autocorrelation for returns. results from the study of lo (2002) illustrated that sharpe ratios, especially for hedge funds, can be overestimated by as much as 65%, thereby accentuating the need to adjust for sc in monthly returns. from a different perspective, černý (2002) argued that the traditional sharpe ratio is closely related to quadratic utility and extended the definition of the sharpe ratio to an entire family of constant relative risk-aversion utility functions, which restated the equilibrium restrictions of the generalised sharpe ratios, as originally published by dowd (1999). this renewed generalised sharpe ratio exhibited more consistent performance rankings for different investment opportunities, even with the presence of non-normal returns (černý 2002). however, harding (2002) addressed the limitations posed by non-normal returns differently. he claims that risk is not always a meaningful and observable quantity, which implies that the creditability of the standard deviation depends on the ability to compute it from a stationary and parametric process, which is not always possible with the presence of non-normal returns. this argument implies that the earlier suggestion by markowitz (1959) must be revised, where the favourable attributes of the semi-variance, as a downside risk measure, must be re-established for portfolio selection purposes. harding’s statement builds on an earlier study of sortino and van der meer (1991), where the lpm of the second order is utilised as a risk denominator alternative (see equation 16). later on, the study of kaplan and knowles (2004) further extended the application of lpms as risk denominators, where sortino and van der meer’s downside risk measure was augmented by the validation of lpms of the third order, which led to the development of the kappa 3 ratio (see equation 17): in equation 16 and equation 17, rp denotes the annualised return of the share under evaluation, rf denotes the annualised risk-free rate, , where τ is the minimal acceptable return (rp = 0 will be adopted as τ in this study), and n represents the chosen order of the lpms. the downside deviation of the order substitutes the standard deviation as an admissible risk denominator, which accentuates the behaviour framework of kahneman and tversky’s (1979) loss aversion preferences and the axiomatic approach of gul’s (1991) disappointment aversion preferences, where a greater weight is assigned to losses relative to gains. in contrast, the study of young (1991) argued that the maximum loss of capital over a specified period (maximum drawdown) may be more insightful as a lpm risk denominator, which led to the introduction of the calmar ratio (see equation 18). the maximum drawdown (md) represents the maximum loss an investor can suffer when buying at the highest point and selling at the lowest following trough. this admissible risk denominator’s attributes also inspired an array of different variations of the calmar ratio, including the burke ratio (burke 1994), the sterling ratio (kestner 1996; adjusted to the sharpe ratio framework, see e.g. bacon 2008; kolbadi & ahmadinia 2011), the martin ratio or ulcer performance index (martin & mccann 1998) and the pain ratio (zephyr association 2006): in equations 18–22, rp denotes the annualised return of the share, rf denotes the annualised risk-free rate, md denotes the maximum drawdown that is the maximum cumulative loss between a peak and a following trough, where , with t denoting the number of return observations, p(u) denoting the return value at the peak over the interval of size t, and t(u) denoting the return value of the following trough over the interval of size t, dj denotes the drawdown since the previous peak in period j, denominator d denotes the fixed number of observations as preferred by the investor (in this study it will be the actual number of drawdowns) and n denotes the duration of a drawdown. by incorporating the duration of drawdowns, as originally introduced by the ulcer index (martin & mccann 1989), the martin and pain ratios are able to penalise managers that take too long to recover to previous highs. although the martin and pain ratios can be sensitive to the frequency of the time period under evaluation, the incorporation of both the duration and depth of the drawdowns in the performance measurement process provides a unique risk perspective that other risk-adjusted performance ratios tend to overlook. in addition, the burk ratio also utilises the square root of the sum of the squares of each drawdown in order to penalise major drawdowns relative to less significant occurrences. introducing another unconventional risk perspective is the original sterling ratio (kestner 1996), which suggests the use of the average largest drawdown plus 10% as the admissible risk denominator. the additional 10% is intended for arbitrary compensation, as the average largest drawdown tends to be smaller than the maximum drawdown. however, by excluding the 10% and by converting the original sterling ratio to a sharpe ratio framework, as suggested by bacon (2008), the substitution of the denominator with the fixed term d imposes a more restricted performance measurement. this entails that the average of only a fixed number of the largest drawdowns is adopted as the admissible risk denominator. besides the modification suggested for the original sterling ratio, bacon (2008) also proposed several composite indicators that can serve as additional variations of the original sharpe ratio framework. for example, from the work of young (1991) and kestner (1996) the sterling-calmar ratio (see equation 23) was developed. this ratio adopts the average of the maximum drawdowns as a risk denominator and serves as an extension of the fixed term d proposed earlier. additionally, the work of sharpe (1966) and keating and shadwick (2002) inspired the development of the omega-sharpe ratio (see equation 24), which builds on markowitz’s (1959) approach of adopting a semi-variance methodology. by utilising the downside potential as a substitute for the standard deviation, the omega-sharpe ratio introduces the sum of the returns below a desired target as an alternative denominator for the sharpe ratio framework (adapted from bacon 2008). in equation 23 and equation 24, rp denotes the annualised return of the share, rf denotes the annualised risk-free rate denotes the average of the maximum drawdowns and , with rt as the minimum target. according to bacon (2008), the omega-sharpe ratio is simply ω – 1, which should generate identical performance rankings to the original omega (ω) ratio that can be illustrated as follows (keating & shadwick 2002): in equation 25, , with rp as the annualised return of the share and rt as the minimum target (this study will set rt = 0). the ω ratio is considered superior to most traditional performance measures, as it includes all the information encoded in all the order moments (de wet et al. 2008), which accentuates the pertinence of the omega-sharpe framework. in addition to the above mentioned risk denominators, the literature also presents a vast selection of alternative risk denominators and adjustments, applicable for the sharpe ratio framework. however, this study will only add the work of treynor and black (1973), grinold (1989), modigliani and modigliani (1997), israelsen (2005), pezier and white (2006), and gatfaoui (2012) to limit the scope of this study. the three former studies introduce additional variation of the sharpe ratio, whereas the latter three propose useful adjustments of the sharpe ratio that are worth reporting. firstly, treynor and black introduce a novel performance ratio (the appraisal ratio) that adopts non-market volatility (unsystematic risk) as an admissible risk denominator to measure the fund manager’s ‘share-picking’ and fund management skills. by converting the original appraisal ratio to a sharpe ratio framework, the portfolio’s alpha is substituted by the excess returns as the numerator. modifying the appraisal ratio enables the performance measurement process to evaluate to what extent the minimum required rate of return is outperformed relative to each unit of unique risk (company-specific) that is associated with each individual share under consideration (adapted from agarwal 2013): in equation 26, rp denotes the annualised return of the share, rf denotes the annualised risk-free rate, denotes the annualised variance of the share, βp denotes the beta of the share and denotes the annualised variance of the market. an alternative performance measure is introduced by grinold (1989), where the attributes of the information ratio are justified from an active portfolio management perspective (see also sharpe 1994). this ratio adopts the tracking error (active risk) as the risk denominator, which elaborates on the divergence between the share price’s behaviour and the behaviour of the mark index (in this study the jse all share index will be used as the market proxy). by converting the information ratio to a sharpe ratio framework, the market excess returns are substituted with the risk-free rate excess returns as follows (adapted from israelsen 2005): in equation 27, rp denotes the annualised return of the share, rf denotes the annualised risk-free rate and denotes the annualised variance of the market excess returns (rp − rm), with rm as the annualised returns of the market proxy (benchmark). lastly, the study of modigliani and modigliani (1997) argues that the risk of both the share or portfolio and its benchmark must be identical in order to perform a risk-adjusted performance comparison. this led to the development of the m2 measure, which allows the portfolio manager to situate the portfolio’s performance in relation to that of the market proxy (benchmark): in equation 28, σm denotes the annualised standard deviation of the market, σp denotes the annualised standard deviation of the share, rp denotes the annualised return of the share and rf denotes the annualised risk-free rate. the m2 measure holds its meaning with the presence of negative returns and is expressed in percentage points, making its interpretation sometimes easier than the traditional sharpe ratio (modigliani & modigliani 1997). besides the array of variations of the sharpe ratio that are at portfolio managers’ disposal, several other studies have proposed adjustments to the traditional sharpe ratio in order to overcome two main shortfalls, entailing the inability to account for negative returns and higher moments. for example, the study of israelsen (2005) suggests adding an exponent to the standard deviation (risk denominator), in order to improve the sharpe ratio estimate when excess returns (rp − rf) are negative (israelsen 2005): in equation 29, rp denotes the annualised return of the share, rf denotes the annualised risk-free rate, σp denotes the annualised standard deviation of the share and er = (rp − rf), where abs.er denotes the absolute value of er. in terms of adjusting for higher moments, the studies of pezier and white (2006) and gatfaoui (2012) proposed two different techniques. pezier and white suggest the explicit adjustment for skewness and kurtosis, by incorporating a penalty factor for negative skewness and excess kurtosis as follows: in equation 30, sr denotes the traditional sharpe ratio estimate, s denotes skewness and k denotes kurtosis. on the other hand, gatfaoui (2012) proposes scaling the traditional sharpe and treynor ratios to account for both skewness and kurtosis as follows: in equations 31–34, w− = n− ÷ n and w+ = n+ ÷ n, with n− and n+ denoting the number of observations below and above the mean of the share’s returns and n denoting the total number of observations under investigation. additionally, wm− = m− ÷ m and wm+ = m+ ÷ m, with m− and m+ denoting the number of observations below and above the mean of the market’s returns and m denoting the total number of observations under investigation. ex_ denotes negative excess returns, ex+ denotes positive excess returns (rp − rf),σp denotes the annualised standard deviation of the share, where σp− and σp+ denote the downside and upside deviations of the security, σpm denotes the covariance between the security and the market under evaluation, and denote the downside and upside deviations of the market, rp denotes the annualised return of the security and rf denotes the annualised risk-free rate. in equation 33, and in equation 34 . gatfaoui (2012) argues that rendering the sharpe and treynor ratios more homogeneous in terms of skew risk and offsetting the related skew-based biases will improve portfolio decision-making. method and data the scope of this study will be limited to the risk-adjusted performance ratios with the attributes derived from the different adjustments or suggested amendable risk measures as summarised in table 1. each of these ratios will provide a unique perspective and was selected to address the most common obstacles observed in portfolio selection and performance evaluation (see table 1 and previous section). each of these ratios was used to compile its own representative long-only equity portfolio, which consisted of 40 shares that were selected from an investment universe of 583 listed and 357 delisted south african shares. the performance of each portfolio was then compared and evaluated against equity market, money market and bond market proxies (each representing a buy-and-hold strategy), from a one-year, three-year and five-year momentum investment strategy. every one, three and five years each portfolio will be rebalanced based solely on the new set of rankings provided by each of the 24 sharpe ratio variations under evaluation. since the literature has already provided evidence that portfolio and individual share returns exhibit non-normal distributions, overall risk-adjusted outperformance will be measures based on an index that is compiled from seven categories. each of these categories will provide a different risk-adjusted perspective that will help to derive a comprehensive conclusion, which is not restricted to the assumption of normal returns and will incorporate both an upside and downside risk and performance perspective. these categories entail geometric returns, upside potential (returns above zero and scaled according to the number of observations), downside potential (returns below zero and scaled according to the number of observations), standard deviation, maximum downturn (maximum loss from peak to succeeding trough), upside risk (returns above zero) and downside risk (returns below zero). table 1: summary of risk-adjusted performance methodology. this study will consult two sets of index rankings to derive a final conclusion. the first set of rankings (equally weighted) will assign the same weight to all seven categories, whereas the second set of rankings (50:50 weighting) will assign 25% to geometric returns and upside potential, and will divide the remaining 50% evenly between the risk measures, namely downside potential, standard deviation, maximum downturn, upside risk and downside risk. to validate this index approach, table 2 and table 3 report on the level of normality of the individual share returns (of the data distributions) and the preliminary portfolio return statistics to be consulted. table 2: descriptive statistics of shares. table 2 emphasises the results of van heerden (2015), who confirmed the presence of higher moments and non-normal distributions in the south african equities market. share returns exhibited platykurtic, leptokurtic, and normal and non-normal distribution characteristics, making a comparative performance evaluation with only traditional risk-adjusted performance ratios, such as the traditional sharpe and treynor ratios, impossible (see table 2). based on the study of harlow (1991) and lhabitant (2004), these results imply that risk measures that are derived from or are variation of variance (e.g. standard deviation and beta) will exhibit the tendency to underestimate the level of actual risk. this justifies the notion that a risk-adjusted performance evaluation process must distinguish between upside and downside risk or performance. this firstly substantiates the use of the seven different categories (and not only standard deviation as a risk measure) to derive more comprehensive risk-adjusted performance evaluation scores; secondly, it implies that traditional risk-adjusted performance ratios should not be consulted in isolation, and that other ratios (as reported in table 1) that make use of alternate risk denominators that distinguish between upside and downside risk must also be consulted to construct the long-only equity portfolios. additionally, in order to justify the number of shares that must be included in a portfolio, the literature was consulted. however, there is no consensus regarding what is the optimal number of shares in an equity portfolio that will be beneficial from a diversification or risk-adverse point of view. although the optimal number of shares would ultimately depend upon the investor’s life cycle, strategy, goals, risk preference and other constraints, the universe of shares being analysed and the weighting scheme used to construct portfolios, studies such as evans and archer (1968), statman (1987) and tang (2004) argue that between 10 and 40 shares will be adequate. according to newbould and poon (1993), 20 shares can lead to a risk-efficient portfolio; however, domian et al. (2007) argue that portfolios of 8–20 shares will be inadequate, as long-term investors will not be able to outperform treasury bonds. nevertheless, the results from table 3 justify the notion of including only 40 shares in an equity portfolio, as the portfolios that were constructed in this study were able to generate a low volatility (standard deviation), ranging between 0% and 1.68% over the different portfolios and investment horizons under evaluation. table 3: portfolio composition statistics. the results from table 3 also substantiate the appeal of a 40-share portfolio, as it exhibited not only the ability to produce the lowest volatility, but also the highest annual risk-adjusted returns compared to all the buy-and-hold proxies, from a one-year, three-year and five-year momentum investment strategy perspective. this accentuates that a 40-share portfolio can be beneficial for both active and more passive equity portfolio managers. even though table 3 reports lower average annual risk-adjusted returns across all the portfolios under evaluation, compared to all the buy-and-hold proxies, from a one-year, three-year and five-year momentum investment strategy perspective, it only highlights the importance of identifying the risk-adjusted ratios with the ability to promote continuity in terms of identifying a portfolio composition that will always outperform the market from a risk-adjusted perspective. not all risk-adjusted ratios can lead to profitable portfolio compositions, which can be explained by the lower average annual risk-adjusted returns across all the different portfolios under evaluation compared to the buy-and-hold market proxies. regarding the data, this study uses monthly share price data, spanning from january 2000 to december 2017, that were sourced from iress (2019), where the natural logs were used to estimate the share returns, which were also adjusted for dividends and splits. the jse all share (j203) index was used as the overall market proxy (benchmark) in the estimation of applicable ratios, whereas the j203 and the jse top 40 (j200) index were used as proxies for equity buy-and-hold strategies. the 12-month jibar rate, and the 1–3-year and 3–7-year bond indices were used as proxies to present money market and bond market buy-and-hold strategies, which were all sourced from iress (2019). the returns of the money market and bond market proxies were converted to monthly yield-to-maturities before commencing with the risk-adjusted performance evaluation process. due to data unavailability the money market and bond index proxies could only be consulted from 2005. furthermore, based on the findings and arguments posed by van heerden (2016) and grandes and pinaud (2004), this study utilises the three-month negotiable certificates of deposits (ncds) rate as the risk-free rate proxy, which was sourced from the south african reserve bank (sarb) (2019). however, due to the unavailability of data the transaction costs and taxes involved in the portfolio rebalancing process were excluded from this study. ethical consideration ethical clearance was not required for the study. results from the results reported by tables 4–6 (the 50:50 weighting approach), it is evident that there is no consistency in terms of the best-performing ratio between the three momentum investment strategies or over the different time periods under evaluation. these results accentuate the study of van heerden and coetzee (2019), who also recognised the difficulty of establishing an ‘all-inclusive’ group of ratios that will ensure continuous profitable share selections. however, by dividing the 24 sharpe ratio variations into four quantiles, ranked from best to worst, a more comprehensive performance comparison could be derived. even with the first quantile of performing ratios exhibiting a varying composition over time, the portfolio compositions derived from the first quantile of performing ratios were able to outperform all the buy-and-hold proxies under evaluation (see tables 4–6). the only two exceptions were in 2006 (for the five-year momentum investment strategy) and 2007 (for all the momentum investment strategies), where not all ratios in the first quantile were able to outperform the equity market and the money market buy-and-hold proxies. even with the shortcomings of beta as a risk denominator (as acknowledged above), it was interesting to note that the traditional treynor ratio yielded the best-performing portfolio during the 2008-financial crisis period, from a one-year momentum investment strategy perspective. however, from a five-year momentum investment strategy perspective the appraisal ratio yielded a better-performing portfolio. the relevance of adjusting for kurtosis and skewness, as proposed by gatfaoui (2012), is also highlighted by the dominance of the scaled sharpe ratio 1 (s*) during the financial crisis period from a three-year momentum investment strategy perspective. in addition, the importance of adjusting for sc, skewness and kurtosis after the financial crisis period can be accentuated by the results reported by tables 4–6, which support the findings of chatterjee et al. (2015). tables 4–6 report that the sc-adjusted sharpe, the s*, the scaled sharpe ratio 2 (s**), and the scaled treynor ratio 1 and 2 (t* and t**) exhibited a greater tendency to rank under the first quantile of performing ratios, from a one-year, three-year and five-year momentum investment strategy perspective. furthermore, it is worth noting that the var-sharpe ratio exhibited the highest consistency in ranking under the first quantile of performing ratios, from a one-year and five-year momentum investment strategy perspective, with the only exception during the pre-financial crisis period from a three-year momentum investment strategy perspective. the runner-up entailed the appraisal ratio, which also exhibited some consistency in ranking under the first quantile of performing ratios. however, the only exception was during the post-financial crisis period from a three-year momentum investment strategy perspective (see tables 4–6). table 4: overall performance summary for portfolios at rebalancing year, following a one-year momentum investment strategy (50:50 weighting). table 5: overall performance summary for portfolios at rebalancing year, following a three-year momentum investment strategy (50:50 weighting). table 6: overall performance summary for portfolios at rebalancing year, following a five-year momentum investment strategy (50:50 weighting). even with some ratios exhibiting consistency in terms of outperformance, the implication of these results is that active and more passive portfolio managers will have to consult different compositions of ratios in order to ensure a more profitable share selection process. from tables 4–6 it is, however, evident that all 24 constructed portfolios were able to outperform the j200 index in 2008 and in 2016 from a one-year, three-year and five-year momentum investment strategy perspective. moreover, all 24 constructed portfolios were able to outperform the money market buy-and-hold proxy in 2008, 2009, 2010 and 2012 and the 1–3-year index or the 3–7-year bond index in 2006, 2007, 2009, 2010, 2013 and 2015. this implies that all markets are not always information efficient, which suggests the ability of active portfolio managers to outperform the market for only certain time durations (see also heymans & santana 2018). the inconsistent presence of outperformance may further suggest the existence of time-varying market (information) efficiency, which accentuates the studies of mcmillan and thupayagale (2008) and bonga-bonga (2012). nevertheless, it is still difficult to establish ratio dominance by consulting only tables 4–6. consequently, to enhance the insight of ratio dominance from a momentum investment strategy perspective, a comparison was done with both the 50:50 and equally weighted ranking approaches, as reported in table 7 (but only for the first quantile of performing ratios). the motivation for this approach was based on the notion that the equally weighted approach yielded similar results to that of the 50:50 ranking approach in terms of outperforming the buy-and-hold proxies, although the compositions of the first quantile of performing ratios differed slightly. also, as overall dominance only rests with the first quantile of performing ratios, the author did not deem it necessary to duplicate the reporting style of tables 4–6 for the equally weighted approach; however, these results are available on request. the results from table 7 accentuate the notion of sharpe (1994), who acknowledged the ambiguity of the sharpe ratio’s predictive properties. besides the fact that the traditional sharpe ratio was never able to produce a more dominant portfolio composition, table 7 reports that only variations of the traditional sharpe ratio accomplished that feat. the results again emphasise the var-sharpe ratio’s consistency in ranking under the first quantile of performing ratios, as derived from tables 4–6. additionally, table 7 reports that the var-sharpe ratio yielded the best-performing portfolio in 2007 from a one-year and five-year momentum investment strategy perspective, in 2017 from a three-year momentum investment strategy perspective and in 2009, 2012 and 2014 from a five-year momentum investment strategy perspective. the dominance of this ratio may be explained by the presence of more non-normally distributed share returns in the var-sharpe portfolios compared to other competing portfolios during the period of outperformance. even with the shortcomings of var as a risk denominator (as stipulated earlier), it seems that this risk denominator was able to capture more of the outliers and asymmetric features of the returns compared to the other risk denominators under evaluation, thus providing a more accurate risk-adjusted performance evaluation during the share selection process. the applicability of the var-sharpe can further be motivated by figure 1, which reports the correlation between the different portfolios that were derived from the top-ranking ratios as reported by table 7 and table 8. during 2007, 2009, 2012 and 2014 the highest correlation with a var-sharpe portfolio was 82.50% and 75% (and highest average correlation of 84.71% and 76.32% from a one-year momentum investment strategy perspective) with a cvar and mvar sharpe portfolio, which makes sense as cvar and mvar have similar fundamental features and are thus deemed less desirable from a portfolio diversification point of view due to their poorer ability to yield top-performing portfolios. furthermore, the third highest correlation (45%) with the var-sharpe ratio was with an omega-sharpe portfolio in 2009 and with an appraisal ratio portfolio in 2014 (highest average correlation was 31.73% and 32.88% from a five-year momentum investment strategy perspective). even with some level of correlation with the other competing portfolios, these results still fail to overshadow the contributing ability of the var-sharpe ratio to enhance portfolio diversification and to yield top-performing portfolios. however, inconsistent rankings between the three momentum investment strategies and over the different time periods under evaluation are still evident in table 7, making it difficult to draw an overall conclusion. figure 1: summary of portfolio correlations. table 7: weighting comparison of the first quantile of performing ratios (at portfolio rebalancing dates). to overcome this drawback, this study evaluated the number of events in which each ratio yielded the best-performing portfolio (derived from both the 50:50 and equally weighted ranking approach), which is summarised in table 8. from the results reported by table 8 it is advisable that the traditional sharpe ratio, the m2 measure, israelsen’s modified sharpe ratio, pezier and white’s adjusted sharpe ratio, the sterling-calmar ratio and the t** should not be consulted for share selection purposes. none of these ratios was able to yield an outperforming portfolio over the time period under evaluation. however, from a one-year momentum investment strategy perspective the var-sharpe, cvar-sharpe, mvar sharpe, calmar and sterling ratios were the top five best-performing ratios, which were able to provide a 57% chance (in-sample ex post) of yielding the top-performing portfolios (see table 8). table 8: overall summary of credibility of ratios. however, according to figure 1 there is a high average correlation between the var, cvar and mvar sharpe ratio portfolios (84.71%, 88.09% and 76.32%), which suggests that the omega-sharpe or pain ratio must be considered as possible substitutes for the cvar and mvar sharpe ratio portfolios in order to enhance the level of portfolio diversification. then again, there is also a high average correlation of 81.91% present between the omega-sharpe and pain ratio portfolios, which suggests that the traditional treynor ratio should also be considered as a possible substitute for the cvar and mvar sharpe ratio portfolios. based on the results reported by figure 1, the pain and treynor ratio portfolios can be considered as the best alternatives for the cvar and mvar sharpe ratio portfolios, as they exhibited the lowest average correlation with all the top-performing portfolios under consideration. this implies that the revised top five ratios (var-sharpe, calmar, sterling, pain and traditional treynor ratios) were able to provide a 51% chance (in-sample ex post) of yielding the top-performing portfolios (see table 8). on the other hand, from a three-year momentum investment strategy perspective this composition differs slightly, where the t*, the sc-adjusted sharpe ratio, the s*, the traditional treynor and the var-sharpe ratios were able to provide an 73% chance (in-sample ex post) of yielding the top-performing portfolios (see table 8). this combination of ratios may also ensure some level of diversification, as figure 1 reports 28% as the highest average level of correlation between the portfolios under evaluation (was between the var-sharpe and the sc-adjusted sharpe ratio portfolios). from a five-year momentum investment strategy perspective, the var-sharpe, the appraisal, the sortino and the omega-sharpe ratios and the t* provided an 81% change (in-sample ex post) of yielding the top-performing portfolios. however, based on the results reported by figure 1 there is a high average correlation present between the sortino, omega-sharpe, the sc-adjusted sharpe, modified information ratios and the s** portfolios. this implies that there are no substitutions available (as reported by table 8) with the ability to yield a top-performing portfolio without decreasing the level of portfolio diversification. therefore, from a five-year momentum investment strategy perspective only the var-sharpe, appraisal and sortino ratios should be considered, as these ratios were able to provide a 65% chance (in-sample ex post) of yielding the top-performing portfolios (see table 8). in conclusion, due to the inconsistent results of the top five best-performing ratios between the three momentum investment strategies, an equity portfolio manager’s ability to yield the best-performing portfolios will drop to approximately 52% (in-sample ex post) when consulting only the var-sharpe, the t*, the appraisal, the sc-adjusted sharpe and the omega-sharpe ratios. however, due to the high average correlation between the sc-adjusted sharpe, the omega-sharpe and the sortino ratio portfolios (see figure 1), only the var-sharpe, appraisal ratios and the t* ratios should be considered in order to ensure better portfolio diversification and consistency between the three momentum investment strategies under evaluation. however, with these three ratios providing only a 37% change (in-sample ex post) of yielding the top-performing portfolios, the conclusion can be drawn that both active and passive portfolio managers will have to consult different ratios in conjunction with the var-sharpe ratio in order to ensure better diversified, outperforming equity portfolios. conclusion and recommendations this study proved that from a risk-adjusted performance perspective it matters which risk denominator is considered to be admissible for the sharpe ratio framework. although the standard deviation exhibited poor evidence as a risk denominator, the results suggested that variations of the traditional sharpe ratio may be more advisable in order to enhance the ability to make more profitable share selections. this study also proved that an equity portfolio of 40 shares can be considered as a viable size, as these portfolios exhibited a low volatility and the ability to outperform most of the buy-and-hold proxies (market proxies) from a risk-adjusted returns perspective. however, it will be interesting to see if this number will also be applicable if the long-only equity portfolio is limited to only selected or to fewer sectors. more importantly, the results validated the need to adjust for skewness, kurtosis and sc in a risk-adjusted performance evaluation process. and although the literature highlighted the importance of acknowledging the negative impact of non-normally distributed returns, the results from this study indicated that the attributes of a risk denominator’s perspective (like that of the var-sharpe ratio) can overshadow the fundamental shortcoming of assuming the presence of a gaussian distribution. the study proved that var can be considered as the more commendable risk denominators to consult, especially from a one-year and five-year momentum investment strategy perspective. however, the attributes of adjusting for skewness and kurtosis (gatfaoui 2012) exhibited more promise for a three-year momentum investment strategy approach. it will be interesting to determine if the creditability of var as a risk denominator will decrease over a longer investment horizon. future studies can also consider the impact of weighting allocations in an equity portfolio and the ideal weighting allocations to consider. the scope of this study also only considered a sharpe ratio framework, but can be extended to include other ratios and variations thereof. furthermore, the evidence suggested the presence of time-varying market efficiency, where the level of market efficiency may serve as a valuable asset allocation or selection tool for active portfolio managers. lastly, the methodology of how to measure total risk must be revised. the results revealed that the standard deviation (total risk) failed as a risk denominator. as it measures only the dispersion of returns around its historical average and penalises positive and negative deviations from the historical average in a similar manner, future studies must consider revising the method of measuring total risk in order to eliminate the ‘smoothing’ effect caused by the mean, which can lead to underestimation of actual risk if ignored. acknowledgements competing interests the author has declared that no competing interests 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discrimination, sexual harassment and· job satisfaction. a questionnaire was developed and used as a measuring instrument on a probability sample of female employees in a public sector department. results show that the respondents do not experience sexual discrimination to a large extent, and that they believe that sexual harassment will have a negative effect on job satisfaction, absenteeism and negativity towards the work environment. jel introduction together with race and class, gender serves as one of the basic reference points around which almost every society is organised (card, 1999). being born male or female, fundamentally shapes peoples' lives and plays a major role in determining emotions, personality traits, identity and responsibilities people expect to assume (card, 1999). while the entry of women into the higher-paid, male-dominated occupations and jobs has increased, most men still feel that women do not have the required skills to become their equals, and even more so, to become their supervisors or managers (hews, 1989), according to bews (1989) the problem with most organisations is that, while managers claim to run equal opportunities organisations, many are just paying lip-service to the elimination of gender r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 608 sajems ns vol 5 (2002) no 3 discrimination and do not institute real changes to accommodate women on an equal level with men in the corporate world. discrimination against women in an organisation may lead to a lowering in productivity, increase in labour turnover and a decrease in profits (sinclair, 1996). sexual discrimination may also lead to such extreme consequences as law suits against the organisation (rantalaiho & heiskanen, 1997). while employers today are providing more equal opportunities to their employees, these are often perceived by female employees as mere token attempts to achieve minimal compliance with equal opportunity policies, rather than a true commitment to end sexual discrimination (powell, 1989). erwee (1989) concludes that little advancement has been made regarding equal opportunities for women in organisations, due to the fact that such a strategy often implies a painful change in the structure, culture and operations of the organisation. discrimination can be described as the denial of equality. it is a set of negative behavioural actions directed at the members of some distinct social group (bubeck, 1995). stereotypes consist of information and beliefs about specific groups, and are essentially negative in nature (slabber!, 1990). mercer (1986) defmes equal opportunity as respect for the individual person as a distinct or unique humlul being, not to be confused with others because of race, religion or gender. in south africa, from a legal point of view, the state is defined as sovereign, non-racial and non-sexist in its new constitution. the principle of equality on the basis of gender and race is accordingly at the centre of the new constitutional dispensation. equality of race and gender is also guaranteed in the bill of rights. this dual recognition of race and gender in the constitution accepts that inequality and discrimination in south africa have often been based on both race and gender and not only on race or gender (ajbertyn & white, 1994). although sexual harassment also happens outside the workplace, it is more difficult to avoid the harasser in the workplace. many women eventually resign jobs solely in an attempt to avoid the harasser (renwick, 1994). some still consider sexual harassment of women as an office joke, or allege that women bring it upon themselves. some men even regard it as a fringe benefit to which their position, power and gender entitle them (prekel, 1989). sexual harassment is often about the abuse of power (broomberg, 1993). broadly defined, sexual harassment is unwanted behaviour of a sexual nature which has a negative effect on the recipient, and can be verbal, non-verbal or r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 609 physical (lubbe, 1995). according to lubbe (1995), the various behaviours covered by legal definitions of sexual harassment, are: verbal: threats, rude and abrasive remarks, sexist jokes, noises, sexual propositions and demeaning references to women. non-verbal: leering, whistling, offensive pornography, unwanted sexual letters and continued pressure for sex/dates. physical: unwelcome touching, patting, pinching, obscene gestures, assault and indecent exposure. according to the equal employment opportunity commission, a more general definition of sexual harassment would be: unwelcome sexual advances, requests for sexual favours and other verbal or physical conduct of a sexual nature (finnemore, 1998). as human beings, employees in the workplace have thoughts and feelings that strongly influence their behaviour in a job situation. these thoughts and feelings are part of their conscious states and provide the inputs by them to make decisions about their actions and reactions to their jobs. these conscious states are known as attitudes and beliefs (mccormick & ligen, 1987). job satisfaction is a specific subset of attitudes held by employees and can be defined as the favourableness or unfavourableness with which employees view their work (werther & davis, 1985). employees' attitudes serve several functions. they provide information about employees' reactions to other individuals, events or objects; they guide behaviour; they are even related to the physical and mental health of employees (mccormick & ligen, 1987). many of the conditions or factors that lead employees to hold positive or negative views of their jobs have been identified through research. these are highly varied in nature, and are not easily summarised. however, according to baron & greenberg (1990), most seem to fall into three major categories, namely: i. factors relating to organisational policies and/or procedures. 2. factors relating to specific aspects of jobs or the settings in which they are performed. 3. factors relating to personal characteristics of employees. it is clear that issues such as gender discrimination and sexual harassment in the workplace could form part ofthese categories of factors that influence employee attitudes and job satisfaction. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 610 sajems ns vol 5 (2002) no 3 this study perceptions play an important role in any organisation, as they influence the attitudes, behaviour and even loyalty of employees towards the organisation. thus it should be important and of value to any modern organisation to determine how women employees perceive the male and female workforce, the expectations female employees have. the extent to which discrimination and harassment against women are perceived to be present, as well as the nature and extent of side-effects negative perceptions could have in the work environment. the purpose of this study, therefore. is to determine the extent to which women perceive discrimination and harassment to be present in a public sector department, as well as their perceptions of job satisfaction. research method the research method followed in this study is discussed under the headings of research strategy. research group, sample, and data analysis. research strategy this study made use of the survey method, to determine the perceptions of women employees in a public sector department with regard to sexual discrimination, harassment and the possible influences of these aspects on job satisfaction. a standardised questionnaire, developed by silberman (1991), and using a 5-point likert scale, was applied to a probability sample of 100 respondents from the specific department's population. the questionnaires were distributed together with an information brochure, indicating the motivation for and characteristics of the study. as well as all relevant instructions. the employees were also informed that the study was conducted with the approval and support of the department's top management. the following are the particulars of this questionnaire: the instrument consisted of 84 questions, divided into two main sections with certain components, namely section 1: biographical data, sexual discrimination and sexual harassment, and section 2: job satisfaction. the 5-point likert~scale used for the evaluation of the items, was applied as follows: respondents used five response categories, namely: strongly agree, agree, uncertain, disagree and strongly disagree. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 611 for favourable statements or items, the strongly agree response was given a weight of 4, the agree response a weight of 3, the uncertain response a weight of 2, the disagree response a weight of 1 and the strongly disagree response a weightofo. for unfavourable statements or items, the above mentioned weighting system was reversed. approximately half the items of the questionnaire were favourable, to balance the number of unfavourable items. the advantage of having both these categories of items in the questionnaire, is to minimise possible response sets of subjects that might be generated if only or a majority of favourable or unfavourable items were included in the instrument. due to the personal nature of the topics covered in the questionnaire, the survey was conducted anonymously. the questionnaire was assessed by a panel of experts from the university of pretoria. the appropriateness of the empirical indicators (questions), as well as the content validity thereof, was confirmed by the panel. the reliability of the questionnaire was determined with the aid of the spss computer package (morgan & griego, 1998). an alpha coefficient of 0.66 for section 1, and 0.96 for section 2 of the questionnaire was obtained. research group the research group consists of female employees of a national, public sector department. sample a probability sample of 100 female employees from a total female employee population of350 was used for this study. the 100 respondents were drawn by (after making a random start) selecting every lih person within an alphabetically ordered sampling frame list. data analysis after the questionnaires were completed by the respondents, the data was captured in order to obtain statistical information for analysis and interpretation. the data derived from the questionnaires was analysed by means of descriptive r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 612 sajems ns vol 5 (2002) no 3 and inferential statistics of the spss windows computer programme (morgan & griego, 1998). the frequency distribution of the biographical variables is displayed in the tables below. in the evaluation of the questionnaire data, various statistical methods were used, of which only the results of one-way analysis of variance and frequency distributions will be reported in this article. results of the study description of the sample: the frequency distributions of the biographical variables are presented in tables 1 to 5. table 1 marital status marital status frc;quency per cent cumulative per cent single 27 27.0 27.0 married 55 55.0 82.0 divorced or widowed 18 18.0 100.0 total 100 100 according to table i, the majority of the sample are married women. table 2 age group age group frequency per cent cumulative per cent under 30 53 53.0 53.0 -. over 30 47 47.0 100.0 total 100 100 according to table 2, the majority of the sample are under the age of thirty years. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 613 table 3 educational level educational frequency per cent cumulative level percent grade 12 (matrie) 49 51.6 51.6 other 46 48.4 100.0 total 100 100.0 (95) no data 5 according to table 3, the majority of the sample have matriculated, but have not obtained tertiary qualifications. . table 4 length of service length of frequency percent cumulative service percent t 6 years 58 59.2 59.2 7 + years 40 40.8 100.0 total 100 100.0 (98) no data 2 according to table 4, the majority of the sample have worked in the department for less than six years. tables job category job category frequency percent cumulative per cent clerical 57 57.0 57.0 management levels 43 43.0 100.0 total 100 100.0 according to table 5, the majority of the sample occupy clerical positions. management levels consist of employees with tertiary qualifications. one-way analysis of variance: the results of this analysis are shown in table 6. only the results of those variables with statistically significant differences among the various groups will be discussed. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 614 samms ns vol 5 (2002) no 3 table 6 one-way analysis of variance variable by mar f-value p-value sexual discrimination: blamed unfairly 3.0103 0.0539 same benefits 8.2720 0.0005 * problem solving 0.0818 0.9215 promotion 3.2825 0.0417 * paternalistic 5.4327 0.0058 * support 3.1030 0.1276 leadership 1.2411 0.2936 sexual harassment: job benefits 0.8949 0.4120 submission 3.6072 0.0308 * directorate 2.9313 0.0581 leave me alone 1.5446 0.2186 morale 1.8982 0.1554 absenteeism 7.9497 0.0006 * productivity 1.8380 0.1646 performance 2.6868 0.0732 satisfaction 8.3280 0.0005 * image of department 9.5572 0.0002 * less respect 3.5437 0.0327 * negative attitude 9.2566 0.0002 * less confidence 3.0698 0.0510 law 1.8991 0.1552 power 0.6768 0.5106 victims & harassers 2.3050 0.1052 legitimate 1.4146 0.2480 counsellors 0.9751 0.8897 report 0.4118 0.6702 aware 0.2471 0.7844 action 004118 0.6702 position 0.5294 0.6003 job satisfaction: job security 5.0584 0.0082 * orosspay 1.3046 0.2760 pay 1.8701 0.1597 personal growth 2.7178 0.0712 quitting 5.5724 0,0051 * respect 5.3146 0.0065 * excuse 4.4845 0.0137 * worthwhile accomplishment 0.9878 0.3761 type of job 2.7828 0.0668 support 4.0922 0.0197 * r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 615 table 6 continued variable by mar f-value p-value encourage independent thought 0.6251 0.5373 suggestions 1.5702 0,2132 challenges 3.3746 0.0383 • accomplishment 1.4835 0.2319 choice 0.5988 0.5515 quality of supervision 4.2379 0.0172 • different supervision 2.4049 0,0372 • attitude to people 3.2710 0.0422 • example of fellow employees 2.1658 0.1202 attitude future 1.0226 0.3635 0.6423 0.5283 quit: satisfied 2.8525 0.0626 supervisor traits 2.8721 0.0615 supervisor dealings 5.0262 0.0084 * recognition 0.5743 0.5650 day never ends 1.8083 0.1694 friend 4.0889 0.0198 * enjoy 1.5899 0.2093 earnings 6.0763 0.0033 * force 1.0373 0.3583 trust 4.1580 0.0185 • happier than colleagues 4.0417 0.0206 • 4.4078 0.0147 * * p :5:0.05 table 6 indicates the following results regarding sexual discrimination; same benefits: with regard to the receipt of the same benefits as their male counterparts occupying the same job category, married women seem to differ significantly from divorced/widowed women. promotion: with regard to whether the respondents rate their prospects of being promoted to a higher position within the next three years as very good, group 2 (married women) differs significantly from group 3 (divorced/widowed women). judged according to response frequencies on the 5-point likert scale, it seems that the majority of married women (47.3 per cent) do not rate their prospects of being r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 616 samms ns vot5 (2002) no 3 promoted to a higher position as very good, while the majority of divoroedlwidowed women (52 per cent) do. paternalism: with regani to being treated paternalistically by their supervisors, group 3 (divorced/widowed) differs significantly from group i (single) and group 2 (married). it appears that the majority of both single (66.6 per cent) and married (563 per cent) women have never been treated paternalistically by their supervisors, while the majority of divorcees/widows (55.6 per cent) believe that they are treated in a paternalistic fashion. the following results regarding sexual harassment have been reported: submission: regarding the use of a woman's submission toirejection of sexual advances by a person in a higher position as a basis for employment decisions affecting her, group 1 (single) differs significantly from group 3 (divorcedjwidowed). the majority of single women (63 per cent) seem to agree that a woman's submission to or rejection of sexual advances by a person of higher authority may be used as a basis for employment decisions affecting them, while the majority of divorcees/widows (61.1 per cent) disagreed. absenteeism: with regard to sexual harassment affecting absenteeism, group l(single) differs significantly from group 2 (married) and group 3 (divorced/widowed). the majority· of single women (51.9 per cent) appear to feel more strongly than married (27.3 per cent), divorced or widowed. women (22.3 per cent), that women experiencing sexual harassment will tend to stay away from work more often in order to avoid such experiences. satisfaction: with regard to the que..cjtion whether women who are experiencing sexual harassment have less satisfaction in their work than the average female employee, group 1 (single) differs significantly from group 2 (married) and group 3 (divorcedlwidowed). it appears that au the single women (100 per cent), . in comparison to 25 per cent of the married women and 16.7 per cent of the divorcees/widows. believe that women experiencing sexual harassment will probably have less work satisfaction than the average woman. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 617 image of department: with regard to the question whether women who are experiencing sexual harassment have a negative image of the department, group i (single) differs significantly from group 2 (married) and group 3 (divorced/widowed). it appears that more than half of the single women (52 per cent), in comparison to less than 25 per cent of the married women and only 16.7 per cent of the divorcees/widows, believe that those women experiencing sexual harassment will probably have a negative image of the department. respect: regarding the question whether women who experience sexual harassment have less respect for people in power positions who "tum a blind eye", group 1 (single) differs significantly from group 3 (divorced/widowed). while nearly 60 per cent of single women appear to strongly believe that women in the department who are experiencing sexual harassment will have less respect for people in power positions who tum a blind eye, only about 25 per cent of divorcees/widows believe the same. negative attitude: with regard to whether women who are sexually harassed have a negative attitude towards their work environment, group 1 (single) differs significantly from both group 2 (married) and group 3 (divorced/widowed). it appears that the majority of single women (51.9 per cent), in comparison to 25.5 per cent of married women and 11.1 per cent of divorcees/widows, strongly believe that women who are experiencing sexual harassment will have a negative attitude towards their work environment. the results regarding job satisfaction are as follows: job security: it was found that, regarding satisfaction with job security, group 2 (married) differs significantly from group 1 (single) and group 3 (divorced/widowed). it appears that the majority of group i (single) (76.7 per cent) and group 3 (divorced/widowed) (66.7 per cent) are satisfied with the amount of job security they have in the department. only 45.3 per cent of group 2 (married) indicated that they experience job security. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 618 sajems ns vol 5 (2002) no 3 quitting: with regard to whether they would consider quitting their job, group 1 (single) differs significantly from group 2 (married) and group 3 (divorced/widowed). it appears that married women (38.2 per cent) generally more often think of quitting their jobs than single women (29.6 per cent) and divorcees/widows (23.5 per cent). respect: with regard to their being satisfied with the degree of respect received from their managers, group 2 (married) differs significantly from group 3 (divorced/widowed). it appears that 22.2 per cent of divorcees/widows are very satisfied with the degree of respect received from their managers, while only 5.5 per cent of married women feel the same. excuses (to stay away from work): with regard to the question whether they would seize a plausible excuse to stay away from work, group 1 (single) differs significantly from group 2 (married) and group 3 (divorced/widowed). it appears that the majority of all three groups (group 1: 55.5 per cent; group 2: 83.6 per cent; group 3: 100 per cent) would not usually seize a plausible excuse to stay away from work. support: with regard to whether they were satisfied with the amount of support and guidance received from supervisors, group 2 (married) differs significantly from group 3 (divorced/widowed). it appears that the majority of married women (61.9 per cent) are not satisfied with the support and guidance received from their supervisors, while the majority of divorcees/widows (72.2 per cent) are. suggestions: on the question whether they believe that many good suggestions are "killed" by supervisors, group 1 (single) differs significantly from group 3 (divorced/widowed). it appears that the majority of single women (66.6 per cent) believe that many good suggestions are "killed" by their supervisors, while less than half of the divorcees/widows (44.5 per cent) agreed with this. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 619 choice: with regard to the question whether they would choose to work for the department if they could do it over again, group 1 (single) differs significantly from group 3 (divorced/widowed). it appears that the majority of divorcees/widows (77.7 per cent) would still choose to work for the department if they had to do it all over again, while only 44.4 per cent of the single women would do so. quality of supervision: with regard to whether they were satisfied with the overall quality of supervision received, group 2 (married) differs significantly from group 3 (divorced/widowed). it appears that even though the majority of both groups agree that they are satisfied with the overall quality of supervision received in their jobs, the divorcees/widows are more satisfied (77.8 per cent) than the single women (40 per cent). different supervision: on the question whether overall job satisfaction in each directorate was influenced by how they were treated by the supervisors, group 1 (single) differs significantly from group 3 (divorced/widowed). it appears that the majority of single women (62.9 per cent) believe that the treatment they receive from their supervisors negatively influence their overall job satisfaction in their specific directorate. the majority of divorcees/widows (55.5 per cent) believe the opposite. supervisor traits: with regard to whether supervisors have more positive than negative traits, group 3 (divorced/widowed) differs significantly from group 1 (single) and group 2 (married). it appears that the divorced/widowed women are more positive about the traits of their supervisors, in that none of them believe that their supervisors have more negative than positive traits, in comparison to 37 per cent of the single women and 24.1 per cent of the married women. day never ends: regarding whether each day of work seems endless, group 1 (single) differs significantly from group 3 (divorced/widowed). it appears that the majority of single women (62.9 per cent) are of the opinion that each day seems like it will r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 620 sajems ns vol 5 (2002) no 3 never end, while the majority of divorcees/widows (61.1 per cent) feel the opposite. enjoy: with regard to whether they generally do not enjoy their jobs, group i (single) differs significantly from group 2 (married) and group 3 (divorced/widowed). it appears that the majority of all three groups generally do enjoy their work. single women (40.7 per cent) are, however, more negative about their jobs than married (14.5 per cent) or divorced/widowed (5.6 per cent) women. force: regarding the question whether they mostly force themselves to go to work, group i (single) differs significantly from group 3 (divorced/widowed). it appears that 33.3 per cent of the single women, in comparison to 5.6 per cent of divorced/widowed women have to force themselves to go to work. trost: with regard to whether supervisors trust them, group 1 (single) differs significantly from group 3 (divorced/widowed). it appears that while the majority of both groups (single: 59.2 per cent; divorced/widowed: 94.5 per cent) believe that their supervisors trust them, more single women (29.6 per cent) than divorcees/widows (5.6 per cent) believe that supervisors do not trust them. happier than colleagues: regarding the question whether they were happier in their jobs than most other people, group i (single) differs significantly from group 2 (married) and group 3 (divorced/widowed). it appears that, although the largest percentage of all three groups agree that they are happier than most other people, the percentage of single women (37 per cent) who believe this is far smaller than either the married (52.7 per cent) or divorced/widowed (70.6 per cent) women who also agreed to this statement. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 621 conclusions and recommendations the conclusions drawn from the research findings are presented as follows: sexual discrimination: the married women in the study generally do not appear to believe that their chances of promotion within the next three years are very good. sexual harassment: single women tend to believe that a woman's submission to or rejection of sexual advances by a person in a higher position may be used as a basis for employment decisions affecting her. the majority of single women appear to believe that women who are experiencing sexual harassment, will probably tend to stay away from work more often, have less work satisfaction, have a negative image of the department, have less respect for people in positions of authority who "turn a blind eye" and have a negative attitude toward their work environment. the majority of married women believe that the women who are experiencing sexual harassment will probably have less work satisfaction, have a negative image of the department and a negative attitude towards their work environment. the majority of divorced/widowed women believe that women experiencing sexual harassment will probably have less work satisfaction, have a negative image of the department, have less respect for people in authority positions who "turn a blind eye" and have a negative attitude towards their work environment. job satisfaction: single womens' perceptions regarding job satisfaction show that the majority of them believe that good suggestions are ignored/negated by supervisors, they would not seize a plausible excuse to stay away from work, the way their supervisors treat them negatively influence their job satisfaction, they often experience that a work day will never end, they generally enjoy their jobs (but to a lesser extent than married and divorced/widowed women), their supervisors trust them and that they are happy in their jobs (also to a lesser extent than married and divorced/widowed women). married womens' perceptions of job satisfaction show that they are not satisfied with their job security, they generally think more often of quitting their jobs r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 622 sajems ns vols (2002) no 3 (than single or divorced/widowed women), they are not satisfied with the amount of support and guidance received from supervisors, they are satisfied with the respect received from supervisors and they generally enjoy their jobs. the divorcedlwidowed womens' perceptions of job satisfaction show that: they believe that many good suggestions are ignored/negated by their supervisors, they are satisfied with the degree of respect and amount of support and guidance received from their supervisors, they are satisfied with the quality of supervision in their jobs, they would not seize a plausible excuse to stay away from work, they believe their supervisors have more positive than negative traits, they strongly believe that their supervisors trust them, they would again choose to work for the department if they could do it allover again and they strongly believe that they are happier in their work than the average woman. in general, the results of this study seem to indicate that women in the department do not experience sexual discrimination to a large extent. the majority of the women believe that the experiencing of sexual harassment will have a negative impact on job satisfaction, the image of the department (employer), attitude towards their work environment and respect for people in power who do not protect women against harassers. it appears that divorcees/widows are most positive in terms of believing that an experience of sexual harassment will not have too serious an impact on the mentioned behavioural tendencies. single women showed the strongest indication that sexual harassment would indeed have a consequential effect on the mentioned tendencies. pertaining to job satisfaction, single women and women under 30 years of age seem least satisfied with or happy in their work situation, even though married women have indicated that, although they enjoy their work, they most often think of" quitting their job. in general, the divorced/widowed women, women over 30 years of age and women who have been working for the department for more than seven years, seem most satisfied with their supervisors and the supervision received. they are satisfied with their jobs and would choose to work in the department if they could do it over again. single women and those employed in the department for less than six years, tend to be the least positive of all respondents concerning job satisfaction and their relationship with and treatment by their supervisors. with the experiences and results gained from this study, the following recommendations are suggested: special attention should be given to the single women in the department, as they appear to be most negative about their work environment and supervision. in the event of sexual harassment among this group, it appears that they will be most inclined to stay away from work in order r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 3 623 ------....... _-----------------to avoid such experiences, and their job satisfaction will be most negatively affected. work groups should periodically be formed to discuss these issues and to allow female employees the opportunity of airing their views and concerns. it would also be advantageous to grant female employees the opportunity of attempting to find solutions for the manner in which certain problems can be dealt with. at the time of the study, the department did not have a sexual harassment policy in place. due to the fmding that roughly a fifth of the department's female employees seemingly experience sexual harassment, it is evident that this matter needs urgent attention. all women employees should be actively involved in the formulation, implementation and maintenance of such a policy, married women, as the majority group among the female employees in the department, appear to be relatively content m their work, but the indication that the majority of them often think of quitting their jobs, should be a concern to the department's management. it thus will be important to identify the particular aspects which negatively affect this 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(1985) personnel management and human resources, (2nd ed.) usa, mcgraw-hili book company. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction literature review data and methodology empirical results and discussion conclusion acknowledgements references about the author(s) mitteran e. nkongho department of finance, risk management and banking, university of south africa, pretoria, south africa daniel makina department of finance, risk management and banking, university of south africa, pretoria, south africa citation nkongho, m.e. & makina, d., 2020, ‘long-run performance of corporate spin-offs and sell-offs: evidence from the jse limited’, south african journal of economic and management sciences 23(1), a3683. https://doi.org/10.4102/sajems.v23i1.3683 original research long-run performance of corporate spin-offs and sell-offs: evidence from the jse limited mitteran e. nkongho, daniel makina received: 30 apr. 2020; accepted: 08 sept. 2020; published: 07 dec. 2020 copyright: © 2020. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: prior to 1994, there were artificial restrictions on south african corporations as a result of isolation and sanctions. thus, corporate unbundling activities in south africa are still new relative to their overseas counterparts. of recent, no study has vividly examined the long-run performance of spin-offs and sell-offs on the jse limited. in the most recent study on spin-offs and sell-offs, performance was investigated for less than 2 years. long-run performance of spin-offs and sell-offs should be examined for at least 3 years in line with overseas literature. in order to fill the gap in previous literature, this study updates existing literature, and extends the investigation horizon to 4 years. aim: this study seeks to investigate the long-run performance of spin-offs and sell-offs on the jse limited. settings: this study matches the performance of an event firm to that of a non-event firm. the matching was done at sector and industrial level, using the value of equity as a matching measure. performance was examined between 2000 and 2016, for up to 4 years. methods: the method of analysis is the matching firm technique under buy and hold abnormal returns. the creation of shareholder’s wealth was investigated for 26 spin-offs, 17 parent spin-offs, 16 sell-offs and 23 parent sell-offs. results: abnormal returns are significantly positive for spin-offs, parent spin-offs and sell-offs for 1–4 years after unbundling. only parent sell-offs failed to follow this path. conclusion: according to this study, spin-offs and sell-offs unlock shareholders’ wealth for up to 4 years on the jse limited. keywords: corporate unbundling; spin-offs; parent spin-offs; sell-offs; parent sell-offs; matching firm; market value of equity; mergers and acquisition. introduction according to hagel iii and singer (2000), corporate unbundling is a process of breaking up a large business into its smaller components. similarly, moschieri and mair (2005) defines corporate unbundling as an operation where the parent corporation initiates an action of disposing of and selling assets, facilities, product lines, subsidiaries, divisions or business units. generally, unbundling has not been very common in south africa. however, the few corporations that have undertaken the strategy have focused more on spin-offs and sell-offs. a spin-off is a pro-rata distribution of the shares of a firm’s subsidiary to the shareholders of the firm and after the distribution the operations and management of the subsidiary are separated from those of the parent (bhana 2004). in contrast, a sell-off involves the disposal of divisions, business units, product lines or subsidiaries to other firms in exchange for cash (menon et al. 2004). in recent years, unbundling transactions are becoming part of the widely accepted restructuring of the corporate landscape in south africa (bhana 2006). barlow rand set the unbundling era in motion in 1993 by disposing of cg smith, rand mines and reunert. subsequently, in 1999 cg smith unbundled its only two assets: stakes of 57% in illovo sugar and 56% in tiger brands. tiger brands later on disposed of spar in 2004 and adcock ingram in 2008 (thomas 2013). as observed by hattingh (2007), political change in south africa since 1994 led to the selling-off of divisions that were not part of a corporation’s core activities. bhana (2006) also observed that sell-off transactions are rapidly increasing, and that black economic empowerment (bee) has contributed to the acceleration of unbundling activities. in south africa, unbundling has been investigated more around announcements than post-announcements. the major long-term studies conducted include bhana’s (2004) research on spin-offs and majoni et al.’s (2014) research on spin-offs and sell-offs. according to bhana (2004), there are positive returns for up to 3 years, following spin-offs. but majoni et al. (2014) reported negative cumulative abnormal returns for up to 250 days and 500 days following the spin-off announcements. with these results, it is difficult to infer that unbundling transactions in south africa are accompanied by positive returns for years after the events as is the case with europe and usa. however, international studies on unbundling provide that long-term studies on unbundling are investigated for at least 2 years and above, before a proper conclusion can be drawn (bates 2005; cusatis mile & woolridge 1993; dasai & jain 1999; mcconnell & ovtchinnikov 2004; woo, willard & daellenbach 1992). before 2 years, it is considered a re-adaptation phase for the restructured firms and it is hypothesised that with time they would experience greater positive returns. therefore, to conclude if south africa is consistent with the overseas trend of unbundling, it is important to adopt a long study period and investigate performance for up to 4 years, following unbundling announcements. thus, this approach would seek to investigate long-run effects in contrast to the findings of majoni et al. (2014) and at the same time extending the study horizon beyond that of bhana (2004) in line with international literature. the study also compares and contrasts spin-off and sell-off transactions. the rest of the paper is organised as follows. section 2 reviews literature. section 3 discusses the research methodology. section 4 presents and discusses findings. section 5 concludes. literature review in recent years, corporate unbundling has gained popularity as an effective strategy for companies to streamline and refocus their businesses with the overall goal of creating shareholder wealth (majoni et al. 2014). there exist a wide range of reasons why corporations downsize through unbundling. initially, companies saw merger and acquisition (m&a) as a means to increase their market capitalisation. however, due to the excess capacity created by m&a, companies found that they could no more manage all their acquired businesses in an efficient manner. hence, more unutilised assets locked shareholder wealth. veld and merkoulova (2003) proposed that after unbundling, the simpler nature of the firm may lower monitoring and coordinating costs. devogelaer (2003) argued that over time, rapid expansion of a firm’s product line reduces its competitive ability and as such, one of the drivers of refocusing is the need to focus on core competences. gordon (1992) suggested that when companies divest their businesses, the stand-alone entities tend to gain more recognition from analysts and investors than when they were still part of the parent company. managers of large corporations should evaluate the advantages of unbundling to access its benefits and to focus on what is best for their business (moschieri & mair 2005). releasing shareholder value and concentrating on core activities is the sole reason why corporations view unbundling in a good light. according to hellerman and jones (2000), a typical motivation for divestitures is to enable the parent company to focus its core business or unlock unrealised value for its shareholders. liquidity problems are common phenomena in many economies. many stock exchanges have low liquidity because only a few shares are traded. a more focused business may improve access to the capital market and thereby attracting new sets of investors (kirchmaier 2003). according to woo, willard and beckstead (1989), one primary motivation for divestitures is to enhance the firm’s economic value in capital markets. consistently, gordon (1992) observed that spin-off firms have the advantage of gaining access to additional capital in the equity and debt markets. more so, the difficulties faced by holding companies in raising capital can be reduced through unbundling transactions. the issue of whether information asymmetry within a conglomerate can be reduced through unbundling, is an area of debate in the finance literature. krishnaswami and subramaniam (1999) observe the reduction of information asymmetry as the motive behind spin-offs. the reasons behind corporate unbundling can further be viewed from three perspectives. from a legal perspective, unbundling can be voluntary or involuntary (montgomery, thomas & kamath 1984). voluntary unbundling can take place for strategic, financial or organisational reasons. firstly, the strategic reason implies that a company can unbundle to take a position of specialisation in the market. secondly, the financial reason suggests that companies unbundle to generate cash flow required to meet debt obligations. thirdly, the organisational reason states that companies unbundle to solve the problem of bad governance. on the other hand, the government, by forcing enterprises to respond to some regulations, often influences involuntary unbundling. according to the strategic perspective, firms decide to unbundle for corrective or proactive reasons (moschieri & mair 2005). in this situation, the company tries to correct over-diversification problems created by m&a by focusing on its core business area. proactive unbundling is a means of restructuring a company’s asset portfolio. from the perspective of the market, unbundling can be aggressive or defensive (moschieri & mair 2005). hopkins (1991) argued that acquisition can be a defensive reaction to weak or deteriorating industry conditions and competitive positions, and that the attractiveness and concentration of the firm’s home industry are positively related to unbundling decisions. the general view here is that when a business is highly focused, the possibility of a takeover is limited. dann and deangelo (1988) suggested that sell-offs are motivated to prevent a possible takeover. one of the major setbacks of unbundling is lack of synergy benefits and economies of scale. hunt (2004) considered synergy as leveraging the combined strengths of two parties so that by adding the individual capabilities of the two companies, their sum is greater than their individual parts. from the author’s argument, it is clear that conglomerate organisations benefit from inter-division use of facilities and knowledge. economies of scale exist when the marginal cost is less than the average cost, thus reducing the unit cost as quantity increases (besanko et al. 2010). according to clarke (1998), there exist economies of scale for enterprises undertaking m&a transactions. the non-collective nature of individual corporations prohibits them from achieving synergy benefits and economies of scale. empirical studies have proven that shareholders’ wealth is created around announcement of unbundling events (pre and post announcement). jongbloed (2004) observed that a corporate spin-off is an important restructuring strategy to create wealth at the announcement. thus, dasilas et al. (2011) investigated the wealth effects of 239 spin-off announcements that occurred between january 2000 and december 2009 in the usa and europe. a strong positive market reaction of 3.47% on the spin-off announcement date was reported. similar research carried out by murray (2000) in the uk by investigating the wealth effects of spin-offs around announcements for the parent firms from 1992 to 1998 reported positive cumulative average abnormal return (caar) around announcements though it was not statistically significant. this insignificant result may be due to the announcement of minor unbundling events. even though the presence of significant abnormal returns around unbundling announcements have been documented, the sources of these gains are not clear. hite and owers (1983) examined security price reactions around the announcement of 123 spin-offs by 116 firms from 1963 to 1981. the authors reported that voluntary corporate spin-offs have positive effects on a firm’s share price but the sources of the gain are not understood. in a study on the announcement effect of voluntary sell-offs on shareholder wealth undertaken from 1964 to 1973, alexander, benson and kampmeyer (1984) found that sell-offs generate positive cumulative abnormal returns for both acquiring and selling firms’ shareholders. similarly, kiymaz (2006) who studied the impact of sell-off announcements on both the buying and the selling firms from 1989 to 2002 reported that both the buying and the selling firms experienced statistically significant wealth gains during sell-off announcements. tehranian, travlos and waegelein (1987) examined the association between long-term performance and wealth effects accruing to stockholders of divesting firms at announcement of sell-offs between 1974 and 1982. their findings reported that firms with long-term performance plans experienced a more favourable stock market reaction at the announcement of sell-offs relative to firm with short-term performance plans. prior studies of unbundling performance in south africa are limited. one of the earliest studies is by blount and davidson (1996) on the wealth effects of voluntary corporate unbundling announcements. the authors reported a negative share price impact resulting from unbundling announcements. investigating the effects of corporate unbundling announcements by south african listed corporations on shareholders wealth from 1st january 2002 to 31st june 2011, jordan (2012) found significant negative abnormal returns from 27 corporate unbundling announcements. these results are not consistent with bhana’s (2006) study of 58 sell-offs undertaken by companies listed on the jse from 1st january 1995 to 31st december 2001. the results showed that sell-off announcements have a positive effect on the shareholder wealth for both the sellers and buyers. coldwell et al. (2015) studied the impact of bee on divestitures announcement. the authors used two samples. the first sample consisted of firms that were unbundled immediately after the advent of democracy in south africa and the period 1996 to 2002 was studied. the second sample consisted of firms that were unbundled due to the bee act of 2003 and the study period ran from 2003 to 2011. stock price reaction around announcements was positive for the firms restructuring immediately after the advent of democracy in south africa. the case of bee indicated a negative share price impact and thus showing that bee had a negative effect on shareholders’ wealth for corporations refocusing with the aim to achieve bee points. the wealth effects of corporate unbundling might be better understood if post-unbundling performance is also examined. companies whose share prices appreciate significantly around announcement may not show a similar trend many years after. sometimes companies with such performance even close down. hence, post-unbundling performance should be studied for a long time scale. when a company voluntarily spins off its subsidiary, the action is viewed as a positive one for both the parent company and its subsidiary (woo et al. 1989:29). in an analysis of the spinning-off of regional operating companies (rocs) by american telephone and telegraph (at&t), hall (1984) reported that at&t and rocs realised 18.8% return between the end of 1983 and november 1984. in another study, cusatis et al. (1993) investigated the value created through spin-offs by examining the stock returns of spin-offs, their parent firms, and parent-spin-off combinations for periods of up to 3 years following the spin-offs. the sample period ran between 1965 and 1988. the results indicated the presence of significant positive abnormal returns for spin-offs, their parents, and the parent-spin-off combinations. furthermore, a study of value improvement following spin-offs by chemmanur and yan (2003) recommended that spin-offs are associated with long-term performance. in another study, bhana (2004) investigated voluntary spin-offs occurring between 1988 and 1999 on the jse. the study indicated that both the spin-offs and their parents had significant positive abnormal returns for up to 3 years after the spin-offs’ announcement date. nonetheless, woo et al.’s (1992) findings completely disputed the above findings. the authors investigated the 3-year post-restructuring performance of 51 firms that were spun-off between 1975 and 1986. on average, they found no performance improvement of the spun-off units following separation from the parent firms. similarly, a study by majoni et al. (2014) on the impact of spin-offs on shareholder wealth for parent firms listed on the jse over the period 1995 to 2011 reported significant negative cumulative abnormal returns for up to 250 days and 500 days following the spin-off announcement. however, the literature demands that long-run studies should be considered for at least 3 years following the event. if the study had monitored performance for at least 3 years, everything else being equal, different results might have come out. comprehensively, kleiman and sahu (1990) investigated share price performance of 40 newly spun-off firms between 1984 and 1987. after 1 month of trading, the average market-adjusted return for the 40 spun-off firms was -1.7%. after 3, 6, 9, and 12 months of trading the average market-adjusted return for the 40 spun-off firms was 4.8%, 14.6%, 22% and 22.7% respectively. this is a typical study that disputes majoni et al. (2014) on the basis that over time, spin-off performance may improve and if performance is investigated for at least 3 years and above then any result arrived at irrespective of the nature should be considered robust. most studies undertaken for post sell-off performance have shown some similarities with studies carried out on spin-offs. hillier, mccolgan and werema (2005) examined the operating performance of uk firms following a decision to sell-off non-financial assets. the study was carried out between 1993 and 2000. a significant improvement in firm operating performance was reported after the sell-off exercise. again, gadad, stark and thomas (2007) conducted a study on whether sell-offs are associated with changes in operating performance for both the buyer and the seller between the period 1st january 1985 to 31st december 1991. the results indicated that the operating performance of the buyers and the sellers increased by 3% and 3.1% per annum respectively on an average for 3 years after the sell-off. conversely, in a study on sell-offs on the jse over the period 1995 to 2011, majoni et al. (2014) reported that sell-offs are impacted negatively post-announcements. research on corporate unbundling has received little attention in the literature compared to corporate mergers and acquisitions (gadad & thomas 2005). despite this fact, a review of prior literature reveals that an unbundling announcement is not a trivial event and that it is usually accompanied by changes in the wealth of shareholders (bhana 2006). the amount of wealth created by a particular strategy may vary from one country to another. research conducted on spin-off announcements in usa and europe by dasilas et al. (2011) revealed that the us spin-offs provided a stronger response from investors than the european spin-offs. no clear explanation for this wealth discrepancy between countries has been given. however, similar research in south africa may show lesser wealth effects than in usa and europe given that the economy structure consists of many holding companies that could not unbundle due to the apartheid era but only started unbundling a few years ago after the advent of democracy. therefore, if after an unbundling exercise in a particular economy there are no significant returns, it may not necessarily imply that in the future significant returns will not be found. it might be that the market is still trying to adjust and accommodate the strategy. data and methodology the event study methodology, namely, a matching firm approach developed by dasai and jain (1999), which uses the buy and hold technique to calculate abnormal returns was used. this was consistent with the approach adopted by bhana (2004) on the south african companies to determine long-run performance of unbundling transactions. major methodologies adopted by various authors over time to investigate the performance of corporate unbundling events are; the market model approach that aggregates results through caars and the matching firm technique that aggregates results through buy and hold abnormal returns (bhars). literature on corporate restructurings concentrate on the use of either compounded long-run abnormal returns (bhars) or measures of average periodic performance (caars) (gershgoren, hughson & zender 2005). in order to adopt the most appropriate method for the study, the following considerations were met: the bhars under the matching firm technique concentrate exclusively on long-term trends. the bhars directly measure investor experience (gershgoren et al. 2005) and yield solid returns. it is argued that a long-run event study should not use caar as a performance measure because it is a biased predictor of investor experience (barber & lyon 1997). therefore, rejecting the null hypothesis of no abnormal returns measured as average period abnormal return does not imply a lack of abnormal return as measured by the bhar (gershgoren et al. 2005). furthermore, the use of bhar automatically solves the problem of portfolio rebalancing associated with caars. this rebalancing bias arises because while the compound returns of a reference portfolio (an equally weighted index) are determined assuming monthly rebalancing, the compound returns of sample firms are determined without rebalancing (barber & lyon 1997). the bhars can be calculated using a reference portfolio and matching firms. at this level, a reference portfolio can be created by using market value of equity, price earnings ratio and other measures. but the research adopted the bhar by a matching firm technique. according to fama (1998), the bhar under the reference portfolio approach are highly skewed and as such cause standard tests to have the wrong size. nevertheless, the matching firm technique is a one-to-one comparison. the method directly compares two different firms belonging to one sector or industry under one economic environment. unlike the market model, normal returns determined from a market index are compared with returns of event firms. this means that firms which do not belong to the same industry with the event firms are used to determine abnormal returns. as such, caar under the market model is not an appropriate performance measure, especially in the long-run. matching is done on the first day of trade after the event. the process is done on the basis of relevant risk characteristics and the matched stocks not being exposed to the event of interest (sitthipongpanich 2011:63). the measure considered by the study for matching, is the market value of equity. in the selection process, the matching firm considered is the one whose market value of equity is closest to that of the event firm and belongs to the same sector or industry with the event firm. in the case where the first matching firm’s share price data is not available throughout the investigation horizon, the study resorts to the next matching firm. a matching firm operating in a different sector to that of the event firm is only considered if no matching firm operating in the same sector with the event firm is found. the same holds if no matching firm operating in the same industry with the event is found. irrespective of how the matching firm is selected, it must be the closest to the event firm in terms of market value of equity. sources of data and variables the sample consists of companies listed on the jse during the period 2000 to 2016 that had passed through genuine voluntary unbundling announcements (table 1). the study utilized 82 companies which undertook genuine corporate unbundling. the 82 companies resulted in 17 parent spin-offs, 26 spin-offs, 23 parent sell-offs and 16 sell-offs. table 1: final sample statistics from 2000–2016. data were collected from unbundling announcements published by jse securities exchange news service (sens) and share data online. the jse sens database and share data online are very consistent in announcing unbundling events and monitoring them from initial announcements to finalisation. some of the announcements related to sell-offs were obtained from the competition commission of south africa. to arrive at a final sample, the following considerations were made: only finalised events were considered since these events have to be studied for a long-term period. in the case where an event firm was found to have passed through more than one unbundling announcement within the investigation horizon, the firm was not considered. thus, the potential effect of confounding events was mitigated. a firm could also be considered if it had restructured more than once within the study period (2000–2016) and each of the events fell in a different investigation horizon. only voluntary divestitures were considered as forced divestitures are not motivated by wealth creation. in order to allocate matching firms to each event firm, the african markets database was used as it provides all companies listed on the jse and their sectors. the monthly share price data and market value of equity required with respect to the event firms and the matching firms were obtained from i-net bfa database. estimation model the study considered 2 years prior to and 4 years after announcements as a horizon to investigate parent performance. the horizon considered for subsidiaries (spin-offs and sell-offs) is 4 years after unbundling. therefore, abnormal returns are determined from 2 years prior to announcements and 4 years after. the holding periods used for analysis are 2 years prior to unbundling and 6 months, 1 year, 2 years, 3 years and 4 years after unbundling. data analysis assumes the matching firm technique under bhars. the technique follows a sequence of operation shown below. the raw returns for the event firms are calculated by computing returns ri,t for all holding periods considered: where, ri,t is the return for firm i in time t. the matching firms buy and hold returns are also computed as in (1). if the event firm stops trading at a particular point, a buy and hold return is computed using the last available share price and this return is used as a performance measurement for all subsequent intervals (mcconnell, ozbilgin & wahal 2001). the bhars for each event firm is simply the difference between the long-run holding period return for that firm and the long-run holding period return for the matching firm (gershgoren et al. 2005). this is calculated from the following equation: in order to aggregate the data for an overall inference, the mean difference of the buy and hold returns is calculated as: where n stands for the number of firms in a sample. however, a two-tailed t-test was used for testing statistical significance of : where: s is the sample standard deviation of bhars and n is the number of firms in a sample. ethical consideration this is to certify that the disertation entitled, the performance of corporate restructurings: evidence from the jse limited, submitted by, mitteran enow nkongh for the degree of, master of commerce at the university of south africa, university of south africa, 2018/cems/frmb/oo9, 01/06/2018. empirical results and discussion empirical results the results are placed under three major categories, namely, the performance of spin-offs, the performance of sell-offs, and the difference between the performance of sell-offs and spin-offs. the analysis concentrates around bhar (adjusted). the mean raw return (mrr) (unadjusted) is also considered but to a limited extent since the purpose of the study is to compare an event firm’s performance to that of an average firm which did not undertake any restructuring activity. share price performance of spin-offs: parents and spin-offs returns to measure the value created through spin-offs, the study performed an analysis of 17 parents and 26 spin-offs. both the mrrs and bhars (table 2) and (table 3), were calculated from 24 months before the spin-off to 48 months after the spin-off. in calculating bhars, we took the parent and the spin-offs firms’ raw returns and subtracted the returns of their various matched firms on the basis of sector, industry and size factors over the same period. the analysis was run from 24 months before and 48 months after the x-date (date of first trade after the event) for the parents. for the spin-offs, the analysis was run for 48 months after the x-date. table 2: share price performance of 17 parent spin-offs for the period 2000–2016 (n = 17). table 3: share price performance of 26 spin-offs for the period 2000–2016 (n = 26). share price performance of sell-offs: parent sell-offs and sell-offs the performance of sell-offs transactions were analyzed using the same metric as the case of spin-offs. to examine value created through sell-offs, we analyzed the performance of 23 parent sell-offs and 16 sell-offs. like spin-offs, mrrs and the bhars (table 4 and table 5), were examined for 24 months to the x-date and 48 months after. table 4: share price performance of 23 parent sell-offs for the period 2000–2016 (n = 23). table 5: share price performance of 16 sell-offs for the period 2000–2016 (n = 16). share price performance difference between sell-offs and spin-offs the difference in the performance between sell-offs and spin-offs (table 6) would indicate the best alternative on the jse for a long-term period following their announcements. we subtracted the raw returns and the adjusted returns of spin-offs from that of sell-offs. table 6: performance difference between sell-offs and spin-offs for the period 2000 to 2016. for holding periods x-6, x-12, x-24, x-36 and x-48, the differences in their mrrs are −1.63%, −5%, −10.13%, −13.13% and −19% respectively. the differences in their bhars for the same sub-periods are 2.19%, −6.32%, −10.46%, −14.23% and −19.34% respectively. discussion of research results the following hypotheses are considered to verify the significant of bhars for parent firms and their subsidiary for 24 months to the x-date and throughout 6, 12, 24, 36 and 48 months after. hypothesis 1 ha: bharsparent ≠ 0 h0: bharsparent = 0 hypothesis 2 ha: bharsunbundled d ≠ 0 h0: bharsunbundled d = 0 hypothesis 3 ha: bharsselloff – bharsspinoff ≠ 0 ha: bharssell–off – bharsspinoff = 0 considering these three hypotheses, the alternative hypothesis states that any outcome of the result is significantly different from zero. according to the null hypothesis, any outcome of the result is not significantly different from zero. therefore, the null hypothesis can only be rejected if the results are significantly positive or negative, thus, verifying if corporate unbundling is a trivial or non-trivial issue on the jse. the parent spin-offs show a continuous significant outperformance over their matched firms with bhars of 10.56%, 21.25%, 42.5%, 31.57% and 49.06% for 6, 12, 24, 36 and 48 months after the x-date (table 2). like parent spin-offs, spin-offs show a continuous significant outperformance over their matched firms by 0.95%, 11.58%, 19.03%, 26% and 35.34% for 6, 12, 24, 36 and 48 months holding periods accordingly (table 3). furthermore, with the exception of x-6 holding period, a similar trend is depicted for sell-offs with significant positive bhars of 5.26%, 8.57%, 11.77%, and 16% for 12, 24, 36 and 48 months respectively after unbundling (table 5). therefore, the null hypothesis is rejected for parent spin-offs, spin-offs and sell-offs throughout all holding periods after unbundling, except for x-6 holding period for sell-offs. these significant results mean that corporate unbundling on the jse is not a trivial issue, and that it unlocks shareholders’ wealth. this performance is consistent with the study on long-run performance of spin-offs and their parents by bhana (2004) and dasai and jain (1999) in south africa and usa respectively. unlike parent spin-offs, spin-offs and sell-offs, parent sell-offs show a dissimilar performance trend with insignificant positive excess returns of 8.76%, 17.4%, 34.92% and 25.92% for 6, 12, 24 and 36 months respectively after unbundling (table 4). the only significant result occurred at 48 months after unbundling and it is significant at only 10% level. therefore, the null hypothesis is accepted for x-6, x-12, x-24 and x-36 holding periods and rejected for x-48 holding period. nevertheless, from table 6, spin-offs significantly outperform sell-offs for x-12, x-24, x-36 and x-48 holding periods with bhars of 6.32%, 10.46%, 14.23% and 19.34% respectively. sell-offs only significantly outperform spin-offs for 6 months after unbundling. hence, the research rejects the null hypothesis throughout all holding periods, except for x-6 holding period whereby spin-offs underperform sell-offs. the continuous outperformance of spin-offs over sell-offs may be due to a possible hidden agenda by parent sell-offs to completely transfer risky assets to the buyer. two years prior to unbundling, both the parents of spin-offs and sell-offs show positive bhars, but the parent sell-offs experience positive significant bhars of 40% (tables 2 and 4). the significant outperformance of the parent sell-offs over their matching firms prior to unbundling can be attributed to inside trading ahead of public announcement of sell-offs (bhana 2004). therefore, the announcement process of spin-offs can be more information efficient than sell-offs on the jse. tables 4 and 5 display that sell-offs performance is superior to that of their parents. the poor performance of parent sell-offs relative to their subsidiaries may be due to lack of investors’ confidence in the possibility of these companies to create wealth after the sell-off. for spin-offs after the transaction, both the parents and their subsidiaries share common facilities and this can explain why both the parent spin-offs and their subsidiaries continuously outperform their matching firms with strong positive results throughout all holding periods. however, compared to the parents, the stock market performance of their subsidiaries is always stronger potentially because the subsidiaries are smaller in size and are more focused than their corresponding parents (dasai & jain 1999:90). notwithstanding, the bhars for parent sell-offs become more and more positive with positive significant excess return of 40.34% observed for x-48 holding period. this research demonstrates that investors tend to value parent-sell-off companies over time. therefore, after a sell-off, investors’ confidence in the parents progressively increases with time. unlike parent sell-offs, sell-offs show significant outperformance due to the ability of the buyer to integrate the assets in the business. furthermore, the study provides a direct comparison in share price performance between spin-offs and sell-offs (table 6). according to the adjusted returns results, spin-offs significantly outperform sell-offs from 1 year and up to 4 years after unbundling. sell-offs only significantly outperform spin-offs for 6 months after unbundling. under unadjusted returns basis, spin-offs outperform sell-offs for all holding periods and significantly outperform sell-offs for x-6 and x-48 holding periods. overall, restructuring through a spin-off on the jse unlocks shareholder’ value better than a sell-off. unlike bhars, mrrs simply demonstrate the performance of unbundling on an unadjusted basis. therefore, the performance of an event firm relative to an average company is not considered by this measure. both the mrrs and the bhars are derived from buy and hold returns. unlike the bhars, mrrs give the exact position of the company at a particular time without considering the position of an average company operating in the same sector or industry. in a nutshell, the mrrs of an event firm can be very poor, but when the bhar measure is used the firm may still hold a better position than an average company belonging to its sector of operation or industry. mean raw returns are considered to a limited extent since the essence of the research is to compare the performance of companies that restructured with those which did not restructure. overall, the mrrs are positive throughout all holding periods for both samples. the mrrs are weaker relative to bhars, with only spin-offs and parent sell-offs showing strong positive mrrs from 1 to 4 years after unbundling. spin-offs show strong positive mrrs throughout all holding periods. according to these results, on average spin-offs and parent sell-offs do well after unbundling on an unadjusted basis. spin-offs’ performance is outstanding following adjusted and unadjusted performance for 4 years after unbundling. parent spin-offs and sell-offs appear weaker relative to spin-offs and parent sell-offs under mrrs measure. however, parent spin-offs appear better in performance with significant mrrs observed for x-6 and x-12 holding periods. on non-adjusted basis, spin-offs only significantly outperform sell-offs for x-6 and x-48 holding periods. while the findings of the study are not consistent with those by majoni et al. (2014) on the jse who found negative abnormal returns for 250 and 500 days after spin-offs and sell-offs, they are consistent with the general trend of corporate unbundling performance. conclusion this study has extended the traditional investigation horizon of 3 years to 4 years after unbundling in sa. even on the international scale, most studies are limited to 3 years after unbundling. the paper complements the study by bhana (2004) by providing a longer term horizon in investigating the performance of spin-offs and sell-offs on the jse. the results of the study show that spin-offs, parent spin-offs and sell-offs significantly outperformed their matching firms from 1 year and up to 4 years after unbundling. parent sell-offs only experienced a significant bhar in the 48 months holding period after unbundling. again, only the parent sell-offs showed a significant bhar for 2 years prior to unbundling. according to the study, the parent sell-off companies traded ahead of public announcement and this has a transfer effect on sell-offs performance, making sell-offs less market efficient than spinoffs. overall, the study provides that corporate unbundling unlocks shareholders’ value. the strong positive abnormal returns imply that shareholders should take a major step and unbundle unwanted business divisions or subsidiaries that are rent-seeking and less productive. in essence locked wealth by this unproductive division or subsidiary is released and, the entire business becomes focused on its core competence. this study recommends conglomerates to embark on corporate refocusing through spin-offs and sell-offs. the complex nature of big companies may put in a diversification discount due to assets’ under-utilisation. corporate unbundling is undertaken by corporations for several reasons. most often, sell-offs are considered as a means to create cash for other investments or to pay back a company’s debts. therefore, though spin-off has been placed as the first priority on the jse by the research, some companies in need of cash will still refocus through asset sale and especially when they find such assets unprofitable to them. the parent sell-off sample of the research could only show significant outperformance over their matched counterparts for just 48 months post unbundling. for 6, 12, 24 and 36 months after unbundling they show positive bhars which were not significant. therefore, companies willing to downsize their business through sell-off should take necessary steps before the event. nonetheless, the limitation of this study is that the matching firm procedure may not provide results that reflect the whole jse limited, since the event firms are matched to specific firms. this is the main advantage of using a market index (all share index) which constitutes the average performance of companies on the jse limited. considering the growing trend of corporate spin-offs and sell-offs, research on market efficiency of these restructuring strategies should be prioritised. future research should focus on how efficient spin-off and sell-off transactions are around announcements and post-restructuring. acknowledgements the authors would like to thank the university of south africa for funding this research. competing interests the authors have declared that no competing interest exists. authors’ contributions all authors contributed equally to this work. funding information a bursary was provided for this research by the university of south africa. data availability statement the authors confirm that the data supporting the findings of this study are available within the article. disclaimer the views expressed in this article are those of the authors and not those of the university of south africa. references alexander, g., benson, p. & kampmeyer, j., 1984, ‘investigating the valuation effects of announcements of voluntary corporate selloffs’, the journal of finance 39(2), 503–517. 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residential water supply, and an increasing block tariff has been introduced allover the country. water is a necessity, but for most households the marginal consumption is used for less important options. this must be reflected both in the water demand and in the pricing policy. this article introduces three different welfare functions, all including a group of rich consumers and a group of poor ones. the standard additive utility welfare, the weighted utility welfare and the rawlsian welfare function are all used. for each of them the block tariff system is used to fmd the maximum welfare. we also discuss how the 'water for free' policy affects welfare, and how to set a low price segment or a free amount of water and the block tariff in each case. for each tariff system we also do comparative statistics of the parameters to study how changes in the policy approach will influence the optimal water tariff system. in conclusion the article explains how the choice of pricing policy can reflect the underlying welfare considerations. jel q25, d63, h42 introduction in most countries, water pricing has been determined mainly on the basis of financial or accounting criteria. however, in recent times there has been growing emphasis on welfare economic considerations in order to produce and consume water efficiently, while conserving scarce resources, especially in developing countries. a great deal of attention has been paid to the use of marginal cost pricing policies in the water sector, where the w orid bank has been one of the spokesmen for marginal cost pricing, eradication of subsidies and privatisation. yet there are almost no applications of marginal cost pricing r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 355 in the water sector. on the other hand, increasing block tariff (mt) pricing structures are now the preferred tariff structure in developing countries. there are several reasons for this pricing policy. a minimum supply of water is part of the basic needs, and access to water is a main source of conflict in many areas. however, more important is the situation where water supply is an important political issue, linked to the problems of extreme income inequality in many developing countries. a system where the willingness to pay determines the distribution of fails to operate in an acceptable way if large parts of the population have inadequate money incomes to buy basic goods. this situation is the background of this article that focuses on the distribution of residential water. water for irrigation or manufacturing is not addressed. increasing block tariffs in different fontis are a mainstream approach to address problems of unequal income distribution. this article studies the welfare implications of this tariff system. the ibt system has been used as a measure to support fair access to water, but there appear to be very few studies of the welfare implications of this system. a residential water pricing system can be used to promote a number of objectives or criteria. the objectives can be economic efficiency, equity and fairness (which includes fair allocation of costs, assurance of price stability and provision of a minimum level of service to meet the basic water needs of those who cannot afford the full cost). criteria like revenue sufficiency, tariff structure simplicity and resource conservation can also be addressed. although equity is one of the generally recognised objectives, very few of the water demand studies reported in the literature discuss equity issues. rietweld et al. (2000) conclude that a two-part pricing structure with a unifonti price equal to the marginal cost of production, combined with a flxed access charge, would lead to an efficient allocation and that the ibt structure fails to achieve its aim of helping the poor in the case of salatiga city in indonesia. renzetti (1992) flnds that implementing a revenue constrained two-part price, which consists of a fixed charge to make up a deflcit and a marginal price based on off-peak short-run and peak long-run marginal costs, results in an overall increase in welfare compared to average cost pricing. the starting premise for renzetti, however was that marginal cost pricing will maximise social welfare. eberhard (i 999) also points out that renzetti's method fails to analyse welfare distribution between households, a topic that is important in a developing country context the question of how the choice of welfare function influences the decisions on how to arrange the ibt system needs to be addressed. this brings ethics into the discussion of efficient and just water pricing tariff planning. eberhardt (1999) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 356 sajems ns vol 5 (2002) no 2 reviews many other aspects of the discussion on water and welfare. the marginal cost of water supply will differ in the short and the long run, and there is no common understanding of which definition is suitable for purposes of analysis. this discussion follows later, for now it is assumed that water is supplied with a constant marginal cost. in an ibt, it is not defmed how deficits of the water utility will be funded, and possible market distortions from the funding (like from a tax wedge) can influence the welfare analysis. this problem is also left for later. this does not indicate that these questions are unimportant but, the discussion will concentrate on the effects of the ibt, and to do so, the environment of the model must be made as simple as possible. the organisation of the paper is as follows: the next section briefly describes the background on south africa water policy and section three presents the basics for the models used. the fourth section demonstrates the welfare maximising policy suggested by three different welfare functions. two sections subsequently discuss how the model results are influenced by different sets of assumptions. to conclude, a discussion of some possible policy recommendations from the analysis, follows. the south african context south africa's water resources are limited and, in global terms, scarce. south africa's average rainfall (470 mm p.a.) is just over half of that of the world average. the situation is worsened by population growth and the demands of a vibrant economy, and compounded by inequities in allocation based largely on racial grounds and inefficiencies in use. water resources in south africa are not spread evenly across the country. the country suffers also from severe periodical droughts and floods. most of the big cities and industrial centres of the country are situated far from big rivers, in several river catchments the water requirements exceed the natural availability of water. the available water resources are insufficient to meet projected demands at current usage and price levels within the next 30 years (dw af, 1997b). these water resource characteristics will exert a strong influence on the development of a water pricing policy in south africa. south africa is shifting from supply-side management to demand-side management and water pricing is playing a key role in managing the water resource in an equitable, efficient and environmentally sustainable manner. water pricing can be used to assist in the allocation water between towards uses and users, to encourage the more efficient use of water and also promote the sustainability of the water resource. as stated in the 1997 white paper: r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 357 there is a limit to the development of new dams and water transfers that we can afford or sustain. our present use of water is often wasteful and inefficient and we do not get the benefits we should from the investments in our water. water conservation may be a better investment than new dams. we will have to adopt such new approaches to water management if our aspirations for growth and development of our society in the 21st century are not to be held back as a result of limited water resources (dwaf, 1997a: 23). with respect to water pricing and equity, the same paper submits: it is important that the introduction of realistic pricing lor water does not further penalise disadvantaged communities who were already penalised during the apartheid era. white communities were given a strong economic advantage under apartheid through access to cheap water, while economic development in black communities was restricted by a variety of factors, one of which was lack of access to affordable water. in the interests of equity and social justice, this aspect will have to be considered in the question of water pricing. the price to be levied for water reserved to meet basic needs must merit particular attention (dwaf, 1997a: 23). the south african standard on a "basic" level of water supply, sufficient to promote healthy living, draws on the world health organisation standard of 25 litres per person per day. this is equivalent to about 6000 litres per household per month for a household of eight people. this volume of six kilolitres has been set as the basic target for all households in south africa and government has decided to ensure that poor households are given a basic supply of water free of charge. there is no commonly accepted definition of poverty in south africa and local governments will have an important role to play in defining local poverty indicators and identifying which households fall within the local definition (dw af, 2001). in 2002, a combination of rising block tariffs, often with a low rate for the first block, and targeted rebates to poor households is used in south africa to provide pro-poor subsidies. the basics of the model we specify a model with three decision levels. the local government sets the rules for a water utility, which supplies water to the consumers. since we analyse issues of equity, we concentrate on the short-run market for residential r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 358 sajems ns vol 5 (2002) no 2 water consumption. the long-run investment decisions and the water consumption of agriculture and industry are beyond the scope of this study. we simplify the consumer group to two representative ones: one rich consumer, and one poor consumer. for many markets, including south africa an increasing block tariff (mt) is used for pricing residential water consumption. to simplify, we use an mt with two steps: a low price segment, and a high price segment. the local government the local government sets the rules for the water utility. first it specifies the welfare concept to be used for its policy. second, it sets an objective for the management of the water utility. third, it decides on the budget constraint for the water utility by setting the access fee for each consumer group and also the surplus/deficit restriction for the utility. the social welfare function throughout the analysis we use the marshallian consumer surplus (cs) (less the water bill) as a measure of utility for each consumer. however, since each consumer pays an access fee, this must also be deducted from the cs. we specify three main approaches to welfare, the utilitarian, the weighted utilitarian and the rawlsian approaches. the local government must decide on which one of them to use for their water policy. utilitarianism utilitarianism originated in the writings of david hume and jeremy bentham and found its most complete expression in john stuart mill's writings. classical utilitarianism declares that society's welfare should be represented as the sum of the utilities of different individuals. utilitarianism makes use of a social welfare function that measure social welfare, w. the objective of a social decision maker (if one were to exist) should be to maximise w (perman, ma, mcgilvray, 1996: 30). an egalitarian additive utilitarian social welfare function is specified as (1) where ljp and ur denote the utility of the poor group and the rich group respectively. sub or superscript p is used throughout the paper, for the poor group and r for the rich group. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 359 weighted utilitarianism the utilitarian social welfare function is a special case of a weighted utilitarian social welfare function where the individual weights are equal. the weights detennine the relative importance attached to individual utilities in determining social welfare, and must be set by the local government. the distributional weight appropriate for anyone member of a group is the same as the weight of every other member of the same group. the weighted utilitarian social welfare function is an additive function of individual utilities, so that w = aup + (l_a)ur, (2) where a and (\-a) denote the weights used in summing individual utilities to an aggregate measure of-welfare (perman, ma, mcgilvray, 1996: 30). rawlsianism rawls' objection to the ethic of classical utilitarianism is based in the claim that: by being indifferent to the distribution of satisfaction between individuals (and only being concerned with the magnitude of the sum of the utilities), a distribution of resources produced by maximising utility could violate fundamental freedoms and rights which are inherently worthy of protection (perman, ma, mcgilvray, 1996: 34). rawls asserts that if people had to choose principles of justice from behind a "veil of ignorance" that restricted what they could know of their own position in society, they would not seek to maximise overall utility. instead they would safeguard them against the worst possible outcome, first, by insisting on the maximum amount of liberty compatible with the like liberty of others; and second, by requiring that wealth is distributed so as to make the worst-off members of the society as well-off as possible (the so-called difference principle): "[s]ocial and economic inequalities are to be arranged so that they are both (a) reasonably expected to be to everyone's advantage, and (b) attached to positions and offices open to all" (rawls, 1992: 60). economists frequently attempt to infer what the difference principle would imply for the nature of a social welfare function (swf). solow argues (perman, ma, mcgilvray, 1996: 35) that a rawlsian swf for a society of individuals at one point in time is of the so-called max-min form, which for two individuals would be w min {up, if}. (3) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 360 sajems ns vol 5 (2002) no 2 the residential water demand consumers are the fmal users of water. this study concentrates on residential water demand, i.e. demand for general consumption in the households. hewitt (2000: 265) suggests that we can break down household demand for water into indoor and outdoor uses. it is also generally argued that internal water uses (washing, drinking etc.) are inelastic to changes in water tariffs relative to external uses (car washing, lawn sprinkling, gardening etc.). indoor uses are collectively known as basic needs/requirements or hygiene uses, while outdoor uses can be collectively termed recreational uses. munasinghe (1992: 253) argues that "... many poor communities already consume only the bare minimum volume for basic human needs and would not be able to cut back on consumption to any appreciable extent." is price elasticity a function of household income? table 1 shows some empirical findings, mainly from developed economies. table 1 the price elasticity o( demand (or total short-run water use in various international studies researcherls ~ location price elasticity carver and boland ashington d.c. -0,1 agtbee and billings 1974 tucson,arizona -0,18 martin et al 1976 tucson, arizona -026 hanke and de mare 1971 maimi), sweden -015 boistard 1985 france -017 thomas and syme 1979 perth, australia -0,18 veck and bill 1998 alberton & thokoza, -0,17 south africa veck and bill (2000) a study of renwick (1996) estimated price elasticities of -0,53 for low-income, -0,21 for middle income and -0,11 for high-income groups, i.e. the lower the income, the more elastic the demand curve. veck and bill (2000) reported estimates from south africa as shown in table 2. we have to keep in mind that demand elasticities from the developed world are only of limited use because the consumers represent only the wealthier end of the consumer range, munasinghe (1992: 253). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 361 table 2 the price elasticity of demand (ped) for indoor and outdoor water use grouped by income description of group ped indoors ped pedtotal outdoors upper income group -0,14 -0,47 -0,19 middle income group -0,12 -0,46 -0,17 low income group -0,14 -0,19 -0,14 veck and bdl (2000) we observe that outdoor water use in upper and middle income groups is more elastic in demand than the rest of the consumption. to model this in our study, we split the consumer in two typical groups, the rich and the poor. in our theoretical approach we apply this by assuming the demand from the rich group as larger and with a less steep slope of the demand curve. in some cases this is modified this by assuming that both groups of consumers have the same marginal willingness to pay for the first litre consumed. the short-run demand structure a short-run partial equilibrium model is used, with the price of water the only variable affecting domestic water demand. one rich and one poor consumer represent the two groups, and they are both considered as single rational decision-making units; both are utility maximising and have a finite budget. both utility functions are quadratic, which generate linear demand curves. following the above discussion, we assume that the demand curve of the poor consumer is more price inelastic than the demand curve of the rich household, and of course the demand of the poor consumer is smaller than for the rich one of any price of water. each of the two households has its own metered connection. this assumption rules out the problem of indirect purchasing. based on our assumptions we can specify two inverse demand functions, both linear: i=p, t, (4) denoting pi for the price and xi for the quantity consumed. we assume that ex,. ~ a.,., and ~p > ~r • if so, the demand curve of the poor is always below the one of the rich, and its slope is steeper. we shall later study specifically the situation with ex,. = a.,.. figure 1 shows the demand curves for the two groups of the households. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 362 sajems ns vol 5 (2002) no 2 figure 1 the demand curves of tbe two groups p dp,.(x)/dx= -p, x the supply of water water is supplied by a water utility. the utility supplies water at constant marginal costs, c, and an additional fixed cost, f. both seem reasonable for the short-run supply. the utility's production objective (set by the local government) is to maximise welfare, for a specified budget constraint, and a fixed monthly access fee for each group also set by the local government. we assume that the utility has full information of the demand structure of each group. the water utility uses a two-step increasing block tariff pricing (ibt) where the first block is given to the households at a low price (lower than the marginal cost of supplying water), while the price of the second block is set to satisfy the budget constraint for the water utility. the two-step increasing block tariff pricing implicates that water utility on the margin can price discriminate between the two households. this means that the water utility must be able to prevent arbitrage among them. the consumption in the first block is charged with a per unit price that is lower than the marginal cost while the per-unit price of the second block is set to fulfil the budget constraint. the structure is combined with a non-use component: a fixed monthly charge, a tariff for the privilege of having water on tap, i.e. an "assurance of supply" charge. the income these tariffs generate supports the fixed cost of water supply. the fixed tariff of the poor household group is lower than the one of the rich because the fixed tariff is based on level of income. we concentrate on the situation where the poor group is restricted by the price step and consumes exactly the low-priced quantity, x. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 363 the three approaches to welfare applied for the water market three different welfare concepts, utilitarian, weighted utilitarian or rawlsian may be used. first, we study the difference in the optimal solution due to the choice of welfare approach. in the following sections the welfare-maximising ffit water pricing structures, the related optimal solutions generated by these three different welfare approaches and their characteristics are discussed. the study commences with the utilitarian social welfare function, followed by the weighted utilitarian and rawlsian social welfare functions. . the utilitarian social welfare function the utilitarian social welfare function used here maximises the sum of the consumer surpluses of the two household groups. the water utility is not concernned about the distribution of the water between the two groups. on the other hand, one of the very objectives of increasing block tariff pricing is to redistribute water from the rich to the poor. the question is: how will the water utility distribute the water and what kind of an ibt water pricing structure will be used, if the utalitarian social welfare function is maximised? the maximisation problem of the utility can be written as follows, by using the welfare function (1) and substituting for the market demand from equation (4): max wv csp -ip +cs, 4 = oix{ iip -~px pi)dx -ip + )(,pl,p2 of"r {a. -~,x)dx p2xr + (p2-pi)x-4 = ilpx ~px2/2 pix -ip + {ct, -pdl2p, + (p2 pi) x t" (5) with the budget constraint written as: (6) the notation used is: x the size of the first block xt = (0.,. p2)/~r = the demand of the rich household group when the price is p2 pi == the per unit price in the first block p2 == the per unit price in the second block tp == the fixed charge for the poor household group r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 364 sajems ns vol 5 (2002) no 2 t,. the fixed charge for the rich household group c "" the marginal cost f = fixed costs m = surplus requirement for the water utility (net budget allocation from the government for the water supply). for convenience, the surplus for the lump-sum transfers to the utility, s, is set as: (tp + 4) f m = s. (7) these assumptions and notation are also used in the cases of weighted utilitarian and rawlsian social welfare functions. solving this problem yields, the first-order conditions for maximum welfare are pzlj .. c x, '" (0..c)/i3" xu", xp = (up c)/l3p pl lj = c sl2x = cs/y2(ap c). (8) (9) (10) (11) it is not obvious that pi ~ p2. howeverl , it is assumed that pi ~ p2 and also that ~ < «(l-pii2~i' a non-negative s, which means a non-negative net lump-sum cash flow to the water utility, yields pi ~ p2. it is concluded that marginal cost pricing is always optimal for the rich group, while the price of the first step pi < p2 for s >0. the optimal solution is found where the marginal utilities for both groups are equal to the per unit price of water. for s = 0, both groups shall pay the same price, which in tum is equal to the marginal cost. it follows that in this case the per unit prices in both blocks are the same, and the ibt pricing structure is converted to marginal cost pricing. welfare maximum will then be (12) while xp and xr are imaffected. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 365 the weighted utilitarian welfare function now, let the water utility set different distributional weights for the consumer surpluses in its social welfare function. social welfare is defined as a weighted sum of the consumer surpluses. the distributional weights express the relative social values of increases in the water use. the distributional weight appropriate for anyone member of a group is the same as the weight of every other member of the same group. in the case of unitary weights, the same optimal solution as in the case of the utilitarian welfare function is obtained. again, we have simplified with two consumers. if the water utility gives a distributional weight equal to zero to the rich household and a weight equal to unity to the poor, we tum to the rawlsian social welfare function studied in the next section. we assume that the decision-maker has a larger distributional weight for the consumer surplus of the poor than for the one of the rich, and neither of the distributional weights equals zero. the sum of the distributional weights is equal to unity, l>a>l-a>o => i> a> 0.5, where a = the distributional weight of the poor household i a = the distributional weight of the rich household. now, the maximising problem of the water utility can be written as (13) max ww a(o.px vz~px2 pix t,) + (l-a)[(o., pd/2i3,+ <p2 pl)x t,.] (14) x,pl,p2 and the equations (6) and (7) still constitute the budget constraint. however, for simplification, it is assumed that s = o. maximum welfare is similar to the utilitarian case, and the first order conditions yield x '" 0 or a. = -\12 , and for x >0, pi w = {(2a-l)[2a2o./ -[[(2a-l)3a.r8a2(a-l)a.p]+(6a2-6a+ 1)c]cji3,2 -4a2[(2a-l aa.,+[(4a2 -2a-l)a.p -2a(2a-l)a., -2ac]c ]~p~, (15) +[2a2(2a-l)(a:".c)2] 13/} i (16) {[(2alil3r-4a2f3p][4a2o.p (2a-l)2o.,(4a-l)c]~,} p2 w = [(2a 1)(2aa.p c)~ 2a(3p«2a 1)0.,+ c)] / «2a 1i~4a2f3p) (17) xw =xp=[(2a-lia.,-4a2a.p+(4a-i)c]/[(2a-lip,-4a2pp]. (18) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 366 sajems ns vol 5 (2002) no 2 maximum welfare in the case of the weighted utilitarian social welfare function. however, this supplies hardly any information. the rawlsian social welfare function now we turn to a rawlsian welfare function. rawls' 'difference principle' states: "[s]ocial and economic inequalities are to be arranged so that they are both (a) reasonably expected to be to everyone's advantage and (b) attached to positions and offices and open to all." (rawls, 1971: 60). in other words, an unequal distribution is only just if all persons benefit from the allocation. in this case, it means that the water utility's welfare maximisation problem is reduced to maximising the consumer surplus of the poor. the welfare maximising problem of the water utility can thus be written as max [csp-tp] '" a.px • %13,x2. pix-lp, x, pi, p2 (19) still with the budget constraint of (6) and (7), and s = o. solving the maximisation problem yields the first order conditions ( for x > 0), pi r [(2ap2. (0.,.+ e)c)i\4~(apa,.+ (3ap2a,.2e)c) + 2pp 2(0.,.e)2/prj/ [(p,· 4~)(4apa,.3c)] and the optimal size of the first block is xr (0.,.4ap+ 3e)/ (pr4~). the welfare maximum will be (20) (21) (22) comparing the increasing block tariff (lbt) price structures next, the three different welfare maximising ibt water pricing structures may be compared and differences between them discussed. subscript u is used to notate the utilitarian, w the weighted utilitarian and r the rawlsian case. it is possible to demonstrate (see appendix) that the lbt structure for the three approaches will be as in figure 2. the utilitarian case has a similar price for both steps, the rawlsian a relatively small first step volume, combined with a r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 367 low price and a large price difference to the second step, and the weighted utilitarian approach is in between these two extremes. figure 2 the optimal increasing block tarijj for three welfare specifications p !................. . ......... rawlsian weighted uti1itarian c : i -+-\ ......... j i i . x the quantity of water consumed by the poor group is largest in the pure utilitarian case. for the two other cases, the water utility sets the per unit price in the first block lower than the marginal cost. observe how both the size of the low price segment and the price step differs for the three regimes. the comparative statics of the model now we turn to comparative statistics of the model. we want to fmd the effect of shifts in the parameters of the model, and how they will influence the endogenous variables in the different regimes. for this purpose it is convenient to simplify the model by setting <xp = <xr = <x, and s = o. the four parameters: ~ p" c and a can be shifted. decreased /3p while <x is constant, renders the demand curve of the poor more elastic, while the demand also increases. this can reflect a situation with better access to water for more than basic consumption, like a switch from bulk supply or a communal tap to an indoor tap. decreased pr means that the demand of the rich group is more elastic and increased, which can reflect that the rich group has easier access to outdoor use of water. the effect of increased c reflects higher marginal costs for the water utility, like a new pipeline system with higher maintenance costs per unit of water delivered, and funded by the utility. increased a reflects a higher degree of redistribution r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 368 sajems ns vol 5 (2002) no 2 by use of the water market. a justification of the assumption of equal a for both groups can be that this will reflect that the willingness to pay for the basic delivery of water is equal for both groups. the calculations are reported in the appendix, and figures 3 to 6. we denote uswf for the utilitarian case, wuswf for the weighted utilitarian case, and rswf for the rawlsian case. figure 3 tbe effect on the ibt price structure from increased price elasticity of tbe demand of the poor consumer group mt after cbange ......... original mt structure x figure 3 demonstrates that for both the wuswf and the rswf, the low-price segment will increase while the price difference between the two steps decreases for a more elastic demand of the poor. we also observe that the price of the first segment increases. the standard uswf is of course unaffected, since there is no price difference in this case. however, the increased demand of the poor will results in a larger total consumption. turning to the case of a more elastic demand for the rich group, it can be seen from figure 4 that the effects are now opposite to those of the former case. a smaller and cheaper first step is the result, while the second step is priced higher. still, the results are only valid for the wuswf and the rswf case. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 369 figure 4 the effect on the ibt price structure from increased price elasticity of the demand of the rich consumer group p mt after cbange .-....... original mt structure c x increased marginal costs are demonstrated in figure 5. the first step is more restricted, and the price of both steps increases. increased c restricts the option for redistribution. the increased c works this way for the wuswf and rswf cases, while for the uswf the price and the consumption are restricted for both consumers. figure 5 the effect on tbe welfare optimising mt pricing structure of increased marginal costs of supply p mt after change __ ........... original mt structure ch+---a"-""'"------in the weighted utilitarian social welfare function we can also increase the distributional weight of the poor consumer, a. if so we are moving towards the rawlsian situation. not surprising, the price difference between the steps increases, while both the volume and the price of the first step decrease. in some r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 370 sajems ns vol 5 (2002) no 2 way we can say that the subsidy to the poor is concentrated. as shown in figure 6. figure 6 tbe effect on tbe welfare optimising ibt water pricing structure of increased distributional weigbt of tbe poor consumer group p the budget constraint of the water utility ibt after cbange original !bt structure x as reported earlier, the budget restriction set to the water utility is important for the price of the first block. the important variable to study this effect is s = fp+t,.-f-m, which is the net lump sum transfer to the utility, i.e. the allowed deficit for its running operations. if the fixed costs, f , and the surplus claimed by the local government, m, exceed the access fees, the water utility is running a deficit. for the utilitarian case it was found that pl u = c sl2x'= csj3pl2(ap c), 24 which implies that for a negative s, the price of the first block must be higher than for the second one. a negative s reflects a situation where the water utility must support the budget of the local government more than what it recovers from its net lump sum income less its constant costs. it will always be preferable for the utility to recover the money by use of increased access fees. if funded from sales, in this case the first segment of consumption shall be most expensive, pl>pz' this means that a local government, when requesting the water utility to support the local budget, also compels the utility to charge the poor more than the rich for water. however, this may force consumers in the poor group out of the fonnal market. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 371 this model may be used to study the effect of changes in s in the other two cases as well. to emphasise these effects, the demand side is simplified by setting up= a.. = a. > c. it is also assumed that tp and t. are both constanr, and an increased s is interpreted as a smaller surplus claim set on the water utility. the calculations are reported in the appendix. solving the models for this case does not change the optimal size of p2 and x. however, the price of the first block, ph will decrease for increased s in both the weighted utilitarian and the rawlsian case. it is concluded that, if the local government wants to fund its budget from a surplus from the water utility, the utility will react by increasing the price of the low tariff block. discussion and policy implications this study offers some quite straightforward results for how the water utility will react to outside shifts, while maintaining its policy of maximising the aggregated welfare of households. the utilitarian approach to welfare allows limited scope for a policy of redistribution. this welfare function attaches equal welfare value to each rand spent, and this is reflected in the reactions of the water utility. on the other hand, the weighted utilitarian approach to welfare sets a higher value to the consumer surplus of the poor group. this reflects their higher marginal welfare from increased water consumption compared to the rich group, and also the inequity in income distribution. the rawlsian approach emphasises the poor group, but even in this case the water utility must remain within its budget constraint, and ensure that water must be sold to its consumers. some important policy implications arise from this analysis. first, using the utilitarian approach has demonstrated that this approach always yields marginal cost pricing as the optimal solution for all consumers. the first step pricing is only adjusted for lump sum transfers needed to cover fixed costs, or to distribute lump sum transfers. this supports the mainstream rules of thumb for this approach to welfare analysis. the utilitarian approach is mainly a focus on efficiency in the water supply, while redistribution and equity are not addressed. the two other approaches yield more detailed policy implications. figure 2 reveals that both the size of the first step quantity and the price difference between the two steps are influenced by the choice of welfare approach. the rawlsian approach leads to a small low cost quantity, and a big price step, while the weighted utilitarian approach is somewhere between the other two. the policy of an 'increasing block tariff' is supported by the analysis as a welfareimproving way of water distnbution. although 'water for free' is usually not the r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 372 sajems ns vol 5 (2002) no 2 best policy it is generally better to have a positive price in both segments it is possible to include a free quantity by using a welfare function with strong emphasis on a small, extremely necessary supply of water. marginal costs for the aggregated supply is an important part of the factors deciding the price set to the rich consumers for all three approaches. this opposes 'historical costs' as a main decision rule for the supply of water. in the long run, all variable costs shall be included for all consumers. increased variable costs due to increased supply will affect all consumers equally in the short run, and not only the new participants in the market. this study allows an evaluation of the effects of a strong emphasis on poor households. figure 6 shows that this will lead to an increased price for the rich consumer, and that this policy is supported by economic welfare considerations. government must remain aware of changes in the demand structure. better access to piped water through private taps will probably increase the use of appliances for the poor consumer, and this will influence the pricing policy of the water utility. a less steep demand curve for the poor implies less price discrimination between the two steps, while the volume of the low price segment will increase. alternatively, a more elastic demand for the rich consumer will be reflected in a more discriminating price policy towards this group. knowledge of the demand structure of the groups of consumers is essential to model the optimal market policy of the water utility. it is not enough to know the cost structure of the water supply; the demand side must also be considered. the lack of data on the consumer demand structure poses a significant problem for the government. it seems dangerous to allow the local communities to run the water utilities with a surplus. there are two reasons for this: first, an access fee can keep the poor group out of the market for water. second, the price of the first block is a major way of funding lump sum transfers, and if the surplus requirement of the water utility is large, this will undermine the low price for the first segment. the discussion focussed on the marketing of residential water for a water utility. the emphasis was mainly on short run effects, where the fixed investments are more or less sunk costs. the model can also supply arguments for a discussion on how to fund the fixed investment costs. the welfare distortional loss from governmental funding must be compared to the loss from funding the investment cost from the revenue of the water utility. the conclusions build on many simplifying assumptions. further developments become possible by relaxing one or more of the assumptions. increasing marginal costs, instead of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 373 constant marginal costs may be used. it was assumed that the poor group only consumes exact the low priced quantity. the lump sum transfers were simplified. the access fee of the poor group, tp, may exclude them from the market, and a discussion of this is required. in the last part of the paper, demand curves were used, where the marginal willingness to pay for the first litre of water is equal for both groups. this is a fruitful simplification, but other assumptions can also be discussed. the demand structure of the two groups can be more realistically modelled. the linear demand curves approach demonstrates that the demand structure is important for the re-distributional effect of the water market. only two groups and two different price steps were included. this probably illustrates the principles, while a multiple step approach probably is better for practical water management. and, of course, the different welfare functions can be used. the three used in this study demonstrate that welfare considerations are important for a water pricing system, and this is on its own warrants further discussion. endnotes pi > p2 if s < 0, i.e. if the sum of the lump sum transfers to the utility is negative. if so the first step quantity is priced higher than the second step, which is unrealistic for our discussion. the restriction to ~ is to ensure a positive consumer surplus (and hence a positive water consumption of each group). 2 it is obvious that an easy way to support the poor is by way of a lump sum transfer. decreased tp will work this way, and a negative tp will work as a pure transfer to the poor. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 374 sajems ns vols (2002) no 2 appendix solving the maximum problem of equation (s) (the utilitarian case) with the budget constraint (6) is easily done by use of the lagrangian: l = llpx y2ppx2 pixtp+ (a" p2il2l3r+ (p2pi)x 4j..{(p2 c)[(a" p2)/pr x] + (tp + tr) f 2(cpl)x s}. (ai) the variable a. denotes the lagrangian multiplier. the maximisation yields either x 0 or a. -i. for x = 0 the maximisation problem collapses to a oneprice budget constrained delivery, and we assume x > o. if so, the first-order conditions for maximum welfare are found as p2 u =c => xr = (a" c)/p" xu = xp = (apc)/pp pi u " c -s12x = cspp/2(ap c) setting s == 0 and substituting the results into equation (s) yields the variables xp and xr are unaffected. (8) (9) (10) (11) (12) the same exercise conducted for the weighted utilitarian case, maximising equation (14) with the budget constraint (6) is done the same way as above, but setting s = 0 yields the results of the equations (is) (18). so also for the rawlsian case, as shown in the equations (20) (23). to compare the prices and the volume of the frrst step in each case we start by comparing the price of the first block. we find from the equations (18) and (22): xw _ xr = {4(3a-l)(a-i)[p,(ap-c)-\3p(a,,-c)]} / {[(2a-lipr-4a2pp](j},.-4pp)}>o (a2) =:> xw > xr. we find from the equations (10) and (18): xw xu = [(2a:-li)(p,(ap-c) pp(arc»] i {[(2a-lipr-4a 2pp)]m < 0 (a3) =:>xw <xu. we conclude that the quantity of water consumed by the poor group is largest in the pure utilitarian case, and it is smallest in the rawlsian case. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 375 to compare the prices of the first block, we first find from the equations (11) and (20) pt -p1 u = pir c = [2(~,(up-c) pp(a.-c)ij / [(4flp-f3,.)(a.-4up+3c)]~r <0 (a4) ~ pltt<c if 4np ur 3c > 0, which must be fulfilled for x; to be positive. to find the difference between pir and p1w we use the results for the second block. first we find by use of the equations (17) and (21): p2 w -p2r = (2(a -1)[4aflp+~,(2a-l)][pp(a.-c)~,(up -cm / {[(2a-l)2f3,.-4a2j3pj(~r-4(3p)} < 0 ~p2w<p2r the difference (p2 w p2 u) is found by use of the equations (8) and (17) (a5) p2 w -1'2 u = p2 w -c = {2a(2a -l)[~,(up-c)-pp(clr -c)]}/{[(2a-l)2f3,.-4a2(3pj(f3,.-4j3p)}>o ~ p2w> c. (a6) as pl > p2w, we conclude that p2r > c. to compare the optimal per unit prices in the first block in the cases of the rawlsian and weighted utilitarian, we can calculate the difference between the ~ss revenues for the weighted utilitarian case and the rawlsian one, grr gr, grr grw = 4[j3,(up-c) -pp(clr-c)j2 [(2a-l)(a-l)(8a2-sa--l)j3? + 16a2(a-1 )2~/ -16a2(2a-l)(a-l)j3p~r] / (a 7) {~r[4a2~p-(2ai)2~rf(~r-4~p)2} > 0 ~ grr>grw if the gross revenue in the case of rawls is bigger than the one in the case of weighted utilitarian, the subsidies must be bigger too. this can be written as (a8) we know already that xr < xw. together with the equation (a8) this implies c1early that pt < p1w. the comparative statistics of the model are found by partial differentiation of the three optimal solutions with respect to the parameters ~, ~" c and a. the results are reported in the tables al-a4. as explained in the main text, we set up = ur = u, and s = o. decreased ~ or ~r indicates less steep demand curves, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 376 sajems ns vol 5 (2002) no 2 increased c reflects higher marginal costs of supply, while increased a reflects a stronger emphasis on the poor consumer. in the tables we denote uswf for the utilitarian case, wuswf for the weighted utilitarian case, and rswf for the rawlsian case. table al the effeds of decreased pp effectod uswf wuswf rswf axjal}p (ac)/13/>o 12(a-c)/(4l}p-13rl> 0 >0 oplla13p 0 2 -4a+ 1)13,](13.-4(j3,.+213p)(13.-~)(a-c)1 [313.(413 .. -13,ij > 0 table a2 the effects of decreased pr table a3 the effects of increased c >0 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 2 377 table a4 the effects of increased a (only relevant for the weighted utilitarian case) shifts in the budget constraint of the water utility are found by defining s = tp+tr-f-m, which is the net lump sum transfer to the utility, i.e. the allowed deficit for its running operations. a negative s reflects a funding of other budgets from a surplus from the water utility, and a negative shift in s indicates a smaller subsidy cum tax to the water customers. for the utilitarian case we found pi u = c sl2x = cspp/2( ap c), i.e. a pi u las <0. (11) for the two other cases we set for simplification a.p= a r = a > c, and we assume that tp and t,. both are constant. now, the weighted utilitarian model yields for maximum welfare pi = {(2a-i)[2a2(a-c)i3/+(2a2a+(6a2-6a+i}c}i3/] 4a2[(2a-l)a+2ac)]f3ppr} i (a9) { [4a2f3p (2a-lil3r] i [2(4a-l}(a-c)] } s, i.e. a pi u las <0. the rawlsian model yields in maximum pi = [4f3pj1,(a+2c}-2f3p2(a-c} -1>/(2a+c)] i [3i3.(4f3p-p,}] [(4i3p-pr) 16(a-c)] s, (alo) i.e. a plu/as <0. in both cases the coefficient for the effect of s is clearly negative due to the assumptions a>c, ~p>~" a ~ 0.5. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 378 sajems ns vol s (2002) no 2 references baumann, d.d., boland, lj. & hanemann, w.m. (1998) urban water demand management and planning, mcgraw-hill, london. 2 boadway, rw. & bruce, n. (1984) welfare economics, blackwell, oxford. 3 department of water affairs and forestry (l997a) national water policy for south africa white paper. http://wwwdwaf.pwv.gov.za!documents/policies/nwpwp.doc department of water affairs and forestry, pretoria. 4 department of water affairs and forestry (l997b) overview of water resources availability and utilisation in south africa. department of water affairs and forestry, pretoria. s department of water affairs and forestry (2001) free basic water provision: key issues for local authorities, department of water affairs and forestry, pretoria. 6 dinar, a. (2000) the political economy of water pricing reforms, oxford up, oxford. 7 eberhard, r (1999) supply pricing of water in south africa, palmer development group, wrc report no 678/1/99, cape town. 8 hewitt, j. a. (2000) "an investigation into the reasons why water utilities choose particular residential rate structures." in dinar, a., (ed.) the political economy of water pricing reforms, oxford up, oxford. 9 munasinghe, m. (1992) water supply and environmental management: developing world applications, westview press, boulder. 10 perman, r et al. (1996) natural resource & environmental economics, longman, harlow. 11 rawls, j. (1971) a theory of justice, (12th imp.) oxford up, oxford. 12 renwick, m.e. (1996) an econometric model of household water demand with endogenous technical change and demand-side management policies. phd stanford university. 13 renzeiti, s. (1992) "evaluating the welfare effects of reforming municipal water prices", journal of environmental economics and management, 22(2); 147-63. 14 rietweld, p., rouwendal, j. & b. zwart, (2000) "block rate pricing of water in indonesia: an analysis of welfare effects", bulletin of indonesian economic studies, 36(3): 73-92. is veck, g.a. & bill, m.r. (2000) estimation of the residential price elasticity of demand for water by means of a contingent valuation approach. a study undertaken in alberton and thokoza. wrc report no. 790/1/00, water research commission, pretoria. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . f:\ejour\ecoman\ftp\ecoman_v6_n1.prn.pdf sajems ns vol 6 (2003) no 1 25 managing hiv/aids in the south african workplace: just another duty?1 ________________________________________________________________ david dickinson wits business school, university of the witwatersrand ________________________________________________________________ abstract the vast majority of hiv and aids cases are located in sub-saharan africa. aids constitutes a critical threat to the development of south africa, yet the response to date has been slow and often confused. the research of ‘deco’ is examined to outline how the company approached hiv/aids. deco’s policies encouraged voluntary testing and counselling, openness and disclosure. different hiv/aids programme aspects that responded in a reactive and underresourced way and lacking access to managerial structures, had the opposite results. the very real value of aids volunteers’ contribution, is then described and evaluated. a new approach from both management and employees is needed in which a co-ordinated division of responsibility forms a key element in a workplace partnership to combat hiv/aids. jel j53, m14 1 introduction aids presents a major challenge to the creation of a prosperous south africa in which all citizens are able to fulfil their potential. yet the response to hiv and aids has been slow, fragmented, and often confused. at the heart of this failure lies a lack of effective national co-ordination (campbell & williams, 2001; marais, 2000; schneider & stein, 2001). beyond this however, the limited response from other sections of society is also striking. despite a clear economic case for intervention (booysen & molelekoa, 2002), business has largely failed to take a lead in this crisis. according to the south african business coalition on hiv/aids (sabcoha) (2002), the majority of companies have yet to assess the risk within their own workforces, let alone begin to mount a response to this risk. the medical research council (2001: 5-6) argues that south africa is experiencing an hiv/aids epidemic of “shattering dimensions” and that “the rapid change in the empirical death rates confirm predictions of the profound impact of aids on mortality.” it is becoming too late not to act. in seeking to sajems ns vol 6 (2003) no 1 26 respond – with or without a national framework – business can draw on guidelines, such as the nedlac negotiated code of good practice on key aspects of hiv/aids and employment (nedlac/department of labour, 2000). however guidelines such as the nedlac code, while valuable in terms of providing appropriate policy and objectives, do not guide business in terms of policy implementation. this requires a multiplicity of concrete actions, in often complex and localised environments. such actions take the organisation beyond the formal adoption of policy. as companies scramble to upgrade or introduce their own response to hiv and aids, the reality of the epidemic demands not only good policies be in place, but also that hiv/aids programmes in the workplace – and beyond – are effective. to date there have been few publicly-disseminated objective evaluations of workplace-based hiv/aids programmes in south africa. with the exception of the eskom ‘best practice case study’ (department of health, 1999) most reports on companies’ responses to hiv/aids have either been corporate publications written with public relations in mind (for example, anglo gold, 2002), or critiques written largely from an outside perspective (for example, meeson, 2000; meeson & van meelis, 2000). these sources of information are important and are to be welcomed, but they are limited in their ability to tease out the actual problems of implementation – policy vs. practice – in a way that will help improve workplace responses2. this paper draws on independent research within ‘deco,’ a large south african corporation. it examines the interplay of official policies on hiv/aids and the actual practices of hiv/aids programmes, thereby providing lessons on the implementation of hiv/aids programmes in the workplace. in doing so it also raises the question of how hiv/aids in the workplace should be approached. is hiv/aids simply another management duty that can be dealt with in a similar way to other management challenges? or is there a need for a different approach? 2 hiv/aids in the workplace the aids pandemic originated approximately twenty years ago. its origins are uncertain. at this stage the hi virus responsible for aids continues to spread. currently the highest levels of prevalence (infection) and the largest numbers of hiv+ individuals are in sub-saharan africa. it is likely that countries in asia will in time replace africa as the epicentre of the pandemic in absolute numbers. while knowledge of hiv/aids and its prevention is often good, there is frequently a failure or reluctance to act on this knowledge (williams et al, sajems ns vol 6 (2003) no 1 27 2000). where the primary transmission route is sex, infection is embedded within powerful human drives and resilient cultural norms. it has proven extraordinarily difficult to change behaviour with a view to reducing infection (unaids, 1999). despite this, understanding of hiv/aids remains central to any response3. hiv prevalence in south africa is measured by actuarial extrapolations of tests carried out in state antenatal clinics on an annual basis. because of the necessary assumptions required to generate a model representing the entire population, there is room for uncertainty over the exact levels of hiv infection. the trends, however, are clear. hiv infection among those sampled in the antenatal surveys has risen from 0,8 percent in 1990, when the studies were first started, to 24,8 percent in 2001 (department of health, 2002). the estimated incubation period of the hi virus in south africa is 6-8 years. given historical patterns of infection, large numbers of people are now showing aids symptoms and are dying (medical research council, 2001). the situation will continue to deteriorate as the peak of the aids epidemic is not predicted to occur for some years (actuarial society of south africa, 2000). a key concern for companies is that aids, because of its sexual transmission, affects those of working age. what percentage of employees are hiv+ is, however, unclear. this is largely because of the limited number of prevalence surveys conduced by companies to date (sabcoha, 2002), but also because of the reluctance of companies to release this data when it has been collected. johnson and budlender (2002) used prevalence data from four surveys, including one in a ‘large company,’ to evaluate hiv risk factors. they conclude that skilled and managerial employees are at low or very low risk, depending on the socio economic profile of their community, and that semi-skilled or unskilled employees are at medium or very high risk, again depending on the socio economic profile of their communities. the botswana-based mining company debswana survey of 74 percent of employees across its operations revealed a prevalence rate of 22 percent in 2001, with rates of over 30 percent for lower skilled employees (unaids, 2002b). anglo platinum (2002) reported in its 2002 annual report, in line with the king ii report (2002) guidelines, an estimated hiv prevalence rate among its employees of also 22 percent. hiv/aids impacts on companies in a number of ways and estimating the scale of these is complex (unaids, 2002b). the primary impact is on employee’s ability to work effectively as they become ill. this lowers productivity (of the individual and of co-workers) and raises absenteeism. replacement of workers that die from aids involves recruitment and training costs, in addition to lower levels of productivity before the new employee gains experience. other considerations, within the workplace, are the impact of aids illness and death sajems ns vol 6 (2003) no 1 28 on medical, insurance, and pension provision (rosen et al., 2000). outside the workplace there are implications for markets as expenditure contracts and shifts in relation to the impact of aids on individuals, families, and communities (barnett & whiteside, 2002). guidelines for responding to hiv/aids in the workplace (such as the nedlac code of good practice referred to in this article) balance prevention of hiv infection with care for those already infected. one of the central dilemmas in providing treatment is the cost of antiretroviral drugs. while employees on medical aid schemes often have access to managed antiretroviral drug treatment, those without medical aid schemes do not, nor are they generally in a position to fund such treatment directly. given the benefits for the company and individual of effective treatment, a number of south african companies have recently announced schemes providing antiretroviral drugs to their employees and, in some cases, dependants. 3 deco deco is a large south african corporation with over 25,000 south african employees. the company is divided into a number of major ‘divisions’ that operate in a number of diverse production processes. these divisions – some of which are divided into smaller ‘business units’ – are located within a small number of large industrial complexes. the largest division, in terms of employees, is its mining operation. deco’s management is predominantly afrikaans. an engineering background is strongly valued within the company. this technical orientation supports ‘hard’ workplace issues, such as health & safety, as well as providing formidable capacity for project development. by contrast, management tends to struggle with ‘softer’ workplace issues, such as employment equity. the company employs a large number of predominantly white skilled blue-collar workers, such as artisans. approximately 44 percent of the deco workforce is white (85 percent of management and 37 percent of lower grades). lower grades, such as miners and process controllers, are predominantly african. only 12 percent of the company’s workforce is female, distributed roughly equally between management and lower grades. the are three major unions operating in deco, two are affiliated to national federations, cosatu and nactu. these two unions represent predominantly black semi-skilled workers. their memberships are geographically distributed and high membership densities at different sites give both unions influence. the third union, solidarity, represents predominantly white members – much of sajems ns vol 6 (2003) no 1 29 deco’s skilled blue-collar employees – giving the union considerable power. five other smaller unions also operate within deco. 4 methodology given the nature of the research question – the practice of implementing hiv/aids programmes in the workplace – the methodological employed was both quantitative and qualitative in nature. a number of south african companies were approached for research access, but only deco responded positively. even here the company approached research access with caution and a comprehensive research and confidentiality agreement was negotiated. this caution was engendered in part by the sensitive nature of hiv/aids and the fear that research findings might prove to be damaging to the company. the company, and in particular members of its labour relations department (acting as ‘principals’ to the researcher), balanced this fear of negative publicity against the need to know what the company was doing in response to hiv/aids and whether it was effective – something that independent research would assist in doing. beyond this desire for internal information was a realisation that such research could be of wider benefit. the research consisted of a questionnaire sent out to all deco’s divisions and, in some cases, the business units within these divisions. the questionnaire requested basic details on the workplace and on the response mounted to hiv/aids within it. this latter aspect included asking respondents to evaluate their implementation of twelve aspects of best practice programmes drawn from the nedlac code of good practice. respondents had five levels of implementation to choose from, ranging from ‘no action taken or currently planned’ to ‘aspect complete’. these programme aspects (re-organised to assist analysis) are listed below. twelve programme aspects drawn from the nedlac negotiated code of good practice on key aspects of hiv/aids and employment • hiv/aids awareness programmes • promotion of condom distribution and use • provision of access to counselling for people affected by hiv/aids • education and training on hiv/aids • encourage treatment of sexually transmitted infections (stis)4 • enforce the use of infection control measures to ensure hiv is not acquired in the workplace • a ‘wellness’ programme for employees sajems ns vol 6 (2003) no 1 30 • monitoring, evaluation and review processes of hiv/aids workplace programmes • encouraging and offering voluntary counselling and testing (vct)5 for hiv • create an environment that is conductive to openness, disclosure and acceptance of hiv/aids among all staff • maximise the performance of affected employees through ‘reasonable accommodation’ • development of strategies to deal with the direct and indirect costs associated with hiv/aids in the workplace. because of company backing for the research, all questionnaires were completed and returned – representing 18 divisions and business units. nineteen observations were collected for the implementation of the twelve hiv/aids programme aspects as one business unit split its response over two geographical locations. given the different sizes of divisions and business units across the company, questionnaire responses reflect not the number of employees exposed to these programmes, but the scope of the various hiv/aids workplace programmes within the company. the questionnaires were then followed up by in-depth interviews with the senior human resources manager of divisions or business units and with the employees most involved with the workplace’s response to hiv/aids. these individuals occupied a wide range of positions within the company and included human resource managers, medical personnel, industrial social workers, industrial relations officers, corporate social investment personnel, a secretary, and production workers. in addition to raising qualitative issues these interviews shed light on the questionnaire responses. one key fact in this respect was that questionnaire responses were often optimistic in their evaluation of programme implementation. typically, the reported level of implementation might be occurring in some areas of the division or business unit but not in others. thus, analysis of these programmes in this article draws both on the questionnaire responses and the in-depth interviews. in addition to interviews with human resource managers and individuals implementing hiv/aids workplace programmes, in-depth interviews were conducted with representatives of the three main unions operating in deco and with a number of doctors employed by or contracted to deco. in total more than 40 interviews were conducted between september 2001 and february 2002. data from the questionnaire and interviews were supplemented by documentary information. further qualitative information was collected during attendance at the company’s corporate hiv/aids forum and other meetings. as with all successful qualitative workplace studies, a number of individ uals central to the sajems ns vol 6 (2003) no 1 31 process being investigated emerged as key ‘narrators’ for the researcher. these individuals took it upon themselves to explain to the researcher – on an ongoing basis – the wider dynamics of the company within which the response to hiv/aids was embedded. without this information it would have been much harder to understand many processes and events. 5 deco’s response to hiv/aids as with the majority of south african companies, deco’s response to hiv/aids came late in the epidemic. the company’s first official policy on hiv/aids was developed in 2000 and launched on world aids day (1st december) of that year. this policy ‘talked the talk’ and reflected best practice guidelines publicly available. specifically the policy guidelines for the company were: • ensure awareness and understanding of the aids epidemic; • offer voluntary and confidential counselling and testing; • equip line managers, supervisors and human resources to deal with the impact of the disease; • treat sexually transmitted diseases (stis) and dispense free condoms; • educate its employees about how to take care of themselves in order to remain fit and healthy; • support people with hiv or aids for as long as possible by teaching them about positive living and the value of a good diet and regular exercise. the late adoption of the company’s hiv/aids policy meant that it lagged behind the actual implementation of hiv/aids programmes in many of the company’s divisions and business units. a key implication of this was the decentralised nature of the actual response, with individual workplaces responding to the threat of hiv/aids without the benefit of strong central guidance. the nature and extent of these responses was influenced by two key factors – the visibility of aids within the workforce and the initiative taken by individual employees. deco’s mining division provides an example of where the high visibility of aids prompted an early response. this visibility resulted from two factors. much of the mining workforce was low-skilled, low-paid, and often migratory – and at high risk in terms of hiv/aids. the higher prevalence within the mining workforce (estimated at approximately 21 percent in 2002) was made evident by the division’s centralised health care services. in contrast with other deco employees, some 5,500 miners within deco’s mining division’s 8,500 sajems ns vol 6 (2003) no 1 32 employees did not have access to the company’s medical aid scheme. rather, health care was provided by the mine hospital, which also conducted the annual health checks legally required for underground workers. this systematic medical contact with a high-risk workforce led to the early identification of hiv and aids as a problem for mining and prompted the earliest and most comprehensive response to hiv/aids within deco. other deco divisions and business units had lower estimated risk profiles than the company’s mining operations – ranging from a few percent for professional workplaces such as the company’s head office, to the mid -teens for workplaces where larger numbers of low-skilled workers were employed. in these latter workplaces it appears that the visibility of hiv/aids had been masked by the decentralised nature of health care and the absence of annual health checks. spread out among different doctors away from the workplace, early aids cases had tended to go unnoticed – and certainly not collated – by the company. in situations like these where aids has not been visible the response tended to reflect the commitment of individuals within the workforce who took it upon themselves to act. in many situations this was possible because, until recently, the low priority afforded to hiv/aids by the company meant that senior managers devolved responsibility for hiv/aids downwards. this devolving of responsibility often continued until somebody picked up the challenge for reasons other than their job description or career advancement prospects. medical sisters, for example, were often influenced by their contact with workers presenting aids-related symptoms at medical stations. however, the overriding reason for such unofficial ‘aids volunteers’ within deco was the realisation that hiv/aids represented a social tragedy not only for deco workers, but also for their communities and the country as a whole. there was a sense that ‘something had to be done.’ the ‘bottom-up’ responses mounted within the company are discussed later. however, one important point relevant to the overall response of deco is that the junior status of many of these aids volunteers meant that responses were often localised and limited in nature. the tendency towards localisation was exacerbated by the complex geographical spread of some divisions and business units. without access to senior managers and resources, bottom-up responses tended to focus on the immediate workplace – resulting in gaps in the implementation of the hiv/aids programme across the division or business unit as a whole. the absence of backing from senior management also constrained the scope of programmes. while the attitudes of line management was often identified as a key problem by aids volunteers they did not have the authority to integrate their programmes into management hierarchies that would include line managers. sajems ns vol 6 (2003) no 1 33 one response to hiv/aids that was centralised – though not from within the company – was the provision of anti-retroviral drug treatment for members of the company’s medical aid scheme. this was provided via scheme’s administrators who offered an hiv/aids disease management programme. this programme allows members to access managed anti-retroviral drug therapy and vitamin supplements. such programmes work best when hiv+ employees access benefits prior to them entering the aids phase of the disease. asymptomatic hiv+ employees can, if registered on the programme, be monitored on a regular basis and anti-retroviral treatment commenced prior to the need for expensive hospitalisation. however, as the following table illustrates, even where deco workers have access to anti-retroviral drugs via their medical aid scheme only a fraction of the estimated hiv+ workers in deco have yet used their medical aid to establish their hiv status or register on the programme. table 1 deco employees utilising the hiv/aids management programme6 employees with access to hiv/aids management programme7 20,500 employees with access to hiv/aids management programme that are estimated8 to be hiv+ 2,000 employees that have used the hiv/aids management programme for cd4 and viral load tests9 54010 hiv+ employees that are currently registered on the hiv/aids disease management programme11 200 employees who had disclosed their hiv+ status within the workplace12 1-2 this limited take up of available treatment indicates that even where a coherent centralised programme is in place if this is not supported by other programmes its effect will be limited. accessing the hiv/aids management programme requires that employees, first, know that the programme is available and know their hiv status and, second, are not discouraged from accessing it through fear of aids, confidentiality, stigma, or a belief that they will be discriminated against should their status become public knowledge. without a wider, coordinated hiv/aids programme across the company, any individual programme, however good, is likely to be only partially effective. ironically, the deco division that first identified the problem of hiv/aids within its workforce – mining – did so, in part, because it did not have medical aid cover, and hence access to the hiv/aids disease management programme, for many of its workers. unlike the company’s medical aid scheme, mining’s sajems ns vol 6 (2003) no 1 34 health care system, provided through the mine hospital does not include the provision of anti-retroviral drugs for workers or their dependants (though it does provide treatment for opportunistic infections as part of an extensive healthcare programme). provision of anti-retroviral drugs for this group of workers is currently being considered, but is hampered by the group’s low income and the high cost of drugs and drug administration. the company’s generally fragmented approach to hiv/aids and the fact that responsibility had been largely devolved to relatively junior employees was reflected in the composition of deco’s corporate aids forum. the forum, established in 1999, was a valuable resource for information sharing between those carrying out hiv/aids programmes, but it lacked the authority to impose a comprehensive strategy on the company as a whole. at the beginning of the research period the composition of the forum was noticeably atypical of deco management – being numerically dominated by women and predominantly black. indeed, it was clear that while the forum members saw themselves as part of deco they did not see themselves as management (despite the fact that many of them were). rather, ‘management’ was viewed as a group hampering their objectives. numerous discussions focused on how ‘they’ (management) had to be convinced that hiv/aids was a major problem that the company needed to confront. within the research period the profile of hiv/aids within deco rose rapidly. this was due to a number of factors, including pressure from the wider environment, the work of forum members, a knowledge, attitudes and practices (kap) survey in the company’s mining division, the carrying out of a companywide hiv/aids risk assessment and the author’s research project. as a result of this, more senior (and therefore white male) managers joined the forum. these newcomers were welcomed by the existing forum members as reflecting a shift in the company’s thinking over hiv/aids as well as for the capacity that they brought to the group. at the same time, however, the close and supportive relationships previously established within the forum started to shift as a more orthodox managerial approach began to dominate meetings. late in the research period a further shift was evident. the formal prioritisation of hiv/aids at the highest levels of the company was illustrated by the company’s new senior human resources manager been given responsibility for championing the response to hiv/aids. significantly, this manager had previously been md of the deco’s mining division – where the impact of hiv/aids was most apparent. a consulting company was tasked by the new human resources manager to review deco’s existing practices, develop a business case for responding, and design new and improved solutions that could be rolled out across the company’s south african operations. all this amounted sajems ns vol 6 (2003) no 1 35 to a new, externally influenced, more co-ordinated and better-resourced response by deco to hiv/aids. thus, a high-level, well-resourced implementation team has been superimposed upon the largely decentralised and varied response generated from the grassroots in deco. the rest of this article looks at what had been achieved within deco before this shift occurred. the strengths and weaknesses of this response are informative for what they tell us about the reality of implementing good policy. they also draw attention to the challenges that the current, more managerially powerful, approach to hiv/aids now been undertaken in deco face. this new approach needs to address the weaknesses of the company’s current response to hiv/aids while harnessing – and not destroying – its existing strengths. 6 hiv/aids programmes at deco this section looks at the implementation of the twelve hiv/aids programme aspects of the nedlac code of good practice by deco divisions and business units, as outlined in section 4. the responses to the questionnaire provide a platform for analysis that is, critically, informed by qualitative information obtained during the in-depth interviews. the figures following each aspect collapses the possible response options into either ‘no’ for no implementation having taken place, or ‘yes’ for some implementation having taken place – out of a total population of 19 workplaces. because of the important role of supplementary, qualitative information, the quantitative responses indicated correspond to, but do not determine, the categories employed. additionally, the figures need to be considered in the light of the often over-optimistic reporting of implementation that in-depth interviews revealed. 6.1 the easy part: awareness, condoms, and counselling the three aspects of hiv/aids programmes that were reported by deco divisions and business units as most successfully implemented were: • hiv/aids awareness programmes: yes 15 (79 per cent), no 4 (21 per cent); • promotion of condom distribution and use: yes 16 (84 per cent), no 3 (16 per cent); and • provision of access to counselling for people affected by hiv/aids: yes 15 (79 per cent), no 4 (21 per cent). this first tier of a hiv/aids programme – awareness, condoms, and counselling – represented policy aspects that can be relatively easily achieved. sajems ns vol 6 (2003) no 1 36 at a minimum, world aids day events, condom dispensers in the toilets, and an employee assistance programme (eap) (whereby service providers offer a toll free advice number and access to counselling for a monthly fee) allow these aspects of hiv/aids policy to be ticked off as ‘functioning smoothly’. while such interventions should not be belittled, on their own they represent only a minimum level of activity taken in response to a vaguely perceived problem. such activities could be undertaken without undue inconvenience to the work of the division or business unit. thus, such actions can be regarded as a good ‘first step’ in the development of a workplace programme to deal with hiv/aids, but not more than this. 6.2 not quite so easy: education and training, sti treatment, and preventing occupational infections a second tier of hiv/aids programmes that respondents claimed to have successfully implemented or to be implementing – though to a lesser extent than awareness, condoms and counselling – consisted of: • education and training on hiv/aids: yes 14 (74 per cent), no 5 (26 per cent); • encouraging treatment of stis: yes 11 (58 per cent), no 8 (42 per cent); • enforcing the use of infection control measures to ensure hiv is not acquired in the workplace: yes 12 (63 per cent), no 7 (37 per cent); and • a ‘wellness’ programme for employees: yes 9 (47 per cent), no 10 (53 per cent). that these programmes are being implemented, though somewhat behind ‘awareness, condoms and counselling,’ is instructive and supports the idea that hiv/aids programmes are often driven by the ease of implementation, rather than an objective assessment of their effectiveness or efficiency. education and training requires a greater level of resources than awareness – world aids day events, for example, would not constitute education and training. given this, it is not surprising that the level of implementation of education and training programmes lagged slightly behind that of the awareness programme. the role of stis as a co-factor in the transmission of hiv is well known and sti treatment reduces hiv transmission without behavioural change. explaining why sti treatment – despite its efficacy – lagged behind condom distribution is also explained by the question of resources. whereas condom distribution can be managed without medical personnel, the treatment of stis, demands medical expertise which was not always available. additionally, while medical personnel sajems ns vol 6 (2003) no 1 37 were actively involved in hiv/aids programmes in a number of deco workplaces where they have organised the treatment of stis in other workplaces medical personnel consciously did not provide this service. this was due to a number of factors, including the costs involved, the ‘unpleasant’ nature of sti treatment, and moral uncertainties over whether stis should be treated in workplace facilities given that such treatment cannot require the treatment of partners (as government health facilities often do). in light of deco’s strong emphasis on health & safety, it was surprising that a number of deco’s workplaces reported that they had not yet fully implemented infection control measures to ensure that hiv was not acquired in the workplace. to an extent this apparent lack of concern over the issue may have reflected a well-founded understanding that, while the risk of occupational exposure to hiv does exist, the workplace is not the primary location of hiv transmission. this is especially so in white-collar workplace environments that do not involve machinery and the use of hand tools. however, it was also likely that aspects such as infection control measures (e.g. rubber gloves in first aid kits) have been implemented, but as part of ongoing health & safety activity, not as a specific hiv/aids programme. if so, it indicates that responsibility for hiv/aids programmes lay outside of shop floor management and that there was little communication between them and those dealing with hiv/aids. finally, respondents interpreted the question on wellness programmes differently from one another. some regarded an employee assistance programme as counting as a wellness programme – and therefore indicated on the questionnaire that such a programme was in place. others interpreted a wellness programme more rigorously – as a proactive programme designed to educate and help people to improve their diets, reduce stress, and live more balanced lives. most divisions and business units did not have such programmes in place13. 6.3 does it work? the need to monitor a minority of deco’s workplaces reported having ‘monitoring, evaluatio n and review processes’ in place for their hiv/aids programmes (yes, 7 (37 per cent), no 12 (63 per cent)). to some extent this weakness can be ascribed to the relatively short histories of some of the programmes being implemented. however, some programmes had been running for a number of years without any monitoring or review. sajems ns vol 6 (2003) no 1 38 the absence of monitoring, evaluation and review of an on-going programme is a sign of weakness in implementation. this is true for any workplace intervention, but it is especially true in the context of hiv/aids and the known difficulty in changing sexual behaviour. three explanations can be offered for this weakness. first, as outlined above, a number of workplace programmes had been established with little real backing and, as such, existed as a ‘bare bones’ response to show that something was being done. second, those individuals who had picked up the challenge of responding to hiv/aids in deco often lacked the managerial expertise that would have ensured that they monitored the effectiveness of their own interventions. third, it may be the case that limited and uncertain funding for these processes did not encourage budgeting for monitoring. 6.4 testing, disclosure, and accommodation three programme aspects – testing, disclosure, and accommodation – interlock and together form the most difficult and complex aspect of any response to hiv/aids. these are: • encouraging and offering vct: yes 6 (32 per cent), no 13 (68 per cent); • creating an environment that is conducive to openness, disclosure and acceptance of hiv/aids among all staff: yes 11 (58 per cent), no 8 (42 per cent); and • maximising the performance of affected employees through ‘reasonable accommodation’: yes 8 (42 per cent), no 10 (58 per cent), don’t know 1 (5 per cent). these three aspects of an hiv/aids programme support each other: vct is a precursor to disclosure and disclosure is more likely if hiv+ employees are being supported – through, for example, ‘reasonable accommodation’ (whereby steps are taken to provide alternative, lighter duties) in their work. however, the implementation of these three aspects of hiv/aids policy varied. a number of workplaces claiming to have created a conducive environment for openness and disclosure yet had not taken steps to encourage vct, nor put in place policies to maximise the performance of affected employees. in a large number of workplaces vct was not encouraged, or was noted as ‘planned, but not implemented to date.’ in-depth interviews revealed that this was often a result of confusion over whether any form of testing was permissible. encouraging people to go for voluntary counselling and testing (vct) is legal, desirable and good for the company and its employees (as well sajems ns vol 6 (2003) no 1 39 as being part of the nedlac’s code of good practice). the provision of vct services by companies is an issue currently caught in a conflict between the code of good practice and the employment equity act (government, 1998) that the code is derived from14. many managers, often those actively working on hiv/aids programmes, appeared to be confused over vct. this confusion stemmed largely from issues unrelated to the conflict between the code and act, but from an earlier company initiative to conduct prevalence testing that unions, fearing discrimination, had blo cked. as a result, these managers had effectively ‘thrown the baby out with the bath water’ and were steering clear of anything to do with testing. very few deco employees had voluntarily disclosed their status. only one case of an openly hiv+ person was reported to the researcher, while another was beginning to come forward within a limited circle towards the end of the research period. (the first employee who disclosed her status was subsequently ostracised by her co-workers). the status of a number of other hiv+ deco workers had been revealed, but only because the person was in an advanced aids stage and denial or concealment was no longer possible. while workplaces reported, via the questionnaire, significant progress in creating an environment conducive to openness and disclosure, many interviewees expressed frustration that people were not willing to disclose their status. one immediate explanation for this frustration was the failure to implement policies – such as encouraging testing and supporting those with hiv/aids – that would support disclosure. thus, creating an atmosphere in which openness and disclosure of individuals hiv status is only possible if concrete steps to support this are implemented in tandem to programmes that simply encourage this as a ‘good thing.’ in addition to this need for inter-linked policies to be implemented in tandem, some of the structural reasons why openness, disclosure and acceptance do not appear to have been achieved, despite efforts on the part of some managers to ensure such an environment, are discussed later (see section 7). 6.5 strategies to deal with the costs of hiv/aids the vast majority of deco workplaces responded to the aspect of ‘development of strategies to deal with the direct and indirect costs associated with hiv/aids in the workplace’ by reporting that no action had been taken (yes 3 (16 per cent), no 15 (79 per cent), don’t know 1 (5 per cent)). that this was the least implemented of all twelve hiv/aids policy aspects is interesting, especially in a company with high levels of managerial capacity in which management risk analysis and contingency planning is commonplace in relation to other issues. a number of explanations for this can be put forward. sajems ns vol 6 (2003) no 1 40 first, where managers perceive there to be little risk to their workforce – and therefore, low potential cost to their business – there is no pressing need to make preparations. this appeared to be the perspective held by some, though not all, interviewees in white-collar workplaces where in-depth interviews were conducted. second, even where the potential impact of aids was recognised, it was often placed in the context of overall labour turnover. in some workplaces this led to aids being viewed as a contributing but not critical factor in determining labour requirements. in this context special preparation to mitigate the costs of hiv/aids was not seen as necessary over and above existing policies. third, while some interviewees thought that the costs of hiv/aids might be significant, the limited information available on hiv/aids in their workplaces meant that it was not possible to implement plans to deal with the cost of hiv/aids. finally, many human resource managers, when interviewed, revealed that they had put considerable thought into possible – but uncertain – skills shortages as a result of aids. often, their answers to questions during the in-depth interviews demonstrated innovative responses to uncertain skills requirements while bearing in mind the need to maintain budget parameters. whether these responses could all be successful – in the event that a number of deco’s workplaces found themselves needing to rapidly and simultaneously recruit skilled and semi-skilled workers from the same, localised, labour markets – is questionable. however, the obvious capacity and careful thought demonstrated by human resource managers, compared to the level of response indicated in the questionnaire, was in itself instructive and raises again the important point about the lack of co-ordination between different players in the response to hiv/aids. put simply, in-depth interviews revealed that human resource managers tended to fill in those sections of the questionnaire related to workforce statistics, while the questions on hiv/aids programmes were completed by the other individuals – often not human resource managers – who were responsible for such programmes. human resource managers were thinking about the possibility that they might need to find replacement labour as a result of aids, but this seems not to have been apparent to many of those actually dealing with hiv/aids in the workplace. 7 stigma and the structures of discrimination hiv/aids is a heavily stigmatised disease. this is largely due to the fact that it is sexually transmitted, loading infection with moral and cultural judgements. even when such judgements can be put aside, sex remains for many people an embarrassing topic that is difficult to discuss openly. the absence of a cure for aids – and the even greater ignorance of the positive steps that infected sajems ns vol 6 (2003) no 1 41 individuals can take to remain healthy – makes hiv/aids a feared disease and reinforces its stigmatised status. such stigma is independent of the workplace, being generated from wider social values and the nature of the disease. nevertheless, it was apparent during the research that a number of structures within deco (which are described below) have established dynamics that reinforce the stigma attached to hiv/aids – despite the company’s stated policy that: it is essential that an environment be created in which an employee living with hiv or aids is able voluntarily to divulge his/her status without fear of discrimination or retribution. such an environment will assist management not only to support the employee where possible, but importantly also to manage the human resources implications (deco, 2000). as table 1 illustrated, of the estimated two thousand hiv+ deco employees with access to anti-retroviral drugs only 200 were registered for the medical aid hiv/aids programme. finally, as previously mentioned, only one employee had openly disclosed her status at work, while another appeared to be on the brink of doing so. this state of affairs is clearly undesirable. when employees do not access available medication, the company is likely to loose valuable employees. despite the availability of anti-retroviral drugs, a number of interviewees reported cases of employees who had not accessed anti-retroviral drugs, but instead had concealed aids symptoms until they had literally collapsed on the job and had to be hospitalised. at this point the use of anti-retroviral drugs may well be too late (ward, 1999). such people represent bad role models since they send a message that aids is a death sentence. by contrast, individuals who find out their status, take positive action to deal with it and talk openly about what they have done, provide positive role models and send a message that it is possible to live and work productively with hiv. people living openly with hiv are an important resource for any hiv/aids programme; their testaments at meetings are powerful, and often electrifying. their impact is clearly all the more effective when they speak from within the company – rather than as invited outsiders – since they face the same difficulties as fellow employees who may be afraid to know or reveal their status. structures of discrimination were not intentionally designed to exclude those with hiv/aids – indeed they sometimes arose from well-intentioned policies and practices. but these structures of discrimination, in combination with the wider stigma attached to hiv/aids, and the failure to implement the sajems ns vol 6 (2003) no 1 42 interlocking policies around disclosure in tandem, help explain the previously noted contradiction between reported progress in creating an environment conducive to disclosure and the actual cases of disclosure. the fear of being sidelined in terms of training and promotion acted as disincentives for deco’s hiv+ employees to find out, respond to, or disclose their status. interviewees identified line-management as a key problem in this respect. line managers were reported as responding to hiv/aids on the basis of their own – often incomplete – understanding. for example, some supervisors had demanded disposable cups for sections where they suspected somebody might be hiv+. such attitudes form a ‘frontline’ of workplace discrimination and translates into very real consequences over training and promotion decisions. close to the shop floor, such outcomes operated below, and in opposition to, the supportive policy of the company. thus, the wider stigmatisation of hiv and aids entered into the workplace not only through individual’s reluctance to be identified as hiv+ because of the likely negative reactions of co-workers, but also because of fears that the attitudes of those directly above them would result in discrimination. the consequential inaction on the part of hiv+ employees led to the effective denial of anti-retroviral drug treatment for many deco workers. as such employees fall ill with aids-related symptoms their denial is maintained – or respected. unless pro-active action is successfully undertaken to persuade them to access vct for hiv, they proceed down the ‘sick route’ – in which a tacit agreement is maintained to deal with aids-related opportunistic infection, typically tb, rather than the underlying cause. this eventually sees the employee medically boarded from the company on a pension or with a provident fund payout. while humane in respecting individuals’ wish not to disclose, the sick route is clearly sub-optimal for companies, especially where such employees have valuable skills. such outcomes are also sub-optimal for employees who have not taken the most appropriate action to deal with their actual problem and who now face a reduction in income at a time when their own and their family’s resources will be greatly stretched. in some cases this is complicated further by provident fund re-insurers instigating lengthy investigations into the degree of disability when, in fact, the worker has been sent home to die. it also reinforces fears, and therefore stigma, over hiv/aids among the remaining workforce as employees see fellow workers with aids15 quietly dropped from the company into difficult home situations. such processes feed back into the fear and stigmatisation of hiv/aids. this sets up a vicious circle in which merely establishing one’s hiv status, let alone disclosing it, becomes increasing difficult, despite the existence of company policy encouraging vct and disclosure. sajems ns vol 6 (2003) no 1 43 8 the importance of ‘aids volunteers’ within deco’s response the previous section discusses areas of policy that grassroots responses to hiv/aids were not in a strong position to address. the aids volunteers who mounted these responses were not able, for example, to challenge medical boarding processes and even less able to negotiate with provident funds. nor, despite the company policy on aids, did they have the power to influence line managers who often formed the frontline of workplace discrimination. such systemic problems clearly require a co-ordinated response supported by seniorlevel champions and backed by adequate resources – for example, ensuring that all line managers receive training on hiv/aids and are clearly instructed by their superiors that they must carry out company policy towards hiv+ employees based on this training. such weaknesses in the response mounted by these aids volunteers, should not, however, detract from the very real strengths that these individuals – and the groups and processes that they established – brought to the company. compared to managerial-led processes, the strengths that such grassroots volunteers bring include a ‘can do’ approach to the daunting issue of hiv/aids and their ability to communicate on a peer basis with their colleagues and workmates. the concept of peer communication is central to effective responses to hiv/aids (unaids, 2000). because our response and our vulnerability to hiv/aids is embedded within group attitudes and behaviours, effective understanding of the disease and changing behaviour is best achieved through discussions among peers. successful peer educator initiatives therefore consist of a cross section of the company’s employees – in terms of occupational level as well as demographic characteristics, such as race, age, and gender. this closeness to all levels of the company, combined with enthusiasm to address the issue, provides a powerful line of communication into the workforce that management – alone – simply cannot replicate16. within deco a number of peer educator structures had been established – often with minimal support from management. in a sub-unit of the company’s chemical division a secretary put together an ‘aids task team’ which included afrikaans artisans, african shop stewards, and white female administrative staff. meeting during lunchtimes, the group was obviously highly motivated and their report backs made it clear that they were engaging their fellow workers around the issue of hiv/aids on an ongoing basis. such interactions were linked to a series of interventions that the task team undertook. some of these ensured that best practice policies – such as condom distribution – were being carried out. sajems ns vol 6 (2003) no 1 44 while the team’s projects were often driven by the gaps they saw in the company’s response (such as the absence of condom dispensers in some buildings that they worked in), others were deliberately chosen to raise the profile of hiv/aids and provide opportunities for discussion. towards the end of the research period, the task team launched its own research project with the aim of getting the 600 workers in their unit to complete a short survey on hiv/aids. this was carried out to establish the levels of knowledge on hiv/aids among the workforce. however, it also enabled the group to break out of its previously localised response and ensured that team members had direct contact with all their co-workers. after the questionnaires were completed for each shift in each workplace, team members were available to answer questions, a process that further cemented links between the task team and the wider workforce. in another of deco’s large divisions a medical sister – without support from the senior doctor at her medical centre – organised a network of peer educators across all divisio ns and business units on site. on the wall of her office a large map of the plant with it various workplaces was covered with coloured pins that identified the location of this network. using the medical centre she ran training sessions for volunteers and then kept in contact with them by providing condoms that they would come and collect – along with new publicity material – on a regular basis. interviewing one of these peer educators, a process controller in a different division, it was clear that he was using this training not only in the workplace, but also in his community. it was also evident that his regular contact with the sister when picking up condoms was an important source of support and information. this peer educator was assisted by the management of his business unit, who had given him a slot at the ‘coffee sessions’ where shifts discussed production issues. however, it was also evident that there was a lack of co-ordination between the peer educator’s efforts – backed by the bottom-up initiative run out of the medical centre – and the approach being taken by his management. this was manifested in an effective ‘turf war’ over who should be the first line of support for employees concerned about hiv/aids – the peer educators or the management-contracted eap. this situation was not inherently conflictual – having a number of sources of information on hiv/aids is desirable and, if coordinated, not a problem – but became so because of the failure to pull together different approaches to hiv/aids. this example illustrates the need for elements of an effective hiv/aids strategy to be co-ordinated and supported from the centre of a company and for other elements to be delivered by volunteer-type grassroots structures. to some extent, deco’s mining division had made considerable progress in combining sajems ns vol 6 (2003) no 1 45 the ‘top-down’ and ‘bottom-up’ responses to hiv/aids in the workplace. while the division struggled with the problem of most of its workforce lacking access to anti-retroviral drugs, early identification of the problem among its workforce resulted in the appointment of a highly capable and motivated human resource manager to work alongside the mine doctor. access to senior divisional management allowed the roll out of a programme for line manager education on hiv/aids. mine managers were instructed to ask for volunteers from the workforce who were also trained as peer educators. these peer educators were organised into mineshaft committees that ran themselves, each taking different approaches to their task. in may 2002 a peer educator day was organised with some 200 peer educators from the mines attending. each group provided feedback on its programme and took questions from the other peer educators. a number of educational and inspirational presentations were made, including the preliminary results of a kap survey that the human resource manager had commissioned to provide information on the workforce’s understanding of hiv and aids. 9 conclusion: challenges and opportunities the fragmented nature of deco’s initial response to hiv/aids is evident not only in its structures, but also in the implementation of programmes. the primary factors in the response to hiv/aids were the visibility of the disease within the workforce, the ease with which programme aspects could be implemented (rather than their effectiveness), and the presence of committed individuals whose motivation was drawn from outside the company’s management priorities. this amounts to a reactive rather than proactive response, which appears to be typical of corporate south africa’s response to this epidemic to date. reports by managers that their workplaces represented environments conducive to disclosure of employees’ hiv+ status contrasted sharply with the paucity of workers who had taken such steps within the company. this is instructive and drives home the point that having an hiv/aids policy is one thing, but that turning such a policy into a reality requires much more than a document. the low take-up of the confidential aids disease management programme available to most workers in deco further underscores this point. even policies backed by an appropriate programme may not be sufficient to ensure an adequate response in the area of hiv/aids. because of the stigma, fear, denial, and discrimination that surrounds hiv and aids there needs to be a pro-active engagement with all employees using multiple – but above all, peer-based – channels of communication. thus, policy and programmes need to be closely aligned with ongoing processes in which knowledge, attitudes and ultimately behaviour are sajems ns vol 6 (2003) no 1 46 shifted through continuous debate and discussion within employee groups. such an approach requires the mobilisation of grassroots structures – notably peer educator groups and unions – that are able to engage fellow employees using their own languages, understandings, and group identities. thus, in asking whether managing hiv/aids in south african workplaces is just another duty the answer is that a new form of management is required in which the strengths of managerial structures and capacity is combined with the enthusiasm and peer communication strength of bottom-up initiatives. this presents enormous difficulties as south african companies take up the challenge of hiv/aids. it may well be tempting to drive the process ‘from the top’ in the belief that a strong management response will efficiently address the problem. while top-level support and resources are required, such approaches need to ensure that in wresting control of the issue they do not marginalise the responses that must be run by their own employees. rather, ways of nurturing and supporting bottom-up responses need to be encouraged. this demands finding ways of linking top-down and bottom-up responses to hiv/aids that synergise the strengths of the two approaches. this requires us all to think differently. managers need to recognise that their employees can do things that they cannot, and employees need to understand that, in this crisis, they need management support. in south african workplaces, such an understanding – and the resulting joint effort in combating aids – may produce possibilities that extend beyond the immediate cause of partnership. as putnam (1993) points out, the ‘social capital’ of learning to work together can be transferred by participants to different situations. south africa badly needs new partnerships in its workplaces if it is to overcome the legacies of the past and to address the challenges of transformation and globalisation. successfully responding to hiv/aids in our workplaces could well help us take steps in such a direction. endnotes 1 this paper draws on research conducted in ‘deco’ during 2001 and 2002. i am grateful to deco, especially members of the company’s labour relations department, for supporting this research. thanks to all the managers, ‘aids volunteers,’ trade union officials and medical personnel who gave time to complete questionnaires and give interviews. thanks also to karen birdsall, marion stephens at the centre for health policy, university of the witwatersrand, and an anonymous referee for valuable comments. sajems ns vol 6 (2003) no 1 47 2 that meeson & van meelis’ (2000) article is also based on eskom but entitled not the best practice illustrates the problem of establishing what is best practice in the field of hiv/aids. 3 readers who are not knowledgeable about hiv/aids are referred to barnett & whiteside (2002) or whiteside & sunter (2000) for information on the diseases and its likely impact in south africa. 4 the nedlac code uses the term sexually transmitted diseases (stds) – for consistency the term sti is used in this article. 5 the nedlac code uses the term voluntary testing rather than voluntary testing and counselling (vct). the term vct is used in this article. 6 since this research was conducted, there has been a major change in the number of medical aid beneficiaries as a result of the merger and standardisation of a number of company schemes. the estimated take up of managed treatment by hiv+ members, within this larger group, is five percent (i.e. half that indicated in the table). 7 this hiv/aids management programme gave employees, with the company’s medical aid scheme, access to antiretroviral drug treatment. 8 from the actuarial risk analysis conducted for the company in early 2002. 9 cd4 tests measure the strength of the immune system; the viral load indicates the amount of the virus in the body. 10 some individuals would be included in the 540 but not registered on the programme because they had left the company (including cases of death) and therefore the medical aid scheme. the number of such cases was not known due to confidentiality procedures. while this group would reduce the disparity between the 540 who had accessed their hiv+ status and the 200 that were registered on the scheme, it was accepted that they were unlikely to constitute a major part of this number. potentially increasing the disparity between the estimated number of hiv+ employees and those who had accessed their status is that some individuals may have accessed cd4 and viral load tests without a hiv+ test result (for example to reduce the ‘window’ period when seeking to establish their hiv status) and the possibility of fraudulent claims for cd4 and viral load counts. 11 i.e. are hiv+ and are being regularly monitored to determine the progression of the diseases and, if appropriate, are taking antiretroviral drugs. 12 see sections 6.4 and 7 for a discussion of disclosure in the company. 13 the nedlac code of good practice recommends that companies ‘endeavour to establish a wellness programme for employees affected by hiv/aids (13).’ the exact meaning of this is open to interpretation. all that can be said from the data collected is that a majority of workplace responses reported no wellness programme in place and that the understanding of ‘wellness programmes’ differed. sajems ns vol 6 (2003) no 1 48 14 the aids law clinic, university of the witwatersrand announced that it intended to approach the labour court for clarification on this issue in an attempt to remove legal uncertainty over the provision of vct (business day, 4th november 2002). 15 it is important to note that while the highly stigmatised nature of aids means that people are unwilling to discuss the disease openly, this does not mean that people do not know – or think they know – who has aids. this information is discussed or alluded during gossip or other ‘closed’ forms of communication. numerous euphemisms for hiv/aids exist, testifying to the process by which information is transferred without open acknowledgement. a person’s status can be suggested by holding up a hand with thumb and index finger crossed to silently spell out ‘hiv.’ 16 a third channel of communication – in addition to peer educators and the channel of line management – is the unions. unions provide much of the workforce with sources of leadership that have more credibility – in hiv/aids, as well as other issues – than management. references 1 actuarial society of south africa (2000) actuarial projection of the epidemic: summary statistics, www.assa.org.za/ committees/aids/summarystats.htm. 2 anglo gold (2002) anglo gold: facing the challenge of hiv/aids. 3 anglo platinum (2002) annual report 2001. 4 barnett, t. & whiteside, a. (2002) aids in the twenty-first century: disease and globalization, palgrave macmillan: basingstoke. 5 booysen, f. & molelekoa, j. (2002) “the benefits of hiv/aids intervention in the workplace: a case study” south african journal of economic and management sciences, 5(1): 180-202. 6 campbell, c. & williams, b. (2001) “riding the tiger: contextualising hiv prevention in south africa” african affairs 100: 135-40. 7 deco (2000) hiv/aids deco cares. 8 department of health (1999) the electricity supply commission of south africa (eskom). hiv/aids and std directorate, hiv/aids best practice series. 9 department of health (2002) national hiv and syphilis seroprevalence survey in south africa 2001: summary report 10 government of south africa (1998) employment equity act (act no. 55 of 1998). 11 johnson, l. & budlender, d. 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(2000) “practising in parallel: not the best practice” [eskom], south african labour bulletin 24(2): 44-9. 17 nedlac/department of labour (2000) employment equity act: code of good practice on key aspects of hiv/aids and employment. 18 putnam, r. (1993) making democracy work: civic traditions in modern italy. princeton, nj: princeton university press. 19 rosen, s.; simon, j.; thear, d. & vincent, j. (2000) “care and treatment to extend the working lives of hiv-positive employees: calculating the benefits to business,” south african journal of science 96(6): 300-4. 20 south african business coalition on hiv/aids (2002) evaluation of workplace responses to hiv/aids in south africa: a rapid situation analysis. sabcoha, dfid and deloitte & touch human capital corporation. 21 schneider, h. & stein, j. 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(2000) aids: the challenge for south africa, human & rousseau tafelberg: cape town. abstract introduction literature review: mobile phone technology (information and communication) and agricultural development data methodology results and discussion conclusion and policy implications study limitations acknowledgements references about the author(s) omotomiwa (tommy) adenubi une business school, university of new england, armidale, australia centre for agricbusiness, phambook enterprise, ondo state, nigeria omphile temoso une business school, university of new england, armidale, australia isiaka abdulaleem university of reading, reading, united kingdom citation adenubi, o., temoso, o. & abdulaleem, i., 2021, ‘has mobile phone technology aided the growth of agricultural productivity in sub-saharan africa?’, south african journal of economic and management sciences 24(1), a3744. https://doi.org/10.4102/sajems.v24i1.3744 original research has mobile phone technology aided the growth of agricultural productivity in sub-saharan africa? omotomiwa (tommy) adenubi, omphile temoso, isiaka abdulaleem received: 19 june 2020; accepted: 30 aug. 2021; published: 25 nov. 2021 copyright: © 2021. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: a recent increase in the adoption of mobile phone technology generated a great deal of interest and optimism regarding its effect on economic development in sub-saharan africa (ssa), particularly on the enhancement of agricultural development. aim: in this study the impact of mobile phone technology on agricultural productivity in ssa is examined. setting: the empirical assessment uses a panel data set covering 41 countries over a period of 25 years. methods: we employed an econometric approach and panel data covering 41 countries and a 25 year-period (1990–2014) to investigate the effect of the adoption of mobile phone technology and other socio-economic variables on agricultural total factor productivity (tfp). the use of regression analyses allowed us to estimate and measure the contribution of certain variables to agricultural tfp growth in ssa. results: the results show that the uptake of mobile phone technology had a positive effect on agricultural tfp growth in ssa. conclusion: mobile phone technology has been established to be one of the drivers of agricultural productivity in ssa. implication: the implications of this study are that governments, ngos, and businesses working on improving agricultural productivity and food security in ssa need to continue endorsing mobile technology as a means to improve agricultural productivity. keywords: agriculture; ssa; mobile phone technology; total factor productivity; economic growth; population; agricultural productivity; technical efficiency. introduction recent technological advancements in information and communication technology (ict) are having a significant impact on the growth and socio-economic development of businesses, industries, and countries across the world (fao 2017). there is increasing evidence that firms which adopt ict technologies are more likely to foster important organisational changes within their firms, with such changes having a significant impact on their performance and business growth (brynjolfsson & hitt 2000). information and communication technology enabled firms in advanced economies to become more productive, reduce costs, and improve their understanding of the markets they serve. for example, ict applications such as the internet of things, big data and cloud computing allow a large volume of information and data to be generated (data-driven and data-enabled), which in turn is used by scientists and farmers to provide timely analysis and advice, enabling farmers to achieve better yields by optimising their crop and livestock management, as well as resource reallocation (wolfert et al. 2017). on the other hand, developing countries, particularly in sub-saharan africa (ssa), continue to experience a vast infrastructure deficit which constrains their economic growth. surprisingly, although still lagging behind in terms of infrastructure investment, the region experienced a remarkable increase in the adoption of mobile phone technology across the region (aker & mbiti 2010). the number of mobile phone users has grown faster in africa than in any other region in the world, starting with just over 10 000 subscriptions in 1990, increasing to 1.3 million by 2000 and hitting 770 million in 2016 (world bank 2017). sub-saharan africa continues to depend heavily on agriculture, in that the sector contributes on average about 15% to the total gdp (world bank 2017), employs over 50% of the rural population, being the primary source of livelihood for 10% – 25% of the urban population (organization for economic co-operation and development [oecd] & food and agriculture organization of the united nations [fao] 2017). however, despite the importance of the sector to the economy and people of ssa, there is evidence that relative to other developing regions (asia and latin america), the agriculture performance in the ssa region continues to lag behind, and one of the contributing factors to this poor performance is its low agricultural productivity. there are several reasons identified in the literature for why ssa agriculture continues to perform poorly and lag behind the other regions. these include: low investment in infrastructure and agricultural research and development; slow reform of agricultural policies; low levels of education; poor weather conditions; poor trade reforms; and urbanisation (increased rural–urban migration) which have all contributed to low productivity. therefore, improvement in agricultural productivity is considered essential for increasing the desirable agricultural output to meet the demands for food and raw materials arising out of a steady population growth (coelli & rao 2005). thus, the recent increase in the adoption of ict technologies, such as mobile phone technology, provides opportunities for improving agricultural productivity in developing regions, for example, mobile phones have the potential to reduce information and coordination costs, which enables greater farmer participation in commercial agriculture (fao 2017). mobile phone technology could help smallholder farmers to access critical inputs such as credit, seeds, fertiliser and herbicides which might help improve productivity and food security. the development possibilities opened by the rapid increase in mobile phone technology have also been recognised by private, public and non-government organisations. these include: e-agriculture community of practice (fao), infodev (world bank group) and ict-agri – research on the internet of things applications with a focus on precision farming applications on smaller farms. however, despite indications of the impact of mobile phone technology on economic development (including in agriculture), there is limited empirical evidence of the impact that mobile phone technology has on agricultural productivity, particularly in developing countries. thus, the purpose of this study is to provide empirical evidence of whether the recent increase in the uptake of mobile phone technology has had any effect upon agricultural productivity in ssa. specifically, we seek answers to the following questions: to what extent has mobile phone technology helped in improving agricultural productivity? across different income groups, to what extent does the impact of mobile phone technology on agriculture vary? there is a substantial amount of material on the topic of agricultural productivity in ssa (block 1994; fuglie & rada 2012; lusigi & thirtle 1997; thirtle, hadley & townsend 1995). in different studies, various approaches are employed to estimate agricultural tfp growth in ssa, with different sample sizes, methods, and time periods. the majority of these studies conclude that there was a slow growth in agricultural tfp in the 1960s, negative growth in the 1970s, followed by a slow recovery in the 1980s and subsequent years. overall tfp growth has been below 1% annually since 1961 (fuglie & rada 2012). fuglie and rada (2012) employed multivariate regression analysis to examine factors, hypothesised to have an effect upon agricultural productivity, these included: investment in research and development; input subsidies; commodity price intervention; human capital development; investment in the education and health of the labour force; infrastructure investment; and political stability. heshmati and kumbhakar (2011) observed that investment in agricultural research through technical change provided a mechanism for tfp growth, while the other variables provided an enabling environment for economic growth by, for example, facilitating the access farmers have to new technologies and markets. this paper fills a gap in the literature by looking at the impact of mobile phone technology on agricultural productivity in ssa, across different countries over a period of 25 years. the study covers a broader geographical scope and a longer period of time, providing a high degree of robustness in the results. the study also contributes to literature by examining the impact of mobile technology on agricultural productivity, specifically, rather than addressing broader economic growth, or singling out an agricultural product. the relatively long time series data employed in the study has the ability to measure the effect of preand post-mobile phone technology on agricultural productivity, thus allowing multi-temporal and multispatial comparisons. the results of the study could help policymakers make the case to extend mobile phone coverage to states, regions and provinces where it is currently lacking. the remainder of this paper is organised as follows. in section 2, studies on the impact of mobile phone technology (and other ict technologies) on agriculture are reviewed. in section 3, the data and sources of data are described. in section 4, empirical strategy and data used in the empirical analysis are described. section 5 presents the results and the main empirical findings. finally, section 6 presents the summary and conclusion. literature review: mobile phone technology (information and communication) and agricultural development the rapid growth of telecommunications in developing countries, particularly the uptake of mobile technology and coverage, is creating a great interest in its potential impact on agricultural development. it has long been recognised that there exists a positive relationship between investing capital in infrastructure such as communication facilities and agricultural development (antle 1983). in recent times, empirical evidence of the impact of mobile technology (ict) on agricultural development, has been growing (fao 2017). table 1 provides a summary of some of these studies. in a study by lum (2011), the impact of mobile phones on economic development and growth through econometric analysis, using panel data for 182 countries, is examined. the conclusion is that there is a positive relationship between mobile phone and economic development in developing countries; therefore, an increase in the number of mobile phone users leads to an increase in real gdp per capita. table 1: selected empirical studies on the impact of mobile (information and communication) technology on agriculture. nnadi et al. (2012) observed that ict is a medium that has radically improved interaction around the globe, implying the need to create a strong link characterised by the impeccable flow of information; this is because ict improves the quality and timing of information between extension agents and farmers, rather than passing information through a long bureaucratic chain. employing data, collected through focus group discussions and interviews with fishermen and farmers across five states in india, mittal, gandhi and tripathi (2010) remarked that mobile phones enabled the respondents to receive timely information, assisting them to increase their yields. in africa, generally, a large amount of research has shown that an enabling environment relying on free communication and ict, among other factors, is required for long-term social and economic development (perez-estebanez et al. 2017). one of the highly cited papers on this topic, is a study by aker and mbiti (2010) which examined the evolution of mobile coverage and its adoption in ssa, as well the main channels through which mobile phones could enhance economic outcomes and improve economic development. the report concluded that mobile phones have the potential to benefit consumer and producer welfare, and perhaps broaden economic development. using secondary market data on grains from niger, aker (2008) examined the impact of the use of mobile phones on the market performance of grain. it is concluded that the use of mobile phone technology reduced dispersion of grain prices across domestic and cross-border markets. furthermore, mobile phones helped traders to reduce search costs, have better access to market information and reduce inefficiency in moving goods across markets. in malawi, katengeza et al. (2011) assessed the drivers of the adoption by smallholder farmers of mobile phone technology for agricultural marketing. asset ownership was found to play a critical role in enhancing the acceptance of mobile phone technology. in the study, the need is emphasised to improve farmers’ access to mobile phones for agricultural marketing. moreover, it recommended the need to foster a collaborative relationship between government and network operators which should reduce calling tariffs to enhance use, while investment in infrastructure must be increased as well. despite a growing number of studies on the impact of mobile phone technology on different aspects of agricultural development, there is to the best of our knowledge, no study that has evaluated the impact of mobile phone technology on agricultural productivity in ssa, extensively covering countries in multiple periods. this study contributes to the literature by examining the impact of mobile phones on agricultural productivity. thus, rather than addressing broader economic growth, or singling out an agricultural product, we focus on the agricultural productivity. the results of the study could help policymakers make the case to extend mobile phone coverage to states, regions or provinces where it is currently lacking. this study aims to contribute to the existing literature and create a background for further research into the role of mobile phones in the agricultural sector in ssa and elsewhere. data data sources and variable the description of the production input and output variables used in this study are discussed in table 2, whilst their summary statistics are presented in table 3 table 2: production and productivity variables. table 3: summary of descriptive statistics. descriptive statistics the average for the 41 countries during the 25-year period over which the data were collected was 2.92 million worth of agricultural output, with an average harvested area of 4816.18 hectares of land, employing an average of 4.2 million persons in labour. there was an average fertiliser application of 54 327.5 metric tonnes of active ingredients (nitrogen, potassium and phosphorus). output during the period was highly variable, ranging from $34.8 million to over $40 billion. also, there was an average of 19.13 mobile phone subscriptions per 100 people, with a variability ranging from 0 to 171.38 subscriptions per 100 people. table 2 provides a brief description of the variables employed in the study, while table 3 provides a summary of the descriptive statistics. methodology to achieve the objective of this study, two main empirical approaches were used. firstly, agricultural tfp was estimated following an approach by fuglie and rada (2013). according to coelli et al. (2005:62), ‘in the presence of multiple outputs and inputs, total factor productivity may be defined as a ratio of aggregate output produced relative to aggregate input used’. in other words, the growth in the agricultural output of a country is dependent on the factors of production (land, labour, capital, materials), as well as increases in tfp – improvements in the efficiency of an aggregate bundle of inputs (fuglie & rada 2013). following the estimation of tfp, panel data regression models were used to investigate the effect of several macro-economic variables, including mobile phone technology on agricultural tfp growth in 41 ssa countries for the 1990–2014 period. measuring agricultural total factor productivity indexes in order to estimate the tfp for the countries by adopting an approach from fuglie and rada (2013), the following cobb-douglas agricultural production function was used: where ln represents natural logarithms; yt is output at time t; at is the productivity index at time t (a0 is the base-period productivity); xjt is the measured quantity of ‘the effective’ quantity of input j (in constant quality units); zjt is a vector of quality shifters in input j, which may vary over time; øj is the elasticity in output with respect to input quality and the residual εt includes tfp growth and random fluctuations in output: given equation (2)jems-24-3744-i, an index for tfp is derived which is the difference between current output and predicted output without technical change where tfpt is simply tfpteut and â0, â0, are estimated values from equation (2)jems-24-3744-i: where st is local research and developmemnt (r&d) stock; wt is a vector of other variables, affecting the rate of productivity growth, including technology spillover from outside sources and the enabling environment for technology diffusion; α1 is the elasticity of output with respect to local r&d stock (research elasticity); α2 is the vector of coefficients on wt variables. from equation (3)jems-24-3744-i and taking natural logs, we arrive at: the regression provides estimates of the parameters α1 and α2: where ηc is a vector of country-specific random effects. total factor productivity indexes given the estimates of the parameters from equation (5)jems-24-3744-i, growth in tfp over time is calculated for each country as: therefore, the changes in tfp simply calculated by taking the difference between growth in aggregate output and aggregate inputs (adjusted for quality) for the individual country. by setting = 100 as the base year, agricultural tfp indexes for all the countries in the region is derived. using this approach, the indexes of agricultural tfp in the 41 countries for each year between 1991 and 2014 was estimated (figure 1 provides average tfp scores estimated using this approach). figure 1: average agricultural productivity in sub-saharan africa, 1990–2014. determinants of productivity growths fuglie and rada (2013) investigated the effects of a number of variables in agricultural total factor productivity growth (tfp) in sub-saharan africa (ssa). the authors considered the effects of national investments in agriculture, international agricultural research, ‘enabling’ variables for the diffusion of improved technologies, including farmer schooling and health (human capital), governance, and infrastructure. the authors further considered the effect of hiv/aids on the adult population, the incidence of armed conflict and nominal rate of assistance to agriculture on tfp growth. these guided our choice of variables (control variables) in estimating the impact on mobile technology on agricultural tfp growth in (ssa). using a similar approach to fuglie and rada (2013), we employed panel data to investigate the effects of a number of variables on agricultural tfp growth: where tfp represents total factor productivity; refprop represents refugee/population ratio; mobile represents mobile phone subscriptions/100 persons; hiv represents percentage of the total population (15–49) having the virus; hc represents years of schooling and return to education; creit represents agricultural credits; resesp represents agricultural research capacity and expenditure; infra represents the satisfaction of the public with basic infrastructural amenities; safelaw represents safety and rule of law; exchangerate denotes the rate at which the us dollar exchanges for the local currencies of countries included in our sample. we take the logarithmic transformation of exchange rate to stabilise the variance of our data. α0–α9 are vectors of unknown parameters to be estimated and vi represents random noise. results and discussion agricultural productivity growth figure 1 shows that the average level of agricultural productivity in sub-saharan africa is relatively high. although cameroon had the lowest average agricultural productivity between 1990 and 2014; the country’s average agricultural productivity was as high as 73.87 during this period. meanwhile, uganda had the highest average agricultural productivity at 129.74. baseline econometric analysis the baseline regression model is estimated, using the least squares dummy variables (lsdv) method. results are presented in tables 4–6. this section presents the results obtained from our baseline regression model using the lsdv technique. spherical disturbances are ensured using the driscoll-kraay standard errors (driscoll & kraay 1998). table 4 (column 1) provides the results obtained, using the lsdv method. the result suggests that agricultural productivity rises by 12.7%, with one additional person subscribing to a mobileconnection. this estimate supports the idea that mobile technology has been significant in driving agricultural productivity in sub-saharan africa. table 4: world bank classification of sub-saharan africa countries grouped by income levels. table 5: pooled ordinary least squares (pols) and least squares dummy variables (lsdv). table 6: low income, lower middle and upper middle. control variables turning to the results of the control variables, we find that hiv and human capital have a negative impact on agricultural productivity. however, the refugee population ratio and infrastructure have no significant impact on agricultural productivity. robustness tests alternative estimation technique in testing the robustness of our results to an alternative estimation technique, we momentarily drop the lsdv technique and ensure spherical disturbances through a different method. specifically, we employ the pooled ordinary least squares (pols) method and adjust for heteroscedasticity and autocorrelation through the newey-west standard errors (newey & west 1987). using the hausman test (hausman 1978), pols and lsdv are compared and the result recommends the rejection of the null hypothesis that pols is consistent. consequently, the results of the pols method may not be unaffected by endogeneity bias, possibly due to the omission of the country fixed effects. unsurprisingly, the result obtained from the pols technique is slightly different from that of the lsdv method. using the pols technique, the positive impact of mobile phone subscription on agricultural productivity reduces marginally to 11% at 5% significance level (table 5, column 2). impact of mobile technology on agricultural productivity by income groups following the world bank (2021) classification of countries by income levels, we split our sample into low income, lower-middle income, and upper-middle income sub-saharan african countries (see table 4). the world bank defines low-income economies as those with a gross national income (gni) per capita of $1045 or less; lower middle-income with gni per capita between $1046 and $4095; upper middle-income with gni per capita between $4096 and $12 696. subsequently, we investigate the extent to which the results vary across income levels, using the lsdv technique. in the low-income sub-saharan african countries, agricultural productivity rises by 29.8% with one additional person subscribing to a mobile phone (table 6, column 1). also, in the case of the lower-middle income sub-saharan african countries, a similar increase in mobile subscriptions impacts positively on agriculture by about 16.5% (table 6, column 2). the results obtained for low-income and lower-middle income sub-saharan african countries are statistically significant at a 1% level. however, the positive impact of mobile subscription is notably higher in the case of the former. moving on to the result obtained for the upper-middle income sub-saharan african countries, we find that phone subscription does not have a statistically significant impact on this group of countries. controlling for countries with low total factor productivity as part of our sensitivity analysis, we utilise the lsdv method to investigate whether our results are driven by some countries recording the lowest average agricultural productivity during the timeframe of this study (i.e. 1990–2014). to this purpose, we exclude from our sample, cameroon, cape verde and sierra leone; thereafter, agricultural productivity is again regressed on our set of explanatory variables. the results obtained are very similar to those obtained in the baseline (table 7, column 1). consequently, the positive impact of mobile subscriptions is not driven by countries with a low level of agricultural productivity. table 7: accounting for countries with low total factor productivity (tfp), and inclusion of additional control variables. inclusion of additional control variables in this sub-section, we include in our model some control variables which have been proven in the literature to be drivers of agricultural productivity. these variables include land, labour machinery and fertiliser. the results obtained are not significantly different from those obtained previously (table 7, column, 2) conclusion and policy implications this research investigates the contribution of mobile phone technology and its impact on agricultural productivity in ssa. this research work, to the best of our knowledge, is the first to report evidence suggesting that the adoption of mobile phone technology is also a driver of agricultural productivity in ssa. a method employed by fuglie and rada (2013) was used to explain changes in agricultural tfp growth in ssa. these variables were regressed against tfp to explain the changes in agricultural tfp growth. our result indicates that mobile technology enhanced and contributed to agricultural tfp growth in ssa. the use of mobile phone technology helped farmers to access information on prices and logistics, and even assisted them in entering new markets. it also allows the transfer of information between rural areas and core markets. the negative impact of hiv on agricultural productivity suggests that adequate measures should be taken to reduce the spread of it, as it affects the number of people available for agricultural work, in terms of those affected by the disease, and because family members and friends spend otherwise productive time looking after them. according to wdi (2017), the ssa region is the poorest region in the world. there is an urgent need to rescue this region from its present precarious situation. the world development report (2008) states that growth in the agricultural sector has double the potential of other sectors to reduce poverty. riaz (1997) observed that significant improvements in the telecommunications infrastructure in malaysia, aided not only agricultural productivity, but also a successful economic transformation. corroborating this, madden and salvage (1998) reported that failure to advance telecommunication infrastructure in the transitional economies of countries in central and eastern europe led to a decline in trade performance and regional productivity. since mobile phone technology has been found to be positively related to agricultural tfp growth, and there is evidence that telecommunication infrastructure helped to revive weak economies, it is only reasonable that investments in mobile telephony be increased and sustained with the aim of increasing agricultural productivity and, eventually, economic growth. study limitations this research work is limited in terms of data availability. we relied on secondary sources of data; data on a national level for a set of predominantly developing economies where resources devoted to data collection are low which might consequently give rise to estimation issues. our model estimations were inevitably limited in terms of obtaining a set of consistent time series across all the variables which, as hypothesized might influence agricultural productivity. this study paves the way for further studies to employ other methods such as parametric and non-parametric methods, to measure agricultural productivity and to explore other drivers of productivity. acknowledgements competing interests the authors declare that they have no financial or personal relationships that might have inappropriately influenced them in writing this article. authors’ contributions o.a was involved in the conceptualisation of the study, literature review, data analysis, presentation and interpretation of results. o.t. was involved in reviewing the analysis, the write up and the manuscript. a.i. provided quantitative expertise during the review process with a modification to the data analysis and interpretation of results. ethical considerations this article followed all the ethical standards for research without direct contact with human or animal subjects. funding information this research received no specific grant from any funding agency in the public, commercial, or not-for-profit sectors. data availability the data used in the study were obtained from the fao, the world bank, united nations human development data, the next generation of the penn world table, the international 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http://databank.worldbank.org/data/home.aspx. world bank, 2021, world bank country and lending groups, viewed 01 august 2021 from https://datahelpdesk.worldbank.org/knowledgebase/articles/906519-world-bank-country-and-lending-groups. world development report, 2008, what can agriculture do for development? viewed n.d., from http://www.evidenceondemand.info/world-development-report-2008-agriculture-for-development. world development indicators, 2017, statistical data base, viewed 27 february 2018, from https://data.worldbank.org/. microsoft word 1 chan, oerlemans & pretorius sajems 14(4) 2011.docx sajems ns 14 (2011) no 4 361 innovation outcomes of south african new technology-based firms: a contribution to the debate on the performance of science park firms kai-ying a chan graduate school of technology management, university of pretoria leon ag oerlemans department of organisation studies & center for innovation research, tilburg university and graduate school of technology management, university of pretoria marthinus w pretorius graduate school of technology management, university of pretoria accepted: april 2011 science parks are often established to drive regional economic growth, especially in countries with emerging economies. however, mixed findings on the innovation outcomes of science park firms are reported in the literature. this study systematically identifies innovation outputs used in the science park literature and argues: (a) that firms generate different outcomes at various stages of the innovation process; and (b) that their use is a possible explanation for the mixed findings reported in the field. this paper combines a knowledge production function approach, modeling knowledge transfers and spillover flowing to new technology-based firms (ntbfs) in the emerging south african economy with innovation outcomes, which are measured by using a multi-dimensional construct. the estimations produce non-consistent and non-systematic results across different dimensions of innovation outcomes, implying that results are outcome indicator specific and that it makes sense to distinguish multiple indicators of innovation outcomes referring to different phases in a firm’s innovation process. key words: innovative outcomes, science parks, knowledge transfer, spillovers, new technology-based firms jel: d83, l14, o31 1 introduction by now, science parks are an established phenomenon. the concept can be traced back to the 1950s, when the silicon valley region, with the support of stanford university, was transformed from an agricultural valley into the birthplace of the semiconductor and ict industry. following the usa experience in the 1960s, the development of the cambridge science park (uk) and sophia antipolis (france) has set a good example for many european countries. the majority of the science parks that currently exist worldwide were created during the 1990s, while about 18 per cent of them were launched within the first two years of the new century. today there are over 400 science parks in the world, concentrated primarily in countries with developed economies. over 140 of them were established in north america. the reason for this rapid growth of science parks around the world is the belief, held mostly by policy-makers in industrialized economies, that the establishment of these parks would promote economic growth and competitiveness among cities and regions by creating new business, adding value to companies, and creating new knowledge-based jobs (the international association of science parks). the foundation of a science park is abstract 362 sajems ns 14 (2011) no 4 often used as a policy intervention to stimulate high technology start-ups (mcadam & mcadam, 2008). this is where government provides infrastructure, industry provides business skills and funding, and universities provide research knowledge and new technological development; it is also known as the triple helix of university-industry-government relations for innovation (etzkowitz & leydesdorff, 2000). an important function of any science park is to contribute to the establishment of a knowledge-based economy by fostering market-oriented technological development. this type of economy depends on three interrelated processes: local knowledge creation, transfer of knowledge from external sources and transformation of that knowledge into productive activities and valued outcomes (chen & choi, 2004). consequently, networking among firms and between firms and universities to transfer knowledge and foster collaboration and innovation are processes vital to science parks. despite the benefits that science parks might bring, researchers have been studying the science park phenomenon to analyze the extent to which science parks are just ‘high tech fantasies’ (massey et al., 1992; bakouros, 2002) or not (yang et al., 2009). to ascertain the ‘added-value’ of a science park location, researchers believed comparative studies should be conducted (westhead, 1997; lindelöf & löfstsen, 2004). these studies compared the behavior and performance of firms located on a science park with firms that were not in order to explore the potential differences between them. interestingly, in this literature researchers reported mixed empirical findings on the performance of science park firms. some researchers found empirical evidence of the ‘added-value’ of science park location (e.g. felsenstein, 1994; lindelöf & löfstsen, 2004), whereas others clearly questioned the assumed benefits of the science park model (e.g. westhead, 1997; malairaja and zawdie, 2008). the latter group of scholars found that there are no differences between on-park and off-park firms relating to their performance. further details of these comparative studies will be elucidated in a later section. from observations on these studies, we can conclude that there are at best ‘mixed’ findings on the performances of science park firms. the mixed evidence in the empirical literature prompted us to ask the following question: does the use of different innovation outcomes indicators explain the mixed findings reported in the literature? the observations in the later section pointed to the various dimensions of innovation outcomes used in the science park literature and suggested that the outcomes of innovation processes of science park firms can be observed at different stages of this process. this may be one of the main causes of the mixed findings. this study contributes to the science park literature in three ways. first, it provides a review of the comparative studies on the performance of science park firms, indicating mixed empirical findings. this paper suggests that these mixed findings are due to the use of a portfolio of outcome measures, which can actually be related to the various stages of the innovation process through which firms proceed. further, this paper investigates the extent to which knowledge resources transferred both intentionally and unintentionally play a role in the theoretical model developed. in other words, the link between knowledge transfer and firm innovativeness is explored with the result that two largely detached literatures, one on inter-organizational knowledge transfers and the other on knowledge spillovers, are combined in one study. secondly, most science park studies use the number of ‘patents’ and ‘new products/ services’ (e.g. westhead, 1997; siegel et al., 2003; akçomak & taymaz, 2004) as main indicators of firm innovative performance. these indicators give only a partial view of the multiple dimensions firm’s innovation outcomes. in this study, innovation outcomes are conceptualized as a multi-dimensional construct and are thus measured with multiple indicators to come to a more encompassing view of the innovation performance of science park firms. thirdly, most science park studies are conducted in developed economies, whereas the context for this study is an emerging economy, south africa. such empirical studies are relatively scarce, but highly relevant. in developed economies, science parks are often more easily and better sajems ns 14 (2011) no 4 363 connected to the rest of the system of innovation. this is not always true of emerging economies (lorentzen, 2009), which often lack a well-developed, connected system of innovation. consequently, firms located in science parks in emerging economies have to focus more strongly on the interaction with partners located in the same science park. interaction with spatially proximate partners brings certain benefits, but also some potential disadvantages (knoben & oerlemans, 2006), such as lock-in effects. this paper therefore adds to our knowledge of the functioning and outcomes of an interesting aspect of the innovation system in non-western economy. this empirical article is organized as follows. in the next section, the results of a literature review on the performance of science park firms will be presented. in section 3, the results of this review are included in the theoretical framework of this study and relevant hypotheses will be developed. section 4 describes the research methodology applied in exploring our theoretical framework. section 5 discusses the results of the analyses of data on south african new technologybased firms (ntbfs), focusing on firms’ knowledge transfer behaviours and innovation outcomes. section 6 provides concluding remarks and recommendations for policy makers and further studies. 2 science parks and mixed findings: a literature review what is known about the performance of science park firms as discussed in the recent literature? to answer this question, a literature search was conducted using google scholar, science direct, swetwise and proquest as search engines. key words used were ‘on-park firms’, ‘off-park firms’, ‘science park performance’, ‘science park evaluation’, ‘benefits of science parks’ and ‘added-values of science parks’. the main purpose of this literature review was to gain an overview of the empirical results and measures applied in past studies regarding science park firms. the details of the review are summarized in this study.1 besides the names of the author(s), the following criteria were included: • country and period: where and when was the research conducted? in particular we wanted to know the country in which a study was conducted, as collaborating cultures differ from country to country; • research focus: which research questions do studies set out to answer? from this column the researchers’ various foci can be deduced, as well as the existing lacunae; • research methodology: which research methodologies do studies apply to answer their research questions empirically? in these two columns we can explore the ‘commonly used’ research methodologies. this gives an indication of the maturity of the field. moreover, we could learn from these approaches in our own empirical study. • indicators of innovation outcomes: which indicators of innovation outcomes of firms were used in the studies included in this review? • key results: regarding the aspects studied: do onand off-park firms differ from one another? from this column, we can see which findings on science park performance are reported in the literature. an initial observation after analyzing the literature is that westhead, lindelöf and löfsten are very active researchers in this field of study. moreover, most of the studies were conducted in the period between 2002 and 2004, using longitudinal data sets (ranging from three to ten years) which are necessary when examining indicators of firm performance such as ‘employment growth’ or the ‘survival’ of firms over time. the establishment of science parks increased from 1973 (iasp website) until 1987, after which there was a decline, followed by another increase from 1997 onwards. this growth-declinegrowth phenomenon in science park creation may be one of the reasons why more researchers, using comparative approaches, investigate the extent to which science parks bring benefits. it was found that the majority of studies were conducted in western countries (the uk, sweden and italy), while only a few took place within emerging economies (israel, malaysia 364 sajems ns 14 (2011) no 4 and taiwan). there is a clear absence of comparative studies in emerging economies. the collaborative culture differs from country to country. western cultures (western europe, north america and australia) are characterized as individualistic, whereas some nonwestern culture (asian, south american and african) often are characterized as collectivist (green et al., 2005). differences between cultures may influence how firms (residing in a specific country) interact with one another. studies tend to focus on three areas: (1) employment growth (westhead & cowling, 1995; colombo & delmastro, 2002; ferguson & olofsson, 2004; akçomak & taymaz, 2004); (2) industry-academic links (felsenstein, 1994; löfsten & lindelöf, 2002; lindelöf & löfsten, 2004; akçomak & taymaz, 2004; dettwiler et al., 2006); and (3) innovativeness, as indicated by r&d inputs, outputs and productivity (westhead 1997; colombo & delmastro, 2002; siegel et al., 2003; akçomak & taymaz, 2004; yang et al., 2009). an examination of the measurements for innovation outcomes used in these studies gives a mixed picture: researchers apply patent counts (used eight times), followed by the number of new products/services (five times) and copyrights (three times). this finding indicates that researchers use a variety of innovation outcome measures. as far as knowledge transfers are concerned the focus is mainly on the knowledge links with local universities. other linkages, such as with business partners (e.g. buyers or suppliers) or with other science park firms, are often not taken into account. moreover, researchers seem to focus on intended knowledge transfers, paying little attention to unintended knowledge transfer (knowledge spillovers). from the methodological perspective, it can be noted that most studies used a ‘matched sampling’ approach to selecting ‘comparable’ off-park firm, in line with the properties of on-park firms. the two sample sizes are more or less equal, ranging from 40 to 139 for each paired sample. this finding shows a commonly-accepted way of sampling. all the studies used questionnaires and surveys to collect firm-level data. one exception was yang’s study, in which panel data from a financial databank was used. this shows a trend in ‘firm-level’ analysis in exploring performance by science parks. most studies used ‘independent sample t-test’ for continuous and discrete variables and the ‘chisquared test’ for dummy variables. these two statistical analysis tests are commonly used when comparing variables from two independent samples and exploring any significant differences between the groups of firms to show the ‘added-value’ of science parks. moreover, from this literature review it can be concluded that there is a lack of use of multivariate analysis to explore more finegrained and complex relationships between firm characteristics and performance (e.g. using multivariate regression analysis). a comparison of the research findings in the studies included in our review reveals that there are mixed findings when it comes to the added value of science park location to firms: • employment growth: some studies find no significant difference between onand offpark firms (westhead & cowling, 1995; akçomak & taymaz, 2004; ferguson & olofsson, 2004), whereas others report that on-park firms experience higher employment growth (löfsten & lindelöf, 2002; colombo & delmastro, 2002); • interactions with universities: some studies report no significant difference between onand off-park firms (malairaja & zawdie, 2008), while others find that onpark firms experience higher levels of interaction with (local) universities (felsenstein, 1994; lindelöf & löfsten, 2004); • r&d outputs and productivity: some studies find no significant difference between onand off-park firms (westhead, 1997; colombo & delmastro, 2002; lindelöf & löfsten, 2003, 2004), whereas others report that on-park firms have higher r&d outputs and productivity (siegel et al., 2003; yang et al., 2009). studies report similar findings on specific indicators, but these do not support the ‘promises’ that science parks often make: sajems ns 14 (2011) no 4 365 • there are no differences between onand off-park firms regarding sales/profitability (löfsten & lindelöf, 2002; ferguson & olofsson, 2004). • there are no differences between onand off-park firms regarding r&d inputs (westhead, 1997; colombo & delmastro, 2002). from the mixed findings observed, it can clearly be seen that not all science parks deliver on their promises to bring ‘addedvalue’ to their firms and connected regions. in this section it is shown that there is a variety of possible different innovation outputs used, which can be connected to the various stages of the innovation process. in other words, some of the firms are in the early stages of their innovations, when they are seen as the inventor firms, and some of them are close to the full commercialization of their technological innovations. finding different innovative outcomes could therefore result from the mixed types of innovations on which science park firms are working. in order to investigate this possible explanation further, this paper takes on a firm-level knowledge production function (acs, audretsch & feldman, 1994) as a starting point and asks the following research question: does the use of different innovation outcomes indicators explain the mixed findings reported in the literature? 3 theoretical framework 3.1 innovation process model and innovation outcomes in this study, the definition of innovation outcomes is based on the one proposed by ernst (2001): an achievement in the trajectory from the conception of an idea up to the introduction of an invention into the market. many studies use one dimensional conceptualizations only and thus single measurements of innovative performance like ‘patents’ (e.g. bottazzi & peri, 2003) or the number of new products introduced (e.g. stock et al., 2002). with ernst’s definition in mind, one could look at innovation from the point of view of process, that is, looking at the whole innovation process cycle. within this innovation process model, various phases could be identified: basic research, invention, product development, and production, marketing and sales (khilji, mrockowski & bernstein, 2006). certain types of innovation outcomes are associated with each phase. for example, patent outputs are associated with the initial stages, such as basic research and invention, whereas sales of innovative products are usually an indication of innovation outputs during the commercialization stage of production, marketing and sales. consequently, innovation outcomes are a multi-dimensional construct that has to be measured with multiple indicators (see figure 1). f i g u r e 1 the innovation process and innovation outcomes2 stage 1: basic research stage 2: invention stage 3: early-stage technology development stage 4: product development stage 5: production, marketing & sales new products/scope of innovation results innovation salespatents patents in each of the activity phases depicted in figure 1, internal and external resources and capabilities are used to arrive at the outcomes mentioned. in the literature, this approach is referred to as the so-called modified knowledge production-function approach (feldman, 1994), in which it is maintained that the acquisition of and the access to internal and 366 sajems ns 14 (2011) no 4 external resources have to be combined with an effective internal utilization of these resources. consequently, the absorptive capacity and resources have to be combined in one model (see below). 3.2 knowledge resources knowledge is identified as a key resource for a technology-based firm’s ‘competitive advantage’, because it is difficult to replicate and is critical to the process of innovation (murmann, 2003; thornhill, 2006; ichijo & nonaka, 2007). in studies on innovation production functions, knowledge is often referred to as an important input (hall & mairesse, 2006; roper et al., 2008). knowledge can be generated internally within a firm or obtained externally from other actors. for knowledge to be generated internally, a firm must have certain internal resources or capabilities for example, scientists or engineers doing in-house r&d. absorptive capacity as an important basis of a firm’s innovative capability is a crucial internal resource (tsai, 2001; gao et al., 2008). in this age of increasing globalization and complex technological innovation, the use of internally-generated knowledge resources is no longer sufficient for technological innovation. firms often acquire and use knowledge from external actors to complement their internal knowledge bases for innovative products or services development. researchers have distinguished two categories of knowledge transfer: intended and knowledge transfers and spillovers (fallah & ibrahim, 2004; oerlemans & meeus, 2005). an intended knowledge transfer is a conscious and deliberate transfer of knowledge between two or more organizations often in the context of a formal collaboration agreement. on the other hand, knowledge spillovers refer to knowledge flows resulting from deliberate search activities by innovating firms, leading to an inflow of knowledge and information but without the formal consent of the owners of this knowledge and information. 3.3 absorptive capacity as internal knowledge activity absorptive capacity was introduced by cohen and levinthal in 1990, who defined it as firms’ fundamental learning processes, that is, their ability to identify, assimilate and exploit knowledge. moreover, absorptive capacity as a path is dependent on the prior knowledge base of a firm. zahra and george (2002) later proposed additional definitions that divide cohen and levinthal’s definition of absorptive capacity into two main dimensions: potential absorptive capacity (the capabilities to acquire and assimilate knowledge) and realized absorptive capacity (the capabilities to transform and exploit knowledge) (zahra & george 2002). many empirical studies have shown that there is a positive relationship between absorptive capacity and innovation. pennings and harianto’s study (1992) showed that prior accumulated experience in a certain technological area increased the likelihood of innovation adoption. becker and peters (2000) and nelson and wolff (1997) argue that firms need higher absorptive capacities for scientific knowledge than for other types of knowledge. tsai (2001) showed in his study that an organizational unit’s absorptive capacity is positively related to its innovation activity, because ‘organizational units with a high level of absorptive capacity are likely to harness new knowledge from other units to help their innovative activities’. gao et al. (2008) show that firms with a higher absorptive capacity are more likely to innovate than those with a lower absorptive capacity. the above discussion makes it clear that absorptive capacity is strongly associated with innovative performance. we thus propose hypothesis 1 as: the higher the levels of absorptive capacity, the higher the firm’s innovation outcomes. 3.4 intended knowledge transfers as channels of external knowledge resources firms establish linkages with other organizations with the intended purpose of accessing and acquiring different knowledge assets from external actors to develop their own technological innovations. a firm can interact with its partners on a formal basis. one of the common strategies is by means of formal collaborations, like joint r&d, as effective ways of employing outside knowledge resources and increasing the effectiveness of innovations (du & ai, 2008). the governance of this type of collaboration is most often sajems ns 14 (2011) no 4 367 through mutually-accepted contracts to control the relationship between the parties with the intention of increasing the level of success in the knowledge transfer process (mentzas et al., 2006). knowledge also can be transferred between organizations on a non-contractual basis by means of so-called informal networking activities which are conducted without any formal agreements between parties. informal networks can be created by means of informal/social functions arranged between two organizations like breakfast/lunch meetings or golf events. through these informal ties, the knowledge on how new products are created or other innovative ideas can be shared during social conversations. studies have shown the positive relationship between intended formal and informal interorganizational network activity and innovative performance. for example, a study by berg jensen, johnson, lorenz & lundvall (2007) shows that firms that applied a so-called doing, using and interacting mode (informal processes of learning) in combination with a mode accessing and using codified knowledge, outperform firms relying predominantly on only one of the two modes. boschma and ter walt (2007) reported that the strong local network position (a high number of formal inter-organizational relationships) of a firm tended to increase its innovative performance in an industrial district. it is through these intended interactions (i.e. ties in networks) that external knowledge is able to flow to an innovating firm. intended knowledge transfers fuel innovations. firms involved in interorganizational networks are able to gather more knowledge resources to perform their innovative activities. partners with formalized relationships (e.g. through contracts) with a focal firm or those involved in informal relationships are more willing to share (and less likely to hold back) knowledge owing to the trust existing in these relationships. as a result, the receiver-firm is able to access better or more knowledge resources for successful innovations. networks also provide opportunities for firms to compare and integrate intended knowledge flows from various sources so that new knowledge may emerge for technological development. based on the above theoretical arguments, we propose hypothesis 2: the higher the number of intended knowledge transfer relationships, the higher the firm’s innovation outcomes. 3.5 knowledge spillovers as external knowledge resources knowledge spillovers (fallah & ibrahim, 2004; oerlemans & meeus, 2005; erbas et al., 2008) can be defined as knowledge inflows resulting from deliberate search activities by innovating firms leading to an inflow of knowledge and information but without the consent of the owners of this knowledge and information. firms without the knowledge necessary for developing competitive advantage can engage in such activities to reduce their knowledge disadvantage, for example, by ‘hiring away well placed knowledgeable managers in a firm with a competitive advantage or by engaging in a careful systematic study of the other firm’s success’ (barney, 2000: 214), by imitating other firms’ technologies, or by monitoring other firms’ innovative activities. thus, knowledge spillovers ‘denote the benefit of knowledge to firms not responsible for the original investment of the creation of this knowledge’ (almeida & kogut, 1999: 905). previous researchers have attributed positive innovation effects to knowledge spillovers (jaffe et al., 2000; fallah & ibrahim, 2004; oerlemans & meeus, 2005; mukoyama, 2003). learning from knowledge spillover has the same benefits as intended knowledge transfers, that is, there are more knowledge resources to perform innovative activities (alcácer & chung, 2007). however, the main benefit of knowledge spillover is that relatively low costs are involved in acquiring such knowledge, in comparison with the high costs involved (e.g. contract costs) when a firm accesses intended knowledge transfers through formalized relationships or develops this knowledge internally. hence, hypothesis 3 reads: the higher the knowledge spillover, the higher a firm’s innovation outcomes 3.6 science park location as external knowledge resources in the literature, science park location (spl) is reported to have many value-added advantages 368 sajems ns 14 (2011) no 4 for firms (fukugawa, 2006). science park firms are thought to have more networking opportunities with other resident firms on account of their geographical proximity. besides this, which provides the possibility of face-to-face encounters, one of the tasks of a science park management team is to organize networking activities like seminars and social events amongst on-park firms as well as with organizations located outside the science park premises. science park location therefore plays a role in facilitating knowledge transfer and innovative performance by firms, and can consequently be regarded as a (geographical) resource. thus, hypothesis 4 reads: firms with a science park location have higher innovation outcomes in comparison with firms without science park location. the above three hypotheses form the research model that this study will explore empirically. this research model is shown in the figure 2: f i g u r e 2 research model h2 + h3 + h1 + intended knowledge transfer knowledge spillovers innovation outcomes absorptive capacity science park location h4 + 4 methods 4.1 sample and data collection the focus of this study is the relationship between knowledge transfer relationships and multiple dimensions of innovation outcomes at the firm level. units of analysis are ntbfs located in the gauteng region of south africa. on the one hand, gauteng was chosen because it has one of the few well-functioning systems of innovation in south africa (lorentzen, 2009), whereas, on the other hand, variation due to geographical location is excluded, which is an advantage from the methodological point of view. the firms chosen for this study fulfill the criteria for ntbfs: small firm size (the number of employees, including directors/ceos, is fewer than 50), a young firm age (fewer than 10 years since establishment) and highly technology-based (e.g. ict, biotech, electronics industries). this research applies a quantitative research methodology. data on the firms’ knowledge transfer relationships and innovative performance were gathered by means of questionnaires sent to ceos or directors of ntbfs. to ensure quality of feedback, most questionnaires were distributed personally, with short interviews to assist the completion of the questionnaires. a total of 52 valid questionnaires was returned, 24 of which came from ntbfs situated in the innovation hub (a science park) and 28 which came from independent ntbfs not located in a science park. the collected data were analyzed by applying multivariate regression analysis using spss software. 4.2 measurements of variables table 1 lists the items used in the questionnaire to measure the variables proposed in the research framework. the items were based on measures proposed in the literature and a 5-point likert-type scale was used. table 2 shows the literature sourced when constructing our measurements, as well as the reliability statistics (cronbach’s alphas) of the scales used. reliability tests were carried out for the independent variable ‘knowledge spillovers’ and the dependent variable ‘relative innovative performance’, which were measured using multiple items (both have six items using 5-point likert scale). cronbach’s alphas of these two variables are 0.702 and 0.644 sajems ns 14 (2011) no 4 369 respectively. cronbach’s alpha of 0.6 was used as a threshold value, which is sufficient for exploratory studies. these two variables can thus be measured with a single, unidimensional latent construct. 4.2.1 dependent variables in this study, we conceptualize innovation outcomes as a multi-dimensional construct. this study distinguishes various dimensions of innovation outcomes which are associated with various stages of the innovation model: (1) number of patents; (2) number of new products/services developed but not yet introduced into the market; (3) scope of innovation results; (4) innovation sales from improved products/services; (5) innovation sales from products/services new to the firm (see figure 1). the first type of innovation outcome (patents) is associated with the two initial stages of the innovation process, basic research and invention. t a b l e 1 item(s) of variables and their sources independent variables item(s) absorptive capacity indicate level of agreement with the following statements: (1) most of our staff are highly skilled and qualified; (2) we invest a great deal in training; (3) we innovate by improving competitors’ products and processes; (4) most of the time we are ahead of our competitors in developing and launching new products; (5) we have the capacity to adapt others’ technologies; (6) we innovate as a result of r&d carried out within our own firm; (7) we have considerable resources and own knowledge resources for technological development; (8) we are able to introduce into the market innovations which are completely novel on a worldwide scale. (5 points likert scale: 1 = strongly disagree, 3 = neither agree nor disagree, 5 = strongly agree) intended knowledge transfers (otte & rousseau, 2002) formal relationships number of organizations (suppliers, buyers, consultants, competitors, universities, public labs and sector institutes) with which the respondent firm has formal/contractual agreements to acquire knowledge. informal relationships number of organizations (suppliers, buyers, consultants, competitors, universities, public labs and sector institutes) with which the respondent firm interacts on a non-contractual basis (i.e. informal, social basis) to acquire knowledge. knowledge spillovers (howells, 2002) how often does your firm use the following sources from other organizations/actors to acquire knowledge for your firm’s innovations? (1) employing key scientists and engineers (including poaching key staff); (2) acquiring key information at conferences and workshops; (3) reverse engineering of technological knowledge embedded in products developed/produced by other firms/organizations; (4) accessing patent information filed by other firms/organizations; (5) knowledge embedded in organizational processes or routines of other firms/organizations; (6) publications in technical and scientific papers by other firms/organizations. (5 point likert scale: never, rarely, sometimes, regularly or always; α =0.702) sp location is the firm located in the innovation hub (y/n)? dependent variable item(s) firm’s innovation outcomes sales items (laursen & salter, 2006) scope item (oerlemans & meeus, 2005) five indicators of innovation outcomes were used: 1. patents: did the firm file patents in 2007? (yes/no) 2. developed products/services: did the firm develop new products/services but has not yet introduced them into the market in 2007? (yes/no) 3. incremental innovative sales: the percentage of sales of products/services that were technologically improved to the firm in 2007 4. new innovative sales: the percentage of sales of products/services that were developed using technologies new to the firm in 2007. 5. scope of innovation outcomes: the technical performance due to innovations. for the last item, the following question was asked: to what extent did your firm’s product and/or service innovations result in: (a) reduction of development and maintenance costs; (b) quality improvement of products and/or services; (c) increase in production capacity; (d) improvement in delivery times. (5 points likert scale: 1 = very little, 3 = not little / not much, 5 = very much; (α = 0.656)). control variables item(s) firm age number of years the firm has existed. firm size total number of employees including the ceos and directors in 2007. 370 sajems ns 14 (2011) no 4 the second and third types of innovation outcome are the development of new products or services and the scope of innovation outcomes (oerlemans & meeus, 2005). the latter outcome variable is a qualitative dimension indicating that ‘part of the innovative efforts of firms are directed at, for example, a reduction of cost prices, quality improvements or the speeding up of internal processes’ (oerlemans & meeus, 2005: 96). the last two outcome variables are innovative sales (laursen & salter, 2006) which capture the commercial performance of innovations expressed as the percentage of sales of new or improved products and services. this outcome indicator was first introduced into the european community innovation survey. in the questionnaire used for this research, ‘technologically new or improved innovation’ means that fundamental characteristics of products or services are new or significantly improved in relation to the essential characteristics of comparable earlier services or products. there should be a wider range of use for the client and/or the relevant technical product specifications should show significant improvements in comparison with the specifications of earlier versions. these outcomes are innovation outcome measures associated with the commercialization stage (production, marketing and sales) of the innovation process. to conclude, the indicators used in this study as indicators of innovation outcomes are illustrated in table 1. 4.2.2 independent and control variables this study distinguishes between ‘intended knowledge transfers’ and ‘knowledge spillovers’ as specifications of the general concept of ‘knowledge transfers’. intended knowledge transfers are measured by taking two types of knowledge relationships into account: after all, a firm can acquire intended knowledge by means of both formal and informal relationships. knowledge spillovers are observed by the firm’s ‘imitative’ or ‘opportunistic’ behaviour, such as ‘reverse engineering’ or ‘monitor other firms’ innovative activities’. the third independent variable is science park location (yes/no). out of the 52 ntbfs we surveyed, 24 firms are situated in the innovation hub, which is the first internationally accredited science park in south africa. the recipient’s firm age and firm size are included as control variables. we controlled for these, given that these two firm attributes have been important factors for the propensity of firms to acquire and exploit knowledge resources (e.g. bresman et al., 1999; agarwal & gort, 2002; cavusgil et al., 2003). smaller and younger firms often face significant risk and uncertainty owing to lack of knowledge resources (liability of newness). 5 empirical results 5.1 descriptive statistics means and standard deviations associated with the variables under study are presented in table 2. the mean scores for all eight items of absorptive capacity are above the mid-point of 3 (on a scale of 1 to 5); this shows that firms possess an above-satisfactory level of absorptive capacity. on average, ntbfs access intended knowledge from about 10 partners formally and about 37 partners informally. the average of the knowledge spillover score is close to 1.5 on a scale of 5, showing that, on average, ntbfs “rarely” to “sometimes” search in this mode. about 46 per cent of the firms in the sample are located in a science park location. ntbfs report that, on average, 42.12 per cent of their sales come from innovated products and services which are technologically improved to the firm, whereas about 30 per cent of sales were generated with products or services that were technologically new to the firm. the average score for the scope of innovation outcomes (i.e. technical performance owing to innovations) is 3.68, indicating a relatively high level. the averages of firm age and size are 5.13 years and 9.25 employees respectively. this shows that the sample firms are young and small. sajems ns 14 (2011) no 4 371 t a b l e 2 means and standard deviations variables mean std. dev. independent variables: absorptive capacity item 1 absorptive capacity item 2 absorptive capacity item 3 absorptive capacity item 4 absorptive capacity item 5 absorptive capacity item 6 absorptive capacity item 7 absorptive capacity item 8 intended knowledge transfer through formal relationships (number) intended knowledge transfer through informal relationships (number) knowledge spillovers (ks) sp location (spl) 4.23 3.31 3.06 3.73 3.94 3.87 3.60 3.73 9.75 37.49 1.519 0.46 0.899 1.213 1.290 1.012 0.802 1.205 1.107 1.206 12.516 39.45 0.671 0.50 dependent variables: innovation outcomes patents filed in 2007 developed products/services not yet on the market (2007) innovative sales improved to the firm innovative sales new to the firm scope of innovation outcomes 0.135 0.558 42.12 30.10 3.572 0.345 0.501 35.81 30.33 0.809 control variables firm age firm size 5.13 9.25 3.61 9.91 the items of ‘absorptive capacity’ were entered in a principal component factor analysis that produces a two-factor solution (kmo = 0.655; bartlett = 70.411; p = 0.000). table 3 shows that absorptive capacity items 3, 2 and 5 loaded onto a factor that can be named ‘absorptive capacity for incremental innovations’; whereas the second factor containing items 1, 6, 7 and 8 can be labeled ‘absorptive capacity for new innovations’. note that item 6 is not loading onto any of the two factors and is therefore excluded. t a b l e 3 factor analysis for absorptive capacity independent variable component 1 2 absorptive capacity for incremental innovations (acii): item 2: our firm invests substantially in training. item 3: our firm innovates by improving other firms’ products and processes. item 5: our firm has the ability to adapt other firms’ technologies. absorptive capacity for new innovations (acni): item 1: most of the staff in our firm are highly skilled and qualified. item 6: our firm innovates as a result of its own r&d. item 7: our firm has considerable resources and own knowledge resources for technological development. item 8: our firm is able to introduce into the market innovations which are completely novel on a worldwide scale. 0.722 0.762 0.703 0.500 0.809 0.532 0.682 5.2 multivariate regression analysis with the five dimensions of innovation outcomes as dependent variables, as well as two types of intended knowledge transfers (formal and informal ties), a total of 10 models was estimated. the models in this study are estimated by using spss to perform binominal logistic regression analyses for the first four models and ordinary least square-based regression analyses for the next six models. 372 sajems ns 14 (2011) no 4 5.2.1 innovation outcomes: patents and developed products/services not yet on the market if patents filed in 2007 are used as the dependent variable, it turns out that, with the exception of knowledge spillovers in the model for informal ties, none of the independent variables plays a statistically significant role. this model shows that a more frequent use of the knowledge spillover mechanism is associated with a higher probability of filing a patent. additional analyses revealed that firms filing a patent accessed the patents and scientific publications of other organizations. this indicates an imitative mode of innovation. moreover, it is interesting to see that, in the (science park) literature, knowledge transfers are often regarded as generating patents, but this is apparently not really the case here. this finding may be explained by what was found in interviews conducted among sample firms who expressed their reluctance to file patents because of the cost of doing so. in addition, it was expected that the firms with a science park location perform innovative activities and therefore would have filed patents. this was generally not the case in the south african context. for the second innovation output discerned, “developed products/services not introduced in the market yet”, also knowledge spillovers play a positive and significant role. at the firm level, knowledge spillovers are associated with opportunistic behaviours such as imitation, which seems to be displayed by south african firms. firms imitate with the intention of improving the features of their already-existing technologies. in the case of south africa, it seems that firms gain benefits from knowledge spillovers during the early stage of the innovation model when developments take place. t a b l e 4 results of binominal logistic regression analysis (n=52) * p < 0.10; ** p < 0.05; *** p < 0.01; n. r2 = nagelkerke’s r square; hl-test = hosmer and lemeshow-test 5.2.2 innovation outcomes: scope of innovation and innovative sales when it comes to the scope of innovation outcomes, none of the external knowledge resources from either formal or informal ties has statistically significant impacts. this implies that none of the variables indicating the inter-organizational network activity of these types impacts on this dimension of innovation outcome. on the other hand, the absorptive capacity for incremental innovations (acii) has a positive and significant impact. thus hypothesis 1 is partially supported. for the models in which innovation sales from improved products/services are the dependent variable, none of the variables in the two models has statistically significant f-values (p < 0.1), which means that the estimated regression models do not fit the data. it is interesting to observe that the absorptive capacity for incremental innovations has no impact on sales of products or services that are technologically improved (i.e. incremental variable dimension of innovation outcomes patents filed in 2007? developed products/services but not yet introduced on market in 2007? ikt = formal ties ikt = informal ties ikt = formal ties ikt = informal ties constant age size acii acni ikt ks spl 0.06* 0.93 0.97 0.81 0.73 1.21 3.56 0.24 0.05* 0.97 1.12 0.98 0.70 0.99 5.85* 0.31 1.14 0.89 0.69 1.01 1.63 1.04 4.56* 0.39 0.95 0.96 0.72 1.18 1.67 1.00 4.88* 0.37 n. r2 hl-test 15.6% 0.053 16.3% 0.223 28.0% 0.845 26.4% 0.355 sajems ns 14 (2011) no 4 373 innovations). as far as the knowledge transfer variables are concerned, neither intended knowledge transfers nor knowledge spillovers have any impact on this dependent variable. moreover, science park location does not play a role in incremental innovation outcome. overall, regarding this type of outcome, it can be concluded that none of the hypotheses are confirmed. the results of regression analyses for the innovation outcome indicator ‘innovative sales new to the firm’ are shown in the last two models in table 5. only the last model with knowledge transfers via informal ties is statistically significant (f-value p < 0.1). in this model, a higher number of informal knowledge transfer relationships results in a lower level of sales of technologically new product/service innovations. thus hypothesis 2 is rejected for informal knowledge transfer relationships. on the other hand, the other two external knowledge resources (knowledge spillovers and spl) have positive and significant impacts on the innovation outcome of this type. consequently hypotheses 3 and 4 are confirmed for these resources. t a b l e 5 results of ols regression analysis (n=52) * p < 0.10; ** p < 0.05; *** p < 0.01 6 conclusions and discussion 6.1 findings and implications the primary objective of this study was to investigate the effects of internal knowledge resources (in terms of absorptive capacities) and external knowledge resources (in terms of knowledge transfers and science park location) on a variety of innovation outcomes that are associated with the various stages of a firm’s innovation process. the study set out to answer the research question: does the use of different innovation outcomes indicators explain the mixed findings reported in the literature? based on a review of the literature, four hypotheses were formulated. in the empirical section of the paper, a sample of ntbfs located in the gauteng region, which is the economic engine of south africa, was used. data was collected during the firm-level by means of structured interviews with questionnaires targeted at the directors or ceos: 52 valid questionnaires were obtained and about 50 per cent of these firms were located in a science park. statistical analysis using multivariate regression models presents several interesting findings, which will be discussed below. we start our discussion on the findings of this study with the observation that a generally accepted model of knowledge production produces non-consistent and non-systematic results across different dimensions of innovation outcomes. the implication is that it makes sense to distinguish multiple indicators of innovation outcomes referring to different variable dimension of innovation outcomes scope of innovation outcomes innovation sales technologically improved products/services innovation sales technologically new products/services ikt = formal ties ikt = informal ties ikt = formal ties ikt = informal ties ikt = formal ties ikt = informal ties constant age size acii acni ikt ks spl 3.63*** 0.20 -0.34* 0.33* 0.07 0.29 -0.13 0.14 3.54*** 0.22 -0.12 0.39** 0.16 0.21 -0.16 0.14 37.2** 0.12 0.08 0.21 0.10 -0.02 -0.14 0.13 36.6** 0.06 0.13 0.16 0.15 0.22 -0.24 0.10 32.9** -0.07 -0.31** -0.12 -0.11 0.09 0.14 0.22 26.1* 0.01 -0.24 0.01 -0.15 -0.37** 0.35** 0.30** r2 f-value vifs 28.0% 2.06* 1.08 – 2.06 27.4% 1.94* 1.17 – 1.76 10.7% 0.75 1.01 – 1.97 15.9% 1.16 1.04 – 1.65 19.4% 1.52 1.01 – 1.97 26.8% 2.25** 1.04 – 1.65 374 sajems ns 14 (2011) no 4 phases in a firm’s innovation process. a very clear example of this is the variable “number of informal ties”, which has no impact on the probability that a firm has a product or service innovation that has not yet been introduced into the market, but has a negative impact on the sales generated by technologically new products or services. we therefore advise scholars researching the performance of science park firms to start their empirical research from a broad conceptualization of innovation outcomes and not to focus on just one outcome dimension, which is often the case in current research. a second highly interesting finding is that the models perform poorly when outcome measures that reflect outcomes in the early phases of the innovation process are used, whereas the innovation sales indicator, which is a measure related to the commercialization stage of innovations, produces much better results. many science parks are established by policy-makers and regional actors to increase inventions and innovations, which would become visible with higher numbers of patents or newly-developed products and services. this does not seem to be case in the south african context. as the results show, these science park firms are able to market their product and service innovations, but such a location seems not to matter for early stage innovation outcomes. how are these results to be interpreted? one interpretation is that this science park and its firms are doing a good job, as they seem to be able to generate economic value from their innovations. after all, in the past these product and service innovations could have been related to a patent or were not yet introduced on a market. such results would be pleasing to policy-makers because generating economic value is exactly the aim of many parks. however, the question is how sustainable these innovation outcomes are. a critical look at the findings reveals, on the one hand, that intended knowledge transfers lower innovation sales outcomes. this is a very unusual finding, because the vast majority of other studies point in exactly the opposite direction (cassiman & veugelers, 2006; ahuja, 2000). one explanation of this counterintuitive result lies in the way in which these independent variables were measured. all intended knowledge transfers were measured using degree centrality, that is, the number of formal or informal ties with external actors. informal relationships are often maintained with actors who are very similar. this so-called homophily effect (mcpherson et al., 2001) in networks has a negative effect on innovation because similar actors have similar knowledge. maurer and ebers (2006) found that too many relationships with similar actors may result in relational lock-in, which contributes to inertia in social capital and the concomitant negative impact on firm performance. an alternative explanation is related to the quantity and quality of the knowledge and information acquired through informal relationships. as demonstrated here, the ntbfs in our sample hold many informal ties, which could lead to information overload, whereas at the same time the knowledge possessed by these external social actors is not necessarily the most relevant from the business perspective. on the other hand, it is found that knowledge spillovers (often a result of opportunistic behavior) are important to innovation outcomes in the south african context. this corresponds to findings in a study by oerlemans and pretorius (2006) in which they reported that south african firms tended to be imitative by nature. this is not necessarily a bad thing in an economy that lacks all kinds of (knowledge) resources. as yamamura, sonobe and otsuka (2005) show for the japanese motorcycle industry, an imitation strategy can be beneficial in the early growth stages of firms and industries. this concurs partly with the finding in a study by aghion et al. (2001), who show that a little imitation enhances economic growth owing to increased neck-and-neck competition. however, they point out that excessive imitation is growth-reducing. all in all, it could be concluded that this imitation strategy is not viable in the long run. the findings of this research have important implications for managerial practice at different levels. at the firm level, managers of science park firms could reconsider the composition of their network of relations by decreasing the number of informal ties, because there is strong evidence that too many sajems ns 14 (2011) no 4 375 informal ties reduce innovation outcomes. a second recommendation could be to reconsider the imitation innovation strategy. the own or co-development of improved or new products would, in the long run, lead to a more competitive and successful business community in south africa. at the level of science park management, taking a critical look at the activities and composition of firms located in science parks is also a recommendation. although the commercialization of innovative products and services is certainly an important dimension of the performance of science parks, it is also important to have firms that are in the early stages of the innovation process, so focusing more on knowledge development becomes a further consideration. 6.2 limitations and direction for future research although this study reveals valuable insights into the relationship between absorptive capacity, intended inter-organizational knowledge transfers, knowledge spillovers, science park location, and a variety of innovation outcomes at the firm level, some limitations remain. first, these findings are limited to a population of small technology-based firms in south africa. it is therefore worthwhile to examine the relationships proposed in this paper in other contexts. second, the dependent variable in the models (innovation outcomes) does not take process innovations into account. however, from the preliminary data analysis, the business and innovation activities of most firms in the sample are not focused on process development, but more focused on products/services development. thus, although the results of this study do not give a complete picture of technological innovation in ntbfs, they are still valid in the south african context. third, although this research took a differentiated approach by distinguishing between formal and informal knowledge transfer relationships, only the number of direct ties was taken into account. this is a commonly accepted approach in the field (ahuja, 2000), but it implies that other relevant aspects of inter-organizational knowledge transfer relations are not included in the models. examples are the strength of ties (gilsing & nooteboom, 2005) or the characteristics of partners in the networks (tether, 2002). this research raises a number of directions for future research. first, moderator variables may be explored to further examine which factors may have an influence on the relationship between intended knowledge transfers and knowledge spillovers on the one hand, and innovative performance on the other. an example could be the type of partner because the probability of knowledge spillover is higher when the collaborative partner is, for example, a competitor (hamel, 1991). second, this research has been performed in an emerging economy. similar studies could be conducted in other countries with emerging economies to benchmark the results of this research. third, as mentioned earlier in the limitations of this study, other aspects of network characteristics could be included in future studies. for example, knowledge from networks established with ‘technologically similar’ partners may enhance incremental innovations, whereas with partners who have totally different technologies (e.g. ict versus biotech), radical innovations may open up an entirely new market (laursen & salter, 2006). endnotes 1 due to 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south africa citation adriano, j. & callaghan, c.w., 2020, ‘work-life balance, job satisfaction and retention: turnover intentions of professionals in part-time study’, south african journal of economic and management sciences 23(1), a3028. https://doi.org/10.4102/sajems.v23i1.3028 original research work-life balance, job satisfaction and retention: turnover intentions of professionals in part-time study judite adriano, chris w. callaghan received: 14 feb. 2019; accepted: 10 june 2020; published: 28 sept. 2020 copyright: © 2020. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: undertaking degree studies while working can provide life-changing career opportunities. these studies, however, can introduce substantial work-life balance conflict, particularly for those with family responsibilities, with important implications for retention. aim: the aim of this study is to test theory that predicts the effects of certain moderating and mediated influences on the relationship between work-life balance conflict and turnover intentions of professional staff undertaking evening degree classes at a selected south african university. setting: the sample was drawn from a large university in gauteng, south africa. methods: this study applies hayes’s process methodology to test the moderating effects of age, gender, numbers of dependent children, social support, engagement and levels of stress on the relationship between work-life conflict and turnover intentions. further tests of mediation are performed to test the mediating influence of job satisfaction on the same relationship. results: findings suggest a unique configuration of moderating and mediation influences relating to the work-life balance conflict for this cohort, particularly for those with dependent children. those with more children who experience higher levels of work-life balance conflict are less likely to display higher turnover intentions. individuals with higher levels of social support are however more likely to report higher levels of turnover intentions. conclusion: these results support the conclusion that the relationships between work-life conflict and turnover intentions for working individuals undertaking evening degree classes in this context, display a different configuration of moderating influences from those expected in general working populations. employers and other stakeholders should pay particular attention to these implications so as to ensure retention of scarce skills. keywords: turnover intentions; intent to quit; withdrawal intentions; work-life balance, retention, staff development; human resources. introduction when an organisation loses employees, their knowledge is lost as well. this loss of knowledge can be at cost to an organisation’s competitive advantage (omotayo 2015; sarra, benabou & tabeti 2013). the loss of highly skilled employees can result in the loss of tangible sunk costs, related to recruiting, hiring and training, and intangible costs, associated with reduced productivity, loss of knowledge and the loss of employee morale (kantor & crosser 2016). given the direct threat of voluntary exit to inimitable tacit organisational knowledge stocks (kinnear & sutherland 2000), and to competitive advantage (omotayo 2015; sarra et al. 2013), knowledge of what contributes to turnover intentions is of particular importance across contexts in today’s competitive business environments. the retention of skilled professionals is therefore a dominant concern of organisations due to the high turnover rates they are facing globally, as well as increased competition in recruitment (samuel & chipunza 2009). given the costs to organisations of the lack of this knowledge, and resultant uncertainty, it is necessary for human resource practitioners to turn to theory to better understand these relationships. knowledge of the relative salience of the demographic, social and organisational influences on the relationship between work-life balance and employee attrition is therefore an important topic of research across different contexts of work. this study seeks to extend previous work to better understand how theory derived from general work contexts predicts certain moderating influences on the relationships between work-life conflict and the turnover intentions of employed persons that are engaged in evening degree studies at a large south african university. social exchange theory suggests that employee assessments of the quality of their interchange relationships with their organisations are related to their well-being and commitment to the organisation (avanzi et al. 2014). such interchange relationships may however not be independent from demands placed on them by family life and the pressures of part-time study undertaken for work-related reasons. indeed, decreases in an individual’s work-life balance might work through the job dissatisfaction channel to contribute to withdrawal intentions and intent to quit, thus thwarting a firm’s retention strategies. furthermore, the strength of the contribution of work-life balance to employee retention may be influenced by certain demographic characteristics such as age, gender and number of dependent children. similarly, the strength of this relationship may also be influenced by the social support an individual receives, as well as organisational factors such as engagement and stress, which may be experienced more intensely, or even unequally, in a societal context of resource scarcity (papageorgiou & callaghan 2014). maintaining a work-life balance or successfully managing conflict between employee work and non-work-life, including family life (grzywacz & carlson 2007), is thus an important dimension of the reciprocal relationship between an individual and the organisation. job satisfaction relates to the extent to which an individual is satisfied with current work roles associated with the job (oosthuizen, coetzee & munro 2016). levels of job satisfaction are therefore key to employee retention (dockel, basson & coetzee 2006). there is thus agreement in the literature on the importance of work-life balance conflict, and of the effect of job satisfaction as a channel through which deficits in the work-life balance can contribute to voluntary turnover. what is less clear is the salience of these relationships for employees that are undertaking degree studies evening classes in the south african context of gauteng, for the following reasons. firstly, in the fast-paced context of the country’s commercial heartland, work-related work-life balance conflict (wlbc) pressures might be the most intense in the country. having achieved democracy in 1994, the country faces legacy challenges related to disadvantage and inequality, which make the attainment of degree education a necessary condition for career advancement in certain fields. given the country’s historical legacy of educational inequality, many in formal employment were denied opportunities for formal higher education. the part-time degree studies programmes of large gauteng universities therefore have an important role in addressing these legacy effects. undertaking degree studies for career progression may, however, have an important influence on an individual’s work-life balance. the influence of high levels of work-life conflict may be compounded if one’s earlier schooling was compromised by such legacy effects. knowledge of the consequences of these work-life balance effects, related to part-time studies on intent to quit, is arguably of particular importance in such a context. similarly, given the differences in careers that are related to differences in subject choices (papageorgiou et al. 2014), what is lacking is knowledge of these relationships that generalise across an entire sample of students. secondly, what is not clear in the literature is the extent to which undertaking degree studies (where classes are held in the evenings, unlike distance education which is more flexible in its time requirements) while maintaining formal employment, and (in some instances) managing a family and family life, might alter the conditions under which work-life balance and retention relate to each other. whereas the literature relating to general working contexts offers a theoretical model of what these relationships are across contexts, what is lacking in the south african literature is a model of these relationships at this time, for this particular cohort. of particular interest are the moderating roles of demographical variables like age, gender and number of dependent children on the relationship between work-life balance and voluntary exit, or an individual’s intent to leave their employment, or intent to quit. similarly, what is also not well understood about this cohort is the potential role of satisfaction as a mediator of the relationship between work-life balance and intent to quit. under certain conditions, the pressures of having a family to provide for, together with those of part-time degree studies which require evening classes might create dissatisfaction, but it is unclear under which conditions this might contribute to employee attrition. indeed, under certain conditions, dissatisfaction might not influence an individual’s turnover intentions, and might not mediate the relationship between work-life conflict and turnover intentions at all. such a result might have particular importance for employers in this context. thirdly, what is also lacking in this context is knowledge of the role of social support, as well as organisational factors such as engagement and stress, in the relationship between work-life balance and intent to quit for this cohort. such knowledge may provide useful insights for those who are in a position to provide societal support to those undertaking part-time studies while working. these insights might also be useful to employers seeking to support these staff members, and may contribute to more effective retention strategies. given the importance of this knowledge in this context, the study poses the question: under what conditions does work-life balance contribute differently to employee withdrawal cognitions for this cohort of individuals? in doing so, this work therefore seeks to contribute to the literature on work-life balance and turnover intentions, such as that by du plooy and roodt (2013) which seeks to better understand certain moderating effects and their influence on turnover intentions in the south african context. this work has relevance even to research on commitment from the broader regional context (chinomona, chinomona & joubert 2013). in seeking to contribute to the literature, this study therefore seeks to offer useful contextual understanding, and a more holistic perspective (goldman & callaghan 2015), of how direct and interactive effects manifest in the specific and unique context of employees who face work-life conflict from the pressures of work and study in this context. having introduced the focus of the study, it proceeds as follows. firstly, theory is reviewed and hypotheses are derived for testing. next, the methods of the research are introduced. results are then reported and discussed. the article then concludes. theory and hypotheses work-life balance has been defined as the degree to which there is equitable satisfaction and engagement relating to an employee’s work and family roles (greenhaus, collins & shaw 2003). certain studies have failed to find an empirical relationship between work-life balance and turnover intentions (riley 2006), whereas others have found work-life balance to directly affect turnover rates of employees and their turnover intentions (moore 2007). similarly, higher levels of work–family conflict (schilling 2014) have also been found to increase intent to quit. although studies have found mixed results in different settings, given the context of the cohort tested here, who have evening degree classes in addition to working and, in many cases, family responsibilities, hypothesis 1 is derived: increases in work-life balance conflict are significantly associated with increases in intent to quit. noor (2011) defines work-life balance as the efficient management of certain ‘balancing acts’ related to work, family and other activities. individuals in full-time employment who undertake degree studies on evening programmes often have to balance work activities with those of academic studies. older individuals might have been disproportionately exposed to the educational legacy effects of the pre-democracy era. if older individuals experience greater difficulties in part-time degree studies, this might reduce their work-life balance relative to those who are younger. similarly, the length of time out of school might pose greater adjustment pressures, which might be exacerbated by greater family commitments. on the other hand, those older in this cohort might have more experience in managing such pressures, and might in certain cases even have a motivational advantage. what is not clear, however, is whether older or younger individuals are relatively more vulnerable to withdrawal cognitions when their work-life balance is disrupted or reduced. it is not clear if older employees, in this specific cohort, with greater family commitments remain with a firm irrespective of differences in job satisfaction associated with work-life pressures. whereas many of these relationships can be predicted, using a general theoretical model drawn across work contexts, we suggest that this cohort is not typical of general workers across contexts, given the unique historical context of the country which may have resulted in a new paradigm of work post 1994. on the basis of this logic, hypothesis 1.a is derived: higher work-life balance conflict may be less likely to contribute to withdrawal intentions for older employees in part-time degree studies. boundary theory predicts that inter-role conflict can be reduced by adequately managing work and non-work commitments, through effective boundary management, or through the maintenance of temporal, physical, as well as psychological borders (clark 2000). notwithstanding attempts to manage it through boundary management, inter-role conflict can take the form of work–family conflict on account of either interference from family with work, or interference from work with family. work–family conflict can result from time-based, strain-based and behaviour-based conflict (greenhaus & beutell 1985). behaviour-based conflict refers to clashes in behaviour, when certain behaviours, deemed appropriate within the workplace context (for example assertiveness) can, in the family context, produce tension (greenhaus & beutell 1985). time-based strain might be particularly problematic if gender roles place a disproportionate (and unfair) amount of time pressure on women (associated with family responsibilities, or the maintenance of a home, even without dependent children). it is not clear, however, what the extent is to which these family pressures differ by gender in their effect on the influence of work-life balance on withdrawal intentions, in this specific cohort. if women face gender-discriminatory burdens in family life, this might contribute to work-life balance conflict, but the extent to which this transmits to withdrawal cognitions is not clear in this context. hypothesis 1.b is therefore offered: the relationship between work-life balance and intent to quit is moderated by gender. according to spillover theory, excessive time demands in either the family or work domains can result in spillover from family to work or from work to family (edwards & rothbard 2000). nevertheless, an individual with more dependent children might be less risk-taking in their job-changing behaviour. on this basis, hypothesis 1.c is derived: the relationship between work-life balance conflict and intent to quit may be weakened when an individual has more dependent children. although time-based inter-role conflict theory suggests certain negative relationships between different roles, another theory suggests that these relationships can also be positive (pradhan 2016). carlson et al. (2006) suggest two mechanisms through which work–family enrichment can occur. the instrumental mechanism refers to conditions where resources attained in one role instantly enhance performance in a different role. the affective mechanism refers to instances where work–family enrichment transpires incidentally through the impact of a positive outcome. social support, for example deriving from family and other social roles, might contribute to performance in other realms, but can also reduce the reliance of an individual on a job role that they are dissatisfied with continuing in. hypothesis 1.d is therefore derived: the relationship between an increase in work-life balance conflict and intent to quit is increased under conditions of higher social support. similarly, various studies have confirmed that certain experiences in a working environment can augment family life (pradhan 2016). organisational factors that increase engagement may also reduce the contributions of lower work-life balance to increased withdrawal cognitions, hence hypothesis 1.e: the relationship between an increase in work-life balance conflict and intent to quit is reduced at higher levels of engagement. an increase in withdrawal cognitions can result from job dissatisfaction, as well as from decreased work-life balance. job dissatisfaction might however act as a primary channel through which decreases in work-life balance contribute to withdrawal intentions. theory offers certain plausible reasons why this might be so. dissatisfaction with work-life balance pressures might be amplified in a family context, if psychological strain (stress) on an individual due to increased time and work pressures (such as those associated with the demands of evening classes that compound work commitments) extends to a partner or other members of a family, as predicted by crossover theory (pradhan 2016). it bears noting that this cohort was also exposed to the feesmustfall protests and its aftermath, the experience of which might have been stressful for certain students at this institution (jogee, callaghan & callaghan 2018). similarly, stress might be ‘amplified’ through the same mechanism suggested by crossover theory, if an individual’s stress has an influence on other members of the family. hypothesis 1.f is therefore offered: the relationship between increases in work-life balance conflict and intent to quit is strengthened at higher levels of stress. job matching theory is built around the notion that fresh information about the job match, is what results in turnover (mincer & jovanovic 1979). according to this perspective, before commencing a job, employees may have ‘imperfect’ information and as a result may have uncertainties regarding the value they gain as their job tenure increases. similarly, withdrawal cognitions are a function of this match, because the identification of a mismatch in the employment relationship often occurs at the beginning rather than towards the end (mincer & jovanovic 1979). therefore, the longer an individual is with an employer, the less likely it may be for an employee to quit for this reason. key to retention is therefore the subjective job satisfaction of the employee, which may be a function of the extent to which expectations are met in the workplace context. indeed, satisfaction is key to the retention of knowledgeable workers (coetzee & martins 2007; dockel et al. 2006). job satisfaction is defined here as a general affectional inclination of individuals toward work roles that they currently occupy (oosthuizen et al. 2016), which accords with weiss, dawis and england’s (1967) definition of job satisfaction as the extent to which a person accomplishes and sustains correspondence with the surroundings fulfilling their extrinsic and intrinsic desires. low levels of job satisfaction result in augmented intention to leave among employees, intensifying an individual’s turnover intention (martin & roodt 2008; özbağ & ceyhun 2014). job satisfaction has been found to partially (noor 2011) and fully (fayyazi & aslani 2015) mediate the relationship between wlbc and turnover intentions in certain contexts. similarly, job satisfaction has also been found to mediate the relationship between family-to-work conflict and turnover intentions (riley 2006). other research has, however, found job satisfaction to not mediate the relationship between work–family conflict and turnover intentions (özbağ & ceyhun 2014). the action of job satisfaction as a mediator of the relationship between wlbc and turnover intentions might therefore be context specific. hence we derive hypothesis 2: job satisfaction mediates the relationship between work-life balance conflict and turnover intentions in this context. having reviewed certain relevant literature, and having derived hypotheses for testing, the methods undertaken to test these hypotheses are now discussed. methods the study applied a cross-sectional quantitative research design. questionnaires were used to collect data from a cohort of employed degree students taking evening classes. the sample was drawn from a large university in gauteng, south africa. we undertook a quantitative study as certain theoretical frameworks already exist that link the variables. however, these theoretical frameworks, and examples of previous work, were drawn from the broader work context, and it was necessary to test the specific theory in this particular context, with regard to this specific cohort. quantitative methods were chosen as they allow for the summarisation of large amounts of information and are well suited to comparative analysis (kruger 2003). a population refers to people who have certain attributes and are of concern to an investigator. the population for this study comprised the general population of full-time employees employed within various organisations across industries in gauteng that were also studying in university part-time evening degree programmes. an attempt was made to sample the entire part-time studies population of the university. a census sampling strategy was therefore applied. both email and hard copy questionnaires were used to sample responses. refusals were unconditionally respected. a sampling protocol was followed to ensure consistency in the respondents’ experience of the data sampling process. notwithstanding a relatively high number of refusals, 315 usable responses were ultimately attained. this amounted to a response rate of about 29% of the estimated 1100 students in the evening studies programme. an outline of the sample in terms of factual and demographic data is provided in table 1. the majority of respondents are in the age range of 20 to 35 years (71%), with a sizable portion between the ages of 36 and 50 (20%). women comprise the majority, as do those who are unmarried. black employees make up 67% of the sample. the racial breakdown broadly reflects the demographics of the province, gauteng, providing support for the representativeness of the sample. of the total respondents, 52% indicated having dependent children. over half the sample was therefore expected to be managing three-way work-life balance roles that extended to studies, work and family responsibilities. table 1: biographical and demographic profile of respondents (n = 315). we used the principles of reliability and validity to guide the research process. reliability, or consistency, was assessed though cronbach’s alpha tests. piloting was also used to ensure reliability and validity. the scales and their sources are now discussed. turnover intention roodt’s (2004) unpublished turnover intention scale was used to measure the intentions an employee has to either stay with or leave an organisation. the scale is also used by jacobs and roodt (2008). it consists of 14 items measured using a seven-point likert scale which ranges from ‘never’ to ‘always’. the scale has previously been validated in the south african context, attaining a cronbach’s alpha of 0.80 (see bothma & roodt 2013). in this study, its value is 0.84. work-life balance haslam et al.’s (2015) work–family conflict scale (wafcs) was utilised to assess wlbc. the scale consists of 10 items in which five items are used to measure family-to-work conflict and the remaining five items are used to assess work-to-family conflict. these measures apply a seven-point scale to measure participants’ agreement with statements, varying from ‘very strongly disagree’ to ‘very strongly agree’. the alpha in this study was 0.877. job satisfaction the minnesota satisfaction questionnaire (msq) has been widely used to measure job satisfaction (weiss et al. 1967). the scale contains 20 items that measure individuals’ intrinsic, extrinsic and general levels of satisfaction with the use of a five-point likert-type scale, ranging from ‘very dissatisfied’ to ‘very satisfied’. on account of piloting, 18 of the 20 items were retained, with the remaining items measuring a composite of extrinsic and intrinsic motivation. the incorporation of both intrinsic and extrinsic motivation was taken to be important in that this captured an individual’s satisfaction with a broad range of influences. this scale has previously been used in the south african context with acceptable reliability (for example, by visser and coetzee 2005, who obtained an alpha of 0.88 for these items). the alpha for this item in this study was 0.877. stress and engagement the subjective job stress scale (sjss) was used to measure individual job stress (motowidlo, packard & manning 1986). this scale included likert-type scale items that sampled responses ranging from ‘strongly disagree’ to ‘strongly agree’. the alpha for this scale was 0.80. the employment engagement survey (wilson 2009) was utilised to measure employee engagement. these items have demonstrated reliability in wilson’s previous study, with an alpha of 0.77. the alpha found for this study is 0.80. perceived social support zimet et al.’s (1988) multidimensional scale of perceived social support (mspss) was used to measure the degree to which a person recognises social support from significant others, family and friends. the scale consists of 12 likert-type items. it has been found to be reliable in other contexts, such as an alpha of 0.83 in the african context (nakigudde et al. 2009), 0.73 in a cohort of war veterans (wilcox 2010) and 0.91 in the context of thailand (wongpakaran, wongpakaran & ruktrakul 2011). in this study, the alpha value was 0.924. ethical consideration this study adhered to the various ethical guidelines. an ethics clearance certificate was issued after the study was approved by the university of witwatersrand’s ethics committee (protocol number cbuse/1233, 25 may 2017). the confidentiality and anonymity of the research participants was respected. the research respondents were made aware that their participation was voluntary, and respondents were given the freedom to withdraw at any given time. most importantly, informed consent was obtained prior to the participation of the respondents. ethical standards were maintained throughout the processes of the study. data analysis univariate analysis was performed to check for missing values. the biographical and demographic profile of respondents is reported in table 1. descriptive statistics are reported in table 2. multiple linear regressions were utilised to test hypothesised direct, mediated and moderated relationships. hypothesis testing was performed using a significance level of 5%, or α = 0.05. the process macro for spss (hayes 2013) was used for analysis. assumptions of the regression analysis process were assessed, including the assumptions of normality of residuals, homoscedasticity and multicollinearity. table 2: descriptive statistics. residual plots were inspected, and histograms were plotted for residual values. on the basis of these plots the residual distribution was taken to approximate normality. this suggested little evidence of heteroscedasticity. variance inflation tests were performed to test for multicollinearity. these values were also taken to provide reasonable evidence that multicollinearity was not a threat to the interpretation of the results. overall, for most of the variables, skewness was within the acceptable limits of ±2 (field 2000). in order for nominal variables to be included in the regression analysis, this study made use of dummy variables, which are often used in the investigation of the influence of categorical variables (holgersson, nordström & öner 2014; yip & tsang 2007). linear regression models can only be used when there is a quantitative dependent variable, as well as quantitative continuous or dummy predictive variables (çilan & can; 2014; gujarati & porter 2009). therefore, seeing that many predicative variables in surveys are often categorical, they need to be converted to dummy variables in order to use traditional linear regression models. for this reason, the creation of dummy variables is acceptable practice in regression analysis (gujarati & porter 2009). stevens (1946) outlines the four types of scales that include interval, nominal, ordinal and ratio data. the various types of scales can be distinguished by the group of transformations each can be subject to without losing empirical information (stevens 1946). according gujarati (2011), nominal, ordinal, interval and ratio scales are typically used in quantitative analysis. results and discussion the results of the hypothesis testing are now reported and discussed: h1: increases in work-life balance conflict are significantly associated with increases in intent to quit. model 1 includes the covariate factors, namely age, gender and race dummies, and number of dependents. table 3 reports the results of the tests of the hypotheses. after including our variable of interest, wlbc, its coefficient is significant (p = 0.0001), over and above the influence of the covariates. the null hypothesis is rejected. these results differ from those of riley (2006) who found no relationship between work-life balance and turnover intention. these findings suggest that, at least in terms of this core relationship, these results have much in common with those in the broader context of working relationships. table 3: regression coefficients for hypothesis 1. only three demographic variables make a unique statistically significant contribution to the model, namely age, race (black and coloured), as well as our predictor variable, wlbc. in the first model, black employees report significantly higher turnover intentions when wlbc is not included in the model, but when included, both black and coloured employees are associated with higher levels of turnover intentions. older employees report significantly lower turnover intentions, which accords with the literature (see martin & roodt 2008). gender is not significant, however, in its direct association with withdrawal cognitions. h1.a: higher wlbc may be less likely to contribute to withdrawal intentions for older employees in part-time degree studies. the hayes process model was used to test the significance of the interaction term of age and wlbc, which was not found to be significantly associated with turnover intentions (p < 0.216). the model was tested with the inclusion of covariate effects, so as to ensure that the test was not confounded by these other influences. at low levels of wlbc there is little difference between younger and older individuals (figure 1), but at higher levels of wlbc, older employees seem to have marginally higher levels of turnover intentions. this result accords with studies that have not found any moderating effects of age in the prediction of turnover intention. for example, age has been found to fail to moderate certain relationships in workplace contexts, such as those between organisational embeddedness and turnover intentions (peltokorpi, allen & froese 2015), but age has been found to moderate relationships predicting turnover intentions (du plooy & roodt 2013; hellman 1997) in other settings. these findings suggest the importance of context, in that age has a direct and decreasing influence on turnover intentions but does not affect the relationship between wlbc and withdrawal intensions in this setting. h1.b: the relationship between work-life balance and intent to quit is moderated by gender. figure 1: age as a moderator on work-life balance conflict–turnover intention relationship (two-way interaction). the interaction effect between gender and wlbc (figure 2) is not significant (p = 0.935). figure 2: gender as a moderator on the work-life balance–turnover intention relationship (two-way interaction). women have marginally higher turnover intentions than men, both at low and high levels of wlbc. the interaction effect is not significant, however, suggesting that men and women experience these relationships similarly in this context. the finding is however at odds with various studies that found moderating effects of gender in the prediction of the turnover intentions of employees (cotton & tuttle 1986; peltokorpi et al. 2015), but is in line with other studies that have failed to find gender to moderate predictors of the turnover intentions, as well as to moderate the relationship between work-life balance and turnover intentions (du plooy & roodt 2013). this finding highlights the contextual relevance of gender as a moderator of these relationships. the majority of respondents are female, constituting 63% of the sample. a large portion of the sample (33%) reported having 6–10 years of experience. the majority also reported being single (60%), the largest group coming from the banking and finance industries (21%). these demographic characteristics suggest that many individuals in this context might be seeking to qualify before starting a family. these results contribute to the literature on gender differences in university-related environments (fatoki 2015). h1.c: the relationship between wlbc and intent to quit may be weakened when an individual has more dependent children. the interaction effect of wlbc and numbers of dependent children is significantly associated with the intent to quit (p = 0.002), net of differences associated with age, race and gender. as shown in figure 3, individuals with fewer dependent children are more likely to quit, both at low and high levels of wlbc. the difference between these groups is larger at higher levels of wlbc, suggesting that those with family responsibilities might be less likely to quit than their counterparts. this is in line with other studies, for example by almalki, fitzgerald and clark (2012), who found lower intent to quit for those with children, and by deery (2008), who found the number of dependent children to be an important moderator of the work-life balance. it seems that those with more children might be more risk averse, and that even if they experience higher levels of work-life balance conflict they may be more likely to stick it out in a job. h1.d: the relationship between an increase in wlbc and intent to quit is strengthened under conditions of higher social support. figure 3: number of dependents as moderator on the work-life balance–turnover intention relationship (two-way interaction). social support is included here as a measure of the external context that an individual experiences as an employee. the wlbc–social support interaction term is found to be significantly related to turnover intentions (p = 0.014). figure 4 illustrates this relationship. at lower levels of wlbc, individuals with greater social support report being more likely to quit, and this is the same for higher levels of wlbc, although the difference between those with higher and lower levels of social support is greater at higher levels of conflict. figure 4: social support as a moderator of the work-life balance–turnover intention relationship (two-way interaction). the significance of this relationship suggests that social support is an important enabler of exit for individuals experiencing higher levels of wlbc. the null hypothesis is rejected. this finding is also in line with various studies which found social support to be a moderator in the prediction of turnover intentions (see haar, roche & taylor 2012). the fact that many studies have not found a moderating effect for social support (haar 2004; makola, mashegoane & debusho 2015), suggests the importance of context in the determination of these relationships. this result contributes to the growing body of literature, indicating that under the conditions investigated by this study, this moderating effect holds. h1.e: the relationship between an increase work-life balance conflict and intent to quit is weakened at higher levels of engagement. the interaction term for engagement is not significant (p = 0.152), suggesting that work engagement has little influence on reducing an individual’s intent to quit at both low and high levels of work-life conflict. figure 5 shows that individuals with a lower engagement report being more likely to quit at both high and low levels of wlbc, although the difference between these employees and those with higher reports of engagement is slightly narrowed at higher levels of wlbc. these results are similar to those of naicker (2013) who found engagement to not moderate turnover intentions predictions. h1.f: the relationship between increases in wlbc and intent to quit is strengthened at higher levels of stress. figure 5: engagement as a moderator on the work-life balance–turnover intentions relationship (two-way interaction). individuals with higher levels of stress (figure 6) are not found to be significantly more likely to quit at higher levels of wlbc (p = 0.989). individuals with higher stress are more likely to quit at both low and high levels of wlbc, but there is little difference between these and those experiencing lower levels of stress. although a direct relationship has been found between stress and turnover intentions (cropanzano, rap & bryne 2003; moore 2000), in this context the relationships between withdrawal cognitions and both wlbc and levels of stress seem to be independent of each other. h2: job satisfaction mediates the relationship between work-life balance and turnover intentions in this context. figure 6: stress as a moderator on the work-life balance–turnover intention relationship (two-way interaction). in order to test the mediation effect between wlbc and turnover intentions, the hayes test of mediation was applied. the results are shown in table 4. the size of the indirect effect of wlbc on turnover intentions through job satisfaction is weaker than its direct effect, and insufficient evidence is found to support the mediation hypothesis. the null hypothesis is therefore not rejected. table 4: mediation results – total and indirect effects of hypothesis 2. the implication of this result is that wlbc is a direct influence on turnover intentions that does not have to act through the job satisfaction channel to increase turnover intentions. the lack of a mediating role for job satisfaction in the relationship between wlbc and turnover intentions is consistent with other work by özbağ and ceyhun (2014) who found no mediating effects of job satisfaction on the relationship between family-to-work conflict and turnover intentions in the turkish context, in a study on marine pilots. this finding contrasts with findings of a partial mediating effect on job satisfaction on the relationship between work-life balance and turnover intention in malaysian higher education institutions (noor 2011), and a fully mediated relationship in the context of industrial employees in iran (fayyazi & aslani 2015) and healthcare workers in new zealand (riley 2006). is this sample in some way atypical of others, in that the studying process (while working) might lend some robustness of individuals to wlbc, at least to the pressures related to withdrawal cognitions? to test whether the effect of education within this sample would weaken the relationship between wlbc and turnover intentions, further within-sample testing was performed, and this is reported as follows. post hoc testing a further test was performed to ascertain the effect of the interaction of wlbc and prior studies on intent to quit. although individuals with higher education have higher turnover intentions, and although this difference seems to be larger at higher levels of wlbc (figure 7), this difference is not significant in testing. this test was considered to be appropriate in order to gauge the potential influence of educational attainment for this cohort who were undertaking studies. the lack of a moderating effect on education accords with the results of a study by du plooy and roodt (2013) in which education levels were not found to be a moderator in the prediction of turnover intentions, unlike the results of a study by bester (2012), which found that they did. figure 7: education levels as a moderator on the work-life balance–turnover intention relationship (two-way interaction). most respondents (71%) fell into the age group 20–35 years, with most having a school leaving certificate as their highest qualification. those with other qualifications seem to be a minority, and this result suggests that having a prior qualification does not differentiate an individual from the rest of the cohort in terms of their wlbc–withdrawal cognitions relationship. limitations certain limitations of the study need to be acknowledged. firstly, this research was limited to one university and one geographic region, namely gauteng. results may be generalised only to contexts that are similar to this one. a cross-sectional study design was used, which has certain limitations as it cannot show which relationships are increasing or decreasing in their associations over time. the most important limitation of this study is that the methods applied here cannot be used to ascribe causality. this is a typical limitation of non-experimental research. nevertheless, these results are taken to be a valid reflection of the net relationships between tested variables that manifest across the sample. practical implications the findings of this study have practical implications for various organisations regardless of industry. from this study, findings revealed that if work–family conflict is reduced among employees, there would be a reduction in the turnover intention levels of employees. for this reason, policies should be offered that look into ways that they could buffer the effects of work-life conflict, as well as the influence that dependent children have on employees’ intentions to quit which would aid organisations in the retention of their employees. a second implication is that turnover intentions can be alleviated by organisations when the impact of social support is taken into consideration. findings have revealed that high levels of social support influence an employee’s decision to stay within the organisation. conclusion and recommendations for practice and further research the objective of this study was to test certain boundary conditions of theory that predicts certain relationships between wlbc and withdrawal cognitions. in so doing, it sought to quantify the moderating role of a host of demographic influences on the relationship between wlbc and withdrawal cognitions in the south african context. this context is taken to be particularly important in the study of employee retention, particularly given the life-changing opportunities offered by tertiary studies. dependent children and social support were found to influence the focal relationship, in different directions. whereas those with more dependent children might be less able to withdraw from an employment relationship, those with more social support seem to experience the opposite which has been stressed by kahumuza and schlechter (2008) who identify the critical role that social support plays in influencing the rate at which workers quit their organisations. this is in support of eisenberger, fasolo and davis-lamastro (1990) who found that a situational variable such as social support could either strengthen or weaken the way conflict is perceived and can be seen in the manner in which an individual attempts to cope with conflict. however, this is in contradiction with a study conducted in a german context where employees were found to be less likely to have turnover intentions when experiencing work-to-family conflict or family-to-work conflict if they experience high levels of social support (nohe & sonntag 2014). the authors pose the argument that social support can intercede between the negative evaluations that may occur between the various spheres of work-life balance and turnover intentions. therefore, the findings reveal the importance of context in the determination of cases where social support can prevent negative assessments about the workplace in which individuals are experiencing high levels of conflict between their work and family spheres. age, gender, engagement and stress are not found to moderate the focal relationship, and satisfaction is not found to mediate it. these findings raise important questions about the pressures experienced by individuals who are working and attending evening degree classes in this context at this time. we suggest here that individuals might enter a period of ‘stasis’, or stability in their associations between job satisfaction and turnover intentions, whereas while they are studying, they are less likely to intend to quit, even when dissatisfied with their work. this would be an explanation for why these relationships do not reflect those expected in the general working context. we encourage further research to explore other explanations. it might be that individuals who undertake degree studies enter this ‘period of stasis’, in which even the influence of age, gender, engagement and stress does not substantively add to, or subtract from, the influence of wlbc on withdrawal intentions. it might be that the pressures of family life steel an individual to deepen this state of stasis, perhaps to ‘see it out’, perhaps intensifying the perseverance of an individual. it is only social support networks, however, that seem to weaken this stasis effect, perhaps lowering the stakes of leaving a job for those holding out to finish their degree studies. these results contribute to the literature on work-life conflict by offering evidence of under what conditions those seeking to study while working are more vulnerable to wlbc. this work also contributes to a longstanding body of literature in the south african context that has sought to understand the specific determinants of intent to quit across different contexts, for example that by stanz and greyling (2010). it is concluded that this cohort of students, who invest their evenings in degree studies while working, may exist as an important subset of working adults. given their need for perseverance, even while experiencing higher wlbc because of their studies, further research should seek to better understand this phenomenon we identify here, of stasis, or a robustness to the negative influences that are typically expected to manifest in general working contexts. we therefore suggest that further research apply causal research designs to replicate our work, and to extend it to other contexts of study of work-life conflict at the nexus of employment, evening degree studies and family responsibilities. we believe that the findings of such research, if applied by societal stakeholders, can make a difference in the lives of these people. acknowledgements competing interests the authors have declared that no competing interests exist. author’s contributions j.a. conceptualised the 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customer segmentation and target market profuing jzbloom department of business management, university of stellenbosch abstract inadequate market segmentation and clustering problems could cause an enterprise to either miss a strategic marketing opportunity or not cash in on a tactical campaign. the need for in-depth knowledge of customer segments and to overcome the limitations of non-linear problems require a different approach. the objectives of the research are (l) to consider the use of self-organising feature (som) neural networks for segmenting tourist markets and (2) to assess the use of inducing decision trees to obtain rules for profijing existing and classifying new respondents. the fmdings of the som neural network modelling indicate three defmitive natural clusters. the induction of rules from decision trees were used to obtain a broad indication of a segment profile on the basis of a rule set and also enables the segment classification of customers from follow-up surveys. jelm30 1 introduction and background) marketing strategists often encounter the problem of how to segment and compile profijes of an enterprise's existing customers. market segmentation is a process of dividing a market into distinct groups of buyers who might require separate products or marketing mixes (venugopal & baets, 1994: 36). segmentation is based on various consumer characteristics such as demographics, socio-economic factors. geographic location, and product related behavioural characteristics like purchasing and consumption behaviour and attitudes towards and preference for products and services (dibb & simkin, 1991: 5). target marketing is a strategy that aims at grouping a major market into segments in order to target one or more of these segments or to develop products and marketing programmes tailored to each segment (kotler, 2000: 256-58). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 234 sajems ns vols (2002) no i customer clustering and segmentation are two of the most important data mining methods used in marketing and customer relationship management (saarenvirta, 1998: i). behavioural clustering and segmentation help drive strategic marketing initiatives, while sub-segments based on demographic and lifestyle characteristics could also be determined and used for tactical marketing efforts. however, inadequate market segmentation and clustering together with a limited understanding of the characteristics ofa segment profile, could cause an enterprise to either miss a strategic marketing opportunity or not cash in on a tactical campaign. market segmentation has not only developed as a tool to segment markets and identify target markets, but could also be used at a higher level to obtain more in-depth knowledge of the segment characteristics and further assist an enterprise to understand the relationship with its customers. the need for in-depth knowledge of customer segments and to overcome the limitations of non-linear problems requires a different approach. for instance, neural network models based on artificial intelligence technologies, can be developed to create clusters based on combinations of natural characteristics present in a set of customer data (e.g. purchase history, demographic attributes, phsychographic characteristics, etc.). however, many of the neural network modeling applications are used to develop individual models for a specific research problem. the sequencing of modeling applications such as using the output of a neural network modeling application as an input or output for another artificial intelligence technique e.g. the induction of decision trees to obtain rules) also enhances the knowledge base of customers' behavioural characteristics. to illustrate the applications of a self-organising feature map (som) neural network for segmentation and the induction of decision trees to obtain rules, the data of a tourist' survey of domestic tourists to the western cape isused. the use of som neural networks and induction of decision trees in travel and tourism is not widespread. applications of neural networks in the tourism industry refer to, among others, customer analysis and holiday package targeting (ryman-tubb, 1993) and forecasting tourist behaviour (pattie & snyder, 1996). there is an increased need, however, for tools and techniques which could provide further knowledge and understanding of dynamic tourist behaviour. it has become essential for national and provincial tourism organisations to extract knowledge from the data obtained from tourist surveys. the fmdings of tourist surveys to be mostly descriptive and provide little or no indication of behavioural segments, or the underlying profile of the tourist characteristics that form part ofa segment, or future segment classification. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no i 235 in the light of the above, the primary objectives of the research are (j) to consider the use of som neural networks for segmenting tourist markets and (2) to assess the use of inducing decision trees to obtain rules for profiling existing and classifying new respondents by using the output provided by som neural networks. the article firstly considers the nature and scope of a som neural network for learning and grouping data and the induction of decision trees to obtain rules. a conceptual comparison is provided of cluster analysis and som neural networks, and the advantages and disadvantages of decision trees are also discussed. a tourism industry application of using som neural networks and the induction of decision trees to obtain rules, is provided by means of a discussion of the methodology related to the modeling process. the outcomes of the modeling process in terms of the ability of a som neural network to naturally group data and the use of induction to obtain rules from decision trees, are also discussed. a conclusion is provided in the final section. 2 nature and scope of som neural networks and inducing rules from decision trees artificial neural networks (ann) have evolved as a technique to solve a variety of problems in the business field; from classification, grouping and forecasting, to portfolio optimisation, credit scoring and stock picking. neural networks are described as information processing technology, which is inspired by the human brain and mimics its problem solving processes (klimasauskas, 1996: 45). anns exhibit certain features such as the ability to learn complex patterns in a set of data and generalise the learned pattern (venugopal & baets, 1994: 30). there are a variety of neural network algorithms for solving complex business and marketing problems. the appropriate use of a learning algorithm depends primarily on the type of problem which needs to be modelled. a taxonomy of learning algorithms has been proposed in the literature (lippman, 1989: 10). the distinction is primarily differences in the input format, i.e. binary-valued input or continuous-valued input. each of these categories could be further subdivided into supervised learning and unsupervised learning techniques. unsupervised learning algorithms use patterns that are typically redundant raw data, having no labels regarding their class membership or association. during this mode of learning, the network must discover for itself any possible existing patterns, regularities and separating properties. the parameters of the network undergo changes when discovering the properties mentioned previously and setf-organising occurs (turban & trippi, 1996: 16). during unsupervised r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 236 sajems ns vol 5 (2002) no i learning only input stimuli are presented to the network. examples of this type of learning are adaptive resonance theory and kohonen self-organising feature maps (kohonen, 1988). once an acceptable mapping solution is obtained, it is possible to use the output obtained from the som neural network to develop an induction model for obtaining rules from decision trees. decision trees are a way to represent mathematical regularities or relationships underlying a set of observations obtained for a particular problem. in addition, decision trees are hierarchical structures that partition the set of observations to explicitly relate a number of independent variables, known as the attribute, to one or more discrete dependant variables, or classes (gray, 1990: 41-42). a decision tree consists of nodes and branches. each node is either a decision node that consists of a test on an attribute that partitions the current subset of observations into two or more smaller subsets, or a terminal node that classifies the remaining subset of observations in that node with a particular class label. branches indicate the path that must be followed as decisions are made at each decision node until a terminal node is reached (ben-david & mandel, 1995: 110). decision trees are compact and are therefore readily understood. however, complex classification problems may cause the decision tree to become unwieldy with a large number of nodes and branches. although such a tree may be complete and accurate it is often difficult to understand. it is possible to simplify the tree and make it more intelligible by expressing the tree model in terms of so-called if ... then rules, also referred to as production rules (crusader systems, i 998b: 115). production rules have been widely used to represent knowledge in expert systems and they have the advantage of being easily interpreted by human experts because of their modularity, that is, a single rule can be understood. in isolation and does not require a reference to other rules (kamber, winstone, gong, cheng & han, 1997: 10). 3 neural networks, induction of decision trees and multivariate statistical techniques som neural networks provide an opportunity to extract knowledge from data and offer improved performance by overcoming various limitations associated with multivariate statistical techniques such as cluster analysis. although som neural networks also have limitations in respect of explanation, they offer advantages in terms of learning ability, flexibility, adaptation and knowledge discovery (goonatilake, 1995: 21). the nearest neighbour algorithm, which is r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vols (2002) no 1 237 the premise for a som neural network, is a refinement of existing cluster techniques, in the sense that both use distance in some feature space to create structure in the data. the nearest neighbour algorithm offers more refinement, as part of the algorithm provides a way of automatically determining the weighting of the importance of predictors and how distance will be measured within the feature space (berson, smith and thearling, 2000: 144-4s). in the context of this research a comparison is provided of som neural networks and cluster analysis, while the advantages and disadvantages of inducing rules from decision trees are also highlighted. the primary advantages ofsom neural networks over cluster analysis include the following: som neural networks are more robust than cluster techniques. the use of cluster analysis will provide a cluster solution even if no natural clusters exist in the data (mitchell, 1994: 8). various assumptions about the underlying distribution of the data are required to use cluster analysis, while som neural networks do not require any assumptions. the number of clusters requires specification when using cluster analysis, while som neural networks cluster data naturally based on assigning an incoming signal to the segment having the nearest weight vector (venugopal & baets, 1994: 36-37). the relevance of som neural networks for modeling tourism data stems from the need to provide a segmentation solution that will enable decision-makers to allocate the scare financial resources for more focused target marketing. besides overcoming the limitations of cluster analysis, som neural networks enable more refined analysis of tourist behaviour and also provides a level of predictive ability to track changes in tourist profiles and behaviour. the goal of classification trees is to predict or explain responses on a categorical dependent or class variable and on this basis has much in common with multivariate techniques like discriminant analysis. for instance, the hierarchical nature of classification trees is illustrated by a comparison of the decision-making procedure employed in discriminant analysis. superficially, the discriminant analysis and classification tree decision processes might appear similar, because both involve coefficients and decision equations. however, the difference of the simultaneous decisions of discriminant analysis from the hierarchical decisions of classification trees should be noted (statsoft, 2001). for the purposes of this article, the advantages and disadvantages of tree-based methods are discussed as a means to. enhance the classification and profiling of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 238 sajems ns vol 5 (2002) no 1 customer segments. the advantages of decision trees and rule induction in mining data for classification, profiling and decision-making, include: decision trees and rules explicitly represent the relationships discovered by the decision tree or rule induction algorithm and can be effectively understood and analysed by decision makers. the decision path followed by the tree or rule set can be easily followed when determining the class of a new observation, leaving nothing unknown or implied. 1f ... then rules can be imported into the rule base of decision support systems and can be integrated with a knowledge database. the influence and relevance of attributes with regard to classification of the set of training data is shown. the induction of decision trees is very flexible as it easily copes with discrete and continuous attributes. regression and neural network classification require the encoding of discrete attributes as either a number of a continuous scale or as orthogonal unit vectors (crusader systems, 1998b: 119-20). the disadvantages of decision trees are the following: the algorithms to induce trees are dependent on the quality and appropriateness of the attributes of the training data. if the attributes chosen do not adequately represent the underlying relationships in the data then the induction algorithm will group most of the data into one class with few nodes. the divide-and-conquer strategy partitions training data into smaller and smaller sub-sets. the algorithm uses less and less information about the entire training data as tree growth continues. the foundation for decisions based on the attributes lower down in the tree is diluted due to a smaller basis ofinformation. the induced rules may require further processing and analysis after the initial induction cycle to improve comprehension (crusader systems, 1998b: 120-121). the limitations of ouster analysis provide the rationale for the use of artificial som neural networks. decision tree models are inexpensive to construct, easy to interpret and are easy to integrate with database systems and therefore their use for classification and profiling customer segments outweigh the limitations of inducing decision trees. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 239 3 memod on the basis of the research problem specification and the objectives of the research, the use of an unsupervised learning algorithm to group the data into segments and a decision tree algorithm for the profiling of tourist segments was required. decision trees and rules are also generally used for classification purposes. a som neural network is used for the initial grouping of tourists, while the univariate-split decision tree algorithm is used for profiling the segments. the research design is divided into two stages. the flist stage involves the development of a som neural network and the second stage involves using the segment classification obtained from the som neural network model as output . to create a decision tree from which rules are induced for segment profiling. the modeling process uses two different learning algorithms to group the respondents and allow the induction of rules from a decision tree. the rules obtained from the decision tree induction could also be useful for the classification of new tourists from data obtained in follow-up surveys. 3.1 sampling procedure, data capture and scope of data the sample was geographically stratified in line with the distribution of the urban population nationally, and starting points were selected using a geodemographic sampling grid. persons that reside in urban areas within south africa and bad visited the western cape at least once during 1997 and 1998 qualified for inclusion in the survey. a record was kept of unsuccessful contacts in order to be able to calculate the proportion of the urban population that visit the province. a total of 5 642 contacts were required to achieve the final sample of 1 630 respondents. personal in-home interviews were conducted. the questions represented a broad mix of trip, demographic, socioeconomic and geographic characteristics. the nature of the data was predominantly categorical and nominal. the data was captured using a software package, survey system (creative research systems, 2001). the survey system is tailored for survey research conducted using questionnaires. the software handles all phases of survey projects, from creating questionnaires through data entry, interviewing to producing tables, graphics and text reports. the data used for the research presented in this paper is applicable to the domestic tourist market in south africa. it is assumed that the behaviour of domestic tourists will not differ significantly since the period of the survey to the time the analysis was conducted. however, it may be relevant for western r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 240 sajems ns vol 5 (2002) no 1 cape tourism to conduct a second survey in the near future to ascertain whether or not the profile and behaviour of tourists are changing. 3.2 nature and design of a self-organising neural network model and tbe creation and induction of decision trees the design of a som neural network is divided into several distinct steps. several authors including deboeck (1995), masters (1993), blum (1992) and mccord-nelson & illingworth (1993) have outlined a series of steps for building a neural network model. the eight-step procedure proposed by kaastra and boyd (1996: 219), which encompasses many of the steps proposed by the abovementioned authors, is adapted for som neural networks and presented in table 1. the steps for the creation of decision trees and the induction of rules are also presented in table 1, as adapted from brodley & utgoff(l995: 49). table 1 a sequence of steps used to design a som neural network model and create a decision tree for the induction of rules steps for som neural network steps for specification of decision trees specification and rule induction step 1: data collection step 1: data collection step 2: variable selection (number of step 2: attribute selection (number of inputs) inputs, and output) step 3: data pre-processing (e.g. step 3: data pre-processing (e.g. removal normalising, log transformaof outliers and transformations) tion, standardisation, scaling) step 4: selection of training, step 4: selection of training, validation validation and test sets and test sets step 5: specific.ation ofsom neural step 5: specification of decision tree network training parameters and training parameters and configuration values configuration values -number of input neurons -number of input neurons -percentage iterations for -stopping rules (uniform class, constant initial learning rate uniform vector, minimum observations) -learning rate increment -splitting criteria (gain, gain ratio or gain rationog (depth) -neighbourhood radius -pruning algorithm (error based pruning, reduced error pruning) -radius increment r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 241 table i continued steps for 80m neural network steps for specification of decision trees specification and rule induction step 6: som neural network training step 6: rule induction specifications specifications -initial weights (upper and -rule generalisation algorithm lower bound) (upper confidence limit, correctness generalising and best difference) -presentation of records -rule set optimising algorithm (minimum description length principle) -number of iterations (epochs) step 7: evaluation criteria step 7: evaluation criteria for both the decision tree and rule induction (before and after pruning on the training data and validation set) step 8: model deployment step 8: model deolovment source: adapted from kaastra and boyd (1996: 219) and brodley and utgoff (1995: 49) the development of any neural network or rule induction model, is based on a thorough knowledge of the research problem. in addition, the procedure described in table i is not one-off, but may involve revisiting steps between the training and validation of the model to reassess the input variables and network parameters. all the variables included in the survey that had no missing data, were considered for the modeling process. an exploratory data analysis (eda) was conducted to provide an indication of the distribution of the variables. both box and whisker plots and histograms were used to visualise the distribution of the data variables. these descriptive statistical techniques were used together with several descriptive statistics (i.e. mean, median, standard deviation, skewness and kurtosis) to further describe the data. the eda is important to ensure non-inclusion of data variables with substantial positive or negative skewness, as the natural clustering algorithm of the som neural network would tend to consider the data as one group and distinguishing between groups would be more difficult due to the nature of the algorithm. based on the outcomes of the exploratory data analysis and the importance of selecting the right mix of variables for creating a som neural network model, 10 variables, which include trip, demographic, socio-economic and geographical characteristics, are included for the som neural network modeling process. the data captured in survey system was exported in a delimited r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 242 sajems ns vol 5 (2002) no i fonnat into excel, which also facilitated the importation of the data into the modeling software. in order to enhance the description of the segment profile, six additional variables were included for the creation of the decision tree and the induction of the rules. table 2 lists the 10 variables used for the som neural network modeling and the 16 variables for the induction of rules from a decision tree. table 1 variables used for the construction of the decision tree and rule induction variables used for som modeling variables used for creation and procedure induction of decision trees main purpose of visit main pllljiose of visit c----=: .... region visited in the western cape region visited in the western cape province province duration of stay duration of stay total spent on first trip total spent on first trip likelihood to visit the western cape likelihood to visit the western cape again again ethnic group ethnic group occupation occupation origin of tourist origin of tourist income group income group age age education education number visits to the western cape in past 2-years time of the year visit to the western cape infonnation sources of the western cape arrangements for visit likelihood to visit the western cape province again gender the software package used for part of the exploratory data analysis and the modeling procedure is basic modelgen (crusader systems, 1998a). in addition, the software package, statistica, is used for most of the exploratory data analysis (statsoft. 1998). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 243 3.2.1 self-organising neural networks the following discussion of the som neural network modeling process refers to the steps listed in table 1. data variables identified for modeling were scaled or recoded to assume values between 0 and 1 or 0 and i respectively. in this manner each data record is considered by the network as continuous valued input or binary-valued input. in order to create the training, validation and test sets, the data set (1 630 records) was randomly sub-divided so that 70 per cent of the data points were allocated to the training set, 10 per cent to the validation set and 20 per cent to the test set. this classification is based on heuristics and on the principle that the size of the validation set must strike a balance between obtaining a sufficient sample size to evaluate both the training and test sets (kaastra & boyd, 1996: 223). the training parameters used for final som neural network modeling process entails the following measures together with the relevant values. parameter and values learning decrement (per cent) 0.1 initial weights (per cent) -0.5 (lower bound); 0,5 (upper bound) scaling 0.1 (lower bound); 0,9 (upper bound) neighbourhood radius 5 radius increment linear side n of one map side: 40 which refers to 1600 data point images on a two-dimensional grid configured values presentation of data training cases test cases validation cases number of inputs random 70 percent 20 per cent 10 percent 10 neurons. the som neural network was trained for 1000 iterations and the records were presented to the network in a random manner. the fmdings of the som neural network modeling procedure are presented in a following section. 3.2.2 induction of rules from decision trees the second stage of the analysis entailed the induction of rules from a decision tree. the decision tree was created using 16 variables including the 10 variables r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 244 sajems ns vols (2002) no i that were also used for the som modeling process. in order to specify an output variable each respondent belonging to a specific segment was mapped back to the original data set. the model specification for the decision tree included 16 input neurons and a single output neuron representing the segment classification of each respondent. the primary aim of this stage of the research is to develop a trained rule induction model which could be used to provide an indication of the profile of each segment and also assist with the classification of new respondents based on the exiting rule set for each segment. the parameters and configured values used to create the decision tree and induce rules are as follows: decision tree and rule induction specifications stopping rules splitting criteria pruning algorithm rule generalisation algorithm model specification training cases test cases number of inputs number of outputs uniform class minimum observations (2) gain ratio none specified correctness generalising 90 percent 10 percent 16 neurons i neuron. many algorithms are proposed in literature, to induce a decision tree and thereafter use the tree structure as a basis for deriving a set of production rules. it is beyond the scope of this text to describe each of these algorithms, especially those that induce rules from scratch. for the purposes of this article, the well-known ·c4.s algorithm is used for the induction of the decision tree (quinlan, 1993). the c4.5 algorithm generates a classification-decision tree for the given data set by recursive partitioning of data. the algorithm considers all the possible tests that can split the data set and selects a test that gives the best information gain. for each discrete attribute, one test with outcomes as many as the number of distinct values of the attribute is considered. in addition, for each continuous attribute, binary tests involving every distinct value of the attribute are considered. in order to gather the entropy gain of all these binary tests efficiently, the training data set belonging to the node under consideration is sorted for the values of the continuous attribute and the entropy gains of the binary cut based on each distinct value are calculated in one scan of the sorted data. this process is repeated for each continuous attribute (kamber, et ai., 1997: 4). r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no i 245 for the purposes of this research, the uniform class together with the minimum observation stopping rules are used. the uniform class stopping rule is generally used in classification problems and will fire if all the cases at a node are of the same class. the minimum observations stopping rule will fire when the number of cases in a node are less than or equal to the specified number, which is two in this case. the use of two stopping rules is to prevent a large overtrained tree. the gain ratio is used as the splitting criteria in the c4.5 algorithm and is considered as a measure of impurity (quinlan, 1993 & breiman, 1996). it is also a commonly used criterion and generally provides good results. this measure determines the ratio of the extent of information contained within the new smaller subsets of data after a given split in the data has been performed over that contained in the previous larger sub-set of data. the attribute and its associated value on which to split are chosen as the pair that minimises the gain ratio (quinlan, 1993). the rule generalisation algorithm used in this study simplifies the predicate of a rule. the correctness generalising algorithm keeps the optimal predicates to maximise the number of correct cases identified by a rule (crusader systems, 1998b: 71). the c4.5 algorithm uses a criterion that pessimistically estimates the expected classification error rate of a generalised rule to decide which part of the antecedent to remove. the change in the rule that produces the lowest error rate is selected (quinlan, 1993). the outcome of the induction of the decision tree is discussed in a following section. 4 findings of the modeling procedure 4.1 findings of tbe som neural network model it was possible to distinguish three clear segments among domestic tourists that visit the western cape. figure 2 is an illustration of the self-organising feature map, which is obtained through the unsupervised som neural network modeling process. each record in the training set corresponds to a single unit, namely the best matching one. thus, the unit represents the record's image on the feature array (consisting of 40x40 units), which implies 1600 output units in this case. the self-organising feature map is two-dimensional and depicts the natural segments obtained from the interrelationships between the 10 variables used for the modeling of the data. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 246 samms ns vol 5 (2002) no i figure 1 two-dimensional self-organising feature-map of the trained data >figure i indicates four possible segments, three of which are defmitive, while the fourth is smailer and appears to be developing. however, for the purposes of this analysis, the respondents that fonn part of the "emerging" market segment are included together with respondents classified as part of segment 3. table 3 indicates the size and number of respondents classified per segment. table 3 number of respondents per segment for tbe traveller group segment number total respondents per percentage setzment contribution 1 693 42.52 2 421 25.82 3 516 31.66 total 1630 100.00% table 3 shows that segment 1 is the larger of the three segments and that 42.52 per cent of the respondents have a similar profile of attributes, views and characteristics. among the remaining respondents, 31.66 per cent have a similar profile and are grouped in segment 3, while 25.82 per cent of the respondents in segment 2 could be considered as a homogeneous group. the three segment profiles obtained from the classification of each tourist based on the som neural network is presented in table 4 with acronyms for each of the segments based on the profile. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 table 4 profiles of the three segments identified from the selforganising feature map profile ofsegment 1: "adventurists" 247 the largest majority of tourists who fonn part vf segment 1 either visit the western cape for holiday purposes or visit friends and relatives. this group also spends most of their vacation period in cape town and the cape peninsula. other areas of interest to this group are the west coast and garden route. an average duration of stay for this segment is 16 days (median 14 days), while most of the tourists spend between r3 000 and r4 000 on average (median r3 000 to r4 000), irrespective of the purpose of visit. the majority of this segment is from the white population group, of which almost 40 per cent is self employed or work as clerical or sales staff. a small portion (11 per cent) of this group occupies professional positions in the business fraternity. over 63 per cent of the tourists from this segment come from gauteng. these tourists earn an average of between rio 500 and r12 999 per month (median r8 500 to rio 499) and are between the ages of 35 and 39. over 50 per cent of these individuals have a matric qualification, while 37 per cent have an additional diploma or university degree. prome of segment 2: "yuppies" tourist classified under segment 2, visit the western cape for reasons other than vfr., leisure or business. however, almost a fifth do also visit the westem cape for business. they visit primarily cape town or the cape peninsula in the western cape and spend approximately 12 days (median 10 days) in the province. they spend a low average total of between r2 00 1 and r3 000 (median rl 001 to r2 000) during this time. interestingly, the ethnic spread among this segment is similar to that of segment 3, for white, black and coloured/asian groups. almost 40% of this group is professionals, while about 37% is middle management, self employed, clerical or sales staff. approximately a third of these tourists come from the eastern cape, while close to 3()oio come from kwazulu-natal. these tourists earn an average of between r13 000 and r15 999 per month (median rio 500 to r12 999) and are between the ages of 35 and 39 (median 35 39 years of age). sixty per cent of this segment has a matric qualification or diploma and almost 40% a university degree. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 248 sajems ns vol 5 (2002) no i profile of segment 3: "content" tourists classified as part of segment 3, visit the western cape either to see friends or relatives or to have a holiday. almost 15 per cent of this segment also visits the province for business purposes. more than 80 per cent of these tourists visit cape town or the cape peninsula during their visit to the western cape and spend approximately 12 days (median lo days). this segment spends a low average total of between ri 00 i and r2000 (median r 1001 to r2000). as mentioned in segment 2, the ethnic spread among this segment is similar regarding white, black and coloured/asian groups. almost 40 per cent of this group are housewives, students, retired persons or semi-skilled workers. approximately 40 per cent of these tourists come from gauteng, while almost a third are from kwazulu-natal and the free state. these tourists earn an average of between r4 000 and r4 999 per month (median r4 000 to r4 999). the average age of this group is between 40 and 44 years (median 40 44 years of age), while more than three-quarters has a matric, std 8, std 9 or std 9 with a diploma. note: the basis for the creation of the segment profile, is frequency tables compiled for each variable included in the som neural network modeling procedure and several descriptive statistics. these segment profiles should be considered as a means to distinguish between the different segments on an overall basis. the "adventurists" seem to be scattered throughout the province and visit other areas in addition to cape town and the peninsula. they are less trendy than the "yuppies", who prefer to spend their holiday period in areas like cape town and the peninsula that seem to have a certain vacation atmosphere. interestingly, the "yuppies" eam more than the "adventurists" but spend less during their time in the western cape. the tourists in the "content" segment are, by virtue o( its profile, older than those of the other segments; retired, or students and less qualified. their expenditure over the vacation period is also lower than the other two segments. the "content" appear to be more content with life and are less energetic and adventurous than tourists whose profile fits in the other two segments. 4.1.1 implications of tbe segment classification for management decision making the three profiles above provide three different behavioural segments, portrayed by the acronym assigned to each. consequently, decision makers, could develop more focused marketing strategies instead of the less generic ones often derived from the supply-side tourism industry (e.g. attractions). these segment profiles could be incolporated into existing tourism positioning r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 249 strategies, by more specifically indicating to decision makers the kind of tourists the western cape would target in the context of the existing and envisaged tourism framework of the province. in addition, the research conducted in this paper will also allow decision makers to track the behaviour of tourists by conducting similar surveys in the future and also determine the changing profile of key market segments for the western cape. decision makers could also, from a similar analysis performed on tourists that do not visit the western cape, determine corresponding profiles and identify potential tourists that fit the profile of those tourists the industry decision makers in the western cape would want to attract. 4.2 findings of the creation and induction of a decision tree the decision tree and rule induction modeling could also be used to obtain a broad profile of a segment based on a specific set of rules. in addition, the rules could also be used to classify tourists that take part in future or follow-up surveys. by using the variables indicated in table 2 as inputs and considering an output variable representing the segment classification of each respondent, it is possible to compile a decision tree from which rules could be deduced. the creation of the decision tree and induction of rules are based on the set criteria listed in section 3.2.22• the rules indicated in table 5 and in the appendix are interpreted as if ... then rules. this implies that should a tourist assume or adhere to the specifications for an individual rule, it would be possible to assign them to a certain segment classification. in this manner they could assume one of the profiles described in table 4. for instance, consider rule 13 in the appendix and the frrst rule applicable to segment 3 in table 5. a description of the rule indicates that 167 cases were correctly classified as segment 3, while one case was incorrectly classified. the accuracy of the rule is 99,4 per cent which is based on the test set (unseen data). rule 13 could be described in the following manner: if the tourist spends less than r3000 and (s)he is a ''non-professional'' and predominantly african, coloured or asian, and bas a rnatrlc or lower education qualification, and earns less than r6 500 per month and is from the free state, northern cape, kwazulu-natal or the eastern cape, men the tourist would have a similar profile to the 421 respondents grouped within segment 2. the individual rules for the other segments are used in the same manner to describe a particular segment or classification of a tourist. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 250 sajems ns vol 5 (2002) no i table 5 examples of rules for the different segments rules for seement 3 15161'-*_-i-_.--=r=ul=es;;;;...;;;.;;fo:.;:.r~se=~2:o;;;;lm=e:.::n;.;:.t.:;:..1.j.-146='..=3.1...-1---1 if a tourist spends less than r3000 if the tourist is younger than 60 and is a non-professional and years of age and is likely to visit the predominantly african, coloured or western cape in the future and spent asian, and have a matric or lower more than r3 000 during the visit, education qualification, and earn and is predominantly white and is less than r6 500 per month and are from the northern provinces of the from the free state, northern cape, country and earns more than r8 500 kwazulu-natal or the eastern cape per month ... or ... or if the tourist visits cape town and the peninsula and total spending is less than r2000 and is predominantly african, coloured or asian and bas a matric or lower qualification and earns r6 500 or less and is from the free state, northern cape, kwazulu-natal, or the eastern cape then the tourist would have a similar profile to the 516 respondents grouped within segment 3. if the tourist visits other areas than the garden route and cape town and the peninsula, and is not from the eastern cape, but the other provinces, and earns more than r8 500 per month and is a white collar employee .... then the tourist would have a similar profile to the 693 respondents grouped within segment 1. rules for s~ent 2 [42~ i if the tourist is a white collar worker, and has a matric or higher education, and is not from the northern provinces of south africa and is predominantly african, coloured or asian, and spent more than r3 000 during the visit to the western cape ... or if the tourist spends 15 days or less in the western cape, and is from the free state, northern cape or the eastern cape, and has a university degree ... then the tourist has a similar profile to the other 421 tourists which forms part of segment 2. * the value mdlcated m parenthesis represents the number of toullsts for each of the segments. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 251 table 5 clearly indicates the class (segment), the "conditions" applicable to each of the attributes and the classification accuracy of the rule. these rules, which are detennined in a quantitative manner, could also be combined with rule sets (qualitative infonnation) obtained from experts. the use of som neural network models together with the induction of rules from decision trees requires clear research objectives, domain knowledge of the specific problem, representation of appropriate attributes and clarity on the definition and acquisition of data. 5 conclusion inadequate market segmentation and clustering problems could cause enterprises to either miss a strategic marketing opportunity or not cash in on a tactical campaign. market segmentation has not only developed as a tool to segment markets and identify target markets, but could also be used at a higher level to further assist an enterprise to understand the relationship with its customers. the need for in-depth knowledge of customer or tourist segments and the need to overcome the limitations of non-linear problems require a different approach. for instance, som neural network models based on artificial intelligence technology can be developed to create clusters based on combinations of natural characteristics within a set of customer data (e.g. purchase history, demographic attributes, phsychographic characteristics, etc.). the research demonstrates the usefulness of artificial intelligence technology as a means of grouping respondents and for profiling existing respondents by using a rule set applicable to each segment. the som neural network application, which could be considered as an enabler, provided three segments (classes) that could be used to induce rules from decision trees. the rules provide decision makers with clear and concise indications of the segment profile of existing tourists based on an individual rule within a larger rule set. in addition, the rules sets for each segment could be used to classify tourists that partake in follow-up surveys. the artificial intelligence application presented in this paper provides a mechanism for analysts to use if the objective of the research is to create customer segments and to describe the segments through a rule set applicable to each segment. the findings demonstrate that the analysis of data from surveys can be taken to a high level through the provision of knowledge represented in sets of rules also by overcoming the limitations of cluster techniques such as cluster analysis. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 252 sajems ns vol 5 (2002) no i endnotes i would like to express my gratitude to western cape tourism for providing the data to conduct the research presented in this article. the usual caveat applies. 2 the decision tree and the additional rules (i.e. with accuracy of less than 90 per cent) are available on request. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no i 253 appendix rules with accuracy of larger than 90% (a legend is provided to assist with the intelj""tation of the rules) 1468 training cases and 162 validation cases segment i a; segment 2 = c; segment 3 b rule 13'· b 167, i (99.4%) rule 9 * .. b 88,1 (98.9%) rule 72 •• b 79,3 (96.2%) totspend<4 mainarea ::8 educalion < 4 occupation >= 6 totspend< 2 incgroup < 10 race>= 2 race >=2 race>= 2 education <5 education < 5 province >= 6 iocgroup< 9 incgroup<9 occupation < s orovince< 6 province <6 rule 153" a 189, \(99.5%) rule 96'· a 131,2 (98.5%) rule 39 .. a 208, 7 (96.6%) age < 10 incgroup >= 6 incgroup < 14 'iildyvisit < 3 province >= 4 province >= 5 toupend>=4 race < 2 totspend >= 5 race < 2 mainarea < 5 race <2 province >= 6 incgroup < 10 incgroup >= 9 incgroup >= 10 occupation >= s rule 7 •• b 131,2 (98.5%) rule 114 •• a 179,5 (97.2%) rule4s·· b 109,4 (96.3%) education < 4 province >= 5 dayspent < 10 race >= 2 age <6 mainarea >= 7 iocgroup<9 incgroup >= 7 incgroup<8 province<6 race <2 education<5 toupend>=4 toupend<4 incgroup < 10 province >= 6 rule 23 •• a 117,2(98.3%) rule 52 .. b 94,4 (95.7""') rule 120" c 50,2 (96%) mainarea< 6 age>=s occupation < 13 race < 2 totspend < 2 educalion >= 5 province >= 3 incgroup < 10 province < 7 iocgroup >= 9 educalion < 5 race>= 2 occupation < 8. province >= 6 totspend >= 4 ioc2folj1)<1o rule 151·' a 178,3(98.3%) rule so·, b 73,2 (97.3%) rule 127" b 95,3 (96.8%) occupation < 12 occupation >= 6 totspend<4 totspend >= 3 dayspent >= 10 age>=4 incgroup;ii mainarea>=7 incgroup < 11 race < 2 ammge>= 2 occupation >= 10 province >= 6 mcgroup < g province<6 occupation >= 8 education < 5 iocgroup >= 10 totspend<4 race<2 rule 117·· a 18, i (94.4%) rule 69·" a 297, ls(94.9%) rule 104" c 51,3 (94.i%) gendcr< 2 purposc< 8 dayspent < 15 arrange >= 4 totspend >= 4 province < 5 race<2 race <2 education >= 6 totspend>=4 province >= 6 occupation >= 8 iocgroup < 10 occud8tion < 8 rule 112 ... b 70, 4 (94.3%) rule 140 •• a 133, 7 (94.7%) rule9s u b 124,8 (93.5%) occupation >= 12 mainarea <7 iocgroup< 6 iocgroup<7 race < 2 totspend <4 mainarea >= 8 province >= 6 occupation >= 8 iocgroup >= 10 r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 254 sajems ns vol 5 (2002) no 1 rule2"b 17, i (94.1%) rule 25 .. b 139, 10(92.8"10) rule 84 .. c 86, 7 (9\.9%) totspend < 3 incgroup < 10 purpose < 3 province ::>= 3 purpose < 2 mainarea >= 8 race < 2 occupation >= 6 incgroup >= 8 education < s totspend <3 dayspent >= 5 incgroup < 9 province>=3 ' education>= 5 province < 6 province <6 race>=2 occupation < 8 occuilation < 8 rule 17 •• c 90,8 (91.\%) rule 40" a 12, i (91.7%) rule 57 •• a 237, 22 (90.7%) province < 4 purpose < 2 dayspent >= 5 incgroup >= 8 incgroup >= 14 totspend >= 3 education >= s province>= 5 incgroup >= 8 incgroup<9 totspend>=s , education < 5 race<2 i mce<2 province >= 6 occupation < 8 le&ead for tile dilfereat variables included in tile rule induction modellnll: i number of times visited the western cape: purpose of visit to tile western cape i once i visit friends or relatives 2 twice 2 holiday '3 three times 3 business pwposes 4 foor times 4 study pwposes 5 more than 4 i 5 medical treatment maill area visited willie ib western cape i west coast 2 winelands 3 breede river 4 overberg 5 central karoo ,6 klein karoo ,7 garden route ! 8 cane town and cape peninlula iaformadoll _reel for tile western cape i travel agency 2 tourist bureau 3 friends/relations 4 aa 5 magazines 6 newspapers 7 internet ,8 nowhere/myself 9 previnus visillllexperience i 10 tunesharc ii radioltv 12 pampbjeillibrocbures 13 chw'cb 14 organised tours 15 sports organisation 16 wodcibusiness i 17 scboovtedl 18' other ; 6 conference 7 other 8 s~~~~~~~ __ ~~ __ ~~ time of year of visiting the western cape i december/january (swnmer) 2 february/april (autornn) 3 may/august (winter) 4 september/novembei(spring) total spedt on visllirrespective of tile purpose i ro-looo 2 rlooi-2000 3 r2001-3000 4 r300i-4000 5 r400i·sooo 6 rsoo 1-6000 7 r600i·7000 8 r7001-8000 9 8001·10,000 10 more than rio,ooo r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 255 arrangements made for visit to tbe western ukeubood to visit the western cape again cape 1 will definitely visit 1 travel agent 2 will probably visit 2 self/other in party 3 might visit 3 your company 4 will probably not visit 4 family/friends .5 will defmitely not visit 5 airline office 6 tour operator 7 other 8 church 9 school teacher income group occupation 1 up 10 1499 i professional 2 1500-1799 2 senior management 3 18()()"1999 3 middle management 4 2000-2499 4 jw1ior management 5 2500-2999 5 self~ployed 6 3000-3999 6 clerical/ sales 7 4000-4999 7 tradesman / skilled 8 5000-6499 8 semi-skilled 9 65()()"8499 9 unskilled 10 85()()"10499 10 housewife 11 105()().. 1 2999 ii student 12 13000-15999 12 pensioner/retired 13 16000-19999 13 other 14 20000-24999 14 unemployed/not working 15 25000-29999 16 30000-34999 17 35000-39999 18 40000+ 19 confidential province of origin age grouping i wcape 1 18-19 2 ecape 2 20-24 3 ncape 3 25-29 4 free state 4 30-34 5 kzn 5 35-39 6 northwest province 6 40-44 7 gauteng 7 45-49 8 mpumalanga 8 50-54 9 northern province 9 55-59 10 60-64 11 65+ 12 confidential level or edaeatlon gender 1 less chan std6 1 male 2 sid 6-7 2 female 3 sid 8f919+dipioma 4 matrie ethnkgroup .5 matricldiploma 1 white 6 university degree 2 black 3 coloured! asian r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 256 sajems ns vol 5 (2002) no 1 references ben-david, a. & mandel, j. 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(1994) ''neural networks and statistical techniques in marketing research: a conceptual comparison" marketing intelligence and planning, 12(7), 30-38. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction literature review and hypothesis development sample selection and research design empirical results and findings conclusion acknowledgements references appendix 1 footnotes about the author(s) anne-marie eloff school of accountancy, faculty of economic and management sciences, stellenbosch university, stellenbosch, south africa shené steenkamp school of accountancy, faculty of economic and management sciences, stellenbosch university, stellenbosch, south africa citation eloff, a. & steenkamp, s., 2022, ‘integrated report quality and earnings management – evidence from south africa’, south african journal of economic and management sciences 25(1), a4581. https://doi.org/10.4102/sajems.v25i1.4581 original research integrated report quality and earnings management – evidence from south africa anne-marie eloff, shené steenkamp received: 04 mar. 2022; accepted: 22 june 2022; published: 13 sept. 2022 copyright: © 2022. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: no prescribed standard disclosure requirements for integrated reporting exist. instead, the international integrated reporting framework is widely adopted, which provides guidelines for integrated reporting to improve the quality of information reported to end-users. these guidelines, however, allow management a degree of freedom in implementing integrated reporting, making the quality of disclosure thereof dependent on management’s approach to reporting. in contrast to the purpose of integrated reporting stands the management of earnings where management can use judgement to manipulate financial reports to mislead end-users. the conflicting theoretical objectives of integrated reporting and earnings management (em) pose the question of how these two variables relate to one another. aim: we examine the association between the quality of integrated reports and em. setting: our sample consists of 238 company-years from 2013 to 2017 that were listed as part of the johannesburg stock exchange (jse) top 100 companies and were ranked on ernst and young (ey’s) annual excellence in integrated reporting awards. the likely association between integrated report quality (irq) and em was identified based on theoretical frameworks, including the stakeholder and agency theories. method: we perform a robust, one-way cluster regression on our main empirical model, measuring irq on rankings, determined by the annual ey excellence in integrated reporting awards and em through discretionary accruals. results: we find a statistically significant negative association between em, measured as income increasing accruals, and irq. conclusion: results suggest that companies with income increasing em activities are less likely to disclose higher quality integrated reports. keywords: integrated report; report quality; disclosure quality; earnings management; earnings smoothing; south africa; mandatory disclosure; discretionary accruals; ey annual excellence in integrated reporting awards. introduction in this study the relationship between the quality of integrated reports and earnings management (em) for south african listed companies is empirically investigated. integrating reporting was introduced as a reporting format following the change in information preferences from stakeholders and market participants (cohen et al. 2012; krzus 2011). in south africa it is a johannesburg stock exchange (jse) listing requirement to issue an integrated report based on a ‘comply or explain’ basis for the company-years reviewed.1 currently there is no prescribed standard format, or fixed disclosure requirements for integrated reporting. instead, principled and ethically underlined guidance, as provided in the international integrated reporting framework (‘the framework’) by the international integrated reporting council (iirc) (2013), has been widely adopted. in the absence of a standard format for integrated reports, but within the spirit of this principled and ethical underlining of integrated reporting, management is allowed a degree of freedom in implementing integrated reporting. consequently, the level of the quality of disclosure of integrated reports is dependent on management’s approach to reporting. an integrated report is a single interconnected report that has the primary purpose to ‘explain to providers of financial capital how an organisation creates value over time’ (iirc 2013). it highlights the connectivity of information and focuses on providing information that is relevant and long-term oriented (iirc 2013). evidently, the purpose of the framework will not be fully met if information of a high quality is not disclosed. this is further supported by the framework, also listing the improvement in the quality of information as one of the main aims of integrated reports (iirc 2013). in direct contrast to the purpose of integrated reporting stands the management of earnings. healy and wahlen (1999) define em as the alteration of financial reports by management through using their judgement, or by structuring transactions in such a way as to manipulate the financial reports in order to ‘either mislead some stakeholders about the underlying economic performance of the company or to influence contractual outcomes that depend on reported accounting numbers’. the agency theory is used in various studies to explain the motivation for managers of entities to engage in em (sun et al. 2010; zahra, priem & rasheed 2005; xie, davidson & dadalt 2003). the agency theory describes that the separation of ownership might cause managers to use their position and power to promote their own interest, instead of acting in the best interest of stakeholders (cotter, lokman & najah 2011). consonantly, prior, surroca and tribó (2008) state that rational managers would refrain from managing earnings, unless there are private benefits to be gained. em may have severe consequences for shareholders, creditors, employees, local communities and the society (zahra et al. 2005), since users of financial reports will base financial decisions on reported amounts that are not reflective of the true financial position of the company. therefore, in order to provide transparent and reliable financial information (or information of a high quality) to stakeholders and market participants, earnings should be free of manipulation (kim, park & wier 2012). the conflicting theoretical objectives of integrated reporting and em poses the question of how these two variables relate to one another. extant literature investigating the relationship between various forms of disclosure and em may provide insight as to how these variables should relate to each other; however, due to the unique nature of integrated reports, research focused specifically on integrated reporting is justified. integrated reports differ from stand-alone reports due to the concept of connectivity (barth et al. 2017). integrated reports are, therefore, not merely the amalgamation of traditional stand-alone reports, but the presentation of integrated information that interacts and connects in a manner that provides valuable insights to users thereof. the framework defines the connectivity of information as a ‘holistic picture of the combination, interrelatedness and dependencies between the factors that affect the organization’s ability to create value over time’ (iirc 2013). an integrated report of high quality will clearly show ‘an emphasis on value creation and a high level of connectivity between the various elements presented’ (ernst & young [ey] 2017). given the aim of the framework and the distinctive qualities of integrated reporting, an investigation of the relationship between integrated report quality (irq) and em is warranted. prior literature investigating this relationship is limited and has not been performed by using discretionary accruals as measurement of em. the mandatory setting of the south african milieu further enhances the value of this study. the use of south african companies, reduces concerns relating to self-selection bias, which arises in a voluntary setting (barth et al. 2017). we measure irq on rankings determined by adjudicators for the annual ey excellence in integrated reporting awards and em through discretionary accruals using a cross-sectional modified version of the jones (1991) model as proposed by defond and jiambalvo (1994). our sample consists of 238 company-years from 2013 to 2017 that were listed as part of the jse top 100 companies (in terms of market capitalisation) and were ranked on ey’s annual excellence in integrated reporting awards. our study contributes to the growing literature on integrated reporting by investigating the relationship between the quality of integrated reports, which are vastly different from other stand-alone reports due to its focus on connectivity and long-term value creation, and em. the results of the study will also be of value to various stakeholders as it provides valuable insights into current practices relating to integrated reports. an overview of the related literature, as well as the development of the hypothesis are presented next. thereafter the sample selection and research design are discussed, followed by the results and the conclusion of the study. literature review and hypothesis development related literature in recent years there has been a significant increase in research investigating the quality of integrated reports. lee and yeo (2016) investigated whether there is an association between cross-sectional variation in integrated reporting disclosures and firm valuation. they investigated a sample of south african listed firms during the period 2010 to 2013 (thus after integrated reporting became a jse listing requirement in south africa) and compared firm valuation (measured as the sum of the market value of equity and the book value of total liabilities, divided by total assets) to a self-constructed integrated reporting score. they found a positive association between integrated reporting disclosure and firm valuation and interpreted this as evidence suggesting that the benefits of integrated reporting exceed the cost of preparing an integrated report. results from further analysis, performed by lee and yeo (2016), also suggest that the positive association between firm valuation and integrated reporting is stronger in firms with higher organisational complexity and also in firms with higher external financing needs. building on the work performed by lee and yeo (2016), barth et al. (2017) investigated how a higher quality integrated reporting is associated with higher firm value. their study focused on whether the iirc’s dual objective for integrated reporting, namely, improved information quality to capital market participants and improved quality of internal decision making, are achieved. barth et al. (2017) used proprietary data from ey for a sample of south african firms that forms part of the top 100 jse listed firms each year, to measure irq. their results show that the positive association between irq and firm value is, in fact, as a result of both improved information quality and improved internal decision making, thus providing evidence that the objective of the iirc relating to integrated reporting is being met. zhou, simnett and green (2017) investigated the usefulness of integrated reports to capital market participants. they investigated whether there is a relation between companies that produce integrated reports in better alignment with the framework (referred to in the study as higher quality integrated reports) and analyst earnings forecast error for a sample of south african companies. after controlling for financial transparency and the issuance of stand-alone csr reports, they found that higher quality integrated reports are more useful to analysts and investors, than current reporting practices. they interpreted the results as indicating that the quality of integrated reports is of importance to capital market participants. in a more recent study, mans-kemp and van der lugt (2020) set out to assess whether integrated reporting is useful by investigating the relations between the quality of integrated reports and financial and sustainability performance in a south african sample of companies. they found a significant relationship between the quality of integrated reports and companies’ environmental, social and corporate governance (esg) scores, as well as between the quality of integrated reports and earnings per share and leverage. the results show that managerial efficiency and legitimacy are improved by integrated reporting for debt capital providers. buitendag, fortuin and de laan (2017), as well as dilling and caykoylu (2019) investigated the characteristics of entities that report higher quality integrated reports. buitendag et al. (2017) investigated the top 100 entities listed on the jse from 2013 to 2015 and found that the quality of a company’s integrated report is affected by the type of industry, the entity’s size, the composition of the entity’s board of directors and the profitability of the company. dilling and caykoylu (2019) investigated a sample of 110 global organisations that produced an integrated report in 2017 and found that the main disclosure drivers of an integrated report with a higher quality is larger entity size, higher female board ratio and listing in the iirc examples database. none of these studies specifically investigated the effect of em on irq. one of the characteristics investigated by dilling and caykoylu (2019) were, however, corporate earnings quality. they used cash flow from operating activities/net income as a proxy for corporate earnings quality. their results showed no significant association between the quality of earnings and that of integrated reports. our study differs from that of dilling and caykoylu (2019), who examined entities’ characteristics that determine the quality of integrated reports in the following ways: our study explicitly concentrate on the association between the quality of integrated reports and em; our study uses discretionary accruals (estimated by using a cross-sectional modified version of the jones [1991] model) as a proxy for em; our study is performed in a south african setting where integrated reports are mandated; and we use rankings based on the ey annual excellence in integrated reporting awards as a proxy for irq. theoretical frameworks and hypothesis development given the unique qualities of integrated reporting, the potential association between irq and em is explicated based on theoretical frameworks. a negative association between high-quality integrated reporting and em can be explained by both the ethicaland resource-based branches of the stakeholder theory. the stakeholder theory explains the various social contracts that exist between different stakeholders and the entity (deegan 2009). each of these stakeholders has different information needs and according to the ethical branch of the stakeholder theory, it is the ethical or moral obligation of management to provide stakeholders with the information they require (deegan 2009). this branch of the stakeholder theory suggests that managerial engagements are driven by ethical concerns to protect all stakeholder interests (jones 1995) and strongly rely on management’s need to do what is in the best interest of society (kim et al. 2012). the ethical-based theory expects of management to accept their responsibility and, by some guiding moral principle, adhere to the legitimate interest of all stakeholders (carroll 1979; kim et al. 2012). this theory, therefore, suggests that managers will accept its responsibility and adhere to the legitimate interest of all stakeholders (kim et al. 2012). ethically driven managers will, therefore, not engage in em activities. the avoidance of activities such as em may be indicative of managers’ ethical commitment to high-quality integrated reporting. the ethical-based theory is also closely related to the legitimacy theory, which assumes that an entity will ensure that it is perceived to operate within the expectations of society, with which a social contract exists (cotter et al. 2011; deegan 2009). the legitimacy theory suggests that managers will operate within the expectations of society and refrain from engaging in activities, like em; that is deemed unacceptable by society (fombrun & shanley 1990). again, the avoidance of activities, such as em, may be indicative of managers’ commitment to high-quality integrated reporting, especially considering the south african jse requirement to publish integrated reports on a ‘comply or explain basis’ for the company-years under review. this listing requirement inherently creates an expectation in society for entities to produce integrated reports that comply with the principles set out by the framework and resultantly is of a high quality. the resource-based branch of the stakeholder theory suggests that trustworthy and cooperative managerial behaviour is viewed as a resource that leads to entity wealth creation in the long term (jones 1995). principled managerial behaviour may not merely establish an entity’s ethic proprietary, but also creates a reputational asset as a source of future financial well-being (fombrun & shanley 1990). management will aspire to uphold and protect such ethical proprietary and reputational assets to secure long-term future financial benefits. if an entity aspires to protect reputational assets, such aspiration may inhibit its managers from engaging in short-sighted and typical amoral activities, such as em. this is also supported by prior research which indicates that future-orientated managerial behaviour is less likely to engage in em (cheng, lee & shevlin 2016; kim, kim & zhou 2017). refraining from em under the faculty of the resource-based theory may also be indicative of managerial preference to disclose high quality integrated reports. evidently, the ethicaland resource-based branch of the stakeholder theory suggest a possible negative relationship between the quality of integrated reporting and em. in contrast, a positive association between the quality of integrated reporting and em is aligned with the agency theory. the agency theory poses that the separation of ownership might cause managers to use their position and power to promote their own interest, instead of acting in the best interest of stakeholders (cotter et al. 2011). one of many actions that managers can engage in to obtain personal gains at the expense of the stakeholders, is to manage earnings (sun et al. 2010). em has far-reaching consequences for all stakeholders and affected stakeholder groups will react to em by increasing activism and vigilance (zahra et al. 2005). dechow, sloan and sweeney (1996) found evidence that a company’s stock price immediately decreases when shareholders suspect the manipulation of earnings. it is thus clear that when stakeholders’ interests are damaged by em, they will respond adversely to management (sun et al. 2010). the reaction of stakeholders will inevitably result in a decrease in the entity’s corporate reputation and legitimacy. the resource dependence theory suggests that if the entity considers the reputation or legitimacy of the entity to be important, strategies will be implemented to repair the damaged caused (deegan 2009). this managerial behaviour to counter misconduct, such as em, is also considered by sun et al. (2010) who argued that the informativeness of reports may be increased to deflect stakeholders’ attention from the monitoring of em and to minimise the threats of stakeholders’ reaction thereto. evidently, integrated reporting may be driven by management’s quests to promote self-interest and be associated with the agency theory. such integrated reports are regarded as opportunistic integrated reports. opportunistic integrated reports may show a high level of adherence to the guiding principles of the framework; that is, a high level of quality. however, such high level of adherence may be purposefully designed by management to divert end-users’ attention from em. therefore, under the faculty of the agency theory and the opportunistic use of reporting, the relationship between the quality of integrated reports and em can possibly be labelled as a positive relationship. based on the theoretical frameworks we expect an association between high quality integrated reporting and em. since the theoretical frameworks provide support for both a positive and negative association, we propose the following hypothesis: there is an association between earnings management and integrated report quality. sample selection and research design data and sample selection our sample originates from data issued publicly by ey for its annual excellence in integrated reporting awards. we use this ey data as a peripheral measure to operationalise our dependent variable, irq, for five years from 2013 to 2017. to ensure consistency and comparability among companies included in our sample, we used 2017 as our final sample year, since compliance with the king iv report replaced compliance with the king iii report as a jse listing requirement for financial years starting on or after 01 april 2017. following prior studies, we exclude companies in financial industries since the calculation of accruals for these companies can be problematic due to the different nature of their accruals reporting (chen, cheng & wang 2015; chung, firth & kim 2002; dou, khan & zou 2016; katmon & farooque 2017; kim et al. 2012; klein 2002; lobo & zhou 2001). we complement the ey data with information compiled from the bloomberg and iress databases and, when necessary, with information hand-collected from financial statements available in the public domain. after excluding company-years with missing data and insufficient information to calculate discretionary accruals, our surrogate for em, we obtain a crosssectional pooled sample of 263 company-years from 2013 to 2017. we further eliminate 25 observations from our sample to ensure that there is at least three observations per company. this is done to ensure that reasonably balanced clusters will be obtained which will reduce bias in the cluster-robust estimator, since it has been found that bias is larger when clusters are unbalanced (baum, nichols & schaffer 2010). the final sample consist of 238 company-years observations. it is not uncommon in prior literature to draw inferences from small samples to address a research question in a unique setting (barth et al. 2017; clarkson et al. 2013; dilling & caykoylu 2019; katmon & farooque 2017). table 1 illustrates our sample selection and table 2 provides a sample distribution of company-year observations by industry. industry classifications are based on industry classification benchmarks (icb) codes. table 1: sample selection. table 2: sample composition. as evident from table 2 the maximum representation of the sample is noticeably from the 20 companies (38.24% of the sample) in the basic material industry, followed by the 15 (28.57%) consumer services companies. empirical models and measurement of variables main model: equation 1 we investigate the relationship between the quality of integrated reporting and em by performing a robust, one-way cluster regression on the main empirical model pronounced in equation 1. following dilling and caykoylu (2019), sun et al. (2010) and shaw (2003), we regard irq as our dependent variable and em as our independent variable of interest. we cluster the standard errors at company level ‘to account for serial correlation within the error term within the same firm’, since companies appear more than once in our sample (katmon & farooque 2017; landier et al. 2013). to lessen the force of outliers, all observations with an absolute studentised residual of more than two are deleted. the variables in this model are measured as follows (all variable definitions are also summarised in appendix 1): measurement of integrated report quality: as mentioned before, we use data issued publicly by ey, for its annual excellence in integrated reporting awards to operationalise our dependent variable, irq. the ey data is based on scores for irq awarded annually to the top 100 companies listed on the jse in terms of market capitalisation. each company’s score is classified under one of five report categories regarding quality; that is, top 10, excellent, good, average, and progress to be made. we rely on the validity of the publicly released ey data to operationalise irq, based on its assessment and use in prior studies (barth et al. 2017; buitendag et al. 2017; mans-kemp & van der lugt 2020). barth et al. (2017) endorses the validity of the ey scores underlying the publicly known report quality categories by regarding the ey scores as being independently awarded by expert adjudicators, where scores are determined for quality of disclosures based on the guiding principles and content elements outlined by the framework2 and the extent to which the framework’s fundamental concepts relating to how value is created, are incorporated in the integrated report (ey 2017). during the scoring process specific emphasis is placed on ‘the quality of information presented, the relevance, understandability, accessibility and connectedness of that information’ (ey 2017). zhou et al. (2017) also validates their internally generated rankings for irq as being demonstrative of the quality components described in the framework based on its consistency with the external ratings produced by ey. following mans-kemp and van der lugt (2020) we construct the proxy for irq by ranking each of the ey report quality categories. table 3 provides the detail rankings used. table 3: integrated report quality ranking per ernst and young report quality category. measurement of earnings management: we follow a collection of prior studies that use discretionary accruals as an alternate for our independent variable of interest, em, in our main regression (equation 1). specifically, we use a cross-sectional modified version of the jones (1991) model as proposed by defond and jiambalvo (1994). this model is extensively used to measure em by computing discretionary accruals (e.g. chung et al. 2002; dechow, sloan & sweeney 1995; defond & subramanyam 1998; katmon & farooque 2017; kim et al. 2012; kothari, leone & wasley 2005; lobo & zhou 2001; prior et al. 2008; shaw 2003). guay, kothari and watts (1996) and dechow et al. (1995) conclude that this modified version of the jones (1991) model exhibits the strongest power to provide reliable estimates of discretionary accruals. this accruals model is formalised in equation 2 and is separately estimated for each year for all company-year observations categorised under the same industry (icb codes). following prior studies, we estimate these annual estimations for each industry that has at least 11 observations per year (e.g. katmon & farooque 2017; shaw 2003). subsequently, discretionary accruals are calculated from the residuals computed from regressing equation 2. consistent with other studies, the absolute values of discretionary accruals are used as our proxy for em (jordaan, de klerk & de villiers 2018; katmon & farooque 2017). following jordaan et al. (2018) we also differentiate between positive and negative discretionary accruals, to determine whether irq is associated with either positive (income increasing) or negative (income decreasing) discretionary accruals. accruals model: equation 2 where: tait, total accruals for company i in year t (computed as net income minus cash from operations); ait–1, lagged total assets; δrevit, change in revenue for company i in year t from year t–1; δrecit, change in account receivables for company i in year t from year t–1; ppeit, gross property, plant and equipment for company i in year t. measurement of control variables: we include control variables in our estimation that have been identified in prior literature to influence the quality of disclosure of our variable of interest, em. dilling and caykoylu (2019) and mans-kemp and van der lugt (2020) found a positive relationship between irq and company leverage (lev), suggesting that, as predicted by the agency theory, highly leveraged companies will improve their disclosure in an attempt to decrease information asymmetry (dilling & caykoylu 2019). likewise, lev may also be an inducement for em (e.g. kim et al. 2012; prior et al. 2008). we therefore include lev as a control variable and measure lev as long-term debt scaled by total assets (chen et al. 2015; kim et al. 2012). following prior studies (dilling & caykoylu 2019; katmon & farooque 2017; lee & yeo 2016; lobo & zhou 2001; mans-kemp & van der lugt 2020; shaw 2003), we include company size (size) as a control variable in our analyses. prior studies suggest that there is a positive association between size and irq (buitendag et al. 2017; dilling & caykoylu 2019; lopes & coelho 2018). in the em literature, it is also suggested that larger companies are less likely to engage in em, due to higher scrutiny from financial analysts and investors (chen et al. 2015; lobo & zhou 2006). we quantify size as the natural log of the market value of equity, following the specifications in several studies on em and irq (e.g. buitendag et al. 2017; chen et al. 2015; jordaan et al. 2018; katmon & farooque 2017; kim et al. 2012). corporate governance (gov) is included as a control variable, since dilling and caykoylu (2019) and buitendag et al. (2017) found a positive relationship between irq and gov, suggesting that the monitoring role of good gov also extends to the improved quality of integrated reporting. likewise xie et al. (2003) and klein (2002) indicate that gov is related to em and thus may also have an impact on the reporting behaviour of companies. we follow dilling and caykoylu (2019); buitendag et al. (2017) and katmon and farooque (2017) and operationalise gov as an indicator variable, taking a value of 1 in the instance when more than 50% of the board of directors of a company are independent (or non-executive) directors, and zero otherwise. we follow jordaan et al. (2018); lee and yeo (2016); chen et al. (2015) and prior et al. (2008) and control for company performance by including return on assets (roa) in our analyses. lee and yeo (2016) found that companies with higher quality integrated reports show an increased operating performance, while chen et al. (2015) find a significant negative association between their control variable company performance (measured as roa) and em. roa is calculated as net income divided by average total assets (as captured and defined on the bloomberg database). finally, to control for time fixed effects, we include a dummy variable, year. empirical results and findings descriptive statistics we present the descriptive statistics for the main model (measuring em as the absolute value of discretionary accruals) in table 4. table 4 discloses a mean irq of 2.909, indicating that the mean annual quality of integrated reports, based on the annual ey excellence in integrated reporting awards, is between average and good. the standard deviation for irq of 1.153 together with an inter-quartile range of two suggests that, because irq varies between one and five, the year-to-year irq of companies may vary substantially. similar results for irq were reported by barth et al. (2017), in which it was submitted that these results lessen concerns that irq is mostly consistent over time. barth et al. (2017) also base their measure of irq on ey’s integrated reporting awards. the mean for em is 0.048, which is akin to results reported in katmon and farooque (2017) who reported a mean of 0.060. the standard deviation of 11.049 for roa is expressive of the vast difference in roa to be expected between a company generating a negative net loss and a positive net income. table 4: descriptive statistics. table 5 provides the spearman correlations for the variables used in the main regression. to ensure that multicollinearity is not a concern, the variation inflation factor (vif) for all variables in our main model was measured. the untabled vif scores for all variables were less than three, suggesting that multicollinearity is not a major concern in our results, as is it well below the common benchmark of 10 (burns & burns 2008). furthermore, table 5 reveals that all correlation coefficients are well below 80% (a benchmark as used by katmon and farooque [2017]) with a maximum correlation coefficient of 35% reported between roa and em and roa and lev. again, suggesting that serious multicollinearity is not a concern for our model. intriguingly, and consistent with the spearman correlations disclosed in dilling and caykoylu (2019), irq and em are not significantly correlated, suggesting that em does not meaningfully affect the quality of integrated reports. this correlation between em and irq is highlighted in our empirical findings below. table 5: univariate results – spearman correlations. empirical findings the results are unveiled in table 6. we discern between absolute discretionary accruals (em absolute), income increasing discretionary accruals (em positive) and income decreasing discretionary accruals (em negative), following jordaan et al. (2018). our results for em absolute do not indicate a significant association (p-value of 0.901) between irq and em absolute, implying that the quality of integrated reports is not strongly determined by em. the results do, however, reveal that em positive are negatively and significantly (p-value of 0.040) associated with irq, suggesting that companies with income-increasing em activities are less likely to disclose higher quality integrated reports. this is consistent with the negative association described under the faculty of the stakeholder theory, which suggests that managerial engagements are driven by ethical concerns towards stakeholders and/or to secure long-term financial benefits (jones 1995), rather than using integrated reports opportunistically. table 6: empirical results. the inconsequential results for the association between irq and em absolute are consistent with the findings of dilling and caykoylu (2019), in which results were insignificant for the association between the quality of integrated reports and earnings quality. interestingly, sun et al. (2010) also found no significant statistical association between corporate environmental disclosure and em. these insignificant results are, however, contradictory with studies reflecting on the association of stand-alone reports’ disclosure quality and em, in which a significant association was reported (katmon & farooque 2017; lobo & zhou 2001; shaw 2003). this inconsistency may be ascribed to the difference between stand-alone reports and the distinctive quality of connectivity in integrated reports, as well as the compliance requirement within the south african context in which our study was conducted. our results show weak explanatory power for the association between irq and our control variables roa and size. this is consistent with the findings of mans-kemp and van der lugt (2020). the insignificant results for the association with size is contradictory to the results of other studies that explored this relationship, which found a significant and positive relationship between these variables (dilling & caykoylu 2019; lobo & zhou 2001; shaw 2003). in response to the insignificant results for size and roa, we run our regressions excluding these control variables. untabled results of this test substantiate our findings. noteworthy is the significance of the association with lev and gov. the reported significant and positive association between irq and lev, as well as gov, implies that companies which are highly leveraged and has stronger governance monitoring, are more inclined to report higher quality integrated reports. the strong positive association between irq and lev, shows that integrated reporting alleviates the information asymmetry between management and financiers, reducing agency costs and sending a valuable signal to stakeholders (lee & yeo 2016). mans-kemp and van der lugt (2020) also find a significant positive association between irq and lev and argue that the increase in irq of highly leveraged companies could be ascribed to increased pressure from financiers for good quality reporting given the risk associated with high leveraged companies. the significant and positive association between irq and gov is aligned with findings of other studies reporting that stronger governance and board composition result in higher quality reporting (buitendag et al. 2017; dilling & caykoylu 2019; mans-kemp & van der lugt 2020). conclusion extant literature on the association between various forms of disclosure and em focus on stand-alone reporting formats (e.g. katmon & farooque 2017; lobo & zhou 2001; shaw 2003; sun et al. 2010). our study is juxtaposed to prior studies as the purpose of our study is to examine the relationship between the disclosure quality of specifically integrated reports and em. integrated reports are distinguished from stand-alone reports as it aims to highlight the connectivity of information (barth et al. 2017). also, our study is performed in a south african milieu, in which integrated reporting is mandatory for companies listed on the jse. we base our analyses on a robust, one-way cluster regression, operationalising the quality of integrated reports using ey data from its annual excellence in integrated reporting awards, and em by estimating discretionary accruals through the modified jones (1991) model, including several control variables. we hypothesise the potential association between irq and em under the faculties of the stakeholder and agency theories. the ethicaland resource-based branches of the stakeholder theory suggest that managerial engagements are driven by ethical concerns towards stakeholders and/or to secure long-term future financial benefits (jones 1995). contrary to this, irq may be driven by management’s quests to opportunistically use integrated reports to promote self-interest, which is akin to the agency theory. our findings suggest that companies that are less inclined to income-increasing em activities also produce higher quality integrated reports. this suggest that managers who are less inclined to manage earnings upward, will show the same ethical and forward-thinking approach to value creation and prepare integrated reports of high quality. similar to the findings of dilling and caykoylu (2019), our findings also show weak explanatory power regarding the effect of em (measured as the absolute value of discretionary accruals) on the quality of integrated reporting. our findings contribute to the growing literature on integrated reporting, especially since our inferences are from a mandatory setting. it may provide insightful information to specifically the iirc with the main purpose of promoting higher quality disclosures to all stakeholders (iirc 2013) to lessen the consequences of agency-problems. our findings also serve investors in showing that companies that do not engage in income-increasing em are more likely to also present integrated reports of a higher quality. we submit that our inferences may be biased as a result of certain limitations, specifically related to our relatively small sample size. prior studies of a similar nature, which rendered informative results, were also based on sample sizes comparable to ours (barth et al. 2017; dilling & caykoylu 2019; katmon & farooque 2017). furthermore, we acknowledge that the ey scores awarded by adjudicators may be subject to bias; and that our study is constricted to the jse top 100 companies included in the ey excellence in integrated reporting awards. we regard our findings as one of the initial steps in the direction of an improved understanding of factors, specifically em, that influence the quality of integrated reports. future research may dissect in more detail the relationship between the quality of integrated reporting and em from a south african perspective, by considering the impact of specific events on high quality integrated reports and em. acknowledgements competing interests the authors have declared that no competing interest exists. authors’ contributions a.e. contributed to the conceptualisation of the article, wrote the literature review and research design section, and contributed to the hypothesis development, sample selection and results sections. s.s. contributed to the conceptualisation of the article, wrote the sample selection, results and hypothesis development sections, and contributed to the literature review and research design sections. ethical considerations the authors confirm that the project does not involve human participants or the use of their data. the authors confirm that they have collected data that are freely accessible in the public domain only. ethical clearance was obtained from the research ethics committee: human research, stellenbosch university. 02 july 2018. funding information this research received no specific grant from any funding agency in the public, commercial or not-for-profit sectors. data availability data sharing is not applicable to this article as no new data were created or 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& dadalt, p.j., 2003, ‘earnings management and corporate governance: the role of the board and the audit committee’, journal of corporate finance 9(3), 295–316. https://doi.org/10.1016/s0929-1199(02)00006-8 zahra, s.a., priem, r.l. & rasheed, a.a., 2005, ‘the antecedents and consequences of top management fraud’, journal of management 31(6), 803–828. https://doi.org/10.1177/0149206305279598 zhou, s., simnett, r. & green, w., 2017, ‘does integrated reporting matter to the capital market?’, abacus 53(1), 94–132. https://doi.org/10.1111/abac.12104 appendix 1 table 1-a1: summary of variable definitions. footnotes 1. following barth et al. (2017:45), we submit that the ‘comply or explain’ principle and government of integrated reporting in south africa can be classified as a mandatory setting. 2. ey only releases the report quality categories publicly and not the scores underlying the publicly known report quality categories. barth et al. (2017) had privileged and proprietary access to the underlying ey scores, which upholds their assessment of the ey data. abstract introduction methodology findings and discussion conclusion and recommendations acknowledgements references about the author(s) paschal b. nade department of business studies and humanities, nelson mandela african institution of science and technology, arusha, tanzania christian k. malamsha department of co-operative studies, faculty of co-operative and community development, moshi co-operative university, moshi, tanzania citation nade, p.b. & malamsha c.k., 2021, ‘the influence of agri-entrepreneurship courses studied on youth farm entrepreneurial intention: evidence from folk development colleges in tanzania’, south african journal of economic and management sciences 24(1), a3788. https://doi.org/10.4102/sajems.v24i1.3788 original research the influence of agri-entrepreneurship courses studied on youth farm entrepreneurial intention: evidence from folk development colleges in tanzania paschal b. nade, christian k. malamsha received: 01 aug. 2020; accepted: 15 jan. 2021; published: 07 apr. 2021 copyright: © 2021. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: youth engagement in agriculture in developing countries is of paramount importance since much of their livelihoods depend on this sector. aim: this article therefore aims at assessing the influence of studying agri-entrepreneurship courses on youth farm entrepreneurial intention. setting: three of the 55 folk development colleges (fdcs) in tanzania. methods: a cross-sectional design was employed and 300 respondents were randomly selected from three fdcs offering agricultural programmes. both qualitative and quantitative data were collected and analysed by using descriptive and inferential statistics in which frequencies, percentages, mean, standard deviation and somers’s d model were employed. results: the results show that there is a significant relationship between agri-entrepreneurship knowledge and skills acquired and youth entrepreneurial intentions towards farming. conclusion: the fdcs’ agri-entrepreneurial training provides knowledge and skills which influence youth farm entrepreneurial intention. however, the strength of this influence ranges from weak to moderate depending on various factors. regular reviews of curricula to enhance the beliefs that develop a view of farm entrepreneurship as a paying business is recommended. the analysis and implication of this finding has been further explained. keywords: agri-entrepreneurship courses; knowledge; skills; farm entrepreneurial intentions; unemployment; the youth. introduction the effect of agricultural education on increasing productivity and income of farmers has been widely acknowledged by scholars (anang, backman & sipiläinen 2020; ashraf & qasim 2019; ferreira et al. 2018; heanue & donoghue 2014). however, agricultural education has not been quick in responding to the needs of the labour market and the changing environment in this era of unprecedented youth unemployment (alliance for green revolution africa [agra] 2015; sangiga, lohento & mayenga 2015). currently, the youth unemployment situation remains one of the key global challenges. it is estimated that about 67 million (13.0%) young people between the ages of 15 and 24 years were unemployed globally in 2018 while in tanzania youth unemployment stood at 13.4% against overall 11.7% unemployment (international labour organization [ilo] 2019; national bureau of statistics [nbs] 2014). education and training have been positively associated with profitability of enterprise and ability to open up opportunities in different sectors and occupations for the youth (haji 2015; world bank 2014). specifically, entrepreneurial education gives more attention to enterprise development and employment generation (jemal 2017; wale-oshinowo & kuye 2016). further studies have recognised that farm entrepreneurship has proved successful in addressing youth unemployment through the establishment of market-oriented and self-owned farm enterprises (d’souza 2013; hrangao & sorokhaiban 2015). in addition, it is noted that an individual with ‘farm entrepreneurship’ knowledge, skills and behaviours is capable of establishing and developing a profitable farm in a changing business environment (ruddman 2008; kahan 2012; mahendra 2017). following the acknowledgement of entrepreneurial education with regard to employment generation, the government of tanzania allowed entrepreneurship courses to be taught at various levels of education as stated in the national education policy of 1995. folk development colleges (fdcs) also began teaching entrepreneurship courses in line with the major courses as part of the enforcement of the national education policy. in this study the major focus is agriculture; therefore, together with entrepreneurship courses, the researcher coined the term agri-entrepreneurship. in spite of all this, farming lags behind as the career of choice among agricultural students as noted by redecker, wihstutz and mwinuka (2000) who found that fdc graduates were migrating to nearby towns in search of employment and often did not work in their field of training. also, christian (2002) found that fdc graduates were searching for employment in town, despite 55% of their syllabus being based on practical skills. it is further estimated that only 13% of lower tertiary technical college (vocational education and training authority [veta] and fdc) graduates annually get self-employed in farming (united republic of tanzania and international institute for educational planning [urt iiep] 2011). in addition, adams, johanson and razmara (2013) found that only 39% of self-employed fdc graduates were partly involved in farming. more recently ng’atigwa et al. (2020) found that the youth who completed primary school education are more likely to be involved in horticulture agribusiness by about 9.7 times (odds = 9.7) compared with the youth who have a high level of education. agricultural graduates’ effective entrance into farm entrepreneurship in establishing farm-related enterprises presently is not feasible: parental influence, negative image of the sector and education which are seen as impeding factors for the youth to choose a career in farming (ezeh & juniadu 2019; heinert & roberts 2016). for instance, student preand post-attendance tests of agricultural courses show an increase in literacy, but mixed results in terms of attitude and perception toward farm-related enterprises (kaijage & wheeler 2013). also, as the level of education increases the preference and participation and time devoted to agricultural-related enterprises decline. for example, attainment of at least secondary education significantly reduced the probability of participation by 20% and meant fewer working hours than the uneducated (afande 2015; ahaibwe, mbowa & lwanga 2013). this implies that as the youth attain higher education level, they devote their time to non-agricultural activities. agricultural education and training have been unresponsive to changing patterns of demands on the youth and seem to lack current skills like opportunity realisation, multi-institutional management capabilities as well as a market-driven system to prepare the youth for entrepreneurship in farming. this is shown by a growing dependence on white-collar jobs in the government and other places which are difficult to come by these days (agwu, nwankwo & anyanwu 2011; assane 2015; sumra & katabaro 2014; white 2019). thus, despite the abundant untapped opportunities in the agricultural sector (rikken 2015; rutta 2012), the serious youth unemployment (ilo 2019), and the agricultural training initiatives for the youth taken by the government of tanzania and other stakeholders, the majority of the youth have persistently neglected farm-related enterprises. this study focuses on assessing farm entrepreneurial intention of students majoring in agriculture courses that are blended with an entrepreneurship course. the study is guided by the theory of planned behaviour (ajzen 1991), which states that a person’s behaviour is a function of their intention, which in turn is a result of attitude, subjective norm and perceived behaviour control. a person’s attitude, and subjective and behavioural control are determined by beliefs (ajzen 1991). the theory fits the study because the youth may gain beliefs about farm entrepreneurship by studying agricultural courses blended with entrepreneurship courses. therefore, this study is assessing the youth farm entrepreneurial intention by situating agri-entrepreneurship courses in the perceived behavioural control parameter of the theory. in support of the theory, entrepreneurial education has been proven by studies as a key determinant of antecedents (attitude, subjective norms and perceived behavioural control) of entrepreneurial intention; these studies were largely conducted on students majoring in business courses (dorgan 2015; li & wu 2019; wale-oshinowo & kuye 2016). recently scholars have embarked on assessing the entrepreneurial intention of students majoring in other courses such as engineering and agriculture, as presented in the following analysis. a review of empirical studies that assessed the influence of agri-entrepreneurship courses produces different results as follows: schlaegel and koenig (2013) in their review of the dairy sector show that entrepreneurial intentions are central to understanding entrepreneurship as they are the first step in the process of discovering, creating, and exploiting opportunities. despite the recognition of entrepreneurial intention, some weaknesses of curricula have been pointed out. for instance, prathima, kundu and racine (2008) note that agricultural education and training pedagogy in developing countries essentially remains limited to traditional classrooms (with obsolete theoretical training and the collapse of outreach and extension services). also, even with the integration of entrepreneurship courses, learning is often limited to cognition, whereas feelings, motives, and personal experiences are neglected (gemma & manipol 2015; müller 2008). liñán, carlos and jose (2010) found that the entrepreneurial orientation of individuals, especially the conception of who is an entrepreneur and how to make a venture survive and thrive, influence entrepreneurial intention. they caution the traditional teaching that concentrates only on business plan development skills, whereas they should consider other factors for enterprise start-up. similarly, nabi et al. (2018) identified two types of entrepreneurial learning that help in the formation of entrepreneurial intention, which are are understanding the entrepreneurial process and understanding the practical skills. if only one type of entrepreneurial learning is administered, the level of intention decreases; for instance, skills alone are not sufficient to give an individual confidence to start a business. nevertheless, amani and kushairi (2017) found higher levels of agribusiness entrepreneurial intention among students with innovativeness and risk-taking characteristics. this indicates that starting a farm enterprise requires a set of skills and competencies that individuals should study by considering the entire enterprise start-up process. zakaria, adam and abujaja (2014) found that students’ perceptions regarding the prospects of agribusiness enterprises have shown a statistically significant influence on students’ intentions to take up agribusiness as a future self-employment avenue. similarly, shiri, alibaygi and faghiri (2012) revealed that agricultural education contributes to students’ entrepreneurial motivations at a moderate to high level. however, the courses of entrepreneurship education alone explain 35.5% of variances in students’ entrepreneurial motivations. hashemi, hossein and rezvanfar (2012) found the existence of entrepreneurial intention among agricultural students with perceived self-efficacy showing stronger significance than college entrepreneurial orientation. ribeiro, fernandes and diniz (2014) found that 35.2% of the respondents would like to start their own business and contribute to the development of the agriculture sector; however, their findings identified perceived bankruptcy, lack of financial support, and fear of failure as the major difficulties concerning starting a business. while there is a decline in numbers in youth engagement in farming-related enterprises as level of education, an increase in literacy and technical competencies has been noted in the reviewed studies (afande 2015; ahaibwe et al. 2013; kaijage & wheeler 2013). the type of course and content of the course seem to determine farm entrepreneurial intention. however, there are mixed results in terms of farm entrepreneurial intentions as some show more significantly than others. therefore, this study intended to establish whether indeed agricultural courses blended with entrepreneurship courses indeed influence youths’ farm entrepreneurial intentions, with a specific focus on fdcs since they are centred on providing knowledge and skills for self-employment. in this case, intention is the state of mind that directs and guides the actions of the youth toward farm entrepreneurship. it specifically addresses three objectives: firstly, to identify type of knowledge and skills provided by agricultural training institutions in transforming the youth’s intention towards farm entrepreneurship. secondly, to determine the influence of knowledge and skills provided on youth farm entrepreneurial intention. methodology the study area the study involved three out of 55 fdcs in tanzania, namely: mamtukuna (kilimanjaro region), monduli (arusha region) and chisale (dodoma region). these fdcs were selected for this study because one of their major objectives of training is to equip the learners with the knowledge and skills that would enable them to be self-employed and self-reliant based on local situations. the three colleges were selected purposively because of the similarity in the nature of the agricultural courses which were blended with an entrepreneurship course. the study population was all final-year certificate students pursuing agriculture courses. study design sampling procedures and sample size this study employed a cross-sectional design, which was appropriate for this study because the data were collected from three colleges which are located in three different regions at one point in time. a sample size of 300 students was formed from an estimated population of 1200 from the three colleges using the formula developed by israel (2013): in equation 1, n is the sample size, n population size and e is the level of precision. the formula assumes that p = 0.05 (maximum variability). the desired confidence level is 95% and the degree of precision or sampling error accepted is ± 5%. therefore n = 1200/ (1 + 1200(0.05)) = 300. every element in the sample was selected using simple random sampling, as this procedure considers the sampling elements to have homogenous characteristics (all are final year and their courses are blended with an entrepreneurship course). the sample was drawn from fdcs’ admission records and directories. the selection of sample from each institution is shown in table 1. table 1: sample selection by institution. data collection the study employed questionnaires, focus group discussions and an interview guide as data collection tools. pre-testing of questionnaires was done before being administered. the questionnaire forms were distributed to 12 respondents, equivalent to 4% of the sample size during pre-testing. a few unfamiliar terms were noted, and the researcher made adjustment to those terms by replacing them with more familiar terms. three hundred questionnaire forms were administered and its development was guided by the theory of planned behaviour as retested by liñán and chen (2006). the completed questionnaires forms were 294 (98%) which were used in the analysis. six focus groups each consisting of seven students were formed through nomination strategy. six college staff members (two per college) and two ministry of health, community development, gender, elderly and children (ministry responsible for fdcs) officials were purposively selected and involved in interviews based on their role, knowledge and experience. the data collected include: respondents’ socio-demographic characteristics, types of courses studied, types of teaching methodology applied, existence of intention and expected learning outcomes. six items that assess the expected learning outcomes (independent variable) were developed from the content of the courses studied and the teaching methods applied. the six items were developed under the guidance of the damian and wallace (2015) and roomi and redman (2016) studies. the six items were measured by a five-level likert scale labelled 1 = strongly disagree to 5 = strongly agree. likewise, the intention (dependent variable) was assessed by nine items developed under the guidance of liñán and chen (2006) and malebana (2012) and measured on a five-level likert scale labelled 1 = strongly disagree to 5 = strongly agree. data processing and analysis the data supporting the two objectives of this study were analysed by using descriptive non-parametric inferential statistics and content analysis. specifically, respondents’ socio-demographic characteristics, types of courses studied, types of teaching methodology applied, existence of youth farm entrepreneurial intention and perception of the expected learning outcomes were analysed by using frequencies, percentages, means and standard deviations. the relationship between expected learning outcomes and youth farm entrepreneurial intentions were analysed by using somers’ d non-parametric model. somers’ d of y with respect to x is defined as: in equation 2, somers’ d coefficient of association for asymmetrical variables, x is the independent variable pair which include expected learning outcomes assessed by six indicators or items and y is the dependent variable pair which is the intention variable assessed by nine indicators or items. if somers’ d coefficient > 0 ≤ + v 1, the variable is regarded to have impact on intention. the choice of somers’ d is based on the central role it plays in rank statistics for non-parametric (newson 2013). qualitative information collected from key informants and focused group discussion were conceptually analysed by coding the themes systematically and drawing the key that emerged from them. reliability and validity internal reliability of items for the self-administered questionnaire was measured by cronbach’s alpha as defined by fami (2000): in equation 3, α is the alpha coefficient, k is the number of items, is the total variance of the sum of the item and the variance of each individual item. a positive alpha coefficient ranging from 0.7 to 1 was taken into consideration as most recommended internal consistency (gliem & gliem 2003). pairwise deletion method was applied in performing the reliability analysis. to obtain the required alpha results, some of the items that were in the questionnaire were deleted. nine items measuring expected learning outcomes were presented to the respondents but three items were deleted after reliability test results with their overall cronbach’s alpha coefficient reading 0.707. no item was deleted for the entrepreneurial intention item after the reliability test and their respective coefficient read 0.870. to ensure that the instrument covered all the components of information, content validity was determined through reviewing previous studies in assessing the adequacy and the accuracy of what it measures. the questionnaire items that measured farm entrepreneurial intention were adopted and modified and fixed to the context from work of liñán and chen (2006), ajzen (1991) and malebana (2012). the development of topics list, entrepreneurial teaching methodology and expected learning outcomes were guided by the following studies: damian and wallace (2015), gibb and price (2014), roomi and redman (2016), vesala and jarkko (2008), adeyemo (2009), klein and bullock (2006) and vandenbosch (2006). findings and discussion socio-demographic characteristics of respondents the analysis of the data shows that the mean age of the respondents was 20.6 years, the lowest being 15 years, and the highest age was 31 years with a standard deviation of 2.439. the average age falls within the age criterion definition of youth by the united nations. it is also in line with the operational definition of youth used in this study. the distribution by sex shows that women were 11.6% more than men as shown in table 2. the respondents involved in the study were in two main groups. the first group was those who specialised in animal husbandry and the second group was those who studied general agriculture (both animal and crops husbandry). the second group did not specialise because they were not sitting for veta exams which have enrolment limitations as per form four national examination results. in the analysis, the two groups were combined since they are taught using fdc and veta curricula. table 2: socio-demographic characteristics of respondents. farm entrepreneurial courses studied studies by assane (2015) and sumra and katabaro (2014) have noted mismatched, narrow and outdated agricultural education curricula in developing countries. following the inadequacy in the curriculum, competencies that focus on preparing the youth to be farm entrepreneurs were assessed. also, studies by roomi and redman (2016), and vesala and jarkko (2008) have recommended skills training and attribute development for context-specific entrepreneurship education. therefore, the competencies and skills assessed in this study have been categorised according to the aspects that guide farm enterprise development or growth (agriculture and general entrepreneurship competencies). the assessment of competencies and skills was conducted in the form of topics studied at this level, as shown in table 3. the list presented was cross-checked against the existing fdc curriculum. table 3: basic farm entrepreneurial competencies studied (n = 294). the findings (table 3) show that for the agricultural courses, animal husbandry is the most studied topic, followed by crop production; the least studied topic was agro-mechanics, followed by agro-economics. the topics assessed are mostly found in the curriculum of fdcs, except the value addition and value chain. however, content-wise, some topics are taught at a very elementary stage (lower levels of cognitive domain; action verbs such as define and mention) and some important topics are missing. following the inadequate content in the fdc curriculum, in 2013 the government through the ministry of health, community development, gender, elderly and children allowed the parallel use of veta curriculum to supplement the fdc curriculum as explained by the ministry director coordinating community development training institutes and fdcs: ‘we are currently using veta curriculum to cope with changes in the industry and it allows our students to sit for veta exams as our curriculum doesn’t allow our students to proceed for further studies.’ (participant 16, ministry director, 10 february 2016) this was further confirmed during the interviews with fdc principals and ministry of health, community development, gender, elderly and children officials. on the other hand, the review shows that although the entrepreneurship course was not in the fdc curriculum, the students were taught using the veta curriculum. students have studied all courses that teach basic entrepreneurship knowledge and skills, except the human resource management course. the human resource management course is not an entrepreneurship course per se but it is important because it helps an entrepreneur to manage their employees properly during the expansion stage of an enterprise. however, it has not been critically adapted to the agricultural context as it lacks a practical facet. general implication of the score is that learners are expected to possess the right entrepreneurship competencies. based on these findings, the majority of the respondents have basic agricultural and entrepreneurship competencies that can help them to establish farm enterprise. although some basic topics such as value addition, value chain and human resource management are missing in both the fdc and veta curricula, with such competencies, the youth can at least manage to start up an enterprise. this is because the ideal requirement is awareness or exposure and basic applied skills that are enterprise-specific in order to launch an enterprise. the question of adequacy of syllabus in terms of content was asked to the tutors and the response was that with the introduction of the veta-curriculum, their syllabus was deemed adequate; when the follow-up question was asked about why the graduates find it difficult to start or establish an enterprise, the mamtukuna tutors explained: ‘the environment [infrastructure, and few qualified tutors] for teaching does not motivate learners to start their own enterprise. the component that deals with motivation or character development also needs to be added into their syllabus.’ (participant 11, tutor, 21 january 2016) this also emerged during the focus group discussion as one of the discussants explained: ‘there are no laboratories and facilities for conducting experiments, the situation has affected us for example we are not familiar with much of the skills in the topic of anatomy.‘ (participant 5, student, 18 january 2016) what is taught is one thing but how it is taught to obtain the best outcome in learning is a different matter. in this case, the teaching methods that were used to deliver the agricultural and entrepreneurship competencies to fdc students were assessed as shown in table 4. table 4: teaching methods in folk development colleges (n = 294). the findings show that six methods of teaching are commonly applied in the fdcs, with lecture, research and guest speakers less common, as shown in table 4. as far as developing entrepreneurship traits among students is concerned, the last two techniques of research and guest speakers are crucial as noted by adeyemo (2009). research techniques help to build innovation, creativity and analytical capabilities, traits that are important for an entrepreneur. in addition, inviting successful entrepreneurs helps to develop motivation, networking and the development of a good attitude concerning the field in which they are expected to work. thus, less regular use of those methods could have affected the learners’ entrepreneurial traits. during focus group discussions, respondents were asked if they are happy with the teaching methods. they were positive about those courses in which the tutors have good experience and provide practical details in their respective subjects. however, they complained that many of practical skills-oriented topics are only theoretically taught. the focus group discussant explained: ‘[the] majority of tutors do not have practical skills, they teach us theoretically only, also there are no laboratory equipment and tools that are used in conducting experiments. for example, there is not any surgery equipment.’ (participant 4, student, 18 january 2016) the discussion shows that lack of qualified tutors and appropriate infrastructure for student learning are a constraint to the experiential teaching method. the findings concur with prathima et al. (2008) who noted that training is limited to traditional classrooms. perception of the expected learning outcomes in relation to farm entrepreneurship the expected learning outcomes in relation to farm entrepreneurship were assessed as shown in table 5. the findings show that students agreed and strongly agreed with items 1–6 intended to measure the skills, knowledge and any other lesson factors. students gained farm entrepreneurship knowledge and were satisfied with teaching methodology applied compared to skills-related outcomes as evidenced by scores in table 5. these findings concur with those of rammolai (2009) who noted that time was the limiting factor for entrepreneurship studies in zimbabwe. however, the actual time allotted is 6 months per term which exceeds university time allotted per semester by 2 months. moreover, during the interviews with principals of colleges and during the focus group discussions, it was noted that the majority of tutors work part time. this arose during the focus group discussion; for example, one discussant mentioned that: table 5: perception of expected learning outcomes in relation to farm entrepreneurship. ‘we do not get enough time to stay with our tutors, others come and disappear, in one term and within the same course you can have sometimes more than two tutors.’ (participant 7, student, 18 january 2016) in general, the respondents have a good perception of the expected learning outcomes measured in relation to farm entrepreneurship. also, the curriculum used is relevant to the existing environment and industry as no mismatch has been noted at this perception level. however, practical classroom learning is lacking as reported during focus group discussions; this may have implications in terms of a mismatch with industry requirements for farm entrepreneurship. this finding is consistent with gemma and manipol (2015) and prathima et al. (2008) who found much theoretical emphasis in teaching. in addition, the content of the two curricula that are currently used in parallel was reported as sufficient but some of the students who do not sit for veta exams are still using fdc curricula and implementers are not mandated as per evaluation to use the veta curriculum. furthermore, since the fdc curriculum lacks addressing some of the skills and since the objectives of the two curricula are not the same, there is a need to harmonise the use of the two curricula. an index was developed to determine the overall level of attainment of the expected learning outcomes of the respondents which was then analysed by descriptive statistics as shown in table 6. table 6 was developed from table 5 where the likert scale consists of six items and five response options with their respective weights – strongly disagree (1), disagree (2), unsure (3), agree (4) and strongly agree (5) – were transformed into three level responses. with regard to respondents’ responses, the total minimum score for the six items was 6, the total neutral or unsure scores for the six items was 18 and total maximum score for the six items was 30. in developing the index, the researcher grouped the strongly disagree and disagree scores and labelled them as ‘learning has no impact’, unsure was labelled as ‘undecided’ and agree and strongly agree were grouped as ‘learning has impact’. table 6: overall level of expected learning outcomes perception. generally, the descriptive statistics in table 6 show that the courses studied have impact. the implication for this finding is that the youth who studied agri-entrepreneurship courses believe they possess the basic farm entrepreneurial knowledge and skills in the related affective learning domains. they are aware of the concept of farm entrepreneurship, familiar with enterprise start-up and its management and they believe they possess basic agriculture field skills. this finding concurs with nabi et al. (2018) who found the type of entrepreneurial learning (basic knowledge about entrepreneurial process and associated skills) influences individual entrepreneurial intention. youth farm entrepreneurial intention farm entrepreneurial intention as a key aspect in this study was assessed by nine items measured on a five-point likert scale (strongly disagree, disagree, unsure, agree and strongly disagree). the determinants for farm entrepreneurship intention that were assessed include readiness, determination, interest and internal drives (internal locus of control), measured by nine items as shown in table 7. the findings show that the higher ratings of the respondents fall under the agree and strongly agree measurements. there is a small discrepancy between prior intention in relation to item 8. this implies that after students’ enrolment in the college, they received more exposure, skills, knowledge and confidence which led to an increase (scores) in intention to pursue farm entrepreneurship. by considering the eight item scores measuring intention, the agricultural education blended with entrepreneurship course contributes to the increase in farm entrepreneurship intention of the final-year fdc students. this finding is supported by the studies done by malebana (2012) and liñán et al. (2010) who found an increase in intention after studying. also, the scores for prior intention imply that college agriculture education is not the only contributing factor for intention in farm entrepreneurship; there are other factors that are not explained by this study. table 7: farm entrepreneurial intention of the respondents (n = 294). an index was developed to determine the overall level of youth farm entrepreneurial intention of the respondents after exposure to studying agricultural courses. as shown in table 8, the likert scale consists of nine items and five response options: strongly disagree (1), disagree (2), unsure (3), agree (4) and strongly agree (5). with regard to respondents’ responses, the total minimum score for the nine items was 9, the total neutral or unsure scores for nine items was 27 and total maximum score for the nine items was 45. in developing the index, the researcher grouped the strongly disagree and disagree scores and labelled them as ‘no intention’, unsure was labelled as ‘undecided’ and agree and strongly agree were grouped as ‘presence of intention’. generally, the descriptive statistics in table 8 show that the majority of youth have acquired farm entrepreneurial intention. table 8: overall youth farm entrepreneurial intention. the relation between farm entrepreneurial intention and expected learning outcome was assessed. farm entrepreneurship intention was first assessed based on the fact that they have studied the required courses. however, to obtain a direct relation, the learning outcome factors were established and computed against nine factors of farm entrepreneurship intention. the findings (table 9) show that, all eight factors measuring farm entrepreneurship intention, excluding factor number 9, have significant relation for the majority of expected learning outcome determinants. however, the somers’s d coefficient ranges from below 0.02 to above 0.2 indicating very weak to moderately weak strength of relationship. the relationship between youth farm entrepreneurship intention and expected learning outcome was tested at the 5% level of significance. table 9: the relationship between farm entrepreneurial intention and expected learning outcomes. the findings further show that six factors measuring farm entrepreneurial intention have a moderate weak significant relationship with the first determinant of the expected learning outcomes. since the first expected learning outcome determinant focused on the possession of farm entrepreneurial skills, it is clear that the respondents’ farm entrepreneurial intention is influenced by studying agriculture and entrepreneurships courses. also, significant relationships exist between four factors measuring farm entrepreneurial intention and the remaining five expected learning outcome determinants. the implication is that the respondents have acquired farm entrepreneurial knowledge and behavioural competencies which consequently impacted their farm entrepreneurial intention. this finding concurs with emanuel’s (2012) and remeikiene, startiene and dumciuviene’s (2013) studies which found the existence of a farm entrepreneurial intention after studying agriculture courses blended with entrepreneurship courses. this finding is supported by the theory of planned behaviour which asserts that intention can be changed directly or indirectly by the formation of beliefs resulting from the environment (ajzen 1991). beliefs in this case were developed by studying agri-entrepreneurship courses. the impact of the training is manifested through a change in the youth’s attitude, perception and perceived behavioural control with regard to farm entrepreneurship career. the sum of these behavioural antecedents subsequently changes the youth farm entrepreneurial intention. conclusion and recommendations from the findings it can be concluded that the basic courses required for farm entrepreneurship were studied except for a few courses that are largely taught theoretically, with the challenges in the practical aspect (laboratory experiments). on the other hand, there is a significant positive relationship between the agri-entrepreneurship courses studied in the fdcs with the youth’s farm entrepreneurial intention. the implication is that the youth’s farm entrepreneurship intention for fdcs is associated with the learning acquired. they studied the appropriate content through the respective appropriate teaching methodologies as shown in the findings section. the findings also imply that the youth studying in these colleges clearly understand the start-up process of a farm enterprise and associated concepts. the fdc training has also changed the view of agriculture to a paying business as indicated by willingness to engage in farm entrepreneurship and their judgement regarding the benefits that can be obtained by engaging in farm entrepreneurship. it is recommended that the curricula need to be reviewed regularly and behavioural, together with skill components, and their respective teaching methodologies need to be given more emphasis in colleges that teach agriculture and entrepreneurship courses. also, the main goals of establishing fdcs and related colleges need to be revisited from time to time and reformulated if the need arises so as to cope with the contemporary social, economic and technological changes. acknowledgements my sincere appreciation goes to the editors of this article for their efforts and support in editing the document. these include mr boscow mutambira and ms asteria ngaiza. competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions p.b.n. and c.k.m. contributed equally to this article. ethical considerations this article followed all ethical standards for research without direct contact with human or animal subjects. funding information this research received no 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accepted: 15 sept. 2021; published: 17 dec. 2021 copyright: © 2021. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: experts recommend support to patents for stimulating innovation. also, the south african government supports patents, in particular, international patents. in this paper it is examined how this strategy can be designed to successfully trigger economic progress. aim: the present south african activities in patents are investigated in this paper and areas identified where an intensification of patenting looks promising for economic progress. setting: the patent activities since 1985 are analysed and compared to the annual export–import balance from 2009 to 2018, in order to identify starting points for improving economic structures. the data are linked to current suggestions to the national advisory council on innovation (naci) for future technologies. methods: the analysis of patents is performed, using the international patent database patstat, as well as the analysis of the export–import balance at the wits database of the world bank. results: the patent analysis reveals a low level of south african domestic patents, with a focus on less complex goods and a stagnation period of 35 years. the data on the export – import balance show negative figures for consumer goods and even more so for capital goods. conclusion: economic progress can be accelerated by stimulating patent and economic activities to produce more complex consumer and capital goods. however, it may be necessary to focus on certain areas at the beginning in order to achieve a sufficient critical mass of competence and international competitiveness. in any case, the support of patents is only successful when it is closely linked to a strategy regarding technology. keywords: international patents; domestic patents; export–import balance; future technologies; technology focus; south africa. introduction in the discussion on economic growth in developing and threshold countries, experts broadly agree that innovation plays a key role in success (eds. lundvall et al. 2011). when supporting innovation, intellectual property rights, in particular patents, are considered an important tool (chen & puttitanun 2005). in the global environment of innovation, international patents according to the patent cooperation treaty – the so called pct applications – were introduced for facilitating patenting in foreign countries. in order to stimulate innovation, various countries, such as japan or china, actively support pct patents (boeing & mueller 2015). in this context, the south african government also supports pct patents (nipmo 2019). in this paper, we shall examine whether the approach is a realistic tool for stimulating innovation. international patent applications for understanding the link between pct patents and innovation, it is necessary to explain what international patents are, what procedures are followed in their application and what the advantages and disadvantages are. the patent cooperation treaty (pct) is an international treaty accepted in 1970. it introduced the international application, which provides a unified international procedure for filing a patent. the application is made at a receiving office (ro) in one language. the next step is a search, performed by an international search authority (isa), resulting in a search report with a stated opinion regarding the patentability of the invention, which is the subject of the application. it is followed, optionally, by a preliminary examination performed by an international preliminary examining authority (ipea). the ros, isas and ipeas are selected existing patent offices, for example, the united states patent and trademark office (uspto) or the european patent office (epo), working on behalf of the world intellectual property organisation (wipo). in the final step, the inventor/applicant has to decide whether to pursue the application and in which countries to file for patent protection. the wipo has 193 member states. another option is to apply at the european patent office (epo) as well, that is, the so-called euro-pct application. this international application has a number of advantages. in particular: the applicant can submit valid applications designated for foreign countries shortly before the end of the priority year, as a translation into a foreign language and nominating corresponding patent attorneys in the designated states are not necessary at this point in time, while these are required in the standard procedure without pct. the applicant receives valid information on the patentability of the application, through the reports of the isas and ipeas, before making a decision about cost-intensive applications in foreign countries. the international phase ends 30 months after the priority date and, therefore, the applicant has to make the decision concerning applications in foreign countries much later than by the end of the priority year. two and a half years after the priority application, more information should be available on whether the invention will be successful in the market and this could justify the cost of patent applications in foreign countries. to conclude, pct applications are generally made if the aim is to apply at several foreign patent offices. however, the search report and the preliminary examination offer the option to decide not to transfer the application to several national offices. thus, an international application generally implies applications in several countries; however, a certain share of pct applications is not transferred to foreign countries. if a patent application in only one external country is intended, the detour through a pct application is not rational, as it implies additional costs. patent structures in south africa for understanding the patent situation in south africa, it is useful to look at patenting trends. to investigate the patent applications by south africans here, we used and compared different databases, in particular: inpadoc – a database of the european patent office (epo) which comprises patent documents of more than 50 patent offices worldwide; world patens index (wpi) – a database of the provider derwent also with patent documents of more than 50 patent offices, organised according to patent families; and patstat – a relational database of the epo for worldwide patent searches. due to the different structures of the databases, the results differ a little bit, though not much. in figure 1, the situation since 1985, that is, since the apartheid period, is shown. in the case of pct applications by south african inventors, a substantial increase is observed in the 1990s. this is linked to a worldwide acceptance of the pct system during this period, due to a decisive improvement in the administrative application procedures. the pct application had reached a peak in 1998, and had been decreasing since. figure 1: patent applications of south africans in different patent systems. other important channels of applications in foreign countries are applications at the epo, as well as at the united states trademark and patent office (uspto). the uspto applications had increased since 1994 at the end of the apartheid regime (figure 1). the numbers increased steadily until 2013 and then sharply decreased. in 2017 and 2018, the main reason for the decrease was that the majority of the us applications had been filed through the pct system and, due to the late transfer after two and a half years to other offices, the pct applications, with destination uspto, had not yet appeared on the us system. also, the epo applications exhibited a sharp decline in 2017 and 2018, as the majority are euro-pct applications. when the patent families with us, ep or pct applications are counted, the number is only slightly higher than the pct applications, as the majority of applications in foreign countries was filed through the pct system. interpretation of the domestic applications at the south african companies and intellectual property commission (cipc) is very difficult (pouris & pouris 2011). for many years, the applications at the cipc was not documented electronically; then for some years this documentation was realised by inpadoc, and discontinued again after a while. in 2009, the world intellectual property organisation (wipo) took the initiative to digitalise south african applications (http://www.rci.uct.ac.za/news/new-south-african-online-patents-database-now-available-wipo). however, coverage still seems to be incomplete. in general, the number of domestic applications was substantially higher than that of foreign applications. in figure 1, the domestic applications and the pct applications are almost on the same level. this makes the decrease in the number of domestic applications in 2018 incomprehensible. most probably, a considerable number of applications were registered too late. considering the applications of foreigners at the cipc, the development was quite volatile over time. in particular, the strong slumps in 1999 and 2000, and again in 2016 and 2017 were striking (figure 2). the most probable explanation is incomplete registrations on the databases. according to information from cipc, the total number of patent applications in south africa was 7544 in 2017, and 6915 in 2018. this is more than the numbers registered on the databases. assuming that about 15% of the applications had been withdrawn before their publication 18 months later, a level of about 6000 published applications per year would have been realistic. according to the databases, this was achieved between 2001 and 2014. in more recent years, the electronic registration was obviously incomplete. figure 2: patent applications at the companies and intellectual property commission. the cipc states that about 10% of all applications are domestic. in the available electronic statistics this share is about 7%. again this is an indication that the coverage of the electronic databases is incomplete, in particular for domestic applications. against the background of this disappointing situation, it is less meaningful to compare the technological structures of the domestic and pct applications from south africans with those of foreign applicants in this country. figure 3 shows the profile of specialisation in south african pct applications. for this purpose, the specialisation index revealed patent advantage (rpa) is calculated as follows: figure 3: specialisation profile of south african pct applications, 2010–2018 (reference: worldwide transnational patents). therein, the index k stands for the country and the index j for the technology. positive values represent an above-average specialisation, negative ones below-average specialisation; the neutral value is 0. as reference, the international distribution of technologies in transnational patents (frietsch & schmoch 2010) is taken. thus, positive values indicate a specialisation in the specific technology above the international average. the range of technologies is defined according to a classification of the wipo, covering all fields of technology (schmoch 2008). the results for the pct statistics are realistic, because the electronic registrations of their applications are correct. in the profile of the rpa (eqn 1) for the pct applications in south africa, all fields in electrical engineering, semiconductors and information technology show specialisation below average, with the exception of, mainly, it methods. these are software-related patents in the context of commercial applications, such as administration, finance, logistics etc. (figure 3). further positive specialisations refer to technologies linked to general consumption, for example: food chemistry, chemical engineering, consumer goods or civil engineering. in mechanical engineering, positive specialisation can be found in handling, other special machines and thermal processes, but in the core fields of machine tools and engines, specialisation is below average. in some research-intensive fields like biological analysis, or control, the specialisation is positive and in biotechnology, pharmaceuticals and transport at least average; but the total number of applications is quite low compared to other threshold countries. for example, in 2018 the total number of pct applications in south africa was 342, that in brazil 874. a reliable analysis of recent domestic applications in south africa is not possible, as in the last four years, classifications in the majority of the domestic applications were not registered. the specialisation profile of foreigners in south africa is quite similar to that of the south african pct applications. the main differences are the strong focus on biotechnology and pharmaceuticals, as well as the much higher number of applications compared to the domestic applications in south africa. this means that foreign enterprises dominate the south african market by providing in similar fields as south african companies, through exports to, or production in south africa, but with higher intensity and more advanced products. from a certain critical distance, the south african patent system is primarily a competitive tool for foreign enterprises. trade structures in south africa patent applications in foreign countries, in particular pct applications, aim at the protection of exports. therefore, it is interesting to see how the patent statistics are reflected in the export–import balance in south africa. for this purpose, the world integrated trade solution database (wits) of the world bank has been used as data source. in figure 4 the situation is summarised and the dominance of raw materials illustrated; that is, diamonds, gold, platinum, etc. in fact, the exports of raw materials even increased between 2009 and 2018. figure 4: export-import balance of south africa for main product groups (in constant $ 2018). a positive trade balance can also be observed in intermediate goods. intermediate goods are generally less complex elements of more complex products, assembled by a third party. for instance, the product group ‘metals’ comprises the production of steel products, which may be intermediate goods. beverages, food, fuels and lubricants are intermediate goods as well. food exports contribute to the positive balance of intermediate goods. however, the trade balance in manufacturing, consumer goods and capital goods, is distinctly negative. there was a small improvement in time when consumer goods were less negative than capital goods. this reflects a south african technological specialisation in consumer goods (figure 3) and a negative specialisation in production technologies (capital goods). the patents of foreign enterprises focus on consumer goods as well, with positive specialisation in production technologies. this technological dominance of foreign enterprises is reflected in the trade balance in manufacturing. to improve the south african economy significantly, it is necessary to strengthen manufacturing. in more general terms, this can be labelled import substitution, an idea which became popular in the 1950s and 1960s, but was displaced by concepts of trade liberalisation. recently, the idea of import substitution returned (irvine 2020). in this context, south africa’s finance minister intends to set up manufacturing in order to make the products that we need and stop relying on imports from china (the economist 2020). technology and trade strategies in south africa the suggested strategy for substituting imports implies a stronger focus on more sophisticated consumer goods and the establishment of our own structures for producing capital goods. this reorientation is linked to a stronger engagement in research and development (r&d). however, in the last 10 years, the business expenditures on r&d in south africa did, as a matter of fact, even decrease (stats sa 2021). a further element in economic recovery is a stronger focus on the export of manufactured goods. according to this strategy, it is not realistic, regarding the limited resources for r&d, to engage in many different technologies. as the international competition is fierce, it is only possible to become competitive at a high level of competency if the r&d activities are so focused as to achieve a sufficient critical mass. therefore, it is recommendable to rather follow the japanese strategy, which became a model to many southeast asian countries, such as south korea, china, taiwan and singapore (chang 2017; kojimaa 2000; utterback 1976). in 1970, japanese enterprises applied for only 105 patents in the usa, an even lower level than the present level in south africa. at that stage, japan focused on audio-visual technology, for example, small tape recorders or headphones. to achieve competitive solutions, the government cooperated with enterprises and research institutes. in 1980, japan had 9925 patent applications in the usa with a clear focus on audio-visual technology. in the next step, the strategy was extended to computer technology, then to cars. in 2000, the number of japanese patent applications in the usa reached 50 044, and japan gained status as a fully industrialised country. to conclude, an initial focus on a small number of technologies, the coordination of r&d in enterprises with research institutes, and the gradual extension to other technologies, is a good strategy. with a sure focus on one technology, it is possible to achieve international competitiveness. in the early years of this catch-up strategy, japan financed the investment in r&d by selling extremely cheap, simple consumer goods. in south africa, this special support is not necessary as sufficient revenue is generated through the export of raw materials. furthermore, there are already competitive scientific systems at south african universities and research institutes (research councils). so, the basic conditions for a stronger orientation toward r&d are good. to achieve a stronger export orientation, it will be necessary to define possible fields of engagement in a process of discourse between government, enterprises, universities and research councils. it will be important, in particular, for industry associations to agree on targets in order to extend their product range to more sophisticated products. possible technologies for a stronger engagement were identified by the national advisory council on innovation (naci) in an elaborate process (dsi 2019). it suggested the following technologies: sustainable energy, health innovation, high-tech industrialisation, icts and smart systems, nutrition security, water security. in the context of domestic and export activities, we want to illustrate the potential in high-tech industrialisation, icts, smart systems and water security. the area of high-tech industries is typical for a stronger domestic engagement, as at present these technologies are imported from industrialised countries. for a higher level of independence, more competence in south african enterprises is necessary. in the naci report the area is described as follows: high-tech industrialisation: products, processes and services will be transformed through the application of smart and connected systems. the high-tech industry domain therefore focuses on the implementation of advanced manufacturing in south africa using robotics, artificial intelligence, the internet of things and additive manufacturing, among others. this will transform old industries and give rise to new industries. industry actors, including smmes1, will need to equip themselves with the necessary skills, infrastructure and capacity for a successful transition. (dsi 2019:25) it will be difficult initially to achieve the same level as imported technology, for example, in robotics or additive manufacturing, but in a strategic step-by-step process, this could be realised. good coordination between enterprises, government and research institutions is important. a detailed description of high tech industrialisation is found in dsi (2019:92ff.). the south african competencies in icts and smart systems are already quite developed, as high specialisation in it methods in patents is shown (figure 3). the field is described as: icts and smart systems: icts are one of the key enablers of development in all domains, from agriculture to health, and from industry to service delivery and governance. there are a number of technologies under the umbrella of icts. as recognised in the 2016 oecd2 science, technology and innovation outlook, the internet of things promises a hyper-connected and ultra-digitally responsive society that supports human, societal and environmental development. artificial intelligence offers unique opportunities to improve human lives and address major societal challenges. (dsi 2019:25) of course, there is strong competition from many countries, in particular the usa and china. but, there are diverse fields of application and niches could be found as entry points. this field is described in more detail in dsi (2019:100ff.). another example is: water security: water security as a basis for a thriving society and economy will depend on water and sanitation solutions that are responsive to new challenges and emerging needs and opportunities. three aspects are key to water security: (a) water supply will need to be driven by an integrated mix of context-appropriate sources of water at the bulk, regional and local level; (b) the next generation of sanitation and wastewater (urban and industrial) solutions will need to be introduced, understood and then mainstreamed (low or no water toilets, energy and water-efficient technology, and smart waste solutions); and (c) water-sensitive designs for urban, peri-urban and rural spaces should be core to all water and sanitation planning and implementation (including grey water management, climate-resilient infrastructure, circular planning around water, and sanitation and wastewater flows). (dsi 2019:26) in order to cope with water security a mix of technologies and management competencies are needed. south africa could improve its water security, making it a thriving industry, perhaps we would be able to export our know-how to other countries. the relevant technologies and high-level services can be exported to industrialised countries (e.g. california, china), as well as developing ones. in any case, engagement in this area would benefit the situation in south africa, as well as foreign trade. the field is described in more detail in dsi (2019:118ff.). at universities, a stronger orientation towards applied research is important, especially in the context of the selected fields. in this way, relevant research results for enterprises, as well as qualified staff can be provided. at least one of the research councils should engage in applied research for viable enterprises, similar to the research and technology organisations (rto) in europe which is described in more detail on the website https://www.earto.eu/about-rtos/. in terms of patents, the strategy for import substitution is primarily linked to more competitive domestic patent applications, compared to the patent applications of foreign enterprises in south africa. the strategy of exports in specific areas implies an increase in pct applications in these technological fields and building up relevant patent portfolios in these areas. conclusion the analysis of patent and trade structures in south africa shows that targeting an increase in pct patent applications should improve the country’s economic situation. this target does not entail a simple increase in numbers, but must be linked to a coordinated technological strategy. from a midand long-term perspective on exports, this implies a focus on a small number of technologies in the beginning with a gradual extension. a further relevant element in economic improvement is import substitution. this means more economies would be entering the trade balance with additional jobs in south africa. in this context, an increase in the number of domestic patent applications is the main target. to conclude, in the context of patents, an increase in the number of domestic and pct applications is crucial. to this purpose, the electronic registration of patents in south africa should be improved. this would facilitate statistical analysis. but it is more important that south african companies take note, in an easy and reliable way, in which areas their competitors are active. acknowledgements competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this research article. authors’ contributions u.s. and a.p. contributed equally to this article. funding information this research received no specific grant from any funding agency in the public, commercial or not-for-profit sectors. ethical considerations this article followed ethical standards for research without contact with human or animal subjects. data availability the data used in this article, in particular the patent data, are publicly available. if necessary, the corresponding author can provide the data on reasonable demand. disclaimer the views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of any affiliated agency of the authors. references boeing, p. & mueller, e., 2015, measuring patent quality in international comparison: index development and application to china, zew discussion papers, no. 15-051, zew, mannheim. chang, s.j., 2017, ‘international expansion strategy of japanese firms: capability building through sequential entry’, academy of management journal 38(2). https://doi.org/10.5465/256685 chen, y. & puttitanun, t., 2005, ‘intellectual property rights and innovation in developing countries’, journal of development economics 78(2), 474–493. https://doi.org/10.1016/j.jdeveco.2004.11.005 department science and innovation sa (dsi), 2019, south africa. foresight exercise for science, technology and innovation 2030, naci, pretoria. frietsch, r. & schmoch, u., 2010, ‘transnational patents and international markets’, scientometrics 85, 185–200. https://doi.org/10.1007/s11192-009-0082-2. irvine, d.a., 2020, import substitution is making an unwelcome comeback, piie trade and investment policy watch, july 8, 2020, viewed n.d., from https://www.piie.com/blogs/trade-and-investment-policy-watch/import-substitution-making-unwelcome-comeback. kojimaa, k., 2000, ‘the “flying geese” model of asian economic development: origin, theoretical extensions, and regional policy implications’, journal of asian economics 11(4), 375–401. https://doi.org/10.1016/s1049-0078(00)00067-1. lundvall, b.a., joseph, k.j., chaminade, c. & vang, j. (eds.), 2011, handbook of innovation systems and developing countries: building domestic capabilities in a global setting, edward elgar, cheltenham. national intellectual property management office (nipmo), 2019, guideline 2.7, guidelines for the operation the intellectual property fund, nipmo, pretoria. pouris, a. & pouris, a., 2011, ‘patents and economic development in south africa: managing intellectual property rights’, south african journal of animal science 107(11/12). https://doi.org/10.4102/sajs.v107i11/12.355 schmoch, u., 2008, concept of a technology classification for country comparisons, final report to the world intellectual property organisation (wipo), wipo, geneva. statistics south africa (stats sa), 2021, south african national survey of research and experimental development, statistical report 2017/18, 2019, stats sa, pretoria. the economist, 2020, ‘how manufacturing might take off in africa’, the economist, 13 june 2020 edition, viewed n.d., from https://www.economist.com/middle-east-and-africa/2020/06/11/how-manufacturing-might-take-off-in-africa. utterback, j.m., 1976, ‘the process of innovation in five industries in europe and japan’, in k. stroetmann (ed.), innovation, economic change and technology policies, proceedings of a seminar on technological innovation, pp. 251–265, springer, berlin. footnotes 1. small and medium enterprises. 2. organisation for economic cooperation and development. abstract introduction insights from the literature theoretical framework methodology results and discussion summary and conclusion acknowledgements references about the author(s) romanus osabohien department of economics and development studies, covenant university, ota, nigeria centre for economic policy and development research (cepder), covenant university, ota, nigeria eze osuagwu department of economics and development studies, covenant university, ota, nigeria evans osabuohien department of economics and development studies, covenant university, ota, nigeria centre for economic policy and development research (cepder), covenant university, ota, nigeria uche eseosa ekhator-mobayode division of management and education, university of pittsburgh, bradford, united states oluwatoyin matthew department of economics and development studies, covenant university, ota, nigeria obindah gershon department of economics and development studies, covenant university, ota, nigeria centre for economic policy and development research (cepder), covenant university, ota, nigeria citation osabohien, r., osuagwu, e., osabuohien, e., ekhator-mobayode, u.e., matthew, o. & gershon o., 2020, ‘household access to agricultural credit and agricultural production in nigeria: a propensity score matching model’, south african journal of economic and management sciences 23(1), a2688. https://doi.org/10.4102/sajems.v23i1.2688 original research household access to agricultural credit and agricultural production in nigeria: a propensity score matching model romanus osabohien, eze osuagwu, evans osabuohien, uche eseosa ekhator-mobayode, oluwatoyin matthew, obindah gershon received: 09 july 2018; accepted: 14 aug. 2019; published: 27 jan. 2020 copyright: © 2020. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: agricultural production is low in nigeria as a result of low utilisation of farm inputs facilitated by farmers’ inability to save and invest. therefore, credit is needed by farmers to enhance their productive capacity and efficiency in agriculture. aim: given the importance of credit to farmers, this study examined the nexus between households’ access to credit and agricultural production in nigeria. setting: the study made use of data from the living standard measurement study-integrated survey on agriculture (lsms-isa) consisting of 4210 households across the 36 states in nigeria, as well as the federal capital territory, abuja. methods: the study employs the propensity score matching (psm) technique. results: the main result from the study suggests that households who had access to agricultural credit facilities had yields that are thrice those of their counterparts who did not benefit from such facilities. in the event of a shock, the farmers who did not have a source of credit are often forced to adopt measures such as lowering consumption and selling assets, which in the long run worsen their poverty levels. conclusion: the study recommends that policymakers should address underlying factors that prevent access to credit for agricultural production, which is capable of raising the productive capacities of farmers. keywords: access to credit; agriculture; household; production; propensity score matching. introduction in developing countries, about 1.5 billion households live in extreme poverty (food and agricultural organisation [fao] 2016). approximately 75% of these individuals who live on less than $1.25 reside in rural areas of many sub-saharan african (ssa) countries, where they depend mainly on agriculture for survival (fao 2016; osabohien, osabuohien & urhie 2018). it has been noted that for the past two decades, credit policies have expanded rapidly in most of the developing countries, as 2.1 billion people benefited from social protection policies including social assistance, social insurance and labour market interventions (croppenstedt, knowles & lowder 2017). although globally about 35% of the population receives some form of credit assistance, in rural ssa communities many households do not have access to credit facilities, resulting in low agricultural production, among others (adjognon, liverpool-tasie & reardon 2017; fao 2016; osabohien et al. 2019). consequently, the little income generated by rural farmers from agriculture is frequently insufficient and vulnerable to shocks, such as drought, pests and diseases outbreak, weather variations and death. without adequate credit assistance, farmers will no doubt suffer hardship and long-term deficiency, because access to credit provides households with emergency relief, such as the purchase of seeds, fertilisers and livestock, among others. therefore, in the absence of this, farmers are liable to hardship (croppenstedt et al. 2017; rehman et al. 2017). it has also been observed that the insufficient telecommunication base alongside weak agricultural investment and human capital development have increased the vulnerability of farmers and contributed to low production (osabohien, matthew, gershon, ogunbiyi & nwosu 2019; ejemeyovwi, osabuohien & osabohien 2018; osuma, ikpefan, osabohien, ndigwe & nkwodimmah 2018). in most cases, these poor farmers in rural communities often choose livelihood strategies that forego income to ensure survival, so that when shocks occur, they are often forced to cope in ways that increase their vulnerability or undermine their future income generation capacity (dercon 2011). it has been observed that 40% of the rural farmers in ssa rely predominantly on agriculture as an occupation for their livelihoods; well-structured local institutions and credit facilities are needed for production enhancement (osabohien, afolabi & godwin 2018; osabuohien, okorie & osabohien 2018; world bank 2008). households’ access to agricultural credit has been known to be the main input in the development of the agricultural sector (adjognon et al. 2017). the reduction of the contribution of agriculture to the gross domestic product in nigeria has been attributed to the insufficient access to agricultural credit (mallum 2016). the nigerian government has recognised the importance of agriculture in the economy, which has led to the implementation of various agricultural credit policies to enhance the production capacity of the sector (mallum 2016). the major agricultural credit policies in nigeria include the agricultural credit guarantee scheme fund (acgsf), the agricultural credit support scheme (acss) and the commercial agriculture credit scheme. in the credit scheme, the government holds 60% and the central bank of nigeria (cbn) holds the remaining 40% of the shares. the capital base of the scheme was increased to 3 billion naira in march 2001 with a view to increasing households’ access to credit. the acgsf was extended to the farmers by banks up to 75% of the amount in default, net any security realised. between 1978 and 1989, when the government stipulated lending quotas for banks under the scheme, there was a consistent increase in the lending portfolios of banks to agriculture, but after the deregulation of the financial system, commercial banks in nigeria failed to fulfil the agreement by reducing bank loans to the agricultural sector due to the perceived risk. on the other hand, the acss is a programme that advocated that about 50 billion naira in access funds should be granted to farmers. also, the acss was introduced to enable farmers to take advantage of the unharnessed potential of the nigerian agricultural sector, reduce inflation, lower the cost of agricultural production (for example, food items), generate surplus for export, increase nigeria’s foreign earnings, as well as diversify its revenue base (cbn 2019; osabuohien, obiekwe, urhie & osabohien 2018). to access loans under the acss, the applicants (practising farmers and agro-allied entrepreneurs) are encouraged to approach their banks for a loan through the respective state chapters of farmers’ associations and state implementation committees. however, large-scale farmers are allowed, under the scheme, to apply directly to the banks in accordance with the guidelines, while small-scale farmers were systematically excluded as a result of the collateral required to access loans. therefore, the implementation of credit policies in nigeria is often not the major constraint to credit, rather the failure of donor agencies to ensure timely provision of credit to farmers. timely access and credit availability are critical to farmers for acquiring the required inputs and machinery necessary to carry out farm operations. the major problem faced by farmers is limited access to credit facilities, which hinders the adoption of more efficient and modern technologies in the farm operation. this lack of resources not only limits the possibilities of increased productivity, but it also hinders the capacity for smooth consumption (saqib et al. 2018). farmers purchase most of their inputs in cash or from dealers on a credit-in-kind basis, leading to increased dependence of farm households on credit markets. an efficient credit market provides farmers with the opportunity to meet consumption requirements and proper input use, thus improving the welfare of the farmers, small-scale agriculturalists, helping them to manage risks more effectively and improve agricultural production, leading to more sustainable livelihoods and progress out of poverty and hunger (holmes et al. 2011; matthew et al. 2018; saqib et al. 2018; afolayan et al. 2019). generally, agricultural credit facilities can be in the form of a loan or overdraft, among others, that is made available for farmers to help boost their productive capacity, which will increase their earnings; this in turn reduces socio-economic risks, vulnerability, poverty and deprivation (croppenstedt et al. 2017). credit facilities can be in the form of smallholder agricultural policies, which focus on improving crop production, fisheries, forestry and livestock and improving access to markets (osabohien et al. 2019; world bank 2008). credit policies are required in reducing the incidence of rural poverty through the sale of farm yields. however, farmers have been largely neglected regarding access to credit facilities in the majority of developing countries, especially in nigeria where the emphasis has been placed instead upon the primacy of economic growth, rather than the agricultural sector which employs more than 75% of the total labour force in the country (united nations conference on trade and development [unctad] 2016; world bank 2007). saqib et al. (2018), adjognon et al. (2017) and suri et al. (2009) are among the few studies that addressed agricultural credit policies in ssa and provide the framework for agricultural interventions and the livelihood of rural farmers in kenya and in nigeria. these studies described the agricultural intervention as providing income through direct seed and cash transfers in order to reduce hunger and poverty, but whether the credit policies were successful or not remains an issue for discourse. however, in the case of nigeria, there is a dearth of literature that addresses the issues of access to agricultural credit for the rural farmer, which forms the motivation for this study. theoretically, there could be a bi-directional association between access to credit and agriculture production (tirivayi, knowles &davis 2016; matthew, ede, osabohien, ejemeyovwi, ayanda & okunbor 2018). on the one hand, farmers in rural communities who are poor and depend solely on agriculture for a living are often faced with closed access to assets, low agricultural production and recurrent exposure to covariate and peculiar risks (devereux et al. 2008; tirivayi et al. 2016). in addition, the consistency and assurance of credit instruments help farmers to better manage risks and engage in more profitable livelihood and agricultural activities. from the foregoing, this study adds to the existing literature by examining the extent to which households’ access to agricultural credit impact on the farmers’ agricultural productivity in nigeria using wave 2 data from the living standard measurement study-integrated survey on agriculture (lsms-isa). the findings from the study showed that households who have access to agricultural credit in the form of cash or in-kind support had yields thrice those of households that did not have access to agricultural credit. therefore, the study recommends that policymakers should address underlying factors that prevent access to credit for agricultural production, which is capable of raising the productive capacities of the farmers. the remainder of this study is structured as follows: a review of the relevant literature, a discussion of the various underlying theories, an explanation of the methodology, presentation of the empirical results and finally the conclusion of the study. insights from the literature ewetan et al. (2017) examined the effect of government expenditure on agricultural production in nigeria. the study noted that, whether the effect is being looked at from the macroeconomic or microeconomic level, most of the existing literature assumes that government expenditure (credit facility) has a significant impact on agricultural production. the direction of the impact differs from one study to another, with a greater positive effect on average in developing countries. adjognon et al. (2017) used two-stage sampling techniques with data from the lsms-isa for two panel waves: wave 1 (2010/2011) and wave 2 (2012/2013), covering 3000 farming households. they validated the findings of suri et al. (2009) noting that farmers in ssa often experienced low yields as a result of limited access to agricultural credit facility. united nations conference on trade and development (2016) viewed credit facility as a development priority in the post-2015 united nations (un) development agenda, which posits that 80% of the global rural farmers, mainly in africa, have no access to credit facilities. credit policies help households to generate income from farming operation that enables them to handle the different aspects of poverty, employment and deprivation (decent work, education, healthcare, food security, income security) and can, therefore, be a powerful tool in tackling poverty and inequality (adjognon et al. 2017; chandio et al. 2017; rehman et al. 2017; matthew et al. 2019). in addition to the above assertion, united nations development programme (undp 2016) posited that credit policies are among the most successful development experiences the world has seen from the 1990s to date. this is because households’ access to credit have proven to be relevant tools in developing countries’ efforts to fight poverty and hunger, as demonstrated by the substantial progress countries such as brazil, tanzania, ethiopia, senegal, and kenya have made in poverty reduction through the adoption and expansion of credit schemes. credit policies, when efficiently directed towards agriculture, have the potential to contribute significantly to employment generation, poverty reduction and long-term sustainable production, especially when built under a broader, more integrated framework. furthermore, tirivayi, knowles and davis (2016) examined the interaction between credit policies and agriculture using a quantitative study and found that little attention has been paid to the interaction between credit access and agricultural production in rural communities, and how they influence the design and the implementation of credit policies to achieve sustainable agriculture outcomes. in line with that, controlling for seed, njine (2006) compared actual maize and cassava yields from the trial station in kenya, using different fertiliser combinations, with yields obtained by farmers on site with characteristics similar to the trial stations. the study estimated technical inefficiency of the farmers at 60%, suggesting that effective credit towards agriculture is needed for sustainable agricultural production. croppenstedt et al. (2017) examined the impact of agricultural credit facilities on agriculture and pointed out that evidence has shown that economic growth is an important element of poverty reduction. however, in nigeria and other developing countries with a large proportion of the workforce engaged in agricultural activities, growth generated from agriculture is a more potent element of poverty reduction. christiaensen, demery and kuhl (2011) confirmed the validity of croppenstedt et al. (2017) by pointing out that economic growth may not be inclusive and poverty reduction following economic growth tends to be slow and does not really benefit farmers in rural communities; they conclude that growth generated from agriculture is more inclusive than growth generated from any other sector of the economy. barrett et al. (2006) offered supporting evidence of the potential of credit policies in madagascar. barrett et al. also reported that the current spending on agricultural research to enhance the production of crop production in madagascar is about 2.5% of the total annual value of crop production. validating the impact of credit facilities on agricultural production, chandio et al. (2017), in their study, examined the impact of agricultural credit on production in pakistan using a cross-sectional random sampling technique of 180 rice producers in the sindh area of pakistan. the study employed the maximum likelihood estimate and the result showed that households’ access to credit enables them to increase their farm size that significantly impacts on the productive capacity of farmers in the sindh area of pakistan. the study concluded that households’ access to credit and farm size are the two main factors in improving the level of agricultural production in, as well as the technical efficiency of small-scale farmers in pakistan. iganiga and unemhilin (2011) investigated the impact of agriculture credit on the value of agricultural production in nigeria and found that commercial bank credit is positively related to agricultural production using the cobb-douglas production function. in a line study, osabohien, afolabi and godwin (2018) examined the impact of commercial bank credit and the acgsf on agricultural production towards achieving food security in nigeria; the study employed secondary data sourced from the world development indicators and the cbn statistical bulletin for the period (1986–2016) and employed the autoregressive distribution lag (ardl) econometric approach. the study found that access to commercial bank credit increased farm yields by 8.12% and access to the acgsf increased farm yields by 0.2%. these findings from the empirical literature signal the importance of households’ access to credit towards increasing the agricultural production in nigeria. despite the findings of the effect of access to credit on agricultural productivity across various countries, the adoption of an effective credit policy towards the agricultural sector remains relatively low in nigeria. at one level, this situation reflects the lack of adequate public funding devoted to agricultural research and its dissemination, especially in the area of crop production. to make a case for public funding towards agricultural credit, the government is advised to use agricultural credit to encourage the farmers to be able to increase agricultural output. in the light of the foregoing issues reviewed in the literature, it becomes obvious that households’ access to credit will invariably improve agricultural production, thereby reducing the rate of poverty among rural dwellers who solely engage in agriculture. thus, the present study differs from other empirical studies in the field and adds to the literature by probing into the hypothesis of whether households’ access to credit has any significant impact on agricultural production in nigeria, using propensity score matching (psm) on household data sourced from the lsms-isa wave 2 (2012/2010). to the best of the knowledge of the authors, the novel idea that the study is contributing to the body of literature, is in the area of credit assistance and agricultural production of farmers in rural communities in nigeria. theoretical framework some theories have emerged on the analysis of poverty and government intervention in the form of credit facilities, but few theories have been confined to the understanding of households’ access to credit and agricultural production; especially when it has to do with rural farmers. however, this study has examined in summary: the credit channel theory, the classical and the neoclassical views, the keynesian and marxian views, including the social exclusion theory leading to the livelihood portfolio theory proposed by de neubourg (2009), and the cobb-douglas production function. the credit channel theory posited that the interest charged on credit through banks’ capital and other means, particularly when banks’ lending is constrained by a capital adequacy requirement, thus reducing the rate of interest on credit, will enhance the ability of people to borrow for different operations including farming (osabohien et al. 2018). however, lenders will also become more eager to lend during certain periods because of an improvement in their underlying financial condition. from the classical viewpoint, individuals are assumed to work their way out of poverty; hence no form of credit assistance is required for poverty alleviation. poverty is considered inherent and assumes that one can only escape through hard work. in this case, it is difficult for the state to provide support to cushion the effect of poverty. however, under the neoclassical expression, poverty is more economic and deprivation occasioned by market imperfections that exclude the poor from credit and lack of a fair share in the distribution of factors or economic resources (bradshaw 2007). on the other hand, the keynesians are of the opinion that poverty in a society is driven by the lack of public goods and inequality in the distribution of available resources. to this end, a credit facility should be controlled by the state and the distribution should be even, irrespective of social stratification (bradshaw 2007). for instance, human capital development such as education and health provisions should be the obligation of government and individuals should be guaranteed the opportunity to harness such rights in equal proportion. far from this, the neo-keynesians also argued that there should be an overall growth in human development to uplift the individual from poverty (de haas 2010). this can only be achieved through government intervention to reduce the negative influence of macroeconomic factors such as inflation, exchange rate and unemployment on the economic well-being of the populace (osabuohien, obiekwe, urhie & osabohien, 2018). a more radical dimension was taken by the marxian economists espousing that economic growth alone may not possibly lift the poor, especially peasant farmers, out of poverty, because of class struggle in the capitalist system where the factors of production are controlled by the rich (shildrick & rucell 2015). they would rather prefer mainstream economic stability, which includes both economic and environmental improvements, because the poor are most vulnerable to environmental disasters, especially in farming. the social exclusion theorists were the most fundamental in the recognition of structural changes in society. the inadequacy of credit capital was understandably the challenge of this school of thought. nevertheless, they streamlined the definition of poverty to those unable to receive credit benefits (bradshaw 2007; de haas 2010; shildrick &rucell 2015). in addition, sen and dreze (1989) suggested that more attention should be directed to wage and labour market outcomes in the distribution of economic resources, and political considerations should be channelled into an institutional framework for the provision of welfare. as a result, definitions of poverty sprang up from multilateral institutions such as the world bank (2008) – the inadequate physical security and lack of political voice – and the united nation programme (2016): lack of participation in decision-making and in civil, social and cultural life. this broad concept of poverty encapsulates all the social and economic dimensions of deprivation, for both individual and group significance. however, the development of the social exclusion theory leads to what de neubourg (2009) referred to as the livelihood portfolio theory, where institutions – family, markets, social networks, member institutions and public authorities – are believed to be the core driving force of credit policy for the household. under the livelihood portfolio theory, de neubourg, using the welfare pentagon, expressed the interaction between credit agents in the determination of household welfare, given certain basic assumptions of utility maximisation and income constraints, occasioned by consumption risks. these consumption risks are mitigated by public authorities through social security benefits and agricultural subsidies for farming communities or individuals relying on family or communal support to compensate for a shock. methodology data this study used cross-sectional data sourced from the lsms-isa wave 2 (2012/2013). the lsma-isa was conducted by the world bank in collaboration with the national bureau of statistics and applied in osabohien (2018) and osabuohien (2014). the dataset from lsms-isa covers the 36 states in nigeria including abuja the federal capital territory. the data is classified into three groups: agriculture, households and community for the two periods of the survey (post-planting and post-harvest, devarajan [2013]). for the purpose of this study, the community-level data is utilised, involving the merging of both the post-planting and post-harvest data, as the variable of interest is either of the periods. the post-planting interview was carried out in august 2012 – october 2012, while the post-harvest data was conducted february 2013 – april 2013. the data for the study was integrated at household level where the information needed is available, which covered 4210 households. description of the variables engaged is presented in table 1. table 1: description of variables. outcome variable to determine the outcome variable, households were interviewed about their farm harvest in wave 2 (2012/2013) post-harvest agriculture season in the lsms-isa data. questions regarded the land area of crop harvested, name of crops planted, unit of crops harvested and how many units of crops were sold since the last interview. households who harvested crops are represented by 1, while households who did not harvest were represented by 0. reasons for not harvesting were ascertained in the survey; such reasons include: lost crop due to drought, lost crop due to flood, lost crop due to pest, lost crop due to violence, lost crop due to theft, disagreement on land ownership, unable to work due to sickness, no available labour and delayed or deferred harvest. other control variables were considered as important factors that affect production, including the key variable (access to credit), health, education, labour, capital, land and information, which are presented in the next subsection. control variables the control variables which are included in the study are noted below. credit facilities information regarding households’ sources of credit were ascertained, for example: if households borrow money, if collateral is required for loan, time duration (in months) required for repayment of a 10 000.00-naira loan, the interest rate on a 10 000.00-naira loan, how much a household has to reimburse on a 10 000.00-naira loan, months a household has to reimburse on a 50 000.00-naira loan, the interest rate on a 50 000.00-naira loan, much a household has to reimburse on a 50 000.00-naira loan, number of months household has to reimburse on a 100 000.00-naira loan, the interest rate on a 100 000.00-naira loan and how much a household has to reimburse on a 100 000.00-naira loan. health the health of the members of a household was considered as an important factor for production in the study. the health condition of households was ascertained by asking if members of a particular household have visited or consulted a health practitioner during the past four weeks prior to the survey. a household in which no one has consulted health practitioners was represented by 1, while households who has not consulted were represented by 0. households’ reasons for consulting health practitioners include: checkup or other preventive care, prenatal checkup, follow-up appointment, new or acute illness, new injury and so on. health practitioners consulted include traditional healers, doctors, dentists, nurses, medical assistants, midwives, pharmacists, chemists, traditional birth assistants, spiritualists and patent medical vendors. education information about education includes whether members in the household can read and write in the english language and if they have attended any school; a household in which someone can, was represented by 1, while those in which no one can read and write were represented by 0. labour information about farm labour was collected. households who hire labourers to work in their fields were represented with 1, and 0 otherwise. the number of hours worked per week by hired labourers and the amount of their payment (naira) was factored in, as well as whether they receive any in-kind payment or allowance for this work. capital information about capital was based on whether the household owned or rented the farm equipment used, such as tractors. households who own farm implement were represented by 1, and 0 otherwise. information during the survey, households were interviewed about whether they have access to information, for example, if they have access to a radio or television. households could have access to their own radio or through a family member, friend, neighbour, umbrella centre, workplace, mobile phone or others. a household who has access to information is represented by 1, and 0 otherwise. model specification this study employs the psm, which is a non-parametric technique used in the estimation of the effect of a treatment on a group of persons or subjects, in this case agricultural credit given to rural farmers, based on a control group or those who did not receive such agricultural credit. the effect of the treatment on the treated group is matched with the control group and the difference in behaviour or outcome of interest is calculated using a binary logit or probit model. the method of psm has been applied by jalan and ravallion (2003) on the impact of piped-borne water for children’s health in rural india. also, by osabuohien et al. (2019) on female labour outcomes and large-scale investments in tanzania, and by hermann et al. (2018) on the assessment of the impact of household participation in biofuel feedstock production on agricultural input expenditures in order to show that participation in a sugarcane out-grower scheme is associated with a larger amount of land under staple food crops and higher purchase of farm inputs compared to a control group in malawi. computing the change in the outcome of interest mathematically is depicted as for the outcome of the households who had access to credit and for the control (households who did not have access to credit). therefore, the change in the outcome that is attributed to participating in social protection policies is computed as: the average treatment effect therefore will be: e is the mean (or the expected value). this equation attempts to capture the outcome of agricultural production of the households or farmers with agricultural credit, compared to what the households would have experienced without agricultural credit (that is, what their production would have been without agricultural credit). the household characteristics taken into consideration are: age, location, occupation, income, size (number of individuals in the household or family), household head (if the household is led by a male or a female), education, access to credit, health status, number of assets owned by the household, whether the household owns a plot of land, and whether the household cultivates that land. this method was coined by rosenbaum and rubin (1983) by proposing the use of psm as a suitable technique to develop the unequal non-participant data. the psm method of analysis is based on the assumptions of conditional independence and common support. the conditional independence assumption assumes that the potential outcomes for households without agricultural credit are independent of their status of being in this category, given a set of observable covariates ‘x’: after an adjustment has been made for noticeable variations, it can be inferred that the mean of the outcome variable is the same for households both with and without agricultural credit. this condition helped in matching the households without agricultural credit as a control group when measuring the effect of agricultural credit on household production. thus, equation (3) above may be depicted as follows: another assumption is the similar support condition, which considered the prospect that for each value of ‘x’, there is a direct chance of each household being with or without agricultural credit. a recent application of this method is by nkhata, jumbe and mwabumba (2014). various matching algorithms are applicable when using the psm technique. this study used the kernel matching algorithm (kma), as it is found to be suitable for this study mainly because it avoids random pruning. the kma was found to give a more effectual outcome and is more appropriate for handling large, asymmetrically distributed datasets (baser 2006). the kma is designed in a way that each household with agriculture credit with ‘i’ is matched with other control observations that have weights that are inversely proportional to the households without. the weight is computed as: h represents the bandwidth. households in the community with (and without) agricultural credit are indicated as í and j. figure 1 is a graphical representation of the psm. the right-hand side is the participant or the treatment side, while the left-hand side is the non-treatment or non-participant side. the participants are the households who benefited from the programmes (social protection policies), while the non-participants are households that did not benefit from social protection policies. figure 1: graphical representation of propensity score matching. ethical considerations this article followed all ethical standards for research without direct contact with human or animal subjects. results and discussion this section of the study presented the result obtained from the analysis. figure 2 presents the frequency of households’ access to credit across zones in nigeria. there are six geopolitical zones in nigeria: the north-central, north-east, north-west, south-east, north-west, south-south and south-west. each of the six geopolitical zones has six states, excluding abuja, the federal capital territory, making nigeria a 37-state nation. in line with the findings of osabohien et al. (2018), adjognon et al. (2017), chandio et al. (2017) and rehman et al. (2017), farmers’ low production can be attributed to inaccessibility of credit facilities. figure 2: households access to credit by zones in nigeria: (a) north-central; (b) north-east; (c) north-west; (d) south-east; (e) south-south; (f) south-west. figure 2 shows that across the six zones in nigeria, there are far more households who lack access to credit than households who have access to credit. the ‘yes’ columns in the figure represent households who have access to credit and ‘no’ represents those who have no access to credit. in north-central (yes = 135, no = 662), out of the 979 farming households, 135 households had access to credit (13.79%), while a larger number of households (662, representing 67.62%) had no access to credit, thus affirming the reason behind low yields. in the north-central, 111 households had access to credit (17.50%), while 523 had no access to credit (82.49%). north-east is not different as 88 (10.10%) households had access to credit, as compared to 783 (89.90%) households who had no access to credit. similarly, in the south-east geopolitical zone, 163 (27.35%) households had access to credit while 579 (72.65%) lack access to credit. in south-south and south-west, 130 (24.06%) and 187 (23.97%) households had access to credit while 618(82.62%) and 187 (76.03%) households lack access to credit. this result signals the importance of credit to farming households to enhance production. result from kernel density plot the kernel density plot approximated the density function of the outcome (agricultural production) variable and compared its trend as shown in figure 3. the kernel density plot of households’ agricultural labour allocation is shown in figure 3. the results depicted households with agricultural credit being more productive than households without agricultural credit (households without social protection policies). figure 3: kernel density plot of agricultural credit. household characteristics of propensity score matching the household characteristics of interest as mentioned above include size, average age, educational attainment, credit access and land ownership. the descriptive statistics are presented in table 2, which compares the sample characteristics of households with and without agricultural credit. the aforementioned household characteristics are important as they determine how effective households become in terms of productivity. table 2: comparing household characteristics of propensity score match (outcome variable: agricultural production). the probit model for propensity score matching to design a set of variables that can match household characteristics in communities with and without agricultural credit, the probit regression model was applied. the main goal for estimating the probit regression model is to balance the differences in the observable characteristics that may be occurring between the groups (that is, those households who had access to agricultural credit and those households who had no access to agricultural credit). table 2 shows the result from the probit model, which was used to derive the propensity matching scores. for all households, information, health status, property and labour, whether or not a household is cultivating land or owns and cultivates farm plots are found to be significantly associated with agricultural credit (herrmann et al. 2018). figure 4 presents the result of the balancing quality checks and the histograms of the predicted propensity scores for both the treated and control groups. from figure 4, it could be inferred that the propensity score is of equal distribution, suggesting comparability of the treatment and control groups. figure 4: propensity score distribution. discussion and implication of findings the study found that households’ access to credit had a positive impact on agricultural production; this indicates that a unit increase in the effectiveness of access to credit facilities will lead to more than a unit increase in agricultural production. similarly, health status and agricultural production showed a positive relationship that implies that an increase in health status leads to an increase in agricultural production. labour and agricultural production also showed a positive relationship, which means an increased supply of labour, increased the level of agricultural production. the psm and the kernel density plot indicated that households who had access to agricultural credit had yields thrice those of their counterparts who did not benefit from such credit. this validated the need for households’ effective access to credit in order to increase agricultural production. on the other hand, households who did not benefit from credit facilities are compelled to meet the shortfall in their production and living standard by selling their assets. from the results in table 2, we observed that health status, quality of information obtained, availability of land and labour are factors that significantly account for the differences between households with agricultural credit and households without agricultural credit. however, this distinction only drew from the sample characteristics, with less emphasis on the outcome of the experiment. however, the results in table 3 revealed that information and household labour significantly determined whether the household received any form of agricultural credit or not. table 3: probit model for computing the propensity score. information asymmetry is an issue of concern, because of the lack of database; information flow is inadequate, so only the privileged in the society would have access to government credit policies. on the other hand, more labour will be put to work if there is a significant incentive for return on labour productivity. in a similar study for tanzania, hermann et al. (2018) found that for all households’ information, health status, property, labour and whether or not a household owned and cultivated farm plots, are found to be significantly associated with agricultural credit. it is obvious that agricultural credit will improve household health and labour productivity because with extra funds they can purchase better farming tools and good nutrition for an improved standard of living. the findings of this study are in tandem with the results of adjognon et al. (2017) on the impact of credit on agricultural production in ssa. the study of adjognon et al. examined the impact of agricultural input credit on agricultural production in ssa. the study engaged four ssa countries (mali, nigeria and tanzania and uganda) with 3219 (mali), 3000 (nigeria), 3047 (tanzania) and 2910 (uganda) farm households using the lsms-isa using a two-sample technique. the study found that in mali 60% of households has access to a fertiliser subsidy, unlike nigeria where only 5% of the fertiliser used by households was subsidised, thus limiting farm yields. however, findings in this study disagreed with ewetan et al. (2017) who pointed out that agricultural production is the major driver of economic growth using the co-integration approach to examine the long-run relationship between agricultural production and economic growth in nigeria. nevertheless, the non-conformity with ewetan et al. relates to the relationship between agricultural production, economic growth and development. in the case of ewetan et al. (2017), the study was taken at the aggregate level without considering how the production capacity of rural farmers could be enhanced. to this end, the aggregate agricultural production that is a requisite in spurring economic growth and development without the inclusion of farmers in rural communities tends to be increasingly ineffectual. this study also agreed with osabuohien et al. (2019) on the female-labour outcome and large-scale agricultural investment in tanzania, using psm. the findings revealed that women with investment credit tend to be more productive than women without investment credit. the psm technique tends to be a more realistic measure of the changes in the behaviour of subjects in a treatment design, where pre-treatment and post-treatment analysis is of the essence. summary and conclusion this study examined the relationship between households’ access to agricultural credit and agricultural production in nigeria with a view to providing new insights on how the provision of agricultural credit can contribute to increasing agricultural production. the variables include the number of crops produced by household members (farmers in rural communities in which the survey was conducted) measured in percentiles as the outcome variable which captures agricultural production; the major dependent variable is agricultural credit, while other control variables included are agricultural inputs as captured by labour and capital. labour measures the number of hours farmers work on their farmlands, while capital measures the number of hours or weeks machines were put to work on the farmlands. similarly, in relation to health as revealed by literature, healthy farmers are no doubt more productive than farmers who are health challenged. therefore, households’ access to agricultural credit or subsidy improves the productive capacity of farmers and those who have no access to credit facilities fall back on the conversion of existing assets to cash to improve their livelihood thereby deepening their poverty. in conclusion, it is widely believed that agriculture holds the future of the nigerian economy because it generates employment and income for rural dwellers. the agricultural sector cannot operate in isolation but will perform more efficiently when appropriate credit policies are geared towards empowering those who engage in it. in the light of the above, the study recommended that the agricultural sector should be made more attractive through the implementation and execution of effective credit policies that can help pull labour out from other sectors (labour poaching), as this will enhance the productive capacity of the sector. as revealed in the study by psm, households who benefited from agricultural credit had yields thrice those of households who did not have access to credit; this scenario calls for government and donor agencies to effectively implement credit policies in the agricultural sector which will improve the living standards of farmers in rural communities. therefore, this study has contributed to knowledge by evaluating the impact of households’ access to credit facilities on agricultural production in nigeria using psm, which to the authors’ best knowledge has not been examined in the nigerian context. further studies in this area could be conducted to ascertain the performance of the agricultural sector with respect to human capital development because as households begin to receive improved health care facilities and education in new farming techniques and subsidies from the government, there is a tendency for agricultural production to increase. however, a drawback for the implementation of credit policies in a developing country like nigeria is the lack of an adequate database (identification) for the purpose of disbursement of credit incentives. acknowledgements this article draws from the thesis of the first author which was presented and submitted to the department of economics and development studies, covenant university, ota, nigeria. also, a version of the paper presented was at the 4th covenant university international conference on e-governance in nigeria (cucen), covenant university, ota, nigeria, held between 07 and 09 may 2017. the comments at the postgraduate seminars and cucen participants are appreciated. in addition, the support from covenant university centre for research, innovation and discovery (cucrid) during the preparation of this manuscript is acknowledged. competing interests the authors have declared that no competing interest exist. authors’ contributions r.o. made contributions in the areas of conception, data collection and analysis. eze o. did a critical review of the initial draft, ensured that the appropriate methodological approach was followed, and gave the direction for the work. evans o. and u.e.e.-m. provided guidance on how to use the psm method and the data from the lsms-isa, drawing from their previous research experience, as well as guidance in the discussion of the results. o.m. contributed to the literature aspect of the study and o.g. assisted with formatting and referencing, ensuring that all cited studies are referenced. all the authors read through the various versions of the work and approved the version submitted for publication. funding information funding was received from the covenant university centre for research, innovation and discovery (cucrid). data availability statement data sharing is not applicable to this article as no new data were created or analysed in this study. disclaimer the views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of any affiliated agency of the authors. references adjognon, s.g., liverpool-tasie, l.s. & reardon, t.a., 2017, ‘agricultural input credit in sub-saharan africa: telling myths from facts’, food policy 67, 93–105. https://doi.org/10.1016/j.foodpol.2016.09.014 afolayan, o.t., okodua, h., matthew, o. and osabohien, r. 2019, ‘reducing unemployment malaise in nigeria: the role of electricity consumption and human capital’, international journal of energy economics and policy 9(4), 63–73. barrett, c.b., marenya, p.p., mcpeak, j., minten, b., murithi, f., oluoch-kosura, w. et al., 2006, ‘welfare dynamics in rural kenya and madagascar’, the journal of development studies 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south africa is black economic empowerment (bee). in this regard, bee has been employed to assist previously disadvantaged groups of investors obtain a larger share of the equity of south african listed companies. the question has often been asked whether the announcement of bee transactions by listed companies increases shareholder wealth. this article tries to answer this question by examining the share performance of 125 bee transactions involving 95 companies during the period january 2002 to july 2006. the results indicate a positive relation between bee transaction announcements and shareholder wealth creation, but only during the last part of the period covered by the study. jel d64, g14, m14 1 introduction since apartheid was abolished with the first democratic election in south africa in 1994, companies have been encouraged to increase the participation of the black majority population in economic wealth creating activities. various programmes focused on the redistribution of wealth include privatisation, affirmative action, amended fiscal and monetary policy and the introduction of black economic empowerment (bee) as a cornerstone of economic policy (gevisser, 1997; bratton, 1998; engdahl & hauki, 2001; jackson, alessandri & black, 2005). bee, in particular, has become increasingly popular in facilitating an increase in corporate ownership by black investors. in this regard, many firms have demonstrated their corporate social responsibility (csr) by selling part of their equity to black empowerment groups. bee has been justified on an equity basis, as well as for economic reasons and giving previously disempowered people better access to markets and institutions may enable them to acquire additional human capital, a condition necessary for continued sustainable economic growth (black, 2002:1160). the growth of bee has unfolded in a number of phases. the first phase that occurred during 1996-1998, saw market capitalisation increase from 0.7 percent to 6 percent of the johannesburg stock exchange (jse) south africa (engdahl & hauki, 2001:2). this sudden foray into capitalism was arrested by the market crisis of 1998 that witnessed a reduction in bee ownership from 7 percent to 2.2 percent largely because of a major drop in heavily leveraged bee acquired companies’ share prices (southall, 2004:318; beall, gelb & hassim, 2005:693). emerging from this first phase of bee, some economic realities surfaced and black ownership climbed back to an estimated 4 percent by 2004. this second phase has been described as more sajems ns 12 (2009) no 2 181 meaningful and cognizant of the market realities of risk versus return (engdahl & hauki, 2001). with the introduction of the broad based black economic empowerment act in 2003 (bbbee), the emphasis on equity transfers in bee compliance has been reduced, but equity transfer remains a significant component at 20 percent of the overall broad based bee balanced scorecard rating. ten years later the jury is still out with respect to the success or failure of bee. on the one hand, ownership of capital on the jse has increased to 4 percent with a swathe of industry charters promoting bee in the various sectors (southall, 2004; thompson, 2004). in addition, there has been a sustained growth of a black middle class since 1994 (burger & van den berg, 2004) and stateowned enterprises have vigorously promoted both preferential procurement programmes, as well as transformation of their ownership and management structures (southall, 2004; 2005). conversely, many critics suggest that bee is a sham, that it has only benefited the politically connected elite and that it is a front for maintaining the historic demographics of ownership (engdahl & hauki, 2001; mazibuko & boshoff, 2003; southall, 2004; 2005; freund, 2006). finally, there are claims that bee deters foreign investment (thompson, 2004; southall, 2004; 2005; butler, 2006) and that the transfer of ownership to bee partners could tie up r450 billion (cargill, 2005:21) this study investigates the share performance of companies listed on the jse and involved in bee transactions, specifically in terms of its ability to create shareholder wealth. the importance of the study is underlined by the growing frustration of the marginalised (engdahl & hauki, 2001), the escalating ambivalence of cosatu with respect to bee (southall, 2004) and the fear that if the next phase of bee is not successful, that the consequences could be disturbing (butler, 2006:14). this study confines itself to the equity ownership dimension of bee and does not investigate the other aspects of the bee scorecard. the study develops as follows: section one is the introduction. section two sets out the research questions. section three reviews both the csr and event study literature. section four outlines the research design. section five develops the empirical results. section six discusses the limitations of the study and identifies areas for future research. finally, section seven concludes the study. 2 research questions the research questions addressed in this study are the following: 1. are announcements of bee transactions related to shareholder value creation? 2. do the announcements of different types of bee transactions lead to differences in shareholder wealth creation? 3. do different years lead to differences in shareholder wealth creation when bee transactions are announced? in this study the cumulative abnormal returns (car) of share prices are used as a proxy for shareholder value creation and the event study methodology is used. 3 literature survey 3.1 corporate social responsibility 3.1.1 the definition and importance of corporate social responsibility there is growing evidence that market participants care – or at least should care – about csr (boutin-dufresne & savaria, 2004:64). csr has been widely studied in the literature. mcwilliams, siegel and wright (2006:1) define csr as a situation where the firm goes beyond compliance and engages in actions that appear to further some social good, beyond the interests of the firm and that which is required by law. siegel and vitaliano (2007:773) agree that csr occurs when firms appear to advance a social agenda beyond that which is required by rules and regulations. for instance, if a savings and loan institution approves a higher proportion of loans to poor and minority borrowers than that required by the relevant regulations, this 182 sajems ns 12 (2009) no 2 institution is said to be socially responsible. frederick (1994:150) outlines a conceptual transition from csr 1 to csr 2 , which he defines as the transition in business and society scholarship from the philosophical-ethical concept of social responsibility (corporations’ obligation to work for social betterment) to the action-oriented managerial concept of corporate responsiveness (the capacity of a corporation to respond to social pressure). after a bibliometric analysis of 30 years of research and theory on corporate social responsibility, de bakker, groenewegen and den hond (2005:312) come to the conclusion that the field of csr has become firmly embedded in the management sciences. munilla and miles (2005:371) see csr as an important component of stakeholder theory. if a company engages in csr activities and proves that it is socially responsible, this may contribute to its main goal of creating shareholder wealth over the long term. other authors have recently found that csr plays a key role in economic and social development (galan, 2006:1640), that research in csr is driven by interests in the business environment as well as continuing scientific engagement (lockett, moon & visser, 2006:115), and that csr requires a fine balance between social responsibility and responsibility towards the shareholders of a company (windsor, 2006:93). siegel and vitaliano (2007:774) even define “profit maximising” csr as a situation when firms engage in socially responsible actions because they anticipate certain intangible benefits from these actions. examples of such actions include reputation enhancement, the ability to charge a premium price for their output, or the use of csr to recruit and retain high quality workers. these benefits are presumed to offset the higher costs associated with csr, because the resources that must be allocated to allow the firm to achieve csr status are often expensive. finally, messages about corporate ethical and socially responsible initiatives will most likely evoke strong and often positive reactions among stakeholders (morsing & schultz, 2006:323). these researchers also point out that there are potential business benefits of the internal and external communication of csr efforts. shareholders appear to view csr in a positive light (waddock & graves, 1997:303; galan, 2006:1640; munilla & miles, 2005:371) and bee, from an efficiency perspective, may enhance wealth because it could be a strategic opportunity to grow market share (koollen, 2004; woolley, 2005). finally, bee acts as a strategy to integrate south africa into the global arena, it stimulates human resource development and promotes the firm’s social and economic contacts (engdahl & hauki, 2001; jackson et al., 2005). 3.1.2 popular issues related to csr lockett et al. (2006:115) investigated the focus, nature and salience of csr when they reviewed csr-related research published in the management literature during the decade from 1992 to 2002. their results demonstrate that the most popular issues related to csr that have been investigated pertain to environmental and ethical implications. empirical research carried out has been overwhelmingly of a quantitative nature and the field is driven by interests in the business environment as well as continuing scientific engagement. windsor (2006:93) posits that three key approaches to csr should be kept in mind. firstly, ethical responsibility theory advocates strong corporate self-restraint and altruism duties and expansive public policy strengthening stakeholder rights. secondly, economic responsibility theory advocates market wealth creation, subject only to minimalist public policy and, perhaps, customary business ethics. thirdly, corporate citizenship language invokes a political metaphor providing neither true intermediate positioning nor theoretical synthesis, but expands philanthropy as a strategic lever for increasing corporate reputation and market opportunities. 3.1.3 financial performance and csr empirical tests of whether csr companies have higher rates of return have produced mixed results. some researchers found a positive correlation, others found no correlation, while a third group tried to explain why correlations may vary. boutin-dufresne and savaria (2004:57) point out that the value of the socially screened portfolios in the us has grown by 240 percent sajems ns 12 (2009) no 2 183 between 1995 and 2003, 40 percent faster than all professionally managed assets. in 2003 there were as many as 200 mutual funds which were managed according to strong ethical guidelines, versus only 55 in 1995. this reflects a significant increase in investment demand for csr companies’ shares, which is positive for csr. mcguire, sundgren and schneeweis (1988:854) found a positive relationship between csr and financial performance. mcwilliams and siegel (1997a:98) found that when money market managers took into account the csr in the companies that they invested in, this improved their risk assessment. waddock and graves (1997:303) found that csr is positively related to prior financial performance, but also to future financial performance. orlitzky, schmidt and rynes (2003:403) conducted a meta-analysis of 52 previous studies on the relationship between csr and corporate financial performance (cfp) and found this relationship to be positive. a second group of researchers found no positive correlation between csr and cfp. aupperle, carroll and hatfield (1985:446) found no relationship between varying levels of social orientation and financial performance. guerard (1997:11) found no significant difference between the average returns of a socially screened universe (n = 950) and an unscreened universe (n = 1300) for the period 1987 to 1994. mcwilliams and siegel (2000:603) found that csr had a neutral impact on financial performance. one of the third group of researchers is barnett (2007:794) who tried to explain why the effects of csr on cfp vary across firms and time, and developed a set of propositions to aid future research on the contingencies that produce variable financial returns to investment in csr. barnett and salomon (2003:386) hold the view that firms are not inherently good or bad. rather, they are profitseeking, and will engage in those behaviours that they expect to increase their shareholders’ value. csr research thus best functions as a means of helping firms and investors identify what the market wants. campbell (2007:946), however, argues that the relationship between financial performance and corporate social behaviour is mediated by several institutional conditions. these include public and private regulations, the presence of non-governmental and other independent organisations that monitor corporate behaviour and institutional n o r m s r e g a r d i n g a p p r o p r i a t e c o r p o r a t e behaviour. other conditions include associative behaviour amongst corporations themselves and organised dialogues between corporations and their stakeholders. whether more csr leads to better financial performance is thus not an easy question to answer. 3.1.4 csr and investing in south africa the issue of csr and its influence on international investment in south africa has been contested by various researchers. teoh, welch and wazzan (1999:35) studied what they regarded as one of the most important legislative and shareholder boycotts to date, namely the boycott of south africa’s apartheid regime (as an example of csr). they found that corporate involvement with south africa was so small that the announcement of legislative/shareholder pressure or voluntary corporate divestment from south africa had little discernible effect either on the valuation of banks and other corporations with south african operations, or on the south african financial markets. wright and ferris (1997:77) examined the effect on firm value of divestment from south africa by us publicly-traded firms. their results indicate that significant and negative excess returns accrued to shares of companies announcing divestments from south africa, supporting the premise that noneconomic pressures may influence managerial strategies rather than value-enhancement goals. however, posnikoff (1997:76) found that multinational corporations that withdrew investments from south africa at a time when this country had a socially undesirable political system were positively evaluated by international investors. from this sub-section it is clear that the relationship between csr and cfp has been widely studied and debated in the literature. in the next sub-section the methodology of event studies, the research technique used in this study, will be touched upon. 184 sajems ns 12 (2009) no 2 3.2 event studies 3.2.1 event study methodology event studies have been widely used in the financial literature to determine the impact of announcements (for example, of csr transactions) and other actions by top management on the share prices of their companies. since fama, fisher, jensen and roll (1969:1) pioneered the well-known event study methodology, many researchers have used this method of enquiry. the impact of an event on the value of a firm’s common stock is usually assessed by measuring the difference between the actual and expected returns on the stock during a relevant period surrounding the event. woolridge and snow (1990:357) call this approach the market-adjusted returns approach; brown and warner (1985:3) show that this approach is as powerful as other more restrictive models of expected stock returns in detecting significant stock price movements associated with specific events. t h e e v e n t s t u d y m e t h o d h a s b e c o m e popular because it obviates the need to analyse accounting-based measures of profit, which have been criticised because these measures are often not very good indicators of the true performance of firms. managers can, for example, manipulate accounting profits by selecting different accounting procedures. mcwilliams and siegel (1997b:652) outline ten steps for implementing an event study in a comprehensive procedure based on the work of brown and warner (1985:3). many researchers have used this methodology and have had positive experiences of it. others have some reservations concerning this methodology and still others point out that researchers should beware of the method’s implicit limitations. 3.2.2 positive experiences of event studies mcwilliams and siegel (1997b:626) found the event study method to be a powerful tool that can help researchers assess the financial impact of changes in corporate policy. using this method, a researcher can determine whether there is an “abnormal” share price effect associated with an unanticipated event. from this the researcher can determine the significance of the event. this method has been used extensively in studying the financial implications of csr activities. examples of these studies are: awards for affirmative action programmes (wright, ferris, hiller & kroll, 1995:272), withdrawal of investments from south africa (meznar, nigh & kwok, 1994:1663, posnikoff, 1997:76), plant closings (clinebell & clinebell, 1994:553), product recall announcements (davidson & worrell, 1992:467), major layoff programmes (worrell, davidson & sharma, 1991:662) and corporate illegalities (davidson & worrell, 1988:195). brown and warner (1980:205) found that a simple methodology based on the market model is both well-specified and relatively powerful under a wide variety of conditions. brown and warner (1985:3) added to this by examining properties of daily stock returns thus concluding that daily data generally present few difficulties for event studies. bromiley, govekar and marcus (1988:37) found the extension of finance theory in event studies related to shareholder wealth an extremely valuable tool. but, as with most complex tools and particularly those that are still evolving, correct use of this method of enquiry is dependent on a sophisticated understanding of both theory and practice. 3.2.3 reservations concerning event study methodology criticisms have been raised against the use of event studies. mcwilliams and siegel (1997b:626) evaluated the use of the event study methodology to measure the consequences of csr activities. in a large number of events studies of csr appearing in top management journals, the authors found the conclusions unreliable due to what they regard as serious flaws in the research design and implementation of the event study methodology. mcwilliams, siegel and teoh (1999:340) also caution that an analysis of only share price effects relates to financial stakeholders, whereas analysts should keep in mind that non-financial stakeholders are also affected by csr activities. kramer (2001:109) points out that various test statistics have been employed in the finance and accounting literature for the purpose of conducting hypothesis testing in sajems ns 12 (2009) no 2 185 event studies. however, these statistics do not always follow their conventionally assumed asymptotic distributions, even for large samples of firms. the approach of fama et al. (1969:1) assumes that the residuals are independent and identically distributed. however, these assumptions can be challenged due to various reasons. firstly, the abnormal returns – the expectations of the residuals – are likely to differ across firms. secondly, the residual variance may differ across firms. finally, the residuals will not be independent if the event occurs during the same calendar period for some firms and these firms are in the same or related industries. binder (1985:370) proposes a multivariate regression model to overcome at least some of the criticisms above. kramer (2001:109) suggests a simple normalisation of the conventional test statistic with bootstrap re-sampling to overcome these criticisms. dombrow, rodriques and sirmans (2000:361) even suggest a nonparametric approach to event studies. 3.2.4 researchers should be aware of certain aspects when using event studies some researchers have pointed out aspects to beware of when using event studies. mcwilliams and siegel (1997b:626) studied 29 event studies in three top management journals and identified the event window as possibly the most crucial research design issue in an event study. the event window should be long enough to capture the significant effect of the event, but short enough to exclude any confounding effects. salinger (1992:671) notes that cumulative abnormal returns do not accurately measure the effect of an event on firm value if there are dividends during the event window. in event studies of emerging stock markets, bhattacharya, daouk, jorgenson and kehr (2000:69) warn that occurrences such as unrestricted insider trading may cause prices to fully incorporate the information relevant to the event even before the public release of that information. finally, in spite of many criticisms and caveats, from this sub-section it is clear that event studies have much potential when studying the impact of csr activities on share performance. in the following sub-section the research design which was used in this study is explained. 4 research design in this study an event study methodology is used to calculate the cumulative abnormal returns (car) associated with the public announcement of 125 bee transactions involving 95 companies between january 2002 and july 2006 (see appendix 1). although a small number of companies had more than one bee transaction during this period, these were assumed to be independent for the sake of this study. the data obtained from businessmap (2007) was reviewed, and no indication was found to indicate significant dependence. the standard approach to an event study is based on estimating a market-related return for a specific company, and then calculating abnormal returns for a certain number of days before and after the event that is studied. these abnormal returns are assumed to reflect the stock market’s reaction to the arrival of the new information pertaining to the event. the following method was used by mcwilliams and siegel (1997b:628), reuer (2000:8) and jackson et al. (2005:14). the rate of return for the share of firm i on day t is expressed as: r it =  i +  i r mt +  it , (1) where r it = the return on share i on day t; r mt = the return on a market portfolio on day t, such as the all-shares index on the jse securities exchange;  i = the intercept term for share i;  i = the systematic risk of share i; and  it = the error term, where e( it ) = 0. from an estimation of the equation above, one could calculate daily abnormal returns (ar it ), over and above those returns which are associated with the return on the market, for firm i on day t by using the following equation: ar it = r it – (a i + b i r mt ) (2) where ar it = the abnormal return of firm i on day t; 186 sajems ns 12 (2009) no 2 r it = the observed return of firm i on day t; and (a i + b it r mt ) = firm i’s forecast return on day t, based on the market return. the forecast return is constructed from the firm-specific parameters a i and b i obtained from equation (1) by way of the ordinary least squares method, as well as the actual market return (r mt ) obtained on day t. usually the estimation period is from 250 to 50 days prior to the event. the abnormal returns (ar) thus represent returns earned by the firm after adjusting for the “normal” or market-related returns, in other words after subtracting the expected return from the actual return. the car can then be calculated for a firm as the sum of the ar terms over the period in question, for example three or five days. the approach followed by mcwilliams and siegel (1997b:647) as well as jackson et al. (2005:14) includes calculating the car for four different periods. these periods entail different measures which are relevant in the event study, as indicated in table 1. table 1 measures of car for different periods surrounding an event days relative to the event measure of cumulative abnormal return –20 to –3 r1 –2 to +2 r2 –1 to +1 r3 +3 to +20 r4 in line with jackson et al. (2005:15) both a fiveday window (measure r2 for days –2 to +2) and a three-day event window (measure r3 for days –1 to +1) are used here. what one would expect if bee events did indeed lead to a positive effect on share price for a reasonable sample of firms is that the average values of both r2 and r3 would be significantly positive. in addition, the average values of r1 and r4 would not differ significantly from zero. 5 empirical results 5.1 abnormal returns and bee events the first research question of this study asks whether announcements of bee transactions are related to shareholder value creation. positive abnormal returns are regarded, in this study, as an indication of shareholder wealth creation. in order to answer this question a list of the dates of announcements of bee transactions between 2002 and 2006 involving companies listed on the jse was obtained from businessmap (2007), a company specialising in black empowerment data. the public announcement date of a bee transaction involving a company was then regarded as day zero (0) of that transaction. if the announcement was made over a weekend, the first trading day thereafter was taken as day zero. the study used the bfa-net database at the university of pretoria to obtain the necessary daily share prices. each company’s daily share prices were obtained from day –250 to day +20 relative to the bee transaction, as well as the value of the market index for the same number of days. subsequently, for each company, estimates a and b were determined for the parameters  and  in equation (1). these were then used with equation (2) to determine the expected returns for days –20 to +20 relative to the event, the abnormal returns for each of these days, and finally r1, r2, r3 and r4, which are measures of car as indicated in table 1. the average values for r1 to r4 were calculated for the 125 transactions involved, and then t-tests were performed to determine if these measures were on average significantly different from zero. the results are given in table 2. sajems ns 12 (2009) no 2 187 table 2 the average values of car for different windows relative to the announcement of 125 bee transactions variable n average std.dev. t-value p-value r1 125 –0.0114 0.1393 –0.9150 0.1810 r2 125 0.0091 0.0937 1.0858 0.1398 r3 125 0.0115 0.0611 2.1043 0.0187 r4 125 –0.0001 0.1114 –0.0391 0.4844 from table 2 it is clear that, on average, there was a significantly positive average abnormal return of 1.15 percent for the event window from day –1 to day +1 (measure r3). taking the standard deviation and the sample size into account, the associated t-value is 2.1043. for a one-sided test of whether this measure is significantly positive, a p-value of 0.0187 was found with the function tdist on an excel spreadsheet. because this pvalue is less than 0.05, one can conclude that the average return for the event window from day –1 to day +1 was significantly positive. a similar pvalue for measure r2 (for the event window from day –2 to day +2), that is, smaller than 0.05, would have confirmed the fact that a bee transaction is associated with a significant increase in share price, but this was not the case. the relatively large p-value for r2 of 0.1398 indicates that this measure is not significantly positive. similarly, a one-sided test for the averages of r1 and r4 indicates that these measures are not significantly positive. a two-sided test would have given double these p-values, confirming the nonsignificance of these values. the results from this sub-section indicate that an average significant abnormal return over a three day window was found for the 125 bee transactions. this then answers the first research question. 5.2 the impact of types of bee transactions and years the second research question asks whether the announcements of different types of bee transactions lead to differences in shareholder wealth creation. the third research question is whether different years lead to differences in shareholder wealth creation when bee transactions are announced. in order to answer these questions, an analysis of variance (anova) was performed on each of the four measures r1 to r4. in each case the impact of the year (2002 to 2006) and the type of transaction were investigated. the different types of transactions were identified as: 1) the selling of equity to a bee company; 2) the purchasing of a stake in a bee company; and 3) other bee transactions like involvement in partnerships or joint ventures. the p-values associated with the results of the anova performed on each of the measures r1, r2, r3 and r4 to determine whether year or type of transaction contributed to explaining the variance, are given in table 3. table 3 the p-values resulting from the anova on each of the measures r1, r2, r3 and r4 to determine the impact of year and type measure p-value r1 r2 r3 r4 0.9713 0.2474 0.0256 0.5902 table 3 shows that only measure r3 seems to be significantly affected by changes to announcement year and bee transaction type. these factors do not seem to contribute to explaining the variance of the abnormal returns for the other three measures. the output from the anova performed on measure r3 is given in table 4. 188 sajems ns 12 (2009) no 2 table 4 anova on measure r3 to determine the impact of year and type on car associated with bee transactions source d.o.f. sum of squares mean square f-value pr > f (p-value) year 4 0.03776 0.00944 2.71 0.0332 type 2 0.01454 0.00727 2.09 0.1284 model 6 0.05229 0.00872 2.51 0.0256 error 118 0.41052 0.00348 corrected total 124 0.46281 it can clearly been seen in table 4 that the year of announcement had a significant effect on the car. the type of transaction had no impact on explaining the differences between cars. stated differently, different types of bee transactions had no impact on the creation of wealth. this answers the second research question. the third research question addresses the question of whether abnormal returns differed between years. one could extend this question: if there are differences (as indicated by table 4), where are these? in order to answer this question, the average values for measures r1 to r4 have been calculated for each of the years 2002 to 2006, as indicated in table 5. table 5 average values for measures r1 to r4 for each of the years 2002 to 2006 years no. events r1 r2 r3 r4 2002 10 –0.0020 0.0034 0.0158 –0.0278 2003 13 –0.0092 0.0073 –0.0005 0.0192 2004 27 0.0157 0.0029 0.0066 –0.0253 2005 42 –0.0263 –0.0133 –0.0048 0.0218 2006 33 –0.0148 0.0448 ** 0.0386 *** –0.0055 total 125 ** significant at 5% level *** significant at 1% level from table 5 it is clear that measures r2 and r3 had significantly positive average values of respectively 4.48 percent and 3.86 percent for the year 2006. however, for none of the years 2002 to 2005 did these measures have significant positive values. measures r1 and r4 had no significant values for any of the years. 6 limitations of this study and areas for further research although bee is important for south african companies to give expression to their csr objectives, data on bee transactions are not widely available. this limits the type of research that is possible on this important topic. this study did not, for example, investigate the impact of the specific values of the transactions and sajems ns 12 (2009) no 2 189 their relationship to shareholder value. future research should address this relationship. in this study a single market index was used when calculating abnormal returns at the time of the announcement of bee transactions. as is evident from appendix 1, not only were industrial companies involved, but also financial and resource companies. if future research would perhaps use different, more focused indices for these different types of companies, different car values would perhaps lead to different results. during the whole period covered by the study, the jse was in an upward trend. recently, however, a global financial crisis has lead to sharp decreases in international share prices. future research could address the question of whether companies that have engaged in bee transactions behave differently under recessionary economic circumstances (in terms of value created relative to the market) than during periods of growth in the economy. this study focuses on the equity ownership dimension of bee and does not investigate the other aspects of the bee scorecard. naturally, a comprehensive study on the impact of bee should also take these aspects into account. it could be argued that the companies in the study participated in bee activities only due to their desire to score points on their bee scorecards, and not due to any feelings of social responsibility. it may, in fact, be difficult to determine the true motivations of companies that have acted in a seemingly socially responsible manner. future research could address this issue. this study addresses the short-term relationship between a bee announcement and shareholder value. the mediumand long-term relationships were not investigated. are the increases in shareholder value created through bee transactions sustainable over the long-term? this is certainly an important area for further research. csr is especially important for a country like south africa where a large part of the population was, for many years, excluded from many valuecreating opportunities in the economy. this justifies the notion that much more research is needed in terms of the value created for various stakeholders in bee transactions. 7 conclusion a bee transaction is an important vehicle whereby south african companies can give expression to their csr objectives. in this study, the short-term financial impact of 125 bee transactions involving 95 companies is studied. the most important conclusion is most probably the significant positive average return of 1.15 percent found for the three day event window (measure r3) surrounding a bee announcement. it is safe to state, therefore, that bee announcements seem to have a positive impact on shareholder wealth. the results also indicate that there are no significant positive differences on the effect on shareholder wealth creation between different types of bee transactions. there were, however, differences in the impact on value creation when the different years of announcements were considered. surprisingly, the announcement of bee transactions between 2002 and 2005 had no significantly positive impact on shareholder value creation, but for 2006 it had a significantly positive impact over both the three-day and the five-day windows. although previous research found highly significant results from bee announcements for the years 1996 to 1998, the results from this study are not as exciting for the period 2002 to 2006. the reason could be that bee transactions were still new during the years 1996 to 1998, and investors may have had high expectations of companies that engaged in them. many investors during this period may have been more interested in acquisitions than the actual creation of wealth. the market crisis of 1998, however, resulted in a significant drop in bee ownership largely as a result of heavily leveraged bee shares. during the period 2002 to 2005, investors may have, therefore, become more exposed to the economic realities of bee transactions, and more cautious in their evaluation of only the announcements of these transactions. it could of course also be true that the bee activities of previous years had led to a change in the profile of the average shareholder, and therefore also the shareholder’s view of the announcements. why this changed view was only reflected in the year 2006 is not clear. 190 sajems ns 12 (2009) no 2 the results of this study could be important for developing countries. investors who may at first be excited about bee transactions as a way of fulfilling shareholder wishes 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stock market reaction to strategic investment decisions. strategic management journal, 11(5): 353-363. worrell, d.l., davidson, w.n. & sharma, v.m., 1991. layoff announcements and stockholder wealth. academy of management journal, 34(3): 662678. wright, p. & ferris, s.p., 1997. agency conflict and corporate strategy: the effect of divestment on corporate value. strategic management journal, 18(1): 77-83. wright, p., ferris, s.p., hiller, j.s. & kroll, m., 1995. competitiveness through management of diversity: effects on stock price valuation. academy of management journal, 38(1): 272-287. sajems ns 12 (2009) no 2 193 appendix 1 names of 95 companies and announcement dates of 125 bee transactions name date name date name date absa absa absa acucap afgri afharv alexforb alexforb angloplats apex arm aspen aspen assore astrapak aveng basread basread bcx bidvest bjmh brait cadiz capital capitec capitec capitec cargo cashbil comair conduit cullinan dcentrix delta diamondcp discovery drdgold drdgold edcon elbgroup emira enaleni 06.04.2004 04.07.2006 25.07.2006 13.02.2006 24.11.2006 24.02.2002 15.11.2005 19.09.2002 19.03.2002 09.05.2006 13.11.2003 31.01.2002 17.03.2005 10.11.2005 27.10.2004 24.08.2004 18.05.2006 23.09.2005 08.06.2006 09.07.2003 03.08.2003 08.07.2004 20.03.2004 28.07.2004 13.02.2006 10.03.2006 22.09.2004 05.08.2003 04.11.2004 25.07.2006 16.03.2006 08.05.2006 18.02.2002 09.06.2005 18.07.2006 13.09.2005 28.07.2005 13.02.2002 17.06.2005 16.03.2006 05.06.2006 20.02.2006 enaleni eoh erm excell exxaro faritec firstrand gijima ast glenmib gfields gfields group 5 hiveld illovo imperial imperial isa jci johncom johnnic johnnic johnnic johnnic johnnic kgmedia kgmedia kairos kwv-bel m&f m&r medclin methold methold mtn group mtn group mtn group mtn group mustek mvelares mvelagrp nampak nampak 01.11.2005 16.08.2004 13.06.2003 19.05.2006 13.10.2005 30.06.2005 04.11.2004 07.02.2006 13.10.2005 06.06.2005 19.10.2004 10.08.2005 23.04.2006 11.02.2005 10.12.2003 05.04.2005 29.06.2006 01.07.2002 01.12.2004 05.02.2002 05.07.2005 05.12.2005 12.12.2005 20.04.2005 03.01.2006 13.10.2005 15.02.2005 10.06.2004 19.04.2005 17.10.2003 04.10.2005 18.08.2005 18.06.2004 02.04.2004 27.11.2002 13.05.2003 26.07.2006 26.11.2003 18.07.2006 11.05.2004 14.08.2003 18.08.2005 naspers nedbank netcare netcare netcare netcare oceana oldmutual panprop pergrin petmin pinnacle ppc primedia primedia psg psg psg ra-hold rangold resilient resilient sallies sanlam sanlam sappi sasfin schamin setpoint sqone stanbank sunint sunint suprgrp telkom tiwheel trnshex unitrans village winhold zaptronx 21.04.2004 19.04.2005 23.09.2005 08.08.2004 23.03.2006 01.12.2004 26.06.2006 19.04.2005 11.10.2005 08.12.2005 01.02.2006 28.11.2005 12.08.2003 01.11.2005 12.09.2005 26.02.2004 21.09.2003 14.02.2006 27.03.2006 09.12.2004 24.09.2005 08.06.2006 28.02.2006 06.10.2004 05.12.2003 19.04.2006 12.12.2005 22.04.2005 27.05.2005 03.02.2006 16.07.2004 01.11.2004 07.11.2005 15.04.2004 05.07.2005 21.01.2005 28.02.2002 25.08.2004 21.06.2006 02.12.2005 31.03.2006 microsoft word vol6no3'3.doc sajems ns 6 (2003) no 3 473 the dividends from a revenue neutral tax on coal in south africa ________________________________________________________________ t j de wet sovereign bond analyst, standard bank johannesburg j h van heerden department of economics, university of pretoria ________________________________________________________________ abstract south africa is endowed with a significant proportion of the world�s coal reserves, which is used relatively cheaply to supply in more than 75 per cent of the country�s energy needs. in terms of its per capita south africa is one of the largest air polluters in the world. even higher on the list of social preferences in south africa, however, is the problem of unemployment, which also ranks amongst the highest in the world. in this paper we use a computable general equilibrium (cge) model to simulate fiscal policy scenarios that address both these problems, and try to establish a �double dividend�, namely a reduction in co2 levels of pollution as well as a reduction in unemployment levels. jel e62, h21, j65, n5 1 background the south african government has achieved remarkable results in the fiscal management of the country over the past decade. this achievement was the twofold result of broadening the south african tax base and prudent fiscal management. although much success has already been achieved, a number of concerns remain. of these, environmental reform and the high level of unemployment constitute major aspects. south african policy makers will have to consider the objective of increasing future economic growth within a framework that ensures the sustainability of the current economic achievements. sound management of natural resources is therefore becoming an integral part of the south african policy maker�s responsibility. a significant concern towards sustainable development is the current levels of carbon dioxide (co2) pollution in the country. south africa is endowed with a significant portion of the world�s coal reserves and, consequently, this natural sajems ns 6 (2003) no 3 474 resource is used relatively cheaply to supply in more than 75 per cent of the country�s energy needs. the largest consumer of coal in south africa is the electricity supply industry, which uses coal as a primary input to provide for the country�s electricity needs. this, however, results in pollution, and with electricity generation from coal being the single largest source of co2 emissions, this contributes towards 53 per cent of aggregate national co2 emissions. in addition, the use of petroleum products derived from coal contributes another 14 per cent to the national co2 levels. it is therefore not surprising that south africa is the largest contributor towards co2 pollution on the african continent. south african policy makers have a number of policy instruments to their disposal to address this environmental concern; one of which, viz. a system of national carbon taxes, might be a possible remedy. however, the environmental benefits gained from this type of taxation could be costly in terms of lower economic growth. this cost will be amplified if the regulations imposed on firms should reduce the overall level of employment and investment in the economy. the above criticism towards environmental taxation has resulted in a shift in the debate concerning environmental taxation. rather than being judged as an instrument to control pollution, this type of taxation is currently seen as a revenue-raising tool with uncertain environmental benefits, but with large potential for improving social welfare (goulder, 1994). policy makers should therefore use the revenue obtained from environmental taxes to reform the current tax system to achieve certain economic objectives. this possibility certainly seems attractive in the south african context, as the problem of unemployment and the skewed welfare distribution are an even greater concern than that of environmental management. because south africa has a high unemployment rate (which has been the subject of numerous research and policy debates in the country), the notion of a possible �double dividend� that currently features strongly on the european research agenda could also be applicable to the south african market (e.g. capros et al., 1995). the possibility of achieving such a benefit in the south african context should be investigated. therefore, the dual objective of reducing long-term structural unemployment and reducing pollution (e.g. greenhouse gas emission) presents an intriguing opportunity. that is: the double dividend notion presents the possible opportunity for the south african fiscal system to be reformed by switching the burden of taxation from labour as a factor of production to factors of production that contribute towards higher levels of pollution. however, this issue not sajems ns 6 (2003) no 3 475 without its controversies and has gained a significant amount of interest from economists, environmentalists and policy makers. the purpose of the research as presented in this paper is to apply a general equilibrium model of the south african economy to determine whether the current structure of the economy would allow the attainment of a double dividend. the general equilibrium model that is applied is a south african version of the generic orani model (horridge, 2001). a 2001 social accounting matrix (sam) of the south african economy is used as its primary source of data. because the relative abundance of coal in the south african economy has resulted in relatively low energy costs, we try to establish whether a revenue neutral fiscal reform that introduces a tax on the use of coal as an intermediate input could result in an increase in the overall welfare of south african citizens. the revenue raised is returned to the economy in two different scenarios: 1. a lump-sum transfer to the poorest households in the south african economy. 2. a decrease in the intermediate taxation of those products that are both widely used by the poorest households and relatively labour intensive in the production process. these we have identified as food, agricultural and beverage products. by comparing these policy shocks with each other, we conclude that a targeted reduction in the price of food and agricultural products holds the highest benefit for the south african economy. section 2 describes the broad characteristics of the model that is used, while section 3 briefly describes the south african labour market. a description of the labour market is deemed necessary because this market has unique characteristics that affect both the choice of model closure and our choice of products that should experience a direct positive benefit from the tax reform. in section 4 we describe the model closure, and the results of the simulations are summarised in section 5. 2 model characteristics 2.1 framework we use a south african general equilibrium model that reflects the orani general equilibrium modelling methodology. it is a comparative-static model, and simulation results are reported as deviations from a base case scenario. the sajems ns 6 (2003) no 3 476 results do not represent changes over a period of time, but rather differences with respect to the base case at a given point in time. as is described in section 4, we choose a closure that represents a short-run economic environment, while assuming that the supply of highly and semi-skilled labour is fixed within the south african economy. this assumption reflects the reality of the relative shortage of highly skilled and skilled labour and the abundance of unskilled and informal sector labour in south africa. 2.2 database the main source of data that serves as the basis of the model is a 2001 sam. the sam distinguishes between 45 different products and 45 different industries. each of these industries is allowed to produce only one output. with regard to the production of coal, the database includes the south african coalmining industry that supplies coal not only to the south african economy, but also to the rest of the world. although coal is used in the production processes of the major part of the industries in the south african economy, a relatively intensive use of coal is made by four industries, namely: 1 the coke and refined-petroleum industry, 2 the basic iron-and-steel industry, 3 the basic non-ferrous metals industry, and 4 the electricity industry. within the database distinction is made between four groups of labour: 1 highly skilled, 2 skilled, 3 semiand unskilled, 4 informal labour. in addition, south africa�s households are divided into 14 different groups according to their income. the original sam distinguishes between seven different types of government expenditures, 13 different export destinations and 12 different types of fixed investment in the south african economy. however, for the purpose of this study we use aggregated government expenditure, aggregated exports and aggregated investment for the south african economy. the different industries, products and labour groups are summarised in appendix 1. sajems ns 6 (2003) no 3 477 2.3 model elasticities the elasticities used in the model are obtained from a combination of econometric estimations and a review of the relevant literature. the lack both of historical data and relevant research material on some of the markets of the south african economy rendered attainment of the true elasticities a difficult task. the procedure followed to obtain the relevant elasticities is briefly described. 2.3.1 the constant elasticity of substitution (ces) substitution elasticity between different skill types very little (if any) data are available for the estimation of the ces substitution elasticities between highly skilled, semi-skilled, unskilled and informal-sector workers. it is therefore not surprising that the current literature does not provide any insight into the exact values of these elasticities. the uncertainty about the substitution elasticity between different skill types in south africa is, however, not unique: (dixon et al., 1980) maintain that considerable uncertainty exists about the extent to which changes in occupational wage relativities influence occupational labour demands in australia. despite the uncertainties and difficulties surrounding these elasticities, analysis of the south african labour market indicates that one should not expect a high degree of substitutability between the different types of labour in south africa, as structural and institutional factors allow little substitution within the labour market. one could therefore assume a low elasticity of substitution for the south african labour market. given the result for the australian economy, an elasticity of 0.2 is assumed for the south african model. 2.3.2 the ces substitution elasticity between primary factors a review of current literature on the elasticity of substitution between primary factors in the south african economy has not shed any light on the expected elasticities for the industries included in this study. an attempt is therefore made to estimate these substitution elasticities by following the widely used approach pioneered by (ferguson, 1965), in which the elasticity of substitution is estimated by making use of conditions of profit maximisation. the elasticities thus obtained for each industry are summarised in appendix 2. 2.3.3 the armington elasticities although armington elasticities can be estimated separately for each category of demand in the model (i.e. household, investment or import demand), available data can seldom sustain such an attempt. because of the data inadequacies we sajems ns 6 (2003) no 3 478 followed (dixon et al., 1980) and imposed the restriction that the elasticity of substitution between a specific domestic and the imported good is the same for use as an input in the production process, investment or household consumption. (dixon et al., 1980) defend this assumption by pointing out that most of australia�s major imports are predominantly used in the one end-use category only and that this assumption would suffice for south africa as well. we therefore estimate the armington elasticities for the south african industries by making use of a methodology set out by (reinert & roland-holst, 1992) and (kapuscinsky et al., 1996). the elasticities are summarised in appendix 2. 2.3.4 household expenditure elasticities expenditure elasticities are estimated for an �aggregated household� that encompasses the expenditure of the 14 households in the model. it is assumed that these expenditure elasticities are representative of each of the individual households. despite the lack of data for disaggregated households, sufficient data are available to estimate the expenditure elasticity of the aggregated household for each of the 45 products in the model. the demand function estimated is the common log-linear demand equation that represents household consumption as a function of disposable income and relative prices. the expenditure elasticities are summarised in appendix 2. 2.3.5 the foreign elasticity of demand for south african products in order to derive and motivate the use of the price elasticities of exports, the methodology behind the orani model of the australian economy has been used. demand elasticities in the orani model are assumed to be �4 for those goods for which australia does not have sufficient market share to influence the market price. the centre for policy studies at monash university has indicated that model results do not change significantly if the elasticities increase beyond �4 for those commodities that are highly price elastic. south africa�s economy is also a small open economy with little pricing power in international markets. therefore, the price elasticity of �4 has been adopted for all of the industries that are included in the south african version of the orani model. 3 the south african labour market the unemployment rate in south africa is exceptionally high and arguably the most pressing concern that faces policy makers. even according to the conventional (narrow) definition of unemployment, which implies a job-search sajems ns 6 (2003) no 3 479 test, one in every four adults in south africa who want work and are actively looking for it, is unemployed. furthermore, extreme wage inequalities and disparity in the incidence of unemployment exist between different race groups. while africans faced unemployment rates of 41 per cent in 1994, the rate for whites was only 6 per cent. the level of unemployment among africans is one of the highest in the world, and could be the highest, if compared with rates of countries of similar population size. the different skills groups are also pronounced: south africans with higher education (highly skilled and skilled labour) face an unemployment rate of only 6 per cent, while labour-market participants with only primary education, or less, suffer an unemployment rate close to 40 per cent. this phenomenon could partially explain the labour allocation by race, because there is a huge gap between education and skills levels between race groups. from the research that has been conducted on the south african labour market, one could conclude that it operates at a level of full employment for skilled and highly skilled labour, while the unskilled and informal-sector labour suffer high levels of unemployment. although a considerable amount of research has been carried out on the reasons for unemployment, little attention has been directed towards determining whether this unemployment is voluntary or involuntary. the answer to this problem is important for two reasons: 1 research has indicated that the labour-supply function holds important consequences for the success of a double dividend policy. if labour supply is highly inelastic, for instance, wages could increase as result of the policy while employment levels remain constant. this could ultimately result in an increase in the inflation rate and a reduction in the impact of the policy. 2 it gives an indication of how the labour-supply curves of the unskilled and informal sector labour should be treated within the model closure. if unemployment is voluntary, it implies a supply-side problem and the labour-supply curve should be treated accordingly. however, if the level of unemployment is involuntary, it implies a demand-side problem. in one of the few papers addressing this problem, (kingdon & knight, 2001) described their attempts to determine whether unemployment in south africa is voluntary or involuntary. they came to the conclusion that it is very likely that most of the unemployed workers are involuntarily so and would accept formal sector jobs at the going wages. they also stated that it would be remarkable if the unemployed in south africa would choose to remain deprived, but that it appeared as if limited opportunities for entering into the informal sector provided no real alternative to unemployment. these findings are confirmed by studies that analyse the reasons for unemployment, and one can conclude that sajems ns 6 (2003) no 3 480 the unemployed in south africa are not voluntarily so and that they do not obtain a higher level of utility because less labour is supplied. in fact, most studies indicate that the unemployed would readily work at real wages lower than the current wages in the labour market. once again, this is especially true for the unskilled labour force and it seems as if the elasticity of labour supply for the unskilled labour is high. 4 model closure 4.1 the economic environment against this background a suitable closure was established to test the effects of a revenue neutral coal tax on the south african economy. the features of south african factor markets were considered in the closure, as well as the economic variables that have to be evaluated in the experiment. this includes variables such as coal consumption, labour absorption and the welfare of the south african society. the closure adopted to test the effects of a revenue neutral tax on coal in south africa can be classified as a short-run closure within the orani methodology, even though it is assumed that the supply of highly skilled and skilled labour are fixed. this assumption is made to reflect the realities of the south african labour market described above. a realistic closure for these two components of the south african labour market would therefore be to exogenise the real wages for these two groups and to assume that the unskilled and informal sector employment would change in the face of a policy shock, while real wages remain constant. because of the significant unemployment rate among unskilled and informal sector workers, it is assumed that capital and land remain fixed within the model (short-run assumption) and that the price of capital and land will adjust in the face of any policy shocks. this assumption allows firms to change the number of unskilled and informal sector workers in their employment to adjust output. although a lower wage for unskilled labour should result in a lower cost of labour, it should also result in lower income to households who supply the unskilled labour. with regard to the macroeconomic aggregates, it is assumed that government and investment spending are fixed (unless some theory needs to be adopted regarding their behaviour). to allow analyses of the effect of the policy shocks on welfare as well as on the competitiveness of the south african economy, consumption expenditure and the trade balance are endogenous in the model. sajems ns 6 (2003) no 3 481 apart from the above, all technical change and shift variables are exogenous. this assumption allows for the evaluation of the economic effects of the introduction of the revenue neutral tax on the intermediate use of coal in the absence of any technological improvements in the economy. finally, all tax rate variables are exogenous, and the tax rate on the intermediate use of coal, food, agricultural products and beverages can be shocked to determine the effect of such a shock on the south african economy. 4.2 the policy shocks the first policy shock that is simulated with the south african cge model is a 50 per cent increase in the tax rate on the intermediate use of coal across all industries in the south african economy. the tax increase of 50 per cent is chosen to get a clear indication of the economy-wide effects of such a tax. of particular interest will be the effect of such a tax on the demand for coal, consumer welfare, competitiveness, employment and gdp growth. it must also be determined what the change in government revenue will be as result of the policy change. the second policy proposal is a revenue neutral shock in which a 50 per cent tax on coal is introduced, but the revenue from the tax is redistributed as a lumpsum transfer to the households in the three lowest income groupings of the model (d0, d1, d2). the third policy proposal is a revenue neutral shock in which a 50 per cent tax on coal is introduced along with a revenue neutral cut in intermediate taxation of food and agricultural products. the revenue raised by the tax on coal is redistributed by reducing the cost of those products that constitute the bulk of the consumption expenditure of the poorest households in south africa. a comparison between the expenditure patterns of the poorest household groups (d0) and those of the richest (d924) in south africa reveals that the poorest households spend nearly 50 per cent of their income on food and agricultural products, while it constitutes only about 10 per cent of the total expenditure of the richest households. apart from the potential impact of cheaper food and agricultural products on the poorest households, a tax that reduces the cost of these products should directly result in a decrease in the tax burden on labour. these industries are relatively labour intensive and contribute towards 12.5 per cent of the unskilled employment in south africa and 6.5 per cent of total employment. only the gold-mining sector employs more unskilled labour than the agricultural sector. sajems ns 6 (2003) no 3 482 the results of the policy shocks will indicate whether these policy proposals can result in a double dividend for the south african economy. this will be the case if the net result of the policy shock would be both a decrease in pollution levels and, simultaneously, an increase in welfare. other economic variables that are of interest are the change in the level of unskilled and informal sector employment and the effect that these proposals will have on south africa�s external competitiveness. 5 results 5.1 a 50 per cent tax on coal we use a stylised model (adams, 2003: appendix 3) that represents the underlying theory of the cge model to explain the macro-economic results of the simulation. from equation (15) in the said appendix we expect an increase in the indirect tax on coal to increase the cost of low-skilled and informal-sector labour (variable factors of production). this result will be strengthened by a negative terms of trade effect, which occurs in the denominator. equation (14), which relates the price of the variable factors to that of the fixed factors (capital, land, highly skilled and skilled labour), indicates that the increase in the price of the variable factors should result in a decrease in the price of the fixed factors. the increase in the price ratio between the price of the variable factor and that of the fixed factor implies that the quantity of the variable factor that is employed will decrease (equation (13)). the decrease in the quantity employed of the variable factor will result in a fall in output, which will result in a fall in gross domestic product at market prices. if the trade balance increases, the consequence will be a decrease in aggregate consumption. ↑−+++↓↓= )( mxgicy mp (1) given the negative terms of trade effect and the positive trade balance, our simulation results confirm the expected macroeconomic outcomes. the simulation results for selected macroeconomic variables are reported in table 1. sajems ns 6 (2003) no 3 483 table 1: the estimated macroeconomic effects of imposing a 50 percent tax on the intermediate use of coal (percentage changes) real gdp -0.099 employment -0.028 consumption -0.632 exports 0.388 imports 0.144 price of capital -2.029 price of land -0.052 price of highly skilled labour -2.299 price of skilled labour -2.162 because we assume that foreign prices remain unchanged while the nominal exchange rate serves as numeraire, the negative terms of trade effect can only be the result of a fall in the price of exports. this is evident because of the fact that the prices of capital, land and highly skilled and skilled labour will fall. this fall in the price of primary factor inputs is not offset by the increase in the price of intermediate goods in the manufacturing of exports. the result is that the price of exports falls, which results in an increase in exports and a decrease in the terms of trade. apart from the effect of the tax on the macroeconomic aggregates, it is evident from the simulation results that the coke and refined petroleum industries, the basic iron-and-steel industry and the electricity industry will suffer most under the proposed policy change, as they are the industries that rely most on coal as an input into the production process. although aggregate exports increase as result of the fall in the aggregate export price, the industries mentioned above experience a significant fall in their exports. the exports of the coke and refined petroleum industries fall by 3.15 per cent, those of the basic iron-and-steel industry by 6.50 per cent and those of the electricity industry by 7.48 per cent. despite the positive effect of the tax on the competitiveness of the south african economy, it has a negative effect on the aggregate welfare of the south african society as such, as well as on the welfare distribution of the society. table 1 indicates that consumption decreases as result of the tax. the simulation results also indicate that the consumption of the households in the lowest income groups will decrease more than that of the households in the higher income groups. an analysis of the change in the real consumption of the households indicates that the households in the higher-income groups experience a larger decrease in sajems ns 6 (2003) no 3 484 their consumption basket than that of the lower-income households. this is the result of the relatively high weight that capital-intensive products carry in the consumption basket of the high-income households (compared to the lowerincome households) (figure 1). figure 1 percentage change in the household consumption according to income groups 0.6 0.7 0.8 0.9 1 1.1 1.2 1.3 d0 d2 d4 d6 d8 d921 d923 finally, the effect of the tax on coal on the demand for coal seems to be relatively small. the domestic demand for coal falls only by 1.39 per cent. although this could result in some reduction in the levels of pollution, it seems as if the cost of this benefit could be high (in terms of employment loss, etc.). with no attractive alternative energy source available, this result should be expected. 5.2 a 50 per cent increase in the tax on coal, accompanied by a lump-sum payment to the households in the lower-income groups of the south african market the result in simulation 1 indicates that the tax on coal raises revenue of r5.044 billion for the government in the form of indirect taxes. the second policy simulation evaluates the effect of a lump-sum transfer towards the households in the lowest three income groups of the south african economy. the revenue for the transfer is obtained from the tax on coal. the stylised model in appendix 3 indicates that the intermediate tax will increase the cost of the variable factor of production. the simulation results indicate, however, that this policy will also have a positive terms-of-trade effect that slightly offsets the effect of the tax increase on the cost of labour. with reference to the stylised model, the results of the policy shock are, in summary, that: 1 the tax increases the cost of the variable factor of production. sajems ns 6 (2003) no 3 485 2 the increase in the cost of labour results in a decrease in the cost of the fixed factor of production. 3 the relative factor price movements result in a fall in the employment of the variable factors of production. 4 the decrease in the employment of the variable factor of production results in a fall in gdp. 5 the fall in gdp is reflected by a fall in exports (not surprising if one takes into account the positive terms of trade effect). consumption, however, increases as result of the lump-sum transfer to the households at the lower end of the income distribution. table 2 reports the effects of this policy simulation on selected macroeconomic variables. table 2 the estimated macroeconomic effects of imposing a revenue neutral tax on the south african economy (percentage changes) real gdp -0.019 employment -0.203 consumption 1.612 exports -1.868 imports -0.028 price of capital -0.265 price of land -0.745 price of highly skilled labour -0.549 price of skilled labour -0.209 it is evident that this policy will have a positive effect on welfare in south africa, although it will result in a loss in competitiveness, being the result of an increase in the domestic price of south africa�s exports. this increase is brought about by the tax on coal. although the price of the fixed factors of production falls (as is the case in simulation 1), the decrease is not big enough to offset the increase brought about by the additional tax on coal. as a result, exports fall across all industries except coal and other mining. it is significant that the agricultural, food and beverage industries are among those that experience the biggest fall in exports. the fall in the exports of these industries can be explained by the small amounts of capital and skilled labour employed by them, which explains the relative price increase of the (unskilled) labour-intensive products. sajems ns 6 (2003) no 3 486 not surprisingly, the lump-sum transfer towards the lower-income group of households results in an increase in aggregate consumption of the three lowincome household groups, despite the slight increase in consumer prices. figure 2 reflects the positive effect of the policy on south africa�s welfare distribution. figure 2 change in household consumption expenditure after lump-sum transfer -5 0 5 10 15 20 25 30 35 40 45 d0 d1 d2 d3 d4 d5 d6 d7 d8 d91 d921 d922 d923 d924 an analysis of the low-income household expenditure patterns after the policy shock indicates increases in their expenditure across all consumer goods. however, because the prices of relative capital-intensive goods fall relative to those of labour-intensive goods, expenditure on capital-intensive goods increases relative to expenditure on other goods. this includes expenditure on television sets (92 per cent), furniture (76 per cent) and commercial services (94 per cent). the consumption of the other household groups, which do not receive the lump-sum transfer, falls as result of the increase in consumer prices. the effect of the policy proposal on the domestic demand for coal is once again small the domestic demand for coal decreases by 1.31 per cent. this small decrease, despite a relatively high tax shock is, once again, due to the lack of a feasible alternative to coal as an input in the production processes. 5.3 a 50 per cent increase in the tax on coal, and a decrease in the intermediate taxation of food and agricultural products in the third policy simulation the revenue raised through the tax on coal is returned to the economy by reducing the intermediate tax rate on food and agricultural products. the increase in revenue allows a 4 per cent reduction in sajems ns 6 (2003) no 3 487 the intermediate tax rate on food and agricultural products. because the aggregate effects of the intermediate tax are ambiguous with regard to labour and capital, the simulation results of the terms-of-trade effect and the prices of capital and labour are used to explain the macroeconomic effects of the tax. our simulation results indicate that the policy proposal results in positive terms-oftrade effects and that the prices of both labour and capital fall. the fall in the price of labour results in an increase in employment and subsequently an increase in gdp. table 3 summarises the simulation results of selected macro-economic indicators. table 3 the estimated macroeconomic effects of imposing a revenue neutral tax on the south african economy (percentage changes) real gdp 0.0195 employment 0.0677 consumption 0.1569 exports -0.39121 imports -0.15142 price of capital -0.63919 price of land 0.24210 price of highly skilled labour -0.94751 price of skilled labour -0.53043 as in the case of the second policy simulation, the positive terms-of-trade effects are the result of an increase in the price of exports. this increase is the consequence of the intermediate tax on coal, and it is evident that the decrease in the price of food and agricultural products is not enough to offset these price hikes. despite the fall in exports, aggregate consumption increases as result of the reduction in food and agricultural product prices. as is illustrated in figure 3, the policy proposal also has a positive redistribution effect. sajems ns 6 (2003) no 3 488 figure 3 change in household consumption expenditure -0.4 -0.2 0 0.2 0.4 0.6 0.8 1 1.2 d0 d2 d4 d6 d8 d921 d923 the lower-income households experience an increase in their levels of consumption because of a significant decrease in consumer prices. this is not surprising if one considers that food and agricultural products represent nearly 50 per cent of the consumer basket of the low-income households. the effect of the tax on coal on its domestic use remains small � a 1.43 per cent reduction. once again, the effectiveness of the tax is hampered by the lack of a feasible alternative source of energy whatever in the south african economy. 6 discussion the three policy simulations highlight a few important points that policy makers should consider before implementing a tax on energy resources in south africa: 6.1 the environmental effect all three the simulations have indicated that a significant tax on coal will have a positive environmental effect through a reduction in the use of coal. the reduction is, however, small and has to be determined whether such a decrease is sufficient to justify the environmental tax proposal. because there are but a few energy substitution possibilities existing in the south african economy, policy makers should consider establishing alternative energy sources first, before venturing towards energy taxation. sajems ns 6 (2003) no 3 489 6.2 the effect on welfare the results from simulation 1 have indicated that a tax on coal will have negative effects on south african welfare, and close consideration should be given to the manner in which revenue is returned to the economy. if the revenue is used to increase government savings (or repay government debt), aggregate consumption will decrease. the tax will also have negative distributional effects, as the households at the top end of the income distribution will benefit from the fall in the price of capital and the subsequent fall in the price of capitalintensive goods. simulations 2 and 3 indicate that positive welfare and redistribution results could be achieved if the revenue is returned to the economy by means of a lumpsum transfer to the poorest households, or by a reduction in the intermediate tax of products that are both labour intensive and represent a significant portion of household expenditure. the procedure of revenue return will, however, have important trade-balance effects. 6.3 the effect on south africa�s competitiveness the simulation results indicate that the policy proposals have significant termsof-trade effects, which influence south africa�s export performance. because the tax on coal results in a decrease in the price of the fixed factors of production, a policy that does not return the revenue to the economy would actually have a positive effect on south africa�s exports, as the price of exports falls. the fall in the price of exports can be contributed to two factors. the first is the fact that the tax on coal is not directly raised on the export product, but on the intermediate use of coal. although the intermediate tax could raise the export price, its inflationary effect on export prices is less severe than it would be if the tax were directly levied on exports. the second is that the significant fall in the price of the fixed factors of production offsets the inflationary effects of the tax increase. it seems as if south africa�s biggest export products are intensive in the use of unskilled labour and the use of land. however, if the tax revenue is returned to the economy in order to obtain some welfare effects, the decline in the price of the fixed factors of production is not pronounced, and the price of exports increase. because of this, aggregate exports will decrease. the simulation results indicate that lump-sum transfers to households have more severe effects on the competitiveness of the south africa economy than a reduction in the taxes of food and agricultural products. reasons for this are that the lump-sum transfer to the lower income households results in an increase in the demand for products which is relatively capital, land and skilled labour intensive. the increases in the demand for these factors result sajems ns 6 (2003) no 3 490 in an increase the prices of the factors of production that is used in the industries that produce these products. 7 the effect on employment the results of the first two policy simulations indicate that the policy proposals will have a negative effect on employment of the unskilled and the informalsector labour in south africa. the negative effect on employment is especially pronounced in simulation 2. this is the result of the big increase in the terms of trade in simulation 2, which results in a significant fall in exports. the simulation results indicate that a policy proposal that reduces the cost of food and agricultural products will have a positive effect on employment (unskilled and informal-sector labour) because these industries are primarily labour intensive. 8 conclusion our analysis indicates that an increase in the tax on coal will have positive, albeit marginal, environmental benefits for south africa. such a tax would, however, have negative consequences for the south african economy in the form of lower levels of employment, consumption and economic growth. although the analysis indicates that a revenue raising tax (that is not returned to the economy) could have a positive effect on south africa�s exports, it seems that a policy that returns the revenue to the economy could increase the prices of exports and decrease exports. it is therefore important that the revenue from such a tax be disbursed in a manner that will reduce the negative effects thereof. in conclusion, we therefore extend our analysis by testing two alternative simulations. firstly, we make use of the revenue that is raised by the tax on coal to institute a lump-sum transfer to households at the lower end of the income distribution and, secondly, to decrease the tax on food and agricultural products, which are both labour intensive and an important component of (lower-income) household budgets. we find that both these policy proposals have positive welfare effects. the policy proposal that targets the prices of food and agricultural products will also have a positive effect on employment and less of a negative effect on south africa�s competitiveness and a positive effect on economic growth. the analysis focuses on the economic consequences of a tax on coal and does not investigate the administrative feasibility of the tax. although the sajems ns 6 (2003) no 3 491 introduction of a new tax would invariably result in some administrative costs we are of the opinion that the policy proposals should fall within the scope of the south african revenue service�s (sars�s) abilities to raise intermediate taxes in the economy. a lump-sum transfer to households should fall within sars�s ability to raise income taxes. references 1 adams, p.d. (2003) �interpretations of macroeconomic results from a cge model such as gtap,� paper presented at the 6th annual conference on global economic analysis. 2 capros, p., georgakopoulos, p., zografakis, s., proost, s., van regemorter, d., conrad, k., schmidt, t., michiels, e. (1995) �first results of a general equilibrium model (gem-e3) linking the eu-12 countries�, in environmental fiscal reform and unemployment, 3-52, kluwer: boston 3 dixon, p.b., parmeter, b.r., sutton, j., and vincent, d.p. (1980) orani: a multisectoral model of the australian economy, northholland, amsterdam. 4 ferguson, c.e. (1965) �time series production functions and technological progress in american manufacturing industry�, journal of political economy, 73: 135-47. 5 goulder, l. h. (1994) �environmental taxation and the �double dividend:� a reader�s guide�, working paper no. 4896, national bureau of economic research. 6 horridge, m. (2001) orani-g: �a generic single-country computable general equilibrium model�, edition prepared for the practical ge modeling course, june 2001. 7 international energy agency (2001) key world energy statistics. 8 intrilligator, m.d. (1978) econometric models, techniques and applications, north-holland, amsterdam. 9 kapuscinsky, c. & war, p. (1996) �estimation of armington elasticities: an application to the phillipines�, department of economics: working paper no 968, the australian national university. 10 kingdon, g. & knight, j. (2001) �unemployment and wages in south africa: a spatial approach�, centre for the study of african economies, department of economics: oxford. 11 national state of the environment report � south africa, 2003, �climatic and atmospheric change�, national state of the environment report. sajems ns 6 (2003) no 3 492 12 reinert, k. & roland-holst, p. (1992) �armington elasticities for united states manufacturing sectors, journal of policy modelling, 145(5): 631-39. sajems ns 6 (2003) no 3 493 appendix 1 breakdown of database used in the analysis 1.1 the different types of industries and products of the model industry abbreviation industry abbreviation agriculture, forestry and fishing agric metal products, excluding machinery metprod coal mining coal machinery and equipment macheq gold and uranium ore mining gold electrical machinery elecmach other mining othmin television, radio and telecommunications equipment telv food food professional and scientific equipment profeq beverages bev motor vehicles, parts and accessories motveh tobacco tob other transport equipment othtrnsp textiles text furniture furn wearing apparel wear other industries othind leather and leather products leath electricity elect footwear foot water supply watsup wood and wood products wood building and construction buildcnst paper and paper products paper civil engineering and other construction civil printing, publishing and recording media print wholesale and retail trade whsale coke and refined petroleum products coke catering and accommodation services catacc basic chemicals baschem transport and storage transpstor other chemicals and man-made fibres othchem communication com rubber products rubprod finance and insurance finins plastic products plastprod business services busserv glass and glass products glass medical, dental and other health services meddent non-metallic minerals nonmetmin other community services othcomserv basic iron and steel industries basirst other producers othprod basic non-ferrous metals basnfer appendix 2 sajems ns 6 (2003) no 3 494 2.1 elasticity of substitution between capital and labour in the south african economy industry elasticity of substitution industry elasticity of substitution agric 0.74 metprod 0.91 coal 0.38 macheq 0.77 gold 0.42 elecmach 0.66 othmin 0.29 telv 0.83 food 0.34 profeq 0.77 bev 0.28 motveh 0.66 tob 0.66 othtrnsp 0.91 text 0.66 furn 0.58 wear 0.78 othind 0.66 leath 1.02 elect 0.26 foot 0.81 watsup 0.173 wood 0.38 buildcnst 1.05 paper 0.36 civil 0.91 print 0.61 whsale 0.74 coke 0.28 catacc 0.5 baschem 0.83 transpstor 0.66 othchem 0.27 com 1.45 rubprod 0.85 finins 0.34 plastprod 0.73 busserv 0.29 glass 0.72 meddent 0.35 nonmetmin 0.69 othcomserv 0.66 basirst 1.01 othprod 0.66 basnfer 0.81 source: own calculations sajems ns 6 (2003) no 3 495 2.2 estimated armington elasticities product armington elasticity product armington elasticity agric 0.318 metprod 0.85 coal 1.423 macheq 1.07 gold no imports elecmach 0.94 othmin 0.94 telv 0.91 food 1.14 profeq 0.99 bev 0.68 motveh 0.71 tob 0.73 othtrnsp 1.37 text 1.24 furn 0.75 wear 0.68 othind 0.43 leath 1.83 elect 0.94 foot 0.94 watsup no imports wood 0.37 buildcnst 1.57 paper 1.37 civil 2.84 print 0.42 whsale 0.94 coke 0.47 catacc 0.94 baschem 0.56 transpstor 1.17 othchem 0.71 com 0.94 rubprod 1.00 finins 0.94 plastprod 0.94 busserv 0.98 glass 0.35 meddent 1.05 nonmetmin 0.94 othcomserv 0.58 basirst 0.94 othprod 0.65 basnfer 0.94 source: own calculations sajems ns 6 (2003) no 3 496 2.3 household expenditure elasticities for the household consumption commodities distinguished within the model product expenditure elasticity product expenditure elasticity agric 0.99 metprod 0.86 coal 1.72 macheq 0.72 gold 0 elecmach 0.03 othmin 0 telv 2.24 food 0.96 profeq 1.2 bev 1 motveh 1.2 tob 0.05 othtrnsp 1.41 text 0.43 furn 1.85 wear 0.25 othind 0.19 leath 0.89 elect 0.89 foot 0.89 watsup 0.62 wood 0.65 buildcnst 0 paper 1.11 civil 0 print 0.75 whsale 0.81 coke 1.62 catacc 0.9 baschem 1.69 transpstor 1.68 othchem 1.17 com 2.31 rubprod 0.35 finins 1.84 plastprod 0.71 busserv 1.28 glass 0.83 meddent 1.83 nonmetmin 0.89 othcomserv 0.72 basirst 0 othprod 0.72 basnfer 0 source: own calculations sajems ns 6 (2003) no 3 497 appendix 3 a stylised macro model useful for analysing results from a cge model such as gtap levels equations ))1(), 1 ,( ))1(), 1 ,( )( )( 1 })({ 1 )1( )( )( )( ),( ),( )( t tot rorfrp t tot rwfrp rprp rp rp f l k totfp p pxf tot tpp p p rer ror ror g k i yrerfx reryfm g c ypcp yyy klfy mxgicy k l kl rpk rpl s k s l k l kl pgdp mp gdp c wtot fc gdp mp gdp w mp gdp reqi wx mp m fcfc gdp c taxfcmp y fc mp += += = = = × = += = = ×−= = γ= ω×= += = −+++= − φ source: (adams, 2003) (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13) (14) (15) (16) journal 8.indd 222 sajems ns 13 (2010) no 2 a more subtle set of information in corporate annual reports for disadvantaged stakeholders christo j cronjé school of accounting sciences, university of south africa accepted february 2010 abstract the traditional corporate annual report consists of two types of disclosures, that is, mandatory and contextual disclosures. the research problem focuses on the issue whether full disclosure in corporate annual reports could entail mandatory and contextual disclosures as well as a more subtle set of information for disadvantaged stakeholders. to solve the research problem, use was mainly made of a literature review dealing with certain aspects of decision-useful financial reporting. the literature review was complemented by exploratory empirical research. it was found that full disclosure in corporate annual reports could consist of mandatory and contextual disclosures as well as a more subtle set of information for disadvantaged stakeholders. key words: corporate annual reports, information needs of disadvantaged stakeholders, financial decision making jel m14 1 introduction this article indicates that full disclosure in corporate annual reports entails both mandatory and discretionary disclosures (gouws & cronjé, 2008; stanton & stanton 2002: 479) as well as disclosures to enable or empower disadvantaged stakeholders with ‘limited authority, ability, or resources’ (objective no. 2 in aicpa, 1973). hence disclosures for a new stakeholder group emerge. information contained in our thoughts may be surveyed by a higher level of mental activity from which a more subtle level of information may emerge (bohm & hiley, 1993: 385). this perspective shows that the original sets of information in corporate annual reports can be organised into a greater whole. hence the information in corporate annual reports can be contextualised for the decision needs of disadvantaged stakeholders with limited authority, ability or resources in order to make the information more meaningful. in the process, other stakeholder groups could also benefit. corporate annual reports of entities produce two main types of information (cronjé, 2008). the first type is mandatory information created by accounting practices such as international financial reporting standards (ifrss), international accounting standards (iass) and jse ltd regulations. the second type of information disclosed is contextual information created by contextual accounting practices. examples of contextual information are disclosure of environmental and social elements (iod, 2009), disclosure of risks and strategies and disclosure of forward-looking information (iasb, 2009:10; gouws & cronjé, 2008). the mandatory required information, such as the statement of financial position and notes, the statement of comprehensive income and notes and the statement of changes in equity and notes, in corporate annual reports, is contextualised by the contextual (sometimes referred to as voluntary or discretionary) disclosures (gouws sajems ns 13 (2010) no 2 223 & cronjé, 2008). however, these contextual disclosures can still be expanded to cater for the disclosure requirements of disadvantaged stakeholders who include uninformed users with limited authority, ability or resources, resulting in economic inequalities. 2 research problem the research problem focuses on the issue whether full disclosure in corporate annual reports could entail mandatory and contextual disclosures as well as a more subtle set of information for disadvantaged stakeholders. in order to achieve this, this article will investigate certain aspects of decision-useful financial reporting, using mainly a review of current literature. the article will also be complemented by exploratory empirical research. exploratory studies might have certain limitations, for example, they may not guarantee representativeness. it was decided to elicit the viewpoints of the preparers of corporate annual reports regarding certain aspects of disclosures in corporate annual reports. a questionnaire was sent to listed companies, obtained on excel from the jse ltd on 23 november 2006. 3 research method 3.1 the literature review the research is based mainly on a literature review dealing with the concept of the information needs of users in general. to ensure that reliable sources were incorporated, and as part of the inclusion criteria, use was made of south african journals, international journals, relevant books, articles, theses and dissertations. the reference lists of books and articles were used as a source for additional books and articles to be consulted. to find relevant articles, searches were mostly conducted via the electronic library (oasis) of the university of south africa (unisa). both manual and electronic searches were conducted, and primary and secondary sources were utilised. the following words were used for electronic sources: ‘corporate annual reports’, ‘information needs’ and ‘financial decision making’. 3.2 the questionnaire the literature review was complemented by empirical research in which a questionnaire for the preparers of corporate annual reports was sent to listed companies, using an excel spreadsheet of listed groups of companies that was received via email from the jse ltd (dated 23 november 2006). a total of 45 responses were received, which equates to a response rate of 16.5 per cent. the questionnaires were sent via email. the purpose of the study was explained on the cover page and the questionnaire set out on the next page. the following sequence of events was used to prepare, send and analyse the responses to the questionnaires: the statements in the questionnaire were evaluated on a five-point agreement likert scale rating. the respondents were requested to indicate on a scale rating (s/d: strongly disagree; d: disagree; u: unsure; a: agree; s/a: strongly agree) to what extent they disagreed/agreed with each statement. the theme of the statements centred around the concept of financial decision making for the users of information in corporate annual reports. the populations of the preparers of corporate annual reports were defined in terms of electronic mailing lists. returned electronic responses/ questionnaires constituted convenience sampling. the database for preparers contains the email addresses of 357 groups of companies. a generic message was compiled to direct the mail to the financial director of a company. electronically returned questionnaire responses represented conveniently sampled preparers of corporate annual reports. table 1 provides a summary of the preparer responses. thirty potential respondents out of a total population of 357 had no email addresses. forty-five emails bounced back because the email addresses, as per the email list, did not exist. ten companies indicated that they were unable to respond for various reasons (e.g. that they did not have the time or the resources to complete the questionnaire, or that it was not their policy to participate). hence 272 responses could be expected. 224 sajems ns 13 (2010) no 2 table 1: summary of preparer responses total population 357 less: number of potential respondents with no email addresses on the jse list (30) emails that bounced back (45) companies not prepared to respond (10) anticipated number of responses 272 a total of 45 responses were received, which equates to a response rate of (45/272) or 16.5 per cent. the low response rate may not guarantee representativeness. 4 literature review there is a demand for accounting information because individuals wish to improve their investment decisions (iasb/fasb, 2008: 3; may & sundem, 1976: 763; hooks & van staden, 2004: 47) as well as their decisions regarding the allocation of scarce resources (iasb/fasb, 2008: 3). an objective of financial reporting is to provide decision-useful information (iasb/fasb, 2008: 3; stainbank & peebles, 2006: 69: hooks & van staden 2004: 46). the usefulness of information disclosed in corporate annual reports would be improved if it could benefit all users, including disadvantaged stakeholders in their financial decision making. users need decision-useful information in order to interpret and make decisions about, inter alia, the growth opportunities of entities and the allocation of scarce resources. the financial statements required in terms of the statutes as well as the discretionary/contextualised disclosures in corporate annual reports form the basis of this information, and it could be argued that the decision-usefulness paradigm (relating to all disclosures in corporate annual reports, including contextual disclosures) encompasses the accountability paradigm (relating to only the financial statements required in terms of the statutes) (gouws, 1997: 66 & 68). the contextualisation of information in corporate annual reports would act as a guide for the disadvantaged stakeholders in their financial decision making. as a future-oriented concept, ‘usefulness’ seems to point to having meaning and insight into things that may be enjoyed and be of value to future users. it therefore governs the future behaviour of users. the following aspects of decision-useful financial reporting are covered in the literature review: heterogeneous users; the credibility of mandatory disclosures; the credibility of discretionary disclosures; materiality; forwardlooking information; the average layperson; feedback from users; timeliness; management commentary; and the communication of accounting concepts. 4.1 heterogeneous users the decision makers involved in corporate annual reports are the various stakeholders. as far as statutory disclosures in corporate annual reports are concerned, the user groups are identified as present and potential equity investors, lenders and other creditors in making decisions in their capacity as capital providers (iasb/fasb, 2008). information that is decision-useful to capital providers may also be useful to other users of financial reporting who are not capital providers (iasb/fasb, 2008: 1). as far as the contextual disclosures in corporate annual reports are concerned, the user groups also include, say, employees, lenders, customers, environmentalists and the public. users have become heterogeneous (cronjé, 2008: 236) and could include disadvantaged stakeholders who need to be empowered and informed. 4.2 the credibility of mandatory disclosures whether users consider the information in corporate annual reports to be credible sajems ns 13 (2010) no 2 225 will depend heavily on their view of the trustworthiness of the entity’s management and auditors, and on the relevance of the information and the degree to which it faithfully represents the underlying economic phenomena (iasb/ fasb, 2008: 33). for financial information to be useful, it must possess two fundamental qualitative characteristics – relevance and faithful representation (iasb/fasb, 2008: 17). information is relevant if it is capable of making a difference in the decisions made by capital providers. the information has to have predictive or confirmatory value, or both (iasb/fasb, 2008: 17). verifiability is a quality of information that helps assure users that the information concerned faithfully represents the economic phenomena it purports to represent (iasb/fasb, 2008: 20). the statutory disclosures in corporate annual reports are relevant and verifiable because they are disclosed in accordance with the requirements of ifrss and iass and audited. the verifiability of contextual disclosures is more complex because some of these disclosures such as intellectual capital are not measurable. although the verifiability of contextual disclosures is more complicated, they do fulfil a vital role in empowering and informing disadvantaged stakeholders in their decision making. 4.3 the credibility of contextual disclosures birken, edwards and woodland (2005: 193) refer to new tools and techniques of accounting that look outside the traditional boundaries of accounting, and which could form part of the contextual disclosures, for example, strategic management accounting (kaizen, balanced scorecard and value chain analysis), corporate responsibility and ethical investments. the degree of credibility of contextual/discretionary disclosures in corporate annual reports is lower than that of the statutory disclosures (cronjé, 2008: 208 & 223) because they are only subjected to assurance reviews. however, these disclosures are of critical importance to disadvantaged stakeholders to guide them in their decision making and will better address their decisions than statutory disclosures only. 4.4 materiality information is material if its omission or misstatement could influence the decisions that users make on the basis of an entity’s financial information (iasb/fasb, 2008: 22). hence corporate annual reports need to represent in all material respects all the information necessary for users to make proper decisions. according to fasb (1980), in belkaoui (2004: 187), the characteristic used for the recognition of transactions and events is materiality. events and transactions must therefore be material before they will be recognised. this characteristic applicable to the disclosure of statutory information as immaterial information will not necessarily be useful to decision makers. with regard to contextual disclosures, all information that will inform the disadvantaged stakeholders is important (cronjé, 2008: 43). from the above discussion it is clear that the attributes of statutory disclosures and contextual disclosures differ and meet the characteristics of the decision-useful approach to varying degrees. although different in nature, the disclosures complement each other and give rise to full disclosure in corporate annual reports. contextual disclosures can specifically be utilised to facilitate the decision-making needs of disadvantaged stakeholders. 4.5 forward-looking information t h e d i s c u s s i o n p a p e r o n m a n a g e m e n t commentary (mc) calls for information with an orientation towards the future, referred to as forward-looking information (iasb, 2009: 10). preparers of corporate annual reports could therefore make use of the discretionary/ contextual section to report on this forwardlooking information, but need to take care not to speculate about future events and to report only on known future developments. while forwardlooking information is common in statutory disclosures in corporate annual reports, it appears more frequently as part of discretionary disclosures in corporate annual reports. forward-looking information provides users of corporate annual reports with a sound basis on which to construct models for predicting future performance (ebr 360, 2004: 4). an abundance 226 sajems ns 13 (2010) no 2 of information could still be disclosed in the corporate annual reports of entities. according to beattie, mcinnes and fearnley (2002: 43), a comprehensive business reporting package should be developed (corporate annual reports could represent this comprehensive reporting package) to include an analysis by management of past performance (statutory disclosures and discretionary disclosures could provide this), as well as forward-looking information (discretionary disclosures). information that would enable disadvantaged stakeholders to predict future performance would be most valuable. it is acknowledged that it would be difficult to express an audit opinion on this type of information. 4.6 the average layperson to really understand information, disadvantaged stakeholders need to consult the contextual and mandatory disclosures in corporate annual reports. corporate annual reports are not intended for the average layperson (gouws & cronjé, 2001: 170). disadvantaged stakeholders would probably not have the knowledge of the rules used in the preparation of disclosures in corporate annual reports and it would therefore be necessary to utilise quality contextual disclosures to bridge this gap to make disclosures meaningful for the stakeholders’ decision making. disadvantaged stakeholders would also have to make use of facilitators to guide them with relevant data. this would help them to grasp the big picture of an entity. 4.7 feedback from users fo r e n t i t i e s t o p r o v i d e d e c i s i o n u s e f u l information, it would be necessary to obtain feedback from users via proper feedback systems, or users should negotiate with entities (aicpa 1994: 9) to give an indication of what types of information they need to disclose in corporate annual reports. to enhance corporate reporting, users should ideally give feedback, say, by completing questionnaires (that could be included in the corporate annual reports distributed to stakeholders) to indicate the type of decision-useful information they need. where there is no opportunity to provide feedback, the usefulness of annual reports is in question (clatworthy & jones, 1999: 43). it is essential to have an in-depth look at the primary driving force of disclosures in corporate annual reports. statutory disclosures in corporate annual reports are driven by mandatory accounting practices, while contextual disclosures are a response to the feedback and needs of users for more contextual information. corporate annual reports should provide for feedback from users. no opportunity currently exists for the disadvantaged stakeholders to provide feedback on the disclosures in corporate annual reports. hence it would be necessary for the preparers of corporate annual reports to conduct research in order to disclose the required contextual information for their decision-making needs. the preparers need to perform research and negotiate with disadvantaged stakeholders on the types of information to be communicated because having the big picture depends on people deciding that they have the full picture (hines, 1988: 253). the contextual section of the corporate annual report could be used to disclose this agreed-upon information. 4.8 timeliness timeliness means having information available to decision makers before it loses its capacity to influence decisions (iasb/fasb, 2008: 21). information not presented timeously loses its capacity to be relevant and to influence the decision-making process. furthermore, providing information too quickly to users could result in a loss of faithful representation (iasb, 2008: 16). ‘extensible business reporting language’ (xbrl) real-time business reporting is a probable solution to addressing timeliness. xbrl provides real-time business reporting, inter alia, through the internet, which is instantly available for analysis. it involves tagging each individual item of data instead of treating information as a block of text. in the usa, companies are faced with extensive costs, inter alia, of complying with the requirements of the sarbanes-oxley act (sox) regarding corporate governance and transparency. these companies could in future focus on xbrl and the common platform it provides for business information. sajems ns 13 (2010) no 2 227 xbrl is set to become the standard way of recording, storing and transmitting business financial and discretionary information (oecd, 2006: 18). the qualitative benefits of corporate reporting should justify the costs (iasb/fasb, 2008: 22) o f e x t r a c t i n g t h e i n f o r m a t i o n , b u t f o r disadvantaged stakeholders, this would be impossible to access. contextual disclosures of the corporate annual report could be prepared more timeously than mandatory disclosures. cronjé (2008: 125) argues that the reason for this is that mandatory disclosures must first be audited. however, to meet the requirements of the timeliness characteristic of decision usefulness, all disclosures in corporate annual reports need to be available as soon as possible. for the benefit of disadvantaged stakeholders, contextual disclosures could be disclosed on a more regular basis, and not only annually. 4.9 management commentary management commentary (mc) provides a context in which to interpret an entity’s financial position, financial performance and cash flows. it also provides an opportunity to understand management’s objectives and its strategies for achieving those objectives (iasb, 2009: 4). mc encompasses reporting that is described in various jurisdictions as management’s discussion and analysis (md&a), operating and financial review (ofr) or management’s report (iasb, 2009: 7). the commentary to be given in the mc (iasb, 2009:9) • provides management’s view of the entity’s performance, position and development • s u p p l e m e n t s a n d c o m p l e m e n t s t h e information presented in the financial statements • has an orientation to the future table 2 below relates the five content elements to the needs of capital providers when using management commentary to assess an entity’s performance and make financial decisions. table 2: content elements of a decision-useful management commentary content elements user needs nature of the business the knowledge of the business in which an entity is engaged and the external environment in which it operates. objectives and strategies to access the strategies adopted by the entity and the likelihood that those strategies will be successful in meeting management’s stated objectives. resources, risks and relationships a basis for determining the resources available to the entity as well as obligations to transfer resources to others; the ability of the entity to generate long-term, sustainable net inflows of resources; and the risks to which those resources-generating activities are exposed, both in the near term and in the long term. results and prospects the ability to understand whether an entity has delivered results in line with expectations and, implicitly, how well management has understood the entity’s market, executed its strategy and managed the entity’s resources, risks and relationships. performance measures and indicators the ability to focus on the critical performance measures and indicators that management uses to assess and manage the entity’s performance against stated objectives and strategies. source: iasb (2009:30-31) 228 sajems ns 13 (2010) no 2 the mc is intended for use by an entity’s existing and potential capital providers (iasb 2009: 8). management commentary will, however, also play major roles in informing disadvantaged stakeholders because it describes the context in which an entity operates and will be more understandable to the disadvantaged stakeholders than only statutory disclosures. 4.10 communication of accounting concepts according to belkaoui (1995: 41), the level of readability of accounting disclosures is troublesome. the variety and diversity of disadvantaged stakeholders with differences in culture, beliefs, education, perceptions, behaviour and so forth, complicates the task of preparers in providing information in corporate annual reports that will address their needs. a contextual dimension for disadvantaged stakeholders has to be added to corporate annual reports to make them more understandable for them. the following aspects of accounting and corporate annual reports are discussed to demonstrate how they contribute to the communication of accounting concepts: the facilitation process of accounting; corporate annual reports as a necessary ingredient in decision making and the role of accounting in the enablement of disadvantaged stakeholders. 4.10.1 the facilitation process of accounting figure 1 illustrates the way in which accounting facilitates the process of financial decision making. it shows that accounting practices are the generators of accounting information, which is disclosed in corporate annual reports and which could be used to inform disadvantaged stakeholders. figure 1: the facilitation process of accounting accounting practices as generators of accounting information corporate annual reports the disadvantaged stakeholders’ needs for information source: adapted from cronjé (2008:128) accounting facilitates the process of financial decision making, because accounting practices as generators of accounting information react to the needs of users. since one only observes the outcomes of accounting practices, the practices themselves are not so readily visible. the generators of the statutory information to be disclosed in corporate annual reports are the mandatory accounting practices, accounting postulates, assumptions, rules and praxes. the generators of the contextual information are the contextual accounting practices. the information product disclosed in corporate annual reports appears as a visible phenomenon. sajems ns 13 (2010) no 2 229 users’ needs influence the type of information to be disclosed in corporate annual reports. the needs of the disadvantaged stakeholders need to be researched in order to cater for their financial decision making. the accounting practices involved in producing this information are not important for the users (including the disadvantaged stakeholders), but the information product generated by these accounting practices is. this entire process is facilitated by accounting. unfortunately, certain problems are experienced in the understanding of accounting disclosures. according to belkaoui (1995: 41), the level of readability of accounting messages is troublesome and the level of understandability of the meaning of accounting imperfect. the reason for this is that the statutory disclosures in corporate annual reports are driven by mandatory accounting practices such as ifrss and iass, which because of their technicality, have little or no meaning for disadvantaged stakeholders. these disclosures need to be complemented by contextual disclosures (iasb, 2009: 4) and could increase the level of understandability and meaning for disadvantaged stakeholders. the readability of contextual disclosures is less problematic, because the accounting messages can be explained more freely. these disclosures react to the feedback received from different stakeholders and appear, for example, in the form of ratios, graphs and common words and also in narrative and explanatory form (iasb, 2009: 10), which make them more user friendly than statutory disclosures. in order to cater for the information needs of the disadvantaged stakeholders, more use should be made of the contextual disclosures in corporate annual reports. 4.10.2 corporate annual reports as a necessary ingredient in decision making corporate annual reports disclose two types of information, namely mandatory and contextual information. traditionally, the financial statements (mandatory information) at the top of every analyst’s list (knutson, 1993: 16) have shown and are still showing outcomes only focusing entirely on the output of a system. mandatory information seldom informs users on how the results were accomplished. according to gouws and lucouw (1999: 105), in the interpretation process it is necessary to disclose information about the various inputs and processes of the accounting and financial information presented because these will give an indication of the changes in forces, processes and capabilities that determine the numbers (outputs). such disclosures, as currently required by the disclosure of management commentary (mc) (iasb, 2009), would give disadvantaged stakeholders a better understanding of the business of entities. the contextual section in corporate annual reports could be used to disclose more useful information about the inputs and processes that have produced outputs. corporate annual reporting is only an instrument in decision making if users utilise both sources of information, that is, both the statutory and discretionary disclosures of corporate annual reports. the mandatory information per se cannot provide all the information that would be useful to disadvantaged stakeholders because it only reports events and transactions that are measurable in accordance with the requirements of statutory accounting practices. the contextual disclosures fill the gap mandatory disclosures cannot provide (e.g. they report on intellectual capital, which is difficult to measure) in order to reflect the full picture. research evidence suggests that discretionary narrative disclosures in annual reports are of great importance even for skilled users such as financial analysts, who are among the prime users of financial accounting information (smith & taffler, 2000: 624). these contextual narrative disclosures will also be vital in empowering disadvantaged stakeholders with their information needs for decision making. 4.10.3 the role of accounting in the enablement of disadvantaged stakeholders entities in the modern age could adopt a culture of knowledge sharing (von krogh, ichijo & nonaka, 2000: 262). as such the enablement of the disadvantaged stakeholders is of critical importance. this is confirmed by cuganesan, gibson and petty (1997:433) who maintain that accounting has the potential to serve as an emancipator for the benefit of those people who 230 sajems ns 13 (2010) no 2 are presently or potentially colonised, excluded, rendered invisible or exploited by the presently unchallenged operation of ‘mainstream’ accounting. the preparers of corporate annual reports need to emancipate disadvantaged stakeholders by delivering contextual disclosures for them. mandatory disclosures only will not suffice. because intelligence must be broadly distributed (wheatley, 1999: 110), full disclosure in corporate annual reports is necessary. full disclosure encompasses statutory disclosures, discretionary/contextual disclosures and disclosures to enable/empower those with ‘limited authority, ability, or resources’ (objective no. 2 in trueblood (aicpa 1973); wolk, tearney & dodd, 2000: 184). one of the major roles that corporate annual reports have to play is the enablement and empowerment of disadvantaged stakeholders. users need contextualised information from the corporate annual report for their specific financial decisions. according to wolk et al. (2000: 318), the great complexity of business and financial and operating events means that financial statements have to be supplemented with an increasing array of disclosures. the disclosures in corporate annual reports can thus be contextualised for disadvantaged stakeholders in an effort to cater for their information needs in decision making. the next section deals with the research findings of the questionnaires sent to preparers of corporate annual reports. in certain instances in the interpretation process, the categories ‘strongly disagree’ and ‘disagree’ as well as the categories ‘agree’ and ‘strongly agree’ were aggregated. 5 research findings from the questionnaire the research findings from the questionnaire are summarised in table 2 below and cover the responses of preparers of corporate annual reports. table 2: responses of preparers of corporate annual reports (n=45) rating scale: percentage strongly disagree disagree unsure agree strongly agree total statement 1: the objective of business reporting in corporate annual reports has moved away from a narrow approach of accountability to a much wider portrayal by providing information to heterogeneous users for decision-making purposes. 2.2 4.5 8.9 64.4 20.0 100.0 statement 2: it is my view that corporate annual reports provide credible statutory information. 0.0 4.5 0.0 73.3 22.2 100.0 statement 3: it is my view that corporate annual reports provide credible discretionary information. 0.0 8.9 6.7 77.8 6.6 100.0 statement 4: the main objective of corporate annual reports is to represent in all material respects all the information that is necessary for users to make proper decisions. 2.3 4.4 4.4 68.9 20.0 100.0 sajems ns 13 (2010) no 2 231 statement 5: corporate annual reports provide users with enough information about future benefits for their decision making. 11.1 26.7 26.7 26.7 8.8 100.0 statement 6: corporate annual reports are not intended for the average layperson. 2.2 40.0 2.2 35.6 20.0 100.0 statement 7: corporate annual reports must also provide for feedback from users. 11.1 28.9 6.7 48.9 4.4 100.0 statement 8: it would be useful if financial reporting could also be done in digital form making use of ‘extensible business reporting language’ (xbrl). 2.2 11.1 40.0 40.0 6.7 100.0 statement 9: an operating and financial review (ofr), which captures the whole story of entities’ performance and prospects through the eyes of management, should be incorporated in corporate annual reports. 0.0 0.0 2.2 51.1 46.7 100.0 statement 10: to communicate accounting concepts is a difficult task. 0.0 24.4 6.7 53.3 15.6 100.0 5.1 heterogeneous users aggregation of the ‘agree’ and ‘strongly agree’ categories of statement 1 indicates that the majority (84.4 per cent) of the respondents agreed that the disclosure of information in corporate annual reports has moved away from an accountability paradigm to a paradigm in which the needs of heterogeneous users for decisionmaking purposes are eminent. heterogeneous users would include disadvantaged stakeholders. statutory disclosures mostly contain attributes of the accountability paradigm, while discretionary (contextual) disclosures generally contain attributes of the decision-usefulness paradigm. preparers agree that corporate annual reports exist for decision-making purposes. 5.2 the credibility of mandatory disclosures statement 2 illustrates that the majority of respondents agreed with this statement. of the respondents, 73.3 per cent agreed (while 22.2 per cent strongly agreed) that corporate annual reports provide credible statutory information. statutory disclosures are more reliable and verifiable than contextual disclosures. contextual disclosures that may be more relevant than reliable will play a vital role in empowering and informing disadvantaged stakeholders in their decision making. 5.3 the credibility of contextual disclosures the level of assurance from the research results (statement 3) was lower than that from statutory information (statement 2). statement 3 shows that 8.9 per cent of the respondents felt that the discretionary information of corporate annual reports is not at all credible compared to 4.5 per cent of the respondents as per statement 2, who indicated that the statutory information in corporate annual reports is not credible. furthermore, only 6.6 per cent of the respondents strongly agreed that discretionary information is credible compared to 22.2 per cent who strongly agreed that statutory information is credible. the level of assurance in respect of discretionary disclosures is therefore lower than that for statutory disclosures. one respondent 232 sajems ns 13 (2010) no 2 commented that ‘the external auditors need to play a role in the verification of the discretionary information and need to play a bigger role by sitting in on management and board meetings’. the level of assurance for discretionary disclosures, however, was high (84.4 per cent of respondents agreed and strongly agreed) and one could therefore conclude that the discretionary disclosures of corporate annual reports are credible and contribute to disadvantaged stakeholders’ information needs. 5.4 materiality statement 4 shows that 88.9 per cent of the respondents agreed that corporate annual reports need to reflect in all material respects all the information for decision-making purposes. preparers agreed that corporate annual reports should represent information that is necessary for users to make proper decisions. materiality plays a key role as far as statutory disclosures in corporate annual reports are concerned. all information is important for contextual disclosures. immaterial information that informs the disadvantaged stakeholders is meaningful. 5.5 forward-looking information regarding statement 5, the respondents indicated a variety of opinions. the variety of opinions did not give a clear-cut indication about whether corporate annual reports provide users with enough information on future benefits for their decision making. however, the majority (37.8 per cent) disagreed, and one could therefore conclude that there is not enough information in corporate annual reports about future benefits for decision making. forward-looking information relating to future benefits remains a key issue. discretionary (contextual) disclosures should include forward-looking information relating to future benefits for disadvantaged stakeholders, say, as part of the management commentary (mc). corporate annual reports should provide decision-useful information that could enable disadvantaged stakeholders with information to predict future prospects. to enable disadvantaged stakeholders to make predictions, forward-looking information should form part of contextual disclosures. 5.6 the average layperson users must play an active role in extracting the information they need. the majority of respondents (55.6 per cent) agreed with statement 6. although corporate annual reports are knowledge-sharing documents, users (disadvantaged stakeholders) need to develop some skill in extracting the information they require because corporate annual reports are not for the average layperson. alternatively, a facilitator could be used to provide disadvantaged stakeholders with the relevant information. 5.7 feedback from users the majority (53.3 per cent) of respondents were in favour of the idea that corporate annual reports must also provide for feedback from users. currently, there are virtually no processes in place to take care of feedback from users, particularly disadvantaged stakeholders. the feedback on the statutory disclosures needs to be channelled back to the preparers of corporate annual reports, and ultimately to standard setters. feedback on the discretionary disclosures needs to be channelled back to the preparers of corporate annual reports and ultimately to bodies such as the global reporting initiative (gri) and the south african institute of chartered accountants (saica). preparers of corporate annual reports need to conduct research in order to disclose the required contextual information for the decision-making needs of disadvantaged stakeholders. 5.8 timeliness statement 8 shows that there is currently still great uncertainty about the usefulness of xbrl. of the respondents, 40 per cent were uncertain about the usefulness of xbrl, while 46.7 per cent were of the opinion that it is indeed useful. of the respondents, 40 per cent indicated that they were unsure whether xbrl would be useful. is this a reflection of the fact that they were unaware of xbrl, or a belief that the cost of implementation would outweigh its benefits? because financial and other business information needs to be available sooner and faster if companies wish to compete for capital sajems ns 13 (2010) no 2 233 and investor attention, the benefits of adopting xbrl should be clear. for the benefit of disadvantaged stakeholders, using xbrl, contextual disclosures could be disseminated on a timelier basis. 5.9 management commentary the results of statement 9 clearly indicate that most of the respondents were in favour of the ofr, which is the equivalent of the information disclosed in the mc. this could be introduced as part of the contextual disclosures of corporate annual reports as a separate section to be identified as the mc, and would definitely also be of assistance regarding the information needs of disadvantaged stakeholders. 5.10 communication of accounting concepts statement 10 shows that the majority of respondents were aware of this difficulty. one of the respondents added the comment: ‘especially with the introduction of ifrs’. the research results indicate that 68.9 per cent of the respondents were aware that the communication of accounting concepts is a difficult task. the communication of accounting concepts and numbers to disadvantaged stakeholders with different levels of understanding of accounting phenomena and different objectives remains a difficult task. the above research results as a whole show that preparers of corporate annual reports support the importance of distinguishing between statutory and contextual disclosures and the different roles they fulfil in providing decision-useful information to heterogeneous users. 6 conclusion the primary driving force in an information product like corporate annual reports is the users’ need for decision-useful information to optimise returns and reduce uncertainty. the corporate annual reports of companies therefore disclose two types of information. the first type is mandatory information (e.g. the statement of financial position and notes, the statement of comprehensive income and notes as well as the statement of changes in equity and notes). the second type is contextual information (e.g. the disclosure of environmental and social elements, disclosure of risks, strategies and forward-looking information). full disclosure in corporate annual reports includes disclosures that would enable/empower users with ‘limited authority, ability, or resources’ (objective no. 2 in aicpa, 1973). hence corporate annual reports should also address the information needs of disadvantaged stakeholders by producing a more subtle level of information. the contextual disclosures of corporate annual reports could be used to cater for the disclosure requirements of the disadvantaged stakeholders as well. the research problem focused on the issue whether the information in corporate annual reports is meant only for the informed or also for disadvantaged stakeholders. the article started with a literature review to investigate the needs of disadvantaged stakeholders for decision-making purposes, and the following factors were addressed: heterogeneous users; the credibility of mandatory disclosures; the credibility of contextual disclosures; materiality; forward-looking information; the average layperson; feedback from users; timeliness; management commentary; and the communication of accounting concepts, which included the facilitation process of accounting; corporate annual reports as a necessary ingredient in decision making; and the role of accounting in the enablement of disadvantaged stakeholders. for the purpose of an exploratory study it was decided to elicit the viewpoints of preparers of corporate annual reports by distributing questionnaires. the research results as a whole showed that preparers of corporate annual reports support the importance of distinguishing between statutory disclosures and contextual disclosures and the different roles they play in providing decision-useful information to heterogeneous users. the conclusion is that statutory disclosures are only a subset of the disclosures (gouws & cronjé, 2008: 118) that entities release and that the contextual disclosures could play a key 234 sajems ns 13 (2010) no 2 role in the empowerment of disadvantaged stakeholders. for entities to provide decisionuseful information, it is necessary to obtain feedback from disadvantaged stakeholders via proper feedback systems (e.g. questionnaires provided as part of corporate annual reports to be completed and returned by disadvantaged stakeholders), or users (including disadvantaged stakeholders) should negotiate with entities (aicpa, 1994: 9) to give an indication of what types of information should be disclosed in corporate annual reports. feedback could result in seismic shifts in the disclosures in corporate annual reports. it would be necessary to distinguish between the information required and nonessential information (aicpa, 1994: 11). nonessential information would only increase the cost of corporate annual reports to entities. decision-useful information should be limited to what is essential for decision making and should take the needs of the disadvantaged stakeholders into account. for future research, the responses of disadvantaged stakeholders should be obtained 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accepted: 14 nov. 2019; published: 21 apr. 2020 copyright: © 2020. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: despite the positive role of trust as a complex ‘glue’ that keeps the parties of an alliance together, it is unclear how trust dynamics may play out among black and white business partners and what such trust experiences may mean for black economic empowerment in south africa. aim: the study reflects on the prospects for black economic empowerment by exploring trust experiences of managers involved in business alliances between traditional companies and previously disadvantaged institutions. setting: the study focused on managers involved in these alliances in the province of gauteng in south africa. methods: twenty-five managers from mainstream companies (n = 7) and emerging companies (n = 18) were selected through purposive sampling. q-sorting was applied to trust-related items, with follow-up interviews. principal component factor analysis was used to analyse the q-sorted data to reveal the managers’ clustered perceptions about trust in business alliances. interview data were thematically analysed to place the findings from the factor structure analysis in context. findings: the managers shared six nuanced conceptions of trust. generally, the prospects for black economic empowerment appear greater in the groups characterised by integrity, revealing the centrality of honesty in these alliances. conclusion: exploring trust in black and white business alliances may help to disentangle the phenomenon of black economic empowerment in south africa. in a way, managers’ perceptions of trust may be used as a barometer for the functioning of these alliances because trust affects managerial behaviour and, ultimately, whether or not such alliances enhance the prospects for black economic empowerment. the study also offers new ways of thinking about and new ways of advancing theory and practice regarding black economic empowerment. keywords: trust; black economic empowerment; business alliances; traditional companies; previously disadvantaged institutions. introduction business organisations continue to be engrossed in alliances for a variety of reasons, which include obtaining access to new markets and technology, gaining access to resources outside their purview and acquiring business knowledge that lies outside their repertoire of skills (choi, garcia & friedrich 2010; grant & baden-fuller 2004; yang, lin & peng 2011). business alliances are supposed to enable the parties to achieve what they are unable to achieve individually (hamel & prahalad 1989; mccarter, mahoney & northcraft 2011; pucik 1988). unlike experiences in most countries of the world, south africa’s business alliances between white or traditional companies (tcs) and black or previously disadvantaged institutions (pdis) are neither purely voluntary nor driven purely by economic considerations (ahwireng-obeng & ogunjobi 2001). rather, they are largely the result of government suasion and legislation and are therefore meant to facilitate the transfer of business skills to pdis and thereby impact black economic empowerment in a desired manner (ahwireng-obeng & ogunjobi 2001). however, the extant research reveals that the foundation of business alliances is trust or the relationship between people who conceive, develop and maintain such alliances (sklavounos & hajidimitriou 2011). trust is viewed as a complex ‘glue’ that is required to keep two or more parties in an alliance together (tähtinen & blois 2012; zhang 2011). a lack of trust encumbers the partners from realising alliance goals. extensive research has been conducted on the pivotal role of trust as a bond that facilitates good alliance relationships. however, owing to the dearth of research on trust in business alliances between tcs and pdis, it is unclear how trust dynamics may play out and affect black economic empowerment in south africa, which has a history of institutionalised racism (burns 2011). background and context the context within which business alliances between tcs and pdis existed in south africa was characterised by degenerate and abysmal social relations between black and white people for decades (denton & vloeberghs 2003). prior to 1994, the apartheid government practised discrimination and conferred rights and privileges based on race, that is, white, coloured, indian and black. black people were at the bottom of the social strata (davies 2012; esman 1987; seekings & nattrass 2011). through an assortment of legislation as varied as the bantu education act 47 of 1953 (republic of south africa [rsa] 1953), the extension of university education act 45 of 1959 (rsa 1959), and the mines and works act 12 of 1911 (rsa 1911), black people were confined to the fringes of the national economy while white people had more privileges and opportunities (ihederu 2004; tangri & southall 2008). the restriction of blacks to categories of cheap and unskilled labour yielded an asymmetrical distribution of opportunities and ensured uneven business skills and capital among the different strata of the population (lowenberg & battacharya 2010; patel & graham 2012; van scheers 2010). in the post-1994 period, south africa has adopted a remarkable equity regime that promotes equality, prohibits unfair discrimination and affirms previously disadvantaged individuals. the equity regime is underpinned by section 9 of the constitution of the republic of south africa 1996 (rsa 1996a). a plethora of legislation, including the promotion of equality and prevention of unfair discrimination act 4 of 2000 (rsa 2000), the employment equity act 55 of 1998 (rsa 1998) and the commission on gender equality act 39 of 1996 (rsa 1996b), give effect to section 9 of the constitution. germane to economic empowerment is a variety of legislation that proscribes unfair discrimination and the exclusion of previously disadvantaged individuals, and actively encourages corporate south africa to increase its participation in the economy. the economic empowerment of previously disadvantaged individuals and pdis has now evolved into more sophisticated government suasion and legislation, which is exemplified by the broad-based black economic empowerment amendment act 46 of 2013 (rsa 2013). this act enables the black economic empowerment codes of good practice, in terms of which transformation sector charters are introduced and analysed for compliance. in, for example, the mining sector, the scorecard for the broad-based socio-economic empowerment charter for the mining and mineral industry (the mining charter) (rsa 2004) (and its subsequent revisions) endeavours to attain government’s objectives of redressing historical socio-economic inequalities and ensuring broad-based and meaningful participation of black persons and black-owned companies, that is, pdis, in the mining sector. trust as an essential ingredient in business alliances research on the success of business alliances has chronicled the significance of trust for alliance performance (silva, bradley & sousa 2012; stanley & mcdowell 2013). a lack of trust between partners of an alliance encumbers the realisation of alliance goals. trust is the willingness of a party (the trustor) to be vulnerable to the behaviour of another party (the trustee) based on the expectation that the trustee will not abuse that vulnerability, irrespective of the trustor’s ability to monitor or control the trustee (mayer, davis & schoorman 1995). to be regarded as trustworthy, the trustee has to be perceived as high in ability or competence, benevolence or consideration, integrity or openness and reliability (mayer et al. 1995; mishra 1996). perceived ability refers to the trustor’s belief that the trustee will perform as expected because they are competent. perceived benevolence or consideration relates to the trustor’s belief that the trustee cares about the trustor and will not harm the trustor’s interests, while perceived integrity refers to the trustor’s belief that the trustee is committed to a set of acceptable principles (mayer et al. 1995). trust in partners results in more lasting relationships than may otherwise have been the case and reduces the incidence of conflict (hernandez & dos santos 2010). as observed repeatedly by various scholars, organisations are more committed to each other when there is trust, and when there is more trust, they are more likely to commit to each other (harris & wicks 2010). trust promotes society’s economic and social development because it reduces the incidence of corporate misconduct such as managerial opportunistic behaviour (dong et al. 2018). managers’ opportunistic behaviour may be fuelled by the contradictions inherent in the notion of coopetition, which typifies many alliances where organisations in a partnership are direct competitors (wu 2014). under such conditions, organisations in alliances collaborate with each other in some business activities but simultaneously compete in others (dahl 2014; tidström 2014). opportunistic behaviour may also be fuelled by a fear of breeding one’s future competitors (hamel & prahalad 1989; stanley & mcdowell 2013). goal of the study owing to the dearth of research on trust in business alliances between tcs and pdis, it is unclear how trust dynamics may play out and affect black economic empowerment in south africa, which has a history of institutionalised racism. consequently, this study reflects on the prospects for black economic empowerment by exploring trust experiences of managers involved in business alliances between tcs and pdis. in this way, the study makes a novel and valuable contribution to knowledge regarding the field of organisational trust and provides new insights into the functioning of alliances in an economic empowerment setting. such valuable insights into trust experiences could lead to managers’ insightful understanding of the issues that facilitate or encumber trust and the implications of such experiences for black economic empowerment. in a way, managers may use perceptions of trust as a barometer for the functioning of alliances because trust affects managerial behaviour and, ultimately, whether or not such alliances enhance the prospects for black economic empowerment. method a qualitative and constructivist approach, referred to as q methodology, was adopted (stenner 2009). q methodology uses quantitative techniques such as correlation and factor analysis in order to study human subjectivity (goldman 1999). in the lexicon of q methodology, subjectivity is a person’s communication of their viewpoint (coogan & herrington 2011; mckeown & thomas 1988). therefore, q methodology is not about truths; rather, it is about the perceptions and opinions of persons who provide facts (brown 1980; stephenson 1993). ontologically, the study is premised on the view that the managers’ experiences of trust were relative and that there would be as many experiences as the people who expressed them. epistemologically, the assumption was that knowledge is something softer and subjective because it is based on personal and unique experiences (burrell 1999). the researchers interacted with the managers in order to collect the data because, epistemologically speaking, the requisite data lay within the experiences of the participants. consequently, trust in business alliances between tcs and pdis could be understood from the managers’ experiences (and not the viewpoints of the researchers), and the prospects for black economic empowerment could be conjectured from such experiences. sample and setting the study used a small sample of 25 business managers (n = 7 from tcs and n = 18 from pdis). female managers comprised 28% of the participants. q methodology is biased toward a small sample of participants because of its intensive orientation or endeavour to develop an in-depth understanding of phenomena under observation. such a small sample of participants has implications for the generalisability of the results. however, in q methodology, generalisation is concerned with the opinion clusters derived from the present study participants and not with the numerical distribution of the managers among factors. therefore, this study does not focus on the number of people who hold a particular viewpoint but on how and why the managers believe as they do. as brown (1980) states, generalisations in q methodology are best thought of: … in terms of specimen and type – i.e., we are prepared to say what it is that is of concern to specimen persons of the a type, the factor being a generalised abstraction (based on communalities) of a particular outlook or value orientation. (p. 67) the participants were recruited through snowball sampling with the help of the initial six contact managers known to the author. the managers were theoretically relevant to the issue under investigation and were not randomly selected. they were all part of alliances between tcs and pdis in the province of gauteng in south africa. data collection data were collected through q-sorting and post-q-sorting interviews. a q sample comprising 50 items on trust in business alliances between tcs and pdis was used to collect data. the 25 managers ranked the 50 items according to how strongly they disagreed (–5) to how strongly they agreed (+5) with each one. the items placed under (–5) and (+5) markers were assumed to hold greater significance to the q-sorter than items elsewhere in the q-sort. according to mckeown and thomas (1988), what is of greater importance to the respondent is not an artefact of what the researcher has already determined. it is only the q-sorters who determine, by ranking items in relation to others at the poles, those items that are of positive or negative significance to them. this also explains why the middle score (0) is not an average. instead, it is regarded as a point that is neutral in meaning and without significance to the q-sorter. to record the completed q-sorts, the item numbers were written on a score sheet, thus producing the q-sort distribution or template – see figure 1. figure 1: a distribution marker. the post-q-sorting interviews were meant to provide the managers with an opportunity to expound on their reasoning for the sorting of the 50 items and were audio-recorded and later transcribed. the emphasis was on the items ranked at the extremes, that is, (–5) and (+5). the experiences of the managers that emerged from this study are regarded as both subjective and operant (mckeown & thomas 1988). they are subjective because they represent the managers’ points of view and operant because they exist naturally within a particular context. a subjective operant is neither right nor wrong (brown 1980). data analysis principal component factor analysis was used to analyse the q-sort data. factor interpretation requires one to determine the factor scores – a process that involves the systematic examination of the items that define a factor (brown 1980). the factor scores, which refer to an average of the scores given to a particular statement by all the q-sorts defining a factor, helped in connecting the factors with the items that define a factor. as a rule, the factor scores that differ by two (2) are significant and of immediate interest because they distinguish one factor from the others (brown 1980). the distinguishing items are presented in table 1. table 1: factor scores for six clusters. the post-q sort qualitative data obtained from the interviews were thematically analysed according to the procedures proposed by braun and clark (2006). the data collected from the post-q-sorting interviews illuminated the managers’ q-sorts. if, for example, a manager rated an item such as ‘i feel that my alliance partner behaves in an honest manner towards my organisation’ (+5), the focus was on the reason for such a rating. ethical consideration the university of south africa’s ethics research committee granted ethical clearance for the study with clearance number: 2014/cems/iop/024. the researcher observed ethical requirements, which included informed consent, confidentiality, anonymity and the right to withdraw from the study at any stage. results and discussion the results reveal the intricacy of trust dynamics in a south african milieu, with reference to the country’s history of institutionalised racism. the 25 managers expressed their viewpoints, after which their experiences about trust in business alliances between tcs and pdis were classified into six nuanced clusters, labelled as follows: sincerity trust alliances, values trust alliances, duped trust alliances, vigilant trust alliances, deceitful trust alliances and propensity to trust alliances. table 2 sets out the themes peculiar to each group or cluster and provides a sample of verbatim statements typical of each cluster. table 2: clusters of trust. the findings of the study reveal that people’s perceptions that their business partners are high in ability, benevolence, integrity or reliability remain significant barometers of partners’ trustworthiness in business alliances, and support existing research (mayer et al. 1995; schoorman, mayer & davis 2007). generally, the strong perceptions expressed by the sincerity trust and values trust groups regarding the benevolence, reliability or integrity of partners formed the basis for perceptions that partners were trustworthy. similarly, the perceived lack of ability, integrity and reliability expressed by the duped trust, vigilant trust and deceitful trust groups implied low trustworthiness experiences. the findings lend credence to the view that the perceived characteristics of the trustee are crucial for trust formation (beldad et al. 2011; mayer et al. 1995; mishra 1996; silva et al. 2012). using the sincerity trust group as an example, it can be seen from table 2 that this predominantly pdi group viewed their partners as high in integrity because they (the tc partners) were honest with them. table 2 also reveals that the sincerity trust group experienced their partners as high in benevolence and consideration because they did not work against the focal group’s interests or engage in activities that benefited them at the expense of the focal group. clearly, this predominantly pdi group shared strong perceptions that their partners were trustworthy. such perceptions of trust may suggest strong and enduring business relationships, characterised by a low incidence of friction and conflict (hernandez & dos santos 2010). as observed repeatedly by various scholars, organisations are more committed to each other when there is trust, and when there is more trust, they are more likely to commit to each other (harris & wicks 2010). the managers’ trust experiences may then be regarded as a dependable proxy measure of the health and well-being of their business alliances. because business alliances between tcs and pdis in south africa are largely the result of government suasion aimed at empowering the latter companies, it may be theorised that alliance relationships characterised by trust would augur well for black economic empowerment. in other words, trust is crucial in business alliances between tcs and pdis in a country with a history of institutionalised racism and where these alliances are largely the result of government suasion. trust is a crucial driver of governance decisions, collaborative processes and alliance performance in business alliances (brattstörm, faems & mähring 2018). by implication, the managers in the sincerity trust and values trust groups work well with their partners because trust is central to keeping them working together (tähtinen & blois 2011; zhang 2011). milestone achievements in business alliances between tcs and pdis are manifested in the successes conveyed by the sincerity trust and values trust groups. these groups’ strong perceptions that their partners are trustworthy suggest that the institutions concerned may act as conduits for the advancement of black economic empowerment. while the findings of the study support the established crucial role of ability, benevolence, integrity and reliability as perceived characteristics of the trustee in an alliance relationship, they also provide credence to the view that each characteristic may vary independently of the others since each one encapsulates specific elements of trustworthiness. the way in which ability, benevolence and integrity combine into trustworthiness varies between individuals and groups and between situations (mayer & davis 1999). as an example, and as can be noted from table 2, the vigilant trust group formed alliances with their tc partners primarily because of the perception that the partners were competent and offered them the possibility to learn or to have access to invisible assets such as business management and organisational skills, technological capability and knowledge of the market. however, while they were in the alliances, the vigilant trust group experienced their partners as lacking in integrity and reliability because they behaved in a dishonest manner towards them and lacked consistency between their words and actions, as reflected by their failure to keep their promises. this focal group of pdis remained in their alliances with tcs but relied on formal contracts to safeguard their interests against possible opportunism on the part of their tc partners. through contracts, the vigilant trust group: (1) safeguarded themselves against the risk of opportunism on the part of their partners and (2) ensured that the tc partners performed alliance tasks honestly. consequently, trust and formal contracts coexisted in this group. trust and contracts represent crucial modes of managing relationships and risk (malhotra & lumineau 2011). when risk is high and trust is low in an alliance relationship, as in the vigilant trust group, a formal contract is essential for bridging the gap between risk and trust by lowering the perceived risk to a level that allows for trust. the vigilant trust group formed and remained in alliances with their tc partners because they had a strong need to develop their business knowledge and skills. while recognising that business alliances with tcs ‘do not create authentic empowerment because there is no transfer of business skills’, that ‘they [tcs] do not voluntarily enable you [pdis] to learn’ and that tcs encourage pdis to ‘remain dependent’, the group are proactive and learn deliberately by going ‘into their [the tcs’] systems and checking [to learn]’. consequently, it can be hypothesised that in order to bring about authentic black economic empowerment, tcs need to create enabling learning opportunities for pdis, and pdis need to take the initiative to develop themselves. as in the case of the vigilant trust group, pdis who take the initiative to learn may develop the business skills, knowledge and attitudes essential for authentic economic empowerment. the group’s determination to remain in alliances and to learn despite the astounding experiences, coupled with their simultaneous reliance on the mechanisms of trust and written contracts, revealed a unique shade of trust that affected the behaviour of the managers involved differently. the trust experiences of the vigilant trust managers personify the possibility that business alliances between tcs and pdis can enhance black economic empowerment. from table 2 it can be inferred that the duped trust group shared a strong view that their tc partners were competent and knowledgeable about the business and the industry of the alliances but were not reliable and not inclined to empower the group. the group experienced their tc partners as unreliable because they did not keep their promises. interestingly, the duped trust group reported that their tc alliance partners, and not the group, had initiated the alliances, suggesting that the partners could have planned this mode of operation from the beginning. although the duped trust group had not initiated the alliances with their tc partners, they recognised that the ‘credentials required by legislation’ were anchored in their identification as previously disadvantaged and that they had anticipated the possibility of acquiring business skills and knowledge through alliances with tcs. however, the tc partners performed all the work on behalf of the alliances and the focal duped trust group did little or nothing, which resulted in the group not gaining the anticipated business skills and knowledge. the focal group seemed observant of the tc partners’ reluctance to share knowledge but had not anticipated being used as a façade for black economic empowerment. the following remarks provided credence to this assertion: ‘you know, the stuff about window-dressing you read about in newspapers is true. … you think somebody approaches you because he sees talent or potential in you, only to find out that he sees an opener of doors and tenders for himself.’ (participant 3, female, executive director) in the south african and similar settings, where there is a history of social exclusion, access to resources is historically predetermined. as evidenced by the experiences of the duped trust group and supported by the existing literature, resources comprise a combination of finance or capital, on the one hand, and business knowledge and skills, on the other (singh 2012). for example, access to finance is an essential but insufficient factor because lack of business knowledge, skills and experience will undermine economic empowerment initiatives. previously disadvantaged institutions like the duped trust alliance group may not have the ability and the practical skills needed to define their business goals and to make decisions that will facilitate the achievement of those goals. the complexity of black economic empowerment initiatives may lie in the fact that, in many instances, the purported beneficiaries are people who have been marginalised and excluded from the economic mainstream over the years and, therefore, lack more than just access to capital. in an alliance where there is a low level of trust, individuals withhold or distort information about the business (schilke & cook 2013). in the absence of trust, the governance structures and restrictions that preclude participation become disempowering (brattstörm et al. 2018). the duped trust group’s experiences exemplify the setbacks of business alliances between tcs and pdis because the partners used the group as a façade for black economic empowerment. from table 2 it can clearly be seen that the deceitful trust group comprised a group of tcs who shared strong perceptions that their pdi partners lacked business knowledge and skills and could not contribute to business decisions. the deceitful trust group had approached the pdi partners to form alliances so that they (the pdi partners) could open political doors and acquire contracts from government and state-owned enterprises on behalf of the alliances. however, according to the deceitful group managers, it is not improper or wrong to have a pdi partner acquire contracts from government and state-owned enterprises on behalf of the alliance and to not enable the pdi partner to acquire business skills. when tcs use pdis to acquire contracts on behalf of the alliances, the aim is to ‘get even’ with the government for introducing black economic empowerment legislation, which they view as detrimental to whites and, according to them, forces them to work with blacks. the managers’ narratives support this view. the trust experiences of the duped trust and deceitful trust groups personify setbacks for black economic empowerment. the two groups had contrasting trust experiences and fortunes, but these contrasting experiences may have the same debilitating effect on black economic empowerment in that the pdis are precluded from gaining much-needed business skills and knowledge. clearly, in the case of these groups, black economic empowerment may be encumbered by the mistrust and distrust epitomised by the withholding of information about the businesses or the restriction of the pdis’ participation in business matters. some tcs, as in the case of the deceptive trust group, seduce pdis into alliances and thereafter assign them symbolic roles. however, it is also plausible that besides retaliating against the despised policy of black economic empowerment, the deceptive trust group do not involve their pdi partners in the businesses to ensure that business skills are not transferred, thus neutralising future competition. van scheers (2010) reports that tcs generously offer pdis contracts, in return for which the pdis act as their black empowerment partners, but once a bid has been won, they buy their black partners out of the deal. this unscrupulous practice personifies distrust and mistrust and creates black millionaires instantly. however, it undermines the long-term sustainability of economic empowerment of pdis. the deceptive trust group personifies one of the worst cases of how tcs use pdis as fronts and ‘window-dressing’, mobile black executives, ‘rent-a-blacks’, or ‘ghost’ or ‘freelance’ black directors and managers in a bid to procure contracts from government and state-owned enterprises. this phenomenon has been observed in south africa (beall, gelp & ponte 2008; ihederu 2004; ponte, roberts & van sittert 2007; van scheers 2010). however, this practice is not limited to south africa. in malaysia, some individuals from previously disadvantaged groups such as the bumiputera functioned in symbolic capacities only (gomez 2012). in some cases, bumiputeras wanted to get rich quickly and preferred to collect rentier profits as frontmen for the chinese without being actively involved in business management and operations. business alliances between tcs and pdis are a crucial mode for the transfer of skills and the creation of authentic economic empowerment of pdis (ahwireng-obeng & ogunjobi 2001; thomas 2014). however, cronyism, tokenism (ihederu 2004; ponte & van sittert 2007; thomas 2014; van scheers 2010), and so on, exemplify mistrust and distrust, and the trust gap in business alliances between tcs and pdis. it is crucial for business organisations to close the trust gap (martins & von der ohe 2011) to facilitate the transfer of skills, thereby altering the distribution of economic resources and advancing black economic empowerment. black economic empowerment policy is aimed at redressing past inequities so that the citizenry can exercise the newly found political freedom and choice contemporaneously with social and economic freedom and choice (patel & graham 2012). however, redress is encumbered by, among other things, apartheid burdens that have compromised the distribution of opportunities, business skills and capital among the different strata of the population deep into the post-apartheid era. these burdens have been exacerbated by predatory and parasitic political elites and their associates through cronyism and tokenism. black economic empowerment is censured because of allegations that it enriches a small political elite and their cronies. moreover, there is rampant tokenism, where tcs use pdis as a façade for black economic empowerment, among other things (beall et al. 2008; ihederu 2004; ponte & van sittert 2007; thomas 2014; van scheers 2010). the advancement of black economic empowerment requires a multipronged strategy, and business alliances between tcs and pdis may be among many that have a pivotal role to play. favouritism, cronyism and tokenism are some of the practices that are void of trust. in the absence of trust, managerial opportunistic behaviour increases, governance decisions become suspect and the collaborative processes and performance of alliances suffer (dong et al. 2018). consequently, these alliances may not fulfil their role as a conduit for black economic empowerment. conclusion the purpose of this study was to reflect on the prospects for black economic empowerment by exploring trust between tcs and pdis in south africa. the findings of the study add insights into and provide an exposé of the complexity of trust in business alliances between tcs and pdis. some of the aspects of the phenomenon of organisational trust in south african business alliances between tcs and pdis may not exist in other contexts. the phenomenon of black economic empowerment and its encumbrances may be disentangled by exploring trust in black and white business alliances in south africa. the 25 managers expressed viewpoints that formed the basis for classifying trust experiences into six nuanced clusters. generally, the prospects for black economic empowerment appeared greater in the groups characterised by stronger perceptions that the partners were trustworthy. managers’ experiences seemed to affect the prospects for black economic empowerment. the findings of this exploratory and novel study could make several contributions to the study of organisational trust and black economic empowerment. managers and practitioners may become more aware of both the pivotal role of trust in enabling managers to work together and the issues that debilitate trust and sustain the trust gap in business alliances between tcs and pdis. the limitations of this study include the snowball sampling procedure used in selecting the managers, which could inadvertently have resulted in the participation of managers who shared specific perspectives. another limitation is that the data obtained from the 25 managers do not represent the trust experiences of all managers since the sample may not reflect the breadth of managers involved in business alliances between tcs and pdis. however, as per the tenets of qualitative research, the goal was not to generalise the results of the study to the broader population but, instead, to develop a more insightful understanding of trust and its implications for black economic empowerment among the participating managers. a stratified purposive sample, as proposed by creswell (2009), could be used in future research. moreover, appropriate research designs could be developed in future research to investigate the prevalence or generalisability of the findings. the relatively small number of tcs that participated in the study may represent another limitation. researchers could, in future, increase the number of tcs relative to pdis because race or being a tc or a pdi is an important consideration in this study. acknowledgements the author acknowledges prof. melinde 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management journal 54(5), 1069–1080. https://doi.org/10.5465/amj.2007.0767 zhang, y., 2011, ‘trust in business collaboration’, proceedings of 8th smes in a global economy conference, pp. 156–171, khon kaen university, khon kaen, thailand. 322 sajems ns 11 (2008) no 3 the impact of post-merger cross-shareholdings on south african merger control policy1 chris charter cliffe dekker incorporated abstract there is a concentration of eu and us standards in the south african economy. in addition, a number of large industries have been undergoing consolidation. as a result, the phenomenon of cross-holdings, both within and across industries, is not unusual. in cases where the level of cross-holding falls short of joint control, the competition authorities have at times sought to apply the co-ordinated effects doctrine or some variation thereof hoping to lessen potential competition. more recently, the tribunal has also considered the possible unilateral effects of the acquisition of a minority stake in a rival. a number of cases has emerged that to a greater or lesser degree explores the impact of crossholdings and cross-directorships on the competitive behaviour of the firms concerned. this paper includes a review of some of these decisions with a view to determining whether any clear policy seems likely to emerge from the competition authorities. the authorities’ approach to date, reveals an evolution from reflex suspicion to a more reasoned, fact-based outlook. cross-holdings and directorships are treated in the same way as any other evidence relevant to an analysis of a given merger. however, despite the tribunal’s willingness to wrestle with various economic theories, the most recent decision suggests that the acquisition of a non-controlling cross-holding in a company may not fall under the analysis of south african merger regulation at all. should that position change, following clarification by the tribunal or an unequivocal ruling of the competition appeal court, the body of case law goes some way to indicating the type and manner of analysis the authorities will employ. jel g34, l41 1 introduction and legal background section 12a of the competition act, 1998 (“the act”) sets out the methodology to be applied by competition authorities in consideration of mergers. for the present purposes, the relevant provisions are as follows: section 12a. consideration of mergers (1) whenever required to consider a merger, the competition commission or competition tribunal must initially determine whether or not the merger is likely to substantially prevent or lessen competition, by assessing the factors set out in subsection (2) (2) when determining whether or not a merger is likely to substantially prevent or lessen competition, the competition commission or competition tribunal must assess the strength of competition in the relevant market, and the probability that the firms in the market after the merger will behave competitively or co-operatively, taking into account any factor that is relevant to competition in that market… in analysing mergers in accordance with the above provisions, there are generally two main types of anti-competitive effects that need to be dealt with, they are – sajems ns 11 (2008) no 3 323 • whether the merger will allow the merged entity to exercise a greater degree of market power, thereby allowing it to act independently of its customers, suppliers and, in particular, competitors, in raising prices or restricting output (so-called “unilateral effects”); or • whether the merger would propagate an environment where the merged entity and its competitors are more likely to collude, ultimately resulting in higher prices (socalled “coordinated effects”).2 in assessing unilateral effects, the point of departure is generally to consider preand post-merger market shares as an indication of whether the merger is likely to create an entity with a disproportionately high market share.3 where the relevant market remains contested by a number of players (or there is no change in concentration) then the merged entity is unlikely to be in a position to wield market power on its own. however, the merger may nevertheless create or enhance conditions in the market which are conducive to collusion. in many ways, collusive conduct is of greater concern to competition authorities than single firm dominance. this is not only because such conduct often results in the most egregious of anti-competitive outcomes such as price-fixing or market allocation, but also because of the inherent difficulty in detecting and policing conduct between competitors that is practised subtly if not entirely tacitly. to put it crudely, unilateral conduct by a dominant firm can be dealt with relatively cleanly through amputation, while an industry beset by collusion amounts to a cancer which is far more difficult to isolate and treat. of course, in many instances, the same factors which give rise to concerns about unilateral effects also facilitate collusion. for instance, a merger which removes an effective or maverick competitor may make it easier for the remaining players to come to agreement on competitive issues, while at the same time making the merged firm more powerful in its own right. similarly, a merger resulting in vertical integration may give the acquirer significant advantage over its non-integrated competitors, but may also assist in information exchange thereby facilitating collusion. until the primedia case discussed below, the focus of the competition authorities has been on the extent to which certain factors (cross holdings in particular) may give rise to collusion where there is no finding of negative unilateral effects.4 following the primedia case, an economic theory of unilateral effects arising out of cross-holdings has also been posited. 2 theory of harm although the intention of this paper is to focus on the assessment of cross-holdings, it is worthwhile to briefly set out the economic basis for positing a theory of collusion. collusion ultimately requires the resolution of a competitive tension – often referred to as the “incentive constraint” or “cartel problem”. simply put: competitors have an inherent incentive to deviate from collusive action (e.g. by charging less than the collusive price) as this should result in increased sales and thus greater profits. in order for the collusion to remain intact, competitors need to believe that the immediate gain realised after a deviation will be outweighed by profits lost when (and if) competitors react (e.g. by reducing prices in turn, which then need to be matched in order to remain competitive). if it is accepted that any collusive situation naturally gives rise to the temptation to cheat and therefore break the collusion, then it becomes necessary to identify certain elements that should be present in order to counter such temptation. • firstly, the market must be sufficiently transparent in order that participants can readily detect a deviation. • secondly, there must be an apprehension that deviation will be credibly punished (e.g. through aggressive market behaviour by other firms). the punishment should be such that profits will ultimately be diminished by more than the short term gains realised immediately following the deviation. 324 sajems ns 11 (2008) no 3 • thirdly, the structure of the market should be such that collusion is feasible. if a substantial number of firms does not follow a coordinated strategy, then it would not be profitable for the remaining firms to align prices or output as this would be undermined by the behaviour of the nonparticipating firms.5 in principle, parties to a collusive strategy need not in actual fact communicate with one another or reach an express agreement. where the market is sufficiently transparent for deviations to be identified with alacrity and if retribution is likely and credible, then tacit collusion may arise with attendant anticompetitive effects. however, such “conscious parallelism” can be an inefficient means of reducing competition, as merely watching the market can result in mistakes or settling for sub-optimal pricing and output strategies. these are difficult to change without upsetting the delicate balance required to overcome the cartel problem. it would be far more effective for firms to actually communicate with each other or to exchange market information which would allow them to set prices that maximise profits. it is in this milieu that mere (tacit) coordination moves towards collusion. it stands to reason that while tacit coordination may be of some concern to competition regulators, overt collusion is a complete anathema. against the above backdrop, legal and academic authorities over the world have sought to further identify certain more specific factors which, depending on their presence in a given market structure, are likely to facilitate or deter collusion. such factors include the levels of concentration, barriers to entry, countervailing power, product homogeneity, levels of demand and capacity and others.6 one such factor that is often of concern is the presence of structural links between competitors, such as crossownership. in essence, the theory is that such structural links, although falling short of actual control or ownership, make it easier for the linked firms to co-ordinate their action. motta7 states as follows: “first and more obvious, if a representative of a firm is sitting in the board of directors of a rival firm, it will be easier to coordinate pricing and marketing policies. it might also be easier to exchange information on the marketing and pricing policies, which makes it easy to monitor a rival’s behaviour… and is an important facilitating factor for collusion. second, even if a firm did not have any say in the business policies of the other, but just owned a share of it without representation on the board, the incentives to compete in the marketplace might be reduced. this is because the profits of the rival firm would affect the firm’s own financial performance, composed of market profits and financial returns: an aggressive market strategy (like a deviation from a collusive price) would be less profitable than if there were no stake in the rival firm, because it would decrease the returns on financial investments.” (motta, 2004: 144) ac c o r d i n g l y , c r o s s h o l d i n g s a n d c r o s s directorships contain both necessary elements of transparency (through access to or exchange of competitively sensitive information) and punishment (in the form of reduced financial returns) required for collusion. furthermore, board and shareholders’ meetings provide a forum for active coordination. motta goes on to state that “overall, it would therefore seem wise not to allow a firm to have a minority shareholding in a competitor”. (motta, 2004: 144) in the context of cross-directorships, a similar view is manifest in section 8 of the clayton act in the usa, where interlocking directorships between rival firms (over a threshold) are prohibited outright. although the south african competition act contains no express prohibition on crossdirectorships or cross-shareholdings, the possible anti-competitive consequences of such a set-up is given express legislative attention (albeit in the context of prohibited practice) in section 4(2) the act. this provides that an agreement to engage in cartel behavior is presumed to exist between two or more firms if any one of those firms owns a significant interest in the other, sajems ns 11 (2008) no 3 325 or they have at least one director or substantial shareholder in common.8 the question this paper seeks to explore is what is the current attitude of competition authorities to post merger interlocks between firms. although examination of the likely coordination effects of mergers is standard practice, there are relatively few cases that deal specifically with the question of cross shareholdings and cross directorships. nevertheless, there is evidence of evolution in approach in the cases. 3 the distinction between crossholdings and cross-directorships in principle, it is possible for cross-directorships to occur without any concomitant shareholding. however, in the context of merger analysis, it is generally the acquisition of a substantial shareholding that gives rise to the right to appoint a director to the board of the target firm. in the past the impact of cross-directorships was considered as part of the more general enquiry of the competitive effects of the cross-holding. to a degree, this has had the effect of conflating cross-directorships with cross-holdings. it follows that cross-directorships are often viewed by the authorities as the manifestation of the apprehension of coordination that may arise when two rivals have a common shareholder. perhaps for this reason, the authorities have attempted to address such an apprehension by seeking to eliminate cross-directorships rather than cross-holdings. as emerges from certain of the decisions discussed below, this often fails to appreciate the nature of board representation and also tends to underplay the role of shareholders and other management in determining the competitive policy of the firms in question. 4 some south african case law momentum group ltd / african life health (pty) ltd9 the first time the tribunal was called upon to specifically address the question of cross directorships in a merger context was in 2006, when momentum and african life health (“alh”) sought approval for a merger that, on the face of it, was relatively innocuous in that it resulted in a mere 3 per cent accretion of market share in the relevant medical administration market. whilst the commission recommended an unconditional approval of the merger, the tribunal became somewhat fixated with the fact that first rand, the ultimate controller of the merged entity (momentum) also controlled discovery health, another major player in the industry. this fact was not controversial, and the tribunal had previously approved the merger in terms of which this group set-up was achieved. the tribunal also accepted evidence of the parties that discovery and momentum (currently within the first rand group) were encouraged to and in fact did compete vigorously. however, what became a concern to the tribunal in the alh transaction was whether such levels of competition would be sustained in the light of an apparent strategic shift whereby players like momentum and discovery were both seeking to expand into the low-income market. high growth opportunities were perceived here, coupled with the fact that the industry as a whole had been in a process of consolidation. in the tribunal’s reasoning, the alh acquisition was the strategic impetus required for momentum to enter the growth market. it was concerned that competition may be threatened as a result of discovery and momentum sharing the same parent which may enable them to “behave strategically”. in the tribunal’s own words: “it is therefore imperative to maintain the rivalry between these two entities and the concern raised by this merger would be that post-merger there would be an enhanced incentive to co-ordination, rather than rivalry.”10 having previously approved a merger whereby discovery and momentum came to be controlled by first rand, the tribunal could hardly now suggest that one of these two entities be sold, particularly in light of the fact that the transaction under scrutiny did not much change 326 sajems ns 11 (2008) no 3 the combined market shares of the two large competitors. instead, it appears as if the tribunal sought to ensure that any attempt by first rand to coordinate the conduct of the two medical aid companies would be made more difficult. it therefore imposed a condition requiring two common non-executive directors of first rand who were appointed to the boards of momentum and discovery to resign. first rand was also required to ensure that in the future, no common directors were appointed to the boards of momentum and discovery, at both operational and holding company level. it is worth noting that the tribunal apparently did not seek to prevent first rand from appointing directors to each of the momentum and discovery groups, but merely required that such directors not be the same person.11 it therefore appears that in this case, the tribunal understood “cross-directorship” to refer to directorship by the same individual on the boards of two competing companies. momentum group ltd and others v the chairperson competition tribunal and others12 this case followed closely on the heels of the first momentum decision, being an appeal to the competition appeal court against the condition imposed by the tribunal in the first instance. in upholding the appeal, the cac criticised the tribunal inter alia for its statement quoted above, namely that the merger created “an enhanced incentive to coordination rather than rivalry”, which the cac felt was unsupported by evidence and furthermore not borne out by the probabilities. even if the convergence of the two groups were a notional possibility, the cac pointed out that the mechanisms in place for this to occur (i.e. the fact that discovery and momentum exist together as part of the first rand group and the cross-directorships between them) existed prior to the merger and do not arise as a result thereof. the fact that this state of affairs had been previously approved meant that the tribunal could not base a finding of future lessening of competition on the combination of the momentum and discovery interests per se. instead they would have to find that the 3.3 per cent increase in the aggregated market share within the first rand group would somehow tip the scale against competition in the market. according to the cac, such a finding was not supportable on the evidence. the cac also tended to support the notion that while cross-directorships at operating level may be more likely to facilitate the exchange of sensitive information, at holding company level this was less apparent. finally, the cac remarked “that the conditions impose no real safeguard for competition. cross-directorships are prohibited without restricting the attendance of non-directors at board meetings.”13 although the cac did not say so expressly, the controversy is whether the concern should be with common directors (who may indeed be appointed by otherwise unrelated competitors) or whether the same coordination could be achieved through different directors appointed by a common party. it is submitted that in principle, both manifestations may be of concern, although it is to be noted that the former scenario may occur even where there is no common shareholding. although it is tempting to see the cac decision as substantially raising the burden of proof for the competition authorities to allege enhanced co-ordinated effects based on cross-directorships and crossshareholdings, one should be cautious not to lose sight of the specific facts of the matter. it is submitted that the decision should be seen in the context of peculiar evidence as to first rand’s investment policy (in terms of which it cultivated an “owner manager” ethos whereby management of subsidiaries are given the freedom to set and pursue goals within a broad corporate governance framework). the crossdirectorship accrued to a financial investment company, would mean that generic and high level investment information is of more interest to it than operational issues which are entrusted to executives with no link to first rand. in addition and as discussed above, the structural links that the tribunal found worrisome were historical and did not arise as a result of the merger. sajems ns 11 (2008) no 3 327 main street 333 (pty) ltd / kumba resources ltd14 following the cac’s reversal of the tribunal’s charge against cross-directorships in the momentum case, the tribunal had a further opportunity to consider the issue in a case where the commission concluded that post-merger cross-directorships, arising out of a crossholding, should be removed. kumba resources limited (“kumba”) contained the unbundled mining activities of iscor limited (now arcelormittal south africa). controlled15 by anglo american (“anglo”), kumba’s mining activities consisted of iron ore (through sishen iron ore company – “sioc”) coal (through kumba coal) base metals (through kumba base metals) and heavy minerals (through ticor). for various reasons, anglo determined to split out kumba’s iron ore business from its other mining assets, the former to be retained by anglo and the latter to be transferred to a newly created black-owned, listed resource company, exarro limited (“exarro”). anglo would retain a 17 per cent interest in exarro directly and enjoy one seat on the exarro board. e x a r r o w o u l d b e c o n t r o l l e d , v i a t h e interposition of a further investment vehicle16, by eyesizwe spv, in which parties like anglo and bhp biliton (“bhp”) would hold 11 per cent and 9 per cent respectively of the equity interest and would each be entitled to appoint a director to the board. immediately prior to the transaction, anglo and bhp held 11 per cent and 9 per cent respectively in eyesizwe coal, which entitled each of them to a seat on the board. as part of the transaction, eyesizwe coal would be transferred to exarro. although anglo and bhp’s interest in eyesizwe spv mirrored that held in eyesizwe coal, it is worth noting that these interests were now three times removed, as eyesizwe spv, bee holdco and exarro now stood between anglo and bhp, and eyesizwe coal. ultimately, exarro would house the coal, heavy minerals and base metals operations of kumba, the coal mining interests of eyesizwe mining as well as a 20 per cent interest in sioc. given exarro’s fledgling status in a difficult industry, anglo sought to remain associated with the project,17 as reflected by its minority interest and board representation (in the operating company as well as at shareholder level). the post merger ownership structure was presented as follows: 328 sajems ns 11 (2008) no 3 sajems ns 11 (2008) no 3 329 at a horizontal level, the analysis turned on the market for bituminous thermal coal,18 which, pre merger, was produced in various quantities by each of kumba, anglo19 and eyesizwe. the post merger combination of the coal assets of kumba/anglo and eyesizwe gave rise to a 5 per cent increment in market share, which the tribunal found would not substantially lessen competition in the supply of thermal coal. unilateral effects thus disposed of, the commission was nevertheless concerned that because anglo was permitted to appoint a director to the exarro board and to the eyesizwe spv board, this would provide the opportunity for an exchange of commercially sensitive information that would facilitate coordination in the thermal coal market, mainly as a result of anglo’s ownership of anglo coal, a competitor of exarro. the commission therefore recommended that such representations be prohibited as a condition to the merger approval. i n c o n t r a d i s t i n c t i o n t o i t s p r e v i o u s pronouncements on the subject, the tribunal took considerable pains to trawl through and quote various international authorities on the issue of co-ordinated effects. at paragraph 37 of the judgement, the tribunal summarised the position as follows: according to international practice, a merger may give rise to coordinated effects concerns in two instances. in the first instance, it can strengthen an existing coordination. in this instance there would need to be evidence of an existing coordination, and secondly, that the merger is likely to strengthen that coordination. the second instance is that the merger increases the likelihood that firms will coordinate. here there may be no evidence of an existing coordination, but evidence that post merger, it will be probable. the tribunal found that such an approach resonated rather well with the top-notes of section 12a, which, as indicated above, requires a finding as to the “probability that the firms in the market after the merger will behave competitively or cooperatively, taking into account any factor that is relevant to competition in the market including. . . the history of collusion in the market.”20 having thus defined the test for a finding of coordinated effects, the tribunal turned to an exposition of the evidence required to come to a conclusion as to the likelihood of coordination or increased coordination. as a point of departure, the tribunal listed the conditions for coordination already discussed above.21 however, the tribunal stressed that the proffered list should not be taken as a categorical test for the probability of coordination in future merger cases, and that “[t]hese prerequisites are useful therefore, not as a basis for determining what our own legal position on these issues should be, but to help as a method of analysing the theory of harm advanced in this case.”22 in this regard, the tribunal echoes the european cfi decision in sony/bertelsman23 which cautioned against a dogmatic application of the distilled requirements in stating that question of coordinated effects may: be established indirectly on the basis of what may be a very mixed series of indicia and items of evidence relating to the signs, manifestation and phenomena inherent in the presence of a collective dominant position. turning to whether interlocking directorships between competing firms might be amongst such “indicia and items of evidence” as may raise the probability of coordinated interaction, the tribunal quoted with authority a number of inter national sources, ultimately concluding that: [i]t would seem that cross-directorships provide at least two solutions to the cartel problem. firstly, they provide a forum for the exchange of information in a setting conducive to an innocuous explanation. secondly, they provide a highly efficient and expeditious mechanism for monitoring compliance with the terms of the coordination.24 against the theoretical background, the tribunal turned to the specific facts of the case. the commission’s apparent concern with anglo’s presence on the various boards of the exarro group should be seen in light of the fact that anglo competed with exarro and bhp, (the latter also represented at exarro holding company level) in the thermal coal market. 330 sajems ns 11 (2008) no 3 it should also be noted that prior to the merger, bhp and anglo were represented at the board of eyesizwe coal. thus, any coordinated conduct arising out of the cross-directorships among these competitors was as likely premerger as post. the commission indeed appeared to be of such a view when it stated in its recommendation that the merger would result in such coordinated market structure being sustained. in other words, the commission sought to use the merger as an opportunity to remedy an existing anticompetitive market structure, so that “even if a merger did not of itself lead to a substantial prevention and lessening of competition, if the merger perpetuated or sustained an anticompetitive structure, this was sufficient to justify the imposition of remedial conditions.”25 this approach was rejected by the tribunal as being contrary to the manner in which the act should be interpreted; which is that the theory of harm to be proven in this case is whether the merger strengthens any existing coordination, or more colloquially “whether the merger had made a bad situation any worse.”26 factually speaking, the merger resulted in anglo reducing its holding in its erstwhile kumba coal assets. it is also reduced to having only one director at exarro (as opposed to the five originally appointed when those assets were held by kumba) and another at the more rarefied level of eyesizwe spv. bhp that had also been represented at operating company level, is now relegated to a company two steps removed from operations.27 furthermore, the restructure and spin-offs described above resulted in the creation of a company that, rather than being a dedicated coal company, was now a diversified mineral company.28 the tribunal reasoned that in terms of the coordination of coal, while the erstwhile board of eyesizwe may have provided a forum for coordination between that company, bhp and anglo, the removal of bhp to shareholder level, the mineral operations of exarro being generalised and the reduction in anglo’s economic interest in coal would now reduce the ability and impetus to coordinate. accordingly, the tribunal found that: [t]he merger does not meet the test required of strengthening the existing coordination. to the contrary, the merger inhibits this possibility, because it complicates the possibilities for the exchange of information and monitoring, and it changes the incentives of all the firms who may have been party to any pre-existing coordination.29 following that the tribunal’s decision does consider further issues related to the matter at hand that are worth mentioning. in coming to its ultimate conclusion, the tribunal noted that given the diversified nature of exarro, “the type of executive who will be appointed to the exxaro board will need to be a generalist not a coal industry insider.”30 the tribunal considered this nuanced change as indicating that the information flow to (and presumably from) the board would be qualitatively less detailed, immediate and transparent than a company whose sole business is coal. it is perhaps worth pointing out that such an argument, although supportable, is somewhat at odds with the cac decision in the momentum case where the cac impliedly reasoned that the type of individual present at board meetings did not preclude valuable information from being provided to other individuals within a competing organisation who would know what to make of it. the tribunal and commission both appeared preoccupied with the impact of the crossdirectorships on the coal market. however, neither authority raised the question of whether the new structure would allow bhp to gain insight into the iron ore market as result of exarro’s interest in sioc. although this issue was not raised, it may have been disposed of in the light of the tribunal’s view that bhp’s presence at shareholder level rendered it unable to garner useful information about exarro’s operations further down the corporate chain.31 finally, and perhaps most disconcertingly, the tribunal expressly reserved its judgment on whether the commission’s point of law that a merger which merely sustains an anti-competitive market structure, rather than worsens it, may be found to be itself anti-competitive under the act. although the tribunal did state that “this has not sajems ns 11 (2008) no 3 331 been the manner in which we have interpreted the act this far”; it leaves the door open for a different interpretive approach in making the reservation that it has “not yet been called upon to decide the matter definitively…” this is apparently because looking at the facts, the merger in fact weakened the environment for existing coordination and therefore the question of whether sustained criteria for coordination did not actually arise.32 primedia ltd, capricorn capital partners (pty) ltd, new africa investments ltd and the competition commission and african media entertainment ltd33 the tribunal’s approach to cross-holdings was most recently tested in the primedia case, which originated in the conditional approval of an intermediate merger by the commission. although the case ultimately deals with the competitive effects of a cross-holding, it is worth noting that the presence of a primedia director on the board of a rival was initially the cause of the commission’s consternation, which it sought to remedy by imposing a condition that primedia waive its right to appoint a director. this condition was not acceptable to primedia and was appealed to the tribunal, unleashing the series of decisions to follow. the tribunal’s decision to unconditionally approve the merger was then brought under review to the cac by african media entertainment (“ame”).34 the cac referred the matter back to the tribunal for a more thorough analysis of the effect of a cross-holding arising out of the merger. the merger involved the acquisition by primedia and capricorn of the entire issued share capital of new africa investments ltd (“nail”). capricorn is a financial services firm and played no part in the competitive analysis. the controversy arose due to the fact that the acquisition of nail gave primedia an effective 18.1 per cent economic interest in a radio station, kaya fm. at the same time, primedia controlled a stable of radio assets, which notionally competed with kaya fm (although the extent of such competition was a source of much debate throughout the proceedings). the key issue which ultimately arose was whether primedia’s so-called passive investment in kaya fm would give rise to anti-competitive effects. in its initial decision, the tribunal focussed on the question of whether primedia would have de facto control of kaya fm and, finding in the negative, treated this as dispositive of the enquiry. the cac made it clear that the tribunal was bound to consider the competitive effects of even a non-controlling financial interest arising out of the merger. the tribunal’s initial view was arguably somewhat in deference to an assumption long held by authors like areena and turner, that “a non-controlling interest has no intrinsic effect on competition at all”.35 the cac criticised this approach, citing with approval an article by o’brien and salop36 which suggests that partial acquisitions of ownership can indeed have significant competitive effects. as it was enjoined to do, the tribunal in its reconsideration of the matter, spent considerable time analysing the o’brien and salop thesis. where a firm acquires outright control of another, it is self-evident that the merger will have implications for the competitive behaviour of the target firm. o’brien and salop37 however argue that even the acquisition of a passive interest may alter the incentives of the acquiring firm. in the first instance, a passive financial interest can render a price increase by the acquiring firm profitable, to the extent that its investment in a rival subsequently allows it to recoup some of the profits lost due to customers at the margin taking their business elsewhere. a share in these increased profits may compensate for the lost business (in this case, the customers in question were advertisers) to the extent that those customers divert to the investee. this theory thus diverges somewhat from the coordinated effects doctrine generally associated with cross-holdings (and discussed above) as it does not require any conscious cooperation from the target firm, relying purely on the unilateral conduct of the acquirer for a perceived harm to competition. an analysis of this theory of harm requires substantial econometric modelling based inter alia on diversion ratios and the competitive relationship between the acquirer and target. their relative profitability and pricing histories also need to be considered 332 sajems ns 11 (2008) no 3 when ascertaining whether indeed the target is likely to capture sufficient business to enhance the net profits of the acquiring firm. in casu, the tribunal was not satisfied that the evidence supported such a contention. for instance – • it was not clear that the radio stations c o n t r o l l e d b y pr i m e d i a w e r e d i r e c t competitors of kaya fm to the extent that advertisers who chose to desert primedia’s stations following a price hike would “fall with sufficient reliability into the pockets of kaya.”38 furthermore, there was no guarantee that advertisers would not divert to alternative media, such as billboards and print. • whilst primedia enjoyed 100 per cent of the profits in its own stations, it can anticipate less than 19 per cent in respect of kaya fm. it was not evident that this would be sufficient to compensate for any loss of revenue at primedia. • there was no evidence of the relative profitability of kaya fm and primedia, which o’brien and salop expressly consider as a relevant factor. if kaya fm’s cost base were the higher (which was suggested by the available evidence) the return on any revenue diverted to kaya fm will be less than that enjoyed by primedia directly. • as primedia was unable to control the board of kaya fm, there was no guarantee that any increase in profits would find its way to shareholders rather than be reinvested into the business. paradoxically, such reinvestment could be used to more effectively target primedia, thus increasing the potential loss of revenue beyond mere diversion at the margin. ultimately, the tribunal was unable to root in commercial reality the theory that primedia would raise prices, confident of the notion that what it loses to rivals it will gain back in a share of kaya’s earnings. however, the further theory posited by o’brien and salop, which was considered by the tribunal, is based on coordinated effects. essentially, if primedia and kaya fm both increased prices, thus rendering kaya fm a less attractive alternative, customers may elect to bear with primedia rather than divert to kaya fm.39 o’brien and salop refer to this alternative theory as “coasian joint control” and requires the management of each firm to align their strategies to maximise the joint profits of both – in other words, they behave as if they had merged. the theory is another in a litany of propositions to overcome the “cartel problem” discussed above. like most theories of coordination, the fly in the ointment is the presence of transaction costs, which tend to override joint incentives to cooperate and are manifest in the “unilateral incentives to deviate from the cooperative outcome to maximise independent profits”40 – that is, to cheat by secretly cutting prices. applied to the facts of the present case, primedia has the incentive, notwithstanding its “promise” to raise prices to the cooperative (or merger equivalent) level, to secretly cut prices to maximise its profits at the expense of the target firm. “after all,” point out o’brien and salop, “the owner has a 100 per cent stake in the acquiring firm but only a partial interest in the acquired firm.”41 moreover, the management of kaya fm have a similar dilemma: one of its shareholders, primedia (through nail) wants it to cooperate, while the remaining shareholders want it to cheat by cutting prices (all the more so given that kaya fm does not only compete with primedia). as o’brien and salop concede “both types of transaction costs may prevent the coasian outcome from being achieved.”42 recalling the kumba resources case, the tribunal reiterated that coordinated effects can arise either where an existing coordination is strengthened (requiring evidence of coordination and the merger’s propensity to strengthen it), or where coordination becomes probable as a result of the merger. in the present case, a third player in the radio industry, kagiso media investments (“kagiso”) also had an existing passive financial interest in kaya fm. in the first instance, the tribunal found that there was no evidence to conclude that primedia had previously coordinated prices with kaya fm. there was also no evidence to support an allegation that primedia and kagiso had engaged in past coordination. sajems ns 11 (2008) no 3 333 accordingly, the analysis turned to whether the acquisition by primedia of a non-controlling stake in kaya fm could increase the likelihood of coordination. simply put, if the merger allows primedia, kaya fm and kagiso to coordinate a joint increase in advertising rates, the advertising split between the respective radio stations might remain stable, as the stations would remain as attractive to advertisers relative to one another. the objectors to the merger further argued that the presence of a primedia director on the board of kaya fm would be the key factor in cementing the coordination, providing the opportunity to exchange pricing information and monitor cheating. the tribunal ultimately found that while “the possibility of co-ordination to exist post transaction exists as a theoretical possibility… in order to make the case… the evidence needed to be stronger than the mere holding of an interest in a rival and the right to appoint a director to its board… as a result the theory is dependent on making a number of assumptions all of which are premised on shaky foundations”43. among the assumption disregarded by the tribunal were the following – • it was not clear that price coordination would result in stable custom from advertisers. on the contrary, the clear differentiation between the stations (as to target market, content and listenership) concerned could result in advertisers continuing to support some over others. • it was not shown that it would in fact not be more profitable for the rival stations to compete for market share, particularly visà-vis primedia, which had the most lucrative share of the market. • it was questionable whether the information that may be gleaned by the presence of a director appointed by primedia would be particularly valuable. the aggregated way in which management tends to present these matters to boards should be considered, as well as the fact that pricing information could not come through other means (such as advertising agencies). • the absence of reciprocity also posed a problem, in that kaya fm had no concomitant right to a board member at primedia in order to monitor its compliance with any proposed coordination. this would impact on kaya’s incentive to coordinate. • the convoluted structure of control involved certain additional shareholders that had no competing assets and who would have nothing to gain from becoming complicit in a coordination strategy and indeed, may prefer a competitive outlook. this lack of alignment of shareholder interests would also make it difficult for management to implement the coordination, which is the tenet of coasian joint control. • there was no evidence that primedia as the acquiring firm was an industry maverick, whereby it may be discouraged from continuing to compete aggressively because of the effect this may have on the target investment.44 despite the detailed analysis conducted by the tribunal in the light of the cac decision and the latter’s regard for the o’brien and salop thesis, it is worth noting that in a detailed post-script, the tribunal is at pains to express its reservations about such an approach. the tribunal noted that the competition act defines a merger with regard to the establishment of control. as the tribunal ruled that primedia did not control kaya fm, the anomaly had arisen that had primedia acquired the stake in kaya fm directly, rather than through nail. this means the transaction would not have required notification and the analysis that had taken all of two years would not have taken place at all. in a dictum as close as the tribunal has ever come to expressly disagreeing with the cac, the tribunal states – does this mean that passive investments by way of secondary acquisition would not be capable of adjudication even though economic theory suggests that there may be instances of anticompetitive effects? yes, that is what it means.45 the tribunal questioned the applicability of the much vaunted o’brien and salop to south 334 sajems ns 11 (2008) no 3 africa’s control-based merger notification regime, pointing out that the authors write in the context of the us law, which does not impose a requirement of control in order for an acquisition to be notified.46 european merger regulation, like in south africa, is triggered by a change of control. the tribunal summarised a number of writers’ conclusions that while passive financial investment can give rise to anticompetitive effects, “there is also an acknowledgement that these issues are not subject to present merger analysis premised as it is on notions of control.”47 the tribunal concludes this line of reasoning by expressing concern at the notion that a full-blown competitive assessment should be undertaken in each merger notification in which passive, non-controlling investments are embedded. amongst other things, the tribunal questions the capacity of the merger control system to contend with lengthy enquiries in regard to the subtle competitive effects of passive investments, given the fact that anticompetitive effects are rare. the tribunal’s position is best summarised in its own words – that anticompetitive effects may arise out of transactions that fall short of control we recognise as theoretically sound, but it does not form part of our merger review regime which has control as its centre piece.48 should this apparent blockade be lifted, follow ing a clarification from the tribunal or an unequivocal ruling from the cac, the primedia case sets a clear precedent for the type of evidence that will be required to assess the competitive effects of a non-controlling crossholding. 5 in conclusion it is clear that the competition authorities’ a p p r o a c h t o c r o s s h o l d i n g s a n d c r o s s directorships has developed considerably in the level and sophistication of analysis. the case law has shown a certain evolution of approach from somewhat knee-jerk suspicion to a more reasoned and, perhaps, circumspect approach to the question of cross-shareholdings. tribunal has by now adopted an approach that demands evidence of likely coordination, which has come through in recent decisions.49 the analysis may well have reached its zenith in the primedia triptych, with its careful study of economic theory and international jurisprudence. however, the ultimate impact of the primedia case on the approach of the authorities to passive investments may be limited as, rather disconcertingly, the tribunal ultimately pulls the rug out from under the proponents of such enquiries, by arguing that they have no place in merger analysis under south africa law. if this is indeed the case, then it seems as if the opportunity to consider the competitive impact of cross-holdings will only apply where such cross-holdings amount to control in each case (per the momentum life case). in such an event, the analysis will differ substantially from that posited by o’brien and salop and, it must be said, the cac. from a coordinated effects point of view, there is some recourse in section 4(2) of the competition act, which presumes an agreement to fix prices where firms have substantial shareholdings in one another. however, the possible unilateral effect of a passive investment seems, for the time being, to be of academic interest only. endnotes 1 a version of this paper was initially presented at the 1st annual competition commission, competition tribunal and mandela institute conference on competition law, economics and policy in south africa – 21 may 2007 2 in the eu, coordinated effects are sometimes also referred to as giving rise to “joint dominance” while unilateral effects relate to “single firm dominance”. 3 certainly, that is the overwhelming concern with horizontal mergers (ie, those involving competitors). in the case of vertical or conglomerate mergers, others factors will be important, such as the levels of possible foreclosure, although it can be said that the ultimate question remains as to whether such factors will eventually result in increased market power, which in simple terms ought to translate into increased market share. sajems ns 11 (2008) no 3 335 4 indeed, it may be interesting to note that in those cases where an argument for coordinated effects was advanced and eventually rejected, there was a marked absence of alleged unilateral effects. this could indicate that coordinated effects are more likely to raise concern in conjunction with unilateral effects, rather than in isolation. 5 these conditions were set out by the eu court of first instance in the airtours case (case t-342/99) 6 see m motta (2004), competition policy theory and practice page 421 for a detailed list of structural factors which may come into play. 7 op cit pg 144 8 this provision is not particularly well drafted and it has yet to be relied upon by the competition authorities in prosecuting an alleged cartel. however, the tribunal has on a number of occasions sought to highlight the section as indicating a broader legislative purpose extending to merger analysis. 9 tribunal case no 87/lm/sep05 10 paragraph 37 of the judgement 11 as indicated by the tribunal’s statement at paragraph 42 that “given the size of the first rand group and its abundance of executive talent, it can presumably find other suitable directors to replace those to the board the present incumbents elect to resign from.” 12 case no 58/cac/dec05 13 paragraph 13 14 case no 14/lm/feb06 15 as to 66 per cent. anglo also appointed 5 directors out of a total of 15 16 main street 333 (pty) ltd or “bee holdco” 17 it was suggested that anglo had in no small measure staked its reputation on the success of exarro and its association with it, particularly on the board, was required to give the new company credibility. to a lesser extent, bhp remained involved for similar reasons. 18 thermal or steam coal is used in power generation 19 separately from kumba, although, for the purposes of analysing unilateral effects, the authorities correctly treated kumba and anglo as a single economic entity 20 as emphasised and edited by the tribunal in paragraph 38 of the judgment 21 i.e. conditions that allow would-be coordinators to monitor one another’s adherence to the coordination and punish deviation within a market in which coordination is feasible, such as an oligopoly with high entry barriers. 22 at paragraph 42. it does strike one that such an observation, at least in part, may be designed to pre-empt any criticism, previously levelled at the tribunal, of slavishly applying foreign jurisprudence. 23 independent music publishers and labels association (impala) v european commission, judgment of 13 july 2006 case number t-464/04 24 at paragraph 48 25 at paragraph 54 26 this shows a marked departure from the view taken by the tribunal in the first momentum case above 27 this is in keeping with the cac decision in momentum, which viewed interlocks at holding company level more benign than at operational level. 28 of an enterprise value of r24 billion, the coal assets represented only r1.6 billion. by comparison, exarro’s 20 per cent interest in sioc was worth 3.8 billion. 29 paragraph 78 30 paragraph 69 31 indeed, at paragraph 67 the tribunal stated that the relegation of bhp was “probably the most significant fact in the merger.” 32 see paragraphs 55 and 56 33 case no 39/am/may06. see also the cac decision, case no 68/cac/mar/07 34 this case is also significant for confirming the right of an intervenor in merger proceedings to bring a review application against the ruling of the tribunal. 35 see phillip areeda and donald turner, antitrust law (1980) at 322, cited at paragraph 53 of the cac decision. in fairness, the tribunal has clarified areeda and turner’s view as relating not to the absence of a competitive threat arising our of partial holdings, but rather to fact that the nature of the threat is fundamentally different to when two independent firms become subject to a single controlling mind. whilst the latter poses an inherent threat to competition, the former is more difficult to quantify. 36 daniel o’brien and steven salop, “competitive effects of partial ownership: financial interest and corporate control”, antitrust law journal, volume 67, 2000, page 559. 37 the authors furthermore posit a modification of the herfindahl-hirschman index (mhhi) to measure the effects of a passive investment with reference to the structure of the market in which the target and acquirer participate. essentially, the post merger change in concentration (delta) for a passive investment is measured by multiplying the respective market shares of the acquiring and 336 sajems ns 11 (2008) no 3 target firms by the percentage economic interest that the acquiring firm has in the target. 38 see at paragraph 84 of the tribunal decision where an existing wide discrepancy in rates was seen as evidence that kaya did not, pre-merger, act as a competitive restraint on primedia and was therefore unlikely to be the next best substitute for advertisers. 39 note that this theory still requires kaya fm to be the next best substitute in comparison to other available outlets, which the intervenors were unable to convincingly indicate. 40 o’brien, supra, page 582, quoted by the tribunal at paragraph 26. 41 ibid 42 ibid 43 see paragraph 120 of the tribunal decision 44 this observation is largely on all fours with motta’s views quoted (motta, 2004:144) 45 see paragraph 143 of the tribunal judgement. 46 the tribunal as well as o’brien and salop note that section 7 of the clayton act covers the acquisition of any part of a company’s stock where the effect may be to lessen competition. 47 see paragraph 15 of the tribunal decision. 48 at paragraph 164 of the tribunal decision. 49 this puts the south african authorities someway behind the us, where cross-directorships may be per se prohibited, and not even as far as commentators like motta, who show an a priori distrust with cross-holdings. abstract introduction literature review research methodology results and discussions limitations of the study conclusions and recommendations acknowledgements references about the author(s) beauty zindi department of public administration, faculty of management and commerce, university of fort hare, bisho, south africa modeni m. sibanda department of public administration, faculty of management and commerce, university of fort hare, bisho, south africa citation zindi, b. & sibanda, m.m., 2022, ‘educator performance and the strategic plan priorities of the eastern cape department of education’, south african journal of economic and management sciences 25(1), a4666. https://doi.org/10.4102/sajems.v25i1.4666 original research educator performance and the strategic plan priorities of the eastern cape department of education beauty zindi, modeni m. sibanda received: 15 may 2022; accepted: 06 oct. 2022; published: 01 dec. 2022 copyright: © 2022. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the eastern cape department of education (ecdoe) is still experiencing skills shortages among its educators which poses critical challenges in performing their duties of improving learner performance in the province. shortages of skills development programmes in the eastern cape has resulted in poor performance of both educators and learners in most schools. although the ecdoe has clearly espoused its strategic objectives regarding training and development of educators, it is worrying that only a limited number of educators have received capacity development in critical performance areas. aim: the aim of this study is to explore the relationship between educator performance and the strategic plan priorities of the ecdoe. setting: buffalo city education district in eastern cape province. methods: the study adopted a quantitative research strategy and uses a survey questionnaire to collect information from respondents. the sample size was made up of two hundred and seventy (270) participants. the survey questionnaire used a likert scale ranging from one (1) (strongly agree) to five (5) (strongly disagree). the reliability of the survey questionnaires was determined by calculating the pearson’s coefficient, and internal consistency was measured using cronbach’s alpha scale. results: the study established that remediating the lack of training opportunities for educators was the direct objective of the ecdoe strategic plan priorities. conclusion: the article concludes that the ecdoe needs to carry out a skills and capacity audit, based on strategic plan needs analysis. the designing of human capital skills development and training programmes should be informed by the ecdoe’s strategic plan and integrated quality management system that align with educators’ key performance areas. keywords: educator performance; strategic planning; training; eastern cape department of education; human resource development. introduction shortages of skills and capacity among educators is posing serious challenges to improving the performance of learners. considering the low level of performance of schools in the eastern cape province, adams (2021:9) identifies a lack of adequate and necessary skills among educators as the major contributor to poor performance in schools. kennedy (2022) similarly observes a misalignment between training outcomes, and needs of employees, leading to poor performance of educators throughout the province. hartley (2017:20) further observes that many teachers in the eastern cape province are failing to improve learner performance owing to the lack of pedagogical skills and content knowledge. thus, teachers are expected to implement the curriculum, as envisaged in the strategic plan, but with very limited in-service training (carl 2009:130). limited participation in curriculum and assessment policy statement (caps), in which clear curriculum standards and goals are spelt out, is often raised as a constraint to the implementation of the strategic plan of the provincial department of education (pde) (matsepe & maluleke 2019:186–189). the lack of skills and training opportunities is also witnessed in limpopo and the western cape provinces where a limited number of educators have received training. thus, while aligning human capital development to the strategic plan at the pde, district and school are critically important as commitment levels, investment in the professional development of teachers remains low (wolf & floyd 2017:1762). ineffective service delivery in the eastern cape department of education (ecdoe) has been linked to a lack of coordination and synchronisation between human resource development (hrd) and strategic planning functions. this is hampering the administration capacity of the department at all levels and is thus negatively affecting the performance of educators. adams (2021) mentions that many skills development analysts identify lack of investment in human capital development due to, among other factors, lack of understanding of the specific competences required to drive production as a major challenge to efficiency and productivity. kennedy (2022) established that about 83% of south african industries report scarcity of relevant skills as a major hurdle in their recruitment processes. hrd is imperative when it comes to the development and upgrading of skills of workers in an organisation (lim & rager 2015:37; mcchesney & aldridge 2021; wang et al. 2017:1167). brymer et al. (2019:23) posit that in instances of lack of skilled labour, employers have a duty to orient their employees through providing various training and capacity building initiatives. similarly, boon et al. (2018) are of the view that the ecdoe needs to organise more training programmes, like on-the-job training, off-job training, learnership and internship programmes to equip employees with relevant skills to perform their duties effectively and efficiently at their workplaces. this article seeks to achieve the following objectives: explore how educator performance aligns with the strategic plan of the ecdoe; recommend how the ecdoe can improve educator performance in order to achieve the objectives of the strategic plan. literature review the eastern cape province is still suffering from a lack of skills necessary for economic growth and social development. lack of capacity, skills and knowledge affect the performance of educators and learners’ performance. as such, the ecdoe is encouraged to implement training programmes that would lead to improved performance and whole-school effectiveness in the province (chadwick 2017; stone & deadrick 2015; wright, coff & moliterno 2014). thwala (2015:20) confirms that after the attaining of independence in 1994, the new government devoted much of its energy to employees’ skills development, to improve organisational efficiency. the excitement that marked the new dispensation in 1994 has been characterised by incompetent service delivery, caused by shortage of relevant skills, capacity, competences and knowledge of how to deliver goods and services effectively and efficiently. david, michael and ho kim (2018:362) submit that though the new dispensation has achieved a number of objectives, as compared to the pre-1994 government, poverty, corruption and service delivery protests have become the order of the day in many communities. turfail (2017:11) blames deficiency of skills and capacity in the public sector as factors responsible for poor delivery of services in the public sector. precisely, skills and capacity are significant drivers for improving the performance of employees. scholars have also established that, efficient delivery of services is often affected by corruption, nepotism, maladministration, and lack of transparency in the public sector institutions (bapna et al. 2013; delery & roumpi 2017; stone & deadrick 2015; wilson 2016). guiding theory – goal-setting theory this research study is informed by the goal-setting theory which was developed in the mid-1970s by locke and latham (2002:3, 2013:9). it is premised on the assumption that motivating employees significantly increases organisational performance, the satisfaction of individuals and teams and employees’ commitment and productivity (latham & locke 2007:11, 2019:9). goal-setting theory is founded on the assumption that developing individual and organisational goals and ways of achieving them, is of critical importance in achieving the strategic plan objectives in many organisations (skinner 2018:17). the theory is predicated on the assumption that the use of a longitudinal high-performance cycle (hpc) creates a framework for encouraging employees to work towards achieving goals as set in the organisational strategic plan (lunenburg 2011:6; skinner 2018:11). in the context of this study, the hpc forecasts, clarifies and influences employees’ job performance and satisfaction, generating employees’ commitment to the ecdoe (howard et al. 2016:81). in terms of this theory, setting high goals contribute to high performance, contingent rewards and job satisfaction (skinner 2018:23). goal-setting theory, therefore, postulates a relationship between goals and the performance of employees that would lead to the achievement of institutional strategic plan objectives. the theory helps explain how performance and motivation are affected by goals. therefore, it provides a lens for explaining the relationship between skills development, employee performance and the achievement of organisational goals and vision as set in an organisation’s strategic plan (locke & latham 2019:12). likewise, strategic plans, vision and mission of the ecdoe become planning tools, through which the department sets targets and performance indicators for educators so that their performance can be measured against those targets. this theory is further premised on the assumption that the attainment of goals in the ecdoe’s strategic plan brings satisfaction, whereas unaccomplished goals most likely trigger dissatisfaction and leave employees emotionally distressed (borgogoni & russo 2012:10; locke & latham 2019:13), given that goal attainment is inextricably linked to the performance management system and integrated quality management system (iqms). thus, according to (locke & latham 2019:12) the goal-setting theory posits that the public sector can utilise planning tools and techniques such as management by objectives (mbo), high-performance work practices (hpwps) and may do strategic planning that lead to the development of specific goals and functional outcomes. to achieve goals, as set out in the strategic plan, the ecdoe educators need to undertake training which empowers them with relevant skills and the capacity for ensuring high performance (kian, yusoff & rajah 2014:9). as such, a goal-setting theory provides a theoretical lens, which allows this study to explore how the strategic plan informs educator performance, by specifying measurable targets, outputs and outcomes. performance management and appraisal continually feeds into task needs analysis (latham & locke 2007:10) and human capital development programmes and strategies, which will also have to be continually monitored and evaluated and aligned with the strategic plan of the ecdoe. conceptualising strategic planning several scholars have construed the concept of strategic planning differently, depending on the contextual meaning in a particular context. for bryson and george (2020:11), planning is a senior management activity or process that involves determining where (the direction in which) an organisation is going over the next year or more, the means, steps and actions that it needs to take to get there and what it is meant to achieve. several scholars, such as joyce (2017:5), cheon and an (2017:32), bryson (2018:10), and kools and george (2020:263), view strategic planning as a deliberative, disciplined effort to produce fundamental decisions and actions that shape and guide what an organisation (or other entity) is, what it does, and why? this means that it determines the nature or structure of an organisation in terms of what the organisation does, why it does what it does and what it is that it does? (bryson et al. 2017:256). the definition somehow demonstrates organisational task performance, from the objectives and goals to policy implementation, which is referred to as the actions to be taken. furthermore, strategic planning must be viewed as a staged process that requires certain steps to identify the mission statement, long-term goals, environmental analyses, policy implementation, control and the formation of performance strategies (giraudou & mclarney 2016:10; johnsen 2018:400; joyce 2015:30; wilden et al. 2013:19). what this entails, is that strategic planning is a process of identifying the main strategic dimensions, which are relevant when analysing organisational goals and objectives. for drumaux and joyce (2020:7) strategic planning results in a solid, good, complete, integrated, focused, measurable, achievable and balanced strategic plan attuned to various organisational departments. strategic planning is thus critically important in an organisation as it helps an institution to know its financial status or budget to achieve the set objectives. giraudou and mclarney (2016:24) affirm that strategic planning helps an organisation identify the required procedures to generate long-range objectives and evaluate alternative strategies for achieving those objectives. the authors further state that strategic planning plays a critical role in monitoring the strategies to be used by an organisation to achieve the set objectives and reviewing the outcomes with the expected results of an strategic organisational plan (giraudou & mclarney 2016:24). thus, strategic planning involves significant activities like budgeting, performance assessment, the channelling of resources in a productive manner based on sound decisions made (jacobsen & johnsen 2020:16). more importantly, hopkins and rasso (2017:637) points out that strategic planning is a process of applying rigorous investigation and systematic criteria to implement, formulate and control strategy. it can be documented formally by the organisation for clear traces and easy identification of strategic errors. employee performance employee performance is the individual’s capacity to execute their task effectively and efficiently (david et al. 2018:365). for the ecdoe to monitor the performance of its educators, it implements the iqms. the iqms is designed for the purpose of preparing an environment for teacher development and good performance. it is also meant to monitor the overall effectiveness of the ecdoe, evaluate the performance of the educators, identify specific capacity needs of educators for support and human capital development and to promote accountability among educators in their task performance (brown & hanlon 2016:401). with the introduction of the iqms and performance management and development system (pdms) in the ecdoe, the department hopes to achieve the organisational goals, as set out in its strategic plan, mission and vision. the iqms is tailored towards achieving effectiveness, efficiency and productivity among educators. the improved performance of an employee may lead ultimately to the achievement of an organisation’s strategic goals, mission and vision. a critically important focus of performance in an organisation is goal achievement. in this regard, performance-oriented employees meet deadlines, perform their duties effectively and efficiently (kennedy 2022). to achieve this, training of employees is important to strengthen and develop the necessary and relevant skills needed to achieve the objectives of the ecdoe strategic plan. as noted by koukis and jimoyiannis (2019), iqms helps to track employees’ performance and indicate whether they need extra support, can handle a higher level of training or deserve a raise. it is thus important to have a structured iqms and a tracking process to maintain a high standard of performance among the ecdoe educators. overview of skills development programmes in the eastern cape department of education skills and capacity gaps among educators necessitate that the ecdoe embark on several training programmes to improve the performance of its educators. as noted by hartley (2017:20), many educators in the eastern cape province lack teaching skills and knowledge, resulting in the poor performance of learners. notwithstanding such capacity challenges, educators are expected to implement the curriculum as envisaged in the strategic plan, but with very limited in-service training (carl 2009:130). the ecdoe has been offering training programmes such as those in curriculum development and primary school reading intervention programme (psrip). however, such programmes only accommodate a limited number of educators, and falls short of ameliorating the capacity and skills gaps in the ecdoe. in its annual report (2020/21:151) the ecdoe noted with concern that only 94 educators from eight (8) districts were trained in the psrip with the focus on routines/time allocation, core methodologies and early grade reading assessment. the annual report (2019/20:151) further indicated that in 2019 only 1000 educators in districts or circuits were trained in term 2 isixhosa home language, grade 1–3 methodology content module, lessons plan, planners and trackers and merely 36 grade 1 teachers and 8 subject advisors were also trained in phonics. however, as noted, such skills development programmes only accommodate a few educators, leaving a large population without receiving any training at all (ecdoe 2020:53). david et al. (2018:377) notes with concern that this is a problem, given that these statistics paint a gloomy picture of the state of educators’ training, in which only 6807 out of the 55 768 educators in the ecdoe have undergone human capital development in the past year (south africa data driven dashboard 2021). this observation suggests that the ecdoe could be struggling to produce quality results due to inadequacies in skills development training programmes for upgrading the skills and knowledge of educators in order to improve both educator and learner performance in the province (mukeredzi 2013:10; rao & hammza 2018:242; richman 2015:123). it can thus be inferred that inadequate skills development programmes among the educators have detrimental effects on the achievement of the objectives and outcomes of the ecdoe strategic plan. the ecdoe’s strategic plan is predicated on the need to develop high-quality education and learning outcomes through highly skilled and professional educators and to promote equal access to and utilisation of departmental resources. however, with limited rollout of capacity development programmes in the department, achieving the envisaged outcomes becomes a mammoth task. research methodology the study sought to explore the relationship between educator performance and the strategic plan priorities of the ecdoe. the study adopted the quantitative research strategy and used the survey questionnaires to collect data from a sample of 270 educators who teach grades 10, 11 and 12 in the buffalo city education district. the slovin formula was used to determine the sample size. from the calculation, a sample of 267.4 was obtained which was rounded to 270 educators. the survey questionnaire used a likert scale ranging from one (1) (strongly agree) to five (5) (strongly disagree). the reliability of the survey questionnaire was determined by calculating the pearson’s coefficient, and internal consistency was measured using cronbach’s alpha scale (see table 1). items reflecting on the cronbach’s alpha scale ranging from 0.70 and these were deemed reflective of acceptable internal consistency of the survey questionnaire items. hypotheses were developed to test the relationship between educator performance and the strategic plan priorities of the ecdoe. the quantitative analysis model sem (structural equation modelling) assisted by smartpls were used as data analysis tools. in order to test this association, the study employed the simple linear regression to determine the association between these variables, three separate simple regression statistical analyses of data were done. to safeguard the integrity of the inquiry and its outcomes, the researchers sought informed consent and the participants signed consent forms before completing the survey questionnaire. table 1: validity and reliability tests. ethical considerations ethical clearance certificate number sib011szin01 was obtained from the university’s inter-faculty research ethics committee (ifrec and the university research ethics committee (urec). permission to undertake the study was sought and granted by the gatekeeper case study institution, the eastern cape department of education (ecdoe). this study was approved by the university of fort hare’s research ethics committee (urec) 30 july 2020. results and discussions the analysis of variance (anova) was conducted in order to determine the difference in groups larger than two, such as the age groups, ethnicity, teaching level, work experience, highest qualification and number of trainings received. this test was used to measure variations in opinions of respondents based on employee performance and the strategic plan of the ecdoe. the pearson correlation p-value (p < 0.05) was used as a standard measure of the statistical differences among these demographic groups. the f statistics state the direction and the strength of the effect of the difference between demographic variables. table 2 displays the results of the variance analysis. table 2: analysis of variance. table 2 indicates that there is no variation in terms of opinions from respondents that fall in different age groups. the measure of statistical difference p-value is greater than 0.05 on the two variables employee performance (f = 1.737; 0.143) and strategic plan priorities of ecdoe (f = 0.776; 0.542). this means that age has a negative influence on employees’ performance and strategic plan priorities of ecdoe. when employees are getting older and older, their performance at work may decrease, thus making it difficult to achieve the objectives of the department as stated in the strategic plan. with the increase in age, it becomes difficult to actively participate in training programmes, as new and modernised curricula are introduced in the education system and it may become difficult to master and grasp the concepts. this explanation is in line with a study conducted by pineda (2018:45) in tanzania which showed that when employees get older, their quality of understanding of concepts, methods and techniques, used in training sessions, and their level of performance at work may decrease as well. this showed that the level of understanding appears to decrease with the increased number of years of the educators. in terms of ethnicity, this table indicates that there is a positive variation in opinions from educators who fall in different ethnicity groups. the measure of statistical difference p-value is less than 0.05 on employee performance (f = 5.451; 0.001) and strategic plan of ecdoe (f = 2.717; 0.046). this means that ethnicity plays a pivotal role in determining employees’ performance and the achievement of the strategic plan. this illustrates that some ethnic groups perform better than the others (africans, white, indians, coloureds). this is supported by social identity, social categorisation and similarityattraction theories, which argue that when a workforce is ethnically diverse, it could result in psychological processes like in-group liking, in-group attraction, and worst of all, in-group favouritism. this could also bring about many negative outcomes like less communication, less cooperation, less cohesiveness and even conflicts (tajfel & turner 1986), thus making it difficult to achieve the ecdoe goals as indicated in the strategic plan. table 2 further indicates that there is a positive variation in terms of opinions from educators who are on different teaching levels. the measure of statistical difference p-value is less than 0.05 on employee performance (f = 1.411; 0.001) and strategic plan priorities of ecdoe (f = 4.316; 0.015). this means that the level one teachers also contribute to the achievement of the mentioned variables. the achievement of the strategic plan depends on the grade that an educator teaches. this is in line with a survey conducted by mondy and martocchio (2016:50) which showed that those educators who teach senior classes (grades 10, 11 and 12) have more knowledge, skills and capacity to perform their duties effectively and efficiently. senior classes require more reading and research as these involve more challenging tasks and hard work that would improve learner’s results leading to the achievement of the strategic plan. this particular table also indicates that there is a significant association between work experience and an employee’s performance (f = 2.847; 0.025), but there is no significant association with the strategic plan of ecdoe (f = 1.673; 0.157). work experience increases productive employee performance and learners’ performance in the ecdoe. in addition, when employees have more experience in performing their duties, this increases their performance and work productivity. this is in line with a study conducted by delery and roumpi (2017:439) on employees’ performance. the study revealed that employees who were performing better and increased production in the organisation were those who had been employed by the organisation for more than five years as compared to newly employed employees. more so, there is positive variation in terms of the number of training sessions in employees’ performance and the strategic plan of ecdoe. the measure of statistical difference p-value is less than 0.05 on employee performance (f = 3.154; 0.009) and strategic plan of the variables ecdoe (f = 3.760; 0.003). this means that educators who have attended several training workshops have a greater knowledge, skills, and capacity to perform their duties as compared to those who did not attend at all. this finding concurs in alignment with a study conducted by schneider, avivi-reich and mozuraitis (2015:34) which showed that employees who attended several training programmes, gained more skills and improved their capacity, leading to the achievement of organisational goals as compared to those who did not attend. the number of trainings does occupy a central niche in improving employees’ performance and organisational outcomes, thus contributing to the accomplishment of the departmental goals as indicated in the strategic plan. table 2 indicates that there is a positive variation in terms of highest qualifications obtained by the educators. the measure of statistical difference p-value is less than 0.05 on educator performance (f = 9.080; 0.000) and strategic plan of the variables ecdoe (f = 5.430; 0.000). this means that educators with the highest education qualifications have a better chance of understanding concepts, methods and techniques used in training than those with a college certificate. this explanation is in line with studies done by enyekit, ubulom and onuekwa (2018:24) in nigeria and malawi in which employees showed some improvement in job performance after receiving some practical training from the workshops. in support of this, maunganidze (2017:69) points out that the level of education employees acquire, helps them understand how their work impacts the overall success of an organisation and such employees are more likely to take actions that align with the organisational goals and ultimately help to achieve the goals of the strategic plan. table 3 indicates the participants’ view about employee performance. these results indicate that more educators strongly disagreed with all the itemised questions in the table about employees’ performance. table 3: employee performance. based on the results presented in table 3, all the mean responses are sorted according to the mean scores in descending order. the mean scores from six items are less than 2.5 with the sub-variable ‘i am committed to do my work as a result of improved skills acquisition through human capital development at work’ presenting the highest score (mean = 2.31) and the sub-variable ‘does the integrated quality management system contribute to the achievement of the goals, vision and mission as envisaged in the departmental strategic plan’ being the lowest (mean = 2.20). these findings showed that most of the educators do not see the impact of the skills development programmes on their performance and learner results. that is, more participants strongly disagreed with all the items on employee performance. consequently, it is logical to generalise the conclusion by acknowledging that the training given to employees might not have been that effective to positively impact on the department’s strategic plan. contribution of training to new teaching and learning methods training programmes should aim at bringing new skills and various teaching and learning methods to improve the performance of educators in the buffalo city education district. item 4 in table 3 was analysed to predict the perceptions of respondents regarding the development of new teaching and learning methods because of training received. the findings established that 63.91% of the respondents disagreed with the statement that reads; ‘my skills and knowledge at work have improved as a result of employing new teaching and learning methods’ (strongly disagree [38.26%] and disagree [25.65%]). the results suggest that most educators did not acquire any new teaching and learning methods from the training they had attended in 2021. in their study rao and hammza (2018:241) established that there was an outcry in several training workshops organised by the ecdoe: that the facilitators lacked knowledge and skills for equipping and upgrading educators with new skills in most of the workshops attended, thereby contributing to the poor performance of both learners and educators. although the ecdoe strategic plan (2020–2025) clearly stipulates how training should be done, in most cases the hrd hires facilitators who are not fully equipped to spearhead the trainings, leading to poor performance of educators in schools. this is directly contrary to the strategic plan which advocates an improved quality of teaching and learning through a timeous supply and effective utilisation and development of teachers (ecdoe annual performance plan 2021/22:11). although the ecdoe has outlined that one of its strategic objectives is to develop the skills of the department workforce at all levels, it has done little of what is expected, as only a few educators have received training while the majority have been left behind. the performance of educators has changed positively because of trainings received training and development programmes are avenues for greater performance and improvement of results in schools. this can only be achieved if teacher training aims to improve the capacity, knowledge and skills in the teaching and learning process. results indicate that 61.74% of the respondents disagreed with the statement that reads, ‘my performance on the job has changed positively as a result of innovations acquired from the workshops i have attended?’ (strongly disagree [38.70%] and disagree [23.04%]). this means that the training received by the educators may not have added much value to their skills and knowledge development, to capacitate them in improving both educator and learner performance in buffalo city education district. educators were not capacitated with relevant skills that could assist the department to achieve its goals, mission and vision as envisaged in the strategic plan. this could thus be suggestive of irrelevant and poor-quality training, contrary to the objectives of the strategic plan of the ecdoe, which advocate high-quality education and learning using highly skilled and professional educators. thus, one persistent challenge confronting the ecdoe, is skills shortage, resulting from inadequate training and skills development programmes. it becomes prudent that the ecdoe continually rolls out training programmes to equip most educators with the much-needed skills and capabilities which improve their performance in critical strategic plan outcomes. contribution of integrated quality management system to the achievement of the departmental strategic plan to achieve its vision, mission and objectives as envisaged in the strategic plan, the ecdoe utilises the iqms to monitor the performance of educators in the province. results from table 3 indicate that 63.91% of educators disagreed with the statement that reads, ‘does the integrated quality management system contribute to the achievement of the goals, vision and mission as envisaged in the departmental strategic plan?’ (strongly disagree [40.00%] and disagree [23.91%]). in their study, hanafizadeh and rvasan (2017:34) found that most organisations fail to achieve their strategic goals due to the performance of their employees not being adequately monitored. the development and implementation of iqms is seen as a positive move towards improving, monitoring and strengthening the education system and at the same time promoting accountability (jay & miller 2016:15; maharaj 2014:49; republic of south africa 2014:18). the measurement of each individual educator’s performance against the stipulated performance of iqms standards, should be done continually in order to analyse the performance of educators in relation to individual needs analysis. individual needs analysis help the ecdoe to identify the skills gaps of each educator and implement relevant training programmes to address the skills deficit of educators. improvement of learners’ results after receiving training over the past years, the ecdoe has been experiencing low pass rates in its matriculation classes, which forced the department to organise more training to equip educators with more skills, capacity and knowledge to assist them in carrying out their duties and improving learners’ performance. training programmes should aim to equip educators with relevant skills to perform. results indicated that 64.35% of respondents disagreed with the statement that reads, ‘the learners’ results has improved after i have received training on media of instruction and curriculum development’ (strongly disagree [38.70%] and disagree [25.65%]). thus, most educators lacked opportunities to attend training programmes on media of instruction and curriculum development to improve learners’ performance. hussein (2015:19) espouses that organisations must focus on strategies that prioritise improving workforce performance by leveraging on optimised training programmes and the achievement of strategic goals. to do this, organisations need to invest in human resources, ensuring the acquisition of skills, knowledge and competences needed to achieve strategic outcomes. however, as indicated by felton and stickley (2018:21), media of instruction play a significant role in building a bridge between trainees’ knowledge and learning objectives. media of instruction help in building trainees’ retention of knowledge, motivate interest in the subject matter and provide clarity of concepts. instructional media are vital in the training process, since they enhance the ability to learn, influencing trainees to participate actively in training programmes (wang et al. 2017:1171). training and the achievement of the strategic plan the ecdoe aims to achieve its mission, vision and goals as stated in the strategic plan. for the ecdoe to meet its vision, mission and objectives as articulated in the strategic plan, all employees need to co-operate and be dedicated when executing their duties. based on the results, there are mixed reactions towards the training received by the educators and the achievement of the strategic plan. about 61.3% of the participants disagreed with the statement; ‘does the training you have received enable you to achieve the goals of the strategic plan?’ (strongly disagree [37.39%] and disagree [23.91%]). this may be suggesting that the training received by educators did not quite meet the expectation of capacitating the participants to effectively achieve the departmental targets and outcomes as envisaged in the strategic plan. this may be inclusive of training programmes which the ecdoe has been offering, such as those in curriculum development and psrip. in essence, these programmes have been accommodating a limited number of educators, incapable of ameliorating the capacity and skills shortages in the ecdoe. additionally, the ecdoe annual report (2020/2021:151) reports that in 2019 the ecdoe trained only 1000 teachers in districts or circuits in isixhosa home language, grade 1–3 methodology content module, lesson plans, planners, and trackers and merely 36 grade 1 teachers and 8 subject advisors in phonics. given this state of affairs, it becomes difficult for the buffalo city education district to achieve the goals of the department’s strategic plan. the dearth of requisite skills among the educators requires the ecdoe to embark on several training programmes and workshops to enhance the capacity and performance of educators to benefit learners. hartley (2017:20) confirms that many educators in the eastern cape province lack pedagogical skills and content knowledge. this inevitably affects educators’ performance leading to poor learners’ results. the conundrum is thus, teachers are expected to effectively implement the curriculum as envisaged in the strategic plan, with limited skills and capacity, as well as limited empowering in-service training programmes (carl 2009:130). measurability of the strategic objectives the process of creating a measurement strategy requires looking at the department’s objectives and ensuring that all goals contribute to that objective, as well as all the other performance metrics that the department is interested in tracking and reporting. the strategy also makes sure everyone is clear on the key performance indicators of success. based on the results, 67.4% of the respondents disagreed with the statement that reads, ‘the strategic objectives are measurable and can be monitored and evaluated’ (strongly disagree [42.6%] and disagree [24.8%]). it is important that the strategic objectives should be measured and performance checked against set standards. giraudou and mclarney (2016:24) affirm that strategic planning fundamentally helps an organisation identify the required procedures to generate long-range objectives and evaluate alternative strategies. as pointed out by bryson and george (2020:12), measuring of the strategic objective is critically important for monitoring the strategies used by an organisation to achieve set objectives and for reviewing the outcomes against the expected results of an organisational strategic plan. as such, strategic planning involves significant activities like budgeting, performance assessment and channelling of resources into target results, outputs and outcomes in an organisation (jacobsen & johnsen 2020:16). clarity – the strategic objectives in the strategic plan are clearly stated objectives are the mileposts which guide the department and its employees regarding the strategic intentions. they define and articulate visions into clear-cut measurable targets. through clear objectives, employees find guidance in what they are expected to achieve and when. in this study results indicate that 66.5% of the respondents disagreed with the statement that reads, ‘the strategic objectives and strategies in the strategic plan are clearly stated’ (strongly disagree [41.7%] and disagree [24.8%]). there were mixed reactions regarding the clarity of the strategic objectives among the educators in buffalo city education district. for performance to be measurable, strategic objectives and operational strategies should be clearly stated and explained to all employees including the educators. strategic goals optimise the vision and mission of an organisation. they must be measured against strategic planning intents. stakeholders must engage in meetings to discuss the progress of the plan (cole & karl 2016:193). strategic objectives assist in monitoring the vision and mission of the organisation as envisaged in the strategic plan (bryson 2018:53; klijn et al. 2017:1400). objectivity – the desired outcomes are clearly stated and understood in the strategic plan clear objectives allow the department to monitor policy implementation and track results, against key performance indicators and provide feedback, for input, activities, output adjustments and strategic plan review. when the department knows what it needs to accomplish, it is possible to track results and identify barriers to achieve those objectives. results indicate that 69.2% of the respondents disagreed with the statement that reads, ‘the desired outcomes are clearly stated and understood in the strategic plan’ (strongly disagree [43.5%] and disagree [25.7%]). this indicates that the participants expressed different feelings towards the objectivity of the strategic plan. however, in practice the desired outcomes should be clearly stated and easily measurable against the strategic plan. during the development of the implementation plan, the stakeholders need to agree on the objectives to be used for accomplishing the strategic goals, and a detailed action plan must be developed for each goal area or key result area (bryson & george 2020:39; kools & stoll 2016:19). the action plan must include metrics, actions, timelines, responsible persons, and resources necessary to monitor and achieve each objective and key result area. as such, organisations must implement strategies through creating programmes and policies to meet financial budgets, human resource needs, management and operational goals (elliott 2020:21). simple linear regression and hypothesis testing although there is a common understanding that human capital development programmes do add value to trainees, regardless of the level of strategic planning involved, to some extent the nature of the training and the value addition rely on the nature of the plan being used to guide the human capital development programme. as a result, it is important to seek statistical confirmation, instead of basing it on the assumptions and theoretical literature alone. in order to test this association, the study employed the simple linear regression to test these relationships (employee performance and strategic plan of ecdoe). in order to determine the association between these variables, three separate simple regression statistical analyses of data were done. the summary of the first model of the simple linear regression is presented in the following section. hypothesis 1 h10: there is no relationship between employee performance and strategic plan of ecdoe. h11: there is a relationship between employee performance and strategic plan of ecdoe. table 4 focuses mainly on the adjusted r square when assessing the authenticity of the linear regression model on the given data. based on the results that are presented in table 4, it is clear that the model fits the data perfectly. in principle, the ‘adjusted r square is used to determine how well a regression model fits the data’ (ajao, oyeyemi & olayinka 2016). in model one (1), both r2 = 0.698, and the adjusted r square = 0.697. this suggest that our independent variable ‘strategic plan of the ecdoe’ explain over 69% of the variability in our dependent variable ‘employee performance’. in addition, the durbin-watson test for multicollinearity is essential to validate the linear regression model. according to (montgomery et al. 2013), a value of durbin-watson between 1 and 10 suggest that there is no multicollinearity. in the table 4, the durbin-watson is 1.517 suggestive of the nonexistence of multicollinearity. as a result, it is safe to conclude that the model was appropriate for hypothesis testing. although the model fits the data, it is necessary to also test whether the regression model statistically and significantly predicts the outcome variable technological disruptions. therefore, the anova table presented in table 5 was extracted. table 4: model summary. table 5: analysis of variance statistical significance. the results presented show that the regression model used in this analysis predicts the dependent variable (employee performance) significantly well. in the ‘regression’ row under the ‘sig.’ column, the p-value is less than 0.05. therefore, we can conclude that ‘model one 1’ f (528.155) with a mean square of ‘248.857’, and a p = 0.000; the sig or p-value is less than 0.05 (p < 0.05) is a significant fit to predict the dependant variable employee performance. to conclude the existence and significance of the relationship, the coefficients are presented in table 6. table 6: h1: regression model coefficients. assuming a prediction (probability) of, p < 0.05, such predictions suggest that there is a significant relationship between the dependant variable and the independent variable. considering the readings from the previous table, under the ‘strategic plan of the ecdoe’ row and ‘sig.’ column, the reading shows that the relationship between ‘strategic plan of the ecdoe’ and ‘employee performance’ is statistically significant at prediction (probability) p < 0.05, that is (b = 0.927, p = 0.000). the positive beta of ‘0.927’ for ‘strategic plan of the ecdoe’ suggests that 1-unit proportional improvement and/ or alignment to the ‘strategic plan of the ecdoe’ leads to a 92.7% increase in ‘employee performance’. therefore, we can conclude that the ‘strategic plan of the ecdoe’ has a significant and positive influence on ‘employee performance’. the visual display of the relationship is presented in figure 1. figure 1: scatterplot strategic plan of the eastern cape department of education and employee performance. these results are consistent with a study conducted by ajao, oyeyemi and olayinka (2016) on employee performance and the strategic plan. the results revealed that effective strategic planning indeed has a positive impact on performance. although formal planning alone may not bring about better performance, effective implementation will suffice. this means that employee performance acts as a catalyst in achieving the goals in the department’s strategic plan. in addition, strategic planning plays a crucial role in monitoring the strategies to be used by an organisation or employees to achieve the set objectives and reviewing the outcomes with the expected results of an organisational strategic plan (jacobsen & johnsen 2020:16). by doing this, the employees would be able to achieve the goals, mission and vision of the department. the results confirm that h0, stating that there is no relationship between employee performance and strategic plan alignment in the ecdoe, was rejected, while h1 was confirmed. limitations of the study the design and other technical factors associated with this study, significantly weaken the generalisability of study findings. the quantitative research strategy, used in the study, means that the findings and attendant inferences are based on the objective views of study participants and the specific documents consulted. as such, findings in this paper may not be applicable outside of the specific context of the inquiry, or generalised to the whole population. given the foregoing limitations, it is recommended that future researchers should focus on understanding the impact of continuous teacher development programmes in improving learner performance. conclusions and recommendations skills development equips workers with the relevant skills and knowledge needed to carry out their duties. turfail (2017:21) notes that organisations need to embrace skills development to improve the capabilities or knowledge for resourcing human capital. through the implementation of skills development programmes, the ecdoe could achieve its organisational goals set in the strategic plan, mission and vision. thus, the researchers recommend that the ecdoe needs to carry out a skills and capacity audit, based on the strategic plan needs analysis. the designing of human capital skills development and training programmes should be informed by the ecdoe strategic plan and the performance management system that align with educators’ key performance areas, whole-school improvement, and school-effectiveness goals. skills development programmes make it possible for ecdoe’s mission, vision and strategic plan outcomes to be achieved (kramar 2014:1071; lim & rager 2015:16; wolf & floyd 2017:1762). more importantly, as hakooma (2017:50) notes, a poor skills profile is mainly caused by low relevance of much publicly funded training and the low level of investment by organisations in training. it can thus be concluded that inadequate skills and capacity inhibit employees’ performance in the ecdoe, and that new skills and knowledge capabilities are needed to improve the skills and capacity of educators, to achieve the strategic intents of the ecdoe. it is also critically important that the public sector design training programmes for employees based on informed employee needs analysis, to improve the performance of the public sector institutions and to attain the objectives, and key result targets and outcomes envisaged in their strategic plans. acknowledgements this article originated from beauty zindi’s doctoral thesis, completed under the supervision of, m.m. sibanda at the university of fort hare: zindi, b. 2022. human capital development and strategic plan alignment: a case of the eastern cape department of education, unpublished doctoral thesis. university of fort hare, alice. the authors acknowledged university of fort hare for its affiliation support. competing interests the authors have declared that no competing interest exists. authors’ contributions b.z. conceptualised the study, the methodology, conducted the investigation, analysed the data and wrote the original draft. m.m.s. wrote the manuscript, reviewed and edited the manuscript and supervised b.z. funding information this research received no specific grant from any funding agency in the public, commercial or not-for-profit sectors. data availability as the data that support the findings of this study are sensitive, e.g. involving human beings, data are not freely available, but only from the corresponding author, b.z, upon reasonable request in a controlled access repository when and where relevant. disclaimer the views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of any affiliated agency of the authors. references adams, e., 2021, ‘being before: three deluzian becomings in teacher education’, professional development in education 47(2), 392–405. https://doi.org/10.1080/19415257.2021.1891954 ajao, o.s., oyeyemi, o.g. & olayinka, i.m., 2016, ‘bookkeeping and sustainability of small-scale businesses in nigeria: an assessment of agbara local government area, ogun state’, unique journal of business management research 3(1), 1–21. http://www.uniqueresearchjournals.org/ujbmr. bapna, r., langer, n., mehra, a., gopal, r. & gupta, a., 2013, ‘human capital investments and employee performance: an analysis of it services industry’, management science 59(3), 641–658. https://doi.org/10.1287/mnsc.1120.1586 boon, c., eckardt, r., lepak, d.p. & boselie, p., 2018, ‘integrating strategic human capital and strategic human resource management’, the international journal of human resource management 29(1), 34–67. https://doi.org/10.1080/09585192.2017.1380063 borgogni, i. & russo, s., 2012, ‘a quantitative analysis of the high-performance cycle in italy, in e.a. locke & latham g.p. 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acknowledgements references about the author(s) aliksa ludick department trade research entity, faculty of economics and management sciences, north-west university, potchefstroom, south africa david dyason department trade research entity, faculty of economics and management sciences, north-west university, potchefstroom, south africafaculty of agribusiness and commerce, lincoln university, lincoln, new zealand alicia fourie school of economics, tourism research in economic environs and society, north-west university, potchefstroom, south africa citation ludick, a., dyason, d. & fourie, a., 2021, ‘a new affordable housing development and the adjacent housing-market response’, south african journal of economic and management sciences 24(1), a3637. https://doi.org/10.4102/sajems.v24i1.3637 original research a new affordable housing development and the adjacent housing-market response aliksa ludick, david dyason, alicia fourie received: 31 mar. 2020; accepted: 30 apr. 2021; published: 01 july 2021 copyright: © 2021. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: cities continue to grapple with a rising demand for housing, which affects affordability and the well-being of its citizens. this growth continues to put pressure on the delivery of adequate, affordable housing in well-located areas while the availability of infrastructure and proximity to economic nodes remains a challenge. this has led to increasing infill development of medium-density to high-density affordable housing in greenfield areas located adjacent to higher-income neighbourhoods. aim: this study investigates how a new affordable housing development influences the locational and structural values of the adjacent, existing housing market. setting: transactional data of residential sales for two areas in south africa are used to measure the value change. both areas are located within an urban setting next to an open, greenfield area that was redeveloped for affordable housing. methods: two case studies are used and analysed with hedonic pricing modelling to identify and measure the value change for the locational and structural characteristics before and after the development of affordable housing. results: the results reveal a changing housing market as the locational and structural characteristics change in value, further highlighting the importance of careful planning that preserves the existing market and also supplies affordable housing. conclusion: the value of several structural characteristics of properties will change, revealing just how consumer preference responds when affordable housing is introduced in an existing housing market. distance to an affordable housing project continues to influence the house market value and careful consideration should be made when planning to integrate an affordable housing development in an existing neighbourhood. keywords: housing development; affordable housing; hedonic pricing model; residential market; urban; greenfield; impact. introduction the urban settlement patterns in south africa have transformed from the post-apartheid era; however, cities continue to grapple with increasing demand for housing within its boundaries. this has led to the promoting of residential density by encouraging integrated mixed-use development (ed. smith 2003:2), as well as utilising areas that have existing or easy access to horizontal infrastructure. since 1994, various approaches were undertaken by the government to support the increasing demand for housing and since property was available and more reasonably priced at the edge of urban areas, most affordable housing developments took place at the periphery (schoonraad 2000:224). this trend has changed recently with an increasing number of affordable housing initiatives being developed in greenfield areas, used as open space and local parks in cities and often located adjacent to existing neighbourhoods (leshage n.d.; van der westhuizen 2020). this is particularly evident in larger cities and metropolitan areas of south africa where economies of scale in infrastructure provision and better housing opportunities closer to work are targeted. housing affordability within the global economy is emerging as a crisis, as housing costs and household income continue to mismatch (wetzstein 2017). utilising available open space, within and close to existing neighbourhoods, is in response to increasing development cost at the periphery, but one that could ignore other hidden costs in the economy. as a result, existing neighbourhoods are faced with changing locational characteristics that could shape its housing market. the change in the utility from a local park or green space to affordable housing is expected to have an influence on the house prices of the existing adjacent neighbourhood. this study aims to add to this topic by examining the extent of change that an affordable housing development has on the existing market characteristics of an established adjacent neighbourhood. a hedonic pricing model and case studies are used to reveal the locational and structural changes that occur in the housing market within a south african context. in a recent article, phakgadi (2019) highlighted that the constitutional court ruled for potential new subsidised affordable housing developments to be disapproved if the proposed property could disfigure the area or reduce the value of the adjacent properties. housing problems and housing developments in south africa is a contentious issue and, through this research, new learnings related to market-price change would enable more data-driven decision-making when it comes to housing provision. this article proceeds as follows. first, we discuss the regulating environment related to affordable housing development in south africa, as well as the extant literature that relates to affordable housing provision and its effect on the surrounding built environment. this is followed by the methodology and results while we end with a conclusion. background on affordable housing provision in south africa recent news media continue to highlight the nature of urbanisation where housing affordability is at the forefront of the debate (leshage n.d.; van der westhuizen 2020). the response to address and provide housing has had a long history in south africa. in 2004, the national department of housing (ndoh) introduced the breaking new ground (bng) policy in an effort to provide sustainable human settlements and increase the delivery of appropriate housing in the urban core of south african cities. this was done to address the frequent mismatch of housing supply and demand at well-located and in-demand areas. the integrated residential development programme (irdp) within the bng policy was introduced as a result. the purpose of the irdp was to foster integrated housing development that caters for a broad spectrum of typologies and affordability levels within the housing market. the programme delivers four different housing typologies, including government subsidy housing, social housing, a finance-linked individual subsidy programme (flisp) and bonded segment housing. affordable housing can be termed as a house provided by a social housing government institution or an accredited social housing project, built in a designated restructuring zone for low-to-middle-income earners (social housing policy for south africa n.d.). for this article, special emphasis will be given to social housing and flisp initiatives which are henceforth referred to as affordable housing. the flisp housing is intended to assist households to access housing, by providing partially subsidised housing that requires a lower deposit on a house. individuals who can afford personal loans up to r300 000 are eligible for flisp housing. flisp housing is greater than 40 m2 and characterised as a detached, semi-detached single or double-storey building (see figure 1b). figure 1: affordable housing. (a) semi-detached single-story house. (b) medium-density social housing. social housing, illustrated in figure 1a, is available for individuals earning between r1500 and r15 000 per month and only available for the rental market. the amount of rent paid must not exceed 30% of the gross income of the tenant. each unit is between 30 m2 and 45 m2 and comprises one or two bedrooms. the complex is usually characterised by three-storey or four-storey buildings, is access-controlled and is owned by an accredited social housing institution for the first 15 years and may either be refinanced or sold thereafter. many of the programmes that were implemented by the government to combat the housing backlog, provided housing at a sub-optimal location, often located on the outskirts of urban cities and disconnected from economic networks, hindering sustainable livelihoods and opportunities for residents (cogta 2016:63). as a result, the integrated urban development framework (iudf) was designed to address fragmented settlements, restructure urbanisation and promote integration and inclusion in cities (cogta 2016:5). the iudf’s focus is on improving the existing built environment and city footprint, to yield social and economic outcomes by introducing economic nodes and areas for residential housing to stimulate integrated human settlements (cogta 2016:35). the iudf provides the policy framework of development planning into which the irdp feeds to support the housing development component. the outcomes at the heart of the programme are to promote mixed integrated housing developments and address settlement inefficiencies through the integration of individuals from different income groups (national housing code 2009:9). literature review the property price or market price is the actual price of the property on which the consumer and the buyer agree (pirounakis 2013:384). these values are valued differently by buyers and sellers and also based on the characteristics of the house (ball, lizieri & macgregor 2012:13). the location forms part of the value proposition by the market. tiebout’s (1956) invisible foot theory holds that households move between locations that best match their preference, thus the marginal benefit obtained from locational amenities are similar for households living in the same location (hoyt & rosenthal 1997:161). location imparts a monopoly element of uniqueness or exclusiveness, such as the cost advantage of access to different amenities, or the social connection of growing up in a neighbourhood (pirounakis 2013:3). households will choose a neighbourhood based on their sociocultural background or will choose to live where their neighbours are of the same cultural background (oyebanji 2003:10). this brings one back to the invisible foot theory of the concentration of individuals or households with similar preferences for a feeling of security. the location factor that is considered when choosing a residential property reflects the individual’s preferences and choice of the surrounding neighbourhood. it has an impact on the household’s well-being and quality of life (uchenna 2014:24). location factors can include, among other things, the proximity to open spaces and parks, the quality of schools or the proximity to economic active areas (uchenna 2014:3). several studies (du preez & sale 2012; nelson, genereux & genereux 1992) deal with estimating the complex relationship between property prices and locational characteristics or non-market attributes, such as the proximity to waste sites and water pollution. a study conducted on the nelson mandela bay township by du preez and sale (2013) reports that locational characteristics (the distance property is located from the affordable housing development) had a significant negative influence on the property prices in an affluent neighbourhood. with the migration to large urban areas of people seeking employment, the increasing urban population drives demand for housing which regularly outpaces the supply, especially in the affordable housing segment (blaauw et al. 2016; mafukidze & hoosen 2009). this puts pressure on the government and the private sector to allocate sufficient land for housing development to take place. as urbanisation increases, well-located land suitable for affordable housing development becomes more difficult to come by, especially in areas located close to economic nodes that provide employment opportunities (du preez & sale 2012:1). for those areas where such development has already taken place, there is a growing concern regarding the social and environmental sustainability of these completed housing programmes and the impact upon the adjacent neighbourhoods’ property values (goebel 2007:293). however, santiago, galster and tatian (2001) prove that well-maintained affordable housing programmes can raise property prices of the houses surrounding the development. pirounakis (2013:27) describes property price as the value generated from the actual price of the property both the consumer and seller agree upon when making a property transaction deal. this definition assumes both the seller and the buyer have sufficient knowledge of the property and the property market. residential property is valued as a heterogeneous product, which comprises a bundle of inherent attributes or characteristics that may not be separated from each other since these components refer to the implicit price of the property (woo 2014:84). the implicit market price of a property can be expressed as a function of attributes, such as the property’s structural and locational attributes (randeniya, ranasinghe & amarawickrama 2017:113). the characteristics of a house can be divided into structural characteristics, that is, the physical appearance of a property, including the number of bedrooms, number of bathrooms, property age and erf size and its immediate surroundings, as well as locational characteristics, that is, the location unique to a house, proximity to police stations, schools, clinics and retail centres (goodman 1977:475). sirmans, macpherson and zietz (2005:4) summarised the top 20 physical characteristics of a house, by examining approximately 125 studies, and divided them into eight different categories: internal and external house features, construction and structure, natural, location and neighbourhood environment, public service environment, occupancy and selling, financial and marketing. table 1 summarises the top 20 characteristics and their significance. table 1: the top 20 characteristics. property owners have a common belief that affordable housing development located near their homes will automatically decrease their property’s value and the neighbourhood’s aesthetic qualities. the latter is termed the not-in-my-backyard (nimby) theory and based on the idea that affordable housing will be visually unattractive, poorly maintained and managed, which will also, in turn, increase traffic and the level of crime in an area (habitant & humanity 2017). a study compiled by du preez and sale (2012:2) concerning affordable housing in cities and suburbs identified the lack or unavailability of studies that dealt with the impact of a new social housing development on adjacent existing residential property prices. du preez and sale found a case study in the affluent walmer neighbourhood in south africa, which is located next to an informal settlement, called walmer township. the results of the study indicated that affordable housing development had a statistically significant negative impact on the adjacent walmer residential property values, more specifically, the average household is willing to pay between r10 092 and r48 459 to move 200 m further away from the walmer township a house located 500 m away before the development will increase by 49% value if that same house is located 3200 m away post-development, indicating that the adjacent neighbourhoods’ property price would increase for every metre away from the township (du preez & sale 2013:464). the position of this article is to build on the existing literature by identifying if such a development results in a change in market value of the structural and location characteristics of the existing neighbourhood with the development of an affordable housing project. this would enable improved decision-making when identifying open spaces for such developments to encourage appropriate development that aligns with the existing market of the adjacent neighbourhood. methodology this study follows a combined research approach through a case study analysis and a hedonic pricing to determine the change. a cross-sectional data series of various locational and structural aspects of residential properties is used to investigate the residential market structure preand post-development. pre-development is defined as the period leading up to, but excluding, the construction phase of the affordable housing development. post-development refers to the period once construction starts, and was chosen since price shifts were observed in the market once construction started, coupled with long construction times on large residential projects. the market responded immediately in both case studies, a suggestion that the nimby theory applies earlier than would generally be expected. this is encapsulated by the public’s perception of affordable housing developments in close proximity to existing neighbourhoods as detrimental to the area, more specifically, raising the concern about an upsurge in crime due to construction, overcrowding and the general disturbance of peace (du preez & sale 2013:459). the two case studies selected are in south africa: fleurhof in randburg and birch acres in kempton park. these developments were chosen since both case studies are embedded in a previously open-space context where affordable housing typologies have been developed next to an existing neighbourhood, characterised by bonded (middle-to-high-income) housing. since the residential developments in both case studies have already been completed, they are ideal to analyse and develop policy implications. the hedonic pricing model is used to value the property’s unique attributes and combine these to estimate the price of a property. in doing so, it is assumed that individual households have full information concerning the price and the unique attributes of the residential property (ham, maddison & elliot 2013:117). the hedonic pricing controls for all the unique attributes affecting the price of the property. the price of the property represents the aggregate price a consumer is willing to pay for the attributes (chin & chau 2003:4). the hedonic pricing model equation states that the market price of a property is expressed as a function of the structural and locational characteristics (woo 2014:84). the hedonic pricing model used in this research is as follows: in these equations: p = a vector of observed property prices s = a matrix of bedrooms, bathrooms, property age, area size, floor size, garage and pool l = distance located from an open space, pre-(greenfield) and post-(build-up). the residential property data on property prices, structural characteristics and locational characteristics are quantifiable variables. the data includes numerical information such as the actual property price, house attributes and measurable distances. the model used to determine the real price of a property is given as: the dependent variable in the hedonic pricing model, real_price, represents the individual property sales price, β1 – β7 represents the independent variables or structural attributes of each property and z1 represents the distance between the individual property and the open space (pre-development), as well as the proximity between the property and the affordable housing development (post-development). the property prices were adjusted for inflation. the residential property data was sourced from property 24® and lightstone property. du preez and sale (2013) revealed that properties within a 400 m radius revealed the greatest sensitivity towards affordable housing development. additionally, a study by demacon (2017) revealed those properties adjacent to the affordable housing market are referred to as a buffer area and are impacted directly and proportionally more than those located further away. this research study applies these learnings and, as a result, sourced all the transactional data of properties within a 400-m buffer of the development. google earth® was used to measure the distance between affordable housing development and adjacent properties. each house address is measured separately for accuracy in the regression model. the distance located from an open space is recorded as greenfield and distance from the affordable housing is recorded as built-up within the model. to evaluate the effect of the affordable housing development on the location and structural characteristics of the existing neighbourhoods, the model is conducted during two periods. the pre-development phase estimates the value of the characteristics during the period where the site was classified as greenfield. the post-development period is during the period of construction and thereafter. diagnostic tests confirmed that the models as a whole is significant and no problems were observed. ethical considerations this article followed all ethical standards for research without direct contact with human or animal subjects. results fleurhof fleurhof originally consisted of mainly low-density, single dwelling freehold residential units. the affordable housing development utilises the greenfield area adjacent to the neighbourhood and developed high-density freestanding and semi-detached housing, providing for an estimated 83 000 people (calgro m3 2016). freestanding units and apartments were initially sold for r279 000 and r289 000, targeting the affordable housing market (calgro m3 2016). freestanding and semi-detached typologies have a size ranging from 40 m2 to 50 m2, have two bedrooms and one bathroom, while freestanding typologies have a size ranging from 60 m2 to 70 m2 and have three bedrooms and one bathroom. the integrated residential development at fleurhof started construction in 2013 and continued to be under construction in 2018. the period between 2000 and 2012 is considered the pre-development period with 124 transactions while the post-development period is between 2013 and 2018 with 68 transactions (see figure 2). figure 2: fleurhof, preand post-development. a comparison between the average house price before the development with the proposed development price range reveals a significant difference. in 2012, the average property price for fleurhof was r583 845 (adjusted for inflation) while the suburb had an average of three bedrooms and two bathrooms per house, with an average erf size of 848 m2. this value of the affordable housing project is more than 50% below the average house price for the neighbourhood prior to its development. this reveals a significant change in the type of residential typology that is introduced to the market. keeping this price differential in mind, the results of the hedonic pricing model for both periods are summarised in table 2. table 2a: fleurhof model summary. table 2b: fleurhof model summary. comparing the results of the pre-development and post-development model reveals a change in several variables and while these changes will be discussed in more detail in the following section, a couple of relevant changes are emphasised. the prominent result from the model in table 2 is the change in the coefficient symbol of bedrooms from positive prior to the affordable development, to negative and the increasing value related to distance. in most instances, a positive coefficient is expected as bedrooms increase with the price of a house as highlighted by dodds (2010:11). a possible explanation for the contradiction could be due to a changing target market, in which consumers such as young couples prefer smaller houses, which aligns with the affordable housing development. it could also indicate a possible shift in demand for smaller houses, which are more affordable, whereas larger houses with more bedrooms are possibly perceived as more expensive. however, since the r2 is low, the cause for this change from positive to negative could be driven from factors outside of the model. the distance variable continued to be negative in the post-development environment, albeit higher. this suggests that the affordable housing typology introduced to the area did not affect the prices of nearby houses as expected, although priced below the average suburb price. it should be noted that even though the distance is statistically significant, the number of property sales close to the project is low when compared to the total transactional value, with the majority observed farther away from the project. for this reason, an analysis of the transaction data for homes within 160 m of the affordable development revealed that there is indeed a positive relationship between distance and property prices in fleurhof. this result aligns with the existing literature in south africa that finds similar results. the results hold for both the pre-development and post-development scenarios and are illustrated in figure 3. in the post-development period, the relationship reveals that house prices close to the affordable housing project remain up to 140 m. the change from 160 m to 140 m is as a result of low transactional levels post-development. figure 3: price and distance relationship. (a) distance up to 160 m, pre-development. (b) distance up to 140 m, post-development. birch acres birch acres located to the north of kempton park is a large suburb with a variety of residential typologies. in 2003, prior to the affordable housing development, the average house price for properties located within a 400-m buffer of the greenfield area was r190 857 (adjusted for inflation). the suburb had an average of three bedrooms and two bathrooms per house, while the average erf size was 924 m2. the development in birch acres was aimed at the affordable housing market, particularly the flisp market and units sold for an average of r74 000, at 61% lower than the buffer area average house price (demacon 2017:57). the pre-development period is between 2000 and 2003 and includes 168 transactions, while the post-development period is between 2004 and 2009 with 193 transactions (see figure 4). table 3 provides a summary of the pre-development and post-development models. figure 4: birch acres, preand post-development. table 3a: birch acres model summary. table 3b: birch acres model summary. a comparison of the pre-development results with the post-development results reveals that the bed and bathroom variables have stayed relatively consistent in both periods. the results indicate that properties located near an open space (pre-development) were slightly negatively affected by the proximity to the open field as property prices would increase by r10 per metre or r1000 per 100 m as distance increased away from the greenfield area. post development, the value is significantly higher and increased by r35 400 for every 100 m further away. this result aligns with previous studies of a similar nature in south africa (du preez & sale 2013:464) and is an indication that the market perceived the affordable housing as intrusive. in the birch acres case study, the results support wheatley (2011) who states that property owners have a common belief that affordable housing development located near their homes will decrease their property’s value and the neighbourhood’s aesthetic qualities. result discussion and implications both case studies confirm that there are changes to how to the locational and structural characteristics of the adjacent existing property market are valued before and during the construction of an affordable housing project. the results reveal that in both case studies, the property age, number of bedrooms, bathrooms and garage spaces is positively affecting the price of the property before the development. this continued to be positive in birch acres, post-development; however, in fleurhof, a change is observed in bedrooms with a negative coefficient. as explained earlier, this change could be a result of changing consumer preference within the residential market, possibly due to the size and target market related to the housing affordability development. the erf size changes between the two periods are similar in both case studies. in fleurhof the negative coefficient increased in the post-development model, suggesting that smaller is preferred by the market and more so after the development. in birch acres the value decreased substantially, and although it remained a positive coefficient, the change also suggests that the market moved to smaller erf sizes, aligning with the affordable housing project provisions. the coefficient for garages remained positive in both case studies and in both models, with fleurhof showing a lower value associated with an increase in garages, while in birch acres more value is associated with increasing garages. a comparison of the census data in 2001 and 2011 (quantec 2020) for birch acres reveals that more households do have access to cars over this period which could explain the additional value associated with garages. the availability of a pool has increased in value in both case studies after the development. this result is unexpected and could likely reveal an important structural characteristic that supports a property’s value, irrespective of changing market conditions. the locational characteristic of distance reveals a negative coefficient in both periods for fleurhof but increasing postdevelopment. this suggests that properties closer to the affordable development are valued more than those further away. however, an additional analysis presented earlier reveals that the opposite is revealed for properties near the greenfield site preand post-development, with prices increasing as distance from the development site increased up to 140 m post development. in birch acres the coefficient continues to be positive and increase, aligning with the existing literature that locating closer to affordable housing has a negative effect on price. in both case studies the value of the distance coefficient increases in the post-development period. the hedonic pricing model during both periods reveals the change in the structural and locational characteristics that influence the market price of houses in each case study. additional to these observed value changes is the price alignment between the existing market and the newly proposed development. in other words, the price differential. this suggests an analysis of the original price difference between the average property price for the existing neighbourhood versus the average sales price of the affordable housing project. the average sales price in fleurfof prior to the development was r584 000 (inflation-adjusted), while the affordable housing average price was r280 000 (inflation-adjusted) which translates into a price difference of 52%. at birch acres, the average house price was r191 000 (inflation-adjusted) while the average price at the affordable housing development was r70 000 (inflation-adjusted), a 61% difference. the higher price differential in birch areas could further support a positive and increasing distance coefficient evident at birch acres, but not at fleurhof. this points towards a potential price differential cut-off point where a new development between 52% and 61% from the average price has a negative effect on the existing house prices of the neighbourhood. with the increasing demand for land to develop affordable housing development, coupled with the pressure to use infill, greenfield development to limit urban sprawl and utilise existing infrastructure, the results from this study provide important insights to local and regional councils that need to deliberate on relevant planning aspects. the current market pricing, locational and structural characteristics need to form part of a market analysis that evaluates how an affordable housing development could support, rather than negatively influence the existing adjacent housing market. ideally, the affordable housing development should reflect comparable characteristics to the surrounding area. conclusion delivering adequate and affordable housing for a growing market in well-located areas has resulted in the development of affordable housing projects in open spaces next to established middle-to-high-income neighbourhoods. this is in response to limited available land on the periphery of the urban edge, as well as supplying affordable housing in areas located closer to economic nodes that provide reasonable employment opportunities. there is a growing concern in the marketplace about the effect that such developments have on the existing adjacent residential property prices. in an effort to improve decision-making of the regulatory environment, as well as expand on the knowledge of affordable housing and its effect on the existing market, this study provided insight into that and should be useful for both local and regional planning departments when faced with similar applications. the analysis of case studies provides useful support in examining what has worked and what could be done differently. the results from the hedonic pricing modelling indicated that structural and locational characteristics of the neighbourhood changed in value after the development of affordable housing. the change in value for the structural characteristics was an unexpected result and shows that consumer preferences could alter the ideal typology of the neighbourhood housing market. distance to an affordable housing project continues to influence the house market value and careful consideration should be made when planning to integrate an affordable housing development into an existing neighbourhood. ideally, the market price of these units should align with the current market and, to this effect, a price differential analysis could provide useful guidance. expanding on the market differential analysis is a topic that would require further research. lastly, the affordable housing development could consider preserving a part of the greenfield area to represent a green buffer with playgrounds between the existing neighbourhood and affordable housing project. furthermore, the layout of the housing typology should consider and position the higher-priced affordable units closer to the existing neighbourhood to support the existing market values. acknowledgements the authors thank fems for their financial contribution; nwu for the great opportunity to study and christien terblanche for the language editing. competing interests the authors have declared that no competing interest exists. authors’ contributions all authors contributed equally to this work. funding information this research received no specific grant from any funding agency in the public, commercial, or not-for-profit sectors. data availability data sharing is not applicable to this article as no new data were created or analysed in this study. disclaimer the views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of any affiliated agency of the authors. references ball, m., lizieri, c. & macgregor, b., 2012, the economics of commercial property 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https://potchefstroomherald.co.za/74402/residents-worried-about-large-development-planned-for-mieder-park/. wetzstein, s., 2017, ‘the global urban housing affordability crisis’, urban studies 54(14), 3159–3177. https://doi.org/10.1177/0042098017711649 wheatley, d., 2011, hedonic price method. economics network and the centre for education in the built environment (cebe), viewed 02 august 2019, from http://www.cbabuilder.co.uk/quant5.html. woo, a., 2014, ‘sitting of subsidized housing in neighbourhoods: assessing economic, neighbourhood, and social equity impacts’, doctor of philosophy urban and regional sciences, graduate and professional studies of texas a & m university. abstract introduction youth and agriculture: a conceptual framework study area sampling, data collection and indicators of youth characteristics data analysis approach results and discussion conclusions and policy implications acknowledgements references appendix 1 footnote about the author(s) unity chipfupa department of agriculture and animal health, school of agriculture and life sciences, university of south africa, roodepoort, south africa aluwani tagwi department of agriculture and animal health, school of agriculture and life sciences, university of south africa, roodepoort, south africa citation chipfupa, u. & tagwi, a., 2021, ‘youth’s participation in agriculture: a fallacy or achievable possibility? evidence from rural south africa’, south african journal of economic and management sciences 24(1), a4004. https://doi.org/10.4102/sajems.v24i1.4004 research project registration: project number: k5/2789//4 original research youth’s participation in agriculture: a fallacy or achievable possibility? evidence from rural south africa unity chipfupa, aluwani tagwi received: 18 jan. 2021; accepted: 15 sept. 2021; published: 17 dec. 2021 copyright: © 2021. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the realisation of more youth involvement in the agricultural sector has proved to be elusive, so the question of the possibility of a youth-led agriculture needs further investigation. aim: the aim of the study was to assess whether there is potential for the rural youth to participate in agriculture by employing the typology formulation approach. setting: the study is premised on recent calls for strategies to reduce youth unemployment in sub-saharan africa by involving and enhancing the agricultural sector. method: a survey in questionnaire form was conducted with 224 youths from two districts in kwazulu-natal, south africa. the principal components analysis and k-means clustering were performed to determine the youth typologies and assess their potential. results: five typologies were identified. most youths (59.3%) were found in typology 1 (those that see no benefits in farming) and in typology 2 (older, experienced and with access to land). typology 5 (male youths in agricultural cooperatives) had the lowest proportion of youths (5.7%). participants in typologies 2, 3 and 5 were deemed to have high to moderate potential for successful engagement in farming. the highest potential was found in the typology with the least percentage of youths. conclusions: the typologies showed that youths have varying perceptions and aspirations regarding agriculture. while some show an interest and have the potential to participate in farming, others do not. therefore, the blanket notion of the youth’s lack of interest in agriculture should be qualified as it does not always hold. the heterogeneity in characteristics among the youths in these typologies, including their potential to participate in agriculture, expresses the differences in the kinds of support needed to increase their participation. keywords: typology formulation; the youth; agriculture; psychological capital; smallholder. introduction the youth1 are the future of agriculture in sub-saharan africa (ssa). however, getting youths to productively engage in agriculture, including its related value chains, has been difficult while success has been elusive (irungu, mbugua & muia 2015; magagula & tsvakirai 2020; proctor & lucchesi 2012). young people’s participation has been limited, sporadic and not reflective of the investment (both money and effort) made in the sector thus far (magagula & tsvakirai 2020). the trend in youth labour hours in agriculture has been declining. for example, youth hours worked per week in this sector declined by 2.7% from 2008/2009 to 2010/2011; and 9.2% from 2005/2006 to 2011/2012 in tanzania and uganda, respectively (maïga, christiaensen & palacios-lopez 2015). there is also evidence that youths from malawi, nigeria and tanzania are opting out of agriculture (alliance for a green revolution in africa 2015). bezu and holden (2014) revealed that only 9% of ethiopian rural youths intended to work in agriculture. this evidence demonstrates the low participation of the youth in the farming sector. furthermore, the lack of clear agricultural youth policies has also silently relegated youths in ssa, especially those in rural areas, to the periphery of agricultural development programmes (kadzamira & kazembe 2015). it appears that young people are disillusioned when it comes to agriculture. studies posit that the youth view agriculture as a sector of ‘last resort and low productivity’, shunning family farming and opting for wage employment in urban areas (filmer & fox 2014; irungu et al. 2015; kadzamira & kazembe 2015). this thesis emanates from the divergence in youth aspirations and what the agricultural sector can offer (leavy & smith 2010; proctor & lucchesi 2012). some have linked their disillusionment to a lack of information and the slow integration of the fourth industrial revolution into the agricultural sector in africa (magagula & tsvakirai 2020; yeboah 2018). however, these arguments cannot explain the small number of success stories in the youth’s farming observed in several countries in ssa (irungu et al. 2015; proctor & lucchesi 2012). the biggest question is, ‘what would make some youths participate, or not, in farming?’ understanding the typologies and characteristics of youths may reveal what determines their propensity to be even engaged in, never mind succeed in agriculture. the discourse on the youth in agriculture is critical in ssa for both socio-economic and political reasons. there is a cost to youths not working, related to human capital development, health, poverty and social unrest, among others (betcherman & khan 2015; filmer & fox 2014). the economies in ssa have failed to create enough employment opportunities to absorb the ever-growing youth labour force. for example, in south africa, the youth unemployment rate has increased to 43.2% among those 15–34 years (statistics south africa 2020), and 33.4% of them (15–24 years) are in multidimensional poverty (frame, de lannoy & leibbrandt 2016). the situation is even worse for the bulk of young people who reside in rural communities (filmer & fox 2014; sumberg & hunt 2019). given a projected increase in ssa’s youth population of 2.6% per annum, the challenge facing the youth could be even greater in the future (betcherman & khan 2015). thus, considering the current economic trajectory (rising youth unemployment and stunted economic growth), it is expedient to find solutions so that the youth may benefit from opportunities presented in agriculture. agriculture, though low in terms of its gross domestic product (gdp) contribution, remains a key sector in making a livelihood for many households in developing countries, especially in rural communities (kadzamira & kazembe 2015; proctor & lucchesi 2012). the rise in the demand for food and increasing food prices expose the untapped employment and business potential in the sector (filmer & fox 2014). the projections that africa’s food market will grow by over 200% to us$ 1 trillion, from 2010 to 2030, reveal greater prospects for youth engagement in farming (world bank 2013). such participation would also provide a lifeline to a sector with an ageing population of farmers, among other challenges (swarts & aliber 2013). however, seizing this opportunity means the creation of appropriate conditions for a growth in labour demand (betcherman & khan 2015). it also requires research and policies to show comprehensive understanding of the complex youth dynamics, due to spatial differences and heterogeneity in context, aspirations, personality characteristics and resource endowments. unless such conditions and a true understanding exist, the notion of youth engagement in agriculture may remain a fallacy. unfortunately, it could also lead to the premature impression and conclusion that young people are not interested in farming. there are several studies documented on youth interest/participation/perceptions in agriculture (bezu & holden 2014; irungu et al. 2015; kadzamira & kazembe 2015; magagula & tsvakirai 2020; proctor & lucchesi 2012). the general focus has been on the traditional factors (education, skills, land, financial support, markets, information and communication technologies [ict], and institutions) hindering the youth from actively participating in the sector. few researchers attempted to integrate the non-cognitive factors in their analysis when addressing the youth’s perceptions towards farming (magagula & tsvakirai 2020). none attempted to holistically integrate all the facets of psychological capital (psycap), an asset that deals with the mind-set influencing youths’ decisions and behaviour (luthans, youssef-morgan & avolio 2015). this paper posits that though the traditional indicators are critical to youth engagement in farming, the psychological traits of the youths themselves are equally so. understanding the youth’s endowment with psycap provides a holistic and better explanation for their decision-making behaviour (chipfupa & wale 2018). furthermore, consideration of the youth as a homogenous group, ignoring the contextual, gender, resource-based and non-cognitive differences is inappropriate (swarts & aliber 2013). it results in unsubstantiated claims and policies driven by sentiments rather than evidence (sumberg & hunt 2019). unless the complexities of rural young people’s lives are unpacked, it is impossible to design appropriate policies and programmes for supporting the youth in agriculture. youths’ individual life preferences and aspirations are also bound to vary (sumberg & okali 2013), and thus it is normal that young people’s interest in farming would differ. however, this implies that the value for money in agricultural youth programmes can only be realised if research and policy could differentiate between those with the potential and interest from those without. such characterisation is missing in the current youth and agriculture literature (sumberg & okali 2013). this study focuses on the possibility of a youth-led agriculture, using south africa as a case-study. it aims to develop typologies for youths in rural communities. critical analysis of these typologies reveals answers to the following key questions: what type of youths would most likely successfully engage in farming and what type would not, even if support is provided? what support would be required by those in the different youth typologies? what are the implications of the results on agricultural development policies and programmes in ssa? youth and agriculture: a conceptual framework developing typologies for youths requires an understanding of the different individual, social, economic and institutional factors affecting their livelihood decisions and behaviour. the literature shows that there is no single theory capable of explaining youths’ livelihood or career choices, but that there is a need to integrate several theories in order to have a comprehensive understanding (magagula & tsvakirai 2020; mukembo et al. 2014). the theories that help explain youths’ decisions and behaviour include the social learning theory, theory of planned behaviour, role model theory and the human capital theory (hct). while the social learning theory focuses on the interaction of various social factors (socio-demographic, knowledge and perceptions) in determining career choices (krumboltz & mitchell 1990), the theory of planned behaviour assesses how one’s beliefs influence their decisions and behaviour (ajzen 1991). the role model theory emphasises the influence of role models on youths’ decisions, while the hct identifies the importance of skills, knowledge and abilities in their career choices (hornbeck & salamon 1991). informed by these theories, the need to focus on socio-demographic characteristics, knowledge, perceptions, intentions, motivations and family relations as critical elements in the typology formulation is determined in this study. several agricultural studies which applied these theories found that rural youth livelihood choices are influenced by factors such as access to land, social networks, education, household size, parental financial support, age, role models, ict, economic perceptions and marital status (irungu et al. 2015; magagula & tsvakirai 2020; proctor & lucchesi 2012). the observed heterogeneity in the factors has implications for youth cognition, and hence value judgement and decisions regarding young people’s propensity to engage in agricultural activities. this is why the youth are conceptualised as a dynamic and diverse group of people whose various aspirations in life are shaped by societal transformations and experiences (proctor & lucchesi 2012). in addition to the above theories, the psychological capital theory (pct) to broaden the understanding of the differences in the rural youth’s interest to participate in farming is also integrated in the study. the pct deals with the role of psycap in determining human function, including decision making and behaviour (youssef-morgan & luthans 2013). individuals, endowed with positive psycap, are characterised by confidence in their ability to affect their livelihood, optimism about the future, perseverance, even in the face of adversities, as well as resilience (sustaining and bouncing back) (luthans et al. 2015). psycap thus goes beyond what individuals know, their social relations and networks defining who each one is, and what they can become (youssef-morgan & luthans 2013). empirically, psycap has been measured in several recent studies and has been shown to significantly explain decisions about farming and behaviour related to climate change adaptation, water productivity, irrigation expansion and motivation to work, among others (chipfupa & wale 2020; phakathi & wale 2018; wuepper, zilberman & sauer 2019). the inclusion of psycap in youth typology formulation will help explain youths’ decisions beyond their human, physical, financial, natural and social resources. farming itself demands some level of confidence, hope, optimism and resilience, given the different challenges and adversities encountered. psycap potentially affects the youth’s aspirations, energy and hunger for success. it also affects people’s ability to successfully utilise all other resources at their disposal to enhance their livelihoods (phakathi & wale 2018). youths who are poorly endowed with positive psycap will likely not see the opportunities within the agricultural sector. their lack of a positive mind-set is a deterrent in their potential capacity to productively engage in the sector and earn a livelihood. the study uses this conceptual framework to determine the key variables in the characterisation of the rural youth. study area the study was conducted in amajuba and umzinyathi district municipalities in kwazulu-natal province, south africa (figure 1). the selection of the districts, predominately rural, was informed by their level of youth unemployment, potential land capability and the effects of drought. youths constitute the majority (amajuba – 38.7%; umzinyathi – 40.2%) of the population in the study areas (statistics south africa 2018a). recent youth unemployment statistics in the two districts are not readily available. however, provincial statistics show high youth unemployment in kwazulu-natal. about 45.9% of young people aged 15–34 years in the province are not in employment, education or training (statistics south africa 2020). hence, the province has the highest share of people living in poverty (20.6%): that is a poverty incidence of 48.4% (statistics south africa 2018b). figure 1: map of kwazulu-natal district municipalities showing study sites. the biophysical conditions in the study districts show potential for rain-fed farming. land in amajuba is classified as having moderate to high agricultural potential, while that in umzinyathi is considered having marginal to moderate potential. most of the soils are of medium depth, although some pockets of lowand high-depth soils do exist. in the two districts commercial land is set aside for redistribution which could also be parcelled to youths interested in starting their own farming businesses. the average rainfall in amajuba ranges from 620 mm to 1265 mm per annum and that in umzinyathi from 600 mm to 1200 mm per annum. however, both districts experience high evaporation threatening rain-fed crop production. hence, irrigation farming remains an integral part of sustainable agricultural production in the districts. sampling, data collection and indicators of youth characteristics the study employed a cross-sectional research design. it targeted rural youths (18–35 years) who never had formal employment. youths under 18 years were excluded from the study, because most were at school still. a list of unemployed youths, registered with the municipalities in the two districts, provided the population of the study (though not all wards were part of the list, hence caution should be taken when extrapolating the results). following krejcie and morgan (1970), the representative sample size was 217, assuming a 95% confidence level and 5% margin of error. hence, 224 youths participated in the survey (amajuba – 104, umzinyathi – 120). data collection was conducted through a semi-structured questionnaire. the questionnaire was pre-tested before the actual data collection to ensure common translation, consistency, reliability and relevance to the youth. a review of literature helped to identify variables for inclusion in the typology formulation; that is factors that significantly affect participation in agriculture by the youth. data were collected on youth demographic information (age, gender, level of education, marital status, role models) and resource endowment (physical and financial assets, social networks, access to extension, access to government support). a five-point likert scale (1 – strongly disagree, and 5 – strongly agree) was used to collect data on the youths’ managerial skills, perceptions on agriculture and psycap. an indirect questioning approach was taken in measuring psycap to reduce the bias in self-reported scores. different scenarios for each construct of psycap (self-confidence, optimism, hope and resilience) were presented to the participants to indicate the extent to which they would likely take the proposed actions in response to the scenarios. tables 1, 2 and 3 show all the variables that were included in the youth typology formulation. for ease of analysis, principal components analysis (pca) was performed on variables measuring managerial skills, perceptions of agriculture and psycap (see table 1). the resulting indices, together with other variables, were included in the overall pca (see results in table 4). table 1: indicators for managerial skills, perceptions and psychological capital. table 2: descriptive statistics of continuous youth indicators. table 3: descriptive statistics of the categorical youth characteristics indicators. table 4: principal components analysis results – dimensions of rural youths’ characteristics. data analysis approach an analysis of youth characteristics was conducted, using descriptive statistics; that is frequency tables, mean and standard deviation. typology formulation was done through two complementary multivariate statistical approaches, that is pca and k-means cluster analysis (kca). the application of pca reduced dimensionality in the dataset, while kca determined clusters of similar youths, based on the retained factors from the pca. several studies have successfully applied the same approach to farming and livelihood typology determination (chipfupa & wale 2018; yobe, mudhara & mafongoya 2019). the principal components analysis is a data reduction method that, through an algorithm, produces a few uncorrelated indices (principal components), which explain most of the variation in a dataset (hair et al. 2014; manly 2004). the objective is to reduce the number of variables to a few factors, without loss of most of the original information. the approach works best if the original variables are highly correlated. in the study, variables not meeting this criterion were dropped from the analysis. the kaiser-mayer-olkin measure of sampling adequacy (kmo) and bartlett’s sphericity test were used to determine the suitability of the data for pca. a kmo value ≥ 0.5 and a statistically significant bartlett’s sphericity test (p < 0.05) meant that there was sufficient correlation and the data were appropriate for pca. to enhance the interpretability of the pca results, the solution was rotated through the varimax method. only factors with an eigenvalue of 1, or more, were retained. according to hair et al. (2014), given the nature of the data in social sciences, a solution that explains 60 or even less percentage of the variation in the data is acceptable. factors with a loading of 0.4 and above were considered to have a strong influence on the principal components and were interpreted. the retained principal components were used as input in the kca. k-means clustering analysis is a method that uses the values of variables to group homogenous observations into classes (manly 2004). k-means clustering, after pca has been shown as an efficient approach to dimension reduction (ding & he 2004). observations are allocated clusters through partitioning. first, given the predetermined number of clusters, initial cluster centres are calculated for each group. observations are then moved into a cluster with a centroid nearest to it. the process is repeated until stability is achieved and final cluster centres are calculated. the number of clusters was determined by checking the analysis of variance (anova) output after kca. the study settled for a number and solution with the anova table showing a high significance level (p < 0.01) of most of the principal components in forming the final clusters. ethical considerations all ethical considerations for the study were approved by the humanities & social sciences research ethics committee of the university of kwazulu-natal (protocol reference no. hss/1191/018). results and discussion youth characteristics tables 2 and 3 present results of the descriptive analysis of the characteristics of rural youths. most of the youths were female (61%). this is a reflection of the labour migration patterns experienced in rural south africa where there is a higher male out-migration, than female (camlin, snow & hosegood 2014). the average level of education among the youths was matric (grade 12). this meant few have had opportunities for acquiring a post-matric tertiary qualification for various reasons, including poor pass rates, lack of information, lack of finance and lack of career guidance, among others (maila & ross 2018). thus, even if employment opportunities were available, the lack of skills would reduce their employability in the formal sector, relegating them to menial jobs. hence, the importance of promoting youth participation in agriculture as a viable livelihood option. regarding perceptions of managerial and leadership capabilities, the results indicate a lack of leadership training, business planning and financial skills among rural youths. these issues are among those identified as impeding the take-off and growth of small businesses in south africa (mbonyane & ladzani 2011). so without support, young people would have challenges in managing their agricultural enterprises. youths’ management style shows their preference to work alone (as an individual), although if need be, they would be willing to allocate tasks and responsibilities to other people. as reported by officials from the department of agriculture in the two districts, trust plays a crucial role in such decisions. the results show a firm belief that agriculture, both primary and agricultural value-added economic activities (avaea), could provide employment and business opportunities for young people. magagula and tsvakirai (2020) found similar results. however, there is still a large percentage of youths who expressed reservations about the sector. at least 48% said that agriculture is laborious, while 42% and 38%, respectively, believe that agriculture is unattractive, and not meant for the educated. when asked about their job preferences, 38.2% of participants would rather be in an office job than one in the field. similar results were observed in a study in ethiopia (tadele & gella 2012). leavy and hossain (2014), as well as white (2012) extensively discuss the negative values young people attach to farming and the implication it has for agrarian transformation. the findings demonstrated the heterogeneous preferences among young people and the need to identify, target and support those interested in the sector. about two thirds (66.8%) of young people have the emotional support needed to motivate or encourage them to initiate their own small businesses in farming. people known to them with interest in and a positive view of agriculture could also affect their perceptions of farming. most youths (85%) also believe that their families and friends would support them if they opt to pursue a career in farming. the responses also suggest that agriculture has improved the lives of people participating in the sector. seventy percent of the participants reported having observed improvements in the lifestyle of those involved in the sector. whether this translates to young people getting interested in farming is not known. in their study, tadele and gella (2012), found that improvement in agricultural incomes for some farmers did not necessarily lead to others wanting to be part of the sector. the responses from the scenarios of psycap show a fairly high level of endowment. if faced with limited access to land, most youths would approach their families (71.3%), or engage community leaders (66.3%) to help, rather than do nothing (5%). they refuse to lose hope but choose to be optimistic, hoping for a better outcome. the youths’ responses also show some level of resilience and persistence in the face of challenges in business. only 9.8% said that difficulties would make them give up and forget about the business. the rest chose to persevere, but consult an advisor (89.2%), or evaluate their operations (72.2%) to improve performance. though the youth’s level of confidence is high, a percentage is not sure of their own leadership abilities. so if nominated to a leadership position, 32.3% would not accept, but ask the position to be given to someone else, while 21.6% would require time to decide. lack of confidence, which usually manifests as low self-esteem, has been identified as a barrier to young people’s lifelong learning and participation (norman & hyland 2003). the youth’s active involvement in agriculture in the study areas is low. less than a third (31.8%) are employed and earn their livelihood by farming and avaeas (transport of agriculture products, processing). those in this sector operate either as individuals (26.9%), or part of a cooperative of young people (4.9%). however, a good percentage of youths (24.2%) are partially involved in the sector as they are living in an agricultural household. such youths have yet to make a career choice; so their participation is not reflective of their perceptions or interest in agriculture. the remaining 43.9% were not involved in farming or any avaeas. about 70.7% of youths indicated that they have access to agricultural land. however, they do not hold the right of use to this land as their access is through parents. this shows that the gap in the intergenerational transfer of land still exists and potentially affects youth participation in farming (tadele & gella 2012). white (2012) posits that young people’s reluctance to farm could be an expression of their desire not to wait long before they may engage in independent farming. the study also showed that institutional support for young people in farming is lacking. services aimed at the rural youth such as credit, agricultural extension and strong collective action organisations are very limited (table 3). the provision of these services will enhance the youth’s participation in agriculture. dimensions of rural youth characteristics a principal components analysis of youth indicators resulted in the extraction of 10 principal component indices, or dimensions of characteristics of the rural youth (see results in table 4). the extracted indices explained 62.7% of the total variation in the dataset. the kmo value was 0.58 and bartlett’s test of sphericity was significant (p < 0.000); hence the data were appropriate for the pca. in the first dimension (benef) are the beneficiaries of agricultural support programmes. these youths also have easier access to agricultural training and extension services. in the second dimension (experience) fall older youths, experienced in farming with access to land. in the third dimension (sconf_leader) are self-confident young people who exhibit some leadership qualities. the fourth dimension (agric_avaea) represents youths who believe that agriculture is not for the educated and, also have no faith in the potential in avaea to provide a livelihood to young people. in the fifth dimension (assets_educ) is found educated youth who are well endowed with assets. the sixth dimension (neg_att) represents those whose networks have a negative attitude towards agriculture; they also have no or limited access to credit. in the seventh dimension (coop) fall male youths who are members of agriculture cooperatives. in the eighth dimension (optim) are optimistic young people who believe that agriculture could be operated as a business. the ninth dimension (non_impr) represents youths who have not seen the benefit of engaging in agriculture; these youths are also more independent and enjoy working alone. in the tenth dimension (nofin_skil) are youths who lack financial skills. however, they exhibit characteristics of being resilient, and hence would cope in stressful situations. the 10 principal components were used as cluster variables in the clustering process. typologies of rural youth k-means clustering results show that all dimensions, except one, were significant (p < 0.01) in formulating the clusters (see supplementary material). fifteen observations were not included in the clustering process due to missing data. the dimensions which dominate the cluster centres define the characteristics of the youth in that cluster. figure 2 shows the five youth typologies and their final cluster centres. the typologies were further characterised by their psycap endowment (table 5). typology 1 (n = 65; 31.1%) constitutes youths who have not observed any improvements due to farming in the lives of their elders. these youths are part of agricultural youth programmes and encounter challenges in accessing credit. their perceptions of the sector are further influenced by the negative attitude of their close family and friends. though they lack self-confidence, they are resilient and fairly optimistic about the future. other studies have shown that agriculture is held in low esteem by some youths and their parents, especially in developing countries (bezu & holden 2014; sumberg & okali 2013; tadele & gella 2012). typology 2 (n = 59; 28.2%) constitutes older youths, with agricultural experience and access to land, but lacking financial management skills. a few could be members of agricultural cooperatives. their negative experiences made them pessimistic about farming and life in general, and as such, they also lack self-confidence in their ability to transform their own lives. table 5: youth types and level of psychological capital endowment. figure 2: final cluster centres from cluster analysis. typology 3 (n = 44; 21.1%) represents youths who have confidence in their abilities to succeed even in the face of difficulties. most such young people tend to be natural leaders in their circle, due to their leadership qualities. they are also fairly optimistic individuals, though their ability to cope and bounce back is compromised, maybe due to lack of resources. typology 4 (n = 29; 13.9%) includes highly educated youths, endowed with physical assets, especially those related to information and communication technology. these youths are also confident in themselves and tend to exhibit leadership qualities, compared to their peers. however, they seem to have little faith in the future, probably because they failed to secure employment despite their education. as noted in the introduction, youth unemployment is very high in south africa (statistics south africa 2020). typology 5 (n = 12; 5.7%) shows the lowest proportion of rural youths. it represents male youths who are members of agricultural cooperatives. they are fairly confident, optimistic and resilient, and believe that agriculture can be operated as a business. however, they have also not observed agriculture improving the lives of the community people currently engaged in the sector. potential for different youth typologies to engage in agriculture the above description of the various youth typologies affirmed the argument in this study, that the rural youth are heterogeneous regarding their interest and potential to successfully engage in the agricultural sector. this is in line with other youth studies (bezu & holden 2014; sumberg et al. 2012). while some youths show no interest, or their situation makes it difficult to participate in farming or avaeas, others have high hopes and see potential in the sector. table 6 shows the percentage of youth in each typology, currently participating at different levels in the agricultural sector. it also shows the propensity of the different youth typologies to successfully engage in farming, based on an analysis of their characteristics. typology 5 followed by typologies 2 and 4, have the highest percentage of youths currently actively participating in farming. typologies 4, 2 and 3 are the only groups that have some youths operating avaeas as small businesses. typologies 3, 2 and 1 have the highest percentage of youths currently not involved in the sector. table 6: youth current participation (%) and the propensity to successfully engage in farming. the rating shows that the highest potential is found in the typology with the smallest population of youths. those in typology 5 were deemed to have the highest potential for successfully engaging in farming, followed by those in typologies 3 and 2. so youths from these groups should be encouraged to seriously consider farming as a profession. youths in typology 5 require mentoring from successful farmers as models. youths in typology 3 require support with resources (both physical and financial) to enhance their capacity to cope with the challenges encountered in farming. swarts and aliber (2013) also indicated a relationship between the youth’s interest in farming and access to resources for farming. training in financial management, and programmes that build self-confidence, will enhance the agricultural performance of youths in typology 2. giuliani et al. (2017) also identified the lack of training in agricultural and financial practices as key to the youth’s success in farming. these three groups would benefit from support, targeted at agricultural cooperatives, related to their formation and governance, focusing on accountability and collective action. the cooperatives would also act as vehicles for providing mentoring and financial management training to the same youths (giuliani et al. 2017). participants in typology 2 were rated medium, because though they are endowed with land, their experience in the sector negatively affected their perceptions of farming as a career choice. however, given their demonstrated interest, their belief in agriculture could be revived through support, ranging from production and marketing advice, to programmes that seek to build both their cognitive and non-cognitive abilities, for example, mentoring and exchange visits. young people in typology 1 have the lowest potential, despite some of them being currently actively engaged in primary agriculture. given its rating, youths in this typology participate in farming, because they have no other option. due to their perceptions and negative influences, they are likely to abandon farming as soon as opportunities in other sectors arise (tadele & gella 2012). youths like this should be encouraged and supported to start small businesses in other sectors, such as manufacturing, retailing, arts and crafts and services, among others. in other areas, support is needed in the form of financial capital to sustain business operations at the infancy stage. maluleke (2016) indicates that failure to access finances leads to the failure of many small businesses in south africa. similarly, a small proportion of youths in typology 4 are currently engaged in farming, despite their limited potential to have success. this typology is also one of the three that boast a few youths currently operating small businesses in avaeas. studies show that educated rural youths have a preference for employment in other sectors rather than agriculture (irungu et al. 2015; tadele & gella 2012). however, irungu et al. (2015) found that educated and skilful youths in kenya are turning to farming, focusing on higher-value markets and products, though it remains a second option. this demonstrates that it is critical to recognise that educated rural youths are interested in agriculture, but in activities rather higher up the value chain. youths not currently engaged, or partially involved, but belonging to typologies 5, 3 and 2, have the greatest prospects of future participation in farming. agricultural programmes seeking to inculcate and stimulate the greater involvement of young people in the sector should focus on such youths. the results for typology 5 also suggest that rural male youths would be more attracted to farming than their female counterparts. rietveld, van der burg and groot (2020) found that male youths have easier access to land than females. the customary laws existing in most african communities are skewed towards the male child and economically disempower females (bomuhangi, doss & meinzen-dick 2011). whenever they inherit land, women are seldom in control, hence young women’s lack of interest (rietveld et al. 2020). conclusions and policy implications the findings of this study dispelled the blanket notion that young people are not interested in farming and affirmed the possibility of a youth-led agrarian transformation. however, as expected, not all youths would have an interest in the sector. the heterogeneous nature of youths, psycap and resource endowment shape the youth’s aspirations and behaviour, regarding farming. in this study, therefore, is demonstrated the possibility of using typologies to identify youths who are psychologically and emotionally prepared to pursue their livelihood in farming. this is a critical step in forming an agricultural youth policy and various programmes, because it allows resources to be focused and targeted at only those with an interest and the potential to advance the sector. policymakers and implementers should consider utilising similar approaches when designing agricultural youth programmes. regarding youths with no interest in the sector, the approach makes it possible to develop appropriate programmes for their support. the study has also shown that heterogeneous forms of support are required by the rural youth. whilst some youths would require mentoring and training, or the development of different skills (including non-cognitive skills), for others, strengthening their cooperatives, or support in initiating businesses in avaeas, would significantly alter their situation. in all cases, the support to young people should be provided as a package addressing two or more critical aspects. going forward, it is important to note the effect of other people’s experience in agriculture on young people’s perceptions and interest in farming. continuous exposure to negative experiences will indeed turn away many from the sector. thus, development partners’ programmes should strive to create opportunities for exposing youths to successful model farmers. this will provide those who are genuinely interested in farming with a different perspective on agriculture. lastly, it is important to note the gender inequality factors that drive away young women from farming such as access to land and land rights. acknowledgements the study was undertaken as part of a project funded by the water research commission (k5/2789//4), titled ‘entrepreneurial development for establishing small farming businesses and employment by youth in rain-fed crop farming’, implemented in the kwazulu-natal and free state provinces. special mention goes to the msc students and research assistants for their hard work during data collection. competing interests the authors declare that no competing interest exists. authors’ contributions u.c. gathered and prepared the data and edited, analysed and presented the manuscript; 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transforming economies through agriculture, chicago council of global affairs, chicago, il, viewed on 15 december 2020 from https://www.thechicagocouncil.org/sites/default/files/report_youthfor-growth_20180322.pdf. yobe, c.l., mudhara, m. & mafongoya, p., 2019, livelihood strategies and their determinants among smallholder farming households in kwazulu-natal province, south africa’, agrekon 58(3), 340–353. https://doi.org/10.1080/03031853.2019.1608275 youssef-morgan, c.m. & luthans, f., 2013, ‘psychological capital theory: toward a positive holistic model’, in b.b. arnold (ed.), advances in positive organizational psychology, pp. 145–166, emerald group publishing limited, bingley, uk. appendix 1 table 1-a1: anova table from the k-means cluster analysis. footnote 1. there are several definitions for ‘the youth’ depending on context and country. however, this study adopts the african youth charter definition which says that ‘the youth are people between the ages of 15 and 35 years’ (african union 2006). abstract introduction conceptual framework the road safety situation in south africa adherence to road safety laws in south africa enforcement of road safety laws in south africa conclusion and policy implications acknowledgements references footnotes about the author(s) sophia du plessis department of economics, faculty of economics and management sciences, stellenbosch university, stellenbosch, south africa ada jansen department of economics, faculty of economics and management sciences, stellenbosch university, stellenbosch, south africa krige siebrits department of economics, faculty of economics and management sciences, stellenbosch university, stellenbosch, south africa citation du plessis, s., jansen, a. & siebrits, k., 2020, ‘the limits of laws: traffic law enforcement in south africa’, south african journal of economic and management sciences 23(1), a3430. https://doi.org/10.4102/sajems.v23i1.3430 original research the limits of laws: traffic law enforcement in south africa sophia du plessis, ada jansen, krige siebrits received: 18 oct. 2019; accepted: 21 jan. 2020; published: 20 apr. 2020 copyright: © 2020. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the aim of many public policies is to change behaviour. governments tend to rely on regulations, taxes and subsidies to effect such change. these measures, which affect agents’ economic incentives, have a mixed record. a key insight of the new institutional economics is that the efficacy of such formal institutions depends on the strength of their enforcement and the extent to which they are compatible with prevailing informal institutions. aim: this article uses the road safety situation in south africa as a case study to explore aspects of the relationships among formal institutions, law enforcement and informal institutions. setting: south africa has a strong suite of road safety laws but poor road safety outcomes. methods: the article draws on ideas about the relationships between formal institutions, law enforcement and informal institutions to undertake a case study of the road safety situation in south africa. results: the article argues that improved law enforcement cannot fully solve the problem; complementary changes to the informal institutions shaping the behaviour of road users are essential. conclusion: institutional economists have to take a greater interest in the insights of research in behavioural economics, behavioural and cognitive science and other disciplines in order to provide useful advice in settings where such change is an important policy objective. keywords: traffic laws; formal institutions; law enforcement; informal institutions; south africa. introduction the aim of many public policies is to change behaviour. to achieve this aim, governments mostly rely on regulations, taxes and subsidies.1 these measures affect the economic incentives of agents: taxes and subsidies change prices, while non-compliance with many regulations carries costly sanctions. economic incentives have a mixed record as devices for changing behaviour. as bowles and polanía-reyes (2012:369) put it: ‘incentives work, often affecting the targeted behaviour almost exactly as conventional economic theory predicts. … but explicit economic incentives sometimes have surprisingly limited effects, and may even be counterproductive’. ideas from the new institutional economics are valuable for understanding the varied effects of economic incentives.2 institutional economists distinguish between two types of constraints that influence human behaviour, namely formal institutions (e.g. policy rules, constitutions and other laws) and informal institutions (e.g. norms of behaviour, conventions and self-imposed codes of conduct) (north 1994:360). regulations, taxes and subsidies are examples of formal institutions. one of the key insights of institutional economists is that the effectiveness of such institutions depends on the strength of their enforcement and the extent to which they are compatible with the prevailing informal institutions. north (2005) summarises this insight as follows: the policies at our disposal are very blunt instruments. they consist of alterations in the formal rules only, when in fact … performance … is an admixture of the formal rules, the informal norms, and their enforcement characteristics. changing only the formal rules will produce the desired results only when the informal norms that are complementary to that rule change and enforcement is either perfect or at least consistent with the expectations of those altering the rules. (pp. 27–28) the new institutional economics is not the only field in economics that recognises the interconnectedness of formal institutions, enforcement and informal institutions. many microeconomists and behavioural economists now acknowledge that informal institutions influence the efficacy of incentives (cf. festré 2010; gneezy, meier & rey-biel 2011), and law enforcement has long been a major theme in the law and economics literature (cf. polinsky & shavell 2007). yet much scope remains for studying the ways in which enforcement and informal institutions influence the incentive effects of policies to change behaviour. the present article uses the road safety situation in south africa as a case study to explore this issue. conceptual framework figure 1 presents a framework for conceptualising the core issues explored in this article. this framework is an adaptation of one suggested by groenewegen, spithoven and van den berg (2010:26–27, 33). figure 1 depicts the institutional environment as a hierarchy of behaviour-influencing formal and informal institutions.3 the first two levels of the hierarchy consist of informal institutions. values are ‘generally-held preferences about pursuable goals, and embody what most citizens in a certain society consider to be “good”’ (groenewegen et al. 2010:26). norms are ‘generally-held opinions about how to achieve the values’ (groenewegen et al. 2010:26). the notion that people should drive safely, for example, is a norm that contributes to the value of security. values and norms are the bases of legally enforceable public rules (formal institutions, such as traffic laws) and informal private rules of behaviour (road safety-related practices that are not encapsulated in law yet widely applied). as was pointed out earlier, public and private rules and their enforcement jointly shape the behaviour of individuals.4 figure 1: institutions, law enforcement and behaviour. the source of the problem discussed in this article is the coexistence in societies of different sets of values and norms (groenewegen et al. 2010:26). some persons hold the same values and norms that underpin the legally enforceable public rules and choose corresponding informal private rules. hence, they exhibit the forms of behaviour desired by policymakers. enforcement of the public rules would be unnecessary if all persons behave in this manner; in fact, such rules would be superfluous. in most real-world situations, however, some persons choose informal private rules based on values and norms that give rise to inappropriate behaviour. this reality explains why governments create and enforce laws and other formal institutions to change behaviour. this article applies the framework in figure 1 to the road safety situation in south africa as follows. the section that follows, on the road safety situation in south africa, shows that the incidence of road accidents in south africa is high and costly in spite of the country’s relatively strong road safety laws. the limited efficacy of these laws confirms that the road safety situation in south africa is a pertinent setting for studying the links among formal institutions, enforcement and informal institutions. the next two sections discuss the contributions to this state of affairs of informal institutions and law enforcement. the section on adherence to road safety laws in south africa shows that road users in south africa frequently violate road safety laws and argues that such behaviour partly reflects values and norms (i.e. informal institutions) that undermine obedience to such laws. the section on the enforcement of road safety laws in south africa summarises the institutional framework governing the enforcement of road safety laws and presents evidence of the scope of law enforcement actions. it also uses information from an administrative data set of traffic law violations in the city of cape town from july 2014 to july 2016 to provide further insight into the enforcement of road safety laws. this information shows that it would be extremely difficult to eradicate leading causes of road accidents by means of law enforcement activities and that the structures for enforcing sanctions for law violations function extremely poorly. against this backdrop, the article concludes that a combination of law enforcement reforms and changes to informal institutions is necessary to improve the road safety situation in south africa. this section also points out that institutional economists’ limited understanding of the roles and malleability of informal institutions constrains their ability to provide useful policy advice in this, as well as other contexts. hence, it concludes that institutional economists should prioritise research into these issues and intensify their efforts to study relevant findings of psychologists and other social scientists. the road safety situation in south africa the world health organisation (who) (2015:65) links road traffic deaths and injuries to seven major behavioural risk factors: speeding, driving under the influence, failure to use seatbelts, motorcycle helmets and child restraints, drunk-driving, and using mobile phones while driving. according to the who, a strong legislative framework to reduce road traffic deaths and injuries should contain laws to regulate these risk factors. for the first five risk factors, the who recommends best practices that should be incorporated in such laws (evidence is still being gathered on legislative best practices with regard to drug driving and the use of mobile phones while driving). table 1 lists these risk factors and the associated best practices recommended by the who. it also shows the extent to which south african road safety legislation conforms to international best practice. table 1: road safety risk factors, legislative best practices and south african legislation. table 1 suggests that south africa has a strong suite of road safety laws: the country has laws to deal with all seven risk factors. south africa’s seat belt laws are fully aligned with international best practice, while those on speeding, driving under the influence and motorcycle helmets each lacks only one element of such practices. yet road safety outcomes are far from acceptable. according to the road traffic management corporation (rtmc) (2019:7), 12 921 persons lost their lives on south africa’s roads in 2019; furthermore, 12.5% of non-natural deaths and 1.4% of all deaths in south africa in 2016 were caused by transport accidents (statistics south africa 2017:45). an earlier report by the rtmc (2016b:32) shows that south africa suffered 832 431 road traffic crashes in 2015. fully 11 144 were fatal and a further 40 117 major crashes. these crashes caused 13 591 deaths, 62 520 serious injuries and 202 509 slight injuries. modelling based on the latest techniques used in studies elsewhere revealed that the cost of road traffic crashes in 2015 amounted to 3.4% of south africa’s gross domestic product (rtmc 2016b:36). international comparisons confirm the impression of unsatisfactory outcomes. figure 2 shows that south africa’s road traffic death rate in 2016, namely 25.9 per 100 000 of the population, was relatively high for an upper-middle-income country. in fact, the south african road traffic death rate exceeded the average rates for all middle-income countries (18.0) and high-income countries (7.7) and was only slightly lower than that for low-income countries (28.3) (these averages were calculated from the country rates in who 2018:302–313). inconsistencies in the gathering and interpretation of data make international comparisons of estimates of the costs of road traffic crashes hazardous. it is notable, however, that the estimate for south africa quoted above is higher than those for the majority of countries reported by wijnen and stipdonk (2016:105) (cf. figure 3). the south african government is well aware of the scale of the problem. it endorsed the decade of action for road safety 2011–2020 proclaimed in march 2010 by the united nations and included a major reduction in motor vehicle accidents among the goals of the national development plan 2030 (national planning commission 2015:298). figure 2: road traffic deaths per 100 000 of the population (2016). figure 3: latest estimates of the costs of road crashes in 18 countries (percentages of gross domestic product). the new institutional economics suggests that the disjunction between south africa’s relatively strong road safety laws and the high and costly incidence of road accidents may well reflect inappropriate values and norms about prudent behaviour among road users, poor enforcement of road safety laws, or a combination of these two sets of factors. the following sections present evidence on this conjecture. adherence to road safety laws in south africa survey data on the values and norms underpinning the behaviour of road users in south africa do not exist. hence, researchers interested in the nature and effects of such values and norms have to rely on proxies. the connection between informal institutions and behaviour postulated in the conceptual framework section of this article implies that the incidence of violations of traffic laws in south africa is one such proxy. table 2 shows that a recent survey reported 6 333 177 infringements of traffic laws in south africa from february 2015 to september 2016 (rtmc 2016c:9–10). this number implies 0.6 infringements of traffic laws per self-propelled vehicle listed in the national traffic information system (enatis) of the rtmc.5 although indicative of a high incidence of violation of traffic laws, this ratio significantly understates the extent of the problem. many infringements go undetected, and data for only 17 of the 20 months were useable for inclusion in the survey report. moreover, the survey contains information compiled by the national traffic police and the nine provincial traffic departments. it excludes data on offences in five major cities (cape town, ethekwini, ekuruleni, johannesburg and tshwane), where metropolitan police forces are responsible for enforcing traffic laws. this is a large omission: the city of cape town, for example, reported 3 873 818 infringements of traffic laws in the two-year period from july 2014 to july 2016 (cf. the section on the effectiveness of enforcement of fines for offences). table 2: reported traffic offences in south africa (february 2015 to september 2016). the vast majority of the infringements listed in table 2 would have raised the likelihood or human cost of road accidents. these included overloading of vehicles (49.8% of all offences), using vehicles with various defects (15.3%), failure to wear seat belts (6.8%) and speeding (4.3%). it is notable, however, that only 11.7% of all offences were linked to key behavioural risk factors identified by the who (speeding, driving under the influence, failure to wear seat belts and using mobile phones while driving). furthermore, a large portion of the listed offences were not direct causes of road accidents. these included infringements of vehicle licensing laws, which totalled 7.9% of all offences in this period. in addition, 209 457 of the 423 114 offences of driving documents laws represented instances of drivers who held valid professional drivers’ permits or drivers’ licences but were unable to present these when asked to do so by traffic officers. this raises the question whether law enforcement efforts in south africa are focused on the most important causes of road accidents. the focus areas of law enforcement actions section of this article returns to this issue. other proxies also suggest that south africa’s poor road safety outcomes partly reflect risky behaviour probably influenced by informal institutions. international comparisons highlight three examples (cf. world health organisation 2018:302–313, 334–345, 358–369). the first is that 38.4% of the victims of fatal road accidents in south africa in 2016 were pedestrians. the reality that this ratio was lower in 106 of the 129 countries for which the who provided data suggests a relatively high prevalence of risky behaviour among pedestrians in south africa. the second indicator of risky behaviour is the high incidence of alcohol use among road users (including pedestrians). fully 57.5% of all road deaths in south africa in 2016 were attributable to alcohol – a ratio exceeded by only 4 of the 94 countries for which the who provided data. the third is low seat belt usage. in 2016, only 8 of the 76 countries for which the who provided data had lower seat belt usage ratios among drivers than south africa’s 33.0%. enforcement of road safety laws in south africa the evidence presented in the previous section, adherence to road safety laws in south africa, suggests that informal institutions (i.e. the values and norms of many road users) contribute to south africa’s poor road safety outcomes by undermining the effectiveness of the formal institutions (i.e. traffic laws). as was argued in the conceptual framework section of this article, one of the responses available to policymakers when faced with such situations is stricter law enforcement. this section discusses the enforcement of traffic laws and regulations in south africa. the institutional background section sets the scene by outlining the institutional framework governing traffic law enforcement in south africa. against this backdrop, the focus areas of law enforcement actions section comments on the extent of alignment between law enforcement actions and the main causes of deaths and accidents on south africa’s roads, while the section on effectiveness of enforcement of fines for offences confirms the poor functioning of the current adjudication and sanctioning mechanisms. the focus areas of law enforcement actions and effectiveness of enforcement of fines for offences sections use information on traffic law enforcement in the city of cape town to support these arguments. the reason for the focus on cape town is that officials made an unpublished administrative data set of traffic law violations in the city from july 2014 to july 2016 available to the authors. while this reliance on the situation in one city obviously limits the external validity of the argument, there is no compelling reason to assume that the effectiveness of traffic law enforcement is markedly different elsewhere in south africa. in addition, the remainder of this section complements the analysis of the cape town data set with other published information on road safety outcomes in south africa. institutional background the constitution of south africa (act no. 108 of 1996, as amended) apportions responsibility for the making and implementation of road traffic-related legislation among the national, provincial and local governments. schedule 4 of the constitution lists public transport, road traffic regulation, vehicle licensing and municipal public transport among the functional areas of concurrent national and provincial legislative competence. schedule 5 includes provincial roads and traffic, municipal roads and traffic and parking among the functional areas of exclusive provincial legislative competence. some of these matters (municipal public transport, municipal roads and traffic and parking) appear in part b of schedule 4 and part b of schedule 5. section 156 of the constitution assigns executive authority and administrative rights in respect of such matters to municipalities. this division of responsibilities across levels of government has complicated road traffic management in south africa. hence, the rtmc was established in 1999 ‘to pool powers and resources and to eliminate the fragmentation of responsibilities for road traffic management across the various spheres of government’ (rtmc 2016a:16). the rtmc functions at arms length from the department of transport. it has a shareholders committee consisting of the national minister of transport, the members of the provincial executive councils responsible for transport, and two representatives nominated by organised local government. the functions of the rtmc range from training of traffic personnel, provision of road traffic information and vehicle registration and licensing to road traffic law enforcement and adjudication of road traffic offences. the current legal framework for the latter function is the administrative adjudication of road traffic offences (aarto) act (no. 46 of 1998). the aarto act was supposed to have replaced the previous regime in terms of which the criminal procedure act (no. 51 of 1977) was the framework for the administration of all violations of traffic regulations. that system functioned poorly: transgressors paid fines in fewer than 20% of cases related to traffic regulations (aarto background, undated). apart from inappropriate informal institutions (notably a strong culture of non-payment of fines), this state of affairs reflected various shortcomings in formal institutions: some courts resolved to hear only a limited number of cases linked to infringements of traffic laws because of heavy caseloads, aspects of the adjudication process led courts to refuse to consider large numbers of traffic notices, magistrates often reduced traffic fines substantially, and bribing of traffic officials was widespread (aarto background, undated). one of the key objectives of the aarto act is to establish better procedures for the adjudication of traffic law infringements that would encourage compliance with these laws and alleviate the burden on courts of law (aarto background, undated). to this end, the act (south africa 1998) distinguishes between three categories of traffic law violations. while the aarto regulations categorise some violations as ‘offences’ that have to be dealt with by the courts under the criminal procedure act, the majority are categorised as ‘minor infringements’ or ‘major infringements’. the act establishes an administrative process for the adjudication and enforcement of all such infringements. a streamlined fine system and a demerit points system (which provides for the suspension and cancellation of driving licences or permits of repeat offenders) are core components of this process. administrative adjudication of road traffic offences pilot projects were launched in the cities of johannesburg in 2007 and tshwane (pretoria) in 2008. elsewhere in south africa, including cape town, the implementation of aarto has been delayed by legal challenges, inter alia. hence, the criminal procedure act remains the de facto legal framework for traffic law enforcement fully 20 years after the formal adoption of the aarto act. focus areas of law enforcement actions the south african traffic authorities undertake a large number of law enforcement actions every year. from february 2015 to september 2016, for example, the national and provincial traffic authorities held 56 815 roadblocks, stopped 16 233 847 vehicles, weighed 2 950 735 vehicles and tested 211 432 drivers for alcohol (rtmc 2016c:8). the traffic departments of local authorities are also very active. nonetheless, there is much concern about the overall effectiveness of traffic law enforcement. this is confirmed by the generally weak to modest law enforcement scores provided to the who by south african experts (cf. table 3) table 3: expert-provided law enforcement scores for south africa (2009–2018). one of the key aspects of traffic law enforcement is whether the actions of the authorities target the leading causes of road accidents. to explore this issue, the remainder of this subsection compares such causes with the numbers of fines issued by the city of cape town for violations of various traffic regulations. table 4 summarises the leading causes of road crashes in the city of cape town in 2014. the data set provided by the city’s traffic department distinguishes among four types of crashes (those that resulted in deaths, serious injuries, slight injuries and unspecified injuries) and lists more than 50 causes. to compile table 4, the first two types of crashes were combined and the recorded causes grouped into 13 categories. some categories may well overlap (for example, ‘pedestrians’ and ‘hit and run’), but the format in which the data were captured prevents finer-grained classification. seven categories of causes were responsible for 90% of the crashes that resulted in deaths and serious injuries. pedestrians caused more than a third of such crashes. the second most important category was failure to control a vehicle, which caused 15.6% of crashes. this category includes four causes in the data set, namely ‘swerving’, ‘lost control’, ‘drunk in charge’ and ‘blackouts and falling asleep’. hit-and-run incidents (12.0%) and turning and lane changing errors (9.5%, consisting of ‘turning in the face of oncoming traffic’, ‘changing lane while unsafe’, ‘making a u-turn when unsafe’, ‘failing to stay in lane’, ‘no sign of turning’, ‘driving on the wrong side’, and ‘failing to keep left’) were the next most prominent category of causes. these were followed by failure to stop at traffic lights and stop streets (6.3%), other driver errors (5.3%, consisting of ‘did not yield’, ‘entered traffic while unsafe’, ‘vehicle reversed’, ‘driving too fast’, ‘ignored barrier lines’, ‘cut in front of others’ and ‘other’; 6.0%) and failure to maintain adequate following distances. table 4: leading causes of road crashes in the city of cape town (2014). the same seven categories also caused almost 85% of the crashes that resulted in slight injuries. pedestrians (19.6%) were the most important causes of such crashes as well, followed by failure to maintain adequate following distances (18.6%), turning and lane changing errors (13.7%) and failure to control a vehicle (13.2%). it is clear that the vast majority of road crashes in the city of cape town would not have occurred if the formal and informal institutions had significantly reduced these seven sets of causes. a superficial analysis of the fines issued for violations of traffic regulations might suggest that the law enforcement efforts in cape town were too narrow in scope to have prevented the large number of road crashes. south africa’s traffic regulations distinguish among many offences: the data set provided by the city’s traffic department contains 746 distinct types. yet the vast majority of fines are issued for a small subset of these offences. table 5 shows that 68.7% of all fines were issued for the 10 most common offences. seven of these were related to violations of speed limits, two to infringements of vehicle licensing regulations and the tenth for disregarding of no-stopping lines. the next 10 most common offences consisted of a further six violations of speed limits, three infringements of parking regulations, and disregarding of traffic lights. these 20 offences accounted for fully 83.5% of all the fines issued. slightly more than 60% of the fines issued for these offences were for speeding, nearly 30% for licensing-related offences and slightly fewer than 10% for stopping and parking offences. table 5: the 20 traffic offences for which most fines were issued in the city of cape town (july 2014–july 2016). prevention of these offences should contribute to improved road safety outcomes. table 4 shows that failure to stop at traffic lights and stop streets resulted in 6.3% of the crashes that caused deaths and serious injuries in 2014 and 8.1% of the crashes that caused slight injuries. furthermore, one of the purposes of the vehicle licensing regulations is to lower the incidence of defect-related crashes by reducing the numbers of non-roadworthy vehicles. and although it is not included among the causes of road crashes summarised in table 4, speeding is likely to be an important reason for failure to control vehicles and a major determinant of the damages associated with other causes of road crashes (such as collisions with people, animals and objects, hit-and-run incidents, and failures to maintain adequate following distances).6 hence, it is essential to impose fines on violators of these three sets of traffic regulations. yet the statistics on fines suggest that other forms of behaviour that also caused many serious crashes are much less likely to be punished. the most notable of these are jaywalking and dangerous turning, overtaking and changing of traffic lanes. it would be incorrect, however, to interpret the statistics on fines issued as indicative of a lopsided law enforcement effort that focuses excessively on speeding and neglects other major causes of road crashes. the road safety strategy of the city of cape town (2013) for the period 2013 to 2018 shows a strong awareness of the full range of causes of road crashes and contains objectives and action plans for handling each of them. the apparent disjunction between the statistics in table 4 and table 5 largely reflect the reality that some offences are markedly easier than others to detect and fine. the authorities rely heavily on fixed and portable cameras to identify instances of speeding and ignoring of traffic lights and use roadblocks and patrolling officers to identify infringements of licensing and parking regulations. offences such as jaywalking and dangerous overtaking occur at random times in random places, and detection depends on whether traffic officers happen to be in the vicinity. law enforcement, no matter how effective, might not suffice to eradicate such causes of road crashes. hence, section 6 argues that appropriate values and norms (that is, informal institutions) must complement law enforcement to achieve this goal. the effectiveness of enforcement of fines for offences the data set provided by the traffic department of the city of cape town contains various details of each violation of a traffic regulation from july 2014 to july 2016, including a descriptions of the offence, the date of the notice of the offence, the fine issued, whether the charge was withdrawn, and the amount paid (if applicable). this subsection uses some of these details to show that non-detection of behaviour that causes crashes is by no means the only weakness in the enforcement of traffic regulations in south africa. the following analysis confirms another shortcoming already identified and partly explained in the institutional background section of this article: only a small proportion of offenders actually pay the fines imposed for violations of traffic regulations. it transpires from the data set that only 26% of all traffic fines issued in the city of cape town from july 2014 to july 2016 had been paid by the end of august 2016. to be sure, payment patterns over the period as a whole suggested that some of the outstanding fines would have been settled after the end of august. however, such delayed payments would not have had a dramatic effect on the overall payment rate. the basis for this claim is the typical pattern of payments, which is illustrated by the evolution of payment rates for speeding-related fines issued in the second half of 2014 (cf. figure 4).7 hardly any fines were paid in the months of issue, largely because it took time to notify offenders via the postal system. the bulk of compliant offenders paid during the two months after the ones in which fines were issued, and payments decreased notably and steadily in subsequent months. fewer than 2% of fines were paid more than a year after the date of issue. figure 4: evolution of payments for speeding-related fines issued from july 2014 to december 2014 (percentages of issued fines). figure 5 shows that the payment rates for speeding-related fines were significantly higher than those for licensing-related ones in all three years.8 there is no obvious reason for this large differential. figure 5 illustrates another important yet unexplained pattern, namely that payment rates for offences committed in 2016 were markedly lower than those for offences committed in 2014 (the decrease for speeding-related offences was from 52% to 23% and that for licensing-related offences from 8% to 3%). as was shown earlier, payments after the end of august 2016 probably would not have changed this pattern much. hence, it may well reflect the growing realisation among offenders that non-payment has no consequences. figure 5: payment rates for speeding-related and licensing-related traffic fines issued from july 2014 to july 2016 (percentages as at the end of august 2016). it hardly needs to be pointed out that such high rates of non-payment severely diminish the deterrence effect of the fine system. this is an administrative issue that, in principle, should be much easier to resolve than the detection problem discussed in the focus areas of law enforcement actions section of this article. the requirement is a well-designed administrative process that simplifies and expedites enforcement of sanctions for infringements of traffic laws. as was pointed out in the institutional background section of this article, this was the aim of the long-delayed aarto system. conclusion and policy implications this article uses the road safety situation in south africa as a context for exploring ideas from the new institutional economics about the links between informal institutions and the nature and enforcement of formal institutions. by international standards, south africa has a strong suite of road safety laws but poor road safety outcomes. the point of departure of the article is the claim that this state of affairs confirms a core insight of the new institutional economics, namely the pivotal influence on the effectiveness of formal institutions of good enforcement and supportive informal institutions. in support of this claim, the article argues that inappropriate values and norms seemingly underpin the behaviour of many south africans road users and that two major weaknesses mar the enforcement of traffic laws. these are that some of the most important causes of serious road crashes in south africa by nature are extremely difficult to detect and punish and that the administrative and legal processes for punishing transgressors of traffic laws function very poorly. the second problem seems solvable; in fact, a legal framework for this purpose (the aarto act) has been in existence for almost two decades. with the necessary political will, it should be possible to deter many transgressions of traffic laws by more effective penalisation of reckless and negligent behaviour. the first issue is more problematic: in the foreseeable future, technological and resource constraints will continue to hamper efforts by the traffic authorities to credibly threaten all potential offenders with detection and punishment. the policy implication of this analysis is that improvement of road safety outcomes in south africa requires law enforcement reforms, as well as changes to the informal institutions shaping the behaviour of road users. it is clear from policy documents and statements that policymakers are aware of the need for such a two-pronged approach to improving the road safety situation. the following passage in an annual report of the road traffic infringement agency (2015) confirms this: world-wide best practices have proven that for law enforcement to be effective, it must be supported by an equally effective public awareness, communication and education programme, as well as a highly efficient, transparent and expeditious adjudication process to bring traffic offenders to task. (p. 26) outcomes, however, suggest that attempts to augment law enforcement activities with programmes aimed at changing road user behaviour (such as the ‘arrive alive’ campaign – cf. arrive alive 2017) have borne little fruit in south africa. many similar attempts in other areas of policymaking marked by conflict between formal and informal institutions have also yielded disappointing results. this raises the question whether institutional economists understand the requirements for changing values and norms well enough to provide advice that would strengthen such attempts. some economists (e.g. young 1996) have studied the origins of informal institutions, and many theories of institutional change incorporate informal institutions (cf. kingston & caballero 2009). yet much of the existing theoretical work on informal institutions by economists has relied on questionable assumptions about the rationality properties of human behaviour. cognitive and behavioural scientists, however, have made considerable progress as far as understanding change in values and norms is concerned (see, for example, the overview by bicchieri & mercier 2014). thus far, only a small number of economists (including aldashev et al. 2010; denzau & north 1994) have included insights from behavioural and cognitive science into writings on informal institutions. hence, field’s (2007) appeal to institutional economists to take a greater interest in the insights generated by research in these and other disciplines such as biology and neuroscience remains valid. taking heed of this appeal should be a priority for institutional economists working in this field. another rich source of ideas that institutional economists should draw upon more actively is the burgeoning field of behavioural economics. one of the ideas that has emerged from behavioural economics is the notion of a nudge, that is, ‘an aspect of the choice architecture that alters people’s behavior in a predictable way without forbidding any options or significantly changing their economic incentives’ (thaler & sunstein 2008:6). preliminary evidence has suggested that nudges, which should be cheap and easy to avoid, can be useful complements to formal institutions intended to change behaviour.9 various other insights from research in behavioural economics should also enhance institutional economists’ understanding of the forces that shape and change values and norms and, hence, their ability to provide useful advice in settings where such change is an important policy objective. acknowledgements this article is one of the outputs of a project on traffic law enforcement in south africa funded by the national research foundation (nrf) (grant no: 118562). the authors gratefully acknowledge this funding. all errors in this article should be attributed to the authors, and opinions expressed in the article do not necessarily reflect those of the nrf. competing interests the authors have declared that no competing interest exists. authors’ contributions all authors contributed equally to this work. funding information this article is one of the outputs of a project on traffic law enforcement in south africa funded by the national research foundation (nrf) (grant number: 118562). ethical consideration stellenbosch university, research ethics committee: human research (humanities), su-hsd-001857, ethical clearance number: su-hsd-001857, 21 april 2016. data availability statement data sharing is not applicable to this article as no new data were created or analysed in this study. disclaimer the views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of any affiliated agency of the authors. references administrative adjudication of road traffic offences, undated, aarto background, viewed 17 december 2019, from http://www.enatis.com/index.php/statistics/13-live-vehicle-population. aldashev, g., imane, c., platteau, j.-p. & wahhaj, 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national development plan 2030, the presidency, pretoria. north, d.c., 1994, ‘economic performance through time’, american economic review 84(3), 359–368. north, d.c., 2005, ‘institutions and the performance of economies over time’, in c. ménard and m.m. shirley (eds.), the handbook of new institutional economics, pp. 21–30, springer, amsterdam. pejovich, s., 1999, ‘effects of the interaction of formal and informal institutions on social stability and economic development’, journal of markets and morality 2(2), 164–181. polinsky, a.m. & shavell, s., 2007, ‘the theory of public enforcement of law’, in a.m. polinsky & s. shavell (eds.), the handbook of law and economics, pp. 403–454, elsevier, amsterdam. road traffic infringement agency, 2015, annual report 2014/15, road traffic infringement agency, pretoria. road traffic management corporation (rtmc), 2016a, annual report 2015/16, road traffic management corporation, pretoria. road traffic management corporation (rtmc), 2016b, costs of crashes in south africa, road traffic management corporation, pretoria. road traffic management corporation (rtmc), 2016c, traffic offence survey december 2016, road traffic management corporation, pretoria. road traffic management corporation (rtmc), 2019, live vehicle population as per the national traffic information system – enatis, viewed 17 december 2019, from http://www.enatis.com/index.php/statistics/13-live-vehicle-population. south africa, 1998, administrative adjudication of road traffic offences act (no 46 of 1998), government printer, pretoria. statistics south africa, 2017, mortality and causes of death in south africa, 2015: findings from death notification, statistical release p0309.3, statistics south africa, pretoria. thaler, r.h. & sunstein, c.r., 2008, nudge: improving decisions about health, wealth and happiness, yale university press, new haven, ct. voigt, s. & kiwit, d., 1998, ‘the role and evolution of beliefs, habits, moral norms, and institutions’, in h. giersch (ed.), the merits and limits of markets, pp. 83–108, springer, berlin. wijnen, w. & stipdonk, h., 2016, ‘social costs of road crashes: an international analysis’, accident analysis and prevention 94, 97–106. https://doi.org/10.1016/j.aap.2016.05.005 world health organisation, 2009, global status report on road safety 2009, world health organisation, geneva. world health organisation, 2013, global status report on road safety 2013, world health organisation, geneva. world health organisation, 2015, global status report on road safety 2015, world health organisation, geneva. world health organisation, 2018, global status report on road safety 2018, world health organisation, geneva. young, h.p., 1996, ‘the economics of convention’, journal of economic perspectives 10(2), 105–122. https://doi.org/10.1257/jep.10.2.105 footnotes 1. nudging has recently emerged as an alternative or a complementary policy approach for effecting behavioural change (cf. section 6). 2. north’s (1994:359) well-known statement that ‘institutions form the incentive structure of a society’ underscores the salience of incentives in the new institutional economics. 3. voigt and kiwit (1998:84–88) provide alternative definitions of the elements of institutional environments and a well-considered exposition of the relationships between them. 4. this relationship is also captured in the ‘interaction thesis’ formulated by pejovich (1999:171). 5. according to enatis, 10 290 634 self-propelled vehicles were in use in south africa on 31 january 2015. by october 2019, this number had increased to 11 472 664. see road traffic management corporation (2019). 6. other evidence also suggests that speeding is an important, albeit not the dominant, cause of serious road accidents in south africa. the road traffic management corporation (2016c:24–26) reports that inappropriately high speeds caused 9.2% of all fatal accidents in south africa in 2014 and 2015. jaywalking pedestrians were responsible for 41.6% of such accidents, and hit-and-run incidents for 8.8%. 7. the information in figure 4 relates to the 13 speeding-related offences included among the 20 most common fined offences listed in table 4. 8. only those speeding-related and licensing-related offences included among the 20 most common fined offences listed in table 4 are shown in figure 5. 9. the use of ‘speed reduction markings’ on a curve in lake shore drive in chicago is a well-known example of a road safety-related nudge (cf. thaler & sunstein 2008:37–39). these markings are a series of white stripes painted on the road. initially, the stripes are evenly spaced, but they get closer together at the most dangerous part of the curve. this creates the sensation of increasing speed, which makes many drivers slow down. the previously unacceptable number of accidents on that section of the road decreased sharply in the six-month period after the markings were introduced. abstract introduction theoretical background, prior research and hypotheses research data, design and methodology results discussion conclusion acknowledgements references footnotes about the author(s) frank sampong school of management and economics, university of electronic science and technology of china, chengdu, china office of the dean of students’ affairs, kumasi technical university, kumasi, ghana na song school of management and economics, university of electronic science and technology of china, chengdu, china gilbert k. amoako department of accountancy and accounting information systems, business school, kumasi technical university, kumasi, ghana kingsley o. boahene school of management and economics, university of electronic science and technology of china, chengdu, china department of liberal studies, business school, kumasi technical university, kumasi, ghana citation sampong, f., song, n., amoako, g.k. & boahene, k.o., 2021, ‘voluntary social performance disclosure and firm profitability of south african listed firms: examining the complementary role of board independence and managerial ownership’, south african journal of economic and management sciences 24(1), a3346. https://doi.org/10.4102/sajems.v24i1.3346 original research voluntary social performance disclosure and firm profitability of south african listed firms: examining the complementary role of board independence and managerial ownership frank sampong, na song, gilbert k. amoako, kingsley o. boahene received: 09 aug. 2019; accepted: 07 sept. 2020; published: 11 jan. 2021 copyright: © 2021. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: there is growing literature promoting corporate governance mechanisms as important elements that could mitigate the inconclusive findings within the corporate social performance and firm profitability research. a key theoretical assumption within the extant literature that provides support for this proposition is that corporate social performance and firm profitability are organisational outcomes in the presence of good corporate governance. aim: firstly, the aim is to re-investigate voluntary social performance disclosure (spd) and long-term profitability association from the perspective of international standards, using the global reporting initiative g3.1 guidelines. secondly, to examine the joint moderating effect of board independence and managerial ownership (mo) on the voluntary spd and profitability nexus. setting: the south africa institutional setting, where recent corporate governance regimes require firms to voluntarily make corporate governance related disclosures on both shareholder-and stakeholder-related information is used as the study context. method: utilising manually extracted data of listed firms, over the period 2010 to 2015, the generalised least square regression and seemingly unrelated regression (with a 1-year lag as the main independent variable) are used to examine the stated hypotheses. results: we found a positive association between voluntary spd and long-term profitability. we also found that the presence of non-executive directors positively moderates the association between voluntary spd and long-term profitability. thirdly, the proportion of mo significantly positively moderates the association between voluntary spd and long-term profitability. lastly, the complementary role of the presence of non-executive directors and the proportion of mo significantly positively moderates the association between voluntary spd and long-term profitability. conclusion: this study finds support for scholarly theoretical arguments that organisational outcomes are largely possible in the presence of good corporate governance, which has a long-term implication for firms’ shareholder wealth maximisation. this study contributes to the ongoing research examining the notion of substitutive versus complementary effects of governance mechanisms, and a growing research literature on corporate social responsibility (csr) disclosure from the perspective of international standardisation. this study therefore makes far-reaching contributions to the corporate governance and social responsibility literature in an african context. keywords: corporate governance; corporate social performance; complementary/substitutive framework; global reporting initiative; emerging markets. introduction literature contends that corporate social performance (csp) remains an important element since its components of social and environmental stakeholder concerns are likely to affect firm behaviour (stanwick & stanwick 1998) and corporate decision-making (cdm). therefore, previous studies have accorded the csp and firm profitability (fp1) nexus much attention (mcguire, sundgren & schneeweis 1988). nevertheless, to date available evidence remains inconclusive (margolis & walsh 2003). extant literature attributes the inconclusive findings to, among other things, different csr measures and period of examination (de klerk & de villiers 2012), research models adopted and endogeneity issues (li 2016; orlitzky, schmidt & rynes 2003; roberts & whited 2013). consequently, researchers are promoting corporate governance (cg) mechanisms as important elements to mitigate (e.g. arora & dharwadkar 2011; hoje & harjoto 2011; ntim & soobaroyen 2013) the inconclusive findings within csp and fp literature. extant literature provides support by arguing that csp and fp are organisational outcomes in the presence of good cg (aguilera et al. 2008), which has a long-term implication for firms’ shareholder wealth maximisation (swm). thus, the swm principle holds an inclusive, long-term financial goal reflecting investor confidence, which is measured in the face value of the firm’s equity (block & hirt 2002). the cg research has equally investigated the value relevance of boards’ resources (e.g. galbreath 2016; haynes & hillman 2010); in particular, their individual demographic effects (e.g. board independence [bind]) have been examined in isolation with diverse organisational outcomes, including csr. nevertheless, the available evidence still remains mixed. as such, our understanding as to whether or not cg mechanism interactions convey incremental value on organisational outcomes, like csp and fp, is pretty unexplored in the african context. again, in most cases boards have been studied as a separate decision component, outside the scope of management (galbreath 2016). nevertheless, theoretical evidence shows that boards have a collaborative role with management (sundaramurthy & lewis 2003) in cdm. while this research line is arguably limited in the african context, there is an even more lingering research need to explore this notion on voluntary disclosures utilising international standards, due to the emergence of globalisation. the study seeks to re-investigate the voluntary social performance disclosure (spd) and long-term profitability (tq) nexus from the perspective of international standards, using global reporting initiative (gri) g3.1 guidelines. secondly, it seeks to examine the joint moderating effect of bind and managerial ownership (mo) on the voluntary spd and long-term fp nexus. this study is therefore premised on three viewpoints. firstly, we argue that if boards have a collective role, with management, as a unified team to promote shareholder interests, in which mo provides directors or managers with ownership rights, then we propose that their combined effect could harmoniously promote a re-alignment of managerial self-interests with those of shareholders (fama & jensen 1983; jensen & meckling 1976). secondly, we argue that voluntary spd and fp are aligned to firms’ swm, which inevitably becomes a long-term goal benefiting from firms’ strategic posture, since csr actions may require a long period of time to pay off (mahapatra 1984). lastly, this study assumes that boards’ monitoring role and managerial incentive provision are complementary in that their combined interaction is necessary for cdm (galbreath 2016; haynes & hillman 2010), to mitigate the associated financial uncertainty within organisational outcomes, like csp and fp. for instance, it has been asserted that ‘strong social performance may be primarily driven by managerial beliefs’ (mcguire, dow & argheyd 2003:349). this direction of research is relatively unexplored, particularly in the context of less-developed countries context. this study attempts to close this gap in research. the south african (sa) institutional context is used for this study. although, cg and csr research has been extensively examined in sa, this current study further adds to our understanding and consequently makes significant contributions to the cg and csr literature as follows: firstly, it contributes to the ongoing research debate promoting complementary versus substitutive roles of cg mechanisms (misangyi & acharya 2014; oh, chang & kim 2018), particularly at the board management level (galbreath 2016). secondly, it sheds light on a growing literature on international standardisation of social disclosures (e.g. garcia-sanchez 2016; sampong et al. 2018) by providing further evidence in an african context, in support of calls within the broader social and environmental disclosure literature. lastly, and in line with the above two points, this study contributes, in support of calls, to refine the measures of csr and to extend the assessment period within the csr value relevance literature (de klerk & de villiers 2012) from different institutional contexts. the outcome of this study documents a significantly positive moderating influence of the complementary effect of non-executive directors (neds), bind and mo on the association between voluntary spd and long-term profit. this follows an earlier finding of a non-significant positive relationship between voluntary spd and fp. overall, this study finds support for ongoing debates within the extant literature that the inconclusive evidence within the csr–fp nexus could be mitigated by the interaction of cg mechanisms. the remainder of this article is organised as follows: theoretical background, prior research and hypotheses in section 2; research design, data and methodology in section 3; empirical results and additional analysis in section 4; discussion and conclusion in section 5. theoretical background, prior research and hypotheses this section utilises a multi-theoretical view to provide an understanding of previous literature, and formulates hypotheses to achieve the study’s objective. thus, consistent with extant literature, we employ the following theories: legitimacy, stakeholder, agency, resource-dependence theory (rdt), good management theory, complementary theory and complementary asset perspective (cap). thus, consistent with extant literature these theories are largely harmonising in nature rather than opposing (reverte 2009), and provide a richer background to explore the study’s aim as a result of their commonality and compatibility. voluntary social performance disclosure and firm profitability nexus two contradictory hypotheses emerge when we consider the effect of csp on fp. the ‘social impact hypothesis’ – which assumes that meeting the needs and expectations of various stakeholders increases firm value – and, secondly, the ‘trade-off hypothesis’, which assumes that csp increases results in firms incurring unnecessary costs which so lead to a reduction in value (donaldson & preston, 1995). this puts socially proactive and responsible firms at a disadvantage compared with less socially active ones (peng & yang 2014; preston & o’bannon 1997). the csp and fp nexus has extensively garnered prior research, with some widely cited groundbreaking studies (e.g. mcguire et al. 1988; orlitzky et al. 2003). nevertheless, to date the available empirical findings remain largely mixed and inconsistent (mcguire et al. 1988). advocates of a positive csp–fp nexus hold a view that not only may voluntary csp be considered a business objective in itself, but it also serves as a means to an end with regard to fp. on the other hand, those who found a negative relationship suggest that firms’ investment in voluntary csp diverts funds that could have been channelled into other productive investments (peng & yang 2014; preston & o’bannon 1997). as argued in extant literature, the mixed findings within the csp–fp nexus have also been attributed to: methods, model specification and endogeneity issues (e.g. li 2016; orlitzky et al. 2003; roberts & whited 2013) and the social disclosure patterns across different industries and the institutional microand macro-settings (e.g. garcia-sanchez et al. 2016, tshipa et al. 2018), due to associated costs and benefits with diverse industry features. the sa context makes an interesting case to examine voluntary social disclosures, specifically due to its long history of racial segregation, termed apartheid, which resulted in many social disadvantages to the majority of the sa population (southall 2004). consequently, sampong, boahene and kweitsu (2018) contend that the practice of social disclosures has mainly been influenced by ‘apartheid’. nevertheless, the unique cg codes have voluntarily promoted social disclosure in line with international standards. specifically, the king iii cg report recommends that all entities in sa should promote a voluntary disclosure regime based on the third-generation reporting standard (gri, g3) (iodsa, 2009). supporters of social and global reporting standards have equally long contended that social disclosures offer reporting organisations a wide spectrum of intangible benefits, which extends to the firm’s balance sheet (adams 2004). although evidence of the csp–fp nexus has generally been mixed, theoretical understanding generally supports a positive direction (orlitzky et al. 2003). in the sa context, a study that examined inclusion on the johannesburg stock exchange (jse) socially responsible index and fp found no association using logistic regression (du toit & lekoloane 2018). de klerk and de villiers (2012), using a modified ohlson model, found that corporate responsibility reporting is significantly positively related to market value. horn, de klerk and de villiers (2018) using survey data by kpmg international on csr contend that social disclosure has a positive but weak effect on future profits. the advent of socially responsible behaviour, linked to international standardisation, through sustainability reports, ultimately seeks to ensure the long-term sustainability and survival of organisations, while maximising shareholder value and fp. thus, socially responsible behaviour can be a competitive advantage to ensure firms’ long-term profitability. socially responsible behaviour (and its related disclosure practices) is a management practice that ensures an organisation maximises the positive impact of its operations on society in a manner that meets and exceeds the legal, ethical and public expectations. therefore, social responsibility creates a positive long-term value for shareholders even in conditions of uncertainty (mcwilliams & siegel 2000). for instance, waddock and graves (1997) found that an increase in csr could lead to enhanced long-term profitability. supporters of international disclosure standards on social responsibility have long contended that disclosure offers reporting companies a positive impact on fp. studies specifically covering transparency and disclosure have indicated a positive market reactions, which could lead to a corresponding impact on firm value (adams 2004). therefore, based on the available empirical and theoretical evidence within the extant literature that socially responsible behaviour leads to a positive impact on firm profits (orlitzky et al. 2003), we hypothesised that: h1: ceteris paribus, voluntary spd is positively associated with long-term profitability. moderating role of non-executive directors on voluntary social performance disclosure and firm profitability nexus the call for appropriate representation of neds on boards (i.e. board independence) has largely been based on agency theory (at) and rdt. agency theory asserts that boards have a monitoring and controlling role over managers due to their opportunistic behaviour (fama & jensen 1983; jensen & meckling 1976). for instance, outside directors have more opportunity for control and face complexities stemming from their responsibilities as directors (mangel & singh 1993). resource-dependence theory notes that the existence of boards serves as an essential link between firms and their critical resources needed to maximise value (pfeffer 1973:350). for example, neds offer essential resources, by promoting board independence (haniffa & cooke 2002:319) towards voluntary social disclosures. thus, rdt proposes that the unique composition of boards, including expertise, is a firm’s resource (hillman & dalziel 2003) that could affect its value (pfeffer & salancik 1978). in particular, rdt views the board composition as firms’ value-added resources. for instance, larger boards with professionals increase the firm’s expertise and resources (pfeffer & salancik 2003). boards perform a critical supervisory and monitoring role, which is central to ensure that managers act in the best interest of shareholders (fama & jensen 1983; jensen & meckling 1976). in spite of the trade-off that may exist between social disclosure and fp, prior research argues that managers may undertake social responsibility activities for their own benefit, such as public fame, at the expense of their firms’ swm goal. for instance, managers may seek to divert stakeholders’ attention from a poorly performing firm by improving its csr activities (preston & o’bannon 1997). on the other hand, managers may reduce csr overheads in order to boost short-term gains to enhance their personal rewards. these two views show that at the board management level, social disclosure could be used as a signal towards managerial benefits, which could have an adverse effect on firm value whenever managers act unfavourably towards stakeholder interest (baird, geylani & roberts 2012). therefore, towards re-aligning the principal agency conflicts is the promotion of good cg. prior researchers have argued that csr disclosure may have a limiting effect on firm value (horn et al. 2018; sampong et al. 2018) and that because of this possibility, the associated benefits of csr disclosure for firms are largely dependent on good cg (aguilera et al. 2008). therefore, the existence of good cg, in particular bind, could avert corporate irresponsibility. this could lead to an enhanced positive effect of voluntary spd on fp. the reverse is a situation that can aggravate conflicts among various stakeholders (hoje & harjoto 2011) and could result in poor cdm benefits from ineffective cg. in the sa context, the promotion of bind has been advocated by cg codes. for instance, formal cg regimes have sought to largely promote bind. the 2009 cg code of sa, king iii (iodsa, 2009), requires boards to have the majority of neds to facilitate increased monitoring, towards shareholder and stakeholder cg-related disclosures (gyapong & afrifa 2019). the extant literature found a positive impact of the presence of neds on social disclosure and fp (ntim & soobaroyen 2013). from the available empirical findings, one can establish that the proportion of neds should potentially have a positive moderating impact on the association between social disclosure and fp. arguably, the presence of neds on boards provides positive growth, with potentially positive implications for fp and voluntary disclosure (ntim & soobaroyen 2013). hence, we hypothesised that: h2: ceteris paribus, the presence of neds on boards will enhance the positive voluntary social performance disclosure and long-term profitability nexus. moderating role of managerial ownership on voluntary social performance disclosure and firm profitability nexus agency theory suggests that mo has the potential to align the divergent interests of managers with those of shareholders. hence, extant literature empirical evidence shows that mo impacts on organisational outcomes. johnson and greening (1999), for instance, found a positive relationship between top management’s equity and csp. the good management theory asserts that there exists a positive association between csp and firm value (graves & waddock 1994); if so, then mo could promote a more active voluntary social disclosure among managers. hence, the conclusion could hold that mo might enhance initiatives to engage more in voluntary social disclosure in support of fp. this is because managers have power to allocate resources among the wider stakeholder group; hence the provision of managerial incentives (e.g. stocks and bonds) could be an effective way to mitigate associated agency conflicts, and to help align the conflicting interest of agents to those of the owners (fama & jensen 1983; jensen & meckling 1976). more so, where managers own a significant part of the firm’s equity, decisions regarding promoting csr could be better achieved (mcconnell & servaes 1990). however, it has arguably been noted that the different institutional contexts largely exhibited, due to wider differences in development (e.g. garcia-sanchez et al. 2016; sampong et al. 2018), may affect voluntary disclosure differently in developing economies. campbell (2007) argues that developed economies (like the united states and united kingdom) may impose greater institutional pressure (campbell 2007) on managers to undertake more socially related disclosures. however, in developing countries, like sa – where investor protection is relatively low as a result of a weaker external regulatory environment (laporta et al. 2000) – managers may not be subjected to mandatory forms of pressures. unlike the united states and united kingdom, ownership within sa companies is typically characterised by high block and institutional ownership, mainly in the form of complex cross-ownerships and tall pyramids. nevertheless, sa cg codes encourage directors and managers to own shares in companies in order to improve interest alignment, including specifying performance-related elements of director pay (barr, gerson & kanto 1995). for instance, evidence within extant literature supports a positive relationship between top management equity ownership and csp (johnson & greening 1999). by implication, mo should enhance initiatives to engage more in voluntary social disclosures in support of long-term profits. this is because managers have power to allocate resources among wider stakeholder groups, and so, whenever managers own significant part of firms’ equities, decisions regarding promoting csr and its related disclosure could be achieved much easier, which should lead to increased profitability. from the above, we hypothesised that: h3: ceteris paribus, the percentage of managerial shareholding will enhance the positive voluntary social performance disclosure and long-term profitability nexus. complementary role of non-executive directors and managerial ownership on voluntary social performance disclosure and firm profitability nexus the complementary theory (aguilera et al. 2008:483) and cap (dierickx & cool 1989; galbreath 2016) both highlight the collective nature of boards and management in cdm. complementary theory presents a more integrative view of cg that considers how governance elements interact and potentially complement each other (aguilera et al. 2008) to impact on cdm, including voluntary disclosure. inherently, extant literature notes that because there may be great difficulty and uncertainty involved in observing executive behaviours, as well as in measuring performance outcomes in corporations, managerial incentives and boards’ monitoring role may necessarily function as complements, as the two must be present for effective governance (aguilera et al. 2008; galbreath 2016; milgrom & roberts 1992). in a similar vein, and as implied by the rdt (pfeffer & salancik 1978, 2003), cg structures are critical firm resources that are used to achieve organisational goals. hence for effective cdm, the firm’s resources must be uniquely combined to achieve success (misangyi & acharya 2014). this supports the cap. the cap suggests, for instance, that there are ‘strong relations of complementarity and co-specialization among individual resources, so that it is not really the individual resources but rather the way resources are clustered and how they interact’ (foss 1998:143), which is important for competitive advantage. thus, cap holds that the effective applicability of the firm’s resources means that there exists a bilateral dependence among the resources (galbreath 2016). as such, it has been argued that anything that is a strength or weakness to the firm can be considered as a resource (wernerfelt 1984). for instance, aguilera et al. (2008) suggested that ‘performance incentives for executives are more effective when complemented with a high level of board independence and an effective market for corporate control’ (as cited in misangyi & acharya 2014). evidence on the effect of board independence on voluntary csr and firm value supports a positive effect. similarly, the impact of mo has been found to be positive. arguably, these mechanisms are firm resources that aid the swm goal. as such, it is believed that all individual units are contributors towards the firm’s swm and its overall survival. hence, we argue that the complementary interaction of the firm’s available resources is particularly necessary towards the achievement of optimal organisational gains. for instance, aguilera et al. (2008) suggested that ‘performance incentives for executives are more effective when complemented with a high level of board independence and an effective market for corporate control’ (as cited in misangyi & acharya 2014). from the aforementioned theoretical and empirical evidence, we could conclude that cg mechanisms, from the perspective of utilising them as complements, should have a high marginal impact on the different organisational activities, compared with their individual effects. thus, the board management monitoring roles and performance incentives must be present for effective governance and cdm (galbreath 2016; milgrom & roberts 1992). therefore, from the above, we could argue that the firm’s monitoring functions and incentive alignment are necessary to mitigate the agency conflict. hence, the following hypothesis is formulated: h4: ceteris paribus, the complementary effect of the proportion of neds on board and percentage of managerial shareholding will incrementally enhance the positive voluntary social performance disclosure and long-term profitability nexus. research data, design and methodology sample selection and data this study utilised an unbalanced data set of 126 listed jse firms during the 2010 to 2015 period. data were obtained from the african market database. we excluded firms with more than 2 years missing data and all financial institutions, which produced total firm-year observations of 747. our data set indicates both cross-sectional and time series components. hence, given the nature of the data and to allow for time series and cross-sectional data observations, this study employs a panel regression technique. this is consistent with extant literature. south africa is chosen as our study context because of its many unique features that seek to promote good cg and social disclosure. for instance, cg in the sa context has arguably been noted as well developed, which compares well with most developed and middle-income economies. again, although the sa cg regimes stress the need to comply with affirmative actions, it equally endorses a voluntary disclosure regime based on international reporting standardisation (sampong et al. 2018). variables description and measures dependent variable tobin’s q (tq) is the dependent variable, which is a measure of long-term fp. this measure of fp has extensive coverage and usage in extant literature (e.g. sampong et al. 2018; waddock & graves 1997). tobin’s q reflects the market’s expectations of future earnings, which is a measure of expected future prospects of the firm (waddock & graves 1997). this measure has a long-term implication for firms’ swm objective. other forms of fp, like return on assets (roa) and return on equity (roe), are short-term profits which aid the day-to-day running of the organisation, hence we control for their effects in this study. independent variable social performance disclosure is the main independent variable, which is an index constructed through the manual extraction of socially related disclosure information in annual and csr reports of sample companies. the information collected was then analysed in line with the 45 indicators on social performance of the gri g3.1 guidelines2, to ascertain the extent of voluntary spd. the use of the gri g3.1 guidelines was motivated by recommendations of the 2009 sa cg code of sa, which encourages all entities in sa to follow and report, based on the third-generation gri guidelines to promote international standardisation in the sub-saharan african region, king iii (iodsa, 2009). the gri guidelines feature a modular, interrelated structure, and represent the global best practice for reporting on a range of social issues, and have generally been acknowledged as a leader in international standards (mahoney et al. 2013) and regarded a primary tool for disclosure, due to their wide applicability. prior research suggests that content analysis provides valid results for social disclosure research, allowing the researcher to appraise the extent of various items’ disclosure (e.g. krippendorff 2004; guthrie et al. 2004). a key issue in content analysis research is the unit of measure, which is an identifiable component of communication through which variables are measured. the application of content analysis includes word count, sentences or sections, or reading the whole text, the use of advanced software packages to extract information from reports and a dichotomous variable technique (e.g. krippendorff 2004). we used the latter as it has extensive usage in disclosure research, and has proven to be reliable. hence, this study follows prior disclosure research that used a disclosure index and the binary coding technique. the issue of reliability and approval of the quality of content analysis adopted also becomes very important. therefore, to increase reliability and minimise bias (potter & levine-donnerstein 1999), every effort was made by the authors to remain objective in the scoring and coding process. as such, all socially related disclosure information in annual and csr reports were analysed and coded twice and, subsequently, scores compared by the authors to ensure that all relevant information was captured and interpreted correctly. a disclosure index spdit was calculated by: in equation 1, mit is maximum expected score for each category, j is the company, i is the items and xit assumes a value of 1 if a firm disclosed an item, otherwise 0, so that, spdit lies between 0 and 45. however, where a provision does not apply to an industry, we neither score nor penalise. moderating variables the notion of bind is largely promoted in sa cg codes, towards the effective monitoring of boards for both shareholderand stakeholder-related disclosures. for instance, king iii specifically sought to ensure sa bind towards effective board monitoring by, for instance, advocating for a unitary board structure with majority neds3 (gyapong & afrifa 2019). managerial ownership is an essential cg mechanism that can reduce agency problems by aligning the interests of shareholders and managers. extant literature suggests that as the proportion of equity owned by managers increases, their interests will align increasingly more with those of shareholders, denying them the luxury to indulge in opportunistic behaviours (fama & jensen 1983; jensen & meckling 1976). following extant literature, mo is measured as the percentage of managerial shareholding.4 control variables this study employs several control variables to mitigate potentially omitted variable bias. thus, we include these variables in all our regression models to account for factors other than the theoretical constructs of interest that could explain variations in the variables of interests. we rely on extant literature (e.g. arora & dharwadkar 2011; sampong et al. 2018; tshipa et al. 2018; waddock & graves 1997) to select our control variables. these are firm size, firm age, capital expenditure, leadership structure, operating profit, presence of a csr committee and leverage. the extant literature finds mixed evidence on the effect of these control variables on csr and fp. we predict that the effects of the control variables on the dependent and independent variables will be consistent with the mixed findings within the existing literature. finally, we control for variations across time and industry, by including year and industry dummies (see table 1 for all variable description). table 1: variable description. results descriptive statistics and correlation matrix table 2 presents a summary of descriptive statistics (i.e. mean and standard deviation) and the inter-construct spearman correlation matrix for the study variables (excluding industry and year-dummies). it shows a mean of 1.974 for tq, suggesting that, on average, most sample companies exhibited a positive long-term fp over the review period. also, spd has a mean of 0.690, suggesting that, on average, the extent of voluntary spd among sample companies, on the basis of the gri–g3.1 guidelines, was approximately 69%, which is reasonably high. also, the mean for neds (bind) is 0.272, suggesting that, on average, there are about 27% neds on the sample companies’ boards over the study period. additionally, mo has a mean of 5.912, suggesting that, on average and across the sample firm-years, managers’ share-ownership was approximately 6%. table 2 also presents the correlation among the variables. the spearman correlation matrix was utilised as a measure of the strength and direction of association. table 2 reveals the following associations: spd is significantly negatively related to tq. non-executive directors is positively related to tq and spd, while mo is negatively related to tq and spd. table 2: descriptive statistics and correlation matrix. panel regression method our final data set produced unbalanced data as there were some missing years; hence, to take advantage of the variations in the variables of interest over time, an unbalanced regression panel is employed. however, before deciding on an appropriate estimation technique, and consistent with extant literature (e.g. haniffa & hudaib 2006), preliminary tests are performed. we assess multicollinearity using the correlation matrix (table 1), which shows multicollinearity is non-existent. we also use the variance inflation factors (vifs), which show a range of 1.02 to 0.98 (with tolerance levels ranging from 0.83 to 0.98). the range of vifs falls outside the conventional threshold of 10 (kennedy 1998). lastly, we test for internal consistency of voluntary spd index using the cronbach’s alpha test. the outcome shows an overall coefficient alpha of 0.724, which is indicative of internal reliability (potter & levine-donnerstein 1999). the unbalanced nature of our data set indicates that the use of an ordinary least square (ols) regression method may not be appropriate, as it assigns equal weight to each observation and does not use information relating to unequal variability within the data. the generalised least square (gls) regression, however, can produce more accurate estimators in the presence of outliers and unequal data variability, because it accounts for such information. it is equally able to capture firm-specific effects and also able to control for individual heterogeneity within the data set (e.g. tshipa et al. 2018). econometric model estimation the econometric model is employed to test the stated hypotheses: in equation 2, b0 is the intercept, e is the error term and controls is the control variables. all variables are as defined in table 1. hypotheses testing and findings in table 3 the model fit information shows that all the regression models are statistically significant which indicates a better model fit, and reflects the model’s adequacy. wald’s chi-squared test is used to test the level of representation, which is also dependent on the significance levels, allowing for the acceptance or rejection of the models. hence, all the models show significant adequacy. in table 3, all models’ wald’s chi-squared values are statistically significant (at 0.0001) for a 95% confidence level. this suggests that common method bias may not be a problem in our analysis (e.g. podsakoff et al. 2003). in total, three models were estimated to test the stated hypotheses. however, consistent with prior studies (e.g. galbreath 2016; oh, chang & cheng 2018) we first test the control variables effects separately on tq and spd, in baseline model 1. our approach may slightly differ from previous studies, because this study examines the relationship between voluntary spd and fp. the results are largely consistent with mixed findings within the extant literature: showing positive, negative and non-significant effects (see table 3, model 1 and model 2). table 3: generalised least square regression results examining the moderating role of board independence and managerial ownership on the voluntary social performance disclosure and firm profitability nexus. voluntary social performance disclosure and firm profitability nexus table 3, model 2 tests the direct relationship between voluntary spd and tq. we modelled spd, including all the control variables, on tq. h1 suggests a positive voluntary spd and long-term fp nexus. the outcome, table 3, model 2, supports our prediction of a positive relationship (β = 0.059). hence, our finding is consistent with the general positive theoretical notion in extant literature. earlier researchers that found a positive relationship are de klerk and de villiers (2012), as well as spicer (1978). hence, our finding for h1 supports the ‘social impact hypothesis’. moderation test of board independence and managerial ownership the test for moderation follows recommendation by dawson (2014) that an important decision to make before starting the moderation process is whether to use the independent and moderator variables in their raw form or to standardise them. we employed the latter. h2 and h3 suggest that the individual moderating effects of neds (bind) and mo will enhance the direct positive voluntary spd and fp nexus. in model 3, both the two-way interaction terms (i.e. spd*neds and spd*mo) are added to the analysis, because multicollinearity was non-existent (schroeder 1990). firstly, table 3, model 3 supports our prediction for h2. the moderating effect of neds (bind) on the voluntary spd and fp nexus is positive (β = 0.086) showing an increase of β = 0.027, compared with model 2; however the effect was non-significant. based on this we argue in favour of a partial moderation effect of neds (bind). secondly, the moderating effect of mo, table 3, model 3, is significantly positive (β = 0.346; p ≤ 0.01) on the association between voluntary spd and fp. hence, h3 is also supported. finally, h4 examines the existence of a complementary role of neds and mo. model 4 adds the three-way interaction term (i.e. spd*neds*mo) to the analysis. the results in table 3, model 4 show that the combined effect of neds (bind) and mo was significantly positive (β = 0.466; p ≤ 0.05), moderating the direct positive voluntary spd and tq nexus. hence, h4 was also supported. additional analysis this section attempts to deal with the problem of endogeneity, which has arguably been identified in the extant literature as the single most common issue in cg research. as such, ignorance of endogeneity issues may result in unreliable causality inferences (roberts & whited 2013; tshipa et al. 2018). arguably, variables are typically endogenous, instruments are scarce and causality relationships are complicated; nevertheless, it has equally been argued that most econometric methods utilised in extant literature are effective remedies to mitigate endogeneity issues (li 2016). therefore, we examine the robustness of our main findings in table 3 compared to another modelling technique. hence, we employ the seemingly unrelated regression (sure) model, with a 1-year lagged independent variable. thus, we introduced a 1-year lag between spd and tq, such that profitability in a given year (i.e. tqt) depends on the previous year’s voluntary spd (i.e. spdt−1) (sampong et al. 2018). seemingly unrelated regression produces efficient estimates in cases of non-identical prediction equations. this is achieved by weighting the estimates by the covariance of the residuals from the individual regressions (greene 2008; kennedy 1998). in table 4, and consistent with the procedure followed in the main findings, three models were estimated to test the stated hypotheses using the sure (with a 1-year lag of spd) to test the robustness of our earlier findings, utilising the econometric model below: table 4: seemingly unrelated regression results examining the moderating role o f board independence and managerial ownership on voluntary social performance disclosure and firm profitability nexus. in equation 3, b0–5 are the intercepts, e is the error term, spdiit−1 is the 1-year lag of a main independent variable and controls are the control variables. all variables are as defined in table 1. the baseline table 4, model 1 tests the effect of all control variables on tq and spd producing r2 values of 0.167 and 0.515. table 4, models 2–4 indicate a better model fit; particularly all chi-squared values are statistically significant at 0.0001. table 4, model 2 shows a positive (β = 0.078) direct voluntary spd and fp association in the long term, with r2 and δr2 values of 0.170 and 0.003. thus, again h1 is supported. table 4, model 3 reveals r2 and δr2 values of 0.187 and 0.018. again, it shows that neds (bind) positively (β = 0.108) moderates the direct positive voluntary spd and fp nexus, when compared with the outcome in table 4, model 3 (β = 0.078). again, the effect is non-significant. table 4, model 3 again shows a significantly positive (β = 0.393; p ≤ 0.01) moderating effect of mo on the direct positive voluntary spd and fp nexus. hence, h2 and h3 are all supported. lastly, table 4, model 4 (with r2 and δr2 values of 0.194 and 0.006) shows that the interactive effect of neds and mo significantly positively (β = 0.398; p ≤ 0.05) moderates the direct voluntary spd and fp nexus in the long term. the results in table 3 and table 4 show that the study’s findings are robust, with only changes in the coefficients in table 4 due to the 1-year lag of the independent variable. hence, the results are qualitatively robust. discussion this study examines the complementary role of neds (bind) and mo on the voluntary spd and long-term fp nexus. although there is growing research examining the bundle usage of cg mechanisms on organisational outcomes, most prior studies have focused on developed countries, with relatively limited research in less-developed economies. therefore, this study attempts to bridge this gap in extant literature. based on 126 manually extracted unbalanced data of listed companies on the jse and utilising the 45 provisions of the gri-g3.1 guidelines on social performance indicators, as a measure of voluntary spd, this study finds support for all four stated hypotheses, based on the gls and sure (with 1-year lag of the main independent variable). firstly, this study found a positive voluntary spd and long-term profitability association for h1. secondly, the proportion of neds positively moderates voluntary spd and long-term profitability association for h2. thirdly, the percentage of managerial share-ownership and significantly positively moderates voluntary spd and long-term profitability association for h3. lastly, we document a significantly positive moderating effect of the complementary effect of neds (bind) and mo on the association between voluntary spd and long-term profitability. the finding of h4 suggests that the multiplicative effects at the board management level are significant to mitigate agency problems in the long term. this particular outcome is consistent with previous studies that examined the complementary role of cg mechanisms on organisational outcomes, like csr. for instance, galbreath (2016) shows that a senior csr manager appears to complement the board, positively moderating the impact of board resources on csr. similarly, misangyi and acharya (2014) found that high profits result when ceo incentive alignment and monitoring mechanisms work together as complements. hence, this study provides support for ongoing debates within the extant literature promoting the complementary or substitutive effects of cg mechanisms, in an african context. importantly, it provides new additional evidence which is very important to present a much more complete understanding and picture of the ongoing debate within the extant literature, in different institutional contexts. conclusion practically, the study’s findings should be of interest to the sa corporate market, and the sub-saharan african region. for instance, although sa cg regimes promote bind, it is suggested that their application should be done with caution, bearing in mind the associated costs and benefits, at different stages of the business life cycle. thus, we predict that at any organisational stage (i.e. short, medium and long terms), performance should be a reflection of the available monitoring roles and incentive provisions. for instance, as advocated by the king iii code, section 2:18:4 (iodsa, 2009), boards should consider whether their levels of diversity make them effective; they should be tied to the proportion of board management monitoring roles and incentive levels at each stage. theoretically, we contribute by exploring a multi-theoretical view within the cg and csr literature, recognising that there may be limitations with respect to using a single theory to explore the unique role of cg mechanisms on voluntary social disclosure and profitability, given the multiplicity within corporate motivations. although this study extends our understanding on bundle usage of cg mechanisms on voluntary spd, future research avenues have been identified for further investigation. firstly, this study examines the complementary role of cg mechanisms on voluntary spd and long-term profitability. future studies could re-examine the complementary or substitutive roles of cg mechanisms on different csr measures, like environmental disclosures. in addition, this study in the sub-saharan african context is only limited to sa. future research could utilise a cross-country data set to add to our understanding in different institutional contexts. lastly, future research could look at other board diversity measures, like the complementary or substitutive role of women and ethnic minorities. overall, this study presents corporate regulators, boards and management, and policymakers with additional insight into pursuing an ‘appropriate mix’ using cg mechanisms at different stages of the organisation. acknowledgements the authors would like to thank the anonymous reviewers for their time and suggestions which were most helpful in refining and improving this article. the authors gratefully acknowledge the financial support of the ministry of education of humanities and social science grant of china (grant number: 17yjc790127). competing interests the authors have declared that no competing interest exists. authors’ contributions f.s. was responsible for conceptualisation of the study, data collection, cleaning, literature review, research design and methodology, analysis and interpretation of results, and drafting and reviews of the manuscript. s.n. was responsible for supervision and guidance on all aspects of this article. g.k.a. and k.o.b. were involved in data collection, cleaning, coding, literature review, methodology, analyses and interpretation of results, and reviews of the manuscript. all the authors read and approved the manuscript before its submission. 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https://doi.org/10.1002/(sici)1097-0266(199704)18:4%3c303::aid-smj869%3e3.0.co;2-g wernerfelt, b., 1984, ‘a resource-based view of the firm’, strategic management journal 5(2), 171–180. https://doi.org/10.1002/smj.4250050207 footnotes 1. in this article, we denote the general notion of firm profitability, firm financial performance and firm performance with the term fp. 2. available at https://www.globalreporting.org/resourcelibrary/g3.1-guidelines-incl-technical-protocol.pdf 3. non-executive directors are those highlighted as outside directors or neds in the companies’ annual reports. 4. managerial share ownership are those indicated under shareholder types or analysis for directors and managers in the annual reports. abstract introduction literature review research design and data collection results discussions and recommendations concluding remarks acknowledgements references about the author(s) liesel botha school of accounting sciences, faculty of economics and management sciences, north-west university, potchefstroom, south africa susanna l. middelberg school of accounting sciences, faculty of economics and management sciences, north-west university, potchefstroom, south africa citation botha, l. & middelberg, s.l., 2020, ‘corporate political activity as part of enterprise strategy in south african agribusinesses’, south african journal of economic and management sciences 23(1), a3219. https://doi.org/10.4102/sajems.v23i1.3219 original research corporate political activity as part of enterprise strategy in south african agribusinesses liesel botha, susanna l. middelberg received: 05 june 2019; accepted: 14 feb. 2020; published: 28 may 2020 copyright: © 2020. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the south african agricultural sector is facing regulatory uncertainty relating to land reform and distribution, restrictive labour policies and minimum wages. corporate agribusinesses play an important role in the agricultural industry. increasing political influence on their activities manifested in the lack of government support, and the uncertainty surrounding public policy threatens investment and growth in the sector. this calls for an intelligent integrated enterprise strategy that includes corporate political activity (cpa). setting: four south african agribusinesses and two agricultural associations. aim: the purpose is to explore the cpa adopted by corporate agribusinesses and agricultural associations in terms of enterprise strategy during times of regulatory uncertainty. method: qualitative data were collected through semi-structured interviews. a questionnaire, consisting of sections focused on regulatory uncertainty, responses to regulatory uncertainty and strategy, was completed during the interviews. results: the participants experience significant regulatory uncertainty. there is a clear distinction between the strategic approach to cpa followed by corporate agribusinesses and agricultural associations. the parties surveyed pursue a combination of cpa strategies. a desire for greater cooperation and shared prosperity with government is evident, supported by a strong sense of conducting business ethically, traced across the results. conclusion: this article addresses the role that cpa plays in an integrated enterprise strategy – especially in times of regulatory uncertainty – such as the agricultural industry in south africa is experiencing. it not only reports on the cpa approach of both corporate agribusiness and agricultural associations, but also describes the strategies agribusinesses follow during times of uncertainty. keywords: corporate political activity; enterprise strategy; agribusiness; agricultural associations; policy uncertainty; south africa introduction the south african agricultural landscape is facing regulatory uncertainty with the government having influence over restrictive labour policies, minimum wages, as well as land reform and distribution (chamberlain & anseeuw 2018; hall 2004; middelberg 2013; ortmann 2005). with increased political influence, the ability of businesses to affect government policy forms part of an integrated enterprise strategy (kingsley, berg & bonardi 2012:53; liedong et al. 2015:408). schendel and hofer (1979:12) described enterprise strategy as the role of the firm in its broader social, legal and political (i.e. non-market) environment. corporate agribusinesses play an important role to influence public opinion in such non-market environments (griffin & dunn 2004). especially as the leadership of corporate agribusiness and large-scale commercial farming has seen consolidation over the last two decades within agricultural value chains (hall & cousins 2018:12). increasing political influence on south african agribusinesses, manifested in the apparent lack of government providing support services (khapayi & celliers 2016:39) and policy uncertainty (hendriks 2013:3), threatens development in the sector (smith 2016). this calls for an intelligent integrated enterprise strategy that includes corporate political activity (cpa) – concisely defined as activities aimed at influencing governmental regulations and policies in favour of corporate agribusiness (hillman, keim & schuler 2004; lawton, mcguire & rajwani 2013; mbalyoherea & lawton 2018:369). the south african agricultural sector is considered one of the most employment-intensive sectors of the country’s economy with primary agriculture employing 4.5 additional workers for every zar1 million in capital invested (in comparison with 2.94 for the economy as a whole) (boshoff, sihlobo & ntombela 2018:4). taking into account its indirect role in terms of the backwards and forwards linkages with other sectors, it contributes almost 7% to gross domestic product (gdp) (boshoff et al. 2018:4; south african government 2016). the insight that collaboration with a broad range of stakeholders – including government in the political arena – influences corporate value creation and ultimately business sustainability has moved the focus away from shareholder value as the main management concern (crilly 2013). this echoes baron’s (1995) work that non-market strategies become more important where opportunities are controlled by government. uncertainty regarding, among others, land policy (chamberlain & anseeuw 2018; hall 2004), development financing (ncube 2018:89) and water policy (fanadzo & ncube 2018:436; greenberg 2010) is making it increasingly less likely that investors would consider the agricultural sector as an investment option (vorster et al. 2016). this is also considered one of the reasons why the average age of farmers in south africa is increasing. the younger generation is not willing to farm due to the policy uncertainty and political statements by government (willemse, as cited by booysen 2016). furthermore, government does not yet have a ‘scalable solution for making agriculture more remunerative’ for the youth (swarts & aliber 2013:26). the question arises: do south african agribusinesses address this regulatory uncertainty through cpa as part of enterprise strategy? and if so, which cpa strategies do they follow? the term agribusiness includes, for the purposes of this article, all businesses involved in the management of multiple value chains that deliver goods and services by sustainably coordinating food, fibre and renewable resources to serve national and international consumers, as well as those that provide finance and other market advisory services to primary producers (middelberg 2011; shultz & edwards 2005). the extant literature is primarily focused on cpa’s relationship with firm performance – that is, whether cpa leads to improved firm performance (boubakri, cosset & saffar 2012; curran & eckhardt 2018; hadani & schuler 2013; hillman et al. 2004; liedong 2013; mellahi et al. 2016; wu et al. 2012). limited research (moodley 2013) has been done on the relationship between cpa and an integrated enterprise strategy during times of regulatory uncertainty. lawton et al. (2013:97) posit that the cpa function is a ‘largely unexplained and indeterminate variable within companies’ strategic decision-making processes’. this relationship is not considered a developed and sophisticated research area yet and has hardly been studied in developing countries (liedong 2013; mellahi et al. 2016). liedong (2013) goes as far as describing africa as a ‘virgin region’ with regard to cpa research. it is our intention to take the first step in this limited investigated area to report on cpa research in the south african agricultural sector – a sector identified as regulatorily uncertain (hendriks 2013). the aim of this article is to explore the cpa adopted by selected south african agribusinesses in terms of an integrated enterprise strategy, especially during times of uncertainty. there is a need to understand the role that cpa plays in an enterprise strategy and how it best can support the business in engaging with government, especially in addressing the regulatory uncertainty and in turn drawing investors to the corporate agribusinesses and sector as a whole. as mentioned previously, agribusinesses and commercial farming are closely aligned. the latter plays a fundamental role in providing food security in a country plagued by unemployment and exceptional high child undernourishment (hendriks 2013). it is in the interest of both policymakers and agribusinesses to identify and implement the most effective strategies in the current set of uncertain circumstances, and this article aims to contribute accordingly. additionally, this article is unique as it reports on cpa from the viewpoint of corporate agribusinesses and agricultural associations – both key players in the south african agricultural sector. the rest of the article will present a literature review on the topic of cpa, followed by a discussion of the research design and data collection. the third section will communicate the results, while the fourth section will discuss the results and make recommendations. the final section will conclude with closing remarks. literature review conceptualisation of corporate political activity it has long been recognised that political considerations must form part of long-range corporate planning (keim 1981). around the same time, the concept of cpa was defined by baysinger (1984) as being corporate engagement in external political activity in an attempt to shape policy in ways favourable to the firm. a number of subsequent definitions of cpa are available, but the gist of them is founded on baysinger’s version and culminates in corporate attempts to influence government policy to fit business interests (hillman & hitt 1999; hillman et al. 2004; tian & deng 2007). corporate political activity, simply put, navigates itself to the ‘sweet spot’ found in the overlap between what the firm wants, what the government desires, and what the business can do to achieve what they both want (refer to figure 1). figure 1: corporate political activity. in their seminal work on corporate political strategy (cps) formulation, hillman and hitt (1999) elaborated on the theoretical constructs of cpa with specific reference to: (1) response strategies, (2) strategy types, (3) types of cpa – proactive or reactive – and (4) approach to cpa. these constructs form the foundation of the empirical work of this study (refer to table 1). table 1: empirical framework to establish enterprise strategy during times of regulatory uncertainty. previous research on corporate political activity a recent study on engaging multinational enterprises’ stakeholders through cpa was conducted by mbalyoherea and lawton (2018) in uganda. they investigated how such enterprises engage stakeholders through cpa during the reform of the country’s electricity generation sector. data were collected through semi-structured interviews, archival materials and fieldwork notes. these authors argue that the most important stakeholder remains the host government during the early stages of reform. however, as the reform process advances, strategic adaptations are required. the implications of the research are that although the multinational enterprises deployed cpa-driven non-market strategies, they are dependent on the government in uganda creating an environment and opportunity in which to engage. the study focused on the electricity industry with a recommendation that similar studies should be conducted in other industries. our study is focused on the agricultural industry in south africa – an industry that will greatly benefit from research on cpa as it is facing political and policy uncertainty (hendriks 2013). moodley (2013) explored the possible differences in cpa of multinational and local companies in the south african health sector – another sector faced with regulatory uncertainty. the findings highlighted that although there was general alignment in cpa between the two groups of companies, the multinationals were more proactive than the local companies in approaching government. furthermore, local companies adopted an avoidance strategy during times of uncertainty, while companies with a ‘higher turnover are more proactive and relational in their approach to cpa’ (moodley 2013:77). as mentioned earlier, the literature has generally focused on the relationship between firm performance and cpa (curran & eckhardt 2018; hillman et al. 2004; mellahi et al. 2016). it reveals that this relationship is mixed (liedong 2013; mellahi et al. 2016; sun, mellahi & wright 2012). politically connected firms in 23 different countries demonstrated an increase in business performance, financial leverage and the use of long-term debt and liquidity ratios after establishment of the connection (boubakri et al. 2012). sun et al. (2012) averred that corporate political ties generate substantial strategic value for firms. studies in china also found positive yields on political connectedness (lu 2011; wu et al. 2012). in contrast, however, there is evidence of an increasing negative correlation between cpa and organisational performance. in a review of 56 studies of cpa and firm performance conducted between 1988 and 2013, liedong (2013) found that 12.5% of these investigations provided evidence of a negative relationship between them. seventy per cent of the studies that produced negative results were conducted between 2011 and 2013. similarly, in a comparable project undertaken by mellahi et al. (2016), more than half of the empirical studies (10 out of 18) reviewed, conducted between 2010 and 2014, did not find a positive relationship between cpa and performance. studies in the united states and malaysia also indicated corresponding negative relationships (aggarwal, meschke & wang 2012; bliss & gul 2012; hadani & schuler 2013). these negative relationships can be explained by the ‘darker side’ of cpa. society might perceive cpa to be negative in those instances where business–government relations are believed to be unethical (liedong et al. 2015). this particularly applies to emerging markets where high levels of corruption between business and the state are thought to prevail (doh, lawton & rajwani 2012). the difference between legitimate participation in democratic decision-making and the opportunistic pursuit of self-interest has become confusing in recent years. this unethical cpa could tarnish the reputation of a firm (hond et al. 2014). an overview of the institutional context of south africa engau and hoffmann (2011a) identified two main factors that warrant specific consideration in deciding on a strategy: (1) the perceived level of regulatory uncertainty and (2) the firm’s exposure to future regulation. they found that higher levels of uncertainty lead to a broader range of strategies, and the greater a business’s exposure to regulatory uncertainty, the higher the participation levels in cpa. kingsley et al. (2012) concurred that a proper integrated strategy is dependent on a thorough analysis of an entity’s exposure to regulatory uncertainty. failure to align non-market strategies with regulatory uncertainty will have a negative impact on the commercial success of the firm. a non-market strategy is a pre-arranged – and intentional – action plan taken in the non-market environment to increase overall organisational performance (baron 1995:47). where political markets are ideologically motivated and competition between policymakers is low, regulatory uncertainty is higher (kingsley et al. 2012). the two factors that should influence the decision on a strategy, as identified by engau and hoffmann (2011b), warrant consideration in the south african context. the current south african political arena is dominated by the african national congress, whose ideal in terms of land is that it ‘shall be shared amongst those who work it’ (african national congress 2016:1). this was reiterated at the party’s 54th annual conference held in midrand, south africa, in december 2017. the party resolved that the expropriation of land without compensation should be among the mechanisms available to government to give effect to land reform and distribution while maintaining economic stability, food security and agricultural production as a priority (boshoff et al. 2018; ramaphosa 2017). the dominating presence of the african national congress has been evidenced by the most recent national election results of 2019. the party won the election with a 57.5% vote and the economic freedom fighters, another political party, obtained a 10.79% vote nationally (electoral commission 2019). the economic freedom fighters shares a similar view in respect of land to that of the anc as its first pillar of economic emancipation is the ‘expropriation of south africa’s land without compensation for equal redistribution in use’ (economic freedom fighters 2019:1). further describing the institutional environment is the fact that there is no legislation governing private donations to political parties in south africa (february 2017). february (2017) argued that this creates ample opportunity to buy influence and to engage in corruption, and so casts doubt on the integrity of policy decisions. south africa obtained a bleak corruption perception ranking of number 73 out of 180 countries in 2018, with a corruption perception index of 43. the corruption perception index scores countries in terms of perceived corruption, where a score of 100 represents a ‘clean’ country and a score of zero represents a highly corrupt state (transparency international 2018). research design and data collection in this exploratory, qualitative study, data were collected through semi-structured interviews. the participants were selected using purposive sampling, a non-probability sampling technique. neuman (2014) points out that in qualitative studies, the aim is not to select a sample that is a mathematically accurate representation of the entire population, but rather to select participants based on their specific qualities and characteristics, something that the researchers specifically had in mind (etikan, musa & alkassim 2016). purposive sampling was employed using the following criteria: all the respondents had to be employed in the agricultural industry, either by a corporate agribusiness or an agricultural association. furthermore, they had to be familiar with their enterprise’s strategy. six individuals were selected to interview, representing middle management or above: two chief executive officers, one group managing director, one group director of business strategy, one group company secretary, and one legal and policy advisor. these six interviewees represented two groups: (1) four corporate agribusinesses with the aim of generating profit and (2) two agricultural associations – representing the first group as a collective to serve the overarching business interest of its members – with a non-profit goal. the combined turnover of the four corporate agribusinesses was zar24.6 billion (approximately us$1.76 bn using an exchange rate of r1 = $13.98) for the 2016 financial year. these two groups were chosen to obtain a balanced view – from the firm level and from the associations representing these companies. semi-structured interviews are typically scheduled in advance and have an overall topic, targeted issues and specific questions. these types of interviews are not as rigid as structured interviews, but have more focus than the unstructured kind (tharenou, saks & moore 2007). semi-structured, in-depth interviews are the most popular interviewing method for qualitative research (dicicco-bloom & crabtree 2006). in this study, these requirements were met by arranging the interviews well in advance, with five taking place at the premises of the individual parties on a face-to-face basis, and one conducted telephonically, within a time span of one month. the interviewer (l.b.) travelled a combined distance of nearly 2700 km to conduct the interviews, which were based on an adapted questionnaire originally developed by moodley (2013) in his study on cpa of local and foreign firms in the south african health sector. the questionnaire was completed and recorded by the first author (l.b.) during the interviews and afterwards transcribed. most of the questions included responses based on a likert scale with an opportunity for the respondents to motivate their answers. the bulk of the qualitative data was obtained by analysing the narratives provided by the participants. the research method followed in the study was similar to that adopted by godinez and garita (2016), whose research was exploratory, had a small number of respondents, and where data were gathered through in-depth interviews. the adapted questionnaire is based on a framework developed by engau and hoffman (2011a) used to design an enterprise strategy to cope during times of regulatory uncertainty. engau and hoffman (2011a) identify the political activities firms undertake, while hillman and hitt (1999) identified the strategies firms follow during times of regulatory uncertainty. in table 1, the main elements of the framework are presented, then linked to the questionnaire utilised in this empirical study and the content of the questions. the questionnaire was adapted to the south african agricultural context. the questionnaire consisted of four sections that addressed the following topics: (1) general information, (2) regulatory uncertainty, (3) responses to regulatory uncertainty and (4) strategy. the first general information section required details about the interviewee’s position in the company and the firm size, which would enhance the perceived context of the business involved. as evident in table 1, section 2 of the questionnaire on regulatory uncertainty was aimed at identifying the level of the participant’s understanding of the regulatory environment, while section 3 served to identify the activities and strategies followed in response to regulatory uncertainty. the last section – section 4 – on strategy, had the purpose of revealing the types of cpa, as identified by hillman et al. (2004:838), that the businesses involved pursue. table 1 highlights the last step as devising an appropriate strategy. recommendations were made by the authors to the current strategy followed by agribusinesses and agricultural associations in terms of cpa (refer to section 5). ethical consideration ethical consideration was obtained from the north-west university, with ethical clearance number emsrek16/08/26-01-02. results the results are discussed in accordance with each of the sections of the questionnaire highlighted above, excluding section 1, which focused on general information already presented in the research design and data collection account above. the direct quotations, noted below, were not linked to a specific participant so as to maintain the anonymity of each respondent. section 2: regulatory uncertainty regulatory uncertainty was broken down into the following four aspects around agricultural legislation in the questionnaire (table 1): (1) its general direction, (2) the operationalisation (rules, designs and measures) of future legislation, (3) the implementation process and (4) the interaction of new and existing legislation. it appears that the interviewees were more uncertain about the general direction and implementation processes of agricultural legislation than about its operationalisation – and interaction between new and existing legislation. one of the respondents remarked that he is up to date with agricultural policies under consideration, although he is unsure about: ‘… what direction government will be taking, because it is a constantly changing environment.’ (participant 5) four of the six parties questioned indicated that they were uncertain about the general direction, whereas half agreed that they were clear on the operationalisation of, and interaction between, new and existing agricultural legislation. all the respondents noted at least some uncertainty about the latter – five of the six specifically mentioned the uncertainty over land reform and property rights – while two interviewees described the level of uncertainty as quite a lot and a great deal of uncertainty. a clear distinction was noticeable between the responses of the two participatory groups. the agricultural associations, although agreeing with the level of uncertainty for their members, were more confident than the agribusinesses in terms of their awareness of the regulatory landscape and associated developments, as explained in the following quotation: ‘as representatives of our members, we are in a good space. government creates consultation. the members in their operations are however in a different space.’ (participant 5) three participants attributed part of the regulatory uncertainty to policy complexity. each affirmed a different driver of such complexity, namely: (1) the lack of a coherent agricultural policy, enforced by the variety of role players involved in the agricultural sector, and perceived factionalism in government, (2) a constantly changing policy environment and (3) the inability to align commercial farming interests with political ideals. all the parties interviewed voiced their concern about the impact that the regulatory uncertainty could have on the economy of the sector. half of them alluded to reduced investment, and even disinvestment, in the sector because of the extent of this uncertainty. one of the corporate agribusinesses averred: ‘we don’t know where we are heading, and it’s scary.’ (participant 4) nevertheless, two individuals mentioned that government does create consultation opportunities for new legislation. one was fairly confident that the south african constitution presents protection in respect of the rule of law and governs the way in which the legislative process should proceed. he added that the thorough way in which legislation needs to be followed prevents sudden – and drastic – unforeseen changes in the regulatory environment. section 3: responses to regulatory uncertainty engau and hoffmann (2011b:70) found that firms pursue a combination of strategies (avoidance, reduction, adaptation, and disregard of strategies) in response to regulatory uncertainty, but to differing degrees. it appears that the study population follow suit. all of the entities represented in the interviews adopt a combination of response strategies, but – in accordance with the findings of engau and hoffmann – to varying extents. engau and hoffmann (2011a:45) initially identified 13 responses which they subsequently linked to regulatory uncertainty strategies, namely: (1) investigation, (2) influencing, (3) flexibility, (4) cooperation, (5) substitution, (6) stabilising, (7) imitation, (8) simplification, (9) internal design, (10) withdrawal; (11) integration, (12) postponement and (13) no-regret moves. the participants were asked to identify their reaction to regulatory uncertainty using these 13 responses. the strategies can be linked to the responses (in brackets) as follows: avoidance (postponement, stabilisation and withdrawal), reduction (investigation, simplification and influencing), adaptation (internal design, integration, flexibility, cooperation and imitation) and disregard (substitution and no-regret moves). there are 13 questions representing the 13 responses. however, a question relating to withdrawal (question 10 above) was omitted from the questionnaire, as it implies complete abandonment of operations (i.e. exiting from business completely), which is not realistic. the 12 responses were divided unequally between the four strategies (avoid – 2 questions, reduce – 3 questions, adapt – 5 questions, and disregard – 2 questions). to prevent this from inappropriately influencing the results, the option selected – ranging from never, considers, sometimes, often, or main activity – by the participants in response to the questions relating to avoid, reduce and disregard were all weighed as if five questions were asked. this ensured a comparable graphical representation (figure 2). figure 2: response to regulatory uncertainty strategies. figure 2 shows that reduction and disregard strategies are employed to a greater extent than adaptation. avoidance strategies are the least adopted by the participants. the results in terms of each of these strategies are elaborated on below. avoidance strategies as mentioned above, the avoidance strategy can take the form of (1) postponement, (2) stabilisation and (3) withdrawal. withdrawal implies leaving business in uncertain environments and focusing on more predictable circumstances (moodley 2013:31). as mentioned above, a question on withdrawal was omitted. only one agricultural association indicated that postponement was one of their main activities. two of the others would sometimes postpone strategic decisions until they had more certainty. one entity would consider postponement, and the last two indicated that they do not engage in postponement activities. one of the interviewees remarked that postponement would, in most cases, lead to missed business opportunities. stabilisation is created by increasing predictability through the implementation of standard procedures or the establishment of long-term contracts (engau & hoffman 2011a). two participants do not engage in stabilisation, whereas two sometimes do. one respondent considers it one of their main responses: unpredictability is probably the biggest enemy of business … because business can make plans when they know what the environment is, but when you have surprise changes, that is probably the most negative impact you can have on business. one interviewee noted that it is impossible to create predictability, with two others sharing this view. reduction strategies the reduction strategy is one of the strategies that are often employed through investigation, influencing and simplification. one participant sometimes chooses to influence the regulatory environment by means of engagement in the policymaking process. all the other participants either employ a reduction strategy by means of often investigating and influencing policy and policymakers (four participants in terms of investigation and three others in terms of influencing), or regard it as their main activity (two participants in terms of investigation and influencing). it is noteworthy that the individual who indicated that their entity only sometimes takes part in the policymaking process specifically mentioned their affiliation with representative bodies engaging on their behalf. this perceived dependence on agricultural associations seems to be appropriate, as both the representatives of agricultural associations regard investigation and influencing as one of their main activities. four interviewees also indicated that, in order to simplify decision-making, they select specific issues in their business environment to focus on. the remaining two participants do not engage in simplification at all. adaptation strategies the adaptation strategy is indicated by five activities: (1) internal design, (2) integration, (3) flexibility, (4) cooperation and (5) imitation. only one participant – representing an agricultural association – does not engage in rearranging the company’s operations to be less exposed to regulatory uncertainty, although its members (agribusinesses) consider it a big issue. of the remaining participants, two sometimes engage in this activity and three (half of them) often do so. one of the respondents does not engage in changing the company’s organisational structure to deal better with regulatory uncertainty. on the other hand, half of the interviewees sometimes do, while one often engages, and one considers it one of their main activities. the respondent that does not engage is also the largest – in terms of turnover – corporate agribusiness we studied; restructuring probably becomes more complex as firm size grows. five of the participants are flexible in that they enlarge their range of strategic options by preparing for more than one outcome of a policymaking process – although to differing extents: two sometimes prepare, two often do, while one regards it as one of their main activities. the remaining interviewee still prepares for more than one potential outcome of policymaking. cooperation is uncontestedly the most popular activity in respect of the adaptation strategy. five participants often join forces with others whereas the remaining one considers it one of its main activities. imitation is the second-most prevalent activity. all of the participants engage in it: half sometimes observe the activities of other companies and follow them (if appropriate), two often engage in this activity and one considers it as one of their main activities. the last is also the smallest in terms of turnover. disregard strategies this response strategy is one of the most employed strategies in terms of regulatory uncertainty. it consists of no-regret moves and substitution. no-regret moves involve performing activities associated with uncertainty that have positive results regardless of how the uncertainty resolves (engau & hoffmann 2011a, 2011b; moodley 2013:31). two respondents often engage in this activity and two others regard it as one of their main activities. the two entities that do not participate in this activity are the agricultural associations that do not operate with a profit motive. it is encouraging that all of the participants continue to make capital investments, regardless of the outcome of possible future regulation. the disregard strategy is also driven hard by substitution – by replacing uncertain decision criteria with assumptions drawn from comprehensive consideration or detailed analysis of each situation (engau & hoffmann 2011a, 2011b; moodley 2013:31). five of the six participants often agree on the most likely regulation scenario and then focus on preparing accordingly. the sixth participant considers it as one of their main activities. section 4: strategy the purpose of this section of the questionnaire was to identify the types of cpa the participants engage in. the questions were aimed at distinguishing between reactive and proactive cpa and explored the different dimensions of these activities in terms of their approach, participation level and strategy types. it also interrogated the extent to which participants believe their cpa impacts the regulatory environment and concluded with affording the opportunity to provide additional general commentary. proactive vs reactive corporate political activity proactive cpa, also known as ‘buffering’, implies policy shaping by means of proactive behaviour to achieve specific political objectives, while shielding internal operations from the environment (hillman & hitt 1999; hillman et al. 2004; mellahi et al. 2016). buffering activities include lobbying and making campaign contributions (hillman et al. 2004) and, more recently, also formal and informal networks, including board memberships by politicians and executives joining the political arena (mathur & singh 2011). reactive cpa – also termed ‘bridging activities’ – on the other hand, implies no direct participation in the public policy process (hillman & hitt 1999; hillman et al. 2004). bridging is based on the assumption that changes to internal operations to adapt to altering external circumstances will lead to legitimisation and, ultimately, increased firm performance (mellahi et al. 2016; meznar & nigh 1995). four of the participants found it difficult to discern a single type of cpa. they reasoned that generalisation across their entire operation is not possible, as the type of cpa applied depends on the legislation under consideration: ‘… the answer lies in the dynamic nature of interaction with government, depending on the legislation.’ (participant 5) five of the six participants indicated that they do adapt systems and processes to ensure compliance, but only after legislative changes have been finalised – hinting towards reactive cpa: ‘… there are so many changes that take place that it would be absolutely silly to adapt any strategy before you know exactly what the legislation is going to say.’ (participant 5) nevertheless, four of the five organisations that adapt systems and processes after legislative changes have been finalised, indicated that they attempt to share information with policymakers before legislation is drafted. this hints at proactive cpa. when asked bluntly to describe their cpa as either proactive or reactive, the results were equally tied between the two approaches. this can be understood by an explanation provided by one of the participants, who distinguished between trade and transformative legislation. in respect of trade legislation, proactive cpa is employed in pursuit of competitive advantage in the market environment. considering transformative legislation, proactive cpa is not possible due to the uncertainty associated with the legislation, and the length and complexity of the legislation process; hence, a reactive approach is followed in such cases. another possible explanation for the conflicting responses can be that their ideal cps resides with proactive cpa, proven by the strong preference for providing policymakers with information before legislation is drafted. yet the reality and practical implications of the legislative process enforce reactive cpa, as evidenced by the strong indication that adaptation of processes and systems is only applied after legislation has been finalised. approach to corporate political activity there is a clear preference for a relational approach in the participants’ approach to cpa as indicated by an interviewee who noted that: ‘our whole thing is strong relationships.’ (participant 5) all six of the participants reported that they prefer building ongoing relationships with policymakers, as opposed to dealing with such decision-makers only when the need arises. however, all four of the agribusinesses follow a transactional approach in as far as they wait for issues to arise before engaging and influencing policymakers, and they deal with legislative issues on an ad hoc basis. this appears to be the result of the perceived characteristics of the regulatory and legislative environment. one of the barriers to an ongoing relationship with policymakers emerged as a lack of trust in the intentions or motive of the other party. it is also argued that a lack of proper access to policymakers hampers an ongoing relationship, with one participant remarking that it is difficult to get hold of government officials, while another interviewee observed that the staff turnover is high, making it difficult to build relationships. it can be interpreted that there is a disconnect between preference – that is, relational – and ability, namely transactional, of the agribusinesses in terms of their approach to cpa. in contrast to the above, both of the agricultural associations reported a complete alignment with a relational approach for all questions under this section, with one participant conceding that: ‘… you can only really influence if you have relationships of trust.’ (participant 5) it was clear that they do not experience the same challenges in terms of access to policymakers as the agribusiness representatives. participation level in corporate political activity participants were asked to estimate to what extent (rated in percentage) they collectively participate in cpa. five indicated that more than 60% of the cpa they participate in is done collectively, with one of the five participants declaring 90%. this correlates with results across the study – with all agribusiness participants affirming their dependence on agricultural associations when influencing the legislative process or building strong relationships with policymakers. the remaining participant indicated that 65% of their cpa participation is done on their own. strategy types in this part of the questionnaire the interviewees were required to indicate to what extent they engage in the three strategy types, as well as the reason for their choice. the three strategy types are (hillman & hitt 1999:834): information sharing – aimed at a key policymaker and providing this person with the firm’s policy preferences. financial incentivisation – also directly aimed at the key policymaker and aligning incentives to the preferences of the firm through financial inducements. constituent building – an indirect aim of gaining the support of voters. three questions were asked – one for each strategy type – to identify the appropriate strategy types followed by the participants. a participant could follow more than one strategy type. the responses to the three questions relating to the three strategy types are presented in figure 3. figure 3: strategy types. all but one participant reported that they engage in information-sharing strategies. the business that does not engage in such a strategy was the smallest company in terms of turnover and they do not engage in any other type of strategy. participants indicated that they provide information to policymakers directly because they can only influence policy when reliable information is communicated timeously, resulting in better decision-making by government. the financial incentivisation strategy was strongly rejected by all the participants. it is clear that this strategy is perceived as unethical as it alludes to financially incentivising policymakers to promote the policy preferences of your firm. three of our informants used the word ‘bribery’ and comments included: ‘… we’re not morally keen to do that [make contributions].’ (participant 1) ‘… we’re not unethical.’ (participant 4) ‘i disqualify that [financial incentive] strategy fully.’ (participant 5) this alludes to the darker side of cpa, as discussed previously. the two agricultural associations and one agribusiness follow the constituent building strategy with the rest declaring that they rely more on collective constituent building as done by the respective agricultural associations with which they are affiliated. multiple participants referred to the current political environment and barriers to access to policymakers as the reasons for their chosen strategies, with one interviewee pronouncing that they need to stay apolitical due to the sensitive nature of their customer profile. another opined that there is a decline in regulators’ comprehension of the agricultural environment. notwithstanding that, the agricultural associations maintained that influence is dependent on integrity and maintaining a high moral ground. perceived impact of corporate political activity this section of the questionnaire probed the perceived influence to shape regulation. the results produced a fairly equal spread – two participants each perceived their impact on regulation to be little, moderate and significant. the agricultural associations believed they have significant impact as they have strong relationships with policymakers and, hitherto, it has not been necessary to involve the constitutional courts. yet they expect the relationships to be more challenging in the future, as this interview excerpt illustrates: ‘the pressure is always there and it seems that the pressure is actually building, particularly in terms of access to resources, to water, to land, the compensation issue around the land … so there’s a lot of political pressure … and it’s quite a difficult climate to lobby in. … it’s hard to judge by your past performances whether you will be successful in the future.’ (participant 2) the two larger agribusinesses – based on turnover – suggested they had only moderate impact, for differing reasons: one being a lack of direct access to policymakers, and another was that the business’s board does not represent south africa’s demographics sufficiently. the second reason was also alluded to by one of the agricultural associations. they remarked that they have transformed to such an extent that they are now a better representation of the south african population, in terms of race and gender, and they argued that this was one of the reasons that their cps is successful. interestingly, the two agribusinesses that believe they have little impact are the two smaller companies – based on turnover. additional general commentary on the topic of corporate political activity the interviewees had varying positions and strategies in response to the regulatory environment with some participants providing positive comments by conceding the excellence of the south african constitution and legislative processes, and remarking on the majority of the south african population being reasonable. a desire for cooperation and prosperity for all surfaced in three of the interviews. two participants explicitly stated that they are not against land reform, but that the manner in which ownership of land is transformed is of crucial importance. they opined that the integrity of the land market needs to be preserved and maintained and the changing of property rights could lead to the collapse of collateral for significant amounts of finance, which would have a devastating ripple effect on the economy as a whole. furthermore, they posited that transformed land should remain productive because unproductive land leads to loss in economies of scale for agribusinesses. less positive remarks, alluding to the policy uncertainty paralysing the agricultural sector, were also made. that south africa presents a difficult economic and political climate, and a period of uncertainty for business in general, was mentioned twice. in addition, it was averred that volatile exchange rates, the poor economic status of the country and declining investor confidence are all caused by the negative political environment and ultimately affect agribusinesses negatively. two participants noted the adverse effect that political statements that have not been thought through have had on investor confidence. the lack of government support – for drought relief – was mentioned by two of the parties interviewed. another insight provided by both the smallest and largest participant was the need for better access to policymakers for lower level business and individual agribusinesses. this relates not only to influencing new legislation, but also current legislation: ‘… government should maybe consult a bit more or they should be more open to interact with business on a lower level.’ (participant 3) discussions and recommendations the interviews conducted confirm that the participants do engage in cpa as part of an integrated enterprise strategy to address regulatory uncertainty, and they do so in pursuit of business sustainability. there is a fundamental desire for a stable and sustainable operating environment and a call for better access to policymakers, and generally more support from government during difficult economic and uncertain times. a clear distinction can be drawn between the strategic approaches to cpa, followed by corporate agribusinesses and agricultural associations. the agribusinesses seem more anxious and uncertain – this can most probably be ascribed to the associations being better informed and (possibly because of) having better access to policymakers. it is therefore recommended that engagement between agricultural associations and their members should be strengthened through improved communication on topic-specific matters such as land reform and distribution, restrictive labour policies and minimum wages. this study found that the participants experience a great deal of regulatory uncertainty, especially in terms of the general direction and implementation of future agricultural regulation and legislation. uncertainty around land reform and property rights in south africa is posing a substantial threat to future investment in a sector that significantly influences the country’s economy. this finding partly concurs with the arguments of kirsten (2017:14), that mass expropriation of land will lead to a lack of agricultural investments resulting ultimately in no growth in the agribusiness sector. the findings on responses to regulatory uncertainty by participants concur with those of engau and hoffman (2011b:70) and moodley (2013:77), that is, that firms follow a combination of strategies. the south african agribusinesses surveyed adopt, to varying extents, different combinations of cpa as part of their integrated enterprise strategy. they employ disregard and reduction strategies to the greatest extent and the avoidance strategy the least. the disregard strategy is adopted with the greatest alignment among participants. this finding is in contrast to the response of local firms in the health sector that followed the avoidance strategy by primarily engaging ‘to a greater degree in withdrawal and stabilisation activities’ (moodley 2013:77). a reassuring finding with regard to strategy as a whole is that a strong morality element can be traced across the results in terms of approach, participation level and strategy types. all the interviewees strongly rejected the financial incentive strategy, as they argued it is unethical and that there is a perceived connection with bribery. contrary to their desire to follow a relational approach, the corporate agribusinesses engage in a transactional course of action. half of them ascribe this to a lack of direct access to policymakers. moodley (2013:77) however found that wealthier local and foreign companies in the health sector are more relational in their approach. mbalyoherea and lawton (2018) also found that multinational enterprises in uganda followed a more relational approach to cpa. the agricultural associations’ results, on the other hand, are completely aligned with a relational approach. this, clearly, is one of many benefits of collectively participating in cpa, justifying the desire for such collaboration. as a result of these circumstances, it is reiterated again that agribusinesses are sufficiently involved with their respective agricultural associations, and that their views and needs are aligned. there appears to be a disconnect between the participants’ preferences and abilities in terms of the type of cpa they apply. contradictory opinions expressed by the interviewees indicate that there is a definite desire to engage in proactive cpa, yet – depending on the type of legislation – the lengthy and complex legislative process and uncertain regulatory environment sometimes push participants towards reactive cpa. moodley (2013:76) found that foreign companies are more proactive in their cpa than local firms in the south african health sector. during the opportunity given to raise general comments, the participants remarked that, although they are not against land reform, the process should be steered responsibly to ensure that the productivity of land is maintained and its value – used as collateral in finance – is upheld. this view is shared and expanded by boshoff et al. (2018:10) that, other than the financial aspects of land reform, there are other concerns related to policy design that require attention. these include not only legislative interventions recognising a variety of rights in communal areas, but also the direction of land reform programmes towards inclusive agrarian transformation. a limitation of this study is that the sample size of six participants is small. we tried to overcome this by recruiting the representation of agribusinesses representing a significant annual turnover of r24.6 billion. another limitation is that the results are focused on only two kinds of stakeholders in the agricultural sector – corporate agribusinesses and agricultural associations. this limitation creates an opportunity to extend this study to include policymakers and officials from the south african department of rural development and land reform and the department of agriculture, forestry and fisheries. concluding remarks it was revealed that both corporate agribusinesses and agricultural associations do engage in cpa as part of their enterprise strategy, although to differing extents. furthermore, the qualitative data represent the viewpoints of two kinds of key stakeholders in this employment-intensive sector – corporate agribusiness and agricultural associations – especially during this time of regulatory uncertainty. this research provides insight into what responses agribusinesses and agricultural associations employ in response to regulatory uncertainty, and furthermore what strategies they follow to engage government. this research will be useful to policymakers, corporate board members, government officials, and fellow researchers in their aim to enhance collaboration between the state and the private sector, especially during times of regulatory uncertainty. this article is the first step towards reporting on cpa in the agricultural sector in south africa and it emphasises the necessity and need for increasing interaction between government and representatives of the agricultural industry. fellow researchers are encouraged to expand and continue conducting research in this ‘virgin region’. acknowledgements the authors gratefully acknowledge the input provided by the reviewers in improving the quality of the article. competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions l.b. was the principal researcher that conducted the fieldwork and data collection and analysis. s.l.m. acted as supervisor and co-wrote and finalised the article. funding information the authors gratefully acknowledge the national research foundation for providing financial support. data availability statement data sharing is not applicable to this article as no new data were created or analysed in this study. disclaimer the views expressed in this article are the authors’ own and do not 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difference between the risk-adjusted performance of companies with female directors and that of companies without female directors was rejected. implications of the results are discussed and suggestions for future research presented. jel j16 1 introduction according to institutional theory, organisations are defined and shaped by the institutional environment in which they are embedded (dimaggio & powell, 1991). accordingly, legal reform efforts and the introduction of affirmative action legislation in south africa have resulted in an influx of women in the labour force. research is now acknowledging the importance of diversifying human resource structure regarding gender as a necessary requirement for optimising essential resources in organisations. scholars are arguing that, if women remain an under-utilised talent pool, then national economic growth will be hampered in the long-term (cutler & jackson, 2002). it has also been found that female executives add value to organisations by introducing female values like caring, an appreciation for teamwork, intuitive decision making and a sense of social responsibility (claes, 1999). the objective of this paper is thus to determine the performance of jse-listed companies with female directors on a risk-adjusted basis. 2 review of related literature notwithstanding the increase of women in the workforce, there remains a great disparity between the number of women in corporate leadership and the overall female working population. a survey conducted in 2004 by the business women’s association (bwa) showed that, of the 52 per cent of working women in south africa, only 7.1 per cent were directors in the jse-listed companies. the survey revealed further that women comprised only 3.0 per cent of chairs of boards and 1.9 per cent of chief executive officers (ceos). although there are no institutional explanations for the limited representation of women in senior management, a number of scholars have attributed this to the “glass ceiling” effect. the term “glass ceiling” was first used in a 1986 wall street journal article, with reference to the invisible barriers impeding the career advancement of women in the american workforce (baker & lightle, 2001). the term has been further defined as the actual or perceived barrier, or cap, beyond which few 208 sajems ns 10 (2007) no 2 women in public and private organisational structures are able to progress (tavakolian, 1993). in the united states (us), the federal glass ceiling commission‘s report summarised the major barriers to women‘s advancement in organisations as placement in relatively dead-end staff jobs and lack of mentoring, management training and career development, as well as an absence of critical development activities (mcdonald & hite, 1998). crampton & mishra (1999) identify a range of complex reasons explaining why there are fewer women in senior management positions in the us. these reasons include, amongst others, socialisation patterns, choice of positions that lack power or supervisory authority, fulfilling the dual roles of working woman and mother, and the lack of confidence, appropriate skills and attitudes needed for women to succeed as managers. in another study, nelson and burke (2000) report that male ceos view the obstacles to women’s corporate progress as being their lack of general management skills, spending insufficient time in the pipeline, male stereotyping and preconceptions of women, exclusion from informal networks and an inhospitable corporate culture. while there are obviously many explanations for the barriers to women’s career advancement, nelson and burke (2000) identify two as being particularly plausible: (1) subtle forms of discrimination that increase the probability of women’s failure, namely inadequate provision of development opportunities and unwillingness on the part of those in power to confront and eliminate sexism; (2) the fact that women are afforded different development opportunities from those enjoyed by men. the authors point out that, in particular, mentoring is not adequately provided for women, on account of the limited numbers of women in top management. institutional theory, on the other hand, suggests that the glass ceiling is perpetuated by cultural biases, which define leadership competence in terms of male characteristics and traits (frankforter, 1996). researchers have also suggested that male organisational culture explains the persistence of the glass ceiling effect (van vianen & fischer, 2002; cassell & walsh, 1997; maddock, 1999). shakeshaft (1987) emphasises this argument by pointing out that male dominance in key social positions and the prevalence of patriarchal norms reinforcing gender differences constitute a serious impediment to women’s career advancement. the implication is that, if a masculine culture prevails in an organisation, then the institutionalisation of a policy to appoint women to key management positions will be influenced by the men in that particular environment. indeed, researchers argue that institutionalisation of any policy generally depends on the relative power of ‘critical constituencies’ and interested actors who stand to gain from whether or not a policy is fully implemented (dimaggio, 1988; blair-l oy & wharton, 2002). for example, in a study conducted by blair-loy and wharton (2002) investigating the institutionalisation of work-family policies, the ‘critical constituencies’ of these policies were women. this study investigates the institutionalisation of the policy that includes women in the corporate leadership of companies listed on the jse, for the period 2002-2003. it argues that appointing women to corporate director positions signifies those corporations’ responsiveness to employment equity policy, and reasonably expects that the extent to which women are represented in their corporate leadership will affect their share price returns. the purpose of this study is to estimate riskadjusted returns of jse-listed companies with female directors (women portfolio) and to compare them with:  r i s k a d j u s t e d r e t u r n s o f c o m p a n i e s without women directors (no-women portfolio).  risk-adjusted returns of the overall market (market portfolio). a number of scholars (claes, 1999; appold, siengthai & kasarda, 1998; cutler & jackson, 2002) argue that women add value to an organisation by introducing female qualities like team spirit, caring, intuitive decisionmaking and corporate social responsibility. a positive impact by female directors on sajems ns 10 (2007) no 2 209 the performance of companies listed on the jse is expected. this expectation is based on arthur’s (2003) study showing that policy adoption resulting in ‘legitimation’ has a positive effect on the value of a firm. based on arthur’s conclusion, it could be inferred that the same policy adoption would result in superior performance as measured by the sharpe index. in this study, the ‘legitimating process’ refers to compliance with an employment equity policy, as illustrated by the representation of women in top management. it could therefore be expected that the higher the percentage of women directors in a company the better the company’s financial performance, as measured by the sharpe index, to be discussed in the section on methodology below. the hypothesis this study seeks to test is that: h 0 : there is no difference between the performance of companies with women directors and the performance of companies without women directors. h 1 : there is a difference between the performance of companies with women directors and the performance of companies without women directors. 3 methodology data the business women’s association (bwa) gave permission for the writers to use the results of a 2004 nationwide census of female board directors for companies listed on the jse. the bwa data set of 347 observations was the starting point for this research procedure. only those companies listed on the jse on 30 september 2003 were included in this data set. using the bwa data set, data was computed with two variables: (1) companies with female directors, and (2) companies without female directors. share price data for the period october 2002september 2003 was obtained from mcgregor (2004), who provides a comprehensive database of jse-listed companies. risk-free rates were obtained from the website of the south african reserve bank. to eliminate bias due to different financial year-ends, only companies with a common year-end were selected, which reduced the sample size from 347 to 115 companies. daily share price returns were computed over a 12-month period, from 1 october 2002-30 september 2003. 3.1 construction of women and no women portfolios before an assessment of performance was conducted, companies were divided into two distinct groups:  women (these were companies with women directors)  no-women (these were companies without women directors). 3.2 measuring performance according to fabozzi (1999), performance assessment involves performance measurement and performance evaluation. fabozzi (1999) defines performance measurement as the return realised over a certain time interval, called the evaluation period. he defines performance evaluation as the act of determining whether value was added by the out-performance of an established benchmark. the well-established benchmark used in this study was the all share index (alsi), which is regarded as one of the generally-accepted market proxies in the republic of south africa. for the purpose of this study, this benchmark represents the market portfolio. affleck-graves, burt and cleasby (1988) and van den honert, barr and smale (1988) computed share price returns (r i ), using the following formula: r i = p p – p 0 1 0 i i i × 100 where: p 1i is the price of a share i/alsi at the close of a trading day; p 0i is the price of a share i/alsi at the opening of a trading day. this formula was adopted in this study in order to compute daily portfolio and market returns. 210 sajems ns 10 (2007) no 2 daily returns of women, no-women, and market portfolios were thereafter averaged. these averaged daily returns for each of the portfolios were then annualised over the evaluation period. in order to arrive at a risk-free rate, banker’s acceptance (ba) discount rates were obtained from the website of the south african reserve bank. these were utilised to obtain the quoted price in order to compute a risk-free rate. these three-month quotes for bas were obtained for:  the first week of october 2002 (that is, to be redeemed at the end of december 2002);  the first week of january 2003 (that is, to be redeemed at the end of march 2003);  the first week of april 2003 (that is, to be redeemed at the end of june 2003);  the first week of july 2003 (that is, to be redeemed at the end of september 2003). three-month yields were computed in compound factor form and then multiplied together in order to get an annualised return on a strategy entailing purchasing and holding a three-month ba until maturity, re-investing the proceeds in a second ba, and holding until maturity (a roll-over investment strategy). this rolling-over investment strategy was repeated until the end of the evaluation period at the end of september 2003. mayo (2005) maintains that the sharpe and treynor indices are alternative measures of performance. fabozzi (1999) argues that the sharpe index (si) is a measure of the rewardto-risk ratio, and that the risk of the share is measured by the standard deviation of the share. bodie, kane and marcus (2002) maintain that the attractive feature of the sharpe index is that it divides the average return over the relevant time period by the standard deviation of returns over that period, thereby measuring the rewardto-volatility trade-off. bodie et al. (2002) contend that directors seek to maximise the sharpe index of their companies. it is argued in this research that companies maximise the sharpe index by recruiting, training and retaining female directors owing to the benefits associated with women in leadership. this transfers directly to the hypothesis that the performance of companies with female directors, as measured by the sharpe index, will be different from that of companies without female directors, also measured by the sharpe index. companies will therefore partially maximise shareholders’ wealth if they conform to institutional theory. mayo (2005) argues that the sharpe index is given as follows: si = sd r – r i i f where: r i is the average return on women, no-women or market, r f is the return on bankers’ acceptance annualised rate (risk-free rate), and s d i i s t h e s t a n d a r d d e v i a t i o n o f women, no-women or market portfolios. it is further argued that the sharpe index is a measure of the excess of the risk-free return relative to the total variability of the company (bodie et al., 2002). in this research, standard deviation, not beta, is the appropriate measure of a company’s risk, because individual share price returns are used, not portfolio returns, which may be diversified. the higher the sharpe index, the higher the past performance of the company. all companies should therefore aim to maximise the sharpe index. this research infers that the sharpe index will be higher if a company applies ‘smart’ recruitment policy by appointing women to senior management positions and, in turn, complying with the employment equity policy of the republic of south africa. the recruitment policy will be regarded as ‘smart’ if a company recruits, trains and retains a higher percentage of women than other comparable companies. 4 results standard deviations of women, no-women and market over the study period are presented in table 1 below. table 1 also shows the average returns of women, no-women, market and risk-free variables. sharpe indices of all portfolios are also contained in table 1. sajems ns 10 (2007) no 2 211 table 1 sharpe indices of all portfolios variable name/portfolio standard deviation average return sharpe index = (r i – r f ) / sd women 1.25 14.02% 0.35% no-women 0.79 25.62% 15.19% market 1.19 –2.30% –13.37% risk-free not applicable 13.59% not applicable the no-women portfolio has the highest sharpe index. it out-performed both the women portfolio by 14.84 per cent and the market portfolio by 28.56 per cent. the women portfolio out-performed the market portfolio by 13.72 per cent. overall, the no-women portfolio achieved superior results during the evaluation period october 2002 september 2003. a t-test was conducted to compare the differences in the means between the performance of companies with female directors and that of companies with no female directors. table 2 below provides the results of the test. table 2 t-test for comparison of means t df sig (2-tailed) performance:women/no women portfolios equal variances assumed 2.18 98 .031 the null hypothesis that there is no difference between the performance of companies with women directors and that of companies without women directors is rejected. the p-value of .031 (in table 2) represents the probability of error associated with rejecting the hypothesis that there is no difference between the performance of companies with female directors, and that of companies without female directors. 5 discussion and conclusions this study tested the effects of female directors on the risk-adjusted performance, as measured by the sharpe index, of companies listed on the jse over a twelve-month period 2002-2003. the hypothesis that there is no difference between the performance of companies with female directors and the performance of companies without female directors was rejected. these findings indicate that there is a statistically significant difference between the two categories of companies. findings contained in table 1 (above) showed that the sharp index of a group of companies without female directors was higher than the sharp index of a group of companies with female directors. from the perspective of institutional theory, these findings imply that the adoption of a policy to appoint women to top management positions is not perceived to have a positive effect on the performance of these companies. a study conducted by chevalier and ellison (1999), although it differs from the present one in considering how cross-sectional performance is related to observable characteristics like the institution from which a manager received his/ her undergraduate degree, or whether she or he has an mba degree, showed no clear evidence of the relationship between performance and women fund-manager characteristics. the lack of evidence was attributed to the fact that women comprised only 7 per cent of the sample examined. chevalier and ellison’s study (1999) found instead that things like a 212 sajems ns 10 (2007) no 2 better education, social networks and age were predictive of performance. a study by golec (1996) also showed that age and the length of time a manager has managed his or her fund are the most significant predictors of portfolio performance. from the perspective of institutional theory, the findings of this study could be interpreted as indicating that the core constituents of south african firms perceive the institutionalisation of the employment equity policy as having no effect on their individual bottom lines. the present findings also indicate that the employment equity act was possibly adopted for symbolic rather than substantive reasons, which could explain the slow adoption rate of the policy. these findings are not consistent with those of arthur (2003), which showed an increase in share price with the institutionalisation of a work-family policy. it could be argued that the way in which the investors (existing and potential shareholders as indicated by supply of and demand for shares) perceive the policy in terms of adding value determines the institutionalisation of the policy. the findings show clearly that investors at the jse do not see any additional value in recruiting, training and retaining female rather than male directors. it is also clear that investors are interested in the return of their investment, irrespective of the gender of those who handle their investment portfolios. in other words, it does not matter whether a shareholder’s wealth, the supposedly ultimate goal of any manager, is being maximised by a man or a woman. a subject for future research could be that of investigating the underlying reasons for the disparity in the numbers of women and men in corporate leadership viewed from the investors’ perspective. such an investigation would throw some light on whether stereotypical beliefs about women have any bearing on investor perceptions. a critical mass of research is required to address the limited number of women in senior management positions. this is of the utmost importance in south africa at the present time, considering the current focus on employment equity. such research should identify barriers to the corporate progress of women in the country. engaging women at all levels in the corporate, particularly in positions of corporate leadership, would not only have a substantive impact on the economy, but would also ensure optimal use of the country’s human capital. this study has several limitations. first, the effect of different industries was not controlled. industries like retailing, for example, would probably have more women in top management than do the manufacturing and mining industries. further research is needed to examine industry effects on the institutionalisation of employment equity policies. secondly, the small size of the sample and the fact that the study was confined to jse-listed companies limited the generalisation of the findings to other companies. thirdly, studying the effects of the representation of women on share-price returns over a period of one year may have been an oversimplification. fourthly, prior research on mergers and acquisitions at the jse indicated that share prices are highly sensitive to a proposed merger (affleck-graves et al., 1988; van honert et al., 1988), and these effects on share-price returns were not isolated. future researchers may want to exclude from their samples all companies that have been involved in mergers and acquisitions. fifthly, and most important, sharpe indices used in this study can change dramatically, depending on the timeperiod of the analysis. again, a longer-term period would be required to properly address this limitation. further research, focusing on a number of performance variables, may provide a better understanding of the effect of women directors on firm performance. finally, in addition to the drawbacks of measuring short-term performance, the women and no 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(2002) “the glass ceiling is a floor my boss walks on: leadership challenges in managing diversity”, the journal of applied behavioral science, 38 (3): 443-354. abstract introduction goals of the study method discussion limitations conclusion acknowledgements references about the author(s) marita heyns optentia research focus area, faculty of humanities, north-west university, vanderbijlpark, south africa sean mccallaghan optentia research focus area, faculty of humanities, north-west university, vanderbijlpark, south africa werner beukes † nwu business school, faculty of economic and management sciences, north-west university, potchefstroom, south africa citation heyns, m., mccallaghan, s. & beukes, w., 2021, ‘work engagement and perceived customer value, the mediating role of meaningfulness through work’, south african journal of economic and management sciences 24(1), a3749. https://doi.org/10.4102/sajems.v24i1.3749 †, 1983–2020. original research work engagement and perceived customer value, the mediating role of meaningfulness through work marita heyns, sean mccallaghan, werner beukes received: 29 june 2020; accepted: 30 aug. 2021; published: 27 oct. 2021 copyright: © 2021. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: work engagement is considered an important contributor towards the success of any organisation, while finding meaning in work has been proven to enhance productivity and, ultimately, assists in improving the bottom line of an organisation. aim: the aim of the study is to examine work engagement and meaningfulness through work and at the workplace, and how these factors impact on perceived customer value. more specifically, the researchers were interested in whether meaningfulness could mediate the relationship between work engagement and perceived customer value. setting: data were collected from employees at a large south african manufacturing organisation. methods: respondents from a manufacturing organisation in south africa participated in the quantitative cross-sectional study (n = 152). they completed previously validated questionnaires to assess work engagement, meaningfulness through work and perceived customer value from an employee perspective. (males = 52.21%; working less than five years in the industry = 54.61%; non-management = 50%). results: correlation results indicate that features of engagement, meaningfulness through work and perceived customer value were positively associated. a simple mediation model indicates that meaning could be considered a mediator in the relationship between work engagement and perceived customer value. conclusion: study results indicate that work engagement was not sufficient to improve perceived customer value and that finding meaning in and through work was also required. keywords: perceived customer value; employee engagement; manufacturing organisation; meaningfulness through and in work; south africa. introduction a competitive advantage imparted by work engagement is gaining momentum as a preferred topic amongst change and human-resource practitioners (joshi & sodhi 2011). senior leaders further agree that employees’ engagement is crucial to achieving results in business. the significance of the financial implications of engagement has been quantified to the extent that a 5% increase in engagement leads to a 3% increase in revenue growth (aon hewitt 2015). according to watson (2012), research also confirmed that high levels of engagement are associated with better operational and financial results. engagement is considered, by schaufeli (2014), as the relationship employees have with their work and their organisation. employees who are physically, cognitively and emotionally engaged in their work, ensure that companies are more productive and profitable (aon hewitt 2015). however, the opposite is also a reality. evidence suggests that employees who are not fully engaged, do not focus on customers’ needs (kumar & pansari 2016). arguably, scholars suggest that work engagement may have an impact on perceived customer value (barnes, ponder & hopkins 2015; fairlie 2011). employees who experience higher levels of engagement are more likely to deliver positive customer experiences, create customer value, and, thereby, contribute towards something meaningful which adds societal value (fairlie, 2011). although it is evident that research in meta-analytic publications on perceived customer value, from a consumer perspective, is abundant (barari et al. 2021, leuschner, charvet & rogers 2013), it seems that research on perceived customer value, from an employee perspective, is limited (barnes et al. 2015). perceived customer value or perceived customer delight from an employee perspective is considered to be the emotions and behaviour an employee might experience from providing value to a client or consumer (barnes et al. 2015). additionally, slater (1997) observed that perceived customer value, in which an employee forms a link between the producer and the value created, is justified by the price performance relationship. research further indicates that perceived customer value or delight, from an employee perspective, may also be associated with job satisfaction, positive affect, affective commitment and positive behaviour such as in external representation, internal influence and service delivery (barnes et al. 2015). with regards to meaningfulness through, and in work, and work engagement, previous research found that these factors are positively associated (may, gilson & harter 2004). this may be attributed to an increase in employees’ drive towards self-actualisation, which closely correlates with a higher purpose, a sense of work and life accomplishment and with contributing positively to society (fairlie 2011). scholars agree that the antecedents of meaningfulness at the workplace may be psychological meaningfulness, psychological safety and psychological availability (may et al. 2004). according to may et al. (2004), psychological meaningfulness is value assigned to a work goal or objective which is evaluated in relation to a person’s own values and morals. in terms of psychological safety, kahn (1990:708) regards psychological safety ‘as feeling able to show and employ oneself without fear of negative consequences to self-image, status or career’. psychological availability refers to employees’ readiness, or confidence, to fully engage in their role, despite being involved in other life experiences (may et al. 2004). scholars further agree that meaningfulness through work contributes to and/or benefits society as a whole (d’enbeau & buzzanell 2013). this is supported by the view of fairlie (2011) who notes that employees experience increased levels of engagement on which work is meaningful, interesting and that contributes to society. meaningfulness in work has also been associated with multiple individual outcomes. these outcomes include feelings of accomplishment, fulfilment, and satisfaction (steger & dik 2010). finding meaning in and through work has similarly been associated with a desire for increased autonomy and the aspiration to contribute to the organisation (geldenhuys, laba & venter 2014). from an organisational perspective, this kind of meaning has been associated with improved productivity (holbeche & springett 2004). this notion of holbeche and springett (2004) is important as increased perceived customer value has been closely related with productivity (anderson, fornel & rust 1997). through a process of enhanced sense-making, meaningfulness could stretch benefits beyond the organisation, and research has shown that individuals would also exhibit improved behaviour associated with corporate social responsibility (aguinis & glavas 2019). therefore, it is evident that the benefits of meaningfulness through work could also extend beyond the organisation. literature shows, conceptually, that work engagement has an impact on meaningfulness (fairlie 2011; may et al. 2004), as well as on perceived customer value. however, it seems that literature is silent on the effect of meaningfulness on the relationship between work engagement and perceived customer value, if these variables are entered into the relationship simultaneously. consequently, the aim in the present study is to test a mediation model in which work engagement is considered the independent variable, meaningfulness through work as the proposed mediator, and perceived customer value as the dependent variable. figure 1 below shows the proposed mediation model. figure 1: proposed mediation model, work engagement, meaningfulness at work and perceived customer value. work engagement and its features schaufeli (2014) notes that work engagement and employee engagement are used interchangeably; however, work engagement refers to the relationship between the employees and their work, while employee engagement refers to the relationship between employees and the organisation. in the context of this study, the focus is on work engagement. according to schaufeli, bakker and salanova (2006), work engagement is a positive, fulfilling work-related state of mind that is characterised by vigour, dedication and absorption. consequently, work engagement may be assessed by examining vigour, dedication and absorption (schaufeli et al. 2006). vigour is defined as high energy levels, tenacity in difficult assignments and the desire to master certain skills and tasks. dedication is the feeling of inspiration, accompanied by satisfaction, and of work being important and challenging to the individual. absorption is being engrossed in one’s work, accompanied by happiness and deep levels of attentiveness. employees, who experience a state of work engagement, have an effectual vital association with their work and feel that they meet the requirements of their role (schaufeli et al. 2006). work engagement, meaningfulness at work and the importance for perceived customer value work engagement is becoming more important for business leaders and managers, due to its relevance to service-related outcomes; this is mainly due to work engagement being predictive in relation to performance (barnes et al. 2014). not only does work engagement predict performance accurately, but it has also been associated with finding meaning in work (hoole & bonnema 2015). additionally, researchers are now suggesting that complete work engagement could also lead to meaningfulness at the work place (hager 2018). meaningfulness is influenced by job enrichment, work-role fit and co-worker relations (may et al. 2004). job enrichment has an influence on the degree of meaningfulness experienced through work, while meaningfulness has an even larger impact when the individual has sound working relationships with co-workers (may et al. 2004). in terms of the current research, literature shows that when employees experience meaningfulness at the workplace through job design, it may influence employees’ interaction with clients and consumers (kahn 1990). finding meaning in one’s work has also been associated with improved job performance (rodell 2013). consequently, if employees are not fully engaged, they do not focus on customers’ needs. there is potential benefit in each interaction of employees with customers, which may have an impact on the customer’s perception of the organisation and brand image; if employees are disengaged it would probably have a negative impact on organisational performance (kumar & pansari 2016). work engagement, meaningfulness through work and perceived customer value in the south african environment work engagement in a south african environment was found to be associated with psychological meaningfulness (geldenhuys et al. 2014; van zyl, deacon & rothmann 2010). according to geldenhuys et al. (2014), meaningful work is especially important in the south african environment, as this results in employees being committed to their organisations. previous south african research found that work engagement and meaningfulness were associated with satisfaction in life (williamson & geldenhuys 2014). although the relationship between work engagement and meaningfulness is well-documented from a south african perspective, the indirect effect meaning might have on the relationship between work engagement and perceived customer value in a south african environment remains uncertain. further, there seems to be a research opportunity for a more thorough examination of the relationship between work engagement and performance (christian & slaughter 2007). in the case of this study, the performance variable is perceived customer value. perceived customer value has been associated with customer satisfaction (han & xie 2019) and sales performance (chakrabarty, brown & widing 2010). from a south african perspective, perceived customer value has also been associated with consumer satisfaction (mbango & toerien 2019). goals of the study taking into consideration the preceding facts and information obtained from literature, the primary objective of the present study is to determine the nature of the relationship between work engagement, meaningfulness through work and perceived customer value. more specifically, the question we sought to answer is: can meaningfulness be considered a mediator in the relationship between work engagement and perceived customer value? method a quantitative research approach was followed. a non-probability convenience sampling strategy was used to collect data from the employees (n = 152) of a company operating in the manufacturing sector for household plumbing materials. the sample was dominated by the male group (52.21%), while 54.61% of the respondents indicated that they had been working in the industry for less than five years. results also show that 50% of the sample group considered themselves not part of management, and 34.21% of respondents indicated that they regard themselves as skilled and academically qualified. the average age of respondents was 40.67 years. measurements the measuring instrument involved two steps. in the first step, biographical information from respondents was collected, while views on work engagement, meaningfulness through work and on perceptions of customer value were collected in the second step. the utrecht work engagement scale (nine items) the work engagement variable was assessed, using the utrecht work engagement scale (uwes-9: schaufeli et al. 2006). the shortened nine-item scale assesses work engagement through vigour (3 items), dedication (3 items) and absorption (3 items). the uwes-9 makes use of a 7-point likert scale on which 0 indicates never and 6 always. a typical item from the uwes-9 would be: ‘i am proud of the work that i do’. the uwes-9 was found to be a reliable instrument for work engagement in the present study (α = 0.91; r = 0.50). meaningfulness at work scale the meaningfulness variable was assessed by the meaningfulness at work scale (maw: may et al. 2004). the 14-item scale measures meaningfulness through work with validated sub‑ components, namely psychological meaningfulness (6 items), psychological safety (3 items) and psychological availability (5 items). the maw makes use of a 6-point likert scale in which 1 means never and 6 every day. a typical item would be: ‘that your work makes a difference to the world’? the maw demonstrated adequate reliability in the present study (α = 0.86; r = 0.36). perceived customer value scale the perceived customer value was measured, employing the perceived customer value scale (pcs: leroi-werelds et al. 2014). the one-dimensional scale assesses perceived customer value against five items. the pcs makes use of a 9-point likert scale in which 1 means extremely unimportant and 9 extremely important. a typical item would be: ‘the company prices appear to be a bargain’. the pcs demonstrated satisfactory internal consistency (α = 0.64; r = 0.26). procedure the holding company from the manufacturing sector was requested to participate in the research by contacting their executive management and human-resource departments. an introductory meeting was held with representatives from the various human-resource departments to explain the rationale behind and focus of the study. a covering letter, as well as a questionnaire, were distributed to sampled employees, via email, through their human-resource departments. respondents were given 30 days to complete the questionnaire and were reminded once a week. in the covering section of the questionnaire, ethical considerations were addressed by assuring participants of confidentiality and non-prejudice. all the participants were free to voluntarily participate and were not coerced in any way. the holding company from the manufacturing sector granted permission to conduct the research. statistical analysis data was cleaned, captured and analysed with the statistical package for social sciences (spss) and analysis of a moment structure (amos), version 26 (ibm corp 2019). descriptive statistics (means and standard deviations) were calculated in order to determine central tendencies for work engagement, meaningfulness at work and perceived customer value. internal consistency was determined by calculating cronbach’s alphas (α) and inter-item correlations (r). cronbach’s alpha threshold was set at a moderate level (α = 0.60; robinson, shaver & wrightsman 1991) while inter-item correlation was considered sufficient (r = 0.20–0.40; pallant 2007). an exploratory factor analysis (efa) was conducted for individual variables in order to assess the internal structure. principal component analysis was used as the extraction method. examinations included the kaiser-meyer-olkin (kmo) measure of sampling adequacy and bartlett’s test of sphericity. according to field (2009), kmo values should be as close as possible to 1 and bartlett’s test of sphericity should be significant, while eigenvalues larger than 1.00 were used as criteria for factor selection. the minimum threshold set for factor loadings was considered adequate at 0.40 (hinkin 1998). once reliability and the internal structure were confirmed, the work engagement, meaningfulness through work and perceived customer value variables were subjected to a confirmatory factor analysis (cfa) by making use of amos. we considered the root mean square error of approximation (rmsea) and relative/normed chi-square (χ2/df) as absolute fit-indices, while incremental fit-indices included the tucker-lewis index (tli) and comparative fit index (cfi). the cut-off criteria for adequate cfa were considered to be: rmsea < 0.08 (van de schoot, lugtig & hox 2012), χ2/df < 2.0 (tabachnick & fidell 2007) cfi and tli > 0.90 (wang & wang 2012). spearman’s correlations were calculated in order to determine the type and nature of the relationships between the variables under investigation. correlations were firstly analysed for statistical significance (p < 0.05), and additionally assessed for practical significance. practical significance was considered at r ≥ 0.10, medium effect at r ≥ 0.30, and large effect at r ≥ 0.50 (cohen 1988). additionally, the final model was tested for multicollinearity. thresholds for multicollinearity was set at 4.00 for variance inflation factors (vif), and not less than 0.20 for tolerance (hair et al. 2010). direct and indirect effects were assessed by computing a simple mediation model with process (hayes 2017), which is installed in spss. direct effects were considered significant at p < 0.05, while indirect effects were considered significant if the lower-level confidence interval (llci) and upper-level confidence interval (ulci) excluded zero (zhao, lynch & chen 2010). descriptive, reliability and correlation results table 1 shows the results obtained from the descriptive, reliability and correlation analyses. according to table 1, all variables, except psychological safety met the set of minimum criteria for internal consistency. however, pallant (2007) indicates that scales with less than 10 items may present as problematic, so low cronbach’s alphas and, therefore, inter-item correlations should also be considered. psychological safety was assessed against only three scale items. the inter-item correlation for psychological safety (r = 0.25) was considered adequate and the variable was deemed reliable. table 1: descriptive, reliability and correlation results. closer examination of the mean and standard deviation scores revealed that all variables were within each scale’s ‘positive’ range. therefore, we are able to confirm that, according to the respondents, there was a conducive level of work engagement; they experienced meaningfulness at the workplace and had a positive perspective on providing customer value. with regard to the relationships between the variables under investigation, the results from the spearman’s rank order correlations demonstrated that work engagement, meaningfulness and perceived customer value had a significant positive relationship. a strong positive relationship (r = 0.65; p < 0.05; large effect) existed between work engagement and meaningfulness. in reality, this result translates into a situation where respondents, who reported positive levels of work engagement, would also be inclined to report high levels of meaningfulness. in terms of the relationship between meaningfulness and perceived customer value, the result was a moderate positive relationship (r = 0.35; p = 0.05; medium effect). this result suggests that positive levels of meaningfulness will also be associated with positive levels of perceived customer value. the correlation calculation between work engagement and perceived customer value demonstrated a positive result (r = 0.29; p < 0.05; small effect) as well. although interpreted as a small effect, this result implies that respondents, who reported conducive levels of work engagement, were also likely to report conducive levels of perceived customer value. concerns with regard to potential multicollinearity were dismissed, due to results obtained from vif and tolerance computations. scores for vif ranged from 2.74 to 1.56, and for tolerance from 0.37 to 0.63. consequently, work engagement, meaningfulness and perceived customer value may be applied independently with confidence in the simple mediation model. exploratory factor analysis an exploratory factor analysis (efa) was conducted on each individual variable in order to examine the structure. the examinations of eigenvalues and scree plots confirmed the individual factors for each variable. for vigour, the first factor extracted, explained 73.72% of the variance with an eigenvalue of 2.21. factor loadings ranged from 0.75 to 0.77 for vigour (kmo = 0.72; bartlett’s test of sphericity = p < 0.01). with regard to dedication, the first factor extracted, explained 74.33% of the variance with an eigenvalue of 2.23 and factor loadings ranging from 0.67 to 0.90 (kmo = 0.70, bartlett’s test of sphericity = p < 0.01). for absorption, the first factor extracted, explained 63.57% of the variance, with factor loadings ranging from 0.67 to 0.72 (kmo = 0.70; bartlett’s test of sphericity = p < 0.01). for perceived customer value, the single factor extracted, explained 60.03% of the variance with an eigenvalue of 2.40. factor loadings for perceived customer value ranged from 0.56 to 0.92 (kmo = 0.72; bartlett’s test of sphericity = p < 0.01). for psychological meaningfulness, the first factor extracted during the efa explained 70.90% of the variance with an eigenvalue of 4.26. factor loadings ranged from 0.69 to 0.89 for psychological meaningfulness (kmo = 0.85; bartlett’s test of sphericity = p < 0.01). the single factor extracted for psychological safety explained 51.00% of the variance with an eigenvalue of 1.52. factor loadings ranged from 0.40 to 0.62 for psychological safety (kmo = 0.60; bartlett’s test of sphericity = p < 0.01). in terms of psychological availability, the single factor extracted, explained 58.81 of the variance with an eigenvalue of 2.94. factor loadings for psychological availability ranged from 0.63 to 0.86 (kmo = 0.81; bartlett’s test of sphericity = p < 0.01). confirmatory factor analysis a latent variable model was constructed in amos in order to conduct the cfa. work engagement was considered by assessing vigour, dedication and absorption, while perceived customer value was considered as a one-dimensional variable. meaningfulness at work was considered by assessing psychological meaningfulness, psychological safety and psychological availability. the model demonstrated adequate fit (χ2 = 448; df = 289; p < 0.001; χ2/df = 1690; tli = 0.90; cfi = 0.91; rmsea = 0.068). based on the results obtained from the cfa, validity for the present study was deemed acceptable. simple mediation model the results of the simple mediation model are illustrated in table 2. work engagement was considered the independent variable, perceived customer value the dependent variable and meaningfulness the proposed mediator. table 2: standardised regression coefficients: work engagement, meaningfulness at work and perceived customer value. according to the results of the standardised regression coefficients, the first regression (1) in which work engagement was considered the independent variable and the proposed mediator, meaningfulness at work, the dependent variable, yielded a significant result (b = 0.36, t (150) = 10.41, p < 0.01). the second regression (2) in which the proposed mediator, meaningfulness, was considered the independent variable and perceived customer value the dependent variable, also yielded a significant result (b = 0.57, t (149) = 2.83, p < 0.01). the final regression (3) in which work engagement was considered the independent variable and perceived customer value the dependent variable, did not yield a significant result (b = 0.12, t (149) = 1.05, p = 0.29). the indirect effect of meaningfulness at the workplace on the relationship between work engagement and perceived customer value was also significant (b = 0.20, se = 0.08, llci = 0.06 and ulci = 0.36). the indirect effect from the bootstrap analysis with a 95% confidence interval did not include zero; therefore, (a x b) is significant (zhao et al. 2010). consequently, meaningfulness may be considered a mediator for the relationship between work engagement and perceived customer value. the results for the simple mediation model are shown in figure 2 below. figure 2: simple mediation model: work engagement, meaningfulness at work and perceived customer value. discussion the aim of the study is assessing the indirect effect of work engagement on perceived customer value, via meaningfulness at work. the purpose was further to examine the relationships between work engagement, meaningfulness at work and perceived customer value, as well as the direct effects. the primary objective was achieved with evidence from a simple mediation model indicating an indirect effect of meaningfulness on the relationship between work engagement and perceived customer value. this result suggests that work engagement is not adequate on its own to have an impact on perceived customer value; what is also required is an improvement in the meaningfulness through work. not only does this result confirm the present study’s conceptual model, it also confirms the importance of finding meaning for individuals as suggested by d’enbeau and buzzanell (2013). our results further indicate that work engagement could predict meaningfulness by suggesting that an improvement in work engagement may also result in an improvement of meaningfulness at the workplace. this finding confirms the proposed model of hager (2018), who suggested that work engagement could impact on meaningfulness. hager’s study also found evidence that meaningfulness could influence perceived customer value. consequently, enhancing meaningfulness should improve perceived customer value; therefore, confirming the conceptual position of the present study that meaningful work results in perceived customer value. in the present study statistical evidence was not found that an improvement in work engagement results in greater perceived customer value. previous research suggests that work engagement may indeed be associated with a competitive advantage (joshi & sodhi 2011) and that disengaged workers probably did not really consider the needs of their consumers (kumar & pansari 2016). the contradictory results may require further examination, as the current study found proof that respondents from the manufacturing organisation demonstrated signs of employee engagement. the correlation analysis revealed that work engagement and meaningfulness will be associated in the manufacturing organisation. the result implies that higher levels of work engagement would most probably also be associated with higher recordings of employees who find meaning at the workplace. the specific result is consistent with previous south african findings of work engagement being associated with meaningfulness through work (geldenhuys et al. 2014; van zyl et al. 2010) theoretical and managerial applications literature findings indicate that perceived customer value is related to improved customer satisfaction (han & xie 2019; mbango & toerien 2019), including improved sales performance (chakrabarty et al. 2010). the findings of this study indicate that meaningfulness at the workplace predicted improved perceived customer value. the findings further specify that having engaged employees is not enough, but that the manufacturing organisation also relies on creating meaning at work for employees in order to improve their perceptions of customer value. south african organisations wishing to improve indications of meaningfulness at work should direct their attention towards person-job fit, self-concept-job fit (scroggins 2008), calling orientation, job design and co-worker relations (fouché, rothmann & van der vyver 2017). the improvement of work engagement would not only be applicable to the employees’ finding meaning at the workplace, but will also be extended to the customer with enhanced perceptions of customer value, which in return will improve employee productivity and organisational performance. limitations although the study has made valuable contributions towards work engagement, meaningfulness at work and literature on perceived customer value, it has limitations. a quantitative cross‑sectional study restricts causation conclusions from the results and interpretation should be restricted to the sample. common method bias will remain a reality when doing data-using surveys. in a future qualitative study it should be possible to confirm the influence on perceived customer value, and provide more comprehensive insight into this specific relationship. data were collected from only one manufacturing organisation and are, therefore, not representative of the industry. future studies should expand data collection to include more manufacturing organisations in order to generalise results to the industry. conclusion theoretically, work engagement should enhance meaningfulness through and at work and also improve perceived customer value. the current south african empirical investigation found evidence that this conceptual relationship does indeed exist and, therefore, contributes towards the body of knowledge pertaining to work engagement, meaningfulness and perceived customer value. in the present study evidence was found that an improvement in work engagement may also result in an improvement in meaningfulness at the workplace. furthermore, meaningfulness through work was found to have a positive impact on perceived customer value. these findings indicate that work engagement is not sufficient to improve employees’ perceived customer value but that conducive levels of meaningfulness at the work place is also required. acknowledgements competing interests the authors have declared that no competing interests exist. authors’ contributions all authors contributed equally to this work. ethical considerations the north-west university research ethics committee where the study was registered, ensured that ethically acceptable practices were adhered to throughout the study (mspbs16/02/16-01/04). funding information this research received no specific grant from any funding agency in the public, commercial, or not-for-profit sectors. data availability data sharing is not applicable to this article as no new data were created or analysed in this study. disclaimer the views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position 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https://doi.org/10.1080/14330237.2014.980619 zhao, x., lynch, j.g. & chen, q., 2010, ‘reconsidering barron and kenny: myths and truths about mediation analysis’, journal of consumer research 37(2), 197–206. https://doi.org/10.1086/651257 abstract introduction literature review data and method results conclusion acknowledgements references appendix 1 about the author(s) miriam berenice dikuua school of accountancy, faculty of commerce, law and management, university of the witwatersrand, johannesburg, south africa warren maroun school of accountancy, faculty of commerce, law and management, university of the witwatersrand, johannesburg, south africa wayne van zijl school of accountancy, faculty of commerce, law and management, university of the witwatersrand, johannesburg, south africa asheer jaywant ram school of accountancy, faculty of commerce, law and management, university of the witwatersrand, johannesburg, south africa citation dikuua, m.b., maroun, w., van zijl, w. & ram, a.j., 2023, ‘audit regulation and its relevance for audit quality in namibia’, south african journal of economic and management sciences 26(1), a4866. https://doi.org/10.4102/sajems.v26i1.4866 original research audit regulation and its relevance for audit quality in namibia miriam berenice dikuua, warren maroun, wayne van zijl, asheer jaywant ram received: 29 sept. 2022; accepted: 27 feb. 2023; published: 25 apr. 2023 copyright: © 2023. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: corporate scandals have resulted in decreasing levels of confidence in the audit profession so that audit quality is under finer scrutiny. aim: this article has explored the role external audit regulation in namibia plays in ensuring the quality of its financial statement audits. setting: the opinions of audit and regulation experts in namibia were examined. method: a mixed-method approach, grounded in an interpretive epistemology, was employed. a correspondence table was developed, using the current literature. the opinions of audit and regulation experts on the effect that external regulations have on audit quality were then sought, using correspondence analysis and interviews. results: the primary themes of audit quality from a regulatory perspective are maintaining independence and consulting on complex audit matters, the employment of competent members in the engagement team and a culture of quality, driven by firm leadership. it is further revealed that administrative functions play a vital role in contributing to the quality of an audit. conclusion: a conceptual model, linking regulation and audit quality, is presented. independence is considered the cornerstone of the audit profession, while regulations are relevant to independence. regulators may consider introducing measures such as rotation of audit firms or the disclosure of audit tenure in annual financial statements. contribution: this is the first research of its kind in namibia. it is helpful to regulators and audit practitioners because it allows them to gain a better understanding of whether the current regulations adequately enhance audit quality, instead of being perceived as a ‘tick-box’ exercise. keywords: audit quality; external regulation; international standard on quality control 1 (isqc 1); namibia; public accountants’ and auditors’ board (paab); institute of chartered accountants of namibia (ican). introduction the namibian audit profession has been in existence for over 70 years. the key players are the institute of chartered accountants in namibia (ican), established in october 1990 (ican 2018), and the public accountants’ and auditors’ board (paab). the paab was established by the public accountants’ and auditors’ act of 1951, as amended in 1990 (international federation of accountants [ifac] 2020). the ican focuses its efforts on supporting paab and ican members with the implementation of control standards to ensure a high level of audit quality (ifac 2020). the paab has assumed the responsibility of carrying out quality assurance reviews and recognises the importance of quality assurance. the audit function is evolving from a technical process to one from which clients expect value-added insights based on the auditor’s understanding of the auditee and the industry in which it operates (barac et al. 2016). quality assurance is also becoming increasingly important in light of corporate scandals and audit failures. this has given rise to increased scrutiny of financial reports and, following that, audit regulation and quality (hay 2015; knechel 2016). corporate scandals have resulted in decreasing levels of confidence in the audit profession (odendaal & de jager 2008). these scandals have led to serious concerns being raised about auditor independence and audit quality in general (firth, rui & wu 2012). the quality of the audit function, as a means to prevent or detect corporate fraud, is being questioned by users of financial statements (harber 2018). in response, regulators have begun to play a more active monitoring role. they are questioning whether external auditors are, in fact, independent of their clients and are performing audit engagements to the required standard. consequently, there has been a proliferation of rules, regulations and other prescriptions (daniels & booker 2011), aimed at improving minimum levels of audit quality (association of chartered certified accountants [acca] 2010; barac et al. 2016; holm & zaman 2019; humphrey et al. 2011). a significant amount of prior audit quality research assesses the relationship between regulatory developments and audit quality proxies (humphrey 2008), but research dealing with developing economies, especially those in africa, is limited (abozaid, elshaabany & diab 2020; dikuua et al. 2018). at the same time, much of the literature on the quality of audits is concerned with the inferential testing of quality surrogates, rather than direct engagement with key stakeholders (humphrey 2008; hussein & mohdhanefah 2013). this article addresses this particular limitation by providing primary empirical evidence of how audit practitioners interpret and react to regulation in practical settings, using a correspondence analysis complemented by semi-structured interviews. the main objective of the article is to explore the role external audit regulation in namibia plays in ensuring the quality of its financial statement audits. we seek to answer the question: how do external regulatory measures impact audit quality? rather than relying on broad measures of audit quality, typically applied in quantitative studies (such as changes in earnings or financial reporting quality), the provisions of isqc 1 (international standard on quality control 1: quality control for firms that perform audits and reviews of historical financial information, and other assurance and related services engagements) are mobilised to describe audit quality. this allows for a more detailed account of how external regulation contributes to improve the audit quality to be provided. the elements, or features, of audit quality per isqc 1, serve as column headings in the correspondence analysis. certain steps taken by paab and ican to bolster the quality of audit engagements are row headings. a sample of experts completes the resulting correspondence table based on their views of those aspects of isqc 1 aided, or enhanced, by the namibian audit regulation. the remainder of this article is structured as follows: section 2 presents the literature on audit quality in terms of isqc 1 and on audit regulation in namibia. this is followed by the description of the data and method in section 3 and the presentation and discussion of the results of the correspondence analysis and interviews in section 4. the article is then concluded in section 5. literature review the prior research focuses on quality proxies, rather than on specific policies, systems and practices (humphrey 2008) that may contribute to better quality audits. accordingly, in 2013, the public company accounting oversight board (pcaob) embarked on a project to develop audit quality measures. they found that there are two types of audit quality indicators: output-based and input-based indicators. examples of the former include the number of frauds detected and financial restatements required. instances of the latter are processes and procedures adopted to detect fraud and the average experience level of staff assigned to audit engagements. an alternate approach relies on the guidance provided by existing professional standards to examine the processes and systems that must be in place to support the performance of a high-quality audit. international standard on quality control 1 elements of audit quality international standard on quality control 1 has been used previously in audit research. it has been applied in over 50 jurisdictions and has been subject to extensive review (boolaky 2012; maroun 2014; ndaba, harber & maroun 2021). as a result, isqc 1 forms an appropriate basis for this article. the elements of audit quality are discussed below and form the row headings in the correspondence analysis to test the association between quality indicators and the audit regulatory features. firm leadership and a culture of quality the leadership of any firm is responsible for promoting an internal culture of quality (international auditing and assurance standards board [iaasb] 2009a). the international ethics standards board for accountants (iesba) reiterates that the leadership of a firm should promote compliance with the fundamental principles as outlined in the international code of ethics for professional accountants. it also sets out the expectation that engagement team members will act in the public interest and emphasises the importance of ethical behaviour (iesba 2021). a quality-oriented internal culture emphasises the need to have policies and procedures in place to meet the requirement to perform work complying with the relevant professional standards and to issue appropriate reports (iaasb 2009). the first quality element is: q1: establishing policies and procedures promoting a culture of quality, driven by firm leaders and strengthened by enhanced supervision. independence auditor independence is a key indicator of audit quality (pcaob 2013). this sentiment is echoed by the iaasb which identifies independence as a core requirement for ensuring high ethical standards and effective firm leadership (iaasb 2009). codes on corporate governance, such as king-iv in south africa, endorse this view with one of the core objectives of good governance being the promotion of a culture of ethics and independence in order for organisations to deliver desired outcomes (institute of directors in southern africa [iod] 2016). researchers further argue that auditors who have an economic interest in their clients will lack independence and will be less likely to report any irregularities, thereby reducing audit quality (daniels & booker 2011). independence comes in two forms, namely ‘in mind’ and ‘in appearance’ (iesba 2021). the former is: [t]he state of mind that permits the expression of a conclusion without being affected by influences that compromise professional judgement, thereby allowing an individual to act with integrity, and exercise objectivity and professional scepticism. (p. 31) independence in appearance is concerned with: [t]he avoidance of facts and circumstances that are so significant that a reasonable and informed third party would be likely to conclude that a firm’s, or an audit team member’s, integrity, objectivity or professional scepticism has been compromised. (iesba 2021, p. 32) auditors’ independence contributes to achieving trust in the audit profession (power 2003). regulators have introduced measures, inter alia mandatory rotation of audit firms, in an attempt to strengthen the independence of auditors (harber 2018). based on the above, the following statement has been included in the correspondence table: q2: maintaining independence of mind and appearance in accordance with relevant ethical requirements. client acceptance and continuance procedures audit firms are required to adopt client and engagement acceptance procedures to ensure compliance with the fundamental principles of integrity, objectivity, professional competence and due care, confidentiality and professional behaviour (iesba 2021). client acceptance procedures have also been used in prior research as an output measure of audit quality (francis 2011). based on the importance of client acceptance and continuance procedures, the following statement has been included in the correspondence table: q3: ensuring ethical compliance, including client acceptance and continuance procedures. competence of engagement team members under isqc 1, audit firms are required to establish policies and procedures designed to provide the audit firm with reasonable assurance that it has sufficient personnel with the required competence, capabilities and commitment to ethical principles (iaasb 2009). this notion of competence is further supported by codes on corporate governance stating that effective leadership is exemplified by competence (iod 2016). competence and due care, evidenced by attaining and maintaining knowledge and skill at the level required to ensure professional service, are ‘fundamental principles’ characterising auditors and high-quality engagements (iesba 2021). accordingly, the following statement is included in the correspondence table: q4: awareness of the importance of sufficient members in the engagement team with the required competence and capability to apply and comply with the international standards on auditing (isas). consultation alongside independence and competence requirements, effective monitoring, supervision and consultation are critical, especially concerning difficult or contentious issues (iaasb 2009). the ‘collective experience and technical expertise of the firm’ at the appropriate level on complex or controversial and ethical issues strengthen the overall audit process and firm culture (iaasb 2009:26–27): q5: ensuring that appropriate consultation on complex audit matters takes place; that differences in opinion are resolved and that consultation conclusions are implemented. review and monitoring processes consultation in the form of second partner and other specialist reviews may bolster audit quality by safeguarding independence and ensuring that complex issues are not overlooked or misinterpreted during engagements (barac et al. 2016). international standard on quality control 1 emphasises the importance of continual improvement, internal quality control and sound documentation standards (iaasb 2009). ensuring audits are completed and documented timeously is also key to sound audit quality: q6: appointing engagement quality control reviewers to enhance the overall quality of the engagement. q7: ensuring that quality engagement files are completed on a timely basis and that all aspects of the engagement have been thoroughly documented. q8: ensuring that a firm establishes a monitoring process of its internal quality control policies and procedures driving continual improvement. namibian regulatory measures the paab is charged with the legal responsibility of monitoring and maintaining the quality of services provided by registered auditors (ifac 2020). external regulatory measures applicable in the namibian audit environment are summarised below. they are labelled r1 to r8 and are included as column headings in the correspondence table (table 1). table 1: correspondence table. training the paab regulate the training and registration of accountants, as well as the contracts of training officers (paab 2022a). training regulations include core administrative experience, assessment and disciplinary processes. the training regulations specify the selection of people with high intellectual ability, an increased focus on professional values, ethics and business acumen, as well as a balance of compulsory, elective and residual skills development (paab 2022a). the content of the paab’s training programme covers accounting, external reporting and pervasive skills. pervasive skills cover professional conduct, management and leadership, personal attributes and information technology (paab 2022a). these are provided to trainees through a combination of formal education and job experience (paab 2022a). with these points in mind, the following regulatory measures designed to drive better quality audits are identified: r1: the registration and administration of training officers and contracts, respectively, are performed by the paab. r2: training offices are re-accredited on a regular basis to ensure that the educational programmes enforced are distinguished by quality in training and practical experience through the integrated application of knowledge, skill and professional values. practice reviews are conducted in conjunction with the paab training regulations; accordingly, the correspondence table includes: r3: quality assurance reviews are performed on engagement partners’ audit files by the paab on a regular basis and this process is overseen by the paab quality assurance committee. the audit development programme (adp) is a period of specialisation for professional accountants who wish to become registered auditors and accountants (raa) in namibia (paab 2022b). the adp allows candidates to gain exposure to a broad range of complex matters faced by raas in practice and helps them to develop professional competence and judgement, ethical values, as well as lifelong learning skills (paab 2022b). the candidates are exposed to tasks that, over time, increase in complexity and allow candidates to take on more responsibility for the aspects of an audit engagement that present a greater risk to the firm, the clients and other stakeholders (paab 2022b). once an raa, these accountants are expected to continue refining their auditing and managing skills throughout their careers: r4: auditors are required to complete a mandatory 18-month adp to be registered by the paab as a registered auditor. r5: every adp candidate is required to complete a portfolio of evidence, by which certain competencies have to be demonstrated which are evaluated by the paab audit development committee. continuing development of professional knowledge and skill has distinct benefits for the individual professional accountant in maintaining a high level of technical competence, developing new areas of expertise and increasing career options, job satisfaction and client satisfaction. continuous professional development (cpd) can be structured or unstructured (ican 2018). structured learning includes courses presented by educational institutions, member bodies or employers, individual study programmes, participation in conferences, nam briefing sessions or discussion groups and service as a member of a technical committee of a professional body or firm (ican 2018). members’ compliance with cpd requirements is monitored by ican. non-compliant members must present plans to become compliant to the ican secretariate or risk being removed from the register of members (ican 2018). the regulatory measures concerning this, are: r7: holders of the chartered accountant (namibia) designation (ca[nam]) and registered accountants and auditors, are required to demonstrate continued development of professional knowledge and skill which is monitored by the ican. r8: members who do not meet the cpd requirements have to provide an achievable plan of remedial action to the ican secretariat. failure to provide a plan of remedial action, or failure to carry out the plan provided to the ican secretariat, may result in the ultimate revoking of the ca(nam) designation. peer review and inspection peer reviews, together with mandatory inspections, were introduced as a means to re-establish the trust in the audit function by ensuring an improvement in audit quality (löhlein 2016). there are opposing views on whether or not external quality control contributes positively to the improvement of audit quality. in the 6 years of inspection conducted by the pcaob, which were underway in 2012, it remained unclear whether the inspection process benefited audit quality (church & shefchik 2012). in namibia, the paab is responsible for conducting practice reviews to build local capacity. these reviews are focused on technical, as well as ethical issues. in addition, one of the paab’s vital mandates is to investigate, through the paab investigations committee, any allegations of improper conduct that are reported (paab 2020): r6: allegations of improper conduct are investigated, in accordance with the paab disciplinary rules and the ifac code of ethics for professional accountants, by the paab investigations committee. the next section presents the method used and demonstrates how the above regulatory and quality elements were used in the research. data and method a mixed-methods approach, grounded in an interpretive epistemology, was employed to examine the association between audit regulatory features and audit quality in namibia. the opinions of audit experts on the effect external regulations have on audit quality are explored, using correspondence analysis, instead of testing whether a causal relationship exists between the two ‘variables’ (maroun 2014). correspondence analysis has become popular in research and is appropriate for this article because it is exploratory in nature (kudlats, money & hair jr 2014). the aim of this article is not to quantify audit quality but to gain an understanding of the association between external regulation and audit quality (maroun 2014). data were collected in two phases: phase 1 used correspondence analysis to aggregate and summarise the perceptions of audit experts in namibia. phase 2 used the correspondence plot as a basis for semi-structured interviews with five audit experts to further explore the association between external regulation and audit quality to enhance the results from the correspondence analysis. correspondence analysis the purpose of using a correspondence analysis is to explore the relationship between the isqc 1 elements of audit quality and external regulatory measures. while correspondence analysis does not generate empirical results (kudlats et al. 2014; ram et al. 2016; ram 2018), it does provide an opportunity for insight to be derived from how participants correlate audit quality and regulatory measures. in this correspondence table, key external regulations constitute column headings, while isqc 1 audit quality elements constitute row headings. the columns are labelled ‘r1’–‘r8’ and the rows are labelled ‘q1’–‘q8’ resulting in an 8-by-8 correspondence table (table 1) as explained in the literature review. the table was piloted with researchers at a namibian university to identify any validity and suitability weaknesses (ram et al. 2016; ram 2018). the fact that audit experts only were used in this article presents a potential for bias. however, it ensures that only knowledgeable professionals are engaged who add to the internal validity of the findings (maroun 2014). surveying both the setters of regulation and those subjected to the regulations mitigates this risk. the participants provide insight into the correlation between namibian regulatory measures and audit quality in completing the correspondence table. data collection purposeful selection of namibian audit experts and a small sample size enhance the quality of the research findings (maroun 2017; maroun, turner & sartorius 2011; ram 2018) by ensuring that only participants with extensive audit experience and knowledge of isqc 1 and namibian regulation are engaged. this also ensures that the day-to-day audit experiences of the participants are incorporated in the research. seventy-three potential participants were engaged while 42 responded. this response rate may appear low relative to international studies on audit quality but reflects the size of the namibian capital market, as well as the local accounting and auditing profession. for the correspondence analysis, there is a direct relationship between the sample size and the number of row and column headings. studies with comparable correspondence tables (in terms of the number of row and column points) rely on samples consistent with those proposed by this article (kudlats et al. 2014; ram et al. 2016; ram 2018). the paab and ican helped to distribute the correspondence table to potential participants. a covering letter informed them of the purpose and nature of the research. it also included instructions on how to complete the correspondence analysis. the participants were asked to mark an ‘x’ in cells where the isqc 1 audit quality elements (rows) correspond positively with the respective external regulation (columns). data analysis descriptive statistics and a correlation matrix were generated from the correspondence table (kudlats et al. 2014). the results were accumulated into a single frequency table and a two-variable scatterplot (bendixen 1996). column headings (quality indicators) were used to label the axes in the final correspondence plot. namibian regulatory measures were then positioned based on their size, correlation with the axes and inertial contribution. this is explained in more detail below (see figure 1). figure 1: correspondence plot. the approach of kudlats et al. (2014), was followed. step one is to determine the strength of associations between isqc 1 quality traits and regulatory measures. this was measured through the inertial contribution that each point makes to the total inertia of the model. inertia is described as the key measure of association within the plot (ram 2018), which is developed to position each of the regulatory measures with respect to the four categories of quality traits. step two involves determining a suitable number of dimensions. in general, two dimensions on the correspondence plot are acceptable because of the complexity of analysing plots with three or more dimensions (ram 2018). where a two-dimensional solution accounts for a significant portion of the total inertia of the model, two dimensions are considered appropriate (bendixen 1996). step three is to interpret the dimensional representation (ram 2018). based on the descriptive statistics, the quality traits (row headings) and regulatory measures (column headings) that are statistically significant were determined and displayed on the correspondence plot. the total inertia of the model is allocated independently, but equally, to each quality trait and regulatory measure by dividing the total inertia of 100% by the number of points. where the inertial contribution of a quality trait or regulatory measure exceeds the average inertia per trait and measure, it is considered statistically significant (kudlats et al. 2014; ram 2018). step four involves assigning a dimensional reference and the researcher placed each significant trait and measure on the plot, based on the co-ordinates of each point. the sign of the co-ordinate (positive or negative) provides the necessary evidence for whether a significant regulatory measure is to be placed on the positive or negative side of the relevant xor y-axis. for each placement, the grouping of significant traits is analysed for interconnections and, based on these findings, each of the four-axis placements is named. the row and column points are then shown on the same graphical display to allow for easy visualisation of the associations (doey & kurta 2011). a chi-square statistic is used to measure the distance between points on the scatterplot and, in turn, measure the association among variables (bendixen 1996; doey & kurta 2011). to aid further analysis of the results from the correspondence analysis, a limited number of semi-structured interviews was conducted with the respondents. interviews the interviews were semi-structured and flexible to ensure a rich data set was obtained, while staying focused (kudlats et al. 2014; maroun 2014). the correspondence analysis technique was explained to the interviewees at the beginning of the interviews. any misunderstandings or misinterpretations were resolved verbally after which the correspondence plot was provided. the interviewees were then allowed to interpret the plot and provide their views on the relevance of namibian regulation to audit quality. to ensure no ambiguity and prevent rehearsed responses, respondents were asked to explain certain concepts in their own words or to provide different perspectives on the evidence before them (alvesson 2003). a total of five interviews were conducted, which the researcher concluded to be satisfactory as saturation was reached. participants with at least 10 years of experience in the audit profession were selected for the interviews. their views complement the initial analysis of the correspondence plot and further incorporate the lived experiences of auditors in relation to the external regulations and audit quality. to generate and organise findings, the responses were grouped according to the four axes (positive and negative xand y-axes) identified in the first phase of data collection. using these pre-defined parameters did not detract from the exploratory nature of the research and allowed for the methodical analysis of the responses (maroun & atkins 2014). the intention of the semi-structured interviews was not to obtain consensus amongst respondents. at the start of the interviews, the participants were reminded of the nature and purpose of the research, and the fact that there are no correct or incorrect answers. the researcher provided the participant with the correspondence plot (figure 1) and an explanation of the correspondence analysis technique. details of the interviewees are provided in table 2. table 2: details of interviewees. interviewees’ responses were coded on a line-by-line basis by first allocating them to the respective initial correspondence analysis regulatory measures and quality traits. the responses were then categorised into those supporting and those opposing the correspondence plot results. validity and reliability an application for full ethical approval was made to the school committee and ethics consent was received in 2019. the ethics approval number is caccn/1188. informed consent in writing was acquired at all points in the research. all data were kept on a secured laptop and were not provided to any person. to increase face validity (leedy & ormrod 2014), the research supervisors were consulted and the correspondence table was piloted with auditing academics at the researcher’s home university. reliability was strengthened by the fact that the mixed-method adopted in the article, allowed the researcher to triangulate the findings from the literature, the correspondence analysis and the semi-structured interviews. the coding, which was developed in the correspondence analysis tool, is grounded in prior literature, also limiting subjectivity and ensuring thorough and consistent analysis of the responses. the use of correspondence analysis does, however, present certain limitations. correspondence analysis is an exploratory and descriptive tool (kudlats et al. 2014) and can, as a result, not be used for hypothesis testing, or providing a quantitative conclusion (maroun 2014). despite these limitations, correspondence analysis was considered appropriate as it is a quantitative methodological tool which enabled the researcher to improve the interpretation of the data and communicate the findings more effectively using a visual mapping approach (kudlats et al. 2014). ethical considerations the school of accountancy ethics committee approved the study. this committee forms part of the research ethics committee of the faculty of commerce, law and management, which forms part of the human research ethics committee (hrec) (non-medical) of the university of the witwatersrand, johannesburg (caccn/1188). results table 3 provides the preliminary descriptive statistics. the first two dimensions, which are the xand y-axes in the final correspondence plot, account for 72.2% of the total inertia and contributed to most of the exploratory potential of the graphical plot. the model’s inertial contribution is consistent with that reported by previous studies using this method (kudlats et al. 2014; maroun 2014; ram 2018). at 49 degrees of freedom, the chi-square statistic of 232.285 was significant at the 1% level (p < 0.01). in other words, it was more than the critical value using a 99% confidence level. this indicator provides evidence that there are strong associations between the rows and the columns in the two-variable solution. table 3: descriptive statistics for correspondence analysis. the correspondence plot only regulatory measures (rs) and quality traits, as per isqc 1 (qs), that make an above average inertial contribution were included in the analysis for ease of interpretation. statistically significant points were those with inertial contributions exceeding 12.5% (100% inertia divided by the 8 regulatory measures and 8 quality traits, respectively). the researchers chose to round this percentage down to 10%. all the statistically significant points have been included in the correspondence plot (figure 1). each row point’s sign and dimension of significance were used to position the row points on the positive or negative xand y-axes (bendixen 1996; kudlats et al. 2014; maroun 2014). it is important to note that the sign of each row point is not in itself indicative of whether an association is favourable or unfavourable but merely specifies the positioning of each row point on the positive or negative xand y-axes (maroun 2014; ram et al. 2016; ram 2018), relative to different elements of isqc 1 quality traits. the statistics in tables a1 and a2 in the appendix were generated by stata and provided the necessary guidance in selecting the significant quality traits to be loaded on the positive or negative xand y-axes. table 4 shows the loading of the significant quality traits onto the xand y-axes in the correspondence plot and the interpretively developed name for the axis. table 4: relationship between axes and quality traits. similarly, table 5 shows how the regulatory measures were loaded onto the axes. table 5: relationship between axes and regulatory measures. analysis of the final correspondence plot the final correspondence plot is presented in figure 1 with regulatory measures shaded in blue and isqc 1 quality traits shaded in yellow. for ease of analysis, discussion points are summarised according to the labels assigned to the xand y-axis in the final correspondence plot. the views of audit experts are also considered through interviews. independence and consultation the results indicate that there is a strong correlation between the maintenance of independence (q2), consultation on complex issues (q5) and the regulatory measure enforcing the investigation of improper conduct (r6). the correlation between independence and investigations of improper conduct supports the notion that external regulation improves independence in appearance, improving credibility. it is also likely to improve independence, as there is a credible risk of sanctions, should there be a lack of independence (ican 2014). in other words, independence standing alone is insufficient and requires enforcement. independent auditors may also be more likely to consult on complex and potential audit issues. this is because the auditor will not be discouraged from thoroughly investigating the matters to ensure audit quality for fear of risking their self-interests (maroun & atkins 2014). finally, with audit still being a for-profit business, strong investigations over improper conduct may be useful to audit managers that feel the need to justify increased audit expenses to ensure appropriate audit quality. namibian audit experts took a similar view: independence is the cornerstone of the audit profession. without being independent, the audit practitioner cannot be unbiased and free from any conflict of interest. this has a massive impact on the quality of the audit that we deliver. consultation also plays a critical role in the quality of the audit that we deliver. in fact, the firm’s methodology requires that, as a minimum, the engagement team must engage the risk advisory specialists within the firm to confirm whether or not their services are required to assess the client’s systems, based on the size and complexity of the entity. the risk advisory specialists, if engaged to provide their services, must be involved in the audit throughout every stage of the audit from the pre-engagement and planning stages right up to the reporting stage. they are regarded as part of the engagement team. (p1, big 4 firm, audit partner, 22 years’ experience) the namibian audit profession has historically been predominantly self-regulated, with external regulation only bolstering the self-regulatory measures already in place. both independence and consultation have become an inherent part of audit methodologies. the added external regulation, relating to the paab’s investigations process, highlights the importance of these two quality traits: being a smaller audit practice, we do not have the internal structures and resources to employ [full-time] specialists. also, our clients are normally small to medium-sized. therefore, in most cases we do not need specialists to be able to issue an audit opinion. where we do require the services of a specialist, we source someone externally for that specific purpose. (p4, small firm, audit partner, 10 years’ experience) the size of the firm plays a role in determining whether it has the necessary resources to employ full-time or ad-hoc internal specialists. as highlighted by deangelo (1981), the size of the audit firm is commonly used as an indicator of audit quality. the smaller firms usually do not require specialists’ expertise because of the smaller size and level of complexity of their clients. the smaller firms, however, recognise the importance of consultation and, while they may not have the expertise in-house, external consultants are engaged as required. this approach is supported by isqc 1 which indicates that smaller firms can consult externally by making use of ‘advisory services provided by other firms, professional or regulatory bodies or commercial organisations which provide the relevant services’ (iaasb, 2009, p. 62): no matter the size of the audit firm, independence in mind and in appearance is fundamental to the quality of the audit. (p2, small firm, audit partner, 13 years’ experience) independence is a key priority for audit firms of all sizes. the strong association between these two quality traits and the paab’s investigations process suggests that in namibia there is a strong motivation to comply with and apply these to ensure that the practitioners conduct themselves appropriately at all times. engagement team competence the competence of engagement team members (q4) appears to be ameliorated by the regulatory requirement for eligible candidates to register for the adp (r4) and to complete a portfolio of evidence in lieu of demonstrating the appropriate level of competence to register as an raa in namibia (r5). the awareness of the importance of sufficient engagement team members with the required competence and capabilities has been highlighted as a key indicator of audit quality. as highlighted by the iod (2016), effective leadership is exemplified by competence. the correspondence plot (figure 1) indicated that there is a strong correlation between the competence of engagement team members and the implementation of the adp. this demonstrates the positive link between effective leadership and competence. this correlation is further supported by the paab’s view that the adp ultimately aims to develop, inter alia, the candidate’s professional competence, judgement and ethical values (paab 2022b): at first the adp was not well understood and there was not sufficient buy-in from the manager body to register for the programme. however, since the regulator actively started promoting the programme, visiting audit practices to explain the need for the programme, the process and desired outcomes, there has been a definite increase in registrations. (p5, big 4 firm, audit partner, 17 years’ experience) from the above responses, this programme is perceived as positively contributing to the competence of potential raas: i fully agree with correlation between the competence of engagement team members and adp. however, i would have expected that the training office accreditation of firms’ educational programmes (r2) would also have a strong correlation with competent engagement team members. our educational programmes are aimed more at developing our trainees and we strongly believe that competence should be developed from the first day the trainee steps into our firm. (p2, small firm, audit partner, 13 years’ experience) the above respondent highlighted their audit firm’s commitment to the development of the trainees, before they came to a point in their careers where they are eligible to register for the adp. the competence of any potential raa starts on the first day of a traineeship; this is not necessarily covered by the adp but starts by adopting a quality training programme. this association supports the view that a critical factor that contributes to the legitimacy of the audit profession is technical expertise and competence (power 2003) and that an increased level of competence, expertise and proficiency in an engagement team positively affects audit quality (pcaob 2013). the strong association between q4, r4 and r5, highlighted in the correspondence plot, complemented this view, and the responses of the participants further strengthened the association. culture of quality a culture of quality promoted by the firm leadership (q1) shows a strong association with several regulatory measures, namely the training office accreditation process (r2), quality assurance reviews (r3), as well as the requirement for holders of the ca(nam) designation to demonstrate continued development of professional knowledge and skill, which is monitored by the ican (r7). the audit firm leadership or tone at the top plays a pivotal role in the emphasis of the culture of quality, as well as the importance of quality work over financial considerations (pcaob 2013). this view is supported by the iaasb’s stance on firm leadership and the fact that it should promote an internal culture of quality (iaasb, 2009): the tone at the top drives a firm’s culture and personnel management and is quintessential to promoting audit quality. it forms the pinnacle of an audit quality paradigm and is rooted in professional scepticism, objectivity and integrity; however, it also relies on the underlying processes and foundation of operational inputs for support. (pcaob 2013, p. 13) the correspondence plot highlights a correlation between the establishment of policies and procedures promoting a culture of quality driven by firm leaders and strengthened by enhanced supervision (q1), the re-accreditation of training offices to ensure the quality of educational programmes (r2), the quality assurance review process (r3) and the requirement on ca(nam) holders to demonstrate continued professional development (r7). this result is in line with ican’s opinion that cpd plays an important role in ensuring that a high level of technical competence is maintained (ican 2018). maintaining the required cpd hours most definitely contributes to the continuous development of the individual but also bolsters the overall professional skills of the firm and contributes to audit quality. (p5, big 4 firm, audit partner, 17 years’ experience) maintaining the required cpd hours is perceived as a critical part of promoting a culture of quality. this association is strongly supported by respondent p5, as it is perceived to contribute positively to audit quality as a whole: it was not easy to become a partner and rightly so. it reminds me of the saying ‘with great power comes great responsibility’. and our responsibility to establish the appropriate structures, reporting lines, policies and procedures sets the tone of the whole firm. (p2, small firm, audit partner, 13 years’ experience) client acceptance and continuance finally, the plot revealed that the registration and administration of training officers and training contracts (r1) address ethical compliance in terms of client acceptance and continuance procedures (q3). the firm is responsible for ensuring that policies and procedures for the acceptance and continuance of client relationships and specific engagements are established (iaasb, 2009). client acceptance procedures have also been used as an output measure of audit quality (francis 2011). this association may indicate that the underlying concept used for ‘client acceptance and continuous procedures’ has become entrenched and deployed to other areas. this is considered a positive, as incorporating ethical and reputational considerations into more aspects of the functioning of audit firms is likely to both improve audit quality and rebuild trust in the profession (knechel 2016). while a slight association can be made between q3 and r1, the respondents all echo the sentiment that the association is remote, as expressed by a participant: i don’t really understand the correlation between client acceptance and continuance procedures and the registration and administration of training officers and training contracts. (p3, medium firm, audit partner, 15 years’ experience) in this case, there is a disconnect between the initial findings from the correspondence plot and the perceptions of the audit experts. as correspondence analysis is an exploratory method, this type of disconnect is not unusual (kudlats et al. 2014). correspondence analysis should not be interpreted as providing evidence of quantitatively measuring the effect of the current regulatory measures on audit quality (maroun 2014). the next section concludes the article. conclusion this article used interpretive techniques to provide insight into the regulatory environment in namibia and its effect on audit quality. the article departed from the traditional approach of testing audit quality surrogates. direct engagement with a sample of regulators and practising accountants was used to provide insights into exactly how external regulatory measures impact audit quality. the findings complement the largely anglo-saxon focus on audit quality by earlier studies (deangelo 1981; francis 2004; holm & zaman 2012). further, the findings provide one of the first accounts of how external regulations influence those practices that, according to isqc 1, are essential for high-quality audits with a focus on a developing african economy. the correspondence plot showed a definite association between the regulations over investigations of improper conduct (regulation) and independence and consultation (quality traits). these quality traits appear to be engrained in namibian audit practitioners. audit experts agree that the implementation of the adp by the paab has played a significant role in ensuring the competence of engagement team members, specifically that of potential raas in namibia. some respondents think that competence should be harnessed right from the start of the training. this association is further evidenced in the correspondence plot. regulatory measures relating to the accreditation of training offices, quality reviews and continuing professional development have shown a strong correlation with the promotion of a culture of quality by firm leadership. based on the combined results of the correspondence plot and the views of the audit experts, a conceptual diagram (figure 2) was developed to illustrate the associations between external regulatory measures and audit quality. figure 2: conceptual model illustrating links among elements of regulation and audit quality. this figure illustrates that the primary audit quality themes from a regulatory perspective are maintaining independence and consulting on complex audit matters, the employment of sufficiently competent engagement team members and a culture of quality driven by firm leadership. the model reveals that administrative functions form a vital role in contributing to audit quality. the key areas of investigation, registration and accreditation form an overarching regulatory oversight function for upholding and ameliorating audit quality. while much emphasis has been placed on the evaluation of audit quality proxies and regulations (humphrey 2008; hussein & mohdhanefah 2013), this model introduces other elements worthy of recognition – how the profession is administered, investigated and accredited. this article is useful for both audit practitioners and regulators. by examining the associations between namibian regulatory measures and isqc 1 audit quality traits, the research shines light on the enhancement of audit quality through the current external regulatory measures. the research also provides regulators with the necessary insight into the role of external regulations in enhancing audit quality which, while based on insights obtained from namibian auditors, should be broadly applicable in other jurisdictions, where a mix of external and self-regulatory measures is used to safeguard audit quality. with the current disparity between capabilities and resources in large and small audit firms, regulators may consider streamlining some regulations to make them fit for purpose for the smaller audit firms. furthermore, independence is considered the cornerstone of the audit profession and the regulations are relevant for independence. regulators may consider introducing measures such as rotation of audit firms or the disclosure of audit tenure in annual financial statements. future research may include audit clients’ views on what constitutes a quality audit and the inclusion of a comparison of the same in a south african context. there is still a dearth of research concerning audit regulation and quality in developing economies and future research may consider exploring this area. acknowledgements the authors would like to thank lelys maddock for her editorial assistance. competing interests the authors have declared that no competing interest exists. authors’ contributions m.b.d. is the primary researcher in this project. w.m. and w.v.z. provided the conceptualisation, review, supervision and 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and auditors’ board (paab), 2022b, the audit development programme, paab, viewed on 15 april 2022 from http://paab.com.na/audit-development-program.html. public company accounting oversight board (pcaob), 2013, discussion audit quality indicators, pcaob, viewed on 24 june 2019 from https://pcaobus.org/news/events/documents/05152013_sagmeeting/audit_quality_indicators.pdf. ram, a.j., maroun, w. & garnett, r., 2016, ‘accounting for the bitcoin: accountability, neoliberalism and a correspondence analysis’, meditari accountancy research 24(1), 2–35. https://doi.org/10.1108/medar-07-2015-0035 ram, a.j., 2018, ‘taxation of the bitcoin: initial insights through a correspondence analysis’, meditari accountancy research 26(2), 214–240, http://dx.doi.org/10.1108/medar-10-2017-0229 appendix 1 table 1-a1: statistics for quality traits as per isqc 1 in symmetric normalisation. table 2-a2: statistics for rs in symmetric normalisation. microsoft word 5 heymans & dacamara sajems 16(4) 2013.docx 418 sajems ns 16 (2013) no 4:418-434 measuring spill-over effects of foreign markets on the jse before, during and after international financial crises andre heymans and ricardo da camara school of economics, north-west university accepted: june 2013 there is a large body of research that proves the co-movement of international stock markets over time. this co-movement manifests through various instruments ranging from stocks and bonds, to soft commodities and can be visualised as returns and volatility spill-over effects. during the most recent financial crisis, it was once again highlighted that no market is immune to spill-over effects from other international markets. by employing an aggregate-shock (as) model, returns and volatility spill-over effects of the hang seng, london, paris, frankfurt and new york stock markets to the jse are confirmed. the findings also confirm the jse all share index is directly affected through contagion by the returns of the economic area where the crisis originates. however, the results further confirm that south africa has progressed in shielding its stock market against financial crises in recent times. these findings hold important implications for stock portfolio managers in south africa. key words: volatility spill-over effects, financial crises, financial market contagion jel: g1, 2, 11, 15 1 introduction over the past three decades financial markets around the world have become increasingly interconnected (baele & inghelbrecht, 2010). although emerging economies too have benefitted from global financial integration, they have also succumbed to increased financial turbulence in the form of heightened asset price volatility. the south african financial market was no exception, and was severely affected by financial crises over the past 15 years. investors in countries affected by these crises may lose confidence in capital markets when sharp asset price fluctuations cannot be explained by fundamental economic factors, leading to a reduction in capital flows towards equity markets (daly, 2008:2378). it is therefore important to measure volatility in an attempt to better understand the fundamental economic factors that drive the world economy. it is however not sufficient to measure the volatility in the local market alone. in order to fully understand the dynamics of an equity market, it is necessary to be informed where this volatility originates. only after acquiring this knowledge, can market participants hedge their positions accordingly. to date, the current literature does not address the returns and volatility spill-over effects from foreign markets to the jse, highlighting the progression of these effects over different crisis periods. although collins and biekpe (2003) investigated the possibility of contagion from the 1997 asian crisis on african economies, including south africa, no attempt has yet been made to investigate at macro level the degree to which international financial crises influence the south african equity market, in terms of price and volatility transmission. the possibility of changes in the nature of price and volatility transmission before, during, and after a financial crisis has occurred, have also not yet been investigated. this study thus aims to improve the understanding of how the south african equity market interacts with international equity markets by identifying the degree of price and abstract sajems ns 16 (2013) no 4:418-434 419 volatility transmission before, during, and after an international financial crisis. this will be achieved by identifying the origins of the returns and volatility spill-over effects onto the south african stock exchange by means of an aggregate shock (as) model. by employing the as model, it is possible to discern what amount of returns and volatility movement on the jse originates from foreign markets. the paper also aims to add to the current body of knowledge exposing the relationship between the jse and foreign stock markets over the life span of the previous four major financial crises. this insight is not only of value for market participants, but also for policy makers. if investors and policy-makers know the level of price and volatility transmission between international and local equity markets in general, risk assessment and indeed price risk management, could be improved substantially. as such, the results seem to prove this hypothesis in that stringent financial regulation over time reduced south africa’s sensitivity to international crises. the remainder of the paper is organised as follows. section 2 briefly expands on literature of contagion. section 3 provides a description of the data as well as the methods used to arrive at the results. section 4 gives a discussion of the results after which a conclusion is presented in section 5. 2 contagion there are a vast number of studies on the transmission of prices and volatility across exchanges. see for example barclay, litzenberger and warner (1990),1 hamao, masulis and ng (1990)2 and lin, engle and ito (1994).3 in addition to the above studies, kanas (1998) studied the volatility spill-over amoung the three largest european equity markets and found that there were a greater number of spillover effects during the post-crash period of 1987, than during the pre-crash period, indicating greater interdependence after the market crash among the markets studied.4 locally, piesse and hearn (2005) found evidence of volatility and returns transmission between sub-saharan african equity markets, while collins and abrahamson (2004) investigated whether various african equity markets are more integrated regionally or globally. in order to measure the impact of different markets on each other, researchers often prefer data on the volatility of returns in financial markets over data on returns alone (tanizaki & hamori, 2009:28). the reason being that return volatility provides useful data on information flow and information linkages between markets (ross, 1989). information linkages are of the utmost importance to financial market participants. equity traders in a given market for example, incorporate not only domestic information, but also information generated by other equity markets into their buy and sell decisions. provided that the information generated by international equity markets are relevant for the pricing of domestic securities, this behaviour by traders is also consistent with the efficient market hypothesis (emh) (koutmos & booth, 1995:1). although the economic literature on contagion has focused mainly on the analysis of how first moment changes in key variables are transmitted between countries (edwards, 2000:10) the literature on the transmission of changes in second moments (volatility) between countries is growing (tanizaki & hamori, 2009:29). financial volatility influences a variety of economic decisions, such as investment strategies and the pricing of risk. it is thus important to establish whether changes in a volatility system are independent between countries, or if these changes are the result of the transmission of international financial crises (edwards, 2000:10). the significance of financial crises is further emphasised by their effect on economic fluctuations. disruptions to the efficient functioning of financial markets can result in the increased cost of financial intermediation; curbing the availability of an economic lifeline in the form of credit; restraining activity in the real sector of the economy and eventually exposing a country to periods of low growth and/or economic recession and leading to overall financial instability (allen & gale, 2000:2). financial stability is thus greatly affected by volatility, and during an international financial 420 sajems ns 16 (2013) no 4:418-434 crisis, financial stability is of paramount importance, not only in the particular crisis country, but also in countries that have trade relations with the crisis country concerned. investors in the affected countries may lose confidence in capital markets when sharp asset price fluctuations cannot be explained by fundamental economic factors. this situation may result in a reduction of capital flows towards equity markets (daly, 2008:2378). the effects of financial market volatility through crises are seen in the relationship between financial market uncertainty and public confidence (romer, 1990). although it is important to measure volatility for purposes of establishing financial stability, there are various other reasons for measuring volatility. on firm level, the volatility of a firm’s capital structure may provide important information on the probability of default for individual firms. the volatility of equity prices can affect equity market liquidity, since volatility is an important element in determining the bid-ask spread of an equity’s price. volatility also determines the cost of hedging techniques, reduces the level of investment participation by consumers, influences consumption patterns, leverage decisions, corporate capital investment decisions and macro-economic variables. should high volatility persist, it may even hamper the allocation efficiency of capital due to regulatory requirements, forcing firms to allocate a bigger percentage of capital towards cash or equivalent investments as a risk management buffer against the unpredictability inherent in markets (daly, 2008:2378). while the measurement of volatility is clearly important, the measurement of volatility transmission also becomes important in cases where the economy involved has close links with other economies in which high volatility persists. volatility transmission or spill-over effects normally occur via transmission channels that are divided into three categories, namely trade linkages, financial linkages and linkages based on investor behaviour (boshoff, 2006:63). although these linkages transmit spill-over effects in their own unique way, it is often very difficult to test for them separately (see for example glick & rose, 1999; kaminsky & reinhart, 2000; van rijckeghem & weder, 2001). direct real linkages (trade linkages), such astrade in goods and services between different countries, are the easiest way for a shock in one country to be transmitted to others. financial markets may be related if real linkages exist between countries. this is certainly the case when asset values are determined by common macro-economic factors. these trading partners may be negatively affected through losses in competitiveness (forbes, 2004:60) and a decline in demand (income effect) from countries experiencing a financial crisis (van rijckeghem & weder, 2001). local demand for imported goods may also decline significantly during a domestic financial crisis, which in turn, may affect the export performance of trading partners to the crisis country (boshoff, 2006:64). the second category explaining the transmission of a crisis is the linkages created by financial markets (financial linkages). this transmission mechanism can be particularly effective when a financial institution’s exposure in a crisis country is large, and losses require capital asset ratios as well as risk exposure to be readjusted (sbracia & zaghini, 2003:728). there are mainly two channels through which financial institutions can transmit a financial crisis among the countries it operates in; lending activities and liquidity. in terms of lending activities, banks are specifically exposed to financial linkages. since cross-border integration between banks is a common feature of modern finance, a universal lender may end up being the main supplier of funds to numerous countries (sbracia & zaghini, 2003:729). this situation may weaken the ‘value at risk’ position of this financial institution, and force capital withdrawals from its operation abroad in order to meet capital adequacy requirements (sbracia & zaghini, 2003:729). the financial institution may also be required to meet margin calls, and possibly rebalance its portfolios in the specific crisis country (van rijckeghem & weder, 2001:294). this strategy of increasing risk exposure in the crisis country can lead to abrupt reductions of credit lines in non-crisis economies and put productive sectors in the sajems ns 16 (2013) no 4:418-434 421 non-crisis countries under economic pressure (sbracia & zaghini, 2003:730). the second channel, liquidity, is another important variable when dealing with contagion through financial linkages. once a country moves into a market stress situation, liquidity usually dries up (gatev & strahan, 2006:868). as experienced during the sub-prime financial crisis, liquidity plays an important role in the functioning of international financial markets. internationaland domestic interbank markets allow for efficient financial management by, for example, providing liquidity support to troubled institutions facing individual liquidity problems and reducing the opportunity costs of maintaining liquid reserves (prati, bartolini & bertola, 2003:2045). the third category operates independently from the financial market system and is concerned with changes in investor expectations or sentiments (linkages based on investor behaviour). in some instances investor’s portfolio decisions (as opposed to country characteristics), may help to explain contagion (van rijckeghem & weder, 2001:294). in response to economic shocks, some investors may be inclined to re-adjust their hedging strategies in order to protect themselves against changing macro-economic risks. however, it is not only portfolio managers that rebalance their portfolios after a wealth shock. individuals too may find it necessary to rebalance their portfolios. as investors’ risk perception change due to diminishing wealth, they may become more risk averse and move their portfolios toward less risky assets (forbes, 2004:60). leveraged investors may also be required to honour margin calls from clearinghouses, and thus be forced to liquidate their asset holdings (boshoff, 2006:65; forbes, 2004:61). when numerous investors follow this trend, a liquidity shock may be created, and due to information asymmetries, market participants may not be able to distinguish between a crisis country and non-crisis country (boshoff, 2006:65). this creates a situation where asset prices in non-crisis countries face downward pressure form a sell-off in perceived risky assets, propagating the initial crisis across markets (boshoff, 2006:65). as seen during the build-up of the dot-com bubble, the relationship between the real values of companies can be blurred by investors’ feelings towards the equity of these companies. this “irrational exuberance” and similar “herding behaviour” among individual investors may once again be a source of contagion, as capital flows and financial markets are influenced by mass behaviour that aggravates boom periods as well as market busts (kaminsky, reinhart & vegh, 2003:4). it is therefore clear that it is important for both market participants as well as policy makers to understand not only where returns and volatility spill-over effects originate, but also how they progress over time. since market information evolves over the life span of a crisis, the impact of crises may be reduced if policy makers are able to develop policies efficiently. this can only be achieved if it is possible to predict this evolution in a manner of accuracy. this paper will therefore attempt to broaden the knowledge base on how these spill-over effects progress over crisis periods in the south african equity market. 3 data and methodology since the united states of america and the united kingdom consistently remain by value within the top three rankings of south africa’s main trading partners, it follows logically that volatility in these markets should spill over to south africa. also, between 1997 and 2012, the european union features very strongly within south africa’s top ten trading partner rankings, while the asian region is mostly represented by japan and china. from a financial linkage point of view, amongst others through direct participation in the equity and bond market foreigners are actively involved in south african financial markets. a large percentage of the top 40 companies listed on the johannesburg securities exchange (jse), are also listed and actively traded on international equity markets (examples include, old mutual, anglo american plc, bhp billiton, sasol and investec). however, the impact of international financial markets on the south african equity market does not always happen in real time. 422 sajems ns 16 (2013) no 4:418-434 since these markets do not trade under the same trading hours, and differences in opening and closing times exist between these interacting international financial markets, analysis may lead to spurious casual relationships (cheung, fung & tsai, 2010:88). in order to avoid the overlapping and nonsynchronous trading problem, weekly index returns are employed when testing for spillover effects from these markets to the jse (see for example cheung et al., 2010:88 and hung & cheung, 1995:282). since data of a higher frequency (e.g., intraday or daily) contains too much noise, while lower frequency data (e.g., monthly) makes it more difficult to capture changes in information, the use of weekly data is further justified. the data to be used for testing spill-over effects thus consist of weekly returns of the jse all share index (proxy for south africa), the cac and the dax (proxies for the euro-zone), the dow jones industrial average index (proxy for the usa), the london financial times-stock exchange 100 share index (proxy for the uk area) and the hang seng index (proxy for the asian region). the period under revision varies according to the financial crisis being studied. the reason for the varying length stems from the difference in length of each crisis.5 in order to capture the true spill-over effects of every crisis, it is necessary to ensure that only the data that stretches over the true time-frame of each crisis is captured. in order to form a better idea of the comovement among world markets, figures 1 through 6 depict the daily percentage change in the index returns of the six markets under observation. it is interesting to note that the degree of volatility within each market varies according its region of origin. for example the daily volatility in returns around the period of the asian financial crisis is higher on the hang seng than on the london ftse100. f i g u r e 1 the daily jse index returns and daily percentage change source: mcgregor bfa (2013) sajems ns 16 (2013) no 4:418-434 423 f i g u r e 2 the daily cac index returns and daily percentage change source: mcgregor bfa (2013) f i g u r e 3 the daily dax index returns and daily percentage change source: mcgregor bfa (2013) 424 sajems ns 16 (2013) no 4:418-434 f i g u r e 4 the daily djia index returns and daily percentage change source: mcgregor bfa (2013) f i g u r e 5 the daily ftse100 index returns and daily percentage change source: mcgregor bfa (2013) sajems ns 16 (2013) no 4:418-434 425 f i g u r e 6 the daily hang seng index returns and daily percentage change source: mcgregor bfa (2013) in order to acquire a greater understanding of how the relationship, in terms of market efficiency, between the south african equity market and global equity markets evolved over the four crises under observation, the price and volatility transmission were tested by means of an aggregate shock (as) model before, during and after each crisis period.6 the as model follows a two-step procedure in which the fitted values of et and 2 tσ in equations 3.1 and 3.3 respectively, are obtained. these fitted values are then substituted in equations 3.2 and 3.4 respectively, before presenting and interpreting the estimated equations. in the as model, the foreign weekly returns on a foreign market are specified as:7 (3.1) where fwr is the foreign weekly return for period t and et captures the factors that affect returns which are unexplained by the autocorrelation of the current weekly returns with the previous weekly returns (persistence). thus assuming markets are efficient, te represents that part of the returns which cannot be anticipated based on available public information when equity trading is initiated at the start of each week. domestic weekly returns on the jse at the same period t can be modelled as: (3.2) equation 3.2 includes a coefficient φ which is the relationship between the foreign returns and the returns on the jse. the error term, te now represents the unexplained returns on the foreign equity market for period t. an exponen tial generalized autoregressive conditional heteroskedasticity (egarch) process is used in order to determine the level of volatility spill-over between a foreign equity market and the jse. it is assumed that the error term te in equation 3.1 is normally distributed with a mean of zero and a variance that follows an egarch (p, q) process: (3.3) where the natural log of the conditional variance for te in period t is a function of the time invariable mean reversion value, ϖ , the natural log of the past conditional variance, 2 , 1σ −f t , as well as the level of the standardised residuals, ε f ,t−1 σ f ,t−1 , and absolute value of the standardised residuals, , 1 , 1 ε σ − − f t f t . the subscript f denotes foreign (that is cac, dax, djia, ftse100 and hang seng). finally, it is assumed that the error term of the jse weekly returns 426 sajems ns 16 (2013) no 4:418-434 tµ , is also normally distributed with a mean of zero and a variance that follows an egarch (p, q) process: (3.4) in addition to the variables included in the variance specification of the foreign return equation, 3.1, the model specification of the variance of the jse in equation 3.4 includes a foreign measure, 2 ,f tσ which allows for the testing of the relation between local volatility and foreign volatility. the 2 ,i f tκ σ term in equation 3.4 is the foreign conditional variance term, and denotes the relation between local and foreign volatility. the inclusion of the terms , 1 , 1 ε σ − − j t j t and , 1 , 1 j t j t ε σ − − makes it possible to model the asymmetric volatility to past shocks as long as 2γ ≠ 0. the γ2 parameter in the egarch model measures the asymmetry or the leverage effect of volatility. if 2γ < 0 then negative shocks (bad news/negative past errors) will have a greater effect on volatility than positive shocks (good news/positive past errors). when 2γ > 0, then positive shocks (good news) have a greater impact on volatility than negative shocks (bad news). if 2γ = 0 then the model is symmetric. finally, 4β is the autoregressive term on lagged conditional volatility, and thus reflects the weight given to the previous period’s conditional volatility in the conditional volatility at period t. this parameter therefore allows for the measurement of volatility persistence. different lag specification models were estimated for each data set and the appropriate lag specification for the egarch (p, q) term was chosen where the schwarz criterion (sc) values were minimised. 4 results the as model presented above allows one to formally test the relationship of both returns (price) and volatility on the jse and a foreign equity market. the tables below report on the returns and volatility spill-over effects of each foreign market on the jse before, during and after each crisis period. however, since it is challenging to draw meaningful comparisons with the clutter of all the variables, only the following variables are included in the tables below: returns spill-over coefficients, the volatility leverage effects (γ ), the volatility persistence coefficients ( β ) and the volatility spill-over coefficients (κ ). table 1 therefore reports on the returns spill-over characteristics of the five foreign markets during the pre-crisis, crisis and postcrisis periods of the four crises under observation. tables 2 through 4 report on the volatility characteristics regarding the interaction between the different foreign markets and the jse. from the mean equation results in table 1 below, it is evident that the effect of weekly international returns on the jse is positive and statistically significant during all the periods (pre-crisis, crisis and post-crisis periods) of all four crises besides for the impact of the returns transmission of the djia during the pre-crisis period of the sub-prime crisis. this positive association indicates that positive returns on the foreign exchanges are linked to positive returns on the jse and vice versa. it is further noteworthy that the relationship between these markets and the jse strengthens over time for the pre-crisis period. in terms of the cac’s returns for example, a 1 per cent increase in the weekly cac index’s returns was followed by a 0.131 per cent increase in the weekly jse all share index returns before the asian financial crisis while a 1 per cent increase in the weekly cac index’s returns resulted in a 0.806 per cent increase in the weekly jse all share index returns before the eu debt crisis. the same is also true for the dax (0.335 per cent pre-asian crisis to 0.715 per cent pre-eu debt crisis), the djia (0.224 per cent preasian crisis to 0.916 per cent pre-eu debt crisis), the ftse (0.297 per cent pre-asian crisis to 0.846 per cent pre-eu debt crisis), and the hang seng (0.197 per cent pre-asian crisis to 0.457 per cent pre-eu debt crisis). this situation is reversed during the crisis and postlnσ j,t 2 =ϖ2 +β4 lnσ j,t−1 2 +γ2 ε j,t−1 σ j,t−1 +α2 ε j,t−1 σ j,t−1 +κiσ 2 f ,t. sajems ns 16 (2013) no 4:418-434 427 crisis periods where the returns spill-over effect dissipates from the asian financial crisis to the eu debt crisis for the cac, the dax and the djia. by the post-crisis periods, the ftse100 and the hang seng only displayed slight increases from the asian financial crisis to the eu debt crisis. t a b l e 1 returns spill-over effects – all four crises for pre-crisis, crisis and post-crisis periods mean equation variable pre-crisis crisis post-crisis cac → afc cac_resid 0.130596† 0.528666† 0.377924† → dot-com cac_resid 0.620278† 0.507278† 0.745598† → sub-prime cac_resid 0.748618† 0.731754† 0.828298† → eu debt cac_resid 0.806196† 0.481091† 0.352222† dax → afc dax_resid 0.334661† 0.718552† 0.390237† → dot-com dax_resid 0.397403† 0.406177† 0.551017† → sub-prime dax_resid 0.720484† 0.708518† 0.717715† → eu debt dax_resid 0.714684† 0.367851† 0.344167† djia → afc djia_resid 0.224165† 1.039702† 0.683078† → dot-com djia_resid 0.365943† 0.704479† 1.030310† → sub-prime djia_resid -0.176543 0.803556† 0.947223† → eu debt djia_resid 0.916157† 0.720688† 0.660660† ftse100 → afc ftse_resid 0.297245† 0.550258† 0.583942† → dot-com ftse_resid 0.721687† 0.752176† 1.371843† → sub-prime ftse_resid 1.088274† 0.772072† 0.795573† → eu debt ftse_resid 0.846223† 0.727625† 0.590499† hang seng → afc hs_resid 0.197338† 0.224199† 0.406156† → dot-com hs_resid 0.227922† 0.558409† 0.782386† → sub-prime hs_resid 0.487268† 0.534373† 0.449111† → eu debt hs_resid 0.457343† 0.453196† 0.408304† † signifies that the particular coefficient is statistically significant at the five per cent level and * at a ten per cent level. asian financial crisis (afc), dot-com bubble (dot-com), sub-prime crisis (sub-prime), european debt crisis (eu debt) these results suggests that the jse moves more with world markets in ‘normal’ market conditions (pre-crisis periods) as time goes by (from the asian financial crisis to the eu debt crisis), but that market participants on the jse ‘ignore’ international news quicker (crisis and post-crisis periods) as time goes by. this is interesting, as it seems that market participants on the jse incorporated more ‘bad news’ during the asian financial crisis, but paid less attention to ‘bad news’ by the eu debt crisis. there could be many reasons for this behaviour. it could be that market participants had no real other options because their normal investment choices were exhausted (developed countries still pose a great amount of investment risk) – although, this seems unlikely. another, more likely explanation could be that the south african financial system has become more resilient to spill-over effects from foreign countries over time. according to the imf (2010:1), south africa’s sound regulatory system played an important role in limiting the effects of the sub-prime crisis on the local financial system. factors that contributed to shielding the financial system from instability were; a well-capitalised financial sector and limited exposure of domestic financial institutions to risky foreign assets such as sub-prime asset backed securities and credit default swaps (imf, 2010:5). when exploring the progression of returns spill-over effects over the life time of each crisis, similar trends are visible. although the relationship between the foreign markets and the jse grows stronger as each crisis progress, this trend seems to dissipate over time. where all of the markets display higher return spillover effects during the asian financial crisis and the dot-com crisis, none of the markets 428 sajems ns 16 (2013) no 4:418-434 displayed continued growth in integration over the full life cycle of the crisis, by the eu debt crisis. this result is somewhat counter intuitive, since it is to be expected that external shocks would influence the local market more when global macroeconomic conditions are volatile. however, since this trend dissipates over time (from the asian financial crisis to the eu debt crisis) this emphasizes the fact that returns on the jse are being influenced more over time during ‘normal’ market conditions but that these returns move more independently during and after crisis periods as time goes by. t a b l e 2 volatility leverage effects – all four crises for pre-crisis, crisis and post-crisis periods volatility leverage effects pre-crisis crisis post-crisis cac → afc -0.20227 -0.92131† -0.33142 → dot-com 0.12966 -0.09247 -0.77984† → sub-prime -0.94081† 0.32794† 0.11527 → eu debt 0.01586 -0.04252 -0.59348 dax → afc -0.22453 -0.01815 -0.12828 → dot-com 0.03390 0.14582* -0.75584† → sub-prime -1.01075† -0.04107 0.24051 → eu debt 0.20574 -0.04078 -0.13991 djia → afc -0.05743 0.45776* -0.42508 → dot-com -0.16365 -0.06114 -0.38684* → sub-prime -0.45760 0.30746* 0.49268† → eu debt 0.36427 -0.15573† 0.02151 ftse100 → afc 0.25220 -0.32293 0.11807 → dot-com 0.18866 -0.08621 -0.72071† → sub-prime -0.57015† -0.07345 -0.01431 → eu debt -0.00817 -0.38039† -0.59759† hang-seng → afc -0.11695 -0.21419 0.02424 → dot-com -0.03287 0.00409 -0.31844 → sub-prime -0.31362† 0.16632 -0.13911 → eu debt -0.07124 0.15229† 0.27592 † signifies that the particular coefficient is statistically significant at the five per cent level and * at a ten per cent level. asian financial crisis (afc), dot-com bubble (dot-com), sub-prime crisis (sub-prime), european debt crisis (eu debt) by making use of the egarch model it was also possible to measure the volatility characteristics of the jse in terms of the influence that foreign markets exhibit onto the local bourse. only four statistically significant volatility leverage effects were measured during the pre-crisis period. all four of these statistically significant volatility leverage effects were reported for the period before the sub-prime crisis for all the markets besides the djia. before the sub-prime crisis the volatility on all the indices had a negative asymmetric impact on the jse all share index, suggesting that negative returns on all the indices have a greater effect on the degree of current jse all share index volatility. unlike the pre-crisis volatility conditions where all the volatility leverage effects had a negative asymmetric impact on the jse, there are instances where positive asymmetric effects are reported for the crisis periods. the cac for example, displays a negative volatility leverage effect during the asian financial crisis but a positive volatility leverage effect during the sub-prime crisis. the dax displays a positive volatility leverage effect during the dot-com crisis and the djia displays positive volatility leverage effects during the asian financial crisis and sub-prime crisis but negative volatility leverage effects during the eu debt crisis. the other two markets only displayed volatility leverage effects during the eu debt crisis negative volatility leverage effects displayed sajems ns 16 (2013) no 4:418-434 429 by the ftse100 and positive volatility leverage effects displayed by the hang seng. these results suggest that market participants seem to react to a greater extent to positive news, and less so to negative news during crisis conditions. this situation is once again reversed during the post-crisis period in that most of the statistically significant leverage effects are negative. these effects are also more pronounced during the period after the dot-com crisis. t a b l e 3 volatility persistence effects – all four crises for pre-crisis, crisis and post-crisis periods volatility persistence effects pre-crisis crisis post-crisis cac → afc 0.86012† 0.49920† 0.56157† → dot-com 0.26214 0.58169 0.88137† → sub-prime 0.76967† 0.72684† 0.28201† → eu debt 0.34675* -0.89172† -0.74899* dax → afc 0.17791 0.24596 0.48866† → dot-com -1.05426† -0.65473† 0.90999† → sub-prime 0.86728† 0.66629† 0.46245† → eu debt 0.46044* 0.94738† 0.23134† djia → afc 0.70483† 0.61302 0.38874† → dot-com 0.63972† -0.69200† 0.91085† → sub-prime -0.40996† -0.19084 0.01183 → eu debt 0.00361 -0.80729† 0.71738† ftse100 → afc 0.33858† -0.42613† 0.65895† → dot-com 0.65739† 0.62714† 0.66755† → sub-prime 0.85548† -0.32133 0.97112† → eu debt 0.98573† 0.63217† 0.13964† hang-seng → afc 0.73102† -0.96883† 0.60292† → dot-com -0.77490† -0.86613† 0.41641† → sub-prime 0.63538† -0.84264† -0.83509† → eu debt -0.92760† 0.64832† 0.29113 † signifies that the particular coefficient is statistically significant at the five per cent level and * at a ten per cent level. asian financial crisis (afc), dot-com bubble (dot-com), sub-prime crisis (sub-prime), european debt crisis (eu debt) all of the volatility persistence coefficients are significant during the period before the asian financial crisis, with the exception over this period of the dax. volatility persistence was also present for all markets besides the cac in the period before the dot-com crisis. the period before the sub-prime crisis is characterised by the presence of volatility persistence for all the indices, while the period before the eu debt crisis is defined by the presence of volatility persistence for all the markets besides the djia. all the coefficients were also smaller than one, which according to xu and fung (2005) is a requirement for the volatility persistence terms to be stable. a high level of volatility persistence implies that fluctuations will remain in the markets for an extended period. this situation will lead to greater uncertainty from market participants. a heightened level of uncertainty has important consequences for risk management, since investor decisions based on expectations result in higher volatility of equity returns. as was the case with the pre-crisis periods, the volatility persistent coefficients are mostly statistically significant for all the crisis periods under review. once again all the coefficients are stable (smaller than one), with volatility persistence increasing from the asian financial crisis to the eu debt crisis for the dax, ftse100 and the hang seng, and volatility persistence decreasing over the same period for the cac and the djia. these results are consistent with the pre-crises results for all the markets except the hang seng. 430 sajems ns 16 (2013) no 4:418-434 when investigating the progression of volatility persistence from pre-crisis period to post-crisis period, volatility persistence decrease from the pre-crisis period to the post-crisis period in nine instances, and increases from pre-crisis to post-crises eleven times. the results are mixed for the various crises. during the asian financial crisis, volatility persistence increased from the dax and ftse100, and decreased from the cac, djia and the hang seng over the lifespan of the crisis. during the dot-com crisis, volatility persistence increased over all the markets for the lifespan of the crisis. for the lifespan of the sub-prime crisis, volatility persistence decreased for the cac, dax and hang seng and increased for the djia and the ftse100. the results are also mixed over the eu debt crisis with decreasing volatility persistence originating from the cac, dax and ftse100 and increasing volatility persistence originating from the djia and the hang seng. it is interesting that volatility persistence increases over the lifespan of the dot-com crisis, and that the djia itself exhibits the highest level of volatility persistence once the dot-com crisis and 9/11 terror attacks had passed. market participants thus seem to have become more uncertain with regards to their returns from foreign markets, which in turn resulted in heightened levels of volatility. the reason for this could have been driven by uncertainty over the possibility of further terrorist attacks, or uncertainty surrounding what the u.s. government would do about these attacks in the time after the crisis. t a b l e 4 volatility spill-over effects – all four crises for pre-crisis, crisis and post-crisis periods volatility spill-over effects pre-crisis crisis post-crisis cac → afc -0.39167 -0.32324 0.02392 → dot-com -1.01693 0.07767† -0.07613 → sub-prime 0.01672 0.21144† -0.53607† → eu debt -1.01655† 0.58357* 0.64811 dax → afc 0.45507* 0.70176* -0.31142 → dot-com 0.30301 0.43803 0.13903† → sub-prime 0.20938 -0.05967 -0.20280 → eu debt -0.21448 0.10504 0.20118 djia → afc -0.33871 0.91780* 0.34677* → dot-com 0.43017† 0.43673 -0.04028 → sub-prime 0.87581† -0.14471† -0.03610 → eu debt -0.00345 0.09598 0.26777 ftse100 → afc -0.25807 2.82449† 0.17837 → dot-com -0.09434 0.25208 0.16431 → sub-prime -0.08284 -1.57562† 0.40119 → eu debt -0.23303 0.16162 0.13126† hang-seng → afc 0.02695 -0.25372 0.34279† → dot-com -0.72608* 0.13955 -0.20210 → sub-prime -0.13448 -0.02955 -0.19290 → eu debt -0.23962 -0.54205† -0.15822 † signifies that the particular coefficient is statistically significant at the five per cent level and * at a ten per cent level. asian financial crisis (afc), dot-com bubble (dot-com), sub-prime crisis (sub-prime), european debt crisis (eu debt) table 4 above depicts the influence of the five foreign markets on the jse all share index during the four crises under observation. as one would intuitively guess, volatility transmission ought to increase over crisis periods. this is visible from the results – there are only five statistically significant occasions of volatility spill-over from foreign markets onto the jse all share index in periods before crises and after crises, while nine instances of sajems ns 16 (2013) no 4:418-434 431 statistically significant volatility spill-over effects are recorded during the height of the different crises. although these results are widely dispersed, it does seem as if volatility transmission dissipates over time. during the asian financial crisis, for example, all of the markets but the hang seng displayed statistically significant volatility spill-over effects to the jse. by the dot-com crisis, only the cac and the djia displayed statistically significant volatility spill-over effects on the jse, and during the sub-prime crisis only the cac and the ftse100. the cac also displayed statistically significant volatility spill-over effects on the jse during the eu debt crisis. these volatility spill-over effects are again more prevalent after the asian financial crisis than any other post-crisis period. it is interesting to note that, as was the case with volatility persistence, volatility transmission was prominent from the djia to the jse over the dot-com crisis. this might be explained by the fact that during this crisis period, the originating country was hit by a financial and political crisis at the same time. unfortunately, it is difficult because of its timing to measure the impact of the 9/11 terror attacks in isolation in terms of price and volatility transmission.8 although volatility spill-over effects seem to dissipate over time, some markets still display statistically significant volatility spillover effects to the jse during and after the sub-prime and eu debt crises. in these cases, investor behaviour may be influenced not by a negative emerging market sentiment as experienced during the asian financial crisis, but rather a general flight to more secure asset classes. this herding behaviour seems to be an appropriate assumption during the 9/11 terror attacks as well. when investigating the relationship of specific markets compared to that of the jse, it is clear that the volatility spill-over effects from the hang seng was never visible before the eu debt crisis. this is also the first time that south africa had strong trading relationships with asia (mainly in the form of trade relations with china). the ftse100 behaved more or less as expected, while the cac was the only index that displayed influential volatility spill-over effects on the south african market during and after the subprime crisis. naturally, as mentioned in the context of the asian financial crisis investor behaviour will have been a contributing factor as investors tried to shield themselves from excessive losses.9 the cac index seems to be the most consistent “exporter” of volatility transmission towards the jse all share index, while the biggest volatility spill-over effect comes from the ftse100. when comparing the magnitude of the volatility transmission from the ftse100 index experienced during the asian financial crisis, with the magnitude experienced during the sub-prime crisis, there appears to be a decrease of more than eight times from the initial transmission. this reduction of volatility spill-over effects is also observed over time for all the other markets – besides the cac. although the composition of the asian financial crisis and the sub-prime crisis may not be identical, these crises share many similarities (a real estate bubble at the heart of each crisis is one example). this may indicate a positive evolution in terms of the regulation of the south african financial markets in protecting the financial system from instability originating outside the borders of south africa.10 5 conclusion given the main findings from studying the price and volatility transmission during four international financial crises, it is possible to conclude that during the manifestation of an international financial crisis, the jse all share index mostly seems to be affected through contagion by the returns of the originating crisis country. it stands to reason that strong trade and financial linkages between south africa and the other markets under observation, may explain investor behaviour that drives the transmission of contagion effects during a financial crisis. this conclusion is drawn since volatility transmissions during international financial crises appear to emanate directly from the originating crisis country or region. 432 sajems ns 16 (2013) no 4:418-434 the results also clearly show that the south african equity market is becoming more integrated in “normal economic” conditions but that the jse experienced reduced returns and volatility spill-over effects in later years. this is evident from the reduction in both the amount and intensity of returns and volatility spill-over effects experienced over the subprime and eu debt crises. in order to ensure the future stability of the south african financial system, the south african government has proposed the establishment of a single financial market bill. the bill consists of a broad reform of rules and regulations in the financial sector aimed at increasing the stability of banks and insurers, as well as under-regulated products such as derivatives and hedge funds, under bill. this should ensure that the jse continues to be shielded from contagion effects from foreign countries during crisis periods. after the sub-prime crisis, the regulatory scene is also livening up internationally. the most recent example of this is the volcker rule11 and the dodd-frank financial regulatory reform bill.12 in essence, from an international and south african perspective, there appears to be a shift towards greater interventionist regulatory framework, which places emphasis on restructuring of the alternative financial market sector and requiring banks to move away from complex “shadow banking systems” towards a more transparent basic banking model, which facilitates easier regulation and oversight. future research may endeavour to find links between south africa's regulatory progression and the impact that international crises had on the south african financial market. being able to prove that regulation was indeed the most important factor in the reduction of spill-over effects to the south african market will serve as motivation for financial institutions to adhere to regulation. it should also promote these institutions' willingness to put their own precautionary measures in place before rolling out new products and financial instruments. endnotes 1 barclay et al. (1990) found evidence of correlations among dual listed equities on the nyse and the tse. 2 hamao et al. (1990) found that volatility transmission effects between new york and london to be weaker than the transmission effect between the japanese market and new york. koutmos and booth (1995) also found volatility spill-over effects between new york, london and tokyo. 3 lin et al. (1994) used a signal-extraction (se) model and an aggregate shock (as) model to study how returns volatilities of stock indices are correlated between tokyo and new york. 4 see ramchand and susmel (1998) on their investigation of the relationship between time and state varying volatility and correlation between the united states and japan, the u.k., germany as well as canada; and ng (2000) who investigates the extent to which volatility within the pacific-basin region is influenced by a world factor, and how much is explained by a regional factor. 5 all the data was sourced from mcgregor bfa, a professional provider of stock market data. 6 this study employs a similar methodology to the one used by lin et al. (1994) and samouilhan (2006) with regards to the use of an as model. 7 all series were first tested for stationarity (all were non-stationary in levels) and then transformed by taking the natural logarithm differences of the weekly averages. 8 in their study of volatility transmission patterns and terrorist attacks, chulia et al., (2009) found volatility transmission between the us and eurozone equity markets, but noted that the 9/11 attacks occurred during a severe economic downturn. 9 in 2007 foreigners were net sellers of r5.5 billion in equities and r841 million in bonds. this sell-off by foreigners continued during 2008, with net sell-offs of r429 million in equities and r1.6 billion in bonds (jse, 2012). notice the initial flight from equities at the onset of the crisis, and the reversal into bonds a year later. 10 as noted earlier, south africa’s sound regulatory system can be praised for limiting the effects of the sub-prime crisis on the local financial system (imf, 2010:1). 11 this legislation is aimed at protecting individuals. by increasing the transparency of financial markets, the volcker rule places trading restrictions on financial institutions by separating the investment banking, private equity, and hedge fund functions from their consumer services business. 12 this bill was created to prevent the collapse of major financial institutions, such as lehman brothers at the peak of the subprime crisis, by increasing government oversight of trading in complex financial instruments. the reform bill also establishes government agencies to number banking practises of troubled financial institutions, in an attempt to protect unsuspecting borrowers against unfair lending and mortgage practices. sajems ns 16 (2013) no 4:418-434 433 references allen, f. & gale, d. 2000. financial contagion. journal of political economy, 108(1):1-33. baele, l. & inghelbrecht, k. 2010. time-varying integration, interdependence and contagion. journal of international money and finance, 29(5):791-818. barclay, m., litzenberger, r. & warner, j. 1990. private information, trading volume and stock return variances. review of financial studies, 3(2):233-252. boshoff, w.h. 2006. the transmission of foreign financial crises to south africa: a firm-level study. journal for studies in economics and econometrics, 30(2):61-85. cheung, w., fung, s. & tsai, s. 2010. global capital market interdependence and spill-over effect of credit risk: evidence from the 2007-2009 global financial crisis. applied financial economics, 20(1):85-103. chulia, h., climent, f.j., soriano, p. & toro, h. 2009. volatility transmission patterns and terrorist attacks. quantitative finance, 9(5):607-619. collins, d. & abrahamson, m. 2004. african equity markets and the process of financial integration. south african journal of economics, 72(4):658-683. collins, d. & biekpe, n. 2003. contagion and interdependence in african stock markets. south african journal of economics, 71(1):181-194. daly, k. 2008. financial volatility: issues and measuring techniques. physica a: statistical mechanics and its applications, 387(11):2377-2393. edwards, s. 2000. contagion. the world economy, 23(7):873-900. forbes, k.j. 2004. the asian flu and russian virus: the international transmission of crises in firm-level data. journal of international economics, 63(1):59-92. gatev, e. & strahan, p.e. 2006. banks' advantage in hedging liquidity risk: theory and evidence from the commercial paper market. the journal of finance, 61(2):867-892. glick, r. & rose, a.k. 1999. contagion and trade: why are currency crises regional? journal of international money and finance, 18(4):603–617. hamao, y., masulis, r.w. & ng, v. 1990. correlations in price changes and volatility across international stock markets. the review of financial studies, 3(2):281-307. hung, b.w.s & cheung, y.l. 1995. interdependence of asian emerging equity markets. journal of business finance and accounting, 22(2):281-288. international monetary fund. 2010. south africa: report on the observance of standards and codes on banking supervision, insurance supervision, and securities regulation. imf country report no.10/352. 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(cambridge). kanas, a. 1998. volatility spillovers across equity markets: european evidence. applied financial economics, 8(3):245-256. koutmos, g. & booth, g.g. 1995. asymmetric volatility transmission in international stock markets. journal of international money and finance, 14(6):747-762. lin, w., engle, r. & ito, t. 1994. do bulls and bears cross borders? international transmission of stock returns and volatility. the review of financial studies, 7(3):507-538. mcgregor bfa database. 2013. supplier of data. available at: https://expert.mcgregorbfa.com/ [accessed 2012-08-30]. ng, a. 2000. volatility spillover effects from japan and the us to the pacific-basin. journal of international money and finance, 19(2):207-233. piesse, j. & hearn, b. 2005. integration and the asymmetric transmission of volatility: a study of equity markets in sub-saharan africa. south african journal of economics, 73(1):36-53. 434 sajems ns 16 (2013) no 4:418-434 prati, a., bartolini, l. & bertola, g. 2003. the overnight interbank market: evidence from the g-7 and the euro zone. journal of banking and finance, 27(10):2045-2083. ramchand, l. & susmel, r. 1998. volatility and cross correlation across major stock markets. journal of empirical finance, 5(4):397-416. romer, c.d. 1990. the great crash and the onset of the great depression. the quarterly journal of economics, 105(3):597-624, aug. ross, s.a. 1989. information and volatility: the no-arbitrage martingale approach to timing and resolution irrelevancy. the journal of finance, 1989(44):1-17. sbracia, m. & zaghini, a. 2003. the role of the banking system in the international transmission of shocks. the world economy, 26(5):727-754. samouilhan, n.l. 2006. the relationship between international equity market behaviour and the jse. south african journal of economics, 74(2):248-260. tanizaki, h. & hamori, s. 2009. volatility transmission between japan, uk and usa in daily stock returns. empirical economics, 36(1):27-54. van rijckeghem, c. & weder, b. 2001. sources of contagion: is it finance or trade? journal of international economics, 54(2):293–308. xu, x. & fung, h. 2005. cross market linkages between u.s. and japanese precious metals futures trading. international financial markets, institutions and money, 15(2):107-124. microsoft word 3 bekker si 17 2014.docx 22 sajems special issue 17 (2014) : 22-32 project governance: “schools of thought” michiel c bekker graduate school of technology management, university of pretoria accepted: december 2013 the terminology, definition and context of project governance have become a focal subject for research and discussions in project management literature. this article reviews literature on the subject of project governance and categorises the arguments into three schools of thought namely the single-firm school, multi-firm school and large capital governance school. the single-firm school is concerned with governance principles related to intra-organisational projects and practice these principles at a technical level. the multifirm school addresses the governance principles concerned with two of more organisations participating on a contractual basis on the same project and focuses its governance efforts at the technical and strategic level. the large capital school considers projects as temporary organisations, forming their own entity and establishing governance principles at an institutional level. from these schools of thought it can be concluded that the definition of project governance is a function of stakeholder complexity and functional positioning in the organisation. it is also evident that further research is required to incorporate other governance variables and related theories such as transaction theory, social networks and agency theory. the development of project governance frameworks should also consider the complexity of projects spanning across international companies, across country borders and incorporating different value systems, legal systems, corporate governance guidelines, religions and business practices. key words: project governance, governance of projects, meta-governance, governance through projects, project management jel: l890 1 introduction since the late 1990s the term project governance has attracted much attention and debate in the project literature. the quest to define and apply project governance is fuelled by the growing frustration of large capital project failure (flyvbjerg, bruzelius & rothengatter, 2003:12-21; miller & lessard, 2000:14) and the realisation that project management at a technical and operational level should be complemented and supported at strategic and institutional management levels (klakegg & artto, 2008). the incorporation of governance into the project field reflects a widening of focus away from the day-to-day technical, operational and supporting activities that need to be fulfilled to ensure the delivery of project outcomes. addressing governance also acknow ledges the role projects play in the overall organisational performance and the interactions between the multiple actors responsible for the various project and organisational activities (sanderson, 2012:432). given this increased attention and intense debate, providing a state-of-the art overview of the literature is timely and appropriate. this literature review was conducted through topical searches on project governance related articles and documents on google scholar, and specifically publications in the international journal of project management and the project management journal. in reviewing the literature and participating in various workshops on project governance, it has become clear that there is still no commonly understood and agreed upon definition for project governance. however, from the literature some tendencies towards preferred points of departure for constructing project governance definitions and constructs are emerging. these points of departure are linked to the various researchers’ and authors’ industry of application, type of projects, their understanding of the meaning of governance, abstract sajems special issue 17 (2014) : 22-32 23 the type of organisation and the functional positioning of projects in various organisations. given the uncertainty surrounding the definition, and contextualisation of project governance the question remains whether the current available information and literature on the topic can be categorised and funnelled into common ‘schools of thought’? the aims of this paper are threefold. first, an in depth literature review on project governance and the categorisation thereof was conducted with the specific objective of extracting the various definitions and contexts. second, the literature findings were categorised in various ‘schools of thought’. the alignment of project governance principles with the overall corporate governance of the project owner organisation remains important with the third part of the paper explaining this important linkage. lastly, the paper provides a conclusion and recommen dations for future research in the field of project governance. 2 categorisation of project governance concepts in the project governance literature, ruuska, ahola, artto, locatelli and mancini (2011: 650) identified three main categories of project governance based on the variety and level of stakeholder involvement. the first category of literature focuses on analysing a single firm’s governance scheme with its multiple projects. the single firm is the ultimate decisionmaking authority and has full control over policies, processes and activities of projects. the second category considers multi-firm projects where various companies engage in contractual agreements. in this category each participating firm has its own vested interests in the project and the main focus of the governance structure is the protection of intellectual property. the third category considers projects as hybrid or network like structures involving multiple interconnected actors relying on the presence of one supreme hierarchical authority, almost always the lead sponsor or underwriting firm. this form of project governance is analogous to the lead organisation-governed networks as referred to by provan and kenis (2008:235). these projects can involve a diverse accumulation of actors with, quite often, opposing interests and agendas towards the management, as well as outcome of the project. in a second categorisation of projects, morris and geraldi (2011:20-23) argued that the management of projects in institutional contexts could be viewed at three functional levels. these levels and their contexts are: level 1: technical – operational and delivery orientated with the focus on the tools to be used, practices and day-to-day execution and control of project activities. level 2: strategic – managing projects as organisational, holistic entities, expanding the domain to include their front-end development and definition and with a concern for value and effectiveness. this level ensures alignment with the sponsor’s objectives, leadership, contracting strategy, manpower and influencing stakeholders. level 3: institutional – managing projects in the macro-economic environment incorporating political, societal, socio-economical, environmental and statutory expectations and requirements. even though the main difference between the categorisation of projects by ruuska et al. (2011:650) and morris and geraldi (2011:2023) lies within the type of project versus functional approach, some common governance elements are observed. first, the single firm governance scheme focuses more internally conducting governance at a technical level where project control and monitoring activities are exercised. next, multi-firm projects’ governance scheme is concerned with the relationship between contracting parties and operates at a technical and strategic levelfinally, the category of hybrid or network type projects relies on institutional arrangements to ensure some form of governance. the third and last category is most commonly found in stand-alone, large capital projects with multiple, inter-organisational and inter-governmental arrangements. with limited reference to specific project characteristics and emphasis on relationships and contracts among internal and external actors it seems as if project governance in this category is more concerned with stakeholder rather than project complexity. the categorisation of these commonalities forms the basis of the project governance 24 sajems special issue 17 (2014) : 22-32 ‘schools of thought’, which are discussed below. 3 ‘schools of thought’ the three project governance ‘schools of thought’ are based on a combination of the categorisation identified by ruuska et al. (2011: 650) and the functional organisational positioning of project governance (morris & geraldi, 2011:20-23). the terminology for the single – and multi-firm projects is retained while the large, standalone projects are categorised into a large capital project school. the functional differences are incorporated into these schools and graphically explained in the paragraphs that follow. the three governance schools are: • single firm (sf) governance school. • multi-firm (mf) governance school. • large capital (lc) governance school. even though approaches to project governance are categorised into the above schools of thought, it does not mean that all aspects of each category are mutually exclusive. there are potential areas of overlapping of concepts, especially between the mf and lc schools which will be highlighted below in the discussion of each school of thought. 3.1 single firm (sf) governance school the definition and application of project governance in the sf school is driven by projects, or programmes, within a single, autonomous company. due to the internal focus, sf school practitioners are often it companies and organisations more concerned with their internal projects with no, or minimal, external client engagement. projects in these companies are focused towards pursuing improvement of internal organisational performance; they are aligned with organisational strategy, return on investment, adherence to internal policies and procedures as well as protection of company information. due to its top-down nature, the sf school view project governance at a strategic and technical level (figure 1). figure 1 sf school of thought marnewick and labuschagne (2011:668) found it project governance concerns selecting the right internal projects and that they are implemented as per company methodologies and standards. bouraad (2010:75) seconds it project and portfolio governance to the operational manager level and argues that, although necessary, the awareness of the importance and practical application of governance at this level is insufficient in researched organisations. the gap between it governance and its position within project governance is also emphasised by sharma, stone and ekinci (2009:29). however, the importance of understanding and formalising of it project governance will increase in the future due to the incorporation of it governance into corporate governance guidelines such as king 3 (institute of directors south africa, 2009). further sf school thinking is also evidenced in the apm guide of governance of project management (apm, 2004) where the focus is on ‘looking over the shoulder’ of the project manager to ensure compliance to good project management practices. in this respect concepts such as ‘control’, ‘manage’, ‘supervise’, ‘monitor’, ‘strategic fit’, ‘resourcing’, are often found in institutional strategic technical sf school sajems special issue 17 (2014) : 22-32 25 sf governance school thinking. shifting focus to a more technical level, the apm guide to the governance aspects of project sponsors (2009) is concerned with giving guidance to project sponsors on how to conduct their governance activities on the organisational projects (crawford, cooke-davies, hobbs, labuschagne, remington & chen, 2008). currently text books focus mostly on the sf school suggesting that governance models should link governance at different project-related levels such as project, program and portfolio management (renz, 2007; oaks, 2008; garland, 2009; müller, 2009). in the sf school, the value of the project is of secondary concern. this means that large capital projects, of significant monetary value, could also reside under the sf school if such projects are under the single control, influence and authority of the said firm. 3.2 multi-firm (mf) governance school also functioning at the strategic and technical levels the mf governance school concentrates on the contractual relationships among different firms participating in a single, or in multiple projects (figure 2). participating firms could be represented from all spheres of society including profit, non-profit or government entities. winch (1989:331) argued that despite the existence of three influential perspectives in project management namely; socio-technical, organisation and environment, as well as project management practices, they contain no formal framework for analysing and managing the inevitable differences in interest between the different coalition firms who are members of the project. this observation can be traced to the investigation of transaction cost theory (williamson, 1981:548, 573) which suggests mechanisms to analyse differences in interest between exchanging actors. in order to clarify the mutual interest of firms in knowledge and company intelligence winch (2001:803-804) developed the horizontal transaction governance concept covering employment relations and supply chain dynamics across participating firms. figure 2 mf school of thought bosch-sijtsema & postma, (2010), pemsel & müller (2012) and kannabiran & pandyan (2010) investigated the governance factors which enable knowledge transfer in interorganisational develop ment projects. with various parties participating in day-to-day project activities across organisational boundaries some participants will be exposed to sensitive information and know-how of the participating coalition firms. in their research bosch-sijtsema & postma (2010:605) found that a mixture of mutual trust and formal contracts serve as governance mechanisms across organisational boundaries. this finding comple ments previous research in corporate innovation projects where it was found that firms focusing on mutually gaining access to the knowledge bases of their partners can develop a stable relationship based on mutual trust as their main governing mechanism (bosch-sijtsema & postma, 2009:69). supporting the application of project governance at a strategic and technical level abu hasim, kajewski and trgunarsyah (2011:1930) highlighted the importance of proper protocol and institutional strategic technical institutional strategic technical mf school organisation 1 organisation 2 26 sajems special issue 17 (2014) : 22-32 transparency when handling commercial contracts and procurement across the client and participating consultants and contractors. finally, ruuska et al. (2011:650) listed the following key elements of project governance to be considered among multi-firm projects: • contracts between involved actors; • how procurement is organised and carried out; • how networks of suppliers are managed by project actors; • how risks are managed and shared by project actors; • how work is monitored and controlled during the project life cycle; • how the project actors collaborate and develop practices, and; • how communication between project actors is organised. literature supporting the mf school often refer to governance activities with concepts such as ‘relationships’, ‘agreement’, ‘contracts’, ‘collabo ration’, ‘protection’. 3.3 large capital (lc) governance school the lc school tends to view projects as goaldirected temporary organisations which have to define appropriate governance frameworks within which project decisions can be made (bekker & steyn, 2009). sanderson (2012:440) emphasizes the difference between governance and governing. the former is explained as a form of organisation that can be consciously designed ex ante, again highlighting the conceptual view of large projects being considered as temporary organisations with their own governance frame works. governing is concerned with the act of performing governance activities. the intrinsic complexity of many large capital projects, whether private, public or public-privatepartnership projects, lies in their cosmopolitan composition of different contracting companies from different organisations often working across country boundaries. ruuska et al. (2011: 657) emphasise this stakeholder complexity by arguing that large projects continuously face the challenge of governing a project’s internal complex supply chain of multiple, multinational firms while simultaneously governing the network of external actors. large project performances are affected by complex institutional environments, and by the underlying business network of organisations. due to this complex integration of various internal and external stakeholders the conception and context of project governance and the underlying mechanisms of coordination should shift from simplistic governance carried out by either the price mechanism or administrative functions towards mechanisms that emphasize relationships and self-regulation in such hybrid networks. in the lc school the focus shifts from contractual and strategic agreements to higher level, institutional issues that interact with the external/ macro environment (figure 3). figure 3 lc school of thought macro environment institutional strategic technical lc school sajems special issue 17 (2014) : 22-32 27 within the lc governance school the emphasis is on creating an environment, shielded from external environmental, political and strategic influences, within which the activities of project management can prosper. a central theme is ‘decision-making’, as opposed to management and controlling. these complex mechanisms and interactions are commonly found in (international) public and public-private-partnership (ppp) projects. as part of project governance, abednego and ogunlana (2006) studied the complexity of allocating risks in ppp projects. yilin, yaling, ling and zhe (2008) argued that by elevating project governance to a more strategic level in public projects the foundation is laid for continuous improvement during project execution. researching various public projects klakegg, williams, magnussen and glasspool (2008:s30), concluded that a project governance framework should consist of an authoritative, organised structure within the sponsoring institution, comprising of processes and rules to ensure that projects meet their purpose. williams et al. (2010) took the process approach further and concludes that the gatereview process as a quality control mechanism should form an integral part of the governance framework of public projects. this finding supports the view from samset, berg and klakegg (2006) and christensen (2009) who refer to the strategic management of the early phases of major public project as ‘front-end governance’. in their view the establishment of proper governance principles, processes, guidelines and decision-criteria during the early stages of any large project are paramount for potential project success. lastly winch (2001:800) refers to the governance of the project process as the ‘process of the progressive reduction of uncertainty through time’. moving beyond project governance at a strategic level koch and buser (2006:551) developed the concept of meta-governance for ppps. deployed at a macro level, metagovernance instruments includes soft laws, incentives, guidelines, brokering activities and legal mechanisms in the forms of laws and contracting. key concepts found in the lc governance school literature are ‘politics’, ‘policy’, ‘principles’, ‘guidelines’, ‘decision-making’, ‘socio-economics’, ‘front-end’, ‘external stakeholder interest’ and ‘ethics’. 3.4 categorisation of project governance ‘schools of thought’ even though the term project governance is commonly used amongst project practitioners, various other related terms appear in literature. these terms include ‘governance of project management’, ‘governance of projects’, ‘govern ance regime’, ‘governance through projects’, etc. a list of terms, definitions and their context are provided in table 1 with the categorisation into schools of thought added. in the first column the various terms used in literature are listed with the references indicated in the fourth column. the second column depicts the attempted definition by each resource. it must be noted that in all cases the definitions were derived from the arguments contained in the literature with exception of the bekker and steyn (2009) definition which was concluded from a delphi study. unfortunately not all the literature concerned with project governance proposed definitions for the terms. however, some context and key words were provided which are listed across the appropriate reference in the third column. given the key words and context each resource was then categorised as per the defined ‘schools of thought’ namely sf, mf and lc. as an example the first row contains the term “governance of project management” which is listed by two sources namely the apm (2004) and prince2 tm (2009:265). the first reference provides a definition that links project activities with corporate governance while the second reference is more concerned with portfolio management and organisational objectives. both references contain key words such as ‘portfolio direction’, sponsorship’, project manage ment effectiveness and efficiency’, ‘disclosure and reporting’, ‘controlling’ and ‘monitoring’. given these key words, context and definition the reference is categorised with the sf governance school of thought. 28 sajems special issue 17 (2014) : 22-32 table 1 terms, definitions and context as per school of thought terms definition context and key words reference school of thought governance of project management concerns those areas of corporate governance that are specifically related to project activities. ensures that an organisation’s project portfolio is aligned to the organisation’s objectives, is delivered efficiently; and is sustainable. • portfolio direction. • project sponsorship. • project management effectiveness and efficiency. • disclosure and reporting. • controlling • monitoring apm, 2004 (4) prince2tm, 2009:265. sf governance of projects (no specific definition) delivering projects efficiently, avoid wasting resources and involves the framework established around the project execution. • policies • principles klakegg, williams, magnussen & glasspool, 2008:29 lc governance through projects (no specific definition) the context in which the critical decisions are made. • decision-making • guidelines klakegg, williams, magnussen & glasspool, 2008:29 lc governance regime (no specific definition) governance regimes for mega projects are time-dependent and self-organising. they involve a network of actors in a process through which the project concept, the sponsoring coalition, and the institutional framework co-evolve. • coalitions • politics • front-end miller & hobbs, 2005:49 lc governance regime regulatory framework to ensure adequate quality at entry, compliance with agreed objectives, management and resolution of issues that may rise during the project, etc., and standards for quality review of key governance documents. focus on the project life-cycle with specific focus on the decision making at the front-end. • front-end • policy • decision-making christensen, 2009 samset, berg & klakegg, 2006:1 lc project governance a subset of corporate governance focusing on the areas of corporate governance related to project activities, including: portfolio direction, project sponsorship, project and program management and efficiency and disclosure and reporting. • procurement • contracting abu hassim, kajewski & trgunarsyah, 2011:1932 mf project governance the process of project decision making and the framework, models or structures that are established to enable this. does it meet the needs of the organisation? does it offer money? does it have a reasonable likelihood of success? • strategic fit • control, • assure garland, 2009:1-3 sf project governance project governance is a set of management systems, rules, proto cols, relationships and structures that provide the framework within which decisions are made for project development and implementation to achieve the intended business or strategic motivation. • reviews and audits. • ethical, responsible conduct and conflict of interest. bekker & steyn, 2009:87-90 lc continued/ sajems special issue 17 (2014) : 22-32 29 terms definition context and key words reference school of thought project governance a process-orientated system by which projects are strategically directed, integratively managed, and holistically controlled, in an entrepreneurial and ethically reflected way, appropriate to the singular, time-wise limited, interdisciplinary, and complex context of projects. • policies • principles • processes renz, 2007:19 sf project governance • fostering of an environment allowing projects to be successful. • prioritisation of projects for best use of resources • identification of projects in trouble. • rescue, suspension or termination of these projects as appropriate. • control • manage • monitor műller, 2009:17 sf project governance no definition offered • right decision at the right time. • contract fairness. • information transparency. • responsive. • equality. • effectiveness and efficiency. • accountability. abednego & ogunlana, 2006:627 lc metagovernance the regulatory environments of mechanisms and processes that enable or constrain public-privatepartnerships • politics • principles • guidelines koch & buser, 2006:551 lc apart from the categorisation of projects the linkage and alignment with corporate governance seems undisputable. even though this deduction seems logical, the alignment with corporate governance as overarching, and even dictating theme, can cause further complexity. 4 conclusion the definition, framing and practice of project governance can be influenced by the corporate environment within which the project is managed. the definition of project governance varies from a technical level of controlling, monitoring and complying to the strategic levels of management and coordinating and finally the institutional level of guidance, decision-making and responsible citizenship. the differences in governance approaches are driven more by stakeholder complexity rather than project complexity. in this study three project governance schools of thought namely sf, mf and lc, were formulated and various project governance definitions found in literature were categorised in the three schools. projects initiated and managed within a single firm form part of the sf school and are mostly governed by methods, controls, procedures, processes and project governance frameworks internal to the company. these internal governance frameworks are aligned with the corporate governance framework of the respective company but normally operate at a technical level to ensure compliance with the internal processes. a second form of project governance is found among two or more organisations engaging in a contractual relationship and is referred to as the mf school. with these relationships the participating organisations gain access to each other’s intellectual property, knowledge and information and therefore some form of project governance framework needs to be designed and applied to protect organisational and mutual interests. the lc school of project governance is found in large capital projects. the lc school consist of projects that are often standalone, temporary organisations with various internal and external stakeholders. large capital projects include infrastructure ppp projects and often 30 sajems special issue 17 (2014) : 22-32 have project life-cycle spanning over many years, across country boundaries involving various participating contractors, consultants and organisations from different countries. the lc school view project governance at a strategic and even institutional level whereas the total project is seen as a legal entity subject to a governance framework not necessarily defined by the corporate governance framework of the sponsor. project governance is multi-dimensional and the content of a project governance framework is very much dependent on the type of project as well as the number and variety of shareholders and stakeholders involved. 5 recommendations for future research corporate governance is a specialist field with the research done mostly by individuals or teams with an economic, accounting or legal background. thus far it appears as if research in project governance is conducted mostly by scholars with a project management background. in order to merge or align project and corporate governance, project management scholars need to have a proper understanding of the philosophy, definition and mechanisms around governance and corporate governance as well as the different approaches followed by different countries. even though winch (2001: 800) and williams (1981:548) make reference to the role of transaction cost theory in the context of governance, the overall agency problem with associated agency cost in terms of the governance of projects, needs to be further investigated in the project context. as with corporate governance the incorporation of governance in the project environment should take cognisance of the broader set of external forces across nations that influence the structure of the governance system. hoetker and mellewigt (2009:1025) refer to relational and formal governance mechanisms that should be considered when reviewing the transaction type. according to larcker and tayan (2011:8-10), these include the efficiency of local capital markets, legal tradition, reliability of accounting standards, regulatory enforcement, and societal and cultural values. these forces serve as external management, disciplining and controlling mecha nisms that will determine and regulate managerial behaviour. there are no universally agreed-upon standards that determine good governance which makes the formalisation of a project governance framework for especially large, multi-national projects extremely compli cated (complex?). the development of project governance frameworks for projects spanning across national companies, across country borders and incorpo rating different value systems, legal systems, corporate governance guidelines, religions and business practices opens a wide area for further research. with no universally defined, globally acceptable corporate governance framework available, the quest for a standard project governance framework, aligned with corporate governance, remains active. with project governance being a merged concept of project management and corporate governance, it would be beneficial to form coalition research teams to ensure crosspollination of both fields of expertise. references abednego, m.p. & ogunlana, s.o. 2006. good project governance for proper risk allocation in public-private partnerships in indonesia. international journal of project management, 24:622-634. abu hassim, a., kajewski, s. & trigunarsyah, b. 2011. the importance of project governance framework in project procurement planning. procedia engineering, 14:1929-1937. association for project management (apm). 2004. a guide to governance of 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of multiple projects. 22nd ipma world congress, rome, italy, 9-11 november 2008. klakegg, o.j., williams, t., magnussen, o.m. & glasspool, h. 2008. governance frameworks for public project development and estimation. project management journal, 39:s27-s42. koch, c. & buser, m. 2006. emerging metagovernance as an institutional framework for public private partnership networks in denmark. international journal of project management, 24:548-556. larcker, d.f. & tayan, b. 2011. corporate governance matters, pearson education, inc., ft press, upper saddle river, new jersey. marnewick, c. & labuschagne, l. 2011. an investigation into the governance of information technology projects in south africa. international journal of project management, 29(6):661-670. miller, r. & hobbs, b. 2005. governance regimes for large complex projects. project management journal, 36(3):42-50. miller, r., & lessard, d. 2000. (eds.) the strategic management ofllarge engineering projects: shaping institutions, risks, and governance, massachusetts: massachusetts institute of technology. morris, p.w.g., & geraldi, j., 2011. managing the institutional context for projects. project management journal, 42(6):20-32. müller, r. 2009. project governance. gower publishing limited: farnham, england. oakes, g., 2008. project reviews, assurance and governance. gower publishing limited: hampshire, england. pemsel, s. & muller, r. 2012. the governance of knowledge in project-based organizations. international journal of project management, doi:10.1016/j.ijproman.2012.02.002. prince2tm. 2009. managing successful projects with prince2tm. provan, k.g., & kenis, p. 2008. modes of network governance: structure, management, and effectiveness. journal of public administration research and theory, 18(2):229-252. renz, p.s. 2007, project governance – implementing corporate governance and business ethics in nonprofit organisations, physica-verlag heidelberg new york. ruuska, i., ahola, t., artto, k. locatelli, g. & mancini, m. 2011. a new governance approach for multi-firm projects: lessons from olkiluoto 3 and flamanville 3 nuclear power plant projects. international journal of project management, 29(6):647-660. samset, k., berg, p., & klakegg, o.j. 2006. front end governance of major public projects, euram 2006 conference oslo. 32 sajems special issue 17 (2014) : 22-32 sanderson, j. 2012. risk, uncertainty and governance in megaprojects: a critical discussion of alternative explanations. international journal of project management, 30(4):432-443. sharma, d., stone, m. & ekinci, y. 2009. it governance and project management: a qualitative study. database marketing & customer strategy management, 16(1):29-50. williams, t., klakegg, o.j., magnussen, o.m. & glasspool, h. 2010. an investigation of governance frameworks for public projects in norway and the uk. international journal of project management, 28(1):40-50. williamson, o.e. 1981. the economics of organisation: the transaction cost approach. american journal of sociology, 87(3):548-577. winch, g.m., 1989. the construction firm and the construction project: a transaction cost approach. construction management and economics, 7:331-345. winch, g.m., 2001. governing the project process: a conceptual framework. construction management and economics, 19:799-808. yilin, y., yaling, d., ling, y. & zhe, w. 2008. continuous improvement of public project management performance based on project governance. proceedings of the 4th ieee international conference on wireless communications, networking and mobile computing: engineering, services and knowledge management (ems), washington, 15-17 october 2008. abstract introduction overview of employee engagement methodology study results summary of results: statistical tests and box plots for determining whether the normality and homogeneity of variances have been met discussion implications of results for policy and practice study limitations conclusion acknowledgements references about the author(s) robert w.d. zondo department of entrepreneurial studies and management, faculty of management sciences, durban university of technology, durban, south africa citation zondo, r.w.d., 2020, ‘the influence of employee engagement on labour productivity in an automotive assembly organisation in south africa’, south african journal of economic and management sciences 23(1), a3043. https://doi.org/10.4102/sajems.v23i1.3043 original research the influence of employee engagement on labour productivity in an automotive assembly organisation in south africa robert w.d. zondo received: 23 feb. 2019; accepted: 09 dec. 2019; published: 17 mar. 2020 copyright: © 2020. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: productivity of the south african work force remains an issue of central concern for business. it plays an important role in the life of every person and the performance of every business. creating a working environment that encourages worker participation is one way to create the kind of workplace that attracts motivated work teams for productivity improvement. this sentiment underpins the concept of employee engagement. employee engagement is the level of commitment and involvement an employee has towards their organisation and its values. aim: this study examines the influence of employee engagement on labour productivity improvement in the automotive assembly organisations in south africa. settings: the study objectives were achieved by examining the production and related experiences of an automotive assembly organisation that has adopted an employee engagement strategy for labour productivity improvement. the company operates in the ethekwini district municipality in kwazulu-natal. it assessed if employee engagement is responsible for company’s labour productivity. method: the investigation was achieved by collecting quarterly data on absenteeism, employee participation in quality circles and labour productivity before and after the implementation of the strategy. results: employee engagement does not have the ability to improve labour productivity in an automotive assembly organisation in south africa. however, absenteeism rate has an influence on labour productivity resulting from the implementation of employee engagement. conclusion: south african organisations should revise their performance management systems and develop employee engagement strategies that help achieve new business goals. consequently, this study uncovers the strengths and weaknesses of employee engagement for labour productivity improvement in south africa. keywords: absenteeism; automotive assembly organisation; employee engagement; labour productivity; south africa. introduction south africa’s decline in labour productivity in the manufacturing sector is a cause for concern. organisations are faced with the challenge of promoting innovative productivity improvement among employees (zondo 2018). hence, labour productivity plays a crucial role in the organisations’ competitiveness. it represents the total volume of output (measured in terms of gross domestic product) produced per unit of labour (measured in terms of the number of employed persons) during a given time reference period (parry & lacey 2000). its indicator allows the users to assess gross domestic product to labour input levels and growth rates over time, thus providing general information about the efficiency and quality of human capital in the production process for a given economic and social context, including other complementary inputs and innovations used in production. thus, for an organisation to evolve, people working within it have to be involved in processes that improve the organisations’ productivity (zondo 2018). the people involving initiative form the basis for the philosophy of employee engagement. employee engagement is a psychological and physical demonstration of how the employee understands their role in the organisation, and the commitment of stewardship that manifests in high productivity levels of their work (geldenhuys, laba & venter 2014). this includes employees that promote their organisations and feel a sense of belonging and loyalty, and concerns with productivity as their roles (guest 2014). despite the acknowledgement of its importance in business, low levels of employee engagement are reported globally. twenty-six per cent of employees are reported to be disengaged (ariani 2013). bersin (2015) lists the elements that relate to employee disengagement. these include the lack of meaningful work, a less inclusive workplace and the disregard for opportunities for growth. hoxsey (2010) indicates that absenteeism can be an indicator of lack of employee engagement at work. if an organisation is subject to high levels of unplanned and unauthorised absence, it is essential to identify the root causes using an anonymous employee engagement survey. in the united states (us), only 32% of employees are actively engaged (ariani 2013). research estimates that a 21% increase in organisational profitability could result from the improvement in employee engagement levels in organisations. it is estimated that the effect of the disengaged employees costs us$11 billion per annum. in south africa, the gallup 2016 survey indicates that 9% of the south african workforce is actively engaged (engagement 2017). on the other hand, it showed that 45% of the south african workforce was actively disengaged. it reported that less than 20% of the south african workforce’s well-being is supported and their career development encouraged. leadership and communication showed major shortfalls resulting in low engagement levels. in addition, engagement (2017) indicates that the majority of the south african workforce believe that they neither have the autonomy nor opportunity to contribute on issues that affect their work. out of the south africans surveyed, 20% felt no connection to their work. kahn (1990) describes employee engagement as the employment and expression of a person’s preferred self in task behaviour. employee engagement has emerged in business as one of the key factors that organisations ought to prioritise in order to remain competitive. geldenhuys et al. (2014) showed a positive relationship between psychological meaningfulness and work engagement and that meaningful work plays a significant role in employee engagement and sustaining employee commitment as well as productivity. gems (2015) states that work meaningfulness contributes to the core of the organisation. similarly, bakker, demerouti and sanz-vergel (2014) investigated the role of psychological conditions in employee engagement using a cross-sectional design. their results showed the significant role played by psychological meaningfulness in employee engagement. according to gems (2015), during the process of engagement, employees become self-motivated and are driven and energised to perform to the organisation’s expectations. thus, chaudhuri (1986) indicates that quality circles have been the popular employee engagement technique among organisations pursuing excellence. hence, motivation and related techniques tend to be the constructs and predictors of employee engagement and organisational outcomes. other studies by ghadi, fernando and caputi (2013), anitha (2014), guest (2014), and kaliannan and adjovu (2014) examined the relationships between variables like transformational leadership, compensation, training and development, workplace well-being, teams and co-workers, as well as work environment with employee engagement. it established that these factors determine the extent to which employees are engaged. they are the case predictors of employee engagement. guest (2014) adds that productivity improvement is sustainable when everyone in the organisation, from top management to workers on the shop floor, is engaged. participatory mechanisms through engagement philosophy come in various forms, from simple suggestion schemes to interlocking problem-solving groups at all levels in the hierarchy. these participatory productivity improvement schemes are more effective when problem-solving activities are coordinated with and linked to the overall company productivity improvement priorities and strategies. problem statement: low labour productivity level in south africa there is a lack of participation in productivity initiatives at shop floor level in south africa and companies are faced with competitive challenges of promoting innovativeness relating to productivity improvement among employees (zondo 2018). its labour productivity, in the manufacturing sector, is low when compared to korea, the united states of america (usa), taiwan, japan, france and the united kingdom (uk) (klein 2012). the south african manufacturing industry achieved only 36% of the usa labour productivity level in 2014 (the conference board 2015). hence, this study investigates whether employee engagement strategy has the ability to improve labour productivity in the selected automotive assembly organisation in south africa. studies that show a link between employee engagement and labour productivity are lacking. previous studies (ahmed & dajani 2015; farouk 2014; jose & mampilly 2012) have not shown the effectiveness of employee engagement as an intervening variable for labour productivity in the automotive manufacturing industry in south africa. hence, this study evaluates its influence on labour productivity in an automotive assembly organisation in south africa. literature review this section presents the overview of employee engagement, the empirical evidence of employee engagement, as well as employee engagement and company productivity. overview of employee engagement employee engagement is defined as a positive attitude held by the employee towards the organisation and its value (abukhalifer & som 2013). an engaged employee is aware of business context and works with colleagues to improve performance within the job for the benefit of the organisation. it is the harnessing of organisational members to their work roles. during employee engagement, people employ and express themselves physically, cognitively and emotionally during role performance (gems 2015). engagement (2017) defined employee engagement as a positive, fulfilling, work-related state of mind that is characterised by vigour, dedication, and absorption. hence, cherry (2016) defined it as the level of commitment and the involvement an employee has towards their organisation and its values. hoxsey (2010) studied the relationship between employee engagement, organisational commitment and absenteeism. he indicates that, by looking at employees’ absenteeism records, an organisation could pinpoint which employees may not be engaged in their current job. when a member of staff is unexpectedly absent from work, it raises an immediate cause for concern with regard to the likelihood of missing deadlines, disruption to the quality and continuity of service delivery, loss of productivity and efficiency, as well as a drop in motivation and employee engagement. thus, jose and mampilly (2012) described employee engagement as the degree to which individuals are attentive and absorbed in the performance of their roles. consequently, this study assesses the influence of employee engagement on labour productivity in an automotive assembly organisation in south africa. empirical evidence of employee engagement a number of studies were conducted aimed at establishing the value of employee engagement in companies. a study by jose and mampilly (2012) indicates that an organisation’s overall employee engagement level is directly influenced by employee satisfaction, commitment, loyalty and performance. in illustrating the benefits of measuring employee engagement and working strategies to improve employee engagement, jose and mampilly revealed that companies with higher levels of employee engagement have higher levels of profits that are derived from productivity. berdarka and pandita (2014) presented the key drivers of employee engagement. these include communication, work-life balance and leadership. organisations and employees are both dependent on each other to fulfil their goals and objectives. hence, employee engagement should not be a one-time exercise but should be integrated in the organisational culture. bhuvanaiah and raya (2014) discuss a positive behaviour that is associated with an engaged workforce. employee engagement must be managed. this results from employee differences in personality, interest and abilities (gems 2015). kaliannan and adjovu (2014) refer to engaged employees as satisfied and committed, who immerse themselves in the successful attainment of organisational goals and are the force behind organisational success. engagement (2017) identified employee engagement drivers as perceived support, job characteristics, value congruence and internal communication. on measuring the benefits of employee engagement, jose and mampilly (2012) composed a scorecard to measure engagement levels. their organisational scorecards are founded on the basic theory that the overall organisation’s employee engagement level is directly influenced by the component of engagement that includes employee satisfaction, loyalty and performance. jose and mampilly refer to employee engagement as a primary source of competitive advantage. this can be understood as a measure of organisational productivity. gandy et al. (2014) assess employee engagement as a key to organisations realising their competitive advantage, while gems (2015) discussed a connection between employee engagement and organisational outcomes. they explain that when the work environment is conducive to employees focusing their attention on their work and being motivated to do their best, productivity levels experienced by the organisations are high. employee engagement and company productivity a meta-analytical study conducted by harter et al. (2013) examined the relationship between employee engagement and performance. it revealed that employee engagement has a significant impact on employee performance, which is a predictor of productivity. thus, labour productivity becomes an important indicator that is closely linked to economic growth, competitiveness and living standards within the economy (parry & lacey 2000). it is a key measure of human and economic performance. if an organisation has employees whose engagement levels are above average, it is twice as likely to be successful (farouk 2014). hence, employee engagement does influence organisational productivity. gems (2015) indicates that engaged employees are more productive than disengaged. consequently, low levels of employee engagement are detrimental to performance. farouk (2014) explains that engaged employees exercise an element of care in what they do as well as in their efforts to contribute to the success of the organisation. they will have a greater sense of ownership and accountability. employees will become less absent from work and more willing to take on more responsibility and initiatives. the study on 100 best places to work, as conducted by anitha (2014), reveals that employees who have established an engaged relationship with management had a low turnover rate of 13%. they are more committed, loyal to their organisation and less inclined to leave their organisation as they feel a sense of belonging. jose and mampilly (2012) state that good communication is necessary to keep employees engaged with the organisation’s priorities. consequently, the absence of good communication leads to poor engagement and low productivity. communication methods such as one-on-one build engagement with employees (ahmed & dajani 2015). in an effort to facilitate good communication, engagement (2017) encourages organisations to nurture communication by listening to employees’ concerns, thus encouraging employees to participate in workplace discussions. this results in productivity improvement. hence, anitha (2014) indicates that employee engagement is a lever gearing the organisations towards success through productivity. it is an investment that can elicit good returns. farouk (2014) identified strategies that can be used to boost employee engagement as employee training and development, as well as improved leadership and work design. in addition, kaliannan and adjovu (2014) presented numerous drivers of employee engagement. these include two-way communication, as well as training and development. two-way communication leadership, communication and a work-life balance were determined by ahmed and dajani (2015) as drivers of employee engagement. similarly, cherry (2016) deduced that a culture of respect, constant feedback from management, counselling and mentoring are drivers of employee engagement. dulagil (2012) explains that if there is to be any level of engagement, there needs to be clear communication of the core values and beliefs of employees. transparency about the goals and objectives of the organisation should be evident. supervisors and managers should demonstrate care about the health and well-being of the employees (dulagil 2012). there should also be person-job fit alignment so that people are placed in their areas of capabilities. farouk (2014) explored the attitude of employees on productivity. if employees are included in the decision-making process on matters concerning their work, there will be positive benefits for both the employees and the organisation. if organisations endeavour to improve the process of informing employees about changes in relation to their work environment, employees would be more likely to suggest improvements, which in turn increase productivity. training and development leadership, compensation, training and development, as well as workplace well-being are the drivers of employee engagement (anitha 2014). however, training and development are recognised by cherry (2016) as the important determinants of engagement levels for employees. the determinants increase the ability of employees to perform better, thereby contributing to productivity improvement. as a result, this study investigates whether employee engagement has the ability to improve labour productivity in the automotive sector. it explores the suitability of employee engagement as an appropriate tool for labour productivity improvement. employee engagement through quality circles while chaudhuri (1986) defined quality circle as a small group of people doing similar work who meet voluntarily on a regular basis, usually under the leadership of their supervisor, to discuss their work problems, it has evolved into a structured system to harness a collective wisdom on employee engagement in an organisation. it enhances participation and employee engagement in work-related decisions. a study of a quality circle of weekly meetings of supervisors and employees in a unionised foundry to discuss means of improving productivity showed that higher levels of employee engagement were related to increases in a productivity index incorporating such variables as scrap rate and production output (marks et al. 1986). hence, quality circles lead to high internal work motivation, high quality work performance and satisfaction with work, as well as low absenteeism. hypothesis the study is based on the following assumption: h1: the implementation of employee engagement leads to labour productivity improvement in the automotive assembly organisation. h10: the implementation of employee engagement does not lead to labour productivity improvement in the automotive assembly organisation. the following are sub-hypotheses: h2: an increase in the absenteeism rate increases labour productivity in the automotive assembly organisation. h20: an increase in the absenteeism rate decreases labour productivity in the automotive assembly organisation. h3: an increase in the rate of employee participation in quality circles increases labour productivity in the automotive assembly organisation. h30: an increase in the rate of employee participation in quality circles decreases labour productivity in the automotive assembly organisation methodology the method for this research will be discussed under the following headings research design and approach, company that participated in the study, data collection, as well as the measurement and data analysis. research design and approach this study was quantitative in nature. it examines the relationship of labour productivity as a dependent variable with absenteeism rate and employee participation in quality circles, as well as post-employee engagement dummy. bryman and bell (2007) explain that the quantitative approach involves the use of statistical procedures to analyse the data collected. consequently, after the measurements of the relevant variables, the scores were transformed using statistical methods. the study was also conclusive in design. conclusive studies are meant to provide information that is useful in decision-making (yin 2008). company that participated in the study a convenience sample from one large automotive assembly organisation situated within the ethekwini district municipality in the province of kwazulu-natal in south africa was used. the company had adopted an employee engagement strategy and agreed to participate in the study. it implemented an employee engagement strategy in order to give employees the platform to raise issues and concerns they come across (on a daily basis) in their workplaces. the strategy also aimed at improving employee skills so that they could produce products that satisfy the customers. consequently, employee engagement was employed on the company’s blue-collar employees whose jobs require manual labour. the company had 1403 employees. it operates a three-shift system. table 1 presents a percentage breakdown of employees in terms of their level of activities. table 1: percentage breakdown of employees in terms of their level of activities. data collection the collection of data from the company that participated in the study was carried out in two phases. this involved the collection of results preand post-employee engagement from company records for absenteeism, the rate of employee participation in quality circles, and labour productivity. the pre-employee engagement results were quarterly data reflecting the company’s performance over the three-year period prior to employee engagement implementation. this includes data from the first quarter of 2014 to the final quarter of 2016. the post-employee engagement data reflect the company’s performance for two years after employee engagement was implemented. this includes data from the first quarter of 2017 to the final quarter of 2018. measurement and data analysis the company’s quarterly time-series data on absenteeism, labour productivity, and the rate of employee participation in quality circles were used. the measurements were based on a total of 60 observations. a dummy variable which assumed a value of 0 and 1 to represent pre- and post-employee engagement was introduced into the ordinary least squares (ols) model. the aim was to isolate the preand post-labour productivity effects. consequently, if employee engagement proved to be a useful strategy in raising labour productivity levels, this would result in a statistically significant coefficient on the dummy variable. the ols model, analysed using the statistical package for social sciences (spss) version 23.0, was as follows: labour productivity = b0 + b1 rate of employee participation in quality circles + b2 absenteeism rate + b3 pre/post dummy. the above model identifies labour productivity as a function of rate of employee participation in quality circles, the absenteeism rate and the employee engagement strategy. in addition, the normality test was conducted using kolmogorov–smirnov and shapiro–wilk for the overall score of the constructs. table 2 presents results for normality tests for labour productivity rate, the rate of employee participation in quality circles as well as the absenteeism rate. table 2: normality tests for labour productivity rate, the rate of employee participation in quality circles as well as the absenteeism rate. statistical tests in table 2 showed that the data were not normally distributed (p > 0.05). hence, the study was analysed using parametric tests, that is, the t-tests. study results this section analyses the results for preand post-employee engagement means comparison, as well as labour productivity. preand post-employee engagement means comparison table 3 compares the means (in percentages) for employee participation in quality circles, absenteeism and labour productivity. table 3: preand post-employee engagement percentage means comparison. results in table 3 indicate that the percentage mean data for pre-employee engagement on employee participation in quality circle, absenteeism and labour productivity are 31.25%, 21.75% and 42.63%. in addition, the percentage mean data for post-employee engagement on employee participation in quality circle, absenteeism and labour productivity are 43.0%, 31.20% and 71.80%. the results show an increase in mean values on all three variables (that is, the employee participation in quality circles, absenteeism, as well as labour productivity) from the pre-employee engagement to post-employee engagement periods. labour productivity results table 4 presents the results for labour productivity as a dependent variable to the rate of employee participation in quality circles, absenteeism, as well as post-employee engagement dummy. table 4: labour productivity results on the rate of employee participation in quality circles, absenteeism rate, as well as post-employee engagement dummy. labour productivity as a dependent variable to employee participation rate in quality circles the results show that the employee participation rate in quality circles has no relationship with labour productivity. this is determined by its t-value of 1.723. the value is below the critical t-value of 1.960 at the 5% level of significance (curwin & slater 2002), thus accepting the null hypothesis of a relationship between labour productivity and employee participation rate in quality circles. this indicates that the employee participation rate in quality circles is independent of labour productivity. labour productivity as a dependent variable to absenteeism rate results as illustrated in table 4 show that absenteeism rate has a relationship with labour productivity. this is determined by its t-value of 1.980. the value is above the critical t-value of 1.960 at the 5% level of significance, thus accepting the assumption of a significant relationship between labour productivity and the absenteeism rate. this indicates that the absenteeism rate is dependent on labour productivity. labour productivity as a dependent variable to an employee engagement dummy variable results show that employee engagement has no relationship with labour productivity. this is determined by its t-value of 0.945 which is below the critical t-value of 1.960 at the 5% level of significance, thus accepting the null hypothesis of a relationship between labour productivity and employee engagement. this indicates that the employee engagement is independent of labour productivity. it has an adjusted r² of 0.681. furthermore, the serial correlation is also low at 1.416 when compared to the standard value of 1.72 at the 5% level of significance (curwin & slater 2002). summary of results: statistical tests and box plots for determining whether the normality and homogeneity of variances have been met this section analyses data using factorial designs. it incorporates box plots to determine whether the factorial analysis of variance assumptions of normality and homogeneity of variance have been met. porkess (2005) explains that the populations represented should be normally distributed (that is, the normality), making the mean an appropriate measure of central tendency. however, the homogeneity of variance indicates that the population from which the data are sampled should have the same variance. the bartlett’s test was used to verify whether the variances were equal for all the samples (curwin & slater 2002). figure 1 presents a summary of the results from the bartlett’s test for homogeneity of variances. figure 1: bartlett’s test for homogeneity of variances. in addition, table 5 presents detailed results of the bartlett’s test for homogeneity of variances for labour productivity, employee participation in quality circles as well as absenteeism. table 5: bartlett’s test for homogeneity of variances (p = 0.001). the p-value in the bartlett’s test (at p < 0.05) shows that the homogeneity of variances has occurred, thus rejecting the null hypothesis. the p-value at 0.001 is low as compared with the significance level of 0.05. we can conclude that there are distribution changes between the two parts of time-series. this is confirmed by levene’s test of equality shown in table 6. table 6: levene’s test of equality. porkess (2005) defines levene’s test of equality as an inferential statistic used to assess the equality of variance on different samples. in levene’s test of equality, the statistical procedure assumes that variances of the populations from which different samples are drawn are equal. as a result, the findings in table 6 show that the obtained similarities between the variances in the samples for preand post-data at p-value 0.007 have occurred. they are below the statistical significant level of 0.05. box plots in figure 2 confirm the results. figure 2: box plots determining the normality and homogeneity of variance. figure 2 shows that the mode of change from pre- to post-employee engagement period is homogeneous. box plots indicate a similar spread of employee engagement results. statistical tests suggest that the conditions for homogeneity of variances between preand post-employee engagement have been met. discussion this study investigates the influence of employee engagement on the improvement of labour productivity in an automotive assembly organisation in south africa. it examined the production and related experience of the automotive assembly organisation that has adopted an engagement strategy among its employees. quarterly time-series data on absenteeism, labour productivity and employee participation in quality circles were used to analyse data. the results indicate that absenteeism rate has a relationship with labour productivity. however, employee participation in quality circles and employee engagement have no relationship with labour productivity in the automotive assembly organisation in south africa. geldenhuys et al. (2014) presented the number of conditions that lead to the success of employee engagement. there should be a positive relationship between psychological meaningfulness of work and employee engagement. an absence of meaningful work contributes to employee engagement failures, resulting in low labour productivity. implications of results for policy and practice organisations in south africa should revise their performance management systems and develop employee engagement strategies, policies and practices that help to achieve new business goals and support organisational and cultural change (smith 2007). this must be based on an understanding of the economic factors affecting employee engagement and motivation, as well as the significance of the psychological meaningfulness of work that influences employee engagement for labour productivity improvement. besides the achievement of study objectives, the following conclusions can be made on the employee engagement philosophy: it is a lever gearing the organisations towards success through labour productivity. it can negatively be affected by the lack of meaningful work, a less inclusive workplace and the disregard for opportunities for growth. in order to maximise performance, a comprehensive performance policy must be developed, which aligns employee engagement to labour productivity (farouk 2014). study limitations the study was limited to an automotive assembly organisation within the ethekwini district municipality. the investigation was conducted in a single company that has adopted an employee engagement strategy. as there are eight registered assembly companies in south africa (sainfo 2008), the results cannot be extrapolated to other companies within the sector. secondly, it did not examine the process followed during employee engagement, including (among others) the individuals that participated in the implementation process. it used only quarterly time-series data to determine the pre- and post-labour productivity effects resulting from the employee engagement strategy. lastly, the econometrics model used was of the ols variety, solely due to data constraints. future studies ought to use the more advanced johansen value at risk methodology or panel data analysis, both of which rely on large data sets. conclusion an employee engagement process creates a working environment that encourages worker participation and commitment. properly implemented and managed, the system results in improved employee performance. psychological meaningfulness and motivation play a role in employee engagement. hence, the relationship between absenteeism rate and labour productivity exists after the employee engagement is implemented. however, there was no direct relationship between employee engagement and labour productivity in the selected automotive assembly organisation. the system is not a solution to inherent labour productivity problems. it is an approach that takes advantage of a focused organisational strategy to combine employee communication, decision-making and participation. the system can be used for developing employee capability in the organisations. thus, the employees will have the capabilities to solve organisational problems (brewster et al. 2003). future research required during the course of this study, issues relating to the long-term survival of an employee engagement strategy after implementation were not covered. this includes the applicability of employee engagement to a wider sector of the economic activity, including the public sector. the nature of this research did not allow these areas to be covered in depth. it is recommended that future research should examine the following issues in greater depth: when to use and when not to use an employee engagement system. the applicability of an employee engagement approach to other industrial sectors. the process followed during the implementation of an employee engagement system. a more comprehensive investigation should be carried out using a randomised sample of the registered automotive manufacturers that use an employee engagement strategy to see if the results can be generalised. acknowledgements competing interests the author declares that he has no financial or personal relationships that may have inappropriately influenced him in writing this article. author’s contributions i declare that i am the sole author of this research article. funding information the article was paid for by the durban university of technology (dut) researcher fund. ethical considerations the researcher complied to the following: the process for the collection of data did not involve access to confidential personal data; the research fulfils the criteria for informed consent; respondents were not asked to perform any acts or make statements that might be expected to cause discomfort; the researcher did not expect to obtain any direct or indirect financial or other benefits from conducting the 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different market conditions. a total of 288 stocks from five asean countries over an eight-year period comprising four distinct market segments are considered. market phases are distinguished by recursiveregression estimation while the portfolios are scored by use of a meanvariance/tracking-error methodology. the statistical significance of the performance of each individual style, so rated, is investigated parametrically. the study concludes that value reigns under most market conditions, except for the early bull period where growth investing is superior. jelglo background while timing strategies based on size, style and market have long been attractive to investors as potential sources of added value (banz, 1981; rosenberg et al., 1985; fama & french, 1992a, chan et al., 1993 and jegadeesh & titman, 1993), the ability to outperform a benchmark by accurately timing these dimensions remains debatable. however, long-term excess return premiums are reportedly associated with one side of each of these three cases: value along the style dimension, small cap along the size dimension and equity among the market choices (fama & french, 1992a). few academic studies have examined what drives cyclical style return differences or whether and how tactical style allocation can be achieved. further, many studies fail to account for major factors that hinder the comparability of performance among different time periods. finally, the role of investment region selection has similarly been neglected. if these factors are taken into account, future rankings of performance might be predicted more accurately. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 86 sajems ns vol 5 (2002) no i within this context, the pwpose of this study is to detemrine the impact, if any, that growth versus value styles have on the predictability of future perfonnance rankings in the association of south east asian nations (asean) when perfonnance is measured over complete stock market cycles. for the purpose of this study, growth stocks refer to those securities of companies with substantial growth prospects, while value stocks are those stocks which appear to be inexpensive relative to some measure of fundamental value. this general understanding will be translated into empirically detenninable benchmarks in the methodology section. academic foundations the pattern predictability observed by, among others, fama & french (l992a) and malkiel (1993) contributes to a broad definition of the efficient market. it also impacts the equity style allocation (management) process. sharpe's (1992) article showed that size and growth-value characteristics can explain a large portion of the returns of an equity portfolio. the bulk of the returns (97 per cent) from a diversified equity portfolio is a function of these factors. this would indicate that the most critical issue for a holder of such a portfolio is the equity style exposure of the portfolio against a broad benchmark index. the notion that the risk of an equity-style-driven investment process is equal to that of the market, but still able to generate excess returns, troubles some observers. what nonnally happens is that the portfolio is at a lower risk (beta) level than the market about half of the time and at a higher risk the rest of the time. while these two offset each other, resulting in market-like risk, in the short run the risk of being out of sync with the market is the source of excess returns (westervelt & schwab, 1995). if the risk of being out of sync with the market is the source of excess returns, then the common approach to portfolio structure, that of equity style neutrality, must be re-examined. this approach ignores the potential gains from equity style management and relies solely on stock selection as a source of excess returns. a fund manager's aggregate portfolio in an equity-style-neutral structure approximately replicates the market by size and industry weights. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no i 87 importance ofeqmty styletmnng first madison advisors (1995) examined the opportunity to add value through allocation. they found that, over a 15-year period, the opportunity to add value through asset-class allocation was 18.73 per cent. this compared with 15.69 per cent as the opportunity to add value through equity-style allocation within an equity portfolio. although these resulted from unattainable best-case scenarios, one can see that the magnitude of increased returns from equity-style management rivals that of asset-style allocation in relative importance and opportunity. practitioners of equity-style timing believe that splitting the stock universe on the value and growth dimension is a more natural split of the stock universe than any other style definitions, such as beta or size. this is because the differences in returns to these styles are more likely to be driven by economic fundamentals. they believe that business cycles and trends in earnings underpin the differences in returns between the value and growth segments of the stock market and that these fundamental relationships persist (kao & shumaker, 1999). because almost any defmition of value can be used to outperform an index, it has been argued that value has a positive bias versus growth on average, about 300 basis points of outperformance and a larger bias for small capitalization stocks (calderwood, 1995). the value edge differs somewhat by size, index vendor, time horizon and universe used, but it is enduring and is delivered with lower levels of risk than the returns associated with the growth style. calderwood (1995) concludes that the underlying reasons for value's positive bias are a yield premium, value analysts' reliance on hard data, the phenomenon of mean reversion, and most importantly, what he calls 'mental demons', such as fear ofregret. indeed, it has often been proposed that value investing produces above average results; that the results are enduring; and that the benefits are obtainable globally (mitchell, 1995). certainly, widely displayed biases about wealth work to the advantage of value investors; namely, people overvalue certainty, overreact to big events with small probabilities of occurring and are averse to loss. to this can be added two axioms driving superior performance. first, value is a function of anxiety. empirical evidence on earnings revisions in the united states and other developed markets shows that the 'domain of potential losses' (negative revisions) is where abnormal returns are earned. second, mean reversion is strong. returns on equity in the united states and other markets revert strongly to the mean in relatively short periods of time. these two factors help explain the value advantage which may be documented by showing global r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 88 sajems ns vol 5 (2002) no 1 premiums to value investing over time (sanders, 1995). diversification benefits accrue as a bonus because the value premiums between markets are not highly correlated. however, many investment firms with a growth investing focus have experienced remarkable increases in assets under management during the past 20 years. evidence suggests that these firms did not sacrifice returns to achieve that asset growth, as they matched or exceeded standard benchmark measures of performance (hall, 1995). indeed, it is contended that the business of growth stock investing has involved being at the right place at the right time and being patient in the face of unfavorable developments. of course, among the primary factors are low turnover, an emphasis on total returns, a focus on noncyclicals and the importance of favourable macroeconomic conditions (rosenberg, 1995). still, a widely known fact in the investment community is that growth managers, unlike value managers, tend to outperform their growth benchmarks over time, especially in the area of small cap stocks. according to research by trittin (1994) on the performance of institutional money managers tracked by the frank russell company, the average smallcap/growth stock manager outperformed the russell 2000 growth index by about 850 bps a year for the eight-year period that ended on december 31, 1993. for a shorter time period (five years) and with limited data available, the excess return of the average small-cap/value manager over the russell 2000 was about 170 bps a year. based on historical return data, growth managers' tendency to outperform the passive alternative supports the notion that indexing growth stocks and permanently tilting on value could be suboptimal for equity funds. hence the overall outcome of this study is to be able to devise short-term switching strategies to capitalize on abnormal return opportunities. objectives the objectives of this study were to: evaluate variables representing the different styles of value and growth investing; consider over eight years of data on 288 stocks from the aseans countries; construct style portfolios and rebalance them on a monthly basis while calculating returns in local currency and us$ terms; r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 89 break the time-frame up into four distinct segments covering an early bull market, a late bull market, a flat market and a bear market, rather than evaluate each styles action over the entire history. by derming time periods on the basis of market cycles, relative portfolio performance is expected to be more consistent over adjacent time periods than when performance is measured arbitrarily over successive calendar quarters or calendar years (bauman & miller, 1994). the following hypothesis was tested: style action is cyclical in nature. the hypothesis is concerned with relating the value and growth styles to market direction and seeks to determine whether the styles do better under different market conditions. research method data from the jardine fleming asean strategy database was extracted according to constraints of sample size and time frame. relative return and risk was examined with perfect foresight (i.e., taking a long position in the higher performing portfolio and a short position in the lower returning one). monthly data was used and where necessary, annual data was converted into a monthly format through a system of time weighting. rather than evaluate each style's action over an entire history, the time frame was broken up for analysis into four distinct segments covering an early bull market, a late bull market, a flat market and a bear market. this enabled the situation of style action in the context of market direction, based on the premise that style action is cyclical in nature. market phase demarcation was achieved by recursive-regression estimation that tests for structural breaks in the trend of the equity market. sample the study made use of key numbers from over eight years of data on 288 stocks drawn from a jardine fleming strategy database. this database covers stocks in the aseans countries of indonesia, malaysia, philippines, singapore and thailand. the stocks were selected such that each country was represented to at least 50 per cent of its market capitalization and that the total percentage of regional market capitalization referred to, was at least 60 per cent. the obvious attraction of this weighting system is that it reflects the aggregate market. the capitalization-weighted aggregation of all individual securities (often called the market portfolio) must, after adjustment for cross-holdings, equal assetr ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 90 sajems ns vol 5 (2002) no i weighted aggregations of all investor portfolios (umstead, 1988). thus the performance of the market portfolio always equals the gross performance of investors. it provides a useful performance benchmark, presents a distillation of market-place wisdom', and is the only portfolio that all investors can hold simultaneously. table 1 bencbmark coverage snapsbot country no. of stocks in tbe % of total market study capitalization indonesia 37 62 malaysia 89 67 philippines 46 89 singapore 50 51 thailand 66 74 total 288 62 monthly data was used and where necessary annual data was converted into a monthly format through a process of time-weighting based on trading days. in selecting styles for analysis, due to the possible interplay of small-capllarge-cap or winnerlloser effects, only styles that belonged clearly to either value or growth categories were included. hybrid styles were avoided. ignoring other screens such as size and quality was expected to restrict the investigation to the value-versus-growth issue only. a caveat is called for here. the jardine fleming asean strategy database is the most comprehensive database, maintained by an international securities house, for the region as a whole. and monthly sorts of its 288 stocks were no easy feat, implying approximately 340 704 'sorts bad to be made in total. however, this means that only one repetition of each market phase was considered. to ensure that externalities were not captured by those phases the recursive regressions that produced each break: were compared with accepted industry definitions to ensure their congruency (hsbc, 1994). data collection and analysis the specific value styles that were evaluated were per (price-earnings ratio, both current and forward), pbr (price-ta-book ratio, both current and forward), pcfr (price-ta-cash-flow ratio, both current and forward), dividend yield (current and forward) as well as enterprise value2 to sales. current values were calculated using share prices and fmancial numbers at a common point of observation. in contrast, forwan! values, rather than. using forecasts, were r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no i 91 calculated using share prices current at the point of observation and fmancial numbers exactly one calendar year later, this period being the industry nonn. the use of historical actuals rather than forecast figures in the forward calculation was driven by difficulties in obtaining historical consensus figures. fortunately, as it was possible to defme a complete market cycle that ended july 1998, there was no difficulty using actual numbers up to july 1999. the growth styles calculated were eps (earnings per share) growth, sustainable growth rate, net profit reinvestment rate and total assets growth, with eps and total assets growth expressed as year-on-year percentage changes. table 2 gives the definitions used in making both value and growth distinctions. portfolios for the individual styles were constructed with perfect foresight and (as required by the mvte approach) bear-sales were not allowed. the database was thus sorted in ascending order for all value styles (except for dividend yield) and in descending order for all growth styles and the top and bottom quintiles were demarcated. the top quintile (ql) is the preferred style end and represents companies with low per, pbr, pcfr and enterprise value to sales as well as those companies with high eps growth, sustainable growth, np investment rates and total assets growth. by contrast, the bottom quintile (qs) represents the respective opposites and is the style end to be avoided. once the opposing quintiles were demarcated, the average returns of each in both local currency and us$ terms were calculated. the average returns of the top quintile were calculated in absolute and relative terms, the latter with reference to the benchmark, given by the average over the entire database. to make the whole exercise as dynamic as possible the style portfolios were rebalanced every month. in order to incorporate both return and risk aspects of style effectiveness under various market conditions, it was thought applicable to describe style effectiveness by a single number. to do this relative scores were calculated on three variables, all in us$ terms: the cumulative returns of the top quintile relative to the benchmark; the cumulative returns of the top quintile relative to the bottom quintile and the standard deviation of the average returns of the top quintile. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 92 sajems ns vot5 (2002) no i table 2 how screen styles were identified ratio definition value growth employed characteristic characteristic per share price over eps must have been less must have been than 40".4> of the more than 40% of average market pe . the average market pe pbr share price over price < two-thirds of ! price> two-thirds shareholders equity per book value i of book value share pcfr share price over cash must have been less must have been flow per share based on than 20".4> of the more than 20% of eps plus depreciation average market pcfr the average market and amortisation minus pcfr monetary gainlloss and foreign exchange gainlloss per share for the fiscal year dividend dividend on the main dividend yield dividend yield less yield type of share multiplied greater than twothan average by the grossing up thirds of the aaa corporate bond factor, expressed as a corporate bond yield yield. percentage of the price of the main type of share enterprise market capitalization must have been less must have been value to plus latest available net than 20% of average more than 20".4> of sales debt over sales for market ev is with average market fiscal year debt being less than ev is with debt . twice net current more than twice net i assets current assets epsgrowth year on year growth in growth greater than growth greater than earnings per share 1% twice inflation rate sustainable dividend growth rate growth equal or less growth greater than growth rate than overall market overall market growth growth net profit rate of growth in growth rate less than growth rate greater reinvestment reinvested profit dividend growth rate than dividend rate growthmte total assets growth rate of sum of growth rate> rate of growth rate < growth current and fixed assets growth ofliabilities liability growth rate, with a debt.equity debt-equity ratio ratioofl . greater than 1 adapted with reference to arnott & copeland (1985) & forsythe (1995) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no i 93 relative scoring was done for the first two variables (measuring returns) by setting a maximum of the range (across different styles) to 100 and the minimum to o. for the third variable, which reflects the degree of risk (of which a greater quantity is obviously less desirable), the scoring system was reversed with the minimum standard deviation of the range fetching a score of 100 and the maximum a score ofo. these are reported in tables 3, 4 and 5. next, the relative score on each variable was weighted (50 per cent for the first and 25 per cent for the second and third) to derive a composite styleeffectiveness score. one such number was computed for each style in every phase. the composite is tilted in favour of return, with the two variables measuring relative returns holding a 75 per cent weight while the risk variable carries a weight of only 25 per cent. this was based on the assumption that most investors see (high) return as a necessity and (low) volatility as desirable. emerging markets in general and asian equities in particular attract investors who wish to diversify out of their home markets where earnings growth prospects are by and large anemic. for this reason, return rather than risk becomes the paramount consideration), with the risk element already being addressed through abundant exposure to developed country investments. this keeps the overall volatility of their global portfolio at a comfortably low level. a dominant weight for the return parameter also enables it to behave more like a filter, helping to screen out styles that deliver poor relative returns but exhibiting low risk. the composite scores obtained after suitably weighting the individual variable scores were expressed on a range from 0 to 100, with these magnitudes being directly proportional to their effectiveness. thus a higher score signifies that a style is more useful approach for hypothesis testing weekly returns in us$ from the composite or all share indices for all five countries were used to identify market phase turning points. log values of these returns were put through a recursive regression estimation analysis to determine at which point the f-statistic was greater than the market threshold level. for at these points there is confidence that a statistical break point has been reached. weekly returns for these indices were obtained from the fmancial markets news service bloombergs, who in turn receive the numbers directly from each market's news division. however, as a holistic picture of the asean region was desired, all the values needed to be distilled to arrive at one common set of phase periods. thus r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 94 sajems ns vol 5 (2002) no i statistical averaging techniques were used here. this resulted in the following time frames being set: early bull: december 1990 to december 1993; flat market: december 1993 to november 1995; late bull: november 1995 to june 1997; bear market: june 1997 to july 1998. figure i shows the respective periods outlined on the benchmark index (the portfolio of288 securities). the movement during the early bull phase shows an increase in value by 68 per cent. that during the flat period there is 98 per cent confidence that the market remained 2.77 standard errors away from the period's mean of us$ 245.63, implies a narrow range of only us$ 5.51. this quite sufficiently justifies that period being defmed as flat. the bear market is characterized by a decline from us$ 285.68 to us$ 143.35 a loss of 50 per cent. when using recursive regressions, there is a possibility that the null would be rejected not only at the time of the break, but also for observations just before and after it. thus particular care was taken to ensure that each phase delineation was well within industry definitions advanced for them (hsbc, 1994) and so were accepted. placing the analysis into these four distinct market phases enables style action to be understood in the context of market direction, based on the premise to be tested, that style action is cyclical in nature. indices were computed to track the average returns of the top and bottom quintiles in local currency as well as us$ terms. from these, the cumulative returns of opposite style ends were calculated. a similar calculation was done for the relative (to benchmark) returns of the top quintile. in addition to making these return calculations, the standard deviation of average returns of the top quintile as a measure of risk or volatility was found. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vot5 (2002) no 1 figure 1 statistical break points, bencbmarck index ;: ::> .5 ! j i .i 200 150 i 100 50 1------'ijune '97 ~------~========~~----~--~.~ '98 bear 95 the starting point was the argument that the standard mean-variance (mv) utility function is inadequate for investors concerned about portfolios that diverge from the benchmark. for them, the utility function needs to be modified to include dissatisfaction with deviations from that benchmark. one such modification is the addition of tracking error as a parameter in the utility function, that is: maximize u(p) = expret (p) subject to: 'f.p/ = 1; pi ~ 0 for alii where: rt expret(p) = recent expected return of the portfolio rexpte(plf tet exprisk(p) = recent expected standard deviation of portfolio returns expte(p) = percent expected tracking error of portfolio returns rt = risk tolerance tet = tracking-error tolerance pi = proportion of the portfolio allocated to asset i. (1) r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 96 sajems ns vol 5 (2002) no i using this new utility function, the portfolio optimization process seeks out portfolios with high-expected returns and low portfolio volatility on an absolute basis (the my part) as well as relative to a benchmark (the te part). investors may defme the relative importance of these three goals when they assign risktolerance and tracking-error tolerance. in this study the formula will be referred to as the mean-variance/tracking-error (myte) utility function. the study made use of this extended markowitz model of mean-variance. analysis of this utility function ensures that its set of efficient portfolios includes the mean-variance efficient set, a mean-tracking error efficient set and all convex combinations of these two sets. optimization of this utility function may fmd solutions that investors will actually use (chow, 1995). market cycles together with the mvte approach were used to account for or neutralize differences in portfolio risks. it thus avoided the use of risk-adjusted returns such as the sharpe, treynor and jensen statistics that are alleged to be subject to statistical biases, nonstationarity and other measurement problems4• although only one hypothesis, that style action is cyclical in nature, was to be investigated, it was envisaged that many observations about the behaviour of the different styles under the varied market phases would come to the fore. in synthesizing these results it would be important that these too be subject to statistical testing. as each market phase was seen as a separate and independent sample it was possible to arrive at a mean myte score for the phase as a whole. coupled with the relatively small (n=13) number of style effectiveness scores for each phase and the fact that the sample deviation stood in as a population deviation, a parametric test of significance was thought to be appropriate. the results of this analysis (reported as appendix a, at the end of the paper) should show whether the assigned mvte performance not only differed but did so statistically, from what would have been expected. a significance level of 5 per cent was judged to be prudent. synthesis and discussion figure 2 shows the cyclical action of the growth styles (bps growth, total assets growth, np reinvestment rate, sustainable growth rate) in the basket. clearly, the growth approaches yield the best results when the bull market is in its infancy. the rise in the equity market at this time, occurs in the absence of economic or earnings growth but as a result of falling bond yields that improve relative valuation. because participants are acting on prospects for profit recovery, rather than on hard data, the growth style is favoured. the effectiveness of the leading growth style declines substantially as the bull r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 97 market matures; the sustainable growth rate and np reinvestment rate styles are marginal exceptions to this. these, although peaking later in the bull cycle, post return and overall scores that are modest and not statistically significant as appendix a shows. hence the fust observation arrived at. is that growth wins at the beginning of the bull cycle. figure 2 the growth styles 80 70 60 f:so £40 .!! ci'30 20 10 o (12190-12193) (11195-6197) (12193-11195) «(ij97-7198) international investors looking for growth generally make their debut in the early stages of equity bull cycles. the entry of these investors who are diversifying out of slow-growing home markets is a possible reason why growth approaches perform so well in this period. the changing supply/demand balance possibly reflects the high cash and near-cash holdings of participants at this early stage. also, there tends to be an increase in the incidence of positive earnings surprises in this period which produce fluctuations in value parameters such as per and pcfr that have eamings-driven denominators. this tends to focus the spotlight on growth, which is identified as the prime mover of share price performance, while value fades to the background. later on, as the bull market matures, earnings surprises become fewer, making the value parameters more stable. this process leads to a progressive decline in the effectiveness of the growth styles. it is thus also possible to deduce that earnings surprises, often found at the start of the bull phase, support growth approaches. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 98 sajems ns vol 5 (2002) no i not all the growth styles examined in the basket performed equally well. the styles worth following are eps growth and total assets growth, which even then were only statistically significant during the early bull phase. the scores of the other two styles (i.e .. sustainable growth rate and np reinvestment rate) failed to rise above the mediocre. as these styles are most suitable for investors with long-term horizons, their inferior performance may suggest that most asean equity investors have short-term orientations. a further observation is thus that eamings-per-share and total assets growth are the most effective growth styles. a flat market is the worst platform for a growth strategy. all the growth styles post their lowest scores in that phase of market. common sense dictates that as value is relatively abundant and growth scarce in a declining market, growth styles may be expected to deliver their best performances in a bear market. swprisingly, this expectation was belied by the results. in fact, growth approaches exhibited their peak performances in the early stages of a bull market. this is possibly the result of a delayed recognition of the importance of growth, and investor uncertainty about the sustainability of growth patterns in a general climate of bearishness. growth styles, as shown in table 3, are at their least volatile in a bear market. while returns from growth investing do peak in the early stages of a bull market, these gains are accompanied by increased volatility. of the growth styles, the np reinvestment rate and sustainable growth rate are markedly less risky than eps growth and total assets growth in a young bull market. a positively sloped yield curve reduces the discount rate causing earnings revisions to be rife in this period. however, because their impact on the sustainable growth rate and np reinvestment rate is both diluted and delayed this may explain their lower volatility. as the bull market ages, earnings flux ahates and is replaced by its trickle-down effects, operating with a lag, on the sustainable growth rate and the np reinvestment rate. this results in a trade-off between (low) risk and (high) return; price performance for these styles (sustainable growth and np reinvestment) peaks late in the bull cycle and volatility registers a corresponding rise. conversely, for eps and total assets growth, risk drops in the second half of the bull cycle, but with it does relative return. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . samms ns vol 5 (2002) no 1 99 table 3 volatility of growth styles style market phase early bull late bull flat bear eps growth 23 62 0 100 sustainable growth rate 68 50 23 72 total assets growth 0 44 28 na np reinvestment rate 69 0 25 60 .. note: scores range from 0 (maximum nsk) to 100 (minimum nsk) on a standard deviation basis. figure 3 shows those value styles that made use of current rather than forward financial numbers. as with the growth styles, it was discovered that the effectiveness of the value styles varies depending on the overall direction of the market. mature bull markets or flat markets appear to provide the best platforms for value-oriented investment strategies. pe~ is the top pick among the value (current) ratios, showing statistical significance in all but the bear phase. it proved to be more effective than any other value (current) style in late bull and flat markets, with performance peaking at the top of a bull market. its dominance among the value (current) styles is probably due to its popularity among the investment community. as mentioned in the previous section, earnings surprises tend to reduce in number and magnitude in late bull and flat markets, with the market seeking confirmation of a recovery, resulting in greater stability of value parameters such as per and pcfr. this could explain the more general shift to value evident under these conditions. it is thus possible to observe that priceearnings:ratios are the top value (current) style. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 100 sajems ns vol 5 (2002) no i figure 3 the value (current) styles 100 perc 90 80 t! 70 8 60 ri.) so e. 40 ri.) 30 20 10 0 early bull market late bull market flat market bear market (12/90-12193) (11195-6/97) (12193-11195) (6/97-7198) the least risky styles in the value (current) basket are pcfr., and dyc in mature bull and flat markets, though their overall perfonnance on an mvte basis was not statistically significant. however, per." the winner under these conditions on pure return considerations, is more volatile. its risk may be low in the early stages of a bull market, but there, the growth styles perfonn better on return. however, although its volatility is highest in a bear market, this is true for most other styles as well, and this is therefore no exception. table 4 volatiuty of value (curreat) styles style market phase earlybuu late buu i flat bear per., 79 51 f= 3s 0 pbr., 54 62 46 14 pcfr., u 100 62 11 dye 68 89 i 46 25 .. note: scores range from 0 (maxnnum nsk) to 100 (muumum nsk) on a standard deviation basis. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 101 the increased volatility of all value styles under bearish conditions may be the result of the poor predictability of earnings. the contrast with growth styles is most pronounced in a bear market as they exhibit minimum risk then. an interesting observation is that per.: (which is directly driven by earnings and is highly sensitive to changes in depreciation) exhibits greater volatility than pcfr.: (which is depreciation-independent). the latter ratio is comparatively more stable in mature bull, flat and bear markets. depreciation charges tend to peak in a bear market at the same time that earnings are declining, making depreciation a big swing factor. this could explain why per.: is at the bottom of the table (having the highest risk) in a bear market. in a bear market, as bond yields rise and growth and earnings fall, the baton in the value (current) basket passes from per.: to dye. this style produces best results in this type of market when measured by relative performance but fails to offer less risk than the growth styles. however, it is still the least risky value (current) style, which provides greater motivation for preferring it to other value approaches in a declining market. dye volatility is lowest in a mature market, although relative returns are also weak, causing this style to lag behind per.:. thus a bear market provides the best context for a surge in the effectiveness of the dividend-yield style, when it becomes the only style in its class to show a statistically significant performance. this may be a function of general riskaversion triggered off by a deteriorating environment and a reflection of the higher value placed on payout by the investor. generally, there is a higher standard deviation of returns when both bond yields rise and growth and earnings fall. the risk/return ratio rises as the outcomes become less certain. viewed another way, differences in intrinsic dividend-payout potential come to the fore and become emphasized by investors when all stock prices are equally and indiscriminately under pressure. another reason for the superior performance of dividend yield is the tendency of companies' management to fix the nominal dividend rate rather than the payout ratio in a downturn. such a stable dividend policy is seen as signaling strength to the market. the certainty of holding the dividend rate constant in the face of an earnings decline naturally boosts the payout ratio and puts more cash in the hands of shareholders at a time when cash carries a premium. thus it is possible to deduce that current dividend yield performs better than current price-earnings-ratios in a bear market. the performance of enterprise value to sales is inferior in all market situations: rising, flat or declining. the denominator in this ratio has a lower correlation with earnings than is true of other value styles and the leverage insensitivity implicit in the numerator probably makes this style a poor polariser of returns. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 102 sajems ns vols (2002) no i while risk is lower for this style in all kinds of markets, it cannot compete on return and hence cannot be seen as a serious alternative. thus it is observed that enterprise value to sales is not very useful a more structural reason underlying the inferior perfonnance of enterprise value to sales may be the virtual absence of strong (local) brand recognition in the asean. the ratio is best applied to companies with strong corporate or product brand equity. for these companies small differences in the enterprise value-tosales ratio may mean large differences in earnings and share-price perfonnance. most businesses in the asean produce commoditized rather than branded products, hence this style does not work very well. the value (folward) styles shown in figure 4 were made up of value styles that used one-year folward fmancial numbers. most of the perfonnance patterns observed with respect to the current styles also hold good for this group. for example, the effectiveness of perf and pcfrr peaks in a late bull market and that of pbrr peaks in a flat one, the only times these styles become statistically significant. however, the effectiveness of dy c. while still high in a bear market, is bettered, albeit marginally, by its own perfonnance in a trendless marlcet. the dominance of per, evident among the value (current) set of styles, was not reflected in this sample. while pere dominated both flat and mature bull markets among the value (current) styles, on a folward basis, it was pcfrc that perfonned best in a mature bull context and pbrf in a flat market. in mature bull markets and early bear markets, the peaking of the investment boom drives depreciation upward. per is subject to distortion by depreciation but cash flows are immune as the charges are added back in the cash flows. for this reason (and the fact that equity prices lag earnings growth), pcfrf outperforms per in a mature bull market. the fonner is also the best style in this class in the early stages of a bull market. overall, pcfrr is a very useful style in a mature bull market as it combines high returns with low risk. it is thus observed that folward price-to-casb-flow-ratios and price-to-book-ratios are most effective in mature bull markets and flat markets respectively. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vols (2002) no i figure 4 style scores 100 90 60 2: 70 0= 60 ~ 50 .. 'e-40 "-! 30 20 10 o early bull maiket (12l9o-12j93) late bull market (11195-6197) flat market (12.193-11195) bearmaiket (6197-7198) 103 the bear market also shows diversion with pbrr doing marginally better than dye to claim the most effective spot. although dividend yield continues to be an important consideration, investors in a bear market also assess company survivability and pbrr proves to be a better measure of this, as it factors in capital dilution arising from future earnings shocks. it was, therefore, also observed that forward price-to-book-ratios also do well in a bear market. examining the risk profiles of the various classes (current and forward) also leads to interesting conclusions. tables 4 and s show the relative scores of each style. these are relative to the scores of the other styles in the same period and range from a minimum of 0 (indicating high volatility) to a maximum of 100 (signifying low volatility). in most cases, the value (forward) styles score higher than their value (current) cousins. the expectations where the converse is true are for pbr in bear markets, pcfr in mature bull and flat markets and dividend yield in young bull markets. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 104 sajems ns vol 5 (2002) no i table 5 volatiuty ofvalue (forward) styles style market phases early bull late bull flat bear perc 100 68 100 14 pbrr 74 68 50 3 pcfrc 74 95 37 35 dyr 63 92 56 38 .. note: scores range from 0 (maximum nsk) to 100 (minimum nsk) on a standard deviation basis. the value (folward) styles incorporate folward earnings numbers and for that reason is less susceptible to earnings surprises (positive or negative). in contrast the value (current) styles are more likely to be affected by earnings surprises and higher volatility in valuation parameters (per. pcfr etc.) translate into higher volatility for share prices. thus it is possible to conclude that value (folward) is generally lower risk than value (current). scanning tables 4 and 5 to spot extremely low or high scores on risk may also be useful. using discretion and taking scores below 15 and those above 85 as being extremely low and high respectively, it can be seen that perf offers very low volatility in early bull and flat markets; the same being true of pcfr and both dye and dy f in late bull markets. the opposite i.e .• very high volatility is associated with perc, perf, pbrc, pbrrand pcfrc in declining markets. conclusion and recommendations since the study indicates that style effectiveness has a significant cyclical component, it follows that a sound rotational strategy would reward investment managers. during a declining market they would be advised to use a high dividend yield (dye) strategy. although this strategy is marginally riskier than a high dyf strategy, it has outperformed all other styles with regard to relative returns (50 per cent for qi over the benchmark and 18 per cent over qs in us$ terms) on a cumulative basis. however, managers should note that returns in absolute terms for this style (and every other style in the basket) are negative during declining markets. pbrc also stands out on a relative-performance basis in a bear market because it has a considerably less negative qi return than the other styles. while it is inferior to dye, it still outperformed the rest of the field. in a bear market, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no i 105 investor concerns centre on company survivability, and attention shifts from the income statement (earnings and cash flows) to the balance sheet (equity). pbrr works well in particular because, by incorporating forward earnings, it takes into account future dilution of equity (and potential need for recapitalization). finally, dyr is almost as good as pbrr; superior (qi-qs) returns and a lower standard deviation ofqi returns nearly make up for the edge that pbrr has with respect to (q,-benchmark) returns. when evidence of a market turnaround arrives and a bull market gets underway, it is time to switch to a growth-oriented strategy. eps growth and total assets growth are the best bets in the early stages of a rising market. while the latter approach has a marginally higher effectiveness score, the former is less volatile. high eps growth stocks (qi) have returned 105 per cent relative to the benchmark and 391 per cent relative to low eps growth stocks (qs) in the past on a cumulative basis. pcfrr appears to deliver an outstanding performance in the later stages of a bull market. per, is a close second. both these findings are statistically significant at the 95 per cent confidence level. in the period of the study categorized as a late bull market, low pcfrr stocks (q,) gave returns of 76 per cent over the benchmark and 382 per cent over qs. also, a pcfr strategy comes with the bonus of extra low volatility; the standard deviation of returns was the lowest for this style. in a trendless market, both per, and pbrr appear to work satisfactorily. in the study, the former gave higher returns (55 per cent over the benchmark and 82 per cent over qs) than the latter (49 per cent over the benchmark and 72 per cent over qs), but the latter was less volatile. implications for further research the hypothesis advanced in this particular study was that "style action is cyclical in nature". the previous sections have presented evidence that the effectiveness of the various styles and classes do vary depending on the overall direction of the market. the hypothesis could therefore not be rejected. however, many valuable observations relating to the relative action of the particular styles have been uncovered. individual analysis of each of these, r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 106 sajems ns vol 5 (2002) no i while beyond the mandate of this study, seems a necessary and fertile area for ongoing research. endnotes one should not bet against the market portfolio without a strong conviction that the collective thinking of millions of investors is wrong 2 defined as market capitalization plus latest available net debt. 3 this is congruent with the views expressed by solnik (1988), kaplanis & schaefer (1988) and eun & resnick (1989) who showed that the standard deviation for the us equity market was in fact less than that of other market indices when the deviation of returns was calculated in the local currency. when the effect of exchange risk was taken into account, the higher risk of foreign markets became even more pronounced. 4 bawnan & miller (1994), fama & french (1992b), friend & blume (1970), klemkosky (1973) and roll (1978, 1980, 1981) all discuss these deficiencies. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 107 appendix a significance tests for mvte scores market phase style early bud late bud flat bear epsgrowth 72* 43 25 38 total assets growth rate 75* 21 14 0 sustainable growth rate 43 52 23 20 np reinvestment rate 38 42 9 25 63* 86* 84* 36 35 45 75* 28 pcfrc 0 53 46 3 dyc 27 23 51 76* ev/sales 31 33 24 0 perf 27 68* 21 pbrf 46 =t=f 80* 60* pcfrf 72* 50 30 dyf 33 68* 58* mean score 43 51 45 30 std. dev. 22 22 26 24 . . note: * mdlcates perfonnance that is statistically significant at a 95 per cent level of confidence. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 108 sajems ns vol 5 (2002) no i references arnott, r.d. & copeland, w.a. 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(1981) "perfonnance evaluation and benchmark errors (ii)", journal of portfolio management, 7(2): 17-22. 25 rosenberg, b., reid, k. & lanstein, r. (1985) ''persuasive evidence of market inefficiency", journal of finance, 11 (3): 9-17. 26 rosenberg, c.n. jr. (1995) "growth stock investing today" in squires, j.r. (ed.) value and growth styles in equity investing, icfa continuing education series, charlottesville, v a: association for investment management & research. 27 sanders, la. (1995) ''the advantage to value investing" in squires, lr. (ed.) value and growth styles in equity investing, icfa continuing education series, charlottesville, va: association for investment management & research. 28 sharpe, w. (1992) "asset allocation: management style and perfonnance measurement" journal of portfolio management, 18(4): 725. 29 solnik, b. (1988) international investments, reading, mass: addisonwesley. 30 trittin, dj. (1994) "value tiltswhy the free lunch and the active management enigma?" unpublished research report, new york: frank russell company. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 110 sajems ns vol 5 (2002) no 1 31 umstead, d. (1988) "weighing the options: market-weight open to one-country domination" pensions and investment age, 13(5): 13-29. 32 westervelt, b.d. & schwab, t.j. (1995) "basic issues and key elements for equity style management" in klein, r.a. & ledennan, j. (eds.) equity style management: evaluating and selecting investment styles, burr ridge, il: irwin professional publishing. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . abstract introduction literature review research methodology results discussion, conclusions and recommendations contributions and limitations of the study future research acknowledgements references appendix 1 about the author(s) altouise g. jonas department of marketing management, nelson mandela university, port elizabeth, south africa laetitia radder department of marketing management, nelson mandela university, port elizabeth, south africa marlé van eyk department of marketing management, nelson mandela university, port elizabeth, south africa citation jonas, a.g., radder, l. & van eyk, m., 2020, ‘the influence of cognitive dimensions on memorable experiences within a marine tourism context’, south african journal of economic and management sciences 23(1), a3579. https://doi.org/10.4102/sajems.v23i1.3579 original research the influence of cognitive dimensions on memorable experiences within a marine tourism context altouise g. jonas, laetitia radder, marlé van eyk received: 21 feb. 2020; accepted: 27 july 2020; published: 27 oct. 2020 copyright: © 2020. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: consumers are increasingly demanding memorable experiences, thereby placing pressure on businesses to meet these demands. the provision of memorable experiences is particularly important to the tourism industry as its core business is to provide experiences. to stage these experiences, businesses must know which dimensions to include. for this purpose, cognitive dimensions present a reasonable starting point. aim: the current research aimed to explain and examine the cognitive dimensions that have an influence on the memorability of three marine tourism experiences, namely whale-watching, shark-cage diving and visits to marine protected areas. marine tourism is one of the most popular forms of tourism worldwide, but also a desperately under-studied field, particularly in south africa. the results of the research will assist providers and marketers of these activities in satisfying the experience needs of marine tourists by focusing their offerings on those dimensions that will enhance the memorability of the experience. the results will also help fill the gap in knowledge of the cognitive dimensions impacting the memorability of marine tourism experiences. setting: the study was conducted in south africa. methods: data were collected from 444 respondents using an exploratory design, mixed method approach and survey methods. data were analysed through frequency distributions, pearson’s product-moment correlations and multivariate analysis of variance. results: knowledge, meaningfulness, novelty and social interaction positively influence the memorability of marine tourism experiences in south africa. conclusion: the results indicate that positive interrelationships exist among all the dimensions, suggesting that these dimensions all represent the cognitive domain. furthermore, the results also indicate that all four dimensions have a positive influence on memorable marine tourism experiences. these findings are important for the enhancement of memorable marine tourism experiences. an understanding of the identified cognitive dimensions in a marine tourism experience will lead to a more memorable experience for consumers and can result in post-purchase behaviour such as a repeat purchase, loyalty and positive word-of-mouth recommendations resulting in increased profitability for the business. keywords: cognitive; memorable experience; marine tourism; memorable marine tourism experience; marketing. introduction economies worldwide are moving from being service-based to being experience-driven (cornelisse 2018; pine & gilmore 1998). not only is the demand for memorable experiences (mes) increasing (antón, camaréro & laguna-garcía 2017), but experiences are also replacing commoditised products and services as forms of competitive advantage (cetin & bilgihan 2016) and as organisational differentiators (radder, van eyk & koekemoer 2019). memorable experiences have become an important source of information for making repurchase decisions (mahdzar 2018) or providing word-of-mouth recommendations (marschall 2012). satisfactory experiences thus lead to a repeat purchase and loyalty (rather 2018) and ultimately increased profitability (hsieh, chiu & chang 2018). experiences transpire when consumers receive a unique and memorable service, particularly resulting from co-creation between the organisation and the customer (rather 2018). however, experiences are intangible and ever-fleeting (ketchen 2018), and this highlights the importance of their memorability. memorability is improved if the experience is special (triantafillidou & siomkos 2014), positive and easily recalled (stangor & walinga 2014). experiences become memorable when they result in individual outcomes such as personal growth or renewal, mental, spiritual and physiological benefits (jefferies & lepp 2012), or provide customer value, which in turn results in specific feelings and emotions on the part of the customer (radder et al. 2019). the provision of mes is particularly important in the tourism industry as its core business is experience-based (bastiaansen et al. 2019). from a business perspective, mes are valuable in ensuring competitiveness (coudounaris & sthapit 2017), in sustainable development of tourist destinations (chen, cheng & kim 2020) and for retaining and growing tourist markets (mgxekwa, scholtz & saayman 2017). from a tourist perspective, the positive emotions (chen et al. 2020) and memories retained after participating in a tourism experience are some of the most valuable keepsakes, except perhaps for a few souvenirs and photographs (braun-latour, grinley & loftus 2006). problem statement given the importance of staging mes, particularly in a tourism context, a logical next step is explaining and examining those dimensions that influence memorable tourism experiences (mtes). recent research that sought to identify the dimensions impacting mtes dealt with airbnb experiences (sthapit & jiménez-barreto 2018), food, drink and culinary experiences (stone et al. 2017), cultural experiences (seyfi, hall & rasoolimanesh 2020) and hotel experiences (sthapit 2017). during the search for studies on the dimensions of mtes, the dearth of research into the dimensions of memorable marine tourism experiences (mmtes), particularly whale-watching, shark-diving and visits to marine protected areas (mpas), soon became evident. this is surprising given the worldwide popularity (brumbaugh 2017) of marine tourism. in fact, marine tourism ranks among the top-10 tourism activities in south africa (website of south african tourism 2018). furthermore, instead of experience dimensions, research into marine tourism experiences focuses mostly on tourists’ motivation for participation, learning (stephen & wantanee 2016), changes in tourists’ environmental behaviour (ballantyne, packer & falk 2011), profiling marine tourists (buultjens et al. 2018) and challenges and opportunities (dwyer 2017) presented by this tourism type. in the absence of past research into the dimensions impacting marine tourism experiences associated with whale-watching, shark-cage diving and visits to mpas, related research into the dimensions impacting other tourism experiences might be helpful. in research conducted by barbieri, henderson and santos (2014:277) for example ‘three themes regarding what constitutes a memorable surfing trip emerged: living surfing, having indelible experiences and discovering an-other’. hurombo et al. (2014) explored the antecedents of a memorable boating experience and identified eight elements: unique local food, cultural dance and entertainment, social interaction, scenery, encountering wild animals, professionalism of crew members, group involvement and refreshment. wilson (2019) highlighted four components of memorable scuba diving experiences: demand side needs, supply side offerings, me factors and control. against the gap in knowledge caused by the limited research into mtes, the current study aimed to explain and examine those dimensions that have an influence on mmtes, with particular relevance to whale-watching, shark-cage diving and visits to mpas. these experiences all fall within the classification of leisure marine tourism. a reasonable starting point for understanding the dimensions of a me is the cognitive domain. cognition refers to the mental processes that individuals use in evaluating information obtained from perception, knowledge acquired and subjective characteristics (bustamante & rubio 2017) and preceding affective (emotional) processes (savolainen 2015). the tourist experience is formed within the individual tourist’s mind through a cognitive process, which in turn results in the affective state of the experience. the latter corresponds to the individual’s initial expectation and on-site encounter, in which the expectation itself is subjected to personal motivation and state of mind. this complexity of experience formation results from its psychological nature (mohd et al. 2019). kim (2009) holds that the subjective nature of tourism experiences makes it vital to identify the components that have an influence on experience memorability. it is significant that skavronskaya, moyle and scott (2020) highlight that the application of the cognitive psychology theory to tourism experiences is an emerging area of research that can enhance the understanding of the tourism phenomenon, and specifically the mental processes that underlie mes. their comment provides support for examining the dimensions that influence the memorability of marine tourism experiences from a cognitive perspective. the current research explains and examines the cognitive dimensions that have an influence on the memorability of three marine tourism experiences, namely whale-watching, shark-cage diving and visits to mpas. the results will assist providers of these activities in satisfying the experience needs of marine tourists by focusing their offerings on those dimensions that will enhance the memorability of the experience. the results will also help fill the gap in knowledge on cognitive dimensions impacting the memorability of experiences in general, and thus heed the repeated call from researchers (e.g. chandralal & valenzuela 2015; kim et al. 2012; sthapit & coudounaris 2018) for further research into the dimensions of mes in different contexts. the remainder of this article is structured as follows: first, a brief description of marine tourism in south africa, mtes and the cognitive domain is given. thereafter the research methodology is explained and the results are reported. this is followed by a discussion, conclusions and recommendations. thereafter, the contribution and limitations of the study and suggestions for future research are presented. literature review the literature review consists of a brief explanation of marine tourism in south africa, mtes and the cognitive domain and related dimensions. marine tourism in south africa south africa is ideally located for marine tourism activities because of its extensive coastline of more than 3000 km and its rich and complex seascape attributed to being surrounded by three oceans (sa navy 2006). since marine tourism affords south africa substantial development opportunities (bob et al. 2018), the goal of the coastal and marine tourism implementation plan is that, by 2030, south africa will be known as the premier experience-based marine tourism destination in africa, and as a world class marine tourism destination offering visitors a unique range of experiences (department of tourism republic of south africa 2017). recent data related to the economic impact of marine tourism on the south african tourism industry is limited (bob et al. 2018). however, available data indicates that the sector made a direct contribution of r11.9 billion to the country’s gross domestic product (department of tourism republic of south africa 2017) in 2015. this contribution was expected to increase to r21.4 billion in 2020 (department of tourism republic of south africa 2017) and to r177 billion in 2033 (xasa 2017). furthermore, marine tourism in south africa was expected to create between 800 000 and 1 million jobs by 2033 (xasa 2017). these expectations might, however, have to be significantly adjusted given the impact of the covid-19 pandemic on the industry. to make the study manageable, it focuses on three activities in the leisure category of marine tourism. whale-watching, arguably south africa’s best-known marine tourism activity (saayman 2014), was initially shore-based only (o’connor et al. 2009) until boat-based whale-watching operations commenced in 1998 (o’connor et al. 2009). the second activity, shark-cage diving, a relatively new, but rapidly growing activity, allows tourists’ interaction with sharks (vianna et al. 2011). the third activity covers visits to mpas, which are broadly defined as areas ‘of sea/and or coastline … especially dedicated to the protection and maintenance of biodiversity and natural and cultural resources through being managed in a structured and legal manner’ (world wildlife fund for nature 2014:13). there are currently 24 mpas located throughout south africa (world wildlife fund for nature 2014). memorable tourism experiences kim et al. (2012:13) explain that a mte is ‘a tourism experience positively remembered and recalled after the event has occurred’. kruger and saayman (2014) explain that such an experience is remembered and treasured for a considerable length of time after the event has occurred, and often has mental, spiritual and physiological outcomes. memorable tourism experiences are important for three reasons (kim et al. 2012). firstly, consumers have greater motivation to purchase (or engage in an experience) when positive information is retrieved from their past experiences. secondly, consumers place more value and rely more heavily on past experiences as a source of information. lastly, past experiences have a significant influence on future behavioural intentions. according to de freitas coelho, de sevilha gosling and de almeida (2018), research on mtes can be divided into three categories: the expansive perspective, the managerial or economic perspective and the modelling perspective. however, we argue that such research can also be classified as core studies, behavioural studies, experience theory studies and dimension studies. core studies seem to be exploratory in nature, follow a qualitative approach, and attempt to enhance the understanding and explanation of the mte phenomenon, thus helping in building theory. tung and ritchie (2011), for example, conducted in-depth interviews with participants to understand what makes certain experiences memorable, which cognitive processes distract individuals from paying attention to their experiences, and what the conceptual processes of memory formation and retention are. they identified the key dimensions of mes as affect, expectation, consequentiality and recollection. seyfi et al. (2020) aimed at advancing the understanding of mtes and identified six key factors affecting cultural tourist experiences in a specific destination, namely prior perceived experience, significance of the experience, authenticity, engagement, cultural exchange, culinary attraction and quality of service. behavioural studies evaluate different types of outcomes or behavioural intentions associated with mes. for example, lončarić, dlačić and prodan (2018) examined the influence of memorable summer vacation experiences on overall customer satisfaction, sthapit and coudounaris (2018) investigated the relationship between mte dimensions and subjective well-being, and yu, chang and ramonpong (2019) assessed the effect of mte on word-of-mouth and revisit intentions. experience theory studies are built on the four realms of an experience (‘esthetics’, education, escapism and entertainment) proposed by pine and gilmore (1998). kastenholz et al. (2017) examined the influence that the four experience realms have on memorability and the relationships between experience, arousal, memory and satisfaction. escapism and esthetics had the most profound influence on memorability. lai, lu and liu (2019) explored the effects of the four realms on tourists’ intentions to spread word-of-mouth recommendations, based on satisfaction and memory. esthetics, education and entertainment influence satisfaction, while all four realms influence memory and satisfaction. memory ultimately influences word-of-mouth recommendations. experience theory studies appear to be advancing and merging with the fourth types of mte studies that we term dimension studies. dimension studies seek to identify the dimensions that make an experience memorable. dimension studies are important as they highlight the cause of me and therefore can assist practitioners with the design and staging of their experiences. kim et al. (2012) identified seven dimensions of mtes: hedonism, involvement, knowledge, meaningfulness, refreshment, novelty and social interaction, while mahdzar, zaidi and shuib (2016) proposed eight dimensions, namely: perceptions with respect to novelty, social interaction and cultural knowledge, involvement, unexpected happenings, negative experiences, meaningfulness and stimulation. the current study is positioned as a dimension study. since the cognitive domain was chosen as the point of departure in the investigation of the dimensions that impact the memorability of the three marine tourism experiences, the next section provides a review of relevant earlier research on the cognitive domain. cognitive domain the cognitive domain, a component of the customer experience (gentile, spiller & noci 2007) relates to the individual’s belief or knowledge about an object (mcleod 2014) or, by implication, an experience. therefore, the cognitive domain relates to thinking or conscious mental processes (gentile et al. 2007). cognitive evaluations assist in enhancing the recollection of memory since individuals use high levels of cognitive processes in their retrieval processes (kim et al. 2012). chandralal and valenzuela (2013) identified eight cognitive dimensions that influence the memorability of an experience, namely: perceptions of meaningfulness, opportunity to encounter authentic local experiences, significance of the experience, novelty, opportunity for social interactions, serendipity and surprises, local hospitality and professionalism of local guides as dimensions. chen et al. (2020) proposed three cognitive dimensions of mtes, namely: meaningfulness, novelty and social interaction, while kim (2009) highlighted meaningfulness, knowledge, challenge, assessment of service and value, personal relevance and novelty as dimensions impacting the experience memorability. according to jonas (2018) meaningfulness, novelty, knowledge and social interaction impact overall marine tourism experiences, while zhang, wu and buhalis (2018) found that the cognitive dimensions of novelty, knowledge and meaningfulness affect the formation of mtes. four cognitive dimensions were selected for the current study, namely knowledge, meaningfulness, novelty and social interaction. these dimensions were derived from me research by chandralal and valenzuela (2013), chen et al. (2020), jonas (2018) kim et al. (2012), and zhang et al. (2018). jonas (2018) and kim et al. (2012) identified all four dimensions, while the other researchers identified three out of the four dimensions. the four selected dimensions are discussed in the section that follows. knowledge knowledge, an educational outcome of experiences, refers to the acquisition of new information, skills and insights (lončarić et al. 2018). throughout the years, travel has always been considered an educational activity (stone & petrick 2013) as it helps to broaden the minds of travellers (latorre 2011; stone & petrick 2013), through the discovery of new knowledge and emotions and the acquisition of new skills and techniques (cutler 2015). this is also evident in marine tourism, where knowledge acquisition is a key motivator for tourist engagement in various marine tourism activities (geldenhuys, van der merwe & saayman 2019). education is a primary goal of tourism experiences (cetin & bilgihan 2016) as increasingly governments, industry bodies and tourists are demanding visitor experiences that enhance the traveller’s knowledge (ballantyne, packer & sutherland 2011). as a result, coudounaris and sthapit (2017) and zhang et al. (2018) believe that new knowledge should be a fundamental component of a mte. the first hypothesis of the current research consequently states that: h1: there is a positive relationship between knowledge and mmtes. meaningfulness meaningfulness ‘indicates [tourists’] engagement in personally significant activities’ (chandralal & valenzuela 2015:293). for certain individuals, a tourism experience moves beyond observing new sights, meeting new people or visiting new places, to an ‘inner journey of personal growth and self-development’ (kim 2014:37). this inner journey is frequently referred to as a search for meaningfulness and reflects travellers seeking a sense of physical, emotional or spiritual fulfilment by participating in a tourist activity (wei et al. 2019). meaningful tourism experiences are more memorable (gao et al. 2012) and meaningfulness was found to be one of the dimensions most vividly remembered by respondents in a study by chandralal and valenzuela (2013). recalled experiences were highly relevant and personally beneficial to the individual as they helped improve self-confidence or changed their perception of life and the world. sthapit and coudounaris (2018) also found that an experience was memorable if it was meaningful or important and the tourist learnt something new about themselves while vacationing. the second hypothesis of the current study consequently states that: h2: there is a positive relationship between meaningfulness and mmtes. novelty the third dimension of an mmte is novelty. novelty refers to experiencing something new or unique (mahdzar 2018). in the tourism context, novelty-seeking is associated with the desire to enjoy a unique, first-time experience (albaity & melhem 2017). novelty has become an important motivator for individual travel (kim 2014), as is evident in the increasing number of tourists who seek novel experiences (chandralal & valenzuela 2013). novel experiences have also been found to be more memorable than repeat experiences (skavronskaya et al. 2020). according to curtin (2010), participants in whale-watching and bird-watching tours often referred to first-time sightings as being memorable because of the novelty of the experience. barbieri et al. (2014) agree that novel experiences are hard to forget and hurombo et al. (2014) found that respondents’ most vivid memories about food were the novelty of the food. the third hypothesis of the current study consequently states that: h3: there is a positive relationship between novelty and mmtes. social interaction social interaction, the fourth dimension, refers to individuals participating in an experience together with others (gentile et al. 2007). in many instances the presence of fellow tourists, as part of a tourist experience, is unavoidable (huang & hsu 2010). this presence inevitably leads to some interaction among individuals and forms an indispensable part of the consumption experience (huang & hsu 2010) and hence of mtes (wei et al. 2019). chandralal & valenzuela (2015) confirmed that travel experiences where new relations were built or existing bonds with friends and family were strengthened are more memorable than experiences enjoyed alone. the fourth hypothesis of this study consequently states that: h4: there is a positive relationship between social interaction and mmtes. figure 1 shows the hypothesised model for the current study based on the foregoing literature review. figure 1: hypothesised model. research methodology design, target population and sample the research reported here formed part of a more extensive study into marine tourism in south africa. an exploratory research design was applied as it enabled the researcher to gain better insights into the problem (sahu & singh 2016) and assisted in developing new hypotheses and a theoretical underpinning for the study (akhtar 2016). a mixed method research approach was followed as the study included elements of qualitative and quantitative methods. specifically, an exploratory sequential mixed method design was employed, starting with the qualitative phase followed by the quantitative phase (cresswell & cresswell 2017). the exploratory sequential mixed method design thus assisted the researchers in identifying important dimensions related to mmtes (phase 1) for subsequent quantitative analysis (phase 2) (edmonds & kennedy 2016). the target population comprised domestic and international respondents aged 19 years and older who had participated in at least one of three identified marine tourism activities in south africa. non-probability sampling was used to identify possible respondents since no comprehensive list of the target population was available. an online panel company, recruited based on their extensive database, sent an email inviting participation in the study to 11 764 individuals on their database who met the inclusion criteria. interested respondents received the self-administered questionnaire, chosen for its convenience and speed of completion (brace 2013). the survey was open for 4 weeks and yielded 83 usable responses. during the same time and extending for 4 more weeks thereafter, questionnaires were also emailed and physically distributed by the researcher and trained fieldworkers to respondents who met the criteria. this form of convenience and snowball sampling resulted in a further 361 usable questionnaires, resulting in 444 questionnaires being subjected to statistical analysis. measuring instrument a self-administered questionnaire comprising closed-ended dichotomous and multiple choice questions served as the measuring instrument. a survey instrument was developed with the aid of interviews conducted with experts in the field of tourism experiences and information obtained from past research. the survey questionnaire was administered to a sample of the population (cresswell & plano clark 2018). the items used to measure the dimensions for the current study were self-generated and, where necessary, adapted from existing measuring scales (chandralal & valenzuela 2013; kim 2009; triantafillidou & petala 2016). four items were used to measure each dimension and five items were used to measure me. appendix 1 (table 1-a1) lists these items. data analysis the statistical package statistica was used for the data analysis which included sample demographic profiling, calculations of pearson’s product-moment correlations, multivariate analysis of variance (manova) and scheffé post-hoc testing. it was important to establish a profile of the marine tourists participating in the three activities as marine tourism businesses have to know whether the characteristics of participants in these activities differ significantly. such knowledge can help businesses improve their planning and management of activities (munien et al. 2019), aid the development and implementation of more effective marketing activities (devault 2020; geldenhuys et al. 2019) and help direct these activities to a specific segment, ultimately resulting in more success and increased profits (devault 2020). furthermore, an understanding of different profiles can assist businesses in creating appropriate marketing strategies that will appeal to their customers and attract more business. ethical consideration the data collection process was preceded by obtaining ethical clearance from the institution where the study was registered. furthermore, participation in the research was voluntary and anonymous, and respondents could withdraw from participation in the research at any stage of the study. results the results section commences with a summary of the sample’s demographic profile, followed by a cross-tabulation of this profile and the three marine tourism activities. the section continues with the descriptive results, the results of pearson product-moment correlations, the outcome of manova and the scheffé post-hoc analysis. sample’s demographic profile a total of 444 tourists completed the questionnaire, of whom 51.8% were female and 48.2% were male. the largest age group of respondents (42%) were between the ages of 30 and 50 years (mature adults), while slightly fewer respondents (41%) were between 19 and 29 years old (young adults) and 17% of respondents were 51 years or older (seniors). the majority of respondents (77%) had a tertiary qualification. the largest group of respondents (81.1%) spent their childhood in africa, 80.9% are currently residing in africa and 80% were south africans. table 1 shows the results of the cross-tabulation constructed to compare the participation in the three activities in terms of the demographic variables. the largest group of respondents (46.7%) visited mpas while participation in whale-watching accounted for 27.9% and shark-diving for 25.4% of the respondents. shark-diving attracted slightly more male respondents (51.3%), while visits to mpas attracted more female (54.6%) respondents. table 1: cross-tabulation of sample’s demographic profiles among activities. descriptive statistics related to the four dimensions table 2 shows the descriptive results of the study. all the dimensions attracted mean scores above 4.00, indicating that the respondents had a fairly positive perception of the marine tourism experience in which they participated. meaningfulness attracted the highest mean score (m = 4.74, sd = 1.58) on the seven-point scale, while social interaction recorded the lowest score (m = 4.08 sd = 1.54). novelty was the second-place dimension, followed by knowledge. the mean scores ranged from 4.30 to 4.57. the standard deviations ranged from 1.45 to 1.59. table 2: descriptive statistics for the cognitive dimensions of a memorable marine tourism experience. pearson’s product-moment correlation coefficients determine how well the variables are related (statistics how to 2019). the coefficients for the current study are shown in table 3. all the correlations are positive, indicating moderate (0.300 to 0.499) to strong positive relationships (0.500 to 1.000) (kornbrot 2005), thus suggesting that these dimensions all represent the cognitive domain. table 3: correlations between variables – all activities. a manova was used to determine whether significant differences exist in respondents’ perceptions, based on selected profile variables (gender, age, level of education, nationality and activity). the manova results are displayed in tables 4–7. the results for all the activities combined are shown first, followed by the results for each activity. table 4: differences in perceptions of cognitive dimensions based on demographics. table 5: differences in perceptions of cognitive dimensions based on demographics: shark-diving. table 6: differences in perceptions of cognitive dimensions based on demographics: marine protected areas. table 7: differences in perceptions of cognitive dimensions based on profile variables: whale-watching. table 4 shows that there were no statistical differences between respondents’ social interaction and the profile characteristics. a statistically significant difference exists between respondents’ perception of meaningfulness based on gender and the activity in which they participated. statistically significant differences were also shown between respondents’ perception of knowledge based on the activity in which they participated. finally, there is a statistically significant difference between respondents’ perception of novelty based on the activity in which they participated. table 5 presents the manova results for shark-diving. statistically significant differences were identified between respondents’ perception of knowledge obtained during a shark-diving experience based on age. table 6 illustrates differences in respondents’ perceptions, based on gender, age, level of education and nationality, for visits to mpas. there were statistically significant differences between the respondents’ perception of social interaction that they experienced at mpas based on nationality. statistically significant differences were also identified between the respondents’ perception of meaningfulness based on gender and level of education. further, statistically significant differences were observed between the respondents’ perception of knowledge acquired during their experience at mpas, based on level of education. table 7 shows the manova results for whale-watching. there were statistically significant differences between the respondents’ perception of social interaction experienced during a whale-watching experience, based on gender and level of education. further, statistically significant differences are shown between the respondents’ perception of knowledge acquired during a whale-watching experience, based on level of education. the manova also points out statistically significant differences between the respondents’ perception of novelty experienced during a whale-watching experience, based on age and level of education. the manova identifies whether there are significant differences between the mean scores, but it does not indicate where specific differences lie (pallant 2013:259). therefore, a post-hoc scheffé test was performed to determine where the differences occur and to investigate the effect size of the difference. the results of the scheffé tests are presented in table 8 and table 9. table 8: scheffé post-hoc analysis: all activities combined. table 9: scheffé post-hoc analysis: individual activities. table 8 shows that significant differences were found in three dimensions. firstly, in meaningfulness, significant differences in perceptions were uncovered between male and female respondents (p = 0.019). female respondents (m = 4.90) found the experience to be more meaningful than male respondents (m = 4.57). cohen’s d (0.21) indicates a small effect size. significant differences were also identified in perceptions of meaningfulness among respondents who participated in shark-diving experiences and respondents who participated in whale-watching experiences (p = 0.029). shark-diving experiences (m = 5.03) were perceived to be more meaningful than whale-watching experiences (m = 4.48). cohen’s d (0.34) indicates a small effect size. secondly, regarding knowledge, significant differences exist in perceptions among respondents who participated in shark-diving experiences and respondents who participated in whale-watching experiences (p = 0.006). shark-diving experiences (m = 4.65) equipped respondents with more knowledge than whale-watching experiences (m = 4.04). although the difference was significant, the cohen’s d (0.43) shows the effect size was small. lastly, with novelty, significant differences are present in perceptions of novelty among respondents who participated in shark-diving experiences and respondents who visited mpas (p = 0.000). this suggests that shark-diving experiences (m = 5.41) were perceived to be more novel than visits to mpas (m = 4.30). cohen’s d (0.79) shows a moderate effect size. it also emerged that significant differences exist in perceptions of novelty among respondents who participated in shark-diving experiences and respondents who participated in whale-watching experiences (p = 0.000). shark-diving experiences (m = 5.41) were found to be more novel than whale-watching experiences (m = 4.25). cohen’s d (0.80) indicates a large effect size. table 9 summarises the results of the scheffé tests for all the factors concerning shark-diving, mpas and whale-watching. the results will be discussed per activity. shark-diving although differences exist among the different age groups regarding the knowledge acquired during a shark-diving experience, these differences were not significant. marine protected areas as indicated in table 9, statistically significant differences exist between south africans and foreign nationals (p = 0.011) regarding social interaction during visits to mpas. the mean score for foreign nationals (m = 5.14) was relatively high compared to the mean score for south african nationals (m = 3.98). cohen’s d (0.79) shows a moderate effect size, implying that a difference of moderate practical significance exists. significant statistical differences were also found between male and female respondents (p = 0.031) regarding the meaningfulness of their visit to mpas. cohen’s d (0.28) indicates a small effect size. the data also indicates that significant differences exist between respondents who had a tertiary qualification and those without (0.003) concerning the meaningfulness of their visit to mpas. cohen’s d (0.52) suggests a moderate effect size. whale-watching statistically significant differences between male and female respondents (p = 0.025) were observed for social interaction; however, the effect size was small (0.33). statistically significant differences were also uncovered between respondents who had a tertiary qualification and those without a tertiary qualification (p = 0.044). cohen’s d (0.54) indicates a moderate effect size. the results also showed statistically significant differences in perceptions of knowledge between respondents with a tertiary qualification and those without a tertiary qualification (p = 0.012). the effect size is moderate (0.73). statistically significant differences were observed for novelty between the scores for respondents aged 19–29 years and 51 years and older (p = 0.001) and for respondents aged 30–50 years and 51 years and older (p = 0.020). cohen’s d shows a large effect size (0.97) for the age group 19–29 years and 51 years and older. the remaining two cases in which statistically significant differences were found showed a moderate effect size. the data also reveal statistically significant differences between respondents with a tertiary qualification and those without a tertiary qualification. discussion, conclusions and recommendations an integrated approach is followed to present the discussion, conclusions and recommendations to better structure this section dealing with the demographic profile and the four cognitive dimensions. the provision of mes is extremely important for tourism businesses, and to stage these experiences, businesses must understand which dimensions contribute to a me. this study aimed to explain and examine the dimensions that can assist businesses, specifically marine tourism businesses such as shark-cage diving, whale-watching operators and mpas, in providing a me. the findings highlighted differences between the demographic profile of participants in these three activities. for example, more female respondents participated in the selected marine tourism activities and the majority of participants were young and mature adults who are well educated. this supports the findings of geldenhuys et al. (2019) that the largest portion of marine wildlife tourists are female and between the ages of 35 and 40 years with a tertiary qualification, but contradicts the findings of munien et al. (2019) who found that more men participate in marine tourism. the findings of the current research only partially support those of munien et al. (2019) who found marine tourists to be well educated and mainly middle-aged. it is, however, acknowledged that the sample composition of the different studies could have impacted the demographic profiles of the samples. impact of demographic profile on the dimensions perceptions of the four cognitive dimensions (meaningfulness, knowledge, novelty and social interaction) were found to differ based on the demographic profile. women appeared to find visits to mpas more meaningful than men did. this could be attributed to the fact that women are believed to be more reflective than men and take time to think about activities that they have participated in. furthermore, women tend to be more selective than men, mainly participating in activities that hold meaning or pique their interest. age groups differed in terms of novelty and me related to whale-watching. the young and mature adults found the experience to be more novel and memorable than the seniors did. stage of life could be an explanation for this finding. seniors have most likely had more novel and mes than their younger counterparts, therefore making it more difficult for businesses to stage mes for this age group. respondents with different levels of education differed in terms of meaningfulness, knowledge and me related to visits to mpas. respondents with different levels of education also differed in terms of knowledge, novelty, social interaction, meaningfulness and me related to whale-watching experiences. these differences can be ascribed to some individuals (those with tertiary education) being exposed to more information, knowledge and experiences than others. further differences were shown between south africans and foreigners who differed in terms of social interaction related to visits to mpas. south africans found the experience to be more socially interactive than foreign visitors. this could be due to language barriers among different participants, preventing them from interacting with participants who speak a different language, or south africans visiting mpas with family and friends. meaningfulness the findings of the study suggest that respondents were more positive about the meaningfulness of the experience than the other dimensions, demonstrating that marine tourism experiences are perceived to be meaningful. therefore, the meaningfulness of the experience was found to be an influential dimension for mmtes. this supports the findings of sthapit and coudounaris (2018), that meaningfulness significantly increases the memorability of an experience. based on the strong positive relationship that was found between meaningfulness and mmte (this is the case for all activities combined and each of the three activities individually), hypothesis h2 relating to meaningfulness and mmtes is supported. it is known that personally significant and beneficial experiences have a higher likelihood of being remembered, and that tourists’ interaction with marine wildlife in their natural space, or learning something new, contributes to the meaningfulness of the experience. tourism providers should therefore provide tourists with opportunities for learning, stimulate curiosity, or take customers out of their comfort zones. for example, marine tourism operators can establish volunteer programmes extending over a few days or several months, which will provide tourists with a more meaningful experience, should they become involved in these programmes. novelty an analysis of the relationships indicates a strong positive relationship exists between novelty and mmte (this is the case for all the activities combined and for the three activities individually), hypothesis h3 relating to novelty and mmtes is thus supported. the significant influence of novelty on the mmtes found in the current study supports past research findings (e.g. barbieri et al. 2014; kim 2014; skavronskaya et al. 2020) that emphasised the impact of first-time, distinct experiences on memorability. it is recommended that marine tourism businesses enhance the memorability of their experiences by tailoring customised packages to individual tourists’ needs, for example by providing themed tours, or they could also offer rare or infrequent experiences such as birthing turtle experiences in mpas. a novel idea for shark-diving companies and whale-watching operators is to offer simulator programmes for their customers. knowledge the current study indicated that tourists who acquired new knowledge during their experience found the experience to be memorable. the strong positive relationship that was found to exist between the dimensions (this is the case for all the activities combined, and for each of the three activities individually) points to the support of hypothesis h1 relating to knowledge and mmtes. marine tourism businesses can contribute to tourists’ knowledge levels by including educational programmes as part of their experience, setting up a visitor education centre that offers informal face-to-face or virtual talks before and after returning from participation in the experience, interactive material and demonstrations. conservation programmes or talks could be hosted by the different operators – this will assist in creating more awareness and the transfer of knowledge. prior to departure on guided tours the group can be divided into teams. these teams will meet to receive important pre-tour information and will meet again post-tour to share their experience with each other and compete in a small activity related to the tour against the other teams. this is a different method to ensure that customers are acquiring new knowledge. guides should also be well trained and knowledgeable to provide visitors with quality in-depth information through paper-based pamphlets, displays, audio presentations and visual presentations. social interaction the current study found that social interaction among respondents positively affects the respondents’ memories of the experience. this supports chandralal et al.’s (2015) suggestions that experiences where interaction occurs tend to be more memorable than experiences devoid of social exchange. a strong positive relationship exists between social interaction and mmte (this is the case for whale-watching) and a moderate positive relationship exists between social interaction and mmte (this is the case for all the activities combined, shark-diving and mpas). hypothesis h4 relating to social interaction and mmtes is thus supported. to enhance social interaction, whale-watching or shark-diving operators can allocate a space for their customers to interact before departure or while waiting for the information, educational and or dvd-viewing session after the tour, dividing the group into teams and holding quizzes before and after the tour or holding a ‘who spots the whale first’ competition. an online site can be created by the operators for the use of customers who have participated in an experience. customers can join this site to remain in contact with other participants whom they have met while on tour, or to upload images or videos of their experience. this will further assist in improving social interaction. marine tourism businesses (particularly those situated in regions popular for marine tourism activities such as gansbaai in south africa) can also host annual festivals or smaller events, serving as a tool to transfer knowledge and create opportunities for social interaction. contributions and limitations of the study the study makes the following contributions. firstly, this study contributes to the under-researched topic of marine tourism in south africa, particularly shark-cage diving, whale-watching and visits to mpas. secondly, the study contributes to describing the demographic profile of marine tourists participating in the three activities. thirdly, this research adds to the field of the cognitive domain by examining the influence of four dimensions (meaningfulness, novelty, knowledge and social interaction) on mmtes. fourthly, a further contribution of this study is to marine tourism businesses and marketers of these businesses who wish to enhance the memorability of the experience that they stage. the results of this study show which cognitive dimensions should be included to stage mmtes. this information can also be used as an assessment tool to evaluate business strengths and weaknesses and improve competitiveness. a limitation of the current research is the sample distribution. although the sample size was adequate, a more even distribution of respondents among the different activities and nationalities is desired. future research the following possibilities exist for future research opportunities. firstly, research into the dimensions with an influence on mmte could also be investigated in the affective or behavioural domain as this will provide a more comprehensive picture of the dimensions that influence mmtes. secondly, the study could also be repeated within different types of marine tourism activities or different experience contexts such as medical, health or religious tourism. it would be interesting and necessary (for experience staging purposes) to determine whether the same cognitive dimensions examined in the current study also apply to the other contexts. acknowledgements the authors would like to acknowledge the national research foundation for funding received, which enabled the performance of the statistical analysis, and the nelson mandela university for providing funding to complete the study. views and opinions expressed in this article are those of the authors and should not be attributed to the funding bodies. competing interests the authors have no competing interests that may have influenced the findings of this research. authors’ contributions a.j., l.r and m.v.e. worked together to complete the different sections of the article. ethical consideration nelson mandela metropolitan 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relationships with each other. results indicate significant differences between the two groups. senior management prefers the assertive styles (competing and collaborating) with scant attention to cooperation, while middle management primarily uses the avoiding style, which is both uncooperative and unassertive. the implications of these fmdings are discussed, leading to particular recommendations. jeljsq,mi2 introduction conflict appears to be an integral" component of human functioning it has manifested in diverse formats for millennia. the term could be classified according to a myriad of parameters and variables, and this creates difficulty in formulating an operational and exact defmition. robbins (1998) believes that certain common denominators underlie most defmitions, and that formal defmitions should strive for broad flexibility. he accordingly develops the following defmition: ..... a process that begins when one party perceives that another party has negatively affected, or is about to negatively affect, something that the first party cares about" (1998: 434). throughout histoty, particular perceptions/philosophies have developed regarding conflict the so-called traditional view, which was primarily based on attitudes that prevailed about group behaviour in the 1930s and i 94os, maintained a rigid, formalistic approach to conflict. conflict was regarded as r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 259 dysfunctional and had to be avoided at all costs by roleplayers. the more modern approach originated in the discourses and precepts of the human relations theorists, who stipulated that conflict is a natural phenomenon, that it is inevitable and that it should be managed as such (reyneke, 1997). the paradigms of these theorists bave become somewhat archaic it is now generally accepted that conflict should be measured in terms of functionality, i.e. whether it manifests as functional and contributes to personavorganisational growth, or whether it is dysfunctional and impedes group/individual performance (caudron, 2000; alper et al., 2000 and neuper, 1996). it remains a fair assumption that if an individual experiences conflict as destructive and dysfunctional, subsequent behaviour will be adjusted correspondingly, and that such behaviour will impact negatively on the individual's wider sphere of influence (womack, 1988). this assumption is supported by amongst others reyneke (1997) as well as song et al. (2000). under such conditions, within organisational context, non-achievement of stated goals and non-performance then becomes both a feasible and logical consequence. the traditional triad of individual, group and organisational goals and objectives remains constant and in an inviolate relationship. essentially, this means that dysfunctional conflict between individuals will impact negatively on organisational performance (zartman, 2000 and drolet et al., 2000). reyneke (l997) stipulates that organisations generally display an inability to manage conflict constructively such organisations would primarily be centred in the traditional mindset of conflict (see above). conflict within the framework of such organisations would in essence be regarded as a threat, and would impact on interpersonal relations and decision-making. these could have a significant impact on the manner in which the organisation functions. an assumption can be formulated that these two elements of organisational life, (relationships and decision-making styles), could theoretically be linked to productivity and performance. although direct statistical relationships in this context are difficult to detect, it remains a fairly safe assumption (neuper, 1996 and volkema et al., 1995). a complex array of variables determines the nature of these constructs (interpersonal relationships and decision-making styles). variables such as personality, power, reward base, attitudes and perception operate, and eventually determine behaviour. it is not the intention of this paper to attempt even a superficial approacb to understanding these variables. rather, the premise is that ineffective or dysfunctional relationships impact negatively on r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 260 sajems ns vol 5 (2002) no 1 decision-making and invariably results in impaired organisational performance (kets-de-vries, 1999). the conclusion that should therefore be formulated is that dysfunctional conflict should be regarded as a contra indication for maximal performance within organisational context. in a historical sense, certain types of organisations exhibit traditional hierarchical type behaviour. reporting lines, authority bases and the utilisation thereof, as well as definite bureaucratic systems remain at the innermost core of such organisations. in the postmodem economic climate of instinctual and rapid change, globalisation, emerging and rapidly discarded technology and such, organisations such as these become a danger to themselves. they are . archaic and run the risk of losing touch with the harsh reality of the business environment they operate in (alper et al., 2000). in this context, two such organisations were identified as exhibiting certain of these characteristics mentioned above. in south africa, the banking and financial sectors possess an extended history which displays a number of the behavioural elements mentioned above. the banking sector is highly regulated and appears to function in a traditional, somewhat mechanistic fashion. less than a decade ago, four major banks amalgamated into one central organisation, effecting the emergence of a major role player within the industry. although centralised control, domination of the industry, as well as the absence of a significant number of primary competitors would ensure organisational success, it can be stated that productivity and organisational performance could be enhanced further by the utilisation of sound interpersonal skills and decisionmaking techniques, as indicated by the referenced literature. in addition, as was alluded to earlier, conflict management styles are directly affected by interpersonal relationships and decision-making. research memodology measure to assess existing paradigms within this particular industry, an evaluative approach was designed as follow. data was collected through the standardised thomas kilmann conflict mode instrument, which is described as an untimed, self-scoring forced choice instrument designed to measure five distinct modes of conflict-management behaviour. subjects are requested to consider situations in which they may fmd their needs to oppose that of another party. in r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 261 each item the subject has to exercise a choice between two statements, reflecting a personal preference for a particular statement. an example of this is the following: a. "1 try to avoid creating unpleasantness for myself. ii b. _>. 1 try to win my position." subjects responded to each question by choosing either an a or b reaction which would characterise their dominant response in a particular situation in relation to their superior or subordinate. it was stressed that subjects should restrict their answers to the relationship between themselves and their superiors or subordinates. it is generally accepted that conflict management styles would differ per situation/person, but for the purpose of this study, subjects had to focus exclusively on this particular relationship. the questionnaire is widely regarded as the world's leading conflict resolution assessment tool (http://www.skillsone.com). it has been utilised extensively by a wide range of roleplayers, ranging from business consultants, psychologists, organisation development facilitators, through to church groups. an electronic search reveals 2390 sites dedicated to the use of the instrument. the instrument was designed to assess an individual's behaviour in conflict situations, and provides a profile of individuals and groups that illustrates the repertoire of conflict management skills. several construed benefits exist for groups and individuals: developing of an awareness with regard to preferred modes of conflict management developing of a realistic perspective concerning various sources of conflict and its impact on the organisation developing increased effectiveness in conflict management developing an awareness of the need for flexibility in different conflict situations (thomas, 1992). the five possible styles which are measured by the questionnaire are defmed in a matrix format, and determined by relative scores on two axes, i.e. assertiveness and cooperation. the competing style is assertive and uncooperative and could be regarded as utilising personal or positional power. accommodating is regarded as unassertive and cooperative, a style wherein the individual allows the other party to dominate. a voiding is both unassertive and uncooperative, and is nonnally characterised by the individual actively avoiding any type of action. collaborating is assertive and cooperative and represents direct attempts at conflict resolution. compromising is intermediate in both r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 262 sajems ns vol 5 (2002) no 1 assertiveness and cooperation, and is designed to partially satisfy the needs of both parties. the configuration of the styles is depicted in the figure below: figure 1 conflict mode instrument high competing collaborating assertiveness compromising low !avoiding accommodating cooperativeness high source: thomas, 1992 the primary intention of the instrument is to identify an individual's dominant style of conflict management. however, it is also of paramount importance for individuals or groups to acquire style flexibility or variation in responding to various situations. in this sense, different situations would require different modes of conflict resolution, for instance: competing' could be used when quick, decisive action is vital. accommodating could be utilised in order to preserve harmony and to avoid disruption • avoiding is relevant when an issue is trivial or only of passing importance collaboration is used in order to find integrative solutions when the concerns of both parties are too important to be compromised compromising is used in order to achieve temporary settlement of complex issues (thomas, 1992). style variability and flexibility therefore becomes an important outcome of exposure to the questionnaire. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no i 263 subjects subjects were drawn from staff members at two large national banks. the decision to include at least two distinct organisations was based on the premise that results could conceivably be skewed through prevailing organisational cultures. it is improbable that two independent organisations, though operating in the same industry, would both present with such a contaminating variable of this nature. subjects were randomly drawn from two specific organisational groupings, i.e. senior management and middle management. the sample was drawn from particular branches of the organisations, resulting in a fixed definition of the subject groups, in order to circumvent contaminating variables in the form of disparate organisational levels. all senior managers in the subject sample had the job title: branch manager; whereas middle management was classified as assistant branch managers. the nomenclature senior/middle management is used in this article and should be considered in branch context. the resultant sample therefore consisted of individuals from only two job gradings. the final sample comprised 50 subjects, evenly distributed between senior and middle managers, i.e. 25 subjects per sample group. the researcher took a decision not to effect any further control with regard to further variables which could impact on the results. the research design simply focussed on the inclusion of the two subject groupings, without controlling for biographical variables such as gender, age, length of tenure or other nuisance variables. for illustrative purposes only, nineteen (19) of the 25 senior managers were male, with a corresponding figure of 13 applying to the middle manager sample. the average length of tenure for the senior managers was 12.3 years, and 8.7 years for the middle managers. results data analysis a correlational analysis within and between groups was conducted, in order to determine: a) predominant styles within groups; and b) fundamental style differences between groups. a two factor analysis of variance with replication was utilised. the data displayed significant differences, all at the i per cent level of significance. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 264 sajems ns vol 5 (2002) no i for i1tustrative purposes, the average scores obtained by subjects are displayed in table i below: table i illustrates significant differences between the two groups. a cursory inspection indicates that the utilisation of styles if mutually exclusive. senior management subjects cluster around the assertive modes, i.e. competing and collaborating, while these styles enjoy a very low priority amongst middle managers. conversely, the latter group of subjects exhibit a preference for the unassertive modes, i.e. avoiding and accommodation, whereas senior managers rarely utilise these styles. the conclusion here is that senior managers are significantly more assertive in their interaction with their subordinates than vice versa. table 2 illustrates the differences within groups (middle management), and is based on a single factor analysis of variance: table 2 middle managers style variation source of sum of degrees of mean f p-value f-crlt variation squares freedom square between groups 646.27 4 161.57 39.19 i 5.87e-21 34795 within groups 494.72 120 4.12 total 1140.99 124 an analysis of the above indicates a strong degree of homogeneity between individual subjects, although variation is noticeable. however, specific and clear differences emerge between mode utilisation, and the p-value of 5.87e-21 indicates significant differences in terms of mode preferences. table 3 illustrates the differences within groups (senior management) and is based on a single factor analysis of variance: a similar pattern to that of middle managers emerged homogeneity between individual subjects, while the p-value of9.25e-25 stipulates clear differences in tenns of the utilisation of modes. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no i 265 table 3 senior managers style variation source of sum of degrees mean f p-value f..crit variation squares of square freedom between groups 876.24 4 219.06 50.19 9.25e-21 3.47951 within groups 523.76 120 4,36 total 1400 124 table 4 addresses the crucial issue of the comparative style utilisation of the two subject groups: table 4 senior vs. middle managers style utilisation soureeof sum of degrees mean f p-value f-crit variation squares of square freedom rows 52.889 24 2.204 0.534 0.96427 1.88967 columns 1031.04 8 128.88 31.241 5.09e-31 2.60505 defmitive differences between the two groups appear, as indicated by the pvalue of 5.09e-31. again, no fundamental variation exist within the groups, which leads to the conclusion that a fairly unifonn style of mode utilisation exists. it is clear however, that the two groups of subjects exhibit marked differences in mode preferences, a finding which is supported by a cursory examination of table i (simple averages). discussion the results which were obtained from the data sample strongly support initial expectations. i.e. that there would be significant differences in the modes of conflict resolution on different organisational levels within traditional organisations. it is apparent that the styles of conflict resolution relate to the existence of a strict organisational hierarchy, with very little deviation within both organisational groupings, i.e. senior and middle managers. in summative form: senior managers utilise high assertivenessllow cooperation styles, while middle managers (their subordinates within the parameters of the present study) manifest ditectly opposite styles, i.e. low assertivenesslhigh.cooperation. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 266 sajems ns vol 5 (2002) no i this scenario illustrates a system which appears to be distinctly archaic within the context of post modem business management. a distinctly autocratic management style appears to exist, with approval and/or covert condolence from both parties within the relationship. the culture which evolves from this type of relationship essentially portrays a downward cascading of orders or instructions and silent acquiescence from the more junior employees. within these relationships, there would be little opportunity for initiative, self direction and autonomy a situation which is in stark: contrast with the motivational factors as identified by herzberg decades earlier. the relationship which appears to emerge is one of dominance subservience, and in all probability enjoys tacit approval from role players. the rationale behind this statement relates to the extreme uniformity that emerged from the responses of the subjects, as was evidenced by tables 2 and 3. it is improbable that such extreme uniformity would materialise in a boundary free environment, due to the influence that personality and other variables would effect in such a milieu. instead, a more profound and distinct heterogeneity in conflict management styles would be at the order of the day. the extent and degree of the uniformity of responses would therefore indicate that another variable operates within this particular environment: a somewhat sinister variable which impacts very deeply not only on individual personalities, but also on organisational culture and climate. this variable (acquiescence to authority) creates a boundary driven organisation, and limits the behavioural scope of employees. the nature of the response set illustrates a further reality which deserves pertinent attention: if these particular behaviours manifest in such a defined manner as it did in this case, it serves to illustrate that there is a permanency attached to them. this reality points to the fact that behaviour, once acquired, seems to perpetuate itself in a predictive cyclical fashion, le. middle managers obey without question until they are promoted (which they probably will, due to the fact that they do not disturb the organisational serenity). at that stage, organisational culture, as well as a probable sense of entitlement, empowers them to adopt a more assertive/less cooperative behavioural style. a host of models/techniques exist which can be applied to human behaviour within organisational context taylor (200 i) provides interesting viewpoints on the amalgamation of thomas-kilmann and the four functions model of jung. in essence, jung postulates four different levels of perception or behaviour, namely thinking, sensing, intuition and feeling. taylor (2001) correlates these respectively with competing; compromising; avoiding, while accommodation and collaboration both manifests on the feeling level. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 267 within this framework, certain perspectives emerge: integrated human functioning is a result of an interplay between the four levels. if subjects in this particular sample precludes certain of these levels in terms of their interaction with each other, an assumption can clearly be made that the nature of the dyadic relationships is impoverished in nature. impoverished relationships per definition are not building blocks for a healthy organisational culture and could conceivably impact on organisational perfonnance. in addition, it appears as if senior managers operate primarily on the thinking level, while middle managers operate on the intuitive level this indicates that senior managers consciously construct a set of behaviours, while middle managers operate on a more subliminal (anxiety driven?) level. again, contra indications for organisational success are evident in this scenario. both organisations that participated in the .study, have an active and dynamic human resource function, with a strong focus on management development and training. despite the functioning of these departments and their inputs, subjects still displayed responses to the questionnaire which are at complete variance with the philosophies which human resources attempt to engender in employees. this raises two important questions: 1) do the results of this study indicate that the human resource function in totality is being indicted as ineffective and irrelevant? or 2) do the results point to the possibility that the human resource function at these institutions has become a victim of the authority/subservience paradigm? it is not conceivable that the first question deserves serious attentional focus, and the conclusion should therefore be reached that the latter is true, and has become a most unfortunate reality at these institutions. although extrapolation to other institutions within the same industry c8nnot be attempted, certain puzzling questions become relevant. a human resource function's primary role, if it desires to be a functional strategic partner in its organisation, is to identify and rectify dysfunctional behaviours (boase, 1997), and not to become a victim of such processes. in an economic sense, it is apparent that these organisations are not functioning at an optimal level. several authors have indicated an inverse relationship between dysfunctional conflict management and organisational perfonnance (caudron, 2000; alper et al., 2000; song et al., 2000 and reyneke, 1997). despite impressive financial year-end reports to shareholders, it is apparent that organisational climate within these organisations yields a less-than-satisfactory return. it would not be advisable to use the present study as a generic base for generalisation, as the subject sample is relatively small. however, it is pertinent to again refer to the homogeneity of the responses: it is conceivable that this r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 268 sajems ns vol 5 (2002) no 1 could be a reflection of the wider status quo within the banking industry. it is therefore imperative to undertake broad based research within this industry in order to detennine the actual state of affairs. this industry is a major roleplayer within the south african economy, and its functioning has important implications for a wide array of associated organisations within the economic framework. south africa is not in a position to economically dissociate itself from other international role players. within the confined limits of a constrained economy and semi-monopolism of the industry, the two organisations in the present study may continue to declare impressive fmancial returns. globally however, archaic managernent styles and boundary restrictive organisational cultures will contribute to unsatisfactory, and indeed unnoticed, international performance. it is imperative that all south african organisations realise and accept their integral responsibility towards all stakeholders. organisational cultures which are in a sense derived from conflict resolution styles should contribute to the formation of a strong economy which cannot be denied international attention. dysfunctional conflict resolution serves as an economic and moral indictment of all role players, and should not be tolerated. conclusion from the preceding. it is apparent that managers at different organisational levels utilise strongly divergent modes of dealing with conflict. in addition, the conclusion could be reached that the nature of the relationships which are defmed by these modes of conflict resolution, is based on authority and subservience. finally, it emerges that managers at both levels are somewhat dogmatic and exhibit strong adherence to particular styles there is little evidence of style variability and adaptation. these fmdings do not auger well for conflict resolution within these organisations, and raises a number of questions concerning issues such as organisational culture, effectiveness and eventually, productivity. references 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(1998) "interactive video assessment of conflict resolution skills", personnel psychology, 51(1): 1-24. 15 phillips, a.s. & bedeian, a.c. (1994) "leader-follower exchange quality: the role of personal and interpersonal attributes", academy of management journal: 990-1001. 16 reynecke, l. (1997) ''the relation between personality dimensions and styles to handle interpersonal conflict". 17 robbins, s.p. (1998) organizational behavior, simon & schuster, new jersey. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 270 sajems ns vol 5 (2002) no i 18 song, x.m., xie, 1. & dyer, b. (2000) "antecedents and consequences of marketing managers' conflict-handling behaviors, journal of marketing, 64( i): 50-66. 19 taylor, a. (200 1) models for management, available: http://www.arlenetaylor.orglmodels.htm. 20 thomas, k.w. (1992) "conflict and negotiation processes in organizations", in md dunnette & lm hough (eds.) handbook of industrial and organizational psychology: 651-717, palo alto, ca: consulting psychologists press. 21 volkema, r.j. & bergman, tj. (1995) "conflict styles as indicators of behavioral patterns in interpersonal conflicts", journal of social psychology, 135(1): 5, 11,2 charts. 22 vroom, v.h. & jago, a.g. (1995) "situation effects and levels of analysis in the study of leader participation", leadership quarterly: 169-81. 23 womack., d.f. (1998) "assessing the thomas-kilman conflict mode survey", management communication quarterly, 1(3): 321-49. 24 zartman, l.w. (2000) "conflict management: the long and the short ofit", sais review, 20(1): 227-35. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . microsoft word 8 mabuza et al sajems 17(1) 2014.docx sajems ns 17 (2014) no 2:207-219 207 effects of transaction costs on mushroom producers’ choice of marketing channels: implications for access to agricultural markets in swaziland majola l mabuza, gerald ortmann and edilegnaw wale school of agricultural, earth and environmental sciences, university of kwazulu-natal accepted: july 2013 mushrooms are highly perishable agricultural commodities, and as such their marketing is invariably associated with high transaction costs. despite the mushroom enterprise gaining popularity in a number of sub-saharan african (ssa) countries, where production is dominated by rural-based small-scale farmers, no research has been done to study the nature and complexity of transaction costs encountered by these producers in attempting to participate in mainstream supply chains. this study uses cross-section data obtained in 2011/2012 from mushroom producers in swaziland to study the effects of transaction costs on producers’ choice of marketing channels and the quantity of mushrooms supplied. having used cragg’s model for analysis, the results indicate that producers’ decisions of where to sell their mushrooms are significantly affected by household labour endowment, production capacity, access to cooling facilities and market information, and producers’ bargaining position. meanwhile, the quantities of mushrooms sold are significantly influenced by the difficulty in accessing reliable transport and producers’ level of uncertainty in meeting buyers’ quality requirements. the study concludes by highlighting potential interventions that could minimise marketing and transaction costs and further improve the general agricultural marketing environment in swaziland. key words: mushrooms, marketing channels, transaction costs, swaziland jel: q13 1 background oyster mushroom production was officially introduced in swaziland through a united nations development programme (undp)funded initiative in 2001 with an intention to assist rural-based small-scale farmers to diversify and improve their financial independence and livelihoods. preference for mushrooms, particularly the oyster, over other prospective enterprises was mainly influenced by the abundance of production inputs in swaziland (e.g. substrate materials1), their ease of production, suitability in diverse agro-ecological zones, and their relatively high nutritional and medicinal qualities (chang & miles, 2004). however, it is important to note that producers can only realise significant benefits from their ventures if they operate within a commercialised setting, a choice that farmers will make if markets provide incentives to increase production and enhance household income generation prospects (delgado, 1999). worth noting as well, is that market participation is not costless as attempts to commercialise smallholder agriculture in africa have not yielded the expected results primarily due to lack of proper institutions and infrastructure (fafchamps, 2004). these challenges often result in increased marketing and transaction costs, which underlie the failure by farmers to meet market demands for quality, quantity and timeliness (karaan, 1999). the concept of transaction costs was enunciated by coase (1937), who defined them as costs incurred in the process of carrying out any exchange. transaction costs are incurred before (ex ante) and after (ex post) the actual exchange and are broadly conceptualised as the tangible and intangible costs of searching for a partner with whom to exchange a product, screening potential trading partners to ascertain their credibility, bargaining with potential trading abstract 208 sajems ns 17 (2014) no 2:207-219 partners to reach an agreement, transferring the product, monitoring the agreement to ensure that its conditions are fulfilled, and enforcing the exchange agreement (jaffee, 1995). before deciding which marketing channel to use, producers normally have to make a preliminary decision of whether or not to sell, which generally depends on the availability of marketable surplus (goetz, 1992). once the producer decides to participate in the output market, he/she makes a choice between selling at the farm gate, through intermediaries or transporting the product to the nearest lucrative market. mushrooms are highly perishable commodities, and as such their marketing is invariably associated with high transaction costs, which if not contained may ultimately affect producers’ competitiveness in the value chain or perhaps increase to a level where markets may be adjudged to be ‘missing’ (de janvry et al., 1991). as opposed to other food commodities that have a longer shelf life (e.g. grains), mushrooms require rapid and refrigerated transportation to consumption centres or immediate processing into less perishable forms. this limits the period of time during which mushrooms can be marketed as a fresh commodity or used as raw material in processing. such conditions normally subject producers to limited marketing flexibility as they often find themselves in an unfavourable bargaining position, particularly against buyers who have alternative sources of supply (jaffee, 1995). despite the difficulty of measuring transaction costs, some attempts have been made previously to study their influence on the choice of marketing channels for african producers of various agricultural commodities such as beef (shiimi et al., 2012), bananas (woldie & nuppenau, 2011; jagwe & machete, 2011) and coffee (fafchamps & hill, 2005), among others. nonetheless, no attention has been accorded to study the marketing of non-conventional highvalue agricultural commodities (hvacs) like mushrooms, a gap that this study attempts to address. typical of hvacs, which are generally known for having a relatively high income elasticity of demand (kumar et al., 2011), cultivated mushrooms are largely consumed by the urban working class and people with special diet preferences. these consumers purchase mushrooms from a number of selling points, including supermarket chain stores, whose procurement policies provide an opportunity for small-scale farmers to participate in mainstream markets, enabling them to generate substantial returns (emongor & kirsten, 2009). the importance of cultivated mushrooms emanates from various dimensions. for instance, the production procedure qualifies the enterprise as an environmentally unique process for bioconversion of non-edible plant biomass to generate value-added products which are highly nutritious, tasty and relatively quick and easy to prepare. in contrast to other hvacs (e.g. vegetables), cultivated mushrooms contain all essential amino acids, have relatively high levels of vitamins, fibre and inorganic mineral nutrients (chang & miles, 2004). more importantly, they are effective in enhancing the human body’s defence against various types of cancers, viral infections (including hiv), diabetes, constipation and cardiovascular diseases (roupas et al., 2012). as a result of such attributes, a number of ssa countries have since the early 2000s included the mushroom enterprise in their agricultural systems (see zero emissions research initiative (zeri), 2005). therefore, in attempting to improve the benefits associated with the enterprise, it is important to identify possible means of reducing transaction costs which are often considered an embodiment of barriers to market participation by resource-poor producers (key et al., 2000). reducing transaction costs is likely to increase linkages between actors in the mushroom value chain and improve producers’ market access and household income. given the paucity of empirical studies of this nature in swaziland, the results will inform the formulation of pragmatic policy interventions that could improve the general agricultural marketing environment, which constitutes an indispensable element in the advancement of swaziland’s agricultural development programme (see food and agricultural organisation (fao), 2011). the rest of the paper is structured as follows: section 2 outlines the methodology, which constitutes the conceptual framework, empirical model, and data collection procedures. section 3 discusses empirical results, while section 4 concludes the study with policy recommendations. sajems ns 17 (2014) no 2:207-219 209 2 methodology 2.1 conceptual framework in deciding where to sell a particular commodity, producers base their decisions not only on the price they expect to receive, but also on additional costs related to transacting in available markets (jaffee, 1995). considering that transaction costs alone could be a major barrier to market participation, farmers are more likely to choose to supply their commodities through a channel that has less transaction costs in their quest to maximise profit (key et al., 2000). however, transaction costs have a large unobservable component; hence, they are difficult to quantify. this has unsurprisingly resulted in the dearth of literature on the direct measurement of exchange-related costs, particu larly in the area of agricultural marketing (hobbs & kerr, 1999). where attempts have been made previously, researchers (e.g. gabremadhin, 2001; royer, 2011) have based their estimation on the opportunity costs of alternatives, which are also not easily identifiable or quantifiable. as such, aspects like market information search and bargaining procedures are rarely included in most studies and are unlikely to be comprehensive when included. despite collins and fabozzi’s (1991) contention that no one approach of conceptualising and estimating transaction costs is best in all circumstances, in attempting to address the above-indicated inherent challenges, this study borrows from the framework postulated by vakis et al. (2003) which provides a dependable setting for studying producers’ channel choices and quantity supplied as a function of commodity prices and two broad categories of proportional and fixed transaction costs. following vakis et al. (2003), if there exist j available markets where a certain quantity of mushrooms qi can possibly be sold, the producer’s marketing strategy is conceptualised to be influenced by a number of factors. firstly, selling in market j for a given transaction i could be associated with proportional transaction costs tcij p which may arise due to various factors including the distance dij and time mij to reach market ji, and other individual-specific characteristics zij p such as the difficulty to access transport. this can be expressed as: ),,( pijijij pp ij zmdtctc = (1) secondly, the producer considers the expected price pij to be received from alternative markets. the price is decomposed into: ),( biijij zqbpp ±= (2) where pj is a market specific price and ),( bii zqb is the potential price mark-up that the producer expects to receive. the mark-up depends on the quantity of mushrooms sold iq and other bargaining-related attributes such as product quality biz . finally, selling in market ji could also be associated with fixed transaction costs tc f (zij f ) that are invariable with the quantity sold and include costs like searching for potential buyers and obtaining information about prices, markets, or types of possible contractual arrangements. based on the above, and for a given transaction i, a producer chooses to sell iq in the ji market which yields the highest net profit among the k = 1,…, j alternative markets. this can be expressed as: ji = maxk πik =qi ⋅[(pik ±b(qi,zi b)−tcik p(dik ,mik ,zik p)]−tc f (zik f ),k =1,..., j{ } . (3) so, assuming there are two alternative markets (j1 and j2), a producer will choose to sell to j1 if { })()],,(),([( 111111111 fkfpkkkpkbkk ztczmdtczqbpq −−±⋅=π > { })()],,(),([( 222222222 fkfpkkkpkbkk ztczmdtczqbpq −−±⋅=π . (4) however, he/she will sell to j2 if π2k > π1k, and will be indifferent if π2k = π1k. the next sub section presents the empirical model. 210 sajems ns 17 (2014) no 2:207-219 2.2 empirical model upon realising some marketable surplus, producers usually make two types of decisions in relation to their marketing strategy. the first decision relates to the choice of marketing channel, and the second to the quantity of the produce to supply through the selected channel. with very few exceptions (e.g. shiimi et al., 2012), most previous related studies (e.g. hobbs, 1997; gong et al., 2007; woldie & nuppenau, 2011) have analysed the effects of transaction costs on these two choices using the tobit model, implying that farmers make these decisions simultaneously. the broader inference of these studies is that farmers’ supply of commodities is price inelastic, an attribute which entails that farmers are less likely to respond to changing market conditions, making them more susceptible to conditions set by buyers. other researchers (e.g. katchova & miranda, 2004), however, contend that such marketing decisions are made sequentially, suggesting that producers pay attention to market conditions, and with the information gathered, they first decide whether or not to participate in a particular channel prior to making the decision on the proportion of the commodity to sell through the selected channel. sequential decisions are analysed using two-step approaches such as the cragg’s model, also known as the doublehurdle model (green, 2003). within a simultaneous decision-making frame work, the dependent variable is captured as the proportion of the commodity sold through the preferred channel. given that producers who do not participate in this channel will record zero per cent of the commodity sold, the dependent variable becomes censored at a threshold of zero, necessitating the use of a tobit model (green, 2003). the principal underlying assumption of the tobit is that the probability of channel choice also increases the average quantity of the commodity supplied; hence, the effect of a particular variable will be the same on the choice of marketing channel and proportion of quantity supplied (burke, 2009). it is against such attributes of the tobit that cragg (1971) proposed the more flexible double-hurdle model, which allows the outcomes to be determined by separate stochastic processes. following green (2003), cragg’s model is specified as follows: channel choice equation [ ]=> 0pr *iy φ ),( 'γix iz = 1 if yi * >0 [ ]=≤ 0pr *iy 1− φ ),( 'γix zi = 0 if 0 * ≤iy (5) quantity decision e[ yi | zi = 1] = xi 'β +σλ i (6) where γ and β are coefficients to be estimated, y is the observed use of the preferred marketing channel, and x represents the factors that are hypothesised to affect the producers’ marketing behaviour. cragg’s model is a combination of the probit in equation 5 (choice of marketing channel) and a truncated regression model in equation 6 (quantity sold), which can be estimated independently. if zi = xi and γ = β σ , cragg’s model reduces to the tobit model, causing the variables to influence the channel choice decision and quantity supplied in the same manner. in attempting to get an indication of whether marketing decisions by mushroom producers in swaziland are made simultaneously or sequentially, a likelihood ratio (lr) test was conducted wherein the tobit was tested against cragg’s model by respectively estimating the tobit, probit and truncated regression using the same variables, and thereafter computing a likelihood ratio (lr) statistic as follows (green, 2003): [ ])ln(lnln2 trpt lll +−−=λ (7) where ln lt = log of the likelihood for the tobit model; ln lp = log of the likelihood for the probit model; and ln ltr = log of the likelihood for the truncated regression model. λ has a χ2 distribution with r (df), where r is the number of independent variables plus the constant. the tobit model is rejected in favour of cragg’s model if λ exceeds the appropriate χ2 critical value. the next sub-section presents the data collection procedures. 2.3 data collection the study relied on a data set obtained from a wide-ranging survey on mushroom production in swaziland, where data were collected between december 2011 and january 2012. using information gathered from the mushroom development unit (mdu), producers as at december 2011 comprised of 11 farmer groups, whose respective members are located in more or less the same communities, and 74 sajems ns 17 (2014) no 2:207-219 211 individuals found in various locations. farmer groups operate in predominantly two models. in model a members produce mushrooms in one growing room and share all production and marketing activities. in model b, members share all preparatory activities, including substrate gathering and spawning of bags.2 however, instead of producing under one roof, each member manages his/her own production house. groups that operate using model b allow members to make their own marketing arrangements independently. given that the adopted analytical model requires household explanatory variables, it was found reasonable to use data generated from individual producers and members affiliated to groups that operate using model b. among the 11 groups, only two (mbangweni and zombodze) operate using model b. from a total of 38 members from mbangweni and 25 from zombodze, interviews were conducted with 36 members from mbangweni and 24 from zombodze, respectively. from the list of 74 registered individual producers, 43 owned production structures but had not started producing at the time the interviews were conducted. therefore, 31 producers from this category were interviewed, bringing the number of respondents to 91. the dependent and explanatory variables used in the analytical model are presented in the following section. 2.4 dependent and explanatory variables 2.4.1 dependent variable currently, no cultivated mushrooms are exported from swaziland and producers have not yet engaged in any form of mushroom processing. instead, from what they harvest, about six to ten per cent is consumed at household level and the remainder sold through four channels identified as: (i) the farm gate; (ii) retail market (supermarkets); (iii) middlemen; and (iv) food services industry (restaurants/hotels). this can be depicted as follows: channel i (farm gate): producers à consumers; channel ii (retail market): producers à supermarket à consumers; channel iii (middlemen): producers à middlemen à supermarket àconsumers; and channel iv (food services industry): producers à restaurant/hotel àconsumers. about 528 kg of fresh oyster mushrooms were traded by the respondents between november 2011 and january 2012 through the identified channels. further analysis indicated that 42 per cent of these mushrooms were sold at the farm gate, 52 per cent through the retail market, whereas 2 per cent and 4 per cent, respectively, were sold through middlemen and the food services industry. some producers reported to have sold mushrooms through different channels, indicating that the options are not mutually exclusive. on account of these observations, and for ease of analysis, producers who sold to more than one outlet (j1,….,j4) were adjudged to prefer selling through j1 if a greater proportion of their marketable surplus was sold through j1 compared to what they sold to other j outlets. subsequent to the re-classification according to preference, two marketing channels were found prominent, and these were supermarkets (or retail outlets) used by 53 per cent of respondents and the farm gate used by 47 per cent. considering the above observations, the dependent variable was formulated around the retail market option; hence, a value of one was assigned if the producer sold through the retail market channel and zero if the produce was sold at the farm gate. for the quantity model, the dependent variable was the proportion of mushrooms sold through the retail channel, ranging between 0 and 100 per cent. 2.4.2 explanatory variables transaction cost variables were measured by ranking producers’ responses to a list of questions related to the constraints they encounter in marketing their mushrooms. the set of questions were classified into three components, namely (i) information and search costs; (ii) negotiation, bargaining, and transfer costs; and (iii) monitoring and enforcement costs. the adopted measurement criterion works on the premise that transaction costs are assumed to be observable if, ceteris paribus, a particular type of transaction cost is higher in channel (j1) than in channel (j2), and different producers consistently specify the same ranking whenever the two situations are considered (cheung, 1998). the explanatory variables are discussed below and summarised in table 1. 212 sajems ns 17 (2014) no 2:207-219 table 1 variables included in the regression model dependant variables variable description measurement marketing channel through which mushrooms are sold selling at the farm gate or retail market? 1= retail market; 0 = farm gate proportion of mushrooms sold % of total mushrooms sold 0 – 100 household characteristics variable description measurement expected sign 1. education level of producer category last attended 1= illiterate; 2= adult education; 3= primary; 4= secondary; 5= high school; 6= college/vocational 7= university + 2. household labour endowment man-equivalents less than 9 yrs=0; 9-15=0.7; 16-49=1; above 49=0.7 + production 3. size of production spawn-impregnated bagsa number + 4. ownership of refrigerator does the household own a refrigerator? 1=yes; 0=no + 5. group membership is the producer a member of a mushroom producing group? 1=yes; 0=no + information and search costs 6. knowledge of prices in alternative markets was the price in alternative markets known before selling the mushrooms? 1= yes; 0 = no -/+ 7. difficulty in accessing price information how difficult is it to access price information? 1=not an issue of concern; 2=very easy; 3=easy; 4=difficult; 5=very difficult negotiation, bargaining and transfer costs 8. search for trading partner how difficult is it to locate exchange partners/buyers? 1=not an issue of concern; 2=very easy; 3=easy; 4=difficult; 5=very difficult 9. transportation difficulty how difficult is it to transport your produce to the market? 1=not an issue of concern; 2=very easy; 3=easy; 4=difficult; 5=very difficult 10. bargaining power who sets the exchange price? 1=producer; 0= buyer or both + monitoring and enforcement costs 11. quality uncertainty is there uncertainty that your mushrooms will not meet the expected quality of preferred buyer? 1=yes; 0= no note: a‘spawn-impregnated bags’ are substrate bags that have been inoculated with the mushroom seed, known as spawn (gwanama et al., 2011). information and search costs prior to making any exchange, producers will, among other expectations, be required to establish who to sell their mushrooms to and the prices at which to sell them. by so doing, they will incur information costs whose magnitude depends on the time taken to conduct the search. going into production without the knowledge of current prices in alternative markets creates some uncertainty in that despite making their own price expectations, producers will have no guarantee that they will eventually receive that price unless they know in advance which price the buyer will agree to buy at (hobbs, 1997). similar to woldie and nuppenau (2011), information cost due to such price uncertainty was measured by considering whether farmers knew the price in alternative markets ahead of transacting, while the search for price information and trading partner(s) were measured by taking into account the difficulty with which the two were accomplished, respectively. sajems ns 17 (2014) no 2:207-219 213 negotiation, bargaining and transfer costs smallholder farmers are generally price takers and the level of transaction costs is likely to increase if they need to travel long distances to reach their point(s) of sale (pingali, khwaja & maijer, 2005). while transportation costs may not be considered by some researchers as a transaction cost component, the inclusion of transport-related variables in this study was meant to account for the opportunity cost of producers’ time spent in organising transport to convey their mushrooms to distant markets. farmers’ bargaining position was considered as a measure of their influence on exchange agreements, particularly in setting of exchange prices. gong et al. (2007) and woldie and nuppenau (2011) found that farmers who produce in bulk tend to enjoy relatively more bargaining power and are likely to influence buying terms. therefore, it is expected that producers would be inclined to supply a greater proportion of their commodity through a channel where they have a better bargaining position. monitoring and enforcement costs one of the key monitoring costs considered in the study is quality uncertainty. while there are currently no formal quality standards for traded mushrooms in swaziland, supermarkets, the major buyers, generally screen delivered mushrooms for quality based on visual inspection for browning, weight loss and microbial spoilage. producers’ returns are likely to be lower than anticipated if mushrooms do not meet the buyers’ expected quality standards. mushrooms are highly perishable products and, as observed by fraser (1995), if the producer faces some uncertainty about selling his/her mushrooms due to quality considerations, perishability could be of grave concern as he/she may either sell at a reduced price (due to shrinkage) or not sell at all due to advanced spoilage. the inclusion of this variable was based on evidence provided by hobbs (1997) and gong et al. (2007) who found that high levels of quality uncertainty are more likely to result in producers selling their mushrooms through a channel with no stringent quality requirements. no variable was included in the model to capture enforcement costs as none of the farmers had valid contracts of any form with their buyers, except verbal agreements for those supplying retail outlets. furthermore, no conflicts were reported that perhaps warranted follow-up visits or calls from producers as a result of delayed or defaulted payments. household and production attributes while it is generally believed that transaction costs reflect the character of the market, others (e.g. pingali et al., 2005) posit that transaction costs are mainly entrenched in the characteristics of individual households and the environment they live in. in particular, pingali et al. (2005) argue that the time taken to search, process and act on market information decreases with better education. others (e.g. fafchamps & hill, 2005) have established that farmers who produce in large quantities are more likely to travel to the market in search for relatively higher exchange prices. these two factors were respectively analysed by considering producers’ level of education, and the number of spawn-impregnated bags they manage. given the perishability of mushrooms and the amount of work required in the enterprise, it was found prudent to include other variables to account for ownership of cooling facilities (refrigerators) and household labour endowment, respectively. considering members who were identified to participate in household agricultural activities, household labour endowment was measured following langyintuo and mungoma (2008) in man-equivalents. the identified members include even school-attending children who also participate in household agricultural activities, especially outside school-attending hours including weekends and holidays. the following section presents the study’s empirical results. it begins with an overview of the descriptive statistics of variables used in the analytical model, followed by a discussion of the significant factors affecting producers’ channel choice decisions and quantity supplied. 3 results and discussions 3.1 descriptive statistics of variables used in the analytical model the descriptive statistics are summarised in table 2 below. 214 sajems ns 17 (2014) no 2:207-219 table 2 descriptive statistics of variables used in the regression model categorical variables [a] variable [b] unit [c] % of total respondents (n=91) [d] % of [c] from retail (n=48) [e] % of [c] from farm gate (n=43) [f] χ2-value gender of producer female 74.7 55.9 44.1 1.061 male 25.3 43.5 56.5 membership in mushroom producing group member 65.9 53.3 46.7 0.024 nonmember 34.1 51.6 48.4 ownership of refrigerator yes 58.2 64.2 35.8 6.622*** no 41.8 36.8 63.2 knowledge of producer price in alternative markets yes 37.4 55.9 44.1 1.622 no 62.6 42.1 57.9 bargaining power (who sets the producer price?) producer 64.8 28.8 71.2 38.560*** buyer or both 35.2 96.9 3.1 quality uncertainty yes 36.3 75.8 24.2 10.999*** no 63.7 39.7 60.3 type of transport usedb own vehicle percentage 13.2 91.7 8.3 63.705*** public transport percentage 48.4 84.1 15.9 by foot percentage 11 0 100 no need to travel percentage 27.5 0 100 continuous variables variable unit mean of total respondents (n=91) mean retail (n=48) mean farm gate (n=43) t-value age of producer years 50 50 49 -0.588 labour endowment man-equiv. † 4.8 4.6 4.8 -0.356 number of spawn-impregnated bags bags 502 401 581 -2.462** producer priceb e/kg3 51.80 41.00 -3.505*** ordered variables variable unit mode of total respondents (n=91) mode retail (n=48) mode farm gate (n=43) χ2-value difficulty in accessing price information modal score† 3 4 3 14.500*** difficulty in locating trading partner modal score † 3 3 3 5.931 difficulty in accessing transport modal score † 1 1 1 5.032 producer’s education level modal score † 4 4 3 12.144** distance to marketb modal score ♠ 0 7 0 79.021*** source: survey data (2011/12) notes: b indicates variables not included in the regression model †refer to table 1 for measurement of variables ♠ 0=no need to travel; 1=less than 1km; 2=1-2km; 3=2.1-3km; 4=3.1-4; 5=4.1-5; 6=5.1-10km; 7=above 10km *,** and *** represent 10%, 5%, and 1% levels of significance, respectively. the average age of interviewed producers was 50 years, and the majority (75 per cent) were women. almost 58 per cent owned refrigerators, of whom 36 per cent sold at the farm gate, while the rest supplied the retail market. the producers had a relatively low level of education as slightly over 65 per cent did not go beyond secondary school. about 63 per cent indicated that they did not have access to price information in alternative markets and 58 per cent of producers in this category sold their mushrooms at the farm gate. of the 65 per cent who indicated to be selling at prices set by themselves, 71 per cent sold at the farm gate, while the remainder used either their own vehicles or public transport to convey mushrooms to the nearest retail outlets. producers who sold at the farm gate had lower uncertainty sajems ns 17 (2014) no 2:207-219 215 about the quality of their mushrooms which they sold at relatively lower producer prices. due to poor customer turnout in some areas, only 11 per cent indicated occasionally walking around the neighbourhood in search of buyers as a means to avoid losses resulting from spoilage. farmers who were more inclined to sell to the retail market are those who produced relatively more in terms of the number of spawn-impregnated bags they managed. about 66 per cent of the producers were affiliated to mushroom producing groups, of whom 53 per cent preferred the retail market to the farm gate. 3.2 factors affecting channel choice and quantity supplied having detected no significant multicollinearity among the explanatory variables, the regression models were estimated using stata11, and the results are presented in table 3. with a likelihood ratio (lr) of 99.63 at 12df (p<0.01), the tobit model was rejected in favour of cragg’s model, suggesting that mushroom producers are more likely to make their marketing decisions of channel choice and quantity supplied sequentially.4 consistent with fafchamps and hill’s (2005) findings, the results indicate that farmers who produced relatively more (in terms of the number of spawn-impregnated bags) had a high likelihood of selling their mushrooms to the retail market. producers’ quest to supply the retail market was also enhanced by ownership of refrigerators which allowed them to store the mushrooms for a couple of days before transporting them. one of the unique attributes of oyster mushrooms is that although the harvested quantities decline over time, from the first flush they can be harvested continuously for a period of about three to four months, subject to prevailing conditions (gwanama et al., 2011). therefore, the advantage of owning a refrigerator is that a producer may harvest for a couple of days, store and thereafter make a single trip to the market. as indicated earlier, the mushroom enterprise is labour-demanding in almost all production, harvesting and post-harvest handling procedures. it is not surprising, therefore, that high labour endowment enabled the household to produce and market relatively larger quantities, which they were able to transport to the retail market. the results also indicate that producers who were unaware of prevailing prices in alternative markets and had difficulty in accessing price information were more likely to sell their mushrooms at the farm gate. the negative, significant coefficient for bargaining power confirmed woldie and nuppenau’s (2011) persuasion that the paucity of market information denies producers the leverage to bargain for exchange prices; hence, prices and exchange terms were dictated by the buyers. as a result, producers who could not bargain at the retail market were more inclined to sell their mushrooms at the farm gate. despite being price takers and often required to travel, farmers who sold their produce to retail outlets were presumably attracted by market reliability and a comparatively high producer price. another important observation from the results is that producers who were affiliated to mushroom producing groups were more likely to sell to the retail market. while these producers did not sell collectively, it could be inferred that performing certain tasks as a group builds some social cohesion, which enables them to share information beyond the joint activities. in any group setting characterised by mutual trust between members, there are possibilities for sharing skills and information as some members could be more experienced and knowledgeable than others. only two factors were found to significantly influence the quantity of mushrooms sold. the first relates to the difficulty encountered in organising transport, which significantly influenced farmers to sell their mushrooms at the farm gate. as noted earlier, producers who supply the retail market are required to travel, whereas a majority of those who sell at the farm gate rarely transport their mushrooms as buyers generally consist of locally-based community members. accessing the retail market comes with an opportunity cost of time spent in organising transport and time spent during transportation. given that most producers relied on public transport to convey their mushrooms to the market, it is evident that they had no control on regulating transportation periods. the second factor relates to producers’ quality uncertainty. contrary to previous findings (e.g. hobbs, 1997 and gong et al., 2007), the coefficient for quality uncertainty 216 sajems ns 17 (2014) no 2:207-219 was positively related to the quantity of mushrooms sold through the retail market. generally, it would be expected that the more producers become concerned about meeting buyers’ quality requirements, the less of mushrooms they will supply to that particular channel. however, as observed by staal et al. (1997), it could be inferred that while producers were often uncertain about whether their mushrooms would meet the buyers’ expectations for quality, the market reliability and comparatively better exchange price offered by the retail market seemed to outweigh the uncertainty about quality such that producers were willing to increase their supply in order to avoid the farm gate option, which relies mostly on unpredictable consumer turnout. table 3 regression results for factors influencing choice of marketing channel and proportion of mushrooms sold by producers in swaziland explanatory variables tobit probit truncated regression β marginal effects β marginal effects β marginal effects ∂y/∂x z-value ∂y/∂x zvalue ∂y/∂x zvalue constant -63.560 (49.370) -1.031 (1.460) 64.067*** (17.535) producer’s education level 14.256 ** (5.889) 8.252** (3.423) 2.41 0.255 (0.177) 0.088 (0.061) 1.44 3.772 (2.920) 3.344 (2.666) 1.250 labour endowment 2.388 (2.867) 1.382 (1.663) 0.83 0.194** (0.093) 0.067** (0.032) 2.07 0.135 (1.367) 0.120 (1.214) 0.100 number of spawnimpregnated bags 0.066*** (0.022) 0.038*** (0.013) 2.90 0.003*** (0.001) 0.001*** (0.000) 2.98 0.018 (0.013) 0.016 (0.012) 1.390 ownership of refrigerator 29.167 ** (14.800) 16.376** (7.533) 2.17 1.426*** (0.405) 0.487*** (0.128) 3.80 -0.444 (6.293) -0.393 (5.573) -0.070 knowledge of prices in alternative markets -12.331 (14.549) -7.021 (8.106) -0.87 -0.903** (0.435) -0.321** (0.152) -2.10 6.622 (6.955) 5.754 (5.851) 0.980 difficulty in accessing price information -11.665* (6.829) -6.753* (3.928) -1.72 -0.488* (0.290) -0.168* (0.105) -1.60 -1.152 (3.217) -1.022 (2.854) -0.360 difficulty in locating trading partner 7.842 (6.463) 4.540 (3.639) 1.25 0.156 (0.198) 0.054 (0.070) 0.77 -3.562 (2.892) -3.158 (2.579) -1.220 difficulty in accessing transport -5.550 (5.377) -3.213 (3.157) -1.02 -0.175 (0.170) -0.061 (0.058) -1.05 -5.246** (2.526) -4.651** (2.213) -2.100 bargaining power -77.578 *** (15.887) -46.357*** (8.6112) -5.38 -3.584*** (0.653) -0.763*** (0.070) -10.91 -4.647 (6.313) -4.148 (5.749) -0.720 group membership 56.247 *** (16.795) 28.961*** (7.008) 4.13 2.285*** (0.675) 0.740*** (0.151) 4.91 -9.115 (9.561) -7.905 (7.847) -1.010 quality uncertainty 6.942 (16.392) 4.054 (9.594) 0.42 -0.133 (0.438) -0.046 (0.153) -0.30 13.428* (7.267) 11.833* (6.385) 1.850 sigma 50.157 (6.623) 16.280 (2.234) number of observations 91 91 38 log likelihood -231.544 -26.85 -154.881 f-stat. 5.62*** prob. f-test p<0.01 pseudo r2 0.130 0.573 wald χ2 (11df) 47.09*** 25.06*** prob. χ2 for wald test p<0.01 p<0.01 correct classification 84.6% lr test for tobit vs cragg’s model (λ) 99.63*** prob. χ2 for lr test p<0.01 source: survey data (2011/12) notes: *,** and *** represent 10%, 5%, and 1% levels of significance, respectively. figures in brackets are robust standard errors. sajems ns 17 (2014) no 2:207-219 217 4 conclusions and policy recommendations the study sought to analyse the effects of transaction costs on the choice of marketing channels and quantity of mushrooms sold by producers in swaziland. having used cragg’s model for analysis, the research indicates that the difficulty in accessing market information and lack of bargaining power reduces producers’ likelihood of participating in remunerative markets. given that retail outlets are located some distance away from farmers’ production sites, those willing to take advantage of comparatively better producer prices and relatively stable market conditions have to incur transportation costs. hence, the difficulty encountered in accessing transport is likely to reduce the amount of mushrooms supplied to the retail market. the study also highlights the importance of a market information system (mis), which swaziland is yet to establish despite numerous discussions that have taken several decades to conclude. besides improving market transparency, full and easy access to reliable and up-to-date market information would strengthen producers’ bargaining position and competitiveness as they would be able to make timely and better informed production and marketing decisions. furthermore, in the absence of a prescribed quality management system for traded mushrooms, producers are subjected to having their mushrooms bought at lower prices or even rejected without informed justifications. this calls for the government to work with buyers in formulating harmonised measurable quality standards for the benefit of all value chain actors. these standards should be in line with existing international ones in order to facilitate mushroom trade with other countries. with the current lack of coordination in mushroom marketing, major buyers are not spared from encountering transaction costs, given the small-scale exchanges they engage in with individual producers. however, changes that could allow the same volume of business to be concentrated in a smaller number of relatively larger and more secure transactions would benefit buyers and producers alike. this can be made possible by promoting collective marketing through the existing farmer groups. collective marketing would also enable producers to strengthen their bargaining position and share costs related to the search for buyers, monitoring transactions and transportation of mushrooms to distant markets. in view of the sparse distribution of producers, supply chain management could be improved by establishing collection centres (fitted with cooling facilities) in strategic areas where buyers would procure the mushrooms in bulk. this investment could be funded by the government as part of its public mandate towards agricultural and rural development. endnotes 1 substrate material refers to any substance on which mushrooms will grow. the substrate is to mushrooms what soil is to plants. 2 oyster mushrooms are grown from polyethylene bags filled with substrate material. the mushroom ‘seed’ is known as spawn; hence, spawning is an equivalent of planting seeds in crop production. 3 ‘e’ denotes emalangeni, the swaziland currency. e1 = us$ 0.101 on 30th may 2013 (central bank of swaziland, 2013). 4 even though this conclusion emanates from empirical estimation, it is important to acknowledge that the analysis was conducted using data gathered from a relatively small number of respondents (n=91), an attribute considered as the study’s main limitation. worth highlighting, nonetheless, is that unlike in other ssa countries, mushroom production is a relatively new and non-conventional agricultural enterprise in swaziland; hence, very few farmers currently participate in the industry (see mabuza, ortmann & wale, 2012, for details). acknowledgments the authors thank the respondents for their participation and the council for the development of social science research in africa (codesria) for funding the research (grant sgrt.29t11). additional financial support from the national research foundation (nrf) of south africa (grant ifr2011041400080) is also 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accepted: 14 may 2020; published: 12 aug. 2020 copyright: © 2020. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: it is evident from western literature that performance appraisal (pa) results in innovation. however, evidence of empirical research on the different models on the pa-innovation link is seemingly lacking within the south african environment. the south african context may be unique, given the legislative framework within which pa is administered. aim: to provide clarity on the specific pa-innovation models within the south african context. setting: the pa-innovation relationship is contextualised within the south african context, across more than 50 organisations and more than 3000 randomly selected employees. methods: a quantitative research approach was adopted, using a cross-sectional survey design as the study involved 3180 employees from 53 organisations. seven variables were included in the model, namely pa, individual innovative behaviour (iib), proactive personality (pp), transformational leadership (tl), corporate entrepreneurship (ce), work engagement (we) and affective commitment (ac). results: the results reveal that pa directly influences innovation. the pa-innovation relationship is mediated by we and ac, with we having the most significant effect. furthermore, tl and ce moderate the pa-innovation relationship, with tl having the strongest effect and ce having almost no effect. additionally, pp does not moderate the pa-innovation relationship. managing employees with tl practices and instilling we may be at the root of innovation in organisations. conclusion: the research contributes to the body of knowledge on the pa-innovation link, and the outcomes of this study are expected to be of value to all stakeholders and may assist managers to appropriately assign resources to particular organisational variables, thereby enhancing innovation within organisations. this evidence-based information would help managers to increase innovative behaviour, performance, competitive advantage, organisational success, growth and organisational survival. keywords: corporate entrepreneurship; innovation; organisational commitment; performance appraisal; proactive personality; south africa; transformational leadership; work engagement. background innovation is an essential success factor for organisations to endure the harsh business climate (abbaspour 2015; ling & nasurdin 2011; runfeng 2011). in addition, in order to enable the organisation to enhance performance, competitive advantage, success, expansion and its chances of continued existence, innovation is crucial (jafri 2010; ling &nasurdin 2011). focusing on innovation is at the root of a competitive advantage in organisations (jafri 2010; wu et al. 2016). by the same token, studies (abbaspour 2015; subramaniam & youndt 2005) have shown that innovation leads to a competitive advantage and organisational growth. there are a plethora of studies investigating and evaluating the various variables relating to innovation. some of these variables include: affective commitment (ac) (jafri 2010), proactive personality (pp) (seibert, kraimer & crant 2001; tai & mai 2016), organisational climate (michaelis, stegmaier & sonntag 2010; shanker, bhunugopan & fish 2012), organisational culture (michaelis et al. 2010; tipu, ryan & fantazy 2012), leadership (oke, munshi & walumbwa 2009; tipu et al. 2012), work engagement (we) (agarwal 2014; agarwal et al. 2012), performance appraisal (pa) (aktharsha & sengottuvel 2016; choi, moon & ko 2013; runfeng 2011) and other human resource practices (hrps) (aktharsha & sengottuvel 2016; dalota & perju 2010). however, it must be noted that a limited number of variables were used in designing these researches. performance appraisal is important to organisations, and a measure of the quality of human resource management (aggarwal & thakur 2013). several authors (grote 1996; khoury & analoui 2004; nickols 2007), point out that organisations invest many hours and a lot of money in pa. nickols (2007) provides an example of a south african telecommunications company in which the annual costs of pa were approximately us$1.1 million and an example of a western company in which the costs of staff time spent on pa were conservatively estimated to be in the region of us$100 million per year. getting pa wrong has negative consequences that include reduced employee productivity, employee disappointment, employee stress, employee depression, reduced employee morale and diminishing motivation (blankenship 2002; nickols 2007). adding these psychosocial costs to the operational costs associated with pa can negatively influence an organisation’s bottom line, particularly when suitable value is not extracted from an organisation’s pa system (khoury & analoui 2004; nickols 2007). numerous empirical research studies (for example, aktharsha & sengottuvel 2016; bal, bozkurt & ertemsir 2014; choi et al. 2013; ling & nasurdin 2011; runfeng 2011; shipton et al. 2006) provide evidence of a relationship between pa and innovation. these studies provide simple models explaining this relationship mainly within the western context (aktharsha & sengottuvel 2016; bal et al. 2014; choi et al. 2013; ling & nasurdin 2011; runfeng 2011; shipton et al. 2006). research on the pa-innovation relationship using more complex models and specifically investigating these relationships within the south african context is lacking. the south african context may be particularly unique as there exists a need to check pa for compliance with the requirements of pertinent labour laws (swanepoel, erasmus & schenk 2008). this study attempts to both clarify the nature of specific drivers of innovation and contextualise the study within the south african context. research problem literature suggests that the implementation of pa results in innovation. however, this link is complex, and includes many other variables. the proper quantification with regard to the specific mediator and moderator variables that drive innovation is not explored satisfactorily, specifically within the south african context. lacking this distinction of information on the pa-innovation relationship, human resource practitioners and managers may improperly assign resources to particular organisational variables, hampering organisational success. this article aims to empirically test the significance of pa for innovation, in selected south african organisations. different models on the pa-innovation link will be investigated by applying mediators such as we and ac, along with moderators such as pp, transformational leadership (tl) and corporate entrepreneurship (ce) climate. ultimately, a complex data-based model of the pa-innovation link will be produced. literature review most successful organisations employ pa among other hrps to enhance organisational performance and employee efficiency (ayers 2013; denisi & pritchard 2006). according to ahmed, mohammad and islam (2013), pa is responsible for continuous improvement within the organisational setting. the literature reflects that pa is an important hrp. for example, boswell and boudreau (2000), and judge and ferris (1993) indicate that pa is one of the main sub-practices of the nine common hrps. performance appraisal is the method of witnessing and assessing an employee’s performance, formally noting the evaluation, and providing feedback on key performance areas of improvement to the employee (muller, bezuidenhout & jooste 2011). additionally, matookchund (2019) suggests that pa refers to an officially organised means that managers use annually to gauge a subordinate’s actual performance, along with strengths and weaknesses in an effort to develop and reward the employee. performance appraisal is a commonly explored topic in human resource management. for instance, denisi and pritchard (2006), and siaguru (2011), indicate that almost a century has been devoted to the study of pa by human resource practitioners and researchers. just about all organisations make use of some sort of pa system (denisi & pritchard 2006; mitchell 2010). given the above, it is notable that pa and innovation both play a significant role within the organisational context. as highlighted by chen and huang (2009), organisations with extremely effective pa methods attain substantial innovation results. furthermore, a number of studies indicate that there is a significant and positive relationship between pa and innovation (aktharsha & sengottuvel 2016; bal et al. 2014; choi et al. 2013; shipton et al. 2006). this adds credence to the view that the effective implementation of pa results in innovation. there is an abundance of antecedents to innovation. examples listed earlier include leadership styles, organisational climate, pp, commitment and engagement. in considering the link between leadership and innovation, sethibe and steyn (2015), for example, note that the majority of studies concentrated on tl rather than other leadership styles. according to burns (1978), tl is a collaboration between leaders and subordinates in an effort to elevate each other’s principles and motivation levels. a transformational leader is someone who motivates subordinates to achieve more than expected (bass 1985). transformational leaders inspire followers to accomplish organisational goals, stress the need for organisational change and promote innovation (alsalami, behery & abdullah 2014). transformational leadership has a strong and positive relationship with innovation (oke et al. 2009; sethibe & steyn 2016; tipu et al. 2012). research conducted by sethibe and steyn (2016), found no direct or indirect link between transactional leadership and innovation. this notion is reinforced by the work led by oke et al. (2009) who conclude that tl is far more suitable than transactional leadership in fostering innovation. the second variable of interest is the ce climate, which has been a significant topic of interest for researchers in recent years (dess et al. 2003; phan et al. 2009). hornsby, kuratko and zahra (2002) define ce very broadly as the development and implementation of fresh ideas within an organisation, while mcfadzean, o’loughlin and shaw (2005) define it as an effort to promote innovation within the organisation. furthermore, ce is centred around five factors: management support, work discretion, rewards, time available and organisation boundaries (hornsby et al. 2002; morris, kuratko & covin 2010). it appears that corporate climate may also be prominent in promoting innovation. corporate climate is an essential antecedent to innovation (michaelis et al. 2010; shanker et al. 2012). several empirical studies provide evidence that there is a strong connection between innovation and climate (lin & liu 2012; michaelis et al. 2010; shanker et al. 2012). it is stated by many that the pp of employees also contributes to innovation in organisations. bateman and crant (1993) suggest that pp is a character trait embodying proactive behaviour. furthermore, pp is seen as a key characteristic of employees in successful organisations. matookchund (2019) suggests that focusing on the recruitment of proactive employees rather than managing them with tl practices may be at the root of innovation in organisations. it is not surprising, then, that employees with a pp are more likely to seek out new ways to improve their work performance and implement new ideas (kim, hon & lee 2010). some studies (for example seibert et al. 2001; tai & mai 2016) show that pp has a positive and strong connection with innovative behaviour. considering the foundation for innovation, other studies (fuller & marler 2009; seibert et al. 2001) theorise that pp is the basis of innovative behaviour. organisational commitment may also influence innovation. organisational commitment is regarded as a psychological state from a multidimensional perspective, which consists of three distinct types of commitment, that is, affective, normative and continuance commitment (allen & meyer 1990; meyer & allen 1997). the focus of this research will be on ac, as it is often this element of organisational commitment that is presented as the central element (lamba & choudhary 2013; steyn, bezuidenhout & grobler 2017). affective commitment is regarded as an employee’s ‘emotional attachment to, identification with, and involvement in the organisation’ (meyer & allen 1997:67). it is regarded as an emotional attachment that employees feel toward the organisation and their jobs, and the desire to stay loyal (mei, ong & pei 2017; meyer & allen 1997). in a study by jafri (2010), ac is positively related to innovative behaviour, and continuance commitment is negatively related to innovative behaviour. the last variable of concern is we. many scholars have offered a definition for we over the years, but schaufeli et al. (2002) have offered the most accepted definition. engagement is defined as a ‘positive, fulfilling, work-related state of mind that is characterised by vigour, dedication, and absorption’ (schaufeli et al. 2002:74). according to agarwal (2014) and agarwal et al. (2012), we correlates positively with innovative behaviour. these authors also provide evidence that we mediates the relationship between leader-member exchange and innovative behaviour, and partially mediates intention to quit (agarwal et al. 2012). interestingly, tl, ce climate, pp, ac and we are important contributors to innovation which is quite apparent from the literature above. theoretically, the study considers the general systems theory and the input-transformation-output model, which in their simplest form indicate that these variables may be related (kast & rosenzweig 1972; teece 2018). the literature is however not clear on the nature of the relationship between these variables, particularly if they are modelled together. method population, sampling and data collection included in this study are employees from medium-sized to large (more than 60 employees) south african organisations only. many organisations were requested to participate; finally 53 of these organisations agreed and a total of 3180 completed questionnaires were returned. the sample for the 53 selected organisations was not random, but rather a convenience sample. once the organisations had been identified, 60 respondents were selected at random from each of the organisation’s employee records (n = 3180). this data was collected manually through paper-based questionnaires as part of a research project led by the second author of the study. ultimately, the sample comprised 3180 employees employed by 53 organisations within south africa, representing the private sector, parastatals and government departments. the data was gathered as per the ethics guidelines of the university of south africa (unisa), and authorisation was obtained from the unisa research ethics review committee to use the data as secondary data. research approach this study made use of a cross-sectional survey design, centring on quantitative data. a quantitative research approach is appropriate for the nature of this study as it freely permits the formation of relationships among variables (bryman 2012; punch 2005). this article focuses specifically on secondary data for the quantitative research analysis. measuring instruments seven instruments were used in the analysis, namely the quality of a performance appraisal system questionnaire (pa; steyn 2010), the individual innovative behaviour questionnaire (iib; kleysen & street 2001), the utrecht work engagement scale-9 (we; schaufeli & bakker 2004), a part of the organisational commitment scale, specifically the affective commitment scale portion (ac; allen & meyer 1990), the proactive personality scale (pp; bateman & crant 1993), a part of the leadership scale, specifically the transformational leadership scale portion (tl; wolins 2012), and the brief corporate entrepreneurship assessment instrument (ce; strydom 2013): the pa questionnaire, created by steyn (2010), was used to evaluate the perceived efficacy of pa systems in organisations. the questionnaire was based on human resource management literature (cascio 2010; grobler et al. 2006; swanepoel et al. 2008) which describes the characteristics of an effective pa system. grobler et al. (2006) provide a full list of necessities for an effective pa system, and the majority of the literature was therefore adapted from these authors. the pa questionnaire comprised 18 statements designed to prompt the respondent’s views on the pa process. respondents had to specify their views for each item on a five-point scale ranging from 1 to 5 as follows: 1 (absolutely false – this is true in +/10% of all cases), 2 (somewhat false – this is true in +/35% of all cases), 3 (neither true nor false), 4 (somewhat true – this is true in +/75% of all cases), and 5 (absolutely true – this is true in +/90% of all cases). the lowest score that could be achieved was 18, and the highest was 90. a high score indicates that a traditionally defined pa system was in place and working effectively, while a low score indicates that the respondents were convinced that a traditionally defined pa system was not working in their organisation (steyn 2010). furthermore, steyn reports a cronbach’s alpha of 0.84, indicating internal consistency, and significant correlations (in the expected direction) with results such as turnover intentions (r = 0.311; p < 0.01), job satisfaction (r = 0.281; p < 0.01) and employee engagement (r = 0.318; p < 0.01). the iib questionnaire by kleysen and street (2001) was chosen to quantify iib. according to kleysen and street, there is a lack of studies on a multidimensional measure of iib. the iib questionnaire contains 14 questions, randomly itemised to avoid possible response order bias. respondents had to indicate their views for each question on a six-point scale ranging from 1 (never) to 6 (always). the lowest score that could be obtained was 14 and the highest 84. each of the 14 items was prefaced with the following question: ‘in your current job, how often do you …’ (kleysen & street 2001:288). kleysen and street report that a measure of inter-correlation between the 14 questions resulted in a cronbach’s alpha of 0.95 and good construct validity. all five factors are strongly correlated with each other, with the highest correlation being between application and formative investigation (r = 0.81; p < 0.01) and the lowest between championing and generativity (r = 0.68; p < 0.01). kleysen and street thus suggest that the 14 items can be combined into a single measure of innovative behaviour, and this was done for this research. according to schaufeli and bakker (2004), and schaufeli, bakker and salanova (2006), the we scale includes the three founding facets of we: vigour, dedication and absorption. this questionnaire consisted of nine statements (three vigour statements, dedication statements and absorption statements) that are randomly listed to avoid potential response order bias. respondents were requested to indicate their views for each statement on a seven-point scale ranging from 0 to 6 as follows: 0 (never – never), 1 (almost never – a few times a year or less), 2 (rarely – once a month or less), 3 (sometimes – a few times a month), 4 (often – once a week), 5 (very often – a few times a week), and 6 (always – every day). schaufeli and bakker report that for all nine statements, the cronbach’s alpha varies from 0.85 to 0.94 (median = 0.91) across studies done in nine countries. schaufeli and bakker further explain that the cronbach’s alpha value for the total data set was 0.9. schaufeli et al. (2006:701) state that the ‘factorial validity of the we scale was demonstrated using confirmatory factor analysis and the three scale scores have good internal consistency and test-retest reliability’. the organisational commitment scale is used to measure organisational commitment, and the questionnaire consists of 24 items. the focus will be on ac rather than normative or continuance commitment, as lamba and choudhary (2013), and wright and kehoe (2007) indicate that ac is far more important to hrps and organisational performance. the ac scale portion of the questionnaire consists of eight items. respondents were requested to indicate their views for each item on a seven-point scale as follows: 1 (strongly disagree), 2 (moderately disagree), 3 (slightly disagree), 4 (neither agree nor disagree), 5 (slightly agree), 6 (moderately agree), and 7 (strongly agree). the minimum score on the ac scale portion of the questionnaire would be 8 and the maximum 56. a high score would indicate that respondents are of the view that there are high levels of commitment and a low score would show low commitment. allen and meyer (1990) report that the reliability (that is, coefficient alpha) for the ac scale is 0.87 and the internal consistency is 0.86. meanwhile, steyn (2012) reports a cronbach’s alpha of 0.82 for the organisational commitment scale. allen and meyer further explain that convergent validity is evident since the organisational commitment scale correlated significantly with the ac scale. the pp scale, developed by bateman and crant (1993), comprised 17 statements designed to elicit the respondent’s views on proactive behaviour. respondents were invited to indicate their views for each statement on a five-point scale ranging from 0 to 4 as follows: 0 (strongly disagree), 1 (disagree), 2 (not sure), 3 (agree), and 4 (strongly agree). the lowest score that could be obtained was 0 and the highest 68. bateman and crant report internal reliability with a cronbach’s alpha of 0.89. by the same token, bateman and crant argue that the proactive scale was significantly correlated to all three criterion variables, which is indicative of criterion validity, while discriminant validity was exposed between the proactive scale and intelligence, neuroticism, agreeableness, openness, private self-consciousness and locus of control. the leadership scale questionnaire developed by avolio, bass and jung (1999) is used to assess transactional and tl and consists of 21 items. the focus will be on tl rather than transactional leadership, as sethibe and steyn (2016) indicate that there is no direct relationship between transactional leadership and innovation, whereas tl is positively and significantly related to innovation. the tl scale portion of the questionnaire consists of 12 items, as described by wolins (2012), and only this part was utilised for this research. respondents were requested to indicate their views for each item on a five-point scale ranging from 0 (not at all) to 4 (frequently, if not always). the minimum score on the tl scale portion of the questionnaire would be 0 and the maximum 48. strydom (2013) reports reliability with a cronbach’s alpha of 0.87, while sethibe and steyn report a cronbach’s alpha of 0.94 for the tl scale portion. antonakis, avolio and sivasubramanian’s (2003) results indicate that the leadership scale questionnaire is both reliable and valid. the ce instrument by strydom (2013) was chosen to quantify ce climate. the ce instrument consists of 20 items and respondents were requested to indicate their views for each item on a scale ranging from 1 (strongly disagree) to 5 (strongly agree). the minimum score on the ce instrument would be 20 and the maximum 100. a high score would indicate that respondents are of the view that there are high levels of entrepreneurial support in the organisation, while a low score would show low support for entrepreneurship (strydom 2013). strydom reports an adequate reliability score (cronbach’s alpha = 0.810) for the total ce instrument, while also reporting cronbach’s alphas of 0.731, 0.825, 0.740, 0.689 and 0.574 for the subsections management support, work discretion, rewards, time available and organisation boundaries. outcomes with regard to the organisation boundaries subsection should be viewed with some caution, particularly due to its cronbach’s alpha being below 0.6. entrepreneurial spirit intensifies with a rise in employee engagement, commitment and job satisfaction and this is indicative of concurrent validity (strydom 2013). furthermore, strydom reports that, when the factor analysis was concluded, all items loaded as expected, with values above 0.5 suggesting factorial validity for the ce instrument. conceptual model the proposed model (figure 1) was tested with the process macro for the statistical package for social science (spss). figure 1: performance appraisal-innovation model with mediator and moderator variables. hypotheses the following are the hypotheses developed in this study: model 1: the relationship between pa and iib (where pa relates to iib) is mediated by we and ac, and moderated by pp model 2: the relationship between pa and iib (where pa relates to iib) is mediated by we and ac, and moderated by tl model 3: the relationship between pa and iib (where pa relates to iib) is mediated by we and ac, and moderated by ce each of the hypotheses was evaluated in the process macro for spss to obtain the best-fit pa-innovation model. statistical analysis firstly, the standard spss was employed to compute demographic characteristics, descriptive and reliability statistics. then, the process macro for spss was used for the conceptual model assessment. for descriptive statistics, frequencies and percentages were calculated to provide respondents’ demographic characteristics. then, basic descriptive statistics were calculated for the independent and dependent variables. these included means and standard deviations. cronbach’s alpha coefficients as a measure of internal consistency were also calculated to confirm the reliability of all constructs of the validated instruments. hair et al. (2009), and montshiwa and moroke (2014) recommend that reliability is suitable when the alpha is greater than 0.6. therefore, all instruments with a cronbach’s alpha above 0.6 were deemed to hold satisfactory reliability. the mediation and moderation models were assessed with the process macro for spss developed by hayes (2013). process performs centring automatically and also utilises bootstrapping to calculate standard errors and confidence levels for the significance of effects. model estimation in process is typically undertaken with ordinary least squares regression-based path analysis, but it is taken further with conditional process analysis, a class of models that allows mechanisms (that is, indirect effects in a path model) to vary systematically as a function of one or more moderator variables. latent variables were not modelled in process as in structural equation modelling but rather the calculated averages. the sobel test was used to test the significance of the mediation effect. the cut-off point for statistical significance was taken as p < 0.01. preacher and hayes (2004) indicate that the sobel test functions well only in large samples, and the sample size in this study is relatively large (n = 3180). the models that were tested contained two mediators and one moderator as illustrated in figure 1. ethical consideration ethics approval was granted by the university of south africa, school of business leadership research ethics review committee on 24 april 2018 for the study with the ethics clearance number: 2018_sbl_dbl_003_sd. results respondents demographic characteristics the data was drawn from the responses of 3180 employees from 53 organisations within south africa, representing the private sector, parastatals and government departments. gender the respondents were categorised into the two recognised gender groups. the 2016 quarterly labour force survey shows that the gender demographic across south africa as a whole is almost equally spread (statistics south africa 2016), and this is very much in line with the gender sample in this study. a total of 1771 (55.7%) respondents listed their gender as male and 1372 (43.1%) registered their gender as female, while data was missing for 37 (1.2%). race respondents were categorised into four common race groups and this data is in line with the quarterly labour force survey in the sense that, in the larger south african context, black people make up the major workforce group, followed by white people, coloured people and asian people in descending order (statistics south africa 2016). a total of 263 (8.3%) respondents indicated their race as asian, 1830 (57.5%) black, 263 (8.3%) coloured and 787 (24.7%) white, while data was missing for 37 (1.2%). age the 2016 quarterly labour force survey indicates that the age of the south african workforce ranges from 15 to 64 years (statistics south africa 2016), and this closely lines up to the respondents in this study whose ages range from 20 to 72 years, with a mean of 37.81 and a standard deviation of 9.10. educational qualifications a total of 934 (29.4%) respondents hold a bachelor’s degree or higher, 1274 (40.1%) possess a diploma, 789 (24.8%) have matric, and 143 (4.5%) have less than 12 years of schooling, while data was missing data for 40 (1.3%). management and tenure those in management positions totalled 1156 (36.4%) and those in non-management positions represented 1983 (62.4%), while data was missing data for 41 (1.3%). as far as tenure at their present company is concerned, this varied between 1 month and 42 years, with a mean of 8.49 and a standard deviation of 7.45. economic sectors the organisations were categorised into three sectors. a total of 1981 (62.3%) respondents fall within the private sector, 480 (15.1%) are parastatal and 719 (22.6%) are government departments, for example the department of trade and industry, the department of tourism, and so on. from the above mentioned respondents’ demographic characteristics, it is evident that the respondents represent a broad cross-section of the south african workforce. descriptive data presented in table 1 is the total number of observations, means, standard deviations and cronbach’s alphas of all variables contained within this study. table 1: descriptive data (n = 3180). the means and standard deviations presented in table 1 can serve as baseline information for future studies. however, the different instrument scores varied, with tl showing the lowest mean (mean = 2.516; standard deviation = 0.972; number of observations = 3139) and ce showing the highest (mean = 65.743; standard deviation = 9.321; number of observations = 3180). the reliability information presented in the last column of table 1 is important and will be discussed below. reliability also illustrated in table 1, the pa instrument registers a high cronbach’s alpha of 0.930. reliability was computed for the iib instrument, which resulted in cronbach’s alphas of 0.951. reliability for the pp instrument was 0.843 and, for the ce instrument the cronbach’s alpha was 0.762. also, reliability for the tl instrument was 0.946 and, for the we instrument was 0.900. lastly, for the ac instrument, the resulting cronbach’s alpha was 0.806. all seven instruments have a cronbach’s alpha above 0.6, which suggests that the reliability of all instruments is acceptable. model assessment results the output of the mediation and moderation analysis is presented below, per hypothesis. model 1 baron and kenny’s (1986) four steps for mediation are summarised below (supported by the sobel test). step 1: the effect of the independent variable (pa) on the dependent variable (iib) is equal to 0.0524 (p < 0.0001), with a 95% confidence interval of 0.0256–0.0791. therefore, pa has a non-zero relationship with iib since it was statistically significant in the analysis. the results from step 1 indicate that mediation is possible, and that pa has a significant influence on iib. step 2: the effect of pa on we is equal to 0.2338 (p < 0.0001), with a 95% confidence interval of 0.2133–0.2543. the effect of pa on ac is equal to 0.2599 (p < 0.0001), with a 95% confidence interval of 0.2401–0.2797. therefore, pa has a non-zero relationship with both we and ac since it was statistically significant in the analysis. the results from step 2 indicate that mediation is possible. step 3: the effect of we on iib controlling for pa is equal to 0.2970 (p < 0.0001), with a 95% confidence interval of 0.2516–0.3425. the effect of ac on iib controlling for pa is equal to 0.1322 (p < 0.0001), with a 95% confidence interval of 0.0872–0.1771. both we and ac have a non-zero relationship with iib since it was statistically significant in the analysis. the results from step 3 indicate that mediation is possible. step 4: the effect of pa on iib controlling for both we and ac is equal to 0.0522 (p < 0.0001), with a 95% confidence interval of 0.0254–0.0789 and a total mediation effect of 0.1038 (indirect effect). effects (we and ac): the bootstrap estimated indirect effect of both mediators of pa on iib is equal to 0.1038, and the direct effect is equal to 0.0522. the 95% bias-corrected bootstrap confidence interval (5000 trials) for the indirect effect is 0.0882–0.1208, and since zero is not in the confidence interval, it can be concluded that the indirect effect is significantly different from zero. summary: the direct effect from pa to iib equals 0.0524 and is statistically significant (p < 0.0001). the indirect effect from pa to iib equals 0.1038 and is statistically significant. there is evidence of mediation of the effect of pa on iib given that the indirect effect is statistically significant. the results are supported by the we sobel z value of 15.6373 (p < 0.0001), and the ac sobel z value of 10.1179 (p < 0.0001). the interaction is equal to 0.0013 (p < 0.3232) which denotes that pp has a weak moderation effect, and it is also not significant. model 2 baron and kenny’s (1986) four steps for mediation are summarised below (supported by the sobel test). step 1: the effect of pa on iib is equal to 0.0812 (p < 0.0001), with a 95% confidence interval of 0.0486–0.1138. therefore, pa has a non-zero relationship with iib since it was statistically significant in the analysis. the results from step 1 indicate that mediation is possible, and that pa has a significant influence on iib. step 2: the effect of pa on we is equal to 0.2375 (p < 0.0001), with a 95% confidence interval of 0.2169–0.2581. the effect of pa on ac is equal to 0.2628 (p < 0.0001), with a 95% confidence interval of 0.2429–0.2828. therefore, pa has a non-zero relationship with both we and ac since it was statistically significant in the analysis. the results from step 2 indicate that mediation is possible. step 3: the effect of we on iib controlling for pa is equal to 0.4487 (p < 0.0001), with a 95% confidence interval of 0.3999–0.4976. the effect of ac on iib controlling for pa is equal to 0.0868 (p < 0.0006), with a 95% confidence interval of 0.0371–0.1365. both we and ac have a non-zero relationship with iib since it was statistically significant in the analysis. the results from step 3 indicate that mediation is possible. step 4: the effect of pa on iib controlling for both we and ac is equal to 0.0697 (p < 0.0001), with a 95% confidence interval of 0.0381–0.1014 and a total mediation effect of 0.1294 (indirect effect). effects (we and ac): the bootstrap estimated indirect effect of both mediators of pa on iib is equal to 0.1294, and the direct effect is equal to 0.0697. the 95% bias-corrected bootstrap confidence interval (5000 trials) for the indirect effect is 0.1111–0.1493, and since zero is not in the confidence interval, it can be concluded that the indirect effect is significantly different from zero. summary: the direct effect from pa to iib equals 0.0812 and is statistically significant (p < 0.0001). the indirect effect from pa to iib equals 0.1294 and is statistically significant. there is evidence of mediation of the effect of pa on iib given that the indirect effect is statistically significant. the results are supported by the we sobel z value of 15.6373 (p < 0.0001), and the ac sobel z value of 10.1179 (p < 0.0001). the interaction is equal to 0.0816 (p < 0.0001) which denotes that tl has a strong moderation effect, and it is also significant. model 3 baron and kenny’s (1986) four steps for mediation are summarised below (supported by the sobel test). step 1: the effect of pa on iib is equal to 0.0596 (p < 0.0001), with a 95% confidence interval of 0.0301–0.0891. therefore, pa has a non-zero relationship with iib since it was statistically significant in the analysis. the results from step 1 indicate that mediation is possible, and that pa has a significant influence on iib. step 2: the effect of pa on we is equal to 0.2338 (p < 0.0001), with a 95% confidence interval of 0.2133–0.2543. the effect of pa on ac is equal to 0.2599 (p < 0.0001), with a 95% confidence interval of 0.2401–0.2797. therefore, pa has a non-zero relationship with both we and ac since it was statistically significant in the analysis. the results from step 2 indicate that mediation is possible. step 3: the effect of we on iib controlling for pa is equal to 0.4371 (p < 0.0001), with a 95% confidence interval of 0.3884–0.4857. the effect of ac on iib controlling for pa is equal to 0.0715 (p < 0.0040), with a 95% confidence interval of 0.0228–0.1202. both we and ac have a non-zero relationship with iib since it was statistically significant in the analysis. the results from step 3 indicate that mediation is possible. step 4: the effect of pa on iib controlling for both we and ac is equal to 0.0579 (p < 0.0001), with a 95% confidence interval of 0.0284–0.0874 and a total mediation effect of 0.1208 (indirect effect). effects (we and ac): the bootstrap estimated indirect effect of both mediators of pa on iib is equal to 0.1208, and the direct effect is equal to 0.0579. the 95% bias-corrected bootstrap confidence interval (5000 trials) for the indirect effect is 0.1026–0.1404, and since zero is not in the confidence interval, it can be concluded that the indirect effect is significantly different from zero. summary: the direct effect from pa to iib equals 0.0596 and is statistically significant (p < 0.0001). the indirect effect from pa to iib equals 0.1208 and is statistically significant. there is evidence of mediation of the effect of pa on iib given that the indirect effect is statistically significant. the results are supported by the we sobel z value of 15.6373 (p < 0.0001), and the ac sobel z value of 10.1179 (p < 0.0001). the interaction is equal to 0.0098 (p < 0.0001) which denotes that ce has a weak moderation effect, and it is also significant. the overall results of the model assessment are summarised in table 2. table 2: summary of the hypothesised results. as revealed in table 2, some of the hypotheses related to iib were accepted. the strongest model was model 2, providing the best evidence of the relationship between the selected variables. it is also evident from the results that pa has the most significant influence on iib in model 2. furthermore, tl and we are thus the primary concern in an optimal pa-innovation model. discussion although many models on the pa-innovation link are available, complex models are limited. some of these complex models were tested in this study. the south african context may be unique, given the legislative framework within which pa is administered. evidence of empirical research testing different complex models on the pa-innovation relationship is seemingly lacking, particularly within the south african environment. this study provided clarity on the specific pa-innovation models applicable within the south african context. the respondents represented the south african workforce well, in as far as gender, race and age were concerned. in addition, the demographic characteristics of the respondents were closely related to the information presented in the quarterly labour force survey publication (statistics south africa 2016). this study used a relatively large sample consisting of 3180 employees from 53 organisations for the analysis. seven variables were included in the model, namely pa, iib, pp, tl, ce, we and ac. the results reveal that pa directly influences innovation in all three models. furthermore, pa has the most significant influence on innovation in model 2. the pa-innovation relationship is mediated by we and ac, with we having the greatest effect. transformational leadership and ce moderate the pa-innovation relationship, with tl having the strongest effect and ce having almost no effect. this is consistent with the research conducted by oke et al. (2009), sethibe and steyn (2016), and tipu et al. (2012). several empirical studies provide evidence that there is a strong connection between innovation and climate (lin & liu 2012; michaelis et al. 2010; shanker et al. 2012), which is not aligned with the results in this study. furthermore, pp does not moderate the pa-innovation relationship, which is inconsistent with the results of studies by seibert et al. (2001), and tai and mai (2016). the results showed an enhancing effect: as pa and tl increased, innovation increased. presented in figure 2 is a revised model on the pa-innovation link. figure 2: revised performance appraisal-innovation model with mediators and moderators. in figure 2, pp is the grey dotted parts of the model, as this stated model did not materialise. application of the present statistical tools revealed that pa directly influences iib. the study shows the importance of including we, ac and especially tl when investigating the pa-innovation relationship. the results indicate the importance of using pa to enhance innovation. in a study by jafri (2010), ac is positively related to innovation which is partially aligned with the results in this study. it is evident that tl has a much bigger part to play in enhancing innovation. managing employees with tl practices and instilling we may be at the root of innovation in organisations. according to the literature, pp is theorised to be the basis of innovative behaviour (fuller & marler 2009; seibert et al. 2001), which is not consistent with the results of this study. the revised model makes a significant contribution to understanding the pa-innovation link. theoretical implications the pa-innovation relationship and the various variables included in the model were justified through the general systems theory and the input-transformation-output model. not all variables were found to contribute equally to innovation, and the nature of the contribution was specified. the research thus contributes to academic literature and theory on the pa-innovation link within the south african context, where no prior studies of this nature, complexity and using this method have been conducted in one report. this study has led to an increase in knowledge and the unveiling of optimal models on the pa-innovation relationship. a valuable contribution to the body of knowledge was made as a best-fit pa-innovation model has been specified. applying a specific set of mediator and moderator variables to enhance innovation is evident. practical implications the outcomes of this study are expected to be of value to all stakeholders and may perhaps assist human resources practitioners and managers to appropriately assign resources to particular organisational variables, thereby enhancing innovation within organisations. it is evident that tl has a much larger role to play in enhancing innovation than pp or ce. recruitment of proactive employees, managing these employees with tl practices and instilling a culture of ce may be at the root of innovation in organisations. however, managers should focus on managing employees with tl practices to effectively drive innovation within the organisation as tl has the largest positive impact on the pa-innovation relationship. this evidence-based information would assist managers to increase innovative behaviour, performance, the competitive advantage, organisational success, growth and organisational survival accordingly. limitations it is advisable to acknowledge the various restrictions of a study when interpreting the outcomes of that study. this investigation was subject to several particular limitations that merit mentioning. the first limitation is that it makes use of a cross-sectional survey design, focusing on quantitative data. levin (2006) proposes that cross-sectional studies are carried out at a specific point in time and offer no hint of the sequence of events, thus making it impossible to infer causality from the study. however, to overcome the limitations of a cross-sectional study, a longitudinal or experimental design is proposed. only respondents’ perceptions were used which posed the second limitation. had managers or supervisors been included in the reporting, or had organisational statistics, such as registered patents, been used, the results may have been more explanatory. therefore, multi-source and multi-method research is suggested to future researchers. another limitation of the study is that respondents represented the south african labour force as a single unit. thus, additional research is suggested in this regard as it can be anticipated that there might be differences per organisation and also sector-wide. the fourth limitation was the sampling. organisations from the different economic sectors were treated as homogenous. to overcome this limitation, it is suggested that future research be conducted per economic sector as organisations are different and experience varied dynamics and trajectories. the range for generalising the results is limited due to the use of a convenience sample. however, to overcome this limitation, respondents were selected at random from each organisation, each of these organisations varied in size and economic sector (private sector, parastatals, and government departments). acknowledgements competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions n.g.m. was the main author of the article. r.s. was the supervisor of n.g.m and the co-author of the article. funding information this research received no specific grant from any funding agency in the public, commercial or not-for-profit sector. data availability statement quantitative data was used in this study and this data is available on written request. disclaimer the views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of any affiliated agency of the authors. references abbaspour, p., 2015, ‘effect of strategic orientation and hrm strategies on organisational strategic performance: examining mediating role of strategic learning and innovation’, an international peer-reviewed journal (trends in life sciences) 4(4), 125–132. agarwal, u.a., 2014, ‘linking justice, trust and innovative work 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rothmann school of human resource sciences, potchefstroom university for che jc rothmann s buys training academy, potchefstroom ________________________________________________________________ abstract changes that impact on organisations require of managers to accept responsibility for their self-development to remain effective. the aim of this research was to evaluate a self-development programme for managers in a corporate pharmacy group. a two-group true experimental design with pre-, post, and post-post testing was used. a total of 35 managers were randomly divided into an experimental (n = 18) and control group (n = 17). the following measuring instruments were used for the evaluation of the programme: the personal orientation inventory, the generalised perceived self-efficacy scale, the cope-questionnaire and a knowledge test. the results showed that participants showed higher synergy and feeling reflection and greater selfefficacy following the self-development programme. jel m00 1 introduction managers increasingly face higher career demands. this is true for various professions, including pharmacists. ferguson (1998) states that pharmacists must not only make a commitment to life-long professional development but also demonstrate an ability to adapt to developments in pharmacy, medic ine and all other health-related disciplines. grant (2000) emphasises that the striving for continuing professional development should be an internal quality of professionals and that they should naturally adapt to the concept of development and competence. möller, rothmann, rothmann, coetzer and swart (2000) recommended that development programmes for managers in pharmacy groups should start with self-development. a self-development programme forms the basis on which sajems ns vol 6 (2003) no 1 51 other training and development programmes for managers could build. a manager’s effectiveness flows from his or her intraand interpersonal effectiveness (amos & mather, 1998), which are important aspects of selfdevelopment. research in a corporate pharmacy group shows that most of the managers (who were trained as pharmacists) prefer a quiet environment, dislike intrusions and interruptions and experience some problems communicating (rothmann, rothmann, van rensburg & malan, 2000). the above-mentioned personality characteristics are probably encouraged by pharmacy schools (rothmann, basson & rothmann, 2000) and may inhibit pharmacy managers from developing the competencies required for the roles they have to fulfil (davidson, 2000). möller et al. (2000) express concern that the pattern of introversion, neuroticism, a practical approach and inflexibility, combined with situational demands, role overload and pharmacists’ responsibility for management and care, may result in resistance to change, interpersonal difficulties, an inability to control impulses, burnout and eventually impairment. therefore, self-development programmes are necessary to stimulate the self-awareness, self-regard, self-acceptance, flexibility and interpersonal effectiveness to prevent the above-mentioned problems. self-development is also referred to as self-actualisation or psychologically optimal functioning (rothmann & sieberhagen, 1997). psychologically optimal functioning is defined as a positive and dynamic development process through which individuals reach clear self-concepts through feedback from the environment, where they can regard themselves positively while self-objectivity is still possible, and where they can have more effective interaction with the world surrounding them (rothmann, 1999). research (cilliers & wissing, 1993; rothmann & sieberhagen, 1997) shows that methods directed at facilitating psychologically optimal functioning are applicable to the stimulation of selfdevelopment. various theories could be used to conceptualise self-development. analytical theory (jung, 1971) focuses on opposing sub-systems (attitude and functions) within a person as a point of departure for self-development. a balance between these polarities and the transition of an outwardly-directed adaptation to an inwardly-directed adaptation can lead to a feeling of control over self and the external environment (meyer, moore & viljoen, 1994). jung’s theory (1971) relates the individuation process to self-development. individuation not only comprises the initial development of dominant attitudes and functions, but also involves the consciousness of non-dominant attitudes and functions that lead to better adaptation and relationships (day & matthes, 1992). exposure to a form of sensitivity training eases this individuation process as individuals are encouraged to consciously experience their non-dominant attitudes and sajems ns vol 6 (2003) no 1 52 functions through continuous feedback from others. the consciousness of blind spots in the psyche leads to self-awareness (day & matthes, 1992). self-development can take place through programmes directed at the stimulation of personal growth (including self-knowledge, self-esteem, self-efficacy and resilience) and coping (strümpfer, 2000). self-development is also a prerequisite for interpersonal effectiveness (rothmann & sieberhagen, 1997). interpersonal effectiveness could be improved by training in interpersonal skills and facilitative communication. rogers's person-centred theory (1961) offers a structure for individual and group counselling aimed at self-development. according to this theory the individual moves away from the idea of living according to the standards of others towards the perception of him/herself as a self-directed person with standards and values formulated through own experiences (rogers, 1973). rothmann, sieberhagen and cilliers (1998) found that individuals accept greater responsibility based on the application of the methods of this theory in a training programme. related to this, cilliers and wissing (1993) found that a development programme in sensitive relating contributes to psychological optimality. various self-development programmes were found in the literature. jorgensen and rothmann (1998), rothmann and sieberhagen (1997), rothmann, sieberhagen and cilliers (1998) and rothmann (1999) evaluated selfdevelopment programmes that were directed at the intraand interpersonal effectiveness of facilitators. furthermore, olivier and rothmann (1999) and els, linde and rothmann (2001) evaluated self-development programmes directed at the stimulation of an internal locus of control. although these development programmes showed promising results, none of them were directed at stimulating self-development of managers in a corporate pharmaceutical environment. therefore a need exists to develop and evaluate a selfdevelopment programme that is tailor-made for a corporate pharmaceutical group. the general objective of this research was to determine the effect of a selfdevelopment programme for managers in a corporate pharmaceutical environment. 2 theoretical background the ever-increasing changes in the political, social and economic environment have led organisations to recognise the need of continuously developing and investing in their employees. in response to this challenge there has been a stream of initiatives and ideas which have sought to promote ways in which sajems ns vol 6 (2003) no 1 53 employee development can be better integrated with organisational development, to form part of the corporate strategy. since senge (1990) placed the focus on creating “learning organisations”, there has been a renewed interest in human resource development issues like improved communication, involvement and participation, development rather than training and staff empowerment. the emphasis on learning as a competitive advantage has renewed the importance of self-direction and personal responsibility in the development process. out of a myriad of principles that underpin employee development debates, two principles stand out among the rest, namely self-development and self-directed learning (antonacopoulou, 2000: 492). both these principles suggest that employees have the “power” to choose what to learn and how to develop themselves. this perspective is consistent with research observations (boydell, 1976; cunningham, 1999; sutcliffe, 1988) that suggest that individuals cannot be forced to learn or develop against their will. based on the principles of adult learning (knowles et al., 1998), self-development emphasises choice and direction, and aligned to the tenet of human resource management it concentrates on the development of the individual rather than the collective. unlike traditional development methods based on instruction and systematic training interventions, self-development has much in common with experiential and action learning theories which emphasise reflection, experimentation and a “meta-level” of understanding (bova & kroth, 2001; mumford, 1988; revans, 1980). therefore, key elements in the process of self-development are selfawareness, reflection and experimentation. the penguin dictionary of psychology (reber, 1995: 702) defines selfdevelopment as “… generally, growth of self, movement toward emotional and cognitive maturity” and “… in maslow’s model, progress toward selfactualisation”. knowles clearly identifies andragogy as being rooted in humanistic and pragmatic philosophy, reflected by the influence of maslow and rogers (holton, swanson & naquin, 2001). as suggested by pedler and boydell (1980, 1981) and pedler (1984, 1988) the uniqueness of self-development as a process of growth lies in the synthesis of three important dimensions, namely the concept of development, the notion of the whole person and personal responsibility. the first dimension underlying the meaning of self-development is the association with the broader concept of development (for example the changes in the social structures that affect the individual’s life span) (haareven & adams, 1982; hurley, 2002). researchers exploring the structure of the development process have argued that develo pment is a life-long process that involves gradual, incremental improvements and brusque revolutionary steps sajems ns vol 6 (2003) no 1 54 (lievegoed, 1980). each step influences the way individuals construct meaning about themselves and their experiences (boydell, 1982). if experiences are going to result in developmental outcomes, the individual must be able to employ the necessary skills and resources to seek such experiences and to turn them into meaningful life events (hurley, 2002; kolb, 1984). therefore, the focus of development within the self-development process is change, innovation and learning that take place, and not just the quantitative, incremental acquisition of knowledge and skills (collin, 1994). the second dimension of self-development is the emphasis on the whole person (i.e. the development of “self”) and suggests that development is meaningful to the individual when personally significant goals are being pursued (knowles, holton & swanson, 1998; murphy & young, 1995). pedler and boydell (1980: 171) point out that: “self-development takes place when the individual finds significance and personal meaning from particular events or experiences resulting from their actual or symbolic interaction with some part of their environment”. therefore, when setting self-development goals, the individual cannot be separated from what he or she is doing. self-development should aim to integrate the person and the job role. the development process acquires meaning from the integration of the specific knowledge and skills relevant to the particular role and the feelings, intentions and actions of the individual. the third dimension of self-development is personal responsibility. a central characteristic of self-development is choice on the part of the individual. unlike conventional development processes that treat individuals as passive recipients, self-development places the individual at the forefront of the development process. the underlying argument is that development is not a matter of expertise, but a matter of a personal willingness and determination to commit oneself to a process that the individual values and believes in (bagshaw & bagshaw, 2002; hurley, 2002; murphy & young, 1995; pedler, 1984). the individual is therefore free to choose the goals, decide how to achieve them, initiate action for achieving them and evaluate success (megginson & whitaker, 1998; pedler, burgoyne, & boydell, 1986). this dimension of self-development places the individual in control (in theory at least) of the self-development process. the business argument for self-development rests on the idea that corporate survival in a rapidly changing economic environment requires resilient, changeoriented employees (stickland, 1996: 33). the process of self-development generates a change mentality by first encouraging individuals to seek and foster change within themselves. this leads to the habit of learning to learn, and if conducted in the workplace the process becomes assimilated into the work ethic. thus, people learn to be flexible and adaptable in meeting new business sajems ns vol 6 (2003) no 1 55 challenges. self-development enables the organisation to keep up with the dynamics of change as it encourages managers to think positively about change and improvement (temporal, 1984). moreover, self-development encourages participation and may increase individuals’ commitment to the organisation. according to temporal (1984), from the individual’s point of view, selfdevelopment can enhance self-confidence and help to develop latent abilities that could improve initiative and work performance. self-development could help individuals become more forthcoming and more prepared to speak their minds, which may improve their ability to solve problems and provide them with a broader outlook. furthermore, self-development can encourage individuals to be more constructive in their relationships and motivate them to improve themselves. the psychological contract is changing and it is no longer based on loyalty, commitment and life-long employment (herriot, pemberton & hawtin, 1996). the “new” psychological contract centres on concepts such as self-sufficiency, self-responsibility and mutual viability. it aligns itself with the global business pulls towards autonomy and accountability as perceived in an era of restructuring lazy organisations and setting up independent business units to survive and contribute, or to be dispensed with immediately (volpe, 1999: 30). based on the definition of self-development, the aim of a self-development programme is to move participants to an optimal, or at least a higher, state of psychological functioning. the characteristics of psychologically optimal functioning can be divided into intraand interpersonal characteristics: intra-personally the optimally functioning individuals make sense out of life by judging internal and external stimuli as ordered, structured and consistent (viviers, 1999). by means of control they handle external stimuli in daily life. they are integrated and self-sufficient, function in the here-and-now, apply their values in a flexible way, are sensitive to their emotions and show them spontaneously, without being compulsive or impulsive (raskin & rogers, 1989). their self-image is characterised by self-acceptance and positive selfregard (raskin & rogers, 1989). the optimally functioning person accepts responsibility for what he or she does, for choices made and attitudes taken (frankl, 1978; raskin & rogers, 1989). in his or her working life this person has an active relationship with the organisation, is motivated towards his or her work and goals, and tries to perform to the best of his or her ability in order to perform (viviers, 1999: 24). furthermore, the optimally functioning person uses problem-focused strategies to cope with demands, that is, his or her actions taken during stressful events are aimed at changing the circumstances of the stressful event through problem-solving and seeking social support (patterson, 2000: 277). sajems ns vol 6 (2003) no 1 56 the psychologically optimally functioning person maintains interpersonal relationships and social contact with different groups of people in society. this steady social tie with the broader community helps with status integration, coping with life problems and vital readjustment (viviers, 1999: 24). in interpersonal relations the person who has undergone training in sensitive relation forming and facilitative communication will exhibit the elements fundamental to the process: empathy, respect, genuineness and concreteness. 3 method 3.1 research design a two-group design with a pre-, postand post-post-test was used (see figure 1). figure 1 the research design group pre-test intervention post-test post-post-test experimental group y1 xa y2 y3 control group 1 y1 xb y2 y3 where xa = self-development programme xb = no self-development programme 3.2 the self-development programme the course manual was handed out to all participants one month prior to the workshop. participants were requested to study the contents of the manual in preparation for the workshop, because time and work constraints made it difficult to engage pharmacy personnel in a full-time course. the programme for the workshop is given in table 1. sajems ns vol 6 (2003) no 1 57 table 1 workshop programme time activity 08:00 tea and coffee 08:15 participants are welcomed to the workshop and the hope is expressed that they will find the day a meaningful experience. an initial exercise is done in which participants are asked their expectations of the day, as well as norms by which the workshop should be conducted. these are listed on a poster and put up in plain sight of all. 08: 30 each participant receives a poster with the instruction to make a collage, using nothing but clippings from old magazines, with the title: “where am i in terms of my personal development at the moment and where do i want to be one year from today?” 09:30 each participant is given the opportunity to present their collage to the rest of the group, and explain where they see themselves both now and in the future. 10:15 tea and coffee 10:25 a lecture is presented on the mbti ® and its terminology. all participants already know their own mbti®-codes. 13:00 lunch 14:00 a lecture is given on the carkhuff model of facilitative communication. afterwards participants are divided into groups of three, with one playing the observer, a second the client, and a third the facilitator. all participants are given the opportunity to practise the skills and micro-skills as related to the model. 15:20 tea and coffee 15:30 participants are asked to integrate all that was learned during the day into a personal 5-point plan for self-development. they are free to sit with a friend if they prefer. they are also asked to identify personal strengths and weaknesses, as well as opportunities for and threats to their personal self-development within their organis ation. 16:00 participants complete an anonymous questionnaire about the workshop, in order for its effectiveness to be measured and activities adapted. after completing this questionnaire participants are free to go. sajems ns vol 6 (2003) no 1 58 3.3 study population the study population was drawn from managers in the head office, managing directors, operational managers, area managers and other managers (e.g. retail and hospital pharmacies) of a pharmacy group. these managers (n = 35) were divided into an experimental and control group by means of probability sampling. participant’s academic qualifications ranged from standard 8 (10 years of formal schooling), to a master’s degree in either business or pharmaceutically related fields. the characteristics of the study population are given in table 2. table 2 characteristics of the study population variable experimental group control group total number of participants 18 17 35 number of males 2 6 8 number of females 16 11 27 mean age 35.3 35.3 35.3 mean years of service 3.4 3.3 3.35 3.4 measuring battery the personal orientation inventory (poi) (shostrom, 1974) was used to measure the intra-personal traits of individuals who function in a psychologically optimal way. schulz (1994) asserts that the poi's reliability ranges from 0.41 to 0.82. the poi has construct validity due to its significant correlation with the sixteen personality factor inventory (16pf). the time ratio and support ratio have a positive correlation with the emotional stability, assertiveness and enthusiasm items as measured by the 16 pf. fouché and rothmann (2000) found internal consistency coefficients varying between 0.24 and 0.75 at a tertiary education institution. regarding the validity of the poi, she found that the construct validity of the poi was acceptable, except for time ratio (tc). fouché and rothmann (2000, p. 45) found acceptable levels of construct validity for most of the poi-scales. the two main scales, namely time ratio (tc) and support ratio (i), are related to emotional stability and enthusiasm, but also lower levels of suspicion, anxiety, stress, neuroticism and emotional sensitivity. the general perceived self-efficacy scale (gpses) (schwarzer, 1993) was used to measure participants’ generalised self-efficacy. the gpses consists of sajems ns vol 6 (2003) no 1 59 10 items. schwarzer (1993) found alpha coefficients varying from 0.75 to 0.90 for the gpses. by confirmatory factor analyses it was found that the scale was unidimensional in all sub-samples. the scale is not only reliable, it has also proven valid in terms of convergent and discriminant validity. schwarzer (1993) found that the scale correlates positively with self-esteem and optimism and negatively with anxiety, depression and physical symptoms. in samples from 23 nations, the cronbach alpha-coefficients ranged from 0.76 to 0.90, with the majority in the high 0.80s. rothmann and van rensburg (2001, p. 18) found that lower scores on generalised self-efficacy were related to a greater incidence of suicide ideation in police members. the cope questionnaire (cope) (carver et al., 1989) was used to measure participants’ coping strategies. the cope is a multidimensional 53-item coping questionnaire that indicates the different ways that people cope in different circumstances (carver et al., 1989). it measures 13 different coping strategies. carver et al. (1989) reported cronbach alpha coefficients for the cope varying from 0.45 to 0.92. all the sub-scales have sufficient levels of reliability except for mental disengagement, which measures lower than 0.60. test-retest reliability varies from 0.46 to 0.86 and 0.42 to 0.89 (applied after two weeks). a knowledge test was used to measure specific knowledge of broad terms, constructs and ideas as discussed in the manual. the test featured 50 multiplechoice questions, which participants had to answer by in each instance by choosing one of 4 or 5 possible answers. the second part of the test consisted of written questions the participant had to answer. these questions were still directly related to the content of the manual. 3.5 statistical analysis the statistical analysis was done by means of the sas computer program (sas institute, 2000). descriptive and inferential statistics were used to analyse the results. the wilcoxon rank sum test was used to determine the significance of differences between the experimental and control groups. this indicates whether there are meaningful differences for changes in the experimental and control groups. the signed rank wilcoxon test was used to determine the significance of differences within the experimental and control groups, between the pre-, post, and post-post testing. results are regarded as significant if the p-values are smaller than 0.50, since this is the cut-off for most behavioural science research (christensen & stoup, 1991: 231). the p-values obtained (two-sided test) were divided by two, to transform them to a one-sided test (since the alternative hypothesis is indicative of direction) (plug et al., 1988: 70). this value is then multiplied by three (the bonferroni correction) because of the use of a post-post sajems ns vol 6 (2003) no 1 60 test. if the final p-values are statistically significant (p<0.05) the practical significance (d) for the results was calculated (cohen, 1988). 4 results table 3 indicates the significance of differences between the preand post-tests of the experimental and control groups on the poi. table 3 significance of differences between the experimental and control groups on the poi item pre-test – posttest pre-test – postpost-test post-test – post-post-test p d p d p d time ratio (tc) 0.48 1.20 0.32 self-actualising value (sav) 0.11 1.01 0.48 existentiality (ex) 0.61 0.87 1.39 support ratio (i) 1.38 0.15 0.26 feeling reflection (fr) 0.81 0.03+ 0.80** 0.05+ 0.60* spontaneity (s) 1.12 1.32 1.10 self-regard (sr) 0.71 1.21 0.86 self-acceptance (sa) 0.35 1.50 0.36 view of human nature (nc) 0.39 1.33 0.27 synergy (sy) 0.02+ 0.84** 0.49 0.49 acceptance of aggression (a) 1.34 0.88 0.98 capacity for intimate contact (c) 1.50 0.40 0.49 + statistically significant: p < 0.05 * practically significant: d ≥ 0.50 (medium effect) ** practically significant: d ≥ 0.80 (large effect) table 3 shows that a statistically significant difference between the experimental and control groups regarding synergy (sy) was found between the preand posttest. this difference is also practically significant (large effect). the experimental group showed a significant increase in synergy directly after completing the self-development programme. the results show that the individuals who participated in the self-development programme (compared sajems ns vol 6 (2003) no 1 61 with those who were not involved) had a greater synergistic awareness, which means to see opposites in life as meaningful, rather than as antagonistic. regarding the comparison of the preand post-post test and the postand postpost-test, table 3 indicates a statistically significant difference between the experimental and control groups regarding feeling reactivity (fr). this difference is also practically significant (large effect). the results show that the individuals who participated in the self-development programme (compared with those who were not involved) had become more sensitive to their own feelings and needs two months after completing the programme. table 4 shows the significance of differences between the preand post-tests of the experimental and control groups on the gpses. table 4 significance of differences between the experimental and control groups on the gpses item eg (n = 18) cg (n = 17) mean sd mean sd p d pre-test – posttest 2.22 0.54 -0.12 3.17 0.13 pre-test postpost-test 3.11 0.47 0.18 2.32 0.03* 1.26** post-test postpost-test 0.89 2.49 0.29 2.68 0.75 * statistically significant: p < 0.05 ** practically significant: d ≥ 0.80 (large effect) table 4 indicates that there are no significant differences between the experimental and control groups for the preand post-tests regarding the gpses. however, a statistically significant difference was found regarding the change between the pre-test and post-post-test of the experimental and control groups on the gpses. this difference is also practically significant (large effect). the results show that the participants in the self-development programme (compared with those who were not involved) were more inclined to believe that they were able to perform novel or difficult tasks two months after completing the training programme. this would probably facilitate goal setting, effort investment and persistence in the face of barriers and recovery from setbacks. there is no statistically significant difference between the experimental and control groups regarding the gpses between the postand post-post-testing. sajems ns vol 6 (2003) no 1 62 the significance of differences between the pre-, postand post-post-tests of the experimental and control groups on the cope is given in table 5. table 5 significance of differences between the experimental and control groups on the cope item pre-test – post-test pre-test – post-post-test post-test – post-post-test p d p d p d active coping 0.15 0.07 0.63 planning 0.47 1.50 0.41 suppressing of competing activities 0.29 0.09 1.50 restrained coping 0.33 0.39 1.04 seeking social support for instrumental reasons 0.10 1.14 0.28 seeking social support for emotional reasons 0.44 1.32 0.17 positive reinterpretation and growth 0.82 1.04 0.96 accept 1.24 1.28 1.50 turning to religion 1.32 1.16 1.45 focus on and venting of emotions 0.28 0.66 0.26 denial 0.64 1.50 0.36 behavioural disengagement 1.50 0.82 0.96 mental disengagement 1.35 0.91 0.73 alcohol/drug disengagement 1.50 0.95 0.54 table 5 shows that no significant differences were found between the various tests on the cope. the significance of the differences between the pre-, postand post-post-tests of the experimental and control groups on the knowledge test is given in table 6. sajems ns vol 6 (2003) no 1 63 table 6 significance of differences between the preand post-tests of the experimental and control groups on the knowledge test item eg (n = 18) cg (n = 17) mean sd mean sd p d pre-test – post-test 20.94 10.20 -1.31 7.67 0.00* 2.18** pre-test – post-posttest 24.05 12.83 -0.57 5.44 0.00* 1.92** post-test – post-posttest 3.11 6.99 0.74 7.36 0.29 * statistically significant: p < 0.05 ** practically significant: d ≥ 0.80 (large effect) a statistically significant difference was found between the preand post-tests of the experimental and control groups on the knowledge test. table 6 also shows a statistically significant difference regarding the change in knowledge between the preand post-post-tests. both these differences were practically significant (large effects). members of the experimental group (compared with the control group) obtained more knowledge of self-development through the self-development programme. although no increase in knowledge of selfdevelopment was found between the postand post-post-tests, the increase in knowledge of the experimental group was significantly higher when the preand post-post-tests were compared. the qualitative impressions of participants of the self-development programme are given below. this information was gathered from evaluation forms partic ipants completed after the workshop. • the most important things learned from the self-development programme. half of the participants said that the most important thing they had learned was “more about the self”. two further themes that received support were the need for continuous self-development and ongoing evaluation of personal development needs, as well as greater tolerance for and empathy with other people. participants said firstly that they now understood that self-development had to be a personal process linked to the organisation’s needs, but also benefiting the individual. secondly, they mentioned how colleagues now seemed “closer” and “more human” – this was typically expressed by words such as “everyone’s got problems”, and “there is a place in the sun for everyone”. furthermore, participants mentioned a greater awareness of personal actions, thoughts and preferences. sajems ns vol 6 (2003) no 1 64 • meaningful activities. half of the participants said that the collage was the most meaningful activity. the usefulness of this activity was very apparent – some participants reacted quite emotionally to their collages, and others mentioned how they appreciated everyone’s honesty. the second most meaningful activity was the training in facilitative communication. mostly participants considered this useful because they were taught specific skills which they felt they would be able to use outside the workshop. • opinions regarding the successfulness of the self-development programme. except for one participant who did not complete this question, everyone thought that the programme was successful. the reason cited most for the success of the programme was the fact that participants had learned more and felt better about themselves and/or other people. furthermore, participants said that they thought the programme was successful because of the other participants' reaction and participation. mention was made of greater cohesion and empathy within the group at the end of the day. also, participants felt that the programme was a success because they now had a better understanding of the concept of, and need for, self-development. 5 discussion the self-development programme contributed to members’ synergistic awareness. this means that directly following the programme members had a higher tendency to see seemingly antagonistic opposites as meaningfully related. with statements such as “there is a place in the sun for everyone” emerging from the qualitative data, participants are perhaps feeling less competition amongst themselves, by also stating that there is greater compassion and understanding within the group. in defining self-development during the workshop, participants included in the definition the possibility of regression or pain occurring before growth can take place. this is another example of seeming opposites finding integration within participants. the increase in synergistic awareness indicates that participants experienced more meaningfulness in their lives after completing the self-development programme. this is a result of participants making contact with their real selves in an atmosphere of respect and understanding (raskin & rogers, 1989). a definite increase took place in participants’ reflections on feelings both directly following the workshop and even after two months following it. this shows that participants became more sensitive towards their own needs and feelings following this programme (leitschuh & rawlins, 1991). by becoming sajems ns vol 6 (2003) no 1 65 more sensitive towards their own feelings, participants would be less likely to project them to other people. it also seems logical that a greater sensitivity towards own feelings would lead to a greater sensitivity towards the feelings of others. again, this is reflected in the qualitative data, with statements such as “everyone’s got problems”. with half of the participants stating that the most important thing they had learned from the programme was “more about myself”, this long-term effect in reflecting on feelings seems logical. it can thus be stated that the programme fosters a greater sensitivity within participants to their personal needs and emotions, and to those of others. quantitative results indicate that two months after the self-development programme, participants showed greater self-efficacy. this means that the programme contributed to participants' gaining more faith in their personal skills and abilities. in line with the findings of hobfoll (2001), it can be stated that the self-development programme increased the resources of participants, which would be beneficial in terms of work outcomes, especially if it is considered that having one resource is linked to having others (rothmann & van rensburg, 2001). it would seem that an increase in self-efficacy addresses a fundamental need in self-development. if participants gained faith in themselves, it would affect the very way they look at themselves, their work, their organisation, and definitely at their contributions (schwarzer, 1992). this seems highly significant: would persons who have more faith in themselves not be more motivated to sustain their efforts in the face of adversity? the effect of greater self-efficacy in the work situation will lead these persons to make greater contributions if they now feel that their contributions can be meaningful. one can imagine this increase in self-efficacy to be reflected in all aspects of these persons' lives: their behaviour should show more self-confidence, their emotions should be better controlled, and physically they should show greater determination (schwarzer, 1999). directly following the programme, and even after two months, participants showed greater knowledge regarding the elements discussed in the selfdevelopment manual. it could be argued that greater knowledge of psychological health, interpersonal effectiveness, management of conflict, personality preferences and creative problem solving would lead the person to be more aware of all of these aspects. knowledge about self-development could facilitate the long-term development on intraand interpersonal level. this knowledge is also reflected in the qualitative data, with participants stating that they now saw the need and relevance of self-development, felt that they would be better able to successfully communicate with the skills of facilitative communication, and felt that “everyone has a right to their preference”. one should also keep in mind that exposure to constructs and ideas unfamiliar to sajems ns vol 6 (2003) no 1 66 participants might actually stimulate and motivate them to learn more about aspects that were of interest to them. despite the promising results of the self-development programme regarding knowledge as well as some intra-personal and interpersonal characteristics, there were other characteristics and coping strategies that showed no significant changes after participants had gone through the self-development programme. however, it should be taken into account that this intervention was a first effort to stimulate the self-development of managers in a corporate pharmacy group. more development could take place over time and with more intensive interventions. regarding the qualitative evaluation, it seems that the programme contributed to learning about the self, realising the importance of self-development, developing tolerance and empathy for other people and increasing self-awareness. participants regarded the collage as a meaningful activity. the fact that the participants were satisfied with the arrangements of the self-development programme as well as the facilitation and presentation thereof helped create an atmosphere conducive to learning. various limitations regarding this research have been identified. firstly, the empirical study only included members of a single organisation and the results thus cannot be generalised to other organisations. secondly, the effect of the pretest was not eliminated. thirdly, the content of a self-development programme is of such a nature that it is difficult to deal successfully with all aspects in a single day. furthermore, the results of a self-development programme are not meant to be immediate. ideally a longitudinal study should have been undertaken to measure participants perhaps six months or a year after completion of the programme to determine whether long-term change had been effected. 6 recommendations the self-development programme should be presented to all the managers in the corporate pharmaceutical group. the programme should focus on intra-personal and interpersonal growth, as well as on knowledge of self-development. more contact time should be allocated to the self-development programme. it was evident during the presentation that participants had the need to discuss their personal growth issues in a facilitative atmosphere. both the presenters and the co-participants in the programme play an important role in this regard. this is something that participants alluded to, and is also recommended because of the nature of the content of such a programme. the pain or uneasiness that comes to the fore when one has to do self-investigation, could be better handled, perhaps sajems ns vol 6 (2003) no 1 67 in personal development sessions, if more time were available. selfdevelopment should not be an exclusive management development initiative. all levels of employees could learn and benefit from this type of programme. if, for example, levels of self-efficacy could be improved across the board throughout the organisation, this would contribute to organisational effectiveness. longitudinal research should be undertaken to determine the long-term effects of a self-development programme. as mentioned, the results of a selfdevelopment programme are not meant to be instantaneous. follow-up measurement perhaps six months or a year after the 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(2001) “correlates of suicide ideation in the south african police services in the north west province.” poster session presented at the 13th conference of the south african institute for management sciences, stellenbosch, 7-9 september. 52 rothmann, s., basson, w.d., & rothmann, j.c. (2000) “the personality preferences of pharmacy students and lecturers at a tertiary education institution”, international journal of pharmacy practice, 8: 225-33. 53 rothmann, s., sieberhagen, g. & cilliers, f.v.n. (1998) “die kwalitatiewe effek van 'n groepfasiliteringskursus”, tydskrif vir bedryfsielkunde, 24(3): 7-13. 54 sas institute (2000) the sas system for windows release 8, cary, nc: sas institute inc. 55 schultz, d. (1977) growth psychology: models of the healthy personality, new york: van nostrand. 56 schulz, g.m. (1994) “reliability and validity of the personal orientation inventory in south africa”, unpublished master’s dissertation, university of south africa, pretoria. 57 schwarzer, r. (1992) self-efficacy: thought control of action, washington, dc: hemisphere. 58 schwarzer, r. (1993) measurement of perceived self-efficacy: psychometric scales for cross-cultural research”, berlin: freie universität berlin. sajems ns vol 6 (2003) no 1 71 59 schwarzer, r. (1999) “self-regulatory processes in the adoption and maintenance of health behaviors: the role of optimism, goals and threats”, journal of health psychology, 4(2): 115-27. 60 senge, p.m. (1990) “the leaders’ new work: building learning organisations”, sloan management review: 7-23. 61 shostrom, e. l. (1974) manual for the personal orientation inventory (rev. ed.) san diego, ca: edits. 62 sticland, r. (1996) “self-development in a business organization.” journal of managerial psychology, 11(7): 30. 63 strümpfer, d.j.w. (2000) “psychometric properties of an instrument to measure resilience”, paper presented at the annual conference of the society for industrial psychology, pretoria. 64 sutcliffe, g.e. 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(1999) “the new psychological contract”, people dynamics, 17(4): 28-32. 306 sajems ns 11 (2008) no 3 the battle for truth: control and non-voting preference shares daryl a dingley and phumlani mp ngcongo competition law department, webber wentzel paul bj farlam high court of south africa jeremy c marwell jel g34, l41 1 introduction if a financial institution (a) advances funding to another company (b) in return for non-voting preference shares in company b at par value, does that constitute a merger for the purposes of s 12 of the competition act, 89 of 1998 (the act), if those preference shares comprise more than 50 per cent of the issued shares (ordinary and preference) of company b? and what if company b’s articles of association provide that the holder of the preference shares may obtain a right to vote at shareholders’ meetings if any preference dividend is not paid timeously, or if the preference shares are not redeemed within the agreed time? would a provision to that effect play any role in an assessment as to whether the initial transaction constituted a merger and/or requires a further merger notification upon the triggering of company a’s right to vote? these were the interesting questions which the competition tribunal (the tribunal) had to address in cape empowerment trust ltd v sanlam life insurance ltd and another1 (cet v sanlam). (the losing party, cape empowerment trust ltd (cet), took the matter on appeal, but the parties settled after the case had been argued in the competition appeal court (cac), but before judgment had been delivered). to contextualise the issues discussed in this paper, we begin by briefly outlining the facts of that case, the main submissions of the parties, and the findings of the tribunal. we will then analyse the main issues arising for consideration in relation to the scenario sketched in the opening paragraph of this paper, again with reference to the parties’ submissions and the tribunal’s determination in cet v sanlam. by way of comparison, we will also refer to foreign law, particularly united states anti-trust law. 2 the cet v sanlam case on 13 march 1998, the legal predecessor to sanlam life insurance limited (sanlam) and a western cape-based empowerment company, sancino projects ltd (sancino), entered into a written agreement in which sanlam subscribed in cash for 10 million redeemable preference shares in the share capital of sancino with a par value of 1c (with sancino’s issued share capital being increased by the same amount). the shares were issued and allotted by sancino to sanlam at a premium of r0.99 per preference share, and were thus subscribed to by sanlam for r10 million. as the tribunal noted2, sanlam, which is one of south africa’s largest listed life assurance companies, is a significant investor in unlisted projects. sancino, in need of a cash injection in 1998 after some failed investments, was such a project. the present transaction effectively entailed sanlam advancing r10 million to sancino, and, in consideration, receiving 10 million redeemable preference shares, redeemable after four years, in march 2002. immediately prior to the conclusion of the agreement, sanlam was the beneficial owner of 354 192 ordinary shares in sancino’s issued share capital, which then comprised about 3.53 sajems ns 11 (2008) no 3 307 million ordinary shares with a par value of 1c each. sanlam thus owned approximately 10 per cent of the issued share capital in sancino before the issue of the 10 million preference shares. after being issued with the preference shares in march 1998, sanlam became the beneficial owner of about 76.4 per cent of sancino’s issued share capital. the preference shares had the rights and privileges set out in the agreement between sanlam and sancino (the agreement), as read together with article 109 of the articles of association of sancino (the articles). the most important of those rights and privileges were the conditional voting rights. in terms thereof, sanlam had the right to vote its preference shares at any of the meetings of sancino only if any one or more of three circumstances prevailed at the date of the meeting: (i) the preference dividend or any part thereof remained in arrears and unpaid 30 days from the due date thereof; (ii) any redemption payment remained in arrears and unpaid 30 days from the due date; or (iii) a resolution of the company was proposed which directly affected any of the rights attached to the preference shares or the interests of the holders thereof. in terms of the agreement, preference dividends had to be declared on the last day of february each year and were payable on the last day of may in each year, commencing with effect from 31 may 1999. the redemption payment had to be made by march 2002. sancino did not pay preference dividends to sanlam in accordance with the agreement. further, sancino did not redeem sanlam’s preference shares on the fourth anniversary of the subscription date (namely, 13 march 2002). as a result, sanlam had the right to vote its preference shares on the same basis as ordinary shareholders at any sancino members’ meetings from at least march 2002. sanlam was, however, prepared to continue playing a passive role for a number of years. during this time, sancino’s indebtedness to sanlam continued to increase. by january 2006, it had grown to approximately r23 million. notwithstanding its financial obligations to sanlam, sancino was an attractive company by virtue of its minority stake in a company which had a shareholding in the grandwest casino in cape town. cet, an investment-holding company listed on the jse, accordingly acquired a significant minority holding in sancino in 2005, and made plans to obtain a controlling interest. in october 2005, cet made an offer to the ordinary shareholders of sancino to acquire all their shares in sancino at a ratio of seven cet shares for each sancino share. the offer was well received by some sancino shareholders, but not by the sancino board, which, on 28 october 2005, issued a circular to the shareholders informing them that the board did not consider the offer acceptable. sancino’s board also rejected a revised cet proposal in december 2005. sanlam, too, was opposed to cet’s offers. sancino’s board formulated a proposal of its own, and, on 16 january 2006, notified sancino’s shareholders that a special meeting of shareholders was being convened on 8 february 2006 to vote on a number of special resolutions. the effect of these resolutions would be to discharge sancino’s liability to sanlam by issuing to sanlam 2.364 million ordinary shares in sancino in settlement of the outstanding preference dividend (of r13 million), and by converting sanlam’s 10 million preference shares into 1.818 million ordinary shares. cet’s response was to call for a meeting of sancino’s shareholders on 7 february 2006 to consider certain resolutions to be tabled by cet. the resolutions involved, inter alia, sancino borrowing r20 million from cet to redeem in whole or in part sanlam’s preference shares in sancino. in the event of the resolutions to be put to the vote on 7 february 2005 being passed and implemented, sanlam’s chances of converting its preference shares to ordinary shares, pursuant to the 8 february resolutions, would be nullified. but, in reality, cet had little chance of having its 7 february resolutions carried if sanlam were permitted to vote all its ordinary and preference shares. cet accordingly applied to the tribunal for an urgent interdict to prevent sanlam from exercising its voting rights at the 7 and 8 february meetings. cet argued that it was entitled to the interdict because, if sanlam were 308 sajems ns 11 (2008) no 3 to exercise its voting rights, it would constitute the implementation of a merger that had not been approved by the competition authorities. in essence, cet argued that: (i) there was a change of control when sanlam obtained the right to vote its preference shares in sancino in march 2002 as a result of the redemption of sanlam’s preference shares and payment of its preference dividends being overdue; (ii) this change of control in march 2002 constituted a merger (between sanlam and sancino) as defined in s 12(1)(a) of the competition act, and that, as it was a large or intermediate merger, the competition commission (the commission) had to be notified thereof; (iii) neither sanlam nor sancino had notified the commission of the merger; nor had the merger been approved by the tribunal or the commission; and (iv) accordingly, the merger could not be implemented, which meant, inter alia, that sanlam was precluded even from exercising voting rights in respect of its preference shares. sanlam, in response, replied that, with the issue to sanlam of the preference shares in march 1998, sanlam became the beneficial owner of more than half of sancino’s issued share capital. it had thus acquired control of sancino as contemplated in s 12(2)(a) of the competition act. the competition act does not apply retrospectively to an acquisition of control which occurred in march 1998. accordingly, no notification of that merger was required when the relevant provisions of the competition act came into force on 1 september 1999. furthermore, sanlam said, because it had acquired control in march 1998, the accretion of voting rights in march 2002, although a different form of control (s 12(2)(b)), did not result in a fresh acquisition of control (as control had already existed). the tribunal agreed with sanlam’s contentions, which were also supported by sancino (the second respondent before the tribunal). the tribunal found, first, that sanlam had controlled sancino from march 1998 (i.e. prior to the commencement of the competition act) by virtue of owning more than half the issued share capital in sancino. its finding on that issue is summarised in paragraph 56 of the tribunal’s determination: as the owner of the preference shares sanlam owned more than half the issued share capital of sancino, being the sum of the par value of its ordinary and preference shares. taking account of the specific circumstances of sancino’s capital structure, this satisfies the definition of control in section 12(2)(a) of the act. this state of affairs predated the entry into force of chapter 3 of the act and accordingly it was not incumbent on sanlam and sancino to file a notification of this relationship with the competition authorities when the act came into force. secondly, the tribunal found that the position did not change with the acquisition of voting powers by sanlam in sancino as a result of the repeated defaults by sancino. according to the tribunal3 [t]here was no change of control [when sanlam acquired voting powers over a majority of the issued share capital upon the occurrence of sancino’s defaults], but merely the superimposition of another one or more forms of control contemplated by the act. no additional potential threat to competition came into being when sanlam gained the majority voting rights in sancino. notification in those circumstances would have been otiose. 3 non-voting preference shares and control as we have indicated, the first question that arises when a company acquires non-voting preference shares on a scale akin to sanlam’s acquisition in sancino is whether there has been a change of control, and thus a notifiable merger, at that time. that is the primary question we address in this paper. the second question concerns whether there would be a further notification requirement in the event that the conditional voting rights are triggered in respect of those preference shares4. we will consider that question as well, albeit in less detail. sajems ns 11 (2008) no 3 309 the relevant statutory provision in respect of both issues is s 12 of the competition act. it may assist if we quote it at this point. merger defined (1) (a) for purposes of this act, a merger occurs when one or more firms directly or indirectly acquire or establish direct or indirect control over the whole or part of the business of another firm. (b) a merger contemplated in paragraph (a) may be achieved in any manner, including through – (i) purchase or lease of the shares, an interest or assets of the other firm in question; or (ii) amalgamation or other combination with the other firm in question. (2) a person controls a firm if that person – (a) beneficially owns more than one half of the issued share capital of the firm; (b) is entitled to vote a majority of the votes that may be cast at a general meeting of the firm, or has the ability to control the voting of a majority of those votes, either directly or through a controlled entity of that person; (c) is able to appoint or to veto the appoint ment of a majority of the directors of the firm; (d) ....; (e) ….; (f) ….; or (g) has the ability to materially influence the policy of the firm in a manner com parable to a person who, in ordinary commercial practice, can exercise an element of control referred to in para graphs (a) to (f). 4 whether the purchase of non-voting preference shares constitutes the acquisition of control 4.1 the south african approach as the cac stated in distillers corporation (sa) ltd v bulmer (sa) (pty) ltd5 (distillers v bulmer), s 12(2) provides a non-exhaustive list of examples of the change of “control” referred to in s 12(1)(a). thus, when, as in cet v sanlam, a company acquires more than 50 per cent of the issued shares in another, one first looks to see whether the transaction fits into one of the categories listed in s 12(2), in order to determine whether there has been a direct or indirect acquisition of control. the s 12(2) category, which immediately comes to mind in a case like cet v sanlam is s 12(2)(a), which refers to there being control in the event of a person beneficially owning “more than one half of the issued share capital of the firm”. but what exactly does the phrase “issued share capital” cover in this context? more particularly, does it include non-voting redeemable preference shares? and what if the transaction falls within the plain meaning of the words in s 12(2)(a) but does not appear to involve any actual change of control? should s 12(2)(b) be “read down” in such circumstances, thus effectively requiring notification only when there are actual instances of changes of control? in cet v sanlam, cet accepted that, in ordinary commercial parlance, the share capital of a company includes both ordinary and preference shares (citing s 74 of the companies act, 61 of 1973 as authority). in other words, cet’s counsel accepted that the phrase “issued share capital” in s 12(2)(a) of the competition act included all issued shares, including nonvoting preference shares. in our view, that concession was clearly right. in south african company law, the term “issued share capital” means, as the words suggest, all shares issued by the company, or, in other words (because, in terms of s 92(1) of the 310 sajems ns 11 (2008) no 3 companies act, a company cannot issue partly paid-up shares) something equivalent to the company’s paid-up share capital6. a company’s share capital includes its ordinary and preference shares. the term “preference share” is not defined in the companies act. it is simply a term which has become embedded in commercial language to describe a share to which some kind of preferential right to dividends and/or a return of capital on liquidation is accorded. the nature of these preferential rights and the limitations that sometimes accompany them differ widely. it depends entirely on the rights determined by the company when exercising its power to create different classes of shares7. the qualified exclusion of voting rights is a permissible but not necessary feature of preference shares8. it is clear from the use of the term “preference share” in the companies act that preference shares are regarded as forming part of the company’s share capital. for example, ss 75(1)(f) and (g), in dealing with alterations in share capital, speak of the conversion of the company’s “ordinary or preference share capital”. section 98 states that a company that has a “share capital” may issue redeemable preference shares. schedules 3 and 4 of the companies act, specifying the disclosure concerning share capital to be made in prospectuses and financial statements, take it for granted that preference shares are part of share capital and must be disclosed as such9. for example, item 9 of schedule 4 regulates disclosure concerning “any part of the issued share capital that consists of redeemable preference shares”. the definition of “equity share capital” in s 1 of the companies act alludes to preference shares without actually using that term. from the definition it is clear that preference shares form part of share capital, with “equity share capital” constituting a subset of share capital. see, too, the tribunal’s comments at par 48 of its determination in cet v sanlam). cet argued, however, that s 12(2)(a) should not be interpreted in isolation both from s 12(1)(a) and from chapter 3 of the competition act, generally. with reference to the judgment of the cac in distillers v bulmer, cet’s counsel argued that s 12(2) is intended to elucidate and instance circumstances of the concept of “control” in s 12(1)(a), and that s 12(2)(a) is not intended to affect transactions in which the acquirer of shares never intended exercising control or indeed playing any active role in the company in question. more particularly, s 12(2)(a) was not, so cet submitted, intended to apply to the issuing of non-voting preference shares as a funding instrument. what cet’s argument effectively amounted to was that s 12(2)(a) should be read restrictively, through the prism of s 12(1). those submissions could well accord with the way certain funding institutions regard any preference share-based funding structures with which they are involved. according to blackman et al in commentary on the companies act10, preference shares in south africa are primarily funding instruments, properly regarded as akin to debentures. cet’s arguments possibly reflect how sanlam and sancino initially regarded the transaction, that is, as a way of providing funding to enable sancino to discharge a portion of the debts it had incurred in respect of a printing business that it owned, while providing sanlam with maximum security. in addition, cet’s approach has a certain intuitive appeal. company lawyers are, in general, unlikely to talk of a shareholder exercising control of a firm when the shares through which it seeks to exercise that control do not enjoy voting rights. cet’s contentions may consequently also, at first sight, be seen as consistent with the purpose and objects of s 12 of the competition act, in particular the apparent purpose of s 12(1) (the dominant provision in the section). but, in our view, s 12(2) of the competition act ultimately permits of no other interpretation than that reached by the tribunal in cet v sanlam. there are, moreover, a number of factors supporting the tribunal’s interpretation, notwithstanding the apparent incongruity of the notion of control which infuses s 12(1). we say this for a number of reasons. first, the ordinary commercial meaning must surely be adopted when interpreting s 12(2)(a) of the competition act. in the absence of any definition of the term “issued share capital”, the words should be given their usual meaning. sajems ns 11 (2008) no 3 311 secondly, the fact that the issuing of preference shares might be a way of raising capital for a company (as indeed the issuing of ordinary shares can be) also does not mean that the issuing of preference shares to sanlam should properly be categorised as a loan. as the tribunal held in cet v sancino11, it would have to be found that the agreement in that case involved “a sham or disguised transaction” in order to get past the fact that sanlam subscribed for preference shares in sancino in march 1998; it did not make a “loan akin to a debenture”. and there is no basis for reaching such a conclusion: “[o]n every criterion known to the tribunal the preference share issue, in this case, was a real one, conforming to customary norms for preference shares”12, 13 another consideration is that of practicality. a person who beneficially owns more than one half of a company’s issued share capital may not immediately or permanently have voting rights, but the legislature would have been aware that shares (particularly preference shares) may accord voting rights if particular circumstances arise. such a shareholder might acquire and then lose such voting rights intermittently. it would be wholly impractical to view each acquisition of voting rights and each cessation of voting rights as involving a notifiable merger. as a matter of practicality, the transaction could only really be notified at the outset, upon conclusion of the agreement and subscription for the shares. the facts underlying cet v sancino usefully illustrate this. as the agreement in cet v sancino contemplated, the company (sancino) could be in default at various times during the currency of the agreement – as sancino in fact was. if a merger was regarded as occurring and was notifiable only when the preference shareholder’s (sanlam’s) voting rights could be exercised, there could consequently be repeated notifications, and mergers would be constituted or dissolved at any time (notwithstanding the same agreement and share ownership being in place). in other words, there would be what was referred to in the tribunal’s decision as “the problem of ‘see-sawing’”.14 what would make that scenario even more unworkable is that sanlam would be required to notify the tribunal in circumstances where sancino could potentially have cured the default by the time that the tribunal came to consider whether the triggering of sanlam’s right to vote (by no voluntary act on its part) raised any competition concerns. it would moreover be untenable for the purchaser of preference shares in a company not to know whether its subscription for those shares was acceptable to the competition authorities until such time as the company was in default with its obligations. a party in the position in which sanlam found itself in cet v sanlam would have a very real interest in obtaining merger approval prior to the implementation of the agreement. voting rights in the event of the company’s default are conferred on preferent shareholders precisely to enable them to exercise control in periods when their interests require particular protection. the voting rights constitute an important protective mechanism without which the preferent shareholder might well not be willing to subscribe. before implementing the transaction, that shareholder is thus entitled to know that the potential control for which the agreement makes provision has competition approval. it cannot be expected to run the risk at a later stage of losing an important quid pro quo for which it bargained (namely, voting power in the event of default by the company whose shares had been subscribed for). furthermore, practical considerations should not be thought irrelevant to interpretation. the legislature should not easily be taken to have intended an unbusinesslike interpretation. the legislature should also be taken to have been aware that preference shares are extremely common in the commercial world. that being so, it is sensible to accord s 12(2)(a) its ordinary meaning and to treat it as applying inter alia to shares which may from time to time accord the holder voting control15. moreover, interpreting the words “issued share capital” in the way that the tribunal did in cet v sancino is consistent with s 12(2) of the competition act as a whole. that section draws a distinction between owning more than half of the issued share capital of a firm (addressed in s 12(2)(a)) and being entitled to vote a majority of the votes that may be cast at a general meeting of the firm (a power addressed in s 12(2)(b)). 312 sajems ns 11 (2008) no 3 the competition act accordingly contemplates a situation in which firm a beneficially owns more than 50 per cent of the issued share capital of firm b but does not have the right to vote more than 50 per cent of the votes that may be cast at a general meeting of the latter. the competition act indicates that, even in those circumstances, firm a will be regarded as controlling firm b. the tribunal explained the rationale for distinguishing between ownership and voting rights in the context of merger definitions in ethos private equity fund iv / tsebo outsourcing group (pty) ltd16 (the ethos case) and caxton and another v naspers ltd and others (caxton v naspers)17. as the tribunal stated in caxton v naspers at par. 29: in ethos the tribunal explained why merger policy is not confined to an assessment of control via the legal form. we made the point that control can also be exercised by virtue of a party’s economic leverage over another and that this formed the rationale for the language of section 12(2)(a) which emphasises ownership of shares as something distinct from voting rights. the tribunal also held in the ethos case18 that a firm which acquires more than 50 per cent of the issued share capital of another firm obtains control of the latter, notwithstanding a shareholders’ agreement or any other constraint which limits the voting power of the majority shareholder. where the “bright line” in s 12(2)(a) of the competition act is crossed, notification is necessary, irrespective of whether any other incidents of control are present19. as the tribunal noted in its reasons in cet v sanlam20, the cac’s judgment in distillers v bulmer is to the same effect. in that case, the court held that the competition act contemplates more than one type of control, and that more than one firm can accordingly “control” another at any time21. to use the example postulated in distillers, where a beneficially owns more than half of the issued share capital of a firm, but concludes an agreement with b in terms of which the latter can run the business and control appointments to the board of directors, both a and b exercise control for the purposes of s 12 of the competition act. as davis jp stated at 46c: “in such a situation a would control the firm as defined in terms of section 12(2)(a) and b would exercise control as defined in term[s] of section 12(2)(g)”. when examined closely, there also may well be nothing contrary to the purpose of s 12 of the competition act in interpreting s 12(2)(a) the way it was interpreted in cet v sanlam. as the cac held in distillers at 45h, the act was designed to ensure that the competition authorities examine the widest possible range of potential merger transactions to examine whether competition was impaired and this purpose provides a strong pro-pointer in favour of a broad interpretation to section 12 of the act22. the competition act thus creates a regime in which even potentially innocuous transactions are scrutinised by the competition authorities. but that over-inclusive approach was no doubt, for good reason, considered better than an under-inclusive one in which transactions with potentially anti-competitive effects might go undetected and unchecked. moreover, as the tribunal noted in caxton23, s 12 is not confined to an assessment of control via the legal form; it is also concerned with a party’s economic leverage over another. this is confirmed not only by the incidents of control specified in s 12(2), but also by the fact that s 12(1)(a) refers to a merger occurring even when one firm indirectly acquires indirect control over another firm24. a firm that owns the majority of another firm’s issued share capital has such economic leverage, whether its shareholding involves ordinary or preference shares, or, as in the present case, a combination of both. there can also be no doubt that sanlam has, since subscribing for its preference shares, been in a position of some power and influence vis-à-vis sancino. (that influence has only increased as sancino’s indebtedness to sanlam increased over the years). thus, in our view, the tribunal was correct in finding in cet v sanlam that there was a merger in that case in march 1998, when sanlam sajems ns 11 (2008) no 3 313 became the beneficial owner of over 76 per cent of sancino’s issued share capital. the wording of s 12(2) of the competition act permitted of no other interpretation; and, in any event, cet provided no workable alternative. that said, one is nonetheless left with a certain unease about the potential costs of the tribunal’s decision in cet v sanlam and the potentially chilling effect it will have on certain kinds of corporate financing, not only with regard to non-voting preference shares, but possibly also debentures and certain kinds of secured transactions, venture capital funding, and the like. in fact, the tribunal itself was careful to say25 that: [it] should be stressed that our findings in this case – the first in which we have had to consider the role of preference shares in the share capital of a company – are confined to the circumstances of this case, and are not necessarily the last word of the tribunal on the broader topic of control in terms of issued share capital. each case will have to be assessed on its own merits. quite what made the sanlam / sancino transaction different from others involving the issuing of non-voting preference shares to a financial institution was not spelt out. it may well be difficult to distinguish that decision meaningfully in subsequent cases. but the tribunal’s unease about the ramifications of its decision (in relation to a matter which it considered to have “a considerable degree of complexity”26) was clearly apparent, and quite possibly justified. the tribunal ruling in cet v sanlam may, for example, require a reconsideration of the commission’s stance on other forms of funding, notably when a bank acquires an asset or a controlling interest in a firm in the ordinary course of its business in providing finance based on collateral or security. the commission previously indicated in an advisory notice to practitioners that, in those circumstances, it does not require notification at the time of entering into the transaction, or, in fact, immediate notification on default27. such “safe harbour” provisions might now need to be revisited. on one hand, a strict application of the tribunal’s rule in cet v sanlam (that a non-voting interest can establish control) might suggest that the bank safe harbour should be eliminated. on the other, however, a potential expansion in the nature and number of transactions that are notifiable in the wake of cet v sanlam might suggest an increased practical need for this (and other) safe harbours. given the possible practical ramifications of the cet v sanlam decision, in particular, it is interesting to look at how the same issue is treated in foreign jurisdictions. section 1(3) of the competition act provides that “[a]ny person interpreting or applying this act may consider appropriate foreign and international law”. comparative law could thus provide some guidance as to the advisability of the south african approach, as well as possible alternative approaches which could be adopted in the event of the south african legislation being out of kilter with developments in the rest of the world. 4.2 comparative approaches there is some evidence of a potentially different approach in the european union and canada. the commission notice on the concept of concentration under council regulation (eec) no. 4064/89 on the control of concentrations between undertakings 28 provided: sole control is normally acquired on a legal basis when an undertaking acquires a majority of the voting rights of a company. it is not in itself significant that the acquired shareholding is 50 per cent of the share capital plus one share or that it is 100 per cent of the share capital. in the absence of other elements, an acquisition which does not include the majority of the voting rights does not normally confer control even if it involves the acquisition of the majority of the share capital. that approach would appear to be consistent with the emphasis on “decisive influence” in the context of merger notifications in eu competition law29. under eu competition law, it is recognised that the acquisition of control may 314 sajems ns 11 (2008) no 3 be in different forms, but that it is the ability to exercise decisive influence that is paramount in determining whether control has been acquired. accordingly, when confronted with an option to convert or purchase shares, the eu authorities have held that control is conferred only at the point of the option being exercised30, unless there is an agreement that the option will be exercised in the immediate future in accordance with a legally binding agreement that cannot be revoked by the parties. thus, for example, in british airways / tat31, british airways acquired 49 per cent of the share capital of tat and was granted an option to purchase the remaining 50.1 per cent held by tat. tat, in turn, was granted an option to require british airways to do so before a specific date. in analysing the transaction, the ec commission concluded that british airways exercised joint control with tat as a consequence of the shareholding structure provided in the shareholder’s agreement. the ec commission disregarded the potential second acquisition of sole control that would have been conferred on ba by virtue of the option. clearly, the ec commission relied on the point at which the (joint) control was acquired and not the future potential to acquire sole control in terms of the option. as far as canada is concerned, some guidance as to the relevant rules is provided by the interpretation guideline on notifiable transactions under part ix of the canadian competition act, which states: acquisitions of non-voting shares of a corporation are not notifiable under part ix of the act. thus, where non-voting shares are being acquired from a third party holding them and reflecting them on its balance sheet as assets, the acquisition is not notifiable. in the case of an acquisition of convertible securities, such as convertible debentures, convertible non-voting shares, options, warrants and rights, notice of acquisition need only be given where the securities will be converted to voting shares … . there is consequently a basis for thinking that, in europe and canada, the kind of transaction considered in cet v sanlam would not have been notifiable. the european and canadian documents considered above do not, however, by themselves provide a basis for suggesting how those regions would approach a case such as cet v sanlam, or warrant any definitive conclusions being drawn about the approach adopted to acquisitions involving non-voting shares. to be of any real assistance, a more comprehensive analysis is required, something that we have conducted in relation to united states anti-trust law. 4.3 us regulatory background by way of very brief background, us anti-trust law involves several overlapping statutory and regulatory regimes, including, at the federal level, the sherman act32, the clayton act33 and the hart-scott-rodino antitrust improvements act of 1976 (the hsr act)34, as well as the antitrust and competition laws of the 50 individual states. the clayton act is the primary federal statute governing competition issues raised by mergers and acquisitions. it prohibits acquisitions where “the effect of such acquisition may be substantially to lessen competition, or to tend to create a monopoly”35. the sherman act prohibits unreasonable restraints of trade, attempts to monopolise, and monopolisation. the hsr act governs procedural aspects of the review of mergers and acquisitions. it gives two federal agencies—the antitrust division of the us department of justice and the federal trade commission (ftc)—the opportunity to assess anti-trust issues posed by proposed transactions before those transactions are consummated. for transactions meeting certain jurisdictional thresholds (e.g., transaction value), the hsr act requires parties to file a notification and allow a waiting period to elapse before completing the transaction36. while all mergers and acquisitions, regardless of size, are subject to the clayton act, transactions falling within the hsr act’s juris dictional provisions are far more likely as a practical matter to be scrutinised by the reviewing agencies. sajems ns 11 (2008) no 3 315 we thus commence by using the hsr act as a starting point for a comparison with cet v sanlam. we will then examine the impact of the clayton act, and whether acquisitions of the kind considered in cet v sanlam would be subject to the provisions of that statute. 4.4 the hsr act and non-voting shares the plain text of the hsr act is potentially ambiguous about whether an acquisition of non-voting preference shares triggers that act’s notification and waiting requirements. the statute provides: [e]xcept as exempted pursuant to subsection (c) of this section, no person shall acquire, directly or indirectly, any voting securities or assets of any other person, unless both persons (or in the case of a tender offer, the acquiring person) file notification [with the relevant agency] . . . and the [statutorilydefined] waiting period . . . has expired37. the act further defines “voting securities” as: any securities which at present or upon conversion entitle the owner or holder t h e r e o f t o v o t e f o r t h e e l e c t i o n o f directors of the issuer or, with respect to unincorporated issuers, persons exercising similar functions.38 but the act then specifically exempts acquisitions of bonds, mortgages, deeds of trust, or other obligations which are not voting securities from the hsr act’s reporting and waiting period requirements.39 the ftc’s hsr regulations specify, however, that acquisitions of shares that do not currently carry voting rights are exempt from the hsr act’s reporting and waiting period requirements. in particular, 16 c.f.r. § 802.31 (2007) states that “[a]cquisitions of convertible voting securities shall be exempt from the requirements of the act”. according to an explanatory note to the regulation, this exemption “applies regardless of the dollar value of the convertible voting securities held or to be acquired” but “subsequent conversions of convertible voting securities may be subject to the requirements of the act”. in turn, 16 cfr § 801.1(f)(2) (2007) defines “convertible voting security” as “a voting security which presently does not entitle its owner or holder to vote for directors of any entity” (emphasis added). the general rule thus seems to be that convertible shares are subject to anti-trust reporting requirements only at the time of their conversion to voting status. non-voting preferred shares such as those at issue in cet v sanlam would seem to be exempt upon acquisition from the hsr act’s notification and waiting requirements. however, before such shares could be converted into voting shares, the hsr act notice and waiting period requirements would have to be satisfied (assuming the transaction otherwise met the hsr act’s jurisdictional requirements). as stated above, given that the imposition of a “mid-stream” notice and waiting period after a triggering event would introduce substantial uncertainty, for example by impeding a shareholder’s ability to protect her interests by voting her shares promptly, one open question is how parties in practice actually treat shares with automatic conversion triggers (such as the dividend default in cet v sanlam). one possibility is that parties might observe the notification and waiting period requirements for convertible preferred shares at the time of acquisition of such shares, even though a filing would not formally be required at that time. 4.5 the clayton act and relevant case law as indicated in the previous section of this paper, acquisitions of non-voting preference shares are typically exempt from the reporting requirements of the hsr act. such acquisitions would, however, still be subject to the broad prohibitions of section 7 of the clayton act, which provides in pertinent part that: [n]o person engaged in commerce or in any activity affecting commerce shall acquire, directly or indirectly, the whole or any part of the stock or other share capital and no person subject to the jurisdiction of the federal trade commission shall acquire the 316 sajems ns 11 (2008) no 3 whole or any part of the assets of another person engaged also in commerce or in any activity affecting commerce, where . . . the effect of such acquisition may be substantially to lessen competition, or to tend to create a monopoly40. transactions can violate the clayton act without an acquiring party establishing control over a target. in denver & rio grande w. r.r. co. v united states41, the united states supreme court held that: [a] company need not acquire control of another company in order to violate the clayton act. . . . section 7 [of the clayton act] proscribes acquisition of ‘any part’ of a company’s stock where the effect ‘may be substantially to lessen competition, or to tend to create a monopoly’. in support of this proposition, the court cited its earlier decision in united states v e. i. du pont de nemours & co42, where it had held that du pont’s acquisition of a 23 per cent voting stake in general motors violated the clayton act because, inter alia, du pont had purposely purchased the stock to “entrench itself as the primary supplier of general motors’ requirements for automotive finishes and fabrics”. under certain circumstances, acquisition of non-voting shares may also contribute to a finding of “substantially . . . lessen[ing] competition, or . . . tend[ing] to create a monopoly” under the clayton act. in a 1961 follow-up case (“du pont ii”) to the 1957 du pont decision cited above, the supreme court held that du pont’s proposal to transfer its voting rights in its general motors stock to du pont shareholders would not neutralise the earlier violation. the court stated: the divestiture only of voting rights does not seem to us to be a remedy adequate to promise elimination of the tendency of du pont’s acquisition offensive to § 7 [of the clayton act]. under the [proposed remedy], two-thirds of du pont’s holdings of general motors stock will be voted by du pont shareholders. . . . common sense tells us that under this arrangement there can be little assurance of the dissolution of the intercorporate community of interest which we found to violate the law. the du pont shareholders will ipso facto also be general motors voters. it will be in their interest to vote in such a way as to induce general motors to favor du pont, the very result which we found illegal on the first appeal.43 admittedly, du pont ii dealt with the adequacy of a remedy for a prior violation, rather than an initial finding of anticompetitive effect, so it is not directly on point. as the court there explained: the burden is not on the government to show de novo that a ‘pass through’ of the general motors vote, like du pont’s ownership of general motors stock, would violate § 7 . . . . it need only appear that the decree entered leaves a substantial likelihood that the tendency towards monopoly of the acquisition condemned by § 7 has not been satisfactorily eliminated.44 the united states court of appeals for the sixth circuit recently considered a similar factual situation, but in the absence of a prior violation. in united states v dairy farmers of america, inc45., the court upheld, against a motion for summary judgment, the government’s complaint that an ownership agreement between dfa, a dairy farm cooperative, and southern belle, a milk processing plant, had violated the clayton act. after the government had filed its complaint, but prior to dfa’s motion for summary judgment, dfa transferred its 50 per cent common (voting) ownership interest in southern belle into a “non-voting preferred capital interest”, such that voting control then rested solely with aflp (dfa’s partner, which held the remaining 50 per cent of common voting stock). citing du pont ii, the court found that such an arrangement could potentially violate the clayton act: w h i l e d fa d o e s n o t h a v e a v o t i n g interest [in southern belle] under the revised agreement, [dfa] may leverage its position as southern belle’s financier to control or influence southern belle’s sajems ns 11 (2008) no 3 317 decisions. although southern belle may seek alternative financing, the united states correctly points out that such a switch may be a negative signal to other potential lenders. in other words, southern belle may be “locked in” to a relationship with dfa, a fact that dfa could use to its advantage. as a result, dfa’s financial relationship with southern belle could lead to anticompetitive effects.46 however, as in du pont ii, the court noted that a commonality of economic interest between dfa and residual owner aflp muted the isolating value of dfa’s divestiture of voting rights: dfa purportedly cured any potential antitrust problems in the agreement with southern belle by giving all of its voting rights to aflp. this cure, however, ignores the fact that aflp and dfa have closely aligned interests to maximize profits via anticompetitive behavior. as [government witness] professor scott explained, ‘[t]o think that the nature of the interaction between the two dairies will not change is naive, because that would be contrary to the economic incentive of all parties’.47 thus, although neither du pont ii nor dairy farmers of america is squarely on point with cet v sanlam (which, for instance, did not involve a voting entity with common economic interests to sanlam), it seems reasonable to conclude that a us court would, under certain circumstances, consider non-voting preference shares in analysing anti-competitive effect under the clayton act. (as a practical matter, us courts may not be faced with many such cases, given that acquisitions of non-voting shares are exempt from the reporting and other requirements of the hsr act.) but, on a theoretical level at least, to the extent that cet v sanlam brings non-voting preference shares within the general bailiwick of south african anti-competitive effects analysis (from which calculus such shares previously might have been excluded), cet v sanlam could be viewed as consistent with the basic approach of us courts and the clayton act. one important caveat is that the exemption of convertible shares from the hsr act reporting does not directly involve a test for corporate control, as the hsr act applies to the acquisition of “any voting securities” in transactions meeting that act’s jurisdictional thresholds. the acquisition of control (and the relevance of non-voting shares to the control calculation) evidently plays a more central role in south african law, given the explicit role of “control” in the competition act’s definition of “merger”, section 12(1). 5 whether the triggering of voting rights for non-voting preference shares would require a further notification according to the tribunal’s rulings in cases such as ethos and caxton, an increase in the control of a controlling firm does not require further notification from the competition authorities. neither does a change from one kind of control (e.g. share ownership) to another (say, voting rights). the tribunal’s statements in ethos are apposite48: does this mean that ethos might have to notify again if it crosses some other threshold in section 12(2) that it presently does not enjoy now? for instance, if it was able to control or veto the appointment of the majority of the directors of the firm, a power that, as we have seen, it does not presently enjoy. the answer to that question is no. a change of control is a once-off affair. even if a firm has notified sole control at a time when that control is attenuated in some respects by other shareholders and it later acquires an unfettered right, provided that sole control has been notified and that this formed the basis of the decision, no subsequent notification is required.49 the tribunal has, however, held that there is a notifiable merger in the event of a change from joint to sole control.50 the same principle has been acknowledged by the european commission in ici/tioxide.51 in that case, the 318 sajems ns 11 (2008) no 3 european commission held that “decisive influence exercised solely is substantially different to decisive influence exercised jointly, since the latter has to take into account the potentially different interests of the other parties concerned”. as a consequence of this change in the level of control, the european commission found that a concentration (or merger) had occurred. thus, if after the acquisition of preference shares by a financial institution there is a subsequent change from joint to sole control consequent upon the triggering of voting rights in the preference shares, there could potentially be a need for a further notification. in cet v sanlam, there were no facts supporting such a scenario. there was nothing to suggest that any other firm had control, as envisaged by s 12(1) or s 12(2) of the competition act, prior to march 2002, or at any time thereafter. the remaining shareholdings were seemingly relatively small and widespread. that principle was accordingly not applicable. cet nevertheless tried to argue on appeal before the cac that the situation in that case was analogous. according to cet, there should be a further notification when there is a change in the “quality of control”, or where there is a change from “deemed control” to “actual control”. similar contentions were, however, rejected by the tribunal, in our opinion, with good reason. the argument for a further notification appears to overlook the nature of the enquiry that would take place when the competition authorities considered the transaction after its conclusion, and before its initial implementation. postulate what would have happened had the tribunal had to approve the sanlam / sancino agreement before sanlam could take possession of the sancino shares. that evaluation would have involved a consideration of whether there was likely to be any substantial prevention or lessening of competition had sancino defaulted on its obligations and sanlam had been, as a consequence, able to exercise the conditional voting rights attaching to the preference shares. there would therefore be no need to consider that question again if and when the default occurred. in the words of the tribunal52, no additional potential threat to competition would have come into being. a case such as cet v sanlam is therefore not really analogous to one in which an entity that jointly controls a firm increases its shareholding so that it assumes sole control. instead, the factual matrix is more analogous to the one addressed in ethos. sanlam had control of sancino beginning in march 1998 by virtue of beneficially owning more than one-half of the issued share capital of that firm, albeit the control was attenuated in some respects. in march 2002, the restraints on the control were, as a fact, removed when the voting rights were (potentially only provisionally) triggered. however, sanlam enjoyed no greater legal rights: it still owned the same number of preference shares, with the same rights and privileges. it would also not be justifiable to classify sanlam’s pre-march 2002 control as “deemed control”. the competition act does not distinguish between deemed and actual control in s 12(2), or, for that matter, s 12(1). instead, it regards each of the scenarios covered by s 12(2) as involving the acquisition of control. (see also distillers at 45-46, where the court rejected the argument that s 12 was concerned only with actual control.) it is thus of no materiality from a competition law perspective if a firm that has control as envisaged in s 12(2)(a), but not s 12(2)(b), also acquires control in the form contemplated by the latter section. there is a further consideration, which relates to how one acquires or establishes control for the purposes of s 12 of the competition act. section 12(1)(a) of the competition act defines the occurrence of a merger with reference to the time when a party “acquires” or “establishes” control. despite the looseness of this terminology, it seems that the section would, in the context of the competition act as a whole, connote the vesting of control through a deliberative act pursuant to a transaction of some kind.53 thus, where a transaction is concluded on terms which may, without further consensus by the parties, result in one of them acquiring control of the other, as defined in s 12, the transaction sajems ns 11 (2008) no 3 319 is immediately notifiable, even though the circumstances which will trigger the vesting of control may occur only in the future or may, in fact, never occur.54 if this were not so, it would not be possible, in cases where the triggering event occurs without further consensus, to observe the competition act’s injunction against the “implementation” of a merger without approval. by way of illustration, in cet v sanlam the implementation of the agreement involved the issuing of shares to sanlam on terms which were incorporated by way of an amendment to sancino’s articles of association. once that was done, sanlam became the holder of shares which, in circumstances beyond its control and as a result of terms incorporated not only in the agreement but also in sancino’s articles, might result in sanlam’s being entitled to vote a majority of the shares at a general meeting of sancino. sanlam’s entitlement to vote the shares thus flowed from an already implemented agreement. although cet wished to interdict sanlam from exercising its voting rights, this did not and could not change the fact that, in terms of the agreement as read with the articles, sanlam was already entitled to vote the majority of the shares. this was a consequence of the implementation of the transaction in march 1998, and not a consequence of any act of implementation in march 2002. it must be emphasised that it is the entitlement to vote, and not the exercise of the entitlement, which constitutes the control envisaged in s 12(2)(b) (a section which, it will be recalled, provides that a person controls a firm if he “is entitled to vote a majority of the votes that may be cast at a general meeting of the firm, or has the ability to control the voting of a majority of those votes …” (emphasis added)). accordingly, when one speaks of the “implementation” of a merger in this context, one is not talking about the exercise of the voting power. even if a person with control declines to exercise it, this does not mean that the transaction is not a merger. one is, in fact, talking about the acquisition of the entitlement to vote. as the entitlement in cet v sanlam flowed ineluctably (without further deliberative action by sanlam) from the terms of the agreement and the articles of association, the “implementation” must have occurred in march 1998. (in the same way, a merger as contemplated in s12(2)(a) is “implemented” when the acquirer becomes the beneficial owner of the shares, not only when the acquirer, for example, starts to receive dividends). it was also explained earlier how it would be unfair for the competition authorities to disapprove a transaction years after it had been concluded. had the preferent shareholder not obtained voting rights in the event of default, it might well not have been willing to subscribe for the preference shares in the first place. to require the holder of preference shares to subject itself to a second notification prior to exercising voting rights which were secured precisely in order to protect the shareholder’s interests in such circumstances would be unduly onerous and inequitable, and would provide a severe disincentive to the acquisition of preference shares. 6 the road ahead given the terms in which s 12(2) of the competition act is framed, we are of the view that the tribunal’s decision in cet v sanlam that there was a merger in 1998 when sanlam became the beneficial owner of over 76 per cent of sancino’s issued share capital was correct. however, despite our conclusion, a number of important and practical issues arise in consequence of the tribunal’s finding. one of the principal questions raised by cet v sanlam is how, within the strictures of the text of the competition act, to minimise any potential costs of adopting a broad interpretation of the jurisdictional and threshold tests for review of notifiable mergers pursuant to the competition act (i.e., possible over-inclusive competition law regulation) while avoiding establishing a framework so stringent that too few transactions are reviewed (i.e., under-inclusive regulation). the position that non-voting preference shares can confer control under the competition act has serious ramifications. some of these implications are mentioned below. 320 sajems ns 11 (2008) no 3 (1) it may jeopardise the ability of companies to raise funding by issuing non-voting preference shares. (2) it may be viewed as out of kilter with the commission’s stance in relation to other forms of funding, such as where a bank acquires an asset or a controlling interest in a firm in the ordinary course of its business of providing finance for which it obtains collateral or security. in these circumstances, notification is required neither at the time of entering into the relevant transaction nor immediately upon default55. (3) as noted above, an extension of cet v sanlam could potentially chill certain other types of transactions and business activity in addition to non-voting preference shares. if the tribunal’s approach in cet v sanlam endures (and perhaps is expanded to other forms of non-voting financing), the legislature or the competition authorities may be motivated to consider formalising an ownership “safe harbour” mechanism similar to that contained in the commission’s practitioner update for secured transactions involving banking and financial services entities56. despite a relatively expansive interpretation of the jurisdictional and threshold “control” test in the competition act, the creation of other bright-line “safe harbours” to allow firms to organise their financing arrangements without being susceptible to excessively onerous merger review will probably also need to be considered. in this enquiry, the identification of other kinds of financing used in south africa and the delineation of principled distinctions between them for purposes of determining whether the control pre-requisite of the merger review test under the competition act is satisfied will no doubt be instructive. endnotes 1 [2006] 1 cplr 410 (ct), case no. 05/x/jan06; judgment handed down on 15 march 2006 (per reyburn tm, lewis tc and bhoola tm concurring). 2 at par. 8. 3 at paragraph 60 of its determination. 4 if there is not considered to be a merger for competition purposes when the preference shares are first acquired, there can be little question that there would be a direct or indirect acquisition of control when voting rights are acquired with respect to those preference shares as a result of a default. that scenario accordingly need not be addressed. 5 [2001]-[2002] cplr 36 (cac) at 43j. 6 henochsberg on the companies act at 170. 7 see s 75(1)(i) of the companies act, a section which deals with the power of companies to alter their “share capital”. 8 see s 194 of the companies act. 9 see items 8(c) and 37(c) of schedule 3 and items 8 and 9 of schedule 4. 10 vol 1 at 5-175. 11 par. 47. 12 par. 47. 13 regarding the test for simulated transactions, see zandberg v van zyl 1910 ad 302 at 309 and erf 3183/1 ladysmith (pty) ltd v cir 1996 (3) sa 942 (a) at 952c. 14 par. 44. 15 this accords with what the tribunal said in the ethos case at paras 37-42, commenting on the impracticality of requiring the commission to enquire into every change in shareholder relations, an observation made in the context of arrangements between shareholders pertaining to voting. 16 [2003] 2 cplr 371 (ct) at par. 32. 17 [2004] 1 cplr 217 (ct) at par. 29. 18 at par. 30-31. 19 the ethos case at par. 35, 42, and caxton v naspers at par. 43. 20 par. 52. 21 see 46b. 22 see also the comments of davis jp in distillers at 46f: “the purpose of merger control envisages a wide definition of control, so as to allow the relevant competition authorities to examine a wide range of transactions which could result in an alteration of the market structure and in particular reduce the levels of competition in the relevant market”. 23 at par. 29, in the passage quoted above. 24 see also distillers at 46e, where davis jp quotes from richard whish (competition law 4ed at 742) to the effect that “merger control is not, or not only, about pre-emptively preventing a merged entity from abusing its dominant position in the future; it is also about maintaining a market structure that is capable of producing the kind of outcome that follows from competition.” sajems ns 11 (2008) no 3 321 25 at par. 63. 26 par. 64. 27 see practitioner update issue the application of the merger provisions of the competition act 89 of 1998, as amended, to risk mitigation financial transactions (“the financial transactions practitioner update”). however, this provision is similar to article 3(5) of the council regulation (ec) no. 139/ 2004 of 20 january 2004 on the control of concentrations between undertakings [oj 2004, no. l 24/ 1] (“the merger regulations”), which provides that a concentration shall not be deemed to arise where: (a) credit institutions or other financial institutions or insurance companies, the normal activities of which include transactions and dealing in securities for their own account or for the account of others, hold on a temporary basis securities which they have acquired in an undertaking with a view to reselling them, provided that they do not exercise voting rights in respect of those securities with a view to determining the competitive behaviour of that undertaking or provided that they exercise such voting rights only with a view to preparing the disposal of all or part of that undertaking or of its assets or the disposal of those securities and that any such disposal takes place within one year of the date of acquisition; that period may be extended by the commission on request… 28 published in [1989] oj c66/5. 29 article 3 of the merger regulations provides that a concentration occurs pursuant to an acquisition of control. article 3(2) of the merger regulations provides guidance on the meaning of control, stating inter alia that “…control shall be constituted by rights, contracts or any other means which, either separately or in combination and having regard to the considerations of fact or law involved, confer the possibility of exercising decisive influence on an undertaking, in particular by: (i) ownership or the right to use all or part of the assets of an undertaking; (ii) rights or contracts which confer decisive influence on the composition, voting or decisions of organs of an undertaking”. 30 ici/ tioxide [1991] 4 cmlr 792. 31 case m.259 (dec. of 27 november 1992). 32 see 15 u.s.c. §§ 1-7. 33 see 15 u.s.c. §§ 12 – 27, 29 usc. §§ 52 – 53. 34 see 15 u.s.c. § 18a. 35 15 u.s.c. § 18. 36 this paragraph and the following paragraph draw on kenneth r. logan & jack d’angelo, us merger control, mar. 3, 2003, available at http://www. stblaw.com/content/publications/publication14_ 0.pdf. 37 15 u.s.c. § 18a(a). 38 id. § 18a(b)(3)(a) (emphasis added). 39 id. § 18a(c)(2). 40 15 u.s.c. § 18 (emphasis added). 41 387 u.s. 485, 501 (1967). 42 353 u.s. 586, 606 (1957). 43 united states v e.i. du pont de nemours & co., 366 u.s. 316, 331 (1961) (du pont ii). 44 id. at 331-332. 45 426 f.3d 850, 861-62 (6th cir. 2005). 46 426 f.3d at 861-63. 47 426 f.3d at 862. 48 (supra) at par. 36-37. 49 see also caxton v naspers (supra) at paras 42, 44 & 45; brassey et al competition law 2002 p. 239. 50 see iscor limited and saldanha steel (pty) ltd (67/lm/dec01. 51 european commission iv/m0023, decision of 28 november 1990. 52 at par. 60 of its determination. 53 there are a number of contextual considerations that favour this view: (i) section 12(1)(b) refers to the manner of “achieving” a merger, and all the forms given as examples in s12(1)(b) are instances of bilateral or multilateral transactions. (ii) the competition act throughout speaks of the “parties” to a merger. (iii) with reference to mergers, the competition act defines the terms “acquiring firm” and “target firm”. these definitions are based on the acquisition or establishment of control “as a result of a transaction in any circumstances set out in s12”. (iv) in regulating the important aspect of retrospectivity, the legislature in items 4a to 4c of schedule 3 refers to the date on which a “transaction” takes place, and envisages that it is the “transaction” which is notifiable. (v) the competition act prohibits the parties to a merger from “implementing” it pending approval (s13a(3); cf s13(4)). this means that a “merger” must be something which exists and can be identified separately from its implementation. in other words, a “merger” is not the factual acquisition of control. it is the transaction pursuant to which control (perhaps at a later time) is acquired. 54 cf. ethos at par. 41. 55 see the financial transactions practitioner update. 56 see endnote 32 hereof and accompanying text. read online: scan this qr code with your smart phone or mobile device to read online. page 1 of 1 reviewer acknowledgement http://www.sajems.org open access acknowledgement to reviewers in an effort to facilitate the selection of appropriate peer reviewers for the south african journal of economic and management sciences, we request you to take a moment to update your electronic portfolio on https://sajems.org for our files, allowing us better access to your areas of 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nuugulu sanlie middelberg seeku a.k. jaabi shireen van zyl stefanie kuhn talita greyling tessa minter thea visser veronique blum vinessa naidoo vivence kalitanyi waldo krugell yaeesh yasseen yudhvir seetharam zeeshan ahmad zhenjia liu http://www.sajems.org� https://sajems.org https://sajems.org https://sajems.org/index.php/sajems/user https://sajems.org/index.php/sajems/user mailto:publishing@aosis.co.za microsoft word 2 impact of intra-group farrington et al 14_1_ 2 8 sajems ns 14 (2011) no 1 the impact of intra-group processes on family business success shelley farrington and elmarie venter department of business management, nelson mandela metropolitan university christo boshoff department of business management, stellenbosch university accepted august 2010 interpersonal ties and intra-group processes influence the ability of people to work together effectively as teams. in the context of the family business team, intra-group processes describe the interaction that takes place between the family members and the resultant psychological climate that exists in the family business. given the increasing number of sibling teams among family businesses, as well as the challenges they face as team members, this study focuses on sibling teams in family businesses and the intra-group processes that influence their success. the primary objective of this study is to identify and empirically test the intragroup processes influencing the effectiveness of sibling partnerships. a structured questionnaire was distributed to 1323 sibling partner respondents. the respondents were identified by means of a convenience snowball sampling technique, and the data were collected from 371 usable questionnaires. the empirical findings of this study show that the sibling relationship and fairness are important determinants of sibling team effectiveness. key words: family business, sibling partnership, family team, team, intra-group processes jel l25, 26 1 introduction and problem statement teams are central how work gets done in modern-day life (kozlowski & ilgen, 2006). evidence (guzzo & dickson, 1996) exists to show that team-based forms of organising often bring about higher levels of organisational effectiveness than traditional, bureaucratic forms. however, for any team to be effective, it is important that the necessary team design elements, namely context, teammember attributes and group structures, are such that they facilitate task-orientated behaviour. important relationship behaviour must, however, also be present. it can thus be argued that team members must direct their energies towards not only getting the job done, but also to building constructive interpersonal ties and processes (hellriegel, jackson, slocum, staude, amos, klopper, louw & oosthuizen, 2004). team processes are the behaviours and activities that influence the effectiveness of teams (hitt, miller & colella, 2006) and, as such, are the operations within a team that permit it to function smoothly and efficiently (campion, medsker & higgs, 1993). increasingly, attention is being given to various types of family teams in the familybusiness literature, particularly copreneurships (stewart-gross & gross, 2007; rutherford, muse & oswald, 2006) and sibling partnerships (nelton, 1996; ward, 2004). it has even been suggested that although succession has been the main issue of concern among family businesses for the past decade, team management in family businesses should be a major focus in the years to come (sharma, 2004). given that an increasing number of family businesses are being passed on during the succession process to teams of siblings, or are adopting sibling partnerships as ownership structures (aronoff, astrachan, mendosa & abstract sajems ns 14 (2011) no 1 9 ward, 1997; ward, 2004), the importance of such family business teams (sibling teams) should be emphasised. against this background, this study and the ensuing empirical investigation focus on sibling teams in family businesses and the conditions required to ensure their success. for the purpose of this study, the concepts “sibling partnership” and “sibling team” are used interchangeably and synonymously, and refer to a family business where at least two brothers and/or sisters, with a familial bond, are actively involved in the management and/or decision-making of the business, and exercise considerable influence over its strategic direction. this delineation places the decision-making authority of the family business in the hands of two or more siblings. 2 primary objectives the primary objective of this study is to identify and empirically test the intra-group processes influencing the success of a sibling partnership. based on these findings, recommendations will be made to assist sibling teams to manage their family businesses more effectively. 3 intra-group processes and effective teams in virtually every type of organisational context, literally thousands of studies have examined the factors that influence team effectiveness (hitt et al., 2006; kozlowski & ilgen, 2006). however, the input-processoutput (i-p-o) model is the most common framework used to explain the way in which team-design elements interact to enable effective team outcomes (barrick, stewart, neubert & mount, 1998; campion et al., 1993; groesbeck & van aken, 2001). the i-p-o model proposes that a variety of inputs combine to influence intra-group processes, which in turn affect team outputs. substantial research has already examined various inputs of the i-p-o model (e.g. campion et al., 1993; campion, papper & medsker, 1996; howard, foster & shannon, 2005). in this study the focus will be on the process factors (intra-group processes) only, as well as the impact that these factors have on the success of sibling teams in family businesses. based on an integration of prior findings and theories on team effectiveness, and supported by empirical or anecdotal evidence reported in the family business literature, the potential influence of selected intra-group processes on the success of sibling partnerships, was identified. only factors justified by sufficiency of theory in both the teamwork and family business literature are included in this study, and no claim is made of an exhaustive coverage of every possible process factor influencing the effectiveness of a sibling partnership. figure 1 intra-group processes influencing the perceived success of sibling partnerships financial performance perceived success family harmony mutual respect & trust open communication fairness sibling bond h1 h5c-6c h2 h3c -4c h5a-6a h3a-4a h3b-4b h5b-6b financial performancefinancial performance perceived successperceived success family harmonyfamily harmony mutual respect & trust open communication fairness sibling bond h1 h5c-6c h2 h3c -4c h5a-6a h3a-4a h3b-4b h5b-6b 10 sajems ns 14 (2011) no 1 in figure 1 (the hypothesised model) the various intra-group processes identified as influencing the success of a sibling partnership are depicted, namely mutual respect and trust, open communication, fairness, and the sibling bond. effectiveness or success in this study is measured using three variables: the dependent variable perceived success, and two intervening variables, namely perceived financial performance and family harmony. as such, the model proposes that both the financial performance of the business and the family harmony that exists within the family business positively influence perceived success. 3.1 dependent and intervening variables the dependent variable used in this study is the perceived success of a sibling partnership, which is defined as the degree to which the siblings find their ongoing involvement in the sibling partnership to be satisfying. according to astrachan (2006:v), no single measure of performance adequately articulates family and business needs and utilities, and no measure is likely to capture the complexities of the family business in particular. the satisfaction of family members involved in a family business is, however, commonly associated with success in family business research (handler, 1991; sharma, 2004; venter, 2003). similarly, team-member satisfaction, as a measure of team effectiveness, has also been used in several studies assessing team effectiveness in organisations (e.g. campion et al., 1996; campion et al., 1993:825; doolen, hacker & van aken, 2006:140; howard et al., 2005). kreitner and kinicki (1995) propose that in addition to the team members' satisfaction with the team experience, the team members' willingness to continue contributing to the team effort is also a measure of team effectiveness. business performance (financial and growth) is commonly regarded as a measure of success, and has been used by several authors to distinguish between successful and unsuccessful successions (flören, 2002; venter, 2003), successors (goldberg, 1996), family businesses (sharma, 2004; ward, 2004), and even teams in general (ivancevich, konopaske & matteson, 2005; northouse, 2004). venter (2003) has found a positive relationship between the financial security of the owner-manager and the business, and the satisfaction with the succession process, as well as between the financial security of the owner-manager and the business, and the continued profitability of the business after the succession. similarly, adendorff’s (2004) research has revealed a positive relationship between profitability and the ability to satisfy stakeholders’ interests. both anecdotal (flören, 2002; sharma, 2004; ward, 2004) and empirical (malone, 1989; santiago, 2000; venter, 2003) evidence suggests that harmonious relationships between family members are important for successful successions and successful family businesses. malone’s (1989) study has revealed a positive correlation between perceived family harmony and continuity planning. similarly, venter (2003) has reported a significant positive relationship between family harmony and the satisfaction of stakeholders with the succession process. venter (2003) has also reported that family harmony is strongly related to the agreement by family members to continue the business as a family concern. intuitively, it is highly unlikely that family members involved in a family business characterised by disharmonious family relationships and poor financial performance will find their involvement to be satisfying, let alone want to continue being involved. in addition to direct effects, the hypothesised model (figure 1) implies that financial performance and family harmony act as intervening variables between the various intra-group processes (independent variables) and the dependent variable perceived success. for the purpose of this study, financial performance refers to positive trends of growth in number of employees and profit, as well as increasing revenue experienced by the sibling partnership. family harmony, on the other hand, is defined as mutual relationships among family members, which are characterised by closeness, caring and support, appreciation of each other, and concern for each other’s welfare. against this background the following hypotheses have been formulated: sajems ns 14 (2011) no 1 11 h 1 : there is a positive relationship between the perceived financial performance of the sibling partnership and the perceived success of the sibling partnership. h 2 : there is a positive relationship between the level of family harmony existing in the sibling partnership and the perceived success of the sibling partnership. 3.2 independent variables “intra-group processes” refer to the interactions that take place among team members, and include aspects such as communication patterns, personal disclosure of information, decision-making, managing conflict, supportiveness, mutual respect, social cohesion, team flexibility, and workload sharing (barrick et al., 1998; doolen et al., 2006; gladstein, 1984; hyatt & ruddy, 1997). according to doolen et al. (2006), “team processes” refer to both the level of collaboration between team members and the type of activities used by teams to achieve their objectives. the process component of the i-p-o model has been the focus of many team-related studies (howard et al., 2005). campion et al. (1993), as well as hyatt and ruddy (1997) have all found a significant positive correlation between interpersonal processes and team effectiveness. similarly, both doolen et al. (2006) and gladstein (1984) have found support for a positive relationship between team processes and team-member satisfaction. the conclusion of these studies is that teams tend to perform better when they have welldeveloped processes in place (howard et al., 2005). according to barrick et al. (1998), research suggests that there is substantial overlap among the various measures of process. for example, in gladstein’s study (1984), the items measuring open communication, supportiveness, conflict, weighting of individual inputs and discussion of strategy, loaded onto one construct, which she named “intra-group process”. similarly, olukayode and ehigie (2005), as well as barrick et al. (1998), have found positive associations among measures of team interaction processes, implying that a composite score of all the measures can be used as a single measure of a team’s interaction processes. barrick et al. (1998) in fact believe that many of a team’s processes are reflected in the construct of social cohesion, and they regard social cohesion as an indicator of positive interpersonal dynamics within the team. “social cohesion” has been defined as the result of all forces acting on members to remain in the group (kozlowski & ilgen, 2006), and thus reflects synergistic interactions between team members, including positive communication, conflict resolution and effective workload sharing (barrick et al., 1998). for the purpose of this study, four process variables have been included in the hypothesised model (figure 1). these specific intra-group processes that influence the one-toone and inter-group collaboration dynamics between the sibling partners are mutual respect and trust; open communication; fairness; and the sibling bond. in line with the reasoning of barrick et al. (1998), it is assumed that all other process variables not individually included in the hypothesised model, are accounted for in the factor named sibling bond (cohesion). 3.2.1 mutual respect and trust in effective teams a climate of mutual trust exists among all team members (hellriegel et al., 2004; ivancevich et al., 2005). studies (e.g. hyatt & ruddy, 1997; cowie, 2007) have found a significant positive correlation between trust among team members and measures of team effectiveness. trust based on respect, amongst other factors, appears to be essential for building a collaborative climate (northouse, 2004). not only do team members show respect for and accept individual differences, they also feel respected and well regarded by other team members (hellriegel et al., 2004; keen, 2003). from his study, stempler (1988) concludes that respect, understanding, and complimentary behaviour between the next-generation family members and the organisational leader are critical to effective successions. handler (1991) concludes that communication, trust and respect for each other’s ability and position are critical to managing relationships between family members within the firm. similarly, 12 sajems ns 14 (2011) no 1 trust in the successor’s ability and intention to manage the family business effectively in the future is an important determinant of effective successions (sharma, 1997). santiago (2000) also finds that family members who respect one another and who exert efforts to understand each other are likely to cooperate with one another and support each other’s decisions. against this background, the following hypotheses have been formulated: h 3a : there is a positive relationship between mutual respect and trust among the siblings and the perceived financial performance of the sibling partnership. h 3b : there is a positive relationship between mutual respect and trust among the siblings and the level of family harmony. h 3c : there is a positive relationship between mutual respect and trust among the siblings and the perceived success of the sibling partnership. 3.2.2 open communication clear and open communication is crucial for effective teamwork (hitt et al., 2006; ivancevich et al., 2005; keen, 2003) and enhances team members’ satisfaction with their membership of the team (hitt et al., 2006). a number of studies (e.g. barrick et al.,1998; doolen et al., 2006; hyatt & ruddy, 1997; olukayode & ehigie, 2005) among teams in organisational contexts have found positive correlations between team communication and measures of team effectiveness. cowie (2007), for example, reports a significant positive relationship between open communication among management team members and perceived success, the ability to operate efficiently, and their willingness to cooperate with and support each other. effective and open communication is also important for promoting effective teamwork between siblings, and increases their chances of a successful team outcome (aronoff et al., 1997; brigham, 2004; ward, 2004). the willingness to share sensitive and personal information is especially important for the success of a sibling partnership (aronoff et al., 1997; ward, 2004). effective communication, characterised by honesty, openness and consistency, forms the basis of resolving conflicts and promoting harmony in the family as well as in the family business (brigham, 2004; gersick, davis, mccollom hampton & lansberg, 1997). based on the anecdotal and empirical evidence presented above, the following relationships are hypothesised: h 4a : there is a positive relationship between open communication among the siblings and the perceived financial performance of the sibling partnership. h 4b : there is a positive relationship between open communication among the siblings and the level of family harmony. h 4c : there is a positive relationship between open communication among the siblings and the perceived success of the sibling partnership. 3.2.3 fairness various studies (e.g. barrick et al., 1998; campion et al., 1993; campion et al., 1996; olukayode & ehigie, 2005) have found a significantly positive correlation between workload sharing and measures of team effectiveness. for example, naumann and bennett (2000) find that leaders who promote procedural justice and apply rules consistently, are able to minimise relationship conflict between team members. cowie (2007) also reports a significant positive relationship between fairness in workload among management team members and perceived success. kim and mauborgne (1998) find that managers who believe their company’s processes to be fair, display a higher level of trust in, and commitment to, their organisation. in their research on business issues that are a source of tension among members of family businesses, danes, zuiker, kean and arbuthnot (1999) have identified unfair workloads in family businesses as generating the highest level of tensions among family relationships. sibling partnerships are most successful when siblings minimise differences and keep things as equal as possible (fairness) between them (ward, 2004), especially in terms of compensation and workloads (aronoff et al., 1997; lansberg, 1999). it was thus decided to subject the following hypotheses to further empirical testing: h 5a : there is a positive relationship between fairness among the siblings and the sajems ns 14 (2011) no 1 13 perceived financial performance of the sibling partnership. h 5b : there is a positive relationship between fairness among the siblings and the level of family harmony. h 5c : there is a positive relationship between fairness among the siblings and the perceived success of the sibling partnership. 3.2.4 sibling bond according to ilgen, hollenbeck, johnson and jundt (2005), “bonding” is a matter of the affective feelings that team members hold towards each other and the team. bonding goes beyond trust, and reflects a strong sense of rapport and a desire to stay together, even extending beyond the current task context. meta-analytic evidence suggests that bonding is necessary for high levels of team performance (beal, cohen, burke & mclendon, 2003; ilgen et al., 2005). interpersonal cohesion in a team occurs when team members are attracted to each other, enjoy being with each other, get along, and interact well with each other (hitt et al., 2006; keen, 2003). team cohesion is positively related to team performance and viability, and members of cohesive teams are more likely to be satisfied with their teams than are members on non-cohesive teams (hellriegel, slocum & woodman, 2001; hitt et al., 2006). several recent meta-analyses indicate that cohesive teams generally tend to be more productive, and that cohesion is a determinant of job performance (ahronson & cameron, 2007; beal et al., 2003; kerr & tindale, 2004). according to barrick et al. (1998), however, research shows that cohesion is related to team-member satisfaction but not to performance. similarly, gladstein (1984) finds that group rating of supportiveness is positively associated with group rating of satisfaction, but not with actual sales revenue. smith, smith, olian, sims, o’bannon and scully (1994), however, report a positive correlation between a cohesion like measure of top management teams in small high-technology firms and firm financial performance. in families, “cohesion” refers to the degree of connectedness and emotional bonding that family members experience within the family. highly cohesive families tend to stick together during times of distress, and are capable of recognising and maintaining clear boundaries between family subsystems, as well as between the family and the business (lansberg & astrachan, 1994). according to santiago (2000), the more cohesive the family, the greater the desire to share the responsibility of perpetuating the family business. aronoff et al. (1997), assert that family harmony depends on the quality of the relationships between family members. in addition, a large volume of anecdotal evidence suggests that a high-quality relationship between the sibling partners is vital for a successful sibling partnership (gersick et al., 1997; lansberg, 1999; ward, 2004). given the contradictory evidence presented above, the following hypothesised relationships are subjected to further testing: h 6a : there is a positive relationship between a sibling bond among the siblings and the perceived financial performance of the sibling partnership. h 6b : there is a positive relationship between a sibling bond among the siblings and the level of family harmony. h 6c : there is a positive relationship between a sibling bond among the siblings and the perceived success of the sibling partnership. 4 methodology 4.1 scale development the factors under investigation were operationalised using reliable and valid items sourced from measuring instruments validated in previous empirical studies (see table 1). where necessary the items were rephrased to make them more suitable for the present study. in addition, based on secondary sources, several items were self-generated. the measuring instrument was then used to empirically test the relationships hypothesised in figure 1. 14 sajems ns 14 (2011) no 1 table 1 sources of previously validated items used in the measuring instrument factors reference perceived success sorenson, 2000; wageman, hackman & lehman, 2005; sharma, 1997; venter, 2003. financial performance cowie, 2007; adendorff, 2004. family harmony sharma, 1997; venter, 2003; adendorff, 2004; lansberg & astrachan, 1994; sorenson, 2000. mutual respect and trust cowie, 2007; venter, 2003; adendorff, 2004; filbeck & smith, 1997. open communication lansberg & astrachan, 1994; sharma, 1997; venter, 2003; campion et al., 1993; filbeck & smith, 1997. fairness cowie, 2007; wageman et al., 2005; campion et al., 1993. sibling bond venter, 2003; lansberg & astrachan, 1994; sharma, 1997; barsade et al., 2000; filbeck & smith, 1997. 4.2 sampling and data collection a convenience snowball sampling technique was employed for this study. two databases of family businesses were identified, and served as an initial sampling frame from which potential sampling units were identified. in addition, an advanced google search of south african websites resulted in many names of businesses involving siblings. in total, 1 323 potential respondents were identified. this sampling technique and methodology is consistent with that of other family-business researchers who have been constrained by the lack of a national database on family firms (sonfield & lussier, 2004; van der merwe & ellis, 2007; venter, 2003). in the present study, the survey technique was employed and a self-administered structured questionnaire comprising two sections was distributed to potential respondents. in section 1, respondents were requested to indicate their extent of agreement with regard to 41 statements concerning intragroup processes among the sibling team members, using a seven-point likert-type scale. demographic information pertaining to both the respondents and the family businesses was requested in section 2. the data collected from 371 usable questionnaires were subjected to various statistical analyses. an exploratory factor analysis was undertaken, and cronbach-alpha coefficients were calculated to assess the discriminant validity and reliability of the measuring instrument respectively. the relationships proposed in figure 1 were assessed by means of structural equation modelling (sem). 4.3 sample description the vast majority of respondents were male (80.6 per cent), white (95.4 per cent), and actively employed (93.3 per cent) in the sibling partnership. an average age of 40 years was reported, with the majority (72.5 per cent) being younger than 45 years old. most respondents (36.7 per cent) were an oldest child, with 33.2 per cent being a middle child, and 30.2 per cent a youngest child. although 29 per cent of sibling teams consisted of both males and females, the majority (64.2 per cent) of teams consisted of males only. the average team consisted of 2.48 siblings, with an average age difference of 5.66 years between siblings involved in the business. on average the siblings had been in business together for 11.44 years, with the majority (56.8 per cent) having been in business together for less than 10 years. of the sibling owned/managed businesses partici-pating in the study, 26.7 per cent operated in the agricultural industry, 19.4 per cent in the retail, 15.1 per cent in the manufacturing and 11.3 per cent in the finance/business services industries. the majority (73 per cent) of businesses employed 50 persons or less, and 24 per cent indicated employment of fewer than 10 employees. of the participating businesses, 24 per cent indicated having been operating for 10 years or less, whereas quite a large percentage (21 per cent) had been operating for more than 50 years. the oldest business, one that had been sajems ns 14 (2011) no 1 15 passed down from one family generation to another, was reported as being 265 years old. 4.4 discriminant validity and reliability results to assess the discriminant validity among the variables, all items were subjected to an exploratory factor analysis. the software programme spss 16 for windows was used for this purpose. based on the relational nature of the variables, principal axis factoring with an oblique (oblimin with kaiser normalization) rotation was specified as the extraction and rotation method for both models. in identifying the constructs to extract, the percentage of variance explained and the individual factor loadings were considered. the exploratory factor analysis was unable to confirm all the latent variables as originally intended in the hypothesised model (figure 1). the original latent variable financial performance split into two variables, which were subsequently named financial performance and growth performance. the original dependent variable perceived success and the intervening variable family harmony combined to form a new dependent variable. this variable was renamed satisfaction with work and family relationships. most of the items measuring mutual respect and trust, open communication, and sibling bond loaded together onto one construct, which was renamed sibling relationship. as expected, three of the items measuring fairness loaded onto a separate construct. three items did, however, not load onto any of the factors as was expected, and were consequently excluded from further analysis. according to hair, black, babin, anderson and tatham (2006), factor loadings of 0.30 and 0.40 can be considered significant for sample sizes of between 200 and 350 respectively. factor loadings of ≥ 0.4 were reported for all but one factor, namely fair6. despite fair6 having a factor loading of less than the required 0.4, namely 0.36, this item was retained because of its close proximity to 0.4 and because of hair et al.’s (2006:128) rule of thumb stating that for sample sizes of 350 or greater, factor loadings of 0.30 are considered significant. consequently, evidence of construct and discriminant validity for the measuring instrument is provided. cronbachalpha coefficients of greater than 0.70 (nunnally & bernstein, 1994) were returned for all constructs, providing evidence of reliable measuring scales. table 2 summarises the operational definitions of the factors as well as the details concerning the validity and reliability of the measuring instrument. table 2 measurement instrument analyses operationalisation of factors items* factor loadings cronbach-alpha sibling relationship refers to a relationship between the sibling partners characterised by open communication, encouragement, mutual respect and trust, mutual support and understanding, and an ability to manage conflict. 15 max: 0.944 min: 0.600 0.962 fairness refers to the working arrangement between the siblings being fair in terms of workload and compensation. 3 max: 0.768 min: 0.364 0.745 financial performance refers to the business being financially profitable and secure. 3 max: 0.910 min: 0.650 0.877 growth performance refers to the business showing growth in the number of employees, profits and revenues. 3 max: 0.933 min: 0.538 0.781 satisfaction with work and family relationships refers to harmonious relationships existing among family members (i.e. relationships characterised by closeness, caring and support, appreciation of each other, and concern for each other’s welfare) as well the siblings finding their working relationship in the sibling partnership as satisfying. 10 max: 0.904 min: 0.766 0.961 * see appendix a for a detailed description of multiple item scales measuring factors. 16 sajems ns 14 (2011) no 1 4.5 reformulated hypotheses as a result of the exploratory factor analysis, it was deemed necessary to modify the original hypotheses, which are summarised in table 3 below: table 3 reformulated hypotheses h 1 : there is a positive relationship between the perceived financial performance of the sibling partnership and the satisfaction with work and family relationships. h 2 : there is a positive relationship between the level of growth performance of the sibling partnership and the satisfaction with work and family relationships. h 3 : there is a positive relationship between the level of growth performance of the sibling partnership and the perceived financial performance of the sibling partnership. h 4a-4c : there is a positive relationship between the sibling relationship and the perceived financial performance (h 4a ), the level of growth performance (h 4b ), and the satisfaction with work and family relationships (h 4c ). h 5a-5c : there is a positive relationship between the level of perceived fairness among the siblings and the perceived financial performance (h 5a ), the level of growth performance (h 5b ), and the satisfaction with work and family relationships (h 5c ). as previously mentioned, the factor analysis resulted in the original latent variable financial performance splitting into two variables, namely financial performance and growth performance. ample empirical evidence exists to suggest that the growth performance of a business has a positive impact on its financial performance (brigham & daves, 2007:7; ittner & larcker, 1998:32). an analysis of 88 different studies has shown that growth is consistently related to higher levels of financial performance (capon, farley & hoenig, 1990:1148). as a result an additional hypothesis was formulated (see h 3 above) to test this relationship. 4.6 structural equation modelling results sem was the main statistical procedure used to test the significance of the relationships hypothesised between the various independent and dependent variables. the software programme lisrel 8.8 (jöreskog & sörbom, 2006) was used for this purpose. to assess the extent to which the proposed model represents an acceptable approximation of the data, various fit indices were considered. the ratio of  2 to degrees of freedom is 1.75. values lower than 2 are indicators of a good fit (hair, anderson, tatham & black, 1998). the rmsea (0.0478) falls within the close fit range of <0.05 (hu & bentler, 1999), while the upper limit of the 90 per cent confidence interval for rmsea (0.0541) is less than 0.08 (boshoff, 2005; roberts, stephen & ilardi, 2003). these indices all provide evidence of a model with a close fit. the empirical findings of this study (see figure 2) show that neither the financial performance (hypothesis h 1 ) nor the growth performance (hypothesis h 2 ) of the business have an influence on the satisfaction with work and family relationships. this finding suggests that the performance of the business has no impact on whether the siblings experience their work and family relationships as satisfying. no support is thus found for these hypotheses. the growth performance of the business is, however, positively related (path coefficient = 0.74, p<0.001) to the financial performance of the business. support is thus found for hypothesis h 3 . the more the business experiences growth, the more likely is the perception among the sibling team that the business will perform financially. sajems ns 14 (2011) no 1 17 figure 2 empirical findings of intra-group process factors influencing the level of satisfaction with work and family relationships in sibling partnerships financial performance satisfied growth performance sibling relationship fairness h1 h5a h2 h4c h4a h4b h5b h5c h3 0.74 p<0.001 0.17 p<0.05 p<0.001 0.17 p<0.001 0.81 p<0.001 ns ns 0.51 p<0.001 ns ns financial performancefinancial performance satisfied growth performancegrowth performance sibling relationship fairness h1 h5a h2 h4c h4a h4b h5b h5c h3 0.74 p<0.001 0.17 p<0.05 p<0.001 0.17 p<0.001 0.81 p<0.001 ns ns 0.51 p<0.001 ns ns * satisfied = satisfaction with work and family relationships as can be seen in figure 2, a positive relationship (path coefficient = 0.17, p<0.05) exists between the sibling relationship and financial performance (hypothesis h 4a ) of the business. in addition, the empirical results provide evidence of strong support for a positive relationship (path coefficient = 0.81, p<0.001) between sibling relationship and satisfaction with work and family relationships (hypothesis h 4c ). support is thus found for hypotheses h 4a and h 4c . in other words, the better the relationship between the siblings, the more likely the business will be to perform financially, and the more likely it is that the siblings will be satisfied with their work and family relationships. the findings of this study are in line with a large volume of anecdotal evidence suggesting that a high-quality relationship between sibling partners is vital for a successful sibling partnership (hellriegel et al., 2001; hitt et al., 2006; lansberg, 1999; ward, 2004). empirical evidence also supports the findings of the present study. both gladstein (1984) and barrick et al. (1998) found positive relationships between cohesive and supportive teams, and levels of teammember satisfaction. similarly, both gladstein (1984:511) and campion et al. (1996:443) found that support among team members is positively correlated with measures of team effectiveness. furthermore smith et al. (1994) reported a positive correlation between a cohesive top management team and financial performance. in the present study no significant relation was found between sibling relationship and growth performance (hypothesis h 4b ). this finding implies that the relationship between the siblings has no influence on the growth performance of the business. support was thus not found for hypothesis h 4b . the results of this study concur with those of barrick et al. (1998:381), whose research indicates that cohesion is related to team-member satisfaction, but not to performance. the current study has revealed significant positive relationships between fairness and the growth performance (path coefficient = 0.51, p<0.001) of the business (hypothesis h 5b ). this finding suggests that the more the siblings consider the working arrangement between them as fair in terms of workload and compensation, the more likely the business is to grow. in addition, the empirical results show that a positive relationship (path coefficient = 0.17, p<0.001) between fairness and satisfaction with work and family relationships (hypothesis h 5c ) also exists. in other words, the more the siblings consider the working arrangement between them as fair in terms of workload and compensation, the more likely it is that they will be satisfied with their work and family relationships. these findings are supported by a large volume of anecdotal evidence (aronoff et al., 1997; gersick et al., 1997; lansberg, 1999; ward, 2004) that posits 18 sajems ns 14 (2011) no 1 the importance of fairness among siblings in family businesses. in addition, various studies (e.g. barrick et al., 1998; campion et al., 1993; campion et al., 1996; olukayode & ehigie, 2005) of teams in organisational contexts have found a significantly positive correlation between workload-sharing and measures of team effectiveness. similarly, danes et al. (1999:246) have identified unfair workloads in family businesses as generating the highest level of tension among family relationships. in the present study no significant relationship was found between fairness and financial performance (hypothesis h 5a ). this finding implies that the existence or nonexistence of fairness between the siblings has no influence on the financial performance of the business. support was thus not found for hypothesis h 5a . 5 conclusions and recommendations the findings of this study suggest that whether or not the business experiences financial and growth performance has no impact on whether the siblings experience their work and family relationships as satisfying. in contrast, lansberg (1999) and ward (2004) assert that the health of the business influences the health of the family and vice versa. adendorff (2004) also finds a positive relationship between family harmony and profitability, and concludes that profitability will increase when family harmony is enhanced. given the finding of this study, it is suggested that these relationships be subjected to further testing in future studies. a high-quality relationship characterised by open communication, managed conflict, encouragement, mutual respect and trust, as well as mutual support and understanding between the siblings, is vital in a sibling partnership. the relationship between the siblings not only influences the degree to which the siblings are satisfied with their working and family relationships, but also has a significant influence on the financial performance of their business. the importance of creating and preserving a positive relationship between the siblings can thus not be overemphasised for the success of a sibling partnership. it is important that the siblings should have affection and care for each other; at the least, they must like each other and should get along well both inside and outside the family business. cooperation, closeness and intimacy should exist between the siblings, while healthy boundaries between them should be maintained; they should each have their own circle of friends and not interfere inappropriately in each other's lives. they should also have similar values, attitudes and priorities. in addition, siblings must overcome childhood rivalries and misunderstanding from the past; and preconceived stereotypes about each other that come from their childhood must be altered. the results of this study confirm that perceptions of fairness have a significant influence on the growth performance of the business, as well as on the extent to which the siblings are satisfied with their work and family relationships. to ensure perceptions of fairness between them, siblings should ensure equitable workloads, opportunity to voice opinions, fairness in decision-making and managerial processes, and fairness in compensation. rewards and compensation are a particularly sensitive matter among families in business together, and play an important role in developing their perception of fairness. it is thus important that the persons involved in the family business (both family and non-family) be given recognition, and be rewarded appropriately for their accomplishments and contributions. an understandable and equitable reward system that encourages cooperative rather than competitive efforts should be implemented. the findings of this study provide important practical insights into the conditions that should prevail to improve the chances of a successful working arrangement between brothers and/or sisters. parents wishing to hand over the family business to more than one of their children, or siblings wanting to go into business together, would do well to ensure that fairness and a good relationship exists between them, or is at least possible, if they hope for a satisfactory outcome. sajems ns 14 (2011) no 1 19 6 implications for future research mutual trust and respect, as well as open communication, are often considered to be separate constructs in the field of family business research. in this study, the items measuring mutual trust and respect, and open communication loaded onto a single construct, together with the items measuring the sibling bond. this result concurs with that of gladstein’s study (1984) on teams in general, where she also reported that the items measuring open communication, supportiveness, conflict, weighting of individual inputs and discussion of strategy, loaded onto one construct. similarly, barrick et al. (1998) report that many of a team’s processes are reflected in the construct of social cohesion, and that social cohesion is an indicator of positive interpersonal dynamics within the team. based on the finding of this study and in line with the studies of gladstein (1984) and barrick et al. (1998), family business researchers could consider using a single construct such as “social cohesion” or “family cohesion” to reflect the interpersonal processes between family members when undertaking family business research. in this study, the single construct, which described the interpersonal relationship between the sibling partners, was named sibling relationship. it was initially proposed in figure 1 that three constructs act as measures of success. two of these were intervening variables, namely family harmony and financial performance, and one was the dependent variable, namely perceived success. when assessing the discriminant validity by means of an exploratory factor analysis, the original six items measuring financial performance loaded onto two factors, which were renamed financial performance and growth performance. to consider growth and profitability as independent opposing measures of business performance is not uncommon in the literature (cubbin & leech, 1986; geringer, frayne & olsen, 1998; small firm survey, 2007-2008). the original measuring instrument contained six items to measure family harmony and five to measure perceived success; these items unexpectedly loaded together onto one construct. consequently, three new factors emerged for measuring aspects of success in this study, namely financial performance, growth performance and satisfaction with work and family relationships. the results of this study support astrachan’s (2006) view that no single measure of performance is likely to capture the complexities of the family business. the findings of this study do, however, offer family-business researchers three possible constructs for measuring the success of family businesses. according to poutziouris, smyrnios and klein (2006), research to date concerning teams in general is also relevant to business families. the findings of this study support this view in that the intra-group processes identified in the teamwork literature have been shown to have an impact on effectiveness in the context of the family business. this finding has important implications for family business research, given that team management among family businesses is considered to be a major focus in the years to come (sharma, 2004). 7 limitations and future research in all empirical studies, their limitations must be identified and considered when making interpretations and conclusions. the use of non-probability snowball convenience sampling is a limitation that introduces a source of potential bias into this study. as such the findings reported cannot be generalised to the general family business population. another limitation of this study is that the proposed hypothesised model focuses exclusively on a selected number of intragroup processes. future studies could investigate various other relational and taskbased factors and incorporate them into a more comprehensive model that describes the factors influencing the successful functioning of sibling partnerships. in addition, future studies could focus on other family business teams. despite the limitations identified, this study has added to the empirical body of family business research. potential opportunities for examining teams over time in the family 20 sajems ns 14 (2011) no 1 business research setting have been identified. in addition, this study provides an important first step in gaining insights into the intragroup processes influencing the effective functioning of family business teams. acknowledgement this paper is based upon work financially supported by the national research foundation of south africa. references adendorff, c.m. 2004. the development of a cultural family business model of good governance for greek family businesses in south africa, unpublished doctoral dissertation, grahamstown: rhodes university. ahronson, a. & cameron, j.e. 2007. the nature and consequences of group cohesion in a military sample, military psychology, 79(1):9-25. aronoff, c.e., astrachan, j.h., mendosa, d.s. & ward, j.l. 1997. making sibling teams work: the next generation family business leadership series, georgia: family enterprise publishers. astrachan, j.h. 2006. editor’s notes, family business review, 19(1):v-vi. barrick, r.b., stewart, g.l., neubert, m.j. & mount, m.k. 1998. relating member ability and personality to work-team processes and team effectiveness, journal of applied psychology, 83(3):377-391. barsade, s.g., ward, a.j., turner, j.d.f. & sonnenfeld, j.a. 2000. to your heart’s content: a model of effective diversity in top management teams, administrative science quarterly, 45:802-836. beal, d.j., cohen, r.r., burke, m.j. & mclendon, c.l. 2003. cohesion and performance in groups: a meta-analytic clarification of construct relations, in kozlowski, s.w.j. & ilgen, d.r. 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dissertation, port elizabeth: university of port elizabeth (nmmu). wageman, r., hackman, j.r. & lehman, e.v. 2005. team diagnostic survey: development of an instrument, the journal of applied behavioural science, 41(4):373-398. ward, j.l. 2004. perpetuating the family business. 50 lessons learned from long-lasting successful families in business, new york: palgrave macmillan. http://books.google.co.za/books sajems ns 14 (2011) no 1 23 appendix a satisfaction with work and family relationships harm6 relationships among members in our family can be described as positive. psucc1 i am satisfied with the way that my sibling(s) and i work together. harm2 the members of our family are in harmony with each other. harm3 the members of our family are supportive of each other. harm4 our family members appreciate each other. psucc3 i enjoy working with my siblings in our family business. psucc5 i experience my involvement in this business together with my sibling(s) as rewarding. psucc4 i experience my involvement in this business together with my sibling(s) as fulfilling. psucc2 i am satisfied with the functioning of the working arrangement between my sibling(s) and i. harm5 our family members care about each other’s welfare. financial performance fin5 i regard our family business as being financially successful. fin3 our family business is profitable. fin6 the financial well-being of our family business is secure. growth performance fin1 our family business has experienced growth in turnover over the past two years. fin4 our family business has experienced growth in profits over the past two years. fin2 our family business has experienced growth in employee numbers over the past two years. sibling relationship com1 my sibling(s) and i communicate openly with each other. com4 my sibling(s) and i share information with each other. com2 my sibling(s) and i freely express our opinions about day-to-day decisions in the business with each other. com3 in our business my sibling(s) and i discuss all issues that may arise between us. com5 my sibling(s) and i all have the ability to communicate effectively. sib7 my sibling(s) and i are able to constructively manage conflict between us. sib4 my sibling(s) and i encourage each other to give our best efforts. retrust3 my sibling(s) and i trust each other. retrust1 my sibling(s) and i respect each other. retrust2 expressing different views and opinions are encouraged between my sibling(s) and i. sib1 my sibling(s) and i have a mutually supportive relationship. sib5 i have a good understanding of how my sibling(s) make(s) decisions. retrust4 my sibling(s) and i trust each other’s ability to manage our family business. retrust5 i have confidence in the integrity of my sibling(s) working together with me in our family business. sib6 i have a good understanding of the needs and preferences of my sibling(s). fairness fair4 in our family business each sibling is compensated fairly for the work that he or she does. fair6 in our family business rewards for siblings are based on merit. fair1 given their compensation each sibling does his or her fair share of the work in our family business. page 1 of 1 reviewer acknowledgement http://www.sajems.org open access acknowledgement to reviewers in an effort to facilitate the selection of appropriate peer reviewers for the south african journal of economic and management sciences, we ask that you take a moment to update your electronic portfolio on https:// sajems.org for our files, allowing us better access to your areas of interest and expertise, in order to match reviewers with submitted manuscripts. if you would like to become a reviewer, please visit the journal website and register as a user. in order to be considered, please email submissions@ sajems.org indicating your intention to register as a reviewer for the journal. to access your details on the website, you will need to follow these steps: 1. log into the online journal at https://sajems. 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santos peter w. baur philip steenkamp pieter schaap pradeep brijlal precious mncayi rebat k. dhakal reza daniels rhodrick n. musakuro rob venter roger s. brown ronald davies sakshi malik samson mtisi shagaran rathnasamy shaun parsons sithembiso khumalo stefanie kuhn stéphane gagnon sununu i. bah syden mishi tamlyn mckenzie temitope leshoro thando loliwe thokozani p. mbhele veronique blum vivence kalitanyi yeni priatnasari yoshihiko nishiyama yvetter lange zeeshan ahmad zhenjia liu http://www.sajems.org� https://sajems.org https://sajems.org mailto:submissions@sajems.org mailto:submissions@sajems.org https://sajems.org https://sajems.org https://sajems.org/index.php/sajems/user https://sajems.org/index.php/sajems/user mailto:publishing@aosis.co.za sajems ns 11 (2008) no 1 69 a study of customer commitment through the use of the conversion model in the south african motor vehicle industry nic s terblanche dept of business management, university of stellenbosch abstract consumer markets have become increasingly competitive. numerous measures to gauge and predict loyalty and commitment have been developed to assist management in this respect. the marketing literature contains many examples illustrating that longer relationships achieve customer retention, and have been rewarded with a considerable increase in customer net present value. customer retention is undoubtedly a major contributor to profitability in the long term. research shows that the most successful measures for achieving customer retention are customer delight, customer satisfaction and customer commitment. this study makes a closer exploration of customer commitment, as measured by the conversion model, in the south african motor vehicle industry. the findings highlight the commitment segments of the most popular motor vehicle brands in south africa, as well the typical marketing strategies for managing the different commitment segments. jel d12 1 introduction peter drucker once declared that the customer is the one who determines what a business is, what it produces, and whether it will prosper (1973). in recent years, a great deal of research has been undertaken in the field of customer management. the research mentioned above focused on the assessment of approaches that can be used by firms to manage customers as key assets (kumar, lemon & parasuraman, 2006: 87). customer retention has become so important for businesses that it has been labeled the “holy grail” of businesses (coyles & gokey, 2005: 101). the renewed interest in customer retention could have been triggered by the work of dawkins and reichheld (1990), who reported that a small increase in customer retention led to an increase in customer net present value of between 25-95 per cent across a broad spectrum of different business environments. however, other authors argue that the revenue growth and cost savings benefits of customer retention is industry-specific and is not available to firms that typically have a high turnover of customers and low exit barriers in highly competitive markets (egan, 2000: 381-382; pressey & mathews, 2001: 280). recently, ang and buttle presented a view contrary to that of these authors, namely that the focus on customer retention has led to a growing recognition that customers, like products, have a life-cycle that companies can attempt to manage. customers are acquired, retained and can be grown in value over time (2006: 83). the importance of customer retention has become decisive for firms’ financial performance and survival. they have therefore been trying to understand customers’ “unpredictable behaviour” as far as longer-term relationships are concerned. knox and denison (2000), for instance, have suggested that the transition to impersonal, self-service systems may encourage consumers to become more fickle in their shopping behaviour. 70 sajems ns 11 (2008) no 1 2 structure of the article the rest of the article consists of nine major sections. the first section presents an overview of the advantages of customer retention. this is followed by a brief discussion of customer delight, customer satisfaction and customer commitment as means of achieving customer retention. thereafter, customer commitment, the focus of the article, is examined in more detail. the next two sections deal with the purpose and objectives of the study and the theory and practical application of the conversion model to assess and manage customer commitment. then follow sections on the methodology and the empirical findings. the article concludes with managerial implications and limitations of the study. 3 advantages of customer retention several streams of research have focused on customer retention. these suggest that customer retention leads to reduced sales and marketing costs on the one hand, and an increase in the opportunities for cross-selling of products and services and positive word of mouth by customers on the other (grönroos, 1990; reichheld, 1996; kent & löfmarck vaghult, 2000; wirtz & lihotzky, 2003). various studies specifically focused on customer retention as a very important contributor to profitability in the long term (anderson & sullivan, 1993; fornell, 1992; iniesta & sánchez, 2002; heskett, sasser & schlesinger, 1997; heskett, 2002; dick & basu, 1994; anderson, fornell & lehmann, 1994). the advantages of longer relationships to enhancing customer retention and marketing productivity have been addressed by various authors. these longer relationships create interdependencies that result in reduced transaction costs and produce higher quality, while keeping governance costs lower than exchange marketing (sheth & sisodia, 1995; heide & john, 1992; williamson, 1985; heskett, sasser & schlesinger, 1997; palmatier, dant, grewal & evans, 2006). the creation of longterm relationships has also prompted a certain degree of deliberation amongst academics and practitioners. customer delight, customer satisfaction and customer commitment are some of the strategies that have been regarded as essential to the creation of extended-term relationships with the eventual aim of achieving customer retention and loyalty. 4 customer delight, customer satisfaction and customer commitment as means of achieving customer retention the strategies of customer delight, customer satisfaction and customer commitment have been discussed at length in the academic literature (rust & oliver, 2000; szymanski & henard, 2001; gounaris, 2005; bansal, irving & taylor, 2004; auh & johnson, 2005). what constitutes the best measure of customer retention is still open to deliberation. three constructs related to customer retention, namely, satisfaction, loyalty and commitment, have enjoyed wide coverage in academic journals during the past fifteen years (oliver, 1999; auh & johnson, 2005; wetzels, de ruyter & van birgelen, 1998). the relationships between satisfaction and loyalty and between satisfaction and commitment, in particular, have received a great deal of attention in academic literature (oliver, 1999; clerfeuille & poubanne, 2003). various authors have also conceptualised and operationalised customer retention as a dimension of the loyalty construct (boulding, kalra, staelin & zeithaml, 1993; zeithaml, berry & parasuraman, 1996). customer delight is not suitable as a longterm strategy for retaining customers. the reason for this is obvious. each time a customer experiences delight, there is a higher expectation of the next experience. later expectations reach levels impossible for a firm to satisfy. not all high satisfaction levels necessarily convert into continuous future patronage (jones & sasser, 1995). hall (2001) presented some compelling statistics showing that it is possible for current high satisfaction levels in the motor vehicle industry to be experienced as the opposite sajems ns 11 (2008) no 1 71 when a new motor vehicle is purchased. mccarthy (1997: 13) reported a similar finding concerning xerox customers; highly satisfied xerox customers did not always buy again from xerox. it has been stated that “satisfaction alone provides scant information about how customers will respond to competitive offers, product availability, price competition, or even product failure” (hess & story, 2005: 313). nevertheless, hess and story (2005: 315) conclude that satisfaction provides the conditions necessary for commitment. ganeson (1994) and abdul-muhmin (2002: 645) maintain that satisfaction leads to commitment. similarly, dimitriades (2006: 796) and wetzels, de ruyter and van birgelen (1998: 416-418) confirm that satisfaction has a direct and positive effect on commitment. the conclusion to be drawn from this is that satisfaction is an antecedent of commitment. in its role as an antecedent of commitment, satisfaction thus has an indirect positive effect on customer retention. this article focuses on the measurement of customer commitment as a means of assessing customer retention. it also deals with the measurement of customer commitment as a means of assessing customer retention. the conversion model (cm) is used to measure customer commitment. 5 customer commitment there have been numerous attempts to define commitment. it is relevant to consider some of these definitions, as they allow insight into the complexity and the various features of commitment. in earlier research, scanzoni (1979: 87) identified commitment as the fourth phase in relationship building, and observed that it consisted of three measurable conditions, namely, inputs, durability and consistency. inputs consist of important resources being exchanged; desirability refers to association over time between the parties concerned, whilst consistency means the extent of inputs made to maintain the association. dwyer, schurr and oh (1987: 19) defined commitment as “an implicit or explicit pledge of relational continuity between exchange partners”. according to dwyer et al. (1987: 23), commitment implies a willingness to make short-term sacrifices to realise longer-term benefits. commitment embodies the highest stage of relational bonding, and conforms to scanzoni’s three criteria for defining commitment. in their seminal work of 1994, morgan and hunt found that commitment is central to all the relational exchanges between a firm and its partners (1994: 23). following an extensive literature review and an empirical study, they also determined (1994: 25) that co-operation arises directly from relationship commitment. it has also been observed that commitment is comprised of the following three components: an input or instrumental component (which represents some form of investment), an a t t i t u d i n a l c o m p o n e n t ( w h i c h s u g g e s t s a behavioural intention) and a temporal dimension (gundlach et al., 1995: 79). the temporal dimension refers to the time-scale of relationships or the partners’ desire for relationships to continue over time. morgan and hunt (1994: 23) defined commitment as “the belief of an exchange partner that the ongoing relationship with another is so important as to warrant maximum efforts at maintaining it”. this definition has much in common with that of moorman, zaltman and despande (1992: 316), who define commitment as “an enduring desire to maintain a valued relationship”. it can thus be concluded that the words “enduring desire to maintain” point to the shared conviction that a committed partner would prefer the relationship to last for an indefinite period and would therefore be willing to put in some effort to nurture the relationship. the “valued relationship” concept argues that commitment will exist only if partners are of the same opinion concerning the importance of the relationship. while gounaris defined commitment as “the desire for continuity manifested by the willingness to invest resources into a relationship”, he also highlighted the existence of two types of commitment, namely affective and calculative commitment (2005: 127-128). the difference between affective and calculative commitment, originally identified by mathieu and zajac in 1990, stems from different 72 sajems ns 11 (2008) no 1 motivations for maintaining a relationship. the motive for affective commitment appears to be a generalised sense of positive regard for and attachment to the other party. calculative commitment, on the other hand, follows from an anticipation of high termination or switching costs associated with ending the relationship (gounaris, 2005: 128). the above-mentioned definitions of commitment share the following characteristics: • all parties involved provide inputs. • commitment has a long-term orientation. • commitment has a psychological dimension. • the relationship is important to the parties, so they make efforts to maintain it. to avoid possible confusion, there must be a distinction between loyalty and commitment at this point. loyalty is, in essence, behavioural. ceurvorst and kitaeff (1996: 56) define loyalty as the continuous use or purchase of a brand, product or service. continuing as a customer of a bank or airline, repurchasing the same brand of car, and buying the same brand of washing powder are typical examples of loyal behaviour. however, repetition of such behaviour does not automatically point to strong, absolute loyalty. commitment, on the other hand, is psychological in nature. it is the power of the relationship between the individual and a brand, product, or service. the importance of the measurement of commitment to signify retention can be found in the fact that commitment can cease to exist long before it becomes evident in an individual's behaviour. in other words, a customer can become uncommitted to a brand of car long before being in the market for a new car. similarly, a client can become uncommitted to a bank long before making a change. hofmeyr and rice (2000: 80) identify the following three conditions as essential if an individual or customer is to be perfectly committed to something: (1) they must be satisfied with a product or service; (2) they must care about the relationship and see it as important; (3) there is nothing else that appeals to them. 6 purpose and objectives of the study very few studies on the effect of commitment on customer retention have been published to date (bansal, irving & taylor, 2004; garbarino & johnson, 1999; pritchard, havitz & howard, 1999; bettencourt, 1997). this article hopes to make a contribution in this respect. during 2005 and 2006, the cm was used in a study of the fast food and motor vehicle industries in south africa. the rationale for the selection of these two industries was that both are extremely competitive, while their products represent the two boundaries of low-involvement products (fast food) and high involvement products (motor vehicles). this article focuses on the application of the cm in the motor vehicle industry. the primary objective of this study is to explore customer commitment, as measured by the cm, in the south african motor vehicle industry. a secondary purpose of the study is to report on the empirical findings in respect of the customer commitment segments for motor vehicle brands in south africa. the latter will enable us to suggest and discuss the typical marketing strategies that could be followed in the different commitment segments. 7 the conversion model this section deals with the theory underlying the cm, as well as how a practical application of the cm identifies various categories of consumers in terms of their commitment to a particular product or brand. 7.1 the theory underlying the cm shifts in attitudes, generally speaking, precede shifts in behaviour. a customer’s commitment level can therefore be recorded as an indicator of changes in behaviour. the cm theory initially emanated from three sources, namely cognitive and social psychology, catastrophe theory and religious conversion (ceurvorst & kitaeff, 1996: 58). cognitive and social psychology theory serve as the basic foundation for the sajems ns 11 (2008) no 1 73 assumptions about the customers’ consumption decision-making behaviour. customers are motivated by a wide range and intricate network of needs, values, hopes and desires. a further assumption is that consumer decision-making is driven by a consumer’s synthesis of assessments; that is, although consumers may contemplate numerous issues during the decision-making process, in the end they act in accordance “with a generalized impression about what is best”, and “it is usually easier for someone to provide a global rating of a product than to elucidate specific reasons for buying it” (ceurvorst & kitaeff, 1996: 58). catastrophe theory provides the theoretical structure for the multifaceted relationships among the forces that create commitment. catastrophe theory enables the explanation of the transformation of a system’s dynamic structure (in this instance, the interaction of various elements of a consumer). ceurvorst & kitaeff (1996: 60) point out that, in physics, as well as in mathematics and sociology, catastrophe theory describes “how and when equilibrium breaks down” because it is capable of coping with complex, discontinuous relationships between causes and effects. brandswitching is a perfect example of discontinuity in consumers’ behaviour because they change their minds. the cm makes use of catastrophe theory to assess a customer’s “equilibrium” or stability with a brand, product, or service and to detect at what points that stability breaks down. the cm measures the power of the psychological relationship between individuals and all their choices about a brand in a market (hofmeyr & rice, 1995). current users of a product/service are classified in terms of how committed they are to continued use of the brand, while non-users are graded in terms of their readiness to convert to a particular product/service. the allocation of the consumers to different commitment segments (illustrated in figure 1) is done with an algorithm based on the mathematics of catastrophe theory (more specifically the butterfly cusp) (rice & bennett, 1998: 62). the allocation algorithm classifies respondents according to their responses on the four dimensions of satisfaction with the brand, the importance of the brand, the perception of alternatives and a respondents’ degree of ambivalence. positive and negative outranking are applied to the responses to the items representing the four dimensions. the following example illustrates a customer in the entrenched segment: if the brand used by the respondent was ideal, the choice of that brand was extremely important (this means the respondent was involved in both the category and the brand), the respondent perceived the brand to be significantly better than any other brand on the market, and was very certain (that is, not ambivalent at all) about his or her brand choice, then the respondent would be classified as “entrenched” (rice & bennett, 1998: 62). in the extreme opposite position is the strongly unavailable segment consisting of non-users of a brand whose preference is unequivocally for their current choice. this is because either they are entrenched in their current brands, or, if they are open to others, the brand under study is not among them. it is not possible to provide all the possible permutations of the cm dimensions in this article, as the cm is a proprietary technique. it constructs a full overview of the psychological strength of a brand in its market and also produces a specific profile for a respondent. for each respondent, the cm produces a profile of the strength of the respondent’s psychological relationship with each brand in the market. 7.2 the cm categorisation of consumers in terms of their commitment the cm measures the extent of a consumer’s level of commitment to a brand to make predictions about future brand loyalty. the cm employs four dimensions to measure levels of commitment. the first dimension of cm is the customer’s satisfaction with the brand. as discussed in section 4 and based on evidence provided by many researchers, satisfaction correlates poorly with future behaviour (keaveney, 1995; mittal & lassar, 1998; miranda, kónya & havrila, 2005; andreassen & lindestad, 1998). understanding satisfaction enables us to understand consumers’ behaviour to some extent. customer satisfaction falls short in two important areas. firstly, it does not provide for the identification of customers who are at risk, and, secondly, it is unable to provide 74 sajems ns 11 (2008) no 1 any light on non-customers (richards, 1996: 52). satisfaction remains, however, an essential element in our understanding of the relationship between customers and brands, and thus of customer retention. the second dimension is the way customers perceive alternative brands. the evaluation of a brand does not happen in isolation. it amounts to a comparison with all competing brands. however, a high satisfaction score does not indicate that the relationship between the customer and the brand is secure. the third dimension of cm is how important a particular brand is to a consumer. where brand choice is not important, it will be hard to achieve commitment. commitment can be achieved only if both the product category, as well as brand choice, is important to a customer. the underlying assumption is that the more important the brand choice is to the customer, the more time and effort will be needed before a brand is chosen. the fourth cm dimension is the degree of the consumer’s ambivalence about competing brands. the more ambivalent the customer, the greater the likelihood of the choice being delayed. ambivalent consumers are influenced by point-of-purchase marketing stimuli, as they often decide on a particular brand only once they have reached the shop shelf. the cm categorises consumers according to their level of commitment to a particular brand. consequently, a consumer’s relationship with every brand in the market is identified. this information enables us to identify the relative attraction of all other brands when compared with those currently being used by consumers. respondents are then divided into users and non-users, each according to the four segments (hofmeyr & rice, 2000: 25-26). 8 the methodology of the study there are two parts to this section of the article. the first deals with the sample and data collection of the empirical study. the second part accounts for the ways used for measuring a consumer’s commitment, as well as the basis on which consumers are allocated to the different commitment segments. 8.1 sample and data collection of the empirical study a structured questionnaire was used to collect data and was administered by means of personal interviews. the interviews were conducted with respondents during june 2005, using random suburb sampling to obtain a representative national sample. suburbs were drawn from the 2001 south african census and five interviews were conducted in each selected suburb to ensure that a demographically representative sample was realised across suburbs and geographic areas. the total sample for this study was 2000 interviews, conducted in the following seven major metropolitan areas of south africa: • johannesburg • pretoria • cape town • durban • bloemfontein • east london • port elizabeth the sample is proportionate to the south african population in terms of both ethnic group and gender. the geographical and racial dimensions of the sample are set out in table 1. table 1 the geographical and racial dimensions of the sample area race black white coloured indian jhb/pretoria 64% 60% 17% 26% durban 16% 10% 4% 65% east london 3% 3% 2% – sajems ns 11 (2008) no 1 75 port elizabeth 6% 5% 10% – bloemfontein 2% 3% – – cape town 9% 19% 67% 9% number of respondents 1 260 385 240 115 respondents were interviewed at home and had to be 18 years or older to qualify for the interview. fully-trained interviewers working under the supervision of field managers collected the data. the respondents were interviewed by interviewers of the same race group in their home language. in order to ensure honesty and reliability, a minimum 20 per cent check-back was conducted on the total sample, with at least 10 per cent on any one interviewer’s work. a total of 34 motor vehicle brands were included in the study. annexure a contains the names of the brands. 8.2 measurement of consumers’ commit ment and allocation of consumers to commitment segments the questionnaire to measure commitment to a particular brand with the cm is comprised of four items (rice & bennett, 1998; hofmeyr & rice, 2000). these four items and how they are measured are as follows: • need satisfaction: this is the extent to which consumers’ needs are satisfied by a particular brand, measured on a 10-point likert scale. • involvement in the category: this expresses the importance of the brand choice in the category to the consumer, measured on a 7-point likert scale. • attitude to alternatives: this reflects the levels of commitment of the consumer to the brands currently being used, measured on a 7-point likert scale. • intensity of ambivalence: this is the degree to which the consumer is uncertain about the brands on offer, measured on a 3-point scale. the allocation of the consumers to different commitment segments (illustrated in figure 1) is done with the algorithm based on the mathematics of catastrophe theory (more specifically the butterfly cusp), which is discussed in section 7.1 (rice & bennett, 1998: 62). the allocation algorithm classifies respondents according to their responses on the four dimensions of satisfaction with the brand, the importance of the brand, the attitude to alternatives and a respondent’s degree of ambivalence. the four items used to measure customer commitment produce 1470 possible responses. the individual responses to all the brands that are part of a respondent’s evoked set are captured. positive and negative outranking is applied to the responses to the items representing the four dimensions. the end value after positive and negative outranking has been applied assigns the respondent to a particular commitment segment. figure 1 is an illustration of all the segments identified by the cm. the cm divides current users of a brand into one of four segments (hofmeyr & rice, 2000: 25): entrenched: users of a brand who are unlikely to switch to other brands in the near future; average: users of a brand who are unlikely to change in the short term, but might do so in the medium term; shallow: these users’ commitment is below average and some of them are already actively considering alternative brands; convertible: it is highly likely that this group of users will defect to other brands. non-users of a brand, like users, can also be placed in one of four segments (hofmeyr & rice, 2000: 26): available: these non-users of the brand prefer a particular brand to their current one, and, although they have not yet switched over, they are psychologically ready for the change; ambivalent: the brand under study and the user’s current brand are equally attractive to 76 sajems ns 11 (2008) no 1 this segment of non-users, so in essence they are available to the brand under consideration; weakly unavailable: non-users whose first choice lies with their current brands, though not firmly; strongly unavailable: this group of non-users strongly prefers their current brand and will adhere to it, in the short term at least. figure 1 segments of the conversion model source: hofmeyr and rice, 2000: 26. 9 empirical findings figure 2 illustrates the findings for all the brands included in the study. the graph clearly illustrates that commitment is rather low in the motor vehicle industry. the number of observations in figure 2 is the total of all the responses of all 2000 respondents to all the brands they own or would consider buying according to the four items used for measuring commitment. figure 3 illustrates the eight segments produced by the analysis of the data of the six most strongly-supported brands. the number of respondents for each of the six brands is set out in table 2. users committed uncommitted entrenched shallowaverage convertible non-users open unavailable available weakly unavailable ambivalent strongly unavailable sajems ns 11 (2008) no 1 77 figure 2 commitment categories of the conversion model for the motor vehicle brands included in the study table 2 number of respondents for best supported brands brands number of respondents toyota 123 volkswagen 72 nissan 39 ford 55 mazda 34 bmw 33 figure 3 reveals the commitment strengths of the six most popular of the 34 brands studied. it also presents the percentage of current nonusers of the brands studied who might convert to a particular brand, as well as those who are not available to a particular brand. it is clear from figure 3 that toyota is by far the strongest motor vehicle brand in south africa, because 24 per cent of the brand’s customers are entrenched, while the second strongest brand, volkswagen, has only 5 per cent entrenched customers. the remaining brands have 4 per cent or fewer entrenched customers. entrenched customers are the prime customers of a brand, as they are unlikely to switch brands in the near future. these customers serve as advocates for the brand and they are likely to recommend it to others. this in turn endows the brand with valuable goodwill (ceurvorst & kitaeff, 1996: 60). table 3 is a summary of the committed, uncommitted, open and available customers of the six best supported brands. 78 sajems ns 11 (2008) no 1 table 3 percentage of consumers in the different cm segments users non users brand committed uncommitted sub-total open unavailable sub-total total toyota 24% 5% 29% 7% 65% 72% 100% volkswagen 11% 5% 16% 3% 81% 84% 100% nissan 7% 2% 9% 0% 91% 91% 100% ford 8% 5% 13% 1% 86% 87% 100% mazda 5% 3% 8% 0% 91% 91% 100% bmw 5% 2% 7% 4% 89% 93% 100% table 3 shows that 83 per cent of toyota users are committed [(24÷29)(100)]. toyota has the strongest brand strength of the brands studied. ford and mazda, on the other hand, have the weakest brand strength of the six best supported brands, namely 62 per cent (that is [(8÷13)/100]) and 63 per cent [(5÷8)/100 = 63 per cent]) committed users respectively. the most suitable way of managing relationships with customers varies from segment to segment. essentially, customers who use the brand can be divided into committed (entrenched or average) or uncommitted (shallow or convertible), while non-users of the brand can be divided into those who are open to the brand (available or ambivalent) or unavailable (weakly or strongly unavailable). the non-users constitute the largest segment in this study. relationships with committed customers are, generally speaking, the easiest to manage (rice & bennett, 1998:61). this segment of customers prefers the brand and is actually fond of it, believes the advertising about it and is, on the whole, not price-sensitive. despite this favourable attitude towards the brand, it is imperative for these customers to be continuously reminded and re-assured that they have made the right choice. when customer commitment is neglected, their relationship with the brand can deteriorate. this is especially relevant for brands like ford and mazda, as their committed customers constitute only 62 per cent and 63 per cent respectively of their users. a drop of 1 per cent in committed consumers of ford, for instance, means a drop of 8 per cent of the committed share of their users (that is [(8÷13)(100)] = 62 per cent and [(7÷13)(100)] = 54 per cent). advertising is a very functional means of nurturing committed consumers, because advertising reassures consumers, and increases their awareness of the consumption experience. enduring commitment thus demands preservation of the brand. brand faithfulness amongst committed consumers makes brand switching a very difficult matter. the latter is especially true of the most favoured brand on a customer’s list. most markets for consumer goods tend to be fairly stable, with substantial adjustments taking place only when new channels of distribution are introduced into the market-place (such as internet transactions) or when new significant changes are made to product categories (such as hybrid engines in motor vehicles). these “substantial” or “significant” changes result in consumers reconsidering realistic alternatives to the brands they use (hofmeyr & rice, 2000: 36-37). there are many reasons for lack of usercommitment to a brand (hofmeyr & rice, 2000: 38). typical sources are lack of involvement in the category or dissatisfaction with the product or service. lack of commitment can also result from exceptionally heavy involvement with the category, as this can lead to experimenting with brands and ongoing assessments of new brands. uncommitted consumers select the brand they can purchase with the least effort, so convenience and price are their main selection criteria. sajems ns 11 (2008) no 1 79 fi gu re 3 r es ul ts o f t he c on ve rs io n m od el s tu d y: u se r an d n on u se r se gm en ts 80 sajems ns 11 (2008) no 1 advertising does not reach these consumers, as they belong to the group running the least chance of being influenced by any advertising for the category. they block advertising, so marketing efforts should focus on point of sale and promotion activities that increase the visibility of the brand. when consumers are uncommitted but brand choice does matter to them, the marketer faces an intimidating task. perhaps the customer has experienced difficulties in the past. the challenge, therefore, is to establish the exact nature of the problem experienced previously and the most suitable action to be taken. the “promiscuous” consumer also belongs to this segment of consumers. a case in point is the consumers who, on a regular basis, qualify for a new company car. brand choice is very important to such consumers, but they also experiment frequently with other brands. experimentation is integral to the behaviour of these consumers. they read advertisements diligently, so the more information they can be given about a brand, the better. available non-users are not currently using a particular brand, but they are immediately available for acquisition. the extent of this segment matters when new items like microwave ovens and cell phones, for instance, are launched. hofmeyr and rice (2000: 39) report on a study in which the size of the non-user segment available to all brands of cell phones was so large that any focus on competition between brands was irrelevant. the fact that non-users were available to the category meant that the most accessible brand came to mind first and, if competitively priced, would be selected. the reason that ambivalent consumers are not using a particular brand is simply because they are undecided about the brand (ceurvorst & kitaeff, 1996: 60). the brand about which this segment is ambivalent is not regarded as better or worse than the brand they are currently using. only worthwhile incentives will win these consumers over to a brand. reduced prices, very favourable financing options or a spectacular promotion (such as the chance to get a free motor vehicle or attend a course in advanced driving) are typical incentives in this regard. thorough research among these consumers is necessary to understand what would make them use another brand. as indicated earlier, uncommitted users of competitor brands are non-users who are available to or ambivalent about a brand. marketers are frequently tempted to focus more on the unavailable than on the available and ambivalent segments, because, for most brands, the unavailable segment is usually the largest segment. this is also the case with the six brands reported in table 3. the unavailable segment constitutes 65 per cent or more respondents for all the brands studied. the reason(s) for a consumer being unavailable to a particular brand could be one or more of the following (hofmeyr & rice, 2000: 40): • they know of the brand, and may even have tried it, but see no reason to switch; • they are committed to the brands they use; • they are aware of the brand, but have a poor impression of it; • they are unaware that the brand exists. the latter reason for unavailability can be easily rectified. the brand must be exposed to this segment through advertising or other promotion means to encourage trial. as far as established mature brands are concerned, the most common reason for unavailability to a brand is that consumers are satisfied with their current choice (ceurvorst & kitaeff, 1996: 60) and see no reason for switching from their present preference. they can see nothing wrong with a competing brand, but are pleased with what their current brand offers them. advertising has no effect on the unavailable segment of consumers and therefore does not persuade or influence its members (hofmeyr & rice, 2000: 158 & 173; rice & bennett, 1998: 63). the major means of persuading unavailable consumers to consider purchasing a brand is by trial. some motor vehicle retailers send personal invitations to test–drive a new model or attend its launch. the segments recognised by the cm enable us to work out why consumers are unavailable to a brand. it enables us to take decisions and actions to acquire the unavailable segment for a particular brand in the near future. sajems ns 11 (2008) no 1 81 10 managerial implications for the motor vehicle industry customer retention, now accepted as a vital contributor to long-term profitability, has undoubtedly become a major challenge for firms. the daunting challenge for managers is that, although customers might claim to be highly satisfied, they often change to competing brands. it is an undeniable fact that satisfied customers are not necessarily loyal customers. the cm’s major advantage is that it takes into account satisfaction, the psychological significance of the brand choice to the consumer, and a comparative measure of the customer’s preferred brand against the competition to measure commitment. apart from its ability to measure retention, the cm is also effective in revealing possible sources of future business. the tasks for managing individual segments can be summarised as follows: • committed customers need to be continually reassured about the choice they have made. to put consumers’ minds at rest and enhance the consumption experience, frequent advertising for maintenance of the brand is imperative. when independent road tests have been undertaken by journalists or authoritative bodies, the results or the broadcasting times of such tests should be brought to customers’ attention as soon as possible. • when uncommitted customers with no particular brand preference are involved, sales staff should be trained in both technical and other knowledge about the vehicles. • there should be ample opportunities for uncommitted customers for whom brand choice is important to lodge complaints and/or make suggestions. the “promiscuous” type in this segment requires regular advertising and websites should be updated regularly with new information. furthermore, efforts should be made to include such customers on mailing lists. • available non-users are important when new models are launched. accessibility, price and prominence in the mind are important if business is to be done with this segment. • to attract ambivalent consumers there must be a worthwhile incentive. recent examples of this are fixed interest rates over the period of payment, deferred payments and the inclusion of a range of accessories with standard models. the message is clear: it takes an unusual or extraordinary promotion campaign to win over ambivalent consumers to a brand. • 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(1996) “the behavioural consequences of service quality”, journal of marketing, 60(2): 31-46. 84 sajems ns 11 (2008) no 1 annexure a motor vehicle brands included in the study alfa romeo lexus audi mazda bmw mercedes-benz chevrolet mini chrysler mitsubishi citroen nissan colt opel daewoo peugeot daihatsu renault fiat rover ford saab honda suzuki hyundai subaru isuzu toyota jaguar volkswagen jeep volvo kia other (respondent had to specify) land rover none sajems 25-1_2022_contents.indd http://www.sajems.org open access table of contents original research fiscal multipliers in south africa after the global financial crisis theo janse van rensburg, shaun de jager, konstantin hristov makrelov south african journal of economic and management sciences | vol 25, no 1 | a4191 | 31 march 2022 original research the entrepreneurial intention-action gap and contextual factors: towards a conceptual model paul roos, melodi botha south african journal of economic and management sciences | vol 25, no 1 | a4232 | 26 april 2022 original research rural-urban migration and the well-being of the migrantsending households: an impact evaluation study gracious nyoni, umakrishnan kollamparambil south african journal of economic and management sciences | vol 25, no 1 | a4120 | 29 april 2022 original research sustainable supply chain integration: an exploration of south african fast-moving consumer goods manufacturers sa’diyah ebrahim, wesley niemann, theuns kotzé south african journal of economic and management sciences | vol 25, no 1 | a4192 | 23 may 2022 original research the implications of the african continental free trade area on south african agricultural trade: an application of the partial equilibrium mode thembalethu m. seti, olebogeng d. daw south african journal of economic and management sciences | vol 25, no 1 | a4302 | 25 may 2022 original research relationship between black ownership, capital structure and company performance tapiwa dube, leon m. brummer, john h. hall, mpinda f. mvita south african journal of economic and management sciences | vol 25, no 1 | a4419 | 04 july 2022 original research predictors of passengers’ satisfaction with long-distance coach liners in south africa felix amoah, marlé van eyk, mthi yolokazi south african journal of economic and management sciences | vol 25, no 1 | a4506 | 08 july 2022 original research globalisation and economic growth in africa: new evidence from the past two decades parfait b. beri, gabriel mhonyera, gabila f. nubong south african journal of economic and management sciences | vol 25, no 1 | a4515 | 25 july 2022 77 90 105 117 131 142 151 161 page i of ii table of contents editorial netnography: an underapplied research method kim l.a. viljoen south african journal of economic and management sciences | vol 25, no 1 | a4891 | 15 december 2022 research note reforming procurement standards in order to effectively deliver public infrastructure: rethinking the regulatory environment in post-pandemic south africa jonathan klaaren, ron watermeyer south african journal of economic and management sciences | vol 25, no 1 | a4465 | 27 september 2022 research note tax: the pac-man of funding received from the crowd annelize oosthuizen south african journal of economic and management sciences | vol 25, no 1 | a4703 | 08 december 2022 original research the impact of kaizen: assessing the intensive kaizen training of auto-parts suppliers in south africa keijiro otsuka, nkumbuzi ben-mazwi south african journal of economic and management sciences | vol 25, no 1 | a4093 | 18 january 2022 original research a proposed leadership skills development model for african fmcg business-networks: super-cube® craig r. muller, theuns g. pelser south african journal of economic and management sciences | vol 25, no 1 | a4303 | 24 january 2022 original research the significance of an employee value proposition in the retention of teachers at selected south african private schools karen swanepoel, musawenkosi d. saurombe south african journal of economic and management sciences | vol 25, no 1 | a4358 | 23 february 2022 original research a proposed risk framework as a tool for sustainability for the south african wine industry micheline j. naude, rodney t. naude south african journal of economic and management sciences | vol 25, no 1 | a4235 | 28 february 2022 original research goals and benefits of digital transformation projects: insights into project selection criteria warren m. gertzen, elma van der lingen, herman steyn south african journal of economic and management sciences | vol 25, no 1 | a4158 | 28 february 2022 1 3 12 18 27 42 53 64 vol 25, no 1 (2022) issn: 1015-8812 (print) | issn: 2222-3436 (online)south african journal of economic and management sciences http://www.sajems.org open access table of contents original research factors influencing blockchain adoption in the south african clearing and settlement industry musimuni dowelani, chioma okoro, abel olaleye south african journal of economic and management sciences | vol 25, no 1 | a4460 | 10 august 2022 original research theoretical frameworks applied in integrated reporting and sustainability reporting research liya lakhani, shelly l. herbert south african journal of economic and management sciences | vol 25, no 1 | a4427 | 22 august 2022 original research the value of integrated reporting in south africa maatabudi mokabane, elda du toit south african journal of economic and management sciences | vol 25, no 1 | a4305 | 23 august 2022 original research delivering public value by selected government departments in south africa – perceptions of senior managers david pooe, watson munyanyi south african journal of economic and management sciences | vol 25, no 1 | a3791 | 25 august 2022 original research the relationship between investor tax preferences and the payout methods of jse listed companies rudie nel, nicolene wesson, lee-ann steenkamp south african journal of economic and management sciences | vol 25, no 1 | a4534 | 31 august 2022 original research integrated report quality and earnings management – evidence from south africa anne-marie eloff, shené steenkamp south african journal of economic and management sciences | vol 25, no 1 | a4581 | 13 september 2022 original research perceptions of writing prowess in honours economic students jean du toit, anmar pretorius, henk louw, magdaleen grundlingh south african journal of economic and management sciences | vol 25, no 1 | a4323 | 19 september 2022 original research leadership styles and effectiveness in the workplace: a perspective of the millennial generation carolyn easton, renier steyn south african journal of economic and management sciences | vol 25, no 1 | a4541 | 22 september 2022 original research person–organisation fit, job satisfaction and intention to leave in the south african social development sector manare n. maloba, daphne pillay-naidoo south african journal of economic and management sciences | vol 25, no 1 | a4572 | 30 september 2022 173 184 196 204 216 227 237 250 260 original research evaluating the capacity of rural-based south african stakeholders in the transformation of small, medium-sized and micro-enterprises tshililo r. farisani south african journal of economic and management sciences | vol 25, no 1 | a4592 | 06 october 2022 original research lean practices and supply-chain competitiveness in the steel industry in gauteng, south africa sizwe khoza, chengedzai mafini, welby v. loury okoumba south african journal of economic and management sciences | vol 25, no 1 | a4617 | 28 october 2022 original research the relationship between procedural justice and person– organisation fit: the mediating role of organisational trust mervywn k. williamson, kressantha perumal south african journal of economic and management sciences | vol 25, no 1 | a4412 | 02 november 2022 original research the (in)ability of consumers to perceive greenwashing and its influence on purchase intent and willingness to pay jako volschenk, charlene gerber, bruno a. santos south african journal of economic and management sciences | vol 25, no 1 | a4553 | 22 november 2022 original research organisational ambidexterity and social enterprise performance: a ghanaian perspective stephen oduro, alharthi rami hashem e, ahmed h. alsharif south african journal of economic and management sciences | vol 25, no 1 | a4635 | 25 november 2022 original research educator performance and the strategic plan priorities of the eastern cape department of education beauty zindi, modeni m. sibanda south african journal of economic and management sciences | vol 25, no 1 | a4666 | 01 december 2022 original research the ugly truth about social welfare payments and households’ subjective well-being tamanna adhikar, talita greyling, stephanie rossouw south african journal of economic and management sciences | vol 25, no 1 | a4646 | 07 december 2022 new perspective policy uncertainty, the economy and business raymond parsons, waldo krugell south african journal of economic and management sciences | vol 25, no 1 | a4422 | 09 september 2022 reviewer acknowledgement south african journal of economic and management sciences | vol 25, no 1 | a4877 | 19 december 2022 271 283 297 307 316 329 340 357 366 page ii of ii abstract introduction literature review methodology findings conclusion acknowledgements references about the author(s) marco van der walt department of business management, faculty of economic and management sciences, university of pretoria, pretoria, south africa wesley niemann department of business management, faculty of economic and management sciences, university of pretoria, pretoria, south africa arno meyer department of business management, faculty of economic and management sciences, university of pretoria, pretoria, south africa citation van der walt, m., niemann, w. & meyer, a., 2021, ‘the role of personal relationships in supply chain risk information sharing: perspectives from buyers and suppliers of logistics services’, south african journal of economic and management sciences 24(1), a3703. https://doi.org/10.4102/sajems.v24i1.3703 original research the role of personal relationships in supply chain risk information sharing: perspectives from buyers and suppliers of logistics services marco van der walt, wesley niemann, arno meyer received: 13 may 2020; accepted: 28 may 2021; published: 30 july 2021 copyright: © 2021. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the frequent occurrence of supply chain disruptions highlights the importance of sharing supply chain risk information (scri) among buyers and suppliers in third-party logistics (3pl) services. business relationships and long-term collaboration among supply chain partners (scp), such as 3pls and their clients, lead to the sharing of scri. risk information sharing (ris) cannot be effectively carried out unless these relationships are based on more than just transactional information sharing. therefore, a better understanding is needed of how personal relationships influence ris among these partners. aim: the purpose of this study was to explore the role of personal relationships in supply chain ris from the perspective of buyers and suppliers in 3pl services in south africa. setting: the study was conducted among buyers and suppliers in 3pl services in south africa. method: a generic qualitative research approach was followed to conduct 18 semi-structured interviews with senior managers, employed by buyers and suppliers of 3pl services. findings: a personal relationship among buyers and suppliers of logistics services is the cornerstone to ensure that risk information is shared effectively. accountability, reliability, and approachability are the main behavioural attributes required to ensure ris among scps. supply chain partners struggle to determine where the boundaries of a personal relationship lie, especially when risk information is shared. the most common mitigation strategies, when dealing with ris, are the use of a code of conduct, a code of ethics and a standard non-disclosure agreement (nda). conclusion: the study provides insight into the role of personal relationships in supply chain ris, the behavioural attributes required for ris, and the challenges associated with ris when a personal relationship is present. the study is, arguably, among the first empirical studies in the south african logistics services context to investigate the role of personal relationships in supply chain ris. keywords: personal relationships; risk information sharing; supply chain risk mitigation; qualitative research; south africa. introduction keith ferrazzi, a new york times best-selling author, was quoted saying: ‘power comes from sharing information, not withholding it’. likewise, information technology (it) innovations are shaping the modern-day supply chain and, as a result, firms and their supply chain partners (scps) are becoming progressively more dependent on information sharing among one another (colicchia et al. 2018:5; kache & seuring 2017:11). today, the collection and sharing of information is faster and simpler, allowing supply chains to operate in a globally connected environment (colicchia et al. 2018:5). south africa is recognised as the most developed country in africa in terms of the third-party logistics (3pl) industry. as a result, the majority of logistics activities on the continent are performed by south african 3pl service providers (nel, de goede & niemann 2018:2). the utilisation of 3pl service providers creates a network among buyers and suppliers for potential information sharing and risk mitigation (huong tran, childerhouse & deakins 2016:1103). the purpose of sharing information is to ensure real-time information processing and decision-making between the firm and its 3pls (prajogo & olhager 2012:514–516). third-party logistics partners can provide timely feedback, outsource processes and track service activities by sharing information (zacharia, sanders & nix 2011:43–44). information sharing enables firms to experience improved resilience and increased supply chain visibility (brandon-jones et al. 2014:56–57). information sharing between 3pl partners may lead to risk exposure (colicchia et al. 2018:6). these potential risks typically include the risk of leaking business secrets, losing bargaining power with the scp and information security (qi & zhang 2008:3). risk information sharing, supply chain resilience, and risk mitigation facilitate a firm’s ability to anticipate and manage emerging threats (ambulkar, blackhurst & grawe 2015:111–112).the successful mitigation of supply chain risk (scr) requires a strong relationship with a firm’s 3pls (langley & long 2012:26). supply chain ris is the degree to which both priority and critical information are shared with a firm’s scps (li et al. 2015:84–85). prior investigations predominantly focused on the collection and processing of risk information, as opposed to ris (liao, yuan & mccomas 2018:911). supply chain risk is significantly influenced by supply chain integration (jüttner & maklan 2011:253). effective departmental integration reduces uncertainty, while improving visibility, as increased visibility and reduced uncertainty lead to improved scr management (li et al. 2015:84; liu & lee 2018:8). supply chain risk may reduce, either directly or indirectly, after 3pl integration into the supply chain (jüttner & maklan 2011:253; liu & lee 2018:8–9). operational integration and the sharing of risk information among firms and their external partners improve a firm’s scr mitigation (wieland & wallenburg 2013:306). successful mitigation of scr requires a strong relationship with a firm’s 3pls and clients (langley & long 2012:26). risk information sharing enables a firm to build stronger relationships and promote integration between the various scps, resulting in improved performance (khan, hussain & saber 2016:213; liu & lee 2018:17). by integrating it, ris can be done more effectively, reducing incidences of conflict among various functional areas, internally, as well as externally (liu & lee 2018:15). research investigating the role of personal relationships in the logistics context only recently started receiving attention (gligor & holcomb 2013:336; mocke, niemann & kotzé 2016:3; meyer, niemann & kotzé 2017:1; rood et al. 2018:1–2). gligor and autry (2012:26) emphasise the importance of personal relationships, as these influence the communication of information, establishing a steady link between personal relationships and the enhanced communication of information. current research investigates the sharing of information (eckerd & sweeney 2018:413), and the impact of sharing scr information (scri) on relationship resilience (durach & machuca 2018:1868). liao et al. (2018:930) call for further research on the role of personal relationships in ris. additional research is necessary in the 3pl context, as information sharing, and especially ris, may lead to the exposure of unique information risks and practices, due to the nature of the outsourcing relationship (colicchia et al. 2018:17; rajagopal, venkatesan & goh 2017:675). the purpose of this qualitative study is to investigate the role of personal relationships in supply chain ris from the perspective of buyers and suppliers in the south african 3pl context. furthermore, in this study the required personal behavioural attributes to ensure the sharing of scri, as well as the challenges and the types of security risks associated with ris, are explored, including how information-sharing risks are mitigated. in the study a generic qualitative research design is used combined with semi-structured interviews to collect data from buyers and suppliers of 3pl services in south africa. the following research questions guided the study: what role do personal relationships play in supply chain ris between buyers and suppliers of logistics services? which personal behavioural attributes are required to ensure supply chain ris between buyers and suppliers? what are the challenges associated with supply chain ris when a personal relationship exists between buyers and suppliers of logistics services? what are the security risks associated with supply chain ris when a personal relationship exists between buyers and suppliers of logistics services? how is ris mitigated when a personal relationship exists between a buyer and supplier of logistics services? the contribution of this study is threefold: firstly, it was undertaken in response to the call of liao et al. (2018:930) for the role of personal relationships in ris to be probed; secondly, it is one of the first empirical studies to investigate the role of personal relationships in supply chain ris in a logistics-services context; finally, the study identifies new challenges associated with ris. the remainder of the article is structured as follows: firstly, a comprehensive review of current literature is provided; secondly, the methodology of the study is discussed; thereafter, the findings are presented and discussed. finally, a discussion of the findings is followed by the limitations and future research opportunities. literature review the third-party logistics services industry the outsourcing of logistics is a growing field of business and the services provided progress from single service types to a broad range of services, together with supply chain solutions, contributing to the trend of logistics outsourcing (karrapan et al. 2017:2). the 3pl industry consists of specialist service providers who offer various warehousing, transport, and freight-forwarding services (ab talib, abdul hamid & thoo 2015:12). major sectors, such as fast-moving consumer goods (fmcg), the pharmaceutical, it and retail sectors, as well as the automotive industry outsource a range of logistics services to 3pls (karrapan et al. 2017:2). the 3pl industry has grown exponentially in the global market through its vast range of services and activities of warehousing, it services, order fulfilment and management, supply chain consulting and freight-forward services (karrapan et al. 2017:1). the south african logistics industry contributes more than r499 billion to the economy every year. this amounts to 11.8% of the gross domestic product (gdp) which highlights the crucial role the 3pl industry plays in the south african economy (havenga et al. 2016:3). over the last decade 3pls in south africa have enabled multiple firms to integrate their supply chains, contributing to enhanced visibility and more efficiency (mocke et al. 2016:2). thus, the south african 3pl industry is an economic resource and acts as a significant driver in acquiring a global competitive advantage (havenga et al. 2016:6). personal relationships personal relationships can be defined as an interpersonal bond between the managers of different firms, based on strict and formal business exchanges, and distinct from their formal business relationship (porterfield, macdonald & griffis 2012:1). two main characteristics differentiate business and personal relationships from one another (mocke et al. 2016:2–3). firstly, business relationships are perceived as more instrumental, while personal relationships are more emotional and deeply rooted, as participants in business relationships are required to complete tasks in the manner prescribed by their roles (fournier, dobscha & mick 1998:45; grayson 2007:122). secondly, business relationships are rooted in the requirement to perform a specific task; however, personal relationships are characterised by more free and spontaneous actions (allan 1989:20). unique benefits and actions evolve when a personal relationship exists between a buyer and a supplier (gligor & holcomb 2013:336; rood et al. 2018:1–2). these unique benefits include trust, enhanced personal and business understanding, improved communication and increased business volume (gligor & holcomb 2013:336–343). third-party logistics service relationships, rooted in a strong personal relationship, may lend a competitive advantage to both firms involved; as such, a significant relationship cannot easily be imitated (leuschner et al. 2014:25). the collaboration and mutual connection between individuals lead to the establishment of personal relationships and interdependence (gligor & holcomb 2013:329; rood et al. 2018:3). performance levels of both the buyers and suppliers of logistics services may be enhanced by improved business knowledge and communication (zhou et al. 2014:88). personal relationships are established for two primary reasons: the first is to enhance the overall professional interest of both individuals; the second is friendship for its own sake (meyer et al. 2017:15). personal behavioural attributes to achieve effective information sharing, four attributes are required on a personal relationship level among the scps, namely collaboration and relationship length, trust and commitment (li et al. 2015:91). collaboration can be described as working towards improvement for both parties (jin, fawcett & fawcett 2013:205). collaboration and relationship length are the most influential factors in a personal relationship to achieve that competitive advantage, because of the benefits of sharing knowledge and resources. (vaidya & hudnurkar 2013:293). the basis of personal relationships is formed through effective collaboration among scps. this form of collaboration is not only based on quality and price, but rather on the personal relationship itself (vermeulen, niemann & kotzé 2016:6). relationship length refers to how long partners know each other. once a long-term relationship is established, supply chain members can identify their partners’ routine as the result of frequent sharing of scri (li et al. 2015:86). the combination of supplier trust and relationship length can enhance the effectiveness of ris and scr management (li et al. 2015:89). trust within a personal relationship is a professed competence, which includes consistency, confidence, fairness, goodwill, objectivity and the expectation that the partners will be supportive in their actions and not exploit one another (van riper et al. 2016:25). commitment, as a personal behavioural attribute, is a promise or agreement to perform a particular task or action in future (asif salam 2011:360). commitment is also seen as the continued aspiration towards strengthening and maintaining personal relationships (asif salam 2011:360–361). in a relational context, commitment is an arrangement among scps to meet predetermined agreements. both trust and commitment are of vital importance for the improvement of supply chain efficiency, responsiveness and customer satisfaction. trust and commitment refer to the long-term commitment by parties to meet their obligations as agreed upon (jie, parton & cox 2013:1005), suggesting that to achieve successful sharing of risk information, a personal relationship is required. the relationship should focus on the development of trust and commitment in this context (du et al. 2012:96). finally, trust influences social interaction among scps and the quality of the personal relationship positively (barnes et al. 2015:27; skinner, dietz & weibel 2014:206–207; wang et al. 2016:841). the degree of complexity, uncertainty, power asymmetry and dependency all influence the level of trust among scps (lavastre, gunasekaran & spalanzani 2014:3387; wang et al. 2016:842). once these partners share similar characteristics, trust is established, and as the degree of transparency and honesty increases, the level of trust is raised (gligor & holcomb 2013:330). supply chain information sharing supply chain information sharing is the degree to which proprietary and critical information are communicated to scps (huong tran et al. 2016:1103). the sharing of information can take place in two ways: externally, information is shared with partners in the firm’s supply chain to enhance financial work processes, the physical flow and demand planning; internally, information is shared to ensure company growth and effective purchase planning, resulting in improved coordination and flexibility (du et al. 2012:89). a firm’s willingness to share information in the supply chain context is seen as a trade-off between the firm’s responsiveness to information resources and its efficiency in sharing information. the type of information being shared depends on the technology available; however, the question of when and with whom information is shared means that social involvement should be taken into consideration (prajogo & olhager 2012:519–520). social involvement in the supply chain context refers to informal partnerships formed among buyers, suppliers and other service providers. traditional supply chain management investigations focused predominantly on the operational components by emphasising the efficiency of the product and service flow (du et al. 2012:90). in recent times, greater emphasis has been placed on relationship development and performance in the supply chain. these relationships are treated as a range extending from strategic to independent relationships, depending on the level of interdependence, strategic goals, and exclusivity (prajogo & olhager 2012:514). supply chain risk information sharing when a firm implements ris, the firm and its scps agree to exchange scr-related information with one another in an accurate and timely manner. supply chain ris refers to communication beyond the standard exchange of business information about the possibility of unexpected events causing disruptions in the firm’s supply chain (ali, hird & whitfield 2018:3). the execution of the process is a critical element, which leads to enhanced supply chain visibility and a culture of information sharing (li et al. 2015:84). establishing a culture of ris among scps is the first step towards scr management. a strong link must be evident between the validity of the shared information and the success of managing the scr (fan et al. 2017:71). a ris culture is an essential part in the relationship between firms and their suppliers in developing a dependable channel of communication. risk information sharing has a positive impact on the firms’ supply chain practices, such as just-in-time production, planning, and delivery (ali et al. 2018:3). risk information sharing is also capable of facilitating the integration of the firms’ logistics by maintaining a consistent flow of inventory and materials between the firm and its suppliers (kim & chai 2017:45). with improved collaboration and integration in the supply chain, ris can increase the firms’ flexibility and their speed to respond and accommodate various preferences in demand (li et al. 2015:89). this is all made possible by the frequent ris between a firm and its suppliers (kim & chai 2017:45). firms that form part of a personal relationship network might be more willing to share risk-related information among scps (ali et al. 2018:3; nahapiet & ghoshal 1998:250). therefore, firms feel obliged to share risk-related information among partners on the strength of their personal relationships and the degree of their closeness (ali et al. 2018:6; nahapiet & ghoshal 1998:250). establishing a sense of communal value among scps improves the sharing of scri, as the partners become more concerned, not only about maintaining an existing relationship, but also about the welfare of both parties (ali et al. 2018:8). hence, personal relationships can improve understanding among scps regarding risk events, because a disruption in a partner’s operation can negatively affect the entire supply chain function. challenges associated with risk information sharing although ris is used to reduce supply chain complexity and challenges, it comes with its own set of challenges. the most common challenges associated with ris is the lack of trust among scps, because if you do not trust your partner you are not going to share risk information with them. furthermore, the lack of scp commitment is a challenge experienced by partners when risk information is shared, which could lead to inconsistency in supply and fluctuations in customer demand (huong tran et al. 2016:1114). while ris has the possibility of enhancing supply chain visibility, firms might experience ris as a threat to their survival (jüttner & maklan 2011:254). convincing scps to share risk information is a challenge as it is, as it increases a firm’s vulnerability in its efforts to support scr management decisions and practices (li et al. 2015:84). this vulnerability increases as a result of increased supply chain complexities (bode & wagner 2015:216; habermann, blackhurst & metcalf 2015:493). without the required visibility, the possibility of uncertainty arising among scps is increased, which could lead to supply chain inefficiency (kurniawan et al. 2017:8). security risk associated with risk information sharing the risk associated with ris in the supply chain requires rigorous investigation (du et al. 2012:97; wang, ye & tan 2014:7). such risk includes the leakage of private information, both internally and across the supply chain, and the degrading of the quality of information (madenas et al. 2015:1160). both the intentional and unintentional disclosure of confidential information to unauthorised parties pose a security risk (tan, wong & chung 2016:622). direct disclosure refers to sharing confidential information, while indirect disclosure is the disclosure of sensitive information, mistakenly identified as non-confidential information, and thus shared among partners in personal relationships (zhang et al. 2012:1355). however, the loss of intellectual property is perceived as the greatest of risks when sharing scri (huong tran et al. 2016:1119). another critical security risk associated with ris is information leakages (colicchia et al. 2018:14). this is seen as a vital point, as complexity is reflected by the operational structure and mechanisms in the modern-day supply chains (colicchia et al. 2018:16). risk information sharing enables firms to survive in a dynamic and volatile working environment (barnes et al. 2015:26). personal relationships are renowned for informal conversations, and the sharing of sensitive information during these conversations, which might be misused for personal gain (gligor & holcomb 2013:339). as the line between right and wrong fades, scps become all the more aware of the leaking of sensitive scri and how the leaking thereof could have major legal implications (rood et al. 2018:11). information sharing risk mitigation strategies lavastre et al. (2014:3396) identified two strategies for mitigating the information sharing risk, namely the management of the information flow and monitoring the relationships and risks. information flow consists of eight subcategories, namely: (1) the truthful exchange of forecasts regarding future demands and future events; (2) an efficient communication and information exchange to prevent any type of miscommunication; (3) appointing a risk manager who specialises in supply chain management; (4) participating with key partners in the proactive exchange and cooperation of forecasts; (5) ensuring centralised decision-making on all levels of communication for a holistic alignment; (6) making sure that supply chain management is responsive and reactive to change in information; (7) implementing an advanced planning system to conduct activity planning; and finally (8) implementing collaborative information systems to ensure that all functions communicate clearly with one another at all times. the second strategy is to monitor relationships and risks. the subcategories include: (1) developing indicators to measure scr management effectiveness, as this will provide firms with the ability to identify which risk management approaches are working and which are not; (2) developing indicators to monitor the risk related to specific partners, as this will enable the firm to address partner-specific risks as they are identified; and finally (3) developing a set of indicators to monitor and evaluate possible risks without the attendance of the scp (lavastre et al. 2014:3396). furthermore, scps may agree to a code of conduct and ethics. the compliance of suppliers to a code of conduct will increase once the personal relationship among multi-principal collaborators and 3pls is governed by a behaviour-based contract, linked to monitoring protocol (delbufalo & bastl 2018:1245). compliance with the code of conduct will increase when information sharing between multi-principal collaborators is administrated by a formal and informal control mechanism (delbufalo & bastl 2018:1248). in order to assure effective management of ris, both the code of conduct and the code of ethics must be implemented. under the code of ethics, firms are required to establish standards in order to promote ethical and honest conduct, such as the handling of actual conflicts of interest, due to the existence of a personal relationship (banks 2010:341). firms must adequately communicate the code of ethics and ethical guidelines to all of its employees (banks 2010:352). within the service agreement, a firm will require the client to provide access to their system purely for operational purposes, through the signing of an nda (horák, stupka & husák 2019:6). methodology research design in this study a generic qualitative research design is employed. generic qualitative research was appropriate because the researchers possessed some prior knowledge of the specific phenomenon under investigation and wished to fully describe the topic from the perspectives of participants (percy, kostere & kostere 2015:78). this design enabled the researchers to obtain a better understanding of the role of personal relationships in the supply chain ris, from the perspectives of 3pl buyers and suppliers (cooper & schindler 2014:161). cross-sectional primary data were gathered by conducting semi-structured interviews with 3pl buyer and supplier firms in south africa. sampling the unit of analysis in the study was the personal relationship between a buyer and a supplier of logistics services in south africa. the units of observation in the study were the individual participants employed at either the buyer or the supplier firm. the final sample size was based on the principle of data saturation (guest, bunce & johnson 2006:74). the study included 18 participants of which nine represented 3pl firms and the remaining nine 3pl clients. in this study, all the codes were identified after the 12th interview and the main themes were identified. an additional six interviews were conducted without any new significant data being presented. homogeneous sampling, a form of purposive sampling was used in the study. this entails the deliberate selection of firms and individuals based on distinct similarities (creswell 2012:208). the 3pl firms were sampled first, followed by the client firms that met the inclusion criteria. the direct client firms that complied with the inclusion criteria were then determined, using snowball sampling. the 3pl and client firms needed to meet the following inclusion criteria: firstly, 3pl and client firms must have an existing buyer-supplier business relationship of a minimum of two-year duration, guided by a contractual agreement. the two-year duration provided a reasonable amount of time for a relationship to be established. secondly, the firm needed to be based in south africa and operate here. participants from 3pl and client firms had to meet the following inclusion criteria. firstly, participants needed to be in a middle or senior management position, as this ensured that participants had experience in their field and would make a valuable contribution to the study. secondly, the participant had to be engaged in a personal relationship with a staff member of the client or 3pl. the purpose of the interaction was to ensure a direct link between the two firms. thirdly, the participants needed to have a minimum of two years’ experience in the firm, as this is generally the time it takes employees to familiarise themselves with the operations of a firm (oakes 2012:40). snowball sampling of participants was initiated once the data collection process started and it made sense to use referrals, as potential participants could be identified by existing participants (creswell 2012:206–209; polit & beck 2012:517–520). table 1 provides a profile of the participants included in the study. table 1: profile of study participants. data collection semi-structured interviews were held to collect data. these interviews were conducted to understand the experiences and perceptions of participants (myers 2013:5). this data collection method enabled the researcher to ask open-ended questions with the help of a discussion guide developed from literature. guided by the questions, the participants were able to reflect on their own perspectives and beliefs (cachia & millward 2011:268–269; sandelowski 2000:338). a preliminary test was conducted with a participant who complied with the inclusion criteria. minor adjustments were made to the discussion guide; however, the participant was not included in the final sample of the main study. eighteen participants were interviewed face-to-face on a one-on-one basis. interviews were conducted at the respective offices of the participants during september 2019. the researchers transcribed the audio interview recordings. the accuracy of transcripts was ensured by checking the completed transcript against the interview recordings. data analysis thematic analysis was used to analyse the data. it entails a systematic process of identifying codes, grouping the codes, and then organising the codes into themes and sub-themes (creswell & plano clark 2015:289). atlas.ti version 8 was used. an a priori code list was derived from literature. the researchers listened to the audio recordings to familiarise them with both repeated and new responses in order to derive codes. the existing code list was continuously updated every time a new code was generated. trustworthiness a four-criterion framework, consisting of credibility, dependability, confirmability, and transferability, was used to ensure the trustworthiness of the findings (polit & beck 2012:583). firstly, the credibility of the study refers to the accuracy of the findings compared to the study’s aim and how well the participants’ actual perspectives are represented in the findings (lietz & zayas 2010:191–192; polit & beck 2012:584–585; shenton 2004:64–68). credibility was obtained by using site triangulation. this entails recruiting each participant from a unique firm to prevent the themes identified from being exclusive to a particular firm (shenton 2004:65). secondly, dependability refers to the reliability and stability of data under certain conditions and over time. it includes the likelihood of finding similar results if the proposed research study was to be replicated by another researcher under similar conditions and with similar methods and participants (polit & beck 2012:585). through a thorough and comprehensive description of the methodology, the dependability of the study is demonstrated (lietz & zayas 2010:95). thirdly, the study should be a true reflection of the participants’ experiences and not those of the researcher (polit & beck 2012:585; shenton 2004:72). a link between the data collected and the study’s reference literature was made by conducting a thematic data analysis where the main themes and sub-themes where identified to ensure that the true ideas and experiences of the participants are reflected and not those of the researcher (lietz & zayas 2010:197; polit & beck 2012:584–585; shenton 2004:72), thus attaining confirmability. finally, transferability represents the extent to which the findings of the research study can be applied to different groups, settings or contexts (polit & beck 2012:585). transferability was achieved through the provision of a detailed description of the participants, the length and number of the interviews conducted, the data collection methods employed, as well as the findings and limitations of the study (elo et al. 2014:6; shenton 2004:70). ethical considerations the relevant research ethics committee at the university of pretoria approved the study. all participants in the study were required to read and sign an informed consent form before the interview was conducted. the informed consent form clearly explained the purpose of the study, that participation was voluntary, that the participant could withdraw at any time, and assured them of their confidentiality and anonymity. aliases were used in the transcripts and the final presentation of data instead of the names of the participating firms and participants. the study’s findings are presented in the next section. findings five main themes were identified from the data, namely the role of personal relationships in ris, the behavioural attributes required for ris, the challenges associated with ris, the security risks associated with ris and the risk mitigation of information sharing. each of the themes was examined and supported by quotations from the participants. the sections that follow discuss each of the identified themes, highlighting the most significant views in each theme, as mentioned by participants. theme 1: the role of personal relationships in risk information sharing participants emphasised the primary role of a personal relationship among 3pls and client firms in relation to ris, as seen in table 2. table 2: frequencies of the role of personal relationship in risk information sharing. participants indicated that the role of a personal relationship is to build trust among scps; thus, when trust is present, scps are more willing to share risk information and confidential information with one another as supported by the following quotation: ‘you’re able to gain their trust on that person and you then are able to express more confidential information.’ (p18, male, customer service parts and warehousing manager) this finding is in alignment with literature as the establishment of a personal relationship enhances trust among scps (gligor & holcomb 2013:336–343). several participants indicated that a personal relationship promotes openness among buyers and suppliers. as a result of not feeling restricted, scps are more open to sharing scri with one another. this expands on current literature and is supported by the following quotation: ‘because if you do have that kind of relationship, that’s going to be a lot easier to talk about stuff that you shouldn’t be talking about. um, well, sharing information when you have an open friendly relationship is differently risky.’ (p10, male, district assistant manager) the closer the personal relationship among scps, the greater the willingness to share risk information with one another as indicated by participants. this is the benefit of a personal relationship. the following quotation clearly illustrates this point: ‘the better my relationships with my 3pl management, the more willing they are to divulge what’s actually going on.’ (p2, female, transport operations manager) participants indicated that in order to share risk information more freely with scps, a long-term personal relationship must first be established. the longevity of the personal relationship may ensure the sharing of risk information on a regular basis, as seen in the following quotation: ‘it’s just the extent of that … that relationship, which becomes important.’ (p6, male, managing director) the findings regarding the willingness to share risk information and the longevity of a personal relationship are in alignment with those in current literature as the existence of a close personal relationship increases the willingness to share risk information with scps (gligor & esmark 2015:519). furthermore, the establishment of a personal relationship ensures a long-term relationship among parties, resulting in the regular sharing of scri (li et al. 2015:86). collaboration among scps is enhanced when a personal relationship exists, resulting in the improved and transparent sharing of scri, as seen in the quotation: ‘obviously the better the relationship a buyer has got with the supplier in this particular category, the better the chances [are] that … uh, if something does happen, he will be able to access some stock if the supplier has got limited stock or there are issues relating to the provision of stock.’ (p12, male, logistics director) participants stated that a personal relationship makes scps more comfortable. when people are at ease in a personal relationship, risk information is shared more openly beyond the contractual obligations. the following quotation clearly illustrates this point: ‘if you’re more comfortable with someone, you [are] obviously going to give them a little bit more, um … where[-as] if it’s strictly professional, you’re going to keep your … your sensitive information to yourself; where[-as] if you trust someone, you’re more willing to … to tell them sensitive information.’ (p2, female, transport operations manager) these findings regarding better collaboration and more comfort are in alignment with the findings in current literature. collaboration, as a result of a personal relationship, can be described as working towards improvement for either scp (jin et al. 2013:205). personal credibility in a personal relationship refers to the level of confidence and comfort between parties (barnes et al. 2015:38; wang et al. 2016:843). participants mentioned that by establishing a personal relationship with an scp, both individuals gain a higher level of understanding of each other’s operations. the quality of understanding of operations for the scps leads to improved ris. the following quotation clearly illustrates this point: ‘better understanding between the two parties.’ (p11, female, non-executive logistics manager) a personal relationship would ensure that scps share similar values, which will support the sharing of risk information. therefore, the existence of a personal relationship forms the cornerstone of the successful sharing of risk information, as without the personal relationship, partners will not be open to ris. the following quotations illustrates this point: ‘you would probably tend to gravitate to somebody that is like-minded and that has a similar mindset.’ (p4, male, regional executive) ‘well, the relationship between the partners is very important. it’s something, as far as i’m concerned, [that is] mandatory in this kind of business.’ (p18, male, customer service parts and warehousing manager) the aforementioned findings are in alignment with those in current literature, as personal relationships support communication, allowing individuals to share information with one another and gain a mutual understanding (barnes et al. 2015:38; wang et al. 2016:843). trust among scps is increased as a result of shared similar characteristics in a personal relationship (gligor & holcomb 2013:330). the existence of this kind of relationship is based on give and take; as a result, the exchange creates interdependence among the parties involved (mocke et al. 2016:2). the findings indicate that a personal relationship enhances the level of honesty and integrity among scps; as a result, the partners are more prone to sharing scri. these findings expand on current literature and are supported by the following quotations: ‘level of honesty and there is a corresponding level of … of trust between the two parties that … that might favour, that you [are] sharing information to certain of your clients versus just the food basket.’ (p12, male, logistics director) ‘um, i think definitely honesty, integrity, making sure that you always communicate the right stuff.’ (p2, female, transport operations manager) participants also mentioned that a personal relationship contributes towards greater business retention and reduced complexity, because scps are more inclined to share scri with each other. these findings represent an expansion on current literature and are supported by the following quotations: ‘there’s really only one … um, that sits right at the top of everything. and that’s business retention.’ (p14, male, national customs manager) ‘having a good relationship or a good working relationship that allows the business to be a bit more flexible and a little more agile … so you get things done quicker.’ (p8, male, operations manager) theme 2: the behavioural attributes required for risk information sharing the behavioural attributes required in a personal relationship to share risk information can be seen in table 3. table 3: frequency of behavioural attributes required in a personal relationship to share risk information. participants suggested that honesty and trust are the most desired behavioural attributes in a personal relationship before sharing risk information. participants indicated that without honesty and trust, they would not consider sharing risk information. this can be seen in the following quotations: ‘someone that’s honest. honesty, trusting, trusting is … is vital.’ (p18, male, customer service parts and warehousing manager) ‘i think trust is … definitely has [to] be number one. um … you would need to trust each other.’ (p10, male, district assistant manager) some participants stated that the longevity of the personal relationship is vital to the sharing of risk information, as scps are not willing to share risk information with individuals with whom they have not spent an adequate amount of time. this is supported by the following quotation: ‘without a doubt, time spent in your organisation, in that organisation [is] time spent in the industry.’ (p9, male, business development executive) the aforementioned findings are in alignment with existing literature, as logistics managers are more willing to share risk information when they can be honest with their scps (gligor & esmark 2015:519). trust is important due to its sensitive role in ris (vermeulen et al. 2016:6). an influential factor in a personal relationship is the length of the relationship, due to the benefits of sharing knowledge (vaidya & hudnurkar 2013:293). in this study, behavioural attributes identified , not evident in the literature, include accountability, reliability, approachability, humbleness, willingness to go the extra mile for one another, consistency, integrity and extroversion. supply chain partners need to be approachable as a personal relationship is a two-way street and the sharing of risk information requires scps to be able to communicate in all simplicity and assurance with one another. supply chain partners have no need being arrogant; rather one should be humble and empathetic to others in their circumstances, as today you might be the one sharing risk information; however, tomorrow you might be in need of such risk information. the willingness to go the extra mile for one another is vital in any personal relationship. consistency among scps is important as it refers to being stable and dependable, both attributes required in order to effectively share scri. integrity refers to scps being true to their word, whether it is sharing risk information or keeping shared information confidential. finally, a scp must be extroverted and easy to communicate with, otherwise the sharing of risk information will be a difficult and formal process. these findings are supported by the following quotations, which are presented in the same sequence as discussed: ‘someone whom you would be accountable to for the actions.’ (p16, male, senior outbound manager) ‘reliability, consistency. um … we are in it together and [do] teamwork.’ (p7, female, head of supply chain and strategic sourcing) ‘he’s very approachable.’ (p3, male, transport operations manager) ‘because of our relationship … i do … i do go the extra mile and … and likewise, they on that side of the fence, they tell me stuff and they … whenever there’s red, then they’ll flag it to me.’ (p3, male, transport operations manager) ‘integrity. so true to your word.’ (p8, male, operations manager) ’it helps to be an extrovert. if you’re an introvert, you don’t like people. i have found that they do struggle.’ (p2, female, transport operations manager) theme 3: the challenges associated with risk information sharing the challenges associated with ris when a personal relationship exists are presented in table 4. table 4: frequency of challenges associated with risk information sharing. participants stated that the main challenge, associated with ris, is when scps do not know where to draw the line regarding the sharing of risk information, resulting in scps sharing risk information with their scp that they are not supposed to or are not authorised to share. this finding is an addition to literature and can be seen in the following quotation: ‘if you don’t know where to draw the line, yeah, then … then you’re going to open yourself [up] to those challenges.’ (p3, male, transport operations manager) the study found that the possibility of making oneself vulnerable when sharing risk information is a challenge to participants. furthermore, managing the sharing of risk information is also a major challenge, because once the risk information is shared, preventing that information from being shared again by the scp is extremely difficult, if not impossible. this is apparent in the following quotations: ‘you could say things that you really shouldn’t have said and then the other guy, you know, have a conversation in the corridor in their company and shares it with somebody else in confidence and then that person goes and tell somebody, and then, you know, it ultimately could open you up to risk and liability issues.’ (p13, male, director of operations and solutions) ‘there are huge problems that come with that because, for example, if our manufacturing [division] shared information about the ingredients; again, it’s going to be a problem in it [sic] because then somebody else is going to have seen it.’ (p5, male, national logistics manager) these findings are supported by literature. the vulnerability caused by ris increases parallel to an increase in supply chain complexities (bode & wagner 2015:216; habermann et al. 2015:493). convincing scps to share risk information is a major challenge in itself, directly linked to the management and decisions regarding the risk information (li et al. 2015:84). participants identified two challenges, which are not included in existing literature, namely damaging the personal relationship with either the 3pl or client firm, due to ris, because once risk information is shared with a scp, it creates an expectation. should risk information then again not be shared, it could create conflict and in the end damage the personal relationship. in addition, when scps do not know where the personal relationship ends in terms of ris, it also becomes a challenge. supply chain partners who develop too close a personal relationship expose themselves to the challenge of sharing risk information beyond the recommended and authorised boundaries. these challenges are illustrated in the following quotations: ‘the challenge is the degradation of the relationship. um … and then also the loss of the business, loss of the partnership.’ (p14, male, national customs manager) ‘if the relationship becomes very close, you’ve always got to be careful of not talking beyond certain boundaries.’ (p15, male, contract logistics manager) finally, the last two notable challenges indicated by some of the participants were the development of a sense of obligation towards the scp when sharing risk information due to the personal relationship. the personal relationship makes one feel obliged to share risk information with the scp; thus, the information is shared, not based on the value of the information, but rather on that of the personal relationship. furthermore, scps could use the shared risk information against you by going to rivals with the confidential information. these challenges expand on current literature regarding the challenges associated with personal relationships and ris. the following quotations touch on these challenges: ‘i mean, you kind of feel obligated to the person that you’re dealing with that you’re friends with.’ (p5, male, national logistics manager) ‘inevitably you … you work in an environment where you can share information that a supplier might use with some of his other clients.’ (p10, male, district assistant manager) theme 4: the security risks associated with risk information sharing the security risks associated with ris, when a personal relationship exists, are presented in table 5. table 5: frequency of security risks associated with risk information sharing. participants identified the leakage of private information and the loss of intellectual property as the main security risks associated with personal relationships in ris. the loss of intellectual property is directly linked to risk information sharing, as in a personal relationship scps may acquire access to intellectual property: ‘relationship leads to those security risks of leakage of information or the abuse of personal information.’ (p5, male, national logistics manager) ‘it gives them access to how we run and control managers, how we run our risk and security? where do we store our firearms? you know, all of that information in the wrong hands can lead to a problem and … expose our weaknesses and include exposing things to clients that we don’t want to expose or to competitors.’ (p4, male, regional executive) the aforementioned findings are in alignment with literature. the main security risk associated with ris is information leakages (colicchia et al. 2018:14). the loss of intellectual property is seen as the ultimate risk when sharing scri (huong tran et al. 2016:1119). furthermore, participants mentioned that scps are faced with the challenge of unintentionally disclosing confidential information. this is evident in the following quote: ‘you’ve built this relationship, um … things are going well and stuff, and sometimes i think information is shared that shouldn’t be shared. um, [it] just [depends] on how comfortable you are with each other.’ (p11, female, non-executive logistics manager) some participants mentioned the intentional abuse and disclosure of confidential information as a security risk. supply chain partners gain access to risk and confidential information through the established personal relationship and then abuse that relationship by disclosing confidential information to other scps and even possible competitors. this is evident in the following quote: ‘like going directly tell customers that’s the risk on its own [is] a very big one.’ (p1, female, inbound logistics manager) these findings confirm existing literature regarding security risks associated with personal relationships and ris. the unintentional or intentional disclosure of confidential information to unauthorised parties is seen as a security risk of ris (tan et al. 2016:622). direct disclosure is the act of disclosing sensitive information, mistakenly identified as non-confidential information, and therefore shared with scps (zhang et al. 2012:1355). finally, the last two notable security risks indicated during the study expand on current literature regarding the security risk associated with personal relationships in ris. firstly, when a supplier becomes a competitor as a result of the sharing of risk information in a relationship. risk information sharing comes to a point where the scp has gained an adequate amount of risk information and uses it against one in order to serve the same market. secondly, when scps are not willing to sign the company’s nda, it is seen as a security risk, because the scp will then have the right to share any and all information available to them as there are no legal requirements preventing them from doing so. these quotations illustrate the security risks mentioned: ‘so i think it goes back to, am i able to talk to you confidentially and are you … am i certain you’re not going to use that information for your own gain?’ (p4, male, regional executive) ‘but obviously we have risk where some suppliers do not want to sign our agreement.’ (p1, female, inbound logistics manager) theme 5: information sharing risk mitigation the strategies identified to mitigate information sharing risk are presented in table 6. table 6: frequency of codes for information sharing risk mitigation. both buyers and suppliers predominantly use the legal aspect of the matter to mitigate the sharing of risk information among scps. participants indicated that to mitigate the risk, they highly depend on the implementation of the code of conduct and the code of ethics to govern the sharing of risk information among scps. in addition, eight participants indicated that their firms implement a standard nda to be signed by both parties as their strategy towards mitigating the sharing of risk information. see the following quotes: ‘so we do a bit of work around employee engagement; [it] was [in] that code of conduct and how that impacts in his toolbox talks.’ (p4, male, regional executive) ‘so we do have [a] code of ethics that … that talk quite strictly to [sic], uh … relationships with suppliers. and how those are managed.’ (p4, male, regional executive) ‘so i think the nda is a big part of that.’ (p7, female, head of supply chain and strategic sourcing) these findings are in alignment with existing literature regarding information sharing risk mitigation. compliance with the code of conduct increases the effective sharing of information and reduces the risks associated with it (delbufalo & bastl 2018:1248). enforcing the code of ethics bestows a sense of ethical and honest behaviour and, in doing so, it reduces the risk of information sharing (banks 2010:341). to promote transparency regarding the sharing of risk information, an nda may be implemented to govern the sharing of all information (horák et al. 2019:6). the study found that some participants make use of two strategies, namely collaborative planning, forecasting and replenishment (cpfr), as well as slas. by making use of cpfr, the firm is able to manage the information sharing risk by mitigating in advance the possibility thereof and by being proactive in its operations. the use of slas ensures that scps have to uphold a certain level of service and professionalism; it also ensures that risks regarding information sharing are addressed and mitigated in advance. as seen in the following quotations: ‘i think it does help us mitigate risk because we can be more proactive.’ (p2, female, transport operations manager) ‘we’ve just got service level agreements.’ (p11, female, non-executive logistics manager) these findings are in alignment with existing literature regarding strategies for mitigating ris as mentioned in literature, namely management of information flows and monitoring the relationships and risks (lavastre et al. 2014:3396). the study found that a small number of participants make use of kpis and the direct dismissal of individuals to mitigate the risk of sharing risk information when a personal relationship is present. these findings expand on current literature regarding the mitigation strategies of ris in a personal relationship. these quotations illustrate these strategies: ‘we’ve got kpis and service level agreements.’ (p12, male, logistics director) ‘at some stage you need to trust people. um … and that’s the other thing. if somebody … if you give everybody trust and the first person that lets you down, then you’ve got to cut them out and cut them out [so] hard that unfortunately everybody else realises.’ (p6, male, managing director) finally, a single participant indicated that their firm makes use of integrity due diligence (idd) in order to mitigate the information sharing risk in a personal relationship. this finding expands on current literature regarding the mitigation strategies of ris in a personal relationship. the following quotation supports the finding: ‘what we do, is what we call an idd. it’s an integrity due diligence.’ (p14, male, national customs manager) conclusion discussion of the findings the purpose of this study was to investigate the role of personal relationships in supply chain ris from the perspective of buyers and suppliers in the south african 3pl context. in this study findings in five areas are reported in an attempt to answer the corresponding five research questions. these areas relate to the following: (1) the role of personal relationships in ris; (2) the behavioural attributes required for ris; (3) the challenges associated with ris; (4) the security risks associated with ris; (5) information sharing risk mitigation. the first research question explored the role personal relationships play in ris between the buyers and suppliers of logistics services. in the study it is found that personal relationships build trust, and strong trust results in increased ris among scps. it was also found that due to the existence of a personal relationship with an scp, the willingness to share risk information is enhanced, due to mutual interest. furthermore, the findings show that in order for ris to take place, a long-term personal relationship is important, otherwise scps will not feel secure enough to share risk information. the study’s findings confirm those of li et al. (2015:86) who claimed that in order for scri to be shared, a long-term relationship must first be established. the findings also indicate that the existence of a personal relationship among scps encourages collaboration, leading to improved ris due to the establishment of frequent communication channels. the results of the study confirm that collaboration is a result of a personal relationship and teamwork. however, additional roles of personal relationships, not evident in literature, were identified, such as increasing the degree of openness among scps and raising the level of honesty and integrity among scps, due to the existence of a personal relationship, resulting in improved ris. finally, personal relationships contribute positively towards greater business retention and reduce overall complexity, because of the increase in supply chain visibility gained by the effective sharing of risk information among scps. the second research question discloses what personal behavioural attributes are required to ensure the sharing of scri between buyers and suppliers. the findings indicate that trust and honesty are the main behavioural attributes scps look for when establishing a personal relationship in order to share risk information. the findings demonstrate that the longevity of a personal relationship plays a vital role in scps being willing and open towards ris, as longevity indicates a sense of commitment. in addition to existing literature, a vast range of behavioural attributes required within a personal relationship in order to share risk information were found such as: accountability, reliability, approachability, humbleness, willingness to go the extra mile for one another, consistency, integrity and a degree of extroversion. the most significant being the accountability and reliability of the scp. these attributes expanded on existing literature. the third research question examined what challenges are associated with scri sharing when a personal relationship exists between a buyer and supplier of logistics services. sharing risk information in a personal relationship opens the possibility of making oneself vulnerable. these findings confirm the current literature regarding the increase in vulnerability, due to ris and the complexity thereof. the existence of a personal relationship increases the complexity of managing ris, as risk information is shared more freely in a personal relationship; however, that information may also be shared easily in the following personal relationship outside the firm. the findings indicate that a major challenge in a personal relationship and ris is when scps do not know where to draw the line with regard to ris, which may result in scps sharing risk information they are not supposed to. the study further found that a challenge associated with ris in a personal relationship is when scps do not respect the boundaries of the relationship and the scps may use the ris against you by sharing the ris with rivals. the fourth research question assessed the security risks associated with supply chain ris when a personal relationship exists between a buyer and supplier of logistics services. the main security risks are the leakage of private information and the loss of possible intellectual property. the existing literature on security risks associated with ris was corroborated during the study. the results show that the unintentional disclosure of confidential information and the intentional abuse and disclosure of confidential information are further challenges linked to ris in a personal relationship. however, in addition, the study’s findings expand on current literature by identifying that scps becoming competitors and scps not willing to sign the nda are challenges directly linked to personal relationships and ris, because an scp may gain access to the risk information due to the existence of a personal relationship and the risk information being shared. the fifth research question determined how information sharing risk is mitigated when a personal relationship exists between a buyer and a supplier of logistics services. most firms have a code of conduct, a code of ethics and a standard nda in order to mitigate the sharing of risk information. the three methods are used because they govern the decision-making process of each employee regarding ris, especially when working with a client with whom a personal relationship has been established, confirming existing literature on the mitigation of information sharing risk. the findings indicate that firms make use of cpfr and slas when a personal relationship is present and risk information is being shared among scps in an attempt to ensure effective information sharing risk mitigation. both cpfr and slas empower the employer to proactively try and manage any possible future risks associated with ris, as both methods are implemented in advance in order to guide staff in the personal relationships they establish. in addition to existing literature, it was found that to mitigate risk, firms make use of either kpis or the direct dismissal of an offending individual. it was also found that for information sharing risk to be mitigated, firms make use of idd when a personal relationship exists among scps. managerial implications and recommendations firms need to identify a viable approach to managing personal relationships with scps. the reason for this is because the existence of personal relationships with scps is frequent and the ris goes hand in hand with it. personal relationships with scps predominantly build trust and enhance openness, collaboration and the willingness to share; for this reason, management should rather focus on proactively managing the personal relationships in order to gain a competitive advantage. by promoting the development of personal relationships with scps, a better quality of risk information will be shared by both parties leading to enhanced performance and business retention. however, managers must ensure that a clear distinction is made between an appropriate personal relationship and a personal relationship that is too close and, therefore, represents a risk to the firm. managers must find a way to ensure that when a personal relationship is established with an scp, the required behavioural attributes are present. this is especially important when risk information is to be shared. when firms identify a possible personal relationship between an employee and their scp, they should consider reminding the employee of the desired behavioural attributes the firm looks for. thirdly, the findings identify possible challenges to sharing risk information when a personal relationship is present. managers need to ensure that even though such relationships with scps are beneficial, the relationship should not increase the complexity of managing confidential information, as this may counteract the benefits gained. managers must make sure that adequate measures are put into place to ensure that both parties clearly understand the difference between a business relationship and a personal relationship with an scp. this can be done by implementing a process of frequent communication with staff members regarding the importance of discerning between the two at all times. management must have greater control over the sharing of ris among scps and be able to rely on the accountability of staff members. this can be ensured by having employees sign an agreement stating that they will not share confidential information with parties outside the firm. furthermore, if one chooses to share confidential information, one would be held accountable for possible losses or damages as a result of the shared information. managers should stay up to date with current strategies in order to mitigate information sharing risk due to a personal relationship among scps. current methods of mitigation, such as the use of codes of conduct, codes of ethics and ndas, are well established; however, scps are still willing to share risk information in a personal relationship. management needs to identify new ways of keeping employees accountable for their actions, especially when sharing risk information with scps in a personal relationship. this can be done by frequently reminding staff members that they are dealing with confidential and sensitive information and for that reason should not share it beyond what is expected of them. limitations and directions for future research this study utilised a qualitative research design with a relatively small sample to explore the role of personal relationships in supply chain ris. researchers may consider using other research designs and data collection methods such as survey research or mixed methods to assess the influence, the strength and the nature of personal relationships on the level of supply chain ris. furthermore, the study focused on the dyadic perspectives of the relationship between 3pls and clients. future studies may make use of a triadic approach by including first, second and third parties in the personal relationship. the study focused specifically on the 3pl industry in south africa; therefore, research can be conducted in other industries and settings in a developed country with different laws, regulations, and community pressures. acknowledgements competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. author’s contributions this article is based on the m.phil. dissertation of m.v.d.w. who was the main researcher. w.n. and a.m. acted as supervisors determining the conceptualisation, literature review, the research instrument and development of this manuscript. funding information this research received no specific grant from any funding agency in the public, commercial or not-for-profit sectors. data availability data are stored according to 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40–54. https://doi.org/10.1111/j.2158-1592.2011.01004.x zhang, d.y., cao, x., wang, l. & zeng, y. 2012. ‘mitigating the risk of information leakage in a two-level supply chain through optimal supplier selection’, journal of intelligent manufacturing 23(4), 1351–1364. https://doi.org/10.1007/s10845-011-0527-3 zhou, k.z., zhang, q., sheng, s., xie, e. & bao, y., 2014, ‘are relational ties always good for knowledge acquisition? buyer–supplier exchanges in china’, journal of operations management 32(3), 88–98. https://doi.org/10.1016/j.jom.2014.01.001 abstract introduction methodology inside the black economic empowerment honey pot meeting the minerals and petroleum resources development act and the mining charter targets strategies used and outcomes conclusion acknowledgements references footnotes about the author(s) sixta r. kilambo department of economics, faculty of economics and management sciences, university of pretoria, pretoria, south africa citation kilambo, s.r., 2021, ‘black economic empowerment policy and the transfer of equity and mine assets to black people in the south africa’s mining industry’, south african journal of economic and management sciences 24(1), a3479. https://doi.org/10.4102/sajems.v24i1.3479 original research black economic empowerment policy and the transfer of equity and mine assets to black people in the south africa’s mining industry sixta r. kilambo received: 29 nov. 2019; accepted: 09 oct. 2020; published: 13 may 2021 copyright: © 2021. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the minerals and petroleum resources development act (mprda) and the mining charter, which both came into force in 2004, required white-owned and foreign-owned companies operating in the country to transfer 26% of the value of equity ownership and ensure that historically disadvantaged persons (hdsas) attain 40% control of mine assets. the regulations are part of the broad-based black economic empowerment (b-bbee) policy that seeks to transform the whole economy and enable black people to participate fully in all sectors of the economy after years of exclusion under apartheid laws. the inclusion of black people in the industry started with conglomerates unbundling mining houses in the early 1990s. elsewhere such programmes succeed through selective government intervention. the south african government instead is pursuing a hands-off approach leaving hdsas to survive under market mechanisms, which limits hdsas’ chances of exploitation of opportunities. aim: to explain challenges of attaining and sustaining equity target levels and highlight the extent to which black people own equity and mine assets, explore strategies used and reveal other realities in the implementation of the policy. these aims are met by exploring the ownership structures of white-owned, foreign-owned and black-owned companies and bee deals concluded by them between the 1990s and 2015. it was also important to learn from the experiences of countries that pursued similar policies as a means of providing knowledge and information to policymakers and the general public. setting: the study used a sample of 72 mining companies in south africa operating in various mineral categories. methodology: this article used a qualitative approach involving both secondary and primary data. purposeful selective sampling was used to draw from all listed mining companies with a cut-off of july 2011. the market capitalisation of these were used to estimate equity targets owned by black people. another 16 mining companies not listed were used to explore the strategies, challenges and other realities. this required exploring changes in shareholding structures and bee deals concluded. face-to-face structured interviews were conducted with a total of 35 executives, top management or their representatives from 27 companies, a few members of academia and government officials between 2012 and 2014. results: targets set by the mprda and the mining charter have not been met. thus, little equity ownership has been transferred to black people. a broad category of black people have, however, benefited from bee deals. these include individual companies, consortiums, communities and employee ownership schemes. to avoid risks, the sellers of mine assets host black people in separate companies, special purpose vehicles and holding companies. in general, lack of capital, dilution of black shareholding, indebtedness and limited expertise to run extractive ventures successfully challenge the survival of black-owned companies. despite these problems, a few such companies are worth billions of rand. conclusion: the success of empowerment policies that seek to offer selective preferences to enterprises elsewhere has depended on the government’s concerted efforts. these include establishing institutions to oversee policy execution and having financial and other supports. challenges that black-owned mining companies face indicate a call for help. unless the government intervenes and supports them there is a danger that white-owned and foreign-owned companies will completely buy back the assets once sold to black people resulting in a failure of the empowerment policy. keywords: black economic empowerment; bee; economic transformation; mining industry; south africa; south african conglomerates; equity ownership; mine assets. introduction the transformation of the south african economy and inclusion of black people1 in all sectors of the economy was one of the main priorities of the african national congress (anc) government that came to power in april 1994. this process started in mining, an industry with a history of only a few white conglomerates controlling mine assets since the beginning of development of the industry in 1880s. colonial and in particular apartheid2 laws prevented black people from owning and controlling mine assets, limiting them the provision of low-skilled labour. as a result, with the 1955 manifesto, the anc aimed at nationalising this industry in the hope that it will benefit all the people (anc 1955). as it prepared to take power, this idea changed and the anc government accepted the ideology of private ownership and adherence of market forces as the main drivers of the economy. while it called for the economic transformation and, in particular, transfer of equity and mine assets to black people as a way of distributing wealth and balancing economic opportunities, the government has left this process under the whelm of market forces, limiting its successes. trusted to the department of mineral resources (dmr), the economic transformation process in the mining industry started in november 1994 with the call to replace the 1991 minerals act. it took eight years of negotiations with the conglomerates (represented by the chamber of mines), trade unions (represented by national union of mine workers) and other stakeholders. this resulted in the new mining policy – the minerals and petroleum resources development act (mprda), accompanied by the broad-based socio-economic empowerment charter for the south african mining industry (mining charter) that came out in 2002 (dme 1995, 1998) and the mining score card that explains the modalities of compliance. a two-year grace period was given before the full implementation of the act and mining charter, which came into force in 2004. it should be noted that these policies are part of the broad-based black economic empowerment (b-bbee), referred to shortly as bee, policy that aims for economic transformation of not only the mining industry, but the whole economy. hence, each other sector of the economy and each government department has its own charter guiding this process. to ensure the transformation of the industry and the entry of black people, the mprda allowed state custodianship of all mineral resources in the country and the use of licensing as a tool to transfer equity and mine assets to black people. the minister responsible for minerals resources at the time (minister of minerals and energy, which changed to minister of minerals in 2009) has been given the power ‘to grant, issue, refuse, control, administer and manage all reconnaissance, prospecting and mining rights’ (see mprda 2.3a). black people are offered preferences with the issuing of licenses. holders of mining licenses referred to as old order rights, held mostly by companies owned by the incumbents – mostly white-owned companies – at the time, were required to re-apply for new licenses or new order rights within five years (by 2009). the conversion and application of new licenses were tied to the inclusion of black people, referred to in the policy as ‘historically disadvantaged south africans’ (hdsas), as shareholders or business partners. a 50 +1% shares by black people in a company would qualify it to be regarded as a black-owned (bee) company while a 25 +1% share by black people was referred to as a black-controlled company. the mprda set the target for hdsas’ equity ownership and mine asset transfer at 26% and 40% black control of mine assets in 10 years (by 2014).3 the signatory of the mining charter accepted the ‘principle of willing seller – willing buyer at a fair market value’ and if sellers are not at risk (see mining charter, section 4.12). this simply implies the adherence to market forces in transactions of equity and mine assets while the government is a regulatory facilitator. the conglomerates promised to transfer r100 billion to hdsas, which was close to 15% based on r750 billions of mine assets at the time of negotiations (republic of south africa 2002a, 2004). thus, assets expected to be transferred to black people were huge. knowing this fact, and that black people had no capital of their own and no other assets for backups, the government should have instituted proper mechanisms to help them from the start, which did not happen. as we see later, they had to rely on the sellers of equity and mine assets, who tried to avoid the risk of having them in their core assets. to assess the progress, the mining score card demanded that complying companies should reach a target of 15% by 2009, a period that coincided with that of converting licenses (republic of south africa 2002b). those who wrote about the bee policy justified it for: de-racialisation of the economy (balshaw & goldberg 2008; southall 2007), ensuring political stability (hirsh 2005: 164), creating the middle class (marais 2011; mbeki 1999, 2003) and dealing with market failures created by the apartheid policy (iheduru 2004, 2008). after all, the apartheid government also used discriminatory policies (cargill 2010). despite the mining industry being the first to come up with the policy, studies that sought to assess compliance found the target levels reached low (department of mineral resources [dmr] 2009; kio advisory services 2010). critics had already flared up even before this time. they pointed to lack of success due to narrowness of beneficiaries – that the bee policy has produced a few black moguls – dilution of black equity, fronting and the cryonic nature of bee deals. they regarded the whole implementation process as mere window dressing (khehla & reddy 2007; mathe 2008; mbeki 2007, southall 2007). beresford (2015:2–7) who looked at the cryonic nature of bee deals at a later stage saw cronyism as a common practice in a process of class formation in post-colonial africa. the same was witnessed in the economies of asian tigers, post-soviet russia and the oligarchic politics of western countries where private capitalist lobbyists wielded huge influence over public officials. ironically, using the term ‘developmental patrimonialism’, booth and mutebi (2012:381–382) argue that cronyism can act as a bridge to economic transformation and social development. this view would be a problem for some people who have been observing countless cases against cryonic leaders who try to have chunks in national resources meant to be utilised at an equal footing by all citizens, not only in south africa but also elsewhere. developmental capitalism is therefore a mere justification of corruption. south africa is not the first to use preferential policies to deal with racial disparities or for economic transformation. over years, various states in the usa used preferential policies to seek balance in social and economic opportunities skewed against its minorities, mainly black people. policy instruments such as affirmative employment, set-aside programmes and preferential procurement for black businesses, quotas at school colleges and universities level placements and for scholarships and other strategies were used to ensure minorities benefit from the economy at equal footing with others. their experiences indicate that the robustness and successes of such policies depend much on the willingness of those in political power, the establishments of institutions that constantly and closely oversee and support such programmes but, mostly, on state financial support (drake & holsworth 1996). those against it, like sowel (2004), prefer minorities to be left to struggle within the capitalist forces without government intervention. otherwise, america’s affirmative action policy prolongs racial tendencies. many african countries used preferential policies to ensure their citizens’ inclusion in their domestic economies. this has involved the reservation of certain businesses and job placements for locals, enforcement of local content requirements on foreign companies to source from domestic and local companies, demand for equity and assets transfer to locals (see adejugbe 1984; andreasson 2010; iwuagwu 2009; ndongko 1980). countries like tanzania and zambia went as far as the nationalisation and state ownership of mineral resources. similar to south africa’s bee policy is malaysia’s national economic empowerment (nep) programme (1970s to 1991) that sought to uplift its indigenous citizens or what it called the ‘sons of the soil’ or bumiputeras. these formed part of the majority of its population groups that did not face exclusion laws per se, but were just left behind in the country’s economic development trajectory. to mention a few, nep demanded equity transfer to bumiputeras, control of assets and affirmative employment. to support nep, the government of malaysia put in place a series of legislations and programmes. it revamped its education system and promoted the use of the local language (malay) which enabled the majority to attend school and join workplaces. it used preferential quotas for school, college and university placements, scholarships and affirmative employment. the policy required 30% equity transferred to the bumiputeras. preferences licensing and government procurement facilities were major instruments used to enable bumiputeras to take advantage of opportunities. the government created numerous government institutions to oversee the implementation of nep programmes and provide a wide range of supports. numerous parastatals created helped to support affirmative employment programmes, groom entrepreneurs and offered posts to executives and top managers, providing them with hands-on experience. knowing bumiputeras’ lack of financial capacity, the government created a state holding company – the national equity corporation (permodelan nationale berhad) – a vehicle company used to acquire shareholding in various private companies and warehouses on behalf of the ordinary bumiputeras until they were ready to buy. the government established state banks and financial institutions, and bought substantial shares in private banks. its financial capacity was important to support nep programmes (cargill 2010; jesudason 1990; lall 1996; mandla 2006). japan and south korea also used selective government interventions, not to deal with racial imbalances but for economic transformation in general (hughes 1988; kaplan 1972; rhee 1994). their cases also indicate the importance of not only political will and the creation of state institutions to oversee the implementation process, track changes, find problems and solutions but also a continual cooperation between government authorities and business. japan’s exim bank was crucial to offer continual financial support to local firms over a long period until they were strong enough to break into the world markets. in short, all cases explained here happened in free market settings, but indicate the importance of government’s use of selective intervention in the economy and state’s control of finance to support the programmes and cooperation between the state and business. in south africa, such relationships are not harmonious. while the government accuses businesses for their lack of compliance, the businesses see the government as interfering in the working of the market. (for details of these conflicts see bowman 2019; makgoba 2019.) it is true that south africa has numerous public financial institutions, for example the national empowerment fund, established specifically to meet the funding needs of bee beneficiaries. its traditional development bank of south africa over years played a major role in the country’s industrial development. it is questionable if these together with other numerous private banks and financial institutions have the capacity to match the required 26% of mine assets to be transferred. as we see later, capital unavailability in the midst of capital intensity, inherent in extractive industries has been one of the thorny issues for black-owned companies. this article argues for the south african government to selectively intervene and support financially those who aspire to make the most of opportunities offered by the mprda and the mining charter. the bee policy is also happening in free market settings. the initiative was, however, started by the conglomerates (mining houses) themselves under the unbundling process in the early 1990s. these controlled a large part of the economy through pyramid structures, family ownership and cross-ownership that strengthened their concentration of asset ownership. as shackles of apartheid were loosening, they started unbundling their assets; in the process, they handpicked a few black people, and sold to them shares and mine assets. when the mining charter came into force in 2004, this process was ongoing and all of the conglomerates’ transactions with black people prior to this date were recognised under the ‘continuous consequences principle’ clause (see mining charter, section 4.7). thus, deals at pre-policy stages gave the sellers of mine assets compliance points while black beneficiaries’ wealth accumulation capabilities and experiences that made them preferred bee partners for easily jumping on the wagon of cross-ownership and family ownership. it is the view expressed in this article that this might be a better explanation for bee beneficiary narrowness or why only few a black people have become moguls. methodology this article is descriptive and historical by nature. it uses a qualitative method involving the gathering of both secondary and primary data. secondary sources include books, articles from journals, newspapers and magazines, company documents (annual reports, press releases and statements), financial statements, government documents (study reports, mine directories, policy documents and statements), websites and other open-access documents. using a selective purposeful method, a sample of 72 companies was drawn using three main criteria: (1) representation-dominant companies – johannesburg stock exchange (jse), as these make up over 80% of the industry’s market value – and junior companies (non-jse), (2) race (white-owned, foreign-owned and black-owned companies) and (3) coverage – all mine categories (platinum-group metals, gold, diamond, coal, minerals and sand aggregates). all 56 jse-listed mining companies as per 12 july 2011 were included as the market capitalisation of these was used to estimate equity targets. another 16 mining companies not listed on the jse were added, as most black-owned companies are in this group. another consideration was to include mining companies involved in bee deals in all mining categories. in total 72 companies were used to explore strategies used, challenges and other realities. this involved tracing the ownership structures and bee deals concluded by white-owned, foreign-owned and black-owned companies. the concentration was from the unbundling process (early 1990s) that earmarked the entry of black people to 2015 (revision of the mining charter). facts that could explain the strategies used and challenges related to the study were documented.4 structured face-to-face interviews were conducted with executives and top management of mining companies between 2012 and 2014. these included chief executive officers, chief operating officers and managing directors. in total 35 executives from 27 companies (16 from 13 white-owned and foreign-owned companies and 19 from 14 black-owned companies) were interviewed. further interviews were carried out with three members of academia, three government officials and one official each from the development bank of south africa and the national employment fund who was responsible for funding.5 thematic analysis was used which made the writing process easier. the first section below highlights the extent to which black people own equity and mine assets. in particular it explores the ownership structure of the mining companies and deals concluded from the unbundling (early 1990s) to 2015 when the mining charter was revised. it also covers strategies and other realities the discussions provided. the second section focuses on licensing and meeting the targets. targets are assessed using market capitalisation of the 56 jse mining companies. the third section pays attention to various strategies used to accommodate black people. explained here are the use of separate companies, special purpose vehicles (spvs), community trusts and consortiums in concluding deals. the section also explains challenges, mostly the use of debt financing and its outcome. the last section provides conclusions and recommendations. it argues that the successes of similar policies require government support and state control of finance to afford various supports. the article recommends that the south african government needs to intervene to save bee equity ownership and transfer of mine assets. inside the black economic empowerment honey pot as indicated earlier, the entry of black people started with the conglomerates’ unbundling, which occurs when a company with several different lines of business retains core businesses and sells off assets, product lines, divisions or subsidiaries. this important strategy may also involve mergers and acquisitions. mergers involve two companies surrendering their stock to form one completely new company and issue new stocks. acquisitions occur when one company buys another with cash or stocks, or a combination of the two, and absorbs the business and establishes itself as the new owner. the company that is acquired ceases to exist and its stocks are discontinued (not traded) while those of the buyer are traded. in general, poor stock performance or the need to raise capital, distribute cash, achieve cost effectiveness and improve competitiveness are the drivers of such actions (kenton 2018). the unbundling of south africa’s mining companies that started in the early 1990s is peculiar, mostly because of its inclusion of black people, a race that under colonial and in particular apartheid laws was forbidden from buying equity and owning mine assets but was restricted to the provision of low-skilled and unskilled labour. as a result, by the time the liberation movements were unbanned in 1990, there was not a single black owner of mining equity or assets. conglomerates owned by white capital controlled the industry.6 these had strong family ownership, cross-ownership and pyramid structures in which, at the peak, one company will have shares in others down the line. with assets spanning all sectors of the economy, six conglomerates also widely known as mining houses, controlled the mining industry. these were anglo american and its sister company de beers, rand mines, general mining and finance corporation, anglovaal and gold fields (baxter 2009; falkena 1979; fine and rustomjee 1996; nattrass 1981; seidman & seidman 1977). the mining houses performed most of their functions in-house through their various departments. these included geological surveys, exploration, mineral extraction and processing, engineering, local and international marketing and services such as transport, mine safety, catering and cleaning. they consolidated small mines into large companies and mobilised capital and labour from local communities and neighbouring and foreign countries. in return, they kept shareholdings in such companies. capital from mining was crucial in the expansion of the country’s industrial base, which grew initially to satisfy the needs of the mines. in the late 1980s, as it became increasingly clear that the apartheid regime was likely to collapse, the conglomerates had to find a way of surviving in the new political and economic order ahead of them. they started to unbundle their assets and engage with the liberation movements, in particular the anc in exile (taylor 2007). at the centre of these engagements was the issue of nationalisation, which had been the anc’s central position since the 1955 freedom charter (anc 1955, 2010, 2012). this was not an option for white capital if they were to uphold their economic power. their engagement with the anc coincided with the unbanning of the liberation movements and unbundling of mining assets that started in the early 1990s. for scholars, the conglomerates’ acceptance of the bee policy was a way of dampening nationalisation sentiments and guaranteeing their continued enjoyment of their wealth (burton & hoawthorne 2007; dansereau 2005; iheduru 2008; marais 2011). the unbundling process involved a number of measures according to malherbe and segal (2001). these include moving some assets offshore, creating specific companies and subsidiaries in all mining categories (coal, gold, platinum and others) and creating separate companies to handle mining and non-mining assets and others to perform functions previously done in-house. they used such companies to swap and sell some of their assets and shareholdings among themselves, but sold a few to black people. they captured these happenings in a slogan ‘black economic empowerment’ which was then widely used in the media and townships circles even by government technocrats when calling for a greater black participation in the economy. later the words featured in the formal policy. four companies have been at the forefront of unbundling. these are anglo american (and its sister company de beers), rand mines, the general mining finance corporation and anglovaal. for a better understanding of strategies used and its outcomes, this article offers details on changes in the shareholding structure of anglo american from its unbundling and the various bee deals emerging from the process that continued even after the coming into effect of the mprda and the mining charter. in the process, other deals concluded by other conglomerates are brought into the discussion. captured in figure 1 is the entire process of anglo american’s unbundling.7 figure 1: anglo america unbundling and black economic empowerment transactions. anglo american’s unbundling started in 1990 when it split its de beers corporation into two: de beers ag centenary to house its non-south african assets and de beers consolidated mines (ltd) commonly referred to as de beers to house its south african assets. as can be noted in the chart, it then created a series of companies to handle activities in various mineral categories and some used to transfer equity and mine assets to blacks. the diamond assets in the dbcm merged with those from avmin coal8 (finch and venetia diamond mines). by 2006, the dbcm started concluding bee deals with blacks. these included panahalo investments (as lead partner in a consortium with 50%) and esops one for the ‘current employees’, another for identified pensioners of de beers group (35%) and a trust for key employee of de beers (15%). panhalo investments itself was also a consortium controlled by panhalo holdings.9 in the platinum-group metals, anglo america created amplats in 1995 to handle its platinum assets. in 2000, the name changed to anglo platinum and concluded a number of bee deals. these include, at a mine level, the royal bafokeng platinum mine and the royal bafokeng resources, which acquired a 50–50 shareholding in 1997. the royal bafokeng resources is a company owned by the bafokeng tribal community, which owns the land and used to receive royalties. these were translated into bee shares under the mprda and the mining charter. at the modikwa platinum mine it concluded a deal with the african rainbow minerals consortium a subsidiary of african rainbow minerals (arm)10 and offered 50% shareholding in 1999 (anglo american 2006). in 2004, anglo america, which also has a major stake in the northam mine, concluded another bee deal. it offered a controlling shareholding of 63% at its booysendal project to mvelaphanda resources, a bee entity controlled by mvelaphanda holdings (under tokyo sekwale, an anc stalwart once jailed at robben island) and afripalm (under lazarus zim). in the same year, it offered 15% shareholding to the bakgatla ba kgafela, another tribal community, at its union mine (anglo platinum 2005).11 at the bakubungu platinum mine, anglo american, through its anglo platinum, retained 11% and concluded a bee deal with wesizwe platinum anglo platinum ltd 2008a, 2008b12 enabling it to gain control of the mine at the time, but as we see later, it lost them due to escalating debts. being bee compliant comes with the benefit of being approached by other foreign-owned companies who seek to utilise mineral resources in south africa. anglo america seems to show the way. through anglo platinum it created a spv named micawber 277 for its ga phasha project and used it to enter into a 50–50 joint venture deal with the black-owned company pelawan investments.13 in 2004, pelawan then entered into a bee agreement with anooraq canada14 and offered 56.25% shares, making them the main shareholder. the transactions gave anooraq bee status which opened more chances of concluding other bee deals. anooraq then entered into another deal through its subsidiary – plateau resources – with anglo platinum’s subsidiary – rustenburg platinum – over three projects grouped together as bokoni platinum mines (anooraq 2006, 2011). in gold, anglo american split its johannesburg consolidated investments and created anglo gold in 1996. the new company engaged in share exchanges with other white-owned companies including: east rand gold and uranium company limited, eastvaal gold holdings limited, southvaal holdings, free state consolidated gold mines limited (which was known simply as freegold), elandrand gold mining company limited (known as elands vaal), j.h. joel gold mining company limited and western deep levels. the remaining small gold mines were sold to the african mining group, a consortium of black-owned companies formed in 1994 under a lead partner capital alliance holdings led by mzi khumalo.15 capital alliance owned 63% shares in the africa mining group. other shareholders were thebe investments, women development bank holdings and consolidated investment holdings. african mining group’s foray into mining, however, lasted less than two years when it failed to raise enough finance to capitalise its mines and to pay for unpaid shares and service loans (segeant 2006). in 1998, anglo gold sold off some of its assets. one of the beneficiaries was armgold, a subsidiary of arm. in this transaction, anglo gold entered into a contract agreement with armgold in 1998 over its number one shaft of the vaal river operations. in the contract, armgold would receive 40% of all the revenue for running its operation. its success resulted in acquiring the number two shaft of the vaal river operations for r10 million. in 2002, anglo gold sold to the same armgold its free state assets through freegold for r2.523 million. these deals were recognised under continuous consequences principles and enabled armgold to bid for avmin gold in 2004. after acquiring avmin gold, armgold merged its gold assets with harmony gold, a white-owned company, acquiring 14%.16 in 2004, anglo gold merged with ashanti gold from ghana to form anglogold ashanti. the merger was also allowed under continuous consequences principle because of anglo american’s earlier transactions. to date anglo american has completely disinvested from all gold mining in the country even its anglo gold ashanti in ghana. another important deal to mention involves mvelaphanda resources, which does not involve anglo american per se but is important to understanding more of the strategies used. mvelaphanda resources, which also was a beneficiary in the platinum-group metals, had another subsidiary called mvela gold that had acquired 15% of gold fields international mining south africa’s (gfimsa) ordinary shares for r4.139 billion. gfimsa was a part of gold fields international limited that moved offshore at the height of sanctions but came back after the end of sanctions as gfimsa. for its south deep mines, it created two subsidiaries: gold fields operations and gold fields international joint venture holdings. the two were used to create a separate company – newco – that acquired 100% of ‘a’ shares which were equivalent to 90% of the total ‘a’ shares of the company that carry voting rights. then it helped to organise numerous consortiums and offered 90% of ‘b’ shares that carry no voting rights (equivalent to 10%) of newco’s total shareholding. coming back again to anglo american, the company created anglo coal in 1999. it immediately sought to sell off to black people the unwanted coal projects. to do this, it created a holding company known as new coal in 2001 and placed some coals assets from anglo american itself, gold fields and bhp billiton. new coal sold 66% assets to eyesizwe coal – a consortium controlled by black people17 – but anglo america retained 11% and ingwe coal (a subsidiary of bhp billiton) 9%. ingwe coal is a product of a merger of rand coal (from the unbundling of rand mines) and trans-natal coal and minerals (unbundling of general mining and finance corporation). to conclude more bee deals, in 2005 anglo american created two companies: a holding company known as main street 333 (pty) and exxaro. anglo used main street 333, to transfer 54% to a black-owned company called eyesizwe, 15.3% to idc – a financial institution – 9.7% to tiso spv, 9.7% to eyabantu and 11.2% to bee women spv. this qualified main street 333 to become a bee company and it used these qualities to acquire 53.1% of exxaro resources, the other company that was created by the same anglo american. in exxaro, anglo american itself retained 23.7%, and 3% was offered to exxaro employees and 20.2% to minorities (publicly held) (fauconnier & mathur 2008).18 in 2009 anglo american created anglo-inyosi. it used this to transfer 27% shareholding to a black consortium. the members included: pamodzi coal (33%), lithemba consortium (33%), the women development bank holdings (19%) and a community trust. pamodzi coal was itself a consortium whose main members were pamodzi investment holdings (51%), pamodzi coal staff (9%), mzana women investment club (9%) rorisang (2.5%) and other broad-based groupings (13%). the lithemba consortium itself was made up of other smaller consortiums that included lithemba amalahle mining (40%), initiative south africa resources – a women’s group – (16%), women executives south africa (5%), mining partners (8%) girls guides (5%) and other business associations (11%). two individuals acting as lead partners were offered 15%. these were sibongile modise (a wife of the late and former minister of defence mr joe modise) and yoliswa balfour (anglo american 2009a, 2009b, 2009c; anglo inyosi 2010).19 in other minerals (metals, manganese and copper), anglo american has also been involved. it was part of the unbundling of iskor which was once partly owned by the state. in 1999 it was split into two: iskor steel (which was later sold to arcelor mittal) and kumba in which anglo america acquired 66% share and transferred coal assets that were under iskor to exxaro. it used exxaro to become a bee partner of kumba at its sishen and thabazimbi mines. anglo american was also involved in the general mining metals and minerals20 and samancor transactions. together with bhp billiton it took over samancor and split into two: samancor manganese and samancor chrome. samancor chrome took batho barena consortium (with 28%) as its bee partner. in 2005 it was sold to kermas south africa and in 2009 to the international mineral resources due to financial difficulties with its bee partners. samancor manganese sold 26% shares to a black consortium composed of ntsimbintle (9%), ncab (7%), iziko (5%) and hmm education trust (5%) (kilambo 2016). anglo american with rio tinto jointly own the palabora mining company. together they created a separate company called palabora copper and used it to transfer 26% shares to a bee consortium that includes a community trust incorporating the makushane, selwane, maseke, mashishimale and majeje communities (10% shares), the palabora copper employee trust (10% shares) and the negota consortium (6% shares) (palabora mining 2010b). a similar arrangement was made by bhp billiton and rio tinto with regard to richards bay minerals in which they created a community trust incorporating the sokhulu, mbonambi, mkwanazi and dube communities. these together with blue horizon investments acquired 26% shareholding in richards bay minerals. but apart from that, each community was offered a once-off payment of r17.5 million and a promise of r3 million annually for their social projects irrespective of whether the company declared dividends or not (richards bay minerals 2011, 2012). figure 2 shows the dube community receiving its once-off payment. figure 2: the dube community representatives receiving a once-off endowment of r17.5 million from richards bay minerals. as a principal strategist, anglo american provides a very good example of various strategies used to incorporate black people in the mining industry. names might have changed but their assets are spread in all mine categories. in certain mine ventures the sellers have retained 100% shareholding. otherwise consortiums, community trusts, employee ownership schemes and individual companies owned by black people have emerged and concluded deals with white-owned and foreign-owned companies. before discussing more on strategies used and the final outcome of the bee deals, it is important to highlight the degree of compliance with the mprda and the mining charter. meeting the minerals and petroleum resources development act and the mining charter targets one of the aims of the article was to highlight the extent to which black people own equity and mine assets. owning equity and mine assets starts with licensing. as indicated earlier, this is was a tool of transformation under the mprda and the mining charter. black people are given preference when issuing new licenses. it was important to explain the outcome of this. by 2012, a total of 6370 licenses were offered to black-controlled entities (50 +1% shares) which included prospecting rights (69.8%; 4446), mining permits (20%; 1274) and mining rights (10%; 650). hdsa partnerships, also referred to as black-empowered entities (those with 25 +1% shares), received 5215 licenses. the majority are prospecting rights (52%; 2724) followed by mining permits (25%; 1329) and mining rights (21%; 1072). broad-based groups, for example consortiums, communities and women groups, received 1439 licenses. these are further divided into 396 mining permits, 304 mining rights and 738 prospecting permits. it is worth noting that the remaining 50% of licenses (3289) which were issued to white-owned and foreign-owned companies with no black shareholders, imply that not every license offered was tied to having a black partner, a gap that could be used by vendors to retain some assets with 100% ownership (kilambo 2016). based on the directories of operating and developing bee companies provided by the department of minerals and energy there is an indication that black-owned companies have grown from 67 in 2007 to 112 in 201021 as indicated in figure 3. figure 3: number of black economic empowerment companies by commodities. most of these companies are in coal (21) followed by platinum-group metals and consultancy (13). entry of black people in coal is facilitated by a number of factors. these include a high domestic demand to feed eskom’s coal plants, preferential procurement to black people allowed under the mprda and simple technologies used which becomes affordable.22 exploring the challenges of attaining and sustaining equity target levels requires checking whether a 15% (as anticipated by 2009) and a 26% target (by 2014) have been met. the norm has been to use market capitalisation of jse-listed mining companies as data for this are readily available.23 it should be noted that the assessment of compliance targets is happening at a larger value of mining assets. from the r750 billion at the time of the signing the mining charter, these have grown to r2 trillion of jse market capitalisation by 2009. the department of mineral resources’s impact assessment report used this data indicating black people owned 9%. for almost the same period and value, kio advisory services (2010) indicated much lower levels – 5.7% (equivalent to r97 billion of the r1.8 trillion mining assets). my own calculations based on the market capitalisation by july 2011 showed black people commanded 7.4% (or r143.5 billion of the r1.8 trillion) as depicted in figure 4. figure 4: market capitalisation by value of listed mining companies (july 2011). three black-owned companies owned most of this market capitalisation. these were exxaro (r64 billion), arm (r40 billion) and royal bafokeng resources (r13 billion), accounting for 81.8%. these companies have been attracting media attention, cementing criticisms that the bee policy in the mining industry has benefited a few elites. this article has found that beneficiaries have actually broadened as bee deals involve consortiums, community trusts, employee ownership schemes and individual companies as indicated earlier. in the following section, the article explores other realities of deals concluded, in particular strategies used and outcomes in order to shed more light. strategies used and outcomes earlier the article discussed in detail the structure and bee deals concluded by anglo american. the company was at the centre of the unbundling, merging, swapping, selling and buying shares and assets among the other conglomerates. in this section, it is important to elaborate on the strategies in order to understand more of their impact and the nature of challenges encountered. the first strategy is the creation of separate companies, spvs, holding companies and trusts to host black shareholders or partners. although these are normal company strategies worldwide, in this context they help vendors and sellers to retain the controlling shares exclusively in their core assets and dispose the minors to black people. companies like new coal main street 333 (pty) and exxaro mentioned above are among those created for such purposes. the separate companies created allow companies to choose which mine assets to retain 100% ownership of (excluding black people) and which to dispose of, or offer some percentage to black people. this is clearly shown by anglo coal and anglo platinum’s dealings discussed above. for example, in the platinum belt, anglo platinum decided to offer shares at mine level incorporating also the communities. since they initiated the process, the conglomerates were free to handpick a few black beneficiaries and offer shareholding or mine assets repeatedly. as the few handpicked black people accumulated wealth and acquired experience, they became a strategic choice in other transactions even when the mprda and the mining charter came into effect. arm, shanduka and mvelapanda resources are good examples. scholars like thomas picketty (2010) who looked at the challenges of dealing with inequalities argues that those with wealth have the means to invest more in new wealth creating ventures, widening the gaps in wealth inequality. apart from individual companies – some with controlling family shareholding – the trend has been using consortiums. a string of black people join a consortium and smaller consortiums join larger ones and conclude deals with white-owned and foreign-owned companies and even black-owned companies. the dealings in consortiums depend much on a lead partner. this is a person usually offered a larger shareholding, but trusted to act as a go-between for consortium members and vendors. from interviews conducted with executives of white-owned, foreign-owned and black-owned companies, it became clear that most preferred are those that seem to be known around their communities or groups and have the ability to organise, provide guidance, coordinate and negotiate deals with the vendors. mostly importantly are those with political connections, explaining the cryonic nature of bee deals. this has become one of the sources of criticism.24 the executives of black-owned companies that have acted as lead partners complained of the heavy burdens (in terms of finance, management duties and time) that they have to shoulder as they try to meet the expectations of the vendors and consortium collaborators. the white-owned companies expect them to act as a bridge to reach a pool of their black brothers or sisters aspiring to be bee shareholders (kilambo 2016). it is believed here that such differences in the expectations call for government’s guidance for conducting relationships in consortiums. the second strategy involves using community trusts. thus, large and small trusts have emerged to conclude bee deals. this is one of the requirements of the mprda and the mining charter and an indication that mining companies cannot easily bypass communities in which their mining activities take place. large communities like royal bafokeng, which has a strong administrative structure, have entered into partnerships with mining companies operating in their areas and converted their royalties to shareholding. there are, however, different contractual arrangements for smaller communities in which some are offered once-off payments as in the case of the dube community shown earlier. in informal conversations with a few leaders of smaller communities, i found that they have little knowledge of the value of the bee shareholding allocated to them, and no clear demarcation of expenditures on projects offered under company social responsibilities and those from dividend payments received from bee shareholding. this was also observed by busacca (2013) and rajak (2012) who warned that complying companies tend to mix their bee compliance obligations with those that fall under corporate social responsibilities. i also believe what cargill (2010) says: that the government needs to offer guidance on communities’ involvement in mining companies operating in their areas and establish permanent administrative structures. without such, communities are likely to be manipulated by mining companies. from the literature and interviews conducted with executives of mining companies for this article, serious issues were highlighted. black people lack finance for acquiring shares, capitalising mine ventures and covering operational costs. their situation is worsened by them lacking collateral, which is important in sourcing funds from financial markets. thus, they depend on sponsorship from vendors of mine assets. to avoid the risks of transferring assets to cashless black people, sellers use not only separate companies to host black people, but also debt financing. black beneficiaries are allocated free shares without putting money down in the first place. with the sponsorships and guarantee from vendors, willing financial institutions accept such deals with the expectations that shares will be redeemed later through dividends or external finance. (recently this was also noticed by nhasengo 2016.) without payments, debts accumulate. the 1998 financial crisis saw black shareholding being resold back to vendors. the conditions for bee deals include lock-in clauses and ring fencing. lock-ins prevent black-owned companies entering into deals to trade their shareholding until a specified agreed date and ring-fencing gives first option to vendors to buy back their shares when black shareholders are forced to sell. the outcomes of all these are share dilution, liquidation or total exit from bee deals. a few examples below will suffice to explain the outcome of such strategies and their results. the first is mvelaphanda resources, mentioned earlier: its main shareholders are mvelapanda holdings and afripalm holdings which had also acquired 63% of northam platinum in a bee deal with anglo platinum as explained earlier. bound by a lock-in clause, mvelapanda could not quit the deal until the end of the agreement. mvelapanda’s debt accumulated to r5.5 billion by 2010 and it was under increasingly pressure to settle it. moreover, it was accused of being in a pyramid structure because it controlled over 50% of northam and received 75% of its income from northam. to break the pyramid, northam acquired the entire mvelaphanda resources’ issued ordinary shares. this implies mvelaphanda resources ceased to exist so its lock-in-clause was no longer binding. its shares were returned to its original shareholders, which were mvelapanda holdings and afripalm holdings. free from the lock-in-clauses, mvelaphanda holdings and afripalm holdings were now able to strategise on how to get out of their debts. mvelaphanda holdings decided to sell 12.2 million shares in northam to the eurasian natural resources corporation – a foreign-owned company – for r2.2 billion. afripalm also decided to sell some of its shares in northam to the public investment corporation to meet its debts with nedbank. consequently, the two companies’ bee shareholding in northam was diluted to a mere 22% (mvelaphanda holdings 10.6% and afripalm holdings 11.5%) (see northam 2010, 2011). mvelaphanda resources had another subsidiary called mvela gold that had acquired 15% of gfimsa’s ordinary shares for r4.139 billion. it was then forced to sell 11 million of these shares in order to minimise debts. consequently, mvelapanda’s resources shareholding in gfimsa was reduced to only 3% (gold fields 2010). the second is optimum coal mines.25 by the time of its listing on the jse in 2010, black people controlled 61% equity through optimum coal holdings. accumulated debts from the purchase of the mines and operating costs forced black shareholders to sell to xstrata glencore (a new foreign-owned company that operates through its subsidiary, purito bv) and lexshelf (a company connected to cyril ramaphosa). together they bought 71% of optimum coal equity (villa 2013). optimum coals’s capital shortfalls worsened when in 2015 eskom imposed a fine of r2 billion on the company for supplying substandard coal and halted advance payments for the coal deliveries. the only option was for optimum coal mines, together with optimum coal holdings, to be sold. the buyer was tegeta resources, which is part of oakbay investment. its main shareholder (with 29% equity) is the gupta family. the manner in which optimum coal assets were sold to tegeta resources prompted an investigation of state capture against the gupta family by the public protector in 2016. the report released in october 2016 concluded that the conduct of eskom was to blame for forcing optimum coal mine and optimum coal holdings into business rescue and financial stress, leading to a takeover by tegeta resources. this was clear when one considers the fact that eskom paid in advance r659 million to tegeta resources but used this to pay for the purchase of the two entities (public protector 2016).26 the third is incwala resources, another black-owned company created in 2004, which acquired 18% shares in a white-owned company named lonmin at its western and eastern mines and 26% equity in akanani platinum project. by 2010, incwala was unable to service its debts. receiving no financial returns prompted its black shareholders to opt out of the bee deals. to avoid losing its bee status, lonmin had to find another black partner. it got hold of shanduka resources (linked to president ramaphosa). lonmin as a vendor had to provide a loan to shanduka resources of r2.5 billion for five years. to cover this loan, lonmin placed 10 million shares (equivalent to 5% of its issued shares) with international investors (lonmin 2010, 2011). the fourth is wesizwe platinum, a once jse-listed black-owned company, that had to source funds in international markets to develop its bakubungu mine where it was a major shareholder. in 2008, it entered into an agreement with the jinchuan group from china. in a series of negotiations that followed, jinchuan acquired 45% equity of wesizwe platinum hall 2010 for us$200 368 292, provided a debt facility for us$650 million and took over the management of the mine. thus, wesizwe lost control of its mine assets, its shareholding diluted to a mere 16.33% and its bee status was lost. its unpaid-for shares were housed in micawber 809 spv (wesizwe platinum 2011). issues of lack of capital are not isolated from other problems that black-owned companies face. from interviews with the executives of black-owned companies, it was revealed that not only lack of capital, but also limited knowledge of mineral extraction activities, poor technological usage, difficulties in accessing land and export markets limit their successes. most of those interviewed in the coal sector mentioned that the extractive industry is capital intensive and it is difficult to get funding. more knowledge about technology and extractive activities is needed. before exporting, for example, one needs washing and other preparations, but facilities are controlled by older, larger companies. as newcomers, black-owned companies have to cooperate and use their facilities if they want to participate in export markets. when asked about procurement facilities offered under the bee policy, they indicated that with limited capital and operational capacity, they also cannot easily meet their supply quotas. it is worth noting the strategies used by some emerging bee companies to stay in operation. from interviews with clyde johnson, chief executive officer of sedibeng mining, and nchakha moloi of motjoli resources,27 the two companies acquire prospecting and exploration licenses upon finding potential deposits; they enter into joint ventures with other mining companies to develop mining assets to a bankable stage and sell them. the acquired cash is used to develop other assets (kilambo 2016). these kinds of strategies are encouraging and need more investigation. it is believed that these are companies to which the government can selectively offer support. it is also important to look at government’s strategies.28 this has concentrated on specifications of the policy that do not reflect putting in place support mechanisms despite being aware of problems that black people experience in the mining industry. in its suggestions to the amendments to the mining charter, first the government retained the 26% target. secondly, in its frantic move to enable black people attain control, it called for complying companies to allow black people participate fully in annual general meetings and required them to have voting rights. the compliance of this is questionable taking into consideration the dilution of black shareholding and the use of non-voting shares allowed in concluding bee deals. thirdly, the government is calling for complying companies that are in partnership with bee partners to provide them with cash flow throughout their deal term, regardless of whether they made a profit or a loss. again, it is questionable if such a call supports profit motives which private firms strive for and it is not certain whether such cash flows will be used to redeem their shares. fourthly is the continuous consequences principle which failed to scrap the clause requiring ongoing compliance.29 their strategy is thus concentrated on policy specifications and not supporting black entrepreneurs. conclusion in conclusion, black equity stood at only 7.4% (or r143.5 billion of the r1.8 trillion) of jse market capitalisation by 2011. this was a far cry from the 26% expectations of the 2002 mprda and the mining charter. black people have been trying hard to exploit opportunities provided by the new mining regulations signified by a broad category of beneficiaries. these include individual companies, consortiums, community trusts and employee ownership schemes and few of these are worth billions of rand. while part of the explanation for low compliance levels is the unexpected expansion of the value of assets from r750 million in 2002, the government carries the blame. the thorny issue is lack of finance in the face of various problems (lack of expertise, collateral, access to land in mineral-rich areas and others) that black people experience. the government leaves them to struggle within the market forces. white-owned and foreign-owned companies were expected to freely comply to transfer 26%, which is a huge value, to help with funding, collateral and other support. it is not surprising that debt financing and the use of conditions have been preferred by sellers. all these have led to growing indebtedness, dilution of shareholding and black people selling their equity and mine assets back to sellers. the profundity of such realities explained in this article better helps explain challenges of attaining and sustaining target levels, and the limitations of black people’s utilising opportunities offered by the policy. experiences from similar policies elsewhere indicate their successes depended on direct government enforcement through government-created institutions selectively and continuously offering various types of support and mostly state finance. it is suggested here that a new strategy for the implementation of the mprda and the mining charter is needed. in particular, instead of the hands-off approach and the concentration on changing the specifications of the policy, the government needs to be proactive. in particular it should selectively use incentives and provide reliable sources of finance to capitalise mining projects, cover operational costs and offer training in requisite skills. furthermore, the government should move away from voluntary adherence to regulations and effectively use its state institutions to continuously oversee, enforce and monitor the implementation, track the changes in the composition of ownership, unlock problematic areas and find solutions. in short, it should nurture its pool of black entrepreneurs or otherwise it should not expect them to survive and the bee policy to succeed in the mining industry. acknowledgements competing interests the author has declared that no competing interest exist. author’s contribution s.r.k. declares that she is the sole author of this research article. funding information this research received no specific grant from any funding agency in the public, commercial or not-for-profit sectors. ethical considerations this article followed all ethical standards for research without direct contact with human or animal subjects. data availability the authors confirm that the data supporting the findings of this study are available within the article. disclaimer the views and opinions expressed in this article are those of the author and do not necessarily reflect the official policy or position of any affiliated agency of the author. references adejugbe, m., 1984, ‘the myths and realities of nigeria’s business indigenization’, development and change 15(4), 577–592. https://doi.org/10.1111/j.1467-7660.1984.tb00197.x 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south africa and ‘foreign-owned companies’ for those who have their legal jurisdictions outside the country. 2. translated from afrikaans the term ‘apartheid’ means ‘apartness’, a policy introduced in 1948 by the national party government calling for separate development of different racial groups in south africa. colonial and apartheid governments passed various acts, among them the 1913 native land act which forced black people from their land, the 1923 natives (urban areas) act which prevented black people from leasing land in white areas, and the 1926 job reservation act which restricted them to few low-skilled jobs. the 1945 natives (urban areas) consolidation act restricted black people from operating businesses in townships. the 1951 bantu authorities act restricted black people to tribal areas. the 1963 one man one business policy restricted black people from ownership of big business and prevented them acquiring shares (feinstein 2005; kilambo 2016). 3. other elements of the charter require complying companies to ensure: hdsas control mine assets (participation in management), development of management, scientific, engineering or other skills for hdsas, hdsas participate in procurement chain of operations, formulation of integrated socio-economic development programmes for host communities and mobilisation of resources for major labour-sending areas. 4. the focus of the themes were: company names, percentages of shareholding owned and exchanged, nature of the companies (consortiums, communities, employee ownership schemes, individual companies, main companies, subsidiaries, mine projects) and deal specifications (conditions and funding models). 5. interviews needed permissions from higher authorities and took long time. most of the respondents decided to remain anonymous due to the sensitivity of company matters, thus their names or companies were concealed. 6. conglomeration occurs when companies own controlling shareholding in two or more other companies that might have no common business interests. 7. the numbers in circles represent percentage of shareholding exchanged. 8. avmin coal for coal assets and avmin gold for gold assets resulted from the unbundling of anglovaal in 1999. 9. the main shareholders were: e.m. dipico, a former premier of northern cape (18%), peotona capital (16%), b. peterson (13%), mashishi (8%), the women’s trust (17.5%), disabled persons trust (10%) and the community trust (17.5%) (the competition tribunal case no. 12/1m/february 2006). 10. formed by patrice motsepe, arm is under the control of the african rainbow minerals and exploration investments. the motsepe family controls 41.26%, arm broad based empowerment trust 13.45%, black rock inc. 10.61%, public investment corporation 5.16%, fidelity investments 4.17% and allan gray investment council, a financial institution, 3.78% (arm 2010). 11. bakgatla ba kgafela also controls the moepi group (50.1%) and 27% shares in boyston investments, a subsidiary of platmin ltd (canada) (platmin 2010). 12. wesizwe was created in 2008; shareholders were the bakubungu ba ratheo community (25.7%), lincoln ngculu (5.7%), thuthukile sikweiya (5.7%) and vunani capital (6.6%). 13. pelawan investment (proprietary) limited (or simply pelawan) created the pelawan trust with 16 shareholders. some of these include figure eight investments (24%), africa minerals professionals (14%), leswika women investment (10%), africa without boundaries mining (10%) and minorities holding between 0.4% and 6.9% (anooraq resource corporation pre-listing statement; 13 december 2006). 14. anooraq, incorporated in canada in 1983, started operating in south africa in 1999. it created plateau resources as its operating company. it entered into several joint ventures with anglo platinum prior to the pelawan agreement in 2004. 15. members of the capital alliance consortium are the national union of mine workers, mine workers social investment holdings and the south african clothing and textile workers union. 16. harmony gold came into existence in 1997 after the unbundling of rand mines in 1993 which was split into four separate companies: harmony gold mining, durban rooderpoort deep gold, crown consolidated recoveries and rand gold resources (which became an offshore company). 17. established in 1999 with sipho nkosi as its major shareholder; others are daphne nkosi, vincent mtambo, kholu motsoene and mxolisi ncqobo. 18. note that in 2016 exxaro ceased to be a bee company as the bee members of main street 333 sold their shares back to exxaro for r3.5 billion which included r487 million debt owed to exxaro (for the unredeemed shares). its bee shareholding was reduced to 30% (mtongana 2016). in january 2017 black shareholders indicated they wanted to re-purchase their main street 333 shareholding with eyesizwe as main shareholder with 30% shareholding. for more detail, see exxaro’s 2018 annual report. 19. anglo american, through anglo coal, has continued to sell some of its coal mines to black people. 20. this is from the general mining and finance corporation which started unbundling in 1989. its metal assets were put under general mining, gold and base metals (samancor), platinum (impala) and coal (trans-natal and minerals). the latter merged with rand coal to form ingwe coal which sold shares to kuyasa, a black consortium. 21. other sources of data include research channel africa (2006, 2008); empowerdex (2004, 2009). 22. seriti resources led by mine teke is said to be one of black supply that by 2018 supplied about 24% of eskom coal (henderson 2018). simple technique (bore and pillar) is also affordable to black people. 23. market capitalisation is a total value of a firm’s outstanding shares, multiplied by the market price at a time of closing business on a particular day. jse market capitalisation instruments include ordinary shares (these carry rights to dividend and rights to votes), preference shares, debentures and depository receipts. they also include exchange-traded funds, warrants and options (treasury 2017). 24. the list of politically connected individuals is long. it includes president cyril ramaphosa who through shanduka resources benefited from many mining bee deals, including kangra coal, pan african resources, shanduka coal, lace diamonds and assore. the list further includes patrice motsepe of arm whose two sisters are married to president ramaphosa and jeff radebe (the longest serving minister to date whose wife bridget is a major shareholder of makau mining), and tokyo sekwale, the first premier of gauteng and minister of settlements under zuma’s first term. 25. the bee members of optimum coal holdings were: warrior coal (15.9%), kwini mining investments (10.33%), employee trust (9.93%), community trust (9.93%), micsay investments (7.55%), monkge coal investments (5.28%) and mobu resources (2.26%) (optimum coal 2009, 2010). 26. the zondo commission is currently investigating how the gupta family came to capture the state under the zuma presidency for its own benefit. 27. motjoli resources is a 100% black-owned junior mining and exploration company. mr nchakha moloi and ms nonkqubela mayatula founded it in 2004. moloi is a geologist who gained experience as chief executive officer of mintek, alexkor and south african mining development and as deputy director general at the department of mineral resources. mayatula worked with lafarge, coal of africa and was instrumental in providing input for the mprda and the mining charter. 28. note that the 2002 mining charter and its amendment in 2010 ended in 2015. the new minister of finance mr tito mboweni announced the withdrawal of the mprda amendment bill in his mid-term budget review on 24 october 2018, resulting in policy uncertainty (treasury 2018). 29. this was contested by the government but the pretoria high court ruled that the 2002 mining charter did not require mining companies to continually top up their black shareholding to keep it at the 26% level (henderson 2018; mtongana 2018). 214 sajems ns 10 (2007) no 2 the correlation between cherry picking and the distance that consumers travel to do grocery shopping louise van scheers and mc cant marketing and retail, university of south africa abstract retailers often use price promotions to discriminate between consumers who can shift purchases over time and those who cannot. retailers consistently tend to charge lower prices than necessary, pricing defensively to prevent loyal customers from cherry picking, or shifting to competitors. knowledge about cherry picking behaviour will enable retailers to obtain a higher share of disposable income from even price-sensitive shoppers, while at the same time charging higher prices. recent studies indicate that effective cherry picking entails saving costs through price searching over time, price searching across stores, or both. this study examines the relationship between cherry picking and the distance that consumers travel to do grocery shopping. interviews were conducted at ten different retail outlets over three days, and the results show that there is a highly significant correlation between cherry picking and the distance that consumers travel to do grocery shopping. these results should help retailers to benefit from cherry picking by taking a proactive approach to store switching and store location, two of the main influences on cherry picking behaviour. jel d91 1 introduction retailers know the cherry-picking consumer as a shopper who goes from store to store, buying only items that are specially priced. this perception raises various questions for a retailer: who are cherry pickers? how do they behave? and how does this behaviour impact on retailers? secondary research conducted by urbany, dickson and sawyer (2000) and fox and hoch (2003) show that customers are loyal to stores for many different reasons: from choice, because they feel that they and the store have invested time and effort in building a relationship, because their needs are met or exceeded, or because the relationship is profitable to both sides. a number of factors influence the loyalty and commitment of customers, such as the quality and value of a store’s core offering, levels of customer satisfaction, ‘elasticity’ inherent in the sector or product category, other competitors in the market, and various social, demographic and geographical influences. the aim of this article is to examine the correlation between cherry picking and the distance that consumers travel to do grocery shopping, to find out whether geographical influences play a role in customer behaviour concerning store switching and location. crocker (2005) define cherry picking as ‘selecting the best or most desirable’. the term is used to describe both buyer and seller behaviour: it can describe sellers who are selective about which customers they serve, or the behaviour of buyers who are selective about which products or services they purchase at what locations and prices. in both seller and buyer contexts, cherry pickers are opportunistic, taking the best and leaving the rest, according to alba, mela, shimp and urbany (2003). this article focuses on the buyer-side of cherry picking in the context of grocery shopping and compares the behaviour of consumers who switch stores and store location and investigates whether geographical influences, such as store location and clustering of stores, play a role in customer behaviour. sajems ns 10 (2007) no 2 215 a literature review is first carried out, then the problem statement and the study’s specific research objectives outlined, the results of the study presented and recommendations made. the research will also suggest opportunities for future research. 2 reasons for this study limited research has been conducted into cherry picking, store switching and the influence of store location on both of these in the marketing and retail sector. this is evident in the limited knowledge available in the literature about store switching and location behaviour. this study attempts to clarify certain perceptions concerning store switching and location behaviour to establish whether a relationship exists between cherry picking and the distance that consumers travel to do grocery shopping. 3 study objectives retailers can be severely affected by cherry picking and store switching and need to thoroughly understand what influences such behaviour if they are to maintain a substantial competitive advantage in the retail market. to achieve the objectives of this study, the main aim of this article is to determine firstly whether there is a correlation between cherry picking and the distance that consumers travel to do grocery shopping and secondly whether geographical influences particularly store location play a role in customer store switching behaviour. to attain these objectives, the following hypotheses can be drawn: h 1 : there is a correlation between cherry picking and the distance that consumers travel to do grocery shopping. h 2 : there is a significant relationship between store switching and store location. 4 limitations of the study the demographic profile of the respondents is not representative of the broader south african context. this could be attributed to the context of the study, the greater tshwane area, and the specific malls targeted during data collection. 5 literature review the relevant literature will be briefly discussed under the headings of cherry picking and customer loyalty, store switching and location, and cherry picking and distance travelled. 5.1 cherry picking and customer loyalty cherry picking means taking the best and leaving the rest (fox & hoch, 2003). this behaviour occurs of course to various degrees along a continuum, much like a shopper’s degree of price sensitivity. for clarity’s sake, therefore, a shopping trip is classified as cherry picking if two or more grocery stores are visited on the same day. as mentioned above, customers are loyal for different reasons, including:  choice,  a feeling that time and effort have been invested in building a relationship,  the meeting or exceeding of their needs, and  a relationship that is profitable to both sides. this paper focuses on buyer-side cherry picking in the context of grocery shopping and compares the behaviour of consumers who cherry pick by switching grocery stores with the location of these stores. in the literature, economic search theory predicts that buyers’ propensity to cherry pick will be inversely related to their transaction and inventory holding costs, because of both demographic (e.g., working women, age, income, household size, home ownership) and geographical factors (distance between nearby stores). 216 sajems ns 10 (2007) no 2 5.2 store switching and location some studies (e.g. fox & hoch, 2003; carter, 2005; halbritter, 2005) suggest that consumers tend to cherry pick in two related ways. first, each week they can buy their entire market basket at the retailer where they get the best deals. if competing retailers promote nonidentical items, store switching across weeks increases compared to consumers loyal to a particular store. moreover, the transaction costs associated with switching stores across weeks do not seem to be much greater than those incurred by store-loyal shoppers, assuming that travel costs to the stores from which they choose are similar and that consumers switch often enough to be adequately familiar with store layouts. second, shoppers can engage in a more extreme form of cherry picking where store switching occurs within the same week. in this case, customers split their market basket across stores within a week (potentially on the same day) to benefit from deals offered by different stores. gauri, sudhir and talukdar (2005) observe three types of cherry pickers, namely:  shoppers who cherry pick by price searching over time: these consumers may be store loyal but are still price sensitive and so delay their shopping over time while still doing it at the same store.  customers who cherry pick by price searching across stores: these customers still do all their shopping on one day but, based on price, shop across different stores.  customers who cherry pick by switching both across stores and over time: these customers will search for the best deal within the same store over time, and between stores on the same day. what constitutes cherry picking behaviour is central to this study and our definition of such behaviour will form the foundation for all the findings of this research. 5.3 distance travelled by the shopper the cost of shopping also increases with the distance the shopper must travel to the store, reflecting the time and/or direct cost of transportation. we cannot measure travel distance for specific shopping trips, however, because we do not know with certainty where each trip originates and what route the shopper takes. thus we must treat travel distance as a household trait, rather than a state variable. if the simplifying assumptions are made that (i) all trips originate from home, and (ii) the shopper travels from the first store visited directly to subsequent stores without intermediate stops, then the distance between the closest and nextclosest stores reflects the cost of an incremental store visit. we can therefore hypothesize that there is a negative relationship between the probability of cherry picking on a given shopping trip and the distance between the closest and next-closest stores to the consumer’s home. loyalty cards and their influence on store switching and store location do not seem to be the prime reason for choosing a particular store, while factors such as price, quality, service and convenience contribute more to fostering loyal shoppers, according to consumer research in the food and grocery sector. a number of factors influence the loyalty and commitment of customers, such as quality and value of a store’s core offering, levels of customer satisfaction, the ‘elasticity’ inherent in the sector or product category, other competitors in the market, and various social, demographic and geographical influences. to achieve the objectives of this study, the main aim of this article is to determine firstly whether a relationship exists between cherry picking and the distance that consumers travel to do grocery shopping and secondly whether geographical influences, particularly store location, play a role in customer store switching behaviour. the true definition of cherry pickers needed to be studied. therefore the following hypotheses are formulated: h 1 : there is a significant relationship between store switching and store location. h 2 : there is a correlation between cherry picking and the distance that consumers travel to do grocery shopping. the research methodology used in this research will now be explained. sajems ns 10 (2007) no 2 217 6 research methodology secondary and primary sources were used for the necessary information. the main secondary sources were journals, articles, press reports and books. the main primary source of data was questionnaires. the sampling and data collection methods, measurement instruments and inferential statistics of the study can be briefly discussed. 6.1 sampling the target population of this study was grocery shoppers, where grocery shopping is defined as shopping for food, toiletries and detergents excluding bread and milk. these sample elements were targeted in the context of shopping malls through the use of mall intercepts and interviewer-administered personal interviews. mall intercept surveys are a variation of in-house personal interviewing, and involve engaging shoppers in a shopping centre, qualifying them and thereafter conducting the interview. this form of survey is more flexible than in-house personal surveys. the interviewer also has full control of the interviewing environment. this form of interviewing is very useful when testing a concept like cherry picking (tustin, ligthelm, martins & van wyk, 2005). leedy (2004: 18) distinguishes between probability and non-probability sampling. in probability sampling, the probability that any member of the population will be included in the sample can be determined, while in nonprobability sampling, this probability cannot be specified. in this study, probability sampling was used. a sampling frame was obtained of shopping malls in the greater tshwane area and specific shopping malls selected based on convenience and a wide lsm (living standard measure) spread. a relatively representative sample was obtained through targeting shopping malls for various lsm groups in different areas of tshwane. a realised sample size of 176 was obtained from a target sample size of 250, with 100 per cent of the questionnaires usable. this perfect record can be attributed to the use of personal interviews as the data collection method, as will now be briefly discussed. 6.2 data collection the questionnaire was pre-tested in ten quasiinterviews with respondents selected based on convenience. for the actual interviews, respondents were scanned and only ‘main family grocery shoppers’ were allowed to participate. data was collected over three days at ten different shopping malls, using personal interviews as a survey method. a wide spread of respondents was targeted by conducting the survey at different times each day, namely morning, afternoon and early evening. personal interview is generally regarded as the best survey method in testing concepts (tustin et al., 2005) such cherry picking. in-house interviewers, knowledgeable in the field and from an academic background, were used to decrease the likelihood of interviewer bias. no incentives were offered to boost response rate. 6.3 measurement instruments nominal data, in this case demographic variables such as respondent income and age, were investigated using direct questions. location, the main construct of this study, was measured using a likert-type scale. the basic scale design consisted of five scale points with labels ranging from strongly agree to strongly disagree, and 11 scale items. this scale was found to be highly reliable, with a cronbach’s alpha of 0.7. the constructs measuring cherry picking behaviour as price searching across time and price searching across stores were measured using similar scales with five scale items. these two scales were also found to be reliable. no items on any of these scales were reverse scored. 6.4 inferential statistics in addition to describing the sample data using common indicators such as mean, standard deviation and proportion, this study makes inferences about the population as a whole based on what was observed in the sample. inferential statistics allow researchers to make 218 sajems ns 10 (2007) no 2 inferences concerning the true differences in a population (tustin et al., 2005). the data set of questionnaire results is augmented by data reflecting the locations of the households of the respondents and the grocery stores these respondents visit. this data allows us to compute travel distances both from the shoppers’ homes to stores and between stores in order to assess the relationships between these geographic variables and cherry picking. the following null and alternative hypotheses can be formulated: h 0 : µ ≠ 10 km h 2 : µ = 10 km the research findings will be discussed next. 7 research findings descriptive and inferential statistics were used to test the hypotheses of this study. 7.1 descriptive statistics the sample in this study consisted of 67 per cent females and 33 per cent males of an average age of between 24 and 28 years. the language of preference was relatively diverse, with afrikaans (40 per cent), english (17 per cent) and north sotho (15 per cent) the most common languages. this demographic variable is of course greatly influenced by the site of the research, namely gauteng province, where north sotho is a commonly spoken language, and pretoria city, where afrikaans is very common. also important is the race of the respondents, 45 per cent african, 52 per cent white, 2 per cent coloured and 1 per cent indian. two important characteristics are evident from the results. first, 20 per cent of the sample does not cherry pick at all. second, the distribution is heavily skewed with a long right tail. thus, most households are on the low end of the cherrypicking continuum. the mean and median of the per cent cherry-picking distribution are 7.7 and 4.2 per cent, respectively, with households in the top decile cherry picking on only 32.0 per cent of shopping trips. though they may not seem compellingly large, these statistics include the fact that each cherry-picking trip is made up of multiple store visits. if we consider the distribution of store visits, which reflects retailer traffic counts, we find that the mean and median are 13.2 per cent and 8.2 per cent respectively, with the top decile of cherry picks on 49.3 per cent of visits. cherry picking behaviour as described earlier, cherry picking occurs when a consumer visits two or more grocery stores on the same day. the results of the study are shown in figure 1. figure 1 cherry picking behaviour sajems ns 10 (2007) no 2 219 figure 1 shows the distribution across households of cherry picking trips as a percentage of all the household’s shopping trips. 20 per cent of the sample does not cherry pick. households are less likely to cherry pick if the shopper is an working adult female (only five per cent of the sample) presumably because these women’s time is particularly valuable. senior citizens (>65 years old) are less likely to be employed outside of the home and so have more time to invest in shopping. therefore if there is a senior citizen in the household cherry picking increases to 22 per cent. homeownership implies greater inventory carrying capability, and so that home-owning households can afford to cherry pick to take advantage of the discounts available at various stores because they have more opportunity to accelerate purchases by forward buying. as indicated in figure 1, homeownership increases the propensity to cherry pick to about 33 per cent. wealthy households are assumed to have higher opportunity costs and to be less pricesensitive. indeed, high household income has a negative impact on per cent cherry picking, with only three per cent of these respondents’ indicating that they sometimes cherry pick. in contrast, lower income or large households are assumed to be more price-sensitive and will switch stores more often, because they have to spend a greater proportion of their income on groceries (budget constraint). 15 per cent of the respondents indicated that they cherry pick because they have greater returns to price search by virtue of purchasing scale. travel distances and times also influence cherry picking. although distance to nearest store from home does not seem to affect cherry picking, distance from the nearest to next-nearest store is negatively correlated to such behaviour. this suggests that households consider the incremental cost of the extra store visit (which can be very low if nearby stores are close together, but more costly if they are not) against the expected benefit of the additional discounts available if that extra store visit is made. figure 1 shows that each extra kilometre between stores decreases the per cent of cherry picking by about five per cent. consumer loyalty as noted in the literature review, customers are loyal for different reasons; some feel they have invested time and effort in building a relationship with the staff of a particular retailer. question 4 of the questionnaire asked how loyal respondents are to their grocery store. the responses are indicated in table 1. table 1 descriptive data of the customer frequency % cumulative (%) valid not loyal 17 10.12 10.12 indifferent 34 25.6 35.18 very loyal 108 64.29 99.47 total 168 100.0 100.0 missing system 8 total 176 table 1 indicates that 64.29 per cent of the respondents are loyal to their stores, and only 10.12 per cent are not loyal. store location will be discussed next. store location most respondents (65 per cent) agreed that they remain loyal to the store most conveniently located and will not change stores even when a store further from them offers a product at a cheaper price than their regular store. this 220 sajems ns 10 (2007) no 2 response indicates that these respondents will not cherry pick even if another more distant store offers lower prices. store switching the respondents were asked whether they would price shop across stores, that is, switch from their usual store if lower prices were offered at another store. 34.1 per cent strongly disagreed that they would switch, 32 per cent agreed that they would switch and 23.8 per cent indicated that they are indifferent to lower prices and store switching and would not switch stores. this question was further analysed to establish whether race has an influence on the respondent’s perceptions concerning price shopping across stores. the respondents were grouped into african, white, coloured and indian subgroups. more respondents of the african group, 47.4 per cent, strongly disagreed that they would price shop across stores than did respondents from the white group (42.2 per cent). 33.3 per cent of the coloured group’s respondents strongly disagreed that they would price shop across stores. the results for a positive response to price shopping across stores are interesting, with 100 per cent of the indian group, 34.4 per cent of the african group, 31.1 per cent of the white group and none of the coloured group agreeing that they would price shop across stores. the 23.8 per cent of the respondents who were indifferent to price shopping across stores consists of 19.2 per cent of the african group, 26.7 per cent of the white group, 66.7 per cent of the coloured group and none of indian group. these results suggest that respondents of the african group are less likely to price shop across stores than any of the other groups; thus this group is less prepared to cherry pick than any of the other groups. h 1 = there is a significant correlation between store switching and store location. the response to this hypothesis is shown in table 2. table 2 pearson correlation (store in q5) is conveniently located total: price shop across stores (store in q5) is conveniently located pearson correlation 1 0.073 sig. (2-tailed) . 0.348 n 167 166 total: price shop across stores pearson correlation 0.073 1 sig. (2-tailed) 0.348 . n 166 175 table 2 shows that the pearson correlation indicates a perfect correlation of 1 at a significance level of 0.05 2-tailed. the z-test, showed that h01 should be rejected, and ha1 thus accepted. therefore, we can conclude that there is a significant correlation between store switching and store location. the study also aimed to establish how far respondents would be prepared to travel for products on special or offered at lower prices. the respondents who would price shop across stores indicated that they would be prepared to travel 10 km for lower priced products. the study aims to show that there is a significant correlation between cherry picking and the distance that consumers travel to do grocery shopping. the following hypotheses were formulated. h 02 : µ ≠ 10 km h a2 : µ = 10 km sajems ns 10 (2007) no 2 221 the z-test showed that h 02 should be rejected and h a2 thus accepted. therefore, we can conlude that there is a significant correlation between cherry picking and the distance that consumers travel to do grocery shopping. 8 discussion this study aimed to examine the relationship between cherry picking and the distance that consumers travel to do grocery shopping, and to determine whether geographical factors, particularly store location, influence customer store-switching behaviour. data collected from tshwane consumers indicate that there is a relationship between cherry picking and the distance that consumers are prepared to travel to do grocery shopping, and that location does influence cherry picking behaviour. 8.1 summary of research findings most respondents indicate an average income of between r5 000 and r15 000 (43 per cent), or less (39 per cent). the average amount that respondents spend on grocery shopping is r1 560. on average, those who do cherry pick are prepared to travel 10km for products on special or offered at lower prices. 8.2 managerial implications knowledge about store switching and the effect location has on this behaviour can help retailers to get more sales from price-sensitive shoppers and increase their share of the market. retailers need to know how cherry picking affects them. this depends on whether a store is the shopper’s primary grocery outlet or a secondary grocery outlet. a primary store is the grocery chain at which the household spends the most money over a two-year period, and all other stores can be designated secondary outlets. it is one thing to be a shopper’s primary store, and every so often, when the cherry shopper picks your competition, lose a bit of money, and quite another to be that secondary store, and only to get occasional visits. not only do shoppers not spend as much in a secondary store, but also, when they do visit, they opportunistically buy more sale items. however, households that cherry pick more also tend to have more family members and so consume more goods, so overall cherry picking households generate more retailer revenue than do non-cherry picking households. the cherry picking households in this study spend r1 576/month on average, and the households that cherry pick less frequently spend only r1 498/month. knowledge of cherry picking behaviour is also helpful to manufacturers, since most of the saving made through cherry picking comes from buying items on promotion, so ultimately this saving is subsidised by manufacturer discounting. thus the burden of cherry picking is borne by both retailer and manufacturer, since manufacturers sell more on deal because of customer demand. also, cherry pickers are not brand loyal. the results indicate that if retailers advertise products, opportunism in the form of cherry picking is inevitable. while retailers must make broad offerings, they can also find ways to exploit this tendency. cherry pickers tend to opportunistically shop at the second store they visit in a single day, buying less but at a higher discount. cherry pickers tend to be more vigilant shoppers who pay lower prices, but are nevertheless a segment large enough to matter to retailers. fox (2005) advises retailers not to marginalise cherry pickers, whose behaviour simply highlights the effects of price competition with other retailers. all retailers, therefore, must strive to have the most attractive offers and weekly ads. retailers should offer things people want and care about, and stay competitive in the process. the current study shows that not much research has been done in south africa on cherry picking. 8.3 recommendations for future research this study has found that insufficient research has been done on the loyalty card system and its influence on cherry picking and store switching. future research could focus on this area. future research could also include a comparative 222 sajems ns 10 (2007) no 2 study between south africa and the united states of america to determine whether south africans or americans are more prone to cherry picking. 9 references 1 alba, j.w.; mela, c.f.; shrimp, t.a. & urbany, j.e. (2003) “the effect of discount frequency and depth on consumer price judgements”, journal of consumer research, 26: 99-114. 2 carter, b. (2005) “the facts of cherry picking”, international marketing journal, www.findarticles. com. (accessed 24 february 2006). 3 crocker, d. (2005) “cherry picking”, www. dnso.org. (accessed 25 february 2006). 4 fox, e.j. & hoch, s.j. (2003) “cherry picking”, journal of marketing, 69(1) http://proquest.umi. com. (accessed 24 january 2006). 5 gauri, d.k, sudhir, k. & talukdar, d. (2005) “’when’ and ‘where’ to cherry pick? the temporal and spatial dimensions of price search”. international marketing journal, www.google.com (accessed 24 january 2006). 6 halbritter, j. (2005) “cherry picking, the way to go”, international marketing journal www. findarticles.com. (accessed 25 february 2006). 7 leedy, p.d. (2004) practical research (6th ed.) macmillan: london. 8 tustin, d.; ligthelm, a.; martins, d. & van wyk, j. (2005) marketing research in practise, unisa university press: pretoria. 9 urbany, j.e.; dickson, p.e. & sawyer, a.g. (2000) “ insights into crossand within-store price search: retailer estimates vs consumer selfreports”, journal of retailing, 76(2): 243-258. sajems ns 10 (2007) no 3 371 credit market access in uganda: evidence from household survey data 1999/2000 fn okurut department of economics, university of botswana a schoombee department of economics, university of stellenbosch abstract this study investigated the individual and household characteristics that influenced credit market access in uganda using household data for 1999/2000. the results suggest that credit market access was significantly influenced by gender, household wealth, age, regional location, and urban/rural location. jel: g100 1 introduction uganda’s poverty eradication action plan (peap) identifies lack of access to credit as one of the major causes of poverty (ministry of finance, planning and economic development [mfped], 2001). credit can be accessed from either the formal or informal financial sectors. commercial banks dominate the formal financial sector and are mainly urbanbased. prior to reform, the banking sector was riddled with inefficiencies as shown by high intermediation margins, a significant proportion of non-performing loans, and huge losses by state-owned banks funded by the treasury. this provided the economic rationale for adopting reforms of the financial sector in uganda so as to improve the performance of the formal financial sector in the mobilisation and allocation of resources to productive investment, thereby leading to sustainable economic growth. the financial sector reforms included the introduction of new banking laws (the financial institutions statute and bank of uganda act, both of 1993), liberalisation of interest rates, divestiture of public sector banks and liberalisation of foreign exchange markets (nannyonjo, 2002). despite the implementation of these reforms, however, access to formal credit especially for the poor has not improved. access is restricted to a small proportion of the population who can meet the stringent credit requirements, hence leaving most people dependent on informal credit (okurut, schoombee & van der berg, 2005). for this reason, a deliberate policy of developing the microfinance sector was developed, geared towards improving access to financial services for economic agents with limited access to the formal financial sector. access to credit markets enhances household welfare through the provision of investment credit to boost household income (adugna & heidhues, 2000) as well as consumptionsmoothing credit (zeller, braun, johm & puetz, 1994), with the net effect of enabling households to move out of poverty (mfped, 2001). but some households have constrained access to credit markets due to both institutional and household level factors (nwanna, 1995). at the institutional level, the lenders in formal credit markets incur high costs in assessing the creditworthiness of small borrowers yet make low returns due to the small loan amounts involved. this motivates formal lenders to adopt strict collateral requirements as a screening mechanism to minimise default risk, 372 sajems ns 10 (2007) no 3 hence keeping small borrowers out of formal credit markets or rationing their credit. at the household level, low levels of income and asset accumulation, widespread poverty and highly skewed income and asset distribution give small households a high risk profile which makes them less attractive to formal lenders (hoff & stiglitz, 1990). even in informal credit markets, lenders have designed non-price mechanisms for screening and rationing borrowers (zeller, 1994). this study investigates the factors that constrain household access to credit markets, taken in this case as including both formal and informal credit markets in uganda. constrained access to credit can be defined as a state in which borrowers are rationed in credit markets such that they cannot get the amount of credit demanded at the prevailing market interest rates (stiglitz & weiss, 1981). the credit process involves two distinct stages. in the first stage, the borrower who wants credit decides what sum to apply for from a particular lender at the prevailing market price; this constitutes the demand side of the interaction. in the second stage, the lender makes a financing decision on the loan application; this constitutes the supply side of the interaction. the lender undertakes the screening of the potential borrower based on observable characteristics so as to minimise default risk; the results of this screening influence the lender’s response to the client’s loan demand. firstly, the lender may fully grant the loan amount/s demanded by the client. secondly, the lender may partially grant the loan amount/s demanded by the client. thirdly, the lender may completely reject the loan application. the last two scenarios represent credit constraint, the state in which the borrower is constrained in his/her access to credit markets or credit rationed by the lender (zeller, 1994). the rest of the paper is organised as follows: section 2 asks why credit is rationed and provides a survey of the empirical literature on factors that influence lenders’ credit rationing behaviour when lending to small borrowers. section 3 discusses the methodology of the study and its findings, and section 4 presents the conclusion. 2 credit rationing 2.1 why credit is rationed households may be constrained in their access to credit markets due to market imperfections, institutional factors and household-related factors. stiglitz and weiss (1981) argue that market imperfections and information asymmetry problems create an equilibrium in the form of credit rationing in credit markets. at the prevailing market price, lenders will restrict the amount of credit extended to borrowers so as to minimise loan default risk. loan default risk (defined as the risk of the borrower being unable to pay back the principal loan amount plus accrued interest) may be influenced by factors such as the expected returns of the project, the terms of the loan (interest rate, loan period), market imperfections and borrower characteristics. the expected returns on the proposed project have a significant influence on the lenders’ decision to ration credit or not (kochar, 1997). should the expected returns of the project (defined as net income after subtraction of operational costs) be less than the principal loan amount plus accrued interest, then the probability of default will be high. the optimal decision would then be to ration the borrower’s credit. the strength of the previous business relationship between borrower and lender plus the borrower’s reputation in the market also determine the lender’s credit-rationing behaviour (aleem, 1990; bell, 1990, siamwalla et al., 1990). hoff and stiglitz (1990) term this the relationship-specific social capital built between the lender and the borrower and used as a non-price-related mechanism for credit rationing. the stronger and more long-standing the relationship, the lower the probability of the borrower’s credit being rationed. the lender’s assessment of the borrower’s debt service capacity (measured as outstanding debt as a proportion of total household income and household wealth) also affects the likelihood of the borrower’s credit being rationed (zeller, 1994). the larger this ratio, the greater the prospect of the credit being rationed. sajems ns 10 (2007) no 3 373 interlinked credit, defined as credit contracts linked to either product markets (where borrowers have to market their agricultural output at agreed prices through the lenders) or labour markets (where the borrowers undertake to provide labour to the lender at predetermined wage rates) also provides alternative forms of collateral. the borrower’s acceptance of an interlinked credit contract decreases the odds of his/her credit being rationed because this contract lowers the probability of loan default (udry, 1990). this is because such a contract is a non-conventional form of collateral that removes some of the difficulties associated with adverse selection and moral hazard. the interlinked credit contract moreover presents the borrower with a further incentive to repay the loan (bell, 1990). other socio-economic variables that influence the probability of a borrower’s credit being rationed include the borrower’s gender, household wealth and/or asset values (zeller, 1994), education level and access to network information (vaessen, 2001). men mainly control household resources and are perceived by lenders to be more credit-worthy than women. household wealth and/or asset values are important as collateral, hence control of these reduces the man’s probability of credit rationing. education level enhances human capital in the form of skills, which is associated with effective utilisation of credit and minimisation of default risk. access to network information enables the screening of potential clients and reduces default risk as only those with good reputations are likely to be recommended for credit. 2.2 determinants of credit rationing a survey of the empirical literature suggests that household characteristics such as age, gender, education level and income influence lenders’ credit-rationing behaviour. age empirical evidence provided by zeller (1994) suggests that age has a positive and significant effect (at the 5 per cent level) on the probability of households being rationed in credit markets in madagascar. a possible explanation for this result is that older individuals are more likely to apply for bigger loan amounts, which increases the probability of their credit being rationed. zeller et al. (1994) however observe a positive and significant effect of age (with a t-value of 2.91) on the probability of credit access in gambia, as older persons who control household resources may be rated as more credit-worthy, thus reducing the probability of their credit being rationed. gender the gender variable is captured as a binary variable in the empirical literature. evidence from zeller et al. (1994) indicates that being female has a significant negative effect (with a t-value of -5.98) on credit access. this particular result reflects discrimination against women in the credit market. possible reasons for this result are firstly that the membership of the credit union is male-dominated. secondly, in the cultures of the particular communities investigated, men are regarded as the representatives of the households, thus it is argued that there is no discrimination against women since the men in the credit market effectively represent the women. this argument is supported by baydas, meyer and aguilera-alfred (1994) who report that being male does not have any significant effect on access to credit in ecuador. education level vaessen (2001) shows that credit access in northern nicaragua is positively and significantly influenced by education level (at the 1 per cent significance level), possibly on account of increasing returns to investment as a result of education. similar results are reported by baydas et al. (1994), who show that in ecuador the amount of credit supplied is positively and significantly influenced by level of education (at the 5 per cent significance level). the rationale for this result is that the educated are more likely to get loans because they demand larger loans. in addition, lending institutions often prefer to give larger loans in order to minimise transaction costs. in contrast, zeller (1994) reports that education level has a positive and significant effect (at the 10 per cent significance level) on the probability of credit rationing, 374 sajems ns 10 (2007) no 3 which contradicts vaessen (2001) and baydas et al. (1994). a possible explanation for zeller’s results is that the character of the borrower in terms of trustworthiness in servicing debts is critical to the lender, which may not necessarily be correlated with education level. repayment capacity the repayment capacity of the household may be captured by wealth (asset values), debtincome ratio, engagement in off-farm activities and expected business profits. zeller (1994) uses the debt-income ratio, also referred to as the leverage ratio, as a measure of a household’s debt-repayment capacity. empirical results suggest a positive and significant relationship between the probability of credit rationing and the debt-income ratio (at the 10 per cent significance level). the rationale for this result is that the higher the debt-income ratio, the higher the exposure to default risk which raises the household’s probability of credit rationing. zeller et al. (1994) also observe that household per capita income (which is an indicator of repayment capacity) has a positive and significant effect (with t-value of 2.00) on the probability of credit access. in vaessen’s study (2001), dummies for offfarm activities and work as an agricultural wage labourer are used as proxies for the repayment capacity of households. off-farm activities have a positive and significant effect (at the 10 per cent significance level) on the probability of credit access. a possible explanation for this result is that credit institutions prefer to finance off-farm activities (as compared to agricultural activities), which have a high turnover, so as to service short-term loans. also, clients who engage in off-farm activities are perceived by credit institutions to have a higher repayment capacity compared to agricultural households with high income variability due to exogenous production and price shocks. the agricultural wage labourer dummy has a negative and significant effect on household credit access (at the 5 per cent significance level). the argument here is that being an agricultural labourer is a reflection of a lower repayment capacity, as it is the poor who mainly work as agricultural wage labourers. the value of visible assets is also used as a measure of a borrower’s repayment capacity. evidence in zeller (1994) suggests that the total value of assets owned by a household has a negative and significant effect (at the 5 per cent significance level) on the probability of credit rationing. the rationale for this result is that lenders view the borrower’s visible assets as the last resort to liquidate to recover the loans in case of default. bell, srinivasan and udry (1997) also find a positive and significant relationship between visible assets and the amount of credit supplied by lenders in rural punjab, india. intuitively these results are consistent with those reported by zeller (1994), as the household factors that positively influence the quantity of credit supplied by lenders implicitly reduce the probability of such households’ credit being rationed. evidence by baydas et al. (1994) suggests that business profits have a positive and significant effect (at the 5 per cent significance level) on informal credit supply, which implies that the more profitable businesses are less likely to be credit rationed. a possible explanation for this result is that the expected profits from the investments are closely associated with repayment capacity. the higher the expected profit, the lower the default risk and the lower the probability of the household’s credit being rationed. social capital we can define social capital to include personal guarantees and/or recommendations of potential clients which act as social collateral. in effect, the guarantors sign an undertaking with lenders to make good in case of default by the client(s) whom they guarantee or recommend. this motivates the guarantors to monitor and put pressure on the borrowers to ensure full repayment of the loans. for this reason clients who have access to this form of social capital are less likely to be credit rationed. the findings by vaessen (2001) suggest that access to a network of information and recommendation has a significant positive effect (at the 1 per cent significance level) on credit access. further evidence by kochar (1997) in rural india also sajems ns 10 (2007) no 3 375 suggests that the probability of credit access is positively and significantly influenced (at the 5 per cent level) by a social security dummy (=1 if personal guarantees are given for a loan). interlinked credit contracts an interlinked credit contract involves the linking of the amount of credit supplied in the credit market to either the product market (in terms of borrowers undertaking to market their agricultural output through the lenders at pre-determined prices) or to the labour market (in terms of borrowers undertaking to work for the lenders at pre-determined wages for specified periods). the economic rationale of interlinked credit contracts is to enable the lenders to overcome the information asymmetry problems inherent in credit markets and to minimise default risk. bell et al. (1997) find that this kind of linked credit positively and significantly influences the amount of credit supplied (t-value 2.76). these results imply that a borrower’s acceptance of an interlinked credit contract reduces the probability of his/her credit being rationed. household size evidence by vaessen (2001) suggests that family size has a positive and significant effect (at the 5 per cent significance level) on credit access. by implication, larger households are less likely to have their credit rationed. vaessen gives no explanation for this result, but it could be argued that a rational lender will perceive large households as having lower repayment capacity, which will increase the probability of these households having their credit rationed. in conclusion, the empirical evidence indicates that lenders’ credit-rationing behaviour is negatively and significantly influenced by repayment capacity, social capital (guarantee arrangements) and interlinked credit contracts. though household size is reported to have a negative and significant effect on lenders’ credit rationing behaviour, there appears to be no rational basis for this result. age, gender and education level have inconclusive effects on a household’s credit access (as their coefficients are positive and significant in some studies but negative and significant in others). 3 credit rationing in uganda credit rationing in the broader financial sector, comprising both the formal and informal financial sectors, is included in this study. the data comes from the uganda national household survey (unhs) data set for 1999/2000 from the uganda bureau of statistics (ubos) with a sample size of 10 692 households. in this survey, the formal financial sector is taken to include banks and the informal (unregulated) financial sector all other lenders. the variables used in the analysis are presented in table 1. table 1 variables used in this study definition and unit of measurement lessmo = credit rationing status (=1 if credit rationed in credit market, otherwise zero) leve1 = credit demand status (=1 if applied for credit from credit markets) ln(recivo) = natural log of amount of credit received in us dollars ln(age) = natural log of age of borrower dummy: male = gender of borrower (=1 if male, otherwise zero) ln(depr) = natural log of dependency ratio, measured as the proportion of economically inactive persons (children aged below 15 years and older persons aged over 65 years) to economically active persons (those aged 15–65 years) ln(educ) = natural log of highest education level, measured in completed years of schooling 376 sajems ns 10 (2007) no 3 dummy: migration = migration status of household head (=1 if household head migrated to current location, otherwise zero) ln(hhexp) = natural log of household expenditure (measured in us dollars) per adult equivalent household member ln(astva) = natural log of value of household assets (measured in us dollars) per adult equivalent household member ln(lan) = natural log of household land holding, measured in acres per adult equivalent household member ln(hhsize) = natural log of household size dummy: urban = dummy variable for urban area (=1 if household resides in urban area) dummy: central = dummy variable for central region dummy: eastern = dummy variable for eastern region dummy: western = dummy variable for western region dummy: northern = dummy variable for northern region (reference category) 3.1 modelling credit rationing the heckman probit model with sample selection (greene, 2000; heckman, 1976; heckman, 1990) is used to estimate the determinants of constrained access or credit rationing in the credit markets (equation (1)). the dependent variable for the model of interest is lessmo (=1 if credit rationed in the credit market, otherwise zero). for the selection model, the dependent variable is the probability of applying for a loan from the credit market leve1 (=1 if applied for a loan in the credit market, otherwise zero). this specification aims to avoid modelling those who have not applied for any credit, as such persons’ credit is not rationed by financial institutions but rather by themselves. prob(lessmo) = β 0 + σβ i x i + ε i , select (leve1 = ω 0 + σ ω i k i + ε i ) … (1) where: prob(lessmo) = β 0 + σβ i x i + ε i , which is the model of interest prob(leve1) = ω 0 + σ ω i k i + µ i , which is the selection model lessmo = the probability of being credit rationed (lessmo =1 if borrower’s credit was rationed in market, otherwise zero) leve1 = the probability of applying for credit (leve1 =1 if borrower applied for credit, otherwise zero) β 0 , ω 0 = constant terms β i , ω i = vector of coefficients x i = vector of household socio-economic characteristics k i = sub-set of the socio-economic characteristics vector, x i . ε i, µ i = error terms the results are presented in table 2. sajems ns 10 (2007) no 3 377 table 2 heckman probit model with sample selection for credit rationing in the credit market, national and regional, of uganda equation of interest: dependent variable lessmo (=1 if credit rationed in credit market) explanatory variable national region central eastern northern western ln(age) –0.163 (1.83)* 0.361 (1.31) –0.163 (1.81)* 0.310 (1.86)* –0.178 (0.78) gender (male=1) –0.251 (2.80)*** 0.098 (0.26) –0.455 (2.50)*** 0.405 (3.05)*** 0.075 (0.29) ln(educ) 0.004 (1.06) 0.020 (1.28) 0.005 (0.69) ln(depr) –0.204 (3.20)*** 0.387 (1.56) –0.349 (2.99)*** 0.263 (1.22) –0.134 (0.77) ln(hhexp) 0.093 (2.03)** 0.228 (1.28) 0.026 (1.09) 0.176 (4.21)*** 0.145 (1.24) dummy: migration 0.028 (0.72) 0.230 (1.36) –0.001 (0.01) –0.033 (0.40) 0.062 (0.55) ln(astva) –0.099 (3.89)*** –0.006 (0.06) –0.044 (0.57) 0.073 (1.06) –0.020 (0.21) ln(lan) 0.001 (0.06) 0.007 (0.93) 0.026 (0.74) –0.024 (0.52) dummy: urban –0.130 (1.69)* –0.128 (0.57) –0.067 (1.74)* –0.257 (1.28) –0.157 (0.82) dummy: central region –0.360 (2.63)*** dummy: eastern region –0.538 (2.70)*** dummy: western region –0.522 (2.78)*** constant 2.193 (3.52)*** –3.621 (1.62) 2.084 (5.98)*** –4.271 (6.23)*** –0.001 (0.00) dependent variable for selection equation: leve1 (=1 if applied for a loan in credit markets) ln(age) 0.289 (10.43)*** 0.286 (4.80)*** 0.175 (2.32)** 0.223 (2.32)** 0.493 (9.00)*** gender (male=1) 0.418 (15.37)*** 0.382 (6.53)*** 0.524 (2.94)*** 0.358 (3.68)*** 0.331 (7.02)*** 378 sajems ns 10 (2007) no 3 ln(depr) 0.253 (6.98)*** 0.063 (0.81) 0.300 (3.25)*** 0.336 (2.18)** 0.271 (4.47)*** ln(lan) –0.037 (1.95)** ln(astva) 0.131 (13.94)*** 0.067 (0.92) 0.219 (4.13)*** 0.145 (7.97)*** ln(educ) 0.014 (3.98)*** constant –2.945 (25.85)*** –2.585 (10.87)*** –2.289 (7.46)*** –3.159 (6.33)*** –3.477 (16.55)*** /anthro –1.603 (2.76)*** 0.395 (0.31) –8.965 (0.10)** 10.512 (0.07) –0.658 (0.98) rho –0.922 0.376 –1.000 1.000 –0.577 number of observations 20 034 4 038 5 404 3 426 5 873 censored observations 18 505 3 707 4 941 3 309 5 252 uncensored observations 1 529 331 463 117 621 wald chi2 164.6 12.82 76.19 56.42 5.15 prob>chi2 0.000 0.118 0.000 0.000 0.741 absolute value of z-statistics in parentheses * significant at 10%, ** significant at 5%, *** significant at 1% the results suggest that in uganda, at the national level, lenders’ credit rationing behaviour is negatively and significantly influenced by the borrower’s being male. since males arguably control household resources in uganda, this makes them more creditworthy and reduces their probability of being rationed in credit markets. these results suggest that there is gender discrimination against women in ugandan credit markets. these results are consistent with those of zeller et al. (1994), who observe that being female has a significant negative effect on credit access in rural gambia. asset values have a negative and significant effect on the probability of credit rationing. this result is consistent with various studies such as zeller (1994) and bell et al. (1997). since assets are a measure of creditworthiness, households with more assets are less likely to have their credit rationed. the coefficient for dependency ratio, negative and significant, is quite surprising. this is because dependency ratio was expected to have an inverse relationship with the income earning capacity of the household. typically households that have high dependency ratios are also characterised by low education levels with less employment opportunities in high paying jobs. by implication, households with high dependency ratios would be judged by lenders to be less creditworthy, thus increasing the probability of their credit being rationed. age has a negative and significant effect on the probability of credit rationing, which is consistent with zeller et al. (1994). a possible explanation is that older persons are more likely to control household resources, hence to be rated as more creditworthy by lenders. being an urban resident also has a significant negative effect (at the 5 per cent significance level) on the probability of credit rationing. the rationale for this result may be that urban households have a more diversified income base sajems ns 10 (2007) no 3 379 compared to that of rural households which are dependent on highly variable agricultural income vulnerable to exogenous production and price shocks. this makes lenders rate households who base their income on agriculture as less creditworthy than non-agricultural households (vaessen, 2001). household expenditure has a significant positive effect on lenders’ credit-rationing behaviour. this is an unexpected result, since household expenditure is arguably a measure of wealth and high repayment capacity, hence should reduce the probability of credit rationing. regional location, relative to the reference category (northern) negatively and significantly influences the probability of credit rationing. this result may be explained by the fact that the northern region is the poorest in uganda, having been affected by civil war for almost two decades, which makes the region less creditworthy. at regional level, lenders’ credit-rationing behaviour in the central and western regions is not significantly influenced by any of the variables tested. in the eastern region, the probability of credit rationing is negatively and significantly influenced by age, urban dwelling, the male gender and dependency ratio, which corresponds to the results at national level. in the northern region, credit rationing is positively and significantly influenced by the male gender, household expenditure and age, which is in direct contrast to the results at national level. the results of the rural/urban disaggregation (see table 3) suggest that lenders’ creditrationing behaviour for borrowers located in the rural sector is positively and significantly influenced by household expenditure and education level, and negatively and significantly influenced by asset value. for the urban sector probit model, the probability of credit rationing is negatively and significantly influenced by age, dependency ratio, asset value and migration. the only variable that positively and significantly influences the probability of credit rationing in the urban sector is land size, which result is unexpected. this is because land in urban areas in uganda has a higher value compared to land in rural areas and so acts as good collateral. for this reason land size in the urban sector was expected to improve creditworthiness and reduce the probability of credit rationing. table 3 heckman probit model with sample selection for credit rationing in credit markets (rural/urban) in uganda equation of interest: dependent variable lessmo (=1 if credit rationed in the credit market) explanatory variables rural urban ln(age) –0.003 (0.02) –0.622 (6.96)*** gender (male=1) –0.184 (0.94) –0.061 (1.37) ln(educ) 0.011 (1.65)* –0.0008 (0.2) ln(depr) –0.121 (1.10) –0.334 (3.57)*** ln(hhexp) 0.175 (2.30)** 0.016 (0.65) dummy: migration 0.055 (0.84) –0.068 (1.94)** 380 sajems ns 10 (2007) no 3 ln(astva) –0.151 (3.31)*** –0.130 (4.04)*** ln(lan) 0.041 (0.96) 0.007 (2.64)*** constant 0.301 (0.18) 4.124 (11.03)*** selection equation: dependent variable leve1 (=1 if applied for a loan in the credit markets) ln(age) 0.226 (7.49)*** 0.604 (10.2)*** gender (male=1) 0.459 (15.40)*** 0.169 (5.07)*** ln(depr) 0.197 (4.83)*** 0.386 (5.11)*** ln(astva) 0.138 (11.80)*** 0.183 (9.96)*** constant –2.759 (22.11)*** –4.207 (16.73)*** /athrho –0.827 (1.24) –11.2 (8.14)*** rho –0.679 –1.000 number of observations 16 215 3 677 censored observations 14 892 3 471 uncensored observations 1 323 206 wald chi2 29.56 7 186 prob>chi2 0.000 0.000 absolute z-statistics in parentheses * significant at 10%, ** significant at 5%, *** significant at 1% 3.2 modelling the value of credit supplied to eliminate possible sample selection bias, the heckman two-step selection model is used to estimate the factors that influence the amount of credit supplied in the credit markets (heckman, 1976; heckman, 1990). the specification of the model is given in equation (2): q s = δ 0 + σδ i x i + ε i , select (q s =  0 + σ  i k i + µ i )…………………(2) where q s = δ 0 + σδ i x i + ε i , which is the model of interest q s =  0 + σ  i k i + µ i , which is the selection model q s = total value of credit supplied x i = vector of socio-economic characteristics sajems ns 10 (2007) no 3 381 k i = sub-set of vector of socio-economic characteristics, x i . δ 0 ,  0 = constants δ i ,  i = coefficients e i , µ i = error terms the results of the analysis of factors that influence the amount of credit supplied in credit markets are presented in table 4. table 4 heckman two-step selection model for amount of credit supplied in the ugandan national credit market equation of interest: dependent variable lnrecivo (amount of loan received) explanatory variables coefficients ln(age) 0.185 (1.42) ln(hhexp) 1.251 (16.64)*** ln(astva) 0.201 (4.04)*** ln(lan) 0.040 (1.26) ln(hhsize) 0.918 (10.26)*** constant –6.047 (9.35)*** selection equation: dependent variable leve1 (=1 if applied for a loan in credit market) gender (male=1) 0.396 (13.67)*** dummy: urban –0.087 (2.20)** ln(depr) 0.200 (5.02)*** dummy: central region 0.438 (7.37)*** dummy: eastern region 0.636 (11.08)*** dummy: western region 0.765 (13.60)*** constant –2.146 (35.73)*** lambda –0.394 (2.40)** 382 sajems ns 10 (2007) no 3 rho –0.272 sigma 1.445 number of observations 20 003 censored observations 18 730 uncensored observations 1 273 wald chi2(5) 618.6 prob>chi2 0.000 absolute value of z-statistics in parentheses * significant at 10%, ** significant at 5%, *** significant at 1% the results suggest that the amount of credit supplied is positively and significantly influenced by household expenditure, household size and asset value. the positive and significant coefficient for household size agrees with vaessen (2001) but, as argued earlier, is surprising, as such households are arguable less creditworthy. the results for household expenditure and asset value are as expected. both factors suggest creditworthiness and reduce the likelihood of borrowers’ credit being rationed. 4 conclusion lenders’ credit rationing behaviour in the credit markets in uganda, as would be expected, is linked to borrowers’ repayment capacity (or creditworthiness). various factors influence repayment capacity, including individual and household characteristics. these factors were the focus of this study. this research has found, in support of empirical work done in other developing countries, that household asset value has a significant negative effect on credit rationing. this is so at national level, in both rural and urban sectors, and when modelling the amount of credit supplied. age is shown to have a significant negative effect on lenders’ credit rationing behaviour at national level in the eastern region of uganda and in the urban sector. however, in the empirical studies of countries of a similar level of development, age is shown in some instances to have a significant positive and in others a significant negative impact on credit rationing. dependency ratio has a significant negative effect on the rationing of credit at national level in the eastern region and the urban sector. this is surprising, as a higher dependency ratio would suggest a lower repayment capacity and thus less access to credit. h o u s e h o l d e x p e n d i t u r e i n d i c a t e s a n unexpected significant positive impact nationally, in the northern region and in the rural sector. however, when modelling the amount of credit supplied, the results indicate that household expenditure has a positive effect on credit supplied, implying a negative (and expected) impact on credit rationing. notes 1. the study by okurut et al. (2005) explores credit rationing only in informal credit markets in uganda. 2. network information refers to a system in which potential borrowers have to be recommended to the lender by existing clients. the rationale is to screen the potential borrower so as to minimise default risk. this practice is most prevalent among microfinance institutions which give collateralfree loans. those who give recommendations are obliged to act as guarantors in case of default. 3. explanatory variables for the selection equations are chosen to yield the most significant effects, hence the variation of variables across the national, regional, and rural/urban models. references 1 adugna, t. & heidhues, f. (2000) “determinants of farm households access to informal credit in lume district, central ethiopia”, in mauri, a.; garavello, o. & masini, m. (eds.) (2000) african review of money finance and banking: 27–44. sajems ns 10 (2007) no 3 383 2 aleem, i. (1990) “imperfect information, screening, and the costs of informal lending: a study of a rural credit market in pakistan”, the world bank economic review, 4(3): 329–349. 3 baydas, m.m.; meyer, r.l. & aguileraalfred, n. (1994) “credit rationing in small-scale enterprises: special micro-enterprise programmes in ecuador”, journal of development studies, 31(2): 279–309. 4 bell, c; srinivasan, t.n. & udry, c. (1997) “rationing, spillover and interlinking in credit markets: the case of rural punjab”, oxford economic papers, 49: 557–585. 5 bell, c. (1990) “interaction between institutional and informal credit agencies in rural india”, the world bank economic review, 4(3): 297–327. 6 greene, w.h. (2000) econometric analysis. prentice-hall: eaglewood cliffs nj. 7 heckman, j. (1976) “the common structure of statistical models of truncation, sample selection, and limited dependent variables and a simple estimator for such models”, annals of economic and social measurement, 5: 475–492. 8 heckman, j. (1990) “varieties of selection bias”, american economic review, 80: 313–318. 9 hoff, k. & stiglitz, j.e. (1990) “imperfect information and rural credit markets: puzzles and policy perspectives”, the world bank economic review, 4(3). 10 kochar, a. (1997) “an empirical investigation of rationing constraints in rural credit markets in india”, journal of development economics, 53: 339–371. 11 mfped (ministry of finance, planning and economic development) (2001) uganda poverty status report, 2001, kampala. 12 nannyonjo, j (2002) “financial sector reforms in uganda (1990-2000): interest rate spreads, market structure, bank performance and monetary policy”, unpublished phd. götenborg university: götenborg. 13 nwanna, g.i. (1995) “financial accessibility and rural sector development”, savings and development, x1x(4): 453–491. 14 okurut, f.n; schoombee, a. & van der berg, s. (2005) “credit demand and credit rationing in the informal financial sector in uganda”, south african journal of economics, 73(3): 482–497. 15 siamwalla, a.; pinthong, c.; poapon gsakorn, n.; satsanguan, p.; nettayarak, p.; mingmaneenakin, w. & tubpun, y. (1990) “the thai rural credit system: public subsidies, private information, and segmented markets”, the world bank economic review, 4(3): 271–295. 16 stiglitz, j.e. & weiss, a. (1981) “credit rationing in markets with imperfect information”, american economic review, 71(3): 393–410. 17 ubos (uganda bureau of statistics) (2000) uganda national household survey (unhs) 1999/2000, kampala. 18 udry, c. (1990) “credit markets in northern nigeria: credit as insurance in a rural economy”, the world bank economic review, 4(3): 251–269. 19 vaessen, j (2001) “accessibility of rural credit in northern nicaragua: the importance of networks of information and recommendation”, savings and development, xxv(1): 5–31. 20 zeller, m. (1994) “determinants of credit rationing: a study of informal lenders and formal credit groups in madagascar”, world development, 22(12): 1895–1907. 21 zeller, m.; braun, j.v.; johm, k. & puetz, d. (1994) “sources and terms of credit for the rural poor in the gambia”, african review of money finance and banking, 1: 167–186. microsoft word 9 clavier et al sajems 17(2) 2014.docx 220 sajems ns 17 (2014) no 2:220-231 a first step towards service-dominant logic as a new approach to overcome challenges in business intelligence pamela clavier and johan van loggerenberg department of informatics, university of pretoria hugo lotriet school of computing, university of south africa accepted: october 2013 high expectations are set for business intelligence (bi), yet it fails to consistently deliver accordingly: there are numerous reports of bi challenges and failures. existing approaches to address bi challenges are largely found to be ineffective, highlighting the need for a new approach. this paper examines how bi is perceived or understood and establishes that, firstly, bi is inherently grounded in goods-dominant (g-d) logic and secondly, that this can be linked to the challenges that are experienced within bi. a recommendation is made for a shift to service-dominant (s-d) logic as a new avenue of exploration to assist in overcoming bi’s prevailing challenges. identifying the inherent g-d logic in bi provides the first step necessary in making this shift. research findings are based on an interpretive case study of a south african banking institution as well as a literature review. key words: business intelligence, service-dominant logic, goods-dominant logic, business intelligence challenges jel: o32, m15 1 introduction this paper examines business intelligence (bi) – a specialised information system (is) (berstein, grosof, & provost, 2011) – at an abstract level, as a series of exchange activities performed with the ultimate purpose of providing actionable information and/or intelligence for use in decision-making (hočevar & jaklič, 2010). bi is contextualized in terms of exchange because it is identified that there are various exchange activities that take place within the bi environment throughout the bi process, i.e. processes to transform raw data into useful information for insights and decisionmaking (duan & da xu, 2012). understanding bi as an exchange process offers opportunities to understand the various relationships (e.g. bi customer and bi provider), their interactions and their perceptions and understanding of the end-to-end flow that takes place within a bi environment from when data is sourced until when it is used (in another form, e.g. intelligence). this is complemented by application of service-dominant (s-d) logic as a lens through which to view the bi exchange process. s-d logic is a philosophical lens through which economic and social exchange processes can be viewed (vargo, 2011), including exchange processes that take place within the bi environ ment. s-d logic questions traditional views of the exchange of goods and service (kowalkowski & ballantyne, 2009), referring to these views as “g-d logic” (lusch, vargo & wessels, 2008). s-d logic urges for a shift from g-d logic; establishing that g-d logic is an inadequate logic that fails to benefit today’s exchange process (vargo & lusch, 2004a). while s-d logic cannot be proved or disproved (williams & aitken, 2011), it can be demonstrated as a viable approach. various research efforts across disciplines – e.g. information and communication technology (ict), economics and marketing – show how g-d logic fails to serve exchange optimally (vargo & lusch, 2004a), suggesting s-d logic as a more viable approach. abstract sajems ns 17 (2014) no 2:220-231 221 this paper highlights the inadequacies of gd logic that are apparent within the bi environ ment, linking these to how bi is perceived or understood as well as to the challenges that are experienced within bi. a perception results in a set of beliefs through which the world is interpreted or interacted with, which results in challenges or opportunities that are created within a specific situation and context (heylighen, 2000). in this paper, the way that bi is perceived or understood is explored in terms of, firstly, perceptions of bi that emerge from how bi is defined and secondly, the beliefs about bi that emerge in the research material. bi challenges are then examined as possible results of the perceptions and beliefs through which the world of bi is interpreted and interacted with. this provides a broader view under which bi exchange – and the challenges experienced therein – may be understood. findings are based on a literature review – including extensive analysis of bi definitions – and a case study. the case study was conducted over a three and a half year period at one of south africa’s largest banks, referred to as fortune bank (fb) to protect its anonymity. fb and its bi vendors were involved in the case study. this paper’s principal contribution is identification of bi’s inherent g-d logic, providing the necessary first step towards exploring s-d logic as a new approach to overcome bi’s prevailing challenges. research on how bi is typically understood and the relationship between this understanding and the challenges experienced in bi are further contributions. finally, another contribution is the unique application of s-d logic to bi within the realm of information systems (is) research. this paper’s research questions are: 1) how is bi understood/perceived? 2) is the way bi is understood grounded in g-d or s-d logic? 3) can bi challenges be linked to g-d logic or the way bi is understood? 2 literature review 2.1 literature review methodology a systematic literature review was conducted iteratively over four years, with the bulk of the review being completed in 2012. steps based on vom brocke, simons, niehaves, riemer, cleven and plattfaut (2009) were executed to advance knowledge on bi and s-d logic and to identify gaps in the existing body of knowledge presenting research opportunities (henning, van rensburg & smit, 2004). steps included: 1) define scope 2) conceptualise the topic 3) gather literature 4) analyse and synthesise literature 5) compile literature review. the literature review was then used as a foundation for the case study, which is detailed in section 3 of this paper. literature from south african and international academic and practitioner sources was reviewed to gain representative coverage of current and historical as well as conceptual and practical research on bi and sd logic. webster and watson’s (2002) guidelines to identify research material by sourcing material cited in primary material (backwards) and material that cites the primary material (forwards) were followed to gather literature. findings were summarised and categorised using keywords to facilitate identification of relationships, trends and discord in gathered material and to facilitate comparison with case study findings. to analyse literature on bi perceptions, the approach taken by payne and frow (2005) was applied. payne and frow analyse customer relationship management (crm) definitions to understand perceptions of crm. this entailed collation of bi definitions followed by analysis thereof. 70 bi definitions – reflective of academic/ practitioner and south african/global literature spanning from 1986 to 2012 – were selected for analysis based on the definition’s relevance and the source’s academic or professional credibility. analysis was performed by summarising and categorising keywords to flag patterns and discord that emerged in the data that was gathered. in addition to payne and frow’s approach, discourse on bi definitions (e.g. from ackerman, 2005; herschel, 2011; pirttimäki, 2007) was analysed in the same way. the literature review as a whole was refreshed in 2013 to confirm current relevance. the 2013 review was performed through research of a representative sample rather than a repeat of previous in-depth reviews. 222 sajems ns 17 (2014) no 2:220-231 2.2 bi expectations versus bi success bi is consistently ranked as a top business priority in global gartner surveys (hočevar & jaklič, 2010) and is identified as the most essential technology for the organisation to purchase (chuah & wong, 2011) resulting from the benefits the organisation is described to gain after purchasing a bi solution. nearly 90 per cent of organisations across the world have implemented a bi capability, with bi seeing a global spend of around usd$60 billion annually (coulonval, curitz & finkelstein, 2010). south african banks, in particular, are reported to have invested significantly in bi after realising its importance for strategic and tactical decision-making (vanmare, 2006). this sustained intense investment in bi should indicate that investors (organisations) are receiving benefits from their investment. instead, there are reports that bi return on investment (roi) is difficult to measure (vanmare, 2006) and still further reports of major bi challenges and failures. in south africa, financial institutions struggle to realise value from their bi investments due to challenges in unlocking actionable bi for decision-making (ackerman, 2005). in fact, over 50 per cent of bi projects are reported to fail worldwide (atre, 2011; lavalle, hopkins, lesser, shockley & kruschwitz, 2010). 2.3 bi challenges and existing approaches to overcome bi challenges the word “challenge” may be understood as: a new or difficult task that tests ability and skill (e.g. “schools must meet the challenge of new technology”, i.e. “deal with it successfully”) or; to question a statement/action or; an invitation to enter a competition, fight, etc. (hornby, 2005). the understanding presented in the first definition is applicable to bi challenges as discussed in this paper. furthermore, a literature review of bi challenges (clavier, lotriet & van loggerenberg, 2012) establishes that bi challenges are seen as difficulties experienced within or impacting on the bi environment that, if overcome, contribute towards achieving successful use of bi. previous research (clavier, 2012) discusses and categorises bi challenges and existing attempts to resolve them in a literature review. to build on rather than duplicate, only key findings are now repeated. key findings on bi challenges include: firstly, as a specialised type of is (berstein et al., 2011), bi faces many of the same challenges that iss do (e.g. absence of adequate sponsorship (hočevar & jaklič, 2010), in addition to specific bi challenges (e.g. bi is an ill-defined discipline in an ambiguous environment (ackerman, 2005; pirttimäki, 2007; herschel, 2011); secondly, while there are many ways in which bi challenges may be categorised, clear categories emerge consistently in academic and practitioner litera ture, namely: use, data, integration, alignment, personnel and skills, and sponsorship. while the importance of all these bi challenge categories is recognised, this paper focuses on “use” and “data” to enable greater depth within the bounds of the paper’s space constraints. these are incorporated in table 3 to enable a comparison of literature and case study findings. “use” and “data” are selected as, during the literature and case study review, it was discovered that much overlap exists between these categories, added to which, the case study resulted in a rich data set on these specific categories. it is the intention to followup on this paper in the future with subsequent papers that discuss the other challenge categories in similar depth. key findings on existing approaches to resolve bi challenges are that they: largely fail to consistently and comprehensively resolve bi challenges; do not focus on addressing bi’s prevailing challenges as they are not directly associated with challenges; tend to focus on bi up to the end of implementation of an it solution – neglecting use of bi or the full data life cycle; are typically restricted to the environmental and organisational parameters of designing a bi system. these key findings highlight the need for a new approach that overcomes existing approaches’ limitations. in response, this paper recommends taking a step back to first understand bi conceptually and then examining findings gained from this understanding using g-d and s-d logic. to understand bi conceptually, this paper examines how bi is perceived or understood, examining bi definitions and discourse on bi definitions. g-d and s-d logic are then applied. sajems ns 17 (2014) no 2:220-231 223 literature review sections that follow provide context for g-d and s-d logic, position bi in terms of g-d and s-d logic and then present literature review findings on how bi is perceived. 2.4 g-d and s-d logic g-d and s-d logic fit within the multidisciplinary research area of service science (maglio & spohrer, 2008). service science is supported by s-d logic as a philosophical foundation, service systems theory as a theoretical foundation and practical developments such as service management and service computing among others (maglio & spohrer, 2008). vargo and lusch’s ground-breaking sd logic paper (2004a) put s-d logic in the spotlight, attracting much dialogue (randall, 2007). since then, there have been at least six s-d logic focused conferences, twelve s-d logic special issues or journal sections, hundreds of papers and presentations grounded in s-d logic and thousands of citations and cross citations to s-d logic related work – from various disciplines and countries across the world (vargo, 2011; williams & aitken, 2011). this paper therefore unashamedly uses what has already been established in the philosophy of s-d logic as a point of departure. a brief introduction is now provided for the purpose of context for this paper. g-d and s-d logic are lenses or philosophies to view “exchange” (vargo, 2011). exchange is the act of giving and receiving (hornby, 2005), which also applies to economic or social acts of giving (e.g. selling, leasing) and receiving (e.g. buying, renting). exchange centres on relationships and interactions (schultz & gnoth, 2008) to give provider and customer (and others involved) access to resources that provide them with benefit (chandler & vargo, 2011). the traditional view of exchange – g-d logic – promotes value-in-exchange and a separation of producer and consumer (gummesson, 1995; vargo & lusch, 2006), it focuses on the product (including its embedded features), means, producer and production (vargo & lusch, 2006; edvardsson, ng, zhi min, firth & yi, 2011). g-d logic typically sees exchange as a linear series of activities of sourcing, producing and distributing tangible saleable goods, designed and built by a producer who embeds the goods with utility and value during the production and distribution processes with a consumer in mind vargo & lusch, 2004a; edvardsson et al., 2011). in cases where no tangible product is exchanged, e.g. having a haircut, attending a class or consulting with a lawyer, g-d logic refers to a service, where service is seen as unproductive and, although not useless, as failing to contribute to the creation of wealth (vargo, 2011; kowalkowski & ballantyne, 2009). further examples of g-d logic characteristics are tabulated in table 3, where they are used to show the inherent g-d logic that can be observed in bi. it may be argued that g-d logic is now a thing of the past as a result of postindustrialisation and the rise of the service sector (world bank, 2013). however, s-d logic is significantly broader than the traditional view of service (vargo & lusch, 2008) and, as will be demonstrated in this paper, g-d logic is not a thing of the past; there are profound implications of a g-d logic based mindset that can be seen within bi today (clavier, 2012). s-d logic questions g-d logic’s traditional views of service and recognises traditional service as “direct service” and goods as “indirect service” (kowalkowski & ballantyne, 2009). it recognises the service that is inherent in goods and, conversely to g-d logic, defines goods in terms of service. service is seen as the application of competences (skills and knowledge) through deeds, processes and performances for the benefit of another entity or the entity itself (vargo & lusch, 2004b). skills and knowledge are seen to be embedded in goods, where goods are the transport mechanism for distributing these skills and knowledge (vargo & lusch, 2004a). s-d logic’s central tenet is that service is the basis of all exchange (vargo & lusch, 2004a). it’s primary definition being that service is the application of competences for the benefit of another entity (vargo & lusch, 2004a). it sees exchange (including the exchange of goods) as a flow of service where customer and provider collaboratively interact with each other and other economic and social actors to co-create value, which is phenomenologically measured by the customer (and not upfront by the provider) (maglio & spohrer, 2013). s-d logic represents a shift from g-d logic to a focus on value in use, the customer, 224 sajems ns 17 (2014) no 2:220-231 the process, the intangible, the relationship and the doing (lusch & vargo, 2006). 2.5 bi as an exchange process in context of s-d logic exchange (and the lenses through which it is viewed) is directly applicable to organisations, employees, suppliers, customers and other stake holders (schultz & gnoth, 2008). extending this proposition, consider bi as an exchange process: essentially bi consists of a broad series of exchange activities performed by and using various resources (e.g. data, systems, various actors such as it, business, etc.) that are integrated and engage to ultimately provide actionable information and/or intelligence for use in decision-making (hočevar & jaklič, 2010). for example, at an abstract level, the various exchange processes that need to take place to transform raw data into useful information for insights and decision-making (duan & da xu, 2012). the bi provider processes data and information, delivering this (by means of implementing e.g. a bi report, tool or solution) to the bi customer, who is then expected to use what is delivered to analyse and gain insights and intelligence. understanding bi as an exchange process offers opportunities to understand the various relationships (e.g. bi customer and bi provider), their interactions and their perceptions and understanding of the end-to-end flow that takes place from when data is sourced until when it is used (in another form, e.g. intelligence). s-d logic is especially useful for complex and adaptive environments (lusch & webster, 2011) such as bi. s-d logic offers a multidimensional view of all of bi’s role players, resources, relationships and integration points. it views all social and economic actors as resource integrators (vargo & lusch, 2008), broadening the view that bi is all about technology (herschel, 2011). not only can bi be seen in the full context of its end-to-end flow of activities, but use of s-d logic offers the opportunity to understand the detail of the relationships, from the customer and relationship viewpoint, in context of the use or value that can potentially result from the interaction (vargo & lusch, 2008). 2.6 how bi is understood: perceptions of bi as described in the literature review methodology above, bi definitions and discourse on bi definitions were analysed to understand how bi is perceived (i.e. understood or comprehended) by academics and practitioners. such understanding leads to improved understanding of how to overcome bi’s challenges – as per heylighen’s (2000) research. heylighen (2000) establishes that a perception results in a set of beliefs through which the world is interpreted or interacted with, which results in challenges or opportunities that are created within a specific situation and context. four common perceptions consistently emerged in the literature review, described below in table 1 and shown again in table 3. while this list reflects just one subjective view that is based on the reality of the researcher and of the authors whose definitions and discourse were analysed, it serves its purpose as a basis for understanding how bi is perceived. examples of other perceptions that may be used to categorise bi are: strategic/ tactical; internal/external; detailed/broad; integrated/ specific; past/ future; etc. (pirttimäki, 2007). table 1 perceptions of bi common perceptions: bi is ... a technology that consists of one/a combination of components such as hardware, software, databases, etc. controlled, managed and governed by technical practices and methodologies a process that consists of activities to gather, process, analyse and distribute information, transforming data into information into intelligence. it refers to the “means” of bi a product, output, result or outcome representing meaningful and useful information that is actionable. it may be the outcome of the bi or another process (e.g. intelligence from an employee’s own personal knowledge) the capability to perform the bi process or to access and analyse information table 3, which follows in the discussion section of this paper to enable comparison of literature review and case study findings without duplication thereof, lists each perception with: 1) typical beliefs, 2) associated challenges and 3) inherent g-d logic characteristics. 1, 2 and 3 were also sajems ns 17 (2014) no 2:220-231 225 identified in the literature review and case study. as with the perceptions, table 3 reflects a subjective view that may be re-organised by another but serves its purpose as a basis for organising and synthesising the key findings of this research. typical beliefs and associated challenges are linked to bi perception based on the principal focus of the belief/ challenge and whether this can be logically categorised as technology, process, product or capability. table 3’s associated challenges (2) and inherent g-d logic characteristics (3) are introduced in literature review sections above. it is now necessary to introduce table 3’s typical beliefs (3). “belief” is linked to perception based on heylighen’s research, which identifies that particular beliefs (i.e. opinions or convictions) result from understanding (perceiving) something in a particular way. as an example, consider the belief that the earth is flat as a result of a particular understanding (perception) of astronomy. further examples (aligned with this paper’s topic) are reflected in table 3. 3 case study methodology a three and a half year case study was conducted within one of fortune bank’s bi departments to gain understanding of fb’s perceptions of bi, the associated beliefs held about bi and its bi successes, failures and challenges. data gathering was qualitative and interpretive. techniques included observation, interviews and questionnaires. questionnaire and interview questions are reflected in table 2. the researcher observed the bi environment, including bi initiatives (strategic and project) and bi operations, as a full time employee of the bi department. the researcher did this in various roles on core bi projects and operational work. this provided a comprehensive view of the bi department’s relationships and the behaviour between various human and technological entities through its bi processes, documentation and activities. semi-structured interviews were held with 14 senior staff members, each ranging between one to two hours in duration. interviewees were selected based on involvement in a core bi initiative and ability to offer insight based on experience in bi or a related discipline (e.g. mis, decision-support). interviewees were involved as bi providers (from the bi department) or bi customers (e.g. users as clients of the bi depart ment, employed in another of fb’s departments). at the time of the case study, fb was conducting a request for proposal (rfp) to identify a vendor to partner with them to assist them to move one of its bi departments up a few maturity levels to become a business intelligence competence centre (bicc). the rfp process was seen as a research opportunity to take advantage of, as the rfp responses provided a direct vendor perception of bi. fb identified vendors to distribute the rfp based on gartner’s 2008 bi magic quadrant diagram (richardson, schlegel, hostmann & mcmurchy, 2009). the bi department’s senior management team considered this to be representative of bi vendors active in the south african bi market. eight out of 36 vendors responded to the rfp. the bi department considered this to be a good response based on the fact that not all of the vendors approached specialised directly in bi and many had a purely technology focus and were therefore unable to assist from an organisational design and culture point of view, which the rfp called for. the following types of questions were asked: table 2 questionnaire (q) and interview (i) questions* q i define your organisation’s bi process. ✓ ✓ how do you define the term bi? ✓ ✓ what do you see as the components of bi? ✓ ✓ what are the main deliverables of bi? ✓ ✓ how do you use bi? what is its purpose? ✓ ✓ what challenges or failures have you experienced in bi? ✓ what challenges or failures do you consider to be bi challenges or failures? ✓ ✓ what have you done to overcome the challenges? did it work? ✓ ✓ *background questions aren’t reflected. only questions related to this paper are reflected, not all questions asked. 226 sajems ns 17 (2014) no 2:220-231 4 results 4.1 background and context research results consist of descriptions and narrations/diagrams in response to open-ended questions. responses were compared: between data sets (interviews/questionnaires/observations) and with the literature review. the comparative analysis identified specific themes, which were categorised and used to flag the data (electronic text and diagrams). data was analysed according to the core research questions, discussed in next sections. research results indicate, at the time of the interviews/rfp: • interviewees’ experience: two and half years’ to twenty eight years’ experience in banking/it. • interviewees were involved in strategic and operational bi work. strategic work typically being analysis, insight and bi project work. operational work being data collection, processing and maintenance. • two of the eight rfp respondents are local vendors with 50 people or less in their employ, established for five or fewer years. the remaining six rfp respondents operate locally and internationally, each with a surplus of 1,000 employees and over 21 years’ bi experience. 4.2 bi’s core challenges fb’s business intelligence core challenges were identified chiefly through interviews and observations, though rfp responses also provided input. direct and indirect questions were asked during interviews to identify challenges and compare fb’s challenges to those identified in the literature. the case study revealed that key challenges identified in the literature were also experienced at fb, to a greater or lesser extent. additional challenges that emerged in the case study are indicated in table 3 below, suffixed with o, i or v for observed, interviewee or vendor. the case study also highlighted that fb’s and its vendors’ attempts to overcome bi’s challenges are neither aimed directly at bi’s challenges, nor are they consistently successful: there is a need for a new approach. 4.3 how bi is understood: perceptions of bi and beliefs about bi the task of gaining insight on bi perceptions was approached by determining how bi is defined and contextualised. all respondents (interviewees and rfp respondents) were asked to define bi, describe the bi process, explain the purpose of bi and describe its components. the results obtained were fairly congruent with the literature review. technology, process and product perceptions emerged clearly but not that of bi as a capability or a department. the interviewees’ dominating perception is that bi is a product, while only one vendor defined bi in this way. vendors defined bi predominantly as a technology (63 per cent), with limited definitions of bi as a process and technology (1) and as a process (1). beliefs that emerged in the interviews, through observation and those inferenced through the rfp responses are indicated in table 3. 5 discussion 5.1 literature review and case study findings key findings are summarised below in table 3. typical beliefs are linked to challenges and g-d logic characteristics that can be observed in the belief/challenge. all are categorised according to whether the principal focus is technology, process, product or capability. examining table 3, it can be seen that g-d logic characteristics are inherent in the way bi is perceived and that they can be linked to bi challenges, specifically within categories of use and data. it is therefore proposed that a shift is made from g-d to s-d logic as an opportunity to explore new avenues to overcome bi’s prevailing challenges. sajems ns 17 (2014) no 2:220-231 227 table 3 bi’s perceptions resulting in challenges due to an underlying g-d logic associated challenge inherent g-d logic characteristic technology perception collect/process great volumes of data because technological capability exists (willcocks & whitely, 2009) (i, o) data overload leads to low use of bi(i, o, v) individuals cannot process massive amounts of data and information at speed at which technology generates it, resulting in “data deluge” or “analysis paralysis” (lavalle et al., 2010; davis et al., 2011) focus is on means and production: a manufacturing mindset (gummesson, 1995) bi use measured by number of licences sold (pendse, 2009) (o) inflated report of bi use leads to further unused purchases (white elephants) (o) it’s often assumed bi is used simply because it solution is implemented (ackerman, 2005; atre, 2011) vendors see value in exchange, not value in use (chesbrough & spohrer, 2006) decision-making will automatically be enabled through purchase of bi it solution (ackerman & wickens, 2001) (o) human decision-making processes neglected in favour of implementing bi/it solution: unwilling/unskilled decision-makers (i, o, v) typical user is trained only on it solution while they don’t know how to ask the right questions or make correct assumptions to use bi effectively (hopkins et al., 2010) value can be embedded in goods (gummesson,1998). value can be determined by provider alone (spohrer et al., 2008) process perception the bi process is completed with the output of a bi product (i, o, v). advanced feature-rich products are the key to competitiveness (pendse, 2009) (v) assume automatic use of bi solution upon implementation. thus, minimal effort to ensure use after support period (thus low use). neglect of human decision-making (i, o, v) users are often intimidated by bi system features or don’t understand data (structures/organisation) imposed by bi solution designers (lavalle et al., 2010; willcocks & whitely, 2009; pentaho, 2011) production seen as end of value chain (vargo & lusch, 2008). focus on the tangible (gummesson, 1995). activities/entities not equally acknowledged (lusch & vargo, 2005) bi is a repeatable, automated process(i, o, v) more time spent on automation activities than on human decisionmaking. data overload and unproductive bi effort (i, o, v) bi effort is unproductive as user experience is disorienting, frustrating, complicated and time-consuming (atre, 2011; popovič, turk & jaklič, 2010; pentaho, 2011) (lr) focus is on the means, production and producer (vargo & lusch, 2008) bi department is producer and decision-maker is consumer or bi vendor is producer and bi department consumer– i.e. separation, roles are never switched (i, o, v) separation leads to us versus them attitude. vendor and user don’t typically meet. bi decisions made sans business. bi product handed over unsuccessfully (i, o, v) bi users often have business focus while bi solution development has it focus (atre, 2011; popovič et al., 2010) producer/consumer separated and do not switch roles (vargo & lusch, 2008), thereby losing out on contextual knowledge of each other’s environments (chesbrough & spohrer, 2006) product perception bi product, representing the outcome of the bi process, is the focus of the exchange. existence of a bi product is a solution (o) human decision-making processes neglected, leads to low bi use due to bi users unskilled in decision-making processes/use of bi solution(o) goods exchanged for money, rather than services for services (lusch & vargo, 2006). value in exchange (not in use) (chesbrough & spohrer, 2006) 228 sajems ns 17 (2014) no 2:220-231 associated challenge inherent g-d logic characteristic dominant focus on data processing reduces time/capacity for use (popovič et al., 2010; lavalle et al., 2010) if the bi product (e.g. a report/data) exists, it will automatically be used instead of intuition/experience alone (davenport, cohen & jacobson, 2005) (o) users experience frustration using bi product imposed in their world. product may not fit in user world: bi is context dependent (o) providing bi that is relevant, timeous and valued by the user is difficult (coulonval et al., 2010) provider determines value. product created with a customer in mind (spohrer et al., 2008). operand resources are not enhanced by consumer after exchange (value destroyed in use) bi product such as knowledge or intelligence is automatically available through the outcome of the bi process (i, o, v) process to turn bi product into intelligence/knowledge for decisionmaker neglected. lower bi use due to misalignment. bi is context dependent (o) a gap exists between the bi system and human decision making that bi system doesn’t close (todd, 2009; green, 2007) value can be determined upfront and embedded during production by provider (gummesson, 1998). value is not personal, experiential, contextual or meaning-laden (vargo, 2009) capability perception bi users have the capability/know what to ask and what assumptions to make when using bi tools (green, 2007) (i,o) frustration leads to low bi use, bi credibility diminishes due to “wrong” answers (data often blamed and reworked) (hopkins et al., 2010) (i,o) value is obtained during exchange, therefore product’s use is not provider’s priority (chesbrough & spohrer, 2006) the average business user has the know-how or time to use bi tools (lavalle et al., 2010) (o) bi use is low, bi competence often lacking, misalignment between bi-itbusiness when bi or it thinks business should know technology (i,o) it’s difficult to change from making decisions based on intuition/personal knowledge to making them on bi facts (lavalle, 2010) value can be determined upfront by provider: it is not personal, experiential, contextual or meaning-laden (vargo, 2009) and can be embedded in product during production (gummesson, 1998) the ultimate goal of bi is the capability to make decisions, delivery of a bi product enables this capability (o, v) mere product implementation is insufficient to meet business requirements, resulting in low use. skills to use product undeveloped (i, o, v) training often focuses narrowly on how to use bi system, not on how to leverage underlying data (hp, 2009) value determined upfront during production by provider alone (spohrer et al., 2008). value can be created by provider or consumer alone (maglio, srinivasan, kreulen & spohrer, 2006) key: o, i, v, lr: sourced from observation, interviews or vendor responses or referenced if from the literature review 5.2 recommendation: a shift to s-d logic by shifting the perception of bi and the beliefs about bi to be grounded in s-d rather than gd logic, significant progress can be made towards overcoming many of bi’s prevailing challenges. while a lengthy discussion of this is justified, the scope of this paper extends only to highlight the potential of s-d logic. therefore only a few examples are provided herein, leaving potential for further research in this direction. consider the following examples of potential benefits of applying s-d logic: • by shifting the focus from value-inexchange to value-in-use (vargo & lusch, 2008), bi providers may consider allocating more capacity to activities involving bi use than bi production. e.g. assisting customers to understand and use the bi delivered, focusing on human decision-making rather than just implementation of a bi product/ solution. this can potentially also alleviate challenges experienced by bi customers in terms of data overload. bi providers may also measure use differently and not according to the number of licences sold, thereby getting a more accurate view that facilitates improvements in use of bi, where the bi customer needs to actively participate to co-create value or benefit. sajems ns 17 (2014) no 2:220-231 229 • by shifting from a focus on the means, production and producer (vargo & lusch, 2008) to a balanced focus on both production and use, less time can be spent on automation activities versus human decision-making activities. this can also bring the bi customer and bi provider together: both become responsible to cocreate value and use the bi that is delivered. this shift entails that the bi provider realises he/she cannot determine the value upfront (gummesson, 1998) but has to work closely with the bi customer to realise benefit and cannot impose a bi solution on a bi customer. simultaneously, the bi customer realises that participation is necessary, he/she is no longer the “passive recipient” (vargo & lusch, 2008). 6 conclusion this paper starts by establishing that although expectations of bi success are high, there are many failures and challenges reported on for bi and that – due to largely unsuccessful results of existing approaches – a new approach is needed to overcome bi challenges. as g-d and s-d logic are used as lenses through which to examine bi in this research, an explanation of g-d and s-d logic is then provided. this is followed by an explanation of bi as an exchange process, where it is placed in context of s-d logic. with this supporting foundation established, the paper then answers the research questions based on findings from the literature review and case study. “how is bi understood/perceived?” is answered in two ways. firstly, through identification of four core perceptions of bi, namely: bi as a technology, process, product and/or capability. secondly, through identification of beliefs held about bi – these provide additional insight into the understanding of bi and can be seen as the result of perceiving bi in a specific way. in turn, the understanding of bi as one or more perception linked to specific beliefs, results in the occurrence of specific bi challenges or opportunities (heylighen, 2000). “is the way bi is understood grounded in g-d or s-d logic?” and “can bi challenges be linked to g-d logic or the way bi is understood?” are both answered through the linkage of g-d logic characteristics to bi perceptions and beliefs as well as bi challenges, tabulated in table 3. this paper concludes by recommending a shift to s-d logic, briefly describing examples of the benefit that this will bring about for bi in terms of overcoming challenges that can be linked to an inherent g-d logic in bi. this research provides a necessary first step of identifying the inherent g-d logic in bi. it is the intention of the authors to release further papers detailing how s-d logic can be applied to bi and how the shift from g-d to s-d logic can be made. in addition, this research focuses on bi challenges. future research is therefore suggested to examine bi successes in terms of s-d logic in a similar way or using this research as a basis. finally, as this paper focuses on bi challenges in categories of “use” 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accepted: 28 may 2020; published: 25 aug. 2020 copyright: © 2020. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: academic literature has documented the benefits of technology for the tourism business. however, the influence of the fourth industrial revolution environment on the destination reputation, pre-visit experience, visit intentions and how these affect tourists’ satisfaction and loyalty intentions have not received much attention, especially within the african context. aim: the purpose of this study was to empirically test the effect of this environment on all these variables. setting: this study is one of the few empirical types of research conducted in an urban tourism destination centre in a south african context. methods: the study employed a positivist quantitative research methodology. primary data (n = 235) were collected from tourists who visited the vilakazi street precinct during october–november 2019, using the convenient probability sampling approach. for analysis, the study employed structural equation modelling. results: there are positive relationships between the fourth industrial revolution environment and the online reputation and the pre-visit experience. these, in turn, have a positive effect on the intention to visit the precinct, which affects the tourists’ feelings of satisfaction after actually visiting the centre. satisfaction has a positive impact on their loyalty intentions. conclusion: the findings create a space for future research by providing another framework for investigating the usefulness of new technology in the tourism industry, which can also extend to other industries. for managers, the findings can help in the creation of online advertisement strategies, online reputation management and online pre-visit experience enhancement. keywords: fourth industrial revolution; reputation; pre-visit experience; visit intention; satisfaction; loyalty. introduction tourism remains the main source of foreign exchange and a core industry for many countries (watkins et al. 2018), and this includes south africa (pandy & rogerson 2018). this industry offers potential for innovation and the expansion of the economy (biagi, brandano & lambiri 2015; nunkoo 2015). recent developments have led to the conclusion that technological progress and tourism go hand in hand (tussyadiah & sigala 2017), and that tourism markets shape and are shaped by technology (benoit et al. 2018). new technology dictates the strategy and competitiveness of tourism organisations (buhalis 2019), by providing unhindered access to consumers and tourism services, and by enhancing online transactions (ukpabi & karjaluoto 2016). presently, it is hard to decouple technology from tourism (tussyadiah et al. 2017; wang, xiang & fesenmaier 2014). the fourth industrial revolution (4ir, an era characterised by high technological advancement) is therefore expected to cause dramatic changes in this sector in the coming years (gül & gül 2018). law, buhalis, and cobanoglu (2014) indicate that travellers with more information and communication technology (ict) usage experience have greater repurchase intentions. new technological innovations create new possible ways of interacting to which the industry needs to adapt (gretzel & yoo 2013). they can dramatically affect the tourism industry (watkins et al. 2018) by, among others, increasing the range of possible choices (buhalis & law 2008; inversini, canfoni & de prieto 2014). for example: through online comments (josang, ismail & boyd 2007), a destination’s reputation can be enhanced or destroyed (komsic & dorcic 2014; watkins et al. 2018). this would influence tourists’ destination choices (harvey & groutsis 2015), and their intentions to visit or revisit (fu, cai & lehto 2016; kaplanidou & gibson 2010; ledesma, navarro & perez-rofriguez 2005). in addition, digital technology can give customers a virtual experience of their potential destination, which can also affect their choices (prasad & jha 2014). the ict will increasingly reduce costs, allow easy access to information for customers and allow service providers to be in direct contact with consumers (watkins et al. 2018). due to the 4ir environment, consumers have now become ‘prosumers’ (producers + consumers), informed content generators and sources of feedback to organisations, key elements to understand and manage tourism businesses (cid 2018). this relationship between tourism and technology can only grow exponentially, and the impact of the 4ir technology will be more severe on tourist centres’ reputation, pre-visit experience and travellers’ intention to visit (kim et al. 2018). all these aspects affect tourists’ satisfaction and loyalty intentions (swanson & su 2017). from this introduction, it is clear that the 4ir is increasingly becoming more important to the tourism industry. this is, in part, due to its’ potential to impact the online reputation of tourism destinations and to determine how people can virtually experience a tourist destination. the impact of the reputation and the pre-visit experience on the intention to visit an area, is well documented as will be shown below. what is not well established in literature is the extent to which the 4ir technologies affect a cultural tourist destination’s reputation and the virtual experiencing of the destination, and how the combined effect of these two can lead to visitors’ loyalty intentions. in light of the increasing influence of 4ir technologies and the potential of the tourism industry, developing countries should should understand the development and implication of technologies in this industry and implement it more aggressively. the present study uses the vilakazi street precinct because of its characteristics and historic importance to the south african struggle. vilakazi street is in a developing country, within a city with growing tourism (rodegerson & rodegrson 2017), where most johannesburg tourism takes place (kgagudi 2019), and with a growing number of international visitors (booyens 2010; booyens & rogerson 2019; rolfes, steinbrink & uhl 2009). tourists visit this precinct for its historic struggle attractions, such as the house of nelson mandela, the hector petersen museum and desmond tutu’s house (rodney-gumede 2019). in response to that, this precinct has been upgraded and expanded in a major way to include a vast array of shops, stalls and restaurants (booyens & rogerson 2019). the johannesburg development agency (jeda) has also designated the precinct as a centre for heritage tourism (rodney-gumede 2019). in view of the above, gaps in knowledge and its historic nature, vilakazi street in soweto provided an ideal setting for this study. problem statement and purpose of the study vargas-sánchez, plaza-mejia and porras-bueno (2009) state that there is a lack of knowledge about the tourism business in developing countries in the new 4ir environment (bahrin et al. 2016; jones & pimdee 2017). despite the increasing attention on investigating the relationships between technology and the tourism industry (see technology and tourism centres: chen & huang 2017; technology and tourists experiences: kharat et al. 2015; prasad & jha 2014; technology and customers’ behavioural intentions: chen & petrick 2015; kaplanidou & gibson 2010; li & petrick 2010), there has not been an interest in empirically investigating the relationship between the 4ir environment and the tourism industry, with reference to destination area reputation, pre-visit and post-visit evaluation, customer experience and tourists’ loyalty intentions. in consequence, there is a dearth of studies demonstrating these linkages in tourism literature (shakouri, yadzi & ghorchebigi 2019), and even more so for urban cultural tourist destinations areas (vargas-sánchez et al. 2009). secondly, numerous studies have shown the importance of the tourism industry in developing countries (dissanayake, asafu-adjaye, & mahadeva 2017; goffi, cucculelli, & masiero, 2019. for instance, tourism is the principal export for many developing countries (davison, harris, vogel & dixey 2005. however, there is also a lack of practical knowledge in the tourism business in these countries in the new environment (bahrin et al. 2016; jones & pimdee 2017). despite the plethora of research on the impact of the 4ir on economies and tourism, to the authors’ knowledge, there has not been any attempt to establish a generalisation about how the 4ir technologies impact the tourism industry, especially on cultural tourism centres like vilakazi street in soweto. given the importance of the 4ir and the tourism industry, and the dearth of literature dealing with international tourists’ decision-making processes when choosing a cultural tourist destination and the lack of insight in doing business given the importance of these two, an attempt to quantitatively investigate how the 4ir impacts this industry is a worthwhile academic pursuit. the present study isolates the 4ir environment, online reputation, technology-enabled virtual experience of the vilakazi street precinct, the intention to visit, tourists’ satisfaction and their loyalty intentions. this study contributes to knowledge by proposing and quantitatively testing a model that reveals the interrelatedness of these variables. this is important because it opens new avenues for further testing of these relationships in other cultural tourist centres. the study can also find application in management practice. practitioners who would like to use targeted advertisements and promotions for international tourists can use the insight from this study to increase visitor numbers. the rest of the article follows this order: hypotheses development, the methodology of the study, data analysis, hypotheses test results and discussion, implications of the study, limitations of the study and references. hypothesis development this subsection attempts to show how the 4ir links with vilakazi street’s online reputation and tourists’ pre-visit virtual experiences, both of which impact tourists’ intention to visit the precinct, their satisfaction level and their loyalty intentions. the 4ir and vilakazi street reputation the major distinguishing factors of the 4ir are rapid technological advances (syam & sharma 2018), increased digitisation (schwab 2016), and increased connectivity (chukurna & konak 2018). it is fast reshaping a new business environment (philbeck & davis 2018), and thus becoming a major economic issue (delfmann et al. 2018; tohanean & toma 2018). it is altering the competitive landscape by increasing the availability of substitute services (schwab 2016). as an illustration, in the tourism industry, this era has increased the range of possible choices of destinations (inversini, cantoni & de prieto 2014; komsic & dorcic 2016). for marketers, it has delivered tools to build better relationships with customers, and has led to social media marketing measures, which are a necessity to reach more customers effectively, reliably and efficiently (chary 2014). it is also generally accepted that the 4ir affects customer expectations, customer perceptions, customers’ intentions (cervellon & galipienza 2015; kwok & yu 2016; lillqvist & louhiala-salminen 2014) and, ultimately, affects their actual behaviour (schwab 2016). of interest to the present study, ict has given rise to online destination reputation (gössling, hall & andersson 2016), which also influences people’s choices (harvey & groutsis 2015). this concept (firm’s reputation) has received attention from marketing researchers (petersen & lemke 2016; vizcaíno-gonzález, iglesias-antelo & romero-castro 2019). for the tourism industry, destination reputation captures tourists’ beliefs about the quality and features of a destination (fu et al. 2016; kock et al. 2019), affects customers’ service choice, overall attitudes about services and trust, and influences their visit intentions (duygun & mentes 2015). destination reputation, therefore, has a big impact on tourists’ destination choices, visiting experiences and perceived value (fu et al. 2016). people share information about their experiences (cantallops & salvi 2014; chan & guillet 2011), and others refer to online reviews to obtain information on the quality of services provided by a tourism destination (casalo et al. 2015; zhu & zhang 2010). observational learning theory teaches us that people’s decisions are shaped by other people’s experiences (chen, wang & xie 2011; miklós-thal & zhang 2013). under the 4ir era, destination centres can develop both good and bad reputations without direct contact with customers. tourists’ generated content can confirm or refute the online reputation of tourist destinations (de moya & jain 2013). in line with harvey, groutsis and van den broek’s (2018) classification, reputation for the present study will mean that of vilakazi street in soweto, johannesburg, in south africa. competitiveness and reputation mutually influence each other (assaker et al. 2015; de moya & jain 2013). therefore, ict can affect the competitiveness of a destination by enhancing its online reputation: h1: the 4ir has a positive effect on vilakazi street precinct’s reputation. the fourth industrial revolution and vilakazi street tourists’ pre-visit virtual experience when customers, directly or indirectly, encounter a brand (alloza 2008; brakus, schmitt & zarantonello 2009), an experience that can affect their behaviour (prasad & jha 2014) is bound to happen (kumar, dash & purwar 2013). it can, for instance, lead to positive word of mouth (wom, khan & rahman 2015), and to an increase in consumers’ trust and willingness to use that brand (dolbec & chebat 2013). these impressions and behavioural responses can become a tool to attain a competitive advantage (clatworthy 2012). for that reason, marketers often attempt to influence them (kharat & kharat 2017; van der westhuizen 2018). in the 4ir environment, people can also encounter brands virtually (pantano 2015). digital technology can plunge people into a new world of real context (guerra, pinto & beato 2015). this 4ir-enabled virtual experience can generate emotions and social interactions (guerra et al. 2015), and elicit the same reactions and emotions as those felt during a real experience (garrozzino & bergamasco 2010). today people can experience the content with higher vividness and realism (bailey et al. 2015; hsu, tseng & kang 2018), which can stimulate a sense of presence in the real world, and thus facilitate the pre-purchase experience (gül & gül 2018). since services can also be experienced pre-consumption (kharat & kharat 2017), impressions about them can also be formed pre-purchase (ismail, 2010): h2: there is a positive relationship between the 4ir and the pre-purchase experiences of vilakazi street visitors. vilakazi street’s online reputation and tourists’ intention to visit behavioural intentions are intentions to visit or revisit vilakazi street, recommend vilakazi street to friends or others, and say positive things about it and the services it offers (kiatkawsin & han 2017; kim et al. 2018; lo & wu 2014; loureiro et al. 2013). the 4ir can act as both an inspiration and an enabler for tourists (moeketsi 2019). law, buhalis and cobanoglu (2014) state that travellers who use more information and communication technology have greater purchase intentions, and their online review and subjective experience could affect visits by other people to a destination (assaker & mueller 2015). in that way, a destination’s online reputation can influence tourists’ future visit decisions, the intention to further spread positive e-wom (chen & petrick 2015; li & petrick 2010), and, ultimately, enhance their loyalty (chen & petrick 2015; oliver 2010). kim et al. (2018) affirm the same in stating that a destination’s positive reputation has a positive effect on intentions to revisit. studies have shown that there exists a significant relationship between the reputation of a tourism destination centre, tourists’ decision-making (altunel & kocak 2017; suhartanto et al. 2018) and their behavioural intentions (such as initiating a visit or revisit) (kaplanidou & gibson 2010; oliver 2010). in addition, these intentions can be used as a predictor of future consumption behaviour (jin, lee & lee 2013; kim 2018; lai & chen 2011). thus, in association with the literature cited above, this study posits the following hypothesis: h3: the online reputation of vilakazi street in soweto has a positive effect on tourists’ intention to visit. pre-visit virtual experience and intention to actually visit future changes in the tourism market will be under the strong influence of new technologies (petkovic, pindzo & agic-molnar 2018). this technology will increasingly play a significant role for both consumers and service providers (gül & gül 2019; opara & onyije 2013). in the tourism industry, tourists’ visit or purchase intention (pi) is the most vital aspect (tsiotsou 2006), because it shows the probability, willingness and likelihood to visit an establishment (rashid 2009), thus providing the best predictor of their planned behaviour (al-jubari, hassan & linan 2018). it includes consumers’ attitudes, and their motivations (chaniotakis, lymperopoulios & soureli 2010; shah, shahzd & ahmed 2012). further, pi also offers the likelihood to engage in positive wom, and a willingness to pay more for services (hau et al. 2009; zainor & mohd 2018). however, tourists’ visit choices involve subjective judgment about destination areas (blackwell, miniard & engel 2001). consumer behaviour studies show that tourists aim to maximise their utility by choosing an option that best meets their individual travel and vacation needs (kock, josiassen & assaf 2016; prayag & ryan 2012). in the absence of real physical experience, the destination’s online presence can influence their choices and visit intentions. rodrigez-diaz and espino-rodriguez (2018) state that recommendations by friends can be a good variable for perceived value. tourists can vicariously assess the destination using technology (fombrun 2012; walker 2010). online positive or negative messages about a tourism centre can be a proxy for judging their likely experience , should they visit the destination. therefore, technology can determine tourists’ mobility decisions: h4: there is a positive relationship between the online virtual experience of vilakazi street and tourists’ intention to visit the precinct. intention to visit vilakazi street precinct and service satisfaction perception satisfaction represents a positive consumer or tourist feeling towards a brand or a destination; therefore, from a psychological perspective, consumer or tourist engagement has a positive effect on satisfaction (bryce et al. 2015; zhou, zhang & edelheim 2013). moreover, loyalty represents the willingness of consumers or tourists to re-buy or revisit a brand product or destination consistently (so et al. 2016). consumer or tourist engagement demonstrates deep commitment to and connection with the brand or destination, which can enhance the consumer or tourist’s feelings and behaviours (hollebeek 2011; so et al. 2014). an engaged tourist with a destination develops a more favourable attitude, and is, therefore, expected to be more interested to revisit and be more loyal towards a destination (brodie et al. 2012). understanding customer perceptions is crucial to attracting customers to purchase (millar & baloglu 2008): h5: there is a positive relationship between tourists’ technology-enabled intention to visit and their satisfaction or dissatisfaction. satisfaction perception and loyalty to vilakazi street precinct customer satisfaction is the customers’ service interaction-related pleasurable response, based on a comparison of the service outcomes and a reference standard (lechner & paul 2019; oliver 2010). customers’ encounter with a service can either lead to satisfaction or dissatisfaction (hulsheger & schewe 2011; lechner & paul 2017). in turn, perceived satisfaction also influences purchase intention (jaafar, lalp & mohamed 2013). people who are dissatisfied with the service would be disloyal (millar & baloglu 2008). further, customer satisfaction has a positive effect on customer retention and profitability (gupta & zeithaml 2006), which is also the strongest predictor of repeat purchases (hussain 2017). su et al. (2016) identify strong links between service quality, customer satisfaction and customer-company identification, which positively influences repurchase intention. it can, therefore, be concluded that service quality directly influences satisfaction (han & hyun 2018) and behavioural intentions (su et al. 2016). consequently, this study hypothesises that: h6: there is a positive relationship between customer experiences at vilakazi street and their loyalty intentions. the hypotheses (h1-h6) are represented in the form of a conceptual framework in figure 1. figure 1: proposed model. methodology the target population for the study was all guests to the vilakazi street precinct during the months of october and november 2019. the study followed a positivist approach and utilised the survey methodology for data collection. this approach is recommended for its efficiency (moreira, fortes & santiago 2017), objectivity and ease of generalisability (mccusker & gunaydin 2015). due to the impossibility of obtaining a sampling frame, the authors followed a non-probability sampling method. two trained field researchers assisted in the completion of the survey questionnaires by intercepting visitors at vilakazi street over the designated period. measurement scale, data collection and ethical considerations the survey used originally designed questionnaires after an extensive literature review (ashrafi & mueller 2015; huang 2003). measurement items were selected and context-adapted to suit the present study purpose and to ensure the validity and reliability of the measures. six constructs were included, and all the survey questions measured these constructs. to minimise measurement errors, the researchers utilised multi-item measures for each construct (churchill 1979). all scale items were scored on a five-point likert scale ranging from 1 to 5, with 1 = strongly disagree, 2 = disagree, 3 = neutral, 4 = agree and 5 = strongly agree. for the list of the constructs, operational definitions and the sources they were adapted from, see table 1. questionnaire development was in english, as participants were assumed to be english literate. the total number of items in the questionnaires was 37 (see addendum). table 1: variables, operational definitions and sources. to minimise possible bias due to interviewer-participant interaction, participants were told that their partaking is voluntary and anonymous and they were encouraged to state their own personal opinion as truthfully as possible, in accordance with proper academic practice (podsakoff et al. 2003). to mitigate the biasing effect of the research instrument, the questions asked were simple, specific and concise (hulland, baumgartner & smith 2018). different variables measuring disparate items were separated across the survey (tang et al. 2018). further, the cover letter was structured in a way to make it appear that the measurement of the predictor variables is not related to outcome variables. the researchers also avoided the use of words with many meanings, in line with scholarly recommendations (podsakoff et al. 2003). throughout the project, the researchers maintained high standards of values and norms. they obtained permission from the major businesses in the area before data gathering could commence. no data were collected to identify individual participants, and no incentives were offered that could possibly encourage their participation. issues that might have affected the number of positive responses are the trust level between tourists and research assistants, the costs (in terms of time) and the nature of the research instrument (physical paper-based) (koundinya et al. 2016). also, there were no possibilities for using reminders to complete the questionnaires after contact sessions (bosnjak et al. 2008; saleh & bista 2017). respondents’ profile the target number of participants was 400. however, a sample size of 235 was achieved, representing a 59% response rate. this sample size was deemed sufficient after taking into account the analysis method applied in the study. the number satisfies the recommended figure required for smartpls analysis purposes, and it provides more than sufficient (a minimum of 200) statistical power for analysis (hoe 2008). table 2 summarises the profile of the participants. the majority of participants were male, as evidenced by the 52.8% representation. from the table, it is clear that the people who visited the vilakazi street precinct were mostly the aged and highly educated individuals (about 50% of them with master’s degrees). this has a bearing on how to target this segment and to tailor the advertisement messages. the income levels also show that the average visitor is a high net worth individual. unfortunately, a large number of them preferred not to state their income levels. many also chose not to state the amounts they spend on tourism. table 2: respondents’ profiles. data analysis this study applied partial least squares structural equation modelling (pls-sem) for data analysis, due to its numerous advantages over other approaches. the sem approach can include latent constructs in the analysis while accounting for measurement errors in the estimation process (ledermann & kenny 2017) and, most importantly, it provides support for examining and validating hypotheses of causal relationships due to its ability to do away with bias and distortion (avkiran 2018; naor & punj 2015). in particular, pls-sem is a more appropriate approach for complicated models or multi-group analysis than traditional sem based on covariance (hair et al. 2012). smart pls 3.2.6 was applied to analyse both the measurement and the structural models (kim et al. 2018; ringle, wende & becker 2015), in accordance with gerber’s two-step approach (zhaoa, xub & wang 2019). confirmatory factor analysis (cfa) and path analysis were performed simultaneously (davari & rezazadeh 2015). since cfa allows the researcher to test the hypothesis that a relationship exists between the observed variables and the underlying constructs (suhr 2006), it, therefore, evaluates the measurement model’s reliability and validity (how well the latent variables are measured by the observed variables) (li et al. 2016). path analysis is used to investigate the causal relationships among unobserved variables (chin 1998; mueser et al. 2017). the measurement model assessment the measurement model was first evaluated for reliability, convergent validity and discriminant validity as per scholarly recommendations (ashrafi & mueller 2015). cronbach’s alpha coefficients and composite reliability (cr) values formed the basis for testing the reliability of the measurements. diedenhofen and musch (2016) state that cronbach’s alpha values greater than 0.6 are reliable. however, other researchers use 0.7 as a cut-off value (cho, hong & hyun 2009). all the cronbach’s alpha values exceeded the recommended higher threshold value of 0.7 (4ir-env = 0.871; pre-exp = 0.906; tech-int = 0.875; reput = 0.891; sat-dis = 0.904; loyal = 0.848). a cr index greater than 0.7 is deemed acceptable (diedenhofen & musch 2016). from the results output, the lowest cr value was for loyalty (loyal) with a value of 0.850, while the highest cr was for satisfaction (sat-dis) with 0.900. high values for both cronbach’s alpha and cr (shown in table 3) mean that all the measurement instruments used in the study are reliable. table 3: cronbach’s alpha, composite reliability and average extracted values. factor loadings generated with linear structural relations (lisrel) were also used to calculate the average variance extracted (ave), the values used to check for convergent validity (fornell & larcker 1981; igbaria 1993). the ave values are expected to be greater than the acceptable threshold of 0.5 (hamouda & junoh 2018). in this model, the lowest ave is 0.5673, which satisfies the limitation. to check for discriminant validity, the researchers used the inter-construct correlation matrix as recommended (chinomona & preterms 2011). discriminant validity is proved when the value for correlation between variables is less than 1.0 (hox et al. 2017). table 4 indicates the inter-correction values for all the variables and they are all less than 1.0, hence confirming a good discriminant validity. table 4: inter-correlation matrix. structural model: model fit assessment after the reliability and validity checks of the measurement model, the next step was to assess the fit between the data and the proposed structural model. r-square values, t-values and factor loadings were used to assess the cfa model before using the model fit indices. according to hair et al. (2017) r-square should be greater than 0.25, t-statistics should be greater than 1.96 and the factor loadings should be greater than 0.5. the structural model fitness was assessed using the chi-square (χ2/df), the normed fit index, comparative fit index, incremental fit index, goodness of fit index, relative fit index and random measure of standard error approximation. table 5 provides the acceptable threshold values, values for the model and the decisions after comparisons. all the model fit indicators met the acceptable threshold and the data were considered to fit the conceptualised model. table 5: goodness of fit table. hypotheses testing results after model fit tests, the next step was to examine causal relationships among latent variables by path analysis (hair et al. 2017; henseler, hubona & ray 2016; lefcheck 2016). hypotheses are significant at a 95% or higher level (≥ 95%) (hair et al. 2010; hastie, tibshirani & friedman 2009). the t-statistics have to be greater than 1.96 for the proposed relationship to be acceptable. table 6 gives a summary of the outcomes and shows the hypotheses, t-statistics, path coefficients and the decisions taken on whether to accept or reject the hypothesis (shan et al. 2018). the path coefficients demonstrate the strength of the relationships between the dependent and the independent variables (hsu 2008). higher path coefficients indicate strong relationships among latent variables (chinomona et al. 2010). the outcomes of the analysis demonstrated that all six hypotheses postulated were significant with the lowest t-statistical value being 5.480. for the complete list, see table 6. table 6: hypotheses, path coefficients, t-statistics and outcomes. results discussion and their implications all six the proposed hypotheses for the study are statistically significant. individual path coefficients of h1, h2, h3, h4, h5 and h6 were 0.780, 0.870, 0.540, 0.400, 0.820 and 0.860. individually, the outcomes of the hypotheses testing reveal the following: h1: the positive relationship between the 4ir and vilakazi street precinct’s reputation reveals that the 4ir technology can actually lead people to experience the facilities before visiting. a positive reputation enhances the competitiveness of a destination and creates the demand for its services (komsic & dorcic 2016). h2: the results confirmed that technology can help people to experience a service before the actual service is rendered and enjoyed. the 4ir can create a demand for tourism services by providing travel information to tourists, and thus provide the vicarious experience of the destination (huang et al. 2016). participants confirmed that their online exposure to vilakazi street made them want to visit. rácz and zilizi (2019) also confirm that, prior to a visit, tourists can experience a destination visually. marasco et al. (2018) also concluded that online visual appeal has a positive significant effect on behavioural intentions. however, the outcomes conflict with another study conducted in spain (perles-ribes et al. 2019a), which did not find any significant relationship between technology and the pre-visit experience of tourism centres. these various conclusions of this study warrant further investigation, especially with regard to the possible circumstances surrounding their settings. h3: the results confirmed a significant positive relationship between technology-aided pre-visit reputation and the intention to visit vilakazi street. online consumers’ interaction with the vilakazi street precinct can affect visit intentions (law & ng 2016). this is in line with a recent study done on online reputation and its effect on people’s behavioural intentions (zhang et al. 2019). h4: the confirmation of the relationship between tourists’ virtual experience and their resultant intention to visit confirms that online reviews can affect consumers’ evaluation of services and their purchase intentions (forougjhi et al. 2019; liu et al. 2020). h5: the results confirmed the positive association between reputation and the virtual experience-inspired intention to visit and tourists’ post-visit experience. h6: the outcome for this association confirmed that people who came to the precinct were generally satisfied with what they experienced and that the experience positively affected their loyalty intentions. visitors to the precinct had a good experience and exhibited a commitment to revisit in the future (yi & la 2004) and preparedness to spread positive online recommendations (forougjhi et al. 2019). the outcomes confirm, albeit in different contexts (rasoolimanesh et al. 2019), several studies that investigated the consequences of tourist engagement, satisfaction and tourist loyalty (bryce et al. 2015; leckie, nyadzayo & johnson 2016; so et al. 2016). the 4ir technologies have fully immersed the tourism industry, and they are evolving all the time (pencarelli 2019). from the hypotheses outcomes, it is clear that the future of the tourism industry, especially cultural tourism, lies in the strategic adoption of these technologies. they can be harnessed to maximise their positive impacts on this industry (balasubramanian & rgavan 2019). implications of the study and its contribution to knowledge in this highly engaged and connected marketplace, tourists are increasingly turning to online communications to judge the quality of services before they visit. since the tourism product is intangible and cannot be pretested by the potential tourist before purchase, technology makes it possible to have a sense of the experience (ankomah & larson 2019). however, empirical studies demonstrating the linkages between technology and this industry are limited (shakouri et al. 2017). as one of the first empirical studies on the use of technology in a developing country’s urban tourism, we highlight the usefulness of technology in communicating with potential and actual visitors to destination centres. it, therefore, provides empirical evidence of the benefits of implementing 4ir technology in this industry (gretzel & yoo 2013). for academics, it adds to the tools for understanding the role of new technology in enhancing the interface between tourists and service providers. the proposed framework is theory-driven and therefore advances future academic research work by tourism scholars. academics can test the model in other contexts and in industries that exhibit similarities with the tourism industry, especially those that use ict. it, therefore, contributes to the growing literature on services that entail the use of ict. for management practitioners, the study provides strategic knowledge and actionable techniques to increase both the volume and profitability of tourists, and to lock out competition through technology. it also provides actionable guidance to managers concerned with online reputation management, online review solicitation and the combating of negative e-wom. further, organisations can use the results of this study to decide what information to display in their online advertisements and marketing. for vilakazi street businesses, it will help them to identify structural impediments to the full utilisation of their tourism assets and facilities. the policy implications of this study’s findings would be relevant to other tourism centres in developing countries where historic considerations play an important role. limitations of the study our research raises several questions for future research to explore the centrality of novel technology in industries. although the models and data utilised are rich and robust in many ways, our analysis does have its limitations. like many others before us, this research used data from one destination centre, in one industry. as such, future investigations could very easily adapt the proposed framework to different contexts and conduct a cross-industry study on the effect of the 4ir technologies on customer loyalty. in addition, this study used self-reported questionnaires for data collection, and this can lead to biased regression coefficients (antonakis et al. 2010). the other limiting factor of this study is the number of participants, which can render it ungeneralisable. lastly, since the participants were people who visited the centre over a designated period, the possibilities of follow-up studies are much more limited. acknowledgements competing interests the authors have declared that no competing interest exists. authors’ contributions all authors contributed equally to this work. ethical consideration ethical clearance for the study was issued from the university of the witwatersrand’s ethics committee, hrecnm20-02-042, and the protocol number is h20/03/14. funding information it is a self-funded project, no external funding requested. data availability statement data used 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assigned to the tribunal, coupled with inquisitorial nature of the tribunal’s hearings, means extensive interrogation of the analysis and arguments in competition cases in public sessions. this issue draws on papers prepared for and presented at the first annual conference on competition law, economics and policy. held on 21 may 2007, this conference was organised and sponsored by the competition commission, the competition tribunal and the mandela institute, located at the school of law, university of the witwatersrand, johannesburg. the selected papers span the legal and the economic disciplines, reflecting the fact that an important factor in the dynamism of this area of scholarship is the confluence of law and economics. the papers collectively examine a number of the legal tests of economic concepts that are at the heart of the application of competition law, and relate to its main areas: merger evaluation, coordinated conduct (collusion), and abuse of a dominant position. mergers the very essence of a merger, as captured in the competition act, is a change in control. however, the application of this concept to a multitude of possible types of transactions raises important questions. ngcongo, dingley, farlam and marwell examine a situation where a firm extends finance in return for non-voting preference shares amounting to a majority ownership stake. as they note, the position taken by the tribunal that non-voting preference shares can confer control under the competition act has serious ramifications (and may be out of step with the commission). it may jeopardise the ability of companies to raise funding by issuing non-voting preference shares, potentially chilling certain other types of transactions and business activity in addition to non-voting preference shares. they ask how – keeping within the competition act – regulation can minimise any potential costs of adopting a broad interpretation of the jurisdictional and threshold tests for review of notifiable mergers while avoiding establishing such a stringent framework that too few transactions are reviewed. charter addresses the related issue of how to treat cross-holdings and cross-directorships in a merger context. an acquisition of a minority equity stake by one firm in a competitor potentially has unilateral effects in that it can reduce the incentives of the firms to compete. the incentive for a firm to increase prices is greater if some of the customers lost through the price increase move to the competitor firm in which there is a cross-holding. to the extent that some of the value of the business is regained through the cross-holding the incentives to increase prices are greater. common directors across competing firms raises questions of coordinated effects in that collusion requires an agreement or understanding, monitoring of firm behaviour and the ability to punish where there is deviation or ‘cheating’ by a market player from the collusive agreement. these issues have been highlighted by the tribunal in several decisions. nonetheless, in a given merger the analysis must still be undertaken to assess whether the merger strengthens the likelihood of coordination. charter reviews these questions with reference to several key cases, including the recent primedia – nail transaction through which primedia acquired a stake in kaya fm. vertical mergers, by definition, mean an extension of control across different levels of a chain of products or services rather than an 248 sajems ns 11 (2008) no 3 increase in the control by a company of the supply to any single market. the standards by which such mergers should be evaluated have been one of the areas of greatest contestation in south africa, as internationally. saggers reviews the balance between proand anti-competitive effects required in the evaluation of vertical mergers with reference to both a key ruling of the competition tribunal and the european commission’s guidelines on non-horizontal mergers issued in november 2007. he argues that the framework to be used is relatively clear, and that the south african authorities have followed it but that it requires detailed and in-depth analysis which means these cases pose major challenges to the authorities. theron highlights the importance of economic evidence through a case study of the demand forecasts for liquid fuel presented in the sasol-engen merger which was prohibited by the competition tribunal. this provides an important reality check, where the data used for the application of economic tests determine the outcomes, yet there maybe a high level of uncertainty and disagreement about the data, especially in mergers where by its nature the evaluation has a forward-looking dimension. coordination moodaliyar and weeks examine the south african supreme court of appeal’s decision on price fixing and its directive to the competition tribunal to characterise price fixing before determining whether the particular conduct complained of falls within the price fixing provisions of the competition act. moodaliyar and weeks explore the legal and economic rationale for characterisation, drawing from a number of cases in the united states which transformed the approach to applying a strict per se rule to price fixing cases. they analyse various methods and frameworks of characterisation which appear to closely match the directive given by the supreme court ruling. they argue that the preferred interpretation of 4(1)(b) of the act as well of the business of characterisation that the tribunal must now do should tend as much as possible towards a per se rule and thus towards limiting the information to be brought forward. abuse of dominance unilateral anti-competitive conduct can be distinguished as exclusionary or exploitative, with practices such as price discrimination and refusal to supply being exclusionary while excessive pricing is exploitative. hawthorne examines the different provisions dealing with possible exclusionary behaviour, along with provisions such as the prohibition on resale price maintenance which applies to all firms whether dominant or not. he argues that the tribunal’s rulings, and the tests set out in the act itself, do not adopt a consistent standard to the possible exclusion of competitors. specifically he argues that, where the provisions appear to be per se in nature, such as prohibiting a dominant firm from refusing to supply a customer, the tribunal has adopted an approach which requires demonstrating a protection or extension of market power on the part of the dominant firm. however, in cases where there is a rule of reason test specified in the act, such as price discrimination, the tribunal has, in practice, been harsher on the dominant firm and more favourable to small firms in not requiring anticompetitive harm to be demonstrated (although the main ruling on price discrimination was over-turned). interestingly, the tribunal’s excessive pricing ruling in harmony vs mittal steel also illustrates where exclusionary practices may reinforce the exploitative abuse. the tribunal identified the arrangements for the exclusive export channel as at the heart of the charging of monopoly prices in the local market in the presence of large net exports. as discussed by das nair, the excessive pricing charged by mittal was part of a complex set of pricing practices, based on segmenting the local market. this, together with mittal’s costs and the large net exports of steel products, formed the basis of the tests that das nair argues should be used for excessive pricing. while profits may in theory be an important part of the tests, in practice there are many pitfalls in using this as the basis for the evaluation. sajems ns 11 (2008) no 3 249 vertical mergers – the european guidelines on non-horizontal mergers and their relevance for south africa1 grant saggers2 cra international abstract there has been a long and heated debate in the world of antitrust about the likely effects of vertical integration on competition and welfare. the publication of the european commission’s guidelines on the assessment of non-horizontal mergers in november 2007 has again brought this debate into the spotlight. competition authorities find themselves faced with the complex task of balancing the potential pro-competitive efficiencies of these mergers against the concerns that, in some circumstances, vertically-integrated firms could use their presence at multiple levels of the production chain to strategically soften competition. this paper outlines the current thinking on vertical mergers as presented in the guidelines and examines, through an evaluation of a past competition tribunal decision, how the south african competition authorities have handled the complexities presented by vertical transactions. jel g34, l41 1 introduction how vertical mergers affect competition has been a contentious issue in the history of antitrust. prior to the 1970s, fears that a dominant firm would use integration along the production chain to foreclose competitors and leverage its market power saw courts and theorists treat vertical transactions with harsh and heavyhanded scepticism. the rise of the “efficiency” oriented chicago school in the 1970s, with its devastating critique of the prevailing foreclosure theories, brought a reversal in attitude. concerns that vertical mergers could be used to engineer anti-competitive outcomes were replaced by a presumption that firms engaging in vertical amalgamation could be doing so only with the noblest intentions of realising cost savings and pricing efficiencies that would ultimately enhance competition and welfare. for two decades vertical mergers enjoyed leniency in front of the courts3. however, the debate was not over. over the past twenty years, refinements in the thinking on the strategic interaction of competitors have seen game-theoretic models emerge in which foreclosure and collusion are, in certain situations, plausible motivations for vertical mergers. therefore, while vertical mergers in general may continue to be seen as procompetitive, for specific cases involving more concentrated markets the debate has reignited and has as much heat as ever. it is this quarrelsome past that makes the european commission’s publication of guidelines on the assessment of non-horizontal mergers in november 2007 so significant. the guidelines themselves are deceptively modest, presenting only the established, and least disputed, economic theories of how vertical (and conglomerate) mergers impact upon consumer welfare. however, their existence is a far bolder statement. their publication underlines the settlement and convergence of opinion on the likely competitive effects of vertical integration and the market structures 250 sajems ns 11 (2008) no 3 and dynamics that create them. further, their reach extends beyond europe. these guidelines offer an excellent overview of the ‘accepted’ theories and frameworks for analysis. they also offer greater clarity and accessibility than their american predecessor – the us nonhorizontal merger guidelines published in 1984. consequently, they will become an essential reference for antitrust practitioners and the business community both in europe and in lessdeveloped jurisdictions that look to the us and eu for ‘best practice’. the formation of south africa’s competition authority and its subsequent experience with vertical transactions came at a time when much of the modern thinking on vertical integration had begun to crystallise. the competition tribunal’s decisions in vertical cases have, therefore, drawn heavily on the post-chicago school arguments that form the foundations of the guidelines. consequently, the guidelines are highly relevant to the south african authorities to reinforce understanding, to lead future enforcement and with which to evaluate past experience. this paper will briefly introduce some of the key theoretical insights that are incorporated into the guidelines (where necessary augmenting these points with references from academic literature). section 2 will briefly profile the pro-competitive effects of vertical mergers, while section 3 will summarise the ways in which these concentrations can be used to harm competition. section 4 will highlight some of the challenges and complexities in evaluating vertical transactions through an examination of the south african competition tribunal’s mondi/kohler decision. section 5 draws together the conclusions of the paper. 2 the pro-competitive effects of vertical mergers vertical mergers offer substantial scope for the merging parties to reap efficiencies, which may ultimately translate into more lively competition in terms of prices and service for final consumers. when vertically-related producers operate independently, the market externalities created cause the production chain as a whole to operate sub-optimally, to the detriment of both the producers and consumers alike4. vertical integration allows the merged entity to internalise these externalities by aligning the profit-maximising incentives of producers at different levels of the production sequence. efficiencies and how they arise in vertical transactions are given only very brief treatment in the guidelines (in paragraphs 13, 14, 52-57). this is in no way a reflection on their importance or likelihood of occurring. it merely reflects the fact that the impassioned debates surrounding vertical mergers have focused on whether they can be used to strategically soften competition, rather than whether they yield efficiencies – it is accepted that they typically do. in the interests of balance and completeness, it is worth briefly developing the areas in which vertical integration is most likely to lead to efficiencies5. • improved coordination of production due to improved information flow and reduced uncertainty, vertically-integrated firms can realise cost savings through better coordination of their design, production and distribution processes. by bringing different levels ‘under the same roof’ the verticallyintegrated firms can enjoy more accurate production planning, more predictable supply (in terms of both quality of product and timing of delivery) of essential inputs and enhanced likelihood of product innovations due to a better synchronisation of research and development (r&d) spending. • the internalisation of double mark-ups the ‘double marginalisation problem’ is perhaps the most well-known example of an externality arising from vertical i n t e r d e p e n d e n c e ( a n d i s m e n t i o n e d explicitly in the guidelines, paragraph 13). when a firm chooses an output level and mark-up over costs, it does so to maximise its own profits. however, the firm’s own “selfish” profit-maximising behaviour affects the profit-maximisation decisions of the other firms in the vertical chain. ultimately, with both the upstream and the downstream firms adding their own sajems ns 11 (2008) no 3 251 margin, the final price faced by consumers is higher than the price that would have been set had both firms ‘jointly’ profitmaximised (acted as a single overarching monopolist) and chosen a single mark-up. further, the aggregated profits earned by the two vertically-separated firms would be lower than the overall profit earned by an overarching monopolist. therefore, vertical integration, through allowing firms to internalise the double mark-up externality, is beneficial both to consumers (as they now face one mark-up instead of two) and the merging firms (that now have greater overall profits). it is, however, important to note that the problem of double marginalisation does not always arise when firms are vertically separated (for example, there would be no double mark-up in the chain if the downstream market was perfectly competitive). further, the resolving of this problem is not dependent only on vertical mergers, but could also be solved with vertical restraints – for example, maximum resale price maintenance and quantity forcing agreements (motta, 2004). • avoiding opportunistic behaviour for two firms at different levels of the production sequence to have a successful business relationship, one firm may need to develop or purchase a specialised asset to provide a better service to the other. if, however, there are large sunk costs for one firm when making this relationship-specific investment then there is room for the other firm to act opportunistically and renegotiate the division of rents after the investment is made (joskow, 2003). expecting this defection, the investing firm’s ex ante incentive to invest in the specialised asset is weakened, leading to sub-optimal levels of relationship-specific assets. vertical integration would align the incentives of the two parties, thereby helping to overcome the underinvestment in relationshipspecific assets that may arise from fears of opportunistic behaviour. this would be to the benefit of the trading relationship and potentially the consumer as well. • avoiding free riding incentives to “free ride” may arise for firms (in either the upstream or downstream markets) when the benefits of an investment accrue not only to the investing firm, but also to competitors in its market (motta, 2004; joskow, 2003). assume, for example, that a manufacturer sells its product through two downstream distributors and needs these distributors to advertise the products to customers (which will boost the manufacturer’s sales). if, however, the benefits from this advertising accrue not only to the firm making the costly investment, but also to the other distributor (whether it invested or not), then each distributor has the incentive to not invest and rather to “free ride” on the other distributor’s effort. this leads to an under-provision of advertising from the point of view of the manufacturer and the end consumer. a vertical merger would help solve this problem as the manufacturer would now only sell through one downstream firm, ensuring that all benefits from the investment accrue only to its affiliate6. • lowering transaction costs the challenges of aligning incentives of trading partners may force a firm to draw up intricate contracts. the negotiation, drafting and enforcement of these complicated contracts will, however, significantly increase the firm’s transaction costs. by avoiding the need for elaborate and expensive contracts, vertical mergers can yield substantial efficiencies to firms by lowering transaction costs (joskow, 2003; williamson, 1971). it is evident that there are several ways in which vertical mergers can yield welfare enhancing efficiencies. the guidelines make it clear that these efficiencies must be “substantiated” and “verifiable”, and must be shown to benefit the consumer (paragraph 21 and 53). the merging parties must also show that the claimed efficiency gains are unique to the merger (i.e., that the costsavings could not have been achieved through another, less harmful method). the parties may be required to go some way to quantifying the magnitude of the merger-related cost-savings. 252 sajems ns 11 (2008) no 3 finally, it would need to be established that the post-merger market dynamics are conducive to seeing the claimed efficiencies being passed on to consumers. 3 the anticompetitive effects of vertical integration the amount of academic literature that has developed on the anticompetitive effects of vertical mergers is vast7. however, many of the results in this plethora of studies, while important from an academic perspective, are not illuminating for real-world antitrust enforcement as they rely too heavily on the idiosyncrasies of the models from which they are derived. the guidelines, therefore, look only at the arguments and conclusions that appear to transcend model specifics and have arisen frequently in practice. these are that vertical mergers can erode competition and welfare if the merging parties are able to foreclose their rivals’ access to inputs or customers (thereby raising their rivals’ costs or weakening their revenues), and if the merger improves the likelihood of collusion at some level of the production chain8. importantly, the guidelines begin with making it clear that “non-horizontal mergers pose no threat to effective competition unless the merged entity has a significant degree of market power (which does not necessarily amount to dominance) in at least one of the markets concerned” (paragraph 23). evidence of a significant degree of market power is a necessary, but not sufficient, condition for finding competitive harm from a vertical transaction. indeed, the guidelines go as far as to suggest that the european commission is unlikely to find fault with mergers that result in a merged entity with market share of less than 30 per cent or markets with herfindahl-hirschman index (hhi) concentration measures of below 20009. 3.1 foreclosure the guidelines define foreclosure as “any instance where actual or potential rivals’ access to supplies or markets is hampered or eliminated as a result of the merger, thereby reducing these companies’ ability and/or incentive to compete” (paragraph 18). through input and/or customer foreclosure the merged entity might raise the costs (or reduce the revenues) of nonintegrated competitors, thereby eroding rivals’ competitiveness and deterring potential entry, and leaving the merged entity with enhanced market power10. in assessing whether a proposed transaction is likely to result in anticompetitive foreclosure three questions must be asked (the answers to which are often intertwined): 1. does the merged entity have the ability to foreclose? 2. does the merged entity have the incentive to foreclose? 3. would foreclosure have a significant detrimental effect on competition? only if each of the above questions is answered in the affirmative would there be appreciable concerns about the vertical merger resulting in foreclosure. • input foreclosure the theory of input foreclosure posits that after a vertical merger the upstream division of the integrated firm may restrict sales of its output to non-integrated firms in the downstream market, preferring to trade with its own downstream division (“to selfdeal”). this foreclosure could take various forms, including: outright refusal to deal with rivals; restrictions on supplies (and raised prices) to downstream rivals; and, degradation of the quality of inputs sold to competitors. this places downstream rivals at a competitive disadvantage compared with the merged entity’s downstream division which can either grow its market share or enjoy its increased market power and stronger margins on its existing sales (riordan and salop, 1995). the vertically-integrated entity’s ability to foreclose depends on whether it has appreciable market power upstream after the merger (giving it the ability to influence upstream trading conditions and, therefore, sajems ns 11 (2008) no 3 253 downstream price and supply). the merged entity will have limited ability to raise the costs of downstream rivals if there exist strong buyers or the possibility for these foreclosed firms to substitute to alternative inputs – from either other suppliers or entrants. the guidelines note that input foreclosure raises competition concerns only if the foreclosed product is an important and irreplaceable input for the downstream market (being either a critical component or an input that has significant cost relative to the price of the downstream product). even if the merged entity can feasibly foreclose inputs, its incentive to do so will depend on the profitability of the strategy11. input foreclosure results in a trade-off between upstream profit losses (by reducing sales to non-integrated downstream firms the upstream division sacrifices the margin it would have earned on these sales) against the improved profitability of the downstream division12. the entity’s downstream profitability is enhanced by the degree to which its rivals’ costs are raised, and by factors that augment the downstream division’s ability to exert its newly-acquired market power (riordan & salop, 1995). for example, if the downstream final products are highly substitutable then the downstream firm can expect to capture a larger number of customers from its foreclosed rivals, making the incentive to foreclose greater. finally, with ability and incentive established, the vertical merger would raise anticompetitive input foreclosure concerns only if it were shown that this strategy would significantly harm competition and lead to an increase in prices to consumers. so, it would be necessary to assess whether there were rivals downstream that, in spite of the foreclosure, could credibly maintain competitive pricing (through deploying counterstrategies such as changing their product’s input mix or consummating their own vertical mergers). only if all three criteria are present – ability, incentive and substantial harm to competition – can input foreclosure be counted as an anticompetitive outcome of the merger. it is also important to remember that pro-competitive efficiencies stemming from the merger may counteract the negative impact of input foreclosure on competition. for example, the very features that make input foreclosure more likely – market power at both levels of the chain – enhance the likelihood that there will be appreciable pro-competitive gains from eliminating double marginalisation. • customer foreclosure a vertical merger may reduce the competitiveness of rival upstream suppliers if the merger removes an important customer from their customer base, as that buyer now deals only with its own upstream affiliate. the weakened ability of upstream firms to compete – through expansion or entry – may result in higher prices faced by non-integrated downstream firms13. this weakened position may also reduce their ability and incentive to invest in cost reduction, r&d and product quality (which could potentially force exit in the longer run). so, the merged entity benefits from softer competition upstream, and an improved position downstream as its rival input-buyers may face raised costs. customer foreclosure is of particular concern when after the merger there are few remaining downstream firms to which upstream rivals can sell. the guidelines suggest that customer foreclosure can be pursued “if there are significant economies of scale or scope in the input market” (paragraph 62). when economies of scale (or scope) are present, firms rely on increasing their production levels to achieve unit cost reductions and to become more efficient competitors. therefore, if a supplier’s sales fall due to being subject to customer foreclosure, it will move up its cost curve and become a weaker competitor. so, the likelihood of customer foreclosure is diminished if there exists a sufficiently large customer base, at present or in the future, able to turn to independent 254 sajems ns 11 (2008) no 3 suppliers. further, independent suppliers would not be harmed by foreclosure if they can continue to operate at efficient levels by finding alternative markets for their products without incurring appreciably higher costs. as with input foreclosure, even if the merged entity has the ability to foreclose upstream rivals, it will have the incentives to do so only if the profits resulting from its enhanced market share and market power outweigh the costs of no longer sourcing inputs from upstream suppliers. these costs are higher when the upstream division faces binding capacity constraints or is less efficient than its rivals. the incentive to foreclose would also be stronger the larger the downstream division, as it would then enjoy its increased downstream mark-up over a larger sales base. the likely impact on competition of this strategy would depend on the degree to which it augments the market power of the merged entity through disadvantaging rivals and obstructing entry14. factors that undermine the merged entity’s market power (for example, the threat of counterstrategies) would erode the probability of the merged firm engaging in customer foreclosure, and the strategy’s resulting harm on competition. 3.2 facilitating collusion coordination by competitors to restrict output and raise prices is the very antithesis of competition. collusive arrangements are, however, inherently unstable – while coordination brings handsome returns for the conspirators as a group, each individual participant has the selfish incentive to undercut its fellow members for its own even greater short-term gain. the sustainability of collusion is enhanced when each participant’s incentive to deviate is weakened (which occurs when the expected profitability of defection is limited by the threat of early detection and harsh punishment by other members). hence, a vertical merger raises concerns about “coordinated effects” if the market configurations and dynamics it creates make it simpler for the conspirators to reach a common understanding, give greater market transparency (making communication with, and monitoring of, other participants easier), allow participants to more accurately and viciously discipline defectors, and neutralise the threat of disruptive buyers or entrants jeopardising the arrangement. vertical mergers may make it easier to reach collusive agreement by enhancing the symmetry between players, reducing the number of participants in the market (through foreclosure) and/or removing a maverick player that has a history of undermining such agreements. the merger may also improve communication between the upstream (downstream) conspirators if the vertically-integrated firm’s division in the downstream (upstream) market is used as a conduit for exchanging sensitive information (this division can also be used to accurately monitor the behaviour of the other conspirators). however, to enhance the likelihood of collusion, and be of concern to competition authorities, the information exchanged must be “unique” to the merger, meaning that it could not have been gathered in the absence of the merger (riordan & salop, 1995). the prices gathered by the verticallyintegrated firm’s downstream division must also be “projectable” to the prices offered to other downstream firms. if the upstream firms sell products that are highly tailored to the buyer’s specifications, then the prices offered to the downstream division by other suppliers may not be comparable for the purposes of monitoring adherence. the projectability of information increases as the products offered by upstream firms become more homogeneous (riordan & salop, 1995). if a vertical merger has the effect of augmenting entry barriers (through a foreclosure strategy), then it aids collusion by reducing the likelihood that a collusive arrangement will be destabilised by entry into the market. further, the likelihood of upstream coordination may be enhanced if the merger eliminates a disruptive buyer in the downstream market. one mechanism through which vertical integration can aid upstream collusion is by weakening the incentives of non-integrated sajems ns 11 (2008) no 3 255 upstream rivals to cheat by reducing their number of potential downstream customers – these rivals would not be able to sell to the integrated firm’s downstream division during a cheating phase (this is called the ‘outlets effect’ by nocke & white, 2005). the magnitude of the ‘outlets effect’ increases with the size of the ‘outlet’ lost by the upstream rivals through the merger. the upstream rivals’ incentive to cheat is further diminished by the knowledge that the integrated firm can now punish them for upstream cheating by responding aggressively in the downstream market. however, this outlets effect is counteracted by the integrated firm potentially having a stronger incentive to cheat on the agreement. in a non-cooperative equilibrium the integrated firm is earning comparably higher profits than other upstream firms as it incorporates the profits earned by its downstream division. so, the integrated firm has comparatively less to lose than its rivals when they attempt to punish it. the “punishment effect” reduces the merged firm’s desire to sustain collusion, and this effect increases with the size of its downstream affiliate’s profits. while these two effects work against each other, nocke and white (2005: 32) use game-theoretic modelling to conclude that under fairly general assumptions “the outlets effect dominates the punishment effect, so that the vertical merger facilitates collusion [in the upstream market]”15. it is evident that vertical mergers can facilitate collusion. these instances may be of even greater concern to the authorities if the collusion eliminates the newly-integrated firm’s incentive to pass any cost savings or efficiencies resulting from the merger on to the consumer. in summary, vertical transactions involving parties with market power may under certain circumstances give the merged entity both the ability and incentive to engage in conduct that will be detrimental to competition, competitors and consumers. in these instances, the authorities must weigh these anticompetitive outcomes against the potential efficiencies identified and substantiated by the parties. 4 south africa’s experience with vertical mergers the balancing of the likely proand anticompetitive effects of vertical transactions is a complex task. for the south african competition authorities, however, additional factors make it even more arduous. on the one hand, the country’s small markets and history of economic isolation and state intervention have contributed to an economy in which many markets remain concentrated and insulated by entry barriers (kampel, 2004). as explained in the previous section, these types of market configuration are conducive to incumbent firms using vertical integration as a tool with which to protect or extend their market power. further, goals enshrined in the south african competition act 89 of 1998 to promote market access to smaller businesses and historicallydisadvantaged people mean that the authorities should be very cautious of actions by incumbents – like input and customer foreclosure – that could raise entry barriers and thereby slow economic transformation. on the other hand, vertical mergers could unlock much-needed efficiencies and cost savings for an economy in its developmental phase. since the inception of the competition act the south african competition authorities have handled a number of merger applications that have been vertical in nature or horizontal with vertical aspects. in these decisions the authorities have clearly embraced the postchicago view that vertical mergers can, in a subset of cases, harm competition. this position is stated in the tribunal’s schumann sasol/price’s daelite decision: …our analysis will proceed cognizant of, and in general sympathy with, the characteristically permissive approach taken by anti-trust to vertical mergers, indeed to vertical agreements generally. (paragraph 9) however, what the literature does clearly reveal is that, as with much of anti-trust adjudication, 256 sajems ns 11 (2008) no 3 t h e i m p a c t o f a v e r t i c a l m e r g e r o n competition is acutely sensitive to the facts of the case. at the level of general principle, it is fair to say that vertical mergers raise fewer competition concerns and generate larger pro-competitive gains than their horizontal counterparts. on the other hand, it may be credibly claimed that vertical transactions in which one or both of the parties dominate their respective markets are liable to raise greater anti-trust concerns than those involving firms with relatively small market shares. (paragraph 13) to give some insight into the methods used and complexities faced by the authorities in their evaluation of vertical mergers this section looks at one of the tribunal’s precedent-setting vertical merger decisions. 4.1 mondi/kohler16 in may 2002, the tribunal prohibited a proposed transaction in which mondi limited (‘mondi’), an international supplier of paper, board and timber products, would acquire a downstream customer – kohler cores and tubes (kc&t) – which used paper products in the manufacture of cores and tubes. the tribunal prohibited the merger because it was “likely to substantially prevent or lessen competition in both the upstream and downstream markets” through exclusionary foreclosure and through facilitating collusion (mondi/kohler tribunal: paragraph 100). the tribunal’s decision was later upheld by the competition appeal court. before examining the authorities’ arguments and conclusions in this case, it is necessary to introduce some background on the parties, markets and relationships involved. 4.1.1 factual background the tribunal defined the relevant downstream market to be the manufacture of heavy industrial cores and tubes – spirally-wound paper cylinders onto which products such as paper, board, textiles, steel and plastic are wrapped (mondi/ kohler tribunal: paragraph 16)17. heavy industrial cores must have a superior ‘crush strength’ – the ability to withstand the weight of the material coiled around them. this is important because, while the value of a tube is only a fraction of the value of the material wound onto it (for example, aluminium foil), if the tube collapses or crushes, the surrounding material is wasted as it cannot be easily unwound. cores manufacturers, therefore, purchased specialised core-board specifically designed to build up the wall thickness of the tubes. the relevant upstream market was defined as “that in which core-board is supplied to manufacturers of cores and tubes” (mondi/kohler tribunal: paragraph 39). in south africa, mondi and sappi each had shares of approximately forty per cent in this market, and formed “a long-standing duopoly spanning a significant number of markets within the broadly defined paper products market” (mondi/kohler tribunal: paragraph 27). the remaining small portion of the market comprised superior-quality specialpurpose board imported from europe and asia. within the core-board market, the local duopoly enjoyed substantial market power: • barriers to entry were high, as the duopoly controlled the local supply of raw materials needed for the production of paper and there were significant economies of scale when producing core-board. • downstream cores and tubes manufacturers had little countervailing buyer power because both mondi and sappi were themselves large consumers of the downstream market (they required tubes onto which to wind their paper products). if a downstream firm attempted to bargain or threatened to substitute away from the duopoly’s products, the members of the duopoly could move their custom to another firm. this would severely handicap the renegade firm. indeed, kc&t had previously attempted to import coreboard from indonesia, but as an extract of the kc&t divisional budget for 2001/02 (as cited in mondi/kohler tribunal: paragraph 77) revealed: “we had been importing raw materials at prices well below the local mills’ prices. however, the local mills represent 25 per cent of our turnover and mondi has taken business away from us as a result of the imports. as a result of this we have stopped importing raw materials and are working with mondi to gain more business”. sajems ns 11 (2008) no 3 257 • imported core-board placed little competitive constraint on the pricing of the local duopoly. imports from europe were very expensive due to their superior quality (and were used only in the most technically demanding cores and tubes). there did appear to be competitively priced, although potentially lower quality, core boards from less-developed countries (for example, indonesia). however, a number of factors prevented downstream firms accessing these. the most important of these factors was the duopoly’s threat to no longer buy cores from a firm that chose to import board. other factors included: tariffs (although these were scheduled to fall from 8 per cent to 2 per cent over the next two years), freight and storage costs, and the volatility of the exchange rate. the downstream market was concentrated and sheltered, as importing cores and tubes would not be viable due to prohibitively high freight costs. within the national market of heavyindustrial cores and tubes, mondi’s target, kc&t, was “overwhelmingly the most powerful firm”, with a market share of well over 50 per cent (dwarfing those of other competitors) (mondi/kohler tribunal: paragraph 27)18. substantial sunk costs in purchasing industryspecific machinery made entry into this market difficult. demand for high-quality industrial cores was price inelastic because the value of the core was only a fraction of the value of the material wound around it, meaning industrial consumers were willing to pay a premium for superior cores. despite these market power augmenting features (and a market hhi estimate of 2502), kc&t described the market as having “flat demand, excess capacity, mature technologies, [and] low returns” (mondi/kohler tribunal: paragraphs 38 and 61). in the production of heavy industrial cores and tubes, downstream firms predominantly used two types of core-board, ndicore (manufactured by mondi) and spiralwind (produced by sappi). ndicore, a strong board with exceptional crush strength, was the industry’s premier core-board, and was designed by mondi in 1996 specifically for use in the production of heavy industrial cores and tubes. ndicore was priced at approximately r3,723 per ton. ndicore accounted for only 12,000 tonnes of mondi cartonboard’s 130,000 tonnes of board production (at its springs mill) each year and was “a relatively low return part of the carton board business” (mondi/kohler tribunal: paragraph 11). the competitive product offered by sappi was less easy to tear than ndicore, but had lower crush strength. ndicore cost about 15 per cent more per ton than spiralwind, but offered a better yield, resulting in an effective price differential of approximately 8 per cent. at the time of the proposed merger, sappi was in the process of developing a higher ‘crush strength’ board to compete directly with the superior ndicore. this innovation was, however, expected to take another three years. both duopoly members also sold kraft paper (at prices of between r3,247 and r3,555 per ton), which was used to a limited extent in the manufacture of cores and tubes, but was not specifically designed for this purpose. the kraft paper produced by mondi and sappi was almost identical in terms of quality and price (mondi/kohler tribunal: paragraphs 12 and 94). l a s t l y , t h e r e h a d b e e n s o m e f u r t h e r developments in the markets at the time of the transaction. first, sappi had recently announced a policy to purchase only cores and tubes that used spiralwind. second, even though mondi’s acquisition of kc&t was not yet complete, mondi was already at an advanced stage of negotiations in a transaction that would dispose of one of kc&t’s three factories (a factory that before the merger supplied tubes predominantly to sappi) to another downstream firm (the name of the prospective buyer was kept confidential in the decision). 4.1.2 the tribunal’s reasons the tribunal noted that both levels of the chain had hhi figures in excess of 2000 with structural features that gave participants market power. the tribunal, therefore, concluded that the merger would cause harm to competition through: • aiding collusion between the two upstream suppliers. “we [the tribunal] are concerned that the transaction is the centrepiece of a 258 sajems ns 11 (2008) no 3 strategy designed to facilitate the flow of price and other competition sensitive information between mondi and sappi thus cementing the domestic duopoly, indeed cartelising a number of segments of the broad domestic paper manufacturing market” (mondi/kohler tribunal: paragraph 86). the tribunal noted that the transaction also removed the only buyer capable of upsetting collusion upstream. • input foreclosure. the tribunal was concerned that the merged entity would predominantly ‘self deal’ as a strategy to weaken downstream rivals by leaving non-integrated downstream firms dependent on sappi for core-board. sappi could then behave as a monopolist, lifting its prices and, in so doing, raising the costs of the merged entity’s downstream rivals. on this foreclosure concern alone, the transaction would have been prohibited. • customer foreclosure. kc&t was the only firm with the potential size to attract an international supplier of core-board. therefore, with the merger removing kc&t from a potential entrant’s customer base, entry into the upstream market would be blockaded. given these anticompetitive effects, and the parties’ failure to present satisfactory evidence of pro-competitive efficiency gains, the tribunal concluded that the transaction’s net effect on competition and welfare was negative and, consequently, that the merger be prohibited. 4.1.3 evaluation of decision the market dynamics and configurations were clearly conducive to anticompetitive harm emanating from the proposed transaction. however, some of the arguments underlying the ultimate prohibition appear incomplete and require more in-depth analysis and commentary. it is in this examination that the theories and frameworks outlined in the previous sections are useful. • facilitating collusion the core-board market, with its symmetric duopoly, stable market shares, high entry barriers, and mature technologies, was ideally suited to coordinated pricing. indeed, so well suited that, as the tribunal noted, there was “prima facie evidence that coordination is already the order of the day” as was evidenced by the fact that “the list prices for mondi and sappi kraft were set for the same period and changed at the same time and by effectively the same amount” (mondi/kohler tribunal: paragraphs 94 and 96). therefore, the tribunal was correct to be anxious that the transaction could reinforce this collusion, but its arguments to reach this conclusion need to be refined. the tribunal’s primary argument was that, by using kc&t as a conduit for information exchange, the transparency of the market was improved as was the ability to detect cheating. however, for this “new communication channel” to be of concern to the competition authorities in the adjudication of this merger, the information exchanged must have the characteristic of “uniqueness”, i.e., it would not have been exchanged in the absence of the merger (riordan & salop, 1995). the market was already highly transparent – pricing changes were announced in advance and there was no evidence presented that there was competitive (or confidential) discounting from listed prices. further, the duopolists’ positions as both suppliers and consumers of the market gave them both a unique vantage point from which to observe the dynamics in the downstream market and to monitor each other’s conduct. so, the new channel of communication appeared to be of little additional value to the duopoly, and it is only this “unique” information that should count against the merger. the tribunal also cautions that the communication channel could be used to cartelise other paper markets in which the duopoly members interact. yet, the tribunal does not explore the duopoly’s existing relationships in these other markets. if one of the duopoly members was already vertically-integrated in one of the other paper production chains, then a communication channel between mondi and sappi already existed, meaning this merger added nothing “unique” to the exchange of information. sajems ns 11 (2008) no 3 259 the tribunal’s second argument was that the transaction removed the “disruptive buyer” from the downstream market. kc&t could theoretically destabilise upstream coordination in several ways, including: by threatening to find alternative core board supplies, and by playing mondi and sappi off against each other. however, it is not clear that this disruptive behaviour could arise in practice. kc&t’s dependency on the duopoly as customers appears to prevent it from successfully and repeatedly employing disruptive strategies without risking being discovered and then permanently losing two irreplaceable clients19. so, with kc&t unlikely to behave disruptively in any event, the argument that the transaction would remove a disruptor is weak in this case. an argument that the tribunal could have developed was how the transaction affects the incentives of sappi or mondi to cheat and their ability to punish defection. through acquiring kc&t, mondi would substantially reduce the number of downstream “outlets” to which sappi could sell its product during a defection. therefore, the incentive for sappi to cheat on a collusive agreement would be weakened, as the profitability of defection is reduced. this “outlets effect” is counteracted by the “punishment effect”, which strengthens the incentive of the merged entity to cheat. the magnitude of the “punishment effect” depends on the acquired downstream firm’s pre-merger profits, and, as kc&t was earning low returns prior to the transaction, the “punishment effect” would be small, meaning that the merged entity’s incentive to cheat would not increase significantly (mondi/ kohler tribunal: paragraph 61). further, sappi’s policy to only buy tubes manufactured with spiralwind would reduce mondi’s incentive to cheat. thus, it appears that in this transaction the “outlets effect”, which would be substantial given kc&t’s size, is likely to dominate the ‘punishment effect’, meaning that the merger would enhance the likelihood of successful collusion upstream. the core-board market appeared ripe for coordination and the proposed merger could enhance the likelihood of this outcome. but, the tribunal needed to present more detailed theoretical arguments as to how this occurs. particularly, the proposed merger cannot be wholly blamed for aiding collusion if collusion already existed and appeared likely to continue irrespective of whether the vertical merger occurred. therefore, the tribunal needed to address the evidence of existing collusion more directly – something that it did not do. • input foreclosure the transaction immediately raised concerns of input foreclosure given the size of the merging parties in their respective markets. however, “self-dealing” is not necessarily done with anticompetitive intent – for the merged entity to realise certain efficiencies from the merger (for example, lower transaction costs), it can be expected that its upstream division will attempt to satisfy as much of the downstream affiliate’s demand as possible. it is only when self-dealing is done to strategically increase input costs for downstream rivals that it is anticompetitive. yet, the presence of an alternative upstream supplier – sappi – apparently thwarted any ability to successfully foreclose. the tribunal responded to this correctly by arguing that once mondi began to self-deal, sappi would become a monopolist over the remainder of the market, and could, and would have the incentive to, raise its prices. with the costs for downstream rivals of the merged entity now higher, the integrated entity would earn greater profits downstream while sappi would earn increased profits upstream. therefore, despite the presence of an alternative supplier, the merged entity would still have the ability to foreclose. however, as explained in the eu’s guidelines, not only must the authority show the ability to foreclose, but also both the incentive to foreclose and that this foreclosure will be appreciably detrimental to competition – two things that the tribunal failed to satisfactorily address. the profitability of foreclosure depends on the extent to which the foreclosure 260 sajems ns 11 (2008) no 3 raises downstream rivals’ costs. however, given the significant degree of market power upstream, core board prices were potentially already near monopoly levels, making it unclear that the costs of inputs for downstream rivals would rise much further if foreclosure was pursued. thus, the incentive to foreclose may be weak. for the tribunal to determine the potential harm of input foreclosure, it would need to estimate the degree to which the post-foreclosure core-board price would rise compared to the pre-foreclosure price. however, a challenge facing the tribunal is that the “appropriate” pre-foreclosure price may not be the price prevailing in the market at the time of the proposed merger, as this price may already be distorted by existing anticompetitive conduct in the market. if explicit collusion did exist upstream, then it would be perverse to conclude that input foreclosure would not be profitable or harmful and that therefore foreclosure should not be a concern – the upstream collusion may collapse in the future, meaning that the vertically-integrated firm could then harmfully foreclose. however, if the prices pre-foreclosure are high because of appreciable “natural” market power (i.e., market power that exists because of the structures and dynamics and not because it has been artificially augmented by anticompetitive conduct), then the authorities would be correct in viewing the existing price level as the appropriate preforeclosure price and the conclusion that foreclosure would be less likely to arise (and if so would not be harmful) would be valid. therefore, to overcome this challenge the tribunal would need to gain a detailed understanding of upstream dynamics to come to an “appropriate” price benchmark – the price level that would prevail if the price was not being held at artificially high levels by proscribed anticompetitive conduct. the authorities must, therefore, attempt to examine the effect of the foreclosure in an environment in which the existing anticompetitive behaviour has been removed, as the existing anticompetitive conduct distorts how harmful the foreclosure appears to competition. in this case, the tribunal clearly needed to investigate the evidence of upstream collusion in greater detail if it was to understand the likely injury potential input foreclosure would cause to competition. • customer foreclosure the high entry barriers into the upstream market meant that the only potentially viable entrant would be a large international core-board supplier. yet, the additional feature unique to this case, that mondi and sappi were both large consumers of the downstream market (and could, therefore, discipline a downstream firm for sourcing inputs from elsewhere) makes entering the upstream market an almost impossible task. in halving the customer base for a potential entrant, the tribunal was correct in arguing that the transaction would blockade entry, although the incremental effect on entry barriers would be small (given their height prior to the merger). 4.1.4 conclusions about mondi/kohler the above commentary suggests that in this particular case, the authorities would have benefited from a more rigorous analysis of upstream market dynamics and a more thorough investigation into how the theories of foreclosure and collusion apply in this setting. the economic justifications underlying the tribunal’s decision were valid – the proposed merger did appear to improve the likelihood of foreclosure and coordination. however, the extent to which this likelihood was improved, and the resulting harm to competition, was perhaps not as great as the authorities claim. the unique feature of this case, that the upstream duopoly was at the same time a supplier and significant consumer of the downstream market, makes the analysis of likely competitive outcomes of the transaction more difficult to understand. the duopoly’s “supplierand-buyer” relationship with the downstream market so impaired the competitive process sajems ns 11 (2008) no 3 261 already that the anticompetitive consequences emanating from the proposed merger appeared relatively small. indeed, the net effect on competition of this merger would have been entirely different had mondi and sappi not enjoyed this “supplier-and-buyer” position. without this relationship, the duopoly would have had less room to discipline downstream firms that sourced core-board from overseas. consequently, the upstream market would have been wider and more competitive, potentially making it difficult for the duopolists to behave anticompetitively before or after the vertical integration. the outcome of the merger application could also have been changed by the parties providing satisfactory evidence of efficiency gains. there are potentially many areas in which this transaction could have realised cost savings – market power at both levels of the chain suggest savings from removing double markups, and repeated transactions between the parties (given that they are both a buyer and a supplier to the other) suggest substantial savings from lowering transaction cost. however, the parties’ apparent failure to identify and substantiate these (mondi/kohler tribunal: paragraph 61), means that no resistance to the authorities’ evidence of anticompetitive effects was offered. 5 conclusions the eu guidelines on non-horizontal mergers provide an excellent summary on the theories and frameworks that should be used in evaluating vertical mergers. given that the south african competition authorities have clearly embraced the post-chicago school of thinking on the competitive effects of vertical transactions, the eu’s guidelines will provide a useful reference with which to inform and formalise future investigations and analysis of vertical mergers in south africa. the south african authorities should certainly draw heavily from these guidelines if they wish to draw up formal guidelines of their own. the mondi/kohler case was an important, but complex, one for the south african authorities. it gave the authorities the opportunity to lay out how they would evaluate foreclosure and collusion concerns emanating from a vertical transaction. however, the idiosyncrasy of the case, namely that the upstream duopoly was also an important consumer of the downstream market, made understanding the likely anticompetitive effects of the proposed transaction more difficult. there are areas of the authorities’ analysis that could have been refined. the case particularly highlights a problem that is likely to face the south african competition authorities in a number of cases – that existing anticompetitive behaviour in the market may make understanding the effects of vertical mergers more complex. it would not be appropriate for the authorities to be lenient on an anticompetitive act because a previous anticompetitive action had made it appear less harmful to competition. to overcome this problem, the competition authorities would need to do highly detailed investigations of market dynamics. the authorities may, as a result, require greater time and resources to evaluate vertical cases. endnotes 1 this paper was originally written for the first annual competition commission, tribunal and institute conference on competition law, economics and policy in sa at university of the witwatersrand in june 2007. at that time the european commission had published only a draft version of the guidelines on non-horizontal concentrations for public discussion. the paper has since been updated to reflect the finalised guidelines published in november 2007. 2 the author is sincerely grateful to robert stillman, ragvir sabharwal, rameet sangha, and simon roberts for their comments and advice. the author thanks also two anonymous referees for their recommendations. 3 see riordan and salop (1995), riordan (2005), and bork (1978). 4 externalities can arise out of the individual producers in the chain failing to appreciate that their own profit-maximising decisions (with respect to output, price, research, quality, etc.) affect the supply decisions and profitability of producers at other links in the chain. see joskow (2003); motta (2004); and williamson (1971). 262 sajems ns 11 (2008) no 3 5 bishop et al (2005) gives an in depth analysis of the various efficiencies that can result from nonhorizontal mergers. see also riordan and salop (1995). 6 vertical restraints (for example, exclusive territories or exclusive dealings agreements) could also solve this externality (motta, 2004). 7 see, for example, church (2004) for a review. 8 see riordan and salop (1995) for a review of other, more specialised ways (for example, to avoid pricing regulation at one level of the chain) in which vertical mergers could be used to adversely affect competition. 9 while these levels provide “safe-harbours” for small non-horizontal mergers, the commission states that the thresholds are only reference points and should not be interpreted as a presumption that a merger falling below these levels will not be scrutinised and possibly prohibited (paragraphs 25-27). 10 entry barriers might be raised, for example, if, on account of foreclosure preventing the entrant access to sufficient customers or inputs to achieve minimum efficient scale levels of production, the entrant is forced to enter both markets simultaneously, at greater capital requirements and cost (pitofsky, 1997). 11 the guidelines note that a monopolist may have the incentive to integrate and foreclose to ‘restore’ a monopoly profit that it was failing to extract because of, for example, a commitment problem (paragraph 44). analysis of this branch of the foreclosure debate is beyond the scope of this paper. the interested reader is directed to rey and tirole (2007), riordan (2005), and church (2004). 12 the guidelines note that, all else being equal, the profitability of foreclosure will increase the lower the margins upstream and the higher the margins downstream (paragraph 41). it is important, however, to note that margins may change as a result of the merger (for example, because of efficiencies). therefore, focusing only on the “pre merger” margins may lead to incorrect conclusions. 13 input prices could rise on account of the merged entity having increased market power, the foreclosed upstream suppliers moving up their cost curves (and passing a portion of these cost increases onto customers) or the higher entry barriers surrounding the upstream market (resulting from the customer foreclosure) making the market more susceptible to a collusive outcome. 14 the concern about foreclosure obstructing entry “is particularly relevant in those industries that are opening up to competition or are expected to do so in the foreseeable future” (guidelines: paragraph 75). 15 vertical mergers can also increase the likelihood of a collusive outcome in the downstream market. chen and riordan (2003) show how an upstream firm can use a vertical merger to encourage non-integrated downstream rivals into accepting exclusive dealing arrangements, thereby cartelising the downstream market. 16 the analysis of the mondi/kohler case in this paper is based solely on the arguments and factual background given in the non-confidential written decisions on the matter published by the competition tribunal (case no. 06/lm/jan02) and by the competition appeal court (case no. 20/cac/jun02). there may have been additional information confidential to the authorities (and not expressed in the written decisions) that determined their decisions. 17 the tribunal explained that there was a separate market for the manufacture of light cores and tubes (like toilet rolls). producers in these separate markets require different qualities of input and place little competitive constraint on each other (mondi/kohler tribunal: paragraph 36). 18 the tribunal stated kc&t’s share of the market for all cores and tubes (both heavy and light industrial) as 45 per cent (with the second largest competitor, framen, at 11 per cent). within the market for the manufacture of heavy industrial cores (the relevant market), the market into which kc&t focused its cores and tubes production energy, kc&t would have a share greater than 50 per cent (although a precise share was not calculated in the decision). 19 in fact, kc&t had attempted to import core board on one occasion. this led to a rapid and forceful punishment by mondi and kc&t’s quick retreat from its disruptive position. so, the tribunal is incorrect in proclaiming this example as evidence of an active disruptive buyer downstream. rather, the outcome of this example may show that kc&t (and other firms that observed the duopoly’s response) had learnt to avoid behaving disruptively in the future. references 1 bishop, s.; lofaro, a.; rosati, f. & young, j. (2005) “the efficiency-enhancing effects of non-horizontal mergers”, a report by rbb economics for the european commission, office for official publications of the european sajems ns 11 (2008) no 3 263 communities, luxembourg, [online] available at http://ec.europa.eu/enterprise/ library/libcompetition/doc/non_horizontal_mergers.pdf (accessed november 2007). 2 bork, r.h. (1978) the antitrust paradox: a policy at war with itself, basic books inc.: new york, new york. 3 chen, y. & riordan, m.h. (2003) “vertical integration, exclusive dealing, and ex post cartelization”, discussion paper #:0203 -13, department of economics, columbia university: new york, new york. 4 church, j. (2004) “the impact of vertical and conglomerate mergers on competition”, church economic consultants ltd. and department of economics university of calgary, final report for the directorate general for competition, european commission: brussels, [online] available at http://ec.europa.eu/comm/ competition/mergers/others/merger_impact.pdf (accessed april 2007). 5 joskow, p.l. (2003) “vertical integration” in c. ménard & m. shirley, (eds.) handbook of new institutional economics (forthcoming), kluwer academic publishers: norwell, massachusetts. 6 kampel, k. (2004) “the role of south african competition law in supporting smes”, crc international conference pro-poor regulation and competition: issues, policies and practices: cape town, south africa, [online] available at http:// www.competition-regulation.org.uk/conferences/ southafrica04/kampel.pdf (accessed april 2007). 7 motta, m. (2004) competition policy theory and practice, cambridge university press. 8 nocke, v. & white, l. (2005) “do vertical mergers facilitate upstream collusion?”, working paper 05-013, penn institute for economic research department, university of pennsylvania: philadelphia, pennsylvania. 9 pitofsky, r. (1997) “vertical restraints and vertical aspects of mergers – a u.s. perspective” in a speech at the 24th annual conference on international antitrust law and policy, new york, usa, october 1997, [online] available at http://www.ftc.gov/speeches/pitofsky/fordham7. shtm (accessed april 2007). 10 rey, p. & tirole, j. (2007) “a primer on foreclosure”, in handbook of industrial organization, vol. iii, m. armstrong & r. porter (eds.): amsterdam, north-holland. 11 riordan, m.h. & salop, s.c. (1995) “evaluating vertical mergers: a post-chicago approach”, antitrust law journal, 63 (2): 513-568. 12 riordan, m.h. (2005) “competitive effects of vertical integration”, discussion paper no 0506-11, department of economics, columbia university: new york, new york. 13 williamson, o. (1971) “the vertical integration of production: market failure considerations”, the american economic review, 61: 112-123. 14 european commission (2007) guidelines on the assessment of non-horizontal mergers under the council regulation on the control of concentrations between undertakings, [online] available at: http://ec.europa. eu/comm/competition/mergers/legislation/ nonhorizontalguidelines.pdf (accessed november 2007). 15 south african government (1998) republic of south africa competition act 89 of 1998. government gazette, 400(19412): cape town, republic of south africa. 16 united states department of justice (1984) merger guidelines, [online] available at http://www.usdoj.gov/atr/public/guidelines/2614. htm (accessed april 2007). case references 17 mondi/kohler, competition tribunal, republic of south africa, ‘reasons for tribunal decision (non-confidential version), in the large merger between mondi limited and kohler cores and tubes a division of kohler packaging limited’, case no: 06/lm/jan02, may 2002. 18 competition appeal court, ‘judgment in the appeal of mondi limited and kohler core and tubes’, case no. 20/cac/jun02, february 2003. 19 schumann sasol/price’s daelite, competition tribunal, republic of south africa, “reasons for tribunal decision (non-confidential version), in the large merger between schumann sasol (south africa) (pty) limited and price’s daelite (pty) limited”, case no: 23/lm/may01, july 2001. abstract introduction research objective research method literature review research findings and discussion limitations conclusion recommendations acknowledgements references footnotes about the author(s) namhla vumazonke college of accounting, faculty of commerce, university of cape town, cape town, south africa shaun parsons college of accounting, faculty of commerce, university of cape town, cape town, south africa citation vumazonke, n. & parsons, s., 2023, ‘an analysis of south africa’s guidance on the income tax consequences of crypto assets’, south african journal of economic and management sciences 26(1), a4832. https://doi.org/10.4102/sajems.v26i1.4832 original research an analysis of south africa’s guidance on the income tax consequences of crypto assets namhla vumazonke, shaun parsons received: 15 sept. 2022; accepted: 30 nov. 2022; published: 28 feb. 2023 copyright: © 2023. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: a media statement issued by the south african revenue service (sars) in 2018 represents the primary guidance available to south african taxpayers on the income tax consequences of crypto asset transactions. aim: this study assessed the adequacy of the guidelines available to south african taxpayers on the consequences of crypto asset transactions, and identified the income tax consequences for transactions not addressed in these guidelines. setting: this study compared the scope and depth of the sars guidelines to guidance issued in other jurisdictions. this distinguishes it from other studies focusing on the theoretical income tax consequences of crypto asset transactions. method: the first phase of the study was an in-depth documental analysis to benchmark the sars guidelines against the guidance of tax authorities in other jurisdictions. in the second phase of the study, a doctrinal legal research methodology was adopted to identify the income tax consequences of transactions not addressed by sars, applying existing legislation and case law, and taking into account the guidance of the other selected tax authorities. results: the study found that the sars guidelines did not comprehensively address all the crypto asset transactions addressed by the other selected tax authorities. conclusion: the study recommended that sars provide comprehensive guidance to south african taxpayers on the income tax consequences of crypto asset transactions, the development of which would be supported by consequences identified in this study. contribution: this study contributes to the understanding of, and development of taxpayer guidance to address the income tax consequences of crypto asset transactions in south africa. keywords: cryptocurrency; crypto asset; south african income tax; south african revenue service; tax literacy; tax compliance. introduction in 2018, for the first time, the south african revenue service (sars) issued a media statement providing guidance and accompanying answers to frequently asked questions (faqs) to south african (sa) taxpayers on the taxation of crypto asset transactions (hereafter referred to collectively as the ‘sars guidelines’). the sars guidelines indicate that ‘normal income tax rules’ will apply to such transactions, and that crypto asset gains or losses must be declared as part of taxable income (sars 2018b:1). the sars guidelines, together with a brief information page added subsequently to its website (sars 2021), remain the only guidance on crypto asset transactions provided to sa taxpayers by sars. the only amendments to the south african income tax act no. 58 of 1962 (‘the act’) to address the income tax consequences of crypto asset transactions occurred in the year following the publication of the sars guidelines. ‘cryptocurrency’ was added to the definition of a ‘financial instrument’ (section 1) and related activities included in the list of so-called ‘suspect trades’ (section 20a), wherein losses of individuals may be ring-fenced in certain circumstances. at the same time, the value-added tax act no. 89 of 1991, was amended (section 2[1][o]) to designate cryptocurrency transactions as financial services and, are therefore, exempt from value-added tax (vat) (taxation laws amendment act 2019). in 2021, the references to ‘cryptocurrency’ were amended to the more broadly-defined ‘crypto assets’ for income tax in order to align with the terminology of the proposed south african regulatory framework for crypto assets (intergovernmental fintech working group, 2021; national treasury 2021). the term ‘cryptocurrency’ was retained in the vat act, suggesting a narrower application focused on eliminating double taxation when used as a medium of exchange (greeff 2019). the lack of comprehensive guidance on the income tax consequences of crypto asset transactions in sa is concerning, as guidance provided to taxpayers is a potentially significant contributor to improved tax compliance (brackin 2014). tax compliance with regard to crypto asset transactions has been identified as an area of concern in sa (select committee on finance 2021). in surveying jurisdictions’ responses to the taxation of crypto asset transactions, the organisation for economic co-operation and development (oecd) (2020) encouraged tax administrations to develop comprehensive guidance for taxpayers. in their review of the sars response to the taxation of crypto asset transactions, bornman, soobramoney and loonat (2022) concluded that it did not fully live up to the administration’s commitment to service orientation expressed in its strategic plan of 2020. research objective two objectives were pursued in this study. the first objective was to assess the scope and depth of the sars guidelines on crypto asset transactions compared to those of other selected jurisdictions. this will add further weight to the conclusions of studies (such as by bornman et al. 2022) on the adequacy of guidance provided in sa to date. the second objective was to extend the existing research by providing recommendations regarding specific income tax consequences that may arise on transactions not yet addressed by the sars guidelines. these recommendations would support sars in developing comprehensive guidance to taxpayers on crypto asset transactions. research method the oecd has defined financial literacy as the combination of awareness, knowledge, skill, attitude, and behaviour necessary to make informed financial decisions and attain individual financial well-being (oecd infe 2011). tax literacy is less researched and is a newer concept than financial literacy (cvrlje 2015). tax literacy is a component of financial literacy, which focuses on an individual’s understanding, comprehension, and numerical skills in tax-related matters within their local and international jurisdiction (bornman & wassermann 2020). cvrlje (2015) links increased tax literacy with reduced levels of non-compliance and improved tax morale. it is critical for the country’s tax authority to provide its taxpayers with sufficient appropriate, clear, and continual guidance. such guidance improves their understanding of the requirements of the tax legislation and the consequences of non-compliance, as well as their ability to accurately complete tax returns and calculate tax consequences (brackin 2014). tax administrations may follow ‘norm-orientated’, ‘service-orientated’, or ‘power-orientated’ strategies for encouraging compliance (bornman 2015:170). this study adopted the view that the provision of comprehensive guidance is consistent with a service-orientated approach to furthering tax compliance concerning crypto asset transactions (bornman et al. 2022). the first phase of this study was conducted through document analysis. documental analysis is a process of accessing empirical knowledge and answering research questions from documented material. documental analysis uses data from government records, regulations and statistics, as well as journals. the data assist the researcher to gain insight into a current research problem, support the research question from the data available, and generate new knowledge of the research question (gross 2018). in the document analysis, the sars guidelines were benchmarked for completeness and comprehensiveness against the crypto asset income tax guidelines and regulations issued by selected countries. the united states of america (usa) was selected for comparison because it is the largest global economy, with the us dollar considered a universal currency (amadeo 2020), and because of its early response to the income tax consequences of crypto asset transactions (bal 2015a). only us federal income tax was considered in this study. the united kingdom (uk) and australia were selected because they each have a similar tax system and have been influential in the development of the tax system in sa (harris 2016; hattingh 2016) and because both have issued comprehensive guidance on the tax consequences of crypto asset transactions. details of this guidance are presented in table 1. table 1: summary of documents reviewed for the study. the first phase of the study identified the transactions omitted from the sars guidelines and the extent to which they were addressed in other jurisdictions. this analysis supports the recommendations for the scope of comprehensive guidance to address the income tax consequences of crypto asset transactions in sa. the second phase of the analysis focused on doctrinal legal research. the doctrinal legal research method involves a systematic process for testing propositions through analysing laws, regulations, and statutory provisions (mckerchar 2008). in the doctrinal legal research phase, the sa income tax consequences for those transactions not addressed in the sars guidelines were analysed against the provisions of the act, as amended, and relevant case law. in this analysis the income tax guidance provided to taxpayers in the other jurisdictions addressed in phase one is also considered. this second phase of the study supports recommendations about the appropriate consequences to be incorporated into comprehensive guidance to sa taxpayers. the next section contains a literature review. the findings of the document analysis of jurisdictional guidance are then presented. thereafter, the sa income tax consequences of the crypto asset transactions not addressed in the sars guidelines are analysed. the study then concludes and makes recommendations for developing comprehensive guidance in sa. the limitations of the study are noted, and areas for future research are suggested. literature review this section provides a brief introduction to crypto assets, the defining characteristics of the underlying technology, and the identified taxable events to which they may give rise. terminology ‘currency’ is an instrument used as a medium of exchange to facilitate transactions between parties, helping buyers and sellers find the right ‘price’ at which the transaction can take place (peetz & mall 2017). ‘fiat currency’ is any government-issued currency that is in a tangible form of coins or notes. fiat currency is typically not backed by a physical commodity such as gold but by the government’s financial system (hong, park & yu 2018). although the concept of cryptocurrency can be traced back as far as 1983, it became a practical reality in 2009 with the launch of bitcoin, which served as the prototype for the many thousands of crypto assets that exist today (bal 2014, 2015b; hileman & rauchs 2017). bitcoin aims to be ‘an electronic payment system based on cryptographic proof instead of trust, allowing any two willing parties to transact directly with each other without the need for a trusted third party’ (nakamoto 2009:1). cryptocurrency is legally distinct from fiat currency because it is not recognised as legal tender, and economically distinct because of its questionable ability to function as a unit of account, store of value and medium of exchange (parsons 2022b). many countries and publications use different terminologies, including ‘cryptocurrency’, ‘crypto asset’, ‘virtual currency’, and ‘digital currency’ in addressing the same core concept (parsons 2022a). the term ‘crypto asset’ encompasses ‘cryptocurrency’ (or ‘exchange tokens’), ‘utility tokens’ and ‘security tokens’, all of which apply distributed ledger technology (dlt) to different ends (oecd 2020). utility tokens, such as ether and siacoin, function as tokens issued by a particular platform and are used as a means of payment on that platform for the use of the network, but are non-redeemable and carry no rights to any actual pay-out (dewey 2019). security tokens, such as blockestate and tzero, are used for either investment or borrowing (houben & snyers 2018). the term ‘crypto asset’, as used in the remainder of this study, is consistent with the dominant terminology currently utilised in literature and guidance. however, this study focused on the income tax consequences of crypto assets in south africa when used as a medium of exchange, which aligns with the use of the term ‘cryptocurrency’ in the sars guidelines. a brief introduction to crypto assets crypto assets, like bitcoin, use dlt to record and share data across multiple ledgers. distributed ledger technology allows different network participants to transact with one another, with data being recorded, shared and synchronised across the network (natarajan, krause & gradstein 2017). the blockchain is the public ledger of all transactions, which are shared across the network and validated as true records by ‘miners’ through a consensus mechanism. for participating in this mechanism, miners are rewarded with newly-minted tokens (bal 2018). mining is used in some instances (such as bitcoin) to introduce new crypto asset tokens into the ecosystem. other crypto assets have been introduced through initial coin offerings (icos), in which tokens are sold in a market similar to shares, or airdrops, and tokens are given away to selected participants to promote their adoption (kaal 2018; landoni & pieters 2019). crypto asset tokens are also bought and sold in the secondary market, either privately or on crypto asset exchanges (law library of congress 2018). crypto asset tokens are stored in a ‘wallet’. users access their wallets and transfer tokens by means of cryptographic keys (herbert & stabauer 2017). each crypto asset transfer is initiated by the user, broadcast to the network, validated by miners, and added to the blockchain as an irreversible record of the transaction (nakamoto 2009). a user who forgets their key, risks losing access to their tokens (webb 2018). while many new crypto assets are the product of a process of development, others are the consequence of a ‘hard fork’. a fork occurs when there is disagreement regarding the adoption of new protocols to the blockchain. this results in the creation of two separate blockchains: one maintaining the existing protocols and another adopting the new protocols. in some instances, this is merely a temporary situation arising from differences in timing of adoption, after which the two blockchains return to consensus. this is referred to as a ‘soft fork’ and is a frequent occurrence. in others, a permanent divergence occurs: the ‘new’ blockchain retains the transaction history of the ‘pre-existing’ blockchain but adopts a new name and results in the creation of ‘new’ crypto assets, each mirroring a pre-existing crypto asset on the pre-existing blockchain. for this reason, the holder of each pre-existing crypto asset token receives an equivalent new crypto asset token, which then proceeds to exist independently on the new blockchain. at the same time, the holder continues to hold their pre-existing crypto assets, which exist on the pre-existing blockchain and are unaffected by the new crypto assets. the hard fork of bitcoin cash from bitcoin is one such example (bernstein et al. 2020; landoni & pieters 2019; webb 2018). taxable events a comparative analytical study of over 50 countries found that most countries did not specifically amend their income tax legislation to address crypto assets (strauss, schutte & fawcett 2020). this is consistent with the response of sa, where amendments were limited to the addition of crypto assets to the definition of ‘financial instrument’ and their inclusion as a so-called ‘suspect trade’, in respect of which losses arising for individuals may be ring-fenced in certain circumstances (taxation laws amendment act 2019). in 2020, the oecd conducted its first survey of the tax treatment of crypto asset transactions among participating countries. in that report, the oecd concluded that the following taxable events should be included in comprehensive country guidance: the creation of crypto assets by mining, icos and airdrops; the exchange of crypto assets for other crypto assets, for fiat currency, or goods and services (including as payment of wages); disposal by gift or inheritance; loss or theft; and hard forks (which the oecd included within ‘emerging developments’) (oecd 2020).1 these 11 transactions identified by the oecd, as listed in table 2, were used in this study as the foundation for considering the completeness of jurisdictional guidance available in the countries investigated. table 2: income tax consequences of crypto asset transactions identified in benchmarking. research findings and discussion comparison of south african revenue service guidelines to selected jurisdictions the sars guidelines and faqs were analysed and compared to guidance documents of the tax authorities of the usa, uk and australia (see table 1). the results of the benchmarking exercise are shown in table 2. the benchmarked countries explicitly addressed 10 of the 11 crypto asset transactions identified. initial coin offerings were the only transaction not addressed by any of the benchmarked countries. by contrast, the sars guidelines addressed only six of the 11 transactions. the transactions covered by sars were among those found by strauss et al. (2020) to be most frequently addressed by tax administrations. the five crypto asset transactions not addressed in the sars guidelines were: blockchain hard fork, receiving an airdrop, donating crypto assets, including to charities, initial coin offerings, and loss or theft. for the transactions addressed, the sars guidelines were broadly consistent with those of other jurisdictions regarding income tax consequences. the sars guidelines, however, did not address business users of crypto assets to the extent of the benchmarked jurisdictions. the sars guidelines also contained significantly less detail than the guidance of the benchmarked jurisdictions, such as worked examples for the various transactions addressed. analysis of the transactions not addressed in the south african revenue service guidelines having identified five transactions not addressed in the sars guidelines in the first phase of the study, in the second phase, the determination of the appropriate sa income tax consequences of each of these five transactions are considered. blockchain hard fork in the usa, rule 2019–24 provides that when the fork results in the creation of a new crypto asset, which is referred to as the taxpayer’s e-wallet, then the event results in taxable income, provided the taxpayer can transfer, sell or exchange the crypto asset (irs 2019b). such abilities represent evidence of the ‘accession to wealth’ of the taxpayer recognised in usa tax law (landoni & pieters 2019). the income is equivalent to the market value of the crypto asset when it is received (irs 2019b). in the uk, the hmrc refers only to the application of the capital gains tax act in both its guidance to individuals and businesses. the capital gain (or loss) arises only on the disposal of the new crypto asset. the allocation of the cost of the pre-existing crypto asset between the pre-existing and new crypto asset for capital gains is derived from the cost of the pre-existing crypto asset and the values of the two crypto assets at the date of the fork (hmrc 2018a, 2019). presumably, the subsequent use of a crypto asset received in a hard fork as trading stock would not preclude it giving rise to revenue income arising on disposal merely by virtue of the means of acquisition, although this is not stated by hmrc. the ato considers that a hard fork gives rise to cgt for taxpayers who hold the pre-existing and new crypto asset for investment purposes. it treats the new crypto assets as trading stock for businesses where it is held for sale or exchange in the ordinary course of business (ato 2020). although no explicit reference is made to the timing of recognition of revenue income, by implication this will give rise to revenue income at the earlier of the disposal dates, or at year end, since australia recognises unrealised increases in trading stock value as income (ato 2022a). the cost of the new crypto asset to be recognised in the hard fork is zero (ato 2020). in recommending an income tax consequence of a hard fork for sa taxpayers, the guidance issued by the three other tax authorities was considered. the irs treats any income arising from a hard fork as revenue for the taxpayer, the ato indicates that a hard fork may give rise to either a capital receipt on disposal or revenue income if held as trading stock, and hmrc only contemplates a capital gain or loss. blockchain hard fork: south african income tax consequences the taxpayer bears the burden of proving that income is not revenue in nature (s102; tax administration act 2011). the mere fact that a profit has resulted from a transaction is insufficient to make that profit revenue in nature; rather, it must be the product of ‘an operation of business in carrying out a scheme for profit-making’ (commissioner for inland revenue v stott 1928 [3], satc 253 [a], p. 259). the intention of the taxpayer plays a vital role in determining whether income is capital or revenue in nature (commissioner for inland revenue v stott 1928 [3], satc 253 [a]). the taxpayer’s intention will be determined by taking into account their stated intention (or ipse dixit) together with the surrounding facts in each specific case (malan v kommissaris van binnelandse inkomste 1983, 45 satc 59). the taxpayer’s intention in acquiring the asset will be decisive unless other factors show that it was sold as part of a scheme of profit-making (commissioner for inland revenue v stott 1928 (3), satc 253 (a). it is, however, possible that taxpayers may, subsequent to acquiring a capital asset, change their intention and enter into a scheme of profit-making involving the disposal of that asset, in which case the resultant income will be revenue in nature (natal estates limited v secretary for inland revenue 1975, 37 satc 193). proving a capital intention with respect to crypto assets may be challenging since crypto assets do not yield any fruit, such as dividends or interest, as do other long-term investments; the yield is in the appreciation of the market value of the crypto asset. however, sa has a history of comparable cases dealing with long-term holdings of appreciating assets. in commissioner for inland revenue vs nel 1997, 59 satc 349, even though the taxpayer acquired kruger rands (that is, gold coins) for their value appreciation, the court concluded that, as they were held for a long period and disposed of for a purpose other than profit-making, the proceeds on disposal were capital in nature. on the other hand, commissioner for inland revenue vs nussbaum 1996, 58 satc 283, concluded that the taxpayer who frequently and profitably disposed of investments was, in fact, pursuing a secondary profit-making scheme. thus, the length of time held and the reasons for disposal, as well as the frequency and profitability thereof, would assist in determining whether the disposal of crypto assets is tantamount to a profit-making scheme. a taxpayer benefits from a hard fork through the receipt of new crypto assets as a result of being a holder of the pre-existing crypto asset. therefore, it is submitted that the taxpayer’s intention at acquisition for the new crypto asset might be imputed from the intention with which the pre-existing crypto asset was held. consideration might also be given to whether any activities undertaken by the taxpayer to benefit from the hard fork amounted to a scheme of profit-making. the sars guidelines indicate that mining will give rise to revenue income, and do not contemplate the possibility of non-trade mining activities. this is consistent with the approach of the irs and hmrc (which includes non-trade mining income as miscellaneous income rather than a capital receipt). crypto assets received in mining will be held as trading stock until it is sold or exchanged. therefore, if crypto assets obtained in mining, subsequently give rise to the receipt of new crypto assets through a hard fork, such additional crypt assets might also be initially regarded as revenue in nature (if revenue is recognised on receipt in this instance). recognition of revenue income may occur either initially on receipt of the new crypto asset, with a subsequent inclusion of the incremental profit upon disposal, or only upon disposal. since the us concept of ‘accession to wealth’ is not explicitly recognised within the act or sa case law, and since the australian requirement to mark trading stock to market is not present in south africa, there may be justification for recognising revenue income only on disposal. furthermore, no trading activity or reliable market values may exist on the date of the hard fork, making any recognition of revenue on receipt difficult to quantify. however, recognition at receipt or accrual seems to most closely align with the definition of gross income in the act. it will therefore be important for sars to address the timing of revenue recognition in this context. if the new crypto asset is revenue in nature and such revenue is recognised upon receipt, the value will be included in the taxpayer’s trading stock in terms of section 22(4) of the act at its current market value upon receipt (income tax act 1962). this trading stock amount will be equal to the amount included in income on that date. this is consistent with the conclusion of basson (2020) in her analysis of the income tax consequences of mining activities. since a crypto asset is defined in section 1 of the act as a ‘financial instrument’, no unrealised impairment loss may be recognised at year end. this designation, notwithstanding, income on disposal, cannot be treated as capital in nature merely due to the length of time held, since section 9c applies only to equity shares and not to all financial instruments (income tax act 1962). alternatively, if the taxpayer is able to discharge the burden of proving that the crypto asset received, represents a capital asset, the proceeds on disposal will be taken into account in the determination of a capital gain. the proceeds will be valued at either the amount of fiat currency received or at the market value of the non-monetary proceeds received, in accordance with the barter transaction rules referred to by sars in addressing other crypto asset transactions. it should also be noted that the possibility of crypto asset transactions falling within personal-use asset exclusions from cgt, as contemplated in australia, is precluded by their inclusion within the definition of financial instruments in the act in 2019 (basson 2020). paragraph 20 of the eighth schedule to the act stipulates that the base cost of a capital asset consists of the actual expenditure incurred in the acquisition of the asset, including the allowable expenditure directly incurred in the acquisition and disposal of the asset (income tax act 1962). the new crypto asset is received by the taxpayer for no consideration, while the pre-existing crypto asset continues to be held. however, the taxpayer may incur expenditure for the negligible fees incurred on either receipt or disposal of the new crypto asset. therefore, it is proposed in this study that these costs should be the only amounts on which the base cost is determined and that no portion of the cost of the pre-existing crypto asset be assigned to the new crypto asset received. this would conceptually align with the treatment of shares received for no consideration in section 40c of the act, which stipulates that when a taxpayer acquires shares, share options or other rights by virtue of their existing shareholding, the cost of acquisition should be deemed to have a nil value of actual expenditure incurred (income tax act 1962). receiving an airdrop crypto assets in both a hard fork and an airdrop are received for no consideration. however, an airdrop is typically an active distribution by a promoter of a crypto asset, rather than a by-product of events on the blockchain (oecd 2020). the hmrc and ato have addressed the income tax consequences of airdrops in their jurisdictions. the irs has not specifically addressed airdrops related to marketing or advertising campaigns, but only those related to hard forks (which were considered in the preceding analysis of hard forks). the ato guidelines provide that an airdrop of crypto assets, received in a taxpayer’s digital wallet or e-wallet as part of a marketing or advertising campaign, is treated as ordinary income at the fair value of the crypto assets at the time of receipt. the ato has, however, expanded its guidance to indicate that airdrops that represent the first distribution of a new crypto asset do not give rise to tax consequences on receipt, because they do not yet have a market value as they are not actively traded (ato 2022b). either the trading stock rules (for business activities) or cgt rules apply to the subsequent disposal of the airdropped crypto assets (ato 2020). if the taxpayer receives an airdrop of crypto assets in their personal capacity without assuming any corresponding obligation, hmrc advises that it will not be taxable at the time of receipt. where crypto assets are received in exchange for services, or other performance obligations from the taxpayer, the airdrop will be included in either the taxpayer’s other income, or receipts from trade. on disposal, the proceeds from the disposal of the airdropped crypto assets will be considered capital in nature. however, if the airdropped crypto assets form part of the taxpayer’s business activities, the income tax rules will take preference over capital gains (hmrc 2018b). the ato treats all receipts as revenue in nature, while hmrc treats only those received in return for some reciprocal action as revenue. this inclusion by hmrc would seem to address a concern that a payment might be incorrectly referred to as an airdrop, while a ‘true’ airdrop is gratuitous. the income from subsequent disposal of the airdropped crypto assets is treated similarly in both jurisdictions, namely as capital for investors or revenue for businesses. receiving an airdrop: south african income tax consequences in determining the income tax consequences of an airdrop for sa taxpayers the proposed tax treatment of hard forks was considered, because in both cases, the taxpayer involuntarily receives new crypto assets at no personal cost. as with hard forks, an airdrop increases a taxpayer’s wealth. here too, the taxpayer will have to prove that the receipt of the new crypto assets is of a capital nature, failing which the income arising will be considered revenue in nature. it is submitted that this would likely require that the receipt of crypto assets be fortuitous rather than ‘designedly sought for and worked for’ (see commissioner for inland revenue vs pick ‘n pay employee share purchase trust 1992, zasca 84, p. 280), and might be informed by the extent and nature of the taxpayer’s collective crypto asset activities. likewise, the taxpayer’s intention, subsequent to acquisition, and the possibility of a change in intention to a scheme of profit-making, or vice versa, would also need to be considered in determining the nature of the income arising on subsequent disposal. the ato and hmrc consider that taxation first occurs, either upon receipt (if revenue), or only upon disposal (if capital). if such an approach is adopted in sa, airdropped crypto assets of a revenue nature will be taxable at the earlier of accrual or receipt date to the taxpayer, in terms of the gross income definition in section 1 of the act. upon receipt of the crypto asset, the taxpayer will add its value to their trading stock and any subsequent change in value will be realised upon disposal in terms of the trading stock rules of section 22 of the act (income tax act 1962). alternatively, the lack of an observable market value on receipt may make it more pragmatic to recognise income only on disposal (as is the case in australia with respect to initial distributions). again, guidance from sars on the timing of recognition that it considers appropriate, is therefore important. by contrast, taxpayers whose new crypto assets are capital in nature will have no inclusion in taxable income upon receipt, while a capital gain will only arise upon disposal. such crypto assets will have a base cost of nil since no cost is incurred by the taxpayer. donating crypto assets, including to charities according to the irs, donating crypto assets to a charitable organisation will not be considered as ordinary income, or a capital gain or loss, as such transactions are exempt from tax. the value of the available charitable contribution deduction is based on the period for which the crypto asset was held. for crypto assets held for longer than a year, the value is the market value of the crypto assets on the donation date. when the crypto assets are held for less than a year, the deduction is the lesser of either the market value of the crypto assets on the date of the donation, or their cost (irs 2019a). charitable contributions are only deductible to the extent that the taxpayer does not receive a benefit in return (irs 2022), and this limitation would presumably extend to the exemption as well. guidance has not been specifically provided by the irs for non-charitable donations. in the uk, charitable donations do not attract capital gains for individuals or corporation tax for businesses, unless they are ‘tainted’ (when the taxpayer enters into an arrangement to obtain financial advantage from a charity after making a donation) or represent an attempt to realise a gain from the disposal (hmrc 2018b, 2020). in contexts other than donations to charities, the hmrc guidance provides that a disposal of crypto assets in the form of a donation to a person other than a spouse or civil partner will attract cgt (hmrc 2018b). for a company, the donation of crypto assets, other than to a member of the same group of companies, will attract corporation tax. the value of the donation for the corporation tax calculation will be the value of the crypto assets at the time of the donation (hmrc 2019). in the ato guidance, the donation of crypto assets is treated as a disposal of crypto assets and, as such, will give rise to revenue income when held as trading stock, and capital disposal in other instances. the value of the donation will be the market value of the crypto assets in the calculation of the capital gains, or the application of trading stock rules (ato 2020). the ato does not specifically consider the deductibility of donations made in crypto assets. there is consensus in the irs, hmrc and ato guidelines that donations will give rise to either a capital or revenue disposal. the irs and hmrc explicitly consider the availability of exemptions with respect to donations to charities. donating crypto assets: south african income tax consequences south african taxpayers are entitled to a limited deduction for donations made to public benefit organisations (pbos) in terms of section 18a of the act. in terms of section 22(8)(c) of the act, the donation to a pbo of crypto assets held as trading stock will be deemed to be disposed of at an amount equivalent to the taxpayer’s section 11(a) or section 22(1) deduction. this amount will be available for the allowable deduction in terms of section 18a. an investor will disregard the capital gains or losses for any donation made to a pbo, in terms of paragraph 62 of the eighth schedule to the act, and will be entitled to a deduction of the cost of any crypto assets donated to a qualifying charity, limited to 10% of the taxpayer’s taxable income before such deduction (income tax act 1962). for any other donation made, the normal trading stock rules or cgt consequences will apply. the cost of any crypto assets purchased as trading stock, or the value of any crypto asset giving rise to revenue on receipt, will be added to the taxpayer’s cost of trading stock on acquisition. in terms of section 22(8)(b) read with section 22(8)(b) of the act, crypto assets held as trading stock will be deemed to be disposed of at an amount equal to the market value of the crypto assets at the time of the donation to a non-pbo (income tax act 1962). the investor taxpayer’s capital gain or loss on the donation to any person other than to a pbo (or to other parties qualifying for exemption, such as between spouses), will be determined in terms of paragraph 38 of the eighth schedule to the act. this states that the donation made will constitute a disposal with a value equivalent to the asset’s market value on the date of the donation (income tax act 1962). initial coin offerings determining the income tax consequences for icos is complex, considering the unique characteristics of crypto assets, coupled with the fact that there are no formal guidelines available from the benchmarked authorities regarding the income tax consequences of an ico on those jurisdictions. unlike other financial instruments defined in section 1 of the act, crypto assets do not provide the crypto asset holder with a residual right to the equity of a company or any rights to dividends. in an ico, the issuer offers crypto asset tokens that the purchaser hopes will be accepted in the future by someone other than the issuer. thus, the crypto asset purchaser has no ownership interest in or future claim against the issuer (oecd 2019). an ico is therefore distinguishable from the initial public offering (ipo) of shares, from which its name is derived. initial coin offerings: south african income tax consequences the sa taxpayer must include in gross income the total amount received by, or accrued to the taxpayer, in cash or otherwise, during the year of assessment, excluding receipts or accruals of a capital nature (income tax act 1962). the issuer in an ico sells the new crypto assets for fiat currency (cash) or in exchange for other crypto assets. thus, the consideration accrues to, or is received by, the taxpayer issuing the crypto asset on the date of the ico issue. furthermore, when an ico occurs for the benefit of the issuer with no future obligation to the crypto asset holder, it is submitted that the income arising is ‘designedly sought for and worked for’ rather than fortuitous, and therefore not capital in nature (see commissioner for inland revenue vs pick ‘n pay employee share purchase trust 1992, zasca 84, p. 280). therefore, in the absence of any further obligation by the issuer to the holder, it is submitted that the proceeds of an ico represent gross income for the issuer upon receipt or accrual. for the purchaser, the cost of acquisition represents either a deductible expense, if acquired as trading stock, or the base cost of the crypt asset in other cases. loss or theft the irs does not address loss or theft, while the position of his majesty’s revenue and customs (hmrc) differs from that of the ato. hmrc does not consider loss or theft to be a disposal, and therefore no income tax consequences arise. in contrast, the ato accepts loss or theft as a disposal of no value, if the crypto asset, the wallet in which it was stored, or the access key, cannot be replaced or recovered. the taxpayer will be required to provide supporting evidence such as the cost of the crypto assets lost and the details of when they were acquired and lost. loss or theft: south african income tax consequences in terms of sa tax legislation, the issue at hand would be whether a disposal has taken place. paragraph 11 of the eighth schedule to the act provides a definition of ‘disposal’, which includes ‘the sale, donation, expropriation, conversion, grant, cession, or any other alienation or transfer of ownership of an asset’, and goes on to include such events as ‘forfeiture, termination, …, cancellation, surrender, …, abandonment, …, scrapping, loss or destruction’ (income tax act 1962). such a definition would accommodate involuntary disposals such as loss or theft. however, it would be necessary to demonstrate that a true alienation, or loss, of ownership had occurred. this may more readily be accepted in the case of stolen crypto assets or lost computer hardware than in the case of the loss of a password. there is no obvious parallel in this context in the literature of which the authors are aware. here too, the taxpayer would benefit from guidance from sars in this respect. limitations the study was conducted using the sars guidelines, in the form of a media statement released on 06 april 2018, together with accompanying faqs, as the basis for conducting the benchmarking exercise with other jurisdictions. the sars guidelines are not in the form of an interpretation note and, therefore, are not an ‘official publication’ as defined (tax administration act 2011). the study focused on crypto assets that function as a means of payment, such as bitcoin. security and utility tokens, such as neufund and ether, did not form part of the research and may have income tax consequences beyond, or different to, those considered in this study. furthermore, the focus was exclusively on the income tax consequences of crypto asset transactions. other taxes, such as vat, donations tax, and estate duty, did not form part of the ambit of this study and may present scope for further research. conclusion this study’s first objective was to ascertain whether the sars guidelines, provided in its statement of 2018, comprehensively addressed the income tax consequences of all the crypto asset transactions identified in the literature and dealt with in the guidance of the other benchmarked authorities (i.e. that of the usa, uk and australia). the sars guidelines addressed six out of the 11 crypto asset transactions identified. in these instances, it was found that the income tax consequences were broadly consistent with those of the benchmarked countries. the sars guidelines were, however, found to be brief and vague by comparison. they did not comprehensively address the crypto asset transactions considered or provide references to the relevant sections of the act to support their conclusions. a high level of knowledge was assumed to be held by taxpayers. for example, the sars guidelines referred to, but did not elaborate on, the income tax consequences of barter transactions. the sars guidelines lacked explanatory examples that the other benchmarked authorities included in their guidance. this suggests that these guidelines were perhaps intended to be a temporary measure. the study identified five crypto asset transactions that were not addressed by the sars guidelines (as indicated in table 1). for only one of these transactions was no guidance provided by any of the three benchmarked jurisdictions. therefore, the findings support the conclusion that the sars guidelines do not comprehensively and specifically address the income tax consequences of a broad range of crypto asset transactions. the study’s second objective was to analyse and determine the income tax consequences of the five transactions not addressed by the sars guidelines. these transactions were the hard fork of an existing crypto asset blockchain, receiving crypto assets in an airdrop, donating crypto assets, icos, and the loss or theft of crypto assets. in determining the income tax consequences of these transactions the application of relevant provisions of the act was considered in this study, as well as the positions taken by the benchmarked jurisdictions. it was found that it was possible to determine income tax consequences2 for all five identified transactions, although the outcomes were not always readily apparent. it may be unrealistic to assume that similar conclusions could be reached by ordinary taxpayers without specific guidance. these findings provide further evidence of the need for comprehensive guidance in sa regarding the income tax consequences of crypto assets and support the development of such guidance. recommendations this study recommends that sars develops comprehensive guidance for the income tax consequences of crypto asset transactions. the current sars guidelines should be elaborated on for the crypto asset transactions already dealt with, and their scope extended to include those transactions identified in the study that, to date, have not been addressed by sars. the recommended comprehensive sars guidance may be best positioned in the form of an official publication as either an interpretation note or a comprehensive guide, both of which are normally more detailed than the seemingly temporary media statement format employed in 2018. in developing comprehensive guidance, consideration should be given to both the approaches of other countries referenced in this study, and to other jurisdictions that have issued comprehensive guidance. the application of the act to those crypto asset transactions not yet addressed by sars, but identified and addressed in this study, may also inform the development of an interpretation note or comprehensive guide. explanatory examples, such as those included by these other jurisdictions, as well as decision trees or flow charts, would assist sa taxpayers in determining the income tax consequences of their crypto asset transactions. the guidance that is accessible, user-friendly and comprehensive is likely to assist in improving the tax compliance of sa taxpayer crypto asset users. acknowledgements this article is partially based on the dissertation of the first author, namhla vumazonke, presented for the degree of master of commerce (financial reporting, analysis and governance) at the university of cape town, supervised by the second author, prof s. parsons, received 13 december 2021, available here: https://open.uct.ac.za/handle/11427/36207. the authors would like to express their appreciation to the university of cape town for administrative support. competing interests the author(s) declare that they have no financial or personal relationship(s) that may have inappropriately influenced them in writing this article. authors’ contributions n.v. was the primary researcher as part of his master of commerce study. s.p. supervised the research project and contributed to the drafting of the published article. ethical considerations this article followed all ethical standards for research without direct contact with human or animal subjects. funding information this research received no specific grant from any funding agency in the public, commercial or not-for-profit sectors. data availability the data that support the findings of this study are available in the public domain. disclaimer the views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of the university of cape town. references amadeo, k., 2020, ‘why the us dollar is the world currency’, the balance, viewed on 30 may 2020 from https://www.thebalance.com/world-currency-3305931. ato, 2020, tax 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on 18 august 2022 from https://www.parliament.gov.za/storage/app/media/pbo/analysis_and_reports/2021/june/03-06-2021/may_2021_pbo_select_finance_committee_cryptocurrency_25_may.pdf strauss, h., schutte, d. & fawcett, t., 2020, ‘an evaluation of the legislative and policy response of tax authorities to the digitalisation of the economy’, south african journal of accounting research 35(3), 239–262. https://doi.org/10.1080/10291954.2020.1810504 tax administration act no. 28 of 2011, government printer, pretoria. taxation laws amendment act no. 23 of 2019, government printer, pretoria. value-added tax act no. 89 of 1991, government printer, pretoria. webb, n., 2018, ‘a fork in the blockchain: income tax and the bitcoin/bitcoin cash hard fork’, north carolina journal of law and technology 19(4), 283–311, viewed on 25 march 2020 from https://scholarship.law.unc.edu/cgi/viewcontent.cgi?article=1361&context=ncjolt. footnotes 1. the other items listed by the oecd for consideration, which are not relevant to this study, were stable coins, central bank digital currencies, interest-bearing tokens, and related services, such as exchanges and wallet providers. 2. or the absence of a taxable event in the case of a lost password. sajems ns vol 5 (2002) no 1 iii occupational segregation of work and income disparities among south african women p laltbapersad department of economics, vista university abstract despite the increase in the number of women participating in the south african labour market in recent years, little progress has been made in removing wage disparities, eradicating women's marginality in the labour market, reassessing women's work or changing the traditional occupational ghettos of women. not only does the south african labour market exhibit anomalies in respect of the gender composition of occupations, there are substantial differences by race. a good barometer of determining the extent to which men and women undertake different types of jobs, is to analyse the percentage of male and female workers per occupational category. jeljl6 introduction the primary objective of this article is to examine gender segregation of occupations and the implications thereof on remuneration and income levels. the principles of patriarchy and sexism impinge on women's role in society, in the household and in the labour market there are stark differences in the nature and scope of male and female labour force participation. whilst male participation in the labour force is contrived on the absence of domestic and childcare responsibilities, women bear the brunt of unpaid work in the home. women's responsibility for familial tasks negatively impacts on their economic status. a further factor that impairs women's labour market status is the structure of labour markets. research by barron and norris (1976: 64) on dualism in labour markets revealed that the primary sector which offers socalled 'good' jobs, is male oriented, whilst the secondary sector which comprises 'mediocre' jobs, is female oriented. even the occupational structure reveals a strong gender bias, in that males dominate managerial, professional and technical posts. blue collar work is primarily reserved for men, and white collar work is for women. moreover, the gender segregation of occupations is complicated by a vertical dimension within occupations, that causes men and women to be hired at difi'ereqt levels. this phenomenon is clearly r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 112 sajems ns vol 5 (2002) no 1 distinguishable in the managerial vocation where men hold the executive positions or regional managerial posts, whilst women are likely to be administrative and departmental managers. such a rigid occupational structure along gender lines translates into economic inequality. to acquire a more comprehensive understanding of the influence of gender parameters on the labour market, gender.sensitive indicators that compare the situations of males and females to expose relative inequalities, are used. to lay the groundwork for such an analysis, we begin by examining the results of the south african enterprise labour flexibility survey undertaken by the international labour office in south africa in 1995 (standing et al., 1996: 339-345). this is supplemented by a 1998 empirical study of the sexual composition of staff in manufacturing and retailing ftmls. lastly, to gauge the extent of occupational segregation and income disparities between racial groups, a segregation index will be applied to the 1996 south african population census (census in brief, 1996). reasons for occupational segregation a marked feature of most workplaces, industries, occupations and jobs is that they are clearly segregated along gender lines (reskin, 1984: 1). reasons for women's concentration in a limited number of occupations are varied and range from the view that women chose to adhere to certain occupations to the deliberate! decisions to acquire less human capital. also, responsibility for familial duties may be another factor that perpetuates occupational segregation. economic explanations for occupational segregation identify discrimination as a cause of wage inequality (op cit.: 5). more general theories of discrimination expound the role of ''taste for discrimination", the actuality of overcrowding, monopsony in the labour market, statistical discrimination on the part of employers and dualism of the labour market as key elements that actuate inequality in the labour market (reskin, 1984: 2). according to reskin (1984: 3) the segregation and gendering of work can be characterised in three ways: first, social engineering may push certain sexes into different ambits of society, that is, women into the private (or domestic) sphere, and men into the public sphere; second, certain industries and occupations tend to be dominated by one gender, for example, the construction industry and managerial occupations are filled by men, and sales and clerical work by women; and third, work is functionally segregated, that is, men and women perform different types of jobs within the same work setting. women's jobs are usually subsidiary and peripheral to the mainstream jobs undertaken by r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vols (2002) no 1 113 men. diversification of jobs generates conditions that are unique in tenns of authority structures, pay rates and the provision of training opportunities. such a stratification of work hinders movement between hierarchies and confines women to the lower echelons. there is no simple dichotomy between male and female occupations but rather an amplitude of differences between and within both occupational categories and industries. the segmentation of jobs in tenns of educational criteria, skills acquired, ability to operate apparatus or perfonn a designated function, generates jobs that are deemed suitable for a particular gender. typically, female occupations contain fewer promotion opportunities and have many ports of entry in comparison to male jobs. female workers are further differentiated in tenns of age, education and marital status (beechy & perkins, 1987: 134). job segregation and pay differentials since men and women perfonn different types of work, a wage differential develops between the sexes. a gender-stratified occupational structure shores up earnings inequalities and denies women economic parity. studies indicate that there is an inverse relationship between remuneration and the percentage of women in an occupation, holding constant factors such as the length of the workday (beller, 1984: 11). reskin (1984: 4) contends that 'the more "female" an occupation, the less it typically pays'. a major consequence of lower earnings for women is that both women and their families become more susceptible to lower standards of living and general poverty. two models attempt to explain lower wages for women. the exclusion model argues that women are excluded from higher-paying jobs and hired to fill lower-paying ones. this model assumes that pay rates are independent of market forces. the crowding model argues that women are consistently excluded from desirable jobs and crowded into undesirable ones. in this case, market forces ultimately determine wage rates. however, a bloated supply of female labour pushes down wages in desirable jobs (jacobsen, 1986: 242). a person's labour market position does not only detennine a person's wage rate, but also reflects the value that both employers and societies attach to the worker's output. wage levels measure the income that the individual earns for consumption purposes, and ultimately her standard of living. the problem with income inequality is that it tends to become more pronounced over time, thereby complicating its future circumvention. also, low rates of pay for the jobs women perfonn cannot be easily corrected, as most fums tend to adopt existing nonns in deciding their remuneration packages. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 114 sajems ns vol 5 (2002) no i results of ilo survey the south african enterprise labour flexibility survey of 1995 (standing et ai., 1996: 339-45) of 354 manufacturing fmns, aimed to provide information on the employment and hiring practices of firms. regarding the effect of gender in hiring, the survey found the following: 52.1 per cent of all firms opted for male production workers; and 6.6 per cent of all fmns in general were recruiting black women (op cit.: 339). employers that reported a preference for men for production jobs based their argument on 'physical strength' (op cit.: 392). the survey showed that occupational segregation in manufacturing was rife as men tended to occupy mostly managerial, the highly skilled and supervisory positions. on the other hand, very few women occupied senior positions (op cit.: 407). the sectoral distribution of women workers revealed a low share of employment in all sectors, namely: 70 per cent in textiles and garments; • 28 per cent in paper and printing; 22 per cent in chemicals; 21 per cent in food processing; 15 per cent in metals and engineering; 14 per cent other. women were virtually excluded from apprenticeships due to the fact that they accounted for a negligible portion of employment in all sectors, except the textile and garment industry. food processing plants employed no female apprentices. both the paper and printing sectors and the metal engineering sectors employed few female apprentices, namely 2.4 per cent and 3.5 per cent respectively. only the textile and garment industries boasted a large proportion of female apprentices (that is, 58.6 per cent) (op cit.: 402). the small number of female apprentices could be attributed to the fact that employers became reluctant to appoint apprentices during the 19908 as the tax incentive on apprenticeships was removed. another reason for this trend is that employers began to utilise less skilled workers to carry out the routine parts of an artisan's job, leaving the parts requiring more skills to the teclmicians. statistical discrimination regarding women's work ethic also negatively impacted on the hiring of female apprentices (department of labour, 2000: 14). training opportunities for women were scant, with only 23 per cent of women having access to training opportunities. many employers also reported a preference for allocating training opportunities to men and the accessibility of r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vols (2002) no i lis training for women varied directly with the female share of the workforce (op. cit.: 407). the allocation of training opportunities could be viewed as a means of reinforcing gender-based, sectoral segregation of employment. employment trends in manufacturing and retailing industries a survey of manufacturing and retail industries was undertaken in 1998 and aimed to determine the distribution of men and women, irrespective of race, across the occupational hierarchy (lalthapersad, 1998). respondents were asked to provide information on the distribution of males and females, irrespective of race, in terms of the 9 broad categories of occupations as stipulated by the standard classification of occupations (scq). three hundred questionnaires were mailed to retailing and manufacturing firms in the gauteng area. the industrial registrar of the bureau of market research (bmr) served as basis for choosing the sample. in manufacturing, only those firms with a staff complement of more than a hundred were considered whilst in retailing enterprises, a complement exceeding thirty was required. 26s questionnaires were received which gives a response rate of 88 per cent. in analysing all data, t -tests were performed to establish whether differences between the scores were statistically significant. an important consideration in the selection of level of significance is the total number of statistical tests to be performed. as the total number of tests increases, the probability of a type-i error also increases. qne approach to counter this accumulating effect, is to reduce the level of significance for the individual statistical test so as to compensate for the overall type-i effect (winer, 1971: 14-1s). in this study, statistics were performed mostly on an item level. in order to achieve a reasonable protection against type-i error, a level of 0.005 was selected. in the following section, the results of this study are discussed. figure i below, details the occupational distribution in manufacturing industries. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 116 sajems ns vol 5 (2002) no 1 figure 1 percentage of men and women per occupational group in manufacturing industries, 1998 l'rodoietloll& foremen r.......". oericol& .. i .. odwmlcii omen in manufacturing industry, extremely high proportions of men occupied the following job categories: production and foreman (89.7 per cent); artisan and apprentice (97.5 per cent); management (89 per cent); and professional (83.4 per cent) (lalthapersad, 1998). also, a higher percentage of males (63.8 per cent) perfonned unskilled work compared to females (36.1 per cent). women workers were located mainly in the service occupations (69.9 per cent) and clerical and sales (69.8 per cent). the proportion of female artisans and apprentices were marginal (le. 2.4 per cent) (lalthapersad, 1998: unpublished phd thesis). figure 2 displays the results for retail trade. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 117 figure 2 percentage of men and women per occupational group in retail trade, 1998 llbfua:rct. unstilled rm\!d.ii1i •••• ~ •••••• liii==:t~==:j\ $c rv iccopcl'1iilor •••••• , traaapor!i ••••• m cleric .. ia •• le • ••••• 6014 100% iliwom •• om •• in retailing. the following results were noteworthy: males abounded in four occupational categories, namely, production and foremen (69 per cent), artisan and apprentice (90 per cent), management (72 per cent) and professional (80 per cent); females prevailed in three occupational categories, namely, service sectors (67 per cent), unskilled (69 per cent) and clerical and sales (77 per cent); and comparing the retail and manufacturing, it is apparent that the number of females in the categories of professional (19 per cent) and especially management (27 per cent) is substantially higher in retailing (jacobsen, 1986: 56) and (lalthapersad, 1998). higher numbers of females in managerial positions in retailing industry could be attributed to factors such as the magnitude of such enterprises and an evidently large contingent of female workers. the segregation of jobs is extremely marked as evidenced by .the distribution of males and females between occupations. the professional, managerial, production worker, artisans and apprentice categories are overwhelmingly male in both industries. on the other hand, the sales, clerical and service occupations are primarily female. this situation complies with duality in the labour market, namely, whilst the primary sector is essentially male, the secondary sector is exclusively female. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 118 sajems ns vol 5 (2002) no 1 the low proportion of women in managerial, technical and professional occupations, is a crude indicator of women's share of decision-making positions in the economy. furthermore, the jobs women perform are an extension of the caring they provide in the home. the nature of clerical work is such that it can be easily deskilled through the application of microelectronic technology. such an actuality would inflict major job losses among female workers. south african statistical data limited research has been done on the employment and economic sectors of women in south africa. therefore, there is limited statistics and no reliable data base on wage and employment trends. information on wages and other aspects of remuneration such as fringe benefits is also flawed. figures on many aspects of women's activities are non-existent (standing et 01., 1996: 7). also, over the years, a change in the compilation of employment figures has rendered comparative analysis difficult. in fact, the ilo has warned that all data before 1994 be examined cautiously. in light of this, the only major and reliable source of data on the south african labour force, remains the 1996 south african population census data. hence, the 1996 south african census data was utilised to apply the segregation index. segregation index valves the extent of occupational segregation can be measured using the index of segregation. the segregation index attempts to estimate the overall level of segregation. the duncan index of dissimilarity can be used to measure segregation for an array ofvarlables (beller, 1984: ii). the index is calculated as: ( xi yi) looxi; -x-y i_i 2 where : n = the number of occupations xi = the number of persons of a group in occupation i x = the total number of persons in this group y f the total number of persons in a comparison group in occupation i y = the total number of persons in the comparison group. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns vol 5 (2002) no 1 119 the index ranges from zero (complete integration) to 100 (complete segregation). the index value is influenced by the degree of aggregation of occupations. the fewer the occupational categories, that is, if occupations are lumped together, the smaller the value of the index (beller, 1984: 12). in the case of south africa, there are only 10 broad occupational categories such that segregation values are low. table 1 was derived from the 1996 south african population census data and displays the index value per occupational group for the total south african labour force, irrespective of race. table 1 gender index values per occupational group occupation % legislators 45.5 professionals 10 technicians 4 clerks 38 service workers skilled agriculture craft workers plant assemblers elementary unspecified/ other 'source: own four occupational categories appear to be highly segregated, that is: legislators (45.5 per cent); skilled agriculture (59 per cent); craft workers (74 per cent); and plant assemblers (68.5 per cent). the latter three occupations are manual in nature, physically demanding and tend to employ mostly men. the low proportion of women in the above occupations is exacerbated by the fact that women tend to be denied apprenticeship and training opportunities and are thereby excluded from such occupations. a lack of access to, technical education may also be a compounding factor. three occupational categories have intermediate levels of segregation, which categories are: unspecified/other which includes infomial sector work and domestic work r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 120 sajems ns vol 5 (2002) no i (42 per cent); clerks (38 per cent); and service workers (30 per cent). two occupational groups exhibit high integration, namely: professionals (io per cent); and technicians (4 per cent). the reason for the professional group being highly integrated is that most matriculated black women opted for the nursing and teaching professions as these were the only well-paying occupations open to them. the high number of female technicians results from the fact that many white women qualified as technicians since they benefited from a well developed educational system under the policy of separate development. in table 2, the income levels of males and females of each population group are assessed against their respective group. table 1 gender index per income level income level % black % coloured 0/0 indian 0/0 white r3501+ 0.8 4.5 13.1 29.4 r1501r3500 6.8 6 6 17.5 riooi r1500 11.3 0.9 7.7 4.7 rsoirlooo 3 0.9 7.2 3 ro-rs,oo 21.7 10.6 4.1 3.7 source: own for the white population, the index value is highest for the two top income levels due to the previous preferential treatment of white males under the apartheid system.· the two top incomes' bracket cumulatively, accounts for more than a third of all white workers, and compares disproportionately with the other race groups, namely, black (7.6 per cent), coloured (5.1 per cent) and indian (13.7 per cent). for the black population, an index value of 0.8 per cent for the highest income level implies complete integration of both sexes. such a result is encouraging for two reasons. first, black men and women have only recently started to acquire jobs previously denied. to them. second, black workers have embarked on occupational mobility. furthermore, the result is encouraging because even though black women comprise a smaller portion of the labour force, they have r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . samms ns vol 5 (2002) no 1 121 attained income parity with black men. there is quite a high level of integration for the income bracket rsoi-rl001. but segregation is relatively high for the ro-rsoo income bracket. the latter situation is due to high unemployment rates among both black men and women. for the coloured population, there is intennediate segregation in the top income bracket and low segregation for the income level's riooi-ri500 and rsoirlool. relatively high segregation occurs in the lowest income group of ro-r500. the coloured population, like the other two non-white groups were subjected to artificial restrictions in the labour market and tended to occupy mainly secondary sector jobs. for the indian population, segregation in the top income category is high due to the low number of women participating in the labour market. however, the remaining income brackets exhibit a greater degree of integration. conclusion intra-occupational segregation (that is, the concentration of men and women in certain occupations) is an indelible feature of most labour markets. the influence of gender is pervasive in occupational categorisation, that is, some jobs are principally male or outrightly female. this difference in the occupational structure invariably precipitates income inequality, a skewed distribution of fringe benefits and amplifies economic inequality between men and women. women's poverty is the inevitable result of their disadvantaged position in the labour market. women's vulnerability resides in their monopolisation of the service and retail sectors, sectors that are susceptible to retrenchment and downsizing in recessionary periods. according to bhorat (2001: 35) since 1994, 140000 female jobs were lost and black women alone accounted for 118 703 of the said job losses. hence occupational stratification could be largely responsible for the socioeconomic gap between the sexes. a rigid occupational segregation, also impinges on the future occupational structure as sex-tying of jobs becomes more entrenched. to break this convention, women have to be imbued with the necessary support structures and training opportunities to enable them to filter into non-traditional jobs that remunerate fittingly. government has already taken the initiative by legislating the employment equity act in 1998, which seeks specifically to advance women by prohibiting discrimination on the grounds of gender and endorsing affmnative action measures to remedy past imbalances in the labour market. to support companies to reach their employment equity targets, government has passed the skills development act and the skills development levies act, which aims to provide previously disadvantaged groups, such as blacks and women, with the necessary skills to enhance their employability. in r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . 122 sajems ns vols (2002) no i light of the aids pandemic that is expected to reduce the labour force quite drastically, occupational separation will prove to be ineffectual and will be tantamount to a loss of much needed human resources. references barron, r.d. & norris, g.m. (1976) "sexual divisions and the dual labour market", in barker,d.l. and allen, s. (eds.) dependence and exploitation in work and marriage, london: longman. 2 beechey, v. & perkins, t. (1987) a matter of hours, cambridge: pluto press. 3 beller, a.h. (1984) "trends in occupational segregation in the workplace", in reskin, b.f. (ed.) sex segregation in the workplace, washington: national academy press. 4 bhorat, h. (2001) "explaining trends in south africa 1993-1998", in new agenda, 4: 21-38. s department of labour (2000) the national skills development strategy, pretoria 6 jacobsen, j.p. (1986) the economics of gender, massachusetts: blackwell publishers. 7 lalthapersad, p. (1998) ''the casualization of black female labour in south africa," unpublished phd thesis, vista university, pretoria. 8 reskin, b.f (1984) sex segregation in the workplace: trends, explanations and remedies. washington: national academy press. 9 statistics south africa (1998) census in brief report no. 1-0301-11, ssa: pretoria. 10 standing, g.; sender, j. & weeks, j (1996) restructuring the south african labour market -the south african challenge, geneva: ilo office. 11 winer, bj. (1971) statistical principles in experimental design, tokyo. mcgraw-hill. r ep ro du ce d by s ab in et g at ew ay u nd er li ce nc e gr an te d by th e p ub lis he r (d at ed 2 00 9) . sajems ns 11 (2008) no 1 1 calculating operational value-at-risk (opvar) in a retail bank ja’nel esterhuysen investec bank ltd and school of economics, north west university paul styger school of economics, north-west university gary van vuuren financial institutions, fitch ratings and school of economics, north west university abstract the management of operational value-at-risk (opvar) in financial institutions is presented by means of a novel, robust calculation technique and the influence of this value on the capital held by a bank for operational risk. a clear distinction between economic and regulatory capital is made, as well as the way opvar models may be used to calculate both types of capital. under the advanced measurement approach (ama), banks may employ opvar models to calculate regulatory capital; this article therefore illustrates the differences in regulatory capital when using the ama and the standardised approach (sa), by means of an example. economic capital is found to converge with regulatory capital using the ama, but not if the sa is used. jel g21, c15, 16 1 introduction during the early 1990s, the two biggest risks for banks were market and credit risk and a great deal of attention was focused on measuring and managing these risks (harmantiz, 2003: 1). today’s turbulent financial markets, growing regulatory environments and increasingly complex financial systems, however, have led risk managers to measure and manage risks other than market and credit risks, which have come to be known collectively as operational risk (harmantiz, 2003: 1). infrastructure failures (e.g. information technology, terrorist attacks), fraud (e.g. rogue trading), and legal and regulatory risks (e.g. fines) have become the motivators behind the move to proactively manage operational risk in large financial institutions (dev, 2006: 12). although credit and market risks are well understood, and are more likely to damage an institution, operational risk remains an enigma for risk managers, owing almost entirely to lack of understanding of the nature of the risk (dev, 2006: 12). unlike market and credit risks, which tend to be confined to specific areas of the business, operational risk is inherent to all businesses and processes: it is a broader concept than merely operations or back-office risks. operational risk is anything but well understood (dev, 2006: 12): there is disagreement even about specific contingencies that should be considered ‘operational risks’ (for example, should legal risk, tax risk and reputation risk be included?). the debate is more than simply academic (harmantiz, 2003: 2), as the outcome defines the entire initiative for managing operational risk. acknowledgement of the above, coupled with a burgeoning awareness of the importance of operations to business, led the basel committee on banking supervision to include an explicit capital requirement for operational risk when 2 sajems ns 11 (2008) no 1 revising the basel capital accord. the revision began in 1998, and the first consultative document was published in june 1999 (cruz, 2002: 271). the introduction of this additional capital requirement (bis, 2005: 33) took a good part of the financial services industry, those who did not believe this would happen, by surprise (olsson, 2002: 255). under the 1988 accord, it was assumed that the credit risk charge implicitly covered other risks, including operational risk. from january 2008, the new capital guidelines are going to require those financial institutions that elect to use more risk-sensitive modelling approaches to reporting capital to implement robust systems for collection and tracking data (dev, 2006: 13). as a result, most financial institutions have begun to devote significant resources to identifying, measuring, analysing, reporting and mitigating this potentially catastrophic risk class. the aim of all these institutions is to implement a framework that will meet the requirements of the new basel capital accord, including, amongst others, operational loss data collection, operational loss data tracking and a robust internal risk-control system (dev, 2006: 13). within this new framework, banks will implement one of three approaches for calculating minimum regulatory capital for operational risk. these approaches are the basic indicator approach (bia), the standardised approach (sa) and the advanced measurement approach (ama), with complexity increasing from first to last (esterhuysen, 2006: 132). the new capital accord also describes a model for calculating economic capital against extreme risks under the ama, a major contribution to the quantification of operational risk (esterhuysen, 2006: 133). banks therefore calculate two types of capital, regulatory and economic, for operational risk, with the consequent possibility that either too much or too little capital provision is made (belmont, 2004: 121). banks usually employ their own internal capital models (cruz, 2002: 271), which include value-at-risk (var) models for market risk. with the ama, the basel committee will allow banks to use these internal var models to calculate minimum regulatory capital for operational risk, if proof of model accuracy can be provided to regulators (esterhuysen, 2006: 221). the aim of this article is to explain how var for operational risk is calculated and how this may be used to calculate the minimum regulatory capital charge for operational risk under the ama. the way in which this capital calculation method aligns economic and regulatory capital more closely is also demonstrated. actual operational loss data from a south african retail bank is used to demonstrate how regulatory capital is calculated with ama based on a var model. the difference in regulatory capital, calculated with and without an underlying var model, is also explored. the remainder of this article is structured as follows: section 2 provides a brief theoretical background on the basel committee’s proposals for calculating regulatory capital for operational risk, as well as a short discussion on var for operational risk. section 3 explains the methodology employed in this research, and includes a description of a retail bank as well as a brief description of the method for calculating var for operational risk. the results of the calculation of regulatory capital based on var and gross income is discussed in section 4. section 5 concludes the article. 2 literature review two types of capital play a role in safeguarding banks against operational risk, namely economic and regulatory capital, defined as follows: regulatory capital is the amount of capital a regulator requires a bank to hold to safeguard it against operational risk and is based on the proposals of the basel committee with its new basel capital accord. economic capital is the amount of capital a financial institution itself deems necessary to operate normally, given its risk profile and its state of controls (mueller, 2005: 5). as these definitions indicate, regulatory capital is calculated for operational risk based on the proposals of the basel committee in its new basel capital accord. these proposals are based on three approaches, which include the following: sajems ns 11 (2008) no 1 � 1. the basic indicator approach (bia). this approach uses gross income as a proxy for operational risk, with the capital charge equal to 15 per cent of the average of gross income for the last three years. 2. the standardised approach (sa). this approach also employs gross income as a proxy measure for operational risk, but in this case it is divided into eight standard business lines, each with a different risk weight factor to calculate capital. 3. the advanced measurement approach (ama). in the ama approach, the regulatory capital requirement is the risk measure generated by the bank’s internal operational risk measurement system (model) (bis, 2005: 221). banks must adopt certain criteria based on gross income to calculate regulatory capital for operational risk for both the bia and the sa. the ama banks’ own internal operational risk measurement models may be used to calculate regulatory capital. internal operational risk measurement models predominantly involve calculating the var of operational risk in order to determine the amount of regulatory capital required for operational risk (cruz, 2002: 12). when calculating var for operational risk there are three basic principles that should be kept in mind (cruz, 2002: 34), which include the following: • time horizon: the time horizon (period) is, for example, the length of time over which an institution plans to calculate var. the period proposed by the basel committee is one year. • the confidence level: the level of confidence at which the institution will make the estimate. popular confidence levels are 95 per cent and 99 per cent. • the currency unit: the currency which will be used to dominate the value at risk. a variety of models exists for calculating var for operational risk. each model has its own set of assumptions, the most common of which is that historical operational loss data is the best estimator of future changes (cruz, 2002: 35). chenobai et al. (2004: 111) note that the three most frequently-used models for calculating var for operational risk are the historical data model, the variance-covariance model and the loss-distribution model. belmont (2004: 12) and cruz (2002: 113) conclude that the loss distribution model is the most accurate for calculating operational risk var in most banks. chapelle et al. (2005: 14) and alexander (2003: 110) propose an adapted version of the standard loss distribution approach (lda), deriving the aggregated loss distribution by convolving the frequency distribution of loss events and the severity distribution of a loss given event (see figure 1). chapelle et al. (2005: 14) have emphasised that mixing two empirical loss distributions models the severity distribution is calculated more accurately than with a single empirical loss distribution. the model proposed by chapelle et al. (2004: 14) is divided into two parts: the first with losses below a selected threshold (considered as normal losses), and the second with large, potential abnormal losses. both parts are estimates with the usual density functions for fat-tailed distributions. in addition, the loss distribution approach models the frequency using a poisson1 distribution, with parameter µ equal to the number of observed losses during the whole period (alexander, 2003: 23). chapelle et al. (2004: 14) note that it is consequently possible to combine the calibrated frequency and severity distribution to compute the aggregated loss distribution by running monte carlo simulations. the procedure may be described as follows: 1. generate 10,000 poisson random variables representing the number of events for the 10,000 simulated periods. 2. for each period, generate the required number of severity random variables (that is, if the simulated number of events for period k is x, then kx severity losses need to be generated) and to sum these to obtain the aggregated loss for the period. � sajems ns 11 (2008) no 1 3. obtain the vector representing the 10,000 simulated periods. when sorted, the smallest value thus represents the 0.0001 quantile (1/10,000), the second the 0.0002 quantile, and so forth, which makes the var for operational risk very easy to calculate. 4. the last step involves running steps 1 to 3, for example, ten times, and evaluating the average var from these ten runs for operational risk. figure 1 shows these steps schematically. to take the extreme and various rare losses into account, this model applies extreme value theory2 (evt) to the results (chapelle et al., 2005: 14). the advantage of evt is that it provides a tool to estimate rare and not-yetrecorded events for a given database (chapelle et al., 2005: 14). chapelle et al. (2005: 15) mention further that the use of evt emerges very similar to var for operational risk, except at very high percentiles, i.e. > 99.99th percentile. as the basel committee (bis, 2005: 143) recommends a confidence level of 99.90 per cent, the monte carlo simulation will allow this model to compute a sufficiently complete sample, including most of the extreme cases (peters et al., 2003: 29). figure 1 the loss distribution approach banks usually use these models to calculate economic capital, but they will also be permitted to use them to calculate regulatory capital under the ama if they can prove to their respective regulators that these models are accurate and robust. the next section explains how var is calculated for operational risk from a standardised and advanced approach. 3 methodology to illustrate how var for operational risk is calculated and how regulatory and economic capital are calculated using the ama, actual operational loss data were obtained from a south african retail bank. real gross income (source: esterhuysen, 2006: 221) sajems ns 11 (2008) no 1 5 data were also obtained (from the same south african retail bank) to demonstrate how regulatory and economic capital are calculated with the sa. results from these calculations are discussed in section 3. 3.1 south african retail banks the bank explored is a typical south african retail bank, comprising several divisions (esterhuysen, 2003: 134), including compliance, finances, marketing, procurement, distribution, and legal and banking products, as shown in figure 2. figure 2 elements of a south african retail bank (source: esterhuysen, 2003: 134) 3.2 calculation methodology the method used to calculate the var for operational risk was the loss distribution approach (see figure 1). it was conducted with a microsoft excel spreadsheet based on the principles discussed by cruz (2003: 35-71) (see appendix a). 3.3 sample data the data sample used includes the operational losses for the last three years, shown in table 1. the data also includes the gross income for the same bank for the last three years (2003, 2004 and 2005), as shown in table 2. the operational loss data in table 1 is actual data obtained from a south african retail bank and is set out from the largest to the smallest loss. these losses, recorded in 2003, 2004 and 2005, were extracted from the bank’s internal operational loss database (i.e. they are regarded as internal operational loss data). table 1 operational loss data (in r) from a south african retail bank 9 669 000 328 416 222 910 161 333 118 397 94 636 76 991 55 476 15 245 3 177 1 464 5 380 000 325 492 211 048 154 216 117 855 93 588 75 745 45 731 13 603 2 873 1 250 1 139 196 323 414 207 425 154 010 114 745 93 085 75 587 42 161 10 209 2 626 1 069 1 101 618 319 171 196 441 151 088 112 393 92 396 73 119 37 918 10 000 2 621 1 000 845 663 303 966 195 847 141 580 110 535 92 311 69 008 36 561 9 472 2 621 686 724 299 248 189 670 138 644 109 561 87 434 64 343 36 002 8 000 2 419 684 420 296 288 185 932 135 024 106 718 86 239 64 276 22 979 7 661 2 275 6 sajems ns 11 (2008) no 1 574 061 293 205 175 863 132 092 104 918 85 347 63 471 21 874 6 696 2 077 461 773 286 591 175 668 128 575 103 937 81 380 63 009 21 671 6 091 2 000 352 522 278 993 170 182 126 390 101 302 80 021 59 948 21 671 5 400 1 692 329 410 274 708 164 826 118 516 100 501 78 656 57 316 17 681 3 587 1 568 gross income data in table 2 are based on the definition of the basel committee in its new framework, where gross income is defined as net interest income plus net non-interest income, with the intention that it should be gross of any provisions; be gross of operating expenses, including fees paid to outsourcing service providers; exclude realised profits/losses from the sale of securities in the banking book and exclude extraordinary or irregular items, as well as income derived from insurance (bis, 2005: 221). table 2 gross income from a south african retail bank 2003 2004 2005 net interest income plus net non-interest income* 312 009 876 371 654 826 407 765 891 plus operating expenses 44 328 745 51 998 213 61 558 901 plus provisions 14 990 342 12 896 872 15 892 334 minus realised profits – – – minus income from insurance 3 231 000 5 689 198 11 895 324 gross income 368 097 963 430 860 713 473 321 802 * net interest income plus non-interest income is referred to as profit from ordinary activities before goodwill amortisation, i.e. operating expenses and provisions are already included. 4 results this section aims to explain the var calculation for operational risk so that a better understanding of the management thereof may be instituted. this section will also explain how regulatory and economic capital are calculated (using both the sa and ama approaches) as well as the role that var plays in the calculation of these two types of operational risk capital. 4.1 the standardised approach (sa) the basel committee specifies eight business lines within the sa whereby regulatory capital is calculated by means of multiplying a beta factor () with the average gross income for the last three years for each business line. the loss data used in this example is extracted from the retail division of a south african bank and thus falls under the “retail banking” business line for which the basel committee proposes ( = 12%). regulatory capital, based on the definition of gross income in section 2, is then calculated as (using data obtained from table 2): regulatory capital sa = 3 1 gross income t 2003 2005 = e o! .  = 3 1 368 097 963 430 860 713 473 321 802 × 12%+ +^ h = 50 891 219 sajems ns 11 (2008) no 1 � the minimum regulatory capital the bank is thus required to hold under the sa for the “retail banking” business line is r50 891 219. economic capital is calculated for the same business line, using var (which employs the loss distribution approach: see figure 1). this calculation is conducted in microsoft excel, and uses the operational loss data from table 1. appendix a details the calculation methodology. as illustrated in figure 1, the first step in calculating var for operational risk is to derive the frequency distribution for the sample in table 1. figure � frequency distribution the next step in the calculation of var for operational risk is to derive a severity distribution for the sample in table 1. an exponential severity distribution for the data in table 1 is illustrated in figure 4. figure � severity distribution 8 sajems ns 11 (2008) no 1 following this, by running 5 000 monte carlo simulations it is possible to derive an aggregated loss distribution from the simulated frequency and severity distributions, illustrated in figure 5: figure 5 aggregated loss distribution the next step is to calculate the percentiles from the aggregated loss distribution in order to determine the var. these percentiles are illustrated in table 3. if the bank chooses a 99.9 per cent confidence level, it will use the 99.9th percentile at which confidence level var for operational risk is r13 384 748, the amount of economic capital the bank will hold for operational risk. if regulatory capital is calculated by means of the sa, and economic capital by means of var, regulatory capital will then be almost four times more then economic capital. this difference is illustrated in figure 6. table � percentiles percentile value percentile value 99.9 13 384 748 75 9 227 356 99 12 076 551 70 8 994 968 95 10 923 061 65 8 774 800 90 10 276 852 60 8 559 977 85 9 861 256 55 8 347 726 80 9 503 911 50 8 121 771 sajems ns 11 (2008) no 1 � figure 6 regulatory capital calculated on a proxy of gross income and economic capital calculated by a var approach the next section describes the calculation of regulatory capital by means of the ama, and discusses the differences when compared with calculating regulatory capital by means of the sa. 4.2 the advanced measurement approach (ama) regulatory capital calculations with the ama permit banks to use, amongst others, a var approach. in section 3.1, the minimum operational loss at a 99.9 per cent confidence level was calculated at r13 384 748, which is equal to the minimum amount of economic capital the bank will hold for operational risk. if banks are allowed to use var calculations to calculate regulatory capital, the amount of regulatory capital the bank will hold with ama will also be r13 384 748, i.e. economic and regulatory capital are equal. there is a reduction of r37 506 471 (r50 891 219 – r13 384 748) in regulatory capital when the bank migrates from the sa to the ama (see figure 7). figure � regulatory and economic capital with the ama 10 sajems ns 11 (2008) no 1 4.3 discussion the basel committee’s intention with its operational risk capital framework is to guide banks to better align minimum regulatory capital with economic capital when a bank moves from a simple approach to a more complex approach. the example illustrates how the regulatory capital will decrease if a bank with proportionately low documented operational losses to gross income moves from the sa to the more complex ama. it is important to note that the calculation of regulatory capital with the sa is based on gross income, which is a poor indication of the real operational risks occurring in a bank. however, this is the only proxy for operational risk offered in the accord for a bank that is incapable of reporting operational loss data and complying with the other qualitative requirements for reporting under the ama. with the ama, the basel committee proposes that banks use their last three years of operational loss data to calculate var for operational risk. if operational losses are used to calculate regulatory capital, it will also mean that banks will hold less regulatory capital if they can prevent or decrease some of their operational losses if they implement a more robust operational risk management and control environment. consequently, banks that manage operational risk appropriately will incur a less punitive capital charge under the ama. this is, however, not the case with the sa, as gross income is not impacted by a robust operational risk management environment. when a bank uses var to calculate regulatory capital, this figure could equal economic capital if the bank were to use var to measure economic capital. because var for operational risk is also based on past operational losses, the bank will hold regulatory capital commensurate with the size of operational risk it faces, as recorded operational losses are perhaps the best indicator of the magnitude of operational risk. banks might experience an increase in regulatory capital when they migrate from the sa to the ama if they have a large number of extensive operational losses. however, their compliance with appropriate regulations will ensure that they will be holding a more representative amount of capital. this statement introduces one of the key conclusions of this article, which is that the amount of regulatory capital calculated by the ama correlates directly with the size of operational risk faced by the bank. this is one of the advantages of calculating regulatory capital by means of var. in addition, the basel committee states that banks must hold capital equal to their unexpected losses with the ama if they have figure 8 expected and unexpected losses sajems ns 11 (2008) no 1 11 made provisions for their expected losses. expected losses are the operational losses expected to occur at least once a year and are calculated as the mean of the loss distribution. in the current example, this is calculated by estimating the average loss resulting from the 5 000 monte carlo simulations. unexpected losses are the difference between the 99.9th percentile value (or the var value) and the expected loss (mean) as illustrated in figure 8. note that, in the example, the mean of the aggregated loss distribution is not equal to the 50th percentile (see table 3). if the bank in the example made operational loss provisions equal to or greater than its expected losses, regulatory capital required under the ama is r6 874 634, which consequently means that regulatory capital will be less than economic capital, as illustrated in figure 9. regulatory capital could still equal economic capital when var is used to calculate regulatory capital: the two types of capital will be different only if a bank has accurately forecast and designated provisions for expected losses. figure � regulatory capital if provisions were made 5 conclusion as the deadline for the implementation of the new basel capital accord has recently passed, banks are focusing not only on the identification and management of operational risk, but also on the measurement thereof. banks must be able to measure operational risk (under ama) in order to be able to hold the requisite capital. the basel committee has proposed three approaches within its new framework: the basic indicator approach, the standardised approach and the advanced measurement approach. with the ama, the basel committee has proposed the most prudent level of regulatory capital, which has resulted in the majority of international banks aiming to implement this approach. further, the capital value under the ama will be a truer reflection of the operational risk a bank faces. with the ama, banks will be allowed to use their own internal capital models to calculate regulatory capital if they can prove to their respective regulators that these models are accurate. these models are usually value-atrisk (var) models, which banks use to calculate economic capital. banks aiming to calculate var for operational risk based on past operational losses have found that the challenge was not always just in the calculation, but was also in understanding the results and the management of these losses. 12 sajems ns 11 (2008) no 1 this article illustrates how operational risk may be measured using var techniques in the calculation, as well as how this var figure influences the amount regulatory capital banks will hold for operational risk. banks may hold less capital when they use the ama to calculate regulatory capital by means of var, but this might not always be the case. for example, it may happen that, if a bank has experienced large operational losses in the last three years but has not experienced much growth in terms of gross income, the bank will hold more regulatory capital with the ama than with the sa. alternatively, the ama may benefit banks that have accurate operational loss data that has been collected over some time; var can be computed from this data, which will mean not only that the amount of regulatory capital will be more aligned with economic capital, but also that banks will hold regulatory capital more aligned with the size of operational risk. the amount of regulator capital will thus be directly correlated to the size of operational risk. banks have to understand what is used in the var calculation in order to ascertain ways of decreasing this figure. the calculation of var for operational risk is based predominantly on recorded operational losses. consequently, if the value and frequency of operational losses increases, operational risk var will increase. it is not certain whether banks will hold less regulatory capital when they move from the sa to the ama, but it might mean that they hold more. this, however, should not discourage banks from implementing the ama nor from calculating regulatory capital by means of var, as it will ensure a more accurate regulatory capital figure. banks will also benefit from implementing a robust operational risk management environment as this will ensure that operational losses are better controlled, implying a lower var for operational risk and a lower regulatory capital figure. additional research could address the other three factors proposed by the basel committee for operational risk var calculation, including the external operational losses database, business expertise, and scenario analysis. this article has focused only on the operational losses from the internal operational loss database. endnotes 1 the poisson distribution is defined as a mathematical statement of the probability that exactly k discrete events will take place during an interval of length t (alexander, 2003:15). 2 extreme value theory (evt) is a statistical discipline to describe and understand quantifiable rare events. it is especially well-suited to describe the fat tails of profit and loss distributions (alexander, 2003:2). 3 it is, of course, also possible to calculate other percentiles, for example the 99th percentile or the 95th percentile. references 1 alexander, c. (2003) “statistical models of operational loss”. in operational risk: regulation, analysis and management (pp. 102–189). ft prentice hall: new york. 2 bank for international settlements (bis), basel committee on banking supervision. (2005) international convergence of capital measurement and capital standards: a revised framework. november 2005. bis, basel, switzerland. 3 belmont, b. (2004) value added risk management in financial institutions, (1st ed.) john wiley & sons ltd: chichester, uk. 4 chapelle, crama, a., hubner, y., & peters, j. p. (2005) “measuring and managing operational risk in the financial sector an integrated framework”, working paper, hec management school, university of liege, november 2003. 5 chernobai, a., menn, c., truck, s. & rachev, s. t. (2004) “a note on the estimation of the frequency and severity distributions of operational losses”, journal of applied probability trust, university of california, santa barbara, usa, december: 13-27. 6 cruz, m.g. (2002) modelling, measuring and hedging operational risk, john wiley & sons ltd: west sussex, uk. 7 dev, a. (2006) “operational risk: some issues in basel ii ama implementation in us financial institutions”, risk, washington, usa, april. 8 esterhuysen, j.t. (2003) “the management of operational risk in south african banks” (thesis: mcomm), potchefstroom, south africa: pu for che. 9 esterhuysen, j.t. (2006) “managing operational value-at-risk (opvar) in a banking environment” (thesis: dcomm), north-west university, potchefstroom, south africa. sajems ns 11 (2008) no 1 1� 10 harmantzis, f. (2003) “turbulent times focus attention on operational risk management in financial services”: [online] available at: http:// www.lionhrtpub.com [date of access:4 april 2005]. 11 hoffman, d.g. (2002) managing operational risk: 20 firm wide best practice strategies, john wiley & sons ltd: chicago, usa. 12 mueller, h. (2005) “economic capital – recent market developments and current trends, paper prepared for the society of actuaries’ risk management section council, uk, october. 13 olsson, c. (2002) risk management in emerging markets: how to survive and prosper, prentice hall, new york, usa. 14 peters, j.p., grama, y. & hubner, g. (2003) “basel ii project: computation of opvar”, working paper, hec management school, university of liège, belgium. appendix a calculating var for operational risk in microsoft excel step 1 – simulating frequencies this article uses the poisson frequency distribution to model the frequency of the operational loss data illustrated in table 1. it is therefore important to calculate . the data in table 1 was collected over 2 years, but, as discussed, var is calculated over one year. thus, if there were 144 data points over 24 months,  = 57 – the number of data points over 12 months. figure 10 shows the requisite excel spreadsheet with three columns labelled “run#”, “frequency” and “adj total”. the “run#” column is a list of the number of simulations that will be performed, in this case, 5 000. in the “frequency” column, poisson random numbers are generated as follows: step 1 – choose the tools function on the toolbar step 2 – at tools, choose the data analysis function step 3 – choose the random number generation function step 4 – select the following: 1. number of variables = 1 (only one frequency per simulation) 2. number of variables = 5 000 (the number of simulations) 3. distribution = poisson 4.  = 57 figure 10 simulating frequencies in excel run # frequency adj total 1 62 2 59 3 57 4 53 ... ... 5000 49 1� sajems ns 11 (2008) no 1 if these basic steps are followed, 5 000 poisson random variables are generated that simulate the frequency of the operational loss data in table 1. the next step is to model the frequency, which is done by counting how many of a specific random number there were in the 5 000 simulations. for example, of the 5 000 simulations, there were 7 occasions when the loss was r0.20 when the loss was r1.18 when r2, and so on. the highest poisson number in the test result was 82, so only 83 rows are required, as illustrated in table 4. table � example – simulated frequencies random variable count 0 0 1 12 ... ... 83 0 in explanation of the above, for example, in the truncated data, there were 14 instances of 2 out of the 5 000 simulations, which means that there were two days out of the 5 000 simulated days on which the loss occurred 14 times per day. in order to calculate the probability, the number per day is divided by 5 000 simulations, for example 14 divided by 5 000, which will be a percentage. after the above process has been carried out, the results can be graphed, as illustrated in figure 3. step 2 – simulating severities the next step involves modelling the operational loss severity in table 1. this is also performed in the “adj. total” column in the microsoft excel spreadsheet. the severity figures will also be based on random generated numbers, and will be based on the frequency for that specific simulation. for example, if the frequency states “3”, then three uniform random numbers should be generated to calculate the simulated severity for simulation number 10. these uniform numbers will then be equal to p, i.e. the probability that helps to find the quantile in the exponential distribution function. the following example will explain the above, assuming that the following are given: the average of all the losses () = 145.917  for exponential distribution = 1 n = 145.917 1 = 6.853 × 10-6 cumulative exponential distribution function x = ln – (1 – )p m to explain figure 11, 5 randomly generated values are simulated by means of the exponential distribution, and are then added to calculate the severity for the first simulation. this can also be calculated in excel by using the loginv function, in which p is equal to the frequency of the first simulation, the location is the number of the simulation, and the scale is . the excel spreadsheet then automatically calculates 5 000 severities, as illustrated in figure 12. sajems ns 11 (2008) no 1 15 figure 11 calculating random generated severities run# frequency adj total 1 5 this is the value of exponential distribution calculated with the probability in 1, 2 or 3, by means of the cumulative exponential distribution function of: x = ln (1 – )p m 1 0.740027 196 575 2 0.014311 2 103 3 0.76089 208 782 4 0.907813 347 856 5 0.846326 273 290 1 028 607 figure 12 simulating severities run # frequency adj total 1 62 6 885 094 2 59 9 199 841 3 57 8 307 141 4 53 6 972 763 ... ... ... 5 000 49 7 955 055 figure 4 is a graphical representation of the severity distribution. it is important first to choose loss bands for the data, in this case 17, r1 million bands. the severity is calculated using excel’s “frequency” function. step 3 – ordering the data and calculating percentiles the next step involves adding a column to the spreadsheet (in figure 13 labelled “ordered data”). the data in the “adj total” column is then ordered from high to low, as shown in figure 13. figure 1� ordered values run # frequency adj total ordered total % 1 62 6 885 094 14 116 282 99.9 2 59 9 199 841 13 639 821 99 3 57 8 307 141 13 598 795 95 4 53 6 972 763 13 573 857 90 ... ... ... ... 5 000 49 7 955 055 3 097 617 0 16 sajems ns 11 (2008) no 1 the mean is then calculated, i.e. the average of all the 5 000 aggregated values: 5 000 r41 128 240 000 = r8 236 448 the percentile is estimated and empirical results indicate that it is best to use the 99.9th percentile.3 the percentiles can be calculated from the ordered total in the excel spreadsheet by using the “percentile” function in which the “data array” is all the data in the ordered total column and “k” is the required percentile (for example the 99.9th percentile will be 0.999). the calculated percentile values are shown in table 5. choosing a confidence level leads directly to the operational var. table 5 var percentiles percentile value percentile value 99.9 13 384 748 80 9 503 911 99 12 076 551 75 9 227 356 95 10 923 061 70 8 994 968 90 10 276 852 65 8 774 800 85 9 861 256 60 8 559 977 80 9 503 911 55 8 347 726 abstract introduction the rationale and application of broad-based black economic empowerment codes in south africa prior studies on the financial motives for companies to engage in broad-based black economic empowerment activities methods results conclusion acknowledgements references about the author(s) jan a. dreyer school of accountancy, stellenbosch university, stellenbosch, south africa suzette viviers department of business management, stellenbosch university, stellenbosch, south africa nadia mans-kemp department of business management, stellenbosch university, stellenbosch, south africa citation dreyer, j.a., viviers, s. & mans-kemp, n., 2021, ‘broad-based black economic empowerment and corporate financial health’, south african journal of economic and management sciences 24(1), a3652. https://doi.org/10.4102/sajems.v24i1.3652 original research broad-based black economic empowerment and corporate financial health jan a. dreyer, suzette viviers, nadia mans-kemp received: 08 apr. 2020; accepted: 29 sept. 2020; published: 21 jan. 2021 copyright: © 2021. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: legislation was implemented in south africa in 2003 and revised in 2013 to promote broad-based black economic empowerment (b-bbee). aim: to investigate the relationship between b-bbee compliance and a range of financial health measures among publicly listed companies. setting: altogether 379 companies listed on the johannesburg stock exchange over the period 2004–2015. methods: data on the sampled companies’ b-bbee scores (in total and per element) were sourced from empowerdex, whereas financial data were downloaded from bloomberg. panel regressions were computed to investigate hypothesised relationships. results: a significant increasing trend was noted in b-bbee compliance over the research period. no significant relationships were found between the total b-bbee score, individual b-bbee elements and any of the considered accounting-based measures (annual percentage change in turnover, return on sales, return on assets and return on equity). a significant negative relationship was observed between the market-based price/earnings ratio and total b-bbee score, while a significant positive relationship was noted with the cost of equity. the latter seems to indicate a negative perception among shareholders towards b-bbee. conclusion: although b-bbee legislation has been partially successful, more can be done to achieve its goal of empowering black employees and small business owners. management teams should be more diverse and greater emphasis should be placed on socio-economic development and skills development. companies should caution against overemphasising the importance of black ownership, as shareholders seem to view this b-bbee element in a somewhat negative light. keywords: broad-based black economic empowerment; social justice; financial performance; cost of equity; risk. introduction a new era dawned in south africa in 1994 as the apartheid regime was replaced by a democratic one and freedom for all citizens seemed possible at last. amidst the changing political landscape, the late president nelson mandela pleaded for reconciliation among all racial groups. he stated that physical freedom was not sufficient, and that economic freedom had to be cultivated (ponte, roberts & van sittert 2007; tangri & southall 2008). a staggering 80% of black business owners felt that their foundation was weak at the end of apartheid, and that they could not compete fairly with white individuals (masito 2007). one suggestion to level the playing field was to introduce legislation to promote black economic empowerment (acemoglu, gelb & robinson 2007; jeffrey 2014). legislation has been introduced in other contexts to address race and gender imbalances in the labour force in general and at board level in particular. for example, in 2003, only 9% of all directors of listed companies in norway were women. to address this imbalance, a 40% mandatory quota was introduced (ahern & dittmar 2012). although the legislation was initially opposed (wiesema & mors 2016), attitudes have since changed (seierstad 2016). a number of laws were promulgated in south africa to promote racial equality, the most prominent being the employment equity act (no. 55 of 1998) and the broad-based black economic empowerment (b-bbee) act (no. 53 of 2003) (hereafter referred to as the 2003 act). in drafting the latter, the black economic empowerment (bee) commission (2001) advocated that b-bbee should be a ‘people-centred strategy’ which should empower all black people in every sphere of life. in contrast to norway’s board gender quotas, compliance with the 2003 act is only mandatory for companies doing business with the south african government. as non-compliance does not result in penalties, a mere 60% of companies surveyed in 2016 achieved a desirable score (bee commission 2017). although the average score increased slightly from the previous year, it does suggest that some companies are not taking b-bbee compliance seriously. as b-bbee is aimed at rectifying the injustices of the past, pike, puchert and chinyamurindi (2018) argued that the phenomenon should be studied through the lens of the social justice theory. governments should accordingly aim to provide economic systems that promote the principles of equality and fairness (rawls 1999). sartorius and botha (2008) reported that compliance soon after the promulgation of the 2003 act was primarily driven by the view that b-bbee is a necessary and important step in rebuilding the south african economy. scholars have, however, become more critical as the years passed with many claiming that legislation only benefits a few elite citizens (hoffman 2008; patel & graham 2012; tangri & southall 2008), while creating very little wealth for the disadvantaged majority in the country (andrews 2008; krüger 2011). compliance with the 2003 act can furthermore be motivated by the organisational legitimacy theory. as initially explained by dowling and pfeffer (1975), organisational legitimacy refers to the combination of a company’s values and objectives, and the values and objectives of the broader environment of which they form part. in the context of b-bbee, attention should thus be given to economic upliftment and corrective action to amend past injustices to gain organisational legitimacy. apart from the social justice and legitimacy perspectives, south african and foreign companies are increasingly questioning whether there is a clear financial motivation to comply and improve compliance with the 2003 act (de wet 2016; kleynhans & kruger 2014). contradictory results have been reported on the relationship between b-bbee and financial performance in previous studies (acemoglu et al. 2007; kleynhans & kruger 2014; mathura 2009; morris 2018; van der merwe & ferreira 2014). it should, however, be noted that these authors utilised relatively small samples, mainly employed accounting-based and market-based performance measures and, with the exception of morris (2018) and van der merwe and ferreira (2014), focused on total b-bbee scores without accounting for the individual elements of the scorecard. in this study, a more comprehensive analysis was therefore conducted. attention was not only given to the total b-bbee score that a company achieved on the department of trade and industry’s (dti) scorecard, but also to the individual elements of the scorecard, including ownership, management, employment equity, skills development, preferential procurement, enterprise development and socio-economic development. the study covered a large sample of 379 companies that were listed on the johannesburg stock exchange (jse) for more than a decade (2004–2015). broad-based black economic empowerment data were sourced from empowerdex, a leading b-bbee rating agency in south africa. financial health was measured in terms of accounting, market-based and value-based performance, a company’s cost of equity and default risk probability. data on all of these measures were downloaded from the bloomberg (2018) database. the aim of the study was to investigate the relationship between b-bbee scores (in total and per element) and various financial health measures. directors and managers are more likely to implement b-bbee strategies if increased compliance is associated with improved financial results. wider acceptance of b-bbee among locally listed companies could have a positive economic impact in many ways. a discussion on the rationale and application of b-bbee will be presented next, followed by pertinent research on the financial motives to enhance b-bbee compliance. thereafter the methods used to collect and analyse secondary data will be outlined, followed by pertinent findings. recommendations will then be offered to policymakers, corporate decision-makers and shareholders. the rationale and application of broad-based black economic empowerment codes in south africa following the transition from the apartheid government to a democratic government in 1994, political equality was deemed insufficient to rectify the social and economic inequalities permeating south african society at the time (acemoglu et al. 2007). in line with the belief that policy was vital to affect economic transformation, the 2003 act was promulgated, and revised in 2013 (dti 2013; republic of south africa 2003). the 2003 act compelled all companies with a turnover of more than r10 million per year to comply with a set of requirements to promote equality and increase broad-based and effective participation of black people in the local economy (republic of south africa 2003). the 2004 draft of the codes of good practice focused on seven elements of economic empowerment, namely ownership, management, employment equity, skills development, preferential procurement, enterprise development and other elements (collated as the residual element) (dti 2004). these elements provide a common base for measuring compliance with the 2003 act. the 2004 codes were adjusted in 2007 and 2013 to promote companies’ level of participation. the latest 2013 codes came into effect on 01 may 2015 (empowerdex 2016). the weightings and requirements of the compliance levels were amended. according to empowerdex (2016), the 2013 codes were likely to have a negative impact on the b-bbee ratings of businesses, as the requirements became stricter. the difference in elements and weighting for the respective elements of the 2004, 2007 and 2013 codes are shown in table 1. table 1: elements and weightings of the broad-based black economic empowerment codes. perusal of table 1 reveals that there has been limited change in the weightings of the elements in the 2004 draft codes compared to the 2007 codes. there were only slight changes in the employment equity and skills development weightings. the 2004 codes also made provision for a residual element, which entailed a company’s corporate social investment activities. in the 2007 codes, the residual element was renamed socio-economic development initiatives. a number of changes occurred in 2013. the entire weighting for employment equity was distributed to ownership, management control and skills development in equal proportions. emphasis shifted to a representative workforce and the empowerment of black owners and managers. preferential procurement and enterprise development were consolidated into enterprise and supplier development. the aim is to assist and accelerate the development of small to medium enterprises owned by black people (dti 2013). according to magure (2012), reformative policy should be a by-product of economic policy focusing on economic growth. marazanye (2016) added that stakeholder buy-in is critical for the success of any reforming act. without stakeholder buy-in, the act becomes a legal and financial burden to conducting business and is likely to result in failure. chidede and warikandwa (2017) added that foreign direct investment is critical to economic growth. as such, a reformative act should be implemented in such a way that foreign direct investors are not deterred from investing in a country. according to de wet (2016), investors allocating capital to companies with high b-bbee scores are typically interested in the potential financial benefit in addition to the moral justification. in this study focus is therefore placed on the possible financial motives for companies to engage in b-bbee compliance. prior studies on the financial motives for companies to engage in broad-based black economic empowerment activities financial benefits that are related to b-bbee compliance can be measured by using accounting-based, market-based, value-based and risk-based metrics. while accounting-based metrics measure the historic profitability of a company, market-based measures account for the creation of shareholder wealth and expectations regarding future profits (verweire & van den berghe 2004). value-based measures reflect profit relative to the cost of the capital. default risk probability indicates whether companies with increased b-bbee compliance would be more or less likely to meet their debt repayments (bloomberg 2018). a number of researchers considered the relationship between a company’s total b-bbee score and accounting-based financial performance (acemoglu et al. 2007; kleynhans & kruger 2014), and between total b-bbee score and market-based financial performance (de villiers & ferreira 2011; mathura 2009; morris 2018; van der merwe & ferreira 2014). these scholars reported inconclusive results. in their evaluation of the individual elements of the b-bbee scorecard, van der merwe and ferreira (2014) also reported conflicting observations. whereas a significant positive association existed between management control and total share returns for the top empowerment companies over the period 2005–2011, significant negative associations were noted between the ownership and preferential procurement elements of the b-bbee scorecard and total share returns. the authors concluded that the costs relating to these two b-bbee elements exceeded the perceived benefits of being compliant in the short term. morris (2018) took a slightly different approach and evaluated the link between business risk and the individual elements of the dti’s b-bbee scorecard. she found no significant relationships between any of the elements and the sampled companies’ unleveraged betas (which she used as a proxy for business risk). this study covered 137 industrial firms listed on the jse over the period 01 january 2010 to 30 april 2015. based on the empirical evidence, morris (2018) concluded that b-bbee: … should not be classified as a business risk factor [for jse-listed industrial companies] and should not be treated with underlying bias (racial or otherwise) as a problematic issue to be addressed as part of an entity’s corporate risk management strategy. (p. 115) other authors in the field performed event studies to compute cumulative abnormal returns before and after b-bbee equity deal announcements. with the exception of mehta and ward (2017) who reported a significant positive short-term and significant negative long-term impact, others reported insignificant results (chipeta & vokwana 2011; strydom, christison & matias 2009; ward & muller 2010; wolmarans & sartorius 2009). akinsomi (2016) compared the risk-adjusted returns between listed b-bbee compliant and non-compliant property companies in south africa from 2006 to 2012. the author found that investors are more likely to provide capital to compliant companies as they have significantly higher returns than their non-compliant counterparts. the growing number of scholars evaluating the market impact of b-bbee activities (which are reflected in companies’ b-bbee scores) attest to the importance that local and foreign investors attach to the topic. the mixed evidence presented by prior researchers compelled the authors to look at more aspects of financial health. this more holistic approach provided a different perspective on financial performance and risk. as far as could be established, no previous studies employed a combination of accounting-based, market-based, value-based and risk-based measures when assessing b-bbee compliance. a summary of local and international studies on the relationship between b-bbee (in the south african context) and ethnic diversity (in the international context) and various financial performance measures are presented in table 2. table 2: overview of studies on empowerment and financial performance measures. care should be taken when interpreting some of the results indicated in table 2, given the small sample sizes that were considered. kleynhans and kruger (2014) rightfully suggested that a longer-term study should be conducted to draw valid conclusions on the relationship between profitability and b-bbee. as indicated in table 2, international authors typically measured ethnic diversity in terms of the percentage of minority directors serving on boards. the majority of these studies yielded positive results. in contrast, mans-kemp and viviers (2015) reported a negative relationship between the percentage of black directors and total share returns for a sample of jse-listed companies. given the stated gaps in the literature, a comprehensive analysis was conducted by including b-bbee scores in total and per element. the relationships between these b-bbee measures and a range of accounting-based, market-based and value-based measures, cost of equity and default risk probability were investigated over a longer study period and for a larger sample in comparison to previous authors. the following hypotheses were formulated: ha1: there was a relationship between total b-bbee scores and the financial health of selected jse-listed companies over the period 2004–2015. ha2: there was a relationship between the individual b-bbee element scores and the financial health of selected jse-listed companies over the period 2004–2015. methods in this section, the collection and analysis of quantitative b-bbee and financial health data for 379 companies (1767 observations over 12 years) will be explained. sample selection since the study focused on the financial health of companies listed on the jse, the population included all companies listed on the bourse over the study period (see table 3). the sample included all companies that were included in empowerdex’s list of most empowered companies from 2004 to 2015. the list is annually populated based on voluntary participation by companies. empowerdex ranks these companies based on their total b-bbee scores and releases the scores of the most empowered companies. table 3: details on the population and sample. as the b-bbee scores were not available for all the sampled companies for the entire study period, an unbalanced panel design was used. as indicated earlier, the financial health data were downloaded from the bloomberg database, whereas the b-bbee scores were sourced from empowerdex (measured based on the 2007 codes). the operationalisation of the variables is explained in table 4. table 4: operationalisation of the variables. fixed, random and pooled ordinary least square (ols) panel regression models were employed to investigate the nature of the relationships between the dependent, independent and control variables. the f-test and hausman test were used to determine the appropriate regression model. the equations for the pooled ols model (equation 1), fixed effects panel regression (equation 2) and random effects panel regression (equation 3) are presented below: in equation 1: yit = dependent variable β0 = intercept β1 = regression coefficient xit = independent variable ∈it = error term in equation 2: yit = dependent variable for entity i at time t b0i = (i = 1…n), the intercept for each entity (separate intercepts are indicated for each unit) dt = dummy variable for each time period b1= regression coefficient xit = independent variable for entity i at time t ∈it = error term in equation 3: yit = dependent variable for entity i at time t b0 = intercept b1 = regression coefficient xit = independent variable for entity i at time t µi and ωt = separate error terms for entity i and time t ∈it = within-entity error where applicable, the results were adjusted for heteroskedasticity. in an attempt to address autocorrelation, a 1-year lag was used in line with the release of the b-bbee scores. the empowerdex lists of most empowered companies reflected scores that were measured for companies during the previous year, whereas the financial health data were used for the year in which the list was published (e.g. the 2012 b-bbee activities of a company were measured in 2013 and the scores released in 2013. the 2013 financial health data were then used, since the potential financial health effect should be dependent on the b-bbee score). multicollinearity was addressed by calculating variance inflation factors and were all found to be less than 10. to ensure the reliability and validity of the financial data, checks were conducted in instances where the parameters changed considerably over time, and parameters that were deemed very high or low. extreme values were winsorised. the cost of equity analysis was reperformed removing the low and negative values, with the results not differing. delisted companies were included for the years that they were listed on the bourse. empowerdex’s b-bbee scores were verified, where available, against the audited b-bbee certificates. the robustness of the results was improved by including several control variables, and testing and adjusting for specification errors. results an overview of the b-bbee scores will be provided, followed by a discussion of the financial health measures. the panel regression results will then be presented. descriptive overview the descriptive statistics for the total b-bbee score are provided in table 5 and the b-bbee elements are provided in table 6. the total b-bbee score is divided per year, while the b-bbee elements are presented in total. table 5: descriptive statistics for the total broad-based black economic empowerment score. table 6: descriptive statistics for the broad-based black economic empowerment elements. as seen in table 5, the total b-bbee scores were widely distributed for the sample companies. during 2012, one company had a very high b-bbee score. this achievement could be ascribed to the bonus points available in the 2007 codes. this company managed to comply with some of the additional criteria for bonus points, which enhanced its total b-bbee score. based on the mean scores, companies almost doubled their compliance scores from 2009 to 2010. the 2010 scores were based on approximately the 100 most empowered companies, as opposed to approximately the 200 most empowered companies prior to 2010. a slight reduction in the mean and median total b-bbee scores was noted during the last part of the study period. the revised codes were published in 2013. companies could arguably have spent more time understanding the newly released 2013 codes, as opposed to focusing their efforts on compliance with the 2007 codes. as mentioned earlier, the 2013 codes were stricter and could arguably have required more time from companies to fully understand the new requirements. except for enterprise development, the mean and median for all the elements of the b-bbee scorecard were close to each other. the standard deviations indicate considerable variation in the elements’ scores. the maximum values typically correspond with the maximum points available as per the b-bbee scorecard. in some cases, more points than the maximum were achieved due to bonus points available through certain sector charters, and through the 2007 codes. the financial health descriptive statistics are shown in table 7. table 7: descriptive statistics for the financial health variables. the relatively large standard deviations, in comparison with the mean and median values of the respective measures, were expected due to the diverse industries represented within the sample and the unstable economic climate during the period under review. the 2004–2007 period represented the commodity boom, while from 2008 to 2010 the global financial crisis had a detrimental impact on the financial results of local companies. the effect the economic climate could have had on the sampled companies’ performance was moderated, to a certain extent, by controlling for variables such as market capitalisation, total revenue and total assets. the sampled companies generated approximately 19% return on equity on average over the duration of the study period, which is in excess of the required return (cost of equity). this difference resulted in an average excess return percentage of almost 9%. the market values of shares were, on average, double the book values, which is an indication of a positive market sentiment (damodaran 2007). this positive sentiment is also reflected in the economic value-added mean value. the likelihood of the sample companies not being able to meet their future financial commitments is small, given the low default risk probability. panel regression results significant panel regression results were reported for three financial health variables, namely the price/earnings (p/e) ratio, cost of equity and default risk probability. the results adjusted for heteroskedasticity will now be presented. the panel regression results for total b-bbee score and the b-bbee elements as the independent variables and the p/e ratio as the dependent variable are shown in table 8. table 8: price/earnings ratio and total broad-based black economic empowerment score and individual elements. in table 8, a significant negative relationship is observed between the sampled companies’ p/e ratios and total b-bbee scores. the negative link could indicate that investors were not willing to pay more for the shares of companies with high b-bbee scores. van der merwe and ferreira (2014) also found a negative relationship between a price-based measure (total share return) and b-bbee scores which seemingly confirms negative sentiment among market participants no prior studies investigated the relationship between b-bbee and earnings per share (the numerator in the p/e ratio). a possible explanation could be that earnings per share is susceptible to manipulation and hence not a very reliable accounting-based performance measure (the cfa institute 2016). significant relationships are also reported in table 8 between the sampled companies’ p/e ratios and two of the individual scorecard elements. whereas a significant negative relationship was observed between p/e ratio and skills development, a positive relationship existed between p/e ratio and socio-economic development. there is no apparent reason for this contradiction, as both of these elements require financial commitments from companies. to further investigate whether the observed negative relationships could be attributed to risk, default risk probability was evaluated (refer to table 9). table 9: default risk probability and total broad-based black economic empowerment score and individual elements. a positive relationship is noted between the total b-bbee score and default risk probability (table 9). the result was, however, only significant at the 10% level. this result could partly explain the low p/e ratio (as reported in table 8), as companies with higher risk of default would be likely to have a lower market valuation (correia et al. 2013). another measure that can be impacted by risk is cost of equity. the analyses reported in table 10 were performed to investigate whether this perceived higher risk is reflected in a higher cost of equity. the cost of equity of a company indicates the return that ordinary shareholders require on their investment. if a company has higher risk, it would most likely result in a higher cost of equity. in this study, the capital asset pricing model (capm) was used. despite several shortcomings, capm is often used in the south african context (nel 2011). table 10: cost of equity and total broad-based black economic empowerment score and individual elements. a significant positive relationship is noted between the total b-bbee score and cost of equity in table 10. this finding seems to corroborate the significant negative regression coefficient reported for the p/e ratio (table 8) and the positive regression coefficient for default risk probability (table 9). an increase in default risk probability (especially in emerging economies) often results in higher cost of equity and a lower p/e ratio. significant positive relationships are furthermore noted between the cost of equity and ownership, employment equity, preferential procurement and enterprise development (table 10). the empirical evidence suggests that ordinary shareholders in this sample may have regarded the companies with higher total b-bbee scores as having more risk, resulting in a higher cost of equity. the findings contradict those of morris (2018) who found no relationship between b-bbee scores and risk and akinsomi (2016) who showed that b-bbee compliant companies had less risk than their non-compliant counterparts did. cost of equity was negatively correlated with management control and with skills development. the significant positive relationship between cost of equity and employment equity came as a surprise, given that a negative relationship existed between management control and cost of equity. even though these results may seem to contradict each other, they are in line with the findings of bouslah, kryzanowski and m’zali (2012) who investigated the link between employee diversity concerns and company risk. the significant negative relationship between cost of equity and management control appears to be in line with findings of marimuthu (2008), albeit for different measures. marimuthu found a positive association between board diversity and return on assets, but it could be seen as a similarity to the decrease in cost of equity as both point towards improved financial health. a significant positive relationship between cost of equity and preferential procurement was also noted, indicating that the sentiment towards preferential procurement could be negative. the significant negative link between cost of equity and skills development could be seen as contradicting the negative relationship noted between the p/e ratio and skills development. this ambiguity may point towards positive and negative perceptions towards skills development. it could also indicate that either the association with p/e ratio or the relationship with cost of equity, or both, might be spurious. significant relationships with the control variables were also typically reported, strengthening the notion that these control variables could have a moderating effect on the results, had they not been controlled for. both alternative hypotheses (ha1 and ha2) were accepted. a significant positive relationship between total b-bbee score and cost of equity was reported, and a significant negative relationship between total b-bbee score and p/e ratio was observed. these two observations were further supported by a positive (significant at the 10% level) relationship between total b-bbee score and default risk probability. significant relationships between the elements of the b-bbee scorecard and cost of equity, and between the elements of the b-bbee scorecard and p/e ratio were noted. a significant positive relationship between socio-economic development and p/e ratio was noted. similarly, positive relationships with cost of equity were observed between ownership, employment equity, enterprise development and preferential procurement. based on the findings of van der merwe and ferreira (2014), it could be assumed that certain investors do look at the b-bbee activities and scorecards of companies. therefore, based on the empirical results, it is deduced that stakeholders yield a positive sentiment towards management control, skills development and socio-economic development. stakeholders do not, however, seem favourable towards ownership, employment equity, preferential procurement and enterprise development. despite the fact that the relationships with total b-bbee score indicate a negative relationship with financial health, there are elements that were positively related to economic health, as discussed above. as such, directors should strive to have a more diverse management team, invest in socio-economic development and skills development. directors should be wary of the negative associations between ownership, employment equity, preferential procurement, enterprise development and financial health. conclusion broad-based black economic empowerment legislation was implemented in 2003 to redress the adverse economic impact of the apartheid regime on ordinary citizens. the act was revised in 2013 and three codes of good practice were published since 2004. since the introduction of b-bbee legislation, the question is increasingly being raised whether there is a financial motivation for companies to achieve a higher level of compliance. previous authors reported inconclusive evidence of the nature of the relationship between b-bbee and financial performance. the authors of this study investigated the relationships between b-bbee scores (in total and per element) and a range of financial health measures for 379 jse-listed companies over the period 2004–2015. the sample consisted of all the listed companies for which empowerdex provided compliance scores. a larger sample, a longer time frame and more comprehensive measures were used than those considered by previous authors. an increasing trend was noted in b-bbee compliance over time. the panel regression analyses revealed no significant relationship between the total b-bbee scores, or any of the respective b-bbee elements, and the considered accounting-based measures. in contrast, a significant negative relationship was observed between the market-based p/e ratio and total b-bbee score, while a significant positive relationship was noted for the cost of equity. this negative association might indicate a negative perception of shareholders regarding b-bbee. companies with high b-bbee scores may be perceived to have more risk, as is shown by the positive link with default risk probability. compliance with b-bbee can be seen as one of the ways in which companies can be good corporate citizens who promote social justice. it is, however, not the only way in which companies can contribute to sustainable development. corporate leaders and policymakers are encouraged to reflect on how they can truly contribute to a more empowered south african society. directors who are responsible for developing and implementing empowerment strategies play an integral role in the sustainable future of b-bbee. directors could focus on the elements of the b-bbee scorecard that seem to be viewed in a positive light by shareholders. based on the findings of this study, a more diverse management team should be pursued, and a greater emphasis should be placed on socio-economic development and skills development. corporate decision-makers should caution against overemphasising the importance of ownership, given that shareholders seem to view this element in a negative light, based on the link with cost of equity. the provision of capital by shareholders is essential to ensure a sustainable future for companies. meaningful engagements between shareholders and managers could lead to enhanced b-bbee practices. the importance of b-bbee compliance should not only be stressed in private, as is currently the case (see viviers, mans-kemp & fawcett 2017), but should also be raised at companies’ annual general meetings. it is foreseen that an engagement regarding race diversity will eventually lead to discussions on enhanced gender and age diversity as well, following international trends. future researchers can take a closer look at some of the contradictory relationships observed in this study and could use one or more multi-factor asset pricing models to compute cost of equity in a follow-up study. broad-based black economic empowerment can also be studied from a qualitative perspective by conducting interviews with foreign and south african investors and companies to gauge their views on the effectiveness of empowerment initiatives. for the purpose of this study, the sample was limited to empowerdex’s list of most empowered companies. in future, a b-bbee compliance index can also be compiled for small, medium and large companies based on their reporting on the matter. broad-based black economic empowerment appears to have positive and negative dimensions. if the positive dimensions are embraced and the negative ones addressed, the reformatory act can truly help south africa to become more equal. acknowledgements prof. martin kidd for the statistical analysis; ms elizma beets for the language editing. competing interests the authors have declared that no competing interest exists. authors’ contributions all authors contributed equally to this work. ethical consideration this article followed all ethical standards for research. funding information this research received no specific grant from any funding agency in the public, commercial or not-for-profit sectors. data availability statement data sharing is not applicable to this article as no new data were created or analysed in this study. disclaimer the views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of any affiliated agency of the authors. references acemoglu, d., 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world federation of exchanges, 2016, monthly reports tool, viewed 06 september 2016, from http://www.world-exchanges.org/home/index.php/statistics/monthly-reports abstract introduction capital structure: literature review determinants of capital structure and research hypotheses data, estimation methodology and model results and discussion conclusion acknowledgements references appendix 1 footnotes about the author(s) jorge h.f. mota department of economics, management, industrial engineering, and tourism, university of aveiro, portugal antonio c. moreira department of economics, management, industrial engineering, and tourism, university of aveiro, portugal citation mota, j.h.f. & moreira, a.c., 2017, ‘determinants of the capital structure of portuguese firms with investments in angola’, south african journal of economic and management sciences 20(1), a885. https://doi.org/10.4102/sajems.v20i1.885 original research determinants of the capital structure of portuguese firms with investments in angola jorge h.f. mota, antonio c. moreira received: 25 jan. 2014; accepted: 12 oct. 2016; published: 28 feb. 2017 copyright: © 2017. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: this article seeks to complement the previous literature and clarify the particularities of the capital structure policy of firms with foreign direct investment in angola. aim: this article seeks to identify the determinants of the capital structure of portuguese firms with direct investment in angola and to understand whether the determinants normally considered by standard finance theory are in line with those used by firms when structuring their capital structure policy to participate in the specific market of angola. setting: this article examines 26 large portuguese firms with investments in angola using econometric panel data for the period 2006–2010. methods: the study applied fixed and random effects methods and panel-corrected standard errors that maintain efficiency and unbiased behaviour even in the presence of panel-level heteroscedasticity and contemporaneous correlation of observations among panels. results: the results provide evidence that the determinants normally considered by standard finance theory are in fact – in terms of sign and coefficient dimension – those used by firms for structuring their capital structure policy when involved in the internationalisation process of entering angola. specifically, age, asset structure, return on assets and tangibility have a positive influence on the capital structure of portuguese firms that have invested in angola, while non-debt tax shields and liquidity have a negative influence on these companies’ leverage ratios. when comparing our results with studies that have analysed the capital structure determinants of listed portuguese firms – firms belonging to the psi 20 index and large firms in the portuguese corporate sector – we found similarities in the sign and coefficient dimension of the determinants of capital structure. however, the profitability coefficient sign is in line with the trade-off framework (i.e. profitability is positively related to debt) but not with pecking order theory (i.e. profitability is negatively related to debt). conclusion: our results suggest that the high-growth angolan market is seen by larger portuguese firms as a low-risk diversification process because of the economic hardship portugal has gone through, as well as cultural and linguistic similarities to portugal. as such, the angolan market is seen as an extension of the portuguese domestic market that has increased potential. this scenario potentially reduces the firm default probability and the cost of debt. maintaining the tax shield benefits of debt and decreasing the cost of debt – through a reduction in the default probability – have induced profitable firms to use more debt. introduction capital structure has always been a polemical subject when it comes to financial theory. the selection of which capital structure to follow in a given project is a crucial decision, given the need to maximise returns for all firms’ stakeholders (abor & biekpe 2009) and the way this choice can interfere with firms’ capacity to deal with an external competitive environment (abor 2005). since the groundwork research done by modigliani and miller (1958), several studies have attempted to determine the optimal capital structure, particularly research concerned with bankruptcy cost, agency theory and pecking order theory. these theories suggest that the selection of an appropriate capital structure depends on the features that determine the various costs and benefits associated with debt and/or equity financing. therefore, the study of the determinants that influence capital structure is clearly of vital importance. although much research has been done on market imperfections, bankruptcy costs and information asymmetry, there are few studies on firms’ capital structure in africa (abor 2005; abor & biekpe 2009; boateng 2004; ezeoha & okafor 2010). moreover, documented studies have not been conducted on the determinants of the capital structure of firms belonging to less intensely developed countries with investments on the african continent. accordingly, the main purpose of this article is to identify the key determinants of the capital structure of portuguese firms with investments in angola. angola had a civil war from 1975 to 2002. the end of the civil war provided a wide range of investment opportunities, mainly because of the shortage of numerous goods and services, as well as the presence of a significant domestic market with a high purchasing power in some social strata. this opportunity combined with the small psychic distance between portugal and angola to open a window of opportunity for many portuguese firms to invest in angola, where they innovated and sometimes created completely new concepts for this market but, sometimes, took on high risks. by studying the decisions made about the capital structure of portuguese firms with investments in angola, one can explore how these investors decide what the best capital structure policy for their investments is, providing this field of study with a new perspective. this article analyses portuguese firms that have direct investments in angola, in the form of either branches or subsidiaries but with headquarters in portugal, with the goal of identifying the determinants of their capital structure. the objective is to understand whether the determinants normally considered by standard finance theory are, in fact, those used by firms for structuring their capital structure policy when participating in the specific market of angola. the article is organised as follows: after this brief introduction, a review of the literature on capital structure is described in the section ‘capital structure: literature review’. in the section ’determinants of capital structure and research hypotheses’, the determinants of capital structure are examined. in the section ‘data, estimation methodology and model’, the research methodology is presented. the results are presented in the section ‘main results and discussion’. lastly, the discussion of findings and conclusions are presented. capital structure: literature review the capital structure theory has been quite often debated in the corporate finance literature. it concerns the ways firms use equity and debt capital to finance their assets. modigliani and miller (1958) developed three crucial irrelevance propositions about capital structure theory: the value of a firm or project is independent from its financial structure, the value of the firm or project increases with debt in direct proportion to the equity/debt capital ratio and, lastly, the weighted average cost of capital remains unchanged regardless of the financing source used. although this fundamental theory has replaced durand’s (1952) traditional theory, in which he states that capital structure influences firms’ value, research contradicting this idea has been carried out to explain the way firms finance themselves. along these lines, modigliani and miller (1958) draw some further conclusions: a firm’s market value is independent of its capital structure, the higher the expected returns, the higher the risk involved and, lastly, the rate of return demanded by shareholders of indebted firms is higher than the rate of return demanded by shareholders of non-indebted firms. myers (1977) asserts that firms that are quite indebted may not perform projects in which the net present value is positive, as generated cash flows will mostly be destined to cover already assumed commitments and the surplus will not be enough to cover the initial investment. later, myers (1993) claimed that it is possible to estimate the optimal debt ratio of a firm by considering the net tax benefits, which are related to the existence of debt and its associated costs. brealey, myers and allen (2007) argue that capital structure acknowledges that debt ratios objectives may vary from firm to firm. accordingly, firms with tangible assets and high earnings before income taxes may need to establish high debt ratios so that they can secure tax benefits. corporations with low profits – with risky intangible assets – should resort to their own equity. according to crnigoj and mramor (2009) and tahir and alifiah (2015), the current theory of capital structure is based on two strands: the trade-off and pecking order theories. falling within the first thread, chang and yu (2010) state that the optimal capital policy of firms is based on the trade-off between debt tax benefits and bankruptcy costs. according to the pecking order theory, firms do not seek an optimal capital structure. the structure instead reflects financing options taken in the past (myers 1984; myers & majluf 1984), that is, a hierarchical order is followed when choosing financing sources because of information asymmetry. this hierarchy of sources stems from the financing of investments, first, with internal funds (i.e. retained earnings), followed by new debt issuance and, lastly, by new shares issuance (brealey et al. 2007). this information asymmetry theory also is one of the fundamental theories that help explain capital structure. information asymmetry occurs when managers have more information than investors (brealey et al. 2007). the cited authors argue that information asymmetry jeopardises the choice between internal or external financing and new share issuance. according to istaitieh and rodríguez-fernández (2006), the capital structure literature can be classified according to the following typology: the stakeholder theory of capital structure, the theory of market structure and the competitive strategy theory. the first theory relies on the idea that debt affects non-financial agents such as collaborators and suppliers, as well as shareholders and creditors. therefore, both non-financial agents (i.e. clients, workers and suppliers) and financial agents (i.e. shareholders and bondholders) need to be taken into account. regarding the second theory, the level of debt might affect the market, and the market structure also can impact the capital structure of firms (santos, moreira & vieira 2013, 2014, 2015). ultimately, the last theory – competitive strategy theory – states that the capital structure of firms is related to their competitive strategy, as both aspects strive to leverage the firms (istaitieh & rodríguez-fernández 2006; oinoa & ukaegbu 2015). in their definition of capital structure, silva and queirós (2009) claim that it is important to analyse the trade-off between equity and debt as this trade-off will influence the degree of enforceability and the cost of each financing source in the capital structure. an accurate definition of short-, mediumor long-term maturities and of sources of capital (i.e. equity and/or debt) is important to minimise capital costs and the risk of not fulfilling firms’ financial obligations and, at the same time, to maximise the return of invested capital (menezes 2003). boateng (2004) developed a different perspective on the definition of capital structure. he argues that this structure needs to be defined based on the properties of the various costs and benefits linked to debt and equity. however, ezeoha and okafor (2010) and chadha and sharma (2015) claim that the definition of capital structure depends on the dominant character of firms’ structure in each country and on the level of development of the markets involved. in addition, parsons and titman (2008) and chadha and sharma (2015) assert that changes in capital structure are influenced not only by the availability of capital generated internally but also by market conditions. andrikopoulos (2009) also states that managers’ salaries and firms’ value should be taken into account when defining their capital structure. titman and wessels (1988) conclude that capital structure is chosen in a systematic way, which agrees with modigliani and miller’s (1958) argument. however, the evidence against the hierarchy of financing theory shows that external financing is valued and that firms issue more shares than debt (frank & goyal 2003). after studying the indian market, handoo and sharma (2014) concluded that liquidity, size, profitability and growth might have different results when measured as short-term debt, long-term debt or total debt ratio, each having a different impact on the leverage structure of listed indian firms. hovakimian, hovakimian and tehranian (2004), after studying financing options, concluded that the importance of return on shares is related to the search for leverage. nevertheless, the cited authors also argue that firms with high profits do not compensate for accumulated deficits with leverage through the issuance of debt. rocca et al. (2009) conclude that the diversification of choices is important in debt financing. diversified firms cannot be considered a homogeneous group, and they increase their use of debt to profit from tax deductions and benefits. saito and hiramoto’s (2010) study of the impacts of international activities on capital structure found that brazilian multinationals use more debt in international activities, at 9.6% of their leverage, of which 5.8% comes from long-term sources. international activity, therefore, increases shortand long-term leverage. the cited authors also maintain that international activity is positively related with the use of external debt and that multinationals, on average, add more than 12.7% external debt to their capital structure. the effect of foreign presence on the leverage of domestic firms was subsequently analysed by anwar and sun (2015), who concluded that the impact of a foreign presence on leverage is important, although this varies from industry to industry because of heterogeneity of productivity patterns. determinants of capital structure and research hypotheses asset structure as leverage is negatively influenced by asset structure, firms tend to prefer short-term rather than long-term debt (daskalakis & psillaki 2008). therefore, smalland medium-sized businesses, having fewer fixed assets, usually find it more difficult to secure loans (abor & biekpe 2009), while firms with greater fixed assets do not apply for loans as often (psillaki & daskalakis 2009). brito, corrar and batistella (2006) and menike (2015) argue that asset structure positively influences long-term debt, that is, firms that have fixed assets to offer as collateral for their debts are considered more creditworthy. however, karadeniz et al. (2009) maintain that fixed assets and returns on assets have a negative influence on debt and debt ratio. therefore, the following hypothesis was formulated for the present study: h1: a relationship exists between capital structure and asset structure. age age is usually expected to have a positive effect on capital structure – as represented by debt to equity ratio – given that firms increase their liquidity capacity over the years. abor and biekpe (2009) conclude that age is important when obtaining funds through loans as firms that have been in their business for a considerable period have collateral to offer to banks if they cannot pay their debt. menike (2015) also found that the younger the firm, the more prone it is to resort to long-term debt. for bhaird and lucey (2010), the age of a firm positively influences profit retention but negatively influences long-term financing. ahmed, ahmed and ahmed (2010) assert that age negatively influences leverage. it is worth pointing out, in this context, that leverage variation might be explained by the increase in the age of firms, which could compel managers to focus a significant part of their attention on the intrinsic characteristics of their firm and its financing decisions (chadha & sharma 2015; kayo & kimura 2011). therefore, the following hypothesis was considered in the present study: h2: a relationship exists between capital structure and age. liquidity liquidity is measured through the current assets/current liabilities ratio, providing information on whether firms can meet their short-term financial commitments. ahmed et al. (2010) conclude that liquidity has a negative impact on the debt to equity ratio, that is, equity capital will increase more substantially over time than liabilities. antão and bonfim (2008) and sbeiti (2010) assert that liquidity has a negative impact on financial leverage, which is to say that firms with higher levels of liquidity tend to avoid increasing their use of external debt, a finding that gave rise to this hypothesis in the present study: h3: a relationship exists between capital structure and liquidity. intangibility the level of intangible activity is expected to have a positive impact on leverage as firms with high expenditures on research and development need higher levels of external capital than internal capital. this result suggests that internal financing is not enough to support the high-level growth of these firms regarding their increased need for investment (bhaird & lucey 2010). thus, the following hypothesis was suggested for the present study: h4: a relationship exists between capital structure and intangibility. profitability based on pecking order theory, myers (1984) argues that decisions on capital structure follow a hierarchical order when it comes to choosing financing sources. this hierarchy mainly consists of financing investments with retained earnings, followed by new debt issues and, lastly, by the issuance of new equity. consequently, firms’ profitability has a negative impact on their use of debt (chang, lee & lee 2009; nunkoo & boateng 2010). rebelo (2006) also asserts that profitability has a negative impact on total debt, and abor (2005) claims that profitability has a negative impact on short-term debt. some other studies (chadha & sharma 2015; chang et al. 2009; crnigoj & mramor 2009; daskalakis & psillaki 2008; psillaki & daskalakis 2009) found that profitability positively influences leverage, based on the trade-off theory. according to jensen and meckling (1976), myers (1977) and harris and raviv (1990), the tax shield benefits of debt outweigh any increase in debt cost, and this is related to a potential increase in the probability of default, which will induce profitable firms to use more debt. psillaki and daskalakis (2009) add that: the pecking order theory is especially appropriate for small and medium-sized firms … these firms do not typically aim at a target debt ratio … instead, their financing decisions follow a hierarchy, with a preference for internal over external finance, and for debt over equity. (pp. 325–326) abor and biekpe (2009) link profitability with age, risk and growth. they found that profitability has a negative relationship with age and growth. at the same time, risk has a positive link with profitability. lastly, brito et al. (2006) found that profitability is not a crucial factor in capital structure. thus, the following hypothesis was formulated for the present study: h5: a relationship exists between capital structure and profitability. tangibility firms with higher tangible assets can use debt more easily as creditors believe these firms can fulfil their obligations more easily. therefore, tangibility should positively influence leverage. while couto and ferreira (2010) and chadha and sharma (2015) assert that tangibility is a determinant factor of capital structure, nunkoo and boateng (2010) argue that tangibility has a positive influence on leverage. 1 in addition, onaolapo and kajola (2010) contend that tangibility is negatively influenced by profitability, and serrasqueiro and nunes (2010) maintain that there is no positive relationship between debt and tangibility. however, ahmed et al. (2010) suggest that leverage has no statistical relevance in terms of asset tangibility. accordingly, the following hypothesis was suggested in the present study: h6: a relationship exists between capital structure and tangibility. non-debt tax shields non-debt tax shields (ndts) are characterised by the weight assigned to the depreciation of assets (rebelo 2006). although, for chadha and sharma (2015), ndts influence the capital structure of indian manufacturing firms, according to rebelo (2006), ndts do not seem to be a factor when it comes to technology firms’ level of debt. however, serrasqueiro and nunes (2010) say that there is no relationship between ndts and debt. therefore, it was decided to test the following hypothesis in the present study: h7: a relationship exists between capital structure and ndts. growth the growth of firms is expected to have a positive impact on leverage. however, some studies have concluded otherwise, which might be a consequence of using different variables for growth, such as net assets growth rate (couto & ferreira 2010; rebelo 2006), total assets growth rate (chang et al. 2009; nunkoo & boateng 2010) or speed of adjustment (oinoa & ukaegbu 2015). sbeiti (2010) argues that growth needs to be defined through the following ratio: total assets book value minus net assets book value and the market value of equity over the total assets book value. another definition given for growth is firms’ market value divided by the firms’ book value (karadeniz et al. 2009). although abor and biekpe (2009) define growth as sales growth, brito et al. (2006) use a sales logarithm (ln). studies have produced contradictory results. while couto and ferreira (2010) assert that growth does not explain the level of debt, rebelo (2006) and chadha and sharma (2015) argue that growth has a positive impact on the total debt. moreover, chang et al. (2009), nunko and boateng (2010) and sbeiti (2010) found that growth has a negative impact on leverage, when growth is measured by the market-to-book ratio (chang et al. 2009) and by market leverage (sbeiti 2010). karadeniz et al. (2009) maintain that growth and debt are not correlated in turkish firms. however, brito et al. (2006) assert that growth has a positive relationship with long-term debt. this evidence goes against bankruptcy cost and agency cost theories but confirms the information asymmetry theory, that is, firms finance their growth through debt to indicate to the market that their shares are underestimated (brito et al. 2006). lastly, abor and biekpe (2009) also argue that growth has a positive relationship with long-term debt as growth usually puts pressure on retained earnings. for example, high-growth ghanaian firms incur more external debt when they finance operations. nevertheless, as financing opportunities can create conflicts between creditors and managers, small firms use more short-term debt (abor & biekpe 2009). size as large firms are usually more diversified than smaller firms are, they are less prone to financial difficulties and have fewer bankruptcy costs (brito et al. 2006; omet et al. 2015). therefore, it is expected for size to have a positive influence on leverage.2 although nunkoo and boateng (2010) maintain that size has a negative influence on leverage, most studies argue otherwise (ahmed et al. 2010; brito et al. 2006; crnigoj & mramor 2009; daskalakis & psillaki 2008; menike 2015; psillaki & daskalakis 2009; sbeiti 2010). bhaird and lucey (2010) were able to determine that size has a positive relationship with profit since surviving firms are increasingly dependent on internal capital and their accumulated profits are reinvested. lastly, karadeniz et al. (2009) found that size does not appear to be linked to debt ratio. data, estimation methodology and model data studies of capital structure and the main factors considered when choosing it are increasingly important in the corporate finance literature. in this study, the goal was to analyse a specific case not studied before: portuguese firms with direct investments in angola. thus, this study had the objective of verifying how the following factors influence the capital structure of portuguese firms with subsidiaries or branches in angola: asset structure, age, liquidity, intangibility, profitability, tangibility and ndts. although other determinants influence capital structure (i.e. growth and size), they were not included in this study because of the unavailability of data for the firms in our sample. table 1 below summarises the hypotheses tested and the corresponding random variables linked with their measurement. table 1: explained variables, explanatory variables and hypotheses. the sample in study comprises 26 firms dating to the period 2006–2010, which were chosen according to the availability of data. the data were gathered by using a list of the portuguese firms with direct investments abroad, provided by the agency for investment and external trade of portugal in luanda. based on this list, an analysis of the firms’ websites was conducted with the objective of collecting the information available. firms without any website or information were first contacted via e-mail to acquire the required data. in the cases in which no information was acquired, telephone calls were made. the banks on the list were not considered, given that they have a different tax code, accounting rules and operation modes. information, thus, was collected from the following firms: compta, auto sueco, fdo, conduril, enoport, eurico ferreira, galp, visabeira, martifer, mota-engil, monteadriano, orey, petrotec, pt, sumol, tomás de oliveira, obrecol, efacec, glintt, opway, m. couto alves, abrantina, soares da costa, somague, teixeira duarte and msf. the data were extracted from the consolidated financial reports and statements of these 26 firms, which were normally made available on their websites. the collected data cover the following variables: total assets, fixed assets, tangible fixed assets, intangible assets, total net assets, depreciations, equity capital, short-term debt, long-term debt, total debt, liabilities, net profits, distributed dividends, sales, earnings before taxes, price per share, size and age. estimation methods and model according to hsiao (2003), panel data methodology uses a set of data that follows a given sample over a period, providing multiple observations for each variable in the sample. this methodology increases the amount of data because of the cross between longitudinal and time series study methods. this increases the degrees of freedom and decreases the collinearity between explanatory variables, which leads to a greater efficiency of the econometric estimation. this methodology also allows the researcher to analyse various economic issues that cannot be accurately studied using only longitudinal or time series studies. the main advantages of this methodology are (wooldridge 2010) that the estimates are more efficient as the variables are less collinear, the opportunity to analyse individual dynamics, more information about the ordering of events over time and the opportunity to control any heterogeneity not identified individually. fixed and random effects models were considered (two estimation methods inside the panel data models) when specifying the econometric model. the rationale behind the choice between the two models are: the fixed effects model is the most suited to analyse the exclusive impact of variables that change over time – that is, this model is suitable for studying the causes of change inside an entity (gujarati 2003; hsiao 2003); in random effects model, changes in individuals or cases are seen to be random and not correlated with the independent variables included in the conceptual model, allowing the variables that do not change over time to play an important role as explanatory variables, in marked contrast to the fixed effects model (johnston & dinardo 1997). complementarily, a test created by hausman allows researchers to ascertain which model is more suitable: the null hypothesis assumes that the random effects estimator is the most appropriate (johnston & dinardo 1997). thus, if the null hypothesis is rejected, the random effects model cannot be the most appropriate, and the fixed effects model should be chosen (gujarati 2003). although, panel data models can be estimated even when there are severe deviations from the classical assumptions and ‘complex error compositions’ are present (basu & rajeev 2013; couto & ferreira 2010; marques & fuinhas 2012:11; petersen 2009), the inadequate verification of the existence of heteroscedasticity and autocorrelation phenomena in panel data models can lead to inefficiency and biased estimates of coefficients and standard errors. therefore, the panel data model needs to be complemented by carrying out tests to verify the presence or absence of heteroscedasticity and cross-sectional independence. furthermore, whenever there are divergences regarding the classical assumptions of the aforementioned cases, it is necessary to introduce the respective corrections, not to compromise the suitability of the results. the procedure needs to be as follows. after testing for the presence of heteroscedasticity and panel autocorrelation, if any deviation from the classical assumptions is detected, beck and katz’s (1995) correction factor – panel-corrected standard errors (pcse)3 – should be applied. the pcse estimator performs well in the presence of panel-level heteroscedasticity and contemporaneous correlation of observations among panels.4 marques and fuinhas (2012), who studied the robustness of results obtained by the pcse estimator as compared with the results obtained by standard panel data estimators (i.e. fixed and random effects), assert that the use of the pcse model is indeed the most adequate method, as this provides the best results. to test the formulated hypotheses empirically and take into account the defined methodology, the following model was defined5: results and discussion to carry out the data analysis in this study, static panel data and econometric methodologies using the program stata 11 were chosen. this study’s data produced an unbalanced panel, given the lack of information for all variables in all the years covered. table a1 in appendix a shows the descriptive statistics.6 following established procedure, an initial analysis of the data was made. the results of the specification tests are outlined in table 2. table 2: specification tests a wooldridge test was carried out to test the presence of autocorrelation. the results support the following conclusion: at a significance level of 5%, the null hypothesis of no first order serial correlation cannot be rejected, that is, there is no serial correlation. following baum’s (2001) guidelines, a modified wald test was run to test for groupwise heteroscedasticity in the residuals of a fixed effect regression model. as seen in table 2, the null hypothesis of homoscedasticity is rejected, so the claim can be made that the errors exhibit groupwise heteroscedasticity. lastly, the results of a hausman test – the null hypothesis posits that the individual-level effects are adequately modelled by a random effects model – support the following conclusion: the null hypothesis is rejected, and the fixed effects model is the most suitable model for this study. given that there is a deviation in classical assumptions, in particular when it comes to the existence of heteroscedasticity, the pcse estimator had to be used to rectify the deviation. table 3 displays the results of the model using fixed effects and random effects and applying the pcse estimators. for the first two models, the results are presented without any model correction [i.e. conventional standard errors (cse)], using robust standard error (rse). table 3: models with application of the robust standard error to random and fixed effects models the results of the fixed effect and random effect models, with cse and rse, allow a comparison of the robustness of results achieved by the pcse estimator with the results achieved by fixed and variable effects estimators. the analysis was then continued using data from the pcse estimator as it is considered to be more robust and to provide better results. from all the hypotheses subjected to empirical analysis, only two were not statistically significant: hypotheses 4 and, partially, 5. these postulated the existence of a relationship between capital structure and the level of intangibility and return on sales and/or return on assets. for the second hypothesis, only the relationship with return on sales was not statistically significant. the analysis results shown in table 3 confirm that variables such as asset structure, age, liquidity, tangibility and ndts have a p-value below 5%. the return on assets has a p-value below 10%. this leads to the rejection of the null hypothesis of the aforementioned variables not being statistically significant. as can be observed, the asset structure (i.e. hypothesis 1) has a positive impact on the leverage ratio (0.2079). this conclusion goes against what rebelo (2006) proposes but corroborates the findings of brito et al. (2006), who claim that the asset structure has a positive influence on long-term debt, which overlaps with its negative impact on short-term debt (chadha & sharma 2015; handoo & sharma 2014; omet et al. 2015). a firm’s age (i.e. hypothesis 2) also has a positive impact on the leverage ratio (0.1483). this conclusion agrees with the results achieved by abor and biekpe (2009) and chadha and sharma (2015). they assert that age is an important factor when accessing capital through loans. the case of portuguese firms with investments in angola shows that the age of firms can be used as an advantage to obtain financing for their investments in angola. liquidity (i.e. hypothesis 3) has a negative impact on the leverage ratio (-0.4566), which is in agreement with the results obtained by sbeiti (2010), who maintains that firms with a higher level of liquidity usually avoid the use of external debt. concerning the firms studied, the liquidity level is in most cases used to finance their own assets in angola. profitability was divided into return on sales and return on assets (i.e. hypothesis 5). however, only the positive (0.1178) relationship between the leverage ratio and returns on assets is statistically significant, which is in agreement with psillaki and daskalakis (2009), crnigoj and mramor (2009) and chang et al.’s (2009) conclusions. therefore, we can say that it is clear that the firms analysed choose to invest in angola when their return on assets allows it, an approach that tries to diminish investment risks and pursue a path of sustained growth. the fact that return on sales is not statistically significant is related to the fact that, when firms decide to invest in angola, they consider not only normal, short-term business outcomes but also the outcomes of normal, long-term investment. the assets’ tangibility (i.e. hypothesis 6) has a positive influence on the leverage ratio (0.1675) since firms with higher tangible assets can more easily use debt because they have collateral to present to banks. this conclusion was also reached by nunkoo and boateng (2010), handoo and sharma (2014), chadha and sharma (2015) and omet et al. (2015). ndts (i.e. hypothesis 7) maintain a negative relationship with the leverage ratio (-0.1999). this conclusion contradicts the findings of authors such as rebelo (2006) and serrasqueiro and nunes (2010), who did not find any evidence that this factor has an influence on debt. the present study shows that the investment of portuguese firms in angola has an increasingly higher importance in depreciations of assets, as a consequence of the investments made. conclusion in this study, the factors that influence the choice of the capital structure of 26 portuguese firms with investments in angola were examined. with the exception of these firms’ profitability, we found similarities in the sign and coefficient dimension of capital structure determinants when we compared our results with studies that analysed the capital structure determinants of listed portuguese firms, firms belonging to the psi 20 index and large firms in the portuguese corporate sector (antão & bonfim 2008; couto & ferreira 2010; serrasqueiro & rogão 2009). these comparisons allowed us to conclude that making direct investments in a foreign market – specifically an african market such as angola – during the process of internationalisation of firms’ investment does not change financing policy, in particular, the sign and coefficient dimension of capital structure determinants. the studies that were used in our comparison of results used samples of large portuguese, non-financial firms with their investments focused on the portuguese and european markets (i.e. their main markets). moreover, the firm size of our sample matches the firm size of other samples of large portuguese, non-financial firms, with the only difference being their international investments. regarding the results, as expected, asset structure is positively related with the leverage ratio, with a coefficient of 0.2079. likewise, tangibility is also positively related with the leverage ratio. when the sign and coefficient dimension of the relation between tangibility and leverage in our study is compared to the above-mentioned studies, we can conclude that our result of 0.1675 is similar to the other studies’ results. serrasqueiro and rogão (2009) got 0.13159; antão and bonfim (2008), 0.07; and couto and ferreira (2010), 1.2405 – in this case, only regarding the coefficient sign. this result is in tune with more recent studies outside portugal (chadha & sharma 2015; handoo & sharma 2014; omet et al. 2015). a firm’s age and profitability – represented by the return on assets – are also positively related with the leverage ratio. in the specific case of the relationship between profitability and leverage, compared with other studies in terms of sign and coefficient dimension, our result of 0.1178 has the same dimension but with an inverse sign in contrast to what was obtained by serrasqueiro and rogão (2009), -0.17137; and couto and ferreira (2010), -0.1330. this result is also similar to that of more recent studies outside portugal (chadha & sharma 2015; handoo & sharma 2014; omet et al. 2015). lastly, liquidity and ndts are negatively related with the leverage ratio. the liquidity coefficient is -0.4566, as compared with antão and bonfim’s (2008) -0.01. the ndts coefficient is -0.1999, as compared with antão and bonfim’s (2008) -0.04 and couto and ferreira’s (2010) -0.0003. in general, this leads to the conclusion that the capital structure determinants normally considered by standard finance theory are, in fact – in terms of sign and coefficient dimension – similar to those used by portuguese firms investing in the angolan market. however, the sign of the profitability coefficient is in line with the trade-off framework (i.e. profitability is positively related to debt) and not with pecking order theory (i.e. profitability is negatively related to debt). the explanation offered for this finding is that internationalisation to angola is seen by portuguese firms as a diversification strategy involving a market in which the cultural and language differences are quite low. as such, taking into account the high-growth rate of the angolan market vis-à-vis the portuguese market in the period studied, this investment was seen by creditors as a low-risk, high-potential one. angola is considered, on the one hand, an extension of the portuguese domestic market and, on the other hand, a way out of the crisis in the portuguese economy. this scenario potentially reduces the firms’ default probability and, as a consequence, the cost of debt. as it maintains the tax shield benefits of debt and decreases the cost of debt (i.e. through a reduction in default probability), this opportunity has induced profitable firms to use more debt. it is possible to advance that the determinants of the capital structure of firms from less intensely developed countries investing abroad on the african continent do not necessarily differ from other previous studies (abor 2005; abor & biekpe 2009; antão & bonfim 2008; boateng 2004; couto & ferreira 2010; serrasqueiro & rogão 2009), which has important consequences for firms seeking a foothold in africa. however, generalisations need to be taken cautiously, as the portuguese firms analysed in this sample covered a period of economic hardship in portugal, while the angolan economy was booming. this research also has important implications as it complements studies especially in less-endowed countries or in africa. for example, results obtained in the hospitality industry in turkey (karadeniz et al. 2009) show that countries with lack of funds supply, because of underdeveloped capital marks, as is the case of african countries, might be good opportunities for firms investing abroad if these are able to lower the risks. moreover, when analysing the ghanaian case, one can claim that the african market is an important opportunity for internationalisation as debt is the main financing option of ghanaian firms (abor 2005; abor & biekpe 2009) and joint ventures are natural market entry options to reduce business risk and leverage market potential (boateng 2004). it is important also to emphasise that foreign firms investing in africa need to seriously take into account corporate governance decisions as government policies may not only discriminate between indigenous and foreign shareholders (boateng 2004; ezeoha & okafor 2010) but also change the rules of the game that may jeopardise foreign investment and local development alike (boateng 2004). this study has some limitations that conditioned the research. the first limitation is the small dimension of the sample, which consisted of 26 firms. another limitation is the size of the firms studied. as they are all large firms, it was not possible to test whether size influences capital structure. this limitation is linked to the ease of obtaining data from large firms, as opposed to smaller firms. lastly, not all firms had data for every year considered in this study. 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discussion see, among others, couto and ferreira (2010), serrasqueiro and rogão (2009), antão and bonfim (2008) and kyereboah-coleman (2007). 3. which is the most efficient when the data do not have serial correlation (autocorrelation), comparing its results with those achieved from the classical panel data estimators (fixed and random effects). 4. additionally, it allows: the error term to be correlated over the firms, the use of firstorder autoregressive process for error term over time and the error term to be heteroscedastic (cameron & triverdi, 2009; marques & fuinhas 2012). 5. in this model, β values represent the coefficients of the independent variables. i represents the entity (firm) and t represents the temporal unit (year). μitrepresents the error term. 6. from observation of the descriptive statistics, it is possible to conclude that the debt of portuguese firms with direct investment in angola is on average around 110%. moreover, the liquidity, return on sales, return on assets and ndts are variables with some degree of volatility, as their standard deviations are above their mean values. the portuguese firms with direct investment in angola appear to be moderately volatile in asset structure, intangibility and tangibility, which suggests some degree of stability. microsoft word 9 mustapha & mendi sajems 18(1) 2015.docx 128 sajems ns 18 (2015) no 1:128-142 how to cite doi: http://dx.doi.org/10.17159/2222-3436/2015/v18n1a9 multinational corporations as channels for international technology transfer: evidence from the south african innovation survey nazeem mustapha human sciences research council pedro mendi navarra center for international development and department of business, universidad de navarra accepted: october 2014 in this article, we investigate the importance of south african subsidiaries of foreign multinationals as channels to introduce foreign innovations in the south african market. we use firm-level data from the 2008 wave of the south african innovation survey, which covers the period 2005-07. we find that subsidiaries of foreign multinationals are significantly more likely to introduce product and process innovations, as well as foreign new products and processes than domestic firms. however, we also find that they are not more likely to introduce foreign innovations developed in collaboration with or mostly by another firm outside their own multinational, or innovations that are new to the south african market. key words: international transfer of knowledge, international transfer of technology, new economy, technology adoption, r&d, innovation, technological innovation jel: o32, 33 1 introduction a large body of literature in economics and business has regarded multinational corporations (mncs) as essential channels for the international diffusion of new technologies. in this article we evaluate the performance of south african subsidiaries of foreign mncs in terms of innovativeness, and as vehicles in the international diffusion of technology, in comparison with domestic firms. for this purpose, we analyse data from the 2008 south african innovation survey. this survey, conducted at the enterprise level, makes use of the same methodology as that in the community innovation surveys (cis), and covers innovation activities carried out between 2005 and 2007. in particular, we inquire into whether subsidiaries of foreign mncs are more or less likely to innovate than domestic firms, as well as to introduce products that are new at least to the south african market. these questions have been addressed in a large number of studies that make use of cis-type data. additionally, we make use of a question included in the south african survey, but not in most comparable surveys, of the geographical origin of the product or process innovation, whether in south africa or abroad. hereby we will assess whether south african subsidiaries of foreign mncs are more likely to introduce innovations developed outside south africa, and by third parties outside south africa. finally, we test whether the impact of expenditure on internal r&d is different for south african subsidiaries of foreign mncs. the remainder of the paper is structured as follows: section 2 provides some background discussion on innovation and the role of mncs; section 3 proposes the hypotheses to be tested; section 4 discusses the data used in the present study; section 5 presents the results from the econometric estimations; finally, section 6 includes some concluding comments abstract sajems ns 18 (2015) no 1:128-142 129 and discussion of the limitations of the present study. 2 background the introduction of new products and processes is an important source of welfare gains. new products bring about increases in consumer surplus through greater product variety, as argued theoretically in dixit and stiglitz (1977). similarly, new processes imply access to superior technology, which is an engine for productivity growth. indeed, jones (1995) finds that cross-country differences in per capita incomes may be explained largely by differences in total factor productivity. in this line, coe and helpman (1995) link the international diffusion of technology with international trade, and mendi (2007) finds evidence of trade in disembodied technology positively affecting the importing country’s total factor productivity. thus, the process of technological diffusion has very relevant consequences for economic growth. particular in the case of less developed countries (ldcs), the effect may be one of abandoning a situation of underdevelopment and catching-up with more advanced economies. the use of foreign technologies by domestic firms, especially subsidiaries of foreign mncs, may bring about productivity gains to other domestic firms (blalock & gertler, 2009). indeed, positive spillover effects of foreign direct investment (fdi) are what would be expected in the “pipeline” model of technology diffusion most commonly used as a framework for understanding the process by which fdi has a positive effect on a host economy. this model posits that innovation capital and assets are produced at the headquarters of technologically advanced mncs. the action of foreign subsidiaries of such mncs is to take the knowledge capital and assets in a relatively unchanged form into the foreign environment. that environment is assumed to be sufficiently different to the more attractive technological culture of the mnc or its subsidiary to the extent that local firms would seek to draw value from interactions with the subsidiary. such engagement would be successful in generating enhanced economic growth provided the local firms are receptive enough to technology transfer and have the ability to incorporate the enhanced capabilities brought on through its interactions with the foreign subsidiary of the mnc. in this way the foreign subsidiary is seen as a conduit for the transference of innovative capability produced by the head of the mnc. another mechanism through which the presence of a subsidiary of a foreign mnc could generate economic growth is through a perturbative effect on local firms who would find it necessary to compete harder with the more technologically developed foreign subsidiary thus promoting knowledge growth in local firms that are sufficiently technologically astute. marin and bell (2006) argue that under some circumstances there is no conclusive evidence for positive effects on the local economy by the presence of foreign subsidiaries of advanced mncs particularly for ldcs. more recently, marin and sasidharan (2010) argued for the importance of distinguishing subsidiaries according to their orientation to carry out creative versus exploitation activities in the economy of developing countries. they used an unbalanced panel data approach on manufacturing firm-level data in india to support their view that subsidiaries that are oriented to technologically creative activities have a significantly positive effect on technology transfer, whereas those engaged in exploitation activities have none and sometimes even generate negative effects. in view of the positive effects of technological diffusion on growth, a recurrent question in the literature in economics and business is the study of the channels and the nature by which international technology diffusion takes place, for instance merchandise trade, movement of people, trade in machinery, reverse engineering, or trade in disembodied technology (coe & helpman, 1995; fosfuri et al., 2001; xu & wang, 1999; or zhu & jeon, 2007). transfers of knowledge within multinationals stand out as a particularly relevant channel, see lichtenberg (2001), or keller and yeaple (2013) for a recent contribution. in fact, in a similar way as trade in goods, most trade in disembodied technology takes place within multinational corporations (see bea, 2013 for us data). this paper takes precisely 130 sajems ns 18 (2015) no 1:128-142 this point and focuses on the role of multinationals in the process of international technology transfer. notwithstanding the mixed evidence from studies conducted in a developing economy context on ‘demand-side constraints’ (marin & bell, 2006), the potential gains from foreign spillovers may greatly depend on the level of absorptive capacity of domestic firms, i.e. their ability to acquire and make use of external knowledge (zahra & george, 2002), and on their level of engagement with foreign subsidiaries in innovative activities (marin & sasidharan, 2010). many contributions to the literature have searched for evidence of subsidiaries of foreign mncs acting as key players in the process of technological diffusion. in a pioneering empirical study, mansfield and romeo (1980) analyse the transfer of technology from us-based mncs to their overseas subsidiaries, focusing on the nature of the technology being transferred and the evaluation of the benefits to the host country. later studies use survey-level data, typically from oecd countries, to analyse the determinants and consequences of firms’ innovation activities. for instance, veugelers (1997), and veugelers and cassiman (1999) study the determinants of firms’ decisions whether to make or buy technology. in this line, cassiman and veugelers (2006) find evidence that there are complementarities between external and internally-developed knowledge. in a contribution closely related with ours, veugelers and cassiman (2004) analyse the role of subsidiaries of foreign mncs as effective channels for the acquisition of foreign technology. they use survey data from the belgian community innovation survey, to test whether belgian subsidiaries of foreign mncs are more likely than domestic firms to transfer technology locally. the authors control for the fact that subsidiaries of foreign mncs could more easily source technology from other countries. they find that subsidiaries of foreign mncs have an easier access to foreign sources of technology but, controlling for access to foreign technology, they are less likely to transfer it locally. un and cuervo-cazurra (2008) compare the performance of spanish firms and subsidiaries of foreign multinationals in terms of r&d expenditures to find that the latter invest less on r&d than spanish firms, a result that is driven by lower expenditures on external r&d, not internal r&d. the question of whether multinationals acquire the most efficient firms and what the effect is of foreign acquisitions on innovation performance, has also attracted attention from research scholars. in this line, stiebale and reize (2011), using data from german firms find a negative effect of foreign acquisitions on the propensity to perform innovative activities and on r&d expenditures of innovative firms. guadalupe and kuzmina (2012), using a dataset of spanish manufacturing firms find that multinational firms acquire the most efficient firms and that the effect of foreign acquisition on the introduction of new products and processes is positive. generally for countries outside the oecd, lack of data has been an impediment to the conduction of similar studies. one exception is oerlemans and pretorius (2006), which analyses firm-level data from the 2001 south african innovation survey to study the determinants of innovation outcomes. the authors stress the importance of an educated workforce for innovation, although r&d intensity seems not to have a significant impact on innovation, albeit the effect varies across industries. they also find evidence of foreign-owned firms generating better innovation outcomes. the characterisation of innovation in south africa is that of incremental innovators working in imitation mode. the south african economy has been described as mixed in that it has aspects of developed economies as well as those of less-developed economies, which creates an interesting backdrop for an investigation of the effect of fdi on the host economy. 3 multinationals and innovation despite the growing importance of arm’slength transfers of technology, i.e. those that involve two unaffiliated parties, see arora et al. (2002), the process of international diffusion of technology is predominantly conducted within the framework of mncs. although far from being cost-free, as documented in teece (1977), internal transfers of technology are sajems ns 18 (2015) no 1:128-142 131 considered to be less problematic than arm’slength transactions. similarly, buckley and casson (1976) argue that knowledge will typically be diffused internally, given that it is easily transferred and difficult to protect, although it is also acknowledged that internal transmission costs depend on factors such as distance. as argued in arora (1996) within an mnc, the scope for opportunistic behaviour is smaller, especially when knowledge has an important tacit component. in fact, kogut and zander (1993) argue that multinationals arise because of their greater efficiency in transferring knowledge internationally, especially know-how. the firm is viewed as a repository of knowledge that consists of how information is coded and action coordinated. thus, the mode of technology transfer is influenced by the characteristic of the advantage that motivates the growth of the firm across borders. the relative advantage of the multinational is especially relevant when tacit knowledge complements codifiable technology. in fact, cantwell (2001) argues that technology has two elements it is codifiable and tacit, specific to particular firms. of course, the second element is difficult to transfer between independent firms, and will be the object of transfer within mncs. by their very nature, mncs are exposed to a richer variety of knowledge sources, which may be more efficiently transferred internally to other parts of the mnc than through arm’slength agreements. thus, subsidiaries of foreign mncs are expected to have access to a wider pool of knowledge and to information channels within the mnc that make the acquisition of information external to the subsidiaries more efficient than in the case of stand-alone firms. in this line, gupta and govindarajan (2002) find empirical evidence for knowledge inflows into subsidiaries depending on richness of transmission channels, motivational disposition to acquire knowledge, and the capacity to absorb incoming knowledge. therefore it is reasonable to expect that the access to a wider pool of knowledge and to information from the parent firm or other subsidiaries within the mnc will make subsidiaries of foreign mncs more active innovation players than comparable domestic firms. these arguments lead us to formulate a number of hypotheses to be tested using data from the 2008 south african innovation survey. first, if mncs are indeed more efficient in the internal transmission of knowledge, and have access to a wider pool of knowledge, we expect them to be more innovative overall than domestic firms, as well as being more likely to introduce innovations that are new to the domestic economy. this will be formally stated as hypotheses 1a and 1b. h1a: south african subsidiaries of foreign mncs are more likely to innovate than domestic firms. h1b: south african subsidiaries of foreign mncs are more likely to contribute to novel innovations than indigenous south african companies. the next two hypotheses emanate from the expected greater relative efficiency of subsidiaries of foreign mncs as channels for the diffusion of foreign technologies into south africa. the existence of communication channels within the mncs makes it more likely that south african subsidiaries of foreign mncs be more aware of products developed outside of south africa, whether within the mnc or by foreign external parties. this is materialised into hypotheses 2a and 2b. h2a: south african subsidiaries of foreign mncs are more likely to introduce innovations developed outside south africa than domestic firms. h2b: south african subsidiaries of foreign mncs are more likely to introduce innovations developed by third parties outside south africa than domestic firms. finally, local r&d is important to absorb foreign technology and to adapt existing products and/or processes to the domestic environment. it is likely that r&d performed by local subsidiaries complements tacit and codified knowledge developed elsewhere within the mnc. additionally, the performance of internal r&d increases the absorptive capacity of the firm that performs it, and it is likely that the local research carried out by subsidiaries of foreign mncs complements r&d carried out elsewhere. thus its impact on the novelty of innovations, as well as on the likelihood of adapting knowledge developed 132 sajems ns 18 (2015) no 1:128-142 elsewhere is greater. in this line, we formulate hypotheses 3a and 3b: h3a: the impact of internal r&d expenditures on the likelihood of introducing innovations new to the south african market is higher for south african subsidiaries of foreign mncs. h3b: the impact of internal r&d expenditures on the likelihood of introducing innovations developed outside south africa and by third parties outside south africa is higher for south african subsidiaries of foreign mncs. 4 the data: the south african innovation survey the 2008 south african innovation survey was conducted by the centre for science technology and innovation indicators (cestii) of the human sciences research council, on behalf of the department of science and technology (dst) of south africa. this is the second wave of innovation surveys conducted by the cestii following the same guidelines as the community innovation survey (cis), after the 2005 survey. previous efforts to use cis-based surveys include the 1996 survey of innovation in south african manufacturing firms and the south africa innovation survey 2001; see oerlemans et al. (2004). the population in the 2008 survey was 22,849 enterprises. out of these, a stratified sample of 2,836 enterprises was selected, successfully collecting information from 757 firms on their innovation activities from 2005 to 2007. the main results from the analysis of the survey data, reported by cestii (2011), suggest that the population of south african firms sampled have a relatively high rate of innovation at 65 per cent. this is comparable to the rate of innovation of firms in oecd countries, although it is observed to be very sensitive to firm size. we assess here the role of subsidiaries of foreign mncs as channels for local diffusion of foreign technologies. table 1 lists the main variables used in the present study, distinguishing between dependent, independent, and control variables. the variables that will appear as dependent variables in the econometric specifications that will be estimated are innovative, forinn, forinnext, and innovmode. the innovative variable takes the value one if the firm had introduced at least one product or process innovation in 2005-07, or had some on-going innovation activities in 2007, even if it was not a successful innovator in 2005-07. innovmode takes value one if the innovation represents a novelty at least in the south african market, zero otherwise. forinn is an indicator variable that takes value one if the firm introduced an innovation –whether product of processthat originated abroad during 200507, zero otherwise. to the best of our knowledge, this is the first time the forinn variable has been used in an analysis of the determinants of innovation. forinnext is also an indicator variable that takes value one if the firm introduces an innovation originated abroad and that was developed in collaboration with or mainly by third parties. regarding the independent variables, forsub is a binary variable that takes value one if the firm is a subsidiary of a foreign mnc, zero otherwise, rdintensity is expenditures on r&d per employee, and interaction is the product of rdintensity and forsub. this interaction term is introduced in the econometric specifications in order to search for incremental effects of r&d on performance variables within subsidiaries of mncs, relative to domestic firms. we control for industry fixed effects by including six industry dummies as control variables (the south african innovation survey uses sic, rev. 3). as additional control variables, log(employees) is the logarithm of the number of employees in 2005, a proxy for firm size, whereas knowledge is the percentage of the firm’s employees with higher education. finally, the costfactor, knowledgefactor, marketfactor, and reasonsfactor variables reflect the firm’s perceptions on the importance of different categories of obstacles to innovation. the questionnaires contain a number of questions in each category, expressed as a 4-point likert scale, ranging from one to four. using these responses, these four variables have been normalised to be between zero and one and represent the average importance of cost, knowledge, and market factors as obstacles to innovation, as well as sajems ns 18 (2015) no 1:128-142 133 the importance of reasons not to be innovative. specifically, if a category of obstacles j includes nj items and if sij is the score of item i, then the constructed variable takes value equal to the sum of the scores of the nj items minus the number of items, nj, and divided by three times nj. for instance, since costfactor includes three items, n=3, which implies that costfactor equals the sum of the scores of each item minus three, divided by nine. table 1 description of the variables variable specification dependent variables innovative takes value one if the firm introduces either a product or a process innovation, regardless of its origin, or has some ongoing innovation activities, between 2005 and 2007; zero otherwise innovmode takes value one if the firm has introduced an innovation that was either new to south africa or new to the world during 2005-2007; zero otherwise forinn takes value one if the firm introduces either a product or a process innovation originated abroad; zero otherwise forinnext takes value one if the firm introduces either a product or a process innovation originated abroad and if the innovation was developed in collaboration with or mainly by other enterprises or institutions; zero otherwise independent variables forsub takes value one if the firm belongs to a foreign multinational; zero otherwise rdintensity expenditures on r&d per employee in 2007 interaction forsub*rdintensity control variables ind1 sic1=2: mining and quarrying ind2 sic=3: manufacturing ind3 sic=4: electricity, gas and water supply ind4 sic=6: wholesale and retail trade ind5 sic=7: transport, storage and communication ind6 sic=8: financial intermediation, computer and related activities, research and development, architectural, engineering and other technical activities knowledge percentage of the firm’s employees with higher education log(employees) logarithm of the number of employees in 2005 costfactor a measure of the extent of how cost factors inhibit innovation that ranges from zero to one. constructed as (importance of lack of funds within own enterprise or group + importance of lack of finance from external sources + importance of innovation costs too high 3)/9 knowledgefactor a measure of the extent of how knowledge factors inhibit innovation that ranges from zero to one. constructed as (importance of lack of qualified personnel + importance of lack of information on technology + importance of lack of information on markets + importance of difficulty in finding co-operation partners for innovation 4)/12 marketfactor a measure of the extent of how market factors inhibit innovation that ranges from zero to one. constructed as (importance of market dominated by established enterprises + importance of uncertain demand for innovative goods or services 2)/6 reasonsfactor a measure of the extent of how reasons not to innovate inhibit innovation that ranges from zero to one. constructed as (importance of no need due to prior innovations+ importance of no need because of no demand for innovations -2)/6 table 2 displays descriptive statistics of the variables used in the present study. out of the 757 observations, 454 firms introduced at least one product and/or process innovation in 200507, or had some on-going innovation activities in 2007. this represents 60 per cent of the total number of observations. 151 of these introduced either a product or a process innovation that was originated abroad (forinn=1). this is 20 per cent of the observations, and 33 per cent of innovative firms. regarding foreign ownership, 115 of the firms in the sample are subsidiaries of foreign mncs. most firms in our sample are in manufacturing (40 per cent) and wholesale 134 sajems ns 18 (2015) no 1:128-142 and retail trade (34 per cent). finally notice that, while 757 valid responses were obtained, the number of observations actually used in the different econometric specifications will be lower, due to the fact that some variables are not observed for all firms. appendix table 1 presents contingency tables of selected binary variables, specifically innovative and forsub, innovmode and forsub, forinn and forsub, and froinnext and forsub. appendix table 2 is a correlation matrix of all the variables used in the analysis, excluding pairs of binary variables. table 2 descriptive statistics variable observations mean standard error dependent variables innovative 757 0.6 0.49 innovmode 382 0.35 0.48 forinn 454 0.33 0.47 forinnext 438 0.23 0.42 independent variables forsub 757 0.15 0.36 rdintensity 435 12.88 73.87 interaction 435 5.84 67.26 control variables ind1 757 0.05 0.01 ind2 757 0.4 0.02 ind3 757 0.03 0.01 ind4 757 0.34 0.02 ind5 757 0.09 0.01 ind6 757 0.09 0.01 knowledge 582 18.95 21.94 log(employees) 713 4.15 1.99 costfactor 757 0.36 0.33 knowledgefactor 757 0.3 0.26 marketfactor 694 0.35 0.35 reasonsfactor 757 0.25 0.29 5 empirical analysis in this section, we describe the econometric analysis that is carried out to test the hypotheses laid out in section 3, and present the results obtained. probit regression results are presented for all industries, as well as conditional on non-services industries (mining and quarrying; manufacturing; electricity, gas and water supply) and services industries (wholesale and retail trade; transport, storage and communication; financial intermediation, computer and related activities, research and development, architectural, engineering and other technical activities). in some of the specifications, correction for sample selection will be introduced, whenever the dependent variable is observed conditional to the firm being innovative. the statistical analysis was conducted using stata and checked with sas. table 3 reports estimated marginal effects of a probit model where the dependent variable is innovative, and forsub is the independent variable. additionally, we control for industry fixed effects, size, the percentage of workers with higher education, and obstacles to innovation activities (costfactor, knowledgefactor, marketfactor and reasonsfactor). according to hypo thesis 1a, we expect the coefficient on forsub to be positive and statistically significant. sajems ns 18 (2015) no 1:128-142 135 table 3 multinational corporations and innovativeness regression results for all industries, and subset by non-services industries and services industries (i) all industries (ii) sic={2,3,4} (iii) sic={6,7,8} forsub 0.137** 0.048 0.216*** (0.049) (0.067) (0.07) knowledge 0.003** 0.001 0.003** (0.001) (0.002) (0.001) log(employees) 0.073*** 0.078*** 0.068*** (0.014) (0.018) (0.02) costfactor 0.051 0.026 0.102 (0.089) (0.11) (0.136) knowledgefactor 0.542*** 0.436*** 0.608*** (0.122) (0.152) (0.185) marketfactor -0.053 0.002 -0.098 (0.085) (0.108) (0.127) reasonsfactor -0.379*** -0.476*** -0.291** (0.082) (0.116) (0.115) industry dummies yes yes yes observations 520 242 278 log likelihood -264.63 -107.06 -153.60 standard errors in brackets and significance level (∗∗∗significant at 1%, ∗∗significant at 5%, and ∗significant at 10%). coefficients and standard errors of the six industry dummies are not explicitly reported to save on space. the first column of table 3 reports estimated coefficients using observations from all industries. consistent with hypothesis 1a, the effect of forsub, is positive and significant, suggesting a higher propensity to innovate by subsidiaries of foreign mncs. although in the case of the services industries the effect of forsub is positive and significant, with non-services industries the effect, while positive, is not statistically significant. a number of other results are obtained in table 3. firstly, the probability of a firm being innovative is strongly and positively associated with firm size, consistent with the statistically significant coefficient of log(employees) across all industries and when subset by non-services and services industries. secondly, the presence of a large number of employees with a high level of education, is positively associated with innovative firms as can be seen from the positive and significant coefficient for knowledge but not significant for nonservices industries, as seen in column (ii). the factors recorded in the survey hampering innovation or influencing the decision not to innovate, were cost-, knowledge-, and market factors as well as some other reasons. this finding is consistent with previous findings in similar studies, such as baldwin and lin (2002), or d’este et al. (2011), that suggest that precisely innovative firms are the ones most aware of the how various obstacles hamper innovation. in all three cases the coefficient reasonsfactor indicated that innovative firms’ successful innovations relate to their need to innovate. following the evidence that south african subsidiaries of foreign multinationals are more innovative than domestic firms, we examine the issue of the novelty of these innovations. hypothesis 1b predicts that subsidiaries of foreign mncs are more likely than local firms to introduce products that are new at least to the south african market. for this reason, the first column of table 4 reports estimated coeffi cients of a probit model where the dependent variable is innovmode and the independent variables are forsub, rdintensity, and interaction. notice that innovmode is observed only if the firm is innovative, and thus only observations from innovative firms is used, reducing the number of observations to 310. the results fail to support hypothesis 1b, since the coefficient on forsub is negative and statistically insignificant. furthermore, the coefficient rdintensity is positive and statistically significant, while interaction is negative and statistically significant. this is 136 sajems ns 18 (2015) no 1:128-142 contrary to hypothesis 3a, which predicts a greater relevance of internal r&d activities for subsidiaries of foreign mncs. the fact that innovmode is observed for the subset of innovative firms only, calls for correction of sample selection with innovative being the selection variable. for this reason, we estimate a probit model with sample selection, as described in maddala (1983). sample selection is corrected for by including an inverse mill’s ratio, obtained from the selection equation, where the dependent variable is innovative and the independent variables are forsub, knowledge, log(employees), costfactor, knowledgefactor, marketfactor, reasonsfactor, as well as industry dummies. this method is more computationally efficient than using maximum likelihood estimation, but it is known that the resulting estimates, although consistent, are not asymptotically efficient under normality assumption. subsidiaries of multinationals are expected to be able to draw more easily on the innovative processes and practices of their parent companies, and therefore transfer of foreign technology new to the south african market. therefore, we expect a positive relationship between a firm being a subsidiary of a foreign mnc and the probability of the firm introducing a product or process innovation that is of high novelty value, at least in south africa. the estimated marginal effects computed using the estimated coefficients in the regression equation (where the dependent variable is innovmode) are displayed in columns (ii), (iii), and (iv) of table 4, whereas the estimated coefficients in the selection equation (where the dependent variable is innovative) are not reported. table 4 regression results for multinational corporations and the type of innovations developed by all industries, non-services industries and services industries (i) basic: all industries (ii) correction: all industries (iii) correction: sic={2,3,4} (iv) correction: sic={6,7,8} forsub -0.006 -0.065 -0.166 * 0.061 (0.075) (0.076) (0.098) (0.129) rdintensity 0.007 *** 0.005 ** 0.002 0.008 ** (0.002) (0.002) (0.003) (0.004) interaction -0.007*** -0.005** -0.002 -0.008 ** (0.002) (0.002) (0.003) (0.004) knowledge 0.004 *** 0.004 ** 0.006 ** 0.002 (0.001) (0.002) (0.003) (0.002) log(employees) 0.078 *** 0.045** 0.098 *** 0.006 (0.017) (0.023) (0.037) (0.03) industry dummies yes yes yes yes observations 310 452 210 242 log likelihood -172.57 -388.26 -178.66 -199.99 heckman ρ -0.582 ** -0.347 -0.711 * (0.032) (0.434) (0 .072) standard errors in brackets and significance level (∗∗∗significant at 1%, ∗∗significant at 5%, and ∗significant at 10%). coefficients and standard errors of the six industry dummies are not explicitly reported to save on space. the marginal effect of forsub is found to be statistically insignificant in specifications (ii) and (iv), and negative and statistically significant in specification (iii). the significant and positive coefficient for rdintensity in column (ii) indicates that r&d-intensive firms in the overall sample contribute positively to the propensity for innovation that is new to the south african market or the world. thus, the introduction of innovations that are new to the market seems to be driven mainly by the firms’ internal capabilities. however, the coefficient on interaction is negative and statistically significant in specifications (ii) and (iv). this suggests that internal capabilities are not as important for subsidiaries of foreign multisajems ns 18 (2015) no 1:128-142 137 nationals, which implies that these firms are simply transferring already-developed technologies without much contribution from the local subsidiary. therefore, we do not find evidence of subsidiaries of foreign multi-nationals being significantly more active than local firms in the introduction of technologies that are new to the south african market. like in the previous case (table 3), firm size and the percentage of employees with higher education have a positive effect on the introduction of products new to the south african market, which influences sectors throughout and the sub-case of non-services industries (table 4). we now compare the propensity to introduce innovation developed outside south africa between local firms and subsidiaries of foreign mncs. in order to do so, we estimate a probit model where the dependent variable is forinn, an indicator of the innovation being developed outside south africa and forsub, rdintensity, and interaction as independent variables. in addition to the industry dummies, we include log(employees) as well as knowledge as control variables. on the one hand, hypothesis 2a predicts a positive estimated coefficient on forsub, and in column (i), (ii) and (iii) of table 5 we indeed obtain a positive and statistically significant coefficient on this variable. on the other hand, hypothesis 3b predicts a positive and statistically significant coefficient on interaction. however, the marginal effects of rdintensity as well as of interaction both fail to be statistically significant in all cases. the fact that forinn is observed only if the firm is innovative, calls for correction of sample selection, in a similar way as we did in columns (ii), (iii) and (iv) of table 4. the selection equation has innovative as the dependent variable, and industry dummies, forsub, knowledge, log(employees), costfactor, knowledgefactor, marketfactor, and reasonsfactor as independent variables. in columns (ii) and (iii), the marginal effect of forsub is positive and statistically significant, but that of rdintensity and interaction is found to be insignificant. these results support hypothesis 2a, but not hypothesis 3b. regarding the control variables, knowledge is positive and statistically significant in columns (i) and (ii), whereas log(employees) is positive and statistically significant in column (i) only. table 5 regression results for multinational corporations and the introduction of foreign innovations by all industries, non-services industries and services industries (i) basic: all industries (ii) correction: all industries (iii) correction: sic={2,3,4} (iv)correction: sic={6,7,8} forsub 0.289 *** 0.240 *** 0.204 ** 0.204 (0.069) (0.075) (0.091) (0.148) rdintensity -0.001 -0.001 0.001 -0.001 (0.001) (0.001) (0.003) (0.001) interaction 0.004 0.004 -0.000 0.021 (0.003) (0.003) (0.003) (0.02) knowledge 0.003 ** 0.003 ** 0.003 0.002 (0.001) (0.002) (0.002) (0.003) log(employees) 0.027 * 0.018 0.029 -0.005 (0.015) (0.023) (0.031) (0.032) industry dummies yes yes yes yes observations 367 507 237 270 log likelihood -212.16 -456.64 -208.96 -241.39 heckman ρ -0.248 -0.056 -0.642 (0.5437) (0.928) (0.281) standard errors in brackets and significance level (∗∗∗significant at 1%, ∗∗significant at 5%, and ∗significant at 10%). coefficients and standard errors of the six industry dummies are not explicitly reported to save on space. 138 sajems ns 18 (2015) no 1:128-142 we finish our empirical analysis by studying the determinants of forinnext, the indicator of the foreign technology being developed outside the multinational in collaboration with or mainly with other enterprises as dependent variable. according to hypothesis 2b, we expect a positive relationship between a firm being a subsidiary of a foreign mnc and the probability that the firm introduces an innovation originated outside south africa and developed outside of the mnc. according to hypothesis 3b, we expect the impact of r&d carried out internally, to be greater in the case of subsidiaries of foreign mncs, and thus the coefficient of interaction is expected to be positive and statistically significant. table 6 presents estimated coefficients of different specifications where forinnext is the dependent variable. in a similar way as in the previous tables, the first column reports marginal effects of a probit specification without correction for sample selection. in this case, contrary to hypothesis 2b, the marginal effect of forsub is found to be negative and statistically significant. the marginal effects of rdintensity and interaction are found to be statistically insignificant. like in the previous case, the nature of the variable calls for correction for sample selection. columns (ii), (iii) and (iv) of table 6 report estimated marginal effects of econometric specifications where the regression equation has forinnext as the dependent variable, and forsub, rdintensity, and interaction as independent variables. the selection equation has forinn as dependent variable, and forsub, knowledge, and log (employees) as independent variables. we fail to obtain statistical significance of the marginal effects of forsub and interaction in the selection equation, thus failing to confirm hypotheses 2b and 3b. table 6 regression results for multinational corporations and the introduction of foreign innovations developed outside the group by all industries, non-services industries and services industries (i) basic: all industries (ii) correction: all industries (iii) correction: sic={2,3,4} (iv) correction: sic={6,7,8} forsub -0.443 *** -0.124 -0.215 0.081 (0.112) (0.176) (0.505) (0.127) rdintensity 0.009 0.011 0.004 0.007 (0.012) (0.012) (0.007) (0.009) interaction -0.008 -0.01 -0.004 -0.009 (0.012) (0.012) (0.006) (0.009) industry dummies observations yes yes yes yes 129 380 193 187 log likelihood -53.4 -279.24 -139.16 -135.67 heckman ρ 0.93 -0.674 0.975 (0.246) (0.65) (0.12) standard errors in brackets and significance level (∗∗∗significant at 1%, ∗∗significant at 5%, and ∗significant at 10%). coefficients and standard errors of the six industry dummies are not explicitly reported to save on space. 6 concluding comments this paper has analysed the innovation propensity of south african subsidiaries of foreign multinationals, in comparison with indigenous firms. our empirical findings on the role of subsidiaries of foreign mncs in the process of technological diffusion are mixed. we do indeed find that subsidiaries of foreign mncs are more likely than domestic firms to not only innovate but also to introduce innovations originally developed in foreign countries. however, we do not find evidence of these subsidiaries being more likely to generate innovations that are new to the global or to the south african market, or developed by foreign actors external to the mnc. sajems ns 18 (2015) no 1:128-142 139 these results suggest that south african subsidiaries of foreign multinationals specialise in the transfer of technologies developed within its own multinational, and show no particular advantage in transferring foreign technologies developed by third parties. furthermore, internal r&d capability seems to stimulate innovations, while r&d expenditure of subsidiaries of foreign multinationals seems to impact negatively on the propensity for novel innovations. hence, policies based on the promotion of fdi are likely to mostly attract knowledge developed within mncs, and not that developed by other external players. for this task, domestic firms seem to be better suited, and their expenditures on internal r&d seem to have a greater return. a number of limitations to this study could be mentioned. first, from a methodological perspective, the use of survey data poses the risk of common-method bias. with survey data, false correlations may arise if respondents provide answers to unrelated survey questions that make them appear consistent with each other. this problem is most acute when both the dependent and independent variables are perceptual and come from the same source (chang et al., 2010). we believe that this could be the case for obstacles to innovation variables, but less for the rest of the variables, which are more objective by nature. in any case, the obstacles to innovation variables are used as controls in the main regression (see table 3) and in the selection equations of the rest of the specifications. another important limitation is that we do not have information on the productivity of firms. the present study simply assessed the relative performance of south african subsidiaries of foreign mncs in the dimensions that were observable given the available data. however, no distinction could be made regarding the actual impact on productivity of the different innovations introduced by the firms in the sample, say within the group of innovations that are new to the south african market. this type of limitation calls for the use of more detailed, perhaps industry-specific data. endnote 1 the south african standard industrial classification uses isic rev. 3 as its parallel. acknowledgements we thank the associate editor of sajems, as well as an anonymous referee for their comments, which substantially improved the quality of the manuscript. we also thank comments from participants at the second navarra development week. mustapha thanks the south african department of science and technology for research funding. mendi gratefully acknowledges financial support from ministerio de economía y competitividad (eco2010-18680), as well as from fundación can. references arora, a. 1996. contracting for tacit knowledge: the provision of technical services in technology licensing contracts. journal of development economics, 50(2):233-256. arora, a., fosfuri, a. & gambardella, a. 2002. markets for technology: the economics of innovation and corporate strategy. cambridge, ma: mit press. baldwin, j. & lin, z. 2002. impediments to advanced technology adoption for canadian manufacturers. research policy, 31:1-18. blalock, g. & gertler, p. 2009. how firm capabilities affect who benefits from foreign 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sajems ns 18 (2015) no 1:128-142 141 veugelers, r. & cassiman, b. 1999. make and buy in innovation strategies: evidence from belgian manufacturing firm s. research policy, 28:63-80. xu, b. & wang, j. 1999. capital goods trade and r&d spillovers in the oecd. canadian journal of economics, 32:1258-1274. zahra, s. & george, g. 2002. absorptive capacity: a review, reconceptualization, and extension. academy of management review, 27(2):185-203. zhu, l. & jeon, b. 2007. international r&d spillovers: trade, fdi and information technology as spillover channels. review of international economics, 15:955-976. appendix table a.1 contingency tables of selected variables used in the empirical analysis forsub=0 forsub=1 total innovative=0 277 26 303 innovative=1 365 89 454 total 642 115 757 pearson’s stat. 17.137 probability 0.000 forsub=0 forsub=1 total innovmode=0 201 48 249 innovmode=1 105 28 133 total 306 76 382 pearson’s stat. 0.172 probability 0.679 forsub=0 forsub=1 total forinn=0 269 34 303 forinn=1 96 55 151 total 365 89 454 pearson’s stat. 40.615 probability 0.000 forsub=0 forsub=1 total forinnext=0 277 59 336 forinnext=1 82 20 102 total 359 79 438 pearson’s stat. 0.222 probability 0.637 table a.2 correlation matrix of the variables used in the empirical analysis (1) (2) (3) (4) (5) (6) (7) innovative (1) 1.000 innovmode (2) 1.000 forinn (3) 1.000 forinnext (4) 1.000 forsub (5) 1.000 rdintensity (6) 0.0435 0.0738 0.0584 0.1106* 1.000 interaction (7) -0.0369 0.1112* 0.0738 0.1738* 0.9022* 1.000 knowledge (8) 0.0621 0.1215* 0.1415* 0.0280 0.1287* 0.0687 -0.0148 log(employ) (9) 0.3421* 0.2825* 0.0749 0.0918 0.1414* -0.0534 -0.0359 costfactor (10) 0.1893* 0.054 -0.0750 0.0095 -0.0688 0.0204 -0.0540 knowfactor (11) 0.2894* 0.1212* -0.0394 0.0262 -0.0093 0.0747 0.0323 marketfactor (12) 0.1048* -0.0427 -0.0490 -0.0220 0.0295 0.0433 0.0633 reasonsfactor (13) -0.1092* -0.1381* 0.0209 0.0630 0.0375 -0.0004 0.0011 142 sajems ns 18 (2015) no 1:128-142 (8) (9) (10) (11) (12) (13) knowledge (8) 1.000 log(employ) (9) -0.2898* 1.000 costfactor (10) -0.0427 0.0612 1.000 knowfactor (11) -0.0536 0.1883* 0.6312* 1.000 marketfactor (12) -0.0258 -0.0156 0.5464* 0.5969* 1.000 reasonsfactor (13) -0.1004* -0.0305 0.2360* 0.2672* 0.4039* 1.000 abstract introduction literature review and hypotheses development conceptual framework methodology results and analysis discussions and conclusions implications limitations and further research acknowledgements references about the author(s) stephen oduro faculty of economics, university of international studies of rome unint, rome, italy alharthi rami hashem e department of financial and administrative sciences, ranyah university college, taif university, taif, saudi arabia ahmed h. alsharif azman hashim international business school, universiti teknologi malaysia, johor, malaysia citation oduro, s., alharthi, r.h.e. & alsharif, a.h., 2022, ‘organisational ambidexterity and social enterprise performance: a ghanaian perspective’, south african journal of economic and management sciences 25(1), a4635. https://doi.org/10.4102/sajems.v25i1.4635 original research organisational ambidexterity and social enterprise performance: a ghanaian perspective stephen oduro, alharthi rami hashem e, ahmed h. alsharif received: 24 apr. 2022; accepted: 22 aug. 2022; published: 25 nov. 2022 copyright: © 2022. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: despite the important role of social enterprises in addressing the gaps in social service and infrastructure provision by national governments, the organisational capabilities that make social enterprises competitive and effective are still under-researched in emerging economies. aim: the purpose of the study is to extend the extant studies on the nexus between organisational ambidexterity and firm performance to the social enterprise context. more specifically, we draw on the dynamic capability theory to investigate business-like social enterprises in ghana and how organisational ambidexterity (i.e. exploitation and exploration) influences their social and economic performance. setting: organisational ambidexterity was tested on 317 randomly selected social enterprises in ghana. method: the study employed a quantitative research design via a survey questionnaire while the structural equation modelling technique in analysis of a moment structure (amos) software was used to test the study’s hypotheses. results: it was found, among other things, that both exploration and exploitation are positively and significantly related to social performance (social marketing achievement and social value creation) and economic performance (commercial marketing achievement and economic value creation) of social enterprises. that is, the simultaneous pursuit of exploitative and explorative initiatives does not decrease but increase social enterprise performance. these results defy the conventional wisdom that the trade-off between exploitative and explorative functions may decrease organisation efficiency and bring unnecessary costs. conclusion: organisational ambidexterity can be considered a cradle of strategic revitalisation and competitive advantage for social enterprises enhancing social and economic performance. therefore, we suggest that social entrepreneurs should pursue exploitative and explorative ambidexterity simultaneously through appropriate structural ambidexterous mechanisms like structural separations or contextual ambidexterous mechanisms such as non-structural separations of units. keywords: organisational ambidexterity; social enterprise; social performance; economic performance; ghana. introduction the ability to act efficiently while being adaptive to the ever-changing, exacting, and tumultuous business environment has become a prerequisite for the survival of firms today more than ever before (hölzl 2022; weaver & blakey 2022), rendering it a vital expedition in research to explore and determine the means to create and build organisational ambidexterity (oa) in companies (hölzl 2022; junni et al. 2013). indeed, kafetzopoulos (2021:1) captures this reality well: ‘nowadays, a major topic for researchers and an important issue for almost all companies in the world is ambidexterity’. organisational ambidexterity refers to a firm’s capability to pursue both exploitative and explorative innovation strategies, simultaneously, to secure sustainable competitive advantage (o’reilly & tushman 2008). the extant literature differentiates between two main internal strategies of oa, namely exploitative and explorative (o’reilly & tushman 2008; hughes 2018), based on the structural ambidexterity framework (o’reilly & tushman 2008; raisch & tushman 2016). according to the dynamic capability theory (dct), oa is a dynamic capability that helps organisations to adjust to changing business trends over time (junni et al. 2013), enhance a firm’s financial performance (auh & menguc 2005), innovation (rothaermel & deeds 2004), new product development (ferreira, cardim & branco 2018) and overall firm performance (cao, gedajovic & zhang 2009; kafetzopoulos 2020). this dynamic and innovative capability is also practical for social enterprises that do not possess abundant resources (farhoud et al. 2021; madden 2012; weaver 2020). the importance of social enterprises, defined as enterprises with ‘revenue-generating interventions for the alleviation of social problems’ (weaver & blakey 2022:3), in addressing crises such as ethnic, racial, religious discrimination, economic recessions, pandemics, and uncertainty, which are long-standing issues that tend to reoccur, has received increased attention among social activists, policymakers, practitioners, and academics. in ghana, for example, the dynamic role of social enterprises is highly underscored due to the (1) ‘increased focus on the role of the private sector and (2) continuing gaps in social service and infrastructure provision by the state’ (darko & koranteng 2015:5). to help develop and support social enterprise development ecosystems in ghana, government and private stakeholders have made several initiatives, including the business development fund, the ghana regional appropriate technology industrial services (gratis), (obeng & blundel 2015), and growth mosaic, ispace, and incubators like impact hub accra, reach for change, and technoserve to offer business support to social entrepreneurs and small-business owners in an attempt to promote social entrepreneurship across the country (agyeman-togobo et al. 2016). however, to successfully deliver social and economic value to the world, social enterprises have to respond quickly and adaptively in times of crisis to the ever-increasing societal problems and concerns (farhoud et al. 2021; weaver & blakey 2022). in fact, farhoud et al. (2021) postulate that social enterprises must move swiftly to identify novel business roles and opportunities in today’s exacting, turbulent marketplace. in particular, since the covid-19 pandemic, companies across all sectors have had to adapt and shift rapidly to changing business demands in terms of government requirements regarding lockdowns and how customers’ needs and wants are to be met, as well as how they are to be protected. this way, social enterprise experts opine mission agility during this crisis and its aftermath – and without doubt, one key internal strategy to accomplish this is by deploying oa (bacq & lumpkin 2021; weaver 2020). notwithstanding, the ambidexterity research map still has some blind spots (kafetzopoulos 2020). amongst these blind spots is the impact of oa on social enterprise performance, particularly in emerging economies. organisational ambidexterity has been researched in different contexts like high-tech small and medium enterprises smes (venugopal et al. 2020; wang & rafiq 2014), family-owned businesses (mazelli et al. 2020), and environmental dynamism (mammassis & kostopoulos 2019), but the current study is one of the few to examine this focal relationship in the social enterprise context in sub-saharan africa. a large share of the extant literature has been concentrated in the conventional entrepreneurship arena in the developed world (i.e. for-profit enterprises) (gottschalck et al. 2021; kafetzopoulos 2020; santoro, messeni-petruzzelli & del giudice 2021; simsek 2009). to this end, we have limited understanding and insight vis-à-vis the applicability of the oa framework in the social enterprise context in emerging economies and the extent to which it influences the performance of these not-for-profit organisations (nowak & raffaelli 2022). yet, as stated before, ambidexterity is critical not only for the organisational prosperity and performance of traditional entrepreneurship firms but also for non-conventional enterprises like social enterprises, which also need capabilities of exploitation and exploration to rapidly or swiftly respond to societal challenges at hand, by harnessing technological and social innovations (kamaludin, xavier & amin 2021). another blind spot on the ambidexterity research map, even within the conventional entrepreneurship literature, is the mixed findings on its impact on the performance of firms (jurksiene & pundziene 2016). while some scholars argue that pursuing oa benefits firms, since its elements complement each other (cao et al. 2020; gottschalck et al. 2021; kafetzopoulos 2020), some postulate that oa has no significant impact (venkatraman, lee & iyer 2007) and that oa may even decrease firm performance because its elements compete for scarce resources (atuahene-gima 2005). so, there is yet to be theoretical or empirical consistency about the effect of oa on enterprise performance, thus needing further inquiry for validation. this study, answering researchers’ call for more empirical research to ‘examine whether ambidexterity leads to success’ (kafetzopoulos 2020:4; raisch & birkinshaw 2008), moves the extant literature in advance by designing a comprehensive conceptual model that examines the relationship between oa and organisational performance in the social enterprise context in an emerging economy. therefore, from the perspective of the dct, we raise the nagging question: does oa (exploitation and exploration) positively or negatively influence social enterprise performance in emerging economies like ghana? to answer this question, the study empirically examines the independent effect of exploitative ambidexterity and explorative ambidexterity on each dimension of social enterprise performance (i.e. social performance, social marketing achievement & social value creation) and economic performance (commercial marketing achievement & economic value creation) based on a sample of 317 ghanaian social enterprises. this sample includes firms that generate income from business activities (i.e. income from different sources like trading activities or service offering for new fundraising (guo 2006), thus excluding red cross, the salvation army, united way of ghana, and religious-based organisations. accordingly, the study’s contributions are four-fold, reflected in its objective. firstly, we introduce the concept of oa to social enterprise research in an emerging market and develop hypotheses concerning its influence on social enterprise performance. informed by the dct, this study serves as one of the limited studies to investigate the value and role of oa in social enterprises as a strategic technique for enhancing performance. secondly, we investigate the social enterprise performance using a multidimensional performance framework, namely social performance (1) social marketing achievement and (2) social value creation, and economic performance (3) commercial marketing achievement and (4) economic value creation to address the prevailing contradictory findings in oa – performance associations on a micro-level, which in turn, extends the development of business models. this adds theoretical value to social enterprise research because one of the daunting aspects of social enterprise research is how to measure the impact of social interventions (liu, eng & takeda 2015). thus, distinguishing the differential effects of oa on diverse wings of firm performance can add theoretical value to research and practice. thirdly, we extend the debate regarding the role of oa in enhancing the performance of organisations to emerging economies like ghana, which is under severe financial and economic debt, coupled with the aftermath of the covid-19 pandemic. scholars have called for the examination of oa in a different context (cao et al. 2009) and culture (malik et al. 2019; peng 2019), since most of the existing studies are concentrated in the advanced world and in for-profit enterprises. we believe that the implications of the study’s findings may offer useful insights to other emerging economies that are known to experience similar economic downturns like ghana. lastly, it is envisaged that the study’s findings will enable managers and practitioners to appreciate the relevance of oa to social enterprises, its impact on performance, and, most importantly, how it can be deployed to improve social enterprise performance. thus, the study may offer valuable insights to social enterprise owners/managers in achieving the amalgamation of the steadiness of organisational transformation and social service deliverance. we have organised and structured the other sections of the manuscript in this fashion: in section 2 the theoretical underpinnings of our research and the logical arguments of our hypotheses are particularised; in section 3 the research methods employed to analyse the study’s hypotheses are detailed, while in section 4 the findings of the study are addressed; in section 5 is the discussion of the results in relation to the extant literature, while in section 6, the last section, the managerial and theoretical implications of the study are delineated, pointing out potential, thought-provoking avenues for further research. literature review and hypotheses development organisational ambidexterity from a dynamic capability theory the present study is rooted in the dct, which is an outgrowth of the resource-based view (rbv) of the firm. the rbv attributes firms’ performance variances to diversity in resources owned and controlled by the enterprise, noting that resources that are rare, inimitable, organisable, and valuable in a special way generate superior firm performance (hesterly & barney 2015). however, recent scholars have criticised the rbv for being internally oriented and static, thereby failing to account for performance differences in turbulent, dynamic environments (chinakidzwa & phiri 2020; zhou et al. 2019). moreover, merely possessing resources is not sufficient; capabilities are needed to profitably transform resources into value (chinakidzwa & phiri 2020). dynamic capabilities underscore the ‘key role of management in appropriately adapting, integrating, and reconfiguring internal and external experience, resources, functional competencies within a changing environment’ (gregory, ngo & karavdic 2019:12). the dct is based on the premise that firms can rapidly and speedily adjust and change their internal resource arrangement to facilitate organisational processes after witnessing lucid signals from the marketplace (morgan 2012). dynamic capabilities are organisational capabilities that ‘enable the firm to implement strategies using new and different combinations and transformation of resources’ (teece et al. 1997:8) to adapt the altering business conditions. we take the view that dynamic capabilities – in this case, oa, will enable social enterprises to develop and identify capabilities that will enable them to respond to social problems and market opportunities (gregory et al. 2019). since dct has the power to explain performance differences in volatile, unpredictable, and dynamic markets like today’s turbulent, exacting marketplace caused or exacerbated by the covid-19 pandemic, it forms the theoretical bedrock for our arguments. the quest for a better way of achieving change in today’s competitive business and economy has sparked an accelerating research interest in oa during the recent two decades (tarba et al. 2020). scholars employed the human characteristic of ambidexterity as a symbol to represent organisations. ambidexterity literally means ‘right on both sides’ (simsek 2009:599). therefore, organisations that are ‘capable of exploiting existing competencies as well as exploring new opportunities with equal dexterity are akin to humans employing both hands equally’ (simsek 2009:599) thus, oa is defined as a firm’s capability to concurrently orchestrate exploitative strategies and activities that streamline present operations to maximise value and explorative activities that accomplish future business opportunities and growth (venugopal et al. 2020). ambidextrous enterprises are not merely effective and efficient in managing current business requirements but also sufficiently flexible to adjust to the changes in the progressively dynamic, volatile, and unpredictable business environment (limaj & bernroider 2019), which in turn, leads to sustainable competitive advantage (mazzelli et al. 2020). generally, the literature suggests two main forms of ambidexterity: exploitative ambidexterity and explorative ambidexterity. exploitative ambidexterity permits organisations to respond to disruptions and changes by adjusting or adapting to current competencies and business demands, while explorative ambidexterity allows firms to respond to market changes by developing novel products and services and exploiting novel markets (cegarra-navarro, sánchez-vidal & cegarra-leiva 2011; lubatkin et al. 2006). exploration looks at ‘search, variation, risk-taking, experimentation, play, flexibility, and discovery’ (p. 71), while on the other hand, exploitation looks at ‘refinement, choice, production, efficiency, selection, implementation, and execution’ (march 1991:71). empirical evidence shows that these two dimensions are important drivers of firm performance (o’reilly & tushman 2013), although the prevailing studies are limited to the for-profit context, particularly in smes (lee & kreiser 2018). exploitative and explorative activities demand significantly diverse, often even conflicting cultures, capabilities, processes, and structures; thereby, inconsistencies, contradictions, and conflicts are predictable (o’reilly & tushman 2004). whereas earlier research often deemed the trade-off required to accomplish high levels of exploitation and exploration as not possible to put into operation, other studies pointed out a series of solutions to implement oa, such as structural separation (o’reilly & tushman 2004) and non-structural, context-related factors like values, mindset or culture (eisenhardt & martin 2000). as well, research underscores different types of strategies adopted by firms with regard to oa. for instance, scholars draw on a time-dependent perspective to differentiate between two approaches of oa as manifested in organisations: sequential ad simultaneous. on the one hand, the sequential ambidexterous approach occurs when a firm systematically uses a temporal cycle by either, firstly, implementing exploration or exploitation, followed by seasons of rotations (venkatraman et al. 2007). on the other hand, simultaneous ambidexterity takes place when an organisation synchronously pursues exploitation and exploration simultaneously (o’reilly & tushman 2013). other scholars also differentiate between structural ambidexterity and contextual ambidexterity that may affect a firm’s exploitative and explorative strategies. structural ambidexterity addresses the overall organisational structure in distinct, discrete subunits that may influence the concurrent development of exploitation and exploration (diaz-fernandez, pasamar-reyes & valle-cabrera 2017; simsek 2009). research demonstrates that strategic structural ambidexterity enhances contexts for appropriate exploitation and exploration (raisch et al. 2009), facilitates differentiation of tasks (venugopal et al. 2018), and promotes diverse cultures and processes (o’reilly & tushman 2004). on the other hand, contextual ambidexterity involves the incorporation of both activities into one business unit, performed by all workers with no additional specialisation. organisational ambidexterity and social enterprise performance social enterprises are organisations that pursue a social mission and utilise innovative revenue generation approaches to fulfill their mission (kilpatrick et al. 2021; weaver 2020). thus, social enterprises are characterised by social mission and value creation, social innovation, social change, and entrepreneurial spirit. farhoud et al. (2021) stress that social entrepreneurs, as a result of the increasingly dynamic, volatile business environment, coupled with the unpredictable nature of government programmes and implementation of social interventions (weaver & blakey 2022), shift their enterprises’ resources and capabilities between novel and current products and services to execute social missions. social entrepreneurs not only identify and solve social matters but also explore social needs, determine social opportunities, and develop strategies to meet them (davis & bendickson 2021; weaver & blakey 2022). farhoud et al. (2021) postulate that social enterprises must move swiftly to identify novel business roles and opportunities in today’s exacting, turbulent marketplace. social enterprises are relevant modulators and facilitators of ambidexterity for several reasons. first, two diverse but mutually exacting systems interact within this context: the firm system and stakeholders’ expectations. the resulting feature of social enterprises, especially the influence of stakeholders (e.g. donors) in terms of expectation, allows them to reach an increased degree of exploration for growth and survival in the future and exploitation of existing processes and competencies simultaneously. in fact, the heightened requirements for accountability toward stakeholders demand not-for-profit enterprises to enhance resources, mobilise for the transformation and evolution, and at the same time guarantee frequent production to create social, economic, and environmental values. through ambidextrous functioning, social enterprises can accomplish this (peng 2019). social enterprises may build an environment that offers the necessary unique focus on performance and social support. peng (2019:1) noted, ‘organizational ambidexterity might provide some strategic leads for balancing the possible paradoxes within different kinds of expectations of the stakeholders’ of not-for-profit organizations’. due to the recent pandemic, stakeholders’ demands and resource tensions have led social enterprises to novel changes to secure augmented efficiency. in some instances, social enterprises should be able, with fewer means, to ‘do more and do it better’ (peng 2019), which could create some kind of organisational tensions and organisational paradoxes (bloodgood & chae 2010); thereby requiring social enterprises to discover novel strategic visions to achieve a balance between organisational change and stability of social intervention efficiency. thus, social enterprises must handle the contending pressures of distilling current routines and structures for efficiency with the need to innovate and grow. secondly, because social enterprises develop and distribute social programmes, previously executed by governmental organisations, they should balance the efficient delivery of current products and services with alterations in the larger business context that might influence future demand (peng 2019) in such areas as discontinued or new funding opportunities (sherlock & gravelle 2018) and changes in growth potential (kaplan & grossman 2010). thirdly, social enterprises operate within a central mission which orchestrates the scope of their products, programmes, and services, making them unlikely to achieve growth via unrelated diversification. these conditions make social enterprises an exceptional context for investigating oa and exploring if and how social enterprise managers/owners attempt to engage in explorative and exploitative ambidexterity. research demonstrates that oa leads to superior performance since the firm demonstrates efficiency in executing present market demands, while simultaneously manifesting the flexibility required to adapt to new opportunities and challenges in the business environment (peng 2019). thus, we expect that oa will enhance social enterprise performance. while the cost related to achieving a greater level of both aspirations are high (haibin and atuahene-gima, (2007), ambidexterity in product innovation management: the direct and contingent effects on product development performance, and a score of businesses remain unsuccessful (o’reilly & tushman 2004), we believe that the unique context of social enterprises eases ambidextrous thinking and the implementation of it in a firm’s strategic orientation. inspired by the dct, we distinguish between exploitative and explorative ambidexterity and examine their relative impact on relative dimensions of social enterprise performance. madden (2012) found that oa is positively related to the fiscal performance in a not-for-profit enterprise. other studies (e.g. peng 2019; plimmer, bryson & teo 2017) found that oa can increase the performance of not-for-profit enterprises. however, one crucial limitation of these studies is that they did not examine the relative effect of exploitative and explorative ambidexterity, nor did they use a multidimensional approach to capture social enterprise performance. however, the social entrepreneurship literature suggests that enterprise performance should be captured into multiple dimensions (pearce, fritz & davis 2010; van der vaart 2021), because a multidimensional performance framework offers a healthier test of the focal relationship. accordingly, we used two dimensions subdivided into four dimensions to capture social enterprise performance, namely social performance (1) social marketing achievement and (2) social value creation, and economic performance (3) commercial marketing achievement and (4) economic value creation (liu et al. 2015). thus, we expect that higher levels of exploitative and explorative ambidexterity will lead to a higher level of social enterprise performance, as reflected in the following hypotheses, informed by the dct: h1a: a social enterprise’s exploitative ambidexterity is positively related to its social performance in terms of social marketing achievement. h1b: a social enterprise’s exploitative ambidexterity is positively related to its social performance in terms of social value creation. h1c: a social enterprise’s exploitative ambidexterity is positively related to its economic performance in terms of commercial marketing achievement. h1d: a social enterprise’s exploitative ambidexterity is positively related to its economic performance in terms of economic value creation. h2a: a social enterprise’s explorative ambidexterity is positively related to its social performance in terms of social marketing achievement. h2b: a social enterprise’s explorative ambidexterity is positively related to its social performance in terms of social value creation. h2c: a social enterprise’s explorative ambidexterity is positively related to its economic performance in terms of commercial marketing achievement. h2d: a social enterprise’s explorative ambidexterity is positively related to its economic performance in terms of economic value creation. conceptual framework figure 1 and figure 2 demonstrate the conceptual framework that guided the study. the model 1a divulges that oa, specifically, exploitative ambidexterity (h1a-d) has a positive, significant effect on the respective dimensions of social enterprise performance, namely social performance: (1) social marketing achievement; (2) social value creation, and economic performance; (3) commercial marketing achievement; (4) economic value creation (liu et al. 2015). likewise, model 1b highlights that oa, specifically, explorative ambidexterity (h2a-d) will have a positive, significant effect on the respective dimensions of social enterprise performance, namely social performance: (1) social marketing achievement; (2) social value creation, and economic performance; (3) commercial marketing achievement; (4) economic value creation (liu et al. 2015). finally, we also used the size of the enterprises, specifically, turnover in the past three years, as a control variable because of their potential effect on enterprise performance (liu et al. 2015). figure 1: conceptual model of the exploitative ambidexterity – social enterprise performance relationship. figure 2: conceptual model of the explorative ambidexterity – social enterprise performance relationship. methodology aim, design, and setting of study we examined the hypothesised relationships in a research context of ghanaian social enterprises. a quantitative research design is employed, and the research instrument used is a survey questionnaire. selection and description of participants to test the study’s hypotheses, we designed a large-scale empirical instrument and sent it to the owners/managers of the social enterprises to obtain primary data. we designed the questionnaire, based on the methodologies and recommendations from social entrepreneurship literature (liu et al. 2015), and observed methodological measures to reduce concerns about responses biases (podsakoff 2003). moreover, we conducted a pilot-test incorporating numerous social enterprises owners, researchers, and managers to boost our survey questionnaire further. we employed a convenience sampling method as the address base and addressed the survey instrument to 1200 individual respondents who were owners/managers of social enterprises in ghana. we have included social enterprises in the analysis of the study based on the following two criteria: firstly, the enterprise generates income from business activities (i.e. income from divergent avenues like trading ventures or service offering for novel fundraising (guo 2006; liu et al. 2015); and secondly, the enterprise has been able to generate sufficient revenue from multiple sources and has a track record of trading activities in the past three years. we found enterprises with annual revenue above ghs80 000 (approximately $10 000). with the inclusion criteria established, we sent out emails in january 2022, followed by a bespoke letter outlining the research scheme and purpose. after we sent out two mailing lists, 417 enterprises returned the survey instrument, representing a response rate of 34.75%. we tested the quality of the dataset created (tabachnick, fidell & ullman 2007) before we proceeded to the empirical analyses. firstly, we examined every item’s means, standard deviations (sds), and minimum and maximum values for plausibility. however, we did not find any error concerning the accuracy of our data entry. nevertheless, some of the questionnaires reported missing values in diverse aspects of the questionnaire. we solved this problem by deleting these cases from the created dataset (draper & smith 1998), reducing the usable sample to 317 social enterprises. in addition, we checked for potential biases because of the cross-sectional survey nature of the study, since this could decrease the validity of the findings. here, a commonly reported problem is the characteristic difference between the respondents of a study and non-respondents (armstrong & overton 1977). to test for any potential discrepancies between early and late responses, we used the non-parametric kolmogorov-smirnov test and mann-whitney u-test. our analysis did not reveal any statistically significant response biases between the early and late responses. apart from non-response bias, the impact of common method bias has been a relevant issue in entrepreneurship and management research (podsakoff 2003). this bias points out a variance in findings associated with the employed measurement approach instead of to the constructs of the study (podsakoff 2003). harman’s single-factor test – a method commonly used to assess common method bias in a single-method research approach – was used to this effect (malhotra, kim & patil 2006). our analysis again demonstrates that common method bias is no issue in our applied measurement method. operationalisation of constructs we adapted the lubatkin et al.’s (2006) (from gottschalck et al. [2021] scale to assess exploitation and exploration. depending on their enterprise’s oa in the previous three years, the owners/managers of the social enterprises were asked to evaluate six (6) statements each on exploitation and exploration on a scale of 1 (strongly disagree) to 5 (strongly agree). regarding the social enterprise performance, we measured it using the respondents’ subjective assessment for the reasons following. firstly, obtaining and appropriately interpreting a social enterprise’s performance is daunting because there is scarcely any dependable access to data on performance for privately held enterprises (dess & robinson 1984). secondly, social enterprises are not required by law to publish their financial performance and/or non-performance (liu et al. 2015). thirdly, research shows that managerial actions and decisions are driven principally by perceptions or views of organisational performance (morgan, kaleka & katsikeas 2004). this way, strategic management scholars have made extensive use of perceived performance indicators, which have shown relevant reliability and validity applicable to objective performance assessments. to assess the perceived performance of the social enterprises based on the four dimensions, we asked the respondents to rate the extent to which they have achieved their social and economic performance. firstly, social performance is examined via social marketing achievement and social value creation by adapting the scale of liu et al. (2015). social marketing achievement involves the enterprise’s marketing programme’s effectiveness concerning whether or not it has accomplished its preset donor and volunteer contribution-based targets, and it was measured using five items. on the hand, the social value creation measures how well the enterprise is able to create social value, based on critical social performance indicators like serving more beneficiaries, bidding for public service contracts, expanding social service to more locations, among others (gainer & padanyi 2005). it was measured using five-scale items (liu et al. 2015). likewise, we examined economic performance based on economic marketing achievement and economic value creation, adapting the scale of liu et al. (2015). commercial marketing achievement involves the effectiveness of the enterprise’s marketing programmes vis-à-vis preset market-based goals (cano et al. 2004). in contrast, economic value creation involves the ability of the enterprise to create economic value from its social mission programmes based on key economic performance measures in the past year. accordingly, we measured the commercial marketing achievement using five items, while six items were used to capture the economic value creation of the social enterprises (liu et al. 2015). previous studies have used size as a control variable (e.g. alegre-vidal & chiva-gomez 2013), stressing that large enterprises are likely to possess a strong resource-base of well-established reputation and brand to garner business opportunities in both social and commercial contexts. thus, an enterprise’s size, measured in this study by the total revenue of the enterprises, may potentially influence its ability to achieve high social and economic performance. therefore, we used turnover instead of staff (number of employees) because the total number of staff might not be a true reflection of the size of social enterprise, due, in part, to the fact that social enterprises tend to consist of paid and volunteer employees, and so there is a considerable variation in the hours of each volunteer (liu et al. 2015; liu & ko 2012). accordingly, we measured the size of the social enterprise using a 5-point likert scale (1 = very small, 5 = very large) that allows for the differentiation of the total revenues of the social enterprises. an interval of ghs 80 000 (approximately $10 000) was maintained between each point scale. by employing a likert scale, we sought to quell the conventional problem that sometimes arises from firms’ reluctance to disclose financial information, coupled with the fact they may not provide accurate figures when they choose to disclose financial data (zahra, neubaum & el-hagrassey 2003). three hundred and seventeen (62% men, mage = 48 years, sd = 12.91) participated in an online survey. the research study was carried out according to the principles of the declaration of helsinki. measurement validity and reliability to evaluate the quality of our construct measures regarding construct dimensionality, reliability, and convergent/discriminant validity, we carried out a confirmatory factor analysis (cfa) via amos version 28. as a first step, we calculated the kaiser-meyer-olkin (kmo) value to measure the sampling adequacy. as a rule of thumb, the kmo value must exceed 0.50 before one can proceed to the factor analysis (janssens et al. 2008). table 1 shows that the fit indices of the model fit are very satisfactory (χ2 = 512.068 [degrees of freedom {df} = 315; p < 0.001]; rmsea = 0.06; nnfi = 0.95; cfi = 0.96; gfi = 0.87; rmr = 0.06; kmo = 0.95). moreover, table 1 shows that all of the average variance explained (ave) exceeds the 0.5 thresholds (fornell & larcker 1981), while all of the composite reliabilities also exceed the 0.7 thresholds (hair et al. 2014), indicating that our model meets the convergent validity and construct reliability threshold, respectively. table 1: measurement validity and reliability. table 2 shows that the discriminant validity, a measure of non-linear correlation, is also confirmed (hair et al. 2014; henseler & chin 2010). table 2: discriminant validity. results and analysis to test the formulated hypotheses of the study, we used bootstrapping analysis in amos. this procedure is considered the best approach for testing hypotheses (hayes & scharkow 2013). the empirical results are shown in table 3. table 3: the outcome of hypotheses test. our h1a states that a social enterprise’s exploitative ambidexterity is positively related to its social performance in terms of social marketing achievement. supportively, the finding confirms this assertion (β = 0.371, p = p < 0.001), indicating that a positive relationship exists between exploitative ambidexterity and social marketing achievement. likewise, h1b predicts that a social enterprise’s exploitative ambidexterity has a positive effect on its social performance in terms of social value creation. supportively, the results confirm this hypothesis (β = 0.492, = p < 0.001). these results reflect experts’ suggestions that social enterprise performance can be predicted based on their ability to advance a profound comprehension of the societal needs, as well as their capacity to address the needs responsively (e.g. brooks 2008; kamaludin et al. 2021). moreover, h1c predicts that a social enterprise’s exploitative ambidexterity is positively related to its economic performance in terms of commercial marketing achievement. we find support for this hypothesis (β = 0.322, p < 0.01). as well, h1d predicts that a social enterprise’s exploitative ambidexterity has a positive effect on its economic performance in terms of economic value creation, an assumption that is supported (β = 0.412, p < 0.001). these echo the results of other studies that highlight the important role of exploitation in enhancing the economic performance of social enterprises (madden 2012) and traditional for-profit firms (atuahene-gima & murray 2007; gottschalck et al. 2021). vis-à-vis our h2a-d, which predicted a positive association between explorative ambidexterity and social performance and economic performance, we found the following interesting results. firstly, explorative ambidexterity was found to be positively related to social marketing achievement (β = 0.231, p < 0.01); thereby confirming h2a. secondly, our h2b that a social enterprise’s explorative ambidexterity has a positive effect on its social performance in terms of social value creation is supported (β = 0.497, p < 0.001). thirdly, h2c predicted that a social enterprise’s explorative ambidexterity is positively linked to its economic performance in terms of commercial marketing achievement, an assumption that is supported by our data (β = 0.465, p < 0.001). lastly, h2d predicts a positive nexus between explorative ambidexterity and the economic performance of social enterprises in terms of economic value creation. this hypothesis is supported (β = 0.313, p < 0.01). these results parallel the prevailing notion in the literature that social enterprises’ ability to improve their social and economic performance depends on its capacity to explore social needs, determine social opportunities, and develop strategies to meet them (davis & bendickson 2021; weaver & blakey 2022). the finds, in relation to the extant literature, in terms of consistency and discrepancies, are discussed in the next section. discussions and conclusions the purpose of this research was to investigate the nexus between oa and the performance of social enterprises in ghana. firstly, the study found support for the (h1a) positive relationship between exploitative ambidexterity and social performance (i.e. social marketing effectiveness and social value creation); thereby confirming previous studies and suggestions (i.e. farhoud et al. 2021; hughes 2018; weaver & blakey 2022), that organisations’ ability to respond to disruptions and changes by adjusting or adapting to current competencies and business demands through exploitative activities may enhance enterprise performance (cegarra-navarro et al. 2011). this finding indicates that the ability of social enterprises to embark on exploitative activities such as commitment to lower cost and quality, continual improvement of the dependability of its products and services to the society, and constant surveys of the existing community’s satisfaction may indeed enhance its social marketing effectiveness in terms of the acquisition of new donors, volunteers and growth of overall donors (liu et al. 2015), as well as its social value creation in such areas as bidding for public service contracts and government grants and expanding social service to more beneficiaries (peng 2019). likewise, our findings demonstrate that (h1b) exploitative initiatives of social enterprises are positively related to economic performance (i.e. commercial marketing effectiveness and economic value creation). for instance, it was found that exploitative ambidexterity significantly influences commercial marketing effectiveness; that is, the ability of the enterprise to grow its market share, acquire new enterprise customers, and increase sales from enterprise customers. again, exploitative ambidexterity (h1c) significantly influences economic value creation in such areas as business unit profitability, enterprise customer satisfaction, and reaching enterprise financial goals (madden 2012; plimmer et al. 2017). thus, the greater the capability of social enterprises to meet current customer needs and existing business demands by employing current knowledge and technology, the higher the chances of enhancing their social and economic performances concerning social marketing activities, social value creation, commercial marketing activities, and economic value creation. similarly, we found support for the positive association between explorative ambidexterity and social performance and the economic performance of social enterprises (h2a-d), which confirms earlier reflections (e.g. farhoud et al. 2021; gottschalck et al. 2021; junni et al. 2013; weaver 2020) concerning the potential of exploration to improve the performance dynamics of firms. for example, our results reveal that exploration initiatives of social enterprises are positively related to social performance in terms of social marketing achievement and social value creation (h2a-b). this means that the ability of a social enterprise to experiment with novel alternatives to expand product-market knowledge beyond its existing market, technology, and product expertise may improve its chances of increasing volunteer hours from current volunteers, acquiring new donors, and achieving growth in overall donation/volunteer time. also, a social enterprise’s ability to look for novel technological and societal ideas by thinking or cogitating ‘outside the box’, basing its success on its capability to explore and exploit new technologies and social solutions and searching for creative ways to satisfy its customers or society’s needs and wants (liu et al. 2015; nowak & raffaelli 2022; weaver 2020) may indeed enhance its social value creation in terms of serving more poor and needy in the community, providing more social service, expanding social service to diverse locations, and bidding for public service contract. furthermore, findings divulge that exploration positively (h2d) enhances economic performance in terms of commercial marketing effectiveness and economic value creation (bacq & lumpkin 2021; jurksiene & pundziene 2016). similarly, exploration improves the economic value creation of social enterprises concerning customer satisfaction, business unit profitability, and delivering value to the customer (gottschalck et al. 2021; santoro et al. 2021; simsek 2009). therefore, our finding indicates that as long as the social enterprises exhibit a forward-thinking and opportunity-seeking orientation in solving societal problems, their social and economic performance will correspondingly increase and grow. taken together, our results demonstrate that oa (i.e. exploitation and exploration) positively influence the investigated performance dimensions of ghanaian social enterprises. thus, the capability of social enterprises to concurrently orchestrate exploitative strategies and activities that streamline present operations to maximise value and explorative activities that accomplish future business opportunities and growth to improve social and economic performance (gottschalck et al. 2021; kafetzopoulos 2020; venugopal et al. 2020). our findings contradict arguments in the literature that oa has no significant impact on conventional firms (venkatraman et al. 2007) and that oa can even decrease firm performance because its elements compete for scarce resources (atuahene-gima 2005). one possible reason for the significance of the oa model in the social enterprise context is the nature of organisational structure. social enterprises are organised and structured differently from traditional firms, but structural conditions tremendously influence oa effectiveness, whether an organisation is using structural ambidexterous mechanisms (i.e. structural separations) or contextual ambidexterous mechanisms (i.e. non-structural separations of units). another possible reason may be due to the timing of the study, because we measured the performance of the social enterprises in the past three years, which may involve performance during the covid-19 pandemic. this, because the pandemic forced firms to put mechanisms and strategies in place that not only enable them to address current needs but to explore future needs. hence, the pandemic might have pushed the social enterprises to be more ambidextrous in addressing social needs, hence the significant performance gains. also, during the pandemic, social enterprises activities were highly prominent. thus, the pandemic might have occasioned the increased social performance of social enterprises. these findings provide fresh insights into the long-standing debate about whether ‘ambidexterity leads to success’ (kafetzopoulos 2020), or not, and whether the adoption of oa is beneficial to social enterprises or third-sector organisations. thus, it can be concluded that the extent to which social enterprises can improve their social performance (social marketing achievement & social value creation) and economic performance (commercial marketing achievement & economic value creation) largely depends on their ambidextrous orientations regarding exploitation and exploration. conclusively, oa can be viewed as a cradle of strategic revitalisation and competitive advantage for social enterprises to have enhanced social and economic performance, which, in turn, can help many people in need in a more effective, speedier, and efficient way in today’s complex society with its complex social problems and needs. implications theoretical implications this study makes numerous theoretical contributions. firstly, this quantitative survey concurrently investigates the two components of oa in association with the social and economic performance of social enterprises and extends the existing work on oa (lubatkin et al. 2006; o’reilly & tushman 2013; raisch et al. 2009; simsek 2009) to the social enterprise context. our focus on social enterprises in emerging economies adds theoretical value as it enables us to evaluate oa in the social entrepreneurship context. contrary to expectations, we found that oa does not decrease but increases social enterprises’ social and economic performance. secondly, the present study allows greater comparability and generalisability by being grounded in a well-established theoretical model (the dct), which highlights how firms can integrate, realign, and readjust their strategies to adapt to the changing environment; thereby showing the applicability of the theory to the social enterprise setting. thirdly, our study responds to calls by numerous field scholars for urgent, large-scale quantitative analysis of social enterprises (liu et al. 2015; meyskens et al. 2010). fourthly, our results provide valuable insights into how both exploitative and explorative ambidexterity independently impacts diverse social enterprise dimensions; thereby exposing social managers to the performance effects of oa. finally, our study, extended to an emerging market, unlike previous studies, allows for cross-cultural and cross-country validation of the oa model. managerial implications the findings of the research also put forth several relevant managerial implications. the first implication is in regards to the relative, joint effect of exploitative and explorative ambidexterity. this implies that managers can develop and implement them jointly to improve performance, notwithstanding the conventional thinking that it is impossible to put them both into operation because of the trade-off necessary to accomplish high levels of exploitation and exploration. therefore, the result offers valuable insights to social enterprise owners/managers on achieving the amalgamation of the steadiness of organisational transformation and social service deliverance via oa. the point is that although balancing the two may not be achieved on a silver platter, our results show that it is possible and that through solutions such as structural separation (o’reilly & tushman 2004) and non-structural separations (eisenhardt & martin 2000), firms, including social enterprises, can leverage the strategic gains from both exploration and exploitation simultaneously. hence, social enterprises should not be side-minded, whether because of their culture, mission, perceived lack of resources and capabilities, or philosophy. instead, they must engage in some level of exploration and exploitation to reap the benefits associated with the oa model. moreover, in a resource-constrained context like social enterprises, managers must manage the trade-offs between exploitation and exploration by focusing on such factors as efficiency, cost, and incremental innovation for exploitation and flexibility, speed, and radical innovation for exploration. therefore, social enterprises must realign and readjust their competencies, structures, leadership skills, and strategies. again, social enterprises’ managers should foster employee work engagement behaviours through social awareness (organisational awareness, attunement, empathy) and relationship management (teamwork, inspiration, influence) to facilitate a shared vision and a collective comprehension of how employees and leaders will manage the exploitation-exploration trade-off. because oa can only be nurtured in a supportive context and environment, where employees are motivated to make their own decisions in terms of the amount of exploration and exploitation since management is not involved in single decisions but responsible for shaping the context, social enterprises that aim to be ambidextrous must harness ambidextrous employees who can understand the demands of both exploitative and explorative activities and ultimately manage to accommodate its tension. finally, our comprehensive analysis of the oa – social enterprise performance relationship may represent a solid foundation for policy recommendations to governments and national decision-makers regarding technological and institutional capacity and systems that must exist to enable social enterprises to achieve a relative balance between exploration and exploitation. limitations and further research we admit that our research suffers from numerous limitations because of the research design, but also that these offer opportunities for further study. first and foremost, we examined only one dynamic capability of social enterprises – oa, which has been analysed in conventional entrepreneurship settings. this precludes the examination of other dynamic capabilities. therefore, future studies should explore other dynamic capabilities that relate to social enterprise performance like technological capabilities, marketing capabilities, supply chain management capability, etc. secondly, a research design that involves inviting respondents to complete a survey may be subject to self-serving bias (mhelembe & mafini 2019; morgan et al. 2003). while we took meticulous measures to maximise respondent objectivity, questions about how valid it is for social enterprises to evaluate their own oa are still rife. thus, future studies may employ a secondary data-based study design to overcome this shortcoming. thirdly, because of the dynamic capability nature of oa, we did not include mediators and moderators in the model. therefore, we advocate that future studies examine mediators like leadership quality, organisational culture, organisational learning/unlearning, or entrepreneurial orientation in the oa – social enterprise performance. thirdly, the cross-sectional nature of our study did not permit us to make definite causal inferences about the effect of oa over time, mainly because our focus lies in understanding the validity and causal inference of the hypothesised relationships instead of the causality. also, a survey design that assesses a single point in time restricts any conclusions about causality. in future this concern should be addressed. furthermore, given that social enterprises implement the oa model gradually and develop their exploration and exploitation over long periods of time, coupled with the reality that we examined the relationship between oa and social enterprise performance employing cross-sectional data, future scholars should use a longitudinal study design to offer valuable insights to the extant knowledge on this subject. it might use state-of-the-art technology such as but not limited to eye-tracking and electroencephalography to study, explore, and predict the consumer behaviour toward organisations, which may enhance the organisational strategies and enterprise performance as well. (alsharif et al., 2021; 2022). finally, future studies may not only replicate our research model in different emerging economies with different performance indicators, but also focus their investigation on providing a more fine-grained one, as to the drivers or determinants of oa in social enterprises. anchoring this result with a theory-based delineations is a thought-provoking avenue for future research. notwithstanding these shortcomings, our study makes valuable contributions to the existing knowledge on the effects of oa on social enterprise performance, contributes to social enterprise theory and practice, and also offers managerial implications for social enterprise owners/managers. acknowledgements the authors would like to thank taif university researchers supporting project number (tursp-2020/338), taif university, taif, saudi arabia for supporting for this study. competing interests the author(s) declare that they have no financial or personal relationship(s) that may have inappropriately influenced them in writing this article. author’s contributions s.o. contributed to the conception of idea, drafting of the article, analysis and interpretation of data; final approval of the version to be published. a.r.h. contributed to the editing of the production; editor’s comments; revision of the manuscript for relevant intellectual content; solicitation of funding for the manuscript; and the final approval of the version to be published. a.h.a. did the revision of the manuscript for relevant intellectual content; editing of the production editor’s comments; solicitation of funding for the manuscript; and the approval of the version to be published. ethical considerations this manuscript followed all ethical standards for research with direct contact with human subjects. in particular, the authors secured permission to carry out the research from the owners or managers of the social enterprises before the questionnaire’s administration. no respondent was forced, threatened, or coerced to participate in the study, and further, the authors ensured maximum confidentiality and anonymity in the data collection and analysis of study results. any information collected from participants will not be made public without their permission. furthermore, no information will be published about the identities of any specific individuals or the organizations they work for or are affiliated with. funding information taif university researchers supporting project number (tursp-2020/338), taif university, taif, saudi arabia. data availability the data that support the findings of this study are available on request from the corresponding author. disclaimer the data presented here do not necessarily reflect the official policy or position of any affiliated agency of the author. references agyeman-togobo, k.t., lord-gustav, t.d. & sharp, t., 2016, ‘the state of social enterprise in bangladesh, ghana, india, and pakistan’, viewed 23 february 2022, from 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17 (2014) no 5:584-600 a primer on counterparty valuation adjustments in south africa gary van vuuren and ja’nel esterhuysen school of economics, north west university accepted: april 2014 counterparty valuation adjustment (cva) risk accounts for losses due to the deterioration in credit quality of derivative counterparties with large credit spreads. of the losses attributed to counterparty credit risk incurred during the financial crisis of 2008-9 were due to cva risk; the remaining third were due to actual defaults. regulatory authorities have acknowledged and included this risk in the new basel iii rules. the capital implications of cva risk in the south african milieu are explored, as well as the sensitivity of cva risk components to market variables. proposed methodologies for calculating changes in cva are found to be unstable and unreliable at high average spread levels. key words: counterparty credit risk, cva, credit ratings, basel iii jel: c02, 22, 51, g21 1 introduction the 2008-2009 financial crisis originated when asset price bubbles inflated, interacting with new kinds of financial innovations that masked risk (baily, litan & johnson, 2008). in december 2010, the basel committee on banking supervision (bcbs) updated basel ii with a set of rules known as basel iii (bcbs, 2011) designed to augment and repair the basel ii rules which did not function effectively in the financial crisis. amongst these are new regulations for cva and cva risk. the traditional approach to control counterparty credit risk was to establish limits against future exposures and verify potential trades against these limits – these are commonly referred to as potential future exposures (pfes) (algorithmics, 2012). the severe volatility experienced during the financial crisis, however, led to a comprehensive review of accounting for counterparty credit risk (ccr). as a result, the value of derivatives transactions with counterparties is now adjusted by dealers to reflect the possibility of loss incurred because of counterparty default (hull & white, 2012). this adjustment is known as the credit value adjustment (cva). cva eliminates the need for controlling ccr through limits by introducing dynamic ccr pricing directly into new trades. many banks already take cva into account in their accounting statements, but the financial crisis has led innovative banks to more accurately assess cva, and integrate cva into pre-deal pricing and structuring. calculating cvas is, however, computationally intensive (pykhtin & zhu, 2007: gregory, 2009a). in addition to the measurement of cva, cva risk arises from changes in (a) counterparty credit spreads and (b) market variables that affect the no-default value of derivative transactions (hull & white, 2012). cva risk, therefore, may only be accurately assessed after the effect of changes in both components have been identified and measured. while basel iii requires an assessment of cva risk arising from changes in counterparty credit spreads to be included in the market risk capital calculation, cva risk – arising from changes in underlying market variables – is not required under basel iii.1 this article explores the impact of cva risk on regulatory capital requirements for banks and examines the influence of high spread levels on the accurate assessment of cva risk. this paper proceeds as follows: section 2 provides a broad literature review explaining abstract sajems ns 17 (2014) no 5:584-600 585 the concept of ccr, its importance in modern finance, why cva is necessary and problems with the concept of cva and its practical implementation. section 3 covers the various methodologies proposed by several authors to measure cva and provides a synthesis of these methodologies into a coherent approach for the south african market. in addition, this section details the data requirements and establishes the requisite mathematics for measuring cva. due to the calculation complexity involved in determining portfolio cva, a single, simple interest rate derivative was used as the underlying derivative transaction to explain the processes involved. the results obtained from models proposed in section 3 are provided in section 4, along with a discussion of these results and an interpretation of model strengths and weaknesses. the influence of changes in average spread levels on cva is explored and found to be counterintuitive and potentially inaccurate if applied indiscriminately. the effect of changing underlying market factors on risk capital is also investigated, despite the omission of this effect from basel iii rules. using south african data, specific attention is paid to the south african market. section 5 proposes future research and concludes. 2 literature review it became apparent in the 1990s that over the counter (otc) derivatives trading gave rise to significant credit risk exposure (canabarro & duffie, 2003). banks implemented two principal measures to deal with this risk: risk reduction via enforced close-out netting agreements with (or collateral posting from) the relevant counterparty and risk pricing by charging counterparties a spread, dependent on the riskiness (for example, credit rating, maturity) of the transaction. this charge – the cva – is minimal for a transaction in which the collateral is exchanged daily, in cash, on the full mark-to-market of the derivative portfolio, but it can be substantial if the counterparty is not obliged to post collateral, and particularly if the credit quality of the counterparty is poor (for example, rated subinvestment grade or worse than bb-). currently (2014), the majority of a typical bank's cva comprises two classes of counterparty namely sovereigns (which traditionally do not post collateral despite their substantial derivatives trades) and corporates (which unlike most banks, are often not in a position to move collateral every day). these corporates may be willing to post collateral less frequently, but resent such restrictions on cash flows and often demand that banks only request collateral when requirements exceed a certain threshold (hull & white, 2012). individual cvas may be insubstantial, but the total cva for banks' corporate derivatives books can be extensive. canabarro & duffie (2003) introduced methodologies to measure, mitigate and price ccr. monte carlo simulation techniques were proposed as a pricing mechanism for ccr and a practical estimation of cva using currency and interest rate swap trades between two defaultable counterparties was presented. portfolio level counterparty risk and credit mitigation techniques were discussed by de prisco & rosen (2005) who also employed monte carlo simulation to calculate statistics relevant to ccr measurement. a practical implementation of collateral modelling was proposed. the measurement of the expected exposure in credit derivative portfolios was also affected by wrong way risk. (wrong way risk arises when the exposure to a counterparty is positively correlated with the credit quality of that counterparty, so default risk and credit exposure increase together). gibson (2005) discussed both an analytical and a monte carlo simulation method to measure expected exposure and expected positive exposure for margined and collateralised counterparties. the former method uses a gaussian model to determine the mark-tomarket value of a portfolio exposed to counterparty risk. the latter simulation method however uses a gaussian random walk to explore the relationship between collateralised exposures and other variables, such as the initial mark-to-market, the threshold, and the re-margining period. redon (2006) presented two analytical methods to measure expected exposure subject to wrong way risk. the first calculates expected exposure as a weighted average of expected exposure in the presence and absence of 586 sajems ns 17 (2014) no 5:584-600 country crises, while the second – based on a merton model2 of default risk – estimates expected exposure by assuming brownian motion to model the mark-to-market value of the portfolio subject to counterparty risk. correlating the brownian motions used to model both default and mark-to-market allow the determination of wrong way risk and the derivation of analytical expressions for expected exposure. pykhtin & zhu (2007) demonstrated how margin agreements may be employed to reduce ccr and, through the exploration of differences between counterparty and contract-level exposures, presented a methodology for calculating expected exposure and cva assuming wrong way risk. bilateral counterparty risk was discussed in detail by brigo & capponi (2008) who demonstrated that in the absence of spread volatility, cva decreases as the correlation between investor and counterparty tends to 1. modelling the joint default of the investor, counterparty and underlying credit default swap (cds) led to the conclusion that pure contagion models may not be appropriate for modelling cva risk in high correlation environments. the authors also concluded that simple add-on approaches to capture cva behaviour (such as those described by the bcbs, 2006) were ineffectual. gregory (2009b) calculated bilateral cva for a portfolio comprising otc derivatives. a gaussian copula model which permitted simultaneous defaults was used and the effect of these defaults (which effectively represent systematic risk) on the measured cva, was shown to be insignificant. using a structural model subject to jump diffusion, lipton & sepp (2009) explored ccr in cds contracts. from their results, novel techniques were developed for measuring cva. a markov portfolio credit risk model which accounts for default and wrong way risk dependence by allowing simultaneous defaults among underlying credit names, was proposed by assefa, bielecki, crépey & jeanblanc (2009). employing the standard assumption of no dependence between exposure and probability of default, a relationship between the counterparty's hazard rate and the value of variables was specified, whose values can be generated by monte carlo simulation (and used to calculate cva). the results obtained show good agreement between the behaviour of expected positive exposure and cva (assefa et al., 2009). other authors who tackled the wrong-way risk problem include cespedes, de juan herrero, rosen & saunders (2010) and sokol (2010) who both approached the problem by assuming the exposure follows a one-factor markov process and a copula (gaussian or otherwise) determines the dependence between this process and the time to default. cva losses were considerable for some banks during the credit crisis. under basel ii, the risk of counterparty default and credit migration risk were addressed, but mark-tomarket losses due to cva were not (i.e. cva risk had no capital assigned to it). roughly two-thirds of losses attributed to ccr during the financial crisis, however, were due to cva losses. only about one third were due to actual defaults (bcbs, 2011). basel iii now includes charges for cva risk designed to ensure that banks carry substantial amounts of capital against cva risk – particularly for over-thecounter derivatives trading with counterparties who do not post daily cash collateral. it is important to note that the new capital does not provide for the risk of loss due to counterparty default, but rather the risk that the cva might increase (hull & wihte, 2012). a separate but related problem involves central counterparties (ccps). in 2009, the group of 20 mandated local regulators to route a portion of derivative trades through domestic central counterparties (ccps) (group of 20, 2009). in part because this exercise involves co-operative cross-border regulatory schemes, most large international markets (including the eurozone, australia, hong kong and canada) have retreated from the directives, stating “concerns of domestic supervisors” (wood, 2013). south african derivative dealers are active and enthusiastic participants of international markets and must, therefore, address clearing mandates of international dealers despite the absence of a domestic ccp (february 2014).3 south africa is also committed to the successful implementation of basel iii which includes cva capital charges (and thus clearing incentives for derivative counterparty risk). understanding the vagaries of cva is thus of critical importance to the south african derivatives market (wood, 2013). sajems ns 17 (2014) no 5:584-600 587 3 methodology and data since all derivatives involve counterparties, valuation of derivative transactions must take into account the possibility of loss incurred because of counterparty default (hull & white, 2012). derivative valueadjusted = derivative valueno default − !"#. cva is thus a cost. to measure cva and ultimately the cva risk associated with derivative transactions, the underlying derivative(s) must first be valued. in practice, banks will more likely trade portfolios comprising several derivatives, but for this article, a single, simple interest rate swap was used. this serves the triple purpose of (a) providing a basis for the complete cva calculation without the introduction of unnecessary complexity, (b) calibrating the south african yield curve using the vasicek mean reverting interest-rate model and (c) elucidating the effects of elevated credit spread levels on cva. 3.1 construction and calibration of the south african yield curve yield curve models are divided into two principal types: equilibrium approaches and no-arbitrage models. the former focus on modelling the dynamics of the instantaneous rate. yields at longer maturities are then derived using assumptions about the risk premium. equilibrium models focus primarily on time-series dynamics at the expense of inaccurate fitting of the complete cross-section of the yield curve. the latter models emphasise perfect fitting of the term structure at points in time so as to guarantee that no arbitrage possibilities exist. although these models are of particular importance for pricing derivatives, they ignore time series dynamics of the yield curve which can be important for bond pricing and other fixed-income securities (diebold & li, 2006). the vasicek model – which follows the equilibrium tradition and an early proponent of term structure models – appeared in 1977. subsequently, it has survived and inspired several other models and it remains of considerable importance in valuing securities that require accurate time-series dynamics, including bond options, futures and other interest rate derivatives (vasicek, 1977; mamon, 2004). a key innovation of the vasicek model, supported and justified through economic arguments, was the introduction of a meanreverting stochastic process to model the evolution in time of the short rate. the model assumes that the current short rate is known with certainty and its subsequent evolution is governed by (vasicek, 1977): !!! = ! ! − !! !" + !"!! (1) where the current short rate, rt is a continuous (no jumps) function of time and follows a markovian diffusion process, γ!is the long run mean of the short rate, ! is a measure of the speed of the return of the short rate to the long run mean (the mean reversion coefficient), σ is the short rate volatility and zt is a standard wiener process. research has relaxed the condition of constant volatility (brenner, harjes & knoner, 1996; hong, li & zhao, 2004) and shimizu and yoshida (2006) have adapted equation 1 to include diffusion processes with jumps. the parameters of equation (1) (α,γ and σ) were estimated using maximum likelihood methods (james & webber, 2004) and historical south african data spanning 2001 – 2013 procured from south african banks. discount factors (used to price the interest rate swap – see section 3.2) were calculated from (hull & white, 1990, 1995): !!! = !! exp(−!!!!) (2) where !! = exp !! − ! ⋅ !!! − !! 2 !! !− !!!!! 4! !and!!! = 1 − exp −!" ! . 588 sajems ns 17 (2014) no 5:584-600 figure 1 shows the term structure (up to 10 years) of one possible yield curve constructed using the vasicek model. relevant parameters were derived directly from the south african market. figure 1 one simulation of the south african yield curve using the vasicek model. for this research, 10,000 such interest rate scenarios were generated 3.2 pricing a simple interest rate swap a simple floating rate note (frn) was used to price the interest rate swap. the frn pays a floating rate coupon ƒ at the end of each coupon period h and the accrual period is the same for all coupons. the floating rate is fixed at the prevailing market rate, for the ith coupon period, at the beginning of each coupon period ti. the floating rate thus corresponds to the forward rate between ti and ti%+!h measured at time ti. the present value of the frn today is the expected value of the future floating cashflows plus the principal at maturity. future forward rates, ƒ"(ti,%ti,%ti%+ h), are unknown, but these may be set equal to today’s expected forward rates ƒ"(0,%ti,%ti%+ h) using the principal of no arbitrage.4 the frn value is the present value of the sum of ! expected floating rate coupons, ƒih, plus principal: !!!"# 0,! = !!ℎ ⋅ !" 0,!! + ℎ + !" 0,! ! !!! (3) with the ith forward rate given by ƒi%=!ƒ"(0,%ti,%ti%+ h) and df the relevant discount factors (vasicek, 1977). the value of this frn (assumed to have no credit risk exposure) can be shown to equal par (i.e. 100 per cent) by substituting the definition of the forward rate (equation 4, below) into equation 3: ! !,!,! + ℎ = 1ℎ !" !,! !" !,! + ℎ − 1 . (4) simple fixed/floating interest rate swaps may be represented by a series of fixed (or floating rate) payments, exchanged with a counterparty into a series of floating (or fixed) rate cash flows. such a swap – paying a fixed rate ! plus principal and receiving a floating rate plus principal – is used as the underlying derivative in this paper (vasicek, 1977). assume j% =% 1,% …,% n floating coupons with accrual periods hj and i = 1, …, m fixed rate coupons with coupon period li. the principal amounts are the same on both sides of the swap, so they cancel and: 0% 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 0 1 2 3 4 5 6 7 8 9 10 in te re st 'ra te years sajems ns 17 (2014) no 5:584-600 589 !swap 0,! = !!floating leg − !!fixed leg% = !! ⋅ ℎ! ⋅ !" 0,!! + ℎ! −! ! !!! ! ⋅ !! ⋅ !" 0,!! ! ! !!! . (5) market rate swaps are constructed such that the initial mark-to-market value is zero, thus the fair market coupon (annualised swap rate r(0,t) for maturity t) may be derived by rearranging equation (6) to solve for the swap rate r(0,t) =!c: ! 0,! = 100% − !" 0,!!! ⋅ !" 0,!! !!!!!! . the market swap rate, r(0,t), is the swap level conventionally quoted in the market (vasicek, 1977). this rate is the annualised fixed rate paid or received on a market swap with a given maturity t. note that the discount factors, df, are calculated using equation 2. figure 2 shows the net exposure (to one counterparty) of a 10-year interest rate swap as a percentage of notional associated with the simulated yield curve in figure 1. for this research, 10,000 such exposure profiles were generated corresponding to the 10,000 interest rate scenarios. figure 2 one simulation of net exposure (to one counterparty) of a 10-year interest rate swap 3.3 cva calculation cva is the market value of counterparty credit risk: the difference between the risk-free portfolio value and the true portfolio value that takes into account the counterparty’s default. when there are netting and collateral agreements, cva must be calculated at the counterparty level and not separately for each individual trade (hull & white, 2012). in addition to modelling limitations, calculating cva is computationally intensive. it is now standard for banks to employ monte carlo simulations to compute counterparty exposures. this is the most expensive step: a single simulation of a portfolio of 50,000 positions, over 2,000 scenarios and 100 time steps, requires 10 billion valuations. a comprehensive risk analysis requires a large number of cva calculations for sensitivities, cva var and marginal cva of new trades (rosen & saunders, 2012). cva can be defined either on a unilateral or a bilateral basis. unilateral cva assumes that the institution which does the cva analysis (the bank) is default-free. it gives the market value of future losses caused by the counterparty’s potential default. bilateral cva takes into account the possibility of both the counterparty and the bank defaulting. this is required for an objective fair value calculation since both bank and counterparty require a premium for the credit risk they bear, otherwise, they would not agree on the fair value of the trades. unilateral cva is now part of basel iii, (bcbs, 2009) while bilateral cva is more in line with the market practice at top financial !4% !2% 0% 2% 4% 6% 8% 10% 0 2 4 6 8 10 sw ap %m tm years 590 sajems ns 17 (2014) no 5:584-600 institutions for pricing and hedging, as well as accounting rules (fasb, 2006). assuming no wrong way risk (equivalent to assuming that the default probability, exposure and recovery values are independent), cva is given by: !"# !,! ≈ 1 − ! ⋅ ! !! ⋅ !! !! ⋅ ! !!!!,!! ! !!! (6) where ! is the recovery rate, ((1!–!r) is the loss given default), b(tj) is the risk-free discount factor at time tj, ee(tj) is the expected exposure at time tj, q(tj)1, tj) is the marginal default probability in the interval [tj)1, tj] and where m is the maturity (gregory, 2009b). note that default is present in equation 6 only via default probabilities, thus when employing a simulation framework to estimate cva, only exposures need to be simulated, not default events (which are rare) (gregory, 2009b). 3.4 estimating the components of the cva calculation expected exposures are the probabilityweighted positive exposures: calculating these is a non-trivial exercise. consider the positive exposure profile for a 10 year interest rate swap in figure 3 below. the effective exposure (ee) is the positive mark-to-market value (since it is only these exposures – the positive mark to market (mtm) values – which are of concern to the institution since losses will only occur for these exposures) of an institution's exposure to a counterparty. the expected positive exposure (epe) is the average ee through time while the effective ee is the non-decreasing ee: the value ratchets up, never down, over the derivative’s lifetime. the effective epe is the average of the effective ee. note that future exposures are simulated, thus the potential future exposure (pfe, not shown in figure 3) is the exposure exceeded with a given probability (usually 95 per cent or 99 per cent). if 1,000 simulations of possible future exposure profiles are generated, the pfe is the 50th largest exposure at a 95 per cent confidence level. in principle, this is similar to the well-known and widely used historical value at risk methodology in market risk. figure 3 various relevant exposure measures based on a single simulation of possible future exposures of a 10 year interest rate swap the ee represents the expected (probabilityweighted) exposure value conditional to being in the shaded area (i.e. exposure > 0) in figure 4 below. 0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% 4.0% 4.5% 0 1 2 3 4 5 6 7 8 9 10 ee "a nd "e pe years ee epe effective5ee effective5epe sajems ns 17 (2014) no 5:584-600 591 figure 4 exposure metrics ee and pfe. positive exposures (of concern to the institution) are represented by the shaded region to estimate the value of ee analytically, consider a normal distribution with mean µ and standard deviation σ where the former represents the expected mark-to-market value of the derivative value (or the portfolio of derivatives) and the latter represents the standard deviation of these mark-to-market values. the mark-to-market value, v, of this transaction at any time t is given by v!=!µ!+!σz where z is a standard normal variable. it follows that the (positive) exposure, e, may be written as e!–!max!(v,0) =!max (µ%+!σz,%0). the expected exposure in this case is: !! = (! + !") ⋅ ! ! !" ! !!! , (7) and where the lower integration limit is from% µ%+!σz, hence ! = − !!. integrating equation 7 gives: !! = ! ⋅ ! ! + !" ⋅ ! ! !" ! !!! % = ! ! ! !" + ! ! ⋅ ! ! !" ! !!! ! !!! % = !φ ! ∞−!! + !" ! ∞−!! % = ! φ ∞ − φ −!! + ! ! ∞ − ! − ! ! % = ! 1 − φ −!! + ! 0 − ! − ! ! hence !! = !φ !! + !" ! ! ,% where φ(…)!is the normal distribution function, φ(…) is the cumulative normal distribution function and use has been made of the fact that ∫ ! ⋅ exp ! ! ! = exp !! ! and ! ! = ! ! !! exp − ! ! !!! ! ! . to generate the results required, 10,000 interest rate scenarios (and associated exposure profiles for each scenario) were generated using monte carlo simulation. recovery rates are assumed to be constant. although this condition may be relaxed, recovery rates are notoriously difficult to estimate practically, so this assumption is not unusual (e.g. gregory, 2009b, hull & white, 2012). risk neutral discount factors are determined using equation 2, which are – in turn – based on an interest rate model (in this case, a mean-reverting, vasicek interest rate model). marginal probabilities of default may be calculated from credit spreads. if the complete term structure of credit spreads for the relevant counterparty cannot be observed in the market this may be estimated using credit spread data for similar companies (in the same sector, for example, and preferably operating in the same geography). a reasonable estimate of the risk neutral marginal probability, q(0,j), !between times! 0 and tj is given by !!,! = exp − !!!! !!! where sj is the credit spread for a maturity of tj. it follows that the marginal risk neutral expected(mtm ee pfe((at(95%( confidence( level) 0 exposure 592 sajems ns 17 (2014) no 5:584-600 probability of default – defined by qj – may be given by: !! = exp − !!!!!!!! 1 − ! − exp − !!!! 1 − ! . (8) swap values were obtained from one of the ‘big 4’ south african retail and commercial banks. with the components of equation 6 established, these are combined and the results obtained presented in the following section. 4 results of the 10,000 possible exposure profiles generated from the 10,000 interest rate scenarios, (for clarity) only 50 are shown in figure 5(a) below. figure 5(b) illustrates the expected exposure, the potential future exposure and the expected (average) values of each of these swap mtm metrics. figure 5 (a) 50 possible swap mtm exposures corresponding to 50 interest rate simulations and (b) relevant metrics for positive mtm exposures 4.1 effect of credit spread changes on cva credit spreads for maturities up to 10 years for south african issuers of differing credit quality are shown in table 1, spanning from the onset of the crisis in 2008 until december 2012. credit spreads were at their highest levels, during the european sovereign crisis in 2010, but have since recovered. these data provide an indication of levels to which credit spreads may rise. it is likely that worse credit quality issuers suffered even higher spreads. table 1 south african credit spreads for different credit quality issuers. maturity in years 1 2 3 4 5 6 7 8 9 10 spreads (in bps) 2008 a250 197 180 165 141 125 111 99 85 75 b 488 408 367 345 273 232 198 168 127 115 2010 a279 214 191 188 183 170 130 130 115 98 b 568 525 452 378 322 268 232 228 208 125 2012 a199 176 174 148 128 123 115 110 98 89 b 344 293 267 252 206 180 158 138 112 105 !20% !15% !10% !5% 0% 5% 10% 15% 20% 0 2 4 6 8 10 sw ap %m tm years(a) 0% 1% 2% 3% 4% 5% 6% 7% 8% 9% 0 2 4 6 8 10 ee %a n d %p fe years ee pfe eepe epe (b) sajems ns 17 (2014) no 5:584-600 593 the spreads for these different quality issuers – spanning 5 (2008-2012) turbulent years – are shown in figure 6 below. figure 6 spreads for (a) ‘good’ (a-) and (b) ‘poor’ (b) quality south african credit issuers recorded over the period 2008 – 2012 using equations 6 and 8, the cva for a 10year, otc interest rate swap with payments netted off and settled on a quarterly basis, was calculated using south african spreads derived from the recent market (december 2012) and as shown in table 1 (in basis points (bps)). the results obtained compare favourably with those estimated from other studies conducted in similar markets (see, for example, carlson & silén, 2012). cva for low spreads (2012) high spreads (2008-10) is shown in figure 7. figure 7 cva for a 10-year interest rate swap evaluated in a ‘low’ spread regime (e.g. 2012) and a ‘high’ spread regime (e.g. 2008-10) over all recovery rates the cva for different credit spreads, seen in figure 7, was measured over all recovery rates (i.e. 0%!<!rr%<!100%). using a recovery rate of 55 per cent,5 the cva is roughly three times higher when spreads are wide than when spreads are tight. at low recovery rates, the 0 100 200 300 400 500 600 0 1 2 3 4 5 6 7 8 9 10 sp re ad 'in 'b ps maturity credit'rating:'a4 2008 2010 2012 (a) 0 100 200 300 400 500 600 0 1 2 3 4 5 6 7 8 9 10 sp re ad 'in 'b ps maturity credit'rating:'b 2008 2010 2012 (b) 0 5 10 15 20 25 30 35 40 45 50 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% cv a$ in $b ps $(e xp os ur e$ =$ 1) recovery$rate spreads3(2012) spreads3(2008610) 594 sajems ns 17 (2014) no 5:584-600 effect is more dramatic (up to six times greater). figure 8 shows the full relationship of cva to recovery rates and the absolute spread level. figure 8 cva for a 10-year interest rate swap evaluated over a 1,000 bps absolute change in credit spreads and all recovery rates 4.2 cva risk: changes in spreads cva is affected by two types of exposures: one from movements in counterparty credit spreads and the other from movements in underlying market variables. considering the former, the impact on the cva of a small change in spreads (δs) over all si (i.e. a small parallel shift) may be estimated using a delta/gamma approximation, i.e. δ! ! = ! ⋅ δ! + !!γ ⋅ δ! ! where δ%= df%/%dχ and γ!= d2f%/% dχ2 (hull & white, 2012). using equation 6, the change in cva is: δcva= !! exp − !!!!!!!! 1 − ! − !!!! exp − !!!! 1 − ! ⋅ !!δ!! ! !!! % + 12 1 − ! !!!!! exp − !!!!!!!! 1 − ! − !! ! exp − !!!! 1 − ! ⋅ !! δ! ! ! ! !!! (9) note that equation 9, the δcva, is affected by changes in spreads (δs) and the absolute spread level. the influence of both the change in spread and the absolute spread level is shown in figure 9. to remain consistent with bcbs senior debt lgd values (bcbs, 2009), a fixed recovery rate of 55 per cent was chosen for this analysis. the results of figure 9 pose some interesting questions. for low average spreads (such as those enjoyed by good quality credits during benign economic periods), as expected, cva increases with increasing !. however, for high levels of average spreads (i.e. poor quality credits in volatile market conditions), an increase in spreads results in a decrease in cva. it is difficult to believe these results were a deliberate attempt by this approach's proponents to restrict potentially punitive regulatory capital charges when markets are volatile and spreads are high. capital equations governing the basel ii internal ratings based (irb) approach for credit risk reduce the amount of regulatory capital required for unexpected credit losses at high probabilities of default (i.e. for pds > 40 0% 20% 40% 60% 80% 100% 0 5 10 15 20 25 30 35 40 45 0 200 400 600 800 1000 recovery(rate cv a( (in (b ps (fo r(e xp os ur e( =( 1) spread (bps) sajems ns 17 (2014) no 5:584-600 595 per cent, see laurent, 2004) which seems counterintuitive at first glance. the resolution of the paradox, however, is fairly simple. at a given confidence interval6 total credit losses are the sum of expected and unexpected losses: the former are covered by bank pricing and provisioning and these increase with pd at a rate faster than regulatory capital (which covers unexpected losses) increase. as pds increase, therefore, regulatory capital, covering unexpected losses, decrease since expected losses become more ‘expected’ and bank impairments increase faster. this logic cannot be applied to the shape of the δcva versus δs curves (higher spreads should result in higher cva regardless of average spread). ignorance of this could be detrimental to banks reserving capital for potential cva losses, especially in highly volatile market conditions. using this model (albeit when applied to the problem of wrong way risk), hull & white (2012) found similar issues and argued that the sign of the calculated effects were counterintuitive. figure 9 δcva in bps as a function of spread and change in spreads figure 10 effect on δcva of δs for various average spreads. for a recovery rate of 55 per cent at average spreads of ≈ 400bps, δcva/δs%≈%0 !10% !5% 0% 5% 10% !40 !30 !20 !10 0 10 20 30 40 δs δ cv a% (in %b ps ) average spread%(bps) !40 !30 !20 !10 0 10 20 30 40 !10% !8% !6% !4% !2% 0% 2% 4% 6% 8% 10% δ cv a$ (b ps ) δs average0spread0~01000bps average0spread0~050bps average0spread0~0400bps 596 sajems ns 17 (2014) no 5:584-600 the slope of δcva versus δs changes sign (for a recovery rate of 55 per cent) when the underlying credit has an average spread of ≈ 400bps. as shown in figure 10, at this average spread, the change in cva for changes in spreads is negligible. these average spread levels are not rare (see figure 6 and table 1): they are commonplace for low maturity, poor quality credits or during stressed market conditions. that the proposed methodology suggests no increase in cva for any changes in spread at these average spread levels, requires further investigation. the results at higher average spreads (namely that cva decreases for increasing changes in spreads) is patently incorrect and potentially highly damaging. 4.3 cva risk: changes in underlying market variables establishing the influence of small parallel variations in counterparty credit spreads on cva and risk capital is a simple exercise using equation 9. to accomplish the same for changes in underlying market variables is more complex since they evolve in time via geometric brownian motion paths or mean reversion processes. the simulation dynamics for each is quite different. using equation 6 and rewriting b(tj) . ee(tj) as vj, consider a market variable u with an initial value of u0. assume vj changes to !!! and !!! when u0 changes by a small amount, ∈ to u0! +! ∈ or u0! –! ∈ respectively. the associated partial derivatives of equation 6 are: !cva !" = 1 − ! 2! ⋅ !! !! ! − !!! ! !!! % !!cva !!! = 1 − ! 2!! ⋅ !! !! ! + !!! − 2!! ! !!! hull & white (2012) provide a discussion on the challenges posed by these complexities and offer an alternative way of measuring wrong way risk. wrong way risk may be modelled by changing the way the vjs are calculated, but the calculation of the q(t)s (equation 8) may be altered to incorporate the way variables used in the monte carlo simulation – discussed in section 3 and used to determine cva – evolve. to accomplish this, hull & white (2012) introduce hazard rates: direct measures of the probability of default and although hazard rates are not observable in the market, they are related to credit spreads which are observable. a commonly-used approximation for the average, risk-neutral hazard rate between time 0 and ! is: ℎ ≈ ! !1 − ! (10) where s(t) is the credit spread for maturity t. hull & white (2012) asserted that a counterparty’s hazard rate may be modelled using a deterministic or stochastic variable that (a) affects the exposure to the counterparty and (b) can be calculated in the monte carlo simulation (section 3). potential candidate variables include credit spreads, share prices, relevant commodity prices (e.g. the oil price for an oil producer, the gold price for a gold producer, etc.). a robust relationship which satisfied the constraints outlined above was found to be: ℎ ! = exp![! ! + !" ! + !"] (11) where a(t) is a function of time, the constant parameter b is a measure of the right-way (defined as the situation in which exposure to a counterparty is negatively correlated with the credit quality of that counterparty. so default risk and credit exposure move oppositely). a wrong way risk in the model is where w(t) is the value of the portfolio with the relevant counterparty, the constant σ measures the noise implicit in the model and ∈ is a normally distributed such that ∈% ~%n(0,1).%hull & white (2012) found that unless σ% >> w(t), the noise term σ∈% is negligible and may be ignored. equation 11 becomes: ℎ ! = exp![! ! + !" ! ] (12) and for small percentage changes in ℎ: δℎ ℎ = !δ! (13) two approaches to estimating ! were proposed (hull & white, 2012): 1) assemble historical data on the counterparty’s credit spreads and associated ws. these credit spreads may be converted into hazard rates using equation 10 and b may be estimated using simple linear regression techniques on equation 13; or sajems ns 17 (2014) no 5:584-600 597 2) employ subjective judgement about the amount of counterparty right/wrong-way risk. although hull & white (2012) adopt the latter approach, arguing that the former approach assumes the influence of the market factors on counterparty credit spreads is repeatable and thus unrealistic. subjective judgements are not without their biases, so here, the former approach was used. equation 12 may be discretised: ℎ!" = exp![! !! + !!!"] where hij and wij are the values of h(ti) and w(ti) on the jth! simulation for the ith time step. to match survival probabilities, equations 10 and 12 are combined such that: 1 ! exp − ℎ!"!" ! !!! = exp −!!!!1 − ! ! ! !!! % 1 ! exp − exp ! !! + !!!" δ! ! ! !!! = exp −!!!!1 − ! ! ! !!! (14) for a total of m simulation trials and k time steps. the data required to estimate b effectively (the slope of the regression generated from equation 14) were procured from south african banks spanning 10 years from january 2003 to january 2013. combining equations 10 and 13, the percentage change in spreads may be used as a proxy for percentage changes in hazard rates. i.e. δs/s%≈%δh/h. credit spreads as well as associated change in portfolio value, δ! were assembled for different counterparties of various credit rating grades, and for differing contract maturities. linear regression of these quantities is shown in figure 11 (δw in r000s). figure 11 regression of δs/s%on δw%for south african data from jan-03 to jan-13 the slope is an estimate for b in the south african market (0.0035 ± 0.0002 with 95 per cent confidence). this value of ! is then substituted into equation 14 and ! for each simulation trial determined via a newtonraphson technique. having established a, true hazard rates can be backed out from equation 14. these are shown in figure 12 for varying maturities and spreads. the recovery rate was again assumed to be 55 per cent. slope&=&0.0035 r²&=&0.67 020% 015% 010% 05% 0% 5% 10% 15% 060 040 020 0 20 40 60 δ s/ s δw 598 sajems ns 17 (2014) no 5:584-600 figure 12 relationship between spread level maturity of underlying derivative and hazard rates. as before, the outcome depends heavily on the absolute spread level as expected, when spreads are high, hazard rates increase exponentially for longer matureties, as shown in figure 13. figure 13 relationship between hazard rates and maturity for various average spreads 5 conclusions a step-by-step guide for measuring cva has been established for a simple otc interest rate derivative. implementation of cva and its associated sensitivity measures for a portfolio of derivative instruments is considerably more complex. much of this complexity is, however, computational rather than analytical so success ful execution involves more computing time rather than calculation difficulties. cva risk, which arises from changes in both counterparty credit spreads and market variables that affect the no-default value of derivative transactions, was also explored in detail. cva is a complex derivative, so it is difficult to estimate the effects of these changes on cva without a robust mathematical model. high average spreads manifest in times of high market volatility, or in counterparties of poor credit quality, affect cva risk in counterintuitive (and potentially dangerous) ways. these high spread levels 0 2 4 6 8 10 0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% 0 100 200 300 400 500 600 700 800 900 1,000 maturity (years) ha za rd /ra te spread (bps) 0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% 0 1 2 3 4 5 6 7 8 9 10 ha za rd &ra te s maturity spread3=31000bps spread3=3400bps spread3=350bps sajems ns 17 (2014) no 5:584-600 599 have been observed in south africa and, although relatively rare, are not impossible. although there may be an economic justifycation for the behaviour of cva when spreads are high, care must be taken not to install complex models blindly without understanding model outputs while considerably more testing is required before market implementation. it has been demonstrated that a relationship between hazard rates and other observable variables may be modelled and that these models are simpler, computationally faster, and easier to back test than more complex models that have appeared in the literature to date. the model proposed by hull & white (2012) has been used to calibrate south african data in stressed and unstressed market conditions. further research is needed to determine which variables work best and to determine the appropriate functional form for the relationship. endnotes 1 several banks consider these basel iii proposals to be inadequate and have developed sophisticated, internal models for managing both types of risk (hull & white, 2012). 2 the 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(ed.) london: risk books. vasicek, o.a. 1977. an equilibrium characterization of the term structure. journal of financial economics, 5(2):177-188. wood, d. 2013. special report: south africa. risk special report. available at: http://www.risk.net/riskmagazine/special/2251551/special-report-south-africa [accessed 10-05-2013]. abstract introduction and background research methodology results discussion and research implications conclusions, limitations and directions for further research acknowledgements references appendix 1 about the author(s) estelle van tonder school of management sciences, faculty of economic and management sciences, north-west university, potchefstroom, south africa daniel petzer henley business school africa, johannesburg, south africa department of marketing management, faculty of economic and management sciences, university of pretoria, pretoria, south africa citation van tonder, e. & petzer, d., 2023, ‘promoting customer advocacy in the ride-hailing sector: a generational cohort perspective’, south african journal of economic and management sciences 26(1), a4670. https://doi.org/10.4102/sajems.v26i1.4670 original research promoting customer advocacy in the ride-hailing sector: a generational cohort perspective estelle van tonder, daniel petzer received: 18 may 2022; accepted: 23 nov. 2022; published: 10 feb. 2023 copyright: © 2023. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: growth in the ride-hailing sector has contributed to intense competition among transportation network companies (tncs), with many new platforms entering the market and tnc brands aiming to achieve market dominance. in this turbulent business environment, advocacy presents a viable tool for attracting customers and maintaining market share. aim: this research provides insight into the interrelationships between affective commitment, service quality, and perceived justice, their influence on advocacy in the ride-hailing sector, and the extent to which two viable generational cohorts (baby boomers and generation y), guided by different life perspectives, moderate the magnitude of the relationships established. setting: a self-administered survey was conducted among ride-hailing customers of a specific tnc brand in south africa. method: the survey included previously validated measurement scales to assess the constructs of the study. the final sample comprised 150 baby boomers and 309 generation y individuals. data analysis included multi-group structural equation modelling, bootstrapping, and the wald test. results: affective commitment positively influences perceived justice and service quality, with customer advocacy intention as the end result. generational cohorts moderated most of the direct effects and the indirect effect between perceived justice and customer advocacy intention through service quality. conclusion: overall, the study contributes to the conversation regarding affective states influencing cognition and provides a fresh perspective on the affect-cognition-behaviour relationship in a ride-hailing service context. contribution: the study provides a fresh perspective on the affect-cognition-behaviour relationship within a ride-hailing service context and advances knowledge of customer advocacy in relation to tnc brands. keywords: advocacy; customer citizenship; generational cohort; ride-hailing; sharing economy. introduction and background the days of the sharing economy being considered a niche market have long passed, as the sharing economy has become a profitable and budding market, attracting large investments and a multitude of customers (möhlmann 2015:193). since their rapid growth in popularity following the 2008 financial crisis (kuswanto et al. 2020:76), the sharing economy and platform business models have become part of many consumers’ daily existence in terms of accommodation-, entertainmentand transportation-related services (lee et al. 2018:829; wang et al. 2022:197). of particular interest to this study are transportation network companies (tncs) and their ride-hailing platform business models. typically, tncs use smartphone application platforms to link drivers and customers requiring ride-hailing services. drivers (fellow community members) cooperating with tncs transfer customers (service recipients), using their own cars, receive payment by card or in cash, as is the case in some developing countries (wadud 2020). the long-term survival of tnc brands is important. in addition to stimulating economic development (gao, wang & yao 2022), these companies may contribute to reducing road traffic and subsequently car pollution (wang et al. 2022:198). customers sharing rides may also benefit from greater flexibility, compared to public alternatives (guan et al. 2022), and save on travel expenses. nevertheless, in recent years, growth in the ride-hailing sector has contributed to intense competition among tncs, with many new platforms entering the market and tnc brands aiming to achieve market dominance (guo, li & zeng 2019:1044). moreover, switching between ride-hailing companies does not require much effort, which poses a threat to the sustainability of tnc brands (cohen, fiszer & kim 2021:2432). in this turbulent business environment, advocacy presents a viable tool for attracting customers and maintaining market share. advocacy behaviours are perceived by customers as more credible than commercial media, may enhance a firm’s reputation, and contribute to growth in market share (iyer, yazdanparast & strutton 2017:647; yi & gong 2013:1280). therefore, customers viewing the tnc brand positively, sharing their thoughts with other customers (fellow service recipients), and recommending the service of the tnc brand to them, may contribute to more customers hailing rides from the tnc brand and remaining loyal to it. of further interest is that particularly strong support has been found for the notion that customers experiencing service quality and relationship quality benefits, such as affective commitment, may be motivated to engage in favourable advocacy behaviours (ahmadi 2019:51; bendapudi & berry 1997; de matos & rossi 2008:581; nguyen-phuoc et al. 2020:96; ok et al. 2020:132; yavas, benkenstein & stuhldreier 2004:144–145). recent research in the ride-hailing industry has further elucidated the matter by indicating that affective commitment towards the tnc brand may influence advocacy behaviours, but is more likely to be fully mediated by service quality in a ride-hailing context. the authors claimed that, supported by the defensive motivation theory (chen, duckworth & chaiken 1999), ride-hailing customers’ strong emotional bonds with the tnc brand may favourably affect their judgements of the service provided, which could stimulate further advocacy behaviours (van tonder & petzer 2021). the perspective of affective states influencing cognition also seems to be acknowledged within the broader research domain. for example, according to kühn and petzer (2018:262), the ‘affect-cognition link’ denotes a relationship between customers’ affective states and the assessment of their surroundings. clore and schnall (2005:439) affirmed that affective states may impact attitude formation. additionally, in her widely cited experimental research, edwards (1990:203) acknowledged the possibility that cognition may follow affect. however, still absent from the affect-cognition-behaviour relationship identified in the ride-hailing service context, is an understanding of the role of customers’ perceptions of perceived service justice received. along with investigations of service quality, it seems necessary to account for the influencing effect of customers’ perceived justice (service fairness) experienced from the tnc brand. fundamentally, customers are keen on not only favourable, but also equitable treatment from their providers (chen et al. 2012:400). subsequently, their reactions to services are dependent on judgements of both service quality (favourableness) and perceived justice experienced (carr 2007:108). previous research further denotes that perceived justice may positively influence customer satisfaction levels and behavioural intentions of loyalty towards the service provider, such as advocacy (carr 2007:115; chi, wen & ouyang 2020:1029) and service quality (kwortnik & han 2011). moreover, considering the premises of the defensive motivation theory (chen et al. 1999) and other scholarly findings in the field (clore & schnall 2005:439; edwards 1990:203; kühn & petzer 2018:262; van tonder & petzer 2021), it is plausible that perceived justice experienced may similarly be influenced by customers’ strong emotional bonds with the tnc brand. a further related concern is the extent to which the potential interplay between affective commitment, service quality, and perceived justice motivates the baby boomer (born between 1943 and 1970) and the generation y (born between 1980 and 2000) cohorts to become involved in the promotional activities of tnc brands in the sharing economy. these cohorts were significant to this study, given that they appeared to have a vested interest in ride-hailing services. ride-hailing services are beneficial to older adults who cannot drive anymore and may not want to rely on friends and family for transportation. it has also been noted that generation y consumers are less inclined to travel by private car and are open to alternative modes of transport, including ride-hailing services (alemi et al. 2018:49, 60; gurău 2012:103; hole, zhong & schwartz 2010:88; mitra, bae & ritchie 2019:700; winter et al. 2020:5). however, the likelihood of the two cohorts to perform the role of a ‘marketing agent’ and advocate on behalf of the tnc brand, and the extent to which their emotions and service perceptions may stimulate these behaviours, is still poorly understood. extant literature denotes that older customers may be more easily satisfied and more faithful towards their service provider (trabelsi-zoghlami, berraies & yahia 2020:1642). generation y consumers seem to be more doubtful, expecting high levels of service (kueh & voon 2007:656; valentine & powers 2013:598). further investigation of the above matters would allow for greater understanding of the interrelationships between affective commitment, service quality, and perceived justice influencing advocacy behaviours of valuable baby boomers and generation y cohorts, and thus the extent to which they may act as marketing agents for the tnc brand. against this background, the objective of the current research was to explore the relationships between affective commitment, service quality, and perceived justice, their influence on customer advocacy intentions, and the extent to which the generational cohorts (i.e. baby boomers and generation y) moderate the magnitude of the relationships established. subsequently, this research makes three important contributions to marketing and quality literature. firstly, the study contributes to the conversation regarding affective states influencing cognition (perceived justice and service quality) and provides a fresh perspective of the affect-cognition-behaviour relationship within a ride-hailing service context. secondly, the study advances knowledge of customer advocacy in relation to tnc brands. the proposed model provides a more comprehensive perspective of the extent to which customers’ overall service perceptions, as balanced by service quality and perceived justice, may impact advocacy in the sharing economy, as well as the mediating role that service quality and the moderating role that generational cohorts may play in influencing these behaviours. third, the proposed model paves the way for further research on generational cohorts’ potential to perform a ‘marketing agent’ role in the sharing economy and to aid tnc brands in managing a competitive advantage amidst fierce competition. a theoretical framework is presented next, providing more insight into perceived justice, affective commitment, service quality, and customer advocacy, as well as the theories grounding these constructs. moreover, the hypotheses of the study are formulated for empirical testing. subsequent to an outline of the research methodology, the research findings are addressed. thereafter, theoretical and practical implications are highlighted and guidelines are provided for further research on this topic. theoretical framework customer citizenship and advocacy behaviour advocacy is perceived as a symbol of customer loyalty and a dimension of customer citizenship behaviour that is rooted in the social exchange theory (yi & gong 2013:1280). the principles of customer citizenship behaviour evolved from the theory of organisational citizenship behaviour (choi & lotz 2016:540; fowler 2013:1–2). it is argued that customers could, similarly to full-time employees of a firm, voluntarily engage in citizenship behaviours that may benefit the firm to reciprocate the favourable treatment received (blau 1964; deckop, cirka & andersson 2003:104; fowler 2013:1, 5; kim & choi 2016:387). multiple studies have been undertaken to understand the factors that influence customers’ citizenship behaviours (gong & yi 2021:173–175). moreover, several dimensions of customer citizenship behaviours have been previously identified that may benefit the firm, including customers helping other customers, customers giving feedback to the firm, and advocacy behaviours (yi & gong 2013). advocacy is perceived as the positive references that customers provide about service providers (fullerton 2003:339). customers engage in advocacy voluntarily and out of obligation to be good to the firm that benefitted them (blau 1964; kim & choi 2016:387). advocacy could assist in promoting the service provider to the advocating customer’s friends, family, and other contacts, including social media contacts (arguello, monferrer tirado & estrada guillén 2020:192). in a sharing economy context, advocacy behaviours additionally involve customers writing positive online reviews about the service provider on independent websites (zhang 2019:657). in this study, customer advocacy intention was considered (and measured) as the extent to which customers would speak positive words about the tnc brand and recommend it to fellow customers (yi & gong 2013). service perceptions as noted earlier, customers’ reactions to services are dependent on judgements of both service quality, as well as perceived justice experienced. service quality service quality is grounded in services marketing (fullerton 2005:1373) and is well-studied across various contexts (izogo & ogba 2015; lepmets et al. 2012; narteh 2018; sadeh 2017). previous research has provided extensive insight into dimensions of service quality (izogo 2017:21). the most ground-breaking research was presented by parasuraman, zeithaml and berry (1988:16), who defined perceived service quality as ‘a global judgment, or attitude, relating to the superiority of the service’. five dimensions were proposed for assessing service quality: reliability, assurance, tangibles, empathy, and responsiveness (izogo 2017:21; parasuraman et al. 1988:29). subsequently, many studies have pinpointed different operationalisations of service quality across varying countries and contexts (izogo 2017:22; prakash 2019). most notable are the studies by cronin and taylor (1992) (five dimensions), rust and oliver (1994) (three dimensions), and brady and cronin (2001) (three dimensions). additionally, dagger, sweeney and johnson (2007:137) proposed that service quality should be examined at overall, dimensional, and sub-dimensional levels. the authors opine that the customers’ perceptions of service quality at a particular level influence perceptions on a subsequent level, and they measure service quality in their study on an overall level (dagger et al. 2007:137). this research was interested in an overall assessment of service quality that would aid in obtaining a holistic perspective of customers’ beliefs regarding the level of service experienced from the tnc brand. subsequently, the scale developed by dagger et al. (2007) for measuring overall service quality was selected for further investigation in the study. more specifically, the construct was assessed by measuring the degree to which the respondents found the tnc brand to be superior, excellent, impressive, and of a high standard (dagger et al. 2007:137). perceived justice the concept of justice or fairness is rooted in the equity theory (adams 1965), and has been widely applied in various fields to explain social interaction between human beings and their interaction during transactions (xing et al. 2020:198). in a social exchange relationship, perceived justice is experienced when the level of input provided is in balance with the outcome received (adams 1965; kau & loh 2006:102). accordingly, marketing scholars view service fairness (justice) as ‘customers’ perceptions of the degree of justice in the service firm’s behaviour’ (seiders & berry 1998:9), in relation to their social exchange relationship with the firm. typically, perceived justice is measured in three dimensions: interactional justice, procedural justice, and distributive justice (mohd-any et al. 2019:664). interactional justice refers to the outcomes of the communication between the customer and the firm providing the service. justice perceived, depends on the extent to which customers having social exchanges with the firm experience empathy, politeness, and courtesy (la & choi 2019:208). procedural justice is experienced when the affected customer’s complaint is dealt with by the service provider through means, procedures, and policies (ortiz et al. 2017:439–440), and consumers perceive the procedures followed by the service provider to be fair (aurier & siadou-martin 2007:452). blodgett, hill and tax (1997:188) opine that distributive justice refers to the sense of justice the customer experiences based on the outcome received from the firm providing the service. therefore, the customer believes the treatment received from the firm is fair (voorhees & brady 2005:194). the current research was interested in customers’ overall perceptions of service justice received from the tnc brand. perceived justice was accordingly measured as the extent to which customers believe they receive fair treatment from the tnc brand overall and can count on them to be fair (choi & lotz 2018:628). the relationship between service perceptions and customer advocacy previous research has confirmed positive relationships between service quality and positive customer recommendations (chenet, dagger & o’sullivan 2010:340). zeithaml, berry and parasuraman (1996:34) explain that customers praising the firm is a sign of them bonding with the firm and that these behaviours may be triggered by customers experiencing service quality. customers’ relationships with service providers are improved when service quality is experienced, which may contribute to them saying positive things about the service provider to friends and peers (roy et al. 2018:295). additionally, grounded in the principles of customers’ citizenship behaviour and the social exchange theory (blau 1964), it is plausible that customers of ride-hailing services will voluntarily engage in customer advocacy behaviours to reciprocate favourable treatment of service quality experienced. moreover, prior research has established positive relationships between customer perceptions of perceived justice (service fairness) and customers’ positive recommendations of the firm (choi, lotz & kim 2014:15; roy et al. 2018). grounded in the principles of customers’ citizenship behaviour and the social exchange theory (blau 1964), it is plausible that customers of ride-hailing services may also voluntarily engage in customer advocacy behaviours to reciprocate favourable treatment of service justice experienced. as per van tonder and petzer (2021:1272), service quality influences customer advocacy intention in the ride-hailing sector. furthermore, a conceptual model proposed by bai and li (2021:225) indirectly links justice to helping behaviour in a study on strategic alliances, while bizri and hamieh (2020:705) and jnaneswar and ranjit (2022:5) proposed that justice directly impacts citizenship behaviour in an organisational context. consequently, it was hypothesised that in the context of tnc brands: h1: service quality positively and significantly predicts customer advocacy intention. h2: perceived justice positively and significantly predicts customer advocacy intention. the relationship between individual service perceptions perceived justice (service fairness) and service quality are described as ‘inseparable’ (berry 1995; chi et al. 2020:1033), with a positive relationship between perceived justice and service quality having been identified (kwortnik & han 2011). consumers may reflect on fairness when evaluating overall service quality (chen et al. 2012:405). when individuals or groups are not favoured above others, customers may perceive this approach of fairness as a sign of good service quality (carr 2007; giovanis, athanasopoulou & tsoukatos 2015:749). xing et al. (2020:206) found that perceived justice influences service quality in a study of patients concerning doctor-patient interaction. accordingly, it was further proposed that customers perceiving the service provided by the tnc brand as fair, will also conclude that good service quality was achieved. hence, perceived justice may be a signal of good service quality. accordingly, it was hypothesised that in the context of tnc brands: h3: perceived justice positively and significantly predicts service quality. affective commitment customer commitment is rooted in the relationship marketing theory. dwyer, schurr and oh (1987:19) define commitment as an implied and overt undertaking between a buyer (customer) and a seller (service provider) to continue their business relationship. this view is echoed by other key scholars in the field. moorman, zaltman and deshpande (1992:316) consider commitment to be the lasting aspiration to continue a relationship that is valuable to both parties concerned. morgan and hunt (1994:23) perceive commitment as ‘an exchange partner believing that an ongoing relationship with another is so important as to warrant maximum efforts at maintaining it’. fullerton (2003:334) noted that commitment is frequently operationalised as affective commitment by marketing scholars and is considered important when building long-term relationships with customers (panchapakesan, amin & herjanto 2022:315). someone who is attached to an organisation (e.g. employees and customers) can be considered affectively committed (al samman & mohammed 2021:850). customers can be considered to be affectively committed when they have an affinity towards the firm providing the service, regardless of the type of service being provided (fullerton 2005:1375). furthermore, a customer who is affectively committed to a service provider has the propensity to exhibit emotions towards the service provider (izogo 2017:20–21). in the context of this study, affective commitment related to customers’ feeling of belonging and attachment to the tnc brand (choi & lotz 2018:628). the relationship between affective commitment and service perceptions it is possible that both customers’ views of service quality and perceived justice are born out of their affective commitment to the tnc brand. according to chen et al. (1999) and the defensive motivation theory, consumers with a particular level of commitment towards an object could want to guard their current beliefs and the attitudes they have developed towards this object in instances where novel information may be discovered. given this state of affairs, also described as their ‘defense motivation’, consumers committed to the tnc brand could employ cognitive processing that is selective in nature when they are exposed to information contrary to their beliefs and attitudes of the brand, irrespective of whether these indeed align with reality (ahluwalia, unnava & burnkrant 2001:460; chen et al. 1999:45; van tonder, de beer & kuyper 2020:549). van tonder and petzer (2021:1272) also found that affective commitment influences service quality in the ride-hailing sector. thus, it was hypothesised that in the context of tnc brands: h4: affective commitment positively and significantly predicts service quality. h5: affective commitment positively and significantly predicts perceived justice. the mediating effect of service quality considering the possibility that customers’ perceptions of service quality come from their views of perceived justice (kwortnik & han 2011:323) and the service quality which customers experience may voluntarily advocate the brand to reward the firm for the high service standard (blau 1964), it is likely that service quality could provide an indirect path to connect perceived justice and customer advocacy behaviours. customers perceiving the service provided by the tnc brand as fair, subsequently believing the service received from the tnc brand is of a superior standard, may want to engage in behaviours that would be advantageous to the tnc brand in return, such as advocating it to other customers. therefore, it was hypothesised that with respect to tnc brands: h6: perceived justice has a significant positive indirect effect on customer advocacy intention as mediated by service quality. the moderating effect of generational cohort according to koksal (2019), the generational cohort theory first introduced by karl mannheim in 1952 is premised on the fact that individuals born during the same time period, and so morphing into adulthood simultaneously, are exposed to equivalent economic, social, political, and cultural experiences that result in similar preferences, behaviours, and values throughout their lifetimes. several generations have been identified based upon this premise. in this section, the focus is on baby boomers and generation y, as these consumers are of interest in this study. although they have almost all retired (arora & dhole 2019), baby boomers have proven themselves as adept users of new technologies, since they have lived through changes in technology throughout their lives and are important mobile services users (kumar & lim 2008). according to gardiner, grace and king (2013), baby boomers are in an intermediate phase of their lives, as they are stepping back from formal employment to retirement and have children who are leaving or have already left the household. all of these changes impact their behaviour as consumers (koksal 2019). in contrast, generation y exhibits significant differences from earlier generations with respect to how the gender roles in the workplace and family are defined (melancon, forbes & fugate 2015). as stated by melancon et al. (2015), numerous millennials (i.e. generation y) have been raised in non-traditional households, with many experiencing their parents playing non-traditional roles. in addition, they have experienced women entering the workforce in roles traditionally reserved for males (melancon et al. 2015). generation y consumers are technologically literate and have media knowledge as a result of growing up in technology-enabled environments; are willing to take risks; and are sociable, fun-loving, and carefree (farris, chong & dunning 2002; naim & lenkla 2016). concerning the relationships proposed in this study, it is plausible that age may affect perceptions of services. almutawa, muenjohn and zhang (2018:657) opined that customers’ differences impact service quality. it seems easier to please older customers who have a greater tendency to be loyal to a service provider (trabelsi-zoghlami et al. 2020:1642). in contrast, generation y has been described as having a ‘strong sense of fairness and ethics’ (hernaus & vokic 2014:619). this generation tends to be sceptical (valentine & powers 2013:598) and has high service standards (kueh & voon 2007:656). members are also characterised by their willingness to complain when service failures occur (soares et al. 2017). therefore, compared to older baby boomers, generation y may be less likely to develop views of service quality as a result of perceived justice experienced. additionally, being more sceptical, generation y consumers may be less motivated to advocate in favour of the tnc brand when experiencing perceived justice and quality service. hence, it was hypothesised that with respect to tnc brands: h7: generational cohort moderates the direct effect of service quality on customer advocacy intention. h8: generational cohort moderates the direct effect of perceived justice on (a) customer advocacy intention and (b) service quality. in view of the above, it was expected that the indirect effect of perceived justice on customer advocacy intention through service quality would be weaker among ride-hailing customers of the generation y cohort. consequently, it was also hypothesised that: h9: the indirect effect of perceived justice on customer advocacy intention through service quality is moderated by generational cohort. finally, it is plausible that the relationships between affective commitment and service perceptions may also vary from cohort to cohort. besides having higher service expectations and being more sceptical, generation y customers tend to be less loyal to service providers than other cohorts and are more willing to revert to another service provider if dissatisfaction is experienced (soares et al. 2017:523). similar behaviour has been observed in the workplace, where generation y employees tend to be less committed than the older generation and are more willing to revert to another employer if their expectations have not been met (rani & samuel 2016:1702). subsequently, it is plausible to argue that ride-hailing customers from the generation y cohort are less likely to judge the service of the tnc brand favourably when they are affectively committed to it. given their tendency to be more sceptical and keep their options of an alternative service provider open, generation y customers are less likely to employ selective cognitive processing when being affectively committed and having to judge the service of the tnc brand (ahluwalia et al. 2001:460; chen et al. 1999:45; van tonder et al. 2020:549). hence, the impact of affective commitment on perceived justice and service quality may be lower among generation y ride-hailing customers, considering that they tend to be less loyal to service providers (soares et al. 2017:523). thus, it was hypothesised that with respect to tnc brands: h10: generational cohort moderates the direct effect of affective commitment on (a) service quality and (b) perceived justice. figure 1 depicts the conceptual model of this study. figure 1: conceptual model. research methodology questionnaire and measurements a self-administered survey was conducted to obtain more insight into ride-hailing customers’ affective commitment to the tnc brand, their perceptions of the service provided, and their intentions to advocate the brand. the survey included four measurement scales that were validated previously to assess affective commitment and perceived justice (choi & lotz 2018), service quality (dagger et al. 2007), and customer advocacy intention (yi & gong 2013). the statement measuring pride was excluded from the affective commitment scale, as it did not fit appropriately with the other scale items. appendix 1 contains the items used to measure the constructs and also cites the authors from whom the abovementioned authors either adopted or adapted the scales used in their respective studies. the responses were captured on a seven-point likert-type scale that assessed the level of agreement, ranging from 1 (‘strongly disagree’) to 7 (‘strongly agree’). sample procedure, data collection, and analysis the population included ride-hailing customers of a specific tnc brand in south africa. participation criteria included individuals older than 18 years who had ordered a ride at least once during the last year using the tnc brand’s mobile app. since a sample frame did not exist, trained fieldworkers handed surveys to qualifying respondents for completion in public places, such as shopping malls. the survey included three screening questions aligned to the definition of the target population. fieldworkers were instructed to fill age and gender quotas, and employed purposive sampling. the respondents voluntarily participated in the study and did not receive any form of remuneration for completing the printed survey. the fieldwork was supervised by an accredited research agency in south africa. data were collected over 3 months in 2018. gender representation was almost equal among the final realised samples, which consisted of 150 baby boomers (49% male and 51% female) and 309 generation y respondents (50.8% male and 48.9% female). in each cohort, one respondent did not reveal their gender. most of the respondents from the baby boomer cohort were older than 55 (60.7%). almost two thirds of the generation y cohort were older than 20 (65.4%). in both cohorts, the majority of the respondents have been hailing rides from the tnc brand for at least 2 years (baby boomers: 60.4%; and generation y: 72.2%), book a ride with the tnc brand at least twice a month (baby boomers: 64.7%; and generation: y 83.2%), and reported their main reason for booking rides with the tnc brand as needing a transfer for socialand not work-related visits (baby boomers: 72%; and generation y: 78.6%). overall, these findings demonstrate that the respondents have utilised the services of the tnc brand and were in a position to relate to their own experiences in completing the survey. the results were analysed using mplus version 8.4. confirmatory factor analysis (cfa) and multi-group structural equation modelling (sem) using maximum likelihood estimation with robust standard errors and a meanand variance-adjusted test statistic were applied to test the research hypotheses. the χ2 difference test, bootstrapping (95% confidence interval and 5000 replications), and the wald test were employed to assess the extent to which generational cohorts moderate the direct and indirect effects between perceived justice and customer advocacy intention through service quality (wang & wang 2012:278). ethical considerations ethical clearance was obtained from the university of pretoria’s gordon institute of business science (gibs) ethics committee chaired by prof gavin price (04 june 2018). results individual measurement model results following the procedure prescribed by wang and wang (2012), individual measurement models were assessed. table 1 denotes that adequate cfa fit statistics were obtained for the individual measurement models based on the cohorts (hair et al. 2014). table 1: confirmatory factor analysis fit statistics for individual measurement models based on the cohorts. as further denoted by table 2 and table 3, for each measurement model, all standardised factor loadings were more than 0.7 and statistically significant (p < 0.001), all average variance extracted (ave) values exceeded 0.5, and all composite reliability (cr) values were larger than 0.7, thereby evidencing convergent validity and reliability (hair et al. 2014). table 2: assessment of latent variables. table 3: latent factor correlation matrix with average variance extracted values on the diagonal in brackets. no discriminant validity problems were identified either. as shown in table 3, in all instances, the ave values of the respective latent variables exceeded the shared variance among them (fornell & larcker 1981; hair et al. 2014). common method bias assessment harman’s single-factor test (podsakoff et al. 2003) was applied to assess common method bias. in both cohorts, the total variance explained by a single factor was less than 70% (baby boomers = 63.52%; generation y = 54.73%). previous investigations in business research denoted that significant potential for common-method bias only exists in the event of the common method variance bordering 70% or higher (fuller et al. 2016:3196). accordingly, common method bias was not a concern in this study. measurement invariance and multi-group measurement model results table 4 presents the fit statistics of the measurement invariance test. with respect to all models examined, the χ2/df values never exceeded 5, the cfi and tli values were not lower than 0.90, all rmsea values met the 0.08 cut-off criteria, and all three p-values were more than 0.05 (hair et al. 2014). accordingly, evidence was provided of strong measurement invariance. table 4: measurement invariance fit statistics. the multi-group measurement model, based on the cohorts, also presented acceptable fit statistics: χ2 = 419.83; df = 190; χ2/df = 2.21; cfi = 0.97; tli = 0.97; rmsea = 0.073. the χ2 contribution was 171.17 for the baby boomer cohort and 248.66 for the generation y cohort. all standardised factor loadings were more than 0.7, statistically significant (p < 0.001), and ranged between 0.90 and 0.98 for the baby boomer cohort, as well as between 0.82 and 0.96 for the generation y cohort. regarding both cohorts, all ave values exceeded 0.5 and all cr values were larger than 0.7, thereby evidencing convergent validity and reliability (hair et al. 2014). in all instances, the ave values of the respective latent variables exceeded the shared variance among them, subsequently evidencing discriminant validity (fornell & larcker 1981; hair et al. 2014). multi-group structural equation modelling results adequate fit indices were obtained for the multi-group sem model, as depicted in figure 1: χ2 = 247.28; df = 192; χ2/df = 1.29; cfi = 0.98; tli = 0.98; rmsea = 0.035. the χ2 contribution for the baby boomer cohort was 100.83, and 146.45 for the generation y cohort. a competing model was additionally assessed. supported by the work of choi and lotz (2018), and engizek and yasin (2017), the effect of perceived justice and service quality on affective commitment with customer advocacy intention was measured. the impact of perceived justice on service quality remained intact. compared to the initial model, the competing model presented inferior model fit statistics: χ2 = 310.34; df = 194; χ2/df = 1.60; cfi = 0.96; tli = 0.96; rmsea = 0.051. subsequently, the initial model was retained for further investigation. table 5 further evidences that all standardised regression weights of the multi-group sem model depicted in figure 1, were positive and significant (p < 0.001), except for the relationship between perceived justice and customer advocacy intention in the baby boomer cohort. therefore, h1 and h3 to h5 were supported in both cohorts, and h2 was supported in the generation y cohort (hair et al. 2014). table 5: multi-group structural equation modelling results. moderation and mediation tests the χ2 difference test was conducted next to determine if generational cohorts moderate the relationships established (wang & wang 2012:275). each individual path examined, was first constrained to be equal among the different cohorts and subsequently compared against the unconstrained path. statistically significant differences (p < 0.05) between the constrained and unconstrained paths were found concerning the first three relationships denoted in table 6, but not the last two relationships. therefore, only h7, h8a, and h8b were supported, indicating that generational cohorts moderate these relationships (wang & wang 2012:276). table 6: moderation results of direct effects. indirect effects were assessed, using the model constraint command in mplus (wang & wang 2012). regarding h6, the percentile bootstrapping results indicated that the indirect effect between perceived justice and customer advocacy intention through service quality was supported in both samples. specifically, the indirect effect established in the baby boomer cohort (estimate = 0.41, 95% ci [0.24, 0.63]) seems to be higher than the indirect effect noted in the generation y cohort (estimate = 0.11, 95% ci [0.05, 0.20]). therefore, h6 was supported in both cohorts. the wald test further showed that the indirect effects established in each cohort are significantly different (χ2 = 10.96; df = 1; p < 0.05). consequently, h9 was supported (wang & wang 2012:278). considering that the direct relationship between perceived justice and customer citizenship advocacy intention (h2) is not significant when accounting for service quality in group one (baby boomers), indirect-only mediation is evident (zhao, lynch & chen 2010:201). in contrast, as all three relationships (h1 to h3) remain significant when accounting for service quality in group two (generation y), the findings support complementary mediation (zhao et al. 2010:201). figure 2 provides a graphical depiction of the research findings. figure 2: structural model. discussion and research implications as positioned earlier, competition in the ride-hailing industry is fierce, with many tnc brands offering ride-hailing services. in this turbulent environment, customer advocacy behaviour presents a cost-effective and credible solution for enhancing tnc brand credibility and to grow market share (iyer et al. 2017:647; yi & gong 2013:1280). consequently, the current investigation helps to explain the matter by providing novel insight into the extent to which overall assessment of service quality and perceived justice (service fairness) may be interrelated and impact on customer advocacy intentions and the magnitude to which customers’ emotional bonds with the tnc brand may be responsible for this development. the findings further indicate the degree to which generational cohorts moderate the direct and indirect relationships investigated. the investigation of the individual direct, indirect, and moderating effects further contributed to several theoretical and managerial implications. confirmation of affective commitment as an antecedent of service quality (h4) and perceived justice (h5) supports the argument that customers’ emotional bonds with the tnc brand may influence service perceptions (chen et al. 1999; van tonder et al. 2020). it seems that affective commitment does not only impact service quality in a ride-hailing context (van tonder & petzer 2021), but could also influence customers’ views of perceived justice experienced. another interesting observation is that the relationships between affective commitment and the individual service perceptions do not seem to be moderated by generational cohorts (h10a and h10b). hence, even though generation y may be less loyal to service providers than baby boomers (soares et al. 2017:523), it seems that once they have established emotional bonds with the brand, they are, similar to baby boomers, likely to develop favourable perceptions of the service levels experienced. furthermore, the impact appears to be strong in both cohorts, considering the large effect sizes that were obtained (h4 and h5). the implication of these findings is that, in the sharing economy, the value of affective commitment extends beyond mere relationship building with customers (fullerton 2005) and behavioural consequences. furthermore, affective commitment may strongly affect service perceptions, and thus the study’s findings offer further validation for the application of the defensive motivation theory (chen et al. 1999) in an informal service context and within diverse age cohorts. grounded in social exchange theory (blau 1964), it was expected that views of service quality and perceived justice would contribute to customers of ride-hailing services voluntarily engaging in customer advocacy behaviours to reciprocate favourable treatment experienced. yet, the current findings evidence that only h1 was supported in both cohorts, while h2 was significant in the generation y cohort. hence, it appears that at face value and considering h8a, views of perceived justice may not contribute to customer advocacy in the baby boomer cohort. however, further insight into the matter is obtained by also considering h6 and h9. it seems that service quality provides an indirect path for connecting perceived justice with customer advocacy intention and this indirect effect is significantly different and much stronger in the baby boomer cohort (β = 0.41) than in the generation y cohort (β = 0.11). moreover, considering h7 and h8b, denoting significant differences between generational cohorts, it seems that as proposed, generation y (characterised by being sceptical with a strong sense of fairness and expectations of high service quality) may be less likely than older baby boomers to develop perceptions of service quality as a result of service justice experienced, and may also be less likely to be motivated to act as ‘partial employees’ of the tnc brand and engage in customer advocacy behaviours to reward the tnc brand for the service quality experienced. nevertheless, a further interesting observation is that, while a relatively low indirect effect was established in the generation y cohort, the direct effect between perceived justice and customer advocacy intention was still relatively large (h2). these findings are significant, as it seems that although the high service standards of generation y may contribute to them being more reluctant to develop perceptions of service quality when perceived justice is experienced, their ‘strong sense of fairness and ethics’ (hernaus & vokic 2014:619) may motivate them to reward the tnc brand with advocacy behaviours when service fairness is experienced. perceived justice may not strongly convince generation y that a high service standard was experienced. however, their perceptions of perceived justice as informed by emotional bonds (affective commitment) with the tnc brand are significant, and could motivate them to still perform their ‘marketing agent’ role and engage in customer advocacy behaviours to reward the tnc brand for the service fairness experienced. the implications of these findings are that, while it is important to focus on service quality as a key antecedent of customer advocacy (ahmadi 2019:51; de matos & rossi 2008:581; van tonder & petzer 2021; yavas et al. 2004:144–145), perceived justice is also relevant and seems to directly or indirectly influence customer advocacy behaviours. in a sharing economy context, the service standards of the generational cohorts may further affect the magnitude of the indirect effect between perceived justice and customer advocacy intentions through service quality. from a managerial perspective, the relationship between service quality and advocacy has been verified multiple times in the formal service environment (ahmadi 2019:51; de matos & rossi 2008:581; yavas et al. 2004:144–145) and appears to be relevant also in a ride-hailing context, as noted previously (van tonder & petzer 2021) and confirmed in this study. hence, tnc brands aiming to obtain a competitive advantage through customer advocacy may be doing well by focusing on service quality. it is especially important for baby boomers to perceive service quality, as they are most prone to show advocacy behaviours when high service standards are experienced. service quality may be enhanced by, for example, ensuring drivers are always on time for scheduled appointments, the vehicle is always neat and clean, and driving rules are kept. additional indicators of service quality may include the driver’s friendliness, playing the radio station requested by the customer, and providing occasional discounts, which demonstrate care towards the customer. furthermore, it could be useful for tnc brands to recognise the importance of fostering affective commitment between them and customers, and to build strong emotional bonds with customers to improve their perceptions of service quality. based on the research findings, both the baby boomer and generation y cohorts may benefit from this strategy. in developing emotional bonds with customers, tnc brands could demonstrate care by ensuring that the interaction between drivers and customers is professional and the atmosphere inside the vehicles is pleasant and relaxing. smartphone application platforms connecting customers and drivers also serve as a viable tool for obtaining constructive feedback from customers and strengthening emotional relationships with them. transportation network companies brands should harness these big data opportunities to take advantage of customer feedback to foster affective commitment. additionally, customers must be treated as individuals and feel recognised by the brands. online chatbots assisting with booking services or dealing with customer questions could aid in personalising the service, while incentives to regular customers may further promote bonding. however, tnc brands also need to concentrate on perceived justice (service fairness) to further enhance customer advocacy intentions. this is especially essential in motivating advocacy behaviours of generation y consumers, who have high service standards, but strongly value fair behaviour. transportation network company brands are expected to focus on clearly defined service standards and staff training to ensure fair service is provided. potential problems must be anticipated and problem-solving policies must be designed to ensure service failures are dealt with fairly. fair service treatment could also include ensuring customers are appropriately informed about travel and service arrangements; customers are not confronted with unreasonable barriers when, for example, requesting refunds; and protection of consumer privacy. perceptions of perceived justice could be enhanced further by focusing on affective commitment and developing strong bonds with customers. by following this approach, customers who are emotionally attached to the tnc brand may develop heightened perceptions of fair treatment and perceived justice, as denoted by views of empathy, politeness, and courtesy experienced (la & choi 2019:208; ortiz et al. 2017:439–440; voorhees & brady 2005:194). finally, opportunities must be provided for the baby boomer and generation y cohorts to engage in customer advocacy behaviours through social-media platforms and online reviews. for instance, hashtags could generate interesting conversations among customers experiencing a sense of community and wanting to endorse the tnc brands. key questions may prompt conversations and steer customer endorsements in the desired direction. moreover, tnc brands could ask customers for testimonials and encourage them to share inspiring stories with other customers on online review platforms. conclusions, limitations and directions for further research the current research provides more insight into the affect-cognition-behaviour relationship in a ride-hailing service context. specifically, this study verified the extent to which ride-hailing customers’ views of service quality and perceived justice, as informed by affective commitment towards the tnc brand, may impact advocacy intentions, as well as the mediating role that service quality and the moderating role that generational cohort may play in influencing these behaviours. the research findings further advance the understanding of differences between baby boomers and generation y and their potential to aid brands in the sharing economy to manage a competitive advantage amidst fierce competition. future research could validate the model among other generational cohorts, including generation x and generation z, and verify the extent to which the emotional bonds of these customers influence their service perceptions and customer advocacy behaviours. most of the respondents in the current study indicated their main reason for booking rides with the tnc brand as needing a transfer for social visits. it would be interesting to draw comparisons between the perceptions and behaviour of the current sample and those of respondents who book rides with tnc brands for work-related purposes. the current study measured overall views of service quality and perceived justice. greater insight is needed into the extent to which affective commitment may impact interactional, procedural, and distributive justice at an individual level (blodgett et al. 1997:188; la & choi 2019:208; ortiz et al. 2017:439–440), as well as the various sub-levels of service quality (dagger et al. 2007). the survey was conducted in south africa, a developing country with a sub-standard public transportation system. it may be worthwhile to test the same model in a more developed country, considering that respondents with access to advanced public transportation systems may be less committed to tnc brands and less inclined to judge the services of a tnc brand favourably. further research could explore the extent to which the intended levels of customer advocacy may vary if the communication is directed towards customers belonging to the same cohort as the respondent, or another cohort (mazzarol, sweeney & soutar 2007:1488). finally, the confounding effect of brand familiarity within the proposed model was not assessed and future research may want to further investigate this matter. acknowledgements the authors would like to acknowledge and thank the anonymous reviewer and editor for their valuable guidance and contribution to an earlier draft of this article. competing interests the author(s) declare that they have no financial or personal relationship(s) that may have inappropriately influenced them in writing this article. authors’ contributions the research model was conceptualised by e.v.t. who was also responsible 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truths about mediation analysis’, journal of consumer research 37(2), 197–206. https://doi.org/10.1086/651257 appendix 1 items used to measure the constructs of the study perceived justice(items from ambrose & schminke 2009 validated in choi & lotz 2018) pjust1: i am treated fairly by x. pjust2: i can count on x to be fair. pjust3: the treatment i receive from x is fair. pjust4: x treats its customers fairly. affective commitment (items from meyer, allen & smith (1993) and huang and you (2011) validated in choi & lotz 2018) ac1: i feel a strong sense of belonging to x. ac2: x has a great deal of personal meaning for me. ac3: i feel emotionally attached to x. ac4: i feel like part of the family at x. service quality(items from brady & cronin 2001 and parasuraman, zeithaml, & berry 1988 validated in dagger et al. 2007) sq1: the quality of the service provided by x is excellent. sq2: the quality of the service provided by x is impressive. sq3: the service provided by x is of a high standard. sq4: i believe x offers services that are superior in every way. customer advocacy intention(yi & gong 2013) ccba1: say positive things about x to others. ccba2: recommend x to others. ccba3: encourage friends and relatives to use x. microsoft word 5 urban sajems 16(3) 2013.docx 298 sajems ns 16 (2013) no 3:298-315 product innovation of private health insurers in south africa and the impact of entrepreneurial orientation boris urban and milton streak wits business school, university of the witwatersrand accepted: march 2013 recognising that health insurer product innovation plays a critical role in aligning incentives among all stakeholders in the healthcare value chain, this study investigates the relationship between the level of health insurer product innovation and entrepreneurial orientation (eo). taking cognisance of the importance of external collaboration between health insurers and healthcare service providers, the study is able to diagnose perceptions of strategic regulatory factors and their impact on levels of eo. the focus of the study is on the demand (financing) and supply (healthcare delivery) structures of the healthcare value chain, incorporating health insurers, health insurer administrators and healthcare service providers. a conceptual model is formulated on the basis of literature and tested using confirmatory factor analysis. the results indicate that eo at organisational level is a strong predictor of health insurer product innovation and that external collaboration between health insurers and healthcare service providers is a weak predictor of health insurer product innovation. practical implications are that both the supply and demand side structures indicate that the restructuring of relationships between health insurers and healthcare service providers is a necessary driver for collaboration in terms of health insurer product innovation progress and success. healthcare executives need to work with, and actively lobby regulators to ignite both demand and supply side innovation activities in the healthcare value chain of the private healthcare industry of south africa. key words: product innovation, regulation, external collaboration, entrepreneurial orientation, health insurers, corporate entrepreneurship, healthcare industry jel: m19 1 introduction in the context of healthcare inequalities and a struggling and underfunded public healthcare system in south africa, the south african private healthcare industry is viewed as a national asset. the private healthcare industry in south africa is complex and requires expertise and innovativeness to ensure the financial sustainability of private health insurers and the industry as a whole. the private healthcare insurance market in south africa is voluntary and accounts for 60 per cent of total healthcare expenditure, but it serves only 16 per cent of the south african population those with higher incomes (centre for development and enterprise, 2011; council for medical schemes, 2010/11). approximately five-million formally employed people in south africa are not yet insured for healthcare (mcleod & grobler, 2010). it is essential that they enter the private healthcare insurance market to ensure growth and future sustainability of the private healthcare industry. this could align the incentives of stakeholders (demand and supply side structures) in the private healthcare value chain, and thus could create the necessary access to private healthcare cover for the uninsured. this research builds on the existing framework by guth and ginsberg (1990) which integrates corporate entrepreneurship into the strategic management of a company (morris, kuratko & covin, 2008). innovation throughout the entire healthcare value chain is required to drive sound healthcare reform ensuring sustainable, cost-effective quality healthcare delivery in the private healthcare industry. the focus of the study was on the demand (financing) and supply (healthcare delivery) structures of the abstract sajems ns 16 (2013) no 3:298-315 299 healthcare value chain, incorporating health insurers, health insurer administrators and healthcare service providers. according to porter and teisberg (2006), health insurer product innovation, focusing on positive sum competition on results, plays a critical role in aligning incentives among all stakeholders in the healthcare value chain. external collaboration among health insurers, health insurer administrators and healthcare service providers – focusing on innovation and building of systems that promote health and treat illness – is essential in creating future sustainable healthcare delivery systems (mintzberg, 2011). the aims of the study were to investigate firm-level entrepreneurial orientation of health insurers, health insurer administrators and healthcare service providers in south africa and its relationship to health insurer product innovation. furthermore, the research study aimed to investigate the extent to which health insurers and healthcare service providers collaborate in designing and implementing new innovative health insurer products. the study further investigated the moderating effect of the presence of perceived strategic regulatory factors necessary for encouraging health insurer product innovation in the private healthcare industry in south africa. the study starts by briefly reviewing past research on eo and related constructs in order to operationalize these constructs and design suitable measures. a conceptual model is formulated and hypotheses are developed to test linkages between the variables under study. the results are scrutinized in terms of previous theory and contextualised from a private health care management perspective. both theoretical and practical implications are drawn from the empirical evidence, and recommendations for future research are made. 2 entrepreneurial orientation (eo) extensive research exists on the eo construct which reflects how a firm operates rather than what it does (lumpkin & dess, 1996; li, huang & tsai, 2009). the concept of eo incorporates organisational-level processes, practices and decision-making styles of innovative organisations (lumpkin & dess, 1996; urban & barreira, 2010). the strength of an organisation’s eo can have a positive effect on performance (green, covin & slevin, 2008; morris & sexton, 1996; wiklund & shepherd, 2005; zahra & covin, 1995). eo is also an important predictor of firm growth: firms that nurture structures and values conducive to intrapreneurial activities are more likely to grow than firms lacking in such characteristics (antoncic & hisrich, 2001; dess, ireland, zahra, floyd, janney & lane, 2003; urban, 2008). according to li et al. (2009) in order for organisations to respond to the dynamic and competitive environment in which they operate, they need to transfer eo consistently into feasible strategic activities that fulfil the organisations’ objectives and achieve superior performance. the literature confirms three dimensions that characterise an entrepreneurial orientation: innovativeness, risk taking and proactiveness (morris et al., 2008; urban & barreira, 2010). according to dess and lumpkin (2005), prior research has explored the direct relationship between eo and performance (rauch, wiklund, lumpkin & freeze, 2004) as well as the sustainability of that relationship (wiklund, 1999). dess and lumpkin (2005) also indicate that the eo-performance relationship is dependent on the fit between eo and factors like environment, structure and strategy (dess, lumpkin & covin, 1997). wiklund and shepherd (2003) have suggested that eo acts as a moderator and found that the relationship between knowledge-based resources and performance was stronger in organisations with higher levels of eo (dess & lumpkin, 2005). furthermore, dess and lumpkin (2005) indicate that exploring relationships among the individual dimensions of eo and performance is superior to considering eo as a onedimensional construct and that the individual dimensions of eo were more robust predictors of organisational growth than a summated onedimensional eo construct. according to urban and barreira (2010) the eo concept is best understood as a complex mix of personal and situational factors, and in addition to individual and organisational differences, forces operating within other, larger cultural contexts also determine levels of eo (aloulou & foyolle, 2005). therefore, organisations with eo typically 300 sajems ns 16 (2013) no 3:298-315 out-perform other similar organisational types with less eo, especially in volatile times (knight, 1997; urban & barreira, 2010). previous research demonstrates a strong link between eo and new product development improvement (drucker, 1979; lumpkin & dess, 1996; li, liu & zhao, 2006). according to li et al. (2009), the resource advantage theory stipulates that innovative competencies may be a source of competitive advantage because they are deeply rooted in the context of the organisation and cannot be explicitly articulated or imitated (barney, 1991; nonaka, 1994; hunt & arnett, 2006; hunt & morgan, 1996). other researchers suggest that by increasing commitment to innovative products and processes, organisations can renew their operations in the marketplace and improve their profitability (li et al., 2009; lumpkin & dess, 1996; miller, 1983; zahra & garvis, 2000). similarly, li et al. (2006), develop a systemic conceptual model to describe the relationship among organisational orientation, internal control systems and new product development. recognising that eo includes major processes, innovations and different types of venture creation initiatives, constructs related to entrepreneurship within organisations and their ability to transform organisations though strategic renewal (guth & ginsberg, 1990; morris et al., 2008), are examined in the next section. 3 corporate entrepreneurship (ce) and entrepreneurial strategy according to morris et al. (2008), ce is a term used to describe entrepreneurial behaviour inside established medium and large organisations. other terms used interchangeably with ce include intrapreneurship, corporate venturing and organisational entrepreneurship (morris et al., 2008). at the core of these terms is innovation. innovation is concerned with introducing something new to the market place and corporate venturing is concerned with entrepreneurial efforts that lead to the creation of new business ventures within corporate organisations (morris et al., 2008). according to ireland, covin and kuratko (2009) entrepreneurial strategy is a core construct within the ce literature and a specific manifestation of firm-level entrepreneurship. ireland et al. (2009) suggest that the organisational-level outcomes of ce strategy are competitive capability and strategic repositioning. further research (covin, ireland & kuratko, 2003; ireland et al., 2009) demonstrates that exploiting entrepreneurial opportunities enables organisations to both strengthen existing competitive capabilities and build new competitive capabilities. competitive capability, as per ireland et al. (2009), is the capacity of firms to create and sustain economically viable industry positions (nelson, 1991; teece, pisano & shuen, 1997). according to ireland et al. (2009), strategic repositioning can alter relationships among competitors in an industry, by strategically locating the organisation within a newly defined competitive space (ireland et al., 2009; stopford & badenfuller, 1994). having conceptualised the constructs under scrutiny, the study is now contextualised in the south african private healthcare industry. 4 the private healthcare industry in south africa according to monitor group (2008), the south african private healthcare system is ranked high on the performance versus cost rankings and compares more favourably with health systems in developed economies. conversely, the public healthcare system in south africa is ranked low in terms of performance versus cost. the cost ranking of the south african private healthcare system compared to performance is however out of line and it is therefore imperative that costs and access are more aggressively managed through innovation in the healthcare value chain. according to the centre for development and enterprise (2011), the average cost of belonging to a private health insurer has increased fivefold in real terms since 1980. innovation is critical if health insurers want to win subscribers and stay ahead of the competition (porter & teisberg, 2006). additionally, health insurers view external collaboration between health insurers, health insurer administrators and healthcare service providers as a major driving factor of product innovation and healthcare sajems ns 16 (2013) no 3:298-315 301 efficiencies (porter & teisberg, 2006) in the healthcare system. acknowledging the healthcare landscape in south africa, it is imperative to investigate whether health insurers, health insurer administrators and healthcare service providers are able to act entrepreneurially in terms of product innovation. to this effect, the firmlevel eo of health insurers, health insurer administrators and healthcare service providers in the south african private healthcare industry, are specifically investigated. 4.1 health insurer product innovation damanpour and wischnevsky (2006) suggest a method to address the different scopes of newness in the innovation literature. they differentiate between the generation and the adoption of innovations. the generation of innovation refers to situations where a firm internally generates a product, process or technology that was previously unknown to the market in which the firm operates. the adoption of innovation, on the other hand, refers to the assimilation of knowledge and technologies, that have been developed elsewhere and that are new to the organisation only (pérez-luño, wiklund & cabrera, 2011). innovation output has been associated with organisational performance (rosenbusch, brinkman & bausch, 2011). according to wiklund (1999) and soininen, martikainen, puumalainen and kylaheiko, (2011) innovation keeps organisations ahead of their competitors, thereby gaining competitive advantage and leading to improved financial results. product innovation translates into superior sales and growth rates, and is a more complex process with multiple inputs requiring more advanced knowledge contributions and absorptive capacity (goedhuys & veugelers, 2011). pérez-luño et al. (2011) classify innovation output as the proportion of total innovation output (number of innovations that organisations produce) that falls within each of the two categories: innovation generation and innovation adoption. 4.2 external collaboration between health insurers and healthcare service providers zillich, douchette, carter and kreiter (2005) define collaboration among healthcare professionals as a joint communication and decision-making process with the goal of satisfying the patient’s wellness and illness needs, while respecting the unique qualities and abilities of each professional. this definition is also applicable in terms of the collaboration between healthcare service providers and health insurers and/or health insurer administrators in developing and implementing new innovative health insurer products. discussions around healthcare reform rarely focus on health outcomes, instead the emphasis is on cost, cost-shifting and access (teisberg & wallace, 2009). in healthcare, patient outcomes define quality and quality can be enhanced by preventing errors, reducing waste and improving coordination (teisberg & wallace, 2009). each of these changes creates better experiences for patients and brings down costs (teisberg & wallace, 2009). according to porter and teisberg (2006), health insurers have a unique and essential role in value-based competition and innovation in healthcare. they emphasise that health insurers must rethink and reorient their whole approach toward value-based competition. health insurers must become health organisations dedicated to patient and physician information, support and service, not just organisations for administrative, auditing and financial services (porter & teisberg, 2006). health insurers must therefore move from being adversaries to true partners in value creation for patients (porter & teisberg, 2006). it is critical to restructure the health insurer– healthcare service provider relationship so that the adversarial mind-set between health insurers and healthcare service providers makes way for a spirit of collaboration in terms of creating value for patients (porter & teisberg, 2006). when health insurers and healthcare service providers join forces around value and health results, efficiency improves exponentially and administrative costs fall (porter & teisberg, 2006). according to vanvactor (2011), external collaboration and cooperation is critical in today’s business environment. as related by kouzes and posner (2007), and vanvactor (2011) collaboration is so critical to success that every significant relationship should be treated as if it is a lifelong endeavour. healthcare 302 sajems ns 16 (2013) no 3:298-315 management is an evolutionary process and the relationships established among multifaceted partners can produce dynamic effects on an organisation’s environment (vanvactor, 2011). 4.3 healthcare regulation according to dassler (2006) traditionally, two theories of regulations have emerged, first the concept of ‘regulatory intervention’ or, in different terms, the way regulators conduct market intervention and distinguish between market-driven and non-market-driven approaches. second, in the context of ‘regulatory governance’, majone (1996) identifies a substantive and proceduralist model. this study however, focuses on the former regulatory theory as this has a direct impact on the development or generation and adoption of innovative healthcare products and services, relating to the external collaboration between healthcare service providers and healthcare insurers. in the healthcare sector, regulatory bodies play a pivotal role in balancing cooperation and competition by means of reforms introduced through legislation (baretta, 2008; mur-veeman, eijkelberg & spreeuwenberg, 2001; provan, 1984). according to baretta (2008), within the healthcare sector, regulatory bodies can influence the level of competition by, for example: • increasing the number of healthcare service providers authorised to provide healthcare services, • choosing a competitive financing model for healthcare service providers, • establishing the same spheres of activity for many (or all) healthcare service providers, and • adopting mechanisms for evaluating performance of healthcare service providers based on the pursuit of individual goals. therefore, a regulatory body in the healthcare sector is potentially able to act as a coordinator system through its own power to balance competition and cooperation (baretta, 2008). 5 model and hypotheses development based on the abovementioned theoretical underpinnings, a conceptual factor model a priori was developed, which allowed for deductive reasoning to hypothesise the structure beforehand and to then evaluate its goodness of fit to data (kline, 2011). the researchers formulated explicit hypotheses regarding the number of latent variables and how they relate to the observed variables. h 1: a positive correlation exists between the (a) level of new product innovation by health insurers and (b) entrepreneurial orientation. h 2: a positive correlation exists between the (a) level of new product innovation by health insurers and (b) external collaboration between (c) health insurers and (d) healthcare service providers. h 3: the relation between the (a) level of new product innovation by health insurers and (b) entrepreneurial orientation is moderated by perceived strategic regulatory factors necessary for encouraging health insurer product innovation, such that the relation is weaker where these strategic regulatory factors have lower presence and stronger where they have higher presence. h 4: the relation between the (a) level of new product innovation by health insurers and (b) external collaboration between (c) health insurers and (d) healthcare service providers is moderated by perceived strategic regulatory factors necessary for encouraging health insurer product innovation, such that this relation is weaker where these strategic regulatory factors have lower presence and stronger where they have higher presence. figure 1 highlights the hypothesised relation ships between the independent variables (eo, external collaboration and regulation) and the dependent variable (health insurer product innovation). each construct is operationalised in the following section. sajems ns 16 (2013) no 3:298-315 303 figure1 conceptual research model entrepreneurial   orientation (eo) external collaboration regulation i p r t rs ri rr c hi  &  a sfc shd (iv1) (iv2) (imv3) (dv) h1a,b h2a,b,c,d h3a,b h4a,b,c,d internal   innovation  input innovation  output health   insurer   product   innovation eo*regulation external   collaboration  * regulation a g oc interaction  variable interaction  variable 6 research design the research study was based on explanatory research and followed a quantitative approach. the methodological approach adopted, was an online survey that was administered by an independent business research organisation in order to ensure data confidentiality of participants. the questionnaire was delivered via the internet in the form of an online questionnaire and elicited perceptions of respondents at senior managerial levels. management perceptions are the preferred measure of ce (antoncic & hisrich, 2004). 6.1 population the sampling frame of participants in the supply and demand side structures of the healthcare value chain, was determined by consulting the council for medical schemes (2011) annual 2010/11 report. this report provided the sampling frame for health insurers and health insurer administrators and identified the sampling frame for healthcare service provider disciplines responsible for the majority of annual healthcare benefits paid in the industry. the focus of the sample populations were ceos and senior executives of health insurers, health insurer administrators and healthcare service providers, representing demand and supply side structures as indicated in the private healthcare value chain (stremersch, 2008). a personalised e-mail was sent from the researcher, positioning the study and stating the objectives and the value of the research to the south african private healthcare industry. the e-mails were followed up with periodic telephone calls. in total, 154 respondents completed the online survey, however 15 respondents did not fully complete the survey and their responses were not included in the data set, leaving the total number of respondents at 139. the health insurer response rate achieved was 24 per cent, totalling 34 responses. of these 14 were open health insurers (51.8 per cent of all registered open health insurers) and 20 closed health insurers (27.3 per cent of all registered closed health insurers). following the definitions of the council for medical schemes’ annual report, 50 per cent of large open health insurers (>30,000 beneficiaries) and 60 per cent of the number of large closed health insurers (>30,000 beneficiaries) responded (council for medical schemes, 2011). the percentage of private healthcare lives covered by the 34 health insurers that responded, totalled 68 per cent of all private healthcare lives in the south african private healthcare industry. the health insurer administrator responses totalled 83. the responses from the general practitioner representative organisations totalled 11. seven responses were received from the 304 sajems ns 16 (2013) no 3:298-315 specialist representative organisations and four of the five private hospital groups responded. based on the sampling method and response rates, the researcher considers all samples as adequate representations of their respective populations. 6.2 structure of the research instrument the questionnaire consisted of parts a to e (detailed below) and all were measured using a 7-point likert scale. section a – this section focused on biographical data (control variables for the study, i.e. firm size, firm age, industry sector, geographical area). this section also included questions derived from the literature on organisational competitive capability described by ireland et al. (2009). section b – this section focused on entrepreneurial orientation as one of the independent variables. the eo instrument was based on the original covin and slevin (1989) scale as modified by kreiser, marino and weaver (2002). the eo dimensions measured in this section were innovativeness, proactiveness and risk taking. section c – this section focused on external collaboration between health insurers and health care service providers and provided the data to measure this independent variable. zillich’s et al. (2005) instrument used to measure physician-pharmacist collaboration (ppci) from a physician perspective, formed the basis for the collaboration measurement instrument. this instrument was adapted to measure health insurer, health insurer administrator and healthcare service provider collaboration from the respective perspectives. as per porter and teisberg (2006), this instrument was designed to measure the extent to which the healthcare insurer and healthcare service provider relationships needs to be restructured in order to facilitate value-based competition or innovation in healthcare. specific constructs of trustworthiness (t), role specification (rs), relationship initiation (ri) and health insurer and healthcare service provider relationship restructure (rr) were also measured in this section. section d –thefocus here was on regulation as the independent moderator variable of the researcher’s model, affecting product innovation by health insurers. the section was not based on a previous instrument and the construction of the instrument followed guidelines in terms of strategic regulatory factors present in healthcare regulation, encouraging health insurer product innovation and value-based health care delivery by porter and teisberg (2006), and christensen, grossmann and hwang (2009). the instrument was designed to measure the following constructs: • encourage competition in healthcare to reduce prices, • improve health insurance and access to private healthcare, • standards for coverage, • structure of health care delivery. section e – here the focus was on measuring the dependent variable, health insurer product innovation. the questionnaire was designed to measure two aspects of this construct, internal innovation input and innovation output. internal innovation input was measured by questioning the research and development intensity of organisations, and innovation output was measured through items on the following constructs: innovation adoption, innovation generation and organisational competitiveness. this section of the questionnaire was based on combining and adapting previous measurement instruments used by pérez-luño et al. (2011), rosenbusch et al. (2011) and the gem global report of 2010 for internal innovation input and innovation output (kelly, bosma & amoros, 2010). 6.3 common method bias according to podsakoff, mackenzie, lee and podsakoff (2003), common method biases arise from having a common rater, measurement context and item context, or from characteristics of the items themselves, and in any given study, it is possible for several of these factors to be present. it is therefore important to evaluate the conditions under which the data are obtained to assess the extent to which method biases may be a problem (podsakoff et al., 2003). podsakoff et al. (2003) indicate that method biases are likely to be particularly powerful in studies in which the sajems ns 16 (2013) no 3:298-315 305 data for both the predictor and criterion variable are obtained from the same person in the same measurement context using the same item context and similar item characteristics. the researcher applied procedural controls through obtaining measures of the criterion variable from other sources. by introducing an independent scale of organisational competitive capability (ireland et al., 2009)he could check and correlate the criterion variable. furthermore, the respondents clustered around measures of innovation input were compared in terms of the dependent variable measures of innovation adoption and generation and organisational competitiveness, as a validity check of the dependent variable measures. the researcher made sure to respect respondent anonymity. the researcher also applied confirmatory factor analysis (cfa) to the empirical data of the scales of each construct to check whether a single factor could account for most of the variance in the data as would occur if there was strong method bias in the responses (podsakoff et al., 2003). the cfa method is a more recent and more sophisticated test of common method bias than ones like the harman single-factor test that uses exploratory factor analysis (efa) to examine the unrotated factor solution for the dimensionality in the data (podsakoff et al., 2003). the basic assumption of these tests is that if a substantial amount of common method variance is present, either a single factor will emerge from the factor analysis or one general factor will account for the majority of the covariance among the measures (podsakoff et al., 2003). 6.4 structural equation modelling (sem) the researcher’s model (figure 1) comprised the relationships among the constructs ofeo, external collaboration, regulation and health insurer product innovation. it also specified their respective measurement scales, which tests for support by the empirical data gathered. kline (2011) explains that models may be tested in three contexts, first a strictly confirmatory context in which the researcher’s model is accepted or rejected based on the fit of the data. second a less restrictive context of multiple alternative models in which some of the models may be retained and others rejected, and third, a context of model generation in which the researcher’s model is modified if the empirical data does not fit (kline, 2011). the research study is best characterised in the context of model generation as efa was applied to determine the dimensionality of the constructs of the model and then cfa was applied to test and compare both the empirically and theoretically derived factor structures. although sem was proposed to evaluate the model, the sample size realised did not allow the application of this statistical procedure. instead, regression analysis was applied to each of the research hypotheses separately to test the structure of the model and ignoring the psychometric properties of scale reliability and validity. 6.5 efa and cfa the measurement adequacy of the scales of each of the model’s constructs was evaluated separately using first reliability measures, then efa and then cfa, of empirically and theoretically based models. the researcher studied the construct validity of the scales using the statistical techniques of cfa and efa. efa was used to identify the number of constructs and the underlying factor structure (suhr, 2006). it was used to explore the possible underlying factor structure of a set of measured variables without imposing any preconceived structure on the outcome (child, 1990). in the present research, cfa was used as a statistical tool for testing hypotheses about convergent and discriminant validity (kline, 2011). cfa allows the researcher to test that a relationship between the observed variables and their underlying latent construct(s) exists. analysis of the results of efa was also considered in evaluating construct validity, particularly when the cfa results were weak. as the sample size achieved in the research did not allow for factor analysis of all 74 items of the research instrument simultaneously, cfa and efa were performed in turn on all the items of the scales and subscales designed to measure each of the constructs of the model. thus, separate factor analyses were computed on the items of the subscales of the independent variables of the model (eo, 306 sajems ns 16 (2013) no 3:298-315 external collaboration and regulation), on the items of the subscales of the dependent variable, health insurer product innovation (health insurer product innovation adoption, health insurer product innovation generation and organisational competitiveness). thereafter, a higher order cfa was used on the subscale scores (rather than the item scores) to test the model for a second-order factor structure (hair, black, babin & anderson, 2010). this second order cfa was performed on the subscale scores of eo, external collaboration, regulation and health insurer product innovation to establish construct validity at the subscale level. this second order cfa aimed to assess whether the subscales that purported to reflect the same construct were more highly intercorrelated than subscales purported to reflect different constructs. multiple linear regression was then performed to test the structural aspects of the model. the regression equation of the model (refer figure 1) was: level of health insurer product innovation = 𝔞 + β⁾(eo) + βⁿ(external collaboration(t,rs,ri)) + β₀(external collaboration(rr)) + β₁(regulation) + β₂(eo*regulation) + β₃ (external collaboration (t,rs,ri)*regulation) + β₄(external collaboration(rr)*regulation) 6.5.1 independent variable 1 entrepreneurial orientation (eo) – measurement constructs: innovativeness (i), proactiveness (p), and risk-taking (r). the eo instrument was based on the original covin and slevin (1989) scale, as modified by kreiser, marino and weaver (2002). 6.5.2 independent variable 2 external collaboration – measurement constructs: trustworthiness (t), role specification (rs), relationship initiation (ri) and relationship restructure (rr). the external collaboration measurement instrument was based on the instrument used by zillich, douchette, carter and kreiter (2005). the instrument was further adapted to include items designed to measure the extent to which the health insurer and healthcare service provider relationship needs to be restructured as indicated by porter and teisberg (2006). 6.5.3 independent variable 3 regulation – measurement constructs: increased competition (c), increased health insurance and access (hi & a), standards for coverage (sfc) and, structure of health care delivery (shd). this section is not based on a previous instrument and the construction of the measurement instrument followed guidelines in terms of strategic regulatory factors encouraging healthcare innovation by porter and teisberg (2006) and christensen, grossman and hwang (2009). 6.5.4 dependent variable health insurer product innovation – measurement constructs: internal innovation input and innovation output. this section included measurement constructs for innovation output, which contextualised both innovation adoption (a) and generation (g), as well as organisational competiveness (oc). this section was adapted from previous measurement instruments used by perez-luno, wiklund and cabrera (2011) and rosenbusch, brinkman and bausch (2011). 7 results and discussion the majority of respondents (60 per cent) represent health insurance administrators (hias), 25 per cent of respondents represent health insurers (his), and almost 16 per cent represent healthcare service providers. of the 34 health insurers who responded, 20 (59 per cent) represented closed health insurers and 14 (41 per cent) represented open health insurers. the majority (88 per cent) of respondents worked in organisations that operated nationally. of the other respondents, half worked in organisations that operated primarily in gauteng and the others operated primarily in kzn, limpopo, western cape, north west and eastern cape. other characteristics of the organisations represented by the respondents are firm age and firm size in terms of number of permanent employees and membership/patient base. these results show that: • nearly three-quarters of healthcare service providers (73 per cent) had been in sajems ns 16 (2013) no 3:298-315 307 operation for more than 20 years and almost two-thirds had a staff complement of 10 or fewer. their membership/patient base ranged between under 5 000 to over 100 000. • over half of health insurer administrator organisations (59 per cent) had been in operation for between 11 and 20 years. almost all the organisations (98 per cent) employed more than 200 staff. furthermore almost all (83 per cent) had a membership/patient base of more than 100 000 for the current financial year. • a third of the health insurers had been in operation for between 11 and 20 years and 56 per cent for longer. almost half (47 per cent) employed 10 or fewer staff members, while 26 per cent employed more than 200 staff. almost half (47 per cent) had a membership/patient base for the current financial year of over 100 000. the validity of the theoretically derived scales of the model was investigated using efa to see whether there was evidence of empirically derived combination of items that differed from theoretical expectation. if so, the empirically derived scales were retained and cfa was applied to both the original theoretical as well as the new empirical scales and tested for model fit for each construct. the criterionrelated validity of the scales of the dependent variable was also considered. three sets of factor analyses (efa and cfa) were performed in turn on all the items of the scales and subscales designed to measure each of the constructs of the model (eo, external collabora tion and regulation). a fourth set of factor analyses was performed on the items of the subscales of the dependent variable, health insurer product innovation (health insurer product innovation adoption, health insurer product innovation generation and organisational competitiveness). thereafter, a higher order cfa was used on the subscale scores (rather than the item scores) to test the model for a second-order factor structure in order to establish construct validity at the subscale level. 7.1 eo the cronbach alpha values of the theoretically derived measures of the constructs of regulation, entrepreneurial orientation (eo) and external collaboration variables are all adequate and above the 0.7 cut-off level for internal consistency as indicated by hair et al. (2010). 7.1.1 efa results the data matrix of the nine eo variables showed sufficient correlations to proceed with the application of factor analysis as the kaisermeyer-olkin (kmo) measure of sampling adequacy was high at 0.9 and bartlett’s test of sphericity was significant (p<0.001) 7.1.2 cfa results the cfa results, using the theoretically derived scales for eo indicate that there is a strong relationship between eo as an observed variable and its underlying latent constructs. the factor loadings for all three latent variables are in the range of ± 0.8 to ± 0.93. this is high and practically significant and is an indication that the factors account for more than 70 per cent of the variance of the variables. there is supportive evidence of the construct validity of eo. 7.2 external collaboration 7.2.1 efa results the data matrix of the 18 external collaboration variables showed sufficient correlations to proceed with the application of factor analysis as the sampling adequacy kmo measure was high at 0.8 and bartlett’s test of sphericity was significant (p<0.001). the efa results show that two items: ‘quality patient care mutual dependency’, and ‘product innovation mutual dependency’ load highly on a different factor from the other items purported to measure role specification (rs). these items were moved accordingly, and the resultant scale was termed the empirically derived scale. 7.2.2 cfa results cfa was applied to both the theoretically and empirically derived scales of external collaboration, and their parameter values and model fits were compared in order to decide on the measurement scales that would ultimately be used in the regression analyses to test the model of the research. 308 sajems ns 16 (2013) no 3:298-315 the cfa results using the empirically derived scales for external collaboration indicated that there is a moderate to strong relationship between external collaboration as an observed variable and its underlying latent constructs, trustworthiness (t), role specification (rs), relationship initiation (ri) and relationship restructure (rr). using the empirically derived scales for the cfa estimates, the factor loadings for trustworthiness are in the range of ± 0.65 to ± 0.86, which are considered to be practically significant. the factor loadings for role specification are in the range of ± 0.56 to 0.88, which likewise are considered to be practically significant. the factor loadings for relationship initiation are also considered to be practically significant and are in the range of ± 0.56 to ±0.86, and the factor loadings for relationship restructure are in the range of ± 0.7 to ± 0.85, indicating practical significance. using both the theoretically and the empirically derived scales, the cfa has confirmed that two items, which were expected to measure the latent variable ‘role specification’ (rs), fit better measuring the latent variable, ‘relationship initiation’ (ri). in both cases, the factor loadings using the empirically derived scales have slightly reduced when these items were moved to the latent variable, relationship initiation. the construct validity of the empirically derived external collaboration variable was therefore supported. 7.3 regulation (moderator variable) according to the researcher’s model, regulation was expected to serve as a moderating variable, whereby the relationship between eo and health insurer product innovation, and between external collaboration and health insurer product innovation, were expected to be weaker when the presence of strategic regulatory factors are low and stronger when they are high. furthermore, according to theory, the regulation construct was expected to reflect four underlying regulation factors (increased competition, health insurance and access, standards for coverage, and structure of healthcare delivery). 7.3.1 efa results the data matrix of the 16 regulation variables showed sufficient correlations to proceed with the application of factor analysis as the sampling adequacy measure of the kmo measure of sampling adequacy was high at 0.9 and bartlett’s test of sphericity was significant (p<0.001). 7.3.2 cfa results the cfa results using the theoretically derived scales for regulation indicated a moderately strong to strong relationship between regulation as an observed variable and its underlying latent constructs; increased competition; health insurance and access; standards for coverage and structure of healthcare delivery. the factor loadings for the increased competition variable are considered to be practically significant and are in the range of ± 0.56 to ±0.88. the factor loadings for health insurance and access are in the range of ± 0.67 to ± 0.85, indicating practical significance. the factor loadings for standards for coverage are in the range of ±0.42 to ± 0.93 indicating practical significance for all items except item 13. item 13, however, still meets the minimum level for interpretation of structure. the factor loadings for structure of healthcare delivery are in the range of ± 0.8 to ± 0.93, indicating practical significance. 7.4 product innovation (dependent variable) the cronbach alpha values for the theoretically derived measures of the innovation generation construct and the organisational competitiveness construct (the dependent variable, health insurer product innovation), are around 0.9, indicative of high internal consistency reliability. however, the cronbach alpha and average inter-item correlations values for innovation adoption, designed to measure a dimension of health insurer product innovation, are at 0.5 and 0.28 respectively, indicating the presence of unacceptably high error variance in the scores of this scale. 7.4.1 efa results the data matrix of the 13 health insurer product innovation variables showed sufficient correlations to proceed with the application of factor analysis, as the sampling adequacy measure of thekmo measure of sampling sajems ns 16 (2013) no 3:298-315 309 adequacy was high at 0.9 and bartlett’s test of sphericity was significant (p<0.001). the efa results show that one of the items expected to measure innovation adoption; ‘generated new hi for organisation’ and one of the items expected to measure innovation generation; ‘generated new hi making your organisation competitive’ loaded highly on different factors. 7.4.2 cfa results cfa was applied to both the theoretically and empirically derived scales of health insurer product innovation (innovation output). their respective parameter values and model fits were compared in order to decide on the composition of the measurement scales of the dependent variable to be used in the regression analyses designed to test the researcher’s model. the cfa results using the empirically derived scales for health insurer product innovation indicated that there is a moderate to strong relationship between health insurer product innovation as an observed variable and two of its underlying latent variables, innovation generation and organisational competitiveness. the relationship between health insurer product innovation output and its latent variable innovation adoption is weaker. the factor loadings for innovation generation are in the range of ± 0.67 to ± 0.85, indicating practical significance. the factor loadings for organisational competitiveness are in the range of ± 0.8 to ± 0.96, indicating practical significance. 7.5 second order confirmatory factor analysis second order cfa was performed at the subscale level (rather than at the item level as used in the other cfas) to confirm whether the subscales of the four constructs of the model did indeed reflect these constructs as expected from the theory. table 1 presents the model estimates for the second order analysis, highlighting the second order constructs (red colour indicator). table 1 model estimates second order cfa variables parameter estimate standard error t statistic prob. level (eo)-1->[innovati] 0.934 0.018 53.2 0.000 (eo)-2->[proactiv] 0.913 0.02 46.4 0.000 (eo)-3->[risk tak] 0.839 0.029 29.1 0.000 (external collaborati)-4->[trustwor] 0.703 0.061 11.5 0.000 (external collaborati)-5->[role spe] 0.722 0.06 12.1 0.000 (external collaborati)-6->[relationship] 0.653 0.065 10.1 0.000 (external collaborati)-7->[restruct] 0.325 0.088 3.69 0.000 (regulation)-8->[encourag] 0.701 0.05 14 0.000 (regulation)-9->[hia impr] 0.858 0.033 26.3 0.000 (regulation)-10->[improve ] 0.789 0.04 19.7 0.000 (regulation)-11->[hd struc] 0.816 0.037 22.1 0.000 (hi product innovatio)-12->[adoption] 0.179 0.087 2.06 0.040 (hi product innovatio)-13->[generati] 0.880 0.03 29.8 0.000 (hi product innovatio)-14->[organisa] 0.890 0.029 30.9 0.000 consistent with the cfa results conducted at item level, the cfa analysis failed to confirm the validity of the relationship restructure (rr) subscale expected to reflect external collaboration, and the innovation adoption subscale designed to reflect health insurer product innovation. these results lend further evidence to the revision of the theoretically derived scales and subscales of the model to strengthen the psychometric quality of the predictor variables of the research model. 7.5.1 summary of cfa analyses table 2 presents the model fit results. model fit is also presented using theoretically and empirically derived scales for the external 310 sajems ns 16 (2013) no 3:298-315 collaboration variable (independent variable) and the health insurer product innovation variable (dependent variable). second order results have also been used as a method to improve model fit. table 2 model fit results regulation external collaboration theoretical external collaboration empirical eo hi product innovation theoretical hi product innovation empirical 2nd order basic summary statistics discrepancy function 1,475 2,304 2,108 0,556 1,59 1,253 0,886 ml chi-square 199,187 311,036 284,553 76,152 219,485 172,912 121,408 degrees of freedom 98 129 129 24 62 62 71 p-value 0 0 0 0 0 0 0 rms standardized residual 0,059 0,082 0,085 0,046 0,079 0,076 0,076 noncentrality fit indices population noncentrality parameter point estimate 0,813 1,289 1,162 0,406 1,206 0,795 0,368 90% ci 0.53 -1.15 0.94 -1.69 0.83 -1.55 0.24 -0.63 0.9 -1.57 0.54 -1.11 0.17 -0.62 steiger-lind rmsea index point estimate 0,091 0,1 0,095 0,13 0,139 0,113 0,072 90% ci 0.07 -0.11 0.09 -0.11 0.08 -0.11 0.1 -0.16 0.12 -0.16 0.09 -0.13 0.05 -0.09 population gamma index point estimate 0,908 0,875 0,886 0,917 0,844 0,891 0,95 90% ci 0.87 -0.94 0.84 -0.91 0.85 -0.92 0.88 -0.95 0.81 -0.88 0.86 -0.92 0.92 -0.98 adjusted population gamma index point estimate 0,872 0,834 0,848 0,845 0,77 0,84 0,926 90% ci 0.83 -0.91 0.79 -0.87 0.81 -0.89 0.77 -0.91 0.72 -0.82 0.79 -0.89 0.88 -0.96 single sample fit indices joreskog gfi 0,839 0,8 0,81 0,886 0,797 0,839 0,888 joreskog agfi 0,776 0,735 0,748 0,786 0,702 0,764 0,834 in summary: • the chi-square statistic values for all the variables and the second order analysis are relatively large and the corresponding pvalues are small. this is an indication that the proposed theory does not fit reality well. • the steiger-lind rmsea index values for all the variables and second order are all greater than 0.05, indicating weak model fit. • the population gamma index values for all the variables and second order are all smaller than 0.95, indicating weak model fit. • the adjusted population gamma index values for all the variables and second order are all smaller than 0.95, indicating weak model fit. • the joreskog gfi index values for all the variables and second order are all smaller than 0.9 or 0.95, indicating weak model fit. • the joreskog agfi index values for all the variables and second order are all smaller than 0.95, indicating weak model fit. assessing the standardised root mean residual (srmr) values for all the variables and second order, indicated values smaller than 0.1 (values are within the guideline), indicating better model fit. the larger discrepancy function values for all the variables and second order indicate that the model does not fit the data well. the model fit analysis shows weak model fit, despite attempting to improve the values using the empirically derived instead of the theoretically derived scales. the reliabilities presented for the theoreticcally based scales have been revised to include the reliabilities of the empirically based ones. in table 3 the reliabilities of the empirically based scales are marked with an asterisk. sajems ns 16 (2013) no 3:298-315 311 table 3 reliabilities of the empirically based scales number of items cronbach alpha average inter-item correlation regulation increased competition 3 0.786 0.56 hi & access to private healthcare 6 0.899 0.61 standards for coverage 4 0.779 0.48 structure of healthcare delivery 3 0.913 0.79 eo innovativeness 3 0.871 0.70 proactiveness 3 0.892 0.74 risk taking 3 0.919 0.80 external collaboration trustworthiness (t) 6 0.881 0.57 role specification (rs) 5 0.695 0.33 relationship initiation (ri) 2 0.871 0.77 relationship restructure (rr) 5 0.896 0.64 external collaboration 18 0.879 0.28 external collaboration (t, rs, ri)* 13 0.872 0.37 health insurer product innovation innovation adoption 3 0.509 0.28 innovation adoption* 2 0.627 0.46 innovation generation 7 0.907 0.59 innovation generation* 6 0.905 0.62 organisational competitiveness 3 0.921 0.81 organisational competitiveness* 4 0.929 0.78 *empirically derived scales • the reliability of ‘innovation adoption’, although improved using the empirically derived rather than the theoretical scale, is still unacceptably low – the cronbach alpha value has increased from 0.51 to 0.63 and the average inter-item correlation has increased. thus the construct of innovation adoption was excluded from the model due to its poor reliability and validity results. • the cronbach alpha value using the empirical result for ‘innovation generation’ shows little change and the cronbach alpha value for the new organisational competitiveness scale is similar. • the empirically derived ‘external collaboration’ scale (comprising trustworthiness (t), role specification (rs) and relationship initiation (ri) items) reliability is good, with improved average inter-item correlation, using the empirically derived instead of the theoretically derived scale. the average inter-item correlation for innovation generation using the empirically derived scale has improved slightly, although the inter-item correlation for organisational competitiveness has decreased slightly, using this scale. 8 conclusions and recommendations theoretical development is enriched in a number of ways by this study. the importance of eo in organisational performance has been recognised in the literature and this study revealed that eo is critical to health insurer product innovation in the private healthcare industry in south africa, and provides additional grounding for statements about the strong positive effect of eo on organisational performance (green, covin & slevin, 2008; morris & sexton, 1996; wiklund & shepherd, 2005; zahra & covin, 1995). the practical implications stemming from this study, for healthcare executives are: 312 sajems ns 16 (2013) no 3:298-315 • to ensure that their organisations have the necessary internal innovation input capacity to drive innovation output, and • to ensure that external collaboration between health insurers and healthcare service providers are more actively focused on by actors in the healthcare value chain. both the supply and demand side structures (subgroups identified for the purposes of this study) have indicated recognition for the fact that the restructuring of relationships between health insurers and healthcare service providers is a necessary driver for collaboration in terms of health insurer product innovation progress and success. as supported by porter and teisberg (2006), this finding suggests that executives of health insurers should actively focus on the following initiatives as examples that could drive greater innovation activities between health insurers and healthcare service providers, such as to: assist healthcare service providers to maintain more up-to-date patient information, reward healthcare service providers for improving results over time, introduce simplified billing practices in terms of contractual arrangements between health insurers and healthcare service providers, reduce administrative complexities by eliminating paperwork and transactions, make new investments in technology and related infrastructure to facilitate collaboration practices. the policy implications highlighted by this study relate to the perception of the low levels of strategic regulatory factors present in healthcare regulation in south africa, necessary to drive health insurer product innovation. the strategic regulatory factors necessary to drive health insurer product innovation are increased health insurance and access to health insurance, standards for coverage, and the structure of healthcare delivery (porter & teisberg, 2006). healthcare delivery is viewed as a critical component in terms of driving value-based competition and innovation in healthcare (porter & teisberg, 2006). healthcare executives need to work with, and actively lobby regulators to investigate these aspects, which could ignite both demand and supply side innovation activities in the healthcare value chain of the private healthcare industry of south africa. 8.1 limitations of the study the research study has several limitations that could provide opportunities for future research. the following limitations have been identified: • the research study only focused on health insurers, health insurer administrators and healthcare providers and did not take into account any significant contribution to product innovation from other actors in the healthcare value chain like employers, corporate and individual pharmacies and pharmaceutical manufacturers. • the measurement scales for innovation adoption need to be refined due to low reliability and validity. 8.2 recommendations for future research future research could involve a larger sample of actors in the demand and supply side structures of the south african private healthcare value chain, focusing especially on supply side innovation and the structure of healthcare delivery. according to mintzberg (2011) healthcare actors need to build systems that both promote health and treat illness and to do that, more cooperation not more competition between healthcare actors is required. future research could focus on the relationship between market dynamism in the private healthcare industry in south africa and external collaboration between the various actors in the private healthcare value chain. based on the results of this study, further investigation of the impact of regulation on innovation progress in the private healthcare industry is 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zahra, s.a. & garvis, d.m. 2000. entrepreneurship and firm performance: the moderating effect of international environmental hostility. journal of business venturing, 15:469-492. zillich, a.j., douchette, w.r., carter, b.l. & kreiter, c.d. 2005. development and initial validation of an instrument to measure physician-pharmacist collaboration from the physician perspective. value in health, 8:59-66. microsoft word 5 youth entrepreneurship mahadea et al 14_1_20 66 sajems ns 14 (2011) no 1 assessing entrepreneurship perceptions of high school learners in pietermaritzburg, kwazulu-natal darma mahadea school of economics and finance, university of kwazulu-natal shaun ramroop and temesgen zewotir school of statistics and actuarial science, university of kwazulu-natal accepted november 2010 although south africa achieved positive economic growth rates since the advent of democracy in 1994, the formal sector has not been able to absorb the annual increasing number of job-seekers on the market and solve the unemployment problem. the exercise of entrepreneurship, through business formations and expansions, is regarded as a vehicle for job creation and output expansion. according the global entrepreneurship monitor (gem) reports, south africa’s level of early stage total entrepreneurial activity (tea) is rather low relative to other countries at a similar level of development. this is partly owing to skills and resource limitations. if more individuals could realistically be exposed to practical entrepreneurship education at the secondary school level, south africa’s base for entrepreneurial capacity can be enhanced. this study uses quasi logistic regression to examine the probability of secondary school learners, in pietermaritzburg, the capital of kwazulu-natal province in south africa, to start their own business in the future. it also probes the association between the socio-economic attributes of these learners and entrepreneurship. on the basis of a survey of 275 senior school learners from 5 schools, the regression results indicate that gender, ethnic background and having a role model as well as acquiring personal skills to run one’s own business are significant factors influencing an individual’s propensity to venture into small firm self-employment in the future. black learners are perceived to have a significantly greater disposition to enter into business than other groups, and male scholars are found to have a greater probability of starting their own business than female. as potential entrepreneurs do not necessarily come exclusively from a business family background, the supply of effective entrepreneurship can be augmented, if more young individuals with the relevant skills endowment can start opportunity firms and necessity ventures. key words: entrepreneurship, school learners, economic growth, gender, employment creation jel j00, o17, 55, z13 1 introduction although south africa registered positive economic growth rates since the advent of democracy in 1994, this economic expansion has not been accompanied by significant growth in employment. indeed, south africa achieved an average economic growth rate of 3 per cent over the period 1994-2003, around 5 per cent during 2004-2007 and 2.8 per cent in 2008 (sarb, 2009). after a period of contraction, amid global recession, during two quarters in 2009, the economy bounced back with a growth of 4.6 per cent in the first quarter of 2010 (sarb, 2010). despite these robust growth rates in a strengthening economy, unemployment rates in postapartheid south africa remain extremely high. increasingly, there are signs of economic disillusionment as the south african economy has not generated enough employment opportunities to absorb an increasing annual number of school leavers. lack of employment opportunities is associated with rising poverty, as partly evidenced by the number of people receiving social grants, rising from 2.8 million in 1994 to 13.5 in 2009, whilst the number of taxpayers is around 4 million (cilliers, 2009). on an expanded definition, south africa’s abstract sajems ns 14 (2011) no 1 67 unemployment rate, which includes the discouraged worker effect, is close to 30 per cent, while the ‘official unemployment rate is about 25 per cent in the first quarter of 2010 (sarb, 2010). statistics south africa estimates that about 40 per cent of the south african population is below the age of 20 and another 19 per cent is in the 20-30 age group (statistical release po302, 2008). in the south african context, persons in the 15-35 age category are regarded as the youth group (national youth policy, 1997:7), from which future leaders and wealth producers of the south african economy will emerge. the youth of south africa are valued members of the nation. they represent the hopes and aspirations of the country’s future development. although the young individuals have a tremendous potential to make a contribution to the value-adding activities of the country, a high proportion of the youth, about 50 per cent are unemployed or underemployed, and many are condemned to a marginalized existence of poverty on the fringes of the informal economy (mlatsheni & rospabe, 2002; statistics south africa, 2008). according to a report commissioned by the umsobomvu youth fund, about a third of the south african youth live in poverty (morrow, pandey & ritcher, 2005). many young individuals lose their self-dignity when they are without a gainful employment for a prolonged period, after years of secondary or tertiary education. some young persons, out of desperation, resort to criminal activities. over a third of the prison population in south africa is under the age of 26, reflecting a high incidence of crime among the south african youth (morrow et al., 2005). according to herrington, kew and kew (2010:15), a culture of entrepreneurship can unleash the economic potential of all people in south africa, particularly the youth. the south african youth need to be provided with options that allow them to contribute towards the economy. the question then arises as to whether the young secondary school learners tend to become engaged in the entrepreneurial environment in the country. this paper thus examines the socio-economic attributes of the secondary school learners in pietermaritzburg, the capital of kwazulu-natal province, and seeks to isolate certain factors that may influence their dispositions to venture into small business entrepreneurship in the future. it is understood that youth entrepreneurship can create employment and income opportunities for young individuals who think imaginatively and apply their skills to risktaking associated with starting up and running a small firm with a view to answering customer needs. this article consists of five sections. after the introduction, section 2 presents a brief review of the literature on entrepreneurship in the context of south africa and with particular reference to the youth. sections 3 and 4 describe the research objectives and methodology. the results of the study are presented in section 5. sections 6 and 7 present some recommendations and concluding remarks. 2 entrepreneurship harnessing the creative talents of the youth and promoting a culture of entrepreneurship among our school leavers is critical for fostering youth economic participation and for advancing economic growth and development. an estimated 826 000 youth arrive annually on the labour market, having completed grade 12 or having dropped out of school and seek employment (morrow et al., 2005). given the labour market dynamics in south africa, it is a reality that many individuals will not find employment after finishing their secondary education. young people need to be able to think of self-employment as a route to selfempowerment rather than seeking wage employment. this route may be more appealing to the youth if they are adequately exposed to the basics of micro business entrepreneurship at school. the development of an entrepreneurial spirit among the youth is thus vital to pushing back the frontiers of poverty and generating employment opportunities in south africa, as well as to addressing problems of delinquency and crime arising from joblessness. encouragingly, various institutions, ntsika enterprise promotion agency and khula enterprise, now merged as the small enterprise development agency (seda), the umsobomvu youth fund 68 sajems ns 14 (2011) no 1 (uyf) and recently the national youth development agency (nyda) have been created by the government to nudge people to self-employment and to support young entrepreneurs. more recently, against the background of a high rate of unemployment in the country, the youth entrepreneurship campaign 2010 (yec2010) has been set up as partnership between uyf, south african youth chamber of commerce and nafcoc youth, to promote the culture of youth entrepreneurship and increase the total entrepreneurial activity in south africa. it is hoped that through these interventions, many individuals in the informal sector may graduate to the mainstream economy in years ahead. south africa suffers from a deficiency in high levels of entrepreneurship. according to the global entrepreneurship monitor (gem) reports, the perceived availability of business opportunity and business skill levels of the people studied in the 2001, 2002 and 2008 were well below the international mean (driver, wood, fisher, herrington & segal, 2003:3; herrington, kew & kew, 2009). the gem report 2005 (von broembsen, wood, herrington, shay & sheppers, 2005) revealed that south africa displays the lowest levels of entrepreneurial activity of all developing countries, ranking lower than countries such as india, brazil, mexico and argentina. according to the 2009 gem global report, south africa ranked 35 th out of 54 participating countries with a total early stage entrepreneurial activity rate (tea) of 5.9 per cent in 2009, which is below the average (11.7 per cent). south africa’s tea decreased from 9.4 per cent in 2001 to 5.9 per cent in 2009, reflecting that in 2009 fewer individuals (5.9 out of 100) between the ages of 18-64 went into business than in 2001 (gem, 2010; herrington, kew & kew, 2010). it thus seems that the level of entrepreneurial activity is not high enough to sustain south africa’s growth and employment expectations (maas & herrington, 2007). the gem reports also noted education and training, with gender discrimination as two limiting factors in the environment for entrepreneurship. similarly, janse van vuuren (2005) argues that low entrepreneurial activity in south africa may result from a lack of knowledge or selfconfidence among individuals to start a business. encouragingly, the proportion of young individuals in the 18-24 age group involved in early-stage entrepreneurial activity increased from 16 per cent to 17 per cent in 2008, and the tea increased from 5.2 per cent in 2006 to 7.8 per cent in 2008. however, the tea rate at 7.8 per cent is still below the average (10.6 per cent) for the all gem countries (herrington, kew & kew, 2010). burger, o’neill and mahadea (2004:190) point out that in south africa an increasing number of people start businesses not because they have found an appropriate niche in the market, but because of necessity. burger et al. (2004:190), orford et al. (2003:10) and driver et al. (2001:11) refer to this as necessity entrepreneurship and contrasted it to opportunity entrepreneurship where people start business ventures to react to opportunities which they have perceived in the market. unlike the opportunity enterprisers, the necessity entrepreneurs usually end up earning below the poverty level, just as is the situation with at least 45 per cent of self employed people in south africa (bhorat & leibrandt, 1998:28). in spite of the recognition that entrepreneurship is vital to job creation and economic growth in a rapidly flat globalizing world, we do not have sufficient knowledge regarding the ‘optimal’ way to promote this critical factor from the youth sector. most of the studies in this area have focused on men and women as adult entrepreneurs, on the informal sector, small, micro and mediumsized enterprises (smmes), and large firms in the corporate sector. accordingly, not much is known about potential entrepreneurs among the secondary school-going learners and the benefits that they may generate to improve youth livelihoods. this study addresses this gap. however, it must be stated that a unique feature of the revised national curriculum (2005) of the outcome based education (obe) relating to economic and management sciences learning hinge on the development of skills to taking initiative and calculated risks in conceptualizing, starting and running a business. in short, the schooling system should equip the learner to develop entrepreneurial attitudes, knowledge and skills. according to sajems ns 14 (2011) no 1 69 the gem reports, the proportion of young people who believe they have the skills to start a new business is significantly lower than that in other developing countries. people who believe that they have the ability to start a business are five times more likely than others to attempt starting one (gem report 2005:34). the report further states that while there are many different factors which are likely to influence an individual’s beliefs in his ability to start a business venture, such as exposure to entrepreneurs among family members and role models or close friends, the education system is a primary influence on an individual’s attitudes towards entrepreneurship (von broembsen et al., 2005; gem, 2009; herrington et al., 2010). 3 aims of the study this study aims for an improved understanding of potential youth entrepreneurship particularly among secondary school learners in pietermaritzburg, in an attempt to determine their pre-entrepreneurial characteristics, their basic understanding of entrepreneurship and whether the school, gender and family environment influence nascent entrepreneurial behavior among the school learners. some of the entrepreneurial characteristics included whether or not the students’ parents owned business, whether or not the students worked at a small business, whether or not a student has a business role model, an exposure to entrepreneurial activity at school and the necessary personal skills and confidence to run a business. there are other entrepreneurial characteristics that are relevant to small business entrepreneurship, such as achievement motivation (n-ach), locus of control, agreeableness, innovation and extraversion (timmons, 2007; shane, 2003). but owing to pressing resource constraints, these latter attributes were not considered in the present study. the main objectives of this study are, thus, to identify the profile of students who aspire to entrepreneurship as a potential career and to examine the socio-economic and demographic influences which motivate them to entrepreneurship. 4 research methodology this study uses the survey method. to gather information relevant to the research, five secondary schools were chosen randomly in central pietermaritzburg, the capital of kwazulu-natal province. data collection was made through the use of questionnaires, consisting mainly of closed ended questions, and interviews. the data was analysed by using spss. questions elicited information on issues of learners’ demographic profile, socioeconomic and family background, acquired skills, experience in and exposure to a small business, role models, and interest in starting a business in the future. the sample consisted of 275 learners from one private, one semiprivate and three government schools. the subjects were senior secondary school-going youth learners, specifically grade 10, 11 and 12 scholars. in addition to descriptive statistics, a generalized linear model (glm) of a quasi logistic regression nature was used to examine propensity of the learners to venture into entrepreneurship at the small firm level. the quasi logistic regression was chosen after examining the model for under and over dispersion. dispersion exists when the variance of a variable exceeds the mean. 5 results the results regarding the entrepreneurship perceptions of high school learners in pietermaritzburg are presented below in two stages. initially, the results deal with the descriptive statistics, summarized largely in a tabular form. thereafter, the learners’ aspirations towards entrepreneurial activity in the starting of a small business, based on the findings of the quasi logistic regression model, are presented. 5.1 descriptive statistics in this study, an almost equal number of learners were randomly drawn from each grade. about 31 per cent, 33 per cent and 36 per cent of the respondents were from grades 10, 11 and 12, respectively. the socio70 sajems ns 14 (2011) no 1 demographic variables as predictors are encoded as race (black, coloured, indian or white), sex (boy or girl), residential area (urban or rural), parents own business (yes or no), have ever worked at a small business (yes or no), have a business role model (yes or no) and exposed to entrepreneurial activity at school (yes or no). the dispositions include having the necessary personal skill to run own business (yes or no) and confidence to manage own business (yes or no). finally, the response variable of interest is whether a learner is interested in starting a small business of his/her own in the future or not. the results on socio-economic attributes of the learners are summarised in table 1 below. table 1 socio-economic profile of learners frequency percentage school type state school learners 89 32.4 semi-private learners 39 14.2 private school learners 147 53.5 gender male 83 30.2 female 192 69.8 age group 14-15yrs 57 20.7 16-17yrs 178 64.7 18-19yrs 39 14.2 grade grade 10 84 30.7 grade 11 90 32.8 grade 12 100 36.5 race black 96 35.0 white 115 42.0 coloured 10 3.6 indian 53 19.3 area urban area 236 87.1 rural area 35 12.9 most of the learners that participated in this study (53.5 per cent) came from the private school, 14.2 per cent of the learners came from a semi-private school and 32.4 per cent came from three government schools. with regard to gender, there were more female learners (69.8 per cent) than male (30.2 per cent). the highest number of learners came from the 1617 years age group (64.7 per cent), whilst the representation from the 14-15 and 18-19 age groups were 20.7 per cent and 14.2 per cent respectively. of the learners 42 per cent were white, 35 per cent black, 19.3 per cent indian and 3.6 per cent were coloured. this is so because the majority of the white learners came from the private school. as far as area of location is concerned, 87.1 per cent of the respondents came from the urban area and 12.9 per cent came from the rural area. respondents were asked various questions regarding their personal and parental background, involvement in business and acquired skills. results to the questions of interest are presented below in tables 2-8. sajems ns 14 (2011) no 1 71 • does your parent own their own business? table 2 business ownership frequency percent no 181 65.8 yes 94 34.2 the majority of the learners (65.8 per cent) indicated that their parents do not have their own business. • have you ever worked at a small business? table 3 work in a small business frequency percent no 152 55.3 yes 123 44.7 as far as work experience is concerned, over half (55.3 per cent) of the learners did not have any work experience in a small business. only about 45 per cent had some work experience in a business. • do you have a business role model? table 4 business role model frequency percent no 139 50.5 yes 136 49.5 here, there was an almost even split with 50.5 per cent of the learners not having a role model and 49.5 per cent having a role model. the eminent business persons, such as tokyo sexwale, patrice motsepe, cyril ramaphosa, mark shuttleworth, bill gates and their parents were some of the people that learners offered as their role models. • have you been exposed to any entrepreneurial activity at school? table 5 exposure to school entrepreneurial activity frequency percent no 132 48.0 yes 143 52.0 only 52 per cent of the learners have been exposed to an entrepreneurial activity at school whilst 48 per cent have not been exposed to such an activity. • do you have the necessary personal skills to run your own business? 72 sajems ns 14 (2011) no 1 table 6 skills to run own business frequency percent no 83 30.2 yes 192 69.8 almost 70 per cent of the learners felt that they have the necessary skills whilst 30 per cent felt that they do have the necessary personal skills to run a business. • do you have the confidence to manage your own business? table 7 confidence to manage own business frequency percent no 40 14.5 yes 235 85.5 importantly, 85.5 per cent have the confidence to manage their own business whilst 14.5 per cent felt that they do not have the confidence to manage their own business. • are you interested in starting your own small business in the future? table 8 interest in small business entrepreneurship frequency percent no 59 21.5 yes 216 78.5 it is worthwhile noting that almost four fifths (78.5 per cent) of the learners are interested in starting their own small business in the future. a generalised linear model approach is used to examine the socio-economic and acquired skills as possible factors in influencing the learners’ interest in starting a business in the future. the nature and results of this model are presented below. 5.2 generalised linear model (glm) a generalised linear model (glm) analysis was carried out to investigate the demographic, socio-economic and locational factors affecting the students’ interest in starting a small business of his/her own in the future. since the response variable of interest is dichotomous i.e. yes or no, it may not be reasonable to assume that data are normally distributed. as a result the classical linear model is not applicable. a generalized linear model extends the traditional linear model to a wider range of data analysis problems and a function can be used to link the expected response mean and a linear function of the explanatory variables. accordingly, the glm model is used, by choosing an appropriate link function and response probability distribution (mccullagh & nelder, 1989; agresti, 2002). the link function simply links the mean response to the explanatory variables whilst the chosen probability distribution is used to model the response variable. the best known class of generalised linear models for dichotomous responses assume a binomial distribution for the response variable. although a generalised linear model can be applied to a binomial distribution using a probit, logit or complementary log-log link, the logit link is particularly attractive for a binomial distribution. the resulting model which is called logistic regression is used sajems ns 14 (2011) no 1 73 in this study. logistic regression describes the relationship between the dichotomous response variable and a set of explanatory variables. the explanatory variables may be quantitative or qualitative. the logistic regression model overcomes the problem of linear regression for binary data by “linking” the binary response to the explanatory variables through the probability (i.e. ) of either outcome, which does not vary continuously from 0 to 1. the transformed probability is then modeled linearly with the explanatory variables. the logistic regression uses the logit transformation of the probability, π, of the event of interest, which is starting a business of one’s own in the future. pp xxxit             ... 1 ln)(log 22110 therefore, π, the probability of outcome of interest for a given value x1 = x1, x2 =x2, …, xp=xp is given by: )...exp(1 )...exp( 22110 22110 pp pp xxx xxx       where 0 is the intercept, the βs are regression coefficients of the independent factors (i = 1, 2.. p) .., and xs are a set of predictors. the βs are typically estimated by the maximum likelihood (ml) method, and it is preferred over the conventional weighted least squares approach. the ml method is designed to maximize the likelihood of reproducing the data given the parameter estimates. the interpretation of results is rendered using the odds ratio, or. the or indicates a measure of the strength of a probabilistic relationship between the explanatory variable and the response variable. this measure ranges from 0 to infinity, with a higher value indicating a stronger relationship between the two variables. if b is the logistic regression coefficient estimate for predictor x, then exp(b) is the or corresponding to x. in other words, the chance of the outcome of interest for a given category of x is or(= exp(b)) times that of the reference category of x. the complementary interpretation is the sign of the coefficients: the positive coefficients show the increase of the chances for the given category of x relative to its reference category, and the negative coefficients show the decrease. deviance and pearson chi-square divided by the degrees of freedom are used to detect over-dispersion or under-dispersion in the logistic regression. values greater than 1 indicate over-dispersion, that is, the true variance of the response variable is greater than what it should be under the given model. if this happens the resulting estimates are consistent; however, estimates of the variance are not. the over or under-dispersion can result in spuriously small/large standard errors of the estimates (barron, 1992). this inconsistent variance estimate invalidates any hypothesis testing. the most widely implemented approach to remedy this is the use of “quasi-likelihood”, which adjusts the logistic regression to overcome the problem of over and under-dispersion. this adjustment provides for a valid inference (allison, 1999). 5.3 logistic regression results table 9 shows the results of the logistic regression fit statistic in explaining the interest of high school students in starting a small business in the future. 74 sajems ns 14 (2011) no 1 table 9 goodness of fit statistic for the logistic regression criteria df value value/df deviance 255 225.0295 0.8825 pearson chi-square 225 233.5885 0.9160 based on the results of table 9, the model does not fit the data well as the values of pearson chi-square (233.5885) and deviance divided by the degrees of freedom (225) are significantly less than 1, which shows evidence for some under-dispersion (0.9160). this means that the computed 95 per cent confidence intervals (cis) are too wide (table 11) and represent a generous upper bound for the true odds ratios. we refitted the model by adjusting for under-dispersion using the quasi logistic regression. the result is presented in table 10. the values of pearson chi-square (1.0223) and deviance (1.0612) divided by the number of degrees of freedom are both close to 1. table 10 goodness of fit statistic for the quasi logistic regression criteria df value value/df deviance 255 260.6921 1.0223 pearson chi-square 225 270.6076 1.0612 it is reasonable to assess the magnitude of the effect of several factors on an individual learner’s intention to start a small business. the results from the quasi logistic regression analysis are presented in table 11. if the confidence interval includes an exact value of 1, then the result is insignificant and can be interpreted as there being no difference at the 5 per cent level (in the chance of having an interest in starting one’s own small business in the future) between a particular category and the reference category. this means that there is no significant difference in the probability of starting one’s own business between specified levels of different explanatory or independent variables and the reference category. otherwise, the chance of having interest in starting own small business in the future for a given category is or times that of the reference category. in table 11, if we look at rural area as a reference category, the confidence interval (-0.8766, 1.2190); accordingly the comparison between urban and rural location is not different. thus, there is no difference in the probability of starting one’s own business whether the learner comes from a rural or urban background. table 11 results of the quasi logistic regression with estimates of odd ratios (or) and 95 per cent confidence intervals (ci) coefficient 95% ci or gender (reference=boy): girl -0.9638* -1.9286 -0.0903 0.381441* grade (reference=12): 10 11 -0.7826 -0.9106* -1.5959 -1.7334 0.0039 -0.1184 0.457216 0.402283* area (reference=rural): urban 0.2120 -0.8766 1.2190 1.236148 race (reference=indian): black white colored 2.0465* 0.1136 0.3427 1.0056 -0.7009 -1.5773 3.2113 0.9191 3.1285 7.740761* 1.120304 1.408746 sajems ns 14 (2011) no 1 75 confidence to manage business (reference=no): yes -0.0005 -0.81357 0.812569 0.9995 personal skill to run own business (reference=no): yes 0.9883* 0.2968 1.6902 2.68666* working experience (reference=no): yes 0.1050 -0.5711 0.7873 1.110711 having role model (reference=no): yes 0.7615* 0.1027 1.4415 2.141486* entrepreneur activity at school (reference=no): yes 0.3912 -0.2660 1.0598 1.478754 parents own business (reference=no): yes -0.0174 -0.6788 0.6543 0.982751 * significant at 5 per cent level; adjusted r2 = 0.88 for the same race and grade students, boys are more likely to start their own business than girls. in fact, the chance of a girl’s aspiration to have their own business in the near future is 0.3814 (=exp(-0.9638)) times less than the chance for a boy (table 11). in terms of gender difference, the probability of a girl being interested to run her own business in the future is thus less than that of a boy. this statement is also confirmed by the negative coefficient (-0.9638) associated with the gender predictor. when controlling for all other variables, the black learners have the higher aspiration to have their own business as compared to the indian learners. the black learners are 7.74 (=exp(2.0465)) times more likely than indian learners to start their own business in the future. the probability of students who have an interest to own business in the future is identical for coloured, white and indian race groups. this is confirmed from the results in table 11. the comparison between coloured and indian learners does not show a difference in their propensity to start a business; the confidence interval of coloured learners versus indian learners is (1.5773, 3.1285). similarly, when comparing white and indian learners there is no difference between these groups in their propensity to start a business; the confidence interval between the white learners versus indian learners which is (-0.7009, 0.9191). for a given race, grade 11 students’ aspiration rate to own a business is 0.402 (=exp(-0.9106)) times that of grade 12 students. to the contrary, grade 10 students’ aspiration rate is not significantly different, at the 5 per cent level, from that of grade 12 students’ aspiration rate to own business in the future. the proportion of learners who have an interest to own business in the future is identical for the grade 10 and grade 12 learners. those scholars who feel that they have the necessary personal skills to run their own business are about 2.68 (=exp(0.9883)) times more likely to start their own business than those who feel they do have the personal skills to start their own business. this result accords with the findings of the gem reports. with regard to having a role model or not, the results indicate that learners who have a role model are 2.14 (=exp(0.7615)) times more likely to start their own business than their counterparts that do not have a role model. thus, having a business role model and the necessary personal business skills are critical significant factors in influencing someone to start a new business. of great interest to increase potential entrepreneurship is the influence of ethnic background. it must be reiterated that the results indicate that black school learners are found to have a significantly greater likelihood (7.74 times) to start their own ventures than the indian learners (table 11). this result tends to accord with those of burger et al. (2004) and the gem report (2009). similarly, learners who do not have the necessary personal skills to run their own ventures are more likely to enter the labour market as wage employees rather than as employers. on the other hand, the confidence to manage a business, work experience in a small business, the locational background of the learner, and whether or not the learner’s parents owned a business do not appear to significantly influence a learner’s propensity to 76 sajems ns 14 (2011) no 1 start a small business of their own in the future. this tends to suggest that entrepreneurship is a complex phenomenon that is not necessarily confined to an individual that comes from a business background or an urban location. entrepreneurship is thus a learnable attribute (drucker, 2002), and potential entrepreneurs come from diverse backgrounds and not necessarily from a business family. however, certain elements of entrepreneurship cannot be taught, as these can be an inborn trait into an individual’s dna. nevertheless, potential entrepreneurs can be ‘made’ and their entrepreneurial potentials can be activated or switched on through openness to experience, learning and ideas (harrison, 2005:16). 6 limitations one of the shortcomings of this study is that the schools considered are only from urban areas, though the learners are both from urban and rural areas. perhaps one of the reasons why the black learners have a higher aspiration to have their own business as compared to the other race group learners might be linked to the immediate need to contribute their family livelihood. accordingly, a future direction of this study is to investigate the entrepreneurial aspirations of the high school learners in both urban and rural schools of south africa. basically, most high school learners in a general education program are preparing to enter the labour market as job-seekers rather than self-employed job-creators, and only a small proportion pursue university education. career guidance is rather limited. we are curious why boys have a greater propensity toward entrepreneurship than girls. perhaps the business role models are mainly men and the perception that entrepreneurship a maledominated field meant mainly for men will be the main obstacle against the effort exerted in building a culture of entrepreneurship in south africa. another aspect of the future direction of this study is to assess whether the high school learners believe that entrepreneurship is predominantly a masculine or gender related activity. further this study was rather narrow in its consideration of entrepreneurial characteristics. it is important to consider whether other entrepreneurial attributes, such as need for achievement, locus of control, extraversion and innovation, do influence young learners’ propensity to consider business entrepreneurship as a career option in south africa. hopefully, the results of a future study on these attributes may serve to support the literature and findings of other researchers, such as mcclelland (1961), rotter (1966), evans and leighton (1986), storey (1994), hirsch and peters (2001), shane (2003), and herrington, kew and kew (2010). they have found that, inter alia, the level of education, nach, locus of control, innovative behavior, experiential or environmental factors and gender, as well as access to resources are critical determinants of an individual’s propensity to venture into business entrepreneurship and succeed in such a role. 7 recommendations youth are favourably disposed towards small business entrepreneurship. the youth constitute the major percentage of the south african population and their significance for future economic expansion cannot be discounted. against a background of low labour low absorption capacity of the formal sector in south africa, that decreased from 80 per cent in the 1970s to 50 per cent after 2000 (barker, 2007), and of low employment elasticity of economic growth, that has decreased from 0.55 in the 1980s to 0.33 in the early 2000s (barker, 2007), it is encouraging that the many young individuals at the pietermaritzburg secondary schools, particularly among the black learners display high potential levels of entrepreneurial propensity. a very high proportion of the learners (about 70 per cent) have a fair understanding and skills of how to manage or run their own business and possess reasonably high levels of entrepreneurial confidence. with the creative energy and vibrancy of the youth group, it is possible that many young individuals are likely to be grabbers of sajems ns 14 (2011) no 1 77 opportunity rather than reactive necessity enterprisers who venture into entrepreneurship because they have no alternative option. business is about competitiveness, innovation, knowledge, resources and people skills to serve customer needs. over half of the learners (52 per cent) have been exposed to business entrepreneurship at schools. almost two thirds (69.8 per cent) believe that they have acquired the necessary skills to create and manage their own business and about half have suitable business role models to whom they want to aspire. this result is consistent with the findings of burger et al. (2004) and various gem reports in south africa (driver et al., 2005; orford et al., 2003; herrington et al., 2010). the learners felt that their participation in entrepreneurial ventures at schools enhances their entrepreneurial propensity. while entrepreneurship confidence among the youth in south africa is growing, it should be recognised that not all young educated people can become entrepreneurs. although the positive value of entrepreneurship education at secondary schools cannot be ignored, a stronger base for self-employment can be created if this positive mind-set is extended to tertiary education learners with possibilities for business incubators and strategic alliances among learners and institutions. the majority of the surveyed learners in government and semi-private schools may not necessarily have strong financial backgrounds and thus see the opportunity of starting their own businesses as a means to gain income and improve the overall quality of their lives. fewer learners (37 per cent) attending the private school compared to learners in the public schools indicated that they would start a business of their own in the future. however the private school learners were specifically from a girls’ high school. it is to be understood that many of the girls from the surveyed private learning institution are from a comfortable background, as many of their parents are in well-remunerated professions. and the female learners may have career aspirations and marriage with future family plans that limit their propensity to go into selfemployment. so for the latter group, entrepreneurship is a less preferred career option relative to professional employment, as the opportunity cost for the entrepreneurial path may be perceived to be rather high in terms of forgone income, quality of life, leisure time, risk-taking hazards owing to high crime rates and intrinsic rewards. entrepreneurial education is one of the keys to solving the economic problem in south africa. burger, mahadea and o’neil (2004:203) state that “entrepreneurship is critical to combating unemployment and poverty in south africa”. however, transforming generations of young learners is by no means an easy feat. many individuals in south africa perceive that obtaining a job in the government sector is a preferred career option because of the attractions of security, gravy train or rent-seeking tendencies and corruption. however, the fact that the revised national high school curriculum now includes topics that cover entrepreneurship and selfemployment is extremely positive and a step in the right direction towards attitudes to enterprise development and building a culture of entrepreneurship in south africa. 8 conclusion from the current research it is apparent that race group plays an important role in determining a learner’s propensity to become an entrepreneur. black learners have a greater positive disposition towards becoming entrepreneurs compared to learners belonging to other ethnic groups. this fact is also echoed in burger et al. (2004:203) and gem reports (orford et al., 2003; herrington et al., 2009). the type of school or the learning environment that an individual is exposed to also plays a pivotal role in determining whether or not a learner is favourably disposed towards becoming an entrepreneur. it is an established fact that drugs, child abuse, teenage pregnancies and school dropouts are major setbacks among learners in certain schools. having the relevant entrepreneurial skills and career choice knowledge as well as relevant counseling can influence youth learners in becoming entrepreneurs and hence minimise business failures. burger et al. (2004:204) state that 78 sajems ns 14 (2011) no 1 “with relevant education and training as well as adequate entrepreneurial development support, youth entrepreneurship can be further empowered”. in particular, exposing the emerging youth entrepreneurs to cutting edge education and training, modern business ideas and technology, and global markets, and addressing constraints specific to their business entry or expansion phases are challenges that need to be addressed. overall it is positive to see the extent to which learners’ desires and ambitions are being adapted and shaped through relevant entrepreneurship education in secondary schools in pietermaritzburg, kzn. this could form a sound basis for an enhanced total entrepreneurship activity rate in south africa, much needed for employment creation and economic development against a background of job losses and recessionary circumstances. references agresti, a. 2002. the analysis of categorical data, new york: wiley. allison, p. 1999. logistic regression using the sas system, sas publishing. barker, f. 2007. the south african labour market, pretoria: van schaik. barron, d. 1992. the analysis of count data: overdispersion and autocorrelation in sociological methodology, peter v. marsden (ed.): 179-220: blackwell. bhorat, m. & leibrandt, m. 1998. poverty amongst the self employed. studies in economics and econometrics, 22(3):25-41 burger, l; o’neill, c. & mahadea, d. 2004. perceptions of entrepreneurship as a career option in south africa: an exploratory study among grade 12 learners. south african journal of economics and management science, 2:187-205 cilliers, s. 2009. for richer or for poorer, in weekend witness, 5 dec. driver, a., wood, e., segal, n. & herrington, m. 2001. global entrepreneurship monitor, south african executive report, cape town: ince. driver. a., wood, e., fisher, c., herrington, m. & segal, n. 2003. global entrepreneurship monitor: 2001, south african executive report, cape town: ince. drucker, p. 2002. innovation and entrepreneurship, new york: harper & row. gem. 1999. global entrepreneurship monitor, executive report babson college, kauffman foundation and london. gem. 2003. global entrepreneurship monitor, executive report, babson college, kauffman foundation and london. gem. 2009. global entrepreneurship monitor, executive report babson college, kauffman foundation and london. evans, d.s. & leighton, l.s. 1986. some empirical aspects of entrepreneurship. american economic review, 76 (4):519-535. harrison, t.l. 2005. instinct: tapping your entrepreneurial dna, new york: warner business books. herrington, m., kew, j. &. kew, p. 2009. global entrepreneurship monitor: 2008, south african executive report, uct: graduate school of business. herrington, m., kew, j. &. kew, p. 2010. tracking entrepreneurship in south africa: a gem perspective, uct: graduate school of business. hisrich, r.d. & peters, m.p. 2001. entrepreneurship, new york: mcgraw-hill. janse van vuuren. 2005. land het gemiddeld minder woekeraars as sy ontwikkelende eweknieë: sa gaan mank aan entrepreneurs. sake-beeld: 20, 11feb. kassiem, a. 2003. 75 per cent of matriculants won’t get jobs or further education. cape times, december 24. [online} available at: http://www.capetimes.co.za/index/php. maas, g. & herrington, m. 2007. entrepreneurship: low levels threaten growth. management today, 23(2). mcclelland, d. 1961. the achieving society, van nostrand: princeton. mccullagh, p. & nelder, j.a. 1989. generalised linear models, london: chapman & hall. sajems ns 14 (2011) no 1 79 mlatsheni, c. & rospabe, s. 2002. ‘why is youth unemployment so high and unequally spread in south africa’, dpru working paper no. 02/65, development policy research unit. university of cape town. morrow, s., panday, s., richter, l. 2005. where are we now and where are we going: young people in south africa, johannesburg: umsobmvu youth fund. orford, j., wood, e., fischer, c., herrington, m. & segal, e. 2003. global entrepreneurship monitor, south african executive report, uct: graduate school of business. republic of south africa. 1997. national youth policy, pretoria: national youth commission. republic of south africa. 2005. revised national curriculum statement, pretoria: department of education. republic of south africa. 2005. revised national curriculum statement additional, pretoria: department of education. rotter, j.b. 1966. generalised expectancies for internal and external control of reinforcement, psychological monographs: general and applied, 80(1). sarb. 2009. south african reserve bank quarterly bulletins: 251-253 (march) sarb. 2010. south african reserve bank quarterly bulletins: 256 (june), pretoria. shane, s. 2003. a general theory of entrepreneurship, cheltenham: edward elgar. statistics south africa. 2001. the youth of south africa report, pretoria: statistics south africa statistics south africa. 2008. mid-year population estimates 2008, statistical release po302, pretoria storey, d.j. 1994. understanding the small business sector, london, routledge. timmons, j.a. 2007. new venture creation, new york: mcgraw-hill. von broembsen; wood, e.; herrington, m.; shay, d. & sheppers, r. 2005. global entrepreneurship monitor, south african report, uct, cape town. abstract introduction literature review research method findings and discussion conclusion acknowledgements references about the author(s) cornelie crous ufs business school, faculty of economic and management sciences, university of the free state, bloemfontein, south africa marike c. van wyk department of business management, faculty of economic and management sciences, university of the free state, bloemfontein, south africa citation crous, c. & van wyk, m.c., 2021, ‘balancing quantitative and qualitative value-creation reporting’, south african journal of economic and management sciences 24(1), a3936. https://doi.org/10.4102/sajems.v24i1.3936 original research balancing quantitative and qualitative value-creation reporting cornelie crous, marike c. van wyk received: 30 nov. 2020; accepted: 19 july 2021; published: 31 aug. 2021 copyright: © 2021. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract method: the demand for a balanced disclosure of quantitative and qualitative value creation in an organisation and for its stakeholders has increased in recent years. aim: therefore, this study focused on the disclosure of 97 companies listed on the johannesburg stock exchange over a period of five years (2015–2019). method: a three-phased content anlaysis was followed. results: the researchers found that value-creation disclosures are mostly concerned with quantitative value creation, and that they focus on value concepts, such as returns to investors, cash flow, increase in employee numbers, and benefits to employees. some companies have progressed in their integrated reporting practices and now include a reference to value creation by balancing the different forms of capital. however, their reports still do not include concrete statements or definitions about what value creation is considered to be; neither do they disclose qualitative value-creation concepts. conclusion: the authors thus conclude that imbalanced reporting skewed towards quantitative value concepts persists. keywords: integrated reporting; value creation; qualitative value creation; quantitative value creation; stakeholders. introduction since the issue of the first international integrated reporting framework (irf) in 2001, international debates have continued about the concept of value creation, its meaning and how best to define it, the processes involved in creating value, whom value is created for, and how companies should report on these concepts. conventional approaches to value in an organisation can be found in strategic management literature in the works of authors such as freeman (2001) and porter (1980). terms such as ‘use-value’ and ‘exchange value’ are traditionally linked to value from a consumer perspective, and later research links value creation to the value an organisation creates for shareholders. traditional corporate reporting focused on the concept of value creation as financial value for investors and shareholders, thus focusing on shareholder-centred reporting and concepts such as profit, reduction in costs, cash flow, and market metrics (glassman, potoski & callery 2017; schoenmaker & schramade 2019; sheveleva 2018; sofian 2018). the irf, however, indicates that value is not only created for the organisation and its investors, but for other stakeholders as well (international integrated reporting council [iirc] 2013). other stakeholders, recognised in the literature, include employees (also referred to as human capital), society or communities (social capital), customers, and the company boards to a limited extent. the value created for these stakeholders is almost always related to economic or financial aspects. value for customers is defined either as products or services provided to them, or as the reduced costs of products (freudenreich, ludeke-freund & shaltegger 2019; ifac 2020). value creation for employees is linked to salaries, benefits, and number of employment opportunities created in the form of employee numbers (iirc 2017; sunder 2017). however, several authors acknowledge that the aspects of non-financial value creation or qualitative value creation for employees, such as job satisfaction, job quality, and the impact of leadership on the morale and behaviour of employees are challenging to define and thus do not receive the much-needed attention in corporate reporting (freudenreich et al. 2019; iirc 2017; lev & sunder 1979). the value created for company boards, similar to that of customers, can be qualitative in nature. this qualitative value could include a better understanding of risks and opportunities facing the organisation, building trust and relationships, a clearer articulation of strategy, and enhancement of their governance role (adams 2017; iirc 2014). value for society or communities is often equated with corporate social responsibility (csr) expenditure or shared value (gokten & gokten 2017; sheveleva 2018; sofian 2018) to the exclusion of qualitative aspects, such as social licencing, legitimacy to operate, and cultural relationships and beliefs (freudenreich et al. 2019; gokten & gokten 2017). from the extant literature mentioned above, it is clear that value creation is not only a quantitative or economic concept, but should also include qualitative or non-financial aspects (freudenreich et al. 2019; iirc 2017; lev & sunder 1979; gokten & gokten 2017; sofian 2018; sheveleva 2018). the international focus on financial value, sometimes to the exclusion of qualitative or non-financial value, warrants investigation. beyond the literature, the definition of value creation among companies issuing integrated reports demonstrate an overall focus on the quantitative value creation to the exclusion of qualitative value creation. this article is aimed at stimulating the debate on what is implied by the term value creation, with reference to both quantitative and qualitative value-creation concepts. by analysing the extant literature, we demonstrate focus on the overarching quantitative value creation and only minimally on qualitative value-creation concepts. we demonstrate the quantitative emphasis through an analysis of published reports by environmentally sensitive companies listed on the johannesburg stock exchange (jse) between 2015 and 2019. the article continues with a literature review providing an overview of the development of the term value creation in strategic management literature. this is followed by a discussion on how both qualitative and quantitative value creation have been defined for different stakeholders in literature. the results of the analysis of the integrated reports of the listed companies will then be presented, while recommendations for further research concludes the article. literature review overview of the development of the term value creation value creation has not only been a key concept in financial and management literature for decades, it also remains a quintessential objective performance measure for organisations across the board (sheveleva 2018). the goal of any organisation is to deliver value to its investors (knight 2002), as well as ultimately to maximise its shareholder value (sacui & dumitru 2014) through an array of operational, financial and investment policies (burcă & cilan 2016) in line with the shareholder value perspective. there is no single universal definition that scholars agree on for the complex multi-dimensional construct that is value creation. often the discipline and focus of theory and research determine the vantage point from which the term is considered. however, the general interpretation of value in a business context is economical, in that companies create value for their shareholders that is quantifiable in monetary terms (sheveleva 2018). bowman and ambrosini (2000) proposed that a clear distinction be made between use value and exchange value. in an attempt to arrive at a broad definition of value creation, and drawing on the work of bowman and ambrosini, lepak, smith and taylor (2007:190) they defined value creation as ‘the difference between use and exchange value that can apply to all levels of analysis’. from a fundamental consumer perspective, use value refers to consumers’ individual – and therefore subjective – assessment of product or service qualities in relation to their personal needs, that is perceived value (bowman & ambrosini 2000). perceived value can be construed as a qualitative measure, and may include aspects such as customer satisfaction, retention and loyalty, which will be discussed later in this article. exchange value refers to the monetary value due to consumers, or quantitative aspects, at the exact point of ‘exchange’ or purchase in order to obtain a product or service (bowman & ambrosini 2000). from their resource-based stance, bowman and ambrosini (2000) reiterated that value could only be created once inert resources – tangible and intangible alike – are subjected, through human intervention, to a production process in which the resources are activated, developed, and made operational. it was held that only through the subjugation of the values acquired by the firm, that is resources, to a transformation process could new use value ultimately be created. this, in essence, limited the extent to which any organisation could add value to that which was ultimately owned by the organisation. in this context, the emphasis is on strategy, according to the work of porter (1980:xv), who reiterates that ‘the value of resources and capabilities is inextricably bound with strategy’. the proposition of generic and corporate strategies by porter (1980) is central to deconstructing the notion of value creation. generic strategy pertains to the creation of a competitive advantage within the industry it competes in so as to create optimal value for both the individual consumer and the organisation. value is added to benefit the individual consumer through a trade-off between the benefits and sacrifices, as perceived by the consumer, in line with the previous example of use and exchange value (bowman & ambrosini 2000). inversely, consumers add value through the trade-off between the benefits and sacrifices as perceived by the organisation. according to porter (1980), creating value for customers, at least on an individual level, suggests: (1) increased effectiveness through differentiated treatment, based on the individual consumer’s needs, value and potential; (2) efficient and effective processes; (3) better margins; and (4) increased relevance and reduced reaction time. corporate strategy is concerned with improving shareholder value, the maximisation of long-term profitability and, ultimately, the value of the organisation. this is achieved not only through competing in the relevant industries and the number of business, but also through adding value synergistically and sustainably. in essence, corporate strategy enables organisations to pursue new strategic avenues that ultimately hold the potential to increase the value for the shareholder and the value of the organisation. from this vantage point, the primary strategies, defining value, rest on both internal (investigation and selection of additional strategic avenues within the organisation), and external business endeavours (mergers, acquisitions and alliances). the notion of value creation has, however, gone through a transformational process of its own over the years, in which the initial definition evolved from one that was primarily concerned with financial capital to one that now acknowledges that value is ‘multi-capital and multi-dimensional’ (iirc 2013:10). the evolution of value-creation concepts is a result of how they allow an enhanced understanding of the changing values, priorities, and strategy-identifying approaches of organisations over the years (sheveleva 2018). in their review of the evolution of value creation, specifically in the field of strategy, ramaswamy and ozcan (2013) point out that it was not until the 1980s that organisations began to change how they viewed the process of value creation. this emerged in the work of authors such as barney (1991) and wernerfelt (1984). smaller competitors with less access to resources began to outmanoeuvre and successfully compete with larger organisations. in examining this phenomenon, three fundamental causes, related to resources, from which ultimately value creation emerged: (1) resources are not only financial and physical but also intellectual; (2) resources are mutually interchangeable, and through the strategic use of joint ventures and alliances, the resources of external parties can innovatively be leveraged; and (3) the starting point has to be the realisation that strategy is about the efficient and effective use of resources ‘whether reusing and redeploying core competencies in new applications across businesses or changing industry norms’ (ramaswamy & ozcan 2013:7). these assumptions led to senior management shifting its focus away from being mere resource allocators to becoming the leveragers of corporate resources. as a result of smaller firms’ relationships and alliances with external parties, and their access, consequently, to an entire resource base, the concept of value creation evolved from being limited to internal resources and competencies to a significantly broader idea of what the organisation owned. the notion of a global resource base is also in line with porter’s (1989) emphasis on the importance of capturing the benefits of relationships between businesses and business units in order to create synergy and ultimately increase the value creation of the organisation. up until this point, the responsibility for creating value was still solely that of the organisation itself. the different forms of value created – whether on a corporate level (shareholder value) or an individual consumer level (perceived value) – were financial. all of this was, however, disrupted at the turn of the century as (1) customers increasingly became a source of talent, knowledge and competence (ramaswamy & ozcan 2013); and (2) the call for a new model for conducting business emerged (porter & kramer 2019). the concept of creating shared value (csv) was suggested as a model that would ultimately bridge the gap between business and society brought on by the value perspective of the shareholders’ narrow-minded pursuit of short-term profits at the expense of the broader community. the notion of csv is concerned with the generation of economic value in a manner that also brings about value for society at large by addressing its unique challenges (porter & kramer 2019; windsor 2017). the use of csv as a proxy for value creation has, however, been criticised due to its ideological similarity to csr and its philanthropic goals with little or no profit maximisation or value creation for society (komonen 2019; sheveleva 2018). as windsor (2017:81) states: ‘csr activity remains costless to the firm, which may enjoy reputational benefits’, as the organisation is responding to social requests rather than behaving responsibly. regardless of the critique, the csv approach brought an increase in organisations’ competitiveness, while the social and economic conditions of the communities in which organisations conduct their business were uplifted. suddenly, the scope of value creation was broadened and challenged to move beyond mere financial (quantitative) value creation to include elements of shared value and non-financial (qualitative) value creation. non-financial, qualitative value creation instils trust and confidence as it is directly associated with management strategy and the environmental context that guides the decision-making process (burcă & cilan 2016). value creation for different stakeholders now more than ever, organisations are aware of the importance of addressing the needs and expectations of a diverse and ever-increasing number of interest groups (sheveleva 2018). this results in the focus ultimately shifting from a shareholder perspective to a stakeholder perspective. stakeholders are ‘groups and individuals who benefit from or are harmed by, and whose rights are violated or respected by, corporate actions’ (freeman 2001:59). the rationale for stakeholder engagement is rooted in the possible advantages and additional value that can be derived from this endeavour as a result of greater trust in the organisation based on increased accountability and transparency. sheveleva (2018) emphasises the need for effectively integrated stakeholder thinking as this is the only way in which sustainable stakeholder value can be created. the question remains, however, as to how this value can and should be defined. according to windsor (2017:76), the concept of value ‘lacks theoretical precision and empirical verification’. although the concept has developed in the management and strategy disciplines, there is little agreement among scholars on its definition. one definition of value is ‘the surplus or gain in someone’s welfare relative to a previous condition’, alluding to a quantitative economic concept (windsor 2017:76). the irf (iirc 2013) conceptualises value as twofold: for the organisation, and for other stakeholders. the value created for the organisation itself pertains to the organisation’s obtained financial returns that are transferred to the shareholders, while value created for others pertains to more abstract concepts, such as relationships, endeavours and interactions (sheveleva 2018). both of these concepts include objective (quantitative) and subjective (qualitative) aspects. furthermore, the irf links value creation closely to the six capitals. by recognising the interconnectedness of the six capitals (financial, manufactured, human, relational, natural, and intellectual) and understanding how to balance these capitals within an organisation, management could create value in the short, medium and long term for all stakeholders (ifac 2020; sheveleva 2018). this interconnectedness denotes complex relationships which rest on more than just economic and quantitative aspects for both the organisation and other stakeholders. value to the organisation lies in the profitability of the organisation (barnabe, giorgino & kunc 2019; freudenreich et al. 2019; śledzik 2013). this approach to defining value is related to the shareholder and agency theories in which management creates value for shareholders and the organisation, among others, in the form of profits, increased cash flow and return on investment (roi), as well as reduced costs, fixed asset investments and taxes (dalbøl & dalbøl 2011; karia 2019; śledzik 2013). on the other hand, value for others is linked to the stakeholder theory according to which an organisation should consider the legitimate needs of different stakeholder groups to ensure the sustainability of the organisation (acciaro 2015). additionally, scholars argue that value is only created for others if an organisation does manage the relationships effectively, as well as appreciate the active contribution of the stakeholders (freudenreich et al. 2019; komonen 2019). identifying multiple stakeholders and their contributions to an organisation is not an easy task. value-creation literature commonly focuses on investors as the primary stakeholders (adams 2017; barnabe et al. 2019; freudenreich et al. 2019; glassman et al. 2017; gokten & gokten 2017; sheveleva 2018; śledzik 2013), and to a lesser extent on other stakeholders, such as employees, the board of directors, suppliers, customers, and society or communities at large. determining the quantitative (objective) value an organisation creates for each group seems the prevalent method of defining value for each group. identifying qualitative (subjective) value is, however, more complicated. as providers of capital to organisations, authors identify investors as the primary stakeholders in any organisation. as such, the majority of the value-creation literature focuses on how value is defined and created for them (adams 2017; barnabe et al. 2019; freudenreich et al. 2019; grassman, fuhrmann & guenter 2019; śledzik 2013). flower (2015) and cheng et al. (2014) criticised the irf for promoting practices that allowed organisations to focus their reporting on the providers of capital to the exclusion of other stakeholders. statements in the irf, such as ‘ir aims to improve the quality of information available to the providers of financial capital to enable a more efficient and productive allocation of capital’ (iirc 2013:2), as well as the statement, ‘the ability of an organization to create value for itself enables financial returns to the providers of financial capital’ (p. 4), certainly support this argument. value to customers is often expressed as providing goods and services at affordable prices and better resource allocation to reduce related costs (freudenreich et al. 2019). the qualitative value related to customers, such as customer satisfaction and customer loyalty, is not addressed in extant value-creation literature except for linking value back to the organisation as increased profits and cash flows (dalbøl & dalbøl 2011; śledzik 2013; titko & shina 2017). the emotional value created (how customers feel) is either not recognised by management or not considered to be relevant to purposes of reporting. similarly, the value created for employees, in the form of human capital, is often reflected in company reports and literature with quantitative measures, such as the number of hours worked, financial benefits received, rewards schemes, and education provided (gokten & gokten 2017; śledzik 2013; sunder 2017; titko & shina 2017). the qualitative value an organisation creates for employees, such as quality leadership, low employee turnover, staff morale, employee-driven innovation, institutional knowledge, fair staff policies, productivity, skills level and capabilities are recognised in the human-capital literature only. value-creation literature, however, excludes these concepts as they are seen to be emotional and not directly linked to financial performance (adams 2017; gokten & gokten 2017; iirc 2017; karia 2019; śledzik 2013; sunder 2017). social value is linked to the competitive advantage gained from the ‘sustainable development of markets and society’ (freudenreich et al. 2019:3). this relationship, unlike that of customers, suppliers and employees, is not governed by an economic contract. social value creates a stable operating environment for an organisation in which to operate and results in legitimising its operations and granting the organisation a social licence to operate (freudenreich et al. 2019; gokten & gokten 2017). gokten and gokten (2017) argue that social value is not easy to identify and define as it includes non-financial aspects, such as social and political pressure and mutual trust between the organisation and society. research method because companies trading in environmentally sensitive industries tend to issue higher-quality non-financial reports to improve their reputation (azapagic 2004; cho & patten 2007; christian 2016; de villiers & alexander 2014; farneti & guthrie 2009; maubane, prinsloo & van rooyen 2014), all companies listed on the jse in environmentally sensitive industries were selected. these industries include chemicals, construction and material; forestry and paper; industrial metals and mining; mining, oil and gas; and pharmaceuticals. a total of 97 companies were identified, of which only 65 issued integrated reports over a six-year period. the study focused on analysing the published integrated and annual reports for these companies in the period 2014 to 2019. in some cases, companies issued both an integrated, as well as an annual report. in these cases, both reports were analysed. the integrated reports and annual reports all included detailed financial statements prepared according to international financial reporting standards (ifrs). the financial statements include profits, cash flow, salaries, return on investment and other quantitative benefits to shareholders. the financial statements were used as a proxy for quantitative value creation, and financial capital disclosure and no detailed analysis was performed. a three-phase content analysis was conducted. in the first phase, the atlas.ti program was used, and an automated code was created to search the reports for the use of the term value creation. the results are reflected in table 1. the second phase involved a detailed analysis of each occurrence of the term to identify any explanation or definition provided by the sampled companies. the third phase of the analysis used atlas.ti again to summarise the number of occurrences in which the term value creation occurred in conjunction with the qualitative aspects in the reports. a co-occurrence table was generated and is presented in table 2. table 1: number of occurrences of the term ‘value creation’ per year. table 2: co-occurence of ‘value creation’, qualitative and quantitative concepts. findings and discussion a total of 594 reports were analysed for the 97 companies in the sample. the term value creation was used a total of 1058 times over the 6-year period. table 1 summarises the results from phase one of the data analysis. the search yielded between 65 (2019) and 473 (2017) instances of value creation per year across all the reports. in 2017, the term was used 102 times in a single report. the increased use of the term indicates that these companies became increasingly aware of their responsibility to report on the value they created between 2014 and 2017. from 2018, the number of times the term was mentioned in a single report decreased significantly to a maximum of nine times in 2018 and eight times in 2019. although there was a decrease in the use of the term value creation, five aspects that require further consideration in a detailed analysis of the published reports were identified. firstly, several companies linked their value creation to the irf and the use of the six capitals. the concept ‘six capitals’ occurred 724 times over the six-year period. this practice demonstrates a positive move towards considering the balance between the capitals and recognising their complex interrelatedness (ifac 2020; sheveleva 2018). bhp billiton (2019:11), for example, included a statement in their 2019 integrated report under the explanation of their operational model that states: ‘we have a simple and diverse portfolio of tier one assets around the world, with low-cost options for future growth and value creation’. gold fields (2019:1) stated that they ‘embrace integrated thinking and [take] an integrated approach to value creation, which aligned with the iirc six capital model’. although these statements refer to the irf and value creation, they are general in nature and do not provide a definition of how these companies quantify or qualify value creation. similarly, adcock ingram (2018) refers to the six capitals and relationships in their value-creation statement while including reference to stakeholders: when making decisions on how to manage and grow the business, we consider those resources and relationships that are critical to our ability to create value. input from each of the six capitals is needed for the effective management and subsequent value creation for all our stakeholders. (p. 10) exxaro resources (2018) also references the six capitals and links the balancing of these capitals to sustainable growth and benefits for stakeholders, without providing a specific definition of what they consider the value they create to be: exxaro uses the six-capitals model (natural, human, social, manufactured, intellectual and financial capital) as a balanced approach to increase our potential to invest and develop for sustainable growth … to maximise the benefit to all stakeholders, internally and externally. (p. 8) secondly, the majority of companies relate value creation in the integrated reports to financial or quantitative value, in keeping with the main focus in the literature on value creation (burcă & cilan 2016; porter 1980; ramaswamy & ozcan 2013; sacui & dumitru 2014; sheveleva 2018; windsor 2017). this is demonstrated by the inclusion of the financial statements prepared according to ifrs and the mention of quantitative aspects in the narrative descriptions of value creation. return on assets (n = 321), return on capital (n = 1039), dividends (n = 3627), profitability growth (n = 69), cash (n = 9337) and shareholders’ returns (n = 1101), occurring mostly in the narrative descriptions, are all linked to quantitative value creation and placed additional focus on the quantitative information contained in the financial statements. this emphasis on financial and quantitative value creation demonstrates the companies’ focus on shareholders and investors as primary stakeholders to the exclusion of other stakeholders (adams 2014; barnabe et al. 2019; freudenreich et al. 2019; grassman et al. 2019; śledzik 2013). the company accentuate (2019) relates value creation to profitability growth; lonmin relates it to shareholders’ return (lonmin 2016:2); and pan african resources (2015:5) relates it to ‘share price performance, sustainable earnings, cash flow growth and by consistent dividend payment’. another example is the use of metrics to quantify value creation in the 2019 integrated annual report by african rainbow minerals (2019): underpinned by metrics that measure the sustainability of value creation for stakeholders (minimum rate of return; other hurdle rates; payback periods; return on assets; return on capital employed; dividend pay-out/cover ratio, etc). (p. 1) thirdly, companies acknowledge the value they create for customers in the products and services they offer (n = 84 occurrences linked to value creation), supporting the literature that emphasises value to customers as quantitative in nature (bowman & ambrosini 2000; freudenreich et al. 2019; porter 1980; sheveleva 2018; śledzik 2013; titko & shina 2017). omitted from the integrated reports is the acknowledgement that value creation to customers also includes qualitative values, such as loyalty (n = 0 linked to value creation) and customer retention (n = 0 linked to value creation) (bowman & ambrosini 2000; dalbøl & dalbøl 2011; titko & shina 2017). this qualitative focus on products and services is demonstrated by african oxygen (afrox) (2019:12) in their integrated report, where they state: ‘value creation at afrox is the sustainable and effective delivery of products and services to add value for its customers in a profitable manner’. fourthly, although companies recognise the importance of society in their value-creation process (n = 264 linked to value creation), only two companies include social value or social licence to operate in their value-creation definition in integrated reports. in their 2016 integrated report, arcelormittal (2016) equated social-value creation with the broad-based black economic empowerment (bbbee) initiatives of the company and their business incubation project, not really defining qualitative value to society. only one company seemed to acknowledge that social value is linked to qualitative aspects, such as relationships. anglo american platinum (2017) states: our social licence to operate is highly dependent on our ability to demonstrate value creation to host communities and thus a positive impact on social capital. all our activities impact on social capital – the resources and relationships provided by people and society. these impacts can be described as the extent to which a company’s actions or decisions contribute positively or negatively to a change in the welfare, capabilities, relationships or livelihoods of people living in society. (p. 30) finally, defining qualitative value created for employees, such as providing quality leadership and fair staffing policies, is overlooked when preparing integrated reports (adams 2017; gokten & gokten 2017; śledzik 2013; sunder 2017). the value created for employees is quantified and, more often than not, reported as the investments in skills development (n = 108), staff or employee loyalty (n = 16) and education or the number of job opportunities created. wesizwe platinum (2014), for example, reported its goal of employing an estimated 3300 people by 2021. the absence of qualitative value creation is even more concerning when compared to the risks disclosed in the integrated reports. only 16 reports included staff retention and human capital as high-risk areas for the companies. this pattern is manifestly challenging for companies, as it appears that human capital and related value creation are not central concerns for south african listed companies. conclusion the concept of value creation is not a novel one and has enjoyed much attention from financial and strategic management scholars, such as porter (1980) and freeman (2001). the concept, however, evolved from focusing on shareholder value to one that also includes consideration of the value added to other stakeholders. traditionally, in most of the literature, the term value creation is defined on a quantitative level in terms of maximising profits for shareholders. value for other stakeholders is also often quantitatively expressed as the use value for customers, benefits to employees, and csr expenditure in relation to communities. despite criticism of the continued focus on quantitative value creation in the irf since its introduction, scholars have used this document to define and research the concept of value creation. the literature suggests that by considering the legitimate needs and contributions of stakeholders, organisations may determine qualitative value creation, such as customer satisfaction, staff retention, institutional memory, and staff focus on innovation which leads to increased legitimacy and social licence to operate (freudenreich et al. 2019; gokten & gokten 2017; śledzik 2013). regardless of the increasing focus on qualitative value-creation concepts in the literature mentioned above, our findings suggest that jse-listed companies still do not sufficiently address or define non-financial and qualitative value creation. the reporting themes identified in the data analysis clearly show a propensity for quantifying value creation in integrated reporting. this pattern continues in the reporting on value creation for customers, which is linked to products and services offered, the societal value linked to legislative requirements and bbbee, and value for employees linked to remuneration and number of jobs created. perhaps the focus on quantitative value is driven by the need to receive the greatest external interest, or perhaps the omission of qualitative value creation aspects in integrated reporting is due to the uncertainty by report preparers on what exactly non-financial value creation is. either way, it is clear that more research is needed into how organisations, report preparers, and users of integrated reports perceive qualitative value creation. acknowledgements competing interests the authors have declared that no competing interest exist. authors’ contributions all authors contributed significantly to the conceptualisation, design, drafting and approval of the final manuscript. c.c was the project leader. m.c.v.w. was responsible for the literature on value creation from a strategic management persepctive. c.c. incorporated the aforementioned literature into the integrated reporting literature, and conducted the data anlaysis and interpretation. both authors conducted the final review and approval of the article before publication. ethical considerations this article followed all ethical standards for research without direct 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individuals fw struwig department of business management, nelson mandela metropolitan university w plaatjes department of business management, walter sisulu university abstract this article focuses on the development of a framework for investigating the personal financial management knowledge of individuals. content analysis is used to derive the components included in the personal financial management requirements framework. the framework developed includes six components, namely basic concepts in personal finances, management of personal finances, risk management, future planning, investing in financial resources and miscellaneous factors. a qualitative validation process revealed that the framework indeed covers what the average south african citizen is required to know about personal financial planning. the real test of this framework will be to use it in developing an instrument to test individuals’ knowledge of personal financial management. this process of empirically testing the framework, using such an instrument, warrants a separate article. jel g29, m20 1 introduction compared to a generation ago, south africans now live in a world of great financial complexity and challenge. changes in the financial services market and increases in the number of financial instruments available to families, coupled with intensive marketing campaigns within the financial services’ sector, have made successful personal financial management much more difficult, and may even cause financial problems for families. money is an ancient and necessary human invention, but nowadays the explosion of information technology, forceful retail marketing techniques and the resourcefulness of criminals and fraudsters have all made the financial services sector a complex phenomenon. this sector in the twenty-first century is undergoing a major transformation, which has resulted in the need to educate consumers in personal finances. knowledge of personal financial management is required to improve an individual’s or family’s standard of living. without personal finances education, personal financial problems arise, which can have detrimental effects on an individual’s life at home and/or work. these problems include declining productivity, divorce in marriage and a poor self-image. swart (2005) confirms that financial education is failing in south africa. to be able to educate individuals about personal financial management one has to consider the current knowledge of those individuals before a proper and useful training programme can be designed. in this article, a personal financial management requirements framework is developed to guide and enable the investigation of the personal financial management knowledge of individuals. to develop this framework, relevant literature is first evaluated, to determine what individuals have to know about personal financial management. 22 sajems ns 10 (2007) no 1 content analysis techniques are used to develop these components to include in the framework. content analysis is part of qualitative research, and involves a systematic and intensive analysis of data, often sentence by sentence or phrase by phrase, with constant comparison (strauss, 1993: 22). the focus of such analysis is not ordering a mass of data, but rather organising the many ideas that have emerged from analysis of the data. thereafter experts in the field of personal financial management evaluate the proposed personal financial management requirements framework to validate it, by ensuring that it does indeed include all relevant issues. 2 the concept of personal financial management many studies (e.g. chambliss, 1990; gitman & joehnk, 1990; whittaker, heystek & metz, 1990; toohey & toohey, 2000; rosefsky, 2002) fail to define the concept “personal finances” or “personal financial management” adequately. instead of using the concept “personal finances” or “personal financial management”, for example, gitman and joehnk (1990) use “personal financial planning”, but fail to define it properly. other studies use alternative terms. godwin (1990: 103) for example uses the concept “family financial management”, and defines it as “the planning, implementation, and evaluating by family members that [are] involved in the allocation of their current flow of income and their stock of wealth toward the end of meeting the family’s implicit or explicit financial goals.” swart (2002) describes a similar conceptual framework for personal financial planning, though he does not define personal financial management. he sets out the management process of individual households as including the planning, organising, leading and controlling of the money matters of the household (swart, 2002: 4). for the purposes of this study, “personal finance(s)” or “personal financial management” will be defined as “a set of activities, including planning and decision making, organising, leading/implementing and controlling the allocation of income and the accumulation of wealth by an individual or family, with the aim of achieving implicit or explicit financial goals in an efficient and effective manner”. 3 the importance of personal financial management training and education swart (2005) outlines the advantages of individuals’ gaining financial expertise through training and education. these individuals, he says: • have obtained one of the best life skills; • possess entrepreneurial skills; • are financially informed; • have a financial advantage over others; • can take personal responsibility for their financial future; • have a better chance of financial success in business and in marriage; and • should be financially independent at retirement. these advantages make knowledge in financial management lucrative to individuals. 4 a literature overview of the components included in personal financial management table 1 outlines the components included in personal financial management as derived from literature using content analysis. sajems ns 10 (2007) no 1 23 table 1 the components included in personal financial management author component garman and forgue (1988) planning personal finances managing personal finances managing expenditure protecting income and assets planning investments retirement planning estate planning gitman and joehnk (1990) foundations of financial planning measuring financial standing insuring financial resources planning finances planning retirement and estate managing investments tax managing credit managing basic assets whittaker, haystek and metz (1990) managing finances and credit investing financial resources planning assets, insurance and retirement financial advice kapoor, dlabay and hughes (1991) planning personal finances managing personal finances making purchasing decisions insuring resources investing financial resources controlling the financial future gordon-fish (1994) introduction to finances employment managing finances, banking services taxes and marriage investing financial resources assurance, retirement and wills health care dewing (1995) finances, insurance and tax accommodation job applications and interviews advice and assistance 24 sajems ns 10 (2007) no 1 author component rosefsky (2002) basic requirements accommodation investing financial resources providing for needs protecting resources financing swart (2002) career planning income tax planning estate planning investment planning protection planning credit planning health care planning retirement planning emigration planning ernst & young, nissenbaum, raasch and ratner (2004) financial planning accommodation investing financial resources retirement planning health care marriage/divorce protecting resources woerheide (2004) financial planning accommodation protecting resources investing financial resources retirement planning estate planning to derive the components outlined in table 1, an intensive study of the relevant literature was conducted. many more frameworks than those listed in table 1 were investigated, but some frameworks were excluded because the core categories were saturated and were linked in numerous ways with the proposed categories. the efforts of researchers such as joo (1998) and kim (2000) were adapted for south african conditions to ensure their components are also covered in the framework. the components included by the various authors as outlined in table 1 can be analysed, and some of them proposed for inclusion in the framework for personal financial management requirements. these components were derived using content analysis. a text, which can be written, spoken or visual, has content, in other words the messages it contains in the form of words, meanings, symbols and themes. content analysis is the gathering and analysis of textual content, and can include quantitative and qualitative evaluations of text. the central idea in content analysis is that the many words of the text are classified into relatively fewer content categories (struwig & stead, 2001). sajems ns 10 (2007) no 1 25 5 proposed components for inclusion in the personal financial management requirements framework 5.1 component 1: basic concepts in personal finances basic concepts in personal finances include the personal financial management process, the economic environment and various aspects relating to earning an income. (a) personal financial management process to understand personal financial management, it is important to consider the personal financial management process. this process involves setting personal financial goals and implementing strategies to achieve them (kapoor et al., 1991; whittaker et al., 1990). a personal financial plan includes the “financial” goals, a net worth statement, an income and expense record, an insurance and assurance plan, a saving and investing plan and a budget (mccorkle, et al., 2002). (b) economic environment the microand macro-economic environments have to be explained in order to understand financial terminologies and opportunities. the micro environment includes economic problems (resources, needs and wants), opportunity cost, etc. the macro environment consists of the economy as a whole, monetary policy (including interest rates and money supply), inflation (including the basic time value of money), economic indications, balance of payments, fiscal policy, exchange rates and financial institutions (including range of services banks offer and the reserve bank) (gordon-fish, 1994; rosefsky, 2002; swart, 2002). (c) income the income of individuals is influenced by the availability, standard, quality and content of the education they have received. education influences not only the enjoyment of life but also the attainment of a “job”, which here means a satisfying career and a good income (sylvia & horne, 1992). a job includes the role of employment in an individual’s life, factors in choice of work, the quest for a job, the curriculum vitae, the interview process and ways to negotiate the best remuneration package. various important factors in discussing a “job” are items to be aware of when starting new employment or changing careers, strategies amidst organisational change, taking advantage of fringe benefits and tax breaks, being unemployed and work and income legislation (gordon-fish, 1994; dewing, 1995; rosefsky, 2002; swart, 2002). 5.2 component 2: management of personal finances the management of personal finances includes the budgeting process and various aspects of credit, savings and income tax planning. (a) budgeting process budgeting serves as a guide to help people live within their income. the budgeting process includes drawing up and operating a budget (which includes tracking and reconciling the budget). ways of overcoming budget shortfalls and various available personal financial software packages should also be examined (chambliss, 1990; gitman & joehnk, 1990; theys, 1993; mccorkle et al., 2002; saqa, 2002; swart, 2002). important aspects of expenditure are firstly, avoiding the trap of failing to plan for all expenses and secondly, identifying how one wastes money. expenditure may include financial expenditures and maintenance issues related to maintaining assets. planning for major expenditure can de done using the life cycle planning method (garman & forgue, 1988; toohey & toohey, 2000; saqa, 2002). important aspects of record keeping are firstly, organising personal financial records, secondly, determining one’s current financial position and thirdly, using a cash flow statement to assist with financial planning (kapoor et al., 1991; sylvia & horne, 1992). 26 sajems ns 10 (2007) no 1 (b) credit credit appears to be the major cause of financial downfall for many individuals. important factors to understand include the various forms of debt, the concept of delay and why individuals use (burger, 1990; chambliss, 1990; theys, 1993; dewing, 1995): • various forms of debt: these include the different types of credit cards, revolving credit, basic features of consumer loans and instalment payments (gitman & joehnk, 1990; liberman & lavine, 1994; mccorkle, et al., 2002). • applying for credit: this process includes understanding credit requirements; evaluating credit applications by a lender i.e. credit worthiness; answering questions such as, ‘should i co-sign a loan for a friend or a relative?’; reviewing the do’s and don’ts of applying for a loan; and knowing the various sources of credit (chambliss, 1990: 59-87; gitman & joehnk, 1990: 219-251; kapoor et al., 1991; rosefsky, 2002; swart, 2002) • credit record: an individual’s credit record consists of credit information maintained in reports at the credit bureau. maintaining a credit rating includes checking and understanding your credit report and correcting errors (whittaker et al., 1990; kapoor et al., 1991; liberman & lavine, 1994; mccorkle et al., 2002; swart, 2002). • credit management: this includes managing credit cards and protecting credit users; deciding how much open-ended credit to use; choosing whether to borrow or wait and pay cash; planning credit use; and understanding credit agreement contracts (garman & forgue, 1988). • the cost of credit: questions to understand include how the cost of credit is calculated, how much credit one can afford to use and the best way to compare different credit plans. leasing, borrowing-to-buy and rent-to-own options have different contract terms and costs. the various forms of credit, including retail charge cards, bank credit cards and open lines of credit, should included in the requirements framework (kapoor et al., 1991; mccorkle et al., 2002; rosefsky, 2002). • excessive debt: this includes indicators and consequences of excessive debt, credit card problems, credit matters to beware of and where to seek assistance in case of credit problems. individuals with excessive debt have a number of options including re-negotiating a repayment schedule or selling assets (garman & forgue, 1988; kapoor et al., 1991; van der watt, 1991; liberman & lavine, 1994; smith, 1994; mccorkle et al., 2002). • bankruptcy: issues to discuss include the protection of assets from creditors, the declaration of bankruptcy, various ways of getting credit after bankruptcy and the three types of bankruptcy (chambliss, 1990; liberman & lavine, 1994). • credit and the law: laws and regulations exist to protect consumers from shady lenders. the following issues are important: current laws that protect the rights of borrowers; legal expiry date of debts; different types of debt; classification of debts; ranking or prioritising of debts; offering a settlement; voluntary distribution; administration orders and the sequestration of estates (kapoor et al., 1991; theys, 1993; mccorkle et al., 2002). (c) savings individuals should understand the various concepts involved in savings, including reasons for saving, the importance of saving, setting saving targets, the saving process, places to save, available types of savings instrument, advice for becoming a disciplined saver, special purpose accounts, comparison of savings accounts and savings plans and saving versus investing (chambliss, 1990; gitman & joehnk, 1990; whittaker et al., 1990; kapoor et al., 1991; mccorkle et al., 2002). a saving mindset must be cultivated, and individuals understand such matters as why spending less should be easier than saving more, and how to apply savings strategies for purchasing large appliances (toohey & toohey, 2000: 13-58). sajems ns 10 (2007) no 1 27 (d) income tax planning individuals should know about the basics of income tax planning, including how to determine their taxation liability and the different types of taxes payable. the basics of income tax planning include the definition of tax, the principles of income tax, the income tax act, the margo report, the importance of keeping tax records, managing taxes, the various ways to pay tax and places to get help; these must included in the requirements framework (jordaan, 1989; gitman & joehnk, 1990; whittaker et al, 1990; kapoor et al., 1991; gordon-fish, 1994; dewing, 1995). determining one’s taxation liability involves understanding the tax year and tax rates, methods of avoiding tax, tax-cutting strategies and tax evasion versus tax avoidance, as well as how to document income and expenses, how to complete a tax return, and what to do if one is audited (garman & forgue, 1988; gitman & joehnk, 1990; kapoor et al., 1991; rosefsky, 2002). the different kinds of tax include estate duty and capital transfer tax, transfer duty, stamp duty, the tax implications of retirement and its impact on a will and the standard income tax on employees (site) (garman & forgue, 1988: 99-229; jordaan, 1989: 181-200; gitman & joehnk, 1990: 98-128; sylvia & horne, 1992: 33-83; swart, 2002: 69-75). 5.3 component 3: risk management risk management includes an overview of insurance and assurance, and what medical and hospital options are available. (a) insurance overview an insurance overview should contain a definition of insurance, the concept of risk management, the difference between insurance (short-term) and assurance (long-term), the process of applying for insurance, risk assessment, lodging a claim, the regulation of insurance and selecting an insurance agent (fowler, 1987; garman & forgue, 1988; whittaker et al., 1990; gitman & joehnk, 1990; kapoor et al., 1991; sylvia & horne, 1992; dewing, 1995). various kinds of insurance are available, including fire, theft, all risk, engineering, glass, marine and transport, first loss, aviation, motor vehicle, liability, credit, surety or fidelity, loss of profits and legal expenses. other types of insurance include personal accident and sickness, endowment “insurance,” and the classification of pure risks and business insurance (fowler, 1987; jordaan, 1989; burger, 1990; gitman & joehnk, 1990; sylvia & horne, 1992; dewing, 1995). a description of group insurance should include the various types, continuation options, contributions to personal security programmes, group disablement and group life insurance (fowler, 1987). individuals also need to understand policy wording and concepts such as “utmost good faith”, indemnity (not for profit), substitution rights of insurer, the average clause, insurable interest, reinsurance and actuaries (fowler, 1987; gitman & joehnk, 1990). (b) assurance overview an overview of assurance should contain a definition of assurance, the reasons for life assurance, the difference between a policy owner and a policy holder, the basic elements of an assurance policy and drawing up a personal prosperity plan. aspects of assurance coverage include assurance policies with profits and nonprofit policies, the “basic building blocks” of an assurance policy, disablement insurance, how premiums are determined, variable or linked policy benefits, profit sharing policy benefits, capital bonuses policy benefits, how inflation affects policy values, lodging a claim and the payment of benefits. also important are the life assurance requirements over one’s lifetime and the purchasing of life assurance (fowler, 1987; garman & forgue, 1988; sylvia & horne, 1992). 28 sajems ns 10 (2007) no 1 various types of assurance policy packages exist, such as: whole life assurance, endowment, annuities, certain immediate and deferred, retirement annuity, terms, level or decreasing, guaranteed insurability, accident benefits, disability, dreaded disease, premium waivers, income protection, joint life insurance, key man insurance, deferred compensation and partnership insurance (fowler, 1987; sylvia & horne, 1992). these need to be adequately understood. the concepts and wording of the assurance policy such as the growth factor, brokers and surrendering a policy must be understood (fowler, 1987; gitman & joehnk, 1990; sylvia & horne, 1992). (c) medical aid and hospital plans important aspects of health cover/medical aids include the nature and importance of medical costs, factors that affect health, providing for medical expenses, the types of health insurance cover, determining health insurance requirements, the health insurance policy, the principles of health insurance, the cost of medical care and loss of income and the life office association (fowler, 1987; garman & forgue, 1988; kapoor et al., 1991; sylvia & horne, 1992; gordon-fish, 1994). understanding the health-care system includes knowing about the medical services offered by the various types of hospitals and clinics, the ambulance services, the hospice and various other ways to stay healthy (sylvia & horne, 1992; gordon-fish, 1994). group schemes for medical aid and medical benefits are also important (fowler, 1987). 5.4 component 4: investing in financial resources investing in financial resources requires knowing about various aspects relating to accommodation, vehicles and investment planning. (a) accommodation rental accommodation involves aspects such as available housing alternatives, housing space, life values and goals, the pros and cons of buying and renting, shopping for rentals, ways to negotiate a lease agreement, the lease and some important clauses (for example month-to-month tenancy), combinations of leasing and buying, rental laws, terminating a lease and helpful advice regarding leasing (garman & forgue, 1988; kapoor et al., 1991; sylvia & horne, 1992; gordon-fish, 1994; liberman & lavine, 1994; rosefsky, 2002). pre-purchase factors for consideration when buying a home include the dilemma in timing the purchase of the dwelling at the right price, factors that affect the price of a home, making the purchase, financing a home, calculating affordability (including the government subsidy), the various aspects of a mortgage bond and an overview of timeshare. there are various types of home ownership, namely sectional title, share block, cluster housing, plot and plan schemes and self-help schemes (garman & forgue, 1988; sylvia & horne, 1992; kapoor et al., 1991; gordon-fish, 1994; rosefsky, 2002). the cost of purchasing a home includes ‘hidden’ costs arising from property insurance, property taxes, utilities, maintenance and repairs and the laws regulating housing. an overview regarding home improvements and extensions is also an important factor in the framework (garman & forgue, 1988; sylvia & horne, 1992; rosefsky, 2002). preparing a home for sale includes aspects such as setting a price, options in selling a house, contracting an estate agent versus selling it yourself, tax implications, documenting the sale, when to sell a house, the transfer, possession of the property, the concept of ‘voetstoots’ and taking the moving expenses into account (garman & forgue, 1988; sylvia & horne, 1992; gordon-fish, 1994; rosefsky, 2002). (b) vehicles an overview of buying new and used vehicles includes setting the criteria for choosing a vehicle, checking the condition of the vehicle and the roadworthy certificate, transferring ownership, examining the cost of optional extras, sajems ns 10 (2007) no 1 29 exploring trade-in, warranties and guarantees. various financing options are included, such as, where to get a vehicle loan, simple interest on a vehicle loan, the deposit, terms of the loan, tax-free borrowing for a vehicle, variable-rate vehicle loan, leasing versus purchasing of a vehicle, negotiating the best price for a vehicle, different ways to save money and repossessing a vehicle (garman & forgue, 1988; kapoor et al., 1991; sylvia & horne, 1992; liberman & lavine, 1994). (c) investment planning an investment planning strategy should include setting investment goals and an investment philosophy, choosing alternative investments, exploring factors affecting the rate of return, achieving investment goals, choosing fixed asset investments and using computer-based investment analysis (garman & forgue, 1988; chambliss, 1990; gitman & joehnk, 1990; toohey & toohey, 2000; rosefsky, 2002). 5.5 component 5: planning the future planning the future consists of estate and retirement planning and planning a will. (a) estate and retirement planning the main activities of estate planning should include meeting retirement goals, deciding when to start planning for retirement, and understanding estate planning, limited rights, the jargon of estate planning, what an estate plan should accomplish and how estate taxes work. the most essential part of retirement planning is providing for a surviving spouse and other heirs (including minors), planning for continuity, massing a will, ensuring substitution, appointing executors and administrating an estate. additional factors to consider are inflation, financial planning for retirement, investment strategies for retirement, the role of a trust in estate planning, the types of retirement accommodation that are available, tax-sheltered retirement benefits and the main sources of retirement income (garman & forgue, 1988; gitman & joehnk, 1990; kapoor et al., 1991; toohey & toohey, 2000; rosefsky, 2002). (b) planning a will wi l l s a n d o t h e r d e v i c e s f o r p a s s i n g o n accumulated wealth, including trusts, donation tax and transfers at death, are also important in the framework (garman & forgue, 1988; gitman & joehnk, 1990; rosefsky, 2002). 5.6 component 6: miscellaneous the miscellaneous component is the most dynamic of all the components, as any subject of a current or common nature that affects individuals financially may be included. this section includes finances in marriage and parenting, advice and assistance ‘persons’ and consumer complaints. (a) finances in marriage and parenting the term marriage includes common-law marriage. the section includes finances in marriage, finance in parenting, where to find help in times of crisis, registering a birth, teaching children “at the dinner table”, spending money on children, financial discipline and children, setting high expectations for children without driving them insane and getting through the “problem” years without losing money or one’s mind (sylvia & horne, 1992; toohey & toohey, 2000). (b) advice and assistance advice and assistance includes legal aid organisations, the consumer council, family planning, child welfare, substance abuse organisations, physical abuse organisations and emotional/psychological counselling organisations (dewing, 1995). (c) consumer complaints consumer complaint procedures should be clearly understood. a complaint should be directed to the organisation concerned through its progressive tiers of management. if this approach fails formal complaints can be lodged with quasigovernmental/community agencies that can assist consumers in resolving problems with goods and services (mccorkle, et al., 2002). 30 sajems ns 10 (2007) no 1 table 2 outlines the components contained in the proposed financial management requirements framework. table 2 proposed personal financial management requirements framework component 1: basic concepts in personal finances component 2: management of personal finances component 3: risk management • the process • the economic environment • income from the viewpoint of education and the job • budgeting: • credit • savings • income tax planning • insurance • assurance • medical aids and hospital plans component 4: investing financial resources component 5: planning the future component 6: miscellaneous • accommodation • vehicles • investment planning • estate and retirement planning • planning a will • finances in marriage and parenting • advice and assistance • consumer complaints the components outlined in table 2 constitute a framework that can be used to evaluate the personal financial management knowledge of individuals. individuals are expected to have knowledge of these components to be able to manage their personal finances. 6 evaluation by personal financial management experts 6.1 the sample a sample of twenty personal financial management experts in south africa was invited to evaluate the proposed personal financial management requirements framework (table 2). the names of these personal financial management experts were sourced from various websites, telephone directories and telkom’s number enquiry call-centre. of the twenty experts invited, nine were willing to evaluate the framework. three of the nine personal financial management experts are well known financial experts in south africa. of the financial experts, 67 per cent are from the gauteng area and 11 per cent each from western cape, eastern cape and kwazulu natal. 6.2 how the evaluation was performed the sample of twenty personal financial management experts were each e-mailed or faxed an invitation to participate, the personal financial management requirements framework (table 2) and a questionnaire. the purpose of the invitation was to explain the objective of the research and its expected outcomes, to assure prospective participants of confidentiality and to indicate the researcher’s contact details. the questionnaire indicated the task requirement, the time involved in the evaluation process, the due dates and the questions requiring answers. the completed (signed and dated) invitations were returned to the researcher by fax or e-mail, who then sent an explanation of the framework to the expert for complete evaluation. as mentioned above, nine completed invitations were returned. 6.3 the questionnaire the questionnaire consisted of four openended questions that required an analysis of the framework and comments on the components. the intention of the questionnaire was to obtain qualitative data and an in-depth analysis of the content. sajems ns 10 (2007) no 1 31 6.4 reliability and validity of the study in content analysis, the method used to develop the personal financial management requirements model, information is broken down conceptually and put back together in new ways (de vos, strydom, fouch & delport, 2002). there are various ways of confirming or validating qualitative data. one such method, namely theoretical validity, requires that there be common agreement among the researcher and the participants about the concepts or theory used to explore the phenomena being investigated (struwig & stead 2001). the intention of the qualitative study was thus to ensure that the personal financial management requirements model developed by the researcher does indeed contain relevant and necessary concepts. in qualitative research, reliability is also synonymous with consistency. proper text analyses were done to ensure that the results were reliable. 6.5 the findings of the personal financial management experts (a) the respondents all the respondents are certified financial planners and most of them have post-graduate qualifications. with the exception of one respondent, who has eight years’ experience, the respondents all have more than ten years experience in the financial planning business. two thirds of the respondents are male and one third female. (b) analysis of the experts’ findings the consensus of the personal financial management experts who responded is that the requirements framework indeed covers what the average south african citizen should know regarding personal financial management. the main criticism involves the depth of the framework content. two of the respondents stated that the framework may include too many aspects and in fact includes more than what the average individual should know about personal financial management. themes that emerged from this analysis include the following: • personal finance is a skill that is learnt by doing rather than by theoretical learning; • money is an emotional subject; • your financial plan should be driven by your lifestyle goals; • each individual should have a life plan; • each individual has a money personality that influences his or her behaviour; and • individuals may not see insurance and investments as separate. 7 conclusions and recommendations the personal financial management requirements framework developed can be used in various ways. firstly, it can be used to investigate and analyse the personal financial management knowledge of individuals to ensure proper training and education in specific areas. secondly, it can be used as a theoretical base to develop an instrument to investigate the personal financial knowledge of individuals. the proposed personal financial requirements framework includes six cardinal components, namely: 1. basic concepts in personal finances; 2. management of personal finances; 3. risk management; 4. future planning; 5. investing in financial resources; and 6. miscellaneous. this framework was examined and evaluated by leading personal finances experts. these experts agreed that the personal financial requirements framework indeed covers what the average south african citizen is required to know about personal finance. the themes that emerged in analysing the responses of the personal financial management experts provide valuable guidelines for developing an instrument to investigate the personal financial management knowledge of individuals. suggestions include the following: • practical exercises will be necessary as personal finances is a skill that is developed by doing; • lifestyle planning and management are important; and • proper understanding of what investments are will be required. 32 sajems ns 10 (2007) no 1 the real test of this framework will be utilising it for the development of an instrument to test individuals’ knowledge of personal financial management. the process of testing the framework, however, warrants a separate article. references 1 burger, m. 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(2004) core concepts of personal finance, john wiley: new york. abstract introduction literature review research design research method results discussion practical implications conclusion acknowledgements references about the author(s) leoni van der vaart school of industrial psychology, faculty economic and management sciences, north-west university, optentia research focus area, vanderbijlpark, south africa citation van der vaart, l., 2021, ‘the performance measurement conundrum: construct validity of the individual work performance questionnaire in south africa’, south african journal of economic and management sciences 24(1), a3581. https://doi.org/10.4102/sajems.v24i1.3581 original research the performance measurement conundrum: construct validity of the individual work performance questionnaire in south africa leoni van der vaart received: 23 feb. 2020; accepted: 22 oct. 2020; published: 27 jan. 2021 copyright: © 2021. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: performance remains high on the agenda of both researchers and practitioners, and rigorous measurement is central to evidence-based investigations. several instruments have been developed to measure performance, of which one – the individual work performance questionnaire (iwpq) – seems to be a scientifically rigorous instrument. despite the growth in iwpq validation studies, little is known about its psychometric properties in south africa. aim: the current study seeks to address the construct validity of the iwpq. the objective was to evaluate the construct (i.e. convergent, discriminant and nomological) validity of the instrument. setting: information technology professionals were targeted in the current study, and the final sample consisted of 296 employees. method: latent variable modelling was performed, using both independent cluster and exploratory structural equation model frameworks, with the meanand variance-adjusted weighted least squares estimator. the analysis was complemented with the heterotrait-monotrait method. results: the results supported the construct validity of the instrument. specifically, individual work performance was found to be a three-dimensional construct with acceptable convergent and discriminant validity. job resources were also related to the three performance dimensions. conclusion: the factor structure of the iwpq mirrors the factor structure found in the literature. researchers and practitioners can use this instrument in south africa to identify determinants and consequence of individual work performance, as well as to evaluate the effectiveness of performance improvement interventions. keywords: individual work performance questionnaire; autonomy; social support; coaching; opportunities for development; validation. introduction employee performance – ‘behaviours and actions that support organisational goals’ (campbell 1990:67) – matters for both individuals and organisations. high-performing individuals are rewarded with bonuses and advancement opportunities, whereas organisations gain a competitive advantage and higher financial returns (yeshitila & beyene 2019). information technology (it) professionals are particularly under pressure to perform because of the expectations resulting from the digitisation and automation of work (i.e. fourth industrial revolution) (van zyl et al. 2019). consequently, organisations are interested in ways to improve their (it) employees’ performance and often rely on the results of empirical investigations to make decisions relating to performance improvement (koopmans et al. 2011, 2015). reliable and valid research results are needed for organisational decision-making and can mainly be ensured through the use of psychometrically sound measuring instruments in investigations (see ramos-villagrasa et al. 2019). several instruments exist for measuring performance. one of these instruments, the individual work performance questionnaire (iwpq) (koopmans et al. 2013), was constructed using a conceptual framework developed from the results of a comprehensive review of the performance literature (koopmans et al. 2011). the instrument not only has a solid theoretical underpinning, but its developers took an iterative approach in developing and improving the questionnaire before making it available for use. several other advantages also exist: (1) as a multidimensional instrument, it captures the full range and complexity of performance behaviours necessary in the contemporary world of work, (2) it is a generic instrument that can be used in any organisation, enhancing its practical usefulness and enabling the generalisation of findings across studies, and (3) it is also short (18 items) and easy to administer (dåderman, ingelgard & koopmans 2020; koopmans et al. 2013). the initial study (koopmans et al. 2013), as well as several follow-up studies (koopmans et al. 2014a, 2014b), demonstrated the psychometric soundness of the questionnaire in the netherlands: validity (i.e. face, structural, construct, convergent and discriminant) and reliability. the instrument has since been translated and validated in some countries outside of the netherlands: argentina (gabini & salessi 2016), indonesia (widyastuti & hidayat 2018), north america (koopmans et al. 2015), spain (ramos-villagrasa et al. 2019) and sweden (dåderman et al. 2020). all these studies are in support of the psychometric soundness of the instrument. despite the growth in iwpq validation studies, three noteworthy limitations still exist: firstly, published studies are scarce and mostly limited to the netherlands. secondly, to date, none of them was conducted in south africa. results of validation studies cannot be generalised indiscriminately because the importance of the different performance dimensions and the exact indicators associated with each dimension may be context-dependent (koopmans et al. 2011). self-report measures also require individuals to reflect on their lived experiences, and these experiences are often influenced by cultural elements (lenz et al. 2018). lastly, almost all of the previous studies were done using a confirmatory factor analysis (cfa) framework, despite more recent studies showing that the underlying assumptions of this framework may be too restrictive for the social sciences domain (morin, arens & marsh 2016a; howard et al. 2018). the current study aims to address these limitations by investigating the psychometric properties (i.e. validity and reliability) of the instrument in a sample of it professionals in south africa. the current study also uses an exploratory structural equation (esem) approach, which relaxes some of the assumptions of the cfa framework (howard et al. 2018). in doing so, the article contributes to the limited literature on the validity of the instrument outside of the netherlands, using appropriate and sophisticated statistical techniques. the potential benefit from an organisational perspective is to provide organisations with a psychometrically sound performance measuring tool to identify the determinants and outcomes of performance behaviours and to evaluate the effectiveness of performance improvement interventions. literature review individual work performance questionnaire a lack of consensus regarding the definition and operationalisation of performance resulted in several measuring instruments being developed to measure employee (or individual) performance. using different definitions and instruments is problematic as it makes it challenging to identify and reach consensus about the determinants and consequences of individual performance and prevents us from evaluating the effectiveness of interventions (koopmans et al. 2013, 2014a). a comprehensive definition, that most researchers will agree with, is the first step in facilitating the development of an instrument that is able to measure the construct optimally (koopmans et al. 2011, 2013). guided by campbell’s widely accepted definition of work performance and a thorough systematic review of the occupational health, work and organisational psychology, as well as management and economics literature, koopmans et al. (2011) performance operates by means of four dimensions: task performance, contextual performance, adaptive performance and counterproductive work behaviour. task performance (tp) is defined as ‘proficiency with which central job tasks are performed’ (koopmans et al. 2011:862). these types of behaviour may vary across jobs and are usually prescribed by the job description (aguinis 2013). task performance behaviours include, for example, completing job tasks, updating knowledge, and planning and organising (koopmans et al. 2011). contextual performance (cp) is defined as ‘behaviors that support the organizational, social, and psychological environment in which the technical core must function’ (koopmans et al. 2011:862). these behaviours go beyond the job description and refer to, for example, taking initiative and being proactive (koopmans et al. 2011). adaptive performance (ap) is defined as ‘behaviors in reaction to the work environment’ (koopmans et al. 2011:862). these behaviours include, for example, generating new and innovative ideas or being flexible and open-minded with others (koopmans et al. 2011). counterproductive work behaviour (cwb) is defined as ‘behaviors that harm the well-being of the organization’ (koopmans et al. 2011:862) and included, for example, presenteeism, theft or substance abuse (koopmans et al. 2011). following conceptualisation and operationalisation of work performance, koopmans and colleagues followed an iterative process to develop, improve and validate the different versions of the instrument. initially, koopmans et al. (2013) developed a 47-item version of the questionnaire (iwpq 0.1) based on selected indicators from the literature review. after piloting the instrument to evaluate face validity, clarity and readability, they administered the instrument among a representative sample of dutch employees. results of their study indicated, firstly, that three dimensions fit the rasch model significantly better than four dimensions: ap should merge with cp (koopmans et al. 2013). the findings, secondly, indicated which generic items fitted the rasch model for all occupational sectors and resulted in a 14-item version of the scale (iwpq 0.2) (koopmans et al. 2013). lastly, person-item threshold maps indicated that the discriminative ability of the instrument could be improved by including items that measure work performance at the higher (for tp) and lower (for cwb) ends of the scale (koopmans et al. 2013). due to poor targeting of some of the iwpq 0.2 items, more difficult items were added for tp and cp and easier items for cwb that resulted in a 27-item version (iwpq 0.3) of the instrument. the items were again tested in a representative sample of dutch employees, with a series of analyses indicating items that should be deleted in the final version to improve the targeting of the instrument. the final version (iwpq 1.0) resulted in five items measuring tp, eight items measuring cp and five items measuring cwb, and results indicated a good fit to the rasch model and acceptable reliability coefficients ranging from 0.74 to 0.85 (koopmans et al. 2014b). the construct and discriminative validity of the iwpq 1.0 was consequently supported in the netherlands (koopmans et al. 2014a). since these initial studies, the self-report scale has been validated in various countries outside of the netherlands: north america (koopmans et al. 2015), indonesia (translated) (widyastuti & hidayat 2018), spain (translated) (ramos-villagrasa et al. 2019), argentina (gabini & salessi 2016) and sweden (translated) (dåderman et al. 2020). results from these studies support the face, content, construct, convergent and discriminant validity of the instrument as well as its internal consistency. consistent with theory, for the present study, it is hypothesised that: h1: individual work performance is a three-dimensional construct. h2: the iwpq displays acceptable convergent validity. h3: the iwpq displays acceptable internal consistency. all, but one (see ramos-villagrasa et al. 2019) iwpq validation studies evaluate the construct (i.e. factorial) validity of the instrument using cfa. confirmatory factor analysis is by far the most widely used method to evaluate construct validity in psychological research, when compared to esem. few instruments meet the cut-off criteria for fit statistics and may then be deemed worthless (howard et al. 2018). consequently, researchers question the inherent independent cluster model (icm) constraints of cfa. these constraints imply that cross-loadings between items and non-target factors should be constrained to zero (howard et al. 2018). although one cannot ignore the benefits of these constraints, that is, more parsimonious models and clearly defined constructs, the assumptions underlying these constraints may not be ideal for psychological measures as they often measure closely related constructs. hence, the conceptual overlap between constructs results in items that are hardly ever uniquely related to a single construct (howard et al. 2018; morin et al. 2016a). an alternative to cfa is esem, a novel approach that allows items to cross-load on non-target factors when assessing conceptually related constructs (morin et al. 2016a, 2016b). therefore, esem enables researchers to circumvent the restrictive assumptions inherent in icm-cfa that often leads to over-inflated correlation coefficients. exploratory structural equation modelling integrates exploratory factor analysis, cfa and structural equation modelling into a single model. this integration allows researchers to optimise the benefits of each in one model (for a detailed overview of cfa vs esem, refer to howard et al. 2018). in addition to a cfa model, the current study will also specify an esem model as the three performance dimensions are conceptually related, resulting in items that may not be uniquely related to a particular performance dimension. this is particularly so for tp and cp. the lines, between what an employee is supposed to do as part of their job description (i.e. in-role) and what is considered additional tasks (i.e. extra-role), may become potentially more blurred in the current work environment (koopmans et al. 2011). job resources’ association with individual work performance to further test for construct (i.e. discriminant validity and nomological) validity (hair et al. 2014), the context of the job-demands resources (jd-r) theory was used (demerouti et al. 2001) in which job resources affects work performance via a motivational process (bakker & demerouti 2017). job resources can be defined as: … physical, psychological, social, or organizational aspects of the job that may […] be functional in achieving work goals, reduce job demands and its related costs, or stimulate personal growth and development. (demerouti et al. 2001:501) job resources is frequently cited in work design models when explaining the impact of work on performance (van veldhoven et al. 2020) and meta-analytic results support the link between job resources and performance at work (christian, garza & slaughter 2011). resources, such as autonomy, social support, coaching and opportunities for development, potentially satisfy basic psychological needs and, therefore, exert a motivational effect that enhances performance. the self-determination theory (sdt; ryan & deci 2017), and more specifically the basic psychological need mini-theory (bpnt; ryan & deci 2017) of the sdt, holds that individuals have three basic psychological needs. autonomy concerns the need to experience volition and willingness and results in one experiencing one’s actions, emotions and thoughts as self-endorsed. competence concerns the need to experience a sense of effectiveness while also mastering the environment. relatedness involves the need to develop meaningful and satisfying relationships but also a sense that one is adding value to the lives of others (vansteenkiste et al. 2020). within bpnt, it is argued that need satisfaction can be fostered through need supportive behaviour by key organisational figures (ryan & deci 2017). leaders and co-workers that provide: (1) others with autonomy to satisfy employees’ need for autonomy, (2) coaching and opportunities for development that are likely to enhance feelings of competence and relatedness and (3) social support to satisfy others’ need for relatedness. van den broeck et al. (2016) demonstrated the beneficial effects of experiencing autonomy, competence and relatedness on good quality motivation and performance. taken together, the jd-r model and sdt provide evidence that job resources are associated with optimal performance (van wingerden et al. 2018). consistent with theory, in the present study, it is hypothesised that: h4: the iwpq will display acceptable discriminant validity. h5: autonomy, social support, coaching and opportunities for development are positively associated with tp (5a) and cp (5b) but negatively associated with cwb (5c). research design research approach for the purposes of this study, a quantitative research approach was followed with a cross-sectional survey design. this approach and design enabled the exploration of the factor structure (or the dimensionality) of the instrument and the associations between the performance constructs and job resources at a specific moment in time. research method participants a convenience sample of 296 it professionals across various organisations in south africa was included. information technology professionals were defined as those employees who test, build, install, repair or maintain computer software systems. the population is deemed appropriate for validating the questionnaire for two reasons: it professionals play an increasingly important role in the fourth industrial revolution (van zyl et al. 2019) and their work is considered highly complex knowledge work. consequently, they must perform their core tasks (tp) well. at the same time, there are both the expectation and opportunity to generate innovative solutions (cp) as well as additional pressure that may make them more susceptible to negativity (cwb). the final sample comprised mainly men (74.3%; n = 220). the average age of the respondents was 37 years (sd = 9.81), and the average tenure in their current position was 6 years (sd = 5.85). measuring instruments a biographical questionnaire was used to obtain information regarding the participants’ age, gender and years of experience within their position to describe the sample. individual work performance was measured using the iwpq 1.0 developed by (koopmans et al. 2014b). task performance consisted of five items (e.g. ‘i kept in mind the results that i had to achieve in my work’), cp of eight items (e.g. ‘i continually sought new challenges in my work’) and cwb of five items (e.g. ‘i talked to colleagues about the negative aspects of my work’). participants were asked to reflect on how frequently they displayed a particular behaviour during the past three months ranging from 1 (seldom) to 5 (always) and 1 (never) to 5 (often) in the case of cwb (koopmans et al. 2014b). autonomy, social support, coaching and opportunity for development was measured using the job demands-resource questionnaire (bakker 2014). participants were expected to rate their work situation on a five-point frequency scale ranging from 1 (never) to 5 (very often). autonomy consisted of three items (e.g. ‘do you have control over how your work is carried out?’), social support consisted of three items (e.g. ‘if necessary, can you ask your colleagues for help?’), coaching consisted of five items (e.g. ‘i feel valued by my supervisor’ and opportunities for development consisted of three items (‘in my work, i can develop myself sufficiently’) (bakker 2014). research and ethics procedure ethics approval was granted by the research ethics committee of the university (nwu-hs-2017-0046). the following ethical considerations guided data collection: (1) participants were not put at risk unnecessarily; they were also respected at all times, (2) participants were provided with an information letter covering aspects such as inclusion criteria, purpose of the research and the possible publication of anonymous results, benefits for the participants, the expectations or requirements from participants, possible risks and mitigation thereof where possible, guarantee of anonymity and confidentiality, the right to withdraw from the study without foreseen negative consequences, and contact details of individuals in the event that the participant needs more details regarding the research, and (3) participants were asked to consent to participation before continuing with the questionnaire. convenience sampling, in which potential participants are sampled because they are more available when a probability sample is not possible for sources of data (creswell & creswell 2018), was utilised. data was collected via three avenues to ensure a more heterogeneous sample: (1) approaching it-related organisations in the johannesburg area, (2) a professional social media platform (i.e. linkedin) and (3) a data collection and research solutions company. a short introductory summary of what the study entailed, a google forms link to the consent form, and the questionnaire were sent. regarding the data collection company, inclusion criteria for the sample were provided to source participants after which the same mail was sent to them. statistical analysis for the descriptive statistics, rstudio version 1.2.5033 (rstudioteam 2019) was used with r base-version 3.6.2 (rcoreteam 2019). in rstudio, the ‘psych’ package’s describe function was used to calculate the means and standard deviations for each of the factors in the model (revelle 2018). mplus 8.4 (muthén & muthén 1998–2019) was used to perform the cfa and esem analyses and to calculate the reliability coefficients. to evaluate construct validity, hair et al. (2014) recommend one investigates convergent, discriminant and nomological validity. the first step was to evaluate the factor structure (or the dimensionality) of the iwpq that will be used in subsequent analyses. this step entailed comparing different measurement models for iwpq, guided by the literature and using both cfa and esem frameworks. the meanand variance-adjusted weighted least squares (wlsmv) estimator was used due to the categorical nature of the data (kline 2016). acceptable model fit statistics, indicated by several goodness-of-fit indices, also indicate acceptable construct validity (hair et al. 2014). the following cut-off criteria were used to evaluate the model fit (kline 2016): root mean square error of approximation (rmsea) ≤ 0.08, standardised root means square residual (srmr) ≤ 0.10, tucker-lewis index (tli) and the comparative fit index (cfi) ≥ 0.95. next, tests for convergent and discriminant validity were implemented. convergent validity was evaluated based on (1) the standardised factor loadings of items ≥ 0.50 or ideally ≥ 0.70, (2) an average variance extracted (ave) of ≥ 0.50 and (3) construct reliability (cr) of ≥ 0.70 (hair et al. 2014). in order to evaluate the reliability of the measuring instrument, composite reliability coefficients (ρ) were calculated as they are deemed more appropriate for latent variables (raykov 2009). cronbach’s coefficient alpha is also reported for potential future comparison by other researchers. for cronbach’s coefficients, the ‘scalereliability’ function was used from the ‘userfriendlyscience’ r package (peters 2018). discriminant validity was assessed by the: (1) ave of each construct being greater than their shared variance with other variables (hair et al. 2014) and (2) heterotrait-monotrait (htmt) ratio of correlation with values close to 1.00 indicating a lack of discriminant validity. using the htmt as a criterion involves comparing it to a predefined threshold. if the value of the htmt is higher than this threshold, one can conclude that there is a lack of discriminant validity (henseler, ringle & sarstedt 2015). some authors suggest a threshold of 0.85 (kline 2016) whereas others suggest a threshold of 0.90 (gold, malhotra & segars 2001; teo et al. 2008). the ‘semtools’ package’s ‘htmt’ function was used to calculate the htmt values in this study (jorgensen et al. 2019). nomological validity was evaluated by estimating the correlations between the performance constructs and autonomy, social support, coaching and opportunities for development. previous studies suggest that more favourable evaluations of the latter should relate to more favourable evaluations of tp and cp, whereas the opposite would be expected for cwb. the standard cut-off criteria were used for effect sizes: r = 0.10–0.29 (small effect), r = 0.30–0.49 (medium effect) and r ≥ 0.50 (large effect) (cohen 1992). results factorial structure of the individual work performance questionnaire six competing measurement models were estimated. in the first model, the items were allowed to load onto their respective a priori factors – tp (five items), cp (eight items) and cwb (five items) – in line with previous research (koopmans et al. 2014a; ramos-villagrasa et al. 2019). the three factors were allowed to correlate. in the second model, the items loaded onto their respective a priori factors but the three performance factors were then allowed to load onto a second-order (performance) factor as recommended by (koopmans et al. 2011). the third model was similar to model 1, except the items were also allowed to load onto a general (performance) factor. all these models correspond to the icm-cfa framework: cross-loadings were constrained to zero. models 4 to 6 were the esem versions of the three icm-cfa models. exploratory structural equation modelling was specified using target rotation: all items were freely estimated on their a priori factors, but they were also allowed to cross-load. the cross-loadings were targeted to be close to zero, as is usual in esem modelling (gomes, almeida & núñez 2017). table 1 presents the goodness-of-fit indices for each of the estimated models. table 1: fit statistics for the measurement models. all models demonstrated acceptable fit when compared to most of the goodness-of-fit cut-off criteria. when comparing the different icm-cfa models with each other, the 90% confidence intervals for the rmsea showed several overlaps between the solutions, indicating a low degree of differentiation between competing models. in each case, the cfi and tli were above and the srmr value below the required cut-off values. consequently, none of the models seems to be superior compared to the others. when comparing the icm-cfa models with their esem counterparts, the cfi and tli values of models 4 and 5 are lower than models 1 and 2, and their rmsea values are higher. the esem counterparts have a poorer fit to the data than their icm-cfa counterparts. additionally, few of the cross-loadings in the esem model were significant (see table 2) and the correlations between the performance variables were within acceptable bounds (see table 3). model 6 has the best cfi, tli and srmr values; however, its 90% confidence intervals for the rmsea again overlaps with that of the icm-cfa models indicating little differentiation. in this case, the most parsimonious model (with fewer parameters estimated) is preferred (howard et al. 2018), that is, model 1. this lends support for hypothesis 1. table 2: standardised factor loadings for independent and exploratory structural equation modelling. table 3: means, standard deviations, reliability and correlations. none of the models’ root mean square error of approximation (rmsea) values met the minimum criteria of ≤ 0.08 and, consequently, model improvement was performed guided by high modification indices (mi) values. the residual item-variances of cp3 (‘i worked on keeping my job-related knowledge up-to-date’) and cp4 (‘i worked on keeping my work skills up-to-date’) and cwb4 (‘i talked to colleagues about the negative aspects of my work’) and cwb5 (‘i talked to people outside the organisation about the negative aspects of my work’) were allowed to correlate. correlated residuals are permitted when the items measure the same construct (hair et al. 2014; kline 2016) and can be a consequence of similar prompts (i.e. updating of…) or overlapping item content (i.e. negativity). these modifications resulted in a model with a very good fit to the data: χ2 = 393.25 (p < 0.001), df = 130, cfi = 0.97, tli = 0.97, rmsea = 0.08 [0.08, 0.09], and srmr = 0.05. convergent and discriminant validity based on the most parsimonious individual work performance questionnaire (ipwq) measurement model, a full measurement model was constructed in which autonomy, social support, coaching and opportunities for development were included. the initial model presented with an ultra heywood case – cwb3 had a standardised factor loading exceeding 1.00 and cwb5 had a standardised factor loading of less than 0.50. these two items were consequently removed from the model and the final model had a very good fit to the data: χ2 = 1047.77 (p < 0.001), df = 383, cfi = 0.95, tli = 0.95, rmsea = 0.07 [0.07, 0.08] and srmr = 0.06. the model is depicted in figure 1. the criteria for convergent validity was met. all factor loadings were significant and above 0.50 (most are above 0.70) (see table 2). the ave of each construct was above 0.50: for tp ave was 0.70, for cp 0.63, for cwb 0.52 and all cr values exceeded 0.70 (see table 3). this provides support for hypotheses 2 and 3. figure 1: final confirmatory factor analysis model. for discriminant validity, the ave of each construct should be greater than their shared variance (hair et al. 2014). the ave for all the variables ranged from 0.52 to 0.82. the shared variance between the performance dimensions ranged from 0.04 to 0.47 and between the performance dimensions and autonomy, social support, coaching and opportunities for development, the shared variance ranged between 0.00 and 0.34. furthermore, results of the htmt analyses showed values ranging from 0.16 to 0.59 which is below the lowest recommended thresholds of 0.90 and 0.85. therefore, discriminant validity was supported between all constructs suggesting that this performance measure is independent of other related constructs and that the performance dimensions are also independent of each other. this result supported hypothesis 4. nomological validity table 3 contains the correlation coefficients between the performance constructs and autonomy, social support, coaching and opportunities for development. most of the correlations are significant, and they are all in the expected direction providing support for the nomological validity of the instrument. in terms of the correlations, all three performance factors correlated with each other: tp had a positive relationship with cp (r = 0.69; large effect) and both tp and cp had negative relationships with cwb (r = −0.27 and r = −0.21; small effect). task performance had significant positive relationships with autonomy (r = 0.58; large effect), social support (r = 0.19; small effect), coaching (r = 0.33; medium effect) and opportunities for development (r = 0.44; medium effect). this supports hypothesis 5a. contextual performance had significant positive relationships with autonomy (r = 0.58; large effect), coaching (r = 0.24; small effect) and opportunities for development (r = 0.52; large effect) but was unrelated to social support (r = 0.08, ns). counterproductive work behaviour was only significantly negatively related to autonomy (r = −0.24; small effect) and opportunities for development (r = −0.16; small effect). these results provide partial support for hypotheses 5b and 5c. additionally, using the decision-making tree provided by podsakoff et al. (2003), a latent common methods variance factor was added to the measurement model to test for common method bias (cmb). in this model, items load onto their a priori theoretical construct as well as onto the latent common methods variance factor. the factor loadings of the two models (i.e. with and without the latent common methods variance factor) are compared and a change in the factor loading values of more than 0.20 is deemed problematic: such items may be affected by cmb. results indicated that one item of each of the autonomy, social support and opportunities for development scales and three items of the coaching scale may be affected by cmb. these items were removed from the measurement model (without the latent common methods variance factor) and the correlation coefficients of this model were compared to the model with the latent common methods variance factor. results indicated that the relationships were almost identical, with no substantial deviations. therefore, cmb was not considered a concern in this study. discussion given the academic and organisational importance of performance, scientifically rigorous measurement is imperative. the current study aimed to contribute to the limited body of knowledge on the psychometric properties of the iwpq by validating (i.e. convergent, discriminant and nomological) the instrument in a south african context. results demonstrated that the instrument is valid for a sample of it professionals in south africa. this means that the constructs are accurately operationalised in this specific sample – the indicators measure the latent constructs (i.e. tp, cp, and cwb) as they are intended to. more specifically, results indicate that individual work performance comprises three separate but related constructs. this is in line with studies from other countries (koopmans et al. 2014a; ramos-villagrasa et al. 2019). the findings indicate that researchers should refrain from calculating one performance score as important information relating to each performance dimension will be lost if we were to assume that performance can be summarised with a single score. even though the operationalisation of tp and cp, and for the biggest part of cwb, accurately reflects their respective constructs, two problematic items were highlighted in the cwb sub-scale: ‘i focused on the negative aspects of situation at work instead of the positive aspects’ and ‘i talked to people outside the organization about the negative aspects of my work’. pending replication of the current results, the finding suggests that the psychometric properties of these two items should be carefully monitored in future studies. from a methodological point of view, the results of the current study question the usefulness of more sophisticated analytical (i.e. esem) frameworks when modelling performance. although some support (see ramos-villagrasa et al. 2019) is starting to emerge for esem models, more research is needed to provide conclusive evidence regarding the factor structure of the iwpq. the results of the current study not only show that the indicators are good reflections of their respective latent constructs, but they also converge or share a high proportion of variance (i.e. convergent validity). this is in line with previous research (koopmans et al. 2014a; ramos-villagrasa et al. 2019) and indicates that the items measure the same underlying latent construct. at the same time, the results also indicate that the performance constructs are genuinely distinct from each other as well as from other constructs (i.e. discriminant validity), in line with previous research (koopmans et al. 2014a). it is not surprising that the two positive forms of performance are more strongly correlated with one another than with the negative form. the lines between tp and cp are often blurred in modern organisations and meta-analyses have found modest correlations between the cwb and the other two performance dimensions (koopmans et al. 2011). the instrument also measured performance consistently in the current study, which is in line with previous research (koopmans et al. 2015; ramos-villagrasa et al. 2019) and lends further support for its convergent validity. the results regarding the association between the iwpq dimensions and job resources are mostly as expected and provide evidence for the instrument’s nomological validity. the iwpq tp positively associated with all of the job resources in line with jd-r theory (bakker & demerouti 2017) and the bpnt (ryan & deci 2017). thus, having flexibility and control, receiving support from colleagues and supervisor, and having the opportunity to learn and develop oneself enable employees to perform their core job tasks well. the iwpq cp was related to all, but one, job resource – social support. although the other resources enable employees to create a conducive environment in which they can perform their core functions, this is not dependent on support and validation from colleagues. the iwpq cwb was only associated with autonomy and opportunities for development, but as expected in a negative direction. the findings suggest that support from colleagues and one’s supervisor does not prevent behaviour that harms the well-being of the organisation – as these associations were non-significant. although all the non-significant results were unexpected from a theoretical point of view, and although it could be the result of methodological artefacts, recent empirical studies challenge the universality of job resources (see van veldhoven et al. 2020 for an overview). in a series of papers, van veldhoven et al. (2020) argue that researchers should seek a more nuanced understanding of why, when and for whom job resources are beneficial. practical implications the current study presents it organisations with a psychometrically sound performance measuring tool that they can use to identify the determinants and outcomes of performance behaviours and to evaluate the effectiveness of performance improvement interventions. a scientifically rigorous instrument that goes beyond measuring prescribed job tasks is essential in modern-day organisations where employees are often expected to go beyond the scope of the tasks allocated to them (carpini, parker & griffin 2017; griffin, neal & parker 2007). in improving tp and cp performance and lowering cwb, organisations can consider providing employees with more flexibility and control, encouraging team cohesion through team building activities, developing empowering leaders (supervisors) and providing employees with enough opportunities to learn and develop new skills. limitations and recommendations the study is not without limitations. most noteworthy is the use of a cross-sectional survey design. although cross-sectional designs are still useful for exploratory studies where limited information is available (spector 2019), they pose a limitation for the evaluation of predictive validity. the study also made use of self-report surveys. although self-report surveys have several advantages in performance research (i.e. easily obtainable, employees have more opportunities to observe own behaviour, the halo effect is avoided and it ensures confidentiality and fewer missing values) (koopmans et al. 2014a; widyastuti & hidayat 2018), one cannot ignore the fact that common method variance is a likely outcome of self-report surveys. common method variance means bias is introduced in the ways in which constructs are measured (podsakoff, mackenzie & podsakoff 2012). due to this, relationships between constructs can be over-inflated (spector et al. 2017). to counter the shortcomings (i.e. causal inferences and cmb) of cross-sectional research, future studies should employ longitudinal research designs. researchers should, however, not employ a longitudinal design blindly. along this line, (spector 2019) suggests that researchers should carefully consider which variables precede the others and how long one variable should be allowed to ‘develop’ or ‘change’ before measuring its outcomes and establishing causal inferences (spector 2019). furthermore, the current study employed statistical methods to test for cmb but several design strategies are also recommended: (1) using different sources (i.e. employees and leaders) to obtain predictor and outcome responses, (2) temporally separating the predictor and outcome variables (i.e. measure at different time points), (3) using different response scales for the different variables, (4) clearly formulating items and avoiding wording that enhances the likelihood of socially desirable answers, and (5) striking a balance between positive and negative items (podsakoff et al. 2012). although we proactively implemented measures to reach a broader audience of it professionals and the sampling strategy respects the voluntary participation of participants, we cannot ignore the possible biases introduced by self-selection. it is recommended that researchers use random sampling strategies in future studies in an attempt to obtain a representative sample to replicate the findings of the current study. apart from the methodological limitations and recommendations, an important limitation of the current study is the omission of dependent variables to evaluate the concurrent (and predictive) validity of the iwpq. consequently, future research is encouraged to include ‘outcome’ variables (e.g. objective organisational performance metrics) to evaluate the concurrent and predictive validity of the iwpq. conclusion the results of the current study provide sufficient evidence for the construct validity of the iwpq in a south african context. individual work performance consists of three related constructs: task performance, contextual performance, and counterproductive work behaviour, and the different types of performance sufficiently explain variance in their respective indicators (except for two of the cwb items). the different types of performance are also sufficiently different from each other as well as from other related constructs (i.e. job resources). in future, researchers (also in south africa) can use the iwpq questionnaire to develop a more mature and unified knowledge based on individual work performance. acknowledgements jessica gutierrez for data collection and prof. leon de beer for critically reading the manuscript. competing interests the author has declared that no competing interest exists. author’s contributions the author conceptualised and wrote the manuscript and conducted the data analysis. ethical consideration ethics approval was granted by the research ethics committee of north-west university (nwu-hs-2017-0046). funding information this research received no specific grant from any funding agency in the public, commercial or not-for-profit sectors. data availability statement data sharing will be done in line with ethics requirements. the data and syntaxes are the intellectual property of north-west university and will be provided upon reasonable request. contact author for more information. disclaimer the views and opinions expressed in this article are those of the author and do not necessarily reflect the official policy or position of any affiliated agency of the authors. references aguinis, h., 2013, performance management, pearson prentice hall, upple saddle river, nj. bakker, a.b., 2014, the job demands–resources questionnaire, rotterdam university, rotterdam. bakker, a.b. & demerouti, e., 2017, ‘job demands-resources theory: taking stock and looking forward’, journal of occupational health psychology 22(3), 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2013 was a major milestone in the history of the south african journal of economic and management sciences (sajems). it was the year in which we commemorated sajems’ 25 years of publishing high-quality academic research. it is one of the few south african accredited journals covering the broader economic and managerial sciences. as an interdisciplinary publication, sajems addresses a wide spectrum of topics, with a focus on consumers, firms and/or regulators. this spectrum includes contemplation of the philosophical presuppositions of scientific disciplines on the on hand, through to qualitative and quantitative research, across a wide spectrum of methodologies and scientific world views. it was therefore a decision of the editorial board to commemorate this milestone with a special edition focusing on a multi-disciplinary topic that embodies the integrated nature of the management sciences. as such the focus of this edition is on linking project-based production and project management, which is from a disciplinary point of view combining engineering (project) and management sciences. the status of sajems is confirmed by the fact that it is a refereed scientific journal, which enjoys international recognition by being indexed in i) thomson reuters’ social sciences citation index, ii) in econlit (the electronic database of the journal of economic literature) and australian business deans council list. furthermore, sajems is also accredited by the south african department of higher education and training (dohet) as journal in which south african universities qualify for subsidisation. south african research environment a number of factors shape and affect the south african research environment. a key characteristic of this evolving environment is the increasing pressure on academics to publish in peer-reviewed and/or accredited journals. the two institutions driving this process are the dohet and the national research foundation (nrf). • the dohet announced in 2003 that south african universities would qualify for subsidies for research outputs if the outlet in which an article appeared featured either in the ssci or ibss indices, or alternatively the special dhet-south african approved list. • the nrf on the other hand encourages researchers to obtain a rating via its researcher evaluation and rating initiative, which promotes research excellence while ensuring that top researchers are easily identifiable. the publication of articles in peer-reviewed journals is a key component of this initiative. historic overview since its inception in 1988, sajems has maintained its identity and solidity as an academic mouthpiece. an important decision early on in the journal’s life was that the journal would not be ‘semi-official publication’ of its home institution of the university of pretoria, but that it would rather be governed by an editorial board, hence retaining its independence. this requirement gained importance in the course of the south african academic research environment in the 1990s, as conditions for academic journals became more stringent in view of the impending system of journal accreditation, leading to stricter measures for academic publications across all the tertiary institutions in the country. the basic university funding formula of the time changed considerably, as academic journals now had a different form of revenue, namely page fees payable by authors and the local universities benefiting in terms of subsidy for publications by staff members in such journals. ii sajems special issue 17 (2014) : i-iii over the years sajems has also published several special editions, including: • globalisation issue ns vol 4 no 3 september 2001. • environmental issue ns vol 5 no 2 june 2002. • symposium on competition law and economics, ns vol 11 no 3 september 2008. • the 5th annual international conference of organisational innovation, ns vol 16 no 5 2013. the journal has over the course of its existence had a wide variety of editors. some of the brief highlights and objectives of the editors are as follows: • the founding editor was prof geert de wet, department of economics, university of pretoria (1988 – 1997). • prof ab boshoff, graduate school of business, university of pretoria (1997 – 1998) took over the journal when there was no one to succeed prof de wet when he passed away. he tried to encourage management submissions, as economics submissions were by far in the majority. • prof ml truu, department of economics, university of pretoria (sept 1998 – jun 2001), changed the numbering of the journal, changed the look and to improve wider exposure, from bilingual to english only. he also endeavoured to increase the circulation, as well as widen submissions to other institutions. he also placed great value on good grammar. • dr sm brink, department of economics, university of pretoria (sept 2001 – mar 2003) took over the editor role and managed it through difficult times when prof truu passed away. • prof ti fenyes, department of economics, vista university (jun 2003 – dec 2003) increased issues from 3 a year to 4. • prof jn blignaut, department of economics, university of pretoria (march 2004 – dec 2007) invited academics from various sa universities to join the editorial board and serve as section editors. he secured juta publishers to publish the journal with a new professional look. he applied for and secured isi accreditation and introduced submission fees to improve the quality of submissions and improve the finances of the journal. • prof sf koch, department of economics, university of pretoria (mar 2008 – mar 2012) managed to expand the editorial board to include foreign universities. during his tenure the scope was narrowed to a more specific african emphasis, and under his leadership the journal took the leap to electronic open access publishing away from physical copies. • prof p buys, school of accounting sciences, north-west university (jun 2012 – date) made history by being the first non-economist to manage the journal. he refined the policies and procedures to encourage the academic quality of papers and further emphasised the african integrated business nature. sajems publication view when considering research conducted in global research publications, several interesting aspects come to light. • in line with international trends, the south african research environment seems to indicate a noticeable tendency for articles to be published by multiple authors, with a decrease in single authorship. in a longitudinal context, the ratio fluctuated from as low as 20 per cent to more than 60 per cent for single author articles. throughout the history of sajems however, single author articles average around 33 per cent of all articles published and around 66 per cent for multi author publications. • another inclination identified by several studies, was the prevalence of authors affiliated with a journal’s home institution. in the case of sajems, the same trend was found, with the mostrepresented institution being the university of pretoria, contributing to around a quarter of all articles published, with no other south african institution contributing more on average than 10 per cent. notwithstanding, a positive aspect is that the second most-published group in sajems is foreign institutions, contributing to around 15 per cent of our publications. sajems special issue 17 (2014) : i-iii iii one of the editorial objectives of sajems is to publish ‘practically useable’ research, which can be applied in the real business environment. one way of promoting this is to encourage practitioners to partake in research endeavours and to publish their findings. over the recent years, we have been reasonably successful with practitioners contributing from 6 per cent to as much as 21 per cent of annual article publications, with a historical average of around 10 per cent. finally, in terms of academic disciplines represented in sajems, history confirms the journal’s interdisciplinary view of the economic and management sciences with economics accounting for an average of 35 to 40 per cent of articles, business between 25 and 30 per cent, while human capital management, accounting and marketing accounted for around 10 per cent respectively. special edition in this commemorative special edition of sajems, the reader can look forward to a wide range of diverse reading material. the contributions range from a macro discussion of projectification of society to decision-making quality within project teams (the micro level). i would like to express my sincere appreciation to the editors of this special edition, prof leon oerlemans of tilburg university in the netherlands, and prof tinus pretorius, of the university of pretoria in south africa, for the many hours they invested in ensuring that the articles comprising this special edition are of a very high standard. i am confident you will find it an interesting read. prof pieter buys editor abstract introduction literature review method results discussion conclusion limitations and recommendations acknowledgements references about the author(s) carolyn easton graduate school of business leadership, university of south africa, midrand, south africa renier steyn graduate school of business leadership, university of south africa, midrand, south africa citation easton, c. & steyn, r., 2022, ‘leadership styles and effectiveness in the workplace: a perspective of the millennial generation’, south african journal of economic and management sciences 25(1), a4541. https://doi.org/10.4102/sajems.v25i1.4541 original research leadership styles and effectiveness in the workplace: a perspective of the millennial generation carolyn easton, renier steyn received: 30 jan. 2022; accepted: 06 july 2022; published: 22 sept. 2022 copyright: © 2022. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: millennial leaders are seen in the workplace as the leadership pipeline for the preceding generations, generation x and baby boomers, particularly given that the older baby boomer generation are retiring. however, the correlation between leadership styles and leadership effectiveness and the consequences for leadership development have not been fully researched in the literature on millennial leaders. aim: the aim of this research was to test differences between leadership styles and leadership effectiveness as perceived by both millennial followers and millennial leaders. setting: this research was conducted in south africa, in a variety of organisations, and through sampling of employees across generations. methods: cross-sectional data were collected with instruments based on the pearce typology of leadership styles, after which the data were segmented according to three generations. after confirming reliability and general factorial validity of the instruments, regression analysis was performed to determine the contribution of four leadership styles towards leadership effectiveness. results: two of the leadership styles, namely empowering and transformational, were perceived by both millennial followers and leaders as being statistically significant predictors of leadership effectiveness, whilst the remaining two leadership styles, directive and transactional, did not have a statistically significant contribution towards leadership effectiveness. conclusion: the results support the alternative hypotheses aligned with the literature review that millennials prefer empowering and transformational leadership styles as they regard these styles as effective. however, important to note is that generation x has very similar preferences. this knowledge will assist with improved development of millennial leaders in the workplace. keywords: generations; effective leadership; leadership styles; directive leadership; empowering leadership; transactional leadership; transformational leadership; millennial leaders. introduction there are limited research studies focusing on millennials in leadership roles and, more importantly, their leadership styles and how they are formed (churchill 2018). as the millennial generation continues on the path of dominating the global workforce (deloitte 2019), these individuals are also taking on leadership positions in which they may be leading older employees, whilst their own leadership traits and styles are still not fully understood (gabriel, alcantara & alvarez 2020). organisations should therefore be supporting the millennial generation to explore their own leadership styles rather than role modelling the leadership practices of the older generations (heyns, eldermire & howard 2019). this sentiment is shared by alkan and aydoğdu (2019) who report that organisations need to understand the millennials’ perceptions and expectations of an effective leader and adopt an appropriate leadership style in the workplace. literature review in today’s age, organisations need effective leaders who grasp the complexities of the changing global environment and influence followers to achieve desired goals (nanjundeswaraswamy & swamy 2014). effective leadership has become more important than ever before, considering the uncertain times we live in, particularly with the effect of the covid-19 pandemic (decuypere 2021). this study focused on three generations in the workforce, starting with the oldest generation being the baby boomer generation (1946 and 1964), followed by generation x (1965 and 1979), with the youngest generation being generation y, better known as the millennial generation (1980 and 2000) (kaifi et al. 2012). millennials are seen to be the generation that will define the future of leadership as we see it in the workplace, yet there are not many millennial role models for these emerging leaders to follow (folarin 2021). leaders may also become effective managers through suitable role models they compete with (long 2017). knowledge of the traits and characteristics of the millennial generation is needed to turn these employees in the workplace into future leaders (folarin 2021). effective leadership styles successful leaders should adopt leadership styles that suit the cultural expectations of their followers (solomon & steyn 2017a). the most effective leadership style may imply the use of a combination of styles in which one style can complement the other (solaja & ogunola 2016). a review of the literature on elements that are considered by the millennial generation as indicative of good leadership in the workplace was integrated and is summarised in table 1 as follows. table 1: millennials’ view of elements of good leadership. in this study we have adopted the leadership typology of pearce et al. (2003) as a structure to discuss leadership styles. this typology supports the existence of four leadership styles, namely: directive leadership, empowering leadership, transactional leadership, and transformational leadership. according to pearce et al. (2003), these leadership styles can be defined as follows: directive leadership refers to behaviour of the leader who gives orders on how the work needs to be done. empowering leadership develops the followers so that they become effective and capable self-leaders. transactional leadership refers to behaviour of one who establishes the parameters of the exchange relationship between the leader and the follower. transformational leadership refers to behaviour that encourage vision, produce inspiration from their followers, and motivate change. the literature on leadership styles further expands on the four different leadership styles. directive leadership informs employees about exactly what they are supposed to do. the leader tells the employees about their task, what is expected, how it must be done, and provides the deadline for the completion of that task (wachira, tanui & kalai 2016). with empowered leadership, workers are allowed more independence and self-leadership, whilst managers provide support and encouragement, promote participative decision-making, and build trust (liu 2015). empowerment programmes in the workplace are generally intended to improve employees’ motivation and creativity in their work roles (amundsen & martinsen 2015). a transactional leadership style occurs in a leader-follower exchange relationship in which corrective actions are an exception and followers are rewarded when they have achieved specific goals (holten & brenner 2015). transactional leaders, therefore, use praise, reward and promise to motivate employees. for corrective action they will make use of negative feedback, threats, or disciplinary action (solaja & ogunola 2016). transactional leaders will not continually look at their staff’s performance but only offer assistance when needed (cheung, yeung & wu 2018). they will use contingent rewards to incentivise their employees to share knowledge that they own (masa’deh, obeidat & tarhini 2016). transformational leaders are charismatic, influencing their followers towards a vision through their insistence on moral and ethical standards (dartey-baah 2015). by portraying these powerful visions they also promote creativity among their followers in the workplace (banks et al. 2016; jaiswal & dhar 2015). transformational leaders encourage and inspire their followers to achieve results that are higher than expectations (jauhar et al. 2017), but also bring their followers into the decision-making process and allow them to develop as individuals (solaja & ogunola 2016; yahaya & ebrahim 2016). transformational leadership signifies four dimensions, namely idealised influence, intellectual stimulation, inspirational motivation, and individualised consideration (aga, noorderhaven & vallejo 2016). millennials and leadership axten (2015:52) indicates that ‘millennials are social creatures, due to coming of age when cell phones were available’. ‘they have experienced constant interaction with their parents and will expect that connection with their workplace leaders’ (axten 2015:52). millennials prefer leaders who display a leadership style that shows care for their followers as opposed to meeting their own personal agendas (long 2017). they prefer leaders who give personal attention to their employees, getting to know them by being more orientated towards people rather than tasks (maier et al. 2015). millennial leaders consider meaningful relationships as an important element of leadership (medyanik 2016). millennials have started a new trend in leadership in which leaders do not command, but rather direct their followers and thereby strive towards inclusive leadership as opposed to authoritarian leadership (folarin 2021). the millennial generation does not believe in the notion that hierarchy creates a good leader (pratama, nasution & absah 2019). they prefer not to work under a leadership style with highly autocratic directives as they highly value empowerment and need the opportunity and encouragement to make their own decisions (maier et al. 2015). they also adhere to professional ethics in the workplace, having a dynamic transparent leadership style (akmalaputri, yuniawan & djastuti 2018). millennials see leaders as guiding and empowering personnel and also as role models (lamasan & oducado 2018). they expect leaders to be charismatic by providing their workers with a sense of purpose through encouragement (grubbström & lopez 2018). millennials also expect leaders to provide their followers with challenging tasks that are still within their capabilities, thereby rewarding innovation and tolerating failures (axten 2015). millennials prefer leaders who are inclusive, collaborative and committed in their leadership approach (maier et al. 2015). the millennial leaders want to contribute towards the organisation by using their skills and prefer to be trusted and empowered to lead (sledge 2016). millennials have high expectations of their leaders, like immediate feedback, immediate training and immediate recognition (axten 2015). as they do well in work environments that provide progressive career paths, they will need reaffirmation that they are moving in the right direction, requiring a leader who motivates with rewards, sets goals and mentors their employees (bodenhausen & curtis 2016). the social learning theory was first explored by bandura in the 1960’s. according to the social learning theory, human behaviour is learned through observations of others’ modelled behaviour so that the individual forms an idea of how the behaviours are performed and the consequences of such behaviour (decker 1986). employees in the workplace have different perceptions of leadership effectiveness (baker 2015). perceived effective leaders utilise different leadership styles in the workplace (long 2017; solaja & ogunola 2016). there is thus a need to understand the millennial generation’s perception of effective leaders in the workplace (alkan & aydogdu 2019; seldon 2014). the aim of the research was to investigate and examine the relationship between millennials’ perceived leadership styles, adopted in the workplace, and their perceived effectiveness in these leadership styles with the intention to better understand how to suitably develop millennial leaders. from the literature review, we can infer that there are certain leadership styles which the millennial generation perceive as effective, such as empowering leadership (lamasan & oducado 2018; maier et al. 2015; medyanik 2016; sledge 2016) and transformational leadership (axten 2015; bodenhausen & curtis 2016; grubbstrom & lopez 2018). by applying the leadership typology of pearce et al. (2003), we can test whether these differences really exist. two general null hypotheses were set. the first null hypothesis reads as follows: h10: millennial followers, just as followers from any other generation, perceive all leadership styles as being equally effective. the following alternative hypotheses were also set (see box 1). box 1: alternative hypotheses to h10. the second null hypothesis reads as follows: h20: millennial leaders, just as leaders from any other generations, are perceived to be effective, irrespective of the leadership style they apply. the following alternative hypotheses were based on the literature provided when stating h10, and are therefore not repeated here, as well as on the general principle of the cognitive dissonance theory (festinger 1957), in which actors act in accordance with what is expected of them or according to the values to which they hold true. the alternative hypotheses read as follows (see box 2). box 2: alternative hypotheses to h20. the approach according to which these hypotheses were tested is described below. method population and sampling the target population was employees across generations. this research was conducted in a variety of organisations in south africa (sa). the sample consisted of 1140 respondents across 19 south african organisations. simple random samples of employees were drawn irrespective of their age or position in the organisation. these organisations included both private and public entities representing, among others, the telecommunication, financial services, media, manufacturing, and electronics industries. nineteen organisations were identified using the criterion of each having an employee who was a registered master’s level student at the graduate school of business leadership (gsbl) of the university of sa. entrance to the organisations, and therefore access to the respondents, was achieved by leveraging the respective students as fellow researchers. random samples of 60 employees were drawn in each organisation. design cross-sectional data was collected with various instruments based on the leadership typology of pearce et al. (2003), after which the data were segmented according to the three generations. the perceptions of followers and leaders about the effectiveness of the four leadership styles (leadership effectiveness) were the dependent variable. measurement instruments demographic data were collected on followers, as well as leaders. respondents were asked about their own age, sex and race. they were also requested to make an educated guess at the age of their leaders, and report on their leaders’ gender and sex. age data were transformed to create three generational groups of followers and three groups of leaders. data were also collected using a questionnaire incorporating various instruments selected, based on their ability to measure the four leadership styles: namely directive, empowering, transactional, and transformational, as well as their ability to measure perceived leadership effectiveness. approval for the use of the instruments was obtained from the respective authors. empowering leadership was measured using the 10-item instrument of ahearne, mathieu and rapp (2005). the reliability of the items developed to measure empowering leadership is confirmed by yoon (2012), reporting a cronbach coefficient alpha of 0.93. directive leadership was measured using six items developed by pearce and sims (2002) and four items from hwang et al. (2015). the items developed by pearce and sims (2002) are confirmed as reliable (cronbach coefficient alpha of 0.88) (hinrichs 2011), while hwang et al. (2015) confirm the reliability of their items developed to measure directive leadership (cronbach coefficient alpha of 0.85). both transactional leadership and transformational leadership were measured with instruments developed by pearce and sims (2002). reliability of these instruments was confirmed by pearce and sims (2002), with a cronbach coefficient alpha of 0.87 for transactional leadership and 0.72 for transformational leadership. effective leadership was measured using the 4-item instrument of cicero, pierro and van knippenberg (2010), and reliability of the instrument was confirmed by cicero et al. (2010) (cronbach coefficient alpha of 0.83). examples include: ‘my leader is very effective as a leader’ and: ‘my leader influences my level of commitment effectively’. the same instrument was used with success by solomon and steyn (2017b) reporting acceptable reliability (cronbach coefficient alpha of 0.95), as well as evidence of concurrent validity. statistical analyses the data analysis was done using the ibm spss (statistical package for social sciences) software package. data were inspected for normality and outliers before commencing with the analysis. frequency analysis was performed to provide a descriptive view of both follower and leader demographics based on the size of group, sex and race. this collected data were compared to the population data. before considering the data from the scales, reliability and validity were assessed. for the reliability assessment of the scale, cronbach’s alpha coefficient was calculated. while reliability was deemed as satisfactory when the alpha scores were above 0.70 (devellis 2012), alpha scores above 0.80 were regarded as preferable (pallant 2020). factorial validity was assessed using principal components analysis. to assess the factorability of the data, bartlett’s test of sphericity was applied wherein p < 0.05 is required for the factor analysis to be appropriate (pallant 2020). the kaiser-meyer-olkin (kmo) measure of sampling adequacy was also applied to determine a good factor analysis with 0.60 of the indexes ranging from 0 to 1, recommended as the minimum value (tabchnick & fidell 2013). the number of factors retained was based on kaiser’s criterion, applying the ‘eigenvalues greater than one’ rule (pallant 2020). to evaluate factor acceptability, item loadings of 0.30 to 0.40 are considered minimally acceptable and item loadings of 0.50 and above are considered favourable based on the guidelines of hair et al. (2010) and osborne and costello (2009). regression analysis was used to determine the ability of the four leadership styles to predict leadership effectiveness. leadership styles, in which the significance for beta values was below 0.001, were considered as having contributed distinctively and independently to the variance in leadership effectiveness (dependent variable). ethical considerations an application for full ethical approval was made to the research ethics review committee of the graduate school of business leadership and ethics consent was received on 8 march 2016. the ethics approval number is 2016_sbl_003_ca. the data were collected by prof renier steyn, the co-author to this article, and the protocols set out in the ethics application were strictly followed. verbal informed consent was obtained from all individual participants involved in the study. written consent was not obtained on the basis that the selected respondents were advised that participation was completely voluntary and anonymous and those who agreed to participate were handed a hard copy of the questionnaire and requested to complete it at a meeting held. results demographic variables descriptive statistics were calculated for both the followers and the leaders. table 2 depicts the size of both groups. table 3 shows the sex composition of both groups and table 4 shows the race composition of both groups. table 2: count: followers and leaders. table 3: sex: followers and leaders. table 4: race: followers and leaders. both the baby boomer generation followers (6.3%) and baby boomer generation leaders (13.1%) are shown to be the minority generation. the millennial generation dominates in size (62.7%) in the follower sample; however, in the leader sample this group is less well represented (37.4%) than the generation x leaders (49.5%). table 3 represents the number of women followers (53.7%) exceeding the number of men followers (46.3%) in the millennial generation. conversely, for generation x, the number of male followers (54.3%) exceeded the number of female followers (45.7%). in the baby boomer generation, the number of men followers (69.0%) exceeded the number of women followers (31.0%) by a much larger difference. contrary to the gender ratio shown in the follower sample, male leaders are shown as dominant in all three generations (millennials 56.5%, generation x 62.5% and baby boomer 72.3%). the difference in size between male leaders and female leaders does decrease across the generations from baby boomer leaders to millennial leaders. an interesting point to note from table 4 is the representation of the race groups per generation in the follower sample, considering the increase in black employees across the generations (baby boomers 47.9%, generation x 60.9% and millennials 71.8%) and the decline in white employees across the generations (baby boomers 45.1%, generation x 24.3% and millennials 12.6%). the coloured and asian respondents together continue to constitute the minority race group in the baby boomer generation (7%) and generation x (14.9%). however, in the millennial generation together (12.7%), they are about equal in size compared to the white respondents (12.6%). in the leader sample in table 4, the black leaders were also the dominant size in all three generations; that is, millennials (67.6%), generation x (50.2%) and baby boomers (55.4%). however, these percentages do not align with the same trend of increase as seen in the follower sample; in that, there were more black leaders in the baby boomer leader group than in the generation x leader group. reliability in table 5 below, the cronbach’s coefficient alpha values of all the factors exceeded 0.70 which is acceptable (devellis 2012) and four met the 0.80 criteria, which is preferable (pallant 2020). table 5: reliability data (n = 1131). factorial validity the validity of the instruments was assessed through factorial analysis. when applying kaiser’s criterion of eigenvalues greater than one to the four leadership styles, the following number of factors, that exceed the 60% rule of thumb (field 2018), were extracted: one factor on empowering leadership was extracted, explaining 62.1% of the variance in the data. three factors on directive leadership were extracted, explaining 75.8% of the variance in the data. the items loaded on the factors were in line with pearce and sims (2002) and hwang et al.’s (2015) instruments and the conceptualisation of the construct by pearce and sims (2002). three factors on transactional leadership were extracted, explaining 62.43% of the variance in the data. the items loaded on the respective factors were in line with the full-range-leadership-model (avolio & bass 2001). four factors on transformational leadership were extracted, explaining 68.01% of the variance in the data. the items loaded on the respective factors were in line with the full-range-leadership-model (avolio & bass 2001). when applying the varimax rotational approach and kaizer normalisation on the directive, transactional, and transformational leadership items, the results showed that all the measurement items loaded onto their respective factors had no significant cross-loadings. the results (not presented in table format here) show support for the factorial validity of the scales used. when identifying the suitability of the data for factor analysis on leadership effectiveness, bartlett’s test of sphericity was applied, and this showed the values to be significant (p < 0.001), indicating the factor analysis to be appropriate (pallant 2020). the kmo measure of sampling adequacy of 0.856 also met the criteria of a good factor analysis as it is higher than the minimum value of 0.60 (tabchnick & fidell 2013). using kaiser’s criterion, only one component was retained, explaining 87.03% of the variance in the data. the component matrix showed that the four items of leadership effectiveness all loaded on the single component. in evaluating factor acceptability, all four item loadings were above 0.90 and therefore considered favourable (hair et al. 2010; osborne & costello 2009). the solution could not be rotated, given that only one factor was extracted. regression stepwise regression was undertaken to determine the effect of the leadership styles (predictors) on leadership effectiveness (dependent variable), considering the followers’ generation as a form of categorisation (table 6), and the leaders’ generation as a form of categorisation (table 7). in table 6 leadership effectiveness is predicted, given the generation of the follower (observer), thus irrespective of the leader, whilst in table 7 leadership effectiveness is predicted, given the generation of the leader and irrespective of the follower. table 6: model summary, anova, and coefficients for leadership styles predicting leader effectiveness, given the generation of the followers (the observers). table 7: model summary, anova, and coefficients for leadership styles predicting leader effectiveness, given the generation of the leaders (the actors). it can be observed from table 6 that the leadership styles explained 70.9% of the variance in leadership effectiveness with millennials, 69.4% with generation x, and 46.4% in the case of baby boomers. for the baby boomers, leadership styles were therefore not an important predictor of leader effectiveness. to determine which of the leadership styles contributed to the prediction of leadership effectiveness, an analysis of the categorisation of the follower generation showed the following: two of the leadership styles, namely empowering and transformational, were found to be statistically significant predictors of leadership effectiveness in the case of millennials. two of the leadership styles, namely empowering and transformational, were found to be statistically significant predictors of leadership effectiveness with generation x. one of the leadership styles, namely empowering, was found to be a statistically significant predictor of leadership effectiveness regarding the baby boomers. across the generations, empowering leadership seems to be the leadership style which is associated with leadership effectiveness. although transformational leadership was also regarded as a statistically significant predictor of leadership effectiveness with the millennial followers and generation x followers, this was not the case with the baby boomer followers, which speaks to their lower regard of the importance of aspirational leadership. next, the generation of the leaders is considered, and how effective they are perceived to be. the analysis of the categorisation of the generation of leaders showed: two of the leadership styles, namely empowering and transformational, were found to be statistically significant predictors of leadership effectiveness in the case of both millennial leaders and generation x leaders. three of the leadership styles, namely empowering, transformational and directive, were found to be statistically significant predictors of leadership effectiveness with baby boomer leaders. in all cases empowering or transformational leadership seem to be the leadership styles which are associated with leadership effectiveness, whilst for baby boomer leaders, directive leadership also seemed to be associated with leadership effectiveness. discussion given that millennials are a unique group in the workplace and demanding to be led and lead in a particular manner, as suggested by the literature, it follows then that millennials will view a certain leadership style as effective when used on them compared to other leadership styles. as leaders it could also be expected that they will lead effectively when aligned to their unique values and differently from the ways leaders from other generations lead. in the literature review a valiant effort was made to suggest that empowering and transformational leadership should be associated with leadership effectiveness amongst millennials, rather than transactional, and particularly, directive leadership. the statistical results support millennials perceiving empowering and transformational leadership styles as leading to more effective leadership the sample could be deemed as representative of the working population in sa in as much as the gender distribution (in general), as well as the race composition of the total group reflected the numbers provided by stats sa (given statistics sa 2020 data). there were more black leaders in the millennial leader group than in the other generations, which testifies to the effects of affirmative action on the workplace in sa. of interest to note, is that there were more black leaders in the baby boomer group than in the generation x group, which may speak to struggle veterans being recognised in the corporate world in line with legislative black economic empowering (bee) policy. changes in the nature of the workforce over the years, as represented by the sample of followers and leaders, are explainable. baby boomers were the minority group in the sample, aligning with their retirement age (brack & kelly 2012), whilst millennials were the majority group in the sample of followers, aligning with this generation currently dominating the workforce in size as a productive age group (pratama et al. 2019). millennials were not the majority in the sample of leaders, aligning with this generation becoming the leadership pipeline to succeed the older generation leaders (brack & kelly 2012). the instruments used showed acceptable psychometric characteristics and the cronbach alphas were acceptable (0.73 to 0.94) for the leadership styles and preferable (.95) for leadership effectiveness. with regard to factorial validity, the instruments also showed acceptable results across all the instruments used. the results pertaining to the effectiveness of leadership styles, per generation of observers (see table 6), reveal large variations in the absolute amount of leadership effectiveness being explained by leadership styles, as reflected in the r2 numbers reported. in the millennial generation, 70.9% of effectiveness was explained by the leadership styles they were exposed to, followed by generation x observers for whom 69.4% was explained, and for baby boomers a significantly lower effectiveness of 46.4%. with millennials then, and, also largely generation x, the type of leader behaviour influences the effectiveness thereof to a large extent. for the baby boomers, leadership styles are only part of what leader effectiveness entails. thus, for baby boomers a large portion (100% – 46.4% = 53.6%) of leader effectiveness is explained by factors other than leadership styles. also, of interest to note, is that transformational leadership was not a statistically significant predictor for baby boomer followers, highlighting their low regard for aspirational leadership. considering the first null hypothesis, that all leadership styles are judged as equally effective, it was found with millennial followers that two of the leadership styles, namely empowering and transformational, were statistically significant predictors of leadership effectiveness. the null hypothesis was therefore rejected. thus, the alternate hypothesis of empowering leadership being preferred may be accepted, which is aligned to the literature of lamasan and oducado (2018), maier et al. (2015), medyanik (2016) and sledge (2016). the alternate hypothesis of transformational leadership being preferred, is aligned with the literature of axten (2015), bodenhausen and curtis (2016) and grubbström and lopez (2018). the alternate hypothesis of transactional hypothesis being less preferred is aligned with the literature of axten (2015), maier et al. (2015) and medyanik (2016). the non-significant relationship found with the directive leadership style is also aligned to the literature of folarin (2021), maier et al. (2015) and pratama et al. (2019), which suggest that millennials will not prefer or associate effective leadership with directive behaviour. the results discussed above confirm that millennial followers associate certain leadership styles with effectiveness, and this is well in line with the present literature on millennials. however, millennials do not really differ in the manner that generation x associate leadership styles with leader effectiveness, and although millennials differ more than baby boomers on this matter, the similarities regarding empowering leadership outweigh the difference with respect to transformational leadership. therefore, although millennials (62.7% of the follower sample) judge certain leadership styles as more effective than others, the next most populous group in the workplace, generation x (31.0% of the follower sample), agrees with them, with only the baby boomers (6.3% of the follower sample) marginally disagreeing. considering the second null hypothesis, that millennial leaders are perceived to be effective irrespective of the leadership style that they apply, this was also rejected, because empowering and transformational styles were seen as more effective. the other leadership styles did not predict leader effectiveness in the sample of millennial leaders evaluated. the alternative hypotheses were then affirmed. however, as in the case of the first hypothesis, the results pertaining to generation x were very similar, indicating that generation x leaders, who displayed empowering leadership, as well as transformational leadership attributes, were also deemed as effective. for the baby boomer leaders some ‘leniencies’ were seemingly showed, in that they were judged as effective leaders, even when they displayed directive leadership. conclusion this study focused on how the millennial generation perceives the overlay between leadership styles and leadership effectiveness and how effective millennial leaders are regarded when applying different leadership styles. the expected conclusion is that millennial followers perceive those engaged in empowering leadership and transformational leadership as more effective (hypothesis 1), and that millennial leaders who display empowering leadership and transformational leadership, are perceived to be effective leaders (hypothesis 2). however, most followers, millennials included, perceive those individuals engaged in empowering leadership and transformational leadership as more effective, and most leaders, millennials included, who display empowering leadership and transformational leadership, are perceived to be effective leaders. the conclusion which should rather be made is that empowering leadership and transformational leadership are the leadership styles associated with leader effectiveness, and that this finding is largely independent of generational perceptions. also, transactional leadership and directive leadership are not, in general, associated with leader effectiveness, and should be avoided. does this conclusion provide any foundation for the development of millennial leaders? yes, definitely! leadership development should focus on the development of empowering leadership, as well as transformational leadership. also, millennial leadership training should not be exclusive to any group, as it seems that the current era of the fourth industrial revolution requires a certain type of leader, irrespective of the age of the leader. the concern of some, with regard to who is leading who, may therefore be inappropriate. the focus should rather be, as suggested in this research, on what type of leadership is required. limitations and recommendations the authors used a convenient sampling method to select the organisations and randomly selected employees (respondents) in each organisation. it should be noted, however, that the demographics of the respondents seemed to closely reflect the demographics of the country as a whole. future researchers are urged to use random sampling of both organisations and respondents. a further limitation of the study is that the respondents were requested to make an educated guess at the age of their leaders and report on their leaders’ gender and sex. the study is also limited in being an example of single-source (tapping on the perceptions of followers about their leaders) and single-method (using surveys) research. future researchers are advised to gain information on self-reports from leaders themselves, additionally, as well as to use techniques beyond surveys – for example, observations from qualified assessors. data management was also not treated appropriately in the study. no tables explaining drop-outs were discussed, nor detailed discussions of cleaning the data from outliers. the study also contrasted the different generations in the analysis rather than providing a more detailed discussion from the literature on the two generations, generation x and baby boomer generation. the primary finding of this research is that millennials perceive certain leadership styles as more effective, and that when they apply these styles, they are deemed as effective. as the same applies to generation x, and also somewhat to the declining numbers of baby boomers, it is recommended that the concern with generational differences be set aside, and that the current workplace rather be evaluated to find appropriate leadership styles. all employees deem the same leadership styles as being effective, and all leaders who apply them, are deemed effective. acknowledgements competing interests the authors have declared that no competing interest exists. authors’ contributions c.e. contributed towards the article through conceptualisation of the research problem, methodology, and formal analysis. carolyn was also the writer of the original draft of this article. r.s. contributed towards the article by being the supervisor in reviewing the article and also provided the data and software validation. funding information this research received no specific grant from any funding agency in the public, commercial or not-for-profit sectors. data availability data sharing is not applicable to this article as no new data were created or analysed in this study. disclaimer the views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of any affiliated agency of the authors. references aga, d.a., noorderhaven, n. & vallejo, b., 2016, ‘transformational leadership and project success: the mediating role of team-building’, international journal of project management 34(5), 806–818. https://doi.org/10.1016/j.ijproman.2016.02.012 ahearne, m., mathieu, j. & rapp, a., 2005, ‘to empower or not to empower your sales force? 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introduction research aim, objectives and rational literature review research design results conclusion acknowledgements references about the author(s) cara thiart school of accountancy, faculty of economic and management sciences, stellenbosch university, stellenbosch, south africa citation thiart, c., 2023, ‘the correlation between environmental, social and governance ratings and the transparency in johannesburg stock exchange companies’ tax practices’, south african journal of economic and management sciences 26(1), a4886. https://doi.org/10.4102/sajems.v26i1.4886 original research the correlation between environmental, social and governance ratings and the transparency in johannesburg stock exchange companies’ tax practices cara thiart received: 21 oct. 2022; accepted: 03 apr. 2023; published: 23 may 2023 copyright: © 2023. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background and aim: the study explores the correlation between environmental, social and governance (esg) ratings and the extent of corporate tax transparency to investigate whether esg ratings are indicative of transparent corporate tax practices. to gain more insight, the correlation exploration is extended to the ratings achieved in the governance category and the transparency and reporting subcategory included in the overall esg rating. setting and method: the extent of corporate tax transparency disclosures in the corporate reports of 112 companies, listed on the johannesburg stock exchange (jse) on 28 february 2022, was assessed using a content analysis. the correlation between the esg ratings and the extent of corporate tax transparency of these companies was then explored through correlation analysis. results: the study provides evidence of significant correlation between overall esg ratings and corporate tax transparency. however, no correlation was found between the ratings achieved in the governance category, or the transparency and reporting subcategory and corporate tax transparency. the latter might, however, be explained by the negatively skewed distributions of the ratings achieved in the governance category and the transparency and reporting subcategory. contribution and conclusion: the study provides persuasive evidence that esg ratings can be used as indicators of transparent corporate tax practices. it might provide valuable insight to boards of companies about the correlation between esg ratings and the transparency of tax practices, encouraging them to incorporate tax governance as part of the esg agenda. additionally, it may be utilised by investors when making investment decisions. keywords: environmental, social and governance (esg); corporate tax transparency; tax governance; transparency and reporting; corporate social responsibility; johannesburg stock exchange (jse); south africa. introduction the environmental, social and governance (esg) imperative is high on the agenda of many legislators, investors and the general public. environmental, social and governance aspects are referred to by a variety of terms, including ‘responsible’, ‘impactful’ or ‘sustainable investing’ and ‘corporate social responsibility’. regardless of the terminology, esg typically supports the notion that companies that include esg values into their strategy create long-term value (institute for pension fund integrity [ipfiusa] 2020). much of the focus among esg proponents has been on environmental factors with, mostly overlooked to date, how tax fits into the esg discussion. all three esg categories involve tax. the ‘e’ (environmental aspect) stems from how taxes were used from ancient times as a tool to steer behaviour, in this case through the levy of environmental taxes to reduce environmental damage (organisation for economic cooperation and development [oecd] 2011). according to morris and visser (n.d.), a company’s tax policy and approach to tax is no more a matter of mere compliance. it is also becoming a powerful indicator of how a company views its position in society by paying a fair share of taxes and also accepting responsibility for workplaces fit for the requirements of future generations of the workforce. it’s a critical element of an organisation’s social contribution, the ‘s’ in esg. the latter is supported by kpmg (2021) who recognises that stakeholders focused on esg expect companies to pay their ‘fair share’ of taxes and to conduct their tax affairs in a sustainable manner which is measured in terms of good tax governance. the importance of good tax governance, which correlates to the ‘g’ in esg, has been emphasised by a large number of global initiatives, led by intragovernmental organisations over the past decade, according to which companies have been urged to report on how much and to whom they pay corporate taxes (see the 2014 report good tax governance in transition, the 2030 agenda for sustainable development, the 17 un sustainable development goals of the united nations and the responsible tax principles developed by b team) (oikos, vbdo & pwc 2014; the b team 2018; un n.d.). the latter relates to the increased focus on corporate taxation and the transparency of the tax policies and practices which have been high on the agenda of the oecd for the past decade (oecd 2015b). more organisations are paying attention to esg issues as standards around corporate responsibility rise, and many people predict that in 5 years, esg imperatives will produce greater shareholder value than they do now. this, together with transparency becoming more prevalent, urges organisations to act on sustainability requirements. since sustainability is built on the assumption that developing such strategies fosters company longevity, it would be expected that tax, labelled as being ‘essential to finance investments in human capital, infrastructure and the provision of services for citizens and businesses’ by the world bank (nd.), must form part of the discussion. in contrast, very little is being said about if and how corporate governance affects, influences or is reflected in corporate tax transparency. research aim, objectives and rational the overall aim of the study is to explore whether enhanced corporate tax transparency practices have a favourable impact on esg ratings. the overall aim can be divided into the following specific objectives: to obtain the esg rating of jse-listed companies from an appropriate rating agency, to examine and link the rating categories, included in the overall esg rating, to corporate tax transparency. to examine and assign a measure to the extent of corporate tax transparency disclosures of these jse-listed companies. to explore the correlation, if any, between esg ratings and the extent of corporate tax transparency. although numerous studies have been done to investigate correlation and effect between and on corporate governance and tax planning, or aggressive tax practices (hanlon & heitzman 2010; hoi, wu & zhang 2013; knuutinen 2014; lanis & richardson 2012; preuss 2010; stiglingh, smit & smit 2021), very little research has been done to gain an understanding of whether corporate governance affects, influences or is reflected in corporate tax transparency. this exploration of the correlation between esg ratings and corporate tax transparency thus adds to the existing body of research and provides a platform for future research to be done. it is therefore deemed appropriate and necessary. literature review the increased focus on corporate taxation and the transparency of the tax policies and practices of (especially) multinational entities (mnes), launched from the oecd, started the project on base erosion and profit shifting (beps), the oecd/g20 beps project in 2013. the oecd/g20 beps project attempts to equip governments around the globe with solutions to close loopholes in existing international standards that allow corporate profits to be artificially moved to lowor no-tax jurisdictions with little or no economic activity (oecd 2015a). one of the three pillars the oecd/g20 beps project is structured around improvement in transparency (oecd 2015a). during 2015, the global forum of the oecd laid the groundwork for a new level of transparency and information sharing through the introduction of non-public country-by-country (cbc) reporting and the automatic exchange of these reports among revenue authorities (oecd 2015b). these reports provide detailed information on the global activities, financial structure and economic substance of multinational entities for each country in which it operates (oecd 2015c). in short, cbc reporting aims to identify whether taxes are paid in the jurisdictions where the economic activity of the company takes place (oecd 2017). if not, it might signal to companies engaged in tax planning strategies, to reduce their overall group-effective tax rate. following the oecd’s beps project, various organisations and initiatives that promote widespread adoption of esg factors added tax criteria to their frameworks and standards for esg reporting, resulting in corporate tax becoming a leading governance consideration, particularly tax transparency and corporate income tax responsibility (barendregt, anselmi & tsiosta 2022). the world economic forum, for example, defined ‘total tax paid’ as a reportable indicator to reflect a corporation’s direct and indirect tax contribution to public budgets. standard 201–1 of the global reporting initiative (gri), an oecd partner, identified tax as a significant component of a country’s economic value generated (barendregt et al. 2022), and standard 207: tax 2019 (gri 207), the first public global standard for comprehensive tax disclosures, was recently introduced as part of the global gri sustainability reporting standards. in south africa, there is no formal obligation to provide esg disclosures under the present disclosure regime (davids & kitcat 2021). however, the king code on corporate governance (currently king iv) recommends the gri as a guideline for sustainable reporting. this is further supported by the johannesburg stock exchange (jse) who operates the ftse/jse responsible investment index series which leverages the global ftse esg ratings to offer investors and stakeholders access to esg data, as well as a benchmark and a tradable index product. in addition, the jse developed its sustainability and climate change disclosure guidance which aims to guide south african companies on how to approach sustainability reporting (https://www.jse.co.za/). this guidance considers the gri, task force on climate-related financial disclosures and international sustainability standards board, to name a few. other sustainability guidelines, indices, espousing the esg agenda in south africa include the international integrated reporting committee (iirc), the financial stability board’s task force on climate-related financial disclosures (tcfd) and the sustainability accounting standards board (sasb) (davids & kitcat 2021). to this end, there is an onus on south african companies to report on material esg impacts and king iv recommends that an institutional investor’s ethical investment code adopted in terms of principle 17, as well as the implementation of its principles and practices, should be made public. the king reports on corporate governance in south africa (the king reports) stress the importance of companies acknowledging all stakeholders and taking a ‘triple-bottom-line’ approach. the triple-bottom-line strategy focuses on a company’s social, environmental, and financial sustainability (dekker & esser 2008). the king reports are not required to be applied, but they were introduced with an ‘apply-or-explain’ approach that was later revised to an ‘apply-and-explain’ approach that encourages companies to use sustainability initiatives, or explain why they haven’t. as previously stated, this is especially true of jse-listed companies, as the jse listing requirements compel listed companies to conform with the king report or otherwise justify their deviation from the norm (jse n.d.). as early as 1994 when the king committee on corporate governance issued its first report, king i, the need for companies to be socially responsible in the communities in which they operate was emphasised. the overall objective of the introduction of king i was to promote corporate governance and adequate standards for the board of directors of listed companies. the king i report on corporate governance was updated in 2002 with the publishing of the king ii report on corporate governance. the updated report expanded on the stated objective of king i through the introduction of seven good corporate governance characteristics, namely discipline, transparency, fairness, social responsibility, independence, accountability and responsibility, expected to be applied in business dealings. the third revised issue, the king iii report, became effective in march 2010. this version introduced sustainability, highlighting corporate citizenship, integrated reporting and disclosure as key elements. with the release of the king iv report on corporate governance, which superseded the king iii report with an effective date of 01 april 2017, a further update to the current king report on corporate governance was noticed. one distinction in this version is the emphasis on integrated reporting, which is in keeping with current international sentiment that favours increased accountability and transparency. another significant difference between the king iv report and its predecessors is that the king iv report covers tax policy and strategy creation within the scope of a company’s obligations. according to the king iv report, the governing body, that is, the board of directors, is responsible for ensuring that the company’s tax policies are transparent and responsible. the king iv report emphasises the need for transparency and responsibility as part of a company’s responsibilities to act as responsible corporate citizens. part 2 under the fundamental concepts of the king iv report states: [t]ax has become a complex matter with various dimensions. the governing body should be responsible for a tax policy that is compliant with the applicable laws, but that is also congruent with responsible corporate citizenship, and that takes account of reputational repercussions. hence, responsible tax policy and transparency in this regard are put forward as a corporate citizenship considerations in king iv. (p. 32) sustainability guidelines, indices and governance codes espousing the esg agenda, however, rely on a company’s own assessment of its performance. this allows companies to evaluate and decide what is viewed as material, meaning that in many cases various esg topics, including corporate tax and the disclosure thereof, are not mentioned, or are classified as being of ‘minor’ importance. environmental, social and governance matters stem from corporate social responsibility (csr), and while csr attempts to hold companies accountable, esg criteria make its efforts quantifiable. corporate citizenship defines how a company accepts responsibility for its impact on the society in which it operates by acting in ways that do not harm the wider community, employees, customers, or the environment (alva 2020). in the 2016 tax transparency benchmark (vbdo & oikos 2016), angélique laskewitz, executive director of the dutch association of investors for sustainable development (vbdo), makes two key observations: taxes must be seen as part of a corporation’s responsibility as a corporate citizen, and if a company is not upfront about its taxes, it must be hiding something. the latter is one of the many perceived advantages of corporate tax transparency, reducing tax-related reputational risk (stiglingh et al. 2017). according to actionaid (2011), there are three criteria that guide sustainable tax planning behaviour: strict adherence to tax regulations is no longer adequate to prevent public scrutiny of tax planning tactics; increased risk and criticism result from a lack of transparency and complicated tax planning methods; the structures and practices of tax planning are at the centre of tax responsibility, not the actual amount of taxes paid. van der enden (2016) argues that a company’s tax governance should be aligned with its sustainability plan, and the transparency thereof indicates to stakeholders that a company is operating responsibly. this view is supported by kpmg (2021) which notes that public disclosure of a company’s tax strategy, the amount paid in taxes, and where those taxes are paid are important elements of sustainable tax practices. the views derived from the vbdo, actionaid, van der enden and kpmg, support the expectation that enhanced corporate tax transparency should have a favourable impact on esg ratings. the aim of this study is to explore this expectation by analysing the correlation between esg ratings and the corporate tax transparency of jse-listed companies in south africa. environmental, social and governance ratings are obtained from csrhub (https://www.csrhub.com), a global rating agency, and examined with reference to the different rating categories included in the overall esg rating. the overall esg rating, the governance category rating and the transparency and reporting category rating are then correlated to a tax transparency score, assigned through a content analysis of various corporate reports of jse-listed companies, all of which are explained in the next section. research design research methodology the research design is an exploratory investigation that involves the correlation analysis of two variables: esg rating and the extent of corporate tax transparency. a mixed-method design in three phases was used to perform the study. in the first phase, the esg rating of jse-listed companies was obtained from csrhub and examined, based on the rating achieved for different categories included in the overall esg rating. in the second phase the content of the corporate reports (either the tax report, the sustainability report or the integrated report) of the companies for which an esg rating was obtained and examined to assign a measure to the extent of corporate tax transparency disclosures, yielding primary data on the extent of corporate tax transparency disclosures. since proxies for measuring corporate tax transparency are rare in the scholarly literature, the content analysis was judged necessary (venter, stiglingh & smit 2017). in phase three, correlation analyses were performed to explore the correlation between esg ratings, and the extent of corporate tax transparency of the companies included in the data. data selection the data were selected from all the companies listed on the jse’s main board as of 28 february 2022, which was provided by the jse. for two reasons, a jse listing is considered a prerequisite: (1) the content analysis relies on publicly available corporate reports and (2) the jse listing requirements necessitate the application of the king iv report and other sustainability indices. companies for which csrhub was unable to offer a full esg rating across all rating categories on 28 february 2022 were removed from the data. following that, the iress research domain (https://researchdomain-iress-co-za.ez.sun.ac.za/default.aspx) was used to examine the organisational structure of the remaining list of companies in order to identify organisations that did not qualify as mnes, that is, companies that only traded in south africa and had no international footprint. non-mnes’ legal structures do not allow for international tax planning or profit shifting; hence this step was deemed necessary. six companies were eliminated, leaving 112 companies in the data, summarised in table 1. table 1: defined data set. the market capitalisation of the companies included in the data totalled more than r5.5 trillion, and were spread across all 10 industries of the jse and 48 of the jse’s subsectors. altogether 94 of the 112 companies in the data have a primary listing on the jse. data collection environmental, social and governance ratings the first variable, the esg rating as provided by csrhub, was used as a proxy for the data companies’ extent of csr. csrhub is a rating agency with a web-based database providing the public open access to esg performance, sustainability ratings and information on more than 22 000 companies in more than 148 countries of which south africa is one. the csrhub aggregates esg data sets from leading analysts which include asset4 (thomson reuters), cdp (carbon disclosure project), iw financial, msci (esg intangible value assessment, esg impact monitor, governance metrics, and carbon tracker), reprisk, trucost and vigeo eiris (csrhub n.d.). these data sets are combined and normalised, whereafter csrhub rates the company’s esg performance on a scale of 0–100 points, 100 being the most positive rating. the overall esg rating of the company is calculated as the weighted average of four categories: employees, environment, community relations and governance. the overall esg rating positions the aim of the study to explore the correlation between esg ratings and corporate tax transparency. the governance category included in the overall esg rating encompasses a company’s commitment to sustainability and corporate responsibility at all levels, as well as its directors and management (csrhub n.d). the enlightened measurements in the governance category date back to the king iv report, which places the obligation for ensuring that a company’s tax policies are in place, transparent and accountable to the board of directors. to explore how tax governance is reflected in the overall esg rating, the rating of a company’s governance category, which can be viewed separately, supports the aim in the form of a more in-depth analysis of the correlation between the governance category esg rating and corporate tax transparency. providing even more condensed data are the three subcategories included in the governance category, comprising: board, learnership and ethics, and transparency and reporting. the efficiency of a company in adopting best practices in corporate governance principles relating to board membership, and best practices related to board activities and functions, is covered by the board subcategory (csrhub n.d.). the learnership and ethics subcategory assesses how a company manages its relationships with numerous stakeholders, including shareholders, customers, communities and regulators, among others. the company’s ethical decision-making culture is also part of leadership (csrhub n.d.). the transparency and reporting subcategory assesses, among other things, whether a company is transparent to stakeholders and whether its sustainability of csr reports are accurate, complete and reliable. it also assesses whether these reports are made available to the general public (csrhub n.d.). the scoring of the three subcategories can also be viewed separately. to support the aim in an even more in-depth exploration, the rating achieved in the transparency and reporting subcategory of the overall esg rating is correlated to corporate tax transparency. table 2: measurable criteria (gri 207 2019). from csrhub’s database, the overall esg rating and the rating achieved in the governance category and transparency and reporting subcategory of all jse-listed companies for which csrhub has a completed esg rating across all categories on 28 february 2022 were obtained. these ratings form the proxy for measuring the esg of the companies included in the data. the extent of corporate tax transparency the second variable is the extent of corporate tax transparency disclosures of the data companies. the content of the various corporate reports of the data companies, which are freely available in the public domain, was examined to assign a measure to the extent of corporate tax transparency for each company. the examination resulted in primary data on corporate tax transparency disclosures for each company. there is no single universally accepted definition for the term ‘tax transparency’. the cambridge dictionary defines the term ‘transparent’ as ‘a situation in which business and financial activities are done in an open way without secrecy, so that people can trust that they are fair and honest’. in collinsdictionary.com the word is described as ‘if a situation, system, or activity is transparent, it is easily understood or recognised’. tax transparency, according to bdo, refers to the way in which an organisation discloses how its profits are taxed and how much tax it actually pays (bdo n.d.). the oecd’s cbc reporting framework and the automatic exchange of these data among revenue authorities are not publicly available unless an organisation willingly shares such information in the public domain, as indicated in the literature review. many large companies issue annual reports that include information related to their corporate tax affairs, but the extent of the disclosure varies. as a result, a number of public corporate tax transparency initiatives have been launched in a number of jurisdictions. with clause 149 of the finance bill of 2016, her majesty’s revenue and customs (hmrc) introduced significant new tax governance requirements, requiring qualifying companies to publish their tax strategy outlining their approach to various tax components and encouraging all other (non-qualifying) companies to do so (hmrc 2016). the australian taxation office (ato) implemented the australian tax transparency code in february 2016 which sets out a set of principles and standards of tax information to be disclosed by companies (the board of taxation 2016). although this application of the code is voluntary, it is encouraged. furthermore, the ato requires corporations, through section 3c of the australian taxation administration act 1953, to publish information about public and foreign-owned entities with income above $100 million, as well as australian private enterprises with income surpassing $200 million, in an annual corporate tax transparency report. this transparency report discloses tax information which includes, among others, the amount of total income, taxable income and tax payable (ato n.d.). on 28 september 2021, the european commission’s council adopted the so-called ‘public country-by-country reporting’ directive after much debate and controversy. this directive would alter eu directive 2013/34 to compel mnes, with revenues of more than eur 750 million, to publish an income tax report. the amount of profit and loss before income tax, the amount of income tax accrued, and the amount of income tax paid on a cash basis will all be included in the income tax information report. the latter must be disclosed in each jurisdiction where the mne operates (ernst & young 2021). the polish government published substantial revisions to corporate income tax law on 30 november 2020, which took effect on 01 january 2021. tax capital groups and taxpayers with revenues of more than €50 million are now expected to prepare and publish an annual report on the execution of their tax strategy. these reports should be made public and include exact information on the tax processes and procedures used to manage tax compliance, transactions with related parties, executed or planned restructurings, and transactions with businesses from black-listed jurisdictions (ey 2021). the global movement for enhanced public tax transparency is further being pursued by investor action and industry non-profit groups such as vbdo (see the 2014 report good tax governance in transition, the 2030 agenda for sustainable development, the 17 un sustainable development goals of the united nations and the responsible tax principles developed by b team) (f pwc 2014; un n.d.; the b team 2018). most recently, the gri, a partner of the oecd, introduced the gri 207: tax 2019 (gri 207 2019), the first public global standard for comprehensive tax disclosures, as part of their gri sustainability reporting standards. according to pwc (2021), tax is increasingly being integrated into the esg agendas, with the gri 207 standard serving as an example of how tax and a company’s responsibility to the environment, society and good governance are linked. in accordance with the oecd’s cbc reporting framework, the gri 207 entails four parts that encourage public cbc disclosure of a company’s business activities and tax payments: disclosure 207-1 approach to tax. disclosure 207-2 tax governance, control and risk management. disclosure 207-3 stakeholder engagement and management of concerns related to tax. disclosure 207-4 public country-by-country reporting (gri 207 2019). companies that identify tax as a material topic must adhere to the disclosure criteria of gri 207, although all companies are free to use gri 207 to any extent desirable: criteria: the corporate tax information outlined in terms of disclosure 207-4 of gri 207 (2019) was used as the theoretical framework and proxy for measuring the extent of corporate tax transparency (through disclosure) in the data companies’ corporate reports (pwc 2021). examination of the 2020 year-end of the jse top listed 100 companies revealed that more than 60% follow the gri standards in esg areas, hence this proxy was deemed appropriate. for purposes of the study, the gri 207 disclosure recommendations were converted into measurable criteria for the content analysis on the following basis: approach: the available corporate report(s) (the tax report, the sustainability report and/or the integrated report) of the companies included in the data set were obtained, scrutinised and evaluated against the measurable criteria. interpretation and limitation of scope: the corporate reports of the data companies were examined to the extent to which the measurable criteria were addressed in any of the reports. the author used judgment throughout the examination procedure in order to analyse the content as thoroughly as feasible. a point (1) was awarded in circumstances where the measurable criteria could be determined from disclosed information without it being specifically reported as part of gri 207. data analysis to explore the aim of the study, the correlation between esg ratings and corporate tax transparency is explored. correlation is a measure of association between variables and the most commonly used correlation coefficients are the pearson and spearman coefficients (keller & warrack 1997). when two variables are correlated, their magnitude might fluctuate in the same direction (positive correlation) or in the opposite (negative correlation), depending on which variable is changing (rodgers & nicewander 1988). pearson correlation is frequently used in the context of a linear association between two normally distributed random variables. a spearman rank correlation can be used to describe the monotonic association between two variables and is useful in cases where the distribution of data is not normal and/or contains outliers (caruso & cliff 1997). a spearman coefficient is basically a pearson correlation coefficient calculated with the ranks of the values of each of the two variables instead of their actual values (kutner et al. 2005). in the study, the opposite, that there is no correlation between esg ratings and corporate tax transparency, was assumed. the p (probability) value indicated by the pearson and spearman correlations is a measure of how probable it is that any observed correlation is due to chance (keller & warrack 1997). a p-value ranges between 0 and 1, where a p-value close to 0 indicates that the correlation is unlikely due to chance and signals a very high probability that the assumption of no correlation is wrong, thus indicating correlation between the variables (keller & warrack 1997). in statistics, a p-value of 5% is accepted as strong (p = 0.05). below this level, there is at least a 95% probability that the correlation is statistically significant and that these two show a true relationship. where significant correlation is found, a linear regression analysis is performed to explore how the two variables affect each other and it uses a mathematical equation (keller & warrack 1997) of: the regression establishes how x causes y to change. the p-value of the analysis tests whether the regression coefficient beta is equal to zero, indicating no effect. a p-value of less than 0.05 indicates that changes in the one variable are related to changes in the other variable. the beta (shown as b) indicates how much y changes for each one-unit change in x (keller & warrack 1997). to ensure the validity of the correlation and regression analysis, the durbin watson statistic is used to guarantee that no autocorrelation exists at lag one, which would undervalue the standard error and may cause us to believe that predictors are significant when they are not (keller & warrack 1997). where the durbin watson test statistic values are in the range of 1.5 to 2.5, it is acceptable, with d = 2 signalling no autocorrelation. as a final validity test, the breusch-pagan test is run to see if the errors have constant variance, also known as whether heteroskedasticity is present in the regression analyses. this is important because one of the fundamental assumptions of regression is that the variance of the errors is constant across observations (keller & warrack 1997). in cases where heteroskedasticity is present, bootstrap samples are created to ensure that the relationship between the variance of each error and the corresponding regressor is retained (mackinnon 2002). the mackinnon and white procedure (1985) to adjust the results for heteroskedasticity is then applied. results correlation results both the pearson and spearman correlation tests indicated a highly significant correlation between overall esg rating and the total corporate tax transparency of the companies included in the data. the spearman correlation is r = 0.335 with t-statistic t = 3.73 and p-value = 0.000304. the pearson correlation is r = 0.357 with t-statistic t = 4.01 and p-value = 0.00011. since both correlations are positive it signifies that as one variable (either the overall esg rating or corporate tax transparency) increases, the other variable (either the overall esg rating or corporate tax transparency) also increases. as a result of the significant correlation, the regression analysis of y = corporate tax transparency on x = overall esg ratings is of interest. the regression analysis gives the following information: the estimated regression equation is: detail is shown in table 3. no regression is thus rejected since the slope estimate is b = 0.1767, also with t-statistic t = 4.01 and p-value = 0.00011 (or f-statistic = 16.116 and p-value = 0.00011). the percentage variation of the extent of corporate tax transparency explained by the overall esg rating is 12.778%. table 3: regression summary. the durbin watson statistic for the test of serial correlation in the residuals is d = 1.981, which is close to 2, implying no serial correlation. the breusch–pagan test that the residuals are homoskedastic is rejected since the test statistic is bp = 9.46, with degrees of freedom = 1 and p-value < 0.001. thus, the results should be adapted for heteroskedasticity. this is done using the mackinnon and white procedure (1985). this test concludes that the test of no regression is rejected with t = 3.25 and p-value = 0.00152, confirming the correlation and regression found. although both the pearson and spearman tests indicated a highly significant correlation between overall esg rating and the total corporate tax transparency, the shapiro-wilk test indicated that the residuals of the regression analysis are not normally distributed, statistic sw = 0.837 and p-value p = 0.000001, which indicate that the appropriate test of no correlation is the one according to the spearman correlation. this correlation is summarised in table 4. table 4: spearman correlation statistics. both the pearson and spearman correlation tests indicated no significant correlation between the rating achieved in the governance category and corporate tax transparency, indicating no significant correlation between the rating achieved in the governance category and corporate tax transparency. the spearman correlation is r = −0.045 and p-value = 0.6363. the pearson correlation is r = 0.07 and p-value = 0.46. on the same basis, both the pearson and spearman correlation tests indicated no significant correlation between the rating achieved in the transparency and reporting and corporate tax transparency, indicating no significant correlation between the rating achieved in the transparency and reporting and corporate tax transparency. the spearman correlation is r = −0.03 and p-value = 0.636. the pearson correlation is r = −0.11 and p-value = 0.23. although the tests indicate a significant correlation between esg ratings and corporate tax transparency, the results should be interpreted with caution since no significant correlation was found when the rating achieved in the governance category, and the transparency and reporting subcategory of the overall esg ratings were tested. this could signal that the significant correlation is coincidental and that the overall esg rating is not necessarily indicative of good tax governance. the data are further analysed using descriptive statistics in an attempt to gain additional clarity, but further research is recommended. descriptive statistics the descriptive statistics for the companies included in the data are listed in table 5. the mean for the extent of corporate tax transparency variable is very low. this suggests that the vast majority of the companies in the data do not disclose corporation tax information other than what is required by international financial reporting standards. this is supported by the fact that the minimum for the extent of the corporate tax transparency variable is zero, indicating that 37.5% of the companies included in the data do not disclose any of the gri 207’s recommended tax disclosures. the mean values of the ratings achieved in both the governance category, and the transparency and reporting subcategory are noticeably smaller than the median, indicating that the distribution is negatively skewed. this indicates a large gap in the distribution of these ratings, which could explain why there was a significant correlation between the overall esg rating and corporate tax transparency, but no correlation when the overall esg rating was replaced with the ratings achieved in the governance category or transparency and reporting subcategory. table 5: descriptive statistics. corporate tax transparency was second-greatest in the company with the best overall esg rating. this company earned the second-highest rating in the governance category, as well as in the transparency and reporting subcategory. two companies included in the data achieved the highest extent of corporate tax transparency possible, disclosing all of the gri 207’s required corporate tax aspects. one of these companies’ esg ratings are all substantially over their respective means, ranging close to their respective maximums. in contrast, the other company’s esg rating, achieved in both the governance category and transparency and reporting subcategory, is below the respective means, ranging near to the respective minimums. the companies included in the data with a secondary listing on the jse had an average extent of corporate tax transparency that was 1.043 points more than the companies with a primary listing on the jse. this is proof of international initiatives imposed by the foreign jurisdictions where these companies are primarily listed and is indicative that south african companies are not yet following international trends on public corporate tax disclosures. the south african revenue service announced regulations establishing the cbc reporting standard for multinational groups in south africa (sa cbc regulations) on 23 december 2016, in response to the oecd’s recommendations on the oecd/g20 beps project (sars 2016). multinational groups with a total consolidated group turnover above r10 billion are required to adhere to the sa cbc regulations, which mandate thorough tax reporting on a country-by-country basis (sars 2016). the total consolidated revenue of the data companies with a primary listing on the jse was compared to the r10 billion cbc reporting threshold, yielding 52 companies with a probable cbc reporting filing obligation. since these companies should have tax-related information readily available for each jurisdiction in which they trade, since increased public corporate tax disclosure is expected, and is confirmed by an average extent of corporate tax transparency of 3.019 compared to 1.65 of companies without a filing obligation. however, 33 of the 52 companies included in the data, with a probable cbc reporting filing obligation, received a corporate tax transparency extent of 3 or lower (out of 16). it’s worth noting the following findings from the content analyses: some companies boldly state that tax is not a material item in their operations. tax was listed as a material item by one company, but only for taxes paid in south africa. all other jurisdictions in which the company trades are not considered material, so it is not reported. one company applied the first two parts of gri207, gri 207-1 and 207-2, while gri 207-3 and gri 207-4 were not applied. many companies state in their integrated report that it has a tax strategy in place but do not disclose it. some companies combine all of their foreign jurisdictions’ tax information to report on their foreign activities, instead of disclosing on a country-by-country basis. all the companies in the data set, however, publicly declare that it views itself as a responsible corporate citizen through its tax payments made to governments. conclusion over the last few years, corporate tax transparency has garnered a lot of media attention, with many initiatives initiated by governments, regulators, investor action organisations, and industry non-profit organisations to improve tax governance through disclosure. tax fits into all three categories of esg. the ‘e’ ties back to environmental taxes, the ‘g’ relates to the governance of tax and the ‘s’ stands for a company’s social contribution in the form of corporate tax paid. to this end, the paying of a corporation’s fair share of corporate tax, as well as transparency of a company’s tax practices are becoming a powerful indicator of how a company understands its role in society and its commitment to its goal in the context of the esg imperative. since there is little being said about tax as part of the esg imperative, the aim of the study was to explore the correlation between esg ratings and the corporate tax transparency of jse-listed companies. csrhub, an open-access rating organisation, provided the esg rating of the companies included in the data. the weighted average of four categories, namely employees, environment, community relations, and governance, is used to calculate the esg rating. in order to gain a better understanding of how tax governance is reflected in the esg rating, the ratings achieved in the governance category, and transparency and reporting subcategory, were explored. a content analysis was used to assign a measure to the extent of corporate tax transparency disclosures of the companies included in the data. following that, a correlation analysis was conducted to see if there was any correlation between esg ratings and corporate tax transparency. the study found a significate correlation between the overall esg rating and the corporate tax transparency of the companies included in the data. the correlation found provides persuasive evidence that companies with a higher overall esg rating are also more transparent with their corporate tax practices. this conclusion must, however, be interpreted with caution as no correlation was found between the ratings achieved in the governance category, transparency and reporting subcategory and the extent of corporate tax transparency. descriptive statistics did, however, indicate negatively skewed distributions of both the ratings achieved in the governance category and transparency and reporting subcategory. since this is an indication of large gaps in the distribution of these variables, it might explain why no correlation was found. there are limitations to this study. for starters, the data excludes several of the top 100 jse-listed companies based on market capitalisation since csrhub either does not provide the rating of these companies or had incomplete ratings. despite this, the data include 112 companies with a combined market capitalisation of almost r5.5 trillion as of 28 february 2022. secondly, because the data only contained jse-listed companies, the findings may be more specific to south africa which is classified as a developing country and not necessarily applicable to other jurisdictions. thirdly, the research is purely exploratory and only covers one year of data. the results may vary from year to year as a company’s perception of tax as a material element shifts, resulting in more or less disclosure in terms of gri 207. finally, the author used judgment to assign the measure to the data companies’ extent of corporate tax transparency disclosures throughout the content analysis, resulting in a less-than-rigid interpretation of the criteria. the study attempts to add to the limited scholarly literature on tax as part of the esg imperative by adding to the current body of knowledge on the correlation between esg ratings and company tax transparency. the study’s findings may be valuable in informing company boards about the impact of corporate tax transparency on esg ratings. additionally, investors may utilise it to make investment decisions. future research could include conducting the same study with a global set of data, which would yield a larger data parameter and provide more insight into the correlation between global esg ratings and corporate tax transparency. another relevant area for future examination is the correlation between esg ratings and corporate tax transparency across longer time periods, particularly in future years, given the ongoing demand and need for greater corporate tax transparency. acknowledgements competing interests the author(s) declare that they have no financial or personal relationship(s) that may have inappropriately influenced them in writing this article. author’s contributions c.t. declares that she is the sole author of this research article. ethical considerations ethical clearance to conduct this study was obtained from the research ethics committee: social, behavioural and education research of stellenbosch university (no. 25170). funding information the research received no specific grant from any funding agency in the public, commercial or not-for-profit sectors data availability data sharing is not applicable to this article, as no new data were created or analysed in this study. disclaimer the views and opinions expressed in this article are those of the author and do not necessarily 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stiglingh, m. & smit, a., 2017, ‘integrated thinking and the transparency of tax disclosures in the corporate reports of firms’, journal of international financial management & accounting 28(3), 394–427. https://doi.org/10.1080/10291954.2020.1738072 microsoft word 3 copreneurs task-based factors farrington et al 24 sajems ns 14 (2011) no 1 task-based factors influencing the successful functioning of copreneurial businesses in south africa shelley farrington, elmarie venter and carey eybers department of business management, nelson mandela metropolitan university christo boshoff department of business management, stellenbosch university accepted october 2009 globally, evidence exists to suggest that the number of copreneurial businesses or spousal partnerships are on the increase. the primary objectives of this study are to identify the task-based factors influencing the effectiveness of a copreneurial business, to propose a conceptual model based on these factors and to subject the model to empirical testing. the model is empirically tested among copreneurial businesses to assess potential relationships between selected independent variables (shared dream, leadership, personal needs alignment, division of labour, complementary skills, supportive employees, competencies and adequate resources) and measures of copreneurial success (perceived success and financial performance). in order to address the primary objective of this study, a questionnaire was administered to a sample of 1548 respondents (spouses in business together) of which 380 questionnaires were useable for statistical analysis. the empirical results revealed that apart from division of labour all the other factors investigated exert a significant influence on the successful functioning of copreneurial businesses. key words: copreneurs, husband-and-wife teams, successful copreneurial businesses, copreneurship as a route to entrepreneurship jel l25, 26 1 introduction, problem statement and research objectives copreneurships are a particular type of family business where married couples or couples in a marriage-like relationship, share in the ownership, management and responsibility of a single business (rutherford, muse & oswald, 2006; barnett & barnett, 1988). although the concept of copreneurship has been around for almost twenty years (barnett & barnett, 1988), as they become more common these types of family businesses are receiving an increasing amount of attention in the small and family business literature (marshack, 1994; rutherford et al., 2006; muske & fitzgerald, 2006; poza & messer, 2001; rowe & hong, 2000). according to fitzgerald and muske (2002), much of the growth in entrepreneurship is attributed to an increasing number of wives becoming involved in business partnerships with their husbands. to date, however, little research has been conducted on copreneurs in business together and few theoretical guidelines exist to assist these couples to manage their copreneurial relationship (jaffe, 1990; marshack, 1994; muske & fitzgerald, 2006; poza & messer, 2001; rowe and hong, 2000). while numerous popular articles on the subject exist, these are not research-oriented but rather anecdotal or based on single-case studies (marshack, 1993). this limited scholarly research on gender ownership makes it difficult to do research on the phenomena of copreneurship. in addition, the term “copreneur” is not widely recognised, even by organisations that represent or support small businesses, and it is typically associated with the role of women as working spouses in small family firms (o’connor, hamouda, mckeon, henry & johnston, 2006). according to cole and johnson (2007) abstract sajems ns 14 (2011) no 1 25 copreneurs face the unique challenge of balancing their romantic personal relationship with their professional business one. in their research danes and olson (2003) found that when couples work together the potential for tension and conflict is high. given these unique challenges the question thus arises as to what conditions are necessary to ensure the successful creation and maintenance of such copreneurial businesses, and ultimately the survival of these family businesses. despite their unique nature and challenges, a husband and wife in a family business, are basically a team just like any other within an organisational context. consequently it is important that the spouses work together in their business as a team if they want their copreneurship to be successful. teamwork and collaboration are critical to the success of any business partnership (gage, gromala & kopf, 2004; ward, 2004). this being the case, the organisational concepts of effective teams are as relevant to spousal teams as they are to other teams. to function effectively, certain basic elements are required to exist in the working conditions of a team; the extent to which these elements are present increases the chances of a successful team outcome (hofstrand, 2000). against this background the primary objectives of this study are to identify these basic elements or task-based factors influencing the effectiveness of a copreneurial business, to propose a conceptual model based on these factors and to subject the model to empirical testing. the lack of existing theory and empirically based research on copreneurs or copreneurial teams has necessitated a triangulation of theories and a multidisciplinary approach in order to identify the factors influencing the effective functioning of a copreneurial business. in this study, theories from the organisational behavior (teamwork) as well as family business literature have been adopted to explain this phenomenon in the field of family business. o’connor et al. (2006) also emphasised the importance of teamwork in their research on copreneurial businesses. for the purpose of this study the concepts “copreneurs”, “copreneurial businesses” and “husband-and-wife teams” are used interchangeably and synonymously. 2 attributes of effective copreneurial teams literally thousands of studies in almost every type of organisational context have examined factors that influence team effectiveness (hitt, miller & colella, 2006; kozlowski & ilgen, 2006). consequently, there is a large body of research on how to build effective teams and on identifying factors related to team effectiveness (kozlowski & ilgen, 2006; robbins, 2003; sheard & kakabadse, 2002). numerous general models of effective teams have been proposed by, amongst other, hellriegel, jackson, slocum, staude, amos, klopper, louw and oosthuizen, (2004); kreitner and kinicki (1995); mondy and premeaux (1995); and robbins (2003). these and the classic models of campion, medsker and higgs (1993), gladstein (1984) and hackman (1987) condense current knowledge about what makes teams effective (robbins, 2003). these normative models are useful for highlighting the necessary factors to be considered when teams are configured (kozlowski & ilgen, 2006). although these models differ in many respects, they all, implicitly or explicitly, address similar issues and offer similar suggestions on how to design effective teams. these issues are of nearuniversal importance to all teams and the suggestions offered can be applied to almost any team, in almost any context (guzzo & dickson, 1996; yancey, 1998). after a careful analysis of various theoretical models, team-based research and lists describing the characteristics of and requirements for effective teams, four general categories or themes are proposed representing summaries of the key components of previous theories, namely, context, composition, structure, and processes. in addition, each general category comprises a number of underlying components. these four categories reflect the necessary criteria, characteristics and essential requirements for effective teams and high levels of team performance. the input-process-output (i-p-o) model, which proposes that inputs lead to processes that in turn lead to outcomes, is the most common framework used to explain the way in 26 sajems ns 14 (2011) no 1 which team design elements interact to enable effective team outcomes (barrick, stewart, neubert & mount, 1998; campion et al., 1993; groesbeck & van aken, 2001). the i-p-o model posits that a variety of inputs combine to influence intra-group processes, which in turn affect team outputs. inputs refer to the composition of the team in terms of the constellation of individual characteristics and resources at multiple levels (individual, team, organisation). processes refer to the activities that team members engage in, in combining their resources to resolve (or fail to resolve) task demands. processes thus mediate the translation of inputs to outcomes. output has three facets: performance judged by relevant others external to the team; meeting of team member needs or team-member satisfaction; and viability or the willingness of members to remain in the team. these tripartite facets capture the prevalent conceptualisation of team effectiveness (barrick et al., 1998:377; kozlowski & ilgen, 2006). in her model, gladstein (1984), for example, categorises the various factors influencing group effectiveness into input and process variables. input variables are further divided into group composition (adequate skills, heterogeneity, organisational tenure and job tenure); group structure (role and goal clarity, specific work norms, task control, size and formal leadership); and resources available and organisational structure (available training, markets served, group performance rewards and supervisory control). in hackman’s (1990) input-process-output model, inputs include task design, group composition, training, resources, and some elements of context. internal processes include communicating, managing conflict, making decisions, and learning. outputs include productivity, quality, innovation, customer satisfaction, and employee satisfaction (howard, foster and shannon, 2005). taking cognisance of the input-processoutput (i-p-o) model, the general categories identified, namely, context, composition, structure and processes are further delineated into either input or process variables. context, com-position and structure are all categorised as input variables because of the high degree of correlation that has proved to exist between them (barrick et al., 1998; olukayode & ehigie, 2005). a considerable amount of research has examined various inputs of the i-p-o model (howard et al., 2005). for example, campion et al. (1993) have found that almost all of their proposed input variables or design characteristics of work groups, relate to one or more of their three criteria of team effectiveness. these results have been confirmed in a follow-up study (campion, papper & medsker, 1996). consequently, it was decided to focus on the input factors, namely context, composition and structure (and their underlying components) and the impact they have on husband and wife teams in business. considering the influence that input factors have on the ability of team members to complete the task at hand, these factors can also be described as task-based factors. 3 proposed conceptual model the factors included in the conceptual model are justified by sufficiency of theory in both the teamwork and family business literature. as such the model is based on an integration of prior findings and theories on team effectiveness and supported by empirical or anecdotal evidence found in the family business literature. the conceptual model proposed in this paper suggests that three input or task-based variables impact the effective functioning of copreneurial businesses, namely context, composition and structure. these three taskbased factors are divided into six underlying independent variables, namely: internal context; complementary skills; division of labour; shared dream; governance; and leadership. figure 1 illustrates the hypothesised relationships between the above mentioned independent variables, and the dependent variable, namely, perceived success. furthermore, although financial performance is not a task-based factor as such, assessing the financial performance of a business is necessary when establishing the overall successful functioning thereof. as a result, sajems ns 14 (2011) no 1 27 financial performance has been included as an intervening or mediating variable in the conceptual model. anecdotal and empirical evidence supporting the hypothesised relationships is discussed in the paragraphs below. 3.1 dependent variable: perceived success of the copreneurial business as illustrated in figure 1, the dependent variable in this study is the perceived success of a copreneurial business. perceived success is defined as the degree to which the copreneurs find their ongoing involvement in the copreneurship as satisfying as well as beneficial to their family, marriage and personal development. the satisfaction of family members involved in a family business is commonly associated with success in family business research (handler, 1991; ivancevich, konopaske & matteson, 2005; sharma, 2004; venter, 2003). figure 1 proposed conceptual model of task-based factors influencing the perceived success of a copreneurial business financial performance perceived success context internal context composition complementary skills structure leadership governance shared dream division of labour h1a h1b h2a h2b h3a h3b h4a h4b h5a h5b h6a h6b h7 3.2 independent variables: task-based factors influencing copreneurial businesses in this study the factor, internal context refers to the internal environment of the copreneurial business, specifically in terms of access to adequate and suitable resources, information, equipment, employees and working conditions. for any team of people to perform successfully, an internal organisational context should exist that provides team members with the necessary support and infrastructure to complete the task at hand effectively (hitt et al., 2006; robbins, 2003). in studies on team effectiveness, significant relationships and positive correlations have been found between variables relating to context (resources, information and training, amongst others) and measures of team effectiveness (campion et al., 1993; doolen, hacker & van aken, 2006; hyatt & ruddy, 1997). the following hypotheses have been formulated to test the impact of internal context on the success of a copreneurial business: h 1a : there is a positive relationship between internal context and the perceived success of the copreneurship. h 1b : there is a positive relationship between internal context and the financial performance of the copreneurship. teams function most effectively when composed of highly skilled and competent individuals who can offer a diverse set of complementary skills and experiences (hitt et al., 2006; robbins, 2003). in this study complementary skills refers to the copreneurs 28 sajems ns 14 (2011) no 1 being competent and being competent in different areas. team member heterogeneity in terms of abilities and experiences has been found to have a positive effect on team performance (gladstein, 1984; hackman, 1987). for family businesses managed by teams of siblings for example, it is also suggested that the siblings should have a more or less even distribution of complementary skills and talents among them (aronoff, astrachan, mendosa & ward, 1997; gersick, davis, mccollom hampton & lansberg, 1997; lansberg, 1999). according to tompson and tompson (2000) spouses in business together should possess individual skills that are compatible with each other. similary, both nelton (1986) and o’connor et al. (2006) assert that when spouses can effectively combine their individual skills in a complementary manner, their copreneurship is more likely to be successful. synergy among copreneurs will only be possible if individual skills are mutual and complementary (roha & blum, 1990). based on the discussion above, the following hypotheses have been formulated: h 2a : there is a positive relationship between the complementary skills among copreneurial couples and the perceived success of the copreneurship. h 2b : there is a positive relationship between the complementary skills among copreneurial couples and the financial performance of the copreneurship. a team’s leadership is crucial to the effectiveness of the team, and the team leader strongly influences all aspects of a team’s composition and behaviour (hitt et al., 2006; ivancevich et al., 2005). cowie (2007) reports a significant positive relationship between leadership and the ability of a team to operate efficiently. several studies (gladstein, 1984; guzzo & dickson, 1996) have also found support for a relationship between leadership and measures of team effectiveness. in his research on the contributions of leadership styles to family business success, sorenson (2000) found that participative leadership was significantly and positively associated with financial performance. both participative leadership and referent leadership were positively and significantly related to family outcomes. sorenson (2000) concludes that referent, and in particular participative leaders, enable family businesses to obtain desired outcomes for both the business and the family. according to marshack (2002) copreneurs must openly and honestly decide how leadership is going to develop within their business. leadership, that emphasises flexibility, a win-win philosophy, quality over quantity, robustness and prudence, is essential for success. in addition, success in business would not be possible without leadership that build the trust and confidence of employees (marshack 2002). in this study leadership refers to the spouse(s) having a consultative or participative leadership style, having referent and expert leadership, and being visionary. it is consequently hypothesised that: h 3a : there is a positive relationship between leadership and the perceived success of the copreneurship. h 3b : there is a positive relationship between leadership and the financial performance of the copreneurship. governance structures, such as advisory boards, boards of directors and frequent family meetings, are increasingly emphasised as important correlates with both family business longevity over multiple generations and firm performance (astrachan & aronoff, 1998; astrachan & kolenko, 1994). in this study the factor governance refers to the overall existence of governance structures, policies and procedures in the copreneurship. anecdotal evidence suggests that the implementation of governance structures, policies and procedures promotes family business success, stimulates growth and contributes to the continuity as well as sustainability of the family business (aronoff et al., 1997; lansberg, 1999; ward, 2004). hauser (2004) maintains that well-governed families also manage well-governed businesses, which in turn earn consistently high profits. in her study, venter (2003) reports a positive relationship between the existence of governance processes and planning, and the continued profitability of the business. adendorff (2004) also reported a positive relationship between profitability and sajems ns 14 (2011) no 1 29 perceived good governance. effective teams in general have norms or codes of conduct that govern their behaviour (keen, 2003, northouse, 2004). hyatt and ruddy (1997) found a significant positive relationship between norms and roles among team members and manager ratings of team effectiveness. although governance structures in copreneurial businesses are usually informal (governance for the family business, 2008), based on the discussion above, it has been hypothesised that: h 4a : there is a positive relationship between governance and the perceived success of the copreneurship. h 4b : there is a positive relationship between governance and the financial performance of the copreneurship. according to lansberg (1999: 75) a shared dream among family members is described as a “collective vision of the future that inspires family members to engage in the hard work of planning and to do whatever is necessary to maintain their collaboration to achieve their goals”. in this study the factor shared dream refers to whether the dreams that the spouses have for themselves in their copreneurship are aligned with each other’s dreams, their involvement in the business is entirely voluntary, and they agree on the future direction of the business. ring and van de ven (1994) contend that a shared vision (dream) promotes coherence in stakeholders’ expectations and opinions on organisational goals, and consequently promotes cooperative behaviour through clarified role interactions. similarly, lansberg (1999) is of the opinion that a balance between individual dreams and the shared dream is essential to the psychological well-being of all family members, as well as to the harmony of the family business. in their study, mustakallio, autio and zahra (2002) found support for their hypotheses that a shared vision was associated with increased decision quality and increased managements’ decision commitment, respectively. in addition, they found that a shared vision was positively associated with strategic decision quality and commitment. associations between the existence of a mission and indicators of business effectiveness, namely return on assets, return on investments, sales growth, market share, quality, employee satisfaction, and product/service development, have also been found to be significant (denison, lief & ward, 2004). studies among teams in general show a significant relationship between the existence of clear goals and measures of team effectiveness (doolen et al., 2006; guzzo & dickson, 1996). hyatt and ruddy (1997), for example, found a significant positive correlation between commitment to common goals and goal orientation among team members, and team effectiveness. according to guzzo and dickson (1996), team goals often coexist with individual goals, but when team and individual goals are in conflict with one another, dysfunctions can result. in her study, cowie (2007) reported a significant positive relationship between the commitment to and existence of clear and challenging goals, and financial performance. according to van auken and werbel (2006), as well as campbell (2008) copreneurs should ensure that their vision concerning the business, its goals, risks and rewards, is shared between them. if their dream for the business is not shared, feelings of resentment may arise, ultimately leading to marital strife (campbell, 2008). charles (2008) asserts that copreneurs should not only have a shared dream concerning the business, but, should also share personal and relationship goals to avoid drifting apart. based on the above it is hypothesised that: h 5a : there is a positive relationship between the existence of a shared dream between copreneurial couples and the perceived success of the copreneurship. h 5b : there is a positive relationship between the existence of a shared dream between copreneurial couples and the financial performance of the copreneurship. in effective teams, members mutually agree on responsibilities (keen, 2003; robbins, 2003) and job descriptions, and individual tasks and responsibilities are specified and clearly laid out (hitt et al., 2006). in this study division of labour refers to each spouse being assigned a clearly demarcated area of authority and 30 sajems ns 14 (2011) no 1 responsibility in the business, as well as the spouses being in agreement on this assignment. several studies (e.g. ancona & caldwell, 1992; keck, 1997) show that functional assignment diversity (the existence of distinct organisational roles or positions) affects firm performance. roure and keeley (1990), for example, report that the degree to which team members hold a range of key positions is associated with entrepreneurial success. similarly, beckman and burton (2005) found strong support for their hypothesis that management teams with functional assignment diversity will reach firm outcomes more quickly than teams that do not. in her study, cowie (2007) found a significant positive relationship between clear responsibilities and the willingness of team members to cooperate with and support each other. handler (1991) concluded from her study that separate positions and areas of responsibility promote a positive relationship between family members in business together. both, marshack (1994) and robin (2007) contend that copreneurs should occupy specific and clearly defined roles within their businesses, and the more distinct these tasks and responsibilities are, the more beneficial it will be for the business. according to tompson and tompson (2000), clearly defined roles ensure that respect and order is maintained between the spouses. similarly, blum and roha (1990), as well as gale (2002), contend that clearly defined roles (clear division of labour) significantly reduce the likelihood of power battles and rivalry between the spouses. without clear roles and job descriptions for spouses in business together, problems, conflicts and resentments may rise (husbands, wives and business, 2008). based on the discussion above, the following hypotheses have been formulated: h 6a : there is a positive relationship between the division of labour amongst copreneurs and the perceived success of the copreneurship. h 6b : there is a positive relationship between the division of labour amongst copreneurs and the financial performance of the copreneurship. 3.3 itermediate or mediating variable: financial performance for the purpose of this study financial performance refers to positive trends of growth in number of employees and profits, as well as increasing revenue experienced by the copreneurial business. financial performance is commonly regarded as a measure of success and has been used by numerous authors to distinguish between successful and unsuccessful successions (flören, 2002; venter, 2003), successors (goldberg, 1996), family businesses (sharma, 2004; ward, 2004) and even teams in general (ivancevich et al, 2005; mondy & premeaux, 1995; northouse, 2004). in her study venter (2003) found a positive relationship between the financial security of the owner-manager and the business, and the satisfaction with the succession process, as well as between the financial security of the owner-manager and the business, and the continued profitability of the business after the succession. adendorff’s (2004) research also revealed a positive relationship between profitability and the ability to satisfy stakeholders’ interests. tagiuri and davis (1992) indicated that one of the main goals of the owner-managers of successful smaller family businesses is to provide themselves with financial security and benefits. similarly, o’connor et al. (2006) observed that spouses tend to establish businesses out of a desire to create wealth. it is doubtful whether stakeholders in a copreneurial business would find their involvement as satisfying were their business to experience financial difficulties. the following hypothesis is thus formulated: h 7 : there is a positive relationship between the financial performance of the copreneurial business and the perceived success of the copreneurial business. 4 methodology 4.1 sample and sampling method no complete lists distinguishing family from non-family businesses are available in south africa (van der merwe & ellis, 2007; venter, sajems ns 14 (2011) no 1 31 2003). three databases of family businesses were, however, identified and used to initiate the sampling process in this study. the first database used is one developed by venter (2003) in her study on the succession process of small and medium-sized family businesses in south africa. venter’s (2003) database contains a list of 1 038 family businesses throughout south africa. the second database of family businesses used, was one developed by the department of business management at the nelson mandela metropolitan university. the names and details of 749 small and medium-sized family businesses appear on this list. the third database used was one developed by farrington (2009) for her study on sibling partnerships among small and medium-sized family businesses in south africa. this database contains the names of 1 323 siblings involved in south african family businesses. these three databases served as the initial sampling frame (list of names), from which potential sampling units were identified. in addition, an advanced google search of south african websites resulted in many names of businesses involving copreneurs. respondents were identified be means of convenience snowball sampling which was initiated by contacting family businesses on the three databases, as well as those identified via the google search. once identified, suitability and willingness to participate in the study were confirmed telephonically, details were captured on a database, and respondents were requested to identify other copreneurial businesses that could be approached to participate in this study. these potential respondents were then also contacted telephonically and the process was repeated. this sampling technique and methodology is consistent with that of other family business researchers who have been constrained by the lack of a national database on family firms (sonfield & lussier, 2004; van der merwe & ellis, 2007; venter, 2003). 4.2 method of data collection each factor under investigation (construct) was clearly defined and then operationalised. operationalisation was done by using reliable and valid items sourced from validated measuring instruments used in previous studies, as well as several self-generated items based on secondary sources. these items were then used to empirically test the relationships hypothesised in the conceptual model. section 1 of the measuring instrument consisted of 58 statements (items) relating to various task-based factors influencing the perceived success of a copreneurial business. using a 7-point likert-type scale, respondents were requested to indicate their extent of agreement with regard to each statement. the 7-point likert-type scale was interpreted as 1 = strongly disagree and 7 = strongly agree. demographic information pertaining to both the respondent, the marriage relationship as well as the copreneurial business was requested in section 2. structured questionnaires (1548) were made available to identified respondents by means of a convenience snowball sampling technique. the data collected from 380 usable questionnaires was subjected to various statistical analyses. an exploratory factor analysis was undertaken and cronbach-alpha coefficients were calculated to assess the discriminant validity and reliability of the measuring instrument. the relationships proposed in the conceptual model were assessed by means of multiple regression analyses. 4.3 the realised sample the demographic characteristics of the sample show that most of the respondents were female (55 per cent), between the ages of 40 and 51 years old (37 per cent), and white (98 per cent). almost half (49 per cent) indicated having been in business together with their spouse for 10 years or less, and 74 per cent reported operating their copreneurship from their family home. most (50 per cent) of the respondents indicated employing 10 or less people, and operating their copreneurial businesses in either the retail/services (30 per cent) or hospitality (22 per cent) industries. most (52 per cent) respondents reported that the ownership of their copreneurial business is divided equally between them and their spouse, with the vast majority (92.1 per cent) being actively employed in the business. although 32.1 per cent of the respondents reported that leadership is shared equally 32 sajems ns 14 (2011) no 1 between them and their spouse, 31.8 per cent indicated that the spouse that was most knowledgeable took the lead among them. 4.4 discriminant validity and reliability an exploratory factor analysis was conducted to identify the unique factors present in the data and as such assess the discriminant validity of the measuring instrument. the software programme spss 15 for windows was used for this purpose. in order to conduct the factor analysis the data was divided into two models. the first model related to the dependent variables and the second to the independent variables. for the model relating to the dependent variables, principal axis factoring with an oblique rotation was specified as the extraction and rotation methods. principal component analysis with a varimax rotation was specified as the extraction and rotation methods for the model relating to the independent variables. in determining the factors (constructs) to extract for each model the percentage of variance explained and the individual factor loading were considered (see tables 1 and 2). table 1 rotated matrix: the dependent variables perceived success financial performance growth performance psucc2 0.860 -0.046 -0.029 psucc6 0.843 -0.066 -0.036 psucc3 0.800 -0.003 0.022 psucc7 0.797 -0.071 0.007 psucc1 0.732 0.104 -0.075 psucc5 0.580 0.003 0.138 psucc4 0.488 0.247 0.010 fin5 -0.026 0.983 -0.038 fin3 -0.038 0.828 0.090 fin6 0.095 0.640 0.068 fin1 0.030 0.028 0.839 fin4 -0.007 0.234 0.760 fin2 -0.005 -0.042 0.483 although all seven items intended to measure perceived success loaded together onto one construct as expected, the six items measuring financial performance, did not. these six items loaded onto two separate factors, that were named financial performance and growth performance. these three factors explain 69.19 per cent of the variance in the data and are regarded as the dependent variables in this study. factor loadings of ≥ 0.4 (hair, black, babin, anderson and tatham, 2006) are reported for all factors, consequently providing evidence of construct and discriminant validity for the measuring scales. with regard to the exploratory factor analyses undertaken on the independent variables (table 2), the original six factors did not load as expected, instead eight new factors emerged. of the original six items intended to measure shared dream, three items loaded together i.e. share1, share2 and share3. in addition, two other items, namely lead7 and gov1 also loaded onto shared dream. shared dream explains 32.65 per cent of the variance in the data. the other three items (share4, share5 and share6) originally expected to measure the construct shared dream loaded together onto a separate factor. based on the nature of the items that loaded together, it was decided to name this factor personal needs alignment. personal needs alignment explains 6.39 per cent of the variance in the data. sajems ns 14 (2011) no 1 33 table 2 rotated factor matrix: the independent variables s h a re d d re a m l e a d e rs h ip p e rs o n a l n e e d s a lig n m e n t d iv is io n o f la b o u r c o m p le m e n ta ry s k ill s s u p p o rt iv e e m p lo y e e s c o m p e te n c ie s a d e q u a te re s o u rc e s share1 0.812 0.158 0.145 0.114 0.074 0.134 0.080 0.073 share2 0.767 0.210 0.014 0.140 0.191 0.042 0.033 0.153 share3 0.760 0.145 0.301 0.175 0.040 0.066 0.084 0.032 lead7 0.726 0.139 0.123 0.066 0.176 0.044 0.159 0.170 gov1 0.537 0.072 0.126 0.254 0.045 0.223 0.211 0.041 lead1 0.210 0.833 -0.001 0.035 0.003 -0.019 -0.010 0.190 lead6 0.143 0.774 0.253 0.082 0.150 0.006 0.114 0.002 lead3 0.137 0.675 0.191 0.246 0.056 0.246 0.081 -0.112 lead2 0.213 0.592 0.134 0.098 0.276 0.324 0.142 0.092 share5 0.321 0.117 0.818 0.083 -0.010 0.118 0.119 0.072 share4 0.254 0.105 0.788 0.066 0.090 0.016 0.078 0.211 share6 -0.003 0.247 0.613 0.083 0.259 0.078 0.078 0.053 div4 0.091 -0.034 0.079 0.803 0.120 0.121 0.123 -0.026 div5 0.218 0.179 0.027 0.713 0.109 0.058 0.022 0.150 div1 0.264 0.315 0.130 0.598 0.025 -0.008 0.110 0.129 cskills5 0.226 0.091 0.084 0.098 0.841 -0.019 -0.015 0.123 cskills6 0.132 0.172 0.177 0.147 0.776 0.095 0.184 0.117 cont5 0.215 0.152 0.050 -0.035 0.012 0.823 0.025 -0.043 cont6 0.053 0.067 0.107 0.236 0.051 0.765 0.069 0.262 cskills3 0.161 0.104 0.050 0.072 0.057 0.068 0.823 0.101 cskills2 0.160 0.076 0.167 0.136 0.086 0.025 0.765 0.173 cont2 0.387 0.093 0.112 0.108 0.084 0.038 0.152 0.775 cont1 0.054 0.059 0.257 0.117 0.243 0.202 0.237 0.728 only four items used to measure the construct leadership loaded together onto one factor. leadership explains 7.06 per cent of the variance in the data. three of the items (div1, div4 and div5) expected to measure the construct division of labour loaded onto one factor. the items div2, div3 and div6 did not load as expected and were therefore not used in subsequent statistical analysis. division of labour explains 5.9 per cent of the variance in the data. only two (cskills5 and cskills6) of the six items expected to measure the construct complementary skills loaded onto one factor. complementary skills explains 5.48 per cent of the variance in the data. the items cskills2 and cskills3 loaded together onto a separate factor which was named competencies. competencies explain 4.63 per cent of the variance in the data. only two (cont5 and cont6) of the 6 items expected to measure the construct internal context loaded onto one factor. this factor was named supportive employees and explains 4.80 per cent of the variance in the data. the items cont3 and cont4 did not load as expected and were therefore not used in subsequent statistical analysis. the remaining two factors (cont1 and cont2) loaded together separately onto another factor named adequate resources, which explains 3.53 per cent of the variance in the data. 34 sajems ns 14 (2011) no 1 the eight independent variables cumulatively explain 70.46 per cent of variance in the data. factor loadings of ≥ 0.4 (hair et al., 2006) are reported for all factors, which provides evidence of construct and discriminant validity for the measuring scales. table 3 measurement instrument analyses operationalisation of factors items* cronbachalpha values perceived success refers to the copreneurs finding their involvement in the copreneurship satisfying, as well as beneficial to their marriage and personal development. 7 0.885 financial performance refers to the business being financially profitable and secure. 3 0.872 growth performance refers to the business showing growth in employee numbers, profits and turnover. 3 0.700 shared dream refers to the spouses having a vision for their business and agreeing on its future direction. 5 0.827 leadership refers to the spouse(s) being inspirational, considerate and participatory in their leadership style. 4 0.809 personal needs alignment refers to the spouses being able to realise their ambitions and personal goals through their involvement in the business and this involvement in the business is entirely voluntary. 3 0.808 division of labour refers to each spouse being assigned a clearly demarcated area of authority and responsibility in the business, as well as the spouses agreeing on each other’s roles and positions in the business. 3 0.666 complementary skills refers to the spouses bringing a diverse blend of knowledge, skills, perspectives and experiences into the business. 2 0.721 competencies refers to the spouses being competent to perform the tasks associated with running their business i.e. they have the necessary business experience and qualifications. 2 0.626 supportive employees refers to the spouses having competent and supportive employees. 2 0.602 adequate resources refers to the copreneurial business having sufficient access to the adequate resources and information necessary for the effective functioning of the business. 2 0.716 * see appendix a for a detailed description of multiple item scales measuring factors based on the results of the factor analyses and the items that loaded on to each construct, the operational definitions were reformulated. the operationalisation of the constructs identified, the minimum and maximum factor loadings as well as the cronbach-alpha coefficients for each of these constructs are summarised in table 3. in addition, cronbach-alpha coefficients of greater than 0.70 (nunnally & bernstein, 1994; peterson, 1994) are reported for all constructs, suggesting that reliable measuring scales were used to measure the constructs under investigation. 4.5 revised theoretical model and hypotheses based on the results of the factor analyses the proposed conceptual model (figure 1) was modified (figure 2) and the hypotheses reformulated in table 4 below. sajems ns 14 (2011) no 1 35 table 4 reformulated hypotheses h 1 : there is a positive relationship between the growth performance and the perceived success of copreneurship. h 2 : there is a positive relationship between the financial performance and the perceived success of the copreneurship. h 3a-3c : there is a positive relationship between shared dream and the dependent variables, perceived success, growth performance and financial performance of the copreneurial business. h 4a-4c : there is a positive relationship between leadership and the dependent variables, perceived success, growth performance and financial performance of the copreneurial business. h 5a-5c : there is a positive relationship between personal needs alignment and the dependent variables, perceived success, growth performance and financial performance of the copreneurial business. h 6a-6c : there is a positive relationship between division of labour and the dependent variables, perceived success, growth performance and financial performance of the copreneurial business. h 7a-7c : there is a positive relationship between complementary skills and the dependent variables, perceived success, growth performance and financial performance of the copreneurial business. h 8a-8c : there is a positive relationship between competencies and the dependent variables, perceived success, growth performance and financial performance of the copreneurial business. h 9a-9c : there is a positive relationship between supportive employees and the dependent variables, perceived success, growth performance and financial performance of the copreneurial business. h 10a-10c : there is a positive relationship between adequate resources and the dependent variables, perceived success, growth performance and financial performance of the copreneurial business. 4.6 multiple linear regression multiple linear regression is a tool for predicting a dependent variable based on several independent or explanatory variables (cooper & schindler, 2007; hair, anderson, tatham & black, 1998) and as such allows for the simultaneous investigation of the effect of two or more independent variables on a single dependent variable. multiple linear regression analysis was performed to assess whether the independent variables as identified in this study exert a significant influence on the dependent variables namely perceived success, financial performance and growth performance of a copreneurial business. as such three separate regression models were used and the results thereof are discussed in the paragraphs below. in addition to serving as the dependent variables, financial performance and growth performance, together with the other independent variables, were also modelled as independent variables influencing the perceived success of a copreneurial business. 36 sajems ns 14 (2011) no 1 figure 2 revised conceptual model of task-based factors influencing the perceived success of a copreneurial business align employee share resources cskill division leader psucc h 5c h 6c h 1 h 9a resource competent groperf finperf h 2 h 3c h 4a h 4b h 4c h 5a h 5b h 6a h 6b h 7a h 7b h 7c h 8ah 8b h 8c h 9b h 9c h 10a h 10b h 10c h 3b key: psucc = perceived success; finperf = financial performance; groperf = growth performance; share = shared dream, leader = leadership, align = personal needs alignment, cskill = complementary skills, employee = supportive employees, competent = competencies; and resource = adequate resources 4.6.1 regression analysis results: perceived success of a copreneurship based on the multiple regression analysis it has been established that the independent variables explain 64.8 per cent of the variance in the perceived success of a copreneurial business. as can be seen in table 5, a positive relationship was found between perceived success and the independent variables, namely shared dream (t=2.094; p<0.05), leadership (t=7.258; p<0.001), personal needs alignment (t=11.654; p<0.001) as well as complementary skills (t=3.599; p<0.001) and competencies (t=2.942; p<0.01). in other words, the more that spouses agree on the future direction of their business, exhibit leadership that is inspirational, considerate and participatory, and are able to realise their personal ambitions through their involvement in the business, the more likely the spouses will be satisfied with their involvement in their copreneurial business. similarly, the more that spouses are competent to manage their business and possess competencies that complement each other, the more likely the copreneurs are to experience their involvement in the copreneurship as satisfying, as well as beneficial to their marriage and personal development. based on these results, support is thus found for hypotheses h 3a , h 4a , h 5a , h 7a and h 8a . sajems ns 14 (2011) no 1 37 table 5 independent variables and perceived success of a copreneurship dependent variable: perceived success r-square = 0.648 independent variables beta t-value sig.(p) shared dream 0.088 2.094 0.037* leadership 0.280 7.258 0.000*** personal needs alignment 0.453 11.654 0.000*** division of labour 0.073 1.964 0.050 complementary skills 0.133 3.599 0.000*** competencies 0.108 2.942 0.003** supportive employees -0.073 -1.992 0.047* adequate resources -0.008 -0.187 0.852 growth performance -0.044 -1.162 0.246 financial performance 0.017 0.415 0.678 (*p<0.05; **p<0.01; ***p<0.001) the results of this study reveal a negative relationship between supportive employees and perceived success (t=-1.992; p<0.05). this negative relationship implies that the more competent and supportive the employees, the less likely the spouses are to experience their involvement in business together as satisfying and beneficial. as a result, no support was found for hypothesis h 9a , which proposed a positive relationship between supportive employees and perceived success. the results of the regression analysis further reveal that neither the financial nor the growth performance of the business has an impact on the perceived success of a copreneurship. in addition, the results also show that division of labour and adequate resources do not influence the extent to which respondents experience their involvement in the copreneurship as satisfying and beneficial to their marriage and personal development. consequently, no support was found for hypotheses h 1 , h 2 , h 6a and h 10a . 4.6.2 regression analysis results: financial performance of a copreneurship with regard to the influence of the independent variables on the financial performance of a copreneurial business it is evident that the independent variables explain 32.9 per cent of the variance in the financial performance of the copreneurship. table 6 illustrates that a positive linear relationship emerged between personal needs alignment and financial performance (t=3.901; p<0.001), implying that the more the spouses can realise their personal goals in the business and that their involvement is voluntary, the better the financial performance of their business is likely to be. a positive linear relationship was found between complementary skills and financial performance (t=2.140; p<0.05), as well as between competencies and financial performance (t=4.052; p<0.001). in other words the more complementary the spouses’ skills and abilities are to one another, and the more competent the spouses are to perform the tasks required of them to run their business, the more likely the business is to be perceived as financially profitable and secure. a positive linear relationship was also found between supportive employees and financial performance (t=4.615; p<0.001), as well as between adequate resources and financial performance (t=3.099; p<0.01). this means that the more competent and loyal the employees of the business are and the more access the business has to necessary resources, the more likely the business is to perform financially. however, the results show that a shared dream, leadership and division of labour do not influence the financial performance of a copreneurship in this study. based on these results, hypotheses h 5c , h 7c , h 8c , h 9c and h 10c cannot be rejected, whereas hypotheses h 3c , h 4c and h 6c are rejected. 38 sajems ns 14 (2011) no 1 table 6 independent variables and the financial performance of a copreneurship dependent variable: financial performance r-square = 0.329 independent variables beta t-value sig.(p) shared dream -0.037 -0.637 0.525 leadership -0.076 -1.434 0.153 personal needs alignment 0.205 3.901 0.000*** division of labour 0.024 0.470 0.639 complementary skills 0.107 2.140 0.033* competencies 0.199 4.052 0.000*** supportive employees 0.220 4.615 0.000*** adequate resources 0.172 3.099 0.002** (*p<0.05; **p<0.01; ***p<0.001) 4.6.3 regression analysis results: growth performance of a copreneurship the findings of this study (see table 7) show that the independent variables explain 22.8 per cent of the variance in the growth performance of the business. table 7 independent variables and growth performance of a copreneurship dependent variable: growth performance r-square = 0.228 independent variables beta t-value sig.(p) shared dream 0.054 0.867 0.387 leadership -0.025 -0.431 0.667 personal needs alignment 0.090 1.591 0.113 division of labour -0.041 -0.757 0.449 complementary skills 0.188 3.494 0.001** competencies 0.021 0.396 0.692 supportive employees 0.308 6.010 0.000*** adequate resources 0.058 0.966 0.335 (*p<0.05; **p<0.01; ***p<0.001) table 7 reveals a positive linear relationship between complementary skills and growth performance (t=3.494; p<0.01). this means that the more complementary the spouses’ skills and abilities are to one another the more likely the business is to experience growth. also illustrated in table 7, is a positive linear relationship between supportive employees and growth performance (t=6.010; p<0.001). in other words, the more loyal and competent the employees of the business are, the more likely the business is to experience growth. support has therefore been found for hypotheses h 7b and h 9b , meaning that these hypotheses cannot be rejected, whereas hypotheses h 3b , h 4b , h 5b , h 6b , h 8b and h 10b are rejected. in other words, the results indicate no support for a positive linear relationship between shared dream, leadership, personal needs alignment, division of labour, competencies and adequate resources, and the dependent variable growth performance of a copreneurship. thirteen significant relationships were identified between the various independent and the dependent variables. these significant relationships are summarised in figure 3. it should be noted that the model, as illustrated in figure 3, was not tested as a single model, but split into three models with each being subjected to a regression analysis. sajems ns 14 (2011) no 1 39 figure 3 summary of significant relationships between the independent and dependent variables align employee share cskill leader psucc resource competent groperf finperf h 3a h 4a h 5a h 7a h9a h 8a h7b h 9b h 5c h 7c h9c h8c h 10c key: psucc = perceived success; finperf = financial performance; groperf = growth performance; share = shared dream, leader = leadership, align = personal needs alignment, cskill = complementary skills, employee = supportive employees, competent = competencies; and resource = adequate resources 5 conclusions and recommendations the results of the study show that the copreneurial businesses involved in this study perceived the following task-based factors as influencing the success of their business, namely: shared dream, leadership, personal needs alignment, complementary skills, supportive employees, competencies and adequate resources. a shared dream and leadership play a significant role in determining the satisfaction levels of copreneurs in a copreneurial business. the findings of this study show that the more that spouses agree on the future direction of their business and exhibit leadership that is inspirational, considerate and participatory, the more likely the spouses will experience their involvement in the copreneurship as satisfying, as well as beneficial to their marriage and personal development. in addition, the ability of spouses to realise their personal ambitions (personal needs alignment) through their involvement in the business, influences their degree of satisfaction with their involvement in their copreneurial business, as well as their perception of its benefits for their marriage and personal development. furthermore, the more that spouses are able to realise their personal ambitions through the business the better the financial performance of their business is likely to be. when spouses share a future vision for their business it drives their sense of purpose for working together. finding and emphasising this common ground, keeping the final destination in mind, and understanding what is required to get there, is of key importance to a successful copreneurship. in order to ensure a shared dream for their business, spouses should ensure that both of them are committed to this dream and that an overlap exists between their individual dreams or personal 40 sajems ns 14 (2011) no 1 ambitions, and their shared dreams. as such the spouses should be able to live out their own dreams and achieve their personal ambitions through their involvement in their copreneurial business. a shared dream between spouses should provide direction, be clearly specified and be revised when necessary. when spouses work together in a business, it is important that they develop their own leadership and decision-making style, which is best suited to their particular circumstances. despite the fact that husbands tend to be the primary decision-makers in copreneurial businesses (o’connor et al., 2006), the ideal is when leadership between the spouses emerges naturally, the leader is comfortable with power, and is the most competent person to take the lead. in addition to being inspirational, considerate and participatory, it is important that the leader can be trusted to make good decisions and is future orientated. the findings of this study show that the more competent the spouses are to manage their business, the more likely the copreneurs are to experience their involvement in the copreneurship as satisfying and beneficial to them, and the more likely the business is to be perceived as financially profitable and secure. in addition, the study reveals that not only should the spouses be competent, their competencies should also complement each other’s. the more that spouses possess competencies that complement each other’s, the more likely the copreneurs are to experience their involvement in the copreneurship as satisfying as well as beneficial to their marriage and personal development. in addition, the more complementary the spouse’s skills and abilities are to one another, the more likely the business is to perform financially and experience growth. when copreneurs appropriately combine their varied knowledge, talents, unique skills and experiences, the resulting synergy raises their overall level of performance, and brings many benefits to their copreneurial business. to ensure that these benefits materialise, areas of authority and responsibility should be assigned according to the strengths and particular area of expertise of each spouse. in similar vein, robin (2008) asserts that when dividing the labour between the spouses care should be taken not to divide the work according to traditional gender stereotypes, as is often the case (marshack, 1994; o’connor et al., 2006), but rather on the basis of individual abilities, preferences and skills. the competence and loyalty of employees has a significant positive influence on the ability of a copreneurship to perform financially and to experience growth. competent and supportive employees make a vital contribution through expanding the knowledge base of the copreneurial business by bringing additional qualifications and skills; by showing objectivity; and promoting accountability and professionalism. it is important that care should be taken that employees do not play the spouses off against each other and that the spouses should be in agreement and have a clear policy on employees. in addition, it is important that loyalty and respect for the spouses be developed and maintained among employees. the results of this study do, somewhat surprisingly, reveal a negative relationship between supportive employees and perceived success. having competent and loyal employees working in a copreneurship reduces the likelihood that spouses will experience their involvement in business together as satisfying and beneficial to their marriage and personal development. a possible explanation for this finding could be that spouses involved in coprenerial businesses with competent and loyal employees, are probably less likely to work as many hours and as closely with their spouse, than in businesses where competent employees do not exist. this reduced contribution to the business and reduced interaction with their spouse, could result in their not experiencing their involvement in the business as satisfying or beneficial to their marriage and personal development. in addition, the results indicate that whether the copreneurship has adequate resources or not has no influence on the extent to which respondents experience their involvement in the copreneurship as satisfying and beneficial. however, the results do show that the more access the business has to the necessary resources, the more likely the business is to perform financially. if financially possible, sajems ns 14 (2011) no 1 41 copreneurs should ensure that their business has access to adequate and suitable resources, information, equipment, employees, and working conditions. surprisingly the results of this study show that that neither the financial nor the growth performance of the business has an impact on the perceived success of a copreneurship. considering the definition of perceived success as operationalised in this study, namely the degree to which the copreneurs find their involvement in the copreneurship as satisfying as well as beneficial to their marriage and personal development, one would expect a relationship to exist. the findings imply that the performance (financially or growth) of the copreneurial business has no impact on whether the copreneurs experience their involvement as satisfactory or beneficial. 6 implications for theory and research the value of this study lies in the expression “forewarned is forearmed”. anticipating potential obstacles and challenges allows one to implement steps to address these issues the moment they arise or to potentially avoid them altogether. although many of the task-bassed factors identified as influencing successful copreneurships have been shown as important determinants of success within other contexts and fields of study, this study, however, relates them specifically to spouses working together in family businesses. as such insights are provided into the conditions that should prevail to improve the chances of a successful working arrangement between husbands and wives. this study has added to the body of family business research by investigating a particularly limited segment of the literature, namely copreneurships in family businesses. the use of a relatively large empirical sample size in this study, also adds to the field of family business which has traditionally been characterised by smaller samples and qualitative research. this study has integrated many of the traditional theories of teamwork, and has tested these theories among spousal teams in family businesses. by investigating these teams within the context of the family business, the present study has also contributed to the fields of organisational behaviour and general psychology by either confirming or refuting many of these theories within a specific context. 7 limitations and future research the use of a snowball convenience sampling technique is a limitation of this study. nonprobability sampling introduces a source of potential bias into the study, and consequently the findings can not be generalised to the general family business population. future research should strive to develop a more comprehensive database from which probability samples can be drawn. in addition, the data collected relies on the self-report of respondents. relying on one-time individual self-report measures to assess constructs, is another important limitation. one important limitation of this study is that the proposed conceptual model focuses exclusively on task-based factors and fails to include relational-based factors affecting the successful functioning of copreneurial businesses. relational-based factors refer to factors that influence the interaction between people when they work together as a team and include amongst others, fairness, mutual respect and trust, open communication, spousal relationship, family harmony, commitment, non-family members and balance between work and home. these relational-based factors should also be investigated and incorporated into the conceptual model that describes the factors influencing the successful functioning of copreneurial businesses. as family businesses make up a large percentage of sme worldwide, it would therefore be useful to replicate this study in other countries in an attempt to verify to what extent the factors influencing the success of copreneurial businesses in south africa differ from those affecting these types of businesses abroad. the question of whether culture influences the success of these family businesses would also be worth pursuing. specific attention should be given to black42 sajems ns 14 (2011) no 1 owned copreneurship. future research could also investigate whether the perceptions of factors influencing the success of copreneurial businesses, differ between husbands and wives. an interesting finding in the current study is that the growth and financial performance of the copreneurial business has no influence on whether the spouses are satisfied with their involvement in their copreneurial business or experience this involvement as beneficial to their marriage or personal development. these relationships should be subjected to further testing and investigation. despite the limitations identified, this study has added to the empirical body of family business research and has highlighted numerous opportunities for investigating teams within the context of the family business. references adendorff, c.m. 2004. the development of a cultural family business model of good governance for greek family businesses in south africa, unpublished doctoral dissertation, grahamstown: rhodes university. ancona, d. & caldwell, d.f. 1992. demography and design: predictors of new product team performance. in beckman, c.m. & burton, m.d. 2005. founding the future: the evolution of top management teams 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[online] available at: http://www.workteams.unt.edu/literature/paper-myancey.html [accessed 2007-05-10]. appendix a perceived success psucc1 i am satisfied with the way that my spouse and i work together. psucc2 i enjoy working with my spouse in our family business. psucc3 i experience my involvement in this business together with my spouse as rewarding. psucc4 my involvement in this business together with my spouse is beneficial to our whole family. psucc5 my involvement in this business together with my spouse has contributed to my own professional growth and development. psucc6 my involvement in this business together with my spouse has been beneficial to our marriage relationship. psucc7 my involvement in this business together with my spouse has improved the health of our marriage relationship. financial performance fin5 i regard our family business as being financially successful. fin3 our family business is profitable. fin6 the financial well being of our family business is secure. growth performance 46 sajems ns 14 (2011) no 1 fin1 our family business has experienced growth in turnover over the past two years. fin2 our family business has experienced growth in employee numbers over the past two years. fin4 our family business has experienced growth in profits over the past two years. shared dream share1 my spouse and i have agreed on the vision for our family business. share2 my spouse and i have agreed on the goals for our family business. share3 my spouse and i have agreed on the future direction for our family business. lead7 my spouse and i have a vision for our family business. gov1 my spouse and i hold regular scheduled meetings concerning our business. leadership lead1 the spouse that takes the lead in our family business is always considerate of others working in the business. lead6 the spouse that takes the lead considers the opinions of others when making decisions. lead3 the spouse that takes the lead in our family business encourages others involved in the business to voice their opinions. lead2 the spouse that takes the lead in our family business inspires loyalty among those working in the business. personal needs alignment share5 i can realise my ambitions through my involvement in our family business. share4 i can realise my personal goals through my involvement in our family business. share6 it is my own choice to be involved in our family business. division of labour div4 in our family business a clearly defined division of labour exists between my spouse and i. div5 in our family business clearly demarcated areas of authority and responsibility exist between my spouse and i. div1 my spouse and i have agreed on each others roles or positions in our family business. complementary skills cskills5 my spouse and i bring different strengths (abilities) to our family business. cskills6 my spouse and i bring a diverse mix of knowledge, skills, perspectives and experiences to our family business. supportive employees cont5 our family business has the support of employees working in the business. cont6 our family business has employees with the necessary competencies. competencies cskills3 my spouse and i have the appropriate business experience that enables us to contribute to the functioning of our family business. cskills2 my spouse and i have the qualifications that enable us to contribute to the effective functioning of our family business. adequate resources cont2 our family business has sufficient access to information required to function effectively. cont1 our family business has adequate access to the resources required to function effectively. microsoft word 12 khuzwayo & mare sajems 17(5) 2014.doc sajems ns 17 (2014) no 5:691-699 691 aspects of volatility targeting for south african equity investors bhekinkosi khuzwayo stanlib asset management eben maré department of mathematics and applied mathematics, university of pretoria accepted: july 2014 we consider so-called volatility targeting strategies in the south african equity market. these strategies are aimed at keeping the volatility of a portfolio consisting of a risky asset, typically an equity index, and cash fixed. this is done by changing the allocation of the assets based on an indicator of the future volatility of the risky asset. we use the three month rolling implied volatility as an indicator of future volatility to influence our asset allocation. we compare investments based on different volatility targets to the performance of bonds, equities, property as well as the absolute return peer mean. we examine risk and return characteristics of the volatility targeting strategy as compared to different asset classes. key words: volatility, equities, risk, return, draw-down, asset allocation, vix, implied volatility jel: b16, 26, c59, g19 1 introduction volatility targeting strategies aim to allocate between cash and a risky asset, typically an equity index, with the aim to keep the overall volatility of the strategy stable at a targeted level. the effect on asset allocation due to volatility targeting is deleveraging of the risky asset in periods of high volatility and leveraging in periods of low volatility. volatility targeting holds the promise of higher risk-adjusted returns (as well as decreased tail-risks) relative to a static asset allocation, see for example, ribeiro and di pietro (2008) and de rossi and nakisa (2011). the latter authors note that a study of volatility controlled strategies leads to insights for fund managers typically constrained by targeted tracking error mandates which in turn are directly impacted by market volatility. risk budgeting is also directly impacted by volatility. additionally, investment strategies with controlled volatility lend themselves to structured products with riskcontrolled derivative structures as an overlay. on 1 august 2012 the ftse/jse launched a new suite of indices called the ‘ftse/jse africa top40 risk target indices’ or the ‘risk target indices’. these indices are set to target 10, 15 and 20 per cent volatility on an excess and total return basis, respectively. see, ftse (2012) and jooste (2012). the purpose of this article is to investigate some key aspects of volatility targeting in a south african equity market setting, focusing on the potential risk management aspects and benefits of the strategy. in section 2 we provide an example of the workings of the strategy over time based on the ftse/jse all share (all share) index; we also review relevant literature. in section 3 we compare risk and return of volatility controlled strategies to typical south african investment asset classes as well as risk controlled investment strategies typified by the absolute return peer universe. we provide conclusions as well as some suggestions for future research on this topic in section 4. 2 aspects of volatility targeting in an equity based volatility targeting strategy the optimal allocation to equities can be calculated as follows: abstract 692 sajems ns 17 (2014) no 5:691-699 atilityequity vol ghtequity wei where y volatilittarget equity = = = σ σ equity equity equity w w the equity volatility is the decision-making variable in the formula above. to implement the formula we would typically, at time t, generate a forecast of the equity volatility for time t+1, thereby adjusting the exposure to the equity so as to set the ex ante volatility of the strategy equal to the targeted volatility. in general, the future volatility of an asset is not known with certainty although there are numerous techniques to forecast it with a fair degree of accuracy using simple measures of past volatility and historical returns. see, for example, the review by poon and granger (2003) which compares historical volatility and garch-based forecasting methods as well as implied volatility with findings which support implied volatility forecasts. in this paper we shall use option implied volatility. see also, banerjee, doran and peterson (2007). at the onset of every investment period, typically daily, one would invest the allocation above to equities and the balance in cash. note that the ratio could be larger than one which would imply a geared position in equities. for the purpose of our analysis we cap the equity investment at 100 per cent therefore allowing no gearing as is typically the norm in the south african investment industry. by construction this strategy will up-weight equities during times of low market volatility and down-weight equities during times of increased market volatility. for the purposes of illustrating the method we use the 12-month realised historical volatility as our decision variable. the graph below depicts rolling 12month volatilities and returns of the all share index over the period 1976 to 2012. figure 1 rolling 12 month return and volatility of the all share index we note that we would not typically use the 12-month historical volatility to influence our asset allocation change decisions; though, we would typically use a volatility forecasting methodology or make use of implied volatility. it is used here mainly for illustrative purposes. in figure 2 we show what the optimal asset allocation to equities and cash would have been over the period december 1976 – july 2012, assuming a volatility target of 15 per cent p.a. the figure also depicts the cumulative returns of equity on a logged-basis (in red). sajems ns 17 (2014) no 5:691-699 693 figure 2 optimal asset allocation: equities and cash (target volatility15 per cent p.a.) we note some important points. as the market rallies the equity allocation increases until there is a significant decline in the market. consequently, the equity allocation is generally at its highest (i.e. 100 per cent) just before a downturn. subsequent to a downturn the equity weight is reduced. however, the reduction only happens after the downturn which means that the strategy would fail to avoid the large drawdowns in equity markets. secondly, after a crash the equity market seems to rally. however, the equity allocation is at its lowest just after the crash. as a result, the strategy also fails to capture the initial phase of the market upturn. all-in-all such a strategy would be expected to underperform equity at a reduced volatility. however, the drawdowns could be similar to equity drawdowns given that the portfolio is generally fully exposed to equity prior to significant market drawdown periods. volatility targeting strategies are a recent financial innovation. we highlight some relevant research here to illustrate the insight and background – clearly, if such a strategy were to be successful it would need to exploit some relation between volatility and future returns; however, a detailed study on the causality between volatility and returns is beyond the scope of this article. black (1976) noted that the volatility of a stock depends on the level of the stock. consider figure 3 below. this figure details the daily change in the cboe volatility index (vix) against the daily percentage change in the s&p 500 equity index. this figure demonstrates a strong link between short-term index-based returns and implied volatilities of options traded on the index. french et al. (1987) demonstrated a positive relationship between expected market risk premia and predictable volatility of stock returns. chu et al. (1996) relate variation in stock market volatility to regime shifts in stock market returns and note the asymmetric relationship. more recently, li et al. (2005) found evidence that stock market returns and stock market volatility are negatively correlated, lending support to claims by bekaert and wu (2000) as well as whitelaw (2000). see also, cont (2001), who notes the persistence of volatility in the equity markets, i.e., periods of high volatility tend to be followed by periods of high volatility. 694 sajems ns 17 (2014) no 5:691-699 figure 3 daily vix changes vs. daily percentage change returns in the s&p 500 index . the relationship between returns and volatility is difficult to capture, however, and also changes over time, see for example, poterba and summers (1986), harrison and zhang (1999) and baillie and degennaro (1990). using s&p500 data, bollerslev and zhou (2006) consider and explain implied and realised volatility and return relations. a number of papers consider the implied volatility skew for equities, detailing an increase in implied volatility with a decrease in equity returns, see, for example, derman (1999). banerjee et al. (2007) demonstrate links between vix-related variables and returns. copeland and copeland (1999) also demonstrate use of the vix for market timing while fleming et al. (2003) demonstrate the economic value of volatility timing using realised volatility. malz (2000) demonstrate that implied volatility could signal increased likelihood of market turmoil. graham and harvey (1996) examined invest-ment newsletters offering advice on asset allocations – finding no evidence of forecasting ability although, interestingly, the disagreement between newsletters is found to be correlated with future realised and implied volatility. it is clear from the literature surveyed above that there is informational content in asset return volatilities (measured on a historical and implied basis). the link with future returns is less clear and varies by holding period. however, from the literature surveyed above one can follow the logic of a volatility targeted investment; in periods of high volatility, frequently associated with bear-markets, the strategy would have a lower weight in the risky asset than in periods of lower volatility, frequently associated with bull-markets. in principle, the volatility weighting becomes a tactical asset allocation methodology. 3 risk and return comparisons in this section we consider a more realistic volatility targeting strategy than demonstrated sajems ns 17 (2014) no 5:691-699 695 in section 2. using the results by malz (2000) and banerjee et al. (2007) and inspired by poon and granger (2003) we consider using implied volatility to forecast future volatility and conse quently to signal asset allocation changes. we use the rolling 3-month interpolated implied volatility obtained from safex traded options on the ftse/jse top40 index to signal volatility changes. the rolling implied volatility is obtained by linearly interpolating implied volatility data between the so-called ‘near’ and ‘middle’ safex futures contract expiration dates to obtain a consistent 3-month volatility control. the data used in our analysis covers the period from november 2000 to july 2012. we also use equity invested in the ftse/jse top40 index and cash investments are based on the so-called stefi (short-term fixed interest call deposit index). we consider weekly portfolio changes. we also assume the strategy is implemented on the ftse/jse top40 index using futures – this is a practical assumption and has the benefit of simplifying our analysis as the futures are highly liquid and transaction costs are minimal. the performance of volatility targeting strategies of 10, 15 and 20 per cent is compared to equity and cash in figure 4 below. note that we also consider an alternative strategy to avoid drawdowns and thus preserve capital. we therefore analyse the volatility targeting strategy relative to the peer mean of the absolute return funds in the south african setting. these funds typically have an investment objective of delivering inflationlinked returns, at least, but simultaneously preserving capital over rolling twelve month periods. figure 4 cumulative returns of the strategies from figure 4 we note the following. all the strategies have underperformed equity and outperformed cash. in addition, the volatility targeting strategies have outperformed the absolute return peer mean. however, we notice that these strategies have significantly higher drawdowns than the ‘average’ absolute return fund. the attractive characteristic of the absolute return peer mean is the consistency of the series. this series has very low drawdowns relative to the other strategies. in figure 5, below, we analyse these strategies on a risk-return chart. on a risk-return basis we note that the absolute return peer mean has delivered a return comparable to bonds at a relatively low risk. the volatility targeting strategies have delivered returns that are similar to south 696 sajems ns 17 (2014) no 5:691-699 african bonds but at a meaningfully higher risk. considering the volatility targeting strategies, the strategy targeting 10 per cent has the highest risk-adjusted return. the slope of the line through this point gives the riskadjusted return of this strategy. points above this line have a higher risk-adjusted return and vice versa. as can be seen on a risk-adjusted basis this strategy is inferior to the absolute return peer mean. figure 5 risk – return analysis: february 2001–february 2013 the motivation behind lower volatility is that such portfolios supposedly have lower drawdowns than the market. as a result they should be more likely to preserve capital than equities in the short term. in figure 6 we analyse the probability of these strategies delivering a negative 12 month return. in addition we also analyse the magnitude of such returns. this will help us understand, not only the probability of delivering negative returns, but also the magnitude of such negative returns. equities have approximately 20 per cent probability of delivering a negative 12 month return. on average the magnitude of such a return is 18 per cent. on the other hand property has a 10 per cent probability of delivering a negative return, with an average magnitude of around -9 per cent. the volatility targeting strategies have at least a 12 per cent probability of delivering a negative 12 month return (for the volatility target of 10 per cent). this probability is higher than that for property and bonds. this is one negative aspect of volatility targeting, especially for an investor targeting capital preservation (or seeking risk reduction). in addition the magnitude of such negative returns is at least 3 per cent (for the 10 per cent volatility target) and more than 8.5 per cent for the 15 per cent volatility target. this highlights the fact that volatility targeting as a strategy fails to avoid the drawdowns inherent in equity markets (although the drawdowns for the lower volatility target seem comparable to bonds). in contrast the probability of a negative 12 month return for the average absolute return fund is less than 5.0 per cent p.a. this is a compelling finding that says the average absolute return fund will preserve capital at least 95 per cent of the time on a 12 month sajems ns 17 (2014) no 5:691-699 697 basis. in addition the magnitude of such negative returns is very low (lower than bonds). all in all, an investment in an average absolute return should preserve capital at least 95 per cent of the time. however, if there is a negative 12 month return it can be expected to be at most 2.0 per cent p.a. this renders itself as a compelling argument for absolute return investing as opposed to volatility targeting. figure 6 probability and magnitude of negative 12 month returns: february 2001 – february 2013 we conclude this section by comparing the sharpe ratio of the different investment strategies described above in table 1. table 1 asset class returns and sharpe ratios asset class annualised return (per cent) sharpe ratio equities 15.9 0.4 bonds 11.7 0.4 absolute return 9.9 0.2 vol target (10%) 12.6 0.4 vol target (15%) 13.8 0.4 vol target (20%) 14.1 0.3 we note that the sharpe ratio, calculated over the full period of the analysis, does not provide for a clear investment decision between the strategies this provides further illustration for our preference of comparing the drawdown characteristics of the different strategies. 4 conclusions and future research we have examined the performance of volatility targeting strategies for the all share index by making use of implied volatility as a signalling factor. we compared the performance of these 698 sajems ns 17 (2014) no 5:691-699 strategies to the returns of traditional asset classes in the south african market including the absolute return peer universe. our analysis shows that the volatility target strategies outperform equity on a risk adjusted basis. our analysis does indicate though, that one needs to be careful to consider these strategies as risk controls the volatility control does not necessarily provide protection against the meaningful drawdowns in the equity market. we have made comparisons with bonds and the absolute return peer universe which provide a clear advantage from a risk management perspective. the volatility targeting strategies do, however, seem to capture more returns. we have not performed work on volatility forecasts using historical index return series; we note that the ftse/jse top40 risk target strategy relies on an exponential moving average methodology. this is clearly an area for interesting future research which should incorporate the stochastic nature of volatility as well as the accuracy of volatility forecasts in relation to conditional equity returns. another interesting area of research would be an investigation of protective strategies based on derivatives where the decision to protect would be based on a volatility control. this is an area that has not been investigated. acknowledgements the authors wish to express their gratitude towards dr brett dugmore from bnp-paribas-cadiz securities as well as emlyn flint from peregrine securities for assistance with historical data. the authors also wish to express their gratitude towards the comments and suggestions made by two anonymous referees that aided in the presentation and finalisation of this article. references baillie, r.t. & degennaro r.p. 1990. stock returns and volatility. the journal of financial and quantitative analysis, 25(2):203-214. banerjee, p.s., doran, j.s. & peterson, d.r. 2007. implied volatility and future portfolio returns, journal of banking and finance, 31:3183-3199. bekaert, g. & wu, g. 2000. asymmetric volatility and risk in equity markets. the review of financial studies, 13(1):1-42. black, f. 1976. studies of stock price volatility changes. proceedings of the 1976 meeting of business and economics statistics section of the american statistical association, 27:399-418. bollerslev, t. & zhou, h. 2006. volatility puzzles: a simple framework for gauging return-volatility regressions. journal of econometrics, 131:123-150. chu c-sj, santoni, g.j. & liu, t. 1996. stock market volatility and regime shifts in returns. information sciences, 94:179-190. cont, r. 2001. empirical properties of asset returns: stylized facts and statistical issues. quantitative finance, 1:223-236. copeland, m.m. & copeland, t.e. 1999. market timing: style and size rotation using the vix, financial analysts journal, 55(2):73-81. derman, e. 1999. volatility regimes, risk, 12(4):55-59. de rossi, g. & nakisa, r. 2011. understanding volatility targeting strategies, ubs investment research. fleming, j., kirby, c. & ostdiek, b. 2003. the economic value of volatility timing using ‘realized’ volatility, journal of financial economics, 67:473-509. french, k.r., schwert, g.w. & stambaugh, r.f. 1987. expected stock returns and volatility, journal of financial economics, 19:3-29. ftse. august 2012. ground rules of the management for the ftse/jse top 40 net risk target index series 2 version 1.2. graham, j.r. & harvey, c.r. 1996. market timing ability and volatility implied in investment newsletters’ asset allocation recommendations, journal of financial economics, 42:397-421. harrison, p. & zhang, h.h. 1999. an investigation of the risk and return relation at long horizons, review of economics and statistics, 81:399-408. sajems ns 17 (2014) no 5:691-699 699 jooste, r. august 2012. risk target indices. available at: http://www.fm.co.za/fm/2012/08/24/risk-targetindices [accessed 2013-01-01]. li, q., yang, j., hsiao, c. & chang, y. 2005. the relationship between stock returns and volatility in international stock markets. journal of empirical finance, 12:650-665. malz, a.m. 2000. do implied volatilities provide an early warning of market stress? riskmetrics journal, 1:41-60. poon, s-h. & granger, c.w.j. 2003. forecasting volatility in financial markets: a review. journal of economic literature, 41(2):478-539. poterba, j.m. & summers, l.h. 1986. the persistence of volatility and stock market fluctuations. the american economic review, december 1986, 76(5):1142-1151. ribeiro, r. & di pietro, v. 2008. volatility signals for asset allocation. jp morgan investment strategies, 51. whitelaw, r. 2000. stock market risk and return: an empirical equilibrium approach. review of financial studies, 13:521-547. microsoft word b short bios of_contributors_si.doc iv sajems special issue 17 (2014) : iv-v short cvs of contributors to the special issue michiel c bekker michiel (giel) bekker is a senior lecturer in project management in the graduate school of technology management, university of pretoria, south africa. he is also an erasmus mundus scholar at umea business school, sweden and herriot watt university, edinburgh, scotland. he is a registered professional engineer and holds an m.eng (mechanical), mba and phd from the university of pretoria. his research interests are in project governance, project complexity and large capital project performance. he is also a recipient of the project management excellence award in project execution from the project management institute of south africa. kai-ying chan kai-ying (alice) chan is a senior lecturer in the graduate school of technology management at university of pretoria, south africa. she holds a phd from university of pretoria (2010). her phd research focused on organizational networks and firm innovation in a science park. her current research topics include project teams, innovative activities and performance. she is currently one of the researchers in the dfid project with the focus on south african innovation. tsun-jin chang tsun-jin chang is an associate professor in the department of marketing management at shih chien university, kaohsiung campus, taiwan. he received a bsc in business administration from tam kang university, and an mba and a phd in management from the institute of business management of national sun yat-sen university, taiwan. his current research interests include organizational innovation, new product innovativeness, cross-functional new product development (npd) teams, r&d-marketing interface, and employee creativity. anna jerbrant anna jerbrant is an associate professor in the department of industrial economics and management, at the royal institute of technology (kth, sweden). anna holds a phd degree from kth (2009). her research is focused on increasing the understanding of the organizational challenges that contemporary project-based organizations face with increased competition in a globalized world. the findings emphasize the importance for the multi-project management to focus on the balance between creativity, flexibility and structure. anna has published several articles in the international journal of project management, the international journal of managing projects in business and the international journal of project organization and management. frien van kessel frien van kessel is a tenured lecturer of the international business school of fontys university of applied sciences in venlo, the netherlands. as an external doctoral student he is linked to the department of organization studies at tilburg university, the netherlands. his dissertation focuses on the role of intra-organizational environments for creativity and innovation outcomes. monica lindgren monica lindgren is professor of industrial economics and management at the school of industrial engineering and management, kth royal institute of technology, stockholm, sweden. prof. lindgren’s research interests are located within the general area of critical organization studies and include project-based work, entrepreneurship, gender and leadership. her research has been published in journal of management studies, human relations, scandinavian journal of management and ephemera: theory & politics in organization. she is a member of the team behind the international making projects critical workshop series. sajems special issue 17 (2014) : iv-v v leon oerlemans leon oerlemans is professor of organizational dynamics in the department of organization studies at tilburg university, the netherlands. he is also extraordinary professor economics of innovation at the university of pretoria, graduate school of technology management, south africa and co-founder and core fellow of the center for innovation research at tilburg university. research topics include temporary organizations, interactive learning and interorganizational relationships and networks. amoungst others, his work has been published in journal of management, research policy, organization studies and technovation. johann packendorff johann packendorff is associate professor in industrial economics and management at the school of industrial engineering and management, kth royal institute of technology, stockholm. his research explores issues related to project management, entrepreneurship and leadership. dr packendorff’s research has been published in journal of management studies, human relations, scandinavian journal of management and international journal of project management. he is a member of the team behind the international making projects critical workshop series, and a board member of the swedish project academy. tinus pretorius tinus pretorius is professor of technology management in the department of engineering and technology management and is also chairperson of the graduate school of technology at the university of pretoria in south africa. he holds a phd in engineering with specialization in technology management. his research focuses on technology and innovation management and includes project management strategy as one of his areas of interest. he is a rated researcher and published in various international journals (e.g. technovation, south african journal of science) and conference proceedings. he is also a registered professional engineer, fellow of the sa engineering academy and a member of the ieee. saskia van stroe saskia van stroe is a professor in sustainable innovation in the international business school of fontys university of applied sciences in venlo, the netherlands. she holds a phd in chemical engineering from eindhoven university of technology, the netherlands. previously, she worked as an r&d project manager and as a head of consumer and market insight at unilever; and as strategic marketing manager at d&m europa. currently, she also works as a management consultant at smart group organization advice. shang-pao yeh shang-pao yeh is professor of tourism in the department of tourism at i-shou university, taiwan. he is also the editor-in-chief of annals of leisure and recreation research. he holds a doctor of management from webster university, a master of public administration from university of southern california, and a mba from northrop university. his current interests of research are knowledge management, human resource management, and strategic management in tourism and hospitality industry. abstract introduction twitter as a social media stakeholders’ engagement platform methodology results conclusion acknowledgements references appendix 1 about the author(s) george f. nel school of accountancy, faculty of economic and management sciences, university of stellenbosch, stellenbosch, south africa yadah du toit school of accountancy, faculty of economic and management sciences, university of stellenbosch, stellenbosch, south africa citation nel, g.f. & du toit, y., 2023, ‘stakeholders’ engagement in 280 characters: evidence from jse-listed companies’, south african journal of economic and management sciences 26(1), a4964. https://doi.org/10.4102/sajems.v26i1.4964 original research stakeholders’ engagement in 280 characters: evidence from jse-listed companies george f. nel, yadah du toit received: 10 dec. 2022; accepted: 18 apr. 2023; published: 24 aug. 2023 copyright: © 2023. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: twitter is revolutionising the way in which companies engage with stakeholders. while prior research examining companies’ use of twitter focused on the capital market consequences thereof, empirical evidence on how companies use twitter, still remains scant. aim: we aim to improve our understanding of the use of twitter, specifically (1) whether companies use twitter as a two-way stakeholders’ engagement platform, and (2) whether companies change tweeting behaviour around result release dates. setting: the sample consists of 70 companies for which 73 018 tweets were downloaded from twitonomy during the period 2017–2020. methods: the data were analysed using the mixed-model analysis of variances (anovas) and generalised estimations equations. the agency, legitimacy, signalling and capital need theories were used to set expectations and interpret results. results: although there was no significant increase in the overall number of tweets, most companies significantly improved their level of engagement from 2017 to 2020. this is especially true of larger companies, the more profitable companies and companies with increased future growth potential. furthermore, companies tweet significantly more around result release dates. this is most pronounced in primary industries and companies reliant on capital markets. contribution: this is the first study that aimed to explore the two-way use of twitter as a stakeholders’ engagement platform, in the context of a developing country, including possible reasons why companies tweeting behaviour changes around result release dates. it is proposed that regulatory bodies should take note of possible risks, and that companies should be aware of what their peers are doing. keywords: stakeholders’ engagement; social media; twitter; tweet; annual results; interim results; two-way engagement. introduction almost 170 years after the rothschilds became the richest family in the world by using pigeons to carry short and important messages, the world’s richest man has obtained control of twitter, the modern short-message bird, if you like. several factors revolutionised the use of social media (sm), including twitter, in company–stakeholders’ engagements, with one early milestone being the 2013 expansion of the united states (us) regulation fair disclosure to include sm channels (best & caylor 2019). social media (sm), defined as ‘web-based applications and interactive platforms that facilitate the creation, discussion, modification and exchange of user-generated content’ (aichner & jacob 2015:258) refers to an array of different and expanding platforms. twitter is still relatively small in comparison with linkedin, youtube and facebook, but it has become one of the most important sm outlets used by companies (jung et al. 2018) and shareholders (husain, jain & varshney 2021). for example 69% of the united kingdom (uk) ftse 350-listed companies (amin, mohamed & elragal 2020) and 93% of the us s&p 500-listed companies (johnston 2022) have active twitter accounts. given the nature of sm, these statistics are ever changing, but in early 2023 twitter remains one of the top ten sm platforms for corporate use (munson 2022). many have started to question twitter’s popularity after the tumultuous 2022 period when elon musk acquired twitter, with prediction of a mass exit from users. for example, companies such as general motors, audi, volkswagen, pfizer and others stopped using twitter during 2022 (germain 2022), and it has also been reported that more than half of twitter’s top advertisers halted spending on the platform (germain 2022). despite this, twitter remains popular as it is the fourth most visited site in the world (meltwater 2023). twitter also saw a 2% increase in the number of daily active users since musk’s acquisition of the platform, with a 6.7% increase in time spent on twitter (kemp 2023). twitter also still ranks first as the sm platform used to keep up to date with news and current events, with web traffic referrals in second place (meltwater 2023). ample research examined and confirmed: the positive association between twitter use by companies and liquidity and share price returns (ganesh & iyer 2021; mhanna & sun 2020; tan & tas 2021); the ability of twitter sentiment to forecast liquidity and share price returns (saleemi 2020); and the negative association between twitter use, and both information asymmetry (blankespoor, miller & white 2014; prokofieva 2015) and the cost of equity (albarrak et al. 2020; elnahass, papaguannidis & salama 2020). we know, therefore, how twitter affects certain variables, but have little understanding of how companies use twitter, specifically around result release dates and as a stakeholders’ engagement tool. freeman (1984:46) defines stakeholders as ‘any group or individual who is affected by or can affect the achievement of an organization’s objectives’. so in addition to shareholders, stakeholders also include employees, customers, unions, legislators, service providers, communities, the media, and the environment. in south africa, companies listed on the johannesburg stock exchange (jse) are recognised as leaders in stakeholder relationships and integrated reporting because of the well-known king reports. the king iv corporate governance framework specifically advocates a stakeholder-inclusive approach. while empirical research has indicated the benefits of twitter as a two-way interaction platform (chahine & malhotra 2018), research to date has shown that many companies shy away from the use of technology to engage in stakeholder dialogue (capriotti, zeler & oliveira 2021; hetze et al. 2019; nel & baard 2022; yue et al. 2019). to investigate stakeholder dialogue, capriotti et al. studied facebook, hetze et al.explored corporate websites, nel and baard looked at the email functionality, and yue et al.researched ceos’ use of twitter. with the aim of expanding the growing body of knowledge on the corporate use of twitter, this study examined companies’ use of twitter as a two-way stakeholders’ engagement platform (trends and determinants), as well as whether companies change tweeting behaviour around result release dates. this study, therefore, aimed to answer three research questions: question 1: has the use of twitter as a two-way stakeholders’ engagement platform increased from 2017 to 2020? question 2: what characteristics best explain companies’ use of twitter as a two-way stakeholders’ engagement platform? question 3: do companies change their tweeting behaviour around result release dates, and if so, which companies? in order to measure stakeholders’ engagement, the ratio between the number of tweets a company replied to on per calendar year and the total number of tweets made per company per calendar year were evaluated. for result release dates, both the annual and interim results release dates were examined. to assess companies’ tweeting behaviour around result release date, the average daily tweets in a 10-day period (5 days prior to and 5 days after the results release date) was compared to the yearly average daily tweets. the yearly average daily tweets are calculated over 182 days prior to and 182 days after the results release date, excluding the tweets in the 10-day period (also refer to table 3 in the methodology section for a detailed discussion of all variables employed in this study). the south african context also provides a unique opportunity where sm use and stakeholders’ engagement are concerned. firstly, more than 70% of the south african population are internet users that spend an average of more than 9 h online daily (meltwater 2023). this ranks south africa as the country who spends the most time online – around 50% more than the global average of daily online time. of that time, more than a third is spent on sm, where half of south african sm users also indicated that they use sm for work-related activities (meltwater 2023). given this uptake of sm (including twitter), coupled with the stakeholder-inclusive approach, advocated by king iv, and the potential benefits of sm for stakeholder communications, this study aims at contributing to these contexts in a number of ways. more specifically, the results of this study are important for stakeholders, companies, and regulators alike. for stakeholders, the outcome may inform them on whether or not to subscribe to companies’ twitter accounts, based on which companies in south africa use twitter and what they use it for. the findings may also assist companies in developing optimal strategies through benchmarking with their peers. finally, we believe that the findings will offer regulators greater insight into issues relating to corporate use of sm and enhance their assessment of potential risks in the cost-benefit nexus of establishing best practices and standards to regulate companies’ use of twitter. since financial disclosure on sm is not regulated in south africa, one such risk could be that companies are tweeting about financial information before announcing it on sens, which is a requirement in south africa. in the us, elon musk tweeted about taking the company tesla private in 2018 without following the necessary requirements for such disclosure in the us, causing the company’s share price to increase by 11% (bloomberg 2019). another possible risk is the spreading of fake news on sm which can also affect share prices in the short term (wang & chiang 2019). consequently, fake news can be used for short-term stock speculation. with the rapid increase in artificial intelligence products, the latest being chatgpt, regulators must start assessing how to regulate companies’ use of sm in order to address these risks. twitter as a social media stakeholders’ engagement platform from a theoretical stance, nuseir and quasim (2021) claim that legitimacy theory (deegan 2006), signalling theory (connelly et al. 2011) and capital need theory (shehata 2014) best explain companies’ use of a voluntary disclosure channel, such as twitter, to communicate with stakeholders. additionally, esterhuyse and wingard (2016) advocates that agency theory (jensen & meckling, 1976) also provides rational for companies’ engaging in any voluntary disclosures. legitimacy theory proposes that to gain legitimacy, companies need to operate within an unwritten social contract containing implicit and explicit expectations (deegan 2006). consequently, by engaging in activities contrary to society’s expectation, companies may face losing their legitimacy status, and with that, access to critical resources (haji 2013). companies therefore undertake various strategies to either protect or restore their legitimacy (suchman 1995). one such strategy could be to use twitter to interact with stakeholders to positively influence society’s perception of the company. another could be to use twitter to keep up with societal norms and technological changes, such as updating stakeholders continually throughout the day. furthermore, due to a separation in ownership, information asymmetry exists between management and stakeholders. agency theory suggests that companies will try to decrease this asymmetry in order to decrease the associated agency costs. likewise, signalling theory suggests that companies will take action in order to signal inside information, such as increased profitability, to stakeholders to try to shake up this asymmetry. one way then, for companies to decrease information asymmetry, is to engage with stakeholders via twitter. finally, capital need theory asserts that voluntary disclosure, including the optimal use of twitter to engage with stakeholders, will positively influence capital providers’ views of companies and thereby decrease financing costs (shehata 2014). in the remainder of this section twitter is positioned first in the sm realm by exploring the advantages and disadvantages thereof, followed by a brief discussion of related literature, and finally, variables are elaborated on that may explain variations in companies’ use of twitter. advantages and disadvantages of twitter in company–stakeholders’ engagements table 1 presents sm platforms in six categories, based on two characteristics: self-presentation or self-disclosure and social presence or media richness. self-presentation refers to the desire by companies to control the impression stakeholders form of them by the self-disclosure of information, while social presence is influenced by the intimacy and immediacy of the medium. intimacy ranges from mediated (e.g., telephone conversations) to interpersonal (e.g., face-to-face discussions), and extends immediacy from asynchronous to synchronous. twitter, regarded as a microblog (aichner & jacob 2015), is depicted under blogs. table 1: classification of social media. one disadvantage of twitter and a possible reason why companies do not adopt twitter is the fear of losing control, given the retweet twitter functionality. cade (2018) reports results showing that the influence of negative news strongly depends on the number of retweets. furthermore, negative sentiment is empirically linked to decreasing liquidity and share returns. alternatively, twitter can be used to manage negative news. following an experiment that entailed a hypothetical company, best practice for companies in dealing with negative news is to address the issue directly or redirect investors to positive news (cade 2018). the worst outcome would be to abstain from the conversation. several studies have, however, concluded that companies are less likely to use twitter when they have negative news (johnston 2022; jung et al. 2018; xiong et al. 2019). the use of twitter has also been linked to earnings management (ruangprapun 2022), and impression management using visuals to accentuate positive news (nekrasov, teoh & wu 2021). overall, hong and huang (2005) found that companies purposively participate in stakeholders’ engagement to manage liquidity. twitter therefore provides companies with the opportunity to actively manage earnings and impressions by emphasising positive news. another possible advantage is the replies twitter functionality which provides companies with access to two-way synchronous stakeholders’ engagement. finally, two further disadvantages may be twitter’s limited character count and ‘noise’ from a shareholder perspective. nuseir and qasim (2021) argue that given the unique characteristics of different sm platforms, each is best suited for a specific use by companies. they claim that twitter is best fit for the fast sharing of up-to-date information, and for directing followers to other platforms. the 280-character count may therefore not really matter to companies, given their use thereof. in support, a report published by twitter indicated that only 5% of tweets are longer than 190 characters, following the allowed increase from 140 to 280 characters in november 2017 (perez 2018). it is noteworthy that the results of the current study reported no significant increase in the number of tweets made by companies between 2017 and 2018. turning to possible twitter ‘noise’, zhou et al. (2015) reported that only 3.45% of tweets made by us companies are related to corporate disclosures. this points towards substantial ‘noise’ for users concerned with related investment decision information only. using uk data, amin et al. (2020) categorised company tweets in 12 categories in which financial disclosures and corporate sustainability disclosures represented only 7% and 8.8% of the total tweets respectively. despite this possible ‘noise’, the widespread use of twitter indicates its usefulness in decision-making scenarios that range from share selection to product sales prediction, crime prevention, epidemic tracking, covid-19 and traffic monitoring (zhang et al. 2022). the twitter body of knowledge although some studies investigated a ‘package’ of four or more sm platforms (aichner & jacob 2015; husain et al. 2021; khlifi 2021; rautianen & jokinen 2022), the majority investigated only a single sm platform, with twitter being the most popular. empirical research that examined the use of twitter can be categorised as descriptive, determinant or effect studies. although there is no shortage in variety of research designs such as event studies (boylan & boylan 2017; chahine & malhotra 2018; dinh, kopf & seitz 2017), true and quasi-experimental studies (cade 2018; kelton & pennington 2020; rakowski, shirley & stark 2019; snow 2015), surveys (husain et al. 2021) and systematic literature reviews (nuseir & qasim 2021; zhang et al. 2022), the majority of studies in this domain depended on quantitative research methods such as multivariate regressions using archival data. furthermore, these studies can be categorised according to the proxy used to measure twitter. a substantial number of studies measured twitter use by assigning a binary variable if companies had adopted twitter (balasubramanian, fang & yang 2021; boylan & boylan 2017; ghardallou 2021; jung et al. 2018; khlifi 2021), while others used a combination of the number of tweets, replies, likes and followers (ganesh & iyer 2021; mhanna & sun 2020; ruangprapun 2022). a few studies measured the sentiment of company tweets (hamraoui & boubaker 2022; nyakurukwa & seetharam 2022), whereas others went even further and categorised the tweets using automated methods such as supervised or unsupervised machine learning and advanced textual analysis techniques (albarrak et al. 2020; araujo & kollat 2018; majumdar & bose 2019; nekrasov et al. 2021). for several possible reasons (e.g., the availability of data), most published studies to date used data from developed countries for example us, uk, australia and europe (lombardi & secundo 2020). furthermore, twitter adoption (by investors and companies) in developing countries is often lower compared to developed countries. in poland only 64% of financial market professionals use sm, with 50% of them using sm only once a month or less frequently (cwynar et al. 2019). in thailand, only 24 out of 50 set50 companies had a twitter account in 2019 (ruangprapun 2022). looking at south africa, the results of a survey completed by 48 c-suite respondents ranked facebook and twitter as respectively the lowest and second lowest out of 20 tasks or tools available to investor relation professionals (nel & van der spuy 2021). the results of current studies may therefore not translate to developing countries, creating a gap in the body of knowledge. possible explanatory variables in explaining variations between companies although empirical research on the determinants of companies’ use of twitter appears to be scant, with the exception of amin et al. (2020) and ruangprapun (2022), a substantial body of empirical evidence is available on the determinants of companies’ use of corporate websites (mokhtar 2017). drawing from these studies, the following six variables were examined in the current study as variables that could explain companies’ use of twitter: size, future growth opportunity, profitability, dependency on capital markets, industry membership and shareholder dispersion. size, measured as market capitalisation, is the variable most often used in the literature to explain variations in disclosure levels. larger companies are more visible with presumably higher reputational risk, and they have more resources, creating an expectation for them not only to tweet more frequently, but also to have increased two-way stakeholders’ engagement. companies with future growth opportunities and intangibles, proxied by market-to-book ratio, are expected to increase stakeholders’ engagement in order to decrease information asymmetries regarding these opportunities and intangibles (ohlson 2005; orens, aerts & cormier 2010). it is therefore likely that these companies will use twitter as a two-way stakeholders’s engagement platform. signalling theory and capital need theory explain why profitable companies and companies that are more dependent on capital markets are anticipated to tweet more often. profitable companies, measured as return on equity, may have an added incentive to increase tweets and engagement with stakeholders to distinguish themselves from less profitable companies in ‘spreading the news’. likewise, companies more reliant on capital markets experience higher pressure to engage with stakeholders (cormier, ledoux & magnan 2009). as in nel, smit and brummer (2017), we used a categorical variable for companies that have issued shares in the preceding 12-month period as proxy for capital market reliance. while some industries, such as consumer industries, may be more accustomed to increased disclosure and stakeholders’ engagements (de vries, erasmus & gerber 2017), others, such as basic materials and industrials, could have increased pressure to increase tweets and stakeholders’ engagement to legitimise their operation. the current study grouped the industries into two categories, consumer industries and primary industries. finally, a more dispersed shareholder base may result in higher agency costs and information asymmetry. both of these are factors that may motivate companies to develop their twitter presence and engagement. following celik, ecer and karabacak (2006), our proxy for shareholder dispersion was free float. methodology in terms of research methodology, this study relied on a positivist research philosophy, with a deductive approach – using archival longitudinal secondary data collected over four years. this section discusses the compilation of the study sample, followed by a brief overview of the data sources used to collect the required data. finally, research methods are discussed in turn for each of the three research questions. sample the population was defined as all companies listed (and not suspended) on the jse as on 01 january 2017. to ensure data availability to answer the research questions, 229 companies were excluded for several reasons (summarised in table 2), with the main reason being that 114 of the 299 companies were found to have no active twitter account (i.e., 38%), resulting in a final study sample of 70 companies. this compares favourably with the 53% of saudi arabian (ghardallou 2021), 52% of thailand (ruangprapun 2022), and 31% of uk-listed companies (amin et al. 2020) that were reported to not have an active twitter account, but unfavourably with only 7% of us s&p companies found to not have an active twitter account (johnston 2022). table 2: study sample. data sources, variables used and statistical analysis twitonomy, a database extending beyond the tweets currently accessible via twitter’s application programming interface, was used to obtain company-initiated tweets and replies for 2017–2020. this time period includes one covid-19 year (2020) which could possibly skew the results. for robustness, the 2020-year was removed and similar results were obtained. to limit the possible effect that a further covid-19 year could have on the data, the 2021-year was not included. furthermore, given the unpredictable 2022 when musk acquired twitter, this year was also excluded. all other variables used in this study were captured from either iress or obtained directly from the jse. table 3 provides a brief description of each variable used in this study, as well as which research question(s) each was used for. all variables were measured daily, except for the following variables that were measured on an annual basis for practical reasons; market-to-book (mtb), return on equity (roe), free float (f.flt), engagement (eng) 2, industry membership., johannesburg stock exchange (ind.jse.). table 3: variables used to answer the research questions. various mixed-model analysis of variance (anova) models were used to address the research questions. in all mixed-model anovas, the companies were entered into the model as random effect. the statistical analysis is discussed in more detail in the remainder of the section. research question one: twitter as a two-way stakeholders’ engagement platform to ascertain whether the use of twitter as a two-way stakeholders’ engagement tool increased from 2017 to 2020, the various years were entered as fixed effects, while no. tweets and eng 1 were employed as dependent variables. following chahine and malhotra (2018), eng 2 dichotomised eng 1 to distinguish between companies that engage with stakeholders and those that do not. since eng 2 is a categorical variable, a generalised estimating equation (gee) was used to examine whether the use of twitter as a two-way stakeholders’ engagement tool increased from 2017 to 2020. in all cases, fisher’s least significant difference (lsd) was used for post-hoc testing. research question two: determinants of companies that use twitter as a two-way stakeholders’ engagement platform to answer this research question, six company characteristics, namely size (size), future growth opportunity (mtb), profitability (roe), dependency on capital markets (net.iss), industry membership (ind.iss) and share dispersion (f.flt) where entered as fixed effects. these characteristics were regressed on eng 1 in a mixed-model anova and eng 2 in a gee model. in both regression models we have only analysed the contemporaneous association between the independent and dependent variables. research question three: tweeting behaviour around result release dates to examine whether companies tweet more around result release dates, a period fixed effect was entered into the mixed-model anova. the period fixed-effect tests whether there is a significant difference between financial year-end (fye) results and fye year in respect of the release of annual results, and betweenfinancial interim(fi) results and fi year in respect of the release of interim results. refer to table 3 for a brief description on how these variables were calculated. following this,size, roe, net.iss and ind.jse were entered as fixed effects into mixed-model anova’s in order to determine which companies, if any, increase their tweets around result release dates. ethical considerations ethical clearance to conduct this study was obtained from the stellenbosch university social behavioural and education research. (no. 23572). results selected descriptive statistics the descriptive statistics are set out in table 4. for one variable, size, the natural logarithm was used to reduce the skewness in distribution. descriptive statistics for size are presented prior to the natural logarithmic transformation, which was used in all further analysis. appendix 1 shows relevant correlation coefficients for 2017–2020. table 4: selected descriptive statistics. while some companies made only one tweet in an entire year and had not responded to a single stakeholder tweet, other companies tweeted daily and were extremely active in replying to stakeholder tweets. as nearly 50% (eng 2, not tabulated) of companies had not replied to at least one stakeholder tweet, our results suggest that companies may have a low interest in using twitter to engage with stakeholders. similar results were reported for companies’ use of facebook (capriotti et al. 2021) and ceos’ use of twitter (yue et al. 2019). furthermore, table 4 provides evidence of the cross-sectional variation in both size and roe. although not tabulated, similar variation was evident in mtb and f.flt. just over 50% of the companies included in the study sample had issued at least one new share in at least one of the years examined. regarding industry membership, 44 companies were categorised as consumer industries and 26 as primary industries. it is noteworthy from appendix 1 that positive and significant correlation coefficients exist between no. tweets and our proxy for stakeholders’ engagement, eng 1 and eng 2, in all years. additionally, no. tweets, eng 1 and eng 2 are positively and significantly correlated with size and mtb in all years, and with roe in all years, except 2017. research question one: twitter as a two-way stakeholders’ engagement platform table 5 section a reports the results from the mixed-model anovas used to examine the use of twitter. as is evident from table 5 section a, no. tweets had not increased significantly from 2017 to 2020. this was confirmed by the results of a fisher lsd post-hoc test (not reported), which showed no statistically significant difference between any of the years. table 5: results for twitter as a two-way stakeholders’ engagement platform (n = 70). although the total number of tweets had not increased over the study period, both variables used to measure stakeholders’ engagement increased significantly from 2017 to 2020: eng 1 at the 1% level (table 5 section a) and eng 2 at the 10% level (table 5 section c). the results of a fisher lsd post-hoc test, reported in table 5 section b, shows that, while eng 1 did not increase significantly year-on-year from 2018 to 2020, it did increase significantly from 2017 to 2018 and the cumulative increase over two or more years between 2017 and 2020 is also significant. even though 29 out of 70 companies had not replied to a single stakeholder tweet in 2020, companies appear to have used twitter increasingly to legitimise stakeholder relationships. more specifically, as depicted in table 4, the average of eng 1 increased from 0.09 in 2017 to 0.19 in 2020. russo et al. (2022) report results that suggests that the mere existence of a twitter account, as opposed to the actual communication activity thereon, could potentially play a superior role in maintaining stakeholder relationships. research question two: determinants of companies who use twitter as a two-way stakeholders’ engagement platform table 6 shows the results of the two models that regressed the independent variables mentioned earlier on both eng 1 (panel a) and eng 2 (panel b). as previously discussed, a mixed-model anova was used for the continuous variable, eng 1, and a gee model for the dichotomous variable, eng 2. the unavailability of f.flt for some company observations explains the decrease in company observations from 280 used in research question one to the 260 as depicted by table 6. table 6: regression results for determinants of companies that use twitter as a two-way engagement platform (n = 260). overall, also considering the robustness tests discussed below, size, mtb, and roe appear to be the variables that best explain variations in companies’ use of twitter for two-way stakeholders’ engagement. more specifically, larger companies (size), companies with more future growth opportunities (mtb), and more profitable companies (roe), exert more effort to engage with their stakeholders. the agency theory may explain the positive associations with size and mtb, and signalling theory with roe. similar results were reported by hoffmann and aeschlimann (2017), amin et al. (2020) and ruangprapun (2022) for size, by ruangprapun (2022) for market-to-book ratio, and by amin et al. (2020) for profitability. additional tests to test the robustness of the results reported in table 6, three additional regressions (not tabulated) were performed for eng 1 and eng 2. in the first thereof, the two regressions mentioned, were repeated but excluding 2017, due to the increase in character count allowed in november 2017. while the results did not change significantly for eng 1 (except size which was now significant at the 10% level only), mtb was no longer statistically significant at the 10% level for eng 2, and roe was only significant at the 10% level. next, 2020 was removed to control for the potential skewing of results given the impact of the covid-19 pandemic. in explaining eng 1, both size and mtb remained significant at the 5% level, while only mtb remained significant at the 10% level for eng 2. finally, both 2017 and 2020 were removed, and the regressions therefore repeated only for 2018 and 2019. regarding eng 1, size was no longer found significant, but mtb and roe were significant at the 1% and 10% levels, respectively. somewhat similar, size was also no longer significant in explaining eng 2, while both mtb and roe remained significant at the 10% and 5% levels respectively. research question three: twitter behaviour around results release dates both figure 1a and 1b depict statistically significant differences at the 1% level between the average daily tweets around results release dates in comparison with the average daily tweets for the rest of the year. figure 1: (a) average daily tweets 10 days around the financial year-end result release dates (fye results) and average daily tweets for the year (fye year). (b) average daily tweets 10 days around the financial interim result release dates (fi results) and average daily tweets for the year (fi year). in support of the results shown in figure 1a and 1b, the results of the two mixed-model anovas reported in table 7 for the period fixed effect (period) show a statistically significant difference at the 1% level between results release date tweets and tweets during the rest of the year for both annual and interim results release dates. although no similar evidence is available for the use of twitter around results release dates, these results support evidence provided by hasan and cready (2019) that shows an increase in facebook activity around earnings announcements. table 7: mixed model analysis of variance results for tweeting behaviour around result release dates (n = 70). interestingly, but not surprising, given the results reported in table 5 section a, no statistically significant difference was found for the year fixed effects (year) in both panels a and b in table 7. this implies that the average daily number of tweets made by companies did not increase significantly over time. finally, table 7 shows that the interaction variable (year x period) was not statistically significant for both tweets related to the annual (panel a) and interim (panel b) results release dates. this means that although companies tweeted significantly more around results release dates compared to the rest of the year, the ratio between the average daily tweets around results release dates to the rest of the year did not change significantly over the -year study period. the statistical difference between the average daily tweets around results release dates in comparison with the rest of the year is therefore not dependent on the year. additional tests as shown in figure 2a and 1b, tweet volume increased significantly around result release dates, irrespective of whether new shares were issued (net.iss = 1) or not (net.iss = 0), for both annual and interim result release dates. in respect of annual result release dates (figure 2a), companies that issued shares during the year reported statistically significant more tweets at the 10% level in comparison with companies that had not issued new shares during the year. in figure 2b, the same pattern, although not statistically significant, is shown for interim result release dates. these results provide support for the capital need theory where companies that are more reliant on capital markets exert more effort in engaging with stakeholders. figure 2: (a) average daily tweets 10 days around the financial year-end result release dates (fye results) and average daily tweets for the year (fye year) – issue of shares. (b) average daily tweets 10 days around the financial interim result release dates (fi results) and average daily tweets for the year (fi year) – issue of shares. similar to the mentioned results, all companies had higher tweet volumes around result release dates, irrespective of industry membership, with consumer industries depicted by ind.jse = 1 and primary industries by ind.jse = 0. figure 3b shows a statistically significant higher tweet volume at the 5% level in the 10-day period for companies that are members of the primary industries groups. although it was expected that consumer industry companies would tweet more, the increased tweets by primary industry companies may be explained by pressure to legitimise their results as a result of environmental and social concerns. figure 3: (a) average daily tweets 10 days around the financial year-end result release dates (fye results) and average daily tweets for the year (fye year) – industry membership. (b) average daily tweets 10 days around the financial interim result release dates (fi results) and average daily tweets for the year (fi year) – industry membership. while larger and more profitable companies tweeted significantly more than their smaller counterparts based on the correlation coefficients reported in appendix 1, no similar evidence was found to corroborate that these companies change their tweeting behaviour around result release dates. this therefore suggests that jse-listed companies do not appear to use twitter to only accentuate good news, which validates their use thereof. conclusion social media is revolutionising the way in which companies share information with stakeholders. while there are various sm channels, this study chose to focus on twitter. prior research examining twitter focused on the capital market consequences of companies’ use of twitter; however, empirical evidence of companies’ use of twitter as a stakeholders’ engagement tool, as well as their use thereof around result release dates, appears to be scant. the extant literature further predominantly reports data from developed countries. against this backdrop, the study employed data from jse-listed companies to explore how companies use twitter to engage with their stakeholders, and whether companies’ tweeting behaviour changes around result release dates. the findings that emerged from the study can inform: stakeholders on whether to subscribe to company twitter accounts, companies of what their peers are doing and; regulators about possible risks which need managing, such as financial disclosure on sm and the sharing of fake news on sm to manipulate share prices. the results suggest that, specifically for smaller and less profitable companies, stakeholders should not expect companies to engage with them in two-way communication via twitter. nevertheless, jse-listed companies were found to have progressed significantly in using twitter as a means of engaging with stakeholders over the four years considered for the study. larger companies and companies with higher future growth prospects (and intangibles) are therefore starting to conform to the added pressure caused by higher agency costs and information asymmetry over the years. even though the signalling theory explains why more profitable companies have increased engagement with stakeholders via twitter, they (more profitable companies) do not appear to change their twitter behaviour around result release dates. the results further show that, in general, companies tend to be significantly more active on twitter around result release dates. this is even more prevalent in companies that are reliant on capital markets, in line with the capital need theory. additionally, companies that have added pressure to legitimise their results due to possible environmental and social concerns also show an above-average increase in tweets around result release dates. possible limitations that warrant future research are the inclusion of only one covid affect year, not including the period in which musk acquired twitter, not categorising company tweets based on the content thereof, not analysing lagged and lead associations, and finally, not considering empirical evidence that companies use different sm platforms purposively and distinctly. acknowledgements competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions g.f.n. and y.d.t. were equally involved in all parts of the research. funding information this research received no specific grant from any funding agency in public, commercial or not-for-profit sectors. data availability the data that support the findings of this study are available from the corresponding author, g.f.n. upon reasonable request. disclaimer the views and opinions expressed in this article are those of the authors and do not necessarily 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management, faculty of economic and management sciences, stellenbosch university, stellenbosch, south africa marilee van zyl department of business management, faculty of economic and management sciences, stellenbosch university, stellenbosch, south africa citation mans-kemp, n. & van zyl, m., 2021, ‘reflecting on the changing landscape of shareholder activism in south africa’, south african journal of economic and management sciences 24(1), a3711. https://doi.org/10.4102/sajems.v24i1.3711 original research reflecting on the changing landscape of shareholder activism in south africa nadia mans-kemp, marilee van zyl received: 18 may 2020; accepted: 16 oct. 2020; published: 25 jan. 2021 copyright: © 2021. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: investors around the globe are increasingly focusing on investing in a responsible manner by accounting for environmental, social and corporate governance aspects alongside financial performance. shareholder activism is a prevalent responsible investment strategy that is gradually gaining traction among south african investors. aim: the primary objective was to gauge the views of selected local institutional investors on the nature of shareholder activism endeavours in south africa. the secondary objective was to offer suggestions on the way forward for shareholder activism considering rapid technological development and the covid-19 pandemic. setting: south africa offers a well-developed framework for responsible investors. given their substantial shareholding, institutional investors in particular have considerable power to influence the practices and policies of investee companies. method: semi-structured interviews were conducted with 13 representatives of local institutional investor organisations. thematic analysis was conducted to analyse the primary data. results: interviewees mostly engaged in private with investee companies on corporate governance issues. they explained that more information is required to meaningfully engage on social and environmental considerations. participants indicated that they consider and employ public activism mechanisms if private engagements are deemed unsuccessful. conclusion: technology will play an increasingly important role to enhance shareholder activism in future, but also offers various challenges. although social media might be a valuable avenue to disclose information, it should be cautiously managed. selective engagement details could be published on institutional investors’ and companies’ websites to enhance transparency regarding the nature and outcomes of engagements. virtual and hybrid annual general meetings are likely to enable more shareholders to become active owners in future. keywords: shareholder activism; institutional investor; fourth industrial revolution; periods of crisis; covid-19. introduction environmental, social and corporate governance (esg) matters tend to come to the forefront during times of crisis, such as the 2008 global financial crisis (sampei 2018) and the covid-19 pandemic (sparks 2020). arjaliès (2010) confirmed that the 2008 crisis was a catalyst that considerably fuelled the responsible investment movement that aims to bring social responsibility to the asset management sector. according to michael fox (in gordon 2020), a prominent esg fund manager in the united kingdom, covid-19 ‘has done more for esg [and by implication responsible investment] in 10 weeks than the last 10 years’. institutional and retail investors can employ several strategies, including screening and shareholder activism, to invest in a responsible manner by accounting for esg aspects in addition to financial performance (viviers et al. 2008). positive and negative screening entails that certain companies are either included or excluded from an investment portfolio based on esg considerations, while impact investors intend to achieve a positive socio-economic or environmental impact (schueth 2003). viviers and els (2017) reported that the majority of local responsible investment funds focus on impact investing. loop, bromilow and malone (2018) remarked that ‘activism is about driving change’. shareholder activists could accordingly use their ownership position to influence the policies and practices of investee companies (sjöström 2020). they can use voice and exit mechanisms to convey their dissatisfaction pertaining to financial and sustainability considerations to corporate leaders (mcnulty & nordberg 2016). a voice mechanism refers to private or public engagement with management (mccahery, sautner & starks 2016). investors can alternatively utilise an exit mechanism by selling their shares in an investee company (levit 2019). given their large shareholding in multiple companies, institutional investors are a key force to bring about change in capital markets as they have considerable power to challenge corporate behaviour (oh, park & ghauri 2013; organisation for economic co-operation and development [oecd] 2011; sandberg 2013). institutional shareholder activism could hence be deemed a valuable governance mechanism to bring change in capital markets (romano 2001). south africa has a history of pro-esg initiatives, including the king reports on corporate governance, regulation 28 and the code for responsible investing in south africa (crisa). the country hence offers a well-developed framework to conduct responsible investment research. principle 17 in the king iv report suggests that the governing bodies of institutional investors should ensure that responsible investment is practised to promote sound governance and value creation in investee companies (iodsa 2016). several local institutional investors, however, do not integrate esg considerations into decision-making processes (tomlinson, bertrand & martindale 2017). those that account for such considerations mainly focus on governance aspects (feront & bertels 2019; zhang 2016). although most south african institutional investors publicly support responsible investment, actual changes to their investment policies are often superficial (feront & bertels 2019). a gradual increase has been seen in activism endeavours among institutional and retail investors due to south africa’s favourable regulatory environment (deloitte 2019b). when reflecting on responsible investment in the country, the limited universe of listed companies and the fragmented pension fund market should be taken into account (tomlinson et al. 2017). as such, local institutional investors prefer to engage in private on pressing matters (viviers & smit 2015; yamahaki & frynas 2016). they aim to avoid the potential negative impact on share prices and corporate reputation related to the application of public mechanisms (mccahery et al. 2016). several corporate leaders also prefer private discussions, as these are deemed more constructive than public activism. the former allows activist institutional investors to negotiate solutions with boards or managers without necessarily jeopardising relationships (viviers & smit 2015). the fourth industrial revolution, characterised by increased usage of advanced technology to blend digital and physical environments, offers several opportunities and challenges for companies and their retail and institutional shareholders, including online meetings and management of personal information (coulibaly 2020). the rapid spread of digital technology in the so-called age of transparency could considerably enhance shareholders’ access to information and, by implication, informed decision-making (coulibaly 2020). enhanced transparency is of particular importance during periods of crisis (lang & maffett 2011; moon 2020). the impact of the fourth industrial revolution (deloitte 2019a) and the covid-19 pandemic (gottfried & donahue 2020) on shareholder activism endeavours warrants investigation. semi-structured interviews were conducted with representatives from selected local institutional investors, given that they are extremely influential compliance officers whose actions have implications for a range of stakeholders (iodsa 2016). the primary objective was to investigate their views on the nature of shareholder activism endeavours in south africa. the secondary objective was to offer suggestions on the way forward for shareholder activism considering rapid technological development and the covid-19 pandemic. respondents’ feedback was contextualised by accounting for changes pertaining to shareholder activism in response to the challenging and changing corporate circumstances, as highlighted in literature and the media. guidance regarding ways to enhance the application and effectiveness of shareholder activism in future could be useful to respond to challenges and changes in times of crisis. the theoretical framework and literature review are presented next, followed by a description of the qualitative methodology applied in the study. after a presentation of the results, recommendations will be offered to improve the application and effectiveness of shareholder activism mechanisms in light of the fourth industrial revolution and the covid-19 pandemic. theoretical framework the nature of shareholder activism, be it financial or social, depends on the goals of the activist and could be related to various theories explaining managerial behaviour. social activism is linked to environmental and social issues, while financial activism is related to insufficient financial performance at investee companies (goranova & ryan 2014). jensen and meckling’s (1976) agency theory is deemed the primary theoretical lens in activism literature (goranova & ryan 2014). the agency theory is based on the complex relationships between principals (shareholders) and agents (managers). although shareholders expect managers to optimally account for their interests, managerial actions might be driven by self-interest. if corporate agents focus on their own gains, the agency problem arises. in an attempt to minimise this problem and the associated costs, independent directors are supposed to monitor managerial actions and decisions. several companies incentivise agents to guide their behaviour (goranova & ryan 2014; jensen & meckling 1976). local shareholder activists are, however, increasingly voicing their discontent regarding the perceived disconnect between managerial incentives and firm performance (viviers et al. 2019). this perceived misalignment represents a lost opportunity to alleviate the agency problem (ertimur, ferri & muslu 2011). to mitigate the agency problem and asymmetric information, institutional investors should continually communicate with investee companies (nix & chen 2013). enhanced communication will ensure that alignment between the interests of a company and its shareholders is improved. as a result, investors’ trust and confidence in investee companies are likely to increase (nix & chen 2013). while the agency theory is mainly linked to financial activism, social activism is related to the stakeholder theory (goranova & ryan 2014). freeman (1984) argued that shareholders form part of a diverse range of stakeholders who are affected by a company or have an influence on a company. the stakeholder theory thus postulates that corporate leaders should manage the complex relationships among a broad range of stakeholders, while cautioning against an excessive focus on shareholders’ interests (borlea & achim 2013). the role of directors as corporate monitors, as suggested by the agency theory, should hence be reconsidered. based on the stakeholder theory, it might be more apt to deem them mediators rather than corporate monitors (lan & heracleous 2010). shareholder activism is likely to increase the interaction between the owners and managers of a company and could result in positive outcomes for a range of stakeholders (mcnulty & nordberg 2016). some shareholders are, however, self-serving and likely to drive their own agenda at the cost of other stakeholders (lan & heracleous 2010). shareholder activists should thus be mindful of the benefits and costs related to their activism efforts (gantchev 2013). shareholder activism as a responsible investment strategy as explained in the introduction, responsible investors account for financial and esg considerations that could influence long-term value creation for a range of stakeholders. globally, a growing number of activist investors take esg considerations into account. the percentage of institutional and retail investors that applied esg principles to their investment decisions worldwide increased from 48% to 75% between 2017 and 2019 (deloitte insights 2020). despite the country’s well-developed responsible investment landscape, only a limited number of south african investors apply the responsible investment philosophy when making investment decisions (viviers & els 2017). the local responsible investment landscape the responsible investment landscape in south africa changed considerably over the last decade (2011 to 2020). the king iv report on corporate governance, regulation 28 and crisa had multiple implications for responsible investment policies and practices in the country (viviers & els 2017). a sound corporate governance framework is critical in attracting investors for economic growth and can substantially enhance investor confidence (beekes & brown 2006). the king report can be seen as a form of ‘soft law regulation’ to guide sustainable behaviour (esser 2017). compliance with the king guidelines is voluntary, but listed companies must comply with these guidelines as part of the johannesburg stock exchange (jse) listings requirements (jse 2017). the local stock exchange also launched the jse socially responsible investment (sri) index (now called the ftse/jse responsible investment index series) in 2004 to identify listed companies that integrate triple bottom principles into their activities, and to facilitate investment in such companies (jse 2015). the performance of locally listed companies is annually reviewed against a set of esg considerations to determine constituency. since then, the index series evolved considerably to further promote sustainable development (jse 2015). in addition to the publication of the pioneering king report, south africa was the second country in the world to formally encourage institutional investors to consider esg aspects when making investment decisions (deloitte & touche 2014). regulation 28 of the pension funds act (no. 24 of 1956) was revised in 2011 to ensure that retirement funds meet long-term obligations to their members by obliging institutional investors to account for esg factors (deloitte & touche 2014). furthermore, crisa was published in 2011 to guide the investor community to give effect to the king iii report and the united nations-supported principles for responsible investment (un pri) initiative (deloitte & touche 2014; iodsa 2011). this code postulates that organisations that exhibit sound corporate governance practices are expected to create value in a sustainable manner. the term ‘value’ does not only refer to financial aspects, but includes social and environmental aspects (iodsa 2011). when crisa was launched, the former south african minister of finance, pravin gordhan, remarked that the 2008 financial crisis emphasised the importance of a longer-term investment focus (deloitte & touche 2014). the process to revise crisa commenced in 2020. the un pri offers guidance to investors around the globe to invest in a responsible manner over the long run. the majority of the local signatories are investment managers and service providers (tomlinson et al. 2017). prominent asset owners such as the government employees pension fund perform an important role in developing scheme practices that smaller local pension schemes can adopt (tomlinson et al. 2017). ertimur et al. (2011) confirmed that institutional investors can leverage other (minority) shareholders’ support by setting an example. given their power, institutional investors can be a considerable driving force for improved performance (ivanova 2017). institutional investors are such influential stakeholders that the king iv report includes a specific principle to highlight their primary responsibilities (iodsa 2016). king iv proposes that an institutional investor’s governing body should provide direction for responsible investment and approve policies in this regard. institutional investors should furthermore disclose their code on responsible investing and details on the application thereof (iodsa 2016). the guidance note published by the financial sector conduct authority (2019) sheds more light on sustainable investments and assets in the context of retirement funds’ investment policy statements. based on an extensive review of the changing esg landscape in south africa, tomlinson et al. (2017) encouraged the financial sector conduct authority to cautiously review the mandates of investment managers to ensure that they reflect the expectations for investment practice as set out in regulation 28. they indicated that crisa could benefit from appointing a permanent secretariat to enhance its stewardship. emphasis was placed on the inclusion of esg aspects as part of trustee training. they furthermore suggested that investors should be educated on the application of different esg approaches. given that enhanced transparency aids informed decision-making, it is likely that the financial sector conduct authority and the jse will place even more focus on the quality of disclosure on material esg factors in future (tomlinson et al. 2017). reflecting on shareholder activism mechanisms responsible investors can employ three main strategies, namely screening, impact investing and shareholder activism. in this study, focus is placed on shareholder activism, with pertinent reference to the south african context. as explained in the introduction, shareholder activists aim to influence the behaviour of investee companies by exercising their rights as owners. they can employ a range of private and public voice mechanisms to focus attention on financial and esg considerations (schueth 2003). as the name implies, private engagements occur behind the scenes, such as writing emails or arranging confidential negotiations with key decision-makers of investee companies. in contrast, public voice mechanisms include raising concerns at annual general meetings (agms), voting and filing shareholder resolutions. shareholders can also engage in debate via traditional and social media. proxy voting furthermore enables shareholders to delegate voting power to delegate voting power to a representative (viviers & smit 2015). alternatively, an investor can opt to exit from an investee company by selling their shares. if an institutional investor employs this mechanism, it signals dissatisfaction to other shareholders and could have a devastating impact on a targeted company’s share price (levit 2019). when several shareholders divest concurrently, the investee company’s market capitalisation and cost of capital might be severely affected (gillan & starks 2003). given the size of the south african share market, a limited number of local shareholders have utilised this mechanism (viviers & smit 2015). some researchers deem the mere threat of exit sufficient to signal their discontent with an investee company’s actions, policies and practices, without having potential detrimental consequences for a range of stakeholders (admati & pfleiderer 2009; levit 2019; mccahery et al. 2016). the selection of a specific engagement mechanism depends to a large extent on the investor’s ability to gain access to the investee company’s management. large institutional investors typically prefer private mechanisms. if private engagement is deemed unsuccessful, they consider (more hostile) public shareholder activism mechanisms (mccahery et al. 2016). a growing number of activist south african investors are voicing their concerns in public. for instance, several shareholders publicly opposed perceivably excessive executive compensation at multiple local companies in 2020 (just share 2020a). despite the increase in emolument-related shareholder activism, only a few executives announced that they were willing to take a pay cut following the south african lockdown related to covid-19. likewise, only a limited number of institutional fund managers responsible for the pensions of millions of south africans have made public commitments to cut their salaries and make donations to the so-called solidarity fund (just share 2020a). previous scholars assessed the effectiveness of public activism endeavours globally (cai & walkling 2011; kimbro & xu 2016) and locally (viviers et al. 2019; viviers & smit 2015). based on a review of 24 510 votes cast by 17 south african investment managers and interviews with selected investment managers, viviers and smit (2015) reported that proxy voting was deemed a last resort in the local context. less than 7% ‘against’ votes were recorded, mainly pertaining to executive remuneration. they furthermore noted that companies that were excluded from the ftse/jse sri index attracted more shareholder opposition than constituents (viviers & smit 2015). bauer, moers and viehs (2015) assessed the determinants of withdrawal of shareholder proposals in the united states and reported that proposals filed by influential institutional investors were more likely to be withdrawn than those filed by private investors. there is a limited body of research on private engagements between institutional investors and investee companies, given the confidential nature thereof (semenova & hassel 2019). there is hence scope to assess institutional investors’ selection and application of specific activism mechanisms in south africa. the fourth industrial revolution and the covid-19 pandemic have multiple implications for shareholder activism endeavours, as explained next. exploring the potential impact of the fourth industrial revolution and the covid-19 pandemic on shareholder activism endeavours rapid technological developments have multiple implications for listed companies and their shareholders (goldman sachs 2019; uldam 2018). covid-19 furthermore forced companies to reconsider the way in which they engage with shareholders, inter alia, due to challenges associated with social distancing (kennedy-good & chalwin-milton 2020). shareholder activists are increasingly moving from traditional media platforms such as newspapers to social media, including twitter, to raise their concerns and enhance awareness of corporate issues (uldam 2018). although the usage of social media gives users unprecedented visibility, online security and the protection of personal information are prominent concerns (uldam 2018). the long-lasting impact of negative comments raised in the media on companies’ reputations should also be considered (chartered governance institute of southern africa 2020). the king iv report confirmed that the increased usage of social media platforms will radically enhance transparency. governing bodies are hence urged to ensure sufficient oversight of technology and information management. proactive monitoring will enable them to timeously respond to adverse social media events (iodsa 2016). annual general meetings are essential corporate events that allow shareholders the opportunity to share their views and receive feedback from corporate leaders (kennedy-good & chalwin-milton 2020). shareholders also cast their votes on tabled resolutions, either in person or via proxies. a surge was noted in proxy voting in 2009 following the 2008 global financial crisis (gottfried & donahue 2020). a similar trend is expected following the covid-19 pandemic. although technological developments associated with the fourth industrial revolution enabled companies to facilitate online meetings and voting for some time, local companies still opted for in-person meetings until march 2020. social distancing as a result of covid-19, however, brought about considerable challenges to facilitate in-person meetings and engagements. local legislation allows for electronic agms if reasonable participation and simultaneous discussion among attendees are possible (chartered governance institute of southern africa 2020; kennedy-good & chalwin-milton 2020). electronic meetings are, however, not a possibility if a company’s memorandum of incorporation prohibits such events (kennedy-good & chalwin-milton 2020). as such, several local companies had to postpone their in-person agms during 2020 (larkin 2020). in response, the jse (2020) in collaboration with the meeting specialist launched a platform that enables listed companies to hold virtual agms and conduct electronic voting. in addition to complying with a legal requirement to facilitate a mandatory yearly shareholder gathering, this pioneering initiative allows shareholders to participate in agms irrespective of their location, by using a range of technological devices at their disposal. virtual meeting attendance is furthermore cost-effective, as shareholders and board members are not required to travel (jse 2020). an executive director at alexander forbes, the first company that made use of the meeting specialist’s platform, remarked that in due course, virtual meetings will become a routine addition to conventional meetings (jse 2020:1). companies that plan to conduct virtual meetings should ensure that their online facilities are easily accessible and can deal with a large number of individuals concurrently attempting to log in (kennedy-good & chalwin-milton 2020). the local non-profit shareholder activist organisation just share (2020b) recognised that virtual agms are reasonable, given restrictions imposed by the covid-19 pandemic. just share, however, cautioned jse-listed companies against infringing shareholder rights and non-compliance with the companies act (no. 71 of 2008) when opting for online meetings. they furthermore expressed concern that shareholders’ questions might be moderated before being submitted to directors. as such, just share urged listed companies to ensure meaningful, real-time shareholder participation in future. shareholder activists could arguably use the case of covid-19 to illustrate why specific esg-related changes are essential, in particular related to board composition and the perceived disconnect between executive pay and performance (gottfried & donahue 2020). some shareholders might, however, question whether they should challenge companies that are already experiencing considerable financial hardship owing to share markets around the globe being under severe pressure (orol 2020). given that a stable macroeconomic environment is a prominent catalyst of shareholder activism, the ultimate impact of the covid-19 pandemic on shareholder activism remains uncertain (gottfried & donahue 2020) and requires further investigation. this study was conducted to shed light on the way forward for shareholder activism in south africa. research design and methodology the authors gauged selected south african institutional investors’ views on shareholder activism. this research formed part of a broader study, covering corporate governance developments in south africa, given the king iv publication and its focus on institutional investors. as mentioned, institutional shareholder activism is a valued corporate governance mechanism (romano 2001). the target population comprised all local institutional investors. given that the largest institutional investors are typically pension funds and the fragmented nature of the local pension fund industry comprising more than 3000 funds (tomlinson et al. 2017), it was impractical to conduct interviews with all local institutional investors. non-probability sampling was hence employed. asset managers who directly invest in locally listed bonds and equities formed part of the sample frame. the researchers employed a combination of judgement and snowball sampling to select participants. an industry contact assisted the researchers to make initial contact with potential participants. thereafter, snowball sampling was used based on referrals from interviewees. a number of previous researchers employed qualitative methods when assessing shareholder activism (including adegbite, amaeshi & amao 2012; tomlinson et al. 2017; yamahaki & frynas 2016), as the phenomenological paradigm allows in-depth analysis of participants’ views. the usage of semi-structured interviews gives researchers more control over the quality of the collected data, as uncertainties can be clarified by posing open-ended and theoretically motivated questions (galletta 2013). semi-structured interviews were conducted with 13 representatives from 12 local institutional investors to gauge their views on the nature of shareholder activism in the country. one of the interviewees requested that their risk assurance manager participate during a joint interview. given that there is no ‘ideal’ sample size for qualitative research, focus should be placed on the adequacy of selected participants (o’reilly & parker 2013). as their industry experience ranged from 6 to 26 years (16 years on average), participants offered informed opinions and extensive feedback on the topic under investigation. the institutional investors’ approximate size of assets under management ranged between r200 million and r630 billion (average of r252.8 billion) at the stage when the interviews were conducted. to enhance confirmability and to ensure that relevant questions were included, the interview guide was discussed with three corporate governance experts prior to conducting the interviews. a funnel interviewing technique was employed: after participants expressed broad viewpoints, they were encouraged to offer more focused responses. clarifying questions were asked in some instances to ensure that participants’ views were accurately captured. interviewees answered questions pertaining to the institutional investors that they represent, including whether they are a signatory of the un pri and subscribe to crisa. they were also requested to indicate what they consider to be the biggest implications of publicly proclaiming to be a responsible investor. examples of main and additional clarifying questions (in brackets) that were included in the interview guide include: do you engage with investee companies on behalf of your clients? (which form of shareholder activism do you consider to be most efficient to promote change, private or public? please motivate your answer.) are the stakeholder engagement processes of investee companies efficient in creating a platform for stakeholders to discuss their concerns? (how do you think investee companies can improve their stakeholder engagement processes to make it easier for stakeholders to raise their concerns?) do you think that shareholder activism in south africa will be able to ‘enforce’ efficient compliance to the king iv guidelines? (do you think social media can play a role to enhance stakeholder inclusion?) the interview guide and informed consent form were distributed to participants prior to conducting the interviews. they were requested to provide their biographical details and answer questions related to their employer via email before the interviews took place. seven of the interviews were conducted in person and the remainder via teleconference. the interviews ranged between 40 and 90 minutes in duration. although participants had the option to decline to answer questions and withdraw from the study at any stage, none of them opted to withdraw. permission was requested from each interviewee to transcribe their interview. braun and clarke’s (2006) six-step thematic analysis approach was employed to derive themes from the transcribed data. the six-step process entailed that one of the researchers first familiarised herself with the collected data. secondly, initial coding took place by assigning preliminary codes, based on the meaningful data features to offer an indication of the context of the interviews. thirdly, preliminary themes and sub-themes were identified. inductive coding was applied. fourthly, the identified themes were reviewed and discussed by the researchers whereafter they were finalised (step 5). the final step entailed that conclusions were formulated based on the themes related to shareholder activism. participants’ responses were contextualised, given changes in the corporate landscape in response to the fourth industrial revolution and the covid-19 pandemic. to enhance the credibility of the findings, some interviewees were contacted to confirm that their views were accurately conveyed in the transcription. pertaining to the dependability criterion of trustworthiness, the study can be replicated in future by following the outlined approach. transferability was addressed by offering details on the research context to allow reflection on the applicability thereof in other settings. inferential validity was accounted for by using the king iv report, crisa and applicable literature to develop the interview guide and interpret the results. attention was also given to thematic analytical validity by including data extracts to support the themes that were derived. ethical consideration ethical clearance was obtained to conduct this study from the research ethics committee (rec) of stellenbosch university. project number: 6906. results and discussion an interviewee raised the view that shareholder activism in south africa is ‘picking up momentum’ due to institutional investors being ‘forced’, through crisa and the un pri, to apply esg principles and to scrutinise the governing bodies of investee companies. the chartered governance institute of southern africa (2020) confirms that shareholder activism is gaining momentum in the country. participants were requested to state whether the institutional investor that they were affiliated with was a signatory to the un pri and subscribed to crisa when the interview was conducted. this body and code have prominent implications for responsible investors (deloitte & touche 2014). seven of the institutional investors were signatories to the un pri and eight subscribed to crisa. one institutional investor originated from a large institution that was a signatory to the un pri. a participant explained that this institutional investor ‘takes the matter of ri [responsible investment] seriously, but it requires a lot of focus, attention, people and resources’. as such, this participant noted that the institutional investor will subscribe to crisa ‘when they have the capacity to do so’. two institutional investors supported and followed the principles outlined by the un pri and crisa without becoming a signatory or officially subscribing to the code. another participant remarked that crisa has ‘a higher degree of relevance for local institutional investors’ (than the un pri), given that their investors are largely south-african-based. as such, this institutional investor did not regard it necessary to become a signatory to the un pri, given the subscription to crisa. the interviewee indicated that this decision would be reconsidered as the institutional investor grows, more offshore investors are included in their investor base and due to pressure from investors. tomlinson et al. (2017) emphasised the importance of growing market awareness of esg investment approaches. most of the participants were, however, not convinced that south african shareholder activists will be able to enforce corporate governance compliance, as suggested in king iv (iodsa 2016). principle 17 in this report is specifically applicable to institutional investors. all the participants stated that they are supportive of this principle. it was highlighted by four participants that they believe that institutional investors that subscribe to crisa, and actively apply its guidelines, will be able to comply with principle 17 of king iv. several of the participants were of the opinion that their employers were already complying with this principle by actively pursuing crisa. an interviewee remarked that principle 17 made their client base more aware of responsible investing. details will now be provided on the shareholder activism themes that emerged from the thematic analysis. participants’ views on responsible investor status participants expressed contrasting views on whether responsible investor status should be publicised. four participants stated that a public declaration in this regard is mostly ‘window dressing’. the other participants argued that a mere proclamation of responsibility is not sufficient; it should be visible in actions. goh (2018) agreed that it is debatable whether a mere proclamation will truly result in improved behaviour. the difference between intent and actual corporate actions may tarnish a company’s reputation (greyser 2009). an interviewee remarked that ‘actions speak louder than words’. if investors fail to act in a responsible manner, it will become known regardless of whether or not they proclaim to be responsible investors. a counterpart added that such practices must be ‘imbedded in your culture and investment philosophy’. this view is supported by the king iv report (iodsa 2016). a related opinion was raised by an interviewee: ‘transparency is really important for driving behaviour’. sufficient information on financial and non-financial performance should hence be shared with stakeholders. by definition, responsible investors aim to incorporate financial and sustainability information when making investment decisions (viviers et al. 2008). a participant, however, warned against undue pressure by clients to deliver superior investment performance. an excessive focus on financial considerations contradicts the responsible investment philosophy. the rapid spread of digital technology could considerably enhance transparency (coulibaly 2020) which is of particular relevance during periods of crisis (lang & maffett 2011; moon 2020). views on applying public versus private shareholder activism mechanisms the majority of the interviewees indicated that they prefer private engagements, as public activism is typically confrontational and hostile in nature. the view was raised that shareholders are not ‘active enough’ which makes interaction challenging. yamahaki and frynas (2016) and viviers and smit (2015) confirmed that shareholder activism typically occurs behind closed doors in the country, given the confidential nature of discussions. this tendency might also be partly ascribed to the country’s limited investment universe (tomlinson et al. 2017) and the subsequent drive to protect relationships with investee companies (viviers & smit 2015). in an attempt to enhance transparency, several participants mentioned that they provide some information on engagements in reports that are made available on their websites. the shareholder activist just share (2020b) encourages other institutional investors to follow suit. ten participants (more than 75% of the sample) suggested that institutional activists should initially consider a private mechanism, such as engagement. if the investee company does not respond, or if the private engagement is not deemed successful, the institutional investor can consider employing public mechanisms. mccahery et al. (2016) shared this view. a possible reason for the preference for private engagements is that public activism could be rather costly (admati & pfleiderer 2009). activist investors often only enjoy a fraction of the benefits negotiated by them. the related free-rider problem implies that all shareholders might benefit if one investor publicly raises concerns, although they do not bear any costs or engage themselves (gillan & starks 2000). due to institutional investors’ large stakes in investee companies, they might be able to cover the associated costs when there is a possibility of significant returns as a result of their activism endeavours (gillan & starks 2000). another possibility mentioned by an interviewee is ‘semi-private’ engagements in which stockbrokers invite portfolio managers to engage with a company’s management in a group meeting. other participants deemed public activism endeavours more effective than private engagements, given that the responses ‘are there for the public to see’. participants concurred with viviers and theron (2019) that public shareholder activism might have considerable negative repercussions for institutional investors. the example of futuregrowth asset management was mentioned by several participants. after publicly proclaiming that they would not issue new loans to state-owned enterprises (soes) given governance-related concerns, futuregrowth withdrew their support pending review of the soes’ governance structures. some of the soes’ credit ratings were subsequently downgraded (viviers & theron 2019). after several engagements, futuregrowth announced that they would resume lending to specific soes. their public shareholder activism approach was received in a negative and emotive light, since trust was compromised. this is a prime example of good intentions of an institutional investor being perceived incorrectly. given the outcome of this case, asset managers might be encouraged to rather pursue private engagements (viviers & theron 2019). shareholder activism research suggests that it is beneficial to form coalitions with other stakeholders (sjöström 2020). participants, however, expressed concern about the implications of the acting in concert provision included in the companies act (no. 71 of 2008). to act in concert means: any action pursuant to an agreement between or among two or more persons, in terms of which any of them co-operate for the purpose of entering into or proposing an affected transaction or offer. (republic of south africa 2009: 212) interviewees implied that this provision has a major implication for shareholder activism, as it makes it difficult for institutional investors to coordinate with other shareholders to initiate change. in the light of rapid technological developments associated with the fourth industrial revolution, several participants mentioned that social media should be employed to create and enhance awareness of topical issues. uldam (2018) confirm that social media is increasingly used by activists, often with devastating outcomes for corporate reputations (chartered governance institute of southern africa 2020). concerns were likewise raised by participants about expressing views on social media, especially facebook and twitter, that could be interpreted out of context. an interviewee argued that, as these platforms can ‘disrupt the control of the corporate narrative that the company may think it has’, they can be detrimental to an entity’s reputation and brand. the view was expressed that media statements are often blown out of proportion as stakeholders might ‘read their own personal bias into it’. this finding supports the king iv recommendation that social media should be proactively monitored (iodsa 2016). a chief information officer can be appointed to assist in this regard (maruca 2000). it is likely that more focus will be placed in future on the impact of brand trust on the relationships between a business and its stakeholders (davis & mulcahy 2018). engagement frequency and prevalent topics eight participants (more than 60% of the sample) stated that the frequency of engagements varies due to the considerable number and nature of issues that require attention. follow-up meetings with management of investee companies to reflect on the success of engagements were brought up by five interviewees. semenova and hassel (2019) likewise reported that nordic institutional investors mentioned follow-up private engagements if an engagement case has not been closed within two months. the interviewees indicated that engagements mainly centred on executive remuneration concerns. engagements on board composition were also mentioned. an interviewee referred to voting on executive remuneration as ‘a good example of what you can achieve if you want shareholder activism to play a more prominent role’. a counterpart suggested that ‘roadshows’ could be held to facilitate robust discussions with large investors on executive remuneration. literature confirms that shareholder activism in south africa is primarily event-driven and focused on corporate governance issues such as emolument and board diversity (davids & kitcat 2019; viviers, mans-kemp & fawcett 2017; viviers et al. 2019). this tendency could be partly ascribed to the introduction of say-on-pay guidelines and board diversity targets in king iv (iodsa 2016). a participant ascribed the focus on the g-component of esg to governance information being more accessible than data on social and environmental considerations. this participant stressed that more information is required to ensure meaningful engagement on sustainability topics in future. this call by participants is echoed by researchers (eccles & klimenko 2019). suggestions to enhance engagement and facilitate change an interviewee remarked that clients should pressurise companies to improve their engagement processes in future. it was suggested by this participant that contracts should be amended to offer more details on the expected behaviour of the institutional investor on behalf of the client. although viviers and smit (2015) indicated that proxy voting seems to be the last resort for local shareholder activists, an interviewee expressed the view that proxy voting is expected to gain more traction in future: ‘it’s a two-way street; the institutional investors move on their own accord, but they will need the pressure from clients’. gottfried and donahue (2020) confirmed that it is likely that this shareholder activism mechanism will receive more attention following the disruption in markets caused by the covid-19 pandemic. the participants provided several recommendations on how to improve engagements in future, given rapid technological advancement. they deemed agms a prominent engagement platform, in addition to semi-annual and annual results presentations. the view was expressed by an interviewee that ‘companies can use technology a lot more through webcasts’. by presenting a company’s results and agm via webcasts, more shareholders would be able to engage in discussions. purcell (2008) suggested that electronic communication channels will not only result in more effective engagements and better representation at meetings, but shareholders will also have the opportunity to vote directly without going through a proxy. despite such calls, the first platform to facilitate electronic agms in south africa was only introduced by the jse (2020) in march 2020 following the covid-19 pandemic that brought about social distancing. the impact of technology on shareholders’ preference for specific activism mechanisms warrants further investigation. conclusions and recommendations for future research south africa provides a well-developed framework to conduct research on responsible investment, including the king iv report, crisa and regulation 28. responsible investors can employ a range of strategies, including shareholder activism, to account for esg and financial considerations when making investment decisions. an increase in shareholder activism endeavours are noted among local shareholders of all sizes. given their considerable shareholding in listed companies, institutional investors in particular can have a substantial impact in encouraging more responsible corporate behaviour. despite a range of public and private voice mechanisms at their disposal, literature indicates that local institutional investors prefer engaging in private with investee companies, mainly to protect the latter’s reputation. this study was conducted to investigate the views of selected institutional investors on the nature of shareholder activism endeavours in south africa by conducting semi-structured interviews. the secondary objective was to contextualise their feedback by accounting for the impact of the fourth industrial revolution and the covid-19 pandemic on the way forward for shareholder activism endeavours. the results of the thematic analysis show that the majority of the interviewees preferred private engagements, as they deemed public activism to be too confrontational. several participants were discouraged to engage in coalitions to drive change, given the acting in concert provision provided for in the companies act (no. 71 of 2008). regular engagements and follow-up discussions with the management and directors of investee companies were mentioned. some interviewees stated that engagement details are shared on the investee company’s website. based on these findings, it is suggested that more institutional investors should follow suit. enhanced transparency will enable a broader range of stakeholders, including minority shareholders, to make more informed decisions. the majority of the interviewees were of the view that shareholder activists will not be able to enforce compliance with the king iv guidelines, despite an acknowledgement in this report that they are deemed the ultimate compliance officers. engagements were largely focused on corporate governance concerns, in particular executive remuneration and board composition. interviewees remarked that more information is required to meaningfully engage on social and environmental aspects. if more clients apply pressure on institutional investors, and they in turn engage more frequently with investee companies, it can be a tipping point for shareholder activism in south africa. technological systems and devices are likely to be considerable enablers in this regard. interviewees indicated that social media could be valuable to enhance awareness of material esg information, but might have potential detrimental consequences if quoted out of context. a chief information officer could assist to properly manage social media. participants furthermore indicated that the format of agms should be reconsidered. they suggested that technology could be utilised more extensively to enhance shareholder participation. this suggestion is particularly apt in the light of the covid-19 pandemic. webcast agms, hybrid meetings (in-person meetings that are simultaneously webcast) and virtual results presentations will enable more shareholders to become active owners. shareholders will have to rethink the application and effectiveness of the mechanisms at their disposal to ensure that their voices are heard, while simultaneously being sensitive not to (further) endanger the livelihood of companies given challenging economic circumstances. based on the reported results, and in line with the views of just share (2020b) and kennedy-good and chalwin-milton (2020), the following guidelines are suggested for virtual agms and hybrid meetings in future: shareholders should be timeously informed about meetings and technical arrangements, such as login details, and how to cast their votes. platforms should be able to accommodate a large number of participants to log in within a short time period. the functionality of platforms should be tested before a meeting takes place. in addition to electronic questions, shareholders should have the option of submitting questions verbally, in real time, without moderation. sufficient time should be allocated for the question and answer session by accounting for potential technological challenges. technological support should be available during the entire meeting to address challenges. a summary of the questions and answers covered during an agm could be published on the company’s website to inform other stakeholders. a similar study can be conducted in future to determine longitudinal changes related to shareholder activism endeavours in response to the covid-19 pandemic and rapid technological development by reflecting on, inter alia, the employed measures and outcomes. while this study centred on institutional investors, interviews can be conducted with institutional and retail investors. the views of trade union representatives might also be gauged, given the considerable social impact of the pandemic. surveys could also be considered to gauge these stakeholders’ views on activism endeavours. researchers can, furthermore, give attention to changes related to corporate risk oversight and the management of investor relations in response to periods of crisis. acknowledgements competing interests the authors have declared that no competing interest exists. authors’ contributions n.m.-k. conceptualised and wrote the article. m.v.z. conducted the interviews and the thematic analysis. she 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financial sciences 12(1), 1–14. https://doi.org/10.4102/jef.v12i1.199 yamahaki, c. & frynas, j.g., 2016, ‘institutional determinants of private shareholder engagement in brazil and south africa: the role of regulation’, corporate governance: an international review 24(5), 509–527. https://doi.org/10.1111/corg.12166 zhang, q., 2016, ‘corporate governance, institutional investors and firm performance: a comparative study of south africa and china’, unpublished doctoral dissertation, department of business management, stellenbosch university. abstract introduction literature review research methodology results recommendations limitations of the study and recommendations for future research acknowledgements references about the author(s) felix amoah department of marketing management, faculty of business and economic sciences, nelson mandela university, gqeberha, south africa marlé van eyk department of marketing management, faculty of business and economic sciences, nelson mandela university, gqeberha, south africa mthi yolokazi department of marketing management, faculty of business and economic sciences, nelson mandela university, gqeberha, south africa citation amoah, f., van eyk, m. & yolokazi, m., 2022, ‘predictors of passengers’ satisfaction with long-distance coach liners in south africa’, south african journal of economic and management sciences 25(1), a4506. https://doi.org/10.4102/sajems.v25i1.4506 original research predictors of passengers’ satisfaction with long-distance coach liners in south africa felix amoah, marlé van eyk, mthi yolokazi received: 22 jan. 2022; accepted: 18 may 2022; published: 08 july 2022 copyright: © 2022. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: long-distance coach liner bus transportation forms an important economic sector in south africa as it contributes to the gross domestic product (gdp) and employment, and significantly impacts the daily life activities of many people. while this is commendable, there have been reports relating to inefficiency, reliability (late arrivals and departure times) and safety concerns. these concerns have the potential to negatively impact on passengers’ satisfaction. aim: no south african investigative research study could be found on the predictors of passengers’ satisfaction with long-distance coach liners. this study was conducted to identify predictors of passengers’ satisfaction with long-distance coach liners in south africa. setting: the target respondents were passengers who recently travelled on a long-distance coach liner in south africa. the potential respondent had to be at least 18 years of age. methods: primary data were collected using an online survey, and respondents recruited through convenience and snowball sampling. of the 409 questionnaires received, 399 useful questionnaires were included in the data analysis. results: the results of the study indicate that peace of mind (β = 0.552, p = 0.000) and efficiency (β = 0.455, p = 0.000) have a predictive power on passengers’ satisfaction. conclusion: the findings suggest that when there is an improvement in peace of mind and/or efficiency, passengers’ satisfaction will also improve. it is thus recommended that operators/managers of long-distance coach liners prioritise the elements that contribute to peace of mind at all touchpoints (e.g. safety, security, privacy, professionalism of drivers) and efficiency in delivering services to passengers (e.g. reliability and punctuality). keywords: bus transportation; efficiency; long-distance coaches; passenger satisfaction; peace of mind. introduction the transport industry is an emerging global economic sector that supports national and international commerce by facilitating the movement of freight and people (lubbe & vermooten 2021). the transport industry also supports other economic sectors, such as manufacturing, agriculture (govender 2014; potgieter 2016; shange 2017) and tourism (lubbe & vermooten 2021). in south africa, the transport industry is a major investment sector that contributes significantly to the country’s gross domestic product (gdp) and to employment through job creation (aidoo et al. 2013; dube & anno-frempong 2016). in the first quarter of 2021, the transport industry was among the top 10 south african industries that registered growth in the economy, together with the finance, mining, storage and manufacturing industries (stats sa 2021). according to stats sa (2021), the transport, storage and communication industry grew by 4.8%, with the land transport sub-sector contributing significantly to that growth. the land transport sub-sector consists of various modes of transport, such as bicycles, mini-buses, buses, taxis, cars and trucks (competition commission of south africa 2021; thomas 2016). the mode of transport selected for this study is buses, specifically long-distance coach liners. the latter was selected, as long-distance passenger transport service developed an extensive route network since 1979, connecting major cities in seven southern african countries (intercape 2018). as the bus transportation system developed, so have passenger expectations of the service. instead of just mobility from one point to the next (dash & samanataray 2018), passengers are increasingly in pursuit of personal, memorable, meaningful and unique experiences during their journeys (mao & lyu 2017). satisfaction is attained when the passenger experience exceeds passenger expectations (van lierop, badami & el-geneidy 2018). delivering passenger satisfaction will eventually improve the competitiveness of the industry, as passenger satisfaction will enhance the chances of the passenger boarding the same mode of transport in the future, referring the mode of transport to friends and family and resisting the influence of competitive offers from other modes of transport (kastenholz et al. 2018; prayag et al. 2017). regardless of the established importance of passenger satisfaction, the road passenger transport sector in south africa has been criticised for its inefficiencies and lack of customer-focus, reliability, comfort and safety (mamabolo & sebola 2018; vilakazi 2013). similar to other modes of road transportation, several of these challenges (e.g. late arrivals of buses at points of departure and destination, uncomfortable seats, non-functional entertainment facilities, non-functional toilet facilities in the buses and dysfunctional air conditioning) have also been reported within the long-distance coach liner sector (intercape 2018). these challenges have the potential to increase passenger dissatisfaction within the industry, while an understanding of passengers’ satisfaction with particular reference to long-distance coach liners in south africa could assist operators of long-distance coach liners in improving their services and sustain the growth and development of the sector in line with changing passenger expectations. however, there is currently no research on the predictors of passengers’ satisfaction with long-distance coach liners in south africa. this study was conducted with the aim of filling this particular knowledge gap by investigating the predictors of passengers’ satisfaction with long distance coach liners in south africa. in order to achieve the above-stated aim, the objective of the study was to identify predictors of passengers’ satisfaction with long-distance coach liners in south africa. literature review theoretical and empirical contexts of the study are discussed below. firstly, the south african transportation industry is described. this is followed by a discussion of the main concept underlying the study, namely passengers’ satisfaction and a proposed hypothetical framework. transportation industry in south africa transportation involves the provision of passenger or freight transport by rail, road, water or air (dube & anno-frempong 2016). the transportation industry consists of several sectors, such as freight, logistics, airlines, marine, road and rail transportation and infrastructure (dube & anno-frempong 2016). the industry also includes associated activities such as terminal and parking facilities and cargo handling (dube & anno-frempong 2016). within the transportation industry, the bus transportation sector is the oldest and most prevalent mode of transportation that facilitates the movement of people within and between cities (conserve energy future 2019; vuchic 2017). a bus is commonly viewed as a road-based rubber-tyred vehicle, they come in different sizes and capacities and/or body types, operating on a number of routes, with the ability of transporting at least 18 passengers (govender 2014; vuchic 2017). sirajudeen and senthilkumar (2019) define a bus as a large motor vehicle with a long body, fitted with seats or benches, usually operated as part of a scheduled service. bus transportation has been in existence in south africa since the 1930s (davis 2021), and in 1980, the southern african bus operators’ association (saboa) was established and registered as a non-profit organisation with the aim of creating a transformative and sustainable bus (including coach) industry in south africa (walters 2018). as south africans become more mobile and more dependent on transport, buses have become an important mode of transportation (litman 2021). the development of bus transportation among public and private providers may generate a competitive environment, while passengers could benefit from competitive pricing and improved services (suwan & saosaovaphak 2012). bus services expanded into the new townships emerging since 1994 (ehrenreich 2018). stats sa (2014); this confirms that 20% of households in south africa have at least one member who uses bus services. this suggests that bus patronage is on a steady rise and affects the daily life activities of people. while acknowledging the importance of buses for the daily commuting of passengers to and from work and education establishments, this study focuses on long-distance coach liners. long-distance coach liners are buses that travel long distances which include daily or overnight trips to predetermined destinations, or trips to foreign countries (holz-rau, scheiner & sicks 2014; van de velde 2009). most long-distance coach liners have onboard facilities such as a toilet, entertainment (sound system and video) and wi-fi, and occasionally offer snacks. passenger satisfaction customer satisfaction is founded on different theories with the expectancy-disconfirmation, transaction, and cumulative satisfaction theories widely cited (fornell 1992; oliver 1981; zeithaml, berry & parasuraman 1993). the expectancy-disconfirmation theory measures customer satisfaction based on how customers’ expectations and the performance of a product or service are conceived (almsalam 2014). the customer would be satisfied when perceived performance exceeds expectations (gebremichael & singh 2019). on the contrary, when perceived performance is below expectation, the customer would be dissatisfied (almsalam 2014; gebremichael & singh 2019). customer satisfaction can also be determined after a one-time experience (transaction satisfaction) or after several encounters/use (cumulative satisfaction) of a product or service (fornell 1992; zeithaml et al. 1993). the current study relied on the cumulative satisfaction theory developed by fornell (1992). the cumulative evidence of satisfaction may provide insight into the entire experience of the passenger, reflecting pre-consumption, during and post-consumption experience of travelling with a long-distance coach liner. customer satisfaction in the context of this study is operationalised as the extent to which the entire travelling experience in a long-distance coach liner passenger is perceived as pleasant (fornell 1992; islam et al. 2014; khan & kadir 2011). satisfied customers are likely to be loyal to a product, or service, and are less sensitive to high prices, or price changes, and tend to be less sensitive to competitive offers. while satisfied customers have the potential to uplift the business to higher levels by influencing others to buy the product or services through positive word of mouth, dissatisfied customers are likely to switch to competitors (liu, huang & li 2018; prayag et al. 2017). several studies concluded that customers desire a holistic ‘personal experience that dazzles their senses, touches their hearts, and stimulates their minds, while indulging in fantasies, feelings and fun’ (ali, hussain & omar 2016; hosany & witham 2010). therefore, it is the memory of an experience that determines whether the consumer is satisfied, repeats, recommends or talks positively about a brand, product or service (flacandji & krey 2020). proposed hypothetical framework currently, consensus has not been established on the dimensions of customer satisfaction based on the cumulative theory of satisfaction. therefore, this study provides ground-breaking findings to assist future studies with established dimensions. thus, in order to measure passengers’ satisfaction in this study, five dimensions, namely aesthetics, entertainment, peace of mind, economic value and efficiency have been selected from literature (amoah, radder & van eyk 2016; carins, rundle-thiele & ong 2020; khan, garg & rahman 2015; klaus & maklan 2013) due to their influence on customer satisfaction in various fields. aesthetics refers to consumers’ perception or interpretation of the physical environment (carins et al. 2020; hosany & witham 2010), which is made up of a functional spatial layout (hosany & witham 2010) which stimulates emotions associated with pleasure (feeling good/happy), arousal (e.g., excitement or action) and dominance (control/importance) (kastenholz et al. 2018). the physical environment (outside, inside and with comfortable seats) at a destination plays an important role in determining attitudes, intentions regarding future patronage and willingness to revisit, or purchase, and may change both emotions and customers’ behaviour (carins et al. 2020; wahyuddin et al. 2020). thus, the well maintained interior and exterior condition of a long-distance coach liner; the cleanliness of the coach liner and its staff; the physical environment inside the coach, which includes colour, lights, design and interior decorations, may influence the perceived aesthetics of the long-distance coach liner. while several studies (carteni & henke 2017; hosany & witham 2010) recognise the role of aesthetics in influencing consumer behaviour, decision-making and services evaluations, carins et al. (2020) established that aesthetics predictively impacts satisfaction within an ‘institutional food service setting’. within the transportation industry, wahyuddin et al. (2020) found that aesthetics has a significant effect on satisfaction. kastenholz et al. (2018), however, concluded that aesthetics has an indirect effect on satisfaction. based on these divergent findings from different studies, this study hypothesises that: h1: aesthetics directly and significantly predict passengers’ satisfaction with long-distance coach liners. entertainment typically occurs when people actively or passively observe others’ activities and/or performances (radder & han 2015). a functional sound system and video equipment, attractive movies and music played on board, as well as the provision of wi-fi facilities provided on board a long-distance coach liner may contribute to entertainment and significantly affect passengers’ satisfaction. for example, music influences and stimulates emotions, moods, behaviour, consumption, involvement, patronage, pleasure and a sense of identity (åstrøm 2017). wang and loo (2019) identified that the provision of information and communication technology (ict) and in-vehicle e-activities which form a vital component of entertainment have a significant effect on passengers’ travel satisfaction. davras and caber (2019) initiated a study to analyse the effect of hotel services on customer satisfaction. the findings from their study show that entertainment has a considerable impact on passengers’ satisfaction. similarly, giao et al. (2021) found that entertainment services significantly impact domestic tourist satisfaction. these findings, from a variety of studies, suggest that if long-distance coach liner operators provide entertainment programmes that are differentiated and not easily imitated, passengers are more likely to be satisfied. it is, therefore, hypothesised that: h2: entertainment directly and significantly predicts passengers’ satisfaction with long-distance coach liners. peace of mind reflects a mental state of being in peace and harmony without experiencing any disruptions (ahmadpour et al. 2014). amoah et al. (2016) define peace of mind as physical and psychological safety, security and privacy. klaus and maklan (2013) assert that peace of mind is linked to emotions and involves how the customer assesses the entire service provider before, during and after the service encounter. in a study conducted by govender (2014), safety was researched from three angles, namely (1) safety of passengers, (2) safety of drivers and (3) safety of buses. in the context of this study, safety of passengers refers to the passengers’ fears that they are likely to be involved in an accident as a result of using a particular transportation mode; the condition of the vehicles; and driving behaviour as the driver may, for instance, not be obeying the road rules and signs (govender 2014). security is described as protection of an individual, location or reputation from harm that is caused by a person or an object (ahokas 2017). it is important that passengers feel secure at the waiting environment, during the trip and when arriving at the destination (govender 2014). privacy is the state when an individual is free from public interruption and intrusion (surbhi 2018). although ensuring privacy in the transport industry may be difficult, it is important that management of long-distance coach liner companies should strive to ensure that the privacy of each individual traveller is respected. for instance, providing a wide space between seats for the passenger to pass without disturbing others allows passengers to enjoy some privacy (ahmadpour et al. 2014). passengers’ peace of mind could be ensured when their seats have small compartments for the storage of personal belongings, hence creating a sense of being protected (ahmadpour et al. 2014). a study by khan et al. (2015), which focused on customer service experience and its effect on satisfaction in hotel operations, identified that peace of mind has the most dominant predictive effect on customer satisfaction. it is, therefore, hypothesised that: h3: peace of mind directly and significantly predicts passengers’ satisfaction with long-distance coach liners. based on prior studies, economic value was identified as a relevant dimension in measuring passenger satisfaction. economic value represents the value that a customer assigns to goods or services based on the benefits derived (banton 2020). according to khan and kadir (2011), value can be described in terms of benefits received and sacrifices made by passengers. sacrifices of passengers may include time, effort and money paid in exchange for the benefits received. benefits include value for money (amoah et al. 2016). both these factors, namely benefits and sacrifices, may influence the passengers’ satisfaction. price, which is the amount of money that customers give up in order to obtain products or services (kotler & armstrong 2015), could influence the attainment of economic value and is, therefore, an important element considered by customers when they formulate their perceptions of a service. a general perception by customers is that higher prices represent better quality, while a lower price might indicate a substandard service (amoah et al. 2016). in the context of this study, providing information relatively quickly regarding bus timetables, travelling routes, a simplified ticketing process for travelling costs, bus fares, and any other costs encountered, may influence economic value. furthermore, passengers might appreciate a reasonably priced long-distance coach liner fare that offers good value for money. a study by shoki et al. (2012) on perceived value, satisfaction and loyalty among mobile phone users found that economic value has a predictive power on customer satisfaction. it is, therefore, hypothesised that: h4: economic value directly and significantly predicts passengers’ satisfaction with long-distance coach liners. efficiency constitutes the final dimension of passenger satisfaction, which is defined by amoah et al. (2016) as the process of completing a task quickly, without wasting time, energy and resources. efficiency also implies the ability to perform the services adequately (sidjabat 2019). efficiency embodies reliability and effectiveness of operations and services (passenger focus 2013). reliability is influenced by customer expectations which involve services being accomplished on time, in the same manner, without defects, every time (dhillon 2011). effectiveness in relation to bus transportation is linked to service punctuality (prompt arrivals and departing times) (sidjabat 2019). it is important for long-distance coach liners to operate efficiently (van jaarsveld 2012) and inform passengers about adjustments in travel times in the event of emergencies as bus delays may have a negative impact on passengers’ satisfaction (passenger focus 2013). sidjabat (2019) found, in a study which focused on the impact of effectiveness and efficiency on transit passenger satisfaction in an airport context, that efficiency has a predictive effect on passenger satisfaction. it is, therefore, hypothesised that: h5: efficiency directly and significantly predicts passengers’ satisfaction with long-distance coach liners. from the foregoing discussions, the hypothetical framework in figure 1 below was formulated to guide the study. figure 1: hypothetical framework. research methodology this study followed a positivist research paradigm which allowed for the application of statistics in the data analysis (ling & ling 2017). in order to achieve the aim of the study, predictors of passengers’ satisfaction with long-distance coach liners in south africa needed to be identified and described. consequently, the study was descriptive in its design. descriptive studies are concerned with existing conditions or relationships, prevailing practices, views, attitudes and developing trends about a topic (ling & ling 2017). a complete sample frame of the passengers of long-distance coach liners in south africa did not exist. in such instances, where the sample frame is unknown, but is expected to exceed 5000 people, based on the population, a sample size of 400 as recommended by gay, mills and airasian (2012) was adopted for the study. primary data was collected through an online questionnaire that was accessible through a link. the link was distributed to the target population through emails and social media platforms, such as facebook, whatsapp and twitter. the inclusion criteria were both male and female passengers of long-distance coach liners in south africa. two screening questions were employed to ensure that only respondents, forming part of the target population, were recruited for the study. firstly, the potential respondents should have travelled on a long-distance coach liner in south africa within the previous 12 months. secondly, the potential respondent had to be at least 18 years of age. only respondents who met these two criteria were allowed to proceed with the completion of the questionnaire. the online survey tool selected for this study was surveymonkey, an internet-based platform for researchers onto which surveys may be launched (ainsworth 2019; comparecom 2020; waclawski 2012), which was selected for use in this study. the advantage of using an online questionnaire is that it is flexible in collecting data, which allows the researcher to organise the questions and receive replies from respondents without talking to them separately (kilani & kobziev 2016). both convenience and snowball sampling were used to recruit the target respondents. convenience sampling helped to recruit respondents who were easily and readily available to take part in the study (etikan, musa & alkassim 2016). snowball sampling enabled the researchers to request potential respondents for additional contacts, or forward the link of the questionnaire to other potential participants (gogtay & thatte 2016). the questionnaire for this study consisted of the following three sections. section a contained the cover letter accompanying the questionnaire. section b comprised several statements relating to the five dimensions of satisfaction. a 5-point likert scale was used to capture the passengers’ level of agreement with the statements relating to their satisfaction with long-distance coach liners, ranging from strongly disagree (1) to strongly agree (5). all the scale items employed in the questionnaire were adapted from previously validated studies. the items measuring aesthetics were adapted from carreira, patricio and jorge (2014), carins et al. (2020) and aidoo et al. (2013). the entertainment items were adapted from carreira et al. (2014), schiefebusch (2015) and de aquino et al. (2018). the items measuring peace of mind were adapted from schiefebusch (2015), de aquino et al. (2018) and carreira et al. (2014) while the items measuring economic value were adapted from karim and fouad (2019), carreira et al. (2014), and vilakazi and govender (2014). the items measuring efficiency were adapted from carreira et al. (2014) and fan, guthrie and levinson (2016). the items measuring satisfaction were adapted from ratanavaraha et al. (2016), de aquino et al. (2018), de meyer and mostert (2011) and palawatta (2015). section c of the questionnaire collected details about characteristics of respondents such as gender, age, country of permanent residence, current occupation and purpose of travel. dichotomous type questioning was used in section c. ethical clearance was obtained prior to data collection and data analysis was performed using international business machines (ibm), statistical packages for the social sciences, (spss) version 26. ethical considerations ethical clearance was obtained from the faculty ethics committee of the faculty of business and economic sciences, nelson mandela university (h20-bes-mrk-071. 12 june 2020). results profile of respondents a total of 409 questionnaires were received of which 10 were excluded from the study because they had not been correctly completed. the remaining 399 valid questionnaires were used for data analysis. as displayed in table 1, of the 399 respondents, 44.6% were male and 55.4% were female. the age group 18–25 years was best represented in the study (53.9%), followed by those respondents between 26 and 35 years of age (38.1%). only a small proportion of the respondents were older than 45 years (3.0%). the results indicate that 96.5% of the respondents who completed the questionnaire were south african residents. the largest proportion of respondents was students (42.6%), followed by 34.1% of respondents being full-time employed. only one respondent was retired. according to the results, slightly less than half of the respondents (48.9%) had travelled on a long-distance coach liner once in the six months prior to data collection, followed by those who had travelled once in the year (28.3%) prior to data collection. table 1: respondents’ profile. exploratory factor analysis prior to commencing with the exploratory factor analysis (efa), kaiser-meyer-olkin (kmo) measure of sample adequacy of 0.937 and bartlett’s test of sphericity (χ2 = 7874.204; df = 630; p = 0.000) were attained for the proposed independent factors. as with regard to the items measuring, the proposed dependent variable, the kmo measure of sampling adequacy of 0.92 and bartlett’s test of sphericity (χ2 = 2537.996; df = 28; p = 0.000) were obtained. based on the p-value, these statistics suggest that the data for both the intended independent and dependent factors were suitable for factor extraction. the results of the kmo and bartlett’s tests enabled all 44 items to be subjected to principal factor analysis with kaiser rotation. next, the principal axis factoring (paf) extraction method was used to determine the number of factors that could be extracted from the dataset. the kaiser’s criterion of selecting factors with eigenvalue more than 1 was used for factor extraction (hair et al. 1995). five factors with eigenvalues more than 1 could be extracted from the items measuring the proposed independent variables. the resulting five factors cumulatively explain 49.649% of the observed variability. the results also identified the existence of one factor with an eigenvalue more than 1 and explained 64.915% of the variability in the proposed items measuring the dependent factor. reliability of the measuring instrument a reliability coefficient (cronbach’s alpha) was calculated for each factor to estimate the internal consistency of each of the items (hair et al. 1995) and the following results were obtained (table 2). the cronbach’s alpha values for all factors were above 0.70, which satisfies the minimum threshold of 0.70 and confirms the reliability of the measuring instrument (salkind 2018). table 2: reliability test. to determine discriminant validity, the square root of the average variance extracted (ave) was determined for each factor obtained in the efa. to determine whether there was sufficient divergent validity between factors, the square root of the ave should be more than the correlation coefficient between the pairs of factors. therefore, these values were compared to the inter-factor correlations with the results shown in table 3 below. table 3: discriminant validity. based on the results observed, factors such as entertainment and economic value indicated full divergent validity, while efficiency and peace of mind indicated partial divergent validity, as the square root of ave was greater than two of the remaining four factors. given that the factors identified during the efa had sufficient reliability and the factors indicated divergent validity to some extent, the factors were deemed adequate for further analysis. correlation analysis pearson product moment correlation factors (table 4) were computed to assess the relationship between the independent and dependent factors. the results show that all correlation factors were statistically significant at p < 0.01 (zhu 2016). the largest correlations were found between peace of mind and satisfaction (r = 0.815) and efficiency and satisfaction (r = 0.803). this implies that peace of mind has the strongest relationship with satisfaction. the smallest correlation was found between entertainment and economic value (r = 0.336). table 4: correlations between factor scores. regression analysis the r2 of 0.761 demonstrates that 76.1% of the total variance in satisfaction is explained by the independent factors of the model. the adjusted r2 of 0.758 (75.8%), f value = 250.225, p = 0.000, indicate that the model is significant. the coefficients of the model are presented in table 5. the results show that entertainment (β = 0.027, p = 0.366), aesthetics (β = 0.035, p = 0.413) and economic value (β = 0.002, p = 0.958) were not statistically significant predictors of passengers’ satisfaction. only two factors, namely efficiency (β = 0.455, p = 0.000) and peace of mind (β = 0.552, p = 0.000), were found to be significant direct predictors of passengers’ satisfaction. based on the results h3 and h5 were supported, whereas h1, h2 and h4 were not supported. to ensure that multicollinearity was not a cause for concern, the variance inflation factor (vif) values were obtained for each predictor. a vif of 10 or higher indicates a serious multicollinearity issue. as the vif values of each predictor were below 3, there does not appear to be cause for concern within this model (the final model is presented in figure 2). figure 2: final model result. table 5: model hypotheses testing. conclusion several findings were made during the study. aesthetics was found to be significantly related to satisfaction (r = 0.615). however, aesthetics lacked a significant predictive effect on passengers’ satisfaction (β = 0.035, p = 0.413). this implies that increasing aesthetics will not significantly improve passengers’ satisfaction. thus, h1 stating that aesthetics directly and significantly predicts passengers’ satisfaction with long-distance coach liners is not supported. the findings contradict previous results by wahyuddin et al. (2020). entertainment was found to be significantly related to satisfaction (r = 0.543) but lacked a significant predictive effect on passengers’ satisfaction (β = 0.027, p = 0.366). this implies that increasing entertainment will not significantly improve passengers’ satisfaction. the findings do not support h2 of the study which hypothesised that entertainment directly and significantly predicts passengers’ satisfaction with long-distance coach liners. the results also contradict previous findings by giao et al. (2021). peace of mind was found to be most strongly correlated with passengers’ satisfaction (r = 0.815), and has a significant direct predictive effect on passengers’ satisfaction (β = 0.552, p = 0.000). the results of this study are in alignment with those of the study by khan et al. (2015) which concluded that peace of mind significantly predicts passengers’ satisfaction. thus, h3 of this study is supported. economic value was found to be significantly related to satisfaction (r = 0.486), but lacked a significant predictive effect on passengers’ satisfaction (β = 0.002, p = 0.958). this implies that increasing economic value will not significantly improve passengers’ satisfaction. the findings in this study deviated from previous results by shoki et al. (2012). thus, h4 of this study is not supported. finally, efficiency was found to be significantly related to satisfaction (r = 0.803, p < 0.01) and demonstrated a significant direct predictive effect on passengers’ satisfaction (β = 0.455, p = 0.000). this implies that when efficiency is improved passengers’ satisfaction will be increased. the results from this study support the findings by sidjabat (2019) which concluded that efficiency has a predictive power on passengers’ satisfaction. based on this result, h5 of this study is thus supported. overall, the findings indicate that peace of mind and efficiency are the only factors with direct predictive capability of passengers’ satisfaction with long-distance coach liners in south africa. the study identified specific dimensions that have predictive effect on customer satisfaction. the findings thus contribute to the cumulative theory of satisfaction in which this study was grounded. recommendations the aim of this study was to investigate the predictors of passengers’ satisfaction with long-distance coach liners in south africa. since the findings of the study show that peace of mind and efficiency are predictors of passengers’ satisfaction with long-distance coach liner services, the following recommendations are presented. these recommendations are premised on the understanding that increasing the peace of mind or efficiency will cause an increase in passengers’ satisfaction with long distance coach-liner services. recommendations increasing peace of mind long-distance travel operator managers are advised to strengthen security systems on board the coach to ensure that passengers always feel safe. closed-circuit television (cctv) cameras can be installed in the bus to monitor and alert drivers of passengers’ behaviour in the bus. furthermore, private security personnel may be contracted to ensure that safety measures in the bus and at embarkation and disembarkation points are in place. there should be regular training for drivers on professional driving techniques (e.g. how to maintain an average speed, how to detect faults in the bus movements). recommendations increasing efficiency based on the above findings, it is recommended that small booklets/pamphlets be provided on each seat of the coach that will provide information with clear instructions on how to use/operate vital equipment in the coach. prior to departure, the driver or assistant driver needs to educate passengers on the use of key equipment/facilities in the coach. customers do not like to wait for the service; thus, employees of long-distance coach liners need to be well-trained to be punctual and consistent with bus departure and arrival times. managers of long-distance coach liners are advised to provide reliable services. travel time and waiting time are to be noted by long-distance coach liner management as a factor that influences travel decisions. to improve bus services, for example, reduce bus delays; and bus operators should adjust driver schedules by redeploying drivers to meet an original bus timetable as often as possible (kang, meng & zhou 2020). limitations of the study and recommendations for future research the first limitation of the study relates to the data collection method. based on covid-19 regulations in 2020, data were collected through an online survey, with the questionnaire distributed to respondents via email and social media, such as facebook and whatsapp. due to the data collection method, not all people included in the target population had internet access and so some potential respondents could not participate due to internet access limitations. due to this, the results should be generalised with caution, and it is advised that future studies should strive to use a data collection technique, such as an intercept interview to reach different types of respondents. the 18–25 years age group was best represented in the study (53.9%). future studies should strive to obtain the perception of a more equal distribution of age groups. moreover, due to covid-19 national regulations, inter-provincial travel was prohibited during the period of data collection. consequently, there was a low response rate among respondents who travel multiple times per month. most respondents travelled only once in the previous 6 months. for this reason, it was difficult to determine the recent service offered by long-distance coach liners in south africa. acknowledgements the authors would like to thank the respondents who participated in the study. without your support, this study would not have been possible. competing interests the authors declare that no competing interest exists in this manuscript. authors’ contributions f.a. is a senior lecturer (department of marketing management) at the nelson mandela university, gqeberha, south africa. dr. f.a. was the main supervisor of the study and prepared the article. prof m.v.e. is an associate professor in the department of marketing management at the nelson mandela university, gqeberha, south africa. prof m.v.e. was the co-supervisor of the study and prepared the article with dr amoah. miss y.m. is an mcom candidate (marketing management) at the nelson mandela university, gqeberha, south africa. miss y.m. conceptualised the research idea, collected the data, interpreted the results and performed the final write-up of the study. funding information the authors would like to thank the national research foundation scholarship (nrf) and postgraduate research scholarship (pgrs) of the university for their financial support to the student (miss yolokazi mthi). data availability the authors confirm that the data supporting the findings of this study are available within the article. supplementary data may be obtained from the corresponding author upon reasonable request. disclaimer any opinions, findings, conclusions and recommendations in this article are those of the authors and not necessarily the 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<0.001, <0.0001, <0.00001, <0.000001, <0.0000001…’, journal of sport and health science 5(1), 77–79. https://doi.org/10.1016/j.jshs.2016.01.019 238 sajems ns 10 (2007) no 2 entrepreneurial intensity: a comparative analysis of established companies in south africa mj scheepers, j hough and jz bloom department of business management, university of stellenbosch abstract entrepreneurship is gaining recognition as an important way of attaining a sustainable competitive advantage and positive financial returns. this article compares the entrepreneurial intensity (ei) of information and communication technology (ict) companies with that of listed jse companies (excluding ict listings). a cross-section telephone survey was conducted. the findings suggest that ict companies are more entrepreneurial than jse companies. additionally, the size of a company shows no relation to ei, but age is negatively correlated to ei. by implication, the older the company, the less entrepreneurial it becomes. the findings suggest that organisational factors influence ei and that ei is industry specific. the managerial implication for companies that want to become more entrepreneurial is that they should create organisational conditions conducive to the development of corporate entrepreneurship. jel l26 1 introduction both large and small companies are urged to act in more innovative and entrepreneurial manners in order to prosper and flourish in the globalised knowledge economy (see covin & slevin, 1991; lumpkin & dess, 1996; barringer & bluedorn, 1999; leibold, probst & gibbert, 2002). however, conventional wisdom often equates entrepreneurship with the single start-up event of a new small business, while entrepreneurship in a corporate environment is sometimes perceived as a contradiction in terms. innovative acts in larger corporate environments are thus generally not seen as entrepreneurship or entrepreneurial in nature. larger companies claim that it is easier for smaller, agile, flexible enterprises to act entrepreneurially. by implication, smaller companies should therefore be able to formulate responses to environmental changes much more rapidly than larger companies are able to do. smaller companies, on the other hand, claim that they have to implement survival strategies. they have neither the capacity nor the access to resources (e.g. information and human resources) available to larger companies. va r i o u s a u t h o r s a g r e e t h a t c o r p o r a t e entrepreneurship (ce) is crucial to the survival, improved financial performance and eventual success of an enterprise, regardless of its size (zahra, 1995; knight, 1997; zahra, jennings & kuratko, 1999; goosen, 2002). ce and innovation have gained prominence and interest among practitioners and scholars globally. most of the completed research has been conducted in developed countries like the usa, canada and certain european countries, while some has been conducted in countries with transitional economies like slovenia. limited research has been conducted in developing countries, including south africa. locally, only two doctoral studies have been completed on sajems ns 10 (2007) no 2 239 ce: struwig (1991) focused on ce as a strategy for managing change and innovation, while goosen (2002) focused on the link between ce and financial performance. at a practical level questions remain: what makes one company more entrepreneurial than another? do company characteristics such as size or age determine a company’s entrepreneurial responses? or are responses prompted by the external environment and the sector in which a company operates? do certain internal factors play a determining role? in an attempt to answer these questions, this article will compare the entrepreneurial intensity of established companies listed on the johannesburg securities exchange (jse) with information and communication technology (ict) companies in respect of corporate characteristics (age, size and sector) and organisational and environmental factors. a theoretical background of ce and entrepreneurial intensity (ei) will be provided. the research methodology will be presented, followed by a discussion of the results. finally, the managerial implications and opportunities for further research will be highlighted. 2 importance of the research in south africa, the innovation imperative is emphasised by intensified competition, national policy and the growth of e-business innovations and the importance of the ict sector (see scheepers, 2005; department of science and technology, 2004; paterson, 2005). the importance of this research can be attributed to the existence of these three factors. firstly, despite increased competition in the ‘new’ economy, too many enterprises still offer their customers similar, ‘me too’ products. inadequate competitor differentiation takes place while the majority of companies fail to use the latest technology to gain a sustainable competitive advantage (scheepers, 2005; minniti, bygrave & autio, 2005). this lack of innovation could lead to the obsolescence of products. for example, dvd technology is fast replacing the video recorder, and digital cameras are taking the place of photographic film cameras. lack of innovation could lead even to the decline of an industry, as in the case of the south african textile industry (jafta, 2003). secondly, the national macroeconomic strategy on growth, employment and redistribution (1996) and the white paper on science and technology (1996) emphasise that south africa has to develop sustainable economic growth, improve its international competitiveness and build its capacity for innovation if it is to overcome some of the economic challenges facing the country. in the new globalised economy, the management of technology, innovation and information has emerged as a key requirement for success in the 21st century. a sound scientific and technological basis from which wealth-creating innovations and applications can develop is therefore essential for improving economic growth in south africa (department of science and technology, 2004; national research foundation, 2004). thirdly, the information and communication technology (ict) sector has been identified in the national research and development strategy as one of the ‘leading sectors’ in innovation and economic growth (mbeki, 2002: 1). the industry is expected to show growth rates in excess of 10 per cent in the next three years (economist intelligence unit survey, 2005). annual innovations within this industry are reported in the e-business handbook (paterson, 2005). these innovations are elaborated on in concrete and practical terms, but it appears that limited attention has been given to the ce process that takes place in turning ideas into innovations. the entrepreneurial practices, applied to e-business of two company groups, were compared. the two groups were the ict companies and companies listed on the jse (excluding ict listings). both groups of companies have participated in the annual e-business survey for over four years and are aware of innovation practices. they also face the pressures of intensified competition and the innovation imperative (paterson, 2005; department of science & technology, 2004). 240 sajems ns 10 (2007) no 2 3 literature review / background c o r p o r a t e e n t r e p r e n e u r s h i p ( c e ) a n d entrepreneurial intensity (ei) have been emphasised by academics and in the popular literature as essential survival strategies for businesses in the new economy (planting, 2004; wiklund, 1999; zahra & garvis, 2000; goosen, 2002). but to what, exactly, do the terms ce and ei refer? and what are the main company characteristics and organisational and environmental factors that influence entrepreneurial behaviour in enterprises? this section will explain the term corporate entrepreneurial intensity and subsequently analyse some of the factors that influence entrepreneurial behaviour in enterprises. 3.1 explaining corporate entrepreneurial intensity (cei) the term corporate entrepreneurial intensity (cei) was created by combining two related terms, corporate entrepreneurship (ce) and entrepreneurial intensity (ei). generally, ce refers to the development of new business ideas and opportunities within large, established corporations (birkinshaw, 2003: 3). a number of different terms have been used to describe this type of entrepreneurship, such as corporate entrepreneurship (zahra, 1993; dess, lumpkin & mcgee, 1999), corporate venturing (von hippel, 1977; altman & zacharakis, 2003), intrapreneuring (pinchot iii, 1985; antoncic & hisrich, 2001; goosen, 2002), internal corporate entrepreneurship (burgelman, 1984), internal entrepreneurship (vesper, 1984), strategic renewal (guth & ginsberg, 1990) and venturing (hornsby, naffziger, kuratko & montagno, 1993). in most cases, corporate entrepreneurship describes the total process whereby established enterprises act in an innovative, risk-taking and proactive manner (zahra, 1993; dess et al., 1999; bouchard, 2001). this behaviour has various outcomes. an outcome may be a new product, service, process or business development. it may be ‘new’ organisations created as ‘spin-out ventures’ (hornsby et al., 1993; altman & zacharakis, 2003) or it may involve the restructuring and strategic renewal within an existing enterprise (volberda, baden-fuller & van den bosch, 2001). ce is a multi-dimensional phenomenon. corporate venturing, intrapreneurship and strategic renewal are therefore different components of ce (hisrich & peters, 2002: 46; covin & slevin, 1989). where corporate venturing focuses on the creation of new businesses within or outside the existing enterprise, intrapreneurship focuses on the individual who drives the entrepreneurial process. strategic renewal involves strategy reformulation, reorganisation and organisational change leading to new combinations of resources, often resulting in competitive advantage (zahra, 1993). in this article, the authors propose that ce be seen as a process through which both formal and informal creative activities are encouraged and intangible resources are managed. in addition, ce aims to create new products, services, processes and businesses to improve and sustain a company’s competitive position and financial performance. since ce is a process, it should not be seen as a single event, but rather as part of the organisational culture of an enterprise. the level of entrepreneurship will vary in intensity, depending on changes in the culture. the popular view held among scholars is that the variable nature of entrepreneurship can be measured in terms of entrepreneurial orientation (eo) (barringer & bluedorn, 1999; kreiser, marino & weaver, 2002). entrepreneurial orientation consists of three sub-dimensions: innovativeness, risk-taking and proactiveness. however, because morris and sexton (1996) regard ‘entrepreneurial orientation’ as a one-dimensional view of the entrepreneurship phenomenon, they added another dimension, namely frequency of entrepreneurship, and called this phenomenon entrepreneurial intensity (ei). these authors tested ei empirically as a two-dimensional construct. they argue that ei is a function of the degree and frequency of entrepreneurship as shown in figure 1 (morris & sexton, 1996: 7). frequency of entrepreneurship refers to the number of times an enterprise acts sajems ns 10 (2007) no 2 241 entrepreneurially (for example, in developing new products or processes), while the degree of entrepreneurship, similar to eo, is measured by three sub-dimensions: innovativeness, risktaking, and proactiveness. source: morris and sexton, 1996:7 figure 1 the variable nature of entrepreneurship the first sub-dimension of the degree of entrepreneurship, namely innovativeness, refers to the creation of new products, services and technologies. the second sub-dimension, risk taking, involves the willingness to commit significant resources to opportunities with a reasonable chance of costly failure. these risks are typically calculated and manageable. the third sub-dimension, proactiveness, reflects top management orientation to pursuing enhanced competitiveness, and includes initiative, competitive aggressiveness and boldness (morris, 1998). antoncic and hisrich (2001: 198499) support morris and sexton’s (1996: 7) view that ei is a function of degree and frequency of entrepreneurship. conversely, other authors question the fact of three dimensions to measure the degree of entrepreneurship (eo). lumpkin and dess (1996) argue that five dimensions should be used to measure eo, namely autonomy, competitive aggressiveness, proactiveness, innovativeness and risk-taking. in contrast to these views, this article argues for a view of autonomy as an internal condition that influences the organisational climate. competitive aggressiveness forms part of the proactiveness sub-dimension. other researchers support this view (morris, allen, schindehutte & avila, 2006; kreiser et al., 2002). the term corporate entrepreneurial intensity refers to the variable nature of entrepreneurship within an established enterprise. as shown in figure 1, various positions of ei are possible, as different scores can be obtained on the frequency and degree axes of entrepreneurship (see figure 1). before these dimensions are critically analysed, it is important to acknowledge that theorists’ understanding of cei is in its infancy. very little empirical work focusing on entrepreneurial intensity specifically has been done in this area (eg morris & sexton, 1996; barringer & bluedorn, 1999). morris and kuratko (2002) argue that different norms of cei should exist between industries. cei is expected to differ among departments, divisions, units and geographical areas within the same company. it is also unclear whether high levels of cei are sustainable. in addition, the influence of environmental and organisational factors on cei is not clear. this article addresses some of these issues. 242 sajems ns 10 (2007) no 2 3.2 factors influencing corporate entrepreneurial intensity (cei) the cei of an enterprise is influenced by a number of factors, as shown in figure 2. this article examines the company characteristics, and organisational and environmental factors that impact on cei within enterprises in the target population. 3.2.1 company characteristics in this study the following characteristics were measured: group, size and age of companies. size was measured as the number of full-time employees per company. age was measured using years in existence, while the two main sub-groups were jse and ict companies, as discussed in the introduction. 3.2.2 organisational factors ce researchers have measured and analysed a number of organisational factors influencing cei (see covin & slevin, 1991; damanpour, 1991; zahra, 1991, 1993, 1995; zahra & covin, 1995; hornsby, kuratko & zahra, 2002; goosen, 2002). these factors both individually and in combination affect the organisational climate that moulds managers’ and employees’ attitudes towards, and interest in ce efforts (kuratko, montagno & hornsby, 1990). as shown in figure 2, hornsby et al. (2002) added to the work of other authors and identified a set of organisational factors that are consistent throughout the literature in the field. these factors are management support for ce, work discretion and autonomy of workers, the reward system, the availability of time and organisational boundaries. based on extensive research in the field, hornsby et al. (2002) developed and refined the corporate entrepreneurship assessment instrument (ceai) to measure the five factors identified in figure 2. adapted from covin & slevin (1991); zahra (1993); hornsby et al. (1993) and hornsby et al. (2002) figure 2 a proposed model of corporate entrepreneurship the first factor, management support, captures the encouragement and willingness of managers to facilitate entrepreneurial activity within an enterprise. although a company’s strategy has a pervasive influence on its entrepreneurial efforts, strategy in this article is measured by its implementation, that is, management support for innovation. autonomy refers to sajems ns 10 (2007) no 2 243 employees’ discretion and the extent to which they are empowered to make decisions on the performance of their own work in the way they believe is most effective. rewards and reinforcement develop individuals’ motivation to engage in innovative behaviour. innovative organisations are characterised by their provision of rewards subject to performance, offering challenges, increasing responsibilities and making the ideas of innovative people known to others in the organisational hierarchy (kuratko & hodgetts, 2004). resource availability seems best represented by time availability. i n e n t r e p r e n e u r i a l w o r k e n v i r o n m e n t s , employees are permitted to conduct creative, entrepreneurial experiments in a limited portion of their working time. finally, a supportive organisational structure, in which low perceived divisions exist among different departments or functions, encourages ce (morris, 1998; russell & russell, 1992; lumpkin & dess, 1996; goosen, 2002). a supportive organisational climate for ce will therefore be characterised by management support, appropriate rewards, workers who enjoy autonomy, time availability and flexible organisational boundaries between departments. organisational factors are not the only dimension influencing cei; environmental factors also play a role. 3.2.3 environmental factors the business environment poses challenges and offers new opportunities to companies. in response, companies may initiate innovative strategies or develop entrepreneurial products (services, processes or businesses) to capitalise on opportunities (zahra, 1991). managers’ perceptions of the environment influence the strategic choices made (zahra, nielson & bogner, 1999). measuring managers’ perceptions of the nature of the environment in south africa is a complex task, because most empirical research on this phenomenon has been completed in developed countries, while south africa is still a developing country (dess & rasheed, 1991; zahra, 1991, 1993). when the research reported on in this article was being conducted, no cross-cultural validated research instrument was available. this research therefore measured three sub-dimensions of the environment that theoretically influence cei, namely dynamism, hostility and heterogeneity. this was in line with the work of researchers in developed countries, as shown in figure 2. dynamism can be defined as the perceived instability of an enterprise’s market, because of the rate, unpredictability and persistence of change in its external environment (zahra, 1993; anderson, 2005; lumpkin & dess, 2001). hostility refers to unfavourable environmental changes, which create threats to a company’s mission. hostility arises from several sources like radical industry changes, new legislative requirements placed on an industry, or intensified competition (zahra & garvis, 2000; lumpkin & dess, 2001). heterogeneity refers to the complexity of a company’s business environment because of the multiple market segments it serves (dess & beard, 1984). dynamic environments create opportunities for companies to act more entrepreneurially. hostile environments create threats, which may force a company to respond in innovative ways to minimise threats. heterogeneous environments compel companies to develop entrepreneurial plans to cope with environmental complexity (zahra, 1991). thus, in dynamic, hostile and heterogeneous environments, it is anticipated that cei will be higher. 4 research methodology against the backdrop of the literature review provided, it is expected that cei will be influenced by not only the organisational climate within an enterprise, but also factors in the internal and external environments. the following hypotheses were tested: h 1 : a statistically significant relationship exists between frequency and degree of entrepreneurship. h 2 : company characteristics influence corporate entrepreneurial intensity (cei). h 3 : c o m p a n y c h a r a c t e r i s t i c s i n f l u e n c e organisational factors supporting cei. h 4 : c o m p a n y c h a r a c t e r i s t i c s i n f l u e n c e environmental factors supporting cei. 244 sajems ns 10 (2007) no 2 the company characteristics referred to in the hypotheses are size, age and group (jse or ict companies). the purpose of this quantitative study was to compare the e-business cei of jse and ict companies. a cross-sectional survey design consisting of two phases was used: a pilot study to test the measuring instrument and the administration of the telephone survey. the target population consisted of two groups: jse-listed; and ict-listed and non-listed companies. ict-listed companies were grouped with ict non-listed companies for the purpose of statistical analysis. the reasons for choosing these two groups were discussed in section 2. jse companies were identified by referring to the register of all listed jse operating companies at the end of 2004. the database obtained from it web in may 2005 (it web, 2005) was used to identify ict companies. the final population consisted of 715 companies. the key respondent targeted in jse-listed companies was the information technology (it) manager or the chief information officer (cio), on account of their knowledge of e-business innovations, while the chief executive officer (ceo) or sales manager was the target respondent from ict companies. thus a methodology similar to that of the annual e-business survey was followed. during the pilot study, data was collected by using a questionnaire and conducting personal interviews with the middleand seniorlevel managers of 41 companies in the gauteng area. the data of the pilot study was used to determine whether questions were clear and understandable, and how much time it would take to complete the questionnaire. the results of the pilot study determined the refinement of the questionnaire. a telephone survey was conducted from august to october 2005. a total of 315 respondents participated in the survey, providing a response rate of 44 per cent. data was captured electronically during the interview. a measuring instrument was developed to measure cei, company characteristics, and the organisational and environmental factors that influence the cei within south african enterprises. in order to ensure the validity and reliability of the measuring instrument, it was essential to define the key dimensions clearly. items from existing measuring instruments that had proved reliable and valid in previous research studies were used where possible. these were enhanced by questions formulated by the researcher, and based on the literature to ensure that each variable in the measuring instrument was represented by at least three items. useful existing research instruments were the entrepreneurial performance index (epi) of morris and sexton (1996); the entrescale (kwandwalla, 1977; miller & friesen, 1983; covin & slevin, 1989; knight, 1997); zahra’s ce scale (1991, 1993, 1995) and the corporate entrepreneurship assessment instrument (ceai) of hornsby, kuratko and montagno (1999). cronbach alpha coefficients were computed and used to assess the internal consistency of the measuring instrument on responses obtained from the pilot study. where coefficients were lower than 0.6, dimensions were reworded and adapted before the new items in the telephone survey were tested. a nine-point likert scale was used to record the responses during the telephone survey. dimensions measured were frequency and degree of entrepreneurship, and organisational and environmental factors. the estimated cronbach alpha co-efficients for the dimensions frequency, degree of entrepreneurship and organisational factors were 0.79, 0.66 and 0.70 respectively. these coefficients would appear to satisfy nunally’s (1978) suggested minimum criterion for internal reliability. coefficients lower than 0.5 are regarded as questionable, coefficients close to 0.70 as acceptable and coefficients of 0.80 as good (sekaran, 1992:174). as the estimated cronbach alpha coefficient for environmental factors was 0.16, it was excluded from further analysis. statsoft, inc (2005) was used to conduct the statistical analysis. the following descriptive statistics were used for the initial descriptive analysis: mean, median, standard deviation and coefficient of variance. significant differences and correlations were used to compare the two groups and to test the hypotheses. sajems ns 10 (2007) no 2 245 5 results corporate characteristics and a descriptive analysis are presented in this section. thereafter the comparative analyses of specific dimensions will be discussed. 5.1 corporate characteristics of respondents the corporate characteristics of the respondents are discussed in terms of the three variables: group, size and age. more jse companies (61 per cent) participated in the survey than did the 39 per cent of ict companies. the size and age of companies participating in the survey are shown in figure 3. the number of permanent employees determined company size. respondents’ answers were categorised into eight ‘size’ categories, as shown in figure 3. the largest category (35 per cent) includes companies with 1-99 employees. however, when all the categories with above 200 employees (usually seen as large companies) are taken into account, it adds up to 56 per cent of the respondents. figure 3 size and age of companies companies were also categorised according to their age, that is, years of existence. respondents’ answers were categorised into six categories as shown in figure 3. the largest group of respondents (37 per cent) falls into the category 7-15 years of age. companies younger than seven years include 18 per cent of the respondents, while companies older than 15 years amounted to 45 per cent. it should also be noted that only 2 per cent (7 out of 302 companies) were younger than three years. 5.2 descriptive analysis of the dimensions a descriptive analysis of the dimensions was conducted as part of an exploratory approach to analysis of the data. a profile of the respondents participating in the study is shown in table 1, using the mean, standard deviation and coefficient of variance. 246 sajems ns 10 (2007) no 2 table 1 descriptive statistics of constructs construct / dimension n mean average percentage standard deviation coefficient of variance frequency 230 22.95 64% 5.18 22.57% degree of entrepreneurship 315 16.75 62% 3.92 23.40% organisational factors 315 30.85 69% 4.71 15.27% environmental factors 315 15.00 56% 2.71 18.07% respondents answered all the questions pertaining to the degree of entrepreneurship, organisational factors and environmental factors, but only 230 respondents answered all the questions pertaining to frequency. because a company can show varying activity levels in product and/or service and/or process and/or business development, only 230 companies were active on all four of these frequency levels. all the questions were measured on a nine-point scale. the mean of frequency was calculated from four constructs, the degree of entrepreneurship from three, the organisational factors from five and the environmental factors from three. the standard deviation shows how the observations are spread around the mean. the coefficient of variance describes how large the measure of dispersion is relative to the mean of the observations among different random variables. from table 1 it can be derived that observations of respondents on the frequency and degree of entrepreneurship are spread in a pattern similar to each other, while observations on organisational and environmental factors show a similar common dispersion pattern. opinions of respondents on the frequency and degree of entrepreneurship differ from the views of respondents on organisational and environmental factors. a reason for this could be that organisational and environmental factors, as shown in figure 2, are antecedents to the entrepreneurial process. depending on an enterprise’s combination of organisational and environmental factors, various different positions in terms of ei are thus possible. 5.3 comparative analyses in this section the aim is to determine whether certain key variables are significantly associated, and furthermore whether certain sub-groups are significantly different. correlations among certain variables were calculated, and the fstatistic and p-values were used to determine whether the differences among groups were significant. the focus is on the following specific dimensions:  corporate entrepreneurial intensity (ie frequency and degree of entrepreneurship),  company characteristics (sector, age, size) and cei, and  organisational factors. an assumption inherent to the cei concept is that a direct relationship exists between frequency and degree of entrepreneurship. figure 4 shows a scatterplot where the strength of the association between frequency and degree of entrepreneurship is illustrated. a positive linear relationship exists between frequency and degree of entrepreneurship at the 99 per cent significance level (r=0.375; p<0.01). sajems ns 10 (2007) no 2 247 figure 4 scatterplot of frequency and degree of entrepreneurship 5.3.1 company characteristics in table 2, the mean scores of each sub-group and the associated 95 per cent confidence intervals, f-tests and probability values are shown. there was a significant difference between jse and ict companies regarding their corporate entrepreneurial intensity (cei) at the 5 per cent significance level. the mean for cei is calculated by summating the degree and frequency scores, each measured on a nine-point scale. the mean score for the jse companies was 11.10, with a lower limit of 10.73 and an upper limit of 11.47. however, the score of the ict companies as a group was higher, with a mean score of 11.68, and a lower limit of 11.26 and upper limit of 12.11. table 2 groups compared: cei and organisational factors groups compared mean 95% confidence limit f test p value jse cei vs ict cei f = 4.13 0.043* jse cei 11.10 10.73 – 11.47 ict cei 11.68 11.26 – 12.11 jse vs ict frequency f = 0.02 0.88 jse frequency 5.71 5.48 – 5.94 ict frequency 5.73 5.47 – 6.00 jse vs ict – degree f = 11.88 0.001** jse degree 5.35 5.17 – 5.53 ict degree 5.87 5.64 – 6.10 jse vs ict – organisational factors f = 5.58 0.019* jse organisational factors 6.08 5.95 – 6.22 ict organisational factors 6.34 6.17 – 6.52 * significant p<0.05 ** significant p<0.01 248 sajems ns 10 (2007) no 2 the jse companies’ mean score on the frequency dimension was 5.71, while the ict mean score was 5.73. the difference between the means of the two groups was not statistically significant (p = 0.88, thus p>0.05). the statistically significant difference between the two groups becomes clear when the degree of entrepreneurship is examined. a significant difference existed between jse and ict companies (p<0.01) regarding the degree of entrepreneurship. the score of the jse companies, as a group, was 5.35, while ict companies’ score was higher at 5.87, as can be seen in figure 5. table 2 shows that, as could be expected (from the degree of entrepreneurship), significant differences existed between jse and ict companies regarding the organisational factors influencing cei. jse companies scored 6.08, while ict companies scored higher, at 6.35. 5.3.2 the influence of company size on corporate entrepreneurial intensity no statistically significant correlation existed between company size, measured by the number of employees, organisational factors and cei or its sub-dimensions: frequency and degree of entrepreneurship (see table 3). goosen (2002) supports this finding, confirming that, within south african companies, company size does not have an influence on the levels of entrepreneurship. table 3 company size: comparison cei and organisational factors company size compared: correlation p-value company size vs cei r = 0.08 0.26 company size vs frequency r = 0.09 0.19 company size vs degree r = –0.01 0.82 company size vs organisational factors r = –0.03 0.63 * significant p<0.05 ** significant p<0.01 vertical bars denote 0.95 confidence intervals figure 5 box plot: jse and ict companies, compared in terms of degree of entrepreneurship sajems ns 10 (2007) no 2 249 5.3.3 the influence of company age on corporate entrepreneurial intensity an assessment of the relationship between company age, cei and organisational factors gives rise to several interesting observations. table 4 indicates that company age has a poor negative correlation with cei. the negative correlation between company age and frequency was not significant. however, company age and degree of entrepreneurship showed a negative correlation that was significant at the 1 per cent level (p<0.01). furthermore, a negative correlation also existed between company age and organisational factors at the 5 per cent level (p<0.05). table 4 company age: comparison cei and organisational factors company age compared: correlation p value company age vs cei r = –0.13 0.07 company age vs frequency r = –0.03 0.64 company age vs degree r = –0.20 0.00** company age vs organisational factors r = –0.12 0.03* * significant p<0.05 ** significant p<0.01 if significant differences in the degree of entrepreneurship and the organisational factors existed, the next question that arose was whether there were significant differences between the various categories of age groupings regarding the dependent and independent variables. table 5 aims to answer this question by showing the various age classifications, the mean scores obtained relative to cei, the frequency and degree of entrepreneurship and the organisational factors. table 5 company age: comparison cei and organisational factors age classifications n cei frequency degree organisational factors younger than 3 yrs 7 11.27 5.27 6.00 5.77 3-6 yrs 46 11.88 5.80 6.03 6.40 7-15 yrs 107 11.25 5.66 5.53 6.29 16-25 yrs 38 11.72 5.89 5.77 6.16 26-49 yrs 37 11.24 5.80 5.36 6.09 50+ yrs 56 10.89 5.60 5.12 5.99 f statistic 1.03 0.36 3.19 1.66 p value 0.40 0.88 0.01* 0.15 * significant p<0.05 ** significant p<0.01 note: the p-values and f statistics representing the various age classifications show whether significant statistical differences exist regarding cei, frequency, degree and organisational factors. 250 sajems ns 10 (2007) no 2 as can be seen in table 5, there were no significant differences among the various age classifications regarding cei and frequency. however, when the degree of entrepreneurship was analysed, there were seen to be significant differences between the various age classifications (p<0.05). the findings suggest that as companies grow older the degree of entrepreneurship declines. it may be possible to postulate that younger companies’ policies, procedures and routines are not formalised and that employees solve problems as they arise. these solutions may sometimes be unconventional and more creative, compared with those of older companies, where formal policies and procedures may guide more bureaucratic decision-making. when company age was correlated with the organisational factors, the probability value indicated that the differences in the age groupings were not statistically significant. the findings may be distorted because only seven companies among the respondents had been operating for fewer than three years; another analysis that excluded these seven companies was therefore carried out. the results, shown in figure 7, suggest that, in terms of organisational factors, differences between the age classifications of companies were not statistically significant (p = 0.16). however, a declining trend is discernible. in other words, as companies increase in age, the internal organisational factors become less supportive of entrepreneurship. 6 discussion of results the discussion of results in this section will focus on the relationship between frequency and degree of entrepreneurship and the influence of company characteristics on corporate entrepreneurial intensity, organisational factors and environmental factors. first, a statistically significant relationship was found between the frequency and degree of entrepreneurship. by implication, the number of times an enterprise acts entrepreneurially is related to the degree of risk-taking, innovativeness and proactiveness. morris and kuratko (2002) argue that enterprises should engage in a number of entrepreneurial projects and experiment with various projects, in other words, they should increase the frequency of figure 7 companies older than three years vs organisational factors sajems ns 10 (2007) no 2 251 entrepreneurship. the work of zahra (1993), covin and slevin (1991) and kreiser et al. (2002) is consistent with the argument by morris and kuratko (2002). all these authors focus on growth orientation as the defining characteristic of ce. in other words, growth implies repeated entrepreneurial acts. firms producing a single entrepreneurial business, such as a single invention over a long period of time, are thus not considered particularly entrepreneurial. rather, a continued effort to develop new products, services, markets and processes, amongst other things, is indicative of a highly entrepreneurial enterprise. secondly, the results, presented in section 5, indicate that cei is influenced by certain c o m p a n y c h a r a c t e r i s t i c s . t h e c o m p a n y characteristics used to differentiate among the companies were group, size and age. in a comparison of ict and jse companies, the results show that ict companies are more entrepreneurial than jse companies (excluding ict-listed companies). one reason for the difference between them may thus be the fact that they operate in different industry conditions with different requirements for success. in the case of jse companies, shareholders may value stability, while ict companies need to focus on immediate accommodation of changing market conditions. a further reason may be that there are different cei norms for different industries, as argued by morris and kuratko (2002). size as a company characteristic does not influence ei, but age does. the older the companies, the less entrepreneurial they become. this could be ascribed to policies and routines being formalised and entrenched as companies mature, with the result that employees tend to follow the ‘rules’ and do not act innovatively. furthermore, the implication of this finding is that cei as a new, separate concept does not exist. the entrepreneurial behaviour of both small and large companies varies in intensity, so size cannot be used to distinguish between different types of entrepreneurial intensity. the term ei captures the variable nature of the entrepreneurship phenomenon, which presents itself in different contexts (large and small companies). thirdly, statistically significant differences exist between jse and ict companies when organisational factors are compared. the organisational climate of ict companies appears to be more supportive of entrepreneurial behaviour than it does in jse companies. in other words, in ict companies there appears to be more support for ce from management. rewards to encourage ce are in place, flexible organisational boundaries exist, time to solve problems in an entrepreneurial manner is available, and employees enjoy greater autonomy in comparison to those in jse companies. the reason for this may be that the target respondent interviewed in ict companies is an active problem-solver serving customer needs, while the jse companies may see e-business as a support function and are themselves the customers. from a customer’s point of view, the service provider is often expected to be more innovative than the customer. however, when company size and organisational factors are compared, no correlation is found between the two concepts. a negative, but statistically significant relationship exists between company age and organisational factors. in other words, it is not size that matters, but age. the older an enterprise becomes, the less supportive the organisational climate becomes for entrepreneurship. finally, although no direct relationship was found between frequency of entrepreneurship and company characteristics, frequency does indirectly affect ei, because a positive correlation exists between frequency and degree of entrepreneurship. as discussed at the beginning of this section, a company’s orientation towards growth and continual focus on developing new products, services, processes and businesses, are indicative of higher levels of the degree of entrepreneurship. 7 further research although the study had certain limitations, for example, one respondent per company, a singular focus on e-business and the inability to measure external factors, several avenues 252 sajems ns 10 (2007) no 2 for further research exist. avenues with both practical and academic relevance are identified below.  this article reports on a study in which a large-scale empirical survey was conducted, comparing two different company groups. it appears that few surveys focusing on the entrepreneurial intensity of a large number of companies have been conducted in south africa. resource limitations allowed for data collection of only one respondent per company. it is suggested that further research triangulate the views of one respondent with secondary sources, or that multiple respondents per company be involved.  because ce is such a comprehensive topic, the focus of the broader study was on ebusiness. this being the case, caution should be exercised in generalising the findings. future research should test them across sectors, company size and age. longitudinal surveys should also be conducted to ascertain whether high levels of entrepreneurial intensity are sustainable over time.  a reliable measuring instrument should be developed to measure the environmental factors and determine which environmental conditions are conducive to ce. the interaction between the organisational climate and environmental conditions is also an avenue of research that would add value for managers. findings in this regard would enable managers to assess their internal and external environments and use these assessments as input for their strategic processes. 8 conclusion the purpose of this study was to compare the e-business entrepreneurial intensity of jse and ict companies. company characteristics, organisational factors and environmental factors were compared. the findings support the literature to a great extent. it has been confirmed that ei varies among different industries or company groups. ict companies are more entrepreneurial than jse companies. the reasons for this might be that e-business impacts the main operations of ict companies, while jse companies may view e-business only as a support function. the organisational factors that support ei are linked to the level of entrepreneurship within companies. the organisational climate of ict companies is more supportive of entrepreneurial behaviour than that of jse companies. the managerial implication is that jse companies that aim to become more innovative and entrepreneurial ought to develop management support for ce, implement ce rewards, allow their employees greater autonomy and time to work on creative solutions and bring employees from different parts of the company together. the theoretical advance offered by this article is two-fold. first, different industries or groups of companies differ in terms of ei. this finding addresses one of the gaps in the ce field identified by morris and kuratko (2002). further research should aim to develop norms within specific industries for appropriate levels of ei. secondly, this article contributes to understanding the role of organisational factors. the fact that the organisational climates of ict companies are more supportive of ei implies that support for ce, rewards, time availability, flexible organisational boundaries and autonomy of employees are important factors if a company wishes to develop entrepreneurially. interestingly, the findings presented in this article show that it is not the size of companies that matters, but age. as companies grow older and become more established, their degree of entrepreneurship declines. as companies’ age and their problem-solving approaches, policies and procedures become part of routine and they are recorded, they tend to solve problems habitually and not in an entrepreneurial manner. additionally, the implication of this finding is that cei, as a new, separate concept, does not exist. the term corporate entrepreneurial intensity is inappropriate. the term ei captures 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(1999) “ce, knowledge, and competence development”, entrepreneurship theory and practice, spring: 169-189. references about the author(s) kim l.a. viljoen department of business management, faculty of management and commerce, university of fort hare, east london, south africa citation viljoen, k.l.a., 2022, ‘netnography: an underapplied research method’, south african journal of economic and management sciences 25(1), a4891. https://doi.org/10.4102/sajems.v25i1.4891 editorial netnography: an underapplied research method kim l.a. viljoen copyright: © 2022. the author licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. boundary-crossing has become a distinctive feature of disciplines as composition scholars continue to bravely cross borders into other disciplines to deepen understandings of–and take risks with–methodologies that may not be familiar. indeed, the ubiquity of social media has destabilized our traditional methods for studying communication, leaving many researchers to wonder, what methods are most appropriate for studying the contested and shifting spaces of online communities? (covington 2019, n.p.) as researchers, we are constantly looking for new information and breakthrough methodologies to improve and progress our disciplines. netnography, for those who are not yet aware of it, is such a breakthrough – providing the access to and analysis of a wealth of information that has never been accessible. specifically taking marketing academics into consideration, netnography provides an open window into consumer’s lives. although it has been used extensively in western countries for close to three decades, it is fairly new to south african scholars. netnographic research only started to surface in south africa just under 10 years ago. over a 100 papers across different disciplines have since been published, with a marked increase in the last 4 years. the research conducted is diverse and has ranged from analysing the online content of the #feesmustfall movement to predicting the outcome of municipal elections. there have also been multiple marketing research papers using netnography with topics ranging from analysing consumer behaviour online to examining how organisations interact with their target markets in social media spaces. plain old sentiment analysis is no longer enough, it needs to be accompanied by explanations of online trends and patterns and why consumers feel the way they do about products, brands and organisations. robert kozinets, coined the term ‘netnography’ in 1995, and first used it to analyse online content in relation to the star trek movies. from there he went onto becoming prolific in his research domain, with an average ih-index of 95 with over 40 000 citations across his publications. kozinets et al. (2010) defines netnography as ‘an adaptation of ethnography for the online world, which is concerned with the study of online content, cultures, and communities as distinct social phenomena, rather than isolated content’. he continues by stating that it is a particularly good method to examine the relationship between online and offline actions. for those who may be rusty in using ethnography, or who have never used it at all, it is often used by anthropologists to examine the behaviour of people, society, and culture in their everyday lives. fast forward 30 years, organisations and people now have online customs and carry out their businesses and lives online. consider for a moment that there are nearly 2 billion websites, with over 5 billion internet users, and this number is growing (statista 2022). as the global population grows, so does our electronic footprint, with large amounts of data and information being generated on social media and organisations’ websites – and it all exists in the public domain. this means it is freely accessible to be analysed and transformed into something meaningful. the opportunities this presents for researcher are endless and by no means discipline specific. a fundamental question for researchers is what is netnography? is it a paradigm? a design? an approach? or a data collection method? is the information gathered on websites and on social media classified as primary or secondary data? the ethical researcher would go further, and ask how ethical it is to follow, document and analyse what organisations and people are doing and saying online. none of these are easy questions, but as scholars we are required to apply our minds to the answers. to answer the question ‘what is it?’ in essence it is a three-pronged qualitative data collection method; researchers can either collect online information directly, or they gather data generated through the capture and recording of online community events and interactions or lastly, it can be data the researcher sketches as field notes (kozinets et al. 2010). interested scholars might find costello, mcdermott and wallace’s (2017) discussion of the history of netnography an essential reading, it provides a rich explanation of the journey scientists have been on over the last decade to accurately capture the multi-dimensionality of the concept. even kozinets himself has evolved his definition over the years and continues to evolve and refine the method, continually adding new dimensions to it. with respect to the question of whether netnographic data is primary or secondary one might assume that since it already exists and is available for use, it is secondary data. although understandable, this assumption doesn’t take the whole picture into account. the fact is that although data may already be there, it is raw and has not yet been turned into anything meaningful – which fundamentally means it is primary data. this is still up for debate of course, as is so much in research and dependent on the given parameters of a specific research project. being an ethical researcher requires that we also apply our minds to the ethics of research in the online space, which adds an entirely new dimension to ethical research practices. of course, all the traditional ethical standards in research apply, taking the helsinki declaration and belmont principles into account. further online ethical considerations are highlighted in cilliers and viljoen (2021) and are premised upon the argument of what is in the private domain versus the public domain. generally, if the data is freely available online, then the owner of the data cannot expect privacy. with respect to social media, the onus is on the users to protect their information, because it too is otherwise freely available to be viewed by anyone. with netnographic research in mind, scholars also need to engage with the protection of privacy of information (popi) act, to ensure that any data collection and reporting methods are both ethical and lawful. having answered these and other methodological questions, it is useful to consider what is the fundamental value of bringing this topic up now? what scholarly value does it hold for management academics? as we emerge into a new post covid world, we have seen huge and lasting changes in the way people work and connect. management scientists cannot be left behind online, and social media research is here to stay, and it is not just for anthropologists. the plethora of data available online knows no boundaries and in the future may not continue to exist in its current state. this is a something that requires reflection and action by researchers. references cilliers, l. & viljoen, k., 2021, ‘a framework of ethical issues to consider when conducting internet-based research’, south african journal of information management 23(1) https://doi.org/10.4102/sajim.v23i1.1215 costello, l., mcdermott, m. & wallace, r., 2017, ‘netnography: range of practices, misperceptions, and missed opportunities’, international journal of qualitative methods 16. https://doi.org/10.1177/1609406917700647 covington, b., 2019, ‘a review of netnography: redefined by robert kozinets’, enculturation journal 28, n.p. kozinets, r.v., valck, k., wojnicki, a. & wilner, s., 2010, ‘networked narratives: understanding word-of-mouth marketing in online communities’, journal of marketing 74. statista, 2022, data published by statista research department on 20 september 2022, viewed 06 october 2022, from https://www.statista.com/statistics. abstract introduction and background problem statement research objective and research methodology the south african income tax implications international comparison conclusion acknowledgements references about the author(s) annelize oosthuizen school of accountancy, faculty of economic and management sciences, university of the free state, bloemfontein, south africa citation oosthuizen, a., 2022, ‘tax: the pac-man of funding received from the crowd’, south african journal of economic and management sciences 25(1), a4703. https://doi.org/10.4102/sajems.v25i1.4703 research note tax: the pac-man of funding received from the crowd annelize oosthuizen received: 02 june 2022; accepted: 07 oct. 2022; published: 08 dec. 2022 copyright: © 2022. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract small businesses often struggle to get funding due to the lack of collateral. alternative funding, such as crowdfunding, became increasingly popular after the financial crisis in 2008. the objective of the study was to determine if funding, received by businesses from alternative sources of funding, is subject to income tax in south africa. a legal doctrinal research approach was applied by reviewing available literature, tax legislation and relevant case law in south africa, the united states of america, united kingdom and australia. it was determined that existing income tax provisions do not specifically refer to crowdfunding and principles laid down in decided tax case law need to be considered to determine if the amount received, is a gift made out of pure generosity. the amount is likely not to fall within the ambit of ‘gross income’ of the project owner if the donor expected nothing in return and the funding was not used by the project owner to supplement trading activities. with reward-based crowdfunding, the funding is highly likely to fall within the ambit of gross income since something is expected in return for the funding provided to the business. it is imperative that south africa issues application guidance to reflect the intended meaning of the legislature regarding the tax treatment of funding received by project owners. contribution: this article demonstrated that it is imperative that south africa issues application guidance to reflect the intended meaning of the legislature regarding the tax treatment of funding received by project owners. keywords: alternative funding; crowdfunding; donation-based crowdfunding; funding; reward-based crowdfunding; tax. introduction and background small businesses struggle to get funding (bradford 2012; cosh, cumming & hughes 2009; shadrach-razzino, chetty & pick 2017). it is also no secret that one of the reasons for the difficulty to get funding from traditional sources (such as banks), is the lack of collateral that new and upcoming businesses often suffer (cosh et al. 2009; lee, sameen & cowling 2015). many are forced to turn to other sources of funding such as crowdfunding. the principle of crowdfunding is not new. in essence, any donation to a cause can be seen as funding provided by the crowd (i.e. the public). however, the internet has created an opportunity for an intermediary platform to facilitate this process and to make it open to any member of the public to provide funding to a project (belleflamme, lambert & schwienbacher 2014). crowdfunding is therefore defined as: [a]n open call, mostly through the internet, for the provision of financial resources either in the form of donation or in exchange for the future product or for some form of reward to support initiatives for specific purposes. (belleflamme et al. 2014:588) with crowdfunding, the project owner creates the project for which funding is required on the crowdfunding platform. funders are then requested to provide funding. the funding amounts are deposited into the bank account given on the platform and are transferred to the owner of the project once the stated goal amount has been reached (depending on the terms and conditions explained on the platform). there are four main crowdfunding models which are classified according to what the funder receives in exchange for funding provided: donation-, reward-, debtand equity-based crowdfunding. with donation-based crowdfunding, the donations are paid to the project owner without providing anything in return to the funders (other than maybe recognition) (bradford 2012; li, wang & yue 2015). with reward-based crowdfunding, the project owner provides something (such as the product that they want to sell) in return for the funding received, other than interest (which is debt-based crowdfunding) or shares (which is equity-based crowdfunding) (bradford 2012). according to belleflamme, omrani and peitz (2015) and dietz (2013), it is not always easy to distinguish between donationand reward-based crowdfunding since simply mentioning the funder’s name can be seen as a reward (advertising). debt-based crowdfunding is the provision of a loan by the different funders so the funders receive interest (if charged at all) on the loan amounts (hemer 2011). with equity-based crowdfunding, the funders receive a combination of shares and voting rights and consequently dividends on their investment (hemer 2011). in contrast to a bank where you do not have control over to whom your savings are loaned, the decision as to whom you want to donate or provide money to, lies solely with the funder. problem statement although the concept of crowdfunding through an internet platform is relatively new, crowdfunding is growing. in south africa, backabuddy (a donation-based crowdfunding platform) raised r162 002 743 as at 21 april 2020. this increased to r348 406 228 as at 22 august 2022 which is an increase of 115%. similarly, during this period the funding raised by jumpstarter (a reward-based crowdfunding platform) increased from r581 420 to r1 198 633 (with 106%). thundafund (a reward-based crowdfunding platform that originated in south africa but moved their administrative functions to kenya) increased from $3 240 657 to $5 040 657 (with 55%). although many researchers focus on the advantages, disadvantages and psychological aspects of crowdfunding, one aspect that is often ignored, is the tax implications of such funding received. concerns have been raised globally about the uncertainty of these tax implications (brandon 2015; dietrich & amrein 2016; rudarakanchana 2013). furthermore, since any person (regardless of their education, background and demographics) can create a project that needs funding on the platform, the project owner might not even be aware of, or consider, the tax implications. this could lead to adverse tax implications such as less after-tax funding, as well as penalties and interest imposed by tax legislation for non-compliance. this can have far-reaching consequences, which might lead to unexpected tax consequences for the taxpayer and a loss to the fiscus if taxpayers do not comply with income tax legislation. research objective and research methodology the objective of the study is to determine if funding received from alternative sources of funding, such as crowdfunding, is subject to income tax in south africa for the project owner (i.e. the business) who received the funding. applicable taxes include, amongst others, income tax, capital gains tax and value-added tax. however, this study focusses only on the income tax consequences. the study is therefore limited to only the provisions of the income tax act 58 of 1962 of south africa (hereafter referred to as the ita) (south africa 1962) dealing with funding received and not on other tax legislation, such as value-added tax (vat). donations tax is furthermore not addressed in detail since it has implications to the funder and not the project owner. through applying a doctrinal legal research approach, the south african income tax implications and case law principles were firstly explored. this was then extended to explore principles applied in the united states of america (usa), the united kingdom (uk) and australia for comparative perspectives to provide additional weight to the recommendations for law reform (hutchinson 2012). since crowdfunding makes use of the internet which eliminates boundaries as to who can participate, it was deemed appropriate to also investigate the income tax implications in other countries. the reason for selecting the specific countries is that the usa is seen as the leader of the market of crowdfunding business (de beer 2014). the usa-based crowdfunding platform kickstarter is mostly referred to in research (such as dietz 2013; ganatra 2016; koch & siering 2015; rudarakanchana 2013) whereas the uk is one of the first countries to provide specific tax incentives for crowdfunding. furthermore, south african income tax law has much in common with australia, in terms of the origins of its tax law, being reliant on legislation from new south wales at that time (harris 2016). although the laws of these countries are not enforceable in south africa, the income tax treatment of crowdfunding in these jurisdictions has persuasive value. the south african income tax implications funding received by the owner of the project, is taxable in south africa if the amount falls within the definition of gross income in section 1 of the ita. gross income in the case of a resident is the total amount, in cash or otherwise, received by, or accrued to, or in favour of such a resident. a non-resident is taxed in south africa only if such a amount was from a south african source. it is not gross income if the amount is of a capital nature. furthermore, the amount received might be specifically exempt from being subject to tax. it follows that, if the project owner is for example a public benefit organisation, or a small business funding entity, the funding received will not be taxed if it complies with the requirements of being exempt as determined in section 10(1)(cn) and section 10(1)(cq) respectively. however, with crowdfunding that is being used by entrepreneurs to create businesses, the project owners will not be a qualifying exempt entity since the entrepreneurial entities will not comply with the provisions contained in sections 30(1) and 30c(1) to be qualifying entities. the funding received will, therefore, only be excluded from the ambit of gross income if the receipts are of a capital nature. if the funding is received from the disposal of an asset by the project owner, there might be consequences regarding capital gains tax. however, this is unlikely since funding is normally not received from the crowd because of the disposal of an asset by the project owner. with debt-based crowdfunding, the amounts received by the project owner are repayable and are therefore not the disposal of an asset. similarly with equity-based crowdfunding, the funding is provided through purchasing shares in the company which are of a capital nature and not a disposal for capital gains purposes (in terms of paragraph 11(2)(b) of the eighth schedule of the ita). the main uncertainty is therefore with the donationand reward-based crowdfunding models in order to determine if the funding received is of a capital nature or not. the ita does not contain a specific provision stating that a donation is excluded from gross income since it is always of a capital nature. it is therefore important to explore principles laid down in decided case law. limited case law is available in south africa that applies to the tax implications of funding received, since most case law, dealing with whether a receipt is of a capital nature or not, dealt with the proceeds from the disposal of an underlying asset. it was held in commissioner for inland revenue v lunnon [1924] a.d. 94; 1 satc 7 that a gratuity that was paid to a former director to compensate him for services rendered in previous years on the board of directors (when the compensation that was paid during those years was not in line with the value of his services rendered), was of a capital nature and not taxable as gross income. the court stated that: now this gift had none of the attributes of income; it was not produced by the respondent’s capital, nor was it earned by his labour or his wits or in any other way. there was no recurrence about it. what was sometimes called annuality was not necessarily a decisive test as to whether a receipt or accrual was capital or income; but it was an important element to be taken into consideration. and in the present instance it was wholly absent. this grant was a fortuitous addition to the capital of the recipient, and it appeared to his lordship to be of a capital nature, like any ordinary donation or legacy. (lunnon [1924] a.d. 94 at 9) the amount received was therefore not taxed since it was determined that it was not produced through services rendered (his labour) and was fortuitous. the gross income definition was subsequently amended with the addition of a specific inclusion provision (paragraph [c]) which determines that an amount constitutes gross income if it was received or accrued in respect of services rendered. with reference to this addition to the gross income definition of the ita, the court stated in itc 599 [1945] 14 satc 272(u) at 273 that: it may perhaps be relevant to detail how that section came to be passed. in the ordinary case where there is an accrual or gift for which no liability rests on the donor to pay, it may be fairly assumed to be an accrual of a capital nature although i do not know of any express decision that crisply decides that point. it is therefore evident that the receipt will be of a capital nature if the donation was made out of free will and the donor was not under an obligation to pay the amount. the court found similarly in itc 1545 [1992] 54 satc 464(c) at 476 that ‘a payment or disposal of property which is motivated by self-interest or some reason other than “liberality and generosity” is not “gratuitous” and is therefore not a donation’. it therefore follows by applying the principle in itc 599 [1945] already mentioned that, if funding is received from a donor who has an obligation to pay, it is not a receipt of a capital in nature. when a donation is made solely out of pure generosity for charitable purposes, it is clear that the funding will not be included in the definition of gross income. this is because the donor was under no obligation to pay the amount and the funder is under no obligation to provide something in return. the amount was paid out of pure generosity. however, if a donation is made to a business which requested funding in order to fund business operations or to be utilised for the creation of a product to be sold, it is more complex. if a reward is offered in return for the funding, the funder provides the funding in anticipation of the reward. the funding is therefore not provided out of pure generosity and the project owner is under an obligation to provide the reward. it can therefore be said that the funding provided in such a case is motivated by self-interest of the funder (such as the acquisition of the product [the reward] or some reason other than pure and sole generosity as referred to in itc 154 [1992] mentioned before). furthermore, since the project owner is a business, which will utilise the funding to fund its business operations, it will have a profit-motive. it was held in commissioner for inland revenue v pick ’n pay employee share scheme purchase trust [1992] 54 satc 271(a) that whether a business was operated with the intention of producing a profit, determined if the proceeds from operations qualified as revenue. additionally, it was determined in that case that receipts that were entirely fortuitous and not anticipated or worked for, did not qualify as receipts of a revenue kind and did not meet the criteria for gross income. when a business uses reward-based crowdfunding, a reward (whether a product, service, or a marketing opportunity for the funder) is received by the funder for funding provided to the project owner. with many such projects, the funding provided is merely a prepayment for the acquisition of the ultimate product that is being created by the project owner and for which funding is requested. the funding is therefore used by the project owner to create the underlying trading stock for the business. it will consequently be more difficult to argue that such funding received was of a capital nature and is therefore not subject to tax for the project owner who received the funds. international comparison it was determined that the income tax legislation in the usa, uk and australia also do not contain specific, explicit sections dealing with the tax consequences of the receipt of funding from crowdfunding by the project owner. tax incentives are available in the uk and australia for funders of debtand equity crowdfunding. the focus of this study is, however, on the receipt of funding by the project owner. such funding received are also taxed based on existing principles laid down by case-law in the usa, uk and australia. case law and other principles were investigated to provide further guidance in these countries. united states irc §102(a) of the internal revenue code (irc) (usa 1986) determines that the value of property acquired by gift, bequest, devise, or inheritance is not gross income. the court case of commissioner of internal revenue v glenshaw glass co, [1955] 348 u.s. 426, is frequently cited and provides that income is ‘undeniable accessions to wealth … over which the taxpayers have complete dominion’. since the definition is very broad, it is possible that funding received through crowdfunding might be taxed, depending on the type of crowdfunding transaction. it follows that, if the funding provided is classified as a gift (i.e. a donation) as determined in irc §102(a), the amount so received, is not gross income. it is therefore paramount to determine if the amount received is a gift or not. similar to the principle laid down in the south african case itc 599 [1945] referred to (that it is a gift if there is no obligation to make the payment), it was held in bogardus v commissioner of internal revenue, [1937] 302 u.s. 34. at 41 that it is not a gift if the payment was made from the ‘constraining force of any moral or legal duty’. however, it was held in old colony trust company et al. v commissioner of internal revenue, [1929] 279 u.s. 716 that, even if there is not a moral or legal requirement for a person to make a payment, it does not mean it is a gift: a claim that it is a gift presents the sole and simple question whether its designation as such is genuine or fictitious – that is to say, whether, though called a gift, it is in reality compensation. (bogardus v. commissioner of internal revenue [1937] at 40) other factors therefore also need to be considered. if the payment was not made for services rendered, but made ‘out of affection, respect, admiration, charity or like impulses’, it is a gift (robertson v united states [1952] 343 u.s. 711 at 714). a gift is proceeds from a ‘detached and disinterested generosity’ (commissioner of internal revenue v lobue, [1956] 351 u.s. 243 at 246.) based on the above principles, it is again evident that it will be very difficult to argue that funding received through reward-based crowdfunding will be a gift since something is received in return for the funding provided. it was held in bogardus v commissioner of internal revenue [1937] at 45 that ‘what controls is the intention with which payment, however voluntary, has been made’. it was determined that it is not a gift if the payment was made because of the ‘incentive of an anticipated benefit’ of an economic nature (bogardus v commissioner of internal revenue [1937] at 41) and ‘where the payment is in return for services rendered, it is irrelevant that the donor derives no economic benefit from it’ (robertson v united states [1952] at 714). it follows that, similar to in south africa, an amount will fall within the ambit of gross income if something (such as a product or a service) was received in return for the funding provided. through studying the usa platform kickstarter, dietz (2013) determined that the platform accommodates both donations and/or rewards-based crowdfunding. this hybrid model complicates differentiation between what is a gift and what is a sale. project owners may receive donations that are taxable (if viewed as regular sales transactions) or contributions that are viewed as non-taxable gifts (dietz 2013). gifts will qualify for the gift exclusion in irc §102(a). to provide some guidance, the irs issued information letter 2016-0036 stating that: […c]rowdfunding revenues are generally included in income if they are not 1) loans that must be repaid, 2) capital contributed to an entity in exchange for an equity interest in the entity, or 3) gifts made out of detached generosity and without any ‘quid pro quo’. however, a voluntary transfer without a ‘quid pro quo’ is not necessarily a gift for federal income tax purposes. in addition, crowdfunding revenues must generally be included in income to the extent they are received for services rendered or are gains from the sale of property. (department of treasury internal revenue service 2016:1–2) these principles are in alignment with the discussion of south african income tax principles mentioned when it was determined that funding received from debt-based and equity-based crowdfunding is not included in gross income. where funding is received in anticipation of a reward to be provided to the funder, the funding is not a donation and is more likely to fall within the ambit of gross income. united kingdom in terms of the income tax (trading and other income) act 2005, profits received or accrued from trading is subject to income tax (part 2 chapter 1, section 5 and section 8) (united kingdom 2005). the question of whether a voluntary receipt was a trading receipt and taxable, was the subject in numerous judicial cases in the uk. it was held that a gift was not a trading receipt if it ‘was wholly unexpected and unsolicited’, ‘was made after the business connection had ceased’, ‘was in recognition for past services rendered … though not because those past services were considered to have been inadequately remunerated’, ‘was made as consolation for the fact that the services were no longer to be performed’, or if there was ‘no suggestion that at a future date the business connection might be renewed’ (in simpson (inspector of taxes) v reynolds & co (insurances) ltd ca, [1975] 1 w.l.r. 617 at 619 (confirmed later in walker (inspector of taxes) v carnaby, harrower, barham & pykett, [1970] 1 all er 502). in mcgowan (inspector of taxes) v brown and another, [1977] 1 w.l.r. 1403 the court determined that even if the payment was voluntary, it is taxable if it was earned (i.e. work was done in exchange for the gift, creating a moral or legal obligation to pay). it was determined in commissioner of inland revenue v falkirk ice rink ltd, [1975] stc 434 that, given that the donation received, was utilised to boost the ice rink club’s trading revenue and allow the business to carry on its operations, the donation was considered a trading receipt. in murray (inspector of taxes) v goodhews ca, [1977] 1 w.l.r. 499 (1978) it was noted that the decision to tax a receipt should be made based on the recipient’s intentions, not the payer’s. based on the aforementioned guidelines, which state that the recipient’s motivation should be taken into account, it would seem that funding given voluntarily to a project owner may be subject to taxation as income when received in a business capacity, because the money is used to finance commercial activities. another issue is concerned with at what time the funding received should be taxed. in lunar missions ltd [2018] tc 06286, the court had to determine the time of supply for vat purposes. whether the monies were liable to vat upon receipt of payment, was the question at hand. since it was unknown at the time the money was received, what (if anything) would be supplied, it was decided that the funds received did not constitute prepayments. whether something would be supplied depended on whether or not the funding goal was achieved. it was decided that the funders were supplied with single-purpose vouchers that awarded them the right to receive a single type of service. the time of supply for vat purposes was determined to be when the vouchers were issued and not when they were redeemed, since they were classified as single-purpose face-value vouchers. despite the fact that vat is not included in the scope of this study, the findings of the previous decided case provide guidance as to when an amount might become subject to income tax for the project owner. it might be argued that the funding received from reward-based crowdfunding is not subject to income tax until the funding goal is achieved. for income tax purposes, a sale does not occur until the funding goal is achieved and therefore no amount is received or accrued in terms of the gross income definition. if the funding is only made available to the project owner by the crowdfunding platform once the funding goal is achieved, the project owner cannot be said to have received the funding before then, for his or her own benefit (as referred to in geldenhuys v commissioner for inland revenue [1947] (3) sa 256 [c] for purposes of the ita of south africa). this does not indicate that the money will not be subject to tax, as shown by the court cases mentioned before when it must be further determined whether the amount is of a capital nature or not. australia chapter 1 part 13 section 6–1 of division 6 of the income tax assessment act 1997 of australia determines that income is subject to tax if it is ‘assessable income’ (australian government 1997). assessable income comprises ordinary income (section 6–5) and statutory income (section 6–10) (australian government 1997). a gift is normally of a capital nature and therefore not assessable income. however, if there is a link between the activities of the taxpayer and the gift, it will be income if the gift is in a relevant sense a product of the activities (scott v federal commissioner of taxation [1966] 117 clr 514; hayes v federal commissioner of taxation [1956] 96 clr 55, 56). funding received, can therefore be accessible income if it can be related and linked to the business activities of the person that received the funding. this is applicable when the funding received from the crowd is being used by businesses as discussed above. it was held in federal commissioner of taxation v montgomery [1999] 198 clr 639 that: [i]ncome is often (but not always) a product of exploitation of capital; income is often (but not always) recurrent or periodical; receipts from carrying on a business are mostly (but not always) income. there are four positive characteristics of income as expressed in decided in case law: first, income is a gain; second, income is a flow that comes in to a taxpayer; third, there is a difference between income and capital; and most significantly, there must be an income-earning activity, such as the provision of services or carrying on a business. (martin & o’connell 2018:18) conclusion to ascertain the tax repercussions of donationand reward-based crowdfunding in south africa, the usa, uk and australia, existing income tax law provisions and principles laid down by the courts should be applied. within the current income tax legislation of the selected countries, it was evident that funding received, will be subject to tax unless it is of a capital nature, being a donation or a gift. since what constitutes a donation or a gift is not conclusively defined, numerous court cases have provided principles that need to be considered. the main issue with donation-based crowdfunding is to determine if the funding was provided to the project owner without expecting anything in return. if something was expected in return, it appears that the funding received might not be regarded as a receipt of a capital nature. furthermore, if there is a connection between the funding and the taxpayer’s business activities, it appears that the income is likely to be of a revenue nature. this will be the case when the funding received from donationand reward-based crowdfunding is used to supplement trading revenue and/or to fund business activities. by being subject to income tax, the available funding to be used by the project owner (the business) is minimised. this is in contradiction with the south african government’s aim to assist small businesses. provisions dealing with small business funding entities, as well as venture capital companies (vccs) were enacted to promote the creation of small business. however, these provisions predate the rise in popularity of crowdfunding and are not applicable to it. crowdfunding democratises access to investments through allowing any person (regardless of their demographics etc.) to invest directly in an upcoming business and not through another entity, which is the case with small business funding entities and vccs. although most of the principles discussed in this article are in essence the same in all countries, case law decided in one country, is not law in another country. uncertainty about the tax implications of crowdfunding is increased with limited available case law in south africa on funding received (and none dealing specifically with crowdfunding). it is imperative that application guidance is issued by south africa to reflect the intended meaning of the legislature regarding the tax treatment of funding received by project owners. further research is also needed on other tax consequences of crowdfunding, such as the vat, as well as on the tax implications for the funder. acknowledgements competing interests the author has declared that no competing interest exists. author’s contributions i declare that i am the sole author of this research article. ethical considerations this article followed all ethical standards for research without direct contact with human or animal subjects. funding information this research received no specific grant from any funding agency in the public, commercial or not-for-profit sectors. data availability data sharing is not applicable to this article as no new data were created or analysed in this study. disclaimer the views and opinions expressed in this article are those of the author and do not necessarily reflect the official policy or position of any affiliated agency of the author. references australian government, 1997, income tax assessment act, viewed 24 april 2019, from https://www.legislation.gov.au/details/c2020c00381. backabuddy, n.d., viewed 22 august 2022, from https://www.backabuddy.co.za/. belleflamme, p., lambert, t. & schwienbacher, a., 2014, ‘crowdfunding: tapping the right crowd’, journal of business venturing 29(5), 585–609. https://doi.org/10.1016/j.jbusvent.2013.07.003 belleflamme, p., omrani, n. & peitz, m., 2015, ‘the economics of crowdfunding platforms’, information economics and policy 33, 11–28. https://doi.org/10.1016/j.infoecopol.2015.08.003 bogardus v commissioner of internal revenue, [1937] 302 u.s. 34. bradford, c.s., 2012, ‘crowdfunding and the federal securities law’, columbia business law review 2012(150), 1916184. brandon, g., 2015, ‘taxation and crowdfunding – the start’, taxation in australia 49(8), 446–449, viewed 08 march 2017, from http://web.b.ebscohost.com/ehost/pdfviewer/pdfviewer?vid=12&sid=31dd676c-9682-489f-9dbf-317342d9b6f2%40sessionmgr103&hid=115. commissioner of inland revenue v falkirk ice rink ltd, [1975] stc 434. commissioner for inland revenue v pick ’n pay employee share purchase trust, [1992] 54 satc 271(a). commissioner for inland revenue v lunnon, [1924] a.d 94; 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accepted: 17 nov. 2022; published: 23 feb. 2023 copyright: © 2023. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: companies are increasingly encouraged to focus on the creation of sustainable value. financial research institutions evaluate companies’ performance based on pre-established indicators relating to environmental, social and governance (esg). these scores are intended to inform decisions by equity investors, among others. however, traditional asset pricing models do not include esg scores. aim: the purpose of this research is to discover whether the inclusion of esg scores in the fama-french five-factor model (ff5f) will improve the model’s predicting power. setting: financial research institutions aim to improve the information environment in the south african capital markets. johannesburg stock exchange (jse)-listed firms are also required to produce integrated reports, emphasising responsible investment. method: for the largest 40 jse-listed companies, data over the 5-year period from 2015 to 2019 were employed to compare the predicting power of the ff5f model before and after the inclusion of esg scores. results: the results showed that the predictive power of the ff5f model is only marginally improved when the esg scores are incorporated. conclusion: these findings indicate that equity returns are not significantly influenced by esg scores. this research provides the basis for further endeavours on the share-price implications of esg performance. contribution: this research contributes to the growing strand of literature on responsible investment and the creation of sustainable value. the research also offers a theoretical contribution by connecting literature on asset pricing with work on sustainability. keywords: esg; esg performance scores; sustainability; fama-french; jse; asset pricing; esg performance. introduction on september 2015, the united nations (un) launched the un sustainability development goals (sdgs). for the world to meet the sdgs and related sustainability agenda by 2030, participation and commitment is needed from all spheres (united nations 2015). there have also been attempts by the investment community to build a more sustainable future. as a result, there is greater pressure from stakeholders and society at large for business entities to focus equally on the social and environmental concerns that affect their business – a concept commonly referred to as ‘the triple bottom line’, as coined by elkington (1997). there has also been a growing need for a universal, uniform set of standards for measurement and reporting on environmental, social and governance (esg) performance – just as for financial performance (harvard business review 2022). fortunately, in recent years, regulators have also intensified their responses to these global cries. for example, the european union released its sustainable finance action plan, which came into effect over the course of 2021. this major piece of regulation is aimed at promoting sustainable investment by clarifying the revised and increased roles and duties asset managers and investors now have in relation to the sustainability agenda. asset pricing theory can be used in the positive and in the normative context. when observing the pricing of assets in the market, a position could be taken to try to understand the actual pricing behaviour of the assets and conclusions be formed around why the pricing of assets behaves in the way that it does, and should the observation not agree with a developed asset pricing model, a stance could be taken that the model needs improvement. this is an example of the positive use of asset pricing models and how they are typically applied in academic spaces. alternatively, a stance could be taken that the market is incorrect and therefore ‘mis-pricing’ the asset. this could present trading opportunities for investors (cochrane 2009). thus, asset pricing models, although theoretically founded, could be useful tools for shrewd investors. however, although international and south african studies generally accepted the fama and french (2015) five-factor model as an improvement to both the original capital asset pricing model (capm) and the fama and french (1992) three-factor model (charteris, rwishema & chidede 2018; cox & britten 2019; fama & french 2016), it still failed to fully explain the expected returns as observed on international markets and the johannesburg stock exchange (jse) (alrabadi & alrabadi 2018; chiah, zhong & li 2016). therefore, given the failure of the fama–french five-factor model (ff5f) to fully explain stock performance, there may be scope to improve this model by incorporating an additional risk factor (chiah et al. 2016). motivated by the increasing importance of, and focus on, esg by investors and academics at large, this research proposes that this additional factor may be an esg factor, measured by esg performance scores. this research provides initial empirical evidence of whether the inclusion of esg scores in the ff5f improves the model’s predicting power of expected returns. the purpose of the research is to investigate whether the inclusion of esg scores will improve the explanatory power of the ff5f in predicting expected returns. its aim is not to evaluate the significance levels of the relationship of each of the factors in the ff5f in the context of returns on the jse. nor does the research seek to empirically test the validity of the five-factor model as a whole in explaining expected returns. rather, as in fama and french (2015) and cox and britten (2019), it investigates whether the explanatory power of the ff5f model is improved by the inclusion of esg scores. theoretical background the capital asset pricing model the seminal work by markowitz (1952) on portfolio selection theory laid the foundations for modern portfolio theory. it provided a framework for the creation of investment portfolios based on mean-variance analysis. the theories are based on the assumptions of rationality and risk preferences of investors. the notion of portfolio return being a function of market and firm-specific risk factors precipitated the creation of various asset pricing models. the capm, as developed by treynor (1961), sharpe (1964), lintner (1965), mossin (1966) and black et al., jensen and scholes (1972), was the first coherent framework for evaluating the effect of risk factors on the price of assets (perold 2004). the capm modelled the return of an asset as a function of systematic risk and idiosyncratic risk. the former risk is the undiversifiable risk that is faced by all investors resulting from macro-economic and political factors. the latter type of risk, that is, idiosyncratic risk, is born out of firm-specific factors attached to that share. the capm has enjoyed a great deal of popularity, both academically and in practice. it is frequently the only asset pricing model taught in most undergraduate and postgraduate finance classes. in addition to this, it is heavily used by portfolio managers and investors for a host of reasons, including estimating the cost of equity for listed securities, selection of investment projects, evaluating the performance of mutual funds and other portfolios (fama & french 2004) and for the purposes of performing valuations. despite the popularity of the capm, there is empirical evidence that challenges its ability to fully explain returns (banz 1981; bhandari 1988; fama & french 1992). one of the most prominent earlier studies to challenge the empirical validity of the capm was that of basu (1977). the objective of the basu (1977) research was to empirically research whether the investment performance of common stocks was related to their price-to-earnings ratios (hereafter p/e ratios). he found that when the stocks were sorted on p/e ratios, the stocks with higher p/e displayed higher expected future returns than what was predicted by the capm. banz (1981) also highlighted problems linked with the use of the capm. the study showed that the common stock of small firms, on average, outperformed that of larger firms; that is, smaller firms displayed higher average risk-adjusted returns, relative to larger firms – a concept commonly referred to as the ‘size effect’. despite these findings, it was not until fama and french (1992) that research challenging the role of beta and the capm gained traction. they examined the size and book-to-market anomalies that were discovered by prior literature and confirmed the empirical shortcomings of the capm. their study found that the combination of the size and book-to-market equity absorbed the role of market beta in explaining cross-sectional returns. the fama–french three-factor model having noted the empirical contradictions of the capm in explaining expected returns (see banz 1981; basu 1977), fama and french (1992, 1993) extended the capm to a three-factor model that captured the value and size premium in addition to the contribution of the excess market return. size (measured by market capitalisation) and book-to-market equity (the value effect) had been found to capture the cross-section of average returns that were often associated with size, leverage and book-to-market equity in earlier literature. notably, size and book-to-market ratios proxied underlying asset risks rather than mere anomalies (fama & french 1992). the fama–french five-factor model the ff5f was developed in fama and french (2015) with the aim of improving on some of the empirical failings of the fama–french three-factor model (ff3f), given that the model was found to not adequately capture cross-section returns. the ff5f is therefore an extension of the ff3f, with fama and french (2015) adding an investment and profitability factor to the model in an attempt to address the empirical embarrassment of the ff3f. the ff5f is specified as: where α, rf, bi(rm – rf), sismb, hi hmlt and ε are defined as can be seen in the ff3f; r and c represent the loadings on the respective profitability and investment factors, and rmw and cma represent the respective profitability and investment factors. fama and french (2015) studied companies listed in the new york stock exchange (nyse), national association of securities dealers automated quotations (nasdaq) and american stock exchange (amex) from july 1963 to december 2013. from testing the ff5f in numerous sorts, they found that the ff5f showed an improvement in explaining expected returns when compared to the ff3f, as it produced lower intercepts. fama and french (2015), however, found that there was very little difference between their ff5f and a four-factor model that excluded the hml factor. this suggested that the hml factor was superfluous in the dataset, as the hml associated returns were already captured by the other factors. in addition to this, they found that their model mispriced small stocks that had negative exposures to the profitability and investment factors. in response, fama and french (2016) considered anomalies that were not addressed by the ff3f, such as accruals, net share issues, momentum and volatility. their results showed that with the exception of accruals and momentum, the list of anomalies left unexplained by the ff3f shrink when the ff5f is used. in south africa, charteris et al. (2018) sought to investigate whether the alternative three-factor model formulated by chen, novy-marx and zhang (2011) and a ff5f could explain momentum on the jse. the results of the study indicated that the capm, ff3f and the carhart (1997) four-factor model could not explain the momentum of past returns on the south african market. on the contrary, for the models that included the investment and profitability factors as pricing factors, as in chen et al. (2011) and the ff5f, charteris et al. (2018) found that the pricing errors were significantly lower than was observed for the capm and the classical ff3f. profitability was found to be significantly and positively related to returns, with investment displaying a weaker relation to momentum than profitability. hypothesis development it is apparent from the prior literature that the cycle of model development, empirical testing in context and model redevelopment is likely to continue in future asset pricing research endeavours. in developing the study hypothesis, the authors therefore evaluated recent applications of asset pricing models in a south african context. empirical testing of asset pricing models on the jse includes tests of the capm (for example, ward & muller 2012), the ff3f model (for example, basiewicz & auret 2010) and the ff5f model (cox & britten 2019). since ward and muller (2012) confirmed the findings of van rensburg and robertson (2003) that returns of jse-listed shares showed an inverse relationship with beta, subsequent research has found that the addition of factors tended to enhance the accuracy of returns predicted by the models. notably, cox and britten (2019) found that the ff5f, on an overall basis, explained the cross-section of returns on the jse with greater accuracy than the ff3f. yet, despite the ff5f accounting for the highest number of risk factors, recent empirical tests show that the model still has shortcomings in explaining returns of jse-listed stocks (mosoeu & kodongo 2020). the authors therefore use the ff5f as a base model and consider whether the model’s predictability will be enhanced through the inclusion of additional factors. the hypothesis is developed from literature that suggests the potential explanatory power of sustainability-related metrics for returns on the jse. there is a rapidly growing strand of literature that focuses on the relationship between sustainability and stock returns. yet the empirical evidence from studies, much like that of asset pricing models, tends to be inconsistent. griffin and mahon (1997) suggest that this may be caused by variations in methodology and the choice of measurement approximations. for search endeavours that, like this study, use stock returns as a measure of financial performance, three categories were identified by wagner, schaltegger and wehrmeyer (2001), these being: portfolio studies, event studies and multivariate regression studies. maiti (2021) investigated the durability of the esg factor in a portfolio study. having formed portfolios based on the individual esg components’ risk factors, maiti (2021) results found evidence of an esg risk factor at a significant level of 5%. in an event study, capelle-blancard and petit (2019) investigated the stock market’s reaction to both positive and negative esg news for 100 firms listed on the dow jones. it was found that, on average, firms faced a drop of 0.1% of their market value following negative esg publicity but gained nothing from positive publicity. moreover, the authors found that investors have a stronger response to media reports than communication from the companies themselves and even nongovernmental organisation (ngo) disclosures. lastly, some studies utilise regression analysis to investigate the link between esg and financial performance. la torre et al. (2020) investigated how companies’ esg performance affected their returns. the results from the study indicated that although a correlation exists between the esg index and most stock returns, this correlation is weak and even absent for some firms. the statistical analyses also highlighted that the stock return effects arising from esg strategies are limited and may be concentrated to only some industries, for example, the energy and utilities sector, where operating activities are likely to have a high environmental and social impact. from an ideological standpoint, it can be argued that the utilisation of firm resources for sustainability objectives decreases shareholder value (derwall et al. 2005). the reasoning is that the costs involved in such pursuits, such as costs of abiding by additional standards, translate into higher operation and product costs, which erode competitive advantage and subsequently profitability (walley & whitehead 1994). there is evidence that indicates that investors may support this view. halbritter and dorfleitner (2015) and naffa and fain (2022) find no significant relationship between esg performance and stock returns. others believe that the improvement of a firm’s sustainability practices could enhance its operational efficiency or create new sales opportunities (derwall et al. 2005). for example, porter and van der linde (1995) argued that company policies that translate to improved sustainability practices could translate to cost and pricing advantages because of a more parsimonious utilisation of all forms of capital. it follows then that the benefits of sustainability-related practices should outweigh the costs, and firms that embrace this practice would be expected to report higher corporate earnings relative to less socially and environmentally responsible firms. however, the extent to which esg practices and policies translate to investment abnormal returns is a function of the ability of market participants to incorporate sustainability into their projections of future returns. from the review of asset pricing literature, it is apparent that market returns are proportionally related to underlying risk factors and that an ideal equity portfolio is one that is well-diversified. thus, following this reasoning, socially responsible investors should expect to report suboptimal returns, as their portfolios would inherently lack diversity, given that such portfolios are ordinarily grouped based on firm-specific characteristics – for example, esg scores. environmental, social and governance ratings and scores are used in most of the studies empirically testing sustainability performance effects on returns (alda 2020; derwall et al. 2005; eccles, ioannou & serafeim 2014; galema, plantinga & scholtens 2008; kempf & osthoff 2007; lee, faf & rekker 2013; statman & glushkov 2009). the benefit of using esg scores is that the sustainability effects on shares can be decoupled and the effect of each dimension analysed separately. this may have the added benefit of informing researchers and investors of the most critical elements of sustainability for particular firms – a concept referred to as esg materiality. most of the studies on the united states (us) market find esg performance to have a positive relationship with returns, with some studies finding that high esg firms significantly outperform low esg firms (derwall et al. 2005; eccles et al. 2014; galema et al. 2008; kempf & osthoff 2007; lee et al. 2013; statman & glushkov 2009). other studies find a significant positive relationship between specific elements of esg and returns: using esg scores, mǎnescu (2011) found that community relations criteria (social) displayed a significant positive influence on returns. galema et al. (2008) also found that the employee relations indicator (social) had a significant positive relationship with the stocks’ returns. based on empirical evidence from prior literature, this study hypothesises as follows: h1: the inclusion of an esg scores factor in the fama–french 5 factor model will improve the model’s predictability of returns. h0: the inclusion of an esg scores factor in the fama–french 5 factor model will not improve the model’s predictability of returns. methodology data given the goal of the study, the data analysis was structured in such a way that if the results of the research found that inclusion of esg scores improves the predicting power of the ff5f, this would support the researcher’s proposal to extend the ff5f into a possible six-factor model that will better predict returns on the jse. the researcher would achieve this goal by comparing the coefficient of determination (r-squared) of the existing five-factor model with the r-squared of the proposed six-factor model including esg scores. the sample consists of companies included on the jse top 40 index during the fiscal year end of 2015 to 2019, representing approximately 80% of the total market capitalisation of all companies listed on the jse. given the rampant effects of the coronavirus disease 2019 (covid-19) pandemic on financial markets, the researcher sought to exclude this period from analysis in the study as this may skew the results of the research. both esg combined score (esgcs) data and share price data were obtained from the refinitiv workspace database. one of the advantages of this is that the researcher was able to collect all the data needed for the research from one reputable source, and this adds to the reliability of the data and consistency in methodologies used in the calculation of key ratios. over the last 16 years, refinitiv’s esg performance scores have been used widely in academic research (berg et al. 2021). furthermore, for the purposes of managing esg investment risks, major asset managers, such as blackrock, have chosen refinitiv as their global esg data provider. refinitiv esg data has been also referenced in esg research conducted by the world economic forum (2020) and in an organisation for economic co-operation and development (oecd) report (berg et al. 2021). in reporting esg data, refinitiv makes use of percentile rank scores which range between 0 and 100, allowing empirical analysis. in addition, the database assigns letter grades (ranging from a+ to d-) to each company based on their performance. the conversion between these two scoring formats is shown in table 1-a1, found in the appendix 1. although some research relies on esg disclosure scores in their assessment of esg performance (gutsche, schulz & gratwohl 2017), this study utilised esg performance ratings data. environmental, social and governance disclosure scores are usually based on self-reported company information. on the contrary, esg performance scores use a variety of sources to evaluate a firm’s exposure to esg risk and how effectively it manages such risk. therefore, motivated by this, the research avoided the use of esg disclosure scores in favour of esg performance data in order to further improve the validity of the research. suitable for this objective, the esg scores provided by the refinitiv database provide a comprehensive evaluation of a firm’s sustainability impact and are prepared using verifiable data sourced from the public domain, such as company and ngo websites, regulatory reports, corporate social responsibility reports and media reports. the esg data is updated by refinitiv annually based on the company’s fiscal year and aligned with corporate reporting patterns. a combination of human and algorithmic processes is utilised, which includes independent audits, logical error checks and management reviews to ensure that data quality is as high as possible. the scores are based on the data available, account for notable industry performance measures and have minimal company size and transparency biases (refinitiv 2020). for the environmental component, issues surrounding the utilisation of resources, carbon emissions and operational innovativeness are considered. the social component considers the employees, human rights and community. the governance component considers factors around management, shareholders and corporate social responsibility strategy. these measures are then translated to a percentile-based score (ranging from 0 to 100) for each of the three pillars. the total esg score is a weighted sum of the scores for each pillar. the weights vary based on the industry for the environmental and social category, while weights for the environmental pillar vary based on the governance considerations as per the firm’s country of origin (refinitiv 2020). the environmental pillar score measures a firm’s performance in implementing best environmental practices to minimise environmental impact of operations and to take advantage of opportunities to generate environmentally sustainable value for stakeholders (refinitiv 2020). the social score reflects the impact of management practices on the well-being of its employees, customers and society (refinitiv 2020). finally, the governance score is an indication of the firm’s implementation of best practice policies that are designed to ensure that those charged with its governance act in the best interests of its long-term stakeholders (refinitiv 2020). the overall esg score is obtained by aggregating these pillar scores based on the 10 category weights. for the purposes of the research, a combined esg score was selected as a proxy for each respective company’s esg performance. the esgcs provides a balanced and thorough scoring of a company’s esg performance. the score is reliable as it overlays self-reported information with information on esg controversies from global media sources (refinitiv 2020). the primary goal of the score is to discount the esg performance score based on negative stories in the media, and this is done by incorporating the impact of significant and material esg controversies in the overall esgc score (refinitiv 2020). the controversy scoring is based on 23 esg controversy topics, such as anticompetition behaviour, child labour, wage controversies, strikes, taxation fraud reports and others. when the respective company has been involved in any such controversy, the score is calculated as a weighted average of the overall esg score and the esgc score per fiscal period, with the recent controversies impacting the score in the latest completed period. in the event that a company is not involved in such controversy, the esgc score is simply the overall esg score for that company (refinitiv 2020). given that larger firms tend to attract relatively more media attention than smaller firms, severity weights are applied when performing the controversy scoring. for example, a firm with a market capitalisation of less than 2 billion would receive a controversy weighting of a 100%, whereas a firm with a market capitalisation more than or equal to 10 bn would receive a weighting of only 33%. medium-sized firms, that is, those with a market capitalisation greater than or equal to 2 bn, but less than 10 bn, receive a weighting of 67%. analysis as this study used panel data in the form of annual returns and esg scores data of the jse top 40 companies from 2015 to 2019, a statistical ordinary least squares (ols) regression model along with the r statistics package (r foundation for statistical computing, vienna, austria) was relied upon for the analysis in this study. the use of statistical regression models has been extensive in seminal studies developing and empirically testing asset pricing models, with almost all of such studies relying on statistical regression models for attempts to determine the strength and character of the relationship between one or more independent variable(s) and expected returns. for this research, two regression models were used. one was the ff5f as it exists, with factors defined as they were developed by fama and french (2015). the other was a statistical regression model similar to the first, with the sole difference being the addition of an esg scores factor. it was specified as: where all the factors – save for the proposed esg factor – are defined and measured as per the ff5f above. the esg factor (lilemla) is defined as the return spread of stocks of esg leaders minus esg laggards. where esg leaders are those firms with high esg performance – as measured by esg performance scores – and esg laggards are those firms with low esg performance. the independent and dependent variables remain as per ff5f. the esg factor (lilemla) is an additional independent variable. in the context of this research, r-squared was a statistical measure of the proportion of variation in returns (the dependent variable) that is explained by the five and six factors (the independent variables) of the ff5f and the proposed six-factor model including the esg factor. therefore, it follows that should the r-squared of the proposed six-factor model have exceed that of the ff5f: the researcher will accept h1. in this instance, the researcher may then be able to conclude that the inclusion of esg scores in the ff5f would improve the model’s predictability of returns and therefore propose that the model be extended into a sixfactor model incorporating an esg scores factor. results this study was designed to investigate whether the inclusion of an esg scores factor in the ff5f would improve the model’s explanatory power of returns for shares on the jse. of the 40 companies that make up the jse top 40, the researcher was able to gather esg data, share price data and financial data for 38 of the jse top 40 companies. for prosus n.v. and pepkor holdings ltd, the researcher was unable to gather esg scores data because of data paucity for the 2015, 2016, 2017 and 2018 financial years for these two companies. this meant that the researcher could not use these companies in the regression analysis, and thus they have been excluded from further analysis. factoring in this exclusion, the market capitalisation of the sample captures 82.57% of the jse main board, which, for the purposes of this research, is sufficiently representative. regression results: fama-french five-factor table 1 presents descriptive statistics as well as the regression results for the ff5f model, excluding esg scores. table 1: regression results and descriptive statistics for the fama and french five-factor model. with the exception of profitability factor (rmw) and the investment factor (cma), all the factors provided results that are significant, at least at a 5% level. it can be inferred that despite there being a premium associated with firms that invest conservatively, the relationship is insignificant. these results are similar to those of cox and britten (2019). the market premium factor (rm-rf) provided the highest coefficient, with a positive premium of 2.004. following this was the value factor (hml), which provided a negative premium of -0.936, indicating an inverse relationship between portfolio returns, significant at a 1% level. this is contrary to the finding of cox and britten (2019) that high book-to-market (b/m) exhibit a greater premium compared to low b/m shares. both studies, however, show significance at the 1% level, with the hml having the strongest relationship with returns. this suggests the importance of the value factor in the south african market. the results of this study provide clear evidence of the size effect, as in mosoeu and kodongo (2020), because smb was significant at the 5% level. however, the positive coefficient is inconsistent with the results of mosoeu and kodongo (2020). these differences may be explained by the sample of firms that were analysed in each study. while the present study chose the largest firms on the jse, the prior study included the entire jse, including smaller firms. the profitability factor produced a positive coefficient of 0.215. however, this factor was insignificant. notably, the r-squared for the unadjusted ff5f model was 0.344. this suggests that ff5f and the factors chosen in this study do not sufficiently explain the returns for the majority of shares on the jse and are consistent with the findings of mosoeu and kodongo (2020). regression results: adjusted fama-french five-factor table 2 presents the factor summary statistic results for the six-factor model, including an esg scores factor. all variables are as defined in the ff5f, with the exception of the esg scores. table 2: regression results for the adjusted fama and french five-factor model (with environmental, social and governance score). the market premium factor also continues to show a high correlation with expected returns, producing a positive coefficient of 2.802, significant at a 10% level. the profitability factor and the investment factor both displayed positive correlation with expected returns of 0.322 and 0.241, respectively. the authors note that the size and profitability premiums increase in the six-factor model. this is similar to the results of cox and britten (2019), as their size and profitability premiums increased as they moved from a three-factor to a five-factor model. as expected, the results are largely consistent with those of the original ff5f model of this study, as shown in table 1. of particular interest is the correlation produced by the esg scores factor. this factor produced a negative correlation of 0.207. interestingly, this indicates that a negative relationship exists between the esg scores reported by jse-listed companies and their returns. this result, however, is not significant. the adjusted ff5f produced some correlation with jse expected returns; however, the direction of this correlation was surprising, as esg scores were seen to be inversely related to expected returns. similarly, employing panel regression on the jse over the 2012 to 2019 period, ball (2021) investigated the relationship between esg and corporate financial performance and during this period also found no statistically significant evidence of a relationship between the two. however, as the main objective of the research performed in this study is the investigation of the model itself, instead of individual factors, more importance will be placed on the model statistics results and the statistical significance thereof. notably, the r-squared for the ff5f model with esg scores was 0.352. this indicates that the inclusion of esg scores does, in fact, improve the predictability of the ff5f asset pricing model (r-squared of 0.344), although only marginally. a key delimitation of this study is that its primary purpose is not to empirically test the validity of the ff5f in explaining returns of jse-listed companies’ shares. instead, irrespective of the predicting power of the ff5f model as it stands, this study sought to investigate whether there is improvement in that predicting power through the inclusion of esg scores. therefore, although the above r-squared results from both models suggest that the models do not seem to capture most of the returns on the jse, the results are acceptable for the purpose of answering the research question and addressing the aim of the study. the null hypothesis of this study was that the inclusion of an esg score factor would not improve the predictive power of the ff5f model. based on the results discussed above, because the ftest of overall significance for the adjusted ff5f of 0.000000000176 is below alpha, that is, the significance level of 0.05, the null hypothesis is rejected in favour of the alternative hypothesis. therefore, inclusion of an esg scores factor to the ff5f results in a marginal improvement of the model’s predictability of expected returns on the jse. the results show that the inclusion of esg scores enhances the explanatory power of the ff5f. however, this was only a slight improvement. as such, it appears that sustainability-related factors do not materially influence investment decisions and that esg performance is not significantly priced by the market. conclusion this research presents a nexus of key areas of finance research – asset pricing and sustainable value creation. the aim of the research was to discover whether the inclusion of esg scores in an adjusted ff5f would improve the model’s predicting power of expected returns on the jse. it was found that although the adjusted ff5f captured more returns than the ff5f, there was only a slight improvement in the predicting power of the model. however, given the fast-growing interest and focus on esg in the world and the increase in sustainability-related regulation, the researcher suggests that this improvement in predicting power of the model is likely to grow as esg becomes more integrated in investments by investors. there is scope for further research on the addition of esg factors in the development of asset pricing models in the future, especially during and after the covid-19 period, which highlighted the importance of sustainability-related practices. furthermore, this research also forms a basis for further endeavours on the trade-off between esg aspects that is often required in the resource-constrained firm setting. this may be achieved by disaggregating the esg performance scores and analysing each in the context of firm and share price performance. furthermore, as esg scores tend to be subjective and dependent on the respective databases’ ratings approach, using data from other financial research institutions may also provide more insight on the relationship between esg scores and jse expected returns. lastly, the results of this research could be compared to the results of research that has used esg disclosure in integrated reports as a proxy for esg performance. acknowledgements competing interests the authors declare that they have no financial or personal relationship(s) that may have inappropriately influenced them in writing this article. authors’ contributions a.s. conceptualised the research topic, supervised the project and reviewed the first draft. l.n. collected the data and wrote the first draft. ethical considerations this research was granted an ethics waiver by the school of accountancy ethics committee and ratified by the university human research ethics committee (non-medical) (ref. no. wsoa-2021-10-07w). funding information this research received no specific grant from any funding agency in the public, commercial or not-for-profit sectors. data availability data were obtained from university financial databases. disclaimer the views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of any affiliated agency of the authors. references 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36(81), 4. ward, m. & muller, c., 2012, ‘empirical testing of the capm on the jse’, investment analysts journal 41(76), 1–12. https://doi.org/10.1080/10293523.2012.11082546 world economic forum, 2020, annual report 2019–2020, p. 152, viewed 02 november 2022, from https://www3.weforum.org/docs/wef_annual_report_2019_2020.pdf. appendix 1 table 1-a1: environmental, social and governance score conversion between percentage and letter grades. abstract introduction1 literature review and definitions overview of the system of national accounts the income-statement approach the balance-sheet approach the link between household saving and wealth conclusion acknowledgements references footnotes about the author(s) fanie joubert department of economics, college of economic and management sciences, university of south africa, pretoria, south africa theo van der merwe department of economics, college of economic and management sciences, university of south africa, pretoria, south africa citation joubert, f. & van der merwe, t., 2021, ‘household saving and wealth in south africa’, south african journal of economic and management sciences 24(1), a3764. https://doi.org/10.4102/sajems.v24i1.3764 original research household saving and wealth in south africa fanie joubert, theo van der merwe received: 15 july 2020; accepted: 30 aug. 2021; published: 26 oct. 2021 copyright: © 2021. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: a detailed picture of the saving behaviour of south african households would enable researchers to determine whether households are proactively attempting to safeguard themselves financially. aim: of this article is to analyse household saving(s), using both an income-statement (saving) and a balance-sheet (savings or wealth) approach, while investigating the link between the two as well. setting: the perception that households are ‘dis-savers’ without really delving into the details, definitions, or reasons why this may or may not be the case. this notion is proven superficial as it ignores various interacting definitional and measurement issues. methods: a descriptive analytical methodology is applied to household saving (flow) and savings (stock or wealth) in the period 1995 to 2018, with the focus on macro-economics, while data are sourced from the south african system of national accounts (sna). results: findings include a long-term decline in net household saving to gross domestic product (gdp), which turned negative in 2006, so that dissaving occurred. in contrast, household wealth recorded an average nominal increase of 10.3% in the period 1995 to 2018. focusing on the link between the two concepts, it is confirmed that net revaluation of assets plays a prominent role to support the rise in wealth, while the role of saving diminishes over time. therefore, the need for additional methodological updates is highlighted. more research is required on the various possible factors driving household income and expenditure trends, and their sustainability. the contribution of household saving to total saving should be evaluated in detail. keywords: household saving; household wealth; theories on saving; south african system of national accounts. introduction1 saving, specifically household saving, is a complex subject as theoretical (definitional) differences could lead to diverse conclusions regarding the state of saving in a country. this creates confusion to users of the data, such as politicians, analysts and academics, and impacts directly on the appropriateness of research findings and policy recommendations. the confusion stems, inter alia, from the (erroneous) interchangeable use of terms such as saving and savings (or wealth). the aim of this paper is to analyse household saving(s), using both an income-statement, or flow (saving) approach, and a balance-sheet, or stock (savings or wealth) approach. the link between the two is also highlighted. the paper has a macro-economic focus and data are sourced from the south african system of national accounts (sna). to define, delineate and measure household saving and savings; as indicated earlier, theoretical concepts that are often blurred in the literature. it further highlights and quantifies the link between the two concepts, an important empirical exercise often neglected in related research. it is key to note that the south african reserve bank (sarb) is in the process of a significant methodological overhaul of data for various sectors of the economy (including households), especially regarding their national income and product accounts (nipa), as well as financial account data. the current data, therefore, need to be interpreted with caution. this also means that the ‘elusive’ link between the various accounts should become clearer in future (for example, household saving measurements, as observed in the production, distribution and accumulation accounts; the household balance sheet; and the national financial account [nfa]). at the time of writing, the sarb confirmed that the figures used in this article are based on the best (most relevant) data publicly available. the rest of the article is structured as follows: in section 2: definitions and appropriate literature is discussed, while an overview of the systems of national accounts (sna) is provided in section 3: this is followed by 4: the income-statement approach, with detailed definitions and measurements of south african household saving from the flow perspective. section 5: the balance-sheet approach, with definitions and measurements of household wealth. the link between these two measures is analysed in section 6, and followed by section 7, the conclusion. literature review and definitions as far as the distinction between saving and savings is concerned, hodgetts, briggs and smith (2006:3) mention that ‘the topic of saving is muddied by the tendency for “saving” to mean different things to different people’ and that a clear distinction needs to be made between the verb saving and the accumulated stock of savings (the noun, also referred to as wealth or net worth). looking at the period 1985 to 2005, they found that new zealand households had been dissaving since the early 1990’s, while household wealth increased rapidly, driven strongly by positive houseprice revaluations. they warn that a low or negative household saving rate, even when accompanied by strong rises in savings (or wealth), still carries various ‘adverse economic implications’, including more pressure on current account deficits, rising external debt and higher household indebtedness that may lead to increased financial vulnerability. as far as south africa is concerned, prinsloo (2000) looked at trends in saving between 1960 and 1999 and found a decreasing trend in gross household saving as a percentage of household disposable income, notably from the mid-1980s. unfortunately, his definition does not explicitly address the difference between saving and wealth (savings); however, he states that ‘in terms of standard accounting practice, the saving of a household will be equivalent to the increase in (its) net asset value’ (prinsloo 2000:21). he identified ‘rising marginal personal-tax rates’ and ‘persistent high inflation’ to be disincentives to saving. combining these with changes in the real after-tax interest rate, he arrived at a ‘3-sides-of-the-same-coin’ argument; and it followed that an increase in interest rates alone is unlikely to incentivise south african households to save, if the impact of taxes and inflation is not sufficiently addressed (prinsloo 2000:16–17). seminal works related to the theoretical underpinnings of household savings in south africa, include those by aron and muellbauer (2006), as well as aron, muellbauer and prinsloo (2006a, 2006b); these provided the first estimates of household sector balance sheets (or wealth), covering the period 1975 to 2005 (see, aron et al. 2006a). kuhn (2010) provided further important refinements to the work of aron et al. (2006a), and supplied a detailed analysis of the trends for the period 2005 to 2009. as far as empirical literature is concerned, orthofer (2015, 2017) made important contributions, and lamented the lack of focus on and attention to what exactly is measured as saving in the national accounts. her findings for south africa mirror those of hodgetts et al. (2006), in the sense that a steady decline in household saving rates is observed, while household net worth had simultaneously risen strongly, driven to a large extent by the appreciation of asset valuations, notably domestic corporate equities. she remarked that ‘the full integration of the south african national accounts will contribute to our understanding of aggregate saving and wealth dynamics in future’ (orthofer 2017:239). she also raised an important warning, related to the distribution of wealth in south africa, specifically the highly concentrated nature of equity ownership. as mentioned earlier, and also revealed in literature, the definition of saving is very important. this section, therefore, is concluded with some definitions focusing on the important, yet easily confusing distinction between the terms saving and savings. grammatically, saving is usually seen as a verb, such as ‘saving money when buying an item on special’ or ‘saving for a special occasion’. savings is used as a noun, such as ‘i’m going to put some of my savings into a down payment on a car’, or, ‘i asked my financial advisor for a summary of my retirement savings’ (oxford learner’s dictionary; examples adjusted by authors). use of both words evidently stem from the same origin, save, and are, therefore, often explained together in dictionaries. conceptually, in economics saving is usually regarded as a flow concept, for example ‘the part of your monthly income left over after paying all your bills’. in contrast, savings could be regarded as a stock concept, referring to an individual’s ‘net worth calculated by subtracting liabilities from assets’ or it could be used in reference to ‘savings institutions’ (poole 2007:2–3). poole (2007) further makes the important statement that ‘you may use your saving to pay down debt or add to your assets’, hinting on the theoretical link between the two words. as far as possible, it will be indicated whether the flow or the stock concept is referred to. this approach is supported by literature, typically differentiating between household saving (as measured by using the income-statement approach or the flow measure), and household wealth (as measured by a balance-sheet method or the stock measure). overview of the system of national accounts similar to the way in which organisations are required to record their business activities according to a set of generally accepted accounting principles, so too a system was developed allowing countries to record their macro-economic activity according to a standard internationally accepted statistical framework. according to the united nations (un) website, the sna is defined as a: ‘statistical framework that provides a comprehensive, consistent and flexible set of macroeconomic accounts for policymaking, analysis and research purposes’. the sna is a joint project produced and released under the auspices of the un, the european commission (ec), the organisation for economic coordination and development (oecd), the international monetary fund (imf) and the world bank group (wbg) (united nations, 2009: iii). for most countries, this official framework of reporting economic activity began during or after world war ii. for example, the first official national accounts for the united states were published in 1942 (mohr 2016:18). south african national accounts data are available from 1946, and the latest version of the accounts is the 2008 sna, which replaced the 1993 version (sarb 2015). the full set of national accounts includes various items such as nipa, input-output tables, the nfa, national balance sheets and the balance of payments (bop). the responsibility for compiling these accounts was traditionally divided between statistics south africa (production and income) and the sarb (expenditure, as well as institutional sector accounts, balance sheets and accumulation accounts) (orthofer 2015:16), but statistics south africa now also prepares the expenditure accounts. in defining the household sector in south africa, it is important to note that, not only are private households included in the sna, but also unincorporated business enterprises of households, non-profit institutions serving households (npishs), as well as private trusts and friendly societies. the justification for including unincorporated businesses is based on the unlimited liability of owners, meaning that household assets are at risk in the case of bankruptcy. npish, private trusts and friendly societies are included because the boundaries between them and private households are not always clear (orthofer 2015:11). there is a possibility that the sarb in future may exclude all, or at least some of these four additional items mentioned, thus focusing on households only. such an approach should be welcomed, as various items currently included (e.g. depreciation or rent on subsoil assets), are linked to the related enterprises and institutions, which creates confusion. the income-statement approach the flow measure of household saving relates to the concept that saving is the part of income not consumed, and is sometimes described as ‘abstinence’ or ‘postponed consumption’. in accounting terms, it is a flow measure typically found in the income statement of entities. an example often used to illustrate the term relates to changes in the water level of a dam, where the flow of water in and out of a dam is measured over a specific period of time, expressed as a rate. the flow concept dominated the saving literature in most countries after world war ii, predominantly due to the availability of data. from a theoretical perspective, saving in the household sector, in its most basic form, is represented by: where: s: household saving (gross saving) y: household disposable income2 c: household consumption expenditure (hodgetts et al. 2006:9). however, provision is also made for the consumption of fixed capital (cfk, depreciation of the household sector’s capital stock; or housing stock). this reflects the amount that households need to invest annually to maintain their stocks’ productivity. from this, net saving (sn) can be calculated as follows: where cfk is the depreciation in the housing stock.3 household saving is recorded in the production, distribution and accumulation accounts for households and npishs (see table 1). it includes six accounts, namely the production account, generation of income account, allocation of primary income account, secondary distribution of income account, use of disposable income account and capital account.4 the first five of these accounts enable the calculation of the gross (and net) saving of households, and is discussed further below. table 1: production, distribution and accumulation accounts of south african households,5 2018 (r millions). the first account, the production account, shows the net output of production when production is defined as an activity that ‘uses inputs of labour, capital, and goods and services to produce outputs of goods and services’ (united nations 2009:95). an example is subsistence agriculture or other forms of agricultural production, part of which is consumed by the household itself (intermediate production). as this is often part of the informal sector, it provides various measurement challenges (united nations 2009:466). output, less intermediate consumption, is stated as gross value added at basic prices (see table 1). the second account, the generation of income accounts, is merely an extension of the production account as more production costs and subsidies are taken into consideration. it views households in their capacity as producers, whose activities generate primary incomes (united nations 2009:131).5 the costs include labour costs (compensation of employees6) and taxes on production. this gives the gross operating surplus of household production. in 2018, the gross operating surplus contributed 21.2% to the gross disposable income of households. the third account, the allocation of primary income account, shifts the focus from households as producers to their capacity as recipients of primary incomes. included in this account is the most prominent source of household income, namely the compensation of employees. the account also includes property income received and paid. compensation of employees equalled 79.1% of the gross disposable income of households in 2018. compared over time to the size of the economy, compensation of employees dropped from just below 50.0% in 1998 to 43.5% in 2002. it remained at, or close to this level, until 2007, after which it started to recover. by 2018, it was 47.6% of gdp. property income received, reached a high of 18.2% of gdp in 1998. it declined with a noticeable drop of 4.0 percentage points from 2008 to 2010, linked to the slump during the 2008 and 2009 global financial crisis (gfc) also causing an economic recession in south africa. the slowdown narrowed the gap between property income received and paid, thus placing pressure on household income. the fourth account is the secondary distribution of income which deals with current transfers or instances in which income is received, without any goods exchanging hands or services rendered (united nations 2009:157). this differs from the primary income account in which actual goods or services are provided by households in exchange for compensation. prominent items in this account include social assistance payments, as well as taxes on income and wealth. social benefits received, include current transfers to households by government. this item equalled 14.8% of gross disposable income in 2018. compared to the size of the economy, social benefits received, rose sharply from 6.8% of gdp in 2005 to 9.8% in 2015. of important is that although social assistance payments7 are included here, social benefits received are defined more broadly and also include, for example, payments made in respect of sickness, unemployment, housing, education or family circumstances (united nations 2009:172). also evident from this account is the impact of taxes on income and wealth, measuring 17.2% of gross disposable income during 2018. looking at the trend over time, it rose from 7.6% of gdp in 2005 to 10.3% in 2018. personal income tax (pit) has been contributing a relatively larger share of total government revenue over time, while the highest marginal tax rate of pit was increased to 41.0% in 2016, and to 45.0% again in 2017. social contributions paid, should not be regarded as the counterpart of social benefits received, and are defined as ‘actual or imputed payments to social insurance schemes’, which also include voluntary contributions, or those made by employers on behalf of their employees (united nations 2009:158). gross disposable income of households forms the last line item in the secondary distribution of income account and decreased from 62.8% of gdp in 1998 to 56.4% of gdp in 2008. thereafter it improved again to 60.1% of gdp in 2018. income usually has an important impact on saving which the world bank (2011:27–28) refers to as the ‘income channel of saving’. the bank notes that the size of the impact depends on the level of a country’s development and whether economic agents view movements in income of a transitory nature, or regard it as a permanent change. in its analysis, the world bank concluded that the role of household income growth in south africa was insufficient (‘it did not play as major a role, as it could have’) to support household saving. the focus shifts in the fifth account to how households utilise their income, aptly named the use of disposable income in the households’ accounts. the account consolidates three important concepts namely household income, consumption and saving (united nations 2009:179). household income (line item total available household resources8) declined from 67.3% of gdp in 1997 to 61.3% in 2018 while consumption (final consumption expenditure of households) declined from 63.3% of gdp in 1997 to 59.9% in 2018 (see figure 1). therefore, disposable income of households, as measured against the size of the economy, decreased at a faster pace. this means that the financial buffer (or gap) that existed between households’ income and spending during the 1990s and early 2000s, was wiped out by 2006. figure 1: total available household resources and final consumption expenditure, 1995 to 2018. possible reasons for the disappearance of the buffer are provided by the bankserv disposable salary index (bdsi), which mentions that although gross salary increases in general have been above the rate of inflation since the early 2000s, expenditure pressures were also severe, especially those related to income tax, medical aid and unemployment insurance fund (uif) contributions (bankserv africa 2016). a further detailed analysis of these and other possible drivers of household income and expenditure remain important research objectives, but fall outside the immediate scope of this paper. the gap between consumption expenditure and household resources increased somewhat during 2008 to 2010 and again towards the end of the analysis period. however, the size of the gap remains less than half the size it was during the late 1990s (see figure 1). household saving (gross saving) is calculated as the difference between income and consumption. in nominal terms, it amounted to r18.1 billion and r67.1 bn., in 1995 and 2018 respectively, with an average of r28.4 bn. recorded during the period. compared to the size of the economy, gross saving declined notably after 1995, but has been recovering somewhat since 2014 (see figure 2). figure 2: gross and net saving of households, 1995 to 2018. to determine net saving, depreciation (or the cfk, at replacement value) has to be factored in. depreciation remained very stable from 1995 to 2018, averaging around 1.6% of gdp. the net saving of households declined from 2.4% of gdp in 1997 to a negative (dissaving) −1.4% in 2007; that is at the height of the strong economic growth spurt south africa experienced at the time.9 it seems likely that the gfc imparted some caution to both banks (limiting their credit extension) and consumers (more prudent management of their household finances), as net saving ‘improved’ to −0.3% of gdp by 2009. evidence of this improvement is revealed by domestic private sector credit extension which declined from an average rise of 21.3% in 2008, to merely 6.8% in 2009 (in addition, actual negative year-over-year figures were recorded during the first quarter of 2010) (sarb 2021). however, as soon as the economy regained traction (around 2010), net saving again declined to −1.4% in 2013. it did improve somewhat towards the end of the analysis period, albeit mostly in negative territory still. the balance-sheet approach the balance-sheet approach views household savings as the accumulation of wealth, and is therefore a stock concept measured at a specific point in time. formal (or standardised) measures and accounting practices related to the household balance sheet have been lacking in the national accounts (both globally and in south africa), and evidence of research aimed at reliable estimating techniques for south africa could only be found from the mid-2000s onwards. still, south africa remains one of the first emerging market countries to have incorporated household balance-sheet estimates into its sna. these figures have since been recalculated (backdated) to 1975 (aron & muellbauer 2006; orthofer 2015:1–3, 16, 33). in this article the figures of the sarb for the period 1995 to 2018 are used. household wealth (w) is calculated as the market value of assets (a), less liabilities (l), or in mathematical terms: household assets can be defined as: [a] store of value representing a benefit or series of benefits accruing to the economic owner by holding or using the entity over a period of time. it is a means of carrying forward value from one accounting period to another. (united nations 2009:39) for most assets, there is a corresponding liability, defined as being established when: [o]ne unit (the debtor) is obliged, under specific circumstances, to provide a payment or series of payments to another unit (the creditor). (united nations 2009:39) from a theoretical perspective, strong emphasis is placed on the distinction between tangible (e.g. residential property) and non-tangible (financial) assets. using these concepts, the determinants of equation 3 can be further refined as follows: where: a: the value of tangible and non-tangible assets (at + ant) : the value of tangible assets (capital stock) in the previous period : the value of non-tangible assets in the previous period cfk: consumption of fixed capital it: investment in tangible assets int: investment in non-tangible assets rt: revaluation of tangible assets rnt: revaluation of non-tangible assets rb: revaluation of borrowed amount bt−1: level of borrowing in the previous period (hodgetts et al. 2006:25–26). the sarb uses the same concepts to present the household balance sheet, but refers to non-tangible assets as financial assets, while tangible assets are called non-financial assets. non-financial assets include items such as residential buildings, while financial assets include various bank deposits, interest in pension funds and long-term insurers, and even foreign assets. on the liability side of the household balance sheet, mortgage advances and other debt (including instalment sale and leasing, as well as personal loans) are listed (for a detailed list of all household assets and liabilities included by the sarb see kuhn 2010). table 2 provides the balance sheet data of the household sector for 2005 and 2018 respectively. over time, and compared to the size of the economy, total household assets performed strongly during the early 2000s as it rose from 217.5% of gdp in 2002 to 295.7% in 2006. it declined during the gfc but by 2018 it had again recovered slightly to 262.6% of gdp (see figure 3). the category for financial assets, is the largest household asset category and contributed two-thirds (64.8%) to total assets in 2018, while non-financial assets contributed only 35.2%. figure 3: total, non-financial and financial assets of households, 1995 to 2018. table 2: balance sheet of the household sector, 2005 and 2018. interest in pension funds and long-term insurers is the largest financial asset class and contributed 52.5% to financial assets for 2018 (it is also the largest of all asset classes, both non-financial and financial). looking at this item’s performance over time, a distinctive ‘w’ pattern is evident, as interim high points were reached during 2006 (96.7% of gdp) and 2014 (100.0% of gdp) respectively. this is most likely linked to strong bull runs in local equities, experienced in both these periods. after 2014, the item decreased notably to 89.4% of gdp in 2018. non-financial assets are driven strongly by the residential property market, and the housing boom experienced during the early 2000s in the south african economy is clearly visible in the data. residential property assets almost tripled from r528 bn. in 2002 to r1.5 trillion in 2008. compared to the size of the economy, residential buildings peaked at 68.5% of gdp in 2007. following the gfc, this item decreased to 58.0% of gdp in 2012, after which it again increased marginally, but remained well below its previous peak. on the liability side, mortgage advances to households contributed roughly half (47.1%) to total liabilities, while the other half is made up of other debt items, including instalment sale and leasing, as well as personal loans (see table 2). mortgage advances rose especially strongly around the residential property boom of 2003 to 2007. thereafter the demand for mortgages had been muted, as the item dropped from 32.4% of gdp in 2007 to 21.0% in 2018. in contrast to this, the demand for other debt items (such as instalment and leasing credit, personal loans and open accounts) showed an upward trend and caught up with mortgages in 2014, after which it remained the main household liability. prinsloo (2000:21) noted that an inverse relationship could be expected between consumer credit and saving. various researchers tested this empirically and found evidence of a negative (inverse) correlation between the liberalisation (expansion) of credit markets and household saving in south africa (see, for instance, aron & meullbauer 2000, 2012; harjes & ricci 2005; viegi 2014:134–136). the focus now falls on net wealth that is calculated as assets less liabilities. compared to the size of the economy, net wealth in south africa peaked in 2006 at 245.4% of gdp. it dropped to 201.9% of gdp in 2008, as the gfc impacted on asset valuations. a distinctive ‘w’ pattern is evident again between 2007 and 2014 as wealth fluctuated in accordance with economic growth and financial market trends during the period. a notable improvement is evident during 2012 to 2014. however, after 2014 net wealth shows mostly a declining trend and in 2018 it measured 218.1% of gdp, or roughly the same level as it was during 2012 (see figure 4). figure 4: household net wealth, 1995 to 2018. another measure is to look at how household net wealth changed on an annual basis. this indicates an average annual nominal increase of 10.3% for the period 1995 to 2018. the strongest performances were measured during 1999, 2004 and 2006, all of which recorded rises above 20.0% year over year. the only negative value was recorded in 2008, which measured −4.8%, while in 2018 a rise of merely 0.3% was recorded (see figure 4). compared on a preand post-gfc basis, it is evident that the nominal rise in household wealth had been weaker post-gfc, as it averaged 8.4% (2009 to 2018), compared to an average of 11.7% before the crisis (inflation did average around 1.0 percentage point higher during the pre-gfc period). interestingly, the weakness post-gfc has been more prominent in the non-financial asset category as it rose by an average of 6.4% (2009 to 2018), while financial assets rose 8.9% during the same period. pre-gfc, non-financial assets recorded exceptionally strong rises on an average of 14.8%, while financial assets rose with 11.1%. the next section determines whether or not any ‘flow through’ occurred by linking household saving to wealth. the link between household saving and wealth the link between the income-statement and the balance-sheet approaches is important because it enables analysts to determine the extent to which households’ decisions in one time period effect their financial circumstances in another time period, or more specifically, to identify how saving decisions effect the accumulation of wealth. given that saving is a flow concept and wealth a stock concept, the link between these two concepts only becomes evident when time (e.g. change in wealth over a given period) is factored into the analysis. an identity may be used to assist in this regard. it relates to the fact that investment is financed from one of three sources, namely from current income, by borrowing or by capital transfers,10 which equals: where: it: investment in tangible assets11 int: investment in non-tangible assets12 s: gross saving δb: net change in household borrowing ct: capital transfers (including those from overseas) (hodgetts et al. 2006:25). by subtracting liabilities from assets (that is subtract equation 5 from equation 4), and using the identity provided in equation 6, it can be shown that: w = w–1 + rnet + sn + ct or stated differently: where: δw: change in wealth (wt – wt–1) rnet = rt + rnt – rb (net revaluations) sn = y – c – cfk (hodgetts et al. 2006:26). the three theoretical factors contributing to the change in household wealth are: net revaluations, net saving and capital transfers. alternatively, yet similar to this, orthofer (2015:5) defines the change in household wealth in more detail as: where: ss,t: stock of savings (changes in wealth) sf,t: flow of saving (‘saving-induced wealth’) : asset revaluations kt: capital transfers ot: other13 factors both hodgetts et al. (2006) (see equation 7) and orthofer (2015) (see equation 8) list the three factors contributing to the changes in household wealth as net revaluations, net saving and capital transfers; however, orthofer (2015) also explicitly includes a fourth, namely ‘other factors’ (e.g. destruction or a discovery). net saving represents the part of disposable income that is not spent on consumption expenditure. when positive, it can be used ‘to acquire non-financial or financial assets of one kind or another, including cash, or to repay liabilities’. but when negative, ‘the excess must be financed by disposing of assets, or incurring new liabilities’ (united nations 2009:197). stated differently, a high level of saving should mean that net worth and assets could be acquired without increasing debt. conversely, in a situation of low savings (or dissaving), wealth should be reduced, ceteris paribus, and existing assets be decreased and/or liabilities will have to be increased (hodgetts et al. 2006). using the methodology of hodgetts et al. (2006), the change in south african households’ net wealth is calculated using three factors, namely net saving, revaluations and capital transfers. net-saving and capital-transfer data are available from the sarb; however, the revaluation of assets is treated as a balancing14 item. the contribution of net saving to the acquisition of wealth peaked in 1998 at 24.0%, after which the contribution of saving declined to the point where it turned negative in 2006 (see table 3). in other words, households were increasing their borrowing and/or utilising existing wealth. in 2017, saving again made a small positive contribution, but this turned negative once more in 2018. table 3: decomposition of households’ net wealth, 1996 to 2018. the prominence of the net revaluation of assets (treated as the balancing item in the calculation) is evident as it alone explains almost all the movements in the change of wealth, especially from the mid-2000s onwards. it is very likely that the stellar rise in residential property prices and equity markets are responsible for the bulk of the revaluation adjustments. the contribution of capital transfers remains rather insignificant throughout the respective time, with exceptions in 2008, 2011 and 2018, during which the contribution was almost half (49.0%). this was, however, due to weak or negative changes in net wealth recorded during these periods. the 2018 value clearly indicated how sensitive this type of analysis is and confirmed the need for an improved (or a more insightful) methodology and data linking saving to wealth. international evidence supports these findings and suggest that asset revaluations are often the most important driving factor for household wealth. hodgetts et al. (2006) analysed data for new zealand and indicated how the revaluation effect completely ‘swamped’ other factors between 2002 and 2005. the problem is that this could fluctuate significantly according to, among other factors, different accounting principles (e.g. book or market values), to the point where it could be regarded as merely ‘paper profits’. orthofer (2015:4) ran a similar test and found that between 1975 and 2014, south african real net household saving accounted for merely 15.0% of the increase in real household wealth. during a discussion with employees of the sarb, they also expressed caution about the various assumptions and estimates included in the calculation. however, they simultaneously confirmed that for the time being these calculations are based on the best available data. they also indicated that they are in the process of a major overhaul regarding various aspects of the household-sector data. hopefully, future data from the sarb will enable analysts to ‘close the elusive loop’ between household saving and household wealth. conclusion a descriptive analytical methodology is used to highlight the trends in household saving and wealth (savings) in south africa for the period 1995 to 2018. it further links the two concepts by providing empirical estimates of the ‘flow-through’ effects, in the form of a decomposition of wealth. household saving, as measured by the income statement approach, indicates a long-term declining trend in net household saving to gdp. since 2006 it turned negative (dissaving). this decline stabilised around 2008, as net household saving fluctuated around the −1.0% to gdp level since then, and actually improved to record a small positive value of 0.1% of gdp in 2017. however, the latest available value for 2018 indicates a small dissaving again. there are two major determinants of this trend, namely disposable income of households and final consumption expenditure of households. compared to gdp, both of these have been trending downwards, but over time the difference or buffer that existed between them had been eroded to the point where it disappeared in 2006. however, after 2010 the downward trend in both the disposable income of households and final consumption expenditure of households stabilised somewhat, which also explains the stabilisation in the saving rate. compared to the size of the economy, household wealth in south africa peaked in 2006 at 245.4% of gdp. the gfc had a significant impact, and household wealth dropped to 201.9% of gdp in 2008. some recovery occurred around 2012 to 2014; however, net wealth had been mostly on a declining trend since then and in 2018 measured 218.1% of gdp. as far as annual performance, households’ wealth rose by an average nominal increase of 10.3% for the period 1995 to 2018. lastly, an analysis of the link between saving and wealth shows that the contribution of net saving to the acquisition of wealth peaked in 1998, after which it declined and turned negative in 2006. the prominence of the net revaluation of assets in the change of wealth is confirmed as it explains almost all the movements, especially from the mid-2000s onwards. drivers for the revaluations include a strong rise in the valuations of residential property values and equities. future research should focus in more detail on the factors driving household income and expenditure trends in south africa, and whether they are sustainable. also important is the role that household saving plays (or should play) in total saving in the economy, as well as what an optimal mix between the major saving categories (including households, businesses and government) should be. acknowledgements competing interests the authors have declared that no competing interest exists. authors’ contributions all authors contributed equally to this work. ethical considerations ethical clearance was obtained from unisa, school of economic sciences, research ethics review committee. ethical clearance number: 2016_cems_ses_001. funding information this research received no specific grant from any funding agency in the public, commercial, or not-for-profit sectors. data availability data sharing is not applicable to this article as no new data were created or analysed. disclaimer the views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or positions of any affiliated agency of the authors. references aron, j. & muellbauer, j., 2000, ‘personal and corporate savings in south africa’, world bank economic review 14(3), 509–544. https://doi.org/10.1093/wber/14.3.509 aron, j. & muellbauer, j., 2006, ‘estimates of household sector wealth for south africa. 1970–2003’, review of income and wealth 52(2), 285–307. https://doi.org/10.1111/j.1475-4991.2006.00188.x aron, j. & muellbauer, j., 2012, ‘wealth, credit conditions and consumption: evidence from south africa’, cepr discussion paper no. 8800. aron, j., muellbauer, j. & prinsloo, j., 2006a, ‘estimating household-sector wealth in south africa’, south african reserve bank, quarterly bulletin 2006, 61–72. aron, j., muellbauer, j. & prinsloo, j., 2006b, ‘estimating the balance sheet of the personal sector in an emerging market country’, united nations university working paper no. 2006/99, september 2006. bankserv africa, 2016, average salaries, pensions barely grow above inflation, viewed 07 september 2017, from https://www.bankservafrica.com/press-office/articleid/118/average-salaries-pensions-barely-grow-above-inflation?category=\bdsi harjes, t. & ricci, l., 2005, ‘what drives savings in south africa?’ in m. nowak & l.a. ricci (eds.), post-apartheid south africa: the first ten years, international monetary fund, washington, dc. hodgetts, b., briggs, p. & smith, m., 2006, ‘household saving and wealth. reserve bank of new zealand’, paper prepared for reserve bank workshop titled ‘housing, savings and the household balance sheet’, wellington, 14th 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http://unstats.un.org/unsd/nationalaccount/sna2008.asp viegi, n., 2014, ‘(dis)saving in south africa’, in h. bhorat, a. hirsch, r. kanbur & m. ncube (eds.), the oxford companion to the economics of south africa, pp. 134–139, oxford university press, oxford. world bank, 2011, ‘south africa economic update: focus on savings, investment and inclusive growth’, issue 1, july 2011, viewed 20 october 2016, from http://documents.worldbank.org/curated/en/115621468115472034/south-africa-economic-update-focus-on-savings-investment-and-inclusive-growth footnotes 1. findings in this article form part of a doctoral thesis, which was shared by one of the authors with the south african reserve bank, during a meeting on 26 july 2017. feedback from this meeting has been incorporated into the thesis and this article. the authors thank the members of the sarb for their inputs. 2. also referred to as ‘total available household’s resources’, (sarb 2016:s-132, kbp6847). 3. also referred to as ‘consumption of fixed capital at replacement value’ (see sarb 2016:s-132, kbp6849). 4. the capital account looks at the changes in assets held by households, specifically the ‘values of non-financial assets that are acquired, or disposed of’ (united nations 2009:195). 5. households and non-profit institutions serving households. 6. this item relates to the compensation of employees by unincorporated enterprises owned by households (united nations 2009:131). it should not be confused with the compensation of employee’s item, recorded in the primary income account. 7. social assistance payments rose from around 2.5% of gdp in 2005 to 3.0% in 2015. 8. total available household resources is calculated by adjusting gross disposable income with two items namely the change in the net equity of households in pension fund reserves and a residual (a statistical discrepancy between the expenditure components of gdp [sarb 2016]). 9. south africa’s gdp rose on average by more than 5.0 per cent per year during the period 2004–2007 (sarb). 10. capital transfers are cash injections into the household sector, which is not part of current income, for example, capital transfers by immigrants (hodgetts et al. 2006:9). 11. this item includes houses and flats (hodgetts et al. 2006:9). 12. this includes financial assets (hodgetts et al. 2006:9). 13. examples of other factors can be the ‘result of the discovery of a subsoil resource or the destruction of assets as a result of war or a natural disaster’ (united nations 2009:330). 14. orthofer (2015:21) encountered a similar challenge and lamented the fact that a fully integrated set of national accounts (from which this type of data could simply be read) had not yet been published by the sarb. abstract introduction and background literature review research methodology results reliability and validity assessments correlations and discriminant validity measurement model evaluation (goodness-of-fit indices) structural model and hypothesis testing discussion conclusion acknowledgements references about the author(s) david pooe department of business management, college of business and economics, university of johannesburg, johannesburg, south africa watson munyanyi department of business management, college of business and economics, university of johannesburg, johannesburg, south africa citation pooe, d. & munyany, w., 2022, ‘delivering public value to selected government departments in south africa – perceptions of senior managers’, south african journal of economic and management sciences 25(1), a3791. https://doi.org/10.4102/sajems.v25i1.3791 original research delivering public value by selected government departments in south africa – perceptions of senior managers david pooe, watson munyanyi received: 04 aug. 2020; accepted: 16 mar. 2022; published: 25 aug. 2022 copyright: © 2022. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: over the years, the expectations of both the public and private sectors regarding value have changed significantly, thereby increasing the need for government departments to revisit their public-value creation model. aim: this study sought to explore perceptions of senior managers in selected national government departments in south africa with regard to the influence of information sharing, process innovation, stakeholder analysis and engagement in the relational governance and public value. setting: the respondents were 230 senior managers from the five national government departments who, over time and in various groups, attended the executive development programme hosted by the national school of government. methods: a quantitative research approach involving a cross-sectional survey design was followed in the study. data were analysed by means of structural equation modelling (sem). results: in the study a strong, positive relationship was found between information sharing, process innovation, stakeholder analysis and relational governance. further, a strong positive relationship between relational governance and public value was also established. conclusion: based on the perceptions of senior managers, government departments seeking to deliver superior public value need to focus primarily on managing their relational governance. to that end, it is vital that they develop their information-sharing and process innovation, as well as stakeholder analysis and engagement. keywords: information sharing; process innovation; stakeholder engagement; relational governance; public value. introduction and background there is relentless pressure on governments to deliver public goods and services of value to their citizens (link & scott 2019). the rising expectations of citizens, limited resources, as well as changing social, environmental and economic conditions exert pressure on governments across the world to continue to find new and innovative ways of delivering public services (taylor 2018). for the south african government, the delivery of many such services is a matter enshrined in the constitution of the republic of south africa, 1996 (cordella & bonina 2012). lues (2007) stresses that the main function of public service in south africa is service delivery. the white paper on transforming public service delivery (south africa 1997) puts all public sector managers in the driving seat of service delivery and consequently urges them to strive for excellence. yet, the effective delivery of goods and services remains a real challenge (epp & baumgartner 2017; makoti & odeku 2018). yotawut (2018) believes that the best way to get public managers to think about what the most valuable aspect is of the services provided by government and how they can best manage the effective delivery of such services is through the ‘public value’ lens. according to meynhardt, brieger and andere (2017), the question of public value, which is far more difficult to measure than mere financial performance, preoccupies public sector managers. grant et al. (2014) add that the role of public managers in public value creation is to steer networks of delivery and maintain the overall capacity of the system. that said, since government services are widely utilised, the notion of public value places the broader community at the centre as a collective beneficiary availing themselves of government’s collected provisions (oecd 2019). yotawut (2018) defines public value theory as ‘an approach that explores how public organisations operationalize the principles of public value by focusing on the role of public engagement which distinguishes public services from private competitive markets’. public value could be viewed as the kind of values the public sector aspires to and the value added by government services (benington 2015; benington & moore 2011; moore 2013). while mazzucato and roy (2019) argue that there is a strong need to rethink the nature and character of value chain creation, especially in the public sector, there are many factors that contribute to the inefficiency of governments, thereby compromising their ability to deliver public value to their citizens. the sheer size of governments, which has in general increased over time, could threaten the delivery of goods and services of public value (higgs 2008; lee, kim & borcherding 2013; nyasha & odhiambo 2019). as noted by demattos, miller and park (2012), such complexity may affect a government department in a number of ways. firstly, the ability to share information within the complex system of government may prove to be a challenge (perrin, barrigar & gellman 2015). particularly in the public sector, information sharing is central to the ability to influence the planning and deployment of public services (clark, brudney & jang 2013; clark et al. 2020). the ability to share information within the government system often proves to be a challenge (oecd 2014; perrin et al. 2015). secondly, despite the efforts to innovate, following the embrace of new public management by many governments, the nature of the public sector and its governance requires that process innovation receives attention (khodadad-saryazdi 2022). however, the ability to process new and innovative ideas may be throttled (oecd 2014). thirdly, the huge and complex government system may force the departments to be inward-looking and thereby neglect meaningful engagement with stakeholders (haarhoff 2019; kolk & pinkse 2006). according to meynhardt (2009:212), public value creation ‘is situated in relationships between the individual and society’. in this regard, turrel (2017) posits that co-production is core to the creation of public value, so that public organisations work along with service providers to design and deliver services. many government programmes and projects require a high level of expertise in stakeholder engagement (mosaic 2020) without which the delivery of goods and services of public value may be threatened (higgs 2008; lee et al. 2013; nyasha & odhiambo 2019). fourthly, delivering public value also requires that processes facilitating relationship building and mutual respect among stakeholders be well designed to establish better communication and conflict management (keast et al. 2004). such network settings become fertile ground for the co-creation and co-production of a number of outcomes and innovations, and consequently enhanced public-value propositions (page et al. 2015). bryson et al. (2017) add that governance structures also play an important part in public value management. the study investigated perceptions of public managers since grant et al. (2014:1) stress that managers cannot, on their own, decide what public value is; rather, they need to canvass the views of all elected officials and other stakeholders. against this background, this study sought to explore perceptions of senior managers in selected government departments with regard to the influence of information sharing, process innovation, and stakeholder analysis and engagement on relational governance and the public value. the remainder of the article is organised as follows: the next section reviews the literature by reflecting on the concepts key to the study. based on the literature review, hypotheses are postulated and the conceptual model posited. the sections that follow explain the research methodology employed in the study and discuss the research findings. the article concludes by discussing the implications of the study, its limitations and directions for future research. literature review perceived public value bryson, crosby and bloomberg (2014:446) define public value as ‘something that is valued by the public or is good for the public as assessed against various public value criteria’. according to grant et al. (2014:1), public value creation is ‘the process of adding value to the public sector through the exercising of managerial authority – all the time’. as it became evident that the new public management (npm) which emerged in the uk in the 1980s was not an answer to the challenges of public administration, moore’s (1995) notion of public value management (pvm) was generally well received (meynhardt et al. 2017). hence, public values research was welcomed as a breath of fresh air in the development of public administration theory and practice (bozeman 2007; rutgers 2015). the public value framework is based on networked governance whose objective is to achieve public value (moore 2005). according to meynhardt (2019:11), public value does not suspend ‘the profit motif, but enquires about its legitimate cause in society and how it interacts with other values’. public value creation represents mental images of community and society, as valued by the public (meynhardt 2019). public value emphasises the attainment of composite and socially shared expectations like fairness, trust, and legitimacy over and above economic viability (uyarra, ribeiro & dale-clough 2019). thus, public value stresses the need for interaction and exchange between public managers and stakeholders such as politicians and others for value creation. public value creation can be defined as ‘the process of adding value to the public sector through the exercising of managerial authority’ (grant et al. 2014:2). although public value creation is described as a process, its measurement can be regarded as a mix of process and outcome. according to meynhardt et al. (2017:142), public value creation is realised ‘when people perceive a positive contribution to what they regard as society’. public value is defined by the european commission (2008:42) as the ‘total societal value that cannot be monopolized by individuals, but that is shared by all actors in society and is the outcome of all resource allocation decisions’. meynhardt (2015:148) also describes public value as value from and for the public and that its assessment involves measuring subjective meaning and value. hence, grant et al. (2014) posit that public value should be measured at different points along the public value chain, which they define as a map of organisational production, including inputs, activities or projects, partners, outputs, client satisfaction, and outcomes. public value is often context-specific and highly influenced by political processes and the collective expectations of various stakeholders (rose, flak & sæbø 2018). this suggests that shared value is greater than the sum of individual values, stressing the collective significance of what is good for society (cordella & bonina 2012). the public value notion can be distilled to citizens’ shared expectations regarding government and public services. while private entities are concerned with profit maximisation, the value public entities deliver to their stakeholders goes beyond economic gains (marques & simões 2020). public entities, including government departments, are accountable to citizens to achieve political and social objectives such as proficiency in public service delivery, equity, social inclusion, honesty, community regeneration and well-being, stewardship, and accountability. as a result, public entities not only expedite efficiency and sustainability but also concern themselves with accountability as to public value (twizeyimana & andersson 2019). enhancing public value has been accepted as a viable channel to address the socio-political complexities associated with the public sector. perceived relational governance the literature identifies two governance mechanisms, namely contractual governance and relational governance. contractual governance relies on rules, performance indicators, sanctions, and risk allocation to govern exchanges, while relational governance stresses the role of trust, flexibility, and interdependence in ensuring partners’ commitment and performance (benítez-ávila et al. 2018; mu, wu & haersham 2021; warsen, klijn & koppenjan 2019). relational governance refers to the more ‘human’ elements (description follows) of the relationship, which serve to coordinate activities and mitigate the risks of opportunistic behaviour (lioliou et al. 2014). previous studies have operationalised relational governance in different ways. these are mainly relational norms and trust, the former relating to values and social rules shared by the partners, such as communication, mutual dependence, inclusion, and conflict resolution, among others (benítez-ávila et al. 2018; kern & willcocks 2000; poppo, zheng zhou & ryu 2008). scholars generally agree that focusing on partnership quality and relational quality is key to establishing decent relationships with stakeholders (odongo et al. 2016; parks 2017). poppo et al. (2008) observed that trust and the relational norms have the effect of decreasing transaction costs and improving knowledge transfer. all the more so, considering that collaborative networks between public, private and non-profit organisations have become crucial to enhancing governments’ ability to ‘develop the necessary capacity to address complex problems and achieve collective goals’ (goldsmith & eggers 2004:6). in fact, ekuma (2017:12) argues that ‘a shift in focus to “relationality” reflects changes in the wider global political economy, including emerging complex and multi-faceted policy problems that require heterodox and context-sensitive responses from governments and greater collaboration among key stakeholders’. relational governance also enables public entities to provide citizens with services that are ordinarily accessible only from private markets (frasure & jones-correa 2010). relational governance is rooted in both social ties and formal contracts (castro & roldán 2015). relationality enhances the reflexive capacity of partners involved in various forms of exchange within the network, and this should contribute to improved performance (vincent-jones 2012). thus, the importance of relational governance between government departments and their stakeholders cannot be overstated. appreciation and maintenance of relationships over time lie at the core of the relational governance perspective. hence, for organisations to facilitate superior relational governance, they need to recognise and satisfy the needs of stakeholders (he et al. 2018). scholars have argued that focusing on partnership quality and relational quality is considered key to establishing decent relationships (odongo et al. 2016; parks 2017). perceived relational governance and perceived public value the existence of trusted relationships with business partners enables the creation of solid inter-organisational integration structures that could facilitate the exchange of information across disparate entities. through superior relations, an organisation could obtain high-quality information, better service, and reliable deliveries, which in turn enable the organisation to achieve its mission, objectives, and strategies. based on this dimension, organisations that initiate and manage superior relationships can leverage for improved innovativeness and better service delivery (mitrega et al. 2017). in the public sector, superior relational capabilities have been credited with enhancing collaboration and the exchange of problem-solving ideas and resources which allow for good governance and citizen satisfaction (aldama-nalda & gil-garcia 2011). stewart (2020) notes that public value is created in the policy development process and, as such, the work of public servants in achieving policy outcomes should be recognised by public services as a whole and those in the political sphere. since policy development may call for adjustments in the process of public value creation, such a reorganisation may call for developing governance structures that involve improved participation by citizens, civil society or other stakeholders (bloom & sancino 2019). considering that networked governance of public, private and third sector providers and co-production are central to the creation of public value (turrel 2017), and that different stakeholders often experience public value differently, relational governance becomes especially crucial. in this regard, williams (2002) notes that complex policy challenges require the forms of governance that promote collaboration, partnership and networking and that such challenges require public managers with a relational style, inclined to build social capital. hence, the study postulates: senior managers’ perception of relational governance positively and significantly influences their perception of public value in a government department. perceived information sharing and perceived relational governance by sharing information governments are able to discharge their responsibilities effectively while establishing a networking government which facilitates a synchronised government response to emergencies (estevez, fillottrani & tomasz janowski 2010). de tuya and de tuya (2019) hold that sharing information effectively and efficiently means that organisations results in creating certain social–technical conditions that facilitate a more fluid and productive interaction of stakeholders, thereby reducing lead times in the decision-making process. yet, while government agencies know the importance of information sharing when addressing policy issues, they also realise that it can be a complex task (yang & maxwell 2011). in their study, kamal, singh and ahmad (2012) identified individual factors (such as trust and reciprocity), organisational factors (policy, top management support, and resource allocation) and technological factors (it capability and information security) as critical in contributing to the success or failure of interdepartmental information-sharing practice among government agencies. pardo, gil-garcia and luna-reyes (2008) argue that the new generation of public servants need to understand the important role of information and technology in creating conditions for collaboration in delivering effective public service. two dimensions of information sharing exist, namely human-to-human interaction and human-to-information interaction. human-to-human interaction relates to the extent to which human beings use information to connect with others, for instance on social media, while human-to-information interaction denotes the acquisition and sharing of information through information and communication technologies (fidel 2012; lu et al. 2010). in today’s complex governance environment, information-sharing initiatives between organisations face many challenges. however, generating an information-sharing culture results in several benefits that may lead to improved operational performance and customer satisfaction (fawcett et al. 2011). pardo et al. (2008) believe that an improved understanding of what constitutes cost to society has led to the prioritisation of collaborative governance and information sharing in public administration. in the public sector an efficient process for sharing information gives public entities a better understanding of stakeholders’ needs and expectations (wong et al. 2015). information sharing is useful in promoting the building of better partnerships and integration between stakeholders, leading to better performance (khan, hussain & saber 2016). however, a more recent study investigating a multiple department collaboration on integrating key informational resources found that, in most cases, information sharing is still an exception rather than the rule (park 2022). mu et al. (2021:13) argue that repeated contacts and communication between stakeholders are beneficial for ‘removing ambiguities, improving mutual understanding, and most importantly, increasing perceived mutual interdependence’. yet, a study by sayogo and gil-garcia (2014) found that public managers, who typically spend 80% – 85% of their total work time on routine tasks, find it particularly hard to build an environment where information is easily shared between stakeholders. hence, the following hypothesis is advanced: senior managers’ perception of information sharing positively and significantly influences their perception of relational governance in a government department. perceived process innovation and perceived relational governance de vries, bekkers and tummers (2014:12) define public sector innovation as ‘the introduction of new elements into a public service – in the form of new knowledge, a new organisation, and/or new management or processual skills, which represents discontinuity with the past’. the types of innovation include (1) process innovations, (2) product or service innovations; (3) governance innovations, and (4) conceptual innovations (bekkers & tummers 2018). this paper focuses on process innovation. the key difference between private and public sector innovation is that the former is driven by a narrower interest of competitive advantage, while the latter is driven by the broader enhancement of public value through improved governance and service delivery (buchheim, krieger & arndt 2020; hartley 2005). process innovation is defined as ‘the implementation of a method for the production and provision of services and goods that is new or significantly improved, compared to existing processes in the organisation’ (bloch 2011:14). process innovation represents the capacity of an organisation to lower the costs of production by altering the production function, thereby allowing an organisation to position its products and services at competitive prices (li & ni 2016). it is divided into efficiency process innovation, the introduction of new ways of delivering services for operational efficiency and cost reduction, and quality process innovation, which is the introduction of new processes that produce better quality goods or services (chai et al. 2020). this form of innovation is achieved through integration mechanisms, which represent the complementarity between product and process innovation (hullova et al. 2019). given that resources are scarce and need to be effectively managed for value maximisation, organisations need to come up with a process innovation strategy and support organisational innovativeness (diéguez-soto, garrido-moreno & manzaneque 2018). in their study, bland et al. (2010) found that the intentional design, development, and institutionalisation of several mechanisms to facilitate the completion of the innovation process will increase the capacity for public sector innovation, through the network form of governance. although this most recent study by liu and zhang (2021) was conducted in the private sector, it is one of the few studies that investigated, in part, the relationship between relational governance and innovation. the study found that relational governance has a positive impact on firms’ open innovation. for government institutions, united nations (2006) posits that innovations in governance have a number of positive results, which include regaining people’s trust and restoring legitimacy. a previous study found that, properly managed, the network form of governance should increase the capacity for innovation (bland et al. 2010). yet, in a network setting between various stakeholders characterised by high levels of complexity, problems associated with coordination can undermine the innovation process (goldsmith & eggers 2004). part of the problem relates to ideas about relational governance, the role of social capital and trust within this network and the role of senior managers, whose role is to link people, resources and ideas (bekkers & tummers 2018; klijn & koppenjan 2015). a recent study by australian public service revealed that innovations with external target groups are more likely to be built on ideas from external stakeholders (boon, wynen & callens 2021). hence, the following hypothesis is postulated: senior manager’s perception of process innovation positively and significantly influences their perception of relational governance in a government department. perceived stakeholder engagement in strategic planning and perceived relational governance a stakeholder refers to any group or individual affected by or able to influence the attainment of an organisation’s objectives. stakeholder analysis and engagement refers to the means and organisational activities and arrangements that are undertaken to involve external stakeholders in the organisation’s operations and decision-making (greenwood 2007; passetti et al. 2019). by definition, stakeholders are in a position in which they can influence the organisation to achieve its objectives (brugha & varvasovszky 2000). this process is primarily concerned with the involvement of all key actors and the management of interactions and co-creation or solution development processes. stakeholders have become key actors in the operation of organisations, and understanding their dynamics implies capturing their peculiarities and complexities. these peculiarities and complexities include the interests they represent, their values, culture, knowledge, and other attributes unique to them. the stakeholder engagement process varies in dimensions, depending on the type of participants, which could be government, civil society organisations or citizens, the scale of the process, and the degree to which participation will lead to decision outcomes (lumpkin & bacq 2019; herremans, nazari & mahmoudian 2016). according to alford, douglas, geuijen and t’hart (2017:590) generating public value involves ‘managing down’ and ‘managing out’: managing down a specific government department or entity, and managing out to the broader value chain of stakeholders. these stakeholders must be actively involved in the organisational planning process and in the development and improvement of services. as part of stakeholder analysis and engagement, organisations have focused their efforts on defining, identifying, measuring, categorising, and engaging stakeholders, including those less obvious and otherwise marginalised (colvin, witt & lacey 2016). stakeholder engagement in the strategic planning process ensures the legitimacy of the decisions, especially made with a view to prioritise public services (manny 2012). although some critics have questioned the significance of stakeholder analysis and engagement, owing to its potential for stakeholder conflict, it has generally been lauded for adding value to organisations (derakhshan, turner & mancini 2019). in public entities, stakeholder engagement processes are more complex and allow for the inclusion of a wider selection of stakeholders (crow & albright 2019; crow, albright, & koebele 2016). according to bovaird (2004), public services are usually delivered through a range of public, private and voluntary sector organisations. mannya (2012) identifies external stakeholders as crucial for strategic planning and management particularly for their ability to bring about fresh ideas and perspectives necessary for assessing opportunities and organisational capabilities for effective delivery of public services. leimenstoll (2011) also adds that stakeholders may well be the dominant force in driving strategic action. external public sector stakeholders, such as regulatory authorities and local communities, have a direct influence on the success and value creation of public service initiatives. cairns, goodwin and wright (2016) emphasise the need to introduce strategic measures to address the diverse expectations and perceptions of stakeholders sustainably. it is thus a process that requires a deeper understanding of the characteristics of those stakeholders, as well as their role in transforming the organisation (jacobs et al. 2017). it is therefore important that both private and public entities identify their key stakeholders and the role they play in the organisation to optimise and improve their operational performance and deliver public value. building and maintaining strong relationships with stakeholders has the potential to increase value for organisations; hence organisations must effectively deploy resources towards stakeholder relationship management (obeng 2019). in their study of a large public construction project, karlsen, græe and massaoud (2008) found that trust between stakeholders could be built by improving communication skills, showing commitment and sincerity, establishing common goals and working towards reaching them. in fact, in a recent study, haarhoff (2019) found that developing mutually beneficial relationships with external stakeholders leads to public value and societal legitimacy. having found a significant and positive relationship between stakeholder involvement and service delivery, a recent study by keranga et al. (2021) attributed the strong association to communication and meaningful stakeholder involvement in strategic planning – attributes which characterise relational governance. from the arguments above, it may be noted that continual engagement and analysis of the various public stakeholders could provide valuable insights which facilitate the creation of organisational competencies and superior strategy. this leads us to the following hypothesis: senior managers’ perception of stakeholder engagement in strategic planning positively and significantly influences their perception of relational governance in a government department. conceptual model the initial and most critical stage in the analysis of data using the structural equation modelling (sem) techniques is the pictorial representation of the hypothesised relationship. as such, based on the theoretical grounding provided in this study and a review of the literature, the relationships between the variables in this study are depicted in figure 1. figure 1: conceptual model. research methodology this study adopted a quantitative approach using a cross-sectional survey method as a research design. data were collected by means of a self-developed questionnaire from literature and some previously validated instruments. this study was conducted among senior managers from the five national government departments in the public sector in south africa. these senior managers were enrolled for an executive development programme (edp) hosted by the national school of government. they attended the edp in various groups over the period may 2018 to april 2019. specifically, the respondents completed the questionnaires after they had attended a 3-day session for the strategic planning and management module. the edp mainly catered for senior managers at deputy-director, director and chief-director levels. the five departments have some 950 senior managers. of some 300 questionnaires issued, 230 were returned, duly completed, to be included for analysis. this amounted to a response rate of 76.7%. this was largely due to the convenience nature of the sampling method. that said, participation in this study was voluntary and respondents were assured of the confidentiality of their responses. in this study, data were analysed, first, by means of exploratory factor analysis (cfa) and confirmatory factor analysis (cfa). sem was implemented for cfa and hypothesis testing, using the eqs structural modelling software. eqs software provides a platform for conducting a variety of statistical procedures, including multiple regression, multivariate regression, cfa, and path analysis. sem is a statistical methodology, grounded in theory, which employs multivariate analysis to examine the relationships among variables. this analytical method has an advantage over conventional multiple regression, because when using this technique, models developed from theory can be evaluated and validated with room to make the necessary changes in the model. it is performed in a two-stage process involving cfa and path analysis. following a recommendation by anderson and gerbing (1988), two-step staged sem was performed, involving a confirmatory analysis and a structural model and hypotheses testing. cfa encompasses reliability and validity tests conducted to evaluate the measuring instrument and measurement model evaluation tests, which are meant to evaluate how well the data fit the model. structural modelling and hypothesis testing are carried out to enable decision-making with regard to the hypothesis in question. the results of this study are presented for cfa and structural model and hypothesis testing. results table 1 shows the profile of the respondents as follows: table 1: respondents’ profile. from the results presented in table 1, it can be noted that most of the respondents (51.7%) held the position of director in their departments. this was followed by the position of deputy director, which represented 34.3% of the total number of respondents. the remainder of the respondents held the posts of chief director (9.6%), deputy director general (0.4%), and other posts (3.9%). the ‘other’ category was made up of assistant directors, a chief engineer, a production engineer, a scientist, and a senior legal administrative officer. these are the principal positions in the public sector, which enhance the richness of the responses provided in this study. regarding educational qualifications, most of the respondents held a bachelor’s degree (35.7%), an honours degree (29.6%) or a master’s/ph.d. (23.9%). those holding a certificate, diploma or national diploma made up 8.3% of the total number of respondents, while other qualifications accounted for the remaining 2.6%. because of the levels of education recorded, it should be noted that the respondents were sufficiently educated to understand the concepts under study and interpret the questionnaire well. forty-nine point one per cent of the respondents were between the ages of 41 and 50 years. this is an age group that is deemed to have acquired substantial work experience, which is instrumental in ensuring the richness and quality of responses obtained in the study. in addition, 23.5% were between 35 and 40 years of age, which added to the work experience needed in a study like this. respondents between the ages of 51 and 60 years (21.3%) were also well represented. those between the ages of 31 and 35 years and those over 60 years only constituted small proportions of the respondents, namely 5.2% and 0.9% respectively. exploratory factor analysis efa allows for exploration, and is useful to test an empirical measurement instrument, that is, one that has not been previously tested and used (finch 2013; williams, onsman & brown 2010). the suitability of the data for efa had to be established before factor extraction and rotation could be conducted. factorability of the data set refers to the suitability of data for factor analysis. the kaiser-meyer-olkin (kmo) measure of sampling adequacy determines the strength of the relationship between variables for factorability of the variables, and is an indication of the sample adequacy (beavers et al. 2013:6). a kmo value of 0.5 is acceptable; more desirable, though, is above 0.6 (kaiser 1974). the results of the kmo and bartlet tests are shown in table 2. table 2: kmo and bartlett’s test. according to table 2, kmo = 0.898, which indicates that the sample is adequate and factor analysis may be conducted. the bartlett’s test of sphericity must be significant (p < 0.05) to indicate that data are suitable for factor extraction, and in this case p = 0.000 (pallant & manual 2007). this is determined, based on the relationship between variables, where correlations must be significantly different from 0 to continue with efa (maskey, fei & nguyen 2018). the rotation method used was varimax rotation with kaiser normalisation. all items had loadings above 0.4. the factor loadings are presented in table 3. table 3: validity and reliability assessments. reliability and validity assessments in this study, the process of ensuring the reliability and validity of the research scales culminated in a rigorous review of the literature and the adoption of previously validated construct items. this was followed by a statistical evaluation of the construct items. the cronbach’s alpha (α) coefficient and the composite reliability (cr) measure were used to evaluate the reliability of each construct in the measuring instrument. the factor loadings and the average variance extracted (ave) were used to evaluate the reliability of the measuring instrument. the results are presented in table 3. to establish the reliability of a measuring instrument, both the α and the cr values should exceed 0.7. in this study, the α values ranged between 0.788 and 0.890 while cr values were between 0.808 and 0.845, satisfying reliability requirements. table 3 shows factor loading for constructs; all the items (except for ppi4 and psesp5) had factor loading above 0.5, which is a requirement for convergent validity (anderson & gerbing 1988). items ppi4 and psesp5 were excluded for further analysis because they had loadings of 0.476 and 0.448, which were lower than the benchmark. in addition, the table shows ave scores ranging from 0.518 to 0.560, satisfying the recommended criteria that ave values should be above 0.5 for discriminant validity to hold good (fornell & larcker 1981). correlations and discriminant validity the validity of the measuring instrument was also tested through discriminant validity, which evaluates the extent to which a construct’s items differ from those of another construct. this was done following the procedure recommended by hair et al. (2010), which involved comparing the correlation between the latent constructs and the square roots of ave for the constructs. using this procedure, validity is achieved when the square root of the ave exceeds the correlation coefficients associated with each latent variable in a measurement model. from the results presented in table 4, it appears that all the latent constructs demonstrated satisfactory discriminant validity properties. the square root of ave for each latent construct was greater than the correlations between pairs of the constructs as suggested by hair et al. (2010). in addition, brown (2015) argues that discriminant validity is problematic when inter-construct correlations are above 0.85 (large effect), but the results in table 4 show that the correlations ranged between 0.407 and 0.709, and hence did not give rise to any discriminant validity concerns. because the validity assessment showed satisfactory psychometric properties for the latent constructs, there was no need to modify the original model and no new variables were formed. after satisfactory reliability and validity assessments, there was a need to proceed to measure model goodness of fit evaluation and various indices were used such as the cmin, the normed fit index (nfi), the incremental fit index (ifi), the goodness of fit index (gfi), and the root mean square error of approximation (rmsea). table 4: correlations and discriminant validity. measurement model evaluation (goodness-of-fit indices) as part of cfa, the goodness of fit indices were computed to evaluate how well the model fits the data. the results presented in table 5 indicated that the model fits the data reasonably well, suggesting an acceptable model fit. table 5: the goodness-of-fit indices. to evaluate the goodness of fit of the model, the χ2/df ratio, the comparative fit index (cfi) and the rmsea, inter alia, were computed. to achieve goodness of fit, the value of the χ2/df ratio must be below the threshold value of 3, according to carmines and mciver (1983). as such, a satisfactory fit was obtained because the value of the ratio in this study was 1.815. fit was also obtained using other indices shown in table 3. the values of the cfi were observed to be 0.931, which was greater than the 0.90 minimum required, and the rmsea value was also within the acceptable value range of ≤ 0.05 (hu & bentler 1999). conclusively, cfa confirmed the adequacy of all the construct items and there was a need to evaluate the structural model to confirm the hypothesised structure. structural model and hypothesis testing once the reliability and validity of the scales had been assessed, and the goodness of fit of the model obtained, the parameters of the structural model were assessed. the structural model in the form of the conceptual model shown in figure 1 was evaluated with the aid of eqs structural modelling software. the model has 5 unobserved latent factors, and 22 observed variables, and these were used to estimate the path coefficients, the explanatory power, and the relationships between the constructs in the structural model. table 6 presents the path coefficients and resultant decision of the hypotheses testing. table 6: structural model and hypothesis testing. discussion as presented in table 5, perceived information sharing (pis) was positively related to perceived raltional governance (prg) with a β value of 0.238 (at 5% level of significance) while perceived process innovation (ppi) is at the same level of significance. in the conceptual model and hypothesis development, it was proposed that pis positively and significantly influences prg and that ppi positively and significantly influences prg. the results presented show that both hypotheses were supported. the results are in line with previous studies. in their study, johnston and hansen (2011) found that in the public sector context, sharing information is critical for improvement in governance infrastructures, thereby enhancing the public sector’s ability to fulfil the service provision mandate to citizens. mu et al. (2021) also found that information asymmetry, opportunism, and distrust make the relationship commitment between stakeholders challenging. while this study found a positive and significant relationship regarding the perception of senior managers with regard to the relationship between ppi and prg (β = 0.252), another study found that a network form of governance, properly managed, should increase the capacity for innovation (bland et al. 2010). this result also finds resonance in bekkers and tummers’s (2018) observation that public sector innovation increases legitimacy and trust in government. the study also found that senior managers perceive stakeholder engagement as being positively and significantly related to relational governance (β = 0.443 at 5% level of significance). this finding concurs with lieutenant (2021) who posited that ‘stakeholder engagement is all about humanising the relationship between an organisation and those who are impacted by, interested in, or have influence over its activities’ and that ‘effective engagement builds healthy, trusted relationships that benefit everyone’. in turn, the hypothesis that prg positively and significantly influences perceived public value (ppv) was supported, with β = 0.606. the result obtained is in line with the arguments raised by schoenherr and swink (2012), that superior relationship management capabilities enhance an organisation’s ability to create sustainable value. these results are further supported by oppong, chan and dansoh (2017) in their study on the prioritisation of stakeholder management in the quest to enhance the public value. in a nutshell, all four hypotheses proposed in the conceptual model (figure 1) were supported. conclusion this study sought to investigate perceptions of senior public managers with regard to the influence of information sharing, process innovation, stakeholder analysis and engagement on relational governance, as well as the public value in selected national government departments. although some individual relationship have been explored in some previous studies, the grouping of these relationships are unique in this study as postulated in the conceptual model. this study’s results indicate that from the senior managers’ perspective, government departments could greatly improve their public value by focusing on relational governance. this suggests that government departments that seek to deliver superior public value, need to focus primarily on managing their relational governance. to that end, it is vital that they develop their information sharing, process innovation, as well as stakeholder engagement. the networks that flow from stakeholder engagement will strengthen relational governance, which the results of the study have shown to be important for public value creation. the relational nature of government activities becomes the core attribute of the process of public value creation (mendoza & vernis 2008). these relationships stem from diverse drives such as the need to access additional competences and resources, to increase productivity and quality and to reduce costs and risk (wallenburg & schäffler 2016). public managers are urged to use ict tools to facilitate participation between the different stakeholders in ways that are flexible, easy to use and attractive to use (osmani 2014). there is a need for governments to transform their digital platforms for the co-creation of public value and efficient utilisation and management of public resources (cordella & paletti 2019: meijer & boon 2021). turkel and turke (2016) also posit that it is important to create management systems that distribute internal accountability for public value creation across the public managers. a recent survey also indicates that for information sharing, specifically institutional mechanisms such as incentives for sharing, a quality information system, and a flexible structure, permitting work autonomy, does matter (park 2022). increasing the capacity for public sector innovation, through relational governance, requires the ‘intentional design, development, and institutionalisation of several mechanisms to facilitate the completion of the innovation process’ (bland et al. 2010). this is critical for government departments since the legitimacy of governments is determined by the manner and extent to which they are able to develop and implement new services, technologies, organisational structures, management approaches, governance processes and policy concepts when dealing with societal challenges (bekkers, edelenbos & steijn 2011). the increasing enormity and complexity of government requires it to continually redefine its vision and mission and innovate its business processes as it strives to deliver public services efficiently and effectively. investment on information sharing platforms, and the improvement in the quality and quantity of information shared with the various stakeholders by government departments, will go a long way in enhancing trust, commitment and communication – all of which are essential for improved relational governance. improved relational governance will lead to perceptions of enhanced public value by stakeholders. notwithstanding the theoretical and practical relevance of this study, the study is not without its limitations. data in this study were collected on a cross-sectional basis and, therefore, failed to ascertain the in-depth views of senior managers in regard to the objectives of the study. although cfa confirmed the reliability and validity of the measuring instrument, the directional nature of the relationships among variables should be viewed with caution, due to the cross-sectional nature of the data. since the study used non-probability sampling, the results cannot be generalised to all senior managers in government. future studies could employ a mixed method of data collection which includes a qualitative approach in which the qualitative views of senior managers in the form of interviews or focus groups are considered to enrich the study. also, resources permitting, future studies could consider probability sampling techniques that would help justify the generalisability of the findings. finally, future research could also compare the difference that other variables such as the size, sector, cluster, experience and education levels of senior managers will make to the results of the study. acknowledgements competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. author’s contributions d.p. conceptualised the study, designed the questionnaire and wrote the article. w.m. analysed the data and contributed towards the literature review. ethical considerations this article followed all ethical standards for research without direct contact with human or animal subjects. funding information the authors received no 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the construct of networking as embedded in the theory of social capital, hypotheses are formulated which allow for statistical testing. the results add to the ongoing debate on this dualistic typology of entrepreneurs, where in several instances significant differences are detected across networking diversity, ties, types of assistance and support perceptions. key words: networking, entrepreneurship, necessity-driven, social capital jel: d8, j24, l26, m13 1 introduction research among countries in transition underlines the point that entrepreneurship exists in every country (luthans, stajkovic & ibrayeva, 2000). this entrepreneurial spirit can be fostered where environmental factors such as family and support systems, financing sources, local communities, government agencies, and cultural factors have a positive affect on entrepreneurial behaviour (bygrave & minniti, 2000). in the absence of political stability, and formal support structures, networking and personal trust become even more important during transition as they offer some form of consistency and predictability in the times of fundamental change. entrepreneurial activity does not occur in a vacuum, but instead is rooted in cultural and social contexts, specifically within webs of personal and institutional networks (chan, bhargava & street, 2006; jackson, amaeshi & yavuz, 2008). not only can an individual’s social network be influenced by a variety of social relations and support factors, but the greater the political and societal legitimacy of entrepreneurship in a particular region, the greater the rate of business formation (carter, reynolds & gartner, 2004; jack & anderson, 2002). social networks provided by extended family, community-based or organizational relationships are theorized to supplement the effects of education, experience and financial capital (greve & salaff, 2003). there is growing literature suggesting the importance of networks to entrepreneurs and even arguing that social capital may be the most significant source of advantage for entrepreneurs (arenius & de clercq, 2005; audretsch & keilbach, 2004; davidson & honig, 2003; mitchell & co, 2004). studies indicate that networking allows entrepreneurs to enlarge their knowledge of opportunities, to gain access to critical resources, and to deal with business obstacles (adler & kwon, 2002; low & macillan, 1988; mcmillan & woodruff, 2002). through networks, entrepreneurs can provide the functions of missing formal institutions, such as contract enforcement and credit (welter & smallbone, 2006). researching entrepreneurship using a social capital perspective is important, as social capital is a crucial asset for small business owners struggling to survive in competitive markets (aldrich & zimmer, 1986), and abstract 408 sajems ns 14 (2011) no 4 particularly as collaboration between network actors requires expertise and competence if the relationship is to be successfully maintained (human, 2009). entrepreneurial activity in africa is heavily skewed toward low-expectation entrepreneurial activity; this is according to global entrepreneurship monitor (gem) report on high-growth entrepreneurship (autio, 2007; naude, thomas, wood & aloe, 2008). the primary objective of gem is to explore differences in national levels and types of entrepreneurship. the relative prevalence of opportunity-motivated versus necessitymotivated (i.e., entrepreneurs who say they are involved in an entrepreneurial effort to take advantage of opportunity or because they have no better choices for work), entrepreneurial activity provides useful insights into the quality of early-stage entrepreneurial activity. gem research has consistently shown that the economic contribution of opportunitymotivated entrepreneurs is higher than for necessity-driven entrepreneurs, who are alternatively termed as survivalists since they face structural challenges where expected returns are low and intermittent, with low expectations of growth and job creation, and where motivation is personal survival (morris & pitt, 1995; ngiba, dickinson & whittaker, 2009). this is in contrast to opportunity-driven entrepreneurs, who say are they are pursuing a business opportunity and strive for independence, and are largely responsible for up to 80 per cent of all job creation by entrepreneurs (autio, 2005). the classification of necessity-driven entrepreneurship (nde) versus opportunity-driven entrepreneurship (ode) with which this paper employs to scrutinize social capital, has been found to differ systematically in terms of (1) expectations of job creation, (2) projections for out-of-country exports, (3) intention to replicate existing business activity versus creating a new niche, and (4) participation in one of four business sectors (hessels, van gelderen & thurik, 2008; mcmullen, bagby & palich, 2008). despite the importance of these differences and entrepreneurial networking, little empirical or theoretical research has examined the dynamics of social capital in an emerging country context. not only is there is reason to suspect that the nature of networking between nde and ode may differ, but there have been calls for research on these two categories of entrepreneurs, so that this dualistic typology may further be interrogated (mcmullen et al., 2008; williams, 2008). by identifying these dominant categories of entrepreneurs, and linking them with research variables previously not related, will help elucidate how these entrepreneurs react differently or similarly to different phenomena as specified for this article. recognising that nde versus ode has been found to differ systematically on several variables, particularly in terms of growth expectations and of job creation (hessels, van gelderen & thurik, 2008), further investigation advances the topic where it has much relevance. the critical question that this paper raises, concerns that which we can learn about entrepreneurial social capital, considering that there is an under-explored and unarticulated set of networking principles and practices which have not been previously linked to the categories of nde versus ode. therefore the objective of this study is to identify any differences in networking practices and support perceptions between nde and ode. not only is there a reason to suspect that the nature of networking between nde and ode may differ, but by linking these two types of entrepreneurs with social capital, the study’s research question will be addressed. the article starts by reviewing theory on social capital and networking as it relates to entrepreneurship. as an explanation for the phenomena under study, hypotheses are formulated, which allows for differences between the variables to be tested. the study ends by drawing conclusions on the empirical findings and identifies the limitations of the study and provides suggestions for future research. 2 literature review every new venture, from mom-and-pop convenience stores to silicon valley superstars sajems ns 14 (2011) no 4 409 such as google, starts with an ‘investment’ from the founders themselves or the so called 3fs (family, friend, or foolhardy strangers) (bosma & levie, 2009:52). this community of investors is vital to the start-up process, with perceptions of social capital provided by a community being essential to entrepreneurial start-ups. this notion of community support may also be captured as the ‘batho pele’ principle in the broader south african context (mofolo, 2009). the study of social capital and its impact on economic decision-making and actions stems from classic literatures in economics and sociology (granovetter, 1973). social capital may be understood as the goodwill that is engendered by the fabric of social relations and that can be mobilized to facilitate action (adler & kwon, 2002; audretsch & keilbach, 2004). it refers to the relationships and networks from which individuals are able to derive institutional support and allows them to act together more effectively to pursue shared objectives (putnam, 1995). social capital is often explained in terms of social exchange, which allows for better understanding of the effects of exchange ties on performance. adler and kwon (2002) argue that the breadth of the social capital concept reflects a primordial feature of social life – namely, that social ties of one kind (e.g., friendship) often can be used for different purposes (e.g., moral and material support, work and social advice). in practice, the social capital concept has been traditionally conceptualized according to two main configurations of networks: structural and relational-cognitive ones (pirolo & presutti, 2010:200). social capital is often operationalised through the identification of networks and network relationships, sometimes defined by the strength of ties, repetitive group activity such as the frequency of meetings and other formal interactions, as well as informal gatherings and other social activities, and social and family relationships. the analysis of network structure requires, first, attention to the quality of the constituent ties, that is, their frequency, intensity, multiplicity, and so forth, and to their configuration (adler & kwon, 2002; mcmillan & woodruff, 2002). from an entrepreneurial perspective, social capital provides networks that facilitate the discovery of opportunities, as well as the identification, collection and allocation of scarce resources and strategic initiatives (davidson & honig, 2003; miller, besser & malshe, 2007). small firms are important in innovations through their linkages with larger firms (naude, 2007), thus impacting the performance of internationalized firms, (pangarkar, 2008; pollard & simberova, 2002), and influencing a nation’s economic activity through the interplay of established, new and small firms (minniti, bygrave & autio, 2005). certain networking activities have been positively associated with firm performance, for instance aldrich and zimmer (1986) report a positive relationship between firm survival and number of times per week of contact with network members. moreover surviving entrepreneurs are reported as being more active in social relations than their unsuccessful counterparts (sawyerr, mcgee & peterson, 2003). in a review of business networks, blundel and smith (2001) conclude that during venture creation, most entrepreneurs rely on informal sources in their personal networks in order to mobilize resources, especially before a venture is set up. based on a synthesis of research investigating the nature of networking in small firms (see: carson et al., 1995; curran et al., 1993), networking is described as an activity that varies according to the individual ownermanager and furthermore, according to the person with whom the interaction takes places. investigating the role of personal networking activities, sawyerr, mcgee and peterson (2003) show that small firms rely on a welldeveloped web of personal networks in dealing with uncertainty in the external environment. by researching levels of membership and activity in social networks for the selfemployed and their employed counterparts, dodd (1997) finds that both groups exhibit statistically significant levels of similarity. generally at least some aspects of business networking are generic, and the owners approach some tasks in similar ways in different environments; nonetheless given the 410 sajems ns 14 (2011) no 4 socially-embedded nature of networking activities, differences between communities are generally anticipated (cooper & denner, 1998). street and cameron (2007) find that characteristics of small business external relationships, such as relationship strength, network size, network structure, relationship type, goal compatibility, and existing trust, represent the largest area of research regarding antecedents of relationships. an entrepreneur’s network of social ties creates opportunities for social capital transactions. external ties to others provide entrepreneurs the opportunity to leverage their resources. thus, multiple diverse contacts are important, regardless of their strength (aldrich & carter, 2004). this diversity in network ties is crucial for entrepreneurs, as diversity increases access to a wider circle of information about potential markets, new business locations, innovations, sources of capital, and potential investors. on the other hand in homogeneous networks, information known to one person is rapidly diffused to others and interpreted in similar ways. in granovetter’s (1973) classic work, the importance of maintaining an extended network of weak ties in obtaining resources is emphasized. weak ties are loose relationships between individuals, as opposed to the close ties that would be found in a nuclear family. weak ties are useful in obtaining information that would otherwise be unavailable or costly to locate. they extend one’s network by linking individuals or organizations together and providing an interface for exchanges to take place (aldrich & carter, 2004). in contrast, an example of strong ties would be a sibling or parent helping out for free in some aspect of the start-up activities. thus, strong ties, such as those derived from family relationships, provide secure and consistent access to resources. the most reliable relationships in a personal network are strong ties, which are usually of long duration. they are long-term, two-way relationships, not governed by short-term calculations of selfinterest. networking and member relationships are nearly invisible to most scholars who study entrepreneurship and economic development in africa, however research is emerging which focuses on the phenomenon of entrepreneurship. for instance by focusing on a new entrepreneurial group who founded a system of regional enterprise networks in response to liberalized economic and political conditions, mcdade and spring (2005) describe how with donor funding assistance, these entrepreneurs organized 31 national, three regional, and one pan-african business network in west, east, and southern africa. since joining these networks some members are reported to be doing business with firms in other african countries network members, but have not established linkages with traditional formal or informal sector small-scale entrepreneurs, which comprise most of the entrepreneurial landscape. moreover, some members contend that there is more ‘talking’ than actual business being transacted. nonetheless in spite of their poor social network infrastructure, african firms of varying size and structure make very effective use of business networks (ahwireng-obeng, 2006). empirical work has in fact provided evidence of some international similarities, as well as some national-level characteristics (dodd & patra, 2002). in south africa, as in many parts of the world, the schism between the poor and rich is widening and entrenched inequalities act as a major deterrent to growth, development, and employment creation (lopez-claros, altinger, blanke, drezniek & mia, 2006). additionally south africa has a dual-logic economy, where on the one side there is a highly developed economic sector and on the other side one struggling for survival (maas & herrington, 2007). these schisms in many ways parallel the nde and ode divide, which are often construed as the motivational ‘push-pull’ dichotomy, where in developing countries one would expect greater push factors to be prevalent among entrepreneurs. south africa’s total early-stage entrepreneurial activity (tea) index, the primary measure used to compare rate of new business start-ups amongst countries was relatively low (5.90 per cent) for 2009 (bosma & levie, 2009:21). the profile of people who are categorised within nde versus ode in the latest gem report indicates sajems ns 14 (2011) no 4 411 that in south africa approximately 41 per cent of tea is nde and 46 per cent is ode (bosma & levie, 2009:25). the ratio of ode to nde is 3.8:1 and indicates that the proportion of ode is almost four times higher than that of nde, and is substantially higher than the average ratio of 2.5 across all gme countries (herrington, kew & kew, 2008:18). however this high ratio of ode over nde in 2008 is not borne out by an increase in the tea index. moreover south africa has staggeringly high levels of unemployment (2007 = 23 per cent) relative to the rest of gem sample (herrington, kew & kew, 2008:16). one would expect, therefore, that necessity would serve as a strong stimulus for an increased tea rate for south africa. despite these anomalies the nde versus ode rates are significant when read in conjunction with high-growth expectation earlystage entrepreneurs (hea) indicators of job-growth expectation, innovation and international orientation. south africa was one of the countries with the lowest hea rates over the 2004-2009 periods. additionally if one compares ode rates with nde rates of other developing countries, and excludes nde, south africa’s entrepreneurial activity is still the lowest of developing countries (von broembsen, wood & herrington, 2006:19). 3 research problem and hypotheses currently in south africa most research and policy initiatives focus on nde, who represent the unemployed masses. although micro enterprises or survivalists may have entrepreneurial characteristics, their ability to grow and create employment, are restricted by their scarcity of skills, business knowledge and resources (pretorius & van vuuren, 2002; urban, barreira & van vuuren, 2008). the level of growth aspiration of these necessitydriven entrepreneurs, or lack thereof appears to vary significantly according to economic context, quality of populations in terms of high-growth potential, the difference between income substitution and income generation, and the different societal opportunity structures that these entrepreneurs face (autio, 2007). after the construct of networking as embedded in the theory of social capital, has been unpacked, hypotheses are formulated which allow for statistical testing. based on the theoretical underpinnings discussed in the literature review, the following hypotheses are formulated and set at the 0.05 significance level (p-value < 0.05): null hypothesis 1: configurations of diversity in entrepreneurial networking will not differ between nde and ode. null hypothesis 2: configurations of networking ties will not differ between nde and ode. null hypothesis 3: configurations of networking assistance and support relationships will not differ between nde and ode. null hypothesis 4: configurations of networking climate support perceptions will not differ between nde and ode. ha: for all the above hypotheses the alternative states that there will be a difference between nde and ode in the configurations of networking diversity, ties, assistance and support relationships, and climate support perceptions. 4 nature of research since existing research has not yielded generalisable knowledge on differences in variables of social capital under scrutiny for nde versus ode, it was posited that a crosssectional survey based descriptive study, generating empirical results will add to the body of knowledge in this new direction of study. several studies have shown that the patterns of social capital development are strongly influenced by the social context where business partners are embedded (pirolo & presutti, 2010). subsequently the empirical research was conducted inside two delimited geographical areas, conducive to yielding respondents in both category of entrepreneur. the unit of analysis for this study was the individual entrepreneur who then also served as a proxy for their venture. 412 sajems ns 14 (2011) no 4 5 the sample frame recognizing that the question between nde and ode is polyvalent and people operating somewhere in-between these extremes tend to answer as being opportunity-driven (bosma, jones, autio & levie, 2007), specific sampling frames were identified for each type of entrepreneur. for ode, a generic sampling frame was identified from membership lists of businesses operating in the greater johannesburg area, these included: the johannesburg chamber of commerce and industry (jcci), the business referral and information network (brain), the department of trade and industry (dti), and the sa institute of intellectual property law. the population of these databases is approximately 4600 firms. the survey was solicited electronically with periodic reminder telephone calls. nde were solicited as part of an experiential exercise conducted by trained university students in the soweto township area. informal activity is pervasive in townships (bradford, 2007) most of which are single-person operations (morris & pitt, 1995). both categories of entrepreneurs are based in the gauteng province, the economic hub of south africa, which has the highest number of both formal and informal entrepreneurs (sa business guidebook, 2005). 6 the sample given the difficulty of accessing sampling frames for probability samples in social sciences research (mitchell et al., 2002), nonprobability sampling was used to gather data from respondents who met the pre-determined screening criteria of owning and managing a running business that has paid salaries, wages or any other payments to the owners for more than 3 months, (autio, 2007), and not employing more than 200 people (sa survey, 2006). coinciding with previous discussions and definitions, when operationalising the sample, the following broad criteria were used for nde – “were you pushed into entrepreneurship because all other options for work are either absent or unsatisfactory”, and for ode – “did you become an entrepreneur to exploit a perceived business opportunity” (bosma & levie, 2009). respondent’s biographical data served as control variables, which included age, gender, and race/ethnicity. based on eligibility criteria and suitability of respondents, 101 usable responses (an effective 47 per cent response rate) from an initial 213 surveys were generated as the final sample for ode. based on pre-determined selection criteria, and using structured personal interviews, 102 usable responses (an effective 39 per cent response rate), from an initial 255 surveys were obtained as the final sample for nde. for both ode and nde a wide range of businesses were sampled which included: agriculture, small-scale manufacturing, construction, financial, business, retail, motor trade and repair services, catering, accommodation and other trade, transport, storage and communications businesses. for nde, the trading environment was characterized by mostly informal premises, and some of these included; street trader or hawker, craft market, home or friend’s home, container or caravan, or local shopping centre. a profile of respondents is shown in table 1. 7 the measures apart from the respondents biographic details, the questionnaire surveyed several networking activities and sought a number as an answer (for example, of meetings per week, or hours expected), therefore responses were solicited in a manner to allow for quantitative analysis and most items were measured with either categorical, ratio or interval (1-5 likert) scales. to allow for meaningful comparisons with earlier work, a core set of questions based on the panel study of entrepreneurial dynamics (psed) (gartner, shaver, carter & reynolds, 2004) survey were selected. the psed provides systematic, reliable data on those variables that explain and predict nascent entrepreneurship. the first section (a) of the questionnaire was concerned with the diversity and tie strength in network relationships and focused on the number of persons who had sajems ns 14 (2011) no 4 413 been helpful to the respondent with the start-up process. next three aspects of the respondents’ relationship with these helpers were surveyed: first, how similar are the helpers to the respondent and to other helpers. second, how strong is the tie between the respondent and the helpers? questions included how long have you known (each helper), and how many times have you talked with (each helper) about business matters in the last week? by asking respondent how long he/she has known the helper is relevant because a number of previous studies have argued that ties of long duration almost reflect a strong commitment and most likely reciprocal relations between two people. thirdly, the respondent would describe his or her relationship in terms of network support, based on a list of role relationships. for section (b), respondents were asked in what way has each helper contributed to the start-up effort and on what terms? they were also asked which of these forms of assistance has been most important for the new business start-up. in section (c), climate support perceptions of entrepreneurial networking were measured. respondents were asked to what extent they agree/disagree with the various types of influences on networking in terms of business start-ups. 8 data analysis the proposed measures have been previously subjected to factor analysis, with satisfactory results achieved in terms of factor loadings and reliability (carter, reynolds & gartner, 2004). nonetheless reliability was re-tested, and item statistics were calculated using the cronbach’s alpha. descriptive statistics were calculated and the result output was split by group (nde versus ode) which entailed conducting crosstabs on the categorical variables. following prior methods used to detect significant differences in entrepreneurs (chan, bhargava & street, 2006), and based on data type collected, the hypothesized differences across variables were tested using chi-square methods. 9 empirical results to test for reliability of scales, cronbach’s coefficient alpha was used as it has the most utility for multi-scales at interval level of measurement. a correlation matrix was calculated for items per scale, indicating relatively low inter-correlations between items. an overall satisfactory cronbach’s alpha of 0.712 was obtained for total items measuring networking principles of diversity, ties, and support relationships. for items measuring climate perceptions of entrepreneurial startups, the cronbach alphas for total items was 0.700 indicating an acceptable degree of reliability (cooper & emory, 1995). having calculated sample statistics, results in table 1 show that the only significant differences detected on the demographic variables, in terms of helpers for opportunitydriven entrepreneurs versus necessity-driven entrepreneurs are on race/ethnicity (helper 1 = χ² = 9.536, df = 4, p = .049; helper 3 = χ² = 13.079, df = 4, p = .011). it is noteworthy that the number of people identified as helpful was the 1-3 category of helpers, with no significant differences detected between the groups. research on entrepreneurial networking has found that most business owners name no more than three helpers (aldrich & carter, 2004), which resonates with the present study results. 414 sajems ns 14 (2011) no 4 t a b l e 1 sample statistics with differences between nde (n = 102) vs. ode (n = 101) variables nde per cent ode per cent χ² sig. (p-value) gender 2.186 (0.139) male 47 57 female 53 43 age in mean years 32 34 standard deviation 11.4 11.6 race/ethnicity 9.526 (0.049)* black sa 47 40 asian/indian sa 12 6 white sa 22 41 coloured sa 9 6 nonsa (immigrant) 11 8 number of people identified as helpful 0.195 (0.907) 1-3 58 59 4-7 33 31 < 7 9 10 *indicates statistical significant difference where p < .05 (two-tailed). to test hypothesis 1 in terms of configurations of diversity in entrepreneurial networking between necessity-driven entrepreneurs and opportunity-driven entrepreneurs, table 2 shows that the three helpers’ characteristics in terms of age and gender tend to be relatively similar to the demographics of the necessitydriven entrepreneurs and opportunity-driven entrepreneurs themselves. these results add support to the argument that a degree of homogeneity in networks exists and that people tend to associate with others who have similar characteristics, values and interests, that is, diversity is relatively low. the only significant differences in table 2, are detected on race/ethnicity for helper 1 (χ² = 9.536; df = 4; p = .05), and helper 3 (χ² = 13.079; df = 4; p = .011). subsequently null hypothesis 1 is rejected and the alternative is accepted as some network diversity is evident between nde and ode. hypothesis 2 was tested in terms of networking ties, which measured length of relationship and frequency of contact, i.e., by asking how many times the respondents had talked with helpers about business matters in the past month. in terms of networking ties, measured via length of relationship and frequency of contact, see table 2. results indicate that the both ode and necessitydriven entrepreneurs have known helper 1 mostly for a length of 2-4 years. necessitydriven entrepreneurs knew helper 2 for 5-7 years and opportunity-driven entrepreneurs new him or her for 2-4 years while opportunity-driven entrepreneurs knew helper 3 for 2-4 years and necessity-driven entrepreneurs knew him or her for 5-7 years. these results are pertinent because of the relatively strong commitment and likely reciprocal relations to occur between two people who have accrued this length in a relationship. furthermore by asking how many times the respondents had talked with each helper about business matters in the past month – significant differences exist relating to all three helpers: helper 1 = (χ² = 10.086; df = 3; p = .013), helper 2 = (χ² = 12.446; df = 3; p = .002), and helper 3 (χ² = 11.455; df = 3; p = .005). following granovetter (1973) strong-ties are defined as those with whom the entrepreneur interacts at least twice a week. weak-ties are relationships that are enacted less than twice a week, but at least once a year. based on these results null 2 is rejected, since entrepreneurial networking relationships differ between ode and nde in terms of strong network ties as opposed to weak network ties. testing hypothesis 3 for differences in configurations of networking assistance and support relationships first required that the respondents rank 6 different forms of assistance rendered by each helper. based on these rankings significant differences were found for helper 1 on total items = (χ² = 18.758; df = 9; p = .027) (not shown). additionally, to establish on what terms the help was provided, respondents indicated that the assistance was sajems ns 14 (2011) no 4 415 mostly provided free, with significant differences between groups for helper 1 = (χ² = 20.942; df = 4; p = .001) helper 2 = (χ² = 12.695; df = 4; p = .05), helper 3 = (χ² = 18.925; df = 4; p = .001) (not shown). once respondents had delineated their network support structure in terms of helpers, basic descriptives were calculated from a list of role relationships, to establish any differences between ode and nde (see table 3). based on interval scales, mean scores and standard deviations were calculated. moreover, by applying tests of normality, and calculating the kolmogorov-smirnov and shapiro-wilk statistics, test scores indicate that normality was violated. hence, to test between the two groups, non-parametric tests were calculated, and the mann-whitney u and wilcoxon w test statistics rendered an overall non-significant z score (-.214). these results mean that the alternative hypothesis 3 is rejected as no significant differences were detected on items measuring support relationships. testing hypothesis 4, where configurations of networking climate support perceptions were surveyed, by applying tests of normality and calculating the kolmogorov-smirnov and shapiro-wilk statistics, test scores indicate that normality was violated. based on nonparametric tests, the mann-whitney u and wilcoxon w test statistics rendered an overall significant z score (-3.910; p = .001). therefore significant differences were detected between ode and nde in terms of climate perceptions, leading to the rejection of null hypothesis 4. moreover, the relatively high level of scores in terms of all the variables measuring climate perceptions suggests that necessity-driven and opportunity-driven entrepreneurs are generally positive about environmental conditions. t a b l e 2 differences in networking relationships, diversity and ties with helpers between nde (n = 102) and ode (n = 101) variables type helper 1 per cent χ² sig. (p-value) helper 2 per cent χ² sig. (p-value) helper 3 per cent χ² sig. (p-value) gender 1.679 (.167) 0.731 (.547) 0.411 (.514) male opportunity 59 60 43 necessity 41 40 57 female opportunity 42 36 38 necessity 58 64 62 age in mean years opportunity 36 36 34 necessity 64 64 66 race/ethnicity 9.536 (.049)* 4.172 (.383) 13.079 (.011)* black sa opportunity 53 38 40 necessity 43 46 38 asian/indian sa opportunity 18 20 18 necessity 12 12 13 white sa opportunity 18 28 23 necessity 37 33 40 coloured sa opportunity 10 12 19 necessity 7 8 7 nonsa immigrant opportunity 1 2 0 necessity 1 1 1 length of relationship with helper 3.377 (.3467) 7.554 (.053) 0.790 (.887) less than 1 year opportunity 9 8 10 necessity 12 25 17 2-4 years opportunity 35 35 33 necessity 40 26 29 5-7 years opportunity 24 28 28 necessity 27 31 31 8 years or more opportunity 32 29 29 necessity 21 18 23 416 sajems ns 14 (2011) no 4 number of times talked … last week 10.086 (.013) * 12.446 (.002)*** 11.455 (.005) ** once or less opportunity 10 16 11 necessity 15 17 22 2-5 times opportunity 36 28 29 necessity 52 51 40 6-9 times opportunity 19 29 22 necessity 21 22 18 10 times or more opportunity 35 27 38 necessity 12 10 20 * indicates statistical significant difference where *p < .05 (two-tailed); ** p < .01 (two-tailed); ***p < .005 (two-tailed). t a b l e 3 statistics for networking support relationship between nde (n = 102) and ode (n =101) role player mean std. deviation mann-whitney u z sig. (p-value) spouse/partner opportunity 3.41 0.706 necessity 3.22 0.687 -1.131 0.221 family/relative opportunity 3.30 0.798 necessity 3.45 0.712 -1.722 0.545 business associate opportunity 3.13 0.566 necessity 2.94 0.755 -.985 0.664 friend/acquaintance opportunity 3.22 0.761 necessity 2.78 0.744 -1.145 0.299 teacher/counsellor opportunity 2.94 0.635 necessity 3.03 0.675 -1.977 0.355 other relationship opportunity 3.47 0.776 necessity 3.77 0.778 -1.112 0.244 note: a non-parametric test was used because data were not normally distributed. mann-whitney u and wilcoxon w test statistics rendered an overall non-significant z score (-.214). t a b l e 4 statistics for climate support perceptions between nde (n =102) and ode (n = 101) type of support mean std. dev. cronbach’s alpha mann-whitney u z sig. (p-value) bankers and other investors go out of their way to help new firms get started. opportunity 2.69 1.032 0.737 necessity 2.14 0.788 0.788 -2.114 0.020** state and local governments provide good support for those starting new firms. opportunity 2.64 1.082 0.739 necessity 2.54 1.278 0.764 -1.544 0.050* other community groups provide good support for those starting businesses. opportunity 2.80 0.985 0.737 necessity 2.99 0.885 0.774 -3.122 0.000*** young people are encouraged to be independent and start their own businesses. opportunity 3.45 1.212 0.702 necessity 2.32 0.865 0.700 -4.114 0.001*** the local media do a good job of covering local business news. opportunity 2.89 1.154 0.731 necessity 2.14 1.002 0.755 -1.227 0.002*** many of my family and kin have started new firms. opportunity 2.85 1.116 0.740 necessity 2.99 1.114 0.788 -1.421 0.003*** sajems ns 14 (2011) no 4 417 those with successful businesses get a lot of attention and admiration. opportunity 3.53 1.287 0.726 necessity 2.01 0.778 0.711 -2.997 0.004*** most of the leaders in this community are people who own their own businesses. opportunity 3.27 1.116 0.723 necessity 3.22 1.416 0.785 -3.989 0.001*** there are many examples of well respected people who made a success… opportunity 3.63 1.154 0.700 necessity 2.99 1.121 0.711 -1.558 0.000*** a non-parametric test was used because data were not normally distributed. mann-whitney u and wilcoxon w test statistics rendered an overall significant z score (-3.910; p = .001). *indicates statistical significant difference where *p < .05 (two-tailed); ** p < .01 (two-tailed); ***p < .005 (two-tailed). 10 conclusion in line with contemporary views on the importance of social capital for entrepreneurs, the centrepiece of this study focused on uncovering differences in networking activities and perceptions of support between nde versus ode. at a general level the empirical findings provide mixed results in terms of the four hypotheses, where in several instances significant differences were detected. the findings related to the first hypothesis add to the ongoing debate of diversity in entrepreneurial networking, as differences were detected between ode and nde, leading to rejection of the null hypothesis. however, the results indicate a tendency towards homogeneity in networks, suggesting that network diversity is relatively low for both nde and ode. at the same time, the prediction that networking ties will not differ between nde and ode, as formulated in hypothesis two, is rejected as several significant differences were reported in terms of length of relationship and frequency of contact with each of the helpers. moreover, these relationships are based on strong network ties rather than weak network ties. on the other hand, null hypothesis three is accepted as no significant differences were detected between nde and ode with respect to network support relationships. configurations of networking climate support perceptions were predicted not to differ between nde and ode, however, several differences were found, leading to the rejection of hypothesis four. plausible explanations for some of these empirical results are made and interpreted in conjunction with previous findings. while it can be assumed that the degree of networking is indeed related to the type of entrepreneur investigated, this present research together with similar research (o’donnell, 2004) shows that networking also varies according to individual differences and the context in which the actor is involved. mitchell and co (2004) find that most network members are either friends or family members, that is, most of the contacts were made through the entrepreneur’s own effort rather than through referrals. south african entrepreneurs have been found to have established their network ties for a long time, although they spend less time in developing and maintaining contacts compared to their international counterparts. previous comparative studies on networking in different countries provide evidence of some international similarities, as well as national-level characteristics (cooper & denner, 1998). in the present study networking practices differ between ode and nde in terms of diversity, and on networking ties which for ode seem to be based more on strong than weak ties. past research points out that ties to more than one person with similar characteristics or in a similar social location are redundant and thus of questionable value in providing new information (aldrich & carter, 2004). moreover, these findings on network diversity suggest that homogeneous networks are prevalent in terms of helpers for both opportunity-driven and necessity-driven entrepreneurs. a network’s level of diversity 418 sajems ns 14 (2011) no 4 depends, in part, upon the mix of strong and weak ties. two forces promote homogeneity in personal networks. first, people tend to associate with others who have similar values and interests. it has been argued that people learn more from people like themselves than from other groups or experts (flora & flora, 1993), and that communities tend to learn best from those that are at the same level as themselves. second, people tend toward emotional and personal balance across their social relations. reflecting on the relatively average mean scores obtained on variables measuring networking assistance and relationship support obtained through networking, it could be postulated that in an emerging country context, such as south africa, individuals and firms often form loosely-structured networks without clear governance mechanisms to coordinate activities, pool resources, and pursue joint growth (luthans, stajkovic & ibrayeva, 2000). this means that networking is largely unstructured and coincidental in nature. as complex networks of socio-economic institutions are formed and shape the development of new technologies, knowledge intensive or ode are particularly affected, as they must deal with and act in these dynamic networks (groen, 2005). although this study makes a unique contribution by investigating a set of networking principles and practices which have not been previously linked to nde versus ode, this dualistic typology has begun to be questioned (williams, 2008). particularly nde and ode are largely treated as entirely separate categories constituted via their negation of each other. recently, however, researchers have questioned the separateness of opportunity and necessity drivers and argued that they co-exist in entrepreneurial motives. the co-presence of necessity and opportunity drivers among informal entrepreneurs notes that motives shift over time, and that there is a transition from necessity to opportunity orientated motives as businesses mature. indeed necessity-driven informal entrepreneurship may well provide a seedbed or platform from which opportunity-driven entrepreneurs emerge (williams, 2008). 11 implications based on this original investigation into social capital of ode and nde, several interesting practical and theoretical implications are observed. although efforts are under way to improve south africa’s human capital through education and skills training (urban, 2008), aspects of social capital are often neglected. a strong entrepreneurial culture cannot develop and flourish in areas with limited access to social capital, networking structures, social relations and support factors (welter & smallbone, 2006). key to countering these obstacles is to improve the country’s social capital base through entrepreneurial networking. one way to increase the social capital base of entrepreneurs is to devise a coherent and nationally-aligned government vision for building entrepreneurship which includes a better working relationship between government, intervention agencies and target communities. it is important to clarify that the findings and propositions made in this paper do not suggest that nde should be discouraged – particularly as these necessity-driven entrepreneurs can make a living for their families and could support their children’s education. this in turn could position them better in the job market to become opportunity-driven entrepreneurs (bosma & levie, 2009:11). national policy makers need to tailor their entrepreneurial development programmes to the profile of these broad categories of entrepreneurs. one of the strategies in promoting entrepreneurship is conducting appropriate research aimed at better understanding the capacities of different types of entrepreneurs in south africa. such research may help target advisory services and finance more precisely so that entrepreneurial performance improves. understanding networking behaviours would assist national policy makers who are trying to encourage more opportunity-focused entrepreneurial behaviour. sajems ns 14 (2011) no 4 419 12 limitations and future research limitations of the study include that data may have been contaminated by common method variance, since all variables were surveyed from the same set of respondents. another limitation of this research is that a crosssectional study loses its dynamic aspects of entrepreneurial networking. a relatively static picture of network positions was surveyed. by investigating the dynamics of networking processes in a temporal framework, jack, dodd and anderson (2008) demonstrate that networks are vital living organisms, changing, growing and developing over time. as a directive for future action, it is suggested that policy makers and entrepreneurial development agencies, facilitate the emergence of both nde and ode social capital, allowing for strengthening of specific network practices, as well insuring that the benefits of co-operation increase between these two types of entrepreneurs. such practices would allow for the development of a new type of integrated economy, where the intensive development of local and international networks allows for 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high-growth entrepreneurs: the relevance of business knowledge and work experience on venture success. journal of contemporary management, 5:58-71. von broembsen, m., wood, e. & herrington, m. 2005. global entrepreneurship monitor, south african report. graduate school of business: university of cape town. welter, f. & smallbone, d. 2006. exploring the role of trust in entrepreneurial activity. entrepreneurship theory and practice, 30:465-476. williams, c.c. 2008. beyond necessity-driven versus opportunity-driven entrepreneurship. international journal of entrepreneurship and innovation, 9:157-165. world economic forum. 2006. global competitiveness report 2006/7. available at: url: http://www.weforum.org/en/initiatives/gcp.html (accessed november 2007). abstract introduction literature review research design findings discussion conclusion and recommendations acknowledgements references about the author(s) tshililo r. farisani graduate school of business and leadership, college of law and management, university of kwazulu-natal, durban, south africa department of management, it and management, college of law and management, university of kwazulu-natal, durban, south africa citation farisani, t.r., 2022, ‘evaluating the capacity of rural-based south african stakeholders in the transformation of small, medium-sized and micro-enterprises.’, south african journal of economic and management sciences 25(1), a4592. https://doi.org/10.4102/sajems.v25i1.4592 original research evaluating the capacity of rural-based south african stakeholders in the transformation of small, medium-sized and micro-enterprises tshililo r. farisani received: 15 mar. 2022; accepted: 31 may 2022; published: 06 oct. 2022 copyright: © 2022. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the south african job creation challenges have been well documented by different scholars. the knowledge gap is what the transformational role of rural stakeholders is in securing sustainable livelihoods through small, medium-sized and micro-enterprises (smmes). this study is an attempt to fill that gap. aim: the study is aimed to contribute to an understanding of the capacity of rural-based stakeholders in the transformation of rural economies to sustainable livelihoods and smmes in south african municipalities. setting: this study focused on the capacity of rural-based stakeholders in the transformation and sustainability of south african smmes in the municipalities of jozini local municipality (jlm) and matatiele local municipality (mlm). methods: a qualitative, inductive, interpretative approach was used to achieve the research objectives. data were collected from 34 purposive (social network analysis group) interviews and 35 snowballing (semi-structured one-on-one) interviews with selected participants from the two rural municipalities. data were analysed using nvivo 12. results: the findings of the study reveal that the rural-based stakeholders are not capacitated to transform and sustain, on their own, livelihoods and smmes, without well-coordinated external support from national, provincial and district stakeholders. conclusion: it is, therefore, concluded that such a lack of capacity and poor coordination between the relevant stakeholders impact negatively on the transformation sought to assist securing a sustainable livelihood by means of smmes. the original contribution to knowledge (also summarised as a framework) in this study lies in the process that rural-based stakeholders follow in creating sustainability in rural smmes and livelihoods. keywords: capacity; rural-based professionals; smmes; job creation; local leadership; sustainable livelihoods framework. introduction cimadamore (2016) has correctly pointed out: during the past decades … the international community has consolidated a discourse on the eradication of [extreme] poverty that has been articulated in various international commitments (such as the united nations decades for the eradication of poverty, the millennium declaration, and the millennium development goals [mdgs]/sustainable development goals [sdgs] initiatives). (p. 131) it is in this same spirit that the south african government had over the last two decades and a half, been trying to contribute to the eradication of poverty through job creation and the sustainability of other livelihood strategies within south africa (sa). research papers by ssekitoleko and du plessis (2021), and paver et al. (2020) corroborate this and point out that the goal of sa’s post-1994 national government (ng) has always been to redress the imbalances of the past and implement a developmental local government (lg) that creates jobs, grows the economy and mitigates poverty using small, medium-sized and micro-enterprises (smmes). in displaying transformational leadership in this way, sa strives to be an example that africa and the world can learn from (gorgens-ekermans & roux 2021). gorgens-ekermans and roux (2021:2) went on to point out that ‘leaders possess the capacity to influence followers to aspire towards a collective purpose’. muller and pelser (2022) affirm and assert that ‘a gap exists to unify traditional and contemporary leadership theories which employ collaborative, multi-level techniques to increase leadership capacity’. such a collective in sa rural areas is composed of all stakeholders (such as lg, traditional authorities, private companies [including smmes] and other organised groups) and often led by rural traditional leaders and/or local municipality leaders. in line with this goal pursued by the sa government, the paper is aimed to contribute to an understanding of the capacity of rural stakeholders in the transformation and sustainability of south african smmes during the current job creation challenges in rural municipalities. therefore, the following objectives anchor this study: (1) to identify the stakeholders who are key in transforming structures and processes favourable to smmes; (2) to evaluate the strengths/abilities, and weaknesses of the rural local-based stakeholders; (3) and to explore the processes that local leaders follow in communicating to the local smmes. the jozini local municipality (jlm) and the matatiele local municipality (mlm), rural-based local municipalities in sa, were chosen as relevant case studies due to their ongoing job creation challenges and existing smme sustainability initiatives. therefore, the original contribution to knowledge (also summarised as an adapted sustainable livelihoods framework [slf] in figure 5) is in the process that rural-based stakeholders follow to empower rural smmes, rural entrepreneurs or aspiring entrepreneurs to change the unemployment challenges and create sustainable livelihoods to rural people. literature review what follows in this section is a snapshot of important role players/stakeholders, their influence and governing legislation in the development initiatives carried out in rural areas to sustain local livelihoods. local government madumo (2015) explains that in sa, the constitution is the supreme law of the land and, therefore, any other legislation or policies, not consistent with it, are null and void. madumo further explains that the state is composed of three arms: namely, national government (ng); provincial government (pg); and local government (lg). section 152 (1) of the constitution sets out the objectives of lg and how lg must conduct its affairs in pursuit of accountability, the provision of services, promotion of social and economic development, promotion of safety and health, as well as the involvement of local communities. molepo and maleka (2018) also point out that the local government municipal systems act (act 32 of 2000) forms part of the legislation promulgated to ensure that lg’s organisational, planning, participatory and service-delivery systems are performing optimally. it is, therefore, clear from all the legislation in place, that lg and their officials have all the necessary powers to be the formidable local partners to other departments and agencies in the implementation of sa’s smme policies and strategies to create jobs and sustainably local livelihoods. nevertheless, lg needs rural traditional authorities to be effective in rural areas. traditional authorities the aim of the traditional leadership and governance framework act (act 41 of 2003) is to create opportunities whereby traditional authorities and lg officials may work together to improve service delivery. mabunda (2017) states: in terms of indigenous law and the legislation of certain functional activities of local government, traditional leaders find themselves as part and parcel of the developments taking place in their areas. (p. 82) these effectively place the traditional leaders in a position to influence the processes in new economic development initiatives and, therefore, smmes in their areas. mabunda (2017) points out that the traditional and governance framework act (act 41 of 2003) provides for structures that not only empower the traditional leadership, but also the citizens in rural areas to participate in improving service delivery. the traditional leadership and governance framework bill (tlgfb) of 2003 further provides for the traditional authorities to be at the heart of local governance in the country; that is, they need to work with other local community structures (lcs). local community structures such as non-governmental organisations in rural areas, several organisations or structures operate, for various reasons, associated with job creation and other livelihood strategies. non-governmental organisations (ngos) are also present on their own, or through invitation by the government, to participate in initiatives for sustainable rural economic activities. all such organisations and institutions in local (rural) areas will be referred to as local community leadership (lcl) (nel 2018) as there are different structures working for the sustainability of local enterprises. the formations of lcs and management of local relations through lcl are, therefore, the fulfilment of section 152 (1) (e) of the constitution and the municipality systems act (act 32 of 2000), as they make provisions for the local community to participate in the governance of their area. thebe (2016) is also amongst those who advocated the involvement of all other stakeholders in the area by arguing that such participation serves both the government and the people better. thebe’s advocacy is consistent with muller and pelser’s (2022) assertion quoted in the introduction section. the following section reviews the challenges that lg, traditional authorities and lcs currently face in trying to partner with each other and other implementing partners. challenges of the institutions and organisations in rural areas the challenges of the institutions and organisations to be mentioned impact the partnerships needed to implement rural-friendly smme strategies, processes and policies. traditional authority challenges dodo (2013) argues that traditional leaders are dignified civil servants without any real power to contribute to sustainable livelihoods for their subjects. mabunda (2017:81) affirms this view by arguing that, ‘traditional leaders fail to realise the nature of the abuse because of poverty and semi-illiteracy, and they easily fall into the trap’. meaning the trap of apartheid to use traditional leaders against their subjects. educational qualities are thus brought into such an argument, pointing to the fact that smme policy making and implementation might need some form of literacy on the part of the implementing partners. while matsila (2016) agrees that traditional leaders acted improperly during apartheid days, matsila insists that there is still a role for them in securing sustainable rural livelihoods. furthermore, traditional leadership is still very active and highly respected in rural areas. matsila credits such respect from the locals as born of cultural tenacity. on the other hand, mabunda (2017) details his concern in this way: a major concern is the lack of understanding between the roles of councillors and the roles of traditional leaders. when local councillors were appointed, their roles appeared to be the same as the roles that traditional leaders are supposed to perform. (p. 80) nevertheless, tutu (2008) pours water on the suggestion of conflicts born out of overlapping roles. tutu points to the collaboration that is already happening in many rural areas whereby roles are shared between local councillors and traditional leaders. the partnership between traditional authorities and lg officials is, therefore, very important in ensuring that smme policies and strategies are implemented, monitored and evaluated. local government’s challenges local government’s challenges (relevant to the study) are summarised in this section under three headings: past imbalance, leadership challenges and the lg’s inability to self-monitor and evaluate livelihood strategies such as smmes. past imbalan ces: despite the current lg enabling legislation, past imbalances continue to hinder the lg from being an effective partner in implementing smme policies and strategies. taylor (1994) credits the challenges of lg in impacting rural economic activities and smmes in general to the enduring effects of the pre-democracy era in sa. mazibuko (2013) also points out that pre-1994, government institutions were directly used to suppress the indigenous black majority’s livelihood options by crafting and advocating policies that disempowered them. mazibuko, also points out that land reform policies were adopted, and relevant authoritative institutions enforced such policies. now lg does not seem to be capacitated to reverse the impact of these past policies on its own. mubangizi (2019) also points out that the habit of allocating insufficient lg resources to deal with the needs of rural people is a product of apartheid. mubangizi further illustrates that because of the nature of the location of rural municipalities (economically depressed areas), such municipalities find it difficult even to rely on tax revenue as other metropolitan municipalities could. capacitated lg leadership, therefore, becomes very important so that whatever little resources exist are managed properly. leadership challenges: moreover, researchers such as luthuli (2009) established that effective leadership in public administration is born out of experience and proper qualifications, the very attributes that the rural leadership are accused of lacking. matjie (2018) affirms and adds that being emotionally competent and possessing effective leadership abilities are important skills that are expected of leadership. in rural municipalities, where economic challenges seem to be more dominant than opportunities, informed leadership of the municipality cannot be more relevant. local governments’ inability to self-monitor and evaluate livelihood strategies such as small, medium and micro-enterprises: mubangizi (2019) argues that because rural municipalities … … are located in economically depressed areas and have difficulty in attracting and retaining skilled managers, professionals, and technicians, it follows that some of these municipalities are seriously challenged to fulfil their obligations. (p. 556) without skilled lg officials, it becomes impossible for lg to self-monitor and evaluate themselves without the assistance of other stakeholders. community leadership challenges mthethwa (2012) argues that there is a need for more research to understand the ways that local structures may contribute to policymaking and implementation processes. baruah (2012) concurs and points to examples whereby the institutions, meant for the empowerment of the poor, were formed in haste without an adequate framework, or the participation of the poor themselves. other studies on livelihood approaches and their implementation, such as the one done by gok (2012) argued that smmes’ owners who participated in rural local structures are equally to blame for unsuccessful, pro-poor policy implementations due to lack of cooperation. nevertheless, williams et al (2011) argued that while strained relationships between members of the rural local structures could have a negative impact, it is the political interference by those in power that makes local structures weak and unable to participate meaningfully in policymaking and implementation. the following section reviews the steps that could be taken to monitor and evaluate smme implementation strategies by all concerned stakeholders using slf as a guide. sustainable livelihoods approach and framework toner and franks (2006) argued that the sustainable livelihoods approach offers the best framework to deal with poverty and the roles that institutions, their policies, processes and their officials play in livelihood strategies. small, medium and micro-enterprises are strategies to secure a livelihood, and as has been reviewed in preceding sections, there is a close link between policies, strategies and relevant institutions. scoones (2009); and baffoe and matsuda (2017) are amongst the researchers who corroborated this view citing the unique ability of the slf to address issues associated with empowerment processes and roles of the different stakeholders. the slf make it possible to position different stakeholders/professionals/representatives at appropriate places, according to their specialisation, or mandate, as per the relevant legislation. this means that professionals that make themselves available to support lg in sustaining rural smmes will be easily placed where they may make a difference, while government departments, focusing on certain areas, would be positioned at their appropriate place within the partnership arrangements. an example of such partnership arrangements, from left to right (see figure 1), would include a combination of institutions (such as all levels of government departments and local institutions) and experts (ngos and community based organisations) in different categories, such as the vulnerability context, livelihood assets, as well as transforming structures and processes. figure 1: the sustainable livelihoods framework. nevertheless, several researchers (carney et al. 1999; mazibuko 2013) raised issues over recent years of what they considered a gap in the ability of the sustainable livelihoods approach (sla) ability to solve perceived power relations problems in processes that lead to the empowerment of the locals. mclean (2015) also argues that sla lacks flexibility and that in so doing, therefore, imprisoned other aspects that should have been there to solve power relations problems. these power relations problems that are being raised, have to do with how much voice other rural stakeholders have at different levels, and how much influence they have. this is where the institutional theory’s cultural cognitive element comes in. institutional theory scott and meyer (1983:140) place the institutional theory as a theory that seeks to explore the rules and processes that organisations are required to conform to, so that they get support or legitimacy in the eyes of their sponsors and other important actors/stakeholders. scott (2013) corroborates and points out that analysing an organisation’s subjections to the institutional process is certainly the institutional theory’s main concern. while the institutional theory has three elements (regulative, normative and cultural cognitive), only the cultural cognitive element will be explored in detail here. palthe (2014) points out that the cultural cognitive element allows for the analysis of the impact of shared values, beliefs and assumptions. to successfully work with rural stakeholders, all of the other stakeholders, professionals and representatives, need to understand and respect the values, beliefs and assumptions of the locals. research design research approach the study employed a qualitative research methodology and followed the inductive research approach. according to eriksson and kovalainen (2008), the inductive research approach is a process that requires the observation of patterns before generalisation, conclusions and new theories or frameworks are proposed. an interpretive paradigm was chosen for this study due to its ability to provide an understanding of people’s lived experiences (chilisa 2011). research method sampling purposive sampling was used in this study. due to the nature of rural areas, whereby institutions are scattered and not properly documented, it was important for snowball sampling to be carried out to supplement purposive sampling. snowball sampling assisted in identifying institutions that could give further corresponding information, or other rural smme supportive institutions that the researcher was not familiar with, but which other participants knew, as they worked together for local smme sustainability. the social network analysis (sna) tool became important in this regard, due to its ability to identify existing and potential institutions (connections) that are critical for smme sustainability in rural areas (jaja, dawson & gaudet 2017). data collection and methods in line with the interpretive paradigm, sna, together with one-on-one interviews, were chosen as research instruments for the collection of data from two rural municipalities. the study was conducted (as part of a phd research project) in a space of two years during which both primary and secondary data were collected. secondary data were collected throughout the study period while primary data were collected in six months from two municipalities about 800 km apart. this meant that time was set aside for each local municipality (jozini & matatiele local municipalities) that had more participants confirming their availability. table 1 below gives an account of the participants and tools used in this study. a total of 69 participants representing all leaders and stakeholders in the study areas were interviewed. altogether 18 such participants were interviewed from jlm, using sna, and 16 participants were similarly interviewed from mlm using sna. the rest of the participants were interviewed using semi-structured interviews making sure that all institutions and structures (see figures 2 and 3 in the following findings section are represented (jensen & jankowski 1991). that is, all leaders/stakeholders who availed themselves to represent their institutions were interviewed in both municipalities. secondary data were collected from the websites of jlm, mlm, the department of small business development (dsbd) and the operating documents of the mlm led (local economic development) unit. figure 2: summary of jozini local municipality’s small, medium and micro-enterprises social and institutional networks. figure 3: summary of matatiele local municipality’s small, medium and micro-enterprises, social and institutional networks. table 1: interview table showing participants and tools used in this study. data analysis in line with the research objectives mentioned in the introduction section, this study followed the grounded theory (gt) analysis. strauss and corbin’s (1990:7) clearly defined process was followed in this study. strauss and corbin (1990) state that gt process starts with: [o]rganizing data into discreet categories according to their properties and dimensions and then using descriptions to elucidate those categories and then theorizing, conceiving or intuiting ideas-concept – then also formatting them into a logical, systematic, and explanatory scheme. (p. 7) nvivo 12 was used to analyse the vast data collected due to the software’s ability to analyse different types of data. bazeley and jackson (2007) corroborate by pointing out that: the efficiencies afforded by software release some of the time used to simply ‘manage’ data and allow an increased focus on ways of examining the meaning of what is recorded. (p. 22) nvivo 12 made it possible to import and analyse and present the data collected during fieldwork using semi-structured interviews, social network analysis, and secondary data. findings the analyses in this section are presented in line with the study objectives. these are: 1, to identify the stakeholders who are key in transforming structures and processes favourable to smmes; 2, to evaluate the strengths/abilities, and weaknesses of the rural local-based stakeholders; 3, and to explore the processes that local leaders follow in communicating to the local smmes, the identification of the professionals and rural community leaders who are key in transforming structures and processes favourable to smmes (see figures 2, 3 & 4); strengths/abilities, weaknesses of the local community leaders, and processes that local leaders follow in communicating to the local smmes (see figure 4). figure 4: summary of the capacity of leaders in the transformation of small, medium and microenterprises. figures 2 and 3 below summarise institutional networks in both jlm and mlm. identification of stakeholders who are key in transforming structures and processes favourable for small, medium and micro-enterprises local economic development (led) officials, traditional leaders, ngo leaders and local business leaders play crucial leadership roles in sustaining rural smmes. the participants in both study areas in mlm and jlm indicated that such stakeholders/leaders play different, complementary roles. the interviewed local economic development officer (participant 1, male) responsible for smmes at matatiele local municipality gave a detailed explanation concerning such roles. he states that: ‘small enterprise development agency (seda), dsbd (national office), department of economic development and environmental affairs (dedea) – it is based in maluti i.e provincial province), matatiele business chamber, matatiele multi secondary sectoral cooperatives: responsible for smmes in matatiele, eastern cape development cooperation (based in mtata), sars assist with developing a business plan, increasing individual smme capacity i.e. training smmes with financial management, business management, bookkeeping and marketing. dsbd assist with infrastructure like working material e.g. if you are in the catering business, they provide equipment for catering. our office also assists with business plan development and grant funding. the grant funding is for equipment i.e. we advertise and the smmes in the area apply for the funding, upon successful application of an applicant, we procure the equipment for them. we also monitor the funded smmes every month.’ it is, therefore, clear that different departments and their agencies are being credited for crucial resources needed in sustaining rural smmes. resources such as financial, physical, human and social resources. the led officer is, therefore, crucial in making sure the resources that smmes need are available to them. the senior led officer in jlm, (participant 2, male) in ndumo responsible for smmes also explained how he ensures that the smmes are supported using a formal platform. he stated: ‘we form a formal business structure known as jozini business chamber of commerce. it’s a legal entity that starts with provincial. we do business issues with them’. he went further to explain that such a platform is crucial for relevant stakeholders to discuss on an equal footing among themselves issues of business sustainability within the municipality. that is, how to mobilise different resources to sustain the business ecosystem whereby smmes thrive and, in turn, create jobs. mobilising available human resources is particularly important given that jlm is a rural municipality with limited resources. a senior councillor interviewed at jlm, (participant 6, male) corroborated the municipality’s lack of financial and human resources by admitting that ‘they are not enough’. traditional leaders in rural areas covered in these study areas have been described by the participants as influential when it comes to land and other resources. the traditional leader interviewed (induna) (participant 4, male) corroborated with the other participants concerning their influential role in sustaining local rural smmes. in his own words he stated: ‘we work together with umnotho phansi, farmers. they are the ones that if they have issues, they talk to us and we look for a way forward. we talk to the higher authorities.’ he further pointed out that these issues often had to deal with resources that the local smmes need to sustain their smmes. resources, such as financial (grants), physical (land and equipment) and human resources (e.g. relevant professionals to attend to water-related challenges). thus, traditional leaders assist directly with staff capacity in the rural municipalities and national developments that do not have staff based in rural areas. non-governmental organisations differ in size and footprints. some ngos have footprints in one municipality only while others have offices and officials in several municipalities, provinces and even countries. the size of the ngo will determine the leadership hierarchies and other important support services needed by the local smmes. in both jlm and mlm there are several ngos such as lima (found in both municipalities and has national footprints in other provinces) or technoserve (found in jlm but has international footprints). a participant (participant 5, female) who works for an ngo in matatiele and acts as a secretary to the local sustainable livelihood partnership at mlm elaborated on the role of ngos in sustaining rural smmes. she remarked that ‘we are the implementation agency for the government’. she went on to explain how they assist the local municipality and the department of economic development and environmental affairs to reach the far-flung rural villages with their support. the support to farmers ranges from financial (market to auction animal) to physical resources (vaccinations). business leadership in both jlm and mlm has also been found to be according to the size of the organisation in question. in jlm, massmart has boxer and cambridge stores and each store has different leaders (managers) with buying authority to trade with local smmes. the bigger the size of the spar franchise (as the one at ndumo, jlm) the higher the likelihood of smmes negotiating directly with leaders on various business terms when it matters. the participant (participant 7, male) who works for jlm in ndumo spar elaborated on the business relationship between themselves and the local rural small-scale farmers. he stated that: ‘we receive potatoes, cabbages, carrots as well as other fresh produce from the local farmers. we buy from them because we receive it fresh, rather than to buy it from johannesburg. the difference is the cost. if you order from johannesburg, which we call the fruit spot, we get it at a higher price as opposed to buying it locally.’ the perspective (on the value of the products to the retailer’s branch) of the rural store manager is, therefore, crucial and determines whether the local farmers have a market and the much-needed financial resources. strengths/ abilities, weaknesses of the local community leaders local leaders have several strengths or abilities, as well as weaknesses that are crucial in sustaining or transforming rural smmes. strengths and abilities of the local leaders that assist in sustaining or transforming rural small, medium and micro-enterprises there are several strengths or abilities (of local rural leaders) that are crucial in sustaining or transforming rural smmes as identified in both the jlm and mlm study areas. these include the leaders’ deep knowledge of the communities they serve, their ability to fluently speak the language of the locals, and the walking distance between rural-based leaders and local smmes. deep knowledge about the locals is important because the local leaders understand the background of the people better and, therefore, may give resources needed by the smmes without much background research on the applicant. a good example is the business relationship between ndumo retail store manager and the local rural smmes in the area as described above. weaknesses of the local leaders that impact negatively on sustaining or transforming rural small, medium and micro-enterprises the jlm rural-based councillor interviewed, (participant 3, male) in ndumo pointed out that illiteracy among the local traditional leaders is a problem. he points to how they treat women who need land for business or personal purposes by stating that: ‘if a woman wants the land to build a house or if they want to have a company, there is a challenge because induna or inkosi will ask them about their husband. according to their laws, they cannot give a woman land.’ nevertheless, one traditional leader interviewed disputed such utterances of the councillor. on the other hand, the same village traditional leader, who disputed the councillor’s explanation of traditional leaders’ illiteracy impact on women, showed confusion and a lack of understanding regarding the local processes. when asked whether the prospective business owners who needed to be allocated land to build their new business in the area are happy with the process, participant 4, (male_, stated that, ‘they are happy about the process because it is quick’. on further questioning concerning the number of those who were frustrated along the process and never returned to follow up and get the land to build the business, he stated, ‘there are many’. his inconsistency may be associated with illiteracy and may be one of the reasons some of the ‘many’ he referred to are not returning. ngos in both jlm and mlm seem to also send the less educated and less experienced in deep rural areas to work daily. the reasons for such habits are many, amongst them being the unwillingness of more qualified and more experienced personnel to live in deeply rural areas. therefore, the more experienced personnel and better services and resources would likely be easily accessible in local towns and not in the villages themselves. the same applies to municipality officials (such as led officials, responsible for agriculture or smmes) who prefer to send interns to villages while they remain in their offices. processes that local leaders follow in communicating with the local small, medium and micro-enterprises there are different processes that local leaders of ngos, local big businesses, municipal offices and chiefs use in communicating with the local smmes. the officials of the local municipality led departments in both jlm and mlm hold quarterly meetings with the majority of smmes. such quarterly meetings happen between the led official responsible for a specific sector (e.g. tourism) and the representative of small businesses in the form of local associations or structures that represent them. a participant (participant 8, female) who has been a led intern in jlm for over a year in tourism stated: ‘in each year we have 4 quarters. in every quarter we have a midterm. and then there is another program that is called the tourism forum whereby it’s also set quarterly. we invite all the stakeholders that we work with.’ according to all the local municipality officials interviewed, the district municipality and provincial officials from the same ministry often attend such quarterly meetings organised by the local municipality official responsible for implementing that ministry’s policies, laws and regulations. the smmes interviewed disagree with the assertions of the led officer in mlm that opportunities are widely and locally ‘advertised’. they claim that opportunities are not well advertised and communicated but given to friends and well-connected business associates of the municipal officials. a white business owner (participant 9, male) interviewed at mlm also complained about the lack of communication and support from the local municipality when there are tenders. he stated: ‘i employ 20 black people on a full-time basis, and they don’t factor that in their bee [black economic empowerment] application to my business’. eight hundred kilometres (800 km) away from mlm, a jlm senior councillor (participant 6, male) interviewed corroborated the assertion by stating that the problem that hinders sustainability of rural smmes and sustainability of livelihoods is often ‘politics’. non-governmental organisations in the mlm study areas are more active than in jlm and, therefore, it was easy to see current communications between ngos in mlm than in jlm. in mlm, officials of ngos such as lima, conservation sa, meat naturally and ers, have been praised by the local municipality officials and interviewed smmes for being very active. in the jlm study area, lima and technoserve, the ngos that had contributed to much of the development in the area, were closing offices, and, therefore, communication was rare and the local smmes were not sure what would happen in the future. very few were available to be interviewed among mlm’s big businesses to conclude research on the communication between smmes and big businesses. the only big business owner to be interviewed indicated that there are little to no business deals between his business and local smmes; that is, the business gets suppliers from other big business in the area, while the rest of the services are on house/produced within the business and no contracting of smmes. in jlm, the retail, local game reserve and local lodge indicated that they have business relations with the local smmes. nevertheless, communication between local supportive big businesses and smmes has been described as informal; that is, there are no weekly or monthly meetings, but communication occurs when a big business such as spar contacts the local farmers or smmes for a once-off business deal. figure 4 summarises the capacity of professionals and rural community leaders in the transformation of structures and processes favourable for smmes in the study areas. discussion this section is subdivided into three subheadings in line with the study’s objectives: the identification of rural stakeholders in transforming structures and processes favourable to smmes; strengths/abilities, weaknesses of the local community leaders; and processes that local leaders follow in communicating to the local smmes. identification of rural stakeholders who are key in transforming structures and processes favourable for small, medium and micro-enterprises the findings and analysis section has shown that led officials, traditional leaders, ngo leaders/professionals and local business leaders play crucial roles in sustaining rural smmes. it also became clear that there are fewer staff/professionals available to deal with various issues related to the sustainability or transformation of rural smmes to enable job creation. this is consistent with mubangizi’s (2019:556) analysis as elaborated in the literature review section. chirau and blaser-mapitsa (2020:4) corroborate by indicating that results from their study in south african local municipalities show that ‘20% of the employees have a formal m&e qualification while 80% do not have’. other stakeholders’ expertise outside of the municipality’s human resources is, therefore, important in sustaining or transforming rural smmes. musakuro and de klerk (2021) affirm by pointing out that ‘talent management is one of the most important and key strategic issues that managers face in the modern-day business environment’. the findings also revealed that local stakeholders are crucial in availing themselves of much-needed assets/resources (see livelihood assets base in figure 1 and figure 5) to make rural smmes and economic activities sustainable. the formation of jlm’s jozini business chamber of commerce is one such example of the findings. these are consistent with toner and franks’ (2006) analysis concerning the sustainable livelihoods approach and framework. figure 5: a proposed framework adapted from sustainable livelihoods framework. turning the weaknesses of the local community leaders into strengths and connecting local strengths with provincial and national strengths in the following two subsections the process is discussed of turning the weaknesses of the local community leaders into strengths that sustain rural smmes and connect local strengths with provincial and national strengths. strengths and abilities of the local leaders that assist in sustaining rural small, medium and micro-enterprises the findings section revealed that deep knowledge, living within walking distance (to rural smmes) and the ability to fluently speak the language of the locals are strengths. strengths that are crucial for professionals and the rural community leaders (from the transforming structures. see figure 5) to possess in their daily duties to sustain rural smmes. the deep knowledge that ndumo spar manager possessed concerning the products of local farmers and what his customers needed, gave him the ability to act in sustaining both his store’s financial growth and fulfilling the local smme’s market and financial needs. speaking the same language and living within walking distance made it easier for knowledge sharing. that is, the retail store manager can tell the farmers the quality he expects for his customers and the prices such quality will earn. such knowledge assists the local farmers to comply with the required quality from seedling to harvest. such findings and analysis are consistent with the cultural-cognitive element of scott and meyer (1983)’s institutional theory. palthe (2014) points out that the cultural cognitive element allows for the analysis of the impact of shared values, beliefs and assumptions. the findings are also consistent with the regulative element because farmers may conform to the rules that the retail manager sets for the good quality of the products. this is consistent with gorgens-ekermans and roux’s (2021) views on transformational leadership and influence as quoted in the introduction section. weaknesses of the local leaders that impact negatively on sustaining rural small, medium and micro-enterprises the key finding about the weaknesses of the local leaders in both jlm and mlm is that the leadership and professionals closest to the rural smmes are less capacitated regarding education and the resources of the very institution or organisation (local municipality, ngo or traditional authority) specialises in. this is consistent with the findings of dodo (2013) and mabunda (2017) concerning traditional leadership’s capacity as discussed in the literature review section. as part of the rural transforming structures (see figure 5), traditional leaders are key links between the smmes, other transforming structures and their assets/resources needed for smme sustainability. moreover, the lack of capacity on the side of the officials (see figure 5 for the transforming structures’ relevance), sent by their respective institutions, has been shown to vary. to vary and sometimes fall outside the ability of the institution’s capability to address. as the participants in the findings revealed, the inability of rural municipalities to acquire enough funding to address incapacity, is seen to be beyond the local leadership powers because of current and past systems in place. mubangizi (2019) corroborates that the resources awarded to lg, are not nearly enough to deal with the needs of rural people. as already discussed in this article, the habit has its roots in the apartheid system. capacitated lg leadership, therefore, becomes very important so that whatever little assets/resources exist, are managed properly (see figure 5). muller and pelser (2022), as well as thebe (2016), concur and advocate the involvement of all other stakeholders in the area. their arguments are consistent with slf and institutional theory’s cultural cognitive element. rural and cultural-based communication processes gorgens-ekermans and roux (2021) point out that transformational leadership is only evident when the leaders communicate clearly about being tasked with empowering others. the findings and analysis section revealed several communication strategies used by different leaders/professionals/stakeholders when they communicate with their counterparts. these communication methods range from contact meetings, phone calls, media and organisational websites. the findings also reveal that readily available and cheap methods are not being used enough in such communications: methods such as whatsapp and facebook are hardly mentioned in communication meetings, advertising tenders or opportunities, and the selling or advertising of local products. relying on traditional methods of newspaper and websites has been found to reach very few rural smmes with announcements of new tenders or local opportunities the local municipality or local ngo have to offer. the majority of rural smmes spend more time on social media platforms like whatsapp and facebook and do not read a newspaper or browse the local ngos websites. such findings reveal the breakdown of communication regarding better ways to pass critical information between stakeholders (see figure 5 arrows for suggested smooth flow of information and resources). the findings are consistent with those of mthethwa (2012) and baruah (2012). both researchers point out that when lg leaders close or rarely use communication channels between themselves and the other stakeholders, the sustainability of local livelihoods is impacted negatively. by keeping communication channels open, the local municipality officials in the study areas may effectively advertise tenders and opportunities needed by rural smmes to sustain themselves and their local livelihoods. the favoured, locally friendly and traditional method of using the local traditional leaders to inform the local smmes about tenders and opportunities has proved ineffective. such ineffectiveness has been blamed on nepotism and corruption on the part of the municipality officials and the local traditional leaders. such findings are consistent with those of williams et al. (2011) and mulika and routray (2016) who have all identified unwanted interferences that undermine the fight against rural unemployment challenges, transformation or the sustainability of local livelihoods. this is also consistent with louw and barker (2021), as well as gorgens-ekermans and roux’s (2021) assertion that leaders influence those they lead. the following adapted slf (figure 5) is proposed to summarise the previous discussion section and contribute to the processes that are favourable (i.e. in line with the cultural-cognitive element of scott and meyer [1983]’s institutional theory) for the empowerment of rural smmes and sustainability of rural livelihoods through relevant stakeholders. the emphasis on the collective human resources from all stakeholders/institutions improve local leadership mindset/capacity and do away with the local municipality’s leadership mindset/capacity challenges (muller & pelser 2022). conclusion and recommendations this study is aimed to contribute to an understanding of the capacity of rural stakeholders in the transformation and sustainability of south african rural smmes during the current job creation challenges in rural municipalities. to achieve the aim of the study, three objectives were pursued: (1) to identify the stakeholders who are key in transforming structures and processes favourable to smmes; (2) to evaluate the strengths/abilities, weaknesses of the local community leaders; (3) and to explore the processes that local leaders follow in communicating to the local smmes. the findings of the study reveal that the rural-based stakeholders/leadership (from transforming structures. see figure 5) are not capacitated to transform and sustain smmes and livelihoods on their own without well-coordinated external support from national, as well as provincial and district stakeholders/leadership. it was also established that there are both rural-based leadership/stakeholder weaknesses and strengths that work for and against the transformation of failing smmes and the sustainability of local livelihoods. existing and long practised local processes have both benefits/advantages and limits in sustaining smmes and rural livelihoods. it was further established that communication between stakeholders is inadequate and does not factor in rural smme’s existing communication trends. it is, therefore, concluded that rural stakeholders’ lack of capacity and the poor coordination between relevant stakeholders impact negatively on the transformation and sustainability sought to sustain smmes and livelihoods. the original contribution to knowledge (also summarised as a framework in figure 5) in this study is in the process which rural-based stakeholders (from transforming structures) follow in the empowerment of rural smmes. the proposed adapted slf suggests practical processes that could be beneficial to all stakeholders and serve as a guide. a guide in the distribution of much-needed assets/resources and empowerment processes that lead to job creation and sustainability of livelihoods in rural areas. limitations and recommendations well-coordinated external leadership support from national, provincial and district stakeholders would be critical to ensure the sustainability (by providing assets/resources. see figure 5) of rural smmes and livelihoods. key rural stakeholders such as municipal councillors, led managers and rural traditional leaders (i.e. leaders from the transformational structures. see figure 5) need to inform national, provincial and district stakeholders/leadership on what assets/resources are key in sustaining rural smmes, who in turn sustain rural livelihoods through the jobs that they create. that is, local leaders need to be specific on what assets/resources (financial, physical, human, social and natural) are needed and where to avoid duplication of allocation of assets/resources while other areas experience lack. to maximise the roles of traditional leaders and other rural-based leaders/stakeholders, lg needs to motivate funding from relevant ng departments and big businesses to train such stakeholders. that is, the lg leaders, such as the municipality manager and led manager, are responsible for finding alternative ways and funding to make use of the local human resources to supplement their poor capacity as shown by findings. the recommendation concerning the communication process is that this process should be chosen by rural leaders and officials/professionals when communicating with rural smmes, and it must be accessible. that means only communication processes that all stakeholders can identify with and find easy-to-use must be prioritised. there is a need for further research on the role of big businesses in empowering rural smmes to use technology in areas they need support in the most, such as marketing, diversity and innovation. again, for the big business leaders to be fully committed and feel a sense of belonging, the lg leaders need to show that they take their concerns seriously, such as being discriminated against when there are business opportunities in the local municipality. research on alternative empowerment processes that does not exclude people by their skin colour, such as bee, is therefore necessary. this study focused on two rural municipalities that share their borders with foreign countries and therefore more research that includes other inland rural municipalities is needed. acknowledgements the author wishes to acknowledge his wife mrs nickie hlekani farisani for her support throughout the writing of the article. some of the writing and research of this article was derived from t.r.f’s phd thesis titled ‘sustaining south african rural smmes, a sustainable livelihoods research’ submitted in january 2021 and passed in september 2021. competing interests the author declares that he has no financial or personal relationships that may have inappropriately influenced him in writing this article. author’s contributions t.r.f planned and conducted the research, reviewed the literature, formulated the research design, collected and analysed the data, made interpretations and finalised the paper. prof betty.c. mubangizi supervised the phd thesis but was unable to contribute directly to this paper. ethical considerations this study followed all ethical standards according to the university of kwazulu-natal guidelines (hssrec/00000253/2019. 29 august 2019). funding information the research for t.r.f.’s phd thesis titled ‘sustaining south african rural smmes, a sustainable livelihoods’ was sponsored by both the university of kwazulu-natal (ukzn) and the national research foundation (nrf). the financial assistance of the nrf is hereby acknowledged. opinions expressed and conclusions arrived at are those of the author and are not necessarily to be attributed to the nrf or ukzn. data availability the data that support the findings of this study are available upon reasonable request. 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https://doi.org/10.1080/00220388.2010.527949 abstract introduction literature review methodology results and discussion conclusion acknowledgements references appendix 1 about the author(s) emmanuel orkoh trade research entity, faculty of economic and management sciences, north-west university, potchefstroom, south africa phillip f. blaauw trade research entity, faculty of economic and management sciences, north-west university, potchefstroom, south africa carike claassen trade research entity, faculty of economic and management sciences, north-west university, potchefstroom, south africa citation orkoh, e., blaauw, p.f. & claassen, c., 2021, ‘spousal effects on wages, labour supply and household production in ghana’, south african journal of economic and management sciences 24(1), a3535. https://doi.org/10.4102/sajems.v24i1.3535 original research spousal effects on wages, labour supply and household production in ghana emmanuel orkoh, phillip f. blaauw, carike claassen received: 31 jan. 2020; accepted: 09 dec. 2020; published: 02 mar. 2021 copyright: © 2021. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the relationship between spousal wages and hours of work, including the phenomenon of a spousal premium or penalty, is well documented in the literature. however, there is limited information on the situation in developing countries where labour market rigidities and cultural norms are factors in the division of labour between husbands and wives. aim: this article addresses the research gap by analysing spousal wages among couples and the cross-wage effect of spousal time allocation. setting: households in ghana, where sociocultural norms largely influence the role of men and women constituted the context of the study. methods: the instrumental variable tobit estimation regression was used to analyse pooled data from three ghana living standard surveys. results: the results reveal elements of a working spousal wage premium (due to positive selection rather than specialisation) for both men and women regardless of their ethnic affiliations. the analysis of the effect of wage on spousal hours of work also suggested complementarity in employment and household labour decisions between couples. conclusion: men’s and women’s participation in household production significantly improves each other’s labour market participation and labour supply. these results corroborate the evidence of a wage premium in the literature. we recommend that government should promote equitable wage rates in the labour market and prioritise policies such as paternal leave which could encourage men to participate in household production and indirectly promote women’s labour force participation. keywords: spousal wage; time allocation; two-step instrumental variable tobit; couples; ghana. introduction the theory of working spouse premium or penalty postulates that a spouse’s hours of work impact their partner’s wages while the theory of labour supply suggests that spouses’ wages influence their partners’ hours of work (killewald & gough 2013; song 2007; weeden, cha & bucca 2016). these seemingly contradicting theories have attracted a vast amount of empirical literature in developed countries (glauber 2007; kelly & grant 2012; killewald 2013; schmitt 2010). however, very limited evidence exists in developing countries where labour market rigidities, social norms and cultural values play an important role in shaping the extent of validity (or otherwise) of these theories (petersen, penner & hogsnes 2011). most of the studies on marriage premiums or penalties have focused mainly on the husband. according to breusch and gray (2004), the little evidence that is available shows positive (but small), zero or even negative effects of marriage on women’s remuneration. in many developing countries, social norms and cultural practices influence intra-household bargaining power, gender roles and resources allocation (doss 2013). this means that analysis of the determinants of labour market outcomes and household production need to be context specific. this article contributes to the empirical discourse by extending the debate to include unpaid hours of household work. in this regard, the article analyses the simultaneous determination of spousal wages and time allocation to paid and unpaid work activities in ghana, which provided the setting for the study. the first specific objective of the article is to estimate the spousal hourly wages among couples. under this objective, the effects of the husband’s hours of paid and unpaid work on the wife’s hourly wages and the effects of the wife’s hours of paid and unpaid work on the husband’s hourly wages are analysed. the second objective estimates the cross-wage effect of spousal time allocation. the effects of the husband’s hourly wages on the wife’s hours of paid and unpaid work are assessed. similarly, the effect of the wife’s hourly wages on the husband’s hours of paid and unpaid work is examined. following the feedback effect between the labour market and household conditions, the article extends the analysis to include the wife’s and husband’s hours of unpaid work or household production. more importantly, it explores the evidence of the premium or penalty from a developing country perspective, where the literature on these phenomena is sparse. to the best of the authors’ knowledge, this is the first article to provide evidence on these issues from a multi-ethnic ghanaian perspective. also, both nominal and real wages are considered in this analysis to assess the implicit effects of inflation on spousal time allocation. this article specifically contributes to the design of family-oriented labour market policies on wage determination which can assist in altering gender inequality in intra-household time allocation to labour supply and household production in ghana and other developing countries. the next section of the article presents the literature while the subsequent sections discuss the methodology, the empirical estimation techniques and the data used in the analysis. this is followed by a discussion on the results. the article ends with a conclusion and some policy recommendations. literature review this section is divided into two subsections. the first presents the literature on the spousal wage premium and wage penalty. the second focuses on the spousal wage and hours of work. we separate the review into these two theoretical perspectives in order to discuss their variant versions and the available empirical studies that have attempted to validate them in detail. spousal wage premium and wage penalty the notion of a spousal wage premium suggests that marriage is associated with higher wages which mostly favour men while the theory of a spousal wage penalty posits that marriage contributes to lower wages with women being the most disadvantaged. the source of the premium has been explained from three theoretical perspectives: (1) the ‘specialisation thesis’, (2) the ‘selection hypothesis’ and (3) productivity theory (barg & beblo 2007; strike 2012). the specialisation thesis postulates that the division of labour in the household enables married men to specialise in market production and earn higher wages than their unmarried counterparts because they spend less time on home production (becker 1991; chun & lee 2001; gray 1997; korenman & neumark 1991; song 2007). contrary to this hypothesis is the selection hypothesis which indicates that married men, who earn above average wages, have certain observable qualities such as trustworthiness, stability and competence which make them more valuable in the marriage and labour market (chun & lee 2001). the productivity theory also suggests that marriage makes men more productive in the labour market because they feel a sense of financial responsibility from home (hill 1979; strike 2012). empirical validations of these theoretical debates in the united states (us). indicate that on average, married men earn higher wages than their unmarried counterparts, but the opposite appears to be true for married women (groothuis & gabriel 2010). the premium among men is estimated to be within the range of 15% and 32% (bartlett & callahan 1984; korenman & neumark 1991). chun and lee (2001) used the standard mincer-type human capital function to analyse the 1999 us current population survey data and estimated the average premium to be 12.6%, but 3.4% for husbands whose wives worked full time and 31.4% for husbands whose wives were not in the labour force. a comprehensive review of the production, specialisation and selection theories particularly in the us suggests that although no single theory completely captures all the sources of the wage premium, the findings of the majority of the empirical studies, support the productivity theory of causal effect of marriage on wages of married men (groothuis & gabriel 2010; hill 1979; strike 2012). thus, men become more productive after marriage. although the productivity theory seems to have gained the most empirical support, some recent studies provide evidence that make the finding less conclusive. nakosteen and zimmer (2001) and groothuis and gabriel (2010) drew conclusions that support the selection theory that us men’s income and their propensity to marry are positively correlated. using the 1979–2012 waves of the national longitudinal survey of youth 1979 (nlsy79), killewald and lundssberg (2017) argue that the observed wage patterns in the us are mostly consistent with men marrying when their wages are already rising more rapidly than expected and divorcing when their wages are already falling, with no additional causal effect of marriage on wages. this conclusion is supported by a recent study that used the same nlsy79 data to argue for the discarding of the notion of a wage premium for married men because selection into marriage operates not only on wage levels but also on wage growth. as a result, men on a steep career track are equally likely to marry (ludwig & brüderl 2018). in an earlier study, barg and beblo (2007) indicated that husbands’ wages were mostly due to positive selection. as a result, there was weak evidence for specialisation to explain the conditional male wage premium (mwp) between married and cohabiting men. killewald and lundberg (2017) assert that marriage changes men’s labour market behaviour in ways that augment their wages. however, these changes do not necessarily occur at the expense of women’s wages. unlike the us and some european countries such as the united kingdom (uk) and germany, studies in scandinavian countries such as sweden, denmark and norway do not show substantial marriage premiums (ludwig & brüderl 2018). contrary to the literature on the notion of a wage premium, other studies in the us have found evidence of a working spouse penalty. those studies conclude that married men who have gainfully employed wives experience less intra-household division of labour but they earn lower wages than their counterparts who have non-working wives (chun & lee 2001; gray 1997). this observation has been explained from the perspective of employers’ preference for single earners, geographical mobility, productivity and the income effect of wage on spousal labour supply. an explanation for the employers’ preference for single earners is that employers perceive single-earner husbands to be more in keeping with social expectations and values than dual-earner husbands. in addition, by virtue of the principle of distributive justice in wage determination, employers consider single-earner husbands to have greater needs than dual-earner husbands; hence the need for the former to be given higher priority (song 2007). regarding geographical mobility, it is argued that dual-earner husbands are less mobile and more prepared to accept discriminatory wage offers. furthermore, they are perceived by employers as not being productive enough to support their households. as a result, their spouses have to work so that the household can survive. such perceptions about the productive capability of dual-earner husbands work to their disadvantage in wage determinations. it is also argued that wives who are married to high-income-earning husbands enjoy large income effects which allow them to work fewer hours than those married to low-income-earning husbands. the large income differential enables wives of high-income-earning husbands to reduce the number of hours of labour supply (song 2007). the evidence of a spousal wage penalty against women depends on several factors including their motherhood status and race (budig & england 2001; glauber 2007). it is argued that mothers may earn less than other women because having children causes them to lose job experience, become less productive at work, trade off higher wages for mother-friendly jobs, or become the subject of discrimination by employers. it is also argued that the relationship may be spurious rather than causal because women with lower earning potential may have children at relatively higher rates (budig & england 2001; budig & hodges 2010; gough & noonan 2013). unlike men, the literature on women is predominantly focused on the motherhood wage penalty which is an entirely different research area that falls outside the scope of this article because of the need to distinguish between married and single parents. spousal wages and hours of work the literature on collective time use models indicate that gronau (1973, 1977) and becker (1965) had attempted to derive a time use model which focused on labour supply from the maximisation of a household utility function subject to budget and time constraints. however, none of them explicitly set up a theory of a multi-person scenario. building on these weaknesses, beblo (2001) formulated a multi-person case model of time allocation to labour supply and household production. the model which was reduced to a two-person (male-female) household explains how specialisation and division of work among couples is determined by their comparative advantages in the competing time uses. the household was compared to a market where products are traded at prices that are determined by a partner’s productivities in market work (measured by the wages) and household production. the main conclusion of the model is that a higher male wage rate explains the well-known gender-specific division of work. also, a wage differential in the labour market which takes the form of poor promotion prospects or lower pay for women contributes to specialisation even if the husband and the wife have equal levels of education. in addition, the childbearing ability of women and the complementarity between the bearing and rearing of children lead to a female comparative advantage in household activities. in an illustration of how partners’ wages determine their time allocation to paid work, unpaid work and leisure in the two-person household scenario, beblo (2001) postulated that men and women allocate their time to all three time uses according to the equality of the individual wage rate, marginal household productivity and the marginal rate of substitution between leisure and consumption when wages for men and women are equal. however, if wages are not equal, specialisation equilibriums will take place where at least one of the partners chooses one or two of the following three scenarios of time use. when the woman’s wage rate is equal to the marginal productivity of the household, but the man’s wage rate exceeds the household marginal productivity, he will allocate his time to market work (paid work) and leisure and supply no housework. in that case, it is the woman who performs all principal time uses. when the woman’s wage rate falls short of the household marginal productivity but the man’s wage rate is equal to the marginal productivity of the household, the man does market work, non-market work and no housework while the woman specialises in household production and spends the rest of her time on leisure. this is because the wage rate that she could receive outside the household is too low for her to participate in the labour market. when the woman’s wage rate falls short of the marginal productivity of the household, but the man’s wage rate exceeds the household marginal productivity, the woman specialises in non-market work while the man specialises in market work (beblo 2001). a study in australia shows that even if women’s earnings reduce their own unpaid work, they do nothing to increase their husbands’ unpaid work. also, women’s earnings only reduce their housework when they contribute less than half of the family income (bittman et al. 2003). a similar study conducted in spain confirmed that despite the decline in the gender wage gap, specialisation in home production continues to be high, with women providing most household produced goods and services. although a woman’s time spent on home production decreases as her wage increases, at higher wage levels the effect becomes less pronounced. also, a woman’s relative share of housework decreases as her relative wage increases, but only up to the point where she earns the same as her husband. a woman’s time devoted to household activities, such as care where there are no credible alternatives, are less elastic to an increase in their relative wages (fernandez & sevilla-sanz 2006). parera-nicolau and mumford (2005) found a negative effect of an increase in the hourly wage on the working hours of working mothers in the uk. kimmel and connelly (2007) found a substantial positive wage elasticity for caregiving time, while both leisure and home production time declined with increase wages in the us. these results support the findings of their earlier study which showed that the caregiving choice of mothers responds positively to higher wages just as hours of paid work. connelly and kimmel (2009) also observed that an increase in partners’ wages was positively associated with women’s primary care on all days, but negatively associated with their market work on weekdays in the us. while they found little evidence that men’s time use responded to changes in their own wages, they concluded that increases in women’s own wages increased their market work on weekdays. also, increases in men’s partners’ wages increased men’s passive childcare time on weekends and reduced their market-work time on weekends. gupta and ash (2008) showed that in the us women’s own earnings are negatively associated with their housework hours, independently of their partners’ earnings and their shares of couples’ total earnings. increases in wives’ relative wages in two-earner households enable them to enjoy significantly more leisure time (relaxing and watching television) and spend significantly less time doing chores, cooking and cleaning. it also enables wives to spend more time with family members while the reverse is true for husbands (friedberg & webb 2005). argyrous and rahman (2014) found that mothers in australia perform a larger share of childcare, regardless of their earning power or their partner’s availability to take on some of the tasks. this result corroborates findings of bloemen and stancanelli (2014) who noted that the wife’s wage rate has a significant and positive effect on the husband’s housework and childcare hours, but the wage rate of the father has a significantly negative effect on the mother’s hours spent on paid work. in the african context, the literature on the relationship between wage and intra-household time allocation remains limited. the few available studies have explored the impact of an array of non-wage related factors such as non-market income (ranchhod & wittenberg 2007), environmental degradation (dimoso & antonides 2008), and differences in time allocation to various household activities from the perspective of gender, age and geographical location (arbache, kolev & filipiak 2010; floro & king 2016). others have also looked at the pattern of children’s time allocation to labour and schooling (bock 2002) and the effect of employment status on gender time allocation to paid work (komatsu & floro 2016). from a ghanaian perspective, there is no study on the relationship between intra-household time use and wage, although data on time use has been a component of the time use and employment module of all six rounds of the ghana living standards survey (glss) since 1987. as in the case of most african countries, the identified studies on time use have focused on a wide range of socio-economic factors but none has considered the effect of wage. the issues covered are the impacts of infrastructure such as electricity and water on time use by men and women, determinants of domestic and market time use of children and the impact that these activities have on their school attendance (costa et al. 2009; coulombe & wodon 2008; morka 2015). methodology the choice of the empirical estimation strategy was informed by the two theories (the working spouse premium or penalty theory and the labour supply theory) discussed in the preceding sections. the working spouse premium or penalty theory requires that the wife’s (husband’s) hours of work appear in the husband’s (wife’s) wage equation. the labour supply theory hypothesises that the husband’s (wife’s) wages affect the wife’s (husband’s) hours of work. other important considerations are issues of endogeneity between hours of work and wages and the high proportion of zero observations for hours of work, which could be attributed in part to the data collection and generation process. we address these issues in order to obtain reliable estimates by specifying a model that simultaneously takes into account each partner’s wage and hours of work, the endogeneity between hours of work and wage, and the censoring nature of the data. following hotchkiss and moore (1999), jacobsen and rayack (1996) and song (2007), this article employs the two-step instrumental variable (iv) tobit estimation approach which has been described extensively by maddala (1983) and cameron and trivedi (2005). the iv tobit estimation technique addresses the issue of censoring which could bias the estimates and the potential endogeneity of hours of work and wages. this approach which involves simultaneous analysis of each partner’s wage and hours of work also addresses the issue of interdependence between the two variables. the first step in this estimation strategy involves the specification of a reduced-form equation for the husband’s (wife’s) wage using ordinary least squares (ols). this equation contains all the exogenous variables that affect both wage and time use. it also contains the husband’s (wife’s) hours of work as an explanatory variable. similarly, the reduced-form equation for the husband’s (wife’s) hours of work also contains the wife’s (husband’s) wage and is derived using a tobit estimation approach. the second step involves the predicted values of wage and hours of work from the first-step estimations being used as instrument variables in place of the observed values of wage and hours of work. the wage equation is estimated by ols and the equation for hours of work is estimated by a tobit approach. in line with cameron and trivedi (2005), the bootstrap pairs procedure is used to correct the standard errors for the second-step estimates. the spousal wage and hours of work equations are specified as: in equation 1 and equation 2, the variables hit and wit represent the vectors of paid and unpaid hours of work, and wages. the subscript i represents either the husband or the wife and the subscript t represents the time of the survey. the variables xit and zit are the vectors of the exogenous variables that affect wage and hours of work. although both xit and zit contain some common variables, each contains variables that make it possible to identify the structural model. zit contains non-wage income (remittance used as a proxy) which affects hours of work but does not affect wage; xit contains two variables (sector of employment and availability of a union at the workplace) that affect wage but not hours of work. from equation 1 and equation 2, the estimable equations for wages, paid and unpaid hours of work are respectively expressed as equations 3, 4 and 5 with their a priori expectations: in equation 4 and equation 5, the subscripts p and h represent hours spent on paid and unpaid (household) work. unpaid hours of work is an aggregated variable computed from hours spent on various household activities, including cooking, cleaning, shopping, collecting food from the garden, taking care of the sick and caring for children. similarly, hours of paid work is an aggregated variable computed from hours engaged in primary and secondary occupations. nominal wage was computed as the sum of the nominal income earned from main and secondary occupations while real wage was computed by dividing the nominal wage by the consumer price index (cpi). also, wage had been captured in hourly, daily, weekly, monthly, quarterly and yearly units (ghana statistical service 2014a). however, to ensure consistency between the time use indicators, all these units were converted into weeks. for policy purposes, the weekly wages were further computed on hourly bases by dividing the total wage receipts in a given period by the number of hours worked (ghana statistical service 2014a). this means that the results are interpreted as hourly wages and weekly hours of work. an earlier study by song (2007) suggested a non-linear relationship between spousal wage and hours of work. the net effect of a further increase in wage depends on the dominance between the income and substitution effects and the perception of the individual regarding leisure. given that leisure is a normal good, an increase in wage will induce the individual to spend more hours on paid work if the substitution effect outweighs the income effect (ehrenberg & smith 2016). considering the feedback effect between labour supply and household production, the inverse of these hypotheses may hold for the effect of further wage increases on hours of unpaid work, holding other factors including sociocultural norms that affect gender roles in developing countries constant. the natural logs of both wage (wage) and square of wage (wagesq) are therefore included in the analysis to capture this non-linear relationship. also included in the analysis is the natural log of remittance (rem) which is used as an exclusion restriction in the equations for hours of work. included as other control variables in both equations are age (age), square of age (agesq), ethnicity (ethnic), education (edu), the number of children under the age of 5 (child) and place of residence or geographical location (urban). the normative expectation of the culture of ethnic groups shapes the distribution of decision-making power and access to resources. ghana is made up of over 90 different ethnic groups with the akan, mole-dagbani, ewe and ga-dangme being the dominant ones. these different ethnic groups are characterised by a variety of kinship systems which influence gender equality in access to resources and power of decision-making in the household. mainly residing in the southern part of ghana, the akan constitutes the largest ethnic group and is organised along matrilineal lines while most other ethnic groups, in the northern and eastern parts, are patrilineal. among the ethnic groups, only the ga ethnic groups are known to have somewhat anomalous bilateral inheritance and kinship structures (baden et al. 1994). according to baden et al. (1994) the matrilineal systems gives women greater access to resources outside marriage as opposed to patrilineal systems, but they offer little economic security to women. in this analysis, we recoded ethnicity which was captured by ghana statistical service into eight categories: the akan, ga-dangme, ewe, guan, mole-dagbani, grusi, gurma, and other minor ethnic groups in order to assess the effect of these ethnic affiliations on spousal wages and hour of work. education has three main categories: (1) no education, (2) basic education (if a respondent completed primary or junior high school) and (3) secondary education plus (if a respondent completed at least senior high school). in the wage equation, two variables are included that capture the availability of unions at the workplace and sector of employment as exclusion restrictions. the inclusion of each of these variables is underpinned by theoretical and empirical findings. selection of instrument aside from the fact that the relationship between wage and hours of work could be endogenous due to simultaneity, omitted variable bias or misspecification and measurement errors, the interaction between the husband and the wife regarding decision-making on labour market participation and home production suggests the presence of interdependence between spousal wage and hours of work. from this perspective, the couple’s wages and hours of work could also be endogenous. previous studies have addressed this potential endogeneity by using variables such as family non-wage income, education of the respondent, union status or membership, region of residence, and industry or sector of employment (connelly & kimmel 2009; sedigh et al. 2016; song 2007). others have used pre-tax wage, the square of the pre-tax wage, capital income and the square of capital income (bloemen & stancanelli 2014; daunfeldt & hellström 2007). in this study, education, sector of employment and availability of unions at the workplace were directly included in the regression for hours of work as potential instruments. however, the results of the wald test of exogeneity (see tables 5–8) showed that education was directly correlated with hours of work. theoretical and empirical studies suggest that union organisation and membership significantly increase wages (bryson 2007; farber 2005). evidence in ghana and other countries such as ivory coast, india, germany and canada suggests that public sector workers enjoy a public sector wage premium (baffour & turkson 2015; glinskaya & lokshin 2007; venti 1987; younger & osei-assibey 2017). moreover, both union membership and sector of employment have been used as instruments for wage in previous studies (sedigh et al. 2016; song 2007). the union variable is binary and takes on the value 1 if there is a trade union at the place where the respondent works and 0, otherwise. likewise, the sector of employment variable is binary and takes on the value 1 if the respondent works in the public sector and 0 if they work in the private sector. sample design and data the study relied on pooled data from the last three rounds of the glss (glss4, glss5 and glss6) conducted in 1998/1999, 2005/2006 and 2012/2013. each covered a nationally representative sample of households interviewed over a period of 12 months and a variety of topics including the demographic characteristics of the population, education, health, employment and time use (ghana statistical service 2000). the surveys used a two-stage stratified sampling design which involves the selection of enumeration areas (eas) to represent the primary sampling units (psus) (see ghana statistical service 2000, 2014a). these psus are allocated to the 10 regions using a probability proportional to population size (pps). the eas are further divided into urban and rural areas. this is followed by listing of households in the selected psus as the secondary sampling units (ssus). at the second stage, households from each psu are systematically selected to constitute the nationally representative sample (ghana statistical service 2014a). the glss4 used a sample of more than 5998 households, and over 25 000 persons (ghana statistical service 2000). during the glss5, the sample was increased to 8687 households in 580 eas, and 37 128 individuals. the sample sizes were further increased to 16 772 households and 72 372 household members during the glss6 (ghana statistical service 2014a). however, after the sample was restricted to only couples in the households where the husband and wife lived together, a pooled sample of 10 948 was arrived at, as presented in table a1 in appendix 1. as indicated in the introduction, the article considered couples in the same households so as to match the partners and enhance the analysis of intra-household interactions between couples. results and discussion this section comprises two main sub-sections. the first sub-section analyses the empirical findings of spousal time allocation and wages (spousal premium or penalty) while the second sub-section presents and discusses the result on the analysis of the cross-wage effects of spousal labour supply and household production. the essence of this analysis was to examine the extent of interaction between time allocation and the wages of the wife and the husband. the estimates of both the ols and two-step iv tobit models are presented to compare the potential biases. however, given the observed downward biases of the ols estimates, the iv estimates are interpreted. at the bottom of the output tables, the statistic and p-values of the durbin-wu-hausman test of exogeneity are reported. the results show that, at the conventional levels of statistical significance, the ols estimates are biased in a downward direction; hence the need to reject the hypothesis that the hours of work are exogenous in the wage equations. estimates of spousal wage premium or penalty table 1 and table 2 present estimates of the effect of the wife’s hours of paid and unpaid work and other control variables on the husband’s hourly wage. table 3 and table 4 in turn present the effects of the husband’s hours of paid and unpaid work on the wife’s hourly wage equation. the estimates of the full sample models in table 1 show evidence of a working spousal wage premium. thus, an increase in the wife’s hours of work significantly increases the husband’s hourly wage. in a developing country like ghana, wage and time allocation of men and women, married and unmarried differ due to factors including cultural values and social norms imbedded in ethnic practices, which influence the exercise of bargaining power and resource allocation in the household (orkoh, blaauw & claassen 2020; sayer 2005). these potential differences were explored in earlier studies by hotchkiss and moore (1999) and song (2007) who found evidence of a premium or penalty in their sub-sample analyses based on the race or ethnicity of the respondent. song, for instance, found a working spouse penalty among white husbands and a working spouse premium for hispanic husbands, but the wife’s hours of work had no effect on the wages of black husbands in the us. in the current study, we test the consistency of the results by running a sub-sample analysis across ethnic groups using both paid and unpaid hours of work. the estimates of paid hours of work (see table 2) suggest evidence of a working spouse premium for the husband regardless of the ethnic affiliation. evidence of this spousal premium is confirmed by the negative relationship between hours of unpaid work and a husband’s hourly wage. these results support the selection thesis that men in ghana who are already on a steep career track are more likely to marry and, in fact, marry women who are equally employed (barg & beblo 2007; ludwig & brüderl 2018). table 1: effect of the wife’s hours of work on the husband’s wage. table 2: instrumental variable estimates of the wife’s hours of work and the husband’s wage by ethnic affiliation. table 3: the effect of the husband’s hours of work on the wife’s wage. table 4: instrumental variable estimates of the husband’s hours of work and the wife’s wage by ethnic affiliation. in addition to the wife’s hours of paid and unpaid work, the husband’s own age has a non-linear relationship with his hourly wage. the hourly wage first increases with an increase in age and then becomes negative after a certain age threshold. as a person ages and gain more experience at work, they are more likely to receive higher wages. however, after a certain age (mostly after the retirement age threshold), age tends to have less effect on wages due to factors including poor health, or occupational immobility which in turn can result from technological advancement. unlike for the within group analysis, results with ethnicity as a control variable (see table 1) indicate that keeping the akan ethnic group, which constitutes the majority (47.5%) of the ethnic groups in ghana, as the reference category, the results show that wage decreases for a husband who is affiliated with the ga, guan, ewe, mole-dagbani, grusi and other ethnic groups. these differences in the effect of ethnicity on the spousal wage could be explained by ethnic practices that determine women’s access to resources. compared to the akan ethnic group, which is organised on a matrilineal system, almost all of these ethnic groups are organised on a patrilineal system which does not give greater access to resources outside marriage (baden et al. 1994). the estimates of education confirm the expected positive association with wages. geographical location (settlement) remains one of the factors that directly determine households’ access to social services and engagement in economic activities and indirectly affects their time allocation decision and earnings. this analysis shows that a husband in an urban area earns higher wages than his counterparts in the rural areas. consistent with the a priori expectation, the availability of a union in the workplace has a positive influence on the husband’s wage. in summary, this analysis has shown evidence of a working spouse wage premium for men in ghana regardless of their ethnic affiliation or level of education. the models in table 3 indicate a positive association between the husband’s labour supply and the wife’s wage. the magnitude of the coefficients, however, is smaller than those revealed in the models for the husband’s wage. contrary to the results in the husband’s wage equations, there is a positive association between the husband’s hours of household production and the wife’s wage. however, across ethnic affiliation (see table 4), the results show that an increase in the husband’s hours of unpaid work is negatively associated with the wife’s wages. this negative association could mean that when men increase their hours of household production, women do not necessarily channel their free hours into market labour but rather into leisure. this in turn could be explained by either personal preference, labour market conditions that do not favour women, social norms imbedded in ethnic practices or a combination of any of the three factors. these results suggest that the differences in spousal time allocation to household production and labour supply affect spousal wages of couples in ghanaian households differently. the observed positive association between spousal hours of labour supply and wages lends support to the findings of jacobsen and rayack (1996) who observed a working spouse wage premium. thus, married men (wives) whose wives (husbands) are gainfully employed earn higher wages than their counterparts who have non-working wives (husbands). the key explanations for these results could be: (1) the complementarity in the market production of the couples, (2) that men who are highly productive tend to marry women who are also highly productive in the labour market through assortative mating, and (3) that additional income from the working wife (husband) may allow the husband (wife) to pursue well-paying job opportunities. regarding the other correlates in the full models (see table 3), the age of the wife also shows the same non-linear relationship with her hourly wage. with the akan ethnic group as the reference category, wage increases for a woman who is affiliated with the mole-dagbani ethnic group but increases for a woman who is affiliated with the gurma and other ethnic groups. the results for ethnicity as a control variable show weaker evidence among wives compared to those found in the models for the husbands. in all the models, education and urban residence are positively associated with the wife’s wage. these findings give some idea of the gender inequality that exists in terms of access to the formal labour market and wages in ghana, which is largely influenced by decisions regarding the division of labour between couples in the household. on average, men in ghana have greater access to wage employment while women are more likely to be engaged in self-employment and informal market activities (ghana statistical service 2014b). this phenomenon is influenced by several factors, including but not limited to gender disparity in education, especially at the higher level, and the limited availability of flexible work conditions (e.g. early childhood education in public schools, onsite day care services and efficient transport systems) in the labour market which make it difficult for women to balance parenting with work. for instance, the gender parity index (gpi) increased marginally from 0.960% in 2005 to 1.01 in 2019 while the gross enrolment rate (ger) in tertiary education for women increased from 4.20% to 15.80% within the same period (world bank, 2020). across geographical location (see table 3), the analysis shows that a woman in an urban area earns a higher wage than her counterpart in the rural areas. also, availability of a union in the workplace and employment in the public sector have significantly positive influences on the wages of the wife. cross-wage effect of spousal time allocation this section discusses the results on the spousal wages and hours of paid work in table 5 and table 6 and the results for wages and hours of unpaid work in table 7 and table 8. the essence of this analysis is to explore the feedback effects of labour market outcomes on intra-household hours of work. like the analysis of spousal wage premium or penalty, only the iv tobit estimates are interpreted because of the downward biasness of the tobit estimates. table 5: the husband’s hourly wage and the wife’s hours of paid work. table 6: the wife’s hourly wage and the husband’s hours of paid work. table 7: the husband’s logged hourly wage and the wife’s hours of unpaid work. table 8: the wife’s logged hourly wage and the husband’s hours of unpaid work. spousal wages and hours of paid work the results in table 5 show a non-linear relationship between the hourly wage of the husband’s and the wife’s labour supply. thus, the cross-wage effect of the husband’s hourly wage on the wife’s weekly hours of paid work is first positive and then becomes negative after a certain wage threshold. the turning point (see bottom of the output tables) shows that at wages below these thresholds, a wife whose husband earns a higher wage spends fewer hours on paid work than a wife whose husband earns a comparatively lower wage. in monetary terms, the turning points in the tobit and iv tobit estimates for the nominal wage (columns 2 and 3 of table 5) translate into approximately gh₵12 and gh₵13. similarly, the turning points for real wage (columns 5 and 6) translate into approximately gh₵38 and gh₵42. considering the other correlates of the wife’s hours of paid work, age has a non-linear relationship with work hours. the wife’s hours increase with an increase in her age up to a certain point and then begin to decrease. compared with a wife who has no education, a wife who has acquired a higher level of education will spend more hours on paid work and fewer hours on unpaid work. it is furthermore observed that the number of children under the age of 5 in the household, ethnic affiliation and geographical location of the wife have significant effects on her hours of work. compared with a wife who belongs to the akan ethnic group, her counterparts affiliated with the ga-dangme, ewe, mole-dagbani, or gurma ethnic groups will spend fewer hours on household production. a wife who lives in an urban area will spend significantly fewer hours on household production but more hours on paid work. similar to that of the wife, the husband’s labour supply models in table 6 show a non-linear relationship with his hourly wage. the point at which a further increase in nominal hourly wage is associated with a reduction in hours of paid work (columns 2 and 3) is equivalent to gh₵12. the corresponding values for the real wage (columns 5 and 6) are gh₵25 and gh₵28. it is obvious from the values of the turning points for the real wage that the husband’s hours of paid work are more responsive to further changes in the wife’s. the magnitude of the increase in the husband’s hours of paid work due to an increase in the wife’s hourly wage is within a range of 13 h to 16 h per week, while that of the wife is between 9 h and 11 h per week. these results reflect the unequal gender opportunities in the labour market and male dominance in household decision-making in a culturally conservative ghanaian society, regardless of the economic status of a woman. although remittances have an insignificant effect on the wife’s hours of labour supply, it significantly reduces the husband’s hours of paid work. the observed negative effect of remittances on hours of work confirms the findings of earlier studies (adams & cuecuecha 2013; ilahi 2000). across ethnic groups, time spent on paid work is on average, significantly higher among husbands affiliated with the ga-dangme, mole-dagbani or gurma ethnic groups than a husband from the akan ethnic group. these results highlight the need for policies on gender equality in the household and in the labour market to consider ethnic diversity and cultural practices that influence men and women’s time allocation to labour supply and home production. the results also indicate a positive association between education and hours of paid work. thus, husbands who have completed at least some basic education spend more time on paid work than their counterparts who have no level of education. compared with the estimates in the models for the wife’s hours of work, one can conclude that education has a relative larger impact on women’s hours of work than those of men. as observed in the models for the wife’s hours of work, the number of children under the age of 5 in the household reduces the husband’s hours of labour supply. across geographical locations, the estimates of the hours of labour supply do not show any significant difference between husbands in the urban areas and those in the rural areas. spousal wages and hours of unpaid work in table 7 and table 8, the relationship between spousal wages and hours of unpaid work is not monotonic. the relationship between the husband’s hourly wage and the wife’s weekly hours of unpaid work is first negative and then becomes positive after an indicated wage threshold in the tables. the implication is that above the wage levels determined by the turning points, the wife will reduce her hours of labour supply and increase her hours of household production. further increase in the husband’s hourly wage above the threshold will reduce the wife’s hours of unpaid work by not less than 32 h per week. it can be inferred from the results that an increase in the husband’s hourly wage enables the household to hire others to assist them with household duties. this relieves the wife of some hours of household responsibilities which she could channel into paid activities or leisure. in addition to wages, other control variables that significantly affect the wife’s hours of unpaid work are ethnicity, education, presence of a child under 5 years of age in the household and geographical location. apart from the other minor ethnic groups, a woman from the ga-dangme, mole-dagbani, ewe guan, grusi or gurma ethnic groups spends fewer hours on unpaid work than her counterpart from the akan ethnic group. while a similar negative association is observed for education and urban residence, the presence of a child under 5 years of age is positively associated with the wife’s hours of unpaid work. as observed in table 8, the nature of the relationship between the wife’s wage and the husband’s hours of unpaid work is similar to those of the wife. however, the reduction in the husband’s hours of unpaid work due to an increase in the wife’s hourly wage is lower (2–3 h per week) than the 32 h per week for the wife. thus, changes in the husband’s wages have a bigger impact on household production than those of the wife’s. apart from ethnicity, all the other control variables show a similar relationship with the husband’s unpaid hours of work as observed in the models for the wife. for instance, remittances and urban residence significantly reduce the husband’s hours of unpaid work while the presence of a child under 5 years of age increases the husband’s hours of unpaid work. however, ethnic affiliation shows some heterogeneities. compared with a husband from the akan ethnic group, a husband who is affiliated with the mole-dagbani, grusi or other ethnic groups spends more hours on unpaid work, but a husband from the ga-dangme and ewe ethnic groups spends fewer hours on household production. it can be inferred from these differential effects of ethnic affiliation on hours of work that ethnic practices and ethnic-related social norms largely shape intra-household decisions on labour force participation, labour supply, and household production. on the basis of these results, policies on gender equality in the household and in the labour market would give due cognisance to ethnic diversity and cultural practices that could affect the success of such policies. conclusion studies on the sources (specialisation, selection and productivity) of spousal wage premiums and penalties have been conducted mainly in developed countries, with very limited evidence from developing countries, where social norms influence gender roles and intra-household resource allocation. this article has contributed to filling the research gap on the spousal effect of wages and time allocation from a developing country perspective. it specifically contributes to the limited literature on female aspects of the spousal wage premium or penalty and the interrelationship between labour market outcomes and household production in ghana. the estimates of the two-step iv tobit showed elements of a working spouse wage premium (due to positive selection rather than specialisation) regardless of the gender and ethnic affiliation of the respondent. the wife’s hours of paid (unpaid) work have positive (negative) effects on the husband’s wage, while the husband’s paid and unpaid hours increase the wife’s wage. the analysis of the effect of wage on spousal hours of work also suggested complementarity in employment and household labour decisions between couples. thus, men’s and women’s participation in household production significantly improves each other’s labour market participation and labour supply. these results corroborate the findings of some of the extant studies, which found evidence of a wage premium mainly for men (groothuis & gabriel 2010; hill 1979; song 2007; strike 2012). these results suggest that labour market policies such as paternity leave, which would encourage men’s (husbands’) active participation in household production, would go a long way in enhancing women’s (wives’) labour force participation and earnings. the article recommends that government and labour unions should step up their efforts to expand the coverage of the current five working days’ paternity leave that covers only health service, education and mining sector workers (otoo, osei-boateng & adjaye 2009) to include all workers in the formal sector as this would indirectly improve women’s wages in the household. furthermore, policies aimed at minimising gender inequality in terms of opportunities in the labour market will play a critical role in ensuring a more equitable response of men’s and women’s hours of market production to changes in wage rates. while this study provides concrete basis for gender mainstreaming in labour market policies and intra-household resources allocation, it relied on pooled data which makes it difficult to track the dynamics of intra-household wages and hours of work over time. future studies should consider using a panel data approach that would allow for the analysis of changes in spousal wages and hours of work overtime. acknowledgements we are grateful to ms ali parry for assisting in editing the article, and all her suggestions to improve the quality of the article. competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this research article. authors’ contributions c.c. worked on the introduction and contributed to the review of the literature; p.f.b. contributed to the literature review and discussion of the results; e.o. did the data management and contributed to the discussion of the results and conclusions. in essence, the workload was equally shared among the authors of the article. ethical consideration this article followed all ethical standards for research without direct contact with human or animal subjects. funding information this research received no specific grant from any funding agency in the public, commercial or not-for-profit sectors. data availability data used for this analysis are freely available and can be downloaded upon request from the website of the ghana statistical service: https://www.statsghana.gov.gh/gssdatadownloadspage.php. disclaimer the views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of any affiliated agency of the authors. references adams, r.h.j. & cuecuecha, a., 2013, ‘the impact of remittances on investment and poverty in ghana’, world development 50(2013), 24–40. https://doi.org/10.1016/j.worlddev.2013.04.009 arbache, j.s., kolev, a. & filipiak, e., 2010, gender disparities in africa’s labor market, world bank publications, washington, dc. argyrous, g. & rahman, s., 2014, ‘how does paid work affect who does the childcare? an analysis of the time use of australian couples’, review of economics of the household 1–16. https://doi.org/10.1007/s11150-014-9274-5 baden, s., green, c., 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for activities performed by individuals 15 years and older. table 2-a1: descriptive statistics of the variables of interest. microsoft word 2 packendorff & lindgren si 17 2014.docx sajems special issue 17 (2014) : 7-21 7 projectification and its consequences: narrow and broad conceptualisations johann packendorff and monica lindgren school of industrial engineering and management, kth royal institute of technology accepted: december 2013 in this article, we argue that an increased focus on the processes of projectification would be beneficial to project research. by introducing a distinction between narrow and broad conceptualisations of projectification, we extend this research area from its current concern with the increased primacy of projects in contemporary organisational structures into an interest for cultural and discursive processes in a society in which notions of projects are invoked. through an illustration from our earlier empirical research on the sustenance of project work form and its consequences, the implications of applying broad conceptualisations are further discussed. key words: projectification, organisational structure, discourse analysis, project research jel: m100, 140, 500, o320 1 introduction in this article we focus on the emerging notion of projectification (cf. midler, 1995; maylor, brady, cooke-davies & hodgson, 2006) – suggesting that it should be seen not only as a management fad and a structural trajectory in corporate re-structuring, but also as a multifaceted phenomenon to be studied in its own right. by theorizing projectification as a cultural and discursive phenomenon as well, project research may be able to analyse both how and why corporate structures change as a result of increased project intensity, and how these change processes unfold. this includes their consequences for individuals, project teams, organisations, industrial networks and society. the notion of projectification has emerged as projects have become a common form of work organisation in all sectors of the economy during recent decades. it is perhaps most visible in the transformation of traditional firms into “project-based firms”, i.e., organisations in which almost all operations are organised as projects and where permanent structures fulfil the function of administrative support (cf. hobday, 2000; cicmil & hodgson, 2006; söderlund & tell, 2009). the basic reason for this diffusion seems to be that the project, viewed as a task-specific and time-limited form of working, is perceived as a controllable way of avoiding all the classic problems of bureaucracy with which most “normal” organisations are struggling (packendorff, 1995; hodgson, 2004; cicmil, hodgson, lindgren & packendorff, 2009). the project is seen as a promise of both controllability and adventure (sahlin-andersson, 2002) and as a necessity when complex and extraordinary business tasks are to be managed (cicmil et al., 2009). in that sense, projectbased work is also part of the wave of new ‘postbureaucratic’ organisational forms that have entered most industries during the most recent decades (cf. clegg & courpasson, 2004; gill, 2002; hodgson, 2004; lindgren & packendorff, 2006a; söderlund, 2011). it is thus not surprising to find that the scholarly debate on topics like research directions, areas of interest, theoretical and methodological assumptions relating to this development have been intense (cf. packendorff, 1995; söderlund, 2004; winter, smith, morris & cicmil, 2006; cicmil et al., 2009; jacobsson & söderholm, 2011; hällgren, 2012). from its very inception, project management research has been defined through its focus on the abstract 8 sajems special issue 17 (2014) : 7-21 single project as unit of analysis, understood as a manageable and researchable item whose intrinsic mechanisms were to be uncovered in pursuit of project success (packendorff, 1995). as a result of the practical developments whereby projects became a dominating form of organising in many organisations, project management research eventually also came to include inquiry into the management of bundles of projects, for instance, programmes, project portfolios, and project management offices, and the processes whereby projects and programmes were granted increased primacy as organisational forms (maylor et al., 2006). as suggested by söderlund (2004), a re-phrasing of the field from ‘project management research’ to ‘project research’ is thus important in order to acknowledge this development. this was also to further extend the area of interest beyond single organisations through analysing the organising of inter-firm projects (cf. braun, müller-zeitz & sydow, 2012) and through attending to patterns and developments at sectorial and societal levels (lundin & söderholm, 1998). the development towards the use of projects for handling complex tasks and creative renewal in contemporary organisations has, in project research literatures, increasingly been referred to as ‘projectification’1 (cf. midler, 1995; ekstedt, lundin, söderholm & wirdenius, 1999; bredin & söderlund, 2006; maylor et al., 2006; kerr, 2008; arvidsson, 2009; ekstedt, 2009; blomquist & lundin, 2010; aubry & lenfle, 2012; bergman, gunnarson & räisänen, 2013). in this narrow view of projectification – which maylor et al. (2006) refer to as ‘organisational projectification’, research is focussed mainly on the contents and consequences of organisational re-structuring initiatives taken in order to increase the primacy of projects within a firm and its immediate supply network (p. 666). however, the concept has also been employed in a broader sense, building on recent critical inquiry into individual experiences of project work (cf. packendorff, 2002; lindgren & packendorff, 2006a; hodgson, paton & cicmil, 2011; lindgren, packendorff & sergi, 2014) and the analysis of projects as a central discursive theme in contemporary society (cf. lindgren, packendorff & wåhlin, 2001; chiapello & fairclough, 2002; cicmil et al., 2009; kuura, 2011). taken as a whole, extant research thus presents us with a situation whereby processes of projectification are becoming increasingly relevant for the understanding of almost any aspect of the contemporary economy. at the same time, most project research appears to be empirically limited to reified and entitative notions of ‘projects’ or ‘programmes’, without reflecting on the processes whereby these phenomena are constructed, developed and institutionalised. arguing that an increased focus on the processes of projectification in the broad sense would be beneficial to project research, we will (1) explore the established narrow usage of the concept; (2) identify streams of thought in the emerging broad notion of projectification; and (3) provide an illustration from our own on-going research into the benefits of moving from a narrow to a broad view. before delving into these three main issues, we will briefly relate this back to the on-going debate on current developments in project research and practice. 2 project research – from where, to where? project work was for a long time seen as a marginal phenomenon in the world of organisations, and was also constructed as an opposite of dominating on-going operations (lundin & söderholm, 1995; ekstedt et al., 1999; cicmil et al., 2009). the increased use of projects and project management in almost all societal sectors has resulted in a powerful and well-established practical knowledge field that set out to provide project managers with tools and methodologies for achieving project success. it is a discipline originally focussed on forms and vocabularies for planning and control, supported by powerful conceptual and visual imagery such as gantt charts and network diagrams. since the 1970s, several aspects of the task of leading projects have gradually been included, such as team leadership, risk management and stakeholder management. the creation of globally-accepted project management certifications built on these forms and vocabularies and the ensuing professionalisation of the project manager’s sajems special issue 17 (2014) : 7-21 9 role are some of the most recent ingredients in the establishment of project management as a distinct practical discipline in business life and society (hodgson & cicmil, 2007). the discipline also incorporates current developments in the management of portfolios for projects and project management offices, thereby expanding into positions and organisational levels other than the single project. project research thus set out early to understand the specifics of this ‘deviant’ form of organising, materialising as projects, temporary organisations, adhocracies or an instance of post-bureaucratic organising (clegg & courpasson, 2004; hodgson, 2004; lindgren & packendorff, 2006a). the scholarly field thus sprung out of a growing need to handle exceptional situations in a structured manner and the notion of exceptionality is still a trigger for research (cf. hällgren & wilson, 2011). the theoretical and practical developments have often paralleled each other, and project research has increasingly adopted theoretical concepts and constructs from general management and engineering research in order to advance understanding of projects and project management (packendorff, 2014). the on-going debates on theoretical influences and perspectives within project research are of vital importance for future developments, in the sense that all wellestablished disciplines usually find ways of escaping stagnation, at the same time becoming easy victims of precisely the same thing. among the promises in current project research, we thus find an expanding but maturing stream of research concerned with the development of the discipline beyond established concepts and theories. it is a growing literature questioning the relevance and consequences of dominating perspectives (cf. packendorff, 1995, cicmil et al., 2006; blomquist & lundin, 2010), vividly debating, for instance, theoretical foundations (söderlund, 2004, 2011), axiological assumptions (cicmil & hodgson, 2006), root metaphors (packendorff, 1995), ontological/epistemological orientations (winter, smith, morris & cicmil, 2006; blomquist & lundin, 2010; sergi, 2012), field limitations (hallin & karrbom gustavsson, 2010) or the way of identifying research problems and questions (hällgren, 2012). twenty years ago, project management was still a marginal phenomenon. now it is a dominant work form in many organisations and industries, and has also attracted increased interest in general management literature (cf. söderlund, 2011). project researchers should thus have an even better opportunity than before to contribute to the development of general knowledge on contemporary management problems and practice (jacobsson & söderholm, 2011; packendorff, 2014). as project research gradually evolves into a distinct field in its own right, characterised by more or less notions that are taken for granted on how projects should be studied and theorised, project researchers will inevitably be met by expectations to ‘perform research’ in a legitimate manner. that could mean to submit to labelling projects without further ado, to exaggerate similarities between projects while suppressing the differences, and to add knowledge to extant bodies of knowledge without questioning the raison d’être of these bodies, thereby taking part in promoting and sustaining a certain view of reality, of knowledge, of good and bad. it would also imply that projects to be studied are sought within the usual industries, among the usual professionals and through the established channels (hallin & karrbom gustavsson, 2010). the alternative is, of course, to embrace the fluidity and ambiguity of the project concept, viewing project work as an ongoing social construction in society, of which we are all coconstructors, as a process of institutionalisation and change, of power and emancipation (sergi, 2012). but that does imply that research must be founded upon explicit assumptions about ontology, epistemology and axiology, rather than slipping into the comfort of letting project management journal editors judge what is publishable. attention to basic assumptions will not only enhance the development of project research and its relevance to general management scholars; but may also imply a changed view of how project management knowledge is made relevant and available to practitioners. project management knowledge is often presented to the public in the form of a toolbox, generally applicable and ready for use (packendorff, 1995), thereby conveying an image of project management practitioners in 10 sajems special issue 17 (2014) : 7-21 desperate need of clarity, order and standardised procedures. as noted by pellegrinelli (2010), research should instead be a reflection and articulation… “…of their lived experiences –what they often see and tend to do. […] managing is often less about planning, directing and controlling and more about coping. the absence of clarity and certainty is not an impediment to action, but a call for it – to ‘get on’. social reality for them feels malleable and changing, amenable (at least to some degree) to their influence. some practitioners have got over, or learnt to live with, the sea-sickness” (p. 237). where research on projectification is concerned, the taken-for-granted nature of rational and structural approaches inherited from mainstream project research implies obvious limitations to the research questions that can be stated, the methodologies that might be employed, the theoretical perspectives that are seen as relevant, and the analyses and conclusions that are made possible. our notion of ‘narrowness’, in the views of projectification that tend to dominate project research, stems from such limitations. by limiting research on projectification to organisational restructurings only, many questions concerning the reasons, implications and consequences of projectification are left unanswered and suppressed. our alternative, the broad notion of projectification, implies a widened approach to all these issues. the main differences between the narrow and broad views of projectification are summarised in table 1. table 1 narrow and broad conceptualisations of projectification in project research narrow view of projectification broad view of projectification notion of projects organisational units characterised by temporariness, uniqueness, goal-focus and complexity. projects as labels, cultural symbols and discursive notions notion of projectification processes of organisational restructuring initiatives taken in order increase the primacy of projects within a firm and its immediate supply network processes of invoking projects as habitual, legitimate and performative responses main theoretical perspectives structural organisation theory, contingency theory, strategic management, human resource management sociology, symbolic interactionism, discourse analysis, critical management theory main research interests • organisational restructurings towards project-based forms • drivers of organisational projectification • consequences of projectification in terms of efficiency, innovation, customer orientation, professionalism and new patterns of work • projects and project management as ideal and normal in organisations, societal life and private life • consequences of projectification for individuals, groups, organisations and societies. • dominating and suppressed aspects of projects and project management. the narrow and broad conceptualisations differ not only in terms of what projectification means (formal restructuring vs. cultural construction) but also in terms of consequences. while the narrow conceptualisation is aimed primarily at identifying how projectified structures are built and how this affects organisational effectiveness and prosperity, the broad conceptualisation also includes consequences for individuals, groups and societies. in the following two sections, we will further discuss the two conceptualisations, with their main underpinnings, directions and research implications. 3 projectification as restructuring: narrow views the conceptualisation of projectification that we term narrow is usually based on an instrumental and structural notion of the project form as an organisational solution to certain types of tasks. this is a notion reminiscent of classic organisation theory, in which the need for handling complex and nonroutine tasks was identified during the heyday of contingency theory. examples of such early sajems special issue 17 (2014) : 7-21 11 theoretical treatments are the identification of single unit production tasks (woodward, 1958), the ‘adhocratic’ organisational form needed for innovative and extraordinary work (mintzberg, 1979) and the notion of temporary organisational settings as rational and task-oriented exceptions from ordinary organisational life (miller & rice, 1967). these lines of reasoning were later extended in several ways, such as heckscher and donnellon’s (1994) suggestion of post-bureaucratic ways of organising work according to tasks rather than departments, goodman’s (1981) treatise on temporary systems as an emerging form of work organisation, and ciborra’s (1996) idea that innovative organisations should be analysed as platforms enabling various organisational forms, improvisations and experiments in pursuit of innovation and creativity. against this general backdrop, the specific use of projects and project management in contemporary organisations has been further analysed in a series of writings intended to shed light on what the project form may contribute to organisational prosperity, how the project form is combined with other organisational configurations, and what managerial challenges occur in the process of projectifying on-going operations (söderlund & bredin, 2011). this is often done by invoking the notion of the project-based organisation as a distinct organisational form, a solution to certain strategic and managerial problems, and the end state of a series of organisational restructurings (hobday, 2000; söderlund & tell, 2009). referring to davies et al. (2006), maylor et al. thus trace projectification back to the insight that: “[…] organisations in all types of industries are finding that traditional organisational structures, including functional departments, business units and divisions set up for managing high-volume throughputs of standardised products and services and for making decisions in a relatively stable technological and market environment, are no longer adequate. in the rapidly changing and increasingly turbulent and uncertain environment they face today, organisations are finding that some sort of project organisation is better suited to the kind of one-off or temporary problems that they have to deal with” (maylor et al., 2006:664). in contemporary literatures, this increased use of the project-based form in an organisation takes several different shapes and is justified with reference to both historical developments and intended benefits. while the individual project as such, a temporary, unique, goalfocussed and complex undertaking (cf. packendorff, 1995), seems to be a rather standardised matter, there is a range of possible ways of incorporating it into an existing organisation. the various matrix arrangements available are a recurring theme in the literature (larson & gobeli, 1987; davies et al., 2006; maylor et al., 2006; arvidsson, 2009), as well as the various solutions to the problem of integrating multiproject-based operations into coordinated portfolios through standardised project management methods and project management offices (de maio, verganti & corso, 1994; engwall & jerbrant, 2003; blomquist & müller, 2006; aubry et al., 2007). the project-based organisational form thus centres on the individual project as the unit in which production and innovation take place, in a setting characterised by product/systems complexity, cross-functional cooperation, batch oriented production, horizontal communication and team-based work (söderlund & tell, 2009; söderlund & bredin, 2011). a limited number of studies have focussed explicitly on the processes of projectification over time. midler (1995) and söderlund & tell (2009) describe projectification as a series of restructurings whereby traditional functional structures are gradually transformed into heavyweight project forms and projects become increasingly autonomous and customer focussed. in both these cases, the drivers are external market demands, implying increased customisation and technology integration, in combination with internal aspirations to simplify organisational communication and decision-making and to empower project teams. in their review of several studies of projectification, maylor et al. (2006) also add that these restructurings imply an increased number of projects, increased reliance on codified bodies of project management knowledge (such as stage-gate models and inhouse standardised frameworks), an increased emphasis on project performance when evaluating 12 sajems special issue 17 (2014) : 7-21 organisational effectiveness, and an increased prevalence of project management offices and similar functional devices geared to projectbased operations. some of this research is also concerned with the consequences of projectification. maylor et al. (2006), turner, huemann & keegan, (2008) and söderlund & bredin (2011) point to potentially negative consequences for both organi sational and individual levels, such as the danger of re-bureaucratisation, neglecting the need for integration of projects into programmes or portfolios, limited time for knowledge development, overwhelming deadline stress, and lack of trust and social continuity. jerbrant (2014) emphasises that projectification is indeed driven by perceived consequences, in the sense that every subsequent restructuring solves some problems but also creates new ones, thus portraying projectification also as a series of emerging uncertainties that have to be handled. all in all, the narrow conceptualisation of projectification shows great efforts to identify the basic structural tenets of project-based organisational forms and the conditions associated with the gradual restructuring of former functional organisations. the literature also demonstrates a well-developed understanding of the relation between market developments, technological change and the aspects of organisations that are affected and altered in the processes of projectification. some research has also taken individual perspectives into account, departing from not only organisational effectiveness but also individual well-being as central to the understanding of consequences and outcomes. the basic weakness of the narrow view, i.e., that projectification is analysed as a rational and straightforward process rather than as a development characterised by aspects such as bounded rationality, power and politics, cultural norms and constructs is, however, not alleviated. 4 projectification as cultural and discursive processes: broad conceptualisations the broad conceptualisation of projectification involves the cultural and discursive societal processes whereby projects and project-like circumstances are institutionalised in individual lives, the organising of all sorts of work, and society at large. unlike the definition by maylor et al. (2006) of ‘societal projectification’, this broad view is not a mere extension of the study of the implementation of projectbased structures beyond firms and their immediate supply chain networks, but rather a different theoretical view in which formal structural units are seen as institutionalised social constructions and not as stable entities. it is a conceptualisation that draws not only on sociological understandings of an increasingly episodic orientation in contemporary society (cf. bennis & slater, 1968; sennett, 1998), project-oriented discursive modes of justification (chiapello & fairclough, 2002), but also on the tendency to perceive all sorts of individual and societal processes as temporary and transitory by nature: “many observers have noted the contemporary decay in production of thoroughgoing literary utopias (in sharp contrast with the ferment of the 18th and 19th centuries), and their replacement by satirical or polemical versions of life in the mass society of the future (e.g., george orwell’s 1984); what has gone unremarked is the enormous proliferation of short-term quasi-utopias of all sorts – conferences, meetings, “task forces”, research projects, experiments and training exercises. it is as if we have traded the grand visions of social life as it might be lived for miniature societies, to which one can become committed intensively, meaningfully, satisfyingly – and impermanently” (miles, 1964:465). in their discussion on the cultural and political modes of understanding and justifying reality with reference to the history of mankind, chiapello & fairclough (2002) claim that a new ‘justificatory regime’ is emerging in contemporary society – the project-oriented cité. in comparison with the six historical cités which were based on, e.g., religious beliefs, bourgeois civil society values, industrial logics or market mechanisms – the project-oriented justificatory regime puts primacy on activity, project initiation and social networks as basic tenets of societal activity. the successful and prosperous individual is an adaptive, flexible and connective team player, able to generate enthusiasm and handle multiple cultural sajems special issue 17 (2014) : 7-21 13 traditions, always prioritising availability, employability and new projects over social stability and lifelong plans (cf. also bennis & slater, 1968; lindgren et al., 2001). “in contrast with the industrial cité in which activity means ‘work’ and being active means ‘holding a steady and wage-earning position’, in the project-oriented cité activity overcomes the oppositions between work and non-work, steady and casual, paid and unpaid, profitsharing and volunteer work. life is conceived as a series of projects, the more they differ from one another, the more valuable they are. what is relevant is to be always pursuing some sort of activity, never to be without a project, without ideas, to be always looking forward to, and preparing for, something along with other persons, who are brought together by the drive for activity. when starting on a new project, all participants know that it will be short-lived. the perspective of an unavoidable and desirable end is built in the nature of the involvement, without curtailing the enthusiasm of the participants. projects are well adapted to networking for the very reason that they are transitory forms: the succession of projects, by multiplying connections and increasing the number of ties, results in an expansion of networks” (chiapello & fairclough, 2002:192). beyond the notion of projects as a core aspect of contemporary societal life, projectification is also discursively linked to the strong and dominating notion of project management as a standardised field of codified knowledge (cf. hodgson & cicmil, 2007). by naming something as a ‘project’, a number of discursive expectations on the work process are brought from the well-established project management discipline into the local situation by project participants (pellegrinelli, 2010; lindgren et al., 2014). projects are usually expected to be planned, controlled, detached episodes of passion, dedication and commitment, arenas for flexible action and task-focussed social relations (nocker, 2009), as strictly coordinated and enclosed activity systems (bechky, 2006). they are also constructed as exceptional work episodes, as temporary ‘states of emergency’ where danger and urgency prevail and everyday norms and rules do not apply (lindgren & packendorff, 2006a; lindahl, 2007). hence, as extraordinary settings in which individuals submit to almost any kind of conditions because it is a only passing moment. the labelling of projects is also closely related to reification (cicmil et al., 2006). ‘a project’ is often compartmentalised by its co-constructors into an independent and distinct object that is controllable and manageable if proper methodologies are used. the inherent performativity of the project concept (pellegrinelli, 2010; sage, dainty & brookes, 2013), with its emphasis on rationality and controlled passion can thus be expected to be an important aspect of understanding projectification. the processes and consequences of projectification have been increasingly studied in this fashion during the past decade (cf. lindgren et al., 2001; sahlin-andersson, 2002; grabher, 2002; clegg & courpasson, 2004; hodgson, 2004; lindgren & packendorff, 2006a, 2006b, 2007; cicmil et al., 2009). this research has emphasised the need for examining the underlying discursive developments in which the notion of rational project management has become a legitimate and desirable phenomenon in contemporary society and a driver behind the creation of projectified organisations within which the work occurs. among the themes of these studies we find, e.g., the (re-)masculinisation of post-bureaucratic work practices (gill, 2002; buckle & thomas, 2003; lindgren & packendorff, 2006a; styhre, 2011), the performative notion of project management as creeping into established professional identities (hodgson, 2002; lindgren & packendorff, 2007; paton, hodgson & cicmil, 2010), and the construction of new power relations in the wake of standardisation and professional certification initiatives (hodgson & cicmil, 2007). the project management discourse thus contributes to the reification of projects as distinct, given, unquestionable and manageable items separated from their history and context (cicmil & hodgson, 2006; lindgren et al., 2014); to the dichotomisation of projects vis-à-vis permanent and stable organisational arrangements, (cicmil et al., 2009); to the ‘grandiosification’ of projects as a superior alternative to ineffective, rigid, boring bureaucracies (gill, 2002; grabher, 2002), and to the compartmentalisation of projects into settings in which admirable achievements take place under conditions where normal rules do not 14 sajems special issue 17 (2014) : 7-21 apply (lindgren & packendorff, 2006a; lindahl, 2007). some recent research also highlights the emotional consequences of the projectified work, portraying projects as emotionally charged and potentially addictive and harmful spaces (rehn & lindahl, 2011; rowlands & handy, 2012; lindgren et al., 2014). amid the consequences of projectification, it is also important to note the ambitions and hopes tied to projects and how such ambitions and hopes have become taken for granted in project work. through goal-setting and planning, ambitions and hopes are projected into the future, almost to the extent that the future is ‘lived’ in advance, taken for granted and secured through project planning (pitsis, clegg, marosszeky & rura-polley, 2003). being successful in a projectified society is closely linked to being available, flexible and connected, while sacrificing lifelong plans, stable conditions and social predictability (chiapello & fairclough, 2002). invoking the project discourse thus implies not only the exclusion and suppression of non-project aspects, but also the disconnecting of everything that does not fit into the project management discourse. to sum this up, the broad conceptualisation of projectification includes the focus on organisational restructuring in the narrow view, but extends the notion of projectification into societal and individual life and employs cultural, sociological and critical theoretical perspectives in the analysis of processes and the consequences of this. it implies that the increased prevalence of projects and project management processes in organisations is not only analysed from the perspective of rational structural responses to competitive and technological changes, but is also set in a cultural and discursive context in which notions of projects and project management are central to societal development in general. we will now illustrate how these insights can be useful in the study of projectification in practice. 5 applying narrow and broad views of projectification: an empirical illustration in this section we will return to some of our earlier research on projectification processes in order to illustrate how a broad conceptualisation may contribute to knowledge and theoretical development. in the particular study revisited here, we considered the consequences of increased project-orientation in organisations (cf. lindgren & packendorff, 2006a; 2006b; 2007, 2008, 2009; lindgren et al., 2014). a range of organisations in ict consulting and the performing arts were studied by means of interviews with individuals who were working in projects and who were members of the same project teams. this means that individuals were asked for the spontaneous story of their life, including both work and life in general, during the implementation time of their respective projects. individual interviews lasted for about two-three hours. after typing up the tape-recorded material, we extracted different narratives linked to aspects of projectification by means of thematic analysis. inspired by martin’s (2001) method, we thus emphasised narratives on the production and re-production of the project work form, the invocation of project management discourses, how the individuals related their way of living to what was happening in ‘projects’, and the dynamic relations between organisation and ‘projects’. it appeared that all the organisations studied experienced similar problems in the wake of their on-going projectification, usually manifesting in individual stress, delays and budget overruns in projects, and a lack of overview of the project portfolio. integrating the various problems into a model of ongoing projectification (lindgren & packendorff, 2008), we found that they were indeed related and tended to sustain each other over time. we summarised this in terms of an ‘evil cycle of projectification’ (see figure 1) built from a narrow conceptualisation. according to the narrow-view analysis, the legacy of neglecting capacity issues in projectbased environments (stage a) is reflected in the attitude that additional projects can always be added and that starting a project earlier will imply that it will also be delivered earlier (b). when adding projects to the portfolio, it is usually possible to identify individuals who have enough spare time to take on additional tasks (c). the usual consequences of this are delays and budget overruns in project implementation (d), as it now appears that the sajems special issue 17 (2014) : 7-21 15 organisational capacity was indeed lacking in terms of overload and managerial attention. owing to improvisational measures and firefighting, most projects are still being delivered satisfactorily (e). the impediments to learning and improvement thus remain too significant for the basic lack of understanding concerning organisational capacity to be alleviated (a). the measures taken in the organisations studied included support and anti-stress training for employees, increased emphasis on leadership and control in the individual projects, and the introduction of project portfolio management models. nevertheless, the basic problems tended to persist. figure 1 ‘evil cycle’ of projectification, narrow-view analysis source: adapted from lindgren & packendorff (2008:55) this narrow view analysis of the processes of projectification reveals not only the incremental and stepwise manner in which the project form is granted primacy in organisations (cf. jerbrant, 2014), but also the fact that the project-based organisations may well become subject to inertia and bureaucratisation (cf. also hodgson, 2004). processes of projectification imply not only that operations are split up into flexible and innovative units, but also that several aspects of repetitive organising that could also be beneficial in project-based settings are left behind. in this case, we find not only the familiar tendency to overlook issues related to capacity and load in project work (cf. wheelwright & clark, 1992), but also an absence of hrm in project situations (bredin & söderlund, 2006), neglect of the additional pressures on employees caused by organisational complexity, and multiple deadlines (cf. turner et al., 2008; cicmil & gaggiotti, 2009), and a lack of insight into the operational risks related to reliance on heroic action. in the cases studied here, the notion of projects serves not only to structure operations in a dynamic and flexible way, but also to transfer responsibility and accountability from managers to teams and individuals without offering relevant organisational infrastructures or resources. from this narrow analysis of projectification, we can thus identify several important aspects of problematic organisational restructurings and point to possible ways of resolving them. at the same time, it was clear to us that many of these problems were already familiar to managers and employees in the organisations studied, and that almost nobody could imagine an alternative way of organising project-based 16 sajems special issue 17 (2014) : 7-21 work. as noted by the ict consultant carl and his project leader eric: “the salespersons will always promise the customers quicker and cheaper projects than possible. they will always make them believe that we will fix their problems through a fast installation of our software, but in practice, we always have to make far-reaching modifications. and those modifications mean delays. when the project schedule cracks down, we just have to sit there with our extra hours. it has been like that in almost all my projects” (carl). “well, you don’t actually plan for that kind of work peaks. when you make a time schedule, you estimate the duration of each work package and then add some slack. you don’t plan for any bigger problems. no projects go exactly as planned and you don’t know everything from start. but if you were to investigate and estimate everything beforehand, you would never come to the implementation phase” (eric). in order to understand how the various actors tend to be repeatedly caught up in such situations, a broad notion of projectification can be employed, whereby the actions taken are seen as internalising cultural values and invoking performative discourses on projects and project management. from such a perspective (figure 2), general discursive notions of projects as temporary, extraordinary, adventurous, controllable and delimited are drawn upon in work episodes labelled ‘projects’. extraordinarisation implies a discursive view of all projects as more or less unique, so it is not really possible to handle them together in a fully-integrated way. this is supported by the notion of projects as temporary, so they spill over to a view of project work as temporary, optimistically framed as opportunities that cannot be missed. people justify the fact that they are at the mercy of such conditions by drawing upon project-orientation in constructing their identities, performing as flexible, innovative, dedicated professionals. when problems appear, they may question the number of concurrent projects, thereby dismissing the situation as a matter of planning. they thus understand the situation to require even more project planning rather than questioning the processes of extraordinarisation and temporarisation. the consequent difficulties are then compartmentalised as isolated mistakes and as instances of heroic action that have created some sense of meaningfulness and excitement. when actors frame their work in such a way and take this way of working for granted as inevitable, project work and its consequences will be justified as normal and necessary and will thus be sustained over time. at the same time, other notions appeared to be suppressed and sometimes non-existent, such as repetitiveness (people and organisations live through a series of projects, not one project only), normalisation (project work is and should be seen as everyday things in these contexts), resilience (awareness of the limits of heroic masculinity is needed), risk (project risks and deviations cannot be fully controlled) and inter-relatedness (projects are related to each other and to the rest of the organisation throughout their existence). it can thus be concluded that the problems identified and their sustainability may depend upon invoking project management in a traditional and nonreflective way, and that some of the measures taken may actually aggravate the situation, as they are also based on traditional notions. with this brief illustration, we maintain that a broad conceptualisation of projectification offers a better understanding of its reasons, as well as new ways of explaining the persistence and continuation of project-based work forms despite their problematic consequences. projectification is driven not only by notions of suitability and effectiveness for certain organisational tasks, but also by the widespread legitimacy of project management as a rational managerial toolbox and project-orientation, as an internalised understanding of what it means to be a successful, productive and enterprising individual in contemporary society. at the same time, it should be noted that this broad understanding is not external to narrow conceptualisations and understanding of projectification, but rather builds on and includes them, but with different ontological, epistemological and axiological assumptions as points of departure. it also implies that new ways of formulating and resolving consequences of projectification can be identified (spicer, alvesson, & kärreman, 2009). for example, the broad conceptualisation offers new ways of attending to the unwanted and problematic sajems special issue 17 (2014) : 7-21 17 consequences of organisational projectification as identified through research employing narrow conceptualisations; by redefining problems with overload, stress or high project failure rates as problems related to institutionalised over-optimism, responsibilisation of individuals and expectations of omnipotence in project control, focus could shift to organisational cultures and management ideologies as sources of improvement instead of project maturity models and control systems. figure 2 evil cycle of projectification, broad-view analysis 6 conclusion in this article, we have argued that an increased focus on the processes of projectification would be beneficial to project research. by introducing the distinction between narrow and broad conceptualisations of projectification, we have extended this research area from its current concern with the increased primacy of projects in contemporary organisational structures (cf. maylor et al., 2006) to an interest in the cultural and discursive processes in society in which notions of projects are invoked. what separates the two conceptualisations is not the levels or units of analysis, but basic research assumptions. based on this, we propose that future research on projectification should actively employ a view of projects and project-based organising as cultural and discursive phenomena. we would thus not only be able to add to our knowledge of how project-based work is organised in everyday practice, but also increase our understanding of how societal discourse, organisational culture and individual identity construction are inter-related in the reproduction of project work in specific and post-bureaucratic organisation in general. we would also become more aware of both the full consequences of project-based work practices, and possible ways of attending to these consequences critically and constructively. the study of projectification is not a matter for project researchers alone. scholars of organisational theory interested in ‘bringing work back in’ to enhance understanding of contemporary organisational matters (cf. barley & kunda, 2001) should find studies of projectification most useful in developing new theoretical notions on, for instance, postbureaucratic organisations, virtual organisations, 18 sajems special issue 17 (2014) : 7-21 entrepreneurial processes, the organisation of innovation work, new leadership forms and new hrm practices. when work processes, complex tasks, long-term work change and life itself are increasingly treated as instances of project management, what happens, who benefits and what power structures emerge? are we experiencing a shift towards post-bureaucratic organisation, or is it better understood as rebureaucratisation at different levels of analysis? what about projects as outbursts of emotional labour, as projections of desire and hope rather than rationally planned activity systems? in addition to this, work-life problems in projectified work need continued attention, as do also the related issues of leadership and followership, of entrepreneurship and innovation. project research has an important role to play in such a 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capital markets is discussed with reference to two models, the fdw and the reefm models. the fdw model provides a diagrammatic explanation of the behaviour of the property market, while the reefm is an econometric model based on statistical principles that are able to forecast property-market behaviour by interpreting specific given variables. the reefm model as the perceived more sophisticated model, untested in south africa, was then analysed to test its applicability in the south african context. the findings confirmed the applicability of the model, although one part is not confirmed and is suggested for further research. key words: fdw model, reefm model, property economics, property market behaviour jel: g140, 170, 100, 190, p470 1 background the unique characteristics of real estate create, on the one hand, many opportunities for real estate investors, and, on the other, many difficulties. the different factors influencing the behaviour of real estate should therefore be investigated carefully. dipasquale and wheaton (1992:181) stated that analysing the market for real estate presents challenges because of the interrelation of spaceand asset markets. the earliest recording of work that distinguishes between use decisions and invest ment decisions with respect to real estate was probably weimer (1966), but hendershott and ling (1984) were the first to integrate space and capital markets into real estate. according to viezer (1999:504), hendershott and ling’s model evaluated investment value responses to tax code alterations in a dynamic programming algorithm that used a traditional discounted cash-flow equation with assumed parameters. corcoran (1987) graphed the space market and capital market of real estate separately, but interdependently, explicitly distinguishing between the shortand long-run supply of space. a similar model was published by fisher (1992: 167). fisher shows the equilibrium existing between the shortand long-run situations of the space and capital markets. dipasquale and wheaton (1992) and fisher, hudson-wilson and wurtzebach (1993) further refined this model, which is referred to as the diagrammatic model by viezer (1999:504)). the model was officialized in a textbook on property economics by dipasquale and wheaton (1992) as the fdw-model, the most detailed treatment found in a seminal textbook. du toit (2002) carried out research on the fdw-model and describes the principles of the model with an accompanying practical example of office space in pretoria. the fdwmodel conceptualizes the interrelationships between the market for space, asset valuation, construction sector and stock adjustment. viezer (1998) developed a completely new model that similarly describes the space and asset markets in the property sector, but this model is of an econometric rather than diagrammatic nature. viezer refers to it as the real estate econometric forecast model (reefm), and uses statistical principles to explain the property market, in contrast with the diagrammatical fdw-model. abstract 384 sajems ns 16 (2013) no 4:383-394 2 research problem the literature reviewed shows the development of models that distinguish between space and capital markets in real estate. this appears to be a logical exposition of measuring the activities in the real estate market, with the possibility of explaining the movements in the real estate sector. although some research could be found on the application of the fdwmodel in the south african context, nothing could be found on the application of the reefm model in south africa, even though it appears to be more sophisticated, with welldescribed econometric equations. the aim of this study is to test the applicability of the reefm model in the south african context by way of statistical analysis. the different equations specified in the model will be analysed by applying south african data and testing the significance of each equation by diagnostic testing. if each equation in its own right can be confirmed, using the results of all the preceding equations, the model can either be confirmed as applicable or rejected as not applicable to south african data. the null-hypothesis, that the six stochastic and four deterministic equations of the reefm model, as proposed in section 4, do not properly explain behaviour in the south african market. if the null-hypothesis can be rejected, then the alternative hypothesis can be accepted that the equations form a meaningful model for explaining behaviour in the south african property market. 3 the fdw model 3.1 the fdw-model defined archour-fischer (1999:33) states that the fischer dipasquale-wheaton model is an elegant metaphor that integrates the different markets in the built environment, with specific reference to the property market, the capital market and construction activity. du toit (2002:10) describes the fdw model as being a static quadrant model that has the ability to trace the relationships between real estate market and asset market variables. archour-fischer also suggests that it is a dynamic model (archour fischer, 1999:40-42), in which the parameters of the model can be changed to determine the influence in the different markets represented by the model, although viezer (1998) criticizes the application of the model (see section 2.3). taking into consideration the flow of real estate as discussed by dipasquale and wheaton, it is evident that the depreciation of real estate and the subsequent replacement of such depreciation is an output of the model, as it is a reduction in the stock level seen in quadrant four of the model. the reduction and replacement cause a shift in the supply and demand patterns so that the market reacts to it. it thus acts as an input to the rest of the model. the model reacts to the changes and further depreciation takes place, resulting in a change in the then present stock level. a discussion of the theory relating to the model will be presented in the following section. it should, however, be emphasized that du toit has already extensively discussed the principles of the model, and it is not the intention of this study to reproduce his work. however, it is necessary to include a detailed discussion of the model in order to explain different concepts later in the article. figure 1 shows a graphical illustration of the model, which consists of four quadrants, as shown in figure 1, and represents the following (archour-fischer, 1999:34-37): quadrant 1 – demand function on the market for space; quadrant 2 – the valuation function; quadrant 3 – the construction function; quadrant 4 – the adjustment supply. quadrant 1 indicates the demand function on the market for space demanded by users, represented in this study by the occupiers of office space. with a static supply, the price of space or rent level will increase when demand increases, and conversely. in equilibrium, the supply of property should be equal to the demand at various price levels. in quadrant 2 the rent level applicable to the equilibrium level of demand is discounted at the capitalisation rate, which is illustrated in figure 1 as the slope of the asset valuation curve, to arrive at the asset value, represented by the function p = r/i. sajems ns 16 (2013) no 4:383-394 385 quadrant 3 represents the construction activity, which is a function of the asset value. when the asset value is higher than construction costs (represented in figure 1 as the intersection of the construction curve and the x-axis), new f construction will be triggered, otherwise construction will come to a halt. thus, p = f(c). the level of construction activity is carried over to quadrant 4, the adjustment of supply, and is given by the function s = c /d, or ∆s = c – ds. 3.2 theoretical testing 3.2.1 assumptions some of the information crucial to the calculation of the variables and equilibrium level in the model was not supplied by the author of the literature (archour-fischer, 1999). the missing variables were therefore selected as follows: • market capitalisation rate (i) – 11 per cent • the α parameter 0.01 it should be noted that only the α or the β parameter need be supplied, as the other is then calculated from given data. the value of 0.01 assigned to the α parameter indicates a slope of the construction function of 0.01. this means that the construction activity will change one unit for every hundred units change in the value of space. the β parameter is then calculated as r 1 669.90, which indicates that new construction will be triggered when the value per unit is more than that shown in the figure below. figure 1 diagrammatic fdw-model table 1 gives a summary of the functions used above. table 1 fdw-model functions quadrant 1: demand for space r = f1(s) s = e(b – a . r) quadrant 2: determination of value p = f2(r) p = r/i quadrant 3: construction function c = f3(p) c = (p – β)/α quadrant 4: stock adjustment function s = f4(c) s = c/d where: r = rent per unit i = the capitalisation rate s = supply c = construction e = the number of office workers α and β = construction parameters a and b = demand parameters d = a depreciation rate p = price or value per unit source: archour-fischer, 1999:38-39 rent market for space d(r, econ.) = s 1 2 stock (sq ft) asset valuation p = r/i price (r) 3 4 stock adjustment s = c/d construction sector p = f(c) construction (sq ft) 386 sajems ns 16 (2013) no 4:383-394 3.2.2 calculations in order to test the validity of the model’s functions, the different calculations should indicate an equilibrium level. the first function, the demand for space, determines the supply, according to the given figures. the last function also calculates supply, but from another set of parameters. therefore, should there be equilibrium, both calculations would result in the same answer. the calculations are carried out separately for each quadrant, which will indicate how each quadrant is influenced. the last quadrant should end with the same answer as that of the first quadrant. quadrant 1: s = e(b – a . r) = 100 000 office workers (420 – 2 × r 201.78 per worker) = 100 000 (420 – 403.56) = 100 000 (16.44) = 1 644 000 m2 quadrant 2: p = r / i = 201.78 / 0.11 = r 1 834.36 quadrant 3: c = (p – β) / α = (1 834.36 – 1 669.90) / 0.01 = 16 446 m2 quadrant 4: s = c / d = 16 446 / 0.01 = 1 644 600 m2 the results for s above are indicated by 1 644 000 m2 and 1 644 600 m2. this indicates a variance of 0.03%, which is accepted as a result of the approximation of decimals and is statistically within acceptable range. 3.3 remarks on the fdw model the fdw model seems to offer an acceptable interpretation of the property market using a diagrammatic model, which is mathematically explained by the developers of the model. however, viezer (1998) points out that the fdw model is of little value as an investment tool, and he develops a real estate econometric forecast model (reefm) that is able to forecast implicit market returns. the reefm seems to be of much more value as an investment tool, as it can be used for calculating historical returns and forecasted returns. according to archer and ling (1997), a multi-factor asset pricing model should be used to determine the discount rate, which in turn would determine both the market value and the cap rate, rather than assuming that the cap rate is exogenously determined. viezer (1998) developed an econometric model for the integration of real estate’s space and capital markets – the real estate econometric forecast model (reefm). in his research, he answers the above comment by archer and ling by including a stochastic equation for, inter alia, the cap rate. viezer’s equation contains five predetermined variables four of which are taken, with some modifications, from the prespecified arbitrage pricing theory (apt) model by chen, roll and ross (1986). the fdw model is interpreted by viezer (1998) to suggest that equilibrium is a natural state where all values are determined simultaneously, but in reality there are lags in the adjustment process. viezer (1999:507) also modifies the dipasquale and wheaton (1992) model by positing that real construction costs are a function of the lagged net change in stock, rather than a current-period new construction. viezer further points out that the fdw model is of little value in terms of practical advice, and is limited to forecasting the changes in the direction of real estate markets and general levels of return. he maintains that the model should be estimated statistically in individual markets if it is to be useful to the practitioner. the reefm integrates real estate’s space and capital markets econometrically rather than diagrammatically. the model also links the shortand long-run markets, and calculates implicit market returns for property markets (viezer, 1998:143). the model can therefore be used as an effective investment or forecast tool. the only forecast inputs needed are the local economic variables, and national financial variables (viezer, 1998:144). sajems ns 16 (2013) no 4:383-394 387 4 the reefm model 4.1 principles of reefm it should be emphasised that it is not the intention of this paper to either explain or to discuss the fundamentals of the reefm, or to investigate the validity of the research by viezer (1998). the paper will test only the applicability of the model for use in the south african property market. the conceptual framework of reefm is illustrated in figure 2 (viezer, 1998:107). reefm is a recursive model, containing six stochastic equations (occupancy, real rents, capitalisation rate, market value per unit, change in stock, and real construction costs) and seven deterministic equations (a net operating income proxy, market value per unit, stock of space, vacancy rate, implicit appreciation market return, implicit income market return and implicit total market return) (viezer, 1998:134-5). the six stochastic equations given by viezer are all in the format: yi = αi + β1xi + εi where: αi = y intercept for the population; β1 = slope for the population; εi = random error in y for observation i. this relationship is confirmed by two sources, with different formats for the same equation: yi = β0 + β1xi + εi (levine, berenson & stephan, 1998:538) and; µy = α + βx (steyn, smit & du toit, 1989:378), which is the function of a straight line relationship between x and y. each of the stochastic equations is a variation of the above equation, allowing for the different variables that influence the yi factor. in all six equations the variable: σt=1 t-1δtyrdumt is also added, which is missing data indicators to be used in estimating the unbalanced panel (viezer, 1998:115). the deterministic equations are in different formats, calculating a specific result in each case by combining the results from the stochastic equations. in both the stochastic and deterministic equations, the variables are given in the format vp.m.t., which in this case would indicate a variable (v) for property type p, in metro area m, at time period t. the different equations will be discussed in the text to follow, and the similarities and differences relating to the fdw model will be explained. figure 2 reefm’s conceptual framework source: viezer, 1998:107 d local and national economic factors occupancy occupancy vacancy rent $ s sf space market rent capital market noi discount rate cap rate lag current dividend discount model market value determination of construction market value versus cost stock versus occupancy change in stock construction cost arbitrage pricing theory 388 sajems ns 16 (2013) no 4:383-394 4.1.1 short-run asset market occt = αt + β1rnt$t-1 + γ1econt + σt=1 t-1δtyrdumt + εt 1 (viezer, 1998:115) rnt$t = αt + β1vact-1 + σt=1 t-1δtyrdumt + εt 2 (viezer, 1998:115) viezer explains occupancy (occp.m.t.) as a function of lagged real rent, (rnt$p.m.t, nominal rent deflated by the consumer price index) and an economic variable. the economic variable in the case of office space would be office employment. real rents, in turn, respond with a lag to vacancies in the market (viezer, 1998:114-15). on the contrary, the fdw model only takes the demand as equal to the supply of office space, using only the equation s = e(b – a.r) to calculate this (see section 2.2.2). rent levels are taken as a given, and are not calculated as above. this means that the variables are calculated according to a much less scientific method, limiting the capabilities of the model for the historical explanation of the market, as well as possibilities for forecasting, which would be much more useful. the first deterministic equation is a proxy for the net operating income (noip.m.t). the net operating income is determined by multiplying the occupancy by the rental levels. however, the rental levels are calculated for real rent in terms of equation 2 and should therefore be inflated by the consumer price index (cpi). the equation for the net operating income is therefore: noip.m.t = occp.m.t x rnt$p.m.t x (cpi/1000) 3 (viezer, 1998:117) 4.1.2 short-run capital market the capital market attempts to translate the results of the short-run space market into asset prices. “the reasonably calculated expected future net income flow of an investment property discounted to its present value, when capitalised at the prevailing rate sought by prudent investors, represents the estimated capitalised value of the property at that time” (saiv, 1999:6-4). when considering the future income stream, it increases approximately in line with inflation, or the country’s cpi. the income stream can therefore be capitalized by dividing the first year’s income by the capitalisation rate, which is the discount rate minus cpi. as the discount rate is not determined, the cap rate cannot be determined from the discount rate. however, viezer determines the cap rate with the equation: capp.m.t = αp.m.t + β1riskt + φ1termt + γ1inflt + η1%δeconp.m.t + ξrntp.m.t-1/msfp.m.t-1 + σt=1 t-1δtyrdumt + εp.m.t 4 (viezer, 1998:123) the variable rntp.m.t-1/msfp.m.t-1 considers the backward-looking comparisons of appraisers and therefore takes into consideration historical data. %δeconp.m.t is the percentage change in the economic variable as used in the equation for occupancy. inflt is the current inflation rate, while riskt and termt are risk variables used by viezer as the difference between the corporate baa bond rate and the 10-year treasury bond rate, and the difference between the 10-year treasury bond rate and the 3month treasury bill rates respectively (viezer, 1998:123, 124). with the cap rate established, it is possible to calculate the market value per unit for the metro property stock with the equation: msfep.m.t = noip.m.t x (1 + (passp.m.t x inflt)) ÷ stkp.m.t 5 capp.m.t (viezer, 1998:124) the pass variable indicates the extent to which the inflation rate is passed through to the property appreciation. the msfe variable is then regressed to determine the actual property value per unit: msfp.m.t = αp.m.t + β1msfep.m.t-1 + σt=1 t-1δtyrdumt + εp.m.t 6 (viezer, 1998:124) sajems ns 16 (2013) no 4:383-394 389 while the above equations are used to determine the per unit market value of property, the fdw model divides the demand, multiplied by the rate per unit, by the cap rate to get to the market value. while reefm takes into consideration different risk factors as well as economic variables for calculating the cap rate, the fdw model does not indicate how this is calculated (du toit, 2002:31). from this it is also taken that reefm calculates the market value of property in a much more scientific way, which creates an opportunity for explaining the current market as well as forecasting future trends. 4.1.3 long-run space market the long-run space market is the addition of new stock or construction and the removals of stock or depreciation. these construction and removals are a function of the difference in quantities (stk – occ) and real prices (msf$ – cst$) (viezer, 1998:132). the asset market is expressed in quantities and the capital market is expressed in prices with the following equations: asset market: newp.m.t – rmvp.m.t. = αp.m.t + β1(stkp.m.t-l – occp.m.t-l) + γ1(msf$p.m.t-l – cst$p.m.t-l) + σt=1 t-1δtyrdumt + εp.m.t 7 (viezer, 1998:132) the stock of space in the current period takes into consideration the stock in the previous period, plus the current period’s construction, minus the current period’s removals: stkp.m.t = stkp.m.t-1 + newp.m.t – rmvp.m.t 8 (viezer, 1998:132) capital market: cst$p.m.t. = αp.m.t + β1newp.m.t-1 – rmvp.m.t-1 + σt=1 t-1δtyrdumt + εp.m.t 9 (viezer, 1998:132) in the above, the real construction costs are indicated as being a function of the lagged net change in stock (viezer, 1998: 132). the last equation to close the loop for the model is the vacancy rate: vacp.m.t = 1 – (occp.m.t / stkp.m.t) 10 (viezer, 1998:133) the fdw model is represented as a static model, and does not take into consideration any new construction. construction is calculated by the fdw model only as the replacement of depreciation. the depreciation rate is given as a set figure (archour-fischer, 1999:37). from this it is evident that any influence of the long-run space market on the equilibrium level is excluded from the fdw model, which puts into question the validity of any practical use of the fdw model. 5 case study in order to apply the theory to practice, secondary data of macro-economic statistics (south african reserve bank, 2013) and information of offices in the property market (rode, 1990 to 2008) were investigated. data were captured per quarter for the period from quarter 1 (1990) to quarter 3 (2008). the totals were aggregated to a national level, and were substituted into the theoretical model for analysis. the data is mostly of a time-series nature and for regression purposes is transformed by way of first differences and log-transformation where applicable. details of transformation and the different data sets that were used are explained in the text. 5.1 short-run space market the short-run space market consists of two stochastic and one deterministic equation. the first stochastic equation, occt, is a function of real rent and an economic variable as per equation 1. the economic variable for office type properties is the number of office workers. for the purposes of calculation in this study, the figures for total employment in the private sector are used. 390 sajems ns 16 (2013) no 4:383-394 rnt$t. levels are a function of the vacancy levels in the preceding period, and could therefore be predicted when the vacancy level is available using equation 2. the applicability of preceding-period vacancies to determine real rent is tested by a regression of the actual quarterly rental levels to the actual quarterly vacancy level preceding the current time period with one year in terms of equation 2. the result is an adjusted r square of 0.043 with an f-value of 4.351. the critical f-value is 3.98 and 7.05 at the 0.05 and 0.01 levels respectively. although the regression rejects the hypothesis that previous-period vacancies cannot explain the variance in real rents, the correlation is negligible. furthermore, the durbin-watson statistic shows a value of 0.212, while dl and du are 1.583 and 1.641 respectively. this also suggests evidence of autocorrelation. by transforming the data by way of a first difference, the durbin-watson statistic changes to 1.524, which just fails to reject the hypothesis that no autocorrelation exists, but the r square changed to -0.014 with an f-value of 0.043. by using annual rather than quarterly data, the adjusted r square increased to 0.649 with an f-value of 28.757. the critical f-value is 8.86 at the 0.01 level, confirming that previous-period vacancies are a good indicator of current period rental levels. the durbin-watson statistic for the annual data was determined as 1.543, with dl and du at 0.776 and 1.054 respectively. the hypothesis that autocorrelation is present in the annual data can therefore be rejected. the actual versus the calculated real rent is shown graphically in figure 3. the use of equation 1 to calculate occupancy, revealed that first difference transformed rentals of the preceding-period, in combination with employment data that is also first different transformed, failed to predict occupancy. however, if the first difference of current-period rentals is used, an adjusted r square of 0.360 is determined, with an f-value of 5.50. the critical f-values for the 0.05 and 0.01 levels of significance are 3.74 and 6.51 respectively. it could therefore be accepted with at least 95% confidence that 36% of the variance in the occupancy is explained by current-period rentals and employment. figure 3 calculated vs. actual change in real rent the durbin-watson statistic for the regression is 1.548, with dl and du for the 0.01 level at 0.66 and 1.254 respectively. the suggestion of any autocorrelation in the data can therefore be rejected. the actual versus the calculated occupancy is illustrated in figure 4. sajems ns 16 (2013) no 4:383-394 391 figure 4 calculated vs. actual change in occupancy 5.2 short-run capital market equation 4 calculates capitalisation rates with reference to bond rates, inflation, changes in employment (south african reserve bank, 2013) and previous-term rent/value relationships (rode, 1990 to 2008). the data has been log transformed for purposes of calculation. the quarterly data provided reasonably good results, but the durbin-watson statistic at 0.328 failed to reject the hypothesis of no autocorrelation. annual data not only resolved the autocorrelation, but also increased the adjusted r square from 0.366 to 0.634, while the f-value changed from 8.86 to 6.882. the critical f-value for the annual data is 5.06 at the 0.01 level, indicating that equation 3 can largely explain the movement in capitalization rates with 99% confidence. the comparison of actual versus calculated capitalization rates is illustrated in figure 5. figure 5 calculated vs. actual capitalization rates 9 10 11 12 13 14 15 16 9 10 11 12 13 14 15 16 c al cu la te d c ap . r at es actual cap. rates 392 sajems ns 16 (2013) no 4:383-394 with the capitalisation rates determined, it is possible to capitalise the noi, which is determined in terms of equation 3, then to calculate the market value per unit in terms of equation 5. equation 6 is then used to regress the actual property value per unit. the first difference transformed quarterly data and provided a good fit, but once again the durbinwatson statistic at 0.244 failed to reject evidence of no autocorrelation. the annual data provided an adjusted r square of 0.622 with an f-value of 20.744. the critical f-value at the 0.01 level is 9.65. the durbin-watson statistic in this case is 1.409, with the dl and du values at 0.653 and 1.010 at the 0.01 level. it is therefore confirmed that evidence of autocorrelation is rejected. the calculated vs. actual change in msf values is presented in figure 6. figure 6 calculated vs. actual change in msf 5.3 long-run space market for the asset market, the regression of the first difference of new-rem as per equation 7 resulted in an adjusted r square value of 0.553 for the annual data. new-rem is taken as the annual change in all fixed assets as reported by the south african reserve bank (2013). the fvalue is 5.944 with a critical f-value of 5.14 at the 0.05 level. the hypothesis that equation 7 is true could therefore be accepted at the 0.05 level, but failed to reject the null hypothesis that equation 7 is not true at the 0.01 level. the durbin-watson statistic obtained a value of 1.804, which confirms that no autocorrelation is present. the comparison of calculated versus actual change in new–rem is displayed in figure 7. when analysing the capital market, the only equation that failed to provide satisfactory results was the change in construction cost to be a function of the change in stock. by analysing quarterly or annual data the adjusted r square values were 0.20 with the f-values also below 0.20. this indicated that equation 9 failed to reject the hypothesis that construction costs are not affected by previous-period changes in stock. however, this is not considered critical at this stage in order to arrive at a conclusion, but it is recommended that the specific analysis of this be investigated by way of further research. sajems ns 16 (2013) no 4:383-394 393 figure 7 calculated vs. actual change in new-rem 5 conclusion the paper investigated different models that considered the space and capital markets in real estate, testing the applicability of the principle of space and capital market differentiation on the south african property market. although the theoretical principles of two models, the fdw and reefm models, were discussed, only the reefm model was tested empirically for application in the south african context. the different equations that form the reefm model were tested individually and it was found that all but one equation had statistical significance when explaining office property behaviour. the model as a combination of the set of equations could also be accepted as applicable because the results of each equation were carried forward to the next. the hypothesis at each equation is therefore tested according to the calculated data from all the equations combined. by confirming the applicability of the individual equations, the combined dataset could therefore also be accepted as applicable. the value of this paper lies in the possibility of applying the model in the south african context in order to monitor property behaviour more closely. it is recommended that the model also be tested on other real estate asset types, i.e. industrial, retail or residential, or to apply the principles on smaller markets, i.e. specific geographical areas. as such it could be used successfully to explain specific property economics, or even to valuate property in general. references archour-fischer, d. 1999. an integrated property market model: a pedagogical tool. journal of real estate practice and education, 2(1). archer, w r & ling, d.c. 1997. the three dimensions of real estate markets: linking space, capital, and property markets. real estate finance, 14:7-14. chen, n., roll, r. & ross, s.a. 1986. economic forces and the stock market, journal of business, 59:383-403. corcoran, p.j. 1987. explaining the commercial real estate market. journal of portfolio management, 13:15-21. dipasquale, d. & wheaton, w.c. 1992. the markets for real estate assets & space: a conceptual framework. journal of the american real estate and urban economics association, 20(1):187-97. 394 sajems ns 16 (2013) no 4:383-394 du toit, h. 2002. appraisal of the fischer-dipasquale-wheaton (fdw) real estate model and development of an integrated asset market model (ipamm). unpublished treatise submitted in part fulfilment of the requirements for the msc (real estate), university of pretoria. fisher, j.d. 1992. integrating research on markets for space and capital. journal of real estate and urban economics association, 20(1):161-80. fisher, j.d., hudson-wilson, s. & wurtzebach, c.h. 1993. equilibrium in commercial real estate markets: linking space and capital markets. journal of portfolio management, 19:101-107. hendershott, p h & ling, d c, 1984. prospective changes in tax law and the value of depreciable real estate. journal of the american real estate and urban economics association, 12:297-317. levine, d.m., berenson, m.l. & stephan, d. 1998. statistics for managers. new jersey: prentice hall. rode & associates. 1997 to 2002. rode’s report on the sa property market. 1990:1 2008:3. south african institute of valuers (saiv). 1999. the valuers’ manual. (7th ed.) durban: butterworths. steyn, a.g.w., smit, c.f. & du toit, s.h.c. 1989. moderne statistiek vir die praktyk. (4th ed.) pretoria: j l van schaik. south african reserve bank. 2013. available at: http://www.resbank.co.za/qbquery/ timeseriesquery.aspx. online interactive data [accessed 2013 april to may]. viezer, t.w. 1998. statistical strategies for real estate portfolio diversification. doctoral dissertation, ohio state university, columbus, oh. viezer, t.w. 1999. econometric integration of real estate’s space and capital markets. journal of real estate research, 18(3):503-19. weimer, a.m. 1966. real estate decisions are different. harvard business review, 44:105-112. about the author(s) sizwe khoza department of logistics and supply chain management, faculty of management sciences, vaal university of technology, vanderbijlpark, south africa chengedzai mafini department of logistics and supply chain management, faculty of management sciences, vaal university of technology, vanderbijlpark, south africa welby v. loury okoumba department of logistics and supply chain management, faculty of management sciences, vaal university of technology, vanderbijlpark, south africa citation khoza, s., mafini, c. & loury okoumba, w.v., 2023, ‘corrigendum: lean practices and supply-chain competitiveness in the steel industry in gauteng, south africa’, south african journal of economic and management sciences 26(1), a4900. https://doi.org/10.4102/sajems.v26i1.4900 note: doi of original article published: https://doi.org/10.4102/sajems.v25i1.4617 correction corrigendum: lean practices and supply-chain competitiveness in the steel industry in gauteng, south africa sizwe khoza, chengedzai mafini, welby v. loury okoumba published: 21 june 2023 copyright: © 2023. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. in the published article, khoza, s., mafini, c. & loury okoumba, w.v., 2022, ‘lean practices and supply-chain competitiveness in the steel industry in gauteng, south africa’, south african journal of economic and management sciences 25(1), a4617. https://doi.org/10.4102/sajems.v25i1.4617, on page 7 the following paragraph is updated as it was incorrectly formulated: the original incorrect wording: explanatory factor analysis a harma’s one-factor score test was conducted by running the preliminary explanatory factor analysis (efa) on the sample data. in contrast, the unrotated factor solution was examined to determine the number of necessary factors to account for the variance in the variables. the single factor that emerged yielded one general factor accounting for approximately 24.89% of the covariance among the measures, concluding that common method variance is not a problem. the revised and updated wording: exploratory factor analysis a harman’s one-factor score test was conducted by running the preliminary exploratory factor analysis (efa) on the sample data. in contrast, the unrotated factor solution was examined to determine the number of necessary factors to account for the variance in the variables. the single factor that emerged yielded one general factor accounting for approximately 24.89% of the covariance among the measures, concluding that common method variance is not a problem. the authors apologise for this error. the correction does not change the study’s findings of significance or overall interpretation of the study’s results or the scientific conclusions of the article in any way. abstract introduction and background literature review conceptual model and research propositions research methodology research results discussion of the results conclusions, theoretical and managerial implications limitations and suggestions for further research acknowledgements references about the author(s) welby v. loury-okoumba department of logistics, faculty of management sciences, vaal university of technology, vanderbijlpark, south africa chengedzai mafini department of logistics, faculty of management sciences, vaal university of technology, vanderbijlpark, south africa citation loury-okoumba, w.v. & mafini, c., 2021, ‘supply chain management antecedents of performance in small to medium scale enterprises’, south african journal of economic and management sciences 24(1), a3661. https://doi.org/10.4102/sajems.v24i1.3661 original research supply chain management antecedents of performance in small to medium scale enterprises welby v. loury-okoumba, chengedzai mafini received: 16 apr. 2020; accepted: 30 oct. 2020; published: 22 feb. 2021 copyright: © 2021. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the failure rate of most small to medium enterprises (smes) in south africa remains very high, with up to 70% of such businesses closing down within the first 5 years of operations. high business operating costs incurred by smes are often cited as one of the major causes of these failures. it may be argued that to reduce these costs, and hence improve the success rates of sme ventures, supply chain management (scm) strategies should be adopted and implemented. aim: this article provides an analysis of the connection between scm strategies, supply chain agility and supply chain performance among smes in south africa. setting: a total of 407 owners, managers and professional employees of smes operating in gauteng were recruited purposively to participate in the study. method: to test the proposed relationships, the collected data were analysed using exploratory factor analysis, pearson correlations and regression analysis. result: the results of the study disclosed that all four scm strategies (supplier collaboration, total quality management, technology adoption, supply chain integration) correlated with and predicted supply chain agility. technology adoption (β = 0.54) emerged as the strongest predictor of supply chain agility. in turn, supply chain agility correlated with and predicted supply chain performance. conclusion: the article concludes by recommending specific interventions that may be employed by smes to ensure that the adoption of scm strategies yields positive outcomes. keywords: buyer-supplier collaboration; supply chain integration; total quality management; it adoption; supply chain agility; supply chain performance. introduction and background the body of literature on south african small to medium enterprises (smes) continues to grow. some researchers (balogun, nazeem & agumba 2016; ghebrihiwet 2019; maduku, mpinganjira & duh 2016) have directed attention to the impact of smes on the south african economy. others (fatoki 2014; makhitha 2017; neneh & van zyl 2017) have concentrated on the challenges faced by smes in south africa. also, additional studies (dzomonda, fatoki & oni 2017; hove-sibanda, sibanda & pooe 2017; mathu & tlare 2017) have placed emphasis on entrepreneurship factors determining the success of smes in the country. yet other scholars (aliyu, modu & tan 2018; chakraborty, mutingi & vashishth 2019; chingwaru 2015 three) have conducted comparative studies involving smes in south africa and those in other parts of the world, such as zimbabwe, egypt and nigeria, india and namibia. several common gears of observations bind these studies together. firstly, the studies concur that smes are essential to the south african economy, contributing extensively to its growth and development. secondly, most studies assent that the sme trajectory in the country is a difficult one and is riddled with numerous internal and external problems that have claimed the existence of numerous enterprises soon after their formation. thirdly, the studies commonly accept that the path followed by smes in south africa is neither unique nor isolated since similar enterprises in other developing countries face comparable problems. the importance of smes to the south african economy is without dispute, having been documented in several studies (alkhajeh & khalid 2018; bushe 2019; leboea 2017; maduku et al. 2016). their most significant roles are in areas such as employment creation, innovation and productivity, with up to 91% of smes contributing about 52% to 57% to the country’s gross domestic product (gdp) (small enterprises development association 2019). yet conflicting evidence indicates that regardless of their importance, smes face numerous challenges, such as lack of capital, fierce competition in most sectors, shortage of skills, corruption, dependence on obsolete management models and negative economic development, among others, that impede their prospects of survival, growth and success (molefe, meyer & de jongh 2018; moos & sambo 2018; muriithi 2017). so pronounced are these challenges that between 70% and 80% of south african smes fail to reach their maturity stage (dzomonda et al. 2017; neneh & van zyl 2017; small enterprise development agency [seda] 2018). the existence of these challenges presents opportunities for further research to generate more information on how they may be overcome. the current study investigated the connection between supply chain management (scm) practices, supply chain agility (sca) and supply chain performance (scp) in south african smes. although smes are important to the south african economy, their continued struggles and failures act as stimuli for further research, based on the view that empirical research is an avenue for the generation of lasting solutions to such business problems. the dependence of smes on ineffective business management strategies triggers the suggestion to identify scientifically those models that are applicable to the situation in south africa. governments, communities of practice, business owners and managers may then tap into such resources to identify and use relevant information to turn their businesses around and flatten the curve of failed smes in south africa. the current study approaches the management dilemmas facing smes from a scm perspective. at most, scm remains an emergent concept to most smes, yet has now become an activity of strategic importance that determines either the success or failure of a business (kot 2018; kot, goldbach & ślusarczyk 2018). it may further be argued that knowledge about the application of the scm concept to smes in south africa is still in its infancy, which increases the necessity of continual empirical studies directed to this critical sector. using the scm standpoint, the study identifies four practices relevant to smes. these include buyer-supplier collaboration (bsc), supply chain integration (sci), total quality management (tqm) and information technology adoption (ita) – practices that have been applied extensively in past studies (basheer et al. 2019; thai & jie 2018). in line with evidence from prior literature (ngai, chau & chan 2011; prajogo & olhager 2012; revilla & villena 2012; yang 2013), the study links these scm practices to sca, which in turn enhances scp in smes. thus, the study presupposes that performance of sme supply chains in south africa can be improved through the implementation of scm practices. some evidence exists of previous research narrowed down to scm practices in south african smes (e.g. abualrejal et al. 2017; eicker & cilliers 2017; fatoki 2019; mofokeng & chinomona 2019; molefe et al. 2018). however, a comprehensive literature search made by the authors of the present article revealed that it is not easy to find any prior south african studies that tested the conceptual model evaluated in the current study. the current study is thus intended to occupy this gap. literature review supply chain management practices supply chain management practices are activities intended to manage the operations, as well as functions of a supply chain, ensuring a flow of goods, services money and information from sources to the end users (shukla, garg & agarwal 2011). it is widely recognised that scm practices are effective in providing core value to an organisation’s strategic direction in terms of adhering to or meeting performance objectives (chardine-baumann & botta-genoulaz 2014). they are sets of practices that perform a strategic role in the competitive aspirations of businesses and contribute to improving the performance of an organisation’s supply chain (banerjee & mishra 2015; randall et al. 2011). examples of scm practices include sci, customer service management, geographical proximity, just-in-time (jit), business intelligence, logistics and distribution, supplier collaboration, and lean and green scm (banerjee & mishra 2015; govindan et al. 2014). the current study concentrates on four practices proposed by wiengarten et al. (2010), namely bsc, ita, sci and tqm. their selection is based on the rationale that these are fundamental aspects of the sustainable performance of sme organisations’ supply chain environment (banerjee & mishra 2015). buyer-supplier collaboration buyer-supplier collaboration is the ability of two or more partner organisations to work together in joining supply chain-related activities, which is essential in meeting requirements and expectations of customers (fawcett et al. 2011). collaborative engagement between buyers and suppliers calls for a synergistic working engagement between supply chain partners, with the purpose of exchanging proprietary knowledge and information, expertise, as well as technologies (osarenkhoe 2010). factors such as the setting of mutual goals and objectives, an organisation’s internal governance and mutual trust, as well as information exchange are essential in influencing buyer and supplier decisions to collaborate (grudinschi, sintonen & hallikas 2014). buyer-supplier collaboration may also be strengthened through the effective sharing of information and quality communication between supply network members, as this helps to establish inter-organisational learning (claro & claro 2010). in addition, innovation practices centred on new products and strategic, operational development play a critical part in allowing buyers and suppliers to join forces, to meet market and customers’ requirements (jajja et al. 2014). within smes, an effective and efficient collaborative working engagement contributes significantly to the abilities of such enterprises to meet their performance objectives (kwofie, aigbavboa & matsane 2017). furthermore, alliances across sme supply chains are essential in optimising operational activities, in the process ensuring that customers’ and consumers’ requirements are met (kwofie, aigbavboa & matsane 2017). supply chain integration supply chain integration is the combination of internal and external resources from both organisations’ supply chain partners (whipple, wiedmer & boyer 2015). according to wong, boon-itt and wong (2011), sci is a multidimensional construct, consisting of internal and external integration factors. on the one hand, internal integration refers to the interconnectivity of all cross functions within an organisation’s environment (wiengarten et al. 2016). on the other hand, external integration involves integration between a firm’s upstream (customers) and its downstream (suppliers) business associates (wong et al. 2011). supply chain integration aims to achieve effective synergy and cooperation in operations processes, which is crucial to attaining the ideal competitive advantage (kumar et al. 2017). hence, the concept is more of an interactive approach of different supply chain networks rather than separated and disjointed functions (ataseven & nair 2017; whipple et al. 2015). in the context of smes, it could be argued that sci is a strategic activity that contributes to competitive performance. to support this view, madzimure (2019) found that the capabilities of smes to integrate their internal logistics and network activities, correlates with the effectiveness of their operations. hence, conceivably, smes could benefit from adopting a more integrative approach to their business functions. total quality management total quality management is a business management strategy designed at enhancing the overall quality, management and performance of a firm to achieve competitive advantage (lee et al. 2010). it is focused on ensuring sustained operations through the effort and contribution of an organisation’s primary stakeholders, such as suppliers, top management, employees and customers, to meet the expectations and requirements of the customer (teeravaraprug, kitiwanwong & tong 2011). it involves principles such as supplier quality management and improvement systems, customer focus, continual improvement, education and training, and benchmarking (farish, anil & satish 2017). agus and hassan (2011) identified supplier relations, benchmarking activities and quality measurement as prominent precursors to positive tqm adoption, and as underlying factors in assuring competitive objectives. application of tqm yields paybacks, such as the overall improvement of efficient and productive operation activities, enhanced employee morale, and further contributes to the achievement of a competitive advantage to the organisation (aamer, al-awlaqi & alkibsi 2017; nasim 2018). from an sme perspective, most small businesses have been slow to adopt tqm. however, a recent study by tolke and kalpande (2020) confirms that tqm is equally beneficial to smes, leading to such advantages as minimisation of waste, reduction of lead and process time, and assuring production procedures are implemented swiftly. information technology adoption information technology adoption refers to multilevel applications that enable the sharing or exchange of input and output data between different organisations’ networks (kisielnicki, grabara & nowak 2005). it involves the sharing of formal, informal and technical information and data between two or more individuals or organisations (beynon-davies 2009). strong strategic involvement from top-level executives can spark the implementation of it-related practices and applications (jin & kang 2013). examples of it systems applicable to scm include electronic data interchange, system handling of real-time orders, materials requirements planning and jit, which are useful in facilitating the integration and coordination of information between supply chain partners (dolci maçada & grant 2013). implementation of it systems can yield paybacks such as better availability of goods and services and higher performance in terms of speed and flexibility (pan, pan & lim 2015). within the sme environment, the importance of it as a driver of business performance cannot be overlooked. for instance, evidence from a study by mathu and tlare (2017) suggests that ita has been recognised as one of the most significant drivers of sme success through its effects on boosting the distribution, tracking and tracing of products and the effective management of inventories. additionally, enagi and van belle (2019) found that ita leads to competitive advantage in smes. small to medium enterprises could therefore stimulate their success by keeping abreast with technological changes and ensuring that their operations are it-driven. supply chain agility supply chain agility refers to an organisation’s ability and capability to detect and swiftly respond to changes in their markets (degroote & marx 2013). it involves the effective and efficient implementation of performance indicators such as speed, responsiveness and flexibility of operations processes, which are aimed at addressing the business’s challenges and changes in a sound manner (gligor & holcomb 2012). the most common determinant factors of sca include information sharing, relationship partnerships, internal integrative processes and the use of it (bottani 2010; chang, tsai & hsu 2013; ngai et al. 2011). firms that demonstrate agile attributes are better positioned to take advantages of market-related opportunities (chan, ngai & moon 2017). this implies an adequate response to environmental changes allows agile firms to sustain their level of operational competitiveness. likewise, sca is one of many key success factors among smes. a study by govuzela and mafini (2019), found superior business performance in agile smes in south africa. hence, sca is critical in enabling smes to respond quickly and swiftly to the market, as well as demands by consumers and customers for specific changes, which may facilitate the resilience of these businesses. supply chain performance supply chain performance refers to the effectiveness and efficiency of an organisation’s entire supply chain activities (gunasekaran, patel & tirtiroglu 2001). it may also refer to the assessment of tangible and intangible competitive performance factors in a supply chain (eng 2004). corsten and felde (2005) view it as the return on both assets and sales derived from the effectiveness of operations. these varied views depict that scp encompasses a variety of elements that characterise it. higher scp is vital in improving the firm’s market share (gunasekaran et al. 2017). it is also linked to the capability of businesses to reduce their operational costs through the timely delivery of the required quality and quantity of products or services (qrunfleh & tarafdar 2014; whitten, green & zelbst 2012). superior supply chain network performance facilitates a high level of synergistic activities across the value chain, thereby enabling businesses to meet and exceed the market requirements (bayraktar et al. 2020). thus, supply chains, among both smes and larger businesses, that perform optimally, respond better to meeting the needs of customers and other stakeholders. conceptual model and research propositions figure 1 presents the conceptual model of the study, which consists of four predicting constructs (bsc, sci, tqm and ita), one mediator (sca) and the outcome (scp). figure 1: conceptual model. supply chain management practices and supply chain agility literature exists that links the scm practices, considered in this study, to sca. several studies (allred et al. 2011; hofer et al. 2014; revilla & villena 2012; yang 2013) found that bsc leads to enhanced sca as it facilitates knowledge and information sharing and the flow of products and materials between buyers and suppliers, which enables them to respond rapidly to fluctuations in the market. comprehensive engagement and interactions between buyers and suppliers in supply chains equips businesses to adapt to unforeseen supply disruptions (srinivasan, mukherjee & gaur 2011). further research-based evidence (e.g. kocoglu et al. 2011; leuschner, rogers & charvet 2013; ngai et al. 2011) in different contexts has also found direct connections between sci and sca. other studies (lotfi et al. 2013; prajogo & olhager 2012) maintain that the integrated networks are characterised by an increase of performance objectives such as delivery, cost, quality and flexibility, enabling firms to adapt to disruptive changes in the environment. the application of tqm procedures, such as the jit, results in the reduction of cycle time, better inventory management and minimisation of delivery dependability, which is linked to an increased operational response to customers’ requirements in terms of prompt delivery and availability (lee et al. 2010; vanichchinchai & igel 2011). supply chains that adopt tqm tend to outperform their competitors in terms of innovation and manufacturing capabilities and operational readiness, as well as the superior quality of products and materials, making firms better placed to address any unpredictable changes (konecny & thun 2011; wang, chen & chen 2012; yunis, jung & chen 2013). also, a number of studies (acar & uzunlar 2014; fawcett et al. 2011; jacques 2012) have confirmed the relationship between ita and agility. information technology is an important form of supply chain integrative efforts, as it facilitates information sharing and collaboration, and the lowering of transactional costs which are essential in nurturing organisational agility (marinagi, trivellas & sakas 2014; singh & teng 2016). use of advanced it allows better flexibility to adjust to fluctuations in the markets (acar & uzunlar 2014). based on these insights, the following propositions are put forward: proposition 1: bsc predicts sca among smes in south africa. proposition 2: sci predicts sca among smes in south africa. proposition 3: tqm predicts sca among smes in south africa. proposition 4: ita predicts sca among smes in south africa. supply chain agility and supply chain performance the performance outcomes associated with sca provide a clue to its connection with scp. supply chain performance increases responsiveness and awareness of perceived supply distortions in the market (blome, schoenherr & rexhausen 2013). it is also linked to waste minimisation efforts in producing lean supply chains (gligor, esmark & holcomb 2015). agile supply chains are also suitable environments for joint engagements between supply chain partners in terms of risk-sharing, as well as business ventures (gaur et al. 2011). supply chain agility is also regarded as a strategic tool to achieving long-term sustainable competitive dominance through its effect on delivery time, quality products and dependability of services (eckstein et al. 2015). sukati et al. (2012) add that sca is a crucial factor that defines the success and survival aspirations of any organisation that operates in a highly volatile and turbulent market. betts and tadisina (2009) found that sca moderates the relationship between collaboration and performance. additionally, a study by govuzela and mafini (2019), reveals that sca is important in improving the performance of smes in south africa. this leads to the following proposition: proposition 5: sca predicts scp among smes in south africa. research methodology design and participants the study followed a quantitative method using a survey design, anchored to deductive reasoning and a positivist paradigm, because it sought to test relationships between different constructs (ang 2014).the target population of this study was owners, managers and professional employees of smes operating in gauteng, south africa. since gauteng is the economic nucleus of the country, it was anticipated that the results from the current investigation could provide a practical foundation of representation of the undercurrents in smes enterprises in south africa. owners, managers and professional employees of smes were deemed to be the most suitable group of respondents in this study because they have a better understanding and practical knowledge of and expertise in issues related to scm in their respective industries. the list of these smes was obtained from the small enterprise development agency (seda). using this list, 72 smes in different industries were identified and contacted. the smes were divided (stratified) by industry (retailing, construction, manufacturing, agriculture and service) and then random selections were made. respondents were selected purposively from these smes. the use of a purposive sampling technique was intended to assist in selecting only those respondents that were relevant to the study. to be selected, respondents had to have at least a ‘matric’ education level and be familiar with the scm constructs under consideration in the study. the final sample was made up of 407 respondents, and is in line with green’s (1991) rule of thumb that for a correlation or regression, the minimum number of sampling units can be calculated using the formula n > 50 + 8m (where m is the number of independent variables). in applying green’s rule to the current study, the minimum number of respondents was supposed to be 370, since there were four independent variables. therefore, the final sample size applied in this study (n = 407) is consistent with the general sample size recommendations for multivariate data analyses. data collection procedure data were collected using a structured and self-administered survey questionnaire. the questionnaires were distributed between july and september 2017 using a combination of email surveys and the drop-and-collect method. respondents were given a period of 3 weeks to complete the questionnaire. various ethical considerations such as informed consent, voluntary participation, confidentiality and anonymity, and the right to withdraw from the study were observed throughout the data collection process. respondents were not given any incentives for participating in the study. research instrument measurement scales were operationalised from previous studies. buyer-supplier collaboration was measured using a five-item scale adapted from flynn, huo and zhao (2010) and zacharia, nix and lusch (2011). to measure sci, a five-item scale adapted from previous studies by stank, keller and daugherty (2001), narasimhan and kim (2002) and flynn et al. (2010) was used. measurement of tqm was achieved with the use of a five-item scale adapted from hung et al. (2011), while ita was measured using a four-item scale derived from jin et al. (2014). moreover, sca was measured using a five-item scale adapted from goldman, nagel and preiss (1994), and youndt and snell (2004), while scp was measured using a five-item scale adapted from beamon (1999). all measurement scales were previously validated, having attained cronbach’s alpha values of least 0.7 in prior studies. response options were presented on a five-point likert-type scale that was anchored by 1 = strongly disagree and 5 = strongly agree to express the degree of disagreement or agreement. data analysis the data collected in the study were analysed using the statistical package for social sciences (spss version 25.0). the main statistics employed in the study include an exploratory factor analysis (efa), pearson correlations and regression analysis. ethical considerations vaal university of technology, hdc190815, received on 19 august 2015. research results demographic profile of respondents a total of 700 questionnaires were issued to all targeted smes. from the initial 700 questionnaires, 456 were returned, of which 49 were discarded because they had errors. this culminated in 407 valid questionnaires available for use in the final analysis, representing a response rate of 58%, which is considered to be acceptable by mcguirk and o’neill (2016). the demographic details of the final respondents are presented in table 1. table 1: demographic details of respondents. the results from table 1 show that 243 (59.7%) of all respondents participating in this survey were male, while 164 (40.3%) were female. regarding the race distribution of the respondents, 200 (49.1%) were african, followed by 113 (27.8%) that were white. in terms of age distribution, 179 (44%) of the respondents were aged between 36 and 45 years, followed by 114 (28%) that were aged between 46 and 55 years. with respect to their levels of education, 146 (43.2%) of the respondents were in possession of a degree, followed by 116 (28.5%) who were in possession of a diploma. regarding the occupational status of respondents, 203 (49.9%) were professional employees (those individuals who possessed scm-related qualifications, as well as more than 3 years industry experience), while 120 (29.5%) occupied managerial positions, and 84 (20.6%) were owners. exploratory factor analysis exploratory factor analysis using the principal components analysis procedure was performed to check the factor structure of all research constructs. to determine the factorability of the data, a kaiser-meyer-olkin measure of sampling adequacy (kmo) and bartlett’s test of sphericity were computed. the smallest kmo value attained was 0.916, which is above the minimum cut-off value of 0.5 and all results for bartlett’s test were significant at 0.000, thereby signalling the factorability of the data (bartlett 1951; kaiser 1970). communalities for all items were acceptable as they ranged between 0.403 and 0.843, which were above the recommended minimum threshold value of 0.3 (child 2006). only those factors with eigenvalues greater than 1 and items with factor loadings higher than 0.5 were retained, in line with the seminal recommendation by kaiser (1960). the efa procedure revealed that each of the six research constructs had a unidimensional structure. the results of the efa, including the cronbach’s alpha, mean scores, standard deviations and tests for normality are presented in table 2. table 2: factor analysis, descriptive statistics and tests for data normality. table 2 reveals that the factor loadings derived from the efa for all six constructs were acceptably high, surpassing the 0.5 minimum cut-off value. eigenvalues were above the lowest prescribed cut-off value of 1.0 and ranged from a minimum of 2.604 (sci) to a maximum of 3.976 (scp). in terms of the cumulative percentage of variance explained, all six constructs exceeded the recommended minimum of 60% (hair et al. 2014). therefore, all six constructs were accepted and retained in the study, and no items were discarded from any scale. the range for the overall mean scores for the scales (4.359–4.6430) signified an inclination towards the ‘agree’ and ‘strongly agree’ positions on the likert scale. this result demonstrated that respondents generally answered in agreement with the questions on each measurement scale. thus, respondents perceived that all four scm practices were being implemented in smes. they also confirmed that their supply chains were agile enough and were performing optimally. standard deviations for all constructs were close to each other (0.517–0.633), indicating that, at most, data were normally distributed. further tests for data normality were performed using d. argostino’s k-squared test. most scores for skewness and kurtosis were within acceptable ranges, indicating that the data had satisfactory symmetry to assume a normal distribution. hence, the data were considered to be normally distributed, allowing for the application of parametric statistics. validity and reliability validity is the degree to which the instrument measures the construct it purports to measure (scholtes, terwee & poolma 2011). a set of measures were taken to establish the face and content validity of the measurement scales. to test for face validity, three academics who specialise in scm at a south african university of technology, reviewed the questionnaire to ensure that the context of the study remains as transparent as possible in guiding the respondents in their understanding of the survey. after effecting the revision of the questionnaire, a pilot study was undertaken to test for content validity and reliability of the questionnaire. the pilot study involved testing the questionnaire using 40 conveniently chosen respondents who were in the vaal triangle region. this decision was taken to ensure that businesses operating in this region did not form part of the final survey. constructive feedback was obtained from the returned questionnaires, which indicated a number of minor issues that still needed to be addressed. these ranged from complex and technical terminologies to acronyms that were used which made some questions vague. further revisions were subsequently made in line with the feedback provided. construct validity was first tested using factor loadings derived in the efa procedure. the fact that all factor loadings were higher than the recommended lowest cut-off value of 0.5 (kang 2013), indicated that construct validity was acceptable. construct validity was also tested using inter-factor correlations, in accordance with the recommendation by polit and beck (2012). as indicated in table 3, positive inter-factor correlations were computed, further illustrating that construct validity was adequate in this study. predictive validity was tested using regression analysis. results in the two regression models (table 4 and table 5) indicate the existence of positive relationships between the dependent and independent constructs, thereby confirming that predictive validity was satisfactory in this study. table 3: correlation analysis. table 4: regression model 1: supply chain management practices and supply chain agility. reliability refers to the degree to which measures are free from errors and therefore yield consistent results (ang 2014). construct reliability was tested using the cronbach’s alpha coefficient. alpha values (table 2) ranged between 0.820 and 0.935, way above the minimum recommended threshold of 0.7 (devellis 2012; kline 2000). therefore, all measurement scales used in the study were considered to be reliable. pearson correlations correlation analysis is intended to use available statistical data to test the strength and direction of the linear association between two or more quantitative constructs (franzese & iuliano 2019). in this study, correlations were tested using the pearson correlation coefficient. since data were normally distributed, the parametric pearson correlation was preferred in place of its non-parametric equivalent, the spearman correlation. the results of the pearson correlations are presented in table 3. table 3 reveals the correlations between the constructs. the matrix shows strong to very strong significant positive correlations between the different constructs. the lowest correlation (r = 0.502; p = 0.000) was observed between bsc and ita while the highest correlation (r = 0.766; p = 0.000) occurred between bsc and sci. by implication, an increase in any one of these constructs leads to increases in the other five, and the reverse is also true. since there were significant positive correlations between the six constructs, it was necessary to perform a regression analysis in order to test for prediction between them. regression analysis regression analysis is a technique for modelling the causal or predictive relationship between a dependent variable and an independent variable (angelini 2019). in the current study, regression analysis was used to estimate the relationship between scm practices, sca and scp in smes. using the enter method, which ensures that variables are entered into the model in only one step, two regression models were run. the least squares regression equation for the first model was formulated as follows: in equation 1: β0 is the constant or intercept. β1–4 are the coefficients of the independent variables. sca is the dependent variable. the results for regression model 1 are presented in table 4. table 4 reveals that the four scm practices (adjusted r2 = 0.607) contributed to 60% of the variance in sca. this result suggests that the remaining 40% is accounted for by other factors that influence sca in smes but were not included in this study. the durbin-watson statistic fell within the recommended range of 1.5 to 2.5, indicating that there was no need to be concerned about autocorrelations in the data (chatterjee & simonoff 2013). with respect to testing for multicollinearity, all tolerance values were higher than the recommended lower threshold of 0.2 (weisburd & britt 2013), while all variance inflation factor values were less than the strict recommended upper limit of 5 (ringle, wende & becker 2015). thus, collinearity diagnostics indicated normal data in regression model 1. beta values were all positive, with ita (β = 0.365) emerging as the greatest contributor to contributor to sca. the least squares regression equation for the second model was formulated as follows: in equation 2: β0 is the constant or intercept. β1 is the coefficient of the independent variable (sca). scp is the dependent variable. the results for regression model 2 are presented in table 5. table 5: regression model 2: supply chain agility and supply chain performance. as indicated in table 5, sca (adjusted r2 = 0.399) contributed to nearly 40% of the variance in scp. this result signifies that 60% of the variance in scp is attributed to other influences that were not part of the present study. the durbin-watson statistic (1.949) fell within the recommended range of 1.5 to 2.5, indicating the unimportance of residual errors in this model. the tolerance (1.0) and variance inflation factor (1.0) values were both within the prescribed thresholds, thereby reducing any concerns regarding multicollinearity in this study. a positive relationship (β = 0.633) was observed between sca and scp. discussion of the results this study aimed to investigate the connection between scm practices, sca and scp in south african smes. five propositions were put forward. the first four propositions suggested that each of the four scm practices (bsc, sci, tqm and ita) predicts sca. the fifth proposition suggested that sca predicts scp. this section discusses the individual results of each proposition. supply chain management practices and supply chain agility the first proposition of the study suggested that bsc predicts sca in south african smes. results of the correlation analysis revealed a significant strong positive association (r = 0.582; p < 0.01) between bsc and sca. in the regression analysis, bsc was statistically significant sca (β = 0.164; t = 3.290; p = 0.001). the second proposition highlighted that sci predicts sca. a significant strong positive correlation (r = 0.585; p < 0.01) was observed between sci and sca. regression model 1, however, reveals that sci was statistically insignificant (β = 0.072; t = 1.406; p = 0.161). the third proposition submitted that tqm predicts sca. consistently, a significantly strong correlation emerged between the two constructs (r = 0.693; p < 0.01). likewise, tqm was statistically significant in the regression analysis (β = 0.316; t = 7.026; p = 0.000). the fourth proposition advanced that ita predicts sca. in the correlation analysis, there was a significant strong positive association (r = 0.543; p < 0.01) between the two constructs. in the regression analysis, ita was also statistically significant (β = 0.365; t = 8.485; p = 0.000). the results above suggest that improvements in collaborations between buyer and supplier businesses, the application of tqm and the adoption of it have the effect of enhancing the agility of smes. these results are consistent with previous studies (ferreira et al. 2011; kumar, singh & shankar 2016; lai, yeung & cheng 2012; pan et al. 2015; vanichchinchai & igel 2011) that stress the importance of bsc, tqm, and ita as drivers of sca in small businesses. thus, south african smes that engage in bsc, tqm and ita are likely to have greater capabilities to respond rapidly to changes in the environment. the results further indicate that sci does not predict sca, although the two are positively correlated. this is a novel result that contradicts previous evidence (e.g. narasimhan, swink & viswanathan 2010; ralston et al. 2015; wiengarten et al. 2016) which suggests that integrative processes across business partners facilitate the sharing of knowledge, as well as other core competencies (inclusive of sca), enabling businesses to develop competitive advantages. perhaps, within the context of south africa, most smes have not yet managed to integrate with their internal and external stakeholders. the operational environment is quite harsh and unpredictable (businesstech 2019), making it difficult for emerging enterprises to acquire the capital and other resources required to embrace and implement disruptive business practices such as sci. most smes in south africa are faced with the possibility of failure early in their growth stage, due to adverse factors such as the lack of funding and technical know-how, capacity and ability (small enterprise development association 2018). as a result, most of the available resources are directed to sustaining the business, which is a priority, in the hope that other practices will only be adopted and implemented later, after the sme has weathered the early turbulence it faces. most smes in the country only attempt to implement sci later in their growth stage when they have amassed sufficient capitalisation and other resources necessary to do so successfully. given these circumstances, it is logical that sci did not predict sca in the present study. further analysis of the results reveals that ita (β = 0.365) emerged as the most robust predictor of sca when compared to bsc, sci and tqm. this result is not surprising, given the widespread acknowledgement of it as a basic business tool in most commercial enterprises in south africa. as a result of the drive by government and other relevant communities of practice, a large majority of smes in south africa adopt it early in their life cycle, making it part of their daily operations. there is, therefore, a widespread conviction among smes that it can drive the operations and success of their businesses and that its adoption and implementation should take precedence over other scm practices. supply chain agility and supply chain performance the results of the correlation analysis revealed a significant strong positive association between sca and scp (r = 0.633; p < 0.01). regression model 2 also indicated that sca was statistically significant (β = 0.633; t = 16.444; p = 0.000). these results illustrate that these two constructs increase or decrease conjointly and that sca leads to scp in smes. this result is parallel to previous results (degroote & marx 2013; lavastre, gunasekaran & spalanzani 2012; liu et al. 2013; qrunfleh & tarafdar 2014; sayed & sunjka 2016) that link sca to scp in business organisations. this result is reasonable, given the acclaimed benefits of agility to business organisations. these benefits include improved alertness, flexibility, risk mitigation, better inventory, supplier and customer management, and reduced costs, as well as the increased possibility of survival, among others (eckstein et al. 2015; mishra, datta & mahapatra 2014; whitten et al. 2012). it could then be that smes in south africa have realised some of these benefits and linked them to their own efforts to achieve agility within their supply chain networks. conclusions, theoretical and managerial implications the study tested the connection between scm practices, sca and scp in south african smes. the study suggests the importance of the application of scm practices in south african smes. collaboration between buying and supplying firms, a holistic approach to managing quality (tqm) and the use of it are practices that facilitate better agility for smes as they operate within their supply chains. however, due to limited funding opportunities and the lack of technical capacity, most smes in south africa have not yet realised the importance of sci as an enabler to agility. in this sense, sci failed to predict sca. the study further revealed that agility in smes leads to better scp, making it necessary for emerging businesses to direct their focus towards developing the ability to respond rapidly to environmental changes as a way of improving their performance. theoretically, the study generated new information on the nexus between scm practices, sca and scp, which is specific to the sme sector in south africa. the study is an essential source of information on how scm practices, sca and scp relate to each other within smes, given that previous empirical evidence on this topic is rare within this context. furthermore, this study constitutes an addition to the body of scm literature, in that it provides some insights into relevant and key practices that are valuable to optimising scp in smes. practically, the study provides information to owners and managers of smes regarding the dimensional considerations available to them when attempting to improve the performance of their businesses and shared networks. the study proposes that it is worthwhile to direct efforts towards improving bsc, tqm and ita, as this will enhance the agility of a business, leading to the attainment of envisioned performance outcomes within sme supply chains. the study further confirms the importance of ita as a superior practice that merits priority attention ahead of the other scm practices considered in this study. in addition, the results of the study could be applied in the diagnosis of performance-related challenges in smes. for instance, the fact that ita emerged as the most significant predictor of sca implies that more attention should be directed to it than the other constructs considered in this study. limitations and suggestions for further research caution should be exercised when generalising the results of the study in other contexts since data were collected in only one province (gauteng). the use of a non-probability purposive sampling technique made the study susceptible to sampling bias. however, sampling bias was reduced by collecting data from different regions of gauteng. future studies could be conducted using a mixed-methods approach to capture more in-depth information from respondents. the study could be extended to larger businesses since scm practices, sca and scp are all relevant to businesses of various sizes. the study could also be extended to smes in other provinces of south africa that were excluded in the current attempt. acknowledgements competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this research article. authors’ contributions w.v.l.-o. was responsible for the data collection and wrote the literature review section. c.m. wrote the research methodology and results sections and made language additions to the manuscript. funding information this research received no specific grant from any funding agency in the public, commercial or not-for-profit sectors. data availability quantitative data used in this study are available for sharing. disclaimer the views and opinions expressed in this article are those of the authors and do not necessarily reflect the 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outcome of the study was the creation of a single list using a cross-section of international sources, of low-carbon environmental goods, and their ranking according to their inherent ability to reduce greenhouse gas emissions, south africa’s capacity to produce them, and their economic benefits, as reflected in the export opportunities they present. these export opportunities were revealed through the application of the decision support model (dsm), an export market selection tool that incorporates a systematic filtering and screening system. the results of the analysis should help guide policymakers in their strategic deliberations on which export sectors to incentivise and support with a view to encouraging more ‘green’ growth in south africa in the years ahead. key words: economic growth, exports, green growth, greenhouse gas emissions, low-carbon technologies, low-carbon environmental goods jel: f18, q42, 56 1 introduction economic and environmental objectives are traditionally seen as contradictory, as continued economic growth puts increasing pressure on certain biophysical limits that produce symptoms like extinction, resource shortages and climate change (czech, 2000:177). consequently, it is difficult to enforce policies that simultaneously encourage stronger economic growth on the one hand and decrease in greenhouse gas emissions on the other. export promotion and foreign market development are usually seen as stimulants to economic growth, which, in south africa’s case, is recognised as an important element in the fight against poverty, inequality and unemployment. yet greater export volumes often endanger the environment. if a country’s economic wellbeing is enhanced by an increase in exports, a strategy should be formulated that ensures that higher export volumes also have, in some way, positive consequences for the environment. an increase in exports has a range of positive consequences. it stimulates the circular income-spending-production flow of an economy (mohr & fourie, 2008:51), thereby generating higher levels of foreign exchange for a country. furthermore, increased exports have a positive effect on the balance of payments (mmieh, owusu-frimpong & mordi, 2012; aitken, hanson & harrison, 1997). in addition, a study by naudé, bosker and matthee (2010), using data from 1996 to 2001, found that a region that was more open to trade had higher levels of local economic development, a bettereducated population and higher gdp growth. increased exports also promote economic growth when they are accompanied by greater worker productivity (abor, 2010:9), and can improve a firm’s technological base and competitive advantage (mmieh et al., 2012). abstract 428 sajems ns 17 (2014) no 4:427-439 for example, a 10 per cent increase in south africa’s openness to trade from 1990 to 1998 led to a 5 per cent increase in long-run total factor productivity gains (jonsson & subramanian, 2001). not surprisingly, south africa’s national development plan identifies increased exports as a key driver of higher economic growth rates (national planning commission, 2011). south africa has seen many ups and downs in its economic growth performance over the years. in the decade before the first democratic elections, sanctions on trade and capital flows, together with political turmoil, contributed to weak economic growth in the country. after 1994, economic growth trends began to improve, helped by a more liberal trade regime, which included the elimination of various trade barriers (du plessis & smit, 2007). however, in recent years, the global financial crisis and changing global alliances and market requirements have made the business of exporting from south africa more challenging, which has taken its toll on economic growth. clearly, export promotion has to be taken to a new level if the country is to meet its growth and development goals. however, an increase in exports is usually accompanied by higher levels of greenhouse gas emissions. this runs contrary to the idea of responsible growth. ‘green’ growth is a relatively new term, and is associated with an economy whose growth strategy incorporates environmental, economic and social objectives (low, 2011:1). environmental objectives would include lowering greenhouse gas intensity, maintaining biodiversity and the integrity of ecosystem services, and increasing climate change resilience. economic objectives would include increasing the economic growth rate and boosting capacity in less productive areas. finally, social objectives would include raising the level of human development and reducing poverty. these environmental, economic and social objectives are shown as the medium grey segments in figure 1, while green growth is depicted as the dark star in the centre. the light grey segments each represent the intersection between two of the broader environmental, economic and social objects. figure 1 various components of a green economy source: low (2011) this study will focus on low-carbon growth, which is an important element in the green growth mix. in figure 1, low-carbon growth is shown as the intersection (light grey area) between economic growth and lower greenhouse gas intensity. lower greenhouse gas emission is important to ensure a healthy environment. a healthy environment offers various benefits to an economy in terms of the goods and services it provides. the most fundamental of these environmental services is the biophysical environment that resides within the limits of organic life (tietenberg & lewis, 2009). one of the most critical of the biophysical variables that maintain these limits is a very narrow range in ambient temperatures. this temperature range is created by an atmospheric greenhouse sajems ns 17 (2014) no 4:427-439 429 effect that maintains global temperatures at an average of 14oc (world meteorological organization, n.d.). the composition of atmospheric gases should therefore be sustained, as any alterations could shift global temperatures to outside the optimal range for organic life forms. south africa is a carbon-intensive economy, which means that the amount of greenhouse gas emitted for economic output is high (davidson, winkler, kenny, prasad, nkomo, sparks, howells & alfstad, 2006:4). the carbon intensity of an economy can be reduced by consuming more low-carbon environmental goods. therefore, if low-carbon environmental goods are commonly used in south africa, this could potentially decrease the carbon intensity of the economy. this argument is not as straightforward as it might appear, however, as some low-carbon goods can produce negative environmental effects at the production stage, such as the release of fluoride pollution during the production of solar panels. there can also be undesirable secondary effects when lowcarbon goods are used, such as birds being killed by the blades of wind turbines. in view of such complexities, this study will consider the effects of low-carbon goods only when they are consumed as intended, e.g. generating electricity from wind turbines, and not the potential negative implications for the environment when the goods are produced or unintended effects in consumption. there is a clear connection between a strong export culture and positive economic growth trends. thus, promoting the export of lowcarbon environmental goods with particularly high export potential could eventually lead to higher economic growth in south africa, with lower greenhouse gas intensity. against this background, the aims of this study are: • to explain the relationship between greenhouse gases and increased export activity; • to create a list of low-carbon environmental goods and identify which of these have the greatest potential for reducing greenhouse gases and encouraging economic growth in south africa; and • to explore the economic benefits of the best low-carbon environmental goods, including the intensive and extensive export opportunities associated with them. 2 literature review clearly, policymakers in south africa should aim to boost economic growth through a more focused export promotion effort that would also be gentler on the environment. the following literature review examines what various authorities and other entities say about the interrelationships among enhanced export levels, the environment and economic growth, and the key role that low-carbon environmental goods can play in an economy. 2.1 the relationship between the environment and increased export activity a study by the world trade organization (wto) and the united nations environmental program (unep) identified three effects of liberalised trade on greenhouse gas emissions: the scale effect, the composition effect and the technique effect (tamiotti, the, kulaçoğlu, olhoff,, simmons & abaza, 2009). the scale effect shows the degree to which greenhouse gases may increase as a result of greater economic activity (tamiotti et al., 2009). if south africa were to maintain its current level of carbon intensity, the scale effect would reveal an increase in greenhouse gas emissions due to heightened economic (industrial) activity. another dimension of the scale effect would be that increased transportation across borders would similarly increase greenhouse gas emissions (tamiotti et al., 2009). the composition effect shows the degree to which the liberalisation of trade would change the relative prices of goods and services produced by certain sectors, which in turn could affect the relative size of those sectors and the composition of total production (tamiotti et al., 2009). if less carbonated sectors expanded and replaced carbon-intensive sectors, greenhouse gas emissions would decline (tamiotti et al., 2009). lastly, the technique effect shows the degree to which the adoption of superior lowcarbon technologies could potentially reduce the carbon intensity of the economy, at either the production or the consumption stage. as indicated earlier, this study will investigate only those goods that have a positive 430 sajems ns 17 (2014) no 4:427-439 environmental impact at the consumption level. the wto’s doha ministerial mandate aimed to improve the global environment through the technique effect by encouraging the free trade of environmental goods (tamiotti et al., 2009). however, the net effect of trade liberalisation on greenhouse gas emissions is difficult to quantify. while the scale effect points to an increase in emissions, the composition effect points to a decrease. thus, the two effects work in opposite ways. whether the technique effect reflects a rise or fall in greenhouse gas emissions depends on the products traded and the countries involved. in this study, the spotlight is on low-carbon environmental goods shipped from/to south africa. given that south africa is a greenhouse gas-intensive country and low-carbon environmental goods, by definition, decrease greenhouse gas emissions, the use of the technique effect in this study will reveal a potential reduction in emissions. through a combination of the three effects, an increase in exports of low-carbon environmental goods could have a positive environmental outcome for south africa. the liberalisation of lowcarbon environmental goods would therefore enable them to circulate more freely in the country, which would help to decrease the carbon intensity of the economy. 2.2 diffusion of low-carbon technologies the impact of the technique effect depends on how well goods are accepted into the country. the acceptance of new technologies by a community is called the diffusion of technologies into that community. this diffusion does not occur instantaneously, but follows an sshaped curve over time, known as a sigmoid curve (löschel, 2002:106). technologies can be diffused through various channels, such as foreign direct investment, imitation, knowledge spill-overs, the migration of skilled labour, or international trade (groizard, 2007:2). of all the channels, trade consistently proves to be one of the most important (groizard, 2007:2), with increased trade having the potential to significantly accelerate the rate of diffusion. in this regard, the removal of trade barriers since 1994 has increased the rate at which technologies have been diffused into developing countries by about 80 per cent (mundial, 2008). it follows that trade liberalisation has a key role to play in diffusing low-carbon technologies into developing countries or carbonintensive economies (panitchpakdi, 2011). importantly, too, the spread of environmental goods into an economy is accompanied by the sharing of knowledge and environmental best practices, and general cooperation between the countries concerned. a study by the international energy agency (iea) concluded that existing low-carbon technologies could substantially reduce global carbon levels (iea, 2008). thus, liberalising the trade in low-carbon environmental goods could increase the rate of diffusion of lowcarbon technologies, which has the potential to reduce the greenhouse gas intensity of the south african economy. furthermore, if the export of these goods was encouraged, south africa’s economic growth rate could rise. however, given the country’s uneven economic capacity and potential, selective industry protection would undoubtedly be needed to steer such a reorientation. 2.3 deriving a list of low-carbon environmental goods according to steenblik (2005:1), environmental goods and services (egs) can be defined as those goods and services that measure, prevent, limit, minimise or correct environmental damage vis-à-vis various environmental entities. on the other hand, low-carbon environmental goods are defined as those goods that emit minimal or zero greenhouse gases during end use (solarpowernotes, n.d.). the possible adverse effects associated with the production of these goods are not considered in this study. low-carbon environmental goods are only one type of environmental good. in order to create a list of low-carbon environmental goods, it is necessary first to make a list of all environmental goods and then isolate the lowcarbon environmental ones. despite the doha ministerial mandate calling for the elimination of tariffs on environmental goods, there is no official, universal list of environmental goods. four existing lists of environmental goods – classified according to their hs-6 codes for sajems ns 17 (2014) no 4:427-439 431 ease of comparison are used in this study. they are from the world trade organization (wto), the world bank (wb), the international centre for trade and sustainable development (ictsd) and the fondation pour les etudes et recherches sur le développement international (ferdi). in order to distil the low-carbon goods from the environmental goods, the research findings of the international institute for sustainable development (iisd) were consulted (wooders, 2009). 2.3.1 the world trade organization (wto) list this list was produced by the friends of the egs group, who submitted an informal document listing 153 environmental goods, arranged in 12 sub-groups, to the wto’s committee on trade and environment special session (ctess, 2007). the list can be accessed at: http://www.mfat.govt.nz/downloads/nz-wto/ wto-dohaministerialdeclaration27apr07.pdf. the iisd classified only goods in the renewable energy plant sub-group as having a high potential to reduce greenhouse gas emissions (wooders, 2009). as a result, only this sub-group, which contains 30 of the 153 environmental goods, has been included in the study. 2.3.2 the world bank (wb) list it was considered particularly important to include this list in the study, as the world bank is a key role-player in debates about environmental goods. the list contains 13 environmental goods, which are divided into four sub-groups: a) clean coal technologies; b) wind energy; c) solar photovoltaic system; and d) energy efficient lighting (wooders, 2009). 10 of the 13 goods overlap with those in the wto list. nine of these 10 are in the subgroup renewable energy plant, and are already identified as low-carbon environmental goods. the remaining four goods were not included in the study, because the iisd concluded that they did not have sufficiently high potential to reduce greenhouse gas emissions (wooders, 2009). 2.3.3 the international centre for trade and sustainable development (ictsd) list this list, which was compiled by laborde and lakatos in 2012 and submitted by the ictsd, is the most recent. the ictsd categorises environmental goods in three sub-groups: a) renewable products and energy sources; b) environmental monitoring, analysis and assessment equipment; and c) waste management, recycling and remediation. of the 63 environmental goods appearing in the ictsd list, 50 overlap with those in the wto list. of these, 26 goods are in the subgroup renewable energy plant, and are therefore already included in the final list of low-carbon environmental goods. the other 24 products were not included in the study because they were viewed by the iisd as having low, negligible or no potential to reduce greenhouse gas emissions (wooders, 2009). of the 13 goods named by the ictsd but not included on the wto list, nine are listed as renewable products and energy sources by the ictsd and so they are included in the final list with the exception of ‘fluorescent, hot cathode lamps’ (hs-6: 853931) which are not specified as renewable energy but rather as a lighting source which has a limited potential to reduce greenhouse gas emissions. 2.3.4 the fondation pour les etudes et recherches sur le développement international (ferdi) list this list is the result of a joint effort by representatives of australia, colombia, hong kong, china, norway and singapore to arrive at a core of 26 goods from the original 411 codes. it was considered important to include this list in the study because it is a good example of multinational collaboration (balineau & de melo, 2011). from the core list of 26 goods, 23 goods overlap with those in the wto list, of which 13 goods are categorised in the renewable energy plant sub-group and are therefore already included in the final list. the remaining 13 goods were dropped from further consideration because the iisd concluded that they did not have sufficient potential to reduce greenhouse gas emissions (wooders, 2009). 2.3.5 final list of low-carbon environmental goods a final list of low-carbon environmental goods was derived (see table 1) by working through 432 sajems ns 17 (2014) no 4:427-439 the steps outlined in sections 2.3.1 to 2.3.4. in the table, the second column gives the hs-6 code for each product, and the third column gives a short description of the product as defined by the united nations commodity trade database (un comtrade, 2010), while the last column indicates what the product is used for. table 1 derived list of low-carbon environmental goods hs-6 code product description used for 1 730820 towers and lattice masts used to elevate the blades of wind turbines. 2 761100 aluminium reservoirs, vats, tanks, etc., volume >300l used in the production of biogas and solar thermal energy. 3 840681 turbines nes, of o <40mw designed for geothermal energy generation and cogeneration, which is more effective than conventional methods. 4 840682 turbines nes, of o >40mw derive electrical power from environmental recovery operations. 5 840690 parts of steam and vapour turbines used in maintenances of energy recovery turbines. 6 841011 hydraulic turbines, water wheels, power < 1000 kw generate hydroelectric power. 7 841012 hydraulic turbines, small (1-10mw) generate hydroelectric power. 8 841090 parts of hydraulic turbines and water wheels generate hydroelectric power. 9 841181 gas turbine engines nes of a power < 5000 kw generate electrical power from recovered landfill gas or biogas. 10 841182 gas turbine engines nes of a power > 5000 kw generate electrical power from recovered landfill gas or biogas. 11 841221 hydraulic power engines and motors, cylinders generate hydroelectric power. 12 841229 hydraulic power engines and motors, others generate hydroelectric power. 13 841581 air conditioners nes with reverse cycle refrigeration transfer the heat available in land and water masses to either heat or cool buildings. 14 841861 compression refrigeration equipment with heat exchange condensers and heat exchangers transfers the heat available in land and water masses to either heat or cool buildings. 15 841869 refrigerating or freezing equipment nes transfers the heat available in land and water masses to either heat or cool buildings. 16 841919 instantaneous/storage water heaters, not electric nes heat water through solar thermal energy. 17 841990 parts, laboratory/industrial heating/cooling machinery used in maintenances of solar water heaters. 18 848340 gearing and screws convert slow rotation of blades of wind turbines to a sufficient speed to generate electricity. 19 848360 clutches, shaft couplings, universal joints used in the maintenance and assembly of wind turbines. 20 850161 ac generators, of an output < 75 kva used in conjunction with boilers and turbines to produce energy from renewable energy sources, such as biomass. 21 850162 ac generators of an output 75-375kva used in conjunction with boilers and turbines to produce energy from renewable energy sources, such as biomass. 22 850163 ac generators 375-750kva used in conjunction with boilers and turbines to produce energy from renewable energy sources, such as biomass. 23 850164 ac generators of an output > 750 kva used in conjunction with boilers and turbines to produce energy from renewable energy sources, such as biomass. 24 850231 wind-powered electricity sets generate electricity from wind. 25 850239 electric generating sets used to minimise the loss of (domestic) energy transmission in the national grids. continued/ sajems ns 17 (2014) no 4:427-439 433 hs-6 code product description used for 26 850300 parts for electric motors and generators are components of the nacelles and blades in wind turbines used to generate electricity. 27 850440 static converters convert solar energy into electricity. 28 850610 primary cells and batteries (manganese dioxide) store renewable energy. 29 850630 primary cells and batteries (mercuric oxide) store renewable energy. 30 850640 primary cells and batteries (silver dioxide) store renewable energy. 31 850650 primary cells and batteries (lithium) store renewable energy. 32 850660 primary cells and batteries (aird zinc) store renewable energy. 33 850690 primary cells and batteries, parts store renewable energy. 34 850720 lead-acid electric accumulators except for vehicles provide energy storage in off-grid photovoltaic systems. 35 853710 electrical control and distribution boards, < 1kv control the functioning of the photovoltaic system. 36 854140 photosensitive/photovoltaic/led semiconductor devices generate electricity from solar power. 37 900190 prisms, mirrors and optical elements nes, unmounted used to intensify and concentrate solar power. 38 900290 mounted lenses, prisms, mirrors, optical elements nes used to intensify and concentrate solar power. 39 903289 automatic regulating/controlling equipment nes control the processes in generating renewable energy. source: compiled by the author with ctess (2007) 3 empirical analysis the empirical analysis was conducted with two main objectives in mind: to rank the identified low-carbon environmental goods, and to identify intensive and extensive opportunities for the top-ranking goods. the intensive margin is defined in the world bank’s trade diagnostic toolkit as the increase in existing product-country export opportunities (reis & farole, 2012:5). the extensive margin, in turn, is defined as a new product-country combination resulting from producing and exporting a ‘new’ product or exporting an existing product to ‘new’ markets (reis & farole, 2012:5). for the majority of countries, particularly those in the middle to high-income categories, most export growth takes place in the intensive margin. this is true of south africa as well. to reduce their vulnerability to external shocks, countries need to expand their exports in the extensive margin – by both creating new trade flows through new product innovation and selling existing products in new markets. yet new export initiatives are fraught with challenges, and many falter within a short period (viviers, cuyvers, matthee, steenkamp, grater & krugell, 2013). in view of the many hurdles south african producers face in getting new products off the drawing board and into production, the focus of this analysis was on identifying low-carbon environmental goods already being produced in south africa and prioritising them in terms of their export potential in existing and new markets. 3.1 ranking the identified low-carbon environmental goods the 39 products classified as low-carbon environmental goods depending on their end use (see table 1) are not identical in terms of their ability to reduce greenhouse gas emissions or stimulate economic growth. nor are they equal in terms of south africa’s current capacity to produce them. the goods needed to be further classified according to three criteria: i) the ability to reduce greenhouse gas emissions; ii) south africa’s capacity to produce the goods; and iii) the potential economic benefits to be derived from exporting the goods. this process facilitated the final ranking of the goods. 434 sajems ns 17 (2014) no 4:427-439 3.1.1 criterion 1: ability of the good to reduce greenhouse gas emissions this criterion is based on the consensus of the different role players (the wto, the wb, the ictsd and the ferdi). a score of 1 was given to a product that each role player has identified as being a low-carbon environmental good. thus, a maximum score of 5 was assigned to a product that appeared in all four lists and was also judged by the iisd as having a high potential to reduce greenhouse gas emissions. this total score was the first of three used to rank the low-carbon environmental goods. 3.1.2 criterion 2: south africa’s capacity to produce the good it was important to take south africa’s capacity to produce the goods into consideration, particularly as the country’s production capacity in respect of the 39 low-carbon environmental goods varies. to measure south africa’s production capacity in respect of existing products, the revealed comparative advantage1 (rca) was used. the rca measures whether a certain country exports proportionately more of a specific product in relation to its total exports than all other countries do, relative to their total exports (huberty & zachmann, 2011). the rca of the identified environmental goods differed substantially, although the average rca could be used to detect the current relative advantage that south africa has over other countries in exporting a specific product. the average rca was determined over a five-year period from 2006 to 2010 in order to lessen the effect of possible outliers, and international trade centre data (itc, 2011) were used. for this exercise, a score out of 5 for each of the final low-carbon environmental goods that south africa currently produces was derived from the rca of the different products. this rca serves as a proxy for south africa’s production capacity in respect of such products. 3.1.3 criterion 3: potential economic benefits to be derived from exporting the good the third and last criterion looked at the economic benefits that could potentially result from exporting each low-carbon environmental good. in measuring the benefits of increased exports of such products, only the potential export value was taken into account. other benefits, such as an increase in consumer demand, government spending and investment, were not considered. thus, potential export value can serve as a proxy for potential economic benefits. in order to calculate the potential export value of a specific good, the market share and growth, and the number of countries that present export opportunities for the product were taken into consideration. steenkamp (2011) used these aspects to estimate the potential export value of each product-country combination. the potential export value is an estimation of the export potential of a particular product-country opportunity. it was used simply to rank the export opportunities, thereby identifying the most lucrative ones; it is not a specific objective to be pursued. 3.1.4 final ranking of low-carbon environmental goods according to criteria 1, 2 and 3 each of the three criteria discussed above assigned a score out of 5 to each low-carbon environmental good. to ensure a more normal distribution of scores, the methodology of the international trade centre (itc, 2012) was used to calculate the scores for criteria 2 and 3, as follows: 𝑠𝑐𝑜𝑟𝑒!"#$!/! = 5  𝑖𝑓𝑥 ≥ 𝑎 0  𝑖𝑓𝑥 ≤ 𝑏 𝑥 − 𝑏 𝑎 − 𝑏 ×5 𝑖𝑓𝑎 < 𝑥 < 𝑏 where 𝑠𝑐𝑜𝑟𝑒!"#$  !/! is the score out of 5 allocated to the specific product in criterion 2 or 3; 𝑥 is the rca of the specific product 𝑥 for criterion 2 or the potential export value in criterion 3; 𝑎 is the value of the product with the second highest rca or potential export value and represents the upper threshold; 𝑏 is the value of the product with the second lowest rca or export value and represents the lower threshold. a score of 5 was allocated if the 𝑥 ≥ 𝑎 was true. a score of 0 was allocated if the 𝑥 ≤ 𝑏 was true. a score calculated by !!! !!! ×5 was allocated if 𝑎 < 𝑥 < 𝑏 . thus, if the rca or potential export value of the specific product sajems ns 17 (2014) no 4:427-439 435 was not in the upper or lower threshold, a percentage of the maximum 5 points was given. this depended on where the rca or potential export value of the specific products lay relative to the other goods. the score was rounded to the second decimal point. to calculate the final score, the three points out of five for criteria 1, 2 and 3 respectively were multiplied in order to favour those goods with similar scores for all three criteria. 3.1.5 results from the 39 low-carbon environmental goods identified as potentially having a positive effect on both the economy and the environment, the five goods attracting the best scores were (in descending order): photosensitive semiconductors (hs-6: 854140); towers and lattice masts (hs-6: 730820); electrical control and distribution boards less than 1kv (hs-6: 853710); gearing, ball screws, speed changers, torque converters (hs-6: 848340); and static converters (hs-6: 850440). table 2 shows the top five goods in terms of the final score, as well as their respective scores for criteria 1, 2 and 3. table 2 top five low-carbon environmental goods hs-6 product specification criterion 1 criterion 2 criterion 3 final score 854140 photosensitive/photovoltaic/led semiconductors 5 1.31 5 32.75 730820 towers and lattice masts 4 5 0.44 8.8 853710 electrical control and distribution boards, < 1kv 5 0.45 2.81 6.32 848340 gearing and screws 4 0.72 1.62 4.67 850440 static converters 3 0.3 4.6 4.14 3.2 identifying the intensive and extensive export opportunities for the best low-carbon environmental goods the process of establishing which products could, in the face of increased exports, contribute to more responsible or ‘green’ growth in south africa would be incomplete if actual foreign market potential was not addressed. the decision support model (dsm) has been used for this purpose. the decision support model (dsm) incorporates a screening process that facilitates export market selection through the identification of realistic export opportunities in the form of product-country combinations. the dsm uses a system of elimination, starting off with all possible world-wide product-country combinations and, through a unique filtering process, narrowing down the possibilities to those with the greatest potential in terms of market size, growth, accessibility and potential export value. filter 1 eliminates all countries that are high risk from a political and commercial point of view or have worrying macroeconomic indicators (cuyvers, steenkamp & viviers, 2012). filter 2 eliminates countries whose import demand is too small or that have inadequate growth prospects (cuyvers et al., 2012). filter 3 eliminates countries on the basis of their perceived inaccessibility owing to, for example, the level of market concentration (measured by the herfindahl-hirschman index) and various barriers to entry, including transport time and cost, the quality of the country’s logistics infrastructure, ad valorem equivalent tariffs and non-tariff measures (cuyvers et al., 2012). filter 4 then categorises the final round of potential markets according to the exporting country’s current export performance in these markets in comparison with the performance of the top six competitors in each market. a potential export value is also assigned to each identified product-country combination with a view to prioritising the short-listed export opportunities. the dsm was chosen as an appropriate methodology for identifying realistic export opportunities in this study, because, unlike most market selection tools, it investigates both existing and new export opportunities, thereby extending the scope of the export promotion effort (cuyvers et al., 2012). 436 sajems ns 17 (2014) no 4:427-439 the list of low-carbon environmental goods derived in this study was run through the dsm in order to identify viable export opportunities for these goods. the export opportunities arising out of this process were either intensive or extensive in nature. the top 10 intensive export opportunities for the top five low-carbon environmental goods are shown in table 3. the first column ranks the export opportunities according to the potential export value; the second column lists the hs-6 code; the third column gives the product specification according to the un comtrade (2010); the fourth column gives the export destination; and the last column gives the potential export value in thousands of us dollars (usd). table 3 top 10 intensive export opportunities for top five low-carbon environmental goods rank hs-6 code product specification export destination potential export value in usd (thousands) 1 854140 photosensitive semiconductors germany 922 362 2 853710 electrical control and distribution boards <1kv united states 838 671 3 850440 static converters united states 790 475 4 854140 photosensitive semiconductors spain 647 886 5 850440 static converters china 546 884 6 850440 static converters japan 346 731 7 854140 photosensitive semiconductors united states 307 954 8 850440 static converters germany 281 620 9 853710 electrical control and distribution boards <1kv canada 273 184 10 853710 electrical control and distribution boards <1kv china 248 574 source: steenkamp (2011) the top 10 extensive export opportunities for the top five low-carbon environmental goods – involving the export of existing products to new markets are shown in table 4. table 4 top 10 extensive export opportunities for top five low-carbon environmental goods (existing products to new markets) rank hs-6 code product specification export destination potential export value in usd (thousands) 1 854140 photosensitive semiconductors china 953 255 2 854140 photosensitive semiconductors hong kong 363 505 3 854140 photosensitive semiconductors czech republic 177 443 4 850440 static converters czech republic 92 705 5 850440 static converters poland 78 762 6 854140 photosensitive semiconductors croatia 55 907 7 853710 electrical control and distribution boards <1kv russia 41 890 8 853710 electrical control and distribution boards <1kv india 22 923 9 848340 gearing and screws russia 18 999 10 730820 towers and lattice masts australia 15 788 source: steenkamp (2011) 4 conclusions and recommendations the global economy is rapidly evolving and many countries, including south africa, are finding themselves under increasing pressure to expand their economies in a responsible manner. by adopting a ‘green’ growth mentality, they will be making a vital contribution to the sustainability of the planet while also creating sajems ns 17 (2014) no 4:427-439 437 new export opportunities for themselves that will help to drive their domestic economies. with growing concerns, though, that increased export volumes are harmful to the environment, it is essential that the government and other stakeholders in south africa apply their minds to devising a strategy that creates a much-needed momentum in the export sector but also meets environmental objectives, notably bringing about a reduction in greenhouse gas emissions. this study offered new insights into how that can be done. the study presented an initial backdrop to the export-environment-growth conundrum by highlighting the important role played by lowcarbon environmental goods in enhancing environmentally-responsible growth through increased export activity. a complicating factor in researching low-carbon environmental goods was that there is no internationally accepted list of such goods. a key focus of this study, therefore, was deriving a single list, drawing from the lists of the world trade organization (wto), the world bank (wb), the international centre for trade and sustainable development (ictsd) and the fondation pour les etudes et recherches sur le développement international (ferdi). a consolidated list of 39 low-carbon environmental goods was compiled, using various qualifying criteria. these goods were further evaluated in terms of their ability to decrease greenhouse gas emissions, south africa’s capacity to produce them, and the potential economic benefits to be derived from exporting the goods. a final list was then compiled showing the products that offer the best prospects for a positive effect on the south african economy and the environment as a whole. the top five low-carbon environmental goods, ranked in terms of their assigned final score, are: photosensitive semiconductors (hs6: 854140); towers and lattice masts (hs-6: 730820); electrical control and distribution boards < 1kv (hs-6: 853710); gearing, ball screws, speed changers, torque converters (hs6: 848340); and static converters (hs-6: 850440). using the decision support model (dsm), the intensive and extensive export opportunities associated with these top five lowcarbon environmental goods were identified. in this regard, the best overall intensive export opportunities according to their potential export value are: hs-6: 854140 – photosensitive semiconductors to germany (usd 922.3 million) and hs-6: 853710 -electrical control and distribution boards smaller than 1kv to the united states (usd 838.6 million). the best overall extensive export opportunities, according to their potential export value, are: hs-6: 854140 photosensitive semiconductors to china (usd 953.2 million) and hs-6: 854140 photosensitive semiconductors to hong kong (usd 363.5 million). while the study focused on the economic and export potential of the low-carbon environmental goods that south africa already produces, there is scope for more research to be done into potential new areas of production, given the right circumstances and incentives. the production-linked effects of low-carbon environmental goods also represent a rich opportunity for more in-depth research. in the meantime, the results of this study should help to channel thinking by both the south african government and the private sector when it comes to export expansion and promotion. endnote 1 𝑅𝐶𝐴!,!"# =   !!,!"#  /  !!"# !!,!  /  !! where, the 𝑖 is the specific product, 𝑋!"#shows total exports of south africa and, 𝑋!shows total world exports. the rca therefore shows the ratio between the 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accepted: 28 sept. 2022; published: 22 nov. 2022 copyright: © 2022. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: environmental concerns have led to consumers increasingly being willing to pay a premium for environmentally friendlier products. unfortunately, this has led to the practice ‘greenwashing’, which yields handsome financial rewards. consumers are not sufficiently aware of greenwashing, and little is known about the effects of such knowledge. aim: this article explores how consumers who become aware of greenwashing, respond in terms of purchase intent and willingness to pay. setting: the population was south african middleto upper-income consumers. the findings were based on 120 responses. methods: the study used a 2 × 2 experimental design in which greenwashing knowledge and greenwashing presence were manipulated. results: we found that consumers reward greenwashing when it is undetected. educating consumers about environmental issues does not develop their ability to identify greenwashing. in contrast, consumers who are educated about greenwashing and become aware of it, penalise such products through what we term a ‘greenwash penalty’. we define the greenwash penalty as the shift in consumers’ willingness to pay a premium for a product when they become aware of greenwashing. purchase intent (pi) is also impacted by greenwashing. conclusion: companies often try to drive awareness of environmental problems. our research shows that such initiatives reward all companies that make claims, even when such claims are false. companies that sell truly green products must educate consumers about the potential harm of misleading information. once consumers are able to spot greenwashing attempts, companies that sell real green products should then provide true and transparent information about their own products. keywords: greenwashing; willingness to pay; purchase intent; environmental knowledge; greenwashing knowledge; greenwash penalty. introduction concern about environmental issues such as climate change, plastics pollution, and loss of biodiversity is likely at its highest point in history. many of the environmental issues faced by humanity were non-existent until the mid-1900s, and the general population was mostly unaware of them (cohen 2015). the high levels of awareness and concern observed currently, can partly be explained by increased media coverage (particularly social media), activism, and data and images of environmental problems having become ubiquitous. consumer attitudes towards the environment have gradually changed, due to the growing number of people who realise the added impact of their behaviour on climate change and environmental degradation (kong et al. 2014). increased levels of consumers’ environmental awareness have resulted in a greater demand for environmentally friendly (green) products (baum 2012; parguel, benoît-moreau & russell 2015; pimonenko et al. 2020; zhang & sun 2021). green products are considered less damaging to the environment than their ‘non-green’ counterparts, because they are recyclable, organic, made from recycled materials, or their production has a smaller carbon footprint. as the demand for green products increased, so did the supply, as did the claims that organisations made about their products (delmas & burbano 2011). whatever green claims are made about products, such claims should be clear, true, and accurate (chen & chang 2013). consumers’ willingness to pay a price premium for goods and services that they perceive as environmentally friendly has, unfortunately, led to some organisations making untrue claims in order to get ahead of their competition (nguyen et al. 2019; parguel, benoît-moreau & larceneux 2011; pimonenko et al. 2020). this phenomenon is called ‘greenwashing’, and refers to environmental claims that are vague, exaggerated, or even false (nguyen et al. 2019; parguel et al. 2011). organisations utilise greenwashing to intentionally mislead or deceive consumers about the actual environmental impact of their practices, products, and/or services (nyilasy, gangadharbatla & paladino 2013). despite increased efforts by researchers to investigate the effects of greenwashing on marketing to consumers, many of these studies have largely lacked any theoretical approach that considers the underlying mechanisms and boundary conditions (de medeiros & ribeiro 2017; schmuck, matthes & naderer 2018; schuitema & de groot 2015). naderer and opree (2021) further noted that there is scant research about the efficacy of greenwashing literacy interventions. consumers’ attitudes towards products greatly affect their interactions with these products, including what they think they know, how they feel about the products, and their purchase intentions (zhang & sun 2021). concerns around greenwashing include the average consumer being unaware of and/or unable to identify this practice (aji & sutikno 2015; delmas & burbano 2011; smith & brower 2012). while educating consumers about environmental issues may appear to be the obvious solution to developing their ability to identify greenwashing, educational initiatives have had mixed results (chan & lau 2000; connell 2010; eze & ndubisi 2013; scott & vigar-ellis 2014; urbanski & haque 2020; zsóka et al. 2013). an alternative strategy is to educate consumers about greenwashing itself, resulting in more critical consumer thinking regarding green marketing and greenwashing. developing a critical consumer attitude towards green claims in marketing may be a more effective strategy to combat greenwashing than educating consumers about environmental issues (nadányiová 2016; wang et al. 2018; wood 2015). educating consumers about the practice of greenwashing itself may lead to consumers becoming skeptical of marketing claiming greenness (do paço & reis 2013; krafft & saito 2014; nyilasy et al. 2013). eng et al. (2021) also suggested that the efficacy of greenwashing literacy interventions should be assessed, while controlling for knowledge about the environment. yet, limited research is available that shows the positive impact of educating consumers about greenwashing itself as a means of modifying consumer attitudes towards green claims about operations, products and services (nadányiová 2016; wang et al. 2018; wood 2015). the aim of this article is to show the impact of consumers’ knowledge of greenwashing and their attitudes toward marketing claims of greenness of products on their purchase intention and their willingness to pay a certain price for a product. a review of prior research and fundamental constructs green marketing and greenwashing green marketing was developed as a marketing strategy aimed at reversing the wasteful and unsustainable consumer practices imbedded in society (mceachern & carrigan 2012), and has shown to improve consumers’ attitudes towards products, as they feel they are contributing to conservation of the environment (gonzález et al. 2015; green & peloza 2014; olsen, slotegraaf & chandukala 2014; townsend 2017). green marketing is a holistic concept that explicitly or implicitly addresses the relationship between a product and the biophysical environment. it promotes a green lifestyle, with or without highlighting a product, represents an organisation’s image of being environmentally responsible; focuses on the beneficial environmental attributes of a product, internal production techniques, or disposal methods within an organisation; and positively associates the organisation with environmental causes (krafft & saito 2014; kumar & kumar 2013). the change in consumers’ attitudes towards the environment has increased the pressure on organisations to operate in an environmentally friendly and sustainable manner (aji & sutikno 2015; kumar & kumar 2013; prody 2016). thus, organisations have seen green marketing as a way to address consumer demands regarding environmental issues (aji & sutikno 2015). however, green marketing can easily be exploited by organisations for financial gain (alves 2009; nyilasy et al. 2013). for example, organisations that greenwash could use deceptive green marketing to create a façade of environmental sustainability and conservation (aji & sutikno 2015; alves 2009; kong et al. 2014; nyilasy et al. 2013). consequently, concerns around greenwashing practices have grown (aji & sutikno 2015; delmas & burbano 2011; smith & brower 2012). as greenwashing relates to environmental claims that are vague, exaggerated, or even false (nguyen et al. 2019; parguel et al. 2011), many consumers are often unaware of and unable to identify deceptive green marketing messages about the environmental impact of practices, products, and services (nyilasy et al. 2013; urbanski & haque 2020). greenwashing is commonly found in instances where organisations apply an eco-branding strategy to portray their products and services as being more environmentally beneficial than these truly are (bäverstam & larsson 2009; orsato 2016; zhang & sun 2021). for example, companies could use environmental terminology such as biodegradable, environmentally friendly, and ozone friendly (alves 2009; do paço & reis 2013; krafft & saito 2014), coupled with ambiguous, unclear, or unsupported claims about their products. these claims often capitalise on consumers’ lack of knowledge or understanding of environmental terminology (borin, cerf & krishnan 2011; do paço & reis 2013; krafft & saito 2014). grimmer and woolley (2014) suggest that consumers who are knowledgeable and concerned about the environment are attracted to clearer green claims, but consumers with low to no knowledge and concern for the environment are not. various researchers (alves 2009; do paço & reis 2013; townsend 2017; urbanski & haque 2020) have highlighted that it is becoming increasingly difficult for consumers to differentiate between true and false green marketing claims, because consumers are constantly bombarded with such claims, and are also faced with an increasing number of deceptive green marketing claims that cannot be corroborated. environmental awareness environmental awareness refers to consumers’ beliefs, knowledge, and experience of the environmental effects of green products (paladino & ng 2013). many consumers are increasingly paying attention to environmental issues, and their environmental awareness positively impacts their feelings towards green products (diamantopoulos et al. 2003; paladino & ng 2013). when consumers exhibit environmental knowledge, they understand the environment and the key attributes of green products (gleim et al. 2013; li et al. 2016). research suggests that consumers’ knowledge of environmental issues could influence their feelings towards green products and the environment (chan & lau 2000; connell 2010; eze & ndubisi 2013; paladino & ng 2013; polonsky et al. 2012). green products, purchase intent, and willingness to pay green purchasing is defined as the specific purchase of environmentally beneficial products and avoiding products that are harmful to the environment (chan 2001). furthermore, green purchasing, most often measured as green purchase intention, refers to the consumer’s willingness to purchase a certain product (chen, chen & tung 2018; joshi & rahman 2015). willingness to purchase or willingness to pay is also often expressed as the intention of a consumer to pay a stated amount (in research using dichotomous choice questions), or as the maximum a consumer is willing to pay (in research using open-ended questions) (chan et al. 2011). according to chen et al. (2018), consumers’ feelings towards the environmental impact of a green product are significantly affected by their environmental awareness, compared to other behavioral component factors, a finding corroborated by chen and chai (2010) and diamantopoulos et al. (2003). specifically, the more consumers care about the environment, pay attention to social well-being, and desire to protect the environment, the more favourable their attitudes are toward society and the environment. this provides them with an incentive to participate in environmentally responsible behaviour (chen et al. 2018). de medeiros and ribeiro (2017) define consumers’ feelings towards the environmental impact of green products as their emotions regarding environmental activities and issues, while kim (2002) reported that these feelings enhance green purchase intentions. various studies have indicated that consumers’ feelings towards the green attributes of products positively influence purchase intention and willingness to pay a premium for green products (costa pinto et al. 2016; paladino & ng 2013; tung et al. 2012; young et al. 2010). consumers’ attitudes towards products largely influence their interactions with those products. consumers’ attitudes include what they think they know, how they feel about the product, their purchase intentions towards the product, and their willingness to pay for the product (zhang & sun 2021). while educating consumers about environmental issues may appear to be an obvious solution to developing their ability to identify greenwashing, educating consumers about environmental issues has had mixed results in terms of changing their attitudes towards green products (chan & lau 2000; connell 2010; eze & ndubisi 2013; scott & vigar-ellis 2014; zsóka et al. 2013). some researchers have suggested that consumers’ attitudes to purchasing green products could be influenced by the opinions of social influencers and consumers’ cognitive values (paladino & ng 2013). the higher the consumer’s evaluation of greenness is, the greater their intention to purchase green products becomes (chen et al. 2018). yet, consumers’ feelings towards the negative environmental impact of green products have been found to influence their purchase intentions more than their feelings towards the environmental benefits (i.e. positive impact) of the green product (chen et al. 2018; leonidou, leonidou & kvasova 2010; nyilasy et al. 2013; sun & willson 2008). research has shown that increasing consumers’ knowledge of environmental issues enhances neither their ability to identify greenwashing (krafft & saito 2014; smith & brower 2012; urbanski & haque 2020) nor their purchase intentions (chan & lau 2000; connell 2010; eze & ndubisi 2013; scott & vigar-ellis 2014; zsóka et al. 2013). de medeiros and ribeiro (2017) and schuitema and de groot (2015) suggest that educating consumers about greenwashing itself, could lead to positive outcomes in terms of making consumers more critical about green claims. in light of this, we postulate the following: h1: consumers’ willingness to pay and purchase intent (pi) are influenced by their knowledge of greenwashing. research method the experiment to investigate consumers’ pi under conditions of greenwashing advertising, a 2 × 2 full-factorial experiment was conducted. in the process of identifying a suitable product for the experiment, the theories of fcb’s grid was applied. the grid is an instrument with which to assess the relationship between consumers’ attitudes and product choices, based on their involvement (high or low in terms of consumption) and motive. purchase intention is classified as rational or irrational (krafft & saito 2014; lee, edwards & la ferle 2014). as respondents were required to make fair and rapid judgments based on the advertisement used in the experiment (cf. krafft & saito 2014), a product that was typically classified as a low-involvement, rational motive product on the fcb grid had to be selected; we chose washing detergent. as green advertisements are often used to market detergents, it is a product category that is affected by greenwashing (krafft & saito 2014; lee et al. 2014). it is also a product category with which consumers are familiar and which they purchase often (krafft & saito 2014). to negate the halo effect of brands, a fictitious detergent brand kleen was used. the greenwashed advertisement of kleen washing powder mirrored detergent advertisements that claim the use of natural ingredients that make detergents less harmful to the environment. however, such claims often lack proof of testing and results, fail to stipulate the amount of natural ingredients, and the products contain the same toxic ingredients, in comparable amounts, found in other detergents. the kleen detergent advertisement was manipulated by either stating that the detergent contained natural ingredients (i.e. greenwashing) or no claims about its environmental friendliness were made in the advertisement (i.e. no greenwashing). consumers’ knowledge about greenwashing was manipulated by giving them a leaflet containing information on greenwashing or not giving them any information on greenwashing (cf. chan & lau 2000; connell 2010; eze & ndubisi 2013; scott & vigar-ellis 2014; zsóka et al. 2013). research has shown that middleand upper-income consumer segments have higher purchase intentions towards green products (oliver, volschenk & smit 2011; wong 2017), and are thus at a higher risk of being misled by greenwashing claims. previous researchers have shown that even environmentally concerned and educated consumers will perceive greenwashed advertising in a positive light (do paço & reis 2013; krafft & saito 2014; townsend 2017). therefore, middleto upper-income consumers were considered a suitable target population for the current research. a screening question about their income-bracket was used to ensure that respondents were, in fact, part of this demographic. data collection shoppers were approached in a shopping mall and asked to participate in the study. a total of 131 shoppers agreed to participate, of which 120 were eligible for participation based on their reply to the screening question. the shoppers were then randomly exposed to the non-greenwashed advertisement or the greenwashed advertisement, and were either provided with information about greenwashing or not. thereafter, respondents were asked to answer a questionnaire to ascertain the effect of the experimental conditions on their intent to purchase kleen, as well as the price they would be willing to pay for the product. measurement to measure the dependent variables, purchase intent and willingness to pay, a questionnaire was designed. purchase intent was measured using an adaptation of suki’s (2016) three-item measurement by dropping one item. willingness to pay was measured using an open-ended question: ‘how much would you pay for 1 kg of kleen washing powder?’ to control for respondents’ knowledge of and feelings toward the environment, flynn and goldsmith’s (1999) eight-item measure of subjective knowledge (sk) was shortened to six items and suki’s (2016) six-item measure of attitude towards the environment was adapted to only include the four items on individuals’ feelings toward the environment. in all instances, question wording was adapted to include reference to kleen. respondents had to indicate their pi, and rate their knowledge of and feelings towards kleen washing power’s impact on the environment on a five-point likert scale (1 = strongly disagree; 5 = strongly disagree). assessing unidimensionality: purchase intent, knowledge of and feelings toward the environment even though scale adaptation is a common practice in business research, evidence should support the validity of the adapted scale (heggestad et al. 2019). consequently, validity of the various adaptations was assessed. as the items within each subscale was designed to measure a single underlying latent variable, these items needed to operate as a unidimensional scale. to test this assumption of unidimensionality, principal components analysis (pca) was utilised as it is an appropriate method to assess covariation amongst items when scales are modified (skrondal & rabe-hesketch 2004). principal components analysis was further utilised to determine the number of components to extract from the data and assess the underlying structure of items in each scale. the internal consistency of the scales (i.e., reliability) was also assessed by calculating cronbach alpha (as depicted in table 1). table 1: construct validity check of scale adaptations. the sampling adequacy and inter-item correlations of each measurement scale were determined using the kaiser-meyer-olkin (kmo) and bartlett’s test of sphericity. based on field (2017), the kmo statistic was found to be satisfactory in all instances (kmo: pi = 0.500; sk = 799; f = 768 i.e. kmo > 0.665) and bartlett’s test of sphericity significant (pi: χ2 = 149.895, df = 1; p < 0.05; sk: χ2 = 858.06, df = 66, p < 0.01; f = χ2 = 272.444, df = 6, p < 0.05), indicating that the data was suitable for factor analysis. using the kaiser criterion (i.e., retaining factors with eigenvalues (λ) greater than 1), the results indicated that, in all instances, one component should be retained (eigenvalue: pi = 1.849 i.e., λ > 1, explaining 92.45% of variance; sk = 3.03 i.e., λ > 1, explaining 50.5% of variance; f = 2.969 i.e., λ > 1, explaining 74.23% variance). results of the pca, therefore, confirmed the unidimensionality of the three scales; in other words, confirming the construct validity of the adapted scales (pi, sk, f). as depicted in table 1, the factor loadings for the three scales were all found to be greater than 0.4 (field 2017). the cronbach’s alpha coefficient was calculated and found to be satisfactory (cronbach alpha: pi = 0.802; sk = 0.883; f = 0.918). based on the above evidence, it is possible to assume that the adapted scales for pi, sk and feelings toward the environment (f) were found to be both valid and reliable and appropriate for use in further analyses. realised sample for purposes of this research, the target population consisted of consumers who considered their effect on the environment before purchasing everyday household products. only respondents who indicated a high level of environmental mindfulness towards their consumer behavior were included, yielding a sample of respondents from the middleto upper-income segments. this is aligned with literature that posits that middleto upper-income segments are more mindful of their environmental impact as consumers (wong 2017). there was a high women-to-men ratio in each of the four sample groups; approximately two-thirds of the respondents in each sample group were women. this was to be expected, as many female consumers do the purchasing of general household goods such as washing powder. there was a positive skew in the age range of the respondents, with the majority of the respondents in the younger age ranges. this is aligned with literature that posits that younger generations are more mindful of their environment, and may also have contributed to the positive skew in the responses to the screening question (barber 2010). results preliminary analysis because our study involved a 2 × 2 design, we conducted a two-way multivariate analysis of variance (manova). preliminary analysis showed no violation of the assumptions of normality (purchase intention: skewness and kurtosis z < 3.29, p > 0.05; willingness to pay: skewness and kurtosis z < 3.29, p > 0.05 for sample size 50 < n > 300). preliminary analyses also revealed that the dependent variables, knowledge of greenwashing and feelings towards the environment are not highly correlated to each other (r < 0.0), and that the variance between groups is equal (f[3; 1030.389] = 1.751; p > 0.05). manipulation check before testing our hypothesis, we checked the effectiveness of our manipulations. to check the manipulations when measuring purchase intent, a two-sample t-test revealed that there was a significant difference (t[118] = −6.623; p < 0.05) between the conditions knowledge of greenwashing (m = 1.76; s = 0.801) and no knowledge of greenwashing (m = 3.05; s = 1.267). similarly, there was a significant difference (t[117] = 2.110; p < 0.05) between the conditions greenwashing advertisement (m = 2.66; s = 1.514) and no greenwashing advertisement (m = 2.18; s = 0.871). with regard to the manipulations when measuring the variable willingness to pay, a two-sample t-test also revealed a significant difference (t[118] = −4.511; p < 0.05) between the conditions knowledge of greenwashing (m = 26.12; s = 5.861) and no knowledge of greenwashing (m = 32.44; s = 9.095). similarly, there was a significant difference (t[117] = 2.305; p < 0.05) between the conditions greenwashing advertisement (m = 31.05; s = 9.822) and no greenwashing advertisement (m = 27.61; s = 6.152). these results showed the effectiveness of the two manipulations when measuring both purchase intent and willingness to pay. hypothesis testing to assess the possible influence of respondents’ knowledge of greenwashing and their feelings toward greenwashing, we included knowledge and feelings toward greenwashing in our model. the results revealed that knowledge of greenwashing and greenwashing advertisement respectively explained 36% of the variance in willingness to pay (f[5] = 14.438; p < 0.05) and 65% in the variance of purchase intent (f[5] = 45.055; p < 0.05). only feelings toward greenwashing correlated with purchase intent (f[1] = 26.215; p < 0.05), as illustrated in table 2. table 2: model explaining variance in willingness to pay and purchase intent. results revealed a two-way interaction effect between knowledge of greenwashing and greenwashed advertisement for both pi (f[1] = 26.096, p < 0.05) and willingness to pay (f[1] = 18.605; p < 0.05). further analysis revealed that willingness to pay was significantly higher in instances where greenwashing was present in the advertisement and respondents had no knowledge of greenwashing (m = 37.79; s = 8.862). willingness to purchase was significantly lower in instances where greenwashing was present in the advertisement and respondents had knowledge of greenwashing (m = 24.31; s = 4.870). purchase intent was significantly higher in instances where greenwashing was present in the advertisement and respondents had no knowledge of greenwashing (m = 3.93; s = 1.067), and significantly lower in instances where greenwashing was present in the advertisement and respondents did have knowledge of greenwashing (m = 1.38; s = 0.393). in instances where the advertisement had not been greenwashed, no significant differences were evident (illustrated in figure 1). figure 1: two-way interaction effect on willingness to pay and purchase intent (a–b). to verify our results, we performed a bootstrap with 1000 iterations, the results of which confirmed the results of our experiment (illustrated in table 3). table 3: bootstrap results. the results suggest that, when a product is greenwashed, the amount that consumers are willing to pay differs significantly (p < 0.05) when consumers do have knowledge of greenwashing, compared to when consumers do not have knowledge about greenwashing (r24.31 and r37.79 respectively). however, when a product is not greenwashed, there is no significant difference (p > 0.05) between the amount consumers with knowledge of greenwashing and those without are willing to pay (r27.87 and r27.35 respectively). it would seem that, although consumers are willing to pay a premium for products that are (seemingly) green (i.e. r37.79 compared to r27.35), they would pay even less for a product that is greenwashed (i.e. r24.31 compared to r27.87). consumers’ willingness to pay less for a product because of greenwashing could suggest that consumers penalise organisations for greenwashing once they have sufficient knowledge about greenwashing. discussion implications green companies often try to drive awareness about environmental problems to increase sales of their products. our research shows that such initiatives reward all companies that make claims, even when such claims are false. our results also confirm that educating consumers about environmental issues does not develop the ability of consumers to identify greenwashing, confirming a large body of prior research (chan & lau 2000; connell 2010; eze & ndubisi 2013; scott & vigar-ellis 2014; zsóka et al. 2013). this study set out to determine what the impact would be on consumers’ pi and their willingness to pay a premium if they are aware of greenwashing. we therefore had to create an experiment that firstly contrasted a product that was greenwashed with one that was not. we also had to distinguish two groups of consumers: those who had knowledge about greenwashing (through an intervention) and those who did not. knowledge and feelings about environmental issues were not manipulated and thus served as control variables. our results show that, when the advertisement had been greenwashed and respondents had no knowledge of greenwashing, their pi and willingness to pay were high. however, when the advertisement had been greenwashed and respondents had knowledge of greenwashing, both their pi and willingness to pay were lower. results from this research, therefore, show that greenwashing has a negative influence on consumer behaviour, confirming the findings of urbanski and haque (2020) and zhang and sun (2021). in the case where the advertisement had not been greenwashed, pi and willingness to pay did not differ between respondents who were knowledgeable about greenwashing and those who were not. consumers’ willingness to pay less for a product because of greenwashing, suggests a greenwash penalty once they have sufficient knowledge about greenwashing. we noted a reduction of more than a third (r24.31 vs r37.79) in the average price that consumers were willing to pay for a greenwashed product once they became aware of the deception. the price that ‘greenwash-knowledgeable’ consumers are willing to pay for a greenwashed product is even lower than what they would pay for the conventional product (i.e. no green claim) (i.e. r24.31 compared to r27.87). all four manipulations of the 2 × 2 experiment had similar levels of environmental awareness and feelings (a control variable), implying that the results of the manipulation were not due to respondents’ level of environmental awareness or feelings towards the environment. on the contrary, the results show that, despite having environmental knowledge (i.e., a control variable), the greenwashed advertisement succeeded in misleading the respondents with less knowledge about greenwashing. the more knowledgeable consumers are about greenwashing, the higher the likelihood is that they would be able to identify greenwashing in advertisements. consequently, not only could ‘greenwash-knowledgeable’ consumers be less likely to pay a premium for products with greenwashed advertisements, but the likelihood of these consumers purchasing those products could decrease. recommendations the greenwash penalty is not an indictment of the quality of a product. the greenwash penalty is an expression of distrust in the brand. as a result, consumers (like the respondents in this study) would rather choose products that make no claims above products that make false claims. the implications of this study are relevant for companies that sell truly green products, as well as those that attempt to deceive consumers. marketers of truly green products and services should educate consumers about greenwashing so that they are able to distinguish real green from fake green products. this will benefit their own products, while it could impact the legitimacy and credibility of competing, but fake green products. in industries in which there are a few companies that show superior environmental performance, it may be sensible to collaborate to educate consumers or to create credible environmental certifications. there are mainly two benefits to collaborating with competitors around raising awareness of greenwashing. firstly, coopetition among real green companies would reduce the risk of free-riding behaviour from fake green companies on green marketing campaigns. collaboration would also reduce free riding between real green firms. if one company does a greenwashing awareness campaign, it would benefit other real green companies too. because it is in the interest of all real green companies, collaboration makes sense. the second reason for collaboration is to share the costs of creating awareness about greenwashing. education of consumers may be an expensive, difficult, and long process. multiple companies providing complementary but marginally different messages, may confuse consumers. alignment around the purpose and message of greenwashing awareness campaigns will increase the efficacy of such campaigns while reducing costs for individual companies. once consumers are able to recognise greenwashing, truly green companies should provide consumers with certifications and information that would enable consumers to make the right choices. again, coopetition would benefit all green companies in such endeavours. for a sole leading green company, there may be a potential premium in marketing its products as green. as competitors respond by also introducing green products, green attributes or certification no longer would allow premium prices. when leading performance becomes the standard, certification can be used as a barrier to entry for fake green companies. the study should pose a warning to companies that greenwash. when consumers become aware of attempts to deceive them, they are less willing to buy, and less willing to spend their money on such products compared to products that make no claims. future research this study only focused on two aspects of how consumers respond to greenwashing of a low-involvement, rational motive product, namely pi and willingness to pay. we see three broad areas for further research. the first opportunity is for studies that explore how consumers would respond to other types of products such as high-involvement products. secondly, studies should investigate how companies should think about green services, where green attributes may be less tangible. thirdly, more studies are needed to explore penalties for greenwashing that go beyond pi and willingness to pay. acknowledgements competing interests the authors have declared that no competing interest exists. authors’ contributions j.w.v. proposed the original idea of the article. b.s. was a master’s student under his supervision, and c.g. advised throughout about the methodology and analysis. b.s. operationalised the conceptual thinking and collected the data. j.w.v. and c.g. assisted with the refinement of the experiment. after his master’s was completed, b.s. stepped out from the project and j.w.v. and c.g. wrote the article and did further analysis on the data. ethical considerations before commencement with data collection, ethical clearance was granted by stellenbosch university (usb-2018-8019). the university of stellenbosch ethics committee approved the research. there were no major risks for participants or the researcher in the execution of this study. 30/08/2018. funding information this research received no specific grant from any funding agency in the public, commercial, or not-for-profit sectors. data availability the data that support the findings of this study are available on request from the corresponding author. disclaimer data sharing is not applicable to this article as no new data were created or analysed in this study. references aji, h.m. & sutikno, b., 2015, ‘the extended consequence of greenwashing: perceived consumer skepticism’, international journal of business and information 10(4), 433. alves, i.m., 2009, ‘green spin everywhere: how greenwashing reveals the limits of the csr paradigm’, journal of global change and governance 2(1), 2–26. barber, 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management of the compliance burden placed on it by taxation laws. a survey was conducted amongst small, medium and micro establishments in the business services sector in gauteng province, south africa. the study finds that the majority of smmes in the business services sector outsource their tax responsibilities due to lack of skills and time. also, the significance of taxation inputs for making business decisions and preferences for administrative relief measures varies according to the size of the organisation. jel e62, h25, l11 1 introduction this study focuses on the impact taxation has on the administration and management of small business services establishments in gauteng. the rationale for research into small establishments in the business services sector lies in the following: • in the 2005 budget review, the minister of finance announced further taxation changes to recognise the services sector for its prominence in stimulating growth, and stated that small business tax relief measures would also be extended to small, medium and micro establishments (smmes) in the services sector (national treasury, 2005). • lionel october, deputy director-general of the department of trade and industry presented the government’s new small enterprise development strategy at the end of 2005. according to october’s presentation, some of the objectives of the revised strategy are to: – create an enabling environment for small enterprises; – create sustainable jobs in the small business sector; – improve coordination of government initiatives for supporting the small business sector; and – increase small businesses’ contribution to the gdp (seda, 2005). • the south african revenue service (sars) has launched a wide-ranging programme of measures to support small business. this study evaluates some administrative measures aiming to reduce compliance cost and provide a more enabling environment for small businesses (deloitte & touche, 2005). it is clear therefore that small business tax surveys are not only important in the support of national accelerated and shared growth strategies and sustainable development, but also in the development of skills. such research is of major importance in understanding current and future tax issues anticipated to shape the business services tax environment. 2 background the selection of the population used in the survey considered three aspects, namely: • the size of the organisation to be surveyed; sajems ns 10 (2007) no 1 73 • the sector of the economy being investigated; and • the region selected. the motivation for each of these selections, which were smmes, business services and gauteng, will be discussed below. 2.1 small, medium and micro enterprises (smmes) in terms of the national small business act 102 of 1996, as amended, small businesses can be classified as micro-, very small, small or medium enterprises, following a complex set of thresholds. table 1 provides an extract of the classification in terms of the national small business act for the business services that are included in this study. medium, small (small and very small) and micro establishments in the finance and business services sector are included in the study. business services establishments in the informal economy (non-vat registered establishments) are excluded from the study. table 1 classification of micro-, very small, small or medium enterprises sector or subsector in accordance with the standard industrial classification (sic) size or class total full-time equivalent of paid employees fewer than: total annual turnover (rm) less than: total gross asset value (fixed property excluded) (rm) less than: finance and business services medium small very small micro 200 50 20 5 26,00 13,00 3,00 0,20 5,00 3,00 0,50 0,10 community, social and personal services medium small very small micro 200 50 20 5 13,00 6,00 1,00 0,20 6,00 3,00 0,60 0,10 source: national small business act 102 of 1996 of the three criteria prescribed in the national small business act, i.e. total number of full-time employees, total annual turnover and total gross asset value, used to categorise businesses as micro, small, very small or medium, the number of employees is often the most effective, as it is generally the easiest to ascertain and can be compared across all sectors except agriculture. accordingly, this study applies “employment” figures to classify businesses as small, medium and micro establishments. 2.2 business services sector figure 1 is based on data from the data mining system of the south african reserve bank (sarb) and statistics south africa. it is notable that for the past decade, the annual real growth of the business services sector has outpaced the real gdp growth of the economy as a whole. the real growth of the business services sector was 6.3 per cent in 2002, 4.1 per cent in 2003 and 7.5 per cent in 2004 (sarb, 2006). this provides further justification for studying the business services industry. in fact, the share of the business services industry in the total economy has increased by approximately five percentage points between 1980 and 2004. 74 sajems ns 10 (2007) no 1 figure 1 gdp and business services growth performance (per cent), 1969-2004 source: sarb, 2006 2.3 gauteng region according to the department of trade and industry (2004), gauteng is the leading province in south africa for both formal and informal business. gauteng accommodates 46.7 per cent of all formal smmes and 26.9 per cent of all informal smmes, with kwazulu-natal in second place with 12.6 per cent of all formal smmes and 25.3 per cent of all informal smmes. sars maintains a database of the number of business services establishments registered for levy payments in terms of the skills development act 97 of 1999, by employment size and province. the database clearly indicates that most registered business services employers, namely 54.4 per cent, are based in gauteng (sars, 2003). on the basis of this distribution of business activities, gauteng was selected as the focus of the study and, more specifically, the formal sector in gauteng. 3 research objectives the reasons for conducting a tax survey confined to the business services industry of gauteng in particular are evident from the background to the study provided in the previous section. the objectives of the study are to: • determine how business services establishments of different sizes manage and administrate the taxes, duties and/or levies for which they are responsible; • determine the significance of tax inputs and the usage of tax advice in business decisions in business services smmes; and • assess business services establishments’ preferences for various tax measures to reduce the administrative burden of managing tax matters, and determine whether different measures are preferred by the various categories of smmes. 4 research methodology the research methodology used to construct a model able to meet the primary research objectives of the study is explained in this section. 4.1 sample population the sample population consisted of micro (120 employees), small (21-50 employees) and medium (51-200 employees) business services establishments operating in gauteng. financial sajems ns 10 (2007) no 1 75 managers, general managers, accountants and owners of business services smmes were targeted as sample elements / respondents. 4.2 data collection methodology interviewer-administrated telephonic interviews were used to collect data from the sample of business services smmes operating in gauteng. this method was supplemented with a self-administrated approach for respondents preferring to receive the questionnaire by fax and complete and return it again also by fax. 4.3 sample the bureau of market research (bmr) register of business services establishments (bmr, 2004) was used as sample frame. to ensure that only micro, small and medium business services establishments operating in gauteng were selected from the sample frame, all foreign elements, for example large business services establishments (200+ employees), were removed from the database. a systematic disproportionate stratified sampling approach was used to select 200 business services smmes. this sampling method ensured that a systematic sample from the micro, small and medium business services subgroups was selected. the disproportionate sample approach was required because a large proportion of business services establishments located in gauteng are micro establishments. the bmr business services register confirms that at least 85 per cent of business services establishments operating in gauteng can be classified as micro establishments. the disproportionate approach ensured that at least a minimum of 30 small and 30 medium business services establishments were included in the sample. to meet the objectives of the study, an interviewer-administrated paper-based questionnaire was designed. questions to meet the objectives of the study were formulated in consultation with role players such as the national treasury and sars. questions to elicit both closed-ended and open-ended responses were included. various data capturing and verification procedures were followed to ensure the accuracy of the data. 4.4 validity of the data in total, 130 responses were received, which represents a response rate of 65 per cent for the survey. sample surveys are subject to error and mainly yield estimates but no precise values. sample error occurs when the selected sample does not perfectly represent the population. the formula for allowable sample error is: z e x =v where e = allowable error and z = number of standard deviation units that will yield the desired level of confidence (90 per cent level of confidence). taking the potential sample error into account, a confidence interval that will probably contain the population parameter can be stated. table 2 shows the interval estimate for the total population based on a 90 per cent level of confidence for selected research variables investigated in the survey. it is clear, for example, that the figure for business services micro establishments that outsource their capital gains tax responsibilities is between 24.8 per cent and 19.3 per cent. table 2 interval estimates for selected research variables research variable sample statistic (per cent) interval estimate (per cent) lower higher outsourcing capital gains tax functions (micro) 20.4 19.3 24.8 burden to comply with tax regulations has increased substantially over past three years (micro) 34.8 27.8 30.7 76 sajems ns 10 (2007) no 1 handling sdl* internally (small) 57.6 47.0 68.2 burden to comply with tax regulations has increased substantially over past three years (small) 49.2 38.5 59.9 handling sdl* internally (medium) 92.0 83.0 100.0 burden to comply with tax regulations has increased substantially over past three years (medium) 16.0 4.0 28.0 * skills development levies 5 taxation requirements for business services smmes 5.1 tax implications for the different establishment types income tax (also referred to as normal tax) is levied in terms of section 5(1) of the income tax act 58 of 1962 on the taxable income received by or accrued to any person during the specific year of assessment. calculating the taxable income of the person depends on the nature of activities and legal form of the relevant taxpayer. there are basically two broad categories of taxpayers; the first category includes persons taxed directly on the income received (for example, a sole trader or partnership) and the second category includes those cases where the business is taxed and not the individual (for example, companies and close corporations). trusts are also taxed as separate legal persons, but due to the complexities surrounding trusts, they fall outside the scope of this study. the procedure for determining the taxable income of the different enterprise types is summarised in annexure a. as no trusts are included in the survey they are not included in the annexure. it is important to note that a close corporation is included in the definition of a company in terms of section 1 of the income tax act 58 of 1962, thus any reference to companies includes close corporations. 5.2 direct and indirect taxes taxes can be divided into two groups, namely direct and indirect taxes. for business services establishments, this income tax classification is important in determining how much tax an establishment pays. in this section, the income tax classification of business services smmes will firstly be investigated. this will be followed by an outline of the various other direct and indirect taxation requirements with which business services smmes have to comply. noncompliance with these rules as a result of lack of proper administration or management may lead to penalties and interest being charged, which could be detrimental to businesses. 5.2.1 income tax the income tax act 58 of 1962 provides details of the different components that are used to calculate taxable income and tax liability. a taxpayer’s annual tax liability is calculated on the basis of the annual tax return that that taxpayer must submit. the information in the tax return is used to calculated the taxpayer’s taxable income for the year of assessment. this amount is then multiplied by the appropriate tax rate depending on the business services smmes taxation classification. the following tax rates can be applied to a business services smme depending on the legal structure of that smme: • a sole proprietor or each individual partner of a partnership is subject to tax on his/her taxable income at progressive rates ranging from 18 per cent to 40 per cent; and • companies and close corporations pay tax at a flat rate of 29 per cent on their taxable income for the year of assessment (except in the case of a small business corporation or personal services company – refer to the next sections) and 12.5 per cent secondary tax on companies on the net amount of dividends declared (sars, 2006). sajems ns 10 (2007) no 1 77 5.2.2 small business corporations to support the development of small and medium enterprises a graduated company tax rate structure for incorporated small and medium size enterprises was introduced in 2000 and is reviewed on a regular basis (manuel, 2000; 2005; 2006) in 2001 another major concession was introduced, allowing the immediate writeoff of all plants and machinery used in a process of manufacture or similar process in the year they are brought into use for the first time. an accelerated write-off allowance for depreciable assets (other than manufacturing assets) acquired on or after 1 april 2005 is also available at 50 per cent of the cost of that asset in the tax year during which that asset was brought into use for the first time, 30 per cent in the second year and 20 per cent in the third year (income tax act 58 of 1962). to enjoy these concessions, companies and close corporations must comply with the following requirements: • the shareholders or members must be natural persons and must hold the entire shareholding/members’ interest of the company/close corporation; • shareholders or members may not hold any shares or interest in the equity of any other company (with limited exclusions); • the gross income of the corporation for the year of assessment must not exceed r14 million; • not more than 20 per cent of the total of all receipts and accruals and all capital gains of the corporation may consist collectively of investment income and income from rendering a personal service – a small business corporation which is engaged in the provision of personal services will still qualify for the relief if at least four fulltime employees are employed throughout the year of assessment; these employees should be engaged in the business of the small business corporation rendering that service on a full time basis; and • the company/close corporation may not be an employment company (i.e. a labour broker without an exemption certificate or a personal service company) (sars, 2006). the first important aspect of these requirements to consider is the requirement that small and medium size enterprises be incorporated. figure 2 provides the enterprise form of the participants in the survey to show how many of them trade in the form of a company or close corporation. figure 2 profile of participating business services smmes by enterprise form figure 2 shows that more than half of the participating establishments are close corporations and companies (59 per cent) that might qualify for the small business corporation concessions based on legal form. the sole proprietors (17 per cent) and partnerships (24 per cent) will thus however not qualify for any of the concessions. the next important consideration of the small business corporation definition is the annual turnover of a company. statistics south africa’s integrated business register (2004) classifies entities registered with the companies and intellectual property registration office (cipro) by turnover. this register shows that almost half the cipro-registered active entities are micro enterprises, and almost 90 per cent are either micro or very small. on the basis of the information provided, small, medium and micro enterprises, which form the basis of the study, comprise almost 99 per cent of the total number of companies registered in 2004. (statistics south africa, 2004) the annual turnover of respondents participating in the survey is shown in figure 3. 78 sajems ns 10 (2007) no 1 figure 3 business services smmes by turnover category based on current legislation, all micro and most small establishments will comply with the turnover requirement of the small business corporation definition. having complied with the legal form and turnover requirements, the next important requirement for business service smmes relates to personal services. the following section analyses personal services in a business service environment. figure 4 distribution of registered corporations by industry, 2004 source: statistics south africa, 2004 sajems ns 10 (2007) no 1 79 5.2.3 personal service entity a company defined as a personal services entity will not be entitled to the concessions granted to small business corporations, although the company will be defined as a micro, very small, small or medium enterprise in terms of the national small business act 102 of 1996 (as amended). statistics south africa classifies service establishments as those who derive 50 per cent or more of their turnover from services rendered (statistics south africa, 2005). one of the factors considered in selecting the business services sector was the number of corporations involved in the business services sector. figure 4 provides a more detailed overview of corporations registered with cipro by subsector. figure 4 reflects the relative importance of the finance and business services industry in particular, with 43 per cent of all active firms being financial and business services establishments. the survey included the following finance and business services industries according to the standard industrial classification of all economic activities (sic) (sic code in brackets): • renting of machinery and equipment (85), • computer and related activities (86), • research and development (87), • legal; accounting, bookkeeping and auditing activities; tax consultancy; marketing research and public opinion research; business and management consultancy (881), • architectural, engineering and other technical activities (882), • advertising (883) and • business not elsewhere classified (e.g. labour recruitment and provision of staff; investigation and security activities; building and industrial plant cleaning; photographic activities; packaging activities) (889) (postma, dorfling & van wyk, 2004). based on the sic activities included in the survey, a number of establishments can be classified as personal service companies therefore disqualifying them from the benefits granted to small business service corporations. the fourth schedule of the income tax act 58 of 1962 defines a personal service entity as a company where services are rendered on behalf of that company to a client of that company personally by any person who is a connected person in relation to that company and: • that connected person would be regarded as an employee of that client if that services were rendered by that connected person directly to the client; • that connected person or that company is subject to the control or supervision of that client as to the manner in which or the hours during which the duties are performed in rendering that service; • the amount paid or payable in respect of that service consists of or includes earnings which are payable at regular intervals, daily, weekly, monthly or other intervals; or • more than 80 per cent of the income of that company consists of amounts directly or indirectly received from one client (stiglingh, venter & hamel, 2006). an smme classified as a personal services entity will not only not qualify as a small business corporation but will also pay income tax at an increased rate of 34 per cent (income tax act 58 of 1962). the definition does however have an important exclusion if the entity employs more than three full-time employees who are engaged on a fulltime basis in the business of such a company of rendering any such service, other than any employee who is a shareholder or member of the company or is a connected person in relation to such person. of the respondents included in the survey, just more than a third (or 46 of the 130) were micro establishments (1–20 employees), 45.4 per cent were small (21–50 employees) and 19.2 per cent were medium (51–200). table 3 profiles the participating business services smmes according to number of employees. 80 sajems ns 10 (2007) no 1 table 3 profile of participating business services smmes by number of employees characteristics smme category micro small medium average number of full-time staff 8 27 108 average number of full-time administrative staff 4 7 12 as discussed previously, almost all small and micro establishments will qualify as small business corporations in terms of the turnover rule. however, micro establishments will have to satisfy the criterion for the minimum number of employees before they are eligible for this tax benefit. because of the important contribution of business services to the south african economy, which was mentioned above, and in response to various industry representatives approaching the government about the cash flow hardships that the personal services entities regime has imposed on small businesses, the government has proposed certain amendments to the income tax act no 58 of 1962 to limit the scope of the personal services entities (national treasury, 2006). the proposed amendments are: • to limit the personal services entity regime to situations where the client controls or supervises how the work is performed, but only if that work is performed at the client’s premises; should the client thus control and supervise work performed by the entity on a limited basis, i.e. not all the work is done at the client’s premises, the company will no longer be deemed to be a personal services entity; • the third criteria for a personal services entity as stated above will be deleted; a client will now be allowed to make regular payments to an entity providing a service, as this is normally due to administration rather than an employee/employer relationship; and • the last proposed amendment reduces the number of full-time employees to three or more instead of four and more (national treasury, 2006). 5.3 other direct taxes • capital gains tax: a capital gain arises when the proceeds from the disposal of an asset exceed the base cost of that asset. a capital loss occurs when an asset is disposed of and the base cost of that asset exceeds the proceeds of that asset. for individuals, only 25 per cent of the net capital gain, after deducting the annual exclusion, is included when calculating the tax payable. for companies and close corporations, only 50 per cent of the net capital gain on the disposal of assets is included in the taxable income. capital gain forms part of an smme’s taxable income (sars, 2006). compliance: capital gains and losses must be declared in the income tax return for the tax year in which the asset is disposed of (stiglingh et al., 2006). for any costs incurred, the base cost documentary proof must kept and provided on request (de koker, 2005). • secondary tax on companies (stc): section 64b of the income tax act 58 of 1962 stipulates that stc is payable by all south african resident companies on the dividends (including deemed dividends) which the company declares to its shareholders. stc is not part of the normal tax payable by a company and must be separately calculated. stc is calculated as follows: 12.5 per cent of the net amount of the dividend. (stiglingh et al., 2006) compliance: stc is payable on the last day of the month following the month in which the dividend is declared. non-payment or late payment will lead to interest and penalties being charged (clegg & stretch, 2005). sajems ns 10 (2007) no 1 81 • provisional tax: those taxpayers earning income not classifiable as remuneration (as defined) are normally required to pay provisional tax. provisional tax is a method to pre-pay the tax that is due for the year of assessment. the provisional tax is paid biannually (venter, hamel & stiglingh, 2006). compliance: smmes earning an income of more than r10 000 must register within 30 days as provisional taxpayer (sars, 2005a). three provisional tax payments must be made during the year, the first within six months of the commencement of the year of assessment, the second before the last day of the financial year and the third normally within six months of the end of the year of assessment. each payment must be accompanied by the appropriate tax return providing detail of the payment. the third provisional tax payment is voluntary and can be made by companies or close corporations whose taxable income exceeds r20 000. non-payment will lead to interest being charged. non-payment or late payment of any of the other payments will lead to interest and penalties being charged (sars, 2004a). • employees’ tax: employees’ tax refers to the tax that the employer withholds from his/her employees at the end of each pay period (venter et al., 2006). compliance: any business that pays remuneration to employees that exceeds the tax threshold must register within 14 days of becoming an employer. (venter et al., 2006). the employer must complete and submit a monthly return (emp201). the return and the payment must be made within seven days of the end of the month in which the tax was withheld (sars, 2005b). at the end of the year the employer must issue each employee with an employee’s tax certificate (irp5) (silver & klein, 2005). it must also submit an annual reconciliation (irp501) to the local sars branch office, within 60 days of the end of the tax year (clegg, 2004). 5.4 indirect taxes • value added tax (vat): vat is an indirect tax levied in terms of the vat act 89 of 1991. vat must be included in the selling price of every taxable supply of goods and/or services made by a vendor. in determining the vat liability, the vendor must subtract all the input tax claimed from the output tax charged. should the output tax exceed the input tax, the vendor has to pay the excess to sars. should the input tax exceed the output tax, the vendor will be entitled to a refund from sars (sars, 2006). compliance: a person with taxable supplies of more than r300 000 (excluding vat) must register as a vendor for tax purposes (de koker & kruger, 2004). every vendor is registered for a specific tax period, depending on the size of the business. the tax period may vary from one month to four months. the vat returns (vat 201) and any vat due to sars must be filed and paid before the 25th of the month following the end of the tax period (tustin et al., 2005). a supplier must furnish a recipient with a tax invoice within 21 days of a request to do so (sars, 2004b). if there is a change in the conditions of sale a debit or credit note should be issued (brettenny, 2005). late payment or submission of a vat return could lead to interest and penalties being charged. • skills development levies (sdl): the levy is calculated as a percentage of the earnings of the employees (sars, 2006). the levy is payable to the sectoral seta which is concerned with the development of skills in that sector (warren, 2004). with certain exceptions, every employer, as defined in the fourth schedule to the income tax act 58 of 1962, is liable for sdl (skills development levies act 9 of 1999). compliance: sdl contributions are payable on a monthly basis, on or before the seventh of the month following the month to which the sdl contributions accrue. sdl contributions are normally submitted with paye and uif on the emp201 form (skills development levies act 9 of 1999). 82 sajems ns 10 (2007) no 1 • the unemployment insurance fund (uif): the unemployment insurance fund insures employees against the loss of earnings due to termination of employment, illness and maternity leave. a monthly contribution has to be made by the employer (1 per cent) and the employee (1 per cent) based on the earnings of the employee (sars, 2006). compliance: the unemployment insurance contributions act 4 of 2002 requires employers who are registered with sars for purposes of employees’ tax or skills development levies to pay their uif contributions to sars. those who are not required to register with sars must pay their uif contributions over to the unemployment insurance commissioner (unemployment insurance contributions act 4 of 2002). uif contributions are payable on a monthly basis, on or before the seventh of the month following the month in which the uif contributions accrue (sars, 2005b). • custom and excise duties: custom duty is a consumption tax levied on imported goods and is usually calculated as a percentage on the value of the goods. excise duty is a consumption duty levied on certain locally manufactured products (sars, 2006). compliance: goods imported, documents relating to the importation, including the transport document and suppliers’ invoices, must be produced if required by a customs controller (corbin & cowell, 1994). • transfer duty: transfer duty is levied on the purchase price payable for the acquisition of fixed property. transfer duty is levied at a progressive rate of 0 per cent to 8 per cent depending on the value of the property acquired and the legal form of the purchaser (sars, 2006). compliance: transfer duty must be paid to the commissioner within six months of the date of the transaction (transfer duty act 40 of 1949). • donations tax: donations tax is a tax imposed on persons who want to donate their assets in order to avoid normal income tax on the income derived from those assets and/or estate duty when those assets are excluded from their estates (jordaan et al., 2006). compliance: donations tax must be paid to the commissioner within three months of the date upon which the donation was made. the payment must be accompanied by a return on the form prescribed by the commissioner (venter et al., 2006). • stamp duty: stamp duty is levied on instruments such as leases of immovable property and unlisted marketable securities at different rates (sars, 2006). compliance: the instrument must be signed at the time of execution thereof or at the latest within 21 days of execution thereof (goodall, jacobs & king, 2004). 5.5 conclusion from the discussion in this section it is clear that there are many legal requirements that smmes must meet. correctly applying the legislation and complying with relevant timeframes place a major burden on smmes. considering that micro business services establishments only have on average three full-time administrative e m p l o y e e s a n d m e d i u m s i z e d b u s i n e s s services establishments only have 12 full-time administrative employees, most smmes will find it difficult, not only to comply with the requirements but also to keep up to date with changes. 6 analysis and interpretation of research findings this section provides an analysis of the tax survey conducted among business services smmes in gauteng during the period november 2005 to january 2006. 6.1 corporation profile table 4 profiles the participating business services smmes according to selected characteristics. sajems ns 10 (2007) no 1 83 table 4 profile of participating business services smmes by selected characteristics characteristics smme category micro small medium average number of years in operation 11 15 19 average number of full-time staff 8 27 108 average number of full-time administrative staff 4 7 12 percentage of full-time administrative staff dealing with tax matters 45 per cent 34 per cent 35 per cent table 4 shows that participating smmes are fairly experienced, reflected in their average number of years in operation. the mature status of participating smmes was very encouraging for purposes of collecting objective and reliable data. the data confirms the government’s view that the smme sector should be targeted for future growth. the information indicates that the longer a business is in operation, the larger it becomes and the more people it can employ. for example, an average micro businesses that had been in existence for 11 years employs eight fulltime staff members while medium businesses that have been operating for 19 years employ an average of 108 full-time staff. it should therefore be a priority to ensure that as many of the micro and small establishments as possible grow to become medium organisations. the analysis also shows that almost half the administrative staff of micro establishments deal with tax matters, compared to only a third in the case of small and medium establishments. there seems to be a correlation between the size of an establishment based on employee figures and size based on turnover. the more employees an establishment has, the bigger its turnover. the information also clearly indicates that the government is targeting the correct section of the sector in terms of small business corporations. figure 5 establishments outsourcing their direct tax liabilities 84 sajems ns 10 (2007) no 1 6.2 management and administration of taxation functions the research model was constructed to determine which taxes/duties/levies are managed and administrated by smme business services establishments internally and which are outsourced. figure 5 indicates the percentage of establishments liable for various direct taxes that elect to outsource the responsibility for these taxes to a third party. it is clear from figure 5 that the size of an establishment has a direct impact on its ability to administer and manage different tax functions internally. as can be seen from table 4, the larger the establishment, the more administrative personnel it can appoint. this therefore increases the business’s capability for handling the function internally. it is also clear that employees’ tax functions are generally performed internally, irrespective of the size of the establishment, possible due to the routine nature of this tax function compared to the other tax functions. table 5 outsourcing the responsibility for indirect taxes/duties/levies responsibility for taxes/duties/levies micro (per cent) small (per cent) medium (per cent) value-added tax (vat) 50.0 33.9 8.0 customs and excise duties 21.7 10.2 12.0 stamp duties 30.4 22.0 12.0 unemployment insurance fund (uif) levies 41.3 33.9 8.0 skills development levies (sdl) 28.3 33.9 8.0 workmen’s compensation levies 26.1 15.3 4.0 regional service council levies (rsc) 53.0 40.0 43.0 in relation to indirect taxes, it is clear that medium establishments are better positioned to manage the functions as they outsource considerably fewer responsibilities than do small and micro establishments. this can be illustrated by the fact that 50 per cent of micro establishments outsource their vat functions compared with 33.9 per cent of small establishments and only 8 per cent of medium establishments. it is interesting to note that the tax function that is outsourced by most smmes is regional service council levies. the government’s decision (manuel, 2006) to repeal these levies and not to replace them with any other tax should bring welcome relief to smmes. to b e t t e r u n d e r s t a n d t h e r e a s o n s f o r outsourcing tax functions and responsibilities by smmes, respondents were asked to identify the main reason why they outsource these functions. the reasons provided for outsourcing the functions are provided in table 6. of the reasons cited for outsourcing tax functions, lack of time to handle these functions internally is mentioned as a major factor by all three categories of smmes. besides time, lack of adequate tax skills to handle functions internally is a further reason for outsourcing tax functions. due to the ever-changing nature of taxation, a great deal of time is required to keep up to date with changes and it is very difficult to find staff with appropriate tax skills. table 6 confirms that the changing nature of taxation is one of the major challenges facing smmes. it could therefore be expected that establishments would invest in training and updating their sajems ns 10 (2007) no 1 85 employees to ensure compliance with the latest requirements and utilisation of new incentives. however, according to figure 6, this is not the case. figure 6 indicates the percentage of table 6 reasons for outsourcing tax functions reason smme category micro (per cent) small (per cent) medium (per cent) unskilled tax staff 32.6 28.8 12.0 cheaper to outsource 23.9 18.6 4.0 time factor 43.5 30.5 24.0 smmes that perform tax functions internally and that have invested in training for their employees in the past. figure 6 investment in staff taxation training it is clear from figure 6 that very limited investment is made to support the tax training needs of employees and managers. 6.3 value of tax inputs/advice on effective management of the business it is interesting to note that 35 per cent, 49 per cent and 16 per cent of micro, small and medium establishments respectively believe that the burden of complying with government tax regulations has increased substantially over the past three years. the research model is therefore useful in determining the value of tax inputs/advice/information to smmes in coping with this burden through planning, survival and income/expense management. it is clear from the analysis presented in table 8 that business services smmes hardly use tax inputs/advice/information for management and planning purposes. this suggests that smmes either do not have the required skills to utilise tax inputs as a strategic management tool, or that they do not see the potential advantages of an effective tax information system to support business planning and strategising. 86 sajems ns 10 (2007) no 1 table 8 value of tax inputs/advice/information statements smme category micro (per cent) small (per cent) medium (per cent) tax functions are only performed because they are compulsory 39.1 30.5 24.0 inputs from tax staff/division/consultants are used for shortterm tactical business planning 10.9 1.7 20.0 inputs from tax staff/division/consultants are used for long-term strategic planning 10.9 18.6 28.0 tax knowledge support effective management of income/ expenses 17.4 8.5 12.0 information provided by tax advisors is important for the survival of the establishment 26.1 20.3 28.0 the most logical reasons for the low level of utilisation of tax inputs/information could be that tax functions are viewed as compulsory activities or that the tax functions are handled by outside consultants whose mandate probably does not included the supply of tax related information but merely dealing with tax responsibilities on behalf of smmes. another factor that could determine whether taxation contributes to the management of a business could be the person/department responsible for managing the tax functions. respondents who perform tax functions internally were asked to indicate whether the tax functions are the responsibility of top management of the establishment or a financial/accounting department. only 27 per cent of micro, 21 per cent of small and 28 per cent of medium establishment indicate that top management is responsible for tax functions. this could thus be a contributing factor to why taxation is not seen as an input in business decisions. 6.4 tax measure preferences during the last couple of years, the national treasury and sars have introduced a number of initiatives to support the smme sector. these invitatives include a reduction in the number of vat returns that need to be submitted by small business corporations and the provision of an accounting software package. in this study respondents were asked to indicate which of a range of possible options to reduce tax compliance burdens they would prefer. a preference index was compiled to assess the preferences for the various tax measures presented to the smmes. this index was compiled by allotting multiplying values to each of the rating options: not preferred = 0; preferred = 50; and highly preferred = 100. table 9 preference index for tax measures by smme category tax measures micro (index) small (index) medium (index) higher vat thresholds 55 36 22 filing returns for vat less often 61 43 28 filing returns for employees’ tax less often 58 36 24 sajems ns 10 (2007) no 1 87 special simplified tax regime for smmes 59 66 57 reduced penalties/interest charges for smmes 75 81 82 sars ‘help desk’ to provide information/assistance 76 79 80 reduced tax rates for smmes 65 78 66 it is interesting to note that the majority of respondents did not select a reduction in the rate of tax paid as their first choice. both small and medium business services establishments selected a reduction in the penalties and interest charged as their preferred option. the reason for this selection can be found in the number of administrative staff employed by the establishments. in table 6, respondents indicated that lack of time was the main reason for deciding to outsource their tax responsibilities; this being the case, they probably also find it difficult to complete the functions retained internally in a timely manner. the second support measure selected was the establishment of a sars helpline; in this regard, sars must be congratulated for recently establishing smme support desks at their branches. however, based on the responses received from the survey, the existence of this support function is either not properly communicated to smmes or is not complying with the requirements of smmes. 7 cconclusion the government’s accelerated and shared growth strategy has identified the smme sector as an important economic role player in creating wealth and job opportunities in south africa. due to the cost impact of taxation on an smme, not only in the form of actual taxes but also possible interest and penalties, the design of appropriate tax management strategies is fundamental to the survival of smme. this study finds that, due to the complexity of tax legislation and lack of time and skills, the majority of business services smmes outsource various tax functions. the study finds that the larger the establishment becomes, the better it is equipped to perform these functions internally. the results of the survey indicate that the longer an establishment exists, the more it shows growth in its turnover and also in the number of people it employs. considering the objectives of the accelerated and shared growth strategy, special attention should be given to support smmes in the early years of their existence. generally, tax inputs are not considered as an important factor when making business decisions. the survey indicates that the value of tax advice decreases as establishments grow from micro to small businesses and then increases as they grow further to become medium-sized businesses. the reason for this could be that, at the start of a new business, the different tax implications are important for that business, as non-compliance could be fatal. as the business grows, the initial tax problems have been dealt with and the management’s concern regarding the future of the business decreases. however, as the business becomes larger, taxation again become important in attempts to increase the business’s profits. it is suggested that improving tax skills and knowledge among smmes will lead to more effective management of taxation functions, which may ultimately result in cost savings and help to ensure the long-term survival of the establishments. references 1 bmr (2004) register of business services establishments, university of pretoria: pretoria. 2 bretanny, a. (2005) a student’s guide to the value-added tax act (8th ed.) lexisnexis butterworths: durban. 3 clegg, d.j.m. (2004) the lexisnexis practical guide to fringe benefits 2004/2005 (13th ed.) lexisnexis butterworths: durban. 4 clegg, d.j.m. & stretch, r. (2005) income tax in south africa, lexisnexis butterworths: durban. 5 corbin, p. & cowell, a. (1994) johannesburg chamber of commerce and industry importer’s 88 sajems ns 10 (2007) no 1 manual, johannesburg chamber of commerce and industry: auckland park. 6 department of trade and industry. (2004) annual review of small business in south africa, small business development agency: pretoria. http://www.thedti.gov.za/article/ articleview.asp?current=1arttypeid=2&artid=104 9 (accessed on 19 february 2006). 7 de koker, a.p. (2005) silke on south african income tax, lexisnexis butterworths: durban. 8 de koker, a.p. & kruger, d. (2004) vat in south africa, lexisnexis butterworths: durban. 9 deloitte & touche (2005) tax grapevine, deloitte & touche: johannesburg. 10 goodall, b., jacobs, a. & king, r. (2004) momentum tax and investment easy guide 2004/2005, lexisnexis butterworths: durban. 11 jordaan, k., koekemoer, a., stein, m.l., stiglingh, m., van schalkwyk, l. & wassermann, m. (2006) silke: south african income tax. lexisnexis butterworths: durban. 12 manuel, t. (2000) budget speech 2000/2001, department of finance: pretoria. 13 manuel, t. (2005) budget speech 2005/2006, department of finance: pretoria. 14 manuel, t. (2006) budget speech 2006/2007, department of finance: pretoria 15 national treasury (2005) explanatory memorandum on the taxation laws amendment bill, 2005, department of finance: pretoria. 16 national treasury (2006) explanatory memorandum on the revenue laws amendment bill, 2006, department of finance: pretoria. 17 postma, j.a., dorfling, j.h.s. & van wyk, h. de j. (2004) a guide to the fifth edition of the standard industrial classification of all economic activities (sic), unisa bureau of market research: pretoria. 18 sarb (2006) “statistics and economic information”: online download facility. http:// www.reservebank.co.za (accessed 19 february 2006). 19 sars (2003) business register for levy payments, south african revenue service: pretoria. 20 sars (2004a) guide for provisional tax, south african revenue service: pretoria. 21 sars (2004b) vat 404: guide for vendors, south african revenue service: pretoria. 22 sars (2005a) irp 12 volume 42, south african revenue service: pretoria. 23 sars (2005b) emp 10 volume 46, south african revenue service: pretoria. 24 sars (2006) tax guide for small businesses 2006/07, south african revenue service: pretoria. 25 seda (small)business development agency) (2005) “brain business newsletter: seda summit 2005 special edition, http://www.brain.org. za/newsletter/2005/dec05 /dec_newsletter.htm (accessed 19 february 2006). 26 silver, m. & klein, j. (2005) pay less tax, lexisnexis butterworths: durban. 27 south africa (1962) income tax act 58 of 1962. 28 south africa (1996) national small business act 102 of 1996. 29 south africa (1985) regional services levies act 109 of 1985. 30 south africa (1998) skills development act 97 of 1998. 31 south africa (1999) skills development levies act 9 of 1999. 32 south africa (1949) transfer duty act 40 of 1949. 33 south africa (2002) unemployment insurance contributions act 4 of 2002. 34 statistics south africa (2004) integrated business register. statistics south africa: pretoria. 35 statistics south africa (2005) retail trade sales: statistical release p6242.1, 2 november. statistics south africa: pretoria. 36 stiglingh, m., venter, jmp. & hamel, eh. (2006) a student’s approach to income tax: business activities, lexisnexis butterworths: durban. 37 tustin, d.h., abrie, w., basson, j.p.c., de clercq, b., de hart, k.l., doussy, e., graham, c.r., hamel, e.h., howell, r., olivier, p., posthumus, l.c., steyn, m., swanepoel, a., ungerer, m., venter, j.m.p. & wentzel, m.s. i. (2005) the status of tax management and administrative skills of sme manufacturers: gauteng 2005, unisa press: pretoria. 38 venter, jmp, hamel, eh & stiglingh, m. (2006) a student’s approach to income tax: natural persons, lexisnexis butterworths: durban. 39 warren, r.c. (2004) the payroll administrator’s manual, lexisnexis butterworths: durban. microsoft word 2 liu si(16) 2013.docx sajems special issue 16 (2013) : 9-15 9 a study on the performance of labour outsourcing in the public sector hong-cheng liu* department of public policy and management, i-shou university, taiwan governments in many countries are gradually adjusting their traditional concepts and committing private businesses to conducting governmental business and services in order to achieve economic and operational goals and to introduce more dynamic technologies from private organisations for better financial flexibility. with a freely competitive mechanism in private markets, the quality and efficiency of public services could be effectively promoted in order to enhance economic benefits. using data from garbage clean-up outsourcing in various districts under the 2008-2010environmental protection bureau, kaohsiung city government, the data envelopment analysis (dea) and the malmquist productivity analysis were combined to measure the total efficiency (te), pure technical efficiency (pte), and scale efficiency (se) of the garbage clean-up services in 11 districts in kaohsiung city to provide follow-up information on the garbage clean-up outsourcing initiative of the environmental protection bureau, kaohsiung city government. the empirical results for overall efficiency show that optimal total efficiency was reported in the hsin-hsing district (0.99), optimal pure technical efficiency in the hsin-hsing district (0.99), and optimal scale efficiency in the san-min district (1.00). key words: public sectors, data envelopment analysis, labour, outsourcing, pure technical efficiency, scale efficiency, performance, decision-making units jel: h000, m100 1 introduction with economic development and the enhancement of economic awareness, the desire of the public is to see that the service provided by the government is multifaceted in scope and quality. one of the facets of this service is dealing with the garbage clean-up problem (closely related to public living). this has become a complicated issue. there have been numerous instances in western countries and japan where garbage clean-up outsourcing is practiced to simplify government functions, saving personnel expenses and enhancing service quality and efficiency. according to a survey carried out by the japanese ministry of home affairs, about 40 per cent of garbage clean-up is outsourced to the commercial sector and the expenses are merely one-third of the expenses when this function is managed by the public sector. when garbage clean-up services were outsourced in wandsworth, england, savings on personnel and service expenses amounted to about 44 per cent. about 80 per cent of the garbage in the usa is cleaned up by the commercial sector, thereby trebling efficiency. privatisation of garbage clean-up in canada saves more than 30 per cent of the expenses incurred when this function is managed by the public sector. since 1991, taichung ching-shui, nantou puli, miaoli xihu, miaoli toufen, miaoli city, chunan city, taichung city, hsinchu city, and tainan city in taiwan have all had experience of garbage clean-up outsourcing. taichung city, hsinchu city and tainan city implemented outsourcing in 2000 and achieved favourable efficiency and service quality. as a result, the environmental protection bureau of the kaohsiung city government decided to implement outsourcing in some districts with the objective of reaching environmental protection policy goals. with industrialization, kaohsiung city represents a typical pattern of metropolitan living. there is a rapid flow of population and exchange of information; traffic flows are heavy. sustainable development concepts, including modern waste treatment and environmental ecology creation and waste abstract 10 sajems special issue 16 (2013) : 9-15 treatment for renewable energy, have been implemented. nevertheless, the government cannot increase the number of cleaners and vehicles in such a short period of time because there is a policy of downsizing and a shortage of financial resources. pressure on public services is increasing, but the bureaucracy cannot effectively respond to the demands of the public, which considers the quality and effectiveness of government services inadequate. the enhancement of environmental awareness has meant that public requirements in respect of the scope and quality of government services have increased, resulting in an expansion of executive and operational manpower, high personnel expenses and social and public comments. in addition to the restrictions imposed by the downsizing policy and the shortage of financial resources, kaohsiung city government also faces the dilemma of increasing environmental work. satisfying public expectations and promoting overall environmental quality has become a major objective for the kaohsiung city government. 2 literature review 2.1 labour outsourcing labour outsourcing refers to an organisation’s selecting some or all functions other than those that affect it score competitiveness for external suppliers to execute so that the organisation can concentrate on the most precise and valuable activities and commit the rest of the business functions to external suppliers (quinn, 1999). in other words, outsourcing where external private groups provide internal services has become one of the most popular innovations that has been applied on a large scale to enterprises and government organisations for years. for organisational functions not related to core competitiveness, quinn (1992) argued that labour outsourcing is not a critical strategy or an activity with special benefits. labbs (1993) considers outsourcing to been trusting necessary functions for organisational operation (non-core parts) to external service providers on contract. lu (2001) regards labour outsourcing as transferring the continuous management of a certain labour service to a third party in terms of a service agreement. fong (2009) regards outsourcing as part of organisational management where the relative assets are managed by external suppliers at a price agreed by both parties (with provisos). f.g. maurice (1999) considered labour outsourcing in terms of a contract as the allocation of some organisational activities and decisions to an external supplier for execution. handy says in the elephant and the flex: looking backwards to the future in 2001 that an organisation is like an oxalis which is composed of three leaves: (1) core work team, (2) contract workers, and (3) flexible labour in an organisation. chen (2009) considers labour outsourcing to be an obvious improvement when the organisation appears to be showing poor operating performance and showing low value (e.g. in physical work). 2.2 labour outsourcing performance the success of labour outsourcing relies on the ability of an organisation to exercise control (charles & james, 2000). each section in an organisation has to engage in mutual negotia tion and cooperative functions when selecting external suppliers, signing contracts, transferring labour services, controlling the quality of labour services and managing prices in order to fulfil the original purpose of labour outsourcing and reap the benefits. corbett (1996) and rendon (2002) mention that a correct and suitable external supplier with competitiveness should be selected for labor outsourcing. when selecting external suppliers, a contract agreement is necessary in order to reduce the amount of supervision required afterwards. lin (2009) says that the key factors in evaluating labour outsourcing performance in the construction industry are quality, costs and time effectiveness. after researching labour outsourcing of governmental sectors, dehoog (1984) proved that strong professional ethics and the capability of external suppliers were the key factors in the success of actual outsourcing performance and the achievement of a satisfactory standard. niimura satoshi (2010) proposes the following three elements for labour outsourcing contracts: 1. quality assurance requires the technical quality of all operations to be achieved. 2. appropriate price refers to achieving the desired quality at a sajems special issue 16 (2013) : 9-15 11 price below the target price. in other words, when the quality and price have been agreed upon at the lowest contract cost, the required quantity and quality may be completed before the delivery date. gilley and rasheed (2000) studied the effects of the items and organisational strategies for labour outsourcing and environmental change on the labour outsourcing performance and found correlations with the strategies and environmental change, rather than with the items themselves. 2.3 data envelopment analysis data envelopment analysis, proposed by charnes, cooper and rhodes (1978), is a performance evaluation approach which mainly evaluates efficiency by means of the model that estimates the production frontier using a nonparametric approach proposed by farrell (1957) (i.e. estimation with non-default functions replacing traditional default functions). taking pareto optimality as the definition of efficiency, the other benefits would not suffer, no matter how the resources were re-allocated in order to make higher profits. charnes, cooper and rhodes further expanded dea to a multiple evaluation with several inputs and outputs in the constant returns to scale, (i.e. they applied the measurement with various inputs and outputs to the performance evaluation). as dea acquires the production frontier with mathematical models, the comparison between the actual data of various decision-making units (dmus) and the production frontier could measure the relative efficiency and relative inefficiency of dmus without default production functions and para-meters to achieve the improvement suggestions for relative efficiency. farrell (1957) proposed the efficiency models of input orientation and output orientation. the former advocated efficiency evaluations with minimum input, under the current output. the latter compared the efficiency of decision-making units with maximum output, under the restricted input resources. in general, the inputs of profit-making businesses are controlled by the decision-making units, but the output can hardly be controlled because of the restriction on the market commonly imposed by input orientation. this study therefore applies dea with input orientation to analyse the operational performance of the assembly industry. further applications of dea are discussed by cooper et al. (2000). 3 research methods when using data envelopment analysis to evaluate efficiency, each increased input/ output item would reduce the discrimination of the data envelopment analysis. suppose that there are four inputs and five outputs for twenty input-output ratios. theoretically, at least two dmus are required for the discrimination. golany and roll (1989) further propose the rule of thumb for data envelopment analysis that the number of evaluated decision-making units should be twice the sum of the number of inputs and outputs. a total of three input/output variables were selected for this study, and 11 dmus were strictly selected to ensure that the rule of thumb is adhered to. all the data on variables are acquired from publicly issued prospectuses and annual reports. the definitions of the variables are given below. i input variable 1 number of employees: the sum of the employees 2 operating costs: expenditure on labour services for the environmental protection bureau ii output variable volume of garbage clean-up: the volume of garbage delivered to rubbish disposal stations 3.1 empirical analysis 3.1.1 analysis of relative efficiency table 1 shows the relative efficiency of the districts in kaohsiung city. the average total efficiency in the three years was 0.90; hsinhsing district recorded the optimal total efficiency (0.99) in 2003, followed by san-min district and chien-chin district (0.98), and nan-tzu district exhibited the worst (0.78). san-min district and hsin-hsing district reported the optimal total efficiency (0.99) in 2004 and nan-tzu district had the worst (0.79). apparently, the hsin-hsing district achieved the best total efficiency in the three years, while the nan-tzu district reported the worst. 12 sajems special issue 16 (2013) : 9-15 table 1 relative efficiency of the districts in kaohsiung city district in kaohsiung city total efficiency pure technical efficiency scale efficiency yen-chen district average in 2008 0.96 0.96 0.90 average in 2009 0.96 0.96 0.90 average in 2010 0.96 0.95 0.91 three-year average 0.96 0.96 0.90 ku-san district average in 2008 0.80 0.79 0.82 average in 2009 0.81 0.78 0.80 average in 2010 0.80 0.79 0.81 three-year average 0.81 0.79 0.81 tso-ying district average in 2008 0.92 0.90 0.89 average in 2009 0.92 0.91 0.89 average in 2010 0.91 0.91 0.88 three-year average 0.92 0.91 0.89 nan-tzu district average in 2008 0.78 0.74 0.83 average in 2009 0.79 0.78 0.84 average in 2010 0.79 0.76 0.84 three-year average 0.79 0.76 0.84 san-min district average in 2008 0.98 0.93 1.00 average in 2009 0.99 0.91 1.00 average in 2010 0.99 0.92 1.00 three-year average 0.99 0.92 1.00 hsin-hsing district average in 2008 0.99 0.99 0.94 average in 2009 0.99 0.99 0.92 average in 2010 0.99 0.98 0.93 average in three years 0.99 0.99 0.93 chien-chin district average in 2008 0.98 0.97 0.90 average in 2009 0.98 0.98 0.91 average in 2010 0.97 0.98 0.91 three-year average 0.98 0.98 0.91 ling-ya district average in 2008 0.88 0.85 0.96 average in 2009 0.89 0.84 0.94 average in 2010 0.89 0.85 0.95 three-year average 0.89 0.85 0.95 chien-chen district average in 2008 0.90 0.87 0.97 average in 2009 0.91 0.88 0.95 average in 2010 0.91 0.88 0.96 three-year average 0.91 0.88 0.96 chi-chin district average in 2008 0.82 0.88 0.74 average in 2009 0.83 0.87 0.76 average in 2010 0.83 0.88 0.75 three-year average 0.83 0.88 0.75 hsiao-kang district average in 2008 0.83 0.77 0.86 average in 2009 0.84 0.76 0.85 average in 2010 0.84 0.77 0.86 three-year average 0.84 0.77 0.86 total average in 2008 0.89 0.88 0.89 average in 2009 0.90 0.88 0.89 average in 2010 0.90 0.88 0.89 three-year average 0.90 0.88 0.89 the average pure technical efficiency in the three years was 0.88.hsin-hsing district achieved the optimal pure technical efficiency (0.99) in 2003, followed by chien-chin district sajems special issue 16 (2013) : 9-15 13 (0.97), and nan-tzu district had the worst (0.74). hsin-hsing district achieved the optimal pure technical efficiency (0.99) in 2004 and hsiao-kang district showed the worst (0.76). further, hsin-hsing district displayed the best pure technical efficiency in the three years, while hsiao-kang district and nan-tzu district recorded the worst. the average scale efficiency in the three years was 0.89. san-min district achieved the optimal scale efficiency (1.00) in 2003 and chi-chin district had the worst (0.74). san-min district showed the optimal scale efficiency in 2004 (1.00) and chi-chin district had the worst (0.76). apparently, san-min district demonstrated the best scale efficiency for the three years, and chi-chin district the worst. 3.2 sensitivity analysis in this study, the input and output variables were gradually deleted for the dea so as to investigate the sensitivity of efficiency to such changes. when the gross fixed assets and the volume of garbage clean-up were deleted from table 2, two relatively efficient dmus still remained, showing that two such variables had little effect on efficiency. when the number of employees and costs were deleted, the number of relatively efficient dmus was reduced, which reflects the importance of these two variables in that they are able to affect the relative efficiency evaluated by the dea. table 2 sensitivity analysis of the deletion of single input and output items dmu original relative efficiency deleting number of employees deleting costs deleting gross fixed assets deleting volume of garbage clean-up yen-chen district 0.96 0.90 0.91 0.87 0.94 ku-san district 0.81 0.80 0.80 0.76 0.77 tso-ying district 0.92 0.90 0.88 0.85 0.82 nan-tzu district 0.79 0.77 0.73 0.74 0.76 san-min district 1.00 0.96 0.95 1.00 1.00 hsin-hsing district 1.00 0.98 0.98 1.00 1.00 chien-chin district 0.98 0.94 0.95 0.88 0.90 ling-ya district 0.89 0.86 0.82 0.85 0.84 chien-chen district 0.91 0.87 0.87 0.82 0.83 chi-chin district 0.83 0.78 0.76 0.79 0.81 hsiao-kang district 0.84 0.80 0.74 0.81 0.80 number of efficient dmus 2 0 0 2 2 data source: own results 3.3 analysis of slack variable according to table 3, the relative efficiency could be achieved by reducing the number of employees by 1 per cent in the yen-chen district, by 1 per cent in the tso-ying district, by 2 per cent in the nan-tzu district, by 1 per cent in the chien-chin district, by 2 per cent in the ling-ya district, by 1 per cent in the chien-chen district, and by 3 per cent in the hsiao-kang district. relative efficiency could be achieved by increasing the costs by 2 per cent in the hsiao-kang district, by 1 per cent in the ling-ya district, and by 2 per cent in the chien-chen district. relative efficiency could be achieved by reducing the gross fixed assets by 2 per cent in the tso-ying district, by 3 per cent in the sanmin district, and by 1 per cent in the chi-chin district. relative efficiency could be achieved by increasing the volume of garbage clean-up by 2 per cent in the ku-san district, by 1 per cent in the tso-ying district, by 6 per cent in the nan-tzu district, by 1 per cent in the lingya district, by 1 per cent in the chien-chen district, and by 3 per cent in the hsiao-kang district. 14 sajems special issue 16 (2013) : 9-15 table 3 improvement of the districts in kaohsiung city decision-making unit (dmu) improvement in input item improvement in output item number of employees costs gross fixed assets volume of garbage clean-up yen-chen district -1 -2 0 0 ku-san district 0 0 0 2 tso-ying district -1 0 -2 1 nan-tzu district -2 0 0 6 san-min district 0 0 -3 0 hsin-hsing district 0 0 0 0 chien-chin district -1 0 0 0 ling-ya district -2 -1 0 1 chien-chen district -1 -2 0 1 chi-chin district 0 0 -1 0 hsiao-kang district -3 0 0 3 data source: own results 4 conclusions and suggestions based on the survey of the 2008-2012 garbage clean-up outsourcing performance of the environmental protection bureau, kaohsiung city government, a total of 11 districts were analysed on the basis of garbage clean-up performance with the aid of data envelopment analysis. according to the research results, hsin-hsing district in kaohsiung city achieved optimal efficiency in the four years, with a total efficiency and pure technical efficiency hat surpassed those of the other districts. this is possibly because hsinhsing district is the first district to have implemented garbage clean-up outsourcing. before then, the environmental protection bureau, kaohsiung city government, sent representatives to inspect and learn from taichung city and tainan city about the feasibility reports, and held forums with relevant sections and the leaders of towns and villages conducting such businesses. they also formulated a trial plan in hsin-hsing district and strove to gain the support of elected representatives, local citizens and internal staff. they drafted the contract for outsourcing, and thoroughly communicated and propagated this initiative by dealing with any questions. during the planning process, the schedule control appointed the hsin-hsing district to promote garbage clean-up outsourcing. based on research analyses, hsin-hsing districthas identified the following characteristics for successful garbage clean-up outsourcing. (1) the residences in the hsin-hsing district were concentrated and the volume of garbage to be cleaned up was moderate. the short distance to the xichingpu rubbish disposal station reduced the costs and the businesses showed greater willingness to bid for the contract. (2) the development of the hsinhsing district is almost complete and the volume of garbage is stable. moreover, it is situated in a business district where there are less harmful and toxic wastes. (3)the area of hsin-hsing district is small with a definite boundary and the clean-up business is easily supervised. acknowledgments the author would like to thank the national science council of the republic of china for financially supporting this research under contract no. nsc: 102-2410-h-214-008. the authors are grateful to the valuable comments made by the reviewers. sajems special issue 16 (2013) : 9-15 15 *corresponding author contact hong-cheng liu, hcliu@isu.edu.tw references charles, l.g. & james, e. 2000. inside outsourcing/the insider’s guide to managing strategic sourcing. naperville: brealey. charnes, a., cooper, w.w. & rhodes, e. 1978. measuring the efficiency of decision making units. european journal of operational research, 2(6):429-444:44. chen, jia-rong. 2009. a study on outsourcing management mechanism-cht as an example. sun yat-sen management review, 2(3):42-73. cooper, w.w., seiford, l.m. & tone, k. 2000. data envelopment analysis: a comprehensive text with model, applications, references and dea-solver software. kluwer academic. corbett, m.f. 1996. outsourcing as a strategic tool. canadian business review, 23(2):14-16. dehoog, r.h. 1984. contracting out for human service. state university of new york press. farrell, m.j. 1957. the measuring of productive efficiency. journal of the royal statistical society: 253-281. fong, feng-lieh. 2009. research on the relationship among labor outsourcing management, job satisfaction. management magazine, 298:66-71. gilley, k.m. & rasheed, a. 2000. making more by doing less: an analysis of outsourcing and its effects on firm performance. journal of management, 26(4):763-790. golany, b. & roll, y. 1989. an application procedure for dea. omega, 17(3):237-250. labbs, j.j. 1993. successful outsourcing depends on critical factors. personnel journal:51-60. lin, kun-zong 2009. a study of outsourcing companies management strategies in the construction industry. management magazine, 293:44-46. lu, na. 2001. outsourcing mode how to use external resources to enhance their competitiveness, taipei: business weekly. maurice, f.g. 1999. strategic outsourcing: a structured approach to outsourcing decisions and initiatives. new york: ama. niimura satoshi 2010. considerations of diversification. technology and training, 19(4):7-16. quinn, j.b. 1992. leveraging knowledge and sever ice based strategies through outsourcing. intelligent enterprise, free press:71-97. quinn, j.b. 1999. strategic outsourcing: leverage knowledge capabilities. sloan management review:9-21. rendon, r.g. 2002,world class contracting: how winning companies build successful partnerships in the e-business age. project management journal, 33(3):66-67. microsoft word 6 careerdev ofsa knowledge vstaden & dtoit 14_ 80 sajems ns 14 (2011) no 1 career development of south african knowledge workers roelof van staden and adeline du toit centre for information and knowledge management, university of johannesburg accepted aug 2010 the demand for knowledge workers is on the increase, yet little is known about their career perceptions and attitudes. the objective of this article is to determine the factors affecting the career development of knowledge workers in south africa. part-time learners of a postgraduate course were used as a purposive sample and 82 completed questionnaires were received. the results of the online survey provide an interesting look at the unique career issues knowledge workers experience from a south african perspective. issues identified dealt with the lack of importance placed upon organisational training, the lack of interest in temporary work assignments and the low importance placed on learning from mentors. organisations need to take note of their reward structures as knowledge workers have indicated that promotions and rewards based on their knowledge is insufficient. key words: career perceptions; knowledge economy; knowledge workers jel d80, 83 1 introduction knowledge is stored in the minds of knowledge workers, which means that organisations need to balance business needs against the needs of knowledge workers (stokely, 2008:47) to ensure that organisational knowledge becomes a strategic asset in order to remain competitive and survive in the knowledge economy (zack, 1999). products, services and processes that create value are becoming more complex, requiring even more changes in the way organisational knowledge is managed. this result in changes in the way knowledge workers develop their careers. the knowledge economy is forcing knowledge workers to realise that multiple assignments, projects, jobs and possibly multiple careers are the norm. even though the knowledge economy can be turbulent, successful knowledge workers are able to see new opportunities for themselves and society (drucker, 2001:283). the demand for knowledge workers is on the increase, yet little is known about their career perceptions and attitudes (pringle & mallon, 2003:839). the primary objective of this article is to determine the factors affecting the career development of knowledge workers in south africa. the secondary objective is to determine via an empirical survey causes of career dissatisfaction and areas where career development is needed among south african knowledge workers. south africa is becoming less competitive owing to lack of skills, for example the limited availability of knowledge workers such as engineers (van tonder, 2007). van tonder (2007) notes that south africa is now ranked 50 th, out of 55 countries in the imd world competitiveness yearbook from a previous best of 38 th place. with only 44.6 per cent of skilled workers receiving any form of training, south africa is not investing in the small knowledge worker population (smith, 2008). if prosperity and even survival depend on knowledge worker productivity (drucker, 1999:83), then organisations in south africa need to address issues concerning knowledge workers. reliance on knowledge workers creates interesting problems for south african organisations, as specialisation and dual career ladders are required to ensure that the abstract sajems ns 14 (2011) no 1 81 knowledge residing in the minds of knowledge workers is not lost. 2 knowledge workers bergeron (2003:58) defines knowledge workers as individuals who contribute to the intellectual capital of their organisation. the products or output of a knowledge worker is considered to be knowledge assets consisting of documentation, newsletters, online weblogs and other publications. drucker (2002:238) defines knowledge workers from an individual’s point of view. an individual with significant amounts of theoretical knowledge and learning constitutes a knowledge worker. paton (2005:23) defines a knowledge worker as an educated individual in a specialist knowledge area. for the purpose of this article, a knowledge worker is seen as an individual that has considerable knowledge and learning in a specialist field. knowledge work is discretionary behaviour and activities that are performed by knowledge workers (efimova, 2003:1; schell, 2008:4). information gathering, imagination, experimenttation, discovery and integration of knowledge within larger systems are all part of knowledge work (myers, 1996:46). technical skills, behavioural competencies and attitudes contribute to the knowledge work that is performed (mercer, 2008). 3 demand for knowledge workers the ability of an organisation to attract and retain knowledge workers is central to its present and future success in the knowledge economy (templer & cawsey, 1999:71). if one takes into account that knowledge workers will become the dominant group of workers in the future (drucker, 2002:237), then knowledge workers will appear to have borderless, upward career mobility with the potential for failure or success. the growth in certain economic sectors, coupled with knowledge workers entering retirement, creates a unique demand for knowledge workers. such growth requires knowledge workers to obtain formal education to enter these areas of knowledge work. once knowledge workers enter these sectors, continuing education will be required to ensure that their knowledge is kept up to date. such a scenario highlights the need for continuous learning of knowledge workers as knowledge rapidly becomes obsolete in knowledge organisations. the transition of knowledge workers from a young age to an older age requires succession planning to ensure that knowledge remains in organisations (harman & brelade, 2000:31; stovel & bontis, 2002:309). the increase in longevity of workers has created a unique problem for organisations. knowledge workers can no longer perform the same kind of work for fifty years. second careers after retirement are seen as ways to keep mentally fit (drucker, 2002:249). becoming a freelance worker, contractor or consultant also aids organisations, as new ideas and innovations can be brought into organisations as part of any knowledge worker’s job (drucker, 1999:86; higgins & tap, 2008:35). organisations should therefore adapt their knowledge management programmes to retain key expertise in an effort to reduce costs and develop new products and services (stankosky, 2005:150). 4 career development of knowledge workers the period of the 1950s to the 1980s characterised traditional careers, as careers were seen as stable and predictable. careers were a succession of related jobs arranged in a hierarchy of status levels through which people moved in an ordered and predictable sequence (currie, tempest & starkey, 2006:756). the organisation determined what constitutes career success, which was usually measured by promotions and increases in salary. the changes in traditional organisational structures are forcing many individuals to change their view of a career, as the career options in flatter organisations are limited (evans, 2003:180). the change of career type from a traditional hierarchical career to a 82 sajems ns 14 (2011) no 1 career characterised by a lack of organisational support and boundaries has shifted the responsibility for career development away from organisations to individual knowledge workers (currie et al., 2006:756). myers (1996:184) and tampoe (quoted by carter & scarbrough, 2001:218) identified four key career motivators once a knowledge worker has moved beyond career entry. these four key motivators are personal growth, operational autonomy, task achievement and money. personal growth is the first key motivator and can be described as the opportunity for individuals to realise their potential through intellectual, personal and career development. organisations need to address job design, assignments and career progress to provide meaningful and challenging work that will lead to personal growth for knowledge workers (mercer, 2008). knowledge acquisition forms part of personal development, leading to a sense of achievement and recognition of peers and ensures that workers grow as individuals and as professionals (lin, kuo, ho & kuo, 2008:93; svetlik & stavrou-costea, 2007:197; thite, 2004:33). career development programmes need to offer career path design, mentoring, training, improving work environments and competitive compensation packages (currie et al., 2006:760). the stimulation and challenges provided by the job that a knowledge worker performs also contribute to personal growth. knowledge workers like software developers desire challenging work and learning opportunities (dovey & white, 2005:253). people are motivated when they are interested in the job, even though they may find the status, perks or responsibility associated with it of little value. operational autonomy is the second key motivator and can be described as a work environment that allows knowledge workers to have control over the tasks that are assigned to them within the constraints of the organisational setting. the organisational culture and leadership influence the manner in which knowledge is managed (mercer, 2008). knowledge workers need a dynamic knowledge-based organisation to be able to define and direct their own jobs if they are to take responsibility for their tasks (drucker, 1999:84; myers, 1996:46). organisational culture needs to align itself with the values and habits of knowledge workers to provide such a level of autonomy (nemeth & nemeth in nonaka & teece, 2001:101). the key to obtaining this level of autonomy lies in the level of flexibility a knowledge worker’s manager will allow (mercer, 2008). task achievement is the third key motivator and can be described as the sense of satisfaction that a knowledge worker gets from producing work of a high standard and quality that the individual feels proud of. aligning the personal goals of knowledge workers with organisational goals will enable them to be motivated through task achievement to work towards common goals and not egotistic ones (kelly, 2007:126). another issue related to task achievement is the boredom associated with repetitive or less challenging tasks. tasks need to be kept challenging in order to prevent boredom from reducing the sense of accomplishment that knowledge workers get from their working careers (dovey & white, 2005:253; drucker, 2001:281). the importance of financial compensation (the last motivating factor) may be less important for knowledge workers than traditional workers as job security for knowledge workers depends on the development of a body of knowledge and skills that they can transfer from one organisation to another (mcgregor, tweed & pech, 2004: 159). money is seen as a reward for the contribution made by knowledge workers to the success of the organisation. even though money cannot ensure the retention of knowledge workers, remuneration should be structured according to the way work is defined in the organisation and could include basic pay, incentives, benefits and retirement funds (mercer, 2008). the study of money as a motivational factor has always featured prominently in career studies (petroni & colacino, 2008:22). an interesting finding in this regard shows that male knowledge workers change jobs more often for higher pay than their female counterparts (yang & lee, 2009:87). sajems ns 14 (2011) no 1 83 5 survey on career development of knowledge workers 5.1 research methodology knowledge workers are considered to be people with considerable theoretical knowledge and learning (drucker, 2002:238). as such, knowledge workers are responsible for their own learning and development (gottschalk, 2005:27), using diverse sources to obtain more information and knowledge. even though knowledge workers may be educated in a specific knowledge area, they are continually learning (paton, 2005:23). the knowledge economy requires knowledge workers to obtain new skills and talents (waddock, 2007:544) in order to contribute to the organisation’s competitive advantage (drucker, 2002:124). knowledge workers are thus considered to be individuals taking part in some form of learning, in order to increase their knowledge. the population for the empirical survey consists of all knowledge workers in south africa and a sampling frame could not be established. the population thus needed to be more narrowly defined for the purposes of this research project. part-time learners of a postgraduate course were used as a purposive sample to access the knowledge worker population. the respondents were all enrolled at the university of johannesburg for the m.com (business management) course. the respondents came from various backgrounds and educational levels. an online survey was chosen as the research instrument and featured a welcoming page, attempting to gain the respondent’s cooperation, providing instructions on how to complete the questionnaire and the approximate time it would take to complete (zikmund, 2003:222). the questionnaire was divided into eight sections: biographical data, knowledge as seen from a career perspective, career motivators: career readiness, path, strategy and satisfaction. each section was given a rating using a five-point likert scale, in order to obtain a positive or negative response from respondents. the web address of the online survey was distributed via electronic mail to 266 respondents. out of the 90 questionnaires completed, eight were unusable and 82 questionnaires were usable, which resulted in a response rate of 31 per cent. the reliability of the research items was determined using cronbach’s alpha test (see table 1), determining whether the measuring instruments are homogenous (cooper & schindler, 2003:237). table 1 reliability section cronbach alpha knowledge 0.730 knowledge development 0.683 career motivators 0.725 career readiness 0.754 career strategy 0.874 satisfaction 0.896 the reliability coefficient for each section is greater than 0.7, indicating positive reliability, except for the section on knowledge development. the section on knowledge development has a cronbach alpha of 0.683. the sections mentioned in table 1 are thus considered to be reliable for the purpose of this survey. 5.2 findings 5.2.1 biographical data the gender of the respondents that completed the online questionnaire was mostly male (69.5 per cent) with a low response rate from females (30.5 per cent). the age group 25 to 84 sajems ns 14 (2011) no 1 40 provided most responses, with the number of responses from people older than 40 years tapering off to only two people older than 55 years. the demographic data are indicative of a broad range of knowledge workers and the area of specialisation of the respondents was predominantly the business and information technology fields. one respondent was in the educational field and the other two respondents in the logistics field. the length of employment indicates that knowledge workers are no longer content with lifelong employment with one organisation and 47.5 per cent of the respondents have worked for their current employer for less than three years. this correlates with the finding of bergeron (2003:593). 5.2.2 knowledge the descriptive statistics related to knowledge as seen from a career perspective are shown in table 2, with the results in percentages. the modal category for each option is shaded. table 2 knowledge totally agree agree neutral disagree totally disagree knowledge is crucial in giving me a competitive advantage in my career 58.5% 34.1% 6.1% 1.2% 0.0% my job requires more knowledge than it ever did before 47.6% 32.9% 17.1% 2.4% 0.0% knowledge is a key factor in any decision made with regard to my career 31.7% 47.6% 12.2% 8.5% 0.0% the higher my level of knowledge, the more rewards i will receive 24.4% 40.2% 24.4% 8.5% 2.4% table 2 indicates that knowledge is seen as a key component in a knowledge worker’s career, with more than 58 per cent of the respondents indicating that they totally agree that knowledge is crucial to providing knowledge workers with a competitive advantage in their careers. the importance placed upon knowledge in career decisions is consistent with knowledge workers creating a competitive advantage in the knowledge economy through the use of knowledge (harman & brelade, 2000:2). the amount of knowledge required by knowledge workers’ jobs is indicative of the amount of information required by knowledge workers in the knowledge economy (bontis, 2001:3; deng: 174). 5.2.3 knowledge development respondents were asked what steps they have taken to increase their knowledge to further their career aspirations. the descriptive statistics related to knowledge development as seen from a career perspective are shown in figure 1. sajems ns 14 (2011) no 1 85 figure 1 knowledge development knowledge development 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% pr of es si on al ex pe rie nc e m an ag em en t e xp er ie nc e li fe lo ng le ar ni ng u pd at e kn ow le dg e pe rs on al de ve lo pm en t n ew de ve lo pm en ts pe rf or m an ce ap pr ai sa ls in te rn al tr ai ni ng ex te rn al tra in in g totally disagree disagree neutral agree totally agree figure 1 indicates that knowledge development is required by knowledge workers as 68.3 per cent of the respondents totally agree that lifelong learning is important, which agrees with learning being a lifelong process (alley, 1999:189, drucker, 2001:305). the majority of the respondents (68.3 per cent) also totally agree that they are responsible for their own personal development, as it seems that employers are no longer willing to take this responsibility (thite, 2004:32). the low number of respondents (0.08 per cent) who totally agree that they mainly use internal training to develop their knowledge is indicative of the low investment that south african organisations make in knowledge workers, according to smith (2008). the number of respondents (0.23 per cent) who totally agree that they primarily use external training to develop their knowledge should be a cause of concern for organisations as this could indicate that organisational training and development programmes are not living up to the expectations of knowledge workers. 5.2.4 career motivators respondents were asked to identify factors that motivate them in their careers as knowledge workers. the descriptive statistics related to career motivators are shown in figure 2: figure 2 career motivators c are e r m oti vators 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% awards recognit ion monet ary rewards challenging assignment s social st at us job securit y no ext ent lit t le ext ent neut ral some ext ent large ext ent 86 sajems ns 14 (2011) no 1 figure 2 indicates that challenging work assignments, monetary rewards and recognition by peers are seen as very important career motivators. recognition by peers is noted as an important motivator by bergeron (2003:73), defillipi, arthur & lindsay (2006), drucker (2002:259) and thite (2004:33) and is seen as a career motivator to a large extent by 27 per cent of respondents. monetary rewards are recognised by 45 per cent of respondents as a key career motivator (myers, 1996:184) with 46 per cent of respondents seeing challenging work assignments as a motivational factor to a large extent and 40 per cent of respondents as a motivational factor to some extent in their careers (dovey & white, 2005:253; mercer, 2008). social status is considered the least important career motivator for these knowledge workers. 5.2.5 career readiness table 3 indicates that 56.1 per cent of respondents totally agree and 37.8 per cent agree that technology is an important part of career readiness for knowledge workers. this finding supports the findings of carter and scarbrough (2001:216) that technology is an important part of knowledge management. the majority of the respondents (46.3 per cent) agree that they have created their own knowledge career strategies. fifty percent of respondents agree that they have enough knowledge to start their careers, which may be a sign of overconfidence, as the skills and knowledge required by knowledge workers are continuously changing (drucker, 2002:27). table 3 career readiness totally agree agree neutral disagree totally disagree i see new technology as beneficial to my career 56.1% 37.8% 3.7% 2.4% 0.0% i adapt to any challenges in my career 40.2% 57.3% 2.4% 0.0% 0.0% i feel that i am in charge of my own knowledge career 36.6% 54.9% 7.3% 1.2% 0.0% i have created my own knowledge career strategy 25.6% 46.3% 18.3% 8.5% 1.2% i have enough knowledge to kick off a fulfilling career 24.4% 50.0% 15.9% 9.8% 0.0% 5.2.6 career path table 4 indicates that the need to become a specialist is very important to 48.8 per cent and important to 37.5 per cent of the respondents. according to no doubt research (2003:3) knowledge workers are highly specialised and loyal to their specific field of knowledge. dual career ladders are very important to 31.3 per cent of the respondents. this finding correlates with the findings of holman, wall, clegg, sparrow and howard (2003:146) and petroni and colacino (2008:22) on the importance of dual career ladders. whilst still enabling knowledge workers to stay in a profession without becoming a manager the need for upward career growth is thus seen as an important career path for knowledge workers. matching personal and organisational goals is very important to 42.9 per cent of the respondents which is indicative of knowledge workers to be motivated through task achievement, working towards organisational and personal goals (kelly, 2007:126). the lack of importance attached to temporary work assignments by 42.5 per cent of respondents could be attributed to the economic downturn, or the lack of temporary work assignments available to knowledge workers in south africa as discussed by mckenna (2006:11). sajems ns 14 (2011) no 1 87 table 4 career path very important important neutral unimportant very unimportant becoming a specialist in my field of knowledge 48.8% 37.5% 8.8% 5.0% 0.0% dual career ladders (managerial and professional options) 31.3% 40.0% 21.3% 6.3% 1.3% lifetime employment with a single organisation 3.8% 6.3% 32.5% 41.3% 16.3% matching my career goals with organisational goals 42.9% 42.9% 13.0% 1.3% 0.0% a portfolio of multiple jobs with different organisations over the lifetime of my career 15.0% 40.0% 32.5% 10.0% 2.5% temporary work assignments followed by short periods of unemployment 1.3% 11.3% 23.8% 21.3% 42.5% 5.2.7 career strategy figure 3 indicates that knowledge workers feel responsible for their own careers and that they actively try to manage their careers through networking, gaining experience and continuous learning. 39 per cent of respondents indicated to a very large extent the most important career strategy as the continuous learning of new skills, while 46 per cent of the respondents indicated this to a large extent. such a strategy should result in knowledge workers reaching their long-term career goals (marcus & watters, 2002:91; stokely, 2008:49). only 42 per cent of the respondents consult mentors to a large extent and 22 per cent to a very large extent. knowledge workers need mentoring to ensure that knowledge sharing occurs and that an opportunity is provided for the individual being mentored to convert experience into knowledge (harman & brelade, 2000:73). the least important career strategy is seen as building a network of contacts, which is something knowledge workers need to take note of, as myers (1996:52) claims that the development of social networks is critical in boundaryless careers in order to add more value to organisations. figure 3 career strategy c are e r strate gy 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% cont act net works consult ment ors increase work experience learn new skills do more t han expect ed no ext ent small ext ent moderat e ext ent large ext ent very large extent 88 sajems ns 14 (2011) no 1 5.2.8 satisfaction experienced as a knowledge worker the descriptive statistics related to the satisfaction experienced in the careers of knowledge workers are shown in table 5. most knowledge workers feel that they achieve a sense of accomplishment and this finding is related to the findings of dovey and white (2005:253). forty percent of the respondents are very satisfied with their flexible work conditions, which corresponds well to the requirements placed on knowledge workers by the new boundaryless career (lee-kelly et al., 2007:204; marcus & watters, 2002:92; thite, 2004:37; tomlinson:153). the majority of respondents (36.3 per cent very satisfied and 47.5 per cent satisfied) indicate that they work on challenging assignments or projects. the results indicate that knowledge workers are in fact satisfied with their careers to a large extent, yet certain areas are to be looked at in order to ensure knowledge workers stay motivated. table 5 indicates that 46.2 per cent of knowledge workers are satisfied with their careers to date, with 19.2 per cent being very satisfied. this means that organisations should create a work environment that is aligned with the expectations of knowledge workers to allow them to achieve job satisfaction (wong, 2005:273). table 5 satisfaction experienced as a knowledge worker very satisfied satisfied neutral dissatisfied very dissatisfied a sense of accomplishment 41.3% 40.0% 12.5% 5.0% 1.3% flexible working conditions 40.0% 38.8% 15.0% 6.3% 0.0% the contributions made by you as a knowledge worker 37.5% 48.8% 7.5% 6.3% 0.0% working on challenging assignments or projects 36.3% 47.5% 13.8% 2.5% 0.0% opportunities for career advancement 30.0% 37.5% 20.0% 5.0% 7.5% being rewarded for your knowledge 21.3% 46.3% 17.5% 12.5% 2.5% being promoted based on what you know 20.0% 55.0% 15.0% 7.5% 2.5% career progress to date 19.2% 46.2% 21.8% 10.3% 2.6% 6 recommendations lifelong careers with one organisation are a thing of the past. knowledge workers are more concerned with lifelong learning in a succession of jobs in order to gain the experience necessary to provide the organisation with a competitive advantage. the majority of the respondents are employed at their current organisation for less than three years. the movement of knowledge workers in a knowledge economy between organisations correspond to the nature of modern careers, which can be seen as a sequence of jobs or projects over the course of a person’s life. knowledge workers therefore take control of their own careers, as their careers consist of a series of projects or assignments, irrespective of the organisation employing them. knowledge workers are more aware of the challenges posed by modern careers and they are better prepared to enter their careers and ensure further development. it is very important for the majority of respondents to match their personal career goals with organisational goals in order to stay motivated in their careers. matching individual and organisational goals are dependent on trust between knowledge workers and the organisation if this level of alignment is to be achieved. being able to match personal goals with organisational goals generates a sense of accomplishment for knowledge workers, sajems ns 14 (2011) no 1 89 which is required to build a fulfilling career. the necessity for good communication skills need to be understood by organisations in order to use these knowledge workers to generate a competitive advantage as communication, forms a considerable part of the work that knowledge workers perform. knowledge workers require more knowledge to be effective in their jobs as the amount of knowledge keeps increasing. the need for knowledge workers who are able to deal with large amounts of knowledge in south africa is acknowledged by the respondents. respondents confirmed that the use of knowledge provides them with a competitive advantage in the knowledge economy. knowledge workers use temporary assignments as part of career preparation, yet the respondents indicated that they are not interested in short work assignments. the underlying reason may be due to the fact that the respondents are mostly employed as full time workers, yet the lack of interest in temporary assignments may lead to a loss of opportunity for knowledge workers entering their careers. lifelong learning throughout the career of a knowledge worker is essential to stay competitive and deliver value to the organisation. the acknowledgement of lifelong learning by the respondents is indicative of the value placed upon learning over the course of a knowledge worker’s career. lifelong learning provides knowledge workers the ability to gain access to better positions over the course of a career. personal development is the responsibility of each knowledge worker. managing their careers leads to better motivation and ultimately an increase in organisational performance. personal development also leads to a sense of achievement, providing personal and professional growth. however, internal training is rarely seen as a means for gaining more knowledge by the respondents and could be an indication that south african organisations do not invest in knowledge workers or that knowledge workers do not attach a lot of value to internal training. south african organisations need to assess their internal training and development programmes if they are to deliver any value to knowledge workers. organisations should ensure that their training programmes are innovative to ensure that they respond to the demands of the knowledge economy. mentoring is an area of concern as the respondents indicated that they are not keen to consult mentors in their field of specialisation (see figure 3). this is in stark contrast to literature, which notes that knowledge workers need mentoring to ensure that knowledge sharing occurs in order to ensure a successful entry into the job market. awards, recognition from peers, money, challenging work assignments and status are all considered important career motivators for knowledge workers. money is still considered to be a primary career motivator by the respondents. organisations need to take note of their reward structures, as knowledge workers have indicated that although knowledge gives them a competitive advantage in the knowledge economy, promotions and rewards based on their knowledge are insufficient. informal measures such as recognition are also starting to become more important for knowledge workers and should be used in conjunction with the traditional measures to ensure that knowledge workers achieve a sense of career progress. respondents also consider autonomy important, in order to control the tasks assigned to them within their organisation. knowledge workers thus strive to create their own work environment. this is descriptive of the level of satisfaction that knowledge workers experience throughout their careers. a sense of accomplishment reduces feelings of boredom associated with repetitive and less challenging tasks. challenging tasks generates the sense of accomplishment needed in order to create a fulfilling career. providing knowledge workers with a series of challenging work assignments allows them to develop their careers through such assignments. 7 conclusion this article aims to investigate the issues and aspects related to career development of knowledge workers in south africa. the career issues affecting knowledge workers were established through an online survey, 90 sajems ns 14 (2011) no 1 providing a view on the autonomy, rewards, training and progress experienced by knowledge workers in their careers. knowledge workers play an increasingly important part in the knowledge economy and contribute to the competitive advantage and future potential of organisations. the impact made by knowledge workers on the knowledge economy has prompted management to take note of the key issues affecting knowledge workers 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[online] available at: www.kwdi.re.kr/data/04forum-6.pdf [accessed 2009-03-13]. zack, m.h. 1999. knowledge and strategy. boston: butterworth-heinemann. zikmund, w.g. 2003. business research methods. ohio: thomson south-western. http://www.mercer.com/referencecontent.htm?idcontent=1314145 http://www.nodoubt.co.nz/articles/knowledgeworker.pdf http://www.hrm.strath.ac.uk/ilpc/2005/conf-papers/paton.pdf http://www.fin24.com/articles/default/display_article.aspx?articleid=1518-1786_2318068 http://www.oecd.org/dataoecd/35/9/2101026.pdf http://www.solidaritysa.co.za/tuis/wmview.php?artid=997 http://www.kwdi.re.kr/data/04forum-6.pdf sajems ns 11 (2008) no 3 337 characterising price fixing: a journey through the looking glass with ansac kasturi moodaliyar oliver schreiner school of law, university of witwatersrand, school of law keith weeks enforcement and exemptions division, south african competition commission abstract in february 2005 the supreme court of appeal of south africa ruled that in deciding whether firms have contravened section 4(1)(b) of the competition act 89 of 1998, as amended, by engaging in, for example, ‘per se’ illegal price fixing, the competition tribunal must admit evidence relating to the nature, purpose and effect of the horizontal agreement or practice in question. this article examines the economic and legal rationale, as well as the implications, for allowing an appropriate characterisation of conduct to determine whether such conduct falls within the per se prohibition. firstly, we comment on the rationale behind the per se rule as a standard for the adjudication of certain types of conduct. we analyse a number of cases in the united states, which, post 1979, revolutionised the approach to the strict per se rule. secondly, we examine how the per se standard is reflected in the particular structure found in section 4(1) of the competition act and evaluate whether it makes for a sufficiently robust application of the per se rule. thirdly, the content of the supreme court decision regarding characterisation is critically examined with a view to assessing whether such characterisation is consistent with the policy objective of achieving maximum deterrence of hard core cartel behaviour like price fixing and market division. finally, we explore and suggest (in the absence of a tribunal decision) a possible framework, based on decision theory, for determining a method of characterisation that is consistent with the robust application of the per se standard and is in line with the supreme court ruling. jel l41 1 introduction it is well understood by economic thinkers and policy makers that agreements between competitors that prevent or restrict competition can do serious harm to the ability of the market mechanism to deliver the benefits of productive enterprise to consumers. agreements by cartels to divide markets, limit output or fix selling prices constitute among the most egregious of these restrictions. public policy toward cartels and cartel-like behavior is manifest in the competition laws of the greater majority of those countries that have allowed some form of market system to underlie their economies. in enacting laws against cartels these countries have accepted the conventional economic wisdom that, as a general rule, agreements among competitors to fix prices or divide markets are likely to have such a deleterious effect on competition that it is of great importance that laws preventing such conduct be applied effectively and expeditiously. south africa is no different in this respect. in addressing cartel behaviour section (s) 4(1)(b)(i)-(iii) of the south african competition act 89 of 1998, as amended, (“the act”) contains provisions prohibiting the restrictive horizontal practices of price fixing, dividing markets and collusive tendering. however, the act is in 338 sajems ns 11 (2008) no 3 the early stages of its implementation and the jurisprudence has not yet settled on a definitive approach. this state of affairs is most evident in the recent ruling of the supreme court of appeal (“the sca”) of south africa in the matter of the american natural soda ash corporation (ansac) versus the competition commission (‘the commission’), the botswana soda ash company (botash) and others1. the ansac litigation dates back to late 1999 when botash filed a complaint with the commission alleging that ansac was operating in south africa in contravention of inter alia s 4(1)(b)(i) and s 4(1)(b)(ii) of the competition act. in other words, botash alleged that ansac had engaged in price fixing and division of markets. the commission finalised its investigation in 2000 and referred the complaint to the competition tribunal (“the tribunal”) for adjudication. at the pre-hearing stage the tribunal asked the parties to present their arguments on the interpretation of s 4(1)(b) and then attempted to determine whether s 4(1)(b) allowed for an efficiency defence2. in 2001 the tribunal made further determinations on s 3(1) and botash’s locus standi in this case. the tribunal found against ansac, who subsequently appealed to the competition appeal court (cac). the cac agreed with the tribunal’s decision and ansac lost its appeal. however, it did not end there as ansac then brought its case to the sca, whose ruling this article is primarily concerned with. this article examines the economic and legal rationale, as well as the implications, for allowing an appropriate characterisation of conduct to determine whether such conduct falls within the per se prohibition. firstly, we comment on the rationale behind the per se rule as a standard for the adjudication of certain types of conduct. we analyse a number of cases in the united states, which, post 1979, revolutionised the approach to the strict per se rule. secondly, we examine how the per se standard is reflected in the particular structure found in s 4(1) of the competition act and evaluate whether it makes for a sufficiently robust application of the per se rule. thirdly, the content of the supreme court decision regarding characterisation is critically examined with a view to assessing whether such characterisation is consistent with the policy objective of achieving maximum deterrence of hard core cartel behaviour like price fixing and market division. finally, we explore and suggest (in the absence of a tribunal decision) a possible framework, based on decision theory, for determining a method of characterisation that is consistent with the robust application of the per se standard and is in line with the sca ruling. 2 distinction between cartels and joint ventures cartel3 agreements are usually entered into by two or more competing firms, who agree to coordinate their business in a conspiracy primarily to lessen competition between them. cartel agreements include price fixing, dividing markets and collusive tendering. cartels “remove producers’ incentives to perform at the highest level possible, thus undermining the goal of producing robust and competitive businesses, and they keep prices higher and performance lower, thus harming buyers” (fox, 2002: 800). they are thus said to be ‘naked’ agreements as there are no pro-competitive reasons arising from these types of agreements (hovenkamp, 1999: 144). firms who are party to the naked agreement should be subject to the per se rule, because the arrangement would “always or almost always tend to restrict competition and reduce output.”4 there are other types of collaborative arrangements between competitors, which are created for legitimate reasons. joint ventures, for example, are usually entered into to achieve economies of scale, to allow firms to produce or supply products at lower cost, or to enable them to bring to market a product that they would not be able to do individually. perhaps the most important feature that distinguishes cartels from other joint ventures is the absence of a potentially efficiency-enhancing economic integration among the participants.5 however, even though joint ventures may have the intention to promote efficiency, they may also lessen competition among the joint venture sajems ns 11 (2008) no 3 339 partners.6 “if the ventures dominate a market they may attempt to earn monopoly profits by reducing output and raising price, dividing markets, or by refusing to compete in innovation or some avenue other than price. they may also try to protect their own competitive positions by excluding price cutters or firms that are more innovative than themselves” (hovenkamp, 1999: 198). in such cases, joint ventures may be prohibited per se if they involve price fixing, or alternatively, prohibited under a rule of reason analysis if they are otherwise anticompetitive. however, if it is not clear from the facts, then it is also necessary to establish whether the restriction on competition is ancillary to some core purpose of the agreement that may be procompetitive.7 according to miles a restraint is ancillary if: “(1) it is related to and implemented in connection with a venture that itself is likely to generate significant procom petitive effects through significant partial economic integration; (2) it significantly promotes the venture’s achievement of those effects, and (3) there is no obvious method for pro moting those effects that would have a significantly less restrictive effect on competition” (miles, 1997: 66). where an agreement is found to be ancillary to achieving the joint venture benefit it does not automatically mean that the agreement is legal. the agreement will be analysed to see if there are any pro-competitive effects arising from it. 3 reflection on the ansac decisions although the ansac decisions dealt with a number of important legal issues, this article is concerned only with the extent of admissible evidence in the adjudication of alleged violations of s 4(1)(b) of the competition act. in essence, the commission, the tribunal and the cac were all of the view that the act is quite clear about the per se anti-competitive nature of price fixing and market division agreements. in particular, the tribunal and the cac held that in order to find parties in contravention of s 4(1)(b)(i) or s 4(1)(b)(ii) no more evidence is required other than the facts necessary to establish that an agreement to fix prices or divide markets had indeed taken place. once established, no further evidence would be admissible as such agreements are prohibited per se, thus ruling out the need to consider any other justification. in this regard the tribunal and the cac relied on the clear distinction, explicitly written into the legislation, between the general undefined restrictive horizontal practice in s 4(1)(a), prohibited only on the basis of proof of harm to competition and allowing an efficiency defence (a “rule of reason” standard), and the specific named restrictive horizontal practices in s 4(1)(b) of price fixing, market division and collusive tendering, which require no further proof other than the existence of the agreement or concerted practice and which allow no justification (a per se rule)8. however, in its appeals, ansac introduced a legal complexity that had vexed courts in the united states for years. the sherman act does not explicitly distinguish per se conduct from conduct to which a rule of reason standard should be applied. in fact, read literally, the sherman act appears to prohibit all restrictions or restraints on trade regardless of their form. as even the most benign commercial contracts involve some form of restraint, a blanket prohibition would obviously be absurd. the courts were thus obliged to develop these distinctions through judicial interpretation. this development of the law by judicial interpretation has not been a smooth process and has involved considerable difficulties of semantics and legal interpretation. in particular, the process of properly characterising what constitutes per se prohibited conduct has been fraught with difficulties (calkins, 2000: 67). it may well be the case that section 4 of the south african competition act has been constructed with these distinctions included in order to specifically avoid such difficulties. however, although section 4 of the south african competition act is more concise than the united states’ sherman act9, the legal complexity around properly characterising conduct as per se prohibited appears not to have been avoided. 340 sajems ns 11 (2008) no 3 in its appeal to the supreme court (supreme court of appeal of south africa 2005, para 38), ansac argued that the tribunal had erred in not admitting evidence relevant to “characterise” the conduct in order to determine whether or not it fell within the ambit of s 4(1)(b). the sca found that the tribunal had erred in not construing the scope of the legislative prohibition in s 4(1)(b) and thus had erred in not admitting evidence relating to the “nature, purpose, and effect” of the ansac agreement (sca 2005: para 40, 43, 69, 47, 65). as a consequence of this ruling the tribunal is now required to explicitly construe the scope of s 4(1)(b) in order to establish to what extent evidence may be admissible to determine whether the character of the agreement is such that it does (or does not) fall within the legislative prohibition in s 4(1)(b). the sca noted further in this regard that “it is for the tribunal to consider, in the manner and in accordance with such procedure as it may decide…” (sca, 2005, para 60). as of the writing of this article the tribunal has yet to make this determination. 4 rationale for the per se rule in dealing with conduct like price fixing or market division, competition enforcement agencies generally pay little attention to whether or not the offending parties have market power. it is the act of price fixing itself that is prohibited, regardless of its actual effect. this reflects a view that price fixing by competitors does not have any evident benefit and is potentially so harmful that it should be considered unacceptable and unlawful behaviour by any firm or grouping of firms. according to pitofsky, “per se rules are adopted when experience has revealed that certain conduct almost always results in serious anticompetitive consequences, and is almost never justified for business reasons” (pitofsky, 1983: 1487, 1489). in this view, agreements between competitors to fix prices (and certain other forms of market fixing) should not be tolerated because, were this behaviour to become pervasive, the mechanism by which markets are believed to deliver benefits and ultimately prosperity to consumers would crumble. in the language that has developed in united states antitrust law, restrictions like price fixing and market division are deemed to be per se illegal10. in northern pacific railway v united states the supreme court provided the ideal rationale for per se: …there are certain agreements or practices which because of their pernicious effect on competition and lack of any redeeming virtue are conclusively presumed to be unreasonable and therefore illegal without elaborate inquiry as to the precise harm they have caused or the business excuse for their use. this principle of per se unreasonableness not only makes the type of restraints which are proscribed by the sherman act more certain to the benefit of everyone concerned, but it also avoids the necessity for an incredibly complicated and prolonged economic investigation, in an effort to determine at whether a particular restraint has been unreasonable an inquiry so often wholly fruitless when undertaken.11 the per se rule exists for the reasons stated above but also because it reduces administrative costs and is a convenient means to maximise deterrence (hylton, 2003: 122). according to pitofsky (1983): “per se rules represent a recognition that (1) antitrust trials, absent a per se approach are long, expensive, and complex, (2) efficient enforcement of the antitrust laws is a justifiable policy goal, and (3) there is a virtue in telling businessmen accurately and precisely the location of legal limits on business conduct”. in this regard, the enforcement of laws against cartels can be compared to the enforcement of laws against speeding. as noted by george stigler: economic policy must be contrived with a view to the typical rather than the exceptional, just as all other policies are contrived. that some drivers can safely proceed at eighty miles per hour is no objection to a maximum-speed law (stigler, 1952, page 1). sajems ns 11 (2008) no 3 341 this view is also expressed in arizona v maricopa county medical society, where the court noted: for the sake of business certainty and litigation efficiency we have tolerated the invalidation of some agreements that a fullblown inquiry might have proved to be reasonable13. the court in arizona also indicated that agreements should first be characterised to determine whether they fall into the per se category or whether wider analysis under rule of reason should be undertaken. in broadcast music inc v columbia broadcasting system (bmi)14, the court had to determine whether the issuing of a blanket licence constituted a per se violation of the sherman act. the court steered its reasoning toward the rule of reason approach and found that there was no violation with such arrangement as it was necessary to implement such a blanket licence to ensure the maintenance of the copyright laws which protect the composers of music. many have criticised the bmi ruling. hovenkamp (1999: 211) indicated that this case may be “sui generis” and that it was not clear whether the bmi case involved price fixing by ‘competitors’ because there was no indication whether one song competed with another and that they competed in the same market. hylton also criticised the decision stating: “if every cartel could rely on the bmi exception, there would be nothing left to the per-se rule” (hylton, 2003: 122) . in the indiana dentists case a group of dentists decided to collectively withhold x-rays from a medical insurance company who purchased dental services on behalf of its insured clients15. the court held that: [a] concerted and effective effort to withhold (or make more costly) information desired by consumers for the purposes of determining whether a particular purchase is cost justified is likely enough to disrupt the proper function of the price-setting mechanism of the market that it may be condemned even absent [of] proof that it resulted in higher prices. the court applied the rule of reason analysis and held that it was not necessary to conduct a market definition analysis. it was clear that the agreement had anticompetitive effects and was thus condemned illegal16. the court’s approach in this case seems closer to a per se analysis, yet introduces elements of a rule of reason analysis. in vogel v american society of appraisers (vogel)19 the court questioned the associations rule which barred fees as a percentage of appraisals. the court cited bmi and went on to apply the per se rule against the price fixing agreement and held that “we should take a quick look to see whether it has clear anticompetitive consequences and lacks any redeeming competitive virtues” (vogel: 603). the ‘quick look’ is a preliminary enquiry to determine whether the per se rule should apply. these cases illustrate that in the united states there is no clear cut answer, perhaps even confusion, when it comes to applying the per se standard. courts have taken very different approaches, depending on the facts of each case, as to whether the per se or rule of reason should be applied. hovenkamp (1999: 253) aptly states that: “because per se rules are empirical judgments, their fate is to go through a continual evolutionary process”. in order unravel this apparent dilemma one must examine the rationale for having a per se standard in the first place and examine what distinguishes it from a rule of reason standard. according to whinston (2006: 18-19), the justification of the per se rule as an administratively convenient means to achieve maximum deterrence is an application of the theory of optimal statistical decision making to the design of optimal legal rules. on this basis whinston argues that simply because a particular practice could in theory raise or lower welfare does not mean that it should be accorded a rule of reason standard in practice. the difference between a “per se” and a “rule of reason” standard depends on how much evidence we require before we can decide on an agreement (hovenkamp, 1999: 251). a rule of reason standard requires detailed analysis of market power and its effects, as well as the consideration of possible efficiency gains. as a consequence, cases that apply the rule of reason 342 sajems ns 11 (2008) no 3 are likely to be lengthy and costly affairs. if every price fixing case were to be handled in this way effective deterrence would be severely hampered. in addition to the administrative cost burden the rule of reason standard tends also to favour defendants as it allows for sophisticated economic arguments to be submitted on market power and its effects. as noted by stephen calkins: any plaintiff filing a “full blown” rule of reason case faces the prospect of long, expensive discovery, extensive motions practice, and then a merger like battle over market power without the benefit of the prophylactic language of [the] clayton act section 7. making a decision turn on a full, formal proof of market power, the antitrust equivalent of the full monty, is a defendants’ paradise (calkins, 2000: 521). therefore, in order for the law to be effectively enforced, a distinction is made between conduct which has been identified as almost always harmful and conduct which is potentially harmful. price fixing, division of markets and bid rigging are almost always harmful. a statistically optimal rule prohibiting such conduct would thus be one that does not permit any justification. as soon as the door is opened to allow defence of such conduct, then the balance of convenience swings in favour of the defendants, an outcome which would undermine any public policy to break down cartels and cartel-like behaviour. by contrast, horizontal arrangements like joint ventures are only potentially harmful insofar as they involve agreement between competitors. however, such joint ventures, upon closer examination, may prove to be beneficial. 5 deconstructing section4 it appears that the construction of the legal rule against restrictive horizontal practices in the south african competition act is based on a similar premise to that discussed above, namely, it provides for a statistically optimal rule to maximise deterrence of the hard core cartel conduct of price fixing, division of markets and bid rigging. in the united states the distinction between conduct which must be accorded a per se standard and conduct which must be accorded a rule of reason standard has developed by judicial interpretation. as indicated by the court in the national collegiate athletic association v university of oklahoma (ncaa) case “there is often no bright light separating per se from rule of reason analysis. per se rules may require considerable inquiry into market conditions before the evidence justifies a presumption of anticompetitive conduct.”20 in south africa, however, this distinction has been written into the legislation. section 4(1) of the competition act is divided into two distinct parts. s 4(1)(a) refers to: an agreement or concerted practice between parties in a horizontal relationship that is prohibited if “it has the effect of substantially preventing, or lessening, competition in a market, unless a party to the agreement, concerted practice , or decision can prove that any technological, efficiency or other pro-competitive gain resulting from it outweighs that effect. the wording in s 4(1)(a) is clearly akin to a rule of reason standard as it requires proof of harm to competition and allows defence on the basis of efficiency and pro-competitive gains. s 4(1)(b), on the other hand, sets out three types of restrictive horizontal practices which are prohibited outright and require no proof of harm to competition and allow no defence on the basis of technological, efficiency or procompetitive gains: (i) directly or indirectly fixing a purchase or selling price or any other trading condition; (ii) dividing markets by allocating cus tomers, suppliers, territories, or specific types of goods or services; or (iii) collusive tendering. these three restrictive horizontal practices are specifically named, without reference to their effects on competition and allowing no defence, sajems ns 11 (2008) no 3 343 because they constitute those types of cartel behaviour that are considered to be almost always harmful and should thus be prohibited per se. in its decision on ansac, the sca (para 37) recognised this, stating: it is clear from its juxtaposition with s 4(1)(a) that s 4(1)(b) is aimed at imposing a ‘per se’ prohibition: one, in other words, in which the efficiency defense expressly contemplated by sub-para (a) cannot be raised. therefore, it is clear from the structure and content of section 4 of the competition act, and the sca agrees, that it was the intention of the legislature that a distinct per se prohibition be applied to the restrictive horizontal practices of price fixing, division of markets and collusive tendering. given the clear division in the structure and the concise wording, one would naturally have expected that s 4(1)(b) would allow for a robust application of the per se rule, with little need for courts to engage in judicial interpretation. however, the experience with the ansac cases shows that in law matters are rarely that simple. the ruling of the sca regarding ansac has identified a legal complexity regarding the scope of s 4(1)(b), which the tribunal is now required to clarify. it is to this ruling we now turn our attention. 6 the supreme court of appeal ruling on ansac in its decision the supreme court (para 61) agreed with the tribunal that conduct falling within the scope of s 4(1)(b) cannot not be justified on the basis of any further evidence relating to efficiencies or pro-competitive gains. indeed, any such further evidence would not be admissible. the sca confirmed, as did the cac, that this is correct and also implicitly affirmed the importance of the per se rule as a statistically optimal means to maximise deterrence: price-fixing is inimical to economic competition, and has no place in a sound economy. adopting the language of antitrust law, price-fixing is anti-competitive per se. all countries with laws protecting economic competition prohibit the practice without more (sca, 2005: para 37). however, the sca was of the view that the tribunal had misdirected its enquiry (and thus misunderstood ansac) by focusing its attention solely on whether conduct that does fall within the ambit of s 4(1)(b) can nevertheless be justified on the basis of the criteria contemplated in s 4(1)(a). according to the supreme court, the tribunal failed to recognise that the real issue was not about justifications but rather about determining whether the conduct complained of falls within the ambit of s 4(1)(b) at all. in particular, the sca (2005: para 41) was of the view that the tribunal did not address itself properly to the issue of whether the ansac agreement constitutes price-fixing as prohibited by the act. it pointed to the fact that the tribunal had only admitted evidence pertaining to the terms of the agreement and had thus, “perhaps inadvertently”, precluded any other evidence that may have been relevant to determining whether the agreement falls within the ambit of s 4(1)(b). the sca was of the view that in endorsing the tribunal ruling the cac had fallen into the same error. whether the tribunal and the cac had “erred” is in fact debatable. a close reading of the tribunal decision reveals that it did in fact determine that the ansac agreement falls within the ambit of s 4(1)(b). the difficulty, however, is that this determination is implicit in the tribunal’s ruling and does not follow explicitly from the tribunal having first construed the scope of s 4(1)(b). it appears that, given the particular content and structure of s 4(1)(b), both the tribunal and the cac were of the view that this extra step was not required. the extra step of construing the scope of s 4(1)(b) would have implied, at least in the tribunal’s view, that a purposive interpretation of the act is necessary. this in fact is what the tribunal understood to be ansac’s main contention in its submissions. in responding to ansac’s submission that the scope of s 4(1)(b) must first be construed, the tribunal argued that a purposive approach 344 sajems ns 11 (2008) no 3 to statutory interpretation is only required “for circumstances in which the statute under question is ambiguous” (49/cr/apr00: 18). the tribunal went on to argue that there is no ambiguity in s 4(1)(b) and thus little scope for interpretation (49/cr/apr00: 18). the sca (2005: 37: para 51) understood the issue somewhat differently, arguing that in south africa, where the prohibition is decreed by legislation, it necessarily follows that one can only establish whether the form of conduct complained of falls within the ambit of the prohibition by first construing the scope of the relevant prohibition. although the sca was careful to point out that the scope of the prohibition is a matter of “statutory construction”, it then went on to argue that once the scope had been established a factual enquiry must then be conducted to establish the nature or character of the conduct – in order to determine whether it falls within the legislative prohibition (sca, 2005: 35: para 47). the sca summarised its approach as an enquiry: to establish whether the character of the conduct complained of coincides with the character of the prohibited conduct: and this process necessarily embodies two elements. one is the scope of the prohibition: a matter of statutory construction. the other is the nature of the conduct complained of: this is a factual enquiry. in ordinary language this can be termed ‘characterising’ the conduct – the term used in the united states, which ansac has adopted (sca, 2005: 35: para 47). it is interesting to note that, despite its references to a factual enquiry, the sca was unwilling to provide guidance on what that factual enquiry should entail. the sca ultimately ruled that the tribunal failed to expressly construe s 4(1)(b) and establish its scope, and thus could not have properly established what evidence may have been admissible – presumably because such evidence may have been necessary for the purposes of characterising the conduct. but the sca based this ruling on the premise that the scope of the prohibition in s 4(1)(b) is not self evident. it is here where the main difference of opinion between the sca and the tribunal and cac is to be found. clearly, the sca, the tribunal and the cac agree that the scope of s 4(1)(b) is a matter of statutory construction. however, the tribunal and the cac appear to have been of the view that the scope of s 4(1)(b) is clearly set out in terms of the content of the legislative prohibition in s 4(1)(b). as the tribunal noted in its decision: section 4(1)(b), on the other hand, specifically details the very content of the agreements that it seeks to proscribe these being agreements to fix price or any other trading condition, agreements to divide markets, and collusive tendering. but this is all that is specified. in plain contrast with the requirements of section 4(1)(a), those who set themselves the task of impugning agreements described in section 4(1)(b) do not have to establish any deleterious impact on competition (49/cr/apr00: 17). the sca, however, was not convinced that the formulation set out in s 4(1)(b) sufficiently captures the scope of the prohibition, and thus concluded that the scope of the prohibition is not self evident. the sca alluded to the possibility of a legitimate and economically beneficial joint venture consisting of competitors who necessarily set a uniform price for the purposes of selling the services or products of the venture. this obviously begs the question as to whether such a venture would be captured by the per se prohibition in s 4(1)(b)? the sca was of the view that there is no a priori reason to assume that it should. in particular, the sca questioned (without providing answers) whether, upon properly construing the scope of the prohibition, such an arrangement would indeed constitute prohibited price fixing as contemplated by s 4(1)(b). the question posed here cannot easily be dismissed because it implies potential economic harm arising from an inappropriately applied per se rule. such an outcome would surely not have been intended by the legislature or the policy makers. from an economic point of view the character of the legitimate joint venture is quite different sajems ns 11 (2008) no 3 345 from the character of the cartel arrangement to fix prices and restrict output. however, both the legitimate joint venture and the cartel arrangement may involve competitors entering into an agreement which results in the setting of a uniform price. on a purely literal interpretation of s 4(1)(b)(i) both arrangements would be prohibited per se. however, for the good of the economy, only the cartel arrangement should be prohibited and the joint venture allowed. in this context “characterisation” makes perfect economic sense. however, what does this mean for the application of a per se rule? the view of the cac, in its ruling, is clear on this issue: were this court to adopt the approach urged upon us by the applicants, it would in effect be blurring the distinction between per se and rule of reason and effectively render section 4(1)(b) a form of rule of reason approach (competition appeal court, 2001: 8). the cac went on to argue, with reference to its understanding of how characterisation works: that however is not the way per se jurisprudence works, nor does it reflect the clear intention of the act which adopted a clear policy choice. the policy choice it made was to highlight three separate forms of activity being price fixing, dividing up of markets and collusive tendering, which, as with much comparative competition law, are regarded as egregious activities of a kind, which competition authorities must prohibit (cac, 2001: 8). if experience shows that certain types of arrangements are almost always anti-competitive then the implementation of a per se rule prohibiting these types of arrangements also makes good sense from an economic policy point of view. as noted previously in this article, the sca clearly recognised the per se nature of s 4(1)(b), and thus implicitly acknowledged the intention of the legislature in having a statistically optimal rule to maximise deterrence. however, the sca also found that an overly literal interpretation of s 4(1)(b) may potentially produce an outcome, in prohibiting certain types of arrangements, that would also not have been intended by the legislature. the question that must now be addressed is whether the sca’s apparent endorsement of a process of characterisation is, or can be made, consistent with the policy objective of the per se rule in s 4(1)(b), namely, to maximise deterrence of certain types of arrangements? in order to address this issue we examine what is meant by characterisation and discuss the legal and economic rationale for it. we then examine how the notion of characterisation might best be interpreted and applied in order that it be consistent with the application of the per se standard as a statistically optimal rule to maximise deterrence. 6 characterising price fixing agreements: legal and economic rationale the decision to categorise an agreement or practice as having the same character as the practice of “fixing a purchase or selling price”, ‘dividing markets’ or “collusive tendering”, as they appear in s 4(1)(b), implies that they have been given a specific meaning which in turn confers on them a certain character. obviously we must be clear on what the meaning and character of the phrases describing these practices are before we attempt to categorise different agreements or practices on the basis of whether or not they have the same character. for the purposes of this article we will focus only on the phrase describing the practice of “fixing a purchase or selling price”. however, the analysis can easily be carried over to the other practices set out in s 4(1)(b). the question, ‘what do the words ‘fixing a purchase or selling price’ mean?” leads one to consider the tribunal’s reference to alice’s celebrated rejoinder to humpty dumpty: with due respect to the learned authorities upon which mr. unterhalter relies, the statute is, in this instance, so devoid of ambiguity that he may have rested his case 346 sajems ns 11 (2008) no 3 on alice’s celebrated rejoinder to humpty dumpty: “when i use a word”, humpty dumpty said, in a rather scornful tone, “it means just what i choose it to mean – neither more nor less.” “the question is”, said alice, “whether you can make words mean so many different things” (carrol, 1980: 113)” (competition tribunal, 2001: 18. 49/cr/apr00) however, despite its clear structure and concise wording the section nevertheless does not permit an ordinary literal interpretation. the words “fixing a purchase or selling price” must be understood in terms of the context within which they are written in the act and with reference to the intention of the legislature – as opposed to merely reflecting on the ordinary literal meaning of the words. the literal theory stipulates “words should be given their ordinary and grammatical or natural and ordinary meanings as the first step in the process of interpretation” (devenish, 1992: 26). literal theory may only be departed from if there is ambiguity or absurdity that would lead to an unjust result (devenish, 1992: 28). however, we submit that a more holistic approach to the literal theory should be taken. this is so evidenced by the fact of the very appearance of these types of practices in s 4(1)(b). they have clearly been singled out for special treatment because of their character as the most egregious types of anti-competitive cartel behaviour. the court in the bmi case recognised the impact of a restrictive literal interpretation, examined the purpose and effect of the arrangement and stated that: in characterizing this conduct under the per se rule our inquiry must focus on whether the effect and, because it tends to show effect… the purpose of the practice is to threaten the proper operation of our predominantly free market economythat is whether the practice facially appears to be one that would always tend to restrict competition and decrease output, and in what portion of the market, or instead one designed to ‘increase economic efficiency’ and render markets more rather than less competitive21 further, the wording in section 4 also imposes a certain character upon the listed practices in s 4(1)(b). firstly, the main heading in section 4 refers to restrictive horizontal practices prohibited.22 secondly, s 4(1)(b) refers to “any of the following restrictive horizontal practices” – thus establishing price-fixing, dividing markets, and customer allocation as a subset of restrictive horizontal practices to be prohibited in terms of the requirements set out in section 4. it therefore follows that any practice or agreement that allegedly contravenes any of the provisions in s 4(1)(b) must first be properly characterised in order to determine whether the alleged practice falls within the ambit of s 4(1)(b), that is to say, is of the same character as the character of the practices set out in s 4(1)(b). 7 how should we characterise agreements? “all analytical approaches begin with an initial characterisation of an agreement” (correia, 1998: 737-771). once an agreement is characterised as “price fixing” it is per se illegal. the question is, how do we determine the method of characterising an agreement? this is a sophisticated economic and legal question and it is important to outline the periphery of this issue. although the sca has ruled that characterisation must feature in the tribunal’s adjudication of these matters, it is not at all clear what the appropriate method for characterisation should be. the sca noted that it was not within in its mandate to construe the scope of s 4(1)(b) and thus determine what evidence is admissible. this is left to the tribunal to consider, “in the manner and in accordance with such procedure as it may decide” (sca, 2005: 43: para 60). in this regard, the tribunal is faced with a difficult task: it must decide an appropriate method to “characterise” the conduct complained of that is not inconsistent with the application of the per se rule. the cac, for example, could not see how characterisation could not blur the line between the per se and rule of reason standards. sajems ns 11 (2008) no 3 347 be that as it may, it is of the utmost importance that whatever method of characterisation is introduced, it is constructed in such a way that the balance of convenience remains firmly in favour of the enforcing agency so as not to undermine its effectiveness in clamping down on hard core cartel conduct. we do not presume here to be so ambitious as to propose what an appropriate method of characterisation should be in the south african context. rather, we discuss some of the principles that might be applied. in this regard, we draw from lessons learned in the united states where the concept of characterisation was introduced and developed. important cases which we discuss include the amicus brief in the ncaa case, the massachusetts v board of optometry case, and a six-step approach proposed by author herbert hovencamp (1999). we then analyse beckner and salop’s (1999) principles of decision theory and show how these principles might be applied in the south african context. in the ncaa v board of regents case the united states solicitor general, with the federal trade commission, filed an amicus brief in which they proposed a “truncated” rule of reason when analysing problematic price fixing agreements: [c]ourts should first ask whether challenged conduct is likely, absent an efficiency justification23, to lead to the restriction of output, for such conduct is inherently suspect. where output restriction does appear likely, we must ask whether there is a plausible efficiency justification for the practice, i.e., is there reason to believe that the restraint may nonetheless have significant efficiency benefits and therefore enhance competition and output. in the event that there is no plausible efficiency justification, the suspect practice is per se illegal…. but, in cases where the participants raise a plausible efficiency justification for conduct that is facially suspect, per se characterisation is inappropriate, because more scrutiny is needed to evaluate the restraint’s overall competitive effect. it may be that further examination will show that the proffered efficiency justification should be rejected; in that event, the conduct can still be condemned as unreasonable without completing a ‘full’ rule of reason analysis that includes market definition and market power determination. on the other hand, if efficiency benefits are shown to be likely, a more elaborate rule of reason inquiry is called for, with a thorough analysis of market power, in order to determine whether the practice is, on balance, harmful or beneficial.24 this method of characterisation has similar elements to that proposed in massachusetts v board of optometry: first we asked whether the restraint is ‘inherently suspect’. in other words, is the practice the kind that appears likely, absent an efficiency justification, to ‘restrict competition and decrease output?’ for example, horizontal price fixing and market division are inherently suspect because they are likely to raise price by reducing output. if the restraint is not inherently suspect, then the traditional rule of reason, with attendant issues of market definition and power, must be employed. but if it is inherently suspect, we must pose a second question: is there a plausible efficiency justification for the practice?… such an efficiency defense is plausible if it cannot be rejected without extensive factual inquiry. if it is not plausible, then the restraint can be quickly condemned. but if the efficiency justification is plausible, further inquirya third inquiryis needed to determine whether the justification is really valid. if it is, it must be assessed under the full balancing test of the rule of reason without further inquirythere are no likely benefits to offset the threat to competition.25 the court in california dental association took an opposing view to the mass. v board of optometry case above and indicated that there is a clear distinction between per se and rule of reason analysis. 348 sajems ns 11 (2008) no 3 herbert hovenkamp (1999: 256-257) discussed how the process of characterisation can take place by providing a road map guide containing six steps. we have taken this road map and drafted a flow diagram identifying these steps. hovenkamp’s road map to characterisation step 1: yes (go to step 2) no legal step 2: ancillary (go to step 3) naked illegal step 3: market power ex is plausible market power is not plausible legal (go to step 4) step 4: yes (go to step 5) no illegal step 5: no (go to step 6) yes illegal step 6: balancing. hopefully, few cases require real balancing; but if a challenged restraint simultaneously produces opportunities for both anticompetitive practices and substantial efficiencies, a court must have a guide one way or the other. the best guide seems to be that if the threat to competition is real, and if the defendants cannot come up with a way of restructuring their venture so that this threat is substantially dissipated, the court’s only conclusion must be to condemn the arrangement. at this point, intent and good faith may become relevant, particularly in cases where the defendants have technical expertise and their professional judgment must have a certain amount of deference if their market is to function properly. nevertheless, any court faced with the prospect of balancing must go back to step 5 and look hard for workable less restrictive alternatives. can the same efficiencies be achieved by reasonably available alternatives that have less potential to harm competition? if yes, the practice in its present form is illegal, although the injunctive remedy should be limited to condemning the current form or ordering the alternative.if no less restrictive alternative is available then proceed to step 6. does the agreement arguably threaten either to reduce output or raise price in some nontrivial way? is this agreement naked or ancillary to some other joint venture or agreement that is itself plausibly efficiency creating or otherwise beneficial to consumers? an agreement is naked if it is formed with the objectively intended purpose or likely effect of increasing price or decreasing output in the short run. as a result a naked agreement is rational only on the premise that the participants have market power. by contrast, an ancillary agreement reduces cost or improves the product and can be profitable whether or not the firms have any market power. look at the market power held by the parties to the challenged restraint. how numerous are they? how concentrated is the market? is there a substantial competitive market outside the venture? are entry barriers high or low? is the venture non exclusive – that is, are participants to the venture free to offer the covered product or service outside the restraint imposed upon the venture? is there strong evidence that the challenged practice creates substantial efficiencies by reducing the participants’s costs or improving product or service quality? sajems ns 11 (2008) no 3 349 in the arizona v maricopa county medical society26 case, the supreme court applied the per se rule to an agreement by physicians who sold their services at a maximum fee. hovenkamp (1999: 261) suggests that the court was wrong to apply the per se rule as it failed to analysis some additional evidence mentioned in its opinion. using his “road map” guideline above he states that: under the road map given above, the maricopa joint venture at least arguably threatens to raise prices or reduce output, if we accept the claim that maximum price fixing can be disguised minimum price fixing. it flunks step 1. step 2 required much more analysis than the supreme court was willing to give. the maricopa agreement was a joint venture producing transactional efficienciesin this instance, reducing customer search costs for a variety of medical services. effectively, the maricopa health consumer was given a list that said ‘the doctors on the enclosed list have agreed to charge no more than the stated prices for the enclosed list of services.’ at that point the customer could still make a choice between buying inside the venture or buying outside. the supreme court was wrong to end the inquiry at step 1 (hovenkamp, 1999: 261). in a south african context, courts should use caution when using hovenkamp’s road map to characterise agreements. under s 4(1)(b) the analysis would probably stop at step 3, with a distinction between naked and ancillary agreements. it would be perilous to go the route of a market analysis, as this leads to a rule of reason approach, which would be inconsistent with the structure in s 4(1). earlier in this article we noted that the rationale for a per se standard is that it functions as a statistically optimal rule to maximise deterrence. the idea of a statistically optimal rule is drawn from the application of decision theory to the design of optimal legal rules (whinston, 2006: 18-19). in considering the development of an appropriate method of characterisation it might also be instructive to apply the principles of decision theory. in this regard we draw largely on the work of beckner and salop (1999: 41-57) in their article on decision theory and antitrust rules. beckner and salop note that judicial decisions must necessarily take into account that information is imperfect and costly to gather and process. in general terms, the court will want to minimise the expected consumer welfare cost of making a false decision. in making its decision the court must consider the cost, in consumer welfare terms, of erroneously prohibiting the conduct (a false negative) as well as the cost of erroneously approving the conduct (a false positive) and weigh these up against the net consumer welfare benefit arising from the conduct in question. in the case of collusive price fixing the cost to consumers is likely to be quite high and the benefit low or non-existent. in such a case the court will want to minimise the cost of a false positive finding (beckner & salop, 1999: 49-51). so far we have analysed the decision process as if it were applied only with regard to the specific facts of a single case. the reality, however, is that cases make precedent and thus have implications in the broader regulatory environment. it is for this reason that legal rules are designed on the basis of statistically optimal outcomes. in particular, the judicial decision must consider the issue of optimal deterrence. according to beckner and salop (1999: 51) over deterrence might involve deterring welfare enhancing cooperation or innovation by firms that fear a finding of liability even when their conduct does not reduce consumer welfare. under deterrence might involve firms being overly aggressive in the expectation that their conduct might escape punishment. concerns about optimal deterrence may lead courts to shade the standard in one or the other direction to take into account differences in the cost of false convictions versus false acquittals. in addition to minimising the cost of false decisions and applying statistically optimal rules, courts will also want to reduce the costs of information gathering and processing. this implies a rationalisation which pays attention to the level of information necessary to avoid 350 sajems ns 11 (2008) no 3 the false decisions, and the sequence in which different types of information are gathered and processed. the important point to note is that information is costly to gather and imperfect information may result in false decisions. courts must weigh the expected benefits of additional information against the cost of gathering and processing the additional information. if, on the basis of the limited information available to it, there is a strong presumption on the part of the court that the alleged anticompetitive conduct will result in net consumer harm, then there is a strong justification to make a decision on the basis of the limited information available – rather than incurring additional costs in gathering and processing further information (beckner & salop, 1999: 52). if one applies the above reasoning to the south african context it could be argued that the per se rule (implied in the structure of s 4(1)) is designed to prevent potentially harmful underdeterrence, whereas the requirement to ‘characterise’ (implied in the ruling of the sca) is meant to prevent potentially harmful overdeterrence. most importantly, however, the per se standard, as a distinct feature of the structure of s 4(1), appears designed to place a strict limit on the amount of information that should be considered by the court in deciding cases involving allegations of the anticompetitive practices set out in s 4(1). but is it possible to reconcile the per se objective, which places a limit on information gathering and processing, with the objective of characterisation, which requires at least some level of information? we suggest that this can be done if the judicial decision process of the court is placed firmly within a decision theoretic framework. further, a rigorous application of decision theoretic principles should allow the court sufficient discretion (not easily challenged on appeal!) to restrict the extent of information gathering and processing required for characterisation so as to preserve the robustness of the per se standard as a means to maximise deterrence of hardcore cartel conduct. beckner and salop (1999: 53) elaborate on the application of decision theory with reference to a multistage decision making process. the multistage decision process is based on the understanding that the decision maker faces costs in gathering and processing information and that imperfect information may lead to erroneous determinations. it also recognises that decisions have to be made regarding the extent of information costs and the priority accorded to gathering different types of information relevant to presumptions about particular outcomes. in particular, it is assumed that the courts hold certain presumptions about the expected benefits and harms arising from particular classes of activities. beckner and salop identify seven steps in the multistage decision making process. we summarise these with reference to the decision tree in annex 1. our purpose here is not to provide a detailed analysis of each stage of the decision process, but rather to identify some features of a general decision making framework that a court could apply when adjudicating on an alleged contravention of s 4(1)(b) of the competition act. we have identified the relevant stages below27: stage 1. initial characterisation in this stage the court gathers information but does not make any decision. beckner and salop note that the information considered at this stage would be of a limited nature but sufficient to allow the court to form its initial presumptions about the case. according to beckner and salop this initial characterisation could be based on the specific facts of the case as well as the courts experience and knowledge regarding a broader class of cases (beckner & salop, 1999: 56-58). the sca ruling referred to evidence relating to the nature, purpose and effect of the agreement that must be considered in determining whether the agreement falls within the scope of s 4(1)(b). while the nature and purpose of the alleged conduct may be more or less self-evident on the basis of basic low cost information, the same cannot easily be said about the effect of the agreement. the danger in allowing evidence on effects is that it could allow “front loading” (beckner & salop, 1999: 58) by defendants of costly fact gathering at the initial stage and thus, as the cac had feared, blurring the line between the per se and rule of reason standard. sajems ns 11 (2008) no 3 351 but rule of reason analysis at this stage is not in line with decision theoretic principles as it would not allow the court to first make an informed decision on whether the benefit from engaging in further cost based information gathering would be justified given the expected consumer harm arising from the complained of conduct. despite the unfortunate use of the word “effect” by the sca, the per se standard may nevertheless be rescued by the fact that the court is not constrained, when conducting an initial characterisation, from having reference to general experience and knowledge about a broader class of cases. in terms of s 4(1)(b) this “broader class” of cases is clearly stated in the legislation, namely fixing a purchase or selling price, dividing markets and customer allocation. once initial characterisation places the complained of conduct within this “broader class” of cases, the “effect” of such conduct is surely evident with reference to generally available experience and knowledge about the class of conduct and which will not be specific to the facts of the individual case. if it transpires that the tribunal is required to admit some form of evidence on effects then this should be limited to only low cost information that clearly contradicts the general experience and knowledge about the broader class of conduct. the tribunal may take judicial notice of certain legal, social and economic aspects of the society in which such laws operate (driedger, 1983: 150). stage 2. summary disposition based on initial characterisation at this stage the court could make a decision about the case. such a decision would be based on the initial characterisation of the case. if the court were to make a decision in favour of the plaintiff it would probably be because the court had formed a presumption that the complained of conduct is of such a nature that it should be prohibited per se (driedger, 1983: 57). there is no reason to believe, in the context of s 4(1)(b), that making a decision at this stage would be inconsistent with the sca ruling. the important point is that the decision is based on an initial characterisation which necessarily involves construing the scope of s (1)(b) and conducting a limited fact-based inquiry. stage 3. re-characterisation if, in the previous stages, the court found that it was not able to make a decision on the basis of available information, it may then gather additional low-cost information (driedger, 1983: 57). if there is uncertainty regarding evidence of the purpose of the alleged conduct then the tribunal may admit further low-cost information at this stage. it is still important that “front loading” of costly information not be permitted at this stage. the purpose here is simply to supplement and refine the initial characterisation. the extra step may be necessary in more complicated cases where an initial characterisation may not be straight forward. stage 4. summary disposition based on stage 3 re-characterisation as with stage 2, the court may make a decision on the basis of the information gathered in stage 3 and, this time, on the basis of a slightly more informed presumption. we note here that progression of decision making to any further stages would bring us into the territory of rule of reason analysis. in the s 4(1)(b) context this would imply that a decision had been made that the alleged conduct does not fall within the ambit of s 4(1)(b) but should either be decided in favour of the defendant or (more likely) be evaluated under s 4(1)(a), which would have to be adjudicated according to a rule of reason standard. the tribunal would then go back to the start and progress through all the decision stages right the way through to the final stage. in conclusion, any argument suggesting that the sca ruling implies that the judicial d e t e r m i n a t i o n s o f t h e tr i b u n a l s h o u l d proceed beyond stage four in the multistage decision process (to stages which require the consideration of more “costly” information) would introduce a method of characterisation that would be completely incompatible with the maintenance of the per se standard as envisaged 352 sajems ns 11 (2008) no 3 in the competition act. this would imply a fundamental inconsistency in the sca ruling, as the sca had explicitly confirmed the per se standard inherent in the structure of section 4(1) and the content of 4(1)(b). finally, it would seriously undermine the public policy objective of a statistically optimal rule to maximise deterrence of hardcore cartel behaviour. 8 conclusion in this article we have shown that the structure and content of s 4(1)(b) does not rule out some method of characterising conduct in order to determine whether it falls within the scope of s 4(1)(b). we have examined the legal and economic rationale for this and established that an appropriate method of characterisation is not inconsistent with maintaining a per se standard for the adjudication of conduct falling within the ambit of s 4(1)(b) of the act. however, it is recognised that without a clear framework for determining an appropriate method of characterisation there is a very real risk of a blurring of the line between per se and rule of reason. this would have dire implications, as it would open the door for “front loading” of costly information by defendants and thus seriously undermine the effectiveness of the per se standard. in order to overcome this problem we suggest a framework based on the rigorous application of decision theoretic principles. this should allow the tribunal sufficient discretion (hopefully not easily challenged on appeal!) to restrict the extent of information gathering and processing required for characterisation so as to preserve the robustness of the per se standard as a means to maximise deterrence of hardcore cartel conduct. endnotes 1 american natural soda ash co v the competition commission, botswana ash company and others case no 554/03. 2 american natural soda ash corp et al v the competition commission, botswana ash (pty) ltd et al competition appeal court case number 12/cac/dec01. 3 “the word cartel came into english in the 16th century from the old italian word cartello, which meant a note or letter of defiance, a preliminary step in the etiquette of dueling. a cartel in this sense is now obsolete. a second meaning of cartel that slipped into the language a little later (and is still in use) is a written agreement between opposing armies for the exchange of prisoners. this meaning was extended by german writers in the 1880s to describe a government coalition that brought together normally antagonistic political parties. shortly thereafter the word kartell was applied to a combination of two or [more] business rivals for the purpose of regulating prices or output of an industry. the word cartel was first used in english in 1902 in this business sense in three british publications to refer to what were formerly called “producers syndicates” or “trusts” in the sugar and steel industries.” ‘oxford english dictionary in john conner (2001: 20) gslobal price fixing: our customers are the enemy, kluwer academic publishers: boston. 4 broadcast music v cbs 441 us 1 (1979) 19-20. 5 see aba section of antitrust law in angland, j, chair [et al.] (1997) antitrust law developments (4th ed.) american bar association: chicago, illinois, (pg. 398), in gregory j werden ‘antitrust analysis of joint ventures: an overview’ (1999). 6 see copperweld corp v independence tube corp 467 us 752, 768 (1984). 7 see nfl v north am. soccer league 459 us 1074, 1079 (1982) and scfc ilc, inc v visa usa, inc 36 f 3d 958, 970 (10th cir 1994). 8 see american natural soda ash corp et al v the competition commission, botswana ash (pty) ltd et al. competition tribunal case number 49/cr/ apr00 and 12/cac/dec01. 9 section 1 sherman act 15 us 1890: “every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or commerce among the several states, or with foreign nations, is declared to be illegal. every person who shall make any contract or engage in any combination or conspiracy hereby declared illegal shall be deemed guilty of a felony, and on conviction thereof, shall be punished…” 10 in united states v socony-vacuum oil co 310 us 150 (1940), the court held that all price fixing by firms competing in an open market is per se unlawful. 11 356 us 1 (1958) 5. 12 also consider, bork, rh “fixing the price fixing confusion: a rule of reason approach” (1983) yale law journal, 9: 706-709. in k.n. hylton (2003) sajems ns 11 (2008) no 3 353 antitrust law: economic theory and common law evolution, (pg. 122), cambridge university press: new york. 13 457 us (1982) 332, 334. 14 441 us (1979) 1. 15 ftc v indiana federation of dentists, 476 us 447, 106 s ct 2009 (1986). 16 ibid at 457, 106 s ct at 2017. 17 california dental association v ftc us 119 s ct 1604 (1999). 18 744 f 2d 598 (7th cir 1984). 19 national collegiate athletic association v university of oklahoma 468 us 85 (1984) 104. 20 441 us 1(1979) 19-20. 21 in chotabhai v union government (minister of justice) and registrar of asiatics1911 ad 13 at 24, c.j. de villiers expressed the traditional literal viewpoint in this regard by stating that “the headings of different portions of a statute may be referred to for the purpose of determining the sense of any doubtful expression in a section ranged under any particular heading”. j. didcott, in s v liberty shipping and forwarding (pty) ltd and others 1982 (4) sa (d) 285-6, observed that: “the headings to a section may be brought into account … to resolve an ambiguity or doubt raised by the text…” 22 an efficiency justification exists if the challenged restraint increases the quantity or quality, or reduces the cost, of overall output – e.g., by creating a new product, improving the operation of a market, or reducing production or marketing costs – and is reasonably necessary to achieve such efficiencies (calkins 2000: 523). 23 brief for the united states as amicus curiae, ncaa v board of regents in calkins (2000: 523). 24 110 ftc 549 (1988) 604. 25 457 us 332, 102 s ct 2466 (1982). 26 beckner and salop (1999: 57) list a few other stages which we do not find relevant for the purposes of this article but are as follows: stage 5: sequencing and more complete information gathering on first issue; stage 6: subsequent summary disposition based on partial information or more complete information gathering on second issue; and stage 7: full merits determination. references 1 beckner, c.f. & salop, s.c. (1999) “decision theory and antitrust rules,” antitrust law journal, 67(1): 41 – 67. 2 calkins, s. (2000) “california dental association: not a quick look but not the full monty,” antitrust law journal, 67: 495-557. 3 competition appeal court (2001) american natural soda ash corp et al. v the competition commission, botswana ash (pty) ltd et al., competition appeal court case number 12/cac/dec01. 4 competition tribunal (2000 and 2001) american natural soda ash corp et al. v the competition commission, botswana ash (pty) ltd et al., competition tribunal case number 49/cr/ apr00 and 12/cac/dec01. 5 correia, e. (1998) “joint ventures: issues in enforcement policy” antitrust law journal, 66: 737771. 6 devenish, g.e. (1992) interpretation of statutes, juta: cape town. 7 driedger, e.a. (1983) “construction of statutes: 150” in devenish, g.e. (1992) interpretation of statutes (pg. 118), butterworths: toronto. 8 fox, e.m. (2002) cases and materials on the competition law of the european union, thomson west: st paul, minnesota. 9 hovenkamp, h. (1999) federal antitrust policy: the law of competition and its practice (2nd ed.) west publishing company: st paul, minnesota. 10 hylton k.n. (2003) antitrust law: economic theory and common law evolution, cambridge university press: new york. 11 miles, j.j. (1997) “joint venture analysis and provider controlled health care networks,” antitrust law journal, 66: 127-166. 12 pitofsky, r. (1983) “commentary: in defense of discounters: the no frills for a per se rule against vertical price fixing,” geo lj, 71: 1487, 1489. 13 stigler, g.j. (1952) “the case against big business”, fortune magazine may 1952 in michael d. whinston (2006) lectures in antitrust economics, (pg. 18), the mit press: cambridge massachusetts. 14 supreme court of appeal (2005) american natural soda ash co v the competition commission, botswana ash company and others case no 554/03. 15 werden, g.j. (1999) ‘antitrust analysis of joint ventures: an overview’, antitrust law journal 66: 701-755. 16 whinston (2006) lectures in antitrust economics, the mit press: cambridge massachusetts. abstract introduction literature review methodology findings and discussion conclusions and recommendations limitations of the study and future research acknowledgements references about the author(s) marna landman gordon institute of business science, university of pretoria, johannesburg, south africa morris mthombeni gordon institute of business science, university of pretoria, johannesburg, south africa citation landman, m. & mthombeni, m., 2021, ‘determining the potential of informal savings groups as a model for formal commitment saving devices’, south african journal of economic and management sciences 24(1), a3940. https://doi.org/10.4102/sajems.v24i1.3940 original research determining the potential of informal savings groups as a model for formal commitment saving devices marna landman, morris mthombeni received: 08 dec. 2020; accepted: 02 june 2021; published: 20 july 2021 copyright: © 2021. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: saving behaviour has attracted research attention over the past 20 years. typically, individual and household saving rates among low-income groups are inadequate. research suggests that informal savings groups are effective vehicles for encouraging saving among low-income individuals. yet little is known about the drivers of positive saving behaviour among informal savings groups, which makes it difficult for formal providers to design interventions that promote higher levels of saving. aim: this study aimed to explore both the rational and non-rational drivers of saving behaviour among low-income members of informal savings groups, the attributes of informal savings groups that positively influence their collective saving behaviour, and to identify the valued features of savings groups that encourage the adoption of informal commitment saving devices (csds). methods: the study was informed by a literature review followed by field research in which semi-structured interviews were conducted with 10 savings groups and 10 individual members of savings groups. the participants’ perspectives were analysed and compared within the context of behavioural economic theory. results: the study revealed seven characteristics of informal savings groups that potentially serve as interventions to explain non-rational saving behaviour. it also identified seven features valued by users of informal csds (including flexibility, restricted access to savings and no transaction fees) which could be salient to providers of formal csds. conclusion: on the basis of the findings, a behavioural design framework was proposed to inform the design features of formal csds that may ensure customer retention and improved saving outcomes. keywords: saving behaviour; savings group; behavioural economics; commitment saving device; saving promotion intervention. introduction informal savings groups, also referred to as ‘stokvels’ in south africa (african response 2012), were born out of the country’s repressive, race-based policies that restricted the economic participation of the black population. these savings groups are unregulated societies aimed at individuals who are under-served by traditional banking and non-banking financial institutions (burlando & canidio 2017; dupas & robinson 2013). with south africa’s transition to democracy in 1994, the rational expectation was that stokvels would lose their appeal as a viable savings vehicle. however, they have not only survived, but also flourished (african response 2020). this suggests that there must be non-rational reasons for the resilience of these informal savings groups, despite the presence of world-class financial institutions in the country. bounded rationality, also described as ‘approximate rationality’ (simon & herbert 1955) means that decision-makers act purposefully, but not necessarily perfectly rationally due to limitations in time, information or the cognitive ability to evaluate available information (gigerenzer & goldstein 1996). whereas rational decision-making is applying logic in the cause of action towards specific goals, and irrational decision-making is the opposite of rational, non-rationality involves more realistic decision-making with bounded rationality under conditions of uncertainty (back 1961; gigerenzer & gaissmaier 2015). non-rational decision-making, best described as ‘intuitive judgement’ and ‘choice’ in psychology literature, works alongside rational decision-making (ireland & miller 2004; simon 1993) to expand the motivation for saving beyond economic factors (utility maximisation) to psychological drivers (intuition and emotion) as well (kahneman 2003). how these economic and psychological motivators interact in decision-making falls within the ambit of behavioural economics. therefore, this paper is concerned with how non-rational decision-making operates alongside, as opposed to an alternative for, rational decision-making. an informal savings group is a self-selected group of individuals who periodically contribute to the shared goal of the group (le polain, sterck & nyssens 2018). the funds collected by the informal savings groups are generally kept aside in secure storage, or in bank accounts, and distributed to members (partially, or in full) on a rotational basis (james 2015). commitment to the group and its common goal positively influences saving behaviour, with the result that there is a low incidence of default among savings group members (ksoll et al. 2016). so as ‘commitment saving devices’ (csds), informal savings groups have been proven to increase individual and household saving rates (le polain et al. 2018; steinert et al. 2018). participation in informal savings groups can lead to asset accumulation and wealth creation, and reduce individuals’ and households’ vulnerability to unexpected financial shocks or burdens, such as the devastating social and economic impact of the coronavirus disease 2019 (covid-19) pandemic evidenced by lockdowns, business failures and increased unemployment levels in many countries (brewer & gardner 2020; karlan, ratan & zinman 2014). some scholars are of the view that participation in informal savings groups encourages greater economic activity and leads to improved household welfare (ksoll et al. 2016) and higher levels of consumption (le polain et al. 2018; martin & hill 2015). it might also help people overcome their innate resistance to saving (steinert et al. 2018). the ability of savings groups to attract savings from resource-constrained, low-income individuals has fuelled scholarly interest in how their positive attributes could be modelled in formal saving devices (dupas, keats & robinson 2019; le polain et al. 2018). nevertheless, not all informal savings groups are without risks or shortcomings. some offer loans to members at high interest rates, which expose vulnerable borrowers to high levels of indebtedness and the group’s collective savings to an elevated risk of defaults on repayments (le polain et al. 2018), while savings stored in cash are also at risk from theft. regulators have long prescribed mechanisms to mitigate the risks of saving in collective mechanisms, such as bank accounts, or mutual funds. however, such formal savings mechanisms have historically not addressed the needs of those who chose informal savings groups as informal savings mechanisms. it seems that it may be desirable for providers of formal savings mechanisms to mimic elements of informal savings groups, with a view to providing users of such mechanisms, who are typically vulnerable members of society, with the appropriate product features and risk mitigation protection provided by regulated mechanisms. a stokvel is a particular informal group savings mechanism that is similar to a rotating savings and credit association (rosca) (prina 2015), such as an accumulating savings and credit association (asca) (le polain et al. 2018) or a village savings and loan association (vsla) ‒ both found in africa (ksoll et al. 2016). similar savings facilities in other parts of the world are the bishi in india, the tanda in latin america, the hui in asia and the gam’eya in the middle east (low 1995). yet, as savings vehicles, the efficacy of stokvels is still not well understood by the providers of formal group savings mechanisms (african response 2012) – partially because of the generally limited knowledge of what exactly drives behaviour in the informal saving sector (cronqvist & siegel 2015). this is exacerbated by the superficial knowledge of scholars and practitioners alike of saving products and the behavioural interventions that encourage saving among low-income individuals (cronqvist & siegel 2015; dholakia et al. 2016). the aim of this study was to arrive at a better understanding of the rational and non-rational behavioural factors contributing to the resilience of informal savings groups, notably stokvels, as informal savings mechanisms in south africa. the study followed a three-step approach. firstly, it identified (from literature) the drivers of informal savings groups’ rational and non-rational saving behaviour (cronqvist & siegel 2015). secondly, it explored (using field research) the ability of informal savings groups to positively alter saving behaviour through various interventions (steinert et al. 2018). thirdly, it identified the valued features that make informal savings groups effective csds (le polain et al. 2018). according to dupas et al. (2017), financial service providers could benefit from a better understanding of how formal csds might be improved to ensure a greater up-take and retention in informal savings groups, with attendant benefits. for this reason, we posit that the features of informal savings groups may inform formal csd providers on how to provide appropriate features and protection to individuals that typically use stokvels. literature review saving behaviour in the context of behavioural economics as indicated by cronqvist and siegel (2015), low saving rates can be addressed only when saving behaviour is properly understood. the concept of ‘saving behaviour’ encompasses more than just the financial dimensions of saving; it also includes psychological dimensions such as emotions, fear and risk perceptions, for example (ed. ranyard 2017). giné et al. (2018) highlight the importance of knowing what the drivers of behavioural change are, as they might affect the design of csds and their impact on individual and societal welfare. standard economic theory favours external perceptible mechanisms, underpinned by assumptions of rational economic behaviour. friedman’s (1957) well-known permanent income hypothesis asserts that individual saving behaviour is driven by the need to balance current and anticipated future consumption. for example, individuals accumulate savings while earning an income, with the expectation of dissaving once retired. ok, ortoleva and riella (2015) explain rational choice as the ability to rank alternatives according to preferences and then to choose the highest-ranking item in order to maximise utility. however, these standard economic models do not account for uncertainty when executing saving plans and only partially explain what drives individuals’ saving propensities (cronqvist & siegel 2015; hoff & stiglitz 2016; thaler 2016). in other words, under conditions of uncertainty, standard economic models of rationality will in general not suffice to explain low-income individuals’ experience or their saving behaviour. the literature review therefore focused on understanding how non-rational decision-making extends rational decision-making in saving behaviour. according to various scholars (see table 1) concerned with non-rational decision-making explained by behavioural economics literature, the main behavioural economic concepts that influence saving behaviour are: loss aversion, mental accounting, commitment, peer pressure, present bias, lack of self-control, status quo bias, confirmation bias and social determinants. table 1 presents conflicting scholarly evidence in respect of some of these concepts, suggesting that they can be a positive or a negative influence on saving behaviour, depending on the context. it is therefore advisable to disentangle the negative from the positive effects of behavioural economic concepts, especially to illuminate how non-rational factors better explain the propensity of low-income individuals to save in situations of elevated uncertainty. table 1: saving behaviour in a behavioural economics context. loss aversion according to thaler (2015:34), ‘losses hurt about twice as much as gains make you feel good’. on this basis, thaler (2015) invoked the concept of loss aversion. imas et al. (2016) assert that gains and losses are evaluated in relation to a reference point, which is usually the status quo. they demonstrated empirically that individuals anticipate loss aversion, basing their decisions on this expectation. in a positive sense, individuals who are extremely loss-averse will be encouraged to save more (cronqvist & siegel 2015) as a precautionary measure against future economic shocks. vulnerable, lower-income individuals and households are very aware of these adverse shocks, which prevent them from capitalising on opportunities with expected high but risky returns (gloede et al. 2015). conversely, loss aversion has a negative influence on savings, should a household become accustomed to a certain level of disposable income and regard anything less than that (due to saving) as a loss (thaler & benartzi 2004). however, this is mostly applicable to higher-income groups who are less dependent on precautionary savings and not typically reliant on csds. mental accounting mental accounting refers to the mental earmarking of money for a specific purpose, such as saving, to overcome a lack of self-control. it is a mechanism designed to overcome behavioural biases that inhibit saving behaviour. by mentally allocating money towards savings, the money is considered to be less available for other expenses. karlan et al. (2016) describe mental accounting as the establishment of a strong connection between current saving behaviour and future saving goals. however, mental accounting is only possible if saving is top of mind. therefore, reminders can serve as a useful intervention. commitment commitment is the act of binding oneself to a specific course of action. laibson (2015) describes commitment as a restriction of one’s choices. a commitment to save is a restriction of choice that follows on from mental accounting. according to laibson (2015), commitment carries costs in the form of loss of flexibility and direct commitment product costs, which often exceed its benefits. while low-income individuals display a strong commitment to save (galperti 2015; o’donoghue & rabin 2015), they also have a heightened preference for flexibility in the face of possible income uncertainty (afzal et al. 2018). however, a preference for flexible access to savings to ensure liquidity in the short term (bond & sigurdsson 2018; carvalho et al. 2016) could be an obstacle to the accumulation of wealth through savings over the long term (prina 2015). peer pressure laibson and list (2015) describe peer pressure as a set of social preferences that respond to incentives. humans are not motivated solely by self-interest, as standard economic theory suggests; they also consider other people’s intentions, behaviour and actions when making decisions (laibson & list 2015). conventional wisdom suggests that peer pressure moves behaviour towards the norm. thus, the majority of people wish to conform and to adopt one or other pattern of behaviour. bursztyn et al. (2014) identified two reasons for peer pressure positively influencing saving behaviour: social learning and social utility (bursztyn et al. 2014). in short, individuals are motivated to save when they see peers saving and when the perceived value (utility) of savings products or assets depends on a peer’s ownership thereof. however, peer pressure does not always have a positive effect on saving behaviour. in a controlled laboratory experiment on the effects of peer pressure on sharing income in rural villages in kenya, subjects were given the choice between a private, risk-free savings account and a profitable but risky public investment. from a pure economic perspective the results were surprising ‒ women were willing to sacrifice the profitable returns or even pay a fee to keep their income a secret from neighbours and family (jakiela & ozier 2016). transparency of income and investment returns resulted in these women saving an estimated 22% less than they would have if the returns had been hidden (jakiela & ozier 2016). this need for income privacy suggests that it could also be costly for an individual, should their higher returns signal that they have financial means to support the community. from a non-rational decision-making perspective, this saving behaviour is less surprising. present bias according to standard economic theory, rational behaviour implies that there is no difference between people’s intentions and their eventual actions. however, humans often plan to act in a certain way, but then change their minds at the last minute (laibson & list 2015). present bias helps to explain saving behaviour. individuals may save less if money at hand in the present is considered to be certain, whereas the benefit from available funds in the future is viewed as uncertain. according to o’donoghue and rabin (2015), present bias is a discounting model that functions on the timing of utility; it involves a trade-off between immediate and future utility. yet individuals differ in their time preferences and therefore discount the value of savings at significantly different rates (jackson & yariv 2014). lack of self-control berheim et al. (2015) explored whether difficult economic circumstances exacerbated self-control problems and found that self-control regarding saving can be limited by low initial assets to absorb income shocks. poverty may therefore perpetuate itself as it impedes self-control, while high initial wealth, in contrast, allows for asset accumulation and decision-making with fewer constraints (bernheim et al. 2015). in a field experiment conducted on farmers in rural malawi, giné et al. (2018) found that the commitment to save was sometimes revised only because of a lack of self-control over present biases. individuals are often aware that they lack the self-control to follow a saving plan, which can then create a demand for csds to limit their choices (galperti 2015). literature, therefore, suggests that a perceived lack of self-control in saving could be due to either internal (willpower) or external (limited income and asset buffers) factors, depending on the context in which the individual finds themselves. status quo bias status quo bias relates to decision-makers’ propensity to select a default option (de haan & linde 2018). de haan and linde (2018) warn against unintended, negative consequences in which good default options are followed by inferior ones. enrolling in a savings scheme at the default rate allows for at least some savings to be accumulated, but there is heterogeneity in how much people are supposed to save. consequently, the default option can lead to under-saving in some instances. by settling for the default rate, people might forego opportunities that could potentially increase their savings for future consumption. confirmation bias this phenomenon typically arises when external facts become known or events occur that are consistent with beliefs, thus reinforcing such beliefs. according to bénabou and tirole (2016), a confirmation of beliefs boosts confidence and creates an anticipatory utility that future events will not disturb, even in the presence of contradictory information. in the context of saving behaviour, confirmation bias may prompt an individual to disregard current risks in favour of embracing saving mechanisms that are perceived and proven to be effective. social determinants hoff and stiglitz (2016) propose that two social determinants of behaviour – social context and culture – may also influence saving decisions. interaction with others are at the centre of this theory, which explains how influences at the moment of decision-making (social context) and more constant influences (culture) impact economic decisions and behaviour (hoff & stiglitz 2016). saving promotion interventions interventions are based on the assumption that economic participants act non-rationally and need to be nudged to change their behaviour to achieve a desired outcome. therefore, interventions to change saving behaviour are expected to increase saving rates and savings balances, without removing freedom of choice. possibly the most well-known example in the literature of a successful saving promotion intervention, which entails non-rational nudging, is the save more tomorrow™ (smart) plan by thaler and benartzi (2004). workers in the usa were offered the option of increasing their retirement saving rate sometime in the future, but ideally with their next salary increase (thaler & benartzi 2004). this plan was effective for a number of reasons: it addressed present biases by postponing increased savings into the future, it mitigated loss aversion by linking savings to salary increases, and it leveraged off status quo biases by using the default option in the plan (thaler & benartzi 2004). berg and zia (2017) conducted an experiment to test the effects of financial educational messages relayed through a popular television soap opera in south africa. using this medium was found to have positive effects on the financial behaviour of the study’s participants because of their emotional connection to and admiration for the actors delivering the messages. incentives can also serve as interventions to change saving behaviour. in this regard, the effectiveness of monetary versus ‘social’ (non-monetary) incentives has attracted growing attention in research. in an experiment conducted on savings groups in chile, kast et al. (2018) found that the monetary incentive of earning higher interest was less effective than receiving stickers in recognition of achieving saving goals. the possibility that interest rates did not play a significant role in saving decisions was offered as (at least part of) the reason for these somewhat surprising results from a standard economic theory perspective (kast et al. 2018). savings groups as commitment saving devices the main purpose of csds is to mitigate a lack of self-control, which may lead to inadequate savings or the early withdrawal of savings (karlan et al. 2016). a formal csd, such as a savings (bank) account, requires either a committed amount to be saved by a set deadline or regular deposits of a selected amount until the commitment ends (karlan et al. 2016). according to bernheim et al. (2015), these devices are effective because they require a savings goal, restrict access to funds until the goal is achieved and provide access to funds (liquidity) once the goal is achieved. giné et al. (2018) assert that csds provide opportunities to improve the lives of the poor as they are a potentially cost-effective means of driving saving behaviour. flexible saving devices that allow small, frequent deposits in line with the periodicity of income are particularly appropriate for the poor in developing countries (afzal et al. 2018). small deposits seem more affordable when income is low, infrequent and variable. unsophisticated, easily accessible saving devices, such as lockboxes, are well suited to such a market (dupas & robinson 2013). interestingly, dupas et al. (2019) found that access to accounts in rural areas leads to positive spill over effects in their communities, where savings are kept and spent, thus confirming that greater financial access can improve community welfare. csds require financial responsibility and, if observed by peers, the demand for these devices rises and savings increase (exley & naecker 2017). the main constraint to the uptake of formal csds is the opposing needs for flexibility and liquidity. therefore, the trade-off between the preference for flexibility and liquidity needs to be considered in the product design (galperti 2015). other constraints identified by dupas et al. (2019) in a study conducted in rural kenya were high transaction fees and a lack of trust in financial institutions. informal savings groups can be regarded as csds because they have similar features to formal, commercial savings products. however, an informal savings group is distinctive in that it is accessible and effective in mobilising savings among low-income groups in developing countries. literature states that model csds should offer flexibility, liquidity and low transaction fees, and should be trustworthy places for storing funds. the popularity of savings groups (le polain et al. 2018) suggests that they possess some of these features, which could be replicated to increase up take and customer retention in alternative csds to benefit financial service providers (dupas et al. 2017). the study probes this assumption by empirically investigating whether stokvels possess the requisite features of a model csd, which might help to explain their large following in south africa, alongside formal csds. methodology informal savings groups operate in the informal economy; thus comprehensive statistics on the total population of savings groups in south africa are unavailable. an exploratory, qualitative study was therefore conducted, using semi-structured interviews on two levels. the study focused specifically on how behavioural biases influence the decision-making in saving groups and analysed the design and composition of savings groups from a behavioural perspective. level 1 interviews took place in focus groups (each group comprising about 14 participants) with 10 different informal savings groups (representing 296 members). they set out to answer the following research questions: research question 1: what drives the saving behaviour in lower-income informal savings groups? research question 2: what inherent characteristics of members in informal savings groups serve as natural saving promotion interventions? level 2 interviews were conducted with 10 individual members of different informal savings groups. they set out to answer the following research questions: research question 2: what inherent characteristics of members in informal savings groups serve as natural saving promotion interventions? research question 3: what features of the structure of informal savings groups are valued and should be replicated in formal csds? this multilevel approach to data collection was adopted to exploit benefits of each interview type and to compensate for its limitations (brewer & hunter 2006). the overlap in data collection for the second research question was intended to corroborate the data from two independent sources (myers 2013) as a form of triangulation. the selection of specific informal savings groups was purposive to ensure a diverse combination of views. according to patton (2002:243), common themes emerging from a diverse sample ‘cut through the noise of variation’ and afford the researchers greater insight from the perspectives obtained. for this reason, each set of 10 interviews was divided into traditional stokvel savings groups and saveact savings and credit (ssc) groups. interview participants had different cultures and home languages and resided in different provinces. level 2 participants were selected from the researchers’ own contacts, from the latter’s recommendations of other individuals and from the ssc database. hence, a combination of purposive and snowball sampling was used. mixed-methods sampling is a form of triangulation aimed at strengthening a study by obtaining different, information-rich perspectives (patton 2002). the first eight interviews were conducted with individual members of stokvel savings groups and the last two were conducted with ssc group members. according to gaskell (2000), data should be gathered until no new patterns emerge from the data and thematic saturation is reached. in this study, the data collection from the savings group interviews approached thematic saturation after 10 interviews. the decision to extend the level 2 interviews to include ssc groups was made when the researchers realised that data saturation was imminent. despite the change in the type of informal savings group, few new insights were obtained in the ninth interview, with data saturation almost reached during the tenth interview. it was, therefore, apparent that the insights of individual participants from different types of savings groups did not differ significantly. the interviews with the informal savings groups and individual members located in the province of gauteng were conducted by one of the researchers in english, while the interviews with savings groups and individual members located in the province of kwazulu-natal were conducted by saveact’s fieldworkers in isizulu, one of south africa’s 11 official languages. this was to obtain rich data in the participants’ home language and to reduce interviewer bias, thereby enhancing the trustworthiness of the data. as far as possible, interviews were conducted in a location close to the participants, such as a member’s house or a community space, to ensure the neutrality of the interview environment. figure 1 provides a matrix of the triangulation strategies adopted to ensure the data quality. figure 1: triangulation strategy matrix. the interview data retrieved from all the interviews were analysed in a similar fashion, using a 15-point checklist of criteria for the purpose of thematic analysis, as proposed by braun and clarke (2006). themes emerging from the interview data were compared and contrasted, the findings interpreted and conclusions drawn (yin 2016). we acknowledge that the generalisability of this qualitative study’s results cannot be assured by nature of the methodology and that additional limitations to the study exist. despite the triangulation strategy, limitations such as researcher bias, time horizon of the study, cultural differences and lack of gender diversity in the sample groups remain. these limitations are discussed in more detail in the conclusion section. findings and discussion although not without shortcomings (afzal et al. 2018; greaney, kaboski & van leemput 2016), informal savings groups are widely credited to be effective saving mechanisms (burlando & canidio 2017; kast et al. 2018; ksoll et al. 2016). in this regard, the findings from this study were illuminating. drivers of saving behaviour in savings groups any study on economic behaviour should start by considering the aspect of rationality, in line with standard economic theory. this study identified two key drivers of rationality in the context of informal savings groups: preferences and optimisation. all the savings groups revealed clear preferences in terms of their saving purpose, operational procedures, membership requirements and formal meeting proceedings, and these were well defined in their rules or constitutions. the study’s findings supported the notion of well-defined preferences driving rational decisions, according to standard economic theory (thaler 2016). however, it was beyond the scope of this study to determine whether the highest-ranking preference (carvalho et al. 2016), or the optimal preference in the best interests of the group, was always adopted. the informal savings groups also demonstrated rationality through optimisation (thaler 2016) by taking the initiative to save in the first place (greaney et al. 2016; ksoll et al. 2016; le polain et al. 2018) and, through bulk buying, to leverage off economies of scale. one of the groups explained: ‘the reason why we decided to form this group is that we can’t do things on our own as people, but if you team up with the others and put together our money, you are even able to borrow money for a sizeable amount and do big things that you would not have been able to do yourself.’ (we are doing group) the informal savings groups earned interest on amounts accumulated in bank accounts (stokvel groups), or on loans offered to members (ssc groups), or they saved on bank charges (ssc groups) by not using bank accounts. however, the informal savings groups did not pursue the best available options in terms of interest rates, or safe places to store their funds, despite of being aware of and having access to them. contrary to standard economic theory, grounded in rationality through optimisation (thaler 2016), the informal savings groups nevertheless expressed a belief that they had chosen the best options in the circumstances. therefore, savings groups try to achieve optimisation, but they do not necessarily succeed in the way that an objective, economically rational man or woman would. optimal choices are based on unbiased beliefs (thaler 2016), which may partially explain why optimisation was not achieved in all the saving decisions made by the informal savings groups in this study. biases identified in the savings groups’ saving decisions were: status quo bias, viewed as negative in the literature (dean et al. 2017; de haan & linde 2018), confirmation bias, also viewed as negative in the literature (bénabou & tirole 2016), and loss aversion, primarily viewed as positive in the literature for low-income groups (cronqvist & siegel 2015; imas et al. 2016; thaler 2015). determining whether the identified biases, individually or collectively, had positive or negative effects on savings groups’ saving behaviour was beyond the scope of this study, and thus no empirical inferences can be made in this regard. however, the mere presence of these biases seems to indicate that they played a role in driving non-rational saving behaviour in the savings groups, as indicated in earlier scholarly works. present bias is associated with a lack of self-control and the need for instant gratification (jackson & yariv 2014; laibson & list 2015; o’donoghue & rabin 2015), and is arguably the most frequently cited bias in saving behaviour analyses. this study set out to determine drivers of saving behaviour at the savings group level, although the results seem to indicate that present bias does not play a role at this level. however, individual members stated that their present bias or need for instant gratification on a personal level was mitigated by saving through a savings group. this was also given as the main reason for joining a savings group in the first place. the fourth and final identified driver of saving behaviour in informal savings groups was social influences – more specifically, relationships and culture. savings group members met regularly and were in close contact with one another between meetings, contributing to their social capital. as the ariel group explained: ‘we communicate with each other, we have a relationship. we console each other, we are together and we are helping each other. we are family.’ while hoff and stiglitz (2016) propose that social context and culture are two social determinants of behaviour, they add that there is a lack of evidence as to whether these behavioural determinants have a positive or negative influence on saving. this study found that relationships and culture seem to positively influence saving behaviour in the context of savings groups. the findings in respect of research question 1 suggest that informal savings groups’ saving decisions are driven by both rational and non-rational behaviours. figure 2 provides a high-level overview of these findings. figure 2: overview of results: research question 1. table 2 illustrates the coherence between the responses of the two types of groups (stokvels and ssc groups). it shows the number of groups (out of five) that responded positively in terms of the four drivers and their sub-categories. table 2: overview of drivers of saving behaviour. from an empirical point of view, the success of savings groups seems to indicate that behavioural change occurs through the mechanism of non-rational saving behaviour. the findings in respect of research question 2 are discussed next. saving promotion interventions embedded in informal savings groups as discussed, the ability of members of informal savings groups to change their behaviour was demonstrated in the findings on present bias in relation to research question 1. saving as part of a group also seemed to resolve individuals’ lack of self-control when trying to save on their own. this is consistent with literature which indicates that awareness of present bias mitigates its effects (kuchler & pagel 2020). research question 2 was answered through the identification of seven possible saving promotion interventions embedded in the characteristics of informal savings groups: trust, discipline, peer pressure, mental accounting, commitment to others, emotion and incentives. individually, none of these interventions may be considered a new contribution to literature, but the combination of interventions provides a means of bridging the theoretical gaps identified. the range of interventions was identified by two independent sources: savings group participants (level 1) and individual participants as members and consumers of informal savings groups (level 2). however, the findings revealed that the two levels of participants attached different meanings to the interventions. these are compared and contrasted in table 3. table 3: comparison of levels 1 and 2 responses: research question 2. of interest is the coherence between the two levels of participants in terms of the discipline, peer pressure and commitment to others as interventions (shown as ‘*’ in table 3). for these three interventions, savings groups and individual members agreed on some aspects relating to how they operate. the discipline to save was achieved through rules and the strict enforcement thereof. groups pushed members to save and an obligation or a ‘have to’ mentality was instilled in them. a pattern of ‘force’ (as opposed to ‘choice’) emerged from these findings, which suggested two possible categories of interventions: ‘hard’ interventions (including discipline, peer pressure and commitment to others) and ‘soft’ interventions (including trust, mental accounting, emotion and incentives). hard interventions seemed to require a certain level of force to instil positive saving behaviour, while soft interventions relied on a more indirect approach to bring about the same result. however, neither the relative importance of hard and soft interventions, nor the relationships between them, were established as part of this study. while behavioural economic theory uses the term ‘commitment’ broadly in relation to saving behaviour (laibson 2015; o’donoghue & rabin 2015), the findings from this study indicated that a more appropriate term in the context of savings groups might be ‘commitment to others’, meaning a member’s obligation to fulfil their duties or promises to others. in other words, scholars should investigate how individual commitment to an informal savings group improves individual commitment to save. such an understanding might illuminate features of informal csds that may be salient to providers of formal csds, with consequentially benefits for low-income individuals. features for replication in alternative commitment saving devices concerned with getting the best outcomes for themselves as consumers of saving devices, individual members of savings groups were considered to be in the best position to advise on the most valued features of such devices. flexibility and effectivity (refer table 4) emerged as the most valuable ‘soft’ features of informal savings groups, in line with the extant literature on requirements for csds (afzal et al. 2018; giné et al. 2018). members viewed flexibility as freedom of choice in terms of their saving purpose, the use of funds saved and the affordability of periodic saving contributions. this freedom of choice is exercised at an individual level by switching between informal savings groups after a completed saving cycle. individual participants also expressed the need for five ‘hard’ product features in csds: access to the savings device in the first place, restricted access to their savings, liquidity, low or no transaction fees and interest earnings during the saving cycle. these features are presented in table 4. table 4: overview of results: research question 3. the desire for restricted access to savings (bernheim et al. 2015) and also liquidity appear to be juxtaposed. however, this anomaly is a reality for consumers in low-income groups who have to balance the need for restricted access, in order to mitigate self-control problems, with the need for liquidity in case of emergencies (galperti 2015). participants seemed to value the ability of savings groups to get this balance right. responses also revealed that savings were restricted over the short term, long enough to build up a sizable lump sum, but not too far into the future for the restriction to be regarded as paternalistic. in emergencies, participants were assisted with either short-term loans from their savings group or one-on-one loan arrangements with other members. transaction fees can be a deterrent to saving through a formal csd (dupas et al. 2019). both the informal savings groups and the individual members seemed to be strongly opposed to transaction fees and appreciated the fact that their informal savings groups did not charge any fees, except for avoidable fines. the findings on the value of interest earnings were somewhat ambiguous (kast et al. 2018), with participants revealing a possible status quo bias in this regard. a pattern emerging from the responses was that participants valued the interest-free option that their savings groups offered them at the time of the interviews (status quo) and disregarded other potentially better options. for this reason, interest-free was considered a valued feature, but possibly less important than the other hard features in the context of csds. this study clearly supports the literature on the desired features of csds in general. with all these features considered to be present in savings groups, it is suggested that stokvels can be regarded as model csds. with the research questions having been answered, the findings in respect of these groups’ saving behaviour, specific interventions and valued features as informal csds were combined to create a proposed behavioural design framework. this is discussed now. proposed behavioural design framework the research findings revealed that there are lessons to be learnt by both informal and formal csd providers about the viability of savings groups acting as effective saving devices. for both informal providers and formal providers alike, the key insight is that incorporating elements of soft and hard features has different effects on behaviour as indicated in the behavioural design framework for csds (see figure 3). figure 3: behavioural design framework for commitment saving devices. figure 3 illustrates the following design dimensions for csds, based on the research findings: quadrant i: participants identified five valuable features of csds that should be incorporated into the product design to attract customers. it was noted that the ‘interest’ feature generally refers to ‘interest free’, except in exceptional circumstance relating to deviations from group norms by individual members. these features are also expected to enhance saving behaviour once product interventions have been successfully applied. quadrant ii: three interventions were found to be the most powerful drivers of change in saving behaviour. participants acknowledged their non-rational decision-making from time to time and required these features in order to save consistently. all are regarded as hard commitment features because they rely on force, rules, penalties or terms and conditions (t&cs) to function effectively. quadrant iii: soft commitment interventions use an indirect approach to changing saving behaviour by focusing on customers’ mind sets and perceptions. quadrant iv: the qualities of flexibility and effectivity in csds are often only perceived once a customer has used a product for some time. these qualities are therefore important for retaining customers. even though this behavioural framework is meant for general application, it is based on the informal savings group model. therefore, its effectiveness will be enhanced if consumers have access to a savings network or savings support group. ultimately, the framework suggests ways to make the uptake of formal csds and saving decisions easier, while making withdrawals of savings more difficult. conclusions and recommendations using stokvels as a referent, this study has provided revealing insights into the saving behaviour in informal savings groups and their role as model csds. in probing the specific drivers of saving behaviour (research question 1), the study revealed both standard (rational) and non-standard (non-rational) drivers. rational drivers were preferences and optimisation, while non-rational drivers were biases (e.g. status quo bias and loss aversion) and social influences (e.g. relationships and culture). the study also revealed a number of saving promotion interventions embedded in the characteristics of informal savings groups (research question 2), including trust, discipline, peer pressure, emotion and incentives, which could potentially change saving behaviour for the better. one of the general themes emerging from the responses was that being part of a group instilled a sense of discipline that would not necessarily have been present, had participants not been forced (even in a subtle way through the concept of group commitment) to abide by the rules of the group. in appraising the most valued features of informal savings groups (research question 3) which may warrant replication in formal csds, the study identified both ‘soft’ and ‘hard’ features. hard features included access to the savings device in question, restricted access to savings, liquidity and no transaction fees. soft features comprised flexibility and effectivity. in several respects, the study’s findings support the behavioural economics literature, while also adding new insights into the behavioural aspects of informal savings groups as model csds that expand on existing theories and studies. within the context of savings groups, the findings revealed drivers of positive saving behaviour, seven possible interventions to change saving behaviour for the better, and seven valuable features of effective csds. moreover, the collective research findings were combined to create a proposed behavioural design framework for csds, incorporating these elements to help product developers design new saving devices or enhance existing ones. the recommendations flowing from the insights obtained during the study are two fold. firstly, low-income customers should not be underestimated. participants in this study were assertive and expressed their wants and needs clearly and without hesitation. their respective saving purposes were clearly defined, they ran household budgets, and were creative and resourceful when it came to stretching their income. business practitioners would therefore be well advised to conduct in-depth research to better understand the lived experiences of customers in the low-income bracket (martin & hill 2015). secondly, products and services need to strike a comfortable balance between affordability and effectivity – in other words, value for money. low-income groups are very sensitive to income shocks and need to allocate their limited income carefully to ‘make ends meet’ (le polain et al. 2018; martin & hill 2015). this is evident from the rising popularity in zero-fee bank options offered by digital banks such as tymebank in south africa. businesses are therefore advised not to plan marketing campaigns that rely mainly on push strategies without understanding the market. such campaigns are generally not well received and could even damage the brand. any successful formal csd offered to the market will be a compromise between what consumers want and what the product developer can offer, given its resource constraints. to serve low-income markets well, businesses need to be resourceful in their design thinking so that they can deliver affordable and effective savings products. applied behavioural economics has demonstrated that having a significant impact is not necessarily dependent on a substantial (administrative) investment in product design or financial incentives (tantia, white & wright 2015). limitations of the study and future research as this was an exploratory, qualitative research study, the generalisability of the results cannot be assured. other limitations of the study, in terms of its particular methodology and scope, are as follows: researcher bias: one of the main risks associated with qualitative research is the potential for bias on the part of the researcher(s), which may affect the results. in this study, the researchers recognised this possibility and steps were taken to mitigate this risk by introducing external interviewers into the data collection process. however, the possibility of some bias in the areas of data collection and analysis cannot be ignored. time horizon: this study was cross-sectional in nature, as interviews were conducted at only one point in time during 2018. however, human behaviour is subject to change and thus no inferences can be made about the transferability of identified behaviour into future periods (williams 2007). cultural and language differences: since most interviews in the study were conducted in english, certain meanings and nuances might have been lost or misinterpreted due to the cultural and language diversity among participants. limited diversity of the sample group: data collection in the informal market presents unique challenges as connections need to be established and relationships built in order to gain access to participants. for this reason, the researchers had to rely on external assistance to arrange focus group interviews which, to some extent, limited the diversity of the sample selected. the study highlighted a number of areas that would benefit from further research: it should be empirically determined whether identified biases have positive or negative effects on saving behaviour in csds. the relative importance of hard and soft interventions, as well as the relationship between them, should be investigated. in the absence of any immediate plan at policy level to bring about a step change in the lives of the poor (especially in the wake of covid-19), informal savings groups will continue to play an important role in south africa. participation in informal savings groups does, however, span all income groups, although the saving purpose seems to change as income grows (african response 2012). for example, those in a reasonably healthy financial situation might see an opportunity to create longer-term wealth, without the costs typically associated with more formal financial services. future research should therefore explore the point on the income growth scale where members no longer regard informal savings groups as effective and decide to leave permanently. the proposed behavioural design framework (see figure 3) should be tested in a series of experiments to determine the optimal combination of interventions and features that may increase the effectiveness of formal csds. the importance of each intervention and feature relative to the others should also be tested under different scenarios. these additional areas of research will generate important new insights into the saving behaviour of low-income groups, which will help to inform the optimal design of csds for this particular market. catering to this particular market calls for sensitivity to people’s varied needs and constraints, as well as an appreciation of the pivotal role that savings groups, notably stokvels, currently play and will continue to do in helping many people in south africa to manage their finances in a responsible and confident manner. acknowledgements prof. marianne matthee (gibs) gave invaluable feedback on earlier drafts that contributed to the manuscript evolving from a summarised version of the research report to a more coherent manuscript; prof. charlene lew (gibs) provided shape and focus by highlighting the sections of earlier versions that were detracting from the main argument at the core of the manuscript. competing interests the authors have declared that no competing interest exists. authors’ contributions the first author produced an mba research report under the supervision of the second author. in producing the research report, the first author was guided through the entire research process and was assisted to gain access to respondents otherwise difficult to reach. the second author contributed to the drafting of the manuscript including co-developing the main conceptual framework titled ‘behavioural design framework for csds’. while the authors conceptualised the manuscript together, the second author took the lead in the drafting and finalisation of the manuscript. this entailed paring down a broader research report with several research strands into a more targeted argument. this also involved the final copy edit for this publication. ethical considerations this article followed all ethical standards for research without direct contact with human or animal subjects. funding information this research received no specific grant from any funding agency in the public, commercial, or not-for-profit sectors. data availability the researched was informed by qualitative research interviews. the interview transcript is available on request from the authors, but such transcripts will be provided without identifiers. disclaimer the views and 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(1990) method to test for seasonal unit roots and finds that government revenue and government expenditure have unit roots at all frequencies. the johansen procedure test results reveal that these variables are cointegrated. it is further established that revenue and expenditure are linked bidirectionally by granger causality in the long-run, while there is no evidence of granger causality in the short-run in south africa. jel: h2, h24 1 introduction the close relationship between government revenue and government expenditure has attracted considerable interest. as narayan (2005) argues, this is not surprising given the impact of the revenue-expenditure nexus on budget deficits. much work has been done on the revenue and expenditure nexus, using diverse methods ranging from traditional to advanced econometric techniques. in developed countries, von furstenburg, green and jeong (1986) investigated the nexus between government revenues and expenditure in the us over the period 1955-1981 and found unidirectional granger causality running from expenditure to revenue. this finding was supported by a study by anderson, wallace and warner (1986). another study by manage and marlow (1986), however, contradicts this, finding causality running from revenue to expenditure, thus supporting the tax-spend hypothesis. in a further twist of this tale, ram (1988) found evidence of bi-directional granger causality, which conforms to the fiscal synchronisation hypothesis, and owoye (1995), using engle-granger error correction method for the g-7 countries for the period 1961-1990, found evidence of the fiscal synchronisation hypothesis in canada, france, germany, uk and the us. however, in italy and japan they found evidence of a tax spending causality. joulfaian and mookerjee (1991), investigating 22 oecd countries, found granger causality from revenue to expenditure in most of the countries except for canada, iceland and japan, and causality running from expenditure to revenue in all countries except for france, greece and ireland. in latin america, granger causality was tested by shah and baffles (1994), who found evidence in brazil of unidirectional causality running from revenue to expenditure. however, in argentina and mexico they found evidence of bi-directional causality between government expenditure and revenue. in the middle east, fasano and wang (2002) investigated the nexus among the oil-dependent gulf cooperation council countries and found evidence of bidirectional causality for qatar, kuwait and saudi arabia and unidirectional causality running from revenue to expenditure in bahrain, the united arab emirates and oman. in africa, sajems ns 10 (2007) no 2 257 carneiro, faira and barry (2004) researched government revenue and expenditure causality and cointegration in guinea-bissau and found evidence of temporal causality and a long-run relationship between government revenue and expenditure. narayan and narayan (2006) investigated the nexus between government revenue and expenditure in 12 developing countries using annual data. they looked for evidence of causality between government revenue and government expenditure within a multivariate framework using the toda and yamamoto (1995) test of granger causality. the main findings were that the tax-spend hypothesis is supported by data from mauritius, el salvador, haiti, chile and venezuela. for haiti, there is evidence of the spend-tax hypothesis, while for peru, south africa, guatemala, uruguay and ecuador there is evidence of fiscal neutrality. in another study, chang, liu and caudill (2002) used cointegration and vector autoregression to test the revenue-expenditure nexus in 10 countries during the period 1951-1996. they found that the spend-tax hypothesis is supported by data from south africa and australia, the tax-spend hypothesis by data from japan, south korea, taiwan, uk and the us; the fiscal synchronisation hypothesis by data from canada; and fiscal neutrality by data from new zealand and thailand. in asia, narayan (2005) tested the nexus between government revenue and expenditure in nine asian countries. the study used the bounds testing approach to cointegration and causality. it was found that in three out of the nine countries government revenue and expenditure are cointegrated. the findings in this study on the direction of causality were mixed; for indonesia, singapore, sri lanka in the short term and nepal both in the long and short-term, data supports the tax-spend hypothesis. for indonesia and sri lanka a spend-tax trend was found in the long term but in all other countries evidence of neutrality was found. a number of studies have used cointegration analysis and error correction techniques to test for the nexus between government revenue and expenditure. in china, for example, li (2001) found bi-directional causality between government revenue and expenditure. in the us, baghestani and mcnown (1994) used a cointegration approach and found evidence of cointegration but not of causality of any kind during the period 1955-1989, while jones and joulfaian (1991) used engle-granger error correction for the period 1792-1860 and found evidence in support of the spend-tax hypothesis. this paper seeks to add to existing knowledge about the government revenue-expenditure relationship in south africa in a number of ways. firstly, monthly data rather than annual data is used, unlike in most other studies; for example, narayan and narayan (2006) and chung et al. (2002) use annual data for the periods 1960-2000 and 1951-1996 respectively. secondly, this study performs unit roots using a modified version of the method developed by hylleberg, engle, granger and yoo (1990)1, to take into account seasonal unit roots at monthly frequency. thirdly, this analysis transcends the standard var by using the vector error correction model (vecm) approach to test the revenueexpenditure nexus in south africa. the rest of the paper is organised as follows: section 2 discusses the theoretical issues surrounding the revenue-expenditure nexus and outlines a method to be used to test for unit roots denominated in monthly frequency. it also discusses cointegration and granger causality tests. section 3 presents the unit root results using the hegy method and cointegration between government expenditure and revenue. it also presents granger causality results. section 4 discusses some conclusions and policy recommendations. 2 theoretical framework and research method a study of the literature reveals four schools of thought regarding the revenue-expenditure nexus, namely the tax-spend, spend-tax, fiscal synchronisation and fiscal neutrality schools. according to the tax-spend theory, rising taxes will simply cause the government to increase 258 sajems ns 10 (2007) no 2 expenditure (see friedman, 1978). as argued by friedman (1982), budget deficit cannot be reduced by simply raising taxes as this only results in more spending, leaving the deficit at the highest level acceptable by the public. the spend-tax school argues the opposite, that rising expenditure causes a rise in revenue. this is motivated by the seminal work of peacock and wiseman (1961, 1979) who argue that increases in government spending in crisis situations leads to permanent changes in expenditure rather than revenue. the third theory, the fiscal synchronisation school, argues that governments may change expenditure and taxes simultaneously. this was proposed by musgrave (1966) and meltzer and richard (1981). this theory assumes bi-directional causality between government expenditure and government revenue. to prove the fiscal synchronisation hypothesis, barro (1979) developed a tax-smoothing model based on ricardian equivalence, stating that deficitfinanced government expenditure today results in future tax increases. the fourth school, the fiscal neutrality school, argues that decisions to spend and raise revenue are taken independently (baghestani & mcnown, 1994). 2.1 seasonal unit root tests on monthly data prior to investigating expenditure-revenue causality in south africa, it is imperative to determine the order of integration of these variables. this is necessary because, as argued in the literature, if the variables are stationary, granger causality is performed directly via a standard var. also, if unit roots exist then estimation of a vecm is necessary. s e v e r a l m e t h o d s a r e p r o p o s e d i n t h e econometric literature for testing unit roots in the context of seasonal time series. these include methods developed by hylleberg et al. (1990), canova and hansen (1995), caner (1998) and shin and so (2000). the hegy method is used in this study, as it allows for simultaneous testing for a unit root at frequency zero (non seasonal unit root) when unit roots may be present at some or all of the seasonal frequencies. we apply the method to monthly data in a manner consistent with the approaches of beaulieu and miron (1993) and ghysels, lee and noh (1994). to test for unit roots at various frequencies, equation 1 is estimated using the ordinary least squares method. y d t y y y y y y y y y y y y 8, t s s 1 11 s, t 2 2, t 1 3 3, t 1 4 3, t 2 5 4, t 1 6 4, t 2 7 5, t 1 8 5, t 2 9 6, t 1 10 6, t 2 11 7, t 1 12 7, t 2 i 8, t i t i 1 p d b r r r r r r r r r r r { f = + + + + + + + + + + + + + + = = ! ! (1) the estimated coefficients of this model facilitate testing for seasonal unit roots by examining the significance of the parameter  i (i = 1,2,3...12), where t is the deterministic time trend, d s,t is the orthogonolised seasonal dummy variable and  t is the error term. a number of transformations shown in equations 1.1 through 1.8 in appendix 1 are performed on the variables of this model. equation 1 is the augmented dickey-fuller auxiliary regression. in order to render the residuals from this equation, white noise, lagged y 8,t is incorporated on the righthand side. to remove seasonal unit roots and preserve the long-run or zero frequency unit root, y 1,t transformation (equation 1.1 in the appendix) is performed. other transformations include y 2,t , which preserves the frequency, , corresponding to a semi-annual period; y 3,t , which preserves the frequency, (1/2)[], that corresponds to quarterly data frequency; y 4,t , y 5,t , y 6,t and y 7,t which preserve the frequencies (5/6)[]; (1/6)[]; (2/3)[]; and (1/3)[] respectively. the null hypothesis of a non-stationary component at the frequencies (1/2)[], (5/6)[], (1/6)[], (2/3)[] and (1/3)[] are respectively based on the fvalues which have a non-standard distribution. the joint f-tests for = = 0, = = 0, = = 0, = = 0, and = = 0 are denoted as f(, ), f(, ), f(, ), f(, ) and f(, ), respectively. in this regard, if = sajems ns 10 (2007) no 2 259 = 0, the possibility of seasonal unit root at frequency (1/2)[] is not rejected; if = = 0, the possibility of seasonal unit root at frequency (5/6)[] is not rejected; if = = 0, the possibility of seasonal unit root at frequency (1/6)[11/6] is not rejected; if = = 0, the possibility of seasonal unit root at frequency (2/3)[4/3] is not rejected; and if = = 0, the possibility of seasonal unit root at frequency (1/3)[] is not rejected. when using the f-values, the null hypothesis of unit root at each frequency is rejected if the f-value is too large compared to the critical values2. 2.2 cointegration analysis a number of methods are suggested in the literature to test causal links between government expenditure and government revenue. in this study, the cointegration approach (johansen, 1985; 1988) is used. in this approach, vector z t is defined where z t = (gr t ,ge’ t )’, gr t is the dependent variable and ge t is the independent variable (or otherwise). if the variables in z t are non-stationary, then by granger representation theorem, parameters can be reset as a vector error correction model (vecm) as follows: 'gr gr ge gr get gr t ge t i t i i p j t j t j p 0 1 1 1 0 d a c s r d j d f= + + + + += = ! ! (2a) or 'ge ge gr ge grt ge t gr t i t i i p j t j t j p 0 1 1 1 0 d a c s r d j d f= + + + + += = ! ! (2b) where  is the difference operator and ge and gr are the logarithms of government expenditure and government revenue, respectively. 2.3 granger causality thus evidence of a cointegrating relationship between government revenue and government expenditure is crucial for the correct specification of a model to test for granger causality. if the absence of cointegration among the variables is established, then a var model is estimated. however, if the variables are non-stationary and cointegrated, a vecm is specified and estimated as: ( ) ( )gr l gr l ge ectt p t q t t t0 11 12 1 1 1= + + + +b h fd d d -rr (3a) and ( ) ( )ge l ge l gr ectt p t q t t t1 21 22 1 1 2d b d d f= + + + +j-r r (3b) where ( )l lij p ijn n p 1 1 ij = r = r ! and ( )l lij p ijn n q 1 1 ij r= = r ! . l is the lag operator while all other variables are as previously defined. using equations 3a and 3b, longand short-run granger causality can be tested. granger causality in the longrun is tested by checking the significance of the parameter estimates of the error correction term (ect t-1 ) where the null hypothesis to test is stated as h 0 : = 0 (i.e. government expenditure does not granger-cause government revenue in the long-run) in equation 3a and h 0 : = 0 (i.e. government revenue does not grangercause government expenditure in the longrun) in equation 3b. on the other hand, granger causality in the short-term is tested via restrictions (joint insignificance) of the parameters q 12r and q 22r in equations 3a and 3b, respectively. this is performed using the wald parameter restrictions test, in which the null hypothesis is h 0 : q 12r = 0 (i.e. government expenditure does not granger-cause government revenue in the short-run) in equation 3a and h 0 : q 22r = 0 (i.e. government revenue does not granger-cause government expenditure in the short-run) in equation 3b. 260 sajems ns 10 (2007) no 2 3 empirical results 3.1 data description and initial analysis this study uses monthly data to test the government revenue-expenditure nexus in south africa. the data is obtained from the south african reserve bank; website www. reservebank.co.za, for the period october 1994 to june 2004. the data has not been seasonally adjusted. source: south african reserve bank figure 1 trends of government expenditure and government revenue in south africa 1994-2004 figure 1 shows a graphical representation of the logarithm of government revenue (ln_rev) against government expenditure (ln_exp) in levels as well as first differences. from the figure it appears that government revenue and expenditure are not stationary. differencing the variables results in the graphs dln_exp and dln_rev which suggest that these variables are integrated in the first order. however, due to the seasonal complications found in time series data of high frequency, formal tests of unit root were conducted, as explained in the next section. 3.2 unit root results the results for conventional augemented dickey fuller (adf) (dickey & fuller, 1979; 1981), phillips-perron (pp) (phillips & perron, 1988) and kwiatkowski(kpss) (kwiatkowski, phillips, schmidt and shin, 1992) tests for unit root3 and the hegy method are reported in table 1 below. sajems ns 10 (2007) no 2 261 table 1 test for seasonal unit roots for government expenditure intercept intercept and seasonal dummies intercept and trend intercept, seasonal dummies and trend t( 1 ) 2.434202 2.439681 –1.927677 –1.169930 t( 2 ) –0.400737 –1.313065 –0.721005 –1.424828 f( 3 , 4 ) 0.538541 2.318863 0.167818 2.338509 f( 5 , 6 ) 0.307488 0.424772 0.147318 0.161822 f( 7 , 8 ) 0.275262 0.724540 0.195340 0.332690 f( 9 , 10 ) 0.629254 2.687057 1.436506 2.397425 f( 11 , 12 ) 1.107888 0.994433 1.416435 1.019352 f( 2 ...... 12 ) 0.686406 1.783679 0.649698 1.629416 f( 1 ...... 12 ) 0.676260 2.279471 0.957883 1.749941 table 1 shows the unit root results of government expenditure; critical values4 are reported in the endnote. the presence of a unit root at a particular frequency is established if the relevant test statistic is less than the corresponding tabulated critical value given in beaulieu and mirron (1993). the seasonal unit roots for government expenditure at monthly frequencies are reported in table 1. from the table it is evident that the model with intercept only shows that the null hypothesis of unit roots at annual and semi-annual frequencies are accepted at 5 per cent level. based on the f-value, on the other hand, the null hypothesis of unit root at quarterly and all other higher frequencies are accepted at 5 per cent level. this, therefore, suggests that government expenditure is non-stationary at annual to monthly frequency. the same results are also found when testing for unit roots using other model specifications listed in columns 3 through 6, which leads to the conclusion that government expenditure is non-stationary. table 2 shows the results of the unit root tests for government revenue. it can be observed that the null hypothesis of seasonal unit roots at annual frequency is accepted at 5 per cent level of testing. table 2 test for seasonal unit roots for government revenue intercept intercept and seasonal dummies intercept and trend intercept, seasonal dummies and trend t( 1 ) 0.007052 –0.487238 –0.760089 –2.044336 t( 2 ) 0.043711 –1.304305 0.170368 –1.301686 f( 3 , 4 ) 4.737344 3.020342 3.255362 2.279778 f( 5 , 6 ) 4.823091 2.6788675 3.817982 3.119904 f( 7 , 8 ) 4.844743 3.824544 3.914884 4.432018 f( 9 , 10 ) 0.008397 4.238258 0.061539 4.399489 f( 11 , 12 ) 1.091147 1.172266 0.830559 0.854623 f( 2 ...... 12 ) 1.69040 2.596049 1.266843 2.890457 f( 1 ...... 12 ) 1.593439 2.426349 1.602339 2.905330 262 sajems ns 10 (2007) no 2 the seasonal unit root at semi-annual intervals is not rejected at 5 per cent level of testing. the null hypothesis of unit roots at quarterly frequency has an f-statistic of 4.74, which is lower than the tabulated critical value of 6.35; thus the unit root is accepted at 5 per cent level. other frequencies also have f-values lower than the critical values tabulated at 6.34, 6.30, 6.37, and 6.31, which, therefore, accept the null hypothesis of unit roots at all frequencies. the same results are found with other specifications leading to the conclusion that government revenue is non-stationary at annual and higher frequency. 3.3 cointegration results as a prerequisite to cointegration within a vector autoregressive framework, a number of tests were conducted. firstly, lag selection was performed using lag selection criteria; most of the tests admit a lag length of 3. tests on the stability of the var showed that our var is stable. the cointegration results based on johansen procedure are reported in table 3. table 3 cointegration test results panel a: rank test (trace) hypothesised no. of ce(s) eigenvalue trace statistic 0.05 critical value prob.  = 0 0.187527 23.93173 20.26184 0.0149 1 0.024373 2.541508 9.164546 0.6693 panel b: rank test (maximum eigenvalue)  = 0 0.187527 21.39022 15.89210 0.0061 1 0.024373 2.541508 9.164546 0.6693 as reported in table 3, the trace test for c o i n t e g r a t i o n s h o w s o n e c o i n t e g r a t i n g relationship at 5 per cent level of testing. the same is true for the maximum eigenvalue test. there is, therefore, a long-run relationship b e t w e e n g o v e r n m e n t e x p e n d i t u r e a n d government revenue in south africa during the period under study. existence of cointegration between these variables, as demonstrated by granger (1988), is evidence of causality at least in one direction. the resulting cointegration graph is presented in figure 2. figure 2 cointegrating vector sajems ns 10 (2007) no 2 263 the long-run models of government revenue and expenditure are as follows: ln_exp = –0.002trend + 1.083 ln_rev (–0.932) (4.191) and ln_rev= 0.002trend + 0.923 ln_exp (1.325) (4.702) in the long-run government expenditure model, the time trend is negative and not significant at the conventional levels of testing. the estimated coefficient of government revenue is positive and significant at 1 per cent level of testing. this, therefore, suggests that a 1 per cent change in revenue leads to a 1.083 per cent change in government expenditure. on the other hand, the long-run government revenue model shows that the estimated coefficient of the time trend is positive but not significant at the conventional levels of testing, while the coefficient of government expenditure is positive and significant at the 1 per cent level, which suggests that a 1 per cent change in government expenditure leads to a 0.923 per cent change in government revenue. in terms of fiscal policy, these results suggest that any increase in revenue will lead to a more than proportionate increase in expenditure such that if the government plans to have a balanced budget, any unexpected increase in revenue will simply occasion higher spending, which will eventually lead to higher fiscal deficits. the same is true where a change in government expenditure leads to a less than proportionate change in government revenue, which implies that government revenue will not respond proportionately and may result in increasing fiscal deficits. table 4 error correction models of government expenditure and government revenue d(ln_exp) d(ln_rev) ecm(–1) –0.675*** (–4.380) –0.529*** (–2.667) d(ln_exp(–1)) –0.324** (–2.296) –0.399** (–2.383) d(ln_exp(–2) –0.191 (–1.488) –0.376** (–2.466) d(ln_exp(–3) –0.001 (–0.014) –0.052 (–0.441) d(ln_rev(–1)) –0.499*** (–3.023) –0.655*** (–3.337) d(ln_rev(–2)) –0.286** –2.168 –0.668*** –4.267 d(ln_rev(–3)) –0.029 (–0.320) –0.070 (–0.648) c 0.018** (2.345) 0.031*** (3.337) d_1 –0.082 (–1.517) –0.068 (–1.055) d_2 0.390*** (6.889) –0.067 (–0.990) d_3 0.201*** (2.882) 0.046 (0.560) 264 sajems ns 10 (2007) no 2 d_4 0.120 (1.467) –0.346*** (–3.561) d_5 0.042 (0.540) –0.347*** (–3.721) d_6 0.023 0.425 –0.248*** –3.881 d_7 0.047 0.791 0.044 0.632 d_8 0.409*** (7.516) –0.065 (–1.008) d_9 0.083 (1.223) –0.025 (–0.315) d_10 –0.058 (–0.794) 0.016 (0.190) d_11 –0.086 (–1.278) –0.226 (–2.832) r-squared 0.92 0.92 adj r-squared 0.90 0.91 durbin-watson stat 1.987 1.919 t-values in parenthesis table 4 reports estimation results based on equations 3a and 3b. the results show that the error correction term in the government expenditure equation is significant at 1 per cent level of significance. this result suggests that any deviation of government expenditure from its equilibrium path will be restored at a rate of 67.5 per cent per month. on the other hand, the estimated error correction term is significant at 1 per cent in the government revenue equation, indicating that any deviation of revenue from its equilibrium path will require adjustment at a rate of 52.9 per cent per month. all these results, therefore, indicate granger causality of a bi-directional nature in the long-run in south africa. this result supports the fiscal synchronisation hypothesis, and contradicts narayan and narayan (2006), who found evidence of fiscal neutrality, and chang et al. (2002), who found evidence of the spend-tax hypothesis in south africa. in light of these results, granger causality in the short-term must be tested for via the wald coefficient restrictions which are shown in the table 5. table 5 short-run granger causality tests x2(3) prob. government revenue equation d(ln_exp(–1) = d(ln_exp(–2) = d(ln_exp(–3) =0 9.399 0.024 government expenditure equation d(ln_rev(–1) = d(ln_rev(–2) = d(ln_rev(–3) =0 16.193 0.001 sajems ns 10 (2007) no 2 265 from table 5 it is evident that the null hypothesis that the estimated coefficients of government expenditure are jointly equal to zero is accepted at 5 per cent level of significance, which suggests that there is no granger causality running from government expenditure to government revenue. on the other hand, the null hypothesis of the joint insignificance (jointly equal to zero) of the coefficients of government revenue in the government expenditure equation is also accepted at 1 per cent level. these findings, therefore, indicate that in the short-term there is no granger causality of any nature. this finding supports the fiscal neutrality hypothesis, and agrees with narayan and narayan (2006), who used annual data and found evidence of fiscal neutrality in south africa during the period 1960-2000. in the short-term, our findings are plausible because expenditure and revenue decisions are taken independently, since daily, weekly and monthly expenditure decisions are made by various government departments in conformity with the existing law while revenue targets are set by the national treasury. 3.4 impulse responses this section explores what happens to government revenue and expenditure in the case of a temporary shock. through the dynamic (lag) structure of the var, the impulse response function traces the effect of a once-off shock to one of the innovations on current and future values of the endogenous variables. this means that it is possible to identify the pass-through effects of shocks on variables. figure 3 reports the results of impulse responses. figure 3 impulse response representation it can be observed from the results that firstly, a shock in government expenditure causes a permanent positive effect on expenditure over the 60 months horizon. secondly, a shock in government revenue also causes a permanent effect on government expenditure. thirdly, a shock in government expenditure causes government revenue to rise permanently over the 60 months horizon. finally, a positive innovation of one standard deviation of government revenue also causes a permanent effect on revenue. 4 conclusion and recommendations this paper investigates the question of government expenditure and government revenue in south africa within the framework of a var approach. a modified hegy method 266 sajems ns 10 (2007) no 2 was used to test for seasonal unit roots at monthly intervals. it was found that government revenue and expenditure have unit roots at all frequencies. further evidence shows that government revenue and expenditure are cointegrated, which implies that in the longrun these principal components of fiscal policy are linked. in view of this, a vecm was used to test for granger causality both in the long and short term. the estimation results show that in the long run, there is evidence of bidirectional granger causality, which supports the fiscal synchronisation hypothesis. however, there is no evidence of granger causality between government revenue and government expenditure in the short term, which supports the fiscal neutrality hypothesis. the se f in dings have important policy implications in both the short and long term. firstly, in the short term, rejection of the fiscal synchronisation hypothesis confirms that expenditure decisions are made in isolation from revenue decisions. this suggests great risk of budget deficits should government expenditure explode relative to government revenue on a month-to-month basis. secondly, evidence of fiscal synchronisation in the long term implies that government expenditure and government revenue decisions are not made in isolation. in other words, the fiscal authority is in full control of the principal instruments of fiscal policy such that at any time, should there be a rapid growth of government expenditure relative to government revenue, the budget deficit will not spiral out of control. endnotes 1 this method is referred to as the hegy from the names of the authors, s. hylleberg, r.f engle, c.w.j granger and b.s. yoo. 2 a summary of the null hypotheses and alternative hypotheses are presented in table a1 in the appendix. 3 the results of the unit root tests based on these methods show that government expenditure and government revenue are integrated of order 1. to conserve space these results are not reported, however, they are available on request from the authors. 4 • a model with a constant: tstatistics of h 0 : 1 = 0 and h 0 : 2 = 0 are –2.80 and 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(1986) “tax and spend or spend and tax”, review of economics and statistics, 68: 179-188. 268 sajems ns 10 (2007) no 2 appendix appendix 1: transformations on the model y 1,t = (1 + l)(1 + l2)(1 + l4 + l8)y t (1.1) y 2,t = –(1 – l)(1 + l2)(1 + l4 + l8)y t (1.2) y 3,t = –(1 – l2)(1 + l4 + l8)y t (1.3) y 4,t = –(1 – l4)(1 – l 3 + l2)(1 + l2 + l4)y t (1.4) y 5,t = –(1 – l4)(1 + l 3 + l2)(1 + l2 + l4)y t (1.5) y 6,t = –(1 – l4)(1 – l2 + l4)(1 – l + l2)y t (1.6) y 7,t = –(1 – l4)(1 – l2 + l4)(1 + l + l2)y t (1.7) y 8,t = (1 – l12)y t (1.8) table a1: tests of seasonal unit root in monthly data null hypothesis alternative hypothesis test statistic  1 = 0  1 < 0 t( 1 )  2 = 0  1 < 0 t( 2 )  3   4 = 0  3   4 ≠ 0 f( 3 , 4 )  5   6 = 0  5   6 ≠ 0 f( 5 , 6 )  7   8 = 0  7   8 ≠ 0 f( 7 , 8 )  9   10 = 0  9   10 ≠ 0 f( 9 , 10 )  11   12 = 0  11   12 ≠ 0 f( 11 , 12 )  2  ......  12 = 0  2  ......  12 ≠ 0 f( 2 ...... 12 )  1  ......  12 = 0  1  ......  12 ≠ 0 f( 1 ...... 12 ) abstract introduction theoretical context and hypothesis development data and methodology results event study results conclusion acknowledgements references appendix 1 footnotes about the author(s) lerato mapela school of economics and finance, faculty of commerce, law and management, university of the witwatersrand, johannesburg, south africa chimwemwe chipeta department of finance, faculty of commerce, law and management, university of the witwatersrand, johannesburg, south africa citation mapela, l. & chipeta, c., 2023, ‘managerial confidence and capital structure announcement effects on share prices on the johannesburg share exchange’, south african journal of economic and management sciences 26(1), a4849. https://doi.org/10.4102/sajems.v26i1.4849 original research managerial confidence and capital structure announcement effects on share prices on the johannesburg share exchange lerato mapela, chimwemwe chipeta received: 21 sept. 2022; accepted: 03 feb. 2023; published: 31 mar. 2023 copyright: © 2023. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: in an attempt to enhance our understanding of the important determinants of the debt–equity choice, there is a need to explore the behavioural facets driving the decision to issue either debt or equity. furthermore, the divergent set of implications of equity and debt issues on the share prices are empirical matters that need to be addressed. aim: in this article the link is investigated between managerial confidence and the likelihood of issuing debt, as well as the share price implications of equity and debt issue announcements on the johannesburg share exchange (jse). setting: the study is based on the equity bond issue announcements of jse-listed firms for the period 2000–2020. method: in this article, panel data regression and event study approaches are used in a sample of 81 and 113 bond and equity issue announcements, respectively, for 69 firms listed on the jse. results: the main findings of this article indicate that managerial optimism drives debt issuing activities on the jse and that there are negative and significant abnormal returns associated with the announcement of equity issues. conclusion: overall, we conclude that behavioural finance is an important factor driving capital structure decisions, and that signalling, as well as market-timing concerns drive share price reactions on the jse. contribution: this article highlights the importance of behavioural factors in capital structure decisions and identifies the firm-specific channels through which managerial optimism drives leverage. additionally, the article sheds light on the role of signalling and market timing in capital structure decisions. keywords: bond and equity announcements; capital structure; managerial confidence; optimism; issuance; abnormal returns; event study. introduction over the past decades, the south african financial markets have experienced a steady growth. the share market capitalisation to gross domestic product (gdp) and private sector credit to gdp grew by 289% and 156%, respectively, over the period 1990–2020.1 in line with this observation, machokoto, areneke and ibrahim (2020) observe a marked increase of 89% in total debt in south africa for the period 1990–2015. given the above context, and the changing landscape of the south african financial markets, it is imperative to re-examine the determinants and implications of the debt–equity choice on share prices of firms listed on the johannesburg share exchange (jse). accordingly, the seminal work of modigliani and miller (1958) has led to a considerable number of studies, attempting to enhance our understanding of the factors that are reliably important in the determination of optimal capital structure. in light of this, there is a strand of empirical literature that documented the traditional factors driving the choice of leverage in developed markets (see barclay & smith 2005; chen 2004; myers 1977), and likewise, in the emerging markets of africa (see abor & biekpe 2005; chipeta & deressa 2016; gwatidzo & ojah 2014; ramjee & gwatidzo 2012). notwithstanding the above contributions, there is a lack of clarity on the behavioural aspects driving the debt and equity choice for our set of firms. a possible and perhaps promising avenue of further inquiry is how managerial confidence drives capital structure decisions. in line with this proposition, information asymmetry in financial markets is likely to drive managers to signal private information. accordingly, the signalling theory of capital structure suggests that managers typically possess information that is not available to other stakeholders such as creditors and investors (barclay & smith 1999; leland & pyle 1977; nenu, vintilă & gherghina 2018; ross 1977). therefore, the choice of debt over equity can be attributed to higher informational costs associated with equity issues. thus, to avoid further downward pressure on the share price, managers of undervalued firms would be more inclined to issue debt. likewise, the addition of debt to the firm’s capital structure can be seen as a way management communicates their confidence that the firm has sufficient cash flows to meet future interest payment obligations (barclay & smith 2005; onchong’a et al. 2016). furthermore, barclay and smith (2005) find that confident managers are more likely to issue debt when the firm is undervalued. thus, we contend that managerial confidence is likely to be associated with debt issuing activity. we further argue that market-timing considerations drive equity issuing activities (see baker & wurgler 2002; kayhan & titman 2007; lemmon et al. 2005). therefore, an issue of equity conveys information to the investors that the share price is overvalued. the empirical evidence in this regard shows that equity offerings follow a negative price reaction (see bhana 1998; masulis 1980; miller & rock 1985). given the above considerations, we conjecture that debt and equity issues are more likely to have divergent implications on the share price of firms listed on the jse. our article contributes to the growing literature on capital structure in the following ways: firstly, we incorporate behavioural finance aspects into the factors driving capital structure decisions on the jse. in particular, we examine the role of managerial optimism in driving debt issuing activity and highlight the firm-specific channels through which managerial optimism influences the likelihood of debt issues. secondly, unlike the predominant literature on capital structure decisions on the jse (see chipeta 2016; gwatidzo & ojah 2009; machokoto et al. 2020), we examine factors driving actual debt and equity issues, as opposed to the evolution of leverage ratios.2 lastly, we test the signalling and market-timing considerations by exploring the implications of debt and equity issues on share prices on the jse. aside from bhana (1998) who focuses exclusively on the implications of an equity issue announcement on share prices, we explore the divergent nature of the implications of debt and equity issues on share prices in firms listed on the jse. the remainder of this article is organised as follows: in section two the theoretical context is discussed and the research hypotheses are formulated; in section three the data and methodology are considered. in section four the basic and empirical results are discussed, while a conclusion is offered in section five and recommendations made for future research. theoretical context and hypothesis development managerial confidence our first hypothesis attempts to link behavioural finance with variations in capital structure. the behavioural finance literature has argued that human biases directly affect corporate and investment decision making (see de bondt & thaler 1987; kumar & goyal 2015; shefrin 2001). in the context of capital structure, soufani et al. (2012) suggest that chief executive officers (ceos) are subject to sentiments such as being confident and optimistic, ultimately influencing their choice to issue debt over equity. the empirical literature on behavioural finance and leverage decisions largely confirms a positive association between managerial confidence and the choice of debt. for instance, using the university of michigan consumer sentiment index as a proxy for managerial confidence, oliver (2005) finds a positive and significant association between managerial confidence and leverage. in a related study, barros and da silveira (2007) utilise internal measures such as whether a manager is a founder or hired executive, ownership of shares by management, and the duration of time they are holding onto these shares in their personal investment portfolios as an indication of optimism and confidence. they report a significant positive relationship between the confidence proxies and leverage. likewise, other related studies confirm that overoptimistic or overconfident managers choose high levels of debt and issue more debt than equity (esghaier 2017; hackbarth 2008; hasani alghar & rahimian 2018; malmendier & tate 2008; tan 2017). furthermore, malmendier and tate (2015) posit that overconfident ceos tend to shy away from equity as a form of financing in efforts to protect existing shareholders from perceived dilution. these findings suggest that the more confident a manager is regarding the prospects of their firm, the more they will be inclined to issue debt as a form of financing. thus, we formulate and test the following hypothesis: h1: there is a positive and significant relationship between managerial confidence and the choice of debt. having established the behavioural factors influencing the choice of debt, we formulate our second hypothesis which is based on the market-timing theory and the potential implications of equity-issue announcements on the share price. the market-timing theory suggests that managers take advantage of market conditions by issuing equity (debt) when the share price is high relative to its book value. accordingly, the empirical literature on market timing finds that the observed capital structure choices are a result of attempts by managers to take advantage of market conditions (baker & wurgler 2002; huang & ritter 2005). consequently, an equity issue may be perceived by the investors as overvalued. this situation is exacerbated by information asymmetry around financial reporting. for instance, accounting issues such as earnings manipulation, and reporting errors render it difficult for outsiders to make an accurate valuation of the share. thus, managers are often aware of the biased nature of their reporting, hence this enables them to derive a more accurate valuation of whether the share is under/overvalued. therefore, based on the assumption that managers are well informed when it comes to their own share valuation, an equity issue may signal to the market that the firm’s share price is overvalued. the literature on the effects of corporate financing activity on the share price shows that the use of external financing by means of an equity issue is perceived as unfavourable news to the market (see covitz & harrison 1999; kim, ko & wang 2019; miller & rock 1985; myers & majluf 1984; seetharam & da cunha 2018). consequently, an equity issue is likely to be followed by a decline in the share price. given the above arguments, we formulate and test the following hypothesis: h2: equity-issue announcements have a negative and statistically significant effect on the share price. our third hypothesis is formulated on the basis of the signalling theory, and the potential implications of bond-issue announcements on the share price. the signalling theory asserts that, due to information asymmetries, the market reacts to information released by firms, and that management possess information that outside investors do not have access to (see bhattacharya 1979; leland & pyle 1977; lopatta, buchholz & kaspereit 2016; ross 1977). furthermore, not all information possessed by managers can be directly disclosed in financial statements. therefore, management will attempt to make valuable information-revealing decisions in the hope that the market will react favourably to the news. these actions taken by managers in possession of insider information are perceived by outside stakeholders as ‘signals’ of firm quality. the empirical literature on signalling suggests that managers know more about the firm’s future prospects than investors (see besley & brigham 2003; ehrhardt & brigham 2003; howe & morillon 2020). likewise, an issue of debt may be perceived as an obligation of the firm to make regular interest payments over a certain maturity period. accordingly, barclay and smith (2005) argue that managers are aware of the costly risk associated with missing these payments. therefore, increasing debt may convey a ‘credible signal’ to the market that management is confident regarding its ability to pay off future obligation in terms of interest payments. furthermore, the academic literature advanced the notion that the tax deductibility nature of interest payments causes the value of the firm to increase with an issue of debt (see galai & masulis 1976; jensen & meckling 1976; leland & pyle 1977; myers 1977). accordingly, there is some evidence in the literature confirming that debt issues are followed by a share price increase (cornett & travlos 1989; flammer 2021; masulis 1983). given the above arguments, we formulated and tested the following hypothesis: h3: bond issue announcements have a positive and statistically significant effect on the share price. data and methodology data we examined a sample of jse-listed firms engaged in successful equity and bond issues for the period january 2000 – january 2020. we limited our sample period to january 2020 to avoid the confounding effects of coronavirus disease 2019 (covid-19). similarly for the event study, we exclude equity and bond announcements during the period of the global financial crisis of 2008 and 2009.3 data on security-issue announcements and daily share prices were obtained from bloomberg, while data on the rest of the firm-specific determinants of the debt equity choice were obtained from iress expert and equityrt databases. we included financial institutions such as banks, asset management firms and insurance companies because a large proportion of bond issues were conducted by firms in this industry. because these firms are highly regulated, we assigned them a dummy variable to differentiate them from other industries for both the bond and equity issues. after applying the above criteria, the final sample for bond and equity issues was reduced to 69 firms and 1072 observations. to eliminate the confounding effects of outliers, our variables were winsorised at the 1st and 99th percentile. estimation models in order to examine the factors that drive debt-issuing activity, we utilise the following probit logistic regression model: where debti,t is a binary variable that captures the firm’s decision to issue debt relative to equity. β1 confidencei,t captures the effects of managerial confidence4 on the choice of debt relative to equity, and β2x′i,t is a vector of firm-specific control variables identified in the literature to influence capital structure. these variables are defined in the appendix in table a1. to examine the impact of capital structure announcements on the share price, we utilise an event study methodology. to achieve this objective, daily share price returns are calculated for the period ranging from minus 250 to minus 20 trading days for the participating firms, as well as the market index (j203) for the same period. following wolmarans and sartorius (2009), we employ a market model to examine the cumulative average abnormal returns (caars) for five event window periods reported in table 1. the expected return is expressed as follows: table 1: the average values of cumulative average abnormal returns across different windows relative to the announcement of bond and equity issues. where ri,t is the return on security i in period t, αi is the alpha intercept βi is the beta of firm i. rm,t is the return on the jse market portfolio at time t, and ɛi,t is the residual term (white noise). the abnormal returns are calculated as follows: where ari,t is the abnormal return of security i at time t, ri,t is the return on security i at time t, rm,t is the return on the market index at time t. thus, the average abnormal return is estimated as follows: where aart is the average abnormal return for the number of bond and equity issues at time t, n is the total number of bond or equity issue announcement used in the sample. the aars are summed up through the entire event window to form a caars as follows: the significance of the caars is tested using the wilcoxon signed-rank test for caars relating to equity announcements as they were found to be non-parametric. a classic parametric t-test for caars is utilised for the bond announcements as they are normally distributed. ethical considerations the authors confirm that the project does not involve human participants or the use of their data. the authors confirm that they have collected data that are freely accessible in the public domain only. ethical clearance was obtained from the research ethics committee from the university of the witwatersrand. results basic results in this section, we examine whether firm-specific variables explain the debt–equity choice. next, we present event study results that measure the significance of the announcement of debt and equity issues on the listed firm. table 2 reports the summary of descriptive statistics. table 3 reports the pairwise correlations of all the variables used. the correlation coefficients are not large enough to indicate that there is a problem of multicollinearity. the different signs of the relationship between managerial confidence, size and tangibility in the correlation matrix and regression analysis indicate that suppressor effects do exist. this situation is described by falk and miller (1992) when the correlation matrix and regression model exhibit two different relationship signs between variables.5 furthermore, the authors explain that in a situation where suppressor effects are present, the correct sign interpretation is that given by the regression coefficient. table 2: summary of descriptive statistics. table 3: correlation matrix. empirical results in this section, we report the regression and event study results. the regression results are presented in table 4. in line with our expectations, we find that managerial confidence influences the likelihood of issuing debt relative to equity. the coefficient on the confidence variable is statistically significant at the 5% level, implying that a percentage increase in the managerial shareholding results in a 4.74% likelihood of a debt issuance. this finding is consistent with hypothesis 1, and the extant literature that documents evidence that confident managers are more likely to issue debt when faced with a financing decision (see barclay & smith 2005; barros & da silveira 2007; hackbarth 2004; oliver 2005). in an unreported analysis, we perform additional tests to ensure that our results are robust across other alternative measures of managerial optimism. following barclay and smith (2005), we identify observations of firm years in which earnings are lower than the following year, and assign these observations a value of one, and zero otherwise. we do the same for the return on assets and return on equity. none of these coefficients are statistically significant.6 thus, we conclude that increases in the share ownership by insiders, or managerial optimism, is a significant driver of the likelihood of debt issues. table 4: regression results for the factors influencing the likelihood of issuing debt. to probe the channels through which managerial confidence influences the likelihood of debt issues, we interact the firm-specific variables with our confidence proxy and report the results in models 2–6. in line with expectations, we show that confident managers in larger and asset-intensive firms are significantly more likely to issue debt. this finding reinforces the notion that firm size and asset tangibility bolster the confidence in managers to issue more debt. in contrast to our expectations, managers in firms with high market-to-book (mtb) ratios (overvalued firms) are significantly more likely to issue debt. our intuition is that concerns about contracting costs, associated with intangible growth opportunities, do not deter confident managers in their decisions to issue debt. likewise, the positive coefficient on the interaction between leverage and our confidence variable suggests that concerns about financial distress or debt-overhang issues do not deter confident managers from issuing debt. these findings underscore the notion that confident managers underestimate the risk of potential bankruptcy associated with debt issues (see azouzi & jarboui 2012; rihab & lotfi 2016). the signs on the coefficients of the control variables are, by and large, consistent with the theoretical predictions of capital structure. in line with the trade-off theory, size and asset tangibility are positively associated with the likelihood of a debt issue. this is because these variables serve as reverse proxies for financial distress and bankruptcy (see de jong, kabir & nguyen 2008). conversely, the coefficient on the mtb ratio is negative and statistically significant. this finding is in line with the market-timing theory suggesting that managers tend to take advantage of the market mispricing and will issue equity when their share is overvalued. thus, we conclude that, trade-off and market-timing considerations appear to influence the capital structure decisions for our set of firms. having established the factors that drive debt issuance on the jse, we further examine the financial implications of the equity and debt announcements. in the next section we explore an event study approach to achieving this objective. event study results in this section, we discuss the event study results for equity and bond issues. figure 1 shows that equity issues generally experience a decline in returns over the 20 days prior to the event and 10 days after the announcement. the returns over the 41-day period have been mostly below 0% with a huge decline in about 2 days before the announcement. the unexpected spike in the returns immediately after the announcement date is somewhat surprising as one would expect a further decline in the share price immediately after the equity announcement. however, the overall trend in the graph, shows that there are negative caars indicating a negative market reaction associated with equity announcements. figure 1: cumulative average abnormal returns for equity and bond announcements (a–b). conversely, the caars for bond announcements are relatively close to zero for the 20 days before the announcement. additionally, we observe an increase in the caars between day 0 and +3 reflecting the positive news associated with bond announcements. however, from day +3 to around day +6, the returns begin to decline drastically. this reversal can be attributed to the efficient market hypothesis that proposes that there is an almost instantaneous adjustment to the release of firm-specific information. from day +6 onwards, there is a spike in the returns reaching almost 1%, followed by a decline. the results in panels a and b of table 1 report caars for equity and bond issues respectively. for equity announcements, caar1, caar4 and caar5 are negative and statistically significant at the 1% level. however, caar2 and caar3 are negative but not statistically significant. overall, the results indicate that there is a negative and significant share price reaction to equity issue announcements. these results are consistent with hypothesis 2, and the extant literature on share price reactions to equity issue announcements (see bhana 1998; masulis 1980; miller & rock 1985). contrary to our expectations, the results in panel b show that, on average, the returns are consistently below zero for all event windows. however, except for caar5, the abnormal returns are not statistically significant across all event windows. our findings are inconsistent with hypothesis 3 and the literature that argues that debt issues are associated with a positive share price reaction (see cornett & travlos 1989; flammer 2021; masulis 1983; smith 1986). in contrast, our finding is largely consistent with the studies that show that debt issue announcements do not have a material effect on the share price (see mikkelson & partch 1986; eckbo 1986). the plausible explanation to this finding is that, in contrast to equity offerings, debt issues have lower information costs (see myers & majluf 1984), and thus the announcement effect of a debt offering on share prices may be muted. conclusion the purpose of this article is twofold: firstly, to explore the behavioural financial implications on capital structure decisions, and secondly, to examine the announcement effects of equity and bond issues on share prices. we utilise panel data and event study techniques to achieve the former and latter objectives, respectively. in line with the signalling hypothesis, we find that confident managers are significantly more likely to issue debt. we further show that the announcement of equity issues generates negative and statistically significant caars, while the financial implications of bond issue announcements are by and large muted. our results provide useful insights for future research. for instance, it would be worthwhile to expand the sample to explore other african markets with 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from the world development indicators (2022). 2. leverage ratios can be affected by variations in the market value of equity. thus, leverage ratios can vary significantly, even if there is no debt issue. 3. to further ensure that our results are not confounded by major corporate actions around the announcement periods, we eliminate firms that engaged in both bond and equity issues for the 60 days around the announcement date. 4. one of the limitations of capital structure decisions and behavioural finance is that a consensus on an agreed proxy has not been reached when it comes to the behavioural measurement of capital structure (de bondt & thaler 1987; shefrin 2001). however, this study considers the percentage of equity owned by directors of the firm. we argue that managerial ownership is a fitting proxy for confidence because a high-percentage ownership holding is indicative that management is confident about the prospects of the firm, and vice-versa. furthermore, due to the difficulty of measuring confidence quantitatively, we refrain from using the sentiment indices as used in other studies as these do not sufficiently represent the confidence of the board on a firm-level basis. 5. according to falk and miller (1992), there are three possible reasons for this suppressing effect: (1) the two variables’ relationship is very close to zero, thus the sign reflects random variations around zero. (2) there could be one or more variables in the model that contain the same information and therefore are redundant. (3) suppressing occurs due to an important explanatory variable necessary to understand the ‘true’ relationship of the variables, while suppressing the effect of another. 6. the results are available upon request. microsoft word 3 lee sajems 17(1) 2014.docx 140 sajems ns 17 (2014) no 2:140-156 team characteristics, peer competition threats and individual performance within a working team: an analysis of realtor agents chung chan lee national pingtung institute of commerce, department of real estate management, taiwan accepted: july 2013 this paper uses survey data from a questionnaire for brokers given to kaohsiung realtors in order to explore the effect of the threat of peer competition on an individual’s performance. in the empirical model, the branch “average performance of other agents” is used as the proxy variable for peer competition, and the hierarchical linear modeling (hlm) model is applied for estimation. the empirical results suggest that the average performance by other agents has a significant negative effect on an individual’s performance. in branches that have more “agents” or have a “team compensation scheme”, the effect of other agents’ average performance on an individual’s performance is significantly higher than that for the branches with fewer “agents” or without a “team compensation scheme”. these findings are consistent with theoretical expectations. key words: individual performance, team compensation scheme, peer competition threat, hierarchical linear modeling jel: j101, 131, 133 1 introduction early organizational management literature often uses human capital models to verify the impact of education and work experience on an individual’s income. empirical results suggest that education and work experience have a positive impact on an individual’s income (for example, mincer, 1970, 1974; mincer ＆ polachek, 1974). follain, lutes and meier (1987) studied the income of realtors at an earlier stage in real estate research. glower and hendershott (1988); crellin, frew and jud (1988); jud and winkler (1988); and sirmans and swicegood (1997, 2000) also discussed the topic. more recently, benjamin, jud and sirmans (2000) provided a comprehensive review of these works and summarized them in tabular form.1 in addition to these discussions on labor capital’s effect on job performance, the impact of incentives has also become an important labor economics topic in recent years (baron ＆ kreps, 1999; lazear, 1998). lazear (1999) has indicated that, owing to the challenges in accessing data, most discussions have been purely theoretical, with studies from an empirical perspective remaining limited. the research topics have related to “individual performance” measures (relevant studies include those by paarsch and shearer (1999, 2000), booth and frank (1999), and lazear (2000)). drago and garvey (1998) conducted an empirical study on the interactive relationships among members of a working team. however, empirical analysis of the interactive relationships among working team members is, generally speaking, under continuous analysis and development. at present, there is no literature examining real estate agents’ performance using the concept of the working team. kandel and lazear (1992) noted that, in a working team, the team’s norms may be established by peer pressure aimed at enhancing the team’s overall performance. lazear (1998) argued that members of a corporate organization could form a working team. the interactive relationships among team members often have a significant impact on the team’s output. thus, if team compensation schemes are adopted in the corporate organization, team abstract sajems ns 17 (2014) no 2:140-156 141 performance is expected to be enhanced; moreover, a large company size is also expected to increase team performance. crellin, frew and jud (1988) suggested that a larger company size and a higher number of sales agents results in higher incomes for the latter. notably, however, team cooperation may reduce individual working motivation and create social loafing behavior, as team members come to expect more from other employees (karau ＆ wlliams, 1993). lazear (1998) has noted that, although team compensation schemes may improve team performance, they may also result in a freeriding problem by reducing individual employees’ work incentives. teamwork’s impact on a team’s performance has been the focus of previous studies and discussions (kandel ＆ lazear, 1992; crellin, frew ＆ jud, 1988; karau ＆ wlliams, 1993). from the perspective of individual performance, an increase in the number of sales agents increases the level of competition for business among the agents, possibly resulting in a negative impact on individual performance. according to kandel and lazear (1992), when the “average performance of others in the team” increases, it will stimulate the individual performance of each team member. when the average peer performance improves, individuals will be encouraged via peer pressure to improve their own performance. when the team compen sation ratio is higher, others’ average performance will have a greater impact on individual performance. kandel and lazear grounded their proposals in theoretical analysis. although they used japanese general manufacturers as their example, they did not empirically test their theories. therefore, whether or not their theories are applicable to the housing brokerage industry, with its competitive and cooperative peer structure and its emphasis on individual performance, is a subject open to empirical testing. in addition, the housing brokerage industry emphasizes individual performance and team cooperation. in taiwan, the salary structure at real estate brokerage companies typically involves an individual performance-based salary, with some companies also providing team bonuses. peer working relations demonstrate the competitive relationships among members of the corporate organization. with limited resources, peers may strive for business opportunities. according to this study’s survey, 55 per cent of the respondents report that peers have competed with them for business cases in the past.2 the “average performance of other agents” may therefore imply active peer competition over cases, a phenomenon which can cause negative individual performance. in brokerage companies with a team compensation scheme, there will be fewer visible problems related to free-riding and social loafing. if the average performance by others is relatively better, this will highlight the performance of other team members and possibly strengthen the competition threat for individuals. although some empirical studies in educational economics and regional economics use the peer effect as the topic of analysis, there are few empirical analyses of the impact of peer competition on an individual’s performance in real estate studies. the housing brokerage industry itself emphasizes individual performance and team cooperation, as well as competition. hence, understanding the impact of the peer competition threat on the individual performance by realtors is a topic for further analysis and discussion. the main purposes of this study are as follows: (1) to discuss whether the average performance of others (representing a peer competition threat) has any negative impact on an individual’s performance; (2) to discuss whether more agents or a team compensation scheme lead to lower individual performances; and (3) to discuss whether the marginal effect of the average performance by others on individual performance increases with a greater number of agents or with a team compensation scheme. as individual agents are nested in brokerage branches, the research data for this study has a nested structural relationship. using the traditional ols for estimation may violate the error term independence homogeneity assumption (raudenbush ＆ bryk, 2002). this paper thus applies a two-level linear model for estimation. this paper is organized into the following six sections: section 1 is the introduction; section 2 presents the literature review; section 3 describes the research method and empirical model structure; section 4 explains the data source and variable setting; section 5 contains 142 sajems ns 17 (2014) no 2:140-156 the empirical results and analysis; and section 6 presents conclusions and suggestions. 2 literature review traditionally, human capital models are employed to analyze labor income or work performance. regarding the impact of a peer group on individual behavioral performance, many studies have been conducted in educational economics, regional economics, and other fields in recent years (case ＆ katz, 1991; evans, oates ＆ schwab, 1992; norton, lindrooth ＆ ennett, 1998; gaviria ＆ raphael, 2001; mcewan, 2003; mossholder, richardson ＆ settoon, 2011). after accounting for variables previously shown to factor into earnings, anderson, byrd, and hurst (2012) found that persons entering into real estate directly as a first career and those with experience in sales or retail do significantly better than others with different backgrounds. kandel and lazear (1992) found that when the average performance of others in the team increases, this inspires the individual performance of each team member. in other words, when the average performance of one’s peers improves, individuals are encouraged to improve their own performance owing to peer pressure costs. when an individual’s performance is higher than the others’ average performance, the peers’ average performance will increase, thus making the individual’s excellent performance appear less significant. moreover, when the team bonus rate increases, the rising peer pressure leads to a gradient marginal effect of others’ average performance on an individual’s performance. in other words, when the team bonus rate is relatively higher, the effect of others within the same team’s average performance on an individual’s performance will be greater. babcock, bedard, charness, hartman and royer (2012) found that team rewards can transcend personal rewards. lee (2012) discussed the impact of compensation schemes on housing agent performance. according to lee’s results, the individual performance of agents under a type i compensation scheme, which is similar to the japanese model of a high base salary and a low proportion of compensation based on performance, is not significantly better than the individual performance of agents under a type ii compensation scheme, which is similar to the american model of zero base salary and a high proportion of compensation based on performance. corgnet, hernan-gonzalez and rassenti (2013) found that, with the use of team awards, those individuals entrusted by the organization with peer supervision will exert strong peer pressure to bring organizational production levels to a greater level of productivity. for housing brokerage companies in taiwan, some individual branches can be regarded as working teams. on a working team (branch), when the performance of an individual agent is superior to that of others on the team, it may mean that the competition among individuals to perform exceptionally is high. moreover, the survey data from this study suggest that 83 per cent of agents receive an individual performance bonus rate above 50 per cent; and that 55 per cent of agents engage in peer competition for business. these findings suggest that the average performance of other agents in a branch may also imply a peer competition threat. thus, this study proposes h1: h1: the average performance of other agents in a branch has a significant negative impact on individual performance. lazear (1998) argued that the team’s job characteristics, incentive mechanisms (e.g., salary structure) design, and team size will all affect the efforts and interactive relationships among team members. using data from continental airlines in the u.s. during the period from 1994 to 1996, knez and simester (2001) conducted an empirical study in which they found that a team compensation scheme can improve a company’s internal performance. however, lazear (1998) argued that, while the team compensation scheme may help enhance the team’s performance, it may also create a free-rider problem and reduce the work incentives for individual employees. thus, this study proposes h2: h2: a team compensation scheme has a significant negative impact on individual performance. the fierce contention for cases will result in a higher average performance by other agents in a branch and lower individual performance. for brokerage companies with a team compensation sajems ns 17 (2014) no 2:140-156 143 scheme, if others’ average performance is higher, this may indicate that the performance by other agents strengthens the individual competition threat. in other words, the team compensation scheme may lead to the problem of free-riding, thus strengthening the negative marginal effect of others’ average performance on an individual’s performance. thus, this study proposes h3: h3: a team compensation scheme has a significant negative impact on the marginal effect of others’ average performance [on individual performance]. as the members of the working team are relatively few, it is easier for them to engage in mutual monitoring, rendering the free-rider problem less serious. for a larger team, however, it will cost more to implement monitoring, and it is difficult to supervise members. meanwhile, individuals receive smaller percentages when sharing the team’s rewards. as a result, the free-rider problem will be more serious (lazear, 1998). knez and simester (2001) also discussed the impact of company size on the free-rider problem and found that there was no free-rider effect.3 using an experimental approach, falk and ichino (2003) analyzed the performance of employees facing peer pressure. their research findings suggested that “pair work” had a higher output than “work alone”. moreover, the perceived peer pressure among employees with low productivity was more intense than among employees with higher productivity. in terms of studies on the performance of housing brokerage industry employees, follain, lutes and meier (1987), and crellin, frew and jud (1988) found that realtors earn higher incomes when they belong to a larger company with more agents. from another perspective, if the number of sales personnel is larger, the problems of free riding and social loafing will be more serious, and thus the impact on individual performance will be more negative. this result was also found by lazear (1998) and karau and wlliams (1993). janhonen and johanson (2011) further illustrated that the smaller the team size, the more beneficial it will be to the team performance. thus, this study proposes h4 and h5: h4: a greater number of agents will have a significant negative impact on individual performance. h5: a greater number of agents will have a significant negative impact on the marginal effect of others’ average performance [on individual performance]. 3 research method 3.1 hierarchical linear modeling traditionally, an ordinary least squares (ols) regression model has been used to model individual performance. however, this regression mode does not take advantage of nested data when modeling individual performances. rauden bush and bryk (2002) note that previous analyses of multilevel data are vulnerable to problems such as aggregation bias, misestimated standard errors and heterogeneity of regression errors, since an individual agent is not a single object, but is rather an object belonging to a branch and a company organization. individual agents in the same branch (or organization) share the branch’s characteristics; that is, agents share characteristics with each other. branch-level characteristics, such as the number of employees and the group bonus, will have an impact on samples and will enable the residuals to violate any independent assumption of the regression model, resulting in an overestimation of the error variance and an underestimation of the regression coefficient standard error. in the past, ols estimates of individual agent performance have often treated the data that pertains to different hierarchical levels (such as branch characteristics and individual characteristics) as a single level. in fact, relationships between individual agent performance and individual agent characteristics must be addressed in different units or organizational levels. hierarchical linear modeling (hlm) is a relatively new approach to modeling nested data. raudenbush and bryk (2002) outline various applications and statistical techniques associated with the model. hlm can resolve the problems encountered with traditional ols regression analysis by avoiding misestimates of standard errors, as well as by ignoring the heterogeneity of regression error terms and errors in aggregation. 144 sajems ns 17 (2014) no 2:140-156 3.2 traditional regression model to create a traditional regression model, the ols model was first established. with respect to micro-level variables, the dependent variable is individual performance (y). explanatory variables include gender, education (college graduates or above), ihour (individual working hours), oy (average performance of others), hoy (comparison of individual perfor mance and average performance of others), wexp (work experience), swexp (squares of work experience), hoy (the number of brokerage branch agents), and gbon (team compensation scheme). the model settings are as follows: yi = β0 +β1genderi +β2educationi +β3ihouri +β4oyi +β5hoyi +β6wexpi +β7swexpi +β8sizei +β9gboni +ri,ri ~ n(0,σ 2 ) (1) (1) where the subscript of the variable refers to the i th agent rather than the j th branch, indicating that the traditional regression model has not been set according to the nested structure. moreover, the error terms of individuals of different levels i are assumed as independent and homogeneous. hence, the ols model is used for estimation. in fact, the error terms of individuals of different levels are often not independent and homogeneous, but are homogeneous within the group and heterogeneous between groups. therefore, in the nested data structure, the ols model can easily violate the independently, identically distributed assumption. 3.3 hierarchical linear modeling this paper uses the following three hlm submodels: the null model, the random coefficient regression model, and the intercepts and slopes-as-outcomes model for empirical studies. as for micro-level variables, dependent variables include individual performance (y); explanatory variables include gender, education, ihour (individual working hours), oy (average performance of others), hoy (comparison of individual and average performance of others), wexp (work experiences), and swexp (squares of work experiences); and branchlevel characteristic variables include size (the number of brokerage branch agents) and gbon (team compensation scheme). the empirical estimation takes the centered grand mean of the continuous variables. the main goals of this study are as follows: (1) to discuss whether the average performance of others (representing the peer competition threat) has a negative impact on individual performance; (2) to discover whether more agents and a team compensation scheme lead to lower individual performance; and (3) to discover whether the marginal effect of the average performance of others on an individual’s performance increass when there are more agents or there is a team compensation scheme. the research structure is illustrated below in figure 1. 3.3.1 model 1: null model this method tests whether average individual performance in various branches of kaohsiung, taiwan, differ without taking any explanatory variables into consideration. the main purpose of this model is to distinguish between the intra-branch (intra-group) and inter-branch (inter group) variation in individual performances in an analysis similar to the one-way anova. the model settings are as follows: level 1 (micro-level): yij = β0j + rij, rij ∼ n(0,σ 2), (2) level 2 (branch-level): β0j = ϒ00 + u0j, u0j ∼ n(0,τ00), (3) where yij is the performance of the ith agent in branch j; βoj is the group mean of the performance in the jth branch; σ2 is the variance of the error term rij (i.e., variances within groups); ϒ00 is the grand mean performance for all agents in the sample; and the error term u0j represents the random effects associated with branch j and is assumed to have a mean zero and a variance of τ00. the null model is derived by adding eq. (3) to eq. (2) as follows: mixed model: yij = ϒ00 + u0j + rij. (4) sajems ns 17 (2014) no 2:140-156 145 figure 1 research framework level 2: branch-level (characteristic variables) level 1: micro-level (explanatory variables) gender education ihour hoy wexp swexp y(individual performance) (dependent variable) size gbon h1 h4 h2 h5 h3 oy this is the standard one-way anova model with a mean ϒ00, a branch effect u0j and an individual agent’s effect rij. it is therefore possible to treat eq. (4) as an anova model when examining whether there are variances in the mean performance of respective branches. in other words, the equation is used to validate “the differences between an individual agent’s performance and the mean performance of the branches. if the variance between groups or the random component yields a significant test result, the mean performance differs between branches. this means it is necessary to consider the differences between branches. if the test result is not significant, it is acceptable to ignore the differences between these branches. this operation implies that the data can be treated at a single level and can be estimated with eq. (2). however, if there are differences in the mean performance of the respective branches, it is necessary to use eq. (4), so that different regression equations are applied to the respective branches. in the null model, var(yij) = var(u0j + rij) = τ00 + σ 2. if ρ = τ00 / (τ00 + σ 2) ρ is called the intra-class correlation coefficient (icc) or cluster effect (raudenbush ＆ bryk, 2002). the icc measures the proportion of variance in the dependent variable that is accounted for by the group (i.e., branch-level or level-2 units). this coefficient shows the proportion of variance in performance that is attributable to differences at a branch level. as soon as the variance of the mean performance for different branches is confirmed, further discussion on the characteristic variables concerning branches, which can explain such a variance, becomes possible. 3.3.2 model 2: random coefficient regression model if the null model confirms that the inter-group variation in dependent variables is significant, the explanatory variables of agent characteristics are added at level-1, including gender, education, ihour, oy, hoy, wexp and swexp, setting the intercept and slope as random effects. the purpose of doing so is to test whether the variation of intercepts and slopes between groups is significant. the model settings are as follows: level 1 (micro-level): yij = β0 j +β1jgenderij +β2 jeducationij +β3 jihourij +β4 joyij +β5hoyij +β6 jwexpij +β7 jswexpij +rij,rij ~ n(0,σ 2 ) (5) level 2 (branch-level): βlj =γl0 +ulj,ulj ~ n 0,τll( ),l =0~7. (6) no level-2 explanatory variable (branch characteristics) is added in the random coefficient regression model, and only the impact of level-1 explanatory variables (agent characteristics) on dependent variables is taken 146 sajems ns 17 (2014) no 2:140-156 into consideration. in the proposed model, explanatory variables are added in order to understand whether level-1 explanatory variables have a significant impact on dependent variables. a significant level of random-error variance means the marginal values of level-1 agent characteristics are random and not fixed, indicating that there are other factors causing the differences in agent performance in various branches. 3.3.3 model 3: intercepts and slopes-asoutcomes model the intercepts and slopes-as-outcomes model can evaluate whether level-2 characteristic variables can moderate the impact of level-1 explanatory variables on dependent variables. a moderating effect exists between level-2 variables and level-1 variables, so the explanatory power of a level 1 variable can change in strength with a change in a level-2 variable. first, the sizej and gbonj are specified to influence the intercepts and slopes of the level1 prediction equation. this study attempts to verify, in cases with a team compensation scheme, whether a higher number of agents will lead to a lower level of individual performance (eq. (8)) and whether the marginal effect of others’ average performance on an individual’s performance increases in a gradient pattern (eq. (9)). the settings are as follows: level 1 (micro-level): yij = β0 j +β1jgenderij +β2 jeducationij +β3 jihourij +β4 joyij +β5hoyij +β6 jwexpij +β7 jswexpij +rij,rij ~ n(0,σ 2 ) (7) level 2 (branch-level): β0 j =γ00 +γ01sizej +γ02gbon j +u0 j,u0 j ~ n(0,τ00 ) (8) β4 j =γ40 +γ41sizej +γ42gbon j +u4 j,u4 j ~ n(0,τ44 ) (9) βlj =γl0 +ulj,ulj ~ n 0,τll( ),l =1 ~ 3,5 ~ 7. (10) where, ϒ01, ϒ02 denote the cross-level direct impact of sizej and gbonj on individual performance. statistically significant levels of γ41,γ42 indicate the existence of moderating effects between level-2 variables and level-1 variables; that is, the branch characteristics can moderate the impact of an agent’s characteristics on individual performance. the ols model assumes that the random errors are homogeneously variant (ri ∼ n(0,σ 2)), but hlm allows the random errors to vary between groups (as rij ∼ n(0,σ 2)) in equation 7 and uij ∼ n(0,τll) in equations 8, 9, and 10), suggesting the concept of homogeneity within the group and heterogeneity between groups. the ols model estimates the intercept and slope by using the fixed effect; hence, the error terms between data groups are not considered (as ull in equations 8, 9, and 10). it is therefore unclear whether individual performance varies between branches or whether the impact coefficient of individual level variables on individual performance is random; that is to say, whether or not the coefficient will vary between branches or groups. 4 data collection and variable setting 4.1 data collection the data in this study is from a questionnaire survey. the questionnaire survey respondents are housing brokerage agents in kaohsiung, taiwan (including brokers and sales personnel). the advantages of treating real estate agents as the subject of analysis are as follows: (1) for individual agents, work performance can be measured by the individual’s performance without the disruption of uncertain measurements; and (2) the housing brokerage industry usually operates in branches, so the definition of a working team will be more specific. in taiwan’s brokerage market, brokerage agencies can be divided into chain brokerage agencies and independent agencies. independent agencies are generally smaller in size and less institutionalized, and are thus often lacking in brand reputation. they are therefore difficult to investigate. hence, this study used chain brokerage agencies of a larger size (18 sajems ns 17 (2014) no 2:140-156 147 salespeople per branch on average) that were healthy institutions with a better brand image as the survey subjects. the content of the questionnaire was based on the research objective and was modified with reference to past literature and questionnaires (we mainly referred to the study conducted by yu & liu, 2004; lee, you & shen, 2010). to ensure the validity of the questionnaire, experts and scholars were asked to provide feedback prior to administering the formal survey. the questionnaire was then modified on the basis of the feedback received. the survey was conducted in october 2011 via mailed questionnaires. the brokerage companies covered in the survey were chain branch companies, such as pacific rehouse, sinyi, 21st century, u-trust, h&b housing, eastern realty, china trust real estate, taiwan housing, and yung ching realty. this study distributed 867 questionnaires by mail to sales agents in branches of these companies in kaohsiung and obtained 776 responses. after eliminating responses missing some data, there were 518 valid individual responses, with a valid return rate of 66.7 per cent, including 518 cases with micro-level observation values and 47 branch-level observations. the fitness test of the proportion of the actually recovered samples from various realtor brokers in the population resulted in no significant difference, suggesting that the proportion of actually recovered samples is consistent with the population. the content of the questionnaire included basic data concerning individual brokerage agents (including gender and educational background), items from the working perspective of the agents (e.g., years of work experience, work performance, number of hours worked), and information on branch characteristics (e.g., the number of sales agents or whether the branch utilizes a team compensation scheme).4 following the non-response bias test process (armstrong ＆ overton, 1977), this study classified all questionnaires collected into either an early or a late group, so as to examine them for significant differences in basic data and research components. based on a chronological collection time sequence, the 384 questionnaires collected first were labeled as the initial group, while the 134 questionnaires collected later were labeled as the second group. the basic data and research variables for the two groups were compared, and no significant differences were found, indicating that the non-response bias was not a serious issue in this study. 4.2 variable setting and explanations in this paper, variables are defined as shown in table 1. as for the explained variables, individual performance is measured with the logarithmic value of the average monthly turnover of the respondent agent for the previous three months.5 in housing brokerage companies in taiwan, the mode of operation is by “branch,” and agents of the same branch are regarded as members of a “working team” who have a competitive-cooperative relationship. hence, variables can be divided into individual related explanatory variables and branchrepresenting characteristic variables. the micro-level explanatory variables include dummy variables, such as the gender and educational level of the agents. if the agent is male, the variable value is set at 1; otherwise, the value is set at 0. if the agent has a collegelevel education or above, the value is set at 1; otherwise, it is set at 0. the respondents’ daily average number of hours worked is measured in hourly units by the questionnaire item, “how long was your average working day over the past three months?” regarding work experience, the questionnaire item, “how long have you been in the housing brokerage industry, including your current job?” is used to measure the years of employment to date. if the performance of the other agents in the branch is higher, the perceived peer competition threat may be greater. hence, this study uses the performance of the other agents in the branch as the proxy variable for peer competition threat. “comparison of individual performance and average performance of others” is used to measure the impact of an individual’s performance compared to others’ performance. the value is set at 1 if the individual performance is better than others’ average performance; otherwise, the value is set at 0. the branch-level characteristic variables include the team compensation variable and the number of agents in the branch. regarding the team compensation variable, this study sets 148 sajems ns 17 (2014) no 2:140-156 the dummy variable as having or not having a team compensation scheme. the value is 1 if the branch provides a team compensation scheme; otherwise, it is set at 0. table 1 variable descriptions and definitions variable operational definition level-1 (micro-level) variables y individual performance is the logarithm value of the respondent’s average monthly sales performance over the past three months (unit: nt$ 10,000)6; that is to say, performance over the period from july to september, 2011. gender if the agent is male, the value is set as 1; otherwise, it is set as 0. education if the agent has an educational level of college or above, the value is set as 1; otherwise, it is set as 0. ihour individual working hours; that is to say, the average number of hours worked by the respondent every day (unit: hour). oy average performance of others; that is to say, the average performance of other agents in the same branch. hoy comparison of individual performance and average performance by others. if individual performance is greater than the average performance of others, it is set as 1; otherwise, it is set as 0. wexp work experiences, represented by the number of years working in the housing brokerage of the agent (unit: year). swexp squares of work experience, as represented by the square of the work-experience variable. level-2 (branch-level) variables sizej the number of brokerage branch agents, as represented by the number of agents working in the same branch. gbonj the team compensation scheme is set as a dummy variable. if the branch provides team compensation, the variable is set as 1; otherwise, it is set as 0. 4.3 description of sample statistics this study processes micro-level and branchlevel descriptive statistics using spss19.0 and hlm6.05 for empirical model estimation. the basic statistical characteristics of variables are illustrated in table 2. regarding individual characteristics of agents, most of the respondents are male, accounting for 56 per cent of the total (290 people). respondents with a college education or above account for 43 per cent (223 people). the average daily number of hours worked is 8.93 hours. the average value table 2 micro-level and branch-level descriptive characteristics variables mean s.d. min. max. level-1 (micro-level) variables y 12.60 11.82 1 100 gender 0.56 -0 1 education 0.43 -0 1 ihour 8.93 2.37 2 18 oy 12.59 5.08 25.00 4.54 hoy 0.415 -0 1 wexp 4.76 5.39 1 31 swexp 51.59 112.96 1 961.00 level-2 (branch-level) variables sizej 18.19 8.23 5 41 gbonj 0.33 -0 1 sajems ns 17 (2014) no 2:140-156 149 of individual performance is nt$ 126,000 (exchange rate was us$ 1 to nt$ 29.6 in april, 2012); in the same branch, the average individual performance by other agents is nt$ 125,900. agents with an individual perfor mance greater than the average performance by others account for 41.5 per cent (215 people). the average number of years worked is approximately 4.76 years. regarding branch characteristic variables, branches that provide a team compensation scheme account for 33 per cent of the total (16 branches). in addition, the average number of agents in each branch is approximately 18 people. 5 empirical results and analysis this paper employs maximum likelihood (ml) to estimate the fixed and random effects of hlm. 5.1 model 1: null model table 3 provides estimates for the null model. the estimate of ϒ00 is 0.949 with a standard error of 0.020. this finding indicates that the mean individual performance is nt$ 88,920 (= 100.949, with an exchange rate of us$ 1 to nt$ 29.6 in april, 2012). the random effects part shows the decomposition of the variance into its micro-level and branch-level components. the reported χ2 statistic is 77.095, with 46 degrees of freedom. the results indicate that variance at the branch-level is statistically signi ficant, at a better than the required 5 per cent level of significance. for hlm, the estimate for the branch-level variance is 0.008; for the micro-level it is 0.128. the icc is 0.008/ (0.008+0.128) = 0.059. for the model, icc is 0.059, suggesting that 5.9 per cent of the variance in performances is due to differences at the branch level. that is, individual performance varies across branches. according to the criteria proposed by cohen (1988), this moderate correlation icc value suggests that a multilevel model incorporating branch-level and branch characteristics may be useful. 5.2 model 2: random coefficient regression model table 3 shows a partial hlm output for model 2. the essential components of the fitted multilevel model are the following statistical parameters: the fixed effects regression parameters (gammas), and the variance components for the random effects. in the model 1 null model, as shown in table 3, the variance of rij is 0.128, and the variance of rij, or the random coefficient regression model of model 2, is 0.020, which is a reduction of 84.4 per cent, (r2 = (0.128−0.020)/0.128 = 0.844), suggesting that the introduction of micro-level explanatory variables can reduce the variation in individual performance in branches by up to 84.4 per cent. the estimate for ϒ00 is 0.481 (nt$ 30,269). this value is no longer interpreted as the grand mean of performances; instead, it is the expected value of performance when the predictor values are all 0. the coefficients of gender, education and ihour are not significant, while the coefficients of oy, hoy, wexp and swexp are at a significant level. for the sake of simplicity, the estimation results are illustrated in model 3. the random effects part of the model is concerned with the variance components. as shown in table 3, the branch’s average performance β0j variance τ00, is 1.611, and it is at a 5 per cent significance level, suggesting that the 47 branches vary significantly in terms of average performance, a finding that is consistent with the conclusions of the null model. the estimates of the variances of u4j, u6j, u7j and τ44, τ66, τ66, are 0.010, 0.0005, and 0.0001, respectively, which are at a 5 per cent significance level. this finding indicates that the impact of others’ average performance, work experience and squares of work experience on individual performance varies between branches. this result also implies that when neglecting branch characteristics, even after controlling for individual characteristics and job characteristics, the estimated coefficient of individual performance may be biased. 5.3 model 3: intercepts and slopes-asoutcomes model model 3 (table 3) provides a more complex picture of the effects at the micro-level and branch-level. concerning fixed effects at the micro-level, in terms of gender, the estimated coefficient value is 0.0143, which is not significant. when it comes to the impact of gender on performance, conclusions in previous 150 sajems ns 17 (2014) no 2:140-156 studies conflict with each other. for example, the findings by glower and hendershott (1988), crellin, frew and jud (1988), sirmans and swicegood (1997) and jud and winkler (1998) suggest that the working income of female workers is lower. however, abelson, kacmar and jackofsky (1990) argued that the working income of female workers is higher. this paper concludes that men’s performance is not significantly higher than women’s performance among housing brokerage agents in kaohsiung, taiwan. the estimated coefficient of educational level is 0.002, which is not significant. education is the investment of human capital. a higher educational level reflects ample knowledge and better performance. however, the empirical results suggest that the educational level has no significant impact on agent performance. a possible explanation for this finding is that housing sales focus on marketing skills and personality. moreover, continuous on-the-job training has narrowed the gap in terms of the impact of education on agent performance after entering the industry. regarding daily hours worked, longer daily working hours result in a higher level of effort and better job performance. the estimated coefficient of the daily number of hours worked is 0.004, which is not significant. the coefficient estimate of oy, ϒ40 is 0.255, reaching a 5 per cent significance level, indicating that oy is expected to decrease performance by 25.5 per cent (nt$ 32,130, calculated using the average performance of the samples). this result suggests that a better performance by others in the branch will result in a larger peer competition threat and that individual performance is expected to suffer, a conclusion that validates the study’s expectations. kandel and lazear (1992) proposed, from the perspective of theoretical analysis, that the increasing average performance of others in the branch can inspire the individual performance by employees of the branch. they used general manufacturers in japan as an example, without performing empirical tests. the housing brokerage industry emphasizes individual performance (individuals with compensation rates above 50 per cent account for 83 per cent of the total), implying the existence of a peer competition threat, which has been confirmed in this study. in addition, kandel and lazear (1992) used “the average performance of others” to represent a positive impact on individuals that can inspire working incentives while leaving out nasty peer competition. however, this claim is dubious.7 the coefficient estimate of hoy, ϒ50 is 0.172, reaching a 5 per cent significance level. this result indicates that, if the individual performance is higher than that of the average performance of others in the branch, individual competitiveness is strong. then, the “individuals of higher performance than the average performance of the peers” will be higher than the “individuals of performance lower than the average peer performance” by 17.7 per cent (nt$ 22,302), a finding that is consistent with this study’s expectations. the coefficient estimate of wexp, ϒ60 is 0.014. the coefficient estimate of swexp, ϒ70 is -0.001. these results are at a 5 per cent level of significance, suggesting that increased work experience can improve an individual’s performance but that the effect will gradually diminish with the accumulation of more work experience. this result is consistent with the findings of both glower and hendershott (1988) and sirmans and swicegood (1997), who suggested that while experience increases the performance of brokers or sales people, beyond a certain point, additional experience is of lesser value. as far as the cross-level direct effects are concerned, the branch-level coefficient estimate of sizej, ϒ01 is -0.030 and does not reach a 5 per cent significant level. the negative estimation coefficient may be seen from both the branch and individual perspectives. from the branch perspective, the number of agents will affect a branch’s performance. more agents lead to a higher branch performance. however, for individuals, increasing the number of agents can potentially increase the problems of freeriding and social loafing, thus having a greater negative impact on an individual’s performance. lazear (1998) argued that larger-sized teams require higher costs in monitoring members, and furthermore that individuals will have a lower share of team returns; thus, the free-rider problem will be more serious. lazear (1998) further argued that high-tech companies’ research and development teams might consist of only 3 to 5 people. as members of the working team are relatively few, it is easier for sajems ns 17 (2014) no 2:140-156 151 employees to monitor each other and therefore the problem of free-riding is less serious. this study’s research suggests that the average number of agents in a branch was approximately 18; furthermore, the largest branch had 41 agents. this number results in higher costs and greater difficulty in implementing monitoring systems, a finding that is consistent with previous studies’ findings. the coefficient of the estimation of the number of agents is uncertain. for example, follain, lutes, and meier (1987) and crellin, frew, and jud (1988) found that performance improves with the firm’s size, while sirmans and swicegood (1997) found no significant relationship between a firm’s size and its performance. the branch-level coefficient estimate of gbonj, ϒ02 is -0.577 and does not reach a 5 per cent significant level. the negative estimate coefficient may indicate the existence of a free-rider problem. this research finding suggests that the number of agents or having a team compensation scheme does not directly affect an individual’s performance. the cross-level moderate effect suggests that the coefficient of the interaction of variables ϒ41 is estimated at -0.004 with a 5 per cent significance level. the result of this model shows that sizej has significant cross-level interactions. in other words, having more agents in the branch would strengthen the negative impact of a peer competition threat on an individual’s performance, implying that peer competition would be fiercer in cases with limited resources. if performance by others is higher, the impact on the individual’s performance will be more adverse. the coefficient of the interaction of variables ϒ42 is estimated at 0.086 with a 5 per cent significance level. the results of this model show that gbonj has highly significant cross-level interactions. lazear (1998) argued that the free-rider problem is more serious in organizations that provide a team compensation scheme. karau and wlliams (1993) suggested that teamwork may reduce an individual’s working motivation and lead to social loafing. the negative coefficient for interactions indicates that the presence of a team compensation scheme in a branch unit strengthens the effect on others’ performance (oy). in other words, if oy increases, individual performance will decrease by 25.5 per cent (nt$ 32,130). however, with a team compensation scheme, an individual’s performance will decrease by more than 25.5 per cent and up to 34.1 per cent (25.5 per cent + 8.6 per cent). overall, although sizej and gbonj do not directly affect an individual’s performance, the impact of others’ performances on an individual’s performance can be adjusted in terms of cross-level interactions. in addition, the estimated results of model 3 suggest that the variations of u0j, u4j, u6j, and u7j, are significant, indicating that the intercepts and the three slopes (ϒ40,ϒ60, and ϒ70) contain random components and that other important branch-level characteristic variables have not been considered. to further review the moderating effect of the number of agents and team compensation, this paper focuses on the top and bottom 25 per cent according to the number of agents. the average performance by others is added with two standard deviations in order to determine the impact of a peer’s average performance on another individual’s performance in large and small branches, and between branches that do or do not utilize team compensation. as shown in figures 2 and 3, having a greater number of agents or providing a team compensation scheme strengthens the relationship between average peer performance and an individual’s performance. in contrast, having fewer agents or not providing a team compensation scheme weakens the relationship between average peer performance and an individual’s performance. another important aspect of model specification and testing is examining how closely the model fits the data. deviance is a measure of the lack of fit between the data and the model. the deviance for any one model cannot be interpreted directly, but it can be used to compare multiple models among each other. the difference in deviance between each model is distributed as a chi-square statistic with degrees of freedom equal to the difference in the number of parameters estimated in each model. for example, considering table 3, the deviance for model 1 is 427.961, while the deviance for model 2 is -147.350. the difference between these two deviances is 575.311, which is compared to a chi-square distribution with 42 df (45 parameters-3 parameters). the difference is significant; so there is evidence that model 2 fits the data 152 sajems ns 17 (2014) no 2:140-156 better than model 1. additionally, model 3 is significantly better than model 2 (δχ2 = 7.613, df = 4, p-value close to 10 per cent level of significance). figure 2 figure 3 the moderate effect of the size the moderate effect of the gbon 5.4 ols estimation results for purposes of comparison, table 3 presents the ols estimates for this model. using model 3 intercepts and slopes as outcomes, this paper conducts an ols estimation. the results suggest that the estimated ols error (ri) variation is 0.062, which is higher than the 0.020 of model 3. coefficients relating to the branch characteristic variables (ϒ01, ϒ02, ϒ41, and ϒ42) have all been underestimated, thus verifying the findings by raudenbush and bryk (2002). if the ols violates the assumption of the regression model’s residual independence, it will result in an over-estimation of the error variance and an underestimation of the regression coefficient standard error. this result also shows that the ols and model 3 estimates differ substantially for several parameters. for example, the ols ihour coefficient ϒ30, has reached the 5 per cent significance level. it is even more noteworthy that the coefficient of oy ϒ40 is 0.020, thereby reaching the 5 per cent significance level. the estimation result is different from the sign of model 3. regarding the model fitness, the comparison of the aic or bic implies that the model 3 intercepts and slopes model provides a much better fit. table 3 empirical results and analysis model model 1 model 2 model 3 ols ϒ00 0.9485 (0.0203)** 0.4812 (0.1897)** 0.6157 (0.2160)** 0.7309 (0.0220)** gender ϒ10 0.0143 (0.0132) 0.0143 (0.0131) 0.0078 (0.0178) education ϒ20 0.0032 (0.0148) 0.0022 (0.0152) 0.0001 (0.0267) ihour ϒ30 0.0045 (0.0036) 0.0041 (0.0035) 0.0146 (0.0055)** oy ϒ40 -0.2718 (0.0197)** -0.2549 (0.0195)** 0.0197 (0.0044)** hoy ϒ50 0.1775 (0.0236)** 0.1724 (0.0242)** 0.5330 (0.0289)** continued/ 3.09 1.79 0.50 -0.80 -2.10 -4.63 -0.18 4.26 8.71-9.07 large size small size 3.21 1.70 0.18 -1.33 -2.85 -4.63 -0.18 4.26 8.71-9.07 gbon=0 gbon=1 y oy oy y sajems ns 17 (2014) no 2:140-156 153 model model 1 model 2 model 3 ols wexp ϒ60 0.0130 (0.0052)** 0.0136 (0.0051)** 0.0097 (0.0059) swexp ϒ70 -0.0005 (0.0003)* -0.0005 (0.0002)** -0.0003 (0.0002) sizej ϒ01 -0.0302 (0.0276) 0.0008 (0.0020) gbonj ϒ02 -0.5770 (0.4174) -0.0156 (0.0390) sixej x oy ϒ41 -0.0043 (0.0019)** -0.0001 (0.0004) gbonj x oy ϒ42 -0.0860 (0.0348)** 0.0038 (0.0104) uoj 0.0075 (77.0954)** 1.6109 (224.4189)** 1.6186 (325.6178)** u1j 0.0018 (6.2409) 0.0017 (6.2844) u2j 0.0020 (18.3846) 0.0025 (18.5178) u3j 0.0002 (12.6392) 0.0002 (12.6188) u4j 0.0101 (23.5186)** 0.0100 (28.2878)** u5j 0.0069 (18.2886) 0.0088 (18.2310) u6j 0.0005 (39.0383)** 0.0004 (39.2152)** u7j 0.0001 (37.5001)** 0.0001 (37.7128)** rij 0.1279 0.0202 0.0200 ri 0.0620 deviance 427.9610 -147.3501 -154.9628 29.4409 number of estimated parameters 3 45 49 13 aic 433.961 -57.350 -56.963 11.280 bic 436.104 -25.205 -21.961 20.566 notes: *p<0.10, **p<0.05. regarding the fixed effect part, the content inside the () is the robust standard errors; regarding the random effect parts, the content inside the () is the value of χ2. 6 conclusions and suggestions with real estate agents as the object of analysis, this paper examines whether the average performance by others (i.e., the peer competition threat) has a negative impact on individual performance; whether more agents or a team compensation scheme lead to lower individual performances; and, in a branch with more agents or a team compensation scheme, whether the individual’s performance will be greater owing to the marginal effect of the average performance by others. 6.1 theoretical implications the empirical results suggest that the variation of an individual’s performance is significant among different branches. the average performance by others has a significant negative impact on an individual’s performance, as expected. kandel and lazear (1992) used “the average performance of others” to represent a positive impact on individuals that can inspire working incentives while leaving out nasty peer competition. however, this claim is dubious. the housing brokerage industry emphasizes individual performance, which thus implies the existence a peer competition threat (which has been confirmed in this study). in branches with more “agents” or with a “team compensation scheme”, the impact of the average performance of others on an individual’s performance is significantly higher than it is in branches with fewer “agents” or without a “team compensation scheme”, as 154 sajems ns 17 (2014) no 2:140-156 expected. in other words, more agents in the branch would strengthen the negative impact of peer competition threat on an individual’s performance, implying that the peer competition will be fiercer in cases of limited resources. the results of this model show that gbonj has highly significant cross-level interactions. the negative coefficient for the interactions indicates that the presence of a team compensation scheme in a branch unit acts to strengthen the effect of others’ performance (oy). in terms of theory, setting the individual level and branch level of the model can distinguish individual conditions and branch characteristics relating to individual performance contributions. in this study, the model was not only set for the team compensation scheme and the number of agents across the levels directly affecting individual performance, but also took into account the team compensation scheme and the number of agents across levels moderately affecting the others’ performance. further, the coefficient of each variable can be random, i.e., coefficients between the various branches are not fixed. the empirical results also show that the performance of others, work experience and work experience squared really are random, so the model can be made more flexible based on the theoretical construct. this study’s findings can help to elucidate the impact of a peer competition threat on an individual’s performance, as well as whether relevant theories can be tested with actual data. the empirical results of this study also suggest that the interactive relationship between working team members and the impact of peer competition threat are topics that merit further exploration. 6.2 practical implications this paper concludes that men’s performance is not significantly higher than women’s performance among housing brokerage agents in kaohsiung, taiwan. a higher educational level reflects ample knowledge and better performance. however, the empirical results suggest that educational level has no significant impact on agent performance. regarding daily hours worked, longer daily working hours result in a higher level of effort and better job performance. the daily number of hours worked has no significant impact on agent performance. the empirical results suggest that increased work experience can improve an individual’s performance. according to the empirical results, if the realtor brokers want to enhance individual performance, thereby increasing team performance, they should consider selecting those with experience in the brokerage industry as a priority. this has been reflected in the actual market operation in taiwan. the brokers of the direct sales system emphasize brand image with certain requirements, including college education and lack of experience in the brokerage industry to facilitate the hiring and development of new employees consistent with each company’s corporate image. however, brokers of the franchise system emphasize the improvement of individual performance. in most cases, they prefer to hire those with experience in the brokerage industry to minimize educational/training costs and to win profits for the company within a short period of time. 6.3 limitations and future research regarding the limitations of this study, as the research subjects are large chain realtor brokers, the research findings cannot represent numerous independent agencies. second, the data source of this study was a questionnaire survey, and the variables, such as business performance, may include measurement errors. if future studies can obtain human resource data from the brokerage companies themselves, the data collected regarding agents’ business performance will be more accurate, which in turn could allow for improvement upon these research findings. this study could be extended in several different directions in the future. first, the intercepts and some of the slopes have random components, suggesting other important branch level characteristic variables that should be considered. in the future, other important characteristic variables may be included in the model for consideration and estimation. moreover, the impact of peer competition on performance may vary over time. this study adopts a cross-section data analysis approach and is unable to address this problem until further studies are conducted. sajems ns 17 (2014) no 2:140-156 155 endnotes 1 as observed above, many of these research findings are consistent. for example, the number of hours worked, experience, licensing and education all have positive effects on an agent’s income. abelson, kacmar and jackofsky (1990), sirmans and swicegood (1997), and sirmans and swicegood (2000) also found a positive relationship between nonpecuniary factors, such as job satisfaction and agent performance. however, owing to different sampling techniques, many influencing factors could lead to inconsistent results among different studies. in particular, conflicting results often occur in terms of gender, race, franchise affiliation, and the agent’s age. 2 the question in the questionnaire is as follows: “speaking from your experience, when you and your workmates learn about the same business case, have your workmates ever competed with you to win the case? (1) never (2) sometimes (3) frequently”. a total of 233 respondents answered “never” (45 per cent), 238 respondents answered “sometimes” (45.9 per cent), and 47 respondents answered “frequently” (9.1 per cent). respondents who provided one of the latter two answers accounted for 55 per cent. 3 knez and simester (2001) inferred that the lack of a free-rider effect has resulted in the standardized internal working procedures of the airline. employees may easily supervise each other, resulting in the non-existence of the free-rider effect. 4 detailed questionnaire items are available upon request. 5 rubin and perloff (1993) and booth and frank (1999) used “income” as the proxy variable for performance or productivity. however, income reflects the level of performance as well as the employer’s salary structure. therefore, it cannot entirely reflect the level of “performance.” using sales performance as the proxy variable for the sales personnel’s performance or productivity may result in lower measurement error when compared to other proxy variables (e.g., income). 6 for example, if the monthly sales performance is nt$ 3,000,000 for the last three months, and the commission rate is 6 per cent, then the performance will be nt$ 18,000. 7 peer attacks are common among building companies and landlords, housing agents and homeowners, and among real estate agents. peers often strive to achieve their company or personal interests by achieving larger profits, reducing service fees and striving to obtain cases (chou, 1998, housing brokerage market transaction practice, www.ttvs.cy.edu.tw/practice/work9/). references abelson, m.a., kacmar, k.m. ＆ jackofsky, e.f. 1990. factors influencing real estate brokerage sales staff performance. journal of real estate research, 5(2):265-276. anderson, r.i., byrd, a.k. ＆ hurst, m.e. 2012. earnings of real estate salespersons with prior work experience. journal of housing research, 21(1):83-99. armstrong, j.s. ＆ overton, t.s. 1977. estimating 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fore, whereby ethical issues are approached in an integrated manner, emphasising the management of ethics, which entails a cause-effect relation. one of its evaluation instruments is the ethical audit. this paper presents the findings of research focused on 47 executives involved in the management of quality in romanian hospitals. the research concerns, in particular, the relevance and the opportunity for an ethical audit and the assessment of its possible effects. the data were gathered using a questionnaire. the research shows that romanian managers consider the introduction of the ethical audit within the accreditation process as being relevant and pertinent. they believe that ethical monitoring is beneficial for the activity of healthcare institutions, but also that these institutions are as yet not sufficiently prepared to implement ethical audits. this study might be useful for sounding an alarm bell or for suggesting a direction for the qualitative and quantitative improvement of accreditation criteria and for the management of change in healthcare institutions worldwide. key words: ethics in healthcare management, romanian healthcare managers, ethical audit, accreditation jel: i18, m00, m42 1 introduction institutions in the healthcare system now have responsibilities beyond just patient rights or even the rights of employees. their management as with any other organisation, is faced with the need to manage limited resources and competition. moreover, healthcare institutions are subject to strong public scrutiny and must gain the trust and approval of accreditation bodies. this article assumes that the world at large has entered the third generation of ethics and has made the transition to a higher level of ethical issues and methods of solving them. our study presents the results of empirical research which aims to identify the opinions of executives involved in quality assurance in hospitals regarding the relevance of and opportunity for the introduction of the ethical audit within the accreditation system for hospitals in romania. it will add to the small body of studies in the field. we believe that our study could be useful for all countries wishing to strengthen public confidence in the health system by including ethical audits in accreditation criteria. our research primarily conveys the message that managers involved in quality assurance in hospitals should be consulted, because they are the experts needed to support this process and provide information necessary for its implementation. furthermore, the research highlights issues and questions that may be considered in consultation with managers. abstract sajems ns 17 (2014) no 3:284-296 285 2 literature review 2.1 the multiple facets of ethics in the management of the healthcare system and its institutions the principles, methods, strategies, instruments of ethics and good practices used in the management of hospitals and other healthcare units is a wide field of study, intensely analysed and debated in the scholarly literature from multiple points of view. several issues have been analysed since the late 1990s: civic responsibility of the healthcare organisation (hofmann, 1995); the evaluation of the ethical program (neft-smith, scott, edward & fletcher, 1997); good practices in the ethics of hospital units (cassidy, 1998); ethical leadership (johnston, cruess & cruess, 2001; dolan, 2004;) and the challenges raised by ethics and the responsibilities of leaders in the healthcare system (squazzo, 2012); ethical dimensions in public healthcare policies (roberts & reich, 2002); ethics and the safety of hospitals (weinstein, 2002) and ethics and patient safety (lachman, 2008); challenges of ethical committees (collier & sandborg, 2006; hogstel & curry, 2004); the ethics of decision-making (maddalena, 2007; slosar, 2004); ethical transparency and economic medicalisation (poitras & meredith, 2009); the organisational costs of ethical conflicts (nelson, weeks & campfield, 2008; hofmann, 2012); and the ethics of decisions concerning the allocation of resources (hofmann, 2011). the aforementioned issues have the commonality that if they are not considered properly, they can weaken quality of care and organisational performance. the numerous published studies show the complexity of the subject and the many ethical risks which might beset the proper functioning of the healthcare system. they also highlight the need for preparation and prevention, a willingness to approach them attentively, to analyse them according to their particularities, and to frame them optimally in the managerial process by finding adequate instruments for dealing with them. these articles also implicitly envisage the role, importance and structure of the ethical audit (morrell, 2002; kirkpatrick, reamer & sykulski, 2006). as porter (1994:38) highlights, audit practices (and here we can include the ethical audit) have spread “due to changes in public sector management and new prominent ideals of quality, governance and accountability.” another aspect which deserves full consideration is the inclusion of ethics within the accreditation system of healthcare units, highlighting thus the impact of ethics on stakeholders and on the quality of services provided. this would mean moving ethics from the abstract into reality, and rather than taking a declarative stance moving it to the implementa tion level. the fact that the accreditation process verifies whether the institution has a system for handling patient complaints does not fully demonstrate the functionality of the system. only proper consultation of employees and patients regarding the ethical connotations of processes would show the ethical performance of an institution which differentiates it from other institutions. hoffman (1995) and wu, liao, chiu, lin and yang (2011) debate the relevance of and the opportunity for the ethical audit within the accreditation process of hospitals). this article focuses on the latter aspect. 2.2 the third generation of ethics: the management of ethics and auditing towards the end of 1990s, dr. bart colopy (in cassidy, 1998) maintained that the ethical discourse had already entered the second generation of ethics. the first generation focused on the rights of patients, the quality of healthcare services and its effects, and on ethical issues related to decision-making involved in the choice of treatment regarding the assurance of life. for the author mentioned above, the second generation highlighted aspects of organisational and non-clinical ethics (ways of dealing with employees, allocation of budget, handling of conflicts of interests, prioritisation of certain healthcare services at the highest qualitative level for the patient, even in situations where this level is difficult to attain, etc.). apart from the economic pressures specific for a transition period, there are serious ethical dilemmas, rendered more urgent by the fact that one of the ethical responsibilities of organisations which provide healthcare services 286 sajems ns 17 (2014) no 3:284-296 is taking the role of leadership in the improvement of healthcare in communities, in spite of financial difficulties and of the paradoxical situation that the problem of attracting resources from healthcare insurance is resolved by the high degree of employment in hospitals (hofmann, 1995). contemporary challenges for the worldwide management of the healthcare system are generated by diverse factors: technological; economic; socio-political; and cultural. according to the joint commission on accreditation of healthcare organizations1 (1998:1), the necessity of dealing with moral issues was determined in the last 30 years by scientific progress in reproductive technology and by concern for the fragile medical state of new-borns and by the effects of technological development upon prolonging life expectancy. in addition morality was also determined by a wider awareness regarding the legal and moral rights of patients, including the right to selfdetermination, by a progressive change in vision regarding the financing of the healthcare system from “fee to service” to “managed care”, by an enhancement of cultural, ethnic and spiritual diversity, by the rapid aging of populations which influenced the role of caretakers within the core family, and by a new philosophy concerning the meaning of “endof-life care”. these factors take different forms today, some of which are worrying for political decision-makers and leaders: the lack of resources; limited access to medical assistance for uninsured categories of the population,; the migration of doctors and of medical personnel; the internationalisation of access to healthcare; and political changes in general. consequently, all these factors demand new visions and strategies, societal changes which bring about institutional modifications, and an approach at a superior level to ethical issues in the healthcare field. apart from these high-level issues, there are also ethical dilemmas at an individual level which confront medical personnel, such as the case of doctors who must balance the obligation towards patients with their professional oath and with the obligation towards employers (loewy, 1999), all with their own particular challenges. these aspects, analysed in scholarly literature, are today presented in an integrated form, in a type of cause-effect relationship. if the first generation of ethics took into account patients’ rights regarding access to healthcare services, today we have to deal with the problem of quality of this service and implicitly with the question of patients’ perception of its quality. therefore, the new orientation takes into account patients’ opinions, either for the prevention, or for the improvement, through remedies, of medical services. there is, thus, the challenge of the evaluation of an ethical culture and values (orientation towards quality, excellence, listening and involving the patient, transparency, responsibility) which are predomi nant in an organisation, with reference to the satisfaction of patients. the latter is known as the third generation of ethics. the third generation of ethics is responsible for the proper management of ethical behaviour, and applies to the managers who hold responsibility for observing ethical standards (weber, 2001:13). the management of ethical conduct means the identification of risk areas so that the organisation is able to maintain a high degree of trust from the public, and so that it passes the test of accomplishing the accreditation standards required by external evaluators and can thus take an honourable place within the classification processes of hospitals. apart from the aspects embodied by the previous generations, there is the additional need for a strong focus on the identification, through auditing, of the impact of initiatives deemed to establish an ethical climate and to prevent ethical risks within and outside the organisation (ethical culture and the satisfaction of patients, leadership, ethical climate and the satisfaction of employees). there is also the need for the voluntary use of managerial instruments which ensure both ethical behaviour within organisations and in their external relations, and the learning process (ethical policies, ethical programs, officer/ethical counsellor, ethical help lines, medical ethical committees, ethical codes, ethical quality management and ethical training). these instruments ensure integration and recognition within specific networks (ethical associations, partnerships with educational institutions), as well as the assessment of efforts and of the impact of these ethical measures (programmes that monitor the ethical climate, ethical audits). new requirements from the community, such sajems ns 17 (2014) no 3:284-296 287 as the fair handling of diversity, care for the environment, the involvement of the organisation in projects with a social responsibility, represent new challenges for organisations whose mission consists of providing healthcare. in order to deal with all these factors and requirements, the organisation needs an integrated system of ethical management which includes ethical vision, ethical competencies, instruments of planning, organising, leadership, decision-making and evaluation, access to networks, availability and capacity to learn and ethical training. the third generation of ethics also envisages the evaluation of integrity and the ethical reputation of an organisation (through the assessment of the degree of trust) and conformity with the institutional systems of accreditation (see figure 1). figure 1 the three generations of ethics in healthcare organisations ethics, management, auditing and recognition (accreditation) ethical competencies loyalty, mission, vision ethical risk assessment and prevention ethics culture and patient satisfaction leadership, ethical climate, employee satisfaction voluntarily adopted management tools for managing ethics (ethics program, including training, code of ethics, auditing, ethics, ethics committees, counselor ethics, helpline ethics, etc.) participation in networks for promoting ethics environmental protection and social responsibility actions integrity, ethical reputation, recognition the third generation of ethics ethics and organisational issues (non-clinical) organisational ethics ethical treatment of employees (rights) resolving ethical conflicts budget allocation promoting medical care at the highest level of quality in the context of restraints the second generation of ethics ethics and clinical aspects patients' rights quality of care and its effects ethical decision for the choice of treatment the first generation of ethics source: authors, adapted from the presentation of the first two generations of ethics mentioned by dr. bart colopy in cassidy (1998) understanding this transition from the first generation of ethics to the third generation is extremely important for the acceptance of the role of the ethical audit in the ethics and quality management of hospitals, and of the introduction of this audit as an accreditation criterion. in other words, managers and responsible authorities could better realise the need to address ethical issues at a broader level, according to the current context in which their institutions operate. pressures to reduce costs and focus on other priorities, lack of ethical skills (conducting an ethical audit would require “formal education or training related to professional ethics” (reamer, 2007: 186)), but also lack of vision and indifference can block managers, causing them to stay at the stage of second generation ethics. this in turn may affect long-term organisational performance, especially in terms of public confidence. 2.2.1 the tools needed for managing ethical issues and risks: the relevance of the ethical audit one of the instruments, which makes possible timely identification and dealing with ethical risks areas, with multiple advantages, is the ethical audit. according to kaptein (1998:60), the ethical audit is a process which describes, analyses and evaluates the relevant aspects of the ethics in an organisation. hofmann (1995) defines the ethical audit from the perspective of guaranteeing to stakeholders the implementation of the mission originally assumed by the organisation, “even 288 sajems ns 17 (2014) no 3:284-296 in the most difficult times”. also the ethical audit is “…a practical and valuable instrument in evaluating whether the organization complies with its standards and expectations” (hofmann, 2006), which in unfavourable contexts, implies taking risks and facing a large range of potentially negative consequences. wiley (1995, as cited by menzel (2007:72)) considers that the ethical audit has the role of improving the organisation’s performance. in the wake of evaluations, the audit offers management certain focal topics such as: the climate; the working environment; and the codes and consolidation of ethical policies of the organisation. the ethical audit is based on a process of analysis and is a true mechanism of dialogue and of gathering suggestions for improvement. it generates trust regarding external stakeholders, guaranteeing to them that the organisation fulfils its economic, social and environmental obligations (garcía-marzá, 2005). the ethical audit makes it possible to apply ethical issues to professional practices, to survey and evaluate, where necessary, the adequacy of these practices, and to monitor the application the quality assurance strategy (reamer, 2007). it also represents a barometer of organisational well-being by compiling a list which verifies the degree of conformity to ethical standards, written or unwritten (schlegelmilch, 1998:128). it evaluates the fidelity of the organisation towards the values, mission and the ethical code as declared and assumed initially by the organisation. it also assesses aspects regarding the way in which the organisation respects its internal and external stakeholders and their moral and legal rights (employees, patients, clients, providers, volunteers, community). the audit is also part of the construction and the maintenance of ethical climate, it makes place for ethics in communication and leadership and develops practices for financial management, marketing and funding. ferrell, ferrell and fraedrich (2012:244245) and menzel (2007:72) focus on a long list of benefits of the ethical audit. it has a preventive and proactive character because it makes it possible to track actions and behaviours which are mistaken, which produce ethical risks and crises within the organisation in real time. in this way, the audit minimises the potential costs of ethical conflicts and of unethical conduct. this type of audit motivates and assures the perception of an ethical climate and promotes satisfaction among employees. it protects the image and the good reputation of the organisation by avoiding uncontrolled situations and ethical risks which might compromise it. the internal audit cements good practices within organisations, boosting trust and good public opinion as well as credibility with financial institutions. in this context the relevance and structure of the ethical audit used both in the management of the quality of hospitals and in the accreditation process are discussed next. 3 methods 3.1 research aim our research aim is to identify the opinion of hospital executives (involved in quality assurance) regarding the relevance of and the opportunity for the introduction of the ethical audit in the accreditation process of romanian hospitals. this research primarily took as its starting point the work of wu et al. (2011) who studied the problem of including the ethical audit within the accreditation process of hospitals and their optimal structure, using a valid sample of 90 hospital managers in taiwan. also the work of landman, mouton and nevhutalu (2001) from the ethics institute of south africa, which shows the results of the ethical audit (conducted based on a questionnaire) at the chris hani baragwanath hospital was a cornerstone in supporting our approach. in romania we have no similar studies related to consulting hospital managers involved in quality assurance on the integration of ethical audits into institutions’ accreditation criteria. 3.2 research method and tools our method for gathering the data was an inquiry based on a questionnaire including two parts and with a total of 59 items (including biographical data of respondents). the questionnaire was chosen as the method of data collection because hospital managers involved in quality assurance who participated in the research are from hospitals across the sajems ns 17 (2014) no 3:284-296 289 country. under these conditions, the research would have involved high costs and time constraints if not for the questionnaire. as pienaar (2010:182) highlights, “in organisational research, ... business ethics, ... transgressions of organisational standards are sensitive”. also, as stated by an expert in research methodology (chelcea, 2001:255), “the question naire is indispensable for knowledge of the phenomena of consciousness, constructed and mediated by language (knowledge, opinions, beliefs).” 3.2.1 the design of the questionnaire and its distribution in the first part of the questionnaire (whose analysis and results are the subject of this article, see table 5 below), 20 questions related to the expressed opinions regarding the relevance of and the opportunity for introducing the ethical audit within the accreditation process of romanian hospitals were formulated. the second part of the questionnaire was comprised of questions related to aspects which would be adequate for the structure of an ethical audit, and which might be monitored in the course of the accreditation process of romanian hospitals. within the present paper we limit our research to the analysis of the answers obtained in the first part of the questionnaire. the second part of the questionnaire was the subject of another analysis, the results of which have already been published. the questionnaire was examined by eight specialists who have an academic interest in healthcare ethics. the questions were formulated so as to present multiple choices and an ordinal scale of response of the “likert type” (1 – complete disaccord, 6 – complete accord). one of the questions was open-ended. the questionnaire was formatted and distributed with the help of the “googledocs” application. 3.2.2 research subjects, sample method and characteristics of the sample in order to achieve the research objective, we applied a non-randomised sampling method called logical sampling. the questionnaire was applied online between january and july 2012 to 150 executives, all members of the target group within the framework of a european project on the topic of the management of quality in healthcare in romanian institutions. they were informed during project meetings of the purpose of the questionnaire, and about the importance of the ethical audit for the quality assurance process. the main reason for the selection of this target group was that its members are involved in hospital quality assurance, and as suggested by porter (1994:1), the audit is part of the process "audit and other quality assurance initiatives". in addition “many audits, such as medicine, are conceived primarily as internal reviews to improve decision-making...intended to support rather than to discipline” (porter, 1994:4). ethical audit is a tool for monitoring the application of the quality assurance strategy (reamer, 2007). managers involved in quality assurance are those that provide the foundation for the quality of decisions by improving procedures and preventive controls. they know in detail all the strengths and weaknesses of the organisation's activities (are ”the key informants”), and are the ones that provide all the necessary documentation for institutional accreditation given existing data. they are the closest to the “ethical audit”, because they are the ones who know all the details of all organisational work processes. the valid sample is represented by 47 subjects, which constitutes a response rate of 29 per cent from the analysed population. the distribution of respondents according their gender, level of studies, type of education and age is presented below (in tables 1, 2, 3 and 4). table 1 distribution of respondents according to gender gender female male % (no.) 68% (n=32) 32% (n=15) total respondents 100% (n= 47) 290 sajems ns 17 (2014) no 3:284-296 table 2 distribution of respondents according to their level of education level of studies bachelor’s degree master’s degree doctoral post-doctoral % (no.) 66% (n=31) 21.3% (n=10) 8.5% (n=4) 4.3% (n=2) total respondents 100% (n= 47) ethical training 10.64% (n=5) table 3 distribution of respondents according to field of study type of education (studies) medical economic humanities technical % (no.) 40.4% (n=19) 38.3% (n=18) 12.8% (n=6) 8.5% (n=4) total respondents 100% (n= 47) table 4 distribution of respondents according to their age age 25-35 years 36-45 years 46-55 years over 55 years % (no.) 23.4% (n=11) 40.4% (n=19) 27.7% (n=13) 8.5% (n=4) total respondents 100% (n= 47) a percentage of 89.4 of the executives work for institutions which are publicly-funded, while the rest come from institutions funded from mixed resources. of these institutions, 25.5 per cent are emergency hospitals, 17 per cent have a general profile, and 17 per cent provide medical services for patients who are chronically ill. in an equal percentage, 8.5 per cent are respondents from county hospitals and municipal hospitals respectively, 6.4 per cent are from academic hospitals, and 4,3 per cent from clinical units. a percentage of 40.4 are from institutions that have under 200 beds, 34 per cent have between 200 and 500 beds, and 25.5 per cent have over 500 beds. 3.2.3 data analysis the gathered data were analysed with the aid of the statistical program sfinxplus², under the licence of use for alexandru ioan cuza university, iaşi, romania. the following methods and tests of analysis were put to work: analysis of frequencies; calculation of means and of standard deviations; and correlation tests. 3.3 research hypothesis based on the literature we formulated the following hypotheses: 1) executives from romanian hospitals consider that the introduction of an ethical auditing would be relevant and welcome within the accreditation process of hospitals (hofmann, 1995; wu et al., 2011; morrison, 2011); 2) they consider that the implementation of an ethical audit within the accreditation process would have a beneficial role regarding the activity of romanian hospitals (hofmann, 1995; wu et al., 2011; morrison, 2011); 3) they think that managers and healthcare institutions from romania are not sufficiently prepared for the implementation of an ethical audit (reamer, 2007); and 4) in their opinion, there is a strong correlation between the role of ethical auditing and the consolidation of the public’s trust in the capacity of hospitals to provide medical service of superior quality (domingo garcíamarzá, 2005; menzel, 2007). 4 results the averages of the answers for the 20 variables (related to each of the questions) which we will analyse further (from a total of 58 for the entire questionnaire) vary between 5.70 and 3.43, with the total average being 4.79 (table 5). sajems ns 17 (2014) no 3:284-296 291 table 5 research results showing respondents’ opinions regarding the appropriateness of introducing ethical auditing in the accreditation process for romanian hospitals surveyed opinions mean (m) standard deviation (σ) sum part ethical principles should represent an essential aspect of the management of each hospital. 5.70 0.66 268 2.3 quality assurance is an issue related to ethical principles. 5.55 0.75 261 2.2 hospital managers need additional training for policy formulation and implementation of ethical standards. 5.51 0.75 259 2.2 the hospital accreditation process should include assessment of whether hospitals meet ethical standards/adopt ethical behaviour. 5.40 1.08 254 2.1 monitoring and auditing ethics would be beneficial for the management of romanian hospitals. 5.38 0.97 253 2.1 introducing ethical auditing could help strengthen the community's confidence in the ability of hospitals to provide high quality medical services. 5.36 1.11 252 2.1 ethical audit should evaluate ethics management. 5.34 1.03 251 2.1 introducing ethical auditing could help increase hospital performance. 5.28 1.08 248 2.1 the hospital accreditation process should include an audit/diagnostic on ethical standards. 5.26 1.09 247 2.1 hospital managers should be consulted regarding the introduction of an ethical audit of their institution within the accreditation process. 5.19 1.31 244 2.1 availability (of respondent) for involvement in carrying out an audit of ethics in the hospital accreditation process. 5.09 1.21 239 2.0 introducing an ethical auditing accreditation process could contribute to the classification of hospitals. 4.89 1.09 230 1.9 the introduction of ethical auditing could be a criterion for allocating resources more efficiently. 4.79 1.32 225 1.9 in every day activity there is a strong concern for promoting ethical values in institutions. 4.66 1.18 219 1.8 the institution could cope with a rigorous ethical audit process. 4.30 1.40 202 1.7 respondents’ familiarity with/possession of skills in terms of values, principles, standards, ethical tools needed in the management of hospitals. 3.85 1.60 181 1.5 hospital managers are sufficiently prepared for policy formulation and implementation of ethical standards. 3.66 1.43 172 1.4 hospital managers are sufficiently competent to formulate and implement policies and ethical standards. 3.64 1.42 171 1.4 romanian public hospitals are prepared for/ could handle an audit of ethical standards. 3.51 1.38 165 1.4 hospital managers receive sufficient support and resources for policy formulation and implementation of ethical standards. 3.43 1.26 161 1.4 total 4.79 4502 100,0 analysis of the answers given emphasises that the most important and essential aspects for the management of healthcare institutions are: concern for quality (n = 42; 89.4 per cent); efficiency (n = 20; 42.6 per cent); and good relations between patients and institutions (n = 18; 38.3 per cent). a percentage of 78.7 (n = 37) of the questioned executives completely agree that respect for ethical principles represents an essential aspect of the management of healthcare institutions (m= 5.70; σ=0.66). a percentage of 66 per cent of respondents (n = 31) agreed completely that quality assurance must be related to ethics (m=5.55; σ=0.75). these answers concur with the best-known ethical theories (morrison, 2011:230). for example, the kantian vision is that concern for quality constitutes a moral duty, even a categorical imperative and that all human beings are worthwhile and deserve quality services. in turn, the supporters of utilitarianism would consider lack of quality in services as an adverse consequence for individuals, as well as for the organisation, 292 sajems ns 17 (2014) no 3:284-296 which translates into low satisfaction or outright dissatisfaction, or low wages and has adverse legal implications. finally, rawls’ theory of justice argues for the importance of the interest of the community and of the organisation. the relationship between the two variables (that ethical principles represent an essential aspect of quality assurance management) is highly significant and has a positive correlation coefficient of 0.83 (ecarttype of regression coefficient = 0.094). in this case, the former explains 69 per cent of variance in the latter. these results are possibly justified by the fact that respondents are people involved in quality management of the institutions where they work. a percentage of 57.4 (n = 27) of participants are in complete agreement that the accreditation process of hospitals should include the management of ethical values and organisational ethics, that is policies should be formulated and instruments introduced that support ethical standards (m = 5.34; σ=1.03). the correlation coefficient between the management of ethical values and organisational ethics within the accreditation process and the inclusion of the ethical values within the accreditation process is +0.88. the first variable accounts for 76 per cent of variance in the second variable (ecart-type of the regression coefficient – 0.076). nevertheless, only 12 respondents (25.5 per cent) expressed complete agreement and 19 agreement (40.4 per cent), that in their institution there is on-going concern for the implementation of ethical values. over half of the respondents (n = 30; 63.8 per cent) are in complete agreement with the introduction of ethical standards within the accreditation process of hospitals (m=5.40; σ=1.08). concerning the introduction of ethical audit within the accreditation process, 53.2 per cent (n = 30) expressed complete agreement, and 31.9 per cent (n = 15) agreement (m=5.26; σ=1.09). a high percentage of 57.4 (n = 27) expressed complete agreement regarding the beneficial role of ethical monitoring in management of romanian healthcare institutions (m=5.38; σ=0.97). the same percentage of respondents confirm that it would be beneficial to introduce ethical auditing for the accreditation process to increase performance of healthcare institutions (m=5.28; σ=1.08). a percentage of 46.8 respondents (n = 22) expressed complete agreement that they would be available to participate in the process of ethical auditing, while 31.9 per cent (n = 15) expressed agreement (m=5.09; σ=1.21). there is strong dependence between the variable (availability to participate) and the introduction of ethical auditing within the accreditation process with a correlation coefficient of +0.70 (ecart-type of the regression coefficient – 0.095). the first variable explains 49 per cent of variation in the second variable. as far as concrete advantages are concerned, 68.1 per cent of respondents (n = 32) showed complete agreement that public trust would be consolidated if hospitals provide superior quality medical services (m=5.36; σ=1.11). a percentage of 34 per cent completely agreed, while 34 per cent agreed that integration of the ethical audit into accreditation criteria would improve the classification of hospitals (m=4.89; σ=1.09). inclusion of ethical audits might contribute to a more efficient allocation of resources (36.2 per cent accord or agreement and 34 per cent total accord or agreement; m=4.79; σ=1.32). (inclusion of the ethical audit in the accreditation process explains 61 per cent in the consolidation of public trust (correlation coefficient +0.78, ecart-type of the regression coefficient – 0.095). there is also a strong, positive dependence between the variable regarding the beneficial role of the introduction of ethical monitoring in the management of romanian healthcare institutions and the variable regarding the introduction of ethical auditing within the accreditation process. the correlation coefficient is +0.87 (ecart-type of the regression coefficient – 0.083), with the former variable explaining 75 per cent of the latter’s variation. a matter of concern is the perceived preparedness of managers for elaborate ethical policies. responses were rather heterogeneous: 4 respondents (8.5 per cent) completely agreed that they are sufficiently trained, 11 (23.4 per cent) agreed, and 12 (25.5 per cent) were in partial agreement. a similar answer was given to the question regarding the extent to which romanian hospitals are prepared for ethical sajems ns 17 (2014) no 3:284-296 293 auditing: the greatest number of those questioned (n = 16.34 per cent) only partially agreed with this statement, and only 4 completely agreed (8.5 per cent). for dependence between the variables (managers are prepared for elaborate ethical policies and (healthcare institutions are prepared for an ethical audit) there was a significant and positive relationship, the correlation coefficient being +0.79 (ecart-type of regression coefficient – 0.088), the former explaining 62 per cent of the latter’s variation. related to the above questions is the following one regarding the problem of whether managers receive sufficient support and resources for implementing elaborate ethical policies and standards at the institutions they lead. fourteen respondents (29.8 per cent) expressed partial disagreement (m=3.43; σ=1.26). thirteen (27.7 per cent) expressed partial agreement on whether managers are sufficiently competent for this task. only 3 (6.4 per cent) expressed their complete agreement. logically, a big number of respondents (n = 30; 63.8 per cent) consider that managers need supplementary preparation in order to be able to elaborate ethical policies and standards for the institutions that they lead (m=5.51; σ=0.75). over half of the respondents (59.6 per cent; n = 28) completely agreed that the managers of hospitals should be consulted with regard to the introduction of ethical audits among the criteria of the accreditation process (m=5.19; σ=1.31). a percentage of 46.8 per cent (n = 22) and 31.9 per cent (n = 15) expressed complete agreement and agreement for taking part in an ethical audit. 5 discussion and research limitations the consultation of executives regarding the introduction of the ethical audit among the evaluative criteria of the accreditation process of hospitals certainly represents an important step for the assessment of their availability to involve themselves and the institutions they lead in such a process. the research shows that over half of the managers are in complete agreement with the introduction of ethical standards within the accreditation process of hospitals. this shows that they consider the introduction of the ethical audit within the accreditation process as being relevant and pertinent and that ethical monitoring is beneficial for the activity of healthcare institutions. as can be seen from their responses, the most important gain is the consolidation of public trust regarding access to medical service of superior quality. these ethical audits also allow for proper classification of hospitals and for better allocation of resources according to ethical efforts by organisations. the results are all the more convincing, because participants involved (quality management at institutions) draw a clear line between abiding by ethical principles and quality assurance. the findings therefore support the introduction of ethical auditing within the accreditation process, which in turn improves the quality of medical services. among the problems identified by executives, is the insufficient preparation and training of managers for conducting ethical audits. the solution to this challenge is supplementary training for managers. findings of this research demonstrate that romanian healthcare institutions are only partially prepared for ethical evaluation, and a strong concern for ethical values is not manifest. the idea of defining ethical requirements for healthcare institutions through the accreditation is also expressed by morrison (2011: 239). ethical auditing would guarantee standard requirements. if only a few healthcare institutions which are really concerned with the championing of ethical values apply audits, their effect would not be capitalised and would only have a limited sphere of impact. ethical audits are costly (which implies legal justification for the resources involved) and in order to reach an adequate degree of objectivity, they must be handled by external specialists. many hospital managers do not appreciate the advantages of ethical audits especially given the pressure of lack of resources and the absence of managerial contractual obligations. in this context, the problem of integrating ethical auditing into the accreditation process of healthcare institutions arises. there are many beneficial effects through the “forced” implementation of this 294 sajems ns 17 (2014) no 3:284-296 instrument. adding criteria to the accreditation process requires consistency and realism. the actual accreditation standards proposed by the national commission of hospital accreditation (conas2) in romania might add to the list of verification for the presence or absence of stricter managerial and performance aspects, but their foundation has a basis of respect towards ethical values. by taking into account ethical audits, it might be possible to offer concrete answers concerning the preoccupation with ethical values when utilising certain instruments. questions that could be asked are the following: • what are the ethical values that should be taken into account to support the mission of each hospital? • what are the ethical values that could be developed to satisfy the patient and what are the results of these values? • what are the mechanisms for the implementation of ethical policies (ethical programmes, ethical codes, training modules on ethical themes); • what are the components of organisational structure (ethical committees and commissions, ethical lines, ethical counsellors) with responsibilities in ethical monitoring and which of these could be addressed by patients and employees when faced with ethical dilemmas and problems? • how can work climate be characterised from an ethical point of view and what is its relationship with the employee’s performance? • what are the ethical aspects endorsed within public relations strategy? • to what extent does the strategic plan take into account the activity’s effects upon the environment? • what are the ethical values which sustain the functionality of the communication system, etc.? healthcare authorities have a picture of what is going on at the macro-level of the healthcare system and have useful and necessary information for high-level decision-making processes. integration of the entire healthcare system transforms the ethical audit into a control instrument, but also into an instrument of classification of healthcare units. mandatory ethical audits within the accreditation system lead to a more efficient allocation of resources. implicitly, institutions would be more motivated to increase their performance in order to be granted greater access to resources. as loewy (1999) argues, each system has unique ethical problems, and each country’s healthcare system is marked by its own values and societal structures. the main limitation of this research is that a small sample of subjects was used, which does not make it possible to generalise results. the relatively small research sample, might designate this study as being a pilot. however, this is the first study of its kind in romania and is an initial step to creating awareness for hospital managers (especially those involved in quality assurance) that their institutions may be subject to audits of ethics in the accreditation process. in spite of this limited character, the study might be useful for sounding an alarm bell or for suggesting a direction towards the qualitative and quantitative improvement of accreditation criteria and towards the management of change in romanian healthcare institutions and worldwide. this change would consolidate fidelity towards each organisational mission, benefitting all categories of stakeholders. 6 conclusion and further research research shows that managers are open to the idea of introducing the ethical audit as an institutional accreditation criterion. managers used in this study could be the first group of sup-porters to recommend to the responsible authorities the introduction of ethical auditing in hospitals. at the same time, it is important to remember that preparation is needed in this area. ethical auditing is a proactive process, which aims at improving the ethical performance of healthcare institutions. through auditing, every healthcare institution might convey to its (internal and external) stakeholders a message about its ethical preoccupations with respecting moral values, about its constant efforts made in order to provide medical services at the highest level of quality, gaining in this way their trust and support. sajems ns 17 (2014) no 3:284-296 295 from an economic point of view, the results of an ethical audit might contribute to the classification of healthcare units in order to obtain a fair allocation of resources, which would create a competitive framework and ensure their progress and improvement. future research could aim at including a larger number of subjects. to have a complete picture, a future study should follow the integrated opinion of hospital managers, employees, the authorities that are responsible and interested in accreditation of hospitals, patients and lastly the community. endnotes 1 the joint commission on accreditation of healthcare organizations (jcaho/jacho) (now joint commission) is “… a private non-governmental agency that establishes guidelines for the operation of hospitals and other health care facilities, conducts accreditation programs and surveys, and encourages the attainment of high standards of institutional medical care…” (http://medical-dictionary.thefreedictionary.com/joint+commission+on+accreditation+of+healthcare+ organizations). 2 the national commission of hospital accreditation (conas) in romania has among its main responsibilities: the approval of a hospital accreditation; the approval of procedures, standards and methodologies for accreditation of hospitals; the proposal of 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sciences, north-west university, potchefstroom, south africanamibia business school, faculty of economic and management sciences, university of namibia, windhoek, namibia elmarie slabbert tourism research in economic environs & society (trees), faculty of economic and management sciences, north-west university, potchefstroom, south africa citation woyo, e. & slabbert, e., 2021, ‘tourism destination competitiveness: a view from suppliers operating in a country with political challenges’, south african journal of economic and management sciences 24(1), a3717. https://doi.org/10.4102/sajems.v24i1.3717 original research tourism destination competitiveness: a view from suppliers operating in a country with political challenges erisher woyo, elmarie slabbert received: 23 may 2020; accepted: 07 oct. 2020; published: 28 jan. 2021 copyright: © 2021. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: tourism in zimbabwe has been affected by politics for more than two decades following the contested land-reform programme that was done in the year 2000. therefore, understanding the destination competitiveness of zimbabwean tourism is crucial for optimising tourist arrivals in the country as this industry is still contributing to the economy amid the political challenges. aim: given the importance of destination competitiveness, in the era of rising global competition, this study examined the factors that make zimbabwe a competitive tourist destination, regardless of its political challenges. setting: the study used data collected from hospitality and tourism managers for establishments in victoria falls, great zimbabwe, the eastern highlands and harare. these are considered the major tourist destinations in zimbabwe. methods: data were collected using a quantitative design from 301 tourism and hospitality managers. results: the suppliers rated natural attractiveness, cultural attractiveness and human resources as critical dimensions contributing to the competitiveness of zimbabwe. significant to this study was the finding that perceptions differ depending on the type of establishment. conclusion: as competition between destinations in africa is growing, understanding the dimensions influencing destination competitiveness is invaluable, because it enables destination managers to focus on unique critical dimensions to sustain a competitive advantage. keywords: destination competitiveness; tourist destination; political challenges; zimbabwe; africa. introduction the tourism industry is considered a vital part of the economy globally due to its capacity to generate revenue and jobs (musavengane, siakwah & leornard 2019; woyo & slabbert 2019). in zimbabwe, the tourism sector has been the third most important contributor to the gross domestic product (gdp) for the last two decades (world bank 2020). however, the country’s gdp is estimated to have contracted by 8.1% in 2019 and the recession in the destination is projected to continue in 2020 due to persistent climate shock and domestic vulnerabilities worsened by the global coronavirus pandemic (covid-19) (world bank 2020). furthermore, the performance of zimbabwean tourism has been weak in the last 20 years following the violent land reform programme that was executed in the year 2000 (woyo 2018; woyo & woyo 2019). this resulted in the country earning a negative ‘bad boy’ image influencing tourist arrivals to the country. research has shown that tourism is a crucial tool through which a destination’s image can be promoted (bolourchian & karroubi 2020). due to the economic benefits of tourism, tourist destinations globally are increasing investments in the industry to boost local economies (reisinger, michael & hayes 2018), and zimbabwe is no exception (woyo 2018). increased investments in tourist destinations have resulted in increased global competition for arrivals, as several tourist destinations are offering more and more similar tourism products (dwyer 2015; woyo 2018). global competition is forcing destinations to ensure that they are competitive (dwyer 2015); therefore, the influence of competitiveness on destination performance is significantly growing due to global and economic trends (ayikoru 2015; dupeyras & maccallum 2013; dwyer 2015). competitiveness is a complex construct, whose measurement has not been standardised as several aspects are included in its composition (dodds & holmes 2020; woyo 2018). several diverse definitions are evident in literature. d’hauteserre (2000:23) defines destination competitiveness as ‘the ability of a tourism destination to maintain its market position and share and/or improve upon them through time’. dupeyras and maccallum (2013) define destination competitiveness as: … the ability of the place to optimise its attractiveness for residents and non-residents, to deliver quality, innovative and attractive tourism services to consumers and to gain market shares in the domestic and global market places, while ensuring that the available resources supporting tourism are used efficiently and in a sustainable way. (p. 7) based on these two definitions, though not an exhaustive list of the existing definitions, it is critical to note that attracting visitors to a destination is an important focus point of competitiveness. this view is reflected in earlier studies on destination competitiveness in which it was argued that competitiveness in a tourism context should result in increased tourism expenditure, arrivals, provision of memorable experiences, and profits (cimbaljević, stankov & pavluković 2019; tsai, song & wong 2009). research concerning the evaluation of destination competitiveness has focused much on advanced and mature tourism destinations including australia (abreu-novais, ruhanen & arcodia 2018), austria and switzerland (mazurek 2014), canada (dodds & holmes 2020), the caribbean (bolaky 2011), european destinations (vinyals-mirabent 2019), spain and turkey (andreas-caldito, sanchez-rivero & pulido-fernandez 2013). while there are several studies that investigated competitiveness globally, there is limited research from a developing country perspective (ayikoru, 2015; du plessis & saayman 2017; du plessis, saayman & van de merwe 2015) that have used supply-side data to understand the important destination competitiveness factors (woyo 2018), specifically those with political instability and economic challenges, such as zimbabwe. this is regardless of the need for destinations to continually appraise themselves to identify their key strengths and weaknesses (heath 2003). this study aims to identify the tourism destination competitiveness factors of zimbabwe using supply data. the question that remains unanswered is: what are the important determinants of destination competitiveness as perceived by the supply side of zimbabwean tourism? do these determinants differ among different categories of supply-side respondents? background one and a half billion international tourist arrivals were recorded in 2019 globally and at least two billion travellers are expected by 2030 (united nations world tourism organisation [unwto] 2020). in the context of zimbabwe, tourism grew faster following the country’s independence in 1980 (turton & mutambirwa 1996), reaching its peak in 1999 (woyo 2013). during this period, zimbabwe was the fourth most attractive tourist destination in africa following south africa, tunisia and morocco (woyo 2018). however, this growth did not continue, as tourist arrivals have been plummeting over the last 20 years. added to this, growth in the global travel market has slowed in 2020 due to covid-19, a pandemic that brought tourism to a halt by mid-march 2020 (gössling, scott & hall 2020). at the beginning of the 21st century, the robert mugabe administration embarked on a violent and contested land reform policy, which resulted in many white commercial farmers being forced from their land. tourism was the most severely affected economic sector due to the political violence that reared its ugly head from the year 2000 (woyo & slabbert 2020). a government of major political parties was brokered by the then state president of south africa, thabo mbeki, and was established in 2009, following the inconclusive presidential results of 2008. although this arrangement brought some stability, the sector has not fully recovered from the effects of the land reform policy as it continues to receive limited arrivals and its image remains negative. these challenges are exacerbated by a worsening political environment and contested presidential elections (woyo & slabbert 2020). although emerging research is beginning to understand travel behaviour in destinations that are politically unstable and economically distressed (farmaki, khalilzadeh & altinay 2019; hapairai, walters & li 2018; woyo & slabbert 2020), studies investigating what makes zimbabwe competitive in these challenging times using supply data, remains under-researched. the 2019 world travel and tourism competitiveness (wttc) report provides the latest information concerning the competitiveness of destinations. the travel and tourism competitiveness index measures ‘the set of factors and policies that enable the sustainable development of the travel and tourism sector which, in turn, contributes to the development and competitiveness of a country’(world economic forum [wef] 2019). the biennial wttc report provides a benchmark concerning the competitiveness of the travel and tourism sector of 141 economies, including zimbabwe. zimbabwe has been ranked as the worst travel destination for a couple of years (woyo 2018). the destination was ranked 115th out of 141 competing destinations in 2015 (wef 2015), 126 out of 138 in 2017 (wef 2017) and 114 out of 139 in 2019 (wef 2019), implying that its competitiveness slipped due to reduced levels of economic productivity (wef 2019). other challenges faced by zimbabwean tourism as documented by the wef (2019) include inadequate health systems, reduced levels of economic productivity, poor infrastructure, inferior technology and a poor business environment. the quality of a destination is a critical antecedent of competitiveness because it influences visitation and tourism revenue (assaf & tsionas 2015:58). destination quality is measured using infrastructure, human resources and service delivery (assaf & tsionas 2015:59), and zimbabwe is ranked among the lowest 10 destinations based on quality (wef 2019). the question that remains unanswered is, with such a level of performance, what are the factors that make zimbabwe competitive using supply-side insights? in 2013, zimbabwe had the opportunity to co-host the unwto general assembly in the resort town of victoria falls. this opportunity did little to influence the negative perception about zimbabwe as a tourist destination, as its rankings continue to be low in terms of quality and overall competitiveness (wef 2017, 2019). the zimbabwe tourism authority (zta), which is the national tourism organisation in zimbabwe, ran several reputation management programmes from 2000 (woyo 2018). some of the tactics involved celebrities endorsing zimbabwe as a safe destination, following the decline of tourist arrivals, due to the contested land reform programme and contested presidential elections (woyo 2018; woyo & slabbert 2020; zta 2006). additionally, several carnivals have also been hosted since 2013 as a means of improving destination image. however, research investigating the competitiveness factors of zimbabwe as a tourist destination post the 2000 land invasion and the beginning of contested presidential election results using insights from the supply side is limited. understanding these factors from the supply side is critical in unpacking the broad categories of determinants, which the industry needs to enhance in rebuilding the sector and attracting more visitors. literature review research shows that global competition for arrivals is increasing (mackay & spencer 2017). as a result, the promoters of destinations are now thinking and behaving more like businesses through the development of new markets, tourism products and customers as means of creating and a sustaining competitive advantage (kubickova & martin 2020; woyo 2018; woyo & slabbert 2019). furthermore, agents who promote destinations are also beginning to focus on the use of smart technology as a way of creating smart ecosystems to make destination competitive (buhalis & matloka, 2013). it is evident that destination competitiveness constitutes an essential component of destination management and growth that demands continual research. there is a growing stream of literature focusing on destination competitiveness, suggesting that it is an area that has attracted much interest from academics (dodds & holmes 2020; kubickova & martin 2020; villa, darcy & gonzalez 2015; woyo 2018; zehrer, smeral & hallmann 2017). regardless of the growing amount of literature investigating destination competitiveness, the measurement of destination competitiveness continues to be tenuous. the number of variables that are associated with the measurement of destination competitiveness appears to be increasing. previous research shows that the methods of investigation has either employed an objective or subjective methodology (heath 2003; zehrer et al. 2017) using predominantly demand-side respondents. the objective methodology measures destination competitiveness using actual figures (volume, market shares, tourist arrivals, tourism revenue, employment growth, value addition, visitor spending and length of stay) (woyo 2018; zehrer et al. 2017). subjective indicators measure competitiveness ‘on the basis of tourists’ expectations and perceptions of the destinations on the competitiveness of destinations’ (zehrer et al. 2017). these are some of the aspects that show that competitiveness is a multidimensional construct (kubickova & martin 2020) and suppliers in the tourism industry must have a comprehensive understanding of these elements to make decisions on how to improve and sustain the competitiveness of the destination. due to the multidimensionality of the construct, competition in a tourism context happens at multiple levels, including the firm, regional and national levels (kubickova & martin 2020). analysing these levels directly links with the suppliers that operate on all these levels. prior research shows that destination competitiveness has three significant objectives, that is, the economic well-being of residents, destination attractiveness and satisfaction provided by the destination, and sustainability (abreu-novais et al. 2018). to improve the residents’ income and well-being, there is a need to understand the views of supply-side managers on what makes a destination competitive. additionally, for a destination to satisfy the needs of its visitors better than the competition, research must critically unpack the views of the suppliers. these stakeholders not only provide the tourism products to visitors but also sell the zimbabwean experience and have knowledge of destination competitiveness factors that will enhance marketing efforts. several models regarding destination competitiveness have been put forward in the literature (crouch 2011; kubickova & martin 2020). most of the destination competitiveness modelling is underpinned by the ideas of porter’s (1960) diamond model. the analysis of the models shows that there are several determinants of destination competitiveness. these include core resources and attractors, supporting factors and resources, destination policy, planning and development and qualify determinants, endowed resources, created resources, destination management, situational conditions, demand factors and market performance (crouch 2011; dwyer & kim 2003; kubickova & martin 2020; ritchie & crouch 1993). given the uniqueness of destinations, measuring the competitiveness of a destination with political challenges might change the factors or the importance of certain factors. most of the destination competitiveness modelling has been done for european destinations with a lack of similar insights within the african context. to the best of our knowledge, there are destination competitiveness studies but few of these have developed models with the african destination in mind. heath’s (2003) model for south africa, which is presented as a house, argues that tourism competitiveness of destinations is determined firstly by the foundations, which focus on attractions management, addressing the fundamentals, providing the enablers, capitalising the value adders, ensuring appropriate facilitators and aspects that enhance experiences. secondly, the heath model argues the need for the ‘cement’ in the form of effective communication channels, stakeholder involvement and managing competitive indicators. this would then lead to the sustainable development of policy and frameworks for destinations, including marketing. lastly, the model discusses the critical success drivers that include a shared tourism vision and leadership and other aspects, such as political will and entrepreneurship. therefore, research investigating the dimensions of competitiveness in politically and economically volatile destinations using supply-side data is lacking, despite the need for destinations to always analyse the factors that promote such (crouch 2011). this study seeks to close this gap. methods data collection and sampling the study employed a quantitative methodology to identify the factors that make zimbabwe a competitive destination regardless of its political and economic challenges, specifically from the supply point of view. using managers from selected tourism and hospitality establishments in victoria falls, harare, great zimbabwe and the eastern highlands, data were collected using a structured questionnaire (in english). the questionnaire had two major sections. the first section of the instrument collected data on the organisational profile, focusing on the category of the establishment, years of operation, the number of employees, in-season, repeat business and unique selling propositions. secondly, the questionnaire collected data on destination competitiveness measured using a five-point likert scale (1 = strongly disagree; 5 = strongly agree). the scale for destination competitiveness was developed based on an in-depth literature review (assaf & tsionas 2015; kim 2012; buhalis 2000; kulendran & dwyer 2009; mihalic 2016; ritchie & crouch 1993). as stated before, destination competitiveness factors have predominantly been investigated in more mature destinations, with stable economies and political governments. this is the first measurement of destination competitiveness factors for a destination with ongoing political and economic challenges, and in particular, from a supply perspective. a pilot study was thus done among 30 hotel and tourism managers in harare to evaluate the measurement efficacy. the measuring instrument was revised and enhanced following the suggestions of the pilot survey. the responses of the pilot study were not included in the final analysis of the results. data were collected from a convenience sample that was accessible to the researcher and four field assistants between november 2016 and january 2017. these field assistants were informed of the aims of the study and trained by the researcher in harare on how to approach the respondents and collect the data. the database kept by the zta shows that there are 1281 tourism and hospitality operators countrywide (zta 2016). the guidelines of krejcie and morgan (1970:608) were used to derive a sample size of 297. based on this, 320 questionnaires were eventually administered to tourism and hospitality managers, or to those who were seconded by the managers to complete the survey instrument. altogether 301 questionnaires were completed, representing a 94% response rate. data analysis data were analysed using spss version 26.0 focusing on descriptive and inferential statistics. descriptive analyses were performed to determine the profile of the sample using frequencies and percentages (table 1). the study used exploratory factor analysis (efa) to identify the underlying destination competitiveness of zimbabwe as a tourist destination. using the extracted factors, we conducted multivariate analysis of variance (manova) to identify the significant differences in the factors among six groups of tourism and hospitality establishments after checking the assumptions of manova. lastly, the bonferroni post-hoc test was performed to identify where significant differences existed. table 1: description of sample. results summary of demographic characteristics most of the respondents were female (65.78%), who were drawn from several managerial positions, including operations (57.1%) and marketing (31.6%), suggesting that women are represented in management positions. results show that most of the respondents hold a diploma or degree qualification (see table 1). much of the data were collected from tour operators (37.8%), followed by accommodation providers (16.9%). most of these businesses have been operating in zimbabwe for more than three decades (33.2%), while 27.9% of the sample have been conducting business for more than four decades. therefore, the opinions shared by suppliers on the issues under investigation are valuable, given the time these businesses have been operating. relatively newer hospitality and tourism operations were 15.3%. due to the challenging economic environment in zimbabwe, hospitality and tourism operations have a small permanent workforce (20.9%). this creates challenges in building the tourism industry in such a volatile environment, as job creation is minimal. those with a more significant permanent workforce were 6.4% of the sample. altogether 52% of the respondents indicated that they hire between 1 and 20 temporary employees in a month, which is high, depending on the size of the business. the unique selling points for zimbabwe are believed to be the country’s natural, cultural and historical attractions, including victoria falls and the great zimbabwe ruins. organisations that participated in this survey also indicated that their unique selling points stem from the attractions that the country has and the hospitality and service they offer to travellers. therefore, from a supplier’s perspective, zimbabwe must develop its strategic destination marketing communications around the destination’s unique selling points. competitiveness factors of zimbabwe exploratory factor analysis was conducted to determine the underlying destination competitiveness factors before implementing further multivariate analysis. the factors that were retained for analysis were those that generated eigenvalues greater than 1 (malhotra 2010) and factor loadings of 0.50 and above. those that loaded below 0.50 were deleted. the efa results generated a kaiser-meyer-olkin (kmo) above the recommended 0.60 (0.78) (malhotra 2010). bartlett’s sphericity test was significant (p = 0.001), suggesting that the factorability of the correlation matrix in this study was supported. the factors generated high internal consistency and reliability, as the cronbach’s alpha was higher than the recommended 0.60 in all instances (malhotra 2010). the efa produced an eight factor solution (table 2) identifying the competitiveness factors of zimbabwe as a tourism destination with perpetual economic and political challenges. table 2: results of exploratory factor analysis. the first factor to explain the competitiveness of zimbabwe was labelled natural attractiveness, which explained 40.3% of the variance with a reliability score of 0.74. the supply-side respondents perceive zimbabwe as competitive based on the natural attractions that it offers to travellers, including good climate and world-class natural resources, such as victoria falls. this factor was given more prominence, based on the mean score (x = 4.24). factor 2 was labelled destination quality and explained 22.4% of the variance with a reliability score of 0.70. the factor had a mean score of 4.11, suggesting that the supply-side respondents perceive destination quality as a critical determinant of competitiveness for zimbabwe, regardless of its political and economic challenges. the competitiveness of a destination is affected by the quality of the tourism experience (cimbaljević et al. 2019), which tourism suppliers are responsible for. zimbabwe, as a distressed destination, is still receiving tourists (woyo & slabbert 2020) which shows that the destination shows some elements of competitiveness regardless of the challenges it faces. the tourist arrivals to zimbabwe are, however, too low to be competitive per se, but clearly these factors contribute to sustaining tourist arrivals, which range around two million per annum (zta 2019). ground and airport infrastructure were considered an important element of destination quality by the supply-side respondents. however, respondents noted that while zimbabwe’s road infrastructure is important for destination competitiveness, it currently lowers the competitiveness of zimbabwe due to a lack of maintenance (woyo 2018; woyo & woyo 2019). the third factor was labelled cultural attractiveness. this factor emerged as important, with a mean score of 4.03, explaining 15.9% of the variance and a reliability score of 0.70. the local cuisine of the destination showed the strongest association with the latent variable. guan and jones (2015) argue that local cuisine of a destination is a critical antecedent for destination competitiveness and attractiveness, since it is a unique element to be marketed to tourists. quality human resources emerged as the fourth most important factor, perceived by the supply side as a critical determinant of competitiveness of zimbabwe (x = 3.70). this factor explained 10.3% of the variance, with a cronbach’s alpha coefficient of 0.90. the importance of staff should not be underestimated, and african communities are well known for their hospitality, which is an aspect to be highlighted to potential visitors. the fifth factor was labelled tourism infrastructure. this factor explained 12.3% of the variance, with a reliability score of 0.82. the mean score of 3.93 suggests that respondents do perceived this a critical destination competitiveness factor. although tourism infrastructure is well documented in the wider literature (woyo 2018; xie & tveterås 2020), elements that contribute to this factor are likely to differ from one tourist destination to the next. aspects such as money exchange facilities, a variety of restaurants and shopping facilities form part of this factor. there is a need for continually increased capital spending in tourism infrastructure as a means of enhancing competitiveness (xie & tveterås 2020) and this is not currently happening in all areas of zimbabwe. the sixth most important factor was labelled politics and policies (x = 3.31). the concern was to measure the role that political players and tourism policies play in determining the competitiveness of zimbabwe. dwyer and forsyth (2011) argue that policies are critical elements that influence destination competitiveness. even though it was measured in this study, it was clear that the role of politics in determining destination competitiveness in africa and zimbabwe requires further unpacking. this factor was explained by 9.11% of the variance with a reliability of 0.86. the lower rating of this factor was an interesting result with the suppliers considering it less important. the seventh factor was labelled destination management. this factor has been identified in past studies (crouch 2011; ritchie & crouch 1993). the mean score for this factor was 2.96 suggesting that the destination does not perform well in this regard. aspects such as marketing, innovation, the role of destination management organisation and commitment to the development of zimbabwe as a tourist destination were a concern. the last factor was named price competitiveness, which had a reliability score of 0.64. based on the mean, it appears that the destination is not competitive, and past studies have identified that zimbabwe is an expensive destination (woyo 2018; woyo & woyo 2019). the price competitiveness of zimbabwe is weak because of weakening currency induced by economic decline and political instability. based on the indices computed for each competitive factor (table 3), natural attractiveness and cultural attractiveness factors are rated high by managers from all the establishments. however, differences were observed in other competitiveness factors. human resources were rated highly by respondents from the accommodation, tour operator and museum establishments. price received a high value from respondents drawn from the accommodation sector, but most of the establishments rated it lower. other competitiveness factors that were rated with lower indices include destination quality, tourism infrastructure, destination management, as well as politics and policies. table 3: mean scores for indices of tourism establishment categories for competitiveness dimensions. comparing destination competitiveness factors among suppliers the study employed manova in answering the research question, ‘do these determinants differ among the supply-side respondents?’. identified perceptions of supply-side respondents, regarding destination competitiveness factors, using efa, were analysed by means of manova because it allows concurrent examination of multiple independent and dependent variables (hair et al. 2010). the study also employed the tukey test as part of the post-hoc tests. analysed results showed moderate correlations between dependent variables, ranging between 0.179 and 0.78, and this was considered appropriate for the study. the manova analysis of the perceptions of supply-side respondents regarding the destination competitiveness factors of zimbabwe produced a significant model (wilks’s λ = 0.690; f(4, 2,758) = 9.261; p = 0.000). thus, the estimated model indicates that there were significant differences between the respondents drawn from various establishments in the zimbabwean tourism industry. the univariate between-subject tests analysis also showed significant differences based on the category of establishment and the competitiveness factors, particularly with natural attractiveness (p = 0.000), cultural attractiveness (p = 0.003) and human resources management (p = 0.04) (table 4). the bonferroni correction with post-hoc test was applied at the significance level of 0.005 to determine if differences occur between subject tests and establishments. firstly, natural attractiveness was perceived significantly more important by the accommodation sector (x = 3.95) and attractions-based establishments (x = 3.93) than food and beverage establishments (x = 3.35). secondly, food and beverage establishments (x = 4.45) and museums (x = 4.15) considered cultural attractiveness the most important factor influencing destination competitiveness of zimbabwe, compared to accommodation (x = 3.66) and meetings, incentives, conferencing and exhibitions (x = 3.45). thirdly, accommodation (x = 4.17), meetings, incentives, conferencing and exhibitions (x = 3.95), attractions (x = 3.89) and tour operators (x = 3.88) perceived human resources as a critical aspect of competitiveness in zimbabwe. in summary, those in accommodations and attractions establishments gave relatively more weight to natural attractiveness and human resources factors than managers in other establishments. in contrast, food and beverage establishments considered cultural attractiveness to be more important than those in other establishments. other competitiveness factors such as destination quality, price, tourism infrastructure, destination management and politics did not show significant differences among establishments. table 4: results of multivariate analysis of variance. conclusion the current study contributes to literature by identifying the dimensions influencing the destination competitiveness of a country with political challenges from the perspective of suppliers. even though destination competitiveness factors have been identified in previous studies, the grouping of these aspects were unique. the following main findings are evident from the data analysed in this study. firstly, the most important destination competitiveness factors for a destination in distress are natural attractiveness, destination quality and cultural attractiveness. with natural attractiveness as the most important competitiveness factor, the focus of competitiveness building should be on visual appeal and wildlife resources. establishments that sell natural tourism products such as national parks and natural landmarks, including victoria falls, directly contribute to the competitiveness of zimbabwe. this could be attributed to the fact that these products form part of their core business, and most of the international tourists to zimbabwe often visit these places, thus giving the country a default competitiveness dimension. natural attractions are widely marketed in the country (woyo 2018; woyo & slabbert 2019; woyo & woyo 2019), hence the reason why the suppliers perceived natural attractiveness as a competitive dimension for a distressed destination. while these aspects of the destination should continue to be marketed, there is a need to also ensure that the safety of tourists is not compromised. furthermore, it is interesting to note that the suppliers considered natural attractiveness as the most important factor. in their case they have control over factor 2, which is directed at the industry, and these aspects can be effectively managed and improved. although some of these factors have been confirmed in previous studies (crouch 2011; guan & jones 2015), it is the first time they are being reported in a destination with political challenges using the perspectives of the supply side. the importance of natural attractiveness as a competitiveness factor can be of benefit to zimbabwe post-covid-19 as tourists might want to travel to destinations with open spaces where social distancing is easier to adhere to. secondly, there are significant differences between establishments and competitiveness factors and this poses a challenge that must be addressed by policymakers as the establishments should all agree on the destination competitiveness factors since they are selling the same country. perceptions of managers in the accommodation and attractions sector are significantly higher than those of other establishments. these managers perceive zimbabwe as competitive due to natural attractiveness, cultural attractiveness and human resources. this could be attributed to the fact that these are the critical tourism products that zimbabwe sells to tourists. although identified as important competitiveness factors, there are no significant differences between tourism infrastructure, and politics and prices, as all the managers rated them lower. previous studies have established, using demand data, that zimbabwe is an expensive destination (woyo & slabbert 2020; woyo & woyo 2019). woyo and slabbert (2020) argue that zimbabwe could be an expensive destination because of the ‘use of the us dollar which often results in price differentials, especially for the african market, as most currencies are weaker than the us dollar’. it therefore becomes imperative that the issues of price, dilapidated infrastructure and policies be improved to enhance the competitiveness of zimbabwe as a tourist destination. this study offers relevant insights into the competitiveness of distressed destinations because the packaging of competitiveness factors is different to previous studies. understanding the perceptions of the factors contributing to destination competitiveness is critical for the formulation of destination management policies (crouch 2011) and brand messages by the destination management organisation. these policies, when developed, need to be implemented by establishments. the destination management organisations must continue to promote the natural attractions in zimbabwe. however, efforts must be made to innovate new product offerings, especially those that could help to co-create positive tourism experiences like food tourism, gastronomy and cultural events with the aim of attracting more arrivals to the destination. these innovative products must be developed by establishments to be promoted by the marketing organisations of the destination. the study is limited in that only establishments in major tourist hubs in zimbabwe participated in the survey. future studies could include a larger sample across zimbabwe and must also be done in other african countries to further substantiate the competitiveness factors related to the continent. furthermore, instead of using established scales, there is a need for future studies to employ other methodologies and designs like the exploratory sequential design to generate a more nuanced insight into the competitive dimensions of zimbabwe and future studies could make a comparative assessment studying demand-side respondents. other aspects that could be researched include the role of government initiatives on destination competitiveness. acknowledgements this article draws from the phd thesis of the first author, which was presented and submitted to the faculty of economic and management science, school of tourism management, north-west university, potchefstroom, south africa. the support received from peers and reviewers during the preparation of this manuscript is acknowledged. the support received from prof. saayman, as the co-promotor of the phd, is appreciated, and may his soul continue to rest in peace. competing interests the authors have declared that no competing interests exist. authors’ contributions e.w. made contributions in the areas of conception, data collection and analysis. e.s. did a critical review of the initial draft, ensured that the appropriate methodological approach was followed and gave the direction for the work. all the authors read through the various versions of the work and approved the version that was submitted for review and publication. ethical consideration ethical approval for this study was obtained from the faculty of economic and management sciences of the north-west university (potchefstroom campus; approval number: ems15/10/15-02/03). written informed consent was obtained from all respondents before the study. funding information this research received no specific grant from any funding agency in the public, commercial or not-for-profit sectors. data availability statement the authors confirm that the data supporting the findings of this 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zimbabwe tourism statistics and economic indicator highlights, zta, harare. microsoft word 10 lee sajems 17(4) 2014.docx sajems ns 17 (2014) no 4:501-514 501 seeking rigor in south african business research: aspirational principles in contrast to a recent publication gregory lee wits business school, university of the witwatersrand accepted: april 2014 studies of organisational success and other aspects of management are critical in understanding and improving critical areas of african economic stability. this article seeks to urge high levels of rigor in south african research in this area, notably empirical research, proposing several aspirational research principles. first, the article considers claims of uniqueness versus the practical value of embedding research as a replication in a well-considered wider body of knowledge. second is the desirability of conforming to sufficiently high norms of model fit and effect size and accuracy. third is empirical comparison of south african studies with previous findings, with attendant possibilities for new theory development. fourth is proper tests for and treatment of common method bias. fifth is specification of appropriate sets of constructs. finally, this article proposes specification of alternate models that will add substantial rigor to such research. in advocating these possibilities, the current article contrasts these aspirational principles to a recent sajems article. this critique serves an exclusively illustrative purpose, showing some pitfalls of not conforming to the aspirational principles, the benefits of explicitly including certain easy to achieve solutions, and the ease with which greater rigor can sometimes be achieved. ultimately, this article seeks to constructively advance african business research standards. key words: research methodology, empirical and quantitative research, uniqueness, common method bias, small business jel: b40, c18, 52, m13 1 introduction this article seeks to advance the rigor of south african research into the business arena. many areas of business research are widely regarded as critical economic arenas, with substantial promise for broad-based wealth generation, job creation, and other benefits (e.g. liedholm & mead, 2013). the aim of this article is to encourage greater rigor in business research by advocating certain research principles, some of which are well accepted in theory but not always applied, and others which are rarely considered but which i argue can do much to advance the standard of our quantitative methodological practices. the article uses a recent contribution to the south african small business literature by farrington (2012) as an illustration of the pitfalls of research that does not address at least some of these principles. the intention of this article is not to critique this example per se. farrington (2012) is certainly not the only publication in this area which may have been used for this purpose. however, this article argues that it serves as a useful example against which the research principles advocated might be compared. the following sections therefore discuss the specific context of the critiqued article, and thereafter address each major research principle in succession, using farrington’s (2012) article as an illustrative case. 2 the context of the critiqued article the psychology of entrepreneurs and small business owners forms a central pillar in research investigating the drivers of small business success (e.g. begley & boyd, 1988; jain 2011; wiklund, patzelt & shepherd, 2009; xavier, kelley, kew, herrington & abstract 502 sajems ns 17 (2014) no 4:501-514 vorderwülbecke, 2013; frese, 2009; rauch & frese, 2000; shaver, 2010). personality of small business owners is a fecund subset of this literature (beugelsdijk & noorderhaven, 2005; brandstätter, 2011; frank, lueger & korunka, 2007; rauch & frese, 2007; zhao, seibert & lumpkin, 2010). research has investigated a wide variety of personality constructs, including tolerance for risk, locus of control, creativity, individualism, achievement motivation, and innovation (collins, hanges & locke, 2004; farrington 2012; stewart & roth, 2004 & 2007; zhao et al. 2010). the five factor model (ffm) is a useful taxonomy that has enjoyed increasing attention in the context of entrepreneurial outcomes. the ffm employs the facets of extraversion, openness, conscien tiousness, agreeableness, and neuroticism (emotional stability being the positive analogue). in this vein, farrington (2012) provides what is probably the first south african data assessing linear relationships between the personality of small business owner-operators (as measured by the ffm) and success of their businesses as measured by growth and financial performance. (i employ capitalisation of key variables hereafter to highlight key constructs). farrington (2012:383) suggests that no prior model can be found that uses the five-factor model of personality to explain small business success. i do not repeat the theory underlying personality and the ffm here, or that surrounding the use of small business growth and financial performance as key outcomes. farrington (2012) has undertaken an adequate outcome of these, and in addition she discusses in depth the various arguments for links between personality and business growth and financial performance. i refer the reader to that explication for the sake of brevity (see, for instance, barrick & mount (1991) and john, naumann & soto (2010) for more on these theory building blocks). farrington’s (2012) linear hypotheses propose positive relationships between the personality factors of extraversion, conscientious ness, openness to experience and agreeableness with small business success, and negative relationships between neuroticism and the business success. as discussed previously, the following sections suggest some aspirational research principles for such work, and uses farrington’s (2012) article as an illustration either of the pitfalls of falling short of these or of the positive steps that can be taken to extend and improve our local research. exclusively positive contributions are sought in this regard. 3 embedding studies: uniqueness vs. replication it is certainly desirable that south african researchers undertake unique research, and it would hardly be controversial to suggest that such researchers should defend any claims to uniqueness by ensuring that similar work has in fact not essentially been published elsewhere. the latter step clearly requires a careful literature review, with a sober consideration of prior research applicability to the researcher’s own study. a particular danger in this regard is the careful scrutiny of the many sub-disciplines that may contain pertinent commentary on a particular business topic. small business research, for instance, may of course vest in ‘obvious’ categories of outlets such as management and business, less derivative but commonly referenced areas such as psychology, economics and sociology, and in areas perhaps less commonly accessed such as economic geography. these multiple sources of information are not always noticed. the isi citation indices, for instance, delineate economic geography from other disciplines mentioned above because of the distinction between social science and science categories. similar problems may arise with some search engines such as jstor or abi inform. however, cross-cutting search engines increasingly lessen this risk. the desirability for claims of research uniqueness, however, presents an interesting divergence from the reality of much of our publishing. uniqueness at the highest level of application involves genuinely new theoretical ideas or linkages, which involve “the extent to which it runs ahead of existing empirical research in terms of alerting us to research opportunities hitherto unanticipated (lakatos, 1970)” (kilduff, 2002:252). rynes (2002) sajems ns 17 (2014) no 4:501-514 503 notes that claims to uniqueness need to show high incremental contribution, a certain ability to add views that are not obvious, and importance to the management world (see also corley & gioia, 2011). some south african management research indeed makes theoretical contributions, but, arguably, more work builds within the boundaries of established bodies of theory, perhaps with relatively limited twists on existing models or limited methodological or empirical uniqueness. the alternative to claims of high-level uniqueness is to acknowledge openly that the article is (mostly) a replication or extension in a particular geographic, temporal, sectoral, or other context. the context provides some localised ‘uniqueness’, but really at a lower level of empirical differentiation, unless the researcher takes explicit steps to incorporate theoretically defensible additions to the core thinking (such as new theory based on cultural differences). despite the reluctance of social science researchers to do purely derivative research – perhaps because journals are loath to publish these replications and contextual extensions not only have value, they sometimes have even more value than does work that is completely unique (uncles & kwok, 2013). this is because the business world is saturated with models and theories most of which have extremely scant support. establishing and confirming the applicability of existing theory is valuable, especially when new contexts are under investigation (e.g. see easley, madden & dunn, 2000; goldsby & autry, 2011; hubbard & lindsay, 2013; uncles & kwok, 2013). this article advocates for south african researchers to differentiate strongly between work that is genuinely unique at the level of new theory and that which is essentially replication or extension. where the latter is true, the researcher should fight to embed the research in local contextual nuances that may alter effect sizes or even directions of findings, or at least lend alternative possibilities to discussions and implications of findings. the critiqued article is perhaps a case in point. farrington (2012:383) states that “as far as can be established, no studies using the fivefactor model of personality exist attempting to investigate whether the personality dispositions of small-business owners have an influence on the success of their business” (my italics). this claim is, unfortunately, rather radically overstated. in contrast, much similar work had previously been achieved. as a possible illustration, zhao et al. (2010) had previously published a meta-analysis of research precisely on links between the big 5 personality factors of entrepreneurs and business performance, based partly on a 2006 academy of management proceeding. some 28 months had passed between the print publication of zhao et al. (2010) and the acceptance of farrington’s article, and the 2010 metaanalysis covers some 60 prior sources and 66 independent samples, all with at least some measure of association between ffm constructs and entrepreneurial business performance (see table 1 below for a summary). even if farrington was writing her contribution at or after that of zhao et al., the many contributions that feed into the meta-analysis were surely available to her. table 1 summary of zhao et al. (2010) collection of past ffm-firm performance studies growth profitability overall performance k n k n k n conscientiousness 13 1,554 14 1,801 24 3,193 openness 9 1,406 6 998 15 2,461 emotional stabilitya 29 4,446 8 1,588 22 2,845 agreeableness 9 1,476 extraversion 4 931 a emotional stability is the positive analogue of neuroticism. k = independent sample sizes, n = number of respondents in combined samples. zhao et al. (2010) do not present meta-analytical results for agreeableness or extraversion on growth or profitability. 504 sajems ns 17 (2014) no 4:501-514 an argument could perhaps be made that farrington’s study is limited to small businesses and the meta-analysis of zhao et al. (2010) is targeted at entrepreneurs, an important distinction. however, the note above regarding looking to other fields and sub-fields seems important here. an analysis of the sources used by zhao et al. suggests many sources that would apply to the small business context. as stated previously, the intention of this section is not to cavil overly against farrington’s (2012) claim of uniqueness. there need be no doubt that she was unaware of this body of international research. however, it is necessary to set the record straight for the south african scientific community and embed the farrington research in its proper international context. i take this further and compare her results to the international findings below. generally, south african research that is embedded in a well-established milieu, even with some differences, would perhaps best be explicitly positioned as such. 4 size and accuracy in quantitative methodologies since much business research utilises quantitative methodologies, this article focuses substantial comment on such routes of enquiry. many of these studies follow correlational techniques such as correlation analysis, regression, anova and the like. as has long been noted in the broader methodological literature, claims to model fit, effect size and accuracy of parameters require careful consideration. tenuous claims to any of these should not easily permeate research that purports to the higher standards of our discipline. notably, models with little explanatory power, overly low effect sizes, and power issues in the accuracy of slopes should be taken at best with a proverbial pinch of salt. as the example at hand, farrington (2012: 392-392) makes several claims regarding her findings. notably, she infers that her regressions fit and that they show reliable and influential linear relationships. in reality, farrington’s (2012) results are modest at best. analyses of r2s indicate that the financial performance regression explains only 7.7 per cent of dependent variable variance, while the growth performance regression explains only 6.1 per cent. while not zero, these are extremely low squared multiple correlations that call for caution (e.g. cohen, cohen, west & aiken, 2003). farrington (2012) would have done well to justify her implicit claims of fit, perhaps through comparison with other entrepreneurial studies linking psychological aspects to these sorts of outcomes. on financial performance there are several statistically significant slopes, including extraversion (β = .13, p < .05), conscientiousness (β = .14, p < .05) and openness (β = .14, p < .05). on growth performance, openness (β = .16, p < .01) and neuroticism (β = -.13, p < .05) are statistically significant. one extra note here: farrington’s (2012) reported beta for neuroticism on growth (which she puts at β = -.065) is incorrectly reported by more than a half, which can be deduced by the fact that derived covariances from her paper result in the exact same r2 values and paths to multiple decimals excepting that for neuroticism. in almost any standard interpretation of ols regression results, r2 statistics of less than .10 and beta coefficients of less than .20 would usually not be seen to respectively show either fit to a linear model or strong linear relationships (e.g. cohen et al. 2003). this conclusion carried through to correlations, which are likewise small in effect size. to illustrate this point, consider the simulated data scatterplots in figure 1, figure 2 and figure 3, representing regression betas (assumed to be controlled for other predictors) of magnitude β = .07, .15, and .20, and noting that farrington’s (2012) smallest and largest betas with statistical significance are .07 and .16 respectively. few researchers shown such plots would claim any serious linear relation-ships. farrington’s (2012) claims rest largely on statistical significance of results. the statistical significance of these slopes (and presumably the anova f) is perhaps more likely the result of relatively high power by virtue of sample size (cohen 1988). to illustrate the power point, i calculate the power functions of this multiple regression using sas proc power. to achieve power of .80 with a partial correlation of only .06 with such a sajems ns 17 (2014) no 4:501-514 505 regression (far higher than the lowest partial correlation in both farrington, 2012 and zhao et al, 2010 of .01) one would need approximately 2,000 respondents. accordingly, farrington (2012) should not have been too quick either to embrace significance or to interpret it as substituting for large effects, a point often made in research methodology (e.g. ziliak & mccloskey, 2004) but too little applied by researchers. figure 1 scatterplot of data with beta = .09 figure 2 scatterplot of data with beta = .14 figure 3 scatterplot of data with beta = .20 0 1 2 3 4 5 6 7 0 1 2 3 4 5 6 7 8 fi rm  p er fo rm an ce  m ea su re controlled  personality   predictor beta  =  0.07 0 1 2 3 4 5 6 7 0 1 2 3 4 5 6 7 8 fi rm  p er fo rm an ce  m ea su re controlled  personality   predictor beta  =  0.15 0 1 2 3 4 5 6 7 0 1 2 3 4 5 6 7 8 fi rm  p er fo rm an ce  m ea su re controlled  personality   predictor beta  =  0.2 506 sajems ns 17 (2014) no 4:501-514 essentially, management scientists should interpret findings such as those of farrington (2012) somewhat cautiously, not necessarily repeating all claims of linear relationships found. power analyses should become de rigeur where available. moderators seeking out circumstances in which relationships are stronger would perhaps be better in studies such as the example here. this point extends to many similar studies as well – improvements in research reporting by the south african business science community should be sought by journals. an anonymous reviewer of this article makes the valuable point that farrington’s weak findings are valuable as weak findings, in the sense that personality not affecting small business success may be as valuable a conclusion as a positive finding. this is correct. however, it is then incumbent on the researcher not to overstate the findings and to cast the conclusions in the light of weak or no findings. an extra consideration is whether common method bias (podsakoff, mackenzie, lee & podsakoff, 2003) may have driven statistical significance, since data is drawn from a oneshot sample and survey with common measurement characteristics. farrington (2012) explicitly acknowledges this issue. i continue in a constructive vein in section 6 below with the discussion of common method bias, illustrating options for researchers seeking rigor. 5 empirical validation: comparability to prior findings the first aspirational research point urged for caution in claiming uniqueness versus actively but constructively acknowledging essential replication of prior work. a corollary to the latter point is that researchers seeking to model known relationships in local contexts can and should compare their findings to those already found elsewhere, if possible explicitly (e.g. hubbard & lindsay, 2013). where findings show similar effects to those found elsewhere – even weak or null effects this is very useful since it allows researchers to make similar recommendations for managerial or other practice. it also adds to general knowledge regarding the similarity of business conditions to conditions elsewhere in a particular area of study. the opposite is also true: divergences from prior findings (or identification with a particular subset of findings elsewhere), enable researchers to develop genuine new ideas regarding contextual differentiation that hopefully can be explicitly developed at a high level of theoretical rigor. in this regard, it is easy enough to formally compare study findings to those found elsewhere, especially where meta-analyses are available or can be synthesised. such additions to south african studies can easily be achieved and will add substantial rigor and validity. for example, having critiqued farrington’s (2012) conclusions regarding the strength of her results, i note that her findings are by no means out of line with similar studies worldwide, and show that they are stable in the presence of common method bias. to illustrate, i show and test comparisons between the results of farrington (2012) and the meta analytical findings of zhao et al. (2010). to do this i compare r2 statistics using the fisher z comparison test of multiple r statistics, and to compare two given slopes (figuratively β1 and β2) i use the slope comparison test for independent samples (paternoster, brame, mazerolle & piquero, 1998; clogg, petrova & haritou, 1995) as follows: 2 2 2 1 21 sese z + − = ββ equation 1 zhao et al. (2010) only reconstruct a regression of ffm characteristics on general firm performance, but do give meta-analytical correlations for conscientiousness, openness and emotional stability (the inverse of neuroticism) on growth and financial performance (for extraversion and agreeableness they only construct correlations with overall performance). to build correlation matrices from zhao et al.’s findings that correspond with those of farrington, i follow their approach by using the correlations between ffm characteristics derived from the ones, viswesvaran, and reiss’s (1996) meta-analysis. in addition, i use the zhao et al. (2010) ffm correlations with growth and profitability where available. in the case of extraversion and agreeableness i sajems ns 17 (2014) no 4:501-514 507 substitute the meta-analytical correlation with general performance into the growth and financial performance correlation matrices. table 2 shows the comparisons between farrington’s (2012) regression on financial performance and the regression reconstructed from zhao et al.’s (2012) meta-analytical correlations. the final columns show the differences between parameters, including the r2 and slopes. table 2 comparisons of financial performance regressions farrington zhao et al. difference βf sef βz sez βf-z sef-z extraversion .129** .050 .047* .028 .082ns .058 conscientiousness .135** .053 .096*** .029 .039ns .060 openness .139*** .051 .152*** .028 -.013ns .058 agreeableness .031 .051 -.031 .029 .062ns .058 neuroticism -.027 .053 -.119*** .029 .092ns .060 r2 .08 .06 .02ns notes. ***= p < .01, **= p < .05, *= p < .10. n for farrington (2012) data is 383, n for zhao et al. (2010) regressions (estimated as harmonic means of individual component samples) = 1,270. significance for r2 differences estimated with fisher z test of multiple r. significance of differences between paths estimated using z-test method of equation 1. table 2 suggests that farrington’s (2012) financial performance regression and that constructed from zhao et al. (2010) are statistically indistinguishable even at the 90% confidence level. table 3 shows the comparisons between farrington’s (2012) growth regression and that reconstructed from zhao et al. (2012). the final columns again show and test the differences. table 3 comparisons of growth regressions farrington zhao et al. difference βf sef βz sez βf-z sef-z extraversion .069 .051 .060** .025 .009ns .057 conscientiousness .037 .054 .310*** .025 -.273*** .060 openness .162*** .052 .250*** .024 -.088 ns .057 agreeableness -.009 .539 -.070*** .026 .061 ns .540 neuroticism -.126** .053 -.020 .026 -.106* .059 r2 .06 .15 .09*** notes as for table 2, except n for zhao et al. (2010) regression now n = 1,501. in this case, the r2 of zhao et al. (2010) is .15 and that of farrington (2012) is .06, the difference of .09 is statistically significant at p < .01. this difference is driven by statistically significant differences between the conscientiousness path (β = .31 for zhao et al. and .037 for farrington, difference = .27 p < .01) and the neuroticism path (β = -.126 for zhao et al. and .020 for farrington, difference = .106 p < .10). however, differences between other paths are not statistically significant. the conclusion to be drawn from these findings is that farrington’s (2012) research is mostly comparable to the bulk of international findings, a conclusion farrington herself largely comes to but by far less rigorous comparisons and by comparisons with less relevant literature (in that farrington largely compares to individual performance literature). the similarities to comparable findings here encourage not only proximal comparability in the sense of personality-performance literature but may add ammunition to any arguments that south african small business owner managers are in many respects similar to other entrepreneurs in similar global markets, although this would be 508 sajems ns 17 (2014) no 4:501-514 a tentative conclusion. it is an approach that accords with recent authors such as hubbard & lindsay’s (2013) that sameness should be the focus for business research instead of difference. table 3 shows that the noteworthy exceptions to comparability are perhaps conscientiousness on growth (which has a moderate effect in the zhao et al. 2010 meta-analysis and practically none in farrington, 2012) and neuroticism (which is moderate but significant in its effect on growth in farrington but negligible in zhao et al. 2010). interesting additions to the literature would perhaps be an investigation into whether these effects are systemic and endemic to south african entrepreneurship, if so why, and what this entails. as noted, the rigorous comparison of local versus prior international effects is what can really seed this sort of theoretical differentiation. 6 stability to common method bias while the problem of common method bias has long been a feature of cautionary methodological literature, especially in psychological research of a perceptual nature (e.g. donaldson & grant-vallone, 2002; podsakoff et al. 2003 & podsakoff, mackenzie & podsakoff, 2012), explicit remedies for the issue remain all too uncommon in south african business research. common method bias refers to “variance that is attributable to the measurement method rather than to the constructs the measures represent” (podsakoff et al., 2003:879). such bias, which may spuriously inflate correlational effects between constructs, may be caused in various ways (podsakoff et al., 2003 & 2012). these include common sources of data (notably common raters, such as all data being gathered from the same people), effects caused by measurement items (such as when answers to items in a survey are biased by social desirability, complexity, or a common answering format), common item context (such as when external effects create common mood between respondents) and measurement context (such as when a common medium such as a one-shot survey is used to gather data, or gathering measurements at the same time or place facilitates commonality of responses). a large proportion of south african business research utilises one-shot surveys, gathered from the same respondents at a single period in time, and often using similar or even identical answer scales such as likert response formats. as illustrated by a large body of methodological literature (e.g. donaldson & grant-vallone, 2002; podsakoff et al, 2012), this may distort, inflate or depress true relational effects between constructs, although such biases may not always occur and may have been somewhat overstated (conway & lance, 2010; spector, 2006). to the extent that common method bias does distort results, it may then distort theory building (reio, 2010). the reader can pursue a full exposition of possible solutions to the common method bias issue in sources such as donaldson & grantvallone (2002), podsakoff et al. (2003 & 2012) and (reio, 2010). in summary, these include several methodological solutions, mostly involving separation of measurement. specifically, separating the sources of outcome and predictor variable data is most desirable (e.g. gathering data on small business success outcomes from a different source – say accounting statements – than the source from which predictor variables are gathered). researchers can also make gains by gathering outcome and predictor variables at different time periods, places, through different surveys or methods, by use of varied answer formats, and by counterbalancing question order. ensuring anonymity and the like helps to ameliorate anxiety that may color all data, and ensuring clarity and neutrality of question and answer formats helps to avoid underlying confusion or social desirability. in addition to methodological solutions, statistical solutions are available (see above references). theoretically, multi-trait multimethod methods are best, but these tend to be available and practical only in scale validation exercises. certainly, when perceptual methods predominate, at the least researchers should rule out the possibility that all measures (perhaps in a subset) are really measuring a single latent factor – this is referred to as harmon’s single factor test and is usually tested by showing bad fit for a single latent factor underlying all manifest variables in a confirmatory factor analysis (podsakoff et al., sajems ns 17 (2014) no 4:501-514 509 2003). this, however, is a weak test that can only provide an initial indication of a problem without providing a solution (although good fit for a single latent factor would probably indicate a substantial methodological problem). among other intermediate models that can provide partial solutions, podsakoff et al. (2003 & 2012) suggest various solutions. the researcher can extract a large first eigenvector in an exploratory factor analysis, explicitly measure and control for a known common method issue (such as explicitly measuring social desirability and controlling for it), and – probably most feasible and balanced – model path relations between constructs while simultaneously modelling a common latent variable loading on all manifest variables (or at least those in a logical subset). the latter would normally involve a simple application of latent variable structural equation modelling. various other models do exist. as an illustration of the issue, but also of possible constructive remedies, consider that farrington’s (2012) study utilises a one-shot one-source survey to business owners. it uses a single answer format (a 1-5 point likert scale) and does not seem to counterbalance questions. this study would seem widely open to common method bias issues, as indeed noted by farrington (2012:396) in her limitation. few south african business researchers, including the current author, could claim not to have engaged in such research. while i would advocate for partial amelioration of the issue through more varied methodologies as described briefly above, in absence of these researchers should at least explicitly rule out a single factor that could perhaps indicate overwhelming commonality. while farrington (2012:389-390) reports an exploratory factor analysis, she does not report eigenvalues that could be indicative. given that pre-chosen subscales were chosen, confirmatory factor analysis should probably have been chosen in any event. as stated above, a more remedial solution may also be desirable. to illustrate this, i employ the ‘common methods variance’ methodology of podsakoff et al. (2003) for dealing with common method bias, namely by adding a latent factor underneath all the major manifest indicators in re-estimating the farrington (2012) regressions. initial analysis suggests that the performance variables have little loading on this common factor, and are removed, whereas personality variables may benefit from a common method extraction. surprisingly, as seen in table 4, although the latent factor withdraws substantial variance from some of the personality indicators it does not change material slopes or outcomes of any of the regressions. table 4 farrington’s regressions with common method bias latent factor finance growth β se β se extraversion .130*** .049 .070 .050 conscientiousness .135*** .052 .037 .053 openness .139*** .050 .162*** .050 agreeableness .031 .050 -.009 .051 neuroticism -.027 .051 -.126** .052 r2 .076 .061 notes as for tables 2 and 3. this finding may potentially suggest stability of this model regardless of the common method employed by farrington (2012), which is a positive finding for her research. the point of such an observation, however, is that farrington could easily have explicitly controlled for at least some common bias in this way, rather than merely acknowledging the problem without a solution. this article accordingly urges for greater rigor in addressing common method bias. authors should be required to fulfill conway and lance’s (2012) recommendations for broad reporting requirements, namely “(a) an 510 sajems ns 17 (2014) no 4:501-514 argument for why self-reports are appropriate, (b) construct validity evidence, (c) lack of overlap in items for different constructs, and (d) evidence that authors took proactive design steps to mitigate threats of method effects” (conway & lance, 2012:325). whether the latter requirements can stop at minimal methodological steps or whether post hoc statistical controls are desired (recommended by those like podsakoff et al., 2012 and not as supported by others like conway & lance, 2012), more explicit reporting will help to elevate the rigor of south african research. 7 rigor of specification: models, controls and constructs this article argues for greater rigor in the specification of models and constructs, with specific reference to three points. 7.1 controls and constructs the requirement for properly specified construct sets is a well-established methodological concern. of central concern is, of course, adequate measurement of core predictor and outcome constructs. of additional concern in this regard are adequate control variables that can provide the proper contextual background for studies, including but not limited to demographic variables such as age and size of the business and contextual variables such as economic context. failure to include a properly specified set of constructs may weaken a study substantially, or even render its findings meaningless. for illustration, farrington (2012) apparently includes no control variables of any kind in her correlational analyses (she mentions none, and covariances drawn from the correlation matrix and descriptive statistics of the core variables replicate her findings, showing no partialling out of controls). a t-test of outcomes slit by two age categories hardly seems like adequate control. this is arguably a great weakness. firm demographics such as size and age have substantial correlation to the crucial performance outcomes (majumdar, 1997; brush & chaganti, 1999; lundvall & battese, 2000), therefore variances in this regard should have been explicitly controlled for. in addition, farrington’s (2012) data could not have been gathered long after the worldwide economic collapse of 2008-2009. variables controlling for economic conditions in each company’s particular sector or other context may have helped explain important additional variance in the performance outcomes of the regression. such omissions may explain weak findings in the core relationships. in general, south african quantitative research must control as adequately as possible for the many external factors that characterise our complex environment, obviously without engaging in overly complex models that may advance limited increases in explanation at the expense of parsimony. 7.2 more complex modelling possibilities while simple cross-sectional linear methodologies are common, researchers truly interested in exploring areas such as small business dynamics at a high level of competence may wish to consider more complex and perhaps interesting methodologies. times series methodologies, such as panel regression, are particularly desirable in the business context, and perhaps particularly for small business, since organisational performance and other dynamics may fluctuate over time and cross-sectional methodologies are hardly suited to pick up the subtleties of such processes. however, time series data are less available here than in many more advanced economies, and not all research questions suit such methods. for instance, farrington’s (2012) personality study could easily point to the relative stability of personalities as a reason for not bothering with change over time. having said this, experimental designs are a far more rigorous methodology that allow for temporal processes but with stringent controls. as one example in the context at hand, researchers could conduct a controlled contrast of business performance with stable owners versus that when business ownership changes to someone new, which would provide a natural experiment of the effect of a change or stability of owner personality. this would allow for a far more rigorous examination of sajems ns 17 (2014) no 4:501-514 511 the relationships in farrington (2012). while i do not claim that such experimental data would be easy to gather, or that cross-sectional data of the farrington ilk are worthless, these points do illustrate alternative modelling possibilities. the aforementioned experiment would, for instance, help to control against the alternate possibility that certain types of personalities tend to choose certain business options that have variable performance outcomes. even if time series methodologies are not available, another possibility is nonlinear modelling. it is rare indeed to see true nonlinear models in south african business research, other than power-type transformations enacted for the purposes of retaining linear modelling convenience. however, non-linear modelling may provide a fecund avenue for more interesting and powerful findings. as an illustration, perhaps the reason for the small size of farrington’s (2012) effect sizes and squared multiple correlations is the possibility of nonlinear effects in some personality–performance relationships (murphy & dzieweczynski, 2005; ones, viswesvaran, dilchert, & judge, 2007). specifically, inverse curvilinearity may be a possibility for certain relationships, suggested as early as barrick and mount (1991) and murphy (1996). recent evidence exists for exactly such hypotheses. for instance, le, oh, robbins, ilies, holland and westrick (2011) find conscientiousness and emotional stability to have curvilinear relationships with various facets of job performance. low levels of conscientiousness, for instance, leads to issues such as chaotic financial recording, whereas overly high conscientiousness may hinder flexibility and the like. ames and flynn (2007) present evidence that assertiveness may have a negative curvilinear relationship with leadership, since high levels of assertiveness may negatively affect relationships and low assertiveness may stunt the leader’s ability to assert him or herself. in groupwork research, barry and stewart (1997) find the proportion of relatively extraverted members in teams to be related curvilinearly to task focus and group performance, albeit in a small study. in terms of skills development, cucina and vasilopoulos (2004) find nonlinear personality-academic performance relationships, and vasilopoulos, cucina and hunter (2007) find inverse linearity between both conscientiousness and emotional stability on training-based proficiency. many academic journals at the highest levels of the management discipline will generally not publish cross-sectional, exclusively linear analysis of one-shot surveys, because of the great potential for spurious effects (such as personality affecting business choice rather than performance per se). i do argue that journals such as sajems may consider following suit, unless truly interesting effects such as the nonlinear are observed. certainly, more gathering of data observed over time and/or arranged in careful experiments would help to add rigor and validity to the field. 8 conclusion to truly match the higher levels of international business research, the management research community of south africa requires a balanced standard of science that carefully considers the meaning of findings. this article has argued for several research principles to become greater features of business and management research in south african publishing. these are not an exhaustive list, but their application should lead to more rigorous and internationally acceptable research. first, i urge a careful embedding of research in the literature, with an associated consideration of the uniqueness of research versus the benefit of acknowledging studies as essential replications. second is the importance of conforming to norms of fit and effect analysis in quantitative studies, without tenuous claims. third is the possibility of empirical validation against prior research of the same kind, a methodological corollary of the first point. fourth is the muchneeded treatment of common method bias, rather than mere acknowledgement of the problem. fifth is specification of appropriate control variables for models. fifth is specification of more rigorous models, such as times series, experimental designs, or nonlinear modelling, which are increasingly the standard of such research and which may uncover more interesting dynamics. this paper has sought to make specific suggestions and, where possible to actually 512 sajems ns 17 (2014) no 4:501-514 illustrate how easy many of these improvements can be. it has done so through critique of a specific contribution, without any real desire to deconstruct that article per se. it is nonetheless a secondary result of this article that farrington’s (2012) results might be interpreted as weak evidence of personalityperformance links, not seemingly robust evidence as reported by her. in light of similar effect sizes in the bulk of historical findings, and because personality will continue to capture the imaginations of managers and is not negligible, the field needs to move on to exploring more interesting process-based models that explain why, how and when such effects may operate (as also suggested by barrick, 2005). this article has made specific suggestions 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developing countries in asia and south america. evidence suggests that the developmentenhancing effects of fdi are felt more highly in the developing economies, such as economies in africa. however, fdi inflow to the developing economies has been very low. using data generated from the african development indicators (adi) between 1980 and 2008 in econometric estimations, this paper finds that government policies (especially fiscal and monetary policies) play significant roles in facilitating fdi inflow to the african countries studied. the study thereby suggests an improved regulatory framework to make africa more attractive to inflow of fdi. key words: foreign direct investment, africa’s economic development, regulatory framework, multinational corporations jel: d22, e02, f13 1 background information/introduction previous studies on the determinants of fdi inflow have largely been focussed on the developed and emerging economies (culem, 1988; billington, 1999; asiedu, 2002; asheghian, 2004). while a few studies have tried to cover some regions or countries in africa (alfaro, chanda, kalemli-ozcan & sayek, 2004; adam & tweneboah, 2009), none of these studies have specifically targeted a great number of african countries as done in this study. also, the country-specific dynamics (like controlling for resource endowment), which forms a part of the contribution of this study to the body of existing knowledge, are rarely engaged in those studies are rarely discussed in those studies. international investment, an advanced state of international trade, allows for the efficient allocation of global resources in order to reap comparative location-specific advantages in the production of goods and services (steers & nardon, 2006). this asseveration lends credence to the need for countries and corporate bodies to specialise in the production of those goods and services that would yield location comparative advantages and import those goods and services that would yield comparative disadvantages (hill, 2013). this process, among others, has enhanced international trade and has furthered the drive to seek competitively expedient offshore locations with potential sustainability. previous studies on the motivation for offshore investments have been premised largely on competition pressure. for example, porter (1990) observes that national prosperity is created through national values, culture, economic structures, institutions and histories. he states further that differences in these factors contribute to the competitive success of any nation because they form the basis of the nation’s competitive advantage. these resources combined, porter argues, will result in a sustainable national competitive advantage. abstract 558 sajems ns 17 (2014) no 5:557-568 through competitive advantage, a country would be able to acquire and leverage operational and organisational competencies that would further catalyse its advancement and superiority (schmitz, 2007). a competitive country would, through revolutionary changes in national incomes, production techniques and improved operational processes, develop absorptive capacity that would enable it benefit from technological advances in international infrastructure like banking, icts, insurance, and transportation (caves, 1996; asheghian, 2004). such developments have somewhat facilitated both the opportunities to learn about investment opportunities abroad and the means to reap those benefits (korth, 1985). based on this analysis, the findings of david ricardo (comparative advantage), heckscher ohlin’s (factor proportions), through to porter’s competitive advantage of nations all clearly establish the practical inevitability of foreign investment as the foundation upon which a nation’s growth and prosperity can be built. more importantly and recently, multinational corporations (mncs) are globally acclaimed as the conduit through which global trade and investment are conducted. mncs play a very critical role in shaping modern investment history. mncs, using their tools of foreign expansion (fdis), represent an increasingly important element of global commerce and factor mobility (rivera-batiz & oliva, 2003; correa & kumar, 2003). they usually pervade host nations through the inflow of bundles of resources like capital, production techniques, organisational and managerial skills, marketing know-how and market access. mncs can therefore be expected to contribute more to the host nation’s growth than the domestic investments (peng, 2009). conclusively, mncs play a very critical role in dictating the contemporary trading and investment arrangements, and in most cases, they improve human prosperity in the host countries (ashegian, 2004; caves, 2007; hill, 2013). 2 mncs and global trade and investment the principle of foreign direct investment took its evolution from a series of economic theories, especially the theory of the multinational enterprise (mncs) (dunning, 1988; caves, 1996; levi, 2009). the theory of mnc in itself took its root from two different schools of thoughts, namely the locationspecific advantage theory, and the industrial organisation theory, which form the springboard for this study. the location-specific theory postulates that mncs will locate in a host country that exhibits unique comparative advantage over the other locations (porter, 1990; barro & sala-i-martin, 1995; steers & nardon, 2006). these advantages may be resources, market, human capital, technology, geophysics or favourable political economy. given that the overarching driver of offshore investment is the desire to attain sustainable competitive advantage over competitors, the consideration accorded these competitive elements differs from one organisation to another. further, the location-specific advantage theory is a useful determinant of the direction of fdi flow. the theory emphasises geographical economic advantages, which mncs attempt to achieve, by dispersing their investment and production portfolios across geographies (hood & young, 1979; dunning; 1988; buckley, 1990). the earlier japanese and indian automobile investors in the united states adopted this approach. singer sewing machine also adopted the same strategy at the early stage of its overseas expansion (hill, 2013). some of the competitive advantages that mncs enjoy over domestic competitors include the use of advanced technology, lower sunk cost in research and development, better administrative and marketing skills and access to low-cost funding for capital projects (asheghian, 2004; peng, 2009). it is further suggested that favourable investment environments in offshore locations are capable of engendering financial market stability. this could accrue favourable interestand exchange rate differentials for foreign investors (levi, 2009). the industrial organisation theory, on the other hand, bears on the gains that could be derived from competition between the domestic organisations in the host country and foreign investors (hood & young, 1979; caves, 1996; hill, 2013). this theory suggests sajems ns 17 (2014) no 5:557-568 559 that domestic firms will benefit from the presence of mncs in the host market through spillover mechanism, which occurs as they interact in a way that improves their managerial expertise, technological advancement and operational processes (barro & sala-i-martin, 1995; steers & nardon, 2006). overseas investment by multinational corporations (mncs) always forms a strategic part of national economic strategy of not only the developed countries, but the developing countries as well (stiglitz & charlton, 2005; hill, 2013). as a result, institutional supports are garnered to advance the prosperity of multinationals by both the home and host governments (stiglitz, 2002). on a global scale, the significance of investment cannot be over emphasised. for example, the global value of investments was quoted at about us$650 billion between the 1970s and 1980s, more than six times the value of us$105 billion for 1967 (unctad, 2009:xxi). as suggested by the same source, the figures have risen to a very high level in recent times – a momentum that is expected to project into the future. for instance, the world investments rose from us$710.8 billion in 2004 to us$1.7 trillion in 2011 unctad, 2013::xxi). however, the stock reduced to us$1.4 trillion in 2012, of which the developing world attracted us$703 billion. out of these increases, africa’s stock grew from us$44 billion in 2010 to us$50 billion in 2012, which still represents less than three percent share of the global stock (unctad, 2013:3). specifically today, there are about 82 000 multinational corporations worldwide, with overseas subsidiaries amounting to about 810 000 (unctad, 2009). these enterprises and their foreign affiliates play a significant role in shaping the landscape of the world economy – a role that continues to grow in stature. according to the unctad (2009), exports by foreign affiliates of multinational enterprises are estimated to have accounted for about a third of the total world exports of goods and services between 2009 and 2012, and the number of people employed by these enterprises worldwide was more than 12 percent of the world population in 2008. these significant roles indicate why countries across the world initiate sustainable policy frameworks that will not only attract these multinationals into their countries, but also retain them (akinkugbe, 2005). 3 determinants of fdi destination studies have been conducted to understand the determinants of fdi destination. for instance, chakrabarti (2001:91-92) compiled previous work done on the determinants of fdi direction. in that study, the author categorised these factors into basic captions on a scale ranging from positive through to negative and insufficient. he evaluated the findings of various authors along a continuum of eight explanatory variables, namely market size, labour cost, trade barrier, growth rate, economic openness, trade deficit, exchange rate volatility, and tax. while the overall finding was inconclusive on the strength and explanatory power of most of these variables, variables like market size, growth rate, and economic openness are of positive significance in the studies evaluated. asiedu (2002) also compiled 29 previous studies on the impact of six explanatory variables for a country’s attractive ness to inflow of foreign investment. while her finding exhibited some deviation from the findings of chakrabarti, she concurred that factors that influence capital productivity gains, essentially those that revolve around regulatory framework, are positively significant in determining a country’s attractiveness to inflow of foreign investment. alfaro et al. (2004) also did a similar study where the role of the local financial market was established as a determinant of the absorptive capacity of the southern africa host countries. 4 conceptual framework choosing the most appropriate theoretical launch pad for this study was very challenging. this is mainly due to the fact that fdi itself serves divergent purposes for the host and home governments, and for the investing multinational corporation itself. to start with, the investing multinational corporations have a profit maximisation objective as the prime reason for taking the risk of offshore 560 sajems ns 17 (2014) no 5:557-568 investment. conversely, the home countries support and give institutional backing to offshore expansion of mncs on the ground that such an investment will repatriate funds from their offshore subsidiaries, increase demand for resources from the home country, and further the hegemony of the home country in the global manufacturing activities. on the other hand, host countries initiate favourable investment policies in the hope that such inflow will boost the supply of capital in the attracting country, and the envisaged spillover effects will close the existing technology gap in the host economy, and improve the quality of human capital, while fuelling development in less developed industrial sectors of the economy. despite the complexity that pervades fdi initiative, a converging point is reached in consonance with the focus area of this study. to that extent, this study is based on the oli paradigm of dunning (1981). the basic principles of dunning’s oli paradigm revolve around the ownership-specific factors (o), locationspecific advantage considerations (l), and the internalisation theory by market failure factors (i). the practical underpinning of this theory buttresses the conflicting motives of the mncs and the expectations of the home and host country governments mentioned in the previous paragraph. according to dunning, the eclectic paradigm or the ownership-location-internalisation (oli) framework lends credence to the investor motives of mncs and the reactions of home and host governments to fdi. this study, premised on the impact of regulatory framework on fdi inflow, will be restricted to the second and third parts of the oli model. the study will adopt the locationspecific advantage considerations and the internalisation theory by market failure factors, on the ground that these two considerations have been identified as the major regulatory determinants of fdi behaviour in the developing countries (an economic grouping in which most african countries belong). as such, the location-specific advantage in this regard will be viewed from the perspectives of government policy, especially monetary and fiscal policies. these considerations will be primed on the efficiency of the political institutions in the host country to formulate relevant investment-related fiscal and monetary policies. these factors are considered in the following paragraphs, which examine the determinants of fdi behaviour in the african context. 4.1 model specification the dependent variable in this research is the ratio of fdi flows to gdp. this variable has been used in previous studies (alba, park & wang, 2009; alfaro et al., 2004; asiedu, 2002). the variable is adjudged the most efficient measure of fdi inflow because it captures the relative contribution of fdi to gdp. the explanatory variables are identified as trade openness, fiscal balance, exchange rate, inflation, interest rates, government spending and corporate tax. country resource dummy is introduced to control for the variability in fdi behaviour that is resource-induced. this is essential given that only four (south africa, egypt, nigeria and morocco) of the 53 african countries attract diversified fdi that are both resources and service-related. to do this, a dummy variable of ‘1’ is introduced for countries endowed with resources that are generally considered of strategic interest to the foreign investors. evidence suggests that crude oil, coal, platinum and gold dominate that list in africa. further, a dummy of ‘0’ will be introduced for countries that do not possess those resources. in addition, while trade barriers and economic openness are treated separately in chakrabarti’s study, it is my view that trade barriers are restrictive measures that inhibit free trade, and as such, can be measured by the variables that evaluate the degree of economic openness. in other words, the amount of trade restrictions applied by an economy determines the extent to which the economy is opened to international trade (asheghian, 2004; unctad, 2009), which prompted using the ration of mercantile trade to gdp as a proxy. hence, the model specification for this research is as follows: sajems ns 17 (2014) no 5:557-568 561 fdinflit = αi + β1econpenit + b2pcreditit + b3infltnit + b4coptaxit + b5govexpit + b6popgroit + b 7resdumit, + uit where: fdinfl = foreign direct investment inflow, which is expressed as a percentage of gdp ecopen = economic openness, which is measured by merchandise trade to gdp (in percentage) pdebt = public debt govexp = government expenditure as a percentage of gdp popgro = population growth infltn = inflation coptax = corporate tax as a percentage of gdp resdum = resource dummy i = represents the country t = represents time 5 defining the explanatory variables evidence abounds on the importance of economic openness as a determinant of the attractiveness of a country to inflow of fdi. while some studies are inconclusive about the impact of trade openness (wheeler & mody, 1992; ponce, 2006), a few other studies suggest a strong relationship (culem, 1988; kandiero & chitiga, 2003; klasra, 2009). economic openness depicts the extent to which an economy is opened to foreign markets, through its active participation in trade and investment. in this research, economic openness is proxied by the ratio of merchandise trade to gdp. this is so because economic protection is effected through the application of tariffs, especially on manufactured products, but other services and products are largely not immune to this statutory instrument of trade restriction. to that extent, the strength of a nation’s protectionist measures would determine its level of trade (import and export) in merchandise. it must be acknowledged that quite a number of previous studies have proxied economic openness by the ratio of exports plus imports to gdp (lunn, 1980; elbadawi & mwega, 1997; billington, 1999). inflation (an indication of changes in the prices of basic consumer goods over the year under consideration) is used in this study as a measure of the impact of price changes in the domestic market on the consumption of both locally manufactured products and imported products. theories that relate to household consumption have established an inverse relationship between inflation and consumption patterns of households in the affected countries (dunning, 1981; hill, 2013). fiscal balance, which is proxied by public debt, reflects the stability of macroeconomic framework. this variable (along with government consumption) has been used in various studies to measure government policy (kok & ersoy, 2009). the argument in support of this variable is that a stable and healthy economy is expected to minimise budget deficit (public debt), given that a sudden recall of short-term loans by lenders may trigger instability (ito, 1999). to this extent, the level of government deficit may be an indication of the financial resilience of a country and the long-run stability of the macroeconomic fundamentals. it is widely suggested that the cost of capital is reduced if the probability of market failure is minimal, that is, the higher the risks profile of the country, the higher the cost of capital. as such, a country with perceived stable macroeconomic fundamentals is adjudged a stable investment environment. the same explanation goes for government expenditure, which has also been used in previous studies to measure government policy. evidence suggests that government expenditure directed towards production functions are generally growth-inductive while recurrent spending are essentially regarded as wasteful. the administration of corporate tax in a 562 sajems ns 17 (2014) no 5:557-568 country may reflect the strategic interest of the country in local manufacturing, and more importantly, the manufacturing areas that are of strategic importance to the economy. while high corporate tax is used to discourage investment in certain sectors, low corporate tax is expected to boost productivity and investment in certain sectors of the economy. a country that is characterised by high corporate tax may be considered unattractive to foreign investment, thereby limiting competition among the economic agents. this may be a deliberate attempt by a government to protect economic incumbency as a way of retaining economic rents among a few market participants. in addition, the introduction of population growth to the equation is justified on the ground that this variable is considered an important determinant of market size, especially if the population size or population growth potential is commingled with a rise in income level/potential improvement in the standard of living. 6 data analysis 6.1 source of data the data used in this analysis was generated from the world bank african development indicators (adi), a statistical arm of the world bank. the data covers a period of between 1980 and 2008 for 46 african countries. the other african countries were eliminated from the analysis because data could not be generated for most of the variables used in the study, especially for the dependent variable. 6.2 analysis the panel regression estimation technique is applied in this study. a series of diagnostic techniques were undertaken to ensure reliability and to cater for sensitivity. attempts were also made to eliminate redundant variables and to cater for the possibility of omitted variables. to start with, the unit root test was conducted in order to determine the order of integration in the series. according to the literature, the unit root test is also a precursor for the granger causality test. the granger causality test is based on the asymptotic theory, which prescribes the stationarity of variables in the same order of integration (granger, 1988). the unit root test is hereby conducted using the levin, lin and chu (2002) technique (llc). the llc technique is very popular in the literature and it is regarded as the most reliable test in estimating panel data. this is so because the technique generally accommodates fixed effects, individual deterministic trends and heterogeneous serially correlated errors in the series (baltagi, 2008). according to this author, the length of the time series, which is held as infinity, is crucial for determining asymptotic properties of estimators. further, the approach provides a good approximation for the empirical distribution of the test statistic even in relatively small samples (for example where n ranges between 10 and 250, and t between 25 and 250) (baltagi, 2008) as in the case of this study. as informed by the unit root test, all the variables used are integrated in order 1, thereby justifying the application of the orthogonal deviation technique (which is more efficient than differencing the data). a series of other diagnostic methods are also adopted. one of the widely used diagnostic techniques is the random/fixed effect tests as well as test for redundant variables. in the first instance, the hausman test is conducted to determine the applicable dummy (period or cross-sectional effects). this test helps to correct for possible autocorrelation between the regressor variables and the error terms. further, the redundancy variable test was conducted. the stepwise regression approach was used (not reported), to test the explanatory power of the explanatory variables, thereby determining their contribution to the predictability of the model. also, the white diagonal standard errors and covariance technique is used to cater for the standard errors in such a way that they are robust to arbitrary serial correlation and timevarying variances in the disturbances. in essence, the white diagonal robust coefficient variance estimator is designed to accommodate arbitrary serial correlation and time-varying variances in the disturbances of an econometric estimation, especially in the panel regression environment. it should be noted, however, that the use of diagnostics reduces sajems ns 17 (2014) no 5:557-568 563 the number of panel units in the estimation, and as such, influences the explanatory power of the model. more importantly, the durbin-watson statistics that are contained in the generalised method of moments (gmm) technique are used as a diagnostic measure. this application is used to test for potential first order autocorrelation in variables. strong negative numbers or high positive numbers that are above 2 generally suggest that the null hypothesis be rejected on the basis that there is autocorrelation among the variables used. to address possible endogeneity in the series, estimation instruments are restricted to one. in addendum to the regression analysis, it is considered important to ascertain the strength and direction of relationship among variables. as such, the granger causality test is applied. the following paragraphs contain the result of the econometric estimations, beginning with the dynamic panel estimation that is presented in table 1: table 1 determinants of fdi flow to africa (dependent variable – fdinfl) robust standard errors are in parentheses. *** p<0.01, ** p<0.05, * p<0.1. cross-section weights instrument weighting matrix and convergence was achieved after 1 weight iterations. cross-section weights (pcse) standard errors & covariance (no d.f. correction). maximum lags of dependent and predetermined variables for use as instruments are limited to 1. from table 1, columns i to v contain the output for each of the explanatory variables as entered separately, while column vi contains the output for the interacted variables. the result of dynamic panel estimation that is contained in table 1 suggests that all the variables tested in this study (except for corporate tax) are regarded as important considerations for attracting fdi to african countries. with the exception of public debt, the remaining three variables (government expenditure, economic openness and population growth) are statistically significant at 1 percent level. although, corporate tax (coptax) expectedly bears a negative coefficient with inflow of fdi, it is statistically insignificant. surprisingly, government expenditure (govexp) is statistically significant but bears a negative coefficient with the dependent variable. this relationship indicates that an increase in government consumption may reduce the attractiveness of africa to inflow of fdi. these results are robust to low standard errors. four regulatory variables are interacted (in pairs) to investigate the explosive nature of the estimation. according to column vi, government expenditure (govexp) and public debt (pdebt) are interacted. the robust standard error (0.0021) and the p-value of the estimation (0.0000) attest to the statistical significance of the result. further, the result of the interaction indicates that these variables jointly affect (positively) the attractiveness of africa to inflow of fdi. the result of the other interacted variables (corporate tax – coptax and economic openness – ecopen) suggests i ii iii iv v vi vii govexp -0.127359 (0.03299)*** 0.012098 (0.00214)*** pdebt -0.037392 (0.01823** coptax -0.001413 (0.00.3441) -0.00276 (0.0000)*** ecopen 0.064129 (0.01038)*** popgro -0.870171 (0.22967)*** infltn -0.000336 (0.00031) observation 1238 1209 1173 1333 1331 1238 1130 sargan test (prob >chi2) 0.145 0.197 0.330 0.376 0.201 0.358 number of countries 46 46 46 46 46 46 46 564 sajems ns 17 (2014) no 5:557-568 the same level of statistical significance but the result bears negative coefficient. as a test of robustness, two stage least squares (2sls) estimation technique is also applied. the result of the 2sls is presented in table 2. table 2 lends credence to the robustness of the estimation, as it espouses the weighted statistics as compared to the standardised estimation process that is adopted in table 1: table 2 determinants of fdi flow to africa (dependent variable – fdinfl) robust standard errors are in parentheses. *** p<0.01, ** p<0.05, * p<0.1. cross-section weights instrument weighting matrix and convergence was achieved after 1 weight iterations. cross-section weights (pcse) standard errors & covariance (no d.f. correction). maximum lags of dependent and predetermined variables for use as instruments are limited to 1. interpreting the 2sls analysis contained in table 2, the sargan test suggests that none of the variables is statistically significant, thereby negating the null hypothesis that the overidentifying restrictions are valid. looking at individual variables, three of the six explanatory variables are statistically significant, and four bear negative coefficients. government expenditure (govexp), public debt (pdebt), corporate tax (coptax), and inflation (infltn) all bear negative coefficients. the inverse relationship between these variables and the dependent variable are indication that these variables have the tendency to affect negatively the attractiveness of africa to inflow of fdi. further, the positive coefficients borne by economic openness (ecopen) and population growth (popgro), suggest the possible realisation of an improvement in the attractiveness of africa to inflow of fdi the more the governments of the sampled countries initiate economic liberalisation and market size. however, the fact that government expenditure, public debt and economic openness are statically significant buttresses their relevance as the major macroeconomic policies of relevance. the interaction of government expenditure and public debt economic openness and corporate tax expectedly bears a negative coefficient and is statistically significant. the interaction of these variables suggests that fdi inflow would increase by increasing government spending, and that an increase in budget deficit will not discourage inflow of fdi to africa. however, the interaction of corporate tax and economic openness indicates that government intervention is required to further liberalise the economy and reduce corporate tax in order to improve the attractiveness of africa to inflow of fdi. a comparison of the two tables (tables 1 and 2) indicates conspicuous similarity among the results except in instances where the level of statistical significance of the variables is stronger than the other. for instance, the statistical significance of the interacted variables is stronger in table 1 than in table 2. further, i ii iii iv v vi vii govexp -0.154687 (0.0446)*** 0.004587 (0.002607)** pdebt -0.003225 (0.0303)*** coptax -0.00097 (0.00007) -0.000078 (0.000097)** ecopen 0.077236 (0.0191)*** popgro 0.057398 (0.252260) infltn -0.000132 (0.000162) observation 1238 1209 1173 1333 1331 1238 1130 sargan test (prob >chi2) 0.324 0.459 0.117 0.269 0.145 0.876 0.102 number of countries 46 46 46 46 46 46 sajems ns 17 (2014) no 5:557-568 565 population growth bears a negative coefficient in table 1, and positive in table 2. largely, the two estimations yield very similar results. having presented the results of the panel estimation, it is considered essential to establish the direction of causality among the variables that are used in the estimation. the analysis of the (granger) causality test is presented in the paragraphs that follow. the null hypothesis of causality test holds if the probability statistics do not fall within the range of 0.01 or 0.05, and vice versa. table 3 granger causality estimation f-statistics are in parentheses. *** p<0.01, ** p<0.05, * p<0.1. from table 3, only three directional relationships can be established among the variables. for instance, government expenditure is found to be capable of enhancing the attractiveness of africa to inflow of fdi. as suggested by the literature (ashegian 2004; akinkugbe, 2005; caves, 2007), the expenditure has to be directed towards infrastructure development. also, economic openness is found to have a direct causal relationship with inflow of fdi. this further buttresses the possible impact of economic liberalisation as an important determinant of the attractiveness of africa to inflow of fdi. conversely, there is a reverse causality between inflow of fdi and population growth. this may imply that an increase in inflow of fdi may precipitate population growth. arguably, an increase in income level, which may be attributed to inflow of fdi, may result in creating a larger consumer market size. 7 conclusion the literature identifies some of the important determinants of the destination of mncs’ offshore investment. while the explanatory power of a few of the determinants of the direction of fdi flows has been established, the explanatory power of a few others remains contentious. in this research, the conclusion can be drawn that most of the mncs that venture into african countries premise their offshore investment principles on macroeconomic fundamentals, essentially, socioeconomic development. the major determinants identified in this study are macroeconomic policies. factors like government expenditure, public debt, economic openness and corporate tax are found to be important to attract fdi to africa. these findings conform to the postulation of dunning’s (1981) oli theoretical a priori. according to these findings, the locationspecific advantage considerations (such as economic liberalisation, corporate tax and market size) and the internalisation theory by market failure factors (such as public debt) appear to be important determinants of fdi flow to africa. according to international trade theories, foreign investors venture abroad mainly to reap location-specific advantages. theory suggests direction of causality statistical significance govexp fdinfl 0.0044 fdinfl govexp 0.2187 pcredit fdinfl 0.9865 fdinfl pcredit 0.4851 ecopen fdinfl 0.000003 fdinfl ecopen 0.100026 coptax fdinfl 0.7250 fdinfl coptax 0.8358 popgro fdinfl 0.1090 fdinfl popgro 0.0881 observation 1334 number of countries 46 46 566 sajems ns 17 (2014) no 5:557-568 that the overarching determinants of the direction of offshore investment by mncs are microand macroeconomic frameworks of the country. as such, economies with a stable political economy are more attractive than those countries without such a conducive investment climate. evidence suggests that foreign investors are generally backed by the home country to ensure easy access into the foreign country, to leverage operational risks, as well as to ensure an enduring support from the host government (caves, 1996; asheghian, 2004; alba, park & wang, 2009). further, while this study suggests that institutional (macroeconomic) factors play prominent roles in attracting fdi into africa, investor motives are also seen to be keen in this regard. investors are only positively disposed towards long-term commitment to a country or region that offers sustainable macro economic peacefulness, which is why most of their commitments in africa take the form of mergers and acquisitions (unctad, 2013). the saturation in consumer markets across the west suggests that it is imperative to refocus the entry strategies of these multinationals in africa. the reappraisal of the investors’ entry strategy to africa, essentially the embracement of offshore production facilities in the form of greenfield investment, is seen to be a more expedient approach as demonstrated by toyota in the united states. it may equally be important to include spillover of competency, local capacity development and technological spillover in the overseas expansion strategies. while the current investment strategy may be appropriate, its appropriateness is only sustainable to the extent that these institutional frameworks remain favourable to mncs. more importantly, african leaders should rethink their administrative and institutional conscripts in a way that engenders efficiency and efficacy. it is argued that lean and transparent government spending, coupled with accountability, will not only lure greenfield foreign investors. increasing government spending on capital projects that are geared towards infrastructural development is more likely to attract fdi. further, policy initiatives are required to further liberalise economies in african countries, although the liberalisation process should be well guided in order to create appropriate safety nets for potential victims of that process and its antecedent outcomes. references adam, a.n. & tweneboah, g. 2009. foreign direct investment and stock market development: ghana’s evidence. international research journal of finance and economics, 26:178-85. akinkugbe, o. 2005. a two-part econometric analysis of foreign direct investment flows to africa. netherlands: kluwer law international. alba, j.d., park, d. & wang, p. 2009. the impact of exchange rate on fdi and the interdependence of fdi over time. adb economics working paper series, number 164. alfaro, l., chanda, a., kalemli-ozcan, s. & sayek, s. 2004. fdi and economic growth: the role of local financial markets. journal of international economics, 64(1):89-112. asiedu, e. 2002. on the determinant of foreign direct investment to developing countries: is africa different? world development, 30(1):107-19. asheghian, p. 2004. determinants of economic growth in the united states: the 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and foreign direct investment in africa. economic society of southern africa 2003 annual conference, 17-19 september 2003 cape town, south africa. klasra, m.a. 2009. foreign direct investment, trade openness and economic growth in pakistan and turkey: an investigation using bounds test. qual quant research note. springer science+business media b.v. kok, r. & ersoy, b.a. 2009. analysis of fdi determinants in developing countries. international journal of social economics, 36(1/2):105-123. korth, c.m. 1985. international business environment and management (2nd ed.) new jersey: prenticehall. levi, m.d. 2009. international finance (5th ed.) london: routledge. levin, a., lin, c. & chu, c-j. 2002. unit root tests in panel data: asymptotic and finite-sample properties. journal of econometrics, 108:1-24. lunn, j, 1980. determinants of us direct investment in the eec: further evidence. european economic review, 13:93-101. peng, m.w. 2009. global business. new york: south-western cengage learning. ponce, a.f. 2006. openness and foreign direct investment: the role of free trade agreements in latin america. mpra paper no. 8858:1-26. porter, m.e. 1990. the comparative advantage of nations. new york: free press. rivera-batiz, l.a. & oliva, m.a. 2003. international trade: theory, strategies, and evidence. new york: oxford university press. schmitz, h. 2007. reducing complexity in the industrial policy debate. development policy review, 25(4):417-428. steers, m.r. & nardon, l. 2006. managing in the global economy. new york: m.e. sharpe, inc. stiglitz, j.e. 2002. globalization and its discontents. new york: w.w. norton & company. stiglitz, j.e. & charlton, a. 2005. fair trade for all. new york: oxford university press. the united nations conference on trade and investment (unctad). 2013. world investment report: global value chains: investment and trade for development. new york and geneva: the united nations conference and trade and development. the united nations conference on trade and development (unctad). 2009. world investment report. transnational corporations, agricultural production and development. new york and geneva: the united nations. 568 sajems ns 17 (2014) no 5:557-568 wheeler, d. & mody, a. 1992. international investment locational decisions: the case of us firms. journal of international economics, 33:57-76. appendix a: list of african countries covered in the study 1 algeria 24 lesotho 2 angola 25 liberia 3 benin 26 madagascar 4 botswana 27 malawi 5 burkina faso 28 mali 6 burundi 29 mauritania 7 cameroon 30 mauritius 8 cape verde 31 morocco 9 central african republic 32 mozambique 10 chard 33 namibia 11 comoros 34 niger 12 congo, dem. rep. 35 nigeria 13 congo, rep. 36 rwanda 14 cote d'ivoire 37 senegal 15 egypt, arab rep. 38 seychelles 16 equatorial guinea 39 sierra leone 17 ethiopia 40 south africa 18 gabon 41 sudan 19 gambia, the 42 swaziland 20 ghana 43 togo 21 guinea 44 tunisia 22 guinea-bissau 45 uganda 23 kenya 46 zambia sajems ns 11 (2008) no 1 37 the impact of shopping mall development on small township retailers aa ligthelm bureau of market research, university of south africa abstract the retail sector forms a critical element of a community’s economic and social welfare. it provides people with choices and services. these choices were until recently very limited in township areas. the pre-1994 retail landscape was dominated by small, often informal businesses offering basic household necessities to relatively low income earners. this has resulted in township residents’ preference to shop outside townships, known as ‘outshopping’. rapid income growth of township residents since 1994 resulted in a substantial increase in consumer expenditure in these areas, known as ‘in-bound shopping’. this lucrative emerging market forms the last retail frontier in south africa and is being explored by national retailers, especially supermarket chains. this article is aimed at establishing the impact of shopping mall development in townships on the traditional small township retailers including spaza/tuck shops. the net balance sheet on the impact of shopping mall development on small township retailers clearly suggests a decline in the township retailers’ market share. a change in small business model towards, inter alia, effective customer service with a small dedicated assortment of merchandise, satisfaction of emergency needs, selling in small units and extension of credit facilities may result in the survival of some small township retailers (albeit often at a smaller turnover). jel l81 1 introduction the past thirty years have seen widespread decentralisation of retail space throughout the large metropolitan areas to suburban areas. in most metropolitan areas, this trend resulted in a decline of the central city areas. until recently, this new structuring of retail space largely excluded the development of township areas. in the municipal area of johannesburg in 2004, for example, soweto contained an estimated 43 per cent of johannesburg’s population but only approximately 3 per cent of the city’s retail floor spaces (city of johannesburg, 2005: 20). the pre-1994 retail landscape in the township areas was dominated by small, mainly informal retail businesses offering basic products and services to a relatively low income consumer market. these businesses served as convenience shops to primarily lower income groups and attracted only a small portion of the consumer spending in township areas. the majority of township workers engaged in economic activities outside the townships with most of their shopping being in the main city centres or at shopping malls at the fringes of township areas. since the late 1990s township inhabitants have experienced a substantial economic uplift. many township consumers have progressed to a middleincome group resulting in a significant increase in the consumer spending of the inhabitants of these areas. this increase in spending, together with the fact that many traditional retailing areas are becoming saturated, has caused national retailers, especially supermarket chains, to increasingly focus on market expansion strategies in these emerging markets (tagg, 2006; tustin & strydom, 2006). this increasing movement of formal retailers into previously untapped middleand low-income markets 38 sajems ns 11 (2008) no 1 has resulted in an increase in shopping centre development in townships. 2 objectives the article is aimed at analysing the impact of shopping mall development on the survival of small informal and formal retailers located in township areas. focus will be placed on the sustainability of both informal spaza/tuck shops and small township retailers1 that operate in direct competition with the newly established national retailers and franchises. the article also explores the importance of retail development to improve consumer choices, the structure of the retail environment in south africa and consumer income growth prior to conducting inferential analysis of shopping mall development on small township retailers. 3 expanding consumer choices retail intermediaries are a vital link in the distribution channel ranging from the producer/ manufacturer through the wholesaler and retailer to the final consumer. retailing is defined by levy and weitz (2007: 7) as the set of business activities that adds value to the products and services sold to consumers for their personal or family use. retailers are the final business in a distribution channel that links manufacturers to consumers. the value-creating functions of retailers are the following: • providing an assortment of products and services. supermarkets, for example, stock thousands of products allowing customers to choose from a wide variety of brands, designs, colours, prices, etc. at one location. • breaking bulk. it is cost effective for manufacturers to package and transport goods in bulk while consumers demand goods in smaller quantities. • keeping an inventory allowing consumers to purchase products when the need arises. this allows households to keep small inventories at home. • providing various services to customers that make the buying decision far easier and more informed. examples of services are purchases on credit, product information and display of merchandise allowing visual contact and even testing. retailers range from small informal street vendors to large multi-national chain stores selling goods and/or services to final consumers (lewison, 1997; mcgoldrick, 1998; newman & cullen, 2003). the retail sector forms a critical element of a community’s economic and social welfare and provides people with choices of products and services. these choices were until recently, extremely limited in township areas. this was particular relevant for the lower income groups. in a 2004 survey in soweto (city of johannesburg, 2005: 15), it was established that the poorest households (income of less than r500 per month) spent 82 per cent of their income on retail goods and services. of this expenditure, almost half (49 per cent) was spent within the township areas thus giving them limited consumer choice. in contrast, the most affluent households (r12 000 plus per month) spent 91 per cent of their retail expenditure outside township areas suggesting substantially more consumer choice was available for the relatively small percentage of affluent township dwellers. the above clearly shows that the lack of an efficient retail infrastructure in a township has a far more negative impact on the poorer households in that township compared to the more affluent ones. as a result, the following township expenditure dynamics were the norm prior to the recent establishment of township shopping malls (tustin & strydom, 2006; radebe, 2005; de vynck, 2005): • low car ownership and underdeveloped transport systems result in people (especially the less affluent) either walking or using taxis to go shopping within townships. • township dwellers often travel by taxi to shop at nearby urban retail outlets rather than in township shops. • purchases are limited to small quantities of groceries at a time (day-to-day buying). sajems ns 11 (2008) no 1 39 • the concept of ‘shoppertainment’ is not yet well developed in townships. only residents higher up on the social and income ladders prefer to shop outside their neighbourhoods (so-called ‘aspirational shopping’). • the bulk of small township retailers can be classified as survivalists who do business only to fend for themselves. • workers tend to do their shopping close to their places of work, these are primarily located outside townships. • township residents who have moved up the social and income ladders prefer to shop outside townships in upmarket shopping malls, known as ‘outshopping’. the above historical dynamics of township shopping patterns together with continued upliftment of african consumers (see next section) create an environment conducive to profitable retail development in township areas. 4 the emerging middle class south africa has made significant strides in improving the living standards of the previously disadvantaged communities. table 1 depicts the class dynamics of the south african adult population during 1998 to 2003 and includes projections to 2008. it is evident from table 1 that the most significant gains in respect of improvements in social class were made during the period 1998 to 2003 with regard to the african middle class. the percentage of africans in lsm 8-10 (i.e., the realised african middle class) increased from 2.8 per cent of the african adult population in 1998 to 10.5 per cent in 2008. in absolute terms this represents an increase from just over half a million people to an estimated 2.7 million in 2008. the share of the emerging african middle class (lsm 5-7) increased with almost 12 percentage points (or 7.2 million adults) from 52.5 per cent of adult africans in 1998 to 65.2 per cent in 2008. table 1 comparative percentage breakdown of class dynamics by population group, 1998 to 2008 africans asians coloureds whites 1998 lsm 8–101) 2.8 57.2 30.1 87.2 lsm 5–7 52.5 42.5 60.4 12.8 lsm 1–4 44.7 0.3 9.5 0.0 total 100.0 100.0 100.0 100.0 2003 lsm 8–10 5.6 57.3 32.1 87.1 lsm 5–7 60.5 42.6 59.6 12.9 lsm 1–4 33.9 0.1 8.3 0.0 total 100.0 100.0 100.0 100.0 2008 lsm 8–10 10.5 55.4 32.6 86.0 lsm 5–7 65.2 44.5 59.5 14.0 lsm 1–4 24.3 0.1 7.9 0.0 total 100.0 100.0 100.0 100.0 1) living standards measure (lsm) denotes the asset wealth of households as measured by the ownership of a range of assets and amenities. the south african lsm ranges from lsm 1 representing the poorest of the poor to lsm 10 representing the richest of the rich. research shows that lsm 1 to 4 are households living below the bread line, lsm 5 to 7 denote the emerging middle class while lsm 8 to 10 denotes the realised middle class. source: van aardt, 2005 40 sajems ns 11 (2008) no 1 this rapid growth in the african middle class is also reflected in the african share of the country’s total personal disposable income. figure 1 shows an increase in the african portion of the total personal disposable income from 35.7 per cent in 1990 to 46.5 per cent in 2007. figure 1 the population groups’ shares of the total personal disposable income, 1990-2007 source: van wyk, 2006 the emerging trend that can be seen in figure 1 is a substantial growth in the income levels of the african population. the question arises, is this expansion of consumer demand also materialising in township areas, and if the answer is yes, is it sustainable in the long run? a study embracing all the major township areas in south africa suggests a fairly stable demographic pattern in townships (glue metric & lilanda holdings, 2006). the study was only conducted in middle-income areas in the following townships: soweto, tembisa, soshanguve, mamelodi, kwamashu, mangaung and khayelitsha. informal (squatter) and rdp housing areas were excluded from the survey. figure 2 shows that, according to the study, 86 per cent of all middle-income township inhabitants reside in a specific township area for more than four years. it also shows that three in every five respondents had inhabited their townships for longer than 10 years. the relatively stable middle-income demographic pattern is supported by the fact that only 2 per cent of middle-income residents had inhabited their respective areas for less than one year and only 4 per cent for between one and two years. a question was also included in the glue metric and lilanda holdings (2006) questionnaire enquiring about how long respondents planned to live in the townships. figure 3 shows that almost three in every four (72 per cent) of middle-income earners in township areas either plan to live there for some time (29 per cent) or regard the township area as their home without having any intention of moving (43 per cent). a little over a quarter (28 per cent) indicated that they wanted to move as soon as possible, to live in the suburbs (17 per cent), to move to a different suburb (8 per cent), or to live in a rural area (3 per cent). these findings suggest a fairly stable middleincome population base in township areas that may further increase as more people progress into the middle-income group. the gravitation of a relatively small percentage of township residents to suburbs will probably be countered sajems ns 11 (2008) no 1 41 by further growth in the number of middleincome township dwellers as well as income growth within the existing middle-income group. if appropriate retail choices and services are available in township areas, it can be expected that the upsurge in consumer spending in townships will be sustainable, at least for the foreseeable future. figure 2 period of residence in the major township areas of south africa source: glue metric & lilanda holdings, 2006 figure 3 intended stay in township area source: glue metric & lilanda holdings, 2006 42 sajems ns 11 (2008) no 1 5 shopping mall development in townships since the turn of the century townships have emerged as the new market for national retailers. the increasing movement of grocery chains into previously untapped markets has resulted in a substantial increase in shopping mall development in townships. most large shopping mall developments are anchored by national grocery chains offering a wide variety of food and grocery products not previously offered in township areas. the national grocery chains have already asserted their dominance in the formal grocery and food market. at the end of 2005, the three largest groups already commanded just over 90 per cent of the national formal grocery and food market (tustin & strydom, 2006: 54). the national grocery chains will offer products that are similar to some offered by small township retailers; this will undoubtedly lead to increased competition. whether small, often informal, sector survivalists will survive this competition from national retail chains is analysed in section 7 of this article. the south african council of shopping centres does not unfortunately maintain a list of newly developed shopping centres in townships. extracts from the financial press (see detailed press sources in tustin & strydom, 2006 and ligthelm & risenga, 2006) include the following township areas where shopping mall investment has occurred or is planned (see table 2). table 2 shopping mall development in township areas province shopping mall location area size rand (million) sq metre gauteng maponya soweto johannesburg 500 65 000 jabulani soweto johannesburg 250 30 000 protea gardens soweto johannesburg 146 25 000 bara mall soweto johannesburg 420 57 000 diepkloof plaza soweto johannesburg 60 15 000 soshanguve soshanguve pretoria – – eastern cape mdantsane mdantsane east london 100 – new brighton plaza new brighton port elizabeth 15 3 625 motherwell shopping complex motherwell port elizabeth 32 – kwazulu-natal umlazi mega city umlazi durban 150 28 000 limpopo masingita giyani giyani 50 10 190 western cape promenade mitchells plain cape town 400 42 000 mpumalanga kanyamazane kanyamazane nelspruit 80 14 000 north west the crossing mafikeng mafikeng 140 18 500 source: eprop commercial property south africa 2004-2007 (see articles cited in the references). ligthelm & risenga, 2006; tustin & strydom, 2006. sajems ns 11 (2008) no 1 43 6 methodology 6.1 survey in order to fully understand the impact of chain store expansion in emerging markets, a sample of small informal and formal township retailers located in soshanguve were interviewed. the study area, including the neighbouring areas of mabopane, garankuwa and temba, accommodated almost 700 000 people in 2001. the socioeconomic status of the survey area’s population is representative of all the groups typical of township areas, from the low-income to middleand higher-income groups. the average annual household income amounted to approximately r53 800 in 2006 (municipal demarcation board, 2006). the business environment of the study area consists primarily of informal homebased (spaza/tuck shops) and small township retailers typical of the pre-1994 retail township environment. two adjacent shopping malls were opened in soshanguve in march 2006 and house more than 70 shops representative of all the major franchises and national grocery chain stores. these include, inter alia, food and grocery retailers, furniture and clothing stores as well as fast food outlets, banks, music shops and electronic stores. in october 2006, six months after the opening of the shopping malls, interviews were conducted with small retailers and spaza/tuck shop owners. the sampling allowed for the selection of respondent businesses in concentric circles around the new shopping malls. figure 4 confirms that five distance categories of 1 kilometre (or 15 minutes walking time) each were selected. the various residential blocks included in each of these distance categories were selected by using the ‘distance measure’ on a map created by corporate dataware of the city of tshwane (2006). this approach allows a measurement of the impact of shopping mall development on small retailers by distance from the malls. figure 4 sampling plan 44 sajems ns 11 (2008) no 1 due to a lack of a small business sample frame, a judgmental sampling procedure with quotas within each distance category was applied. a total of 100 small informal and formal businesses were interviewed across the five distance categories. the concentric circles were grouped into two categories for analysis purposes. 6.2 limitations the selection of only 20 small businesses per distance category from the shopping malls was governed by the number of small retailers within some of the 1 kilometre wide concentric circles. the methodological limitation of a small sample was addressed by validating the findings of the soshanguve survey with the findings of previous surveys with regard to variables such as age composition of businesses, average employment size and business access to infrastructure (table 3). strong similarities were evident confirming that the results of the soshanguve survey may be used as useful estimates in analysing the impact of shopping mall development on small informal and formal township retailers. table 3 validation of the 2006 soshanguve survey with comparable secondary data sources variable soshanguve gauteng eastern cape kwazulu natal mpumalanga western cape 9 provinces in south africa 11 areas in tshwane sample population small township retailers spaza/tuck shops spaza/tuck shops spaza/tuck shops smes year 2006 2003 2002 2001 sample size 100 560 900 550 age of business: more than 5 years (%) less than 1 year (%) 94.0 6.0 86.4 13.6 89.4 10.6 80.1 19.2 access to: water (%) electricity (%) 89.0 98.0 85.9 97.5 – – 79.1 78.9 average employment size 2.81 1.61 – – method to acquire merchandise: personal visit (%) 80.8 83.4 77.1 – equipment in shop: refrigerator (%) cash register (%) 77.0 22.0 82.6 19.0 – – – – education level of owner: (%) (grade 7 plus) 80.8 (gr 8 plus) 69.5 – – sources: ligthelm & masuku, 2003; ligthelm, 2002; ligthelm, 2001 sajems ns 11 (2008) no 1 45 it would, however, be advisable to replicate this study within twelve months with the same sample to establish the stability of the findings as reported in this article. it would also be advisable to conduct a similar study in an alternative township area such as soweto as that may portray a somewhat different socioeconomic structure with regard to variables such as the levels of income and employment. such a study should preferably also include other economic sectors in addition to the retail sector addressed in this article. this may assist in establishing the representativeness of the soshanguve survey findings for wider application in south africa. 7 survey findings respondent businesses were asked several questions on the impact of the new shopping malls on the surrounding small retailers. these questions ranged from perceived small business mortalities to more exact questions on the decrease or increase in turnover, profitability, stock movement and product range of existing individual businesses. descriptive statistics confirm a generally negative impact of the shopping malls on the surrounding small informal and formal township retailers. table 4 shows that almost half the respondents (47.0 per cent) reported a decline in the number of small businesses in their immediate vicinity during the six month’s existence of the shopping malls. the table also shows that almost three in every five small business retailers experienced a decline in their businesses’ profitability, turnover, stock movement and product range. only a small minority reported better business conditions (between 1 per cent and 4 per cent of respondents). table 4 percentage of businesses that reported a decline of business activities since the opening of the malls by type of activity decline in: decrease % unchanged % increase % total % number of small retailers 47.0 42.2 10.8 100.0 activities within shops: • turnover 66.0 30.0 4.0 100.0 • profitability 61.0 36.0 3.0 100.0 • stock movement 57.0 42.0 1.0 100.0 • product range 59.0 39.0 2.0 100.0 the rest of the discussion analyses the effect of the retailers distance from the malls as a discriminatory factor on their relative performance as well as other possible factors that may enhance the survival of small businesses amidst direct competition from national retailers. 7.1 distance from the malls respondents were divided into two distance categories, namely, those closer than 2 kilometres (or less than 30 minutes walk) and those between 2 to 5 kilometres (between 30 and 60 minutes walk) from the new shopping malls. the following variables were used to determine the difference between the mean scores of the two distance categories: • the change in the number of shops in the immediate vicinity of the respondents (a distinction is made between spaza/tuck shops and small township retailers). • the impact on the respondent’s business regarding its product range, profitability, turnover and stock size since the opening of the malls. 46 sajems ns 11 (2008) no 1 • an average survival score calculated as the average score of the product range, profitability, turnover and stock size. • the average perceived competition posed by businesses in the shopping malls. independent t-tests were conducted to compare the group means using distance from the shopping malls as the independent variable and the variables mentioned above as dependent variables. the normality assumptions for the dependent variables were examined using the kolmogorovsmirnov test and shapiro-wilk statistic. the results show that the scores for the dependent variables deviate significantly from normality. it was therefore decided to do both parametric and non-parametric comparisons of the groups to verify the results. table 5 shows the group statistics for all the dependent variables by the two distance categories from the shopping malls. table 5 group statistic of the dependent variables by distance from the malls dependent variable distance from shopping malls n mean1) std deviation std error mean (a) change in number of spaza shops <2 km 2–5 km 40 58 1.50 1.40 .641 .493 .101 .065 (b) change in number of retail shops <2 km 2–5 km 25 43 1.68 2.07 .557 .768 .111 .117 (c) effect on product range <2 km 2–5 km 41 59 1.37 1.47 .536 .537 .084 .070 (d) effect on profitability <2 km 2–5 km 41 59 1.37 1.46 .581 .536 .091 .070 (e) effect on turnover <2 km 2–5 km 41 59 1.29 1.44 .559 .565 .087 .074 (f) effect on stock size <2 km 2–5 km 41 59 1.34 1.51 .530 .504 .083 .066 (g) average survival score <2 km 2–5 km 41 59 1.34 1.47 .493 .480 .077 .063 (h) average perceived threat from businesses in shopping malls <2 km 2–5 km 41 57 3.672) 3.97 .780 .497 .122 .066 1) scale value used for dependent variables (a)-(g): 1 = decreased; 2 = remained the same; 3 = increased 2) scale values used for dependent variable (h): 1 = strongly disagree; 2 = disagree; 3 = neutral; 4 = agree; 5 = strongly agree table 6 shows the result of the levene’s test for equality of variance to determine the appropriate t-statistic for comparing the score means for businesses within the two distance categories as well as the result of the t-test for equality of means. sajems ns 11 (2008) no 1 47 table 6 independent samples t-test for distance from the shopping malls variables levene’s test for equality of variance t-test for equality of means f sig. t df sig. (2tailed) mean difference std. error difference effect size change in number of spaza shops equal variances not assumed 6.269 .014 .860 69.495 .393 .103 .120 0.008 change in number of retail shops equal variances assumed 1.345 .250 –2.218 66 .030 –.390 .176 0.069 effect on product range equal variances assumed .838 .362 –.996 98 .322 –.109 .109 0.010 effect on profitability equal variances not assumed .079 .779 –.814 98 .418 –.092 .113 0.007 effect on turnover equal variances assumed 2.222 .139 –1.294 98 .199 –.148 .114 0.017 effect on stock size equal variances assumed 1.152 .286 –1.596 98 .114 –.167 .105 0.025 average survival score equal variances assumed 1.761 .188 –1.305 98 .195 –.129 .099 0.017 average perceive threat from businesses in shopping malls equal variances not assumed 5.926 .017 –2.189 62.972 .032 –.303 .138 0.048 an analysis of tables 5 and 6 shows that, on average, the following variables did not show a statistically significant difference between businesses that are less than 2 kilometres away from the shopping malls and those between 2 and 5 kilometres from the malls: • change in the number of spaza/tuck shops • product range • profitability • turnover • product stock sizes • average survival score the reported change in the number of small township retailers differs significantly between those that are less than 2 kilometres (m=1.68 sd=.557) away from the shopping malls and those between 2 and 5 kilometres (m=2.07, sd=.768) away from the shopping malls, t(66)=-2.218, p < .05, η2 =.069. the effect size estimate of .069 in the last column of 48 sajems ns 11 (2008) no 1 table 6 represents, according to cohen (1988), a moderate effect. more specifically, small retail shops that are 2 kilometres or more away from the shopping malls tended on average towards reporting either no change or an increase in the number of small township retailers in their area since the opening of the shopping malls, whereas businesses closer than 2 kilometres from the shopping malls tended on average towards observing a decrease in the number of retail shops in their immediate vicinity since the opening of the shopping malls. the average perceived threat from businesses in the shopping malls differs significantly between small businesses that are less than 2 kilometres (m=3.671, s=.780) away from the shopping malls and those between 2 and 5 kilometres (m=3.974, sd=.497) away from the shopping malls, t(62.972)=-2.189, p<.05, η2=.048. the effect size estimate represents a small to moderate effect (cohen 1988). more specifically, the shops closer than 2 kilometres from the shopping malls feel less threatened by businesses in the shopping malls than those that are between 2 and 5 kilometres away from the shopping malls. a possible explanation for this phenomenon may be that shops closer to the malls, who were initially more exposed to competition from the malls, had already adjusted their business plans (in terms of, for instance, assortment of merchandise, price levels, customer service and stock replenishment) to continue as convenience shops for their immediate and regular customers, albeit at a lower turnover level. the respondents listed the following principal factors in ensuring continued customer support: • friendly service • long and flexible hours • safe environment to buy in • satisfy emergency needs • allow buying on credit • sell in small quantities furthermore, a larger percentage of respondents within 2 kilometres of the malls reported the closure of small retailers since the opening of the malls compared to those beyond 2 kilometres. this implies that the sample within 2 kilometres of the malls probably already excludes a larger proportion of business mortalities than those between 2 and 5 kilometres from the new malls. from the fact that distance from the shopping malls showed no significant difference on the impact on profitability, turnover, product range and stock size of the businesses since the opening of the shopping malls, it can be concluded that all the small informal and formal retailers within 5 kilometres of the shopping malls perceived more or less the same type of negative impact on the profitability of their businesses. this conclusion is corroborated by the mean scores for the perceived effect that the opening of the shopping malls had on these four aspects of the smaller businesses. table 5 shows mean scores of below 2 (where 1 = decreased, 2 = remained the same and 3 = increased) confirming that most of the respondents experienced a decline. in order to ascertain that the non-normality of the data did not influence the results, the mann-whitney u-test was also performed to investigate the effect that distance from the shopping malls may have on the group median scores using distance from the shopping malls as the independent variable and the variables measuring the different quantities (see 7.1 (a) to (d)), as the dependent variables. the advantage of this test is that it does not make any assumptions about the underlying distributions of the dependent variables. these tests corroborate all the findings of the independent t-tests with distance from the malls as the independent variable as discussed above. 7.2 decline in client patronage a question to respondents on the perceived reduction in regular client patronage was used to establish the extent to which the shopping malls development impacted differently on spaza/tuck shops compared to small township retailers. this led to the question: is there a relationship between the type of small businesses and the perceived reduction in regular client patronage since the opening of the malls? the 2 × 2 chisquare test of independence was used to test the relationship between retailers of a certain type and whether they experienced a decline (or even a termination) in their regular customers’ use of their businesses. sajems ns 11 (2008) no 1 49 the results of the test indicate no significant relationship between the type of shop (spaza/ tuck shop or small township retailer) and whether they experienced a decline (or even a termination) in their regular customers’ use of their businesses (2(1, n=100)=2.850, ns). the findings indicate that the proportion of spaza/tuck shops that experienced a decline in patronage of regular customers is not significantly different from the proportion of small township retailers that experienced a decline in patronage of regular customers. the question to respondents on their perceived reduction in regular client patronage also allows the determination of the relationship between the proximity of small businesses to the shopping malls and perceived reduction in regular client patronage since the opening of the malls. as with the previous test, a 2 × 2 chi-square test of independence was used to test the relationship between a shop’s distance from the shopping malls and whether it experienced a decline (or even a termination) in its regular customers’ use of the business. the results of the test indicate no significant relationship between how far a shop is situated from the shopping malls (less than 2 kilometres or 2 to 5 kilometres away) and whether it experienced a decline (or even a termination) in its regular customers’ use of the business (2(1, n=100)=0.028, ns). the findings indicate that the proportion of shops that are closer than 2 kilometres from the shopping malls that experienced a decline in patronage from regular customers is not significantly different from the proportion of shops that are from 2 to 5 kilometres away from the shopping malls that experienced a decline in patronage from regular customers. 7.3 factors responsible for survival the discussion in the previous two sections confirms a generally negative impact of shopping mall development on small informal and formal retailers. the question arises: are there specific factors that can be regarded as the strongest predictors of business survival after the opening of shopping malls? respondents were divided into various dichotomous groups on the basis of relevant information contained in the questionnaire. table 7 depicts the selected dichotomous groups ranging from business maturity to the educational level and age of the business owner. table 7 dichotomous groups to identify predictors of survival variable group 1 group 2 business maturity (age of business) less than 5 years 5 years and older how merchandise is purchased from suppliers own cost and effort use facilities of supplier use of technology in the shop (cash register, computer, etc.) yes no approach to advertising (signage, flyers, posters) active passive employees other than owner’s family yes no highest level of education grade 12 or less tertiary education age (of owner/manager) younger than 30 years 30 years or older the average survival score of businesses in the vicinity of the shopping mall was examined using the kolmogorov-smirnov test and shapiro-wilk statistic. the results indicated a significant deviation from normality of the average survival score for all the dichotomous groups. as a result both parametric and non-parametric comparisons of groups were made to compare the results. independent t-tests were conducted with the different group variables as independent variables and the average survival score as the dependent variable. 50 sajems ns 11 (2008) no 1 table 8 shows the group statistic for the average survival score (dependent variable). table 8 group statistics for average survival score variables group n mean1) std deviation std error mean business maturity less than 5 years 5 years or more 52 48 1.43 1.41 .503 .474 .070 .068 purchasing method own cost and effort use supplier services 82 17 1.43 1.37 .495 .477 .055 .116 use of technology yes no 28 72 1.58 1.35 .549 .449 .104 .530 approach to advertising active passive 44 56 1.49 1.36 .503 .472 .076 .063 non-family employees yes no 57 43 1.45 1.37 .523 .438 .069 .067 highest level of education grade 12 or less tertiary education 79 21 1.39 1.50 .459 .586 .052 .128 age younger than 30 years 30 years or older 22 78 1.38 1.43 .455 .498 .097 .056 1) scale values used for variables: 1 = decreased; 2 = remained the same; 3 = increased. levene’s test for equality of variance was performed to determine the appropriate tstatistic to use to compare the different group means for the average survival score. the results of the test are contained in table 9. table 9 independent samples t-test for average survival score per grouping variable levene’s test for equality of variances t-test for equality of means grouping variable f sig. t df sig. (2tailed) mean differ ence std error differrence effect size business maturity equal variances assumed .000 .993 .221 98 .826 .02163 .09801 0.000 purchasing method equal variances assumed .572 .451 .452 97 .653 .05918 .13103 0.002 use of technology equal variances assumed 3.683 .058 2.121 98 .036 .22619 .10666 0.044 sajems ns 11 (2008) no 1 51 approach to advertising equal variances assumed .540 .464 1.299 98 .197 .12703 .09783 0.017 non-family employees equal variances not assumed 4.627 .034 .828 96.885 .410 .07966 .09618 0.007 highest level of education equal variances assumed 2.351 .128 –.872 98 .385 –.10443 .11978 0.008 age equal variances assumed .996 .321 –.461 98 .646 –.05449 .11810 0.002 an analysis of tables 8 and 9 shows that whether or not technology was used in the shop was the only predictor variable that had a statistically significant effect on the average survival score of a business. the average survival score for businesses situated within 5 kilometres of the new shopping malls differed significantly between those that make use of technology such as cash registers, computers and/or photocopiers (m=1.580, sd=.549) and those who do not (m=1.354, sd=.449), t(98)=2.121, p<.05, η2=.044). the effect size estimate in the last column of table 9 represents a small to moderate effect (cohen 1988). none of the other segmentation variables listed in table 7 had a significant effect on the average survival score of the respondent businesses. these are: • age of the business • method of procuring merchandise (either at own cost or using the facilities of the supplier) • active or passive approach to advertising • employment of non-family members or not • educational level of owner • age of business owner/manager in an effort to ascertain that the non-normality of the average survival scores of all the groups tested in table 9 did not influence the results, the mann-whitney u-test was also performed. the results corroborate all the findings of the independent t-tests with the average survival score as the dependent variable except for the independent variable ‘use of technology’. the independent t-test found that whether or not a shop utilised technology had a significant effect on the average survival score but the mann-whitney u-test found that there is no significant difference between the median scores for shops that use technology (mdn=1.625) and those who do not (mdn=1.000). it can therefore be concluded that making use of technology does not, on average, significantly improve a shop’s chances of survival after the opening of a shopping mall in its vicinity, as was the case with all the other variables tested (see table 9). 8 summary and conclusion the trend emerging from the foregoing discussion depicts a substantial growth in retail infrastructure and facilities in township areas with a concomitant expansion of retail choices. this resulted largely from the progression of many african consumers into a middle-income group. these developments at the top end of the retail market and the fact that many traditional retailing areas outside townships are becoming saturated have caused formal retailers to focus on market expansion strategies in emerging markets. with a sustainable consumer expenditure level in townships, this question comes to the fore: what will the effect be on existing spaza/ tuck shops and small township retailers of the national chains exploring the lucrative township retail market? 52 sajems ns 11 (2008) no 1 a primary factor that may lead to the cannibalisation of the existing small retail market share is the easy access to newly developed shopping complexes. for example, prior to the new shopping mall development almost 40 per cent of retail expenditure in soweto originated from low-income households. the poorest satisfy almost 80 per cent of their retail needs within township areas at small township retailers and spaza/tuck shops (city of johannesburg, 2005). more convenient access to large chain stores would suggest a gravitation of at least some of the low-income section’s expenditure to such stores. convenient access linked to price competitiveness and the extended shopping experience and entertainment at shopping malls would suggest a negative effect on the turnover of small township retailers and spaza/tuck shops. the following services provided by small township retailers and spaza/tuck shops were given as reasons by respondents as contributing to their survival since the opening of the soshanguve malls: • proximity to customers’ dwellings • good and friendly customer service • long and flexible business hours • satisfaction of emergency needs • credit facilities • availability of merchandise in small units the net balance sheet on the impact of shopping mall development on small informal and formal township retailers clearly suggests a decline in the smaller retailers’ market share. however, effective customer service and a small dedicated assortment of merchandise together with other services such as credit facilities and selling in small quantities may result in the survival of some of the small township retailers and spaza/ tuck shops (albeit often at a smaller turnover). the existence of more than 800 small informal businesses (mainly street vendors at mabopane station in soshanguve) amidst the operation of the nearby central city shopping mall, and the existence of huge informal markets close to central business districts and taxi ranks/railway stations in metropolitan areas are cases in point. the latter provide services and products such as fruit and vegetables, traditional healing and medicines, cooked food and homemade clothing products. the question is: what should the product assortment, service levels and location of small township retailers and spaza/tuck shops be to compete effectively in the new retail environment in township areas? in view of the fact that spaza/tuck shops alone employed more than 320 000 people in 2004 (providing a living for more than one million people) it is imperative that further research be conducted on the structural changes in the retail environment of emerging markets (ligthelm 2005). research questions should include a detailed evaluation of the impact of newly developed shopping malls on small township retailers and spaza/tuck shops in a rapidly developed area such as soweto, the adjustments to be effected by small retailers to effectively explore a niche market in terms of product assortment and customer services, and the training and advice needed by small retailers to effectively adjust to the new retail environment. endnote 1 spaza/tuck shops are defined as small informal sector retail businesses operating in a section of an occupied residential home or in any other structure on a stand zoned or used for residential purposes and where people live permanently. small township retailers are defined as stand-alone businesses with a brick and mortar superstructure often located in a demarcated business area but also located in the residential sections of townships. they carry a wider product range than spaza/tuck shops and have more fixtures and fittings often allowing self-service to clients. they employ less than 10 employees on a fulland parttime basis. reference to small informal/formal township retailers includes both spaza/tuck shops and small township retailers. references 1 city of johannesburg (2005) soweto retail strategy 2005, department of finance and economic development: johannesburg. 2 city of tshwane (2006) geographical information system, http://www.gis.tshwane.gov.za (accessed 9 february 2007). sajems ns 11 (2008) no 1 53 3 cohen, j. (1988) statistical power analysis for the behavioural sciences, hillsdale: new york. 4 de vynck, d. (2005) “emerging black middle class flexes muscles”, business report, 10 july. 5 eprop commercial property south africa (2004) “soweto to get r250m shopping mall”, www.eprop.co.za/news/article (accessed 7 march 2007). 6 eprop commercial property south africa (2005) “r80m shopping centre expected to boost township’s development”, www.eprop. co.za/news/article (accessed 7 march 2007). 7 eprop commercial property south africa (2006) “national retailers sign-up as construction on maponya mall gets underway”, www.eprop.co.za/news/article (accessed 7 march 2007). 8 glue metric & lilanda holdings (2006) culture cruizzzing: my health, johannesburg. 9 levy, m. & weitz, b. (2007) retailing management (3rd ed.) mcgraw hill/irwin: new york. 10 lewison, d.m. (1997) retailing management (6th ed.) prentice-hall, inc: new jersey. 11 ligthelm, a.a. (2001) small-scale enterprise development in the tshwane metropolitan municipality: problems and future prospect, unisa, bureau of market research: pretoria. 12 ligthelm, a.a. (2002) characteristics of spaza retailers: evidence from a national survey, unisa, bureau of market research: pretoria. 13 ligthelm, a.a. (2004) informal markets in tshwane: entrepreneurial incubators or survivalist reservoirs? unisa, bureau of market research: pretoria. 14 ligthelm, a.a. (2005) measuring the size of the informal sector in south africa, bureau of market research, unisa: pretoria. 15 ligthelm, a.a & masuku, t. (2003) size, structure and profile of the informal retail sector in south africa, unisa, bureau of market research: pretoria. 16 ligthelm, a.a & risenga, a. (2006) the impact of retail development in emerging markets on small township retailers, bureau of market research, unisa: pretoria. 17 mcgoldrick, p.j. (1998) retail marketing, mcgraw-hill: london. 18 municipal demarcation board (2006) municipal profiles, http://www.demarcation.org.za. 19 newman, a.j. & cullen, p. (2003) retailing: environment & operations (2003 reprint) thomson: london. 20 radebe, s. (2005) “township shopping: it’s not sandton doll”, financial mail, 28 july. 21 tagg, g. (2006) franchising: the cornerstone for shopping centres and the retail industry, south african council of shopping centres: johannesburg. 22 tustin, d.h. & strydom, j.w. (2006) “the potential impact of formal retail chains’ expansion strategies on retail township development in south africa”, southern african business review, 10(3). 23 van aardt, c.j. (2005) a class-based population segmentation model for south africa, 1998-2008, bureau of market research, unisa: pretoria. 24 van wyk, h.d.e.j. (2006) personal income of south africans at national and provincial levels by population group, income group, life stage and life plane, bureau of market research, unisa: pretoria. abstract introduction why south africa? data and methodology results and analysis conclusion acknowledgements references about the author(s) stephanié rossouw school of economics, faculty of business, economics and law, auckland university of technology, auckland, new zealand talita greyling school of economics, college of business and economics, university of johannesburg, johannesburg, south africa tamanna adhikari school of economics, college of business and economics, university of johannesburg, johannesburg, south africa school of business administration, al akhawayn university, ifrane, morocco citation rossouw, s., greyling, t. & adhikari, t., 2021, ‘happiness lost: was the decision to implement lockdown the correct one?’, south african journal of economic and management sciences 24(1), a3795. https://doi.org/10.4102/sajems.v24i1.3795 note: dr tamanna adhikari is a research associate at the school of economics, college of business and economics, university of johannesburg, johannesburg, south africa. original research happiness lost: was the decision to implement lockdown the correct one? stephanié rossouw, talita greyling, tamanna adhikari received: 07 aug. 2020; accepted: 13 dec. 2020; published: 28 apr. 2021 copyright: © 2021. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: amid the rapid global spread of the coronavirus disease 2019 (covid-19), many governments enforced country-wide lockdowns, likely with severe well-being consequences. the actions by governments triggered a debate on whether the costs of a lockdown, economically and in well-being, surpass the benefits perceived from a lower infection rate. aim: to use the gross national happiness index (gnh), derived from big data, to investigate the determinants of happiness before and during the first few months of a lockdown in a country as an extreme case, south africa (a country with low levels of well-being and stringent lockdown regulations). next, to estimate (1) the probability of being happy during a pandemic year, before and after the implemented lockdown, relative to the mean happiness levels of the previous year, and (2) to utilise simulations to estimate the probability of being happy if there were no lockdown. setting: this study considers the effect of government-mandated lockdown on happiness in south africa. methods: we use big data in the forms of twitter and google trends to derive variables and ordinary least squares and ordered probit estimation methods. results: what contributes to happiness under lockdown, except for covid-19 cases, are the factors linked to the implemented regulations themselves. if we compare scenarios preand post-lockdown, we report a happiness cost of 9%. the simulations indicate that assuming there were no lockdown in 2020, the relative well-being gain is 3%. conclusion: if policymakers want to increase happiness levels and the probability of achieving the same happiness levels as in 2019, they should consider factors related to the regulations that can increase happiness levels. keywords: happiness; covid-19; big data; regulations; south africa. introduction whereas the need for curbing the coronavirus disease 2019 (covid-19) infection rate is understandable and the lockdown measures taken by many governments within reason, the question arises as to the well-being cost of these decisions. in this article, we define well-being as the subjective evaluative mood of a country as measured using the gross national happiness index (gnh) derived from big data (greyling, rossouw & afstereo 2019). (please note that we use the words ‘well-being’ and ‘happiness’ interchangeably). most discussions thus far regarding lockdowns have centred around economic loss. while the cost of lockdown on the gross domestic product (gdp) has indeed been high, there could also be a substantial loss in national well-being. often in the past, gdp was erroneously used to measure the well-being of a nation; however, it cannot measure non-market social interactions, such as family and friendship, or attributes such as moral values, happiness or the sense of purpose in life. as such, there is an increasing demand to use subjective measures of well-being and to move beyond the classical income-based approach to measuring human development and progress (algan et al. 2019). furthermore, piekalkiewicz (2017) and bryson et al. (2016) state that well-being predicts one’s future income, affects labour market performance and increases productivity. anik et al. (2009) and lyubomirsky, sheldon and schkade (2005) argue that happiness also has consequences for the health and social sectors of a country. unhappy individuals are physically less healthy, die at a younger age and engage more in risky behaviour, such as drinking and smoking. in contrast, happy people are more active, more creative, and better problem solvers. therefore, maximising well-being should be a priority in policy. previous studies that investigated subjective well-being during pandemics found that community connectedness and not isolation was a mitigating factor in subjective well-being during the h1n1 outbreak (jones & salathe 2009). additionally, those that studied mental well-being saw that anxiety levels waned along with the perception of the severe acute respiratory syndrome (sars) virus being less of an immediate threat (lau et al. 2008). more recently, rossouw et al. (2020) used the gnh to determine the probabilities to move between stages of happiness in new zealand, using a markov switching model. they found that the probability of moving between stages did not change significantly before and during the pandemic. however, the mean levels of happiness for these stages were much lower during the pandemic than before. furthermore, they found that the factors of importance to new zealand’s happiness post-covid-19 regulations implemented were related to international travel, employment and mobility. greyling, rossouw and adhikari (2020a) studied the causal effect of lockdown on happiness in a cross-country study. they found that lockdown had a negative effect on happiness, notwithstanding the different country characteristics, the duration and the type of lockdown regulations. additionally, they found that the more stringent the lockdown regulations, the greater the cost in happiness. hamermesh (2020) used google trends data to predict the life satisfaction of married and single people while in government-imposed lockdown by running simulations. not surprisingly, single people were less satisfied with life than married people. also using google trends data, brodeur et al. (2020) found an increase in searches for loneliness, worry and sadness after a lockdown was implemented, which indicates a negative effect on well-being and mental health. sibley et al. (2020) investigated the effect of lockdown regulations in new zealand on institutional trust, attitudes, health and well-being, using survey data collected at two points in time (december 2019 and april 2020). their preliminary results showed a small increase in people’s sense of community and trust. however, they also found an increase in anxiety and depression post-lockdown and hinted at longer-term challenges to mental health. de pedraza, guzi and tijdens (2020) investigated life dissatisfaction and feelings of anxiety in a cross-country study post-covid-19. they found that people with poorer general health, without employment, living without a partner, choosing to live alone and not exercising daily, report higher dissatisfaction and higher anxiety. additionally, they found that the effect of covid-19 on dissatisfaction and anxiety levels off with a higher number of covid-19 infection cases. however, none of the above-mentioned studies compared the determinants of happiness before and during a lockdown in a developing country, such as south africa, which already suffers from low levels of well-being and a poorly performing economy (an extreme country case). in addition, no other study, to the knowledge of the authors, has attempted to measure the probability that a country can adapt to previous levels of happiness after suffering the consequences of a pandemic, or used simulations to determine the happiness probabilities with and without a lockdown. therefore, in this study, we address the gaps in literature by firstly using the gnh, a real-time measure of well-being, derived from big data, to compare the determinants of happiness before and during the first months of the government-imposed lockdown. this is one of the few studies (see also greyling et al. 2020a and 2020b; rossouw et al. 2020, although these studies address different research questions) that investigates the effect of lockdown on happiness, making use of real-time big data. other studies such as hamermesh (2020) and brodeur et al. (2020) also use big data, although they limit their analysis to google trends. secondly, we first calculate the probabilities to reach the mean happiness levels of 2019, considering that the subsamples of before and after the lockdown were implemented. using simulations, we then address the question of whether the probability of being happy without a lockdown and a higher number of covid-19 cases exceeds the probability of being happy with lockdown and fewer covid-19 cases. in this regard, it is the first study that compares the probabilities to be happy in 2020, considering the mean levels of happiness in 2019 and the first study that simulates happiness levels, if we assumed that there were no lockdown in 2020. our results indicate that, for an extreme country case, what significantly contributes to happiness under lockdown are the factors directly linked to the implemented regulations themselves. these factors can be classified as (1) social capital issues: lack of access to alcohol, concerns about schooling and increased social media usage, and (2) economic issues: employment concerns, the threat of retrenchments and lower levels of consumption. as expected, the number of daily covid-19 cases is negatively related to happiness. surprisingly, we find that the stay-at-home variable is positively related to happiness after lockdown, implying that spending more time at home, without considering the other negative effects of a lockdown, increases happiness. we find the probability of reaching the same mean happiness levels experienced in 2019, considering the two subsamples, before lockdown regulations were implemented, to be 26% and after that 17%. thus, lockdown likely had a happiness cost of 9%. the simulation study reveals that, even considering a margin of error, people in south africa would likely have been happier with a higher number of covid-19 cases and no lockdown regulations (a probability of 27%), than with a lower number of covid-19 cases and lockdown regulations (a probability of 23%). the results of the study inform policymakers on that which significantly contributes to happiness levels during a lockdown with possible applications to other countries with similar lockdown regulations. additionally, by making use of high-frequency real-time data, policymakers are informed of the consequences of their policy decisions with immediate effect, in comparison with significant delays in information (up to two years), associated with survey data. the rest of the article is structured as follows. in the next section, the choice of south africa as an extreme country case is discussed. the ‘data and methodology’ section describes the data, the selected variables and outlines the methodology used. the results follow, and then the article concludes. why south africa? in this study, we define a country as an extreme case if it is under stringent lockdown regulations, coupled with a failing economy and existing low levels of well-being. as such, south africa, a developing country, represents an extreme case. for the period before covid-19, we found that for south africa the mean well-being level, as measured by the gnh, was relatively low at 6.4 (measured on a scale of 0–10), when compared to the mean happiness levels of 7.3 and 7.2 for new zealand and australia (greyling et al. 2019). furthermore, considering the economic well-being of south africans, we found that even before the negative economic impact of the pandemic, gdp was estimated to shrink by 4.8% (bureau of economic analysis 2020), and the unemployment rate reached 29%. additionally, it has been estimated that approximately 3–7 million people can potentially become unemployed as a direct consequence of the pandemic, thereby increasing unemployment rates to approximately 50% (national treasury 2020). moreover, south africa’s sovereign credit rating was dealt a massive blow in march 2020 when it was downgraded to junk status. naturally, the impact of this downgrading stretched into the political sphere, creating instability, as well as impacting on the level of national debt and debt interest payments. lastly, the consumption of south africans has been declining in 2020, with major declines seen after lockdown. south africa’s alert levels of lockdown regulations vary from 1 to 5, with alert level 1 the most relaxed and alert level 5 the most stringent. as south africa manages to curb the spread of covid-19, it moves down the alert levels and south africans regain more of their lost freedoms. south africa went into level 5 lockdown on 27 march 2020, which brought about some of the world’s most draconian regulations. these regulations were comparable only to those implemented by countries such as jordan and the philippines (farge 2020). level 5 lockdown brought with it high economic costs which were cause for concern since south africa was already experiencing a severe economic downturn. additionally, south africans faced restrictions such as not leaving their homes to travel for work, leisure or exercise, not being allowed to purchase tobacco and alcohol, while the police and armed forces were called upon to enforce these restrictions. the data for this article spans the time period when level 5 restrictions were implemented in south africa. at the end of the sample, south africa was under level 4 lockdown which started on 01 may 2020. even though south africans were now allowed to exercise outside from 06:00 to 09:00 and purchase more than just essential goods, the sale of alcohol and tobacco was still banned. taking the above information into consideration, it is clear that south africa is an example of a country as an extreme case, suffering from low levels of well-being and poor economic performance. this situation amplifies the effect of the difficult choices made between curbing the spread of the virus and the likely cost to well-being, related to strict lockdown regulations. data and methodology data in the analyses, we make use of high-frequency daily data spanning the period from 01 january to 08 may 2020, which is 128 days. gross national happiness index – the dependent variable to measure happiness, we make use of the gnh for south africa, which was launched in 2019. the gnh measures the evaluative mood of south africans. to construct the gnh, we extract tweets from twitter and apply sentiment analysis to every tweet. sentiment analysis is the process of determining whether a piece of writing conveys a positive, negative or neutral ‘opinion’. we use natural language processing (nlp) and a sentiment algorithm to determine the sentiment of a whole sentence rather than only the sentiment of a single word. this is the better choice as it helps you understand an entire opinion and not merely a word from the text. the outcome of the sentiment analysis is used in an algorithm to derive the gnh per hour. the scale of the happiness scores is from 0 and 10, with 5 being neutral, thus neither happy nor unhappy. the index is available live on the gnh website (greyling et al. 2019) (see rossouw & greyling 2020 for a detailed discussion of the index). in south africa, the average number of tweets extracted for 2020 is 68 524 per day. south africa has approximately 11 million twitter users, representing a substantial sample of almost 18% of the population (omnicore 2020). rossouw et al. (2020) and greyling et al. (2020a & 2020b) argue that even though twitter is not representative, it does accommodate individuals, groups of individuals, media outlets and organisations, representing a kind of disaggregated sample, not found in survey data. furthermore, we test the robustness of the gnh using the ‘global behaviors and perceptions at the onset of the covid-19 pandemic data’ online survey. the survey results represent 58 countries (those countries in which more than 200 individuals responded), and the total sample was 107 565 individuals (osf 2020). correlating the gnh with ‘anxiety’ and ‘depression’, derived from the above-mentioned survey for the period from 01 march 2020, we find a negative and significant relationship, mostly greater than 0.5 (r > 0.5). it indicates that the gnh and ‘anxiety’ and ‘depression’ measured, using survey data, showed similar but inverted trends. happiness tends to vary depending on the day of the week, normally with a monday low and a saturday high. therefore, we adjust the time series to remove the day-of-the-week effect (helliwell & wang 2011; kelly 2018). in addition to computing the gnh, greyling et al. (2019) extended their analysis in february 2020 to distinguish between the different emotions underpinning the tweets. the team did this to determine the emotions of a nation under challenging circumstances and in events in which one expects significant changes in emotions. subsequently, they differentiate between eight emotions, namely sadness, surprise, disgust, anticipation, fear, anger, trust and joy. selection of covariates to determine the effect of a lockdown on happiness before and after the implemented lockdown, we constructed a treatment variable, named ‘lockdown’. this divides the sample into two distinct time periods: before the first regulations were implemented on 18 march 2020 and after the implementation. the first time period – before 18 march 2020, from 01 january 2020 to 17 march 2020 (77 days) – is coded as 0 and includes a period when the first positive cases were reported in south africa, but no regulations to curb the spread were implemented as yet. the second time period – after 18 march 2020, thus from 18 march 2020 to 08 may 2020 (51 days) – is coded as 1. this period includes the initial two weeks in which there was not a total lockdown, but restrictions on social gatherings were implemented. consequently, south africa moved into level 5 lockdown regulations and on 01 may moved back to level 4. these were stringent and very limiting (see above for the full description). to select the covariates included in the model, we were led by the literature and data availability. the limited time period under observation brought about further limitations as the number of covariates that could be included in the estimation, was restricted to avoid overfitting the models. considering the mentioned challenge and the fact that daily data was scarce, we are restricted in our choice of variables. see table 1 for selected variables and the descriptive statistics for the covariates before and after the implemented lockdown. in the literature, it has been shown that gdp, inflation and unemployment influence happiness (perovic & golem 2010; sacks et al. 2010; stevenson & wolfers 2008). as we were only working with four months of data, we assume the inflation rate to be relatively stable. following the work done by stiglitz, sen and fitoussi (2009), we chose to use consumption as our measure for material well-being since material living standards are more closely associated with consumption than gdp. additionally, sachs et al. (2018) argue that consumption is a more appropriate variable to measure economic activity from a developmental point of view, than income. thus, to estimate consumption, we made use of the daily data available, related to credit and debit card sales, together with atm transactions (beti 2020). we realised that sales were not a perfect proxy for consumption; however, given our data limitations, we believed it provided a reasonable representation of the situation in south africa. we had no daily measure of unemployment; therefore, we used the methodology as set out by nuti et al. (2014), brodeur et al. (2020), greyling et al. (2020a) and rossouw et al. (2020) and used daily searches on google trends for topics related to ‘jobs’, including searches for the south african government’s unemployment insurance fund as a proxy for future uncertainty related to jobs and the economy (see also simionescu & zimmermann 2017). we named this variable ‘jobs’. table 1: descriptive statistics of the variables included in the estimations of happiness. to select other variables included in the estimation of the happiness function, we relied on the analysis of the tweets. we found ourselves in uncharted territory, as there were limited studies estimating happiness functions during a lockdown (greyling et al. 2020a; rossouw et al. 2020). we used the studies mentioned above, as well as the contents of the tweets, to direct us to those covariates that influenced happiness during a lockdown. it was evident from the tweets that the main topics of discussion related to the regulations that were implemented to curb the spread of the virus. these, among others, included the prohibition on the sale of alcohol and tobacco. to proxy the sale of alcohol and tobacco, we followed a similar method to the one used when we derived the measures of ‘concerns related to the economy’. this meant that we used the number of searches for alcohol and tobacco on google trends. the searches for both alcohol and tobacco followed the same trend during the lockdown period and were highly correlated (r = 0.83). to circumvent issues related to multicollinearity, as well as accommodating restrictions in the number of covariates to include in the model, we decided to include only ‘alcohol’ in the regressions. however, we assumed that results drawn from ‘alcohol’ would most likely also apply to tobacco. other topics mentioned were related to concerns about the schooling of children and stay-at-home orders. to proxy concerns about schooling, we once again made use of google trends searches for the word ‘school’. to consider the stay-at-home orders, a proxy for lack of mobility, we made use of the oxford stringency index data set. it included a variable that changed on a day-to-day basis according to the strictness of the stay-at-home orders. it was an ordinal variable and equal to 0 if there were no stay-at-home orders. it changed to 1 if the recommendation was not to leave your house, 2 when people were required not to leave their houses, but could, for example, exercise, do grocery shopping and run essential errands. the value 3 indicated not leaving your home, or with restrictions, such as leaving once a week only, or only one person at a time (hale et al. 2020). thus, a higher value indicated stricter restrictions. we included this variable only for the period after lockdown, seeing that all values before lockdown were 0. furthermore, we included the number of tweets per day, as it formed part of the twitter data extracted daily in south africa (greyling et al. 2019), which was a proxy for connectivity. it also gauged the opportunity cost of not being able to have face-to-face interactions, which seemed to be negatively related to happiness (chae 2018; wilson, gosling & graham 2012). as expected, the number of tweets increased markedly during the lockdown period, from an average of 60 708 tweets per day before the lockdown to almost 80 000 tweets per day during the lockdown. we included the number of covid-19 cases, as well as the squared number of covid-19 cases to control for a possible non-linear relationship between the number of cases and happiness. the data for the number of cases was sourced from the european centre for disease prevention and control (2020). this data was updated each day nationally, using a wide number of mainly official sources, as well as a handful of social media outlets of the national health ministries of each country. methodology ordinary least squares regression we first estimated the following baseline model for the full sample from 01 january to 08 may 2020: here, yt refers to the gnh for each day, lockdownt is our treatment variable capturing the ‘closure’ of both economic and social activity as a response to covid-19. it took a value of 0 before 18 march 2020, and 1 after that. additionally, we used several relevant covariates to account for the changes in happiness over the time under consideration. this was encapsulated in xt. due to the various factors that affect happiness, there may be a correlation with some of our independent variables and the error term, leading to endogeneity concerns. the coefficient could be biased downwards or upwards, depending on the direction of the correlation between the error term and the x variable. for example, the coefficient on the indicator for ‘jobs’ is likely biased upwards as it, in all probability, shows the effect of concerns about jobs, as well as some other negative economic shock on happiness. in the absence of panel data or an appropriate instrument, it was difficult to ascertain causality from equation 1. however, given the sudden and rapid spread of the pandemic and the probability of it having a knock-on effect on the economy, a study in terms of associations was also relevant. a natural extension of the work, as better data becomes available in time, would be to address these concerns. next, we split our sample by our treatment variable to analyse the determinants of happiness before and after the implemented lockdown. the probability of autocorrelation and heterogeneity in our data could not be ruled out, especially due to its time-series nature. however, we used robust standard errors to account for this. additionally, there was a caveat in the choice of our controls. we only have 128 observations and, therefore, using a larger battery of covariates would lead to problems arising due to overfitting of the model. probabilistic models our second objective was to consider the change in the probability of being happy in the year 2020 because of the pandemic and lockdown. to this end, we first transformed our dependent variable on happiness, which was measured on a scale from 0 to 10, to a binary variable. we used the mean of happiness for the year 2019, which has a score of 6.35, as the cut-off point. we then estimated the following ordered probit model: in equation 2, xt is the vector of the covariates as described earlier. using the probit regressions from equation 2, we computed the predicted probabilities of being happy first, over the entire sample, and then before and after the lockdown. due to the method of constructing our binary dependent variable, we could interpret our computed probabilities as the probability of being happier than the mean level of happiness achieved in 2019. lastly, we ran a simulation model to estimate the probability of being happy in the event of no lockdown. to do this, we needed to create several counterfactual scenarios for our variables. we made the reasonable assumption of an increase in the number of covid-19 cases due to no lockdown. to simulate the number of cases, we used the example of spain (a worst-case scenario). spain was a likely choice due to its population size being similar to that of south africa’s and because of its somewhat delayed lockdown response to the pandemic, thus simulating a no lockdown period. spain reported its first covid-19 case on 31 january 2020 and only enforced a total lockdown on 14 march – 43 days later. this fits in well with our timeline as the last date of our sample is 08 may – 43 days after the first reported case in south africa. admittedly, one could also use the example of italy. still, due to the similar trajectory in the two countries, we believed spain was the better choice due to the matching number of days, 43, under investigation. we imputed the number of covid-19 cases for south africa after its first case on 06 march. next, to account for the lack of effect of the lockdown on our other covariates (jobs, schools, alcohol, sales and tweets), we used their 2019 values at the same time of that year – thereby accounting for seasonality. we then estimated equation 2 and reported the resulting predicted probabilities. thus, the predicted happiness levels against the backdrop of the covid-19 pandemic with no lockdown regulations. admittedly creating counterfactual situations in this way has its own concerns as it incorporates year-specific effects. still, we believed that, even with a margin of error, the computed probability would shed light on the true effect of the lockdown on happiness levels. results and analysis descriptive results figure 1 shows the two periods for south africa that we analyse: the period before the lockdown, which covers 01 january to 17 march 2020, and then the period after the first regulations were introduced and the lockdown was implemented, 18 march to 08 may 2020 (periods are divided by the vertical line in figure 1). figure 1: happiness levels before and after lockdown. from figure 1, it is evident that declaring a state of emergency and informing the nation that they will go into a nationwide lockdown, had a significant negative effect on the happiness level (see dotted line representing smoothed gnh – figure 1). while south africans understood that measures had to be implemented to curb the spread of the virus, the limited mobility, being forced to work from home, children not being allowed to attend schools, the restrictions on the sale of alcohol and tobacco, as well as limitations on exercise had a negative effect on happiness. what about the emotions that underpin the evaluative mood expressed in the happiness index? from figure 2, it can be seen that south africans experienced a change in their emotions from before to after the imposed lockdown. south africans were angrier after their first weekend spent in stringent lockdown. additionally, the emotions expressed changed from being joyful, anticipating good things to happen and showing trust, to being angry, anticipating the worst and showing disgust and fear. over the period, the most significant gainers, among the emotions, were anger, up by almost 10%, followed by disgust (+8%). in contrast, the biggest losers were trust (−13%) and joy (−6%). figure 2: emotions of south africans before and after covid-19. regression analysis from the results of table 2, we see that the coefficient on the treatment variable ‘lockdown’ is negative. therefore it is indicative of lower happiness levels after the regulations were introduced than before. table 2: ordinary least squares estimation results of the relationship between different covariates and happiness. let us consider that the year 2020 was tainted by the covid-19 virus from january 2020 onwards, even though the first case of covid-19 in south africa was only announced on 06 march 2020. we can assume that happiness functions might look different in this pandemic year compared to other years. table 2, panel 1, shows the statistically significant determinants of happiness since the beginning of 2020 up to 08 may 2020. sales are significant and positively related to happiness. sales, in this instance a proxy for consumption, are positively related to happiness; thus, if sales increase, happiness would likely also increase (stanca & veenhoven 2015; wang et al. 2019). the covid-19 cases squared variable, which we introduced to test for a quadrative relationship between covid-19 cases and happiness, is positive and significant for the whole sample, although only at the 10% level. additionally, the effect size is very small, and it loses its significance in the subsamples. thus, it seemed in the early stages of covid-19, although the effect size decreased, there was not yet sufficient evidence of a quadratic relationship. additionally, table 2, panel 1, shows that searches for jobs, alcohol and school, the number of tweets, as well as covid-19 cases, are statistically significant and negatively related to happiness. let us consider the time periods before lockdown (01 january to 17 march 2020) (table 2, panel 2) and after the lockdown regulations were introduced on 18 march (up to 08 may 2020, the date of completing the research article) (table 2, panel 3). we find the following differences in the factors that influence happiness. sales (a proxy for consumption) were a significant predictor of happiness before the lockdown period. after the lockdown was introduced, it seems that sales were no longer of importance to happiness. this might be explained as the joy derived from buying dissipated after the lockdown, due to the experience being negative. south africans’ consumption experience was characterised by standing in queues before entering a store, only being allowed to purchase essential goods, enduring the discomfort of wearing masks and always keeping to social distancing rules. before the lockdown, searches for jobs were not significant. still, in the period after the lockdown, concerns about the future of the economy show a statistically significant and negative relationship to happiness, emphasising concerns about the economic effects of the lockdown. the number of tweets was not significant before the lockdown, but after the lockdown, it was significant and negatively related to happiness. in line with expectations, we did note that the number of tweets during the lockdown period increased significantly. as mentioned previously, it had been shown an increase in use of social media is often negatively associated with happiness (chae 2018; wilson et al. 2012). after the lockdown was introduced, the sales of all alcoholic beverages and tobacco were prohibited. once the sales were prohibited, it became more apparent that the lack of these products is a significant contributor to the happiness of south africans. research done by sommer et al. (2017) proved that because of the presence of hordenine in, among others, beer, it significantly contributes to mood elevation. in south africa, which is well-known for its high per capita beer and alcohol consumption (statistics south africa 2017), we noticed that the lack of alcohol played a significant role in the decrease in happiness both before and after the implemented lockdown. the effect size, however, was not significantly different from each other. this could be related to the lack of socialising, which is a large part of the south african culture and synonymous with consuming alcoholic beverages. indeed, when reading through the actual tweets themselves, we noticed that the lack of alcohol was a major tweet topic. before the lockdown period searches for school, a proxy for people concerned about their children’s schooling, was not significant, but after the lockdown was introduced, it became significant. this is an indication of people’s concern for their children’s education and the uncertainty surrounding the schooling process for 2020. furthermore, there was uncertainty about when schools would re-open and how teaching would take place without putting children at risk. the number of daily covid-19 cases was negatively related to happiness, before and after the lockdown. the significant relationship before lockdown is interesting, as the first covid-19 case in south africa was only confirmed on 06 march 2020. this was approximately three weeks before the lockdown regulations were implemented. however, the news about covid-19 was available since the end of december 2019, and the first tests for covid-19 in south africa were done in february 2020. looking at the emotion of fear, we saw that it increased since february and was likely linked to the negative relationship between the number of covid-19 cases and the happiness levels before lockdown, but the emotion of fear started to decline from april 2020. however, the coefficient on covid-19 cases is smaller after the lockdown than before. this reveals that the effect of the number of cases on happiness declined over time. let us only consider the period after lockdown, and introduce the stay-at-home variable, a proxy for lack of mobility (table 2, panel 3). we found that stay-at-home orders played a significant and positive role. as the stringency of the stay-at-home orders increased, happiness increased. this could be thought of as one of the positive effects of the lockdown. in general, people had more time to spend with their loved ones. additional savings had been reported for salaried individuals due to reduced spending opportunities leading to potentially increased happiness levels. traffic and lack of commuting expenses could also be additional explanations for this result. in summary, what changed when the lockdown regulations to curb the spread of the covid-19 virus were implemented? peoples’ happiness levels decreased significantly, as new factors came to the fore, which were not previously relevant or known to affect happiness levels. these include the lack of alcohol, social events and gatherings and concerns about schooling and future employment. what was concerning is that sales, a well-established determinant of happiness, were not significant after lockdown, implying that happiness levels were not increased by higher levels of consumption. this is against the standard utility theory of economics, which shows that there is a positive relationship between consumption and happiness. the main finding, however, is that the number of covid-19 cases, although negatively related to happiness, became less of a threat to happiness after lockdown. this confirms the findings of the studies conducted by jones and salathe (2009) and de pedraza et al. (2020), although they investigated mental well-being and life satisfaction. results on the probability of reaching 2019 happiness levels to measure the probability that south africa could reach the same levels of happiness in the year 2020 as experienced in 2019, we used the same models as estimated using ordinary least squares (ols). however, with the difference that we collapsed the happiness variable to a binary variable. now, 1 indicated a level of happiness equal to or more than the mean happiness level of 6.35 in 2019, and 0 indicated the opposite. furthermore, we excluded the stay-at-home variable from the probit estimations to make the before and after lockdown models comparable (the reader is reminded that this variable had a value of 0 before the lockdown). probability to be happy for the period from 01 january to 08 may 2020 (real-life scenario) table 3, showing the results for the whole time period from 01 january 2020 to 08 may 2020, strengthens the ols estimation results (see table 2) as the results were very similar, with all signs having the same direction as in the ols estimations. table 3: probit estimations on the probability to be happy. this indicates that the direction of the relationships did not change; the similarity of the results held for the period before and after the lockdown. however, the number of tweets was no longer significant in the model. we found that if we increased the cut-off point, of the happiness variable to greater than 6.35, tweets became significant (negative relationship). this implies that the probability of being very happy is negatively related to the number of tweets (re-emphasising the findings in the literature). thus, similar to the ols results, sales increased the probability of being happy. in contrast, increased searches for alcohol, school and jobs decreased the probability of happiness. additionally, as expected, the number of covid-19 cases also decreased the probability of happiness (see table 3). interestingly, in the probability estimations, the squared covid-19 cases were positive, but no longer significant, re-emphasising the ols results. table 3 shows that the predicted probability of reaching the same mean happiness levels in 2020 (01 january to 08 may), as experienced in 2019, is only 23%. thus, there is a relatively low probability that people will be as happy in 2020 as they were in 2019. probability to be happy for the period before lockdown, 01 january to 17 march 2020 (real-life scenario) and after lockdown, 18 march to 08 may 2020 (real-life scenario) as mentioned, we found similar results in the probability estimations as in the ols estimations for the period before and after the implemented lockdown. before the lockdown period, we found that sales increased the probability of happiness, whereas the number of covid-19 cases decreased the probability of happiness. let us consider the predicted probabilities of being happy before the lockdown. we found that the probability of reaching the same mean levels of happiness in 2020, as experienced in 2019 was 26%. after the lockdown, we found that searches for jobs, alcohol, schools and covid-19 cases decreased the probability of being happy. the probability of being as happy as in 2019 after the lockdown was only 17%. thus, south africans had less than a one in four chance to be as happy as they were in 2019 with the lockdown regulations in place. let us consider the real-life scenarios and compare the probabilities to be happy before and after lockdown. it seems that after the lockdown the probability of being happy was much lower than before: the difference between the probability of 26% and only 17%. these results reflect both (1) the observed pattern of the spread of the disease post lockdown, although it seems as if peoples’ fear of the disease was dissipating, and (2) the negative effects of lockdown regulations. simulation of probability to be happy for the period from 01 january to 08 may 2020, if there were no lockdown table 4 gives the predicted probabilities from our simulation exercise in the event of no lockdown for the entire time period under consideration (01 january – 08 may 2020). the details of the simulation can be found in the methodology section. we assumed that the number of covid-19 cases followed a similar trajectory to that in spain, which did not impose a south african-style lockdown, whereas we assume that the other covariates had similar levels (values) to those in 2019. we estimated the probability of being happy if no lockdown were imposed, but with the presence of covid-19. furthermore, we assumed due to no lockdown regulations that the number of covid-19 cases would be significantly higher than in the real-life scenario. table 4: probability to be happy if we assume no lockdown (simulation with spanish covid-19 cases). with these considerations in mind, we found that the probability of being as happy in 2020 as in 2019 was 27%. thus, if we compared the real-life probability of happiness to that found in the simulation model, it was 23% compared to 27%. therefore, we have a loss in the probability of happiness of 4%; we can ascribe this loss to the lockdown regulations. this indicated that even if we consider the threat of covid-19, the stringent lockdown regulations further decreased happiness. we do acknowledge that our assumptions were quite strict. as cases increased, so would the number of deaths and that would reduce the happiness levels. however, given the differences in the healthcare systems between south africa and spain, it was hard to simulate the number of deaths. additionally, our simulations were based on behaviour of people which in 2019 was assumed to be ‘normal’. as the pandemic goes on, we know that people’s behaviour would change. thus, the probability estimates we got, are to be understood against this backdrop. one caveat holds: the population of south africa is approximately 9.5 million more than that of spain (46 million in 2020), so it is plausible that the number of cases in south africa could be higher, which would make the probability of being happy, slightly lower than our estimations. but in general, even considering some margin of error, it seems that the lockdown regulations created a loss in the probability to be happy. conclusion in this article, we used the gnh to explore the factors associated with happiness during the covid-19 pandemic, and we investigate if these factors differed for the period before and after the lockdown. furthermore, we investigated the probabilities to reach the mean happiness levels of 2019, considering the time period before and after the lockdown. additionally, we simulated the probability of happiness if there were no lockdown in south africa and an increased number of covid-19 cases. this is one of the first studies to use a real-time measure of well-being, derived from twitter together with other variables derived from google trends, to estimate the factors related to well-being during a pandemic and provide timely results to policymakers. it is also one of the very few studies that focus on a developing country or a country as an extreme case, such as south africa, which has low levels of well-being and has had very stringent lockdown regulations. in addition, this is the first study that compares the probabilities to be happy in 2020, considering the mean levels of happiness in 2019. lastly, this is the first study to simulate happiness levels if we assume that there were no lockdown in 2020 amid an increase in the number of covid-19 cases. our results indicate that, for a country as an extreme case, what significantly contributes to happiness under lockdown are the factors directly linked to the regulations that were implemented. these factors can be classified as: (1) social capital issues: lack of access to alcohol, concerns about schooling and increased social media usage, and (2) economic issues: employment concerns, the threat of retrenchments and lower levels of consumption. as expected, the number of daily covid-19 cases was negatively related to happiness. surprisingly, we found that the stay-at-home variable is positively related to happiness, implying that spending more time at home, without considering the other negative effects of a lockdown, increased happiness. we found the probability of being as happy as in the year 2019 with lockdown regulations implemented to be 17% and 26% without the lockdown. thus, lockdown likely had a happiness cost of 9%. the simulation study revealed that, even considering a margin of error, people in south africa would likely have been happier with an increased number of covid-19 cases and no lockdown regulations (a probability of 27%), than with a lower number of covid-19 cases and lockdown regulations (a probability of 23%). considering the results mentioned above, it ultimately means that if policymakers want to increase happiness levels and increase the probability to achieve the happiness levels of 2019, they must consider those factors that significantly contribute to peoples’ happiness. these factors include allowing people some of their lost comforts by reinstating the sale of alcohol and tobacco. people should be allowed to return to work, or the circumstances for working from home should be enhanced. furthermore, making it possible for children to be schooled (online teaching or schooling that allows for social distancing) and allowing people to restore a certain degree of their consumption patterns while being careful to prevent the spread of covid-19. additionally, policymakers should assure citizens that there is a credible plan to get the economy, which is currently in dire straits, back on track. such an economic plan should stimulate growth, create job opportunities and increase employment rates, supply the necessary infrastructure and deal with curbing vast budget deficits and debt burdens. one shortcoming of this study is the inability to draw heterogeneous within-country conclusions, seeing that we employ country-level representative indicators for happiness. thus, it is important to interpret our results as the mean effect on happiness. acknowledgements we thank afstereo for the it support in the construction of the happiness index and accompanied emotions. competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions s.r., t.g. and t.a. contributed equally to the design, formulation and execution of the study. ethical considerations this article followed all ethical standards for research without direct contact with human or animal subjects. funding information this work was supported by the university research committee funding of the university of johannesburg. the funders had no role in study design, data collection and analysis, decision to publish, or 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bureau of economic research, cambridge, ma. stiglitz, j.e., sen, a.k. & fitoussi, j.p., 2009, report by the commission on the measurement of economic performance and social progress, commission on the measurement of economic performance and social progress, paris. wang, h., cheng, z. & smyth, r., 2019, ‘consumption and happiness’, the journal of development studies 55(1), 120–136. wilson, r.e., gosling, s.d. & graham, l.t., 2012, ‘a review of facebook research in the social sciences’, perspectives on psychological science 7(3), 203–220. https://doi.org/10.1177/1745691612442904 abstract background literature review research method findings discussion conclusion acknowledgements references about the author(s) luckson phiri department of operations management, faculty of public administration and operations management, university of south africa, pretoria, south africa aletta s. tolmay department of operations management, faculty of public administration and operations management, university of south africa, pretoria, south africa riaan dirkse van schalkwyk department of operations management, faculty of public administration and operations management, university of south africa, pretoria, south africa citation phiri, l., tolmay, a.s. & van schalkwyk, r.d., 2023, ‘micro-economic drivers of the south african foundry industry’, south african journal of economic and management sciences 26(1), a4758. https://doi.org/10.4102/sajems.v26i1.4758 original research micro-economic drivers of the south african foundry industry luckson phiri, aletta s. tolmay, riaan dirkse van schalkwyk received: 12 july 2022; accepted: 03 nov. 2022; published: 27 jan. 2023 copyright: © 2023. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the foundry industry plays an important economic role in south africa and all efforts should be made to sustain the industry. however, the problem is that many foundries are closing down due to economic factors. aim: the primary research objective was to identify from literature the micro-economic drivers applicable to the sustainable competitive advantage (sca) of foundries in south africa. the secondary objectives were to benchmark the perceptions of stakeholders in the most prominent micro-economic drivers identified from literature. setting: with micro-economic drivers identified, management can then compile a sca strategy to retain the industry. foundry representatives from foundries located in all nine provinces of south africa were invited to participate in the study. method: an explanatory sequential mixed-methods approach was followed by first employing a quantitative approach, followed by a qualitative approach to identify the most prominent micro-economic drivers. descriptive data analysis was utilised for the quantitative data and thematic analysis was utilised for the qualitative phase. results: it was found that the most prominent micro-economic drivers are product quality, the ability to innovate, employees’ skills development, and investment in plant infrastructure. conclusion and contribution: the article contributes towards the deficiency in literature by presenting the most prominent micro-economic drivers for the south african foundry industry. the article also makes recommendations on sca strategies for foundries in south africa based on the four micro-economic drivers. keywords: south african foundry industry; sustainable competitive advantage; micro-economic drivers, explanatory sequential mixed-method, foundries closing down. background the foundry industry operates on a globalised platform and offers numerous opportunities, but it also faces many challenges and associated risks, including price volatility and demand fluctuation (ghadge et al. 2017). the problem, identified in a study reported on in this article, is the closing down of numerous foundries in south africa. literature states that the metal casting foundries in south africa are closing because of circumstances on microand macro-economic levels (andreoni, kaziboni & roberts 2021; lochner et al. 2020; mkansi, nel & marnewick 2018; south african institute of foundrymen [saif] 2020; the dtic 2021). the closing down of foundries threatens economic growth, direct and indirect employment and it also negatively affects raw material (casting) supply to original equipment manufacturers (oems) in south africa. the foundry industry in south africa reduced from 450 foundries in the 1980s to 170 foundries in 2014 (mulaba-bafubiandi, mageza & varachia 2016). the industry shrank further from 167 foundries in 2018 (mkansi et al. 2018) to 123 in 2020 (lochner et al. 2020). the main reason for the closing down of foundries is the lack of competitiveness, compared to their international counterparts, and failure to overcome the macroand micro-economic challenges facing the industry (the dtic 2021). it is envisaged that a sustainable competitive advantage (sca) could mitigate the risk of the closing down of foundries; however, in-depth research is still invited (rohdin, thollander & solding 2007). also, haseeb et al. (2019) and cicea et al. (2019) support the need for research on challenges on microand macro-levels to enhance organisations’ ability to gain sca. the study reported on in this article aims to address this problem by first identifying the key micro-economic drivers that enhance sca. with micro-economic, or internal drivers identified, foundries would be able to enhance sca and to prevent possible closures. as a delimitation, the macro-economic drivers will not be addressed in this article. hence, the primary research object is to identify from literature, the micro-economic drivers applicable to the sca of foundries in south africa. the secondary objectives are to benchmark the perceptions of stakeholders within the foundry industry on sca against the most prominent micro-economic drivers identified from literature. finally, recommendations will be made on sca strategies for foundries in south africa to possibly mitigate the closing down of foundry plants. literature review the literature review provides background on the foundry industry, sca and micro-economic drivers. foundry industry according to treyger (2005:1), the metal casting process ‘involves the pouring of molten metal into a mould that contains a cavity of the desired shape’. the world foundry organisation (wfo) (2018) states that the foundry industry in south africa comprises industries that deal with ferrous castings (steel and iron), non-ferrous castings (brass, aluminium and zinc), investment castings, as well as high pressure die castings. three major sectors in south africa consume the majority of the foundry output, namely the automotive, manufacturing and mining sectors (saif 2020; wfo 2018). the foundry industry in south africa serves the following industries in the respective proportions: mining (32%), automotive (25%), manufacturing (24%), railways (9%), agriculture (3%), infrastructure (2%) and other (5%) (saif 2020; the dtic 2021). the foundry industry is of strategic importance as it creates employment to over 14 250 unskilled, semi-skilled and skilled people (saif 2020). over the past two decades (post 2000), the foundry industry had a significant influence on the development of many economies globally, while the metal casting industry is integral to all the world’s manufacturing activities (andreoni et al. 2021). as the foundry industry also plays an important role in the south african economy, contributing largely towards the country’s gross domestic product (gdp) (saif 2020), it is important to sustain the industry (lochner et al. 2020). therefore, this article aims to shed light on the importance of the industry by the identification of micro-economic factors and how to achieve a sca. sustainable competitive advantage sustainable competitive advantage is usually associated with profitability, efficiency and productivity (trnkova & kroupova 2021). parola et al. (2017:4) argue that although the concepts of competitiveness and competitive advantage have been widely used, interchangeably, to refer to the ability of firms to outsmart rivals, the concepts have also been used to refer to ‘rivalry among nations’ (porter 1985) and ‘business ecosystems’ (mäntymäki & salmela 2017). sustainable competitive advantage relates to an organisation’s ability to carry out the set of necessary steps for achieving lower costs than the competition, in an efficient and unique way, creating differentiated value for buyers (porter 1985:20). since porter’s (1985) definition, many authors presented definitions of sca, including barney (1991:102); hoffmann (2000) and barney and clark (2007:77). the authors of this article compiled a combined definition from literature as: [a] pro-business superiority strategy that allows a company to out-compete rivals by offering goods and/or services to customers in a manner that is difficult to replicate within the same window period of incessant advantage. (p. 36) since the introduction of porter’s viewpoint on sca, contemporary theoretical views developed after 2000, namely the resource-based view (rbv), the market-based view (mbv), the knowledge-based view (kbv), the relational view (rv) and the capability-based view (cbv). resource-based view depicts an organisation as a collection of various resources put together for the benefit of the organisation (wang 2014). these unique resources then provide the organisation with an advantage over rivals by means of knowledge, brand equity, cohesive leadership, strong patents, trade secrets, capabilities and innovation (assensoh-kodua 2019; wang 2014). the mbv states that an organisation’s performance is primarily determined by the industry and external market factors (wang 2014). hence, the organisation’s sources of market power play a crucial role in determining its relative performance within the industry. an organisation’s competitive advantage can be attributed to how it is viewed by the market and industry in which it operates and also its ability to take advantage of entry barriers that keep other firms at bay and, therefore, protect profit margins (kaningu, warue & munga 2017). the kbv emphasises that organisational knowledge of strategy is the most important antecedent of the organisations’ performance, innovativeness, and competitiveness (cooper et al. 2020). organisations that are able to create, capture and distribute knowledge more effectively than the competition, position themselves to outperform the rivals (rezaee & jafari 2016). the rv, originally developed by dyer and singh (1998) states that the networking and strategic relationships between organisations is crucial in the creation of a sca. these dynamic networks and relationships enable organisations to keep rivals from capitalising on existing profitable market shares. the cbv emphasises that the capabilities of organisations provide their sca. an organisation should identify its crucial capabilities and position these capabilities strategically to achieve market share. these capabilities might include marketing, innovation, human, financial and managerial capabilities (gimez et al. 2019). in order to achieve sca, organisations should identify the most important micro-economic drivers. management provides control over micro-economic drivers, and with these drivers identified, management can then achieve sca. micro-economic drivers micro-drivers refer to the drivers within organisational control (krajnakova, navickas & kontautiene 2018), while macro-drivers refer to those elements outside the control of organisations (cepel et al. 2019). hence, micro-economic factors relate to the factors internal to the organisation which determine its strengths, weaknesses and responses to threats and opportunities; and management has direct control over these factors (krajnakova et al. 2018). further, porter et al. (2008) state that micro-drivers act directly in the firms, thereby affecting productivity and profitability levels. with micro-economic drivers identified, sca strategies might be designed to take control of the drivers that might improve the sustainability of the foundry industry. for the purpose of this article, an exercise of a systematic literature review (slr) was undertaken to identify the micro-economic drivers affecting the organisation’s business environment. a total of 20 micro-economic drivers were identified from literature (table 1). table 1 provides a summary of the micro-economic drivers affecting local and global foundries. table 1: micro-economic drivers as identified in literature. these micro-economic drivers cover a wide range of factors, ranging from employees’ skills development, investment in infrastructure, organisational culture and governance, production, value to customer, bargaining power with suppliers and more (table 1). it was deemed important by the researchers to classify these micro-economic drivers into categories for a more logical presentation that might possibly enhance sca. an applicable classification approach was identified in literature from the study of siudek and zawojska (2014). siudek and zawojska (2014) classify sca drivers into five categories, namely: (1) assets (resources); (2) processes; (3) firm’s performance; (4) supporting and related industries and clusters, as well as (5) institutions and government policies. the identified micro-economic drivers were then classified into five categories (siudek & zawojska 2014) (table 2). table 2: sustainable competitive-advantage classification of micro-economic drivers. these five categories, with the applicable subsections (table 2), were then tested through descriptive statistics in order to secure statistical validity and reliability. the research method is discussed in the next section. assets and resources mainly refer to the assets of the organisation, especially human resources, technology, intellectual capacity, the organisation’s capacity and the firms contribution to socio-cultural responsibilities (table 2). processes refer to the ability to innovate processes, bargaining power, managerial ability, the quality of products and access to markets (table 2). the organisation’s performance refers to the organisational culture, good governance, price competitiveness and product services, as well as value-added services to the customer. support and related industries and clusters refer to cluster membership that enhances networking potential and finally, institutions and government policies refer to the certification such as iso accreditation and product certification (table 2). research method the research reported on in this article aims to primarily contribute towards the body of knowledge through the identification of micro-drivers from literature that can be used to enhance the sca of the foundry industry in south africa. these micro-drivers were then tested (descriptive statistics and thematic analysis) in order to identify the most prominent micro-drivers as identified by industry experts. finally, recommendations are made on how to mitigate the challenge of foundry closures through sca recommendations. an explanatory sequential mixed methods approach was followed (creswell & creswell 2018). the explanatory sequential mixed-methods design employs an initial quantitative phase of data collection and analysis, which is followed by a qualitative data collection and analysis phase, with the aim of integrating or linking the data from the two separate strands of data. through the explanatory sequential mixed-method design, the qualitative data can be utilised to obtain explanations from the quantitative phase in order to better understand the phenomenon (creswell & creswell 2018). the mixed-method approach enables researchers to produce a more significant contribution towards the field of study and to secure more validity (bowen, rose & pilkington 2017). further, the mixed-method approach was followed because of five justifications for combining both qualitative and quantitative methods which include (1) triangulation; (2) complementarity; (3) development; (4) initiation; and (5) expansion (bryman & cramer, 2012). triangulation refers to the use of different approaches to provide a better understanding of a given phenomenon (turner, cardinal & burton 2015); thereby enhancing the mutual corroboration of the findings (schoonenboom & johnson 2017) and increasing the credibility of the study. first a quantitative phase was introduced, followed by a qualitative phase. the research method followed the steps proposed by bordeianu and morosan-danila (2013), that include the following: step 1: determination of the purpose of the study the first step determined the limitation and delimitation of the study, as well as the target population. the study aimed to determine the micro-economic factors for the closing down of foundries in south africa. this was followed by the prioritisation of these micro-economic factors. step 2: reviewing existing literature secondly, a comprehensive literature review, followed by evaluating existing literature, regarding the micro-economic drivers of sca in the foundry industry, was carried out. in this phase the research instruments to be utilised for testing the micro-economic drivers in the foundry industry were evaluated. a theoretical framework followed that and depicted the micro-economic drivers in the south african foundry industry (table 1 followed by table 2). step 3: generating the research instrument the third step considered the instrumental items, sequencing, format and method of administration for the research to be suitable for the research population. the population comprised the employees of foundry companies in south africa and therefore questions were framed in a language and terminology understood by the industry representatives. step 4: content validity evaluation the opinion of industry experts was sought for the validation of the research instrument, and to confirm whether the instrument addressed the specific research objectives (malmqvist et al. 2019). hence, the items in the questionnaire were guided by the drivers identified in literature, as well as discussions conducted with industry experts. step 5: pilot testing of the research instrument the questionnaire comprised six areas, including the respondents’ demographic variables; ratings on the importance of micro-drivers; the identification of three critical micro-drivers; the ranking of the impact of competitive forces on sca; the ranking of business competitiveness approaches to sca; and suggestions on measures to improve sca. the pilot test according to kumar (2011) helps streamline processes and procedures in preparation for the main study. step 6: construct validity evaluation the sixth step comprised construct validity and evaluation which, according to slavec and drnovsek (2012), relate to the scale’s ability to measure correctly. to achieve validity, the researcher uses alternative measures of a concept and correlates them with a summated scale in order to determine whether the scale measures the concept as intended (hair et al. 2014). according to hair et al. (2014:3), a summated scale is a ‘method of combining several variables that measure the same concept into a single variable in an attempt to increase the reliability of the measurement through multivariate measurement’. hair et al. (2014) state that discriminant validity is tested by confirming the correlation among measures. step 7: reliability testing of the instrument bordeianu and morosan-danila (2013) posit that if the research instrument gives the same results when used on a group of respondents after a short period of time and when no changes are foreseen, then the instrument has a high level of reliability. the calculation of the correlation coefficient precedes this process, with high correlations signifying similarities of the two sets of answers and consequently demonstrating that the chance of errors is less (bordeianu & morosan-danila 2013). cronbach’s alpha coefficient, which further represents another method of determining the reliability of the research instrument, was also calculated. data were collected by the researchers alone to ensure accuracy and uniformity of the data collection process and the respondents were all comfortable reading and writing in english (singh et al. 2018). approach the contact details of the prospective participants were obtained from the foundry industry database of the national foundry and technology network. the contact details of 196 representatives from 95 foundries were available on the nftn list. questionnaires were e-mailed to all 196 respondents (table 3). table 3: sample for the research. this forms part of step 1 of the research method in which the limitations and delimitations were considered. for the qualitative phase, and practical reasons, an interview sheet was compiled in order to obtain in-depth information from 12 industry experts within the foundry industry. amongst the questions, experts were asked to identify the most prominent micro-economic drivers and also motivate why they have chosen these drivers. step 2 (of the research method discussed above) entailed the identification of micro-economic drivers from literature (table 1). after the identification of applicable micro-economic drivers the research instrument (table 4) was compiled as step 3. for step 4 the content validity was tested with industry experts during the pilot study. the pilot study (step 5) was undertaken with seven (7) participants before the actual study was conducted in order to establish if there was clarity regarding the proposed interview questions (majid et al. 2017). the participants in the pilot study all have and represent extended experience in the foundry industry (table 5). table 4: measurement instrument with references from literature (validation). table 5: demographics of participants in the pilot study. the construct validity (step 6) and the instrument reliability (step 7) will be addressed in the findings section. ethical considerations ethical clearance was obtained from unisa (university of south africa) (2020_cems_bm_100; 23 july 2020). findings the first section of the findings indicates the demographical information of the respondents. the second section depicts the data obtained during the quantitative phase, followed by the qualitative findings. demographics the response rate for this study was 88% (table 6) based on 108 usable individual responses received out of 123 survey invites sent (table 6). table 6: demographics. the responses in general represented a good spread (table 6). regarding the role in the organisation, the respondents were classified into five categories: top (9.3%; n = 10); senior (13.9%, n = 15); middle (13%, n = 14); junior management (25%, n = 27); as well as non-management employees (38.9%, n = 42). the different areas of focus were well represented in the study with employees in finance and administration contributing 22.2% (n = 24), operations or manufacturing contributing 18.5% (n = 20), and the sales and marketing divisions constituting 17.6% (n = 19) of the sample. employees involved in strategic management and project management each represented 14.8% (n = 16) of the sample, while those in procurement, buying and tendering constituted 12.0% (n = 13). finally, table 5 illustrates that 18.5% (n = 20) of the respondents have worked for their current organisations for less than a year, while the majority of the respondents (34.3%, n = 37) reported that they had been with their company for between 1 and 5 years. a proportion of 24.1% (n = 26) have worked for their current organisation for between 6 and 10 years, while 23.1% (n = 25) of the respondents indicated that they had worked for their current organisation for more than 10 years. data analysis: quantitative phase twenty micro-economic drivers were tested through descriptive statistics that included (1) investment in plant infrastructure; (2) cluster membership; (3) employees’ skills development; (4) product or service differentiation; (5) organisational culture; (6) governance; (7) price competitiveness; (8) product quality; (9) ability to innovate; (10) technology or equipment upgrade; (11) production or raw material costs; (12) firm capacity; (13) exposure to export market; (14) socio-cultural responsibility; (15) certifications; (16) possession of intellectual property; (17) managerial choice; (18) bargaining power over suppliers; (19) possession of unique resources; and (20) value-add for the customer. the statistical data on the respondents’ feedback are presented in table 7. table 7: statistical data (quantitative research). for the quantitative phase, the respondents expressed the following perceptions: they were of the opinion that product quality was the most important micro-economic driver (mean = 4.66; sd = 0.60), followed by the ability to innovate (mean = 4.51; sd = 0.63), employees’ skills development (mean = 4.45; sd = 0.86), investment in plant infrastructure (mean = 4.35; sd; 0.75), and price competitiveness (mean = 4.31; sd = 0.79) (table 7). data analysis: qualitative phase the qualitative research phase followed the quantitative phase through thematic analysis. the top management of foundries were targeted with the aim to undertake an in-depth interview process, as well as guidance from literature. the interviewees were asked to identify the most critical micro-drivers and motivate why. the qualitative phase maximises the understanding and insights of the research phenomenon (onwuegbuzie & leech 2007). the researchers employed a strategy of the combination of ‘prolonged engagement and richness of data’ to ensure improved credibility of the data collection process (babbie 2010). firstly, a pilot study was conducted with seven participants to clarify the questions (majid et al. 2017), after which 12 participants were considered in sample selection. these 12 participants were randomly selected to obtain representation from different provinces and different designations and experiences (table 8). the four criteria for establishing trustworthiness in qualitative research were considered for validity. these include credibility, dependability, transferability and confirmability (anney 2014). the interviewees were asked about the importance of micro-economic drivers and to prioritise the importance of these drivers. table 8: demographics of interviewees: qualitative phase. for the qualitative analysis, coding was utilised to identify certain themes in line with the framework proposed by braun, clarke and weate (2016). after the transcription process, qualitative data were reviewed several times to ensure understanding of the content, followed by the coding process, and succinct labels were generated to identify the most important features of the data (braun & clarke 2006). then the codes were collated in preparation for theme generation and interpretation. dependability was thereafter addressed through the utilisation of a code-recode approach in which the data were coded twice (anney 2014). the two sets of coded data were then compared to determine whether there were any differences or not (anney 2014). the demographical information of the interviewees is presented in table 8. in line with the quantitative phase findings, the respondents mentioned that quality (table 7; rank 1) is of high importance (table 9 – 1.1.1; 1.1.6; 1.1.7; 1.1.8). the respondents further supported research in innovation (table 7; rank 2) when interviewed (table 9 – 1.1.8; 1.1.9; 1.1.13). finally, employees’ skills development (table 7; rank 3) was also supported during the interviews (table 9 – 1.1.2). table 9: summary of findings: qualitative phase. during the qualitative phase, the respondents were also asked to rank the most critical micro-economic drivers for sca in order of importance. the responses to the highest ranks are indicated in table 10. table 10: ranking of critical micro-economic drivers (qualitative phase). some of the feedback from the interviewees to motivate the most critical micro-economic drivers are depicted in table 11. table 11: feedback from respondents (qualitative phase). when the top five findings of the qualitative and quantitative phases were combined, the critical micro-economic drivers for foundries seem to be: (1) product quality; (2) employees’ skills development; (3) the ability to innovate (research and development); (4) investment in plant infrastructure; and (5) technology (equipment) upgrade (table 10). two constructs, namely product quality (1) and (3) the ability to innovate, form part of sca processes (table 2), while (2) employees’ skills development and (4) investment in plant infrastructure form part of assets/resources (table 2). the firms’ performance, supporting and related industries and clusters, as well as institutions and government policies (table 2) did not feature as sca classifications for the micro-economic drivers during both the qualitative and quantitative phases. the four most prominent micro-economic drivers identified from the qualitative and quantitative phases include: (1) product quality; (2) ability to innovate; (3) employees’ skills development; and (4) investment in plant infrastructure (figure 1). figure 1: combination of micro-economic drivers (qualitative and quantitative phases). price competitiveness (rank 5) and technology (equipment) upgrade (rank 2) did not overlap from the qualitative and quantitative phases as highest priority (table 10). according to the classification of siudek and zawojska (2014) (table 2), product quality and the ability to innovate fall under the sca processes, and employees’skills development and investment in plant infrastructure are classified under assets/resources (table 12). table 12: sustainable competitive-advantage classification (post-quantitative and qualitative phases). discussion the problem addressed in this article is that the foundry industries in south africa are closing down due to various economic circumstances. the aim was to determine the most prominent sca micro-economic drivers in the south african foundry industry. organisations have control over micro-economic drivers, and with these drivers identified, management could address these issues to enhance sustainability in the foundry industry. the study applied an explanatory sequential mixed method to determine the most prominent sca micro-economic drivers in south african foundries. from the five sca classifications recommended by siudek and zawojska (2014) (table 2), processes (inclusive of product quality and ability to innovate) and assets/resources (inclusive of employees’ skills development and investment in plant infrastructure) were identified as critical. it seems as if the following sca strategies were viewed as less critical, namely: (1) firms’ performance; (2) supporting and related industries and clusters; and (3) institutions and government policies (figure 2). figure 2: sustainable competitive-advantage strategy focus for micro-economic drivers. two of the sca micro-economic drivers, according to the classification of siudek and zawojska (2014) (table 11) identified under processes, are product quality and the ability to innovate. firstly, product quality was viewed by the respondents as a critical driver enhancing sca. this is in line with the findings of sitanggang, sinulingga and fachruddin (2019) and they recommend the dimensions to be addressed for quality which include performance, features, reliability, conformance to specifications, durability, serviceability, aesthetics and perceived quality. in order to obtain and maintain a sca, it is recommended that foundries introduce strategies to obtain and maintain product quality. alghamdi and bach (2013) and chigbata and christian (2018) point out that firms worldwide must utilise product quality as a ‘strategic means’ for gaining a sca. the second, processes sca (table 11) identified, is the ability to innovate (research and development). innovation enables and empowers firms to develop new products and establish new ways of cost-effective manufacturing. literature also states that there is a significant and positive relationship between innovation and the ability of a firm to remain competitive (hermundsdottir & aspelund 2020), which should be embraced by the foundry industry. banganayi, nel and nyembwe (2019) point out that innovation technology not only relates to mechanical upgrades but also to information and communication technology (ict), software applications in line with the fourth industrial revolution (4ir). through innovation, foundries will be able to manufacture castings better, quicker and cost-effectively. it is recommended that an organisational culture be cultivated that promotes new ideas and encourages innovation to enable local foundries to compete within the global landscape. further, two of the sca micro-economic drivers, according to the classification of siudek and zawojska (2014) (table 11), identified under the assets/resources category (table 11), are employees’ skills development and investment in plant infrastructure. firstly, employees’ skills development (human capital) was seen as a sca. this is in line with hamadamin and atan (2019:1) who state that sca is no longer defined by the physical assets of the business but more on the skills set; that is, skills possessed by employees, they also add that employees stand out as a major source of gaining sca in any business. this is further supported by rodriguez and walters (2019) who state that the sca of an organisation is dependent on the competency and quality of the employees. it is recommended that management of foundries in south africa formulate a comprehensive training programme for employees. the training should not only focus on technical (hard) skills, but also on softer skills in order to ensure that there is an all-round appreciation of the administration, manufacturing, financial and quality processes, as well as service provision within the industry. organisational practices are also important to promote employees’ knowledge and skills development, while concurrently strengthening the organisation’s sca (grobler & de bruyn 2018). secondly, plant infrastructure (table 11) refers to the investment in the foundry plant infrastructure in order to enhance sca and to align the local foundry industry with the global expectations regarding performance, technology and delivery. the absence of plant infrastructure investment significantly impacts on the growth, profitability and performance of businesses (momoh & ezike 2018). however, the investment in plant infrastructure also encapsulates computer-aided technology and processes. barney (1991:114) states that ‘an information processing system that is deeply embedded in a firm’s management decision making process may hold the potential of sustained competitive advantage’. this view is supported by hoffman (2000) and salisu and julienti (2019) who point out that the ability of firms to adapt to a changing technological environment is key to enhancing firm sca. in conclusion, it is deemed important for the south african foundry industry to design and comply with a designated sca strategy with the associated processes to support the strategy. it is especially important to incorporate processes (product quality and the ability to innovate) and assets/resources (employees’ skills development and investment in plant infrastructure) in the sca strategy. conclusion the article provides valuable insight into the micro-economic drivers of the south african foundry industry in order to enhance sca. the micro-economic drivers were identified from literature (table 1) and a measurement instrument was then designed in order to test perceptions regarding the most prominent micro-economic drivers (table 3). it was determined, after the quantitative and qualitative phases, that the critical micro-economic drivers for the south african foundry industry are product quality, employees’ skills development, the ability to innovate (research and development), and investment in plant infrastructure. the article makes a contribution on three levels, namely, a theoretical contribution (table 1), a managerial contribution (recommendations in the previous section) and a methodological contribution (table 3). in addition, the research also expands on the sca body of knowledge (as proposed by siudek and zawojska 2014) by identifying processes (inclusive of product quality and ability to innovate) and assets/resources (inclusive of employee skills development and investment in plant infrastructure) as critical factors for sustainability in the foundry industry in south africa. taking cognisance of the identified contributions of the study, limitations do exist. the study only included foundries in south africa and although the results might be applicable to other emerging countries, the results might not necessarily be generalised to the global foundry platform. the article provides many opportunities for further research to expand insight into the sca of the foundry industry. the study could be duplicated in other countries (emerging and developed) in order to determine the deviation or duplication of results. further studies may include the macro-economic drivers and the inclusion of more stakeholders, such as government policy makers, might also provide a more holistic view. finally, a longitudinal study might provide more insight as it will be undertaken over a longer period to equalise industry fluctuations. acknowledgements competing interests the author(s) declare that they have no financial or personal relationship(s) that may have inappropriately influenced them in writing this article. authors’ contributions l.p.: conceptualisation, methodology, formal analysis, writing original draft, visualisation, validation, writing, review and editing. a.s.t.: conceptualisation, methodology, formal analysis, validation, writing, review and editing, supervision. r.d.v.s.: conceptualisation, methodology, formal analysis, validation, writing, review and editing, supervision. funding information the research received no specific grant from any 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https://doi.org/10.3390/su11010218 sajems ns 10 (2007) no 1 89 measuring exchange market pressure in south africa: an application of the girton-roper monetary model emmanuel ziramba department of economics, university of south africa abstract the monetary approach to the balance of payments is based on the assumption of a fixed exchange rate, while its approach to exchange rate determination is based on perfectly flexible exchange rate. another monetary model called the exchange market pressure model (emp) was designed to capture the properties of the managed float. this paper applies the monetary model of the emp to the south african experience with floating exchange rate and managed float systems over the period 1970-1993. we show that the emp model is superior to the traditional monetary approach. we do not find evidence of the impact of domestic real income on emp. diagnostic tests suggest that the model is well specified and the residuals pass the typical checking. jel f31, 37 1 introduction south africa is the economic powerhouse of africa. its gross domestic product comprises approximately 25 per cent of the entire continent’s gdp. its industrial output is 40 per cent of total output; and its mineral production is 45 per cent, while its electricity generation constitutes more than 50 per cent of that of the entire continent. this makes it particularly interesting to study the south african economy. table 1 below gives selected economic indicators for south africa. table 1 south africa: selected economic indicators 1999 2000 2001 2002 real gdp growth (in per cent) 2.0 3.5 2.8 3.0 unemployment rate (in per cent) 23.3 25.8 29.5 30.5 change in consumer prices (end of period) 2.3 7.6 3.8 12.1 change in broad money (in per cent) 10.1 7.5 16.7 12.8 current account balance (percentage of gdp, deficit –) –0.5 –0.4 –0.3 0.3 gross official reserves (billions of u.s. dollars) 7.4 7.5 7.5 7.6 exchange rate, rand per u.s dollar 6.15 7.57 12.09 8.66 change in real effective exchange rate (in per cent) –5.2 –3.0 –13.5 –17.2 source: imf (2004), http://www.imf/external/np/sec/pn/2004/pn0467.htm 90 sajems ns 10 (2007) no 1 south africa provides a good example for testing the monetary model for emp for two reasons. first, it can be treated as a small open economy, in the sense that world monetary conditions and world prices are considered to be given. second, after the collapse of the bretton woods system in 1971, south africa experimented with a variety of exchange rate arrangements. van der merwe (1996: 1) classified the evolution of the exchange rate system in south africa since the second world war into five periods, namely: • 1945-1971: an era dominated by the bretton woods arrangements of fixed but adjustable exchange rates; • 1971-1979: a period characterised by the disintegration of the bretton woods system and attempts by south africa to maintain a relatively stable exchange rate of the rand; • 1979-1985: a period of considerable reform of the exchange rate arrangements aimed at developing the market for foreign exchange and a floating exchange rate system; • 1985-1994: a period in which socio-political events forced the authorities to revert to more direct control measures to manage the exchange rate of the rand, and • 1994-1995: the first two years under the new government of national unity, during which south africa’s international financial relations were normalised and steps were taken to develop a forward market with less central bank involvement and progressive relaxation of exchange control. in this study we are particularly interested in the three middle periods, that is, those between 1970 and 1994. during this period, the authorities administratively fixed or intervened in the foreign exchange market to influence the rand exchange rate. south african monetary authorities announced a policy of independent managed floating exchange rate on 21 june 1974 (van der merwe, 1996). for most of the 1980s and early 1990s, the south african government adhered to a managed floating exchange rate regime, with the central bank intervening periodically at its discretion. when the reserve bank intervened in the foreign exchange market, it could buy and sell dollars, supporting the exchange rate of the rand in the process (gidlow, 2004). this policy was changed in 1999, when it was thought to be no longer viable for supporting the rand. given the historical developments in exchange rate policy in south africa, it is felt that the emp model is particularly applicable. this paper is presented in six sections. the second section briefly outlines a simple monetary model of emp. in the third section a brief empirical literature review is given. the fourth section presents the emp estimation result for the period 1970-1993. the fifth section discusses the evidence from raw data. finally, the sixth section presents the summary and main conclusions of the paper. 2 girton-roper exchange market pressure (emp) model the central theme of the monetary approach to the balance of payments is that, under the fixed exchange rate system, excess money supply causes loss of international reserves, which results in balance of payments deficits. under a flexible exchange rate system, this pressure on the balance of payments is absorbed by a depreciating currency. emp arises owing to disequilibrium between the growth rates of domestic supply of, and demand for money. an excess supply of money creates an excess demand for goods and services, which in turn increases the demand for foreign goods and services, and results in reserves flowing out of the domestic money market. the emp model tests whether authorities absorb the foreign exchange pressure by drawing down on reserves or by a depreciating currency. sajems ns 10 (2007) no 1 91 girton and roper (1977) developed a measure for the emp of a currency in a world of managed floating exchange rates. their model is based on the monetary approach to the balance of payments. the monetary model is based on the notion of money demand and money supply. in particular, the model of the emp hinges on two basic conditions. one is the condition of equilibrium in the money market and the other is the imposition of the purchasing power parity condition (kim, 1985). the model can be constructed with the following equations: ms = m(r + d) (1) md = kpy (2) e = p*/p (3) ms = md (4) identity (1) shows that changes in money supply are from either foreign or domestic sources. it shows that money supply is defined as the money multiplier m, times base money (r+d), which is the sum of central bank’s holdings of foreign assets and domestic credit. ms is measured by m1. md in (2) and represents the cambridge cash balance model of money demand, where p stands for the domestic price level and y for real domestic income, while k is the fraction of nominal income people hold in the form of cash, and is assumed to be constant. equation (3) is the purchasing power parity condition, where e stands for the nominal exchange rate defined as units of foreign currency per rand, and p* is the foreign inflation. equation (4) is the monetary equilibrium condition. substituting equation (3) into (2), and (1) and (2) into (4), expressing everything in percentage changes and rearranging terms gives an empirical equation (5). r + e = -d + p* + y – a (5) where r = % change in the international reserve component of the base money; e = % change in the nominal exchange rate, e; d = change in the domestic credit as a proportion of the base money (r + d); p* = % change in the foreign prices; y = % change in real income, and a = % change in the money multiplier. the left-hand side of equation (5) denotes the exchange market pressure. this equation gives three propositions, which will be tested on the south african data. first, an increase in real income results in proportional appreciation of the domestic currency and an inflow of foreign exchange reserves. second, increases in the rate of growth in domestic credit or the money multiplier result in a proportional depreciation of domestic currency and an outflow of foreign exchange reserves. third, an increase in foreign inflation rates results in a proportional appreciation of the domestic currency and an inflow of foreign exchange reserves. 3 empirical literature since girton and roper published their seminal paper in 1977, their model (or its variants) has been extensively applied to a number of countries. it has not yet been applied to the context of an african country. girton and roper (1977) applied their model to the experience of post-war canada, and connolly and silveira (1979) to the brazilian experience. modeste (1981) applied the same model to the argentine experience, while kim (1985) applied it to korea. mah (1991, 1995, 1998) also applied the model to the korean experience. the empirical results of these and other studies on emp are summarised in table 2 below. 92 sajems ns 10 (2007) no 1 table 2 literature review author(s) country(s)/period(s) results girton and roper (1977) canada, 1952 – 1974 the growth rate of domestic credit and the growth rate of domestic income are significant and have the expected sign. the coefficient for the variable q is not significant. connolly and silveira (1979) brazil, 1955 – 1975 and 1962 – 1975 domestic credit, foreign inflation and domestic income perform well in the latter sample; all variables are significant, with the expected signs. in the earlier sample period, only domestic credit is significant. the q variable is insignificant. kim (1985) korea, 1980 – 1983 domestic credit and real wage income are significant, with expected signs except for the foreign rate of inflation. mah (1991) korea, 1980 – 1987 domestic credit, domestic income and foreign inflation all have the expected sign and are significant. the variable q is insignificant. when r only is used as the dependent variable the coefficient of determination is lower. mah (1995) korea, 1980 – 1989 domestic credit, domestic income and foreign inflation all have the expected sign and are significant. when r only is used as the dependent variable the coefficient of determination is much lower. mah (1998) korea, 1980 – 1993 domestic credit, trade-weighted foreign wholesale price index, domestic real income and money multiplier are significant, with expected signs. modeste (1981) argentina, 1972 – 1978 domestic credit, domestic income and foreign inflation all have the expected sign and are significant except for the foreign inflation. the q variable is insignificant. shiva and bahmanioskooee (1998) iran, 1959 – 1990 using the black market exchange rate, domestic credit, foreign inflation (us), real domestic income and the money multiplier are all significant, with the expected sign, except for the foreign inflation. the coefficient of q is negative and significant. using the official exchange rate, only domestic credit and the money multiplier are significant and have the expected sign. sajems ns 10 (2007) no 1 93 4 empirical results table 3 the ols estimates of the emp model (1970-1993) dependent variable d p* q y a adj. r2 d.w (1) r + e (2) r (3) e (4) r + e -83.79 (-6.381) –73.97 (6.212) –9.82 (–1.54) –82.47 (–6.21) 0.0597 (0.048) –0.658 (0.532) 0.717 (1.08) –0.017 (–0.01) –0.36 (–0.90) 0.185 (0.154) 0.700 (0.645) –0.516 (–0.885) –0.092 (–0.074) –0.722 (–6.29) –0.662 (–6.37) –0.060 (–1.07) –0.74 (–6.32) 0.68 0.67 0.020 0.67 2.355 2.67 1.77 2.21 note: the empirical results are based on annual data. the numbers in the parentheses below the estimated coefficients are the t-values. source: data from international financial statistics using annual south african data over the period 1970–1993, the emp is estimated. the results are reported in table 3 above. the regression (1) reports the estimate of the emp model when the dependent variable is the sum of e and r, which is a measure of emp. the results of this regression provide evidence in support of the emp model. all estimated coefficients carry expected signs and those for domestic credit and money multiplier differ significantly from zero, as shown by the high t-values. the estimated coefficients for domestic real income and foreign inflation are not significantly different from zero, even at 10 per cent level of significance. despite this, an f-value of 12.56 (p-value 0.00005) indicates that these four variables together are useful in explaining the combined variation in the balance of payments and the exchange rate. the explanatory power of the model is illustrated in figure 1 below, where the actual and predicted movements in (r + e) are compared. figure 1 relationship between actual and estimated emp 94 sajems ns 10 (2007) no 1 regression (2) reports the results when only r is used as the dependent variable. as can be seen in table 3, all the estimated coefficients carry their expected signs, except for the foreign inflation, which is now negative. it can also be seen that real domestic income and foreign inflation are again not statistically different from zero at any reasonable level of significance, and that the adjusted r2 is slightly lower than when (e + r) is used. regression (3) reports the results when only e is used as the dependent variable. it is evident that this model does not fit the data. first, all the estimated coefficients are statistically insignificant at any reasonable significance level. second, the r2 is very low (0.198), with an adjusted r2 of only 0.02. taking earlier literature into account, it is hypothesised that the magnitude of market pressure, defined as (r + e), is independent of whether the authorities absorb emp in the exchange rate or foreign exchange reserves. this was tested by including the variable q = (e-1)/(r-1) as one of the explanatory variables on the right-hand side of the emp equation (5). if the monetary authorities allow the pressure to be alleviated by depreciation relative to reserve losses, the greater is q. the regression results, which include the q variable, are shown in regression (4) in table 4 above. as can be seen, compared to regression (1), there is a change in signs for income and foreign inflation variables, but there is no change in significance of the estimated coefficients. the variable q is statistically insignificant. the insignificance of the q variable implies a one-to-one tradeoff between reserve losses and exchange rate depreciation for the monetary authorities over the study period. this result is similar to that reported by girton and roper for canada and by connolly and silveira for brazil. after the parameters of the model had been estimated, diagnostic tests were used to check whether the specification of the emp model was correct. normality of the regression residuals of emp (r+e) was checked using the jarque-bera test. the jarque-bera statistic, shown in table 4 in the appendix, is calculated as 1.87 (p-value = 0.393), which indicates no rejection of the normality null hypothesis at any reasonable level of significance. ljung-box q statistic for up to 6th order serial correlation in the residuals takes the value q= 6.286 (p-value = 0.392), which does not reject the null hypothesis of no serial correlation in the residuals. the white test statistic for heteroscedasticity was 12.03 (p-value = 0.150) and does not reject the null hypothesis of homoscedastic residuals. the other tests are also reported in table 4. the cusum and cusum square tests (in figure 2) for the stability of the regression do not reject the null hypothesis of a stable regression at 5 per cent level of significance, and are shown in figure 2 below. when r is used as the dependent variable, there is evidence of non-normality, as reported in table 5 in the appendix. figure 2 recursive residuals tests for exchange market pressure sajems ns 10 (2007) no 1 95 5 evidence from raw data an attempt is made to analyse the raw data based on the sample period 1970-2004. it is evident from figure 3 that the relationship between emp and foreign inflation is positive. figure 4 shows a negative relationship between emp and domestic credit growth rate. it is also evident from figures 5 and 6 that the emp is negatively related to the rate of change in the money multiplier and positively related to real domestic income. figure 3 trends in emp and foreign prices (us) figure 4 trends in emp and domestic credit figure 5 trends in emp and money multiplier figure 6 trends in emp and income 6 summary and conclusion in this study, a monetary model of emp was applied to the south african experience. using annual data for the period 1970-1993, the empirical analysis suggests that the south african experience during the study period provides another good example of a country that alleviated imbalances in its external sector by combining changes in its reserves with changes in its exchange rate. evidence shows that the monetary model is better than models that use changes only in foreign reserves 96 sajems ns 10 (2007) no 1 or the exchange rate. empirical analysis also shows that there is strong negative relationship between the rates of domestic credit creation, money multiplier growth and the rates of change in the emp. we do not find evidence of the impact of domestic real income on emp. the variable q is insignificant. this implies that, over the study period, the south african monetary authorities responded to emp by depreciating currency and losing international reserves. in a managed floating exchange rate system, the policy prescription emerging from this study is that contractionary monetary policy can be used to maintain exchange rate stability in an economy. appendix table 4 diagnostic test: emp (a = 5%) purpose of the test test test statistic p-value decision normality jarque-bera 1.87 0.393 normally distributed heteroskedasticity white 12.03 0.150 no heteroskedasticity heteroskedasticity arch lm 0.012 0.914 no heteroskedasticity serial correlation durbin-watson 2.355 no decision serial correlation ljung-box q 6.286 0.392 no serial correlation stability cusum stable stability cusum square stable table 5 diagnostic test: r (a = 5%) purpose of the test test test statistic p-value decision normality jarque-bera 6.974 0.031 not normally distributed heteroskedasticity white 11.174 0.192 no heteroskedasticity heteroskedasticity arch lm 0.077 0.781 no heteroskedasticity serial correlation durbin-watson 2.666 no decision serial correlation ljung-box q 12.533 0.051 no serial correlation stability cusum stable stability cusum square unstable sajems ns 10 (2007) no 1 97 table 6 south african exchange market pressure: 1971–1993 year e r e + r 1971 –6.25 –22.76 –29.01 1972 –2.30 84.50 82.20 1973 16.69 –12.93 3.76 1974 –2.71 –1.48 –4.20 1975 –20.69 21.74 1.06 1976 0.00 –13.26 –13.26 1977 0.00 –09.99 –9.99 1978 0.00 170.10 170.10 1979 5.15 86.33 91.48 1980 10.86 29.93 40.79 1981 –22.05 -25.15 –47.20 1982 –11.06 0.83 –10.23 1983 –11.95 9.02 –2.93 1984 –38.44 7.09 –31.35 1985 –22.40 0.10 –22.30 1986 17.18 3.02 20.20 1987 13.12 30.87 43.99 1988 –18.85 –18.71 –37.56 1989 –6.23 7.67 1.44 1990 –1.05 18.87 17.82 1991 –6.56 23.84 17.28 1992 –10.15 19.48 9.32 1993 –10.14 0.54 –9.60 note: there are minor inconsistencies due to rounding. all data are annual for the period 1970–1993 and were collected from the international financial statistics of the imf, various issues. data and data sources variables in the emp model (equation (5): r = % change in the international reserve component of the base money (r+d) where r and d are defined below. r = south african reserve bank’s foreign assets (in millions of rand), line 11. d = domestic credit, in millions of rand, line 32. e = percentage change in the bilateral exchange rate of the domestic currency vis-à-vis the united states dollar, e, measured as the volume of the foreign currency that can be purchased 98 sajems ns 10 (2007) no 1 with one unit of domestic currency. using this definition e > 0 reflects an appreciation, while e < 0 reflects a depreciation of the domestic currency. p* = rate of change in world prices measured by the rate of change of the us wholesale price index (converted to base year 1975), line 63. y = % change in real domestic income of south africa measured by the percentage change in the manufacturing production index (1970 = 100), line 66 eyc. a = rate of change of money multiplier. the money multiplier, m, is obtained by dividing money supply, m, by the monetary base (r+d). the definition of money supply used is m1, in millions of rand, line 34. d = δd/(r+d) where r and d are as defined above. q = (e-1)/(r-1), where e and r are as defined above. this measures whether the emp is independent of its composition, e and r. if it is statistically significant, then emp is influenced by its components, that is, e and r. references 1 bahmani-oskooee, m. & shiva, r. (1998) “a method of detecting whether a central bank engages in the black market for foreign exchange: evidence from iran”, economics letters, 60: 97103. 2 connolly, m. & silveira, j.d.d. (1979) “exchange market pressure in postwar brazil: an application of the girton-roper monetary model”, american economic review, 69(3): 448-454. 3 gidlow, r. (2004) “modifications in south african exchange rate policies 1998-2001”, south african journal of economic history, 19 (1): 1841. 4 girton, l. & roper, d. (1977) “a monetary model of exchange market pressure applied to the postwar canadian experience”, american economic review, 67(3): 537-548. 5 international monetary fund, international financial statistics, imf: washington, various issues. 6 international monetary fund (2004) public information notice (pin) no. 01/44 http:// www.imf/external/np/sec/pn/2004/pn0467.htm 7 kim, i. (1985) “exchange market pressure in korea: an application of the girton-roper monetary model: note”, journal of money, credit and banking, 17(2): 258-263. 8 mah, s.j. (1991) “a note on the exchange market pressure: the korean experience, 1980-1987”, applied economics, 23: 587-590. 9 mah, s.j. (1995) “an analysis of the structural change in the exchange market pressure: korea, 1980-89”, applied economics letters, 2: 80-82. 10 mah, s.j. (1998) “exchange market pressure in korea: dynamic specifications”, applied economics letters, 5: 765-768. 11 modeste, n.c. (1981) “exchange market pressure during the 1970s in argentina: an application of the girton-roper monetary model”, journal of money, credit and banking, 13: 234-40. 12 van der merwe, e.j. 1996 “exchange rate management policies in south africa: recent experience and prospects”, south african reserve bank, occasional paper no. 9. 264 sajems ns 11 (2008) no 3 the sasol/engen (uhambo) merger-foreclosure and white fuel demand growth rates nicola theron department of economics, stellenbosch university and econex, cape town abstract during october 2005, the competition tribunal heard evidence on the proposed merger between two large oil companies, sasol oil (pty) ltd and engen ltd. during the hearing it emerged that major aspects that would determine the outcome of the matter were: •  potential foreclosure; •  demand growth rates of white fuel; and •  logistics. the aim of this paper is to examine how the tribunal dealt with the issue of potential foreclosure, by examining the expected growth rates of white fuels. the tribunal had to consider the extent to which foreclosure in the oil industry would be profitable. this depended partly on expected growth rates in the demand for petrol and diesel. it will be argued that although there was conflicting evidence on this point, a proper analysis of economic variables such as expected economic growth rates, petrol demand elasticities and income elasticities, provided sound reasons for the tribunal to prohibit the merger. jel g34, l41 1 introduction during the latter half of 2005, the sa tribunal  considered  the  proposed  merger  in  the  oil  industry between sasol and engen (the “uhambo  merger”).  the  merger  hearing  lasted  several  weeks, as there were several interveners (mostly  the other major oil companies) who asked the  tribunal to prohibit the proposed merger. the  final  decision  of  the  tribunal,  prohibiting  the  merger  was  released  on  the  23rd  of  february  2006.  during  the  hearing  it  emerged  that  the  outcome  of  this  case  would  depend  primarily  on three issues:  •  foreclosure; •  demand growth rates of white fuel; and •  logistics. during the merger hearing, the tribunal heard  from  seventeen  witnesses,  of  whom  six  were  economists or economic experts (including the  economist  of  the  competition  commission).  furthermore,  the  tribunal  considered  a  total  of fourteen witness statements, of which three  were written by economic experts. the role of economists in these proceedings  is  not  always  well  understood  and  is  often  criticised.  economists’  contribution  may  be  in the form of very complicated econometric  m o d e l s   w h i c h   t h e n   b e c o m e s   a   p o i n t   o f  contention  as  it  is  true  that  any  economic  model  is  only  as  good  as  its  assumptions.  the  uhambo  case  has  been  no  different  and  the  divergence  of  economic  models  and  econometric  evidence  caused  the  tribunal  (2006:  237)  to  remark  in  their  final  decision  that: “‘garbage in; garbage out’ is the caution  customarily  urged  upon  those  who  rely  on  econometric and other statistical techniques  and  while  not  all  of  the  data  used  in  the  parties’ model is to be so characterised, some  of  it  does  appear  sufficiently  contrived  to  warrant that description”. sajems ns 11 (2008) no 3 265 it  became  clear  during  the  hearing  that  the  outcome of the case depended on the profitability  of foreclosure. there was some consensus on the  basics of the oil industry structure and market  definition.  the  tribunal  took  the  view  that  since their analysis showed that the merger will  lead  to  a  substantial  lessening  of  competition  in  the  markets  for  petrol  and  diesel,  it  was  not necessary to further examine all the other  petroleum product markets (e.g. bitumen, heavy  fuel oils, lpg, jet fuel, etc.). there was therefore  not the usual dispute about the relevant product  market  that  often  emphasises  the  role  of  the  economist in demarcating the relevant market  for competition purposes.  similarly,  the  definition  of  the  relevant  geographic  markets  was  relatively  straightforward. the history of the main supply agreement  (msa)  implied  a  separate  geographic  market  known  as  the  “inland  market  for  refined  fuels”.  the  tribunal  found  that  the  geographic  upstream  market  was  inland  (the  so-called  market  for  “bulk  supply”),  and  that  the  geographic  downstream  (retail)  market  was national.  given the fact that there was no real dispute  on market definition, it was common cause that  uhambo  would  have  controlled  more  than  80  per cent of the output of refined fuel products  in  the  inland  geographical  market  and  that  its  retail  network  would  have  accounted  for  approximately 40 per cent of inland fuel sales. the aim of this paper is to show that on a very  basic (and crucial) point of the uhambo analysis,  namely the demand growth rates of white fuels,  economic  analysis  could  have  provided  very  clear answers. in what follows, the evidence put  forward by the economists for both the merging  parties  and  the  interveners  will  be  examined  to  see  which  followed  established  economic  principles and theory.  2 foreclosure and the relevance of white fuels demand growth rates the  uhambo  merger  presented  horizontal  as  well as vertical concerns. given the high market  shares  in  both  the  upstream  and  downstream  markets that uhambo would have obtained, the  impact on both the upstream and downstream  markets would ordinarily have to be examined.  however, given the tribunal’s definition of the  relevant upstream market as the inland market,  there  was  no  horizontal  overlap  between  the  sasol  and  engen  refineries  (engen  owns  the  enref  refinery  which  is  situated  at  the  coast).  at the retail level, the horizontal effect would  have  been  a  total  national  market  share  of  34  per cent of petrol sales and 36 per cent of diesel  sales, for uhambo. although this was considered  to be an important issue, the focus throughout  the hearing was on the vertical issues raised by  the proposed merger. the primary economic concern with vertical  mergers  is  the  ability  of  the  merged  firm  to  “foreclose” its rivals and to “raise rivals’ costs”.  in  the  case  of  uhambo,  the  majority  of  the  economists  focused  on  the  issue  of  potential  foreclosure.  the  vertical  issue  was  clear  –  the  merger would combine the substantial upstream  refining  capacity  of  sasol  with  the  significant  wholesale  and  retail  capacity  of  engen.  this  immediately  raised  the  prospect  of  input  foreclosure, and the tribunal also chose this as  their main focus.  however, in order to prove that foreclosure  would  be  profitable,  the  economists  built  some  sophisticated  models  to  present  various  foreclosure  scenarios.  the  economist  for  the  merging parties demonstrated in his model that  foreclosure  would  not  be  profitable.  this  was  disputed  by  the  economists  for  the  other  oil  companies who presented models that showed  that foreclosure would be profitable.  this  highlights  the  usual  debate  around  economic analysis; there will always be economic  experts  who  will  argue  for  and  against  certain  mergers or prohibited practices. but the outcome  of the models depends on the assumptions. the  foreclosure  models  all  had  to  make  certain  assumptions  regarding  the  aspects  of  demand  growth  for  retail  petrol  and  diesel  and  the  current state of the logistics infrastructure.  when  analysing  potential  foreclosure  as  a  result  of  a  vertical  merger,  economists  have  to  consider  the  ability  of  the  merged  entity  to  foreclose, the costs of doing so and the factors  that will affect the returns of such a strategy. the  266 sajems ns 11 (2008) no 3 foreclosure  analysis  in  the  uhambo  case  was  specifically sensitive to different demand growth  scenarios. it is shown in figure 1 on page 269 that  in 2003 there was already a shortfall in the inland  market between demand and supply of petrol,  diesel and jetfuel. given the logistics constraints  in terms of pipeline capacity in transporting fuel  from the coast to the inland area, the other oil  companies would have remained dependent on  uhambo for sufficient supplies to service their  retail networks in the inland area (up to at least  2010 which was the expected completion date of  a new pipeline). this would have given uhambo  the ability to foreclose. uhambo would also have  had an incentive to foreclose as it would have  been  more  profitable  to  supply  its  own  retail  network, in the face of high demand growth for  inland fuel. with low white fuels demand growth  rates (such as those estimated by the parties to  the merger), the possibility of foreclosure would  seem rather remote. conversely, high demand  growth  rates  especially  in  the  inland  market  would  permit  uhambo  to  rapidly  gain  market  share and thus significantly strengthen the ability  of  uhambo  to  self-deal  and  to  foreclose  its  rivals to its upstream production. high demand  growth for white fuels would therefore increase  the  returns  from  a  foreclosure  strategy  and  would make such a strategy more feasible.  the  logistics  constraints  faced  by  the  other  oil companies (the pipeline constraints as well  as  road  and  rail  constraints),  also  contributed  to  the  likelihood  of  foreclosure.  the  tribunal  noted  that  whereas  under  the  previous  main  supply  agreement  (msa),  the  oil  companies  had  to  purchase  all  their  inland  requirements  from sasol, the fact that they were free to ship  product from the coast post-msa did not mean  that  it  was  truly  a  national  market.  “however  what was previously constrained by agreement,  is  now  constrained  by  logistical  capacity  –  the  inland  marketers  may  import  product  from  the coast, but because of inadequate logistical  capacity they are only able to supply a portion  of  their  needs  (2006:  66).”  although  logistic  capacity was the other vital leg of the foreclosure  models,  ultimately  the  state  of  logistics  were  to  be  determined  from  the  evidence  of  the  factual witnesses of the various oil companies.  economists  could  not  testify  as  to  the  true  state of the logistics capacity and had to accept  the  evidence  provided  to  them  by  the  oil  companies. this  paper  will  focus  therefore  on  the  issue  of  petrol  and  diesel  demand  growth  and  the  way  it  was  dealt  with  in  the  uhambo  merger,  which  finally  determined  the  outcome  of  the  foreclosure  analysis.  foreclosure,  although  ultimately  the  decisive  factor  in  the  uhambo  decision, will not be further dealt with here. it  should be briefly stated though, that the tribunal  finally  decided  that  the  “credible  threat”  of  foreclosure was enough to prohibit the merger.  in their own words: “neither the tribunal, nor  the commission, nor the merging parties, nor the  intervenors, can decide with absolute certainty  – beyond all reasonable doubt – whether or not  foreclosure will be profitable. we can however  say with  confidence  that it is a credible threat  (2006: 87).” this finding of a credible threat of  foreclosure  ultimately  caused  the  tribunal  to  prohibit the proposed merger.  3 demand growth rates for petrol and dieseleconomic theory the  demand  growth  for  petroleum  products  is  the  focus  of  the  current  paper.  there  were  widely  divergent  views  on  the  demand  growth  rates  forecasted  for  petrol  and  diesel.  yet,  the  forecasting  of  demand  growth  rates  is  not  a  herculean  task  for  economists  who  should  consider  this  as  part  of  their  basic  toolkit.  economists know that the demand for any retail  product  is  generally  a  function  of  the  price  of  the  product,  income  of  consumers,  the  size  of  the  population  and  the  price  of  substitutes  or  complementary  products.  in  some  instances,  product  specific  factors  and  consumer  tastes  are also included in the demand function, but  researchers often find it difficult to incorporate  qualitative  variables  (e.g.  tastes)  into  demand  equations. when specifying demand equations,  such  as  those  for  petrol  and  diesel  demand,  various  macroeconomic  variables  can  be  considered and tested for significance with the  dependent  variable  (demand).  the  important  point to make is that the choice of variables does  not depend primarily on the “goodness of fit”  sajems ns 11 (2008) no 3 267 or the correlation values, but has to be based on  economic theory. as  the  demand  growth  rates  for  petrol  and  diesel were one of the main issues considered  by  the  competition  tribunal,  it  is  important  to ask what value can be added by economists  forecasting such growth rates. before considering  the variety of growth rates that were presented  to  the  tribunal  by  the  various  parties,  it  is  important  to  say  one  or  two  things  about  the  estimation of petrol and diesel demand.  the  economist  who  has  to  estimate  such  growth  rates  will  as  a  first  step,  based  on  economic theory, ask what might determine the  demand  for  a  specific  product.  this  question  must be answered with reference to the general  determinants of demand, as set out above. the  next step would be to look at the literature to  ascertain what other researchers have found to  be relevant determinants.  the  demand  for  petrol  is  a  well-researched  topic in economic theory. the literature shows  that  both  price  and  income  have  an  effect  on  the amount of petrol purchased by consumers.  but  the  consensus  in  the  literature  is  that  the  income  elasticity  is  generally  higher  than  the  price elasticity. in other words, petrol and diesel  sales  (in  volume  terms)  are  more  sensitive  to  changes in consumer income (or gdp) than to  changes in the real price of petrol or diesel. drollas  (1984)  did  one  of  the  early  reviews  of  price  and  income  elasticity  in  1984.  he  surveyed  mostly  us  studies  and  found  that  the consensus view was that the long run price  elasticity of demand was around -0.8 while the  long  run  income  elasticity  was  slightly  below  unity.  some  studies  (blum  et al.,  1988)  found  larger ranges for some european countries, with  an  income  elasticity  varying  between  0.86  and  1.90. sterner (1990) used pooled data for oecd  countries and found long run income elasticities  of between 0.6 and 1.6. with another technique  (time series data), he found the income elasticity  to vary between 1.1 and 1.3.  later  work  by  goodwin  (1992)  generally  found that elasticity estimates had to be revised  upwards from estimates calculated between the  1980s  and  1990s.  the  extent  to  which  strong  economic performance will affect fuel demand  is  quantified  by  the  income  elasticity  of  the  demand  for  fuel.  more  simply,  the  income  elasticity  measures  the  response  of  motorists  to an increase in income. this is assumed to be  a  positive  relationship.  graham  and  glaister  (2002: 1) in a comprehensive survey found that  the  long-run  income  elasticity  of  fuel  demand  falls in the range of 1.1 to 1.3, and between 0.35  and 0.55 in the short-run.  later work by dahl and roman (2004) looked  at a total of 190 new studies since 1991 that dealt  with  energy  demand.  their  results  generally  correspond with the earlier findings of graham  and glaister  (2002),  who  found that  the  short  run  price  elasticity  of  the  demand  for  petrol  typically falls between -0.2 and -0.3, and the long  run price elasticity between -0.6 and -0.8. dahl  and  roman  found  that  the  mean  value  of  the  long run income elasticity for diesel was above 1  (1.13), and for petrol, the value was 0.69. these  values  are  once  again  in  line  with  the  earlier  research summarised above. d a t a   o n   c o m p a r a b l e   m i d d l e i n c o m e  countries are not as widely available as data for  industrialised countries. ramanathan examined  fuel demand for india in 1999. the author found  a short run income elasticity of 1.18 and a long  run  income  elasticity  of  2.68.  these  estimates  are  very  high,  compared  to  the  international  benchmarks  from  industrialised  countries.  ramanathan believes that the low level of fuel  consumption in india and the gradual increase  in economic growth can explain the differences  between his results and those obtained elsewhere  (graham & glaister, 2002: 17).  the  following  table  summarises  the  results  of  similar  studies  done  for  the  south  african  economy. 268 sajems ns 11 (2008) no 3 table 1 data on south african white fuels price elasticities source country short-term price elasticity long-term price elasticity s.a. cloete & vd m. smit (1988) south africa –0.25 –0.37 s.d. ngumedi (1994) south africa –0.1 to –0.2 bureau for economic policy analysis (1989) south africa –0.31 bureau for economic research (ber) (2003) south africa petrol –0.21 diesel –0.18 petrol –0.51 diesel –0.06 source: ber, 2003 it follows from the above that based on economic  theory and international models used to estimate  petrol demand, the two variables that have to be  included in any petrol or diesel demand function  are  the  income  and  price  variables.  based  on  the  difference  between  the  long-run  price  and income elasticities, it is also clear that the  income variable has a larger effect than the price  variable.  the  income  variable  is  therefore  the  most  important  explanatory  variable  in  petrol  and diesel demand functions. before looking at  the specific choice of variables, it is worth stating  the economic assumptions very simply. if there  is an increase in income, people earn more and  they  have  more  disposable  income,  which  will  increase  their  demand  for  petrol,  as  they  buy  more  or  bigger  cars,  or  go  on  more  holidays  or  generally  use  their  cars  more.  the  data  on  long-term income elasticity suggest that this is a  positive relationship with values that vary quite  widely. and, it is quite likely that the percentage  increase in fuel demand will be higher than the  percentage  increase  in  income,  especially  for  developing countries. the relationship between the price of petrol  (or diesel) and the demand for petrol (or diesel)  is a negative relationship (indicated by the minus  sign  on  the  price  elasticities).  the  economic  reason  is  simple:  as  the  price  of  a  product  increases, the demand decreases.  having  found  then,  based  on  available  economic  literature  that  there  are  strong  positive  relationships  between  income  and  petrol demand and income and diesel demand,  and  a  smaller  negative  relationship  between  the  price  and  demand,  the  economist  can  use  a  time  series  for  these  independent  variables  to estimate the petrol or diesel demand growth  rates.  this  is  fairly  straightforward,  as  long  as  good  estimates  of  the  forecasted  variables  can  be  obtained.  the  petrol  and  diesel  prices  are  notoriously  difficult  to  forecast,  but  there  are  estimates  available.  but  given  the  strong  correlation between income and the demand for  petrol,  good  results could have  been  obtained  by  only  using  the  correlation  between  income  and petrol demand. in fact, this approach was  used  by  the  economists  for  shell,  as  will  be  explained below. 4 demand growth rates – estimates of the economists petrol demand and supply balance the following graphs show the inland demand  and  supply  situation  for  2003  and  2010,  as  forecasted by bp (one of the interveners) at the  time of the hearing. sajems ns 11 (2008) no 3 269 figure 1 inland demand and supply (2003 and 2010) source: bp, 2005 the  important  point  to  note  is  that  in  2003  there was already a shortfall in inland supply for  mogas (petrol), gasoil (diesel) and jet (jetfuel).  in order to meet the inland demand, the balance  was  transported  from  the  coastal  areas  by  the  oil companies, either via rail, road or pipeline.  the second graph shows the dramatic increase  in  the  deficit  for  all  products  in  the  face  of  rapid  demand  growth.  given  infrastructure  constraints and the time it would take to build  a new pipeline from durban to the inland area,  the graphs illustrate that there would have been  an incentive for the merging parties to foreclose  on the other oil companies in the inland market.  this  is  due  to  the  increased  profitability  of  a  foreclosure strategy in the face of high demand  growth  and  demand  exceeding  supply  in  the  inland  area.  the  merged  entity  would  find  it  270 sajems ns 11 (2008) no 3 more profitable to supply its own downstream  retail  network  due  to  the  limited  supply,  and  this would increase the costs of its rivals as it will  have to import product at a higher cost from its  own refineries at the coast.  against  this  background,  one  can  then  consider  the  various  estimates  of  demand  growth presented by the merging parties as well  as the interveners.  growth forecasts and their foundations using  a  petrol  and  diesel  demand  model  developed by the bureau for economic research  (ber)  one  of  the  interveners  (masana)  presented  the  following  petrol  and  diesel  demand growth forecasts.  table 2 petrol and diesel growth rates for the national market and for the inland market petrol national market year demand1 growth (%) capacity surplus surplus (%) 2004 11918 13202 1284 10.8% 2005 12550 5.3% 13202 652 5.2% 2006 12964 3.3% 13202 238 1.8% 2007 13340 2.9% 13202 –138 –1.0% 2008 13753 3.1% 13202 –551 –4.0% 2009 14276 3.8% 13202 –1074 –7.5% diesel national market year demand growth (%) capacity surplus surplus (%) 2004 8621 10580 1959 22.7% 2005 9131 5.9% 10580 1449 15.9% 2006 9467 3.7% 10580 1113 11.8% 2007 9799 3.5% 10580 781 8.0% 2008 10328 5.4% 10580 252 2.4% 2009 10927 5.8% 10580 –347 –3.2% petrol inland market year demand growth (%) capacity surplus surplus (%) 2004 5779 5769 –10 –0.2% 2005 6085 5.3% 5769 –316 –5.2% 2006 6286 3.3% 5769 –517 –8.2% 2007 6468 2.9% 5769 –699 –10.8% 2008 6669 3.1% 5769 –900 –13.5% 2009 6922 3.8% 5769 –1153 –16.7% 1  millions of litres sajems ns 11 (2008) no 3 271 diesel inland market year demand growth (%) capacity surplus surplus (%) 2004 3640 3545 –95 –2.6% 2005 3855 5.9% 3545 –310 –8.0% 2006 3997 3.7% 3545 –452 –11.3% 2007 4137 3.5% 3545 –592 –14.3% 2008 4361 5.4% 3545 –816 –18.7% 2009 4614 5.8% 3545 –1069 –23.2% source: ber/ econex, 2005. the  table  above  shows  how  the  demand  (in  millions of litre) would increase given an initial  level of demand in both the national and inland  markets. according to this forecast, the average  growth rate for petrol over the five years would  be  3.7  per  cent  and  for  diesel  over  the  same  period, 4.9 per cent.  these growth rates were significantly higher  than  those  presented  by  the  merging  parties.  the following graph compares the shortfall of  petrol  in  the  inland  market  in  2009  based  on  four  different  scenarios.  scenario  1  is  that  of  the  ber  as  described  above,  scenario  2  is  a  “low” scenario of constant 2 per cent growth in  petrol demand, scenario 3 assumes a constant  growth  rate  of  4  per  cent,  and  the  last  bar  in  the graph below is based on the forecast of the  merging parties. figure 2 petrol shortfall (2009): inland market source: econex, 2005 figure  2  illustrates  again  the  sensitivity  of  the  foreclosure  scenario  to  the  different  forecasts  of  the  growth  in  petrol  demand.  the  merging  parties argued that the shortfall will be minimal  even up to 2009 and that any further shortfall  will be overcome by the upgrading of the existing  pipeline  that  runs  from  durban  to  the  inland  area (the “djp pipeline”).  the  tribunal  summarised  the  growth  rate  of  petrol demand forecasts of the parties as follows: 272 sajems ns 11 (2008) no 3 table 3 various estimates of petrol demand growth rates source petrol demand growth rate rbb (for bp) 3% econometrix 2.2% total (2005-2014) 2.2% rbb (for shell) 2% econex (for masana) 3.6% sasol (2006 budget) 1.4% uhambo business plan 1% source: tribunal, 2006, p. 91 the  tribunal  (2006:  92)  noted  in  its  decision  regarding  the  growth  estimates  of  the  various  economists  that:  “we  have  been  presented  by  bald  estimates  by  the  participants  in  these  hearings  –  many  of  whom  appeared  to  rely  on  independent  experts  –  but  surprisingly  few  have  attempted  to  explain  the  underlying  basis  for  their  estimates”.  this  is  a  serious  criticism  against  the  economic  evidence  that  was presented during the hearing. the tribunal  had to come to their own conclusions regarding  the determinants of petrol demand (2006: 92):  “in  our  view,  common  sense  would  suggest  a  high  degree  of  correlation  between  income  growth  and  rates  of  fuel  consumption.  it  may  also reasonably be hypothesised that changes in  the distribution of income would correlate with  shifts in demand for fuel products.”  we have argued above, based on the economic  evidence  on  the  income  elasticity  and  price  elasticity of demand for petrol, that the positive  income  effect  is  more  important  than  the  negative price effect. the tribunal also referred  to the positive correlation between income and  fuel  demand.  when  developing  a  model  to  explain the demand for petrol, one has to choose  the  appropriate  income  variable.  although  there is a positive correlation between the gross  domestic  product  (gdp)  and  petrol  demand,  most  studies  on  petrol  demand  find  that  real  disposable  income  of  households  explains  petrol  demand  better  than  gdp.  this  income  variable makes sense intuitively, as petrol sales  to households constitute a large proportion of  total petrol sales. real disposable income is the  key driver of demand for most retail products,  including petrol sales to households.  the  evidence  from  the  literature  as  well  as  the  sa  data  is  that  the  income  variable  is  the  most important determinant of fuel demand; the  gdp growth rate in the case of diesel and real  disposable income in the case of petrol. there is  a negative relationship between the real prices  and volumes sold, but this relationship is weaker  than the income relationship. in  order  to  use  this  information  to  forecast  growth  rates  for  petrol  and  diesel,  one  needs  to  develop  an  econometric  model  that  can  incorporate  these  relationships.  but  before  moving  to  an  overview  of  the  formal  models  presented to the tribunal by the various parties,  it is worth noting that at the time of the hearing,  south africa experienced the longest upswing in  economic growth since 1970. this would a priori  lead one to assume that this increase in general  economic activity would also have implied higher  demand for fuel. at the time of the hearing, the  gdp  forecast  of  the  national  treasury  for  growth was exceeding 4 per cent between 2005  and 2007. the bureau for economic research at  that stage had an average gdp growth forecast  of 3.7 per cent between 2005 and 2009.  economic models used the  literature  and  sa  data  confirm  the  assumption of the tribunal that there is a high  correlation between income growth and growth  in  the  demand  for  petrol.  given  this  high  sajems ns 11 (2008) no 3 273 correlation,  one  can  assume  that  much  of  the  demand for petrol and diesel can be explained  by using only an income variable.  a) shell this  was  the  approach  taken  by  one  of  the  interveners,  shell.  they  used  the  following  formulas to forecast the demand for petrol and  diesel.  although  both  equations  are  affected  by the fact that there is only one variable, and  that gdp (rather than disposable income) was  used in the case of petrol, shell presented these  as a general indication of what drives petrol and  diesel demand.  •  demand for petrol = (gdp – 1.5 per cent) •  demand for diesel = (gdp + 1.4 per cent) applying  these  formulas,  the  economists  for  shell  (rbb  economics)  made  the  following  forecasts  for  growth  in  petrol  and  diesel  demand. table 4 shell demand forecasts for the uhambo hearing 2005 2006 2007 2008 2009 2010 gdp growth 3.5% 3.7% 4.4% 3.3% 2.9% 3.0% petrol demand growth 2.0% 2.2% 2.9% 1.8% 1.4% 1.5% diesel demand growth 4.9% 5.1% 5.8% 4.7% 4.3% 4.4% source: uhambo, economic report filed by rbb for shell, 2005. the question is whether such a ‘rule of thumb’  gives an adequate forecast of the real demand.  the  following  two  graphs  show  what  happens  if we use the formula of shell and apply that to  historic demand data for petrol and diesel. figure 3 shell petrol demand growth forecasts vs real petrol demand growth. source: own calculations 274 sajems ns 11 (2008) no 3 figure 4 shell diesel demand growth forecasts vs real diesel demand growth. source: own calculations it is clear from the graphs above that the shell  formula does not capture all of the fluctuations  in  the  volumes.  a  simple  examination  of  the  graphs shows that the diesel graph seems to have  a better fit than the petrol graph. the next step  would be to add more explanatory variables to  increase the predictive power of the models. b) masana (ber) masana based their demand forecasts on a petrol  demand model that was developed by the ber.  the  ber  estimated  the  demand  for  petrol  and  diesel in 2005, based on quarterly data between  1984  and  2004.  they  used  seasonally  adjusted  volume  sales  of  petrol  and  diesel  as  dependent  variables.  a  regression  analysis  yielded  a  model  where the volume sales of petrol are explained by  real disposable income of households and the real  (inflation-adjusted)  price  of  petrol.  this  model  had an r-squared value of 0.71. the results of this  model suggest that the demand for petrol (volume  sales) is relatively inelastic with regard to changes  in  the  real  retail  price  of  petrol.  the  short-run  price elasticity was –0.19 and the long-run elasticity  –0.62. the short-term income elasticity of petrol  in  sa  was  found  to  be  around  0.10,  while  the  long-run income elasticity was around 1.0.  for diesel, the ber regression results showed  that seasonally-adjusted volume sales of diesel  are  explained  by  the  gross  domestic  product  and the real (inflation-adjusted) price of diesel.  however,  the  demand  for  diesel  was  found  to  be  less  sensitive  to  price  changes  than  the  demand for petrol. (this might explain why the  shell model yielded a better outcome for diesel  demand than for petrol demand (where the price  variable was omitted). the diesel demand model  had  an  r-squared  value  of  0.63.  the  long-run  demand elasticity for diesel was found to be –0.1.  the long-run income elasticity was calculated as  1.36 (ber, 2005: 6). while  the  ber  found  that  south  africa’s  long-run  income  elasticity  for  both  petrol  and  diesel  seem  to  be  in  line  with  international  research,  it  might  be  the  case  that  income  elasticities  are  higher  in  developing  countries.  there may be several explanations for this. as  more  people  become  economically  active  and  the  economy  keeps  growing,  the  number  of  cars purchased may increase and this will lead  to an overall increase in the demand for petrol.  over time, the income elasticity may decrease  as  the  country  develops,  while  still  remaining  positive. sajems ns 11 (2008) no 3 275 c) bp the  other  interveners  also  presented  growth  forecasts. bp based their forecasts on analysis  by  econometrix.  the  report  by  econometrix  also  found  demand  and  income  elasticities  in  the same range as that of the ber. table 5 demand elasticities – 1999-2004 price elasticity income elasticity petrol –0.238162 0.381192 diesel –0.138065 1.474488 source: table 2.1 – econometrix report, par. 2.2.2 econometrix  used  real  gdp  as  the  income  variable for both diesel and petrol. it was argued  above  that  for  petrol  demand,  real  disposable  income of households would be a better income  variable. based on this model, bp predicted a  petrol  demand  growth  rate  of  3  per  cent  over  the relevant period. d) sasol and engen the  economists  for  the  merging  parties  did  not  present  a  formal  economic  model  to  base  their  fuel  demand  growth  forecasts  on.  they  accepted the growth forecasts that came from  the business plans of the merging parties, and  therefore  predicted  that  the  current  (at  the  time of the merger) best estimates was a petrol  demand  growth  rate  over  the  relevant  period  of 1.4 per cent, a diesel demand growth rate of   3.4 per cent and a kerosene demand growth rate of   2.9 per cent. in the original uhambo business  plan presented to the competition commission,  the petrol demand was predicted to grow by only  1 per cent (see table 5 above). especially  in  the  case  of  petrol,  such  low  demand growth rates would have minimised the  threat of foreclosure. the higher diesel growth  rate was assumed to be driven by factors such  as  the  governments’  taxi  recapitalisation  plan  and consumers’ increased preference for diesel  vehicles.  the  following  petrol  demand  equation  was  presented by the merging parties (it appeared  in the affidavit of millard & kanfer (business  enterprises at the university of pretoria), p. 8). petrossa =   0  +  1 cpi -1  +  2 realpp +  3 jan +  4 feb +  5 april +  6 may    +  7 dec +  in the equation above, the dependent variable  is  the  nominal  rand  value  of  petrol  sales  (petrossa).  this  is  then  specified  as  a  function of the consumer price index (lagged),  the  real  petrol  price  and  various  dummy  variables to model the seasonal effects of petrol  demand. there is no income variable. this  model  clearly  disregards  the  body  of  economic  theory  set  out  above  as  well  as  the  evidence  from  the  sa  data  described  above.  what  the  merging  parties’  model  stated  in  essence  is  that  there  is  a  positive  relationship  between  the  demand  for  petrol  and  the  cpi,  and  between  the  demand  for  petrol  and  the  real price of petrol. economic theory predicts  that  inflation  (i.e.  price  increases)  erodes  the  purchasing power of households, in other words,  the higher inflation or prices become, the less  consumers  can  afford  in  volume  terms  (i.e.  with a given budget, they can afford to buy less  petrol  in  volume  terms).  increasing  inflation  will  therefore  reduce  consumers’  demand  for  petrol, i.e. if anything, there should be a strong  negative  relationship  between  inflation  and  petrol sales.  it  is  therefore  impossible  to  find  a  positive  relationship between cpi and real petrol sales.  the  equation  above  is  flawed  as  the  positive  correlation  was  found  between  the  nominal  value  of  petrol  sales  and  the  level  of  the  cpi.  a  positive  correlation  is  meaningless  as  the  correlation between most nominal variables in  276 sajems ns 11 (2008) no 3 the  economy  would  be  positive,  if  inflation  is  not accounted for. the correct way to deal with this issue would  be to examine the relationship between the real  petrol demand and the real petrol price (as was  done in the model of the ber described above).  the real petrol price was the second explanatory  variable in the equation of the merging parties,  and was also found to be positively correlated  to  the  nominal  petrol  sales.  however,  when  the year on year changes in the real values are  used,  one  finds  a  negative  relationship  (with  a  correlation  coefficient  of  -0.73),  as  illustrated  below (figure 5). figure 5 negative relationship between petrol sales and real (cpi deflated) price of petrol source: econex, 2005 the  other  obvious  problem  with  the  petrol  demand  equation  of  the  merging  parties  is  the  omission  of  an  income  variable.  it  was  explained  above  that  the  income  effect  is  stronger  than  the  price  effect  in  determining  petrol  demand.  if  they  did  not  find  a  strong  positive  correlation  between  gdp  and  petrol  demand,  another  income  variable  could  have  been considered such as real disposable income  or even a proxy for income such as sales of new  vehicles or the stock of new and used vehicles  on  the  road,  etc.  but  there  is  no  justification  for omitting the income variable, as this is the  most important determinant of petrol demand.  omitting  the  income  variable  also  ignores  completely the positive growth outlook shared  by most economists at the time of the proposed  merger. an examination of the growth in the sale of  passenger  cars  over  the  five  years  before  the  merger  hearing  would  already  have  indicated  that the demand for petrol must be increasing  over  the  next  few  years,  as  illustrated  below  (figure 6). sajems ns 11 (2008) no 3 277 figure 6 sales of passenger cars source: naamsa, 2006. clearly, the predictions of such a misspecified  model,  which  has  no  foundation  in  economic  theory, must be disregarded. the tribunal was  correct not to accept the very low petrol demand  growth  rates  (1.4  per  cent)  that  resulted  from  this model. this caused them to accept that there  was a credible threat of foreclosure in the face  of higher fuel demand growth rates. 5 conclusions this paper has argued that although the results  of economic models are highly sensitive to the  assumptions of the models, this does not mean  that such models should not be used. in the case  of the uhambo merger, the most important issue  considered  by  the  tribunal  was  the  possibility  or profitability of foreclosure. this in turn was  determined mainly by two issues, the growth in  fuel demand and the state of logistics.  while  the  second  is  primarily  a  factual  issue,  the  first  –  white  fuels  demand  growth  –  is  something  which  can  be  estimated  by  economists.  based  on  economic  theory  and  standard economic analysis, the tribunal found  that  the  fuel  demand  growth  rates  assumed  by  uhambo  in  their  business  model  are  “low  outliers”. this article has shown that assuming  a  1  per  cent  growth  rate  for  petrol  demand  when the economy was growing at much higher  rates and sales of passenger cars were reaching  record  levels,  was  indeed  conservative,  if  not  totally unrealistic. changing this assumption in  the foreclosure models immediately raised the  profitability of foreclosure, and this ultimately led  to the tribunal’s conclusion that foreclosure was   indeed a “credible threat” and that the proposed  merger should therefore be prohibited. 6 references 1  blum, u.; foos, g. & guadry, m. (1988)  “aggregate time series gasoline demand models:  review of the literature and new evidence for west  germany”, transportation research a, 22a: 75-88.  2  bureau for economic research  (2003) “the feasibility of a fuel tax levy in the  western cape”, document for public comment,  based on a research report for the western cape  provincial treasury. 3  bureau for economic research  (2005) “petrol and diesel sales forecasts for south  africa: 2005 to 2009”, report prepared for bp sa.  august 2005. 4  business enterprises, up (2005)  “statistical evaluation of sasol prediction  models: petrol and diesel”, non-confidential version.  278 sajems ns 11 (2008) no 3 5  competition tribunal (2006) “decision  in the large merger between sasol ltd, engen ltd,  petronas international corporation and sasol  oil (pty) ltd and engen ltd”, case no: 101/lm/ dec04. 6  dahl, c. & roman, c. (2004) “energy demand  elasticities – fact or fiction: a survey update”,  paper presented at the energy, environment and  economics in a new era conference, washington  dc, july 8-10, 2004. 7  drollas, l. (1984) “the demand for gasoline:  further evidence”, energy economics, 6: 71-82. 8  econex (2005) “analysis of the competition  aspects of the proposed uhambo merger – a  masana perspective”, non-confidential version.  9  econometrix (2005) “estimating long term  fuel demand scenarios”, non-confidential version.  10  graham, d.j. & glaister, s. (2002)  “the demand for automobile fuel: a survey of  elasticities”, journal of transport economics, 36:  1-26.  11  goodwin, p. (1992) “a review of new demand  elasticities with special reference to short and long  rune effects of price changes”, journal of transport economics and policy, 26: 155-163. 12  ramanathan, r. (1999) “short and long  run elasticities of gasoline demand in india: an  empirical analysis using cointegration techniques”,  energy economics, 21: 321-330.  13  sterner, t. (1990) the pricing of and demand for gasoline, swedish transport research board,  stockholm.  microsoft word 8 pretorius & holtz sajems 16(4) 2013.doc 468 sajems ns 16 (2013) no 4:468-485 business rescue decision making through verifier determinants – ask the specialists marius pretorius and gert holtzhauzen department of business management, university of pretoria accepted: july 2013 orientation: business rescue has become a critical part of business strategy decision making, especially during economic downturns and recessions. past legislation has generally supported creditor-friendly regimes, and its mind-set still applies, which increases the difficulty of such turnarounds. there are many questions and critical issues faced by those involved in rescue. despite extensive theory in the literature on failure, there is a void regarding practical verifiers of the signs and causes of venture decline, as specialists are not forthcoming about what they regard as their ‘intellectual property’. research purpose: this article introduces the concept and role of ‘verifier determinants’ of early warning signs, as a tool to confirm the causes of decline in order to direct rescue strategies and, most importantly, reduce time between the first observation and the implementation of the rescue. motivation for the study: knowing how specialists confirm causes of business decline in practice could assist in analysis and deciding on strategies for the rescue earlier than can be done using traditional due diligence, which is time consuming. reducing time is a crucial element of a successful rescue. research design and approach: the researchers interviewed specialists with extensive experience in credit for rescue and turnaround. an experimental design was used to ensure the specialists evaluated the same real cases to extract their experiences and base their decisions on. main findings: the specialists confirmed the use of verifier determinants and identified such determinants as they personally used them to confirm causes of decline. these verifier determinants were classified into five categories namely, management, finance, strategic, banking and operations and marketing of the ventures under investigation. the verifier determinants and their use often depend heavily on subconscious (non-factual) information based on previous experiences, rendering them ‘irrational’ in modern management perspectives. practical/managerial implications: decision makers and affected persons could benefit from the insights obtained through this study. confirming early warning signs through verifier determinants would be beneficial for entrepreneurs who are creditors, company directors, rescue practitioners, government regulators, court officials and educators alike. contribution/value add: knowing the verifier determinants could assist decision making and improve the effectiveness of rescue strategies. business rescue practitioners can improve their ‘investigation of the affairs’ activity by using such verifier determinants. key words: turnaround, business rescue, decision making, verifier determinants jel: d700 1 introduction in a rescue or turnaround situation, decision makers that depend on financial reports find such reports inadequate and ‘after the fact’. often such data masks the reality that the rescue practitioner faces rather than being of assistance. expert practitioners, however, develop verifiers, or what could be termed ‘verifier determinants’ of early warning signs, to enhance their decision making. turnaround managers and rescue practitioners face several liabilities when confronted with turnaround situations. pretorius and holtzhauzen (2008) have identified elements such as legitimacy, resource scarcity, strategy options, leadership capacity, data integrity and integration as liabilities. verifier determinants specifically address the liabilities of data integrity and integration. so far, the literature has been silent on verifier determinants; authors rather pool the elements of signs, signals, causes and indicators abstract sajems ns 16 (2013) no 4:468-485 469 under the general collective of ‘early warning signs’ (ews). much work has been reported on financial ews in particular because of their quantitative nature, while there is relatively limited reference to non-financial ews, probably because of their abstract and often qualitative nature. ews are mostly used for prediction of failure. early warning signs theory serves as the main base on which verifier determinant theory is built. the use of verifier determinants is aimed at helping to make sense of turnaround and rescue decision making in order to effectively guide rescue plans. figure 1 explores the concept of verifier determinants diagrammatically, to introduce the concept which is elaborated on as the unit of investigation once the literature has been reported. in this article the authors set out to answer three questions: do verifier determinants exist? if so, what are they? if these verifier determinants can be identified, how can they be applied in practice to improve decision making? it is important to investigate ways to improve the functionality of rescue practitioners in order to both enhance rescue decision making and reduce time to implementation. explaining the relationship between early warning signs and verifier determinants therefore has important practical value for the training of rescue practitioners and managers, entrepreneurs other decision makers and regulators. this article starts by defining the concept of verifier determinants and how they can be used. secondly, it links verifier determinants to early warning signs theory, which is well documented in the literature. thirdly, it explains the experimental research design. fourthly, the researchers discuss the findings, tracking substantiation and insights from the subjects to supplement the theory and the literature. finally, the researchers draw conclusions about a framework for verifier determinant use and the application of verifier determinants during the rescue process. 2 background to the origin of verifier determinants and trends from the literature business decline is part of business. it is generally perceived as negatively affecting people and firms; therefore legislation that supports debtor concerns has been instituted. practice shows that sometimes business rescue practitioners (brps) understand neither the complexity of business decline (pretorius, 2009), nor the various reasons that have been suggested for failure, with their many signs indicating the causes. these include diminishing resources, poor leadership, strategic issues, operational issues and combinations thereof. the many variables that determine how business failure occurs influence the decision making of the rescue process. in response to changes in legislation there has been an explosion of consultants who view the opportunity to act as rescue practitioners as lucrative business. such consultants originate from many backgrounds and include liquidators, legal professionals, accounting professionals and more – many without real business acumen. the ad-hoc licensing methodology adopted in south africa contributes to the potential ineffectiveness of practitioners appointed. two years into the new legislation, role players in the rescue industry already doubt brp skills (pretorius, 2013) and the cost of losing rescuable businesses due to this uncertainty needs to be calculated. scientific literature from developing countries on rescue is almost non-existent compared with that from the united states, britain, australia, canada and finland. understandably, rescue practitioners protect their strategies as ‘intellectual property’ that constitutes their competitive advantage. the international literature incorporated in this study involved all scientific resources from the abi-inform, ebsco-host, proquest, science direct, blackwell and other databases for titles published. the following inclusion criteria for literature sources were applied: works concerning failure causes, warning signs, failure prediction, rescue strategy and firm decline were investigated. as for major seminal work, the date was not seen as a limitation, especially when an article was referenced widely; relevance and contribution to the body of knowledge on failure prediction, early warning signs and rescue strategy were paramount. each article was scrutinised for confirmation of concepts, as well as additional concepts and variances under different conditions and 470 sajems ns 16 (2013) no 4:468-485 contexts. when analysed, this research identified key concepts using grounded theory research. the researchers designed the present study to identify and report verifier determinants for the key warning signs and causes associated with decline. they investigated situations in which specialists with many years of rescue and turnaround experience were interviewed under experimental conditions to establish the existence and use of verifier determinants for rescue decision-making. 3 unit of investigation and research objectives a verifier determinant in this study is defined as ‘the root confirmer that a decision maker uses to validate the cause of decline or distress, underscores an early warning sign and focuses rescue strategy choice’ (holtzhauzen, 2010:15). the meaning of a verifier in this study points to some factor or element that confirms, validates and ensures firstly that the cause exists and secondly that the early warning sign used to identify it is in fact present. figure 1 shows the definition diagrammatically. the term determinant therefore mainly reflects the agreement or consensus between the cause and the apparent warning sign verifier as shown in figure 1. as a well known example of a verifier determinant, bankers would study an account of a suspect business client to identify payments containing ‘round’ figures. several such figures would alert the banker to ‘suspicious payments’ to confirm money movements between accounts. further investigation then often may confirm either cash flow pressure or, in extreme cases, pilferage to finance a luxurious lifestyle associated with the ‘bullfrog’ syndrome (richardson, nwankwo & richardson, 1994). this one verifier determinant can act as a ‘trigger’ in several categories, as will be explored in the findings of this research. figure 1 the concept and role of a verifier determinant as used by expert rescue practitioners cause of failure early warning signs rescue strategy drivers focusesconfirms triggers investigation verifier determinant how experts use verifier determinants therefore, the research objectives are: • to identify and determine the existence of verifier determinants; • to establish what they are; and • to establish how specialists in the rescue field use verifier determinants to enhance decision making. 4 early warning signs theory preceding verifier determinant theory 4.1 early warning signs theory early warning signs are regarded as all types of events in business that point to the potential sajems ns 16 (2013) no 4:468-485 471 demise of that business. on a path of organisational decline, cameron, whetten and kim (1987:126) choose to call the warning signs ‘decline attributes’. owing to their very nature as an underlying feature of a path of decline, these elements are occasionally not acknowledged or addressed as warning signs. ueda (2004:612) argues that if a bank identifies a bad signal it then believes that the venture is likely to turn out to be unprofitable. prominent in the literature is the identification of ‘weak’, ‘poor’, or ‘problematic’ management as an early warning sign. it is, however, very difficult to measure and quantify (verify) problematic, weak or poor management. substantial debate is evident in the literature as attempts are made by various authors to clarify the phenomenon of early warning signs resulting from mismanagement. in addition to the literature specifically referring to early warning signs, business failure prediction, successful versus unsuccessful and performing versus non-performing variables are all evident in the body of early warning signs literature. consequently, it may be deduced that, as there are many definitions and descriptions of early warning signs, a working definition is desirable. a definition of an early warning sign arrived at by devereux in a metaanalysis of causes and signs by holtzhauzen (2010:43) is that as ‘an internal or external extension of an event or factor or a combination of all, it may directly or indirectly highlight the pending demise of a business or business unit if not addressed and rectified in the course of business’. ivanova and gibcus (2003:17) refer to problematic management as ‘negative behavioural traits’. back (2005:843), on the other hand, refers to early warning signs as the ‘focus of financial difficulties and behavioural issues’, while carmichael and stacey (2006:3) focus on ‘managerial success variables’ such as accountability, initiative, boundaryless thinking and integrity. bates (2005:345) focuses on deficiencies in the ‘skills set’ of owners and managerial ‘success variables’ as warning signs. some authors, such as moy and luk (2003:207), refer to early warning signs as ‘obstacles’ and ‘problem types’ for growth. one of the main threats to business viability is management and/or directors who contemplate fraud. in line with this, bower and gilson (2003:20) state that fraudulent underreporting of expenses (and other financial performance measures) results in extremely high costs in order to rectify the position. fraudulent business practices are not limited to misrepresentation but also include statutory noncompliance. mueller, mckinley, mone and barker (2001:25) maintain that, in the process of rationalising the causes of organisational decline, management must form an opinion on the stability of those causes and debate them. this is, however, a constricted, simplistic view of early warning signs. singer (1995:325) concludes that ‘constructs such as poor management, strategy, environment, and industry structure are in themselves inadequate explanations of new venture failure or success’. early warning signs shaped from a focus on the skills set of owners contemplate, according to lussier (1995a:8), ‘non-financial business success versus failure variables’. banfield, jennings and beaver (1996:94) focus mainly on the up-skilling of management, addressing need and demand. three broad management areas that need to be monitored were identified in grant thorntons catalyst issues (2004a:1). these are finances, operations and strategic planning. in the broader sense these essential aspects need to be dealt with by the rescue practitioner and entrepreneurs business and strategic rescue planning. beaver and jennings (2005:12) describe the management process as a progression which has highly personalised preferences, prejudices, attitudes, skills demand, and technical and educational needs. they also focus on control by the bureaucratic and hierarchical environment over critical decision making. management plays a significant role in identifying and disclosing early signs of decline. it is, however, clear that when early warning signs begin to appear, the business is already in a sub-normal situation. gilmore, carson and o’donnell (2004:349357) refer to situations where early warning signs appear as ‘risky situations’. some authors, such as nutt (2004:13), franks and sussman (2005:30), fraser (2005:448), and cressy (2006:113), debate fortune as playing a part in the failure of a successful business; this phenomenon is described by elenkov and fileva (2006:135) as ‘bad luck’. by contrast, 472 sajems ns 16 (2013) no 4:468-485 harvey (2002a:3) concentrates on examining the ‘value-creating potential of primary activities’ as early warning signs. pretorius (2008:412) discusses (1) human causes associated with failure in the context of early warning signs; (2) internal and external causes associated with failure; and (3) structural causes associated with failure. he maintains that it is crucial to identify distress warning signs in the business in good time if an attempt is to be made to save the business. seminal work on early warning signs has been largely summarised by academics such as cannon and edmundson (2005), collard (2002), lohrke, bedeian and palmer (2004), mcgurr and devaney (1998), moncraz and kron (1993), sharma (2001), sharma and mahajan (1980), stead and smallman (1999) and tang and chi (2005). it appears that these authors use the following phrases inconsequently to describe ‘early warning signs’: success versus failure variables, causes of decline and or failure, warning indicators for business decline, performing and non-performing variables, root causes for decline or failure, warning indicators, material defects, external and internal factors, distress variables, problems and challenges. a wide range of terminology and application therefore exists around the early warning signs theory. much overlapping of meaning is also evident. this article aims to eliminate some of this overlapping by the use of ‘verifier determinant’ as the term. 4.2 verifier determinants turnaround situations are normally complex and contain many vagaries that influence decision making. at best, some of the frameworks from the literature that assist such decision making and strategising are guidelines only; they require interpretation and situation application, as no two turnaround situations are the same (pretorius, 2008). verifiers are used to confirm the existence of problems in the business or in the business environment, as environmental scanning units seem to be unable to respond to what ansoff (1975:25) calls ‘weak signals’. stubbart (1982:143) concludes ‘we have too many places to look and too few theories of how significant environmental change can be linked to the business’s plans’. the introduction of verifier determinants in this study is intended to fill the gap in this regard by focusing the investigative stage of a rescue situation. in order to achieve the research objective of identifying verifier determinants, different opinions from a business, an accounting and a legal platform were presented. these opinions are given within a framework of early warning sign identification and rescue practice. this article builds on the early warning signs theory to establish verifier determinants that could guide entrepreneurs and rescue practitioners in the timely planning of the immediate rescue and future sustainability of an enterprise. verifier determinants, once identified, could help to authenticate warning signs and could be used progressively in the diagnostic phase of the rescue process. the effectiveness of business rescues depends on the choice of strategy, of which the verifier determinants may be an important component. as soon as they are identified and confirmed, the verifier determinants can assist in defining the rescue event. verifier determinants are used to confirm early warning signs, and can be used extensively to confirm causes, focus on the correct warning sign and substantiate the issues to consider when compiling the rescue plan. identifying verifier determinants may also help to uncover other hidden critical issues. the use of verifier determinants is essential when attempting to classify the warning signs used in the enormous array of business applications such as operational non-efficiencies. these verifiers could also contribute to the day-to-day monitoring of the business, if used as a prolonged business activity. this qualitative research has therefore made a unique contribution to confirming early warning signs by developing the verifier determinants, each with its own set of variables. 5 research design this section covers three aspects of the research design. these are the research approach, the experimental setting as the research strategy, and the research methodology. this is similar to the design that serfontein, basson and burden (2009) describe. sajems ns 16 (2013) no 4:468-485 473 5.1 research approach the research approach was exploratory and qualitative in nature. it identified and explained the embedded experiences of specialist rescue practitioners. these specialists had been involved in many informal turnarounds and rescues as bank officials. in this experimentally designed study in which specialists evaluated real cases that covered recent rescues, several unanswered questions arose. three are particularly interesting for this study. firstly, the researchers needed to identify whether the verifier determinant concept did exist, knowingly or unknowingly, in the minds of the deliberately selected expert subjects. subjects could be using the concept without being able to name it as a concept, or consciously as a method of confirming the causes of decline or early warning signs. secondly, the subjects were given three comprehensive case studies to evaluate in their own time as preparation for the interviews (to later determine how verifier determinants were applied in their evaluation process). during the interviews they were probed with questioning at different levels. at the start questions were open ended, then became more specific as the interviews progressed. once verifier determinants had been identified, the subjects were asked to compare the cases and identify the verifier determinants for each case. possible discrimination with verifier determinants was sought. finally the researchers wanted to know how the specialists used the information obtained with the verifiers to inform the rescue plan, and whether verifier determinants contributed to saving time between the analysis and the steps of the rescue plan process. table 1 summarises the research design. table 1 research design components based on the adapted design description of yin (2003:21). component description research question or problem do verifier determinants exist, and if so, how are they used? context business rescue and turnaround situations propositions* 1. verifier determinants do exist. 2. verifier determinants are used to inform decision making. 3. verifier determinants can inform the rescue plan. 4. verifier determinants save time in the decision making process. unit of investigation primary — verifier determinants secondary — decision making unit of analysis experienced specialist turnaround and rescue practitioners in banking industry logic linking the data to the propositions specialist rescue practitioners use verifier determinants to enhance their decision making. they use conscious and unconscious elements to achieve this. carefully extracting this information could lead to the identification of these verifier determinants. sense making through the research could lead to a framework to enhance rescue plans and improve time efficiencies. criteria for interpreting the findings factors, issues and methods that subjects use to verify signs and causes processes that subjects use to verify signs and causes practical application of verifier determinants * the propositions were set to structure the research process and support the research question. 5.1.1 key scientific beliefs in attempting to answer these questions, the researchers were aware of their own methodological values, beliefs and philosophical assumptions. these assumptions could influence how they conducted the research; they stated them in order to understand the intellectual climate in which they conducted the research. 5.1.2 ontological positions these comprise the researchers views on the very nature and essence of research reality. researcher a is an objective realist who believes that knowledge comes from facts associated with the cases and the context. if the researcher found repeated mentions of applications, preconditions, causes and responses, he could ‘generalise’ them. his interest was mainly business strategy during decline. researcher b is a constructionist practitioner who believes that situations can be explained, especially when one has participated in its processes. peoples views, actions, reactions, interactions, social relations, social and cultural 474 sajems ns 16 (2013) no 4:468-485 practices, rules and values reflect their experiences that guide decision making. therefore, understanding such subjective experiences and interpretations may uncover unknown relationships and lead to improved insights of the experienced reality. his interest was mainly business principles applicable to the turnaround and rescue situations the personal experiences of the specialist subjects and their interpretations of the different contexts of each case were interesting. the specialists shared their experiences willingly and responded openly to all the questions the researchers asked during the interviews. 5.1.3 epistemological positions the theory of knowledge (epistemology) of the researchers diverged to some extent. this allowed for interplay on how one can discover decisions about social phenomena and how one can demonstrate knowledge. researcher a worked primarily from a scientific paradigm, particularly in the primary stages. however, he changed this during the process to a consultant paradigm. he had had experience of rescues and a business failure himself. he had worked as an academic as well as a strategy and turnaround consultant. this influenced his search for factual directives, patterns and answers to correct future situations of a similar nature. researcher b worked from a business rescue practice paradigm and looked for a description of the verifier determinant construct based on intuitive experience as a rescue practitioner over 15 years. thus, both authors were subject to their own biases and therefore we chose structured datagathering methods (interview and repertory grid comparisons) to capture the activities and experiences of the subjects during their evaluations. 5.2 experimental setting using case study evaluations as a research strategy the researchers used interviews to extract the phenomena in a real-world context where the boundaries between phenomena and context are not clear. yin (2003) suggests that the uniqueness of individual experiences is a sufficient rationale for using experimental design based on case studies that eliminate contextual variation. the specific cases the researchers presented to the subject respondents were pre-selected to exhibit different levels of distress, and were ‘real-life’ cases that had been recently experienced by the bank. it was an important breakthrough to identify these experts, because as banking officials of many years standing they shared their thinking openly; there was no real benefit to their trying to protect any ‘intellectual property’, as would be the case when private consultants were interviewed. using a selection of cases ensured that the subjects were bound to comparable application context and eliminated different background expertise that might be industry-specific. this experimental design eliminated the variation that originates from the complex circumstances that could accompany rescues in the real world. the reasoning the researchers used was mostly inductive to explore the subjects understanding, experiences, interpretations and knowledge building for the different cases they judged. 5.3 research method 5.3.1 research setting the researchers interviewed nine specialists purposively selected to participate in this study. industry specialists with practical experience were identified in the target organisation (a commercial bank) and these specialists were selected to participate. three case studies (from a set of six representing two each from standard, sub-standard and special mention categories) were selected at random for each specialist, which resulted in each participant having a sample in which at least two of the main categories of basel ii rating are represented. the case studies were distributed to the participants two weeks prior to the scheduled interview. during this period the subjects were requested to prepare themselves adequately for the interview process. this preparation was estimated to take at least three hours. the subjects were then invited to an interview and encouraged to bring the case studies and all preparatory notes with them. sajems ns 16 (2013) no 4:468-485 475 the estimated time allotted for the interview was three hours, although the first interview took four and a half hours to complete. however, as the researchers gained experience in the interview process, the time spent on the interviews was reduced. subsequently, the average time per interview was calculated at three hours forty minutes. in order to keep the interview process unbiased, the interview content, such as the process to be followed and questions to be asked, was not disclosed to the subjects prior to the interview. subjects were also reassured that there would be total anonymity and that the results would only be used for the research project. subjects participated voluntarily. it was found that they were relaxed when answering the questions, since these were based on their field of expertise. it is believed that these positive interview conditions led to unbiased sharing and meaningful conclusions drawn from the discussions of their perceptions and experience. 5.3.2 background and setting for case evaluation process for the purposes of this study, recent, real-life business profiles were obtained from the bank archive and used. care was taken to disguise case names and potential recognisability by subjects. the real-life cases comprised a stratified random selection drawn from existing businesses in a commercial banking environment. the businesses were geographically spread throughout south africa and the selection was not limited to one province only. the choice of cases was of the utmost importance to ensure that selection bias was ruled out. research cases were obtained from an organisation with a comprehensive database of business data, which made it relatively easy to randomly select the sample of real-life cases. for selecting the case studies to be evaluated, the researchers relied on businesses that were already subjected to basel ii accord categorisation criteria. this research chose to select real-life cases with an in-depth longitudinal character. cases were selected at random, provided that they had at least three years historical financial and other relevant data. this was important to ensure equal representation of the selected cases. in a rescue situation, a commercial bank is ‘exposed both ways’, as the bank is a key component in any rescue attempt, be it informal or formal. the existing basel ii risk rating was applied to each business case and then used in selecting two cases in each category, standard, special mention and sub standard. within each case, the following information was supplied: curricula vitae of managerial staff, historical files consisting of business background, management succession, market and product information, staff growth and considerations, changes in industry type and business model, three years audited financial statements to establish growth, and finally cash-flow projections. care was taken to give equal information for every case to avoid possible bias. the primary aim of the case research and the interview process was to establish the perceptions of specialist subjects in identifying early warning signs, causes and verifier determinants linked to the risk levels (basel rating). 6 entrée and researcher roles the researchers approached the subjects (respondents) based on their involvement in senior committees on rescue funding meetings (all distress cases of each branch were referred to these meetings for discussion and ultimate action by the institution). these types of meeting were typically held weekly and included teleconferencing to involve the key senior decision makers of the different credit divisions within the provincial structures of the bank. the two participating researchers, each with his own approach to investigating and questioning, participated in the process for all the interviews. both researchers gathered their own field notes during the interviews. the notes led to some interaction between the two researcher paradigms. this interaction of paradigms emphasised the value of the supplementary and complementary character of the two ontological positions. the researchers investigated the outcomes of the comparative evaluations separately to explore the interrelationships between identified constructs. 476 sajems ns 16 (2013) no 4:468-485 7 sampling the researchers approached the subjects individually, requesting participation. they were purposely selected based on their specialist expertise and experience as well as their decision-making positions within the organisation. they agreed to participate as they had known the one researcher very well over many years as a colleague. the subjects were all older than 40 years of age and had at least 20 years banking experience gathered while working for different institutions previously, of which at least 15 years was in credit, risk and rescue. all had postgraduate qualifications, but the key determinant was the fact that their job mandate was one of decision making over the ultimate direction of such cases in the respondent organisation. 8 data collection methods the phenomena the researchers investigated involved on the one hand the subjects perspectives: thinking, experiences and decision making, and on the other the real-life cases of distressed ventures, with their specific contexts (see also table 1). therefore, the boundaries between the subjects and the venture contexts were clear, as they had no prior involvement with the specific cases. this meant that the researchers could pursue all sources of evidence to find convergence and divergence. additionally, because the cases were recent, there was sufficient access to case documents, financial statements, ratings criteria from basel ii and background information to produce comprehensive material for the subjects to evaluate. at first, the initial observations of the subjects were important in understanding the comparative aspects of the case ventures and the selection of similarities (or differences) between the cases, as suggested by the repertory grid methodology (repgrid) (feixas & alvarez, 2006) applied. these initial observations also contained the subjects own interpretations of the issues at hand for each case. secondly, after the researchers had held the in-depth interviews and applied the repertory grid evaluations, they used their interview notes and interpretations to make sense of them. the interview protocols for repgrid methodology included: in your opinion, • which two cases are more similar (compared with the other one)? • what early warning signs did you observe? • why is the one (case) different from the other two? • what caused the signs in your opinion and why do you say this? • how did you confirm the existence of the sign/cause? • what is the main differentiating construct? • does this construct fall into the category of an early warning sign or a verifier determinant? • how important was the verifier determinant in your decision making? • the case which was not selected – why was it not selected? • what would be the constructs of your rescue proposal? the repgrid methodology was also applied to establish the constructs (factors) of verifier determinants, as verifiers introduce elements which provide for illogical, subconscious, judgemental information that is not contained in present early warning sign theory. the repgrid methodology concentrates on the criteria which influence the subjects choices. these criteria are the specialists difference in experience, which will, when combined, lead to the formulation of a construct. the repgrid methodology effectively deals with interviewer concerns such as interviewer bias, specificity, and over-dependence on the knowledge of interviewers. the researchers could probe for explanations about the answers the subjects gave throughout the interviews. the researchers individually and separately interpreted the interview outcomes by searching for key issues, insights, similarities and anomalies, together with their own field notes. once they had identified the issues, they coded them. the subjects’ cognitive experience and knowledge of the business case was also then sajems ns 16 (2013) no 4:468-485 477 recorded, the key constructs were identified, the main early warning sign category was identified and subsequently, most importantly, the verifier determinant was identified. a record sheet was used to annotate every discussion topic and/or interview question asked. 9 data analysis though there was only one key source of evidence (the specialists), the researchers used investigator triangulation (yin, 2003:98) to extract as much richness as possible. through the many views of the evidence, specifically those of the specialists own version of their experiences, insights and interpretations, each evaluation, in-depth interview notes, the evaluation forms of the case comparisons, interviews and checking the researcher interpretations, the researchers identified and recorded aspects relevant to the research propositions. they mapped the elements that served as verifier determinants to understand elements, sequences, events, effects, relations, causation, outcomes and timelines. as the cases were real, there was also a record for each within the system to use as reference. 10 strategies used to ensure quality data as there was only one source of evidence, the researchers firstly used investigator triangulation. we checked quality as the interviews progressed. here we asked the specialists, as the key informants, to judge the researchers interpretations of the different issues. as the focus of this study was mainly explanatory, the interview process focused on how things were perceived as the specialists described them, thus using ‘explanation building’ to improve internal validity (yin, 2003:34). 11 reporting the findings the researchers reported the findings by stating the key observations and responding to the research propositions individually. the style was firstly exploratory, to identify the verifier determinants, and thereafter explanatory, to describe verifier determinants and how they are applied in the evaluation process and the rescue plan, and if they have potential timesaving benefits (to find support, or the lack of it, for the propositions; also see table 1). the findings show support for the proposition that specialist rescue practitioners do use verifier determinants to confirm early warning signs and causes of turnaround situations and apply such verifier determinants to the rescue plans. 12 findings the first research objective was to describe the concept of verifier determinants and their relation to early warning signs theory, to lead the identification of such verifier determinants in practice. the second research objective was to determine how verifier determinants are used in decision making, and the final research objective was to describe how verifier determinants inform rescue plans and their effect on time reduction. 12.1 findings linked to proposition 1: verifier determinants can be identified the detailed analysis of responses by the specialist subjects yielded some interesting and salient similarities pertaining to their thinking about early warning signs, causes and verifier determinants associated with each case they evaluated. during the interviews, it became clear that some of the opinions were similar, but with varying denotations and terminology. instances where the outlook on approaches was the same were therefore grouped in the relevant categories. firstly, all subjects had definite ‘thinking structures’ by which they judged the presented situations and made their comparisons. while some could not always immediately and rationally verbalise their thinking and reasoning behind certain judgements, it was possible to extract it through rigorous questioning by the interviewers. 478 sajems ns 16 (2013) no 4:468-485 the subjects identified several verifier determinants related to each category. as expected, these verifier determinants showed a classic resemblance to the warning signs identified in the literature reviewed. the participants were also able to identify the same elements that are used in the basel ii findings, which demonstrate the participants high level of knowledge about applied financial evaluation methods. moreover, the subjects had no trouble in accurately placing the case studies in low, medium, or high-risk categories. five categories of verifier determinants were identified by the subjects during the interviews. this section only reports the verifier determinants for each category and is supported by a simplified case-in-point example, as reported during the interviews. verifier use is elaborated on under proposition 2. 12.1.2 management verifier determinants twelve managerial verifier determinants were used by the specialists. these include (in no particular order): no or limited management information system in operation; managers education does not complement business type; decision maker that is ‘scapegoating’ (blaming); inflexibility when making decisions regarding change; decision maker is absent from work and important meetings; impulsive decision making; decision maker not able to recall management information immediately (has to ask others); absence of up-to-date management accounts; important decisions are made on the golf course; decision makers personal problems – health or marriage issues overshadow business focus; super cars and toys and finally a business that outgrew decision makers skill set. case-in-point example: if, when one is visiting a business and in consultation with its management, it appears that management is unable to recall management information immediately (and relatively accurately) and has to rely on others to submit such information, it verifies that management expertise is lacking in the business. 12.1.3 financial verifier determinants twelve financial verifier determinants were identified by the specialists and include: labour cost that is disproportionate for the type of business; absent or unrealistic cash-flow projections; a high risk (or one big project) dependence; late submission of financial information in an attempt to postpone unfavourable news; sensitivity on tax avoidance; not analysing internal financial information; underutilisation of assets; creative accounting; pricing or discounts for cash generation; slowing down and stretching payments to suppliers in an attempt to generate cash; high executive remuneration; and, finally, dividend payouts that are unstructured and considered too high. case-in-point example: if, when one is visiting a business and in consultation with management, management is over-sensitive about tax evasion and there are signs of creative accounting, this verifies that management is aware of and potentially hiding/distorting financial facts; at the same time the integrity of all other financial information becomes suspect. 12.1.4 strategic verifier determinants ten strategic verifiers were identified by the specialists namely: forced growth attempts (through mergers and acquisitions); overambitious growth strategy; not willing to deviate from strategic plan; non-responsive to small inefficiencies; unclear strategy for product and market; inability to adapt to business life cycles; problematic fit between strategic posture, structure and industry life cycle; overexpansion of capacity without considering market; lack of strategy to combat decline; lack of fusion between strategic issues and everyday operations. case-in-point example: if the decision maker is unable to accept, respond or adapt to change (demanded by the market), but concentrates on internal growth and operations only without having strategic plans in place, this clearly indicates a weak strategic position. 12.1.5 operational and marketing verifier determinants ten operational and market verifier determinants were identified by the specialists, namely: inappropriate channels of distribution; ageing production techniques; decision maker not knowledgeable about new technology; sajems ns 16 (2013) no 4:468-485 479 misinterpretation of competitive advantage; declining emphasis on advertising; poor service or products; reliance on one customer; failure to respond to high cost structure compared with competitors; market forces ignored in planning; core markets moving away from location. case-in-point example: a practitioner is visiting the business and investigating the operational issues, such as distribution channels, and inefficiencies due to inappropriate channels and the management of ‘proof of deliveries’ and correctness and validation of debtor statements verify poor operations. this may show decentralised distribution centres are potentially driven by past decisions rather than sound business choice based on current profitability, which then confirms poor operational decision making. 12.1.6 banking verifier determinants six banking verifier determinants were identified by the specialists, namely: regular stop payments on creditor obligations; increase in short-term requests for cash flow purposes; declining deposit balances and/or returned cheques; rounded amounts paid to creditors; overdraft advance funding other purposes such as asset acquisition; funding structure does not complement business model. case-in-point example: when one is investigating financial and bank statements, the existence of rounded amounts may confirm fund channelling. this then triggers investigation of relevant accounts to determine the financial ‘merry-go-round’ or ‘kite-flying’ used by management. rounded amounts can also verify arrangements to ‘repay’ creditors over an arranged period of time. table 2 lists the verifier determinants identified in this study. based on the below, the research found enough support for the proposition that verifier determinants could be identified, as subjects contributed examples and confirmed their existence. table 2 verifier determinant summary with typical core elements verifier determinant number of elements in category typical core elements management 12 no or limited management information system in operation; decision maker that is ‘scapegoating’ (blaming). financial 12 labour cost that is disproportionate for the type of business; absent or unrealistic cash-flow projections. strategic 10 over-ambitious growth strategy; non-responsive to small inefficiencies. operational and marketing 10 inappropriate channels of distribution; ageing production techniques. banking 6 regular stop payments on creditor obligations; increase in short-term requests for cash flow purposes. 12.2 findings linked to proposition 2: verifier determinants are used to inform decision making once the subjects understood the concept of verifier determinants (the unit of investigation) and what the researchers were looking for, they could easily describe the ‘tools’ they applied to confirm relevant issues and elaborate on why and how they used them. they could then contribute more information about the usage of the different verifier determinants. this section is supported by two anecdotal evidences to explain the role of the verifier determinants in practice. the nature of verifier determinants appears to be less rational and logical, and more intuitive and experience based. while this might appear to be counter to proper decisionmaking principles, this study shows the praxis of how it really happens in practice when practitioners face decision-making situations. in one anecdote, a subject arrived at the premises of the business under rescue and observed several cars with ‘personalised’ number plates parked outside. this verified the ‘super cars and toys’ under the management category of determinants, and further investigation confirmed large outflows into car 480 sajems ns 16 (2013) no 4:468-485 leases for family members – an expense outside the business focus. in another anecdote, the subject visited the factory shop and overheard the shop assistant informing a customer that he could not pay with a credit card as this was a cash shop only. under the financial category it represented ‘pricing and discount verifiers’, and later proved to be linked to deliberate pilferage from the business as well as false write-offs. as with the above, the subjects could share case examples of how they used the verifier determinants to assist their further analysis and eventual decision making. much support was thus found for proposition 2. 12.3 findings linked to proposition 3: verifier determinants can inform the rescue plan subjects reported that their rescue plans were informed by the verifier determinants. the verifier determinants act as key focus factors in the rescue plan. as a case-in-point example, after overhearing the cash store-only remark, the subject appointed a forensic auditor to trace the stores impact on the cash shortage, leading to the finding of several millions of rands(1$ = 8+rand) fraud. this informed the rescue plan to include a proper accounting and control system pertaining to the shop, as well as a daily banking instruction. as the verifier determinants confirm causes of the decline, it follows logically that they have a direct relation to the key focus areas of the rescue plan. support for proposition 3 was therefore established. 12.4 findings linked to proposition 4: verifier determinants save time in the rescue process subjects regularly used the slang term ‘quick and dirty’ to explain their initial analysis and confirmation procedures that involved the verifier determinants. they use the ‘quick and dirty’ short cut to make, at the earliest possible point in time, a ‘proportionate judgement’ related to the category of verifier determinants involved. they report that they make the early decision based on the verifier and thereafter follow the standard analysis (focused due diligence) procedures required by policies of their institution. on the basis of the early decision, they can however act pre-emptively in the strategies that they select for the rescue, as ‘time is of the essence’. ‘for me,’ one subject stated, ‘it is damage limitation tricks that i use; you dont have time to play with.’ the role of verifier determinants seems to be accentuated during the early analysis phase of the turnaround process. the ‘non-factual’ nature of the verifier determinant contributes to the initial short-cut approach. therefore, the researchers found support for the proposition that verifier determinants could save time in the rescue process. 13 discussion and conclusions the discussion expands on some key observations about the existence of verifier determinants as a concept, and the use of verifier determinants during analysis of a rescue situation and creation of the rescue plan. firstly, the subjects confirmed that early warning signs do exist, as well as confirming the general categories as described in the literature; namely, management, financial, operational/marketing, strategic and banking warning signs. during interviews, they would use phrases such as ‘ratios are worsening’ and ‘there is a management problem’. subjects could identify the early warning signs with relative ease from the case material provided and could easily speculate about the potential causes for them. when probed/challenged about how they would confirm these early warning signs, they identified the need for visiting the venture and interviewing the owner/manager as well as staff members. they therefore had to reflect on previous experiences to identify what they would use to verify their ‘suspicions’. this need for the visit and interview suggests that alternative indicators are used as verifier determinants (compared with the basic warning signs themselves) and this is therefore a key finding of this study. secondly, the nature of the verifier determinants that the subjects used varied from rational relationships between elements, to sajems ns 16 (2013) no 4:468-485 481 perceived connections, to personal biases that appeared to have no relationship to the issues they were linked with. nevertheless, these were the constructs that subjects identified. the financial verifier determinants were favoured by most of the respondents as being of high importance. this was to be expected, as the research was conducted in a financial institution and was probably related to the specific requirements under which subjects operated. furthermore, financial verifier determinants are largely measurable. thirdly, while the verifier determinants could be categorised, there were individual verifier determinants that could easily belong to more than one category, which suggest the borders between categories being vague in many cases. ‘not analysing internal financial information’ as a verifier determinant could easily be construed to verify poor management, though it was grouped under financial verifiers. several of the verifier determinants have a similar characteristic. nevertheless, the importance of the correct category is secondary to the fact that these specialists do use verifier determinants, both consciously and subconsciously, to improve their analyses of the situations and consequent decision making. finally, the verifier determinants are often interrelated and indirectly connected. in the case of the cash store quoted above, the following subject statement serves as a good example of the interrelatedness. ‘when arriving at the premises of a filing enterprise for the first time, i saw several motorboats and water skis (super toys) standing in the yard. i knew that the business was small and wondered about where the money came from. the comment in the cash store confirmed the other verifier determinant and directed the investigation’. often management and financial verifiers are somehow connected. the study begins to pave the way for rescue practitioners to become aware of the useful application of alternative ‘tools’ to overcome the liabilities of turnaround managers, as described by pretorius and holtzhauzen (2008). it has proposed practical tools that could be taught to address the liability of data integrity in particular. 13 implications, limitations and future research to generalise using the results of nine specialists only may appear inappropriate. however, the case studies allowed for comparative evaluations and some interesting convergence between subjects. the richness of data through the experimental design confirms the complexity of turnaround situations, their analysis and the decision making involved during strategising to create a rescue plan. future research should attempt to replicate the study with rescue practitioners under chapter 6 or confirm the use of the identified verifier determinants through quantitative analysis. secondly, the qualitative nature of the data is subject to the perceptions and interpretations of the researchers and their research interests, despite all their attempts to be objective. further research should focus on seeking to quantify data collection by expanding the research strategy to include survey analysis. thirdly, the absence of measurable and factual details meant that the interpretation depended mainly on the subconscious and unconscious interpretations of factors based on the interpretations and experiences of the subjects. one should see the findings in this context. although the researchers could not generate deterministic facts for practitioners to use, they did identify some interesting directives for further research. fourthly, even though the subjects could not prove any relationships between verifier determinants that they used and the factual turnaround situations, the existence of such verifier determinants is undeniable. rather than the use of such ‘irrational’ tools being opposed, they should rather be embraced but with the necessary caution. finally, the implications of this research point towards the value of experience for rescue practitioners. the question that arises is how to gain these experiences unless one is directly involved in business rescue. future research should look into the quantification of the verifier measurements through factor analysis to determine the use of elements under each verifier. 482 sajems ns 16 (2013) no 4:468-485 acknowledgements the authors are 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(3rd ed.) series volume 5. london: sage. microsoft word 6 saayman sajems 17(1) 2014.docx 184 sajems ns 17 (2014) no 2:184-193 the non-consumptive value of selected marine species at table mountain national park: an exploratory study melville saayman tourism research in economic environs and society, north-west university accepted: july 2013 this exploratory study aimed to determine firstly the non-consumptive value of five marine species (whales, the great white shark, penguins, dolphins and seals) and secondly the sociodemographic and behavioural variables that influence willingness to pay to see these species. this was achieved by means of a structured questionnaire survey conducted at table mountain national park, the largest urban national park in south africa. the data consisted of responses to 319 fully completed questionnaires. these were analysed using factor analysis and ordinary least squares (ols) regression analysis. the results showed that the variables influencing willingness to pay differed from species to species, with the biggest differences being found in behavioural rather than sociodemographic variables. in showing how much respondents were willing to pay to see the various species and which species they preferred, the results also highlighted the non-consumptive value of the species. key words: factor analysis, marine tourism, non-consumptive value, regression analysis, urban park, willingness to pay jel: c830, h410, q250 1 introduction south africa is a well-known nature-based tourism destination where tourists travel to see and experience the wide variety of fauna and flora on offer. the country boasts 21 national and more than a hundred provincial parks and conservation or protected areas. the most visited national park is table mountain national park, established in 1998 and attracting more than two million visitors a year. situated at the south-western tip of africa, the park stretches from signal hill in cape town to cape point in the south. its current size is 25 000 hectares, and its jurisdiction extends across 1 000 square kilometres of seas and coastline around the cape peninsula (sanparks, 2011). it is also known for two world-renowned landmarks, namely table mountain (a world heritage site and one of the world’s seven wonders of nature) and the cape of good hope. its diverse and unique fauna offer tourists the opportunity to view a variety of marine species. the focus of this exploratory research is on the park’s marine attractions and specifically tourists’ willingness to pay to see marine species. therefore, one wants to know how much, in monetary terms, a visitor values the sighting of particular species. this type of research has been done in several areas of conservation, environment management and wildlife recreation. however, hay and mcconnell (1979:462) stated in 1979 that “no studies have successfully estimated the net economic value of wildlife watching”. ten years later, wagner (1989) also sounded a plea for more research on this topic to gain a better understanding of the non-consumptive value of different species. an assessment of the latest available literature on the topic reveals that the situation has not changed dramatically (see for example tsi, nij & mühlenberg, 2008). rockel and kealy (1991) emphasise the importance of this area of research when they state that although nonconsumptive wildlife recreation or game watching enjoys wider participation than all hunting and fishing combined, it receives comparatively less attention from scientists. in essence, it is true that the tourism and leisure industries do not know the non-consumptive value of different species, yet managers have to manage abstract sajems ns 17 (2014) no 2:184-193 185 these resources. this is a bit like running a business without knowing the value of the goods and services you are selling. in addition to the above, this paper will explain the sociodemographic and behavioural variables that determine willingness to pay. this information will be useful not only for marketing and managing the park, but also to fill the gap in the literature concerning the nonconsumptive value of marine species. the species under investigation in this study are whales, the great white shark, penguins, dolphins and seals, since these are some of the key species among those protected by this park that tourists have a good chance of seeing. 2 literature review the fastest-growing element of tourism today is nature-based tourism, which includes trips to national parks and wilderness areas. many tourists today want get in touch with nature; for them, nature provides a special holiday experience (kuenzi & mcneely, 2008:156). this is confirmed by numerous studies on this topic (see van der merwe, slabbert & saayman, 2011; kruger & saayman, 2009). opportunities for wildlife viewing are a valuable asset to national parks since tourists are willing to pay a significant amount of money to view particular species of animals and nature in general. moreover, in south africa, as in many other african and developing countries, this type of tourism forms the backbone of the tourism industry. it is a growing segment of nature-based tourism (aziz, radam & samdin, 2010). for wildlife tourism to succeed, the market demand must be realistically assessed in terms of price, quality and type of activities preferred, so as to appeal to the kind of tourists that predominate in the area. wildlife watching covers a wide range of different species. some are easy to access, but getting to see species like the “big five” (i.e. lion, buffalo, rhinoceros, leopard and elephant) is difficult and costly (tapper, 2006:16). little research has been done on the topic of how much tourists are willing to pay for the opportunity to see different species in their natural environment, so there are still questions to be answered. in this regard, lindsey, alexander, mills, romanach and woodroffe (2007:30) state that international tourists visiting south africa are primarily interested in large predators, while local, more experienced wildlife tourists show more interest in bird diversity, plant diversity and scenery, and are less interested in high-profile mammal species. the value of wildlife can be divided into direct or indirect value (chardonnet, des clers, fisher, gerhold, jori & lamarque, 2002:15). the direct value is the consumptive use of wildlife where wildlife resources are directly exploited, for example by means of hunting and fishing. indirect value is the nonconsumptive use of wildlife, which essentially means wildlife viewing, and this value is more difficult to determine (hay & mcconnell, 1979; chardonnet et al., 2002:17). whichever way one looks at it, it is clear that tourists do value the non-consumption or viewing of species and it is likely that they place different values on different species. various studies have been conducted on different aspects of wildlife and environmental management as well as wildlife-associated recreation. examples include the work of hay and mcconnell (1979), chae, wattage and pascoe (2012), park, bowker and leeworthy (2002), leeworthy, wiley, english and kriesel (2001), rockel and kealy (1991), tongson and dygico (2004), and zawacki, marsinko and bowker (2000) on wildlife recreation, swanson (1994) and alexander (2000) on the economics of extinction, skonhoft (1998) on the conflict between african conservation and agriculture, and muchapondwa, carlson and kohlin (2008) on managing elephants in zimbabwe. these and several other studies do not, however, address the question raised by this research. the only similar studies are those by hadkler, sharma, david and muraleedharan (1997), tsi et al. (2008), aziz et al. (2010), tisdell and wilson (2001), and wilson and tisdell (2001). however, of these studies, it was only tisdell and wilson (2001) who did research on marine species, namely sea turtles. therefore, much more needs to be done in this regard. a review of the literature revealed three methods of assessing willingness to pay for wildlife viewing (spash, 2000). the first is the travel cost method, which is used to estimate the economic use values associated with the 186 sajems ns 17 (2014) no 2:184-193 particular animal (zawacki et al., 2000; king & mazzotta, 2000). this method uses a costbenefit analysis based on three factors, namely changes in access cost, the establishment or abolition of recreational sites, and changes in the environmental quality of a particular site. it establishes visitors’ willingness to pay by assessing the number of trips they make when one or more of these factors change (zawacki et al., 2000; king & mazzotta, 2000). the travel cost method was not considered ideal for the present study because it is based on the following two assumptions: (i) that people will respond to changes in travel cost in the same way as to a change in the cost of entrance permits (this is not always the case), and (ii) that a person travels for a single purpose (should a person visit another destination, then the value of the original destination would be overestimated). the second method, which was also not considered ideal, is the hedonic price method, which uses the price of goods with different measurable characteristics in order to determine the price of each item (gundimeda, 2005; hanley & spash, 2003). this method is commonly used to set house prices by determining willingness to pay for each characteristic of a house. the third method, which is the one used in this paper, is the contingent valuation (cv) method. according to spash (2000), the contingent valuation method has risen to prominence among the three methods mentioned above. this method is commonly used to determine the economic value of new market environmental attributes or services (king & mazzotta, 2000). it can apply both non-use and use values of environmental services and it generally uses a questionnaire or survey. one of the challenges in this type of study remains sample size, which is generally small (du preez, lee & cloete, 2013; hausman, 2012). a review of the literature shows that the main factors influencing willingness to pay are income, age, education, nationality, marital status, number of children, loyalty and donations (see kosz, 1996; hadkler et al., 1997; tisdell & wilson, 2001; tsi et al., 2008; aziz et al., 2010). all these studies showed that both education and income are positively related to willingness to pay, but education more strongly than income. age showed a negative relation to willingness to pay, which implies that older respondents will probably not be willing to pay as much as the younger ones (kosz, 1996; tisdell & wilson, 2001; aziz et al., 2010). hadkler et al. (1997) found the opposite, namely that older respondents are willing to pay more. marital status generally shows a positive relationship with willingness to pay, which is to say that married visitors are willing to pay more than unmarried visitors (aziz et al., 2010; kosz, 1996), while nationality shows a negative correlation, meaning that international visitors are likely to pay more than local visitors (hadkler et al., 1997; aziz et al., 2010). in terms of profession, the higher the visitors’ professional standing, the more likely they are to pay more (hadkler et al., 1997; tisdell & wilson, 2001; aziz et al., 2010). loyalty is also positively related to willingness to pay (kosz, 1996). an interesting finding from the literature is that people who make donations to conservation causes show less willingness to pay (kosz, 1996; hadkler et al., 1997; tisdell & wilson, 2001). the underlying research questions are: what are the nonconsumptive values of the different marine species? and what are the sociodemographic and behavioural variables influencing willingness to pay to see these species? based on the literature review, the following hypotheses will be tested. hypothesis 1 there is a positive relationship between income and willingness to pay. hypothesis 2 there is a positive relationship between education and willingness to pay. hypothesis 3 married people are willing to pay more. hypothesis 4 foreigners show a higher willingness to pay. hypothesis 5 a loyal customer is willing to buy more. sajems ns 17 (2014) no 2:184-193 187 3 method of research the method will be discussed under the following headings: the questionnaire, sampling method and survey and statistical analysis. 3.1 the questionnaire the survey used a five-section questionnaire adapted from tisdell and wilson (2001) and aziz et al. (2010). the guidelines for performing cv studies by the noaa report were also followed (see arrow et al., 1993). section a elicited the respondents’ sociodemographic particulars (gender, age, home language, marital status and province of residence), section b their spending behaviour, section c their perception of the park’s facilities, section d their reasons for visiting the park, and section e how they rated the park’s marine species and what rand (r) value they would place on them. in determining the value they would place on marine species, respondents could allocate any amount, making this an open question. the questionnaire was pretested with a group of ten people in order to determine whether the questions were clearly understood by the respondents. 3.2 sampling method and survey all tourists who visited table mountain national park during the period of the survey, 18 to 22 august 2011, formed part of the sample and were requested to complete the questionnaire. fieldworkers distributed the questionnaires to visitors at the three key points in the park: table mountain cable station (n=123), boulders beach (n=154) and the cape of good hope (n=42). a total of 319 fully completed questionnaires were used in the statistical analysis. based on the total number of visitors (152 233) to the park during august, this provides a 5.5 per cent margin of error with 95 per cent certainty. forty-three per cent of the respondents were nationals and 57 per cent were international visitors; according to a report by kruger, scholtz & saayman (2012), table mountain national park attracts more foreign visitors than locals. therefore, the profile of the respondents, if compared with results obtained in the research conducted by kruger et al. (2012) over a couple of years, is a good representation of visitors to this park. 3.3 statistical analysis the data were captured using microsoft© excel© and analysed using ibm spss (spss inc, 2010). the statistical analysis was done in three stages. firstly, the data from the survey were pooled. secondly, a principal factor analysis with oblimin rotation and kaiser normalisation was performed on the 40 items that determined the reasons for visiting the park. all items with a factor loading above 0.4 were considered as a contributing factor, since, according to field (2006), for a sample size above 300, one could use factor loadings above 0,3. all reliability coefficients (cronbach’s alpha) were captured to estimate the internal consistency of each factor and all factors had a reliability coefficient above 0.6, which again, according to field (2006), is acceptable for this kind of research. from the factor analysis, eight factors were identified and labelled as facilities (4.21), amenities (4.26), activities (1.95), learning (3.36), attraction (2.98), family and friends (2.76), escape (2.98) and nature experience (3.42). the numbers shown here in brackets are the mean values of the factors. these explained 70.35 per cent of the variance. in the third stage of the analysis, these factors were used as variables in an ordinary least squares (ols) regression analysis. the five species were used separately as the dependent variable in order to discover which variables determined willingness to pay. wooldridge (2009:45) explains that the main reason for incorporating natural logarithms into a model is to impose a constant percentage effect of independent variables on the dependent variable. 4 results this section describes first the findings pertaining to respondents’ preferences for the five species and then the regression analysis of the species separately. respondents first indicated their preference, by rating the species on a scale of 1 to 5, and then indicated how much they were willing to pay to see these animals, by allocating a specific amount per species. table 1 shows 188 sajems ns 17 (2014) no 2:184-193 that the preference of the five species was ranked from most popular to least popular as follows: whales, the great white shark, penguins, dolphins and then seals. when it came to the non-consumptive value, whales were rated significantly higher than sharks, penguins, dolphins or seals. in one case (i.e. the great white shark), there is a difference between preference and willingness to pay. the second analysis entailed a deeper investigation into what drives these differences. this was done by means of regression analysis. table 2 below shows the regression coefficient and the standard error in brackets. table 1 results of visitors’ willingness to pay for marine animals animal animal popularity rand value allocated (average) animal ranking (popularity) most popular very popular popular less popular least popular animal ranking (rand value) whale 1 40% 29% 14% 10% 7% r 322.37 1 penguin 3 23% 17% 21% 26% 13% r144.22 2 great white shark 2 32% 20% 13% 12% 23% r131.44 3 dolphin 4 15% 18% 28% 28% 11% r99.32 4 seal 5 5% 16% 18% 20% 41% r95.29 5 table 2 results of the regression analysis of the five marine species separately variable whale great white shark penguin dolphin seal (constant) 5.501 4.974 2.302 3.226 0.107 age .020 (.191) .027 (.233) .020 (.208) -.003 (-.032) .019 (.171) gender -.728 (-.330) -.845 (-.353)** -.153 (-.071) -.092 (-.044) .045 (.020) factor analysis facilities .216 (.128) -.629 (-.343) -.541 (-.325) -.050 (-.031) .500 (.293) amenities -1.024 (-.505)*** -.902 (-.417)** -.161 (-.080) -.711 (-.374)** -.784 (-.392)** activities -.050 (-.039) .240 (.178) -.033 (-.028) .025 (.021) .071 (.057) learning .742 (.491) 1.351 (.827)** .727 (.491) .922 (.646) .710 (.463) attraction -.086 (-.085) -.157 (-.142) .050 (.050) -.143 (-.143) -.114 (-.110) family and friends -.100 (-.094) -.232 (-.204) .171 (.172) .230 (.238) -.009 (-.008) escape -.069 (-.068) -.119 (-.111) .264 (.266) .152 (.158) .275 (.272) nature experience .115 (.087) .409 (.290) -.376 (-.291) -.214 (-.162) -.202 (-.143) language (comparator afrikaans) other .679 (.296) 1.014 (.411) .629 (.282) -.015 (-.007) .568 (.248) english .104 (.047) .947 (.394) .086 (.039) -.250 (-.119) .613 (.274) marital status (comparator single) living together -.554 (-.202) -1.257 (-.419)** -.173 (-.063) -.324 (-.125) -.374 (-.136) married .066 (.029) -.178 (-.074) -.618 (-.281) -.470 (-.221) -.386 (-.171) continued/ sajems ns 17 (2014) no 2:184-193 189 variable whale great white shark penguin dolphin seal province (comparator western cape) province other -.561 (-.219) -1.388 (-.519)* .659 (.264) .367 (.154) -.699 (-.274) other countries vs south africa .405 (.175) .800 (.324) -.691 (-.307) -.819 (-.377) .091 (.039) education (comparator matric) diploma/degree .266 (.112) -1.116 (-.431) -.419 (-.179) .459 (.199) -1.010 (-.417) postgraduate .903 (.386) -.554 (-.222) -.315 (-.139) .718 (.327) -.545 (-.231) professional .104 (.042) -1.506 (-.564) -.165 (-.068) .484 (.210) -.652 (-.261) income (comparator<r20 000 p.a.) r20 001-r140 000 -.996 (-.272) .077 (.018) -.907 (-.213) -.595 (.900) -.439 (-.116) r140 001-r221 000 -.465 (-.142) .759 (.219) -.020 (-.006) -.081 (-.027) .194 (.058) r221 001-r305 000 .483 (.160) 1.451 (.436) .701 (.241) .749 (.271) 1.428 (.470) r305 001-r431 000 -.430 (-.142) .406 (.127) .132 (.047) -.117 (-.042) -.174 (-.060) r431 001-r552 000 -1.526 (-.357)** -1.147 (-.254) -.285 (-.073) -.476 (-.118) .377 (.092) >r552 000 .196 (.076) .556 (.200) .423 (.169) .211 (.087) .259 (.099) initiated visit to park wild card 1.025 (.312)** .360 (.108) .882 (.293) 1.063 (.385)** 1.358 (.428)** member of conservation organisation -.725 (-.263)** -.344 (-.115) -.501 (-.183) -.087 (-.034) -.785 (-.286) where did you hear of park? website .210 (.090) -.258 (-.105) -.033 (-.014) .234 (.107) -.037 (-.016) shows .824 (.282) 1.021 (.330)* .563 (.194) 1.001 (.350)** 1.315 (.449)** friends -.287 (-.126) -.184 (-.075) -.141 (-.063) -.308 (-.145) -.338 (-.146) radio 1.342 (.203) 2.073 (.298) 1.149 (.174) .154 (.025) 1.632 (.258) tv -1.132 (-.288)** -.967 (-.233) -.079 (-.022) .352 (.764) .055 (.013) magazines .069 (.030) -.033 (-.013) -.431 (.190) .503 (.229) 1.112 (.472)** sanparks -.223 (-.079) -.232 (-.078) -.201 (-.073) -.564 (-.217) -1.399 (-.510)** previous visits -.495 (-.164) -.323 (-.095) .659 (.227) .120 (.205) .771 (.254) facebook -.561 (-.153) -.722 (-.174) -1.756 (-.480)** -.473 (-.127) -.557 (-.147) twitter -1.433 (-.302) -1.1435 (-.250) -.375 (-.079) -.830 (-.161) -.360 (-.069) internet blogs 1.332 (.484)** 1.152 (.373)* 1.102 (.413)** .774 (.305) .850 (.310) r2 0.663 0.625 0.533 0.578 0.684 adj r2 0.251 0.116 0.012 0.061 0.183 *p<0.01; **p<0.05 190 sajems ns 17 (2014) no 2:184-193 analysing the sociodemographic characteristics of visitors in relation to the five species, we can see from table 2 that it was only in the case of the great white shark that males were more willing to pay than females. the same applies to people/couples living together and those living in the western cape province who are willing to pay more to see the great white shark. therefore, this research rejects hypothesis 3 in that the fact that people were married was not found to be positively correlated with willingness to pay. in addition to this, the research finds little support for hypothesis 2, since no relationship was found between education and willingness to pay. an interesting finding is that there is no clear relationship between willingness to pay and income, with only one income category being moderately significant. therefore, hypothesis 1 is also rejected. another interesting finding is that this research also rejects hypothesis 4, since foreigners who make up the largest percentage of the sample are clearly not willing to pay more than locals. looking at behavioural characteristics, one can see that visitors who are motivated by the park’s amenities show a negative relationship with willingness to pay more and were therefore more willing to pay for what the park offers in terms of other attractions and hiking trails than to see whales, great white sharks, dolphins and seals. visitors with a wild card (loyalty card) were also willing to pay more (in the case of whales, dolphins and seals), thereby confirming hypothesis 5. in contrast to wild card members, not all members of conservation organisations or agencies were willing to pay more. it was interesting to note that those who had heard about the park on facebook were not willing to pay more in the case of penguins, and that shows, magazines and internet blogs as marketing tools showed a positive relationship with willingness to pay. the results also show the r-square and adjusted r-square of the regression analysis. for all five species, more than 50 per cent of the variance in willingness to pay is explained by independent variables. in all the regressions, the adjusted r-squares are much lower. this is to be expected since the adjusted r-square penalises one for each variable included. the analysis tested various hypotheses, which resulted in a large number of independent variables, which were retained in the equations. 5 findings and implications the first major finding is that visitors are willing to pay more to see the supposedly less important species than the large predators that lindsey et al. (2007) say are the main interest for international visitors. results show that there is a demand to see these marine species and a willingness to pay for the experience, by both national and international visitors, thereby confirming the non-consumptive value of these species, as indicated in table 1. this implies that the park should not only promote these species, but should also offer visitors the opportunity to experience them. an interpretation centre that provides more detail and information on these species would also be advantageous in promoting them, especially the whales, great white shark, dolphins and seals. there is an interpretation centre for penguins at boulders. secondly, it is also interesting to find that visitors are willing to pay significantly more to see whales than to see the other four marine species. penguins are the second most favoured, followed by the great white shark, dolphins and seals. a possible reason for the high interest in penguins is that the visitor is guaranteed to see them, since the park offers a facility (boulders beach) where they live and breed. in addition, international visitors visit all three key points where the surveys were conducted; and therefore they would probably all be able to see penguins at close range at boulders beach. interpretation of these species also takes place at boulders. the implication of the findings is that offering trips to see these species, especially whales, is a tourism option that management at table mountain national park should strongly consider. the third finding is that the variables influencing willingness to pay for the five species produced a mixed bag of results and that several variables influence willingness to pay. most of the variables that influence willingness to pay are behavioural rather than sociodemographic. in fact, when one compares the five species it is difficult to detect a pattern. this proves that factors that influence sajems ns 17 (2014) no 2:184-193 191 interest in one species cannot be seen as applicable to another. the reason for this is probably the uniqueness of each species and the differences in the likelihood of seeing a particular species. in contrast to findings mentioned in the literature review (tisdell & wilson, 2001; tsi et al. 2008; aziz et al. 2010), this research does not confirm that income influences willingness to pay, and therefore this study does not clearly support research by tisdell and wilson (2001), tsi et al. (2008) and aziz et al. (2010). in terms of age, the results are inconclusive. again, this research contradicts previous work done by kosz (1996) and aziz et al. (2010), but supports research by hadkler et al. (1997). gender was found to be a positive variable only in the case of the great white shark. marital status, specifically as regards couples living together, was found to be significant in the case of the great white shark. for the other species, it was inconclusive, thereby contradicting kosz (1996) and aziz et al. (2010). in no case did being married appear to be a significant variable that influenced willingness to pay and since no previous studies have applied all the categories of marital status it is difficult to make a comparison. there was no significant relationship for nationality (other countries versus south africa), thereby contradicting research by hadkler et al. (1997) and aziz et al. (2010), who found that foreigners are willing to pay more than locals. this research confirms research done by kruger et al. (2012), who indicated that foreign visitors to national parks in south africa spend less than local tourists do. higher levels of education did not appear to be positively correlated with spending either. loyalty was found to show a positive relationship, thereby confirming results by kosz (1996). this research also confirms that in the case of whales visitors who belong to conservation organisations are less willing to pay more. a very interesting finding is that, in the case of whales, the great white shark, dolphins and seals, respondents who are motivated by amenities in the park are willing to pay less to see these species. the amenities that the park offers, such as hiking trails and other activities, are greater attractions and a possible reason for this is that those species are more difficult to see than penguins or that there is not sufficient opportunity to spot them or respondents do not know enough about them or how they should go about seeing them. therefore, park managers should create more opportunity for visitors to see and experience these species. 6 conclusion if one asks whether visitors value (in monetary terms) marine species such as whales, the great white shark, penguins, dolphins and seals, the answer is clearly yes. this study showed, however, that the monetary or nonconsumptive value that visitors attach to the different species differs according to the type of visitors and that several variables influence willingness to pay. these variables also differ from species to species. this is the first time that the non-consumptive value of these marine species has been determined. this innovative research therefore makes an important contribution to understanding the non-consumptive value of marine species and the variables influencing willingness to pay, although it is exploratory. it shows that much more research is still needed on the nonconsumptive value of species. in this regard, this research echoes hay and mcconnell’s (1979) and wagner’s (1989) plea for more research on this topic. this research rejected four of the hypotheses and confirmed one. it clearly shows that the variables influencing willingness to pay differ significantly from one species to the next. an interesting study would be to determine which species would create the optimum demand. this would help conservation organisations to make it possible for visitors to experience them. another possibility would be to determine to what extent interpretation such as information brochures, pamphlets and oral presentations as well as environmental education would contribute to willingness to pay. a limitation of this study is that a larger sample size would be preferable. however, this study is seen as exploratory, since willingness to pay has not been determined for these species. 192 sajems ns 17 (2014) no 2:184-193 acknowledgements the author would like to acknowledge sanparks and specifically mr. glenn phillips and bheki zwane for financial assistance, 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non-consumptive wild-associated recreation in the united states. forest science, 46(4):496-506. microsoft word 5 hsiao et al si(16) 2013.docx 42 sajems special issue 16 (2013) : 42-53 effects of office space and colour on knowledge sharing and work stress luke hsiao department of public policy and management, i-shou university ming-chi hsiao department of tourism management, taiwan shoufo university yu-lan wang* kaohsiung extension education, taiwan shoufo university with the aid of empirical research, this study aims to verify the effects of the variables office space and colour on knowledge sharing and work stress. taking the domestic technology industry as the research sample, purposive sampling was applied in a questionnaire survey. three hundred and sixty-eight questionnaires were distributed to a total of 14 technology companies in the hsinchu and southern taiwan science parks. after 21 invalid responses had been removed, 347 valid copies were retrieved. reliability analysis, factor analysis and hierarchical regression were used to analyse the data. the research outcomes show the significant effects of office space and colour on knowledge sharing and work stress among employees. based on the outcomes, certain conclusions and suggestions are proposed. key words: office space, colour, knowledge sharing, work stress, role conflict, role ambiguity, intention, organisation, technology industry, work load jel: m100 1 introduction time magazine (2006) reported on the office design at google where an office is a playground and the relaxing atmosphere is purposively designed to allow employees to take a nap at anytime and bring pets along, and the offices of some female employees look like toy shops. chang and han (2006) indicate that colour in an indoor environment could have a psychological effect on people’s sense of wellbeing, balance, visual aesthetics and stability. with regard to the planning of office space, harrar (1999) mentions the importance of places and conditions when it comes to knowledge sharing among the employees in an organisation. numerous hierarchies have resulted in a lack of adaptation and flexibility, as the employees are arranged in a narrow area with a hierarchic gap across which communication has to take place. this is unfavourable for face-to-face exchanges and knowledge sharing. employees at an enterprise should have a space for free exchange and open communication so as to reduce the cost of knowledge sharing. independent research showed that offices were considered to be one of the three primary factors in job satisfaction (heather, 2003) and therefore people should pay attention to the issue of office planning. knowledge sharing does not automatically occur in an organisation. hanson (2002) states that knowledge is asymmetricin an organisation where the knowledge flow depends on individual intention. with regard to behaviourism, it should be noted that personal traits, motives, cognition and environmental characteristics could all affect individual behaviours and intentions. moreover, knowledge sharing is restricted as regards channels. an informal mechanism, a so-called pantry and chat room culture, refers to the knowledge exchange and sharing that is apparent when employees converse and chat in abstract sajems special issue 16 (2013) : 42-53 43 informal places. moreover, in relation to the infra-structure of knowledge sharing capability and the sharing of confidences, the provision of a space for interaction and networking in a wide area influences the effectiveness of knowledge sharing. kenneth and julie kendall (1981) pointed out the importance of position, space and colour in the physical environment of office design, stating that they could influence individual and organisational decisions. this study explores the benefits for knowledge sharing of designing a favourable office in an organisation with various colour and space compositions and further attempts to improve management and research methods. 2 literature review and research hypotheses 2.1 office space chang (1995) mentions, in architectural and environmental psychology, that people at higher levels, such as chairmen of the board, bosses and managers, possess personal rooms, while section chiefs and the general staff are spread around a large room. in office design, the size of an individual’s space is determined by hierarchy, egalitarianism and function (downey, 2004). office staff seem to have a psychological preference for small office spaces. from the perspective of interaction and work autonomy, duffy, a british architect, classifies the interior office layout into hives, cells, dens and clubs (chiang, 2000). in addition to individual work space, public space is incorporated into the working environment of the organisation as a whole. public space does not simply provide sufficient meeting rooms or libraries for the staff to confer with each other. the public space as it relates to individual staff (such as a gym or a smoking room) could also help to promote job satisfaction and enhance staff cohesion. according to the 2003 investigation by today magazine conducted in the uk, most british managers were not satisfied with their current workplaces and 53 per cent of them expected the companies to provide fitness equipment, 41 per cent indicated restaurants, and 27 per cent mentioned shower rooms. this is an indication that employees have certain demands for space that are unrelated to the job (anonymous, 2003). 2.2 colour kenneth and julie kendall (1981) suggested that using bright colours on walls in office design could encourage spontaneity and attention to work. colour is a basic element of indoor form that not only creates visual perceptions but also reveals the actual functions of 1. personality presentation; 2. light regulation; 3. space adjustment; 4. match of activities; and 5. climate adaptation (wang, 1993). with regard to space adjustment, deng and weng (1991) and kuo (2006) propose colour conditions to create a comfortable space that would lend itself to a relaxed working environment. the aims of the use of colour are: 1. select the correct lighting and appropriate colours to reduce unnecessary eye strain. 2. maintain pleasant living conditions to enhance the desire to work. 3. promote wellbeing by using colours to enhance security. liu (2006) also states that a more comfortable and favourable interior environment could be created and work efficiency could be promoted by fully utilising colour. some colours are strong (dark colours with high chroma), and others are light. cold colours suggest tranquillity more than warm colours do. pure colours are temperate and are suited to privacy and static activities. in contrast, colours which are strong and active correlate with groups and dynamic activities (wang, 1993). chiu (2012) discovered that demographic variables affect the participants’ preferences. the commonest colours for office space appeared to be achromatic colours, shades of orange and shades of blue; men preferred achromatic colour, and women were in favour of shades of blue. in the face of the development of information technology and the emphasis on humane issues, colours also reflect mobility, dynamism and personalisation. the above literature revealed that the application of colour in the office affects the staff’s work efficiency and the application of that demographic can influence colour preferences. 2.3 work stress stressors, the cause of work stress, are the stimuli that cause a person to feel stress. such 44 sajems special issue 16 (2013) : 42-53 stimuli may originate from interaction with other people, daily activities or individual inner thoughts (lin & ensel, 1989). when a person experiences stress, he or she could face life in a positive manner, or he or she might become depressed, be unable to deal with the stimuli which destroyed the harmony in life, and display abnormal psychological, physiological and behavioural states. such stimuli, which cause individuals to perceive pressure, are regarded as stressors (lai, 2001). with regard to the sources of work stress, ivancevich and matteson (1980) propose the following classification: 1. physical environment; 2. individual; 3. group; 4. within the organization; 5. out of the organisation. according to the stress model proposed by robbins (2001), stress could manifest as physiological symptoms, psychological symptoms or behavioural symptoms. physiological symptoms include headaches and hypertension. psychological symptoms cover anxiety, depression and reduced job satisfaction. behavioural symptoms include changes in productivity, absences from work and resignation. work stress manifests as extreme effects on individual physical health and the overall performance of an organisation. for individuals, discontentment, low self-esteem and anxiety are likely to be the psychological symptoms experienced, while headaches, raspiness, gastric acid, hypertension and heart attacks are the physiological manifestations (chiu, 1994). research findings have showed that the higher work stress of employees in hitech industries can worsen depression. among the perceived sources of work stress, stress from physiological responses and psychological responses appeared the strongest, causing a reduction in well-being (liu & wang, 2009; lee, chen & lai, 2012). 2.4 knowledge sharing intention liu, yung-lun (2003) defined knowledge sharing as the imparting and absorption of knowledge. grant (1996) regarded knowledge diffusion as dependent on common knowledge in that the higher the level of common knowledge, the higher the knowledge sharing intention. common knowledge was further divided into the following: 1. common language; 2. communication symbols; 3. universal or special know-ledge; 4. the meaning of sharing; 5. the understanding of the individual knowledge field. grant (1996) investigated the exclusivity of knowledge and the knowledge diffusion channels that could be effectively used where capabilities and the intention to share know-ledge exist. in the past, knowledge was accumulated by the staff, but not systematically recorded. even if written records were kept, retrieval was considered complex, which obstructed knowledge diffusion. generally speaking, a company could diffuse individual knowledge to other members of staff through project teams and teamwork so as to enhance the knowledge sharing intention. elsbach and bechky (2007) suggest that office design could support the intention to share knowledge, and office space design could enhance social interaction between individuals and groups. office decorating could improve the performance of organisational groups. as a result, office design affects knowledge sharing from the dual perspectives of people and organisations. employees in positions where they exercised a high measure of control in hitech industries showed greater willingness to share knowledge, which revealed positive relations with organisational justice and work values (chen, 2004; hua, 2009). 3 research hypotheses an enormous space could create unnecessarily high operational costs for an organisation. with the industrial and commercial development of recent years, individual work stress has increased and heavier physiological and psychological workloads have affected work efficiency. among the factors causing work stress, ivancevich and matteson (1980) point to physical working environments as one of the stress factors. tang, chen and chen (2002) indicate that noise, inadequate lighting and crowded working space in a working environment could be sources of work stress and influence work efficiency. accordingly, the following hypothesis is proposed: hypothesis 1: office space has a significant effect on work stress on the basis of well-known behaviourist theories (theory of planning behaviour, tpb), lin (2005) concludes that there are complicated sajems special issue 16 (2013) : 42-53 45 factors such as environmental factors and infra structure that affect sharing and when an organisation provides interactive space and venues this could also affect confidence in knowledge sharing capability. hou (1984) conducted inter national research on work stress and classified the stressors into three dimensions, which included the physical working environment. on the basis of the above literature studies, the following hypothesis is further proposed: hypothesis 2: office spacehas notable effects on knowledge sharing intention in terms of behaviourism, knowledge sharing intention could influence knowledge sharing behaviour, together with individual cognition, environmental characteristics and behavioral expectations, which would affect behavioural intentions (lin, 2005). according to the stress model proposed by robbins (2001), stress affects physiological, psychological, and behavioural symptoms, where psychological symptoms include anxiety, depression and lower job satisfaction. behavioural symptoms include productivity change, absence from work and resignation. lan (2000) conducted research related to the effects of stress on individuals and organisations that reported absenteeism, poor interpersonal interaction, a high turnover rate, low work efficiency, low morale, high accident rates and job dissatisfaction, all of which have an influence on an organisation. work stress was shown to have negative effects on psychological functioning, behaviour and cognition (lan, 2000). the following hypothesis is further proposed: hypothesis 3: work stress shows remarkable effects on knowledge sharing intention regarding interior design, liu (2006) suggests that finding the right colour-temperature could help fine-tune the design of a space with a specific atmosphere, and colour distance would change the proportion of a space pattern. in an experiment he conducted louis cheskin recorded excitement, with increasing blood pressure and pulse rates, in a bright-red room and lost production with decreasing blood pressure and pulse rates in a cyancoloured room, where feelings of depression and confusion were generated so that the work was not completed in time. the brightness in a yellow room tired the eyes, but there were no changes in blood pressure. normal reactions were recorded in a green room. however, the monochromatic green colour was rather dull and lifeless and some stimulation was found to be necessary (hiroshi ohchi, 1991). some research also proved that being in a highchroma and high-brightness working environment could easily result in nervousness and an inability to relax. chiu (2012) pointed out the effects of demographic variables on colour preferences. accordingly, the following hypotheses are proposed in this study: hypothesis 4: colour appears to have anotable moderating effect on the relations between office space and work stress lin (2005) mentions the effects of the environment factor on knowledge sharing intention. chang and han (2006) indicated that colour in an interior environment could have the psychological effect of triggering a pleasant sensation, balance and visual aesthetics, and represent stability, while different colours could cause distinct sensations, such as tranquillity, liveliness, pleasure, excitement, depression, coldness and warmth. colour has two effects on interior design. (1) it could optimise a person’s mental processes to enhance physiological functions. for instance, a person working in a room decorated in a cool colour appears to be more efficient than someone in a room done in a warm colour. (2) colour can release spiritual and physical pain. in consequence, by carefully applying colour in interior design, it is possible to plan an excellent office and create a more favourable workplace so as to successfully share and diffuse knowledge. on the basis of the above literature, the following hypothesis is proposed: hypothesis 5: colour has a significant moderating effect on the relation between office space and knowledge sharing. 46 sajems special issue 16 (2013) : 42-53 4 research method 4.1 research framework figure 1 research framework 4.2 research tool and samples the domestic technology industry was selected as the research subject. with purposive sampling, the reliability of the questionnaire pretest reached 839. questionnaires were distributed to a total of 14 technology companies in hsinchu science park and southern taiwan science park. of the 368 copies collected, 21 questionnaires were removed, leaving 347 valid copies. 4.3 factor and reliability analyses the research dimensions in this study were office space, colour, work stress and knowledge sharing intention, and construct validity was tested with the aid of factor analysis. with the aid of principal component factor analysis and the varimax rotated solution, the major factors were extracted, where spaciousness, initiative, and public space were the factors in office space, with the accumulated variance explaining 78.651 per cent. two questions on brightness and saturation were included under colour. work load, role conflict and role ambiguity were the factors in work stress, with the accumulated variance reported as 67.380 per cent. the variance explanation of knowledge sharing intention was 67.493 per cent, after factor analysis (varimax rotated solution). cronbach’s α was further applied to the reliability analysis for an overall reliability α=.845, and the questionnaire design was found to be favourable. analysis 1 this study covered the four dimensions of office space, colour, work stress, and knowledge sharing intention with nine variables of spaciousness, initiative, public space, work load, role ambiguity, role conflict, knowledge sharing intention, brightness, and satura tion. the pearson product-moment correlation analysis was used to test the dimensions; the correlations among the variables are listed in table 1. analysis of effects among dimensions theoretically, office space, colour and work stress were multiple compositions and hierarchical regression analysis was utilised to test the correlations among the variables. regarding the moderating effect of colour, hierarchical regression analysis, as suggested by wang (2002), was applied to test the hypotheses. colour workstress knowledge sharing office space h2 h1 h4 h5 h3 sajems special issue 16 (2013) : 42-53 47 1 effects of office space on work stress with work load as the dependent variable and when controlling the demographic variables, ∆r2=.023 and p>.05, table 2, model ii, showed no notable relations between office space (spaciousness, initiative, public space) and work load. table 1 pearson correlation coefficients of the research variables mean standard deviation 1 2 3 4 5 6 7 8 9 1 spaciousness 3.0528 .97435 (.773) 2 initiative 3.1124 1.14563 .391** (.801) 3 public space 3.7594 1.18962 .299** .238** (.829) 4 work load 3.9316 .67535 .119* .072 .156** (.775) 5 role ambiguity 2.5000 .82676 -.254** -.118* -.275** -.309** (.620) 6 role conflict 3.2594 .88933 .091 .148** .022 .126* .073 (.593) 7 knowledge sharing intention 4.0304 .67136 -.027 .149 ** .190** .271** -.259** -.143** (.946) 8 brightness .6513 .47725 .367** .281** .295** .148** -.293** .074 .118* (.639) 9 saturation .5014 .50072 .271** .292** .223** -.044 -.028 .171** -.044 .298** note: ** stands for p<.01, * for p＜.05; α in shown in ( ) table 2, model ii, shows that the correlations between role ambiguity and office space achieved statistical significance (∆r2=.092, p<.05), with role ambiguity as the dependent variable and the demographic variables being controlled. role ambiguity and spaciousness demonstrated negative relations with public space (β=-.176, β=-.212, p<.05). the initiatives did not achieve statistical significance (β=.004, p>.05). when role conflict was treated as the dependent variable and the demographic variables were controlled, the correlations between role conflict and office space reached statistical significance (∆r2=.023, p<.05). role conflict and the initiatives revealed notably positive relations (β=.130, p<.05) but spaciousness and public spaces did not achieve statistical significance (β=.051, β=-.016, p>.05) for table 2, model ii. table 2 regression analysis of office space and work stress dependent variable work load role ambiguity role conflict independent variable model i model ii model i model ii model i model ii control variable β β β β β β gender -.073 -.054 .024 -.020 -.039 -.036 age -.017 -.009 .048 .029 -.020 -.009 top education .094 .075 -.177 -.131 -.090 -.087 work experience -.024 -.032 -.113 -.101 .007 -.016 predictionvariable spaciousness .059 -.176** .051 initiative .034 .004 .130* public space . 107 -.212*** -.016 r2 .020 .043 .037 .129 .008 .031 adj r2 .009 .023 .025 .111 -.003 .011 ∆f 1.780 2.632 3.259 11.943*** .703 2.687* sig.of f .0132 .050* .012 .000 .590 .046 note: *p<.05, **p<.01, ***p<.001。 48 sajems special issue 16 (2013) : 42-53 2 effects of office space on knowledge sharing a knowledge sharing intention can be a dependent variable and the demographic variables can be controlled. the correlations between office space and knowledge sharing showed statistical significance (∆r2=.063, p<.05), where initiative, public space and knowledge sharing intention showed remarkably positive relations (β=.152, β=.199, p＜.01), but spaciousness and knowledge sharing intention exhibited significantly negative relations (β=-.129, p<.05) in table 3, model ii. table 3 regression analysis of office space and knowledge sharing intention dependent variable knowledge sharing intention independent variable model i model ii control variable β β gender .010 .021 age .261 .255 highest education .024 .017 work experience -.067 -.069 prediction variable spaciousness -.129* initiative .152** public space .199*** r2 .052 .115 adj r2 .041 .096 ∆f 4.693** 7.933*** sig.of f .001 .000 note: *p<.05, **p<.01, ***p<.001。 3 effects of work stress on knowledge sharing with the knowledge sharing intention as the dependent variable and when the demographic variables were controlled, the correlations between work stress and knowledge sharing achieved statistical significance (∆r2=.141, p＜.001).work load and knowledge sharing intention showed remarkably positive relations (β=.250, p＜.001), but role ambiguity, role conflict and knowledge sharing intention presented notably negative relations (β=-.186, β=-.163, p＜.001), as shown in table 4, model ii. 4 moderating effects of colour on the relations between office space and work stress with work load as the dependent variable and when the demographic variables were controlled, colour (low saturation and low brightness, high saturation and low brightness, low saturation and high brightness) did not display moderating effects on the relations between office space and work load, and no statistical significance (∆r2=-.016, ∆r2=.215, ∆r2=.063, p>.05) was recorded. the moderating effects of colour (high saturation and high brightness) on the relations between office space and work load revealed statistical significance (∆r2=.076, p<.05). this is where the public space and work load displayed significantly positive relations (β=.267, p<.05), while spaciousness, initiative and work load did not reach statistical significance (β=.043, β=.010, p>.05) as shown in table 5, model ii. with role ambiguity as the dependent variable and when the demographic variables were controlled, the moderating effects of colour (low saturation and low brightness) on the relations between office space and role ambiguity did not achieve statistical significance (∆r2=.005, p>.05).the moderating effects of colour (high saturation and low brightness) on the relations between office space and role ambiguity showed statistical significance (∆r2=.318, p<.05), where public sajems special issue 16 (2013) : 42-53 49 space and role ambiguity displayed notably positive relations (β=.107, p<.05). the moderating effects of colour (low saturation and high brightness) on the relations between office space and role ambiguity reached statistical significance (∆r2=.061, p<.05) where spaciousness and role ambiguity presented remarkably negative relations (β=.276, p<.05), but office space (initiative, public space) and role ambiguity did not achieve statistical significance (β=-.020, β=.220, p>.05), as shown in table 6, model ii. table 4 regression analysis of work stress and knowledge sharing intention dependent variable knowledge sharing intention independent variable model i model ii control variable β β gender .010 .027 age .261 .271 highest education .024 -.048 work experience -.067 -.084 prediction variable work load .250*** role ambiguity -.186*** role conflict -.163** r2 .052 .193 adj r2 .041 .176 ∆f 4.693** 19.501*** sig.of f .001 .000 note: *p<.05, **p<.01, ***p<.001。 table 5 regression analysis of the moderating effects of colour on the relations between office space and work stress (work load) colour low saturation and low brightness high saturation and low brightness low saturation and high brightness high saturation and high brightness dependent variable work load independent variable model i model ii model i model ii model i model ii model i model ii control variable β β β β β β β β gender .077 .082 .173 .343 -.290 -.329 -.097 -.150 age -.053 -.037 -.127 .024 -.169 -.061 .097 .064 highest education .186 .216 .036 .131 -.071 -.130 .127 .086 work experience .017 .031 .255 .158 .096 .028 -.159 -.112 prediction variable spaciousness -.092 .407 .104 .043 initiative -.078 .055 .239 .010 public space .018 .176 .036 .267** r2 .037 .053 .059 .274 .077 .140 .056 .132 adj r2 -.011 -.033 -.062 .093 .033 .064 .027 .085 ∆f .762 .452 .487 2.769 1.734 1.933 1.961 3.795 sig.of f .553 .716 .745 .060 .150 .131 .104 .012** note: *p<.05, **p<.01, ***p<.001。 50 sajems special issue 16 (2013) : 42-53 with role conflict as the dependent variable and by controlling the demographic variables, the moderating effects of colour (low saturation and low brightness, high saturation and low brightness, low saturation and high brightness, high saturation and high brightness) on the relations between office space and role conflict did not show statistical significance (∆r2=-.033, ∆r2=.007, ∆r2=.051, ∆r2=-.038, p>.05),as shown in table 7, model ii. table 6 regression analysis of the moderating effects of colour on the relations between office space and work stress (role ambiguity) table 7 regression analysis of the moderating effects of colour on the relations between office space and work stress (role conflict) colour low saturation and low brightness high saturation and low brightness low saturation and high brightness high saturation and high brightness dependent variable role conflict independent variable model i model ii model i model ii model i model ii model i model ii control variable β β β β β β β β gender .058 -.014 -.337 -.290 -.171 -.234 .032 .028 age .053 .028 -.275 -.284 -.098 -.120 -.016 -.009 highest education -.106 -.140 .200 .285 -.367 -.411 .071 .089 work experience -.196 -.239 -.052 -.011 .163 .174 .048 .022 prediction variable spaciousness .123 .264 -.144 .087 initiative .043 .076 .168 .149 public space .180 .131 .086 .025 r2 .041 .074 .262 .332 .130 .181 .007 .045 adj r2 -.007 -.010 .167 .165 .088 .109 -.023 -.006 ∆f .862 .910 2.758 .972 3.110 1.648 .221 1.763 sig.of f .490 .440 .045 .420 .019* .185 .926 .157 note: *p<.05, **p<.01, ***p<.001。 colour low saturation and low brightness high saturation and low brightness low saturation and high brightness high saturation and high brightness dependent variable role ambiguity independent variable model i model ii model i model ii model i model ii model i model ii control variable β β β β β β β β gender .092 .009 -.125 -.344 .153 .100 -.145 -.119 age -.089 -.119 .406 .159 .038 -.064 .037 .032 highest education -.043 -.078 .077 .014 -.237 -.136 -.272 -.221 work experience -.199 -.226 -.351 -.154 -.071 -.005 -.013 -.021 prediction variable spaciousness .181 -.368 -.276* -.204* initiative -.091 -.011 .020 .060 public space .178 .416* -.220 .127 r2 .064 .114 .083 .401 .098 .205 .081 .142 adj r2 .017 .033 -.035 .251 .054 .136 .054 .095 ∆f 1.367 1.438 .701 4.957 2.247 3.607 2.944 3.040 sig.of f .253 .238 .597 .007** .071 .017** .023* .031** note: *p<.05, **p<.01, ***p<.001。 sajems special issue 16 (2013) : 42-53 51 5 moderating effect of colour on the relations between office space and knowledge sharing taking knowledge sharing intention as the dependent variable and when controlling the demographic variables, the moderating effects of colour (low saturation and low brightness, high saturation and low brightness, low saturation and high brightness) on the relations between office space and work load did not reach statistical significance (∆r2=..145, ∆r2=.100, ∆r2=.064, p>.05). the moderating effects of colour (high saturation and high brightness) on the relations between office space and knowledge sharing intention achieved statistical significance (∆r2=.079, p<.05). there were significantly negative relations between office space (spaciousness) and knowledge sharing intention (β=-.203, p<.05), but remarkably positive relations between office space (initiative, public space) and knowledge sharing intention (β=.209, β=.234, p<.05), as shown by table 8, model ii. table 8 regression analysis of the moderating effects of colour on the relations between office space and knowledge sharing colour low saturation and low brightness high saturation and low brightness low saturation and high brightness high saturation and high brightness dependent variable knowledge sharing intention independent variable model i model ii model i model ii model i model ii model i model ii control variable β β β β β β β β gender -.086 .005 .378 .512 .023 -.033 -.011 -.055 age .374 .397 .257 .438 -.046 -.108 .298 .241 highest education .102 .126 .147 .153 .115 .060 -.109 -.083 work experience -.008 .027 .239 .095 .006 .042 -.146 -.099 prediction variable spaciousness -.128 .180 -.192 -.203* initiative .070 -.083 .108 .209* public space .208 .305 .152 .234** r2 .062 .207 .362 .462 .016 .080 .073 .152 adj r2 .120 .135 .280 .327 -.032 .000 .044 . 106 ∆f 3.854. 1.473 4.403 1.724 .331 1.865 2.571 3.980 sig.of f .006** .228 .006** .185 .856 .142 .041* .009** note: *p<.05, **p<.01, ***p<.001。 5 conclusions and suggestions to sum up the research results, the findings were as follows: 1. spaciousness and public space in the office space reveal notably negative correlations with role ambiguity, which indicates that the larger office and public spaces could reduce role ambiguity. 2. spaciousness and initiative in the office and public spaces showed remarkable effects on knowledge sharing intention, with initiative and public space revealing significantly positive correlations. this shows that the higher the initiatives in space design, the higher the knowledge sharing intention. 3. work load, role ambiguity and role conflict in work stress displayed outstanding effects on knowledge sharing intention, with work load showing notably positive correlations. it also reflected a heavier work load and higher knowledge sharing intention. 4. colour (high saturation and high brightness) revealed remarkably positive moderating effects on the relations between office and public space and work load. colour (high saturation and low brightness) showed notably positive moderating effects on the relations between office and public space and role ambiguity. colour (low saturation and high brightness, high saturation 52 sajems special issue 16 (2013) : 42-53 and high brightness) displayed notably negative moderating effects on the relations between spaciousness and role ambiguity. accordingly, the following suggestions are made: 1. although the factors in space allocation depend on the size of the individual space, a larger office could effectively reduce role ambiguity, and office space with higher initiative displays higher role conflict. in this case, high-technology businesses should employ broader and open office space designs to effectively reduce their employees’ work stress. another research outcome indicated that a broader space is unfavourable for knowledge sharing intention. businesses therefore have to consider the degree of knowledge sharing between the staff and balance the two conclusions to achieve optimal space planning without pushing up costs unnecessarily. with regard to the creation of public space, the findings showed that a larger public space was able to reduce role ambiguity and could be preference for a hightechnology industry. 2. colour shows significant moderating effects on work stress and knowledge sharing, and different combinations of chroma and brightness reveal distinct effects on work stress and knowledge sharing. businesses should therefore consult with interior designers when planning colour for the office. in conclusion, a high-chroma space could not effectively reduce work stress, while a high-brightness space could. moreover, the chroma and the brightness of colour appear to have lower effects on knowledge sharing, but a space with high brightness and high chroma could affect knowledge sharing intention. 3. work stress shows remarkable effects on knowledge sharing intention. a higher work load could benefit from knowledge sharing, but not role ambiguity and role conflict. for this reason, a high-technology industry needs its staff to generate favourable knowledge sharing intention under moderate work stress. in contrast, knowledge sharing intention could be enhanced by reducing the employees’ role ambiguity and role conflict. 4. the infrastructure of knowledge sharing is a key factor in knowledge sharing intention. the research findings show that the public space in the office could effectively promote knowledge sharing intention, which indicates the importance of an office of the public space. such a conclusion further supports the need for organisations to provide an interactive space and venues for interaction by employees. it is believed that this study could enhance the emphasis of the high-technology industry on the establishment office of the public space. acknowledgement the authors are grateful to the valuable comments made by the reviewers. *corresponding author contact yu-lan wang, yulan.duker@gmail.com references anonymous. 2003. design to work? new zealand management, oct:56. chang, h. 1995. architectural and environmental psychology. garden city 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wang, c. 2002. relations among knowledge learning, knowledge diffusion, and work performance—a case study on shipping. department of shipping & transportation management, national taiwan ocean university. wang, c. 1993. interior design. taipei: yifongtan books. 28 sajems special issue 16 (2013) : 28-41 a weighted linear combination ranking technique for multi-criteria decision analysis jyh-rong chou* department of creative product design, i-shou university, kaohsiung 84001, taiwan, roc multi-criteria decision analysis (mcda) is an alternative approach, which provides a way to systematically structure and analyse complex decision problems. this study presents a novel method of applying the weighted linear combination ranking technique (wlcrt) to mcda. the proposed wlcrt method is based on the linear combinations of matrix algebra calculations. it has distinct advantages in preference modeling, weight elicitation, and aggregation performance. in this method, the decision matrix of preferences is constructed using a 7-point likert scale. the weights of criteria are elicited from the proximity matrix of preference relations using the eigenvector method. then, the weighted generalised means are used to aggregate preference information as well as to rank the order of decision alternatives. the wlcrt method can flexibly reflect different decision attitudes for the decision maker. it is both technically valid and practically useful, and can be used in dealing with multiple criteria analysis problems involving ranking of alternatives. key words: multiple criteria analysis; weighted linear combination, ranking of alternatives, eigenvector method, weighted generalized means, decision, aggregated values, simple additive weighting, technique, optimisation jel: c020 1 introduction human performance in decision terms has been the subject of active research. decision analysis is the study of identifying and choosing alternatives based on the values and preferences of the decision-maker. it can be regarded as the mental/cognitive process of sufficiently reducing uncertainty and doubt about alternatives to allow a reasonable choice to be made from among them. many realworld decision situations involve multiple attributes in qualitative domains. such situations can be modeled as a multi-criteria decision analysis (mcda) problem that involves making numerous and sometimes conflicting evaluations to come to a compromise in a transparent process. mcda is both an approach and a set of techniques with the goal of providing an overall ordering of options. in mcda, values reflect human preferences and in particular the preferences of the decision maker involved in the specific decision context. mcda have undergone an impressive development over the last 40 years. there are many different mcda methods based on different theoretical foundations, such as optimisation, goal aspiration, outranking, or a combination of these. various sophisticated methods have been developed and used, which include the simple multiattribute rating technique (smart) (edwards, 1971), the analytic hierarchy process (ahp) (saaty, 1980), the technique for order preferences by similarity to ideal solutions (topsis) (hwang & yoon, 1981), the electre methods (roy, 1968), and the promethee methods (brans, vincke & mareschal, 1986). a detailed analysis of the theoretical foundations of different mcda methods and their comparative strengths and weaknesses has been presented in the literature (mollaghasemi & pet-edwards, 1997; belton & stewart, 2002). there are many ways to classify mcda methods. according to the assumptions of preference elicitation and aggregation, mcda methods can be divided into two broad categories. one refers to multi-attribute utility theory (maut) methods (e.g. smart); the other refers to outranking methods (e.g. the electre methods and the promethee methods). outranking methods are based on abstract sajems special issue 16 (2013) : 28-41 29 the principle that one alternative may have a degree of dominance over another (kangas, kangas, leskinen & pykalainen, 2001), rather than the supposition that a single best alternative can be identified. outranking is considered a partially compensatory technique that does not rely upon optimisation. the ordering of alternatives provided by outranking methods may be incomplete since the methods allow for intransitivities in criteria weightings and for alternatives that are not considered comparable. maut methods aim to associate a unique number (value) representing the overall strength of each alternative, taking all criteria into account. the basis of maut is the use of utility functions, whose purpose is to create a mathematical model to aid the decision process. the utility theory is used in decision analysis to transform the raw performance values of the alternatives against diverse criteria to a common dimensionless scale (keeney & raiffa, 1976). it gives decision makers the ability to quantify the desirability of certain alternatives and brings together different considerations in a structured way. compared with outranking methods, maut methods present the advantage of simplicity and transparency, leading to a complete ranking of all the alternatives based on the decision-maker’s preferences. mcda is concerned with structuring and solving decision problems involving multiple criteria and numerical analysis of a set of discrete alternatives. it generally consists of three main operations, namely preference modeling, weight elicitation, and aggregation. preference modeling focuses on capturing the decision maker’s preferences for the specific decision context. there are two types of preferences, namely intra-criterion preferences and inter-criterion preferences. the former is judgements that refer to relative values attached to different levels of performances, while the latter is judgements that refer to the relative importance attached to the information carried by each single criterion. the values of judgements can be in ordinal, interval, or ratio scales. ordinal scales on the overall preference values are sufficient if only the best alternative needs to be selected (choo, schoner & wedley, 1999). decision problems involve criteria of varying importance to decision makers. the criteria weights usually provide the information about the relative importance of the considered criterion. criteria weighting is a complex preference elicitation process, which can be classified in different ways (e.g. algebraic or statistical, decomposed or holistic, direct or indirect, and compensatory or noncompensatory). a variety of different methods for determining criteria weights in mcda have been developed, such as swing method (von winterfeldt & edwards, 1986), trade-off method (keeney et al., 1976), ahp (saaty, 1977), smart (edwards, 1971), and macbeth (bana e costa & vansnick, 1994). many researchers have conducted comparisons among different weighting methods (hobbs, 1980; schoemaker & waid, 1982; barron & barrett, 1996; yeh, willis, deng & pan, 1999), and most research has found that different methods yield different weights (belton, 1986; borcherding, eppel & winterfeldt, 1991; olson, moshkovich, schellenberg & mechitov, 1996; pöyhönen & hämäläinen, 2001). the criteria weights are generally treated as deterministic, and are usually determined on a subjective basis. the uncertainty in the elicited weights can influence the resultant ranking of alternatives. therefore, the procedures for deriving criteria weights should not be independent of the manner they are used, and should be taken into consideration as part of the decision analysis process (rios insua, 1990; wolters & mareschal, 1995). aggregation refers to the process of combining several numerical values into a single one, so that the final result of aggregation takes into account in a given manner all the individual values. in mcda, aggregation operators are used to aggregate the different values of the utility functions. maut methods include different aggregation models, but the most used one is the additive model. additive aggregation is based on the mathematical concept of weighted means. however, different weighted versions (e.g. weighted arithmetic mean, weighted geometric mean, and weighted harmonic mean) may produce different aggregation results. some performance values in mcda problems are often subjective and changeable. aggregation could yield inconsistent results, since the weights of criteria and the scoring values of alternatives against the judgemental 30 sajems special issue 16 (2013) : 28-41 criteria always contain some uncertainties. it is an important issue how the final ranking or the ranking values of the alternatives are sensitive to the changes of some input parameters of the decision problem (triantaphyllou & sánchez, 1997; memariani, amini & alinezhad, 2009). sensitivity analysis is a fundamental concept in the effective use and implementation of quantitative decision models. the purpose of sensitivity analysis is to assess the stability of an optimal solution under changes in the parameters. by knowing which criteria are more critical and how sensitive the actual ranking of alternatives is to changes on the current criteria weights, the decision-makers can more effectively pay attention to the most critical ones. they can also make better decisions to the given mcda problem (evans, 1984; rios insua & french, 1991; ríos insua, 1999). the aim of this study is to develop a novel weighted linear combination technique for ranking decision alternatives. it is used as a quantitative decision method to assist decisionmakers in dealing with mcda problems. the proposed weighted linear combination ranking technique (wlcrt) is based on the linear combinations of matrix algebra calculations. it is formulated from a decision matrix of preferences, and the criteria weights are elicited from the proximity matrix of preference relations, using the eigenvector method. the weighted generalised means are then used to aggregate preference information, as well as to rank the order of decision alternatives. the remainder of this paper is organised as follows. section 2 introduces the theoretical foundations. section 3 describes the wlcrt method, and section 4 presents an example to illustrate the practicability of the proposed method. the discussion and conclusions are drawn in section 5 and section 6, respectively. 2 theoretical foundations in this section, some important fundamentals that are used in the proposed method (see section 3) are addressed. these fundamentals include the distance correlation and proximity matrix, eigenvectors and criteria weights, and aggregation and weighted generalized means. 2.1 distance correlation and proximity matrix mcda problems usually involve the ranking of a finite set of alternatives in terms of a finite number of decision criteria. consider a decision problem with m criteria and n alternatives. let c1,c2,…,cm and a1,a2,…,an denote the criteria and alternatives, respectively. the mcda problem under consideration is depicted by a decision matrix of preferences shown in eq. (1). the score dpq describes the performance of alternative ap against criterion cq, where a higher score value means a better performance according to the goal of maximization. (1) in maut, a multi-attribute utility function describes the preferences of the decision maker. it is dependent on the axioms of preferential, utility, and additive independence for normative decision-making. the additive model is the most used maut method, which can be formulized as follows: (2) where u(a) is the global utility value of alternative a; dq(a) is the performance value of alternative a against criterion q; uq (dq(a)) is the local utility value reflecting the performance of alternative a for criterion q; kq is a scaling constant that reflects the importance of criterion q within the decision context. the multi-attribute utility function u is a linear combination of uq. in statistics, canonical correlation analysis is a way of making sense of cross-covariance matrices and a procedure for assessing the relationship between two sets of variables (hotelling, 1936). it identifies linear relationships that describe a maximum correlation between the two data sets, namely predictor and response sets. the predictor set includes variables that describe the cause of changes in the analyzed systems, whereas the response set consists of variables that show the sajems special issue 16 (2013) : 28-41 31 effect of these changes upon that system. the determination of linear combinations that possess a maximum correlation is important for the analysis of common features in both data sets (tishler and lipovetsky, 1996, hardoon et al., 2004). suppose that there are two sets of variables organized in matrices as x = [x1x2…xp] and y = [y1y2…yq]. the object of canonical correlation analysis is to find the largest possible correlation of linear combinations and , where a1 = [a11a12...a1p] and b1 = [b11b12…b1q]. such linear combinations can give insight into the relationships between the two sets of variables. let cxx be the covariance matrix of the x set of variables, cvv be the covariance matrix of the y set of variables, and cxv be the covariance matrix of x and y, where cxx and cvv are the within-sets covariance matrices and cxv is the between-sets covariance matrix. the correlation between variables and is then given by (kursun et al., 2011): (3) where is the covariance of and , is the variance of is the variance of letting s be a vector space, with x and y being n-dimensional vectors within s, eq. (3) can then be rewritten as: (4) where eq. (4) is the well-known pearson correlation coefficient defined as the covariance of the two variables divided by the product of their standard deviations. the pearson correlation coefficient can be used as a distance metric between two vectors (x and y). the distance correlation analysis is a procedure for calculating any of a wide variety of statistics measuring either similarity or dissimilarity between pairs of variables. it can be used to show the interaction between decision criteria. when the pearson correlation coefficient is used to measure the similarity of pairwise distances, it is regarded as a similarity function for measuring the global relations among criteria. the correlation coefficients between m criteria can form to an mm proximity matrix, rmm, which satisfies the following properties: (1) non-negativity: rij ≥ 0, rij ∈ r; (2) reflexitivity: rij = 1, if ; (3) symmetry: if ; and (4) transitivity: if r12 > r23 and r23 > r34 then r12 > r34, r12, r23, r34 ∈ r. the coefficient rij represents the similarity correlation of preferences between two criteria (i and j). it can be used to determine the local priority of criteria by selecting the most similar preferences. for example, if r12 > r13 > r14, then criterion 2 is more important than criterion 3 and criterion 4 in terms of the performance of alternative 1. 2.2 eigenvectors and criteria weights eigenvalues are a special set of scalars associated with a linear system of equations (i.e., a matrix equation) that are sometimes also referred to as characteristic roots, characteristic values (hoffman & kunze, 1971), proper values, or latent roots (marcus & minc, 1988). they can be used for a covariance matrix to convert a set of observations of possibly correlated variables into a set of principal components. technically, a principal component can be defined as a linear combination of optimally-weighted observed variables. given a linear transformation r, a non-zero vector w is defined to be an eigenvector of the transformation if it satisfies the eigenvalue equation rw=λw for some scalar λ. in this situation, the scalar λ is called an eigenvalue of r corresponding to the eigenvector w (kublanovskaya, 1961). letting r be an m×m proximity matrix with eigenvalue λ, the corresponding eigenvectors satisfy: 32 sajems special issue 16 (2013) : 28-41 (5) which is equivalent to the homogeneous system: (6) eq. (6) can be written compactly as (r λi) ∙ w = 0, where i is the identity matrix. according to the eigen decomposition, the diagonal matrix constructed from the corresponding eigenvalues can be expressed as: w -1 ∙ r ∙ w = diag {λ1,λ2,… ,λm } (7) where w is a matrix composed of the eigenvectors of the proximity matrix r; w -1 is the matrix inverse of w. the eigenvector method provides m sets of possible solutions to the linear combination problem of preference relations (m eigenvalues and each eigenvalue corresponding to m eigenvectors). it can be used to derive the global priority of criteria through determining the most significant relationship between preference dimensions. the weights of criteria represent the priority (or importance) of the principal diagonal components within the covariance matrix. they can be elicited by calculating the absolute values of the eigenvectors wi corresponding to the maximum eigenvalue λmax. this weighting method was proposed by the author, which has proven to be useful in related research areas (chou, 2011; 2012). the larger the weight, the greater is the respective criterion’s unique positive contribution to the whole preference relations. 2.3 aggregation and weighted generalized means aggregation refers to the process of synthesizing a collection of numerical values into a unique representative or meaningful value in order to come to a conclusion or a decision. an aggregation operator is generally defined by a function h ∶ [0,1]n → [0,1], which is usually a continuous and symmetric function (klir & folger, 1988; smolíková & wachowiak, 2002). the monotonicity of the aggregation operator is a crucial issue which involves constraints on the derivative of the weighted aggregation operator with respect to the various attribute preference values. the weighted aggregation based on maut is well-known in the literature (calvo et al., 2002; ribeiro & marques pereira, 2003; xu & da, 2003; yan et al., 2011). when it is desirable to accommodate variations in the importance of individual aggregated sets, the function h can be generalized into weighted generalized means (wgms), also known as the weighted rootmean-power (ghiselli ricci & mesiar, 2011), as defined by the formula: (8) where ai is the preference value of attribute i, 0 ≤ ai ≤ 1; wi is the weight of attribute i that represents the relative importance of the aggregated set, ; ∝ is a non-zero real number, -∞ < α < ∞. the wgms are continuous but not symmetric. they are monotonic increasing with ∝. for ∝=1, the function h∝ (a,w) is the weighted arithmetic mean operator h1(a,w). when ∝ approaches 0 (∝→0), the limit of the function h∝(a,w) becomes the weighted geo-metric mean operator h0(a,w); at ∝= -1 h-1 (a,w) is the weighted harmonic mean operator. the parameter ∝ plays an important role in the aggregation sajems special issue 16 (2013) : 28-41 33 operation. by varying the ∝ para-meter within the interval of (−∞, ∞), a homologous h∝ value can be derived; the ∝, h∝ curves can then be plotted. as shown in figure 1, there are three sets of decision alternatives. if ∝> 0, the maximum of h∝ is alternative 2; if ∝< 0, the maximum of h∝ is alternative 3. for a more precise comparison, the average h∝ of each alternative must be solved. figure 1 example of α, hα relation diagram for wgm results it can be observed in figure 1 that the curve levels out as it approaches either positive infinity or negative infinity. hence, the trapezoidal rule associated with the mean value theorem for integrals is used to calculate the average of h∝. the trapezoidal rule is used for numerical integration. it works by approximating the region under the graph of the function h(α) by a trapezoid, whose area is then calculated. as shown in figure 2, suppose that the interval [a,b] is split up into u subintervals. the composite trapezoidal rule is then given by (9) where αi = a + (i∙∆α), for i =1,2,…, u – 1 α0 = a, αu = b;a + b = 0;∆α = (b a) ⁄ u eq. (9) can be rewritten as: (10) using the mean value theorem for integrals, the average of h∝ can be obtained as: (11) 34 sajems special issue 16 (2013) : 28-41 eq. (11) can be used to rank the decision alternatives as well as to accurately find the most desirable alternative(s) from the given alternative set. the higher the value, the better is the decision alternative. figure 2 using the trapezoidal rule to approximately calculate the area of the region 3 outline of the weighted linear combination ranking technique(wlcrt) based on the theoretical foundations given in section 2, the implementation steps of the wlcrt are described as follows: step 1: identify the decision context in the first step, decision-makers have to establish the objectives of the mcda, choose the alternatives to be evaluated, and determine criteria for evaluating the consequences of each alternative. step 2: construct a decision matrix judgements involve attitudinal assessments of human cognitive behavior. in case the evaluation is derived from real statistics, numerical data can be converted into a comparable scoring scale through standardising the original data. the most commonly adopted methods are based on distance measurement using the maximum and minimum values as scaling scores. the standardisation is formularised as: (12) where spq is the raw datum of alternative p against criterion q; sq(max) is the maximum datum and sq(min) is the minimum datum of all the alternatives against criterion q; sr is the standardized range used to convert the score from within the interval [0,1] to within the interval [0.1,0.9]. according to the linear interpolation method, the score dpq can be derived as: (13) step 3: elicit the criteria weights by substituting the scoring data of the decision matrix into eq. (4) to perform the pearson distance correlation analysis in pairs, a proximity matrix of the similarity measures can be obtained. using eigenvalue algorithms (see section 2.2), a set of eigenvalues and their corresponding eigenvectors can be derived. by calculating the absolute values of the eigenvectors corresponding to the maximum eigenvalue, a set of the priorities of the principal diagonal components can be obtained. further normalising these values, a set of weights corresponding to the criteria is elicited as: (14) sajems special issue 16 (2013) : 28-41 35 step 4: aggregate the preference information and rank the decision alternatives based on eqs. (8) and (11), the weighted aggregation operator is expressed as follows: (15) where represents the aggregated value of the pth alternative; the aggregation operator is used to synthesise the weight sand scores for each alternative in order to derive an overall utility value. numerical integration operations (see section 2.3) are used to obtain a set of aggregated values, which are then used to rank the order of decision alternatives. the higher the value, the better is the decision alternative. step 5: sensitivity analysis sensitivity analysis is an important task in mcda. it applies post-hoc analyses to a quantitative decision model, and deals with uncertainties related to how sensitive the alternative ranking is to the changes in criteria weights. in an mcda problem, if the weight of criterion i changes by ∆i, then the weights of other criteria change as (memariani et al., 2009) (16) where wi is one of the original weights, and w'i is its new weight; by cumulatively increasing or decreasing the value of ∆i, a number of new sets of criteria weights can be obtained. using the new set of weights to perform the above aggregation operation iteratively, we can identify the criterion for which the smallest change of current weight may alter the existing ranking of alternatives. 4 illustrative example a decision analysis example is used in this section to illustrate the proposed method. the aim of this example is to assess the competitiveness of the cultural and creative sector in europe. 4.1 identification of the decision context the cultural and creative sectors foster creativity and contribute to innovation in other sectors of the economy. the main objective of this decision problem is to assess which countries are most competitive in terms of the cultural and creative sector. the decision criteria include six items: (1) value added to national gdp, (2) average turnover growth, (3) cultural and cultural tourism employment, (4) average evolution of productivity, (5) average evolution of profitability, and (6) average evolution of intangibles to turnover ratio. nine countries were selected from the eu 25 as alternatives, which include belgium, denmark, finland, france, germany, italy, portugal, spain, and the uk. 4.2 construction of the decision matrix according to the published statistics collected by kea european affairs (2006), the raw data are classified and listed in table 1. using eqs. (12) and (13), the corresponding scores of alternatives against each criterion were derived. the decision matrix was constructed as below: (17) 36 sajems special issue 16 (2013) : 28-41 table 1 original statistics and corresponding scores of alternatives criterion 1 criterion 2 criterion 3 criterion 4 criterion 5 criterion 6 belgium 2.6%, 0.58 5.2%, 0.35 2.7%, 0.31 1.57, 0.73 10.3%, 0.61 2.6%, 0.22 denmark 3.1%, 0.78 2.7%, 0.1 3.3%, 0.63 1.3, 0.1 9.2%, 0.3 8.0%, 0.77 finland 3.1%, 0.78 7.1%, 0.55 3.7%, 0.85 1.45, 0.45 11.3%, 0.9 2.9%, 0.25 france 3.4%, 0.9 6.7%, 0.5 2.5%, 0.21 1.60, 0.81 11.1%, 0.84 4.3%, 0.39 germany 2.5%, 0.54 4.9%, 0.32 3.2%, 0.58 1.5, 0.57 8.8%, 0.19 1.5%, 0.11 italy 2.3%, 0.46 5.3%, 0.36 2.8%, 0.37 1.64, 0.9 8.5%, 0.1 3.6%, 0.32 portugal 1.4%, 0.1 10.6%, 0.9 2.3%, 0.1 1.59, 0.78 10.4%, 0.64 1.4%, 0.1 spain 2.3%, 0.46 10.5%, 0.89 3.1%, 0.53 1.46, 0.48 8.6%, 0.1 3.4%, 0.3 uk 3.0%, 0.74 6.6%, 0.49 3.8%, 0.9 1.40, 0.33 9.1%, 0.27 9.3%, 0.9 range 1.4%~3.4% 2.7%~10.6% 2.3%~3.8% 1.3~1.64 8.5%~11.3% 1.4%~9.3% criterion 1: value added to national gdp (in 2003) criterion 2: average turnover growth (1999-2003) criterion 3: cultural and cultural tourism employment in 2003 (as % of total employment) criterion 4: average evolution of productivity (value added/employment costs) (1999-2003) criterion 5: average evolution of profitability (operating margin) (1999-2003) criterion 6: average evolution of intangibles (knowledge and creativity investments within the cultural and creative sector) to turnover ratio (1999-2003) source: economy of culture in europe. prepared by kea european affairs for the european commission, directorate-general for education and culture, 2006. www.ec.europa.eu/culture 4.3 elicitation of criteria weights mcda problems are usually modeled by choosing a set of criteria that characterise a finite number of alternatives, and by eliciting their relative importance or weights. the process of weighting involves emphasising some aspects of a set of data—giving them ‘more weight’ in the final result. substituting the above scoring data into spss software to perform the pearson distance correlation analysis yields the following proximity matrix: (18) using eigenvalue algorithms, the following set of eigenvalues is obtained: λ = [3.7071.880 0.503 − 0.220 − 0.028 0.159]. the eigenvectors corresponding to the maximum eigenvalue λmax = 3.707 are 0.49, 0.321, 0.448, 0.269, 0.429, and 0.447. by normalizing these values, the criteria weights were elicited as follows: w=[wq ]6×1)=[0.204 0.134 0.186 0.112 0.178 0.186] t (19) the result shows that criterion 1 (value added to national gdp) has the highest importance whereas criterion 4 (average evolution of productivity) has the lowest importance regarding the desired objective. 4.4 ranking of decision alternatives let a = −100, b = 100, and u = 1 000. the data of matrices (17) and (19) were substituted into eq. (15) to calculate the wgms. the set of obtained aggregated values is shown in table 3. the nine alternatives were ranked as follows: uk≻finland≻france≻portugal≻italy≻spain ≻belgium≻denmark≻germany, where the symbol “≻” means “is superior to”. the uk, finland, and france in order have the most competitive cultural and creative sectors in europe. it is worth noting that the uk is slightly superior to finland according to the aggregated values. however, finland is better than the uk in terms of the traditional sajems special issue 16 (2013) : 28-41 37 arithmetic mean (mfinland=0.63≻muk=0.605) or weighted mean (wmfinland=0.648≻wmuk=0.636) results. this divergence of ordering can be explained by figure 1, which is due to the wgm aggregation that flexibly reflects different decision attitudes in the evaluation. table 2 aggregated values and ranks of the decision alternatives belgium denmark finland france germany italy portugal spain uk aggregated value 0.4571 0.4273 0.5634 0.5417 0.3364 0.4670 0.4678 0.4661 0.5789 rank 7 8 2 3 9 5 4 6 1 ranking uk≻finland≻france≻portugal≻italy≻spain≻belgium≻denmark≻germany 4.5 sensitivity analysis as shown in table 4, the ranking of alternatives is altered when we change the weight of criterion 1 by +4δ, where δ=0.015 and the new set of criteria weights is 0.264, 0.124, 0.172, 0.104, 0.164, and 0.172. in case the weight of criterion 1 is changed by +9δ, the alteration of ranking increases from two alterna tives (italy and portugal) to three alter-natives (italy, portugal, and spain). however, the ranking of both the first three and last three alternatives is not changed in this decision case. table 3 sensitivity analysis results weight change belgium denmark finland france germany italy portugal spain uk -13δ 0.4568 0.4175 0.5631 0.5188 0.3354 0.4688 0.4724 0.4681 0.5794 7 8 2 3 9 5 4 6 1 ⁞ uk≻finland≻france≻portugal≻italy≻spain≻belgium≻denmark≻germany -δ original 0.4571 0.4273 0.5634 0.5417 0.3364 0.4670 0.4678 0.4661 0.5789 7 8 2 3 9 5 4 6 1 +δ uk≻finland≻france≻portugal≻italy≻spain≻belgium≻denmark≻germany +2δ +3δ 0.4573 0.4290 0.5635 0.5444 0.3367 0.4666 0.4667 0.4656 0.5787 7 8 2 3 9 5 4 6 1 +4δ 0.4573 0.4295 0.5634 0.5452 0.3368 0.4665 0.4663 0.4654 0.5788 7 8 2 3 9 4* 5* 6 1 ⁞ uk≻finland≻france≻ italy≻portugal ≻spain≻belgium≻denmark≻germany +9δ 0.4574 0.4322 0.5636 0.5491 0.3372 0.4655 0.4643 0.4645 0.5785 7 8 2 3 9 4* 6* 5* 1 ⁞ uk≻finland≻france≻italy≻spain≻portugal≻belgium≻denmark≻germany +13δ 0.4575 0.4341 0.5637 0.5520 0.3375 0.4648 0.4625 0.4635 0.5783 7 8 2 3 9 4* 6* 5* 1 5 discussion weighted linear combination (wlc), also referred to as simple additive weighting (saw), is probably the most used mcda method. although it has the ability to give different relative weights to each of the criteria by aggregation, there are some fundamental limitations in the use of traditional wlc method (jiang & eastman, 2000; drobne & lisec, 2009). this paper presents a novel mcda method for ranking decision alternatives. the proposed weighted linear combination ranking technique (wlcrt) is based on the linear combinations of matrix algebra calculations. it has distinct advantages in preference modeling, weight elicitation, and aggregation performance. the theoretical and practical implications of the wlcrt method are 38 sajems special issue 16 (2013) : 28-41 discussed below. in mcda, prioritisation of the decision matrix is a core issue that influences the final decision result. saaty (1980) advocated the use of the eigenvector method for deriving the weights from a given pairwise comparison matrix (a positive reciprocal matrix). in this method, decision-makers must ensure all judgements are to be consistent. besides, it requires the solution of a set of nonlinear eigenvalue equations which is somewhat complicated and inconvenient for use (wang & chin, 2011). previous research has also found that the priority vector in ahp derived from the eigenvector method can violate a condition of order preservation (bana e costa & vansnick, 2008). distance-based optimisation plays an important role in deriving criteria weights (hwang et al., 1981; hyde, maier & colby, 2005; yu & lai, 2011). the proposed wlcrt method uses a proximity matrix derived from the distance correlation measures of global scoring relations. it can be regarded as a covariance matrix of the standardised random variables that possesses the properties of non-negativity, reflexitivity, symmetry, and transitivity. making use of the eigenvalue algorithm, we can derive a set of weights from the optimally weighted observed variables. the weights corresponding to the criteria are sound as they are elicited from the principal diagonal components within the covariance matrix. they can reasonably reflect the respective criterion’s unique positive contribution to the whole preference relations, giving a valid process of weighting for the mcda. the simple additive weighting (saw), an additive aggregation using the weighted mean operator, is commonly used to synthesize evaluation results as well as to rank the decision alternatives. this method generates a so-called pareto-optimal agreement for one issue, independent of the specific weights attached to the individual preferences (chwolka & raith, 2001). although the saw is an easy and intuitive compensatory technique, it can yield invalid ranking of alternatives as evidenced in the illustrative examples. in practice, an aggregation operator for mcda should not only consider both the relative importance of the criteria and its own achieved performance, but should also convey the influence of the decision maker’s evaluation attitudes. for example, if one takes a more open attitude in evaluation, the operator should give a higher aggregated index toward the maximum value that the operator can produce (i.e., ∝>1). in contrast, if the evaluation attitude of the decision maker is rigorous or conservative, the operator should be toward a minimum aggregation (i.e., ∝<-1) (guh et al., 2008). the proposed wlcrt method uses wgms to aggregate preference information. the wgm operator converts a set of discrete preference data into a continuous utility function. it can flexibly reflect different decision attitudes for the decision maker. by varying the ∝ parameter within the interval of (−∞,∞), a homologous aggregation value can be derived based on a multi-criteria analysis. the numerical integration technique is used to facilitate the calculations of the continuous utility function. the proposed method can be used to objectively rank the decision alternatives as well as to accurately identify the most desirable alternatives. 6 conclusions most mcda problems can be depicted as a matrix format, and the commonly-used additive model of a multi-attribute utility function can be considered a linear combination of its utility values. this study presents a novel method of applying the weighted linear combination ranking technique (wlcrt) to mcda. the proposed method is based on the linear combinations of matrix algebra calculations. it is formulated from a decision matrix of preferences using a 7-point likert scale scoring, or a standardising scale of the existing statistics. based on the linear combination of optimally-weighted observed variables of the covariance matrix, the criteria weights are elicited from the proximity matrix of preference relations, using the eigenvector method. the weighted generalised means (wgms) are then used to aggregate preference information as well as to rank the order of decision alternatives. this study uses the wgms as the aggregation operator to perform preference aggregation. in practice, the proposed method considers the sajems special issue 16 (2013) : 28-41 39 relative importance of criteria, and conveys the influence of the decision-maker’s evaluation attitudes. it can flexibly reflect evaluation attitudes as open, neutral, or rigorous. the sensitivity analysis results have shown 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introduction method analysis discussion conclusion, limitations, and future research acknowledgements references about the author(s) emile s. nkwei department of business support studies, faculty of management sciences, central university of technology, bloemfontein, south africa patient rambe department of business support studies, faculty of management sciences, central university of technology, bloemfontein, south africa amon simba nottingham business school, nottingham, united kingdom citation nkwei, e.s., rambe, p. & simba, a., 2023, ‘entrepreneurial intention: the role of the perceived benefits of digital technology’, south african journal of economic and management sciences 26(1), a4936. https://doi.org/10.4102/sajems.v26i1.4936 original research entrepreneurial intention: the role of the perceived benefits of digital technology emile s. nkwei, patient rambe, amon simba received: 25 nov. 2022; accepted: 14 mar. 2023; published: 31 may 2023 copyright: © 2023. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: existing research recognises that entrepreneurship orientation (eo) is essential for success. however, the mediating role of eo in driving entrepreneurial intention (ei) amongst young adults, especially in the context of the digital revolution, remains largely underexplored. aim: accordingly, this study aimed to investigate the mediated effect of risk taking, innovativeness, and proactiveness on ei in an emerging economy. setting: the sample for this study was drawn from the young adult population in south africa who understands the concept of entrepreneurship. method: in the study, a quantitative method to collect the data is used, while structural equation modelling is used to test the extended theory of planned behaviour (tpb). results: findings indicate that risk taking mediates the effects of attitude, entrepreneurial capability, and the perceived benefits of digital technology on ei. the results did not support the mediating function of proactiveness and innovativeness. in fact, this result challenges the tpb’s simplistic structure and reveals the prominent role of risk taking in determining tpb predictors. conclusion: given the significance of risk taking, governments and entrepreneurship centres are urged to promote risk taking in all their entrepreneurship development programmes. contribution: considering the significance of the global digital transformation, this study extends the tpb by incorporating the perceived benefits of digital technology among the predictors of entrepreneurial intent. it also emphasises the role of risk taking in mediating the effects of these predictors on the entrepreneurial intention of young adults in south africa. keywords: entrepreneurial intention; theory of planned behaviour; perceived benefits of digital technology; risk taking; entrepreneurial capability. introduction entrepreneurship is widely regarded as the key to long-term economic prosperity (eds. ács et al. 2009). it forms the backbone of leading economies such as in china, the united states, and germany, which have instilled an entrepreneurial culture in their citizens. inspired by these nations, in south africa, as in most developing countries, the number of entrepreneurship courses to stimulate the entrepreneurship intention (ei) of the young adult population has increased; young people are of particular interest because they are disproportionately affected by unemployment, poverty, and inequality (francis & webster 2019). although these entrepreneurship courses could create a positive attitude about entrepreneurship amongst young adults, as well as improve their entrepreneurship capabilities, the rate of early-stage entrepreneurs in south africa remains low (11.7%) (global entrepreneurship monitor 2018/2019). young adults are between the ages of 18 and 35, according to previous studies (francis & webster 2019), and make up nearly one-third of the total population of south africa. however, only about 7.5% of these young adults engage in entrepreneurship (global entrepreneurship monitor 2018/2019). literature provides ample evidence that ei is the primary predictor of entrepreneurial behaviour (meoli et al. 2020). therefore, an understanding of the drivers of entrepreneurial intent may play a major role in increasing the number of aspiring entrepreneurs. indeed, ei is arguably the most studied theme in entrepreneurship since the 1990s. past discussions explored ei from generic perspectives, while many studies focused on facilitating conditions such as access to loans (lee & black 2017), incubation programmes, and various government support structures (nakku et al. 2020). however, given the high failure rate of most business ventures globally, researchers are triggered to examine the relationship between ei and key factors of entrepreneurial success, such as entrepreneurial orientation (eo), firm networking, and the use of technology in business (zehir, karaboğa & başar 2020). research suggests that impactful entrepreneurs are opportunity-driven, technologically savvy, and have a high eo (bosma & kelley 2019). in contrast, generic entrepreneurs are less technologically oriented and necessity-driven; they are mainly found in emerging countries due to the scarcity of employment opportunities. while the distinction between impactful and generic entrepreneurs offers a framework for successful entrepreneurship, it is argued in this study that the criteria which informed this specific classification, do not always reflect the digital transformations unfolding in developing countries. although necessity-driven entrepreneurship is often associated with a resource-constraint contexts, such as those prevalent in developing countries (e.g. south africa), most young entrepreneurs, due to their extensive exposure to digital technology, are digitally savvy. in south africa, the commission on the fourth industrial revolution (4ir) was entrusted with conscientising young adults about the advantages of technologically supported innovations for entrepreneurial purposes. given the emergence of these necessity-driven and technologically savvy entrepreneurs, we propose adding this class as a third category to bosma and kelley’s (2019) classification. digital transformation is the increased use of digital technologies to create or alter customer experiences, business processes, and culture to meet the demand of the market. indeed, this transformation has altered the dynamics of business creation, perception, and growth. technologies such as artificial intelligence (ai), the internet of things (iot), blockchain, social media, and additive manufacturing processes have simplified business practices (chatterjee et al. 2021). these technologies empowered many small, micro-, and medium-sized enterprises (smmes) and enabled them to compete with large firms globally. although some scholars speculate that the benefits of digital technology may contribute to both eo and ei, no prior study has established these relationships yet (darmanto et al. 2022). past studies of entrepreneurship (bagale et al. 2021) examined the adoption of digital technology in smmes, but the extent to which the benefits of digital technology affect ei, remains underexplored. although many business concepts such as canvas, voluntary technology dialogue framework (vtdf), and creativity, content common sense (3c) model use digital technology as an instrument of innovation and proactiveness, the interplay between eo, and the benefits of digital technology has received limited attention. against this background, our study investigated the intervening role of eo in driving the ei of young adults in a digital-revolution context; therefore, risk taking, innovativeness, and proactiveness are tested as potential mediators. building from this extended theory of planned behaviour (tpb), our study contributes to the literature on entrepreneurship in three major ways. firstly, it proposes an alternative method for measuring the perceived benefits of digital technology that future studies could use for inferential analyses. with the digital transformation, there is a growing need for frameworks that evaluate various aspects of digital technology. despite the fact that literature documents the benefits of digital technology for businesses, no valid instrument has yet been developed to measure how aspiring entrepreneurs perceive these benefits. this new construct expands the modelling toolkit of digital technology. secondly, the study expands and enriches the tpb, via indirect paths, mediated by risk taking, innovativeness, and proactiveness. it provides new tpb perspectives on how dimensions of entrepreneurial orientation (risk taking, inventiveness, and proactiveness) interact with attitude, entrepreneurial capability, and the perceived benefits of digital technology in shaping entrepreneurial intent in the context of a developing economy. this answers research calls for contextualising entrepreneurship research. these three eo elements are crucial for entrepreneurial success; therefore, integrating them as mediators into the tpb will provide a deeper understanding of how eo regulates the effects of the tpb predictors on ei. this study will contribute to the entire body of knowledge by showcasing how eo either facilitates or inhibits the effect of attitude and entrepreneurial capability on ei, allowing us to promote eo as a proxy for the tpb predictors. thirdly, in a country where the unemployment rate is estimated to be approximately 40%, the study provides new theorisation for exploring ways in which the ei of young adults may be enhanced congruently with their psychosocial conditions. although entrepreneurial intent does not always result in action, it remains the most accurate predictor of new venture formation. understanding the role of eo, as an intermediary, could help improve the government and entrepreneurship centres to stimulate the ei of young adults in south africa, which will hopefully lead to the establishment of successful new businesses. in the subsequent sections of this paper the theoretical framework and development of hypotheses are discussed, followed by the methods, analysis, discussion, implication and future research, as well as limitations and the conclusion. theoretical framework the theory of planned behaviour the interpretations of the theory of planned behaviour produced a muddled picture of the meaning of ei. in the literature, numerous definitions of ei do not seem to converge. in light of that, the views of crant (1996) on ei are adopted, showing it as the desire and the commitment to become a business owner in the future. previous studies (gorgievski et al. 2018) classified entrepreneurship as planned behaviour because it requires an intention to occur; this is probably why the tpb by ajzen (1991) is so prevalent in entrepreneurship studies. the tpb posits that ei is a function of attitude towards entrepreneurship, social norms, and the perceived ability to establish a business (entrepreneurial capability). although recent studies (e.g. ogunsade et al. 2021) found that attitude and entrepreneurial capability are the core predictors of ei amongst university students, the predictive power of these two factors generally is yet to be established among young adults in developing countries. despite its wide application, critics argue that the simplistic structure of tpb limits its ability to unveil the complexity of ei. although many tpb studies included additional factors, such as education regarding entrepreneurship, opportunity recognition, family background, or eo (shekarian & parast 2021), most of these studies only examined the direct effects of the predictors. given the growing number of indirect mechanisms by which these tpb relationships occur in real life, there is a rising demand for mediating or moderating variables in tpb studies that unveil the complexities of ei. according to van trang, do and luong (2019), the fear of business failure impedes ei, even among young adults with entrepreneurial skills. therefore, integrating dimensions of entrepreneurial orientation such as risk taking, innovation, and proactiveness into the tpb, will give greater insight into the intervening role of eo which is critical to counter the fear of business failure. the concept of entrepreneurial orientation entrepreneurial orientation is the proclivity to take risks, innovate, and be proactive in pursuing a business. the willingness to take chances with a business idea is known as risk taking. proactivity is the capacity to foresee future business prospects in terms of products, or technologies, and act on them. the ability to translate new ideas into new products, services, or technological processes is called innovativeness. literature shows that eo is a crucial complement to ei (fatoki 2019). while ei spurs entrepreneurs to start businesses, eo helps entrepreneurs run their businesses successfully with an entrepreneurial mindset (marques et al. 2018). numerous advantages accrue from an eo; it boosts learning and employment capacities and confers a competitive advantage. it also serves as a predictor of business growth and brand success (jiang, wang & jiang 2019). although experts believe that eo is advantageous to entrepreneurship, there is considerable disagreement on how best it can be measured. most studies (mandongwe & jaravaza 2020) measured eo as a single factor, while others (amin 2015) divided it into three sub-dimensions. those who support the multi-dimensional measurement argue that the dimensions of eo exist independently of one another. for example, neneh, van zyl and van noordwijk (2016) discovered that male entrepreneurs are higher risk takers than female entrepreneurs, while female entrepreneurs are more proactive than male entrepreneurs. considering that each component of eo may play a unique role, combining them into a single factor would undermine their contributions. the link between eo and ei among young adults has been established in various developing countries such as indonesia (suartha & suprapti 2016), nigeria (ibrahim & mas’ud 2016), zimbabwe (mandongwe & jaravaza 2020), and south africa (fatoki 2019). most of these studies combined eo with other predictors of ei, such as attitude and family background (wan-ismail & olabinjo 2017); fear of failure and entrepreneurial self-efficacy (okoye 2016); self-efficacy and social networks (ojewumi & fagbenro 2019); educational support for entrepreneurship and informal networking (amos, oluseye & bosede 2015); gender and self-efficacy (ojewumi et al. 2018). although eo has been extensively studied, there are three limitations to be observed: (1) most studies have been conducted in a firm-based setting and a western environment, (2) only a few studies have examined the concept from the standpoint of young adults in connection with digital technology, (3) limited studies have examined the indirect effects of these predictors through each sub-dimension of eo. since eo and its sub-dimensions (risk taking, innovativeness, and proactivity) are conceptualised and predominantly applied in western contexts, they may have different meanings and roles in developing nations. for instance, due to the scarcity of jobs, most young adults in south africa do not have the privilege of choosing between work and entrepreneurship (neneh et al. 2016). so, their concept of risk may differ from that fostered in western nations where employment is not of significant concern. following this contextual difference, validating the roles and significance of these three sub-dimensions of entrepreneurial orientation in a developing country such as south africa, is necessary. based on previously-stated eo definitions, technology has emerged as one of the levers through which innovation and proactiveness are expressed (crant 1996). in contemporary times, new ventures do not necessarily create new products; they can generate revenue by selling existing products on digital platforms. there is an increasing demand for new digital platforms which are business-friendly and more convenient for product delivery. therefore, understanding the benefits of digital technology for entrepreneurial orientation and intention is essential, particularly in south africa, where most young individuals are already accustomed to digital technology. perceived benefits of digital technology the digital revolution is a reality; it is at the forefront of the 4ir, transforming all aspects of the human experience, including entrepreneurship. indeed, with the growing access to computers, smartphones, the internet, and social media, the business landscape and practices have been extensively transformed. consequently, it is more important for a company to have a website than an office building (jahan & martin 2019). emerging research on digitalisation recognises that digital technology provides numerous benefits to businesses. this body of knowledge suggests that digitalisation reduces transaction costs by improving and speeding up information access, allowing smmes to communicate with internal personnel and external suppliers (jin & hurd 2018). moreover, it reduces shipping and border costs, helping smmes integrate with global markets. in some way, digitalisation offers a range of applications with the potential to improve business performance, inspire innovation, and raise productivity. it also helps small and medium-sized enterprises (smes) to compete more equitably with larger firms by decreasing operational costs, economies of scale, and information asymmetries. these benefits make entrepreneurship more attractive to young adults as a career of choice. while research acknowledges the benefits of digital technology, it lacks a proper measurement framework and hence the need to examine its role in shaping ei. previous research studied digital technology in relation to ei. for instance, the relationship between the digitalisation of the economy and the ei of young adults has been explored (youssef et al. 2021). rambe, ndofirepi and dzansi (2016) concluded that eo led to intention in their study and that technological creativity (innovativeness) and entrepreneurial capability affect the eo of young adults in zimbabwe. research elsewhere investigated the link between digital literacy and ei (primahendra et al. 2021). the study by rosin et al. (2020) in particular is one of the rare studies which examined the benefits of digitalisation in the context of a joint venture. they discovered that the digitalisation of small and medium-sized businesses results in resource savings, increased operational efficiency, and greater flexibility. although the study of rosin et al. (2020) provides valuable insight into the contribution of digital technology to business, it presents two significant limitations: (1) most of the benefits were formulated from an existing joint-venture perspective, not from that of aspiring entrepreneurs, and (2) the study largely considered the operational benefits without measuring the perceived benefits. their study provides an opportunity for further research to examine the indirect effect of the benefits of digital technology on ei among young adults. conceptual framework proposed conceptual model and hypotheses development building on the tpb, the proposed conceptual model (figure 1) hypothesises that the effects of attitude, entrepreneurial capability, and perceived benefits of digital technology on (ei) are mediated by risk taking, innovativeness, and proactiveness. the conceptual model is estimated after controlling for entrepreneurial family background, prior education about entrepreneurship, and digital technological literacy. these factors are controlled because they may inflate the relationships specified in the conceptual model. figure 1: conceptual research model. hypotheses development the mediating role of entrepreneurship orientation in the relationship between attitude and entrepreneurial intention entrepreneurial attitude is the psychological disposition to encourage or oppose entrepreneurship after having weighed its merits (kreitner & kinicki 2009). a potential entrepreneur is expected to have developed a positive attitude towards creating a new venture before forming the intent to start a business. however, in some studies it is found that the relationship between entrepreneurial attitude and intention is not always linear; it sometimes involves intervening factors. for instance, song, thominathan and khalid (2021) discovered that pertinent education enhances (mediates) the effect of attitude towards ei. dahalan, jaafar and rosdi (2015) found that the impact of attitude on ei is stronger when a business opportunity (mediator) is identified. although limited studies have investigated the intervening role of risk taking, innovativeness, and proactiveness in ei, their mediating role is well established in other matters. for example, liu et al. (2019) found that risk taking mediates the effect of buddhistic values on new venture performance in china. in vietnam, nguyen, an and ngo (2020), found that proactiveness mediates the effect of relationship quality on firm performance. zanella et al. (2019) also found that innovativeness and proactiveness mediate the relationships between individual alertness and the identification of an opportunity. similarly, this study postulates that young adults with a positive attitude toward entrepreneurship will find it easier to develop the ambition to become entrepreneurs, especially if they are innovative, proactive, and willing to take risks. hence the following hypotheses are formulated: h1: risk taking mediates the effect of attitude on ei. h2: innovativeness mediates the effect of attitude on ei. h3: proactiveness mediates the effect of attitude on ei. the intermediary role of entrepreneurship orientation in the relationship between entrepreneurial capability and entrepreneurial intention entrepreneurial capability is essential to becoming an entrepreneur and succeeding in establishing new business ventures. elsewhere, it is described as the entrepreneurial potential expressed or dormant in an individual (ratnaningtyas, sutardi & makbul 2018). from a tpb perspective, entrepreneurial capability is a form of perceived behavioural control applied to entrepreneurial and technical skills (nguyen et al. 2019). prior empirical research has found that eo is associated with entrepreneurial capability (anak agung ketut et al. 2018). an individual’s entrepreneurial capability is necessitated by the development of the individual’s eo. there is also empirical evidence linking entrepreneurial capability to intention. through their research on young adults’ entrepreneurial activity in nigeria, jegede and nieuwenhuizen (2021) found that this kind of capability and eo were key predictors of ei. given that entrepreneurial capability influences eo and that both the capability and eo are associated with ei, eo could mediate the relationship between capability and intention to start a business. hence, the subsequent hypotheses: h4: risk taking mediates the effect of entrepreneurial capability on ei. h5: innovativeness mediates the effect of entrepreneurial capability on ei. h6: proactiveness mediates the effect of entrepreneurial capability on ei. the effect of perceived benefits of digital technology on entrepreneurial intention through entrepreneurial orientation perceived benefits of digital technology refer to an individual’s opinion toward all applications of digital technology aiding the creation and expansion of businesses. the widespread use of digital technologies facilitated entrepreneurial education and stimulated ei. scholarly research (e.g. chatterjee et al. 2021) associated proactiveness and innovativeness with digital entrepreneurship. in relation to that, goktan and gupta (2015) found that eo facilitates the adoption and use of new digital technology. similarly, kraus et al. (2019) discovered that innovative and proactive people are more likely to explore new business opportunities using digital technology. the mediating effect of eo in relation to digital technology was established by previous research. findings suggested that young individuals’ perceptions of digital technology either encourage or discourage their pursuit of digital entrepreneurship. nguyen, an and ngo (2020) found that proactiveness mediates the relationship between social capital and company performance. the digitalisation of economies stimulates ei by lowering the perceived risks associated with starting a business (youssef et al. 2021). simply put, risk taking mediates the relationship between the digitalisation of economies and ei. given the findings above, the study submits that the effect of perceived benefits on ei may be enhanced by eo. hence, the following hypotheses: h7: risk taking mediates the effect of perceived benefits of digital technology on ei. h8: innovativeness mediates the effect of perceived benefits of digital technology on ei. h9: proactiveness mediates the effect of perceived benefits of digital technology on ei. method this study focuses on young adults for two reasons: firstly, they are one of the segments most affected by poverty, unemployment, and inequality in south africa (francis & webster 2019). therefore, venturing into entrepreneurship might be an effective way to achieve financial stability. additionally, the ongoing digital transformation provides limitless opportunities for young adults to start and grow businesses. as a result, the south african presidential commission on 4ir urged youths to benefit from the technological transformation brought about by 4ir. according to past research (ondimu et al. 2019), young adults are between 18 and 35 years old; therefore, this age group was the focus of our study. before proceeding with the survey, the concept of entrepreneurship was defined and participants were required to confirm that they understood it. this inquiry served as the second screening question. the study adopted a positivist, and cross-sectional approach for two reasons: (1) the measurements of all the concepts, involved in this study, were already available in the literature, and (2) the study aimed to test a conceptual model in a specific context and at a specific time. participants were recruited online by a consulting firm for 3 months. since the survey was conducted online, a non-probabilistic sampling method was more practical because of the pandemic and the lack of a sampling frame for the target population. the link to the survey was sent to 1253 young adults across the country, and 822 questionnaires were returned. after eliminating disengaged respondents and those older than 35, we were left with 617 valid questionnaires. the purpose of the study and the participants’ rights were outlined in an attached informed consent form. all participants were requested to sign the form electronically before completing the online survey. ethical clearance for the study was provided by the departmental research and ethics committee of the central university of technology in south africa. a questionnaire was used to collect data related to the variables involved in the study. the first section of the questionnaire captured the respondents’ demographic information, such as their gender, age, education, province, marital and employment status. the second section contained screening questions that ensured that we only select young adults who are not yet business owners. the rest of the questionnaire focused on the model’s seven constructs, all measured on a five-step likert scale. the constructs were adapted from previous studies and covered three (03) to seven (07) items each. the constructs attitude (e.g. [1] being an entrepreneur would give me some satisfaction, and [2] a career as an entrepreneur is attractive to me) and entrepreneurship intention (e.g. [1] i intend to create a firm in the future, and [2] i have thought very seriously of starting a firm at some point) were both adapted from instruments from asimakopoulos and peña miguel (2019) and youssef et al. (2021). perceived entrepreneurial capability (e.g. [1] i can identify new business opportunities, and [2] i can create products or services that fulfil customers’ unmet needs) was adapted from ndofirepi and rambe (2016). the three dimensions of eo were revised, based on the work of koe (2016), and the construct perceived benefits of digital technology (e.g. [1] digital technology is a great source of information for me, and [2] digital technology presents business opportunities for me) was developed, inspired by the preliminary work of owoseni and twinomurinzi (2019) on dynamic capabilities which is the ability to identify opportunities using digital technology. after collecting the data, it was screened in excel and imported into version 27 of ibm spss statistics, where it was cleaned further. a descriptive analysis was conducted to describe the sample. structural equation modelling (sem) is a flexible and comprehensive method for testing a conceptual model to account for the maximum variance (grotzinger et al. 2019). the aim of this study is to assess the structural relationships between the conceptual model’s variables. since the sem methodology comprises confirmatory factor analysis (cfa) and structural model analysis, it was deemed suitable (gallagher & brown 2013). confirmatory factor analysis assessed the validity of the constructs, whereas the structural model analysis tested the research hypotheses postulated in our conceptual models. the sem analysis was conducted using ibm amos 28; the assumptions of sample size and multivariate normality were rigorously evaluated and satisfied (byrne 2010). analysis profile of respondents descriptive statistics generated for this study indicated that all nine provinces of south africa were disproportionately represented in the sample. gauteng (68.1%), limpopo (11.7%), and kwazulu-natal (7.8%) were the provinces with the highest representation. most respondents (98.5%) were black african males (51.5%), who held either a matric or a postgraduate degree (74.3%). an in-depth statistical analysis of the data showed that 47.6% of the participants were unmarried and either employed (42.9%), or students (30.2%). the average age of participants was 28 years old. control variables considering that the study investigates young adults in general, it was necessary to control for any variable that could give an advantage to some respondents over the rest of the sample. in the particular context, three potential confounding variables were identified, namely (1) prior education regarding entrepreneurship, (2) family background of entrepreneurship, and (3) digital literacy. past research (duong 2021) revealed that entrepreneurial education and an entrepreneurial family background do influence ei and eo scores; hence the decision to control their effects in the model. digital literacy was also controlled because it is most likely to affect the scores of the variable ‘perceived benefit of digital technology’. structural equation modelling analysis structural equation modelling is a statistical technique that employs a confirmatory approach to model testing (byrne 2010). the literature has two approaches to sem: the covariance-based and the component-based methods. while the covariance-based approach requires large sample sizes (200 and above) to test a model, the component-based approach accommodates small sizes (less than 100). since our sample is large (615 units), it was ideal to opt for a covariance-based approach of sem. irrespective of the approach, sem is conducted in two consecutive phases: (1) the cfa phase and (2) the structural model-analysis phase (anderson & gerbing 1988). before the cfa, the outliers were examined through the skewness and kurtosis values; all items fell within the acceptable ranges of plus–minus 3 and minus 10, respectively (kline 2015), indicating that the assumption of normality was not violated. a common-method bias test was performed through harman’s (1976) one-factor to detect any artificial inflation of relationships in the model. harman’s (1976) one-factor results indicate that the highest single factor accounts for the variance of 22.1% (below 50%). in conclusion, there is no common variance bias in the data. confirmatory factor analysis the measurement model was tested to establish the validity of the constructs used in the study. the first item of risk taking was deleted because it was cross-loading with proactiveness; this helped to the improvement of the fit indices (χ2 = 1026.637, p < 0.05, df = 443, χ2/df = 2.317, adjusted goodness of fit index [agfi] = 0.868, tucker-lewis index [tli] = 0.964, comparative fit index [cfi] = 0.968, and root mean square error of approximation [rmsea] = 0.050). the evidence of convergent validity was established through the ave (average variance extracted), factor loadings, and composite reliability. as indicated in table 1, all-composite reliability coefficients are above 0.7, meaning that all the items retained in the model are internally consistent. additionally, all factor loadings are above 0.7, and all aves exceed 0.5 (byrne 2010), proof that the convergent validity of the cfa model is supported. table 1: statistical evidence of reliability and convergent validity. the discriminant validity of the constructs was tested using the fornell and larcker (1981) matrix. the results support the discriminant validity, as the square root of the aves of all constructs (bold) are greater than the highest correlation coefficients of each construct (see table 2). table 2: evidence of discriminant validity. following the statistical evidence of model fit, and the convergent and discriminant validity, we move to the structural model analysis. structural model analysis the structural model analysis tests the research hypotheses, specified in the conceptual model (figure 1). maximum likelihood was used as the model estimation method, and the fit indices of the structural model (figure 2) were satisfactory (χ2 = 1425.717, p < 0.05, df = 536, χ2/df = 2.660, agfi = 0.843, tli = 0.947, cfi = 0.952, and rmsea = 0.056). the robustness of the model is further established as there are reasonably high variances explained in the endogenous variables such as risk taking (63%), proactiveness (64%), innovativeness (69%), and ei (70%). according to ceresia and mendola (2020), the predictive power of the traditional tpb model rarely exceeds 50% of the variance explained in ei. therefore, this model performs better than the original tpb and many other extended versions of the tpb. figure 2: structural model. the model hypothesised that the effects of attitude, entrepreneurship capability and the perceived benefits of digital technology on ei are mediated by risk taking, innovativeness, and proactiveness. in other words, the study tests whether the presence of these three mediators affects the relationship between the three predictors (attitude, entrepreneurship capability, and perceived benefits of digital technology) and the main dependent variable (ei). after controlling for prior entrepreneurial education, family background of entrepreneurship, and digital technological literacy, the results reveal that the effects of attitude and capability on ei are partially mediated by risk taking (table 3). this is because both the indirect (bindat estimate = −0.033; bindec estimate = −0.033, respectively, and p < 0.05 for both estimates) and direct (bat estimate = 0.519; bec estimate = 0.369, respectively, and p < 0.05 for both estimates) effects of these two predictors are statistically significant. the negative coefficients of the indirect effects mean that instead of decreasing the direct effect, the mediator amplifies it. therefore, the direct effect of attitude and entrepreneurial capability on ei is stronger when risk taking is present. so, hypotheses h1 and h4 are supported. table 3: mediation analysis. results further suggest that the effect of the perceived benefits of digital technology is fully mediated by risk taking as its indirect effect on ei is significant (bpbdt estimate = −0.037, and p = 0.05), while its direct effect is non-significant (bpbdt estimate = −0.018, and p > 0.05). this suggests that perceived benefits of digital technology are ineffective in driving ei, unless combined with risk taking. therefore, h7 is supported. the data did not support the other hypotheses; they were, therefore, deemed non-significant. according to the results, not all dimensions of eo mediate the predictors of ei. although proactiveness predicts ei to some extent (β = 0.129, p < 0.05), it does not have a mediating function in the model. risk taking is the only component of eo that mediates the effects of all three predictors (attitude, entrepreneurial capability and perceived benefits of digital technology) of ei. the impact of the two tpb predictors (attitude and entrepreneurial capability) is partially determined by risk taking (confirmed mediator); whereas the confirmed mediator entirely determines the effect of the perceived benefits of digital technology. the implication is that these three predictors need risk-taking to optimise their impact on ei. discussion it was theoretically proposed that attitude, entrepreneurial capability, and the perceived benefits of digital technology affect ei via eo (risk taking, innovativeness, and proactiveness). however, the results revealed that risk taking is the sole element of eo that mediates the effect of the three predictors considered in the study. the implications of these findings are discussed next. theoretical implications this study makes three significant contributions to the body of knowledge. firstly, it contributes to the research on the entrepreneurial aspirations of young people in developing nations, while previous studies (youssef et al. 2021) on ei focused on college students, assuming that entrepreneurial skills and attitudes can only be acquired through formal education. this study broadens the scope of inquiry by including all young adults, regardless of their academic background. we argue that in emerging nations like south africa, many young adults lack access to formal entrepreneurial education in universities. however, those without a college degree may develop their entrepreneurial skills on the job, or through participation in workshops and training events. this segment is unfortunately excluded from most studies; hence we call for more inclusive research on youth entrepreneurship in developing nations. secondly, recent research (lisboa, skarmeas & saridakis 2016) emphasised the moderating role of eo, while the discussion on its mediating function remains underdeveloped. for instance, it was determined that proactiveness and innovation moderate the relationship between product advantages and success. the moderating role of the eo factors was also discovered in the relationship between a firm’s ability ‘to exploit new knowledge and its financial performance; explorative capabilities and new-product differentiation advantages’ and organisational flexibility and strategic performance (e.g. yousaf & majid 2018). this study adds to the body of knowledge by demonstrating that eo factors may also play a mediating role in ei. we theorise that the impact of attitude, entrepreneurial capability, and the perceived benefits of digital technology on the ei of young adults depends on their risk-taking propensity. thirdly, the research utilised a decomposed approach of eo to predict ei. this method enables the assessment of the unique contribution of each component of eo to ei. although risk taking, innovativeness, and proactiveness form eo, they do not all carry the same weight in predicting ei. the results of this study revealed that risk taking is the most important aspect of eo when predicting the ei of the youth in a developing country. it also appears to be a prominent factor in other studies not related to the current one. for instance, risk taking mediated the predictors of prenatal testosterone exposure, opportunity recognition, and personality traits (bergner, auburger & paleczek 2021). although both studies recognised risk taking as a mediator, their conclusions did not apply to ei, and they focused solely on risk taking while not considering the remaining two components of eo. we argue that even though risk taking, innovativeness, and proactiveness operate independently, they remain interconnected through the concept of eo. therefore, this study improves the understanding of the eo framework by highlighting the prominence of risk taking within the broader framework of eo that includes innovativeness and proactiveness. lastly, the partial mediations found in this study theorise that attitude and entrepreneurial capability directly impact ei even in the absence of risk taking. this new perspective partially validates the tpb among young adults in general. the validation of risk taking as a partial mediator calls for the need to modify the simplified structure of the tpb, which postulates that the links between ei and its predictors (attitude and entrepreneurial capability) are linear (ajzen 1991). to extend its applicability, this study provides a new pathway suggesting that tpb predictors affect ei through risk taking. the findings improve the tpb’s predictive power by integrating risk taking as a mediator of the predictors of ei. in other words, the propensity for risk taking contributes to the indirect mechanism by which attitude and entrepreneurial capability affect entrepreneurial intent. the authors are unaware of any previous model having established this. practical and policy-making implications the insights generated in this research should be of great interest to policymakers and entrepreneurship centres, because they are the main promoters of the youth’s entrepreneurship. the study illustrates that ei depends on the association that risk taking has with attitude, entrepreneurship capability, and perceived benefits of digital technology. four practical implications can be formulated from these findings. firstly, this result confirms the findings of previous research (miaomiao & xiaoyan 2019), that attitude and entrepreneurial skills are crucial for fostering ei among young adults in developing nations. therefore, programmes that enhance entrepreneurship attitude and shape entrepreneurial skills would contribute to improving the level of ei among young adults. literature further indicates that entrepreneurial learnership is the most effective way of shaping attitude and entrepreneurial skills. this explains why developing countries are seeing an increase in the number of entrepreneurship centres. although this increase is commendable, it is unfortunate that most of these centres are either very expensive or restricted to university graduates only. like most micro-sized business owners, many aspiring young entrepreneurs do not have university education. so having universities as the primary hub for entrepreneurship education and training may pose challenges for potential entrepreneurs who cannot enrol in formal universities. given that developing countries need more young adults with entrepreneurial skills, governments and non-governmental organisations (ngos) may work together to launch entrepreneurship programmes open to all young adults regardless of their academic background. secondly, every business opportunity expires at some point; therefore, taking risks allows aspiring entrepreneurs to seize opportunities before they expire. this study demonstrates that risk taking is an enhancer of ei predictors as it amplifies their predictive effects. this outcome calls for a stronger emphasis on risk taking in educational entrepreneurship programs. for example, having a module that focuses specifically on risk taking, could help raise awareness about its significance and correct the misconception that risk taking is like gambling. unpacking the concept of calculated risk, will aid in restoring the rationality of risk taking. since entrepreneurship always involves some level of risk, entrepreneurship centres may provide guidelines to identify the business risks that are worth taking. to enforce risk taking among young adults, the government and various stakeholders could adopt policies that encourage risk taking. for example, governments could offer research grants to support high-risk businesses. this research would aim to accurately assess the business risk versus the potential of the opportunity. non-governmental organisations, promoting youth entrepreneurship, may also use mass media or social media to share the success stories of young entrepreneurs who took risks to launch a business venture; this is known as social learning (bandura 1986). when sharing their experiences, these role models could emphasise the importance of calculated risk taking and the advantages of having a business. these programmes could help to destigmatise risk taking, reduce the fear of business failure, and increase the propensity for risk taking among young adults in developing nations. in modern economies, digital technology plays a central role. it provides numerous advantages, including access to global markets and reduced operational and logistic costs. in the study, it is found that the perceived benefits of digital technology influence the ei of young adults, depending on their propensity for taking risks (full mediator). most young adults in developing nations prefer employment, because they believe entrepreneurship is resource-intensive and fraught with failure. a detailed course on the advantages of digital technology for start-ups could address this misconception and increase the appeal of entrepreneurship to young adults. technology companies could offer specialised digital solutions for start-ups that foster business growth and development. conclusion, limitations, and future research the aim of this study was to examine the mediating role of risk taking, innovativeness, and proactiveness in driving the ei of young adults in south africa. the tpb was used as the theoretical framework, and three predictors were considered: attitude, entrepreneurial capability, and the perceived benefits of digital technology. the findings established that risk taking is the only component of eo that mediates the effects of these three predictors. it does not mean that innovation and proactiveness are unimportant in forming ei; instead, it suggests that innovativeness and proactiveness do not enhance the impact of attitude, entrepreneurial capability, and the perceived benefits of digital technology on ei. they might have other functions regarding ei, but not a mediating role. like any other study, this research is not free from limitations. firstly, most respondents came from the gauteng province (68%) and six (06) out of nine (09) provinces have a participation rate of less than 7%. therefore, we suggest that in further studies the conceptual model is retested, using quotas that reflect the distribution of young adults across the nine provinces of south africa. secondly, the results may differ, based on the moderating effect of demographic variables such as gender, age, or employment status. as no interaction variable is considered in this study, future researchers are encouraged to investigate the moderating role of the demographics. acknowledgements competing interests the author(s) declare that they have no financial or personal relationship(s) that may have inappropriately influenced them in writing this article. authors’ contributions e.s.n. wrote the original manuscript and p.r. and a.s. authors reviewed and added their inputs. ethical considerations etchical clearance was obtained from the central university of technology (fmsec81122). your participation in this research is entirely voluntary and you can withdraw from the survey at any time without any reprisal or penalty. for ethical reasons, this research is aimed at adult participants only (persons aged 18 and above). in addition, you have the right to ask questions before, during, and after the administration of the questionnaire. funding information the author(s) received no financial support for the research, authorship, and/or publication of this article. data availability the data that support the findings of this study are available on request from the corresponding author, e.n. disclaimer the views and opinions expressed are those of the authors and do not necessarily reflect the policy or position of any affiliated agency. references ács, z.j., audretsch, d.b., strom, r. & strom, r.j. 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(ed.), digital business strategies in blockchain ecosystems, pp. 265–279, springer, cham. microsoft word 7 angelop et al sajems 16(2) 2013.docx sajems ns 16 (2013) no 2 199 performance satisfaction, shareholder and stakeholder orientations: managers’ perceptions in three countries across continents georgios angelopoulos, john a parnell and gregory j scott centrum católica, pontificia universidad católica del perú accepted: september 2012 managers working in south africa, peru and the united states were classified as stakeholderand/or shareholder-oriented along the perceived role of ethics and social responsibility (presor) scale. the relationship between stakeholder/shareholder orientation and perceptions of organisational performance was further explored. in south africa and overall, respondents with both high stakeholder and low shareholder orientations reported the greatest performance satisfaction. in peru, managers with a high stakeholder orientation reported the greatest satisfaction with organisational performance. a significant link between stakeholder or shareholder orientation and performance satisfaction was not found in the united states, however. directions for future research are outlined. key words: presor, shareholder, stakeholder, stockholder, ethics, corporate social responsibility, peru, south africa, united states jel: m140 1 introduction increased globalisation in recent years has led to considerable discussion and debate regarding the fundamental purpose of the modern firm and the requirements for managerial success in today’s business environment (handy, 2002; pienaar, 2010; scherer, palazzo & matten, 2009; sen, 2009). essentially two distinct perspectives have emerged on the nature of the pursuit of sustainable high firm performance. these perspectives constitute what is commonly viewed as two competing viewpoints, the stakeholder and shareholder perspectives on firm governance (crilly, 2011; garcia-castro, arino & canela, 2011). proponents of the shareholder or shareholder primacy view argue that aside from ethical obligations—engaging in moral and legal transactions—firms should be managed in the sole interest of their shareholders or owners, and to that end seek to maximise profits. firms are best equipped to serve their interests and ultimately those of society by meeting the demand for goods and services in such a way that they maximise both financial returns and client satisfaction in the process. business organisations should engage in social endeavours only to the extent that in doing so they enhance the prospects of higher shortor long-term financial returns. social considerations not linked to shareholder considerations are seen as matters of personal initiative, private charities and foundations, or the responsibility of government. as conceptuallised in this paper and in others, we refer to this as the shareholder or shareholder primacy view (see prahalad, 1994; armour, deakin & konzelmann, 2003; rodin, 2005; rebérioux, 2007; schwartz, 2007; keay, 2008), but it may also be termed the stockholder view (see freeman & reed, 1983; bierema & d’abundo, 2004; charron, 2007; dias & gonçalves, 2007; strine, 2008; matwijkiw & matwijkiw, 2010). proponents of the stakeholder view focus on a different set of priorities. they recognise the growing influence of individuals and entities that are directly affected by a firm’s actions— employees, governments, suppliers, distributers, clients, consumers and others—and suggest that business success has evolved to include abstract 200 sajems ns 16 (2013) no 2 more than just traditional objectives like profit maximisation, but other concerns such as environmental sustainability as well (goodpaster, 1993; kay & popkin, 1998; moura-leite, padgett & galan, 2011; orlitzky, siegel & waldman, 2011). proponents of the stakeholder perspective argue that this evolution is substantial, to the extent that financial returns are often tied directly to the social and sustainability concerns inherent in the perspective (schwalb, ortega, garcía & soldevilla, 2003; schwalb, garcía & soldevilla, 2005; flores & ickis, 2007; gil, 2009). given recent attention to factors such as carbon emissions, energy prices and increased public pressure for greater corporate transparency and consultation, business success would depend on a firm’s ability to satisfy the needs of an array of stakeholders other than shareholders alone. as such, the modern business enterprise should develop partnerships with a broader range of relevant stakeholders to achieve and sustain the highest financial performance possible for shareholders, and in so doing address the needs of a much broader group of constituents on whom the firm´s continued success depends as well. efforts to link or debunk notions of managerial ethics and social responsibility with organisational performance have been pervasive over the past few decades (quinn & rohrbaugh, 1983; zahra & latour, 1987; vitell & hunt, 1990; aquilar, 1994; garciacastro et al., 2011). different measurement tools have been developed that help contribute to our understanding of the relationship between performance and the ethical and social responsibility orientations of organisational decision makers (singhapakdi, vitell, rallapalli & kraft, 1996). most have been developed in western industrialised countries, and the majority of these in the united states. while substantial progress has been made in that regard, competing conceptualisations of and measurement schemes for ethics, social responsibility, and performance have heightened the challenge (shafer, fukukawa & lee, 2007; vitell, ramos & nishihara, 2010). however, there remains a dearth of published work assessing ethical orientations and their prospective links with organisational performance in the developing world (robertson, olson, gilley & bao, 2007). several crosscultural applications of specific measurement tools such as those of axinn, blair, heorhiadi and thach (2004), vitell and paolillo (2004), shafer et al. (2007) and vitell et al. (2010) have been conducted, but additional work is needed. this study explores the interrelated perceptions of business performance, ethics and corporate social responsibility (csr) in a comparative, cross-continental study of south africa, peru and the united states. more specifically, this study seeks to determine whether managers in these disparate nations hold similar or contrasting views on the importance of stakeholder and shareholder considerations with regard to their decisionmaking, and to gain insights into managers’ appreciation of the relative importance of shareholder and stakeholder well-being in defining organisational success. 2 global and country contexts the overwhelming majority of scholarly work on ethics and csr focuses on developed western societies, particularly the united states. given the long history of csr in the united states (bowen, 1953) and its growing importance among united states multinational firms (e.g. porter & kramer, 2002) one would expect american preference for a stakeholder orientation. nonetheless, the united states has also had noteworthy advocates (friedman, 1993) and more recent proponents (karnani, 2011) of the shareholder perspective. in practice, united states corporations and their chief executives offer many examples of both points of view, from the days of hewlett packard (handy, 2002) to the recent period of wall street excess (kliksberg, 2009). interest in the interaction between csr and entrepreneurial activity outside north america and europe has increased recently (lenartowicz & johnson, 2003; belausteguigoitia & portilla, 2004; jain & pisani, 2008; parnell, 2008), in large part because of four developments. the first was the publication of the brundtland report, titled ‘our common future’ in 1987 (wced, 1987). the report highlighted the importance of focusing global attention on the needs of the poor in developing countries and calling for a more inclusive notion of economic sajems ns 16 (2013) no 2 201 development. furthermore, it christened the notion of sustainable development in which the needs of the future were not to be compromised in meeting the needs of the present, and put the concept of intergenerational equity on the agenda of governments and multinational companies in industrialised and developing countries. second, the united nations development program’s 1992 global conference on the environment in rio de janeiro led to the launch of world earth day, which raised global awareness of environmental protection. in business circles this increased an awareness of the link between a sustainable environment and sustainable business. third, many nations in africa, asia and latin america adopted policies to reduce the size and influence of the public sector, ceding greater influence to private firms through programs of privatisation, liberalisation of domestic markets and free trade agreements (robles, simon & haar, 2003; casanova, 2005). at the same time governments´ and civil society´s expectations of the private sector´s contribution to economic growth and social progress took on greater importance (reficco & ogliastri, 2009). fourth, many businesses operating in developing countries saw their growth prospects adversely affected by the recent financial crisis in the industrialised nations (kliksberg, 2009). in short, firms today are confronted with the multiple challenges of achieving greater competitiveness in light of trade liberalisation, sustainability, civil society’s expectations and the added pressure of the global financial crisis. these have resulted in the awareness of a responsibility towards a broader constituency than simply shareholders, and a more detailed set of performance indicators than simply maximising profits (casanova, 2005; reficco & ogliastri, 2009; scherer et al., 2009). hence, the notion of business success and what it means from a societal perspective has in recent years received considerable attention around the globe. south africa is a middle-income emerging economy. while its economy is no longer defined by race as it was in the apartheid years before 1994, inequality remains and its gini coefficient is amongst the world’s highest (bosch, rossouw, claassens & du plessis, 2010). its economy is the largest and most competitive in africa although the economic gap between south africa and some of its neighbours is narrowing. in certain areas such as financial market development and private institution accountability it is globally competitive. in areas such as labour market efficiency, crime prevention, health and education, however, it ranks very poorly (wef, 2011). csr and business ethics are prominent concerns in south africa with the institutionalisation of standards of corporate governance through, for example, wide adoption in the early 1990s of the codes of conduct of the king committee’s report on corporate governance and their revisions in 2002 and 2009 (rossouw, van der watt & malan, 2002; rossouw, 2005). firms are expected to supply information on their csr programs and to have them independently assured (institute of directors, 2009), and the degree of assurance in south africa compares favourably with that in developed countries (marta, singhapakdi & higgs-kleyn, 2001; ackers, 2009). one may, therefore, expect south africans to demonstrate a high stakeholder orientation. south africans would not see profits as the exclusive objective of business activity; moral values would probably be seen as central to success in business. ‘good’ business people tend to be successful, and business ethics are not merely a public relations concept (moore & radloff, 1996; sims & gegez, 2004). the prominence given to the king committee’s codes (rossouw & van vuuren, 2003) and their wide adoption would suggest that great value is placed on ethics and social responsibility. the importance of business ethics has increased in south africa, in part because of legislative requirements (edwards, 2007; johnston, 2011). pienaar and roodt (2001), for example, found no demand for business ethics training among industrial psychologists, but within five years barnard and fourie (2007) found a significant call for such training. certain south african managers may, on the other hand, exhibit a shareholder orientation or indeed a pure profit motive that 202 sajems ns 16 (2013) no 2 extends beyond the shareholder view. historically, south africa has tended to follow the us business model (rossouw & van vuuren, 2003; goosen & van vuuren, 2005); and while business formally endorses good governance and ethical conduct, ethics training in organisations is generally brief (malan & smit, 2001; nicolaides, 2009) and unethical conduct is rife (erasmus & wordsworth, 2004; lloyd & mey, 2010), suggesting that the pure profit motive remains paramount, and for some that goal overrides ethical considerations. peru experienced drastic changes in government economic policy, social and political upheaval, and bust-to-boom shifts in its business environment over the last four decades (jaramillo & silva-jáuregui, 2011). the country survived a military dictatorship from the late 1960s through the 1970s, intense terrorist activity in the 1980s, and hyperinflation exceeding 7000 percent in the early 1990s (murakami, 2007). in 1991, the government responded with efforts geared toward aggressive privatisation and the pursuit of free trade (adex, 2005; gonzález vigil, 2009). an influx of foreign investment followed and has continued up to the present (de althaus, 2007; dube, 2011). political stability, macro-economic caution and the aggressive pursuit of free trade enabled the nation to emerge as one of the fastest growing economies in latin america (tello & tavara, 2010). this economic expansion created heightened interest in the link between corporate activity and society (de althaus, 2007; flores & ickis, 2007; quiroz, 2008; gil, 2009; jaramillo & silva-jáuregui, 2011). in the case of peru, a predominant stakeholder orientation would be plausible because of its roman catholic tradition, the growing influence of civil society (caravedo, 1998; perú 2021, 2010; tromben, 2011), repudiation of corruption (quiroz, 2008) and increased interest in social equity and inclusion (jaramillo & silva-jáuregui, 2011). indeed, peruvian managers appear to have a greater tendency towards idealism than their counterparts in other nations (robertson et al., 2007). the recent, sustained economic boom, however, brought conspicuous tangible benefits, with corporate success receiving wide publicity and admiration in the media (de althaus, 2007; anon., 2008; parnell, 2008; anon., 2009; tello & tavara, 2010), suggesting that a shareholder orientation may also be plausible in peru. csr has been discussed in various business, political, and academic circles in peru (schwalb et al., 2003; schwalb et al., 2005) but research suggests that the concept is still in its operational infancy (burton & goldsby, 2009; tromben, 2011; marquina, goñi, rizo-patrón, castelo, castro, morice, velasquez & villaseca, 2011). while many firms engage in philanthropy or public image initiatives, the relatively few that consider csr to be something more have focused on community relations and the environment (schwalb et al., 2003; portocarrero, sanborn & camacho, 2007; caravedo, 2009) rather than labour or other internal issues (garavito, 2008). 3 the perceived role of ethics and social responsibility numerous scholars and practitioners argue that decision-makers should incorporate ethical and social responsibility considerations into their strategic decision-making processes (velasquez, 1996; shafer et al., 2007; vitell et al., 2010). singhapakdi et al. (1996) developed the perceived role of ethics and social responsibility (presor) scale to measure individual orientations toward ethics, social responsibility and profits. three presor factors were included in their original work, including social responsibility and profitability, long-term gains, and short-term gains. the presor scale is appropriate for international comparison because national culture is a significant factor in ethical decision-making (buller, kohls & anderson, 2000; sims & gegez, 2004; singhapakdi, vitell & leelakulthanit, 1994). although their initial analysis supported the existence of these factors, additional work suggested that modifications were appropriate, while the cross-cultural context of many of the studies suggests their validity in diverse national settings. etheredge (1999) applied the presor scale to part-time chinese mba students in hong kong and identified only two factors, ‘importance of ethics and social responsibility’ and ‘subordination of ethics and sajems ns 16 (2013) no 2 203 social responsibility.’ axinn et al. (2004) assessed the original data of singhapakdi, kraft, vitell and rallapalli (1995) as applied to mba students in malaysia and the ukraine, with results also coalescing along two themes—stakeholder and shareholder views— with the former further divided into two subdimensions. the cross-cultural study by axinn et al. (2004) lends credence to the instrument in malaysia and ukraine. the spanish application in vitell et al. (2010) supported the instrument’s general structure as well. research in the united states and china reported by shafer et al. (2007) supports a twofactor solution with five shareholder view items and eight stakeholder view items. from these studies and less formal operational observations, two different characterisations of managers’ perceptions have emerged. some managers possess a predominantly shareholder orientation, emphasising the fiduciary responsi bility of a firm to its owners. others are more stakeholder-oriented, giving more credence to the interests of multiple organisational stakeholders rather than emphasising just shareholders. broadly speaking, a stakeholder orientation reflects a general thrust in csr literature (see orlitzky et al., 2011). more specifically, it is consistent with sen’s (2009) notion of heightened concern for ethics and social responsibility as an integral part of managing the firm. 4 hypotheses this paper tests the extent to which an individual’s responses along the presor scale are associated with perceptions of organisational performance. four hypotheses are proposed and tested in south africa, peru and the united states. the relationship between presor category and organisational performance is intriguing. prima facie, one might expect individuals with a shareholder orientation to outperform their counterparts on traditional measures of performance, that is, to demonstrate greater satisfaction with performance as defined by their satisfaction with firm profits. h1a: in the united states, respondents with a high stakeholder orientation will report greater satisfaction with performance than respondents with a low stakeholder orientation. this hypothesis postulates a link between organisational performance, ethics and csr. as previously suggested, one might initially expect a stakeholder orientation when traditional measures of organisational performance are employed in the united states. the next hypothesis postulates a link between performance satisfaction and an approach that is more narrowly focused on profit and benefits to shareholders. this assertion assumes that ethics may be traded for profits in many decisions, and that individual predilections are associated with perceptions of performance (i.e. profitability) at the organisational level. h1b: in the united states, respondents with a high shareholder orientation will report greater satisfaction with performance than respondents with a low shareholder orientation. in peru, the case for stakeholder and shareholder orientations could be supported by recent organisational performance and economic success (de althaus, 2007), on the one hand, and the growing interest in ethical issues related to the operations of public and private organisations on the other (quiroz, 2008; caravedo, 2009). the picture is clouded, however, given the limited track record and awareness of such initiatives (marquina et al., 2011) and the expectation that they would be more evident in developed countries with deeper traditions of csr and formalised ethical approaches to business (garavito, 2008; d´alessio & marquina, 2009). nevertheless, the business environment in peru is evolving and expectations regarding organisational behaviour are changing (tromben, 2011; jaramillo & silva-jáuregui, 2011). select case studies documenting the practice of csr refute the notion that such practices are not undertaken or are impractical in peru (schwalb et al., 2003, 2005; sanborn, del castillo & chávez, 2006; flores & ickis, 2007; portocarrero, sanborn, del castillo & chávez, 2007). in some instances these studies quantify the contribution of csr to firms’ financial success rather than confirming a popular notion that they represent only a cost with little net positive impact on the firm´s financial performance. the following hypothesis postulates a link between performance satisfaction 204 sajems ns 16 (2013) no 2 and a broader ethical approach to business in peru. h2a: in peru, respondents with a high stakeholder orientation will report greater satisfaction with performance than respondents with a low stakeholder orientation. a link between a shareholder orientation and stronger performance outcomes seems consistent with two factors in peru: recent rapid growth of the economy, despite growth being concentrated in traditional sectors such as mining and agribusiness (tello & tavara, 2010); and the absence of widespread initiatives linking business performance to csr (garavito, 2008; marquina et al., 2011). this is postulated in the following hypothesis. h2b: in peru, respondents with a high shareholder orientation will report greater satisfaction with performance than respondents with a low shareholder orientation. in the case of south africa, there is support for the view that managers reporting a stakeholder orientation would report greater satisfaction with performance. it is widely held that ethics and organisational success are linked (rossouw et al., 2002; van vuuren, 2002; rossouw & van vuuren, 2003). the following hypothesis postulates a positive link between performance satisfaction, ethics and csr. h3a: in south africa, respondents with a high stakeholder orientation will report greater satisfaction with performance than respondents with a low stakeholder orientation. however, opposition to this perspective is also evident. some believe that directors focus too heavily on csr, that ‘codes of behaviour have been driven to such a degree that they now derogate from the essential requirement… to run successful businesses’ (johnston, 2011: 62). the idea that a preoccupation with ethics hinders business is not uncommon. in south africa, it could also be expected that a shareholder orientation would correspond with greater satisfaction than would the stakeholder orientation. a lack of morality is not the equivalent of a shareholder orientation, although both may share a profit focus. coldwell (2010) identifies ‘amoral’ management as a profitdriven approach with little sensitivity to ethics, but recognises that such an orientation and its prevalence is unmeasured. the following hypo thesis postulates a link between satisfaction with organisational performance and a shareholder orientation in south africa. h3b: in south africa, respondents with a high shareholder orientation will report greater satisfaction with performance than respondents with a low shareholder orientation. one’s management perspective can change when one progresses through an organisation’s hierarchy. indeed, top managers often view strategic and other considerations differently from their counterparts at other management levels (parnell, 2005). the extent to which stakeholder or shareholder orientation might differ is unclear, however. the final hypothesis postulates no difference in orientation by level of management. h4: there will be no significant differences in stakeholder or shareholder orientation across management levels. 5 methods this study utilised the previously validated presor scale of singhapakdi et al. (1996) as the theoretical frame for the further measurement of subjective perceptions of organisational performance. qualitative measures of organisational performance have been utilised in a number of studies to assess subjective areas of performance such as the satisfaction of managers, customers and other stakeholders. invoking a qualitative perspective of performance can provide insight into organisational processes and outcomes that cannot be seen via financial measures (ayadi, dufrene & obi, 1996; parnell, o’regan & ghobadian, 2006). hence, self-reporting scales that assess relative competitive and objective performance in the present study were adopted from ramanujam and venkatraman (1987). the present study employed these scales in south africa, peru and the united states. targeting a minimum of 60 respondents in each country for a multi-nation comparison is consistent with the protocol suggested by malhotra, agarwal and peterson (1996). the questionnaire was presented in usa english in the united states, in uk english in south africa, and in peru it was translated into spanish and checked for accuracy. respondents sajems ns 16 (2013) no 2 205 were graduate business students and working professionals across professions and industries, and all were practising managers. 6 findings a total of 532 usable responses were collected, including 180, 142, and 210 from peru, south africa, and the united states respectively. a summary of the national samples appears in table 1. factor analyses were conducted to assess the integrity of both presor subscales (see table 2). results were generally supportive, including coefficient alphas above .70 and solid factor loadings, with only one below .500 and four below .600. t a b l e 1 sample characteristics variable peru (n=180) south africa (n=142) united states (n=210) mgt experience (years) 5.55 (sd=4.56) 7.54 (sd=7.28) 9.83 (sd=9.65) org experience (years) 6.44 (sd=6.33) 6.99 (sd=6.80) 10.00 (sd=10.17) age 34.28 (sd=7.75) 37.18 (sd=9.31) 36.81 (sd=12.40) sex male 137 (76.1%) 84 (59.2%) 114 (54.3%) female 43 (23.9%) 58 (40.8%) 94 (44.8%) level lower 60 (33.3%) 32 (22.5%) 48 (22.9%) middle 61 (33.9%) 72 (50.7%) 86 (41.0%) upper 59 (32.8%) 38 (26.8%) 76 (36.2%) t a b l e 2 presor subscales variable peru sa us composite shareholder view coefficient alpha .771 .794 .835 .807 1. the most important concern for a firm is making a profit, even if it means bending or breaking the rules. .628 .718 .750 .713 2. to remain competitive in a global environment, business firms will have to disregard ethics and social responsibility. .791 .823 .847 .824 3. if survival of a business enterprise is at stake, then you must forget about ethics and social responsibility. .845 .851 .825 .844 4. efficiency is much more important to a firm than whether or not the firm is seen as ethically or socially responsible. .730 .644 .738 .701 5. if the shareholders are unhappy, nothing else matters. .639 .695 .718 .684 stakeholder view coefficient alpha .843 .803 .826 .834 6. being ethical and socially responsible is the most important thing a firm can do. .513 .694 .648 .608 7. the ethics and social responsibility of a firm is essential to its long-term profitability. .707 .694 .676 .706 8. the overall effectiveness of a business can be determined to a great extent by the degree to which it is ethical and socially responsible. .728 .737 .678 .714 9. business ethics and social responsibility are critical to the survival of a business enterprise. .826 .773 .747 .785 10. a firm’s first priority should be employee morale. .734 .539 .525 .626 11. business has a social responsibility beyond making a profit. .735 .653 .694 .715 12. social responsibility and profitability can be compatible. .724 .446 .701 .647 13. good ethics is often good business. .577 .637 .698 .644 the national samples were categorised along the presor scale. following the distinction in shafer et al. (2007) between shareholder and stakeholder views, each respondent was classified as high or low in shareholder and stakeholder orientations if the factor score for each measure was one-half of one standard deviation or greater from the mean. those with factor scores within one-half of one standard deviation from the mean were not classified. in 206 sajems ns 16 (2013) no 2 other words, respondents with factor scores greater than 0.5 were considered high, those less than -0.5 were considered low, and those between -0.5 and 0.5 were excluded from the test. table 3 provides category membership by nation. t a b l e 3 shareholder and stakeholder categories across nations category peru south africa usa composite stakeholder low 70 78 57 205 % 38.9% 54.9% 27.1% 28.9% high 44 25 85 154 % 24.4% 17.6% 40.5% 28.9% excluded 66 39 68 173 % 36.7% 27.5% 32.4% 32.5% shareholder low 50 28 85 163 % 27.8% 19.7% 40.5% 30.6% high 57 66 47 170 % 31.7% 46.5% 22.4% 32.0% excluded 73 48 78 199 % 40.6% 33.8% 37.1% 37.4% the performance satisfaction scale was also factor analysed to assess integrity (see table 4). one item in the performance satisfaction scale (item 3) did not load well in the peruvian and composite samples but the coefficient alpha statistics were acceptable across all national samples, so no items were removed from the analysis. t a b l e 4 performance satisfaction h1a and h1b were not supported. while high stakeholder and shareholder orientations were associated with performance satisfaction in the united states, the differences were not significant (see table 5) and the hypotheses were not supported. h2a was supported. managers in peru with a high stakeholder orientation reported a greater satisfaction with performance than did those with a low stakeholder orientation. h2b was not supported. in peru, managers with low and high shareholder orientations reported performance satisfaction levels near the mean; the difference was therefore not significant. the view that a high shareholder orientation is associated with greater performance in peru was not supported. h3a was supported. managers in south africa with a high stakeholder orientation reported significantly greater satisfaction with performance than did those with a low stakeholder orientation. variable peru s.a. u.s. total coefficient alpha .686 .954 .865 .827 1 sales growth .802 .858 .730 .816 2 growth in profit after tax .796 .885 .786 .831 3 market share .296 .843 .639 .383 4 return on assets (roa) .851 .869 .705 .816 5 return on equity (roe) .874 .920 .737 .857 6 return on sales (ros) .880 .890 .726 .848 7 overall firm performance and success .851 .880 .752 .842 8 competitive position .826 .830 .662 .787 sajems ns 16 (2013) no 2 207 t a b l e 5 results of t-tests of significance for performance satisfaction category peru south africa usa composite stakeholder low -.200 -.026 -.182 -.308 high .138 .441 -.313 .389 t-value 2.929 2.255 .453 5.139 significance .004 .026 .652 .000 shareholder low .037 .530 -.478 .221 high -.012 -.090 -.089 -.136 t-value .571 3.468 1.419 2.872 significance .568 .001 .159 .005 h3b was not supported. managers with a high shareholder orientation did not reflect greater performance satisfaction. in fact, south african managers with a low shareholder orientation reported the greatest satisfaction with performance with over one-half of one standard deviation below the mean. h4 was supported. none of the differences in stakeholder or shareholder orientation across management level were significant (see table 6). t a b l e 6 stakeholder and shareholder orientation across management level category peru south africa u.s.a. composite stakeholder low .916 1.156 .875 .957 medium .885 1.111 .837 .941 high .932 1.132 .855 .942 f-value .047 .029 .039 .019 significance .954 .972 .962 .981 shareholder low .933 1.00 .895 .936 medium .836 .931 1.200 1.009 high .864 .763 1.070 .931 f-value .250 1.241 1.971 .610 significance .779 .292 .142 .544 7 discussion the data presented in this paper suggests several key differences in stakeholder and shareholder orientations. indeed, results were mixed, suggesting differences across nations. a number of findings warrant elaboration. in peru unlike south africa and the united states there is a long history of business corruption which is a significant hindrance to business (lopez-claros, porter & schwab, 2005; lopez-claros, porter, sala-i-martin & schwab, 2006; porter & sala-i-martin, 2007; quiroz, 2008). hojman and perez (2005) have identified the tumultuous influence of multiple cultures in neighbouring chile that result in ambiguity, inconsistency and contradiction. peru has similarly experienced a mosaic of sharply contrasting cultural perspectives that go with the visible, outward embrace of market capitalism that may not reflect many peruvians’ true position. while the view was not corroborated in this study, previous research also suggests that significant differences exist in the attitudes of middle and lower managers and those at senior executive level (parnell, 2008) while expatriate professionals with whom peruvians work may also affect perceptions (delmestri, 2006). when compared to both peru and the united states, the percentage of south african managers categorised as stakeholder-oriented was lower, and the percentage categorised as 208 sajems ns 16 (2013) no 2 shareholder-oriented was substantially higher (see table 3). on close examination the percentage of south african managers with a low stakeholder orientation was far greater than the percentage with a high stakeholder orientation; and the percentage with a high shareholder orientation was far greater than the percentage with a low shareholder orientation. while south african stakeholder and shareholder orientations were originally considered as a possibility, their extremity was unexpected, and particularly so when compared to peru and the united states. it is surprising given the overt attention paid to csr in south african business, legislation and research, and in the light of earlier cross-national studies such as those of moore and radloff (1996) or sims and gegez (2004). the finding may also point to the possibility that there is a degree of ‘csr fatigue’ amongst south african managers, as expressed in johnston (2011). a key shortcoming of the presor scale is noted. ethics is an individual construct associated with moral decision-making. social responsibility is an organisational construct and refers to the notion that firms have an obligation to society beyond that of producing profits for their shareholders. the presor scale includes social responsibility considerations as part of a broader ethics orientation. rejection of social responsibility appears as rejection of managerial ethics, which is not necessarily the case. moreover, in some nations high degrees of csr can co-exist with low or varying degrees of individual honesty, morality and fairness, and vice-versa. hence, the scale may measure the perceived importance of csr for the business enterprise more than it does the individual’s imperative for managerial ethics. moreover, there is the assumption that managers are willing to sacrifice ethics in their pursuit of shareholder profit. for example, the item, ‘the most important concern for a firm is making a profit, even if it means bending or breaking the rules,’ is two-dimensional, assessing both shareholder orientation and a willingness to compromise ethics. presor presupposes that ethical concerns underpin a shareholder orientation. hence, additional scale modifications might be necessary to categorise managers with greater precision. the links between stakeholder/shareholder categories and organisational performance are not causal and should not be interpreted literally. greater satisfaction with firm performance in one category does not mean that alignment to that category always results in higher performance, especially at firm level. given the influence of organisational culture, one’s ethical perspective is often shared at least to some extent by other members of an organisation, but this is not always the case (parnell & dent, 2009). moreover, ethical views are assessed at the individual level, whereas performance is assessed at the organisational level. hence, the findings reported here are promising, but additional work is warranted. stakeholder and shareholder orientations are, in addition, not mutually exclusive. put another way, some managers may be oriented toward a stakeholder or a shareholder orientation, but others might be oriented toward both, or possibly neither; trade-offs between the two extremes are not inherent. indeed, the extent to which choices must be made between ethics and profits has been widely debated (parnell & dent, 2009; vitell et al., 2010). some scholars and practitioners emphasise the maxim that ‘good ethics is good business’ a perspective also reflected in presor item 13 while others highlight the myriad decisions executives face whereby profits can be maximised at the expense of ethical considerations. managers with both stakeholder and shareholder orientations eschew the notion that interests in ethics and profits are mutually exclusive. the notion of a combined stakeholder/ shareholder orientation may be more common in some nations than in others. for example, such a combination may not be as pervasive in peru because of the relatively few examples of firms embodying such a perspective (schwalb et al., 2003; schwalb, 2010; marquina et al., 2011). in a sense, respondents are probably less likely to opt for something that is practised on a limited scale and hence not readily seen. another distinction warrants clarification the examination of shortand long-term perspectives on performance. although a shareholder orientation might lead to high profits in the short run, one could argue that sajems ns 16 (2013) no 2 209 maximising long-term shareholder returns only occurs when the needs of all stakeholders are considered (jones & wicks, 1999). in this regard, individuals with stakeholder and shareholder orientations appear to focus on the convergence of both sets of interests in the long run. 8 conclusions and future directions the evidence presented in this paper supports the notion that many, albeit not all, business professionals in the united states, peru and south africa tend to see beyond a narrow profits-only orientation in their quest for high organisational performance. although there is evidence of a range of perceptions amongst managers and differences in and across countries, the study’s findings dispel the notion that outside of industrialised countries managers do not link firm performance to questions of ethics and social responsibility. it also suggests that trade-offs do not necessarily exist between concerns for ethics and profits. there are similarities and differences across nations with respect to the link between stakeholder and shareholder orientations and organisational performance. the composite results presented in table 5 underscore the reality that relationships differ markedly across nations. a re-examination of the conceptual foundation for a high orientation in both stakeholder and shareholder orientations is germane. if all stakeholders benefit in the long run from superior firm performance and shareholders benefit from attention given to the needs of other stakeholders (see jones & wicks, 1999), then such a perspective is the most rational. the distinction between a high stakeholder orientation alone and combined high stakeholder and shareholder orientations categories is therefore modest at best. given these considerations, it would follow that organisations should consider social obligations within the context of long-term performance and ‘manage’ csr as they do other business considerations. on the other hand, if the needs of shareholders and other stakeholders do not converge over the long term, then proclaiming both orientations simultaneously is naïve. only those with stakeholder and shareholder orientations understand the necessary shortterm and long-term trade-offs that must be made with regard to myriad conflicting stakeholder interests (see asher, mahoney & mahoney, 2005; jacoby, 2005). most scholars and practitioners occupy a middle ground between these two extremes, assuming partial convergence of shareholder and other stakeholder interests (garcia-castro et al., 2011). numerous positions between these two extremes can be identified, however, each accepting a different degree of possible convergence and favouring one extreme over the other. additional scholarly work is needed to clarify this conundrum. a number of opportunities for future research have been identified. first, the blending of managerial ethics and social responsibility in the shareholder portion of the presor presents a challenge to scholars attempting to categorise managers on various ethical, csr, or profit orientations. additional research on the prospective combinations of stakeholder and shareholder orientations would be fruitful. individuals possessing mixed orientations reject an either/or perspective on profits and ethics. embracing the two perspectives simultaneously is plausible and can be associated with high organisational performance. replications of the present study in other emerging and newly industrialised countries (nics) may identify factors that are associated with economic development status. the need to understand the cultural impact of the relationships among behavioural variables in organisations has never been more important (hutchings, metcalfe, & cooper, 2010). whereas scholars have typically viewed findings in western industrialised organisations as generalisable (boyacigiller & adler, 1991), research highlighting the influence of culture and other factors suggests that is not always the case (lenartowicz & johnson, 2003). additional scholarly work investigating the role of culture and other factors in organisational processes and performance in developing nations is needed (elbanna, 2007; el-amir & burt, 2008). the relationship between managers’ performance satisfaction, shareholder and stakeholder 210 sajems ns 16 (2013) no 2 orientations in developing countries bears monitoring. perceptions are affected by the pace and nature of development and current economic conditions, hence, managers should be assessed to establish whether more unanimous perceptions emerge over time. this is particularly significant in countries such as south africa and peru where economic transition is rapid and management ethos in a greater state of flux than is the case in more established economies. individuals aligning along specific presor categories across national boundaries could have more in common than they would with those in other categories within their own countries. following this logic, exploring the differential construction of the categories across national boundaries, and the degree of similarity of those aligning along particular categories across national boundaries in terms of management variables other than ethics, represent fruitful endeavours for further study. problems arise when constructs and surveys are modified or translated to suit samples in other cultures (punnett & shenkar, 1994; 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accepted: 27 july 2022; published: 07 dec. 2022 copyright: © 2022. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: implicitly, social welfare payments (swps) are a transfer from the wealthy (those in high-income quintiles) to the poor (in low-income quintiles) to reduce poverty and create a more equal distribution of income. previous studies have shown that resources, such as income (including swps), are pooled within households creating positive externalities. studies on the subjective well-being (swb) effect of swps are scarce, and no previous study has investigated whether the expected positive relationship holds across all household income quintiles. aim: this study determines whether the expected positive relationship between swb and swps holds across all household income quintiles. setting: the data for this study were obtained from the national income dynamics study (nids), which is representative of the state of affairs in south africa. methods: we use a pooled ordered probit and quasi-experimental models to investigate the relationship. results: surprisingly, all forms of swps are accessed across all household income quintiles, and the trend over time shows an increase. as expected, the relationship between swp and swb is positive, except in those households in the highest income quintile receiving an swp who experience a negative effect on well-being. conclusions: our study explains the lack of progress in decreasing inequality and lower levels of swb. additionally, our findings are of interest to the ongoing broader debates around the effects of swps globally on poverty, inequality and swb. many checks and balances should be in place to ensure only the most vulnerable access swps. keywords: subjective well-being; social welfare payment; quasi-experiment; propensity score matching; case study south africa. introduction in 2020, 9.2% of the world’s population lived in extreme poverty. the world bank predicted that an additional 88–115 million people would fall into this category in 2021 because of covid-19 (world bank 2020a). therefore, it is no surprise that there is an increased uptake of social welfare payments (swps) worldwide, placing social welfare systems under significant pressure to ensure the survival of vulnerable households (bassier et al. 2020). additionally, an increase in extreme poverty, which may lead to higher levels of inequality, is of great concern because it is causally associated with decreased psychological well-being and increased mental stress. in unequal societies, stressed individuals with lower psychological well-being are poor decision-makers in crucial areas, such as long-term investments in education and health (haushofer & fehr 2014). in addition, higher levels of inequality increase social tension concerning social-capital problems, health-related problems and human-capital problems (eds. helliwell, layard & sachs 2015; wilkinson & pickett 2009). it is widely recognised that countries use swps because they are positively associated with better economic well-being outcomes for underprivileged and vulnerable people (neves et al. 2009). however, human well-being is a multidimensional concept, and it is important to broaden our understanding of the impact of swps beyond merely economic well-being, to the wider concept of subjective well-being (swb). subjective well-being includes satisfaction with life (the cognitive dimension) and a positive mood or emotions (the affective dimension), overall referring to the hedonic perspective of well-being (diener, oishi & lucas 2002). even though swb is now a well-established measure that complements traditional economic measures, such as the gross domestic product, studies focusing on the effect of swps on swb are scarce (see literature review section). furthermore, studies investigating the effect of swps focused on only one specific type of swp, while social welfare systems in most countries are typically made up of a collection of varied payments, and the payments are pooled into the household income (knight, hosegood & timæus 2013; whitworth & wilkinson 2013). in addition, the recipient of an swp is often not the main beneficiary. for example, a mother who receives a child support payment (csp) is not the beneficiary but adds this income to the household budget to provide for the child’s needs. these transfers thus create positive externalities. the south african general household survey states that individuals rely on their ‘households for their physical, social and economic well-being’ (statistics south africa 2018:4). the general household survey defines households as individuals living together under the same roof or in the same yard and sharing resources (brophy et al. 2018; statistics south africa 2018). south africa, as a country, is our current case study and is known for its high levels of poverty and inequality. however, it also has one of the most extensive social welfare systems in the developing world, making it an excellent choice to test whether swps improve swb, and determine whether it holds across all income quintiles (goldblatt 2005). traditional family structures are especially important in south africa as large proportions of the population are subject to poverty and unemployment. social welfare payments are often the primary income source of poor households (88% of the low-income households receive an swp). thus, although these payments are mostly made at an individual level, the money is pooled, and the household members share the effect of well-being. it is essential not only to consider the effect of a single payment on a specific individual’s well-being (estimations would likely be upward biased, as it excludes the shared effect), but to take the effect of aggregated welfare payments on the household’s mean swb into consideration instead. only once the influence on the entire household is considered, can we judge the effect of swps on well-being. considering the positive externalities for households from individually received swps, we contribute to the literature by being the first study to investigate the relationship between swps and people’s swb across household income quintiles. we use the national income dynamics survey (nids) in our analysis. we introduce various estimation techniques to address possible endogeneity and limit the effects of confounding factors. our results show that all income quintiles access all types of swps in south africa. testing the hypothesis that a social welfare system should increase the swb of people, as, among others, poverty and inequality decrease, we find the swb assumption is true for the bottom income quintiles but not for the top income quintiles. additionally, our finding shows that inequality most likely increases as the intention to transfer income from the wealthy to the poor is doubtful if the highest household income quintiles access swps. the rest of the paper is structured as follows. in the next section the country in our case study, south africa, is briefly discussed, as well as the relevant literature on swps. in the third section the methodology is outlined and the data described. the results follow in the fourth section, while the fifth section accommodates the conclusion. background and relevant literature review case study our case study, south africa, is a developing country with approximately 60.7 million people. in 2019 the economy grew by only 0.15%. the estimated unemployment rate (as measured by the expanded definition) is 43.2% (statistics south africa 2021). in 2021, south africa was noted as the country with the highest level of inequality, with a gini coefficient of 0.66 (world bank 2021). according to the human development report (2020), 18.9% of the population, that is, approximately 11 million south africans, live on less than r28 ($1.90) a day, which is close to r800 ($55) per month. south african nids researchers zizzamia, schotte and leibbrandt (2019) estimate that about 52% of south africans live in chronic poverty. however, an additional 11.4% can be classified as ‘transient poor’, and about 19% form part of the ‘vulnerable middle class’. since the enactment of the social assistance act of 1992: [a] policy priority has been the direct transfer of revenue to vulnerable groups outside the labour force, particularly children and older adults living in poverty, adults and children with disabilities, and children needing care due to parental illness, death, abuse or neglect. (godfrey et al. 2016:775) the major share of the social welfare system comprises five categories (two targeted at adults and three at children): the old-age payment (oap), the disability payment (dp), the csp (introduced in april 1998 when it replaced the child maintenance payment), the foster-care payment (fcp), and the care-dependency payment (cdp). three lesser-known swps, also applied for, include grant-in-aid, social relief of distress, and war veterans’ payment.1 according to the south african social security agency (sassa 2020a), by the end of december 2020, more than 18 million swps were paid to more than 11 million beneficiaries. of the swps listed above, most of those paid in 2020 was in the csp category, namely 12 945 457, while the oap was awarded 3 729 103 times (sassa 2020a). literature review in the literature, most studies investigating the effect of swps2 focus on ‘child support payments’. there is a near-uniform belief that csps have a positive effect on the ‘material well-being’ of the child (cooper, mokomane & fadiji 2020; patel & ross 2020) and the caregiver (granlund & hocheld 2020; patel & ross 2020), but ‘negative effects’ are noted on the spouses or partners with increased feelings of shame (granlund & hocheld 2020). cooper et al. (2020) found that the ‘swb’ effects of the csp were low and that recipients experienced a decrease in their level of dignity since they faced negative attitudes and prejudice from their own communities. cooper et al.’s (2020) study was in direct contradiction to those of attah et al. (2016) and diener, oishi and tay (2018). they argued that socio-economic policies, such as income security and social protection programmes, are related to increased psychosocial well-being. additionally, oyenubi and kollamparambil (2022) found that beneficiaries of the csp had more birth attempts than non-beneficiaries, distorting incentives and likely increasing inequality and poverty issues. the effect of ‘old age payments’3 on swb is clearer than csps. consistent and significant positive effects of the oap on the elderly have been found, although there is still a debate regarding gender differences. kollamparambil and etinzock (2019) and grogan and summerfield (2019) found positive relationships between swb and oaps, although they argued that this only applied to elderly females. bando, galiani and gertler (2017) and galiani, gertler and bando (2016) confirmed that oaps decreased depression among the elderly, thereby increasing their mental well-being. studies that contradict the above state no significant relationship (schatz et al. 2012; shin 2018). however, it should be noted that these studies have limitations. for example, shin (2018) did not investigate causal relationships, or consider gender differences. using qualitative methods, knight et al. (2013) focused on 10 households receiving dps in kwazulu-natal, south africa. they concluded that positive health outcomes were associated with households where individuals received the dp while undergoing antiretroviral therapy. very few studies ‘combined different categories of swps’ to determine the impact on the recipients. using the first four waves of nids data, waidler and devereux (2019) investigated the impacts of child support and oaps and remittances on one set of well-being outcomes: food security and nutrition. they found that the csps had no significant impact on the dietary diversity index used in the study. thus, the positive and significant impacts are limited to the oaps and remittances. the oaps’ significance was confirmed in a mackett (2020) study. using the first five waves of the nids data and transition matrices, mackett (2020) studied poverty and labour market outcomes due to receiving swps. mackett (2020) compared those that receive and do not receive swps. against expectation, she found that non-swp recipients had a more favourable market outcome than swp recipients. additionally, mackett (2020) concluded that oaps had a better impact on labour outcomes and poverty than csps. given the above literature review, to the authors’ knowledge and as stated in the introduction, no other study has compared the swb relationship to receiving swps at a household level across income quintile groups. methodology and data methodology we use descriptive analysis to answer the following questions: (1) which household income quintiles access swps, (2) what type of swps are accessed by different income quintiles, and (3) the temporal trend in accessed swps. due to confounding factors and possible endogeneity due to possible omitted variables, we estimate various models to address the main question regarding the relationship between swps and swb across the household and income quintiles. we use a pooled ordered probit model due to the dependent variable’s ordered nature and test the robustness of the results using a pooled ordinary least squares (see table a1). lastly, we use a quasi-experimental model, namely propensity score matching. all estimations are reported for the whole sample, and as the results are similar for income quintiles one to four, but differ for quintile five, we report only the results of quintiles one and five in the main text. to estimate the pooled ordered probit model, we use the following specification: here i = 1,2,3,….10 represents the 10 categories of the swb variable. d refers to our treatment variable, which takes a value of 1 if a household receives an swp and 0 if it does not. x represents a vector of controls for household characteristics, and w refers to wave (time) fixed effects. finally, µ represents the stochastic error term. equation (1) estimates a score as a function of the independent variables and a set of ‘cut points’. the probability of observing outcome i corresponds to the probability that this score, plus the error term µ, is within the range of the cut points estimated in the model. the estimates from these models give us an idea of our treatment’s general association with the outcome variable. we run all diagnostic tests and find an absence of multicollinearity and autocorrelation. we use clustered (at the household level) robust standard error estimations to address heteroscedasticity. as our data comes from non-random observational studies, we admit that traditional econometric methods may bias the effect of the ‘treatment’ (in our case, this is the receipt of an swp) due to the presence of confounding factors. following the seminal work of rosenbaum and rubin (1983), matching techniques, which ‘match’ the treated and the untreated in a range of observable characteristics, are now often used in impact evaluation. therefore, we use a matching technique based on propensity scores to test the relationship between the treatment and the outcome. propensity score matching essentially estimates each household’s propensity to receive a binary treatment (with a probit or logit model) as a function of observables and matches households with similar propensities (caliendo & kopeinig 2008). our quasi-experimental design identifies a control group that does not receive an swp, but is like the treatment group (households who receive an swp). we match the treated and the untreated in a range of characteristics. the control group captures what would have been the outcomes if the policy of swps had not been implemented. the starting point of our analysis is to estimate the ‘propensity score’. we use a probit model for the estimation of our scores. in doing so, we follow caliendo and kopeinig (2008), who states: in principle, any discrete choice model can be used. preference for logit or probit models (compared to linear probability models) derives from the well-known shortcomings of the linear probability model. (p. 37) we were largely guided by theory, and the framework garrido et al. (2014) outlined to select the covariates to match the data. in particular, we are careful only to include relatively unaffected variables by the treatment. after choosing the variables and estimating the probability of receiving the treatment, we ensure that the propensity score is calculated and balances covariates across treatment and control households. in other words, given the control, there is no significant difference in being selected into the treatment group. we report diagnostic tests for the same in the results section. after the initial balance tests, we match the sample to perform our propensity score analysis. there are several ways to do this (e.g. kernel weighting, nearest-neighbour, caliper matching, local linear regression). we choose the nearest-neighbour weighting as it retains the sample size, while leading to the best post-weighting balance (garrido et al. 2014). additionally, we also provide estimates from other matching techniques as robustness tests. our parameter of interest is the average treatment effect on the treated (att) which focuses on those households receiving swps. the propensity score matching estimator for the att can be represented by: here y(d) refers to the outcome based on the value of the treatment d. p(x) refers to the probability for a household to receive the treatment (receive swp) given the household’s observed covariates x. therefore, the att in our case is the mean difference in swb, between those households who receive an swp and those who don’t, weighted by individual household propensity scores. we acknowledge the critique against propensity-score matching, as king and nielsen (2019) argued. the authors argue that propensity-score matching: [a]s it is commonly used in practice or with many of the refinements that have been proposed, can and usually does increase imbalance, inefficiency, model dependence, research discretion, and bias at some point in both real data and in data generated to meet the requirements of propensity score matching theory. (king & nielsen 2019:1) a propensity score method is, thus, a trade-off between sample size, generalisation, and balance. this has implications for the internal and external validity of the estimations. to address king and nielsen’s critique, we apply several diagnostic tests to verify the balancing property of our covariates. we estimate our models with different sets of covariates to address the selection bias. next, in addition to using a caliper method for matching, we also use the nearest-neighbour matching, so choosing a narrow caliper does not taint our estimations. lastly, given the justifiable critiques of the propensity-score matching model, we want to flag to the reader that our intention is not to make any causal claims but to consider the robustness of our baseline models. data the data used in this paper come from five waves of the nids. the first wave was conducted from 2008 to 2009, and wave five in 2017. we choose this dataset as it is a rich dataset, providing information on respondents’ and households’ different well-being domains. the national income dynamics survey is a face-to-face longitudinal survey, following the same individuals (nids 2016). however, nids does not follow households over waves and allocates different household identifiers in each wave. for this reason, we pool the data and include a time-fixed effect to control for the different waves. the number of households is approximately 42 700, and after controlling for successful interviews, it decreases to approximately 42 400. selection of variables we are led by the literature and data availability to select the variables included in the models. in the next section the dependent variable is discussed, followed by the derived variables and the covariates included in the estimations. household subjective well-being: to measure our dependent variable, household swb, we use the mean level of satisfaction of the adults in the household. within the adult questionnaire of the nids dataset, individuals 15 years and above are asked to rate the current level of general life satisfaction on a scale from 1 to 10, where 1 represents ‘very dissatisfied’, and 10 represents ‘very satisfied’. following the standard procedure of deriving life satisfaction at an aggregated level (see the world happiness report by helliwell et al. [eds. 2021] and the uk office for national statistics [2021]), we derive the mean household life satisfaction. additionally, we create a categorical variable in line with the swb literature and use this in pooled ordered probit estimations. the categorical variable measures life satisfaction on a level from 1 being not happy to 10 being very happy and approximates the distribution of the continuous variable. we believe using the swb of adults in a household can represent the mean swb of the entire household. evidence from data collected in the world values survey (inglehart et al. 2014) confirms that among six aspects of life – family, religion, politics, leisure time, work, and friends – family is rated the most important in over 60 analysed countries; followed by work and friends. clair (2012) and casas et al. (2008) argue that it is logical that parents’ swb would influence the swb of their children. there are three primary explanations for this – genetic influences, environmental factors and common stressors (bookwalter, fuller & dalenberg 2006; clair 2012; larsen & eid 2008; powdthavee & vignoles 2008). further, clair (2012), using data from the british household panel surveys, finds a significant and positive relationship between a parent’s life satisfaction and the life satisfaction of their children. covariates and other derived variables: our treatment variable is a binary variable that depicts whether the household receives an swp. our dataset also includes a variable that captures the amounts received by households; however, the missingness on this variable is 38.4% (even after imputation). furthermore, the missingness is not random, with higher income quintiles’ missingness being higher than lower household income quintiles. as our main research question is specifically targeted at analysing receiving swps across quintiles, we opted to use the binary variable. however, as a robustness test, we estimate all models using the amount variable and still find a negative relationship between swps received and swb. variables related to age (frijters & beatton 2012), gender (becchetti & conzo 2013; joshanloo & jovanović 2020), employment (ngoo, tan & tey 2021; schröder 2020), relative income (clark, frijters & shields 2008; rossouw & greyling 2021) and race (rossouw & greyling 2021; van der berg 2011) are that of the household head. additionally, we control for other characteristics of household members related to self-reported health status (rossouw & greyling 2021; kollamparambil & etinzock 2019) and education (dittmann & goebel 2010; ngoo et al. 2021), which are computed to be average levels over the household, as well as the size of the house (kollamparambil & etinzock 2019; reyes-garcía et al. 2016). aside from this, we also control for characteristics related to the location and services available to the household members, namely, type of dwelling (rossouw & greyling 2018; zakerhaghighi, khanian & gheitarani, 2015), access to water (bookwalter & dalenburg 2002; rossouw & greyling 2021) and location of the household dwelling unit (bhuiyan & ivlevs 2019; greyling & rossouw 2019). our analysis is performed across income quintiles. we use the nids dataset’s imputed household income variable to determine the income quintiles, which include all income sources (wages, rent, interest, profit share, remittances, and swps received [brophy et al. 2018]). to derive a household income variable at constant 2014 prices, we deflate household income for 2017 and inflate household income for 2009 and 2011 with the applicable price index (brophy et al. 2018). since we need household income excluding any swps when deriving income quintiles, we deduct household swps at constant prices from household income at constant prices. we divide the income into quintiles using the net household income (household income minus swps at constant prices). first, we run all models using the whole sample and then for the different income quintiles. table a2 summarises the data (see methodology section), where we report the statistics for the full sample and those that receive (treated group) and do not receive (control group) swps. the full summary of our variables by income quintiles and swps can be found in table a3. table a2 shows that households that receive an swp record lower swb than their counterparts. however, if we control for other factors, specifically years of education and level of employment, the group that receives swps experiences higher levels of satisfaction than their counterparts. households receiving swps are less healthy, less likely to stay in formal housing and less inclined to have piped water. the older population, female gender, people of african descent, and traditional and urban areas are over-represented in terms of demographics. results and analysis descriptive analysis we find that, against expectations, households in all income quintiles claim swps, though the percentage of households decreases as the income quintile increases. in the lowest household income quintile, 88% of the households receive an swp, while 37% of households (table 1) in the highest quintile (even the top decile [28%]) receive swps. this finding contradicts the theory that swps transfer from higher-income earners (households) to lower-income earners (households) to increase equality and likely have the opposite effect. table 1: social welfare payments per income quintile. a possible reason for these results could lie in qualifying for an swp. an individual or married couple must pass a means test. given that the means test is based on a certain level of income or assets, it is possible that an individual (even one that is married) could earn an income below the means test, which legally gives them the right to access a particular swp. to provide some perspective, let us consider the highest income quintile. here, we notice that the income band is very wide, from r6941 ($486) to almost r900 000 ($62 993), highlighting that south africa’s income distribution is extremely skewed. this implies that the lowest cut-off point in the highest income quintile is still relatively low, making it possible for individuals in these households (although they are higher-income households) to earn an income below the means test and, therefore, legally have access to swps. table b1 provides the exact cut-offs for each welfare payment. we see that all the cut-offs for all payments (except fcps, which are not means-tested) lie in the highest quintile of income. nonetheless, something is still amiss. if we consider households in the top quintile, their median income is 66 times more than the median in the lowest quintile. thus, a ratio of 1:66 means that for every r1 earned by the lowest quintile, the top quintile earns r66. if swps were introduced to decrease poverty and inequality, it might have the opposite effect on inequality than originally intended and, as shown in the literature, inequality negatively influences swb (ding, salinas-jiménez & salinas-jiménez 2021; margaux et al. 2021). additional reasons for households in the highest quintile claiming swps could be the fcp, which is not subject to a means test and is accessible to all (see table b1 for a summary of swps). table 1 provides further evidence that the type of grants claimed by households in the top income quintile predominantly comprises old age pension and csps. the policy structure makes it possible that grant recipients in an individual capacity may be eligible for these grants even though they are a part of a household in the wealthiest quintile. another major concern from the sassa (2020b) revealed various fraudulent activities related to claiming swps in cases where people are not entitled to claim. according to the report (sassa 2020b), fraudulent behaviour increased over time. they mention that people use fraudulent personal identification documents (ids) or use the ids of people who have passed away. when we consider the different types of swps (table 1), we notice that all income quintiles access all types of swps. again, we notice that as the income quintile increases, the percentage of swps claimed by households decreases. for example, in the lowest quintile, 30% of the households claim csps, while households in the highest quintile claim 7.7%. similar trends are seen with all types of swps claimed. considering the trend over time (table a4), approximately all categories of swps claimed by households increased in both the lowest and highest quintiles. the increases in the csps within the highest and lowest quintiles are remarkable, as is the increase in the oaps in the highest quintile (see figure 1 and table a4). figure 1: trend in child support and old age payments for quintiles 1 and 5. table a4 shows that the percentage of households claiming a csp almost doubled in the lowest quintile, whereas for those households in the highest quintile, csps were a surprising 23 times higher from 2009 to 2017. for the lowest quintile, the households that claim foster care and cdps increased by 74% and 115% over the time period. in the highest quintile, the percentage of households that claim swps (except for csps) increased by between 2% and 4%. considering the increasing debt burden south africa has (nearly 70% of gross domestic product), these trends are not sustainable. we extended our study to include the top decile and the top 1% of households and found similar results; some of these households still access swps. our results warrant further investigation. pooled ordered probit analysis we now focus on answering our main question regarding the relationship between swps and swb across household and income quintiles. we report the pooled ordered probit results followed by the propensity-score matching model and remind the reader that the propensity score matching model is not used to make any causal claims but as a robustness test of our baseline models. our analysis runs all models with and without design weights4 and compares the results. as mentioned in methodology section, we test the robustness of our results using different estimation techniques. our analyses are for the whole sample and subsequent household income quintiles, for brevity, we only report the results on quintiles one and five in the text (see table 2). the complete set of results is reported in table a5. as the primary purpose of table 2 is to analyse associations, we report the coefficients from the pooled ordered probit model and not the marginal effects. table 2: pooled ordered probit with household subjective well-being as the dependent variable. as was expected, variables that have been established in the swb literature, such as self-reported health, dwelling type and access to piped water, all behaved as expected (table 2). therefore, we shall limit our discussion to those covariates that significantly contribute to the existing literature. table 2 shows that our variable of interest, the swp, is positive and significantly related to the mean household swb for quintile 1 (as well as quintiles two to four). in other words, a person who receives an swp has a higher probability of having a higher household swb, than those who do not receive an swp. quintile five is the exception. here, the sign is negative and significant, not supporting the hypothesis that swps increase household swb. we performed the same analysis using the amount of the swp rather than the binary variables as explained in the methodology section. we find the same negative results for quintile five (see table a6). to test the robustness of this finding, we also used household income (without excluding swps) and expenditure at constant 2014 prices to divide the sample into quintiles. this is not ideal, as swps are implicitly included in these measures. nonetheless, we find the negative relationship in quintile five holds, though when household expenditure is used, the relationship is negative but not significant. a possible explanation for this negative relationship can be drawn from the literature (see literature review section). whereas studies find positive effects of oaps on well-being, the debate regarding csps is inconclusive. it could be that those households in the top 20% of income earners experience a significant and continuing decrease in their level of dignity since they, the so-called ‘non-poor’, are applying for swps, whether legitimately or fraudulently. we note that in south africa, people prefer to queue for swps rather than incur banking fees for the direct payment into a bank account (sa news 2021). therefore, communities would likely know who receives swps, and these households may face negative attitudes and prejudice from their communities, which might consider them not poor enough to access swps. the household’s size is positive and significant across all samples, which is in line with the work done by reyes-garcía et al. (2016) and kollamparambil and etinzock (2019). three interesting findings pertain to years of education, age squared and employment status. education is not regarded as significant in those households in the lowest income quintile; thus, the number of years of education does not matter in these households’ swb. normally, education is a pathway to employment and a way to escape poverty. with very high unemployment rates among households receiving swps, the hope of being employed is small. seeing that 88% of this cohort depends on swps, it simply could be that long-term investments in education are not within their reach. we do not find the usual u-shaped relationship between age and swb. instead, an inverted u-shaped relationship is identified in those households that receive swps and find themselves in the lowest income quintile. this indicates relatively low levels of well-being reported for young people, higher for the middle-aged respondents and lower again during people’s later years. this low level of well-being among the youth is easily defended since south africa is battling a youth unemployment rate of approximately 70% (statistics south africa 2021). concerning employment status, we find that employed households have a higher swb than those who are not economically active, except for households in the lowest quintile. here employment is not of any significance. again, considering the remarkable number of households accessing swps, an swp could be seen as a disincentive to work, because of lower wages in the labour market and the effect of generous welfare benefits. this is in line with the work done by gamson and lasch (2013), which states that social welfare systems provide a disincentive for people to work since they end up being financially better off remaining on a benefit. regarding gender, households headed by males enjoy higher swb than those headed by females, which is in line with stoop, leibbrandt and zizzamia’s (2019) argument that individuals living in households with a female head may face higher poverty risks and decrease swb. over the years, relative income has become a more important indicator of well-being than absolute income (see clark et al. 2008; rossouw & greyling 2021). a household’s well-being is not influenced by absolute income levels, but rather by perceived relative income levels. subjective well-being is predicted to be diminished by the higher income of others through feelings of relative deprivation or reduced status (posel & casale 2015). for the whole sample and those households in the highest income quintile, we find that if the household head believes that they have an average or above-average income compared to their neighbour, their swb is higher. this confirms studies, such as kollamparambil and etinzock (2019) and posel and casale (2015). in contradiction with previous findings is the relationship identified within those households in the lowest income quintile. here we find that if the household head feels that the household’s income is above that of his neighbour, the household’s swb is lower. perhaps this indicates a sense of belonging to a community, or it could be that their higher income is conspicuous, and therefore neighbours approach them when a need arises. in line with the findings of stoop et al. (2019), kollamparambil and etinzock (2019) and ebrahim et al. (2011), we also find that those of african descent experience the lowest household swb compared to all other races across all quintiles. we find geography only significant in the sample as a whole, in that people living on farmlands have a higher swb than those in traditional and urban regions. with an urbanisation rate of 66.86% in 2019, poor households in urban centres may experience increased competition for already scarce amenities, thereby decreasing their swb. on the other hand, households that choose to stay on farmlands have better health, more freedom and a constant food source, thereby increasing their swb (see bhuiyan & ivlevs 2019; greyling & rossouw 2019). as an additional robustness test, the results in table 2 are replicated, but this time by creating income quintiles by per capita household income. this accounts for the possibility that higher-income households may be larger, skewing the household income variable. the results, however, are qualitatively the same and can be found in table b2. propensity-score matching motivated by the pooled ordinary least squares results and the pooled ordered probit model (table 2), we further estimate the impact of receiving an swp using propensity-score matching. we match our estimates on health status, dwelling type and gender. the choice of these variables is driven by theory and model fit. the sample’s average treatment effect is given in table 3, column 1. we find that the average swb of the treated households (households that receive swps) is lower than that of the untreated households (households that do not receive swps). this is in line with the estimates reported in table 2. however, this difference is not significant at the usual levels of significance and warrants further investigation. table 3: average treatment effect by income quintiles. figure 2 plots the treatment and control group observations by propensity score. we can see an overlap of treatment and control observations at all levels of propensity scores. the results of the balancing tests are provided in table 4 to verify whether our matching exercise has sufficiently met the balancing assumption. again, we find no significant difference between the mean characteristics of the treated and untreated households in all the variables for which observations were matched. figure 2: treated and untreated observation by propensity-score level. table 4: summary statistics of matched and unmatched sample characteristics. next, we estimate the average treatment effect for the five income quintiles to assess the extent of heterogeneity in the treatment effect. we can now see a pattern explaining the difference being not significant for the full sample. the att at the bottom 20% is estimated to be positive and significant at the 1% level. this means that for households in the sub-sample, the swps of those treated are significantly higher than those who do not receive the treatment (swp). this is in line with the effect in the pooled ordered probit estimates provided in table 2 for the lowest quintile. however, the effect is reversed considering the highest income quintile. for this income quintile, the difference in the att is –0.390, significant at the 1% level. thus, for this group of households, the swb of those who receive an swp is lower than those who do not. again, this is in line with the pooled ordered probit estimates provided in table 2. table 5 provides more robustness checks for the att. we experiment with using different methods to compute the standard errors and different covariates based on the matching observations. we get qualitatively the same results. table 5: robustness. conclusion there are positive externalities to a household when an individual receives an swp. social welfare payments are mostly pooled, and the well-being effect is shared among the household members. this study was the first to consider the relationship between swps and households’ mean swb across income quintiles. theoretically, receiving swps should increase the swb of recipient households. therefore, it is important to determine which household quintiles receive swps and whether swps increase swb across the quintiles. we found that all income quintiles access all types of swps in south africa using pooled ordinary least squares, pooled ordered probit and a quasi-experimental method. testing the hypothesis that a social welfare system should increase the swb of people, as, among others, poverty and inequality decrease, we find the swb assumption is true for the bottom 20% (40, 60 and 80) income quintiles but not for the top 20% (and the top 10%) income quintile. additionally, our findings show that inequality most likely increases as the intention to transfer income from the wealthy to the poor is doubtful when the highest household income quintile access swps while earning 66 times more than the lowest income quintile. our study explains the lack of progress in decreasing inequality and lower levels of swb. since households in the top 20% income group, that access swps, experience a negative effect on their well-being, the swp system most likely has the opposite effect than initially intended, decreasing well-being in some groups and increasing inequality. we provide further evidence that the type of grants claimed by households in the top income quintile predominantly comprises old age pension and csps. the policy structure makes it possible that grant recipients in an individual capacity may be eligible for these grants even though they are part of a household in the wealthiest quintile. these findings are of interest to the ongoing broader debates around the effects of swps globally on poverty, inequality and swb. many checks and balances should be in place to ensure only the most vulnerable access swps. this study has limitations; as in the analysis, we could only use pooled data and not a panel dataset. a panel dataset would likely clarify possible endogeneity arising from confounding factors. nonetheless, using the combined interpretation of our different models’ estimation results, we believe the negative relationship between swps and swb in higher income quintiles is robust. future studies should investigate our findings further as this can be a significant concern to the swp system in south africa. acknowledgements we acknowledge that a previous version of the paper was published as a global labor organization (glo) working paper. please see: adhikari, greyling and rossouw (2021). ‘the ugly truth about swps and households’ subjective well-being’, global labor organization discussion paper, no. 883, glo, essen. competing interests the authors have declared that no competing interest exists. authors’ contributions all the authors contributed equally in conceptualisation, methodology, analysis and writing. ethical considerations this article followed all ethical standards for research without direct contact with human or animal subjects. funding information this research received no specific grant from any funding agency in the public, commercial or not-for-profit sectors. data availability the data that support the findings of this study are available on request from the corresponding author. disclaimer the views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of any affiliated agency of the authors. references adhikari, t., greyling, g. & rossouw, s., 2021, the ugly truth about swps and households’ subjective well-being, global labor organization discussion paper, no. 883, glo, essen. attah, r., barca, v., kardan, a., macauslan, i., merttens, f. & pellerano, l., 2016, ‘can social protection affect psychosocial wellbeing and why does this matter? lessons from cash transfers in sub-saharan africa’, journal of development studies 52(8), 1115–1131. https://doi.org/10.1080/00220388.2015.1134777 bando, r., galiani, s. & gertler, p., 2017, the effects of 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payments size instead of binary social welfare payments variable by quintile. appendix 2 table 1-a2: social welfare payments for the period 2009–2017. table 2-a2: robustness check, dividing quintiles by household income per capita instead of total household income. footnotes 1. see table 2b for exact grants per year with any associated changes. 2. please note that it falls outside the scope of the current study to discuss literature that focused on the relationship between social grants and poverty alleviation. 3. old age payments are a non-contributory means-tested income transfer to persons aged 60 and above. 4. design weights are used to adjust for household non-response. 270 sajems ns 10 (2007) no 2 the determinants of capital structure of microfinance institutions in ghana anthony kyereboah-coleman university of ghana business school, legon abstract using a panel data methodology, this study examines the determinants of capital structure of 52 microfinance institutions (mfis) in ghana. the empirical results show that the mfis are highly leveraged and that their capital structure is explained partly by standard finance theory and by other unconventional variables. specifically, the study confirms that leverage is positively related to asset tangibility, with small mfis using short-term and large mfis using long-term debt. though, the findings confirm that leverage is inversely related to risk, they also suggest that some mfis enjoy long-term debt in spite of risk, while profitability is irrelevant in explaining the capital structure decisions of mfis. finally, the study shows that the reputation and board independence of mfis significantly and positively affect their capital structure decisions. jel g21; g32; c33 1 introduction since the landmark paper by modigliani and miller published in 1958, debate has raged about the theoretical basis for the determinants of capital structure in firms. financial theory has made considerable progress in efforts at explaining capital structure decisions and the variables that determine these. in this quest, various theoretical models have been proposed to explain capital structure patterns across companies and countries, and many of these models have been empirically tested in the real business world. however, most of this research has concentrated on large and listed firms, mostly in the developed world, with the consequence that other critical sectors such as microfinance, especially in developing economies, have been neglected. microfinance institutions (mfis) have evolved in recent years as tools for alleviating poverty. understanding their operation is critical to maintaining this process of poverty reduction, the failure of which would have grave consequences for developing economies. following mfi successes such as the grameen bank of bangladesh and banco solidario of bolivia, considerable attention has been devoted to the sector by several players. these include governments, non-governmental organisations (ngos), community activists and even some large commercial banks, which have re-channelled efforts and resources towards microfinance and microenterprise projects (conning, 1999). interest in the sector has touched on the objectives and methods of microfinancing (rhyne, 1998; morduch, 1999), but most discussions focus on the nature and scope of potential tradeoffs between the outreach potential, impact and financial selfsustainability in microfinance lending. outreach must be recognised as a major performance indicator in the sector. since the initial evolution of microfinance, when most microfinance operations were funded by governments, development-oriented and donor agencies, there has been a gradual but steady shift towards funding by capital markets, which has unavoidable implications for capital structure. this study therefore aims to investigate what goes into the financing decisions of mfis. sajems ns 10 (2007) no 2 271 conning (1999) suggests that ‘all else equal, sustainable microfinance organisations that target the poorer borrowers must be less leveraged’, and kyereboah-coleman (2007) shows that the capital structure of mfis impacts on their performance. this paper reports on a follow-up study to determine the correlates of capital structure of mfis. does the capital structure of mfis follow standard finance theory or not? the paper is organised as follows: section two reviews the relevant literature, section three presents data collection and methodological issues, section four discusses the empirical findings, and section five concludes with the findings of the study. 2 literature review the term ‘capital structure’ can be defined as the relative amount of debt and equity employed to finance a firm’s operations. it must be noted that, in finance, capital structure has been a hotly debated issue for years. one of the earliest important sources on capital structure is the work of modigliani and miller (1958). their analysis of the irrelevance of capital structure to firm value is based on the premise that capital structure does not affect a firm’s cash flow. indeed, in their paper, modigliani and miller show that the financing decisions of firms do not affect their value. their conclusion, however, is based on what is termed ‘restrictive and unrealistic’ assumptions such as a world with perfect capital markets, absence of corporate and personal taxes, and independent firms’ financing decisions. adapting these assumptions to more realistic expectations and repeating the analysis suggests that capital structure decisions do affect a firm’s value. modigliani and miller therefore revised their initial stance in 1963. consequently, several studies have shown that capital structure significantly affect the value of a firm (jensen & meckling, 1976; myers, 1977; grossman & hart, 1982; jensen, 1986; williams, 1987; harris & raviv, 1990; stulz, 1990; harris & raviv, 1991; bos & fetherston, 1993; myers, 2001; boateng, 2004; abor, 2005; kyereboahcoleman, 2007). what has remained a puzzle in this debate is the identification of an optimal capital structure and its explanatory variables. the question has always been: ‘what motivates firms to choose levels of debt and equity or a combination of these?’ to explain this phenomenon and understand whether there is an optimal capital structure for a firm, a number of theories have been advanced. one of the fundamental propositions is agency theory, which states that debt financing creates an agency problem for firms. this is because debt financing leads to three difficulties: a) it creates an incentive for stockholders to accept sub-optimal and high risk projects and in the process transfer wealth from bondholders to stockholders. b) the presence of debt compels firms to avoid undertaking investments whose positive net present value is lower than the debt value. c) it increases the probability of bankruptcy cost with debt level because doubt is cast on the firm’s ability to generate the cash flow needed to meet its debt obligation. from this fundamental theory emerged other popular theories such as the static trade-off and the pecking order theories. myers (1984) advances the static trade-off theory, which explains that a firm usually decides on an ideal debt-to-equity ratio and gradually moves towards this. the implication is that some optimal capital structure exists which will enable the firm to operate efficiently and also ensure that external claims on cash flow (such as taxes, bankruptcy costs and agency costs) are reduced. ‘thus, there is a transition from miller’s (1977) postulate of tax neutrality – later refuted by deangelo and masulis (1980) who introduced the concept of non-debt tax shield – to the static theory which postulates the optimum debt level as a consequence of a trade-off between tax advantages of borrowed money and financial distress costs’ (de miguel & pindado, 2001). in contrast, the pecking order theory suggests that the profitability of a firm affects its financing decisions, and therefore suggests that firms with no predetermined mix of debt and equity prefer internal to external financing and debt to equity if the firm issues securities. 272 sajems ns 10 (2007) no 2 these theories have been used to explain the capital structure of firms. in the extant literature, both internal and external variables have been identified as relevant in influencing a firm’s capital structure. these variables include firm size, profitability, risk level, type of industry, tax shield, profitability margin, firm growth, whether a firm receives subsidy, ownership control and asset tangibility. as mentioned above, most of these studies of the capital structure of firms concentrate on large and listed firms in advanced economies. microfinance is primarily the provision of credit to poor people, who lack access to credit from mainstream financial institutions. this kind of finance has evolved as a poverty reduction strategy in developing countries, such as ghana. the enthusiasm with which microfinance has been greeted worldwide has led to an increase in the number of mfis providing small credit to poor people in the developing world. the microfinance movement has been commended by both academic scholars, major development finance institutions such as the world bank and development practitioners. growing rapidly, the sector is moving away from its original non-profit, socially motivated agenda, with lenders seeking to reach as many of the poor as possible, to state profiteering using various techniques. the use of joint liability contracts and dynamic incentives has shown that mfis can be profitable. this has attracted profitmotivated institutions and other regular banks into the sector. the result has been that some of these institutions are moving away from government subsidies and donor dependence to accessing funds from the capital market. this move is also motivated by the mfis’ desire to ensure institutional sustainability through minimising their subsidy and donor dependence and adopting the practices of good banking. this process has cost implications and has, therefore, further strengthened the profit agenda. the main advantage of profit is the attraction it offers to private investors into the sector. thus, commercial microfinance lenders ought to achieve much better leverage on their equity than subsidised microlenders, allowing commercial lenders to greatly multiply the scale of outreach achieved through extra currency units contributed by donors to equity in the sector. obviously, these trends have implications for the capital structure of mfis. studies of capital structure in the microfinance sector are virtually non-existent, which is the fundamental motivation of this study. kyereboah-coleman (2007), in a study of capital structure and the performance of mfis, found that mfis are highly leveraged. thus, an understanding of the correlates of capital structure in mfis will contribute greatly to the on-going debate about capital structure. are those determinants of capital structure identified in studies of large and listed firms applicable to mfis? do mfis in developing countries such as ghana exhibit the capital structure that conforms to standard finance theories? these are some of the questions this study seeks to answer. 3 data collection and methodology this study uses data from a sample of 52 mfis in ghana. these mfis are sampled primarily according to accessibility to data and records, since mfis are noted for being difficult to acquire data from. the data is captured from annual financial statements and personal interviews and covers a 10 year period, from 1995-2004. analysis is carried out within a panel data framework. this is because panel data provides a relatively large number of data points and, therefore, additional degrees of freedom. we incorporate data from both cross-section and time series variables to reduce the problems associated with omitted variables, since we may not be able to fully specify a capital structure model. variables relating to tax (such as non-tax shield and tax impact) and firm growth were not captured, due to data constraints. thus, our basic model follows that of delcoure (2006) and is specified as follows: v d z , , , ' , i t i t i t i t0 1= + +b b k (1) where i = 1......52; t = 1......10, v d , , i t i t is a measure of debt ratios (where d represents the various debt levels and v representing total assets) explained below for firm i at time t. sajems ns 10 (2007) no 2 273 0b is the intercept. z ,'i t is a 1×k vector of observations on k explanatory variables for firm i at time t. 1b is a k×1 vector of parameters. ,i tk is the disturbance term measured by v, ,i t i i tk +n= , (2) where i n represents the unobservable individual effect and v ,i t is the residual. 3.1 factors important in estimation in any panel data model, choice of an appropriate technique for estimating the basic model is dependent on the structure of the error term, that is: v, ,i t i i tk +n= (3) and the correlation between the components of the error term and observed explanatory variables. the simplest and most basic estimator of the panel data set is the pooled ols where there are no firm specific and time effects. however, johnson and dinardo (1997) argue that pooled ols estimators ignore the panel nature of the data set, and so treat observations as being serially uncorrelated for a given firm, leading to homoscedastic errors across individuals and time periods. these effects could however be negligible and unobservable if accommodated using one of two techniques. the first technique is to reduce the number of parameters to be estimated and justify treating the individual fixed effects as drawn from some distribution. the parameters of this distribution then become the parameters to be estimated. the unobservable effects are therefore included in the error term. the variance-covariance matrix of the resulting non-spherical errors is then transformed to obtain consistent estimates of standard error. in this case, the random effects (re) estimator is the most appropriate (hsiao, 1989). however, a problem arises with the re estimator if the unobservable effects which have been included in the error term are correlated with some or all of the regressors. this simultaneity makes the re estimation inconsistent. thus, as a consistent alternative to the re estimator, a second technique can be used, namely a dummy variable can be included for each firm. this estimation approach is known as the fixed effects (fe) approach and yields consistent estimates regardless of correlation between firm-specific error components and the regressors. however, the fe is less efficient than the re estimator. this inefficiency arises because the fe estimator requires a separate parameter to be estimated for each firm in the sample, rather than the single variance estimate required for the re estimator. in deciding which estimation method to employ, the hausman specification test is recommended. hausman (1978) suggests a test to check whether individual effects are correlated with the regressors (x it ). under the null hypothesis of orthogonality, that is, no correlation between individual effects and explanatory variables, both re and fe estimators are consistent, but the re estimator is efficient while fe is not. under the alternative hypothesis, that individual effects are correlated with the explanatory variables, the re estimator is inconsistent and the fe estimator is consistent and efficient. greene (1997) states that under the null hypothesis the estimates should not differ systematically. thus, the hausman specification test is based on a contrast vector h: h = [bgls–bw]’[v(bw)–v(bgls)]–1[bgls–bw] (4) hence, in estimating our basic model, the hausman specification test is carried out and a choice made between re and fe estimation. in the hausman specification test, if the probability value of the chi-square is ≥0.5, the re estimation is accepted, otherwise the fe estimator is employed. 3.2 variable description and justification the dependent variable is the debt ratio as suggested in the literature. following titman and wessels (1988), we use three leverage measures calculated by finding the ratio of book value of short-term debt to total assets (short-term leverage), long-term debt to total assets (long-term leverage) and total debt to total assets (total leverage). 274 sajems ns 10 (2007) no 2 3.2.1 asset structure lenders normally use tangible assets as security consistent with trade-off theory. jensen and meckling (1976) show that collateral serves to protect lenders from the moral hazard problem associated with shareholder-lender conflict. also, williamson (1988) points out that capital project financing is essentially dependent on asset tangibility. similarly, titman and wessels (1988), rajan and zingales (1995) and chen (2004) show that significant positive relationships exist between asset tangibility and firm debt. to measure asset tangibility, we use the ratio of net total fixed assets to total assets. 3.2.2 volatility of earnings this is a measure of risk, because according to the static trade-off theory, higher volatility of earnings increases a firm’s probability of financial distress. thus, a firm’s debt ratio decreases when bankruptcy costs are higher in situations of higher earnings volatility. studies by marsh (1982), bradley, jarrell and kim (1984), mackie-mason (1990) and de miguel and pindado (2001) find that there is an inverse relationship between a firm’s financial distress cost and debt ratio. we measure our risk (earnings volatility) as the standard deviation of the first difference of the ratio of earnings before interest and taxes (ebit) to total assets. thus, risk = .std deviation ta ebitdc m< f (5) 3.2.3 firm size larger firms tend to be more diversified and are therefore able to absorb risk (rajan & zingales, 1995). in addition, they tend to have easy access to credit and have more diluted ownership, leading to less control over managerial decisions. friend and lang (1988) find that, though, managers may influence debt ratios in order to protect their personal investment in a company, a firm’s debt maturity choice is less dependent on size. in this study we use the natural log of total assets as a measure of size. 3.2.4 profitability concerning profitability, jensen’s (1986) theory of the agency cost of financial structure considers debt as a disciplining device which compels managers to increase shareholders’ wealth rather than building empires. therefore, studies on the links between capital structure and firm profitability have shown that there is an inverse relationship between capital structure and profitability (friend & lang, 1988; rajan & zingales, 1995; wald, 1999; chen, 2004). return on total assets (roa) measured by the ratio of ebit to total assets is our measure of profitability. 3.2.5 other variables in addition to these variables drawn from standard finance theory, we also employ other unconventional variables that could impact on capital structure, particularly in the microfinance sector. first, we use the age of the firm as a proxy for reputation, on the premise that age should have a positive relationship with debt. an old firm generally is a reputable firm that with a reputation for reliability that commands trust. firm age is captured using the number of years the institution has been in operation starting from the year of incorporation. we also use board characteristics such as size, independence, ceo duality and ceo tenure as possible explanatory variables. these translate into agency problems and costs with further implication for firms’ capital structure. for the size of the board, we use the number of board members, and for independence of the board the ratio of non-executive board members to board size. john and senbet (1998) indicate that agency costs are higher when a board is dominated by executive members. in contrast, an independent board ensures effective monitoring and attracts private investment which has implications for debt levels. in the case of ceo duality, agency costs are deemed higher when a ceo doubles as a board chairman, and this discourages private investment and debt. in our study, this is a dummy variable which takes a value of 1 when the ceo also acts as board chairman and 0 otherwise. finally, we use the tenure of the ceo as our last explanatory variable. sajems ns 10 (2007) no 2 275 4 empirical findings 4.1 summary statistics the oldest mfi in the sample has been in existence for 41 years; on average the firms have been operating for 18 years. in size the mfis show a wide spread, with a relatively high standard deviation of 2.67+e07. most of these mfis have a greater percentage (about 71 percent) of their assets in current form, though some have 85 percent of their assets as fixed assets. most of these assets are financed with debt at a mean leverage of 0.76. significantly, the leverage in these institutions is mainly driven by long-term rather than short-term debts. the mfis appear to be moderately volatile in income flow, which suggests some degree of stability, with implications for lower bankruptcy costs and greater sustainability. this is supported by results for profitability performance of roa, though these show a wider spread. concerning institutional governance, the mfis have a mean board size of 6 members, with a maximum of 10 members. the independence of these boards is relatively low, according to the mean board composition of 0.48. this implies that about 52 percent of the board members are executive directors. the leadership structure is equally divided, between separating ceo and chairman roles and a combination of the two. 50 percent of the mfis have the two positions carried out by one person and the other 50 percent have two separate office holders. the longest ceo tenure is 4 years but most of them serve a term of up to 3 years. a summary is presented in table 1. table 1 summary of mfi statistics variable obs mean std. dev min max short-term leverage 520 0.35 0.29 0.0004 0.99 long-term leverage 520 0.41 0.30 0.0000435 0.88 leverage (total) 520 0.76 0.23 0.01 1.00 asset tangibility 520 0.29 0.20 0.03 0.85 earnings volatility 520 0.21 0.38 -0.60 0.70 total assets 520 1.22e+07 2.67e+07 129470.00 1.35e+08 return on assets 520 0.39 1.52 0.06 35.00 firm age 520 17.83 5.02 10.00 41.00 board size 520 6.23 1.83 3.00 10.00 board independence 520 0.48 0.12 0.30 0.70 ceo duality 520 0.50 0.50 0.00 1.00 ceo tenure 520 2.85 0.72 2.00 4.00 log of firm age 520 14.52 1.90 11.77 18.72 log of total assets 520 2.84 0.27 2.30 3.71 276 sajems ns 10 (2007) no 2 4.2 regression results table 2 represents the regression results. 4.2.1 asset tangibility consistent with the static trade-off theory, shortterm, long-term and total leverage are positively correlated with asset tangibility. the argument is that tangible assets are used as collateral as a source of security for lenders in the event of financial distress. jensen and meckling (1976) argue that collateral protects lenders from the moral hazard problem caused by shareholderlender conflict. the use of tangible assets as collateral normally reduces lenders’ risk. while both short-term and total leverage are significant at five percent probability level, longterm leverage is not. a possible explanation is that in most developing countries like ghana, financial institutions regard short-term lending as relatively rewarding as compared to longterm debt. this invariably makes long-term a limited option for several organisations. mfis, considering their historical antecedents and social orientation, are likely to ward off longterm lenders. 4.2.2 earnings volatility (risk) once again, the trade-off theory stipulates that a higher risk increases the probability of financial distress, and so higher bankruptcy costs result in the impact of higher earnings volatility being negative on leverage. the study finds that there is a negative correlation between short-term and total leverage and earnings volatility (risk). the results of the study with regards to short-term and total leverage are consistent with other studies (e.g. marsh, 1982; bradley et al., 1984; mackie-mason, 1990; de miguel & pindado, 2001), though total leverage is insignificant. however, the study also shows a significant positive correlation between institutional risk and long-term leverage, which contradicts standard finance theory. a possible reason could be the willingness of donor agencies to lend to such institutions in the interest of a social rather than financial agenda. this is a plausible explanation because, though most of these institutions are targeting a double bottom-line, some are heavily tilted towards their social mission at the expense of financial sustainability. 4.2.3 firm size studies have found this variable rather inconclusive. while some find a positive relationship with leverage, others find a negative correlation. the pecking order theory suggests that larger firms exhibit lower information asymmetry and are therefore able to issue more equity, compared to small companies. consistent with the findings of titman and wessels (1988), this study finds a negative relationship between short-term and total leverage and firm size. while short-term leverage is statistically significant, total leverage is not. the implication is that small firms use short-term leverage as suggested by marsh (1982). in contrast, also supporting the findings of marsh (1982), longterm leverage is positively correlated with firm size, probably because large firms have relatively more diluted ownership and so lose control over managerial decisions. 4.2.4 profitability at a glance, the pecking order theory seems applicable to short-term leverage because of its negative relationship with profitability, whiles the others show positive signs. however, this effect on mfis’ leverage levels is insignificant. 4.2.5 age of firm using age as a proxy for reputation, the study shows that firms with good reputations attract investors and short-term debt in particular. interestingly, the results show that the older the firm (the higher the reputation), the less the firm attracts long-term debt. firms rather employ more short-term debt. 4.2.6 institutional governance since size of board is inconclusively related to all types of leverage, its effects on mfi structures are insignificant. the independence of the board however is an attraction for investors. thus, short-term, long-term and total leverage are positively related to board independence, though short-term leverage is insignificant at 5 percent. the more independent a board is, the more shareholders feel their interest is protected sajems ns 10 (2007) no 2 277 and thus encourage debt in the operations of the mfi. while ceo duality does not appear to influence either short-term or total leverage, it is negatively related to long-term leverage. indeed, in situations where the ceo doubles as the chairman, agency cost increases and has an adverse impact on the mfi’s ability to attract long-term debt. finally, the study shows that ceos with shorter tenure enable mfis to attract short-term debt whiles mfis with longer tenure for ceos attract long-term debt. this is essentially due to the fact that a shorter tenure leads to frequent changes in leadership which obviously has implications for a firm’s policy and direction. hence, investors are willing to commit long-term debt to the care of a firm only when satisfied that there will be less frequent changes in top management. however, the t-statistics of -1.61 and 1.53 for short-term and long-term leverage respectively in relation to ceo tenure appear rather low; the f-statistics and p-values make these acceptable in the estimation. table 2 regression results dependent variable variable short-term leverage (fe estimates) long-term leverage (re estimates) total leverage (re estimates) asset tangibility 0.2596891 (3.18)** 0.0037977 (0.04) 0.2533483 (3.73)** earnings volatility –0.0599206 (–1.89)** 0.0582923 (1.79)** –0.0051144 (–0.20) log of total assets (size) –0.0634865 (–6.56)** 0.0471971 (4.93)** –0.0045626 (–0.60) return on assets –0.0021889 (–0.28) 0.004655 (0.58) 0.0005246 (0.08) log of firm age 0.5156483 (7.48)** –0.02830497 (–5.59)** 0.0440444 (1.09) board size 0.003356 (0.47) –0.0039486 (–0.53) –0.0008045 (–0.14) board independence 0.0473919 (0.46) 0.2816785 (2.67)** 0.2905328 (3.44)** ceo duality 0.0297935 (1.23) –0.066116 (–2.63)** –0.0269775 (–1.34) ceo tenure –0.0285673 (–1.61)** 0.0284905 (1.53)** –0.0051798 (–0.35) constant –0.2298125 (–1.17) 0.353496 (2.04)** 0.5237044 (3.79)** r-squared 0.4335 0.2869 0.0619 no. of obs. 520 520 520 test of prob. f(9, 501)=10.72 [0.0000] wald chi2(9)=88.49 [0.0000] wald chi2(9)=32.01 [0.0002] hausman test chi2 (9) = 14.06 [0.1201] chi2 (9) = 6.29 [0.7103] chi2 (9) = 4.81 [0.8504] note: all regressions include a constant. t-statistics are in parenthesis and p-values in square bracket. ** indicates significant at 5 percent level 278 sajems ns 10 (2007) no 2 5 conclusion this study aimed at identifying the determinants of capital structure of mfis in ghana, and to ascertain whether standard finance theory explains their financing decisions. this latter aim is especially important, considering the changing pattern of financing of mfis, which has implications for their capital structure. a sample of 52 mfis was selected from ghana and data obtained for a 10 year period from 1995-2004. analysis was carried out within a panel data framework. the results show that leverage, irrespective of its maturity period, is positively related to mfis’ asset tangibility. similarly, the results confirm the finding of other studies that leverage is inversely related to firm risk. however, this study contradicts standard finance theory, since its results suggest that some mfis could still use long-term debt in spite of high risk. again, consistent with other findings, the study shows that small firms tend to use short-term leverage while large firms employ long-term leverage. furthermore, the study finds that profitability is irrelevant in a mfi’s capital structure. the results for more unconventional variables show that mfis with good reputation enjoy shortterm leverage, and that older mfis (with good reputations) employ more short-term than longterm debt. institutional governance variables produce mixed results; the independence of mfis’ boards is crucial in determining capital structure, with a highly significant positive correlation found between board independence and all three types of leverage, and ceo duality impacts negatively on long-term leverage because of increased agency costs. also, shorter tenure for the ceo 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(1988) “corporate finance and corporate governance”, journal of finance, 43: 567-591. abstract introduction kaizen principles and expected changes kaizen tools major characteristics of the selected companies kaizen team and workers’ attitude towards change an assessment of changes in management efficiency concluding remarks acknowledgements references about the author(s) keijiro otsuka graduate school of economics, kobe university, kobe, japan institute of developing economies, chiba, japan nkumbuzi ben-mazwi strategic projects, naamsa (national association of automobile business council), pretoria, south africa citation otsuka, k. & ben-mazwi, n., 2022, ‘the impact of kaizen: assessing the intensive kaizen training of auto-parts suppliers in south africa’, south african journal of economic and management sciences 25(1), a4093. https://doi.org/10.4102/sajems.v25i1.4093 original research the impact of kaizen: assessing the intensive kaizen training of auto-parts suppliers in south africa keijiro otsuka, nkumbuzi ben-mazwi received: 31 mar. 2021; accepted: 28 oct. 2021; published: 18 jan. 2022 copyright: © 2022. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: there has been a growing recognition that the most critical missing factor impeding the growth and productivity of manufacturing enterprises in developing countries is entrepreneurs with strong managerial abilities. as kaizen requires strong communication and cooperation between managers and shop-floor workers, social cohesion between them seems to be a prerequisite for its successful implementation. aim: the question arises whether kaizen can improve efficiency in management in a place like south africa, a country marked by serious ethnic divisions. therefore, the aim in this study is to assess the impact of an intensive kaizen training programme in south africa. setting: so an intensive kaizen training programme was implemented at eight randomly selected automotive parts-suppliers in the three key automotive regions in south africa from 2016 to 2019. method: a combination of a standard survey questionnaire and informal interviews was used to collect the production and management data. given our relatively small sample size, the analysis is descriptive in nature. results: evidence shows that kaizen, a japanese management system, is indeed effective in improving the performance of enterprises in developing countries. conclusion: the kaizen method proves to be so successful in improving efficiency in south africa that it justifies scaling up such a training programme in the future. keywords: kaizen; managerial ability; management training; enterprise performance; automotive industry; auto-parts industry; social cohesion; south africa. introduction innovations in industrial clusters are well known to be key to the successful deployment of manufacturing industries in developing countries. stagnant industrial clusters without innovation and dynamic clusters with active innovation have both already been described in case studies in developing countries in asia and africa (sonobe & otsuka 2006, 2011, 2014), as well as in a comparative study of development in industrial clusters in history and in the developing world (eds. hashino & otsuka 2016). in this study, ‘innovation’ refers to any changes that improve productivity, rather than schumpeterian breakthroughs. within the south african context, the importance of innovation for success has been clearly recognised historically. madi (2000) credits shaka’s success in uniting many tribes in the zulu kingdom to his invention of the iklwa, a short spear that could be used in place of the traditional throwing spear. literature clearly established that a major constraint on growth in manufacturing firms in developing countries is the lack of human capital, in general, and managerial human capital, in particular (e.g. bertrand & schoar 2003; bloom & van reenen 2010; bloom et al. 2020; bruhn, karlan & schoar et al. 2010, 2018). in these studies it is found that management practices and enterprise performance are strongly correlated. a historical study by giorcelli (2019) reveals that italian entrepreneurs who were invited to the u.s. for management training later improved and expanded their businesses significantly. it thus appears likely that managerial human capital is vitally important for innovation or improvements in production efficiency in firms. particularly noteworthy is the critical role of kaizen, a japanese management system, in stimulating innovation in manufacturing enterprises primarily through cost reductions (harada 2015; imai 1997; kaplinsky 1994; eds. otsuka, jin & sonobe 2018; sonobe & otsuka 2014). randomised controlled trials (rcts) have been conducted to assess the effects of kaizen training in small enterprises, employing 5 to 25 workers in industrial clusters in three countries: one in a metal works cluster in ghana (mano et al. 2012); another in garment and steel bar clusters in vietnam (higuchi, nam & sonobe 2015); and a third in a garment cluster in tanzania (higuchi, mhede & sonobe 2019). the training programmes commonly employ not only standard business training (in fields such as entrepreneurship, marketing, and accounting), but also a japanese-style management called kaizen (or the continuous improvement in production management and quality control). kaizen seeks to save costs and adopt a common-sense approach, focused on reducing waste through the elimination of inventories, equalising the work burdens on all workers in a production line, quality management, routinised machine maintenance, and the maintenance of clean and uncluttered work-spaces. since kaizen has proven to be highly effective, it may be no exaggeration to argue that it has been widely adopted by almost all the successful manufacturing enterprises in developed countries in asia (jin 2018; kaplinsky 1994). the automotive clusters in south africa are stagnant, largely as a consequence of a failure in auto-parts production sectors to grow. in response, the automotive industry development centre (aidc) collaborated with the japan international cooperation agency (jica) to offer an intensive kaizen training programme to selected first-tier auto-parts suppliers from 2016 to 2019. in this study, we focus on eight companies trained in kaizen. because of trials and errors in the process and occasional changes in these companies, training was done in seven companies for a few years and in one company for less than a year. as the implementation of kaizen requires active communication and cooperation between managing directors (mds), managers, and shop-floor workers, the social cohesion among them is considered to be critically important. yet social cohesion can be a serious challenge in south africa, a country ridden with ethnic divisions, particularly between the african, coloured, indian, and the white populations. thus, whether kaizen could be effective in this country is an important empirical question. another related issue is the extent to which the adoption of kaizen promotes social cohesion, given that this becomes particularly valuable when kaizen is implemented. shimada and sonobe (2021) found that the introduction of kaizen strengthened social capital in central america and in the caribbean region. kaizen has also been used in the philippines to promote social cohesion among the indigenous people (abadiano 2020). in this study it is attempted to assess the impact of an intensive kaizen training programme, offered by the aidc, on the efficiency of enterprise management. as our sample included only eight companies, we have no way to draw definitive conclusions. our aim in this study is to identify evidence that the adoption of kaizen has brought about significant improvements in the efficiency of management that may be reflected in improvements in performance indicators, such as increased labour productivity and decreased lead time. we presume that findings of significant improvement in management indicators will justify scaling up kaizen training programmes in the future. this paper is organised as follows. in the section ‘kaizen principles and expected changes’ the principles of kaizen and expected changes in production activities are briefly explained, while in ‘kaizen tools’ the major kaizen tools are discussed. this is followed by an explanation of the major characteristics of the selected companies in ‘major characteristics of the selected companies’; a description of the composition of a kaizen team in ‘kaizen team and workers’ attitude for change’; and an assessment of the impact kaizen training has in the section ‘an assessment of changes in management efficiency’. finally in ‘concluding remarks’ the major findings are summarised and the course of future studies on the auto-parts industries in south africa proposed. kaizen principles and expected changes sonobe (2018:4) defines kaizen as ‘the management philosophy and know-how that brings about continuous, participatory, incremental, low-budget improvements in quality, productivity, cost, delivery, safety, morale, and environment’. kaizen is human friendly and participatory, because it is designed to utilise a collection of ideas and insights that managers and workers create and refine through observations and experiments in cooperation. kaizen improves productivity in an incremental, progressive, and step-by-step manner. sugimoto (2018:71) argues that ‘kaizen can be defined as activities that fill the gap between the current state and the ideal state by solving problems or achieving tasks on an operational level’. thus, to be successful, a company practising kaizen must understand the current state, identify the ideal state, and possess the will to fill the gap between the two. the gap between the current state and ideal state is typically revealed by wasteful or non-value-adding activities (muda). in order to increase profit, kaizen emphasises cost reduction, particularly at its basic stage, through the elimination of any form of waste or muda, rather than directly pursuing the production of high-quality, high-priced products or increased sales volume. this is reasonable, as innovation in the process of cost reduction is more feasible than the innovation in creating new products for companies in developing countries. note, however, that advanced kaizen is designed to contribute to improvement in the quality of products, as well as the creation of incremental innovations. consequently, we shall mainly examine changes in management indicators related to cost reduction in the section ‘an assessment of changes in management efficiency’. needless to say, cost reduction leads not only to higher labour productivity, but also to higher total factor productivity, which in turn leads to higher production volume in the longer run. the increase in total factor productivity may not be as great as the increase in labour productivity, to the extent that the implementation of kaizen requires an increased number of labourers and new investment in equipment and machines. large new investments, however, are seldom required for kaizen. thus, we shall compare labour productivity before and after the introduction of kaizen in ‘concluding remarks’. if kaizen is implemented thoroughly, fewer workers will be needed, though labor productivity will rise accordingly. it is strongly recommended that the workers made redundant by the labour-saving improvement, should not be fired, as firing reduces the workers’ incentives to adopt kaizen. these ‘redundant’ workers should instead be shifted to other productive activities. according to harada (2015), the most productive workers should be shifted to other challenging tasks. this approach forms a strong pool in middle management that drives the implementation of kaizen. we shall examine whether the introduction of this method actually decreases the required manpower in the sampled companies. note, also, that since kaizen is expected to improve efficiency in production, it will increase the number of employees in the longer run. we shall therefore examine the changes in the number of employees over time. as the production system must be reformed considerably in order to implement kaizen, mutual understanding and cooperation among mds, engineers, shop-floor managers, and shop-floor workers are indispensable. kaizen experts therefore recommend that a kaizen team be appointed, consisting of mds, engineers, and shop-floor managers, among others, also that weekly meetings for this team be held. the commitment of the md to the implementation of kaizen is also strongly recommended, given that substantial changes in a production system can only be executed with the deep involvement and clear consent of the md as the major decision-maker. indeed, bandiera et al. (2018) find that the working hours of chief executive officers are a critical determinant in the performance of the enterprise. any negative attitude of workers towards the introduction of kaizen is particularly problematic, as the workers do not immediately understand the impact it has. one of the roles of the md is to convey the usefulness of kaizen to the shop-floor workers. thus, we examine the composition of the kaizen team, the participation of mds in kaizen meetings as a proxy for their commitment, and the receptiveness of the shop-floor workers to changes in the production system associated with the introduction of kaizen. the question is how to eliminate muda (non-value-adding activities). overproduction is considered to be the most serious muda, simply because an inventory of unsold products is of no value. therefore, kaizen recommends a production pull system whereby instructions are issued from the final process to the upstream processes to ensure that the required volume of products is produced in correspondence with the actual orders. just-in-time is enforced to provide needed materials on time, and the process is tracked by signboards or kanban. this production system facilitates the on-time delivery of products without holding inventory. the extent to which on-time delivery becomes more common after kaizen is introduced, will be probed. because the kaizen project was applied to a particular production line during training, it made no sense to examine changes in the inventory of final products in this study. harada (2015) argues that waiting time, inspection time, and transport time are all muda, while only processing time is valuable, because only processing adds value. he also argues that work in progress must be reduced as much as possible, that inspection time should be reduced by producing only acceptable products, and that the production line must be designed to minimise transportation time. kaplinsky (1994) points out that work in progress is held back just in case something unexpected goes wrong. the existence of stock, however, absorbs shocks (e.g. machine breakdown), and hence conceals the sources of a problem. on the other hand, the elimination of stock exposes any problems on the production floor, because the solution can be quickly spotted when the production process is interrupted. otherwise, the production process continues and defects accumulate. thus, kaizen recommends that the stock of unfinished goods be reduced to the lowest level possible. in consequence, the percentage of defects, or the rejection rate, is expected to be reduced. in quantitative analyses, the reduction in the number of work in progress and in the rejection rate after kaizen is introduced, is looked into. a reduction in the stock of incomplete products requires continuous one-piece flow processing, a method in which the workers in the same production lines must share an equal workload. hence, when workers complete their tasks and hand over pieces of work in progress to the next process, the next set of workers must have just completed their tasks, and be ready to receive the new pieces. the equipment and machine locations, processing methods, and distribution of workloads must be carefully designed to achieve this flow. when a continuous production process with one-piece flow, rather than batch production, is achieved, the manufacturer will reduce the stock of work in progress, as well as the lead time; that is, the sum of the processing time and the waiting time during which the flow of material is stagnant. work is thus completed faster, which increases labour productivity and the likelihood that errors are more immediately spotted. overtime work is reduced as a result, and the working hours spent per day (or per shift) tend to be curtailed. thus, we shall analyse the extent of the changes in lead time and overtime work. kaizen tools imai (1997), sugimoto (2018), and others have offered detailed descriptions of the numerous kaizen tools in use. our discussion in this section will therefore be brief, drawing on aidc (2019). the most well-known and the most basic tool is the 5s methodology: (1) sort; (2) set in order; (3) shine; (4) standardise; and (5) sustain. ‘sorting’ is the process of sorting all items, and removing the unnecessary ones, so as to reduce time lost looking for items and to increase available space. ‘setting in order’ means putting necessary items in the best places to achieve a smooth and easy workflow. if these 2ss are implemented, efficiency of work improves as tools and materials can be easily found when needed. when the shop floor is ‘shined’, or cleaned, the safety of the workplace improves, abnormalities can be quickly detected, and inefficiencies in the production system can be easily identified. ‘standardised’ production processes are processes in which the first 3ss are repeatedly or continuously applied. ‘sustained’ processes are processes in which workers are self-disciplined, or ‘do without being told’. once the 5s methodology is implemented, the work place becomes tidy, which makes it easier to notice problems or muda. the 5s methodology must therefore be implemented before applying the more advanced tools of kaizen. a material and information flow diagram (mifd) is a powerful tool used to visualise the flow of material and information on the shop floor, evaluate the lead time, and identify the causes of work in progress accumulating. in other words, a mifd identifies problematic areas that need improvement in order to reduce the amount of work in progress. a mifd, which is similar to a lean tool called vsm (value stream mapping), also provides a visual map of how various tasks are interrelated. the establishment of standardised work is essential, as it seeks to create an efficient production sequence. in standardised work, tasks are combined to coordinate workers, machines, and materials in the most efficient manner so as to eliminate the 3ms (muda, mura, and muri): (1) muda, or any waste in the production process; (2) mura, or unequal workloads on people or machines; and (3) muri, or unreasonable burdens on people or machines. ultimately, the crux of kaizen is to continuously improve production systems by coordinating all members of a company, ranging from the md to the managers, and further to all of the shop-floor workers. crucially, the shop-floor workers must recognise the value of kaizen and come up with new ideas, as they are the ones who apply new production systems and are optimally positioned to identify the problems to be solved. our main hypothesis is that kaizen demands significant efficiency in management which increases productivity in labour and delivery on time, reducing incomplete work, rejection rates, overtime work, and lead time. while the required labour for completing given tasks may decline, we expect the number of employees of the enterprises to increase, as the increased efficiency in management will result in expansion of the businesses overall. major characteristics of the selected companies a mixed research method that uses both the quantitative and qualitative approach in addressing the research problem was employed, while the analysis is descriptive in nature. a combination of a standard survey questionnaire and informal interviews was used to collect the production and management data. a simple random sample of eight automotive auto-parts suppliers were selected from each of the three key automotive regions in south africa, which are gauteng province (including johannesburg and pretoria), kwazulu natal (including durban), and the eastern cape (including port elizabeth and east london). four of the eight companies are located in gauteng, two are located in the eastern cape, and two in kwazulu natal (see table 1). all of them are first-tier auto-parts suppliers that directly deliver their products to automotive assemblers. their customers, the automotive assemblers, represent almost all of the major global automotive companies in the world. two of the auto-parts manufacturers were established as early as in the 1960s, and two were established as recently as the 2010s. the average year of establishment of the eight companies is 1992. two of the companies are joint ventures (jvs) with enterprises in europe or japan. although we can hardly claim that these eight companies are representative, our intention was to choose ‘typical’ auto-parts suppliers. table 1: year of establishment, foreign affiliation, location, and major products. judging from the number of workers shown in table 2, three to four of the selected companies are small-sized, employing 10 to 100 persons; two are medium-sized, employing 100 to 250 workers; and the rest are large companies, employing more than 250 workers. the years in operation correlate positively with the sizes of these companies, which probably reflects differences in the accumulation of skills and know-how. most notably, the number of employees in the sixth company, which is the newest, increased five-fold in three years. the number of employees of one jv (no. 4) is relatively large, while that of the other jv (no. 5) is small, with new employees. we were interested to observe that the average number of workers increased from 135 in 2015, just before the kaizen training programme began, to 193 in 2018, after the training had been offered for a couple of years. this increase in the number of workers may suggest that the kaizen training had a positive impact on these companies through cost reduction. table 2 also shows the proportion of direct workers (or shop-floor workers). while this proportion varies from company to company, about three-quarters of the workers on average were engaged directly in production activities in both 2015 and 2018. most of these workers are african and coloured people. table 2: number of workers and proportion of direct workers before (2015) and after (2018) kaizen training. as may be expected, white people accounted for the largest share of managers in all but a few of the companies. yet, their average share declined from 58% in 2015 to 51% in 2018, while the share of african managers increased from 20% to 27% over the same period. while it remains unclear whether or not these changes are significant, the introduction of kaizen may have increased management roles for the african employees. if kaizen did have such an effect, it might indicate that social cohesion improved to some extent. the share of indian workers is large, mainly in the two companies located in kwazulu natal (30% to 50%), where the population of indian descent is relatively large. these companies generally used to apply a top-down management system, as mckee (1999) explains. this hierarchical and control-oriented system is unsuited to today’s rapidly changing organisational structure in the african culture. the management style is also inconducive to efficient corporate management. this is a characteristic of the selected companies in which the kaizen principles were applied. kaizen team and workers’ attitude towards change as mentioned earlier, kaizen experts recommended that the relevant companies form cross-functional kaizen teams. top managers are team members in general, while engineers and shop-floor managers are team members without exception. the inclusion of engineers, particularly industrial engineers, is important, as they are adept at the mechanical aspects of production management. although not shown in the table, four companies increased the number of industrial engineers employed from 2015 to 2018. the shop-floor managers are also essential team members, as they can effectively facilitate communication between the top managers and shop-floor workers, thus fulfilling an indispensable function for the successful implementation of kaizen. many of the engineers and shop-floor managers are non-white people, accounting for about 70% of the kaizen team members on average. note, however, that many of them were junior engineers who were introduced to the companies by aidc. they appear to be actively involved in newly introduced kaizen methods, which may reflect the improved social cohesion between the different ethnic groups. the kaizen meeting is held once a week for at least 1 h in most cases, as recommended (table 3). according to the japanese kaizen experts, the commitment of the mds to its implementation, is key to the successful introduction of kaizen. pretorius (2013) points out that the core tasks of leadership are to direct, inspire, enable, focus, and change the behavior of employees, through commitment. the other important aspect, according to harada (2015), is that the foreman or leader on the shop-floor is the person who actually breaks the standard. this is understandable, insofar as the md is a major decision-maker in the company. some mds, however, fail to recognise the importance of kaizen and consequently withhold their active support of its implementation. although it is hard to assess accurately the commitment of mds, table 3 shows the level of md participation in the weekly kaizen meeting as an indicator of the mds’ commitment. according to this indicator, the mds of the third and fifth companies are the most active in the implementation of kaizen, while the md of the sixth company is inactive, delegating the overall responsibility for implementation to a junior engineer. it thus becomes worthwhile to examine whether the management performance improved more significantly in the third and fifth companies than in the others, particularly in the sixth company. we must note, however, that if the mds in those two companies are more competent than those in the others, in general, then the improvement in efficiency in management of those companies cannot be wholly attributed to the commitment of their mds to kaizen. we may also note that the sixth company is new and started the business from a zero base. table 3: kaizen meeting and change in the workers’ attitude between before (2015) and after (2018) kaizen training. we repeatedly heard during the informal interviews that the shop-floor workers were highly resistant to changes associated with the introduction of kaizen, believing that their methods were already efficient enough. the same tendency was observed in central america and the caribbean by shimada and sonobe (2021), where employees were initially skeptical about the usefulness of kaizen. to convince the shop-floor workers that new methods are superior, trainers had to demonstrate their superiority by showing actual improvements. we were told that once the superiority of kaizen was successfully demonstrated, the workers’ attitudes changed markedly. thus, we asked the workers about their attitudes towards the changes before and after the kaizen training in our questionnaire survey. as is demonstrated in the last two columns of table 3, their attitudes changed from between 2 (‘resistant to change’) and 3 (‘not resistant, not receptive’) to 4 (‘receptive’). another interesting point to confirm was the remarkable change in the workers’ attitudes in the third and fifth companies, where the mds always participated in the weekly kaizen meetings. this finding is consistent with bandiera et al. (2018), who find that the working hours of mds are a critical determinant in the performance of enterprises. a substantial change was also seen in the workers’ attitude in the eighth company, where the md often participated in the kaizen team meetings (see table 3). it would probably be fair to conjecture that there were clear changes in workers’ attitudes towards accepting the new production systems introduced by kaizen in most of the sampled auto-parts manufacturers. an assessment of changes in management efficiency there is significant evidence, based on the rct in the literature, that management training improves not only the management practices (e.g. quality control, inventory management, sales, return on assets, and profit), but also the performance of small to medium enterprises in cotton weaving plants in india (bloom et al. 2013) and manufacturing, commerce, and service enterprises in mexico (bruhn et al. 2018). according to a resurvey at the same plants by bloom et al. (2020), moreover, the intervention generated a persistent or long-term impact on plants in india. bruhn et al. (2018) find similarly the long-term impact of management training on employment generation. the results of management training for microenterprises with few or no paid employees are puzzling. according to a survey of 13 rct-based studies by mckenzie and woodruff (2014), most studies find the significant impact management training has on the adoption of improved management practices, without finding a statistically significant impact on the firm’s profitability. another survey by mckenzie and woodruff (2017) basically supports their earlier data. they identify the following as possible causes for their results: (1) small sample size, (2) assessment of very short-run impacts, (3) large heterogeneity of sample enterprises, (4) short training courses, and (5) focus on microenterprises. while the sample size is very small in our study, the changes were being assessed over a three-year period between 2016 and 2019, the sample enterprises were all engaged in the production of automotive parts (heterogeneity is not a serious constraint), the training course was extended rather than brief, and the enterprises were small to medium. we presume that improved management is more important in small to medium enterprises than in microenterprises, as the monitoring and coordination are more costly in the former than the latter. therefore, we expect to observe the large and economically meaningful effects of management training going forward in this study. mckenzie (2020) attributes the lack of significant management training effects on the performance of enterprises to low powers of statistical analyses. in fact, his meta-analysis demonstrates small but significant effects of management training on the performance of microenterprises. while the best indicator of improvement in productivity is the change in the total factor productivity, difficulties in assessing the value of capital makes it practically difficult to compute this change. since kaizen is designed to achieve low-cost improvement in productivity without much extra investment in equipment, changes in labour productivity can be a reasonable proxy for improvement in the total factor productivity. in order to improve efficiency in management, however, some investments in new equipment may be necessary. increased labour productivity is also consistent with a company’s current policies as it searches for new ways to achieve higher-quality communication, greater speed in making decisions, increased creativity and problem solving, and improved customer services (mckee 1999). as shown in table 4, labour productivity, measured by the number of products divided by the number of workers in the targeted production line in kaizen training, on average more than doubled within three years. note that kaizen is not applied to the entire production system, but to selected production lines. moreover, the third company increased its labour productivity by as much as four times. the md of the third company may have been strongly attracted to kaizen, because of the low productivity before, which created ample room for improvement in productivity. the eighth company also more than doubled its labour productivity, and within a much shorter training period. in contrast, the sixth company recorded an improvement of only 23%, far less than the average. note that the md of the sixth company did not participate in the weekly kaizen meeting (see table 3), which may suggest that a lack of strong commitment could have been a constraint on the effective implementation of kaizen. judging from the generally large increase in labour productivity, the impact of kaizen on efficiency in production seemed enormous. we find little reason to doubt that the introduction of this method significantly improved productivity in the sample companies. somewhat similar to our study, iacovone, maloney and mckenzie (2019) applied the rct to management training in small to medium-sized automobile part-suppliers in columbia, and they did not find any significant effect on performance. however, their training used standard business training programmes, and not kaizen. table 4: change in labor productivity within regular working hours in the targeted production line between before (2015) and after (2018) kaizan training. several indicators support the hypothesis that the introduction of kaizen increases efficiency in management or reduces costs. first, table 5 shows the change in the proportion of products delivered on time from the targeted production lines before and after kaizen training. as would be expected, the proportion of on-time delivery increased in most companies, albeit to a relatively modest degree, over the two years. table 5: change in the proportion of on-time delivery (%) and work-in-progress between before (2015) and after (2018) kaizen training. secondly, although comparable data are only available from four companies, case study reports, submitted by the companies where training was done, to the aidc provide additional valuable information on work in progress (table 5). the volume of unfinished goods declined precipitously and almost disappeared at the first, third, and fifth companies. furthermore, the required manpower declined by 26% on average. while there may have been selection biases to the extent of the reduction in work in progress and required manpower, the evidence provides added support for the significant impact of kaizen on efficiency in management. thirdly, table 6 shows the change in overtime working hours per week before and after kaizen training. these data are important, given that overtime work was commonly performed to complete the required tasks before kaizen was introduced. the overtime work, which the companies were forced to perform to compensate for low efficiency in production, involved costly extra payments. after the introduction of kaizen, the working hours per week declined substantially in all companies but the first, seventh, and eighth. the first company reported that the working hours increased due to the increased volume in production, which could be a sign of successful management production, rather than persistently inefficient management, judging from the substantial reduction in work in progress shown in table 5. thus, we can generally conclude that improved efficiency in production brought about by the adoption of kaizen led to significant declines in the work hours per week. correspondingly, on average, the rejection rate declined from 3.3% in 2015 to 2.2% in 2018. note that the rejection rate is related to both the product quality and production cost. table 6: change in the average over-time working hours per week between before (2015) and after (2018) kaizen training.† finally, table 7 provides strong evidence that the lead time declined tremendously after kaizen was introduced, which led to improved delivery on time to customers. on average, the lead time in 2018 declined to only 38% of the 2015 level. this is highly consistent with labour productivity more than doubling as shown in table 4. particularly noteworthy is the decline in lead time to almost zero in the second, third, and fifth companies, versus the small decline in the seventh company. these findings support our hypothesis that the introduction of kaizen had a significant impact on efficiency in management. this effect is exceedingly important regarding the satisfaction of customers, that is, oems (original equipment manufacturers), because shortened lead time assures on-time delivery. table 7: change in lead time in the targeted production line before (2015) and after (2018) kaizen training (hours). to sum up, the collected data support the hypothesis that kaizen has a significant impact on efficiency in management in the auto-parts industry in south africa. while the impact of kaizen on social cohesion is not known, we cannot imagine that kaizen could improve efficiency in management in the sheer absence of improved social cohesion. concluding remarks during the transition of the south african political landscape to a democratic state in 1994, most automotive oems in the country gained access to the global market. this brought increased international competition and a need for both improved quality and reduced cost in production. many of the oems thus adopted kaizen principles, which has since led to the sustainable success of the automotive industry in south africa. the challenge now remains primarily to the supplier base, which is still inefficient and uncompetitive compared to global counterparts. there seems to be a clear need for kaizen training in all the tiers of component suppliers in future. given our small sample size, it would be difficult to draw any clear-cut conclusions from the descriptive analyses in this study. we also face the constraint of missing data. nonetheless, many of our findings suggest that the introduction of kaizen significantly contributed to improvements in the efficiency in management in the auto-parts companies where training was done. on this basis, we believe that further efforts to disseminate kaizen to a large number of parts-producing companies in south africa would be justified. according to the japanese experts, a major constraint on the wider dissemination of kaizen in this country is the weak commitment of mds. while there may be many reasons for this constraint, a lack of conclusive evidence of the significant impact of the kaizen method may be core among them. thus, we propose to implement kaizen training in a much larger number of parts-suppliers in south africa, in order to collect convincing statistical evidence to support the significant impact of kaizen training. particularly important is the development of secondand third-tier auto-parts sectors, the achilles heel of the automotive industry in this country. indeed, many parts potentially produced by secondand third-tier domestic suppliers are imported from thailand. the massive and increasing importation of components works against the saam (south african automotive masterplan) vision and policy for 2035. the projected drive for localisation and growth in the south african automotive industry, as per saam 2035, will not be realised without comprehensive kaizen training and implementation, especially in the component manufacturers. opportunities for developing such sectors in south africa are becoming ripe, as rising labour costs may be eroding thailand’s comparative advantage in producing exported parts currently. a larger sample size would not be enough to prove the significance of kaizen. to more rigorously assess the ‘pure’ impact of kaizen training, it will be appropriate to apply rcts; that is, trials in which the training is offered only to randomly selected companies, in order to compare their performance with that of a randomly selected control group after training. any differences in the efficiency of management identified in such trials could be attributed to the implementation of kaizen training. indicators of the efficiency in management should be further elaborated on. first, the value of capital should be measured, and data on wage payments and the cost of additional investment, associated with the adoption of kaizen, should be collected, to allow us to measure the total factor productivity index. since products produced by different companies vary, a direct comparison of the total factor productivity would be absurd. we can, however, compare the growth rate of total factor productivity between kaizen-trained and control companies. total factor productivity is a better indicator of efficiency in management than labour productivity. we could also compute the gross profit (i.e. revenue minus wage payment) or gross profit rate (i.e. gross profit divided by the value of capital) as an alternative indicator of efficiency in production. secondly, we could systematically analyse information on work in progress, an apparently useful indicator of performance in management that we failed to collect from all the sample firms in our questionnaire survey. it is presumed that the impact of kaizen training is conditioned on social cohesion between the mds and shop-floor workers, and the commitment of the mds to kaizen implementation. there has been good progress in some of the oems using kaizen to promote social cohesion in south africa. both variables are critically important but difficult to measure. without assessing the roles of these variables, however, our analysis of the impact of kaizen on efficiency in management will be incomplete. indeed, the major purpose of future study will be to demonstrate the importance of social cohesion and the mds’ commitment to improving the performance of auto-parts sectors in south africa. acknowledgements the authors would like to acknowledge the contribution of kimiaki jin, and the two kaizen experts kazunori hayashi and michiharu suzuki, who implemented the training. also yuki higuchi, justine barnes, and anthony black, as well as an anonymous reviewer and editor of this journal, for their useful comments on the earlier version of the article. competing interests the authors have declared that no competing interest exists. authors’ contributions k.o. developed the conceptualisation and methodology, as well as wrote the original draft, n.b-m. contributed to the investigation, project administration, validation, data curation, resources, writing and reviewing and editing. ethical considerations this article followed all ethical standards for research without direct contact with human or animal subjects. funding information the research received no specific grant from any funding agency, even though the japan international cooperation agency is willing to support the publication fees. data availability the authors confirm that the data supporting the findings of this study are available within the article. disclaimer the views and opinions expressed in 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countries, palgrave macmillan, hampshire. sugimoto, s., 2018, ‘kaizen in practice’, in k. otsuka, k. jin & t. sonobe (eds.), applying kaizen in africa: a new avenue for industrial development, pp. 69–110, palgrave macmillan, cham. microsoft word 6'perks sajems ns 13 2010 no 4 sajems ns 13 (2010) no 4 447 exploring the management abilities of spaza shop owners in the nelson mandela metropolitan municipality s perks department of business management, nelson mandela metropolitan university accepted july 2010 south african entrepreneurs have a poor skills record, which often leads to business failure. to effectively manage a spaza shop requires applying management functions and some management skills. the implementation of simple systems can assist spaza shop owners to manage their businesses more successfully and even grow. a quantitative study was done, by interviewing sixty spaza shop owners in the township. the empirical results identified the gaps in the management abilities of spaza shop owners in terms of the eight management functions and show that the purchasing, financial and information management function are the most neglected. guidelines on how each of the functions could or should be applied are given. this research indicates that spaza shops can assist in economic growth and relieve unemployment in the country. jel m11, 13, l26, 81 1 introduction south africa is one of the most sophisticated and promising emerging markets in the world, offering a unique combination of highly developed first world economic infrastructure with a vibrant emerging market economy (timmons & spinelli, 2003:47). more than 80 per cent of businesses in south africa can be described as small businesses (rwigema & venter, 2005:475). most south african cities and towns have at least one township associated with them. new initiatives have been taken to renew and re-vitalize the view of south african townships, especially in preparation for the 2010 soccer world cup (wikipedia, 2009). it is within these townships that many small businesses are struggling for survival and growth. fuller (2003:297) emphasises that “to develop the south african economy, things need to be done at the smallest scale in every township”. policy makers in south africa continue trying to identify and support those productive, and innovative small businesses that will generate employment and promote economic growth within the country (dobbs & hamilton, 2007:296). in 2000, 2,7 per cent of south africa’s retail trade was from spaza shops, amounting to r7,4 billions (ligthelm, 2002:1). this illustrates the importance of spaza ships to the economy in terms of contributing towards income generation and possibly reducing unemployment. the owners of these spaza shops start these micro businesses for various reasons, but can nevertheless be regarded as an entrepreneur in that they have identified an opportunity. small businesses always carry low overheads, which enable them to become more competitive and responsive to demand changes (kesper, 2000:8). the manner in which small businesses entrepreneurs manage their businesses can contribute towards becoming competitive with other small businesses. this study explores how spaza shops in the township are or can be managed. as literature on spaza shops is scarce, the literature study includes the management functions in informal businesses, where possible with specific reference to spaza shops. the results of the biographical profile of the spaza shop owners and their businesses, and how they execute the eight management functions proposed by van aardt, van aardt & bezuidenhout (2000:150) are tabulated, followed by the conclusions and management abstract 448 sajems ns 13 (2010) no 4 implications on how spaza shops could or should apply these management functions. in the next section the research objectives are outlined. 2 problem statement and objectives a spaza shop owner, as an entrepreneur, needs a range of abilities to be able to execute daily business operations, requiring him to be a generalist. hodgetts and kuratko (2001:616) define a generalist as a person who possesses the ability to view operations in broad terms. various authors (smart force, the e-learning company, 2002:1; van dyk, nel, loedolff & haasbroek, 2001:52), identify various skills and daily tasks needed for managing a business, for example financial aspects like budgeting, interpreting financial statements, business. amoungst others the following are necessary: accounting, business finance; marketing by developing a marketing strategy, selling, advertising; human resource management and labour relations; interpersonal skills for customer services, operations management like finding resources and possible suppliers; purchasing such as ordering goods or services, receiving and inspecting the goods and stock control. spaza shops should engage in these management activities on a daily basis. the main objective of the study was therefore to explore how township spaza shops manage their businesses. the secondary objectives of the study were: • to define the range of management functions of micro or small businesses in the informal sector which can be applied to spaza shops; • to explore how spazas shop owners are applying each of these management functions; • to determine the gap(s) between how spaza shops are managed and how they should be managed, and • to address how these gap(s) could be eliminated or reduced. 3 concept clarification the following key concepts used in the article are defined below. a) a very small business very small businesses in south africa can be described as owner-managed, having more than five, but less than twenty employees and less than r2 million in assets, except in the agricultural sector (small business amended act, 2003:6). b) a micro business micro businesses in south africa can be described as informal, having less than five employees, and very few assets (small business amended act, 2003:6). c) a spaza shop according to von broembsen (2008:1) a spaza shop is an informal business run from a room in a shack or small house where customers stand outside and purchase basic groceries over a counter, to the less common and more sophisticated grocery shop. both definitions of micro and very small businesses could be identified as fitting the description of a spaza shops. if having the whole family involved (more than five employees but less than 20), spaza shops can be regarded as a very small business. a spaza shop can also be a micro business should it have fewer than five employees. in the next section, the management functions are discussed. 4 management functions management is the process whereby human, financial, physical and information resources are employed in order to reach the goals of a business (cronje, du toit, marais & motlatla, 2004:122) or is the tasks and activities performed by managers (hellriegel, jackson, slocum, staude, amos, klopper, louw & oosthuizen, 2005:7). the following eight functions are identified by several authors (cronje, et al., 2004; hellriegel, et al., 2005:11; kotler, 1999:9; mol, 2001:99; marx, van rooyen, bosch & reynders, 2004; sajems ns 13 (2010) no 4 449 sibiger, 2001:29; van aardt, van aardt & bezuidenhout, 2000:150): general management; human resources; finance; marketing; purchasing; operations; administration or information; and public relations. table 1 highlights literature on issues within the business functions pertaining to managing spaza shops or small businesses. table 1 literature on issues pertaining to managing spaza shops or small businesses general management (friedrich ebert stiftung library, 2000:1; longenecker, moore & petty, 2000:389; martins & ligthelm, 2004:15; robbins & de cenzo, 1998:75; tladi & isaacs, 2003:3, 4; von broembson, 2005:1; 2007:14,15)  no need for a licence in sa, except if trading in perishable food, medicines, liquor or adult entertainment.  owner’s lack of ability to converse with customers in english limits market access to only the community.  lacks a safe and protected stock storage space.  often victims of break-ins, property theft, vandalism and physical attacks.  lack of security and crime affect spazas negatively.  buys in small quantities as lots of stock can attract more crime.  requires short-term planning with a monthly, weekly and day-tot-day time frame.  should have a short-term operating plan (budget) prepared one year in advance. human resources (katz & green, 2009:634; kirsten, 1995:204; ligthelm & lamb, 2006:1,3; longenecker et al., 2000:409; munbodh, 2003:1)  major source of employment (20,6 per cent of all employment in south africa 2,3 persons employed per business).  normally use family and unpaid labour as employees and rely mostly on manual labour.  employee selection for performance important as it affects profitability and sales revenue.  mostly females are employed to clean, cook, serve clients and pack products on the shelves.  on-the-job training favourable as it is less costly than off-the-job training. purchasing (friedland, merz & van rensburg, 2008:5, 6, 9; hatten, 1997:431; ligthelm, 2002:2; 2004:2; 2007:19; tladi & isaacs, 2003:2, 3, 4, 6; 2004:9; ntloedibe, 2005:1; rogerson, 2008:223, 235; von broembsen, 2005:1; 2008:2; whythawk, 2009)  mostly sell soft drinks, cigarettes, paraffin, candles, maize meal, alcoholic beverages, bread and sugar.  buy stock in small quantities (what they can carry), from a variety of retailers and wholesalers, but mostly wholesalers.  lacks adequate stock storage space.  due to little stock, out-of stock situations requires frequent buying.  pay high prices for stock due to lack of money or inadequate knowledge and insufficient bargaining power or high transport cost.  regard quality as justifying high stock prices in spite of lack of money.  good inventory control advisable as about 80 per cent of the capital tied up in stock.  choose suppliers based on accessibility and proximity of the suppliers to the business; special discounts or prices; customer brand preferences; packaging or quantity; convenience, and other services provided e.g. loading of stock, trolleys, etc.  most important needs are to received discount from wholesalers and transport of products (only soft drinks, dairy and bakery products are delivered).  suppliers offer no credit sales (less than 10 per cent receive supplier credit) or discount.  rely on taxis or hired vehicles for transport (there is an informal transport system operating from wholesalers in cape town).  should forge a long-term relationship with suppliers.  a phone-in order system – pre-packed for pickup or stock delivery is advisable.  only a few engage in cooperative buying schemes.  development of spaza shop business association, to handle group bulk buying, discount and special arrangements from suppliers advisable. 450 sajems ns 13 (2010) no 4 marketing (friedland et al., 2008:5-6; ligthelm, 2004:2; ryan, 2004b:1, 3; the economic impact of coca-cola on south africa, 2008:8; tladi & isaacs, 2003:2; 2004:9; von broembsen, 2005:1)  target market comprises of township residents.  three quarters of the customers buy daily as it is conveniently close to home.  insufficient and limited ranges of products satisfying basic needs are offered.  higher prices compared to shops in town are justifiable, because of their proximity to customers (the community).  shopping hours are from 7am to 11pm.  night shopping, selling in small quantities and giving credit make up for higher prices customers pay.  suppliers provide signboards, sometimes posters for advertising e.g. milk or coke or promotion material such as name on signboard and shop equipment.  signage sought after especially coca-cola signage as it attracts customers and stimulates sales of other products.  promotion material includes flyers, pamphlets and/or specials with word-of-mouth advertising being the preferred method.  severe competition and small customer numbers are challenging but can be improved through clustering. financial management (cgap, 2009:1; friedland et al., 2008:5-6; ikoja-odongo, 2001:3; ndhlovu, petersen & ndhlowvu, 2006; ntloedibe, 2005:1; ryan, 2004a:1; ryan, 2004b:1; the economic impact of coca-cola on south africa, 2008:4; tladi & isaacs, 2003:2, 4, 6; venter, urban & rwigema, 2008:334, 337; von broembsen, 2005:1,2)  need a minimal capital outlay and no skills to start the business.  few have a credit card or cheque account, and use mostly a savings account.  use savings to start the business and credit for expansion.  no formal support received to start the business, with few aware of business support organizations.  those that have used support services are satisfied with service received and resultant business growth.  providers regard poor payment records as a major obstacle in granting credit.  money can be obtained by contributing to a stokvel or from informal moneylenders such as matshonis that charge a high interest rates on loans, but require little paperwork.  wizzit introduced a mobile banking payment system especially for spaza shops.  earnings are about r20 200 annually with bread and soft drinks contributing to turnover the most.  electricity and transport are regarded as the biggest business expenses.  have a high input cost with low profit margins.  cannot leave the business, even for one day.  bad debt, or granting too much credit is one of the biggest problems, together with lack of funding to buy stock or to expand.  no record-keeping, except of purchases, sales and debtors. operations management (kirsten, 1995:202)  operations limited to fast food like ‘vetkoek’ and ‘roast koek’, maize, fried fish, homemade ginger beer, or cement slabs (stoep).  women often involved in cooking and brewing beer.  making food or beer is major source of income. information management (friedland et al., 2008:11; ikoja-odongo, 2001:4, 5; oliver, 2005:1; spaza news, 2005; 2008:1)  information is needed for daily operation and management purposes.  little information available about this sector, indicating a need for empowerment.  need information about marketing, raw materials, supplies and where to seek advice.  network with people they know, with some reading newspapers or listening to the radio.  spaza news established to help owners improve their businesses.  word-of-mouth, printed media and letters, radio and television preferred ways of receiving information due to high level of illiteracy.  information needed on competitors, contracts, marketing, training and raw material prices.  need filing systems for finances (bank statements, bills, mortgage or loan information, receipts for major sajems ns 13 (2010) no 4 451 purchases); correspondence (letters or faxes); and information sources (business cards, warranties and equipment manuals).  should discard unwanted receipts, out-of-date price list and newspapers.  an sms service for placing orders suggested. public relations (bolerjack, 2008:1-5; van rensburg, 1999:177)  recommended to be better than anybody else in the areas of knowledge, product and services offerings, production, compilation, interpretation, provision, marketing, analysis, or understanding the customers.  community participation, public speaking, relationships with local area reporters recommended.  create favourable, objective business image and sound mutual interest group relationships. in all types of businesses, all these functions are essential to efficiently manage a business, especially a micro or very small business. ryan (2004:2b) found that spaza shops wanted business training in management, bookkeeping, computer skills and marketing. the scope of the functions varies according to the size of the business; for example, the human resources function only comes into play when they have employees. in the next section, the methodology of the study is explained. 5 methodology the focus of this study was to establish how spaza shop owners in townships manage their businesses. a survey was conducted amongst spaza shop owners in the nelson mandela metropolitan municipality in port elizabeth, south africa. 5.1 sampling a convenience sample of spaza shop owners in the nmmm, port elizabeth, was chosen from all the township areas in port elizabeth, uitenhage and despatch. fieldworkers chose the spaza shops within their residential area and interviewed those willing to participate. although 60 questionnaires were received, the final response rate was 56 as some questionnaires were incomplete. 5.2 data collection the measuring instrument used in this survey was a semi-structured questionnaire consisting of two sections, containing mostly open-ended questions. section one consists of biographical information regarding the respondents and their businesses. the second section contains open-ended questions on whether and how they execute the particular management functions. the reasons, importance and purpose of the completion of the questionnaire were emphasized to the respondents prior to the interview. self-administered questionnaires would not have had the required result as the literacy level of the spaza shop owners was not known prior to the interview and could thus have impacted the reliability of the results. use was made of field workers that could speak the respective languages of the respondents, as english was mostly the second language of the respondents. field workers from certain residential areas were chosen for more convenience, more control in obtaining feedback and because it was less costly to administer the questionnaire. the field workers were briefed prior to the interviews on how to conduct the interview and the intention of the questions. 5.3 validity and reliability content validity was ensured as the content of the open-ended questions was based on the literature study of the eight management functions. a pilot study was conducted with ten spaza shops to ensure that the questionnaire was worded correctly and to test reliability. field workers could explain the open-ended questions to respondents in their own language and further increase the reliability of the results. 5.4 data analysis the completed questionnaires were checked for completeness and then allocated a number. as respondents gave different responses in the open-ended questions, data sheets were 452 sajems ns 13 (2010) no 4 designed with new categories added as data capturing took place. it was difficult to categorise the responses as respondents had many different views on what was asked. in spite of this the results are meaningful as they captured the real views on how they execute the management functions. the results of the questionnaires were captured in an excel spreadsheet. data capturing was a lengthy process as categories were continuously refined to make the data analysis more manageable. the 56 respondents gave many different responses and expressed their views in poor english which required further refinement of categories. the descriptive results were analysed by calculating the frequency of responses and presented in terms of percentages in tables or figures. 5.5 limitations the sample would have been more representative if spaza shops in other provinces in the country had been included in the study, but this was impossible due to time constraints and the high costs involved. it would have been interesting to compare the various business operations skills levels of respondents in the different provinces. the researcher had to rely on the integrity of the fieldworkers in completing the questionnaires. 6 results 6.1 biographical data the results of the biographical data can be seen in table 2. table 2 biographical profile of respondents biographical criteria category % biographical criteria category % age 26 – 35 18 gender male 59 36 – 45 30 female 41 46 – 55 41 number of employees 1 (only owner) 21 56 – 65 9 2 – 3 59 > 65 2 4 – 5 16 highest qualification grade 7 or less 6 > 5 4 grade 8 – 9 10 time in business (years) 5 or less 52 grade 10 – 11 18 6 – 10 32 grade 12 46 11 – 15 8 certificate 2 16 – 20 2 diploma 7 20 – 25 2 degree 7 above 25 4 post degree 2 none 2 as can be seen in table 2, no respondents were under 25 years of age. the sample comprised more males than females. their qualifications vary from as low as grade 4 to an honours degree. one respondent had never attended school. all respondents operate as sole traders. most businesses had been in existence for ten years or less. some respondents had no employees, just the owner. previous working experience ranged from: teaching 4 per cent, protection services 4 per cent; mechanical engineering 12 per cent; business 4 per cent; administration 10 per cent; sales and marketing 30 per cent; cashier 8 per cent; nursing 6 per cent; building 2 per cent; transport 2 per cent; sajems ns 13 (2010) no 4 453 domestic workers 6 per cent, upholstery 2 per cent and 10 per cent had no experience. the reasons given why they started their businesses are: no shop in area (15 per cent); business reasons such as retrenchment, retirement, business closure, and being medically unfit for work (19 per cent); personal reasons such as divorce and no job satisfaction (4 per cent); needed money to make a living (14 per cent); inherited family business (8 per cent); had money, experience, saw an opportunity (12 per cent); to have independence and achieve goals (4 per cent); and unem-ployment (24 per cent). fifty seven per cent of the sample grew up in a family business environment where a family member like an uncle or parents had a business. only 39 per cent of these respondents had worked in the family business. 6.2 management functions 6.2.1 general management seventy five per cent of respondents plan daily, while there was an even number of respondents that never or occasionally plan. eighty two per cent of respondents daily check whether their stock sold, matches their cash received. ninety eight per cent of respondents arrange their stock to be eye catching (94 per cent); for the display inside to be visible from the outside (2 per cent), and for easy customer access (2 per cent). respondents speak the following languages when they serve their customers: english (36 per cent); afrikaans (22 per cent); xhosa (34 per cent); zulu, sotho, somali (2 per cent each) and setswana and swahili (1 per cent each). as can be seen the majority of respondents have good communication skills and speak two languages, namely english and another language. 6.2.2 human resources twenty one per cent of the respondents do not employ staff. sixty one per cent of respondents who have employees, have employment requirements as can be seen in figure 1. figure 1 employment requirements of respondents 63% 7% 26% 4% ba sic e duca tion m a the m a tics p e rsona lity he a lth, fitne ss fifty seven per cent of the employees have specific jobs such as packing shelves (40 per cent); cleaning (12 per cent), and serving customers (48 per cent). eighty six per cent allows their staff to make decisions as shown in table 3. 454 sajems ns 13 (2010) no 4 table 3 types of decision delegated to employees stock decisions % what quantity of stock to buy 26 what to sell 11 what is on special 5 which stock to purchase 21 when to increase prices 5 how to display stock 5 when to take stock 5 other decisions % returns and queries 11 when to take leave 6 which customers to grant credit 5 table 3 indicates that staff mostly makes stock decisions related to which stock or the quantity of it to buy. table 4 indicates the percentage of staff that were trained and motivated. table 4 staff receiving training and motivation staff trained percentage staff motivated percentage yes 43% yes 66% no 57% no 34% table 4 indicates that less that half of the respondents train their staff, while nearly two thirds motivate staff. table 5 shows how respondents train and motivate staff to sell more. table 5 how staff are trained and motivated training % motivation % show staff how to serve customers 5 give monetary incentives 52 tell staff how to serve customers 5 give groceries to take home 3 on-the-job training 63 tell staff to meet customers needs 14 to pack shelves and serve customers 11 tell staff to sell more 3 to operate the cash register 16 tell staff to friendly and be good to customers 28 on-the-job training is regarded as the most important way of training staff and about half of the respondents give monetary incentives as a motivator to sell more. as indicated in table 6 sixty one per cent of respondents delegate some tasks to staff. sajems ns 13 (2010) no 4 455 table 6 tasks delegated to staff physical in-store tasks % administrative tasks % purchasing products 6 bookkeeping 3 displaying products 12 stocktaking 6 packing shelves 14 counting money daily 3 cleaning 14 issuing receipts 3 baking 6 customer related tasks % cutting and wrapping products 3 customer complaints 3 other tasks % serving customers 9 managing shop in absence 9 generating sales 3 transportation of products 3 lotto machine sales 3 respondents delegate physical minor in-store tasks such as packing shelves and cleaning to staff, but few important tasks such as bookkeeping and counting daily money. 6.2.3 finance table 7 shows where respondents obtain funding to start their spaza shops. table 7 main funding sources own funding % funding source % unemployment insurance 2 bond 2 savings 29 business partners 2 pension 16 friends 2 investments 9 loan 8 salary 3 family 16 retrenchment 5 took over family business 2 inheritance 2 another business venture 2 some respondents used more than one main funding source to start their business. besides using their own funding, twenty per cent had to also obtain a loan to start their business from: absa bank (9 per cent); standard bank (46 per cent); unibank (9 per cent); people’s bank (9 per cent); business partners (18 per cent), and the step-up program (9 per cent). seventy five per cent of the respondents plan their spending, with 20 per cent never or 5 per cent sometimes planning their spending. two per cent of respondents let their budget dictate what to use their profits for, while others use their profits for: savings (33 per cent); paying business expenses (8 per cent); paying house-hold expenses (27 per cent); reinvesting in business (5 per cent); bond repayments (3 per cent); buying stock (16 per cent), and paying loans (6 per cent). eighty two per cent of respondents indicated that they do save money, while 11 per cent never or 7 per cent sometimes save money. eighty six per cent of respondents keep sales records, using the methods indicated in table 8. 456 sajems ns 13 (2010) no 4 table 8 record-keeping methods purchases and sales records % other methods % invoices 10 computer 2 receipts 4 filing system 14 record sales and purchases 6 bookkeeping 6 receipts and invoices 2 record purchases 2 stock counting 6 cash register 10 counter book 38 eighty two per cent of respondents lose money due to stock problems. these problems include: theft (29 per cent); being out of stock (4 per cent); late stock delivery (2 per cent); perishable products (57 per cent) and 8 per cent did not specify their stock problems. 6.2.4 marketing seventy nine per cent of customers are from the community and the remainder can be classified as the general public. ninety five per cent of customers are regular customers. the customers are aware of the business through: word-of-mouth advertising (32 per cent); advertisements on notice boards (19 per cent); advertisements in free papers (21 per cent); advertisements on coke truck (2 per cent); posters (2 per cent): pamphlets (6 per cent); the owner’s personality (3 per cent); being an established business (5 per cent); and the visibility of the business (10 per cent). respondents advertise by means of: a notice board (29 per cent); specials on pamphlets (23 per cent); posters (11 per cent); signage of name of shop (6 per cent); visibility of shop (2 per cent); word-of-mouth (8 per cent); greeting passers-by (4 per cent); product display (4 per cent) and business cards (2 per cent). eleven per cent of spaza shop owners do not use any means of advertising. fifty seven per cent of respondents have specials or give discount. fourteen per cent only sometimes give discount, while twenty nine per cent never give discount or have specials. their business hours vary considerably, from 05:00 to 22:00, with the majority having a 12-hour day, working seven days a week. the business hours categories are available on request. 6.2.5 purchasing all respondents obtain their products from wholesalers. thirty nine per cent of respondents always use the same supplier, while the remainder buy from the supplier with the lowest price. forty one per cent of respondent receive credit from the suppliers. the various periods credit is given for are: 2 days (4 per cent); 7 days (35 per cent); 14 days (15 per cent); 1 month (34 per cent); 6 months (8 per cent), and one year (4 per cent). the 2-days credit was given for purchasing bread. it could not be established for what oneyear credit was obtained. fifty two per cent buys only stock that customers demand or request, or stock which sells quickly (46 per cent), with only 2 per cent buying a variety of stock. how often respondents buy stock is shown in figure 2. sajems ns 13 (2010) no 4 457 figure 2 how often respondents buy stock 10 27 2 4 4 2 8 2 5 0 5 10 15 20 25 30 tw ice a w eek w eekly every tw o w eeks every three w eeks m onthly every 4 m onths low stock levels respondents buy stock weekly, two weekly or when stock levels are low. the amount of stock that respondents buy depends on various factors as outlined in table 9. table 9 factors determining how much stock to buy resource availability factors % stock demand factors % display space 3 customer requests 30 storage space 2 turnover 10 money available 18 stock levels 30 other factors % lifespan of product 5 monthly purchase cycle 2 seventy three per cent of respondents use their own transport to get the stock to their shop, while some stock is delivered by suppliers (8 per cent), hired transport (5 per cent); taxi (3 per cent), bus (8 per cent), or family transport (3 per cent). 6.2.6 operations management fourteen per cent of respondents also offer take-aways or bake bread. the time to make the food varies from 20 minutes to four hours. the food that takes long to make is normally only available at lunchtime. respondents use kitchen appliances such as stoves and pots (30 per cent); microwave (20 per cent), deep fryers (10 per cent); primus stove (10 per cent), bakery equipment (20 per cent) and a blowlamp (10 per cent). they bought the appliances new (63 per cent) or second hand (13 per cent) or use their home appliances (24 per cent). they use their profits to buy the appliances (50 per cent) or obtain a loan (33 per cent) or borrow from their husbands (17 per cent). 6.2.7 information management fifty seven per cent of respondents have a business plan. this does not mean a traditional business plan, but an idea of their future expansion plans. eighty four per cent of respondents read information sources indicated in table 10. 458 sajems ns 13 (2010) no 4 table 10 business information sources magazines % newspapers % retail magazines 1 herald 44 wholesale magazines 1 sunday times 22 liver brother magazine 1 business day 3 enterprise zone 1 sowetan 2 trade value 1 city press 2 makro magazine 1 burger 5 success 1 mirror 1 sa india 1 weekend post 8 illizwi 1 other media included: tv advertisements (1 per cent); catalogues (1 per cent); and whatever reading materials could be found (2 per cent). table 10 shows respondents favoured reading newspapers (88 per cent). respondents have knowledge of customers’ preferences as they: • record it in a book (4 per cent); • obtain information from customers (32 per cent); • notice what is selling (38 per cent); and • notice the decrease in stock levels (26 per cent). seventy seven per cent of respondents give advice to their customers as indicated in table 11. table 11 type of advice given to customers product options % purpose of products % linking product to needs 14 display show product use 5 cheaper quality product replacements 19 demonstrate use of product 2 new products 14 product information 2 better quality products 23 quantity to buy 7 which baby products to use 2 specials 12 advice is given only when asked for in the interest of the customers. 6.2.8 public relations three per cent of respondents did not know why customers buy from them. the other respondents indicated customers buy from them because of: cheap prices (28 per cent); good service (38 per cent); personality such as friendliness and fairness (18 per cent); only shop in area (6 per cent), and other, e.g. having the right stock, good quality, give credit, open early and have qualified staff (7 per cent). returns are handled either by refunding customers (20 per cent) or exchanging the product (58 per cent) or by solving the problem (14 per cent) which could be either refunding or exchanging, depending on the type of returns. eight per cent of respondents do not accept any returns. 7 conclusions 7.1 biographical data nearly half of the respondents have a grade 12 qualification and are 36 to 55 years of age. few respondents are in the 26 to 35 years category. it seems that they probably have sajems ns 13 (2010) no 4 459 furthered their education and/or found employment. more males than females in this sample started spaza shops. regardless of the type of previous working experience, respondents start spaza shops, with some even having no working experience whatsoever. there are many spaza shops across all the township areas, with the majority in the more densely populated areas. as they are informal businesses, they favour sole proprietorship. the majority of respondents had spaza shops for less than ten years. the number of spaza shops has nearly doubled in the last five years (52 per cent versus 32 per cent). spaza shops are not a new business opportunity as two of the shops have been in operation for more than 25 years. the majority (79 per cent) of spaza shops employ staff. the spaza shop owners have entrepreneurial background as they had someone in the family that had a business (57 per cent), and some (39 per cent) even worked in the business. nearly two thirds of respondents are necessity entrepreneurs as they were forced to start the spaza shops, mostly due to lack of income. the other third are opportunity entrepreneurs (only shop in area, had money and wanted to be independent). 7.2 functional activities 7.2.1 general management literature and the empirical findings confirm that the majority of respondents engage in daily planning and plan their monthly expenses (household and business) but do not have a budget. all spaza shop owners are conversant in english and either xhosa or afrikaans and can thus contrary to literature findings, serve their customers in a language they can understand. some can even speak more than two languages. literature indicated that spaza shops do mostly not need a licence to trade, lack a safe and protected stock storage space and are often victims of break-ins, property theft, vandalism and physical attacks. they buy in small quantities due to lack of security and crime. 7.2.2 human resources literature concurs with the empirical findings that spaza shops are a major source of employment and they rely on manual labour such as packing shelves, cleaning and serving customers. spaza shop owners favour on-thejob training by showing staff how to execute jobs such as working the cash register. 7.2.3 purchasing literature and the empirical findings confirm that spaza shops frequently buy either weekly or two weekly, mostly from wholesalers although retailers are also used, depending on who has the best price at the time. furthermore, they buy from suppliers selling the brands customers prefer. the empirical findings contradict literature findings by the fact that spaza shops buy in small quantities as they lack storage space. only 2 per cent of respondents regard storage space as a factor that determines the amount of stock bought. forty one per cent of respondents indicated they receive credit, whereas literature indicated that they mostly receive no suppliers’ credit. contrary to literature findings, the majority of respondents use their own vehicle for transport with only a few relying on taxis or hire transport. 7.2.4 marketing literature concurs with empirical findings that regular customers of spaza shops are mostly from the community (township residents). business hours are very long, allowing for night shopping. customers are mostly aware of the business through word-of-mouth. marketing communication is either by notice boards or pamphlets. 7.2.5 finance literature and empirical findings confirm that spaza shop owners received no formal support to start their businesses and mostly use their savings with their biggest expense being business expenses. the empirical findings find that respondents regard household expenses as big an expense as business expenses. the empirical findings concur with the literature that they do not keep records, except for purchases and sales. 7.2.6 operations management literature concurs with empirical findings that operations are limited to selling take-aways. the empirical findings also indicated that 460 sajems ns 13 (2010) no 4 besides the take-aways respondents also bake bread. 7.2.7 information management literature and empirical findings confirm that they keep abreast of product and supplier information by reading newspapers. they use printed media such as newspapers or magazines to obtain information. the empirical findings contradict the literature study that indicated spaza shop owners prefer to watch television to obtain information. 7.2.8 public relations literature concurs with empirical findings that spaza shops need to be better than others with respect to their offerings of service and products. they have sound customer relationships by accepting returns or exchanging them where possible. in the next section recommendations and management implications for spaza shop owners are given. 8 managerial implications for spaza shops spaza shops have become a popular choice as a way to enter the business market. it can be an alternative opportunity to matriculants who cannot find employment or do not have money to further their studies, to become independent and earn money. this is in line with government’s policy of encouraging the development of the smme sector as it creates employment opportunities. contrary to findings in the global entrepreneurial monitor report previous working experience is not essential, but a basic education level of grade 10 is recommended. growing up in an entrepreneurial environment is beneficial. spaza shop owners should seek to grow and better their standard of living while at the same improving the lives of the community. savings can assist in times of need, or give them the opportunity to expand. table 12 indicates how spaza shops should or could engage in the management functions. table 12 functional managerial recommendations for spaza shops owners general management  stock displays should be eye-catching to the customers  ensure that daily money received matches stock sold.  have long-term expansion plans.  compile a monthly budget showing expenses and income. human resource  provide employment for family members and the unemployed.  selection criteria of staff should include a basic education and favourable personality traits to customers and business.  delegate stock decisions about usage, quantity and which stock to purchase or sell to staff.  delegate physical minor in-store tasks to staff e.g. packing shelves and cleaning.  preferably train staff by showing them what and how to do a task.  motivate staff by offering incentives, preferably money. purchasing  good inventory control using stock control systems is important.  avoid out-of-stock or expiry perishable stock situations by linking demand to stock levels.  build long-term relationships with key suppliers to obtain credit and free delivery.  use a phone-in order system.  belong to a spaza shop business association or engage in cooperative buying schemes to obtain bulk buying benefits, discount and other special arrangements such as getting credit.  buy stock according to customers’ preferences or those that sell fast.  exercise visual stock control to determine when stock levels are low. marketing  trading hours should remain long.  charge fair prices due to severe competition.  give regular customer discount. sajems ns 13 (2010) no 4 461  offer specials at times and advertise using flyers or attractive notice boards.  obtain signage from coco-cola to increase visibility. finance  plan monthly expenses using a budget.  invest monthly savings in a stokvel.  use monthly savings for expansion or emergency purchases.  alternatively, apply for expansion loans (standard bank the most prominent supplier in this sample) if being able to afford repayments.  separate business and household expenses.  employ a simple filing system for record keeping for business documents  employ a basic bookkeeping system to determine profit.  limit customers’ credit to avoid cash flow problems.  keep a tight stock control to avoid losing profits due to stock problems, e.g. perishable products, or theft. operations  use household fixed assets for business purposes if possible, to decrease expenses.  save money to buy new assets to avoid problems in obtaining credit. information management  engage in business planning, especially future expansion plans.  let customer stock demands be a guide to which stock to buy.  advise customers only when asked.  give advice to customers on specials and cheaper or better quality products.  engage in networking to obtain information about suppliers, where to seek advice, on competitors, marketing and training.  implement an sms service for customer to place orders. public relations  create a favourable business image. spaza shop owners should not neglect the purchasing-, informationand financial function. information is knowledge, purchasing systems can increase profits and handling their financial affairs as a business, not as part of their personal finances can lead to possible expansion. finally, spaza shops owners could provide employment opportunities and so relieve unemployment in south africa if managing their spazas as efficiently and effectively as any other business. previous entrepreneurial experience gained from working in a 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[http://www.en.wikipedia.org/wiki/township]. accessed 14 may 2009. http://www.mba.co.za/article!rootid=62subdirectoryid=850 microsoft word 4 jerbrant si 17 2014.docx sajems special issue 17 (2014) : 33-51 33 a maturation model for project-based organisations – with uncertainty management as an ever-present multi-project management focus anna jerbrant school of industrial engineering and management, kth royal institute of technology accepted: december 2013 the classical view of multi-project management does not capture its dynamic nature. current theory falls short in its ability to explain how the management of project-based companies evolves because of their need to be agile and adaptable in a changing environment. the purpose of this paper is therefore to present a descriptive model that elucidates the maturation processes in a project-based organisation as well as to provide an enhanced understanding of multi-project management in practice. the maturation model illustrates the way the management of project-based organisations evolves between structuring administration and managing uncertainties, and emphasises the importance of active individual actions and situated management actions that have to be undertaken in order to coordinate, synchronise and communicate the required knowledge and skills. the outcomes primarily reveal that, although standardised project models are used and considerable resources are spent on effective project portfolio management, the way information and communication are dealt with is vitally important in the management of projectbased organisations. this is particularly true of informal and non-codified communication. key words: project-based organizations, project portfolio management, multi-project management, multiproject settings, project-management office, project maturity jel: l200 1 introduction the organisational design of project-based organisations (pbos), where a large number of operations are organised as simultaneous or successive projects, is often complex and challenging to manage (hobday, 2000; engwall & jerbrant, 2003; elonen & artto, 2003; sydow, lindkvist & defillipi, 2004; söderlund & tell, 2009; arvidsson, 2009; jerbrant, 2013; jerbrant & gustavsson, 2013). and once the complexity involved in managing, controlling and organising a project-based organisation is revealed, there is increased focus on time and activity planning in order to facilitate the coordination of scarce resources within tight time limits. on the one hand, the main focus of the dominant strand of multi-project management theory aims is improve efficiency and rationality in the structuring of the project portfolio’s performance, through the use of practical models and tools for effective resource allocation and project prioritisation (de maio, verganti & corso, 1994; van der merwe, 1997; cooper, edgett & kleinschmidt, 2002; danilovic & sandkull, 2005; moore, 2010). nevertheless, the interdependencies that arise between different projects, as well as between projects and their environment, remain significantly difficult (cooper et al., 2002; engwall & jerbrant, 2003; engwall, 2003; blichfeldt & eskerod, 2008). project portfolio management (ppm) tools and techniques, on the other hand, are often based on the ability to handle preconditions that may vary—for several projects—from one day to the next, making prioritising and planning difficult. in addition, most project-intensive organisational settings are subject to considerable time pressures and constantly changing project organisation practices (eskerod, 1996; ward & chapman, 2003). consequently, the notion of flexibility is very important in the context of ppm (petit & hobbs, 2010), with the result that collaborative and communicative managerial activities have become increasingly important abstract 34 sajems special issue 17 (2014) : 33-51 (dainty, moore & murray, 2006; winch, 2010). this in turn makes the concept of uncertainty management with regard to both project management and project portfolio management essential (petit & hobbs, 2010; petit, 2012). 1.1 aim and contribution this paper is a response to the demand for research aimed at understanding organisational project management structures and the dynamics in project-based organisations (aubry, hobbs & thuillier, 2007, 2008; petit, 2012). the research is focused on changes in and the maturation of the management and organisation of pbos, and the purpose of this paper is to present a descriptive model that elucidates the maturation processes in a project-based organisation as well as to provide an enhanced understanding of multi-project management in practice. therefore, the overall aim of the paper is to enhance understanding of how the management of project-based companies should evolve, in view of their need to be agile and adaptable in a changing environment, to achieve a balance between structuring administration and managing potential uncertainty. the outcomes primarily reveal that, although standardised project models are used and considerable resources are spent on effective project portfolio management, the way information and communi cation are dealt with in the organisation is vital for the effective management of pbos. this is particularly true of informal and noncodified communication. the principal findings of this study are presented in this paper, namely both a maturation model of pbos that illustrates how multi-project management evolves between structuring administration and managing potential uncertainty, and an identified emphasis on the importance of positive individual actions and situated management actions that have to be undertaken in order to coordinate, synchronise and communicate the required knowledge and skills. 2 research design this research belongs to a discipline that embraces social construction (berger & luckman, 1998) and the importance of studying the meanings that different individuals assign to their reality (lindfors, 1993). this research design is therefore differentiated from traditional project research and the positivist approach that characterises it (blomquist, hällgren, nilsson & söderholm, 2009). inspired by hermeneutics (lindfors, 1993), which emphasise interpretation, i have concentrated in my research on looking for context-bound meaning or significance based on empirical, in-depth studies (lindfors, 1993). the research presented here is based on an inductive and qualitative case-study approach that is exploratory and is grounded in an indepth analysis of two individual cases (jerbrant, 2009, 2013). the purpose of the empirical fieldwork was to generate concepts, theoretical models and empirical issues that would guide further research on multi-project settings as an empirical phenomenon. this approach increased the likelihood of uncovering the unknown. the approach to the empirical fieldwork was also inspired by grounded theory (glaser & strauss, 1967) in the sense that a central activity was the generation of a description that captured vital aspects of the phenomenon under study. 2.1 empirical data collection two qualitative case studies carried out at two different project-based industrial companies form the empirical basis of this study. an ethnographically inspired approach was chosen in order to form an in-depth understanding of the practices. as in most ethnographic research, several sources of data were used (observations, interviews, studies of written material, project documentation, technical documents, minutes, company instructions and memos). the total duration of the case studies was one-and-a-half years, and during this time, participant observation was performed three to four days per week in a sequential order at both organisations. in line with the perspective of the study, the empirical data collection began with the interviewing of division managers. this “tour” gave the researcher a broad picture and helped to create contextual awareness. subsequently, interviews were held with departmental managers; project managers and several subproject managers at the functional departments were also interviewed. all in all, approximately 55 semi-structured in-depth interviews were held and transcribed. the longest interview took about four hours, the shortest approximately 30 minutes. on average, sajems special issue 17 (2014) : 33-51 35 the interviews lasted one-and-a-half hours. the first case study was conducted at a contract division that was one of four divisions in a medium-sized engineering company. at the time of the study, the company had approximately 500 employees who engineered, produced and installed signalling and safety systems for railways. the second case study was conducted at an r&d division that was one of six divisions within a medium-sized, private telecom operator. at the time of the study, the company had approximately 500 employees, and was the third biggest telecom operator in the country in terms of capacity. it owned and operated networks for telecommuni cation, data communication and the internet, and provided services for both private and professional customers. the second study was initiated in order to increase in-depth understanding, as well as to test the validity of the findings from the first case study. this organisation was chosen as a contrast with the organisation in the first case study. consequently, the study had a similar research design, and was executed over a shorter period of time. table 1 empirical data collection in summary first case study second case study focus focus on the management and execution of the multi-project business and the pmo manager. focus on the management and execution of the multi-project business and the pmo manager. data collection method longitudinal case study inspired by both ethnographic and grounded theory. longitudinal case study inspired by both ethnographic and grounded theory. a) interviews 35 semi-structured deep interviews the longest interview was about 4 hours long, the shortest approx. 30 minutes. on average, they were approx. 1½ hours long. 20 semi-structured in-depth interviews the longest interview was about 4 hours long, the shortest approx. 30 minutes. on average, they were approx. 1½ hours long. b) observation three days a week for one year at the main office. three days a week for three months at the main office. c) meetings approx. 10-15 steering-group meetings, 2 concluding workshops/seminars. approx. 5-6 steering-group meetings, 2 concluding workshops/seminars. d) documentation project-related documentation, project plans, project reports, progress reports, steeringgroup protocols, work process descriptions, and documents describing the technology and products, and company history. project-related documentation, project plans, project reports, progress reports, steeringgroup protocols, work process descriptions, and documents describing the technology and products, and company history. e) other approx. 100 hrs of informal meetings, lunches, coffee breaks, etc. approx. 100 hrs of informal meetings, lunches, coffee breaks, etc. 2.2 data analysis based on the chosen research design, interpretation is the tool which has enabled this research to move from empirical descriptions to theoretical contributions. therefore, both similarities and differences were emphasised without the need to generalise, since the description of the phenomenon under study is inter-subjective and constructed on social inter actions, based upon the researcher’s interpretations, rather than a representation of reality. at the same time, this research was inspired by a project-as-practice perspective (blomquist, hällgren, nilsson & söderholm, 2009), which makes a distinct contribution to the understanding of project-based organisations owing to its focus on organising on the basis of situated actions. further, the benefits are increased if the practice perspective is explicitly anchored in a process ontology (sergi, 2012) since this enables the recognition of change over time. this approach is highly suitable since these results clearly focus on change, movement, and transition1 over time in both companies’ project-based organisations. accordingly, it was possible in the course of empirical data collection to identify and document the structural processes mainly through the written documentation and some of the interviews; uncertainty management was documented through observations and the descriptions given in certain interviews. therefore, when analysing the empirical material, the procedural focus made it easier to recognise 36 sajems special issue 17 (2014) : 33-51 how the situated actions unfolded and changed over time. 3 literature review this section will provide an overview of the research literature on the subject of the management of project-based organisations. the aim is to focus on the key characteristics of multi-project management literature and then to describe specific contributions to the management of project-based organisations attempting to deal with rising internal and external environmental uncertainties. 3.1 key characteristics of multi-project management theory most multi-project management literature focuses on resource allocation, control and prioritisation between projects (gunnarson, linde & loid, 2000; mcdonough & spital, 2003; crawford, pollack & england, 2006; dawidson, 2006; jerbrant, 2009). the greater part of project portfolio management research follows a rational perspective and develops tools, techniques and methods that focus on structure and control (cooper et al., 2002; mcdonough & spital, 2003; de reyck, grushka-cockayne, lockett, caldemi, moura & sloper, 2005; dawidson, 2006; turner, 2009; moore, 2010; teller, under, kock & gemünden, 2012). the managers of project portfolios are often swamped by issues relating to the prioritisation of projects and the distribution of personnel from low-priority and smooth-running projects with a surplus of resources, to high-priority projects and projects in crisis (blichfeldt & eskerod, 2008). however, one major problem in a project-based business is that most of the time there are no surplus resources available. hence, most management and control routines in multi-project management consist primarily of tools and techniques to manage resource allocation, prioritisation and project selection in the most effective way possible (hendriks, voeten & kroep, 1999; cooper et al., 2002; pennypacker & dye, 2002; turner, 2009; moore, 2010). the growing popularity of project portfolio management in theory and practice, together with the rational tools for structuring work and directing responsibility, has prompted an acceleration of the formalisation movement (thiry & deguire, 2007). as a result, most of the literature focuses on the following aspects: process structure imple mentation to support project selection and portfolio design; scheduling, resource allocation algorithms and prioritisation, and the development of funnels and project management models. one of the most usual ways to initiate and emphasise structure and planning in a projectbased organisation is to establish a project management office (pmo). the primary aim of creating a pmo is usually to increase the number of successful projects and to standardise the performance of individual projects as far as possible. an important task for project management offices is consequently improvement of project portfolio management, for instance by initiating or enhancing project proposal submission, project selection, resource allocation, prioritisation and risk management (moore, 2010). one of the aspects on which the most emphasis is placed when it comes to optimising an existing project portfolio is the creation of transparency through clear goals, roles and processes (jonas, kock & gemünden, 2010). this is often accomplished with an initial focus on managing single projects because without project management formalisation, the formalisation of project portfolio management is elusive (teller et al., 2012). thiry and deguire (2007) state that the growing popularity of programme/ portfolio management and the emergence of a project management office (pmo) as an organisational unit provide impetus for the creation of project-based organisational structures. one main advantage that is often emphasised when introducing a project management office is that the organisation gains a control unit, which is able to respond to many different needs by handling various functions, such as: project definition and planning, cost/benefit analysis of projects, risk management, monitoring and control, access to experience and knowledge, support of project management processes and procedures, knowledge capture and dissemination, provision of specialist skills, and maintenance of project tools, standards and processes (pellegrinelli & garagna, 2009). at the same time, pmos are often perceived as the battleground between empowerment and control, between people and processes, and between different political groupings (pellegrinelli & sajems special issue 17 (2014) : 33-51 37 garagna, 2009), and organisational tensions are often cited as one of the main driving forces behind the introduction and transformation of the pmo. there is a substantial need for flexibility in project portfolio management because of the internal organisational tensions (arvidsson, 2009). the organisational tensions described by arvidsson (2009) are often created by problems in synergy between permanent (line) and temporary (project) functions, and they often take place in organisations where project work has recently been introduced and project strategic alignment, resource allocation, prioritisation and knowledge capturing have not become standardised. during the last decade, views on how to manage project-based organisations have changed, from a sole focus on marketing the use of standardised management processes to a more strategic perspective on the entire project portfolio (dvir, raz & shenhar, 2002; thiry & deguire, 2007; meskendahl, 2010). for instance, pellegrinelli, partington, hemingway, mohdzain & shah (2007) argue that the “strategic manage ment or strategic planning” disciplines perceive the introduction of programmes as a way to implement a strategy, bringing about business change, and as an alternative means of organising project-based activities. meskendahl (2010) empha sises that the managerial focus of firms has shifted towards the management of project portfolios as a whole, and towards the effective link to overall business goals. many organisations may have well-defined and well-scoped strategic processes (moore, 2010), but it is also important to discuss the concept of strategic fit in regard to project portfolio management (meskendahl, 2010). strategy should be placed before project portfolio selection and, furthermore, the strategic goals should ideally be relatively limited. finally, when discussing strategic alignment, projects and especially project portfolios are often emphasised as “powerful strategic weapons” and central building blocks for implementing the intended strategy. 3.2 the need for uncertainty management and a dynamic approach several researchers have recently begun to argue that instead of more scheduling, progress reports, or the spending of more time on review meetings, the whole system of managerial procedures for pbos should be reconceptualised from the ground upwards. in contemporary research, appeals are made for a better understanding of project portfolio dynamics; the main areas under discussion include the need for a holistic approach in multi-project companies on the “edge of chaos” (eskerod, 1996; blichfeldt & eskerod, 2008; geraldi, 2008; jerbrant, 2009; petit 2012). this means that the overly static conception that has dominated the literature is being contrasted with a more dynamic approach. viewing a project-based organisation like a chinese dragon is a good analogy: an untamed creature in a complex interaction with the given circumstances and the project (and portfolio) manager’s ability to manage and improvise based on those facts (eskerod, 1996). but how is it possible to manage and organise something that functions like a living dragon? what seems like the right thing to do at one moment may be completely wrong at the next because of the changing environment; it is therefore necessary to prepare the organisation to cope with the stress involved in managing unexpected events (eskerod 1996; geraldi, lee-kelley & kutsch, 2010; ward & chapman, 2003). although both ward & chapman (2003) and geraldi et al. (2010) focus on the management of single projects, their results are highly relevant for project portfolio management as well. geraldi et al. (2010) argue that it is crucial to build organisations that are able to manage the unexpected and the resulting contextual complexity and cascading effects; unexpected events will always occur in at-risk systems. therefore, geraldi et al. (2010) emphasise that, on an organisational level, it is important to take time to confirm decisions, and on a group level, it is important for stakeholders to be involved and create room to negotiate (communicate) with each other regarding different solutions. finally, on an individual level, it is important to have well-defined leadership, good teamwork, the necessary resources and expertise available at the right time, and the ability to handle stressful situations without panic when unexpected events occur. to summarise, geraldi et al. (2010) reflect upon individual skills and competencies, which transform relations and communication on a project team level, and manifest through a 38 sajems special issue 17 (2014) : 33-51 responsive organisation that empowers individuals. while human behaviour issues play a major role in geraldi’s findings, ward and chapman (2003) are more focused on the need for uncertainty management. uncertainty, according to them, is not only about “lack of certainty” but is also about the “ambiguity” associated with lack of clarity, lack of data, lack of detail, lack of structure, known and unknown sources of bias, and ignorance about how much effort it is worth spending to clarify the situation (ward & chapman, 2003). therefore, uncertainty management is not just about managing perceived threats or opportunities and their implications. the key concept is rather about understanding where and why uncertainty is important in a given project context, and where it is not (ward & chapman 2003). their conclusions focus on how project managers should emphasise uncertainty manage ment rather than risk management, but in a multi-project context what they have to say is equally applicable to project portfolio management. petit (2012) and petit and hobbs (2010) present a conceptual framework that emphasises the operational processes needed when managing project portfolios in dynamic environments. these processes are labelled sensing, seizing, and reconfiguring. sensing refers to the structures, tools and processes needed to sense, filter and interpret changes and uncertainties. seizing refers to the structures, tools and procedures for identifying the fact that changes are required once uncertainty has been sensed. and reconfiguring is defined as the actions taken to ensure the alignment of projects and resources with the changes identified by the sensing mechanisms and decided upon in seizing (petit, 2012). according to petit (2012), this will enable project portfolio management practices to operate successfully. by acknowledging the frequent occurrence of unexpected events in project work, the organisation builds processes for adaptation to change in the corporate culture and strengthens the alignment of strategy and the external environment. further, instead of featuring only routinebased, tacit and team-embodied adaptation capabilities, the conscious and deliberate efforts of top managers must be emphasised (lindkvist, 2004). geraldi (2008) notes that project-based companies could increase their competitive advantage by adopting organisational structures that are “on the edge of chaos”. for multiproject firms being on the edge of chaos implies having a sound balance between the complexity of project portfolios and the flexibility of their organisational units. according to geraldi (2008), balancing on the edge of chaos enables companies to cope with a variety of changing requirements for a certain period of time, thereby enhancing their dynamic capabilities. this is a must for project-based companies since (according to many management and organisational models) successful organisations are those that manage to combine both organisational creativity and innovation with mechanical efficiency, “i.e. organisation[s] able to deal with the coexistence of chaos and order” (geraldi, 2008). the term “on the edge of chaos” implies that different dimensions must coexist in the same organisation. there are two major advantages for a project-based organisation in existing “on the edge of chaos.” first, the coexistence of order and chaos is said to enable companies to deal with heterogeneous demands such as differentiation and integration simultaneously. and second, this way of thinking supports organisations’ change management and therefore makes dynamic stability possible (geraldi, 2008). but of course, regarding a specific firm’s project portfolio, there is a maximum range of heterogeneity that is possible to integrate, and geraldi (2008) states that multi-project businesses must be understood as dynamic systems, embed ded in history and contexts where flexibility and complexity interface, are mutually dependent, and vary over time. 4 empirical findings the findings section first presents a table that summarises the most relevant information about the case-study companies (briefly shown on pages 3 and 4). next the findings are presented from an internal perspective with a procedural structure to support the discussion that follows. sajems special issue 17 (2014) : 33-51 39 table 2 summary of empirical setting contract division r&d division responsibility the production of the company, i.e., all the engineering activities involved in the execution of major contracts (projects) for different clients in all parts of the world (80 % of the company’s turnover). to safeguard the company’s survival in those markets where it is already present, and to enable the company to compete in new markets. size approx. 200 employees. approx. 50 employees. departmental structure five departments: 3 engineering, 1 administration, 1 project management. each of the departments employed 40-70 engineers and technicians who provided the company with the necessary engineering competence within a single technical field. in addition, they had a project management department (20 project managers) responsible for the execution and management of all the contracted projects at the division. six departments: product management, technical development, business development, it systems, juridical issues, project management. each functional department employed 2-15 employees. in addition, they had a project management department (7 project managers) responsible for ensuring that the development of new products and services in the company was effective. project scope execution of complex contracts on turnkey basis for international clients. business and product development of new telecom services and further development of existing products. project management structure matrix structure: all projects cross-functionally coordinated by project managers at the project management department. matrix structure: projects cross-functionally coordinated by project managers at different positions in the organisation. project portfolio number of projects approx. 30 approx. 60 (20 had official priority2) size budget: usd 0.12-2.5 million duration: 1-5 years budget: usd 0-6 million duration: 0.5-2 years technical complexity high low uncertainty in the projects primarily technical uncertainties primarily market uncertainties characteristics of the portfolio divergent, since the different projects were constituted by client contracts comprising tailored systems, although based on a small number of generic technical platforms. scattered, comprising projects of many different types and origins but with a common outlet: the company’s telecom network. prime emphasis for management product performance, effectiveness time, creativity both case-study companies responded to different environmental changes (for instance, increased competition, brand new products, service and process innovations, and an increased focus on time-to-market) by separating these custom assignments into various projects. this resulted in an increased usage of projects as a means of organising, which in turn meant that both companies established a portfolio of projects at an appropriate division. the signal and safety system company also initiated a change in their organisational structure to a project-based matrix organisation, with a dominant line organisation, when they acknowledged the need to manage the design and delivery of an increased number of complex product systems more efficiently. meanwhile, the telecommunication company changed their organisational structure into a project-based organisation by initiating a project portfolio at their r&d division, since they wanted to accentuate the importance of an innovative and creative product development internally. both companies therefore initiated a transformation into a project-based organisation by announcing an increased use of projects as a means of organising. therefore, both companies revealed that they were performing several projects of different scopes, sizes and priorities in parallel at the same time, all of them largely dependent on the same resources (personnel). because of the increased number of projects, a departmental manager described one of the challenges—namely getting an overview of the project portfolio—like this: “we managed to discuss the 4-5 most important projects with presentations by the 40 sajems special issue 17 (2014) : 33-51 project management one by one. then we went through the issues at the technical and production divisions. so there was rarely time for holistic decisions, and we did not have the complete picture.” (head of contract division) at both the organisations, all engineers in the functional departments were engaged in several cross-functional projects simultaneously. as a result, most project managers in the project management department had to accept the fact that the project team members were dividing their time between different project assignments. and since competencies were in short supply, most departmental managers had personnel involved in almost every on-going project at the division. consequently, each functional department within the matrix organi sation was the scene of an on-going political competition between the different project managers regarding priorities, resources, competencies, and attention: “to run around every time there is a problematic situation and straighten things out, having to talk to ten different people, and get ten different answers is very frustrating… maybe, we should arrange a training camp in internal procedures.” (project manager, contract division) “today, the most common reason for conflicts is the instant lack of competent personnel. why did that project get so many better project members than me? furthermore, they [project managers, author’s note] sometimes want to know why their project isn’t prioritized when another project is.” (technical departmental manager, contract division) at the contract division, all projects had a responsible project manager from the project management department and technical specialists (project team members) from the different technical departments. the project managers had formal responsibility for initiating, coordinating and controlling project work within the scope of their project. usually, everybody on the project team (the project manager included) was engaged in several projects at the same time. the accepted approach when executing division business was therefore to include as little technical innovation as possible in the projects in order to make them costefficient. likewise, at the r&d division, all projects also had a responsible project manager from the project management department and technical specialists (project team members) from the different technical departments. this meant that the main focus for the project management department was to manage the development work that was undertaken at the other departments in the division. usually, everybody on the project team (the project manager included) was engaged in several projects at the same time. the accepted approach here when executing division business was to be as innovative as possible in the projects in order to attract new subscribers to the company’s products and services. therefore, both companies established a project management office (pmo), in order to introduce project and portfolio management tools and techniques. both organisations instructed the pmo to improve the project management process, first by developing standardised procedures for managing projects, and then by focusing on improving project portfolio management (for example, through resource allocation and prioritisation processes). however, the project management procedures at the r&d division were rather immature and unsophisticated, and they established their pmo by grouping the most experienced project managers in the company together in one project management department. the department’s role was to oversee the division’s r&d projects, and to provide excellent project management services for the entire company. prior to the creation of the pmo, the project managers were scattered all over the company and once the project management department was initiated they were all located there. this enabled both increased oversight and a stronger emphasis on professional project management of the r&d projects: “before we had a pmo, it wasn’t clear what the project portfolio looked like, and none of us project managers really knew how to use the project management routines that existed. everybody did things in their own way…” (project manager, r&d division) at the same time, a pmo manager with extensive experience was recruited from a competitor and he described his primary mission as to create a focus for and arouse interest in the coordination of the r&d activities, enhance resource allocation and facilitate a more sajems special issue 17 (2014) : 33-51 41 effective and innovative execution of the entire r&d operation. at the contract division, on the other hand, a mature and comprehensive process for project management that had been developed during the last decade was already in place, so the pmo emerged as a more organic structure when the need for resource allocation and prioritisation increased because the number of projects in the portfolio increased significantly. however, it was initially established in the same manner as the r&d division, by locating the most experienced project managers in the same department and then hiring a pmo manager. when the two cases were analysed, three different dependencies between the projects emerged: a resource dependency, a two-fold technological dependency, and an organisational dependency. the resource dependency occurred when multiple projects simultaneously required the same resource. the technological dependency arose when projects were initiated with the same technical solution as a previous project (a “recycled” technical solution), or when one project’s technical solution was dependent upon the completion of another project (such as a delivery project that needed to draw on the result of an r&d project). the head of the contract division emphasised the consequences when the technological dependency is not managed in this way: “one has to make sure that a newly developed product actually fits into the existing system. unfortunately, we have seen, time and again, that some project manager misses this, since it might delay the project’s time-plan. to adapt a development project to the rest of the system takes time, and it’s also something that’s very difficult to make the salespeople acknowledge also.” (head of contract division) in addition, there was a substantial need for organisational collaboration, which arose when different project activities had to be conducted with the knowledge, information, and/or expertise of several other parts of the line organisation. for instance, the head of the r&d division emphasised that the following: “our department can only develop new products to a certain point, but then we have to make a handoff from development to operations, meaning production, billing, purchase, sales, customer service, and so on. and engaging them in the r&d business is really hard, for the co-workers there are of course busy with the present, so how do we make them also take part in developing new products?” (head of the r&d division) the main challenge was that all the dependencies produced negative effects in unexpected areas of the project portfolio. the head of the contract division described it like this: “we have 20-30 ongoing projects at the same time, then one project is delayed, and all our planning is disturbed. and it doesn’t affect only this single project; instead everything slips away and ends up on top of each other.” (department manager, contract division) despite the initiation of a project management office and the establishment of a project portfolio management structure, the lack of information and communication was a constantly recurring theme in the interviews, meetings and observations at both companies where case studies were conducted. steering groups and project sponsors often complained about inadequate or even incorrect information as the reason for decisions regarding, for example, the priority list of the projects. “we still don’t have a good overview of how many r&d projects we have, or how many programs, or an obvious way to resource allocate.” (project manager, r&d division) at the same time, the project managers and project team members often felt that they were being subjected to unreasonable demands to provide written information in the form of reports. “i constantly write reports that i send to them ‘up there’. but i don’t really know what they do with them.” (project manager, r&d division) so, in both organisations, project portfolio management was concentrated on implementing and enhancing the necessary project and portfolio management processes as well as managing short-term issues concerning the prioritisation of projects and the distribution of personnel from low-prioritised, or smoothrunning projects to high-priority projects or projects in crisis. “we do have the will to execute all of these new ideas. but what is lacking are the 42 sajems special issue 17 (2014) : 33-51 resources and an outspoken strategy of what we should focus on.” (project manager, r&d division) “we have an 80-20 relationship today. we can only do 20% of all the things we want to do. 80% we aren’t able to handle, so you really have to prioritize.” (department manager r&d division) but, most of the time, the challenge was to manage the lack of available resources, as two project managers pointed out: “it never goes exactly as planned. some things will take longer, and other things come in between. people here don’t work only with my project; they have other things to do also. so then something takes longer to do they’re supposed to, don’t go as fast as planned. then you don’t reach the project goal because of the resource situation we’ve got”. (project manager, contract division) “we have the desire to do something but often there is a lack of time and resources if we should go for something. so when we go to the other departments, they tell us they don’t have the resources to do this.” (project manager, r&d division) consequently, after both organisations had established a pmo, it became possible for them to manage the majority of the short-term and ad hoc problems in their project portfolios. at the same time, the pmo was also supposed to focus on long-term knowledge development and process improvements. however, this was often subordinated to short-term problem solving on individual projects. managing the problems, challenges and uncertainties was the responsibility of the pmo manager and the procedure followed at both companies was communication and acting as a link between all the important actors. at the contract division, the pmo manager’s actions focused on improving communication between the line organisation and the project organisation, and coordinating the decision making of the steering committees, the ceo, the departmental managers and the project managers. at the r&d division, the pmo manager focused on communication and information flow between the r&d division and the departmental managers at other divisions, and on coordinating the integration of the r&d activities with sales, billing, delivery, etc. for example, both organisations enhanced short-term decision making by forming an operative steering group that was responsible for evaluating, prioritising and distributing resources to every project in the portfolio, primarily on the basis of both urgent problems and resource, time and cost changes. the operative steering group (osg) consisted of the division manager and all the departmental managers in the division; this group was in charge of all projects that required resources of any kind from the division. the steering group prioritises the resources for the project business of the entire division. “if, for example, three kinds of resources are needed from operations, osg can decide in favor of it and we are then entitled to make requests of operations that they have to put it in their next budget. another example is that if a project manager needs a decision on more money for the project, osg also decides on this.” (project manager, r&d division) one prominent role that the pmo managers had to play was the role of mediator, negotiating to balance the interests of different projects. since there was a constant lack of resources, this balancing act became important each time a project encountered problems, since problems spread quickly from one project to another. further, the time-based process in the different projects was frequently interrupted by unexpected events that created distortions and jerkiness within the project portfolio as a whole. the result was continual negation between the portfolio managers and the project managers, departmental managers and pmo managers, focusing on matters like ways of increasing the information available for decision making on both human and technical issues (for a more detailed discussion of this, see jerbrant & gustavsson, 2013). and this meant that in practice the pmo managers’ working days were filled with different kinds of informal communicative actions such as phone calls, e-mails, personal and informal one-toone conversations, and formal one-to-many presentations. it could be argued that by functioning in this way the pmo managers took on an operative and informal stakeholder management role. “everybody works with a lot of projects at the same time, so one has to do the best one sajems special issue 17 (2014) : 33-51 43 can. i usually walk around in the building with the purpose of talking to people, instead of just sitting in my office. because all of the project members are either located on different floors of this building, or even in another city.” (pmo manager, contract division) thus, we can conclude that, in both organisations, the pmo managers played a critical role in determining the quality of the knowledge and information that reached the different decision-making forums. the pmo managers also had overall responsibility for establishing a stronger interaction between the multi-project businesses and the companies’ overall business strategies. 5 discussion in many project-based organisations, projects are seen as an effective and legitimate solution to the management of rapidly changing contextual factors (christensen & kreiner, 1997). and when the organisational structures of the two companies at which case studies were performed are viewed in a historical perspective, it becomes clear that they both, in different ways, managed their contextual uncertainty by increasing the use of projects. but when cross-functional projects became increasingly common in the organisations, this created different coordination problems. the way in which both companies were using projects as a temporary organisational measure (lundin & söderholm, 1995) implies that they were managing a complex social interaction, which means that the focus of project management was mainly on the integration of project activities conducted in different organisational units (hobday, 2000). in both organisations, there was no main business except for the projects; no “functional work” existed. the coworkers performed all their engineering work within different projects. they were engaged in several projects at the same time, and they moved between successive projects over time, but all the time they belonged to the same functional department. consequently, the projects interacted with each other extensively, using the same personnel and technology, and therefore the products of one project would become the prerequisites of another. further, there was an on-going reorganisation, with people moving between different projects and work constellations. the literature review illustrates how the management of pbos often entails structuring efforts in the form of methods and tools for the planning, prioritisation, and control of the project portfolio (cooper et al., 2002; dawidson, 2006; moore, 2010). but describing and analysing the daily execution of the two organisations’ project-based activities also illustrates their uncertainty management, as ward and chapman (2003) say. this uncertainty management in a multi-project setting focuses on managing the unexpected events that occurred because of a resource allocation syndrome (engwall & jerbrant, 2003), lack of communication, overloaded project managers, and organisational fragmentation. based on this, figure 1 illustrates the transition between the first level of uncertainty management and structuring in a traditional matrix organisation and the second level, which reflects uncertainty management in a multi-project setting. according to geraldi (2008), many management and organisational models state that an organisation is successful if it manages to combine organisational creativity and innovation with mechanical efficiency. however, most pbos find it difficult to achieve this (geraldi, 2008). the desire to avoid inefficiency and the urge to minimise uncertainty and risks increases the degree of control and bureaucratisation, which often means a decrease in creativity and flexibility. in both the organisations studied, there was a clear pattern reflecting a growing focus on structure, controlled hierarchy and bureaucracy caused by management’s need for control, predictability and ability to allocate available resources and prioritise among all the simultaneous projects. there was also a blend of the typically hierarchical levels of the line organisations and the hierarchical levels needed to manage the multi-project business. there is therefore an increased need to designate a function that is in charge of and responsible for the control and execution of the entire project portfolio, while at the same time making sure that the project portfolio matches the company’s business model and business goals (pellegrinelli & garagna, 2009; aubry et al., 2007, 2008). 44 sajems special issue 17 (2014) : 33-51 figure 1 the transition between the first and second levels of the maturation model the substantial uncertainty experienced in managing the entire multi-project undertaking has boosted attempts to establish this function in project management offices (pmos), for example. these are often seen, both in theory and in practice, as a means of both structuring a project-based business and also identifying where the responsibility for it lies (aubry et al., 2007; hobbs, aubry & thuillier, 2008; hobbs & aubry, 2010). simultaneously, a pmo manager is usually responsible for organising the project management department as well as the project portfolio. this kind of pmo manager is also responsible for performing many of the manage ment activities that provide the necessary organisational collaboration in a project-based business. on an aggregate level, the two casestudy companies reveal an almost identical pattern of problems and difficulties, as well as problem-solving strategies. in many ways, the management teams of the two divisions faced the same challenges as the companies’ project portfolio managements. both pmos were good examples of how the purpose, design and operation of a pmo can adapt to the changing context (see aubry et al., 2008). this study also emphasises how both organisations’ pmos can be regarded as unstable organisational structures, and how this instability can be seen as an ongoing restructuring process (see hobbs et al., 2008). when studying these pmo managers, it became clear that they made a practice of doing walkabouts, which provided information and knowledge sharing, both top-down and bottom-up, thereby turning the pmo managers into information hubs. during these walkabouts, the pmo managers acquired up-to-date information on processes and progress as well as much-needed information on motivation and team spirit in order to obtain the overview they needed to prepare them to prioritise (jerbrant & gustavsson, 2013). both pmo managers also accepted responsibility for facilitating the execution of the entire project-based part of the organisation, by communicating in turn with the project managers, the technical departmental managers, all the other division managers, top management, and all internal and external clients and customers. this created a situation where the project management office became more of a social venue than a control unit (pellegrinelli & garagna, 2009; jerbrant, 2009). uncertainty management in a multiproject setting (mps) focuses on: •  resource allocation syndrome •  communication between mps and business strategies •  organisational fragmentation that results in overloaded pmo managers uncertainty management in a traditional organisational structure focuses on: •  development and innovation issues •  complex system deliveries (cops) •  need for cross-functionality structuring on a single project level: •  separation of assignments in various projects •  projects as an effective and goal-oriented organisation •  projects as organisational coordination mechanisms •  projects as a dominant organising principle a mu ltipr oje ct se tti ng project management offices (pmo) p ro je ct ifi ca tio n sajems special issue 17 (2014) : 33-51 45 based on this, figure 2 shows the transition at the second level of maturity in project-based organisations; this figure discusses the transition between uncertainty management and structuring in a multi-project setting. figure 2 the transition at the second level between uncertainty management and structuring in a multi-project setting the increased use of projects that cut across established organisational boundaries forces project managers to deal with organised collective effort, integration and social interaction between many activities that are scattered throughout the line organisation. this means that numerous temporary organising processes in pbos are permitted to emerge. one important management challenge for a project-based organisation that we perceive is the fact that all the projects depend on each other, in different ways. resource dependency is often the most visible difficulty and, therefore, it receives the most attention from management. resource dependency is one reason for the typical focus on the introduction of project portfolio management processes and practices, since these mainly provide support for the focus on project selection, resource allocation and prioritisation. in addition, introducing programme management usually solves the technological dependencies that occur either partly or entirely when different projects are initiated using recycled technical solutions. however, the need for organisational collabora tion that arises when different project activities are conducted with the knowledge, information, and/or expertise of several other parts of the line organisation is almost never managed by ppm processes. a key insight from this research is that many project-based organisations find it difficult to deal with the consequences and effects of organisational collaboration requirements because of the increasing number of projects that are performed as temporary organisations (see packendorff (1995) meaning of the concept). the managers in charge of a project-based organisation have to acknowledge that the projects are interdependent on each other, rather than detached from each other (jerbrant, 2009). it is therefore very important that the management of a multi-project setting emphasises all interdependencies, instead of merely focusing on the resource dependency. this leads us to figure 3, which illustrates uncertainty management in a multiproject setting (mps) focuses on: •  resource allocation syndrome •  communication between mps and business strategies •  organisational fragmentation that results in overloaded pmo managers uncertainty management in a traditional organisational structure focuses on: •  development and innovation issues •  complex system deliveries (cops) •  need for cross-functionality structuring on a single project level: •  separation of assignments in various projects •  projects as an effective and goal-oriented organisation •  projects as organisational coordination mechanisms •  projects as a dominant organising principle a mu ltipr oje ct se tti ng project management offices (pmo) p ro je ct ifi ca tio n structuring on pmo-level: •  routines for working by using ppm •  the pmo as a representative for the project portfolio •  the pmo as a operative steering group pro jec t p ort fol io ma na ge me nt (pp m) 46 sajems special issue 17 (2014) : 33-51 the transition between the second level of uncertainty management and structuring in a multi-project setting and the third level, where the uncertainty management in a project-based organisation is revealed. figure 3 the transition between the second and the third levels in the maturation model when using an organising perspective (söderholm, 1991) to analyse a pbo, the analysis is based upon actors, actions, social interactions, situations, action processes, behaviour patterns and activities. in this way, not only structure and stability are revealed, but the continuity of the management process is maintained as well. these active, individual, and situationally grounded negotiations, often performed by the pmo manager, are designed to balance structural requirements with the need for situational leadership. further, when the management of a project-based organisation is studied from the perspective of organisational theory, it becomes clear that communication, information, and decision-making are not adequate. for instance, it is not obvious how project managers should be given a say in the prioritisation process or how the communication between project managers and steering committees should work in order for both project managers and line managers to know how the different projects are being prioritised. to ensure that operations in a multi-project setting run as smoothly as possible, the pmo manager is also responsible for many negotiations with top management, departmental managers, project managers and project team members. therefore, two of the processes that petit (2012) and petit and hobbs (2010) emphasise, namely seizing and re-configuring, are mostly performed informally. these negotiations are also a way of establishing a correlation between the multi-project setting and the overall strategy of the company, something which has been identified as critical both in theory and in practice (meskendahl, 2010; moore, 2010). in the two organisations studied, the actions and negotiations performed by the coworkers at the project management uncertainty management in a multiproject setting (mps) focuses on: •  resource allocation syndrome •  communication between mps and business strategies •  organisational fragmentation that results in overloaded pmo managers uncertainty management in a traditional organisational structure focuses on: •  development and innovation issues •  complex system deliveries (cops) •  need for cross-functionality structuring on a single project level: •  separation of assignments in various projects •  projects as an effective and goal-oriented organisation •  projects as organisational coordination mechanisms •  projects as a dominant organising principle a m ul tipr oj ec t se tti ng project management offices (pmo) p ro je ct if ic at io n structuring on pmo-level: •  routines for working by using ppm •  the pmo as a representative for the project portfolio •  the pmo as a operative steering group pro jec t p ort fol io ma na ge me nt (pp m) uncertainty management of the project portfolio: enhances the pmo as place to meet because of: •  the resource dependency •  the dual technical dependencies •  and the organisational need for cooperation sajems special issue 17 (2014) : 33-51 47 department, especially those by the pmo manager, had to manage all of this. the increased use of projects as way to organise the business gives rise to both certain events and the need for assumptions regarding the business strategy (thiry & deguire, 2007). therefore, the management and control of the project-based part of the business cannot be regarded as a separate issue, but should rather be seen as an integral part of executive management. interaction between the ppm and the company’s long-term strategies and business directions is essential (moore, 2010; turner, 2009). an organisational perspective on the management of an industrial organisation and the control of its project-based business is necessary in view of the importance of managing the need for organisational cooperation that arises from the dynamic context. in the process, several important aspects of managing and organising the special dynamics that characterise pbos are highlighted. one thing that emerges clearly is that organising a project-based business demands a kind of uncertainty management. in this way, both structure and stability become apparent and the continuity of the management process is maintained as well. however, the more active, individual and situational negotiation processes are not sufficiently highlighted, and the need for uncertainty management is diminished. these actions and activities aim to achieve a balance between the need for structure and the need for situated management. another aspect is the importance of integrating the management and organisation of the multi-project undertaking at a top-management level. this management of uncertainty, often performed by the pmo manager, is designed to balance structural requirements against the need for situational leadership on the third level of the maturation model. figure 4 a maturation model of pbo oscillating between structuring activities and uncertainty management uncertainty management in a multiproject setting (mps) focuses on: •  resource allocation syndrome •  communication between mps and business strategies •  organisational fragmentation that results in overloaded pmo managers uncertainty management in a traditional organisational structure focuses on: •  development and innovation issues •  complex system deliveries (cops) •  need for cross-functionality structuring on a single project level: •  separation of assignments in various projects •  projects as an effective and goal-oriented organisation •  projects as organisational coordination mechanisms •  projects as a dominant organising principle a m ul tipr oj ec t se tti ng project management offices (pmo) p ro je ct ifi ca tio n structuring on pmo-level: •  routines for working by using ppm •  the pmo as a representative for the project portfolio •  the pmo as a operative steering group pro jec t p ort fol io ma na ge me nt (pp m) uncertainty management of the project portfolio: enhances the pmo as place to meet because of: •  the resource dependency •  the dual technical dependencies •  and the organisational need for cooperation structuring on an organisational level: •  business program level in the portfolio •  optimal design of the project based organisational structures •  multi-project management as top management responsibility •  project portfolio as a strategic spearhead •  project adapted strategic hrm but: •  uncertainty management, situational leadership, as always remaining multi-project management responsibility project-based organisations 48 sajems special issue 17 (2014) : 33-51 6 conclusions the purpose of this paper was to present a descriptive model that elucidates the maturation processes in a project-based organisation, as well as to provide an enhanced understanding of multi-project management in practice. the maturation model that has been developed provides an understanding of how the management of project-based companies evolves, because of their need to be agile and adaptable in a changing environment. this causes the focus for their project-, programand portfolio management to transfer between structuring administration and managing any uncertainty, which enables their multi-project management maturity to increase. we can therefore conclude that the maturation model describes an organising process that oscillates between structuring activities and uncertainty management, thus providing a dialectical understanding of how solutions on one level can cause problems on new levels. this maturation model resembles a staircase where each step involves a better understanding of the management, governance and organising of a project-based organisation. this illustrates how, by increasing the number of projects, uncertainty management in a traditional organi sational structure often takes care of both rapidly changing contextual environmental requirements and the business operational needs of cross-functionality. but once the projects become a dominant organising principle, resource allocation problems arise, as well as an increased need for communication to overcome the problems of organisational fragmentation, overburdened project managers, and multiproject professionals. this, in turn, places the emphasis on how to structure the project management office level, which implies an increased awareness of routinised project portfolio management, operational steering groups, and the project office as representative of the project portfolio. however, since dependencies and links between the many parallel projects exist, there is a greater need for uncertainty management in the execution of project-based activities. lastly, structuring on an organisational level means enhancing the strategic connection for pbos, thus making multi-project management a top management responsibility, aligning it with the strategy, adapting it to the organisation’s human resource management, as well as emphasising uncertainty management, situational leadership, and the ever-present multi-project management responsibility. the main result presented in this paper is therefore both a maturation model of pbo that illustrates how multi-project management evolves between structuring administration and managing uncertainty, and an emphasis on the importance of uncertainty management in project portfolio management through positive individual actions and situated management actions that have to be undertaken in order to coordinate, synchronise and communicate the required knowledge and skills. based on this, we can conclude that it is essential to understand the balance between structuring mechanisms and the ability to handle the ever-present uncertainty in pbos. this balance is necessary in order to manage the volume of changing requirements—both operational and contextual—during a certain period of time, thereby making it possible to enhance the organisation’s dynamic capability. 7 theoretical and practical implications studying pbos from both a process and a practice perspective clarifies the way the management and control of pbos has to manage two types of organisational coordination require ments. the first is the need for coordination in the part of the business that is project-based, where a need to integrate several different functional areas exists. the second is the need for coordination that arises because the project portfolio has to be aligned with the overall business strategy. both of these aspects require further exploration, and another appropriate area for research is therefore the strategic link between the project portfolios and the overall business strategy as well as the visualisation of business development from the levels of both structuring and uncertainty management. furthermore, there is a need for more research on the maturation model (in order to facilitate its continuous development), as well as continued studies on the content of uncertainty sajems special issue 17 (2014) : 33-51 49 management in different types of project-based organisations. regarding the implications for practice, this thesis emphasises the fact that formal portfolio management methods need to be supplemented by situated actions to deal with the specific kinds of mechanisms characteristic of projectbased organisations. this means, for example, developing an understanding of the pmo manager’s active and situation-specific documents, patterns of behaviour, and guiding principles. endnotes 1 specific characteristics of a process ontology according to sergi (2012:349). 2 the remainder of the project portfolio focused on development ideas: the company’s log of the direction in which the company is heading regarding its development of new products and services. references arvidsson, n. 2009. exploring tensions in projectified matrix organisations. scandinavian journal of management, 25:97-107. aubry, m., 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structure and control. international journal of project management, 15(4):223-233. ward, s. & chapman, c. 2003. transforming project risk management into project uncertainty management. international journal of project management, 21:97-105. winch, g.m. 2010. managing construction projects. wiley-blackwell. abstract introduction literature review research design results discussion limitations and recommendations acknowledgements references about the author(s) christina viljoen workwell research unit, faculty of economic and management sciences, north-west university, potchefstroom, south africa crizelle els workwell research unit, faculty of economic and management sciences, north-west university, potchefstroom, south africa citation viljoen, c. & els, c., 2023, a validation study of the miville-guzman universality-diversity scale in south africa’, south african journal of economic and management sciences 26(1), a4856. https://doi.org/10.4102/sajems.v26i1.4856 original research a validation study of the miville-guzman universality-diversity scale in south africa christina viljoen, crizelle els received: 24 sept. 2022; accepted: 03 nov. 2022; published: 31 jan. 2023 copyright: © 2023. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: in order for organisations to best implement diversity management programmes that will create an environment in which diversity is appreciated and utilised optimally to achieve organisational outcomes, they need to first identify the attitudes and orientations that individuals in the organisation have towards diversity. universal-diverse orientation (udo) is a largely under-researched topic in south africa, and currently no instrument measuring udo has been validated in a south african context. aim: the purpose of this study was to determine the psychometric properties of the miville-guzman universality-diversity scale (m-guds) in south africa. setting: the study was conducted among the general working population in the gauteng province in south africa. methods: a quantitative cross-sectional research design was followed. a heterogeneous sample of 255 south african employees from the general working population in gauteng was selected to complete a voluntary web-based questionnaire. results: the results confirm that the m-guds is reliable; the factorial validity, and convergent and divergent validity of the m-guds are also confirmed. the predictive validity of the instrument is partly confirmed. conclusion: this study contributes to the limited research that has been done on udo in south africa by providing a valid instrument that can give additional insight into organisations on the orientations and attitudes of employees toward diversity. this provides organisations with a platform to assess their diversity orientation that can be used to inform diversity management programmes. contribution: this study contributes to the limited research that has been done on udo in south africa, as well as addresses the gap of a lacking instrument to measure udo in south africa by validating the m-guds. keywords: miville-guzman universality-diversity scale; universal-diverse orientation; diversity of contact; relativistic appreciation; sense of connection. introduction over the last 30 years, there has been a drastic change in the dynamics of the south african workforce. the new constitution opened the workforce to an influx of previously disadvantaged cultural groups, as well as an increase in gender diversity and individuals with various disabilities (viviers, mans-kemp & fawcett 2017). this diverse and unique reality has increased the need for organisations to work towards establishing harmony among their employees and to promote respect and collaboration among its members. diversity management is a framework that guides organisations in transforming their culture into a more diverse and inclusive environment, by distributing work in a fair and organised manner that counters inequality (eds. bendl et al., 2015). organisations that lack diversity management systems, or systems that are poorly executed, run the risk of creating a culture where employees could experience exclusion, conflict, lack of teamwork, gossiping and bullying, or a loss of personal identity (carrim 2016; holck, muhr & villesèche 2016; joubert 2017). organisations need to consider that there are various psychological undertones that drive people’s responses and attitudes towards diversity (april, ephraim & peters 2012). universal-diverse orientation (udo) is a construct that specifically explores individual attitudes and resistance towards diversity. universal-diverse orientation is measured by the miville-guzman universality-diversity scale (m-guds) and was defined by miville et al. (1999) as: [a]n attitude toward all other persons that is inclusive yet differentiating in that similarities and differences are both recognised and accepted; the shared experience of being human, results in a sense of connectedness with people and is associated with a plurality or diversity of interactions with others. (p. 292) therefore, udo refers to the ability of a person to connect with others, based on their similarities, while also fostering an appreciation for others, based on their differences. universal-diverse orientation also specifically incorporates the ability of an individual to push past the discomfort of diverse interactions, by continually engaging in such situations. it was suggested that the m-guds would be useful in creating and assessing interventions that focus on well-being within various settings, and that the development of the individual sub-constructs of udo may be used to achieve overall well-being within these settings (miville et al. 2004). nauly, purba and fauzia (2018) found positive results by using the m-guds to assess the effectiveness of their diversity training modules, having found that positive diversity attitudes are best formed over time and with continual interactions and engagement with diversity, which is also in alignment with various other studies that followed a similar route (fu et al. 2018; kilgo 2015; kohli et al. 2016). when considering the notion of addressing the undertones that direct the attitudes and responses of each stakeholder toward diversity, it is evident that there is more ground to be won by paying attention to individual attitudes towards diversity, and intentionally developing and shaping these personal attitudes through a well-structured diversity management programme over an extended period of time (april et al. 2012). furthermore, the m-guds appears to be a useful tool to shape diversity management programmes and to assist in evaluating the effectiveness of interventions, as well as guiding organisations in developing the individual perceptions and attitudes of their employees (celinska & swazo 2016; fu et al. 2018). to assist in the development of south african employees, diversity management programmes could be more effectively measured, developed and implemented. to this end, the m-guds may be used as a preand post-intervention litmus test to track the development of an organisation’s diversity management processes (celinska & swazo 2016; kohli et al. 2016; vasquez et al. 2017). the m-guds may also be used to determine specific constructs to be developed and assist in identifying the best methods for developing a workforce that is aware of the differences in their team and able to utilise these differences and similarities to achieve better results. however, when considering the benefits that the m-guds could hold for our unique workforce, it should also be noted that the assessment measure has not yet been validated in the south african context. it is essential for assessment measures to be developed and tested in specific contexts. moreover, it cannot simply be assumed that the same results would be achieved in all other contexts, especially not in our diverse nation (eds. foxcroft & roodt 2018). the validation of measuring instruments is an integral part of collecting quality data that may be seen as yielding credible results (kazi & khalid 2012). researchers need to ensure that measuring instruments are viable in different contexts, with terms and wording that are understandable, relatable and adequate for the intended purpose, as well as based on a good theoretical foundation (de klerk, boshoff & van wyk 2009; kazi & khalid 2012). therefore, the main purpose of this study will be to validate the full or long form of the m-guds in a general population of south africa to provide organisations with a measuring instrument that is reliable and valid, catering for all the diverse and unique individuals. literature review conceptualising universal-diverse orientation it is important for organisations to recruit and develop members that are aware of the multidimensionality of others, understanding that each individual represents a collection of various traits at a single moment in time, and cannot just be defined as having a single trait (tatli & özbilgin 2011). once members are able to see and understand how their individual traits fit into the organisational context, they might feel more included in the organisation as a whole, while also being able to further build on their own self-concept (warner 2008). the trait of udo specifically encompasses an individual’s ability to relate and understand diversity among individuals and can be a useful additive to promote connection among organisational members. universal-diverse orientation may briefly be defined as the inclination of an individual to be aware of the differences and similarities that exist between people, and the ability to also accept and appreciate these similarities and differences (miville et al. 1999). individuals with a high level of udo, typically display attitudes towards diversity that are formed from three main components springing from a cognitive, behavioural, and emotional reservoir. these components are referred to as relativistic appreciation (ra), diversity of contact (dc), and sense of connection (sc) (miville et al. 1999). as the cognitive component of udo, ra describes the ability of an individual to recognise and appreciate the characteristics that make others different or similar to themselves (fuertes et al. 2000). diversity of contact is the behavioural component and portrays a person’s desire and tendency to place themselves in situations in which they are exposed to differences (kottke 2011); whereas sc is the affective component that refers to a person’s capacity to form an emotional connection to those that are different and similar, while overcoming the discomfort or anxiety that diverse interactions initiate (fuertes et al. 2000). these three dimensions of udo are a dynamic and complex social structure that represent either an interest in, or a repulsion to interaction with others, as well as the emotional aspect that could create a rejection of or hesitance towards these interactions (miville et al. 2004). from these dimensions, it can be seen that individuals could have the intention to interact with diverse others, while simultaneously feeling resistance towards an unknown or different environment. this resistance could then be counteracted by the actual cognitive understanding and appreciation of the aspects that make people different or similar. sadly, this resistance or anxiety has in the past encouraged society to refrain from voluntary interaction, causing division among various groups instead of encouraging society to grow in an appreciation and utilisation of these differences (miville et al. 2004). however, it seems that people with a high score in udo are able to recognise the growth potential and personal development that could come from interactions with others, and these individuals would actively seek to grow their understanding by intentionally engaging in situations that further develop their appreciation (vasquez et al. 2017). up until 2010, there had not been any studies based on udo within the organisational context. however, kottke (2011) suggested that there should theoretically be a connection between udo and diverse workplaces, and among teams in organisational settings. this was supported by later studies that showed how social integration in japanese companies increased creativity, with this relationship being further moderated and strengthened by organisational leaders with higher levels of udo (suzuki & takemura 2016). this implies that universally diverse leaders can counter the feeling of low cohesion among members by recognising and acknowledging differences and similarities, and then effectively motivating members in the management of this diversity (fuertes et al. 2000; suzuki & takemura 2016). these studies show that there is value in developing universally diverse management in organisations, since the management teams will most likely be the drivers of diversity management in organisations (abramovic & traavik 2017). furthermore, abramovic and traavik (2017) determined in their study that individuals who are more oriented towards the goals of others, and who have been exposed to more positive diverse situations, tend to be more engaged and active in diversity management activities. therefore, there seems to be a connection between the individual’s personal experience in the diverse environment, as well as the manner in which the diversity is managed in the environment. measuring and validating universal-diverse orientation as noted previously, udo is measured by the m-guds, which was originally developed by miville et al. (1999) as a means to determine the attitudes and orientation of an individual toward the similarities and differences of others. the original extended form of m-guds consisted of 45 items in total, with 15 items allocated per construct for ra, diversity of contact, and sc (miville et al. 1999). although the m-guds was originally developed in the united states of america, a short form (m-guds-s) has been adapted and validated in various other countries, including australia, asia, and the united kingdom (jesiek, shen & haller 2012; kegel & deblaere 2014). this shorter version of the m-guds was proposed by fuertes et al. (2000) to make it easier and less time-consuming to administer, while still yielding the desired results. the m-guds-s consisted of 15 items in total, with five items allocated to each construct of udo (kottke 2011). despite the short form yielding similar results in factor structure, reliability, and validity in other countries, we need to consider the unique south african context before distributing the questionnaires in local organisational diversity programmes. considering the extent of diversity and the political history of south africa, it is reasonable to expect that a measure to assess individuals’ attitudes and orientation toward the similarities and differences in others, may perform differently than the authors of the instrument intended. this necessitates that the m-guds be validated for fair usage in the south african context. in the current study, we also endeavoured to validate the original long form of the m-guds since the factor scores and relationships among scales are more clearly defined and allow for analysis of the subscales in the instrument. therefore, the primary objective of this study was to examine the reliability, as well as the construct-, convergent-, divergentand criterion-related validity of the m-guds within the general population of south africa. in the current study it was expected that the m-guds would be reliable, as also found in several previous studies with cronbach’s alphas ranging from 0.72 to 0.92 (çivitci 2020; han & pistole 2017; house, razak & ashraf 2017; miville et al. 1999): h1: the m-guds is a reliable measuring instrument. in the past contrasting results were found for the construct validity of the m-guds. initially, it was postulated that the components of udo can be seen as multidimensional, consisting of the three dimensions relativistic appreciation, diversity of contact, and sense of connection (miville et al. 1999). nevertheless, after analysis, miville et al. (1999) concluded that udo can rather be seen as a unidimensional construct, as the factors are so closely related that they are best observed together, despite being cognitive (relativistic appreciation), behavioural (diversity of contact), and affective (sense of connection) in nature: h2: the m-guds measures one construct that consists of three interrelated components. to assess the convergent validity of the m-guds, we compared the m-guds with the cultural intelligence scale (cqs; earley & ang 2003). cultural intelligence (cq) can be defined as the ability of an individual to understand, function, detect and embrace diverse social interactions (earley & ang 2003). cultural intelligence comprises four components, which are mental, motivational, and behavioural in nature. the mental component of cq is derived from the metacognitive cq and cognitive cq factors, the motivational component from motivational cq, and the behavioural component from behavioural cq (ang et al. 2007). on the other hand, udo consists of cognitive (relativistic appreciation), behavioural (diversity of contact), and affective (sense of connection) factors that determine an individual’s orientation, behaviour and attitude towards diverse individuals (miville et al. 1999). this study aimed to determine the similarities that exist between the cognitive and mental aspects of udo and cq, which are represented by ra, metacognitive cq and cognitive cq factors: h3: the m-guds is positively correlated with the cqs (convergent validity). for the purpose assessing the divergent validity, the m-guds will be compared to the short form of the marlowe-crowne social desirability scale (sds; reynolds 1982). miville et al. (1999) also compared their model of the m-guds with the sds in their validation study, and as desired, they found an insignificant correlation (0.17) between the two models: h4: the m-guds has a low correlation with the short form of the sds (divergent validity). finally, criterion-related validity was established by examining the relationships between udo and two outcome variables – colleague relationships and organisational membership. colleague relationships can be seen as relations among employees who do not directly report to one another (sias 2005). it is expected that udo relates to colleague relationships since it was found that a sc tends to focus more on personal discomfort, and the anxiety or ease with which an individual approaches diverse people or situations, turning the focus more to the individual’s self-efficacy and their reliance on their personal ability to interact with others (miville et al. 2004). furthermore, it was seen that increasing an individual’s ability to empathise with others, assists in combating anxiety and fear related to diverse interactions, and trust is strongly interlinked with both the cognitive (relativistic appreciation) and emotional (sense of connection) aspects of udo (han & pistole, 2017; miville et al. 2006): h5: udo predicts employee relationships (criterion-related validity). furthermore, miville et al. (2004) found that the ra construct of udo correlates positively with collective self-esteem and creates a positive outlook towards a person’s own group and their place in that group. they concluded that it is important for an individual to have a proper understanding and a positive view of their own social group to show an appreciation for and acceptance of other social groups (miville et al. 2004). interestingly, they found that although positive collective self-esteem is highly correlated with udo, one’s personal feelings of self (self-esteem) are also not connected to one’s ability to appreciate diversity on a group level. therefore, it is assumed that organisational membership would be predicted by udo, as it is the sense of belonging that various organisational stakeholders experience by means of support, acceptance, respect and inclusion (cockshaw & shochet 2013): h6: udo predicts organisational membership (criterion-related validity). research design a quantitative, cross-sectional research design was employed to determine the relationships and problems that exist within a specific environment at a specific point in time (de vos et al. 2011; struwig & stead 2013). research participants the study sample was selected by means of heterogeneous sampling and consists of participants from the general working population within various sectors and organisations of the gauteng province in south africa, as this is the most densely populated province in the country with more than 16 million inhabitants (statistics south africa 2022). more specifically, the sample of participants included south african citizens who are employed within the gauteng province and are literate in the english language (n = 255). the distribution of the sample is presented below in table 1. table 1: characteristics of participants (n = 255). an advertisement was placed on the platforms encouraging participants from the gauteng province (including areas such as benoni, carletonville, heidelberg, johannesburg, kempton park, pretoria, vanderbijlpark and vereeniging) to participate in the study. the purpose and duration of the questionnaire, and the inclusion criteria were outlined in the advertisement to ensure that the appropriate target population was reached. interested participants were requested to follow the link to complete the online survey. on the online platform, participants were prompted to read the letter of informed consent that stipulated the purpose of the questionnaire, and notified participants that participation is voluntary, that they have the right to withdraw from the study at any time, and that their responses will be treated as confidential. measuring instrument(s) biographical information for the participants was collected. this included age, gender, cultural group, language, ethnicity, occupation, organisational tenure, and job position tenure. universal-diverse orientation was measured by the full form of the m-guds. this measuring scale consist of 44 items divided into three subscales, including diversity of contact, relativistic appreciation, and sense of connection (miville et al. 1999). these three subscales are measured by a six-point scale ranging from 1 (strongly disagree) to 6 (strongly agree), with 15 items (four reversed scored) measuring diversity of contact, 15 items (four reversed scored) measuring ra, and 14 items (five reversed scored) measuring sc. cultural intelligence was measured with the cqs. this scale was developed by ang et al. (2007) and it consists of four subscales, which include metacognitive cq, cognitive cq, motivational cq, and behavioural cq. these subscales were each measured by a range from 1 (strongly disagree) to 7 (strongly agree) on a seven-point scale with four items for metacognitive cq, six items for cognitive cq, and five items for both motivational cq and behavioural cq for the purpose of testing social desirability, the short form of the marlowe-crowne sds was used (crowne & marlowe 1960; reynolds 1982). the scale was adapted from 18 true items and 15 false items to a reduced five true items and eight false items (crowne & marlowe 1660; reynolds 1982). colleague relationships were measured by means of the nine items derived from the english version of the questionnaire on the experience and assessment of work (vbba scale), as developed by van veldhoven et al. (2002). these items were measured by a four-point scale ranging from 1 (always) to 4 (never). finally, organisational membership was assessed with the psychological sense of organisational membership scale (psom) to determine the respondents’ workplace belongingness (cockshaw & schochet 2010). this added an additional 18 items to the questionnaire rated on a five-point likert scale ranging from 1 (not at all true) to 5 (completely true). statistical analysis the statistical analyses were conducted with spss – version 23 (ibm spss inc. 2016) and mplus 7.2 (muthén & muthén 2014). confirmatory factor analysis (cfa) was implemented to test the hypotheses as outlined by this study (hurley et al. 1997). for construct validity, the goodness-of-fit for the cfa was determined by the χ2 statistic, comparative fit index (cfi ≥ 0.90; byrne 2010), the tucker-lewis index (tli ≥ 0.90; byrne 2010), the root mean square error of approximation (rmsea ≤ 0.08; browne & cudeck 1993), and the standardised root mean square residual (srmr ≤ 0.05; hu & bentler 1999). exploratory structural equation modelling (esem) was used to account for the multiple related dimensions in the convenience of one model (dicke et al. 2018). this method allowed for each item to load onto all the other factors in the model, implying an acceptance that there is a likelihood of a small loading to exist between each item and all the other factors represented in a model (marsh et al. 2009). it was proposed that this method would be more suited since previous research for the m-guds also showed that the construct for udo was identified as an unidimensional construct with high correlations between the factors, instead of a multidimensional construct with more defined sub-constructs that are only related to one another (fuertes et al. 2000; miville et al. 1999). the fit of the esem model was also determined by the same fit indices used for the cfa models. pearson correlations were applied to determine the relationships between the latent variables, with the statistically significance considered at p ≤ 0.05, and practical significance with a medium effect (r ≥ 0.30) or a large effect (r ≥ 0.50; cohen 1988). reliability was determined by the cronbach’s alpha coefficient (α ≥ 0.70; morera & stokes 2016). results the construct (factorial) validity for the long form of the m-guds was firstly tested as three cfa models, yielding unsatisfactory results. initially, the analysis for the first cfa model (model 1) was run with all the items for each factor included. since unsatisfactory results were attained, all the items with low loadings and non-significance were removed for the analysis of model 2; however, this model also presented with a poor fit. consequently, a third cfa model (model 3) was analysed with the remaining items being equally parcelled. although the model fit for model 3 was an improvement from the previously tested models, the results were still not on par with the desired specifications. therefore, the parcelled items were further analysed as an esem model (model 4). according to this method, target rotation was applied, and cross-loadings were allowed on all the other factors. lastly, the esem model was translated through a set-esem approach into a cfa model for the structural model (dicke et al. 2018). refer to table 2 for the results attained from the analysis of the measurement models. table 2: results of the measurement models. from table 2, it can be noted that the cfi and tli for model 1 were both below the cut-off point of 0.90. although the rmsea yielded significant results of above 0.05, the srmr was substantially higher than the proposed cut-off point of ≤ 0.05. in an attempt to improve the poor fit of model 1, all the items with factor loadings less than 0.30 were removed from the model. more specifically, dct9: ‘i do not know too many people from other countries’; dct11: ‘i have not seen many foreign films’; and dct12: ‘i am not very interested in reading books translated from another language’ were removed for diversity of contact. for relativistic appreciation, rap11: ‘it is very important that a friend agrees with me on most issues’; rap12: ‘knowing how a person is similar to me is the most important part of being good friends’; rap13: ‘it is often hard to find things in common with people from another generation’; rap14: ‘placing myself in the shoes of a person from another race is usually too tough to do’; and rap15: ‘it is hard to understand the problems that people face in other countries’ were removed. furthermore, scn9: ‘getting to know someone of another race is generally an uncomfortable experience for me’; and scn14: ‘i am often embarrassed when i see a physically disabled person’ were removed for sc. resultantly, the analysis for model 2 was completed with 10 items remaining for ra, 12 items for diversity of contact, and 12 items for sc. despite all the items with low loadings and non-significant items being removed from the analysis, model 2 still yielded unsatisfactory results with cfi and tli values below 0.90, and an srmr value greater than 0.05. therefore, a load-balancing technique was used by pairing the items with the highest loading into parcels with the items with the lowest loading for a single factor (little et al. 2013). this process was repeated until all the items had been equally parcelled. consequently, model 3 consisted of a three-factor model with five-item parcels for ra, six parcels for diversity of contact, and six parcels for sc. although this method resulted in a significant value for the srmr, the rmsea only indicated a moderate fit (rmsea = 0.08) and the cfi and tli were still slightly below the cut-off point of 0.90. it is also noted that the correlations for all the factors of udo were statistically significant in model 3. the correlations between diversity of contact and ra (r = 0.77), ra and sc (r = 0.70), as well as diversity of contact and sc (r = 0.85) were all statistically significant to a large effect. next, the researcher attempted a relatively novel approach to structural equation modelling known as esem. as noted in table 2, the esem model (model 4) yielded a better fit for the data compared to the three cfa models, with both the cfi and tli above 0.90, an rmsea above 0.05, and an srmr below 0.05 (cfi = 0.95; tli = 0.91; rmsea = 0.06; srmr = 0.03). table 3 provides a tabulated representation of the factor loadings of the item parcels of each udo factor. table 3: standardised loadings for the universal-diverse orientation factors. table 3 indicates that all the parcelled items for relativistic appreciation showed strong factor loadings with the lowest factor loadings being rap1 (λ = 0.64, se = 0.10) and rap5 (λ = 0.62, se = 0.07), and the highest being rap3 (λ = 0.87, se = 0.07). for a sense of connection, scn1 displayed the lowest loading (λ = 0.37, se = 0.09), while scn3 was not significant (λ = 0.28, se = 0.09; p = 0.002); although the rest of the parcels yielded acceptable loadings with the highest being scn6 (λ = |0.89|, se = 0.05). the item parcels for diversity of contact, mostly yielded good factor loadings with the highest loading being dct4 (λ = 0.89, se = 0.07). it is, however, noted that the item parcel for dct1 yielded only a slight loading (λ = 0.17, se = 0.07; p = 0.024), while also having a higher loading to ra (λ = 0.25, se = 0.08; p = 0.003) and a significant loading to a sc (λ = 0.42, se = 0.08; p = 0.001). next the reliability and correlations between the factors for the m-guds were calculated. all the reliability coefficients obtained for the m-guds dimensions were sufficient, with cronbach’s alpha coefficients of 0.79 for diversity of contact, 0.79 for ra and 0.74 for sc. therefore, h1 is supported. the results also suggest that all three factors are positively correlated (p ≤ 0.001). reference is given to correlations in table 4 to determine the convergent and criterion-related validity between the m-guds and the remaining variable in the model. table 4: correlations between the miville-guzman universality-diversity scale dimensions and other constructs. from the results obtained in table 4, it can be noted that the factors for the m-guds are positively related to the different dimensions of the cqs. diversity of contact was found to have a statistically significant correlation with all the cqs factors. however, all the correlations were only practically significant to a small effect, with the exception of motivational cq (r = 0.46; medium effect). despite being insignificantly correlated with cognitive cq, ra has a statistically significant correlation with metacognitive cq (r = 0.37; medium effect), motivational cq (r = 0.53; large effect), and behavioural cq (r = 0.30; small effect). finally, a sc showed a statistical significance with all the factors of the cqs. the correlation between a sc and cqs was practically significant to a large effect with the motivational cq (r = 0.66), and to a small effect with metacognitive cq (r = 0.26), cognitive cq (r = 0.23), and a very small effect with behavioural aspects cq (r = 0.15). additionally, it is noted that h5 and h6 are not supported by the above-mentioned data. interestingly, colleague relationships were only significantly correlated with diversity of contact (r = 0.17; small effect), while there were no significant correlations with any of the other factors. organisational membership yielded significant correlation with the diversity of contact factor (r = 0.16; small effect) and the ra one (r = 0.20; small effect). divergent validity divergent validity was established by comparing the m-guds with the sds. this was achieved by running an additional cfa model that was used to determine the relationships between the udo factors and social desirability, and this model showed a good fit (cfi = 0.94; tli = 0.92; rmsea = 0.06; srmr = 0.04). the results for the divergent validity are displayed in table 5. table 5: correlations between miville-guzman universality-diversity scale and social desirability scale for divergent validity. in support of h4, the results in table 5 show that social desirability did not yield statistically significant results when compared to the udo factors, and all the correlations were below the suggested threshold of 0.85 for discriminant validity (r’s ≤ 0.85; brown 2015). criterion-related validity next, the set-esem structural model (model 5) was tested to examine the criterion-related validity of the m-guds. for criterion-related validity to be determined, consideration was taken of the size and direction of the standardised beta coefficient values (β) and the statistical significance of the paths, which was set at p < 0.05. since the esem method allows for all the items to load onto all factors represented in the model, model 4 (esem) was set into a cfa model by using a set-esem approach. this was achieved by only allowing loading onto the factors that would hold theoretical value and are within the same set of constructs (dicke et al. 2018). model 5 (set-esem) only presented in minor changes in the fit indices, with the only changes viewed in cfi and srmr. nevertheless, the fit indices for the structural model also showed acceptable model fit (cfi = 0.94; tli = 0.92; rmsea = 0.06; srmr = 0.04). the regression results for the structural paths, as set out by the hypotheses, are presented in table 6. table 6: regression results for the structural model. from the above-mentioned results, it can be noted that diversity of contact significantly predicted colleague relationships (β = 0.20, se = 0.10, p = 0.046), while ra and sc did not significantly predict colleague relationships (relativistic appreciation: β = −0.03, se = 0.10, p = 0.780; sc: β = −0.03, se = 0.09, p = 0.784). therefore, h5 is only partially supported by the structural model. furthermore, organisational membership was not significantly predicted by diversity of contact (β = 0.10, se = 0.10, p = 0.354) or sc (β = −0.13, se = 0.10, p = 0.180). however, organisational membership was significantly predicted by ra (β = 0.21, se = 0.11, p = 0.044). therefore, the information provided in table 6 also only partially supports h6. discussion this study aimed to validate the m-guds within the general working population in the gauteng province of south africa. specifically, the objective was to determine the reliability, construct validity, convergent and divergent validity, as well as the criterion-related validity of the m-guds within the given population. for the first objective, the study aimed to determine the reliability of the m-guds measuring instrument in the south african context. the results from the study confirmed that all three factors of the m-guds displayed favourable cronbach’s alpha coefficients (morera & stokes 2016). when considering that reliability indicates the internal consistency of a measuring instrument, the results for the study show that diversity of contact, ra, and sc yield consistent results that are in line with previous research (house et al. 2017; mallinckrodt et al. 2014; nunnally & bernstein 1994). therefore, sufficient proof for h1 was accepted. the second objective attempted to determine the construct-, convergent-, divergentand criterion-related validity of the m-guds in the south african context. for construct validity, the hypothesis was to determine whether the m-guds measures one construct that consist of three interrelated dimensions (h2). in the current study, the results indicated that m-guds consists of three dimensions (i.e. diversity of contact, relativist appreciation and sense of connection) that are related to one another. more specifically, this would mean that there is some conceptual overlap between the dimensions. from previous studies, it was expected that the m-guds would be portrayed as one construct with three dimensions that are closely related to one another (fuertes et al. 2000; miville et al. 1999). therefore, the results for construct validity accepted h2. furthermore, studies also showed that the relationships between the dimensions of the m-guds were stronger and more closely related to the original long form of the m-guds, as was administered in this study. however, we found results that were more in line with the research on the short form of the m-guds. in the short form of the m-guds, there was slightly less overlap between the dimensions, although they still had strong relationships. similar results were found in our study, and it is suggested that future research should explore the usefulness of administering the dimensions separately. convergent validity was determined by considering the relationships that exist among the factors for the m-guds and the cqs. these relationships are considered to determine whether the m-guds is able to gain similar results as another measuring instrument that measures a theoretically similar idea or phenomenon (taherdoost 2016). for convergent validity, h3 aims to determine whether the m-guds is positively related to the cqs. in this study, it was found that the majority of the dimensions of udo yielded positive relationships with the factors for cq, with the exception of the relationship between ra and cognitive cq. therefore, h3 was accepted. the non-significance between ra and cognitive cq would imply that a person can have an appreciation for the similarities and differences in others, even though they have not gained any specific experience or knowledge of the different cultures, morals or norms that differentiates one person or group from another. in other words, they might appreciate a diverse characteristic or phenomenon, without taking the time and effort to research or gain more information on the characteristic or phenomenon. even though both ra and cognitive cq are the cognitive aspects for udo and cq, these two cognitive aspects do not theoretically measure the same dimension of cognitive function. from literature, it is seen that there is also another cognitive component for cq, named metacognitive cq. metacognitive cq specifically measures the mental processes involved in understanding other cultures and increases one’s knowledge about other cultures (van dyne et al. 2012). in the present study, it was revealed that there is a stronger relationship between metacognitive cq and ra. practically, this would imply that a person who is able to notice and appreciate the similarities and differences of others, should also be able to conceptualise these differences in their mind, as well as have control over their thought processes towards diversity (ang et al. 2007). furthermore, it was noted that all of the relationships between diversity of contact and the dimensions of cq were significant. the strongest relationship was found between diversity of contact and motivational cq. this implies that individuals who are more committed and interested in diverse interactions would likely have the capacity to focus their attention and energy on learning about and engaging in diverse situations. this would theoretically make sense, since diversity of contact refers to the interest of an individual to interact with diversity (fuertes et al. 2000), while motivational cq is an individual’s capacity to interact and turn their attention to diverse interactions (ang et al. 2007). therefore, these results show that there should be a capability and motivation to interact with diverse others who drive an individual to engage in the actual interaction with diversity. sense of connection also yielded significant relationships with all the dimensions of cq. more specifically, a strong relationship was noted with motivational cq, and a weaker relationship was noted compared to behavioural cq. the results from this study, therefore, imply that people who can push beyond the initial discomfort of diverse interactions and form an emotional connection with diverse other (sense of connection), will likely display a higher likelihood of focusing their effort and energy on diverse interactions (motivational cq). additionally, these results also show that people who are more comfortable with diverse interactions (sense of connection), will to some extent also have the proficiency to adapt and alter their behaviour and verbal cues to best suit the situation (behavioural cq; ang et al. 2007). this is in line with previous research that suggests that an individual needs to be able to overcome the initial discomfort with differences to develop a connection with those they interact with (kottke 2011), despite not feeling fully comfortable with their own ability to interact and adapt their behaviour in such situations (ang et al. 2007). this is further substantiated in literature since miville et al. (2004) found that sc is strongly related to an individual’s self-efficacy and their personal view of their ability to successfully interact with others. therefore, the weaker relationship between sc and behavioural cq could be that the participants have a self-perception that they are able to engage well with diverse others, although in practice they might not necessarily display this ability. next, divergent validity was determined by assessing the relationship between the m-guds and the sds. the results in this study indicate that there is no relationship between the two constructs. theoretically, it would make sense that they are not related, and the results show therefore that the m-guds does not statistically relate to another construct with which it should theoretically not relate (taherdoost 2016). therefore, h4 stating that the m-guds displays divergent validity from theoretically unrelated instruments, was accepted. the study results corroborate the results of previous research by miville et al. (1999), who identified no significant relationships between the m-guds and the sds. additionally, these results in our study also give further proof of divergent validity, as well as showing that the participants who completed the questionnaire were not attempting to present themselves in a more or less favourable manner (reynolds 1982). criterion-related validity was determined in further support of the second objective. specifically, this study was interested to determine whether the dimensions of the m-guds predict colleague relationships (h5) and organisational membership (h6). the results from the study found that only one dimension of udo (i.e. diversity of contact) predicts colleague relationships, and the other two dimensions, ra and sc, did not predict colleague relationships. therefore, h5 was rejected. the results further imply that colleague relationships would be stronger in organisations in which individuals show a higher interest and intention in connecting with others who are diverse. on the other hand, simply having an appreciation for others might not encourage employees to build stronger colleague relationships. previous studies have found that ra is a predictor of collective self-esteem (miville et al. 2004), and therefore the results that show no prediction between ra and colleague relationships were unexpected. however, according to miville et al. (2004), one needs to first have an appreciation of one’s own group and position in that group before being able to appreciate the role and place of those in other groups. therefore, these results call for additional research on other factors that might affect this relationship. similarly, the non-significant relationship between sc and colleague relationships would suggest that the level of comfort that others feel with diversity will not necessarily encourage employees to improve their relationships with colleagues. since sc specifically considers an individual’s perception of their self-efficacy in interacting with others, it could mean that they see themselves as competent in diverse interactions, but they do not necessarily have the desire to interact with others (han & pistole 2017). previous research showed that trust highly predicts an individual’s sc, and this would allow them to be more open and understanding with others (han & pistole 2017; miville et al. 2006; thompson et al. 2002). therefore, it could be noted that participants might not trust their colleagues, resulting in a lack of agreeableness, anxiety and discomfort (miville et al. 2006). these results indicate that future studies could determine whether trust could be a moderator in the relationship between a sc and colleague relationships. the results for the predictive relationship between udo and organisational membership (h6), suggest that organisational membership is only significantly predicted by ra, while diversity of contact and a sc did not predict organisational membership. therefore, h6 is only partially supported. the results from this study consequently suggest that employees who are able to appreciate the contribution that diverse others make, are likely to experience a greater sense of belonging in the organisation, as they would feel as though they also play a significant part in the organisation. on the other hand, individuals who are interested in other cultures and diverse settings (diversity of contact), and individuals who are comfortable with interactions in diverse settings (sense of connection), might not necessarily feel as though they are more connected to their organisation. although it might be surprising that the affective component of udo (sense of connection) is unrelated to both colleague relationships and organisational membership, it is noted that previous research has found that this component refers more to the individual’s self-efficacy and their reliance on their personal ability to interact with others (miville et al. 2004). consequently, it seems that a sc is focused more on the individual’s perceived personal ability to interact with others than on the actual interaction with others. this differentiation was noticed in later studies that renamed the construct in short to comfort with differences to account for the internal experience of diverse situations, instead of an outward connection with diverse others (fuertes et al. 2000; kottke 2011). the criterion-related validity of the m-guds is therefore still questionable in this study sample and it is recommended that future research should explore the outcomes of udo within an organisational context. practical implications in this study, it was found that the m-guds is a reliable and valid tool to measure udo in the south african context. with these results, organisations in the gauteng province could incorporate the m-guds in their diversity management programmes to gain a better understanding of their employees’ attitudes and orientation toward diversity. additionally, they may use the results from the m-guds as a guide to determine whether the behavioural, cognitive, or affective aspects of udo should be addressed during the diversity management processes. for instance, colleague relationships can be improved within organisations by implementing interventions that would develop diversity of contact. diversity of contact is specifically developed by improving an individual’s self-efficacy (miville et al. 2004). furthermore, organisational membership could be improved by implementing interventions that allow employees to explore more diverse situations and creative works, while also practising reserving their judgement and appreciating the art, moral viewpoints or artists (thompson et al. 2002). consequently, organisations could use these results to improve the diversity attitudes of their employees by providing an environment where they can develop their self-efficacy on a personal level to build on teamwork, colleague relationships, and organisational membership. this in turn will improve creativity, cohesion, and collaboration while benefitting the organisation as a whole. similarly, the m-guds could be used as a means of assessing the effectiveness of a new diversity management policy or practice by conducting a preand post-implementation test after an extended period of time after it has been implemented. limitations and recommendations despite the favourable results achieved in this study, it should be noted that the research study was not without limitations. since the study consisted of an online survey, distributed via facebook, to the general gauteng working population, it should be considered that there is a large section of the employed population that could not be reached, and the possible bias of recruiting participants via social media platforms (i.e. excluding potential participants that do not use these platforms). therefore, it is recommended that future studies make use of other data-gathering methods (i.e. other social media platforms, pencil-and-paper format, etc.), expanding the study to include the nine other provinces in south africa, or to conduct the study within specific industries. this study followed a cross-sectional design of the study and therefore account cannot be taken of specific events or circumstances that might have influenced the responses of participants at the time that the study was conducted. therefore, it is suggested that a longitudinal design should be followed in future research to corroborate the results found in this study. as the long-form of the m-guds was presented in addition to the other measuring instruments utilised for validation, the questionnaire was time-consuming and this might have resulted in employees being reluctant to complete the survey. this might also account for the low response rate that was achieved (n = 255); so it is suggested that future studies validate and implement the short form of the m-guds (m-guds-s) to overcome these limitations. lastly, it is suggested that bias and equivalence should be tested in future studies, especially considering the vast and diverse nature of the south african workforce and the different perspectives and backgrounds on diversity that exist among the different age, ethnic, culture, gender and language groups. acknowledgements this article was submitted as part of mini-dissertation for a master’s of commerce degree in industrial psychology at the school of industrial psychology and human resource management of the north-west university in december 2020 under the supervision of prof. c.e. the title of the submitted mini-dissertation is ‘a validation study of the miville-guzman universality-diversity scale in south africa’. competing interests the author(s) declare that they have no financial or personal relationship(s) that may have inappropriately influenced them in writing this article. authors’ contributions c.v. fulfilled the role of the primary researcher, and this study formed part of her master’s research. she was responsible for the conceptualisation of the article, collecting of the data, the interpretation of the research results, and the writing of the article. c.e. acted as supervisor, and thus played an advisory role in this study and assisted in the conceptualisation of the study and the writing of the research article. ethical considerations ethical approval was obtained from the economic and management sciences research ethics committee of the north-west university (nwu-00774-18-s4. 26 october 2018). funding information this research received no specific grant from any funding agency in the public, commercial or not-for-profit sectors. data availability the data that support the findings of this study are available on request from the corresponding author. disclaimer the views and opinions expressed in this article are those of the author and do not necessarily reflect the official policy or position of any affiliated agency of the authors. references abramovic, g. & traavik, l.e., 2017, ‘support for diversity practices in norway: depends on who you are and whom you have met’, european management journal 35(4), 454–463. https://doi.org/10.1016/j.emj.2017.04.002 ang, s., van dyne, l., koh, c., ng, k. y., templer, k. j., tay, c. et al., 2007, ‘cultural intelligence: its measurement and effects on cultural judgment and decision making, cultural adaptation and task performance’, management and organization review 3(3), 335–371. https://doi.org/10.1111/j.1740-8784.2007.00082.x april, k., ephraim, n. & peters, k., 2012, ‘diversity management in south africa: inclusion, identity, intention, power and expectations’, african journal of business management 6(4), 1749–1759. https://doi.org/10.5897/ajbm11.1184 bendl, r., bleijenbergh, i., henttonen, e. & mills, a.j. 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practices of accounting measurement with the principles of the representational theory of measurement to determine whether the attributes of accounting phenomena are measured on well-founded scales. the results of this study indicate that the concept of the representational scale is misapplied in the accounting discipline. the principles of representation measurement are hinged on the precise specification of how a scale of measurement is formed. consequently, the findings suggest that accounting is not a measurement discipline. key words: representational measurement, nominal scale, ordinal scale, interval scale, ratio scale jel m41 1 introduction the concept of a scale is an integral aspect of measurement. every measurement process has to specify a scale of measurement (ryan, scapens & theobald, 2002). the specification of a scale of measurement is proof that the process is indeed one of measurement. accounting is considered to be a measurement discipline (e.g., iasb, 2009; wolk, tearney & dodd, 2001). consequently, one would expect to find specified scales of measurement in accounting. however, authors such as staubus (2004), ryan et al. (2002), chambers (1997) and willet (1987) have all pointed out that in the accounting discipline there is no specification of a scale of any kind that makes it possible to distinguish the extent to which every object in a specified class of accounting phenomena possesses a specified property. this contradicts the view that accounting is a measurement discipline. narens (2002) also makes the point that a theory of measurement consists of a precise specification of how a scale is formed. the absence of specified scales of measurement in accounting therefore points to the absence of a theory of measurement in accounting. according to luce, krantz, suppes & tversk (1971), every process of measurement must have a theory of measurement. this means that every measurement discipline must have an underlying theory of measurement. the presence of a theory of measurement evidently guarantees the empirical validity of information produced by a process of measurement. authors such as staubus (1985) and ijiri (1975) indicate a consensus that the accounting discipline has not succeeded in inferring a comprehensive and coherent theory of measurement from the observation of accounting measurement practices. consequently, this suggests that researchers have not succeeded in specifying either how scales are formed in accounting measurement or whether the empirical validity of accounting information can be guaranteed. the above discussion points out that accounting is considered to be a measurement discipline in the absence of evidence (scales) confirming that it is such a discipline. as a result, it is necessary to investigate whether this accounting perspective is a delusion. accounting is classified as a social science (ryan et al., 2002). this means that measurement in accounting is viewed from the perspective of social science. the theory that establishes measurement in social sciences is the representational theory of measurement (luce et al., 1971, 1989, 1990). the concept of scale in accounting is thus discussed from the abstract sajems ns 13 (2010) no 4 425 perspective of representational measurement theory. the purpose of this study is to investigate whether numerical assignments in accounting are compatible with the concept of a scale in representational measurement. such an investigation could find evidence supporting the viewpoint outlined in accounting literature that accounting information is empirically valid (is measurement information). section 2 and its subsections present a discussion on the problem statement, the purpose of the research and the research methodology. the concept of a representational scale is discussed in section 3, followed by a discussion of the significance of a scale in accounting in section 4. sections 5, 6, 7 and 8 discuss the properties of the individual scales of measurement and the way in which they are currently applied in the accounting discipline. the conclusions and recommendations are discussed in sections 9 and 10 respectively. 2 research 2.1 statement of problem the problem addressed in this study concerns the reference to accounting as a measurement discipline in the absence of evidence (scales of measurement) supporting this viewpoint. 2.2 purpose of the research the purpose of this study is to find evidence to support the claim in accounting literature that accounting is a measurement discipline (i.e., accounting information is empirically valid), using the concept of a scale in representational measurement. 2.3 research methodology 2.3.1 critical literature analysis the application of measurement theory to accounting is not a new idea. vickrey (1970), noticing the absence of a measurement theory in accounting, questioned the status of accounting as a measurement discipline. he used the realist’s theory of measurement to determine whether the necessary and sufficient conditions for classifying accounting as a measurement discipline exist in accounting. he concluded that accounting is not a measurement discipline, adding that it currently measures no property but the numerosity of monetary units. however, vickrey’s study (1970) overlooks the point that the realist’s theory of measurement is not applicable to social sciences. he consequently evaluated the accounting concept of measurement from an erroneous perspective. according to luce et al. (1971), in certain instances in the social sciences there is no available operation for facilitating the identification of extensive measurement, while in other instances the available operation leads either to trivial results or to a violation of the axioms. there are evidently structures with numerical representations that have no directly observable association operation, such as conjoint ones. this therefore betrays a lack of understanding of the principles of measurement on the part of accounting researchers. other authors, such as staubus (1985, 2004), chambers (1997), abdel-magid (1979) and ijiri (1975), also highlight the lack of success in developing a theory of accounting measurement. this underlines the fact that numerical assignments in accounting are pretheoretic. all measurement magnitudes must be theoretically determined reflections of objectively existing entities (decoene, onghena & janssen, 1995). it can thus be argued that there is sufficient evidence to suggest that numerical assignments in accounting could be anything other than measurement magnitudes. to date, no major attempts have been made to resolve the measurement crises in accounting. consequently, it is necessary to investigate the exact nature of numerical assignments in accounting. 2.3.2 the representational theory of measurement the concept of a scale according to the representational theory of measurement is used in this study to investigate the exact nature of the numerical assignments in accounting. the representational theory of measurement was developed by scott and suppes in 1958. it is a 426 sajems ns 13 (2010) no 4 theory of measurement comprising many related theories of measurement. this group of measurement theories requires in common a scale that can be defined by a set of structurepreserving mappings from a qualitative or empirically-based structure onto a structure from mathematics. the representational measurement theory offers an abstract theory of the kinds of well-behaved scales encountered in science. it places great emphasis on the uniqueness of representations. the list of scale types commonly found in science, and conceptualized by stevens (1946, 1951), namely, ordinal, interval, ratio and nominal, has most empirical examples from representational measurement falling in this list. however, that is not to say that stevens’ (1951) list of scales is exhaustive. narens (1981a, 1981b) shows that there are scales between the ratio and interval scales, but none of them has yet played a role in actual scientific measurement (luce & suppes, 2001). for this reason, the discussion on scales in this study is limited to stevens’ (1951) list outlined above. 3 the concept of a representational scale the concept of a scale is of fundamental importance in representational measurement. a scale is a rule used for the assignment of numerals to properties of objects or events (stevens, 1951). this equates a scale to a specific method of measurement. stevens (1951) also notes that measurement always occurs in a specific way, which means that every measurement process must have a rule of measurement. consequently, it is clear that in a process of measurement the random assignment of numbers to objects is excluded. luce et al. (1971) argue that measurement can take place only if the rule that maps an empirical relational structure onto the numerical relational structure is specified. this indicates that the process of measurement takes place only in the presence of a standardized rule of measurement. therefore, if the term “rule” in the above paragraph is taken to mean the presence of a scale in every measurement process, then it is reasonable to conclude that every process of measurement must have a scale of measurement. similarly, narens (2002:757) defines a scale as follows: s is said to be a representational scale if and only if there exists a qualitative structure x and a mathematical representing structure n for x such that s is a subset of one-to-one homomorphisms from x to n. this quotation points out that a scale of measurement can exist only when there is a qualitative structure that can be represented by a numerical relational structure. it is also clear that a scale is part of the homomorphisms that map a qualitative structure onto a numerical relational structure. a homomorphism is a function that maps an algebraic structure onto another in a way that preserves the properties of the algebraic structure being mapped (bhattacharya, jain & nagpaul, 1986). it is evident from this that a scale indicates the relationship that enables a qualitative structure to be mapped onto a numerical relational structure. it follows, therefore, that a scale explains how the properties of a qualitative structure are represented by an algebraic structure or a rule that explains the representation of an empirical relational structure by a numerical relational structure. according to luce et al. (1971) the scales of measurement are subject to arbitrary conventions. it can be argued from this that scales of measurement are socially constructed. it also suggests that each process of measurement has its own rules of measurement. as a result, there is the possibility of a proliferation of rules of measurement for a single process of measurement. stevens (1951:1) refers to the possible proliferation of measurement rules when he states, and the fact that numerals can be assigned under different rules leads to different kinds of scales and the different kinds of measurements. these words underline the fact that there is no single method of measuring, but many. thus, each type of scale distinguishes one form of measurement from another. these numerous methods of measurement lead to different kinds of scales. it can also be inferred that each sajems ns 13 (2010) no 4 427 frame of reference can have its own rules of measurement. in addition, it should be noted that the rules of measurement are not part of the phenomenon being measured. the empirical relational structure and its empirical properties are not a matter of convention. luce et al. (1971) argue that the empirical relational structure and its empirical properties should be treated as a set of qualitative empirical laws. this means that the phenomenon being measured should be invariant under any set of measurement procedures. a set of measurement procedures does not change the underlying property it is measuring (e.g., a man’s height is not changed in being measured by a metre rule). stevens (1951) characterized scales into four types, namely, nominal, ordinal interval and ratio scales. the type of scale achieved in measurement depends upon the character of the basic empirical operations performed on the property being measured. ordinarily, these operations are limited by the peculiarities of the thing being scaled and by our choice of the concrete procedures. however, once selected, these procedures determine the type of scale that will eventuate (stevens, 1951). the type of a scale indicates the level of measurement. associated with each level of measurement is a set of mathematical operations that may be performed on a measure. each level of measurement involves different properties (relations and operations) of the numbers or symbols that constitute the measurements. the mathematical operations that may be performed on a measure without changing its meaning are termed permissible transformations on its scale. permissible transformations on a scale preserve the relevant relationships of the measurement process (luce et al., 1971). for example, changing the unit of measurement of distance (say, from inches to centimetres) multiplies the measurements by a constant factor. this multiplication does not alter the correspondence of the relationships “greater than” or the correspondence of addition and concatenation. hence, it follows that the change of units is a permissible transformation with respect to these relationships. the concept of a representational scale is inextricably linked to the uniqueness and the existence theorems of representational measurement. a number assigned to measure a property is unique once a unit of measurement has been chosen (luce et al., 1990). this means that a scale of measurement makes a measure unique. it follows that the proof of the uniqueness theorem is equivalent to identifying all possible scales for the measurement of the elements of a given empirical relational system. it can therefore be concluded that the type of measurement can be known if, and only if, the scale of measurement is known. 4 the significance of the concept of a representational scale in accounting the concept of a representational scale discussed in section 3 may be of fundamental significance to accounting. mattessich (1964:63) identifies the nominal scale, ordinal scale, interval and ratio scales as the medium through which accounting information is communicated. according to stevens (1951), the classification of scales into scale types is based on the amount of information about a property that is contained in a scale. this suggests that every measurement scheme should specify the type of scale used in order to indicate the amount of information contained by the measures it produces. it can thus be argued that a scale of measurement is an embodiment of the properties of the phenomenon being measured. it follows that, without the specification of a scale of measurement, it would be not possible to know what a particular numerical assignment represents. therefore, if accounting were a measurement discipline, it should have been capable of specifying the rules of measurement employed in its measurement processes to give meaning to its numerical assignments. failure to do so calls into question the status of accounting as a measurement discipline. measurement is about stating the relationship between the numerals and the objects. a rule of measurement states the relationship between the numerals and objects (boyce, meadow & kraft, 1994). this means that, if accounting has no specified rules of assigning numerals to objects, it implies that 428 sajems ns 13 (2010) no 4 the relations between the numerals and objects are not known. if these relations are not known it would be difficult to determine the meaning of a measurement. it follows that the concept of a scale influences the meaningfulness of a measure. this is reflected by chambers (1997:38): in the third place, every measurement scheme requires the specification of the unit in the scale, and the conditions under which unit measurements shall be deemed to be of equal significance. in brief, this requires specification of the meaning of the “standard” unit. this is necessary since measurements may be taken in a variety of non-standard situations, such that the raw or crude measurements are not comparable or addable. this indicates that a scale used in a process of measurement must be specified. the extract also points out that a scale gives empirical significance to measurements. thus, a scale specifies the conditions under which a measurement has been made. it is clear from the above extract that the essence of meaningfulness is embodied in the description of the scale type and permissible statistics. this evidently highlights the fact that the statistics that can be performed on a measure lead to the formation of meaningful, or meaningless, statements based on measurements made on those scales. the meaning of a measure is therefore embodied in the description of the meaning of the standard unit. it can thus be concluded that, in the absence of specified scales, accounting measurements lack meaning and are incomparable. nevertheless, accounting information is considered comparable in the absence of specified scales of measurement. for example, iasb (2009) points out that users must be able to compare the financial statements of an entity through time in order to identify trends in its financial position and performance. this suggests that it is possible for users of accounting information to compare information from different entities in the absence of specified scales of measurement. the iasb (2009) points out that the measurement and display of the financial effect of like transactions and other events must be carried out in a consistent way throughout an entity and over time for that entity, and in a consistent way for different entities. this highlights the existence of a belief in accounting that measurement is possible in the absence of a specified scale of measurement. it can thus be concluded that the concept of a scale of measurement is not recognized in the accounting discipline. the nature of accounting measurements demands that the scales of measurement should be specified before they are compared. this is because accounting measurements are dependent on the intuition of the accountant. as mattessich (1964:79) states: there neither exists at present the possibility to infer accounting values through “natural laws” (i.e., by fundamental measurement) nor through a combination of two or more fundamental measures that result in derived measurement. most of the economic and accounting measures belong in the category of measurement by fiat, which is reflected in a certain definitional arbitrariness of our discipline. this emphasizes that accounting measurements are dependent on the intuition of the accountant, as accounting is not a natural, but a social science. the use of the phrase “definitional arbitrariness of our discipline” implies that accounting definitions are not based on consistent rules or plans, but are instead dependent on the context in which they are used. it is clear that accounting measurements are socially constructed. consequently, this suggests a need to specify clearly the nature of the social context of accounting measurements before they are evaluated. there could be a difference between the kinds of assigning of numbers arising from different procedures of measurement. therefore, if a scale of measurement was not specified in a measurement discipline, it would not possible to tell whether there were any other numbers that could be assigned as measures of the same property. such knowledge of other numbers that might be assigned is important in determining the uniqueness of a measure. the number assigned to measure a property of an object is unique sajems ns 13 (2010) no 4 429 once a unit has been assigned to it (luce et al., 1971). the concept of a scale is thus also important for the quality of uniqueness of measures. a lack of specified scales of measurement implies that the uniqueness of numbers assigned to represent the properties of accounting objects cannot be determined. the lack of specified scales of measurement has negative implications for the mathematical operations that could be carried out on accounting measurements. chambers (1997) contends that the scales of measurements (or rather measurements taken in them) have different mathematical characteristics. he also suggests that the addition of measures and other forms of relations (inter alia, subtraction, multiplication or division) is common in accounting processes. as a result, it is necessary to consider the conditions under which addition (and other forms of relation) is mathematically permissible (e.g., the addition of different classes of assets). that is, the values of assets and liabilities are added in the balance sheet and in the income statement without first verifying whether these measurements have been made under the same scale of measurement. the lack of specified scales causes inconsistencies in the classification of measures in accounting. chambers (1997:39) notes the following on the classification of measures by the aaa’s report (1971) on the foundations of accounting measures: among examples of primary measures are counts of physical quantities, and prices of non-monetary goods. in respect of prices, it is said that they may be past, present or future prices. no such stipulation is made in respect of physical counts. either, therefore, counts and prices are not members of the same class of measures (i.e. primary measures), or both should be treated in the same way (i.e., it should be allowed that physical counts may be past, present or future counts). the above passage points out that accounting measures that differ are grouped in the same class, and that physical counts and prices are regarded as measures of the same property. it is also clear that there is no specified property represented by physical counts or by prices. furthermore, there is no specification of the scale of measurement that could be used to distinguish the extent to which physical counts and prices possess a particular property. consequently, it is not clear whether physical counts and prices are measures of the same property. this leads to incorrect classification of measures. in this way, the lack of specified scales in accounting casts doubt on the current belief in the literature that accounting is a measurement discipline. 5 the application of the concept of the nominal scale in accounting a nominal scale is the most basic scale of measurement. it is a simple classification or labelling system (stevens, 1951). this suggests that only symbolic representation is necessary for measurement to occur under a nominal scale. luce et al. (1971) note that the numbers in a nominal scale reflect the objects themselves, rather than their properties. for this reason, no mathematical operations may be performed on the numbers in a nominal scale. it follows that the only quantification is the number count of cases in each category (the frequency distribution). as a result the researcher is restricted to the use of the mode as the measure of central tendency (see stevens, 1951). hence, the nominal scale has limited arithmetic properties. the nominal scale is commonly used in the accounting discipline. the activity of classification in accounting arises from the need for a tight net of a large number of concepts (mattessich, 1964). accounting phenomena are classified into five main classes of transactions relating to the statement of comprehensive income and the statement of financial position, namely, assets, liabilities, equity, income and expenses. transactions classified under these headings are discrete and qualitative. they imply no order or any indication that they can be added. nowhere in the accounting literature does it state or imply that mathematical operations of any kind can be performed on the classified transactions. however, there are instances in this literature that are unclear as to whether the nominal scale has been used to effect the mathematical 430 sajems ns 13 (2010) no 4 operation of addition. for example, ias 1 (2009) advocates that an entity present an analysis of expenses using a classification based on either the nature of expenses or their function within the entity, whichever provides reliable and more relevant information. this indicates that expenses will be classified in the financial statements according their nature and function. as has been outlined above (stevens, 1951), seeing that the nominal scale is a simple classification system, it can be inferred that the classification of expenses based on their nature and function implies the use of a nominal scale. furthermore, ias 1 (2009) also indicates that, in analysing expenses, the first form of analysis is the nature of expenses method, and that expenses are aggregated in the statement of comprehensive income according to their nature (for example, depreciation, purchases of materials, transport costs, employee benefits and advertising costs), and are not reallocated among various functions within the entity. an analysis of this indicates that expenses may be classified according to their nature, but it does not mean that the monetary amounts of the individual expenses are representatives of an identical attribute of expenses under the same classification. a statement clearly indicating that the monetary amounts are representatives of identical attributes of expenses under the same classification is necessary, and the attribute must be specified. nowhere in the ias 1 (2009) is there any discussion of the attribute that the monetary amounts of expenses under the same classification represent in either general terms or in terms appropriate for their aggregation in the statement of comprehensive income. willet (1987) notes that it is not known exactly what the monetary units represent in accounting. researchers such as vickrey (1970) and ryan et al. (2002) have concluded that there is no property measured by the financial statements apart from the numerosity of monetary units. this leads to the conclusion that the nominal scale in this case is used to imply the operation of addition. in this case, it therefore follows that the nominal scale has been accorded qualities that are beyond identity and difference. but in defence of the prescriptions of ias 1 (2009), it may be contended that classification can be considered a form of measurement for a monothetic class. a monothetic class is one in which each member possesses all the properties that define the class. if addition is to be implied, then each member of the class must have all the properties that define that class. however, nowhere in ias 1 (2009) is there any discussion of the properties that expenses falling under the same classification should have. this leads to the possibility that each member of the expenses falling under the same classification might possess a large number, but not necessarily all, of the properties that define that class. consequently, classes in which expenses are classified in the financial statements might not be monothetic. one cannot thus easily imply addition without first verifying whether it is possible to add in a given set of circumstances. it can also be inferred that, in spite of the attempt by accounting researchers to use the nominal scale in the classification of accounting phenomena, they have not fully utilized the concept of this scale. this suggests that the concept of measurement might not be part of traditional accounting methodology; otherwise the accounting discipline would have ensured its proper development. 6 the application of the concept of the ordinal scale in accounting the concept of the ordinal scale has its foundations in the concept of order. order is the arrangement of things according to a particular sequence or method (hawker, 2003). to be an order, the relationship must hold in only one direction when viewed relative to two members of the set (stevens, 1951). that is, the relationship always looks the same irrespective of the angle from which it is viewed. this means that in all measurement instances involving the ordinal scale it is necessary to specify the property used to order empirical phenomena and the direction of the order. the function of an ordinal scale is to assist in the determination of greater or lesser, such as the grades of wool or street numbers (luce et al., 1971). it is an order of preference sajems ns 13 (2010) no 4 431 system. the use of the concept of the ordinal scale in the accounting discipline is evident, even though misapplied. for example, ias 1 (2009) requires an entity to present assets and liabilities in order of liquidity only when a liquidity presentation provides information that is reliable and more relevant than a current/non-current presentation. this shows that the property “liquidity” is used to differentiate assets and liabilities in the statement of financial position into a hierarchy. the property of liquidity must therefore be unidirectional among current assets for an ordinal scale to exist. moreover, ias 1 (2009) also requires that entities such as financial institutions present assets and liabilities in increasing or decreasing order of liquidity to provide information that is reliable and more relevant than a current/non-current presentation, because the entity does not supply goods or services within a clearly identifiable operating cycle. this affirms the need to discriminate between assets and liabilities in the financial statements in order of liquidity. it can be inferred that the classification of assets or liabilities in increasing or decreasing order of liquidity implies the use of the ordinal scale. however, the numerals that specify the relative position of a current asset or a current liability in an ordered series defined by the property of liquidity are not provided. the absence of these numerals neglects the principles of the ordinal scale. mattessich (1964:59) outlines the principles of the ordinal scale as follows: the ordinal scale consists of classes that are characterized by numerals which are subject to order ranking in conformity with the numerals assigned. the numbers not only serve the mere purpose of designation, but also have a normative or preferential significance. it enforces such an order ranking and thus creates a hierarchy of classes. it is this order ranking which some scholars consider the decisive criterion of measurement. this extract emphasizes that every ordinal scale should assign numbers to the property of the objects in a class in order for these objects to be ordered in accordance with how much of the property they possess. it can thus be inferred that the lack of numbers reflecting how much of the property of liquidity each component of current assets or liabilities possesses implies that the structure and calibration of the ordinal scale ordering current assets or liabilities according to the property of liquidity is not at present known in accounting. in section 3, it was noted that a measure is meaningful if the scale of measurement is known or if the transformations that leave its scale of measurement invariant are known. it would thus seem that it is currently impossible to establish any order preserving transformations that will leave the unknown scale of liquidity among current assets or liabilities invariant. luce et al. (1971:38) make the point that any finite simple order can be represented by a finite set of real numbers, together with their natural ordering. the set of current assets or liabilities in the statement of financial position is finite. it is therefore necessary to specify the numbers that represent the liquidity of these assets or liabilities in the statement of financial position if an ordinal scale is to be established. a lack of numbers indicating liquidity also makes it difficult to prove the attributes of the relations that define order. stevens (1951:14) identified these attributes as connectedness, asymmetry and transitivity. these characteristics are discussed below: • connectedness: the concept of connectedness is fundamental to defining order in a relation. a relation is connected when, given any two terms of its field, the relation holds between the first and the second or between the second and the first (russell, 1920:33). that is, in a series of items, if any two are chosen there is a relation that holds between them. a relation has to be connected in order to arrange the elements of a set into a hierarchy. for example, a relation of “greater than” in a series of natural numbers implies that if any two different items are selected, one of them is greater than the other (stevens, 1951:12). it is therefore necessary to know the connectedness of the relation of liquidity among current assets. if current assets are arranged in order of increasing liquidity in the statement of financial position, and two 432 sajems ns 13 (2010) no 4 different current assets are chosen, then it should be shown that they are of differing liquidity. • asymmetry: an asymmetrical relation is a relation that holds in only one direction, for example, relationships such as “greater than” (if y >x then x is not greater than y), father of, or successor to (stevens, 1951:13). it must be shown that order holds in one direction only. if the relation were to hold in more than one direction it would not be possible to establish the hierarchy of elements in a set. therefore, if current assets are arranged in order of increasing liquidity in the statement of financial position, then it should mean that current assets that are high up in the series have liquidity greater than that of current assets that are lower in the series. for example, in the statement of financial position it should be empirically shown that cash is more liquid than inventories. • transitivity: the concept of the transitivity of relations is embedded in the concept of relations in abstract algebra. a transitive relation holds on more than two elements of a set without the elements having to be directly related. bhattacharya et al. (1986:10) describe a transitive relation as follows: “let r be a transitive relation on a set x. r is said to be transitive if x r y and y r z imply x r z for all x, y, z is an element of x.” this definition suggests that if x is related to y, and y is related to z in the same way it is related to x, then x and z are related. such a relationship is a transitive relationship. transitivity is necessary in the determination of order in a relationship. the transitivity of a relationship should be empirically testable. if current assets are arranged in order of increasing liquidity in the statement of financial position, it should mean that liquidity as a relation among current assets is transitive. that is, if the liquidity of cash is greater than that of debtors, and the liquidity of debtors is greater than that of stock on hand, then it should be shown that the liquidity of cash is greater than that of stock if liquidity is to be transitive. from the discussion above it is clear that the lack of a scale of measurement that reflects the extent to which different current assets possess the property of liquidity means that the connectedness, asymmetry and transitivity of liquidity among current assets cannot be proved. thus, an ordinal scale cannot exist among current assets and the concept has consequently been misapplied in accounting. 7 the application of the concept of the interval scale in accounting the concept of the interval scale has its foundations in the equality of intervals. stevens (1951) explains that the interval scale is quantitative in the ordinary sense of the word, and that all the usual statistical measures apply, unless they are the kinds that imply knowledge of a true zero point. it is evident from this that an interval scale has an arbitrary origin and that one may make all kinds of numerical statements about the interval scale apart from those that imply a true origin. boyce et al. (1994) also refer to the arbitrary origin of the interval scale when they point out that all that is required in an interval scale is a point of origin and a unit of measurement. in accordance with the theory of the hierarchy of scales, the interval scale includes both the nominal scale and the ordinal scale (stevens, 1951). in addition to its own extra properties, the interval scale includes order and classification. it is therefore clear that the interval scale includes classification, order and equality of intervals. the interval scale is concerned with the distance between or the closeness of two elements in a set (boyce et al., 1994). this means that the value of the intervals between two elements in a set is the sum of the values of those intervals. in the following discussion, applications of the interval scale by leading academics and professionals in the field of accounting are discussed. wolk et al. (2001:9) illustrate the use of the interval scale in accounting as follows: thus, in accounting, both $100,000 of current assets divided by $50,000 of current liabilities and $200,000 of current assets divided by $100,000 of current liabilities sajems ns 13 (2010) no 4 433 indicate twice as much current assets as current liabilities. this means that the monetary amounts that represent current assets can be divided by those that represent current liabilities to give the current ratio. this division indicates that a relationship is implied between the value of current assets and the value of current liabilities. it is also clear from this extract that current liabilities indicate amounts to be paid. the measure of the value of current assets represents what is available, in money or approximate money’s worth, to pay off those liabilities. in order to cover the current liabilities, a measure of insolvency is sought. in order to make the assertion that there are twice as many current assets as current liabilities, one has to be sure that there is equality of ratios between the properties that are subject to division. therefore, if there are twice as many current assets as current liabilities, there is the implication that the value of current assets is identical to the value of current liabilities. however, authors such as stamp (1981), tinker (1985) and mclean (2006) point out that value is a subjective concept that is not a property intrinsic to an accounting entity. it is evident that in current accounting, the empirical properties of value are not known, and that the measurable properties of value are unknown as well. for this reason, it is not true to imply the equality of ratios between the concept of value of an asset and the concept of value of a liability when the value is not known. nor is it verifiable to assert the existence of a true zero point on an unknown scale of value measurement. that is to say, it is not true to assert that value is measurable on a ratio scale when the structure of value is currently not available for verification. furthermore, as was pointed out above, an interval scale implies an equality of intervals between successive elements in a set, and it is also incorrect to imply the existence of equal intervals on an unknown scale of value measurement in both assets and liabilities. thus, it can be concluded that it is not possible to imply the equality of intervals of an unknown variable. 8 the application of the concept of the ratio scale in accounting the concept of the ratio scale has its foundations in the concept of the existence of four relations in an operation, namely, equality, order rank, equality of intervals, and equality of ratios (stevens, 1951). the ratio scale is a combination of the nominal, interval and the ordinal scale, together with the equality of ratios. as a result, the ratio scale exhibits the properties of the nominal, interval and ordinal scales. stevens (1951) also points out that all types of statistical operations are applicable to the ratio scales. it is thus clear that the ratio scale is quantitative in the ordinary sense of the word. the concept of the ratio scale in accounting is expressed in the use of financial ratios as indicators of performance. for example, referring to the quotation in section 4.6, wolk et al. (2001:9) explain the use of the ratio scale in accounting as follows: using the ratio type scale of measurement in accounting is at least possible because the zero point implies nothingness in terms of dollar amounts. thus, in accounting, both $100,000 of current assets divided by $50,000 of current liabilities and $200,000 of current assets divided by $100,000 of current liabilities indicate twice as much current assets as current liabilities. this is possible only because of the uniqueness of the zero point in accounting. the excerpt highlights the fact that a ratio scale is created when accounting information is analysed with the use of ratios. the extract also points out that a ratio scale is created when the monetary amounts representing the value of current assets are divided by the monetary amounts representing the value of current liabilities to produce a current ratio. this division implies that the relationship between the number of monetary units assigned to represent the value of an asset and the asset’s value is identical to the relationship between the numbers of monetary units assigned to indicate the value of a liability and the liability’s value. but ryan et al. (2002) note that there is no agreement relating the number of monetary units assigned to 434 sajems ns 13 (2010) no 4 represent the value of a commodity and the value of a commodity. thus the relationship between the number of monetary units assigned to represent the value of a commodity and the value of a commodity is ambiguous, and this relationship cannot be precisely specified. indeed, it is clear that the relationship between current assets and current liabilities assumed in the creation of the current ratio cannot be empirically tested. it can therefore be concluded that the equality of ratios between current assets and current liabilities cannot be empirically tested. according to stevens (1951) measurement is possible because there is a kind of isomorphism between the empirical relations among objects and events and the numerical structures that represent them. this means that phenomena that cannot be precisely defined are not measurable. since the relationship between the value of an asset or a liability and the number of monetary units used to represent it is not specified, the existence of such isomorphism cannot be verified. the measurement of intervals of monetary units is a ratio scale, but this does not mean that the monetary amount as a measure of the value of an asset or a liability is also a ratio scale. this is because value is subjective and as a result it is currently unknown whether value is measurable on a ratio scale. the ratio character of monetary unit measurement is based on the numerical representation of monetary intervals so that the value associated with the concatenation of adjacent intervals is the sum of values associated with those intervals. that is to say, monetary units can be represented on a number line. furthermore, the concatenation of adjacent intervals of monetary units has, as far as is known, nothing empirically to do with the value of an asset or liability. ryan et al. (2002) point out that monetary units have a standard scalar but there is no agreement relating them to a concept of value. if there is no reason to incorporate the monetary units into an empirical structure of the value of an asset or a liability, then there is nothing empirical about the representation of the value of an asset or a liability that limits which monotonic transformations of monetary units can be used as indices of value. this suggests that the belief that value can be represented numerically is pre-theoretic. there is an extensive theory for monetary unit measurements leading to ratio scale representations, indicating that monetary units can be represented by natural numbers. no comparable structure exists for the measurement of the values of assets or liabilities. a ratio scale exists for monetary units, but there is no independent theory for the measurement of the value of an asset or a liability, other than the pre-theoretic conjecture that the value of an asset or a liability is a monotonic function of monetary units. moreover, there is no empirical relation between the notion of the value of an asset or a liability and the concatenations that pertain to the measurement of monetary units. it should also be pointed out that the division of current assets by current liabilities does not lead to a ratio scale, as the relationship between current assets and current liabilities is not specified. narens (2002) believes it is necessary to specify the mathematical relations between objects before the assignment of numbers takes place. in this case, what is related between assets and liabilities is not known, as it is not specified in the accounting literature. moreover, mclean (2006) considers value to be a subjective concept. it is evident from this that it is not possible to know the exact relationship between the amount of monetary units paid to acquire a commodity and its value. therefore, current ratios as well as other accounting ratios are not based on the ratio scale. from this discussion it can thus be concluded that the concept of a ratio scale is misapplied in the discipline of accounting. 9 summary and conclusions although accounting is currently considered to be a measurement discipline, there is no evidence to support this conviction. the presence of a scale indicates that a discipline is a measurement discipline. however, this study has concluded that there are no specified scales of measurement in accounting. rules for numerical assignments in accounting do not meet the criteria of a true scale of measurement. consequently, this casts doubt on the veracity of the belief that accounting is sajems ns 13 (2010) no 4 435 a measurement discipline. a recapture of some of the main issues discussed indicates that: • a scale is a rule of measurement that specifies the relationship between an empirical relational structure and a numerical relational structure. an example would be the use of a metre rule in the measurement of height. in abstract algebra a scale is referred to as a homomorphism. • a nominal scale is a simple classification system. it is at the bottom of the hierarchy of scales. it has properties that reflect only the identity of the phenomena it is measuring. it is used in the accounting discipline to classify the elements of financial statements. • an ordinal scale reflects the rank or order of the elements in a set. it discriminates between the elements in a set according to how much of the property an element in a set possesses. in the hierarchy of scales, it ranks higher than the nominal scale. it possesses the properties both of a nominal scale and of order. • an interval scale reflects the equality of intervals between successive elements in a set. it is a higher-ranking scale than the nominal and the ordinal scales. it possesses the properties of a nominal scale, ordinal scale and the equality of intervals. this scale has an arbitrary starting point. • a ratio scale reflects the equality of ratios among the elements in a set. it is a higherranking scale than the nominal, ordinal and the interval scales. it possesses the properties of the nominal, ordinal, and interval scales and the equality of ratios. this scale reflects the intrinsic properties of the object it is measuring. it has a true zero point. therefore, it can be concluded that, if accounting is to be considered a measurement discipline, its numerical assignments must be compatible with the concept of a scale in representational measurement. 10 recommendations accounting can be considered a measurement discipline only if it complies with the principles of representational measurement. in particular, numerical assignments in accounting should specify the scale of measurement that distinguishes the extent to which elements in a particular class possesses a specified a property. accounting should be redefined to incorporate the magnitudes that currently fall short of the qualities of measurements until such a time when it is fully developed as a measurement discipline. this recognizes the probable usefulness of numerical indices in accounting. physical indices describe pre-theoretical variables as a useful initial step towards the development of a theory of measurement of such a variable, but this must not be confused with the fundamental measurement of the variable. representational measurement theory helps clarify the status of a numerical assignment, whether indicant or measurement. references abdel-magid, m.f. 1979. toward a better understanding of the role of measurement in accounting. the accounting review, april:346-357. american accounting association, 1971. report of the committee on foundations of accounting measurement. the accounting review supplement, bhattacharya, p.b., jain, s.k. & nagpaul, s.r. 1986. basic abstract algebra, cambridge: cambridge university press. boyce, b.r., meadow, c.t. & kraft, d.h. 1994. measurement in information science. academic press limited. chambers, r.j. 1997. wanted: foundations of accounting measurement, abacus, (341):36-47. decoene, s., onghena, p. & janssen, r. 1995. representationalism under attack. journal of mathematical psychology, 39:234-242. 436 sajems ns 13 (2010) no 4 hawker, s. 2003. the little oxford dictionary, thesaurus and word power guide, oxford university press. ijiri, y. 1975. theory of accounting measurement. american accounting association. international accounting standards board (iasb), 2009, international financial reporting standards (ifrs), 2009: including international accounting standards (ias) and interpretations as at 1 january 2009. luce, r.d.; krantz, d.h.; suppes, p. & tversk, a. 1971. foundations of measurement, (vol. 1) additive and polynomial representations, new york: academic press. luce, r.d., krantz, d.h., suppes, p. & tversk, a. 1989. foundations of measurement, (vol. 2), geometrical, threshold, and probabilistic representations, new york: academic press. luce, r.d., krantz, d.h., suppes, p. & tversk, a. 1990. foundations of measurement, (vol. 3) representations, axiomatization, and invariance, new york: academic press. luce, r.d. & suppes, p. 2001. representational measurement theory. available http:// media.wiley.com / product_ data /except /87/ 04713788 0471378887.pdf. mattessich, r. 1964. accounting and analytical methods, homewood 3, irwin mclean, r. 2006. new concepts in measuring value in einstein (ed.) in the boardroom, john wiley & sons, inc. narens, l. 1981a. a general theory of ratio scalability with remarks about the measurement –theoretic concept of meaningfulness. theory and decisions, 13:1-70. narens, l. 1981b. on the scales of measurement. journal of mathematical psychology, 24:249-275. narens, l. 2002. a meaningful justification for the representational theory of measurement. journal of mathematical psychology, 46:746-768. ryan, b., scapens, r.w. & theobald, m. 2002. research method and methodology in finance and accounting (2nd ed.) mitcham, surrey: international, padstow, cornwall. russell, b. 1920. introduction to mathematical philosophy (2nd ed.) new york: macmillan. staubus, g.j. 1985. an induced theory of accounting measurement, the accounting review, january, 60(1):53-75. staubus, g.j. 2004. two views of accounting measurement. abacus, 40(3):265-279. stamp, e. 1981. why can accounting not become a science like physics? abacus, june:13-27. stevens, s.s. 1946. on the theory of scales of measurement. science, 103:667-680. stevens, s.s. 1951. mathematics, measurement and psychophysics in handbook of experimental psychology, new york: wiley. scott, d. & suppes, p. 1958. foundational aspects of theories of measurement. journal of symbolic logic, 23:113-128. tinker, t. 1985. paper prophets, a social critique of accounting. new york: praeger. vickrey, d. w. 1970. is accounting a measurement discipline?, accounting review, 45(4):731-742. willet, r.j. 1987. an axiomatic theory of accounting measurement. accounting and business research: 155-171. wolk, h.i., tearney, m.g. & dodd, j.l. 2001. accounting theory: a conceptual and institutional approach. south western college publishing. microsoft word 12 esposto sajems si(16) 2013.doc sajems special issue 16 (2013) : 127-136 127 labour market reform and potential inequality of outcomes: the australian story alexis esposto* faculty of business and enterprise, swinburne university of technology the global knowledge economy has transformed the world of work in the last four decades. over the last 40 years the australian economy underwent major structural change a phenomenon that was initiated in the united kingdom and the united states in the 1980s. this paper discusses and analyses institutional change characterised by the decentralisation of collective bargaining structures that began in the early 1980s. the paper analyses the impact of these reforms by providing a simple analysis of job creation over a thirty year period. the paper concludes that institutional labour market change can at times produce negative welfare outcomes, particularly as it relates to employment creation. the impact of these effects is increasing inequality of earnings in the labour force. key words: labour market, institutional change, earnings and income inequality jel: j080, 210, 510 1 the australian labour market in context since the mid-1970s nearly all oecd member countries, including australia, have experienced fundamental economic and social change. these developments have manifested themselves in a variety of ways, including rapid technological change, the freeing up of capital markets, increased overseas trade and substantial changes to the labour market (esposto & abbott, 2011; esposto, 2008). many economists and other social scientists have described these changes as the rise of the global knowledge economy (gke) (e.g. oecd, 1996; houghton & sheehan, 2000). the global knowledge economy is emerging from two defining forces, namely, the rise in the knowledge intensity of economic activities, and the increasing globalisation of economic affairs. the rise in knowledge intensity is being driven by the combined forces of the information technology revolution, and the increasing pace of technological change. globalisation, on the other hand, is being driven by national and international deregulation, transportation improvements and by the it related communications revolution (houghton, 2002). these forces are having a massive impact on nations, regions, firms, communities and individuals in the way in which they perform their daily activities and are required to adapt to such profound changes. these changes can cause both polarisation and convergence of nations, regions, and communities economically and socially. such polarisations manifest themselves in terms of increasing inequalities of income, earnings or wealth, not only between nations, but within and between regions, communities and individuals. others argue that we are now experiencing a period of convergence and that poverty around the world has actually declined and is likely to continue over the foreseeable future, particularly as a result of the rapid economic growth of china, india, brazil and russia (e.g. sala-i-martin, 2006). the way nations such as australia respond or tackle these challenges will be a major determinant of prosperity for the future. since the mid-1970s nearly all oecd member countries, including australia, have experienced fundamental economic and social change. these have manifested themselves in a variety of ways, including rapid technological change, freeing up of capital markets, increasing overseas trade and massive changes to the labour market. throughout this period, and especially during the 1980s and the 1990s, the australian labour abstract 128 sajems special issue 16 (2013) : 127-136 market experienced persistent levels of high unemployment and increasing inequality in the distribution of earnings. at the same time there had been rapid growth in different types of employment (esposto, 2008). in light of these massive changes, this paper analyses the impact of these reforms by providing a simple analysis of job creation over a forty year period. the paper is thus divided as follows: section 1 provides an introduction; section 2 discusses changes in the australian labour market; section 3 presents the various institutional reforms that occurred in australia over the last three decades; section 4 examines labour market change over a 40 year period; section 5 analyses upskilling in employment growth and hours worked; and section 6 provided a discussion of results and conclusions. 2 changes in the australian labour the australian labour market has experienced enormous change over the last three decades. a major feature of this change has been the increasing diversity in the nature of work and the types of employment in which australians are now engaged (vandenheuvel & wooden, 2000). for example, up until the 1970s, most australians workers were in permanent fulltime employment. during the early 1970s, just over one in ten worked in part-time employment – defined by the abs as employment that involves less than 35 hours per week. by 2002 nearly one in three employees were employed on a part-time basis. furthermore, in the early 1980s, alternative work arrangements began to flourish, especially casual employment. two major factors have contributed towards a trend that promotes labour market change, namely, demand and supply factors, and institutional forces. the desire of many workers to combine responsibilities and personal interests with participation in the labour market has impacted the supply side. an example hereof is the entry of many women into the labour market who combine home responsibilities with employment arrangements like casual and parttime work. similarly, students have become strong participants in the labour market by studying and working at the same time. the increasing diversity of employment types in australia has also been strongly influenced by demand factors. according to dunlop (2002), many product markets have changed considerably as a result of globalisation and technological change. this has generated a necessary response by firms to find ways to reduce costs and compete more efficiently in often increasingly volatile and uncertain markets … casual and part-time employment have provided opportunity for employers to do this (dunlop, 2002:156). government policy has also encouraged a move towards labour market flexibility, achieved largely, amongst other things, through the spread of enterprise bargaining and a corresponding decline in compulsory conciliation and arbitration, which was a key feature of australia’s industrial relations landscape prior to the 1980s (campbell & brosnan, 1999). these changes implemented by government over the past two decades continued the trend towards increasing diversity of job types, particularly the rise in part-time and casual employment (e.g. vandenheuvel & wooden, 2000). part-time and casual employment arrangements have taken a more prominent share of total employment, with a corresponding decline in the creation of permanent full-time employment (esposto, 2011). 3 institutional change in australia and abroad in australia, new zealand and the uk these changes in the labour market have been reflected in a corresponding institutional change characterised by the decentralisation of collective bargaining structures that began in the early 1980s (wooden & sloan, 1998). more recently, the australian government introduced further labour market deregulation in the form of legislation known as australian workplace agreements. a common feature of these countries was that, in relative terms, they had reasonable levels of union participation in their workforce, and trade unions played an important role in negotiating wages outcomes sajems special issue 16 (2013) : 127-136 129 for their members, as well as in national policy matters. the uk began the process of transforming industrial relations after the election of the thatcher government in 1979. the government’s strategy was to introduce a variety of laws which transformed the industrial landscape. the salient features of this process were the decentralisation of pay determination, the growth of plant and individual bargaining, and the decline in industrial action by unions and their membership (wooden & sloan, 1998:197). the changes in new zealand were far more dramatic, beginning with the employment contracts act in 1991. this had the effect of accelerating the process of change with the abolition of the award system, and trade unions losing a large number of industrial and legal rights (wooden & sloan, 1998:198). changes to the industrial relations system in australia did not occur with the same severity and speed. according to campbell and brosnan (1999) there was gradual but fundamental process of labour market deregulation, characterised by ‘slow combustion rather than big bang [the new zealand experience], and it continues to splutter and send out sparks’ (campbell & bronsnan, 1999:354). however, the changes have been of a fundamental nature, particularly in the way in which labour relations have been altered. what were the main changes to the industrial relations landscape in australia? wooden (2001) summarises five salient features of the major changes that have occurred in the australian industrial relations system over the last 20 years. the first relates to the spread of enterprise bargaining. the distinctive feature of the system was compulsory conciliation and arbitration, characterised by independent quasi judicial industrial tribunals that had the power to stipulate legally binding awards that were required to be arbitrated or certified by these tribunals (campbell & brosnan, 1999:354). this situation has changed considerably whereby most of the bargaining occurs at the enterprise level and the majority of the awards provide a starting point from which wages and other employment conditions are negotiated (wooden, 2001:244). a second significant feature concerns the role that trade unions now have in the bargaining process of wage determination and employment conditions. before 1993, the majority of industrial agreements would have required union participation. a third significant change has been the introduction of legislation (australia government, 1996) that gives employers the flexibility to use individually negotiated employment agreements that can either supplement and/or replace existing awards. changes to the role of industrial tribunals have also been a significant aspect of labour market deregulation, much of which has been designed to diminish their significance and power. furthermore, the role of the australian industrial relations commission (airc) in the arbitration of disputes has been reduced considerably, in the sense that it no longer has the power to impose arbitrated awards, and has been confined to disputes that relate to matters of awards and where the operation of essential services is in jeopardy (wooden, 2001:247). finally, the changing nature of industrial relations has impacted significantly on union membership. since the 1970s the proportion of employees who are members of a trade union has fallen by 19 percentage points (hawke & wooden, 1998: 76). whether this is entirely due to changes in industrial relations is difficult to ascertain. it is possible to argue that much of the decline in union participation has been due to changes in the composition of employment that favoured industries that would employ a traditionally non-unionised workforce, rather than changes to the industrial relations system: the most important changes … being the shifts in the industrial structure of employment, the relative decline in public sector employment and the relative growth of casual employment. our best guess is that the net effect of structural change was to reduce the overall unionization between 1982 and 1996 by somewhere between 40 and 45 per cent. (hawke & wooden, 1998:79) in summary, the australian experience centres around the fact that enterprise bargaining is in the process of replacing arbitration as the dominant industrial relations paradigm, with employers and employees now expected to negotiate their working conditions and productivity. these changes also form part of 130 sajems special issue 16 (2013) : 127-136 similar processes of deregulation of labour markets around the world, resulting from the emergence of the gke. recent changes: the fair work act of 2011 the fair work act commenced on 1 july 2009, commencing a new period of industrial relations in australia, as a response to the unpopular era of industrial relations in australia (actu, 2011). this new legislation replaced the unpopular workchoices legislation, which was a catalyst for the election loss of the howard government in 2007. the changes introduced by the fair work act aimed at restoring workers rights at work and included the following: • no more australian workplace agreement individual contracts; • a strong safety net through the national employment standards; collective bargaining rights, including a requirement to bargain in good faith; • rights to union membership and representation; • protection from unfair dismissal; and • a genuine independent umpire to resolve disputes (actu, 2011). while these changes were designed to cushion the increasing inequality of outcomes, an analysis of labour market change between 1971 to 2011 indicates that it has shown strong signs of polarisation of labour market outcomes. 4 labour market change and inequality of outcomes the changes discussed above have had a major impact on labour market outcomes in australia. table1 analyses total employment disaggregated to include changes for men and women in full-time and part-time work. fulltime employment for men exhibits strong signs of upskilling in terms of job creation with increases in the demand for skills occurring in the top two skills categories, where the shares grew by 10.7 and 2.6 per cent, respectively. all other skills categories fell, not only in terms of shares. the lowest skills level, skills v experienced a pronounced fall in employment. full-time female employment exhibited the same trend in terms of employment shares as full-time male employment. employment creation also declined in the lowest skills category. in terms of part-time jobs, employment growth occurred in all of the five skills categories for men and women. these changes were very strong ranging from 930 to 393 per cent in jobs created for men and women. however, part-time employment growth for men showed clear signs of deskilling. this can be seen by the decline in demand for skilled occupations and vocations (skills levels i, ii and iii) and increases in demand for lowskilled jobs (skills levels iv and v). women experienced a mixed pattern of skills level changes, favouring upskilling as shown by the growth in employment for managers and professionals (skill i) and the share growth in skills level i. these trends in upskilling reported in table 1 indicate that over the long term the australian labour market has shown clear signs of upskilling in full-time employment for males and females. similarly, there are strong signs of upskilling in part-time employment for women, but these are not as pronounced as those found in full-time work. conversely, for male part-time employment, the trends in employment growth show a clear pattern of deskilling. 5 upskilling in employment growth and hours worked this section extends the analysis carried out above by replicating the work of wooden (2000), looking at changes both in occupational employment and in the occupational composition of hours worked between 1989 and 2009. the reason for conducting an analysis of hours worked is to ensure that labour demand is measured more accurately, particularly across different types of occupations. for example, average hours worked in managerial and professional occupations tend to be higher than in lower skilled occupations. this is because people in these positions tend to work longer hours without pay. in the case of lower skilled sajems special issue 16 (2013) : 127-136 131 occupations such as sales and services, hours worked tend to be smaller because of the high incidence of part-time employment. table 1 change in share for full-time and part-time male and female employees by skills level, 1971-2011 skill level 1971 2011 employment growth (%) change in share (%) males full-time employees (‘000s) i managers/professionals 649.8 1 294.3 99.2 10.7 ii associate professionals 343.8 557.2 62.1 2.6 iii skilled vocations 832.6 934.8 12.3 -3.7 iv intermediate skills 790.8 882.3 11.6 -3.7 v elementary skills 559.3 488.7 -12.6 -5.9 total 3 176.3 4 157.2 30.9 females full-time employees (‘000s) i managers/professionals 161.5 811.4 402.4 21.3 ii associate professionals 98.3 366.2 272.5 7.4 iii skilled vocations 175.1 215.2 22.9 -5.8 iv intermediate skills 415.9 638.1 53.4 -8.2 v elementary skills 305.4 270.9 -11.3 -14.6 total 1 156.2 2 301.8 99.1 males part-time employees (‘000s) i managers/professionals 44.3 223.6 404.7 -8.8 ii associate professionals 14.6 94.7 548.3 -1.0 iii skilled vocations 26.3 172.6 556.4 -1.6 iv intermediate skills 33.3 261.8 686.3 1.9 v elementary skills 34.4 354.5 930.4 9.5 total 152.9 1 107.2 624.1 females part-time employees (‘000s) i managers/professionals 58.3 523.1 797.3 6.9 ii associate professionals 30.2 193.1 539.3 0.2 iii skilled vocations 41.4 204.2 393.3 -2.3 iv intermediate skills 110.8 733.5 562.0 2.0 v elementary skills 133.6 670.5 401.9 -6.8 total 374.4 2 324.4 520.8 source: abs census employment data for 1971. occupations are aggregated to asco 2nd edition major group. ‘inadequately described’ and ‘not stated’ are not included in calculations. estimates for 2011 are author’s calculations based on least square estimates. ‘casual’ and ‘permanent’ employees in the light of the enormous growth in casual employment it is important, in the context of this paper, to consider its definition and nature. casual employment has been defined differently by the australian arbitration award system, in common law, and by the australian bureau of statistics. the employment relationship which employees and employers enter into in australia is governed by the award system. in the majority of awards, the term ‘casual employment’ is poorly defined. as pointed out by owens (2001), the most significant attribute of a contract of employment for casual work is that the law sees each contract as separate (owens 2001:120). furthermore, there are two major features that highlight the difference between casual and permanent employment. the first is that each casual employment contract is treated as being unique in itself, and the second distinction is to be found in length of time provided in notices of termination. this can be found in the common law definition of casual work, which is summarised by brooks (1985). each engagement of a casual worker constitutes a separate contract of employment, and we can safely summarise the common law by saying that the only 132 sajems special issue 16 (2013) : 127-136 distinction of substance between the casual/ part-time employee and the full-time/ permanent employee lies in the period of notice required to properly terminate the contract (brooks, 1985:166). thus, according to the common law definition, casual employment contracts provide employees and employers with the flexibility of termination at short notice. in other words, whereas permanent employees enjoy a minimum period of notice of termination (at least one week), casual employees may not be given notice of termination, and may not always be required to be re-engaged once their contracts expire (burgess and campbell, 1998b:36). according to dawkins and norris (1990), another complexity can be found in the system of arbitral awards, wherein definitions of casual employment can vary considerably both within an industry and between different industries. it is evident that the common law definition is unable to capture all the characteristics of casual employment within specific or individualised contracts. because of this, many researchers regard casual employment as being a negative type, or a ‘substandard’ form of employment, emphasising the fact that the majority of these jobs are characterised by low pay, limited opportunities for career progression, lack of provision for training, low levels of union representation, reduction in employee influence over decision making in the workplace, increase in insecurity regarding the future of jobs, and diminished employee entitlements, such as lack of parental leave entitlements for long-term casuals (e.g. burgess & campbell, 1998a; acirrt, 1999; watts, 2001; campbell & burgess, 2001). for all the inconsistencies in definition and shortcomings in effects for the employees concerned, casual, part-time and fixed term employment have a number of positive attributes. for example, an analysis of the australian workplace industrial relations survey (awirs) which was conducted by wooden (2001) shows that casual and fixed term employment have both positive and negative traits. both permanent part-time and casual employees reported satisfaction with their jobs. casual and part-time employees also reported lower levels of stress compared with their permanent counterparts. significantly, permanent part-time employees reported high levels of satisfaction, which can be attributed to a higher average hourly rate of pay. interestingly perhaps, this group did not appear to be preoccupied about job insecurity. wooden also found that workers on fixed term contracts were more likely to report having influence over decision making, experienced lower stress levels and believed that they received reasonable payment for their work. they often also believed that their employers were likely to provide them with training opportunities (wooden, 2001). a different definition is provided by the abs, which defines ‘casual’ employees as those who were entitled to neither paid holiday leave or paid sick leave, or both, in their main job’. in contrast, ‘permanent employees’ are defined as ‘employees who were entitled to paid holiday leave or sick leave in their main job’ (abs cat. no. 6310.0:2002). according to wooden and warren (2003), the abs definition has a number of limitations. firstly, like most surveys, it has reporting deficiencies. for example, respondents may confuse the actual receipt of entitlements with access to entitlements and may, as a result, make a reporting error. secondly many respondents may not be able to report information about leave entitlements, in which case the abs may code these answers as being negative, and may as a consequence inflate the incidence of casual employees. thirdly, the abs definition of an employee includes owner-managers. many owner-managers who respond to the abs survey may say that they do not provide themselves with either sick leave or paid annual leave entitlements, and may be overstating the number of casual employees (see also for example, murtough & waite, 2000; campbell and burgess, 2001, for a more detailed discussion). finally, the abs survey categorises all employees as either casual or permanent without making provision for those who are on fixed term contracts. most of these are entitled to paid sick and annual leave, and as a result they may be assigned to the criteria of permanent employment status in the survey (campbell & burgess, 2001:89). in spite of these limitations, the abs survey is extremely valuable in the analysis of labour market sajems special issue 16 (2013) : 127-136 133 change. it is historical in perspective, it allows researchers and policy makers to trace how the pattern of casual and permanent employment has changed over time, and it provides much information related to the incidence, characteristics and profile of the casual employment labour market. table 2 shows the growth in employment for men in full-time permanent and casual employment. the changes in employment show clear signs of polarization when comparing employment creation in permanent and casual work. the striking features of these changes are revealed in the share changes. in permanent employment it can be seen that employment growth has shown clear signs of upskilling, where the share growth in the number of persons and hours worked grew in the top three skills levels, but declined in skills iv and v. table 2 growth in male permanent and casual full-time employment and aggregate hours worked per week by skills level category, august 1989 to august 2009 skills category employment (000s) aggregate hours (millions) net change (%) share change (%) male permanent full-time 1989 2011 1989 2011 persons hours persons hours i managers/professionals 707.8 1,136.6 30.6 50.4 60.6 64.8 9.5 8.6 ii associate professionals 381.8 478.9 15.9 21.5 25.4 35.4 1.4 1.5 iii skilled vocations 846.2 754.0 32.9 31.7 -10.9 -3.6 -5.4 -5.1 iv intermediate skills 755.8 823.0 30.2 35.9 8.9 18.9 -0.7 -0.3 v elementary skills 510.2 398.5 20.1 16.8 -21.9 -16.6 -4.8 -4.8 total 3 201.8 3 591.0 129.6 156.3 12.2 20.6 male casual full-time 1989 2011 1989 2011 persons hours persons hours i managers/professionals 49.3 53.9 2.5 2.3 9.3 -9.1 -8.3 -11.6 ii associate professionals 23.9 32.5 1.2 1.4 35.8 17.2 -2.5 -3.9 iii skilled vocations 62.5 98.8 2.6 4.5 58.1 74.8 -3.3 -0.2 iv intermediate skills 52.8 137.6 2.3 6.0 160.7 158.7 10.1 10.4 v elementary skills 45.9 99.4 1.8 4.1 116.6 128.4 4.0 5.2 total 234.3 422.2 10.4 18.3 80.2 75.8 source: abs cat. no. 6310.0, 1989 and 2011 issues. disaggregated data provided by the abs. estimates for 1989 derived by applying concordance weights as per esposto’s methodology (2008:110-113). author’s calculations. for casual full-time work, the growth pattern is reversed indicating clear sings of downskilling. this is manifested by growth in the share of employment in the bottom two skills levels and declines in the share of employment growth in terms of persons and hours worked in the top three skills levels. for women the changes are not too dissimilar to those experienced by men in fulltime work. in full-time permanent employment, women experienced clear signs of upskilling of employment outcomes, whereas in casual work, the experience was more uneven. the share change experienced no change in skills level i, there was a decline in skills level ii and it fell for skills level v. these findings clearly show that job creation in australia is biased towards occupations that are of a permanent nature in full-time work, but not in casual fulltime work, indicating clear signs of polarisation of employment outcomes. these changes may be interpreted as increasing inequalities of employment outcomes. upskilling in job types: permanent and casual part-time employment table 2 shows changes in the share of aggregate hours and employment in part-time work. the demand for male part-time permanent employment declined in terms of total hours worked, indicating clear signs of deskilling, especially in total hours worked. this trend 134 sajems special issue 16 (2013) : 127-136 was more pronounced in part-time work for men, where the demand for work declined in terms of persons and hours worked. part-time employment for women experienced skillsbias in the demand for labour in permanent work and strong signs of polarization in casual part-time employment. table 3 growth in permanent and casual female full-time employment and aggregate hours worked per week by skills level category, august 1989 to august 2011 skills category employment (000s) aggregate hours (millions) net change (%) share change (%) female permanent full-time 1989 2011 1989 2011 persons hours persons hours i managers/professionals 350.3 872.5 13.4 37.1 149.1 176.9 18.6 17.8 ii associate professionals 152.6 308.9 5.9 12.6 102.4 113.8 4.2 3.7 iii skilled vocations 296.6 176.8 10.7 7.1 -40.4 -33.6 -11.0 -10.6 iv intermediate skills 468.5 631.8 17 25.3 34.8 49.0 -1.9 -1.4 v elementary skills 306.2 222.0 11.1 8.7 -27.5 -21.7 -9.9 -9.5 total 1 574.2 2 211.9 58.1 90.8 40.5 56.4 female casual full-time 1989 2011 1989 2011 persons hours persons hours i managers/professionals 15.8 31.1 0.6 1.3 96.6 112.0 -1.0 0.0 ii associate professionals 11.4 17.3 0.6 0.7 51.6 23.7 -3.5 -7.1 iii skilled vocations 13.5 9.9 0.5 0.4 -27.0 -15.2 -9.8 -8.6 iv intermediate skills 22.4 76.9 0.8 3.0 243.1 271.0 16.4 17.1 v elementary skills 26.1 50.2 1 2.0 92.5 101.4 -2.1 -1.4 total 89.2 185.3 3.5 7.4 107.7 112.0 source: abs cat. no. 6310.0, 1989 and 2011 issues. disaggregated data provided by the abs. estimates for 1989 derived by applying concordance weights as per esposto’s methodology (2008, pp. 110-113). author’s calculations. table 4 growth in employment and aggregate hours worked per week by skills level for male and female permanent and casual part-time employment, august 1989 to august 2011 net change (%) share change (%) net change (%) share change (%) male permanent part-time male casual part-time persons hours persons hours persons hours persons hours i managers/professionals 464.3 353.7 4.8 -1.4 134.3 156.7 -0.7 -0.9 ii associate professionals 254.5 214.6 0.9 -4.8 2.0 38.8 -7.7 -5.6 iii skilled vocations 345.3 341.2 0.5 -0.9 35.1 65.4 -5.6 -5.9 iv intermediate skills 485.5 499.9 -2.3 5.6 190.9 254.6 4.0 6.8 v elementary skills 401.3 404.1 -4.0 1.5 213.4 221.5 10.1 5.7 total 409.6 376.4 151.8 181.4 female permanent part-time female casual part-time persons hours persons hours persons hours persons hours i managers/professionals 280.4 339.9 9.3 9.8 278.0 261.2 6.9 6.0 ii associate professionals 119.5 166.3 -1.8 -1.3 -42.7 -39.6 -7.2 -8.8 iii skilled vocations 46.9 59.4 -6.3 -6.8 -36.8 -36.5 -8.0 -9.8 iv intermediate skills 256.4 309.1 9.5 10.1 101.8 146.6 8.6 11.5 v elementary skills 69.9 82.1 -10.7 -11.8 54.6 78.1 -0.2 1.0 total 166.5 203.0 9.3 9.8 55.3 73.9 source: abs cat. no. 6310.0, 1989 and 2011 issues. disaggregated data provided by the abs. estimates for 1989 derived by applying concordance weights as per esposto’s methodology (2008, pp. 110-113). author’s calculations. sajems special issue 16 (2013) : 127-136 135 6 conclusion two main conclusions are arrived at in this study. the first is that the australian labour market exhibited strong signs of upskilling in terms of occupational growth in aggregate over the long term (i.e. between 1971 and 2011). upskilling was also detected when the analysis focused on job types. when occupations were disaggregated into full-time and part-time male and female employees, different trends were observed in different job types. there were very strong signs of upskilling in male and female full-time jobs, where the labour market exhibited strong growth in employment in highly skilled occupations and declines in lowskilled occupations. in terms of part-time employment, there were strong signs of deskilling for men, whereas women experienced upskilling trends. the second conclusion is that over the period of 1989-2011, the patterns of upskilling are mixed for different job types in terms of total employment and total hours worked. permanent male and female full-time employment exhibited clear signs of upskilling both in terms of employment growth and hours worked but this was not the case in casual fulltime work for men and women. women in part-time work experienced upskilling trends in permanent work and polarisation in casual employment. men, on the other hand, indicated clear signs of downskilling in terms of permanent and casual part-time work. the implication of these changes can be regarded as serious, given that potentially they are likely to create greater levels of inequality in the labour market. thus, it is concluded to ensure that heavy institutional reform towards liberalization of the labour market has had a negative result in terms of labour market outcomes. furthermore, the changes described in this section reveal that australia may be experiencing a different scenario of the skill bias technical change (sbtc) hypothesis. it is clear that if wages are inflexible downwards in the australian labour market, but there exists a flexibility of job types (i.e. full-time and parttime permanent employment, and full-time and part-time casual employment, including fixed term employment), one way in which employers may reduce wage costs is by opting to employ workers on a part-time or casual basis. so, if wages are inflexible downwards (i.e. there exists a minimum wage protection scheme regulated by government) but the type of job creation is flexible in nature and this provides a lower cost alternative to employers, then this links to the sbtc hypothesis and job types. this may explain the rise and concentration in employment creation at the very top (e.g. as in the case of most skilled occupations or individuals) which is accompanied by increasing wages, whilst at the same time we see a decline in permanent full-time employment creation from the middle to the bottom of the employment distribution. this decline is then evidenced in a corresponding increase in parttime and casual employment creation occurring from the middle to the bottom of these types of employment distributions. acknowledgement the authors are grateful to the valuable comments made by the reviewers. *corresponding author contact alexis esposto, aesposto@swin.edu.au references australian bureau of statistics (abs). 1986. australian standard classification of occupations/classification and classified list of occupations: link file, cat. no. 2199.0, canberra. australian council of trade unions (actu). 2011. the fair work act: two years on: a review of labor’s changes to workplace laws. available at: http://www.actu.org.au/images/dynamic/ attachments/7201/the_fair_work_act_two-years_on.pdf [accessed 2013-07-01]. australian centre for industrial relations research and training (acirrt). 1999. australia at work: just managing? sydney: prentice hall. 136 sajems special issue 16 (2013) : 127-136 australian government. 1996. workplace relations act, canberra. available at: http://www. comlaw.gov.au/details/c2006c00104 [accessed 2013-07-02]. brooks, b. 1985. aspects of casual and part-time employment. journal of industrial relations, june, 27:158-177. campbell, i. & brosnan, p. 1999. labour market deregulation in australia: the slow combustion approach to workplace change, international review of applied economics, 13(3):353-394. burgess, j. & campbell, i. 1998a. the nature and dimensions of precarious employment in australia, labour and industry, 9(1):31-54. burgess, j. & campbell, i. 1998b. casual employment in australia: growth, characteristics, a bridge or a trap? economic and labour 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economy, supporting paper no.1, centre for strategic economic studies, victoria university of technology, melbourne. houghton, p. & sheehan,p. 2000. a primer on the knowledge economy, working paper 18, centre for strategic economic studies, victoria university of technology, melbourne. available at: http://www.cfses. com/documents/knowledgeeconprimer.pdf [accessed 2013-07-01]. murtough, g. & waite, m. 2000. the growth of non-traditional employment: are jobs becoming more precarious? staff research paper, productivity commission, canberra. organisation for economic co-peration and development (oecd). 1996. the knowledge-based economy, oecd, paris. owens, r. 2001. the “long-term or permanent casual” – an oxymoron or a “well enough understood australianism.” australian bulletin of labour, 27(2):118-136. sala-i-martin, x. 2006. the world distribution of income: falling poverty and convergence period, quarterly journal of economics, 121(2):351397. vandenheuvel, a. & wooden, m. 2000. 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(ed.) understanding and reducing unemployment: national and state perspectives: 69-83, office of economic and statistical research, queensland treasury, brisbane, 2000. watts, r. 2001. the actu’s response to the growth in long-term casual employment in australia, australian bulletin of labour, 27(2):137-149. wooden, m. 2001. are non-standard jobs sub-standard jobs, australian social monitor, march, 3:65-70. wooden, m. 2000. the changing skill composition of labour demand, australian bulletin of labour, 26(3):191-198. wooden, m. & sloan, j. 1998. industrial relations reform and labour market outcomes: a comparison of australia, new zealand and the united kingdom, in debelle, g. and borland, j. (eds.) unemployment and the australian labour market, reserve bank of australia, sydney. wooden, m. & warren, d. 2003. the characteristics of casual and fixed-term employment: evidence from the hilda survey, melbourne institute working paper no. 15/03, melbourne institute of applied economics and social research, university of melbourne. microsoft word 3 gerber et al sajems 17(4) 2014.doc 396 sajems ns 17 (2014) no 4:396-411 an analysis of fundamental concepts in the conceptual framework using ontology technologies marthinus cornelius gerber department of accounting, university of pretoria aurona jacoba gerber cair, csir meraka and department of informatics, university of pretoria alta van der merwe department of informatics, university of pretoria accepted: march 2014 the interpretation of financial data obtained from the accounting process for reporting purposes is regulated by financial accounting standards (fas). the history and mechanisms used for the development of ʻthe conceptual framework for financial reporting’ (the conceptual framework) as well as the financial accounting standards resulted in impressive volumes of material that guides modern financial reporting practices, but unfortunately, as is often the case with textual manuscripts, it contains descriptions that are vague, inconsistent or ambiguous. as part of the on-going initiatives to improve international financial reporting standards (ifrs), the international accounting standards board (iasb) promotes the development of principle-based ifrs, which aim to address the problems of vagueness, inconsistency and ambiguity. this paper reports on the findings of a design science research (dsr) project that, as artefact, developed a first version ontology-based formal language representing the definitions of asset, liability and equity (the fundamental elements of the statement of financial position as defined in the conceptual framework) through the application of knowledge representation (ontology) techniques as used within computing. we suggest that this artefact may assist with addressing vagueness, inconsistencies and ambiguities within the definitions of the conceptual framework. based on our findings, we include suggestions for the further development of a formal language and approach to assist the formulation of the conceptual framework. the project focuses on the conceptual framework for financial reporting after the incorporation of phase a in the convergence project between the financial accounting standards board (fasb) and iasb. key words: accounting ontology, formal ontology, financial accounting standards, conceptual framework, knowledge representation jel: m41 1 introduction a clear, consistent and unambiguous world is not the reality which accountants encounter when they compile financial statements or reports governed by financial accounting standards (bhimani, 2008; schipper, 2003; tweedie, 2007; wüstemann & wüstemann, 2010). the history, some of the mechanisms used to develop these standards as well as the concomitant interpretations of both us gaap and ifrs standards, often resulted in vagueness, inconsistencies and ambiguities in the conceptual framework and financial accounting standards (fasb, 2009). the financial accounting standards board (fasb) does acknowledge vagueness and inconsistencies as is evidenced in the following statement: ʻthe board believes that financial reporting is both simplified and improved by removing obsolete financial accounting standards, eliminating inconsistencies, providing certain clarifications to reflect the board’s intent’ (fasb, 2009). financial accounting standards are used to regulate the interpretation of the accounting abstract sajems ns 17 (2014) no 4:369-411 397 data and the generation of financial statements (camfferman & zeff, 2009; ifrs, 2011). financial statements are the result of the financial reporting process, which involves gathering the financial data of a business or entity during a specific time frame, interpreting this data and then reporting the results to the various users of the financial statements (edwards, 1989; ifrs, 2011). across all continents and in most countries financial accounting standards are maintained and revised by standard setting bodies. at present the two international bodies which are the most prominent drivers behind global financial accounting standards are the united states based fasb (fasb, 2014) and the london-based iasb (iasb, 2014). one of the first joint projects upon which the fasb and iasb agreed was the development of a common conceptual framework to assist the standard setters in developing, revising and interpreting financial accounting standards (fas) (booth, 2003; bullen & crook, 2005). the stated objective of the joint conceptual framework project between the fasb and the iasb was to create a sound foundation for future fas that are principles-based, internally consistent and internationally converged (fasac, 2004; bullen & crook, 2005). in any standardisation effort, definitions and principles of a specific semantic domain are used as foundations for the standardisation process. in the accounting domain where stakeholders should interpret financial data consistently, definitions and principles should support the process and should not be vague, inconsistent or ambiguous. in computing there are new knowledge representation tools with the potential to address the issue of vagueness and inconsistency within semantic domain vocabularies. these tools are for instance used for the development of formal languages (aka ontologies) that are supported by technologies such as reasoners. ontologies are formalisations based upon description logics (dls), a decidable fragment of first-order logic (baader & nutt, 2003; gruninger, bodenreider, olken, obrst & yim, 2008). dls are a family of knowledge representation languages which are equipped with a formal semantics that provides a precise specification of the meaning represented without ambiguity. furthermore, reasoners exist that implement logical deduction from the ontological assertions to infer additional information and consequences from the facts stated in the ontology. if asserted facts contradict each other, the inferencing of the reasoners would indicate an inconsistency (krotzsch, simancik & horrocks, 2012; baader & nutt, 2003). as stated, ontologies are often constructed in such a manner that they represent a formal language for a conceptual domain, necessarily eliminating ambiguities because the ontology engineer is forced to state assumptions explicitly. the reasoning tools facilitate the development of the language by extraction of all the logical implications, including whether all the statements in the language are inherently consistent and not contradictory. such a formal language represented in an ontology typically describes a hierarchy of concepts within a domain and associates each concept's crucial properties with it in a precise and logical manner (bussler, fensel & maedche, 2002). this paper reports on the first version artefact developed during a design science research project. the artefact is an ontologybased formal language for the definitions of asset, liability and equity to support the published, textual version of the conceptual framework for financial reporting. the paper is structured as follows: section 2 provides background information on the conceptual framework and financial accounting standards and the position of the conceptual framework, and it describes related concepts. section 3 presents some background on ontologies within computing as well as related work. in section 4 we discuss the research approach. section 5 describes the construction of the artefact, namely an ontology-based formal language followed with the evaluation of the artefact in section 6. our findings are discussed in section 7 and a conclusion is presented in section 8. 2 the conceptual framework and financial accounting standards 2.1 a brief history of the conceptual framework accounting as a discipline developed centuries ago, primarily because of the need to control 398 sajems ns 17 (2014) no 4:396-411 assets (green, 1974; edwards, 1960) and to record and report on financial transactions to investors and other users of financial statements (edwards, 1996). over time transactions became more sophisticated with greater demands on this recording and therefore a set of generalised rules was developed (riahibelkaoui, 2004). this marked the beginning of accounting practice, as these rules were developed to guide the orderly processing and more consistent reporting of financial data. as business became more sophisticated, the associated accounting practice evolved as well, but in a rather haphazard fashion. as result, the accounting rules became more voluminous and, in general, lacked consistency and coherence (lee, bishop & parker, 1996; vorster, 2007; edwards, 1989). in the second half of the nineteenth century, several factors contributed towards the develop ment of a body of accounting theory and the standardisation of accounting practices (coffman, tondkar & previts, 1993; vorster, 2007). several developments in this arena in the us culminated in the establishment of the fasb with the objective to formulate a conceptual framework of accounting (storey & storey, 1998). soon after its inception in 1978, the fasb published statements of financial accounting concepts no. i, entitled sfac1objectives of financial reporting by business enterprises. since then, a number of sfacs have been issued by the fasb, as a whole constituting what became known as the fasb conceptual framework (coffman et al., 1993; edwards, 1989; storey & storey, 1998). similar developments took place in europe, and in 2001 the iasb adopted the framework for the preparation and presentation of financial statements (camfferman & zeff, 2009), which is based on the fasb’s conceptual framework but is not regarded as a financial accounting standard. in september 2002 a memorandum of understanding (the norwalk agreement) was signed between the fasb and the iasb (fasb & iasb, 2002), resulting in the joint conceptual framework project of the fasb and the iasb of 2004. the purpose of the project was the revision of the respective conceptual frameworks in order to refine, update, complete and join them into a new common conceptual framework with, as purpose, the presentation of a common framework for the development of new, as well as for the revision of existing, financial accounting standards (fasac, 2004). at a news release in september 2010 it was announced that the first stage of this joint project was complete (fasb, 2010). although the joint conceptual framework project was suspended on 17 november 2010 (fasb & iasb, 2010) the iasb decided on a meeting in may 2012 to continue with the conceptual framework project (iasb, 2012a; iasb, 2012b), but this time not as a joint project between the fasb and the iasb. the work in this paper is based on the conceptual framework published in september 2010 by the joint project. the methodology developed and the results reported in this project could assist with the remainder of the iasb conceptual framework project. 2.2 the position of the conceptual framework in financial accounting standards both the iasb and the fasb define the purpose of the financial accounting standards as a mechanism to guide accountants in detail to compile financial reports, and both view the purpose of the conceptual framework to be to assist standard setters in developing and revising financial accounting standards. the conceptual framework, therefore, should provide the foundation and context for the development of financial accounting standards (camfferman & zeff, 2009; ifrs, 2011). the fasb and iasb differ in the scope of the stated purpose of the conceptual frameworks, but at present both the iasb and the fasb state that the conceptual framework does not override financial accounting standards. in this respect it has a lower status than specific financial accounting standards (fasac, 2004). the conceptual framework contains a section discussing its purpose and status, the objective of general purpose financial reporting, qualitative characteristics of useful financial information and, lastly, the elements of financial statements, their recognition and measurement (ifrs, 2011). the challenge to develop a common conceptual framework that is sound, comprehensive, internally consistent, and globally sajems ns 17 (2014) no 4:369-411 399 acceptable is not trivial and it is aggravated by the fact that the domain of financial reporting is primarily a conceptual domain. however, the need for coherent financial accounting and reporting remains, thus requiring the fundamental concepts in a conceptual framework to be inherently consistent and unambiguous. as stated, the purpose of the present project is to investigate how ontology technologies could assist with the enhancement of the conceptual framework. the next section provides background on ontologies within computing. 3 formal languages and ontologies the concept ontology was inherited from philosophy and only recently became accepted in computing (palmer, 2001). the term ontology is currently popular and used to refer to anything from taxonomy, a domain vocabulary and a conceptual model, to a formal logicbased ontology (mcguinness, 2003). in computing an ontology is defined as a shared, formal, explicit specification of a domain, typically describing a hierarchy of concepts and associating each concept’s crucial properties with it (broekstra, klein, decker, fensel, van harmelen & horrocks, 2001). in this project we use the term ontology for a formal ontology specified in a machinereadable vocabulary. the construction and maintenance of ontologies greatly depend on the availability of logic-based languages equipped with a welldefined semantics and reasoning tools. dls provide both the well-defined semantics and the reasoning support (baader, calvanese, mcguinness, nardi, patel-schneider, borgida, lenzerini & rosati, 2003). arguably the most successful application area in this regard is the biomedical field (hahn & schulz, 2007; wolstencroft, brass, horrocks, lord & sattler, 2005), with two well-known ontologies, snomed ct1 and the gene ontology (go)2. snomed ct consists of more than 300 000 concepts and a million semantic relationships where ontology technologies made it possible to perform reasoning tasks on these large-scale medical ontologies in a relatively short time (golbreich, horridge, horrocks, motik & shearer, 2007). as is the case in with both snomedct and go, an ontology is often used to formally specify the terminology, concepts and characteristics in a domain, thus fulfilling the role of a formal language for a specific domain (bussler et al., 2002). 3.1 dls, owl and owl 2 semantics ontologies are formalised with logic-based languages. within computing, ontologies are defined as formalised vocabularies of terms of a domain of interest shared by a community of users (gruber, 1995; w3c owl working group, 2012). because of the standardisation efforts of the w3c with their web ontology language (owl), most ontologies are nowadays specified using owl. owl is the web ontology language, which is a language that specifies structural elements that users could use to construct ontologies (motik, patel-schneider & parsia, 2012). the language elements have formal meaning or semantics and the most recent owl recommendation is owl 2 (w3c owl working group, 2012). owl 2 specifies a number of profiles, which are sub-languages or syntactic subsets of owl 2, namely owl 2 el, owl 2 ql, and owl 2 rl. any profile ontology is also an owl 2 ontology and can be interpreted using the specified owl semantics. the direct semantics of owl 2 extends the semantics of the dl sroiq, specifically with regard to data types, and the link between owl and dls are that any ontology specified using owl 2 language elements could be translated into an ontology with dl axioms, and could therefore use logical inferences and reasoning to compute consequences (motik, patel-schneider & grau, 2012). the model-theoretic semantics for owl 2 is based on sets, and for this paper it is sufficient to note that, conceptually, owl 2 classes or concepts translate into sets. disjoint concepts are sets that do not intersect. sub-concepts are complete subsets of a super set. the topor thing-concept is the set containing the world or all possible individuals, and the noting-concept is the empty set, also used to indicate inconsistency if the set can never have any elements or individuals (motik, patel-schneider & grau, 2012). protégé, current version 4.3, is at present the most popular ontology engineering tool and is regarded to be the most mature. protégé 400 sajems ns 17 (2014) no 4:396-411 supports owl 2 and the install bundle includes several reasoners such as fact++ that could be used to compute logical consequences of the ontology statements. the protégé environment is open source and allows for extension by third party developers through plug-ins (protégé team, 2013; stanford, 2011). for our research project we used protégé with the bundled reasoners because of its availability, extensibility and adherence to international standards. at this stage the decision has been made to incorporate the dolce foundational ontology into the refinement of the ontology artefact during later design research artefact iterations (gangemi, guarino, masolo, oltramari & schneider, 2002), but that discussion is beyond the scope of this paper. the next section discusses some related work that used ontologies within the financial discipline. 3.2 related work an investigation of the literature indicated that formal ontologies with the associated technologies as focused on in this research have not readily been applied to the development of the conceptual framework. a similar approach was proposed in the work of teller (masquefa & teller, 2010), however the present work deviates from teller’s notion of syntactic and semantic modelling. masquefa & teller’s (2010) approach to develop an own formalism compromises the decidability and thus reasoning support of the formalism, and we decided to adhere to the underlying dl and owl representation language as standard in order to reap maximum benefit from the supporting ontology technologies. partridge (partridge, 2002a; partridge, 2002b) discusses some ontological choices necessary for the development of a conceptual framework from a philosophical perspective. we agree with this discussion and the necessity to argue the philosophical grounding of fundamental choices of accounting concepts as a topic of further research. 4 research approach this research project used design science research (dsr), which is research using design as a research method (vaishnavi & kuechler, 2004). the goal of a dsr project is to produce a purposeful artefact that addresses a pragmatic problem, especially in cases where elements of the problem will only arise during an attempted solution, or where the problem is not completely understood (hevner, a. r., s. t. march, j. park & s. ram, 2004; kuechler & vaishnavi, 2008). the driving dsr concept of ‘learning by building’ is especially relevant in cases where a study is testing previously untested interactions between existing artefact components, or where new, untried principles are introduced (kuechler & vaishnavi, 2011). dsr is an iterative activity where the solution artefact is developed through various cycles of awareness, suggestion, development and evaluation (vaishnavi & kuechler, 2004; kuechler & vaishnavi, 2011). crucial to dsr is the notion of rigour and relevance cycles, where relevance pertains to the interaction with the environment in which a real problem is identified and solved, and rigour pertains to the interaction with the scientific knowledge base where knowledge is used and contributed (hevner & chatterjee, 2010). in this research project the awareness of vagueness, inconsistencies and ambiguities within the conceptual framework resulted in a suggestion to use ontologies in computing to develop and ontology-based formal language to represent the concepts of the framework. for this drs project we analysed the textual definitions of the fundamental elements of the statement of financial position as defined in the conceptual framework document published by the iasb, and we developed as artefact the first version artefact that is an ontology-based formal language that represents the definitions of asset, liability and equity of the conceptual framework. within this development phase of the dsr project, we used an ontology engineering approach and development environ ment as discussed in the next section, section 4.1. the dsr evaluation phase evaluated whether these definitions could be formally represented, and whether the approach does assist with the identification of vagueness, ambiguity and inconsistency in the textual definitions. the results of the evaluation are discussed in section 6. the purpose of the dsr research project was to ascertain whether the sajems ns 17 (2014) no 4:369-411 401 use of ontologies and their associated technologies could assist with the specification of clear, consistent and unambiguous definitions of concepts in the conceptual framework through the development of a dsr artefact. 4.1 development environment the development of an ontology-based formal language for a domain commences with the construction of an ontology formally capturing the basic concepts and relationships of the domain. during the development cycle of the dsr project, we used as tools protégé 4.3 with bundled reasoners (e.g. fact++ and pellet) to develop an owl 2 ontology (w3c, 2009) that functions as a formal language for the selected basic definitions of the core elements necessary in the conceptual framework. as a development approach during the dsr development cycle, we incorporated an ontology engineering approach as described by horridge (2009) and noy and mcguinness (2000) that consisted broadly of the following steps: • identification of the concepts and concept hierarchy, including disjointness; • addition of all the relationships between concepts; • refinement of concepts based on relationships they participate in; • identification of definitions; • addition of annotations, which are used for metadata or descriptions of anything that we model; and • refinement of the ontology through various iterations of the above steps. the next sections discuss the execution of the above steps as ontology modelling with concepts and relations necessary to represent the accounting definitions in a formal language. 5 ontology-based formal language development when developing an ontology for any domain, it is usually beneficial to state assumptions about the domain and approach explicitly. 5.1 assumptions for this research project we: • adopt the view that the conceptual framework should encapsulate the basic definitions and principles necessary for the development of accounting standards; • assume the position that the textual representation of the conceptual framework, given the role that it should play, should be sufficient without any further explanations. it should not be necessary to explain concepts or statements from third party sources; • use only the current textual representation of the conceptual framework to develop the formal language and ontology; • regard situations where the published text is unclear, ambiguous or inconsistent, as omissions and propose that this should be amended; • accept the textual description as presented in the conceptual framework, but suggest that this could be augmented with an ontology-based formal language where the semantics are captured unambiguously; and • suggest that, if inconsistencies and ambiguities exist, they do not necessarily have to be solved as the solution may be complex, but they should at least be known. we furthermore use the terms consistency and inconsistency similarly to its use in knowledge representation with logic formalisms such as dls, which are equipped with a formal semantics or a precise specification of the meaning intended. when facts about a domain are asserted in the language creating an ontology, these facts allow for the use of logical deduction to infer additional information from the facts stated explicitly in the ontology through reasoning (krotzsch et al., 2012; baader & nutt, 2003). if facts in the knowledge base contradict each other, the reasoning would detect an inconsistency (antoniou & van harmelen, 2009). according to chapter 4 of the conceptual framework (iasb, 2011), the elements directly related to the measurement of financial position are assets, liabilities and equity. we semantically analysed the definitions and investigated whether these definitions are precise enough to be captured in an ontology to create a formal language. we represented the concepts and relationships using ontology technologies in 402 sajems ns 17 (2014) no 4:396-411 order to create a formal language for the definitions. the next sections discuss our modelling of the various concepts, and the first aspect we address is the notion of time. concepts such as past, present and future appear in the definitions in conceptual framework and standards, and the modelling approach adopted to represent these concepts has to be consistent throughout all the definitions. 5.2 modelling of time: past, present and future adding temporal dimensions to owl is not straightforward as owl’s specific logic-based formalism does not support the modelling of dynamically changing information (krieger, 2008). owl supports only unary and binary predicates and relations cannot directly be equipped with temporal arguments (connor & das, 2011). several solutions to the modelling of time in owl have been proposed in the literature, either by equipping the formal semantics (artale, guarino & keet, 2008; lutz, wolter & zakharyaschev, 2008; krieger, 2008), or through modelling constructs (hobbs & pan, 2004; ma, 2007; connor & das, 2011). an ontologist would choose a solution based on the requirements that the ontology should fulfil. in the basic definitions of the conceptual framework, the concepts past, present and future are pertinent. for the first version of our ontology artefact, we adopted a modelling solution, namely the basic temporal constructs of hobs and pan (2004) that defines (only) two classes of temporalentity namely instant and interval. the predicates begins and ends are the relations between instants and temporal entities, which we called temporal begins and temporalends in our ontology. the granularity of instants is not specified, and can, for arguments’ sake, be a date for example the date-of-reporting. the work of hobs & pan (2004) allows for several formalisms regarding time, and at this stage it seems to be appropriate for the modelling we require for our ontology artefact. unfortunately the conceptual framework definitions do not clearly state what is meant with past, present and future. it is straight forward to assume that past and future are intervals. present is problematic, and for the first version of our ontology, we made the choice to model present as an instant, with a member (individual) dateof reporting. past then has a temporalend which is the dateofreporting, and future temporal begins at the dateofreporting. this solution introduces nominals into our ontology, which could influence reasoning performance but the reasoning was still sufficient for our purposes. figure 1 present as an instant, with past and future as related intervals dateofreporting present past future figure 2: the formal representation of past, present and future internal ⊆ temporalentity ∩ ∃ temporalbegings.instant ∩ ∃ temporalends.instant temporalentity = instant ∪ interval present ⊆ instant future ⊆ interval past ⊆ interval dateofreporting : present future ⊆ ∃ temporalbegings.{dateofreporting} past ⊆ ∃ temporalends.{dateofreportin} 5.3 modelling an asset ʻan asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity’ (iasb, 2011). when we analysed and decomposed this sajems ns 17 (2014) no 4:369-411 403 definition, we identified resource, entity, event and benefit as disjoint concepts to be used for representing asset. the refinements on the concepts are formally represented in figure 3. figure 3 formal representation of asset pastevent ⊆ event ∩ ∃ happenin.past control ⊆ ∃ isresultof.pastevent entity ⊆ ∃ hastypeofcontrol.control controlledresource ⊆ resource ∩ ∃ iscontrolledby.control economicbenefit ⊆ benefit futureeconomicbenefit ⊆ economicbenefit ∩ ∃ happenin.future efeb ⊆ futureeconomicbenefit ∩ ∃ expectedby.entity asset = controlledresource ∩ ∃ from whichinflow.efeb in the modelling of asset, we found the following: • benefit has sub-concepts economicbenefit and futureeconomicbenefit. • the concept of control is implied because control is the result of past events. the concept of control needs further refinement in later versions. there are, for instance, different types of control. modelling control as a concept implies the introduction of object properties that relates entity to control via hastypeofcontrol and resource to control via iscontrolled by. a controlledresource is a resource that is controlled by a control. • the use of the term ‘expected’ is not clear. it could refine futureeconomicbenefit or flow (which is a relation). in other words, does the definition expect flow of benefit, or does it expect future economic benefit? we made the modelling decision to associate it with economic benefit and thus we created an expectedfuture economicbenefit or the efeb concept as a sub-concept of futureeconomic benefit that is also expected by an entity. • finally, the representation definition of an asset is a controlledresource and fromwhichinflow.efeb as depicted in figure 3. 5.4 modelling a liability ʻa liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits’ (iasb, 2011). we identified obligation and settlement as additional disjoint concepts necessary for modelling a liability. the refinements on the concepts are depicted in figure 4. figure 4 liability obligation ⊆ ∃ hassettlement.settlement ∩ ∃ isresultof.pastevent presentobligation ⊆ obligation ∩ ∃ happenin.present entity ⊆ ∃ hasobligation.obligation resourceembodyingeconomicbenefit ⊆ resource ∩ ∃ embodies.economicbenefit settlement ⊆ ∃ fromwhichoutflow.resourceembodyingeconomicbenefit expectedsettlement ⊆ settlement ∩ ∃ expectedby.entity liability = presentobligation ∩ ∃ hassettlement.expectedsettlement when modelling liability, we found the following: the outflow of resources embodying economic benefits refines settlement. however, this implies the addition of a concept resource embodyingeconomicbenefit that is a resource that embodies some economicbenefit. however, the concept and meaning of a resource embodying economic benefit needs clarification. according to the conceptual 404 sajems ns 17 (2014) no 4:396-411 framework only those resources that comply with the definition of an asset belong to the entity and can be recognised as assets of the specific entity. only those resources that can be defined as assets of a specific entity can embody an outflow of economic benefit. a specific entity cannot embody the outflow of any resource, but only resources that belong to that specific entity. this definition should be integrated with the definition of an asset. • the use and meaning of expected is problematic as it is again not clear whether it refines settlement or flow (which is a relation). does the definition expect the flow or expect the resulted settlement? we made a modelling decision to create an expectedsettlement concept as a settlement that isexpectedby some entity. • finally, the formal definition of a liability is a presentobligation and it hassettlement.expectedsettlement. 5.5 modelling equity ʻequity is the residual interest in the assets of the entity after deducting all its liabilities’ (iasb, 2011). analysing this definition, we identified interest as an additional and disjoint concept to be used for equity. residualinterest is a type of interest that has to be refined further as it is interest in assets after deducting liabilities. one way to formalise the notion of deduction in a dl ontology is through set difference or formally: b\a={x ∈ b | x ∉ a}3. for our definition it is viable to use set difference and therefore equity was initially modelled as asset and not liability. however, this definition of equity resulted in an inconsistency in protégé. the reasoner inferred that the equity and therefore asset concepts are inconsistent (or sub-concepts of nothing) as indicated in figure 5. figure 5 inconsistent definition of equity as asset minus liability. inconsistencies are sub-concepts of nothing the definition is inconsistent because, from the previous definitions, an asset is a refined resource and a liability is a refined obligation. an asset and an obligation are derived from different and disjoint concepts and therefore no concept can be created that is a combination of them, in this case deducting liability from asset. 5.6 further modelling of equity to remove the detected inconsistency, we did further semantic analysis of the definition of equity. the definition implies a value, or in the terminology of the definition, an interest to be associated with both assets and liabilities because residual interest is the result. sajems ns 17 (2014) no 4:369-411 405 the inconsistency in the text is caused by the implicit assumption that asset and liability have associated values, which also implies that equity must have a value, even though this implied value is never stated in the text. how this implied that values should be determined is also absent from the definitions. we therefore made a modelling decision to add assetinterest and liabilityinterest as types of interest specifically to be able to indicate that asset and liabilityhasinterest some asset interest and liabilityinterest respectively as indicated in figure 6. furthermore, using set difference for deduction in this ontology: • residualinterest is the set difference between interest and liabilityinterest. • another decision necessary here in order to model the set difference properly is that all interest is either assetinterest or liabilityinterest. • finally, the formal definition of equity is interest and not liabilityinterest. figure 6 equity defined through interest values residualinterest ⊆ interest assetinterest ⊆ interest liabilityinterest ⊆ interest interest ⊆ assetinterest ∪ liabilityinterest asset ⊆ ∃ hasinterest assetinterest liability ⊆ ∃ hasinterest liabilityinterest residualinterest ⊆ interest ∩ ¬ liabilityinterest equity = residualinterest 5.7 logical inferences of equity modelling in the protégé 4 ontology editor the inferred concept hierarchy depicts all the consequences of our asserted statements after the execution of reasoning. figure 7 presents the residual interest concept, which is defined as interest and not liabilityinterest in the right-hand window. the derived logical inferences indicate that equity = residual interest as well as that both equity and residual interest are sub-concepts of assetinterest. this derived information provides compelling evidence for the benefit of these technologies for tasks such as the creation of unambiguous definitions in the conceptual framework, especially when the domain is large and complex. 6 evaluation the purpose of the research project was to ascertain whether the use of ontologies and their associated technologies could assist with the specification of clear, consistent and unambi guous definitions of concepts in the conceptual framework through the development of a dsr artefact. our results indicate evidence that this is the case, as indicated below: • several unclarities exist with regard to concepts such as present, economic benefit, control, and expected. we made certain modelling choices with regard to the representation of these concepts resulting in definitions that are clearer, but these choices need to be verified by domain experts. however, for the purpose of our evaluation, ontologies assisted with the specification of the clear definitions of concepts. • during the representation of liability, we encountered the concept of a resource embodying economic benefit, which is potentially contradictory and needs clarifycation. the conceptual framework asserts that only those resources that comply with the definition of an asset belong to the entity and are recognised as assets of the specific entity. only those resources that can be defined as assets of a specific entity (not any resource as stated) can embody an outflow of economic benefit, as depicted in figure 8. with regard to our evaluation, this result provides evidence that ontologies could assist with ‘tightening up’ of definitions that are too vague. 406 sajems ns 17 (2014) no 4:396-411 figure 7 the inferred concept hierarchy with the inferred fact that residualinterest is assetinterest given the current asserted facts figure 8 only resources under control of an entity (i.e. assets) can embody an outflow of economic benefit from the entity, not any resource sajems ns 17 (2014) no 4:369-411 407 • inconsistencies: during the representation of equity, we modelled assertions exactly as stated in the text. this resulted in an inconsistency as an asset was defined as a refined resource and a liability is a refined obligation. assets and obligations are derived from different and disjoint concepts and therefore no concept can be created that is a combination of both. this result indicated that certain information, namely the value of an asset and liability, were implied and not stated explicitly. the approach therefore allowed us to detect inconsistencies in the stated text, as well as implied assumptions. • using the reasoners that computed the logical consequences of our asserted statements, it was possible to derive additional information, namely that equity = residualinterest as well as that both equity and residualinterest are subconcepts of assetinterest. these consequences need to be verified by domain experts, but the value of the unexpected results that could be derived from asserted facts is evident. such facts could be used to refine a model, and if consequences are not correct, it is necessary to revisit the assertions that, by logical implication, gave the inferred result. we argue that this is a powerful tool when standard setters refine the definitions in the conceptual framework. 7 findings we constructed a first version ontology-based formal language representing the definitions of asset, liability and equity. the results and experience indicate that it is plausible to argue that an ontology-based formal language could be constructed to support the conceptual framework. the most significant findings are that, even with basic assertions, it was possible to identify unclear and vague concepts, as well as contradictions, inconsistencies and the unexpected consequences of assertions that are not evident at first glance of the published text. furthermore, it was possible to create an ontology-based formal language for the definitions where the meaning is much less vague, even though there is not necessarily consensus about current language. vagueness, inconsistencies and ambiguities lead to an inconsistency in the model if they are not clarified and it could have several consequences for stakeholders using the basic definitions. during financial reporting important decisions are made based on these models and different decisions could lead to contradictory financial interpretations and reports. the refinement and usefulness of the artefact ontology-based formal language is a topic for further research, as well as the construction of an approach and environment for users to apply the formal language. in addition, ontology engineering is essentially a collaborative exercise and a formal language should reflect consensus about a domain. from the results we found in this first version of an ontology for the conceptual framework reported on in this paper, it is necessary to establish an initiative including all stakeholders for the further development of a formal language representing the conceptual framework. we summarise the additional findings as indicated below: • a formal ontology of the element definitions could only be constructed after making several modelling decisions about aspects that were unclear from the printed text. these decisions and interpretations are based on assumptions that may not be correct. however, any stakeholder intending to use the definitions will be confronted with the same ambiguities and lack of information and clarity. it is therefore useful to construct a formal model with explicit meaning that could be refined later rather than using an unclear definition. • familiarity with the logic of the dl languages remains a prerequisite for formal dl-based ontology construction, irrespective of the tools used. • the current tools (notably protégé 4.3 with its bundled reasoners such as fact++) are open source, but still provided us with sufficient support to construct our ontology. the availability of mature and standardised tools is an incentive to embrace a project such as described in this paper. however, it is important to note that available ontology tools still have limited functionality for example graphical interfaces as well as 408 sajems ns 17 (2014) no 4:396-411 complex explanations of derived consequences. the lack of tools that assist with ontology debugging, such as explaining an inference result, remains a significant drawback, especially when models are complex. 7.1 possible benefits for standard setters since ontology-based formal languages are based on concepts and the relations between the concepts, the concepts used must be clear and unambiguously defined. defining concepts unambiguously strips the concepts of assumptions that form part of the historical use of a concept, which, without precise clarification of the meaning of the concept, has the effect that different readers may attach different meanings to the same concept. the re-usability of unambiguous concepts is of value in the application of the concepts within the wider accounting domain such, as derived financial accounting standards with the associated interpretations. re-usability of concepts has the following benefits: i. the setting of well-crafted principle-based standards. ii. should assist standard setters to indicate how the principles in the standards compare with the conceptual framework. any departure from the principles could be explained in an annotation. a formal representation language empowers a standard setter to formulate a clear motivation on whether to accept or reject specific inconsistencies and ambiguities. as the meaning of a definition in a text is unambiguously clear, discussion between accountants could concentrate on the merits of a principle or concept (which may be inconsistent) from a theoretical perspective without getting trapped between the possible meanings of the different principles or concepts. furthermore, it is possible to compare and test consistencies between different definitions and concepts. 8 conclusion from the first version of the artefact construction of an ontology-based formal language for the conceptual framework, there is evidence that the construction of a formal language using ontology technologies could play a substantial role to enhance the quality, clarity and re-usability of the conceptual framework definitions. ontology statements are explicit and precise, and consequences of assertions can be exposed using reasoning technologies. such a formal language represents the required definitions of elements in a much more precise and unambiguous manner than the text format used at present and, when used in conjunction with the text, it should promote unambiguously, clarity and consistent financial accounting standards and interpretations globally. based on the results of our project, the following suggestions are proposed for inclusion into an approach that could address the enhancement of the conceptual framework: • the role and status of the conceptual framework within the financial accounting standards should be clarified. • for unambiguous financial accounting standards, the conceptual framework should possibly prescribe all definitions and principles that guide financial accounting standards and interpretations. the conceptual framework as semantic domain model should provide a complete representation of all the principles that would regulate the specific domain it represents. • if the conceptual framework provides the context and principles for financial accounting standards development, the content of the conceptual framework should be clearly specified. this content should include clear definitions of elements. all financial accounting standards and interpretations should preferably adhere to the conceptual framework definitions. any deviations from the set principles and definitions should be noted and explained. • from the work described in this paper there is evidence that tools such as ontology technologies could assist with the creation of clear and unambiguous definitions for inclusion in the conceptual framework. such tools should be identified and included in financial accounting standards development processes. • a rigorous ontology engineering approach should be adopted. this approach should include the participation of stakeholders in sajems ns 17 (2014) no 4:369-411 409 order to establish consensus about the core definitions, concepts and relations in the domain. • given the results of our investigation into the use of formal ontologies for the development of consistent and unambiguous definitions for the elements of the statement of financial position, we conclude that in the accounting world we can still live with inconsistencies if they are known, because we can manage them (e.g. the equity definition), but we cannot live with ambiguities even though they are known, because they can result in diverse interpretations with different results based on the same definitions and principles. endnotes 1 http://www.ihtsdo.org/snomed-ct/ 2 http://www.geneontology.org/ 3 dl is formally based on set 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(see karapatakis (1992) for a comprehensive literature review on financial repression.) our analysis builds on two recent studies, nag and mukhopadhyay (1998) and gupta (2006). analyzing the effects of financial liberalization on inflation for a small open economy, in the presence of informal money markets. nag and mukhopadhyay (1998) show that the new structuralist claim, propagated by van wijnbergen (1982, 1983, 1985 and 1986), of a tight monetary policy and interest rate deregulation, is severely altered when one allows for import penetration and flexible exchange rate. gupta (2006) extends the analysis of nag and mukhopadhyay (1998), by incorporating capital account mobility, relaxing the assumption of perfect wage indexation (which is typically not the case in a small open financially repressed country) and endogenizing money supply, to bring in the role of reserve requirements. the study concludes that financial liberalization and tight monetary policy cause deflation in an economy with a high degree of capital mobility. however, for economies with a low degree of capital mobility, the possibility of stagflation cannot be ruled out. the paper recommends financial liberalization in the form of lower reserve requirements for economies with restricted transactions in the capital account. even though both these studies are insightful, neither of them endogenizes expectations. this paper, therefore, basically extend gupta’s study (2006) by allowing agents to form expectations rationally. however, the model used in this paper only allows agents to choose from a variety of variables offered as state variables in the model, limited by the policy parameters, and, hence, the expectations, though freely and rationally chosen, are determined from within the model, and not through any arbitrary expectations equations as is the case for adaptive expectations. the expectations are, thus, endogenous. to the best of my knowledge, this study is the first to attempt to analyze the shortterm effects of financial liberalization based on rational expectations. u s i n g r a t i o n a l e x p e c t a t i o n s , i n s t e a d of exogenous expectations as in nag and mukhopadhyay (1998) and gupta (2006), this study shows that higher interest rates on deposits and tighter monetary policy are, unambiguously and unconditionally, deflationary. moreover, the effects do not depend on the degree of capital mobility. this study recommends that a small open developing economy should deregulate interest rates and tighten monetary policy if reducing inflation is a priority. the pre-requisite for such a policy, however, is the establishment of a flexible exchange rate regime. this paper is structured in the following fashion: besides the introduction and conclusion, section 2 lays out the economic environment and section 3 solves the model and discusses the effects of financial liberalization on the rate of inflation. 2 the model this model considers a small open economy, operating under a floating exchange rate regime, with one domestically produced good and two different types of imported goods (a consumption good and an imported intermediate good, used in the production of domestic output). the price of the domestic good is endogenous, whilst the price of the imported goods, both consumption and capital, are exogenous. the supply function of the importables is perfectly elastic at a foreign currency price of p*. since p* is parametrically given to the economy, it can be set to unity for the sake of simplicity. notice the implicit assumption that the production transformation schedule is linear for the imported consumption good and the intermediate good, so that the same technology applies to both kinds of importables and they sell for the same price of p*. sajems ns 10 (2007) no 1 109 repression is assumed to be severe enough to give rise to a umm, popularly called a curb market. the curb market is an informal credit market in which money lenders and indigenous banks intermediate between savers and borrowers, and are outside the realm of regulation by the monetary authority. because of the absence of reserve requirements, the curb market is often viewed as a competitive and agile credit market providing more efficient intermediation than the official banking system. moreover, since the banking system operates under interest rate regulations and high reserve requirements, the curb market can be viewed as a residual market that absorbs the excess demand for credit from the official banking system. firms unable to obtain low cost funds from the banking system at the regulated lending rate turn to the umm to satisfy their borrowing needs to finance intermediate input and physical capital requirement. the freely determined rate in the curb market is much higher than the deposit and loan rates in the official banking system, and reflects the true marginal cost of production. hence, the umm rate of interest appears as an argument in both the aggregate demand and aggregate supply side of the model. our model of a small open financially repressed economy is a modified version of the standard mundell-fleming model as outlined in argy (1994) and walsh (2000). the basic structure of the economy can be laid out by considering the factors of four interrelated markets, namely the production, commodity, money and foreign exchange markets. we start off with the labour market. unlike the standard mundell-fleming model, the aggregate supply curve in this model is not perfectly elastic but slopes upward under reasonable assumptions about wage-price flexibility. since this is a short-run model, the aggregate supply is determined by the conditions prevailing in the labour market and by the cost of the imported intermediate good requirement, as shown in equation 1: 1n q t s = – 1 [(1n t ) + r ct ] –  2 [1nw t – 1np t )] +  t (1) where, w, p d ,  and r c represent nominal wage, domestic price level, real exchange rate and real interest rate of the curb market, respectively, with  =sp*/p, where s is the nominal exchange rate;  i ’s > 0, i =1, 2 and  t ~n(0, svm ). equation 1 states that the quantity supplied is negatively related to the marginal cost of hiring one additional unit of labour and the intermediate imported input. note that wage cost is assumed to be financed through retained earnings of the firms. however, the intermediate input is purchased through loans from both banks and the umm. this is merely a simplification, and assuming that labour costs are also loan-financed, does not change our final results, but allows us to be parsimonious with the number of coefficients. the intuition is that the firms do not want to tie up their retained earnings with the foreign suppliers and, moreover, the foreign suppliers require advance payment and, hence, the firms’ reliance on loans. thus, the interest rate of the curb market, which reflects the true marginal cost of production, enters as an argument into the aggregate supply curve, as well as the real exchange rate. to analyze how the nominal wage rate is determined we need to focus on the labour market, and specifically the labour demand and supply equations. labour demand depends negatively on real wage, while labour supply follows a friedman-phelps type of function, where the same depends positively on the expected real wage rate. the intuition behind such a formulation is that labour supply decisions are made on the basis of a one-periodahead nominal wage contract, with nominal wages being contracted to achieve a target level of real wage, based on the price level expected to prevail during the period for which the contract is being drawn up. however, given that firms are fully aware of the price level when making their labour demand decisions, the latter depends on actual real wage. formally, 1n nt d = f 0 – f 1 (1nw t – 1np t ) + t (2) 1n nt s = f 2 + f 3 (1nw t – 1ne t–1 p t ) +  t (3) where f i > 0 , i=1, 2, 3, 4, f 0 > f 2 ,  t ~ n(0, sv| ) and t~ n(0, svl ). 110 sajems ns 10 (2007) no 1 imposing labour market equilibrium, =d st tn n , we can solve for the equilibrium nominal wage rate from equations 2 and 3 in terms of the price level and its expectations. we obtain the following relationship, 2 0 1 1 3 1 3 1 3 1 3 1 ln ( ln ln ) t tt t t t f f w f e p f p f f f f f f χ κ − − − = + + + + + + 2 0 1 1 3 1 3 1 3 1 3 1 ln ( ln ln ) t tt t t t f f w f e p f p f f f f f f χ κ − − − = + + + + + + (4) substituting 4 into 1, we have the aggregate supply equation as follows: 0 1 2 1ln (ln ) (ln ln ) s t t ct t t t tq b b r b p e p eρ −= − + + − + (5) where b i >0, i = 0, 1, 2, and b 0 = 2 0 2 1 3 ( )f f f f β − + , b 1 =  1 , b 2 = 2 1 1 3 f f f β + , e t = 2 1 3 ( )t t t f f κ χ λ β − + + and e t ~ n(0, 2eσ ). next, we turn our attention to the commodity market. the aggregate demand is positively related to the real exchange rate (), while real interest rate in the curb market (r c ) negatively influences the domestic investment demand and, hence, the aggregate demand. with the level of government expenditure (g) and foreign output (y f ,) treated as exogenous, the effects are captured in the disturbance term u. we postulate an is curve of the following nature: 1 2ln ln d t t ct tq a a r uρ += − (6) where a i ’s > 0, i= 1 and 2, and 2~ (0, )uu n σ . before we look into the money market, it is worthwhile briefly discussing the structure of the banking sector. the central bank sits at the apex of all monetary activities, and maintains stability by controlling the base money and credit availability in the economy. for this purpose, the central bank imposes reserve ratio requirements on commercial bank deposits and interest rate regulations on loans and deposits. the umm is outside the realm of the central bank and so is subjected to neither interest rate control nor reserve requirements. the freely determined interest rate of the curb market helps in clearing the money market. to incorporate the role of reserve requirements we endogenize the supply of money. the money demand equation is designed to follow the new structuralist understanding. given this, the nominal demand function for money is given as follows: 1 2 3ln ln ln d t t t d ct tm q y i iδ δ δ ξ− = + − + (7) where , , ,dt t d ctm y i i are respectively the nominal money demand, real gross domestic product, nominal interest rate on deposits and nominal interest rate on the curb market loans. q is the consumer price index (cpi). we define the cpi as lnq=jlnp+(1-j)lns, where j is the share domestic output in the cpi. note,  i ’s > 0, i=1,2,3 and 2~ (0, )n ξξ σ . following the new structuralist argument, we assume that a rise in the bank deposit rate causes a reallocation in households’ portfolios toward bank deposits at the expense of umm securities and not cash, thus causing money demand to increase. similarly, a rise in umm rate of interest causes a reallocation towards umm securities at the expense of bank deposits, thus causing money demand to decrease. this is not an irrational assumption for a developing country, especially when one realizes that most goods are cash goods and hence the demand for currency is pretty inelastic in relation to changes in opportunity cost variables. (see van wijnbergen 1982, 1983 and 1985; buffie, 1984; kohsaka, 1984 and lim, 1987; nag & mukhopadhyay, 1998 and nag, 2000, for the theoretical validity of such a formulation of money demand in a financially repressed economy, and van wijnbergen, 1982 and 1985, and lim, 1987 for empirical support of the same.) on the other hand, the money supply function can be formulated as follows. money supply is a sum of currency in circulation (c) and supply of bank deposits (d) and base money, or high powered money (h) is the sum of currency and reserves (r). thus (ms)/h= ((c/d)+1)/(c/ d+rr/d+er/d), where rr and er are required and excess reserves respectively, and ms is the nominal supply of money. alternatively, ms=((1+cu)/(cu+ +er))h, where cu is the currency deposit ratio,  the required reserve sajems ns 10 (2007) no 1 111 ratio and er the excess reserves to deposit ratio. simple intuition suggests that the currency deposit ratio and the excess reserve to deposit can be postulated as a negative function of y, and i d and a positive function of ic. the rationale for the sign of the currency-deposit ratio with respect to the interest rates is obvious, given that the currency demand is pretty inelastic with respect to interest rate movements. however, as y increases, both c and d rise, but, given that with the growth of banking habits, more payments are settled through banks, deposits increase at a faster rate than currency. hence, the currency-deposit ratio can be postulated to be negatively correlated with the level of income. on the other hand, as income and interest rates in the curb market increase, er falls and rises respectively. and as the interest rate on deposits rises, deposits rise and excess reserve holdings fall, since the interest rate on loans in the official banking sector is also increased to maintain profitability, causing er to fall. taking these arguments into account, and realizing that increases in cu and er reduce the money multiplier, the money supply function in log terms can be constructed as follows: 1 2 3ln ln lnst t dt ct t tm y i i hη η η γ ψ+= + + − + (8) where,  i ’s >0, i= 1, 2, 3 and 2~ (0, )n ψψ σ . combining 7 and 8 and realizing that the fisher relationship links the real rate of interest with the nominal rate of interest as 1ln lnct ct t t tr i e p p+= − + , we have the following equation from the money market equilibrium: 1 1 2 3( (1 ) ln ) ( ln ln )ln ln lnt t t ct t t t dt t tj j s p e p d vh p d r i d yγ +− + − = − − + + + + 1 1 2 3( (1 ) ln ) ( ln ln )ln ln lnt t t ct t t t dt t tj j s p e p d vh p d r i d yγ +− + − = − − + + + + (9) w h e r e , d i ’ s > 0 , i = 1 , 2 a n d 3 , 1 3 3 2 2 2 3 1 1,,d d dη δ η δ η δ= + =− + =− + , and t t tv ξ ψ= + with 2~ (0, )vv n σ . note that we are assuming that the money demand function is more elastic with respect to real income than the money supply. this assumption is required to ensure that the aggregate demand curve is negatively sloped. moreover, given that the new structuralists assume that an increase in the nominal interest rate on deposits will result in higher interest rate in the curb market to clear the money market, we have to assume that the money demand function is more elastic to nominal interest rate on deposits than the money supply function. the choice of the appropriate exchange rate regime is surely a controversial issue. but as nag and mukhopadhyay (1998) and nag (2000) point out, since developing countries depend to a significant extent on imports of intermediate inputs and lack growth of exports due to structural bottlenecks, it is difficult to maintain a fixed exchange rate regime. the tremendous pressure on the balance of payments in an open economic environment inevitably leads to the adoption of flexible policies of exchange rate. in this paper, we assume that the monetary authority allows the exchange rate to float freely. accordingly, the equilibrium in the foreign exchange market is given by the following equation: * 0 1 2 1( ln )/ ln ln ( ln )t t t ct t t t tc eb x c y r r ρρ ρ ϖ++ − −= − − + * 0 1 2 1( ln )/ ln ln ( ln )t t t ct t t t tc eb x c y r r ρρ ρ ϖ++ − −= − − + (10) where, c i ’s > 0, i=1 and 2, with c 1 >  1 , r* is the world real rate of interest. with foreign output (y f ) treated as exogenous, the effects are captured in the disturbance term () and 2 )~ (0,n ϖϖ σ . note c2 captures the degree of capital mobility. the parameter can range between zero to infinity, indicating no and perfect capital mobility, respectively. any positive intermediate value reflects imperfect capital mobility. equation 11 defines the overall balance of payments given initial exports (x 0 ), where the first four terms determine the current account balance. the last term gives us the capital account balance. equilibrium in the foreign exchange market would imply the balance of payments (bp) = 0. finally, to complete the model we need to specify the policy reaction function for highpowered money as follows: 1n h t –  + g 1 e t + g 2 u t + g 3 v t + g 4  t (11) the policy rule specified allows the policy maker to respond contemporaneously to supply shock, aggregate-demand shock, money-demand shock and shock in the foreign exchange market. our final result of financial liberalization on inflation 112 sajems ns 10 (2007) no 1 is independent of the choice of the policy rule. note  is a positive constant and g i >0 , i=1, 2, 3, 4. 3 solution and financial liberalization this section is devoted first to the solution of the model and then to analyzing the effects of interest rate deregulation and lower reserve requirements on domestic price level and output. equations 6, 9 and 10 constitute the is, lm and the bp curves, and along with 5 can be solved for y, r c , p and s, realizing that qd = qs = y. to obtain solutions for the model, we use mccallum’s (1989) minimum state variable (msv) approach, which involves postulating solutions for the endogenous variables of the model based on the minimum number of state variables of the model that defines the economy. then we simply use the method of undetermined coefficients to obtain the final solutions for the endogenous variables. hence, the postulated solutions for lnp, ln s, r c and lny are as follows: in p t =  0 +  1 e t +  2 u t +  3  t +  4 v t (12) in s t =  0 +  1 e t +  2 u t , +  3 m t +  4 v t (13) r ct =  0 +  1 e t +  2 u t +  3 m t +  4 v t (14) in y t =  0 +  1 e t +  2 u t +  3  t +  4 v t (15) where  1,  i,i,i,i = 1,2,3,4 are all positive constants.realizing that e t–1 1np t = e t 1np t+1 =  0 , e t–1 1ns t = e t 1ns t+1 =  0 , we have the following solutions to the coefficients of ln p t : sajems ns 10 (2007) no 1 113 note that we are treating the nominal interest rate on deposits, the world rate of interest and the reserve-requirements as time invariant, since these are exogenous variables. and, hence, they appear in 0. our analysis would not change if the variables were treated as time-variant, once we postulated the solutions for for lnp, ln s, r c and lny to include coefficients corresponding to i d , , . to study the effects of financial liberalization on domestic price level, we take the derivative of 0with respect to id, ,  to obtain –d2, –1,1. the results indicate that financial liberalization, in the form of an increase in the rate of interest on deposits, and tight monetary policy is unambiguously and unconditionally deflationary. moreover, the result does not depend on the degree of capital mobility, and the only pre-requisite for such an outcome is the establishment of a flexible exchange rate regime. moreover, given that the solution to output is unaffected by the change in the controlled nominal interest rate on deposits and reserve requirements. in rational expectation models, a policy is said to be neutral if the unconditional mean and variance of the solution of the output is independent of the policy parameters. so, in this sense, policy is neutral with respect to i d , , . however, monetary policy is not completely neutral, since even though the unconditional mean of the output is independent of the policy reaction function parameters (g i ’s), they appear in the variance of the solution of the output. notethat the following are the other coefficients of the postulated solution of the output: 114 sajems ns 10 (2007) no 1 interestingly, gupta (2006) obtains exactly the same results with perfect wage indexation but exogenous expectations. 4 conclusion and areas of further research this study modifies the standard mundellfleming model and analyzes the effects of financial liberalization on domestic price level and gdp. considering a small open financially repressed economy characterized by a umm, intermediate good imports, capital mobility and endogenous expectations, we show that interest rate deregulation is inflation-reducing. however, financial liberalization fails to affect output. the stagflationary outcome of interest rate deregulation, as claimed by the new structuralists, is thus not an obvious outcome in such an environment. this study thus recommends that a small open developing economy should deregulate interest rates and tighten monetary policy if reducing inflation is a priority. the pre-requisite, however, is establishment of a flexible exchange rate regime. as a future area of research, it would be interesting to analyze the long-term effects of financial liberalization on growth and inflation in a micro-founded dynamic general equilibrium endogenous growth model with a role for money. endnotes this paper was written as a follow-up to my paper titled, “financial liberalization and inflationary dynamics in the context of a small open economy”. references 1. argy, v. (1994) international macroeconomics: theory and policy, routledge: london and new york 2. buffie, e. (1984) “financial repression, the new structuralists, and stabilization policy in semiindustrialized economies”, journal of development economics, 14: 451-482. 3. gupta, r. (2006), “financial liberalization and inflationary dynamics in the context of a small open economy”, south african journal of economic and management sciences, 9: 89-101. 4. karapatakis, a. (1992) financial liberalization and inflation in a small open financially repressed economy: theory, and evidence from cyprus. dissertation, university of connecticut: usa. 5. kohsaka, a. (1984) “the high interest rate policy under financial repression”, developing economies, 22: 419-452. 6. lim, j. (1987) “the new structuralist critique of the monetarist theory of inflation: the case of philippines”, journal of development economics, 25: 377-386. 7. mccallum, t.b. (1989) monetary economics: theory and policy, macmillan: new york. sajems ns 10 (2007) no 1 115 8. mckinnon, r. (1973) money and capital in economic development, brookings institution: washington, d.c. 9. nag, r. (2000) “stabilization dynamics and nonbank financial intermediaries”, indian economic review, 35: 193-209. 10. nag, r. & mukhopadhyay, m. (1998) “macro-economic effects of stabilization under financial liberalization”, indian economic review, 33: 1-17. 11. shaw, e. (1973) interest controls and credit allocations in developing countries. oxford university press: new york. 12. van wijnbergen, s. (1982) “stagflationary effects of monetary stabilization policies: a quantitative analysis of south korea”, journal of development economics, 10: 133-169. 13. van wijnbergen, s. (1983) “interest rate management in ldcs”, journal of monetary economics, 12: 433-452. 14. van wijnbergen, s. (1985) “macroeconomic effects of changes in bank interest rates: simulation results for south korea”, journal of development economics, 18: 541-554. 15. van wijnbergen, s. (1986) “exchange rate management and stabilization policies in developing countries”, journal of development economics, 23: 227-247. 16. walsh, c. (2000) monetary theory and policy, the mit press: cambridge, mass. abstract introduction literature review research methodology findings summary of findings and authors’ recommendations limitations of the study and possible future research conclusion acknowledgements references about the author(s) shaneen conradie school of accountancy, faculty of economic and management sciences, stellenbosch university, stellenbosch, south africa christiaan lamprecht school of accountancy, faculty of economic and management sciences, stellenbosch university, stellenbosch, south africa citation conradie, s. & lamprecht, c., 2021, ‘valuation practices under business rescue circumstances in south africa’, south african journal of economic and management sciences 24(1), a3721. https://doi.org/10.4102/sajems.v24i1.3721 original research valuation practices under business rescue circumstances in south africa shaneen conradie, christiaan lamprecht received: 26 may 2020; accepted: 16 nov. 2020; published: 26 apr. 2021 copyright: © 2021. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: a business rescue plan should indicate the benefits of adopting a business rescue plan as opposed to the benefits of immediate liquidation. performing a valuation is thus a vital aspect of the business rescue process as the estimated values determine the amount to be divided between creditors and, if possible, shareholders. conventional valuation methods have the underlying assumption that the business is a going concern (based on liquidy and solvency tests). however, a company in business rescue is not necessarily a going concern, nor in liquidation, leaving the company in a grey area in terms of valuation. aim: this research explored how the business rescue value of a financially distressed company is determined. setting: the setting for this study was south africa. method: thematic analysis of qualitative data collected through 11 semi-structured interviews with senior business rescue practitioners (brps). results: when the intention is to return the company to solvency, the brps prepared a short-term, undiscounted cash flow budget to determine the business rescue value, but without including a terminal value in the projected cash flows. in contrast, when the intention is to obtain a better return compared to immediate liquidation, brps follow an asset approach to determine the business rescue value. the results also showed that the business, digital and relational acumen of the brp is a major influencer in the business rescue value. conclusion: the financial elements identified and substantiated in this study may serve as best practice guidance in the business rescue industry and lead to an expansion of the existing valuation theory. keywords: business rescue practitioner; business rescue value; chapter 6; companies act; financial distress; going concern; liquidation; valuation. introduction south african companies in financial distress may file for business rescue in terms of chapter 6 of the south african companies act no. 71 of 2008. the companies act (rsa 2008:s150[b][vi]) requires, among other things, that an appointed business rescue practitioner (brp) prepare a business rescue plan to show the benefit of adopting the business rescue plan as an alternative to immediate liquidation. the business rescue plan should indicate to the creditors that a company is worth more ‘alive’ than ‘dead’. in other words, that if the creditors file for immediate liquidation, they will receive less than they would receive through a reorganisation (in south africa [sa] referred to as a business rescue) (altman & hotchkiss 2006:8). thus, showing the benefits in the form of a valuation of the company in business rescue becomes a vital aspect of a restructuring process, since the estimated value of the company determines the size of the pie to be divided between the creditors and, if possible, the shareholders (altman & hotchkiss 2006:103; harvey 2011:181; tma-us 2016:202). a value uncertainty in practice according to practice note 1 of the turnaround management association (tma) of sa, the brp should, while preparing the liquidation value, also prepare a draft business rescue distribution value based on preliminary assumptions and scenarios for the business rescue plan (migwalla 2017). a gauteng high court judgement showed that the court was uncertain how a brp could obtain a better market value for assets in business rescue than a liquidator (bradstreet 2013:45). it is precisely this uncertainty that is the aim of this article, namely how the brp determines the business rescue value of a financially distressed south african company for inclusion in the business rescue plan. when a business goes into financial distress, valuation becomes a complicated matter, one that has not yet been comprehensively analysed (crystal & mokal 2006:1; hrdý & simek 2012:121, 131). conventional valuation techniques are available to the brp. however, damodaran (2009:11) states that analysts often find that the tools and approaches that served them adequately for healthy companies do not hold in a distress scenario. the problem is even worse in a sector with a history of financial distress, since analysts are often slow to let go of old rules of thumb (rot) and metrics (damodaran 2009:11). the two business rescue avenues in sa, the companies act allows for two possible outcomes from a business rescue. in simple terms, goal 1 refers to an instance in which a company is restructured (or revitalised) in order to continue as a going concern on a solvent basis, while goal 2 requires that creditors receive a better return as compared to immediate liquidation (rsa 2008:s128[1][b] [iii]). a brp may achieve a better return under goal 2 through either selling the assets of the company as a functioning unit to another party or through a controlled wind-down of assets (harvey 2011:182). loubser (2013:448) submitted that one cannot assume that selling a company as a going concern in business rescue would always result in a higher return than selling assets in a break-up sale. even if one assumes that a better price can be obtained when selling a going concern in business rescue, business rescue costs such as practitioner fees and employee remuneration may erode the benefit, and the company could just as well have gone into liquidation straight away. to complicate matters, the brp is also under tremendous time pressure to publish the business rescue plan (pretorius 2016:491; rsa 2008:s150), as there is a negative correlation between the time that elapses and the asset value in a distressed company (rajaram, singh & sewpersadh 2018). it may therefore not be possible to perform a comprehensive valuation of the company using the conventional valuation techniques. defining the term business rescue value according to the oxford english dictionary (oxford 2017), the word ‘benefit’ means an advantage or profit gained from something. the word benefit may, therefore, include both monetary and non-monetary advantages or gains. this is also applicable in business rescue as the benefit of business rescue goes beyond the monetary benefit that may be available to the creditors. for example, it will also include the benefit that a successfully completed business rescue will, under goal 1, prevent job losses (conradie & lamprecht 2018; loubser 2010:560; marsden & laher 2018). the non-monetary elements of business rescue success have been sufficiently researched; therefore, this research focuses on the monetary benefit of business rescue. throughout this article, the authors used the term business rescue value, which refers to the value (monetary benefit) determined as the alternative to immediate liquidation. research aim, question and objective to address the problem of conventional valuation methods that may not be applicable in a business rescue scenario, the research aim of this article is to establish how the brp determines the business rescue value of a financially distressed south african company. the aim is addressed by answering the following research question: in business rescue, what valuation approach does the brp use to determine the business rescue value? in order to answer the research question, the research objective is to determine the valuation approaches used by a brp under goal 1 and goal 2 of a business rescue. the remainder of the article is structured as follows: a literature review is provided, followed by the research methodology and presentation of the findings. thereafter, the authors provide a summary of the findings with author recommendations. the article concludes with limitations of the research, possibilities for future research and an overall conclusion. literature review in a distressed setting, the objective is usually to value the enterprise as a whole, as opposed to only the equity (altman & hotchkiss 2006:105). the term ‘reorganisation value’ is often used in international commentary in such an instance. reorganisation value is the fair value of the entity before considering liabilities and approximates the amount a willing buyer would pay for the assets of the entity immediately after the restructuring (aicpa 1990:19, 273, 295). the united states of america (usa) were the first to start with a modern business rescue regime (rajak & henning 1999:263). the usa bankruptcy code is divided into various chapters, of which chapter 11 contains the provisions for reorganisation. being the leading legislation in reorganisations, one would expect that chapter 11 would clearly define reorganisation value. however, steffen (2016:14) noted that reorganisation value is not defined explicitly in the usa, although the reorganisation value is determined primarily by discounting future cash flows for the reformed business (that will emerge from chapter 11 of the usa bankruptcy code), plus the anticipated income from the sale of assets not required in the reconstituted business. the south african companies act does not require the business rescue plan to include a valuation of equity and, therefore, the review below focuses on the main valuation techniques available in valuation theory, with which to value a company (enterprise as a whole). the three main valuation approaches include an income, relative (or multiple) and asset (or cost) approach. income approach a significant technique under the income approach is the free cash flow to firm technique (fcff). the fcff is forward-looking and focuses on future operating cash flows, discounted to a present value using an appropriate discount rate to take the time value of money (tvm) into account (altman & hotchkiss 2006:109; damodaran 2013:7; harvey 2011:183; tma-sa 2016:145). this technique has two main underlying expectations, namely that the company will be a going concern and that the company will generate profits for some time in the future (buttignon 2015:6; tma-sa 2016:152). the latter requires a terminal value, calculated by either using a multiple of revenues (usually derived from healthy, publicly traded firms) (damodaran 2009:31), the gordon growth model or, if it is a deteriorating or finite-lived asset that is valued, the salvage value of the asset (ivsc 2016:43). in sa, under usual business circumstances, valuators tend to use the income approach to value a going-concern company (pwc 2017). the study conducted by pwc (2017), however, did not prescribe the approach to use under business rescue circumstances. alternative valuation techniques to consider under the income approach are the adjusted present value (apv) technique and the modified discounted cash flow (mdcf) technique. the apv might be useful in complicated tax situations and during significant changes in the capital structure (altman & hotchkiss. 2006:113; poniachek 2010; tma-sa 2016:151). the mdcf technique may also be useful as it separates a going-concern value and a value that emerges from the effects of distress (damodaran 2006:15; tma-sa 2016:152). relative (or multiple) approach the relative (or multiple) approach uses a comparative company or industry average or multiple (e.g. profit after tax times 4 equals company value) as a proxy to determine a value for a specific company. aspects to consider when searching for a peer group multiple include variables such as revenue, earnings, customers, product mix, distribution channels and financial leverage (tma-sa 2016:157). the lack of comparable entities might, however, hinder the estimation of a peer group multiple (crystal & morkal 2006:8; harvey 2011:187). furthermore, the company in financial distress will probably have negative cash flows and profits, which will result in a negative value. beyond the difficulties of finding the proxy multiple, the usefulness of historical data for the firm is limited when the firm undergoes significant asset restructuring (altman & hotchkiss 2006:106). under usual business circumstances, pwc (2017:54) found that of all the different multiples available, the market value of invested capital, divided by earnings before interest, tax, depreciation and amortisation (mvic/ebitda) multiple, is the most frequently used multiple in order to value a going-concern entity in practice. asset (cost) approach the final main valuation approach considered, is the asset-based valuation, also known as the cost approach (ivsc 2016:45; pwc 2017:30). this approach is not typically used to value a company or business as a whole (ivsc 2016:54) although the cost approach is often used as a reasonableness check to confirm that the going-concern value is more than the liquidation value (ivsc 2016:45). under the asset approach, a valuator may use different valuation techniques. three of the most common techniques are replacement cost, reproduction cost and the summation (sum of the parts) method (ivsc 2016:46–48). it is important to note that the carrying value (alternatively referred to as the book value) of assets as per financial statements is typically cost price, less accumulated depreciation and accumulated impairment losses. this carrying value may thus not be the same as the realisable value (ivsc 2016:46–47). summary of conventional valuation approaches and techniques before considering other valuation considerations in the south african context, a summary of the conventional valuation approaches and the main valuation techniques, identified from the literature is provided (figure 1). the findings of the study will be contrasted against the conventional valuation approaches and techniques indicated in figure 1. figure 1: valuation approaches and main valuation techniques. other valuation considerations besides the specific valuation approach and technique used to value a company, other qualitative factors may also influence the valuation of a financially distressed company in business rescue. who determines the business rescue value? in a valuation, the different parties (e.g. the shareholders, managers, the brp and creditors) might have different needs and bargaining power (correia et al. 2015:6–2; pwc 2017:17). this might lead to an agency problem (jensen & mechling 1976). internationally, under pre-pack asset sales, assets are usually valued by company management or an independent valuator (mkondo & pretorius 2017:104, 116). the conflicting interest between various role players of distressed firms might, however, result in valuation errors ranging from less than 20% to greater than 250% (gilson, hotchkiss & ruback 2000:70). time value of money time value of money should be explicitly considered in the valuation of distressed companies because reorganisations may take several years (altman & hotchkiss 2006:8; reilly 2013:13). the tvm is reflected in the discount rate. however, determining the cost of capital components (e.g. the cost of debt, cost of equity, debt-equity ratio) and resulting weighted average cost of capital (wacc) discount rate might be difficult (tma-us 2016:212). the average expected business rescue period for south african companies is 16 months (klokow 2018:7). one would, therefore, expect the brp to consider the tvm, given that people prefer to receive money sooner rather than later (adriaanse & van der rest 2017:104). south african context the reader should note that the theory in this section was drawn from the work of various international researchers, for example altman and hotchkiss (2006), damodaran (2009), reilly (2013) and tma-us (2016). it is important to note that these researchers were writing primarily from the point of view espoused in the usa (chapter 11 of the usa bankruptcy code). an important difference between business rescue in sa (chapter 6) and business rescue in the usa is that a company does not have to be in financial distress to file for chapter 11 protection, whereas, in sa, a company must be in financial distress in order to do so. chapter 6 is also the only legislation, when compared to the usa, canada, the united kingdom and australia, that includes a strict definition of financial distress, namely that within the following six months, the company will be unable to pay its debts or the company’s liabilities will exceed its assets (lamprecht 2016:113). theoretical perspective within a constructivist ontology, and taking an inductive interpretive approach to understanding the nature of valuations in a business rescue context, two main theories were used to guide the research, namely agency theory and information asymmetry. firstly, agency theory is a well-known theory that describes the relationship in which one or more persons (the principal) engages with another person (the agent) to perform some service on the principal’s behalf. this may involve delegating a degree of decision-making power to the agent. however, within agency theory, an agency problem may occur when the parties to the relationship have different goals (jensen & mechling 1976). an agency problem often occurs between the shareholders and management of a company, as well as between the shareholders and providers of finance (correia et al. 2015). in the context of business rescue, pillay, rajaram and ramnanun (2020) argued that because agency theory describes the affiliation between agents (brps) and principals (the companies they assist), business rescue falls within the agency theory. pretorius (2016:483) agrees that an agency problem exists between the various role players (shareholders, brps and creditors) in business rescue, due to the different degrees of the risk appetite of these role players. shareholders’ influence over the choice of supervisor might be limited, shareholders will not be able to vote on the proposed plan unless their rights are amended, and even then may find their opposition to a plan, that is supported by the creditors, ignored. the prevailing view is that shareholders in a company rescue are mainly onlookers, although they may be the ones who will lose everything (loubser 2008:389). also, it is impossible to say with any certainty whether the legislature considered the fact that directors could also be employees of the company and thus be entitled to the special rights, powers and super preferences that are given to employees in business rescue proceedings. in the absence of any provision, clearly excluding executive directors from being regarded as employees, it must be assumed that they have all the rights, powers and benefits that any other employees have during business rescue proceedings, even if that position may lead to abuse of the process or have other undesirable consequences (joubert & loubser 2016). secondly, and following from the agency theory, is that classic agency theory also assumes the existence of equal information to the principals and agents (pretorius 2016). in his seminal paper, akerlof (1970), explains the theory of information asymmetry between buyers and sellers in relation to the value of a product. in the context of business rescue, pretorius (2016), levenstein (2015) and deloitte (2017) confirmed the existence of information asymmetry. in this article, the authors use agency theory as a lens to consider whether the brp is acting for its own benefit, for the benefit of the shareholder, or maybe even for the creditor. furthermore, the theory of information asymmetry is used to consider what information is shared between the brp and potential investors for each party to determine the business rescue value. research methodology philosophical view research studies are influenced by the beliefs, values and philosophical assumptions of the researchers. the ontology of the researchers was that of constructivism, with the research participants and their subjective views forming the researchers’ understanding of the research phenomena. within this context, the research participants provided their own understanding and ascribed meanings shaped by their interactions with others and from their own personal histories. the research findings in this instance are shaped from individual perspectives to broad patterns and, eventually, to broad understandings (creswell & plano clark 2011:40). research approach in view of the limited body of research on valuations in a south african business rescue context, the research approach was of an exploratory, qualitative nature. a semi-structured interview method was used to obtain the views of 11 senior brps. given the topic of valuations, the respondents were purposefully selected (rowley 2012:264) to include mainly individuals with a financial background. the remainder of the sample was selected from boutique consulting firms, based on seniority and experience in the business rescue field (e.g. someone who led high-profile business rescues in sa or someone recognised as a leader in the industry by their peers). the selection process resulted in most of the research participants being senior brps, having an accounting background and registered with at least one of the major accounting bodies (chartered institute of management accountants [cima], south african institute of chartered accountants [saica] and south african institute of professional accountants [saipa]). the literature review was used to prepare an interview agenda for the study. the interview agenda was pilot tested (bryman 2012:185) to ensure the questions were clear and relevant, and that they addressed the research question (rowley 2012:265). the pilot testing was followed by semi-structured, one-on-one interviews with individual brps. as suggested by rowley (2012:265), the interviews were conducted in person. the semi-structured interviews permitted a degree of flexibility (king & horrocks 2010), and brps had the opportunity to share information about their personal beliefs, experiences and actions, which may not have been possible if a rigid schedule of questions had been used (stone 2015:259). when needed, the researcher asked additional questions in direct response to the statements made by the interviewee (bryman 2012:471). the researcher conducted the interviews until data saturation occurred (guest, bunce & johnson 2006:59). in this study, data saturation was reached after 10 interviews, with an 11th interview as the concluding interview. the interviews took between 48 and 85 min, with an average length of 60 min. the number and length of the interviews were deemed to be sufficient, compared to a recommended six to eight interviews of 1 hour each (rowley 2012:263). all interviews were audio-recorded. in addition to the audio recordings, the interviewer also made written notes during and shortly after each interview, based on personal reflections in relation to important statements and observations (ritchie et al. 2013:297; rowley 2012:266). subsequent to each interview, a professional transcriber transcribed the audio recordings in order to prepare the audio data for computer-assisted analysis (creswell & plano clark 2011:205). atlas.ti was used to code the transcriptions and personal notes into key themes, concepts and ideas using an inductive mode of reasoning (bryman 2012:404). an immersion approach (stone 2015:259) was used through direct engagement with the coding and thematic analysis process. this involved repeatedly replaying the audio recordings and revisiting the transcripts and notes made during the interviews. the researchers were aware that a theme might be unique to one interviewee’s account (king & horrocks 2010). after coding all the interviews, atlas.ti was used to group specific codes together to form conceptual frameworks based on common themes identified from the different interviews. this rigorous thematic analysis process of data familiarisation, data coding, theme development and revision (creswell & plano clark 2011:205), provided the necessary rich information and findings in order to achieve the research objectives and to answer the research questions. researcher bias can be a factor in qualitative research such as interviews (rowley 2012) and threaten the reliability of data. in this study, the researcher ensured that only experienced interviewees were chosen, that the interview agenda was appropriately designed and tested and that a thorough analysis of the data was performed, resulting in reasonable assurance of the reliability and validity of findings (creswell & plano clark. 2011; rowley 2012). to ensure the trustworthiness of the research, that is, credibility, transferability, dependability and confirmability (lincoln & guba 1985), the researchers employed the following process. the credibility of the findings was ensured by site triangulation (shenton 2004:66) and by selecting participants from several organisations and different provinces. to ensure transferability, the researcher provided a ‘thick description’ of both the participants and the study’s context (lincoln & guba 1985). an in-depth methodological description enhanced dependability (shenton 2004:73), while the secure storage of all the notes, transcripts and audio recordings ensured the confirmability of the findings (milne & oberle 2005:416). ethical considerations this article followed all ethical standards for carrying out research. stellenbosch university approved the study with ethical clearance number: acc-2018-6328. findings interviewees indicated that a single business rescue plan might include a combination of goal 1 (continue to exist) and goal 2 (bril) proposals, especially if it is a business rescue of a large entity. it is important that the reader keeps in mind the fundamental difference between a goal 1 and a goal 2 business rescue because the research found that the goal affects the valuation approach followed by the brp. the next section presents the valuation techniques used under a goal 1 scenario. valuation techniques used to determine the business rescue value under goal 1: returning the legal entity to solvency the study found that under a goal 1 scenario, participants deem traditional valuations according to valuation theory irrelevant. in order to present a business rescue value in the plan, the brp will, after performing a critical trading analysis of the distressed company, prepare a cash flow projection, which will usually be for only 3 years, unless there are compelling reasons that require longer cash flow budgets. company management will assist with the cash flow projection only if the brp is satisfied that management is competent to do so. however, interviewees indicated that management is often incompetent in preparing proper cash flow budgets. the study revealed that brps did not discount the projected cash flows to account for the tvm; neither did the brps calculate a terminal value for the business. their aim was to ascertain when, and how much cash will be available to creditors from the ongoing trade of the company, in order to provide a reasonable return to both old and new creditors: ‘typically that valuation on the outcome is just a pure maths calculation, it says there’s r5 000 a month for 60 months. it’s not so much a valuation as just an exercise in really crunching the numbers, and it’s the free cash flow part, before the discounting if you work it out, but very granular.’ (brp9, july 2018, chartered accountant) the statement above indicates that the valuation is not a genuine valuation but rather a possible valuation which the brp needs to achieve to proceed with business rescue. to incorporate risk in the valuation calculation, some brps indicated that they use scenario analysis and provide a high and low valuation scenario in the plan, while the majority do not provide different scenarios in the plan: ‘i give two scenarios, business rescue and liquidation, which one do you want.’ (brp5, june 2018, chartered accountant) it is important to manage the expectations of the creditors, and thus, the brps preferred to be conservative, by using the lower or average range of values when preparing cash flow forecasts: ‘under promising and over-delivering rather than the converse.’ (brp5, june 2018, chartered accountant) to continue trading, the financially distressed company may require a new equity partner in order to obtain post-commencement finance (pcf). although brp10 had obtained an independent valuation from an independent auditing firm for the equity value of a distressed company once, the majority of the brps indicated that a business in rescue generally has a negative equity value. thus, brps can usually only work with the offers they receive from potential investors: ‘you are going to work with what you have. regardless of the value of the business, you [the new investor] are going to want the lion share. you [the new investor] are going to say listen, i will put in 50 bobs, but i am going to take 60%. this business’s value two years ago was sitting at, you know, a billion. how can you expect to … i say well, take it or leave it. there is a sanity check calculation in the background that might give you an idea of what equity value is, but in most cases, a business in rescue has negative equity.’ (brp6, july 2018, business administrator) the above statement shows the negative effect that the lack of pcf (du preez 2013) has on the business rescue value. because of the dependency on private investor capital, the bargaining power to negotiate a high equity value is limited. it also highlights the agency problem as identified by pretorius (2016), as a brp will sometimes need to accept pcf from a private investor, in return for an equity stake, just to save the company’s operations (and employment). the brp (agent) therefore focused on saving the business operations, and not necessarily on retaining current ownership of the shareholders (principals). one interviewee, brp7, follows a specific recipe when pursuing goal 1 with a new equity partner. during a critical trading analysis of the financially distressed company, brp7 would investigate current expenses line by line on the company’s trial balance and be ruthless in cutting costs. they believe that, if an operating leverage of 20% exists (i.e. the difference between the company’s old and new cost structure), the business may be saved in terms of goal 1. it is then important to establish how much working capital the company needs to keep on trading and to consequently find a funding partner for the required working capital. the funding partner will then, in return, receive an equity stake in the company. figure 2 is an example of a standard pcf agreement used by brp7 when selling shares under business rescue to a new equity partner. figure 2: post-commencement finance agreement when selling shares to a new equity partner. from figure 2, the ability of the brp to critically analyse the short-term cash flow needs of the company in detail is evident. this critical analysis of future cash inflows and outflows will determine both the pcf, as well as the business rescue value of the company (the higher the pcf, the higher the business rescue value). also, it is important to note that the business rescue value under goal 1 will be fluent: it is not an exact value that is determined, because the business rescue value represents in essence the potential cash that the business will generate over a specified time period. previous literature confirms that sars has a preferent claim in liquidation but a concurrent claim in business rescue (werksmans 2012). business rescue practitioners indicated that during the pre-assessment of the company, the voting percentage of the south african revenue service (sars) is a ‘game-changer’ in respect of the business rescue value: ‘if sars has more than 25% voting interest, then at the meeting they are going to have a swing vote. so, where you guys want to value the company, i’m valuing the [sars] vote. if yes [sars’s vote is more than 25%], we look at the liquidation calculation. if sars is going to get 70 cents in liquidation, then, using the free cash flow method, i have to pay all the concurrent creditors the same [in business rescue], even if they are getting zero cents [in liquidation]. i have to go for 70 cents, so that i can win sars in court. then i put that in my cash flow model, and then i work out a value.’ (brp7, july 2018, professional accountant) in summary, the results of this section stand in contrast to previous literature. although the fcff valuation technique was preferred in determining the reorganisation value under international legislation such as chapter 11 of the usa bankruptcy code (altman & hotchkiss. 2006; steffen 2016), and in ordinary business practice in sa (pwc 2017), the fcff was not used by brps to determine the business rescue value. instead, brps determined the business rescue value by using a short-term (3 years) cash flow budget, without the inclusion of a terminal value for the business. in addition, although it was expected that the brp would consider the tvm (adriaanse & van der rest. 2017; altman & hotchkiss 2006; reilly 2013; tma-us 2016), the findings indicated that brps used undiscounted cash flows. furthermore, the position of sars was identified as a significant influencer of future projected cash flows and, therefore, the business rescue value. valuation techniques used to determine the business rescue value under goal 2: sale of business as indicated earlier, two scenarios exist under goal 2 (harvey 2011:182). the first scenario is to pursue the sale of the business as a functioning unit. when a financially distressed business is sold (either as a group or as separate divisions), it involves a cash transaction and, according to the interviewees, valuations would typically be more relevant in this instance. in a goal 1 return to solvency scenario, where a definite possibility of returning the business to solvency exists, a liquidator would not be able to perform the task, as a liquidator’s task is to close down a business and sell the assets. however, when considering goal 2 of business rescue, it becomes more of a grey area – this is where one would be able to argue that either a brp or a liquidator would be able to sell a company or its assets. there is a fine line between use and abuse of the business rescue procedure (bradstreet 2013), and the authors believe that it is the availability of this secondary goal of the legislation that opens up the door for abuse. it is therefore actually only under goal 2 where one can really compare brps with liquidators. the business rescue value is collectively determined by certain role players. table 1 indicates some of the main role players in business rescue and their roles in determining the business rescue value. the table also shows the number of interviewees that mentioned that particular role. table 1: roles within the business rescue valuation process. it is evident from table 1 that, ultimately, the buyer determines the price of the transaction. participants indicated that the brp might perform a high-level valuation of the company solely to determine whether the offers that come in are reasonable: ‘i was a partner at firm x [a large audit firm], so i know how to do a valuation, and i’ve done many valuation advisory engagements, and sell-side mandates and buy-side mandates and various things, and that whole normal world doesn’t apply, because anybody who is buying a distressed business says it’s in trouble, it’s failed. you can say it failed because the owner bought a ferrari with the money; it is not the business’s mistake. they [the buyers] say no, then they push you down. so when you talk valuation techniques, i mean, we do them to get an idea, but the value is what a willing buyer is prepared to pay full stop.’ (brp9, july 2018, chartered accountant) according to interviewees, buyers do not usually disclose their valuation techniques and underlying assumptions, although brps are able to ascertain, from the bids coming in, that buyers tend to focus on the value of tangible assets. in sa, when companies file for business rescue, the level of financial distress is already so bad that, according to brp1, there is not much ‘oxygen left in the tank’. as a result, the financially distressed company does not have either much time or the bargaining power in the selling process as in a typical corporate transaction. since buyers buy the company assets as a functioning unit, the asset value is the value-in-use, as opposed to the liquidation value of the assets. however, buyers still tend to push the price down as low as possible and, in practice, participants experienced that even tangible assets take a haircut: ‘there are deep, deep discounts that come in as a result of the fact that the business is in rescue and in distress. let me give you an idea. to build company h from scratch today would cost you r7 billion, but the bid that we got, the value of that bid, was r1.75 billion.’ (brp6, july 2018, business administrator) a strong theme identified from the data was that investors investing in financially distressed companies do not pay for the future earnings potential of the company. the value of the company comes down to an asset valuation approach, and brps does not separately value the intangible assets of the company: ‘so, if you’re in a retail operation and you have a bad retailer getting bought by a good retailer, he’s going to give you value for the inventory, on the assumption that you haven’t bought too badly – you’re not sitting on jerseys in summer or costumes in winter – and possibly a value for the lease. because if you got prime real estate in an area, that is a key component. however, the ability to turn that store into a profitable store, using his intellectual property, he is not going to pay you for as well. so you generally see asset value, plus a very, very small goodwill component coming out of it in terms of that.’ (brp5, june 2018, chartered accountant) business rescue practitioner 11 confirmed that in the retail industry, the value would be asset-based and possibly an earnings multiple, but on far smaller multiples than one would see in a traditional going-concern business, and particularly given the risk that’s associated with business rescue. as indicated by the examples above, there is a good potential of investing in a financially distressed company in sa, as investors obtain operating companies with all intangible assets attached to it, at bargain prices. at the same time, it set realistic sale expectations for both creditors and shareholders. table 1 indicated that the brp facilitates communications with potential buyers of the financially distressed business. goal 2 of business rescue allows for a return just above liquidation; therefore, the liquidation value sets the first valuation benchmark. the liquidation value is thus a critical piece of information that can lead to both an agency problem and information asymmetry between role players. the majority of brps indicated that the liquidation value is usually independently determined. this is a control that is put in place by brps, although not required by the companies act. some brps indicated that they did not give the liquidation value to potential buyers, although other brps did provide the liquidation value to potential bidders. business rescue practitioners state that they do not give the liquidation value to prevent potential bidders from exploiting the system (brp5, brp6). the above example indicates that brps (agents) do act in the best interest of shareholders (principals) and creditors, in the sense that they try to obtain the highest possible value from buyers by not disclosing the liquidation value. although information asymmetry between buyers and sellers (deloitte 2017; levenstein 2015; pretorius 2016) is created by the non-disclosure of the liquidation value, it enables the brp (agent) to obtain the highest possible business rescue value for the business, which reduces the agency problem. to summarise, this section discussed several themes in relation to valuation in a goal 2: selling of a business, scenario. the main findings included the following: the buyer determines the value of the entity. this value is usually heavily discounted, and based on the value of physical assets, not on the future earnings potential of the distressed company. this confirms the findings by roslynn-smith, de abreu and pretorius (2020:40) that assets are sold for a value between forced sale value and market value during business rescue proceedings. the brp may perform an instinctual valuation for the distressed company, using a combination of conventional valuation techniques. however, brps indicated that this instinctual valuation has little relevance. business rescue practitioners used various types of bidding processes, with a varying degree of sophistication. liquidation value is independently determined. the selling of the business as a functioning unit is only one way of achieving a bril in business rescue. under goal 2, some brps also make use of a controlled wind-down, as explained below. valuation techniques used to determine the business rescue value under goal 2: controlled wind-down the second scenario under goal 2 entails that the brp sells the company’s assets over a specified period and then closes the company and business. table 2 specifies the benefits that this type of business rescue has for the creditors, as opposed to the selling of assets by a liquidator (under liquidation). the table also shows the number of brps that mentioned that aspect. table 2: how the business rescue practitioner creates value through a controlled wind-down. as illustrated in table 2, the four most notable reasons that a brp can create more value under a controlled wind-down in business rescue, as opposed to a liquidator in liquidation circumstances, are: cost savings – brps are reimbursed on an hourly basis, while liquidators ask a prescribed percentage of the value of the assets sold. according to one brp, this would mostly be an advantage for companies with for example high-value real estate, because it would mean that even though the real estate assets are sold for exactly the same value in business rescue as in liquidation, the business rescue value will exceed the liquidation value because the brp does not get a prescribed percentage of the assets sold: ‘on immovable property he’s [the liquidator] going to take his 3% plus vat on the sale of the property, which could be, if you’re selling a property for 100 million, well, thank you very much, that’s a nice fee – r3 million. that’s a lot of time i’m going to have to spend as a practitioner to make that kind of fee.’ (brp10, july 2018, chartered accountant) timing – in business rescue, there are no time constraints to pay out business rescue dividends. a liquidator only pays dividends once the master of the high court has approved the distribution account. the acting chief master, tessie bezuidenhout, recently confirmed that liquidations in sa take too long. in the usa, simple cases are finished within 6 months while, in sa, such cases may take 10 years (saripa 2018). market-related value – although the valuation approach is still an asset approach, it is the value-in-use of the asset sold piecemeal as opposed to the forced sale value. this statement is illustrated by the following comment: ‘the value of the stock itself is higher, this jacket for sale at the victoria & alfred is going to be r5000, stuck in a box, being auctioned with 100 other jackets it’s going to be 50 bucks.’ (brp5, june 2018, chartered accountant) the capabilities of the brp and their team (discussed in more detail below). a brp may sometimes pursue goal 1, but then the creditors do not approve the business rescue plan. this situation may then result in either a liquidation or a controlled wind-down under business rescue. the authors believe that the agency problem features very strongly in such an instance since the brp (agent) was appointed by the shareholders or directors (principals) with the belief that the brp would be able to save their shareholding, but due to lack of creditor support of the plan, the brp is forced to act against the instruction of the principal, and pursue a controlled wind-down. a notable finding in relation to maximising the value under a controlled wind-down was the capabilities of the brp. the interviews revealed that brps have remarkable business acumen (e.g. innovation and creative abilities), digital acumen (e.g. data analytics) and relational acumen (e.g. communication and leadership skills), which enable them to unlock value from a financially distressed business. furthermore, brps also find themselves in better circumstances than a liquidator. for example, brps might obtain employee support during the business rescue, the companies act allows the brps a vast amount of freedom and the public perception of business rescue compared to liquidation is better. business rescue practitioner 9 explained that after working with a company for a while, trying to save it, the brp would have developed a relationship with the management and employees, and gained access to valuable company data. this puts the brp in a much better situation to extract value from the company than a liquidator. ‘i worked with the operational director and the financial director for six months trying to rescue it [the group of companies], and now i was able to say to them right, we need to change our thinking. and because you’ve built up a working relationship, you can run that. a liquidator comes in, and he doesn’t even know what’s available to him, whereas i was able to say shouldn’t we start pairing our discounts, because i’d analysed the business. that’s why the wind-down works better in rescue. because as a practitioner, you’ve got to be more imaginative than a liquidator. a liquidator opens his toolbox, he sees a hammer, and that’s all he’s got, whereas we’ve got the freedom to do more because of the act. your best employees are not going to hang around to work with the liquidator.’ (brp9, july 2018, chartered accountant) the findings indicated that brps have the authority to use assets in the ordinary course of business in order to generate a profit and can, therefore, utilise seasonal cycles to obtain higher asset values. a provisional liquidator has no authority to sell assets while the company is under provisional liquidation. assets are disposed of only after the final liquidation order at a forced sale value. many businesses are sensitive in relation to seasonal cycles. for these businesses, the value of inventory is entirely dependent on the utility it may have at a particular time of the year. for example, sales in the retail sector usually spike over the festive season in december, while in agricultural retail products may expire if they are not sold during the harvest seasons. if the brps can sell assets while it is the high season or close to harvest time, it should be possible to sell the assets at a higher value as compared to a liquidator who missed the season: ‘you have to be quite smart in how you operate to get a better value than liquidation. otherwise, everybody would do this. we closed [number] furniture stores, in three months in company e. we were lucky because it was over november, december, january, and our philosophy were on the last day, as you shut the store and therefore cut your operating costs, you give away the last piece of furniture. so, you start at full retail price, and you tweak your discounts because you’re burning, i mean, you’re burning [amount] in rent, over that three-month period. so, if you’re open for four months, you’re doing worse than that [liquidation].’ (brp 5, june 2018, chartered accountant) the findings further revealed that in business rescue, as opposed to liquidation, it is possible to limit the creditors base, which increases the business rescue value. for example, in the event of the liquidation of a construction business, all construction contracts would be terminated, resulting in the crystallisation of the guarantees as liabilities for the company. in business rescue, the completion of construction contracts and the resulting cancellation of guarantees eliminate the risk of these guarantees crystallising as liabilities of the financially distressed company, and thus this gives rise to higher business rescue dividends. business rescue practitioners were of the opinion that they were able to preserve considerable value for creditors in construction type businesses by using the ring-fencing of debtors technique. this technique results in the construction company being left to trade under business rescue. the brp then completes the ring-fenced construction projects by utilising the company’s construction records and its own employees. after completion of the construction projects, the brp collects the retention monies from existing construction debtors and pays the creditors from the proceeds: ‘we worked out a complete plan where we ring-fenced all the debtors, saying we are going to incur legal costs to collect this, but in the meanwhile, the business has been relieved of all this debt, that’s all you will be paid.’ (brp1, may 2018, attorney) each contract and the expected amounts to be collected from the construction debtors are disclosed by the brp as an indication of the business rescue value. business rescue practitioner 1 had even gone as far as to provide a guarantee to the creditors, equal to the projected liquidation dividend. thus, the creditors did not take on any risk of losing the liquidation dividend if they approved the business rescue plan. the excess cash collected in terms of the business rescue plan could, therefore, be seen as a top-up or ‘agterskot’ to the secured liquidation amount. in order to use the ring-fence technique, the brp requires operational cash flows to complete construction projects and to collect debts from the construction debtors. operational cash flows may come from either the construction company’s guarantee provider or an investor who buys the company: ‘you might go to your guarantee provider, like lombard or credit guarantee and say if i stop, they’re [the clients] going to pull the guarantee and you’re just a creditor who is going to get nothing, whereas if you help fund it and give the client comfort, we will finish it. your liability goes away because that guarantee is not called, the project is finished, and i’ve got some cash in the door.’ (brp9, july 2018, chartered accountant) to summarise, a goal 2, controlled wind-down, business rescue plan can result in a higher asset value compared to liquidation for the following main reasons: market value: the brp obtained market-related prices for the assets as opposed to fire-sale prices in a liquidation scenario. the valuation approach followed is thus an asset approach, and contrasts the reorganisation value which is determined primarily by using the income approach of valuation (altman & hotchkiss 2006; steffen 2016) and ordinary south african business practice (pwc 2017). timing: business rescue dividends can be paid earlier than liquidation dividends. this finding was quite interesting, because previous literature indicated that reorganisation might take several years (altman & hotchkiss 2006:8, reilly 2013:13). in sa, therefore, it is not only the business rescue value but also the liquidation value that should be discounted to account for tvm. cost savings: brp fees are less than liquidator costs, thus even though assets might be sold at relatively the same market value, the business rescue value will be higher than the liquidation value because the cost of realising the assets is lower if this is done by a brp. the expertise and capabilities of the brp can significantly increase the asset value realised. summary of findings and authors’ recommendations the aim of the study was to determine the valuation approaches used by brps under a goal 1 and goal 2 scenario in south african business rescue. the study used constant comparative thematic data analysis which allowed the researcher to identify significant themes relating to the valuation techniques and other valuation-related considerations concerning the business rescue value. although the valuation of the debtor as a continuing entity and the resulting reorganisation value is at the centre of the reorganisation plan in the usa and several other countries (altman & hotchkiss 2006:33), this study found that it is not the case in sa. the business rescue value is determined in a different manner from the chapter 11 reorganisation value. the research found that in sa, the goal of business rescue affects the valuation approach followed by the brp. the study provided evidence that indicated that under goal 1, return to solvency circumstances, a short-term (3 year), undiscounted cash flow budget is prepared by the brp to determine the business rescue value, without the calculation of a terminal value, with the voting position of sars influencing the projected cash flows and therefore the business rescue value in a significant way. in addition, under the goal 2 business rescue scenarios, the study provided evidence that an asset approach is followed to determine the business rescue value. the study supports previous research by pretorius (2016) and pillay et al. (2020) regarding the agency problem. business rescue practitioners might decide to sell a company under goal 2 in order to save a business, even if it means that current shareholders will lose ownership. however, under goal 2, brps advised that the liquidation value should preferably not be disclosed to buyers. although this led to information asymmetry between the buyer and the seller, it assists the brp in obtaining a higher asset value, which in return reduces the agency problem. figure 3 illustrates and summarises the main valuation approaches and valuation considerations used to determine the business rescue value in practice. figure 3: valuation approaches and other valuation considerations. finally, figure 4 provides an overarching summary. figure 4 draws from the findings of the approaches used in business rescue (as depicted in figure 3) and juxtaposes the findings with the summary of the valuation approaches and main valuation techniques generally used for going-concern entities (as depicted in figure 1). figure 4: valuation approaches used in business rescue. figure 4 illustrates that the asset valuation approach is mainly used in a goal 2 business rescue valuation, as opposed to the relative or income approach, which is most often used in going-concern circumstances. under goal 1, the brp uses cash flow budgeting techniques to prepare a short-term, undiscounted cash flow projection. after considering the current valuation practice, as indicated in figure 3 and figure 4, the authors make the following recommendations. firstly, it is recommended that brps consider tvm, by discounting both the liquidation value and business rescue value using, for example, the current prime interest rate plus a risk premium. from a valuation perspective, this is theoretically more accurate, and it will make a comparison between the business rescue value and liquidation value easier and more suitable. secondly, we recommend that under goal 2: sale of business scenarios, brps calculate the instinctual valuation with due care, as this valuation assists the brp with the correct decision-making, a required competency of the brp (pretorius 2014). thirdly, although the findings indicated that brps did not calculate the value of equity, the authors recommend that brps calculate the value of equity of at least profitable divisions of the business. given the vital role that pcf plays in the success of business rescue (britz 2018:131; calitz & freebody 2016; du preez 2013; noomé 2014; prior 2014:71; reineck 2015; vanderstraeten 2016:25), a proper equity valuation might attract potential investors. limitations of the study and possible future research in view of the nature of qualitative research, it was possible that the findings made during the study may have been affected by the interpretation bias of the authors. this bias was, however, minimised by providing thick descriptions of participant responses. another limitation of the study was the fact that only brps were selected as research participants. as indicated in the findings, potential buyers do not usually disclose their valuation calculations to the brp. thus, further studies that involve interviews with successful bidders in distressed companies may provide a different perspective as compared to the findings of this study. lastly, the business rescue industry is prone to a significant lack of formal training in the field of turnaround (pretorius 2014). the researcher, however, minimised this limitation to the study by carefully and purposefully selecting only participants with the appropriate professional background and with sufficient experience in turnaround practice. various opportunities for further research exist in the field of business rescue. participants mentioned that a business rescue plan might show the ‘best valuation’ possible, but that understanding why creditors vote either for or against a business plan is an aspect that merits further investigation from a behavioural finance perspective. another study could also be conducted comparing the actual business rescue dividend paid to creditors to the business rescue value anticipated in business rescue plans, to ascertain the reasonableness of projected business rescue values. lastly, the findings of this study indicated that brps made use of the asset valuation approach and various types of bidding processes. a more granular investigation of the asset approach and further analysis of the bidding processes might provide a better understanding of the valuation phenomena. conclusion by realising the research aim, the study made valuable contributions in respect of valuation theory, specifically the valuation of a company in business rescue in sa. the findings and recommendations made by the authors may also provide valuation guidelines to newly qualified brps and enhance the understanding of the business rescue value by shareholders, creditors and other stakeholders who are inexperienced in business rescue valuations in sa. it appears that the procedures of chapter 6 of the companies act are currently a stumbling block in obtaining an optimal business rescue value. for example, a business rescue value of just above the liquidation value is allowed in terms of chapter 6. also, specific regulatory responsibilities of chapter 6, such as the publication of the business rescue plan within an extremely limited time period together with the requirement of no pre-involvement of the brp with the business, are counterproductive in obtaining an optimal business rescue value, something that might be reconsidered by the legislator. acknowledgements a sincere thank you to each business rescue practitioner who participated in this research study. competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions s.c. collected, analysed and interpreted the data, as 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australian accountants’ advisory relationship with small business’, meditari accountancy research 23(3), 250–275. https://doi.org/10.1108/medar-05-2014-0042 tma-sa, 2016, cra course material, turnaround management association, johannesburg tma-us, 2016, body of knowledge: accounting and finance, turnaround management association, chicago. van der straeten, m., 2016, ‘business rescue: feature’, without prejudice 16(7), 1–34. werksmans, 2012, no preferential creditor status for sars in a business rescue, viewed 20 january 2021, from https://www.werksmans.com/wp-content/uploads/2018/10/155_jn5392werksmans-brief_december-2012_sarsinabusinessrescue.pdf. abstract introduction literature review research methodology empirical results discussion of the results conclusion limitations acknowledgements references footnotes about the author(s) werner h. otto department of commercial accounting, college of business and economics, university of johannesburg, johannesburg, south africa ilse botha department of accountancy, college of business and economics, university of johannesburg, johannesburg, south africa gideon els department of accountancy, college of business and economics, university of johannesburg, johannesburg, south africa citation otto, w.h., botha, i. & els, g., 2023, ‘determining the business environmental factor constructs relevant to small and medium-sized enterprises trade credit management’, south african journal of economic and management sciences 26(1), a4764. https://doi.org/10.4102/sajems.v26i1.4764 note: additional supporting information may be found in the online version of this article as online appendix 1. original research determining the business environmental factor constructs relevant to small and medium-sized enterprises trade credit management werner h. otto, ilse botha, gideon els received: 22 july 2022; accepted: 15 feb. 2023; published: 25 may 2023 copyright: © 2023. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: within the conceptual paradigm that the business environment of south africa could significantly impact on small and medium-sized enterprises, (smes) management of trade credit, the need exists for internal and external business environmental factors to be constructed, in order to understand how smes rate these factors. aim: the research purpose was to identify and construct relevant internal and external business environmental factors and obtain sme ratings for these factors to statistically test the validity and reliability of the measurement instrument. setting: this study was conducted by administering an online questionnaire. method: quantitative research design with purposive sampling as the sampling method, administrated to 10 450 smes within south africa. results: a descriptive statistical analysis revealed that the highest quality internal and external business environmental components were managerial competencies and ethics, respectively. factor analysis resulted in the formulation of five internal and six external business environmental factors. in addition, smes do not rate internal and external business environmental factors equally. managerial competencies obtained the highest overall mean score for all business environmental factors, including the highest for internal factors. small and medium-sized enterprise and debtor ethical performance obtained the highest means score for external factors. conclusion: the formulation of newly constructed internal and external business environmental factors relevant to smes’ management of trade credit. contribution: as far as can be established, research identifying variables and constructing internal and external business environmental factors relevant to sme management of trade credit has not been conducted in south africa. the newly formulated internal and external business environmental factors broaden smes’ understanding of which business environmental factors are relevant to smes’ management of trade credit, including how smes rate these factors. keywords: trade credit; internal business environment; external business environment; management; small and medium-sized enterprises. introduction south africa is striving to make progress related to several united nations sustainable development goals (sdgs). however, the country is constrained by low economic growth that severely limits the attainment of these sdgs that include the eradication of poverty and inequalities. according to the world bank (2022c), south africa’s poverty headcount ratio in 2014 (18.7%) is well above that of middle east and north africa in 2018 (7.0%), while an estimated 55% of the country’s population is living below the national poverty line (world bank 2022b). income inequality, as a threat to economic development, is continually expanding as south africa’s gini index increased from 59.3 in 1993 to 63.0 in 2014 (world bank 2022a). in addition, given south africa’s rising unemployment rate (32.9%), poverty is likely to increase, thus extending the growing dependency on government grants (statistics south africa 2022). it is clear that economic growth holds the key to south africa’s hopes of accomplishing its sdgs. the intrinsic value of entrepreneurship in support of a country’s economic development goals and elevating economic growth throughout africa is paramount (singer, herrington & menipaz 2018). one of the mechanisms to accomplish this is through small and medium-sized enterprises (smes). however, the national export survey (nes), part of the global entrepreneurship monitor (gem) south africa report for 2017/2018, suggests an ordinary entrepreneurial ecosystem showing hardly any improvement from 2016 to 2017 (herrington & kew 2018). the 2019/2020 gem report notes several challenges constraining south african entrepreneurs. poor education stands out as a major constraint to the country’s fourth sdg, namely quality education (bosma et al. 2020). the 2017 and 2018 gem south africa report suggests increased additional challenges experienced by smes related to the country’s entrepreneurial ecosystem when considering the country’s global competitive report rankings for 2016/17 versus 2017/18. the report shows a decline in the quality of education system from 134 to 114 and corruption (irregular payments and bribes) rising from 53 to 91 out of 138/137 countries. other challenges such as business cost of crime and violence, and time required to start a business remained unchanged, while quality electricity supply declined from 112 to 97 out of 138/137 countries (herrington & kew 2018). given the current state of the south african entrepreneurial ecosystem, ample business environment challenges impede the country’s ability to address its sdgs, thus impairing the valuable contribution of smes to become strategic mechanisms in support of economic growth. furthermore, from a local entrepreneurial impact perspective, smes contribute 80% of gross domestic product (gdp) in south africa (baker, kumar & singh 2019); yet the contribution of the sme sector cannot be sustained without the creation of new smes (gree & thurnik 2003). small and medium-sized enterprises’ creation rate measured by numerous gem reports are termed total early-stage entrepreneurial activity (tea) rate. south africa obtained a tea rate of 10.8%, with the country positioned 25th out of 50 participating countries, as observed in the 2019/2020 gem report, while the 2021/2022 gem report observed that south africa’s tea rate for 2021 increased to 17.5% and ranked 11th out of 47 participating countries (hill, ionescu-somers & coduras 2022). adding to this, gem reports provide data related to the south african population’s 18 to 64 age group of the national population who agree that they are aware of good opportunities but are reluctant to start a business for fear it might fail. in 2017, south africa had a fear of failure rate of 31.3%, increasing to 49.8% in 2019, positioning south africa within the top 10 highest fear of failure rates for a participating country (bosma et al. 2020; singer et al. 2018). the 2021/2022 gem report data observed that south africa obtained a failure rate of 53%, ranking the country 5th out of 47 countries (hill et al. 2022). two primary reasons contribute to smes business exit in south africa, namely unprofitability and financial problems in all, contributing to sme business failure on a global scale (bosma et al. 2020; singer et al. 2018). as part of the financial problems leading to business exit, smes’ ability to manage trade credit stands out among the numerous encountered by smes (otto 2015; otto 2018; braimah et al. 2021; singer et al. 2018), which cannot be separated from considerations about the business environment (entrepreneurial ecosystem) in which smes operate. because smes are exposed to several internal and external business environmental variables, while largely dependent on trade credit, the widespread failure of smes observed is not surprising (bosma et al. 2020). this requires investigation. however, the risk perception of lending credit to smes first needs to be reduced in order for credit to be extended to smes (fatoki 2010). small and medium-sized enterprises are more dependent on trade credit; therefore, improving the management of trade credit for smes is one of the key factors to reduce south african smes’ high failure rate, although business environment volatility raises smes’ perceived risk (organisation of economic cooperation and development [oecd] 2006). the oecd (2020) argues that improving south africa’s business environment through prioritisation of reform is fundamentally important in attempting to raise the country’s growth impact, given that smes’ prosperity depends on strengthening the internal and external business environment (beck & demirguc-kunt 2006). small and medium-sized enterprises face numerous constraints affecting their viability and sustainability such as financial problems in the form of proper management of trade credit, due to ample business environment challenges impeding smes’ ability to contribute effectively to south africa’s sdgs. therefore, determining the internal and external business environmental factor construct relevant to smes management of trade credit is deemed important. there is, thus, the need to identify and construct these factors and provide evidence that the measurement is valid and reliable. as far as can be established, research identifying variables and constructing internal and external business environmental factors relevant to sme management of trade credit has not been conducted in south africa. the article’s primary objective to identify, construct, and validate sme business environmental factors relevant to smes’ trade credit management could be achieved through the following secondary objectives: identify, from a review of the literature, internal and external business environmental variables relevant to smes’ management of trade credit. analyse and interpret smes’ ratings, using appropriate descriptive statistical procedures, and determine validity and reliability of the questionnaire. determine which individual questionnaire components ‘belong together’ by grouping them into factor constructs relevant to smes’ management of trade credit and from that, determine if factors derived from the exploratory factor analysis (efa) are rated equally by smes. literature review trade credit finances approximately 90% of global merchandise estimated to be worth $25 trillion and represents approximately 20% of world gdp over the past 25 years (boissay, patel & shin 2020; klapper, leaven & rajan 2012), while locally the usage of trade credit remains vast. kwenda and holden (2014) observed that trade credit financed approximately 50% and 32% of current assets of total assets, respectively, as also confirmed by machokoto, areneke and ibrahim (2020), documenting an 89% increase in south african companies’ usage of trade credit as funding for corporate debt from 1991 to 2015. the decision to extend trade credit is complex, because there is a credit risk for creditors extending trade credit to debtors as, in the event of default, the original investment could become non-salvageable (smith 1987). financial problems in the form of agency problems such as adverse selection and moral hazard are prone to affect smes’ trade credit management, due to the phenomenon known as asymmetric information in smes (nguyen & ramachandran 2006). due to the phenomenon of asymmetric information, the mismanagement of trade credit can occur because of the financial problems that impair the contractual stipulations agreed upon in the initial credit agreement entered into between a creditor and a debtor (fatoki 2010). asymmetric information asymmetric information theory, developed by smith (1987), occurs when a situation of uncertainty arises concerning the debtor’s financial health or creditworthiness, due to the presence of informational asymmetries. trade credit acts as a contractual mechanism for assisting with informational asymmetry in establishing credit terms between both parties involved in the credit agreement that acts as a mechanism of display to provide valuable information specific to the debtors default risk. specially in the case of trade credit, such information proves resourceful to creditors, as it acts as a strategic mechanism in assisting creditors to protect their investment or forecast for the possibility of default posed by the debtor. furthermore, the management of trade credit is of particular importance to smes, while various business environmental variables affect business sustainability for the majority of african smes making various business environment variables related to smes’ management of trade credit relevant and in need of investigation (bosma et al. 2020; oecd 2020). with the aim of the study in mind, the literature (first objective) reviewed eight business environmental variables: managerial competencies, collateral, financial and business information and networking (internal) and legal system, ethical management practices, macro-economic conditions and corruption (external). managerial competencies managerial competencies allow smes to grow into sustainable businesses. therefore, a high managerial competency level exhibited by smes will yield greater financial and business viability. malinao and ebi (2022) support this observation by revealing a positive correlation between new venture profits and greater levels of education and experience possessed by the business. bosma et al. (2004) support this, by indicating that human capital influences the entire set of performance measures, namely employment, profitability, and survival. in addition, should sme owners possess former industry experience similar to their current operating industry, this set of performance measures appears to improve including smes’ survival and creation rate (bosma et al. 2004). studies by veliu and manxhari (2017) support this observation, as the importance of managerial competencies to sme success is amplified, becoming increasingly relevant in the case of south africa that is regularly burdened by education system inequalities, thereby emphasising the relevance of managerial competencies to smes trade credit management (bosma et al. 2020). collateral creditors show a higher level of commitment and assurance and feel better protected with credit extension when collateral is available, given that collateral could reduce the risk of lending, thereby signalling debtor’s capacity for credit repayment (gassiah & kikula 2022; voordeckers & steijvers 2006). however, asymmetric information is a regular occurrence for smes subjected to high trade credit interest rates that act as a display mechanism from which information pertaining to the debtors default risk portrays asymmetrically resulting in uncertainty related to debtors’ creditworthiness (smith 1987). asymmetric information acts as an incentive for the extension of trade credit and the formulation of a credit policy as one of the main fundamental theories of trade credit that underpins this study (smith 1987). collateral solves several financial problems derived from information asymmetry, namely monitoring and screening costs and moral hazard that result in uncertainty specific to debtors’ financial viability, given that collateral requirements mitigate the risk of debtors not committing to credit repayment improving smes trade credit management (barbosa & moraes 2004; blumberg & letterie 2008). financial and business information concrete financial and business information is regularly unavailable for smes, resulting in a financial and business information supply gap that contributes to information asymmetry (nguyen, tran & truong 2022). vander bauwhede, de meyere and van cauwenberge (2015), as well as palazuelos, crespo and del corte (2018) support this observation as creditors feel more secure and willing to extend lending volumes to debtors. in addition, financial and business information availability is important to the entire sme sector as smes source credit as debtors, while facilitating credit supply as creditors termed a ‘two-way transaction’ (otto 2015). therefore, it is observed that smes directly contribute to the viability of their net trade credit positions, as the availability of financial and business information becomes essential to avoid a spill-over of information deficiency, given their interdependency (otto 2015). networking several authors argue in favour of networking, in order to improve smes’ trade credit management. networking opportunities position creditors to benefit from vital resources such as trust-based networks that facilitate the provision of valuable information pertaining to debtors’ reputation, disclosing debtors’ character and capacity, alerting to any possibility of default (amoako & matlay 2015; el ghoul & zheng 2016). however, creditor and debtor relationships usually fall victim to conditions of information asymmetry, although, if networking takes place, asymmetric information can be mitigated among same-sector smes, strengthening inter-sme trade credit management (gulati & gargiulo 2002). legal system from a legal system perspective, an inefficient legal system contributes to unprofitability because of business insolvency impeding operational viability, leaving creditors unprotected and subjected to lengthy judgement periods that regularly end up in liquidations. in practice, creditors remain unprotected in an attempt to resolve accounts in arrears because of business insolvency. the country’s efficiency in enforcing creditor contracts is utterly low, thereby confirming the incapability of the south african legal system in support of smes (palacin-sánchez, canto-cuevas & di-pietro 2019). to this end, it is no surprise that smes in south africa fail extensively, with unprofitability and financial problems observed as the two major reasons for sme failure within the 2017 and 2018 gem south africa report (singer et al. 2018). the study by palacin-sánchez et al. (2019) suggests a significant negative relationship between efficiency of the legal system and trade credit, given that trade credit depends on a country’s institutional factors. the authors state that individuals responsible for formulating and implementing institutional policies should be mindful of how these regulations influence trade credit. therefore, the efficiency of the legal system in south africa could prove to be relevant to smes’ trade credit management. ethical management practices in addition, the general risk perception in credit lending is increased when sound ethical perceptions are lacking as different sources of information will impact on smes’ trade credit decision-making (fatoki 2010). ethics is instrumental in mitigating a variety of trade credit constraints in the business environment, namely adverse selection and moral hazard, due to information asymmetries (howorth & moro 2006). therefore, ethics may well be the most important assessment criteria available to a creditor in extending credit to a debtor (amoako, akwei & damoah 2020). because the essence of successful lending revolves around mitigating asymmetric information, the disclosure of ethical information could limit debtors’ incentives to default, thereby improving smes’ trade credit management. macro-economic conditions small and medium-sized enterprises should also consider macro-economic fluctuations such as inflation, interest rates, and foreign exchange rates, as these might challenge smes’ operational abilities, leaving smes exposed to negative debt leverage (lui 2020). however, smes’ ability to fully comprehend macro-economic conditions is subjected to their managerial competency levels, as the understanding of macro-economic conditions can help smes better plan for disruptive future events as economic downturns impose a destructive influence on smes forcing smes to operate under a negative debt leverage (kwenda & holden 2014). in addition, south africa’s low economic growth prospects impede smes’ ability to act as drivers of economic prosperity as the situation worsened from the devastating impacts of the coronavirus disease 2019 (covid-19) pandemic on trade credit from a creditor’s perspective (lui 2020), raising the usefulness of determining macro-economic conditions as a construct relevant to smes’ management of trade credit. corruption numerous other external business environmental elements challenge smes’ ability to adapt to institutional environmental variations, including being more exposed to variations in economic policy because of corruption (rashid & saeed 2017). small and medium-sized enterprises incorporate 99% of all established businesses globally; yet the effect of corruption is prevalent within smes, while there is hardly any research on how corruption affects the smaller business (le & doan 2020). literature does, however, distinguish between two perspectives, namely ‘grease in the wheels’, incorporating a positive implication because of business corruption, and ‘sand in the wheels’, incorporating a negative implication. according to khwaja and mian (2005), corruption places businesses in a better position to receive external funding by overcoming complex regulations that limit businesses, due to existing bureaucratic processes. this ‘grease-in-the-wheels’ viewpoint is supported by a number of authors stating that smes do decide to engage in corruption as a means of survival, due to problems combining regulatory compliance and bureaucracy, especially in developing countries burdened by defective government bureaucracy and the presence of private monopolies (wellalage, locke & samujh 2019). alternatively, corruption could influence the smes’ repayment capacity once credit is granted. this could impair smes’ management of trade credit, as several studies align with the ‘sand-in-the-wheels’ viewpoint incorporating negative corruption implications threatening smes’ financial viability (le & doan 2020; ullah 2020). bosma et al. (2020) observed that smes are exposed to several business environmental influences all relevant to their operational viability. the above literature shares a common similarity in that south african smes are exposed to numerous internal and external business environmental variables affecting their business success, particularly their trade credit management. it can be argued that smes do not rate these variables equally and that a list of many criteria items can be clumsy with hardly any support in practice. because smes‘ are critical to address south africa’s sdgs, the importance of constructing smes’ internal and external business environmental factors to determine smes’ ratings of these factors relevant to their trade credit management becomes essential, in order to mitigate sme failure as a result of business exits, due to financial problems. research methodology the article used a quantitative research design and the online survey method to collect primary data by means of a questionnaire as measuring instrument. purposive sampling was used as the sampling method. according to johnson and duberley (2000), the positivism paradigm is, to a large extent, adapted in case of business-related research. the epistemology paradigm of this research is positivism, given the application of the survey research method by using a structured questionnaire to test theory and the use of inferential statistics in the research design. the first objective was attained through an extensive review of the literature. this led to the development of a questionnaire that included a set of internal and external business environmental variables that may be relevant to smes’ management of trade credit. exploratory factor analysis was performed to reduce the number of components into constructs. descriptive statistics was applied to rank the individual components, variables, and factors according to their relative importance. data for the article was gathered by means of an online questionnaire.1 the study applied the survey research method: the researcher chose a sample of respondents from a population to administer a standardised questionnaire. an e-mail questionnaire served as the measuring instrument and was designed to determine the impact of eight internal and external business environmental variables on smes‘ trade credit management effectiveness. the questionnaire was administered to 10 450 smes consisting of two main sections, namely sme business environment and sme trade credit management, excluding the biographical section. for the purpose of this article, section b of the questionnaire (sme business environment) included statements formulated for each of the eight sub-sections identified in the literature review. these 49 statements were closed-ended, and a 5-point likert scale was used, except for biographical questions, to rate the responses with the options, 1 = ‘very poor’, 2 = ‘poor’, 3 = ‘average’, 4 = ‘good’, and 5 = ‘excellent’ applicable to all business environment sub-sections, except corruption. in the case of corruption, the options were 1 = ‘no extent’, 2 = ‘small extent’, 3 = ‘moderate extent’, 4 = ‘large extent’, and 5 = ‘very large extent’. scale items were obtained from a combination of studying the literature for theoretical constructs and empirical conclusions, re-working the questionnaire based on the structure of an existing questionnaire used in a previous study designed to measure smes’ management of trade credit (otto 2015), and help from experienced statisticians who set out to peer debrief the questionnaire statements. after all necessary contact information was obtained from the smes’ sample, a letter was e-mailed to each sme. the letter detailed the title of the research project, a short introduction of the researcher, the time to completion of the questionnaire, the assurance that the completion of the questionnaire is voluntary alongside the needed ethical practices disclosure. the electronic link to the completion of the online questionnaire was also available in the letter sent to the respondents. the respondents opened the electronic link to the online questionnaire and thereafter completed the questionnaire. repeated reminder e-mails, restricted to a maximum of three per respondent, were sent to respondents to attain a desirable questionnaire completion rate. software used in administering the questionnaire were typeform.com as administered by the services of ifeedback consulting (pty) ltd, a private company specialising in data collection. after completion, the data for each questionnaire was saved for analysis. the researcher followed and completed the required ethical clearance process stipulated by the university of johannesburg. ethical clearance was obtained from the school of accountancy research ethics committee (sarec20180502-02). the population of south african smes totalled (n = 658 719) in 2018 (seda 2018). the population frame of smes was obtained from insights drawn from similar studies in the past and from expert advice obtained from ifeedback consulting (pty) ltd. using interactive direct business database, the population of smes totalled (n = 45 313), the researcher purposively sampled (n = 10 450) as the population frame of smes. all sme names were cross-checked to eliminate double counting. the empirical study focused on smes operating in the following industries: retail, professional services, mining, manufacturing, information and communication technology (ict), government, financial services, engineering and distribution. the sample size totalled 450 (smes) by applying the zikmund sample size calculator at 5% margin of error and 95% confidence interval (zikmund et al. 2010). the number of distributed questionnaires totalled 10 450, with 434 questionnaires returned, amounting to a response rate of 4.15% of the population total. only a small number of respondents answered the questionnaire in a manner that would result in missing values, due to item non-response. the total sample size for the purpose of statistical analysis equalled 422 respondents (number of accepted questionnaires) who completed between 70.41% and 100% of the questionnaire, and the remaining 12 respondents (number of rejected questionnaires) answered between 0% and 69.39%. missing values, therefore, presented a minute challenge for the researcher to start with the research results, although the number of component non-response cases might still differ because of missing data related to the sample. completed questionnaires were captured on excel, data was analysed using spss 26 employing statistical techniques such as descriptive statistics, frequency distribution, mean, standard deviation (sd), internal consistency, and factor analyses. quantitative data from section b was first analysed descriptively to establish the mean and sd of each of the 49 components. thereafter, efa was applied to determine which of those individual components ‘belong together’ and, in so doing, the components were loaded onto eight initial constructs through initial efa. these components were evaluated statistically for sampling adequacy using the kaiser-meyer-olkin (kmo) test and for sphericity using bartlett’s test, while cronbach’s alpha values were used to test for construct reliability, by indicating internal consistency of the construct expressed as a number between zero and one (tavakol & dennick 2001). the pearson correlation coefficient (p-value) of less than 0.05 is significant for statistical tests, unless otherwise stated (pallant 2016). empirical results the empirical results provided set out to determine the internal and external business environmental factors relevant to smes’ management of trade credit and obtain sme ratings for these factors to statistically test the validity and reliability of the measurement instrument. demographic data section a of the questionnaire collected demographic data revealing the average age of the respondent to be 52 years, predominantly classified as a white male. close to half of the total respondent group is in possession of a postgraduate qualification, while their average trade credit management experience amounted to 18 years. most of the smes were based in gauteng, with close to half of the respondents total operating within the manufacturing industry and three quarters of the total group of respondents operating independently as an entity. in addition, over half of the total group of respondents employ up to 50 staff members, while both smes and individuals equally represent the largest percentage allocation as a description to respondents’ clientele. descriptive statistics related to small and medium-sized enterprise business environment questionnaire section table 1 shows the results of the 49 components in section b of the questionnaire, which tested smes’ ratings pertaining to internal and external business environmental variables relevant to smes’ management of trade credit (second objective). the descriptive statistics mean value and sd are shown for each component. table 1 tabulates descriptive statistics of section b of the survey questionnaire before efa. table 1: descriptive statistics for section b of the questionnaire before exploratory factor analysis (n ranges from 411 to 422). validity statistics related to small and medium-sized enterprise business environment questionnaire section the kmo measure of sampling adequacy demonstrates the suitability of the smes’ business environment data for factor analysis and the bartlett’s test indicates redundancy is not a problem amongst components (table 2). table 2: validity statistics for section b of the questionnaire before exploratory factor analysis. exploratory factor analysis for computed small and medium-sized enterprise business environment factors a principal component analysis extraction method was used with oblimin rotation to reduce the data from the 49 components to a more manageable number of factors for further analysis. eigenvalues greater than 1.00 was the criterion used to identify factors. items with factor loadings less than 0.300 were removed, and another round of efa was carried out (leech, barrett & morgan 2005). eleven items were removed as a result of this process. five internal and six external business environment factors were confirmed after efa. to reach the third objective the results of the initial efa were considered against the research reviewed in the literature section. table 3 show the rotated factor loadings related to smes’ internal and external business environment factors after efa. table 3: rotated factor loading values for small and medium-sized enterprises internal and external business environment factors after exploratory factor analysis. total variance explained for computed small and medium-sized enterprise business environmental factors table 4 shows eigenvalues for the 11 factors. the total variance explained for the internal and external business environmental factors totalled 70.374%. table 4: eigenvalues and total variance explained for small and medium-sized enterprises internal and external business environmental factors. component analysis for computed small and medium-sized enterprise business environmental factors cronbach’s alpha was used to test the construct reliability (table 5). reliability for all 11 sme business environmental constructs is confirmed to be adequate. table 5 presents a selected summary statistics for the 11 factors. table 5: summary statistics. discussion of the results outline and discussion of the research findings this section starts with a discussion on the prioritisation of the 49 components (table 1) in attaining the second and third objectives. the literature review (first objective) provided a basis to develop the questionnaire. these 49 individual components could easily be linked to existing studies. for a detailed review of the questionnaire, refer to (otto 2022). individual components and factor constructs revealing small and medium-sized enterprises ratings of business environmental variables table 1 provides the average mean score values of the set of business environmental components needed to understand smes’ ratings of internal and external business environmental variables before efa (second objective). three of the four internal variables, consisting of several sub-variables, obtained a mean score of more than 3, revealing that respondents rated their business’ credit management in case of managerial competency quality (4.02) as good and their business itself in case of networking (3.40) and financial and business information (3.01) quality between average and good. however, for collateral (2.87), respondents rated the business itself related to quality of collateral between poor and average. only one of the four external variables, ethics (3.61), has a mean score of more than 3, indicating that smes rated either the business’ debtors or the business itself to quality of ethics between average and good. for legal system (2.75) and macro-economy (2.07), the mean scores of less than 3 indicate that smes rated the quality of both variables between poor and average. lastly, for corruption2 (2.72), smes indicated that the extent to which corruption occurs from the perspectives of debtor to sme and sme to creditor is between small to moderate. in relation to efa results, six section b factors have scale means above three out of five and five factors have scale means below two out of five (5-point likert scale was used). in relation to determining if factors derived from the efa are rated equally by smes (third objective), the following factors ranked from highest to lowest mean, indicating that smes do not rate these business environmental factors equally. mc (4.03) reveal the highest means score value of all internal factors, as smes rated this factor as good. this finding corresponds with the observations by veliu and manxhari (2017), bosma et al. (2020), as well as malinao and ebi (2022), expressing the importance of managerial competencies to sme success. net (3.73) obtained the second highest means score that aligns with the findings by amoako and matlay (2015), as well as el ghoul and zheng (2016) who observed the importance of networking in obtaining valuable information to create trust-based networks. fi (3.25) followed closely and showed an average rating that aligns with the findings of vander bauwhede et al. (2015) and of palazuelos et al. (2018). small and medium-sized enterprises rated col (3.02) as average. this corresponds with the study by voordeckers and steijvers (2006) revealing a mediocre importance, less so compared to the previous three factors, of collateral in protecting creditors from information asymmetries. as a last internal factor, ded obtained a mean of 2.96, while dep, external factors listed further, scored a mean of 3.49, which aligns with the studies by howorth and moro (2006) and amoako et al. (2020), in that ethics is instrumental in mitigating financial problems associated with credit lending and therefore important. small and medium-sized enterprises rated els between poor and average (2.75), which corresponds with singer et al.’s (2018) viewpoint that the inefficiency of the country’s legal system contributes to smes’ reasons for business exits. mec obtained a mean of 2.06 that corresponds with the observation by lui (2020), in that smes are constrained by a poor macro-economic climate furthermore impaired by the covid-19 pandemic. lastly, for corruption factors sme rated: ccpp (3.04), cdpp (2.83), and dcul (2.50), showing that smes rate the extent of corruption from creditor to sme as more prevailing than debtor to sme. altogether, given that smes rated the extent of corruption between small to moderate, the results align with the viewpoints of le and doan (2020) and ullah (2020), who observed the negative corruption implications (‘sand-in-the-wheels’ perspective) associated with corruption to smes’ financial viability. validity statistics for small and medium-sized enterprise business environmental variables table 2 depicts the results obtained after performing the kmo and bartlett’s test for item validity tests (second objective). the results for section b are as follows: bts at 1176 and the level of significance at p = 0.000, indicating that the data is appropriate with sufficient correlation between components for the purpose of factor analysis. the result of the kmo measure of sampling adequacy was 0.860 for section b of the survey questionnaire, which indicates that there are sufficient components for each factor. both tests support the appropriateness of the factor analysis technique, given that the results from the kmo were very high and statistically significant, indicating high validity for section b of the questionnaire. exploratory factor analysis and total variance explained for computed small and medium-sized enterprises business environmental factors the results display the factorisation of individual questionnaire components into factor constructs (third objective) and each factor’s eigenvalue (refer to table 3 and table 4). the rotated factor loadings for sme business environmental factors delivered five internal business environmental factors and six external business environmental factors relevant to smes’ management of trade credit. factor one – financial information included three components: b3.2, b3.4, and b3.6. the following components were removed, due to cross loading: b3.3, b3.8, and b3.1. factor two – managerial competencies matching theoretically and empirically, included five components: b1.3, b1.5, b1.2, b1.1, and b1.4. factor three – dcul – sme and debtor corruption through approving unviable loans. debtor’s ethical disclosure of accurate and transparent financial and business information included four components: b8.7, b8.6, b8.8, and b8.5. factor four – efficiency of legal systems, matching theoretically and empirically, included six components: b5.4, b5.2, b5.3, b5.5, b5.6, and b5.1. the fifth factor – debtor’s ethical disclosure of accurate and transparent financial and business information included two components: b6.5 and b3.7, with component b3.5 removed, due to cross loading. factor six – networking included four components: b4.2, b4.4, b4.3, and b4.1. the resultant factor seven – macro-economic conditions is exactly as originally conceptualised and included four components: b7.2, b7.3, b7.1 and b7.4. factor eighth – corrupt debtor payment practices through forcefully delaying payments due to the sme, the second corruption factor, included two components, b8.1 and b8.3 and factor nine – corrupt sme payment practices through forcefully delaying payments due to creditors of the sme included four components: b2.2, b2.3, b2.1, and b2.4. factor ten – sme and debtor ethical performance. ccpp, the third corruption factor, included two components: b8.4 and b8.2 with components b6.4, b4.5, b6.6, b4.6, and b2.5 removed, due to cross-loading. lastly, factor eleven dep included two components: b6.1 and b6.2, with component b6.3 removed due to cross-loading. table 4 displays factors with eigenvalues greater than one, as, according to the rules of factor analysis, only factors that have eigenvalues greater than one should be retained. the initial eigenvalues for section b’s cumulative percentage is 70.374%, with the total factor count amounting to 11. component analysis for computed small and medium-sized enterprises business environmental factors table 5 displays the reliability (second objective) and summary statistics for smes’ internal and external business environmental factors. a cronbach’s alpha coefficient value above 0.7 is regarded as a reliable scale, with the provided results indicating that all sme internal and external business environmental factors have a cronbach’s alpha coefficient higher than 0.7, ranging between 0.915 and 0.707, indicating high factor reliability for all factor constructs. conclusion for the set of internal variables, descriptive results (second objective) illustrated that smes rated the quality of their own managerial competencies as good relative to the business’ management of credit. small and medium-sized enterprises rated their quality of networking and financial and business information between average and good. however, smes rated collateral provision between poor and average. for the set of external variables, smes rated their quality of ethics between average and good, while rating the quality of the legal system and macro-economic conditions between poor and average. small and medium-sized enterprises rated the extent to which corruption occurs as small to moderate. both tests for validity support the appropriateness of the factor analysis technique and the results revealed high factor reliability for all factor constructs (second objective). through a review of literature, followed by quantitative empirical approaches by performing efa, this article constructed internal and external business environmental factors relevant to smes’ management of trade credit in order to determine smes’ ratings of these factors (third objective). five internal business environmental factors, namely fi, mc, ded, net and col including six external business environment factors namely, dcul, els, mec, cdpp, ccpp and dep were constructed. exploratory factor analysis results showed that smes do not rate internal and external business environmental factors equally, with the highest rated internal and external factors being mc (highest rated overall factor) and dep, respectively. overall, smes rated internal business environmental factors higher compared to external business environmental factors. for corruption, the results varied, revealing sme debtor corruption as slightly lower compared to sme creditor corruption and, therefore, more prevalent from creditor to sme. the article contributes to existing theory by fatoki (2010) and the author (in press otto 22), in that it prioritised the 49 individual components that were found in the literature. within the conceptual paradigm that the business environment could significantly impact on smes’ management of trade credit, the value of this article centres around the formulation of newly constructed internal and external business environmental factors relevant to smes’ management of trade credit. these factors are important to broaden smes’ understanding related to the south african business environment by using the study results to improve their own operations. in conclusion, it is evident that a strong set of internal and external business environmental factors were constructed that display high validity and reliability. therefore, the next step is to examine how these internal and external business environmental factors affect smes’ management of trade credit. limitations only internal and external business environmental factors in south africa that impact on smes’ management of trade credit were considered as other relevant variables were excluded from smes’ business environment, namely the international business environment that could be important to further confirm the findings of this article and should be considered for future research. the article focuses on trade credit management alone as funding source, although future research could focus on an extensive survey to determine the impact of internal and external business environmental factors on smes’ management of total capital (debt and equity). this could help confirm the findings of this article. additional guidance can be given to further improvements in data-collection and measurement methods. acknowledgements the authors acknowledge all anonymous reviewers for comments that greatly improve the manuscript. competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions w.h.o.: main author/contributor to the study. i.b.: main supervisor (providing supervising guidance to the study). g.s.: co-supervisor (providing additional supervising guidance to the study). ethical considerations all participating respondents gave their consent before completing the questionnaire. all respondents were properly informed as to the completion of the questionnaire being entirely voluntary, while any and all information, supplied by respondents alongside the identity of each respondent, was treated as strictly confidential. the summary of all data collected will be reported on as a whole, as the researcher was restrained from reporting the particulars of any individual respondent response. the researcher also encouraged sharing a summary of the research results with any respondent wishing to obtain such a report. required information relating to the study title and the purpose of the study was disclosed, along with the needed credentials for both the researcher and the supervisor that included the researcher’s contact details. the latter followed and completed the required ethical clearance process stipulated by the university of johannesburg. ethical clearance was obtained from the school of accountancy research ethics committee. sarec20180502-02. funding information this research received no specific grant from any funding agency in the public, commercial or not-for-profit sectors. data availability the authors confirm that the data supporting the findings of this research project are available within the article. disclaimer the views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of any affiliated agency of the authors. references amoako, i.o. & matlay, h., 2015, ‘norms and trust-shaping relationships among food-exporting smes in ghana’, international journal of entrepreneurship & 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business environment variables given that corruption was the only variable tested with different likert scale question alternatives compared to the other seven variables. 3. the initial efa produced 12 factors. the eleventh most important factor was unlabelled and not used because the factor included components with a weak loading and cross loadings. abstract introduction literature review model specification and methodology trade compliance costs, tariff, and the demand for import trade compliance costs and the supply of exports data and empirical analysis trade compliance costs of importing trade compliance costs of exporting conclusion and policy implications acknowledgements references appendix about the author(s) shahrzad safaeimanesh faculty of economics, administrative, and sciences, cyprus west university, famagusta, turkey glenn p. jenkins department of economics, queen’s university, kingston, canada citation safaeimanesh, s. & jenkins, g.p., 2021, ‘estimation of the potential economic welfare to be gained by the south african customs union from trade facilitation’, south african journal of economic and management sciences 24(1), a3796. https://doi.org/10.4102/sajems.v24i1.3796 original research estimation of the potential economic welfare to be gained by the south african customs union from trade facilitation shahrzad safaeimanesh, glenn p. jenkins received: 08 aug. 2020; accepted: 02 june 2021; published: 16 aug. 2021 copyright: © 2021. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: trade facilitation is important for the south african customs union (sacu) countries because the expansion of international trade is a priority to enhance their economic growth. unfortunately, the high trade compliance costs facing importers and exporters operating in sacu are in conflict with this objective. aim: this article aims to quantify the annual economic welfare gains that the member countries of sacu could realise from reforms that would reduce the documentary and border compliance time and costs. methods: we use a partial equilibrium welfare economics framework of up-to-date sets of general equilibrium estimates of the import demand and the export supply elasticity in a country. the impact on the volume of trade flow and economic welfare is quantified to reduce documentary and border compliance time and trade compliance costs. results: the economic welfare changes from reducing the documentary and border compliance time and costs for imports and exports would be between us$2.2 billion and us$3.7 billion (2018 prices), or between 0.54% and 0.90% of gdp of the sacu countries. the economic welfare gains from reducing the excess administrative costs in imports and exports of sacu members would be between us$2.2 billion and us$3.7 billion (2018 prices), or between 0.54% and 0.90% of the gdp of the sacu. conclusion: the most important reforms needed to realise these cost savings include a single window administrative structure. in this case, both customs, health, welfare, and controls, as well as the payment of all duties, taxes, and licenses are handled by a single administrative office. failure to move fast regarding such changes would have a negative impact on the well-being of sacu members. keywords: trade facilitation; southern africa customs union (sacu); south africa; trade compliance costs; trade reform; economic welfare gains. introduction over the past two decades, policymakers in emerging economies gradually came to understand that if the benefits of international trade are to be realised, trade facilitation measures must be implemented (perera 2016). the reduction in the costs of engaging in international trade must be at the core of the long-term development agenda of emerging economies. in december 2013, after 10 years of negotiations, the world trade organization (wto) trade facilitation agreement (tfa) was formally approved at the ninth ministerial conference of the wto and applied in february 2017. by january 2020, over 85% of the 41 wto member countries from africa had ratified the tfa (hassan 2020; wto 2020). according to trade facilitation implementation guide (tfig 2020a), trade facilitation measures include a wide range of possible interventions. this includes improving the domestic infrastructure for transportation and ports by designing administrative systems that link the management of the port to that of customs, banks, and government ministries, such as those for trade and health (fuenzalida-o’shee, valenzuela-klagges & coryalan-quiroz 2018; unctad 2017). the need for trade facilitation and policies to reduce the costs of international trade in sub-saharan africa (ssa) has been well documented (arvis et al. 2016; djankov, freund & pham 2010; hassan, odularu & babatunde 2020; porteous 2019). over the past decade, several trade facilitation interventions have been initiated in ssa with substantial success. much of the subsequent research on the impact of trade facilitation has been largely focused on the potential impact of reducing the costs on international trade flows. while these studies had estimated the potential impact of trade facilitation on the volume of trade and export diversification in africa, little direct quantitative assessment had been made of its effect on the economic welfare (hoekman & shepherd 2015). this article aims to quantify the gain in the annual economic welfare that could be realised by the member countries of the south african customs union (sacu) from reforms to reduce the documentary and border compliance time and costs for imports and exports. the focus is on reforming a series of administrative functions with costs greatly reduced without significant investment costs. the two aspects of trade compliance costs (cc) evaluated as potential areas for boosting economic welfare, if reformed, are border cc and documentary cc. border cc are associated with the time and costs incurred in customs clearance, goods inspection, and handling at ports and borders (wb 2019a). documentary cc are the time and costs associated to process the required documents to complete the international trade of goods from the country of origin to the destination country (wb 2019a). these costs are estimated annually by the world bank survey on doing business (wb 2018a). south african customs union countries, and particularly south africa, have the information technology and management skills and financial resources to reduce these costs dramatically. examples abound of successful reforms in this area by developing countries, starting with singapore in 1989 (tfig 2020a). the members of sacu are south africa, botswana, eswatini (swaziland), lesotho, and namibia. this union is the world’s oldest customs union still in existence, with its inception in 1889 (ngalawa 2014). due to its size and stage of development, south africa is the dominant partner in setting policy and the day-to-day operations of sacu (manwa, wijeweera & kortt 2019). south african customs union members have agreed on a trade liberalisation policy, with the duty-free transit of domestic products within the common customs area. at the same time, they have implemented a common regime of customs duties on imported goods into sacu countries. according to this agreement, all customs and excise duties collected in the customs union are deposited in the common revenue pool. after deducting the union’s administrative cost, this revenue is shared between sacu members based on a revenue-sharing formula (sacu 2002). as of 2018, 24% of ssa’s total gross domestic product (gdp) is created in the sacu countries, predominantly south africa. in terms of international trade, 36% of the value of imports in ssa, and 32% of its exports are produced by sacu countries. while exports and imports each account for more than 20% of ssa’s gdp, these ratios are much higher for sacu, at 29% and 35%, respectively (imf 2019; wb 2019c). this illustrates the importance of the sacu trading bloc in ssa and, in turn, the importance of international trade in the functioning of the sacu economies. literature review trade facilitation is particularly important for countries in africa because, when considering all the policy measures to stimulate economic growth, expanding their ability to engage in international trade becomes a priority (portugal-perez & wilson 2009; sakyi et al. 2017). in conflict with this need is the heavier burden of trade costs in ssa compared to those in the rest of the world. investigating the impact of international trade and trade facilitation on economic growth in 35 and 52 african countries, respectively, sakyi et al. (2017) and sakyi and afesorgbor (2019) found that the more those countries engage in trade facilitation, the greater the impact of international trade on economic growth. other studies have examined various aspects of the impact of trade facilitation on bilateral trade in ssa (portugal-perez & wilson 2009; turkson, adjei & barimah 2020; valensisi, lisinge & karingi 2016). with a focus on ssa, ferreira and steenkamp (2020) identified an array of potential intra-regional trade opportunities that would occur, with improved integration of trading relationships across the 26 member countries in the tripartite free trade agreement (fta). the authors concluded that the level of unnecessary costs, associated with international trade in the region, must be eliminated. these include poor infrastructure, slow border and customs procedures, and excessive documentation requirements. using a computable general equilibrium (cge) model, balistreri et al. (2018) state that trade facilitation would increase the share of income of the poorest population in the east african customs union and the tripartite fta. portugal-perez and wilson (2009) compiled an extensive survey of the literature on identifying the types of trade costs, and how they might be captured for comparative analysis across countries. three sets of indicators of trade impediments were selected. data on each of these indicators were available across africa. these included a trade restrictiveness index (tri) that combines rates and frequency of import tariffs, along with quantitative trade restrictions, the trading-across-border indicators of the administration costs of trade as reported by the world bank, and the world bank’s logistics performance index (lpi) that reflects the relative transportation costs associated with international trade in each country. these variables were used as explanatory variables in the estimation of a gravity model of international trade. the focus of this analysis is on the determinants of the volume of trade flows. the empirical estimates of the impact of these variables are as expected: the greater the trade restrictions, the lower the volume of imports; the lower the cost of trade administration, the greater the volume of both exports and imports. also the better the transportation system, the greater the volume of trade. given that africa has the highest trade transaction costs among all developing countries, they concluded that reducing such costs is critically important for economic growth and poverty alleviation in africa. in general, the impact of feasible reforms that would lower trade transaction costs is relatively higher than the impact of reducing tariffs. more recently, sakyi et al. (2017) also investigated the effects of trade and trade facilitation on economic growth across 35 countries in africa. they measured the trade-related exogenous variables by the volume of trade and the rate of cc related to export and such costs associated with import. these variables were used as exogenous variables to econometrically estimate an augmented growth model. they found that the direct impact of economic growth is statistically significant and positive. they also measured the impact of trade facilitation on economic growth, via increasing trade level, which stimulates the latter. the greater the extent of trade facilitation in an african country, the greater the impact of international trade on its economic growth. subsequently, sakyi and afesorghor (2019) investigated the effects of individual trade facilitation measures and their combined effect on trade performance, employing data from 52 african countries. in this study a structural gravity model framework is used for the period from 2006 to 2015. the focus of the analysis was on evaluating the impact of improvement in border and transportation efficiency on the volume of a country’s exports and imports. principal component analysis is used to create composite indices from several trade facilitation variables. they found that, while there has been some improvement over time, the trade costs associated with african countries have been consistently and significantly higher than those in any other region of the world. their empirical analysis revealed that the real cost to export and import across borders is the key determinant of the performance of intra-africa trade. trade facilitation that reduced these border costs of trading was particularly important in determining countries’ ability to export. in their study on bilateral trade in ssa, valensisi et al. (2016) found that the costs of processing imports and exports in african countries were very high even for bilateral trade within africa. for example, they found that 10 out of 16 countries in the common market of eastern and southern africa (comesa) region had higher bilateral trade costs within their common market than with the rest of the world. a similar pattern exists in the east african community (eac) countries and the economic community of west african states (ecowas). they concluded that high transaction costs are a significant hindrance to africa’s integration globally and its own regional integration. using cge, a set of trade facilitation measures has been evaluated. it was estimated that establishing a continental free trade area (cfta) could result in more than a 50% increase in intra-african trade. in their study of the opportunities for bilateral trade in ssa, turkson et al. (2020) recognised the challenge of developing efficient procedures and well-functioning institutions for cross-border administration trade. they conclude that african countries remain highly aid-dependent due to their inability to pursue the potential gain from trade fully. to address this problem, they point to the need for reforms to lower the level of cost of trade through the implementation of trade facilitation measures. employing a panel estimation technique, using a gravity model with data from 29 ssa countries, they estimated the impact of strengthening institutions and the business environment by promoting bilateral trade. the results supported the theory that trade facilitation encourages bilateral exports and increases trade flows among the countries. in the above studies, the focus was almost exclusively on how trade facilitation reforms would quantitatively expand the flows of exports and imports. balistrere et al. (2018) attempt to go further in their study. employing a cge model, the authors did an economic welfare analysis of reducing trade costs in the east african customs union and the fta. their focus is on the impact of these reforms on poverty and the incomes of the bottom 40% of the income distribution. their analysis indicated that the effects of the trade reforms to reduce trade costs benefit the poor. they found that trade facilitation tends to increase the incomes of the poor and reduce inequality. the strong influence of trade facilitation on improving agricultural returns tends to benefit skilled labour proportionally and reduce income inequality in these countries. a substantial body of research has been published, focusing on the need for south africa to stimulate its economic growth by diversifying its international markets to those providing a sustainable export demand (matthee, idsardi & krugell 2015; matthee & santana-gallego 2017; mhonyera, steenkamp & matthee 2018; turkson et al. 2020). the european union (eu) is one such sustainable market. the eu and six countries of the southern african development community (sadc) botswana, lesotho, namibia, and swaziland (blns), south africa, and mozambique – in 2016 signed an economic partnership agreement (epa). the objective of this epa is to bring about economic integration between the eu and this southern african region. the estimation of the impact on trade flows, revenue, and economic welfare has been carried out to promote free trade through the existing trade development and cooperation agreement (tdca) between south africa and the eu. the estimated annual trade expansion in south africa is over us$1 billion, with an increase in the economic welfare of approximately us$130 million. however, the tdca only tied the eu and south africa in terms of trade liberalisation. since south africa is adhering to a single external tariff as a member of sacu, it is an imperfect union that does not function as it is supposed to for imports coming from the eu (berends 2016). in 2014 eu and members of the sadc concluded talks on a new epa. the sadc epa entered provisional implementation in 2016 to strengthen sadc epa states’ capacity in trade policy and trade-related issues. south africa is the most important source of import for all sacu members (czermińska & garlińska-bielawska 2018). this article demonstrates the importance of a sustainable trade flow for sacu members’ economic growth. model specification and methodology various models of international trade have been used to estimate the impact of trade facilitation on trade flows. many researchers used gravity equations for this purpose (arvis et al. 2016; jordaan 2014; portugal-perez & wilson 2009). at firm level these effects were estimated through econometric studies of the comparative response of firms across countries (seck 2016). others employed cge models to estimate these effects on the level of trade flow and its impact on poverty (balistreri et al. 2018) and regional integration in africa (valensisi et al. 2016). a partial equilibrium model that has been applied in studies worldwide is the wits-smart model developed by the united nations conference on trade and development. it allows an approximate measure of the change in consumer surplus from a change in trade policies and has been used to analyse the welfare effects, due to trade, of the european fta on south africa (guei, mugano & le roux 2017). this model was built to help developing countries to assess quantitatively the implications of proposals for trade liberalisation through multilateral trade negotiations (mtn), or the effect of changes in the generalized system of preference (gsp) schemes of developed countries. it is an ex-ante partial equilibrium model, measuring through simulation the first-round effect of changes in tariff policies. the focus of this model is on the trade creation and trade diversion effect of changes in tariff policies that, by their structures, will influence the trade flow between it and the country’s various trading partners. these impacts are quantified using a series of import demand functions between each of the countries in the commodities analysis. a similar set of export supply functions is specified for each of the countries’ exported commodities. the elasticity of the substitution of commodities can also be applied to determine the degree of trade diversion between countries due to changes in the relative prices brought about by the tariff reforms. the total trade effect is obtained by summing together the trade creation and trade diversion effects. the welfare effect arises from the benefits consumers in the importing countries derive from the lower domestic prices, due to the removal or reduction in tariff rates, or quantitative restrictions. producers of exports also gain to the degree that the supply of these commodities is less than infinitely elastic. this model has been used to analyse the welfare effects of the european fta on south africa (guei et al. 2017). this model, however, is not well suited for the analysis of the welfare impact of trade facilitation reforms that is the primary focus of this article. such reforms lower the costs of importing all goods by approximately the same percentage, and similarly, the reduction of the costs of exporting goods by a uniform percentage reduction. hence, we can treat all imports as one composite good, and all exports (except oil and precious stones) as another composite good. in such a situation, there is only the impact of trade creation and no impact of trade diversion because relative prices from the various countries are not affected. in such a situation, it is the aggregate elasticity of demand for imports and the aggregate elasticity of exports supply that are the relevant empirical parameters for quantifying the responses of imports and exports to the changes in the administration costs of international trade. hence, a more aggregated partial equilibrium model, such as the one outlined in this article, is all that is needed to quantify the overall impact on the volumes of imports and exports and, more importantly, the measurement of the economic enhancement for importers and exporters that such trade facilitation reforms create. the default position of the wits model stems from the assumption that export supply elasticities are infinite. this reduces its usefulness when estimating economic welfare changes, involving changes in exporters’ trade costs. changing to a finite elasticity will affect results by transforming part of trade creation (quantity effect) into price effect. the maximum estimate of trade creation is achieved with an infinite export supply elasticity. a partial equilibrium framework and country-specific estimates of the export elasticity of supply, derived by tokarick (2014), and the import elasticity of demand by ghodsi, grübler and stehrer (2016), are used in this study. these estimates are available by country, using the gdp function approach initially developed by kohli (1991) and kee et al. (2008). trade compliance costs, tariff, and the demand for import in this section we follow the methodology developed by the wto (2015). the impact of tariffs and import cc on the volume of imports, economic efficiency, and tariff revenues are illustrated in figure 1. in the absence of import tariffs, cc to import, domestic freight, and domestic marketing costs, the quantity demanded of imports would be determined by the demand function for imports and the cost, insurance, and freight (cif) prices of imports at the border of the importing country. this research focuses on the impacts of tariffs (t), the cc associated with the administration of international trade flows (tcm), and their economic resource costs for sacu. we set aside the issues associated with differential domestic freight and domestic marketing costs. the analysis first identifies the quantity of imports, including both final goods and intermediate goods, demanded in a market that was free of both tariffs and trade cc. this is denoted as m1. figure 1: economic impact of tariffs and import compliance costs. in order to import goods, there will be a minimum required rate of trade cc to import (tcm), even in the most efficient of circumstances. the total tcm that is observed for a country can be divided into the lowest rate of import compliance cost that can be expected from an efficient administration system (tc0m) and the amount in excess (tcem). this relationship for a country is expressed in equation 1: tcem is the rate of trade cc that can be potentially eliminated through administrative reforms. while tcm for a country is observed, tc0m is not. however, the rates of tcm for other countries that implemented reforms to improve the efficiency of their trade administration systems are observable. hence, in this analysis the benchmark rates of tc0m are obtained from the observed rates of tcm achieved by the trade administration of other countries. when the minimum or efficient rate of trade cc, tc0m, is added to the cif price, the cost (price) of imports to the country increases. such costs reduce the quantity of imports in figure 1 as the measurement from m1 to m2. in addition, imposing a tariff (t) on the cif price of imported merchandise raises the prices of imports domestic consumers must pay, causing them to reduce the quantity of imports demanded further from m2 to m3. any degree of excess cc, tcem, will further increase the cost of imported items and lead to a further reduction in the quantity of imports demanded (m4 in figure 1). this will also be the quantity of imports that is reported in a country’s international trade statistics. in the pre-reform situation, the price of imported goods can be expressed as cif(1 + tc0m + t + tcem) in which trade cc can also be measured as a percentage of the cif value of the imports. if the small-country assumption holds for sacu countries, the world prices of imported goods are not affected by the quantity of imports demanded by these countries. in this situation, the quantities of imports can be expressed in units of foreign exchange; hence, cif is defined to be equal to 1. if trade administration reforms are implemented that eliminate tcem, they will reduce the cost of a unit of import to (1 + tcem + t), increasing the quantity of imports demanded from m4 to m3. this change in the quantity of imports, denoted as (δm)1, can be expressed as in equation 2: ɛm is the elasticity of demand for imports, while tcem is the proportional change in the price of imports brought about by eliminating excessive trade cc. the gain in economic welfare realised from the elimination of tcem arises from two sources. first, goods being imported before the reform can now be imported at a lower cost (δw1). this is shown as the area of rectangle ehif in figure 1, representing the reduction in real resources used by the required administrative procedures to import goods into the country. this saving of resources can be expressed as in equation 3: the second gain in economic welfare, δw2, occurs because consumers of imported goods are paying a price of (1 + tc0m + t + tcem) for items that after the reform will cost only (1 + tc0m + t). the lower price charged to consumers will increase the quantity of imports demanded by δm1. this increase in imports will have a resource cost of only (1 + tc0m). the economic welfare changes denoted as δw2 are shown as the summation of bfgc and fig areas in figure 1 and can be estimated as in equation 4. in figure 1, the area bigc represents the difference between consumers’ total willingness to pay for the additional quantity demanded (m4igm3) and the economic costs of the additional imports (m4bcm3). substituting eqation 2 into eqation 4, we have: the total welfare gain δwe from a reform to eliminate the excess cc of import administration is given in equation 5: in the case of imports, the study of tariffs and their efficiency costs has a long tradition. by estimating the economic welfare costs of the tariff, a comparison can be made of the relative size of these two sources of economic inefficiency in the market for imports. the economic inefficiency of the tariffs on imports is shown as the area cgd in figure 1. to estimate this familiar triangle of welfare cost, one can consider the change in the quantity of imports demanded if the tariff were eliminated (δm)2. this is expressed as in equation 6: the economic welfare cost as measured by the triangle cgd can then be expressed as equation 7: trade compliance costs and the supply of exports figure 2 illustrates a similar framework for the impact of trade cc on the volume of exports and the economic inefficiency that these costs might create. if there were no export trade cc, the exporter would receive the free on board (fob) price. the quantities of export can be stated in units of foreign exchange, with the fob price defined as being equal to 1. given the supply function of exports, sosx, the quantity of exports would be shown by x1. figure 2: economic impact of export compliance costs. conversely, if the country imposes on exporters a rate of trade transaction cost of tcx, the net remuneration received by exporters would fall to fob (1 – tcx) and the quantity of exports to x3. let us assume that the efficient level of trade cc is denoted by tc0x. at this level of costs, the total value of exports would be x2. the relation between these levels of administration cc of export is expressed as in equation 8: tcex is the excess trade transaction costs that can be eliminated through trade administration reforms. as the cc to export are also measured as a percentage of the dollar value of exports, the remuneration received by domestic producers of exportable goods, net of trade transaction costs, would be (1 – tc0x – tcex). if reforms were implemented to remove the tcex, the remuneration received for a unit of export by the producer would increase to (1 – tc0x). this would bring an increase in the supply of exports from x3 to x2, denoted by (δx)1. this supply response is expressed in equation 9: ɛx is the supply elasticity of export and tcex is the proportional change in the price of exports from the elimination of the excess trade cc. elimination of the excess export cc increases economic welfare, as fewer resources are used in exporting the goods. the economic welfare gain from reducing the excess compliance cost is shown in figure 2 for the current quantity of exports as the area of the rectangle abcd, which can be computed using equation 10: with the increase in the producers’ prices for exports, the quantity supplied will increase. the increase in the level of exports is the source of another economic gain shown as the area of the triangle of dce in figure 2. to quantify this economic benefit (δw4), equation 11 is used: this economic gain occurs because the marginal cost of the additional production (x3dex2) is less than the economic value received net of the compliance from the additional export sales (x3cex2). therefore, the overall economic welfare gain from eliminating the excess cc for exporting, δwex, is shown in figure 2 as the total area of abed. this gain is the sum of the results in eqations 10 and 11, expressed as equation 12: in this article, these economic welfare measurements are estimated for a trade administration reform by sacu member countries. data and empirical analysis to estimate the change in the level of imports and exports and the associated changes in economic welfare arising from the proposed reforms, international trade data for each of the sacu countries is used. information is required on the actual values of the rates of trade cc for both imports and exports, along with import tariff rates and estimates of benchmark values for the rates of trade cc and import demand and the export supply elasticity. description of the variables and the data source for each is provided in appendix 1. import and export data are obtained from the direction of trade statistics published by the imf (2019). trade compliance time and monetary costs are obtained from the doing business survey of the world bank (wb 2019b), and weighted average import tariff rates are available from the world bank (wb 2019b). the import demand elasticity was estimated in 167 countries by ghodsi et al. (2016), using the semi-flexible translog gdp function approach proposed by kee et al. (2008). the export elasticity of supply used for each country are average long-run export supply elasticity adjusted to include the general equilibrium effects of price changes, as estimated by tokarick (2014). the import data between sacu countries are adjusted to avoid double counting the imports arriving in south africa or namibia that are trans-shipped to other sacu countries and counted as imports of the second country. similarly, export values of the interior sacu countries are adjusted to reflect the fact that not all their exports will be shipped by sea via south africa, or namibia, to third countries. the exports of diamonds and precious metals are cases in point. the values of the border-crossing intra-sacu trade flow that is subject to the border and documentary cc to import are presented in table 1, columns 2 and 4 (columns 1 and 3 are representations of the total value of exports before adjustment). the weighted average values for tariffs and the import demand and export supply elasticity in each country are reported in columns 5, 6, and 7, respectively. table 1: value of merchandise imports, exports, tariff rates, and trade elasticity. to estimate the potential magnitude of the excess trade cc, the total cc of the import or export of a shipment of goods must be measured for each sacu country and compared with that of the benchmark countries. trade compliance costs of importing in this article, estimating the gains from reducing trade cc focuses only on reducing border and documentary cc, as these costs have been the focus of wto and world customs organization efforts at reducing trade compliance cost. by taking the total number of hours of waiting for an average import shipment, the average value of the shipment, and the cost of capital, one can estimate the average cost of waiting time to ship imports into a country (equation 13): the real cost of funds for the average importer is assumed to be 12% for 1 year (8760 h). the total compliance time and cost to import are presented in table 2. the first two columns are the hours and us dollar value of compliance time for import. the summation of us dollar cost of border and documentary compliance (wb 2019b) in column 3 is then added to the capital cost of waiting time for the shipment. the sum of the values in columns 2 and 3 then gives the total compliance cost of importing (tccm) (column 4). these rates of cc are what each country imposes on a shipment of imports as it moves from the port in south africa through the official procedures of the internal sacu countries, and it is expressed as a percentage of the world bank standard shipment value for imports of us$50 000 (column 5). table 2: total compliance time and cost to import per shipment (2018). the importation of goods through south africa imposes a tccm rate of 1.67% of the value of the imported goods (table 2, row 5, column 5). inland sacu countries and namibia impose a further cost as the goods are imported there. for botswana, the additional cc are equal to 0.34% of the value of the goods. due to recent trade facilitation reforms, botswana has the lowest second-stage importation costs among inland sacu countries (wb 2018a, 2019b, 2019c). namibia, eswatini, and lesotho have additional customs compliance costs of 0.43%, 0.43%, and 0.49%. the combined rates of the tccms imposed on south africa, and the ultimate country of importation are reported in table 3, column 2. table 3: estimates of the actual rate of cost to import and estimated rate of excess cost to import.* the combined compliance costs are lowest for goods imported by and remaining in south africa, at 1.67%. for inland countries, the rate of compliance costs ranges from 2.01% in botswana to 2.16% in lesotho. a small amount of goods is imported via the port in namibia, mainly used to export raw materials. however, it is relatively efficient, with custom compliance costs for botswana of 0.77% (i.e. 0.34% + 0.43%) and only 0.43% for namibia (table 3, column 3). however, shipping costs to namibia, with its small number of cargo, will generally be higher than shipping via south africa, except for a number of selected high-volume raw materials. in summary, there are three possible avenues for importing goods into a sacu country. firstly, goods may come directly into the country as either air shipments or direct imports by south africa and namibia. the rates of cc for these importations are shown in table 3, column 1. secondly, goods can first be imported into south africa and then shipped to a second country. the rates of cc for these imports are reported in table 3, column 2. finally, a small amount of goods is imported into botswana via ports or airports in namibia. in all countries, a degree of customs cc is necessary to ensure the security and health of residents. however, several reforms worldwide have greatly reduced these costs, while improving the overall quality of the services provided by customs and other government organisations dealing with international trade (peterson 2017; tfig 2020a, 2020b; wb 2019a). the two countries in the region that have been most successful in implementing trade facilitation reforms are mozambique and botswana. as a result of its reforms, mozambique has the lowest cost of trading across borders of any coastal country in the region, except mauritius (wb 2018b, 2019c). in our analysis, mozambique and singapore are chosen as appropriate targets south africa could reach. at the same time, botswana is the benchmark for the inland countries of lesotho and eswatini, and also for the costs incurred by namibia to bring goods from south africa. mozambique has a total cc for imports of us$476.12 (table 2, row 6), which on average is 0.95% of the value of a shipment of imported goods. it is clearly much more efficient than south africa, with a tccm of us$833.25 per shipment, a rate of cc of 1.67% of the value of imported goods. singapore, a pioneer in trade facilitation reform, has total cc for imports of only us$284.66 per shipment, equivalent to only 0.57% of the value of each shipment (table 2, row 7). with its advanced it industry, sophisticated banking organisations, and highly educated public sector, south africa should be able to achieve either one of these benchmarks. the same logic applies to the development of a benchmark of costs associated with the second importation of the goods from south africa to namibia and the landlocked countries of lesotho, eswatini, and botswana. with its rate of customs cc of only 0.34% of the value of the imported goods, botswana is the benchmark for the cc for importation from south africa. the rates of cc of these benchmark countries are subtracted from the current cc of the sacu countries to estimate the potential efficiency gains of trade facilitation reforms. these are presented in table 3, columns 3 and 4, using mozambique and botswana as benchmarks. where singapore and botswana are used as the benchmark rates for ‘normal’ rates of trade cc, the potential efficiency improvements are reported in table 3, columns 5 and 6. the savings in the cost of imports for sacu from trade facilitation reform range from 0.72% to 0.87% of the value of imports, with mozambique as the benchmark value for ‘normal’ compliance costs, and between 1.10% and 1.25% for singapore. the economic efficiency impact of trade administration reforms expressed by equations 3, 4, 5, and 7 for imports are presented in table 4, columns 2, 3, 4, and 6, respectively. table 4: economic welfare effects of the total excessive compliance costs of import and tariff. as shown in table 4, column 1, removing the excess cc would lead to an increase in the quantity of imports across the sacu countries of between 0.87% and 1.34%, and in south africa of between 0.91% and 1.40%. in terms of the percentage response, the biggest impact is on the imports into south africa. the estimated gain to sacu countries in economic welfare from reducing transactions cost of importing is shown in table 4, column 2, rows 2 and 4. the range in the present value of the gain in economic welfare is between us$919.7 million and us$1407.7 million annually, for the current level of imports (estimated using eqation 3). an additional gain in economic welfare occurs with the increase in the level of imports. the incremental gain in economic welfare is between us$56.5 million and us$89.9 million annually. combining these, the annual gain in economic welfare (table 2, column 4, rows 2 and 4) is estimated at between us$976.2 million and us$1497.6 million. for south africa alone, the estimated annual gain would be between us$887.4 million and us$1366.3 million. that means more than 90% of the total economic gain to sacu would accrue to south africa. a perspective of the relative size of the benefits of reforming the trade administration could be gained by comparing these values with the gain in welfare if all import tariffs were eliminated. because the weighted average tariff rates (table 1, column 3) are larger than the size of the potential rates of proposed reductions in trade transactions costs (table 3, columns 3–6), the impact on the quantity of imports demanded in sacu is larger, at 5.63% versus 0.87% – 1.34%. however, the estimated value of the traditional measure of the deadweight loss reduction from the complete elimination of the import tariffs (eqation 7) is reported in table 4, column 6. the annual economic welfare gain amounts to only us$168.5 million. approximately 94% of annual economic welfare gain resulted from the complete elimination of the import tariffs that would accrue to south africa (us$158.3 out of us$168.5). this estimate is consistent with that of guei et al. (2017), who found that the economic welfare gain from the fta between south africa and the eu would be approximately us$134 million per year. the reform of the import administration level would yield the countries of sacu between 5.8 and 8.9 times as much economic gain (table 4, column 7). as was shown in figure 1, the fundamental cause of this huge difference in the current level of economic efficiency losses is that the tariff only creates a triangle of economic inefficiency (triangle gcd, in figure 1), due to the reduction in consumer demand for importables and the stimulation of the supply of importables. most of the price impact of tariffs is borne by consumers through the payment of increased tariff revenues to the government. these tax revenues are not economic welfare costs but represent a fiscal transfer. this is in contrast to the excess trade cc that in their entirety reflect an economic resource cost to the country (area ehig in figure 1). trade compliance costs of exporting to estimate the economic benefits from the reform in the sacu countries’ export administration system that would reduce the cc, we have used equations 8–12. the required data are the level of exports, supply elasticities of exports (table 1), and estimates of export cc (table 5). table 5: total compliance time and cost to export (2018) and estimated rate of excess cost compared to benchmark costs. in the case of exports, we suggest a little potential for reform in eswatini, lesotho, and botswana. according to world integrated trade solution, published by the wto (2015), more than 90% of botswana’s exports and 37.78% of namibia’s exports are diamonds. we assume that the remaining 10% of botswana’s exports are exported via south african to third countries and will be included in south africa’s exports. if these exports are simply sold in south africa as regionally traded goods, we exclude any potential benefits from reforming botswana’s export administration system. the exports of eswatini and lesotho go almost all in the first instance to south africa (sacolo, mohammed & dlamini 2018). hence, they are treated in the same manner as non-diamond exports from botswana. namibia has its own ports, which are mainly used for shipping its non-diamond exports. hence, it is assumed that all namibia’s non-diamond exports are shipped from its ports. it is the export cc of non-diamond exports that are measured by the doing business surveys. thus, we apply these costs to namibia’s non-diamond exports (wb 2019b). our analysis, therefore, focuses on the potential economic benefits of trade facilitation reform of the export administration systems in namibia and south africa. the total cc to export is the aggregation of the total value of the time costs and the direct costs associated with merchandise exportation from sacu countries (table 5, columns 1–4). the cc associated with the administration of exports expressed as a percentage of a standard shipment of us$50 000 value, tcx, is reported in column 5: 2.47% for namibia and 2.84% for south africa. the corresponding benchmark rates of export cc (table 5, rows 3 and 4) for mozambique and singapore are 1.66% and 0.76%, respectively, of the shipment value of export. subtracting these benchmark rates for the normal cc of exporting from the current rates of cc for namibia and south africa gives the rates of excess cc (tcex) (table 5, columns 6 and 7). these are the target of the proposed trade facilitation reforms. the potential reform savings for namibia are 0.81% – 1.71% and south africa 1.18% – 2.08% of the value of exports. these rates can be considered a tax on exports from sacu countries that finances the administrative inefficiency of processing the paperwork to facilitate the administration of the export of commodities. the first step in analysing the impact of the reform is to see how exports would increase if the exports’ cc were reduced to the level of those exporting through mozambique and singapore. this is estimated using equation 9, along with the export supply elasticity and the volumes of exports of namibia and south africa (table 1). the results are reported in table 6, column 1. it is estimated that reform of the export process would increase the volume of exports by 1.03% – 1.83%. table 6: economic effects of excess compliance cost to export. in total, the estimated economic savings in cc imposed by the trade administration are between us$1223.0 million and us$2179.6 million annually, based on the benchmark costs of mozambique and singapore, respectively. the contribution of namibia to these overall efficiency gains is relatively small, at only 3% of the total gain in economic welfare. the economic efficiency won by a reduction in trade cc of both imports and exports to the level of that of mozambique would amount annually to approximately us$2.2 billion (table 7). if singapore is used as the benchmark, the annual gain would be about us$3.7 billion (2018 prices). in terms of relative magnitude to other macroeconomic variables, the annual economic gains possible after this reform would be 0.54% – 0.90% of the combined gdp of the sacu countries. south africa and the other sacu countries are wasting resources of more than half a percent of their combined gdp annually, because of an unnecessarily inefficient system of imports and export clearances and cost imposed on consumers. without the proposed reforms, the welfare of the region is reduced annually by these amounts. table 7: economic effects of tariff and total excess compliance cost of the trade. the governments of the sacu countries are strongly committed to the education of their young populations and spend approximately 6.2% of their gdp on public education services. this rather simple reform of customs and port procedures would yield a benefit to these countries of 8.7% – 14.5% of their total current expenditures on education. comparing the annual economic gains after this reform to the south african government’s average expenditure on health (4.35%) shows that this single reform would save the country from 12.36% to 20.67% of government health expenditure. a major concern, with the imposition of import tariffs, among economists and policymakers discussing sacu’s tariff policies, has been the magnitude of the efficiency costs they create (edwards & lawrence 2008). table 7, column 5, shows a comparison of the relative values of the economic efficiency that could be gained from reforming the management of the international trade flow (δwe) to the economic efficiency gained from a complete elimination of all import tariffs (δwt) (table 4, column 6). the total potential welfare gain for the sacu economic community can also be compared to the total ‘net official development assistance received’ (us$1419 million) in 2018. this comparison indicates that the economic welfare gain could be achieved through these reforms in trade across borders is 1.6–2.6 times greater than the value of loans and grants received by sacu member countries (table 7, column 6). this ratio is even higher in south africa at around 2.3–3.8 times more than the net official development assistance. the result is that inefficiency due to the excess cc is between 13 and 22 times the estimated economic inefficiency cost of sacu’s tariff regime. conclusion and policy implications the economic gain from reducing the excess border compliance and documentary compliance costs for imports and exports are substantial, amounting to 0.54% – 0.90% of sacu countries gdp annually. reforming these administrative practices would provide south african residents with about 95% of the possible benefits of the whole sacu. in south africa alone, the gain from reducing these excess cc would be worth between us$2075 million and us$3471 million. by way of comparison, the costs of implementing major trade facilitation reforms to reduce these border and documentary cc are trivial. for example, the cost of setting up a single window in kenya was us$14.7 million. in south africa, the economic benefits of reducing the excessive trade cc are between us$2.1 billion and us$3.5 billion. the gain for each of the other sacu members in the case of reduction in import cc is as follows: botswana us$31 to us$48 million, namibia us$29 to us$42 million, eswatini us$17 to us$25 million, lesotho us$12 to us$17 million, while for south africa it is us$887 to us$1366 million. south africa is the one that achieves much of the gain. however, more than 85% of the welfare gain in these countries is achievable through the decrease in trade cc in south africa. this demonstrates the importance of south african’s trade facilitation for welfare to improve all members of sacu. the cost to singapore of setting up their trade net system was well below us$50 million in 2019 prices, while the annual operating costs are between us$195 000 and us$1.2 million (jenkins 1996; valensisi et al. 2016; yeow 1996). given the worldwide experience in developing and developed countries, implementing such trade facilitation measures, there is little risk of failure in it-rich south africa. few reforms are available to any country that would yield such widespread economic benefits, from significantly reducing the costs of intermediate input and consumer goods to stimulating international trade flows of exports and imports. failure to proceed quickly with such reforms inflicts costs that sacu countries can ill afford. the most important changes needed to realise these cost savings are, first and foremost, a single window administrative structure. this can be paired with risk-based customs checks, trade logistics system upgrades, regional administrative coordination, and trade stakeholder preparation and consultation. a strong trade facilitation plan is the best way to reduce obstacles by deepening the adoption of regional trade agreements in sacu. this could lead to greater economic integration among sacu countries. the sacu members’ failure to improve costs and leverage has been a major hurdle in bringing about trade facilitation reforms. reforming customs administrations is notoriously difficult. corruption in such organisations and powerful unions serving port employees have often defied the institutional reforms needed to introduce modern structures. often, reforms necessitate modern information technology, which existing administrators and employees will not be familiar with. given the magnitude of the possible gains, future studies should concentrate on the study of transition adoption. future research could also investigate how such measures should be implemented to promote public interest in existing ineffective procedures. finally, the implementation methods of effective reforms should be analysed so that a clearer understanding of the political economy of trade facilitation reform can be established. acknowledgements competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions this article forms part of a ph.d. study at the eastern mediterranean university by s.s. with g.p.j. as the supervisor assisting with the conceptual construction of the study. ethical considerations this article followed all ethical standards for research without direct contact with human or animal subjects. funding information this research received no specific grant from any funding agency in the public, commercial or not-for-profit sectors. data availability data sharing is not applicable to this article, as no new data were created or analysed in this study. disclaimer the views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of any affiliated agency of the authors. references arvis, j-f., duval, y., shepherd, b., utoktham, c. & raj, a., 2016, ‘trade costs in the developing 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november 2019, from https://www.doingbusiness.org/en/data/exploretopics/trading-across-borders. wto (world trade organization), 2015, world trade report 2015, world trade organization, geneva, viewed from www.wto.org/english/res_e/booksp_e/world_trade_report14_e.pdf. wto (world trade organization), 2020, trade topics, trade facilitation, viewed 19 april 2020, from https://www.wto.org/english/tratop_e/tradfa_e/tradfa_e.htmyeow. yeow, t. c., 1996, ‘the computerization of customs in singapore trade net’, in g.p. jenkins (ed.), information technology and innovation in tax administration, pp. 165–176, kluwer law international bv, the netherlands. appendix table 1-a1: list of variables and data sources used in analysis. abstract introduction literature review methods results and discussion conclusion limitations of the study and areas for further research acknowledgements references footnotes about the author(s) michael masiya department of economics, university of south africa, pretoria, south africa zurika robinson department of economics, university of south africa, pretoria, south africa citation masiya, m. & robinson, z., 2023, ‘to what extent do excise taxes affect malawi’s cigarette trade gap with kenya and south africa?’, south african journal of economic and management sciences 26(1), a4605. https://doi.org/10.4102/sajems.v26i1.4605 original research to what extent do excise taxes affect malawi’s cigarette trade gap with kenya and south africa? michael masiya, zurika robinson received: 29 mar. 2022; accepted: 04 nov. 2022; published: 30 jan. 2023 copyright: © 2023. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: while economic theory supports the perception that cigarette taxes incentivise producers and users to identify ways of evading the tax, leading to the smuggling of cigarettes through a profit-maximising mechanism, empirical evidence has produced mixed findings. aim: this study bridges the knowledge gap and contributes to the debate by evaluating the impact of the taxation of cigarettes on cigarette smuggling and assessing the correlates of cigarette smuggling. setting: in the study malawi’s cigarette imports from kenya and south africa from 2007 to 2016 are examined. method: quintile regression and correlation analysis. results: empirical results show that increased excise taxes are not associated with increased smuggling as measured by the trade gap. using the correlation analysis, the study found that an increase in the bilateral exchange rate and corruption in the partner countries are associated with an increase in the smuggling of cigarettes into malawi. conclusion: results tally with several empirical studies while conflicting with others. on the policy implications, the results suggest that tackling cigarette smuggling, using taxes only, may not be sufficient. to be effective, combating smuggling must also include combating corruption, strengthening the rule of law and imposing punitive excise taxes on cigarettes. contribution: this article contributes to the debate on the impact of cigarette taxes on smuggling of cigarettes using malawi’s trade data. interestingly, increased excise taxes on cigarettes were not associated with increased cigarette smuggling. the findings provide valuable insights for policymakers on the complexities of cigarette smuggling and the need to consider a range of factors, such as strengthening the rule of law, to combat cigarette smuggling. keywords: excise taxes; trade gap; cigarette smuggling; trade openness; corruption; rule of law; tax evasion. introduction evidence pointing to the existence of cigarette smuggling has been discussed by galbraith and kaiserman (1997) and goel (2008), among others. price and non-price factors are argued to be the leading causes of cigarette smuggling. as a price factor, cigarette taxes give rise to differential prices between neighboring countries, thereby encouraging price arbitrage and smuggling (chaloupka et al. 2010; guindon et al. 2014; merriman 2012; merriman, yurekli & chaloupka 2000), while as a non-price factor, the effectiveness of law enforcement acts as an incentive, or disincentive, for cigarette smuggling across borders (goel 2008). additionally, cigarette taxes give rise to smuggling through a rational profit-maximising mechanism in two ways. firstly, cigarette taxes incentivise producers and users to identify ways of evading tax – hence the smuggling of cigarettes (guindon et al. 2014). economic theory suggests that increasing taxes in one jurisdiction, which – all else equal – increases the potential profit from evading those taxes, should induce smuggling (joossens et al. 2010; prieger & kulick 2018). secondly, in an attempt to reduce tax liability, producers resort to producing counterfeit cigarettes–incurring less cost in production, and consumers readily resort to the black market as a substitute for expensive cigarettes – given a shifted tax burden (guindon et al. 2014; prieger & kulick 2018). much as some researchers downplay the importance of cigarette excise taxes in inducing smuggling,1 significant evidence points to the increasing relevance of tobacco taxes in influencing cigarette smuggling (baltagi & levin 1986; goel 2008; prieger & kulick 2018; saba et al. 1995; stehr 2005; thursby & thursby 1994); while van walbeek and shai (2015) argue that though increasing the excise tax is the single most effective tobacco control measure, smuggling would distort any estimates of tax incidence resulting from a change in excise tax on cigarettes (saba et al. 1995). stehr (2005) concurs by observing that the cigarette excise tax incidence includes both a consumption response and a tax avoidance response. hence any estimate of the effect of a cigarette excise tax on consumption can be overstated if it does not account for the other crucial component of the response – the cigarette smuggling response. trade taxes remain a significant source of revenue in malawi and other sub-saharan african countries (kassim 2016). in malawi, on average, customs revenues contribute 35% to gross tax revenues. despite this heavy reliance on customs revenues, most african countries continue to reduce their reliance on trade taxes and increasingly use vat (ataf 2017). high cigarette taxes would induce smuggling and so reduce customs revenues. to curb this, the government must measure the extent of the smuggling and determine the appropriate action. malawi imports a significant number of cigarettes, while cigarette taxes constitute over 90% of the cigarette import price (national statistical office [nso] 2016). before 2008, the excise tax regime in malawi was ad valorem, when a 90% excise tax rate was applied on the value of cigarettes in the local currency unit (lcu) – the malawi kwacha. in this case, the excise tax was higher than the 70% prescribed by the framework convention on tobacco control (fctc) (world health organization 2005). in 2008, the ministry of finance announced extensive changes to the taxation of tobacco cigarettes to curb the smuggling of cigarettes and develop a strong tobacco sector (government of malawi [gom] 2009). enhancing the tobacco sector would ensure that malawi attracts investment into value-adding within the country by producing cigarettes, as it is one of the largest producers and exporters of tobacco.2 the ministry proposed three tax laws: to tax cigarettes containing about 70% of malawian tobacco at a lower rate,3 the introduction of mandatory tax stamps to curb smuggling, and a change in the duty system from ad valorem to a specific tax considered to be administratively easy. several other studies have concurred on the undesirability of the ad valorem tax system of taxing cigarettes.4 whether the government switches from ad valorem to a specific tax, the extent of cigarette smuggling must inform the decision for the purposes of tax policy impact measurement. at the policy level, the government would be ignorant about implications of the tax revenue on any changes in the cigarette excise tax regime. cigarette taxes (such as excise taxes) are raised too high to discourage smoking in line with world health organization advocacy (who 2005). however, smuggling may defeat this purpose by making cheaper cigarettes available to the public (chaloupka et al. 2010; merriman 2012). in a similar vein, it would be challenging to estimate the actual number of smokers based only on local production volumes and imported volumes consumed, when there is a surge of illegal cigarettes on the market. therefore, determining the degree of cigarette smuggling in malawi is crucial for achieving a number of goals, including raising revenues, improving the efficiency of tax policies, and reducing smoking prevalence. additionally, no research has been done in malawi to evaluate the effects of the tax policies outlined in the 2008 budget statement. by analysing the influence of malawi’s cigarette tariff on cigarette smuggling, this research fills a knowledge gap. should the malawi government keep using tax mechanisms to combat the smuggling of cigarettes? these are some of the questions we attempted to address in this study. the study is narrowed down to the case of malawi – a country in sub-saharan africa. malawi is a special and interesting case, because it is a large exporter of tobacco. yet, because of its stagnant domestic cigarette industry, it is also a large importer of cigarettes (chirwa 2011; food and agricultural organization (fao) 2001; jaffee 2003). additionally, malawi is one of the third poorest countries in the world, according to the international monetary fund (imf 2017) country report. this means domestic revenue mobilisation is critical for malawi’s economic survival. hence, any threats to tax revenue reduction, such as cigarette smuggling, must be averted at any cost. cigarette smuggling reduces the tax revenue collectable from cigarettes since, as cigarette taxes increase, the number of smuggled cigarettes is likely to increase as well. furthermore, tobacco smuggling makes tobacco cheaper and sabotages national tobacco taxation and control strategies. literature review theoretical literature bhagwati and hansen smuggling theory bhagwati and hansen (1973) were the first authors to introduce theoretical discussions on modern smuggling. thus, the theory is regarded as very pivotal in discussions on smuggling. this study adopts their theory to form a foundation for understanding the links between cigarette smuggling and excise tax in malawi. the theory is anchored to the assumptions that there are zero transport costs in legitimised trade and that smuggling has special real resource costs (norton 1988). bhagwati and hansen (1973) further qualify smuggling as a risk-free transaction within the international trade framework. it is also based on the assumption of perfect competition. bhagwati and hansen (1973) introduce an assumption that allows the smuggling sector to have a constant or increasing rate of transformation of exportable into importable items (norton 1988). furthermore, as argued by norton (1988), the authors assume that an individual smuggler has a constant rate of transformation, thus leaving his output indeterminate. excise tax and smuggling: a theoretical model merriman (2012) provided a theoreotical rationale for the changes in cigarrete consumption, given some tax adjustments. at an initial price p0, in the absence of taxes, the producer’s gross return will just be equal to the price. why? a producer will continue supplying cigarettes until additional cigarettes bring in the same return (in addition to the ones shipped to alternative countries), and this rate of return becomes the international norm. thus the firms will continue supplying until the net (after tax) returns are equal in all countries whereto the cigarettes are being shipped. with tax t imposed, the price moves up to p0+t so that the supplier can make a profit. the supply curve hence shifts to p0+t, reaching a new equilibrium. at this point, the new equilibrium price increases from p0 to p0+t, and consumption falls, because it is now more expensive to purchase the old quantity of cigarettes. merriman (2012) proceeds to introduce smugglers and bootleggers. due to the limited nature of alternatives, the smuggler’s curve is upward-sloping. ceteris paribus, the higher the price, the more the smugglers will supply. however, price is unaffected despite, any increase in the consumption of cigarettes because consumers make decisions considering the transaction price, plus the inconvenience price. relaxing the assumption of static prices, the equilibrium price is lower at the higher supply, and consumption is higher than if smuggling were eliminated. eventually, the increase in cigarette taxes reduces consumption. the tax increase also leads to increased smuggling, unless countermeasures are taken, but the increase in smuggling is less than the decline in legal consumption. empirical literature in this study, we cited most findings from empirical studies in the introductory section. we hereby briefly discuss some tax changes in kenya and south africa that have a bearing on the estimations and empirical findings of this study. in july 2011, the government of kenya introduced a single tax rate of kshs 1200 per 100 cigarettes or 35% of rsp, whichever was higher. this is called an ad valorem tax system with a specific floor (nargis et al. 2015), and the rate on rsp was targeted at the high-end tobacco products. the 2011 tax reform generated additional revenues and a higher tax yield per cigarette which, combined with an increase in the size of the legal market, indicates shrinking in the illegal cigarette market (ross 2017). this was significant because of reduced tax evasion arising from false declaration of the quantity of cigarettes (ngeywo & kenya revenue authority [kra] 2012). however, under the new system, manufacturers were incentivised to under-declare the retail price of cigarettes to reduce tax liability (nargis et al. 2015). south africa makes changes to the excise tax regime every year in line with world standards (legote & axelson 2018). some of the criteria include benchmarks for tax incidence and domestic price movements (legote & axelson 2018). south africa uses a targeted incidence approach, which came into force in the year 1994 and 1995 (legote & axelson 2018). an initial tax incidence was set at 52% of the rsp of the most popular brand in each cigarette category (legote & axelson 2018). the overall incidence encompassed both excise tax and vat (legote & axelson 2018). in the year 2015, the government removed the vat component and the excise tax incidence alone was pegged at 40%. henceforth, every year the excise tax rates have been adjusted to be in line with the tax incidence of 40% (legote & axelson 2018). vellios, walbeek and ross (2020) used the media and products survey and the national income dynamics study to compare tax-paid cigarette sales with consumption estimates from two nationally representative surveys by exploring the size of the illicit cigarette market in south africa and its changes over the period 2002–2017. the results indicate that since 2009, illicit trade has increased sharply and that it was between 30% and 35% of the total market in 2017. prior to that, van walbeek (2014) found no significant evidence that illicit trade in cigarettes in south africa had increased between 2002 and 2009. overall, we observed mixed evidence of the impact of changes in taxes and the tax regime on illicit cigarette trade in the two countries. in our analysis, we estimate malawi’s cigarette trade gap with kenya and south africa. we also discuss how some of the aforementioned tax changes in the two countries may have played a role in the variation in malawi’s excise tax regime and estimated cigarette smuggling. methods estimation of the trade gap in cigarettes in this article, the evasion/trade gap is defined as the difference between malawi’s reported value and quantity of cigarette imports at a disaggregated product level (hs12), for instance, from kenya and south africa, and the corresponding value and quantity of cigarette exports, reported by the same trading partners as their exports to malawi. following donda (2015), the evasion gap is presented in equation 1 as follows: where i_valuemip = is the import value of product p as reported by malawi from its trading partner i. where trading partners i for this study represent kenya and south africa. on the other hand, e_valueipas the value of exports of the product p reported by trading partners i destined for malawi. according to the accuracy assumption, in the absence of measurement errors and tax evasion, the reported exports from partners and imports at the destination should be equal. however, if some large discrepancy is found, it may be attributed to tax evasion given that the margin of error is minimal. the misclassification trade gap by observing trade data, errors can be categorized by origin, currency, and product classification. in analysing the cigarette data, some discrepancies that revealed the underlying measurement errors were observed. after computing all the errors associated with misclassification (mis), we computed the average arithmetic error () for a specified time period t, which is a year, and t = 2007, 2008, ….., 2016: after the computation, we adjusted the value gap (adjusted for cost-insurance-freight (cif)) for the errors as follows: this equation represents the value adjusted for the cif and the absence of all errors. the duty-free goods trade gap consider a good, k, which is duty-free (df) with no levied import taxes5. then, the gap value computed from the good k is given as: then, the average size of the error from df goods () is given by: using this to adjust the gap value, we get the following: this now represents the value adjusted for cif and is absent of all the errors. indicators of cigarette smuggling we rely on import misinvoicing of cigarette imports to denote smuggling. having adjusted values for cif, we remove measurement errors and make adjustments to obtain a discrepancy that may be classified as import misinvoicing. in this study, we have two estimates (smuggling [df and mis]) which differ in the method used to remove measurement errors. data sources and description in the analysis of cigarette imports, two contrasting datasets are used. first, official disaggregated trade data were obtained from the nso in malawi which provide detailed 8-digit hs codes of all products which were imported into malawi, covering 10 years from 2007 to 2016. these are the data that form the basis of what malawi reported as imported cigarettes from its trade partners. secondly, trade data were obtained from the un comtrade, which is a repository of official statistics on international trade, comprising imports, exports, reimports, and re-exports of all countries and their bilateral and multilateral trade partners. that data set was used to obtain the exports to malawi, as reported by trade partners, and compared these to the imports malawi reported as originating from these partners. kenya and south africa are the topmost trading partners for malawi in cigarettes6; hence, in this study, we focused on these two countries. other trading partners have many missing observations, and they were ignored. all data that showed only an export value or quantity, but not a corresponding import value or quantity, and vice-versa, were also ignored. the data on the other variables have been obtained from several sources, and all data span from the year 2007 to 2016. the world bank (2019) databank, the world development indicators (wdi), acted as reliable sources of data for the study, providing data on the following variables: trade openness, gross domestic product (gdp) per capita, and real exchange rates. data on the corruption index were sourced from the global integrity index (gii), data available on the world bank’s website, as well as worldwide governance indicators (wgi). data on crime rates were obtained from the un office on drugs and crime’s international homicide statistics database. finally, the effective excise tax rate was computed from nso’s detailed trade data. the quintile regressions utilise disaggregated trade data from 2007 to 2016 and across the products within the dataset. the data cover various tax rates or tariffs applicable for each traded product within the dataset. the data are obtained from the nso. it is the same data that are utilised in the rest of the study, only that for the quintile regressions, we use the disaggregated form of the data rather than the aggregated form used in the estimation of trade gaps and correlates. the disaggregated form allows the excise tax rates to be segmented into quintiles and permits the analysis of the trends in the various categories across different years. quantile regression: trends in the excise tax rate the study uses quantile regression to understand the trends in the main independent variable of interest to the study, the excise tax rate. quantile regression is a technique that quantifies the association of explanatory variables with a conditional quantile of a dependent variable without assuming any specific conditional distribution. quantile regression determines the median of a data set across a distribution based on the variables within that distribution (buhai 2005). it is an extension of the linear method of regression. it models the quantiles instead of the mean as done in standard regression. in cases where either the requirements for mean regression, such as homoscedasticity, are violated, or interest lies in the outer regions of the conditional distribution, quantile regression can explain dependencies more accurately than classical methods (waldmann 2018). correlates of cigarette smuggling to determine the correlates of cigarette smuggling, this study employed a correlation analysis of the smuggling variables (smuggling [df and mis]), as well as other theoretically and empirically established causes of smuggling. the choice of this technique was based on data availability and sufficiency. while the multiple indicators multiple causes (mimic) model, or panel analysis (gravity model), would be a suitable estimation technique for this kind of analysis, the data which were collected from 2007 to 2016 and from two trade partners, namely south africa and kenya, and malawi itself, were not sufficient for data-hungry techniques like the mimic and panel models. with t = 10 and n = 2 (cigarette imports from 2 trade partners), this study’s total number of observations is 20. the sample size does not permit using the mimic or panel models. we resorted, therefore, to the use of correlation analysis. correlation analysis is a term used to denote the association or relationship between two or more quantitative variables (gogtay & thatte 2017). unlike regression analysis, correlation analysis is not used for prediction, but rather shows the degree of association between two or more variables (asuero, sayago & gonzález 2006). therefore, the results in this study should only be treated as an indication of an association between cigarette smuggling and other theoretically and empirically established causes of smuggling, and not necessarily an indication of causation. potential correlates of cigarette smuggling from literature we resorted to literature to identify some correlates of cigarette smuggling, and we justified the inclusion of each. tariff rates on imported cigarettes in the analysis, we have used the effective tax rate (excise tax collected over value for duty purposes [vdp]) since the actual tax rate may be fixed, and the assumption of variability may be violated (gujarati 2009). it is included because high excise tax rates on imported cigarettes are among the leading causes of cigarette smuggling. the prohibitive nature of cigarette excise tax encourages importers to resort to illegal ways of trade, such as smuggling and the misinvoicing of cigarettes (buehn & farzanegan 2012). trade restrictions buehn and farzanegan (2012) postulated that increased trade restrictions encourage the smuggling of goods. to measure the extent to which trade is restricted, we use the standard-defined measure of trade openness, which is the share of trade (both imports and exports) in gdp.7 we obtain data on trade openness for both malawi and the partner countries (kenya and south africa) since trade is a two-sided coin; restrictions on the partner’s side could affect exports of cigarettes and encourage smuggling out while restrictions in malawi could catalyze the smuggling in of cigarettes. rule of law non-price factors are also the main drivers of cigarette smuggling (goel 2008). while smugglers anticipate higher profit margins from selling cigarettes, they face potential costs of punishment when caught. this depends on how stringent the laws of a country are in terms of fines and penalties for smugglers. a measure of the ‘rule of law’ is available annually and provided by the worldwide governance indicators (wgi) of the world bank, initially developed by kaufmann, kraay and mastruzzi (2009). the wgi rule of law indicator ranges from -2.5, which signifies weak governance, to 2.5, which indicates strong governance performance. however, there is likely to be a correlation problem using this indicator because the corruption index by the wgi also uses the same scale. in addition, the rule of law resonates with levels of corruption in a country; that is, the lower the quality of enforcement, the higher the likelihood of corruption. hence, to avert any possible errors, we select another indicator of rule of law which is given at a different scale and which is less likely to be closely linked to corruption. due to data scarcity of more ideal variables, crime data (particularly homicide rates data) available from the un office on drugs and crime’s international homicide statistics database8 is used to measure the strength of rule of law. in addition, homicide may be present even in countries with the lowest levels of corruption and hence may not be correlated with corruption. yet, high rates of homicide also reflect the strength of law enforcement, hence, this is what the study intends to capture. corruption smuggling is easier in countries with rampant corruption, characterised by bureaucracies that are more likely to abuse power for private gain, and allow smugglers to go scot-free (buehn & farzanegan 2012). the wgi control of corruption measure, which seeks to ascertain the extent to which power is abused for private gain in both petty and grand forms of corruption,9 is used as a measure of corruption. the index ranges from -2.5 (weak governance and high levels of corruption) to 2.5, indicating strong governance. real exchange rate we also postulate that a real exchange rate could influence smuggling. a depreciation of the currency can cause imports to be more expensive when converted to vdp before taxes are imposed. thus, we include a real exchange rate. indeed, ideally, we would have also wanted to include the black-market premium (bmp) as one of the variables, but the data are scarce. the reliable data on bmp, which the pick’s world currency report issued, are only available up to december 1998 (buehn & eichler 2009). in this case, we include the real bilateral exchange rate, which is expressed in terms of malawi kwacha per currency unit of the trading partner obtained by expressing the nominal exchange rate in real terms. results and discussion summary statistics table 1 is the summary statistics of key variables used in the correlation analysis. table 1: summary statistics. table 2: quintiles of average effective tax rates by year. the means of smuggling (df), and smuggling (mis) itself, are very close at $473.96 thousand and $463.96 thousand, respectively. additionally, they are highly correlated with a significant coefficient of 0.97. from table 1, one observes that, on average, the corruption index in malawi has a lower mean value than other partner countries. thus, over the years under study, malawi has had slightly higher levels of corruption than its trade partners combined. on the other hand, crime is high in the trade partners’ countries as well, as indicated by a mean that is over five times more than the mean of the crime rate in malawi. regarding trade openness, malawi has a higher average than its trade partners combined. malawi predominantly imports, and so trade forms a significant portion of gdp. in terms of the excise tax rate, on average, the cigarette tax rate is over 180% of the value of cigarette imports, which is significantly high. before the adoption of the specific excise tax regime, the rate was 90%, and after 2008, the unit tax regime is likely to have resulted in values over 200% in some instances to yield such a high average. the bilateral exchange rate average has no plausible meaning since it varies widely, depending on the partner country. variation in effective tax rates of cigarette imports before the excise tax regime changed to a specific tax in 2008, the average effective tax rate was 105%, and the bands of the excise tax rate did not exceed the 3rd quintile. in the years before 2007, the excise tax rate was fixed at 90% but what is evident from the computation of the effective excise tax rate is that other cigarette importers paid slightly beyond 90%. however, the margin of overpayment did not exceed 25 percentage points. on the contrary, soon after introducing the unit excise tax, the average effective tax rate shot up to quintile 9 at 336%. this can be regarded as an immediate impact of the tax regime change. the year after that, the number of quintiles remained at 7. however, the average dropped to 240%, and it rose again in 2010 shooting up to 332% while occupying all deciles. what is most interesting is how the average values kept fluctuating in the post-ad valorem era despite exchange rate regimes. a major exchange rate reform occurred in 2012 when malawi changed from fixed to float (gom 2013). this moved the exchange rate from an annual average of mk155/usd to mk255/usd, and a year later, in 2013, the value soared to mk361/usd (gom 2013). indeed, one would have expected that with such a change, the average effective excise taxes would rise and keep occupying all deciles. however, an opposite effect was experienced when, from 2013, the value in the last decile (q9) declined, and the trend continued until the number of deciles fell to 7 in 2016 and 5 in 2015. thus, despite an era of a high exchange rate, the effective excise tax on cigarettes was not significantly affected. two quintile regressions were estimated to provide insight into how each quintile of the effective tax rate is affected by year and country of origin. lessons are drawn from the coefficient estimates to understand what other factors could be driving the effective exchange rate apart from simply the change in regime to unit tax. the cif values of cigarette imports in usd are included, which denotes the value of cigarette imports but is not affected by the exchange rate.10 the average exchange rate is also included to examine if the changes in the exchange rate regime had any impact on the average effective exchange rate. alongside these independent variables, we then control for the various dummies of year and country of origin. the results are as presented in table 3 and table 4. table 3: excise tax quintiles and years of cigarette imports regression results. table 4: excise tax quintiles and origin of cigarette imports regression results. overall, the years 2008 to 2014 (after the introduction of specific tax) were statistically significant at 1% significance level, as shown in table 3. thus, the years after the introduction of specific excise were associated with higher quintiles of excise tax rates, which slowed down after 2015. the results are shown in table 4, signifying the importance of cigarettes from kenya in influencing overall effective excise tax rates. it is also clear that the currency rate was significantly affecting the excise tax rate, albeilt a negligible coefficient. however, the exchange rate was not significant in influencing average effective excise tax rates. as shown by table 4, kenya was significantly associated with higher quintiles of effective excise tax rates at 1%. tanzania was also significant at 1% level, although not considered in this study. the rest of the countries were not statistically significant. correlates of cigarette smuggling two models were estimated, one with smuggling (df) and the other with smuggling (mis) as an indicator for cigarette smuggling. table 5 shows the results from correlation analysis using smuggling (mis) as the indicator for cigarette smuggling. table 5: results from correlation analysis using smuggling (mis) as the indicator of cigarette smuggling. based on the results in table 5, the effective tax rate is positively associated with increased smuggling of cigarettes into malawi. this is consistent with the findings in other studies for example, farzanegan (2009). the finding implies that an increase in the effective tax rate is associated with an increase in the smuggling of cigarettes from kenya and south africa to malawi. however, the results show that the correlation between effective tax rate and cigarette smuggling is statistically insignificant with a p-value of > 0.05. the correlation coefficient of 0.037 also appears to be weak. surprisingly, the results show a positive correlation between corruption in malawi and cigarette smuggling. as already noted, a positive and increasing value of the corruption index implies decreasing corruption. therefore, the correlation results in table 5 imply that perceptions of corruption decreasing in malawi is associated with increasing levels of cigarette smuggling. the result is, however, statistically insignificant at 5%, and a correlation coefficient of 0.28 is weak. a possible explanation could be that decreased corruption in malawi translates into the precise and accurate valuation of the imports from the trade partners, such as that the discrepancy between what was reported as exports by the trade partners and what is recorded as imports in malawi, widens (smuggling [mis] rises). corruption in the partner countries is negatively correlated with cigarette smuggling into malawi, and the result is significant at 5%. the correlation coefficient of -0.57 is also strong. this implies that lack of corruption is associated with decreasing levels of cigarette smuggling into malawi, or increased corruption (corruption index approaching -2.5) in the partner countries is associated with increased levels of cigarette smuggling into malawi. as overall corruption increases, so do corrupt practices in the trade of cigarettes to malawi. the result conforms to the expectation. the results from the correlation analysis also show that the bilateral exchange rate has a significant positive correlation with cigarette smuggling and the correlation coefficient (0.62) is strong. the bilateral exchange rate was captured as the trading partner’s malawi kwacha per currency unit. the positive correlation implies that as the local currency depreciates, the smuggling of cigarettes rises. this is likely since an increase in the exchange rate implies expensive imports, stimulating the propensity to smuggle. trade openness for malawi and its trading partners were negatively correlated with cigarette smuggling into malawi. this implies that as malawi and the trade partners remove trade barriers (become more open trade-wise), the tendency to smuggle cigarettes declines. the results are, however, insignificant in both the trade openness variable for malawi, while the trade partners and the correlation coefficients in both cases are very weak. this finding contradicts the positive relationship which was advanced by the theoretical propositions of pitt (1981), as well as thursby and thursby (1994), that in so many instances, legal trade covers or camouflages smuggling to such an extent that an increase in legal trade openness consequently reduces the cost of smuggling. findings in a study in iran by farzanegan (2009) were similar, but is not in line with the findings in this study. crime rate (a variable that denotes the strength of the police and law enforcement agencies) in malawi was found to have a positive correlation with cigarette smuggling, while that of the trading partners was found to have a negative relationship. the result, that the crime rate in malawi is positively associated with increased cigarette smuggling, is consistent with the expected positive relationship that the higher the crime rate, the higher the cigarette smuggling. this entails that the stronger enforcement of the rule of law, depicted by the significant reduction in crime rate, has a negative relationship with smuggling. buehn and farzanegan (2012) stated: given the large standardized coefficient of the rule of law it seems that rather the ease to circumvent administrative rules than high tariffs and trade restrictions determine the level of smuggling. (p. 3057) however, the correlation is statistically insignificant for both the crime rate in malawi and its trade partners. the negative correlation between the crime rate in trade partners and the smuggling of cigarettes (measured by smuggling [mis]) to malawi could be due to increased crime rates in the countries of trade partners which are associated with a high level of export undervaluation. when smuggling (df) is used as an indicator for cigarette smuggling into malawi, results from correlation analysis match those found previously in which smuggling (mis) is used as an indicator of cigarette smuggling. table 6 shows the correlation between smuggling (df) and all other established causes of cigarette smuggling. table 6: correlation between smuggling (df) and all other established causes of cigarette smuggling. as seen from table 6, all the variables maintain their direction of correlation and significance with smuggling. regardless of the estimation method of smuggling used, the theoretically and empirically proposed determinants of cigarette smuggling employed in this study have determinants a consistent association with cigarette smuggling. conclusion this study set out to estimate the level of cigarette smuggling in malawi using missing cigarette imports. the study presented two estimates of cigarette smuggling based on two different error calculation methods that were discussed in the study. the estimates are highly correlated at 0.97, and the means are very close. smuggling (df) has a mean of $463.96 thousand, while smuggling (mis) has a mean of $473.96 thousand. thus, despite the different error calculation methods, the estimates are robust. the study proceeded to use the two cigarette smuggling estimates in the correlation analysis of factors that determine cigarette smuggling. results from the correlation analysis show that corruption in trade partner countries and bilateral exchange rates are significantly associated with the smuggling of cigarettes into malawi. while the bilateral exchange rate is positively associated with smuggling cigarettes into malawi, a low incidence of corruption in partner countries is negatively associated with smuggling cigarettes into malawi. interesting results have also been found in the relationship between cigarette smuggling and other domestic factors, including corruption, trade openness, crime rate, and effective excise tax rate, even though the correlation is not statistically significant. while increasing crime rate, effective tax rate, and lack of trade openness are associated with increased smuggling, low incidence of corruption in malawi is negatively associated with smuggling. this situation can be explained by an accurate valuation of imports which unmasks the smuggling activities initiated by the trade partners. in summary, the results mostly agree with the a priori expectations laid out in the methodology section, especially on most of the variables for malawi. high crime rate, low trade openness, and bilateral exchange rates are each associated with increases in cigarette smuggling. other results from partner countries are against a priori expectations but provide an insightful perspective to understanding cigarette smuggling in malawi. additionally, in the objectives of this article, two questions that this article sought to answer were raised, that is, firstly, whether excise tax rates would be effective in curbing cigarette smuggling, and secondly, whether it should be continued as a measure to curb cigarette smuggling. based on the results it can be conclusively stated that excise tax rates do not curb the smuggling of cigarettes across borders. however, based on the findings, it can be deduced that to be effective, combating smuggling must also include strengthening the rule of law, in addition to imposing punitive excise taxes on cigarettes. limitations of the study and areas for further research the study is limited to malawi; thus, the results cannot be generalised to developed or developing countries. the study is also limited to the period from 2007 to 2016. hence, the small sample size of the data has not permitted the study to employ data-intensive econometric methodologies such as panel-data regressions and mimic models. acknowledgements competing interests the author(s) declare that they have no financial or personal relationship(s) that may have inappropriately influenced them in writing this article. authors’ contributions this article was adapted from part of the doctoral research of m.m. who executed and wrote the article, while z.r. was the study leader and provided conceptualisation guidelines and editorial inputs. ethical considerations the authors obtained permission to conduct the research from the university of south africa (unisa) economics ethics committee and, further, ethical clearance to conduct the study was obtained, prior to data collection. the ethical clearance was valid during the analysis stage and is 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taxes, such as corruption, are key to inducing cigarette smuggling; see for instance, joossens et al. (2010, 2014); townsend (2015), who contend that the role of cigarette taxes in influencing taxes is overrated. 2. tobacco and its products are also a significant foreign exchange earner in many developing countries. some countries like malawi and zimbabwe earned from tobacco exports as much as 74% and 30% of their respective foreign exchange earnings (sarma 2000). 3. see gom (2009). likewise, turkey once taxed cigarettes containing at least two-thirds of oriental tobacco at relatively lower rates than other cigarettes to boost the demand for oriental tobacco grown on a large scale in turkey (chaloupka, yurekli & fong 2012). 4. see https://data.worldbank.org/indicator/ne.trd.gnfs.zs 5. we assume that with duty-free goods, there is zero incentive to evade import taxes. 6. cigarette imports from kenya and south africa account for approximately 90% of all malawi’s cigarette imports on average. 7. see https://data.worldbank.org/indicator/ne.trd.gnfs.zs for a full description of the variable. 8. see www.unodc.org/unodc/en/data-and-analysis/statistics.html 9. see http://info.worldbank.org/governance/wgi 10. when this value is converted into local currency, what results is the vdp which was the value which we later used to compute the effective excise rate via the formula . abstract introduction literature review data and estimation procedure results and discussions concluding remarks and implications acknowledgements references appendix about the author(s) parfait b. beri school of economic sciences, faculty of economic and management sciences, north-west university, potchefstroom, south africa socio-economic research applications and projects, washington, dc, united states gabriel mhonyera school of economic sciences, faculty of economic and management sciences, north-west university, potchefstroom, south africa gabila f. nubong school of economic sciences, faculty of economic and management sciences, north-west university, potchefstroom, south africa citation beri, p.b., mhonyera, g. & nubong, g.f., 2022, ‘globalisation and economic growth in africa: new evidence from the past two decades’, south african journal of economic and management sciences 25(1), a4515. https://doi.org/10.4102/sajems.v25i1.4515 original research globalisation and economic growth in africa: new evidence from the past two decades parfait b. beri, gabriel mhonyera, gabila f. nubong received: 08 jan. 2022; accepted: 17 may 2022; published: 25 july 2022 copyright: © 2022. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: in the last two decades, the world experienced two overlapping global shocks – that is, the 2008–2009 financial crisis and the covid-19 lockdowns – with severe social and economic consequences on african economies that have, once again, brought to the fore the intricate role that globalisation plays in economic growth because of grave risks that often accompany it. aim: we consider three research questions about globalisation: (i) does globalisation heighten economic growth? (ii) is there a statistically significant threshold level of globalisation above which globalisation affects growth differently than at lower levels? (iii) what factors moderate the globalisation-economic growth nexus? setting: a panel of 47 selected countries from africa from 2001 to 2018 is under scrutiny. method: to begin, it applies an overlapping five-year moving average (ma) to smoothen the data. in addition, we employ the revised globalisation index and the two-step systems generalised method of the moment (gmm) in its empirical strategy. results: we find a largely insignificant relationship between globalisation and economic growth. we attribute these results to africa’s infinitesimal share – less than 5% – in foreign direct investment (fdi) and global trade, acute infrastructure deficit and the lack of relevant skills that lead to productivity losses and weak performance within the international business ecosystem. we also find, among others, that globalisation is more effective in countries with more gross capital formation, higher population and urban growth rates. conclusion: for africa to maximise its growth potential from globalisation, sound policies should be put in place to promote trade, fdi, domestic capital formation and urbanisation. we suggest that future studies investigate the long-run equilibrium relationship between globalisation and economic growth. keywords: globalisation; internationalisation; kof index; economic integration; economic growth; trade; generalised method of moment; africa. introduction in the last two decades, the world experienced two overlapping global shocks that had severe social and economic consequences for african economies. to begin with, the 2007–2009 global financial crisis – following a subprime mortgage-backed securities crisis – decelerated economic growth that characterised the preceding quinquennium in africa. although the underdeveloped financial system and weak integration into the global economy insulated africa, the indirect effects were evident in higher lending costs and other impairments due to tightening credits in advanced economies. in october 2008, the international monetary fund (imf) revised its economic forecast in sub-saharan africa (ssa) from 5.2% to 1.7%, reminiscent of the overly optimistic projections during the oil shock in the 1970s (international monetary fund 2009). in addition, the unprecedented health crisis, due to the covid-19 pandemic and slower vaccine roll-out amidst the accelerating pace of climate change are adversely affecting african economies. despite these challenges, current economic forecasts show signs of resilience and rapid recovery in 2022 (up to 3.8%), following a sharp contraction in 2020. however, ssa is still at the lower end of recovery, compared to other regions in developing countries (international monetary fund 2021). these crises revved the nosedive in foreign direct investment (fdi), remittances, commodity prices (export prices and volumes), rising consumer prices, high unemployment and the economic volatility in african countries, which are spillovers directly intertwined with globalisation, and all essential to economic growth. nevertheless, globalisation has beneficial and detrimental effects on growth. these crises, their speeds of transmission and the outcomes they foist on african countries have, once again, brought to the fore the intricate role that globalisation plays in economic growth. the case of african countries is peculiar because of interminable efforts to accelerate deeper integration into the global economy to promote sustainable development. globally, countries vary in their financial integration, technological progress and institutional development, which are strong determinants of their potential to benefit from globalisation (samimi & jenatabadi 2014). the anti-globalisation movements vociferously argue that globalising amidst these polarities perpetuate dependency, leading to more severe poverty and income inequality (salahuddin et al. 2020; yameogo & omojolaibi 2021), which may impede economic growth in developing economies. secondly, some pessimists associate globalisation with a long-term agenda of western countries to dominate developing economies through the expansion of anglo-american capitalism, whose economic, political and cultural ideologies are antithetical (akinola 2020; asongu & nwachukwu 2017; thompson 2007). therefore, a rigorous empirical study of its impact on economic growth with data that cover the past two decades in africa is both timely – especially with recent success in bringing african countries together under the african continental free trade area (afcfta) – and crucial for policymaking in the future of deeper economic integration with the rest of the world. although many studies exploit the availability of large cross-sectional datasets to examine the role of globalisation on economic growth in developing countries (goldberg & pavcnik 2007; samimi & jenatabadi 2014; zahonogo 2018), there are not many rigorous empirical studies on africa. one part of the debate in literature starts from the premise that the protection of infant industries from established foreign enterprises lead to long-run economic growth. in addition, the pro-globalists argue that globalisation increases competition between business corporations by enhancing innovation, productivity, economic growth and better opportunities for citizens. conversely, many african countries are fraught with poor regulations, poorly developed financial markets, telecommunication, transportation and inefficient systems (institutions) that may impede them from taking full advantage of a globalised market to enhance economic growth. also, it is not clear whether africa has benefited from globalisation in the last two decades, given the slow pace of its technological progress, skills, industrialisation, transport, as well as information and communication technology (ict) infrastructure that are known to moderate its positive effects on economic growth (gurgul & lach 2014; latif et al. 2018). against this backdrop, this study answers the following questions: does globalisation heighten economic growth in africa? huh and park (2021) showed that globalisation promoted growth, but high-income countries benefited most. asongu (2017), asongu and nwachukwu (2017), shittu et al. (2020) and zahonogo (2018) have empirically investigated the dynamic impact of globalisation – typically measured with the economic (trade openness), financial or overall indices of globalisation using the kof index – on economic growth over the short run. however, these studies did not provide sufficient granularity on its transmission mechanisms. similarly, globalisation is a multifaceted concept to such a degree that results from studies that measure it with trade openness and fdi may not be reliable because these are not all-encompassing measures of economic globalisation (gygli et al. 2019). although rudra and tobin (2017) find that the effectiveness of globalisation on economic development predicates some preconditions, only a few studies examined such conditions in africa. latif et al. (2018) and samimi and jenatabad (2014) found that direct foreign investment, ict and the income level of countries played a significant moderating role on the impact of globalisation on economic growth in brics (brazil, russia, india, china and south africa) and the organization of islamic cooperation (oic) countries, respectively. on this basis, the study also investigates factors that moderate the impact of globalisation on economic growth in africa. the present inquiry makes two crucial contributions to the literature: firstly, there is no consensus about the development impact of globalisation (asongu et al. 2020). however, its insidious effects on income inequality are well-documented in developing countries, inducing calls for integration that is mutually beneficial (tchamyou 2019). accordingly, these disparities in income are more apparent in africa and other developing countries. therefore, the current study adds another notch to the discourse by employing recent data to examine the short-run dynamic link between globalisation and economic growth, and moderating factors that enhance the relationship in selected african countries. we are not aware of studies in which the moderating role of these existing conditions on the relationship between globalisation and economic growth in africa have been thoroughly examined. the method employed enables us to articulate specific factors that mitigate the dynamic link between globalisation and economic growth. secondly, the study examines the nonlinear relationship between the globalisation-growth nexus. this approach is relevant because it provides insights into at what level a previously insignificant effect from globalisation may become a positive and significant one, which may improve policy decisions. the remaining sections are structured as follows: the second section reviews the theoretical framework – focusing on the transmission mechanisms – and the empirical literature. the third section explains the data and estimation strategies. the fourth section presents the results, while the fifth section concludes the study and makes policy recommendations. literature review theoretical underpinnings does globalisation stimulate economic growth? since it is not easy to dissociate globalisation from trade, a standard answer from most trade theories is that it does. globalisation as an economic concept accentuates two changes: (1) improvements in transport and communication systems, and (2) high mobility of financial resources and trade. it also implies a situation in which countries continually depend on the global system for transactions. three main perspectives shed light on how these affect countries. these are the countries’ external position (systemic approach), the domestic or internal conditions within the nation (sub-systemic), and a combination of the systemic and sub-systemic approaches. in essence, the structure of the international ecosystem, its evolution and the roles that individual countries play in trade, labour and capital supplies influence development outcomes in diverse ways. we isolate three relevant theoretical perspectives that offer enthralling insights into the relationship between globalisation and economic growth. these include (1) the optimists (liberalists or hyper-globalists), (2) the pessimists (dependency theorists), and (3) the transformationalists. the optimists comprise classical theories – that emphasise the labour cost theory of value (comparative advantage) – and neoclassical theories that focus on the importance of opportunity cost due to specialisation in international trade. they perceive free trade, competition and division of labour as preconditions for economic growth (aspers & kohl 2015). one of the most cited liberal theories on the impact of globalisation on development outcomes is the heckscher-ohlin, stolper-samuelson – h-o-s – trade theory (khan 1970; rudra & tobin 2017). it builds on the comparative advantage model to explain how factor endowments shape international trade patterns (o’rourke & williamson 2005). this theory – which takes a global perspective – postulates that a nation would export the good that uses more of its abundant factor relative to the trading partner. the h-o-s model abridges trade within the framework of comparative statics to show its shortto mediumterm effects on economic growth through increased globalisation. in competitive markets, trade leads to divergence in abundant resources, specialisation in production, and equalisation of returns on factors between trading partners (davis & mishra 2007). in the long run, this results in lower income per capita, albeit at a higher offer curve. in an imperfect market, globalisation ignites competition between countries, increases market size, attracts direct foreign investment and remittances from migrants, improves the balance of payments position, develops the domestic infrastructure and propel the transfer of skills and technological innovations that increase productivity and economic growth (gruber 2011). on the other hand, pessimistic theories of globalisation have links with marxism, dependency theories and the world system theory. unlike the optimists, dependency theories contend that the current model of integrating less developed countries (ldcs) into the world system is exploitative, because it enriches advanced economies at the expense of the former. they suppose that the influx of capital, managerial skills and technology hurt developing economies, because it does not consider their relative factor endowments (ahiakpor 1985). accordingly, since these countries lack the necessary capital and skills, imported technology deprives them of a chunk of the value-added in production. many analysts believe that capitalism and the provision of development finance – for instance, through foreign aid and debts (particularly resource-backed debts) as outlined in the modernisation theory – entrap developing nations so much that it becomes impossible to break the circle of dependency. globalisation also leads to unfair competition between local (infant industries) and foreign companies that destroy the former because the latter possesses better managerial and technological skills, which is detrimental to economic growth. finally, transformationalists probably take a more sensible approach by recognising the complex and unpredictable processes that characterise globalisation and its effects on development outcomes. the theory aims to harmonise the centrifugal tendencies of many theories of globalisation – that is, hyper-globalists, sceptics and transformationalists – into a single and rigorous analytical framework. transformationalists argue that the impact of globalisation on economic growth is exaggerated by hyper-globalists even though resisting it, primarily on beliefs about western imperialism, does irreparable destruction to human progress (sen 2002). they also believe that the side effects of globalisation can either be reversed or mitigated. empirical literature several distinguished journals and book publications recognised the crucial role of globalisation on economic growth over the past decades. while this positive relationship remains contentious in the literature, we can isolate three strands of the debate. the first incorporates various studies that validate the notion that globalisation accentuates economic growth. literature in this regard includes pioneering works of dollar (1992), sachs et al. (1995) and edwards (1998), along with a significant body of recent studies stemming from coulibaly, erbao and mekongcho (2018), samimi and jenatabadi (2014) and, hassan et al. (2019). for instance, by employing the fixed effect model, fully modified ordinary least squares (fmols), dynamic ordinary least squares (dols) and the group-mean estimator techniques, latif et al. (2018) found that ict, fdi and globalisation were signficantly associated with the economic growth in brics countries over the long run. gurgul and lach (2014) studied the impact of globalisation on economic growth during the two decades of transition in central and eastern european countries (ceec), using indices from the swiss economic institute. their results were significant across the social and economic dimensions of globalisation, but not for political globalisation. the second strand comprises studies that are more reserved in advocating for the globalisation-led growth link (alesina, grilli & milesi-ferrett 1994; rodriguez & rodrik 2000; rodrik 1998; ulaşan 2015; vamvakidis 2002). this body of academic literature saw the contention of the openness-led growth studies of dollar (1992), sachs et al. (1995) and edwards (1998) by rodriguez and rodrik (2000). they argued that the evidence supporting this positive relationship was weak. their concerns were about the authors’ utilisation of an outlandish trade openness index and the lack of control over some outstanding indicators of economic growth. warner (2003) also repudiated concerns raised by rodriguez and rodrik (2000) by expressing scepticism towards their new index (i.e. tariff revenues divided by imports), which ignored all other trade barriers in their measure of trade restriction in countries. the third strand of literature covers researches that find a nonlinear relationship between globalisation and economic growth. several works in this domain (borensztein, de-gregorio & lee 1998; twerefou, danso-mensah & bokpin 2017) suggest that overall globalisation and its political and social dimensions adversely affect economic growth (bolaky & freund 2004). however, scholars such as borensztein et al. (1998), grossman and helpman (2015), latif et al. (2018), samimi and jenatabadi (2014) and zahonogo (2018) emphasise the effects of complementarities in the globalisation-growth nexus. they generally find human capital stock, level of education, infrastructure, quality of institutions, regulations and financial development to complement the impact of globalisation on economic growth. zahonogo (2018) employed a dynamic growth model and found an inverted u curve relationship between globalisation and the economic progress in 42 countries in ssa. for a country to experience the benefits of globalisation in economic growth, some initial conditions must be present to catalyse these relationships. borensztein et al. (1998), for instance, noted that the progressive technology, brought by fdi enhanced economic growth in countries with adequate human capital. furthermore, samimi and jenatabadi (2014) employed the gmm and found a positive effect of globalisation on economic growth in high and middle-income countries within the oic relative to low-income ones. other studies such as rudra and tobin (2017) and zaidi et al. (2019) convincingly show that globalisation positively influences economic growth in countries with existing conditions. these include financial development, technological preparedness, entrepreneurship, healthy institutions, high population growth and labour force participation rate. asongu and nwachukwu (2017) used the fixed effects and tobit models to show, among others, that middle income, oil-poor countries experienced more globalisation-driven human development. coulibaly et al. (2018) showed that entrepreneurship significantly moderated the impact of globalisation on economic growth in the brics countries. the literature review shows many potential channels through which globalisation affects economic growth. unfortunately, these are not yet adequately researched in empirical studies on africa. similarly, the use of trade openness as a measure of globalisation in some studies does not reflect its multifaceted nature. finally, empirical studies are still fraught with methodological inconsistencies. although several studies use cross-country data, they still suffer from the lack of sufficient observations, and the assumption of homogeneity in conventional panel estimation techniques poses additional challenges (grossman & helpman 2015). a comprehensive review of the literature also suggests that globalisation benefits developed countries and their multinationals more than developing countries (hartungi 2006). this variation is because foreign companies often possess enormous capital for investment, technology and managerial skills that easily outperform infant industries in developing countries. over the past two decades, however, african countries witnessed growing integration and several initiatives to boost private sector development and trade. a prominent view in the literature holds that globalisation is good for growth; yet, there is not enough evidence to support this claim in african countries. this study aims to disentangle the relationship using advanced econometric techniques and, possibly, identify moderating factors in the globalisation-led growth hypothesis. data and estimation procedure data in the study, 47 african countries from 2001 to 2018 are investigated. we exclude archipelagos (são tomé and príncipe and seychelles), also libya, malawi, somalia, south sudan and zambia, because of data constraints. appendix table a1 shows variables and their sources. we glean the data in this study from the world development indicators (wdi) of the world bank (wb 2021); the kof globalisation index (dreher 2006; gygli et al. 2019); and the polity5 project of the centre for systemic peace (csp 2020). to begin, we used the method of linear interpolation to generate missing observations. in addition, we applied an overlapping 5-year moving average (ma) to smooth the data. since the original data covers 2001 to 2018, the final data used in the analysis is a balanced micro-panel with 14 periods. in this regard, year 1 (ti1) is a ma for 2001, 2002, 2003, 2004 and 2005; year 2 (ti2) is a ma for 2002 … 2006, and ti14 averages data points from 2014 to 2018. the method removes outliers in the data due to business cycles and also controls higher degrees of autocorrelation (islam 1995; mankiw, romer & weil 1992). dynamic panel estimation strategy our analysis begins with the neoclassical solow-growth model (yi,t), with capital (ki,t) and labour stocks (li,t) as inputs in equation (1): where a is the residual or technology, i and t represent cross-sections (country) and years, respectively. this model assumes that population growth (n) and savings (s) are exogenous. robert solow concluded that higher savings were associated with more income, while countries with higher population growth rates were poorer. if we follow mankiw et al. (1992) to define equation (1) à la augmented cobb-douglass production function by adding human capital (hi,t) and globalisation (gi,t), we obtain equation (2): where α, β and δ are the responsiveness of output to changes in capital, labour and globalisation, respectively, dividing equation (2) by units of labour and abridging from islam (1995), the linear form of equation (2) within a dynamic panel system is presented as follows: where gi,t is the new index of globalisation and is a list of exogenous variables, ηt measures time effects, while vi represents cross-section (country) effects and μi,t is the idiosyncratic error component. this model provides a convenient environment to account for time and country-fixed effects (islam 1995) and can be estimated, using any variant of panel data techniques. during the analysis, we also include the second-order polynomials of globalisation to examine nonlinearities between globalisation and economic growth in africa. to estimate the moderating effect of existing conditions (ec) on economic growth, we interact gi,t with urbanisation, financial development, institutional quality and population growth at different stages of the regression (gi,t, ec). according to rudra and tobin (2017), improvements in these conditions over time enhance the effect of globalisation on economic growth. equation (4) shows the generic form of the model: as noted in the preceding section, equations (3) and (4) can be estimated with several panel data estimation techniques, such as the first-difference estimators, random effect and fixed-effect models. the first-difference estimator may address the problem of omitted variables. at the same time, it results in endogeneity bias due to correlations between yit-1 and the error term (μit) in equation (5): this problem arises because the transformed dynamic variable (yi,t-1–yi,t-2) correlates with the idiosyncratic error (μi,t–µi,t-1) even at higher lags. similarly, static models such as fixed and random effects (fe/re) assume strict exogeneity, that is, a country’s globalisation and other macroeconomic fundamentals that affect economic growth are orthogonal. however, most cross-sectional time-series variables suffer from simultaneity and endogeneity (beri & nubong 2022). simultaneity bias often happens when the evolution of globalisation does stimulate economic growth. economic growth also increases the likelihood that a country will engage in deeper integration over the next period. therefore, the assumption of strict exogeneity means ignoring this possibility of reverse causality and may result in biased estimated parameters, due to contemporaneous correlations with the idiosyncratic errors. in the presence of these challenges, the gmm model provides robust results (arellano & bover 1995; blundell & bond 1998). however, its challenge is that of obtaining accurate instruments for the estimations. in this study, we estimate a two-step system gmm model using internal instruments, derived from the lags of the endogenous variables and the first differences of the exogenous variables. in addition, we employ the hansen test to verify the validity of these instruments. we ignore results from the sargan test since this estimator relaxes the assumption of homoscedasticity and serial correlation of the idiosyncratic error term in levels (roodman 2009). theoretically, an insignificant p-value for the hansen test within the boundaries 0.1 ≤ hansen ≤ 2.5 is considered a linchpin for valid instruments (roodman 2009). all models account for time-fixed effects to capture, among others: (1) changes in growth in all countries in specific years (schularick & solomou 2011), (2) ensure mean reversion of growth over time and, (3) account for unobserved or inaccurately observed components of the economic environment, such as the investment climate and regulations that affect economic growth (beri & nubong 2021, 2022). figure 1 (a) and (b) presents the scatter plot of economic growth and globalisation over the period considered. a visual analysis shows that there is no direct relationship between the two variables, although this descriptive view does mask time and cross-country heterogeneity. figure 1(a): scatter plot of the overall index of globalisation and economic growth; figure 1 (b): scatter plot of economic globalisation and economic growth. figure 1: scatter plot of economic growth and globalisation. results and discussions preliminary results appendix table a2 shows all transformed variables included in the study. there are 47 countries (n), 14 periods (t), and 658 (n × t) observations (n). the standard deviations are quite large, suggesting that the data spread over a range of values. the use of gmm in this study is because it minimises the spread of these standard errors from the distribution. table 1 shows that the correlation between population growth rate and urbanisation is 0.831, a strong signal of multicollinearity. we do not enter these variables in the same equation during the analysis. the remaining variables have low correlations that cannot influence the results. table 1: matrix of correlations between regressors. we employ a mixed-up strategy approach for stationarity with four lags, that is, the levin-lin-chu (llc) and the im-pesaran-shin (ips) tests (im, pesaran & shin 2003; levin, lin & chu 2002). the llc test assumes that groups are homogenous, while the assumption of heterogeneity is central in the ips test. table 2 shows that only the population growth rate is stationary at first difference. therefore, the transient effects of shocks on economic growth would return to their long-run equilibrium. it also implies that there is no need for a cointegration test, and as a result, our results are unlikely to suffer from spurious relationships. therefore, policy implications drawn from the gmm would be valid. table 2: results of the stationarity test. globalisation and economic growth in africa the first objective of this research was to assess the short-run partial effects of globalisation on economic growth in africa. we controlled for labour force participation, capital and human capital development. from table 3, (1) our baseline model is with labour, gross capital formation and human capital development. model (2) shows the main effect of overall globalisation, (3) examines the second-order polynomial or threshold effect of overall globalisation, (4) presents results on economic globalisation and (5) presents results regarding the threshold effect of economic globalisation on economic growth. table 3: the impact of globalisation on economic growth in africa. according to models (2) and (4), the overall and economic indices of globalisation positively affect economic growth, but the coefficients are not significant at a 5% level. similarly, their second-order polynomials in (3) and (5) show a negative and trivial effect, that is, concavity or an inverted u-shaped relationship over time. therefore, globalisation is not concomitant with economic growth in africa. the results were consistent after removing nigeria, south africa and egypt to control for the effect of large economies (not presented). finally, the coefficients of labour force participation and gross capital formation are positive and significant, as expected from the theoretical and empirical literature (islam 1995; mankiw et al. 1992). regarding the post-estimation analyses, table 3 shows no evidence of second-order autocorrelation as expected (p-value of ar2 > 0.05). all instruments are less than the number of groups, and the hansen p-values lie within the theoretically recommended boundary (0.1 ≤ h ≤ 2.5). similarly, the coefficients of the lag dependent variables are less than one, which satisfy their theoretical expectations. therefore, all estimated coefficients are non-biased, consistent and efficient. these results differ from those obtained by shittu et al. (2020), in which globalisation was a signficant determinant of economic growth in west africa, using data from 1996 to 2016. zahonogo (2018) employed the trade openness index from 1980 to 2012 and showed that globalisation was a significant determinant of economic growth to a particular threshold in ssa, beyond which it declined, while asongu and nwachukwu (2017) showed that globalisation was crucial for human development using data from 1996 to 2011. similarly, samimi and jenatabadi (2014) found supportive evidence for the globalisation-growth nexus in high and middle-income countries of the oic over the period 1980–2008. however, results in this study add to the strand of empirical studies that have not found robust evidence to support the globalisation-led growth hypothesis (alesina et al. 1994; rodriguez & rodrik 2000; rodrik 1998; ulaşan 2015; vamvakidis 2002). schularick and solomou (2011) found that protectionism was insignificant to growth during the first era of globalisation and attributed the results to the triviality of trade policies. these results suggest that, although globalisation was beneficial to economic growth during its initial phases (coulibaly et al. 2018; samimi & jenatabadi 2014; shittu et al. 2020; yameogo & omojolaibi 2021; zahonogo 2018), the effect has slowed down over the past two decades. this may be due to the combined effects of the overlapping economic and health crises and the slowing down in remittances, fdi and africa’s trade share. the moderating role of existing conditions and overall globalisation in the first half of our second objective, we aimed to investigate the interactive effects of existing conditions with overall globalisation on economic growth in africa. these conditions include urbanisation, financial development, population growth and institutional quality. table 4 presents the mediating effects of overall globalisation as follows: (model 1) population growth rate (pop # kofgi), (2) urbanisation (urban # kofgi), (3) financial development (findev # kofgi), and (4) institutional quality (polity2 # kofgi). table 4: existing conditions, overall globalisation and economic growth. results for model (1) show that the combined impact of population growth and overall globalisation is positive and significant at an error margin of 5%. similarly, the combined effect of globalisation and urbanisation is robust at the significance level of 5% (2). therefore, we reject the null hypotheses and conclude that globalisation is significant in countries experiencing a rapid population growth rate and those whose urbanisation is increasing. these conclusions agree with our theoretical expectations. the mediating effects of institutional quality and financial development with globalisation in models (3) – (4) were not significantly associated with economic growth, upholding the null hypotheses. finally, we also found evidence that the effect of interacting globalisation with human capital was detrimental to economic growth in africa at an error margin of 10%. similarly, globalisation was beneficial to economic growth in countries with more gross capital formation at an error margin of 10% (not presented). similar to the previous section, models (1) – (4) are valid because ar2 and the hansen tests are insignificant. in a related study, samimi and jenatabadi (2014) showed that globalisation was more effective in countries with more financial development and a more educated labour force. zahonogo (2018) contended that complementary policies on strengthening the quality of institutions and acquiring new knowledge were necessary for enhancing the impact of globalisation on economic growth in africa. we are not aware of studies examining the mediating effects of globalisation with population growth rate and urbanisation on economic growth in africa. in economic literature, however, population and urbanisation are often associated with a larger market size, more business opportunities and economic growth. the moderating role of existing conditions and economic globalisation in this sub-hypothesis, we present the interactive effects of existing conditions and economic globalisation on growth in africa. like in the preceding section, models (1) – (4) in table 5 show the interactive effects of population, urbanisation, financial development and polity scores (quality of institutions) with economic globalisation. table 5: existing conditions, economic globalisation and growth. according to the results, the mediation effect of population growth rate, urbanisation, financial development, and quality of institutions is not concomitant with economic growth. therefore, we reject the null hypotheses and conclude that there is no significant mediation between existing conditions and economic globalisation for economic growth in africa. our model is valid based on ar2 and hansen tests. in previous studies, hassan et al. (2019) found a signficant correlation between economic globalisation and economic growth in developing countries. although some researchers such as borensztein et al. (1998), grossman and helpman (2015), rudra and tobin (2017), coulibaly et al. (2018), samimi and jenatabadi (2014) and zahonogo (2018) emphasised the importance of complementarities in the globalisation-growth nexus, the results in this study, using the gmm method, have found only labour and urbanisation to significantly moderate the effect of globalisation on economic growth. coulibaly et al. (2018) showed that entrepreneuship was also a signficant mediating variable on the growth-globalisation relationship. concluding remarks and implications globalisation has beneficial, as well as detrimental effects, on nation-states. the reduction or removal of economic, social, cultural and political barriers implies that shocks in one country can speedily spread to other nations within a short period. it was evident during the 2007–2009 financial crisis and the present coronavirus pandemic. the consequences of these shocks often transcend challenges in designing appropriate monetary and fiscal policies in ways that can erode the gains in economic growth over several decades. the effects have been noticeable on low fdi, slumps in commodity prices, remittances and debt accumulation that further obstruct economic recoveries long after the crises are gone. in view of these challenges that rapidly spread across the world due to globalisation, this paper contributes to the literature by thoroughly investigating the relationship between globalisation and economic growth in africa over the past two decades. it considers the last two decades because of the expanding integration of african countries into the global economy and the materialisation of the long-awaited afcfta as part of measures to promote intra-regional trade and investment. in this period also, a spike has been seen in unemployment, trans-atlantic migration in search of better economic opportunities and a dwindling support for globalisation. to identify complementarities that may potentially influence the relationship, we also examined the moderating effects of overall and economic globalisation with population growth rate, urbanisation, financial development, the quality of institutions and other control variables. several regressions were estimated using the two-step systems generalised method of the moment. we found a largely insignficant association between globalisation and economic growth in africa. there is ample evidence in the literature that openness is not associated with economic growth (alesina et al. 1994; rodriguez & rodrik 2000; rodrik 1998; ulaşan 2015). we also found that the second-order polynomial effects of globalisation on economic growth were insignificant and, therefore, no threshold effects. however, results on the control variables showed that countries with a higher labour force participation rate and gross capital formation had a higher likelihood to experience more growth. after obtaining these results, we turned to the moderating role of existing conditions on the relationship between globalisation and economic growth. we found that globalisation (the overall index) was more effective on economic growth in countries with higher population and urban growth rates. however, these multiplicative interactions with economic globalisation did not have a significant impact on economic growth. further analyses showed that countries with more gross capital formation experienced more growth, while globalisation was detrimental to economic growth in countries with more secondary school enrollments. however, these results mask heterogeneity across countries and may require further investigation at country and sub-regional levels to corroborate its conclusion. it was necessary to use a different analytical technique with the revised index of globalisation to produce novel insights, although several studies have explored the relationship in africa. shittu et al. (2020) and zahonogo (2018) used the autoregressive distributed lag model with data from 1996 to 2016, and the pooled mean group estimates with data from 1980 to 2012, respectively. however, these studies found supporting evidence for the globalisation-led growth hypothesis. accordingly, the effect of globalisation on economic growth varies by the period and the samples included in the analyses. we recommend that future studies endeavour to account for variations in economic development (large and small economies) and location of the country (landlocked or coastal), as these factors may moderate the globalisation-economic growth nexus. these results on the negligible impact of globalisation have several practical implications. to begin, trade remains a crucial component of globalisation. it also influences development outcomes, but what is the share of africa’s trade at the international market? the continent accounts for less than 5% of global trade and fdi, and the rate of technology absorption is still slow and inconsequential. these are essential components of economic globalisation that should theoretically influence its effect on economic growth. for globalisation to augment economic growth in africa, policies to boost its global share in trade, fdi and remittances must be promulgated. similarly, it is fast becoming a cliché that african countries trade in raw natural resources and agricultural products – such as cocoa, cotton and vanilla – at the international market, often susceptible to price volatility, especially during economic and health crises. although nordic african countries, rwanda, nigeria and south africa have made significant strides to add value through processing, many countries are yet to take full advantage of available opportunities to promote resource-based industrialisation. the consequences have been overdependence on commodity exports – despite its limited trickle-down effects and the resource curse – at the cost of value addition that processing and manufacturing could bring. for africa to receive commensurate benefits from globalisation, it needs to promote resource-based industrialisation, or more investments in the manufacturing sector for exports. this export-led growth approach to economic growth would enable african countries to take full advantage of market access through preferential trade agreements and initiatives such as the afcfta. the ratification and effective implementation of the afcfta may also provide the necessary impetus on trade, fdi, productivity and economic growth over the next decades because of the support it has garnered from across the continent. the results further demonstrate the interactive effects of population and urbanisation on the globalisation-economic growth nexus. urbanisation is often associated with economies of agglomeration or increasing returns to scale. emerging empirical evidence shows that cities and urban areas play a significant role in attracting fdi. similarly, countries with a higher population often provide a large market size for global enterprises. as globalisation increases, such countries attract more investment and trading opportunities. finally, the results reiterate the importance of promoting domestic capital formation. future studies should investigate the long-run equilibrium relationship between globalisation and economic growth and the role of intra-regional trade vis-à-vis the benefits of globalisation on economic growth in africa. acknowledgements we are thankful to two anonymous reviewers for their insightful comments. all references used in this study have been diligently cited. competing interests the author(s) declare that they have no financial or personal relationship(s) that may have inappropriately influenced them in writing this article. authors’ contributions p.b.b. wrote the manuscripts’ introduction, theoretical framework, method, results and conclusion. g.m. assembled the data and reviewed the empirical literature. g.f.n. wrote the introduction and supervised the research. all authors read and approved the draft manuscript. ethical considerations this article does not contain any studies involving human participants performed by any of the authors. funding information this research received no specific grant from any funding agency in the public, commercial or not-for-profit sectors. data availability the data that support the findings of this study are openly available in the world development indicators, swiss economic institute and the polity 5 databases. all codes used in the econometric analysis shall be made available on request. disclaimer the views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of any affiliated agency of the authors. references ahiakpor, j.c.w., 1985, ‘the success and failure of dependency theory: the experience of ghana’, international organization 39(3), 535–552. 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export promotion officials are under increasing pressure to allocate their scarce resources in a way that strengthens their countries’ existing exports while also focusing on new opportunity areas. a key component of a successful export promotion drive is the ability to identify the right foreign markets. to this end, export promotion – a decision support model approach offers a refreshingly practical, yet empirically sound and finely tuned, approach to export market selection. using a multi-stage filtering process, the decision support model (dsm) described in the book systematically screens markets in terms of a myriad of criteria from political and commercial risk and macroeconomic stability, to market size, accessibility and growth prospects – and generates a list of the most promising and realistic markets for various product categories. this helps export promotion officials to prioritise and plan their various initiatives, and reduces the guesswork that often plagues market selection activities. the dsm has been successfully applied to belgium, south africa and thailand, and those researchers who were involved in rolling out the model in these countries have all contributed to the book. the dsm has over the years undergone a number of revisions in response to evolving business practices and the need to fine-tune the model’s results in the face of growing competition and instability in the global trade arena. a particularly progressive step has been the adaptation and application of the dsm for services in south africa. besides offering a detailed description of the dsm, and the various stages in its development and validation, the book also provides an overview of other export market selection methods and how they have contributed to export promotion initiatives in different parts of the world. what emerges from this analysis is that the dsm is far more comprehensive than earlier models in that it takes many more factors into account and processes significantly more data in order to compare and rank order markets. in giving a detailed description of the development and application of the model, the book enables other researchers to replicate and/or adapt the model for different countries that specialise in different products and have different production capabilities. in fact, certain chapters constitute a veritable ‘how to’ guide to developing and testing the model in a variety of contexts, with special emphasis on varying economic conditions and export cultures. as not all countries can produce the same amount of empirical data needed to validate the model, the book also offers insight into how to cope with such data limitations. another important contribution made by the book is that it turns its attention to how to use the results of the model in a practical sense to develop strong export promotion policies and strategies. this is particularly valuable given the ever-shifting dynamics of the global business environment, and the need for governments to remain responsive to new opportunities and challenges. all these features help to elevate the book from the status of a theoretical treatise to more of an operational manual for export promotion agencies tasked with formulating facts-based and resultsdriven promotional strategies as the precursor to in-depth market and competitive intelligence studies. export promotion – a decision support model approach makes a timeous and important contribution to the literature in the export promotion and development fields, and is highly recommended for academics, foreign policy experts, export promotion officials and export managers. prof patrick de pelsmacker, university of antwerp, department of marketing, faculty of applied economics, prinsstraat 13, 2000 antwerp, belgium. tel. +32 (0)3 2654022. microsoft word 1 tandoh & tewari sajems 19(2) 2016.docx 160 sajems ns 19 (2016) no 2:160-174 how to cite doi: http://dx.doi.org/10.17159/2222-3436/2016/v19n2a1 issn: 2222-3436 the income and price elasticity of demand for housing in ghana: empirical evidence from household level data francis tandoh department of economics, university of zululand devi datt tewari faculty of commerce, administration and law, university of zululand accepted: january 2016 housing is a challenging issue in ghana, due to the rising demand and sluggish supply which has led to a deficit of more than two million housing units. this study aimed to estimate and analyse the determinants of the demand for housing in ghana. the estimated elasticities show that owner and rental demand for housing is price and income inelastic. permanent income elasticities were greater in each case than current income elasticity. the quantile regression showed that permanent income, current income and price were significant for all quantiles of housing units consumed. it is recommended that all these factors be taken into account when addressing the housing supply challenges facing ghana to help clear the existing deficit and to provide for the anticipated increase in demand due to increasing income, since demand for housing in the country is income inelastic. key words: demand, elasticity, ghana, hedonic, permanent income, quantile jel: d11, r21 1 introduction demand for housing1 in ghana is increasing progressively as a result of demographic, economic and social factors. the increasing population is one of the factors which accounts for rising demand in the country. ghana’s population grew from a little more than 2.3 million in 1921 to 26.3 million in 2014. population estimates for 2014 show that close to 56 per cent of the population is between the ages of 15 and 60 years old (ghana statistical services [gss], 2014). smith and searle (2010) argue that youthful populations increase demand for housing. figures from gss (2012), show that the growing population, coupled with a reduction in household size, has resulted in an increase in the number of households. the number of households nearly doubled within 14 years, from 3.7 million in 2000 to 6.6 million in 2014. increasing income per capita and improved access to education, particularly tertiary education, also account for the rising demand for housing in ghana. gross domestic product (gdp) per capita increased from us$218 in 1970 to $1841 in 2013 (gss, 2013). as income rises, demand for housing also increases for two main reasons: the investment motive and the increase in the demand for housing services. finally, changing cultural norms and the fairly stable political and economic environment in ghana also contribute to the increasing demand for housing. high inflation rates coupled with the continued depreciation of the currency motivate ghanaians to invest in real estate as a hedge against rising inflation, thus increasing the investment demand for housing (bank of ghana [bog], 2007). for instance, the national currency of ghana, the ghana cedi, depreciated by 31 per cent against the us dollar in the year 2014. inflation in the same period was 17 per cent and house prices increased by 35.2 per cent in the same period. investing in property is used as a hedge against the high inflation rate, so ghanaians would demand a lot of housing units, not only for consumption but for investment purposes as well. abstract sajems ns 19 (2016) no 2:160-174 161 despite the growing demand for housing, supply is not able to respond appropriately. for instance, in the year 2000 the demand for housing outstripped supply by about 1.5 million housing units.2 this increased to over two million in a period of 14 years in 2014 as shown in table 1-1. this is due partly to the fact that most housing is supplied by individual households who take between five and 15 years to build a single unit (bog, 2007).3 it is estimated that 4.9 million ghanaians live in slums scattered around the major cities and towns and that such settlements are growing at a rate of 1.83 per cent per annum (government of ghana [gog], 2005). table 1 demand and supply of housing in ghana year housing demand housing supply housing deficit 1970 1,678,296 941,639 736,657 1984 2,410,096 1,226,360 1,184,636 2000 3,708,250 2,181,975 1,526,275 2010 5,467,136 3,392,745 2,074,391 2014 6,601,500 4,207,003* 2,394,497 source: gss (2012 & 2014) in spite of the extensive literature on the demand for housing in developed countries and some developing countries, there is a paucity of empirical studies on ghana. malpezzi and mayo (1987) and asiedu and kagaya (1991) conducted empirical studies on demand for housing in ghana, but each focused on a single city, so their findings cannot be generalised to the whole country. besides, these studies are too old to represent current realities. although much has been written on the housing market in ghana (obeng-odoom, 2011, 2010, 2009; karley, 2008; asiedu & arku, 2009), none of these studies attempted to empirically estimate the elasticity (the degree of responsiveness of dependent variable subject to a unit change in the independent variable) of the various determinants of the demand for housing. this study therefore fills this gap in the literature. second, the design and implementation of appropriate urban planning policy depend heavily on price and income elasticity for estimating future increases in the demand for housing. malpezzi and mayo (1987) argue that variations in the assumptions of income and price elasticity increase housing subsidy costs by 73 per cent and lead to a ‘deadweight’ loss to society of 400 per cent. therefore demand elasticities are a vital input in efficient and appropriate housing policy outcomes. this study aims to provide these elasticities for ghana. third, almost all demand estimations in literature utilise the ols or other mean-based regression methods that may clad the effects of the various quantiles of housing demand, thereby either underestimating or overestimating the income and price elasticities of the various consumer units; thus wrong estimates can lead to policy failure. this study provides the income and price elasticity of the various quantiles of housing consumption to aid effective housing demand policy and planning in ghana. in developed countries, almost every house is tradable but this is not the case in ghana. ownership of some houses is not clearly defined: the house belongs to the past, current and future kin of the family. no individual has the power to trade such houses, for any reason. these houses sometimes serve as the family’s source of unity. they exist for consumption, social and cultural purposes and not as an investment. the social relations of housing cause some households to remain in the same house, no matter what the sale of that unit would have fetched for the household and how much it would have fetched if redesigned. although the social relations of housing have dwindled in the bigger cities (un habitat, 2011), households in the majority of towns and villages still cling to this belief. this clearly illustrates that in developing and some emerging economies the functioning of the housing market is not the same as in developed countries. hence the demand conditions are different. the rest of the paper is organised as follows: section two outlines the theoretical and empirical framework; section three presents the owner demand estimates; section four presents a 162 sajems ns 19 (2016) no 2:160-174 discussion for renter demand estimates; section five comprises a comparative analysis of elasticities; while section six concludes the study. 2 theoretical and empirical framework the theoretical framework used housing as a consumer good as elaborated in zabel (2004). this theory is premised on three fundamental assumptions: that the consumer optimises utility given price and income constraints; the consumer chooses an unobservable homogenous commodity called housing, and that a perfectly competitive housing market exists. the individual household i in market j with the utility function (u) depends on the quantity of housing consumed (q), consumption of other commodities (c) and household demographic characteristics (a), such that the utility for each household is assumed to be constant, although households have different demographic characteristics. the consumption decision of an individual household is therefore characterised by the maximisation of the individual’s utility function subject to the budget constraint stated as: maximise utility ( , , )max u q c aij ij ijq ci ij (1) subject to: budget constraints i c p qij ij j i= + (2) where ii is the income of the household i, the price c (other commodities) is normalised to one and pj is the price index of housing which is allowed to differ across markets. solving the budget constraints in terms of cij gives c i p qij ij j ij= − (3) substituting equation (3) into the utility function (1) generates : ( . , , )w max u i p q q aij ij j ij ij i= − (4) where wij represents the indirect utility function. a solution of equation (4) gives the inverse demand function wi qip wi ii ∂ ∂ = ∂ ∂ (5) this therefore gives the demand function of housing of the form: ( , , )q i p aij i j i= (6) it is believed that the demand for housing depends on income, price and the demographic characteristics of the household. this has been the fundamental approach in estimating demand (megbolugbe, marks & schwartz, 1991). equation (6) is the demand function to be estimated if all the variables are known. in reality qi is unobservable rather than the value of a house (v), which is a function of the characteristics (z) of the housing unit (number of rooms, lot size, etc.) and a parameter which allows for variation in the values across location (ϕ). therefore the values of housing unit k consumed by household i in a market j can be stated as: ( , ) i v v z jkj k φ= (7) equation (7) is the hedonic function expressing the value of a house based on its characteristics. from equation (7), one can obtain the parameter ϕj using hedonic price modelling given the observed value of ikjv , and kz . additionally if * kz is defined as a standard unit, then the price sajems ns 19 (2016) no 2:160-174 163 index can be constructed as: 100 1 * ( ; ) * ( ; ) v z j j p j v z j φ φ = × (8) the price index is constructed based on the predicted value of the hedonic estimations for the location or market, where the price index for a market where j = 1 is taken as the base. this therefore means that the value of a housing unit (vk) in a housing market (j) for an individual (i) can be expressed as: . i v q pij jkj = (9) equation (9) postulates that the value of a housing unit in a given market is the product of the price and the quantity of housing units consumed. therefore the quantity of housing units consumed is shown as: . i vkj qij p j = (10) now that qij, pj are known and the individual characteristics are observable, it is expected that equation (6) can confidently be estimated. previous studies (zabel, 2004) advocate using permanent rather than current income. there is a rich literature on the demand for housing as a consumer good. this literature focuses on different thematic areas: demand for housing services; demand for housing characteristics; the simultaneous demand for housing quantity and tenure; and demand for housing space and dwelling type. the demand for housing services is modelled as the services per unit of housing produced by a housing unit as homogenous goods, called housing services (rouwendal, 1998). studies in this category include polinky and ellwood (1979) who reconciled the differences between micro and aggregate data in explaining the demand for housing services, while zabel (2004) argued that estimated price and income elasticities of demand for housing were ambiguous because there was no clear definition of housing services. to resolve this ambiguity and to demonstrate that a coherent measure of housing services requires a constant price in all markets whether or not neighbourhood characteristics are included, an empirical study that classified housing demand determinants into neighbourhood characteristics and structural characteristics was conducted. this approach, based on demand for housing characteristics, examines the specific attributes and neighbourhood characteristics of housing besides income and price as determinants of housing. ioannides (2002) argued that a neighbourhood has a substantial effect on the demand for housing and that the social interaction effect is much stronger than a household’s previous consumption. ioannides and zabel (2008) jointly modelled the demand for housing and neighbourhood choice. this enriched ioannides and zabel’s (2003) study that modelled the demand for housing on the assumption that neighbourhood choice was exogenously determined (neighbourhood choice was determined outside the housing demand framework). they argued that joint modelling of housing demand and neighbourhood choice leads to a consistent estimate despite its complexities, and concluded that ignoring the simultaneous nature of neighbourhood effects and demand for housing biased the estimates. the third category of housing demand is the simultaneous demand for quantity of housing and tenure choice. rapaport (1997) stated that a household's housing demand decision was a simultaneous choice between price and quantity given the community of choice, and that the community factor was usually omitted from housing demand models. therefore the demand for housing was modelled as a 14, dependent on the community and/or tenure status decision and that the price of housing was communityand tenure-specific. house price reflected the available supply of housing given the community and the tax rate, while the price of housing was endogenously determined. ras, gameren and eggink (2005) used a three-step procedure to 164 sajems ns 19 (2016) no 2:160-174 analyse the demand for housing in the netherlands. the quantity of housing services demand was simultaneously modelled for owner occupiers and renters. garcia and hernandez (2008) jointly modelled housing tenure and housing type using micro data from spain. demand for housing space and dwelling type assumes that the consumer measure the attributes of each of the available alternatives. bajari and kahn (2005) estimated households’ willingness to pay for housing attributes and tenure as well as the dwelling type. this study adopts the first category and borrows from zabel (2004) and fontenla and gonzalez (2009) in the empirical model to be estimated. this is due to the fact that this model is the most appropriate in the light of the available data. furthermore, the empirical estimates for the second category require extensive data on neighbourhood characteristics. this presents many complexities in the estimation procedure (ioannides & zabel, 2003). the third category requires the simultaneous estimation of the housing demand and community choice, but due to the extensive nature of the data required to do so, it is practically impossible to adopt this methodology. the final category requires using panel data, so that the choice of households can be observed over time. this requirement makes it impossible for this study to adopt this category. recent studies indicate that the determinants of housing demand in some developing countries were arrived at utilising the first category. therefore, this category was adopted for this study due to its flexibility with cross sectional data (tiwari & parikh, 1999; fontenla & gonzalez, 2009). the empirical estimation of the demand for housing follows three steps: permanent income is estimated in line with the literature (available upon request); the hedonic price model for housing is estimated to help construct a general price index of housing in ghana (also available upon request); and finally, the demand for housing model is estimated given the quantity, price and other variables. the quantity of housing consumed (qij) from equation (6) is stated as a function of permanent income (ipi), transitory income (iti), and housing-price (pj), and other variables are specified in logarithmic terms. that is, the estimated demand equation is of the form: 50 1 2 3 4 6 7 8 9 10 11 12 ln( ) ln( ) ( ) ( ) ( ) ( ) ( ) ( ) ( ) ( ) ( ) ( ) ( ) h i i h hh hh hhij p i t i i age i wed i iqty sizeindex hh hh hh hh hh li ele i i isex gra uni sec urbi i i β β β β β β β β β β β β β ε = + + + + + + + + + + + + + (11) heteroskedasticity-consistent standard error estimators for ols regression (hc3) were employed (hayes & cai, 2007; long & ervin, 2000). table 2 provides a description of the variables. the subscript i represents the i’th household. the variables prefixed with ‘hh’ denote variables that describe the head of the household. the variables prefixed with ‘h’ denote those that describe the housing unit and those prefixed with ‘l’ describe locational variables. table 2 description of housing demand variables variable description hqty quantity of housing units consumed by a household ic current income of the household ip permanent income of the household it transitory income of the household hindex estimated price index of housing hhwed a dummy 1 if the household head is married and 0 otherwise hhsize the total number of people in the household hhsex a dummy 1 if the gender of the household head is male and 0 otherwise hhele a dummy 1 if the highest education of the household head is elementary school and 0 otherwise hhgra a dummy 1 if the highest education of the household head is a post graduate (master’s and doctorate) and 0 otherwise hhsec a dummy 1 if the highest education of the household head is a secondary education and 0 otherwise hhuni a dummy 1 if the highest education of the household head is university degree and zero otherwise (honours) lur household stays in the urban localities source: author sajems ns 19 (2016) no 2:160-174 165 3 permanent income equation estimation various authors have used permanent income as the ideal income for housing demand estimation with its justification long established (see ioannides & zabel (2003); fontenla & gonzalez (2009)). current income ii is made up of transitory (iit) and permanent (iip) income: i i ii ip it= + (12) therefore, to obtain permanent income, current income of the household is regressed on the household demographic characteristics. the functional equation is therefore stated as: ' ln i a x di i i i i iβ γ ε= + + + (13) where it is the observed income of the household, 𝑥"# is the personal characteristics that determine permanent income, and d is a vector of regional dummies. the predicted values become the permanent income while the residuals become the transitory income. 4 owner-occupier households 4.1 descriptive statistics the descriptive statistics show that, on average, ghanaians consume 3,434 units of housing per year with a standard deviation of 2965. the skewness value shows that a smaller number of households consume more housing units than the average unit. this means that the quantity of housing consumed is not evenly distributed. the kurtosis value confirms the non-normality of the quantity of housing units demanded. the average household size of five shows that owner-occupiers have bigger households compared with other tenure status considered in this study, since the overall average household size in ghana is four. the statistics for graduate education are highly skewed, showing only a few graduate household heads. the coefficient of skewness shows that the income of most of these households falls below the mean income. owner occupation was higher in the rural areas (58 per cent) than the urban areas (42 per cent). finally, table 3 shows that 67 per cent of owner-occupier household heads are married. the mean price index for owner-occupied households was 176.8 and the average housing units consumed by a household was 7.5. owner-occupier households have an average current monthly? annual? income of about gh₵600edis (equivalent of us$600) with a standard deviation of 2.6 and a permanent average income of gh₵650 with a standard deviation of 1.5. this shows that there is more inequality in current income than there is in permanent income. table 3 a description of owner occupier in ghana variable observation mean standard deviation minimum maximum skewness kurtosis ic 4016 15.59179 1.291181 9.601383 20.08293 -0.316 3.45 ip 2285 15.66157 .3344995 14.56954 16.94431 -0.11 3.22 lurb 4135 .2309553 .4214948 0 1 1.29 2.6 hindex 4135 100.8845 3.661875 98.48336 112.0798 13.41 6.83 hsize 4135 5.046191 3.104306 1 29 1.3 6.97 hqty 4135 3434.217 2965.993 548.8026 23326.53 3.33 15.17 hhage 4135 50.32938 15.79087 17 99 0.39 2.57 hhgra 2285 .0083151 .0908271 0 1 10.8 118 hhele 2285 .4297593 .49515 0 1 0.284 1.08 hhsex 4135 .7639661 .4246946 0 1 -1.24 2.54 hhwed 4135 0.673518 0.468911 0 1 -0.74 1.55 source: estimation 166 sajems ns 19 (2016) no 2:160-174 4.2 owner occupier elasticities the estimated elasticities for owner-occupier households show that six variables are significant determinants of demand for owner-occupier housing demand. except for price, all the significant variables were positive, as shown in table 4. the estimated permanent income elasticity shows that demand for housing in ghana is income inelastic (housing demand is less responsive to changes in permanent income). this could be due to three possible reasons. the property market in ghana is currently in its infancy. there is also no social housing, since the houses that did exist were divested or reserved for public sector workers. the only alternative to owning a home is private rental housing. this alternative presents many problems, including substandard housing, high rent advances and significant shortages in some areas, leading to higher rents. this suggests that the best option for a household is to move to owner-occupancy which they can do if their income increases. the next possible explanation for the lack of income elasticity is borrowed from brounen et al. (2012), who argued that homeowners benefit from high inflation since house prices rise in an inflationary period and the value of owner-occupiers’ property also increases. since ghana is a highly inflationary country, households demand owneroccupation as a hedge against inflation as well as for the capital gains associated with it. the final reason is the need to hedge against the risk of rent increases. sinai and souleles (2003) argued that the hedge against future high rent payment forces households to move to owner-occupation. the acute shortage of housing units in ghana − especially standard, quality housing − means that households who rent, pay high rents. in order to hedge against higher rents in the future, households would move to owner-occupancy with an increase in income. this finding corresponds with the findings of other studies. for example, malpezzi and mayo (1987) found owner income-elasticity for egypt to be 0.17, while mehta and mehta (1989) estimated owner-income elasticity for india to be 0.2. the quantile estimation shows that the income elasticity of the demand for the various quantiles of housing units is less than the ols (mean) estimates. the income elasticity of the lowest 25 per cent of quantiles is greater than the income elasticity for the top 25 per cent of housing consumers, although the elasticity for both is less than the median elasticity (0.5q) shown in table 4. the quantile elasticities show the need to account for the different units in the elasticity estimation so that reliable policy inferences can be drawn from it with little variation. the price elasticity of demand for owner-occupation shows that the price of housing does not necessarily affect the demand for owner-occupier housing in ghana significantly. this could be ascribed to the mode of housing finance systems in ghana. most households finance their houses with savings or use the incremental housing method;4 therefore an increase in the price of housing does not affect the consumption of housing since the interest rate effect does not come into play. increases in house prices in ghana are the result of increases in the value of land and the cost of building materials (bank of ghana, 2007). as such, an increase in house prices leads to increases in the cost of alternatives or substitutes for owning, that is, in private rental prices which are already very high in ghana due to the acute shortage of housing and the hefty requirement of two to five-year advance payments. an increase in the price of housing leads to a slowdown in the rate at which households add to their building, thus restricting the quantity of housing units owneroccupiers can consume, although this will be very marginal. the dynamics of the housing market do not make the usual shift from owner-occupation to rental housing easy: the costs involved also deter most owner-occupiers in ghana from maintaining their status despite house price increases. therefore the elasticity truly reflects the fundamental characteristics of the housing market in ghana. the estimated price elasticity is less than the literature for developing countries proposes. mayo (1981) proposed 0.38 to 0.37 and the recent findings of studies by fontenla and gonzalez (2009) confirmed this. follain, lim and renaud (1980) achieved a near zero price elasticity of owneroccupation in south korea, while malpezzi and mayo’s (1987) estimate for owneroccupied elasticity in cairo and manila was close to 1 or unity in absolute terms. the price elasticity sajems ns 19 (2016) no 2:160-174 167 estimates were also in line with current estimates for spainwhich range from -0.002 to -0.04 (garcia & hernandez, 2008) and the usa where zabel (2004) found elasticity of -0.001 using 1993 data and -0.011 for 2001 data. the variation in the estimates of the price elasticity is due to variations in the definitions of the price and the models used in the estimation, as well as the procedure and data used in obtaining the price index (zabel, 2004). mayo (1981) argued that the different demographic characteristics across countries make it difficult to make comparisons, therefore it is preferable to restrict discussion to the country under study. the ols estimates show that the gender of the household head, household size and the age and marital status of the head of the household were not significant determinants of the demand for housing in ghana. however, the quantile estimates show that the gender of the household head was insignificant only in the lowest 25 per cent of housing consumers. the size of the household was significant in all the quantiles despite not being significant in the ols estimation. the elasticity from the level of education shows that elementary education was an insignificant determinant of the demand for housing in the top 25 per cent of consumption units but university education was significant at all levels of consumption. table 4 owner occupier demand elasticity (ols and quantile) variable ols 0.25q 0.5q 0.75q hhsex .0017 -.0023 .0032 .0039 hhsize .0041 .0097*** .0076*** .0058* hhage .0064 .0152*** .0063 .0083 hhurb .0439*** .0306*** .0445*** .0576*** hhgra .0003* .0004*** .0005*** .0002** hhele .0027** .0022* .0026** .0021 hindex -.0983*** -.1079*** -.1002*** -.0934*** #ip .1719*** .1548*** .1620*** .1329** #ic .1682*** .1113*** .1431*** .1311*** hhwed .0020 .0059** .0011 .0008 r2= 0.6834 r2 = 30 r2 = 20 r2 = 22 ramsey reset f(3, 5436) = 1.28. prob > f = 0.278 #permanent income (ip)and current income (ic ) were estimated in the model separately source: estimation 4.3 rural and urban owner demand elasticities a breakdown of the demand estimates (both ols and quantile) for the rural and urban locations in ghana shows that permanent income was the major determinant of the demand for housing in urban localities, while current income was the major determinant of demand for housing in rural ones. this finding is consistent with the conditions prevailing in these two localities. most of ghana’s rural dwellers are subsistence farmers. this means that they have no permanent and consistent source of income or expectation of one; they therefore consume housing based on their current income (usually related to harvests from their farming activities). in contrast, most urban dwellers work in the formal sector and earn a regular income so they have expectations of a permanent income for consumption purposes. therefore the permanent income elasticity for the urban areas was greater than the current income. the permanent income elasticity for the median urban housing unit consumer was within the range advocated by malpezzi (1999). the wide difference in permanent income elasticity between urban and rural localities might account for the smaller lower level of the overall elasticity reported above. the elasticity of the educational variables shows that elementary education was only significant in the urban areas and not the rural ones. even in the urban areas the quantile estimates show that it determined consumption only in the lowest 25 per cent of units. while permanent income and level of education were the major determinants of the demand for housing in urban localities, 168 sajems ns 19 (2016) no 2:160-174 current income, age of the household head, gender of the household head and size of the household were the major determinants of the demand for housing in the rural localities in ghana (table 5). table 5 ols and quantile elasticities for owner demand (urban and rural locations) urban ghana rural ghana variable ols 0.25q 0.5q 0.75q ols 0.25q 0.5q 0.75q hhsex -.0080 -.0015 .0071 .0006 .0112*** -.0004 .0033 .0059 hhsize -.0004 -.0056 -.0198* -.0043 .0030 .0129*** .0119*** .0090** hhage -.0010 .0083 -.0213 -.0066 .0114** .0153*** .0104*** .0157** hhgra .0006 .0018*** .0010 .0002 .0008 .0008 -.0002 .0003 hhele .0063** .0082** .0051 .0034 .0004 .0008 .0012 .0010 hhindex -.087*** -.079*** -.075*** -.086*** -.104*** -.118*** -.107*** -.095*** #ip .3335** .1077 .6146** .5986*** .0400 .0544 .0545 .0069 #ic .2749*** .2464*** .2947*** .2029*** .0952*** .0599*** .1107*** .1070*** hhwed .0011 .0015 -.0071 .0059 .0022 .0075*** .0032 -.0013 r2= 0.70 r2 = 0.43 r2 = 0.20 r2 = 0.25 r2 = 0.56 r2 =0.17 r2 = 0.27 r2 =0.45 #permanent income (ip)and current income (ic) were estimated in the model separately. source: estimation 5 rental households 5.1 descriptive statistics the descriptive statistics show that rental ghanaian households on average consumed 5,684 units of housing per year with a standard deviation of 8508. the value of the skewness is 3.7 which shows that a smaller number of households consumed more units than the average. this means that the quantity of the housing consumed was not evenly distributed. the kurtosis value confirms the non-normality of the quantity of rental housing demand. there were extremes in the rental housing market. statistics for household size again show that size was not evenly distributed across households. the average household size of three shows that rental households had fewer members than owner-occupiers. statistics relating to education show high skewness of graduate education in ghana and renting. only a few rental household heads had a graduate qualification. in terms of basic education, the statistics show that it was normally distributed across heads of rental households in which almost half had elementary education. marital status was normally distributed among households (table 6). table 6 descriptive statistics of the rental households in ghana variable observation mean standard deviation minimum maximum skewness kurtosis hqty 1751 5684.319 8508.616 38.07523 108000 5.3947 47.5561 hhsize 1751 3.432324 2.216011 1 15 0.8701 3.7026 hhsex 1751 .7230154 .4476366 0 1 -0.9966 1.9934 hhage 1751 39.63564 12.21151 15 99 .8006 3.8388 hhgra 1434 .0062762 .0790007 0 1 12.5035 157.339 hhele 1434 .4825662 .4998703 0 1 0.0697 1.004 lurb 1751 .8023986 .3983035 0 1 -1.5188 3.3069 hindex 1751 73.9825 94.63124 100 423.5961 1.6525 4.7242 ip 1177 15.74017 .4221134 14.25577 17.15092 -.1381 2.8320 ic 1751 15.8920 1.1942 10.7289 19.2981 -.7490 4.2819 hhwed 1751 .508281 .5000742 0 1 1.001 -.0331 source: estimation sajems ns 19 (2016) no 2:160-174 169 5.2 rental elasticities the rental income elasticity shown in table 7 indicates that renting is income inelastic in ghana. permanent income elasticity is greater than current income elasticity and both are statistically significant. the rental income elasticity reveals three important aspects of the ghanaian housing market in general and the rental market in particular. the high positive income elasticity shows the rental arrangement which prevails in the country. to rent in ghana, one needs to make a payment at least two years in advance. this amount often exceeds current income so people have to borrow money in order to afford the consumption of the housing units they desire. most ghanaians use their permanent income to rent, therefore when it increases, they increase their level of consumption, since they can now pay higher instalments on the loans they took out to rent the unit they occupy. this elasticity is similar to the findings of malpezzi and mayo (1987) for kumasi, the second largest city in ghana. it also compares favourably with the findings of garcia and hernandez (2008). the quantile breakdown shows that income elasticity for the median housing consumer is less than the average elasticity (ols) estimate (table 7). this means that the income elasticity provided by the ols model overestimates the elasticity for the majority of the population. therefore, any policy based on the ols estimation would marginalise the majority of the population of housing consumers in the country. the lower 25 per cent of consumers rent out of current rather than permanent income, as their permanent income is not statistically significant. rental price elasticitiy estimates show that renters respond massively to changes in price. rental elasticity is clearly greater than the price elasticity estimate for owner occupiers. this confirms goodman and kawai’s (1984) assertion that the high transaction cost of switching tenure from ownership to renting makes the price elasticity of renting greater than that of owning. the estimated renter price elasticity for this study corresponds with the findings of zabel (2004). table 7 demand elasticity estimates for renters variable ols 0.25q 0.5q 0.75q hhsex .0052527 .0059035 .010274** .0075398 hhsize .0117822* .0142176 .0144635*** .0211013* hhage -.0047853 -.0046689 .0028192 -.0218723 hhurb .095078*** .0839834*** .0929751*** .1056695*** hhgra .0009607*** .0011127*** .0009005*** .0008451*** hhele .0006612 .0085033* -.0025104 .0002458 hindex -.6991811*** -.6970408*** -.6462982*** -.688394*** ip .3015381** .1263437 .284841*** .3363613* ic .274615*** .2848616*** .211408*** .2609944*** hhwed -.0006464 -.0017595 -.0065741** -.0002878 r2= 0.8234 r2 = 0.34 r2 = 0.44 r2 =0.36 ramsey reset: f(3, 5436) = 1.28. prob > f = 0.278 source: estimation age was expected to have a negative effect on renting since younger households save to buy a home or to make the payment needed by the mortgage market (cho, 2010), but it was found not to be statistically significant. the explanation may be that the effect of age on renting is not important in the rental market in ghana. inheritance and the long period of transition from renting to ownership (if indeed it eventually occurs) might be the reason. the age elasticity contradicts the findings of asiedu and kagaya (1991), who undertook a similar study in kumasi. while the current study found age to be statistically insignificant but negative, their study found it positive − which contradicts the literature − but significant. the reason for this might be the more limited scope of asiedu and kagaya’s (1991) study area compared with the scope of the current study which considers the rental sector in the country as a whole. the estimated results show that education correlates positively with rental housing demand. this can be explained by the fact that most highly educated people work outside their places of origin. they mainly work in cities and 170 sajems ns 19 (2016) no 2:160-174 towns where it is expensive to own a home, which explains why university graduates have the highest positive relationship with renting. marital status shows an inverse relationship with renting, but it was statistically insignificant except at the median consumption level. 5.3 rural and urban rental demand elasticities the breakdown of rural and urban statistics confirms the popularity of renting in urban localities relative to rural localities. permanent income elasticity shows that urban households’ rental decisions were influenced by permanent and current income, except at the lowest 25 per cent of housing consumers. these households based their rental decision only on current income. in the rural localities, however, rental decisions were based on current income, except the median consumer units (table 8). the price elasticities show that both urban and rural rental decisions were mainly influenced by the price of renting. this is the only variable that showed significance in both localities and at all quantiles of housing consumption. the highest price elasticity was recorded at the top 25 per cent of housing consumers. the estimated elasticities show that urban consumers were more sensitive to price changes than those in the rural localities. the quantile estimates for the two localities show that while the top 25 per cent had the highest elasticity value for price in the rural localities, in the urban localities, the lowest 25 per cent displays the highest elasticity. in the rural areas the elasticity was reduced with increasing quantile, while in the urban areas it decreased from the lowest quantile, increased from the median quantile, and peaked at the highest quantile. the results show that university education, current income and price were the main determinants of renting in urban localities. these were significant in all quantile and ols estimates for the urban localities. in the rural localities, however, price was the main determinant and, to some extent, current income as well. age was consistently shown to be insignificant in both rural and urban localities and at all quantiles. the size of the household was only significant at the median and top 25 percentile of consumers in rural localities. the gender of the household head showed positive and significant effects in all quantiles in the urban areas, although it was insignificant in the ols estimates. in the rural localities however, only the ols and the median estimates for household size were significant. the household size showed a positive effect in the instances where it was significant, which means that male-headed households were more likely to rent than female-headed households. rental by graduates was not applicable in the rural localities and was thus omitted in the estimations. elementary education, however, was only significant at the lowest 25 percentile of urban consumers. marital status was consistently shown to be an insignificant factor in rental housing demand in both rural and urban localities and at all quantiles, except the median consumer in the rural localities. table 8 rental demand elasticity estimates for rural and urban localities urban localities rural localities variable ols 0.25q 0.5q 0.75q ols 0.25q 0.5q 0.75q hhsize .0105 .0033 .0088 .0037 .02078 .0333 .0333*** .0282* hhsex -.0040 .01918* .01418** .0203** .0247* .0356 .0213*** .0004 hhage .0014 -.0036 .0040 -.0193 -.0095 -.0531 -.0091 .0060 hhgra .0011*** .0014*** .0010*** .0010*** (omitted) omitted omitted omitted hhele .0021 .0126** -.0027 .0030 -.0037 -.0063 -.0032 -.0003 hhindex -.707*** -.698*** -.652*** -.717*** -.633*** -.662*** -.603*** -.54*** ip .3591** .1355 .3085** .3874** -.0828 .0307 .4433** -.0633 ic .2601*** .2149*** .2270*** .2500*** .3378*** .2575 .3516*** .2520** hhwed .0020 .0005 -.0053 .0042 -.0158 -.0144 -.024*** -.0085 r2= 0.92 r2 = 0.53 r2 = 0.50 r2 = 0.50 r2 = 0.40 r2 =0.26 r2 = 0.20 r2 =0.15 source: estimation sajems ns 19 (2016) no 2:160-174 171 6 a comparison of elasticities 6.1 owner demand elasticities the chow test (a test of whether the coefficients estimated over one group of data was equal to coefficients estimated over another) for the owner-occupier households shows that there were significant differences between the income elasticities for the overall estimates for the country and the various localities. this is evident in tables 3 and 5. for instance, there is a significant variation between the permanent income estimates for the overall country and the various localities. the estimated coefficient for the urban localities is greater than the overall estimates (0.33 for urban and 0.17 for urban). the estimated coefficient for the rural localities is not significant. this and others might have contributed to the significant differences obtained from the chow test. generally, the differences are due to the rural/urban setting in the ghanaian economy. thereare vast differences between rural and urban housing units and housing conditions. this means that a policy or an inference based on the estimates for the whole population will not achieve the desired results. hence there is the need to separate the estimates for the demand for owner-occupied housing elasticities from rental demand elasticities. other variables that showed significant differences included the size of the household and the level of education (table 9). however, the price elasticities are the same whether one considers the whole country or a particular locality. this means that the effect of a price change on owner demand is similar nationwide. age, marital status and the gender of the household head also have similar elasticities, irrespective of the locality or the segment of the population considered. table 9 comparative analysis of owner demand elasticities variable ᵪ2 test decision ic 46.2(0.0000) significant difference ip 5.67(0.0588) significant difference hhsize 17.3(0.0002) significant difference hhsex 1.45(0.4841) no significant difference hhage 0.51(0.7737) no significant difference hhgra 6.78(0.0336) significant difference hhele 5.77(0.0558) significant difference hhwed 0.15(0.9289) no significant difference hindex 0.18(0.9134) no significant difference source: estimation table 10 comparison of rental demand elasticities variable ᵪ2 test decision ic 0.18(0.9118) no significant difference ip 2.02(0.3642) no significant difference hhsize 0.23(0.8909) no significant difference hhsex 2.40(0.3016) no significant difference hhage 0.03(0.9871) no significant difference hhgra 41.6(0.0000) significant difference hhele 0.48(0.7883) no significant difference hhwed 2.88(0.2366) no significant difference hindex 2.84(0.2422) no significant difference source: estimation 172 sajems ns 19 (2016) no 2:160-174 6.2 rental demand elasticities the test for similarity among the elasticity for the various rental demands for housing shows that with the exception of graduate education, all other variables had the same effect whether or not the whole population or specific localities are taken into account. this means that a change in income had the same effect on rental housing in the country, whether one considers a rural or an urban locality. the same applies to the price and other elasticities (table 10). the similarities can be explained by the fact that the whole rental market has a similar pattern in terms of providers and the type of housing, as well as housing conditions. 7 conclusion this study aimed at filling a gap in the literature in relation to the housing situation in ghana, providing both the mean and quantile housing demand estimates for the country. it was undertaken because the housing market in ghana, like most african countries, is practically different from that of the developed and other emerging economies. the study estimated and analysed the demand elasticities for owner-occupier housing units and rental housing units. estimates for rural and urban locations were conducted employing both the ols and quantile regression techniques. the estimated elasticities show that owner demand for housing is priceand income-inelastic. permanent income elasticity was greater than current income elasticity and the price elasticity was close to zero. the quantile breakdowns show the significance of permanent and current income and price. the quantile estimates show that the ols (mean) sometimes overestimates the income elasticities (see table 4). the rural and urban breakdown of variables shows that besides price, permanent income is the main determinant of ownership in the urban localities, while current income is the main determinant of ownership in the rural localities. price effect is greater for rural localities than for urban localities. permanent and current income, graduate education, urban location, household size and price are the factors that determine the demand for renting. these variables have more of an impact on higher quantiles of housing demand than on lower quantiles. the rural and urban estimates exhibit the same trend as the overall estimates. this means that for policy efficiency the various quantiles of the housing estimates must be used instead of the ols (mean) estimates. the results based on the quantile estimates show that stakeholders in the housing industry need to take into account not only locality differences but quantile differences as well, if they seriously wish to improve policies governing the housing situation in ghana for the benefit of her population. endnotes 1 the united nations (un) defines a house as “a structurally separate and independent place of abode such that a person or group of persons can isolate themselves from the hazards of climate such as storms and the sun”. 2 a housing unit is a separate and independent place of abode intended for habitation by a single household or one not intended for habitation but occupied as living quarters by a household at the time of the census (un statistics division). 3 it must be noted that some houses are completed earlier than the stated period but this is rare. 4 that is, they build as and when money becomes available. references asiedu, a.b. & kagaya, s. 1991. a cross-section analysis of household rental housing demand kumasi city, ghana. hokkaido university, japan. asiedu, a.b. & arku, g. 2009. the rise of gated housing estates in ghana: empirical insights from three communities in metropolitan accra. journal of housing and the built environment, 24(3):227-47. bajari, p. & kahn, m.e. 2005. estimating housing demand with an application to explaining racial segregation in cities. journal of business and economic statistics, 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accepted: 11 aug. 2022; published: 30 sept. 2022 copyright: © 2022. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the south african public service sector continues to lose employees due to more favourable working conditions offered by organisations in the private sector. understanding intention to leave (itl) can help public service mangers and leaders retain their highly skilled and high performing staff. aim: the aim of the study was to determine the direct and indirect relationships between person–organisation fit (pof), job satisfaction (js) and itl in the south african social development sector (sds). setting: the sample used in this study was drawn from the sds in south africa (n = 100). methods: cross-sectional survey data were analysed using the statistical package for the social sciences 27. hayes process macro was used to test the mediating effect of js in the relationship between pof and itl. results: results indicated that pof shared a negative relationship with itl, independent of the indirect relationship via js, suggesting a partial mediation effect. the size of the indirect effect of pof on itl, through js, was larger than the direct effect of pof on itl. conclusion: the study provides support for understanding the relationships between itl, pof and js. the findings of this study have managerial implications as it provides insights on how to retain employees and decrease turnover intention in the south african sds. keywords: person–organisation fit; job satisfaction; intention to leave; social development sector; mediation effect. introduction employee turnover intention and subsequently turnover, is one of the biggest managerial challenges for businesses and continues to threaten business sustainability globally (schlechter, syce & bussin 2016). prihandinisari, azizur and hicks (2020) argue that high turnover rates introduce a financial risk management issue which plagues many organisations. high turnover intention generally predicts disastrous consequences for organisations including significant costs for employee replacement, as well as operational disruptions. in south africa, turnover intention is exacerbated by the war for talent in which organisations compete to attract and retain highly skilled employees, because of the skills deficit in the country (potgieter 2018; schlechter et al. 2016; sing 2012). the reasons cited for the skills deficit include rapid economic development, constantly growing infrastructure needs, and changing age demographics with older workers retiring and leaving a skills gaps (mabindisa 2014). while most organisations in south africa must deal with the issue of turnover intention, it is organisations with a lack of resources, such as funding and employee development opportunities, that must mitigate significantly higher levels of turnover intention. in comparison to the private sector, public service organisations are faced with considerably higher levels of turnover intention (prihandinisari et al. 2020). unfavourable work environments, dissatisfaction with one’s job, and lack of intrinsic and extrinsic motivation are all reasons that have been cited for high intention to leave (itl) in the public sector (ayalew et al. 2015; demircioglu & berman 2019; langbein & stazyk 2018). in south africa, the public service sector is in an ongoing battle to retain high-performing employees as a number of employees are moving into the private sector due to even higher-paying jobs, better benefits and greater opportunities for development. similarly, those employees with valuable skills are difficult to attract and are in high demand, thus increasing the need for organisations to compete for these skills in an attempt to ensure that they provide quality services. (kim & fernandez 2017). while there may be discrepancies in the resources available for private and public sector organisations, the need for skilled employees who are able to drive the organisation’s key strategic objectives remains the same, which presents yet another obstacle to public sector management, that is retaining skilled employees. high-turnover intention is associated with the challenges of brain drain, a decreasing workforce, loss of skills, loss of productivity, service delivery backlogs and decreased morale. all of these effects reflect poorly on the image of the public sector and on the competence of its management (muteswa & ortlepp 2011; ogony & majola 2018; sing 2012). one area of public service that continues to report high turnover intention amongst its employees is the social development sector (sds). the mandate of this public service is to facilitate human development and improve the quality of life for the citizens of south africa. this mandate is achieved through a caring and integrated system of social development services and is aligned with the country’s national development plan which focuses on forging partnerships through which vulnerable individuals, groups and communities become capable in their own development and self-reliance (department of social development 2020; national development plan 2010). to fulfil this mandate, the sds must attract, recruit and retain qualified and competent practitioners with diverse skill sets to meet the country’s demand for social development services (department of social development 2020). however, like any other public service area, the sds is not immune to the challenges regarding turnover which negatively affects its ability to achieve its core mandate and this has severe managerial implications. according to a national report on the south african sds, the sds continues to report increasingly high-turnover intention and turnover rates amongst its employees across all levels, different work units and occupational categories. reasons for employee turnover in the sds include seeking better employment opportunities, low job satisfaction (js), poor employee fit with the organisation, and emotionally challenging working conditions such as working in vulnerable communities (department of social development 2020). all these factors contribute to high itl and turnover. this makes investigating itl in the sds a crucial aspect. while the negative effects of itl have been discussed, there are researchers (memon et al. 2018; zhang et al. 2017) who propose factors that can be used to better understand the processes that lead or contribute to itl. one such factor is person–organisation fit (pof). person–organisation fit reflects the extent to which employees perceive the degree of similarity between their values and those of the organisation and how they form attachments to organisations (janse van rensburg, rothmann & diedericks 2017; redelinghuys & botha 2016). employees who believe that there is congruence or fit between their values and beliefs and that of the organisation, are more likely to be committed to and embedded in their jobs and as a result, are less likely to leave the organisation. in addition to pof, there is strong theoretical and empirical support on the role of js in explaining itl (ali & anwar 2021; janse van rensburg et al. 2017). job satisfaction refers to the degree to which employees feel that their needs and wants are attended to, and how these reflect their feelings and emotions associated with a job (ali & anwar 2021). job satisfaction has been studied as a strong predictor of itl, because when employees experience lower levels of satisfaction, they become more inclined to consider leaving their job (hassan & adnan 2016; lee, macphee & dahinten 2020; zhang et al. 2017). in addition to understanding the direct relationships between pof, js and itl, assessing the indirect processes in which pof may explain itl, through js, may provide managers and leaders in the sds with an additional resource of knowledge on how to mitigate turnover intention. there is compelling evidence (jin, macdonald & park 2018; lee et al. 2020; redelinghuys & botha 2016) suggesting that js can mediate the relationship between the pof and itl and may serve as an explanatory mechanism in this relationship. jin et al. (2018) argue that it is vital for researchers to explore the different perspectives on how pof may explain itl through its influence on js as this provides another avenue for intervention design that targets turnover intention. understanding the indirect processes that may occur in the relationship between pof and itl will allow for holistic interventions that consider support mechanisms such as increasing js. by investigating explanatory mechanisms such as js, researchers may offer a more nuanced approach to understanding the dynamic relationship between pof and itl. as a result, there is a call for studies that explore both direct and indirect effects between pof, js and itl in different working populations. the current study makes an attempt to answer this call by investigating the direct and indirect relationships between pof js and itl amongst employees in the sds. literature review and theoretical background person–organisation fit and intention to leave intention to leave is defined as an employee’s intent or decision to leave an organisation and seek employment elsewhere which often leads to actual turnover behaviour (janse van rensburg et al. 2017). researchers in the field of employee retention studies (grobler & grobler 2016; kakar, sofi & mansor 2019) provide strong empirical evidence which supports the negative relationship between pof and itl. this negative relationship implies that when the individual experiences greater fit between themselves and the organisation, the itl the organisation decreases (kakar et al. 2019; kooij & boon 2018). according to the person–organisation fit theory posited by cable and derue (2002), the extent to which an employee is considered to be compatible with the organisation is determined by three dimensions that is value– congruence fit (vcf), needs–supplies fit (nsf) and demands – abilities fit (daf). value congruence refers to the employee’s perceptions or beliefs about the congruence between their personal values and culture of the organisation (cable & de rue 2002). when the individual believes that their values are compatible or supported by the organisational culture, the employee is likely to have a low desire to leave the organisation. jin et al. (2018) assert that when an employee’s values and beliefs are aligned with the organisation, there are positive psychological associations that are created between the individual and the organisation which leads to reduced intention to leave. the second dimension of pof considers the nsf which represents an employee’s judgements regarding whether the rewards they receive (pay, benefits, training) in return for their service are aligned with their personal and professional needs. employees who believe that their needs are not met by their employer are more likely to have a negative association with the organisation which fosters highturnover intention. daf which represents the third dimension of pof, refers to a person’s perceptions of the congruence between the demands of their job and their abilities. de crom and rothmann (2018), argue that when the employee’s work roles match their abilities and self-concept, they are actively engaged in their jobs and find new purpose in their work which is related to high job performance. on the contrary, when an employee possesses inadequate abilities or their abilities are insufficient for the job, work processes are less efficient and work outputs are of a poor quality. these employees are likely to experience high levels of work-related stress, which exacerbates the itl. the three dimensions of pof mentioned above are directly related to turnover intention and these relationships are supported by the job embeddedness theory (jet) (holtom, mitchel & lee 2006; ngo-henha 2018). according to the jet, when employees believe that their values are congruent with the organisation, their needs are addressed and their abilities are compatible with their work roles, they settle in their jobs and organisations. once people make linkages and feel a sense of being settled in their job, organisational fit is experienced and they find it difficult to leave their job or organisation for a new one as this will remove them from their professional and social environment (holtom & darabi 2018; ngo-henha 2018). based on the argument presented above, the following hypothesis is proposed: h1: person–organisation fit (pof) is negatively associated with intention to leave (itl). job satisfaction and intention to leave research conducted in the field of organisational psychology has documented a consistent negative relationship between js and itl (kristof-brown, zimmerman & johnson 2005; naidoo 2018; wheeler et al. 2007; zhang et al. 2017). the direction of this relationship implies that when people perceive themselves as being satisfied at work, they do not think of leaving their organisation, while those who perceive themselves as dissatisfied consider leaving their organisation to look for work elsewhere (buitendach & rothmann 2009; diedericks & rothmann 2014). in conceptualising js, authors have identified two dimensions of js that is intrinsic and extrinsic js, which explains why some people may be satisfied with their jobs while other are not (phuong et al. 2018; radebe 2018). intrinsic js is recognised as emanating from within the individual as it emphasises psychological value and has subjective meaning. the subjective meaning and psychological value experienced by individuals are gained from the job itself and occur when individuals feel a sense of achievement, recognition, and self-actualisation from the work that they do (chang et al. 2021). when employees believe that the job meets their emotional, psychological and subjective needs, they experience a holistic form of work-related wellbeing and are less likely to consider leaving the organisation. similarly, when employees feel demotivated, unfulfilled and no longer value their work, they may consider leaving the organisation to find work that gives them a sense of purpose. this itl the organisation is the final cognitive step of voluntary turnover and spurs on behavioural action to actually leave the organisation (beheiri & ahmed 2018). the second dimension of js is extrinsic or external in nature. unlike intrinsic js, extrinsic satisfaction stems from the work environment or factors external to the employee such as financial rewards, promotions, opportunities for career development and leadership. phuong et al. (2018) argue that while some employees may feel the need for psychological fulfilment from their work, most employees tend to be extrinsically satisfied. this can be attributed to the fact that people primarily join an organisation to be compensated for their services and that they do seek career progress. as a result, financial compensation and opportunity for promotion amongst other external factors could play an important role in whether employees feel that their needs are being met by the organisation. an employee that identifies an incongruence between what they offer to the organisation and what they receive in return is likely to contemplate whether it is in their best interest to remain in the organisation. the relationship between js and itl is supported by the value-perception theory which postulates that the extent to which an employee feels satisfied with the job is dependent on their belief that the job supplies them with things that they value (ekpendu, egbuta & ikechi-ekpendu 2019). when employees perceive the employer’s contribution towards them as less valuable, they begin to experience job dissatisfaction, which results in itl, eventually leading to actual turnover behaviour. thus, the following hypothesis is proposed: h2: job satisfaction (js) is negatively associated with intention to leave (itl). the mediating role of job satisfaction in the relationship between person–organisation fit and intention to leave given the effective role of pof in directly mitigating turnover intention, researchers (jin et al. 2018) have argued that understanding the indirect processes through which pof might explain itl, may offer additional insight on the topic of employee turnover. as a result, this study aimed to understand the role of js as an explanatory psychological mechanism in the relationship between pof and itl. it has been established in the literature that value –congruence need– supplies fit and fit between the individual abilities and demands on the job may all directly explain an employee’s purposeful decision to leave the organisation (redelinghuys & botha 2016). however, there is evidence which suggests that these dimensions of pof may explain how employees experience intrinsic and extrinsic js (redelinghuys & botha 2016). lack of congruence between the employee’s and organisation’s values (vcf) and beliefs, is expected to have a negative effect on factors relating to intrinsic js such as achievement, recognition, responsibility, personal meaning etc. when there is a mismatch between employees’ values and the organisation, they are likely to be less fulfilled and disengaged from their jobs, leading to low js. secondly, when an employee perceives low fit between their needs and the organisation’s attempts to meet those needs (needs–supplies fit), both intrinsic and extrinsic js begins to decrease. when the employee believes that the organisation is unable to meet their external work-related needs such as financial compensation, promotions, supportive leadership etc., the employees begins to experience low extrinsic js. additionally, when the employee believes that subjective needs such as the need for fulfilling work, autonomy, sense of purpose, etc. are not being met by the organisation, intrinsic js begins to decrease. low intrinsic and extrinsic js lead to negative job behaviours such a disengagement which may trigger negative thoughts, relating to leaving the organisation. finally, when employees identify a discrepancy between their skills and abilities and the demands of the job (demands–abilities fit), intrinsic needs related to achievement, self-respect and responsibility remain unfulfilled. peng and mao (2015) added that employees whose abilities do not meet the demands of their jobs, lack confidence, perform poorly at their jobs, experience increased stress and are unhappy in the jobs. the negative experiences result in low levels of js which will spur on action to leave the organisation. thus, the following hypothesis is proposed: h3: job satisfaction (js) mediates the relationship between person–organisation fit (pof) and intention to leave (itl). method a quantitative, non-experimental research method was adopted to investigate the direct and indirect relationships between pof, js and itl proposed in this study. given that the study was confirmatory in nature that is to confirm the relationships found in the literature, the quantitative approach was justified. data were collected using a cross sectional survey design (park & park 2016; sukamolson 2007). research participants the study population consisted of all staff working in the south african sds. using a non-probability purposive sampling design, a total of 119 responses were received using an online survey system that is qualtrics. from the 119 responses, a total of 100 responses (n = 100) were retained as these surveys were fully completed. the selection criteria for the study included employees in the sds in gauteng, south africa and comprised employees across all age groups, genders, occupational groups and occupational levels that is from operational to executive management. since the aim of the study was to investigate itl in the sds, the use of a purposive sampling method allowed the researcher to find relevant people who could provide the necessary information (saunders, lewis & thornhill 2003). the demographic breakdown of the sample can be found in table 1. respondents were primarily women (61.6%), and more than half of the respondents were married (61.6%), which also corresponded with the age groups that is most of the participants were aged between 40 and 55 years (59.60%). in the current sample 71.7% of respondents had a postgraduate qualification that is 4 years and above, while more than half of the respondents indicated that they had been employed in the sds for 10 years or more (62.2%). a total of 43.3% of the respondents were employed at middle-management level, 23.2% at operational level and 18% at seniormanagement level. about 30.3% of the respondents indicated that they would like to remain with the current organisation for more than 5 years, while 26.3% indicated that would like to remain with the organisation for less than 3 months. table 1: demographic breakdown of participants in sample (n = 100). measuring instruments intention to leave the 6-item turnover intention scale (tis-6) as derived from the tis, developed by roodt (2004), was used to measure itl in the current study. the original tis consisted of a 15-item scale and was later adapted to the 6-item scale (tis-6) to ascertain the extent to which respondents intend to stay at the organisation (bothma & roodt 2013). the tis-6 scale is scored on a five-point likert-type scale with scores ranging from 1 (never) to 5 (always). examples of items include ‘how often have you considered leaving your job?’ and ‘how satisfying is your job in fulfilling your personal needs?’ the tis-6 is a unidimensional scale with no sub-dimensions. job satisfaction the minnesota satisfaction questionnaire-20 (msq), as derived from the msq, developed by weiss, david and england (1967), was used to measure js. the original long form msq consisted of a 100-item scale and was later adapted to the msq (short form) with 20 items to assess how respondents feel about different aspects of their present job and their levels of satisfaction with each aspect. the msq (20) contains two sub-scales that assess the intrinsic and extrinsic satisfaction of the respondents. the scale is scored on a five-point intensity scale with scores ranging from 1 (very dissatisfied) to 5 (very satisfied). examples of items include ‘the competence of my supervisor in making decisions’ for extrinsic satisfaction and ‘the chances for advancement on this job’ for intrinsic satisfaction. person– organisation fit this study used the pof scale, developed by cable and judge (1996), to assess the extent to which respondents perceive their fit in their jobs and organisation. the original scale consisted of two items that measured two factors, namely indirect fit (vcf) and person–job fit (daf). the scale was later adapted by cable and derue (2002) to nine items measuring indirect fit (vcf), direct fit (nsf) and person–job fit (daf), with three items for each sub-dimension. the pof scale is scored on a five-point scale likert-type scale, with scores ranging from 1 (strongly disagree) to 5 (strongly agree). examples of items include ‘my organisation’s values and culture provide a good fit with the things that i value in life’ for vcf; ‘the attributes that i look for in a job are fulfilled very well by my present job’ for nsf; and ‘my personal abilities and education provide a good match with the demands that my job places on me’ for daf. research procedure and ethical considerations the study received ethical clearance from a large gauteng-based public university while gatekeeper permission was received from the national department of social development in gauteng. an online survey, consisting of three self-report measures and a biographical questionnaire, was circulated via the employee email system. a link to the questionnaire, the letter of informed consent and the participant information were included in the email communication to all staff members. the completed questionnaires were automatically sent to the qualtrics online survey system. the researcher did not have access to the participants’ email addresses or personal information during the data collection, while the data collection process was managed by a contact person in the department of social development. statistical analysis the data analysis was conducted with the statistical package for the social sciences (spss) version 27. before analysing the data, as related to the proposed hypotheses, the researchers tested for common method bias considering that the instruments used in the study were self-report measures; and the data were collected at one point in time. cronbach’s alpha coefficients were calculated to assess the reliability of the measuring instruments used in the current study. pallant’s (2013) guideline of α ≥ 0.70 was used to determine the reliability of the measuring instruments although values of α > 0.80 are preferable. descriptive and inferential statistics were also used to analyse the sample and responses to the scales. pearson’s product moment correlation analysis were used to assess the relationships between pof, js and itl. cut-off points of 0.30 and above (medium effect) and 0.50 and above (large effect), were set for the practical significance of the correlation coefficients (pallant 2013). hayes’ process macro model 4 (hayes 2018) was used to assess the mediating effect of js on the relationship between pof and itl. ethical considerations the authors obtained ethical clearance from the department of human resource management at the university of pretoria prior to data collection. ethical clearance number: mmd/2020/14. in addition, gatekeeper permission was obtained from the department of social development. results normality of data and common method bias the author assessed the data to ensure that it was distributed normally and to identify and address any outliers. first, univariate skewness and kurtosis were assessed using spss. based on the research done by finch and west (1997) and field (2009), the criteria used to determine whether the data assumed a normal distribution were set at 2.00 for skewness and 4.00 for kurtosis. both skewness and kurtosis ranged between −0.093 and −1.020, indicating that the data were normally distributed. to assess, multivariate normality of data, mardia’s kurtosis co-efficient was calculated. the mardia’s skewness test statistic was 13.28 (p > 0.0001), and the mardia’s kurtosis test statistic was 73.29 (p > 0.0001), which confirmed that the data met the criterion of multivariate normality. to assess the presence of multivariate outliers, the mahalanobis distances were inspected. the assessment revealed one outlier. it was found that while there were slight variations in the co-efficients when the outlier was removed, these variations did not affect whether the proposed hypotheses were accepted or rejected. additionally, the outlier did not affect the assumptions of normality hence the outlier was retained in the analysis. several authors (boguslavsky, 2021; tenopir et al. 2016; yang & berdine, 2016) recommend keeping the outliers in data analysis. the argument is that on some occasions the outliers might simply be valid extreme observations due to random variability and reflect the inherent property of random sampling. the identified outlier was assessed to determine if it was a result of error in data entry or a genuine valid extreme observation in the sample. because the outlier did not appear to be a result of error in data entry it was retained in the analysis. while the possibility of common method bias in this study was acknowledged, researchers (fuller et al. 2016) argue that the concern of common method bias in self-report measures that have proven construct validity is questionable. all measures used in the current study that is tis-6; the msq-20 and the pof scale are validated measures, which reduces the possibility of method bias. additionally, the concern of method bias was further minimised as the researchers found that most of the reported correlations found in this study were in line with previous published findings indicating no significant discrepancy. descriptive statistics, cronbach’s alpha and correlations table 2 shows the results obtained from descriptive statistics, reliability analysis and pearson’s product moment correlation analysis. the results revealed that this sample of employees in the sds reported moderate levels of itl (m = 3.25; sd = 0.95), moderate levels of pof (m = 3.38; sd = 0.81) and moderate levels of pof sub-dimensions; vcf (m = 3.30; sd = 0.98), nsf (m = 3.11; sd = 1.01) and daf (m = 3.70; sd = 1.03), with the mean score for daf being higher than the other two pof dimensions. results also indicated moderate levels of js (m = 3.35; sd = 0.76) with moderate levels of intrinsic satisfaction (m = 3.46; sd = 0.79) and extrinsic satisfaction (m = 3.23; sd = 0.80). the mean scores for intrinsic satisfaction was slightly higher than extrinsic satisfaction. it can be concluded that this sample of sds employees experience moderate levels of itl, pof and js. all scales and sub-scales reported reliability co-efficients above 0.70, indicating an acceptable internal consistency of all the measuring instruments used in this study (see table 2). table 2: descriptive statistics, reliabilities and correlation co-efficients (n = 100). pearson’s product moment correlation analysis was used to test hypotheses 1 and 2 proposed in this study. as indicated in the correlation analysis shown in table 2, pof reported a significant negative relationship with itl (r = –0.65; p < 0.01) (large effect). person–organisation fit sub-dimensions also reported significant negative relationships with itl; vcf (r = –0.388; p < 0.01) (medium effect), nsf (r = –0.733; p < 0.01) (large effect) and daf (r = –0.46; p < 0.01) (medium effect). it appears that in this sample, needs– supply fit reported the strongest relationship with itl. results of the correlation co-efficients indicated that pof and all its sub-dimensions reported a negative relationship with itl, providing support for hypothesis 1 that is pof is negatively associated with itl. results found in table 2 indicate that js reported a significant negative relationship with itl (r = –0.747; p < 0.01) (large effect). the results also indicated towards significant negative relationships with large effects between js sub-dimensions and itl; intrinsic js (r = –0.697; p < 0.01) and extrinsic js (r = –0.722; p < 0.01). results of the correlation analysis indicated that js and all it sub-dimensions reported a negative relationship with itl, providing support for hypothesis 2 that is js is negatively associated with itl. mediation analysis in order to assess hypothesis 3 that is js will mediate the relationship between pof and itl, all the pathways of the proposed mediation model (figure 1) were assessed using mediation analysis (hayes 2018). while the minnesota js questionnaire has both a unidimensionaland multidimensionalfactor structure, the authors opted to use the unidimensional factor structure for the mediation analysis as this is the common practice observed in more than 30 years of js research (hirschfeld 2000). additionally, in a study analysing the factor structure of the minnesota js questionnaire, boshoff and hoole (1998) concluded that it is acceptable to use the instrument as a unidimensional measure. secondly, while the pof scale has been known for its three-dimensional factor solution, authors (chen, sparrow & cooper 2016; grobler 2016) have used the scale as a unidimensional measure. additionally, grobler (2016) argues that the scores of each dimension can be combined to provide an indication of overall person–environment fit in which a high score suggests a high level of pof in all three dimensions. this indicates that a unidimensional-factor structure is also acceptable as was used in the current study. figure 1: results indicating the mediating effect of job satisfaction on the relationship between person– organisation fit and intention to leave. in this study, pof was indicated as the independent variable (x); itl was indicated as the dependant variable (itl) and js was indicated as the mediator (js). in order to run the mediation analysis, the bootstrapping method with bias-corrected confidence estimates were used (hayes 2018). using 5000 bootstrap resamples, a 95% confidence interval (ci) of the indirect effect was obtained. the 95% confidence levels indicate that an indirect effect is significant (at alpha = 0.05) and meaningful if zero does not fall within its 95% confidence interval (pillay 2020). results of the mediation analysis are presented in table 3 above. table 3: standardised regression coefficients for the variables: person–organisation fit, job satisfaction and intention to leave. the first step in assessing the mediation effect was to consider the direct effects proposed in the current study. the mediation analysis confirmed a direct effect between pof and itl (b = 0.35, se = 0.10, llci = −0.54 and ulci = −0.16). the mediation analysis also indicated a significant direct effect between pof and js (b = 0.60, se = 0.07, llci = 0.45 and ulci = 0.74), and finally the mediation analysis indicated a significant direct effect between js and itl (b = −0.70, se = 0.10, llci = –0.90 and ulci = –0.49). once the direct effects as per the pathways were established, attempts were made to analyse the indirect effects in which pof influences itl through its influence on js. the total indirect effect (b = −0.42, se = 0.08, llci = −0.58 and ulci = −0.25) as indicated in table 3 above, was significant as zero did fall in between the confidence intervals. this provided support for hypothesis 3 that is js mediates the relationship between pof and itl. it must be noted that the relationship between pof and itl remained significant in the presence of js which indicates that pof has a negative association with itl independent of the indirect effect through js. this suggests a partial mediation effect. however, it appears that the size of the indirect effect of pof on itl, through js, is slightly larger than the direct effect of pof on itl on its own. results may indicate that js as an explanatory mechanism, adds significant value to the relationship between pof and itl and that pof may account for more variance in itl when js is present in the relationship. the results for the mediation model are shown in figure 1. discussion results of this study provide evidence of the negative relationship between pof and itl. this implies that an increase in the levels of congruence between the employee’s personal values, abilities and needs and the organisation they work for, are associated with decreasing levels of itl the organisation. the negative relationship between pof and itl yielded in the current study, is consistent with the findings of other researchers (grobler & grobler 2016; ohlsson 2018) who reported that pof had a strong negative relationship with itl r = −0.52; p < 0.001; and r = −0.57; p < 0.001 respectively. the findings of the current study indicated that vcf was negatively related to employees’ itl. these results are consistent with pof theory which maintains that people prefer to work in organisations that match their values and goals (kakar et al. 2019). this is because an organisation and an individual will only experience compatibility with one another when there is congruence between their values, goals and culture (grobler & rensburg 2019; wheeler et al. 2007). this study also found a significant relationship between the employees’ need to feel that there is congruence between their abilities and the demands that the job puts on them (daf). when employees believe that their abilities are sufficient to support their work demands, they experience a sense of self-accomplishment and are less likely to leave the organisation. finally, results of the current study indicated that of the pof dimensions explored, nsf shared the largest negative relationship with itl in this sample of employees from the sds. this suggests that there is strong relationship between employees’ itl the organisation and the extent to which they feel the organisation meets their personal and professional needs. when an employee believes that they are rewarded fairly for their contribution to the organisation, they are less inclined to consider leaving the organisation. the findings of this study can also be explained using the attraction, selection and attention model (asa) (schneider, goldstein & smith 1995), which states that when individuals believe that they share mutual attraction with the organisation in terms of the values, need and abilities, they are likely to remain in the organisation. on the contrary, as reflected in the asa model, when employees perceive a mismatch between their values, needs and abilities and what is expected of them in the organisation, they think about leaving the organisation (cable & derue 2002; cable & judge 1996). a strong negative relationship between js and itl was found in the current study. these findings are consistent with those of radebe (2018) (r = −0.55; p < 0.01) and redelinghuys and botha (2016) (r = −0.43; p < 0.01), who reported a negative relationship between js and itl. hassan and adnan (2016) found that when employees feel dissatisfied with their jobs, they are more inclined to make plans about leaving their organisations. similarly, when employees experience a sense of enjoyment and are satisfied with their jobs, they are less likely to consider leaving their jobs or organisations (redelinghuys & botha 2016; wheeler et al. 2007). a negative relationship between intrinsic and extrinsinc js and itl was found in the current sample. these findings are supported by the self-determination theory (sdt). van rooyen et al. (2010), asserted that organisations which create a work climate that satisfies the needs for autonomy, competence and relatedness (intrinsic js), will succeed in increasing js and retaining their staff. this suggests that when employees are allowed to operate autonomously, are working in supportive environments, and are able to use their skills and abilities in their jobs, they experience js, and this leads to them remaining in the organisation. similarly, when the employee believes that the organisation meets their extrinsic needs for financial compensation, good leadership and opportunities for development, they begin to feel appreciated which increases organisational commitment and js leading them to remain in the organisation. the results confirmed that js mediates the relationship between pof and itl in this sample of sds employees. the results indicated that pof had a negative association with itl, independent of the indirect effect through js (a partial mediation effect). however, based on the results, it appears that the direct effect of pof on itl in this sample is slightly smaller than the indirect effect of pof on itl through js. this suggests that although pof is directly related to itl, the size of the relationship is larger when it occurs through js, indicating that js is a stronger explanatory mechanism in the relationship between pof and itl than pof on its own. these findings suggest that in the current sample, employees who perceive greater fit with the organisation, also experience greater levels of js which decreases their intentions to leave the organisation. findings of the current study are consistent with findings in the literature because previous studies (janse van rensburg et al. 2017; ohlsson 2018; redelinghuys & botha 2016; wheeler et al. 2007) found that pof predicts itl by a large margin when it is through js, explaining 20–45% of the variance in itl. a plausible explanation for why the indirect effect of pof on itl is larger through js, could lie in the concept of organisational commitment. organisational commitment is the desire on the part of the employee to remain a member of the organisation and influence whether the employee stays or leaves the organisation (luthans 2011; mafini & dlodlo 2014). according to schreuder and coetzee (2010), attitude, dedication and motivation are important to retain employees. these aspects of attitude, dedication and motivation are often a result of feeling satisfied in one’s job and this leads to the desire to stay in the organisation. as a result, while feeling a strong fit between oneself and the organisation may in some cases determine whether the employee stays or leaves, it is being satisfied with one’s job which fosters greater commitment and that ultimately explains why some people stay or leave the organisation. to support this argument, the mediation analysis in this study also found that pof had a stronger association with js and a weaker association with itl. this suggests that although employees experience poor fit with the organisation they will not necessarily be inclined to leave since this association is only moderate (redelinghuys & botha 2016). instead, poor fit is more likely expected to lead to greater job dissatisfaction which is then related to the inclination to leave the organisation. practical implications findings of this study has managerial implications for leaders in the sds, as the results make a positive contribution to understanding the relationships between these variables, especially within a sds context. managers in the sds can assist in facilitating greater pof through conducting a job/organisational assessment and determining the most suitable characteristics required for organisational/job success. this information can be used when recruiting suitable candidates for the sds as it provides an indication of whether the candidate may fit well in the organisational culture. this can also be achieved through conducting assessments and evaluations of employees’ personality, values and abilities to establish whether there is an optimal fit between the employee, the job and the organisation. the results show that while pof is important in predicting itl, it is a combination of pof and js together that provides a unique explanation for turnover intention. while this study encourages management in the sds to promote an organisational culture that enhances fit between the employee and the organisation, more attention should be placed on enhancing js. to promote intrinsic satisfaction, management in public sds, providing platforms for employees to meet their three key psychological needs, namely autonomy, relatedness, and competence could be considered. the sds can direct attention towards five intrinsic key factors of js, namely the work itself, individuals’ quest for achievement, recognition, responsibility and advancement. this can be done in the following ways: provision of career counselling services. career counselling can assist employees to identify factors in the work context that fulfils them and this will ensure that the quest for personal development is meaningful and focuses on aspects that will enhance intrinsic js. coaches and mentors can also assist employees to keep track of their progress for work fulfilment. job shadowing and job rotation opportunities may assist employees at the lower skills levels to experience greater responsibility and recognition. allowing employees to gain experience of management roles through job shadowing and rotation will facilitate feelings of greater responsibility and achievement. this will also allow them to determine if their abilities are congruent with the demands of managerial roles to prepare them for the future. to promote extrinsic satisfaction, the management in the sds should ensure that the five key extrinsic factors, namely supervision, pay/compensation, organisational policies, working conditions and co-workers, are addressed: stakeholder’s in the sds could consider revisiting their compensation and benefits policies to ensure that employees are fairly rewarded. in instances where financial compensation is not feasible, rewards such as extra days leave or opportunities for development can be used. employee reward programmes which includes opportunities for training and leadership development over and above what is offered to all employees can be offered. leadership and supervision which are aspects of extrinsic satisfaction can be enhanced through assessing leadership climate and identifying areas where leaders need development. leadership climate surveys may be conducted by the hr department of a neutral party and the results be used to develop interventions that aim to enhance leadership capabilities. limitations and recommendations while the findings of this study are supported by literature, they must be applied with caution due to the sample size. the questionnaires were emailed to all employees in the sds, but out of 742 employees, only 119 participated in the research and only a sample of 100 responses were used. future studies should aim to secure a larger sample size which will allow for the generalisation in findings. the study can be replicated to all provincial departments of social development or to a specific group, such as social workers in the department of social development at provincial and national level to determine whether the same results are obtained to allow for generalisability. the restrictive time frames for data collection in this study also posed a major challenge to the researcher as it led to the poor response rate. the use of a cross-sectional study hindered the determination of the cause-and-effect relationship of the studied variables. a longitudinal design may have been more appropriate as it would have allowed the researcher to predict the causal order of variables and understand how the attitudes of employees in the sds change over a period of time. this study only looked at the mediating role of js in the relationship between pof and itl, but the moderating role of js in the relationship between pof and itl can be explored to assess whether js works better as a moderator or mediator in the pof, itl relationship. conclusion the aim of the study was to determine possible relationships and indirect effects between pof, js and itl within the sds. the literature review showed public sector organisations still face challenges of itl as evident in the increasing turnover rates. the literature also showed that pof is important to ensure that employees fit well in with organisations. when employees do not fit in organisations, job dissatisfaction is experienced and they have high itl. it is therefore imperative for organisations to implement organisational practices that foster pof to ensure the retention of talented employees. however, should organisations not succeed in addressing pof, the solution would be to implement strategies that increase js, because js was found to mediate the relationship between pof and itl. recommendations proposed in this research can thus be used by management in the sds and individual employee’s to improve pof and js to ensure that highlyskilled employees stay in the organisation. acknowledgements the authors would like to acknowledge the employees in the national department of social development who participated in the study. competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions m.n.m. acted as first author (as the article is based on her mini-dissertation with d.p.n. as promotor) and wrote the first draft of this article. d.p.n. contributed towards the review, rewriting, statistical analysis and editing of the article. funding information this research received no specific grant from any funding agency in the public, commercial or not-for-profit sectors. 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references about the author(s) aderounmu a. ogunoye department of economics, faculty of the social sciences, adekunle ajasin university, akungba akoko, nigeria department of economics and development studies, faculty of arts and social sciences, islamic university of uganda, mbale, uganda oyebanji j. ibitoye school of economics sciences, faculty of economic and management sciences, north-west university, potchefstroom, south africa ewert p.j. kleynhans school of economics sciences, faculty of economic and management sciences, north-west university, potchefstroom, south africa citation ogunoye, a.a., ibitoye, o.j. & kleynhans, e.p.j., 2023, ‘manipulation of transfer prices by multi-national companies in nigeria’, south african journal of economic and management sciences 26(1), a4657. https://doi.org/10.4102/sajems.v26i1.4657 original research manipulation of transfer prices by multi-national companies in nigeria aderounmu a. ogunoye, oyebanji j. ibitoye, ewert p.j. kleynhans received: 11 may 2022; accepted: 06 feb. 2023; published: 22 mar. 2023 copyright: © 2023. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: transfer pricing manipulation diminishes revenue generation by the host countries. the results of the investigations in the literature show divergence to the extent of the impact of transfer pricing on economic growth in both the lowand high-tax countries, especially as this type of investigation is still scanty in the literature. aim: the study examines the effect of transfer pricing manipulation on economic growth in nigeria. setting: multi-national companies in nigeria. methods: the auto-regressive distributed lag (ardl) approach was applied to data from nigeria between 1986 and 2019. results: the findings reveal an insignificant relationship between economic growth and explanatory variables such as transfer pricing manipulation, unemployment rate, government revenue and trade openness. the result also shows a significant negative relationship between the exchange rate and economic growth. conclusion: the study recommends that the government should implement proper monitoring of multinational companies to check their day-to-day transaction activities. this may help the government to generate more revenue, and serves as an avenue to create more employment opportunities. contribution: in this study an important aspect is indicated in that multinational companies often misuse revenue to gain undeserved profits, rendering unnecessary costs to market and rendering other companies less competitive, as well as exploiting buyers and consumers. this is an important loophole that lawand policymakers as well as governments should pay attention to and act against. keywords: transfer pricing manipulation; government revenue; unemployment; economic growth and auto-regressive distributed lag (ardl); co-integration; analysis introduction this article examines the effect of transfer pricing manipulation on economic growth in nigeria by adopting an auto-regressive distributed lag (ardl) approach to data from 1986 to 2019. taxation is seen as the main source of government revenue (gr) all over the world. as a revenue-generating instrument, taxation is used to achieve objectives that will ensure the well-being of the country’s citizens, such as the maintenance of law and order, provision of securities, and regulation of trades and businesses for social and economic maintenance (oyunda 2015). adegbite (2019) is of the view that the reason for the low gr from taxation can be attributed to tax avoidance, record falsification, tax evasion, gross inefficiency, and total leakages. there is a need for the proper monitoring of taxes received from the host and foreign companies. multinational corporations (mncs) are managed separately with different branches globally but have a common corporate objective of generating abnormal profits. the major aims of business with diversification include risk reduction, increasing growth, stabilisation of income or earnings, and discretional change. diversification is also a source of revenue and assists to reduce dependence on a particular business segment. this decentralisation may be in a certain country or across borders. omoye and okafor (2004) view mncs as firms with global affiliates and head offices situated in a developed region. investments by mncs are important as it supports economic growth in both host and parent countries. in an effort to maximise profits, mncs are involved in various branches, which may involve trade between the parent company and its subsidiaries in other countries, or trade between subsidiaries operating in different countries. the prices they charge during trade are done among the various branches of mncs and are referred to as ‘transfer prices’. transfer price manipulation (tpm) is the trade between related parties at prices meant to manipulate markets or to deceive tax authorities. it can also be referred to as a process where money, goods, services and other assets are transferred from one business to another; sometimes these operations are done via special intermediary units and not directly through main units called transfer centres (jensen & meckling 2016). transfer price manipulation by multinational companies limits economic growth when taxes to be paid are manipulated to reduce the revenue to government. in addition, the continuous practice of transfer pricing in nigeria by foreign investors is fast becoming a concern due to the large of money and the impact on revenue generation in the country. this implies that nigerian law on transfer pricing was promulgated to ensure that the profit from foreign business activities that exploit natural resources, and other business activities, are retained. this is, however, often manipulated in nigeria as much of the transfer pricing activities are usually done by over-invoicing of import activity and under-invoicing of export activity (ajayi 1992). over the years, transfer pricing manipulation was of concern in africa, nigeria inclusive. it is estimated that the capital flight component amounts to 7% of all the trade in africa, amounting to approximately $11 billion annually. the large capital flight could be attributed to about 60% of all the trade transactions in and out of africa being mispriced by an average above 11% (kazibwe 2013). transfer price manipulation has been seen as a major cause of capital flight from nigeria through tax avoidance and has resulted in the loss of big amounts of money. this is considered one of the systems, or ways, that hinder economic growth. the manipulation of invoices by the mncs for capital flight and transfer pricing in nigeria occurred mostly between 1970 and 2004, resulting in an average annual capital outflow of $385 million and a cumulative total of $135bn (ajilore 2010). in addition, between 2005 and 2007, nigeria lost £502m in transfer pricing through trade miss-invoicing (christian aid report 2009). oil companies such as chevron, halliburton and shell international petroleum have avoided some taxes to domestic and foreign governments using accounting and tax transaction packages. in nigeria, shell international petroleum avoided approximately $710 506 000 during 1992, halliburton $14 285 714.20 in 2002 and chevron $17 857 142.86 in 2003 (bakare 2006). insufficient information from the parent company’s results in transfer pricing and other forms of tax avoidance in nigeria, leading to various forms of tax avoidance and other capital flight issues. production in the oil sector is handled by multinational companies with tendencies toward tax avoidance through under-invoicing export or over-invoicing imports (bakare 2006). the need to determine the causes for low revenue from taxation, despite the volume of transaction done by the local and foreign companies, has attracted several investigations alike. various researchers have found that tpm prevents economic growth. ibitoye (2020), for example, examines transfer pricing manipulation and its effect on the nigerian economy. it was found that the gross domestic product (gdp) reacted significantly negative to the rise in transfer pricing. obasi (2015b) also shows a negative relationship between both transfer pricing, unemployment and economic growth in the normalised long-term equilibrium. in contrast to these findings nguyen (2019) finds an insignificant and even negligible effect of transfer pricing on economic growth in vietnam which is a low-tax country. grubert and mutti (1991) also adopt the augmented dickey-fuller (adf) test on cross-sectional data for us mncs and stated that taxes and transfer pricing in multinational companies indicate that the reporting of profits in highand low-tax countries is in line with income shifting behaviour. income shifting implies that the multinational companies usually intent to move their profit before tax to countries or jurisdictions with low tax in order to reduce the burden from tax. in a nutshell the result implies that the low tax determines the level of attraction of foreign companies which also determines the revenue generated. in the same vein, the authors find that real investment also depends on the effectiveness of the host country’s tax rates and tariff strategies. they found evidence of divergence in the results of the investigation from the perspectives of foreign investment in other countries and in host countries on tpms. salihu, annuar and obid (2015) also find a statistically significant positive relationship between tax avoidance and foreign investors’ interest in malaysia. because of the divergence in the result of the investigations on the relationship between transfer pricing, revenue generation and foreign direct investment among mncs both in highand lowtax countries and the scantiness of this type of investigation in the literature, it is sought in this study to re-examine the effect of transfer pricing manipulation and economic growth in nigeria. the intention, therefore, is to answer the question of the effect of transfer pricing manipulation on economic growth in nigeria. nigeria has been chosen as the ‘laboratory’ because of the volume of mncs in the country and the expected impact of the revenue generated from the tax received from the mncs on economic growth. the remaining part of the article is presented as: in the section ‘literature review’ the empirical literature is discussed; in the section ‘methodology’ the model and methodology employed; in ‘results and discussion of findings’ the data and empirical findings are supplied, and finally, the section ‘conclusion and policy recommendations’ concludes the article. literature review the government of countries fix tax to maximise the revenue from taxes collected from the local and mncs, and they fix it low to maximise sales to attract more mncs. on the other hand, the mncs, in a bid to reduce their tax burden, adopt the income shifting strategy by moving to jurisdiction or countries with low tax and avoiding the high-tax countries. horst (1971) develops a model from the idea of a multi-plant monopolist by selling in two different countries to analyse how the mncs maximises their after-tax earning through transfer prices. in the model the firm’s earned profit will be the summation of the after-tax profit from the firms in the two countries, in addition to the term that narrates the impact gained from intrafirm trade. this gives the firms the opportunity to choose whether to adopt the highest or lowest possible transfer prices which may be determined by the differentials in taxes between the importing and exporting countries, and the rates of their tariffs. horst (1971) and eden (1998) view transferred price manipulation as the setting of transfer prices to be above or below opportunity costs in order to avoid but not to use the opportunity of evading the control of the government and/or take opportunity of arbitrage differences between countries the mncs also adopt the transfer pricing manipulations to avoid government price or tax control. to avoid the problems associated with tax, like double tax and tax avoidance, the government adopts the arm’s-length principle. the arm’s-length principle is an international standard for transfer pricing. the arm’s-length principle can be referred to as the difference that exist between two separate enterprises on how they relate there financial and commercial activities with the controlled and uncontrolled cases. the arm’s-length principle can be achieved for controlled transactions when their transactions are in compliance with the comparability analysis and the best method rule. the best-method rule is the method that the company adopts as the procedure that best suits the tax business policy; on the other hand, the comparability analysis is concerned with a situation in which the company of controlled transitions makes several comparison before finalising the transactions that may achieve the goals of the arm’s-length principle (challoumis 2019). eden (2003) views transfer pricing as the price that is set for internal or intrafirm transactions of goods, capital flows, services, and intangibles among the mncs. the impact that the transfer pricing manipulation has on the revenue generation has prompted different controls of transfer pricing and has prompted several empirical investigations. solikhah, aryani and widiatami (2021) examine the impact that tunneling incentives, foreign operations, corporate governance mechanism, governance, debt covenants, and bonus mechanism on transfer pricing by taking panel data from 24 different companies, with 120 units for the period 2014 to 2018, using panel data regression. the study adopts two transfer pricing variables with proxies related party transaction asset liability (rptal) and transfer pricing intensity (tpi). the study has two models based on the differences caused by rptal and tpi. the first model shows that the tunneling incentives, debt covenants, and foreign operations show a significant and positive effect on transfer pricing, and the second model shows that a positive relationship exists between tunneling incentives and transfer pricing. ibitoye (2020) applied time-series data from 1970 to 2016, obtained from world bank data base on transfer pricing manipulation in nigeria. the study employed the ardl technique, and the results show that real gdp reacted significantly negatively to transfer pricing in nigeria. if transfer pricing increases by one standard deviation, the average value of real gdp declines in the long term by 0.24 standard deviation units. the error correction model (ecm) showed that approximately 13.9% of disequilibrium in real gdp is due to a one-time temporary shock being corrected within a year. amidu, coffie and acquah (2019) find that the impact of transfer pricing and the management of earnings affects tax avoidance among some firms in ghana by adopting a panel data set for the period 2008 to 2015. the results of the study show that almost all the firms reviewed within the period show evidence of transfer pricing strategies and earning manipulations for tax avoidance, but more prominent among the non-financial firms than observed among the financial firms, while the financial firms also utilised the transfer planning strategies but not as frequently as the non-financial firms. nguyen (2019) examines the relationship that exist between foreign direct investment, transfer pricing, and earnings in vietnam in 2007 and 2015. vietnam operates a very low tax rate compared to other asian countries like japan and china. the result of the study shows an insignificant or negligible impact of transfer pricing on revenue. ofei et al. (2018) examined two transmission channels of transfer pricing that may result in macro-economic volatility by adopting the egarch model, which is a a dynamic model that addresses conditional heteroscedasticity from 1980 to 2017. the results indicated that it caused macro-economic instability. they found high and statistically significant shocks from transfer pricing, for both trade and budget policy channels. salihu et al. (2015) adopt the generalised method of moment (gmm) approach to examine the link between tax avoidance and profit shifting and foreign investors’ interest in 100 corporations listed in malaysia from 2009 to 2011. a statistically significant positive relationship was found between tax avoidance and foreign investors’ interest in malaysia. cristea and nguyen (2016) collected data from danish exports between 1999 and 2006 with evidence of transfer pricing manipulation by mncs. the study found that the mncs reduced the value of their exports by between 5.7% and 9.1%, which amounts to an approximate $141m shortage in expected export revenue for 2006. this would have formed a tax income of 3.24% from mncs’ tax returns in denmark. a study conducted by mohammad and simpasa (2012) also examined the effect of transfer pricing manipulations on multinational investment in consideration of 80 recognised companies listed on the malaysian board, using panel data from 1972 to 2010. the study found transfer pricing to be prominent among companies that are highly diversified to attain higher rates of return, lower risk and growth opportunities. an article published by argentina’s segmental reporting board, which used panel data covering the period of 1932 to 2015, revealed that transfer pricing manipulation restricts economic growth (pwc 2020). crivelli, de mooij and keen (2015) adopted panel data collected from 173 developed and developing countries and investigated the impact of profit shifting on their economies. they found a negative impact on all countries. kpmg (uganda) released an article titled global transfer pricing review, based on time-series data covering the period of 2009 to 2012, and revealed that if firms adopt a method of decoupling their internal transfer price strategy from the arm’s-length pricing strategy which they adopted for tax valuation purposes, it will affect the preferred internal price by admissible arm’s-length price (explained in the methodology section below). this is evidence that intracompany transactions in combination with the tax valuations assist to induce economically relevant cashflows (kpmg 2015). bradley (2015) investigated transfer pricing and the existence of increased tension between multinational firms and tax authorities in the host countries by adopting the ecm on panel data for the period 1980 to 2013. the study found evidence of increasing tension between tax haven or tax incentive countries and organisation for economic co-operation and development (oecd) countries. ahmed (2010) investigated transfer pricing from the nigerian perspective using the granger casualty test on panel data from the period between 1981 and 2018 and concluded that home taxation of foreign profit could reduce mispricing incentives, but the effect depends especially on the degree of compulsory repatriation. tim, efobi and beecroft (1999) used survey data of ethiopia and analysed the effect of integrating managerial and tax objectives of transfer pricing and concluded that an internal transfer pricing set is equal to the arm’s-length theory price, which will result in low intracompany transfers. methodology model specifications the model used in this study follows the work of obasi (2015a) among the root of the arm’slength theory. the model specification is that national income (gdp) is a function of tpm and the unemployment rate (un), expressed as: gdp = ƒ(tpm, un). transfer pricing manipulation is calculated by subtracting current account balances from foreign direct investment, while the dependent variable, economic growth, is proxied by gdp. the model is specified as: with modification to the work of obasi (2015a), this model can incorporate trade openness (to), the exchange rate (exr), and gr, which then becomes: this can be stated explicitly as: this model was log-linearised and stated as: where transfer pricing manipulation is (fdi – ca), trade openness , ln natural logarithms, and μt are the stochastic variables, with β0 the intercept, while β1 – β5 represent the parameter estimates. auto-regressive distributed lag error correction model the ecm is utilised to determine the short-term dynamics between the variables before the long-term relationship can be established. the model specification in ecm general form is stated below: where l is the lag operator and ecmt-1 represents the error correction term in a year. sources of data this study examines the effect of transfer pricing manipulation on economic growth in nigeria between 1986 and 2019. annual data on unemployment rates, exr, to, and gr from central bank of nigeria statistical bulletins were collected; while data on the gdp, foreign direct investment, current account balances, exports and imports were sourced from the federal bureau of statistics in nigeria for empirical investigation. results and discussion of findings table 1 summarises the results of the estimated mean value used to examine the nature of the data distribution. the exr recorded the highest mean of 107.88, while transfer pricing manipulation has the lowest average value of minus 6.04e+09. a careful assessment of the standard deviation of all the variables shows that the log of gdp (0.999), transfer pricing manipulation (1.23e+10), unemployment (1.436), log of to (1.375) and the log of gr have a low standard deviation, implying a very low variability away from the mean. other variables such as exrs (91.679) have a high variability distant from the mean. table 1: descriptive statistics. table 1 further indicates that, apart from transfer pricing manipulation, the log of to and gr, other variables are positively skewed. the estimated kurtosis statistics of the log of gdp and exr are below 3. this implies that the variables are platykurtic and the tails of the distribution for these variables were thinner than a normal distribution. the kurtosis statistics of transfer pricing manipulation, unemployment rate, to and gr are greater than 3. this implies that the variables are leptokurtic, which further means that the tails of the distribution for the variable are thicker than a normal distribution and therefore implies heterogeneity in the data. the jarque-bera value for all the variables, except the log of gdp, transfer pricing manipulation and exrs passed the significance test of 1%. this implies that the variables are not normally distributed. table 2 shows the results of the adf test, which indicate that all the variables were not stationary in the same order. the gdp, tpm, unemployment and exchange were stationary at first difference, while to and gr were stationary at level. this is because the adf statistics of each of the variables were greater than the 5% critical value of each of the variables in absolute terms. these results show that all the variables under review have a short-term equilibrium relationship. table 2: unit root. concerning the adf tests, the conditions for the ardl co-integration tests were met. therefore, the ardl bound testing approach for co-integration analysis can be employed. the lag length is increased to four lags and even more to the point that there is likely no room for improvement or no more options in the lag length choice (see table 3). the result in table 4 shows that all criteria suggest a maximum of one lag for the ardl model. table 3: lag length selection criteria. table 4a: bound test for the presence of co-integration in auto-regressive distributed lag. table 4b: bound test for the presence of co-integration in auto-regressive distributed lag. the f-statistic is 1.60 and the values of the critical lower bound and the critical upper bound following pesaran, shin and smith (2001) are presented in table 4. the f-statistics are within the lower and upper bound at a 5% level of significance, which is 1.601757. the study, therefore, concludes that there is no evidence of a long-term relationship between gdp and the set of other independent variables. the ardl test shows a negative but insignificant short-term relationship between tpm and the gdp in nigeria (table 5). the exrs and to is also negative but statistically insignificant. unemployment and gr are also negative but statistically insignificant. this result is consistent with obasi (2015b) who also finds a negative relationship between transfer pricing manipulation and unemployment. a year lag between exr and gr, however, tends to have a significant positive relationship with gdp. this implies that the variables tend to have a direct relationship with gdp in the long term. the r2 measures the goodness of fit and is also the coefficient of determination at 0.98587, which implies that 98.6% of the variation in the gdp is explained by other variables. however, because of the significance level of the explanatory variables and the need to know the relevant variables in the model, a parsimonious ardl is adopted. table 5: unrestricted auto-regressive distributed lag. discussion of findings the relationship is investigated that exists between tpm and economic growth in nigeria from 1986 to 2019 by employing an ardl. the first step was to test for the properties of the time-series variables selected by utilising the adf unit root tests at a 5% critical value. the unit root test revealed that only the logarithms of trade openness (lnto) and government revenue (lngr) were stationary at level, while other variables were stationary at first difference. the condition for ardl lag co-integration was met, based on the adf test. the study also found that the absence of long-term co-integration between the variables as the value of the f-statistics, (1.602) based on pesaran et al. (2001), is lower than the upper bound critical value (3.79) at a 5% level of significance. the result of ardl short-term dynamics revealed a negative short-term relationship between gdp and independent variables such as tpm, unemployment rate, to, and the exr and gr. this result is in line with obasi’s (2015b) findings on how transfer pricing affects economic growth in nigeria. the empirical evidence reveals an indirect link between transfer pricing, unemployment and economic variables in nigeria. this is in agreement with ibitoye’s (2020) study on tpm and the nigerian economy for the period 1970 to 2016. using the ardl, the results of the regression showed that real gdp reacted significantly negative to a rise in transfer pricing in nigeria. in addition, the work of asongu (2016) found that transfer mispricing contributed to the diminishing growth of african nations. clive and jorissen (2013) also showed that tpm is negatively related to economic growth in developed countries. conclusion and policy recommendations in this article the effect is examined of transfer pricing manipulation on economic growth in nigeria from 1986 to 2019. the study reveals that transfer pricing manipulation limits economic growth, which confirms the conclusion of several researchers in the past like clive & jorissen 2013 and ibitoye 2020. this result implies that tpm inhibited economic growth in nigeria within the review period. however, in the study a statistically insignificant and negative relationshipis obtained between transfer pricing manipulation and economic growth. the results also agreed with the previous finding that transfer pricing manipulation could negatively affect the unemployment rate, to, exr and gr (ibitoye 2020; obasi 2015b; ofei et al. 2018). this implies that transfer pricing manipulation discourages to, which could affect the growth in economic output. it is, therefore, recommended that there should be proper monitoring of multinational companies to gauge their day-to-day transaction activities as this may help governments to generate more revenue and an avenue to create more employment opportunities. government should, moreover, ensure that penalties are levied on multinational companies that engage in transfer pricing manipulation as a means of earning gr that would have been generated from the import and export of goods and services. there is a clear need to investigate how firms shift profit and the value that the government loses from transfer pricing but there is lack of such empirical investigation. this is due to lack of data set to differentiate the tax considered as ideal by the mncs and the arm’s length price which is the international standard for transfer pricing. acknowledgements the authors acknowledge the support from the world trade organization (wto) and the national research foundation (nrf). the findings, views and opinions expressed, and conclusions arrived at in this article are those of the authors and should not necessarily be attributed to the funding institutions. competing interests the author(s) declare that they have no financial or personal relationship(s) that may have inappropriately influenced them in writing this article. authors’ contributions the authors both contributed to the article. a.a.o. developed the initial concept and analysis, and o.j.i. did the literature study, and empirical analysis and wrote the initial manuscript. e.p.j.l. overviewed and validated the empirical analysis and wrote the final version of the manuscript. a.a.o. is senior lecturer in nigeria and uganda, o.j.i. is a post-doctoral fellow and e.p.j.l. is his supervisor. ethical considerations with regard to this article we declare that all ethical practices have been followed concerning the development, writing, and publication of the article. although it was not deemed necessary the researchers did obtain an ethical clearance certificate for this research from the economic and management sciences research ethics committee (emc-rec) of north-west university, south africa (nwu – 00644-22-a4). funding information the authors acknowledge the support from the world trade organization (wto) and the national research foundation (nrf). the findings, views and opinions expressed, and conclusions arrived at in this article are those of the authors and should not necessarily be attributed to the funding institutions. data availability the data that support the findings of this study are available on request from the corresponding author, e.k. disclaimer the views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy, views or position of their affiliated agencies. references adegbite, t.a., 2019, taxation and revenue generation in nigeria, leibniz information centre for economics, berlin. ahmed, o.i., 2010, ‘the impact of transfer pricing on financial reporting: a nigerian study’, research journal of finance and accounting 6(16), 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beecroft, i., 1999, integrating managerial and tax objectives in transfer pricing, african governance and development institute working paper no. 14/024, yaoundé. microsoft word 1 esterhuysen et al sajems 14_2_ 2011 122 sajems ns 14 (2011) no 2 the effect of stressed economic conditions on credit risk in basel ii ja’nel esterhuysen absa capital: investment bank division of absa bank and school of economics, north-west university gary van vuuren and paul styger school of economics, north-west university accepted september 2010 the robustness of the basel ii accord in protecting banks during volatile economic periods has been challenged during the ongoing credit crisis. in particular, advanced approaches to measuring and managing credit risk have drawn criticism for being both irrelevant and too complex. despite accusations that the accord was largely responsible for the crisis, this article explores which of basel ii’s credit risk approaches were more successful in allocating capital. it was found that, in general, compliance with basel ii actually protected banks during the crisis, with simpler approaches enjoying greater success than more advanced ones in protecting banks against credit risk. key words: credit risk, loss and frequency distributions, credit crisis, basel ii jel c46, g21, 32 1 introduction the global financial crisis, which began in june 2007, has been described as the most serious financial crisis since the great depression of the 1930s (soros, 2008). it resulted in considerable international distress, with almost all major banks experiencing capital shortages, and some defaulting outright. among the principal causes was an explosive increase, by a factor of ten in some cases, in credit defaults, (subramanian, 2009) precipitated by lax lending standards, which had prevailed for several preceding years. an early victim, northern rock, a medium-sized uk bank, requested security from the bank of england after its highly leveraged balance sheet led to investor panic and a bank run in midseptember 2007. although the plea was initially unsuccessful, the uk government did eventually relent and the bank, the first of many, was taken into public hands in february 2008 (subramanian, 2009). northern rock’s problems proved to be an early indication of the troubles that would soon beset other banks and financial institutions. those initially affected, such as northern rock and countrywide financial, were directly involved in mortgage-lending and residential home construction, and short-term financing through increasingly illiquid credit markets became a virtual impossibility (allen & bali, 2007). over 100 mortgage lenders worldwide went bankrupt during 2007 and 2008, and concerns that the large investment bank bear stearns would collapse in march 2008 resulted in its ‘fire-sale’ to jp morgan chase. the credit crisis reached its peak during the months of september and october 2008 (allen & bali, 2007). global stock markets were slower to react: substantial losses were recorded throughout the early part of 2009, until the nadir was reached in mid-march of that year. the crisis caused the failure of several major institutions, which were subsequently acquired under duress): many of these were subject to abstract http://en.wikipedia.org/wiki/northern_rock http://en.wikipedia.org/wiki/bank_of_england http://en.wikipedia.org/wiki/leverage_(finance) http://en.wikipedia.org/wiki/bank_run http://en.wikipedia.org/wiki/nationalisation_of_northern_rock http://en.wikipedia.org/wiki/nationalisation_of_northern_rock http://en.wikipedia.org/wiki/countrywide_financial http://en.wikipedia.org/wiki/bear_stearns http://en.wikipedia.org/wiki/jp_morgan_chase sajems ns 14 (2011) no 2 123 takeover by their relevant sovereigns, including, amongst others, lehman brothers, merrill lynch, fannie mae, freddie mac and american international group, aig. catastrophic failures of inadequate capital allocation and management were exposed, and culpability for the cause, severity and duration of the crisis was placed on, inter alia, regulatory bodies, credit rating agencies and bank ceos. financial institutions began to question the validity and relevance of the underlying credit-risk principles forming the basis of the basel ii accord (basel ii) issued by the basel committee on banking supervision (bcbs) in 2005 (bcbs, 2006a). these principles were devised to provide banks and other financial institutions, like insurance companies, with methods for managing credit risk adequately by providing guidance for assessing credit risk, including equations for determining risk capital for more advanced approaches. because many institutions’ capital levels proved woefully inadequate during the crisis, these principles are inevitably now being challenged (colander, follmer & haas, 2009:2). however, during december 2009, the bcbs approved for consultation a package of proposals for strengthening global capital and liquidity regulations with the goal of promoting a more resilient banking sector, which would form part of its response to addressing the lessons learned from the crisis and to strengthen the basel ii framework (bcbs, 2009). basel ii provides two different approaches for the measurement and management of credit risk; the standardised approach (the simplest, hereafter referred to as the sa) and the internal ratings based (irb) approach. the irb approach is divided into two further approaches of increasing complexity: the foundation (firb) and the advanced (airb) approaches. for the purpose of this study, both will be referred to collectively as the ‘advanced approaches’ (aa). the aa employs complex mathematical formulations, which are now under attack (collander et al., 2009:2). this is because the aa allows banks to use their own internal models to assess credit risk and risk-sensitive capital adequacy levels. many such models are mathematically complex and may be incapable of modelling the ‘exceptional times’ (a generic shortcoming of all mathematical models) experienced by the financial world during the credit crisis. it has been posited that financial engineers were aware of the unrealistic restrictions and severe limitations imposed on the models to ensure stability, but embraced them anyway. the fragility and unreliability of these models under stressed conditions has surprised many (collander et al., 2009:2), although the severity, duration and contagion effect of the crisis admittedly did not seem feasible (subramanian, 2009:3) and was thus not explicitly modelled prior to the eruption of the crisis. banks were perceived as being adequately capitalised prior to the credit crisis (collander et al., 2009:2), and, by basel ii standards, this was certainly true despite the ensuing market mayhem, which revealed inadequate capitalisation. for example, lehman brothers, merrill lynch, fannie mae, freddie mac, american international group and jp morgan were regarded as being among the top 30 largest and most capitalised financial institutions in the world (subramanian, 2009:3). the majority of banks referred to in this article had already been approved for the airb approach or were in the process of applying for it under basel ii (see section 2). the question arises: was basel ii’s simpler approach to credit risk successful in guarding banks against credit risk catastrophes 1 (through the adequate provision of buffer capital), or did basel ii’s advanced credit risk approach succeed in protecting banks from disaster. this article addresses these questions by comparing bank credit-risk losses determined by using the basel ii standardised approach to losses with losses incurred when the basel ii advanced approaches were used prior to and during 2 the crisis. the question of whether or not the sophisticated mathematical approaches to the measurement and management of credit risk used in advanced approaches were more successful than the simpler approaches will be discussed. the remainder of this paper is arranged as follows: section 2 provides a brief literature study of the basel ii advanced credit risk approaches along with a brief overview of the major credit risk losses experienced during the http://en.wikipedia.org/wiki/lehman_brothers http://en.wikipedia.org/wiki/merrill_lynch http://en.wikipedia.org/wiki/fannie_mae http://en.wikipedia.org/wiki/freddie_mac http://en.wikipedia.org/wiki/aig http://en.wikipedia.org/wiki/lehman_brothers http://en.wikipedia.org/wiki/merrill_lynch http://en.wikipedia.org/wiki/fannie_mae http://en.wikipedia.org/wiki/freddie_mac 124 sajems ns 14 (2011) no 2 crisis. a description of the data employed in the study is presented in section 3 and the subsequent analysis of these data follows in section 4. section 5 concludes the paper. 2 literature review basel ii relies heavily on a number of key elements, which now appear to have weakened in light of the credit and liquidity crisis (griffin, 2008:2). firstly, basel ii promotes the use of complex internal quantitative modelling techniques by banks for the calculation of regulatory capital (griffin, 2008:3) and there are concerns about the opacity of these models. secondly, the new capital adequacy rules depend heavily on the research produced by credit-rating agencies. given the culpability ascribed by many to the rating agencies in the structured credit market turmoil, should basel ii really give these agencies a quasi-regulatory role in relation to capital adequacy and counterparty credit risk assessment? thirdly, despite improvements on basel i, the new rules continue to focus on credit origination, rather than on new credit derivative instruments and structured products. fourthly, the imf recently stated that the pro-cyclical nature of basel ii capital requirements, which require banks to hold additional capital against greater anticipated losses as the economic cycle turns downward, could exacerbate an economic recession by forcing banks to restrict their provision of credit in a downturn scenario (repullo & suarez, 2008) 3 . lastly, the credit crunch was partly the result of a widespread lack of information, which exacerbated the initial us sub-prime problems. while enhanced disclosure is one of the three pillars forming the basis of basel ii, it is recognised as the weakest in terms of both prescription and enforcement (griffin, 2008:4). basel ii disclosure is required for external parties like credit rating agencies (cras) and regulators to assess an individual bank’s capital adequacy levels in order to provide the bank with some guidance. however, this disclosure was, in most cases, insufficient, which led to the inadequate assessment of capital by external parties and in turn to inadequate guidance on capital adequacy levels. banks’ capital bases could therefore not protect them against the systematic effects of the crisis. these capital levels and their disclosure should be aligned more with the way in which banks assess credit risk (griffin, 2008:5). although it is not the focus of this paper, a summary of the different basel ii approaches can be seen in figure 1, which highlights the major differences between these approaches and provides a good background for the remainder of this paper. figure 1 brief overview of basel ii credit risk approaches standardised internal ratings based (irb) approaches • apply prescribed risk-weights (which differ from basel i) to exposures residing in asset classes to calculate rwa. • limited recognition of credit mitigation (more than in basel i). two options: • simple approach: substitution of riskweighted collateral for riskweighting of counterparty. • comprehensive approach: calculate adjusted amount of exposure and value of collateral, using haircuts (standard supervisory or own-estimate haircuts). foundation (firb) approach • rwa are calculated using a basel ii risk-weight formula with the following inputs: probability of default (pd), exposure at default (ead), loss given default (lgd) and effective maturity (m). • lgd (45 per cent for unsecured), ead and m is prescribed by sarb. • larger range of credit mitigation recognised. advanced (airb) approach • rwa are calculated using a basel ii risk-weight formula or function using pd, ead, lgd and m as inputs. • m is calculated in a similar way to the duration of a bond or the sarb allows the use of contractual maturity. • range of credit mitigation unlimited as long as the lgd parameter estimate can be proved based on sufficient historical data. credit mitigation (collateral) recognised under all approaches source: complied by the authors from bcbs (2006a) sajems ns 14 (2011) no 2 125 as can be seen in figure 1, the sa applies only prescribed (by the regulator) risk-weights and uses very little credit-risk mitigation; the use of models is almost completely absent. the aa, on the other hand, applies more specific risk measures, for example probability of defaults (pds), loss given default (lgd) and exposure on default (ead), and all these measures are based on comprehensive and complex mathematical models. with the firb, lgd and ead and maturity (m) are prescribed, but with the airb, the bank is allowed to use its own models to calculate all the components and in essence has much more freedom when it comes to calculating risk capital. the implementation of basel ii coincides with the considerable losses reported by some of the world’s largest banks (figure 2), requiring large-scale recapitalisations (benink & kaufman, 2008:2). the risk models underlying basel ii are similar to those employed by many banks (and indeed, the former may have influenced the latter). it is widely known that many models are prone to considerable weakness on account of unrealistic assumptions. recent events have challenged the usefulness of the important elements in basel ii, as the need to recapitalise banks has revealed that many banks’ internal models for both assessing credit risk and calculating risk capital performed poorly in underestimating the risk exposure (benink &kaufman, 2008:2). this reflects some of the difficulties of accounting for low-probability/ high-impact events. figure 2 largest bank write-downs since the beginning of 2008 0 5 10 15 20 25 30 35 40 45 50 55 cit igroup m erryl lynch ub s hsb c wachovia b ank of a merica ikb deut sche rb s wasingt on m ut ual m organ st anley jp m organ deut sche b ank credit suisse wells fargo b arclays lehman brot hers credit a gricole fort is hb os societ e general us d billio ns source: compiled by the authors from cnn money.com most critics of basel ii do not oppose the accord in its entirety, but are more critical of the somewhat arbitrary ‘scientific precision’ imposed by the advanced approaches (diamond & rajan, 2009:1). for example, in the european union (eu), basel ii requires banks and other financial institutions to apply an eu-formulated ‘risk assessment model’ at 126 sajems ns 14 (2011) no 2 the end of each day’s trading to demonstrate solvency. if solvency cannot be established, authorities are informed and the bank ceases trading. this does not pose much of a problem in a rising market (diamond & rajan, 2009:2). in a highly volatile or falling market, however, this could prove catastrophic, not least because the model fails to take into account inevitable changes in market sentiment. in addition, the short-term impact of new information is factored in, regardless of its accuracy or inaccuracy. most models also ignore underlying asset worth (diamond & rajan, 2009:2). in the uk, both northern rock and bradford and bingley fell foul of basel ii. both banks were in the process of applying the basel ii advanced approach (diamond & rajan, 2009:2). cannata and quagliariello (2009:9) were among the first to criticise the assessment of credit under the advanced approaches, which rely on complex models and ratings derived from external credit rating agencies (ecras). the assessment of borrowers’ creditworthiness provided by ecras is a significant aspect of the models used for assessing credit risk in the advanced approaches and there are definite doubts as to the quality and reliability of their inputs into these models (cannata & quagliariello, 2009:9). the degree of independence of the rating agencies’ judgement is also of major concern, which is particularly true in the case of securitisations and structured products (zingales, 2008:12). while the ‘issuer-pays’ model applies to all the products, including corporate bonds, rated by these ecras the standard conflict of interest may be more acute for structured finance ratings, as ecras sometimes discuss the rating implications of particular structures during the structuring process. these conflicts are exacerbated when ecras also sell consulting services to entities that purchase ratings. 4 table 1 highlights the major uk banks using the advanced approaches and their sovereign support provided. table 2 highlights the european countries that had to receive sovereign support, and also illustrates the percentage of their banks using the advanced approaches. it is clear that the majority of the banks that received support were those already using the advanced approach. table 1 top uk banks that received sovereign support (with all using the basel advanced approach) support gbp ₤bn hbos 11.5 lloyds tsb 5.5 royal bank of scotland 20.0 barclays bank 5 6.5 % of total sovereign support 74% source: compiled by the authors from cnn money.com table 2 list of european countries and the sovereign support provided support us$bn % of banks using advanced approach germany 549 90% france 440 75% spain 137 70% austria 21 95% belgium 22 86% source: compiled by the authors from cnn money.com sajems ns 14 (2011) no 2 127 another criticism focuses on rating methodologies that play a role in the risk assessment of models under the advanced approaches. the assignment of a rating is subject to many challenges. for instance, for complex financial instruments the limitations of statistical models have become even more evident, as such products are often illiquid and, in certain market conditions, they do not have a market price (zingales, 2008:12). in addition, the shortcomings of models based on external ratings are clear, and the need to identify possible solutions is unarguable. however, it is quite difficult at this stage to imagine plausible alternatives to the involvement of rating agencies in the assessment of credit quality. further criticism is levelled at the lack of adequate and accurate data: historical data on the performance of us sub prime loans, for example, was confined largely to a benign economic environment with rising house prices (cannata & quagliariello 2009:9). the lack of sufficient historical data or of scenario analysis that adequately assessed how particular asset pools would respond to potential economic scenarios led to errors in ratings. in particular, ecras underestimated the spike in correlations in the defaults that would occur during a broad market downturn (cannata & quagliariello, 2009:9). table 1 shows the four largest banks in the uk, which received sovereign support of over ₤30 billion in total. this support was chiefly to absorb the considerable credit losses that had occurred since the start of the economic crisis. table 2 illustrates the main european countries that provided sovereign support to local banks and also lists the percentage of banks which employed the airb approach for credit risk. it is interesting to note that, for almost all of the major european and uk banks, 85 per cent of sovereign support was provided to banks using the airb approach for assessing credit risk. this indicates significant shortcomings in the airb approach for assessing credit risk and for estimating credit risk capital. benink and kaufman (2008) argue that this could be due to a key, albeit incorrect, assumption that banks’ internal models for measuring risk exposures are superior to any other. the aa implies perverse incentives that induce banks to underestimate their exposure to risk. 6 onado (2008) disagrees that the market is more efficient than regulatory authorities in the detection of adequate capital levels and rejects the assumptions that banks, because of their operational expertise, are able to assess risks and their optimal capital requirements. furthermore, supervisors may also be partly to blame for the inadequacy of some banks’ own internal credit assessment and capital calculation models, as they were required to assess and examine the robustness of these models before the bank was allowed to use them for regulatory purposes (benink & kaufmann, 2008:3). this is because the assessment process was clearly new to both the banks and the supervisory authorities, requiring a gradual learning-by-doing. however, neither party had given itself enough time to really understand the ability of these models to measure, for example, rare but extremely dangerous events. in other words, regulators should have given themselves more time to assess and examine the banks’ internal models before allowing them to use these for regulatory purposes. this points to the possible failure of one aspect of the basel ii advanced approaches, rather than to the entire philosophy of basel ii (benink & kaufmann, 2008:3). the incentives offered by basel ii in terms of lower capital requirements are justified only if the airb approach models for calculating capital and assessing credit risk are both sound and prudent (onado, 2008). in certain countries, validation standards may have not always been sufficiently rigorous and some banks may have underestimated the importance of developing strong risk management and audit functions (onado, 2008). an anonymous risk manager (the economist, 2008:12) stated that: [a]t the root of it all, was and still is, a deeply ingrained flaw in the credit decision making process. in contrast to the law, where two sides make an equal-and-opposite argument and is fairly judged, in banks there is always a bias towards one side of the argument. the business line was more focused on getting a transaction approved than on identifying the risk in what it was proposing. often in meetings our gut reactions as the risk managers were negative, but it was difficult 128 sajems ns 14 (2011) no 2 to come up with hard-and-fast arguments for why you should decline a transaction, especially when you were sitting opposite a team that had worked for weeks on the proposal. in the end, with pressure for earnings and a calm market environment, we reluctantly agreed to marginal transactions. another criticism of banks’ advanced risk assessment methods is that they would privilege the use of standardised and quantitative information, neglecting the soft information that is a key driver in the bank-customer relationship (cannata & quagliariello, 2009:9). this problem should not be underestimated: complex rating methodologies developed by banks for the basel ii airb approach focus too often on quantitative data, disregarding the enormous amount of qualitative information on borrowers, which cannot easily be incorporated into statistical and mathematical models. a more widespread use of quantitative techniques for measuring and assessing credit risk also tends to make the relationship between banks and firms more transparent. it is worthwhile explaining the major differences between the basel ii standardised and advanced approaches (figure 1). basel ii makes use of two approaches to credit risk, including the standardised approach (sa) and the internal ratings based (irb) approach, which is further subdivided into the foundation irb (firb) and the advanced irb (airb) 7 (styger & vosloo, 2005:10). with the sa, banks may not use any internal models. this approach is similar to that of basel i, in which each exposure is assigned a risk weight based on the characteristics of the specific loan (styger & vosloo, 2005:10). a corporate borrower’s credit quality is reflected by its external rating as assigned by an external rating agency, and, if there is no external rating, the loan’s risk is generally weighted by 100 per cent (us under basel i) and a retail exposure (individual) is generally weighted at 75 per cent (styger & vosloo, 2005:11). however, lending that is fully secured by mortgages on residential property that is (or will be) occupied by the borrower, or that is rented, may be risk weighted at 35 per cent (styger & vosloo, 2005:11). this approach is fairly uncomplicated and differs substantially from the advanced approaches. both the firb and airb approaches are based on risk components, which include probability of default (pd), loss given default (lgd) and exposure at default (ead). all these are based on estimates calculated using mathematical/statistical models that employ the bank’s own default history to determine these estimates (styger & vosloo, 2005:12). a corporate or individual borrower’s credit quality is assessed according to the product of the above three estimates, where pd is the possibility (as a percentage) that the borrower will default, ead is the exposure of the bank at the time of borrower default and lgd measures the actual loss after all losses have been realised, including legal fees (if any) (styger & vosloo, 2005:12). table 3 provides a summary of the differences between the firb and airb approaches. table 3 risk estimates with firb and airb approach irb approach foundation advanced pd bank calculates lgd prescribed by the regulator bank calculates ead source: complied by the authors from bcbs (2006a) the basel ii airb approach relies heavily on calculations from models, in most cases complex and technical, that employ banks’ past default history. it is these estimates that are under the spotlight as potential causes of the credit crisis. banks have been accused of neither possessing nor employing adequate loss history on which to base their models, as well as not adequately stress-testing these models to assess the possibilities of extreme sajems ns 14 (2011) no 2 129 losses, such as those experienced in the crisis. in some cases financial engineers involved in model construction simply did not comprehend the true characteristics of rapidly changing markets. in order to test the truth or falsehood of the above accusations, the next section evaluates credit losses experienced by global banks using (a) the sa and (b) the aa to assess credit risk prior to and during the crisis. this evaluation will assist in the determination of the more successful approach in the assessment of (and hence mitigation of) credit risk. the analysis proceeds via the construction of severity and frequency distributions for both sets of data before and during the credit crisis. 3 credit loss distributions and data the bcbs classification of the credit risk loss severity distribution is shown in figure 3. expected losses should be covered by pricing and provisioning; unexpected losses require regulatory credit risk capital. basel ii requires the credit risk capital charge to target unexpected losses and capture tail events (bii 2009:3) at the 99.9 th percentile. banks must either insure or face the consequences of losses beyond this percentile. figure 3 important features of a typical credit loss distribution source: bii (2009:2) the choice of july 2007 as the start of the credit crisis was justified in part by the firstarticle, which mentions the credit crisis by name (moneyweek, 2007), but also by subsequent analysis, which has shown that severe signs of weakness were evident and becoming manifest by late july 2007 (daily kos, 2009). the credit-risk loss data were procured from eight international retail banks through standard and poor’s lossstats ® database, four of which apply the sa, while the other four apply the aa for assessing credit risk. only minor problems were experienced with the data, as the database from which these were sourced provided more than enough data points in order to perform an adequate analysis. however, all losses less than zar100, 000 were excluded, which reduced the data pool quite significantly. before the crisis: benign from an economic point of view, the 4.5-year period from january 2003 to june 2007 was characterised by low interest rates, low inflation, relatively new bank regulations regarding operational risk, explosive growth of credit and other derivatives, considerable loan securitisations, a huge demand for commodities such as oil and metals from india and china and low unemployment. during the crisis: the turbulent twoyear period from july 2007 to the present (june 2009), that is, from the onset of the credit crisis and characterised by almost non-existent interest rates, hugely diminished stock markets, increasing taxes, a severe regulatory environment for, inter alia banks, regulators and rating agencies and rising unemployment. high-level loss characteristics are sum130 sajems ns 14 (2011) no 2 marised in table 4 and a comparison is made between the average number of losses for the banks as well as the value using the sa and aa before and during the crisis. table 4 credit losses by basel ii approach to credit risk preand during the credit crisis zar standardised advanced before during before during total value 1.57bn 1.11bn 0.90bn 1.64bn total number 1,490 1,629 1,035 723 average per year 1.05mn 1.19mn 0.87mn 2.28mn maximum loss 29mn 37mn 20mn 42mn average number per year 331 465 230 362 source: compiled by the authors from s &p’s lossstats ® database figure 4 comparison of loss averages preand during the crisis 0.0 0.5 1.0 1.5 2.0 2.5 before during before during standardised advanced a v e ra g e lo ss (u s $ m n ) p e r y e a r to d a te 0 50 100 150 200 250 300 350 400 450 500 before during before during standardised advanced a ve ra ge n u m b e r p e r ye ar to d at e source: compiled by the authors from s &p’s lossstats ® database the average severity of credit losses increases for banks using both the sa (+13 per cent) and the aa (+162 per cent) from before to during the crisis (also see table 4). the average frequency of losses also increases for both the sa (+40 per cent) and the aa (+57 per cent). 4 analysis figure 5 shows the frequency and severity of bank credit losses for banks using the sa. the onset of the credit crisis is indicated by a dashed line. the average frequency of credit losses for banks using the sa in figure 5(a) increases, which can be seen in figure 4 as well, where the average number of losses per year also shows an increase from 331 to 465 losses per year (40 per cent increase). however, there is very little movement in the severity of these losses before and during the crisis, as illustrated by figure 4 and figure 5(b). in summary, figure 4 illustrates that, although the average frequency has increased, the average severity has not increased by the same magnitude. however, the same cannot be said for the credit losses for banks using the aa, as illustrated in figures 6(a) and (b). figure 6(a) clearly indicates that there has been a significant increase in the average number of credit losses experienced during the crisis, which is further illustrated in figure 4, in which the average number of losses per year increased from 230 to 362, a 58 per cent increase. sajems ns 14 (2011) no 2 131 figure 5 monthly credit loss (a) frequency and (b) severity for the periods under investigation for banks using the sa 0 25 50 75 jan-03 jan-04 jan-05 jan-06 jan-07 jan-08 jan-09 l o s s fr e q u e n c y p e r m o n th 0 10 20 30 40 jan-03 jan-04 jan-05 jan-06 jan-07 jan-08 jan-09 l o s s s e v e ri ty lo s s in u s $ '0 0 0 (b) before crisis during crisis (a) before crisis during crisis source: compiled by the authors from s &p’s lossstats ® database figure 6a and b monthly credit loss (a) frequency and (b) severity for the periods under investigation for banks using the aa 0 25 50 75 jan-03 jan-04 jan-05 jan-06 jan-07 jan-08 jan-09 l o s s fr e q u a n c y p e r m o n th 0 10 20 30 40 50 jan-03 jan-04 jan-05 jan-06 jan-07 jan-08 jan-09 l o s s s e v e ri ty lo s s in u s $ '0 0 0 (a) before crisis before crisis during crisis during crisis (b) source: compiled by the authors from s &p’s lossstats ® database frequency distributions of loss events measured as events per month, for banks using the sa before and during the crisis are shown in figures 7(a) and (b) respectively. these show many similarities – a concentration of low-severity losses and a few large outliers, or tail events. the inter-arrival time of loss events for banks using the sa, also measured before and during the crisis, are shown in figures 8(a) and (b) respectively. before the crisis, the loss events were evenly distributed, the majority of them occurring between 10 to 15 days of each 132 sajems ns 14 (2011) no 2 other. during the crisis the distribution becomes bimodal, with prominent peaks in the five and 10 day categories. both figures 7(a) and (b) and figures 8(a) and (b) again illustrate that the frequency of losses for banks using the sa showed an increase during the crisis. figure 7a and b loss severity for banks using the sa – histograms and distributions for the period (a) january 2003 to june 2007 and (b) july 2007 to july 2009 0 10 20 30 40 50 60 us$2 us$4 us$6 us$8 us$10 us$12 '000 p e rc e n ta g e o f to ta l e v e n ts (a) 0 10 20 30 40 50 60 us$2 us$4 us$6 us$8 us$10 us$12 us$14 '000 p e rc e n ta g e o f to ta l e v e n ts (b) source: compiled by the authors from s &p’s lossstats ® database figure 8 inter-arrival time distribution of credit losses for banks using the sa for the period (a) january 2003 to june 2007 and (b) july 2007 to july 2009 0% 5% 10% 15% 20% 25% 30% 5days 10days 15days 20days 25days 30days days between events p e rc e n ta g e o f to ta l e v e n ts (a) 0% 5% 10% 15% 20% 25% 30% 5days 10days 15days 20days 25days 30days days between events p e rc e n ta g e o f to ta l e v e n ts (b) source: compiled by the authors from s &p’s lossstats ® database the frequency distribution of loss events, measured as events per month, for banks using the aa before and during the crisis, is shown in figures 9(a) and (b) respectively. both these show a concentration of lowseverity losses. figure 9(b), however, shows significant increases in the number of outliers, that is, tail events, indicating an increase in severity. the inter-arrival time of loss events for banks using the aa, also measured before and during the crisis, are shown in figures 10(a) and (b) respectively. before the crisis, the loss events were evenly distributed, the majority occurring within 10 to 20 days of each other. during the crisis, the distribution becomes bimodal, with prominent peaks in the five and 10-day categories. figures 9(a) and (b, and figures 10(a) and (b), illustrate that both the frequency and the severity of losses for banks using the aa increased during the crisis. sajems ns 14 (2011) no 2 133 figure 9 loss severity for banks using the aa – histograms and distributions for the period (a) january 2003 to june 2007 and (b) july 2007 to july 2009 0 10 20 30 40 50 60 us$2 us$4 us$6 us$8 us$12 us$14 '000 p e rc e n ta g e o f to ta l e v e n ts (a) 0 10 20 30 40 50 60 us$4 us$8 us$12 us$16 us$20 us$24 us$28 '000 p e rc e n ta g e o f to ta l e v e n ts (b) source: compiled by the authors from s &p’s lossstats ® database figure 10 inter-arrival time distribution of credit losses for banks using the aa for the period (a) january 2003 to june 2007 and (b) july 2007 to july 2009 0% 5% 10% 15% 20% 25% 30% 5days 10days 15days 20days 25days 30days days betw ee n events p e rc e n ta g e o f to ta l e v e n ts (a) 0% 5% 10% 15% 20% 25% 30% 5days 10days 15days 20days 25days 30days days betw een events p e rc e n ta g e o f to ta l e v e n ts (b) source: compiled by the authors from s &p’s lossstats ® database in summary, although most banks experienced an increase in the number and value of credit losses, the basel ii approaches did protect banks during the financial crisis. however, it can clearly be seen that the sa was much more successful than the aa. this was because, although the frequency of losses increased for banks suing the sa, the severity remained relatively the same. however, the same cannot be said for banks using the aa, as the frequency increased but the losses also became much more severe, which was not the case with the sa. 134 sajems ns 14 (2011) no 2 table 5 summary statistics and goodness of fit test results of the frequency and severity distributions respectively distribution kolmogorov smirnov anderson darling chi-squared parameters statistic rank statistic rank statistic rank k µ σ s a p re c ri s is frequency gen extreme value 0.148 1 0.286 2 n/a 0.5733 0.238 0.328 normal 0.169 3 0.348 3 n/a 0.5896 0.255 0.332 α β severity pareto 0.448 1 8.888 1 23.224 2 0.986 0.039 frechet 0.586 2 9.227 2 55.212 1 0.922 0.012 k µ σ s a d u ri n g c ri s is frequency general pareto 0.521 1 3.221 1 25.221 2 0.946 0.044 0.001 gen extreme value 0.647 2 3.917 2 27.354 3 0.9532 0.232 0.236 α β severity weibull 0.072 1 41.902 1 37.322 1 0.382 0.532 frechet 0.099 2 48.212 3 40.231 2 0.466 0.487 k µ σ a m a p re c ri s is frequency gen extreme value 0.606 1 1.816 1 11.072 2 0.252 0.273 0.361 gen pareto 0.622 2 1.821 2 12.222 3 0.261 0.278 3.771 α β severity gamma 0.486 1 2.542 1 13.912 1 1.102 0.0544 weibull 0.509 2 2.687 2 16.332 2 1.126 0.0584 k µ σ a m a d u ri n g c ri s is frequency gen pareto 0.102 1 5.395 1 29.325 1 0.903 0.001 0.006 gen extreme value 0.111 3 5.8941 2 29.778 2 0.912 0.011 0.201 α β severity frechet 0.139 1 11.901 1 29.113 1 0.705 1.162 weibull 0.172 2 13.221 3 29.728 2 0.847 1.521 source: compiled by the authors. in table 5 above, three different ‘fitting techniques’ were used to determine which distribution best fitted the data. a ranking was allotted to each. this means that the distribution with the lowest ranking of the three techniques best fitted the data. this technique helps to determine which distribution is best to use for modelling a severity and frequency distribution to a specific dataset. this paper has found that the general extreme value distribution best fits the frequency distribution, while the frechet distribution best fits the severity distribution. although the gamma distribution and the general pareto distribution also fit the data well, as indicated in table 5, the authors decided to use the above distributions, as their previous distributions were carried out via these and they have shown the required accuracy and reliability. it is recommended that future research use the other distribution approaches. the above added value to the outcome of this study, as it assisted the authors in identifying the best approach to use in transforming the data into meaningful results. 5 conclusion since the start of the economic crisis in july 2007, numerous banks have written down substantial credit losses, and in many cases have failed completely. criticism has been levelled at, inter alia, basel ii’s methods of measuring credit risk: it is widely believed that the complex advanced approaches are too sajems ns 14 (2011) no 2 135 complex, and that they introduce perverse incentives to banks, permit ‘capital allocation arbitrage’ and encourage lax lending standards. this paper investigated the soundness of the basel ii approaches to assessing, measuring and managing credit risk during two very different periods of market stability – before and during the ongoing credit crisis. whether the methods were satisfactory in assigning adequate capital fell outside the scope of this paper; attention was instead focussed on the methods of assessing credit risk. the literature research and investigation conducted for this paper found that most of these methods of assessing credit risk under the advanced approaches were based on complex mathematical and statistical principles. however, it was not the principles that were being challenged but the suitability of the methods for ‘adapting’ to extreme market conditions. some of the possible reasons discussed in this paper for the failure of these advanced methods include the lack of adequate ‘stressed’ data and over-reliance on external parties, for example, rating agencies and auditing firms, who themselves were reliant on mathematical and statistical data to provide guidance to banks 8 . in addition, the financial engineers responsible for model construction were mathematically competent but economically naive, unable to comprehend the impact and the knock-on effects of extreme market conditions and the inadequate time allowed between model construction and testing and model implementation by banks. furthermore, the ability of these models to adjust in very volatile markets and the signingoff by regulators of internal models and methods who themselves did not always understand the model machinations can also be seen as possible reasons for the failure of these advanced methods. to assess whether the methods employed under the sa were more successful than those employed under the aa, data were sourced from eight international retail banks (four using the sa and four using the aa approach). the frequency and severity distributions of credit losses from these banks were produced and analysed. for banks using the sa, the average frequency increased from before to during the crisis. however, the average severity remained stable, with only a slight increase in the average value. for banks using the aa, the average frequency and average severity increased from before to during the crisis, which means that not only did the average number of events increase, but they also became much more severe. the implication is that, although several market participants were eager to blame basel ii for the financial crisis, it can be said that, in most cases, compliance with the basel ii accord actually protected banks during the economic crisis. the sa enjoyed greater success than the aa: the main reason for the failure of the aa resided in the complex methods on which it relied to assess credit risk. many banks, while continuing to meet the minimum requirements of basel i, had already reviewed their credit standards in order to make them consistent with the incoming basel ii discipline (and ultimately being basel ii aa complaint). it is therefore likely that some banks, in an attempt to transform wellestablished credit processes and risk management methods may have misjudged the actual exposures to new risk types or new manifestations of traditional risks. this does not imply that the new framework should be discarded, but rather that it confirms the need for the ‘testing’ phase of the new rules to be more rigorous. furthermore, regarding simplified supervisory tools, such as the ‘leverage ratio’, which are becoming increasingly popular, the authors believe that these are likely to raise the same problems as those posed by basel i, for instance, the low sensitivity to risk. while it cannot exclude the fact that such tools could be used as a complement to basel ii, especially during periods of stress, when internal models are not fully reliable, the authors are sceptical of the idea that they could serve as a complete substitute for a risk-sensitive regulation. the solution may not lie in drafting new rules under basel iii, but possibly in less of a reliance on complex mathematical and statistical models when assessing credit risk, along with more focus on experience and client knowledge. 136 sajems ns 14 (2011) no 2 endnotes 1 these catastrophes could include large credit losses or a liquidity shortage / mismatch, which could bring about a bank’s failure. central banks were excluded from the focus of this paper since they do not have to comply with basel ii. 2 it is the subject of some debate as to the initial event that triggered the ‘credit crisis’. see section 2 for a more detailed discussion of and qualifying arguments for the author’s choice of mid-2007. furthermore, since the time of writing (january 2010) and despite some evidence of ‘green shoots of recovery’, the crisis is arguably far from over. lending practices remain severely curtailed, stock markets are still below their pre-crisis highs, most economies remain in the grip of recession and many banks continue to be supported by their sovereigns. 3 discussion document presented at the imf’s ninth annual jacques polak research conference in washington, november 2008. 4 zingales (2008:1) pointed out that it is a mistake to think that the significant power attributed to these new mechanisms to these institutions would not have affected the independence of their judgment, because, as power corrupts, absolute power corrupts absolutely. rating agencies are no exception to this rule. 5 barclays bank never received sovereign support, but this is the amount that was raised internally to prevent collapse and is therefore included here. 6 basel ii creates perverse incentives to underestimate credit risk. because banks are allowed to use their own internal models for assessing risk and determining the amount of regulatory capital, they may be tempted to be overoptimistic about their risk exposure in order to minimize required regulatory capital (benink & kaufman, 2008:2). 7 as both these approaches are considered much more advanced than the sa, they are both considered in this paper as being ‘advance’ (aa). 8 this paper by no means implies that rating agencies or audit firms were to blame for the failure of the advanced approaches, but more that banks and other financial institutions were too reliant on their input and did not use enough internal resources to build and test these methodologies. references allen, l. & bali, t. 2007. cyclicality in catastrophic and 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[online] available at: http://www.piie.com/publications/papers/ subramanian [accessed 2009-09-02]. the economist. 2008. confessions of a risk manager, august 7th 2008. zingales, l. 2008. la sospensione del market-to-market (the suspension of market-to-market), il sole24 ore, 15 october (translation from the italian version). http://www.georgesoros.com/creditcrisis08 http://www.piie.com/publications/papers/ subramanian http://www.piie.com/publications/papers/ subramanian 116 sajems ns 10 (2007) no 1 trends and volatility in sub saharan africa’s key primary commodity exports matthew kofi ocran and nicholas biekpe graduate school of business, university of stellenbosch abstract using a garch model the paper sought to test the hypothesis that price volatility of key sub saharan africa primary commodity exports, have not changed over the past four decades. whilst crude oil, aluminium, cocoa and six others have not experienced significant change in price volatility over the period, nine other major commodities recorded changes. efforts need to be made to extensively diversify the portfolio of agricultural commodity exports by including new products of which price volatilities in the past decades have been reduced. this is crucial for countries that depend on up to three primary commodities for the bulk of their foreign exchange earnings. other measures such as value addition can also help in reducing impacts of unfavourable price movements. jel c22, e32, o11, 55, q17 1 introduction much empirical work has generated stylised facts that indicate that volatility, trends and cyclical behaviour are inherent salient features of primary commodity prices. recent trends in primary commodity prices have in general been unfavourable for most exporters. for instance over the last forty years real commodity prices have been continuously declining. many reasons have been given for the long-term decline in prices. one of the important reasons for the long-term decline in trends, has been structural change particularly in agricultural commodity markets. the argument is that basic supply and demand dynamics due to increased productivity have increased supply, hence the fall in prices (fao, 2004). however, the extent to which these features vary across individual commodities traded by various sub saharan african (ssa) countries has received scant attention if any at all. the fact that more than 50 per cent of ssa countries depend on up to three primary commodity exports for the greater share of their incomes (unctad, 2003) makes commodity issues a subject of great concern. therefore the role of commodities markets in the attainment of the united nations’ millennium development goals (mdgs) and sustainable debt burdens for countries that have reached the completion points of the heavily indebted poor country initiative (hipc) cannot be over-emphasised. for example lack of understanding of commodity price behaviour can erode most of the gains from debt relief obtained by commodity dependent countries. the high commodity dependence also makes exports a major source of economic destabilisation. consequently the behaviour of commodity prices assumes increased importance in implementing meaningful economic policies and developing hedging strategies. in the light of the above, additional information on the pattern of trends and volatility features of the individual primary commodities that are exported by ssa countries can be helpful. despite the importance of an understanding of price behaviour of commodities of importance to ssa, the issue has not attracted adequate attention in literature. the research questions that come to the fore are as follows, has there been change in the long-run price trend over the past forty years? sajems ns 10 (2007) no 1 117 has the level of volatility in price changed over the study period? the purpose of the present paper is therefore to study broadly the price behaviour of ssa’s eighteen key primary commodity exports over the period 1960 to 2005. however, the specific objectives are to ascertain whether the long-run price trends and volatility have changed over the past four decades. in order to address the issues raised above, selected primary commodity prices are compared over two sub-periods to see if there have been changes. the sub-periods are the period encompassing the two major oil price shocks, i.e. 1960-1980 and the post-shock period, 1981-2005. the selection of the two sub-periods was also informed by the distinct “breakpoint” observed in the long-term trends of commodity prices as observed by fao (2004). the fao study asserts that the distinct “breakpoint” observed in most commodity price trends may be due to trade liberalisation, technological change and increased manufactured exports by developing countries in asia. the paper draws its relevance from the fact that increased insights into ssa’s commodity price behaviour can be useful in the implementation of macroeconomic policy, particularly in the design of relevant policy instruments to neutralise the effects of unfavourable price movements. the paper is organised as follows; section 2 reviews briefly a selected number of studies on trends, cycles and volatility while section 3 discusses some selected stylised facts about ssa’s major commodity exports. in section 4 the theoretical framework for the paper, a description of the variables used and the sources of data are presented. the empirical model and the results of the study are the subject of section 5. section 6 discusses the conclusions and the policy implications of the study. 2 literature review this section of the paper briefly reviews literature relating to the study. papers that have considered commodity price cycles, volatility and trends are therefore discussed. the discussion identifies a gap with respect to key primary commodity exports of major importance to ssa economies. an attempt is made to fill this gap by focusing on the eighteen key primary commodity exports that most ssa countries depend on for the bulk of their foreign exchange earnings. agenor et al. (2000), reinhart and wicham (1994) and cashin, liang and mcdermot (2000) have shown that commodity price shocks that trigger commodity price cycles can display varying degrees of persistence across commodities. however, two approaches emerge in the literature on the duration of commodity price cycles. the beveridge-nelson decomposition defines cycles in terms of deviation of a price series from a trend-growth cycle (cuddington, 1994; reinhart & wicham, 1994). the second approach which is often used in literature (watson, 1994; cashin & mcdermott, 2002) deals with the price data in levels. the approach thus avoids the element of subjectivity inherent in the selection of detrending methods. consequently, price slumps and booms are then expressed as periods of absolute decreases and increases respectively in the price series and not as periods below trend or above trend. the classical definition therefore renders the decomposition of a series into its “trend” and “cycle” components redundant. following the seminal work of burns and micthel (1946) in the study of business cycles, the definition of booms and slumps depends on movement of prices between peaks and troughs. commodity prices are therefore said to have moved from a boom to slump phase if prices fall from their earlier (local) peak. most previous studies on commodity price volatility (uncertainty) have examined the phenomenon with either unconditional standard deviation or the coefficient of variation (see unctad, 2003; marinkov & burger, 2005). volatility measures based on time series in which cyclical components are filtered out like that provided by the holdrick-prescott and the bandwith filters, have been criticised as ineffective (see agenor et al., 2000; canova, 1998; harding & pagan, 2002). it has indeed been argued quite strongly that the exercise leads to loss of certain features in the time series that rob researchers of full information regarding a given series. 118 sajems ns 10 (2007) no 1 clem (1985) found that the volatility indices for food commodities were consistently higher than those of non-food. the paper used two alternate measures of volatility: a static x and dynamic volatility measure. these measures were based on two different definitions of volatility. whilst the former depended on changes in price level, the latter considered changes in the rate of change. generally the literature points out that volatility measures like standard deviation and coefficient of variation are reckoned to overstate variability in non-trending series. they are also deemed to have no constant range; their squaring further tends to aggravate the problem of outliers (offut & blandaford, 1986). the possibility of variation over time in the confidence interval of volatility forecasts calls for an approach that models the variance of the errors. the body of knowledge on volatility identifies the arch-type of models as the most suitable in the assessment of volatility (bollerslev, 1986, zukonian, 1994; swarmy, 2002). previous studies that considered trends in commodity prices present two main approaches. one group of researchers asserts that difference stationary ought to be used in describing the underlying data-generating processes of commodity prices. grilli and yang (1988) used the time trend approach; however, in a study by cuddington and uzua (1998) it was found that the use of either difference stationary or trend stationary did not make any difference in the results. 3 ssa’s major commodity exports: selected stylised facts ssa countries export over 60 assorted primary commodities, but 19 of these happen to be among the three leading exports of countries in the region. these primary commodities can be broadly classified into (i) agricultural raw materials, (ii) minerals including crude oil, and (iii) food and beverages. as indicated earlier in the paper, the typical ssa country depends on three or less of these primary commodities for more than 50 per cent of their foreign exchange earnings. the region’s commodity problem is defined in terms of the continued heavy dependence on primary commodity exports (ocran & biekpe, 2005). in order to get some understanding of the volatility of the real prices of the commodities being studied, we calculated the percentage month-on-month changes in real prices and plotted them against time (figure 1). a cursory look at the charts indicates that all the major commodities have seen tremendous volatility in prices, with the worst being crude oil; this commodity recorded the highest peaks during the oil price shocks in 1973 and 1978. the first shock was a result of the yom kippur war that caused major arab oil-producing countries to cut back on production. these oil producers also placed an embargo on oil exports to perceived pro-israel countries such as the us and the netherlands. the second oil shock could be described as the iranian oil price shock. following the deposition of the shah of iran and the assumption of power by the ayatollah khomeini, border clashes between iran and iraq developed into full-scale war, which led to the shutting down of iranian oil production facilities. at the time iran accounted for about 20 per cent of the world’s supply of crude oil, and hence the gap left by the absence of iranian output led to a severe price shock. the invasion of afghanistan by the soviet union around the same time did not help matters as this led to panic buying in anticipation of a major world crisis. groundnuts was another commodity that saw huge price changes, with tobacco as the commodity that recorded very modest price changes, that did not exceed 5 per cent in any month-on-month period over the years 19652005. as the developed world becomes more affluent there is an increased demand for sea foods that probably accounts for the big positive spikes in the prices of shrimps (figures below). sajems ns 10 (2007) no 1 119 figure 1 month-on-month changes in real prices 1960(1) – 2004(12) 120 sajems ns 10 (2007) no 1 appendix figure 1 month-on-month changes in real prices 1960(1) – 2004(12) sajems ns 10 (2007) no 1 121 4 methodology the analytical framework for validating the set of hypotheses for the preceding section has two dimensions. first, we respectively present the adf and phillips-peron frameworks testing for unit roots. the second part of this section presents the theoretical underpinnings for the volatility assessment and the adopted garch model is briefly discussed. the garch approach was chosen out of the range of volatility models because of its best fit statistically, particularly in modelling commodity prices (swaray, 2002). 4.1 trends in sub-saharan africa’s key commodity exports studies have indicated that before one proceeds to measure the temporal variation in the second moments of a time series, it is important that other specifications of its trend are considered (cuddington & liang, 1998). however, there appears to be some debate among researchers about whether difference stationary (ds) or trend stationary (ts) models are more appropriate in describing the data-generating processes. following cuddington and liang (1998), we first examine the statistical properties of the price series by testing for unit roots using both the augmented dickey-fuller test and the phillips-peron test. understanding the underlying cause of nonstationarity helps in addressing the question of whether price shocks have permanent consequences for future levels of commodity prices or whether they rather represent temporary setbacks that have no permanent consequences (hamilton, 1994). log p t =  + t + e t (1) (1 – )a(l)e t = (l) t (2) where p t is the natural log of real commodity price index and t is the trend variable time. the error process in (2) is written with the largest root factorised out. it is also assumed that the lag polynomial a (l) is invertible and likewise b (l); therefore a (l)-1 (b) l is a stable polynomial lag operator. it is serially uncorrelated with zero mean and finite variance. if  = 1 in equation (2), the data process underlying the commodity process is said to have a unit root. in that case we first difference equation (1). the presence or otherwise of a unit root is tested with a phillipsperron test; this examines the significance of the regression below: d log p t =  +  log p t–1 + t +  t (3) where  =  – 1 and d log p t , the first difference of log of p . the ordinary least squares regression estimate of the above model and the t-test for the null hypothesis  = 0 or ( – 1) are then obtained. first equation (3) is estimated at the least restrictive level with the inclusion of a constant and time, t. if the null hypothesis is not rejected, the significance of the constant and trend terms are explored to ascertain whether the model will gain more power dropping one or both terms (enders, 1995). it can be asserted that 7 out of the 18 major primary commodity prices in ssa underwent changes that appear to have had a permanent effect on the real prices of the commodities concerned (see table 1 on the next page). table 2 (on the next page) presents the results of the phillips-peron tests on ssa major primary commodities examined in the present study. data for the tests were drawn from the international monetary fund (imf) international financial statistics (ifs) cd rom and they spanned the period 1960(1) to 2004(12). the third column of the table presents the kind of model selected for the analysis; i denotes model with intercept and t model with trend. for all the series except groundnuts, the null hypothesis of  = 0 was rejected at the 5 per cent level. 122 sajems ns 10 (2007) no 1 table 1 unit root test results for real prices of ssa’s key commodity exports real commodity price model selected lag order  coefficient  t-adf t() aluminium i,t 5 0.965 –3.632** beef i,t 0 0.975 –2.922* cocoa i,t 9 0.984 –2.546 coffee i,t 10 0.986 –2.591 copper i,t 1 0.975 –3.937* cotton i,t 1 0.978 –3.619** gold i 12 0.986 –2.588 groundnuts i,t 1 0.963 –3.780** groundnut oil i,t 6 0.972 –3.510* palm oil i,t 5 0.962 –3.556** petroleum i,t 4 0.987 –2.068 rubber i,t 12 0.962 –4.187** shrimp i,t 3 0.968 –3.062* sisal i,t 11 0.973 –4.140** sugar i 0 0.963 –3.114* tea i,t 1 0.979 –2.785 timber i 2 0.962 –3.764** tobacco i,t 11 0.980 –3.173 note: critical values used in the adf test were; 5 per cent =-2.87 and 1 per cent=-3.45 ** denotes significance at 1 per cent and * denotes significance at 5 per cent. source: data used in the analysis was obtained from the international monetary fund’s international financial statistics cd rom, august 2005. the data were monthly data from 1960(1) to 2004(12) except for gold and tobacco. the tobacco series began in 1969 and ends in 2002 whereas gold begins in 1976 and ends in 2004. table 2 phillips-peron unit root test results for real prices of ssa’s key commodity exports commodities test-statistic model selection aluminum –2.120 i beef –2.736 i cocoa –1.540 i coffee –1.889 i copper –3.302 i cotton –1.159 i gold –1.988 i groundnut –3.079** i groundnut oil –2.253 i timber –3.252 i sajems ns 10 (2007) no 1 123 palm oil –3.247 i, t petroleum –1.666 i rubber –3.209 i, t shrimp –2.600 i sisal –2.364 i sugar –2.758 i tea –3.418 i, t tobacco –1.003 i notes: *** denotes significance at 1 per cent source: data used in the analysis was obtained from the international monetary fund’s international financial statistics cd rom, august 2005. the data were monthly data from 1960(1) to 2004(12) except for gold and tobacco. the tobacco series began in 1969 and ends in 2002 whereas gold begins in 1976 and ends in 2004. 4.2 commodity price volatility following the seminal work by engle (1982) that led to the autoregressive conditional heteroskedasticity (arch) model, which makes use of a time-varying and measurable function of the time t-1 information set, various extensions of the model have emerged over the years. one of these extensions is the generalised arch model (garch). see gourieoux, (1997) and bollerslev (1992) for an extensive discussion of the various extensions. the linear arch (q) models usually call for a long lag length “q”. an alternative and more flexible lag structure is offered by the garch extension garch (p, q), as presented in bollerslev (1986). it is, however, worth noting that the simple garch (1, 1) was independently suggested by taylor (1986). in fashioning out the theoretical framework for the garch model used in the present work, the approach is first explained by way of a discussion of the basic arch model, from where extensions are made to derive the garch model. given that the dependent variable of primary commodity prices is denoted p t and that this is a result of an autoregressive process, tt k i it pp εηη ++= − = ∑ 1 1 0 (1) an arch (p) process is obtained by expressing the conditional variance of (1) as a function of its past values squared: 1− ω tt ε ~ ),0( σn (2) 2 1 1 − = ∑+= t p i it εαδσ (3) where 2σ stands for the conditional variance of the information set 1−ωt available at time t-1 and 01 δ , 0≥iα for all pi ,.....2= and 1..........21 nααα ++ are required to render 2 tε positive and covariance stationary. bollerslev (1986) extended the framework represented in (3) into (4), which incidentally is an autoregressive moving average (arma) representation of 2 tε . 2 1 1 2 1 1 2 − − − = ∑∑ ++= t q i it p i it σβεαδσ (4) the resultant arch extension represented by (4) denotes conditional variance of a commodity price series that depends on a constant, past information about volatility (i.e., 2 1−tε terms) and past forecast variance (the 2 1−tσ terms). consequently the lagged conditional variances can be said to capture the adaptive learning phenomenon that characterises the process. a simpler form of equation (4), first suggested by taylor (1986), is the garch (1, 1) model; t t– –1 2 1 2 1 2 = + +v d af bv (5) one of the strengths of the formulation in (5) is its ability to make do with fewer coefficient restrictions. another appealing feature of the garch (p,q) is the model’s time series dependence on 2 tε . however, for a well-defined 124 sajems ns 10 (2007) no 1 variance and covariance function of the model, its coefficients ought to lie inside a unit circle: 0;0, ≥βαδ  and 1βα + . it is also important to note that the sum of βα + is a measure of volatility persistence. 4.3 data issues the us dollar prices of the commodities selected for the study were obtained from imf’s international financial statistics database cd-rom, august 2005 issue. the monthly price data spanned the period january 1960 to december 2004. real commodity prices were generated by deflating the nominal commodity prices using the us consumer price indices. the cpi indices were obtained from the imf’s ifs cd rom. the eighteen leading commodities selected for the study were obtained from an unctad study that identified the key leading exports from ssa (unctad, 2003). commodities considered in the study were: aluminium, bananas, beef, cocoa, coffee, copper, cotton, crude oil, gold, timber, groundnut oil, groundnut, hides, palm oil, rubber, shrimps, sugar, tea, tobacco. the descriptive statistics of the commodity prices are presented in table 3. the price variable in commodity studies is defined differently in the literature. heifer and kinishita (1999) used nominal and real prices from usda for price. however, in an earlier study blandford (1983) simply used nominal prices, while in their paper leon and soto (1997) used real dollars. cashin, mcdermott and scott (1999a and 1999b) used the imf reference international commodity prices deflated by manufacturing unit value index. in a study by dehn (2004), the author constructed an index of cif prices in us dollars. again, cashin and mcdermott (2001), unlike their earlier study, used commodity price weighted by imports and deflated by the us cpi. in the present study, however, we deflate the imf’s commodity prices in us dollars with the us cpi. we felt that since the imf prices were recorded in us dollars, the most appropriate deflator was the gdp deflator. but these were not available in monthly series for the us economy, hence the use of the cpi. table 3 below presents the descriptive statistics of the eighteen key ssa commodities studied. first, the chi2 asymptotic and normality tests indicate significant deviation from normal distribution of the prices of each of the commodities. again, results describing significant excess kurtosis and skewness in the series further reinforce the normality statistic. generally, all the real prices were leptokurtic (i.e., exhibited fat tails) just like the prices of most financial assets. apart from groundnuts, sisal, hardwood timber logs, cocoa and sugar, all the other commodities were significantly skewed to the right, i.e. the right tails of the various distributions were heavier to the left of the means of the commodities. aluminium and beef recorded the least skewness in the commodity group under discussion. whilst aluminium and beef were fairly platykurtic, the rest had very prominent spikes, with groundnuts and sisal exhibiting the highest peak. the least excess kurtosis was seen in shrimps. the stylised facts presented by the summary statistics are consistent with most of the literature (deaton, laorwue, 1992; cashin, mcdermott & scott, 1999; swarmy, 2002). table 3 desctiptive statistics of selected real commodity prices, 1960m1–2004m12 commodities mean min. max. standard deviation skewness excess kurtosis aluminum 23.55 12.83 52.21 7.27 0.33 –0.31 beef 1.82 0.73 4.26 0.69 0.37 –0.33 cocoa 31.56 8.65 123.25 20.92 1.92 4.00 coffee 7.66 1.81 22.66 3.82 0.80 0.80 sajems ns 10 (2007) no 1 125 copper 37.60 13.50 108.57 18.11 1.20 1.33 cotton 1.29 0.36 3.29 0.54 0.56 0.59 gold* 5.16 2.53 14.92 2.25 1.71 3.75 groundnut oil 14.80 5.77 38.39 6.41 1.16 1.76 groundnuts 12.14 5.61 54.50 5.58 3.02 14.20 palm oil 7.66 1.81 22.66 3.82 0.80 0.80 petroleum 0.26 0.08 0.90 0.40 1.30 1.44 rubber 0.84 0.22 2.45 0.40 0.88 0.79 shrimp 0.09 0.04 0.20 0.04 0.98 0.17 sisal 11.30 5.58 37.85 5.78 2.49 7.55 sugar 0.32 0.22 0.91 0.07 1.80 10.15 tea 3.91 0.71 11.92 2.32 0.43 -0.51 timber 2.22 1.22 6.22 0.72 2.07 5.96 tobacco 43.82 25.36 68.86 10.31 0.35 –0.49 notes: data span the period 1963(1) to 2004(12). 5 results 5.1 commodity price volatility following cuddington and liang (1998) and swaray (2002), this paper has sought to ascertain the suitability of garch as a good descriptor of the price instability in the 18 commodities under discussion. garch (1,1) was therefore fitted for each of the commodities. interestingly, the estimated coefficients of the variance equation for every one of the commodities were found very significant at the 1 per cent level of significance, except for tobacco (see table 4). the univariate garch (1, 1) estimates for the mean and variance equations of the eighteen commodities under discussion are presented in table 4 below. thirteen of the eighteen commodities exhibited relatively high coefficient estimates for the variance equations, whilst the parameter estimate for tobacco was low – it was statistically insignificant. on the other hand, low and significant variance equation estimates were observed for cotton, sisal, tea and cocoa. in order to validate the hypothesis that price volatility for ssa key commodity exports varied between the two periods, 1960-1980 and 19812004, we introduced a time dummy that took on the value of unity in the later period and zero in the former. half of the commodities under discussion did not experience statistically significant volatility changes over the two periods. these commodities were aluminium, beef, cocoa, groundnut oil and palm oil. table 4 estimation of the garch (1,1) model, 1960(1) – 2004(12) commodity constant arch(1) () garch (1() time dummy log-likelihood aluminium 5.05e-06* 0.1881* 0.8517* –1.13e-05 1109.111 beef 9.75e-05* 0.1457* 0.8112* –1.43e-06 933.2172 cocoa 0.0011* 0.3062* 0.5078* –0.000198 0.001053 coffee 4.78e-05* 0.2717* 0.7618* 0.0002* 776.873 cotton 7.99e-05* 0.5741* 0.3766* 0.0005* 1034.719 126 sajems ns 10 (2007) no 1 groundnut 0.0005* 0.2460* 0.7301* -0.0001* 685.2739 groundnut oil 0.0003* 0.3878* 0.6149* 2.85e-05 820.1029 palm oil 4.54e-05* 0.0920* 0.8994* 8.71e-05 706.8984 petroleum 0.0002* 0.5712* 0.6052* 2.02e-05 845.8932 rubber 4.54e-05* 0.0920* 0.8994* 8.71e-05 706.8984 shrimp 2.71e-06* –0.0114* 1.018012* –3.65e-05* 712.3838 sisal 0.0004* 0.5664* 0.4032* –0.0001* 1036.266 sugar 0.000219 0.3853* 0.7312* –0.0002* 1044.996 timber 0.0002* 0.2391* 0.7518* 1.05e-05 832.0788 tea 0.0016* 0.2410* 0.4825* 0.0015* 586.3338 copper 5.43e-05* 0.3347* 0.6899* 0.0002* 781.4507 gold 0.0002* 0.1630* 0.8026* –0.0001** 781.7768 tobacco 0.0002* 0.3084* 0.2113 –3.75e-06 1119.462 notes: * denotes significance at 1 per cent level of significance; ** mean significant at 5 per cent level of significance. the other commodities that did not show any meaningful change in volatility over the past four decades were crude oil, rubber, timber and tobacco. on the other hand, the other half of the range of commodities did indeed experience changes in the level of volatility over the two periods. certain commodities recorded increased volatility in the second period (coffee, cotton, tea, copper and rubber), while others saw a relative decline in their price volatility (sugar, groundnut, gold and shrimp). the literature indicates that the magnitude of the summation of the arch and garch terms in the variance equation is an indication of the measure of persistence in volatility shocks. when the sum of the coefficients of the arch and garch terms amounts to unity, the implication is that shocks dampen out quite slowly; thus the lower the value of the terms, the faster volatility shocks die out. persistence measures that approach unity are an indication of the presence of an integrated garch (igarch) phenomenon. consequently, it can be asserted that the autoregressive moving average (arma) process of the variance in a given commodity price could be either non-stationary or possess an infinite variance. the presence of an igarch process in most of the region’s major (15) primary commodities, underscores an incessant variation in the volatility levels of their prices. whilst tobacco, cocoa and tea had the least measure of persistence, crude oil prices exhibited the highest level of volatility persistence; this was followed by sugar, aluminium and coffee (see table 5 below). the level of volatility persistence obtained for the beverages cocoa, coffee, tea and for tobacco compared favourably with that obtained by swaray (2002). table 5 volatility persistence in commodity prices commodities volatility persistence, ( =  + ) petroleum 1.18 sugar 1.12 aluminum 1.04 coffee 1.03 shrimp 1.01 sajems ns 10 (2007) no 1 127 groundnut oil 1.00 palm oil 0.99 timber 0.99 cotton 0.98 groundnuts 0.97 sisal 0.97 gold 0.97 beef 0.96 copper 0.95 rubber 0.90 cocoa 0.81 tea 0.72 tobacco 0.52 source: authors’ computations using eviews. 6 conclusion using the garch model the paper empirically investigated the persistence of shocks in ssa’s major primary prices and again ascertained the asymmetry pattern or otherwise in the nature of the price volatilities. the differences in ssa’s real commodity prices across commodities were examined. the maintained hypothesis that variability in price volatility had not changed for the prices over the past 40 years was examined. the paper also sought to ascertain whether volatility in the region’s key commodity prices had increased or decreased after the 1980s as compared to the period 1960-1980, when the world suffered two major oil price shocks. the highlights of the study can be summarised as follows. for nine of the major exports, volatility variation did not show any significant change over the past forty years. these commodities were aluminium, beef, cocoa, groundnut oil, crude oil, palm oil, rubber, timber and tobacco. on the other hand, the other nine commodities saw changes in volatility variations. however, whilst gold, sisal, shrimps, groundnuts and sugar saw a decrease, the rest rather witnessed deterioration in levels of volatility (i.e., copper, coffee, cotton, tea and sisal). clearly, evidence of long-run volatility persistence in the major primary commodity prices of interest to ssa can be adduced. for these commodities international stabilisation efforts such as that supported by commodity organizations like the international coffee and cocoa organization (icco) cannot be perpetually sustained. usually when commodity prices soar as result of the volatility phenomenon government revenues receive a boost from the windfalls either directly or indirectly, or better still both directly and indirectly. in countries where governments control commodity marketing organisations, the impact on revenues has been direct. indirect impacts are realised in instances where commodity trade is in private hands; in this case revenue from trade taxes and income taxes surge. governments in ssa have typically assumed that positive commodity price shocks are enduring, whilst negative shocks are rather transitory (cooper, 1991). indications are that the windfall gains are often used to provide funding for pro-cyclical expenditures. consequently, when the trend for prices is downward, these countries have had to run huge fiscal deficits (see collier & gunning, 1996). it is important that governments realise that price swings are a more or less permanent feature and that when positive shocks are experienced efforts need to be made to save for a rainy day. the collapse of the various stabilisation schemes under the strain of 128 sajems ns 10 (2007) no 1 continued swings in prices further underscores the inadequacy of external attempts aimed at lessening the effects of negative price shocks. it is important that governments in ssa pursue expenditure smoothening policies so that savings can be made at good times and dissaving in difficult periods. additionally, efforts need to be made to diversify extensively their portfolio of primary agricultural commodity exports by including new products that appear to have reduced price volatilities in the past decades. this is crucial for countries that depend on three agricultural primary commodities for the bulk of their foreign exchange earnings. other measures such as value addition can also help in reducing impacts of unfavourable price movements. references 1 agenor, p.r., mcdermott, c.j. & prasad, e. 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(1994) “threshold heteroskedasticity model”, journal of economic dynamics and control, 18: 931-955. microsoft word 6 jenkins & zeinali sajems 18(1) 2015.docx 70 sajems ns 18 (2015) no 1:70-83 how to cite doi: http://dx.doi.org/10.17159/2222-3436/2015/v18n1a6 cost-effective infrastructure choices in education: location, build or repair glenn p jenkins and armin zeinali department of economics, queen’s university, canada and eastern mediterranean university, trnc, mersin 10, turkey accepted: may 2014 the purpose of this study is to develop a model to arrive at a joint optimising strategy for capital budgeting for the construction of new school buildings and for the renovation of existing schools. this model provides a practical tool for ranking construction projects so as to yield the maximum positive impact on the education system. a key aspect of the model is that it provides the optimal mix of renovation and new construction that should be undertaken under a fixed budget constraint. the model is applied to a sample dataset from the education sector of limpopo province, south africa, in order to quantify the benefits of using the model. the benefits from using this model for decision making on the evaluation of new and renovation investments in school infrastructure is estimated to increase the effectiveness of these investments by up to 300 percent over the counterfactual system for making these decisions. key words: education, cost-effectiveness, school location, school construction, school repair, south africa jel: d61, i28, h52, 75 1 introduction one of the main problems for the education sectors in many developing countries is the lack of school buildings and other infra structure. the number of classrooms is generally inadequate for the large population of students, and often the classrooms are in very poor condition. over time, without renovation, many will become unusable. the lack of school buildings can result in the use of double shifts, or very large class sizes. in 1998, primary and secondary schools in vietnam had on average 1.9 and 1.7 shifts respectively, resulting in average school days of about 3 hours for primary schools and 3.5 hours for secondary schools (glewwe, 2004). in 2004, the department of education in limpopo province, south africa, reported a shortage of about 13 000 classrooms (jenkins & klevchuk, 2004). in 2007, although the primary education enrolment in uganda reached a level of 7.5 million compared to an initial level of 3.1 million in 2003, the ugandan education sector was still suffering from a shortage of classrooms and proper investments in infrastructure (ssewamala et al., 2011). in many developing countries the shortage of school infrastructure has become progressively worse with an increasing political commitment for public provision of primary and secondary education and at the same time rapidly growing populations. in order to alleviate such problems, some developing countries such as south africa are investing heavily in school construction and maintenance. as the amount of funding available for such public sector investments and the capacity to erect such structures is often limited, it is important to have a system and criteria by which budgets can be allocated efficiently. the first objective of this paper is to develop a model for measuring the cost effectiveness of expenditures on both new school classrooms and classroom repair by school district in the limpopo province, south africa. the data used for building such a model and the estimations of the incremental cost-effectiveness ratios were obtained from the administrative records of the government departments of the province. the second objective is to measure the potential gains (measured by the relative change in and index of effectiveness) that might be obtained if an abstract sajems ns 18 (2015) no 1:70-83 71 incremental cost-effectiveness criterion was used to select the location of additional investment expenditures in building new school buildings and to repair the existing stock of school classrooms. when advocating better quantitative analysis to assist decision making, one is often faced with the question of whether the potential gains are significant enough to warrant the additional effort. this analysis is done using data on the school infrastructure of limpopo province. 2 methods 2.1 cost-effectiveness analysis cost-effectiveness analysis is generally used as an alternative to cost–benefit analysis. in particular, cost-effectiveness analysis is very useful when the analyst is reluctant to measure the effects of a project in monetary terms or when such measurement is not possible. the first step in a cost-effectiveness analysis is to find a measure for the effectiveness of alternative projects. in most studies, this measure is either self-evident or defined in the literature. for instance, to compare the costeffectiveness of hiv-prevention projects, the measure of effectiveness is the number of hiv infections averted by each project. however, there is no self-evident measure to show the effectiveness of investments in educational infrastructure, and such a measure has not been defined in the literature (levin, 2001). therefore, the first goal of this study is to define a method to estimate the effectiveness of investment projects in educational infrastructure. the infrastructure investment options in this study are either to build new classroom blocks or to renovate existing classrooms that are in desperate need of repair. repairing a classroom that would be unusable in a few years would have a similar effect to building a new classroom in a few years.1 the only difference would be in the number of years that the classrooms will be usable. therefore, finding a numerical measure for the effectiveness of adding class space is sufficient for the cost-effectiveness analysis of both construction and renovation projects. the effect of class size on the quality of education has been examined by many researchers, and widely discussed in the literature (glewwe, 2002; glewwe & kremer, 2006). through a meta-analysis of 80 studies, glass and smith (1979) showed that a clear and strong negative relationship exists between class size and educational achievement. this relationship is stronger where the average number of learners per classroom is higher. adding class space to a school district lowers the learner-to-classroom ratio (lcr) and enhances the learning of all learners in the school district.2 in this study, the change in lcr in terms of an increase in the number of available classrooms is used to derive a numerical measure of effectiveness. the changes in lcr associated with adding a classroom to a school district can be estimated as the derivative of lcr with respect to the number of available classrooms. equation (1) displays this calculation, with l denoting the number of learners and c the number of available classrooms. ∂lcr ∂c = ∂ ∂c ( l c ) = l c2 (1) to estimate the effects of adding a classroom on the enhancement of learning for all students in the school district, equation (1) should be multiplied by the number of learners in the school district. the total effectiveness, denoted as e, is calculated as shown by equation (2).3 2 2 2 c l l c l e =×= (2) this measure of effectiveness estimates the education quality enhancement (eqe) achieved by the additional class space. therefore, eqe is considered as the measuring unit of effectiveness in this study. an assumption is made that one unit reduction of lcr creates the same number of additional eqe units regardless of the size of lcr where lcr is greater than the standard number of learners in a classroom, and creates no eqe units where the lcr is lower than the standard.4 the application of the above method for measuring the effectiveness of increasing the number of available classrooms is illustrated in three possible scenarios: 1) construction scenario, 2) renovation scenario, and 3) construction-andrenovation scenario. in these scenarios, the costs of infrastructure investments are examined from the perspective of the department of 72 sajems ns 18 (2015) no 1:70-83 education. this perspective is adopted because in the case of limpopo, there is no information available about any costs other than the cost of construction and renovation of school buildings. 2.2 construction scenario this scenario demonstrates a method of determining an efficient budget allocation strategy dedicated to the construction of new classrooms. typically, classrooms are built in classroom blocks, each consisting of a few classrooms. in this scenario, effectiveness is measured by the number of eqe units derived from adding a classroom block. assuming each block contains k classrooms, the changes in lcr associated with increasing by k classrooms, multiplied by the number of learners, will produce the eqe units obtained from building a classroom block in a school district. this calculation is shown by equation (3). )( 2 kcc kl l kc l c l e + =×⎟ ⎠ ⎞ ⎜ ⎝ ⎛ + −= (3) productivity of infrastructure investments, however, depends on a number of other factors, such as location and type of school (e.g. primary, secondary). to account for such differences among school districts, adjustments are needed for the effectiveness derived from equation (3). in many countries, the economic rate of return is believed to be higher for primary than for secondary level education. the difference in economic return can be incorporated into the model by increasing the number of eqe units obtained from infrastructure investments in primary schools by p percent.5 the factor p is set equal to the proportional additional return obtained from investing in primary schools rather than in secondary schools.6 in addition, in many countries investments in education are believed to have a different rate of return in rural areas than in urban areas, and therefore the effectiveness obtained from adding classrooms in rural areas is greater. this differential can be expressed by a factor r for the rural areas, against a base value of zero for urban areas. for example, if it is believed that the rate of return of a typical school investment (all other variables in the model being the same) is 20 per cent higher in rural than urban areas, r is set to 0.2. such factors, as well as any further required adjustments, are included in an adjustment factor (af) for estimating the effectiveness of infrastructure investments. this factor should be set for each school district in the analysis. using af in equation (4), the effectiveness obtained from infrastructure investments has the same value in terms of eqe units in all school districts, regardless of their location or education level. )1( )( 2 !+++= × + = rpaf af kcc kl e (4) furthermore, in order to consider the full impact of building a classroom block on the enhancement of educational achievement, the effectiveness derived from equation (4) should be calculated over the entire lifetime of the block. the effectiveness may change from year to year owing to changes in the number of available classrooms and the number of learners in the school district. the number of available classrooms in the future depends on the number of classrooms currently available and their condition. the condition of a classroom determines the number of years it is expected to be usable. the number of future eqe units created by the addition of a classroom block may also be affected by the growth in the number of potential students in the district. af kcc kl e af kcc kl e af kcc kl e nn n n × + = × + = × + = )( )( )( 2 22 2 2 2 11 2 1 1 ! (5) equation (5) demonstrates the effectiveness of building a classroom block associated with year 1 to year n. to account for the value of time, the future stream of eqe units must be discounted back to the present time. however, the question of what is the appropriate discount rate to use is often raised. in this study, the discount rate is the economic opportunity cost of funds, as originally proposed by harberger (1971) and sandmo and dreze (1971). a study by burgess (2013) compared the economic sajems ns 18 (2015) no 1:70-83 73 opportunity cost of funds with the social rate of time preference and the marginal cost of funds to be used as a discount rate. burgess (2013) showed that under a wide range of circumstances the economic opportunity cost of funds is the most appropriate discount rate. the calculation of the present value of the future stream of effectiveness, or pve, is shown by equation (6) where r stands for the discount rate and n stands for the number of years to be considered in the analysis.7 n n r e r e r e pve )1()1()1( 2 21 + ++ + + + = ! (6) the incremental cost-effectiveness ratio (icer) is calculated for each school district by dividing the given cost of construction of a new classroom block by the pve of building a new classroom block in the district8. this ratio compares the incremental cost and effectiveness of building a new classroom block with a scenario in which there is no infrastructure project. both cost and effectiveness are zero for the scenario with no infrastructure project. the school district with the lowest icer is chosen as the best place to receive the first investment, since eqe units are gained at the lowest price. in order to find the next place in which a classroom block should be built, the icer must first be updated for the chosen school district. the pve is recalculated for that school district, taking into consideration that the school district will have k more available classrooms from the next year. after updating the icers, the school district with the lowest icer among all school districts is selected to be the second location for the building of a new classroom block. the selection is continued in this way until the cumulative cost in a given year of construction becomes equal to the available budget. the final list of selected schools illustrates the most efficient strategy for the location of construction investments.9 2.3 renovation scenario in this scenario the problem is how to determine which schools should be renovated in order to achieve the greatest enhancement of the education system. for this analysis it is assumed that the number of classrooms in need of repair, their renovation cost, and the number of years they are expected to be useful are known for each school. in order to find the effectiveness of the renovation of an old school, the same method is used as in the construction scenario. however, for renovation, the number of classrooms needing repair differs between schools. for a school that has d classrooms in desperate need of repair, the effectiveness of renovation is calculated according to changes in lcr of the school district with respect to the addition of d classrooms. equation (7), which is derived from equation (4) by substituting d for k, shows the number of eqe units obtained from repairing the school. )( 2 dcc dl eqe + = (7) in the same manner as before, the measure of effectiveness should be adjusted for the differences in the economic return on investment in rural and urban areas, as well as in primary and secondary education. )1( )( 2 !+++= × + = rpaf af dcc dl e (8) the renovation of a school will increase the number of classrooms starting from the time that the old classrooms are expected to be unusable, and the effectiveness of the renovation should be considered from that point in time. for instance, if the classrooms will become unusable in m years, the effectiveness should be calculated for each year starting from year m to year n.10 in a similar way to the previous scenario, the pve is calculated from the sum of the present value of the future stream of effectiveness created by the renovation of the school. this calculation is shown by equation (9). n n m m m m r e r e r e pve )1()1()1( 1 1 + ++ + + + = + + ! (9) in the same manner as in the previous section, the icer is estimated by dividing the renovation cost of the school by the pve of the renovation of school. based on their icers, the schools are ranked, and the one with the lowest icer is chosen as the first school to be renovated. the pve is then updated for the 74 sajems ns 18 (2015) no 1:70-83 school district in which the chosen school is located. the renovation of the chosen school will increase the number of available classrooms in the school district from the time that the old classrooms are expected to be unusable. the renovation of the school will lower the lcr of the school district in the future; therefore, the pve and the icer of the renovation of the other schools in that school district should be updated. the chosen school is removed from the list of possible renovation projects. based on the new ratios, the school with the lowest icer in the list is chosen as the second one to be renovated. this selection procedure continues until the cumulative cost of renovation of the chosen schools becomes equal to the available budget. the final list of chosen schools illustrates the most efficient strategy for the location of renovation projects. 2.4 construction-and-renovation scenario in this scenario, the allocation of budget for both construction and renovation projects is carried out jointly. in other words, construction of new classroom blocks and renovation of old schools are ranked in the same list. it is important to note that the effectiveness of building a new classroom block depends on the future condition of the old classrooms in the district. for example, suppose that two school districts have same number of learners and classrooms, but one district has some classrooms that are in desperate need of repair, while the other one does not. the pve of building a new classroom block would be greater for the school district that has the classrooms in desperate need of repair. this difference in the pve comes from the number of available classrooms in the future, which is lower in the school district with old classrooms. in order to develop a scenario without construction and renovation projects, the future condition of the old schools and the number of learners and available classrooms in the future should be estimated for each school district. as in the previous scenarios, the pve of the construction of new classroom blocks and the renovation of old schools is calculated for each school district. the icers are estimated using the given costs and the pve of each of the infrastructure investments. the infrastructure investment (construction or renovation) with the lowest icer is chosen as the first investment in the prioritised list of infrastructure projects. the pve is then updated for the infrastructure investments in the school district in which the chosen investment is located. based on the updated pve, the icers are recalculated for the renovation of old schools and construction of a new classroom block in the school district. all possible infrastructure investments are ranked again based on their icers. the investment with the lowest ratio is chosen as the second place in the prioritised list of infrastructure projects. in the same fashion, the selection and recalculation of the icers are carried out until the cumulative cost of construction and renovation projects becomes equal to the available budget. the prioritised list of infrastructure projects displays the most efficient strategy for allocating the available funds among the construction and renovation projects in the different school districts. 3 application to province of limpopo, south africa the department of education in limpopo is characterised by shortages of classrooms and related infrastructure. in 2004, the estimated number of classroom needed according the department of education’s criterion was about 13 000 in limpopo. since 1995, substantial funds have been allocated to infrastructure investments in education. however, owing to political pressures that have been enhanced by the absence of any formal project evaluation, a large proportion of those investments has been spent in school districts that were not in the greatest need of additional school buildings (jenkins & klevchuk, 2004). 3.1 data and assumptions the data used were collected by the department of education via regional education boards located in limpopo, and reflect the situation of 4 942 schools in limpopo in 2004. in this dataset, each school represents a school district.11 a sample of 494 schools is used to perform the prioritisation analysis. among the data available for each school, the following parameters have been selected for use in the analysis: sajems ns 18 (2015) no 1:70-83 75 • emis number: a unique nine-digit number assigned to each school. • lowest grade: the lowest grade taught in the school. • highest grade: the highest grade taught in the school. • enrolment: number of students enrolled in the school. • perm classrooms: number of permanent classrooms in the school. • prefabs: number of prefabricated classrooms in the school. • classroom condition: a number from zero to six reflecting the condition of the classrooms, where zero and six show the worst and the best conditions respectively. the lowest and highest grades determine whether the school is primary or secondary. grades lower than or equal to seven are considered primary, and those higher than seven are considered secondary. the total number of classrooms in a school is obtained by adding together the permanent and pre-fabricated classrooms of the school. as reported by jenkins and klevchuk (2004), the standard lcr of the schools in limpopo is 40. for the renovation budget allocation analysis, however, more information is required. while the condition of the school is known, the number of classrooms requiring repair within the schools is not known, nor is the cost of repairing each of the old classrooms present in the dataset received from the department of education.12 to prepare proper estimates for such information, some assumptions are made based on discussion with the representative of the african development bank, economists, engineers and people from the department of public works involved in the construction project. these assumptions are as follows: • schools with a classroom condition lower than or equal to two are in desperate need of renovation and will be unusable in the future without renovation. • schools with a classroom condition higher than two are expected to be usable for the next 20 years. • schools with a classroom condition equal to zero or one are expected to lose 75 per cent and 50 per cent of their classrooms in one year, respectively. • schools with a classroom condition equal to two are expected to lose 50 per cent of their classrooms in four years. the renovation costs of the classrooms are assumed to be normally distributed, with the same standard deviation but a different mean associated with the classroom condition. the standard deviation is set at 0.07.13 for schools with a classroom condition of zero, the average renovation cost of a classroom is assumed to be equal to the cost of construction of a new classroom. since classrooms are going to be added by units of one classroom block including four classrooms, the cost of building a new classroom is considered to be one quarter of the cost of building a classroom block. the cost of building a new classroom block was r420 000 in 2004. therefore, the cost of building a classroom is set at r105 000.14 the average renovation cost of a classroom is assumed to be 75 per cent and 50 per cent of the cost of constructing a new classroom for schools with a classroom condition of one and two, respectively. a study by psacharopoulos and patrinos (2004) estimated the economic returns of investments in education for several countries. the economic returns on investment for primary and secondary schools in south africa were estimated at 22.1 per cent and 17.7 per cent respectively. based on these rates of return, the economic return on investments is 25 per cent higher in primary schools than in secondary schools, and the parameter p in the adjustment factor will therefore be 25 per cent.15 3.2 construction scenario in this scenario, the objective of the analysis is to determine the best locations to build the new classroom blocks in limpopo. it is assumed that the available budget for this project is about r250 million. since the analysis is carried out on a 10 per cent sample, the budget available for the analysis is r25 million. the first step in the analysis is to calculate the effectiveness of building a new classroom block. it is assumed that it takes one year for a new block to become ready for use, and that it will be usable for about 20 years.16 as shown in section 2.2, the construction investments are ranked based on the icer of building a new block in each school in limpopo. the ranking for the top 20 schools is shown in table 1. 76 sajems ns 18 (2015) no 1:70-83 table 1 the top 20 schools with the lowest incremental cost-effectiveness ratios school name enrolment no. of classrooms in year 0 classroom condition af pve (eqe units) icer of building a classroom block school rank legadimane primary 685 1 1 1.25 3 736 593 0.112 1 pienaarsrivier 567 1 3 1.25 2 560 122 0.164 2 mantsha primary 876 9 0 1.25 2 546 195 0.165 3 muchuchi primary 531 1 3 1.25 2 245 348 0.187 4 badimong primary 1028 5 2 1.25 1 675 761 0.251 5 marotobane primary 439 1 2 1.25 1 534 701 0.274 6 thomas ntshavheni 396 2 2 1.25 1 025 236 0.410 7 nakgwadi secondary 780 12 0 1 922 836 0.455 8 segopotje secondary 347 5 0 1 767 085 0.548 9 mpapalati primary 772 16 0 1.25 741 565 0.566 10 mashaha secondary 333 1 4 1 706 436 0.595 11 rootse primary 450 3 1 1.25 671 906 0.625 12 mokwasele primary 847 10 1 1.25 634 774 0.662 13 madikoti putsoa 704 15 0 1.25 616 680 0.681 14 kulani primary school 275 4 0 1.25 602 227 0.697 15 nkotobona high 474 3 1 1 596 390 0.704 16 mookamedi secondary 280 5 0 1 499 460 0.841 17 paulos primary 852 11 1 1.25 481 718 0.872 18 sefufule primary 372 4 1 1.25 459 165 0.915 19 lefakgomo secondary 901 12 1 1 430 976 0.975 20 source: col 1-3 limpopo department of education, col 4-7 calculations by authors it is important to note that this ranking does not show the best strategy for budget allocation. only the first school can be chosen with certainty as the best place to receive funding. to determine the next place, it is necessary to recalculate the icer of the chosen school, assuming that the school will have four more classrooms from year 1. legadimane primary school, with the lowest icer, estimated at 0.112, will be chosen as the first place for construction of a new classroom block. with four more classrooms, the incremental costeffectiveness of building a classroom block in legadimane primary school would be 1.012, which would be ranked 23rd. based on the updated icer, the school with the lowest ratio will be selected as second place in the prioritised list of construction projects. the selection procedure continues until the cumulative cost of construction becomes equal to the available budget. the prioritised list of construction investments determines the most efficient sequence for schools to receive funding in order to realise the greatest improvements in the education system. table 2 illustrates the top 20 construction projects on this list. as shown in table 2, badimong primary school and mantsha primary school are both chosen twice. this implies that if the available budget is limited to the construction cost of 20 classroom blocks, the most efficient strategy is to build two blocks at badimong primary school, two at mantsha primary school, and one at each of the other 16 schools listed. 3.3 renovation scenario in this scenario, the objective is to select those renovation projects that result in the greatest improvement in the education system, assuming that an amount of r25 million is dedicated to renovation projects. the first step is to determine the situation of schools without any infrastructure investments in the next 20 years. since the number of learners is assumed to be constant, the main factor in the analysis would be the number of usable classrooms in each year. schools that are considered in this analysis are those that have a classroom condition lower than or equal to two. sajems ns 18 (2015) no 1:70-83 77 table 2 the most efficient locations for building the first 20 classroom blocks school name enrolment no. of classrooms year 0 classroom condition af pve (eqe units) icer of adding a classroom block accumulated cost (r) legadimane primary 685 1 1 1.25 3 736 593 0.1124 420 000 pienaarsrivier primary 567 1 3 1.25 2 560 122 0.1641 840 000 mantsha primary 876 9 0 1.25 2 546 195 0.1650 1 260 000 muchuchi primary 531 1 3 1.25 2 245 348 0.1871 1 680 000 badimong primary 1028 5 2 1.25 1 675 761 0.2506 2 100 000 marotobane primary 439 1 2 1.25 1 534 701 0.2737 2 520 000 thomas ntshavheni 396 2 2 1.25 1 025 236 0.4097 2 940 000 nakgwadi secondary 780 12 0 1 922 836 0.4551 3 360 000 segopotje secondary 347 5 0 1 767 085 0.5475 3 780 000 badimong primary 1028 5 2 1.25 758 478 0.5537 4 200 000 mpapalati primary 772 16 0 1.25 741 565 0.5664 4 620 000 mashaha secondary 333 1 4 1 706 436 0.5945 5 040 000 rootse primary 450 3 1 1.25 671 906 0.6251 5 460 000 mokwasele primary 847 10 1 1.25 634 774 0.6617 5 880 000 madikoti putsoa 704 15 0 1.25 616 680 0.6811 6 300 000 kulani primary school 275 4 0 1.25 602 227 0.6974 6 720 000 nkotobona high 474 3 1 1 596 390 0.7042 7 140 000 mantsha primary 876 9 0 1.25 509 239 0.8248 7 560 000 mookamedi secondary 280 5 0 1 499 460 0.8409 7 980 000 paulos primary 852 11 1 1.25 481 718 0.8719 8 400 000 source: col 1-3 limpopo department of education col 4-7 calculations by authors the average cost of renovation of a classroom with a condition of two is r52 500, which is 50 per cent of the cost of building a new classroom. as previously mentioned, the renovation costs of classrooms are assumed to follow a normal distribution around the average cost, with a standard deviation of 0.07. in the same manner as described in section 2.2, the renovations for the schools are ranked according to their icer from low to high. the most efficient budget allocation for renovation is to choose the schools from this list until the accumulated cost becomes equal to the available budget.17 the list of the top 20 renovation investments is shown in table 3. 3.4 construction-and-renovation scenario in this section, the construction and renovation projects are ranked simultaneously in order to find the most efficient strategy for spending the r25 million dedicated to building and repairing the schools. the potential investment options are renovating schools that are in desperate need of repair and building a new classroom block for every school in limpopo. in this scenario, the first step is to determine the most efficient investment for the schools that are in desperate need of repair. in other words, it is necessary to determine whether building a new classroom block or repairing the school has a lower icer. in the same manner as shown in section 2.2.3, the icers are estimated for the renovation and construction projects of all schools in the analysis. schools are ranked based on their icer. schools in desperate need of repair that have a ratio for renovation and a ratio for construction are ranked based on the lower of the two ratios, which represents the most efficient investment for the school. among all schools in limpopo, thomas ntshavheni primary school has the lowest icer, which is 0.101 for the renovation of the school. this school is selected as the first place to receive the funds. 78 sajems ns 18 (2015) no 1:70-83 table 3 the top 20 chosen renovation projects school name enrolment no. of classrooms year 0 classroom condition af renovatio n cost of the school icer of repairing the school accumulated cost thomas ntshavheni 396 2 2 1.25 50 964 0.094 50 964 badimong primary 1028 5 2 1.25 120 198 0.124 171 162 rootse primary 450 3 1 1.25 74 135 0.221 245 297 nkotobona high 474 3 1 1 70 440 0.236 315 737 mantsha primary 876 9 0 1.25 739 636 0.249 1 055 373 metsi aphepha 375 3 2 1.25 50 571 0.313 1 105 945 sefufule primary 372 4 1 1.25 156 454 0.454 1 262 399 tshililo secondary 347 3 1 1 75 461 0.472 1 337 859 mokwasele primary 847 10 1 1.25 342 282 0.479 1 680 141 maphotle primary 376 4 2 1.25 120 404 0.494 1 800 545 sejadipudi primary 362 4 2 1.25 116 089 0.514 1 916 635 kulani primary school 275 4 0 1.25 314 953 0.558 2 231 588 libson farm primary 225 3 0 1.25 196 467 0.585 2 428 055 segopotje secondary 347 5 0 1 470 833 0.614 2 898 888 ham primary 249 3 1 1.25 71 428 0.694 2 970 316 matangari primary 699 10 2 1.25 241 411 0.716 3 211 727 paulos primary 852 11 1 1.25 402 169 0.735 3 613 896 motsheudi secondary 1013 12 2 1 351 508 0.745 3 965 404 mookamedi secondary 280 5 0 1 378 052 0.757 4 343 456 letupu secondary 313 4 1 1 149 539 0.767 4 492 994 source: col 1-3 limpopo department of education, col 4-7 calculations by authors to find the next place for the allocation of funds, the ranking list should be updated, assuming that thomas ntshavheni primary school is no longer in need of renovation. this assumption means that thomas ntshavheni primary school can use its classrooms for the entire period of the analysis. based on this assumption, the pve of building a new classroom block at thomas ntshavheni primary school falls from 1 025 236 to 520 324 eqe units. consequently, the icer for this school rises from 0.410 to 0.807. table 4 shows the list of top 20 infrastructure investments in this scenario. note that the icer of renovation is not applicable (na) for schools with no classrooms in desperate need of repair.18 4 potential impact of the model to illustrate the advantages of using the suggested model, a comparison is made between the results in terms of the present value of the units of effectiveness produced by a given budget allocation using the model, and a budget allocation that does not use such an analysis or criterion. when describing a budget allocation without any analysis, it is assumed that the budget is randomly allocated to the schools where the lcrs of the schools are higher than the standard ratio, which is 40 in limpopo. therefore, during this random selection, whenever the lcr of a school falls below 40, that school is erased from the list of possible investments. a random selection may not necessarily reflect the current system for budget allocation. however, in the past schools were often built in locations close to other villages where new schools had recently been built. although these schools could be used by more than one village, because of the need for local politicians to be seen to be delivering at least as good a set of educational services as their competing politicians were delivering nearby, the system for school selection is yielding a pattern of resource allocation that is likely to be worse than a random selection rule (jenkins & sajems ns 18 (2015) no 1:70-83 79 klevchuk, 2004). in practice, funding might be given to school districts with an lcr lower than 40, which is worse than the random selection rule used here. in this paper, randomised budget allocation provides a base case for the situation of not using an analysis, in order to quantitatively estimate the advantages of using the suggested system for ranking areas for construction and repair of schools in a realworld situation. the randomised budget allocation iscarried out for an amount of r25 million for the three scenarios similar to those described in the previous sections. the results of the randomised budget allocation are displayed and compared with the model-based budget allocation in table 5 and figures1 to 3. table 4 the top 20 chosen construction and renovation projects school name enrolment no. of classrooms year 0 classroom condition af icer of building a classroom block icer of repairing the school build or repair thomas ntshavheni 396 2 2 1.25 0.410 0.101 repair legadimane primary 685 1 1 1.25 0.112 na build badimong primary 1028 5 2 1.25 0.251 0.139 repair pienaarsrivier 567 1 3 1.25 0.164 na build mantsha primary 876 9 0 1.25 0.165 0.228 build muchuchi primary 531 1 3 1.25 0.187 na build marotobane primary 439 1 2 1.25 0.274 na build rootse primary 450 3 1 1.25 0.625 0.331 repair nkotobona high 474 3 1 1 0.704 0.337 repair maphotle primary 376 4 2 1.25 1.108 0.428 repair badimong primary 1028 5 6 1.25 0.449 na build nakgwadi secondary 780 12 0 1 0.455 0.736 build metsi aphepha 375 3 2 1.25 1.036 0.473 repair sejadipudi primary 362 4 2 1.25 1.195 0.489 repair segopotje secondary 347 5 0 1 0.548 0.495 repair sefufule primary 372 4 1 1.25 0.915 0.500 repair kulani primary 275 4 0 1.25 0.697 0.532 repair mpapalati primary 772 16 0 1.25 0.566 1.195 build mokwasele primary 847 10 1 1.25 0.662 0.587 repair mashaha secondary 333 1 4 1 0.595 na build source: col 1-3 limpopo department of education, col 4-7 calculations by authors table 5 effectiveness of infrastructure projects at three different levels of budget; effectiveness is in terms of thousands eqe units budget (thousands rand) 5 000 15 000 25 000 construction-and-renovation scenario model based 19 677 31 626 38 752 randomised 1 553 6 183 9 964 improvement 1 167% 441% 289% construction scenario model based 18 514 29 871 36 607 randomised 4 833 9 037 13 215 improvement 283% 231% 177% renovation scenario model based 11 328 21 090 27 980 randomised 6 052 13 379 20 876 improvement 87% 58% 34% 80 sajems ns 18 (2015) no 1:70-83 figure 1 results of the model-based and randomised budget allocation for the construction scenario figure 2 results of the model-based and randomised budget allocation for the renovation scenario figure 3 results of the model-based and randomised budget allocation for the construction-and-renovation scenario 0 5 000 10 000 15 000 20 000 25 000 30 000 35 000 40 000 0 5 000 10 000 15 000 20 000 25 000 30 000 p v e , t ho us an ds e q e u ni ts budget, thousands rand construction scenario model-based randomized 0 5 000 10 000 15 000 20 000 25 000 30 000 0 5 000 10 000 15 000 20 000 25 000 30 000 p v e , t ho us an ds e q e u ni ts budget, thousands rand renovation scenario model-based randomized 0 5 000 10 000 15 000 20 000 25 000 30 000 35 000 40 000 45 000 0 5 000 10 000 15 000 20 000 25 000 30 000 p v e , t ho us an ds e q e u ni ts budget, thousands rand construction-and-renovation scenario model-based randomized sajems ns 18 (2015) no 1:70-83 81 as shown in table 5, for the construction, renovation, and construction-and-renovation scenarios the eqe units obtained from the model-based scenarios are about 177 per cent, 34 per cent, and 289 per cent greater, respectively, than those for the randomised budget allocation for a budget of r25 million. the improvement obtained by using the model is even greater when the budget is smaller. among the three scenarios, the improvement in the renovation scenario is not as great as in the other two scenarios. however, this does not imply that the model is less effective for renovation projects. the reason for this difference is that the r25 million that is assumed as the available budget in all three scenarios is a relatively large sum for the renovation scenario given the total number of repairs needed. in fact, the cost of repairing all schools in limpopo is about r50 million, and if the available budget was r50 million, there would be no difference between a model-based and a randomised budget allocation. alternatively, for the construction scenario, with r50 million it would be possible to build only a proportion of the classroom blocks required. a question that is often raised by decision makers for infrastructure investments in education is how to optimally balance budget expenditures between construction and renovation projects. the results of the model-based budget allocation show that the greatest enhancement in the education system is achievable by using the model in the construction-and-renovation scenario. allocating separate budgets for construction and renovation does not generally lead to the greatest enhancement in the education system. the results of the model-based construction and-renovation scenario suggest that about 62 per cent of the r25 million budget should be spent on renovation projects to obtain the greatest enhancement in the education system. figure 4 illustrates the optimal budget mix between con struction and renovation projects when allocating a budget of up to r35 million. it is important to note that these results for the optimal budget mix are heavily dependent on the assumptions for the situation and renovation costs of old schools. the optimal budget mix may be very different for an education system with different situation and renovation costs. figure 4 optimal share of budget to be allocated to renovation projects 5 conclusion around the world decisions concerning the location of school buildings have been the focus of much political lobbying and controversy. as a result, many of the locational decisions for school buildings have produced an inefficient allocation of investments for this sector. while the criteria used in this study to 0% 20% 40% 60% 80% 100% 120% 5 000 10 000 15 000 20 000 25 000 30 000 35 000 40 000 r en ov at io n s pe nd in g, p er ce nt budget, thousands rand optimal budget mix 82 sajems ns 18 (2015) no 1:70-83 rank investment opportunities may not be perfect, it represents a major improvement over the current practice in many countries. the information used to carry out the analysis for limpopo province was information routinely gathered by the government as part of its asset management system, and did not require the development of a special survey or a sophisticated education information system. hence, it has the potential to be relatively easily replicated across other provinces in south africa, and perhaps other counties. the model is operational and its use would have a major impact over time on the educational achievement of learners in the province. endnotes 1 for example, assume that a classroom is expected to be unusable in two years. repairing the classroom makes it usable after year 2 for a certain period of time. on the other hand, building a new classroom in year 2 also provides additional class-space from year 2; therefore, building a new classroom in two years results in similar effects on the supply of education services to those of repairing the old classroom. 2 ‘school district’ represents the catchment area of one or two schools in a district. however, in the available data from limpopo, each school district represents a school. 3 this is an estimate for measuring the effectiveness of adding one classroom to a school district. the formulas for finding the exact amount of effectiveness for infrastructure investments are explained in sections 2.2 and 2.3. 4 the standard number of learners in a classroom differs from one place to another. in limpopo province, south africa, this number is 40 (jenkins & klevchuk, 2004). 5 in countries where the economic return on investment in secondary school is higher than that in primary school, p will become negative. 6 the school districts are specified separately for primary and secondary education, based on the physical location of the available primary or secondary schools. 7 the length of the period of the analysis can be set at the life of a new classroom. 8 in 2004 the policy of the government of limpopo was to pay the same price for the construction of a school consisting of a block of 4 classrooms anywhere in the province. hence, the model here assumes a uniform cost of construction. if different costs were expected to be incurred depending on the location of the new construction, then the incremental costeffectiveness would be calculated on the basis of the site specific construction costs. in addition, we were assured by the ministries involved that the construction costs of building a new school would be incurred over a period of one year or less. hence it was decided to not apply a discount rate to the monthly expenditures within a year. if the construction costs were to be spread out over more than one year then these cost should be discounted back to the same period as the incremental effectiveness is evaluated. 9 a school district may be selected several times. the number of times that the school district is selected indicates the number of classroom blocks to be built in that school district. 10 as in the previous scenario, n stands for the length of the analysis. for simplicity, it is assumed that the renovation of a school will lengthen the useful life of its old classrooms and make it equivalent to that of a new classroom. 11 since the information for each school represents the situation of a school district, there is no relationship between infrastructure investments in one school and the lcr of another school. therefore, in the analyses of this section, the icers are calculated for the schools. 12 in this paper reasonable assumptions are made for this missing information in terms of a distribution of likely classrooms requiring repair and the costs of such repairs. however, in operationalising the model as a planning tool this information is relatively easy to obtain from the work of the survey engineers in the provincial department of public works. they carry out a periodic survey of the state of the buildings in the province as part of their efforts to maintain a record of the public sector assets in the province. the survey engineers could specify the actual number of classrooms requiring repair and also estimate the cost of such repairs, as they are specialists in this area. 13 this value for the standard deviation is chosen since it provides reasonable estimates for the actual renovation cost of the schools. 14 since the data is for 2004, the analysis is carried out in 2004 prices. the present value of the effectiveness of infrastructure investments is also calculated using 2004 as the base year. 15 the information in the available dataset does not specify whether schools are located in urban or rural areas. therefore, the economic returns of infrastructure investment in education systems in urban and rural areas are set equal for schools in this analysis. 16 the discount rate used in these calculations is economic opportunity cost of funds estimated to be 11 per cent for south africa (kuo, jenkins & mphahlele, 2003). 17 in the general model, determining the renovation budget allocation strategy is not as straightforward. since in the limpopo case each school represents a school district, renovation of a school does not alter the icer of other schools. therefore, recalculation of the icers is not required. 18 some schools in table 4 have one classroom with a condition of one or two. since they only have one classroom, no renovation project is assigned to these schools. acknowledgements the assistance and contributions of andrey klevchuk to this research effort are greatly appreciated. the guidance and support of m. benjamin mphahlele, the head of treasury, province of limpopo, during the time this study was initiated was a critical element in its completion. sajems ns 18 (2015) no 1:70-83 83 references burgess, d.f. 2013. reconciling alternative views about the appropriate social discount rate. journal of public economics, 97:9-17. glass, g.v. & smith, m.l. 1979. meta-analysis of research on class size and achievement. educational evaluation and policy analysis, 1(1):2-16. glewwe, p. 2002. schools and skills in developing countries: education policies and socioeconomic outcomes. journal of economic literature, 40(2):436-82. glewwe, p. 2004. an investigation of the determinants of school progress and academic achievement in vietnam. in glewwe, p., dollar, d. & agrawal, n. (eds.) economic growth, poverty, and household welfare in vietnam (pp. 467-501) washington, dc: world bank. glewwe, p. & kremer, m. 2006. schools, teachers, and education outcomes in developing countries. in hanushek, e.a. & welch, f. (eds.) handbook of the economics of education, 2:945-1017. amsterdam and oxford: elsevier, b.v. harberger, a.c. 1971. on measuring the social opportunity cost of public funds. ida economic papers, arlington: institute for defense analyses, program analysis division. jenkins, g.p & klevchuk, a. 2004. project selection handbook for department of education: limpopo province, ddp 2004-03, jdint’l queen’s university, kingston, canada. dintl.econ.queensu.ca/workingpapers/. kuo, c-y., jenkins, g.p. & mphahlele, m.b. 2003. the economic opportunity cost of capital in south africa. south african journal of economics, 71(3):496-516. levin, m. 2001. waiting for godot: cost-effectiveness analysis in education. new directions for evaluation, 90:55-68. psacharopoulos, g. & patrinos, h.a, 2004. returns to investment in education: a further update. education economics, 12(2):111-134. sandmo, a. & dreze, j.h. 1971. discount rates for public investment in closed and open economies. economica, 38:395-412. ssewamala, f.m., wang, j.s.h., karimli, l. & nabunya, p. 2011. strengthening universal primary education in uganda: the potential role of an asset-based development policy. international journal of educational development, 31(5):472-477. abstract introduction egypt as a regional natural gas export hub literature review methodology numerical results conclusion acknowledgements references about the author(s) ahmed ezzat department of logistics of international trade, college of international transport and logistics, arab academy for science, technology and maritime transport, cairo, egypt khaled s. abdallah department of supply chain management, college of international transport and logistics, arab academy for science, technology, and maritime transport, cairo, egypt yasmin adel department of mechanical engineering, université française d’égypte, cairo, egypt citation ezzat, a., abdallah, k.s. & adel, y., 2023, ‘evaluating liquefied natural gas export quantities from egypt using system dynamics approach’, south african journal of economic and management sciences 26(1), a4766. https://doi.org/10.4102/sajems.v26i1.4766 original research evaluating liquefied natural gas export quantities from egypt using system dynamics approach ahmed ezzat, khaled s. abdallah, yasmin adel received: 23 july 2022; accepted: 28 nov. 2022; published: 09 mar. 2023 copyright: © 2023. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: egypt and nearby countries have been discovering new sources of natural gas (ng) leading to proven increased reserves. egypt has two liquefaction stations for exporting liquefied natural gas (lng), while nearby countries do not have such stations. aim: egypt adopted a policy to export lng to major importing countries in europe. hence, this article aims to analyse the dynamics of the factors affecting the lng export supply chain, and the main elements of adequate policies needed to optimise decisions related to lng export in egypt. settings: the input data for this study were obtained from official national and international reports. method: a system dynamics simulation model is used as a decision support system model to optimise decisions related to lng exports in egypt. results: the model gives insight into the effect of investment in new discoveries, investment in renewable energy and changes in population, gross domestic product (gdp) and lng export prices, as well as the quantity of lng re-export on the dynamics of lng export present value and quantity. conclusion: the research provides a novel decision support system that can be used in adopting adequate policies along the lng industry supply chain targets, optimising decisions related to exports of lng. for egypt, investments in new discoveries and making a long-term agreement to buy ng to be re-exported, are recommended strategic decisions to consider when targeting the optimisation of decisions related to the export of lng. investment in the generation of renewable energy and decreasing the home usage patterns come next in importance. keywords: system dynamics; lng supply chain; lng simulation; lng in egypt, lng exports; zohr field. introduction the egyptian economy has been suffering from a large deficit in its energy balance. this increased the structural deficit in the national budget. ng (ng) discoveries in egypt, such as at the zohr gas field, significantly increased the proven ng reserves. the country was transforming into a net ng exporter in 2019. egypt needed to plan its liquefied natural gas (lng) production along the whole supply chain to participate significantly in optimising its decisions, regarding lng in the ng export market, especially in the light of the russian-ukrainian conflict. egypt works according to two parallel trends to make the country a regional hub for exporting energy. the first is to import mediterranean ng, liquefy it to be re-exported as lng along with the production surplus. the second direction is to make egypt a hub for exporting electricity to africa, asia, and europe. several factors led to the electricity surplus in the market, which is expected to grow significantly soon. these factors include: new ng discoveries, diverse renewable energy sources (solar, nuclear, and wind) and interconnected electrical projects. but the lng export market and large demand prioritise the first direction. in this regard, a number of mediterranean countries signed agreements to supply gas to egypt in 2019, for re-export after liquefaction, followed by the formation of the eastern mediterranean gas forum (emgf) to cooperate in establishing a regional gas market in the eastern mediterranean region (amcham 2019). as the generation of electricity accounts for the largest part of ng consumption in egypt, 63% of the total gas consumption (egas 2018/2019), there is a trade-off between the two previous trends. consequently, the research problem is concerned with the conflicting policy trends in egypt. additionally, despite its adoption of the first direction, that is, focusing on the exports of lng, studying how to optimise decisions regarding the export quantity and the present value of lng export along the supply chain were ignored. hence there is an urgent need for a decision support system for ng to help the country understand the dynamics of the industry and different parameters contributing to optimising the decision-making process. system dynamics (sd) simulation is a technique used to evaluate the effect of such dynamics and different parameters on lng export and returns. to the best of our knowledge, this is the first study that builds a decision support system for lng exports and, more specifically, in egypt. the rest of the paper is organised as follows: in the second section the potential of egypt to be a regional ng export hub is analysed; in the third section the theoretical background and relevant literature are discussed; in the fourth section our methodology is analysed, and in the fifth section some empirical results are introduced, while the last section includes a discussion of the results. egypt as a regional natural gas export hub many factors led egypt to become a hub for ng export. taking into consideration that electricity generation uses the largest part of ng consumption, the efficiency of available ng resources becomes important. in this section, the egyptian market of ng is analysed, and the efforts made to turn the country into a regional hub for natural gas export are clarified. the discovery of ng in egypt started in the early 1960s (lynx 2019), and the use of ng for industrial purposes began in 1976 (igu, taqa & ega 2018). egypt’s consumption of ng continued to be equivalent to production, since the first discovery until 2005 (british petroleum statistical [bpsr] 2021; hegazy 2015). in 2003, egypt started a project to export ng abroad (lynx 2019). in 2005, this project took two tracks (amcham 2019). the first concerns the export of ng through a pipeline between egypt, jordan, and israel. the second is through the liquefaction of ng at two stations in damietta and idku, opened in 2005 and 2006. egypt’s gas exports in 2005 amounted to 6.98 billion cubic meters (bcm). since then, the country continues to be a net exporter of ng (hegazy 2015). the average growth of domestic production between 2000 and 2008 reached 17% annually. the share of ng in generating gross domestic product (gdp), jumped to 8.3% in 2005 and 2006 compared to 5.4% in 2004 and 2005, outperforming the petroleum sector for the first time according to the egyptian ministry of planning and economic development data. from 2009 to 2015, an energy problem in egypt began to arise due to several factors (amcham 2019; farag & rowihil 2020; hegazy 2015). the first factor is a drop of 33% in the production due to the dramatic reduction in foreign investment, leading to a reduction in exploration and production. according to schäfer et al. (2018), the reduction in foreign investment is the result of political instability in egypt in 2011, when the management of the demand for energy was not optimised, and the production of some oil and gas fields reached maturity and started to decline. the second factor was the population growth which, combined with a very generous energy subsidy policy, strained production, leading the government to direct the available petroleum resources to supplement the domestic electricity shortage. the third factor is the relatively low prices paid by the government to foreign operators. another contributing factor is that the damietta station was forced to stop exporting lng due to the lack of gas. also, repeated attacks on the gas export pipeline in 2011 and 2012 led to the end of it. finally, the historically extremely low domestic energy prices discouraged new producers to enter the market. hence, egypt became an importer of ng again in 2015 (iea 2019), especially after the ng shortage impacted energy-intensive industries like steel (igu et al. 2018). the ng share of generated gdp significantly decreased from 8.27% in 2008 and 2009 to 3.25% in 2015 and 2016 according to the egyptian ministry of planning and economic development data. since 2016, egypt witnessed an expansion of exploitative activities again for several reasons, including economic and political reforms. egypt witnessed a boom in production, consumption, and foreign trade (farag & rowihil 2020; igu et al. 2018; mop 2020). egypt recently began to switch to the use of ng over other sources in many sectors as a greener energy source. the development of the infrastructure and the encouragement of investment in the field of ng exploration increased production, especially after the start of production at the zohr field in the mediterranean and new discoveries in northern alexandria and the nile delta. this increased the production of ng in egypt and its world share from 2016 to 2019, with a growth in the production rate by 45.2% for the five years as shown in figure 1 in the supplementary file (i.e. from 40.3 bcm to 58.5 bcm) (bpsr). total ng production reached 20% in 2018 and 2019, relative to the previous year (egas, different issues) and its share of generating gdp increased till it reached 5.9% in 2018 and 2019. figure 1: the system dynamics model of liquefied natural gas export in egypt. ng consumption has increased rapidly since 2015, not only in absolute values but also as shares of total energy consumption. this is attributed to the expansion to replace petroleum products with ng as shown in figure 2 in the supplementary file. this replacement includes the connection of ng to homes, instead of liquefied petroleum gas (lpg) and converting vehicles to be fuelled by ng. as a result, since 2015 gas export has been reduced, switching to domestic consumption instead (abbas et al. 2020). consumption of ng in egypt accounted for 54.9% of total primary energy consumption in 2019 (58.9 bcm). this tendency to replace other sources of primary energy with ng continued, resulting in an increase in the sharing of ng as the primary energy consumed in egypt to 57.1% in 2020, as shown in figure 2 in the supplementary file. figure 2: regression of the electric energy consumption. ng consumption is distributed among different sectors: electricity generation, the industrial sector, the sector of petroleum, gas derivatives and petrochemicals, and residential consumption (egas 2018 and 2019). the latest available data, according to the egas database, confirmed that the dependency on ng in the industry was reduced as the government directed the available ng resources to supplement the domestic electricity shortage for residential consumption, as mentioned before. despite the lack of ng during 2013–2015, already mentioned, ng was directed to residential consumption. this was responsible for seeing the residential consumption of ng as a positive trend. the share to supply cars that consume natural gas in egypt has stabilised at 1% since 2005 and 2006. in 2020 and 2021, this supply of ng consumption increased by 20% from 1% to 1.2%, as shown in figure 3 in the supplementary file. figure 3: the fitted line of the electricity generated from oil. despite the increase in domestic demand for ng, because other energy sources have been replaced, especially petroleum products and coal, egypt has succeeded in achieving self-sufficiency regarding ng since september 2018 (lynx 2019), as shown in figure 1 in the supplementary file. the reason for this is the increase in production, especially at the zohr and atoll fields (amcham 2019). in 2020, egypt was considered the second largest producer of ng in africa, following algeria, and the fifth largest in the middle east according to bpsr data. in september 2018, with the recovery of gas prices, egypt resumed exporting ng in pipelines to jordan (lynx 2019; mop 2020). however, most egyptian exports of ng take the form of lng (70% of exports), benefiting from the lng port factories in idku and damietta (abbas et al. 2020). the fact that most of egypt’s ng is exported as lng, is in line with the global trend and expectations that the increase in demand for lng will exceed the demand for ng in general (egging et al. 2008). roar aune einar rosendahl and lund sagen (2009), as well as catalán (2016) ascribed this trend to three main factors. the first is the ability to transport lng a greater distance, making it cheaper compared to compressed ng. the second is the danger of using pipelines for long distances. the third is that the demand for ng is seasonal, while its production is not. this requires producers to raise their stocks to respond to changes in demand. the best way to store ng is to liquefy it. figure 4 in the supplementary file shows the progress of foreign trade in lng and its share in the world. the figure shows the strong correlation between egyptian trade in liquefied gas and its share in world trade. the correlation coefficient between them for export reached 97.8%, while import stood at 99.1%. this indicates that the change in egypt’s share in world trade regarding lng is linked to internal factors related to production and consumption rather than to global trade trends. figure 4: fit line of the gas consumption of the industrial sector (a-b). literature review in this section, three bodies of literature are considered to fill gaps in knowledge related to the objective of the study: identifying the phases through which producing lng passes along the supply chain, determining the main contributing factors affecting the trade of ng and lng, and introducing sd as a decision support tool. following the accelerating trend to replace oil and coal with ng in the energy systems in many countries in order to cut greenhouse emissions, many publications recognised the importance of analysing the whole value chain of lng. some publications determined the phases through which producing lng passes along the supply chain, while others determined the factors affecting lng trade in order to model it. egging et al. (2008) investigated the factors affecting a particular country’s exports of lng along the supply chain in 54 countries. the study stated the phases through which lng passes along the supply chain, starting at discovery and ending at consumption. these phases include discovery, production activities, pipeline and storage operations, liquefaction operations, regasification and storage, tanker transportation activities, related marketing activities and consumption for end use. related marketing activities include marketing operations related to production, transit and consumption. consumption in the end-use phase includes the residential, commercial, manufacturing and electrical energy sectors. this study highlighted the significance of all decisions related to the various phases affecting exports of lng performance. egging, holz and gabriel (2010) established a model to predict future directions in ng marketing in more than 80 countries covering 98% of the worldwide ng market. this study followed the same methodology as egging et al. (2008), while dividing the supply chain into more phases, as it divided the lng market into seven main players along the supply chain: producers, traders, storage operators, lng liquefiers, re-gasifiers, transmission system operators and consumption markets. roman-white et al. (2021) estimated emissions of lng along the supply chain with an application on cheniere energy’s sabine pass liquefaction (spl) that delivers production of lng from the united states to china. the study identified nine main operations along the lng supply chain and all of them result in emissions which need to be managed. these operations include production, gathering and boosting, processing, compression, transporting in pipeline, liquefaction, transport domestically and internationally, regasification and consumption. mishra (2016) stated that lng has become the preferred source of clean energy all over the world. therefore the effects of logistics innovations on lng global supply chains are analysed. the global supply chains for lng are divided into several stages, including exploration, followed by gas separation and processing, storage and liquefaction with transporting in pipelines, liquefaction, transporting in lng tankers, marketing and distribution, regasification and consumption for different purposes. conclusions confirmed that logistic innovations are critical in all stages along lng global supply chains. the review of previous studies regarding the main phases of the lng supply chain stated clearly that all of these studies agreed on the main phases in the lng supply chain. the lng supply chain has two main scopes of activities: an up-stream sector and down-stream sector. the up-stream sector includes activities of exploration and mining. the down-stream sector includes activities of processing, production, liquefaction, transportation, regasification and distribution of lng. all these activities need to be managed efficiently in order to improve the performance of the entire lng supply chain. barnes and bosworth (2015) explored the contributing factors of lng trade around the world, using a gravity model with random effects. they highlighted the significance of gdp per capita for both parties of trade, the percentage of gdp generated from producing ng for both parties of trade, the unemployment rate to control economic conditions, and the distance between the two parties of trade to accelerate the demand for lng. catalán (2016) investigated the main determinants of lng exports using gravity equations. the study illustrated the importance of gdp for both parties of trade, the distance between them, the share in other sources of energy in energy systems for both parties and the share of value added in generating gdp, as the industry is considered the largest consumer of ng. ackah (2014) analysed the main contributing factors of the ng market in ghana. two main contributing factors were added in this study. the first is related to the technological progress which, in turn, is related to the efficiency of using ng whether for production or heating. the second is household spending coupled with changes in consumer preferences. roar aune et al. (2009) assessed the implications of several scenarios regarding future market conditions on the ng global market until 2030. several contributing factors have been used to measure the demand and supply of ng. on the demand side, the main contributing factors were prices of all energy goods, per-capita gdp growth, population, electricity capacities, electricity price, and generation cost. the ng supply was formulated as a function of field characteristics, production costs, net producer prices after tax, the fields’ production capacity, investments in new fields and in reserve extensions, expected prices versus a pre-specified required rate of return, and total transportation costs, whether for lng, or in pipelines. ghorban (2006) inspected the contributing factors of the potential of gas pipeline exports from iran to the indian subcontinent. the study highlighted the significance of supply factors including ng reserves, investments directed to the development of the extractive sector, and the availability of the necessary infrastructure to export gas. nick and thoenes (2014) assessed the factors affecting ng prices worldwide. the study highlighted the significance of meteorology and long-term variations in the price of alternative sources of energy affecting the ng market. in a study mentioned earlier, egging et al. (2008) found the main contributing factors affecting a particular country’s exports of lng along the supply chain to be the total production ceiling, ng selling prices, regulated pipeline transportation costs, capacity of liquefiers, liquefaction costs, maximum lng liquefaction rate of lng liquefiers, the set and capacity of the shipping vessels, the set and capacity of lng re-gasifiers located in the country, as well as the set of storage operators located in the country. a review of previous studies identified the most important determinants of lng exports to be included in the model as: egypt’s gdp, population, rate of return on investment, electricity production by alternative sources (wind, solar, nuclear, hydro-electricity and renewable), electric power consumption and its growth, natural power consumption of end users (gas-powered vehicles, the petroleum sector, residential homes and the industrial sector), ng production, quantity of ng available for export, ng sales price, fixed costs required for the production of lng, and the increase in ng production from each cycle due to new discoveries. many factors combined to highlight the importance of understanding the behaviour of commercial, industrial and social systems by exposing the causal relationships between the different contributing factors and parameters. among these factors are the acceleration of dynamic changes in these systems, the complexity of the systems, and the confluence of several factors influencing their behaviour, considering the need to understand the functioning of these systems in the long term. this helps in making sound decisions, considering the existence of different alternatives to relevant policies (movahednasab, rashidinejad & abdollahi 2019). in response to these requirements, the system dynamics approach (henceforth sd) was designed by jay w. forrester in 1961 to help analyse the functioning of economic and social systems over time, taking into account their complex interrelationships (mudjahidin et al. 2019). in his study, forrester defined sd as: [t]he study of the information-feedback characteristics of industrial activity to show how organizational structure, amplification (in policies), and time delays (in decisions and actions) interact to influence the success of the enterprise. (langroodi & amiri, p. 206:232) system dynamics have been widely used to support decision makers in setting business policies in the fields of manufacturing, management, development and environmental studies, taking into account the dynamic environment of relationships (lee & chung 2012). system dynamics have their basics from feedback control and nonlinear dynamical system methodologies. the use of sd has become common in these sectors, as it allows the design of a dynamic model that is similar to real systems and provides the possibility of simulating reality. this facilitates the testing of proposed policies by developing many possible scenarios and evaluating their results, while allowing for the testing of possible changes in these scenarios dynamically during the specific period of simulation (mudjahidin et al. 2019). a system dynamics model consists of several interrelated variables. some of these variables are represented as stock variables while others as flow variables (langroodi & amiri 2016). the interrelations and feedbacks between variables in the system are represented as causal loops. a causal-loop diagram represents causally interrelated effects between variables in the system, using arrows connecting variables (lee & chung 2012). in each causal-loop diagram, any variable can be included as a constant, or as a function of other variables. the credibility of using sd in expressing the real system requires conducting several tests. some are prior to the design of the system, such as testing the interrelated effects between variables, and whether the variables are considered stocks or flows. some tests are done during the simulation process and others test the simulation output. however, most studies are conducting tests only on the final output of the simulation (mudjahidin et al. 2019). langroodi and amiri (2016) mentioned that since introducing sd models to the supply chain, it has been developed for use in many fields in the past decades. these fields include simulating some products in the supply chain such as food, the automotive industry, electrical and electronic equipment, the maintenance of military weapons, short-life-cycle products and information sharing. additionally, it is used in simulating value, adding to supply-chain demand planning, measuring the effectiveness of using electronic collaboration tools in the supply chain and simulating the planning of remanufacture. from the literature, there is little research on using sd in modelling the dynamics in the lng supply chain. this is especially valid when considering the recent discoveries and the egyptian liquefication stations with no similar stations nearby. also, there are huge reserves in the mediterranean sea near these stations. this creates a research gap for constructing a decision support model to study the dynamics of the lng industry in egypt to optimise the decisions regarding the export quantities and the present value of lng export in egypt. methodology in this section, the formulation of the model is presented. the general description of the model is shown in figure 1. the general relationships are described as follows: to compute the present value of the exports of lng, we need to find the annual sales, adjusted by the rate of return and the fixed cost investments. the present value of lng exports is dependent on the price forecast for lng export and the rate of return. the quantity of annual export is related to quantities in production, imports, and consumption. the surplus quantity from production and import after deducting local consumption, is exported. local consumption comes from the generation of electricity, industrial consumption, petroleum-sector consumption in producing other products, home use, and vehicle fuelling. ng is used to generate electricity when the electricity from renewable sources and oil are not enough to satisfy the demand. the following nomenclature is used:  wind electricity production at time t.  solar electricity production at time t.  nuclear electricity production at time t.  hydro-electricity production at time t.  renewable electricity production at time t. ρ(t) electric power consumption at time t. pp(t) egyptian population at time t. eg(t) electric energy required from gas at time t. eo(t) electric energy required from oil at time t. g(t) ng consumption at time t in residential homes. g1(t) ng consumption at time t in the gas industrial sector. g2(t) ng consumption at time t in gas-powered vehicles. g3(t) ng consumption at time t in the petroleum sector. l(t) local ng consumption at time t. p(t) ng production at time t. r consumption rate for each mwh when generated from ng. the result is the volume of ng required to generate 1 mwh. qe(t) ng quantity available for export at time t. qed(t) ng export demand at time t. qre(t) ng re-export quantity at time t. s(t) sale price per btu rr(t) rate of return at time t f fixed cost pv(t) present value of the project resulting from running the project for t years θ depletion cycle of ng mines in egypt δ ng production increase from each cycle due to new discoveries. starting at the electric energy generation, the total renewable energy generated at time t is defined as the total electricity production from wind, sun, nuclear, and hydraulic sources as these are the sources used in egypt. this is shown in equation (1): for the electric power consumption, a regression analysis is performed using population and time as independent variables. hence, the forecast of the electric power consumption is shown in equation (2) and figure 2: hence, the shortage in electric energy that needs to be generated can be formulated as shown in equation (3), assuming that the energy requirement is a priority that must be satisfied through generating electricity using ng or oil: a regression analysis is performed to estimate the electric energy generated from oil, knowing that the egyptian government adopted the policy of phasing out the use of oil in generating electricity. the independent variable is the population. hence, the electric energy generated from oil is estimated as shown in equation (4) and figure 3: other sources that consume ng in egypt include home usage, usage of vehicles powered by ng, industrial usage, and usage of the petroleum sector. for home usage, ng consumption at time t can be approximated, based on the historical data, by a multiple regression line. it is formulated with population and time as independent variables, as shown in equation (5) and figure 5 in the supplementary file: figure 5: forecast of ng production in egypt (a-b). for industrial usage, ng consumption at time t can be approximated, based on the historical data, by a regression function. it is formulated with gdp as independent variables as shown in equation (6) and figure 4: the usage of ng in vehicles and those in the petroleum sector can both be estimated by regression analysis with time as an independent variable as shown in equation (7) and figure 6 in the supplementary file; and equation (8) and figure 7 in the supplementary file, respectively: figure 6: comparing the simulation results versus the actual results for the quantity of gas available for export. figure 7: most optimistic case versus most pessimistic case. (a) effect on present value; (b) effect on export quantity. then the consumption of ng in given year t it is formulated as follows: the production forecast as shown in figure 5 is based on the assumption that ng production fluctuates in cycles of repeated increase, followed by decrease; hence one cycle is analysed as shown in figure 5b. this function is repeated in a cycle of 15 years with the value of production increased at a rate shown in eq (10). the number of cycles is expressed as the quotient resulting from dividing t by θ as in integer(t/θ), while the remainder represents the value to be used in the cycle represented as t\θ: the quantity available for export is defined as the minimum of the ng export demand and the quantity of ng available for export, where the quantity of ng available for export is the difference between production and consumption at time t as shown in equation (11): hence, the present value of the net profit is equal to the accumulation of the sale price, multiplied by the quantity of ng export, adjusted by the rate of return minus the fixed costs as shown in equation (12): the markov chain monte carlo (mcmc) simulation is used for a normal distribution to estimate the selling price. however, the forecast is not quite similar to the actual historical data. hence, we use the fit function as shown in figure 8 in the supplementary file for the natural liquid gas as a million dollar per billion cubic feet of ng. we select a logarithmic function assuming that the ng is so precious that the world may curb its rate of price increase. the complete model is shown in figure 1. as a validation for the model, the model is run, and the result of the simulation compared to the actual results for the quantity of gas available for export up to 2020 as shown in figure 6. it is observed that the simulation results are close to the actual data. hence, the model can be used to infer the effect of making decisions. numerical results in this section, the model is run several times to give insight into the effect of the different parameters on the dynamics of the lng exports in egypt. the factors studied in this section are the effect of investment in new discoveries, the effect of investment in renewable energy, the effect of population increase, the effect of gdp increase, export prices, and the re-export quantity. the present value and quantity of export are measured as output from the model. the parameters used in the numerical analysis are shown in table 1. table 1: the different values used in the numerical analysis for all the parameters. figure 7a and figure 7b show the performance of the model of the most optimistic versus the most pessimistic scenarios for the present value and the export quantity, respectively. it is observed that the lng industry outcome may vary from large quantities in export and large present value to a small quantity export and small present value. this emphasises the importance of making good decisions to optimise the performance of the model. figure 9a and figure 9b in the supplementary file show the effect of investing in new discoveries for the present value and the quantity of export, respectively, in case of no new discoveries, smaller than usual discoveries, and large discoveries. for the smaller than usual discoveries, 300 bcm are added instead of the 500 bcm per 15-year cycle increase, while for the larger than usual increase, we use 800 bcm increase per 15-year cycle. it could be observed that under the current operating conditions for the other factors, if egypt had not invested in new discoveries (including zohr), zero quantity would have been available for export from 2020 onwards and the present value would have been flat, as no exports would have taken place. if zohr and current discoveries increase the cycle of production by 300 bcf, which is smaller than expected, there may be a couple of years to import, followed by 8 years of export when this increase will not be sufficient for the nation’s consumption. while, if zohr and future discoveries turn out a higher production than expected (cycle-increase by 800 bcf), there may be enough to export in the coming 12 years. should similar new discoveries be made, the export of lng could be sustained. this is supported by the economic theory, according to which investment in new discoveries leads to an increase in the supply of ng, with an increase in potential exports of lng, assuming that the rest of the factors, affecting lng exports, remain unchanged. figure 10a and figure 10b in the supplementary file show the effect of investing in sources of renewable energy for the present value and the quantity of exports, respectively, in the case of normal investment and for a large increase, defined as 10% more energy than planned. it can be observed that the increase in investment in renewable energy is important in long-term planning, but not in the next 10 years, as the results of the investments will not mature until then. the feasibility of such investment is to be compared against the increase in the present value and the expected life of new investments. the significant effect of investing in renewable energy generation on lng export in the long run is supported by economic theory, especially considering that egypt adopted a tendency to export the excess supply after deducting domestic consumption. accordingly, substituting lng with renewable energy sources, especially for electricity generation and industrial sector purposes, will increase the excess supply available for export. however, this effect may be reversed in the short term, as directing investments to the generation of renewable energy may inhibit investment in discovering gas fields, and may reduce the supply of gas, negatively affecting the export of liquefied gas. figure 11a and figure 11b in the supplementary file show the effect of population increase on the present value and the quantity of exports, respectively, in the case of a normal increase and large increase defined as 10% more growth rate than planned. it can be observed that the increase in population, despite being one of the main sources of income in foreign currency, reduces the quantity and the number of years of exports, and reduces the present value. this can be explained theoretically by the existence of a direct relationship between population increase and energy consumption, knowing that electricity generation is the first consumer of ng in egypt. figure 12 in the supplementary file shows the effect of gdp change on the present value. it can be observed that the change in gdp is insignificant in affecting neither the gas consumption nor the quantity significantly. it does not affect the period of export and import. in our opinion, there are two possible explanations for that. the first is that the industrial sector responded to the lack of ng and the price increase by using more efficient equipment. the second reason is that the increase in gas consumption in the industrial sector is much smaller than that in the case of population increase (i.e. the gdp is not expected to increase rapidly and at the same time the efficiency of using ng in industry increases, unlike for the population and electric generation). also, in figure 13 in the supplementary file, lng export price affects the present value of lng export, but does not affect the quantity of lng export as the policy adopted in egypt was to export lng only when there is a surplus in domestic supply. figure 14a and figure 14b in the supplementary file show the effect of buying gas for the sake of re-export on the lng export present value and quantity, respectively, in the case of small, normal, and large increases. it can be observed that in the short term, the buying of ng for re-export increases both the present value and export quantitytrs, but all options result in a surplus in both. but for long-term planning, re-export is necessary to satisfy demand and generate revenue. this can be explained theoretically by the increase in ng supplied in the market to be liquefied for the purpose of being re-exported as lng which confirms the efforts made to establish long-term agreements for buying gas from neighbours to be re-exported after liquefaction. conclusion in this article, we present a sd model for the lng export quantities in egypt. new discoveries have been made locally along with nearby countries. it also has liquefaction stations that may be used to export its production of lng, as well as that of nearby countries. it is hence very important to analyse the dynamics of the elements affecting the quantities of lng exported. the model is based on historical data and is validated by comparing its results against the real-life results in historical data which turned out to be close. the model is run for the most optimistic and pessimistic scenarios and the results show that the export quantities and revenue vary drastically from large quantities for export with large profit to no exports with a need for imports. hence, the effect of different parameters is investigated to have a decision support system to make adequate decisions in future. it can be concluded that investment in new discoveries and in making a long-term agreement to buy gas for the sake of re-export are the recommended strategic decisions to consider. the feasibility of such decisions should be compared against the increase in revenues. however, not taking consistent action in these directions will lead to large shortage in a decade. investments in renewable energy generation and in decreasing the home usage patterns come next in importance. the impact of renewable energy takes effect slowly and is still not as reliable as ng. also affecting the population size or teaching the population to consume the ng more efficiently is not a guaranteed policy to adopt. despite being less important, these shouldn’t be neglected. finally, the export price and the gdp change are not affecting the export quantity in our model. this is explained stating that the change in egypt’s share of lng world trade is linked to internal factors related to production and consumption more than it is to global trade trends. the reason is the tendency in egypt to export the domestic surplus, knowing that electricity generation and the industrial sector dominate ng consumption in the country as mentioned before. possible future research includes the analysis of the other trend in exporting electricity rather than just exporting lng. acknowledgements competing interests the author(s) declare that they have no financial or personal relationship(s) that may have inappropriately influenced them in writing this article. authors’ contributions all authors contributed equally in all aspects of the research. ethical considerations this article followed all ethical standards for research without direct contact with human or animal subjects. funding information this 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accepted: may 2015 despite the widespread use of pay incentives to drive performance, few studies empirically demonstrate their long-term benefits within work-team settings in field studies; even fewer studies incorporate hybrid pay incentives in their design. this longitudinal field study explored the effects on individual work performance of allocating tellers to teams with supervisors who received hybrid pay incentives, where 60 per cent of their incentive was based on the individual performance of each of their team members and 40 per cent on their own performance. it was conducted on bulk-cash tellers working in 19 centres, using a time-series design. the results, derived from quantitative data collected from 82 individual tellers over 24 months, showed that hybrid pay incentives for supervisors of teams of tellers, some of whom were individually incentivised, were associated with significant increases in the volume, speed and accuracy of deposit processing by all the tellers. the findings empirically demonstrate the long term sustainability of improved performance associated with the introduction of hybrid pay incentive structures within work teams. key words: pay incentives, hybrid incentives, team work, interdependencies, longitudinal filed study jel: m52 1 introduction the competitiveness of a firm within a chosen market space depends significantly on how the firm best uses its resources (coff & kryscynski, 2011; shaw, park & kim, 2013). for a large number of firms, a key resource to manage is labour (crook, todd, combs, woehr & ketchen, 2011); it is thus critical for firms to explore practices which support labour productivity improvements (ployhart, weekley & ramsey, 2009). in most firms, work is designed such that it is performed using collaborative effort amongst people, and also between people and machines (messersmith, patel, & lepak, 2011). in firms where labour is a key resource, collaboration happens between people working alone and people working in teams. despite the prevalent assumption that all the people within the firm are working towards the firm’s desired goals, individuals and groups within the firm cooperate and compete in different ways as they apply themselves to their tasks (maruyama & elliot, 2012), resulting in different levels of output despite similar contexts. the challenge for organisations is to create the balance between collaborative and competitive tendencies for individuals within their firms. this is at the heart of how firms can optimise human resource efforts in support of the firm’s objectives (wagner, humphrey, meyer & hollenbeck, 2012). this study examines the effectiveness of combining team design and incentive methods to increase the performance levels of staff over time. 2 literature review teams have been described and classified using various heuristic frameworks (cohen & bailey, 1997; hollenbeck, beersma & schouten, 2012; mathieu, tannenbaum, donsbach & alliger, 2014). cohen and bailey described work-teams as “... continuing work units responsible for producing goods or providing services. their membership is typically stable, usually full-time and abstract 464 sajems ns 18 (2015) no 4:463-474 well defined” (cohen & bailey, 1997:242). most of the units within work places which are controlled through some form of supervision would be classified as work teams. according to banker, field, schroeder and sinha (1996), in traditional work teams, members of the team engage in tasks allocated to them by the supervisor or manager, who has overall control over the allocation of resources and targets, and who controls the flow of work to team members. teams possess boundaries (cohen & bailey, 1997; guzzo & dickson, 1996), which are circumscribed by their team membership definition. teams consist of “... individuals who see themselves and who are seen by others as an intact social entity” (cohen & bailey, 1997:241) and teams are “... individuals who share responsibility for outcomes” (cohen & bailey, 1997:241). practitioners and scholars recognise the team as an important organisational work-form to deliver performance improvements within firms (beersma, hollenbeck, humphrey, moon & conlon, 2003; mathieu, maynard, rapp & gilson, 2008). teams in firms exist at many hierarchical levels and business units (lepine, piccolo, jackson, mathieu & saul, 2008). teams differ in focus, comprising work teams, management teams, project teams among others (cohen & bailey, 1997). studies on the impact of teams on performance include those at the team level, the organisational level within laboratory settings and in “live” working environments (banker et al., 1996; guzzo & dickson, 1996). despite some scepticism on the effectiveness of teams on performance (allen & hecht, 2004) the overriding usefulness of teams in improving performance, contingent on other local factors, is largely undisputed in practice or in the research carried out on teams (devine, clayton, philips, dunford, & melner, 1999; lepine et al., 2008; wageman & baker, 1997). various studies and meta-reviews have focussed on the effects of pay incentives on performance improvements for teams and individuals (barnes, hollenbeck, jundt, derue & harmon, 2011; jenkins, mitra, gupta, & shaw, 1998; mathieu et al., 2008). some studies have looked at the effects of a combination of reward systems in different types of teams (beersma et al., 2003). in general, the studies highlighted the positive influence of the judicious use of the combination of individual and team-based pay incentives on performance. the studies also highlighted the indirect relationships between pay incentives and performance − emphasising the role of intervening variables, such as motivation and goal setting. however, no research could be found in a longitudinal field setting to determine changes in individual performance levels over time after supervisors are incentivised, partially based on their individual team members’ performance i.e. via hybrid incentives. this is the objective of this research. firms tend to structure financial incentives in the hope they will support their desired outcomes (jenkins et al., 1998; wagner et al., 2012). part of the intention in the deliberate structuring of rewards by firms is to support the necessary level of interdependencies within and among teams, and among individuals (jenkins, et al., 1998; wageman, 1995; wagner, et al., 2012). despite the prevalence of work teams within organisations (devine et al., 1999), extant literature shows a gap in studies on the combined effects of direct and hybrid pay incentives on team performance over time. in addition, studies which examine change in performance through time are lacking within the team literature (bell & marentette, 2011; ployhart & vandenberg, 2010; stewart, 2010; sonnentag, 2012). this study draws on the extant literature on cooperation and competition (e.g. beersma et al., 2003; deutsch, 1949), pay incentives and performance (barnes et al., 2011; jenkins et al., 1998) as foundations to examine the effects of both individual team-member pay incentives, and supervisor-level hybrid pay incentives in work-team performance over time. according to the 2012-2013 global competitive index “sub-saharan africa as a whole lags behind the rest of the world in competitiveness, requiring efforts across many areas to place the region on a firmly sustainable growth and development path going forward” (world economic forum, 2012). in south africa, a relatively high level of of labour use within production environments predominates; this dependence on labour is expected to continue, as a means of creating employment. unionisation of labour in south africa is very well developed (vietor, 2007), and is supported by two pieces of legislation: the labour relations act of 1995; and the basic conditions of employment act of 1997. firms which operate within the south african sajems ns 18 (2015) no 4:463-474 465 environment and all firms which rely on labour productivity as a competitive advantage, need to continue to find productivity improvement mechanisms if they are to be sustainable. the use of pay incentives within teams is one of these options. the literature on interdependent work teams and the literature on pay incentives suggest that specific combinations of these two variables result in predictable performance output and improvement (barnes et al., 2011; cohen & bailey, 1997; jenkins et al., 1998; mcgrath, 1984; milkovich & newman, 1999; wageman & baker, 1997). over the years, studies on teams have progressed from research conducted within experimental settings using largely static group compositions (peters, chassie, lindholm, o’connor & kline, 1982), to studies based in field settings (cummings, 2004; gladstein, 1984). more recent research has incorporated the effects of the environment and team composition (ancona & caldwell, 1992; kouchaki, okhuysen, waller & tajeddin, 2012) as well as the incorporation of temporal effects in team studies (marks, mathieu, & zaccaro, 2001; mohammed & nadkarni, 2011). some research has shown that the outputs of work-team members can be influenced through the use of individual incentive rewards, and that group outputs can be influenced through the use of collective incentive rewards systems (allen, sargent & bradley, 2003; condly, clark & stolovitch, 2003; wageman, 1995). the incorporation of these variables in studies has improved the understanding of the complexity of team functioning. several theoretical foundations drive the approaches to compensation and performance, the most prominent of these being individual motivation. motivation theories can be broken down into three categories: intrinsic motivation theories such as expectancy theory; extrinsic motivation theories such as reinforcement theory (komaki, coombs, & schepman, 1996); and interactive factor theories such as social and information processing theories (milkovich & newman, 1999) which focus largely on internally-driven derivations of performance outcomes. expectancy theory is premised on the notion that people are inclined to link their efforts to particular expectations of reward or performance outcomes. proponents for the use of financial incentives associate performance improvements with their use via the reinforcement of “desired behaviours” in employees (jenkins et al., 1998). some employers successfully use financial incentives to reward positive “marginal” productivity variances of employees and to reduce the costs associated with dysfunctional behaviours of employees (abelson & baysinger, 1984; jenkins et al., 1998). in a quantitative meta-review of 39 studies on the relationship between financial incentives and performance, jenkins et al. (1998) found that, although financial incentives were somewhat associated with increased individual performance quantity, this relationship did not exist with performance quality. research has also shown that to employees, in addition to their monetary value, incentives are also perceived as a source of recognition and status (steer, porter & bigley, 1996; jenkins et al., 1998). however, other researchers have argued the negative effects of financial incentives where the incentives appear to reduce intrinsic motivation (eisenberger & cameron, 1996; kohn, 1993), the selfdetermination of employees (deci & ryan, 1985) and desirable risk-taking behaviours of the employees (jenkins et al., 1998). various studies have been carried out on the use of incentives within the team structure (barnes, et al., 2011; beersma et al., 2003; shaw, gupta & delery, 2002) often with contradictory findings. wageman and baker (1997) found that, while incentives were important to performance, the effects were linked to task interdependence, which affected cooperation within the team. beersma et al. (2003) investigated the intervening roles of task dimension, team composition and individual performance levels and found that a competitive (individual) reward structure enhanced the task dimension of speed, while a cooperation (group) reward structure enhanced the task dimension of accuracy. however, in a meta-study on the effects of incentives on workplace performance, condly et al. (2003) found that team incentives were more highly associated with performance outcomes as opposed to individual incentives and that both quantity and quality dimensions of performance were positively correlated with incentives. 466 sajems ns 18 (2015) no 4:463-474 hybrid or interdependent incentives represent any combination of individualand groupbased incentives which organisations can employ, depending on the types of teams present and the levels and types of interdependence present within the team. these and many other intervening variables such as task structure and reward structures (wageman & baker, 1997; crawford & lepine, 2013) and autonomy preferences (wageman, 1995; wagner, et al., 2012) make the structuring of incentive programs highly complex. a number of researchers (barnes et al., 2011; beersma et al., 2003; shaw et al., 2002) advocate the use of hybrid incentive schemes as the ideal mix to use within the team structure, as hybrids provide the best combination of the benefits accruing from individually motivated effort and group-based extrinsic effects and reinforcement (dematteo, eby, & sundstrom, 1998; kozlowski & ilgen, 2006). however, hybrid incentives were also shown to present their own difficulties, most prominent of which is the potential to increase social loafing and the “free-rider effect” (barnes et al., 2011; karau & williams, 1993). the literature reveals wide support for the role of work teams in performance improvement within organisational settings (guzzo & dickson, 1996; stewart, 2006; 2010). there exists empirical support for the roles of interdependent rewards as an important intervening variable in the relationships between work teams and performance (johnson & johnson, 2005; wageman & baker, 1997). theoretical support for the foundations of these inter-relationships is to be found within the seminal goal interdependence theory of deutsch (1949) of cooperation and independence categorised situations which, when structured in one way lead to cooperation, while when structured in another , lead to competitive behaviour. empirical research has also demonstrated the indirect, but positive impact of pay incentives on work team performance. the indirect effects of pay incentives on performance have been shown conceptually and empirically to be mediated by intrinsic and extrinsic motivation (barnes et al., 2011; jenkins et al., 1998; wagner et al., 2012). 3 research objectives the use of pay incentives is ubiquitous in practice. although the effects of incentives in support of performance improvements have been shown in teams, the literature does not give adequate empirical evidence in longitudinal field studies which investigate the following questions: 1) do combinations of hybrid and direct incentives lead to performance improvements in work teams in terms of speed and accuracy; 2) if there is improvement in performance within these work teams and if so, is this performance sustainable? finding answers to these questions are the objectives of this study which are further developed into hypotheses in the methodology section. using an interrupted time-series design, the study investigated performance improvement sustainability within teams based on quantitative analysis of three measures of individual tellers’ performance. this study set out to examine the effects of using incentives to enhance team performance through the alignment of overall team goals by using a combination of individual team member pay incentives based on their own performance and a hybrid incentive pay structure for team supervisors based on a combination of their own and their team members’ individual performance. therefore the research sought to determine the effects on team member performance over time, of introducing a combination of individual pay incentives and hybrid pay incentives for supervisors. the research was designed to compare and explain changes in individual team members’ performance measures over the duration of the study. 4 method the research used an interrupted time-series design. it is classified as quasi-experimental research (huysamen, 2001) as an intervention was introduced in a field setting without laboratory controls. in line with recommendations for studies with a longitudinal design (ployhart & vandenberg, 2010) baseline data was collected for tellers for a period of six months prior to the intervention, which was the introduction of teams and hybrid pay incentives for team supervisors. following the introduction of this intervention, daily performance measures for all the tellers were tracked and sajems ns 18 (2015) no 4:463-474 467 accumulated monthly for an additional period of 18 months, so that in all, 24 months’ data was collected and analysed. the study involved the individual daily tracking of volume, speed and accuracy measures of the deposit-processing performance of all 480 semi-skilled tellers (the population) who worked for a firm in bulk-cash-processing centres. these are dedicated cash deposit handling sites, designed to cater for businesses which have large value cash deposits. this study was conducted in 19 such depots located in various geographical locations around south africa. approximately 70 per cent of the tellers were permanent employees who qualified individually to receive pay incentives for reaching target performance levels in terms of volumes, speed and accuracy of deposits processed (the other tellers were contractors and did not qualify for this direct incentive). the total number of tellers (both permanent and contract) who remained for the duration of the study was 82 (designated the sample) and thus only their data was used for data analysis. in the intervention, approximately six tellers (a mix of contract and permanent tellers) and one supervisor were assigned to a team, based on the historical performance of the tellers, as a means to achieve comparable team composition. the teams had a moderate level of task interdependence. in addition, a hybrid pay incentive structure was introduced for supervisors whereby 60 per cent of their pay incentive bonus was based on the performance ratings of the individual tellers in their teams, while the remainder was derived from the ratings that the tellers within teams gave of their own supervisors. the allocation of tellers and supervisors into teams where the supervisor received a hybrid incentive (i.e. a pay incentive based on components of both individual effort and group effort) was designed to achieve better goal alignment within the team in the hope of achieving sustainable improvements in the performance of individuals within the teams. data on the number of deposits, the deposit value processed, and the time taken by the teller to process each deposit was collected and stored electronically. in addition, a journal of the number of errors made by each teller when processing each deposit was logged on the system to determine their levels of accuracy. all the collected data for the 24month period of the study was processed at monthly intervals to calculate the volume and speed of processing cash deposits and the accuracy with which deposits were counted. this data was aggregated into four periods of six months each by calculating the mean value across the values that were present. the four periods are described as follows: time 1 covered six months before the intervention during which teams and hybrid incentives for supervisors were introduced, with this time period serving as a baseline reading prior to the intervention; time 2 covered the period 1-6 months post intervention; time 3 was 7-12 months post intervention; and time 4 was 13-18 months post intervention. the allocation of tellers and supervisors into teams was expected to create greater structural interdependency and boundaries for each team, resulting in an improvement in the performance variables being measured. accordingly, improvements were expected in the performance measures of speed, volume and accuracy of deposit processing by both regular and contract tellers. it was postulated that, motivated by the hybrid pay incentive structure, supervisors would try to earn maximum pay incentives by attempting to maximise the individual tellers’ performances by “stretching” teller effort for maximum performance. hybrid pay incentives for supervisors were also likely to encourage intra-team support, and improved coordination efforts by supervisors towards their tellers. 5 research hypotheses the introduction of the intervention was expected to result in increases in the average monthly speed with which deposits were processed, the volumes of deposits processed and the accuracy of processing. these improvements were expected to be consistent for all tellers within the teams, regardless of their employment contract which determined whether or not they received individual bonuses, based on the overriding influence of the supervisor, and the influence of the hybrid pay incentives earned by the supervisor. the following research hypotheses were advanced, based on the literature previously discussed and the research design: 468 sajems ns 18 (2015) no 4:463-474 h1: the average number of deposits processed per unit time per teller (speed) will show an improvement from six months before the introduction of the intervention to 18 months following the introduction of the intervention. h2: the average number of deposits processed (volumes) will show an improvement from six months before the introduction of the intervention to 18 months following the introduction of the intervention. h3: the average number of errors (accuracy) will show an improvement from six months before the introduction of the intervention to 18 months following the introduction of the intervention. 6 data analysis the main technique used for testing the hypotheses was repeated measures analysis of variance (anova), computed using statistica software v12® (statsoft). the significance level used in this study is .05. in the data preparation phase, the extremely skewed nature of the speed measure was addressed firstly by removing outliers using the grubbs test, and thereafter applying a square root transformation to achieve an approximately normal score distribution. scatterplots were used to check the data set for the linearity assumption of the relations. furthermore, missing monthly data points were accommodated by changing the unit of analysis from 24 monthly values per teller to four six-monthly values per teller (time periods 1-4 as described previously) wherein the value within a six-month time period was the mean of the values over the six months in that period per teller. violations of the sphericity assumption of the repeated measures test, as shown by significant values on mauchly’s test, were addressed by using the greenhouse-geiser technique which uses conservative estimations of the degrees of freedom to interpret significance levels and partial ƞ2 effect sizes (field, 2013). finally, the more robust multivariate analysis method using pillai’s trace criterion was used to confirm the greenhouse-geiser adjusted univariate test results, with post hoc tests and mean plots used to evaluate the significance and direction of the means over time. 7 results hypotheses 1-3 were designed to test improvement after the intervention over time in three measures of performance of all tellers, irrespective of their employment status (permanent or contracted). testing the employment status (individual teller incentives) effect the underlying assumptions in testing these hypotheses were that there would be no significant employment status effect (i.e. main effect) and that the effect of the intervention of teams and hybrid supervisor incentives on teller performance would not differ depending on whether the tellers were getting individual incentives or not (i.e. no interaction effect). the assumption of a non-significant employment status main effect was supported by non-significant between subjects f ratios with p values of .19, .92 and .17 and low effect sizes (ƞ2 ranging from .00 to .02) for speed, volume and accuracy respectively. the assumption of non-significant interaction effects was supported both by the greenhouse-geiser adjusted univariate tests and the multivariate test using pillai’s trace criterion, with greenhouse-geiser within subjects adjusted p values for speed, volume and accuracy of .47, .31 and .53, and p values for pillai’s trace of .43, .12 and .29 respectively. thus no differences were found in how the intervention, described above, affected the two types of tellers. thus the underlying assumptions were supported. this in itself is a major finding. effects of introduction of teams and hybrid incentives for supervisors the results of the anovas are shown in table 1, presented as a summary of the tests of hypotheses 1-3, omitting main and interaction effects as discussed above. as shown in table 1, both the greenhouse-geiser adjusted univariate tests and the multivariate test using pillai’s trace criterion are significant (p <.001) for testing changes in the speed, volume sajems ns 18 (2015) no 4:463-474 469 and accuracy means over the four time periods. moreover the effect sizes for these tests are moderate to high with values for partial ƞ2 ranging from ƞp 2 = .18 to .47 for the adjusted repeated measures anova results, and ƞp 2 = .32 to .64 for the multivariate anova results. this means that between 18 per cent and 47 per cent of the variance in the performance indicators considered separately, or between 32 per cent and 64 per cent of the variance in the performance indicators considered jointly, are explained by changes over the four time periods. table 1 tests of hypotheses of changes in teller performance measures over 24 months performance indicators tests of within-subjects effects test of repeated measures assumption multivariate tests greenhouse-geisser mauchly's test of sphericity (df=5) pillai's trace f df p ƞp 2 mauchly's w p green house geisser ε f df p ƞp 2 speed 17.3 2.49; 184.01 <.001 .19 0.69 <.001 .83 11.54 3;72 <.001 .32 volume 17.8 2.20; 178.30 <.001 .18 0.58 <.001 .73 14.41 3;79 <.001 .35 accuracy 72.7 1.73; 140.39 <.001 .47 0.33 <.001 .58 45.91 3;79 <.001 .64 furthermore, bonferroni post hoc comparisons of the mean differences from time 1 to time 4 (i.e. from six months prior to the team intervention to 18 months after) showed significant differences (p<.001 throughout) in the direction of increased productivity for the speed, volume and accuracy measures. to support these findings, figures 1-3 show the mean values and 95 per cent confidence intervals for the three performance indicators, shown on the vertical axes, over the four time periods, shown on the horizontal axes, corresponding to hypotheses 1-3. speed was measured in seconds. volumes and accuracy were statistically mapped onto rating scales with a maximum value of 4. figure 1 is the means plot for speed of deposit processing over the four time periods, operationalised as the average time taken to process a single deposit. this graph shows a decrease in time, i.e. an improvement in the average time taken to process a single deposit over the first three time periods, with a marginal but non-significant negative change from time 3 to time 4 (p=.99). figures 2 and 3 respectively are means plots for volumes and accuracy ratings over the four time periods, and both show a monotonic trend in performance improvement over the four time periods. in summary, in all three measures of performance, the post hoc mean comparisons between times 1 and 4 are significant, and the changes in these mean values are in the direction of increased productivity. thus the substantial time effect, together with the increases in the three productivity measures over time, are all evidence for supporting the three hypotheses of the research. figure 1 means plot for average time per envelope processed vertical bars denote 95% confidence intervals time 1 time 2 time 3 time 4 time 55 60 65 70 75 80 85 90 95 100 105 110 sp ee d ( se co nd s) 470 sajems ns 18 (2015) no 4:463-474 figure 2 means plot of volume ratings figure 3 means plot for accuracy ratings 8 discussion the basis for this study was that as the use of pay incentives is ubiquitous in practice, it is in the interests of both practitioners and scholars to examine more fully some of the effects of these incentives on performance of team members over time in a field setting. thus the research was designed to compare and explain changes in individual team members’ performance measures for the duration of the study after being put into teams, and their immediate supervisors’ being given a hybrid incentive scheme, dependent on both their own and their team members’ individual performances. the first major finding was that the effect of the hybrid incentive on the team supervisors affected the performance of both employees on permanent employment contracts who received individual incentives and employees on renewable fixed-term contracts, who received no such incentives, in the same way. there was no significant difference between the two groups’ responses when these individuals worked within a combined team structure in which the team supervisor received hybrid pay incentives. both types of tellers’ performance on the three variables increased to the same extent. this generalisability of hybrid incentives has never previously been demonstrated in the research literature (jenkins et al.,1998; johnson & johnson, 2005; wageman & baker, 1997; condly et al., 2003). this overall positive main effect of team allocation and giving supervisors incentives based on individual team members’ performance adds to the field of knowledge in the remuneration field. vertical bars denote 95% confidence intervals time 1 time 2 time 3 time 4 time 1.0 1.5 2.0 2.5 3.0 3.5 4.0 vo lum es ra tin g vertical bars denote 95% confidence intervals time 1 time 2 time 3 time 4 time 1.0 1.5 2.0 2.5 3.0 3.5 4.0 ac cu rac y r ati ng sajems ns 18 (2015) no 4:463-474 471 the second major finding was that within the setting for this study allocating tellers into teams and providing hybrid pay incentives for team supervisors affected teller performance positively, as measured by improvement in the three measures of teller performance: speed, volume and accuracy of deposit processing. speed and volume were proxy for performance quantity and accuracy for performance quality. complex tasks have been shown by beersma et al. (2003) to require a combination of speed and accuracy but elliot, helsen and chua (2001) have shown that there is a trade-off between speed and accuracy when performing these tasks. in their meta-study, jenkins et al. (1998) showed that incentives appear to have different influences on the degree of emphasis on quality and quantity, i.e. speed and accuracy in teams. however condly et al. (2003), following a review of studies on the effects of incentives on team performance, found that incentives positively affected both task speed and task accuracy. this study’s findings concur with condly et al. (2003) and extend his findings by showing that the allocation of both individually incentivised and non-incentivised tellers to teams with supervisors who had hybrid pay incentives was associated with improvements in both the quality (accuracy) and the speed of task accomplishment (speed of processing deposits and volumes processed). the trade-off did not occur for both types of tellers. this makes a contribution to the literature. the third major finding was that all three hypotheses were supported. the positive improvements in all three measures of performance were sustained for eighteen months after the introduction of the intervention. this study found consistent and sustainable performance improvement associated with the structural interdependence conferred by the work-team structure and supervisor hybrid pay incentives. studies by cohen and bailey (1997), stewart and barrick (2000), wageman (1995) and wageman and baker (1997) have all shown that task types and the design of tasks in teams affect team performance. the structure of the incentive program itself (e.g. hybrid versus individual incentives) has been shown (wageman & baker, 1997; jenkins et al., 1998) to act as an intervening variable between incentives and performance. the findings of this study support and extend these studies. the duration of the study, the field setting, the large sample size and the number of variables measured enhance the validity and contribution of these findings. 9 conclusion the structuring of incentive programs is highly complex and has thus been the subject of much research in the compensation field (barnes et al., 2011; beersma et al., 2003; shaw et al., 2002). this study offers insights on the effects of hybrid pay incentives, how incentives can be structured and the consequences of this structuring within work-teams. the study shows that placing employees into teams with moderate levels of task interdependence and simultaneously putting into place hybrid pay incentives for the team supervisors are useful levers to encourage sustained improvements in employee performance, irrespective of whether they are individually incentivised or not. in south africa, effectively incentivised self-regulating work-teams present an opportunity for increased productivity within labour-intensive settings. these teams provide a platform to reduce the levels of senior management oversight required. for remuneration practitioners, this study offers an opportunity to consider the re-design and/or the introduction of incentivised team-based remuneration structures which may reduce the protracted annual wage negotiations that are common in various sectors of the south african economy. 10 limitations and recommendations the limitation of this study to teams within bulk-cash processing centres in south africa affects the ability to generalise these findings, which in turn offers an opportunity to replicate the study on work-teams in other industry settings. there is an 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[accessed 2015-11-13]. abstract introduction theory and hypotheses methodology results discussion conclusion acknowledgements references about the author(s) mark bussin gordon institute of business science, university of pretoria, pretoria, south africa albert wöcke gordon institute of business science, university of pretoria, pretoria, south africa benno deysel gordon institute of business science, university of pretoria, pretoria, south africa citation bussin, m., wöcke, a. & deysel, b., 2023, ‘the impact of remuneration governance on chief executive officer overpayment’, south african journal of economic and management sciences 26(1), a4860. https://doi.org/10.4102/sajems.v26i1.4860 original research the impact of remuneration governance on chief executive officer overpayment mark bussin, albert wöcke, benno deysel received: 27 sept. 2022; accepted: 30 jan. 2023; published: 17 mar. 2023 copyright: © 2023. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: chief executive officer (ceo) payment and company performance are highly controversial, and existing research has focused on this link for decades. the study was conducted in south africa where corporate governance regulators have introduced measures to improve the relationship between ceo pay and performance. aim: this research aimed to explore the problem by extending pepper and gore’s (2015) behavioural agency theory to examine the moderating effect of remuneration governance on the ceo pay – company performance relationship. setting: the study focused on the top 100 listed companies in which several regulations concerning ceo pay were introduced, which provided the opportunity to examine such regulations on the alignment of ceo pay and company performance. method: panel data from 67 company annual reports were analysed over two decades with 871 datapoints, divided into three periods corresponding with the introduction of regulations. analyses included corrected panel standard errors and estimated generalised least squared hierarchical multiple regression and moderated multiple regression analyses. results: results showed a statistically significant positive relationship between company performance measures and total ceo remuneration (including long-term incentives [ltis]) for each of the three periods. we found that ltis tied to performance-vested criteria and ceo minimum shareholding do enhance pay-performance sensitivity. results further suggest that the behavioural agency theory is incomplete and researchers should consider the role of remuneration governance in moderating ceo overpayment. conclusion: remuneration governance should be refined through the inclusion of retrospective ceo remuneration disclosure to increase pay-performance sensitivity. contribution: this research contributes to knowledge of ceo payment and company performance. keywords: ceo remuneration; pay-performance sensitivity; corporate governance; share-based payments; behavioural agency theory; ceo overpayment. introduction research on chief executive officer (ceo) remuneration originates from the agency theory (jensen 1986; jensen & meckling 1976), which holds that the interests of ceos could be aligned with those of shareholders through long-term incentives (ltis) and increased monitoring. more recently, scholars have expressed frustration at the agency theory’s lack of applicability in explaining a relationship between company performance and ceo remuneration (e.g. boyd & solarino 2016; bussin & modau 2015; hou, priem & goranova 2017; jensen & meckling 1976; martin, wiseman & gomez-mejia 2016; martin, wiseman & gomez-mejia, 2019). drawing on wiseman and gomez-mejia (1998), pepper and gore (2015) proposed seven constructs that form the foundation of the behavioural agency theory. the behavioural agency theory focuses on the role of motivation and behavioural responses from ceos to changes in remuneration package design that are linked to company performance outcomes. there is a shift from assumed rational agent behaviour to bounded rationality in response to loss aversion (bosse & philips 2016; wiseman & gomez-mejia 1998). in the present study, we extend the pepper and gore (2015) model through introducing remuneration governance as a novel moderator in preventing overpayment of ceos. their remuneration is considered excessive when movements do not follow company performance, and the unjustifiable outcomes are likely to be seen as overpayment (kaplan 2008). over the past two decades, ceo remuneration has been under the spotlight in south africa and significant governance regulations were introduced (bussin 2016; institute of directors in south africa 2002, 2016). this has provided us with the opportunity to measure the impact of these, and similar regulations, on overpayment of ceos and to introduce them as potential moderators or mediators in the pepper and gore (2015) model. remuneration governance is linked to pepper and gore’s (2015) process of goal setting, contracting, and monitoring, but focuses on the role of three specific behavioural factors, performance-based lti vesting criteria (pvc), ceo minimum shareholding requirements (msr) and voluntary additional retrospective ceo remuneration disclosure (ret), in moderating the relationship between total ceo remuneration and company performance. leading up to the emergence of remuneration governance, it is argued that two key events significantly impacted the ceo remuneration domain. firstly, the 2000 to 2001 dot.com bubble, fuelled by speculation in technology shares, coupled with a rapid rise in the use of ltis (frydman & jenter 2010), culminated in company bankruptcies due to failures in corporate governance and fraudulent accounting practices (kaplan 2008). secondly, the global financial crisis of 2007 to 2009, fuelled by excessive risk-taking and financial engineering, altered society’s view of the robustness of companies and financial markets, while amplifying the importance of effective corporate governance such as company monitoring and increased disclosure of remuneration (greenwood, landier & thesmar 2015). these two events led to rapid global development of revised corporate governance regulations (beber & pagano 2013; berger, kick & schaeck 2014). these include the promulgation of the us-based 2002 sarbanes oxley act and similar regulatory changes globally, such as revised versions of the south african king code of corporate governance (king ii, king iii, and king iv) and a global set of new accounting standards for share-based remuneration (sbr; kaplan 2008). concurrent with these events, research on ceo remuneration identified the influence of behavioural economics on the research domain. research on behavioural economics, anchored in the behavioural agency theory (pepper & gore 2015; wiseman & gomez-mejia 1998), identified remuneration package design factors that cause behavioural responses in ceos. these behavioural factors include (1) deferral of ceo remuneration ltis, dependent on the company meeting pvc; and (2) the requirement that ceos hold a minimum number of shares (msr) to manage information asymmetry. the research findings on these behavioural factors, once incorporated into corporate governance recommendations, were then adopted by certain remuneration committees (remcos) to refine the alignment of ceos’ and shareholder interests (bettis et al. 2010; martin et al. 2016). when a company does not adhere to the suggested practices, it is likely that the ceo’s variable remuneration is not linked to company performance and therefore is overpaid (kaplan 2008; kaplan & rauh 2010). conversely, a remco’s implementation of these behavioural factors as part of remuneration governance, leads to greater pay-performance sensitivity and therefore reduces possible ceo overpayment. revised corporate governance and legislative requirements, at a fundamental level, were aimed at renewed alignment of agents’ and principals’ interests through revised agent behaviour. in south africa, this led to the issuing of the third edition of the king code of corporate governance (king iii) (institute of directors in south africa 2009). king iii moved from king ii’s pure rule-based remuneration disclosure requirements, to the introduction of a principle that prescribes a clear link to be established between company performance and ceo remuneration. the new regulations incorporated global research on behavioural economics to drive closer interest alignment through risk and goal alignment (cf. pepper & gore 2015). a further key aspect introduced in phases across jurisdictions was a formal ‘say-on-pay’ rule. this rule requires a separate, non-binding advisory vote in respect of executives’ remuneration. in south africa, this was introduced in king iv, effective from 2018 (institute of directors in south africa 2016). in the present study, it is argued that this forms part of a shift in remuneration governance that spurred remcos to employ behavioural factors in remuneration contracts to satisfy shareholders’ demand for a closer pay-performance relationship. these behavioural factors could be seen as proxies for increased remuneration governance. the regulatory interventions, in south africa under the helm of king iii and king iv, fundamentally intensified remuneration governance as a key focus. it enabled shareholder activism as a dynamic force by empowering shareholders through relevant information (almazan, hartzell & starks 2005; cai & walkling 2011; goranova & ryan 2014), and introduced a complementary regulatory environment for remcos in enhancing pay-performance sensitivity and reduced ceo overpayment (gregory-smith, thompson & wright 2014). theory and hypotheses using the behavioural agency theory (pepper & gore 2015; wiseman & gomez-mejia 1998) as a primary theoretical base, this article focuses on the influence of behavioural and information economics, on interest alignment between the agent (the ceo) and the principals (the shareholders), in preventing possible ceo overpayment. chief executive officer remuneration is considered excessive when viewed in relation to company performance, and the unjustifiable outcomes likely to be seen as overpayment (kaplan 2008; kaplan & ruah 2010). the agency problem the relationship between company performance and total ceo remuneration first became relevant following the widespread establishment of companies as legal entities and the resultant division of labour in the 18th and 19th centuries. company shareholders as principals set strategic goals, such as growth and profitability, while entrusting strategic execution and operational management to a third party – the ceo as the agent. this resulted in a conflict of interests, known as the agency problem (jensen & meckling 1976). aware of the divergent interests, principals incur costs, such as bonding, monitoring, and other costs, to seek a closer alignment of interests and mitigate the agency problem (fama 1980; fama & jensen 1983a; jensen & meckling 1976). limited consensus in the literature regarding the explanatory power of the traditional agency theory in managing the agency problem has resulted in scholars express frustration at the theory’s lack of utility (gopalan et al. 2014). according to the behavioural agency theory concepts of behavioural economics in the traditional agency problem are considered. the theory aims to better explain the link between incentives, ceo behaviour, and company performance (bosse & philips 2016; wiseman & gomez-mejia 1998). the emergence of behavioural agency theory while the traditional agency theory is focused on interest alignment, the behavioural agency theory, anchored in behavioural economics, is focused on ceo motivation that drives agent behaviour as an antecedent to principal-agent interest alignment (pepper & gore 2015). according to the theory several factors, beyond monetary incentives that influence agent behavior, are conceptualised. with this approach the aim is to better explain the link between incentives, ceo behaviour, and company performance (bosse & philips 2016; wiseman & gomez-mejia 1998). in accordance the traditional financial economic assumption of rational agent behaviour is replaced with bounded rationality (pepper & gore 2015; wiseman & gomez-mejia 1998). the theory relaxes the assumption that ceos are always risk averse, suggesting that they are primarily loss averse and, when losses are at stake, may, in fact, take risks (pepper & gore 2015; wiseman & gomez-mejia 1998). following the prospect theory, the behavioural agency theory further suggests that ceos respond differently to losses by applying hyperbolic discounting of incentives, depending on whether the losses are immediate or over a longer term. according to pepper and gore (2015), the process of formalised goal setting, contracting, and monitoring drives commitment while increased motivation is leading to closer principal-interest alignment. other changes include inequality aversion and recognising the effect of external motivation (bosse & philips 2016; wiseman & gomez-mejia 1998). the 2000 dotcom bubble, 2004 changes in share-based remuneration disclosure and emergence of remuneration disclosure and governance empirical evidence attributes the rise in ceo remuneration from the 1980s onward to the rise in ltis and, more specifically, sbr (frydman & jenter 2010). as a result, by the early 2000s, there was a period of intense speculation in technology companies, coupled with financial market hysteria, known as the dot.com bubble. this period of share price (sp) growth in the financial markets, and therefore potential ltis, drove the wrong behaviour in the form of excessive financial risk-taking and engineering that culminated in several corporate governance failures at companies such as enron, worldcom and parmalat. in turn, these failures led reworked corporate governance regulations such as the us-based 2002 sarbanes oxley act (kaplan 2008) and south african king code of corporate governance (‘king ii’) (institute of directors in south africa 2002). the regulations considered global research findings with the aim of reducing the ceos’ influence on company directors and remcos when awarding ceo remuneration. these new regulations focused on an increased board monitoring mandate (eisenhardt 1989; garcía-meca & sanchez-ballesta 2009; gomez-mejia, tosi & hinkin 1987; tosi et al. 1999), separation of the ceo and chairman roles by requiring an independent chairman (banerjee, nordqvist & hellerstedt 2020; boyd 1994), and ensuring a majority of independent and non-executive directors (garcía-meca & sanchez-ballesta 2009; morck, shleifer & vishny 1988), all aimed at greater board independence and improved strategic decision-making (bailey & peck 2013) in matters such as ceo remuneration. these revised regulations also provided insight into previously unobserved ceo remuneration figures, along with new perspectives on the alignment of the interests of agents and principals. several countries adopted an increase in disclosure regulations and for the first time in south africa’s king code of corporate, governance required disclosure of ceo remuneration by listed companies (institute of directors in south africa 2002). at global investor level these newly disclosed details, in turn, led the global accounting standard setting bodies to realise that a key loophole pertaining to the use of ltis was that sbr costs were not reported and disclosed as part of ceo remuneration. this was because, at the time, accounting standards did not require sbr to be expensed through the income statement. the south african context provided an opportunity to isolate the impact of these events on ceo pay sensitivity. we took the top 110 companies on the johannesburg stock exchange (jse) for a 13-year period and grouped them into three sub-periods, to enable examination of the impact of the 2006 introduction of expensing of sbr, the 2009 global financial crisis, and the 2016 introduction of say-on-pay rules. this led to the development of our hypotheses. while some remcos may wish to increase the volumes of disclosure for obfuscation (craighead, magnan & thorne 2004; hooghiemstra, kuang & qin 2017; laksmana, tietz & yang 2012), we found that some companies adopted additional performance-linked disclosure practices. these companies voluntarily provided additional retrospective ceo remuneration (ret) and its link to performance by disclosing a clearer process of goal setting, contracting, and monitoring when concluding on ceos’ performance contracts, as envisaged by pepper and gore (2015). we argue that this improved remuneration governance and, consequently, increased pay-performance sensitivity and lower ceo overpayment (balsam et al. 2016; clarkson, walker & nicholls 2011; conyon 2014). this is supported by broader board diversity and other regulatory waves over the past two decades (pandey, andres & kumar 2022), supporting the notion of improved ceo remuneration disclosure, resulting in reduced asymmetry in remuneration-related information. this developed over an extended time-frame, dating back to 1934, when ceo remuneration was first disclosed (frydman & jenter 2010). consequently, we included this behavioural factor as a moderator in our model: hypothesis 1: disclosure of voluntary additional ret moderates the relationship between company performance and total ceo remuneration. the 2007‒2009 global financial crisis, remuneration governance reform, and increased goal setting and monitoring similar to the south sea and tulip bubbles during the 17th and 18th centuries and the 1929 stock market crash, the 2007 to 2009 global financial crisis was an impactful and idiosyncratic event as the financial losses suffered, undoubtedly altered society’s view of the robustness of financial markets (greenwood et al. 2015). following the regulatory changes in the early 2000s, this led to another wave of significant revisions to corporate governance regulations and accounting standards (beber & pagano 2013; berger et al. 2014). these were aimed at renewed alignment of agents’ and principals’ interests through revised agent behaviour and a clear link between company performance and ceo remuneration. these changes to corporate governance regulations, focused specifically on remuneration by identifying additional behavioural insights to spur remcos and in turn ceos into action. the first behavioural insight focused on a refinement of deferred long-term ceo remuneration, from pure time-based vesting, to being dependent on the company attaining certain pvc (bettis et al. 2010; core & larcker 2002; devers et al. 2007). preceding this, the introduction of ltis was a fundamental shift from a post hoc annual bonus to a longer deferral of awarded incentives. this resulted in a time-based vesting criterion being introduced, in which the ceo needed to be in the employ of the company for an additional period to be awarded and paid the ltis. however, these attempts at deferral, inflated lti gains despite poor company performance. consequently, sbr vesting criteria shifted from pure time-based holding periods to time pvc (bettis et al. 2010; core & larcker 2002; devers et al. 2007). this enhances principal-agent alignment by driving agent behaviour to focus on longer-term and sustained company performance to unlock vesting of the ceo’s sbr that has been awarded but payment remains subject to performance criteria being met. this changed remcos’ operating models, as awarding of sbr now requires up-front disclosure of performance criteria, along with performance evaluation against these criteria which also aligns to the clearer process of goal setting, contracting, and monitoring, as envisaged by pepper and gore (2015): hypothesis 2a: a minimum ceo shareholding requirement moderates the relationship between company performance and total ceo remuneration. the second behavioural insight builds on the original proposal of jensen and meckling (1976) to use equity ownership by agents (insider shareholding) to improve interest alignment. it also draws from the efficient contracting hypothesis (fama & jensen 1983b) and introduces ceo msr to manage information asymmetry. previous shareholding research had focussed on the overall effect of ceo shareholding but had not measured the effect of a significant msr (boyd & solarino 2016; core & larcker 2002; dalton et al. 2007; martin et al. 2016). we argue that this behavioural factor, when included in the ceo remuneration goal setting and contracting process, increases principal-agent alignment. the ceo is required to retain a significant portion of his wealth invested in the company, and consequently this drives ceo behaviour with shareholders’ interests at heart as the ceo and shareholders will share the outcome: hypothesis 2b: the use of performance-based lti vesting criteria moderates the relationship between company performance and total ceo remuneration. conceptual model in the present study, it is argued that the behavioural agency model proposed by pepper and gore (2015) can be added to. in their model, the process of goal setting, contracting, and monitoring drives agent behaviour as a motivational input. the role of this process was extended by researching its role within remuneration governance in moderating pay-performance sensitivity. the focus was on the role of certain specific behavioural factors used by remcos, seen as part of remuneration governance, for driving behaviour. ret, msrs and pvc are used in the process of setting performance goals, contracting with the ceo, and monitoring performance. consequently, these factors are set as proxies for how remuneration governance could moderate the relationship between company performance and ceo remuneration. the conceptual model below (figure 1) depicts the research focus. figure 1: conceptual model. in this study, company performance was the independent variable, and total ceo remuneration was the dependent variable. methodology research approach, data and design the study followed a quantitative and deductive approach. the study’s universe of analysis was all public companies in south africa listed on the jse consistently from 2006 to 2018 (divided into three sub-periods: 2006–2009, 2010–2014, and 2015–2018). the starting date of 2006 is based on the effective implementation of new sbr accounting standards that prescribed expensing of sbr. it also covers the 2009 global financial crisis and resultant corporate governance regulatory changes such as the 2016 say-on-pay rules. the study’s population consisted of the top 110 companies on the jse by market capitalisation as of 31 march 2019, representing approximately 95% of the total market capitalisation of the jse’s all-share index. due to several companies being excluded according to the qualification criteria, the jse top 100 population was extended to include the largest 110 companies weighted by market capitalisation, and 67 companies remained listed throughout this 13-year period, resulting in 871 datapoints. data were gathered from refinitiv eikon (previously known as thomson reuters) and companies’ annual reports and annual financial statements. chief executive officer remuneration data for south african companies are not entered into any widely accepted database, while researchers in the usa, for example, can access the widely referenced and accepted execucomp database. due to this lack of a credible south african database and given the importance of lti-related data for research purposes, the data were collected by the researchers by hand from the annual financial statements and/or annual reports. several iterative phases of master data screening were performed to prevent errors, increase data accuracy, identify duplications, and review outliers for possible incorrect capturing, along with tests for completeness of the dataset. independent variable shareholders as principals and investors contribute capital and seek commensurate returns on their invested capital by setting performance targets to align interests (cf. boyd & solarino 2016). these targets are typically in the form of financial performance indicators. consistent with research tradition for studies over extended timeframes, this study used traditional company performance measures in two categories: i.e. market and accounting performance (cf. boyd & solarino 2016; david et al. 2010). while market and accounting performance may co-vary, it is argued, and empirically observed in practice, that both streams of measurement isolate different parts of performance and should be used in tandem to examine overall performance (boyd & solarino 2016): market performance was measured using total shareholder return (tsr) (cf. hou et el. 2017), as reported by refinitiv eikon, calculated as follows: where price(begin) = share price (sp) at beginning of period price(end) = sp at end of period dividends = ordinary dividends paid during the period.    [eqn 1] accounting performance was measured using return on equity (roe), earnings per share (eps), earnings before interest and taxes (ebit), and return on assets (roa) (cf. boyd & solarino 2016; bussin & modau 2015), as reported by refinitiv eikon, calculated as follows: dependent variable a ceo’s total employment-related earnings typically comprise guaranteed pay (gp), stis, and ltis. determinants of how an overall package is structured, include the company’s industry, prevailing corporate governance regulations, signaling intent of the remco, and strategy elements such as company growth rate, maturity, and size (bizjak, lemmon & nguyen 2011; boyd & solarino 2016). for purposes of this study, total ceo remuneration (ceorel) was the total remuneration awarded to a ceo in a particular reporting period (bussin & modau 2015; deysel & kruger 2015). it includes gp and both stis and realised ltis (hopkins & lazonick 2016; kaplan 2008; kaplan & rauh 2010). guaranteed pay includes a fixed salary, pension benefits, travel benefits, and all other perquisites (bussin & modau 2015; deysel & kruger 2015). long-term incentives are typically deferred incentives granted on a discretionary basis to a ceo. deferred ltis include all amounts subject to a suspensive condition, such as the lapse of time (time-based vesting) and/or the satisfaction of certain performance criteria (performance-based vesting) in the form of cash incentives or sbr. share-based remuneration includes share options, share awards, share appreciation rights, restricted share awards, and related incentive plans (deysel & kruger 2015). the initial grant date accounting thereof is based on fair-value accrual, with subsequent re-measurement under certain conditions, while vested value is the fully realised value of the sbr that has been awarded. traditionally, most studies that include ltis in the definition of ceo remuneration have persisted with only using grant date fair value estimates of ltis when measuring ceo remuneration. however, as pointed out by recent ltis-specific research, this potentially incorrectly estimates the realised full value of ceo remuneration (hopkins & lazonick 2016; kaplan 2008; kaplan & rauh 2010). therefore, based on the study context of investigating company performance and ceo remuneration post hoc, ltis’ values as reported in the annual financial statements for ltis that have been exercised, and/or have vested and were realised, were used. this is conceptualised as retrospective (ret) ceo remuneration, also grouped as total ceo remuneration and abbreviated as ceorel (hopkins & lazonick 2016; kaplan 2008; kaplan & rauh 2010). for purposes of clarity, in contrast, prospective ceo remuneration refers to the annual gp and annual stis, along with ex ante ltis prospectively agreed valued at grant date using a fair value model (jensen & murphy 1990). analyses no lagging of variables was proposed, meaning independent and dependent variables were measured concurrently (cf. martin et al. 2016). this is because firms in south africa, and globally in line with developments in accounting standards during the study period, standardised reporting to accrue for stis in the year these relate to. to determine adherence to the assumptions of multiple regression analysis for panel data, several tests were conducted, including autoand/or serial correlation, stationarity, homoskedasticity, multicollinearity, as well as normality of the residual distribution. after considering extreme values and the skewness and kurtosis values for the set of independent and dependent variables, variables were winsorised at the 5% and 95% percentile (cf. david et al. 2010; gopalan et al. 2014). to evaluate and test hypotheses, p-values of less than 0.05 were considered statistically significant. various market-based company performance measures (tsr and sp) and accounting-based company performance measures (roe, roa, ebit, and eps) as independent variables, along with moderators (ret, msr, pvc), were used to test effects on the continual dependent variable (ceorel), using moderated multiple linear regression analysis. to rule out alternative explanations for results, the study included control variables that have been shown to influence ceo remuneration: two control variables were identified and controlled for, company size using total assets (martin et al. 2016); and ceo change, when the ceo changed during a particular year to control for partial-year effects and once-off large bonus pay-outs. four regression models were built to cover the entire research period and the three sub-periods across the various hypotheses. ethical considerations this article followed the ethical guidelines for research using human participants. the gordon institute of business science ethical research committee gave written permission to conduct the research in the form of a letter. results the results are presented in table 1 which depicts the correlations between the variables. remuneration governance was represented by two moderating variables: msr and pvc with the third moderating variable being ret. for these analyses a combined regression model was created, and the interaction effects of all the moderating variables on each other, as well as on the dependent and independent variables, were tested. table 1: summary of statistically significant moderating effects on the dependent variables. hypotheses 1a, 1b, and 2: total period model (2006 to 2018) 2006 to 2018 model: results from the panel estimated generalised least squares (egls) model indicated that the overall model was significant and the r² = 0.614 and adjusted r² = 0.599 were moderate (f = 41.62; p = 0.000; dw stat = 1.262). in the model, the interaction effects of the three moderators msr, pvc, and ret were included. the msr moderator showed a statistically significant moderation effect on the company performance variable measures eps (p = 0.005), roa (p = 0.011), ebit (p = 0.027), and sp (p = 0.001). the pvc moderator showed a statistically significant moderation effect on the company performance variable measures ebit (p = 0.000), eps (p = 0.000), roa (p = 0.004), and sp (p = 0.000). the ret moderator showed a statistically significant moderation effect on the variables eps (p = 0.014), roa (p = 0.037), and sp (p = 0.001). the model indicated that 59.9% of the variation in ceo remuneration was explained by company performance. hypotheses 1a, 1b and 2: analysis of the three sub-periods’ models 2006 to 2009 model: results from the panel egls model indicated that the overall model was significant and the r² = 0.547 and adjusted r² = 0.507 were both moderate (f = 13.46; p = 0.000; dw stat = 1.515). the pvc moderator showed a statistically significant moderation effect on the company performance variable measures eps (p = 0.000), roe (p = 0.003), sp (p = 0.000), and ebit (p = 0.035). the msr moderator showed a statistically significant moderation effect on the variables eps (p = 0.045) and ebit (p = 0.044). the ret moderator was not feasible, as there was only one value for this variable (constant) during this period. 2010 to 2014 model: results from the panel egls model indicated that the overall model was significant and the r² = 0.724 and adjusted r² = 0.697 were both strong (f = 26.61; p = 0.000; dw stat = 1.291). both the msr and ret moderators showed no statistically significant moderation effects on any of the independent variables. the pvc moderator showed a statistically significant moderation effect on the company performance variable measures ebit (p = 0.000), sp (p = 0.000), tsr (p = 0.000), and roa (p = 0.009). the model indicated that 69.7 % of the variation in ceo remuneration was explained by company performance which indicates a highly explanatory model. 2015 to 2018 model: results of the egls model indicated that the overall model was significant and r² = 0.737 and adjusted r² = 0.701 were both strong (f = 20.56; p = 0.000; dw stat = 1.428). the msr moderator showed a statistically significant moderation effect on the company performance variable measures of sp (p = 0.032), ebit (p = 0.021), tsr (p = 0.001), and eps (p = 0.021). the pvc moderator showed a statistically significant moderation effect on the company performance variable measures of eps (p = 0.0021), roa (p = 0.012), and sp (p = 0.001). the ret moderator showed a statistically significant moderation effect on the company performance variable measures sp (p = 0.000), tsr (p = 0.001), and eps (p = 0.000). discussion this research aimed to advance the behavioural agency theory by empirically demonstrating how remuneration governance in the form of ceo minimum shareholding, performance-based vesting conditions and voluntary additional ret moderates the relationship between ceo remuneration and company performance. our results demonstrate msr, pvc and ret to be effective moderators when used by remcos to enhance remuneration governance and forge closer alignment between principals and agents. retrospective chief executive officer remuneration disclosure the models showed a statistically significant moderating effect and moderation occurred within two of the three sub-periods (2006–2009: none; 2010–2014: sp; 2015–2018: tsr, sp, and eps), and in sp, roa, and eps for the total period. the results confirm the corporate governance-related regulatory waves over the past two decades, focused on improved disclosure, and have resulted in reduced remuneration-related information asymmetry (cf. connelly et al. 2011). while some remcos may wish to increase the volume of disclosure for purposes of obfuscation (craighead et al. 2004; hooghiemstra et al. 2017; laksmana, tietz & yang 2012), the results highlight that companies that adopt pro-active, clear, and performance-linked ret disclosure are likely to practise better remuneration governance, due to increased pay-performance sensitivity and therefore lower possible ceo overpayment. chief executive officer minimum shareholding requirement the models showed a statistically significant moderating effect, both for the total period (sp, roa, ebit, and eps) and within two of the three sub-periods for certain specified company performance variable measures (2006–2009: ebit and eps; 2010–2014: none; 2015–2018: tsr, sp, ebit, and eps). the specific variable measures when moderation occurred for the total period had some similarities to the sub-periods. for the full period of 2006 to 2018, 14.7% of the dataset had applied this requirement to ceo remuneration contracts. in 2006–2009, only 5% of the dataset had applied msr as a requirement. however, the figure rose to 27.6% for 2015–2018. requiring a significant minimum shareholding reinforces interest alignment, as more than 1 year’s earnings are invested in the company. these results confirm the results of previous studies that found that the introduction of pvc improves principal-agent alignment (bettis et al. 2010; core & larcker 2002; devers et al. 2007). interpreted in the context of ceo overpayment, the results reveal that companies that adopt msr are likely to practise better remuneration governance, due to increased pay-performance sensitivity and therefore lower possible ceo overpayment. performance-based vesting conditions the models indicated a statistically significant moderating effect, both for the total period (sp, roa, ebit, and eps) and within all three of the three sub-periods for certain company performance variable measures (2006–2009: sp, roe, ebit, and eps; 2010–2014: tsr, sp, roa, and ebit; 2015–2018: sp, roa, and eps). in 2006–2009, 70% of the dataset had already applied the pvc requirement to ceo remuneration contracts, and, in 2015–2018, the number rose to 81.5%. therefore, although most companies had already applied a performance-based measure during 2006–2009, the specific performance measures varied over the periods under study. during the last period, 2015 to 2018, following shareholder engagement driven by the say-on-pay regulation, pvc criteria had converged to include three criteria. firstly, a return measure, such as roe, secondly, an earnings growth measure anchored to inflation, and thirdly, a market-based value growth measure such as sp growth or tsr growth and this is evident in the results where moderation occurred. the results prove that, while there was a statistically significant relationship between ceo remuneration and company performance, the use of pvc in remuneration contracts drives closer pay-performance relationship as lti gains only occur when performance measures are met. conclusion we demonstrate that the behavioural agency theory (pepper & gore 2015) could be expanded by including remuneration governance, measured through msrs, pvcs and ret, in setting performance goals and its role in moderating pay-performance sensitivity and, by extension, therefore moderating ceo overpayment. when pvc and msr is introduced in ceo remuneration packages, risk preference alignment occurs (devers et al. 2007) based on a closer pay-performance relationship (bettis et al. 2010; conyon 2014). this further builds on the literature on efficient contracting, which suggests that msrs improve alignment of ceo remuneration and company performance (fama & jensen 1983b), while contributing to reduced ceo overpayment as a result (cf. kaplan 2008; kaplan & ruah 2010). chief executive officer remuneration is considered excessive when movements do not follow company performance, and the unjustifiable outcomes are likely to be seen as overpayment (kaplan 2008; kaplan & ruah 2010). future directions and limitations additional moderators may appear as remuneration governance matures in response to both accounting standards and corporate governance regulations that are continually refined. the emergence of additional moderators is likely to be a function of behavioural responses by remcos to the latest research incorporated in regulations that enable improved pay-performance alignment. while ceo remuneration as a variable was described and analysed in detail, the ceo as an individual and the effects thereof on remuneration were not considered. this study identified and controlled for one ceo-level item, change in ceo, measured as a change of ceo in a financial year. the study also identified and controlled for a company-level item, company size, measured by revenue. other aspects that may influence ceo remuneration relate to ceo characteristics, such as tenure, age, gender, large ceo shareholding, and the industry in which the company operates. these variables could be identified and added to the dataset to determine their effect on ceo remuneration and its relationship with company performance. the research generated certain demographic data on ceos relating to year of change and shareholding. however, information such as age, tenure, gender, and race were scoped out for purposes of the research focus. in addition, research was focused on the relationship between ceo remuneration and company performance over time at an overall level. while data were gathered to consider the equitability of the quantum value of ceo remuneration when considering each of the individual elements (being gp, stis, and ltis), these were excluded from the primary focus of the study. the results contrast with claims by the media, politicians, and proxy advisors suggesting that ceos are paid irrespective of performance (crotty 2017; mcgregor 2018; rose 2015). the results show that following corporate governance regulatory changes the introduction of behavioural factors such as msr, pvc and ret, which serve as proxies for remuneration governance, drive different behaviour in ceos and remcos. introduction of these behavioural factors into remuneration contracts are effective moderators of a closer link between ceo remuneration and company performance that limits possible ceo overpayment. acknowledgements competing interests the authors declare that they have no financial or personal relationships that may have inappropriately influenced them in writing this article. authors’ contributions all authors contributed equally to writing this article. funding information this research received no specific grant from any funding agency in the public, commercial or not-for-profit sectors. data availability the data upon which this study was conducted are stored by the authors of this study. seeing that the data were collected in the form of financial statements and annual reports, no specific participants were identifiable. disclaimer the 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r.m. & gomez-mejia, l.r., 1998, ‘a behavioural agency model of managerial risk taking’, academy of management review 23(1), 133–153. https://doi.org/10.2307/259103 microsoft word pdfs sajems ns 18 (2015) no 4:449-462 449 how to cite doi: http://dx.doi.org/10.17159/2222-3436/2015/v18n4a1 i s s n : 2 2 2 2 3 4 3 6 foreign aid on economic growth in africa: a comparison of low and middle-income countries aye mengistu alemu* solbridge international school of business, south korea jin-sang lee duksung women’s university, seoul, south korea previous empirical studies on the effects of foreign aid on economic growth have generated mixed results that make it difficult to draw policy recommendations. the main reason for such mixed results is the choice of a single aggregate list of countries, regardless of the disparities in levels of development. this study therefore fills the development gap by disaggregating the african data into a panel of 20 middleincome and 19 lowincome african countries over a period of 15 years between 1995 and 2010, and employing a dynamic generalized method of moments (gmm) model to address the dynamic nature of economic growth as well as the problems of endogeneity. the results of this study support the theoretical hypothesis that a positive relationship between aid and gdp growth exists, but only for low-income african countries, not middle-income ones. on the other hand, the study reveals that middleincome african countries tend to experience a greater impact on their economic growth from foreign direct investment (fdi) and natural resources revenues, mainly oil exports. this implies that the frequent criticism that foreign aid has not contributed to economic growth is flawed, at least in the case of low-income african countries. in fact, foreign aid has played a critical role in stimulating economic growth in such countries through supplementing domestic sources of finance such as savings, thus increasing the amount of investment and capital stock in them. key words: foreign aid, fdi, economic growth, africa, disaggregated data, gmm model jel: f5, 23, o4, 55, c8, 4 1 introduction the role of foreign aid in the growth process of developing countries has been a topic of intense debate. it is estimated that africa has received more than one trillion us dollars during the last 50 years (moyo, 2009). however, many countries are still under-developed and depend on foreign aid to run themselves, indicating that this aid has not been effective. the issue of aid effectiveness was brought vigorously to the fore in 2005 when the paris declaration (pd) was endorsed by organization for economic co-operation and development (oecd) development assistance committee (dac) members. despite continuous aid to african countries, some of them became worse off than they were in the early 1960s. from a recipient country’s point of view, aid should be short-term, when the country suffers a shock internally or externally. likewise, many lowincome countries in africa do not have great opportunities for fdi since they receive limited attention from multinational companies (mncs). in such cases, most low-income african countries mainly tend to have foreign aid, at least to provide their population with basic services such as education, health, roads, etc., and possibly to build institutional capacity to govern their countries. foreign aid to low-income countries may also flow in in various forms such as cash, projects, programs, education and training, technical assistance and others. middleincome countries in africa have a substantial quantity of natural resources that are economical and act as a “pulling” factor for fdi. however, the majority of low-income african countries have very low levels of economic infrastructure such as transportation and basic services abstract 450 sajems ns 18 (2015) no 4:449-462 as well as low levels of human capacity in terms of elementary and secondary enrollment ratios as well as vocational and technical training opportunities. these economic and social environments make it difficult for low-income african countries to achieve economic development. consequently, most of the low-income african countries are heavily dependent upon foreign aid which is mostly channeled through humanitarian aid such as food and emergency needs, with only a small portion being utilized for economic infrastructure. however, empirical studies on foreign aid and economic growth in developing countries have generated mixed results that make it difficult to draw policy recommendations. the main objective of this study is therefore to investigate the effects of foreign aid on economic growth in low-income and non-lowincome african countries. 2 literature review theoretically, the main role of foreign aid in stimulating economic growth is to supplement domestic sources of finance such as savings, thus increasing the amount of investment and capital stock. as morrissey (2001) points out, there are a number of mechanisms through which aid can contribute to economic growth, including: (a) increased investment, in physical and human capital; (b) increased capacity to import capital goods or technology; (c) lack of indirect effects that reduce investment or savings rates; and (d) transfer of technology that increases the productivity of capital and promotes endogenous technical change. there are four strands of literature on the role of foreign aid on economic growth. the first studies claim that foreign capital inflow is necessary and sufficient for economic growth in less developed countries. they assert that there is a positive relationship between aid and economic growth because it not only augments domestic resources, but also supplements domestic savings, assists in closing the foreign exchange gap, creates access to modern technology and managerial skills, and allows easier access to foreign markets, ultimately leading to economic growth (chenery & strout, 1996; islam, 1992; dalgaard, hansen & tarp, 2004; gupta & islam, 1983; burnside & dollar, 2000; hansen & tarp, 2000; morrissey, 2001; gomanee et al., 2005). by the same token, pallage and robe (2001) noted that foreign aid is a major source of economic growth for developing countries, especially in africa, where it averages 12.5 per cent of the gross domestic product and establishes by far the most important source of foreign capital. under such circumstances, foreign aid has the potential to play a key role in boosting developing countries' economic growth as well as reducing poverty. similarly, addison, mavrotas and mcgillivray (2005) examined the trends of oda to africa over the period 1960 to 2002, and concluded that foreign aid does in fact promote growth and reduce poverty. it also has a positive impact on the public sector, contributing to higher public spending and lower domestic borrowing. burnside and dollar (2000) also examined the effect of aid on economic growth, using standard cross-country panel regressions that included an interaction term of aid with a policy index and found that aid has a positive impact on growth in developing countries as long as these countries have sound macroeconomic policies. the second group of studies assert that external capital has significant negative effects on the economic growth of recipient countries. according to this view, foreign aid is fully consumed; it substitutes rather than complements domestic resources; assists import of inappropriate technology; distorts domestic income distribution; and encourages a bigger bloated?, inefficient and corrupt government in developing countries (boone, 1996; easterly, 2003). the third view is that foreign aid has no impact on economic growth (mosley, 1980; mosley et al., 1987). this view is shared by moyo (2009) who argues that aid has not helped to improve social and economic conditions in africa for several reasons: a) sectors that are critical and important to the development of the country have rarely been allocated any resources and less than 6.5 per cent of development aid or assistance received by developing countries over the years has been allocated to areas that are critical to accelerated growth and economic development, such as education, healthcare, infrastructure, energy, agriculture, technology, and the environment; b) the sajems ns 18 (2015) no 4:449-462 451 debt and aid resources have been stolen and corruptly squandered by government officials to enrich themselves, their families, and friends instead of being directed to the productive sectors of the national economy; c) during the cold war, the policies of the developed countries favoured african countries that were friendly with them and as a result, official development aid (oda) was usually quite unpredictable and could not be depended on for making long-term development plans. in addition, many of the western donors often attached conditions to aid that made its effective use for development difficult; d) in many instances, aid was driven by interest groups in the developed countries to sell their products, services, and technologies that were not suitable for african development because they were often obsolete and inappropriate for african conditions. the fourth view is that the relationship between foreign aid and economic growth may depend on the quality of the recipient country’s institutions and economic policies, i.e., integrated monetary, fiscal, and trade policies (burnside & dollar, 2000; mcgillivray et al., 2006). mcgillivray et al. (2006) suggested four different views from positive and negative perspectives and emphasized political conditions and institutional capacity. according to mbaku (2004), african countries failed to use aid efficiently because they lacked competent laws and institutions to use received aid appropriately and effectively. kosack (2003) examined the impact on the human development index, only in democratic countries. he found that aid has a negative impact in autocratic countries but a positive impact on the human development index and growth in democratic ones. however, it must be borne in mind that regional differences in the effects of foreign aid among the recipient countries are inevitable. effects could be influenced by income levels or levels of socio-economic development of recipient countries. ekanayake and charrna (2010) analyzed 83 recipient countries in asia, africa and latin america and the caribbean, using panel data series for foreign aid, and concluded that foreign aid brought mixed impacts on the economic growth of recipient countries. latin american and the caribbean countries especially experienced adverse effects on economic growth, while african countries showed positive effects. ree and nillesen (2009) studied the impact of foreign aid on civil conflict in sub-saharan africa but found no evidence that foreign aid has impact on civil conflicts. some studies show different evidence: negative effects in the short term but positive ones in the long run. for example, moreira (2005) carried out a study of the impact of economic growth at the macro-level using a cross-country regression model and examined the shortand the long term results. the long term effects were found to be better than those in the short term. juselius, framroze and tarp (2011) also found that the impact of foreign aid was positive in the long run. 3 methodology 3.1 scope of the study though often spoken of as a single, homogenous group, african countries are remarkably diverse and heterogeneous in historical, political, social, economic, linguistic, cultural and geographical terms. the region includes both middle-income, lower middleincome, upper middleincome and higherincome economies, some with large and some with small populations; some with a store of natural resources and those with virtually none. thus it is important to examine in detail whether the effect of foreign aid on economic growth in africa has been uniform. accordingly, african countries have been categorised into lowincome and non-lowincome countries based on the world bank’s classification (low-income: gross national income (gni) per capita ≤ $1,005; lower-middle income economies: $1,006 ≤ gni per capita ≤ $3, 975; upper-middle income african economies: $3,976 ≤ gni per capita ≤ $12,275; and higher-income economies: gni per capita ≥ 12,276). 452 sajems ns 18 (2015) no 4:449-462 table 1 list of countries included in the study low-income africa (20 countries) non-lowincome africa (19 countries) benin, burkina-faso, burundi, chad, democratic republic of congo, ethiopia, gambia, guinea bissau, kenya, malawi, madagascar, mali, mauritania, mozambique, rwanda, sierra leone, tanzania, togo and uganda. higherincome economies equatorial guinea uppermiddle economies algeria, libya, botswana, gabon, mauritius, seychelles, south africa and tunisia lower-middle economies angola, congo republic, cote d’ivoire, cape verde, egypt, ghana, morocco, namibia, nigeria, senegal, zambia. 3.2 specifications of model this section discusses the model specifications to examine the relationships between foreign aid and economic growth. the empirical model for estimating the impact of foreign aid on economic growth is based on previous growth literature and other empirical studies. therefore, in deriving our empirical model for estimating the aid-growth relationship, we posit that: δyit = f (pcit, hcit, nrit, zit) (1) where δyit denotes economic growth in real per capita gdp of country i at time t, pcit is a vector of physical capital sources of country i at time t, hcit is a vector of human capital of country i at time t, nrit is a vector of natural resources of country i at time t, and zit is a vector of other growth-determining policy and institutional variables as explained in the empirical literature. the endogenous growth model in particular emphasizes the importance of capital (both physical and human), as well as policy and institutional factors in promoting economic growth. on this basis, our model can be specified as follows: δyit = α + βpcit + η hcit + δnrit +γzit + µt (2) where δyit is economic growth in real per capita, pcit,, hcit, nrit and zit are already mentioned above, µt is the error term. on the other hand, critical capital sources for economic growth of developing countries comprise foreign aid, domestic investment (di) and foreign direct investment (fdi). hence, pc = f (aid, di, fdi) (3) where ‘aid’ denotes foreign aid, which is net official development assistance (oda) as a share of gdp, di denotes domestic investment which is gross capital formation (gcf) as a share of gdp, and fdi represents the share of foreign direct investment to gdp. similarly, we can break human capital (hc) down into two components: education, which is captured by enrolment ratio; and health, which is estimated by life expectancy. hence, hc= f (education, health) (4) natural resources (nr)= f (oil exports, ores and metals exports, arable land ratio) (5) z = f (policy, institutional) = f (degree of openness, exchange rate, inflation index, economic freedom, quality of infrastructure) (6) thus, substituting (3), (4), (5) and (6) in (2), produces our refined model as: δyit = α +β1aidit + β2diit + β3 fdiit + β4 serit + β5 lxpit + β6 oilit + β7 oreit +β8 openit + β9 exchit + β10 infit + β11 efrdit + β12 infrit + β13 lockit + µt (7) 3.3 choice of explanatory variables 3.3.1 foreign aid the relationship between foreign aid and economic growth is not conclusive, and this has already been discussed in detail in section 3 of this article. the traditional justification for foreign aid is that it eases the resource constraints of developing economies, especially on the supply side (munemo et al., 2007). in this view, therefore, foreign aid is regarded as a positive coefficient on economic growth. sajems ns 18 (2015) no 4:449-462 453 3.3.2 fdi inflow the neoclassical approach assumes that fdi promotes economic growth by introducing valuable capital and technology into recipient countries. moreover, fdi is one of the main avenues for the movement of technology, management know-how and modern business methods across national borders. therefore, the rationale for increased efforts to attract more fdi stems from the belief that fdi has several positive impacts on economic growth through productivity gains, technology transfers, the introduction of new processes, managerial skills, know-how in the domestic market, employee training, international production networks, and access to markets to bring about structural change and sustainability. 3.3.3 domestic investment using the solow model as a predictor, the investment ratio is a key determinant of economic growth regardless of a country’s level of development (solow, 1956). investment ratio depends on the saving ratio. the neoclassical growth models of solow (1956) and swan (1956) also predict that an exogenously higher value of i/y raises the steady-state level of output per effective worker as well as the growth rate. thus, domestic capital is expected to influence economic growth significantly. 3.3.4 human capital endogenous growth theory considers human capital as the major determinant of economic growth. in fact, it is the role of human capital that prevents the marginal product of capital from falling and thereby countries get richer (lucas, 1988). however, right up until the second half of the 1990s, the role of human capital was linked to education, although a few authors had already recognized the importance of other factors such as health. mankiw, romer and weil (1992) first considered not only education but also health in a broader analysis of human capital. human capital in this study refers to both education and health. (a) education human capital, particularly that attained through education, has been emphasized as a critical determinant of economic progress (barro & lee, 2001); and growth rates are affected by ideas and invention, which in turn are related to the stock of human capital, either through research and development activities or through the absorptive capacity of technology. according to habiyaremye and ziesemer (2006), there are three different views that explain how education affects the production process and contributes to economic performance. firstly, education has the effect of increasing labor efficiency. secondly, educated workers are able to perform complex tasks and are therefore not substitutable by unskilled workers. thirdly, the education and skills of workers generate more output. applied to the case of developing countries, these views suggest that educated workers help the country to absorb, implement and diffuse foreign technology, and stimulate economic growth. (b) health health, as a form of human capital, should be envisaged as a property that may be improved through investment in resources. barro and sala-i-martin (2004) examined the relationship between economic growth and health and confirmed that good health is a crucial component of overall well-being. similarly, lopez-casanovas (2005) argued that good health raises levels of human capital and has positive impacts on individual productivity and economic growth. as sen (1988) points out, life expectancy implies an intrinsic capability on which personal welfare depends. thus, the health variable is often captured by the life expectancy of individuals. 3.3.5 initial gdp per capita barro and lee (2001) have carried out an empirical analysis for a panel of around 100 countries from 1960 to 1990 and the findings strongly support the general notion of conditional 454 sajems ns 18 (2015) no 4:449-462 convergence. the main implication from this study was, therefore, that poorer countries can achieve faster growth per capita provided that other variables remain constant. 3.3.6 population growth on the one hand, it is believed that population growth enlarges the labour force and, therefore has a positive impact on economic growth. a large population also provides a large domestic demand for goods and services provided that it has purchasing power. on the other hand, a large population growth is not only associated with food problems but also imposes constraints on the development of savings, foreign exchange and human resources. thus, the net relationship between a greater population and economic growth depends on whether the return to human capital and expansion of knowledge is greater than the diminishing returns of natural resources. thus, the effect of population growth on economic growth is ambiguous (barro, 1997). 3.3.7 exchange rate in theory, the depreciation of the local currency exchange rate against the us dollar should represent a window of opportunity to boost exports. thus it has been hypothesized that a depreciating and stable exchange rate is positively linked to economic growth. 3.3.8 inflation a high rate of inflation increases the uncertainty of business and hence is harmful to economic growth. it raises the cost of capital and inhibits capital investment. andersen and gruen (1995) and fischer (1993) find that, on average, a one-percentage-point rise in the rate of inflation can cost an economy more than one-tenth of a percentage point in its growth rate. indeed, fischer? (1993) regards the inflation rate as the best single indicator of macroeconomic policies that may indicate the overall ability of the government to manage the economy. hence, it can be hypothesized that a low and stable inflation rate promotes economic growth and efficiency in the long run. 3.3.9 openness endogenous growth models predict that the openness of an economy could positively influence economic growth, because the flow of goods and investment across borders through international trade could be an effective means of diffusion of technology at the international level. overall, the openness to trade can play an important role in raising the long-term sustainable rate of productivity growth (dobre, 2008). 3.3.10 quality of infrastructure a study by canning and bennathan (2000) indicates that infrastructure, particularly telecommunications infrastructure, significantly increases economic growth. thus, infrastructure is expected to contribute strongly to economic growth. 3.3.11 economic freedom the economic freedom variable aims to capture the freedom to choose and supply resources, completion in business, and the right to secure the property rights of individuals. as a result, economic freedom in a country is expected to promote economic growth via stimulating capital accumulation. 3.3.12 natural resources the effect of natural resources such as oil, ores and arable land on economic growth is also a debatable issue. however, there is an increasing consensus that this depends on how it is managed. if natural resources and their revenue are carefully managed, it would be a blessing; if not, however, it would be a curse. thus, the effect of natural resources on economic growth is ambiguous. sajems ns 18 (2015) no 4:449-462 455 3.3.13 lack of access to the sea almost one-third (or fifteen) of africa's 53 countries are landlocked and have no access to the sea. the prevailing view is that being landlocked causes a disadvantage in economic development. collier (2003) argues that a landlocked status is one of the four key factors preventing the poorest countries from growing and reaping the benefits of globalization. however, in recent years there has been an accelerated economic growth in many land-locked african countries including ethiopia, uganda, rwanda and zambia. thus, the dichotomous dummy variable that captures lack of access to the sea is expected to have an ambiguous effect on economic growth. based on the theoretical explanations discussed above, the independent variables and their expected relationships with economic growth are summarized in table 2. table 2 explanatory variables of economic growth, expected signs and data sources variable +/data sources initial gdp/c world development index (wdi) foreign aid + world development index (wdi) fdi inflow + world development index (wdi) gfcf/gdp + world development index (wdi) oil exports (% of total exports) + http://www.geodatasource.com ores and metal exports (% of exports) + world development index (wdi) arable land ratio + world development index (wdi) population (in mill) + world development index (wdi) degree of openness + world development index (wdi) quality of infrastructure + world development index (wdi) secondary school enrolment ratio + wdi database life expectancy + wdi database exchange rate + wdi database inflation index wdi database economic freedom index + heritage foundation index land-locked (1=landlocked and 0=otherwise) various sources 4 results 4.1 the trend of foreign aid and economic growth in africa the diagrams below show the trends of foreign aid and economic growth in selected low income african countries such as ethiopia, tanzania, and mozambique on the one hand; and botswana and morocco from the middle-income group on the other hand. accordingly, figures (1), (2) and (3) highlight a similar pattern of relationship between foreign aid and economic growth performance in ethiopia, tanzania, and mozambique, respectively. on the other hand, we can find inconsistent patterns of relationship between foreign aid and economic growth in botswana, and morocco as shown in figures (4) and (5) respectively. thus, with this guiding information, it is important to investigate further the exact relationship between foreign aid and economic growth in africa both at aggregate and disaggregated levels, based on the degree of economic development. 456 sajems ns 18 (2015) no 4:449-462 figure 1 the relationship between foreign aid and gdp growth in ethiopia (low-income) figure 2 the relationship between foreign aid and gdp growth in tanzania (low-income) figure 3 the relationship between foreign aid and gdp growth in mozambique (low-income) sajems ns 18 (2015) no 4:449-462 457 figure 4 the relationship between foreign aid and gdp growth in botswana (upper-middle-income) figure 5 the relationship between foreign aid and gdp growth in morocco (lower-middle-income) 4.2 the correlation between economic growth and independent variables before we move on to the regression analysis, it is worth examining the correlations that exist between economic growth and foreign aid. in other words, the correlation coefficients of each variable determine the nature and strength of the relation between each factor and economic growth. accordingly, correlation analysis not only helps to clarify relations among variables but also often suggests directions for experimental research such as regression analysis. table 3 shows that there is a direct correlation between foreign aid and economic growth. similarly, the correlation analysis reveals that initial income per capita is negatively correlated with economic growth. on the other hand, the evidence shows that the ratio of gfcf/gdp, oil exports/total exports, degree of openness, life expectancy, and quality of infrastructure are positively correlated with economic growth in africa. 4.3 regression results one of the most significant results from the full sample as well as the middle-income africa subsample is initial gdp per capita (level of development of a given country at the beginning of 1995) is found to be a strong negative determinant of economic growth. more specifically, the coefficient of the initial gdp/c variable was estimated at -0.001, implying that convergence occurs at the rate of 0.1 per year. on the other hand, no significant evidence was found for lowincome african countries to converge at this point. however, though it was not significant, the negative sign of the coefficient suggests some indications of convergence in the region. 458 sajems ns 18 (2015) no 4:449-462 table 3 partial correlation of economic growth with independent variables variable correlation significance initial gdp/c -0.1571 0.000*** foreign aid 0.0687 0.090* fdi inflow 0.0361 0.390 gfcf/gdp 0.3090 0.000*** oil exports (% of total exports) 0.1970 0.000*** ores and metal exports (% of exports) 0.0115 0.78 arable land ratio 0.0362 0.389 population (in mill) 0.0357 0.396 degree of openness 0.0762 0.069* quality of infrastructure 0.0859 0.040** secondary school enrolment ratio 0.0036 0.931 life expectancy 0.0992 0.018** exchange rate 0.0010 0.981 inflation index (consumer price index) -0.0514 0.221 economic freedom index -0.0016 0.970 land-locked (0=landlocked and 1=otherwise) 0.0551 0.189 our main variable of interest − aid per capita − has been found to be a statistically significant factor of economic growth for only low-income african countries, not for the middle-income african sub-sample. it is obvious that low-income african countries are heavily dependent upon foreign aid for supplementing their basic needs and even to support government budget. in these countries, most foreign aid amounts were not spent on areas related to economic growth. moreover, some low-income african countries are effectively using foreign aid for education and health care, and these would enhance economic growth in the long term. on the other hand, the fdi variable has been found to be statistically significant at the five per cent level for the middleincome african sub-sample, but not for the low-income one. for instance, the result in table 4 (column 3) implies that a one-per cent increase in fdi inflow would result in a 0.1 per cent increase in economic growth in middle-income african countries. thus, whilst foreign aid has a strongly positive impact on economic growth in low-income african countries, it is the fdi inflow that has resulted in a significant impact on economic growth for middle-income african countries. the probable explanation is perhaps that low-income countries have few options of financial resources and this eventually enables them to create a better macro-economic management system and also to utilize foreign aid in a very efficient way. donors also give smaller amounts of aid to middle-income african countries than to low-income ones. likewise, the empirical analysis indicates that a onepercentage increase in the ratio of fixed capital formation to total gdp will increase economic growth by 12.4 per cent and 12.4 per cent for middle-income and low-income african countries, respectively. natural resource variables such as the ratio of oil exports to total exports were found to be statistically significant for only middle-income african countries but not for low-income ones. this is perhaps due to the fact that most of the middle-income african countries are currently oil exporters while many of the lowincome african countries are not. on the other hand, no evidence was found for the minerals and ores variable to induce economic growth in a significant way in both sub-samples. interestingly, however, the arable land ratio has been found to be a very important factor in stimulating economic growth mainly in lowincome african countries. this result is consistent with the current situation that low-income african countries, particularly those with ideal climates and arable land density, have recently achieved economic growth mainly driven by the high price in agricultural commodities. accordingly, the result confirms that a oneper cent increase in the arable land ratio for lowincome african countries would increase economic growth approximately by 3.9 per cent. sajems ns 18 (2015) no 4:449-462 459 table 4 system gmm estimation for the effect of foreign aid and other variables on economic growth independent variables africa middle-income africa low-income africa initial gdp/c -.001*** (.0002) -.001*** (.0002) -.001 (.001) foreign aid .0003 (.0002) .0001 (.0002) .002*** (.001) fdi inflow .001** (.0002) .001** (.0002) .001 (.0012) gfcf/gdp .144** (.063) .124* (.079) .124** (.055) oil exports (% of total exports) .131*** (.047) .127*** (.051) .112 (.098) ores and metal exports (% of exports) .008 (.014) .003 (.029) .007 (.014) arable land ratio .008 (.019) .103 (.066) .039** (.021) population (in mill) .028* (.015) .002 (.019) .029 (.025) degree of openness .042** (.018) .075*** (.026) .005 (.016) quality of infrastructure .067 (.107) .310* (.194) .435 (.561) secondary school enrolment ratio .028 (.023) .115** (.049) .080*** (.028) life expectancy .099* (.056) .037 (.081) .148* (.083) exchange rate -.0001 (.0003) -.0004 (.001) .0002 (.0004) inflation index (consumer price index) -.001 (.0013) -.001 (.002) -.020*** (.004) economic freedom index .014 (.045) -.024 (.077) .075 (.052) access to the sea (0=landlocked; 1=otherwise) 1.407 (.871) 1.638 (1.606) -.302 (.728) constant 2.329 (4.355) -3.407 (8.102) 6.217 94.948) p-value for hansen test 0.36 0.27 0.18 number of countries 39 20 19 observations per country 15 15 15 number of observations 585 300 285 theoretically, the effects of population growth on economic growth are disputable. in line with this, no evidence has been found that population growth is a significant factor for growth in income per capita, both in middle-income and low-income countries. the degree of openness of a country has been found to be an influential factor in economic growth in middle-income african countries but not in low-income ones. the empirical evidence shows that a oneper cent increase in trade openness would result in about a 7.5 per cent increase in economic growth for middle-income african countries. this implies that openness to trade can enhance productivity by enabling more efficient allocation of resources, by providing greater opportunities to exploit economies of scale and by exposing the domestic economy to greater competitive pressures. moreover, infrastructure has been found to be a crucial factor in speeding up economic growth only in middle-income african countries, whereas no significant evidence was found in low-income african countries due to the fact that infrastructural development is still at the infant stage in such countries. the education aspect of human capital has been captured by the level of secondary school enrolment ratio, while the health aspect of human capital is captured by life expectancy variable. 460 sajems ns 18 (2015) no 4:449-462 accordingly, it has been found that education is very critical both in middle-income and lowincome african countries in their efforts to induce sustainable and faster economic growth. by the same token, the life expectancy variable was found to be statistically significant at the ten per cent level, for the full sample as well as the low-income african sub-sample, implying that a healthy labour force is crucial for sustainable economic growth. on the other hand, no evidence was found that the exchange-rate variable significantly affected economic growth, both in the full sample as well as the sub-samples. this result is similar to other previous empirical studies which recorded mixed results for the role of exchangerate policy on economic growth. inflation has a mixed effect on economic growth both in the full sample as well as the sub-samples. for instance, inflation is negatively associated with and statistically significant only for the low-income african sub-sample; while it is statistically insignificant for middle-income african countries. generally, a low, single-digit level of inflation does not seem to have a significantly negative effect on economic growth. however, a high level of inflation (as happened in zimbabwe in 2008/2009) would damage the prospects of savings, investment and economic growth. the economic freedom variable aimed to capture the freedom to choose and supply resources, completion in business, and the right to secure property rights of individuals. all these tend to motivate economic growth via stimulating capital accumulation. however, the empirical results found no evidence that economic freedom affected economic growth in africa at this point. lastly, the dummy variable that captured the state of being ‘land-locked’ was not statistically significant either. 5 conclusion the impact of foreign aid on economic growth is an ongoing issue for discussion. the impact of foreign aid was found to be closely related to the socio-economic environment and political situation of recipient countries. in order to find empirical analysis of the impact of aid on economic growth, this study attempted to use different variables related to economic output. it used data from major african countries by dividing them into lowincome and middleincome countries according to the level of income per capita. the results revealed that the middleincome countries tended to experience a greater impact on their economic growth from fdi as well as from the revenue they generated from the export of natural resources (mainly oil exports); whereas the lowincome countries were significantly affected mainly by foreign aid. thus this study shows that the criticism of foreign aid is flawed, at least in the case of lowincome african countries. in fact, foreign aid has played a critical role in stimulating economic growth through supplementing domestic sources of finance such as savings, and thus 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word 7 wentzel & steyn sajems 17(3) 2014.doc sajems ns 17 (2014) no 3:319-335 319 investment promotion in the south african manufacturing industry: incentive comparisons with malaysia and singapore martha susanna isabella wentzel and maxi steyn college of accounting sciences, unisa accepted: february 2014 south africa needs to increase its inward foreign direct investment (fdi) in order to achieve economic growth. the purpose of this article is to explore which interventions could be launched in the short term to enhance the country’s attractiveness for foreign investors. the findings of the literature review demonstrated that incentives, as a determinant of investment, are the short-term intervention with the most significant potential to attract additional fdi. a comparative study, which provided insight into the incentives that are currently offered to the manufacturing sectors of three countries (south africa, malaysia and singapore), assisted in identifying two additional incentives that the south african government could introduce and three existing incentives that could be amended. the introduction or modification of these incentives could ensure that south africa has a competitive advantage to attract investment from foreign investors and thereby increase its inward fdi in the manufacturing industry. key words: foreign direct investment, manufacturing, incentives, investment in capital assets, incentives that reduce investors’ fiscal burden jel: d92, k34, o14, o23 1 introduction and research objectives ”investment is crucial to growth. it’s what makes economies successful” (hazelhurst, 2011). this statement by the south african finance minister pravin gordhan supports government’s objective of building south africa’s economic capacity and promoting investment (national treasury, 2009:2). investment provides employ ment opportunities, innovations in the goods and services available to consumers and a competitive edge for the national economy. foreign direct investment (fdi) has an additional attribute, namely the flow of capital beyond country borders in search of the highest risk-adjusted return. this process provides economic benefits to the host and home countries (conference board of canada, 2004:1). the south african government acknowledges the importance of fdi in facilitating the growth of the country’s economy. during 2007, then finance minister trevor manuel (national treasury, 2007:9) stated that ”policy reforms will raise investment growth rates, pulling in higher levels of fdi”. the national treasury later confirmed the significance of fdi, stating that, as a low-savings developing economy, with high domestic investment requirements, south africa needs to attract fdi in order to support domestic investment financing requirements (national treasury, 2011:iii). in 2011, however, finance minister pravin gordhan admitted that the government ”may not have done enough” to promote fdi (hazelhurst, 2011). the 2012 world investment report also mentioned that south africa should be attracting higher levels of fdi based on the country’s fdi potential (unctad, 2012:xv, 32). to explore whether there are potential development focus areas which could assist in increasing south africa’s fdi, one of the key determinants that influence foreign direct investors’ decision in choosing an investment location, namely incentives, were investigated. the qualitative research was performed by means of a literature review, where incentives currently provided by south africa and two abstract 320 sajems ns 17 (2014) no 3:319-335 comparable foreign countries, namely malaysia and singapore, were identified. a comparative study was then done where the incentives provided by these three countries were compared and analysed. this comparison focused on the incentives provided to the manufacturing sector specifically, as this sector contributes significantly to the south african economy (wentzel, 2010:5-7). the aim of this comparative study was to determine whether there are additional incentives that south africa can initiate, or existing incentives that can be amended, which will ensure that the country has a competitive advantage for attracting foreign investors. the introduction or modification of these incentives could increase south africa’s inward fdi and assist in the country’s economic growth. this article first analyses south africa’s current status as a potential fdi destination and the key determinants for attracting fdi are briefly considered. this is followed by a discussion of incentives (one of the key determinants) specifically as a short-term intervention to attract additional fdi. thereafter, the results from the comparison between incentives provided by the three countries are discussed and potential future development focus areas are identified which could increase south africa’s attractiveness as an fdi destination. 2 literature overview 2.1 the current status of south africa as a potential investment destination developed and developing countries all over the world are increasingly recognising fdi as an important instrument of economic growth for the host country (asafo-adjei, 2007:91). kamath (2008:35) argues that the growth of the economy can be enhanced by fdi because it ”has a positive impact on exports, imports and has greatly contributed to gdp”. increased fdi can give rise to several benefits for the host country. besides bringing in capital, it facilitates the transfer of technology and technical assistance, as well as the development of domestic industrial infrastructure. other benefits could include increased tax revenue for the host country, employment creation, regional expansion or development and an increase in foreign exchange reserves (tuomi, 2009:7-10). some studies have confirmed that the host country does indeed benefit from fdi. higon and vasilakos’s (2011:663) research determined that the british retail sector has received positive fdi spillovers. although fdi on the african continent at large has been found to have lower impact in terms of linkages and spill-over into the domestic economy compared to global standards (mainly due to a concentration of fdi into resource rather than manufacturing as well as political instability on the continent (unido, 2013:3)), fedderke and romm (2005:738) reported a direct positive impact on economic growth from fdi specifically in the case of south africa. the 2012 world investment report (unctad, 2012:190) reflects south africa’s actual inward fdi by providing the value of greenfield (new) fdi projects. in 2008 this value was $13 533 million, but it declined to $7 695 million in 2009 and to $6 805 million in 2010. in 2011, however, inward fdi in south africa increased significantly as the value of greenfield fdi projects almost doubled to $12 410 million. some of the circumstances that contributed to this turnaround could be the ”continuing rise in commodity prices and a relatively positive economic outlook for subsaharan africa” (unctad, 2012:xvi). the implementation by south africa of the new companies act is also regarded as a reason for increased fdi, as the changes positively affect the restructuring of corporate groups (unctad, 2012:81). south africa further ranked 14th on the list of transnational corporations’ top prospective host economies for 2012–2014. this list reveals the economies that transnational corporations selected as the most likely destinations for their fdi in the medium term (unctad, 2012:22). this ranking for prospective host countries, together with the increase in fdi, could indicate that foreign investors have a favourable attitude towards south africa and have confidence in the country’s potential for growth. despite this improvement, the 2012 world investment report indicates that south africa ”received less fdi than could be expected sajems ns 17 (2014) no 3:319-335 321 based on economic determinants”. this statement is based on south africa’s ranking on the united nations conference on trade and development (unctad) fdi attraction index, which measures the success of economies in attracting fdi, compared to south africa’s ranking on the unctad fdi potential index, which indicates an economy’s potential to attract fdi (unctad, 2012:xv, 32). the organisation for economic cooperation and development (oecd) (oecd, 2008a:560) also previously argued that south africa should be attracting even higher levels of fdi than were achieved at the time. in 2008, the then finance minister, trevor manuel, acknowledged that south africa required higher levels of foreign investment to grow the country’s economy. he appealed to the south african business community to support government’s attempt to ”make this country an attractive destination for foreign investment” (national treasury, 2008). it is believed that south africa has great potential to improve its fdi inflow and to receive benefits accruing from fdi. however, the country has several constraints that hinder fdi, such as skills shortages, exchange controls, crime, extensive labour legislation and low growth rates (tuomi, 2009:37-39, 171; world economic forum, 2010:302). before these problems can be addressed, an understanding of the key determinants that influence the investors’ decision in choosing a host country for investment is necessary. 2.2 key determinants for attracting fdi when an investor decides to invest abroad, several factors influence the selection of a prospective host country. each investment decision considers the unique circumstances and requirements of both the investor and the host country. resource-seeking investors are interested in abundant natural resources, market-seeking investors look for large and expanding markets, and export-seeking investors pursue a competitive and efficient base for export production (easson, 2004:27). the 2003 world investment report (unctad, 2003:85) and the oecd (2007:4) listed a number of host country determinants that influence fdi, such as economic, political and social stability, rules regarding entry and operations, market size, access to output markets, raw material, skilled labour, transport and communication costs, investment promotion, tax rates and investment incentives. zanatta, costa and filippov (2006:6) add that the host country’s bargaining power in attracting fdi is dependent on the assets that it is able to provide to investors, such as its market size, geographical location, human capital and infrastructure. fedderke and romm (2005:758) concluded that fdi is strongly affected by the net rate of return and the risk profile of fdi liabilities. they further argue that policy plays an important role in reducing political risk, moderating wages, ensuring property rights, bolstering growth in market size and lowering taxes. tuomi (2009:39, 63) also considered the variables and determinants that affect the investment climate of the host country and she added factors such as the absence of crime and corruption, basic and specialised infrastructure and the effectiveness and functionality of the financial sector. tuomi (2009:117) went on to classify the determinants that affect the investors’ choice of a host country into three groups, namely: • country endowments; • the investment climate; and • incentives. country endowments refer to the beneficial elements and attributes of a country, such as natural resources, geographical location or a large population. the investment climate of a country is determined by, amongst others, its political and economic stability, the quality of labour and the availability of infrastructure. incentives include, but are not limited to cash grants, tax exemptions and accelerated capital allowances. although wilson’s (1993) study of the characteristics that determine the location decisions for investment of prominent businesses is dated, it is interesting to observe the similarities between his categorisation and that of tuomi. wilson (1993:228) also classified the key investment determinants into three categories of considerations: • coupling considerations (activities that combine a firm’s value chain), such as 322 sajems ns 17 (2014) no 3:319-335 technology, transport costs and the need to be close to customers (markets); • country considerations (or country-specific factors), such as infrastructure, political stability, the labour force and financial systems; and • coordination considerations, which are associated with incentives and tax planning. it is clear that wilson’s categories of investment considerations and tuomi’s categories of investment determinants are very similar. what is interesting, is that in both cases, incentives are mentioned separately as one of the three categories, which indicate their significance in the investment decision. to consider this further, tuomi’s categories of determinants that influence the investment decision are graphically illustrated in figure 1. figure 1 the investment decision: determinants influencing the choice of country determinants influencing the choice of country country endowments: •  large population •  geographical location •  natural resources investment climate: •  political stability •  economic stability •  availability of infrastructure •  quality of labour incentive schemes: •  tax exemption •  accelerated depreciation •  cash grant •  tax holiday •  export processing zone source: tuomi (2009:117) (adapted) all three groups of determinants interact with one another and a change in one of them could affect the other determinants. the improvement of either of the first two groups, namely country endowments and investment climate, would require a long-term approach by a country’s government. the reason for this is that a government might have no or little control over some of these factors, like the availability of natural resources, or the determinants are affected by a number of external factors, such as economic stability. this is why investment experts regard incentives as an important policy variable for improving a country’s investment attractiveness for fdi (lim, 2005:64). incentives can be utilised by a host country to compensate for unavoidable investment obstacles (like political instability), to advertise the country as a desirable location for foreign investment and to encourage specific types of investments that generate particular benefits for the economy as a whole (wentzel, 2010:38-40). although kransdorff (2010:79) believes that fdi increases when the host country’s investment fundamentals (such as political and economic stability) improve, he agrees that competitive incentives (specifically tax incentives) are necessary in the short-term to enhance fdi inflows and boost economic development. the oecd (2007:4-5) agrees that incentives may influence the location of fdi and that ”tax incentives are much easier to provide than to correct deficiencies in, for example, infrastructure or skilled labour”. 2.3 incentives as a short-term intervention to attract additional fdi although incentives were historically found to play a marginal role in the investment decision of foreign investors (moran, 1999:102), kokko (2003:30-31) pointed out that this picture has changed during the past decade. incentives have become an increasingly important determinant of international investment decisions due to globalisation, the increased flow of raw materials, as well as technological and sajems ns 17 (2014) no 3:319-335 323 communication innovations. although incentives may be one of the last considerations in the investment decision, they appear to have an important role to play in finalising choice of location (zanatta et al., 2006:4; lim, 2005:63). mne executives readily admit that the influence of incentives has increased and ”econometric studies, which used to find little or no effect of incentives, now suggest that they have become more significant determinants of international direct investment flows” (conference board of canada, 2004: 21). morisset and pirnia (2000:8) agree that tax policy affects the decisions of some investors some of the time. they noticed that fdi increased more than fivefold between 1985 and 1994 in tax haven countries, which clearly indicates the influence of tax (or the elimination thereof) on fdi decisions. the oecd (2008b:557) confirmed the influence of incentives when it observed that investors were discouraged to initiate long-term investments in south africa during 2007, due to the possibility of the motor industry development programme incentive being discontinued. kransdorff (2010:71-72) adds that tax incentives, specifically, have a very strong influence on attracting fdi when the fundamentals of several host countries are similar. incentives are valuable instruments which can assist in alleviating distortions in the host country’s investment climate and to help attain its growth objectives. all middle east and north african countries offer incentives to boost employment and to improve their competitive position in today’s global economy (oecd, 2007:3). incentives can compensate for market failures, are often regarded as effective policy tools for achieving economic and social objectives and are seen as easy to implement (oecd, 2007:3). incentives may be a viable policy option when the host country faces high unemployment and weak growth. targeted foreign incentives may also be warranted when the policies of the host country unfairly discriminate against foreigners (tuomi, 2009:69-70). according to kransdorff (2010: 75), a country’s fiscal generosity could be signalled to foreign investors by the number and nature of fiscal incentives offered. an argument that is often made in favour of incentives is that, in order to remain competitive, a country must offer incentives if its neighbours offer incentives (moran 1999:103). this argument may especially have some force when the investment decision is strongly affected by taxes (easson, 2004:12; oecd, 2007:7). biggs (2007:4) argues that fiscal incentives and a greater reliance on a diversified tax base (including income tax, vat and other taxes) can help to attract investment, encourage firms to expand supply and advance domestic production. investors are focused on minimising operating costs and reduced taxes will therefore have a particularly strong effect on the investment decision (kransdorff, 2010:71). the conference board of canada (2004:21) found that ”tax policies can have a significant effect on the volume and location of fdi”, due to higher after-tax returns when tax incentives are utilised by investors. most countries have initiated some promotion and facilitation measures to attract and facilitate foreign investment. according to the 2012 world investment report (unctad, 2012:109), these measures ”often include the granting of fiscal or financial incentives, and the establishment of special economic zones”. as at 2011, at least 44 countries had adopted 29 policy measures directed specifically at fdi. twenty-one of these measures offered specific incentives to foreign investors, which directly or indirectly created an attractive environment for fdi (unctad, 2012:76-77). according to tuomi, one of the reasons for the widespread use of incentives is that governments regard incentives as necessary to compete with other countries as investment locations for foreign investors. another reason is that the use of exchange rate intervention is restricted by world trade organisation rules, which increased the need for other instruments that signal which governments are dedicated to development (tuomi, 2009: 27-28). when the host country is able to negotiate favourable terms in achieving its growth objectives when providing incentives, the effectiveness of incentives increases (zanatta et al., 2006:4). some developing countries have utilised incentives effectively to encourage foreign investment. malaysia has been offering incentives such as tax holidays of up to 10 years for foreign investments with pioneer 324 sajems ns 17 (2014) no 3:319-335 status, a reinvestment allowance, an investment tax allowance, and special deductions for training for a while already (nathan-msi group, 2004:3-3). unctad recognised that this incentive policy was one of the primary influences in attracting foreign investment to malaysia (unctad, 2002:207). costa rica’s incentive in the form of an export processing zone was one of the factors that convinced a large international company to choose costa rica as its investment destination in preference to several other countries (nathan-msi group, 2004:3-3). in south africa, as well, the motor industry development programme was a successful instrument for attracting fdi in the manufacturing sector (oecd, 2008c:77; tuomi, 2009:166). motor manufacturers in south africa even warned that south africa’s motor industry (which contributes significantly towards job creation) would not be viable without incentives (cocayne, 2007:4). singapore’s government provides several competitive direct and indirect incentives for fdi in key sectors. unctad found that strong institutions, plentiful infrastructure and generous investment incentives, as mentioned above, are the main contributors to singapore's positive fdi climate (unctad, 2011:39). tax incentives persuaded foxconn (the world's largest manufacturer of electronic components and the largest exporter in greater china) to build five additional factories in brazil to cater to the growing demand for apple ipads and other tablets, and this expansion is expected to produce 400 million units annually (unctad, 2012:55). the 2012 fdi report also recognised that continuous large-scale government tax incentives and subsidies have encouraged rapid growth in the global renewable energy sector (mcmillan, ewing, mcreynolds, et al., 2012: 15). based on all these examples of countries that successfully implemented incentive policies, it is evident that incentives have a positive effect on fdi and growth. due to the fact that south africa possesses positive locational factors (such as a wellsituated geographical location and six deep-sea harbours), cleeve (2008:11) argues that fiscal incentives could significantly influence fdi inflows to the country, especially if investment is efficiency-seeking or strategic-asset-seeking. furthermore, the manufacturing sector in south africa has been identified by the united nations industrial development organisation (unido) as particularly important for growth since it has the highest growth multipliers (unido 2012b:10). to attract increased investment to the south african manufacturing industry, additional incentives may have to be introduced. by studying incentive measures that are provided by other countries, recommendations can be made for the initiation of further incentives. 3 selection of countries and research methodology a comparative study was done between the incentives available in south africa and those available in two foreign countries. this research focused specifically on incentives for manufacturing enterprises and the selection method used in determining the foreign countries therefore made use of information that would ensure the comparability of their manufacturing sectors. the selection of the two countries was based on three criteria, namely performance of the manufacturing sector of each country with reference to manufacturing value added, gross domestic product (gdp) per capita and geographical location. the data for the amount of value added (in us dollars) by the manufacturing sector of most countries in 2009 (the most recent information available at the time the countries were selected) was obtained from the 2011 world development indicators report (world bank, 2011:202). according to this report, south africa’s amount for manufacturing value added during 2009 was the equivalent of $39 014 million. countries with manufacturing value added values ranging from $6 million below to $12 million above south africa’s value added amount were identified. seven countries, namely the czech republic, denmark, finland, ireland, malaysia, saudi arabia and singapore, met these criteria. due to the fact that this study compares south africa to only two foreign countries, some of the seven countries needed to be eliminated from the selection options. for this reason the gdp per capita at nominal values of these countries was sajems ns 17 (2014) no 3:319-335 325 also taken into account for selection purposes. this indicator reveals the comparability of the countries’ economies (kaul & tomasellimoschovitis, 2009). the gdp per capita of countries in 2009 was obtained from the international monetary fund (2009). of the seven countries mentioned earlier, only malaysia’s gdp per capita ($7 469) was similar to that of south africa ($5 635). the other six countries’ gdp per capita range between $14 871 and $55 942, as they have more advanced economies. it follows that south africa could be compared to malaysia, as both these countries have a similar level of economic development and manufacturing value added. it would be useful to compare the incentives offered by south africa to those offered by a government with a more advanced economy, as this could assist in gaining an understanding of what south africa’s approach should be for future growth. singapore was therefore also selected because of its proximity to malaysia. the fact that malaysia and singapore’s economies are primarily dependent on manufacturing (encyclopaedia of the nations, 2010) and both these countries are situated in the same geographical region of southeast asia were regarded as providing sufficient reasons for comparing them to south africa. it is possible that potential bias may occur because of the close geographical location of malaysia and singapore as the potential competition for fdi between these two countries might lead to them offering similar and more favourable investment incentives than south africa. the study made use of a literature review. this involved the collection, analysis and interpretation of relevant published information. the information was obtained from books, articles (both secondary sources) and legislation (primary sources) (such as south africa’s income tax act, malaysia’s income tax act, malaysia’s promotion of investment act, singapore’s income tax act and singapore’s economic expansion incentives act). information was also obtained from electronic sources in accessing the official websites of government entities (such as the south african department of trade and industry, the inland revenue board of malaysia, the malaysian industrial development authority and the inland revenue authority of singapore). 4 analysis and findings the similarities and differences between the incentives offered by south africa and those offered by malaysia and singapore are explained below. prescott (1991:17) warns that a comparison between countries in respect of the specific features of their tax system should be done with caution, due to the fact that the tax systems of countries generally differ significantly. comparison of specific features should ideally take into account the general system of which they are part. however, valuable information, as discussed later, can still be obtained from a comparison between only the incentives (excluding the tax systems) applicable to the manufacturing industry offered by south africa, malaysia and singapore. there are numerous types of incentives, each with unique features. for comparison purposes, this research study classify incentives into three main categories, namely incentives that promote specific investment (incentives encourage and facilitate the incorporation of new manufacturing companies and the expansion of existing ones in specific industries or geographical areas that will benefit the country’s economy), incentives that encourage investment in capital assets (defined after figure 2) and incentives that reduce the company’s fiscal burden (defined after figure 2). incentives that are currently available for the manufacturing sector in south africa (either specifically or as part of incentives generally available to all industries) are summarised in figure 2 under the three main categories of incentives listed above. this article reports only on incentives that encourage investment in capital assets (in other words capital allowances that serve as a tax relief designed to allow the cost of certain of the investors’ assets to be written off against their taxable income) and incentives that reduce the investors’ fiscal burden (in other words tax relief designed to allow investors to deduct certain expenses from their income, or to apply a lower tax rate to their taxable income, thereby reducing their tax liability). table 1 lists these incentives offered by all three countries and shows similar types of incentives offered by more than one country, 326 sajems ns 17 (2014) no 3:319-335 as well as unique incentives offered by only one of them. the sources (literature references) of these incentives are provided in the detailed discussion of each incentive below table 1. figure 2 incentives available to manufacturers in south africa investment incentives promote specific investment foreign investment grant industrial development zones industrial policy projects automotive production and development programme small business corporations enterprise investment programme encourage investment in capital assets reduce the investor’s fiscal burden movable assets used in the production of renewable energy movable assets: wear-andtear allowance urban development zones plant and machinery used by manufacturers buildings and improvements environment assets and expenditure research and development learnership agreements preferential tax rates support programme for industrial innovation source: wentzel (2010:95) (adapted) table 1 comparison of manufacturing incentives offered by south africa, malaysia and singapore to encourage investment in capital assets and reduce investors’ fiscal burden type of incentive south africa malaysia singapore encourage investment in capital assets non-manufacturing assets: wear-and-tear allowance several generators – 6.67% for 15 years several generators – year 1: 60%, year 2:40% several generators – 100% plant and machinery used by manufacturers general after 1 march 2002: year 1 – 40%, years 2, 3, & 4 20% heavy machinery and vehicles: year 1 40%, years 2-4 20% plant and equipment: year 1 34%, years 2-6 14% accelerated: • expand after 15 year ita: year 1 60%, years 2 & 3 20% initial = 20% annual = remaining cost claimed over 5 to 16 years accelerated: • acquired during 2010 and 2011: year 1 = 75%, year 2 = 25% industrial buildings and improvements • industrial building: 5% for 20 years • commercial building: 5% for 20 years year 1 13%, years 2-30 3% initial = 25% annual =3% continued/ sajems ns 17 (2014) no 3:319-335 327 type of incentive south africa malaysia singapore environmental expenditure • environmental treatment and recycling assets – year 1 40%, years 2, 3 & 4 20% • environmental waste disposal assets 5% • environmental remediation and restoration costs – 100% environmental protection equipment: year 1 60%, years 2 & 3 20% • funding for 80% of costs for waste reduction and recycling (applications closed on 28/9/12) • energy-saving equipment: 100% renovation of business premises and infrastructure • refurbishment designated zone = 20% for 5 years • construction in designated zone = year 1 20%, years 2-11 – 8% • renovations between 10 march 2009 and 31 december 2010: years 1 & 2 50% • infrastructure in promoted area: 100% • renovations between 16 february 2008 and 15 february 2013:33.3% for 3 years • 2010 & 2011 100% movable assets used in the production of renewable energy year 1 – 50% year 2 – 30% year 3 – 20% 100% ita for 5 years no similar allowance available reduce the investors’ fiscal burden research and development • qualifying operating expenses – 150% • capital expenses – year 1 – 40% years 2-4 – 20% • revenue costs: 200% • capital expenditure: 50% of costs incurred within 10 years • staff cost and consumables = 150% 400% • expenses for research on specific items = 200% • start-up companies: cash grant of s$20 250 for 3 years and surrender tax loss • partial grant: equipment, training and professional services costs for new research preferential tax rates • corporate tax rate = 28% • small business corporations: first r63 556 = 0% r63 557 r350 000 = 7%, above r350 000 = 28% turnover <r1 m = 0-6% on turnover only • corporate tax rate = 25% • small-scale companies: 20% on the first rm500 000 of chargeable income, 25% income exceeding rm500 000 corporate tax rate = 17% and partial exemption of chargeable income: 75% of the first s$10 000; and 50% of the next s$290 000 training expenses and learnership agreements commence agreement – r30 000/r50 000 per employee complete training – r30 000 per employee or r30 000 per employee per year of agreement (>24 m) 200% or financial assistance no similar allowance available approved foreign loan incentive no similar allowance available no similar allowance available full/partial exemption on withholding tax for interest payments to non-residents approved royalty incentive no similar allowance available no similar allowance available full/partial exemption on withholding tax for royalties or technical assistance fees paid to non-residents the comparison reveals that there are several incentives that are similar for the three countries, but with closer scrutiny it becomes clear that in most instances the benefits that the manufacturing companies receive from the incentives differ. the discussion of the results from the comparison between these incentives considers only the benefit offered to the manufacturer, and does not examine any other requirements that need to be met in order to make use of these incentives or the limitations that apply. the similarities and differences between the incentives offered by the three countries are discussed in further detail in the next two sections. 4.1 incentives that encourage investment in capital assets south africa, malaysia and singapore have a total of five incentives in common, which are 328 sajems ns 17 (2014) no 3:319-335 discussed first. the one incentive that is provided only by south africa and malaysia is discussed thereafter. 4.1.1 non-manufacturing assets for the comparison of non-manufacturing assets, a generator was selected, as this asset is significant in ensuring continued manufacturing operation in the event of power failures. the deduction allowed by south africa in respect of generators, is limited since only a small portion of the acquisition cost (6.67 per cent) is claimable by the investor every year (south africa, 1962:sec 11(e); south african revenue service, 2011). this does not compare favourably with the rates allowed in malaysia and singapore where the full acquisition cost is deductible within two years or less (malaysian industrial development authority, 2012a: [10]); singapore, 1947:sec 19a(3)). it is obvious that uninterrupted manufacturing operations are necessary for the industry to be profitable and in the light of the possible lack of electricity supply by the south african electricity supply commission (escom) (department of minerals and energy, 2008), generators are essential equipment for the south african manufacturing sector. to align south africa’s wear-and-tear allowance rate with those of malaysia and singapore, the south african government could consider allowing the deduction of the full acquisition cost of generators over two years, either equally with 50 per cent each year, or 60 per cent in the year of acquisition and 40 per cent in the subsequent year, as is currently offered in malaysia. 4.1.2 manufacturing plant and machinery a comparison of the deductions available in respect of manufacturing plant and machinery reveals that south african companies are allowed to claim the cost of manufacturing plant and machinery over a shorter period (four years) (south africa 1962:sec 12c) than the other two countries (between 4 and 16 years) (inland revenue board of malaysia, 2012a; singapore, 1947:sec 19). however, both malaysia and singapore offer, in addition, an accelerated allowance on new plant and machinery acquired during or after a specific time frame (malaysian industrial development authority, 2012a:[10]; singapore, 1947:sec 19a(1b)). this enables manufacturing companies to claim the cost of these assets over a period of two to three years, which appears to be more beneficial than the allowance offered by south africa (claimable over four years). manufacturers in malaysia and singapore would be more inclined to acquire new plant and machinery during the specific time frame than a manufacturer in south africa. however, south africa has been offering its allowance over a longer period (since 1 march 2002), and manufacturers are encouraged to purchase new plant and machinery at any given time and not only within a specific time frame. this would probably persuade south african manufacturers to invest in new plant and machinery more often, which could result in a more productive manufacturing industry. no further recommendations are thus offered in order to enhance this incentive. 4.1.3 industrial buildings south africa’s annual allowance rate for industrial buildings of 5 per cent (south africa, 1962:sec 13) is higher than the 3 per cent rate permitted by malaysia (malaysian industrial development authority, 2012b:[1]) and singapore (singapore, 1947:sec 16). however, a significant advantage is created for investors in industrial buildings in both malaysia and singapore since these regimes make provision for an initial allowance in the year of acquisition. malaysia offers an initial allowance of 10 per cent (malaysian industrial development authority, 2012b:[1]), while singapore offers one of 25 per cent (singapore, 1947:sec 16). this incentive, which is essentially an increased deduction in the year of acquisition, may encourage a manufacturing company to invest in industrial buildings and improvements, due to the fact that the immediate benefit of a tax deduction of a greater portion of the capital expenditure compensates for the large initial capital outlay (deposit and transfer duty) in the year of acquisition. in this way the capital expenditure and the major benefit of the investment incentive are linked to each other in the same year of assessment, which would provide relief from a cash flow perspective. the south african government could sajems ns 17 (2014) no 3:319-335 329 consider revising the industrial buildings and improvements incentive in order to allow a significant initial allowance in the year of acquisition, together with an annual allowance thereafter. if the example of malaysia, another developing country, is followed, then an initial allowance of between 10 per cent and 15 per cent should result in a comparable advantage to south african investors in industrial buildings. accordingly, the annual allowance simultaneously could be reduced from 5 per cent to 3 per cent. 4.1.4 environmental assets the environmental protection asset incentives offered by the three countries are very different. south africa’s allowance is claimed over a longer period (four years) (south africa, 1962:sec 37b) than that of malaysia (three years) (ministry of finance malaysia, 2012a), but in addition, south africa allows a remediation and restoration deduction (south africa, 1962:sec 37b) which malaysia and singapore do not offer. singapore’s incentive design is different from south africa and malaysia, as it allows a full deduction for energy-saving equipment (singapore, 1947:sec 19a(6)) and provides a cash grant to reimburse most of the capital cost incurred by a manufacturer with regard to recycling and waste reduction (national environment agency, 2012). it is clear that the design of the current south african environmental incentives was carefully considered, as three different types of environmental expenditure are deductible. in the future, the south african government could consider singapore’s incentives relating to environmental protection should the need arise to encourage this type of expenditure even more. however, there seems no need to adjust these incentives currently offered by south africa. 4.1.5 refurbishment or renovation of buildings all three countries offer a capital allowance for the renovation of commercial business premises (in south africa’s case, only in a specified area called a designated zone), although the rates offered by malaysia (50 per cent) (malaysia, 1967:schedule 3 sec 32a(1)) and singapore (33.33 per cent or 100 per cent depending on the date of purchase) (singapore, 1947:sec 14q(3a)) are more generous than those provided by south africa (20 per cent) (south africa, 1962:sec 13quat). both south africa and malaysia also offer a capital allowance in respect of the construction of commercial buildings and infrastructure in a specified area (designated zone), and again it is evident that these capital costs may be deducted over a shorter period in malaysia (1 year) (malaysia, 1986:sec 4) than in south africa (11 years) (south africa, 1962:sec 13quat). however, manufacturers focus on manufacturing activities and assets, therefore commercial buildings and buildings in designated zones should not form a significant part of a manufacturer’s expenses. no recommendations are currently made to increase the deduction rates allowed by south africa. 4.1.6 renewable resources to generate energy malaysian manufacturing companies that incur capital costs in acquiring equipment that uses renewable resources to generate energy, may claim a 100 per cent investment tax allowance within a five-year period (malaysian industrial development authority, 2012c), while south african companies may claim these capital costs over three years, with a 50 per cent allowance in year 1, a 30 per cent allowance in year 2 and 20 per cent allowance in year 3 (south africa, 1962:sec 12b). it is evident that malaysia provides a more beneficial incentive than south africa. however, due to the fact that half of the capital costs incurred by a south african company may be claimed in the year of acquisition, a significant deduction is allowed initially. the remaining amount is then deductible over the next two years, which is not an extensive period. since the rising capacity shortage in electricity in south africa and the corresponding rising cost thereof is considered to pose a serious challenge not only to the manufacturing industry (unido 2012: 16), but to the economy as a whole in achieving a targeted 6 per cent gdp growth rate (unido 2012:114), measures to further promote the production of renewable energy in south africa should be considered. in this regard an accelerated allowance of 100 per cent of the capital costs could be considered. 330 sajems ns 17 (2014) no 3:319-335 4.2 incentives that reduce the investor’s fiscal burden the two incentives that south africa, malaysia and singapore have in common are discussed first, followed by the one incentive that only south africa and malaysia have in common and the two incentives provided only by singapore. 4.2.1 research and development the comparison between south africa, malaysia and singapore reveals that the research and development incentives of the three countries have various features and rates in common. all three countries provide a research and development incentive which allows the deduction of operating expenses in excess of the actual expense (south africa, 1962:sec 11d; malaysia, 1967:sec 34a(4); singapore, 1947:sec 14da), while only south africa and malaysia offer a deduction for capital expenses incurred for research and development purposes (south africa, 1962:sec 11d; malaysian industrial development authority, 2009:42). although singapore does not specifically provide for a deduction of capital expenditure, it does offer a wide range of other incentives to encourage new and specific forms of research and development, namely: a 200 per cent deduction of specific expenses such as computer software (singapore, 1947:sec 14e); a cash grant for start-up companies that incur extensive research and development expenses in developing a product (singapore, 1947:sec 37h); and a partial grant for equipment, training and professional services incurred for new research (singapore economic development board, 2012). the south african government could consider introducing these incentives if it becomes necessary to further encourage research and development, for example improved manufacturing methods or advanced products. 4.2.2 corporate tax rates the corporate tax rates of south africa (28 per cent) (accountancy sa, 2012:4) and malaysia (25 per cent) (inland revenue board of malaysia, 2012b) are comparable; however, a tax rate that is 3 per cent lower could have a significant impact on a company with high taxable income. both south africa and malaysia also offer special corporate tax rates to small business enterprises (accountancy sa, 2012:7; inland revenue board of malaysia, 2012b). singapore’s corporate tax rate is significantly lower than the tax rates applied in south africa and malaysia, and it is evident that the low tax rate of 17 per cent, together with the partial exemption of income (inland revenue authority of singapore, 2012), is a significant incentive to any profitable manufacturing company. it should be noted, however, that singapore is an advanced economy, which could contribute substantially to the fact that this country is able to charge a significantly low corporate tax rate. it is assumed that an incentive like this would thus not be ideal for a developing country like south africa, since the country relies heavily on its tax revenue from companies (which constitutes 20.4 per cent of taxes on income and profits) (national treasury, 2012:20). although south africa decreased its corporate tax rate from 35 per cent to 30 per cent in 1999, then to 29 per cent in 2005, and again to 28 per cent in 2008 (accountancy sa, 2012:4), a further reduction in the corporate tax rate may be required to ensure the country’s comparability to other countries such as malaysia in order to effectively compete with these destinations as an investment destination. it is acknowledged that several factors would influence a decision like this. furthermore, opposition parties (marais, 2009) have appealed to the government to lower the corporate tax rate and it is expected that serious consideration is annually given to this aspect by the minister of finance. it may perhaps be argued that, if it were possible and beneficial for all parties involved, government would have decreased the corporate tax rate since 2008, but they have not done so. therefore, no further recommendation is made to lower the corporate tax rate with immediate effect. 4.2.3 employee training malaysia allows a double deduction of training expenditure incurred (ministry of finance malaysia, 2012b). however, the south african government allows additional deductions (of r30 000 or r50 000 per employee for every year that the employee is part of a learnership agreement, as well as when the agreement is sajems ns 17 (2014) no 3:319-335 331 successfully completed) to the single deduction of training expenses (south africa, 1962:sec 12h). these two incentives could therefore provide a comparable benefit to companies in south africa and malaysia, depending on the amount of training expenses incurred by them. although the deduction of additional training costs over and above the actual expense incurred is capped in terms of the south african tax rules, the mere fact that an additional deduction is granted is a positive consideration for investors that plan to invest substantial amounts into staff training. therefore no recommendation is made about revising the learnership agreement incentive offered by south africa. 4.2.4 royalties and interest payments to non-residents singapore offers full or partial exemption on withholding tax relating to interest paid on loans obtained to acquire productive equipment (singapore, 1967:sec 59), and on technical assistance fees paid by a manufacturing company to its non-resident holding company (singapore, 1967:sec 64). this reduction in business costs encourages foreign direct investment and the transfer of foreign technology and know-how to the host country. this may be an attractive incentive for south africa to consider in order to increase foreign direct investment and to obtain foreign expertise and skills transfer in the economy. the south african government could consider introducing a new incentive relating to royalties and interest payments to nonresidents, in order to achieve its aim of increasing foreign direct investment. the proposed benefit to the investor is a full exemption of withholding tax on interest payments and royalties or technical fees payable to non-residents. the above analysis clearly indicates that there is some scope for south africa to introduce additional incentives and amend existing incentives in order to remain competitive in the pursuit for increased fdi. it is however paramount from a policy perspective, that in designing fdi-attraction policies, policy-makers in developing countries should consider not only the short-run costs and benefits of fdi, but also their medium to longterm dynamic consequences (unido, 2012a:19). furthermore, when designing incen tives, the united nations industrial development organisation (unido) emphasises that it is fundamental to the host country to focus scarce resources aimed at attracting fdi towards firms that are more likely to produce large spill overs and linkages in the local economy (unido, 2012a:1). 5 conclusion foreign direct investment (fdi) is important for facilitating the growth of a country’s economy. several authors agree that south africa needs to increase its inward fdi. the aim of this article was to explore which intervention measure could be launched to enhance the country’s attractiveness for foreign investors. the literature review demonstrated that there are several key determinants that influence foreign investors’ decisions in the choice of an investment country. incentives are, however, the only determinant that can be employed by a country’s government as a short-term intervention for attracting additional fdi. incentives can be utilised by a host country to compensate for unavoidable investment obstacles (like political instability), to advertise the country as a desirable location for foreign investment and to encourage specific types of investments that generate particular benefits for the economy as a whole. in order to identify additional incentives that the south african government could introduce or existing incentives that could be amended, a comparative study was done. the comparison provided insight into the incentives that are currently offered in the manufacturing sectors of south africa, malaysia and singapore. the research was focused on incentives that encourage investment in capital assets. incentives that reduce the investor’s fiscal burden were also considered. the findings from the comparative study show that malaysia and singapore offer some incentives that south africa does not. all three countries also have several incentives in common, although an analysis of these incentives revealed that the design and benefits 332 sajems ns 17 (2014) no 3:319-335 of these incentives for manufacturers differ in most cases. the results from the analysis of the comparison suggest that incentives relating to the following be considered for introduction or modification in south africa: incentives that encourage investment in capital assets: • amend the current wear-and-tear allowance rate for generators to allow the deduction of the full cost over two years, either equally with 50 per cent each year, or 60 per cent in the year of acquisition and 40 per cent in the subsequent year, which is the permissible rate in malaysia (par 4.1.1). • amend the current allowable deduction rate for industrial buildings by introducing an initial allowance of between 10 per cent and 15 per cent and reducing the annual allowance from 5 per cent to 3 per cent (par 4.1.3). • amend the current capital allowance on equipment used to produce renewable energy by providing an accelerated allowance of 100 per cent of the capital cost incurred (par 4.1.4). incentives that reduce the investors’ fiscal burden: • introduce additional incentives to encourage research and development even further by providing a double deduction of expenses relating to research performed on specific items, a cash grant to start-up companies conducting research to develop a product, and a partial grant for equipment, training and professional services incurred in respect of new research (par 4.2.1). • introduce an incentive to encourage foreign direct investment in the manufacturing sector and the transfer of foreign technology and know-how by providing a full exemption of withholding tax on interest payments and royalties or technical fees payable to non-residents (par 4.2.4). the research that this article reports on contributes to identifying a short-term intervention that could assist in the much-needed increase in fdi and ultimately in south africa’s economic development. it is acknowledged that the south african government cannot merely introduce incentives without careful consideration of all aspects involved and their impact on the economy. in order to achieve the desired outcome, 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(eds.) studies in international taxation. chicago: university of chicago press. world bank. 2011. world development indicators 2011. available at: http://issuu.com/world.bank. publications/docs/9780821387092_part2 [accessed 2012-02-11]. world economic forum, 2010. the global competitiveness report 2010–2011. available at: http://www3.weforum.org/docs/wef_globalcompetitivenessreport_2010-11.pdf [accessed 2011-08-10]. zanatta, m., costa, i. & filippov, s. 2006. foreign direct investment: key issues for promotion agencies. united nations university: policy brief no 10:1-7. available at: http://www.merit.unu.edu/ publications/pb/unu_pb_2006_10.pdf [accessed 2013-09-16]. microsoft word 11 ramlee & berma si(16) 2013.doc sajems special issue 16 (2013) : 115-126 115 financing gap in malaysian small-medium enterprises: a supply-side perspective shamshubaridah ramlee* & berma berma faculty of economics and business, universiti kebangsaan malaysia in malaysia, the issue of financing gap in small medium enterprise (sme) financing is common, but hardly discussed nor researched. the issue of financing gap or lacuna arises due to the mismatch between the demand and supply of institutional funds for smes. smes contend that finance for smes are abundant, however, the supply of bank financing is largely unavailable to them. banks, on the other hand, maintain that lending to these smes remains low because of lack of qualified demand. this brought to the forefront the issue of financing lacuna; a perennial issue in many developing countries, including malaysia. the objective of this paper is to discuss the financing lacuna in malaysian smes, focussing on the supply side. this paper focuses on the supply perspective to fulfil the research gap in understanding the financing lacuna, which has often been overlooked due to the tendency to analyse financing lacuna from the demand side only. this has been based on surveyed data of sme entrepreneurs. this paper outlines the theoretical approaches and practices of smes financing in malaysia, followed by an analysis of the factors that shaped the financing lacuna (gap). key words: financing lacuna, supply side, smes, risk profile, opaque borrowers, lending technology jel: g210 1 introduction the old adage, “all money is not the same” appears to hold some truth for small-medium enterprises (smes) financing in malaysia. smes contend that finance for smes are abundant, however, the supply of bank financing is largely unavailable to them. banks, on the other hand maintained that lending to these smes remains low because of lack of qualified demand. the government has also spent huge sums of money to support the development of smes and this is reflected by the proliferation of loans, grants, guarantee schemes, venture capital and government loan schemes targeted at smes. yet, financing continue to be one of the key development constraints cited by the majority of smes. there is a mismatch between demand and supply of funding for smes or a funding lacuna (gap). the sme funding lacuna is a perennial problem but rarely subjected to open discussion or academic research in entrepreneurship funding literature (oecd, 2007 vol. 1 & 2). undeniably, there is much literature dealing with financing of smes at home (ndubisi & salman, 2006: apec, 1994: smidec, 2007) and abroad. many of these studies focused on sources of capital, capital structure and financing constraints. but few of them investigate smes’ ability to borrow from financial institutions and the reasons preventing these institutions from lending to smes as compared to largescale enterprises. in malaysia, the discussions and research on sme funding are often focused on the problems smes faced in obtaining institutional funds (demand-side). there is, however, very limited research on the determinants of funding to smes from the financial institutions’ perspective (supply-side). this lack of academic research is partly due to the difficulties in collecting hard data of clients and practices from the financial institutions due to the non-disclosure legal requirements. this paper is one step aimed at bridging this research gap by discussing the sme funding lacuna. the objectives of this paper are to discuss the funding lacuna in malaysia by focussing on the mismatch between the demand and supply-side issues of sme financing. the paper will also highlight the policy responses to address sme funding issues. it also provides a synthesis of selected supply and demand side abstract 116 sajems special issue 16 (2013) : 115-126 issues which contribute to the smes funding gap. this paper is organised into four sections. following section one which serves as the introduction, section two defines the conceptual framework of the sme funding gap and the theoretical issues in the demand and supply of sme funding. the sme funding lacuna in malaysia is discussed in section three. the section begins by briefly discussing the demand issues in sme financing, which is followed by an in-depth discussion of the supply-side issues. it also highlights some of the policy responses adopted by government to address the demand and supply-side constraints faced by smes. finally, section four presents the conclusions. 2 sme funding gap: conceptual framework this section outlines the theoretical underpinnings that frame the discussion in this paper. sme financing constraints using the financing gap hypothesis are considered. generally economics has given little attention to small firms. if markets are efficient and information is complete, the size of the company has no effect on its ability to raise funding, for there will be a price that covers the risk. these assumptions have since been challenged. many studies have reported that smaller enterprises experienced higher financing obstacles along the capital structure spectrum than larger enterprises (wattanapruttipaisan, 2003; beck, 2007; beck & demirguc-kunt 2006). studies also show that smaller firms’ financing obstacles have almost twice the effect on their growth as larger firms’ capital constraints. banking systems systematically underserved the sme sector relative to larger firms. export, leasing, and long-term finance are also scarcer for sme firms. this situation cannot be fully explained by one single reason; it is necessary to explain it from both the demand and supply side. while the supply side focuses on the issues affecting the institutions involved in providing finance, the demand side focuses on issues affecting the smes seeking capital. 2.1 sme funding lacuna: the demandside perspective this section discusses the issues from the demand side in obtaining finance. one of the major challenges confronting smes is accessing financial resources, particularly at their seed, start-up and growth. most research on sme financing cited background of sme borrowers, fund availability and accessibility as the key factors shaping the sme funding gap. this study extends the discussion by examining other key elements derived from information asymmetry problems. for a start, it is important to define the access problems. the issue of sme access to finance has long been the centre of academic research. the majority of this research agreed that it is “not easy” to define the access problem. some analysts (claessens, 2006; murduch, 1999) have provided specific definetions to access to financial services by classifying them into different dimensions the dimensions are availability, (are financial services available, and if so in what quantity); cost (at what total price are financial services available); and range, type, and quality of financial services offered. murduch (1999) on the other hand, identified the access dimensions as being related to reliability, (whether finance is available when needed); convenience, (is access easy); continuity, (can finance be accessed repeatedly); and flexibility, (are products tailored to individual needs). a common theoretical argument for the finance gap is information asymmetry leading to credit rationing on the part of bank lenders (berger & udell, 1998; petersen & rajan, 1994). information asymmetry arises due to imperfect market conditions; the relatively low levels of accountability of credit, compounded by poor bookkeeping records; the absence of credible collateral; a lack of transparency; and risks that arise due to the specific markets that smes operate in. to the suppliers of funds, the sme market segment is “high risk” because small loans are risky. banks are reluctant to provide credit to smes, whom they perceive as their riskiest clients, potentially providing insufficient profit margins and high transaction costs compared to large firms. some also argued that micro and small sajems special issue 16 (2013) : 115-126 117 enterprises are not financially sophisticated enough to participate in the formal financial sector or cannot afford market interest rates and therefore require government or donor funded credit subsidies. hence mainstreaming the smes will require government intervention and the overall macroeconomic legal, regulatory and financial framework must be in place to ensure smes’ access to finance (oecd, 2007). 2.2 sme funding lacuna: the supplyside perspective the difficulties standing in the way of flow of institutional funds to the sme sector relate to a host of systemic and institutional barriers cross-cutting supply-side issues. from the supply-side, the constraints include, but are not limited to, cost-effectiveness of loans to smes, opaqueness of borrowers, transaction costs, information, including lending technologies to assess credit applications. the implication of these constraints is that the proportion of loans allocated to smes receiving bank loans is very low. first, there is the cost effectiveness of loans to smes. this issue is related to the scale economies in lending. the higher the loan amount, the lower the lender’s inspection cost per unit of loan, and the lower the borrower’s unit cost of providing information, filling out forms, etc. because there is a correlation between loan size and firm size, regardless of firm quality, scale merits mean that large loans receive precedence over smaller loans. also, the operating costs of sme finance institutions are high. this results in their inability to easily achieve profitability and even if they do, their margins are relatively lower than other formal financial institutions that do not cater to the sme sector. next, information economics highlight the imperfections involved in small firm lending. some argue that banks do not find smes to be profitable due to the high transaction costs and institutional risks arising from asymmetric information between borrowers and lenders; the borrower has private information about the firm that the lender doesn’t have. for smes, because of their small size and obscure accounting, the extent of information asymmetry becomes more serious. incomplete information in terms of creditworthiness and interest rate evaluation of a small firm triggers a “lemon” problem equivalent to that in the car market (akerlof, 1970). the lender cannot fully determine how risky the borrower is, and cannot monitor the borrower once the loan is furnished. this causes problems of adverse selection and moral hazard. the smes are characterised by informational opacity. this can be attributed to the fact that they are typically new entrants to the formal sector and lack any credit history or formal records. even where they keep records these are mostly incomplete or inaccurate. the relative opacity of the smes target group results in relatively higher transaction costs when lending to this sector. asymmetric information results in adverse selection and moral hazard, which are two factors that contribute to credit rationing. this is welldocumented and evidenced in monetary economic literature (diamond & dybvig, 1983). the costs of assessing and processing loan applications are identical for large and smaller loans, and micro-enterprises require relatively smaller loans than larger enterprises to start or expand their businesses. to reduce the fixed cost element arising from loan assessment, tiered interest rates are used. this involves charging higher nominal interest rates on smaller loans i.e. loans offered to the sme finance target group. the argument on sme’s opaqueness is further supported by stiglitz and weiss (1989) who argue that the selection of borrowers in the loan market are more difficult, as rationing credit will enhance the adverse selection and moral hazard problems among borrowers. information asymmetry on borrowers’ repayment abilities increase banks risk of selecting borrowers. with higher interest rates charged, suppliers of credit are attracting a riskier group of borrowers who will be attracted to invest in higher risk projects. this higher risk projects in turn provide higher profit incentives among borrowers, hence necessitating higher monitoring efforts due to moral hazard problems. higher risk perception among credit supplier are not without evidence. research and practices in small business lending often revealed that borrowers are highly opaque. 118 sajems special issue 16 (2013) : 115-126 they have either no or limited track records as a result of a short business history. this fact accentuates the adverse selection problems among borrowers as identifying bankable prospect is difficult. lack of business plans aggravate the negative risks perception of credit suppliers, as road maps for the growth of borrowers are difficult to determine (wattanapruttipaisan, 2003). this translates into an unconvincing financial forecast and eventually difficult repayment performance. studies (berger & udell, 2002; hirofumi, nobuyoshi & udell, 2006) also revealed that financial institutions do not use appropriate financial technologies necessary for appraising and monitoring microfinance credit applications (berger & udell, 2006). generally, the provision of financial services in general and smes in particular involves an assessment of the probability that borrowers will keep their promises to repay the principal and interest on time, and, in the case of micro-enterprises, have the experience to run a particular operation. this function is performed by credit officers. unfortunately, a constant finding in many surveys aimed at assessing the quality of sme finance staff is that they have limited if any previous experience in credit. this situation is exacerbated by the fact that the small-scale finance target group typically lacks any credit history or complete records, as highlighted in earlier paragraphs. this relates to the issue of lending technologies discussed by berger and udell (2006). they used the differences in lending infrastructure to explain the financing problem faced by smes. they argued that large institutions have a comparative advantage in transactions lending based on “hard” information, which include financial ratios and credit scores. this information is relatively easily observed, verified, and transmitted. on the other hand, banks targeting small enterprises have a comparative advantage in relationship lending based on “soft” information, which focuses on the character of the sme owner, and his knowledge of the local community. this information is not easily observed, verified, and transmitted. studies, however, revealed that banks often based their sme credit decisions more on strong financial ratios (hard information) than on prior “soft information” which characterises sme borrowers (cole, goldberg & white, 2004). the implication of this argument is that what matters is not just the number of banks providing funds to smes but equally important is to address the issue of sme opaqueness, and providing funds that are well-suited for opaque smes. berger and udell (2002; 2006) suggested that “better” lending infrastructures can make significant differences in sme credit availability, directly through facilitating the use of the various lending technologies, namely financial statement lending, smes credit scoring, factoring, and asset-based lending. this section has provided the conceptual background for the discussion. the following section discusses the sme funding lacuna in malaysia. it begins by briefly considering the funding gap from the demand perspective, followed by a detailed analysis from the supply-side. 3 sme funding lacuna in malaysia: excess supply versus unfulfilled demand in malaysia, the sme sector has been one of the key drivers of the nation's economic growth. the sme sector has two important roles to play. first, smes are the thrust of malaysia’s economic policy. it strengthens domestic demand, promotes and diversifies endogenous sources of growth, and infuses dynamism into the economic sectors. second, smes are impetus for broad-based economic growth. they provide linkages between subsectors in the malaysian economy. they are the source of dynamism and agility. the sme sector also serves as a seedbed for indigenous entrepreneurship. it has long been recognised that a vibrant sme sector results in a broad and diversified domestic production base, stimulate bumiputera entrepreneurship, promote the development of local technology and contribute to the achievement of macro objectives such as full employment, poverty alleviation and equal income distribution (smidec, 2002; ninth malaysia plan, 2005). to have a better understanding of sme sajems special issue 16 (2013) : 115-126 119 funding lacuna in malaysia, the following section discusses this issue from the supply and demand perspective. figure 3 shows a graphical representation of sme funding in malaysia from the supply and demand perspectives. figure 1 schematic diagram of the conceptual framework of sme funding issues and policy response in malaysia source: authors’ conceptualisation, 2009. 3.1 sme funding: unfulfilled demand from the experiences of policy makers and practitioners it has been realised that the smes are often plagued by constraints. these restrictions, however, are not unique to malaysian smes, but rather a worldwide phenomenon. the smes are constrained from achieving economies of scale in the purchase of inputs like equipment, raw materials, finance, and consulting services. they are often unable to access global markets and are limited in their performance in increasingly open, competitive domestic markets. because of their size, it is difficult for the smes to access functions like training, market intelligence, logistics, and technology. as such, they are unable to take advantage of market opportunities that require large volumes, homogeneous standards and regular supply. furthermore, enterprises compete not only on the basis of prices, but also of their abilities to innovate or upgrade. improvements in product, process, technology, and organizational functions such as design, logistics, and marketing have become the critical success factors in firm competitiveness in a globalizing economy. the smes are thus under pressure to innovate and upgrade their operations in order to participate in international markets. however, they often lack the financial resources to do so. the malaysian government has taken various steps to solve deficiencies in this sector and alleviate constraints that affect it. given its significance and potential as a driver of economic growth, the government has developed and implemented various development programmes, and allocated significant funds and resources to further enhance the growth of this sector. in 2010, banking and financial institutions, comprising banking and non-banking institutions, 120 sajems special issue 16 (2013) : 115-126 approved rm 62.6 billion to more than 140,487 sme accounts, an increase of almost 60 per cent from the year 2006. as of 2010, rm 9.65 million has been allocated to the bnm special funds and guarantee schemes. the government allocated rm 37.22 billion to 83 schemes while the credit guarantee schemes approved rm 48 billion to 410,000 smes. forty one financial institutions utilise the credit bureau services, while 28,230 nonbanking financial institutions use the credit information provided by the sme credit bureau, reducing the opacity information of borrowers. other funds rm 5.6 billion from venture capital, rm 120 million from pawn broking and arrahnu and rm 776.3 million (or 57,403 accounts) from microfinance institutions. figure 2 provides us with the funding landscape for smes in malaysia in 2010. figure 2 sme funding landscape, 2010/2011 source: sme annual report, 2010/2011 in spite of government’s priorities and efforts, certain segments of the sme sector continue to lament the lack of financing access, which is deemed a major challenge that hinders their growth and development. in fact, access to financing has been identified in many business surveys as one of the most significant obstacles to the survival and growth of smes including innovative ones. as chart 1 shows, the majority of smes (only 13.4 per cent) rely on banks and 2.7 per cent on development financial institutions to fund their business (latest published data was not found). the commonly-cited lack of accessibility to institutional funding is timeliness of approval and disbursement. studies (shamshubaridah, 2005; shamshubaridah & berma, 2008; 2009) showed that loan approvals and disbursements take more than 3 months for smes and the time taken becomes longer for smaller-sized sajems special issue 16 (2013) : 115-126 121 loans. banks are seen to be not ‘user friendly’ as tedious processes are involved when applying for loans and disbursements. long processing time in validating information from borrowers’ proposal or business and difficult pre-disbursement conditions, often leave the borrowers with a tight cash flow position (shamshubaridah & berma, 2009). chart 1 malaysian smes sources of funding, 2005 source: bank negara malaysia, 2006 (unpublished) smaller enterprises as compared to larger enterprises in malaysia (smidec, 2002; bank negara, 2005; shamshubaridah & berma, 2008; 2009) experience higher financing obstacles along the capital structure spectrum. moreover, limited market power, the lack of management skills, high share of intangible assets, the absence of adequate accounting track records and insufficient assets, all tend to increase the risk profile of smes. consequently, traditional commercial banks and investors have been reluctant to provide financing services to smes (smidec, 2007). in contrast, larger enterprises with better business plans, more reliable financial information and larger assets have an easier time in obtaining finance through traditional means. ismail & siti (2008) reported the current financing practices and problems of technology based small and medium enterprises in malaysia. they showed that, in addition to entrepreneurs’ personal savings and profits retained in the firms, most malaysian smes have approached external sources to finance business development. enterprises that use external finance rely heavily on debt finance. this empirical evidence confirms enterprises “pecking order theory” as most of the enterprises follow some order of financing preferences. these studies look into the types of financing available at different stages of development namely the seed stage, start-ups and growth as well as the funds that have been made available. the financing amount allocated among sectors, the types of loans (working capital, term loans, revolving credits etc.), and types of instruments, are largely reported to show the extent of financing efforts by the government. other studies look at how smes face challenges in the global and domestic market in an environment of financing constraints (ndubisi & salman, 2006). the most important obstacle in making loans more accessible to any borrower is the information asymmetry between the borrowers and the lenders, where borrowers have private information about the firm that the lenders do not have. the small size and usually having a short business history, obscure accounting, and a lack of business plans, makes the problem even more pronounced for smes. in the case of malaysia where funds availability is never an issue, the lenders have been left with a dilemma to fulfil its role both 122 sajems special issue 16 (2013) : 115-126 as profitable and developmental financiers (shamshubaridah & berma, 2008, 2009). rationing credit by limiting the loan amount or increasing interest rates are the solutions to limit the risks of lenders. however, national developmental objectives (such as the need to target smes in priority sectors and ethnic background) often constrain lending institutions from taking the necessary measures to reduce the asymmetry information faced. given the risky profile of the sme borrowers that need to be served, the regulatory environment in which lenders operate and the transaction costs incurred when using lending technologies, we discuss below how loan accessibility from the suppliers’ perspective has been a perennial complaint among the sme borrowers. 3.2 sme funding: excess funds this section discusses the issues of sme funding in malaysia from the supply perspective. it complements the earlier discussion by analysing the key elements that shape financial institutions from funding smes. the discussion focuses on three key aspects: environment, risk and transaction cost. 3.2.1 environment the economic and business environment in malaysia shapes the supply of funds to smes. the environmental factors include the regulatory requirements, and loan monitoring and collateral requirements. lending institutions worldwide operate within a regulated environment to ensure a smooth flow of funds from the suppliers’ and the demanders’ side amidst the imperfect market where asymmetry information is at its highest. fragility of the financial system has stimulated central banks to a tighter supervision. fear of financial crisis and its spill-overs to the real sectors has given rise to the wider powers of the central banks worldwide. controlling the rise of non-performing loans and deterioration of loan values has prompted the tight control of banking and its functions. malaysian financial institutions are governed by the banking and financial institution act 1989 and development financial institution act, 2002. laws regarding the granting of unsecured loans (section 60, bafia) and monitoring of loans and credit limit to single customers (section 61, bafia) shape the delivery, hence the accessibility of loans. implicit prohibitions to offer loans to potential borrowers without collateral, and collateral monitoring requirements, have influenced the lending technology practices. it is not unusual for financial institutions to insist that loans be secured against other assets and third party guarantees. problems become more acute when applicants for loans are small borrowers with no track record and a short business history, where accumulation of assets that could be pledged to banks are almost impossible. in malaysia, single borrowing limit requirements, measured by the gearing ratio of sme borrowers, have resulted in credit suppliers limiting loan exposure amounts to prospects. efforts to maintain a favourable gearing position is also one of the ways to ensure that credit quality of institutions do not deteriorate adversely. often borrowers are given loans in accordance with the amount of internal savings or other contributions that has been put into the borrowers’ businesses. as smes do not have the luxury of an internal source of funds, efforts to furnish evidence to suppliers of credit on their contribution to the business, often entail a long negotiation process. in most adverse situations, it is not uncommon for credit applications to be rejected or, if approved, leading to a longer period of loan disbursements. government intervention efforts to develop sectors by channelling credits to various institutions, forces credit suppliers to incorporate collateral as a screening device (gale, 1989) in some cases, government development initiatives to develop indigenous groups through the bumiputera commercial and industrial community programs (bcic) requires the channelling of funds through the various non-bank financial institutions (see national development plan, 1990). accessing loan viabilities are even more acute for certain suppliers, since risk profiles are even more severe, especially among the new bumiputera enterprises. often these ethnic borrowers have the assets to be pledged but have difficult asset conditions that may restrict banks from taking it as collateral. restrictions on landed properties such as a ‘malay reserve’ land status, may sajems special issue 16 (2013) : 115-126 123 make fulfilment of loan conditions difficult. shamshubaridah (2005) and shamshubaridah & berma (2008, 2009) found that banks took longer to disburse a loan to bumiputera borrowers, as land offered for security purposes to the banks are not able to attract an attractive forced sale value, due to the restrictions inherent in the type of land. efforts to make funds more accessible among smes are often interrupted by the very opaque nature of the borrowers. although loans are abundant across sectors with varied purposes, lack of quality information as to the bankability of the borrowers forces the credit supplier to institute standard best practice procedures. loan monitoring conditions through various covenants for pre and post disbursements are essential. pre-disbursement conditions such as changing the type of land from agriculture to commercial are the most common way to ensure that assets are of value and used as security. the process however, requires long processing time with the land office department. this in turn affects the swift fulfilment of the loan conditions and hence interferes with the loan disbursement. hence the timely accessibility of the loan. in a situation where land is already able to be changed, ascertaining the land value is yet another problem. lack of funds on the borrowers part to engage in valuers to determine the land value also affect loan delivery timeliness. hence, it is not unusual for commercial or developmental credit suppliers to protect themselves by having a client charter. the charter will specify the suppliers claim on its timely delivery according to the borrowers timely efforts to make the assets chargeable (shamshubaridah, 2005). the establishment of the credit guarantee corporation (cgc), helped to address the issue of shortfall of asset value of financial institutions, arising from the lack or insufficiency of collateral among borrowers. the main objective of the cgc is to assist smes with no track record or collateral, or inadequate collateral, to obtain credit facilities from financial institutions by providing guarantee coverage for any loan facilities demanded. the request for a guarantee facility however, requires another process that needs to be entered into by the borrowers. credit suppliers’ loan considerations are still dependent on the success of the loan guarantee applications. it is therefore not unusual for banks to take considerable time to assess loan applications and slow loan drawdown. 3.2.2 risk the perception of the supplier of funds towards smes is one of the determinants of fund allocations to smes. the opaque nature of sme borrowers in malaysia is not an exception when a financial institution enters into a lending relationship. asymmetry information regarding borrowers’ projects, businesses and promoters’ profile is high. credit rationing in the form of high interest rates and lower loan approval amounts are hence inevitable. specialized financial institutions such as sme bank bhd., exim bank, midf, are often the target for an external financing source among malaysian sme borrowers. the experiences in malaysia concur with the issues that were discussed by stiglitz and weiss (1981). efforts to reduce the risks perception among suppliers of credit include the establishment of credit bureaux such as the sme credit bureau malaysia. this is to provide credit profiles of potential borrowers and help in reducing the risk perception arising from asymmetry information; which translate into better credit input that can be used by banks to process an application. efforts to securitize sme loans through the establishment of the national sme development council will enable banks to diversify its credit risks (omar, 2006). this will increase the lenders tolerance for risks, which will result in banks becoming more realistic when devising loan covenants, hence speeding up loan drawdown and improving accessibility. the establishment of the sme bank berhad and microfinance institutionare is an attempt by malaysia to correct the risks profile of the sme borrowers. with an added corporate advisory services function, consultation given to coach clients in maintaining records and building business plans, will help reduce the opaqueness of the borrowers. formation of a sme special unit in bank negara malaysia further helps to speed up loan accessibility. the sme special unit is to assist the smes in the following areas: 124 sajems special issue 16 (2013) : 115-126 • provide information on the various sources of financing available to the smes; • facilitate smes in their loan application process; • address difficulties faced by viable smes in securing financing; and • provide advisory services on other smes financial requirements. this special unit is part of the on-going efforts to ensure continued access to financing for viable smes across all sectors 3.2.3 transaction costs making loans more accessible is not without a cost for the lenders. although loans are highly subsidized with minimal funding costs for lenders, lending to various sectors with a variety of purpose, make the loans accessibility more challenging and problematic for the banks. higher cost to process credit is inherent in the lending technologies adopted. hard information about lending, through the use of financial statements and fixed assets of borrowers, are almost impossible in most malaysian sme borrowers. standard credit scoring instruments as commonly adopted by malaysian lenders to evaluate applications, are difficult to be used among these sme borrowers as information is difficult to quantify (shamshubaridah, 2005). lenders have to complement hard information lending with the use of soft information technology that is through the use of relationship lending approaches. in the relationship lending technology, infor mation on the riskiness of borrowers is obtained through years of information accumulation. these long years of relationship enable lenders to collect psycho graphics information about borrower’s repayment abilities. it is common for loan officers to maintain personal working relationships that may interfere with the professional demand of the job functions. efforts to use relationship banking apart from the financial statements and fixed asset lending methods translate into costlier processes that will increase the transaction costs. in terms of spatial, it is necessary to analyse the extensiveness of bank branching and its impact on the transaction costs. in malaysia, although high investments in technology may provide the economies of scale advantage, processing loans and disbursement procedures may still increase the cost to make loans more deliverable. loan application and disbursement requirements from branch offices are cases in point. approval for both the former purposes requires the head office subsequent and final approval. these translate into higher transaction costs for the lenders as the work of the branch officers need to be verified and therefore limiting the speed of loans accessibilities. this practice is even more critical among highly opaque sme borrowers. the scale of operations for banks refers to the size of loans extended to borrowers. as has been discussed, smaller loan size borrowers present a higher per unit cost of processing compared to a bigger size loan. this is due to the processing nature of loan applications and disbursement requirements. in fact, the smaller the loans the more tedious the processing time as the opaque nature of borrowers requires more time for lenders to verify and process an application. studies by shamshubaridah and berma (2006) revealed that it took more than 90 days for small and medium size loans to be processed before a lending decision is obtained. enabling a speedier loan disbursement for small sized loans among the sme borrowers is also difficult. in some cases loans are not even disbursed as borrowers are unable to fulfil the pre-disbursement conditions stipulated by the lenders (shamshubaridah & berma, 2006). 4 conclusion financing has always been a perennial problem among malaysian smes. many studies have been done to analyse the problems of sme financing. the most common approach is to analyse sme financing problems from the demand-side. the most commonly cited problems are the opaque profile of the smes, business and promoters background, fund availability and accessibility. this paper attempts to fill the research gap on sme financing by discussing the supply-side focussing on the practices of the supplier of credit, the environment that influences the supply of funds to smes, the risk that the sajems special issue 16 (2013) : 115-126 125 supplier of funds incurred by servicing smes, and the high transaction cost involved in delivering credit to smes. this paper is an initial attempt at filling the research gap on sme financing lacuna (gap) in malaysia. it opens new agendas for academic research and debates on the 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value-based management. dariusz zarzecki (ed.) published by university of szczecin:230-242. smidec. 2002. smi development plan (2001–2005), percetakan nasional malaysia berhad, kuala lumpur. smidec. 2007. sme performance 2007 report. kula lumpur, malaysia (unpublished). stiglitz, j. & weiss, a. 1981. credit rationing in markets with imperfect information, american economic review, 71(3):393-410. wattanapruttipaisan, t. 2003. four proposals for improved financing of sme development in asean; in: asian development review, 20(2):66-104. sajems ns 10 (2007) no 3 313 associations between entrepreneurial empowerment and reasons for self-employment b urban department of entrepreneurship, university of johannesburg abstract building on previous research relating to entrepreneurship, empowerment and self-employment, this article investigates the relationship between entrepreneurial empowerment, entrepreneurial self-efficacy and self-employment. these constructs are formulated into distinct factors and a sample of undergraduate students (n = 112) early in their careers surveyed to establish the structure formed by these factors. these instruments are tested and shown to provide robust scales able to ensure construct validity and reliability. multiple correlational and multiple regression analysis are then conducted to test the relationships between the specified variables, with results indicating almost unequivocal support for the hypothesised associations between entrepreneurial empowerment and reasons for business start-up. in particular the “risk-taking” factor is found to have great predictive power on various reasons provided for business start-up. several practical and theoretical implications are drawn from the empirical results and integrated with established conceptual findings. jel d8, j24, l26, m13 1 introduction 1.1 background to the study modern businesses are often characterised as turbulent and dynamic. individuals who work in them, under these conditions, need to be entrepreneurial. however, instead of becoming adaptable, flexible, autonomous and entrepreneurial, many individuals in this rapidly changing, complex environment tend to react in the opposite way. whetten and cameron suggest empowerment is the key to developing the characteristics required for such a changing environment, saying that ‘to empower means to enable and to develop a sense of self-efficacy’ (2005: 403). empowered individuals feel less constrained and more selfefficacious, autonomous and creative, and are more likely to be innovative and expect more success (conger & kanungo, 1988; thomas & velthouse, 1990). when people are empowered they feel efficacious in that they possess the capability and competence to perform a task successfully. they feel a sense of personal mastery and confidence. some researchers (such as bandura, 1997) believe that self-efficacy is the most important element in empowerment, since it determines whether people will try and persist in attempting to accomplish a difficult task. kantor (2002) argues that empowerment and innovative behaviour are inextricably linked. empowerment in the field of entrepreneurship is most commonly featured in literature on minority and disadvantaged groups (kantor, 2002), where the focus is on the individual’s ability to control his/her own destiny. this kind of ability is often referred to as self-enabled empowerment. empowerment can be a legitimate aim of educational interventions. such interventions attempt to link skills development, foresight and knowledge about innovation and enterprise with empowerment of young individuals, to 314 sajems ns 10 (2007) no 3 help them create a new venture (o’conner & ramos, 2006). the success of entrepreneurs is highly dependent on personal motivation and will to succeed, which is analogous to feeling empowered. the focus of this article is on the individual’s perception of empowerment in the context of starting a business. this investigation is relevant in south africa (sa), where not only is empowerment widely advocated, but also where there is a need to empower individuals to develop their potential to be entrepreneurs (especially for sectors of the population such as women and previously disadvantaged groups who arguably lack entrepreneurial traditions) by increasing perceptions of self-efficacy. starting a business or initiating a new venture is often described as a purposive and intentional career choice, of which entrepreneurial selfefficacy (ese) is a key antecedent (chen, greene & crick, 1998). perceived self-efficacy is the strongest single predictor of career choice (bandura, 1986) and self-reported competence predicts entrepreneurial performance (chandler & jansen, 1992). since self-efficacy reliably predicts the scope of career options considered, occupational interests, perseverance in difficult fields, and personal effectiveness, it has been related to the pursuit of entrepreneurial activity (markman, balkin & baron, 2002). since starting a business and entering into self-employment is often the first step of an entrepreneurial career (katz, 1990), it is important to identify motives and reasons for starting the business. the extant literature suggests a plethora of reasons for start-ups, which include: the need for personal development or independence, approval seeking, following the example of others, desire for financial success and the search for self-realisation (shane, kolvereid & westhead, 1991; douglas & shepherd, 2002; drnovsek & glas, 2002). this study thus begins with a literature review, so as to build on previous research relating to entrepreneurship, empowerment and selfemployment. this review aims to survey the key concepts behind the central research focus, which investigates the relationship between entrepreneurial empowerment (ee), explored using a model of entrepreneurial self-efficacy (ese), and identifies reasons for business startups and self-employment. the methodology primarily uses correlation as a means of analysis, to predict to what extent individuals who perceive themselves as empowered are more inclined towards self-employment as a career option. 1.2 previous research on empowerment empowerment is not a new construct and has been defined in a variety of ways, predominantly in organisational research, as: • the motivational concept of self-efficacy (conger & kanungo, 1988); • a philosophy of delegating (shackleton cited in cloete, crous & schepers, 2002); • an essential information-sharing process that empowers individuals and affects job performance; and • a participative decision-making process (cloete, crous & schepers, 2002). empowerment can be grouped into structural, leadership and motivational approaches, and described as a cognitive state, characterised by perceived control, competence and goal internalisation (menon, 2001). typically, empowerment is conceptualised as a multifaceted construct (thomas & velthouse, 1990). spreitzer (1995) says that empowerment is manifested in a set of four cognitions reflecting an individual’s work-orientation role, namely meaning, competence (synonymous with self-efficacy), self-determination and impact. similarly, according to appelbaum and honeggar (1998), competence is the felt accomplishment of skilful task performance. for thomas and velthouse (1990), competence is the degree to which a task is successfully performed, and is analogous to self-efficacy. general assumptions about definitions of empowerment are made explicit by spreitzer (1995). firstly, empowerment is not an enduring personality trait generalisable across situations, but a set of cognitions shaped by the work environment. secondly, empowerment is a continuous variable, which implies that individuals must be viewed as more or less empowered, rather than empowered or not. sajems ns 10 (2007) no 3 315 lastly, empowerment is not a global construct generalisable across different life situations and roles but specific to the work domain. although awareness of empowerment issues has increased greatly in the workplace, chief executive officers (ceos) tend to work against empowerment both consciously and unconsciously (drnovsek & glas, 2002). although there is much talk about empowerment as a way for bettering the personal lives of individuals, it has become a misused construct, which according to bandura (1997: 477) is heavily infused with promotional hype, naive grandiosity, and virtually every brand of political rhetoric. empowerment is not something bestowed through edict; it is gained through development of personal efficacy that enables people to take advantage of opportunities and to remove environmental constraints. such sentiments are particularly relevant in sa, where empowerment is not only widely advocated but also legislated for in terms of black economic empowerment (bee), a strategy designed by the government to introduce black, coloured and asian citizens into the business landscape without disrupting the economy (sa business guidebook, 2005/6). the legacy of apartheid education, which this bee strategy acknowledges, includes damage done to the self-esteem, motivation and creativity of previously disadvantaged individuals. building entrepreneurial capacity at schools requires inculcating a ‘can-do’ attitude in learners and helping them develop the selfbelief and skills needed for entrepreneurial aspiration (driver, wood, segal & herrington, 2001). empowerment embraces the idea that individuals should be enabled to maximise the opportunities available to them despite the presence of constraints (van jaarsveld, 2005). considering the role of the individual in venture creation, understanding entrepreneurship must begin with a conceptual framework of human agency. bandura (2001) proposes that to be an agent is to intentionally make things happen by one’s own actions. the entire entrepreneurial process unfolds because an individual acts and is motivated to pursue opportunities. effecting agency is thus an integral aspect of empowerment; it blazes a trail toward activities encompassing innovation and entrepreneurship. a key element in the process of empowerment is the innovator’s perception of innovation as possible. if an individual is cognitively empowered but lacks the requisite skills, knowledge and attitudes, his/her empowerment is nullified. therefore o’conner and ramos (2006) suggest building cognition through foresight processes in conjunction with innovation and enterprise skills and attitudes. in conclusion, the multifaceted construct of empowerment can be viewed as an outcome of agency, the ability to act, of which belief in one’s own efficacy is one of the most important foundations (bandura, 1997: 477). 1.3 belief in self-efficacy related to empowerment belief in one’s self-efficacy influences what challenges one undertakes and how long one perseveres in the face of obstacles. selfefficacy is an important motivational construct that influences an individual’s choices, goals, emotional reactions, efforts and persistence. it refers to the individual’s convictions about his/her abilities, or belief in his/her capacity to perform (bandura, 1986, 1997, 2001). self-efficacy is an important construct in behavioural management and has been defined as ‘people’s judgments of their capabilities to organize and execute courses of action required to attain designated types of performance’ (bandura, 1986: 391). two decades of empirical research have generated a large number of studies demonstrating the positive relationship between self-efficacy and various motivational and behavioural outcomes in clinical, educational and organisational settings, which have been extensively documented (e.g. krueger & brazeal, 1994; chen, greene & crick, 1998; krueger, reilly & carsrud, 2000; drnovsek & glas, 2002; bradley & roberts, 2004). previous results of the study of motivation in the context of entrepreneurship in terms of basic concepts such as achievement need, risk taking, tolerance of ambiguity and locus of control have yielded mixed results. however, results 316 sajems ns 10 (2007) no 3 have been more consistent for constructs such as goal setting and self-efficacy. self-efficacy particularly is identified as a key motivational component in ford’s 1996 model of individual creative action. belief in efficacy can raise and sustain motivation but cannot alone produce heightened performances if the necessary sub-skills are completely lacking. of course most people do not hold unfounded beliefs of their own efficacy entirely unrelated to their capabilities. nor does perceived self-efficacy involve only a one-way dependence on sub-skills. but proactive belief in one’s efficacy and capability for self-development can lead to capacity being converted to capability. resilient self-efficacy enables people to override repeated rejection; this is important because early rejection is the rule rather than the exception in many creative endeavours and the more innovative the work the greater the risk of rejection. an optimistic sense of efficacy contributes to psychological well-being; this is demonstrated when the skills and beliefs of anxious and depressed people are compared with those of people who are unburdened by such problems. the groups differ little in their actual skills but they differ substantially in their beliefs about their efficacy. self-efficacy is also linked to initiating and persisting in behaviour under high uncertainty, to setting higher goals and to reducing threat rigidity and learned helplessness (bandura, 1986), all of which resonate with desired entrepreneurial behaviour. to be blunt: no selfefficacy, no entrepreneurial behaviour (krueger & brazeal, 1994). researchers, however, often ignore the concept of self-efficacy despite its importance and proven robustness at predicting both general and specific behaviour (krueger et al., 2000: 418). unlike personality traits, selfefficacy can be developed through training and modelling. efficacy judgements are task-specific and regulate behaviour by determining task choices, effort and persistence. self-efficacy also facilitates learning and task performance particularly early in the learning process (stevens & gist, 1997). self-efficacy can also change as result of learning, experience and feedback (gist & mitchell, 1992: 4), and persons who believe that their skill and ability set is adequate for achieving success with new ventures are motivated to exert the necessary effort. these findings support the view that those who have a high sense of efficacy view situations as presenting realisable opportunities. this link to motivation for start-up ventures, as a critical feature of empowerment, will now be examined. 1.4 motives for starting a business personal motives affect both start-up decisions and the start-up processes. models and theories that delineate how motivations influence the entrepreneurial process are copious. for instance, a model used by shane, locke and collins (2003) explains how the relative power of a particular motivator varies depending on which part of the entrepreneurial process is being investigated. similarly, by extending existing motivational models to integrate the start-up decision with issues of strategy formulation and implementation, sustained entrepreneurial behaviour is delineated by naffziger, hornsby and kuratko (1994: 33). gatewood, shaver, powers and gartner (2002) investigate the role that expectancy of entrepreneurial performance has on perceived ability in motivating persons to persevere in an entrepreneurial task. their findings suggest that the feedback individuals receive regarding their entrepreneurial ability changes their expectancies regarding future business start-ups, but do not alter task effort or quality of performance. other relevant motivational concepts linked to entrepreneurial behaviour and start-ups include the need for independence, drive and egoistic passion (shane et al., 2003). the goal of this study is to explain the factors that motivate an individual to select an entrepreneurial career (i.e. to have high entrepreneurial intentions). this requires indicating how the key concepts discussed so far interrelate. due to the complexity of the entrepreneurial process, the focus of this study is one factor, self-efficacy, which clearly plays a significant role in empowerment and selfemployment intentions. sajems ns 10 (2007) no 3 317 the comprehensive literature review has indicated the current extent of knowledge on this topic, and enabled us to identify salient variables. the following hypotheses can now be formulated and set at the 0.01 significance level: h1: entrepreneurial empowerment along with intention towards self-employment is positively associated with reasons for start-up. h2: entrepreneurial empowerment explains a significant proportion of variance in reasons for start-up. 2 research methodology 2.1 study design in choosing a research methodology for this study, particular consideration was given to the location of the data, the gathering of the data, instrument design and treatment of the data (cooper & emory, 1995). a quantitative approach was chosen, using a cross-sectional predictive study design. this design is suited to solving the main research question, and addressing the limitations of previous studies by empirically testing hypotheses about which speculation is rife. the measures used in this study were drawn from previous studies and include items relating to: • self-employment intent, • entrepreneurial empowerment (using the ese instrument), • reasons for and against potential start-ups and • demographic characteristics that previous research has identified as relevant to this type of inquiry. first the measures were subjected to factor analysis to establish construct validity and reliability. the hypotheses were tested using several significance tests, including descriptive and inferential statistics and multiple correlation and regression analyses to determine the predicted relationships between the specified variables. correlation calculates an index measure of the nature of the relationship between variables. regression predicts the values of a dependent variable (cooper & emory, 1995: 477). as in other similar studies (e.g. kolvereid, 1996), our study uses a sample of students (n = 112) in their early careers. the students were asked to state whether they prefer running their own businesses or being employed by someone else. this measure of choice intention (ajzen, 1991) was followed up a series of questions pertaining to reasons for and against start-up. this link is pertinent, since the reasons that individuals offer for starting a venture or not are traditionally considered to be the basis of intentions (douglas & shepherd, 2002). the study sample was purposive and composed of prospective entrepreneurs, namely second and third-year undergraduate students studying entrepreneurship, small business management or commerce. these students have been exposed to entrepreneurship modules and several of them are also involved in ‘students in free enterprise’ (sife) projects, so they naturally have an inclination towards self-employment. scherer, adams, carley and wiebe (1989) suggest that student populations add control and homogeneity to such studies because individuals studying business already have an interest in pursuing business-related careers and students have the education required to run a business, i.e. they have the basis for evaluating their selfefficacy in some of the skills and abilities used in entrepreneurial careers. once the target population was defined, a sampling frame was constructed. the frame selection process for this study can be viewed as a trade-off between practical considerations on the one hand and the demands of randomisation and generalisability on the other (mouton, 2002: 135). because of practical considerations, the instrument was distributed to students in a classroom setting, which allowed the researcher to maintain control over the environment. this ensured that a high response rate was achieved. 2.2 instrument design psychological empowerment is often measured with the measuring empowerment questionnaire (meq). however, this instrument is typically 318 sajems ns 10 (2007) no 3 used in an organisational or employee context and related to job satisfaction (buitendach & hlalele, 2005). as discussed in section 1, the focus of this study is on self-efficacy, which has been validated by previous studies (bandura, 1997) but not adequately applied in entrepreneurship research. self-efficacy reliably predicts the scope of career options considered, occupational interests, perseverance in difficult fields and personal effectiveness; it is not only related to the pursuit of entrepreneurship, but is also adequate for measuring entrepreneurial empowerment, if set in a suitable methodology as for this paper. based on various ese conceptualisations (noble, jung & ehrlich, 1999; chen et al., 1998; anna, chandler, jansen & mero, 2000), several different items capturing the dimensions of ee were identified and included in the instrument as questions relating to opportunity recognition, innovation, management, risk taking and financial control. respondents were asked to rate their current competence in each item (rated on a 1–5 likert scale from very high to very low). because of the relative newness of the ee construct, exploratory factor analysis was conducted based on the different subdimensions of the ee construct. the internal consistency of the instrument was tested and reliability statistics indicated relatively high internal consistency and homogeneity between the items; cronbach alpha scores of 0.810 and above were deemed acceptable, since the commonly used threshold value for acceptable reliability is 0.70 (nunnally, 1978). 2.3 factor analysis factor analysis, with principal axis factoring extraction using barttlett’s test of sphericity and the kaiser-meyer-olkin measure of sampling adequacy, produced satisfactory results. factor loadings greater or equal to 0.30 are generally regarded as significant, and factors with eigen values greater than 1 (based on scree tests and kaiser’s stopping rule) are used to decide the optimal number of factors to retain (cooper & emory, 1995). the alpha for each individual factor was calculated using only those variables chosen for their loading in the sorted rotated factor-loading matrix. for each factor, only those variables with a positive rotated factor loading on that factor and a zero loading on all other factors were selected. table 1 provides the results of the final five factors with the different factor loadings and table 2 summarises the factors’ eigen values, percentages of variance explained and cronbach’s alphas. 2.4 sample characteristics as in previous studies on individual differences in entrepreneurship, the following demographic control variables were measured, with the results indicated in brackets: age (33 per cent in the 17–20 category; 53 per cent in the 21–24 category), gender (male = 54 per cent; female = 55 per cent), level of education (controlled), and parents, friends or relatives who are or have been entrepreneurs (role model) (yes = 69 per cent; no = 31 per cent). the sample is then selected, limiting the respondents mostly to the 17–24 age group and to a tertiary level of education (current undergraduate students). these subjects should be able to understand the meaning of the ese skills and reasons for start-ups as they are stated in the survey. the common practice of using university students as proxies for entrepreneurs is often frowned upon; however hemmasi and hoelscher (2005) find that a student sample is very similar to actual entrepreneurs provided that its members have high entrepreneurial potential. sajems ns 10 (2007) no 3 319 table 1 factor categorisation for entrepreneurial empowerment (ee) items factor items factor loading opportunity recognition set and meet market share goals 0.838 set and meet sales goals 0.794 establish positioning in market 0.850 conduct market analysis 0.757 innovation develop new business ideas 0.824 develop new markets/products 0.778 find new markets and territories 0.739 develop new methods of production, etc 0.536 management reduce risk and deal with uncertainty 0.786 plan strategically 0.780 establish and achieve goals and objectives 0.884 define organisational roles, etc 0.819 risk taking take calculated risks 0.805 be comfortable with uncertainty and risk 0.524 take responsibility for ideas and decisions 0.938 work under pressure and conflict 0.795 financial control perform financial analysis 0.830 control costs 0.768 develop financial systems and internal controls 0.882 table 2 factors with eigen values, variances explained and cronbach’s alphas factor eigen value percent of variance cronbach’s alpha opportunity recognition 2.967 74.171 0.882 innovation 2.554 63.861 0.810 management 3.003 75.084 0.889 risk taking 2.764 69.099 0.849 financial control 2.365 78.821 0.861 320 sajems ns 10 (2007) no 3 2.5 statistical results descriptive statistics are reported for the items relating to reasons for start-up (see table 3), with the highest mean score for the item ‘i see few other possibilities; the only chance to work is for myself’, followed by ‘i will continue family tradition’. most mean scores represent the midpoint average, with no significant preference for being self-employed or working for someone. anova (not shown) indicates f values of 0.358 and 0.197, both of which are not statistically significant. table 4 represents the mean scores and deviations for the explanatory variable pertaining to parents, friends or relatives who are or have been entrepreneurs. this data was gathered from individual answers and from answers for reasons for start-up. although the group statistics indicate relatively stable means and standard deviations across the factors, levene’s test for equality of variances renders f statistics that are not significant at the 0.05 or 0.01 levels. more importantly, however, an independent sample t-test for equality of means was conducted (not shown), and detected no significant differences. for the explanatory variable relating to degree of preference for starting one’s own business (see table 5), testing for homogeneity of variances using levene statistics indicates significance at the 0.05 and 0.01 levels for factors 1, 2, 3 and 4. anova however indicates no significant differences in the between-group and within-group statistics. similarly, for the degree of preference for being employed by someone (see table 6), the levene statistics indicate significance at the 0.05 and 0.01 levels but anova indicates no significant differences in the between-group and within-group statistics. table 3 reasons for start-ups: item statistics items mean std. deviation reason for start-up – i want to be my own boss 2.48 1.656 reason for start-up – i want freedom at work 2.43 1.576 reason for start-up – i would like to achieve and get approval 2.52 1.623 reason for start-up – i will continue family tradition 2.83 1.458 reason for start-up – i would like to develop a business idea 2.54 1.488 reason for start-up – i would like to have more influence in the community 2.50 1.470 reason for start-up – i see a promising opportunity to seize 2.64 1.299 reason for start-up – i would like to grow as a person 2.39 1.696 reason for start-up – i want to realise my dreams 2.24 1.669 reason for start-up – i want to have control of my life 2.32 1.690 reason for start-up – i want to provide security for my family 2.30 1.655 reason for start-up – i want to get life-time employment 2.31 1.600 reason for start-up – i see few other possibilities; the only chance to work is for myself 2.85 1.245 sajems ns 10 (2007) no 3 321 table 4 descriptive statistics: parents, friends or relatives as entrepreneurs factors do you have any parents, friends or relatives who are or have been entrepreneurs? n mean std deviation std error mean opportunity recognition yes 77 2.7987 0.98928 0.11274 no 35 2.6857 0.89184 0.15075 innovation yes 78 2.7885 0.84427 0.09559 no 35 2.7929 0.93243 0.15761 management yes 79 2.7215 1.02375 0.11518 no 35 2.7714 1.04384 0.17644 risk taking yes 79 2.7089 1.05417 0.11860 no 33 2.8485 1.16078 0.20207 financial control yes 80 2.7583 1.05938 0.11844 no 36 2.8056 0.95743 0.15957 reason for start up yes 77 2.5734 1.31485 0.14984 no 34 2.2964 1.29897 0.22277 table 5 descriptive statistics: preference for starting own business factors n mean std deviation std error opportunity recognition very high 39 2.679 1.263 0.202 high 43 2.825 0.833 0.127 moderate – very low 29 2.732 0.574 0.106 total 111 2.750 0.951 0.090 innovation very high 38 2.67 1.113 0.180 high 44 2.858 0.743 0.112 moderate – very low 30 2.825 0.689 0.125 total 112 2.785 0.871 0.0823 management very high 39 2.698 1.298 0.207 high 44 2.704 1.020 0.153 moderate – very low 30 2.833 0.577 0.105 total 113 2.736 1.030 0.096 322 sajems ns 10 (2007) no 3 risk taking very high 40 2.756 1.318 0.208 high 43 2.773 1.086 0.1657 moderate – very low 28 2.714 0.686 0.129 total 111 2.752 1.087 0.103 financial control very high 40 2.733 1.208 0.191 high 45 2.792 1.033 0.1539 moderate – very low 30 2.755 0.726 0.132 total 115 2.762 1.022 0.0953 reason for start up very high 38 2.542 1.455 0.236 high 43 2.391 1.336 0.2029 moderate – very low 29 2.567 1.124 0.208 total 110 2.490 1.316 0.1255 table 6 descriptive statistics: preference for being employed by someone n mean std deviation std error opportunity eecognition very high / high 43 2.784 0.967 0.147 moderate 42 2.767 0.843 0.130 low / very low 27 2.722 1.129 0.217 total 112 2.763 0.957 0.090 innovation very high / high 43 2.837 0.881 0.134 moderate 44 2.789 0.777 0.117 low / very low 26 2.711 1.011 0.198 total 113 2.789 0.868 0.0816 management very high / high 44 2.823 1.085 0.163 moderate 44 2.676 0.944 0.142 low / very low 26 2.692 1.082 0.212 total 114 2.736 1.025 0.096 risk taking very high / high 42 2.952 0.974 0.150 moderate 43 2.581 0.986 0.150 low / very low 27 2.703 1.351 0.260 total 112 2.750 1.083 0.102 sajems ns 10 (2007) no 3 323 financial control very high / high 45 2.718 0.855 0.127 moderate 44 2.856 1.062 0.160 low / very low 27 2.728 1.233 0.237 total 116 2.773 1.024 0.095 reason for start up very high / high 43 2.538 1.299 0.198 moderate 43 2.361 1.195 0.182 low / very low 25 2.621 1.537 0.307 total 111 2.488 1.310 0.124 2.6 correlation and regression analysis to evaluate the hypothesised relationships between the variables, correlational analysis and multiple regression analysis were performed. it has been suggested that the correlation significance should be checked before making comparisons (cooper & emory, 1995: 485). for the correlation matrix (see table 7), the pearson correlation coefficients are reported with the values in the second line of each row indicating the p values. according to cohen and holliday (1998: 101), a multiple correlation coefficient of 0.7 or above is considered a high relationship. anastasia and urbani (1997) maintain it should be high enough to be statistically significant at the 0.05 and 0.01 levels. for this study’s results, the levels of correlation are generally high and all correlations are statistically significant, which offers preliminary support for the hypotheses. as hypothesised, all the variables indicate significant positive correlations with reasons for start-up, (the explanatory variables ‘parents’ and ‘preference for self-employment’ were not entered into the correlation matrix as no significant differences were detected in the preceding analysis). the highest correlation coefficient between the predicted relationship of the ee sub-dimension management and reason for start-up is 0.740. as anticipated in the instrument design, the results reveal that variables are vulnerable to multicollearanity (when some or all the variables are highly correlated, i.e., correlation is at 0.80 or more) (cooper & emory, 1995). this is addressed in the next section, the interpretation of the regression analysis. table 7 correlation analysis with pearson’s correlation coefficients factors opportunity recognition innovation management risk taking financial control reason for start up opportunity recognition pearson correlation 1 0.794** 0.840** 0.753** 0.733** 0.693** sig. (2-tailed) 0.000 0.000 0.000 0.000 0.000 n 112 109 110 108 112 106 324 sajems ns 10 (2007) no 3 innovation pearson correlation 0.794** 1 0.720** 0.686** 0.535** 0.583** sig. (2-tailed) 0.000 0.000 0.000 0.000 0.000 n 109 113 113 109 113 107 management pearson correlation 0.840** 0.720** 1 0.874** 0.645** 0.740** sig. (2-tailed) 0.000 0.000 0.000 0.000 0.000 n 110 113 114 110 114 108 risk taking pearson correlation 0.753** 0.686** 0.874** 1 0.570** 0.771** sig. (2-tailed) 0.000 0.000 0.000 0.000 0.000 n 108 109 110 112 112 107 financial control pearson correlation 0.733** 0.535** 0.645** 0.570** 1 0.504** sig. (2-tailed) 0.000 0.000 0.000 0.000 0.000 n 112 113 114 112 116 110 reason for start up pearson correlation 0.693** 0.583** 0.740** 0.771** 0.504** 1 sig. (2-tailed) 0.000 0.000 0.000 0.000 0.000 n 106 107 108 107 110 111 ** correlation is significant at the 0.01 level (2-tailed) the use of multiple regressions allows for the partitioning of variance with correlated predictors, thereby reducing the likelihood of making a type 1 error. the coefficient of multiple determinations was used to compute what proportion of the variance of the dependent variables is due to the combined effects of the predictors (cohen & holliday, 1998: 98). the sign of the regression coefficients indicates the nature of the relationship between the variables under study. although no rule exists as to what fraction of variance needs to be explained if the relationship is to be considered strong, many researches say a squared multiple correlation of 0.3 or greater implies at least a moderately strong relationship (sudman & blair, 1998: 517). the regression procedure uses stepwise regression; first the variables that contribute the most to explaining the dependent variable are entered, and the rest of the variables included in order of their incremental contribution after the first variable, provided they are statistically significant. using this procedure, ‘risk taking’ and ‘opportunity recognition’ (see table 8) produce models 1 and 2 with an adjusted r square of 0.579 and 0.607 respectively. interpreting model 1 we can say that ‘risk taking’ as a predictor explains 58 per cent of the variance in the reasons for start-up. from model 2 we can say that including ‘opportunity recognition’ only improves the explanation slightly (61 per cent). sajems ns 10 (2007) no 3 325 in table 9 the anova calculates an f value which has an overall role for both the models and for each of the independent variables and measures. the results in this case represent a set of regression coefficients that are statistically significant from zero. in table 10, collinearity diagnostics reveal relatively high variance proportions (e.g., model 2, dimension 3 = 0.75 and 0.95). such diagnostics should be read in conjunction with the collinearity statistics from table 9, where the variable inflation factor (vif) values of 1.000 for model 1 and 2.225 for model 2 suggest that model 1 is acceptable but that model 2, with its high value, suffers from multicollinearity. when the values are 10.0 or more the regression coefficients can fluctuate widely from sample to sample, making it risky to interpret the coefficients as indicators of predictors (cooper & emory, 1995). table 8 regression: model summaries model r r square adjusted r square std error of the estimate 1 0.763(a) 0.583 0.579 0.848 2 0.784(b) 0.615 0.607 0.819 a predictors: (constant), risk taking b predictors: (constant), risk taking, opportunity recognition table 9 regression for model 1 and 2: anova tests model sum of squares df mean square f sig. 1 regression 98.524 1 98.524 136.931 0.000(a) residual 70.513 98 0.720 total 169.037 99 2 regression 103.885 2 51.943 77.334 0.000(b) residual 65.152 97 0.672 total 169.037 99 a predictors: (constant), risk taking b predictors: (constant), risk taking, opportunity recognition c dependent variable: reason for start up table 10 regression for model 1 and 2: coefficients and collinearity diagnostics model unstandardised coefficients standardised coefficients t sig. collinearity statistics b std error beta tolerance vif 1 (constant) –0.095 0.236 –0.403 0.688 risk taking 0.947 0.081 0.763 11.702 0.000 1.000 1.000 2 (constant) –0.457 0.261 –1.746 0.084 risk taking 0.703 0.117 0.566 6.022 0.000 0.449 2.225 opportunity recognition 0.374 0.132 0.266 2.825 0.006 0.449 2.225 a dependent variable: reason for start-up 326 sajems ns 10 (2007) no 3 3 conclusion 3.1 conclusion the results from this study contribute to the body of research on predicting an individual’s perception of empowerment in an entrepreneurial context. moreover, the instruments used, which have not been previously tested in non-western countries, are validated here in a south african context. the factor structure of entrepreneurial empowerment used in this study in the form of entrepreneurial self-efficacy sub-dimensions is thus confirmed as a robust scale able to deliver construct validity and reliability. essentially this instrument captures the notion of how an empowered individual feels more efficacious in starting a business. such validation is particularly relevant in the african context where psychological variables such as personal empowerment, innovativeness and autonomy explain differences in entrepreneurs’ reaction to the environment (luiz, 2006). the correlation and regression results provide almost unequivocal support for both hypotheses, namely the association between entrepreneurial empowerment and start-up, and reasons for start-up. a substantial amount of variance in start-up is explained by two of the empowerment sub-factors. the stepwise regression procedure reveals that the high correlation and regression results can explain the effects of empowerment on reasons for business start-up to a large extent. in particular the level of perceived efficacy at taking calculated risks is important towards explaining empowerment. from these results, prospective entrepreneurs with a high capacity for taking risks will arguably be predisposed to start their own ventures for a variety of reasons. this finding is congruent with previous research on how empowered individuals see more opportunities in a risky venture and take more risks (krueger & dickson, 1994). surprisingly, in contrast to both common sense and previous findings, having a parent, friend or relative who is or has been an entrepreneur does not increase an individual’s perception of empowerment or significantly affect reasons for start-up. the extant literature suggests that the social context (family/education) can both limit and enable participant agency in innovation and enterprise activities, but is generally accepted as being positively linked to greater self-employment (o’conner & ramos, 2006). based on such established findings, this paper’s preliminary finding needs additional analysis. the focal point of this research is preference for starting one’s own business based on perceptions of empowerment. the results of this study show no significant difference in this preference according to reason for startup. where previous research finds that selfemployed individuals tend to report higher levels of ese (krueger et al., 2000; bradley & roberts, 2004), the failure of this present study to find any significant effects of these explanatory variables suggests that entry into self-employment may be a complex decision which is also mediated by environmental conditions. 3.2 implications although empowerment deal-making has increased exponentially in south africa, there is still a scarcity of blacks wanting to start and build their own businesses. the entry of blacks into the economy has been gathering pace in past years but has been limited by the restriction of black entrepreneurs involved in the day-to-day running of businesses (lediga, 2006). it seems that, in south africa, empowerment has happened at the expense of entrepreneurship, contradicting both commonsense and research findings, as discussed in section 1 of this paper. p o l i c y m a k e r s c o u l d b e n e f i t f r o m understanding that government initiatives will affect business formation only if these policies are perceived in a way that influences intentions and self-efficacy (krueger et al., 2000). government initiatives which focus on a ‘do it alone’ approach tend to produce an entitlement mentality. the psychological component of empowerment is pivotal, and considering the role of the individual in venture creation, it is imperative that policy makers recognise how an individual’s intentions make things happen through his/her own actions. sajems ns 10 (2007) no 3 327 the entire entrepreneurial process unfolds because individual entrepreneurs act and are motivated to pursue opportunities. feeling efficacious must not only be considered an integral aspect of empowerment but also be supplemented with education and training, since empowerment without the requisite skills, knowledge and attitudes nullifies the formula for empowered entrepreneurship. researchers and academics must continue to develop rigorous theoretical frameworks to understand empowerment and the reasons f o r s e l f e m p l o y m e n t i n t h e c o n t e x t o f entrepreneurship. 3.3 limitations and future research the selected measures, which juxtapose selfemployment against employment by another, can be argued (e.g. kolvereid & isaksen, 2006) to be an over-simplification which does not allow for other possibilities, e.g. people can choose to be unemployed or unemployable, or some mixture of full-time salaried work and part-time self-employment. given that people can combine entrepreneurship with e m p l o y m e n t , d e f i n i n g s e l f e m p l o y m e n t as a continuous construct is likely to be a more valid and precise indicator of selfemployment. cross-sectional studies do not allow for true testing of causal relations. the relationships b e t w e e n e m p o w e r m e n t , i n t e n t i o n s a n d behaviour over time need to be examined. such research is particularly important since some researchers e.g. katz (1990) question the intention-behaviour link. this study is also prone to social desirability bias; since ‘entrepreneurship’ is a charismatically charged term, and carries a lot of social weight, respondents may have overestimated their abilities. finally, entrepreneurial empowerment can only be understood as a constellation of personality and environmental features of which self-efficacy is only a part. studies could also be extended to include contextual factors such as legislation and educational systems to help explain venture formation as a more holistic process. references 1 ajzen, i. 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(2005) developing management skills, (6th ed.) pearson: nj. microsoft word 2 saayman et al sajems 18(2) 2015.docx sajems ns 18 (2015) no 2:155-176 155 how to cite doi: http://dx.doi.org/10.17159/2222-3436/2015/v18n2a2 regional economic impacts of events: a comparison of methods lukas van wyk and melville saayman trees: tourism research in economic environs and society, north-west university riaan rossouw and andrea saayman school of economics, north-west university accepted: october 2014 the purpose of this paper is to provide an overview and comparison of three related methods for modelling the short-run economic impact of events, namely the partial input-output (i-o), social accounting matrix (sam) and computable general equilibrium (cge) models. an analysis of strengths and limitations of these different methods suggests that it may be considerations such as the underlying assumptions specific to each model, data collection, expected output, research objectives, and costs involved that determine the choice of modelling framework. data from surveys conducted at the aardklop national arts festival during 2010 were used in the comparative analyses, which were executed by means of two regional (i.e. provincial-level) models and one small-region (i.e. place-specific) model constructed for the small town. key words: event tourism, regional cge modelling, input-output models, social accounting models, south africa jel: c68, d58, o18, 24, q32, r13 1 introduction during the early 20th century, the increased popularity of festivals in the united kingdom (uk) led to their expansion into europe to such an extent that festivals eventually became a global phenomenon (bowdin & williams, 2007:188). the global increase in the number of arts festivals emphasises the collective desire of communities to participate in activities that highlight their artistic culture. schoombie (2003:10) remarks that, by 2003, more than 1.2-million international arts and cultural festivals were listed on the internet. despite this remarkable growth, the financing of festivals is a contentious issue, considering the boosting of community support, socio-economic impact and spin-offs that are generated through such events. only a handful of festivals are financially self-supporting, and very few events would be able to continue in the absence of sponsorships (saayman & saayman, 2012). in most cases, the shrinking, and, in some cases, withdrawal, of financial support by local authorities necessitates the sourcing of alternative funding from private or corporate sponsors, donors, and public contributions in order to ensure the continuance of festivals. in the context of the recent economic recession that currently hampers the recovery of global economies, it can be expected that sponsorships of, and donations for, festivals will be extremely limited. private and public sectors that still provide financial support for arts festivals will most likely continue to do so because of a commitment to their wider social responsibilities and in anticipation of extensive exposure during the event. given this, bowdin and williams (2007:188) argue that event evaluation by conducting quantifiable economic impact studies has become a valuable tool to demonstrate the success and achievements of festivals. in recent years, several methods of conducting these economic impact studies have been developed and the most prevalent models utilised in surveys include multiplier models based on input-output (i-o) and the social accounting matrix (sam) and computable general equilibrium (cge) models (van wyk, 2012). where events take place in rural areas, abstract 156 sajems ns 18 (2015) no 2:155-176 proportional multiplier analysis has become increasingly popular. the proportional multiplier is derived from a small-scale (partial) i-o model that is constructed from local business survey data (vaughan, farr & slee, 2000). a critical assessment and comparison of these models might potentially add insight and value to their future use in the context of event impacts. however, this paper does not attempt to provide an exhaustive review of all aspects associated with the differences between these models. the goal of the paper is to provide a concise overview of the different approaches with the aim of demonstrating the differences that may be obtained in the results which can provide guidelines for organisers, practitioners and academics on the application of these models in small towns. one of south africa’s largest national arts festivals is the subject matter of the case study used in the comparison, namely the aardklop national arts festival hosted in potchefstroom in the north west province. after the literature review and a description of each model, the models are compared, first in a descriptive manner and then in terms of the model results. this is followed by a discussion of the main findings and of the implications for organisers, practitioners and academics. finally, some concluding remarks are made. 2 literature review it is widely acknowledged that different models have different strengths and weaknesses and, in turn, “an important part of the modelling process is to select the type of model that can shed the most light on the issues considered to be most important while ignoring the smallest number of other elements of the problem that might be considered relevant” (denniss, 2012:3). this implies that the choice of method that is used to assess the economic impact of festivals may have significant consequences. serious consideration should therefore be given to the choice of model, as festivals can serve as a means to achieve socio-economic objectives. these objectives may include creating infrastructure, providing jobs, generating revenue, attracting investment, growing the arts, promoting a region, and building a better image (saayman & rossouw, 2010:255). an exploration of the literature indicates that studies applying i-o, sam and cge models for assessing the economic impact of events are abundant and have increased significantly since the mid-1990s. this is clearly summarised in table 1. table 1 models applied to assess the economic impact of events date author o th er 1 c ba ts as & t pf r oi s ec to r m ap pi ng p ro du ct io n/ su pp ly c ha in d es cr ip tiv e re se ar ch fi na nc ia l s ur ve ys in pu tou tp ut s am c ge 1988 myerscough, j. x 1995 adams, p. & parmenter, b.r. x o’brien, j. & feist, a. x 1997 antrobus, g., webb, a. & mather, d. x casey, b., dunlop, r. & selwood, s. x wagner, j.e. x 1998 bryan, j., hill, s., munday, m., roberts, a. & clarke, d. x ryan, c. x hiller, h.h. x x o’connor, j. x travers, t. x welsh economy research unit & dca (cardiff). x continued/ sajems ns 18 (2015) no 2:155-176 157 1999 crompton, j.l. x 2000 bretton hall college. x bryan, j., hill, s., munday, m. & roberts, a. x cambridge arts theatre. x crompton, j.l. & lee, s. x snowball, j.d. x x 2001 blake, a., durbarry, r., sinclair, m.t. & sugiyarto, g. x crompton, j.l., lee, s. & shuster, t.j. x department for culture, media and sport, creative industries. x ryan, c. & lockyer, t. x selwood, s. x 2002 brown, d., var, t. & lee, s. x chang, s. x division of research, moore school for business. x stynes, d.j. x west, g. & bayne, b. x 2003 hill strategies. x king, e.m. x lynch, t. & harrington, j. x mann weaver drew/de montfort university. snowball, j.d. & antrobus, g.g. x x 2004 anon. x california arts council. x clark, d., grainger, j. & jaffry, s. x daniels, m.j., norman, w. & henry, m. x edmiston, k.d. & thomas, m.x. x x mcintyre, m.h. x x narayan, p.k. x saayman, m. & saayman, a. x tremblay, p., boyle, a., rigby, h. & haydon, j. x urs finance and economics. x van schalkwyk, c. x 2005 arik, m. & penn, d.a. x armbrecht, j. & lundberg, e. x blake, a. x bob, u., swart, k. & moodley, v. x economic benefits distribution research working group. x kelsey, c.w. & ford, s. x milne, s., dickson, g., mcelrea, a. & clark, v. x pricewaterhousecoopers. x sqw limited & tns travel and tourism. x tohmo, t. x 2006 brännäs, k. & nordström, j. x dwyer, l., forsyth, p. & spurr, r. (a) x dwyer, l., forsyth, p. & spurr, r. (b) x iris group wendy and macdonald and associates and jp consulting. x mchugh, d. x strydom, a.j., saayman, m. & saayman, a. x 2007 baker associates. x borges, d.r. x bowdin, g.a.j. & williams, m. x centre for tourism research in africa. x çela, a., knowles-lankford, j. & lankford, s. x virginia department of conservation and recreation. x continued/ 158 sajems ns 18 (2015) no 2:155-176 2008 bohlmann, h.r. & van heerden, j.h. x bonn, m.a. & harrington, j. x x hamilton, c., galloway, s., langen, f., cran, a., macpherson, c., burns, m. & snedden, e. x measells, m.k. & grado, s.c. x rivera, m.a., hara, t. & kock, g. x saayman, m., rossouw, r. & saayman, a. x silva, b., mann, m. & daniel, h. x snowball, j.d. & webb, k.g. x stynes, d.j. x van zyl, c. x 2009 saayman, m., saayman, a. & ferreira, m. x sundance institute. x waterhouse, c. x 2010 fourie, j. & santana-gallego, m. x jackman, m. & greenidge, k. x mayne, b. x saayman, m. & rossouw, r. x 2011 rossouw, r. & saayman, m. x x note: 1this category includes the application of other impact modelling methods, including, for example, calculating the impact by means of an economic impact model using the methods of “ticket sales” and “accommodation provided”, willingness-to-pay models, econometric models, qualitative methods, linear regression models, break-even models, standard gravity models, and structural time series models, to name but a few. key to abbreviations: cba: – cost-benefit analysis roi – return on investment tpf: – tourism policy and forecasting models tsa: – tourism satellite accounting despite numerous other methods being applied to assess the economic impact of events (as indicated in table 1), the most prevalent seem to be i-o, sam and cge, and, in certain circumstances, these models have even been integrated or used in combination with other methods/models (see e.g. rossouw & saayman, 2011). i-o, sam and cge models belong to the same family of modelling, namely multisectoral models. moreover, the first and second types are based on the third as a prior database. all three are suitable for specific questions. even though the results of their applications have been so different so many times, they are ideally suited to assess the economy-wide impacts of events (as is clearly shown by the frequency of their use in various studies). since south african festivals have developed as a substantial segment of the leisure and tourism industry, the need to assess their economic impact has increased accordingly. this need has been highlighted in view of the fact that festivals usually require financial support to ensure sustainability. unfortunately, well-founded criticism levelled at the integrity of these analyses and at the outcomes of economic impact studies is well documented. crompton (1999:17) is of the opinion that, although most economic impact assessments are indeed completed with integrity, the accuracy and reliability of some of the assessments are questionable. for example, there are various instances of researchers and consultants applying inappropriate procedures and assumptions in order to generate highly favourable economic impact results (denniss, 2012). also, the tendency to make use of inflated multipliers that enhance the overall economic impact of an event and thus make the economic value more generous than accurate is of great concern to some researchers (kelsey & ford, 2005:7; stynes, 1997:6). in other surveys, several underlying assumptions have been made that have an extensive impact on the outcomes (gilbert, 2008:3; bonn & harrington, 2008:774). some researchers (i.e. jaffee, 2009:12) criticise the accessibility and ease of use of off-the-shelf models and are of the opinion that, “in the wrong hands, the software will produce inflated results at best, and at worst, completely ridiculous projections”. andreatta (2009:1) reports that the economic impact of events may often be inflated, as assessors “rely on questionable attendance sajems ns 18 (2015) no 2:155-176 159 calculations and the application of what economists say is a misused mathematical formula for determining how money trickles through the economy”. lebeau’s view, as quoted by andreatta (2009: 1), that “economic impact studies are not an exact science but rather an education process – we’ve been working on this and trying to make it better every year”, serves as confirmation that adopting incorrect assessment practices may have serious consequences for all stakeholders involved. therefore, it is important to gain a better understanding of the models that are applied in these studies, and, specifically, the models under investigation in this paper. 3 model comparison the models under investigation and applied in this paper are similar impact-type models, that is, single-region multisectoral models. the purpose of describing them is to highlight the relative strengths and weaknesses of such models rather than to determine which models are “the best”. put simply, the best model is the smallest, simplest and most transparent model that sheds light on the link between the variables of most concern to the modellers (denniss, 2012:4). table 2 provides a summary of the main characteristics of each model. table 2 comparison of characteristics of i-o, sam and cge models model level of effects on a local economy shocks that can be analysed results strengths boundaries i-o direct, indirect and induced effects on output, income and employment changes in consumption by product or industry local (placespecific) output, income, employment, production well-understood, standard methodology; standardised construction and presentation assumes: no constraints on availability of factors of production; that prices and wages do not vary; that distribution of factor inputs required by outputs does not vary sam indirect and induced effects on output, income and employment; by disaggregated households, firms and other institutions, products, types of demand and other elements changes in consumption by product or industry; changes in policy: tax rates, government spending, price inflation regional output, income, employment, production; product prices, wage rates; broken down by type of household, labour and capital source disaggregates households, firms and other institutions, products, types of demand and other elements of the economy according to analytical needs and data resources no standard methodology or presentation; same boundaries as i-o model cge indirect and induced effects on output, income and employment; prices and wage rates by industry changes in consumption by product or industry; changes in policy: tax rates, government spending, price inflation regional output, income, employment, production; product prices, wage rates; broken down by type of household, labour and capital source allows factor-ofproduction prices to vary; effects of resource constraints covered; all markets clear no standard methodology or presentation; posited relationship equations, parameters and elasticities seldom made public; heavily dependent on assumptions; requires massive input data that is seldom current; requires validation against the actual economy note: characteristics are not necessarily mutually exclusive or exhaustive. source: adapted from frechtling (2011:13) 3.1 i-o model as early as 1995, lundberg, krishnamoorthy and stavenga identified i-o analysis as the most commonly used method for assessing economic impacts of projects or events. i-o analysis is an analytical framework with the fundamental purpose of analysing the interdependence of industries in an economy (o’connor & henry, 1975:1). an i-o model in its most basic form consists of a system of linear equations, each one of which describes the distribution of an industry’s product throughout the economy. an i-o model makes provision for two kinds of activities on a sectoral 160 sajems ns 18 (2015) no 2:155-176 level, namely (i) the purchase of intermediate and primary inputs and (ii) the supply of intermediate and final outputs. total output of sector 1 (x1) is therefore the sum of the intermediate outputs, plus final demand/ output of sector 1 (f1), or, alternatively stated, final demand is the difference between output and intermediate demand: nnxaxaxaxf 121211111 −−−= , (1) where j ij ij x x a = represents the technical coefficients defined as the quantity of intermediate inputs which a particular sector requires from another sector in order to supply one rand unit of output. equation (1) can be written in matrix format (in order to extend it over all sectors) as: xaif )( −= , (2) where f is a vector of final demand, i is an n x n identity matrix, a is the technical coefficient matrix and x is a vector of production. to assess the impact of a shock to final demand (f) on output, the leontief inverse is applied, that is: x = (i − a)−1f . (3) while i-o analysis is a widely accepted and useful means of economic impact analysis, it is limited in that it does not reveal the personal income distribution effects across different household income segments (holland & wyeth, 1993) and gives no consideration to industry occupation, skills and wages and the resulting income effects. therefore, using i-o models to assess economic impacts will not allow for a clear picture to emerge, from the specified issue under review, of which household income groups are benefiting or suffering and which are not. in south africa, the available i-o models are economy-wide models, and small towns that host events are not expected to have the same economic structure as the economy. to account for this, vaughan et al. (2000) propose the use of a small-scale (or partial) i-o model. for the purpose of this study, a business survey, as discussed in section 4.1 below, was undertaken during 2010 (similar to that explained by vaughan et al., 2000) and an eight-by-eight i-o model was constructed for the local economy. using matrix inversion, the technical coefficients and corresponding output multipliers were derived. by applying the output multipliers to the direct spending of all visitors at the event, the total production effects of their spending can then be calculated. by expanding the i-o table to a nine-by-nine matrix, the effect of household spending and wages, or the effect on income, can be determined. the expanded matrix is based on the assumption that the consumption pattern of the research area is similar to that of the national consumption pattern (as defined in the 2005 nationwide i-o table). the income generated as a result of one additional visitor is thereby calculated. 3.2 sam multiplier model a sam is a data system that includes both social and economic data for an economy. the data sources for a sam come from i-o tables, national income statistics, and household income and expenditure statistics (cameron, 2003). a sam is broader than an i-o table and typical national accounts, showing more detail about all kinds of transactions within an economy. the model structure is therefore similar to that of the i-o model described above. however, an i-o model records economic transactions irrespective of the social background of the transactors. a sam, in contrast to national accounts, “attempts to classify various institutions [according] to their socio-economic backgrounds instead of their economic or functional activities” (chowdhury & kirkpatrick, 1994:58). a sam is a way of logically arranging statistical information concerning income flows in a country’s economy during a particular time period (usually a year). it can provide a conceptual basis for analysing both distributional and growth issues within a single framework (statistics south africa, 1998:7). for instance, a sam shows the distribution of factor incomes of both sajems ns 18 (2015) no 2:155-176 161 domestic and foreign origin over institutional classes, and the redistribution of income over these classes. in addition, it shows the expenditure of these classes on consumption and investment, as well as the savings made by them. king (1988) points out that a sam has two main objectives: firstly, to organise information about the economic and social structure of a country over a period of time; and, secondly, to provide a statistical basis for the creation of a plausible model capable of presenting a static image of the economy as well as simulating the effects of policy interventions in the economy or of other economic impacts. for the analysis, a sam for the north west province as developed by conningarth consultants (2006) was used. this model makes use of a consistent and comprehensive data set in respect of all manual transactions among productive and institutional sectors of the province’s economy. using 2006 prices as a base, it distinguishes 55 sectors, 12 household types and 4 ethnic groups. with the application of multipliers according to the sam for the north west province, the direct spending of visitors to aardklop is converted into the linked increases in production, income and jobs in the region, represented by the indirect and induced impacts. finally, a sam coupled with a conceptual framework that contains the behavioural and technical relationships among variables within and among sets of accounts can be used for the evaluation of the economy-wide effects of policy changes or other economic impacts rather than only for purely diagnostic purposes (pyatt, 1988:349). the conceptual framework is supplied in the form of a cge model. 3.3 cge model while single-region cge models have been applied in past studies (see e.g. partridge & rickman, 1998), such models have been designed for relatively small regions, such as churchill county, nevada (seung, harris, englin & netusil, 2000), fort collins, colorado (schwarm & cutler, 2006), and for a specific purpose. given the availability of a regional i-o table or sam, single-region, general-purpose cge models have been shown to be quite useful (giesecke & madden, 2013:401). a case in point is the amos model of scotland (harrigan, mcgregor, dourmashkin, perman, swales & yin, 1991), which has been utilised for more than two decades. a concern raised by lofgren and robinson (2002) regarding single-region models is that such models’ results may be ambiguous, as they do not capture interregional and nation–region feedback. giesecke and madden (2013) show that such feedback effects are small when the regional economy is not a large contributor to national output. moreover, the studies of mcgregor, swales and yin (1999) and mcgregor, swales and yin (1996) demonstrate that the region-specific effects of a demand shock in a single-region cge model converge on a long-run i-o result in which almost all factors are interregionally mobile (giesecke & madden, 2013:401-402). however, the former study points out that, for the other aggregate region (i.e. the rest of uk), the long-run result yields an opposite sign. this is unlike an i-o result, thus creating a problem with the use of single-region models in a policy context. with the focus being purely on the effects in a single region, the possible (positive or negative) spillover effects to other regions are essentially ignored. this may lead to false results from such models, and the users thereof should clearly state such limitations (giesecke & madden, 2013). the single-region cge model used in this paper is a stand-alone model of a single subnational region. the model is based on a single-region orani-type cge model of the state of paraná, brazil, elaborated on by the centre of policy studies at victoria university in australia (the original model [tpmh0060] is available from http://www.copsmodels.com/ archivep.htm). the model is comparative-static and was developed for use with a regional sam (rolim & kureski, 2006). this basic model was taken and adapted with data from the sam for the north west province of south africa. the resultant model has 46 sectors and accords with traditional neoclassical theories of economic rationality, that is, each sector minimises production costs, dependent on constant returns of scale with known input prices, and households use their earnings in line with traditional functions of utility maximisation (rolim & kureski, 2006). world trade consists of two regions, namely the rest of south africa and the rest of the world, with imports 162 sajems ns 18 (2015) no 2:155-176 being a composite good used in varying shares in all sectors. in the model applied, the primary factor input demand equations are based on the assumption that each industry within the region faces primary factor substitution possibilities described by ces functional forms. the result is cost-minimising input demand and unit cost equations that can be expressed as percentage changes (giesecke & madden, 2013:436), that is: 𝑥!,! ! = 𝑎!,! ! + 𝑦!,! − 𝜎 𝑝!,! ! + 𝑎!,! ! − 𝑝!,! (4) 𝑝!,! = 𝑆!,! ! ∙ 𝑝!,! ! + 𝑎!,! ! ! (5) where 𝑥!,! ! is the percentage change in demand for factor 𝑣 by regional industry j,r; 𝑎!,! ! is the percentage change in the technical efficiency of primary factor input 𝑣 in regional industry j,r; 𝑦!,! is the percentage change in the output of regional industry j,r; 𝑝!,! ! is the percentage change in the price faced by regional industry j,r; for factor ν; 𝑝!,! is the percentage change in the average price of primary factors faced by regional industry j,r; σ is the elasticity of substitution between primary factor inputs; and 𝑆!,! ! is the share of payments to factor ν in industry j,r’s total primary factor costs (giesecke & madden, 2013:436). the adapted sam used as the model database makes no distinction between activities and products. instead, the commodity entries indicate purchases of a compound good made up of provincial (north west) and imported commodities (from the rest of south africa and the world). imported products are only used directly by firms and thus sectors get a dual role of producing and joining compound goods that use their own product plus the equivalent in imported goods. furthermore, the model assumes that local households receive all payments for production factors (rolim & kureski, 2006). to be able to compare the results from the cge model with those of the i-o and sam models, a short-run traditional i-o closure rule is used. in this closure. all factors (and imports) are in elastic supply at fixed nominal prices, and thus there are no relative price changes and the model acts like a typical i-o model. also, household consumption is linked to regional income with subsequent strong multiplier effects. 4 empirical results and comparison the next step is to commence with an empirical comparison of the models. since the i-o model is only a partial (small-city) model derived from primary data, the collection of primary data for the model is first described. secondly, multipliers are derived and compared, and then a case study of the impact of visitor expenditures at aardklop on the local and regional economy is described, which further highlights the differences between the models. 4.1 business survey for the construction of the partial i-o for the festival area, a local business survey that encompassed all business sectors was conducted during july 2010. the purpose of this particular survey was to determine the extent to which goods and services needed to hold the festival were sourced from outside the local community. the survey included specifically sampled businesses in order to ensure the representation of all sectors within the local economy. the sample selection for collecting primary data was based on data obtained from the potchefstroom business chamber. the total number of accommodation establishments in potchefstroom was estimated at 70 (cilliers, 2009). in view of the fact that the accommodation sector represents approximately 4 per cent of the total number of businesses, it was estimated that, in potchefstroom there were in the region of 2 000 business establishments. all geographical business areas in town were identified and each business was listed by means of a door-to-door survey. in order to identify businesses that did not operate from formal business premises, the yellow pages (2009/2010) of the north west province and the potchefstroom business directory 2010 were consulted. sajems ns 18 (2015) no 2:155-176 163 during the survey, a partial approach was applied to the potchefstroom business population of 1 000, implying that 45.54 per cent of businesses would be included. considering that the estimated business population in potchefstroom is around 1 000, a 25 per cent sample implies that 250 questionnaires needed to be distributed for this survey. in order to ensure a proportional business sector representation for potchefstroom during this survey, questionnaires were distributed to the respective business sectors as indicated in table 3. table 3 potchefstroom businesses sector representation and sample selection spending item % presented number of questionnaires accommodation 3.57 20 retail (clothing, special, health and beauty) 11.29 62 wholesale 3.78 21 transport/fuel 2.69 15 manufacturing 6.52 36 restaurants/fast foods 8.07 44 tourism, cultural and leisure service (entertainment) 8.43 46 municipal 1.19 7 total 45.54 250 source: yellow pages (2009/2010) and potchefstroom business directory 2010 the questionnaire developed for this study covered specific business spending and was based on the business survey questionnaire proposed by vaughan et al. (2000), and that by saayman and saayman (2006) and saayman, saayman and ferreira (2009). participants’ responses were accurately captured by making use of the recall method or by consulting authentic data resources such as financial statements. 4.2 multiplier comparison the value-added, income and employment multipliers for each modelling method are presented in table 4. these multipliers represent the change in value-added, income and employment per million-rand increase in final demand expenditure of the sector in question. the multipliers (see table 4) are derived from three models, which include: (i) a partial i-o (type ii) model, which delivers proportional multipliers, since it only models a specific part of the economy; (ii) a sam (type iii) model; and (iii) a cge model under a short-term closure scenario (the closure scenario for the cge model holds capital supply fixed, which represents a standard short-run assumption (west, 1995). with regard to the value-added multipliers in table 4, the sam model produces the largest multipliers, with an average value of 0.786 (or 274.2 per cent of the average type ii proportional i-o multiplier value), because of the additional induced demographic effects. similarly, the shortterm cge model produces the smallest multipliers, with an average value of 0.421 (or 98.0 per cent of the average proportional i-o multiplier), as a result of the constraints on capital supply. one would also expect the sam model to produce smaller multipliers than the i-o model because of the marginal rather than average household-induced relationships, and, similarly, with the longterm cge model, except that the multipliers should get closer to those of the i-o model as supply restrictions are relaxed. however, since both the sam and cge models are at the regional level (at the provincial level) and the partial i-o at a place-specific (small town/ region, i.e. potchefstroom) level, these expected differences are not observed. however, there are also some significant differences in the distributions of the multi-pliers for each model. for example, trade and accommodation has the largest proportional i-o multiplier at 1.494, while the largest sam multiplier is 0.953 for community services. the largest cge multiplier occurs in mining, with a value of 0.717 in the short term. the overall spread of values from the cge model is also greater as a result of the additional limited resource factor. sectors 164 sajems ns 18 (2015) no 2:155-176 which have limited access to capital will experience additional dampening effects, while sectors which can easily draw capital from other sectors will show relatively larger multiplier effects (west, 1995). table 4 value-added, income and employment (per million zar rand) multipliers category i-o sam cge type ii type iii short-term valueadded income employment valueadded income employment valueadded income employment agriculture 0.737 (6) 0.267 (9) 23.462 (1) 0.213 (7) 0.200 (7) 1.590 (4) mining 0.913 (2) 0.473 (2) 7.452 (6) 0.717 (1) 0.065 (8) 2.640 (3) manufacturing 0.329 (3) 0.588 (5) 10.186 (2) 0.616 (9) 0.295 (8) 7.962 (5) 0.567 (4) 0.722 (3) 6.652 (1) electricity and water 0.053 (5) 1.064 (2) 3.821 (6) 0.729 (7) 0.310 (7) 4.664 (7) 0.203 (8) 1.830 (1) 0.880 (9) construction 0.644 (8) 0.314 (6) 9.807 (2) 0.601 (2) 0.700 (4) 0.955 (7) trade and accomm. 1.494 (1) 2.542 (1) 16.365 (1) 0.822 (4) 0.387 (4) 8.662 (3) 0.467 (5) 0.060 (9) 3.310 (2) transport & comms 0.254 (4) 0.378 (6) 3.963 (4) 0.756 (5) 0.326 (5) 3.060 (9) 0.199 (9) 0.585 (5) 0.890 (8) fin. & business serv. 0.397 (2) 0.670 (4) 3.856 (5) 0.903 (3) 0.390 (3) 4.323 (8) 0.250 (6) 0.400 (6) 1.400 (6) community services 0.053 (5) 1.064 (2) 7.816 (3) 0.953 (1) 0.613 (1) 8.281 (4) 0.573 (3) 0.900 (2) 1.560 (5) mean 0.287 0.701 5.112 0.786 0.375 8.630 0.421 0.607 2.209 index 1.000 1.000 1.000 2.742 0.535 1.688 0.980 0.866 0.432 coeff. variation 0.229 0.656 30.331 0.014 0.012 36.079 0.042 0.301 3.459 in terms of relative sizes of the income and employment multipliers, the same general conclusions can be reached as for the production multipliers (also shown in table 3), except for a greater variation in the sam model. the cge model gives marginally greater relative multiplier values as a result of the keynesian-type closure. while the multipliers form one basis for comparison between these models, they can be misleading in some ways if taken as a general guide to the relative differences in any given application. the reason is that impact situations are usually more complex, involving multiple changes across a range of sectors. in the following section, a case study is used to highlight further the differences between the models. these results should be viewed in the context of the festival under review. 4.3 visitor survey since 2002, visitor data has been collected annually by means of surveys at the aardklop national arts festival. the aim of the surveys was to understand visitor spending patterns of a selected sample of visitors. the collated information included participants’ demographic details, their activities during the festival, the length of their stay, and, specifically, their expenditure patterns. the data-collection process was administered by interviewers during face-to-face interviews with respondents in the selected sample. maree and pietersen (2010:158) list the following as being some of the advantages of using this method: a high response rate is obtained, it is possible to use lengthy questionnaires, and the interviewer is able to render immediate assistance to respondents, as a result of which the literacy level of respondents becomes irrelevant. for purposes of this study, the visitor survey was used to determine the shock in final demand due to the festivals. expenditure was based on spending information obtained by means of the survey conducted during the 2010 festivals. the visitor survey was utilised in order to calculate the average spending pattern per visitor group for the various spending items. the spending per visitor was calculated by dividing the estimated average spending per visitor group by the number of visitors per visitor group. in order to provide for the leakage principle (i.e. where expenditure that leaks out of the hosting community’s economy is excluded when assessing economic impact), the research follows the sajems ns 18 (2015) no 2:155-176 165 work by stynes (1999) and the following adjustments have been adopted. a weighting factor of 0.15 was applied to performance spending due to the large portion being paid over to artists, computicket (ticket sales agency) and sars (south african revenue service). the food and restaurant spending weighting factor was adjusted to 0.718 in order to allow for food stalls operated by entrepreneurs from outside the hosting community. a weighting factor of 0.06 was applied to curios and memorabilia spending, as only 6 per cent of entrepreneurs operating these stalls were from the hosting community. because many visitors did not need to travel long distances to the event and therefore ensured sufficient fuel intake before leaving their home town, the spending weighting factor in respect of transport to the event was adjusted to 0.5. with the necessary leakages provided for, the total direct spending was calculated for visitors, which represents the change in final demand. as proposed by stynes and white (2006), a segmentation strategy was followed where the expenditure data were split according to the origin of the visitors. three groups were identified, namely (i) visitors from the north west province in which the festival is held, (ii) visitors from the rest of south africa, and (iii) foreign visitors. by splitting the respondents into various groups, a more accurate value for spending can be determined (saayman, saayman & du plessis, 2005). it is often argued that spending by locals (in this instance, visitors from north west province) should be excluded, since it only represents a shift in expenditure patterns and not new money that flows into the region. however, crompton (2006) indicates that there are two circumstances when local spending can be included: (i) when the existence of the festival caused the residents to stay at home rather than take a trip elsewhere, referred to as the “deflected impact”; and (ii) when a study of the significance of the festival is made, that is, of the size and nature of the influence that the festival has on local economic activity. since visitors travel within the province to visit the festival, it implies that they would travel to another province if the festival took place elsewhere. therefore, there is a strong case that option (i) mentioned above is true and the spending by visitors from north west province is therefore included in the analysis. the contribution is, however, always listed separately in the analysis to allow economic impact estimation with and without locals’ spending. a questionnaire is used to gather expenditure information from visitors, but some visitors travel with fellow visitors (i.e. in groups). the spending per group thus includes spending by visitors and fellow visitors. to determine the spending per visitor, spending on entrance fees was used. given the amount spent on entrance fees to the festival, north west visitors travel in visitor groups of 2.10, other south african visitors in visitor groups of 2.06, and foreign visitors in visitor groups of 2.88. the magnitude of spending for each category was therefore divided by the number of visitors in the group in order to derive the value of spending per visitor. table 5 indicates this spending per visitor based on the survey results (columns 2, 4, 6 and 8), as well as the visitors per group. note that this spending includes the accompanying persons for whom the visitor is financially responsible. table 5 also shows the total visitor expenditure per origin in the festival area (columns 3, 5, 7 and 9), which is derived from the total visitor numbers. table 5 presents a breakdown of the activity sectors where expenditure was incurred. the total direct spending that takes place in the north west economy amounts to r83.9 million, of which r11.6 million is contributed by local visitors and r40.4 million and r2.0 million by visitors from the rest of south africa and abroad, respectively. the estimated spending allows adjustments to exclude direct spending that took place outside the north west province. such exclusions encompassed the remuneration paid to the majority of artists residing outside potchefstroom, production tax paid to sars in pretoria, and commissions payable to computicket in johannesburg. 166 sajems ns 18 (2015) no 2:155-176 table 5 estimated per visitor and total visitor spending by visitor origin (in south african rand) spending item foreign total foreign north west total north west rest of south africa total rest of south africa total per visitor spending total visitors’ spending entrance fees 47 62 213 46 1 036 222 51 1 940 655 145 3 039 090 accommodation 628 824 754 49 1 105 570 238 8 987 535 916 10 917 859 food and restaurants 144 188 512 96 2 156 413 177 6 672 708 580 9 017 632 liquor 53 69 348 101 2 261 652 150 5 659 410 304 7 990 411 soft drinks 87 114 153 59 1 314 641 70 2 658 505 216 4 087 298 performances 58 76 197 21 460 119 33 1 228 912 741 1 765 228 retailers 91 119 860 58 1 306 650 91 3 424 356 240 4 850 866 curios and memorabilia 36 47 259 8 182 291 14 512 475 962 742 025 transport to aardklop 287 376 704 25 557 808 107 4 020 833 837 4 955 345 transport at aardklop 49 64 496 11 251 193 52 1 976 841 113 2 292 531 parking 16 20 833 10 215 007 21 780 263 46 1 016 103 other 35 785 371 66 2 489 558 101 3 274 930 number of visitors (#) 1 313 1 313 22 414 22 414 37 742 37 742 61 469 61 469 total (in zar) 1 496 1 964 330 519 11 632 936 1 069 40 352 051 5 200 53 949 317 source of data: authors’ own calculations based on survey results 4.4 case study results the impact scenario chosen for this study is the impact, on the north west economy, of expenditures by visitors who attended aardklop in potchefstroom in 2010. this application presents a comparison of the three models that is as near as possible to being a valid comparison, since visitor expenditures can be classified as final demand (final consumption expenditure of visitors) in all the models. the total spending by visitors from different origins was allocated to the categories of the i-o model and the north west sam. since a multiplier approach is followed, distinct multipliers for each expenditure-related economic activity are applied. the subsequent change in commodity demand is therefore translated into a change in economic activity by using the partial (small-scale) i-oand sam-calculated multipliers – the so-called “corrected” direct impact of the festival. the multipliers then convert the spending into the associated increase in production, income, and employ ment opportunities due to the circulation of the additional spending through the local economy. the expenditure data by visitors have been deflated to 2006 values, allocated to industry sectors and converted to producers’ values, as shown in table 5, in order to be compatible with the partial i-o, sam and cge data. all results are expressed in 2006 values. the implementation of the impact analyses in all the models is similar, in that the visitor expenditures are incorporated into the models as final demand shocks. what is also important when performing economy-wide impact analyses is to know the duration of the festival in days. the length of the festival can determine which technique is the most appropriate. lastly, when big changes occur due to the presence of events (such as aardklop) that affect various other parts of the economy, it is necessary to apply some reliable form of modelling which will explicitly and accurately capture the potential economy-wide effects of such potentially valuable events. accordingly, the following sections provide a brief overview of some of the most common types of economic modelling used in south african events modelling. the results pertaining to the impact scenario on value-added, income and employment are given in tables 6, 7 and 8, respectively. they show the value impact of visitor expenditure over the industrial sectors in terms of total impact on the north west economy. across comparable industries (multipliers for agriculture, mining and construction could not be calculated for the partial i-o model from the business survey data and can therefore not be compared with the sam and cge results for these industries), and in contrast with a priori expectations, the total impacts derived from the type ii partial i-o model are not greater than those from the other static models sajems ns 18 (2015) no 2:155-176 167 (for most industries), while those obtained from the cge model are also not the smallest (although they are smaller relative to the sam results). it can be expected that the impacts from the sam model will be the largest because of the additional induced geographic effects. table 6 distribution of value-added impacts (in zar millions at 2006 prices) category i-o sam cge type ii type iii short-term foreign north west rest of sa total foreign north west rest of sa total foreign north west rest of sa total agriculture 0.124 (7) 0.533 (7) 0.036 (7) 0.693 (7) -0.003 (10) 0.139 (10) -0.003 (10) 0.142 (10) mining 0.065 (9) 0.234 (10) 0.012 (10) 0.310 (10) 0.290 (8) 1.071 (8) 0.063 (8) 1.437 (8) manufacturing 0.173 (7) 0.166 (6) 0.053 (7) 0.392 (7) 1.073 (6) 4.220 (6) 0.246 (5) 5.539 (6) 2.073 (6) 7.645 (6) 0.418 (6) 10.179 (6) electricity and water 1.065 (6) 3.131 (4) 0.291 (6) 4.487 (6) 0.061 (10) 0.237 (9) 0.014 (9) 0.311 (9) 0.263 (9) 1.053 (9) 0.055 (9) 1.380 (9) construction 0.115 (8) 0.363 (8) 0.016 (8) 0.494 (8) 0.814 (7) 2.911 (7) 0.160 (7) 3.901 (7) trade and accomm. 42.330 (2) 44.060 (2) 12.197 (2) 98.588 (2) 16.754 (2) 55.621 (2) 2.592 (2) 74.967 (2) 3.554 (4) 14.166 (4) 0.890 (4) 18.668 (4) transport and comms 7.085 (3) 1.010 (5) 1.138 (4) 9.233 (3) 3.517 (4) 16.900 (3) 1.015 (3) 21.432 (3) 5.347 (3) 20.147 (3) 1.121 (3) 26.708 (3) fin. and business serv. 3.179 (4) 0.165 (7) 1.499 (3) 4.842 (5) 4.403 (3) 11.964 (4) 0.569 (4) 16.935 (4) 6.181 (2) 20.684 (2) 1.125 (2) 28.098 (2) community services 1.801 (5) 5.293 (3) 0.491 (5) 7.585 (4) 2.968 (5) 9.855 (5) 0.219 (6) 13.042 (5) 2.754 (5) 10.012 (5) 0.610 (5) 13.365 (5) total (in zar million) 55.633 53.825 15.669 125.127 29.080 99.927 4.719 133.723 21.274 77.830 4.440 103.878 note: numbers in parentheses denote the rank. in terms of the aggregate impacts, the estimated value-added (table 6) from the partial i-o model is r125.13 million. the sam model’s estimate is slightly more at r133.72 million (or 106.9 per cent of the partial i-o model), while the short-term cge model produces the lowest estimate of r103.88 million, or only 83 per cent of the partial i-o model’s value. the corresponding multipliers are 0.431, 0.403 and 0.519, respectively. table 7 distribution of household income impacts (in zar millions at 2006 prices) category i-o sam cge type ii type iii short-term foreign north west rest of sa total foreign north west rest of sa total foreign north west rest of sa total agriculture 0.009 (7) 0.033 (8) 0.142 (7) 0.185 (7) 0.020 (9) 0.101 (9) 0.362 (9) 0.485 (9) mining 0.004 (10) 0.024 (9) 0.087 (9) 0.115 (9) 0.532 (2) 2.662 (2) 9.596 (2) 12.836 (2) manufacturing 0.031 (7) 0.062 (7) 0.082 (7) 0.175 (7) 0.069 (6) 0.302 (6) 1.187 (6) 1.558 (6) 0.104 (7) 0.518 (7) 1.867 (7) 2.498 (7) electricity and water 0.148 (6) 0.318 (6) 0.475 (6) 0.941 (6) 0.005 (9) 0.021 (10) 0.084 (10) 0.110 (10) 0.014 (10) 0.072 (10) 0.258 (10) 0.345 (10) construction 0.005 (8) 0.036 (7) 0.112 (8) 0.153 (8) 0.038 (8) 0.188 (8) 0.678 (8) 0.907 (8) trade and accomm. 7.474 (2) 15.466 (2) 21.780 (2) 44.720 (2) 1.059 (2) 6.848 (2) 22.735 (2) 30.643 (2) 0.188 (5) 0.939 (5) 3.386 (5) 4.529 (5) transport and comms 0.805 (4) 2.499 (3) 4.527 (3) 7.832 (3) 0.332 (3) 1.150 (5) 5.525 (4) 7.007 (4) 0.192 (4) 0.962 (4) 3.466 (4) 4.637 (4) financial and business serv. 0.881 (3) 1.287 (4) 1.711 (4) 3.879 (4) 0.232 (4) 1.798 (4) 4.885 (5) 6.915 (5) 0.157 (6) 0.786 (6) 2.832 (6) 3.788 (6) community services 0.395 (5) 0.847 (5) 1.265 (5) 2.507 (5) 0.137 (5) 1.860 (3) 6.174 (3) 8.171 (3) 0.281 (3) 1.403 (3) 5.058 (3) 6.766 (3) total (in zar million) 9.734 20.479 29.841 60.054 1.935 11.929 40.992 54.856 1.526 7.631 27.504 36.791 note: numbers in parentheses denote the rank. 168 sajems ns 18 (2015) no 2:155-176 table 8 distribution of employment impacts (in zar millions at 2006 prices) category i-o sam cge type ii type iii short-term foreign north west rest of sa total foreign north west rest of sa total foreign north west rest of sa total agriculture 3 (7) 11 (7) 1 (7) 14 (7) -3 (9) -13 (9) -44 (9) -59 (9) mining 0 (9) 1 (9) 0 (9) 1 (9) -6 (10) -30 (10) -108 (10) -144 (10) manufacturing 1 (7) 0 (8) 0 (8) 1 (8) 4 (6) 14 (6) 1 (6) 18 (6) 0 (7) -2 (7) -6 (7) -8 (7) electricity and water 4 (6) 3 (4) 2 (6) 9 (6) 0 (10) 1 (10) 0 (10) 1 (10) 0 (6) 0 (6) 12 (6) 14 (6) construction 1 (7) 2 (7) 3 (7) 1 (8) 2 (8) 0 (8) 3 (8) -1 (8) -3 (8) -11 (8) -15 (8) trade and accomm. 265 (2) 290 (2) 191 (2) 747 (2) 95 (2) 314 (2) 15 (2) 424 (2) 9 (3) 18 (4) 107 (3) 134 (3) transport and comms 15 (3) 2 (6) 8 (3) 25 (3) 5 (5) 25 (4) 1 (3) 31 (5) 2 (5) 8 (5) 36 (5) 46 (5) financial and business serv. 4 (5) 2 (5) 3 (5) 10 (5) 9 (4) 23 (5) 1 (5) 33 (4) 5 (4) 28 (2) 86 (4) 120 (4) community services 6 (4) 6 (3) 4 (4) 16 (4) 15 (3) 51 (3) 1 (4) 68 (3) 17 (2) 27 (3) 120 (2) 152 (2) total (in zar million) 294 306 211 810 131 442 20 593 24 33 193 238 note: numbers in parentheses denote the rank. this last point is brought out in tables 7 and 8, which show that the income and employment flow-ons are much smaller relative to the partial i-o model than those for value-added, indicating the greater role played by marginal labour productivity changes. for example, the sam model produces only 91.3 per cent of the household income impact and 73.2 per cent of the employment impact of the partial i-o model, while the short-term cge model falls to 61.3 per cent for income and 29.4 per cent of the i-o value for employment. as mentioned earlier, the length of the festival should be kept in mind when measuring economy-wide impacts of such events. in this case, aardklop takes place over a period of 5 days. therefore, even if 70 000 tickets were sold in 2010, the festival is estimated to generate an extra 810, 593 and 238 jobs (according to the partial i-o, sam and cge, respectively). i-o and sam models are an annual snapshot of an economy. there may be an extra 810, 593 and 238 employed for 5 days, but, averaged over the year, the employment impact is negligible. further, other research among business owners suggests that, at festival time, they do employ more people, but may extend the hours of existing employees or work the existing employees harder. in fact, only 19 per cent of businesses in the survey stated that they employed more staff during the event (5 days). the general distributions of the impacts across the industrial sectors correspond more or less with expectations. the largest effects occur in those sectors directly affected by the visitor expenditure, that is, trade and accommodation and transport and communications. with income and employment, the rankings differ marginally, but, overall, the distributions are much the same. obviously, labour has a greater impact on labour-intensive industries (such as service industries) and less impact on manufacturing and other more capital-intensive industries. generally speaking, the i-o and sam models produce relatively larger impacts in the manufacturing sectors and smaller impacts in the service sectors, particularly with respect to wages and employment. in other words, the service-type industries are better able to support the increase in tourist activity largely within existing resources, whereas manufacturing-type industries, which have more rigid value-added structures, respond in a manner closer to that of the leontief value-added system. however, the cge model results in a much larger redistribution of resources among all the sectors in the economy, in particular from agriculture, mining, metal products, manufacturing and construction (which all experience negative flow-on effects) to the sectors most affected by the boost in tourist activity, that is, trade and accommodation, transport and communications, financial and business services, and community services. this occurs because capital is drawn away from sajems ns 18 (2015) no 2:155-176 169 those sectors with more abundant and less efficient usage, going to those sectors in greater need in the short term. 5 findings and implications when comparing the economic impact results of a small-town festival, such as aardklop, it must be kept in mind that the demographic composition of potchefstroom (as measured by a partial i-o model) is relative to that of the entire north west province (as measured by the sam and cge models). the larger economic impact as measured by the sam and cge models is ascribed to less leakages and larger multipliers allowed for when applying a partial i-o model. having calculated the economic impact of aardklop by applying sam, cge and partial i-o models, the following results and comparisons were derived. firstly, when reviewing the results after applying the partial i-o, sam and cge models to the same set of aardklop data, the calculated economic impact of each model differs substantially. in terms of the aggregate impacts, the estimated value-added (table 6) from the partial i-o model is r125.13 million. the sam model’s estimate is slightly more at r133.72 million (or 106.9 per cent of the i-o model), while the short-term cge model produces the lowest estimate of r103.88 million, or only 83 per cent of the i-o model’s value. the difference in measured impacts in respect of the three models leads to the obvious question as to which is the most reliable. despite the comparative differences between the assessment models that became apparent in this paper, the indisputable fact remains that the hosting of an event has a varying economic impact with associated consequences for all stakeholders. in comparing the calculated results when applying the partial i-o model, it is evident that a greater economic impact is reflected when the sam model is used and a smaller impact when the cge model is used. during this study, a type ii partial i-o model was developed for the small city of potchefstroom. however, provincial sam and cge models had to be applied, as no such models exist for potchefstroom. results indicate that, when a provincial sam model with its secondary effects is applied to data collated from an event hosted by a small city, the calculated total impact is largely overstated. the regional cge model developed for use with a sam (for the north west) calculates a lesser total impact. secondly, in view of the significant differences in the measured economic impact when various models are applied to the same event, it becomes imperative that organisers, economists and academics who use assessment results to inform and guide stakeholders should ensure that the results obtained by means of a specific model relate accurately to the purpose for which the tool was developed. this was once again highlighted. it must be very carefully noted that the reporting of misleading assessment results may have severe, if unintended, economic and social consequences, as mentioned by crompton (1999). finally, a most significant limitation of an i-o model seems to be the inadequate measurement of job opportunities created. some stakeholders may find measuring tools such as sam and cge models preferable for this purpose owing to their ability to better account for additional job opportunities than the i-o models. developing a partial i-o model that is place-specific from primary data, as was done here, is time-consuming and also expensive. the discussion above points out obvious differences between the models. however, the comparison is not as simple as comparing structure, multiplier values or impacts. the environment in which the models operate also plays an important role. it is important to explore the theoretical foundations and empirical possibilities of these models within a wider framework and to develop the capacity to evaluate and compare the models and their applications in different situations using multiple case studies. some other comparable elements which might be given attention in future research include (west, 1995): the levels of complexity of the models, also within model types; the size of the region and the type of model required to appropriately measure economy-wide impacts (large rural areas presumably require modelling strategies different from those encompassing large 170 sajems ns 18 (2015) no 2:155-176 metropolitan areas, and small-area models are invariably constructed from the bottom up, while large regions are more likely to make use of top-down construction techniques); the type of problem being studied must be an important consideration in the choice of model (each model contains particular characteristics which make it more suitable for a given application than other models); and, finally, attention needs to be drawn to the analytical significance of the assumptions and characteristics of the model used (this can vary widely, even within model types). 6 conclusion results derived in this paper demonstrate that there are substantial differences between the three models, which raises the question: which set of results is the more reasonable? in some ways, it often comes down to personal prejudices. it becomes a question of balance between choosing a simple model that is easy to understand versus a more complex model that is often difficult to understand and apply, but which is more theoretically appealing in some ways. therefore, it depends on the application, and, in addition, on the amount of data available. the inconsistency of the measured results between the three models is most notably characterised by an estimated high/low difference of r59.6 million in total impact analysis. the total economic impact variance between the sam and cge model results in an estimated r30 million, while an almost equal difference between the cge and partial i-o results is noticeable. the results further support the concern that the economies of hosting communities normally experience high leakages, and so the local economy does not benefit to the extent that is generally expected and forecast. this phenomenon is apparent from lower multiplier values, and this research once more highlights the significance of not using overinflated multipliers to determine economic impact on hosting communities. this finding is particularly illustrated by the partial i-o results that considered just this principle. this paper confirms the finding of previous studies indicating the variance in measured economic impact results. this is emphasised by an even larger difference in results when the aardklop data was assessed. owing to the variance in the measured results that different models produce, very serious and deliberate consideration should be given to the preferred model that is utilised. a slapdash, hasty approach to the choice, interpretation and application of assessment models must be avoided, as inappropriate result information may adversely influence decision making and have serious consequences for all stakeholders that depend on the sustainability of an event. while many have forecast the end of the simple i-o model, stating that it is inadequate, it has proved surprisingly resilient. one area where i-o still has the advantage over more sophisticated models is at the very small-region level (such as small towns), where the partial i-o model (as constructed here) really provides the only option for planners, despite its known limitations. for future research, it would be advantageous to see the sam and cge frameworks move closer together and, at the same time, make the models more flexible and adaptable to local conditions without resorting to making each model application-specific. again, the point being made here is that the act of selecting what kind of model is to be used to evaluate the economic significance of an event will, inevitably, have an impact on the way that the results will be framed and perceived. acknowledgements the authors would like to thank the two anonymous reviewers for comments and suggestions that have contributed to this paper. the usual caveats apply. in addition, we also need to thank the national research foundation (nrf) for the funding to 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vanderbijlpark, south africa welby v. loury okoumba department of logistics and supply chain management, faculty of management sciences, vaal university of technology, vanderbijlpark, south africa citation khoza, s., mafini, c. & loury okoumba, w.v., 2022, ‘lean practices and supply-chain competitiveness in the steel industry in gauteng, south africa’, south african journal of economic and management sciences 25(1), a4617. https://doi.org/10.4102/sajems.v25i1.4617 original research lean practices and supply-chain competitiveness in the steel industry in gauteng, south africa sizwe khoza, chengedzai mafini, welby v. loury okoumba received: 11 april 2022; accepted: 30 aug. 2022; published: 28 oct. 2022 copyright: © 2022. the author(s). licensee: aosis. this is an open access article distributed under the terms of the creative commons attribution license, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. abstract background: the steel industry in south africa suffered significantly when imported steel took over the market and collapsed big players in the industry in the last decade. the industry requires new business models and paradigms to improve its supply-chain strategies and adopt international standards such as lean supply-chain management practices to become competitive. aim: in the study the relationships are investigated between lean supply-chain management practices, lean culture, and supply-chain competitiveness in the steel industry in gauteng province. setting: the study was conducted in the steel manufacturing industry in the gauteng province, south africa. methods: in the study a quantitative method involving 265 supply-chain and operations managers and practitioners was employed. the statistical packages for social sciences (spss version 27.0) was used to analyse the data in which correlations and regression analysis were employed to test the research hypotheses. results: the results of the study showed that four lean practices, namely just in time, total quality management, strategic partnerships and waste elimination, all predict the establishment of a lean culture. however, human resource management was statistically insignificant. the results further showed that a lean culture predicts competitiveness in the steel supply chain. conclusion: the adoption of lean supply chain management in the steel industry is an essential contributor to its success. keywords: supply chain management; lean supply chain management; just-in-time; total quality management; strategic partnership; waste elimination; human resources; lean culture; supply-chain competitiveness; south african steel industry. introduction the steel manufacturing industry is one of the most important sectors contributing to the highest south african gross domestic product (gdp) growth in south africa, with the top five steel-consuming industries contributing r600 billion to gdp (15% of the total) and employing more than eight million people. this was mainly linked to its overall productivity, estimated at about 65% (organisation for economic cooperation and development [oecd] 2020; statistics south africa 2018). it was thus a vital part of economic growth in the country (alabi 2016). the steel manufacturing industry played a significant role in the national economy and the economies of other african states. these include egypt, mozambique, tanzania, zambia, kenya, uganda, namibia, the drc, ghana, and ethiopia. it created jobs for many south africans (du toit 2014; worldsteel 2020). the south african steel industry has been declining constantly since 2010. challenges prevalent in the sector range from structural problems and persistent excess capacity to market demand negatively impacting trade and employment (department of trade and industry 2018). the effects of the steel crisis are evident across the value chain, from mining primary steel mills to domestic manufacturers struggling to compete, sustaining jobs and the decline in domestic primary steel-production competitiveness (schoeman, oberholster & somerset 2021; van der walt 2012). the emergence of the coronavirus disease 2019 (covid-19) pandemic worsened the situation in the steel industry, especially the implementation of government lockdown measures intended to save lives. the trade and industrial policy strategies (tips 2020) reported that the lockdown measures had devastating consequences for the steel sector, with an estimated r1bn being lost in direct cash-flow revenue and labour costs. evidence of that is south africa’s most important steel-producing company arcelormittal, which reported a drop in sales of about 40% due to the national lockdowns (arcelormittal south africa 2020). further affecting the steel sector is the volatility of the economic environment in the country, characterised by a recession. also, the sector faces other operational challenges. among the prominent ones is the inconsistency of direct supply, which could be attributed to a lack of supply-chain competitiveness (scc) (hannemann 2014; motebele 2018). the inconsistency in supply has resulted in supplier/customer distrust. the inconsistencies in the supply chain could have been caused by the ineffective application of several lean supply-chain management practices such as just-in-time (jit), total quality management (tqm), strategic partnership (sp), waste elimination (we) and human resources (hr). kumar singh and modgil (2020) considered that these practices may enhance scc through their influence on many firms’ lean culture. to solve the supply-chain crisis in south african steel manufacturing, firms have been trying to adopt new business initiatives to succeed in a unique and competitive marketplace (khuluse 2015; viljoen 2015). lean supply-chain management (scm) is an initiative that focuses on practices that eliminate nonvalue-adding activities (hosseini, soltani & mehdizadeh 2018; małysa & furman 2021). these practices comprise jit, tqm, sp, we and hr; and have been widely used in discrete industries such as automobile manufacturing, electronics, and appliances (talib et al. 2020). the application of lean practices to a continuous-process industry, such as steel, has been limited (conejo, birat & dutta 2020). it has been argued that this is because such an industry is inherently more efficient and the need for such improvement activities, therefore, relatively less. (kumar, singh & sharma 2014; van der walt 2012). hore (2019) opines that steel manufacturing firms need sps to gain customers’ trust. this could improve the demand, ensuring that products are enhanced as incorporated in deming’s system of profound knowledge (deming 1986; ochieng 2021). given the current crisis experienced by steel manufacturers, this research aims to empirically investigate the influence of lean supply-chain management (lscm) practices on lean culture and scc. against the above backdrop, this study investigated the relationship between lscm practices, lean culture and scc in the steel industry in gauteng province. the specific objectives of the study are to (1) test the connection between lscm practices and lean culture and (2) test the association between lean culture and scc. the steel industry is an important driver of south africa’s diversified economy, making continual research necessary to generate information for solving its problems. moreover, the body of empirical knowledge applying lscm practices to the south african steel industry is still limited. what is available, are studies by domingo (2013), who looked at implementing lean techniques as drivers of on-the-shelves product availability in the south african food retail industry. also, khuluse (2015) investigated the level of adoption of lean practices among south african’ small and medium-size enterprises (smes). viljoen (2015) established the strategic impact of selected lean factors on the operational performance of a selected south african gold plant. dondofema, matope and akdogan (2017) provided a literature review study of the state of adoption of lean techniques in the broader south african economic environment. fourie and umeh (2017) focused on using lean factors in the maintenance environment. lastly, govender and jasson (2018) explored the benefits and challenges of adopting lean practices as efficiency tools in the south african hospitality industry. however, the current study adopts a different approach in linking lscm to scc, a nexus that is fairly untested in the south african steel industry. the article is organised as follows: the next section presents the review of the literature on the south african steel manufacturing industry and the respective constructs of the study. thereafter, the conceptual model and hypotheses are presented, followed by the research methodology, data analysis and discussion of the results. the article concludes by providing theoretical and managerial contributions, limitations, and conclusive remarks. literature review south african steel manufacturing industry south africa’s large, well-developed steel industry, with vast natural resources and a supportive infrastructure, represents roughly a third of all south africa’s manufacturing. it comprises basic iron ore and steel, basic nonferrous metals, and metal products. the basic industries manufacture primary iron and steel products from smelting to semi-finished stages (cape gate group of companies 2019). primary steel and semi-finished products include billets, blooms, slabs, forgings, reinforcing bars, railway track material, wire rods, seamless tubes, and plates (kariuki 2013). south africa was the world’s 25th-largest crude steel producer in 2018, with an output of 6.8 million tons (mt) (department of trade and industry 2019). south africa exported 2.7 mt of semi-finished and finished steel products worth $2.4bn (r42. 272,341,933.68). the country produced 5.4 mt of iron and exported 662.4 kilotons (kt) of iron worth $245.2 million (r4.318,969,071.50). the volume of basic iron and steel products produced increased by 1.6% between march 2019, while the sales value of these products at current prices, rose by 9% over the same period. high production costs, the inconsistent supply of electricity, and poor domestic demand continue to significantly impact the performance of local manufacturers and wholesalers of basic iron and steel (statistics south africa 2019). steel manufacturing firms must consider the concept of competitiveness to survive in the global marketplace by fulfilling the customers’ requirements for high-quality and low-cost products (kariuki 2013; mondliwa, goga & roberts 2021). the industry is one of the most important sectors contributing to the highest gdp growth in south africa. together, the top five steel-consuming industries contribute r600bn to gdp (15% of the total) and employ more than 8 million people as of 2018 third quarter (statistics south africa 2018; zalk 2021). it is thus a vital part of economic growth for the country (alabi 2016; kan, mativenga & marnewick 2020). moreover, the industry plays a significant role in the national economy and the economies of other african countries, including egypt, mozambique, tanzania, zambia, kenya, uganda, namibia, the drc, ghana, and ethiopia. it creates jobs for many south africans (du toit 2014). steelmaking remains a key strategic industry, contributing to the fiscus and job creation (department of trade and industry 2019). each tonne of steel produced, creates jobs and provides value by beneficiating natural resources. steel is fundamental to manufacturing in south africa and adds significant value, representing more than 190 000 jobs in the direct iron ore, steelmaking and fabrication industries. the steel manufacturers have the prospect of employing many in the nation’s labour force (ocheri et al. 2017; trollip, mccall & bataille 2022). for example, arcelormittal employed more than 10 000 employees directly, while it will create employment for millions of south africans indirectly through the upstream and downstream industries (arcelormittal south africa 2019). this will further help to alleviate the persistent unemployment problem of the nation. as an essential element of industrialisation, the steel industries are vital for developing linkages with all other sectors of the economy. lean supply chain management practices the first objective of lean management is to eliminate every kind of waste in the company to make the business more competitive, through good results about innovation, flexibility, cost, quality, and service (kumar singh & modgil 2020; rocha 2017). the seven forms of waste addressed by lean production include defects, overproduction, delays, transport, over-processing, inventory, and motion. based on this, henderson and larco (2000) defined eight fundamentals of lean manufacturing to guide the implementation. these fundamentals are environmentally safe, orderly, clean, jit, six sigma quality, empowerment, visual management and seeking perfection. these are the bases of lean thinking. since then, many factors have been identified as lean manufacturing practices. however, this study focuses on jit, tqm, sp, we and hr as the lean practices influencing lean culture and ultimately leading to scc. these practices contribute to scc in various manufacturing sectors, especially within the steel industries. these practices are discussed in the sub-sections below. just-in-time the concept of jit is defined as an inventory management philosophy, aimed at reducing waste and redundant inventory by delivering products, components, or materials just when an organisation needs them (sharma, dixit & qadri 2015). just-in-time ensures that only what is required is produced, when necessary, at the right time and in the correct quantity (khuluse 2015). just-in-time is fundamentally the reduction of excess inventory (khuluse 2015). it uses the pull system, and according to simona and cristina (2015), the pull system is the centre of any synchronised factory; it works by working backwards, using signals or cards to trigger or start production. given the tight competition in the steel manufacturing industry, customers’ demands must be incorporated efficiently and in a way that cost effectiveness is recognised. firms effectively implementing jit principles have substantial competitive advantages over competitors that have not (garcia-buendia et al. 2021; madanhire & mbohwa 2016). lastly, organisations that have applied jit, have managed to gain a competitive edge, improve the quality of the products, and reduce waste (juárez, perez & useche 2017; mukwakungu et al. 2019; wyk & naidoo 2016). total quality management total quality management is defined as the sequential development of a product’s quality (anvari, ismail & hojjati 2011). it is an approach in which all the employees work together to improve a product, process, and working environment. its main aim is to ensure customer satisfaction (garcía-alcaraz et al. 2021; soni et al. 2013). total quality management is required to conduct successful continual improvement programmes in the workplace or ‘gemba kaizen’, in japanese lean terms, and embodies the concept of lean culture (panuwatwanich & nguyen 2017). furthermore, it refers to management that can be characterised by its set of principles, practices, and techniques. these comprise customer focus, continual improvement, and teamwork, to name a few (siva et al. 2016). each principle is implemented through a set of practices or simple activities such as collecting customer information and analysing processes (luburić 2013). total quality management focuses on exceeding customers’ expectations, identifying problems, building commitment, and promoting open decision-making among workers (cherrafi et al. 2016; slack & singh 2020). besides, abd-elwahed and el-baz (2018) found tqm to correlate with lean culture positively. strategic partnership an sp is an arrangement between two companies or organisations to help each other, or work together, to make it easier for them to achieve the things they want to attain (caspar-terizakis & yu 2016). besides, a critical partnership with suppliers has organised efforts to create and maintain a network of qualified suppliers. this effort includes all activities needed to improve the current performance of suppliers (mohanty & gahan 2012; tarigan & siagian 2021). also, sp with suppliers has been designed to link the strategic and operational capabilities of separate organisations with suppliers to help them achieve significant benefits (elms & low 2013). the main objective of this concept is to increase the functional capability desired supplier (cacciolatti et al. 2020; mohanty & gahan 2012). a good relationship with business partners, including key customers, plays a vital role in the success of supply chain management practised by an organisation (mumassabba et al. 2015). information sharing with business partners enables organisations to make better decisions and act because of greater visibility (elms & low 2013). well-managed strategic alliances and consolidation are essential to long-term sustainability, growth, and scc (cacciolatti et al. 2020; mráček & mucha 2011). waste elimination in terms of the industry, waste is defined as anything that does not add any value to the end product from the customer’s perspective (demeter & matyusz 2011). wastes are activities that add cost or time, but do not add value, consuming more resources (time, money, space, etc.) necessary to produce the goods or services that the customer wants (pal & kachhwaha 2013). waste includes activities that add cost or time, but do not add value, consuming more resources (time, money, space, etc.) necessary to produce the goods or services that the customer wants (panuwatwanich & nguyen 2017). also, rocha (2017) posited that the first objective of lean is eliminating every kind of waste in the company to change the business into more competitive through good results in innovation, flexibility, cost, quality, and service. the primary work strategy opted for process improvement is applying lean principles in material handling in steel plants. this optimises operational performance (kumar et al. 2014). human resources lean in hr is defined as driving waste out of organisations’ human resource function operation processes (khan et al. 2013). lean as enabled by human resources, refers to how the human-resource processes and functions help create lean success throughout the organisation. adopting lean principles well beyond core manufacturing has dramatically changed many other corporate internal functions, including product development, supply chain management, and accounting (brown et al. 2016). past research suggests that an organisation’s employees can be a source of sustained competitive advantage and determine their organisations’ ultimate success (njeri & thuo 2014). given the importance of people in organisations, most strategic hr departments consider the management of the competencies and capabilities of these human assets the primary goal (karuoya 2014). it is generally accepted that firms can create a competitive advantage from hr and their management practices. effective hr management generates a higher capacity to attract and motivate employees for good performance, and the benefits of having adequate and qualified employees are numerous (carvalho, alves & lopes 2011; mijatović, uzelac & stoiljković 2020). some examples are higher profitability, less rotation, higher product quality, lower costs in manufacturing and a faster acceptance and implementation of the organisational strategy. organisational resources lead to a sustained competitive advantage when valuable, rare, and inimitable and have no substitute (fahmi & abdelwahab 2012; tran & vo 2020). lean culture the concept of a lean culture is regarded as the inclusion and engagement of every employee in continual improvement (miller 2011). pakdil and leonard (2014) described it as one of the four components of a successful lean implementation. they explained that lean implementation consists of four components: lean planning, lean concepts, lean tools, and lean culture. organisations using traditional manufacturing methodologies have struggled to compete successfully with those adopting lean practices (van der merwe, pieterse & lourens 2014). however, lean success is mainly dependent on attaining a lean culture. companies that utilise mass-production systems controlled by top-down management approaches find that the change to a lean system is dependent on a significant shift in organisational culture (imre, jenei & losonci 2013; miller 2011). besides, mann (2014) described the concept as one of the four components of a successful lean implementation and explained that it consists of four components, namely lean planning, lean concepts, lean tools, and lean culture. moreover, organisations or manufacturing industries that have successfully instilled a lean culture within the organisation and workforce will consistently realise scc, more innovative, team-directed solutions, lower employee turnover and more success at sustaining improvements (jekiel 2020; van der merwe 2014). supply-chain competitiveness the competitiveness of a firm’s value chain refers to the capability of the supply chain to deliver value to the customer to competitive advantage. also, it is regarded as the ability of the supply chain to gain a competitive advantage compared to other competing supply chain/s (antai 2011; shang, zhou & van houtum 2010). furthermore, segarra-moliner, moliner-tena and sánchez-garcia (2013) assert that competition and rivalry currently exist between one supply chain and the other supply chain, rather than between two firms based on value delivered to the customer. supply-chain competitiveness is considered an important tool in gaining a competitive advantage. due to speedy technological innovations, globalisation, and widely-used information technology, scc is necessary for firms to focus strategically (deng et al. 2020; rajagopal 2010). furthermore, scc can be achieved by efficient delivery, customer satisfaction, a better quality of products, profitability, more responsiveness, shorter lead times, demand fulfilment, optimal facilities, etc. (naqvi, asim & manzoor 2020; verma & seth 2011). verma and seth (2011) proposed a conceptual framework for scc. it is described that effective competitiveness requires some input elements, and then scc yields outcomes out of a supply chain. furthermore, scc requires agility, coordination, collaboration, cooperation, synergy among partners, mass customisation, customer orientation, process orientation, demand management, and strategic alliances (sakuramoto, di serio & bittar 2018). while scc will yield outcomes like customer value, customer satisfaction, quickness in response to changes, innovation, improvement, profitability, and ultimately competitive advantage. conceptual framework the study tested the conceptual framework presented in figure 1. figure 1: conceptual framework. hypotheses development impact of just in time on lean culture the social values and morals of the employees are major enablers of the jit system (sharma et al. 2015). simplified production processes such as eliminating inventories and large lot sizes in excess, create a needless customer time-cycle delay. masudin and kamara (2018) investigated the links between the jit practices, attempting, in particular, to determine how they are linked to lean culture. the results support the argument that jit practices positively affect culture. syed, barlow and syed (2018) also determined the association between jit and culture. finally, li, wu and holsapple (2017) suggest that employees have a key role in implementing lean culture. however, the jit processes may not be achieved without the employees’ compliance. based on the provided discussion, the following hypothesis can be stated: h1: there is a significant positive relationship between jit and lean culture in the south african steel industry impact of total quality management on lean culture the concept of tqm is one of the critical determinants in a successful lean culture (gimenez-espin, jimenez-jimenez & martınez-costa 2013). many other scholars have also advocated this (panuwatwanich & nguyen 2017; zairi 2013). it was also found that the failure of the tqm implementation primarily derives from the lack of integration of tqm and culture change. to nurture tqm implementation success, several researchers recommended the need for organisations to change their organisational culture (baird, hu & reeve 2011; gimenez-espin et al. 2013). also, viljoen (2015) states that a favourable working environment correlates with strong business performance and proves that organisational culture directly impacts the business. in doing so, steel manufacturing organisations must systematically define and assess their organisational culture based on a well-developed framework or model. it is against this background that this study posits the following: h2: there is a significant positive relationship between tqm and lean culture in the south african steel industry impact of strategic partnership on lean culture embedded in the theoretical ‘relational view’ of management, which supports the view that firms may gain and sustain competitive advantage by leveraging and accessing resources from outside the firm’s boundaries (salimova, vatolkina & makolov 2014). the authors propose a theoretically underpinned model whereby cultural compatibility between strategic supply-chain relationships has the potential to lead to improved performance outcomes for each participant in the chain. the linkages and interdependencies between strategic supply-chain relationships and organisational culture are evident in the literature (mcfarlin 2017; mckay 2014). for example, rationalisation of the supply base should result in a deepening of relationships, which highlights the importance of shared values such as trust cooperation between each supply-chain partner organisation (henderson & dhanaraj 2014). in addition, the focus on strategic relationships has been shown to require compatible cultures (bendiek & kramer 2010). this study proposes a theoretical framework whereby it is posited that strategic supply chain relationships can only be truly successful if lean-cultural fit is achieved. hence the following hypothesis is posited: h3: there is a significant positive relationship between sp and lean culture in the south african steel industry impact of waste elimination on lean culture to achieve we, and continual improvement, organisations need the attitude, culture, and capabilities to constantly improve and sustain themselves in the future (puvanasvaran, huihui & norazlin 2014). it is an organisation that does not require a management initiative, a customer initiative, or a shareholder initiative to improve – it comes from the desire and the will of the people inside the organisation (tang, chen & luo 2011). this requires a commitment throughout the organisation to improve and eliminate those obstacles that delay, prevent, or inhibit improvements (miafodzyeva & brandt 2013). culture determines how people think and behave in any workplace. establishing a we culture within manufacturing is necessary for other we initiatives, such as a waste management plan (miafodzyeva & brandt 2013). by establishing a we culture, the firm creates an environment inducive to bright ideas, increased efficiency and reduced operating costs. hence this study posited the following: h4: there is a significant positive relationship between we and lean culture in the south african steel industry impact of human resources on lean culture human resources and scm importance has been recognised as a means in gaining competitive advantage in different industries (bhaskar & tilak 2013). hence, integrating hr and scm functions enables organisations to craft a unique strategy and increase the firm’s supply-chain performance. according to jurcevic, ivaković and babić (2013) the primary purpose of performance management is to instil in the employees a desire for continual improvement, which is the foundation of lean transformation. selective hiring practices for new employees allow the organisation to select individuals with the desired knowledge, skills, and values to support the organisation’s long-term lean transformation strategy (brown et al. 2016). besides, khan et al. (2013) found a positive impact of hr management practices on supply chain management success. lean transformation success depends on the extent to which hr within the organisation has been embracing the concept. active support and participation in the transformation process to leanness may lead to higher organisational–culture success rates (de menezes, wood & gelade 2010). hence, the study posited the following hypothesis: h5: there is a significant positive relationship between hr and lean culture in the south african steel industry impact of lean culture on supply chain competitiveness organisations adopt lean operations principles either as a defensive strategy to stay competitive, or as an offensive strategy to move ahead of competitors (nordin, deros & wahab 2010). irrespective of adopting a lean approach, the actions required to become lean are the same, and the implementation process may be lengthy. badurdeen, wijekoon and marksberry (2011) affirm that a similar lack of attention to lean culture also prevents south african steel manufacturers from realising the potential benefits of leanness. moreover, punnakitikashem, buavaraporn and chen (2013) conclude that lean culture is vital to any lean implementation plan’s success and that future research is required to create and maintain such a culture. the ill-defined nature of a lean organisational culture and time constraints caused by increased competition is exacerbated by this problem. besides, van der merwe (2014) advanced that manufacturing industries must instil a lean culture in the organisation to attain an adequate level of competitiveness. in terms of innovative problem resolution, lower employee turnover and better success at sustaining improvements, amongst others. finally, miller (2011) and imre et al. (2013) offered similar sentiments that lean-cultured organisations provide many benefits, including greater competitive advantages in supply chains. it is against this background that this study developed the following hypothesis: h6: there is a significant positive relationship between lean culture and scc in the south african steel industry research methodology this study employed a positivist paradigm as its underpinning philosophy, because hypotheses were posited, and the study’s results are expected to be compared to the stated hypotheses. this is consistent with the objective of this study, which investigates the relationships between lscm practices, lean culture and scc, based on a conceptual framework with several quantifiable variables. statistical methods are used to ascertain whether the framework fits the data. the methodology of the study is, thus, structured as follows: research sites and sampling method the quantitative approach was selected since it facilitates results that can be generalised to other contexts. in this case, it was expected that the results of the study could be generalised to different contexts of steel-manufacturing companies throughout south africa. this study followed a correlational research design, specifically a single cross-sectional survey, because data were collected only once from the sample elements (burns, veeck & bush 2018). the cross-sectional strategy was chosen, because it provided inexpensive methods of collecting data over a large sample, and it pairs well with the quantitative method. the target population of this study comprised supply-chain and operations managers and practitioners from steelmanufacturing companies based in gauteng province. confining the study to the province of gauteng is justified by the fact that it is the most thickly populated region (12 564 000 habitants) and includes the most heterogeneous racial and ethnic groups (statistics south africa 2019). moreover, most steel manufacturers are in gauteng province because of its large population. lastly, the province is also known to be the country’s economic hub, which provides opportunities for current and future research. in terms of the sample frame, the lists of the supply chain and operation practitioners were obtainable from the hr databases of the steel manufacturing companies identified for this study. sampling procedure and technique the list of steel manufacturing firms was obtained from the yellow pages and permission was sought from each of these firms. the final sample was composed of 265 respondents. this sample size was deemed acceptable based on two approaches. firstly, the historical evidence approach was used, which focuses on previous similar studies. for example, khuluse (2015) used a sample of n = 250 while viljoen (2015) utilised a sample size of n = 115 for their quantitative studies on lscm. the second approach was based on the sample size for multivariate studies as recommended by seminal scholars. in this regard, pallant (2007) recommends a minimum of 150 respondents, and tabachnick and fidell (2007) propose a sample size of at least 200 cases for multivariate analysis. with these recommendations in mind, a total of 400 firms provided access to collect data from their supply-chain and operation managers and professionals. however, there was no sampling frame from which an accurate list of all targeted respondents could be drawn. as a result, a non-probability convenience sampling technique was applied to choosing the sample. apart from the lack of an accurate sample frame, the respondents were not easily accessible due to the covid-19 pandemic, making it necessary to use the convenience sampling technique. supply-chain and operation managers and practitioners were contacted in person to complete the questionnaire. measures all measurement instruments were anchored in a seven-point likert scale ranging from 1 = strongly disagree to 7 = strongly agree. all constructs had 43-item scales adapted from bortolotti, boscari and danese (2019) for jit, sp, and hr. sadikoglu and olcay (2014) for tqm, manzouri et al. (2014) for we. panuwatwanich and nguyen (2017); ganeshkumar and nambirajan (2013) for lean culture and scc, respectively. appendix 1 provides the list of the measurement instruments in the study. all measurement scales had been validated in previous studies, having attained cronbach alpha values above 0.7. field work data were collected through a survey using a structured questionnaire. the decision to make use of a questionnaire is influenced by the characteristics of the respondents the study intends to collect data from; the importance of reaching each targeted respondent; the importance of respondents’ answers not being contaminated or distorted; the size of the sample and the nature and the types of the questions (saunders, lewis & thornhill 2016). due to the outbreak of covid-19, questionnaires were distributed to steel-manufacturing companies using two methods in this study. the first method was the drop-and-collect method, which involved the face-to-face distribution and collection of hard copies of the questionnaires to and from the available respondents at work. the second method involved email surveys. emails were suitable since some respondents are geographically dispersed in the constituencies to be covered in this study. many of the respondents worked from home, making it challenging to deliver questionnaires in the hard-copy format. email addresses for such respondents were collected from their departments and used as a reference point for contacting them. data collection took approximately four months and were conducted in the vaal region between april and july 2020, in which 400 questionnaires were distributed. upon their collection, the questionnaires were screened to determine their usability. however, some of the questionnaires were not returned, while some were incomplete due to a number of reasons. after systematically screening all questionnaires and discarding the incomplete ones, 265 were found usable, representing a 66.3% response rate. data analysis the principal researcher captured the collected data on an excel spreadsheet. the data on the excel spreadsheet were cleaned by checking for missing entries. a statistician analysed the data using the statistical packages for the social sciences (spss 27.0). the basic statistical techniques applied in the study include descriptive statistics, normality tests, exploratory-factor analysis, correlations and regression analyses. sample profile the majority of respondents were male (61.4%; n = 163). regarding the age distribution of the sampled respondent, most respondents were aged between 34 and 41 years. besides, 47.9% (n = 127) of the sampled population was black-african. also, 41.9% (n = 111) were holders of diploma qualifications. regarding the respondents’ experience, 30.2% (n = 80) were employed between three to five years. furthermore, 188 (71%) respondents were permanently employed. lastly, 61.5% (n = 163) of the respondents were from the supply-chain management/procurement department. explanatory factor analysis a harman’s one-factor score test was conducted by running the preliminary explanatory factor analysis (efa) on the sample data. in contrast, the unrotated factor solution was examined to determine the number of necessary factors to account for the variance in the variables. the single factor that emerged yielded one general factor accounting for approximately 24.89% of the covariance among the measures, concluding that common method variance is not a problem. table 2 presents the efa results, performed using principal components analysis by applying varimax rotation, which helped evaluate construct validity. the suitability of data for factorability was ascertained after examining the significant kaiser-meyer olkin test statistic (kmo = 0.819) and the bartlett sphericity test, which showed a significant result with a considerable chi-square value (χ2 = 8105.213; p ˂ 0.01). most of the items loaded as expected with their factors, except for items sp3 and sp6 and hr5, which were discarded since they yielded weak and insignificant loadings on any of the extracted factors (below 0.50; p > 0.001). table 1 presents the efa’s results. table 1: exploratory factor analysis results. table 2: assessment of data normalcy. the six lean principles remained unchanged, and the labelling remained the same (i.e. jit, tqm, sp, hr, we). just-in-time had a kmo of 0.873, and all items explained 63.2% of the variance, while tqm had a kmo of 0.934 and explained 86.6% of the variance. strategic partnership had a kmo of 0.786, explaining 79.5% of the variance. waste elimination had a kmo of 0.895, with 78.4% of variance explained. human resources had a kmo of 0.830, explaining 73.3% of the variance. lean culture and scc had kmo of 0.909 and 0.939 with 73.7 and 76.5 percentage of variance, respectively. all factor loadings were higher than 0.5, and commonalities were higher than the 0.3 minimum cut-off value. normality and common method bias assessment in measuring normality, field (2013) points out that the central limit theorem stipulates that the assumption of normality has little effect on data analysis for a large sample. although the central theorem provides a studied theoretical background for the issue of normality in this study, the skewness and kurtosis of each construct and item are presented in table 3. the value for skewness and kurtosis between -2 and +2 is considered acceptable to prove normal univariate distribution (field 2013). table 1 indicates that overall, the items of the scales have satisfactory skewness and kurtosis values. the skewness values ranged from -0.848 to -1.711, while kurtosis ranged from 0.658 to 4.470. it can, therefore, be said confidently that the assumption of normality is met. mardia (1974) suggests that the data is non-normal if about 80% of the data presented skewness and kurtosis above the recommended threshold of -3 to +3. the data were distributed normally in this study, and the conceptual model was not complex. this thus required the use-regression model to test the proposed relationships. table 2 presents the assessment of data normalcy. table 3: correlation analysis of the constructs. correlation analysis in this study, pearson correlations were applied to test the strength and direction of relationships between the research constructs. the results are presented in table 3. table 3 shows significant positive correlations between all research constructs. the strongest correlation occurred between lean culture and scc (r = 0.712; p = 0.000). in contrast, the lowest correlation was found between hr and tqm (r = 0.388; p = 0.000). this indicates that a change increase in one construct will change the other constructs, either positively or negatively. regression analysis in the current study, tolerance and the variance inflation factor (vif), both regarded as measures of the impact of collinearity amongst the constructs in a regression model, were assessed, and should ideally be tolerance > 0.1 and vif < 10 (o’brien, 2017:673). the values for all independent variables were within recommended limits and did not indicate any serious multicollinearity threat. the first multiple regression analysis tested jit, tqm, sp, we, and hr to determine if attitudes towards lean culture were predictors. it was found that jit (tol = 0.511, vif = 1.958), tqm (tol = 0.460, vif = 2.175), sp (tol = 0.503, vif = 1.990) and we (tol = 0.549 vif = 1.822) were significant predictors of lean practices towards lean culture. however, hr (tol = 0.708, vif = 1.412) did not predict lean practices toward lean culture. table 4 reports the regression analysis between lean practices and lean culture. table 4: regression analysis of lean practices and lean culture. the predictor variables were the five lean practices (jit, tqm, sp, we, hr) (independent variable). the dependent variable that was entered into the prediction model was lean culture. examining the relationship between lean practices and lean culture rating, the adjusted r2 = 0.483 indicates that lean practices combined, explained 48.3% of the variance in lean culture. table 5 reports the regression analysis between lean culture and scc. table 5: regression analysis of lean culture and supply-chain competitiveness. the predictor and independent variable held constant was lean culture, and the dependent variable was scc. the rating (adjusted) of the relationship between the constructs was r2 = 0.507, indicating that lean culture explained 50.7% of the variance in scc. assessment of measurement instruments (reliability and validity results) table 6 presents the reliability results of the study, as indicated by the cronbach alpha. table 6: reliability results. all scales attained cronbach alpha values above the recommended 0.7 minimum threshold, which confirms that the scales were internally consistent. to test for face and content validity of the measurement instrument, the questionnaire was reviewed by the research supervisors. additionally, a pilot study was conducted, involving a convenient sample of 50 respondents. feedback from the review and the pilot study was used to improve the questionnaire to make it more suitable for the final survey. the efa procedure was used to test for construct validity (refer to table 1), where factor loadings were higher than the 0.5 lower cut-off value, indicating that construct validity was adequate. additionally, the positive correlation values (refer to table 3) further confirmed that construct validity was acceptable. figure 2 shows the conceptual model of the study incorporating the results of the hypotheses testing. figure 2: path coefficient results. hypotheses tests results table 7 shows a rundown of the results from this research and states the decision relating to the hypotheses formulated for this study. table 7: hypotheses decisions. in table 7, h2, h3, and h4 were supported, implying that tqm, sp, and we significantly predicted lean culture. h6 was strongly supported with a beta-value of 0.712, indicating a positive and significant relationship between lean culture and scc. discussion of results regression analysis was used to test the direct causal relationships between the study constructs. the results revealed the following empirical observations. regarding the association between jit and lean culture, the implementation of the jit solutions in the steel industry is not linked to establishing a lean culture or does not predict its improvement. this result contradicts previous studies by wyk and naidoo (2016:237) in the electronics manufacturing industry that showed that adopting jit affects the extent to which lean thinking and the minimisation of waste become entrenched within the organisation. sharma et al. (2015) also established the importance of jit in lean manufacturing processes. furthermore, masudin and kamara (2018) deduced that jit’s philosophy advocates the elimination of waste by simplifying lean production processes. the empirical evidence from this research highlights that tqm is a significant predictor of lean culture. this result aligns with a previous study by sreedharan et al. (2016) and cherrafi et al. (2016:828), who further established that effective tqm requires a lean system among people, machines, and information, stressing a systematic approach to quality. strategic partnership was found to be an essential predictor of lean culture. this point was supported by mumassabba et al. (2015), who stated that sp and lean culture yields better understanding among crucial stakeholders in supermarkets in kenya. the significance of we as a driver of lean culture was advocated by demeter and matyusz (2011). they established that we plays a vital role in the implementation of a lean culture in the manufacturing industry. the results regarding human resources showed a positive relationship with lean culture. this was endorsed by bhaskar and tilak (2013), human resources do play a positive and significant role in the implementation of lean culture through employee engagement. in the study it is, therefore, deduced that employees are the most critical resource of the four resources required to bring about success in any form of organisation. it can be concluded that employees who continually learn and enhance their skills become the organisations’ critical assets. this implies that organisations in the steel industry in gauteng need to investigate hr and align them with the learning culture to more successfully adopt a lean culture. finally, the result demonstrated that a lean culture exerts a positive and significant influence on scc. this, thus means that the steel manufacturing firms with lean culture are more likely to achieve scc. these findings align with vanichchinchai’s (2019) observations in that the author established that lean practices positively influence supply-chain performance in terms of competitiveness and customer satisfaction. according to van der merwe (2014), manufacturing industries that have successfully instilled a lean culture in the organisation and workforce will consistently realise scc, more innovative, team-directed solutions, lower employee turnover, and more success at sustaining improvements. theoretical contributions this study proposed and empirically tested a conceptual model that incorporated lscm practice (jit, tqm, hr, sp and we) as antecedents of a lean culture in the steel manufacturing industry. in addition, scc was also incorporated as an outcome of lean culture. this model’s uniqueness is its holistic stance that posits six lscm practices which directly impact lean culture and, ultimately, scc. finally, the resultant conceptual model proposed in this study would improve the supply-chain model related to the steel manufacturing industry; and researchers studying the supply chain for other industries could use the model. managerial contributions knowing more about the factors enhancing lean culture and improving scc would help these firms create the right strategies to strengthen, enhance, and manage their supply chains. this study provides this much-needed information and indicates the extent to which steel manufacturing’s lscm practices affect lean culture and scc. this would guide the steel manufacturing firms to allocate their resources to improve their scc appropriately. this study would also be helpful for businesses and decision-makers because it would provide insights into lscm grey areas and help improve their business performance in south africa and africa as a whole. limitations and future research in assessing the findings of this study, it should be noted that the study is by no means without limitations, which offers avenues for future research. some of the main challenges that hampered the adequate completion of this investigation are that the study was confined to only steel manufacturing firms in gauteng province, specifically southern gauteng, where there is a market leader of steel producers in the country (arcelormittal south africa). studies (mukhtar 2015) show that market leaders are more proactive in their business operations than their followers, as a result they may have been practising lean manufacturing for a more extended period. another limitation is related to the research methodology employed. a survey using self-administrated questionnaires was employed in this study. while self-reporting may rightly gauge the lscm practices influencing lean culture, the report on these practices may need implicit studies or experimental methods. the third limitation is that the study was cross-sectional in nature. this means that the reported results relate to only a particular point in time. applying a cross-sectional design implies that the investigation has focused on reported lean practices, lean culture and scc instead of emphasising observed changes in these variables over time. in future research a longitudinal survey and observation research focusing on uncovering lscm practices affecting lean culture and scc over a long period may be applied. for example, researchers may track scc frequency should the firms improve their jit, tqm, sp, we and hr. conclusion this study aimed to investigate the relationships between lscm practices, lean culture, and scc in the steel industry in gauteng province. it tested a conceptual model that incorporated lscm practices (predictor variables) and lean culture (mediator variable) to understand the factors influencing scc (outcome variable). it made theoretical contributions by developing and testing the conceptual model and understanding steel manufacturing’s supply chain. practical contributions exposed areas where decision/policymakers and businesses could enhance their efforts in improving scc in the steel manufacturing industry. the study opens avenues for future research to expand the findings obtained and deal with a few limitations. while the factors driving lean culture may help improve supply-chain performance, corresponding efforts should be made to increase the ineffective supply chains in south africa and other parts of the globe. acknowledgements competing interests the authors have declared that no competing interest exists. authors’ contributions s.k. conducted the fieldwork of the study and wrote the research methodology section. c.m. performed the data analysis and wrote the results section. lastly, w.v.l.o. wrote the initial section of the article and performed the literature review. ethical considerations ethical clearance to conduct the study was obtained from the central research ethics committee at a south african university of technology. the study conformed to ethical standards regarding the minimal risk it posed and the voluntary participation and protection of respondents’ identity. it was further supported by providing an ethical clearance certificate conferred by the vaal university of technology (frecms-18032020-028 25264231 [30 april 2020]). funding information the author(s) received no financial support for the research, authorship, and/or publication of this article. data availability data supporting the findings of this study are available from the corresponding author on request. disclaimer the views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of any affiliated agency of the authors. references abd-elwahed, m.s. & el-baz, m.a., 2018, 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and gf ortmann school of agricultural sciences and agribusiness, university of kwazulu-natal abstract this study investigates the economic impact of a land tax implemented under the local government municipal property rates act no. 6 of 2004 on commercial farms using five case studies with fiveyear data sets in the mtonjaneni and umgeni municipal districts of kwazulu-natal. the case of farms’ ability to pay annual rates between 0.25 per cent and 1 per cent of the value of improved land using real annual economic profit with and without rebates of up to 70 per cent proposed by the department: provincial and local government ranged from zero to five out of five years, with a mean of two out of five years. a 2 per cent land tax rate with such rebates could also be financed only in two out of five years on average. these results suggest that proposed annual land tax rates of 1.5 per cent (mtonjaneni) or 1 per cent (umgeni) on these specific farms would markedly reduce the incentive to invest in farm improvements. jel h22, 71 1 introduction since the early 1990s, the south african (sa) government has considered the implementation of a rural land tax, as reflected by 15 drafts of the proposed local government property rates bill. this bill has now been enacted into legislation as the local government municipal property rates act no. 6 of 2004 (hereafter referred to as “the lgmpra”) (department: provincial and local government (dplg), 2004a). president mbeki signed the lgmpra into effect on 2 july 2005 (sa government gazette no. 27720, 2005). prior to that date, farm land in south africa was not subject to property taxes levied by municipalities. the new lgmpra however, incorporates all previously unrated land into municipal boundaries, so that farm land that was not rated under the old municipal ordinances is now liable to pay a land tax (dplg, 2004a). the power for sa municipalities to levy a tax on land stems from section 229 of the sa constitution, which guarantees “rates on property” as “an autonomous source of revenue for municipalities” (franzsen, 2000: 1). in terms of section 229 of the sa constitution, a municipality may impose rates on property and surcharges on fees for services provided by or on behalf of the municipality. however, section 229(2)(a) of the sa constitution states that a municipality may not exercise its power to levy rates on property in a way that would materially and unreasonably prejudice (a) national economic policies; (b) economic activities across its boundaries; or (c) the national mobility of goods, services, capital or labour (dplg 2004a: 28). in south africa, the land tax is intended to “provide local government with access to a sufficient and buoyant source of revenue to fulfill its developmental responsibilities” (dplg, 2004b: 5). there is a relatively limited amount of published literature that analyses the potential economic impact of a land tax on commercial farms in south africa. nieuwoudt (1990; 1995) noted that a land tax is likely to reduce land rents, and hence cause lower farm land values and discourage investment on farms. franzsen (1995; 2000) concluded that the implementation of a land tax on commercial sajems ns 11 (2008) no 3 373 farms could be administratively feasible to levy, assess and collect if it is left to each individual tax jurisdiction to decide after consultation, and in light of its own peculiar circumstances and conditions, which method(s) of valuation and what tax rate to use. van schalkwyk et al. (1994) reported that a land tax may reduce land values, which in turn would affect the security value of land pledged against loans from financial institutions. no published peer-reviewed study in south africa, however, has estimated the economic impact of a land tax on commercial farms using actual accounting and economic data for specific individual farms. the aim of this study, therefore, is to estimate the potential impacts of a land tax on selected commercial farms in kwazulu-natal (kzn) using farm-specific annual data for the period 2001-2006. the study assesses how a land tax affects farm economic profit (the return to risk and land) that shows the ability of the farm to pay a land tax after accounting for the opportunity cost of resources other than land used on the farm. a residual income methodology (rim) is developed to estimate the annual and mean economic profit for five selected commercial farms in kzn within the mtonjaneni and umgeni municipal districts that have different farming enterprises. sensitivity analysis is then used to assess whether or not the annual economic profit can finance a range of land tax rates that these municipalities could apply to the market value of land and fixed improvements (the basis for valuing land in terms of the lgmpra (dplg, 2004a)). this range includes the annual rates of 1.5 per cent and 1 per cent, respectively, proposed by these two municipalities. the sensitivity analysis also accounts for potential land tax rebates as proposed by the dplg in the “generic rates policy format (grpf)” guidelines (dplg, 2004c). the paper is organised as follows: section 2 describes the key provisions of the new lgmpra, while section 3 summarises the grpf guidelines. section 4 outlines the economic effects of a land tax, and section 5 describes the study research methodology. section 6 presents the results of the five case studies. a concluding section discusses some management and policy implications of the results. 2 key provisions in the lgmpra no. 6 of 2004 the key provisions in the lgmpra for this study pertain to the criteria that municipalities must use to value and rate farm land. 2.1 designation of municipal valuers and method of property valuation before the date of property valuation every municipality must designate a person as a municipal valuer; this person may be a municipal official or a valuer who is in private practice. if the valuer is in private practice, the municipality must receive tenders for the intended valuation work so as to follow an open, competitive and transparent process as per chapter 11 of the municipal finance management act. the municipal valuer must determine a “market value” for all properties within that municipality and prepare a valuation role for these properties. market value is defined in section 46(1) of the lgmpra as “the amount the property would have realized if sold on the date of valuation in the open market by a willing seller to a willing buyer” (dplg, 2004c: 50). professional independent valuers must be persons registered as professional valuers or professional associated valuers in terms of the property valuers profession act, 2000 (act no. 47 of 2000) and know how to value properties which have not yet been sold using the “willing seller to a willing buyer” principle (dplg, 2004a: 2). section 46(1) of the lgmpra further states that “in determining the market value of a property used for agricultural purposes, the value of any annual crops or growing timber on the property that have not yet been harvested as at the date of valuation must be disregarded for purposes of valuing the property” (dplg, 2004a: 50). a valuation roll will remain valid for up to four financial years, after which it must be updated (dplg, 2004a: 40). 2.2 determination of the land tax rate the financial liabilities for municipal property rates are calculated by multiplying the market value of immovable property by a cent amount 374 sajems ns 11 (2008) no 3 in the rand that a municipal council has determined. this amount is supposed to be decided by that council taking into account public comments, submissions and inputs on the council’s draft rates policy and budget that is subjected to the process of community participation (dplg, 2004b: 2). the critical determinant of how much property owners will pay is the amount in rands that each municipal council will determine for various property categories. in addition, the lgmpra does not give the right to substantial increases in the total revenue needs of municipalities, nor does it set the cent amount in the rand. each municipality will apparently continue to set and collect property rates in an amount sufficient to meet its needs, taking into account the likely impact of rates on local economic development, ratepayers and their ability to pay such rates (dplg, 2004c: 3). in this regard, it must be noted that most of the developed countries that are south africa’s main trading partners tend to levy annual land taxes on farms at rates below 1 per cent, whereas local municipalities tend to have higher rates – for example the mtonjaneni and umgeni municipalities have proposed rates of 1.5 per cent and 1 per cent, respectively (darroch, 2003; barnsley, 2006; the witness, 2007). farmers in developed countries (except new zealand and australia) also receive higher levels of agricultural support from their governments than do most sa commercial farmers (apart from tariff protection afforded to several industries such as the sa sugar industry) (organisation for economic cooperation and development, 2006). the lgmpra contains what are intended to be checks and balances to protect property owners if a land tax rate levied by a municipality is materially and unreasonably prejudicing national economic policies, economic activities across municipal boundaries, and the national mobility of goods, services and capital. if the minister for provincial and local government is convinced by evidence to this effect, the minister must, in terms of section 16(2)(a) of the lgmpra, and after notifying the minister of finance, gazette a notice to the relevant municipality that the cent amount in the rand must be limited to the amount specified in the notice (dplg, 2004a: 28). commercial farmers will, therefore, have to provide such evidence if they want to appeal against the land tax rates levied by local municipalities. 2.3 compulsory phasing-in of certain rates s e c t i o n 2 1 o f t h e l g m p ra r e q u i r e s municipalities to “phase-in” land tax rates levied on newly rateable property over three financial years. this refers to any property on which property rates were not levied before the end of the financial year preceding the date on which the lgmpra took effect. the phasingin discount must be at least 75 per cent of the land tax rate in the first year that a municipality implements the lgmpra, at least 50 per cent in the second year, and at least 25 per cent in the third year. the full land tax rate then applies from the fourth year onwards (dplg, 2004a: 33-34). 2.4 property rate exemptions, reductions and rebates in addition to the mandatory prohibitions on rating described above, section 3(4) of the lgmpra enables municipalities to grant exemptions from, rebates on, and reductions in property rates based on local conditions and circumstances. owners of agricultural properties who are bona fide farmers qualify for such relief measures (see section 15(2)(f) of the lgmpra (dplg 2004a: 28)). the lgmpra does not specify the extent of these measures, but guidelines for setting rebates for the owners of agricultural land are proposed in the grpf. these guidelines are discussed in section 3 of this paper. a municipality also may not levy rates on a property belonging to a land reform beneficiary or his or her heirs for 10 years from the date on which such beneficiary’s title was registered (dplg, 2004a: 30). sajems ns 11 (2008) no 3 375 3 guidelines proposed by the dplg for land tax rebates for commercial farms section 3(4) of the lgmpra requires that a municipality must consider the following criteria in developing a policy for annual exemptions, rebates and reductions for properties used for agricultural purposes: (a) the extent of services it provides in respect of such properties; (b) the contribution of agriculture to the local economy; (c) the extent to which agriculture assists in meeting the municipality’s service delivery and development obligations; and (d) the contribution of agriculture to farm workers’ social and economic welfare. the guidelines for such criteria proposed in the grpf (dplg, 2004c) are outlined in the following three sections. 3.1 extent of municipal services provided to agricultural properties • 7.5 per cent rebate, if there are no municipal roads next to the property. • 7.5 per cent rebate, if there is no municipal sewerage to the property. • 7.5 per cent rebate, if there is no municipal electricity to the property. • 20 per cent rebate, if water is not supplied by the municipality. • 7.5 per cent rebate, if the municipality provides no refuse removal (dplg, 2004c: 11). 3.2 the contribution of agriculture to the local economy an annual rebate of up to 5 per cent is proposed if an agricultural property contributes substantially to job creation, and the salaries/ wages of its farm workers are reasonable, e.g., if they meet the minimum standards set by the government (minimum wage) or if they are in line with the industry average (dplg, 2004c: 12). 3.3 extent to which agriculture assists the municipality in meeting its service delivery and development obligations • 5 per cent rebate, if the owner is providing permanent residential property to the farm workers and such property is registered in the name of these farm workers; proof must be provided. • 5 per cent rebate, if such residential properties are provided with potable water. • 5 per cent rebate, if the farmer electrifies such residential properties of farm workers. • 5 per cent rebate, if the farmer is availing his land/buildings to be used for cemetery, education and recreational purposes of the farm workers’ children and nearby community in general, etc. (dplg, 2004c: 12). under the three sets of guidelines, a farmer that meets all of the proposed requirements would receive a maximum annual land tax rebate of 75 per cent. the rim for each of the five case study farms accounts for these proposed rebates where applicable. section 4 outlines the economic effects of a land tax on farm land as background for the rim. 4 outline of the economic effects of a land tax on farm land this section outlines the potential effects of a land tax on farm land rents and investment, the advantages and disadvantages of a land tax, and the concept of the capitalisation of a land tax. 4.1 effects of a land tax on farm land rents and investment nieuwoudt (1995, citing pasour (1975)) notes that a rural land tax on the improved value of land (in the long run) falls on new investment and as such will be a disincentive to future investment in land improvements. a land tax reduces current operating returns to land (cash rents), and thereby reduces the incentive to invest in new improvements. this is likely 376 sajems ns 11 (2008) no 3 to reduce future food production and export earnings, and increase food prices in the long run. a land tax is thus unlikely to bring idle land into use. other disadvantages of a land tax include: (a) administration is costly as all properties need to be appraised individually and regularly; (b) in practice it is almost impossible to exclude all improvements from the tax; (c) the tax is a flat rate tax and not progressive; and (d) the tax is the same in relatively higher income years and relatively lower income years during a given valuation cycle, although it may be possible to defer the tax and incur interest charges. the land tax is thus a fixed cost as it cannot be shifted and has to be paid by the farmer regardless of what is produced on the farm. against these disadvantages, the following are advantages of a land tax: (a) evasion and avoidance are not possible; (b) farmers need not keep records on costs and incomes as required for value added tax and income tax reporting; (c) it is a wealth tax; and (d) it may more effectively tax the wealthy landowner who with the assistance of tax experts can plan to avoid income taxes (lindholm, 1972; van schalkwyk et al., 1994; franzsen, 1995; nieuwoudt, 1995; olsen, 2004: 87). 4.2 capitalisation of a land tax pasour (1973; 1975) and barry et al. (2000) show that land taxes or increases in land taxes in the united states were capitalised (discounted) into lower farm land values. the current market value of farm land, v 0 , can be estimated by capitalising the expected annual real earnings from that land (cash rents), r 0 . if r 0 are expected to grow over time at a real rate of g per cent, v 0 is estimated by the constant growth model (if g is constant) as (barry et al., 2000): v 0 = r 0 (1 + g) / (i t – g) (4.1) where i t is the expected real interest rate. reworking equation (4.1) gives: (i t – g)/ (1 + g) = r 0 / v 0. (4.2) equation (4.2) implies that there is a constant ratio between r 0 and v 0 – a rise (fall) in r 0 causes a proportional rise (fall) in v 0 . nieuwoudt (1987: 10) and ortmann (1987: 295) both state that the long-run average rental rate of return for land in sa agriculture (r 0 /v 0 ) is about 5 per cent. rents show the true profits realised from land after considering all costs, including risk and management, where rent is the “payment made per unit of time to owners of property for the use of their land and buildings” (ortmann, 1987: 249). if a land tax of 1 per cent of v 0 is fully capitalised, r 0 after the land tax = 5 per cent – 1 per cent = 4 per cent, a drop of 20 per cent. a fall in r 0 from, say, 100 rand, to 80 rand, thus means that v 0 falls from 100/0.05 = 2000 rand to 80/0.05 = 1600 rand, or by 400/2000 = 20 per cent. land values are thus expected to fall by the same percentage as land rents if a land tax is fully capitalised into lower land values. full capitalisation, however, is unlikely as the supply of improved farmland is likely to be highly inelastic rather than perfectly inelastic in the long-run. the reason is that improvements such as draining, clearing, fencing, irrigation, new pastures, etc. take time to develop in response to higher expected rents. such changes are thus likely to be small relative to the total quantity of improved farmland available during any time period (pasour, 1975). this implies that a relatively small share of the land tax will be “shifted” to consumers in the form of higher prices due to less future investment in land improvements. in addition, if the proceeds from a land tax are used to improve municipal infrastructure, such as the upgrading of roads, r 0 and hence v 0 could rise, thereby partially offsetting the fall in net rent and v 0 caused by the land tax (pasour, 1973). the capitalisation of lower expected net rents into lower expected land values implies that the rim described in section 5.3 below must account for the negative impact of the land tax on rental returns to land. 5 research methodology this section describes the case study farms, study data collection and the rim framework. sajems ns 11 (2008) no 3 377 5.1 target commercial farms in kzn due to cost and time constraints, and the confidential nature of the required data, the selected commercial farms were drawn from farmers in the mtonjaneni and umgeni municipal districts of kzn that were prepared to provide the annual data required for the rim. the mtonjaneni municipal district office is based in melmoth in zululand, some 270 km north of pietermaritzburg, the capital city of kzn. the umgeni municipal district office is based in howick, which is about 35 km northwest of pietermaritzburg. the kzn province has a diverse commercial farming sector operating enterprises such as poultry, livestock, sugarcane, timber, vegetable, maize, and dairy (wikipedia, 2006). the five commercial farms used to develop the case studies in this paper differ in the main enterprises. case study 1 is an 816 hectare (ha) sugar cane and timber farm in the mtonjaneni municipal district. case study 2 describes an intensive poultry (egg) farm with some maize (170 ha in total area), while case study 3 is an intensive dairy farm on 434 ha. case study 4 applies to 239 ha of farm land that is leased out for intensive vegetable production, maize and grazing. case study 5 is a mixed enterprise farm producing maize, potatoes, sheep, cattle and poultry, spanning 374 ha. case study farms 2 to 5 are situated in the umgeni municipal district. these five farms were chosen as their owners were: (a) well-established (operating for over 10 years); (b) able to provide relevant, accurate and audited accounting data for the last five to six years; (c) willing to release confidential accounting and economic data; and (d) operating typical farm enterprises found in kzn. given that land reform beneficiaries receive a 10-year exemption from the payment of property rates, no “land reform” case study was analysed. 5.2 study data collection data were collected from each farmer using face-to-face interviews and a questionnaire designed to estimate the size of annual land tax rebates using the proposed dplg grpf guidelines discussed in section 3. the accounting data were drawn from the farm income and cash flow statements and balance sheets. these data were analysed using the rim described in section 5.3 to estimate the annual return to risk and land (a proxy for rent) for each farm during 2001-2006 if available. the market value of land and fixed improvements for each farm (including the homestead, and excluding the value of standing crops) was estimated by independent professional valuers who requested to remain anonymous and not be cited in this paper. these market valuations are listed in each municipality’s valuation roll and were conducted in accordance with the lgmpra definition of market value (see section 2.1) using the comparable sales method. the research questionnaire contained questions about the extent of municipal services received by the farm; job creation and wage levels on each farm, and services provided to staff; and the farmer/ land owner’s estimated opportunity cost of management (net revenue forgone from his/her next best occupation (olsen, 2004)). 5.3 empirical analysis using the rim framework meaningful conclusions about how to allocate resources need to be drawn from the expected economic, and not accounting, performance of farms (aggarwal, 2001). the rim is useful in this regard as it reduces revenue after accounting costs and income tax by a charge for the opportunity cost of management that is employed to produce the income. this yields an estimate of economic profit (hawawini et al., 2001: 11) that is a proxy for the current annual operating return to risk and land generated by a farming activity. economic profit gives farmers and policy makers a better understanding of whether a farm can afford different levels of annual land tax – a farm with a high accounting profit may not necessarily have a high economic profit. the rim in this paper is adapted from mepham (1980), kay & edwards (1999), and o’hanlon & peasnell (2004), as illustrated in appendix 1 for case study 1 (the rims for the other four case studies are not shown due to the word limitation on this paper, but are available from the authors on request). the rim first estimates annual nominal accounting 378 sajems ns 11 (2008) no 3 profit as farm revenue less fixed costs and variable costs, plus other receipts (if any), for each year during 2002-2006. under fixed costs, the annual depreciation charge is adjusted to current cost terms using the relevant machinery and implement index for each year (see sa department of agriculture (2006: 101)). this implies that the operational capacity of each case study farm is sustained by adequate provision of funds for the replacement of machinery and implements (faul et al., 1981). annual nominal accounting profit (loss) is then expressed in real terms after income tax using the sa consumer price index (cpi) with 2006 as base year (statistics sa, 2006) and income tax rates as reported by the sa revenue service (sars) (sars, 2006). deducting the real opportunity cost of management after income tax then gives an estimate of the annual real economic profit (return to risk and land). the opportunity cost or value of operator labour and management is what the operator (farmer) could receive in a non-farm job that requires similar labour and management skills (olsen, 2004: 209). if this opportunity cost component is ignored, annual farm profit will be overstated and this figure should then be interpreted as the “estimated return to management and profit” (kay & edwards, 1999: 168). in addition, if the opportunity cost of management is not covered (negative economic profit), the farmer would have an incentive to shift his resources out of the current farm enterprises into other uses (doll & orazem, 1984). to allow for uncertainty in obtaining off-farm employment, the opportunity cost of management after income tax in this paper is given by each farmer’s estimate of the real annual net income after income tax that he/she could earn in his/her best alternative non-farm job multiplied by his/her subjective estimate of the probability of actually securing that job. the annual real economic profit (return to risk and land) ignores any (non-cash) capital gains due to the appreciation (if any) in value of improved farm land – it estimates the current operating returns available to pay the land tax after all resources other than land have received payment. the annual real return to risk and land expressed as a percentage of the market value of land and fixed improvements as of 2006 gives the rate of return to risk and land. following barnard & nix (1979: 530), the mean annual real economic profit and rate of return to risk and land for each case study over several seasons (2001-2006 if available) is estimated to effectively compare farm financial results. sensitivity analysis is then used to assess whether or not the annual and mean returns to risk and land can fund different rates of annual land tax ranging from 0.25 per cent to 5 per cent (the latter being the estimated average annual rate of return to farm land in south africa (nieuwoudt, 1987; ortmann, 1987; darroch, 2003)). the sensitivity analysis also accounts for the effects of proposed annual land tax rebates under the grpf guidelines, and hence shows each farm’s ability to pay each land tax rate with and without the applicable rebate(s). for case studies 2 to 5, it also includes the effects of the 50 per cent rebate that has been proposed by the umgeni municipality (despite the grpg guidelines) for agricultural properties (lee, 2007). case study 1 in the mtonjaneni municipal district is subject to the three-year phasing-in period for the land tax, while case studies 2 to 5 in the umgeni municipality are no longer considered as “previously unrated land”, and do not qualify for phasing-in (barnsley, 2006). 6 results 6.1 case study 1 this sugarcane and timber farm (real market value of r7 500 000) qualifies for a 70 per cent land tax rebate (all grpf rebate guideline criteria except for providing permanent housing to farm workers are met). table 1 summarises key annual accounting and economic data, and table 2 shows the annual land tax due with and without the rebate for tax rates between 0.25 per cent and 5 per cent. table 3 tracks the land tax amount due over the three-year phasing-in period for the 1.5 per cent rate proposed by the mtonjaneni municipality. after four years with no rebate the annual land tax is r112 000, while a 70 per cent rebate reduces the annual land tax to r33 750. sajems ns 11 (2008) no 3 379 table 1 key measures: sugarcane and timber farm, mtonjaneni municipality, kzn (2006=100) measure 2006 2005 2004 2003 2002 mean nominal accounting profit (r) 1 218 115 170 790 496 989 1 169 107 1 025 108 816 022 real accounting profit before income tax (r) 1 218 115 178 838 537 867 1 283 323 1 190 602 881 748 real accounting profit (loss) after income tax (r) 773 869 134 924 352 744 792 201 708 279 552 403 real opportunity cost of management (r) 405 000 405 000 405 000 405 000 405 000 405 000 real economic profit (r) 368 869 –270 076 –52 256 387 201 303 279 147 403 return to risk and land (%)1 4.92% –3.60% –0.70% 5.16% 4.04% 1.96% 1note: return to risk and land (%) = real economic profit/real value of land and fixed improvements (r7 500 000). table 2 annual land tax with and without a rebate: sugarcane and timber farm, mtonjaneni municipality, kzn (2006=100) land tax rate 0.25% 0.5% 1% 1.5% 2% 3% 4% 5% amount payable (no rebate) (r) 18 750 37 500 75 000 112 500 150 000 225 000 300 000 375 000 amount payable (70% rebate) (r) 5 625 11 250 22 500 33 750 45 000 67 500 90 000 112 500 table 3 annual land tax over the four-year phasing-in period for a 1.5 per cent tax rate: sugarcane and timber farm, mtonjaneni municipality, kzn (2006 = 100) period with no rebate with a 70% rebate year 1: 75% reduction (r) 28 125 8 436 year 2: 50% reduction (r) 56 250 16 875 year 3: 25% reduction (r) 84375 25 213 year 4: full rate applies (r) 112 500 33 750 the five-year mean return to risk and land for case 1 implies that an annual land tax of 1.96% would, on average, tax away all economic profit. given the fluctuating five-year trend, estimated annual economic profit could probably finance the proposed 1.5 per cent annual land tax in two out of four years during the phasing-in period. in the long-term after the phasing-in period is over, estimated annual economic profit can meet all land tax scenarios from 0.25 per cent up to 4 per cent with no rebate, and 5 per cent with grpf rebate, in three out of five years. a land tax rate of 5 per cent with no rebate can only be met in one year (2003) when it will almost deplete real economic profit. 380 sajems ns 11 (2008) no 3 6.2 case study 2 table 4 gives key annual rim data for this intensive poultry (egg production) farm in the umgeni municipal district with a real market value of r8 232 000. table 5 summarises the annual land taxes that this farm would pay on this market value at rates from 0.25 per cent to 5 per cent, including the 1 per cent rate currently applied by the umgeni municipality (the witness, 2007). case study 2 also qualifies for a 70 per cent land tax rebate under the grpf guidelines (again there is no permanent housing for farm workers). table 4 key measures: intensive poultry farm (egg production), umgeni municipality, kzn (2006=100) measure 2006 2005 2004 2003 2002 mean nominal accounting profit (r) 1 995 217 780 664 1 496 271 708 478 518 905 1 099 907 real accounting profit before income tax (r) 1 995 217 817 449 1 619 341 777 693 602 677 1 162 475 real accounting profit (loss) after income tax (r) 1 240 130 524 451 1 001 547 488 823 314 735 713 937 real opportunity cost of management (r) 1 140 000 1 140 000 1 140 000 1 140 000 1 140 000 1 140 000 real economic profit (r) 100 130 –615 549 –138 453 –651 177 –825 265 –426 063 return to risk and land (%)2 1.22% –7.48% –1.68% –7.91% –10.03% –5.18% 2note: real economic profit/real value of land and fixed improvements (r8 232 000). table 5 annual land tax payable with and without a rebate: intensive poultry farm (egg production), umgeni municipality, kzn (2006=100) land tax rate 0.25% 0.5% 1% 2% 3% 4% 5% amount payable (no rebate) 20 580 41 160 82 320 164 640 246 960 329 280 411 600 amount payable (70% rebate) 6 174 12 348 24 696 49 392 74 088 131 712 123 480 amount payable (50% rebate) 10 290 20 580 41 160 82 320 123 480 164 640 205 800 land tax rates of between 0.25 per cent and 1 per cent with or without rebates could be funded from current operating returns only in one of the five years (2006). a land tax rate of 2 per cent with rebates could also be financed only in 2006, when it would cut the surplus available for new investment after paying the land tax to below 1 per cent of the market value of land and fixed improvements. a land tax rate of 3 per cent with a 70 per cent rebate gives similar results to the land tax rate of 2 per cent with rebates. 6.3 case study 3 table 6 and table 7 show the key annual accounting, economic and land tax data for this intensive dairy farm in the umgeni municipal district (market value of r8 178 00) that has a 70 per cent land tax rebate using the grpf criteria (again farm workers receive no permanent housing). annual land taxes at rates from 0.25 per cent to 2 per cent – all with and without the grpf or umgeni municipality rebates – could be financed from current operating returns only sajems ns 11 (2008) no 3 381 in two of the five years (2003 and 2004). payment of a 1 per cent annual land tax without rebates, or a 2 per cent annual land tax with the 50 per cent municipal rebate, in 2004 would have left a surplus for annual reinvestment of less than r1 000. the mean economic profit and return to risk and land for 2001-2005 were both positive, being r6 479 and 0.08 per cent, respectively. this suggests that an annual land tax rate of 1 per cent of the market value of land and fixed improvements would markedly reduce the incentive to invest in future improvements. table 6 key measures: intensive dairy farm, umgeni municipality, kzn (2006=100) measure 2005 2004 2003 2002 2001 mean nominal accounting profit (r) 460 732 774 047 1 660 214 417 591 11 278 664 772 real accounting profit before income tax (r) 482 442 837 713 1 822 408 485 007 14 294 728 373 real accounting profit (loss) after income tax (r) 323 465 532 558 1 115 645 299 004 11 721 456 479 real opportunity cost of management (r) 450 000 450 000 450 000 450 000 450 000 450 000 real economic profit (r) –126 535 82 558 665 645 –150 996 –438 279 6 479 return to risk and land (%)3 –1.55% 1.01% 8.14% –1.85% –5.36% 0.08% 3note: real economic profit/real value of land and fixed improvements (r8 178 000) table 7 annual land tax payable with and without a rebate: case study 3, umgeni municipality, kzn (2006=100) land tax rate 0.25% 0.5% 1% 2% 3% 4% 5% amount payable (no rebate) (r) 20 445 40 890 81 780 163 560 245 340 327 120 408 900 amount payable (70% rebate) (r) 6 134 12 267 24 534 49 068 73 602 98 136 122 670 amount payable (50% rebate) (r) 10 223 20 445 40 890 81 780 122 670 163 560 204 450 6.4 case study 4 key annual measures relating to the rental income earned by the lessor in case study 4 from leasing out 239ha of land worth r1 964 487 for vegetable and maize production and grazing are shown in table 8. this farm would qualify for a 65 per cent land tax rebate under the grpf criteria. case study 4 differs from the other four cases in estimating annual real economic profit, as the lessor receives cash rent (nominal economic profit) rather than accounting profit as annual income. the implicit assumption in this case study, therefore, is that the opportunity cost of management has been met, leaving nominal economic profit as the return to risk and land before income tax. land maintenance costs were subtracted from nominal economic profit before charging income tax to reflect the lessor’s tax-deductible expenditure in maintaining the leased land. real economic profit after income tax thus shows the equivalent estimated annual return to risk and land. 382 sajems ns 11 (2008) no 3 table 8 key measures: leased land, umgeni municipality, kzn (2006=100) measure 2006 2005 2004 2003 2002 mean nominal cash rent (economic profit) before income tax (r) 84 000 84 000 84 000 79 000 79 000 82 000 annual nominal maintenance costs (r) 17 000 15 350 16 000 14 350 12 750 15 090 real economic profit before income tax (r) 67 000 71 885 73 593 70 966 76 945 72 078 real economic profit (loss) after income tax (r) 54 940 58 946 60 066 57 932 57 172 57 811 return to risk and land (%)4 2.80% 3.00% 3.06% 2.95% 2.91% 2.94% 4note: real economic profit after income tax/real value of land and fixed improvements (r1 964 487). given the annual land taxes estimated in table 9, economic profit could fund rates from 0.25 per cent to 1 per cent with and without rebates in all five years during 2002-2006. however, the limited surplus available for reinvestment relative to the market value of land and fixed improvements at land tax rates of 2 per cent and greater, even with the 50 per cent rebate proposed by the umgeni municipality, would markedly reduce the incentive to make further capital improvements on this farm land. table 9 annual land tax payable with and without a rebate: leased land, umgeni municipality, kzn (2006=100) land tax rate 0.25% 0.5% 1% 2% 3% 4% 5% amount payable (no rebate) (r) 4 911 9 822 19 645 39 290 58 935 78 579 98 224 amount payable (65% rebate) (r) 1 719 3 438 6 876 13 751 20 627 27 503 34 379 amount payable (50% rebate) (r) 2 456 4 911 9 822 19 645 29 467 39 290 49 112 6.5 case study 5 this mixed enterprise farm with an estimated real market value of r3 597 000 qualifies for a 70 per cent land tax rebate using the grpf guidelines (again no permanent housing is provided). tables 10 and 11 summarise the relevant annual accounting, economic and land tax data. case study 5 could not pay any level of annual land tax out of annual current operating returns during 2002-2006. the negative mean annual rate of return to risk and land (-8.50 per cent) implies that the land tax would further worsen this farm’s already weak liquidity position. sajems ns 11 (2008) no 3 383 table 10 key measures: mixed enterprise farm, umgeni municipality, kzn, (2006=100) measure 2006 2005 2004 2003 2002 mean nominal accounting profit (r) 371 917 –169 792 –196 786 226 080 –149 675 16 349 real accounting profit before income tax (r) 371 917 –177 792 –212 972 248 167 –173 838 11 096 real accounting profit (loss) after income tax (r) 265 589 –177 792 –212 972 171 100 –173 838 –25 583 real opportunity cost of management (r) 280 000 280 000 280 000 280 000 280 000 280 000 real economic profit (r) –14 411 –457 792 –492 972 –108 900 –453 838 –305 583 return to risk and land (%)5 –0.40% –12.731% –13.71% –3.03% –12.62% –8.50% 5 note: real economic profit/real value of land and fixed improvements (r3 597 000). table 11 annual land tax payable with and without a rebate: mixed enterprise farm, umgeni municipality, kzn (2006=100) land tax rate 0.25% 0.5% 1% 2% 3% 4% 5% amount payable (no rebate) (r) 8 993 17 985 35 970 71 940 107 910 143 880 179 850 amount payable (70% rebate) (r) 2 698 5 396 10 791 21 582 32 373 43 164 53 955 amount payable (50% rebate) (r) 4 497 8 993 17 985 35 970 53 955 71 940 89 925 6.6 summary of results the estimated mean annual rate of return to risk and land (real economic profit (loss) excluding capital gains, divided by the real market value of land and fixed improvements) for the five case study farms during 2001-2006 ranged from –8.50 per cent to 2.94 per cent, with an average of –1.740 per cent. the five case study farms’ ability to pay annual land taxes of between 0.25 per cent and 1 per cent of the value of improved land with and without proposed grpf rebates from annual current operating returns ranged from zero to five out of five years, with an average of two out of five years. a land tax rate of 2 per cent with such rebates could be financed using current operating returns also only in two out of five years on average. these results suggest that annual land taxes on the market value of land and fixed improvements at rates of 1.5 per cent or 1 per cent proposed by the municipalities concerned would markedly reduce the incentive to make future capital investments on these specific farms. 7 conclusions using the rim framework, study results show that an annual land tax at the proposed rate of 1.5 per cent on the market value of improved land for case study 1 in the mtonjaneni municipality could only be financed by current 384 sajems ns 11 (2008) no 3 operating returns with or without the proposed grpf rebates in three out of five years. for case studies 2 to 5 in the umgeni municipality, only one farm could, on average, pay the proposed annual rate of 1 per cent with or without rebates out of current operating returns during 20012006. these findings, together with the case study farms’ inability to also consistently pay these proposed annual rates or lower annual rates of 0.25 per cent over a five-year period, raise concerns about the negative impact of such rates on future investment in farm improvements, and hence, food production and prices. given that annual land tax rates in the countries that are south africa’s major trading partners tend to be less than 1 per cent, and that most of these countries give considerably more support to agriculture, land tax rates over 1 per cent in south africa will likely further reduce the competitiveness of the sa agricultural sector. study results relate to five case study farms that, while operating typical farm enterprises found in kzn, are not a statistically representative sample of commercial farms in kzn. further research is, therefore, needed in kzn and other sa provinces to estimate how different annual rates of land tax will affect the economic performance of farms in other areas to assess whether rates above 1 per cent can be met from current operating returns without markedly reducing investment in capital improvements. another policy issue raised by this study is the extent to which sa municipalities will adopt the dplg grpf guidelines on land tax rebates for commercial farms. these guidelines are not binding on municipalities, and at the time of writing, the mtonjaneni municipality had offered no rebate, while the umgeni municipality had proposed a flat rate of 50 per cent on all farm properties (despite this study showing that the four farms in the umgeni municipality would qualify for rebates of between 65 per cent and 70 per cent under the grpf criteria). given the lack of published peer-reviewed studies on how these guidelines will affect sa commercial farmers, it is critical that accurate information on the contribution of agriculture in individual municipalities be compiled. this will help municipal representatives to better assess the costs and benefits of different land tax rates and hence set affordable rates that will generate revenue without compromising future investments in farm improvements and the role of agriculture in the local economy. this paper also highlights the need to assess the impact of land taxes on sa farms on a caseby-case, municipality-by-municipality basis, using data that are specific to individual farms. key determinants will be the estimated market value of improved farm land, the rate randage, the extent of land tax rebates, the phasing-in period (if any) and the estimated annual current operating returns to farm land over several years. more research is needed to assess whether or not the costs that local municipalities will incur to implement land taxes (the value of rebates plus land valuation and administration costs) will be less than the revenue that they receive from these taxes. further research could also focus on how a rural land tax may affect land use patterns and investments by commercial farmers in items such as labour training and fire control that currently reduce the costs incurred by municipalities to provide such services. acknowledgements the authors would like to thank the national research foundation (nrf), south africa for financing this study under the grant programme “ e c o n o m i c g r o w t h a n d i n t e r n a t i o n a l competitiveness” (gun 2054254). the authors also thank two anonymous reviewers for their very useful comments that have improved this paper. all conclusions and recommendations expressed in this paper are those of the authors and are not to be attributed to the nrf or to the two anonymous reviewers. references 1 aggarwal, r. 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(1984) production economics: theory with applications (2nd ed.) wiley: new york. 7 department: provincial and local government (dplg) (2004a) “local government: municipal property rates act no. 6 of 2004”, department: provincial and local government, republic of south africa. http://dplg. gov.za [accessed on 30 may 2006]. 8 department: provincial and local government (dplg) (2004b) “guidelines on valuations for municipalities”, department: provincial and local government, republic of south africa. http://dplg.gov.za [accessed on 30 may 2006]. 9 department: provincial and local government (dplg) (2004c) “generic rates policy format”, department: provincial and local government, republic of south africa. http://dplg. gov.za [accessed on 30 may 2006]. 10 faul, m.a.; everingham, g.k.; redelinghuys, h.f. & van vuuren, l.m. (1981) financial accounting, butterworth: pretoria. 11 franzsen, r.c.d. (1995) “viability of a rural land tax in south africa”, property management, 13(3): 21-42. 12 franzsen, r.c.d. (2000) “local government and property tax reform in south africa”, http:// www.lincolninst.edu/pubs/pub-detail.asp?id=299 [accessed on 13 july 2006]. 13 hawawini, g.; subramanian, v. & verdin, p. (2001) “is performance driven by industryor firm-specific factors?”, working paper, insead business school, fontainebleau, france. 14 kay, r.d. & edwards, w.m. (1999) farm management (4th ed.) mcgraw-hill: new york. 15 lee, c.r. (2007) personal communication, legal representative for the kwazulu-natal agricultural union, dargle, south africa. 16 lindholm, r.w. (1972) “twenty-one land value taxation questions and answers”, the american journal of economics and sociology, 31(2):153-164. 17 mepham, m.j. (1980) “the residual income debate”, journal of business finance & accounting, 7(2): 183-199. 18 nieuwoudt, w.l. (1990) “efficiency of land use”, agrekon, 29(4): 210-214. 19 nieuwoudt, w.l. (1995) “the impact of a land tax on future investments: a note”, the south african journal of economics, 63(1): 85-90. 20 o’hanlon, j. & peasnell, k. (2004) “residual income valuation: are inflation adjustments necessary?”, review of accounting studies, 9: 375-398. 21 olsen, k.d. (2004) farm management: principles and strategies iowa state press: iowa, united states of america. 22 organization for economic cooperation and development (oecd) (2006) agricultural policies in oecd countries at a glance: 2006 food, agriculture and fisheries directorate, organization for cooperation and development: paris, france. 23 ortmann, g.f. (1987) “land rents and production costs in the south african sugar industry”, the south african journal of economics, 55(3): 249-258. 24 pasour, e.c. (1973) “real property taxes and farm real estate values in north carolina”, american journal of agricultural economics, 55: 549-556. 25 pasour, e.c. (1975) “the capitalization of real property taxes levied on farm real estate”, american journal of agricultural economics, 57: 389-397. 26 south african department of agriculture (2006) “price indices of machinery, trucks and implements”, http://www. nda.agric.za [accessed on 8 march 2007]. 27 south african government gazette (2005) gazette no. 27720, government printer: pretoria. 28 south african revenue service (2006) “income tax tables 2001-2006”, http://sars. co.za [accessed on 5 march 2007]. 29 statistics sa (2006) “the consumer price index and annual inflation rate on a monthly basis”, http://statssa.co.za.com [accessed on 23 november 2006]. 30 the witness (2007) “umgeni lowers rates randage”, the witness 2 june 2007: 4. 31 van schalkwyk, h.d.; van rooyen, c.j. & jooste, a. (1994) “possible effects of an agricultural land tax in south africa”, agrekon, 33(4): 206-211. 32 wikipedia (2006) “kwazulu-natal”, http:// en.wikipedia.org/wiki/kwazulu-natal [accessed on 10 november 2006] 386 sajems ns 11 (2008) no 3 a p p en d ix 1 r im a na ly si s: s u ga rc an e an d ti m be r fa rm in t he m to nj an en i m u ni ci pa lit y, k z n ( 20 02 -2 00 6) , ( 20 06 = 10 0) ye ar 20 06 20 05 20 04 20 03 20 02 r ea l m ea n r r r r r r ev en u e 9 99 1 60 6 8 35 2 39 8 9 86 1 73 9 8 24 6 88 1 6 64 1 93 1 c an e sa le s 5 94 9 03 9 4 91 4 98 3 6 20 0 18 7 6 06 0 05 2 4 73 4 21 5 m ar gi na l m ill in g pr of it s 62 2 76 6 59 8 12 6 1 05 8 05 7 1 04 3 37 3 83 2 15 2 ti m be r sa le s 3 31 4 11 1 2 71 6 85 4 2 57 5 03 9 1 14 3 45 6 1 07 5 56 4 c on tr ac ti ng in co m e 1 51 3 12 2 45 3 28 4 56 0 0 se ed in co m e 10 4 17 7 0 0 0 0 a d d : o th er r ev en u e 99 7 37 0 64 6 88 2 99 9 52 5 98 0 00 0 54 5 95 r en ta l 96 5 39 8 57 7 49 9 98 1 30 0 98 0 00 0 53 3 75 in su ra nc e re ce iv ed 31 9 72 69 3 83 18 2 25 0 1 22 0 le ss : va ri ab le c o st s 10 0 71 5 73 9 16 0 86 3 10 2 54 3 88 7 95 6 11 5 5 56 7 24 0 b us in es s ru nn in g co st s 1 36 5 42 5 1 01 3 59 8 1 56 4 96 5 1 83 4 23 5 90 7 56 4 o th er v ar ia bl e co st s 1 30 5 36 8 1 49 7 30 1 1 29 2 19 5 46 3 83 4 1 00 0 10 5 c on tr ac ti ng c ha rg es 2 49 0 95 5 2 37 6 58 1 1 98 2 39 1 2 30 0 46 3 1 62 4 43 0 fe rt ili ze r 57 5 07 2 33 5 03 9 48 2 82 1 1 08 6 40 0 45 0 17 0 r en t pa id 95 0 00 0 90 0 00 0 67 2 00 0 0 0 se ed 31 4 80 51 2 89 10 7 37 7 23 0 12 0 tr an sp or t & lo ad in g 1 72 9 30 1 1 62 4 72 2 2 25 9 59 4 1 63 9 65 8 1 16 6 38 9 c he m ic al s 65 2 15 5 42 6 82 6 64 6 70 4 22 5 04 8 23 7 10 5 r ep ai rs & m ai nt en an ce 97 1 81 7 93 5 50 7 1 24 6 34 1 38 3 46 5 18 1 47 7 sajems ns 11 (2008) no 3 387 le ss : fi xe d c o st s d ep re ci at io n pl an t & e qu ip m en t 28 3 03 9 27 4 68 9 19 6 06 3 12 4 45 8 11 9 31 1 a d d : o th er r ec ei p ts in te re st r ec ei ve d 58 3 75 1 60 7 06 2 86 1 76 22 7 99 15 1 33 a cc o u n ti n g p ro fi t n om in al a cc ou nt in g pr of it 1 21 8 11 5 17 0 79 0 49 6 98 9 1 16 9 10 7 1 02 5 10 8 81 6 02 2 r ea l a cc ou nt in g pr of it b ef or e in co m e ta x 1 21 8 11 5 17 8 83 8 53 7 86 7 1 28 3 32 3 1 19 0 60 2 88 1 74 8 r ea l a cc ou nt in g pr of it a ft er in co m e ta x 77 3 86 9 13 4 92 4 35 2 74 4 79 2 20 1 70 8 27 9 55 2 40 3 le ss : o p p o rt u n it y co st s r ea l o pp or tu ni ty c os t of m an ag em en t a 40 5 00 0 40 5 00 0 40 5 00 0 40 5 00 0 40 5 00 0 40 5 00 0 r et u rn t o r is k an d l an d ( ec o n o m ic p ro fi t) 36 8 86 9 -2 70 0 76 -5 2 25 6 38 7 20 1 30 3 27 9 14 7 40 3 a n ot e: r ea l o pp or tu ni ty c os t of m an ag em en t = e st im at ed a nn ua l r ea l a ft er -t ax in co m e in n ex t be st li ne o f w or k m ul ti pl ie d by t he f ar m er ’s s ub je ct iv e es ti m at e of t he p ro ba bi lit y th at h e/ sh e w ill s ec ur e th at jo b. 388 sajems ns 11 (2008) no 3 call for papers: sa journal of economic and management studies (sajems)� special issue: new frontiers in strategy guest editor johan hough (jhough@sun.ac.za) university of stellenbosch co-editor: ernst neuland (mwneulnd@mweb.co.za) institute for business innovation co-editor: marius pretorius (marius.pretorius@up.ac.za) university of pretoria co-editor: paul sulcas (psulcas@gsb.uct.ac.za) university of cape town submission deadline: september 15, 2008 a central focus of strategic management research and practice has been the development of concepts, models and tools to guide effective market-based, competitive strategies. today, however, strategists face mounting external pressures from increasingly mobile, influential, new media savvy and demanding stakeholders. these increasingly diverse and changing groups of stakeholders are having a greater impact on competitive and corporate level strategies and on the practices of strategic management. these influences no longer are localized in their impact. they are felt on national, regional and global levels. consequently, on-market strategies are being employed in an ever widening circle of market settings: agriculture, airlines, autos, bio-tech, chemicals, food processing, e-commerce, entertainment, natural resources, pharmaceuticals, retail, etc. trends of globalization of capital flows are increasingly expanding the influence of non-financial stakeholders (e.g., political, social, regulatory, legal) over company policy. these stakeholders also affect and shape performance expectations. in large public corporations, strategic plans are increasingly developed for consumption by non-market forces where the strategy discourse reflects non-market considerations. the time is ripe for an open and critical debate about the impact of strategies on strategic actions, competitiveness and performance. types of papers for this sajems special issue this special issue aims at providing an opportunity for debate on the above-mentioned and related topics. we invite papers, including case studies, with different theoretical concepts, frameworks and methodologies, both empirical and theory-building. as this topic lies at the intersection of several subject domains, papers can draw from several fields, such as strategy, innovation, international business, and technology. aspects of the phenomenon can also encompass other areas such as entrepreneurship, operations research, marketing, finance, hr and organisational behaviour. examples of sub topics that may be included in this sajems special issue this special issue seeks to explore themes such as the ones shown below. the list below is not meant to be exhaustive, and authors are welcome to contribute papers with other perspectives as well. • how can operational performance and benchmarking add to strategy implementation and competitiveness? • how to implement blue ocean strategies through effective leadership and teamwork • how can companies create and capture new markets by using strategic maps and other implementation tools? 1 sajems is an isi accredited journal sajems ns 11 (2008) no 3 389 • why are companies considering the off-shoring and/or outsourcing of core functions that comprise a firm’s competitive advantage? • what role do emerging markets like south africa, india, brazil, china, etc and/or emerging market firms play in the global outsourcing/off-shoring phenomenon? • what precautionary mechanisms are being put into place to protect proprietary knowledge and capabilities of the firm to prevent the loss of future competitiveness? • what is the role of global mergers and acquisitions and strategic alliances to ensure sustainable competitiveness? • business ethics and corporate governance as part of organisational strategy • strategic planning in knowledge-based industries and ventures • ownership, management and operational issues in family businesses • issues of particular significance to the future of south africa including bbbee, hiv/aids, sme’s, triple bottom line guidelines and timeline for this sajems special issue all manuscripts should be prepared according to sajems “instructions to authors” (see appendix for these instructions). please submit manuscripts (not under review elsewhere) in electronic msword format to sajems@up.ac.za. deadline for papers for this sajems special issue: september 29, 2008 decision on acceptances for this sajems special issue: march 15, 2009 microsoft word 7 bussin sajems 18(2) 2015.docx 232 sajems ns 18 (2015) no 2:232-244 how to cite doi: http://dx.doi.org/10.17159/2222-3436/2015/v18n2a7 ceo pay-performance sensitivity in the south african context mark bussin department of industrial psychology and human resource management, university of johannesburg accepted: october 2014 the topic of executive pay-performance sensitivity has resulted in mixed research findings. literature related to executive remuneration constructs, company performance measures and the underlying theories is critically reviewed in this article. the literature is compared to research findings within the south african context pre, during and post the global financial crisis of 2008. the researcher found similar results in the south african context compared to research in other countries and industries. the research challenges the notion that there is one dominant theory driving ceo compensation. the principal-agent theory, supported by the optimal contract theory, are foremost during periods of strong economic performance, while the influence of managerial power and other behavioural theories appear to prevail during periods of weak economic performance. this article proposes some critical considerations in order to manage this tension. key words: ceo remuneration, compensation, pay-performance sensitivity, principal-agent theory, company performance, optimum contracting, governance, south africa jel: l1, 2, j3, g2, 3 1 introduction and literature review 1.1 context in 2008 the financial services industry went into a liquidity crisis; lehman brothers and bear stearns were decimated, while other banks received government bail-outs. bebchuk, cohen & spamann (2010) indicated that executives in the financial services industry, and in particular at bear sterns and lehman brothers, were well compensated despite the risks that eventually led to the downfall of both companies and the global recession that ensued. the south african retail sector was also hard hit from the onset of the financial crisis of 2008. englund and macdonald (2008) reported that retail sales in september of 2008 declined by 1.2 per cent. it has been widely argued that executive remuneration policies were partly responsible for the dramatic collapse in market capitalisation of the united states (us) banks and subsequent global economic crisis (haldane, 2011; fahlenbrach & stultz, 2011; bebchuk & spamann, 2010). the structure of executive remuneration at banks where incentives for taking excessive risks are provided, has been an issue of concern for a number of years (bebchuk & spamann, 2010). the role that incentive remuneration played in causing the financial crisis is evident in the significant corporate governance and regulatory changes that have occurred since the economic recession of 2008. former imf chief economist, raghuram rajan (2005), tabled a controversial paper suggesting that compensation practices in the financial sector were creating significant risks for the global financial system. he stated that executives in the financial sector received substantial incentive pay-outs despite engaging in business practices that eroded company performance, threatened company sustainability and the entire financial system in the long-term. the argument was built on the sentiment that there is a weak pay-performance relationship which had allowed risky business practices to occur. on 28 april 2013 business times published an article called ‘bang goes bank boss pay’ (sunday times, 2013). the article gave an indication of how south african banks have taken to heart threats in the united kingdom (uk) and the us to impose a cap on bankers’ abstract sajems ns 18 (2015) no 2:232-244 233 salaries, slashing their ceo’s packages. the article also indicated however, that some organisations have not shown similar restraint, paying large salary increases despite poor company performance. based on the differing outcomes regarding ceo’s salaries, it is evident that there is a challenge in finding a balance between remuneration that will attract and retain ceos but not over pay them, especially when company performance is not favourable. 1.2 executive remuneration theory executive remuneration is a broad field. this article focuses on ceo remuneration. a number of prominent academics tosi and gomez-mejia (1994), yanadori and milkovich (2002) and edmans and gabaix (2009) narrowed the focus of executive compensation to that of the ceo. the ceo plays a pivotal role in managing company resources, within the context of a continually changing external environment in order to create value for the shareholders. a great number of academic researchers have investigated the relationship between ceo remuneration and company performance while considering principal-agent relationship as the primary basis. principal-agent theory the principal-agent relationship arises when the individual who owns an organisation is not the same as the individual appointed to manage or control it. the separation of ownership and control leads to two distinct set of actors. ‘the principal’ is a shareholder in the corporation and ‘the agent’ acts as a manager for the principal. agents are often viewed as utility maximisers and if they are not monitored, they place their own interests above those of the principal whom they serve (hope & thomas, 2008). this is counter the shareholders’ desire for profit maximisation (o’reilly & main, 2010). the principal-agent conflict is further exacerbated by the fact that the various actors experience differing levels of risk. it is unlikely that the ceo will ever experience the same risk as shareholders without pledging his or her own capital; and shareholders typically employ agents so that they can focus on running the business from a pragmatic perspective, free of the emotional burden that investor risk creates. according to the agency framework, ceo remuneration is an efficient means of aligning executive interests more closely with those of shareholders through a remuneration contract that rewards superior company performance (jensen & meckling, 1976). corporate governance mechanisms are also utilised to ensure that the interest of both the principal and agent are aligned. according to mcknight and weir (2009), corporate governance mechanisms are used to “realign the interests of agents and principals and so reduce agency costs”. much criticism has been levelled at companies and their remuneration committees for the increases in ceo compensation in the face of disappointing financial results. ozkan (2007) stated that it is widely felt that the link (correlation) between executive remuneration and company performance is not strong enough, meaning that executives receive their remunerations regardless of the results of their respective organisations. the amount of legislation dealing with executive remuneration has thus increased in terms of requiring remuneration contracts that reward superior organisation performance (morrissey, 2009). the corporate governance and disclosure requirements, that are currently applicable in south africa through the implementation of the companies act (2008) and king code and report on governance in south africa (king iii) (institute of directors southern africa, 2009), have given a clear indication that there is a need to ensure that executive remuneration is linked to company performance. optimal contracting theory the need for greater alignment has given rise to an optimal contracting theory which focuses on aligning both managers’ and shareholders’ interests through the use of financial incentives (jensen & meckling, 1976). the literature suggests that pay-performance sensitivity is dependent on achieving an optimal contract and deviations from an optimal contract result in weak payperformance sensitivity. edmans and gabaix (2009) proposed that optimal contracts should “attract talented ceos and incentivise them to exert effort, exploit growth opportunities and reject 234 sajems ns 18 (2015) no 2:232-244 wasteful projects, while minimising the cost of doing so”. optimal contracting is accepted as a key approach to remedying the fundamental agency problem afflicting management decision-making. advocates of the optimal contract theory seek to achieve greater pay-performance sensitivity. managerial power theory there are also alternate theories that have been proposed regarding the drivers of executive compensation. gabaix and landier (2008) proposed labour market considerations and the lack of suitably-skilled ceos as undermining factors in the determination of ceo compensation. the dominant response to the optimal contracting theory has been that of the managerial power theory. managerial power theory suggests that rather than serving the shareholders’ interests, boards are ‘captured’ by the ceo and made to serve his or her interests (o’reilly & main, 2010). cheng and indjejikian (2009) supported the managerial power issue, indicating that ceos have strong negotiation power with their boards. similarly, bebchuk and fried (2004) provided a compelling argument for behavioural considerations indicating that managerial power plays a perverse role in the determination of ceo compensation. managerial power is thus both a potential instrument for addressing the principal-agent theory and a part of the problem itself (bebchuk & fried, 2003). it is suggested that ceos have influenced remuneration committees to increase fixed-pay (despite poor company performance) in order to compensate for the loss of shortand long-term incentive pay-outs (frydman & jenter, 2010). through managerial power, ceos are able to influence boards and compensation committees and thus influence the structure of their remuneration packages (doscher & friedl, 2011). the extent to which an organisation can develop a remuneration structure that links remuneration outcomes to measures of company performance, remains a key management challenge. remuneration structures and -policies have been subject to challenges in the form of behaviourist complications. research done into the factors driving changes in remuneration policies in south africa, showed that financial results of the company, governance and merit pay are key factors that are receiving closer attention; reflecting a greater shareholder expectation that pay should be linked to performance (bussin & huysamen, 2003; bussin & satram, 2012). 1.3 remuneration constructs a remuneration package has various levels: salary; annual bonus and longand shortterm performance incentives (frydman & jenter, 2010). the financial reward system can be segmented as follows (21st century pay solutions group, 2010): figure 1 total reward   source: 21st century pay solutions group (2010) sajems ns 18 (2015) no 2:232-244 235 well-designed incentives or variable packages should be linked to the financial performance of the company, however the issue of guaranteed cost to company (ctc) pay solutions for ceos, warrants further investigation (hoi & robin, 2004). the remuneration concept has various constructs (ellig, 2007): • ‘salary’: guaranteed pay that the executive will receive which is normally a risk-free monthly payment. • ‘benefits and perquisites’: constructs such as health care, survivor protection and retirement funds. • ‘short-term incentives’: cash payments for achieving of short-term and standard annual goals and objectives. • ‘long-term incentives’: multi-yearly and could include equity-based payments. further definitions (21st century pay solutions, 2010): • ‘fixed-pay’: salary and benefits, all guaranteed components of the remuneration package. • ‘total remuneration’ or ‘total cost of employment’: fixed-pay and short-term incentives. • ‘total earnings’ or ‘total cost to company’ (ctc): fixed-pay and all incentives. compensation models developed by consultants including worldatwork (2011), mercer, towers perrin, and academics like armstrong and brown (2006) indicate that the main components of ceo compensation include fixed pay, short-term incentives and long-term incentives. the most common determinants for executive pay are organisation size; organisation performance; executive-specific factors; organisation structure; job or position-specific factors and job complexity (bussin, 2011). ellig (2007) argues that the structure of an executive’s remuneration package will follow the path where it is the easiest for the executive to earn. should short-term incentives be difficult to obtain due to factors outside the control of the ceo, the structure of the remuneration would lean towards a guaranteed ctc or fixed-pay. the inverse is also true, that should short-term incentives be easier to obtain the structure of remuneration will gravitate towards higher incentive pay. the global trend is to cut or suspend short-term, long-term and incentive bonuses. the south african trend for upperand middle-management mirrors this showing the trimming of benefits and bonuses (bussin, makhubela & quail, 2009). this highlights the need to better understand the guaranteed ctc of ceos and how this is aligned to the determinants of executive remuneration structure. 1.4 company performance measures according to frydman and jenter (2010), a remuneration package of an executive has various levels which consists of basic salary, annual bonus, short-term and long-term performance incentives. similarly, organisation performance can be operationalized in many different ways, accounting-based measures and market-based measures (attaway, 2000). fatemi, desai & katz (2003) argue that such measures do not account for the risk incurred by the organisation’s executive in their search for growth and profitability; suggesting two additional measures, namely economic value added (eva) and market value added (mva). according to the economic theories of remuneration, company performance should affect an executive's remuneration only to the extent that it serves as a proxy for unobservable managerial effort or productivity. although these theories uniformly suggest a relationship between compensation and observed performance, most analyses are not in agreement with regard to the measure of company performance. in the empirical compensation literature there is no consensus on the optimal measure of company performance as researchers have operationalised organisation performance in many different ways (bacidore, boquist, milbourn, thakor, 1997; attaway, 2000; eriksson & lausten, 2000; carpenter & sanders, 2002; fatemi et al., 2003). therefore, measures of company performance can be divided into three main categories: absolute financial performance measures (audited measures within a specific year), financial performance ratios (ratios derived from absolute performance measures) and market performance measures (performance within equity markets). 236 sajems ns 18 (2015) no 2:232-244 general observations with regard to previous studies by researchers on the pay-for-performance link used different company performance measures and usually highlight the advantages in their chosen company performance measures and disadvantage in the company performance measures not chosen. for example, the study by murphy (1985) argues that company performance should be measured by market-based measures because they reflect shareholders’ wealth while pointing out few weaknesses in considering accounting-based measures, e.g. accounting-based measures are considered to be either backward looking or there is danger of these measures being manipulated by executives to make themselves look good. in terms of accounting-based company performance measures, the following are some of the practices executives commonly use to manipulate indicators: manipulating depreciation policy (accelerated versus straight-lie); changing inventory valuation procedures; using short-term, noncapitalised leases to obtain productive equipment; and using window dressing techniques such as holding borrowed money as cash until the end of an organisation’s financial year to make sure that the organisation’s balance sheet looks favourable. the health & racquet, enron and worldcom scandals are some of the few examples in manipulating accounting-based measures. to the contrary, carpenter and sanders (2002) contend that accounting-based measures are more informative of the managerial contribution than market-based measures because they are less affected by the noise of the market. research studies in support of accounting-based measures include those done by madura, martin & jessell (1996) which points out that there are shortcomings with stock prices as a measure of company performance because stock prices tend to move with the market, which can hide the difference in cross sectional performance over a given period. since company shareholders are generally considered to be the principals in agency theories, it may seem appropriate to define company performance in terms of market-based measures rather than accounting-based measures. in this proposal the market will provide a source of information for shareholders that is ‘independent’ of the company and its agents. additionally, as accounting standards around the world are continually being tightened it is suggested that the opportunity to manipulate accounting-based measures will continue to be reduced over time. as a result, researchers like eriksson and lausten (2000) conclude that they do not see the use of accountingbased measures in the form of accounting profits as a company performance measure, as any great disadvantage to their analysis. company market-based performance measures include stockholders equity, stock performance (return on common stock and changes in market value). accountingbased measures include profitability (earnings per share, return on investment, and total profits). the marketand accounting-based company performance measure examples illustrate that by their very different nature, the weak association between these two types of measures is not unexpected. a 2010 study by gentry and shen (2010) investigated the relationship between accounting and market measures of company performance. using financial data from all publicly traded firms in the compustat from 1961 to 2008 they found that although measures of accounting profitability and market performance correlate positively across industries, their covariance is less than 10 per cent and provides no evidence of convergence. both company performance measures are valid estimators but from different perspectives; accounting-based measures capture historical performance while market-based measures capture future performance. in addition, in order to avoid potential biases inherent in using either market-based or accounting-based company performance measures, researchers like canarella and gasparyan (2008) suggest using both accountingand market-based measures in establishing the closest link between the ceo remuneration and company financial performance. other research studies have indicated that measures based on accounting or the market may bear little resemblance to the economic return earned by the organisation since, for example, accounting-based measures, do not account for the risk incurred by the organisation’s executives in their search for growth and profitability (bacidore et al., 1997; kyriazis and anastassis, 2007; fatemi et al., 2003). as a result, these research studies have suggested two additional measures into investigating the relationship between executive remuneration and risk-adjusted organisation performance measures, namely economic value added (eva) and market value added (mva). sajems ns 18 (2015) no 2:232-244 237 economic value added (eva) measure was devised by stern stewart & co. a worldwide management consulting firm founded in new york in 1982 (stewart, 1990). economic value added is a performance measure that attempts to measure and capture the true economic profit of an organisation by providing a measurement of an organisation's economic success (or failure) over a period of time (ward & price, 2006). market value added (mva), on the other hand, is simply the difference between the current total market value of an organisation and the capital contributed by shareholders. market value added (mva) is not a performance metric like economic value added (eva), but a wealth metric instead, which measures the level of value an organisation has accumulated over time. chari (2009) did a comprehensive literature review on different performance measures used by organisations, focusing on a comparison between eva and other performance measures. the research study by chari (2009) verified the soundness of claims made by proponents of eva, that eva was superior to other metrics as it is the financial performance measure that comes closer than any other measure in capturing the true economic profit of an organisation which helps executives make better decisions and motivates them to perform better. according to stewart (1990), “eva stands well out from the crowd as the single best measure of wealth creation on a contemporaneous basis and is almost 50 per cent better than its closest accounting-based competitor (including earnings-per-share (eps), return-on-equity (roe) and return-on-investment (roi) in explaining changes in shareholder wealth” (chari, 2009). 1.5 pay-performance sensitivity murphy (1985) found that fixed pay, short-term incentives and total earnings are positively related to total shareholder return and measures of company performance. pay-performance sensitivity refers to the correlation between remuneration outcomes and measures of company performance, with not one definitive measure but rather a broad set of variables. the literature on pay-performance sensitivity has yielded mixed results. gerhart and milkovich (1990) found that variable pay is positively correlated with company performance but that fixed pay is not sensitive to company performance. jensen and murphy (1990) concluded that for every $1000 change in market value, the ceo would experience a $2.59 change in total remuneration. concluding that while the pay-performance relationship was positively correlated, it was not particularly favourable and was declining over time. belliveau, o’reilly iii & wade (1996) showed evidence of a positive relationship between ceo pay and company performance. abowd (1990) analysed the pay-performance relationship and found that greater use of variable pay was positively related to total shareholder return and gross economic profit. other studies include those done by coughlan and schmidt (1985) which studied the relationship between ceo remuneration and stock price performance and their results led them to conclude that the two were linked. veliyath and bishop (1995) also found a strong relationship between executive remuneration and stockholders equity. us industry specific studies include those done by akhigbe, madura & ryan (1997) in commercial banks, and barber, ghiselli & deale (2006) in the restaurant segment of the hospitality industry. the akhigbe et al. (1997) study found that the accumulated human capital of ceos and the commercial bank size were positively related to the total ceo remuneration which included salary, bonus, and stock options. the study also found that ceo remuneration had a positive significant relationship with both accounting-based performance measures and marketbased performance measures. barber et al. (2006) found a positive link (correlation) between executive remuneration and share price for larger restaurant organisations. a study by merhebi, pattenden, swan & zhou (2006) examined 722 australian organisations between 1990 and 1999 and found results which were consistent with other findings for organisations in the us, uk and canada when market-based model specifications were used. their results found that ceo remuneration and company performance association is positive and statistically significant. firth, fung & rui (2006) conducted a ceo pay-performance study in china. their study found that there was a positive relationship between ceo remuneration and company performance measured 238 sajems ns 18 (2015) no 2:232-244 in both accounting and shareholder wealth terms. research conducted in the uk where stathopoulus, espenlaub and walker (2005) found that there was a link between higher-performing companies and executive remuneration, and that the link between poorer-performing companies and executive remuneration was weak. in contrast, numerous studies have found little evidence of a positive relationship between the two variables (tosi, werner, katz & gomez-mejia, 2000). jensen and murphy (1999) studied large organisations in the us, testing the relationship between ceo wealth and shareholder wealth and found little evidence of a relationship between executive remuneration and company performance. duffhues and kabir’s (2008) research supports these results finding no evidence of a positive relationship between executive remuneration and company performance. gregg, jewell and tonks (2005) also found the link between executive remuneration and company performance to be weak. varying methods of data collection, statistical techniques, samples and industry contexts may contribute to these variances. empirical compensation literature indicates that there is no consensus on the optimal measure of company performance as researchers continue to operationalise company performance in many different ways (bacidore et al., 1997; attaway, 2000; fatemi et al., 2003; chari, 2009). finally, the literature suggests that moderator variables may play a role in the pay-performance relationship, such as the size of the firm and the role of monitoring systems within the organisation. firm size is shown to have a large influence on the variance of ceo pay-performance sensitivity (tosi et al., 2000; haynes, thompson & wright, 2007), while the impact of monitoring remains unclear in the face of conflicting evidence (petra & dorata, 2008; lee, lev & yeo, 2007). 2 the south african context with the wealth of pay-performance sensitivity research in different geographies and industries showing mixed results, this article aims to examine four studies conducted in the south african context in different industries in order to understand the pay-performance relationship in the south african context. the growing role of governance within the south african context must be acknowledged. a pursuit of more effective governance structures has resulted in many countries adopting a code of corporate governance (collier, idensohn & adkins, 2010). in south africa, the code driving governance of executive remuneration is known as the king code of governance for south africa. a critical element of king iii is the requirement that ceo remuneration be linked to measures of company performance. this has manifested itself in practice guidelines for all of the components of ceo remuneration, including fixed pay, short-termand long-term incentives. king iii does not constitute formal regulation it is a code of practice as opposed to statutory legislation where legal sanctions are applied for non-compliance. despite the fact that king iii relies only on selfregulation, it appears to have a significant impact on the manner in which ceo remuneration is addressed. king iii requires disclosure between salary and performance-related elements as well as an explanation of the basis on which remuneration is measured. this means that it will become increasingly difficult for executive directors not to be remunerated according to performance. in addition, the fact that king iii also suggests that shareholders approve the remuneration policy of a company will increase the accountability of executive directors to shareholders (scholtz & smit, 2012). in contrast to the deep crisis that occurred in developed nations, the south african banking sector remained reasonably stable. the international monetary fund (2009) suggested that despite the crisis intensifying across the world, south african banks had remained ‘orderly and stable’. recently, in the south african mining industry a strike resulted in the tragic death of mine workers as violence broke between the south african police services and the mine workers. the strike was owing to the fact that miners were complaining that mining benefits were not reaching the workers and the surrounding communities. more importantly criticism was put on high executive sajems ns 18 (2015) no 2:232-244 239 remunerations compared to the low wages of the mine workers (leon, 2012). although poor company performance was the reason given for low wages, executive remuneration did not reflect a strong pay-performance sensitivity. 2.1 pay-performance sensitivity in the south african context the following studies were all quantitative, archival studies conducted using south african companies and ceo remuneration data to research the relationship between ceo pay and company performance. shaw (2011) looked at financial service companies between 2005 and 2010. his research study categorised company performance measures into three main categories: absolute financial performance measures, financial performance ratios, and market performance measures. company performance measures were further broken down into: economic profit, accounting profit, and shareholder returns in the form of return on equity (roe) and headline earnings per share (heps). he included two critical company characteristics which are indicators of company performance, namely debt to assets ratio and total assets or book value. his research found a moderate to strong relationship between ceo remuneration and company performance. however, the results of the study indicated that there has been a decline in the relationship since 2008 (the start of the financial crisis). the results of the study also yielded an associated structural change in the mix of remuneration components, “most notably there was an observed shift in ceo remuneration from variable pay to fixed pay” (shaw, 2011). van blerck (2012) also researched companies in the south african financial sector over 20022011. he used the following company performance measures: economic value added (eva), return on equity (roe) and share price. his research supported shaw’s (2011) research findings. van blerck (2012) found a moderate correlation between share price and executive remuneration. additionally, his research found that executive remuneration correlated strongly to eva, and the correlation strengthened after the 2008 financial crisis. nel (2012) looked at the relationship between company financial performance and ceo guaranteed ctc in the south african retail and consumer goods sector. his study reviewed data over a six year period and included the financial crisis (2006-2011). he utilised the dupont model to analyse the relationship between ceo remuneration and company financial performance. the dupont model includes the performance of management and strategic decisions into the assessment of the financial performance of an organisation. dupont analysis is an expression which breaks return on equity (roe) into three parts, namely profitability (measured by profit margin), operating efficiency (measured by asset turnover) and financial leverage (measured by multiplier) (ward & price, 2006). his study illustrated that the financial company performance in the south african retail and consumer goods sector had little or no effect on the ceos guaranteed ctc. nel (2012) suggested that the ceos’ managerial power could have led to an increase in their guaranteed ctc that was misaligned with the financial performance of their respective organisations after the 2008 global financial crisis. the last study was conducted over a seven year period (2006-2012) using south african companies and ceo remuneration data from various industries (modau, 2013). modau studied 21 of the johannesburg stock exchange’s (jse) top 40 organisations which had a combined market capitalisation of between 50 per cent and 82 per cent of the total jse market capitalisation. her research used the following company performance measures: market capitalisation (mc), earnings per share (eps), return on equity (roe), economic value added (eva) and market value added (mva). modau’s (2013) major findings indicate that there was a structural change in the ceos’ total remuneration packages after the 2008 financial crisis. ceos remuneration structure moved away from short-term incentives and focused more on fixed pay. this structural change supported shaw’s (2011) research findings. modau’s (2013) findings regarding the positive relationship between ceo total remuneration and roe support those found by nel (2012) and van blerck (2012). the next most significant finding was that of the relationship between ceo total remuneration and eva which tended to change direction depending on the global economic 240 sajems ns 18 (2015) no 2:232-244 standing. when the global economy was experiencing uncertainty or difficulty (e.g. 2008 global financial crisis and august 2011 stock market fall), eva was found to be leaning towards being more directly related to ceo total remuneration. when the global economy was performing well, eva was found to be leaning towards being more inversely related to ceo total remuneration. 3 conclusion in theory, efficient compensation contracts should be designed well enough to link ceo remuneration with company performance, providing strong incentives for executives to operate organisations in the best interests of the shareholders. additionally, one of the aims of the implementation of the companies act (2008) and king iii was to influence and strengthen the link between executive remuneration and company performance. however, current research discussions highlighted that executives are becoming more innovative in bypassing the payperformance requirement. one such method took precedence after the 2008 global financial crisis as after the event executives have noticeably been moving away from focusing on shortterm incentives and paying greater focus to fixed pay. the primary aim of such a move was mainly to avoid performance related elements in determining their remunerations. this has created a natural disconnect between what executives are being paid and company performance resulting in inverse relationships between some of company performance measures with ceo total remuneration, especially fixed pay. the link between ceo remuneration and company performance has been lost. this is supported by the research in both the south african context, different industries and other geographies. the relationship between the principal-agent and the managerial power theory is exposed as a fluid relationship, largely dependent on the external environment. the changes observed within the south african context with regards to the weakening relationship between company performance and ceo pay, along with the structural changes in ceo pay and the increased risk profile, suggests that managerial power has become more prominent in light of the deteriorating economic conditions. ceos have asserted managerial power as suggested by bebchuk and fried (2004) and have begun to manage the risk component in their compensation packages. this contrasts with the initial expectation that the level of pay-performance sensitivity would strengthen over the period, based primarily on the influence of increased monitoring and regulation. instead, the role of the external environment played a far more influential role. as such, pay-performance sensitivity was higher over periods of good performance and lower over periods of weaker company performance. the findings suggest that pay-performance sensitivity is likely to fluctuate based on macroeconomic trends. the research challenges the notion that there is one dominant theory driving ceo compensation. within the context of the literature the rational principal-agent theory, supported by the optimal contract theory, is found to be strong during periods of strong economic performance, while the influence of managerial power and other behavioural theories appear to be stronger during periods of weak economic performance. in managing the tension between the principal-agent theory and the managerial power theory, i would propose a number of possible considerations. firstly, a stronger test of the pay-performance relationship and the power of incentive design is required in order to ensure that executives are rewarded or penalised for poor performance. the question on how executives are paid also needs to be considered. there is also a need for a robust and valid model which contains partial regression coefficients which are positive and significant to ensure consistency with the agency notion that top executives are rewarded for increases in shareholder wealth. additionally, boards and remuneration committees need to pay more attention to the different accountingand marketbased measures available, in assessing top executives’ performance. compensation committees are likely to have to make greater use of discretion during periods of poor economic performance as behavioural considerations become more influential. as a result, compensation decision-making policies and processes will need to be robust in order to ensure consistency and fairness in the application of discretion. more attention is also required with regards to the different behaviours sajems ns 18 (2015) no 2:232-244 241 by top executives in making the companies act (2008) and king iii requirements ineffective as they avoid being measured for performance. king iii needs to be considered while designing better and more robust pay-performance models. managerial power manifests itself in the need to attract, motivate and retain leadership skills, particularly during periods of economic downturn. a target range of pay-performance sensitivity should be pursued by organisations, rather than an absolute level. this will allow organisations to manage the relationship between the principalagent theory and the managerial power theory within a reasonable level, and with some degree of flexibility. finally, in managing the impact of managerial power, compensation committees will need to understand the role that size and book value (bv) plays in 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new and increased emphasis has been placed on the importance of the concepts of earnings quality and earnings management practices. despite increased research focusing on business ethics since 1990, there is little evidence that business schools and the profession are educating accountants about earnings management practices. therefore, this study, similar to other studies, continues to use the bruns and merchant survey and compares the results of studies on students and business managers on earnings management practices. students and business managers were surveyed at the nelson mandela metropolitan university (nmmu) and these results were compared to four studies prior to the sarbanes-oxley act 2002 in the us. the expectation will be of changes in attitudes towards earnings management since the financial scandals and passing the act. therefore, the aim of the study is to determine if there have been changes in attitudes towards earnings management practices. no surveys using the bruns and merchant (1990) questionnaire are available in sa. therefore, the study in sa was compared to available studies in the us. key words: bruns and merchant study, business managers, business schools, earnings management, ethics, students jel: m14, 41 1 introduction bruns and merchant (1990) was the first to conduct a survey of the readership of the harvard business review on the acceptability of practices in earnings management. the survey required the readers to rate the acceptability of 13 earnings management practices. the authors were shocked by the results and observed that where a practice is not explicitly prohibited or where there is a slight deviation from the rules, it seems that it becomes an ethical practice regardless of who might be affected by the practice or the information that flows from it (bruns & merchant, 1990). this means that anyone who uses information on short-term earnings is vulnerable to misinterpretation, manipulation, or deliberate deception as some of the earnings management practices can be immoral and unethical (bruns & merchant, 1990). in later years, companies like enron and worldcom that were once viewed as icons and symbols of success became images of greed and unethical behaviour. as a result of the financial scandals and fraud of these companies and the subsequent demise of arthur anderson, business ethics has become a much researched and discussed topic. business ethics has not only revived academics’ and accounting practitioners’ interest in ethics and earnings management practices but it also supports the view that there is a lack of ethics and ethical behaviour on the part of businesses and management (karassavidou & glaveli, 2006). rather, in many companies, there is a concern for the bottom line or ‘making the numbers’ which seems to override any concern for ethical values (verschoor, 2002). abstract sajems ns 14 (2011) no 4 423 public confidence in the accounting profession has been shaken by the financial frauds and failures in these companies and the fraud charges brought against management. for its 2002 annual meeting, the american accounting association chose the quality of earnings project as its main theme and, in turn, academic journals have invited and published research articles that focus on earnings management practices (giacomino & akers, 2006). following the scandals, the united states (us) congress passed the sarbanesoxley act of 2002 (south africa followed with corporate governance) that holds executives personally responsible and criminally liable for certifying financial statements (elias, 2004). earnings management and business ethics also has implications for academia. leading accounting associations, since the 1990s, have called for increased emphasis on ethics education in accounting curricula. they recommend that business and accounting curricula should emphasise ethical values by integrating their development with the acquisition of knowledge and skills to help prevent, detect, and deter fraudulent financial reporting (fischer & rosenzweig 1995). therefore, the purpose of this study is to determine whether the ethical perceptions of a survey in south africa (sa) differ from surveys in the usa that used the bruns and merchant (1990) study prior to the introduction of the sarbanes-oxley act in the us and corporate governance in south africa. the aim is to determine whether the demand for and introduction of courses in ethics in business schools changes the ethical perceptions of students and business managers. 2 the research problem as scandals of public companies come more to the fore one realises that people, and not accounting, are responsible for the major losses suffered by innocent people. business schools, which are considered a basic source of providing managers and entrepreneurs, seem to be blamed for much of the unethical behaviour in business (karassavidou & glaveli, 2006). however, earnings management is not a new phenomenon and has been used for many years. since the seventies researchers stressed the importance of ethics in accounting. bernstein and siegel (1979) agree that earnings figures should have integrity and should not be the product of manipulations designed purely to increase the reported income of an entity. earnings should also be reliable and provide a good indication of the earning power of the company. since then, many cases of financial fraud and failure in companies have come to light throughout the world. the failure of a company is not simply a matter of accounting and auditing but the involvement of a convergence of factors including personal values, integrity and ethics (akers, eaton & giacomino, 2004). the problem with earnings management practice is that it also has consequences for accounting educators. they are the main suppliers of business managers. educators should attempt to minimise the difference between students and business managers as conflicting opinions begin to develop during undergraduate business education. this results in students often adopting the attitudes of their professional reference groups before they even commence their professional careers (giacomino & akers, 2006). this study therefore compares a recent survey on the ethical perceptions of students and business managers and compares it to four similar surveys (clikeman, greiger & o’connell, 2001; fischer & rosenzweig, 1995; rozenzweig & fisher, 1994; merchant & rockness, 1994) performed in the us prior to the introduction of the sarbanes-oxley act. the aim is to determine whether the introduction of the act and educational interventions in business ethics courses effectively improved the ethical perceptions and skills of accounting students and practitioners. 3 purpose of the study research has focused on detecting earnings management practices but the ethical perceptions of students and business managers 424 sajems ns 14 (2011) no 4 are also important. the question is how a student will react when confronted with an ethical conflict in the business world. therefore, the purpose of this study is to compare a survey on ethical perceptions of selected earnings management practices in sa with surveys performed in us prior to the introduction of the sarbanes-oxley act in 2002. sufficient time has passed since the publicity of cases such as enron and worldcom that changes in the views on the morality of earnings management may be expected throughout the world. 4 literature study defining earnings management earnings management has been practiced for many years. it occurs when managers use judgement in financial reporting and in structuring transactions to alter financial reports either to mislead some stakeholders about the underlying economic performance of the company or to influence contractual outcomes that depend on reported accounting numbers (healy & wahlen, 1999). this definition focuses on the exercise of judgement in financial reports to mislead stakeholders who either do not or cannot do earnings management and also to make financial reports more informative to users. there is therefore a good and a bad side to earnings management. the bad side is the cost created by misallocation of resources and the good side is the potential improvements in management’s credible communication of private information to external stakeholders, improving resources allocation decisions. belkaoui (2004) agrees that various definitions have been offered to explain earnings management as a special form of ‘designed’ rather than ‘principled’ accounting. earnings management may be seen as a purposeful intervention in the external reporting process with the intent of obtaining some private gain by either a selection of accounting methods within gaap or by applying given methods in particular ways (belkaoui, 2004). earnings management may also be seen from either an economic (or true) income perspective or an informational perspective. the true income perspective assumes firstly the existence of a true economic income which is distributed by a deliberate earnings management and/or by measurement errors embedded in accounting rules, and secondly as noisy unmanaged earnings acquire through earnings management of new properties in terms of amount, bias or variance. however, the informational perspective assumes that earnings is one of the signals used for decisions and judgements, and furthermore that managers have private information which they can use when they choose elements within gaap under different sets of contracts which determine their conversation and behaviour (belkaoui, 2004). managers manage earnings through their choices of accounting policies, judgements, or their timing or selection of operating decisions. furthermore, managers’ actions are related to a number of their incentives. in this regard, an association was found between accounting accruals and the incentives managers received from earnings-related bonus plans. managers also have a tendency to decrease earnings when earnings are extreme in either direction, or to overstate earnings because they have not been performing well, or to boost earnings by squeezing reserves (merchant & rockness, 1994). earnings management activities include accounting-based activities or operating-based activities. as an example of an accounting method, a manager may unjustifiably adjust the amount of a reserve thereby changing income. on the other hand, when a manager postpones discretionary expenses into the future in order to improve current income, it will be an example of an operating method (kaplan, 2001). not all earnings management actions are illegal and many are within the manager’s prerogatives. the ethical perspective, however, raises the question as to whether it is the right thing to do. although an individual’s moral code should prevent earnings management actions, if it does not, the individuals engaging in these actions are acting in a socially sajems ns 14 (2011) no 4 425 unacceptable way (merchant & rockness, 1994). ethics in the accounting curriculum the treadway commission (cohen & pant, 1989), called for changes in accounting education that would increase the extent to which ethical issues are incorporated into classroom practices. the commission argued that the responsibility of the accounting profession and their accountability to the public requires a much broader exposure to ethics. business schools should include ethics discussions in every accounting course and, ideally, it should be part of all business courses. business and accounting curricula should emphasise ethical values by integrating their development with the acquisition of knowledge and skills to help prevent, detect and deter fraudulent financial reporting (cohen & pant, 1989). fisher and rosenzweig (1995) also supported the treadway commission to address their concerns by identifying specific topics in ethics and accounting for curricular development. earnings management practices are one such topic to be included because of ethical ambiguities associated with these practices. if the educational curricula of accountants and managers can inculcate ethical sensitivity to earnings management, then perhaps it can help to reduce the tendency to engage in these practices (fischer & rosenzweig, 1995). it is therefore important for educators to be familiar with current attitudes of students towards earnings management practices if they are interested in integrating ethical concerns into accounting programs. in response to this concern, many business schools have begun to review the role of ethics in their curricula and many have initiated new business ethics courses, developed cases, conducted workshops and seminars to put the spotlight on the need for principled leadership. woo (2003) stresses that one of the primary goals of educators should be to help students understand how they might react when presented with an ethical conflict, no matter how big or small. karassavidou and glaveli (2006) believe that a lack of ethics and ethical behaviour on the part of businesses, leaders and managers seems to pervade the societies universally having a direct outcome on leadership and organizational effectiveness, employees’ job satisfaction and turnover, orginisational justice and in general on businesses’ ability to compete, create jobs and contribute to a country’s economic development and social prosperity. furthermore, the authors blame business schools for much of the unethical behaviour in business because they are considered the basic source of providing leaders, managers and entrepreneurs. therefore, many universities and business schools are increasingly requiring form their students to take courses in business ethics (karassavidou & glaveli, 2006). chang and leung (2006) agree that whilst much research has concentrated on ethical reasoning and ethics education to enhance the ethical conduct of accountants, it is also important that the profession and researchers also direct their attention and efforts to cultivating the ethical sensitivity of accountants. surveys in earnings management in response to corporate scandals and the loss of confidence in the accounting profession, researchers embarked upon similar research as bruns and merchant (1990) in earnings management practice and corporate-ethical values. bruns and merchant (1990) prepared a 13-action questionnaire that consisted of practices that the authors considered short-term earnings management practices. this questionnaire was used by merchant and rockness (1994) where general managers, staff managers, operation-unit controllers, and internal auditors were sampled in two entities. in their study, accounting manipulations were judged more harshly. rosenzweig and fischer (1994) found that respondents with more years of experience and higher levels of responsibility (partners) judged practices less harshly than accountants with less than six years experience and at the entry and junior levels. 426 sajems ns 14 (2011) no 4 fischer and rosenzweig (1995) surveyed undergraduate students, mba students, and practicing accountants on their attitudes on the ethical acceptability of earnings management practices and found that operating manipulations were judged less ethically by accounting practitioners. clikeman et al. (2001) surveyed students and made comparisons by culture, based on national origin and gender. however, in their study, no significant differences were found. furthermore, elias (2004) surveyed certified public accountants (cpas) and reported on their low perceptions of corporate ethical values. kaplan (2001) did not utilise the bruns and merchant (1990) questionnaire. he presented two groups of respondents, managers and shareholders, with only three earnings management actions. it involved an operating activity gain through deferral of discretionary expenses, an accounting activity gain by requesting an invoice from a consulting firm to be delayed, and an accounting activity loss through an unnecessary increase in the obsolescence reserve. the results indicated that managers rated operating manipulations more ethically than accounting manipulations, whereas the shareholders rated both as unethical. another survey was performed by karassavidou and glaveli (2006). they investigated the ethical orientation of undergraduate business students in greece. the researchers found that academic dishonesty is positively related to students’ attitudes towards unethical managers’ behaviour in the business context. chang and leun (2006) surveyed 156 accounting undergraduates to investigate the ethical sensitivity of accounting students and the effects of their ethical reasoning and personal factors on their ethical sensitivity. they found no significant relationship between accounting students’ ethical sensitivity and their ethical reasoning. their survey also indicated that an accounting ethics intervention may have positive effect on accounting students’ ethical sensitivity development. giacomino and akers (2006) surveyed students and business managers to measure their perception of specific earnings management actions. the questionnaire was similar to that used by bruns and merchant (1990) but an additional seven practices were included, totaling 20 items relating to ten earnings management practices. their results showed no significant difference between students and business managers and also between genders. the findings of the 13 practices similar to the bruns and merchant (1990) study were used to compare their study with four studies using the bruns and merchant (1990) questionnaire prior to 2002. the average of the prior studies was determined and the comparison indicated that the respondents in their study had stricter views. jooste (2010) proceeds with a similar study as giacomino and akers (2006) and surveys the ethical perceptions of students, business managers and gender on 20 short-term earnings management practices. the results indicated no significant difference between genders but found a significant difference between students and business managers. business managers rated the practices less ethically than students. see annexure 2 for the actual questionnaire the respondents completed. 5 methodology this study is similar to the study by giacomino and akers (2006) where the authors compare a 2006 survey of students and business managers from marquette university, milwaukee, usa, with four us studies (clikeman et al., 2001; fischer & rosenzweig, 1995; rozenzweig & fisher, 1994; merchant & rockness, 1994) prior to 2002 (hereafter referred to as prior studies). the objective, given the publicity of cases such as enron and worldcom, was to determine if there have been changes in attitudes towards earningsmanagement practices. the authors argued that sufficient time has passed since the fraud cases and the issuance of the sarbanes-oxley act in 2002, that they might expect some change in the views on the morality of earnings management. the fraud cases in the us received worldwide publicity, even in sa. furthermore, the sajems ns 14 (2011) no 4 427 king report and corporate governance in sa followed the sarbanes-oxley act in the us. sa universities also introduced ethics courses in business studies. therefore, this study aims to determine if perceptions changed towards earnings management practices. due to a lack of similar studies in sa, this study, similar to that of giacomino and akers (2006), compares a survey from nmmu in sa with the four us studies (clikeman et al., 2001; fischer & rosenzweig, 1995; rozenzweig & fisher, 1994; merchant & rockness, 1994) prior to 2002. this study will use the average of the prior studies determined by giacomino and akers (2006) to compare 13 earnings management practices actions (the same 13 as in the bruns and merchant study). the aim of this comparison is to determine whether there have been changes in the attitudes of respondents in sa since the highly-publicised cases of enron and worldcom and the issuance of sarbanesoxley act 2002 and corporate governance in sa. 6 research design the average of the studies from the study by giacomino and akers (2006) will be used (see annexure 1). the means of the nmmu survey (jooste 2010) will then be compared with the average of the prior studies. the findings will be analysed to determine if there are changes in perceptions on earnings management practices. sample two groups were surveyed, undergraduate accounting students at the nmmu and business managers. the business managers were students in an mba course at the nmmu and qualified accountants employed by accounting firms. demographic data students 259 business managers (bm) 94 not answered (5 students; 2 bm) 7 total : 360 prior studies four studies (clikeman et al., 2001; fischer & rosenzweig, 1995; rozenzweig & fisher, 1994; merchant & rockness, 1994) subsequent to the bruns and merchant (1990) study have utilised the bruns and merchant questionnaire. annexure 1 lists the mean values from the four studies’ responses and the study at nmmu for 13 practices. the 13 practices correspond with the original bruns and merchant questionnaire. the average of the prior study for each of the 13 actions is also provided in annexure 1. the questionnaire bruns and merchant (hbr, 1989) study prepared a 13-action questionnaire based on practices that the authors considered short-term earnings management practices. the practices involve the choice and timing of operating events and the choice and timing of recognition of specific revenues and expenses, therefore covering operating manipulations and accounting manipulations. the respondents were informed that the questionnaire referred to a $1 billion company consisting of different divisions which has a januarydecember fiscal year. each division has a turnover of $100 million and net profits before taxation of $12 million. the respondents were required to rate each question on a five-point likert scale ranging from 1 to 5 as follows: 1 = ethical practice (mean below 1.5). 2 = questionable practice. i would not say anything to the person involved, but it makes me uncomfortable (mean between 1.5 and 2.5). 3 = minor practice. the person should be warned not to engage in the practice again (mean between 2.5 and 3.5). 4 = serious infraction. the person should be severely reprimanded (mean between 3.5 and 4.5). 5 = totally unethical. the person should be fired (mean between 4.5 and 5). on the questionnaire’s first page the respondents were informed that the questionnaire consists of a short description of a variety of actions that individuals have taken. some of 428 sajems ns 14 (2011) no 4 these actions are clearly ethical. others are judged by some or most people to be unethical, and the judgments as to the degree of severity of the infraction may vary (hbr, 1989). in table 1, the 13 earnings management practices are listed as well as the averages of the mean values from prior studies and the mean value from the nmmu study. t a b l e 1 mean values of short-term earnings management practices no short-term earnings management practices nmmu prior studies 1. paint ahead of schedule 1.87 1.18 2. defer discretionary expenses to meet quarterly budget 2.98 2.06 3. defer discretionary expenses to meet annual budget 3.18 2.46 4. defer supplies expenses by delaying recording invoice 3.54 3.24 5. credit that has more liberal terms to reach budget target 2.47 1.93 6. work overtime to reach budget target 2.19 1.53 7. sell excess assets to reach budget target 2.40 1.41 8. prepay expenses to reduce income by $60 000 2.89 3.07 9. increase reserve for inventory obsolescence; reduce income $700 000 3.22 3.28 10. reduce reserve for inventory obsolescence to continue work 3.00 3.19 11. reduce reserve for inventory obsolescence to meet budget target 2.70 3.50 12. request deferred billing for supplier, $30 000 3.20 3.17 13. request deferred billing from supplier, $500 000 3.76 3.93 average rating for study overall 2.88 2.61 research method this descriptive study compares surveys to determine the changes in ethical perceptions subsequent to the enron and worldcom scandals and the sarbanes-oxley act in 2002, followed by corporate governance in sa. the results on how the respondents rated 13 earnings management actions at nmmu and the average of four studies prior to 2002 were compared. table 1 provides a breakdown of the survey groups. findings the mean values of nmmu are above the average of the prior studies for eight of the 13 actions (1, 2, 3, 4, 5, 6, 7 and 12). this indicates that the respondents in the nmmu study have stricter views than the respondents in the prior studies for these actions. in five of the 13 actions (8, 9, 10, 11 and 13) the respondents in the prior studies had stricter views. the greatest difference in the mean values is 0.99 (action 7), namely, sell excess assets to reach budget target. the smallest difference is 0.03 (action 12), namely, request deferred billing from supplier for $30 000. the overall average rating for all 13 actions for the nmmu was 2.88, which is 0.27 higher than the overall average of the prior studies. in the comparison by giacomino and akers (2006), such a small difference is not rated as a substantial difference, which indicates that the perceptions regarding earnings management have not changed substantially since 2002. according to giacomino and akers (2006), small differences in mean values suggest that the results are consistent with the findings of the bruns and merchant study conducted in 1990 and the prior studies. this indicates that perceptions regarding earnings management practices have changed, but they have not changed significantly owing to events such as the issuance of the sarbanes-oxley act of 2002 and the financial frauds and failures of enron and worldcom. the overall response showed a significant lack of agreement and the dispersion of ratings varied considerably. the surveys suggest that the 13 earnings management practices are not acceptable, since only two practices (1, paint ahead of schedule, and 7, sell excess assets to sajems ns 14 (2011) no 4 429 reach budget target) were rated as ethical practices by prior studies. although nmmu has the stricter view, the following similarities were found: • totally unethical: the person should be fired (mean between 4.5 and 5) no practice was rated as totally unethical by both groups. • serious infraction: the person should be severely reprimanded (mean between 3.5 and 4.5) two practices were rated as a serious infraction by nmmu of which one was rated the same by the prior studies. the practice is: request deferred billing from supplier, $500 000 (13) nmmu rated one more practice as a serious infraction, whereas the prior studies rated it as a minor infraction, which is: defer supplies expense by delaying recording invoice (4) • minor infraction: the person should be warned not to engage in the practice again (mean between 2.5 and 3.5) five of the seven practices rated by nmmu were also rated by the prior studies as a minor infraction, namely: prepay expenses to reduce income by $60 000 (8) increase reserve for obsolescence, reduce income $700 000 (9) reduce reserve for obsolescence to continue work (10) reduce reserve for obsolescence to meet budget target (11) request deferred billing for supplier, $30 000 (12) nmmu rated one more practice as a serious infraction, whereas the prior studies rated it as a minor infraction, which is: defer supplies expense by delaying recording invoice (4) • questionable practice: i would not say anything to the person involved, but it makes me uncomfortable (mean between 1.5 and 2.5). two of the four practices rated as a questionable practice by nmmu received the same rating by the prior studies, namely: more liberal credit terms to reach budget target (5) work overtime to reach budget target (4b) the nmmu also rated paint ahead of schedule (1) and sell excess assets to reach budget target (7) as a questionable practice. both these actions were rated by the prior studies as an ethical practice. the prior studies rated the following actions as a questionable practice: defer expenses to meet quarterly budget (2) defer expenses to meet annual budget (3) • ethical practice: (mean below 1.5) paint ahead of schedule (1), and sell excess assets to reach budget target (7), were rated by the prior studies as an ethical practice. in this comparison, further interesting earnings management findings were evident. it was found that for some of the practices, the dollar amount, timing of the action, the method used, and the extent of the budgets affected the respondent’s views. • dollar amount both actions 12 and 13 request the supplier to defer a bill, for $30 000 and $500 000 respectively. where the dollar amount is $500 000 both the nmmu and the prior studies rated the action more serious. this is also consistent with those of giacomino and akers ((2006). the prior studies also reported that materiality was a factor and that large amounts were judged more seriously than small amounts. • timing of the transaction in both actions 2 and 3 discretionary expenses were deferred to meet different budgets. where the action was to meet the annual budget both the nmmu and the prior studies judged the action more harshly than where the action was to defer discretionary expenses to meet quarterly budgets. 430 sajems ns 14 (2011) no 4 • method used the prior studies also reported that the methods used to reach budget targets affected the views of the respondents even though the result turned out the same. action 5 called for more liberal terms to reach the budget target, whereas action 6 required working overtime, and action 7, to selling excess assets to reach the budget target. both the prior studies and the nmmu study rated more liberal credit terms as less acceptable than working overtime or the selling of excess assets. • quarterly or annual budgets in actions 2 and 3 the deferral to meet the annual budget is viewed as more serious by the nmmu than the deferral to meet the quarterly budget. these findings are also consistent with those of the prior studies and the studies by bruns and merchant (1990) and giacomino and akers (2006). overall, these results seem to be consistent with the findings of the bruns and merchant (1990) study as well as the prior studies by merchant and rockness (1994), rozenzweig and fisher (1994), fischer and rosenzweig (1995), and clikeman et al. (2001). this similarity was also found in a survey by giacomino and akers (2006). this study also found that the respondents do not support the acceptability of these earnings management practices, since only two (by the prior studies) were rated as an ethical practice. however, the greatest concern of the findings was the total lack of agreement as no action was unanimously rated as unethical. 7 implications for academia although this study shows that there have been some changes in perceptions regarding earnings-management practices since 2002, the changes seems to be insignificant. this means that business students still need more exposure and an understanding of methods used to manage earnings, as was suggested by fischer and rosenzweig (1995). therefore, this has implications for academia and becomes the responsibility of universities and business schools. they are the basic source of providing leaders and managers and also seem to be blamed for much of the unethical behaviour in business (karassavidou & glaveli, 2006). giacomino and akers (2006) suggest that business publications should continue to report fraudulent financial reporting in the media and academic journals on a regular basis. fraudulent reporting is often the result of earnings management. fisher and rosenzweig (1995) suggest that greater emphasis be placed on earnings management practices in the accounting curricula. although difficult, it should be integrated into business courses, or be a separate business ethics course or an accounting course taught by accounting and business ethics academia. furthermore, giacomino and akers (2006) suggest that the ‘real-world’ aspects of earnings management practices be enhanced and that experienced business professionals become an integral part of accounting courses. in addition, differences between business managers and students should be minimised as conflicting opinions begin to develop during undergraduate business education. students appear to adopt the attitudes of their professional reference groups before they even commence their professional careers. therefore, by using experienced business professionals during lectures and making discussions of earnings more realistic, the differences between students and business managers may be reduced with reference to perceptions of earnings management practices. 8 conclusions ethics in accounting has been an issue for many years. in earlier years, the treadway commission (cohen & pant, 1989) called for changes in accounting education and called on business schools to include ethics in every accounting and business course. furthermore, bruns and merchant (1990) did a survey on earnings management that revealed unfavourable results. therefore they suggest that the key to moral behaviour is the obligation to look beyond self-interest and to focus on the concerns of others. they regard sajems ns 14 (2011) no 4 431 the morality of doing otherwise questionable and the ethical perspective therefore raises the question as to whether earnings management practices are moral. this followed with the bankruptcy of enron and worldcom in 2001 that shocked the business world and resulted in serious harm to all stakeholders. as a result, the sarbanes-oxley act was introduced in 2002 (followed in sa by corporate governance). the concept of earnings management practices has received considerable attention in the accounting literature, and sufficient time has passed since the financial scandals and the passage of the sarbanes-oxley act so that one would expect some change in the ethical perceptions towards earnings management. therefore the question to be raised, in the light of all the research, is whether the ethical perceptions of accounting students and practitioners have changed since 2002. many accounting practitioners and students think that ethics is a list of rules, such as the ten commandments or explicit organisational codes of ethics. hence, the assumption is that if something is not expressly prohibited, there is no need to worry about ethics (giacomino & akers, 2006). based on this view, earningsmanagement practices are not problematic if no rules are broken by engaging in it. however, if a respondent has this rule-based view of ethics, he or she would judge accounting manipulations (a violation of accepted accounting practice) as more unethical, since they violate explicit rules, while operating manipulations do not (fischer & rosenzweig, 1995). it seems from the surveys in the study that ethics is still viewed in this light. this study compared a survey performed at nmmu with us studies prior to 2002 using the bruns and merchant (1990) questionnaire. the results indicated that since 2002 there has not been a substantial change in the views of students and business managers regarding earnings management practices. the us studies were used in the comparison as no sa studies using the bruns and merchant (1990) survey exist. this still has implications for educators and business schools to increase changes in accounting curricula and to include greater ethics discussions. therefore, it is suggested that the survey should also be repeated in the future to determine if there are changes in the ethical views of accounting students. the results may enable accounting educators to understand what students feel and how they may react to earnings management practices when in practice. furthermore, if courses are introduced to address aspects of earningsmanagement practices, a further survey can determine whether it contributed towards changing the ethical views of the students or if the attitudes of students towards earnings management practices can be improved. akers et al. (2004) found that very little research and few curricular activities have been done with respect to the role of personal values in accounting. their study (akers et al., 2004) includes a step-by-step discussion of how accounting programmes can apply intervention methods to change students’ personal values toward a desired end. the intervention methods include programmatic, curriculum and classroom activities. these intervention methods were introduced at a comprehensive, private university in the midwest of the us. their aim was to introduce an effective tool that can be used by accounting educators to positively influence the next generation of accountants. to date no further studies have been published by the authors in this regard. the results of this nmmu study need to be interpreted in the light of possible weaknesses. the respondents in the study may not be representative of students and business managers of the local country. overall, business managers were found to view the earnings-management practices less favourably than the students. this may be due to the fact that students have fewer risks than business managers and also the possibility that students may not fully understand the wording of the questionnaire on earnings management. it is suggested that a follow-up survey be performed in sa using similar respondents. this could indicate, amongst others, whether the introduction of king 111 in south africa has contributed towards changing the ethical perceptions of students and business managers. 432 sajems ns 14 (2011) no 4 references akers, m.d., eaton, t.v. & giacomino, d.e. 2004. measuring and changing the personal values of accounting students. journal of college teaching & learning, 1(4):63-70. belkaoui, a. 2004. accounting theory (5th ed.) singapore: thompson learning. bernstein l.a. & siegel, j.g. 1979. the concept of earnings quality. financial analysts journal, 35: 72-75. bruns, w.j. & merchant, k.a. 1990. the dangerous morality of managing earnings. management accounting, 72(2):22-25. chang, s.y.s. & leung, p. 2006. the effects of accounting students’ ethical reasoning and personal factors on their ethical sensitivity. managerial auditing journal, 21(4):436-457. cohen, j.r. & pant, l.w. 1989. accounting educators’ perceptions of ethics in the curriculum. issues in accounting education, 4(1):70-81. clikeman, p., greiger, m. & o’connell, b. 2001. student perceptions of earnings management: the effects of national origin and gender. teaching business ethics, 5(4):389-410. elias, r. 2004. the impact of corporate ethical values on perceptions of earnings management. managerial accounting journal, 19(1):84-98. fischer, m. & rosenzweig, k. 1995. attitudes of students and accounting practitioners concerning the ethical acceptability of earnings management. journal of business ethics, 14(6):433-444. giacomino, d.e. & akers, m. 2006. the ethics of managing short-term earnings: business managers and business students have few problems with earnings management practices. journal of college teaching & learning, july:57-71. healy, p.m. & wahlen, j.m. 1999. a review of the earnings management literature and its implications for standard setting. accounting horizons, 13(4):365-383. harvard business review. 1989. ethics test for everyday managers. harvard business review, march-april:220-221. jooste, l. 2010. accounting ethics an empirical investigation of managing short-term earnings. south african journal of economic and management sciences, 13(1):98-111. kaplan, s.e. 2001. ethically related judgments by observers of earnings management. journal of business ethics, 32:285-298. karassavidou, e. & glaveli, n. 2006. towards the ethical or the unethical side? international journal of educational management, 20(5):348-364. merchant, k.a. & rockness, j. 1994. the ethics of managing earnings: an empirical investigation. journal of accounting and public policy, 13:79-94. rosenzweig, k. & fischer, m. 1994. is managing earnings ethically acceptable? management accounting, 75(9):31-34. verschoor, c. 2002. it isn’t enough to just have a code of ethics. strategic finance, december:22-24. woo, c.j. 2003. personally responsible. bized. may/june:22-27. sajems ns 14 (2011) no 4 433 annexure 1 mean values of responses from studies using the bruns and merchant survey (1990) earnings management practice no nmmu clikeman et al. 2001 fisher & rosenzweik 1995 rosenzweik & fisher 1994 merchant & rockness 1994 prior studies 1. 1.87 1.09 1.20 1.18 1.26 1.18 2. 2.98 2.81 1.98 1.62 1.81 2.06 3. 3.18 3.56 2.29 1.88 2.09 2.46 4. 3.54 2.96 3.27 3.29 3.42 3.24 5. 2.47 2.24 1.70 1.81 1.96 1.93 6. 2.19 2.08 1.42 1.3 1.31 1.53 7. 2.40 1.73 1.41 1.25 1.25 1.41 8. 2.89 2.76 2.96 3.27 3.27 3.07 9. 3.22 3.06 3.21 3.32 3.51 3.28 10. 3.00 2.55 3.11 3.50 3.59 3.19 11. 2.70 3.16 3.43 3.71 3.69 3.50 12. 3.20 2.76 2.89 3.24 3.76 3.17 13. 3.76 3.76 3.75 4.15 4.05 3.93 average rating 2.88 2.66 2.51 2.58 2.69 2.61 sample size 360 115 500 265 308 type of respondents nmmu clikeman et al. 2001 fisher & rosenzweik 1995 rosenzweik & fisher 1994 merchant & rockness 1994 undergraduate accounting students, mba students, chartered accountants fourth year accounting students undergraduate accounting students, mba students, management accountants management accountants general managers, staff managers, operating-unit controllers, internal auditors annexure 2 questionnaire on ethics this questionnaire includes short descriptions of a variety of actions that individuals have taken. some of these actions are clearly ethical. others are judged by some or most people to be unethical, and the judgments as to the degree of severity of the infraction can vary widely. please indicate your judgment as to the acceptability of each of the practices using the following scale: 1. ethical practice 2. questionable practice. i would not say anything to the person involved, but it makes me uncomfortable. 3. minor infraction. the person should be warned not to engage in the practice again. 4. serious infraction. the person should be severely reprimanded. 5. totally unethical. the person should be fired. (assume that the divisions referred to are part of a r1 billion corporation, which has a january-december financial year. each division has annual sales of r100 million, with annual before-tax operating profit of r12 million.) answer each question separately. (assume the incidents are independent.) questionnaire on ethics ethical practice totally unethical action 1 2 3 4 5 1. the division's buildings were scheduled to be painted in 2002. since the division's profit performance was way ahead of budget in 2001, however, the division general manager (gm) decided to have the work done in 2001. amount: r150 000……………….. 1 2 3 4 5 2. the gm instructed his employees to defer all discretionary expenditures (e.g., travel, advertising, hiring, maintenance) into the next accounting period so that his division could make its budgeted profit targets. expected amount of deferral: r150 000. 434 sajems ns 14 (2011) no 4 a. the expenses were postponed from february and march to april in order to make the first quarter target. 1 2 3 4 5 b. the november and december expenses postponed to january in order to make annual target. 1 2 3 4 5 3. on december 15, a clerk in the division placed an order for r3 000 worth of office supplies and the supplies were delivered on december 29. this order was a mistake because the division gm had ordered that no discretionary expenses be incurred for the remainder of the fiscal year, and the accounting policy manual states that office supplies are to be recorded as an expense when delivered. the division gm learned what had happened, however, and to correct the mistake, he ordered the accounting department not to record the invoice until february. 1 2 3 4 5 4. in september, a gm realized that the division would need strong performance in the last quarter of the year in order to reach its budget targets. a. he decided to implement a sales program offering liberal payment terms to pull some sales that would normally occur next year into the current year; customers accepting delivery in the 4th quarter would not have to pay the invoice for 120 days. 1 2 3 4 5 b. he instructed manufacturing to work overtime in december so that everything possible could be shipped by the end of the year. 1 2 3 4 5 c. he sold some excess assets and realized profit of r40 000. 1 2 3 4 5 5. at the beginning of december 2001, a gm realized that the division would exceed its budgeted profit targets for the year. a. he ordered his controller to prepay some expenses (e.g., hotel rooms, exhibit expense) for major trades show to be held in march 2002 and to book them as 2001 expense. amount: r60 000……….………. 1 2 3 4 5 b. he ordered his controller to develop the rationale for increasing the reserve for inventory obsolescence. by taking a pessimistic view of future market prospects, the controller was able to identify r700 000 worth of finished goods that conservative accounting would say should be fully reserved (i.e., written off), even though the gm was fairly confident the inventory would still be sold at a later data at close to full price. 1 2 3 4 5 6. the next year, the division described in question 5b sold 70% of the writtenoff inventory, and a customer had indicated some interest in buying the rest of that inventory the following year. the gm ordered his controller to prepare the rationale for reducing the reserve for obsolescence by r210,000 (i.e., writing up the previously written-off goods to full cost). the gm's motivation for recapturing the profit was: a. to be able to continue working on some important product development projects that might have had to be delayed due to budget constraints………………. 1 2 3 4 5 b. to make budgeted profit targets……….………. 1 2 3 4 5 7. in july 2002, a gm noticed that scrap costs in the plant were running way ahead of plan. so that senior management would not become alarmed, he instructed his controller to “bury” most of the scrap costs in other expense accounts where they would not be noticed. over the remainder of the year, the controller buried approximately r60,000 of scrap costs. effect on net income: zero……….………. 1 2 3 4 5 8. in november 2001, a division was straining to meet budget. the gm called the engagement partner of a consulting firm that was doing some work for the division and asked that the firm not send an invoice for work done until the next financial year. the partner agreed. estimated work done but not invoiced: a. r30 000……….………. 1 2 3 4 5 b. r500 000……….………. 1 2 3 4 5 9. a gm had an idea for a new product. she asked her marketing people to conduct some focus group interviews and a field study to determine the market potential, and she asked her controller to estimate the costs of entering the market. the projections promised only a 22% return when the desired return for his business was 35%. however, still convinced that the product was a good idea, the manager “jacked up” the sales projections and “shaved” the cost estimates to show a forecasted 35% return. the gm's superiors were preoccupied with other problems, and they did not question the projections. thus the new product was approved. sajems ns 14 (2011) no 4 435 a. after six months of sales, the product earned a 22% return. 1 2 3 4 5 b. after six months of sales, the product earned a 35% return. 1 2 3 4 5 10. at the end of december, a division was struggling to meet its profit targets. the gm told his production manager to ship some customer orders early so that the associated revenue and profits could be recognized in the current year. the items were in inventory, and expected delivery times were two days. the customers' firm delivery dates were: a. january 3……….………. 1 2 3 4 5 b. january 14……….………. 1 2 3 4 5 c. january 28……….………. 1 2 3 4 5 d. february 12……….………. 1 2 3 4 5 demographics: gender: female ____ male ____ qualification: _______________________________